All of our U.S. government contracts can be terminated by the U.S. government for its convenience. Termination for convenience provisions provide only for our recovery of costs incurred or committed, settlement expenses and profit on work completed prior to termination. In addition to the right of the U.S. government to terminate, U.S. government contracts are conditioned upon the continuing approval by Congress of the necessary spending. Congress usually appropriates funds for a given program on a fiscal year basis even though contract performance may take more than one year. Consequently, at the beginning of a major program, the contract may not be fully funded, and additional monies are normally committed to the contract only if, and when, appropriations are made by Congress for future fiscal years. We obtain U.S. government contracts through a competitive bidding process. We cannot assure you that we will continue to win competitively awarded contracts or that awarded contracts will generate sufficient net sales to result in profitability. If we are unable to comply with complex U.S. government regulations governing security and contracting practices, we could be disqualified as a supplier to the U.S government. As a supplier to the U.S. government, we must comply with numerous regulations, including those governing security and contracting practices. Failure to comply with these procurement regulations and practices could result in fines being imposed against us or our suspension for a period of time from eligibility for bidding on, or for award of, new government contracts. If we are disqualified as a supplier to government agencies, we would lose most, if not all, of our U.S. government customers and revenues from sales of our products would decline significantly. Among the potential causes for disqualification are violations of various statutes, including those related to procurement integrity, export control, U.S. government security regulations, employment practices, protection of the environment, accuracy of records in the recording of costs, and foreign corruption. The government could investigate and make inquiries of our business practices and conduct audits of contract performance and cost accounting. Based on the results of such audits, the U.S. government could adjust our contract-related costs and fees. Depending on the results of these audits and investigations, the government could make claims against us, and if it were to prevail, certain incurred costs would not be recoverable by us.
We could be adversely affected by the results of ongoing investigations into our compliance with export regulations.
In October 2007, our Florida-based subsidiary, Comtech Systems, Inc. (“CSI”), received a customs export enforcement subpoena from the U.S. Immigration and Customs Enforcement (“ICE”) branch of the Department of Homeland Security. The subpoena relates to CSI’s $2.0 million contract with the Brazilian Naval Commission (the Brazil contract) and it required the production of all books, records and documents, including copies of contracts, invoices and payments related to agreements between CSI, its agent, its subcontractor and the Brazilian government. We believe that the ICE investigation is focused primarily on whether or not CSI was in compliance with export-related laws and regulations, including the International Traffic in Arms Regulations (“ITAR”) and the Export Administration Regulations. CSI produced documents in response to the subpoena request. Customs officials have detained certain inventory related to the Brazil contract pending resolution of this matter.
We engaged outside counsel to assist CSI in its response to the subpoena and related matters and to conduct our own investigation. Based on our ongoing investigation into this matter, we believe that the detained inventory, which consists of commercial satellite equipment, was not modified or adapted in any way to meet Brazilian military requirements and was only subject to the jurisdiction of the Department of Commerce and not the jurisdiction of the U.S. Department of State. In addition, in order to provide certain defense services, including conducting factory acceptance testing at CSI’s Florida facility, we obtained a license (referred to as a Technical Assistance Agreement (“TAA”)) from the U.S. Department of State. We believe that the TAA authorized all activities under the Brazil contract that were subject to the jurisdiction of the U.S. Department of State.
We believe that CSI made a good faith effort to comply with applicable regulations; however, we believe that CSI made inadvertent administrative errors resulting in a TAA that did not become effective on a timely basis. The administrative errors relate primarily to the execution of non-disclosure agreements (“NDA”) with certain third country national employees of CSI’s agent. These individuals have now signed appropriate NDAs, and, in December 2007, CSI filed an amended TAA with the U.S. Department of State. CSI has requested that the U.S. Department of State confirm CSI’s and our view that the Brazil contract does not require any other State Department license.
In March 2008, the Enforcement Division of the U.S. Department of State informed us that they were reviewing our amended TAA. In May 2008, the U.S. Attorney’s Office in the Middle District of Florida informed us that, based on its conversations with the ICE agent who initiated the subpoena, it was closing its investigation into the Brazil matter. In June 2008, the ICE agent informed us that he would recommend that the detained inventory be released back to us upon the U.S. Department of State confirming our position that a State Department license for the hardware shipped was not required. In August 2008, the ICE agent informed us that the U.S. Department of State wanted to clarify certain technical matters and, on its behalf, the ICE agent was going to interview one of our engineers. This interview occurred in September of 2008. We continue to remain cautiously optimistic that we will be able to shortly reship the Brazil inventory to our customer.
In addition to their review of the Brazil contract, in March 2008, the Enforcement Division of the U.S. Department of State informed us that they sought to confirm our company-wide ITAR compliance for the five-year period ended March 2008. In response, we expanded the scope of our own investigation. In June 2008, we provided detailed information and a summary of our findings to the U.S. Department of State. In July 2008, the U.S. Department of State requested supplemental information and we responded to their request. Our findings to date indicate that there were certain instances of exports and defense services during the five-year period for which we did not have the appropriate authorization from the U.S. Department of State; however, none of those instances involved Proscribed Countries as defined by ITAR. We are awaiting additional feedback from the U.S. Department of State as it relates to all of the aforementioned matters.
Since the receipt of the original Brazil subpoena in October 2007, we have engaged outside counsel and export consultants to help us assess and improve, as appropriate, our internal controls with respect to U.S. export controls laws and regulations and laws governing record keeping and dealings with foreign representatives. In addition, in connection with our August 1, 2008 acquisition of Radyne, we are expanding our export internal control assessment to include our newly acquired subsidiaries. To date, we have noted opportunities for improving our procedures to comply with such laws and regulations, including at our newly acquired Radyne subsidiaries and are in the process of making improvements.
During fiscal 2008, we have taken numerous steps to significantly improve our export control processes, including the hiring of additional employees who are knowledgeable and experienced with ITAR and the engagement of an outside export consultant to conduct additional training. We are also in the process of implementing enhanced formal company-wide ITAR control procedures, including at our newly acquired Radyne subsidiaries. Because our assessments are continuing, we expect to remediate, improve and enhance our internal controls relating to exports throughout fiscal 2009.
Because the above matters are ongoing, we cannot determine the ultimate outcome of these matters. Violations of U.S. export control-related laws and regulations could result in civil or criminal fines and/or penalties and/or result in an injunction against us, all of which could, in the aggregate, materially impact our business, results of operations and cash flows. Should we identify a material weakness relating to our compliance, the ongoing costs of remediation could be material. In addition, inventory related to the Brazil contract (including the inventory that has been detained) had a net book value of $1.1 million as of July 31, 2008. If this inventory is permanently seized or not returned to us timely, or we can not resell the inventory to other customers, we would be required to write-off the value of this inventory in a future accounting period.
Our dependence on international sales and international sales agents may adversely affect us. U.S. export laws may also restrict our ability to sell our products abroad which reduces our ability to obtain sales from foreign customers. Sales for use by international customers (including sales to U.S. domestic companies for inclusion in products that will be sold to international customers) represented approximately 26.7%, 26.2% and 35.6% of our consolidated net sales for the fiscal years ended July 31, 2008, 2007 and 2006, respectively. Approximately 21.4% of our backlog at July 31, 2008 consisted of orders for use by foreign customers. We expect that international sales (including sales from Radyne) will continue to be a substantial portion of our consolidated net sales. These sales expose us to certain risks, including barriers to trade, fluctuations in foreign currency exchange rates (which may make our products less price-competitive), political and economic instability, exposure to public health epidemics, availability of suitable export financing, tariff regulations, and other U.S. and foreign regulations that may apply to the export of our products and the generally greater difficulties of doing business abroad. We attempt to reduce the risk of doing business in foreign countries by seeking subcontracts with large systems suppliers, contracts denominated in U.S. dollars, advance or milestone payments and irrevocable letters of credit in our favor. However, we may not be able to reduce the economic risk of doing business in foreign countries, in all instances. In such cases, billed and unbilled receivables relating to international sales are subject to increased collectibility risk and may result in significant write-offs, which could have a material adverse impact on our business, results of operations and financial condition. In addition, foreign defense contracts generally contain provisions relating to termination at the convenience of the government. In some countries, we may rely upon one international sales agent. We attempt to reduce our reliance on sales agents by establishing additional foreign sales offices and by engaging, where practicable, more than one independent sales representative in a territory. Certain of our products and systems may require licenses from U.S. government agencies for export from the U.S., and some of our products are not permitted to be exported. In addition, in certain cases, U.S. export controls also severely limit unlicensed technical discussions such as with any persons who are not U.S. citizens or permanent residents. As a result, in cases where we may need a license, it may reduce our ability to compete against a non-U.S. domiciled foreign company who may not be subject to the same U.S. laws. We cannot be sure of our ability to gain any licenses that may be required to export our products, and failure to receive required licenses could materially reduce our ability to sell our products outside the U.S.
We have significant operations in Florida and California, and other locations, which could be materially and adversely impacted, in the event of a natural disaster or other significant disruption. Our telecommunications transmission segment designs and manufactures our over-the-horizon microwave equipment and systems out of two facilities located in Florida, where major hurricanes have occurred in the past. As of August 1, 2008, our RF microwave amplifiers segment manufactures and designs traveling wave tube amplifier and klystron amplifiers in Santa Clara, California, close to major earthquake fault lines. Our operations in these and other locations (such as in our high-volume technology manufacturing center located in Tempe, Arizona and our mobile data communication segment’s network operations center located in Germantown, Maryland), could be subject to natural disasters or other significant disruptions, including hurricanes, typhoons, tsunamis, floods, earthquakes, fires, water shortages, other extreme weather conditions, medical epidemics, acts of terrorism, power shortages and blackouts, telecommunications failures, and other natural and manmade disasters or disruptions. In the event of such a natural disaster or other disruption, we could experience disruptions or interruptions to our operations or the operations of our suppliers, distributors, resellers or customers; destruction of facilities; and/or loss of life, all of which could materially increase our costs and expenses and materially adversely affect our business, revenue and financial condition.
All of our businesses are subject to rapid technological change; we rely upon licensed technology for some of our products and we must keep pace with changes to compete successfully. We are engaged in businesses characterized by rapid technological change, evolving industry standards, frequent new product announcements and enhancements, and changing customer demands. The introduction of products and services embodying new technologies and the emergence of new industry standards could render any of our products and services obsolete or non-competitive. The technology used in our products and services evolves rapidly, and our business position depends, in large part, on the continuous refinement of our scientific and engineering expertise and the development, either through internal research and development or acquisitions, of new or enhanced products and technologies. We may not have the economic or technological resources to be successful in such efforts and we may not be able to identify and respond to technological improvements made by our competitors in a timely or cost-effective fashion. Our DoubleTalk® Carrier-in-Carrier® bandwidth compression technology is licensed by us from a third-party. A significant technological breakthrough by others, including smaller competitors or new firms, could have a material adverse impact on our business, results of operations and financial condition.
Reductions in telecommunications equipment and systems spending may negatively affect our revenues, profitability and the recoverability of our assets, including intangible assets. For the last several years, the U.S. and global economies have been growing and our revenues and profits have increased as our customers have increased their spending on telecommunications equipment and systems. However, during fiscal 2008, adverse conditions in the U.S. consumer mortgage market have negatively impacted the global economy and nearly all businesses, including ours, are facing uncertain economic environments. Some economists are now predicting a recession. Our businesses have been negatively affected in the past by uncertain economic environments both in the overall market, and more specifically in the telecommunications sector. As a result of the current global economic conditions, our customers may reduce their budgets for spending on telecommunications equipment and systems. As a consequence, our current customers and other prospective customers may postpone, reduce or even forego the purchase of our products and systems, which could adversely affect our revenues, profitability and the recoverability of our assets, including intangible assets. Although we remain confident that the long-term demand drivers for our businesses, including our satellite earth station products, remain strong, it is currently difficult to assess whether or not future bookings will meet or exceed the levels experienced in fiscal 2008.
Our mobile data communications business is subject to unique risks. Our mobile data communications business segment is reliant upon just a few contracts. In addition to the other risk factors described in this section, the risk factors applicable to our mobile data communications business include the following: | · | Our mobile data communications segment’s revenues and profits are primarily derived from the Movement Tracking Systems (“MTS”) contract and the U.S. Army’s Force XXI Battle Command, Brigade and Below command and control systems (also known as Blue Force Tracking (“BFT”)) contract. Both of these contracts can be terminated at any time and orders are subject to unpredictable funding, deployment and technology decisions by the U.S. government for its convenience. Termination for convenience provisions provide only for our recoverygovernment. Because both of costs incurred or committed, settlement expenses and profit on work completed prior to termination. In addition to the right of the U.S. government to terminate, U.S. governmentthese contracts are conditioned uponindefinite delivery/indefinite quantity (“IDIQ”) contracts, the continuing approval by Congress of the necessary spending. Congress usually appropriates funds for a given program on a fiscal year basis even though contract performance may take more than one year. Consequently, at the beginning of a major program, the contract may not be fully funded, and additional monies are normally committed to the contract only if, as and when appropriations are made by Congress for future fiscal years.We obtain U.S. government contracts through a competitive bidding process. We cannot assure you that we will continue to win competitively awarded contracts or that awarded contracts will generate sufficient net sales to result in profitability.
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If we are unable to comply with complex U.S. government regulations governing security and contracting practices, we could be disqualified as a supplier to the U.S government.
As a supplier to the U.S. government we must comply with numerous regulations, including those governing security and contracting practices. Failure to comply with these procurement regulations and practices could result in fines being imposed against us or our suspension for a period of time from eligibility for bidding on, or for award of, new government contracts. If we are disqualified as a supplier to government agencies, we would lose most, if not all, of our U.S. government customers and revenues from sales of our products would decline significantly. Among the potential causes for disqualification are violations of various statutes, including those related to procurement integrity, export control, U.S. government security regulations, employment practices, protection of the environment, accuracy of records in the recording of costs, and foreign corruption. The government could investigate and make inquiries of our business practices and conduct audits of contract performance and cost accounting. Based on the results of such audits, the U.S. government could adjust our contract-related costs and fees. Depending on the results of these audits and investigations, the government could make claims against us, and if it were to prevail, certain incurred costs would not be recoverable by us.
Our dependence on international sales and international sales agents may adversely affect us.
Sales for use by international customers (including sales to U.S. domestic companies for inclusion in products that will be sold to international customers) represented approximately 35.6%, 44.0% and 45.4% of our consolidated net sales for the fiscal years ended July 31, 2006, 2005 and 2004, respectively. Approximately 28.4% of our backlog at July 31, 2006 consisted of orders for use by foreign customers. Direct and indirect sales to a North African country during the fiscal year ended July 31, 2006 were 9.7% of consolidated net sales. We expect that international sales will continue to be a substantial portion of our consolidated net sales.
These sales expose us to certain risks, including barriers to trade, fluctuations in foreign currency exchange rates (which may make our products less price-competitive), political and economic instability, exposure to public health epidemics, availability of suitable export financing, tariff regulations, and other U.S. and foreign regulations that may apply to the export of our products and the generally greater difficulties of doing business abroad.
We attempt to reduce the risk of doing business in foreign countries by seeking subcontracts with large systems suppliers, contracts denominated in U.S. dollars, advance or milestone payments and irrevocable letters of credit in our favor. However, we may not be able to reduce the economic risk of doing business in foreign countries, in all instances. In such cases, billed and unbilled receivables relating to international sales are subject to increased collectibility risk and may result in significant write-offs, which could have a material adverse impact on our business, results of operations and financial condition.
In some countries, such as the aforementioned North African country, we rely upon one international sales agent. We attempt to reduce our reliance on sales agents by establishing additional foreign sales offices and by engaging, where practicable, more than one independent sales representative in a territory.
Foreign defense contracts generally contain provisions relating to termination at the convenience of the government. In addition, certain of our products and systems may require licenses from U.S. government agencies for export from the U.S., and some of our products are not permitted to be exported. We cannot be sure of our ability to gain any licenses that may be required to export our products, and failure to receive required licenses could materially reduce our ability to sell our products outside the U.S.
All of our businesses are subject to rapid technological change; we must keep pace with changes to compete successfully.
We are engaged in businesses characterized by rapid technological change, evolving industry standards, frequent new product announcements and enhancements, and changing customer demands. The introduction of products and services embodying new technologies and the emergence of new industry standards could render any of our products and services obsolete or non-competitive. The technology used in our products and services evolves rapidly, and our business position depends, in large part, on the continuous refinement of our scientific and engineering expertise and the development, either through internal research and development or acquisitions, of new or enhanced products and technologies. We may not have the economic or technological resources to be successful in such efforts and we may not be able to identify and respond to technological improvements made by our competitors in a timely or cost-effective fashion. A significant technological breakthrough by others, including smaller competitors or new firms, could have a material adverse impact on our business, results of operations and financial condition.
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Reductions in telecommunications equipment and systems spending may negatively affect our revenues, profitability and the recoverability of our assets, including intangible assets.
From the second half of fiscal 2001 through fiscal 2003, our revenues from commercial customers were negatively affected by the uncertain economic environment both in the overall market, and more specifically in the telecommunications sector. Since 2003, the telecommunications sector has stabilized and is growing again; however, if the economy slows, some of our customers may reduce their budgets for spending on telecommunications equipment and systems. As a consequence, our current customers and other prospective customers may postpone, reduce or even forego the purchase of our products and systems, which could adversely affect our revenues, profitability and the recoverability of our assets, including intangible assets.
Our mobile data communications business is subject to unique risks.
Although sales and earnings have increased significantly in the past few years, our mobile data communications business has a relatively limited operating history compared to our other business segments. It is subject to many of the risks inherent in the operation of a new business enterprise. In addition to the other risk factors described in this section, the risk factors applicable to our mobile data communications business include the following:
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| • | Our contract for the U.S. Army logistics community’s MTS system currently obligates us to provide hardware, including mobile satellite transceivers, and satellite and other services, through July 2007, at fixed prices and other terms set forth in the contract. The U.S. Army is not obligated to purchase any equipment or services under the contract. Orderscontracts. |
| · | Our MTS and related sales relating to this contractBFT contracts are subject to unpredictable funding and deployment decisions. | | | | | • | The MTS contract is not subject to automatic renewal or extension upon itstheir scheduled expiration inon July 2007. As such,12, 2010 and December 31, 2011, respectively. In addition, the U.S. Army may decide to recompete the contract in which case a new MTS contract for allaward future orders, at any time, to other parties. If another party is awarded future orders or a portionif one or both of our efforts could be awarded to another party in the future. If the MTS contract iscontracts are not renewed, extended or if we fail to succeed in a recompete process, it would have a material adverse impact on our business and results of operations. |
| | | | •· | In general, asfiscal 2007, the BFT program’s prime contractor, Northrop Grumman Corporation, awarded a contract to a competitor to develop a new prototype network and related equipment to increase network capacity for the U.S. Army’s BFT tracking system. Although we seekare currently working closely with the U.S. Army to growprovide additional enhancements to our mobile datanetwork capabilities and communications performance and believe that we have and are developing new products that provide compelling technological advancement to our existing products and that are, importantly, backwards compatible with the large number of existing BFT and MTS systems in active deployment today, it is possible that the U.S. Army (including our MTS customers) will ultimately cease or reduce its ordering levels of our products and services. If this occurs, it would have a material adverse impact on our business weand results of operations. |
| · | We currently anticipate that we will needcontinue to maintain a substantial inventory in order to provide terminalsproducts to our customers on a timely basis. Certain components that we needrequired in our production process have purchasing lead-times of four months or longer, and the MTS contract requiresdelivery timetables on our contracts require us to provide mobile terminals within 90 daysproducts in shorter timeframes after we receive an order. If forecasted orders are not received, we may be left with large inventories of slow moving or unusable parts or terminals that would result in an adverse impact on our business, results of operations and financial position.condition. |
| | | | •· | We lease the satellite capacity necessary to operate our system from a limited number of third party satellite networks. Our ability to grow and remain profitable depends on the ability of our satellite network providers to provide sufficient network capacity, reliability and security to our customers. If our satellite network providers were to increase the prices of their services, or to suffer operational or technical failures, our business, results of operation and financial condition could be adversely affected. |
| | | | •· | Our systems occasionally experience downtime. All satellite communications are subject to the risk that a satellite or ground station failure or a natural disaster may interrupt service. Interruptions in service could have a material adverse impact on our business, results of operations and financial condition. Should we be required to restore service on another system in the event of a satellite failure, our costs could increase which would have ana material adverse effect on our business, results of operations and financial condition. |
| | | | •· | To date, commercial satellite-based mobile data applications have not been a material part of our business. In addition, we do not have extensive experience designing, manufacturing or selling microsatellites and related components. Our future success in commercialdeveloping these markets will depend on, among other things, our ability to access the best distribution channels, the development or licensing of applications which create value for the customer and our ability to attract and retain qualified personnel. We may have to increase our operating expenses to be successful in the commercial satellite-based mobile data market.these markets. |
| | | | •· | There are several existing and potential commercial and defense-related competitors, such as Qualcomm, Inc. and Northrop Grumman Corporation, that participate in the mobile data communications market and who have much greater financial resources than us. Existing competitors, including terrestrial-based service providers, are also aggressively pricing their products and services and may continue to do so in the future. Competitors such as ViaSat, Inc. and Harris Corporation continue to offer new value addedvalue-added products and services, which we may be unable to match on a timely or cost effective basis. Companies, such as Surrey Satellite Technology, Ltd. and MicroSat Systems, Inc., compete against us in the microsatellite and related components markets. Increased competition may adversely impact margins throughout the industry. We anticipate that new competitors will also enter the mobile data communications market in the future. This |
| could adversely impact our penetration intoexisting business, results of operations and financial condition and could also impair our ability to penetrate the commercial market in a significant way and could negatively impact our existing business, results of operation and financial condition.way. |
Our backlog is subject to customer cancellation or modification and such cancellation could result in decreased sales and increased provisions for excess and obsolete inventory. We currently have a backlog of orders, mostly under contracts that the customer may modify or terminate. Almost all of the contracts in our backlog are subject to cancellation at the convenience of the customer or for default in the event that we are unable to perform under the contract. We cannot assure you that our backlog will result in net sales. We record a provision for excess and obsolete inventory based on historical and future usage trends and other factors including the consideration of the amount of backlog we have on hand at any particular point in time. If our backlog is canceled or modified, our estimates of future product demand may prove to be inaccurate, in which case we may have understated the provision required for excess and obsolete inventory. In the future, if we determine that our inventory is overvalued, we will be required to recognize such costs in our financial statements at the time of such determination. Any such charges could be material to our results of operations and financial condition. Our dependence on component availability, government furnished equipment, subcontractor availability and performance and key suppliers, including the core manufacturing expertise of our high-volume technology manufacturing center located in Tempe, Arizona, may adversely affect us. Although we obtain certain components and subsystems from a single source or a limited number of sources, we believe that most components and subsystems are available from alternative suppliers and subcontractors. A significant interruption in the delivery of such items, however, could have a material adverse impact on our business, results of operations and financial condition. In recent years, we have increased the company-wide dependency on our high-volume technology manufacturing center located in Tempe, Arizona, which is part of our telecommunications transmission segment. In fiscal 2008, 2007 and 2006, intersegment sales by the telecommunications transmission segment to the mobile data communications segment were $123.8 million, $78.3 million and $55.7 million, respectively. Intersegment sales in fiscal 2008, 2007 and 2006 by the telecommunications transmission segment to the RF microwave amplifiers segment were $16.0 million, $6.5 million and $7.5 million, respectively. If a natural disaster or other business interruption occurred, we do not have immediate access to other manufacturing facilities, and as a result, our business would suffer. In addition, if our high-volume technology manufacturing center is unable to produce sufficient product or maintain quality, it could have a material adverse impact on all three of our business segments, our results of operations and our financial condition. We intend to continue to increase our company-wide dependency on our high-volume technology manufacturing center. For example, the success of the Radyne acquisition will depend, in part, on our ability to realize anticipated efficiencies and cost savings, primarily through the result of closing Radyne’s Phoenix, Arizona, manufacturing facility and integrating that operation into our Tempe, Arizona facility. We also intend to continue to seek contracts with third parties to outsource a portion of their manufacturing to us. No assurances can be given that we will be able to achieve these efficiencies and cost savings. In the past, the U.S. government experienced delays in the receipt of certain components that are ultimately provided to us for incorporation into our satellite transceivers that we ship to the U.S. government. If we do not receive these government furnished components in a timely manner, we could experience delays in fulfilling orders from our customers.
Contract cost growth on our fixed price contracts and other contracts that cannot be justified as an increase in contract value due from customers exposes us to reduced profitability and the potential loss of future business and other risks. A substantial portion of our products and services are sold under fixed price contracts. This means that we bear the risk of unanticipated technological, manufacturing, supply or other problems, price increases or other increases in the cost of performance. Operating margin is adversely affected when contract costs that cannot be billed to the customer are incurred. This cost growth can occur if initial estimates used for calculating the contract price were incorrect, or if estimates to complete increase. The cost estimation process requires significant judgment and expertise. Reasons for cost growth may include unavailability and productivity of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in performance, availability and timing of funding from the customer, natural disasters, and the inability to recover any claims included in the estimates to complete. A significant change in an estimate on one or more programs could have a material impact on our business, results of operations and financial condition. Adverse regulatory changes could impair our ability to sell products. Our products are incorporated into wireless communications systems that must comply with various U.S. government regulations, including those of the FCC, as well as international laws and regulations. Regulatory changes, including changes in the allocation and availability of frequency spectrum, and in the military standards and specifications that define the current satellite networking environment, could materially harm our business by (i) restricting development efforts by us and our customers, (ii) making our current products less attractive or obsolete, or (iii) increasing the opportunity for additional competition. Changes in, or our failure to comply with, applicable laws and regulations could materially harm our business. In addition, the increasing demand for wireless communications has exerted pressure on regulatory bodies worldwide to adopt new standards and reassign bandwidth for these products and services. The reduced number of available frequencies for other products and services and the time delays inherent in the government approval process of new products and services have caused and may continue to cause our customers to cancel, postpone or reschedule their installation of communications systems including their satellite, over-the-horizon microwave, or terrestrial line-of-sight microwave communication systems. This, in turn, could have a material adverse effect on our sales of products to our customers. The EU has adopted two directives to facilitate the recycling of electrical and electronic equipment sold in the EU. The first of these is the Waste from Electrical and Electronic Equipment directive, which directs EU member states to enact laws, regulations, and administrative provisions to ensure that producers of electrical and electronic equipment are financially responsible for the collection, recycling, treatment, and environmentally sound disposal of certain products placed on the market after August 13, 2005, and from products in use prior to that date that are being replaced. The EU has also adopted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) directive. The RoHS directive restricts the use of lead, mercury, and certain other substances in electrical and electronic products placed on the market in the EU after July 1, 2006. Similar laws and regulations have been or may be enacted in other regions, including in the U.S., China and Japan. Other environmental regulations may require us to reengineer our products to utilize components that are more environmentally compatible, and such reengineering and component substitution may result in additional costs to us. There can be no assurance that such existing or future laws will not have a material adverse effect on our business. Our investments in recorded goodwill and other intangible assets as a result of prior acquisitions, including goodwill and other intangible assets resulting from our Radyne acquisition could be impaired as a result of future business conditions, requiring us to record substantial write-downs that would reduce our operating income. We have goodwill and intangible assets of $31.9 million recorded on our balance sheet as of July 31, 2008. This amount will materially increase as a result of the Radyne acquisition. We evaluate the recoverability of recorded goodwill amounts and intangible assets annually, or when evidence of potential impairment exists. The annual impairment test is based on several factors requiring judgment. Changes in our operating performance or business conditions, in general, could result in an impairment of goodwill which could be material to our results of operations. In addition, if we are not successful in achieving anticipated operating efficiencies associated with the Radyne acquisition, our goodwill and intangible assets may become impaired.
The loss of key technical or management personnel could adversely affect our business. Our success depends on the continued contributions of key technical management personnel, including the key corporate and operating unit management at each of our subsidiaries. Many of our key personnel, particularly the key engineers of our subsidiaries, would be difficult to replace, and are not subject to employment or noncompetition agreements. Our growth and future success will depend in large part upon our ability to attract and retain highly qualified engineering, sales and marketing personnel. Competition for such personnel from other companies, academic institutions, government entities and other organizations is intense. Although we believe that we have been successful to date in recruiting and keeping key personnel, we may not be successful in attracting and retaining the personnel we will need to continue to grow and operate profitably. Also, the management skills that have been appropriate for us in the past may not continue to be appropriate if we continue to grow and diversify. Our business and operating results may be negatively impacted if we are unable to continue to manage growth of our businesses. Certain of our businesses have experienced periods of rapid growth that have placed, and may continue to place, significant demands on our managerial, operational and financial resources. In addition to anticipated organic growth, our revenues are expected to significantly increase in fiscal 2009 as a result of the Radyne acquisition. In order to manage this growth, we must continue to improve and expand our management, operational and financial systems and controls. We also need to continue to recruit and retain personnel and train and manage our employee base. We must carefully manage research and development capabilities and production and inventory levels to meet product demand, new product introductions and product and technology transitions. If we are not able to timely and effectively manage our growth and maintain the quality standards required by our existing and potential customers, we could experience a material adverse impact on our business, results of operations and financial condition.
Our markets are highly competitive. The markets for our products are highly competitive. We cannot assure you that we will be able to successfully compete or that our competitors will not develop new technologies and products that are more effective than our own. We expect the DoD’s increased use of commercial off-the-shelf products and components in military equipment will encourage new competitors to enter the market. Also, although the implementation of advanced telecommunications services is in its early stages in many developing countries, we believe competition may intensify as businesses and foreign governments realize the market potential of telecommunications services. Many of our competitors have financial, technical, marketing, sales and distribution resources greater than ours. Protection of our intellectual property is limited; we are subject to the risk of third party claims of infringement. Our DoubleTalk® Carrier-in-Carrier® bandwidth compression technology is licensed by us from a third-party. Our businesses rely in large part upon our proprietary scientific and engineering know-how and production techniques. Historically, patents have not been an important part of our protection of our intellectual property rights. We rely upon the laws of unfair competition, restrictions in licensing agreements and confidentiality agreements to protect our intellectual property. We limit access to and distribution of our proprietary information. These efforts allow us to rely upon the knowledge and experience of our management and technical personnel to market our existing products and to develop new products. The departure of any of our key management and technical personnel, the breach of their confidentiality and non-disclosure obligations to us or the failure to achieve our intellectual property objectives may have a material adverse impact on our business, results of operations and financial condition. Our ability to compete successfully and achieve future revenue growth will depend, in part, on our ability to protect our proprietary technology and operate without infringing upon the rights of others. We may fail to do so. In addition, the laws of certain countries in which our products are or may be sold may not protect our products and intellectual property rights to the same extent as the laws of the U.S.
We believe that we own or have licensed all intellectual property rights necessary for the operation of our businesses as currently contemplated. If the technology we use is found to infringe on protected technology, we could be required to change our business practices, license the protected technology, and/or pay damages or other compensation to the infringed party. If we are unable to license protected technology that we use in our business or if we are required to change our business practices, we could be prohibited from making and selling our products or providing certain telecommunications services.
Our operations are subject to environmental laws and regulations and we may be subject to environmental liabilities. We engage in manufacturing and are subject to a variety of local, state and federal governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances used to manufacture our products, such as the fabrication of fiberglass antennas by our Comtech Antenna Systems, Inc. subsidiary. We are also subject to the RoHS directive which restricts the use of lead, mercury and other substances in electrical and electronic products. The failure to comply with current or future environmental requirements could result in the imposition of substantial fines, suspension of production, alteration of our manufacturing processes or cessation of operations that could have a material adverse impact on our business, results of operations and financial condition. In addition, the handling, treatment or disposal of hazardous substances by us or our predecessors may have resulted, or could in the future result, in contamination requiring investigation or remediation, or leading to other liabilities, any of which could have a material adverse impact on our business, results of operations and financial condition. Our fiscal 2004 and fiscal 2005 Federal income tax returns were recently audited by the Internal Revenue Service and our fiscal 2006 tax return has been selected for audit. Other returns may be selected for audit in the future. Although adjustments relating to our fiscal 2004 and fiscal 2005 tax return were immaterial, a resulting tax assessment or settlement for fiscal 2006 and other periods that may be selected for future audit could have a material adverse impact on our results of operations and financial position. We are subject to income taxes in both the U.S. and certain foreign jurisdictions, including Canada. Significant judgment is required in determining the provision for income taxes. Although we believe our tax estimates are reasonable, the final determination of tax examinations and any related litigation could be materially different than what is reflected in historical income tax provisions and accruals. Recently enacted securities laws and regulations are increasing our costs and possible future changes to financial reporting standards may result in incremental costs. The Sarbanes-Oxley Act of 2002 required changes in some of our corporate governance, public disclosure and compliance practices. These changes resulted in increased costs and as we grow, we expect to see our costs increase. The SEC has promulgated and proposed new rules on a variety of subjects including the possibility that we would be required to adopt International Financial Reporting Standards (“IFRS”). If we are required to change our financial reporting standards and policies to comply with IFRS, our costs could significantly increase. In addition, the NASDAQ Stock Market LLC (“NASDAQ”) has revised its requirements for companies, such as us, that are listed on the NASDAQ. These changes are increasing our legal and financial compliance costs including making it more difficult and more expensive for us to obtain director and officer liability insurance or maintain our current liability coverage. We believe that these new and proposed laws and regulations could make it more difficult for us to attract and retain qualified members of our Board of Directors, particularly to serve on our audit committee, and qualified executive officers. We are subject to the ongoing internal control provisions of Section 404 of the Sarbanes-Oxley Act of 2002. Identification of material weaknesses in internal controls (including those at our newly acquired subsidiaries at Radyne), if identified, could indicate a lack of proper controls to generate accurate financial statements.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and related SEC rules, we are required to furnish a report of management’s assessment of the effectiveness of our internal controls as part of our Annual Report on Form 10-K. Our independent registered accountants are required to attest to and report on management’s assessment, as well as provide a separate opinion. To issue our report, we document our internal control design and the testing processes that support our evaluation and conclusion, and then we test and evaluate the results. There can be no assurance, however, that we will be able to remediate material weaknesses, if any, that may be identified in future periods, or maintain all of the controls necessary for continued compliance. There likewise can be no assurance that we will be able to retain sufficient skilled finance and accounting personnel, especially in light of the increased demand for such personnel among publicly traded companies.
Changes in financial accounting standards related to stock-based awards are expected to continue to have a significant effect on our reported results. In fiscal 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” a revised standard that requires that we record compensation expense in the statement of operations for employee and director stock-based awards using a fair value method. The adoption of the new standard had a significant effect on our reported earnings, and could adversely impact our ability to provide accurate guidance on our future reported financial results due to the variability of the factors used to estimate the value of stock-based awards. As a result, the ongoing application of this standard could impact the future value of our common stock and may result in greater stock price volatility. In addition, since our inception, we have used stock-based awards as a fundamental component of our employee compensation packages. We believe that stock-based awards directly motivate our employees to maximize long-term stockholder value and, through the use of long-term vesting, encourage employees to remain with us. To the extent that this accounting standard makes it less attractive to grant stock-based awards to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could have a material adverse impact on our business, results of operations and financial condition. We face risks from the uncertainty of prevailing political conditions. Current global political conditions are uncertain. For example, the winner of the November 2008 U.S. presidential election could significantly change policies or priorities which could have a negative impact on our business. Because the accuracy of our budgeting and forecasting process relies on stable political conditions, the prevailing political environment renders estimates of future income and expenses even more difficult than usual to formulate. The future direction of the political environment could have a material adverse impact on our business, results of operations and financial condition. Terrorist attacks and threats, and government responses thereto, and threats of war elsewhere may negatively impact all aspects of our operations, revenues, costs and stock price.
Terrorist attacks, the U.S. government’s and other governments’ responses thereto, and threats of war could adversely impact our business, results of operations and financial condition. Any escalation in these events or similar or future events may disrupt our operations or those of our customers and may affect the availability of materials needed to manufacture our products or the means to transport those materials to manufacturing facilities and finished products to customers. In addition, these could have an adverse impact on the U.S. and world economy in general. Provisions in our corporate documents, stockholder rights plan, and Delaware law could delay or prevent a change in control of Comtech. We have taken a number of actions that could have the effect of discouraging, delaying or preventing a merger or acquisition involving Comtech that our stockholders may consider favorable. For example, we have a classified board and the employment contract with our chief executive officer and contracts with other of our executive officers provide for substantial payments in certain circumstances or in the event of a change of control of Comtech. We also adopted a stockholder rights plan that could cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our Board of Directors. These provisions could prevent us from being acquired. In addition, our certificate of incorporation grants our Board of Directors the authority to fix the rights, preferences and privileges of and issue up to 2,000,000 shares of preferred stock without stockholder action. Although we have no present intention to issue shares of preferred stock, such an issuance of any class or series of our preferred stock could have rights which would adversely affect the voting power of the common stock or which could delay, defer, or prevent a change in control of Comtech. In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, an anti-takeover law. In general, this statute provides that except in certain limited circumstances a corporation shall not engage in any “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A “business combination” includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, for purposes of Section 203 of the Delaware General Corporation Law, an “interested stockholder” is a person who, together with affiliates, owns, or within three years did own, 15% or more of the corporation’s voting stock. This provision could have the effect of delaying or preventing a change in control of Comtech. Our debt service obligations may adversely affect our cash flow. The higher level of indebtedness resulting from the issuance of our 2.0% convertible senior notes increases the risk that we may default on our debt obligations. Our 2.0% convertible senior notes, may, at our option, be redeemable for cash on or after February 4, 2009. Holders of our 2.0% convertible senior notes have the right to require us to repurchase some or all of the outstanding 2.0% convertible senior notes on February 1, 2011, February 1, 2014 and February 1, 2019, and upon certain events, including a change in control. Should we decide to redeem some or all of the outstanding 2.0% convertible senior notes, or if the holders of our 2.0% convertible senior notes require us to repurchase some or all of the outstanding 2.0% convertible senior notes, we cannot assure you that we will be able to generate sufficient cash flow to pay the interest on our debt or that future working capital, borrowings or equity financing will be available to pay or refinance such debt. The level of our indebtedness, among other things, could: make it difficult for us to make payments on our debt; make it difficult for us to obtain any necessary financing in the future for working capital, acquisitions, capital expenditures, debt service requirements or other purposes; limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; and make us more vulnerable in the event of a downturn in our business. Our stock price is volatile.
The stock market in general, and the stock prices of technology-based companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of any specific public company. The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate significantly in the future as well.
Factors that could have a significant impact on the market price of our stock are described throughout the Risk Factors section and include:
| Our backlog is subject to customer cancellation or modification and such cancellation could result in decreased sales and increased provisions for excess and obsolete inventory.
We currently have a backlog of orders, mostly under contracts that the customer may modify or terminate. Almost all of the contracts in our backlog are subject to cancellation at the convenience of the customer or for default in the event that we are unable to perform under the contract. We cannot assure you that our backlog will result in net sales.
We record a provision for excess and obsolete inventory based on historical and future usage trends including the consideration of the amount of backlog we have on hand at any particular point in time. If our backlog is cancelled or modified, our estimates of future product demand may prove to be inaccurate, in which case we may have understated the provision required for excess and obsolete inventory. In the future, if we determine that our inventory was overvalued, we would be required to recognize such costs in our financial statements at the time of such determination. Any such charges could be material to our results of operations and financial position.
Our dependence on component availability, subcontractor availability and performance and key suppliers, including the core manufacturing expertise of our high-volume technology manufacturing center located in Tempe, Arizona, may adversely affect us.
None of our business segments generally maintain a substantial inventory of components and subsystems. Although we obtain certain components and subsystems from a single source or a limited number of sources, we believe that most components and subsystems are available from alternative suppliers and subcontractors. A significant interruption in the delivery of such items, however, could have a material adverse impact on our business, results of operations and financial condition.
In recent years, we have increased the company-wide dependency on our high-volume technology manufacturing center located in Tempe, Arizona, which is part of our telecommunications transmission segment. In fiscal 2006, 2005 and 2004, intersegment sales by the telecommunications transmission segment to the mobile data communications segment were $55.7 million, $19.5 million, and $12.8 million, respectively. Intersegment sales in fiscal 2006, 2005 and 2004 by the telecommunications transmission segment to the RF microwave amplifiers segment were $7.5 million, $8.6 million and $3.6 million, respectively. If a natural disaster or other business interruption occurred, we do not have immediate access to other manufacturing facilities, and as a result, our business would suffer. In addition, if our high-volume technology manufacturing center is unable to produce sufficient product or maintain quality, it could have a material adverse impact on all three of our business segments, our results of operations and our financial condition.
Contract cost growth on our fixed price contracts and other contracts that cannot be justified as an increase in contract value due from customers exposes us to reduced profitability and the potential loss of future business and other risks.
Almost all of our products and services are sold under fixed price contracts. This means that we bear the risk of unanticipated technological, manufacturing, supply or other problems, price increases or other increases in the cost of performance. Operating margin is adversely affected when contract costs that cannot be billed to the customer are incurred. This cost growth can occur if initial estimates used for calculating the contract price were incorrect, or if estimates to complete increase. The cost estimation process requires significant judgment and expertise. Reasons for cost growth may include unavailability and productivity of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in performance, availability and timing of funding from the customer, natural disasters, and the inability to recover any claims included in the estimates to complete. A significant change in an estimate on one or more programs could have a material impact on our business, results of operations and financial position.
Adverse regulatory changes could impair our ability to sell products.
Our products are incorporated into wireless communications systems that must comply with various U.S. government regulations, including those of the FCC, as well as international laws and regulations. Regulatory changes, including changes in the allocation and availability of frequency spectrum, and in the military standards and specifications that define the current satellite networking environment, could materially harm our business by (i) restricting development efforts by us and our customers, (ii) making our current products less attractive or obsolete, or (iii) increasing the opportunity for additional competition.
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Changes in, or our failure to comply with, applicable laws and regulations could materially harm our business. In addition, the increasing demand for wireless communications has exerted pressure on regulatory bodies worldwide to adopt new standards and reassign bandwidth for these products and services. The reduced number of available frequencies for other products and services and the time delays inherent in the government approval process of new products and services have caused and may continue to cause our customers to cancel, postpone or reschedule their installation of communications systems including their satellite, over-the-horizon microwave, or terrestrial line-of-sight microwave communication systems. This, in turn, could have a material adverse effect on our sales of products to our customers.
The EU has recently adopted two directives to facilitate the recycling of electrical and electronic equipment sold in the EU. The first of these is the Waste from Electrical and Electronic Equipment directive, which directs EU member states to enact laws, regulations, and administrative provisions to ensure that producers of electrical and electronic equipment are financially responsible for the collection, recycling, treatment, and environmentally sound disposal of certain products placed on the market after August 13, 2005, and from products in use prior to that date that are being replaced. The EU has also adopted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) directive. The RoHS directive restricts the use of lead, mercury, and certain other substances in electrical and electronic products placed on the market in the EU after July 1, 2006.
Similar laws and regulations have been or may be enacted in other regions, including in the U.S., China and Japan. Other environmental regulations may require us to reengineer our products to utilize components that are more environmentally compatible, and such reengineering and component substitution may result in additional costs to us. There can be no assurance that such existing or future laws will not have a material adverse effect on our business.
Acquisitions and strategic investments may divert our resources and management attention; results may fall short of expectations.
We intend to continue pursuing selected acquisitions of and investments in businesses, technologies and product lines as a key component of our growth strategy. Any future acquisition or investment may result in the use of significant amounts of cash, potentially dilutive issuances of equity securities, incurrence of debt and amortization expenses or in process research and development charges related to intangible assets. Acquisitions involve numerous risks, including:
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| • | difficulties in the integration and assimilation of the operations, technologies, products and personnel of an acquired business; | | | | | • | diversion of management’s attention from other business concerns; | | | | | • | increased expenses associated with the acquisition; and | | | | | • | potential loss of key employees or customers of any acquired business. |
| We cannot assure you that our acquisitions will be successful and will not adversely affect our business, results of operations or financial condition.
We have investments in recorded goodwill as a result of prior acquisitions, and changes in future business conditions could cause these investments to become impaired, requiring substantial write-downs that would reduce our operating income.
Goodwill recorded on our balance sheet as of July 31, 2006 was $22.2 million. We evaluate the recoverability of recorded goodwill amounts annually, or when evidence of potential impairment exists. The annual impairment test is based on several factors requiring judgment. Changes in our operating performance or business conditions, in general, could result in an impairment of goodwill which could be material to our results of operations.
The loss of key technical or management personnel could adversely affect our business.
Our success depends on the continued contributions of key technical management personnel, including the key corporate and operating unit management at each of our subsidiaries. Many of our key personnel, particularly the key engineers of our subsidiaries, would be difficult to replace, and are not subject to employment or noncompetition agreements. Our growth and future success will depend in large part upon our ability to attract and retain highly qualified engineering, sales and marketing personnel. Competition for such personnel from other companies, academic institutions, government entities and other organizations is intense. Although we believe that we have been successful to date in recruiting and keeping key personnel, we may not be successful in attracting and
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retaining the personnel we will need to continue to grow and operate profitably. Also, the management skills that have been appropriate for us in the past may not continue to be appropriate if we continue to grow and diversify.
Our business and operating results may be negatively impacted if we are unable to continue to manage growth of our businesses.
Certain of our businesses have experienced periods of rapid growth that have placed, and may continue to place, significant demands on our managerial, operational and financial resources. In order to manage this growth, we must continue to improve and expand our management, operational and financial systems and controls. We also need to continue to recruit and retain personnel and train and manage our employee base. We must carefully manage research and development capabilities and production and inventory levels to meet product demand, new product introductions and product and technology transitions. If we are not able to timely and effectively manage our growth and maintain the quality standards required by our existing and potential customers, we could experience a material adverse impact on our business, results of operations and financial condition.
Our markets are highly competitive.
The markets for our products are highly competitive. We cannot assure you that we will be able to successfully compete or that our competitors will not develop new technologies and products that are more effective than our own. We expect the DoD’s increased use of commercial off-the-shelf products and components in military equipment will encourage new competitors to enter the market. Also, although the implementation of advanced telecommunications services is in its early stages in many developing countries, we believe competition may intensify as businesses and foreign governments realize the market potential of telecommunications services. Many of our competitors have financial, technical, marketing, sales and distribution resources greater than ours.
Protection of our intellectual property is limited; we are subject to the risk of third party claims of infringement.
Our businesses rely in large part upon our proprietary scientific and engineering “know-how” and production techniques. Historically, patents have not been an important part of our protection of our intellectual property rights. We rely upon the laws of unfair competition, restrictions in licensing agreements and confidentiality agreements to protect our intellectual property. We limit access to and distribution of our proprietary information. These efforts allow us to rely upon the knowledge and experience of our management and technical personnel to market our existing products and to develop new products. The departure of any of our key management and technical personnel, the breach of their confidentiality and non-disclosure obligations to us or the failure to achieve our intellectual property objectives may have a material adverse impact on our business, results of operations and financial condition.
Our ability to compete successfully and achieve future revenue growth will depend, in part, on our ability to protect our proprietary technology and operate without infringing upon the rights of others. We may fail to do so. In addition, the laws of certain countries in which our products are or may be sold may not protect our products and intellectual property rights to the same extent as the laws of the U.S.
We believe that we own or have licensed all intellectual property rights necessary for the operation of our businesses as currently contemplated. If the technology we use is found to infringe on protected technology, we could be required to change our business practices, license the protected technology, and/or pay damages or other compensation to the infringed party. If we are unable to license protected technology that we use in our business or if we are required to change our business practices, we could be prohibited from making and selling our products or providing certain telecommunications services.
Our operations are subject to environmental laws and regulations and we may be subject to environmental liabilities.
We engage in manufacturing and are subject to a variety of local, state and federal governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances used to manufacture our products, particularly in the fabrication of fiberglass antennas by our Comtech Antenna Systems, Inc. subsidiary. We are also subject to the RoHS directive which restricts the use of lead, mercury and other substances in electrical and electronic products. The failure to comply with current or future environmental requirements could result in the imposition of substantial fines, suspension of production, alteration of our manufacturing processes or cessation of operations that could have a material adverse impact on our business, results of operations and financial condition.
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In addition, the handling, treatment or disposal of hazardous substances by us or our predecessors may have resulted or could in the future result in contamination requiring investigation or remediation, or leading to other liabilities, any of which could have a material adverse impact on our business, results of operations and financial condition.
Our fiscal 2004 Federal income tax return is being audited by the Internal Revenue Service, other returns may be selected for audit and a resulting tax assessment or settlement could have a material adverse impact on our results of operations and financial position.
We are subject to income taxes in both the U.S. and certain foreign jurisdictions, including Canada. Significant judgment is required in determining the provision for income taxes. Although we believe our tax estimates are reasonable, the final determination of tax examinations and any related litigation could be materially different than what is reflected in historical income tax provisions and accruals.
In fiscal 2006, we were informed by the Internal Revenue Service that our Federal income tax return for the fiscal year ended July 31, 2004 was selected for a general tax audit. The audit is in the early stages and additional income tax returns for other fiscal years may be examined. If the outcome of the audit differs materially from our original income tax provisions, it could have a material impact on our results of operations and financial position.
Recently enacted securities laws and regulations are increasing our costs.
The Sarbanes-Oxley Act of 2002 required changes in some of our corporate governance, public disclosure and compliance practices. For example, the SEC has promulgated new rules on a variety of subjects. In addition, the NASDAQ Stock Market LLC (“NASDAQ”) has revised its requirements for companies, such as us, that are listed on the NASDAQ. These changes are increasing our legal and financial compliance costs including making it more difficult and more expensive for us to obtain director and officer liability insurance or maintain our current liability coverage. We believe that these new laws and regulations could make it more difficult for us to attract and retain qualified members of our Board of Directors, particularly to serve on our audit committee, and qualified executive officers.
We are subject to the ongoing internal control provisions of Section 404 of the Sarbanes-Oxley Act of 2002. Identification of material weaknesses in internal controls, if identified, could indicate a lack of proper controls to generate accurate financial statements.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and related SEC rules, we are required to furnish a report of management’s assessment of the effectiveness of our internal controls as part of our Annual Report on Form 10-K. Our auditors are required to attest to and report on management’s assessment, as well as provide a separate opinion. To issue our report, we document our internal control design and the testing processes that support our evaluation and conclusion, and then we test and evaluate the results. There can be no assurance, however, that we will be able to remediate material weaknesses, if any, that may be identified in future periods, or maintain all of the controls necessary for continued compliance. There likewise can be no assurance that we will be able to retain sufficient skilled finance and accounting personnel, especially in light of the increased demand for such personnel among publicly traded companies.
Changes in financial accounting standards related to stock option expenses are expected to continue to have a significant effect on our reported results.
In fiscal 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” a revised standard that requires that we record compensation expense in the statement of operations for employee stock options using a fair value method. The adoption of the new standard had a significant effect on our reported earnings, and could adversely impact our ability to provide accurate guidance on our future reported financial results due to the variability of the factors used to estimate the value of stock options. As a result, the ongoing application of the new standard could impact the future value of our common stock and may result in greater stock price volatility.
In addition, since our inception, we have used stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of long-term vesting, encourage employees to remain with us. To the extent that this accounting standard makes it less attractive to grant options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could have a material adverse impact on our business, results of operations and financial condition.
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We face risks from the uncertainty of prevailing economic and political conditions.
Current global political and economic conditions are uncertain. As a result, it is difficult to estimate the level of expansion, if any, for the global or U.S. economies generally or the markets in which we participate. Because our budgeting and forecasting process relies on estimates of growth in the markets we serve, the current economic environment renders estimates of future income and expenses even more difficult than usual to formulate. The future direction of the domestic and global economies and political environment could have a material adverse impact on our business, results of operations and financial condition.
Terrorist attacks and threats, and government responses thereto, and threats of war elsewhere may negatively impact all aspects of our operations, revenues, costs and stock price.
Terrorist attacks, the U.S. government’s and other governments’ responses thereto, and threats of war could adversely impact our business, results of operations and financial condition. Any escalation in these events or similar or future events may disrupt our operations or those of our customers and may affect the availability of materials needed to manufacture our products or the means to transport those materials to manufacturing facilities and finished products to customers. In addition, these could have an adverse impact on the U.S. and world economy in general.
Provisions in our corporate documents, stockholder rights plan, and Delaware law could delay or prevent a change in control of Comtech.
We have taken a number of actions that could have the effect of discouraging, delaying or preventing a merger or acquisition involving Comtech that our stockholders may consider favorable. For example, we have a classified board and the employment contract of our chief executive officer provides for a substantial payment in the event of a change of control of Comtech. We also adopted a stockholder rights plan that could cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our Board of Directors. These provisions could prevent us from being acquired. In addition, our certificate of incorporation grants our Board of Directors the authority to fix the rights, preferences and privileges of and issue up to 2,000,000 shares of preferred stock without stockholder action. Although we have no present intention to issue shares of preferred stock, such an issuance of any class or series of our preferred stock could have rights which would adversely affect the voting power of the common stock or which could delay, defer, or prevent a change in control of Comtech. In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, an anti-takeover law. In general, this statute provides that except in certain limited circumstances a corporation shall not engage in any “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A “business combination” includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, for purposes of Section 203 of the Delaware General Corporation Law, an “interested stockholder” is a person who, together with affiliates, owns, or within three years did own, 15% or more of the corporation’s voting stock. This provision could have the effect of delaying or preventing a change in control of Comtech.
Our debt service obligations may adversely affect our cash flow.
The higher level of indebtedness resulting from the issuance of our 2.0% convertible senior notes increases the risk that we may default on our debt obligations. We cannot assure you that we will be able to generate sufficient cash flow to pay the interest on our debt or that future working capital, borrowings or equity financing will be available to pay or refinance such debt.
The level of our indebtedness, among other things, could:
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| • | make it difficult for us to make payments on our debt; | | | | | • | make it difficult for us to obtain any necessary financing in the future for working capital, acquisitions, capital expenditures, debt service requirements or other purposes; | | | | | • | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; and | | | | | • | make us more vulnerable in the event of a downturn in our business. |
Our stock price is volatile.
The stock market in general, and the stock prices of technology-based companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of any specific public company. The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate significantly in the future as well. Factors that could have a significant impact on the market price of our stock are described throughout the Risk Factors section and include:
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| •· | strategic transactions, such as acquisitions and divestures; |
| · | | issuance of potentially dilutive equity-type securities | | •· | future announcements concerning us or our competitors; |
| | | | •· | receipt or non-receipt of substantial orders for products and services; |
| | | | •· | quality deficiencies in services or products; |
| | | | •· | results of technological innovations; |
| | | | •· | new commercial products; |
| | | | •· | changes in recommendations of securities analysts; |
| | | | •· | government regulations; |
| | | | •· | proprietary rights or product or patent litigation; |
| | | | •· | changes in economic conditions generally, particularly in the telecommunications sector; |
| | | | •· | changes in securities market conditions, generally; |
| | | | •· | acts of terrorism or war; |
| | | | •· | inflation or deflation; and |
| | | | •· | rumors or allegations regarding our financial disclosures or practices. |
Shortfalls in our sales or earnings in any given period relative to the levels expected by securities analysts could immediately, significantly and adversely affect the trading price of our common stock.
None.
Historically, we have not owned any material properties and facilities and have relied upon a strategy of leasing. Our properties and facilities (including Radyne facilities) are noted below:
| · | Shortfalls in our sales or earnings in any given period relative to the levels expected by securities analysts could immediately, significantly and adversely affect the trading price of our common stock.
We have never declared or paid cash dividends.
We have never declared or paid a cash dividend and do not intend to declare any cash dividends on our common stock in the foreseeable future.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our corporate headquarters are located in an office building complex in Melville, New York. The lease, which is for 9,600 square feet, provides for our use of the premises for seven years through July 2013. |
| · | Our RF microwave amplifiers segment is primarily locatedmanufactures our solid-state, high-power, broadband amplifiers, in a 46,000 square foot engineering and manufacturing facility on more than two acres of land in Melville, New York.York and a 6,000 square foot facility in Topsfield, Massachusetts. We lease thisthe New York facility from a partnership controlled by our Chairman, Chief Executive Officer and President. The lease, as amended, provides for our use of the premises as they now exist for a term of ten years through December 2011. We have a right of first refusal in the event of a sale of the facility. The base annual rent under the lease is subject to customary adjustments. Our RF microwave amplifiers segment manufactures our satellite earth station traveling wave tubes amplifiers, certain solid state amplifiers, and klystron tube amplifiers in two leased manufacturing facilities located in Santa Clara, California. These two facilities comprise approximately 71,000 square feet and are subject to lease agreements that expire in 2012. Our RF microwave amplifiers segment also operates a small office in the United Kingdom. |
| · | Although primarily used for our satellite earth station product lines which are part of the telecommunications transmission segment, all three of our business segments utilize our recently expanded 136,000 square foot, high-volume technology manufacturing centerfacilities located in Tempe, Arizona. ThisThese manufacturing center utilizesfacilities, comprising 176,000 square feet, utilize state-of-the-art design and production techniques, including analog, digital and RF microwave production, hardware assembly and full service engineering. The leaseleases for this facility expires inthese facilities expire through fiscal 2011 and in each lease we have the option to extend the term of the lease for up to an additional five-year period. As a result of the Radyne acquisition, we also currently occupy approximately 75,000 square feet of building space in Phoenix, Arizona. The lease for this building currently expires in October 2018. On August 1, 2008, we adopted and initiated a restructuring plan to achieve operating efficiencies and are currently in the process of consolidating Radyne’s Phoenix, Arizona-based operations into our Tempe, Arizona facility. We are currently in preliminary negotiations with a tenant who subleases, from us, a portion of Radyne’s Phoenix, Arizona facility. This tenant is interested in subleasing the remaining portion of this facility from us. If these negotiations are not successful, we intend to perform an assessment of whether or not we will be able to sublease the Phoenix, Arizona facility for the remaining duration of the lease, and at what rent, if any, we might be able to receive, given the poor real estate market conditions in the Phoenix, Arizona areas as well the uncertainties relating to the local economic environment. |
| · | Our telecommunications transmission segment leases an additional tenfourteen facilities, fivesix of which are located in the U.S. The U.S. facilities (excluding our Tempe, Arizona facility)Arizona-based facilities) aggregate 118,000159,000 square feet and are primarily utilized for manufacturing, engineering, and general office use. Our telecommunications transmission segment also |
operates five small offices in China, India, North Africa, Thailand,Singapore, the United Kingdom and Canada, thatall of which aggregate 25,000 square feet and are primarily utilized for customer support, engineering and sales. |
| · | Our mobile data communications segment operates intwo main facilities aggregating 57,000 square feet. We maintain a 31,00032,000 square foot facility located in Germantown, Maryland. TheMaryland which contains our main network operations center. This lease termsexpires in March 2018. Our mobile data communications segment also maintains a 25,000 square foot facility in Ashburn, Virginia, which is used to support the design, sales and manufacture of our microsatellite and SENS products. This lease expires in 2012. We also have two small offices located in Colorado that are primarily used for all of theseengineering capabilities. |
The terms for all of our leased facilities are generally for multi-year periods and we believe that we will be able to renew these leases or find comparable facilities elsewhere.
In October 2007, our Florida-based subsidiary, Comtech Systems, Inc. (“CSI”), received a customs export enforcement subpoena from the U.S. Immigration and Customs Enforcement (“ICE”) branch of the Department of Homeland Security. The subpoena relates to CSI’s $2.0 million contract with the Brazilian Naval Commission (the Brazil contract) and it required the production of all books, records and documents, including copies of contracts, invoices and payments related to agreements between CSI, its agent, its subcontractor and the Brazilian government. We believe that the ICE investigation is focused primarily on whether or not CSI was in compliance with export-related laws and regulations, including the International Traffic in Arms Regulations (“ITAR”) and the Export Administration Regulations. CSI produced documents in response to the subpoena request. Customs officials have detained certain inventory related to the Brazil contract pending resolution of this matter.
We engaged outside counsel to assist CSI in its response to the subpoena and related matters and to conduct our own investigation. Based on our ongoing investigation into this matter, we believe that the detained inventory, which consists of commercial satellite equipment, was not modified or adapted in any way to meet Brazilian military requirements and was only subject to the jurisdiction of the Department of Commerce and not the jurisdiction of the U.S. Department of State. In addition, in order to provide certain defense services, including conducting factory acceptance testing at CSI’s Florida facility, we obtained a license (referred to as a Technical Assistance Agreement (“TAA”)) from the U.S. Department of State. We believe that the TAA authorized all activities under the Brazil contract that were subject to the jurisdiction of the U.S. Department of State.
We believe that CSI made a good faith effort to comply with applicable regulations; however, we believe that CSI made inadvertent administrative errors resulting in a TAA that did not become effective on a timely basis. The administrative errors relate primarily to the execution of non-disclosure agreements (“NDA”) with certain third country national employees of CSI’s agent. These individuals have now signed appropriate NDAs, and, in December 2007, CSI filed an amended TAA with the U.S. Department of State. CSI has requested that the U.S. Department of State confirm CSI’s and our view that the Brazil contract does not require any other State Department license.
In March 2008, the Enforcement Division of the U.S. Department of State informed us that they were reviewing our amended TAA. In May 2008, the U.S. Attorney’s Office in the Middle District of Florida informed us that, based on its conversations with the ICE agent who initiated the subpoena, it was closing its investigation into the Brazil matter. In June 2008, the ICE agent informed us that he would recommend that the detained inventory be released back to us upon the U.S. Department of State confirming our position that a State Department license for the hardware shipped was not required. In August 2008, the ICE agent informed us that the U.S. Department of State wanted to clarify certain technical matters and, on its behalf, the ICE agent was going to interview one of our engineers. This interview occurred in September of 2008. We continue to remain cautiously optimistic that we will be able to shortly reship the Brazil inventory to our customer.
In addition to their review of the Brazil contract, in March 2008, the Enforcement Division of the U.S. Department of State informed us that they sought to confirm our company-wide ITAR compliance for the five-year period ended March 2008. In response, we expanded the scope of our own ongoing investigation. In June 2008, we provided detailed information and a summary of our findings to the U.S. Department of State. In July 2008, the U.S. Department of State requested supplemental information and we responded to their request. Our findings to date indicate that there were certain instances of exports and defense services during the five-year period for which we did not have the appropriate authorization from the U.S. Department of State; however, none of those instances involved Proscribed Countries as defined by ITAR. We are awaiting additional feedback from the U.S. Department of State as it relates to all of the aforementioned matters.
Since the receipt of the original Brazil subpoena in October 2007, we have engaged outside counsel and export consultants to help us assess and improve, as appropriate, our internal controls with respect to U.S. export controls laws and regulations and laws governing record keeping and dealings with foreign representatives. In addition, in connection with our August 1, 2008 acquisition of Radyne, we are expanding our export internal control assessment to include our newly acquired subsidiaries. To date, we have noted opportunities for improving our procedures to comply with such laws and regulations, including at our newly acquired Radyne subsidiaries and are in the process of making improvements.
During fiscal 2008, we have taken numerous steps to significantly improve our export control processes, including the hiring of additional employees who are knowledgeable and experienced with ITAR and the engagement of an outside export consultant to conduct additional training. We are also in the process of implementing enhanced formal company-wide ITAR control procedures, including at our newly acquired Radyne subsidiaries. Because our assessments are continuing, we expect to remediate, improve and enhance our internal controls relating to exports throughout fiscal 2009. Because the above matters are ongoing, we cannot determine the ultimate outcome of these matters. Violations of U.S. export control-related laws and regulations could result in civil or criminal fines and/or penalties and/or result in an injunction against us, all of which could, in the aggregate, materially impact our business, results of operations and cash flows. Should we identify a material weakness relating to our compliance, the ongoing costs of remediation could be material. In addition, inventory related to the Brazil contract (including the inventory that has been detained) had a net book value of $1.1 million as of July 31, 2008. If this inventory is permanently seized or not returned to us timely, or we can not resell the inventory to other customers, we would be required to write-off the value of this inventory in a future accounting period.
No matters were submitted to our stockholders during the fourth quarter of the fiscal year ended July 31, 2008.
The graph below compares the cumulative total stockholder return on our common stock with the cumulative total return on the S&P’s 500 Index and the NASDAQ Telecommunications Index for each of the last five fiscal years ended July 31, assuming an investment of $100 at the beginning of such period and the reinvestment of any dividends. The comparisons in the graphs below are based upon historical data and are not indicative of, nor intended to forecast, future performance of our common stock.
Our common stock trades on the NASDAQ Stock Market LLC (“NASDAQ”) under the symbol “CMTL.” The following table shows the quarterly range of the high and low sale prices for our common stock as reported by the NASDAQ. Such prices do not include retail markups, markdowns or commissions.
| | | Common Stock | | | | | High | | | Low | | | Fiscal Year Ended July 31, 2007 | | | | | | | | First Quarter | | $ | 36.96 | | | | 26.88 | | | Second Quarter | | | 39.86 | | | | 33.56 | | | Third Quarter | | | 40.23 | | | | 33.21 | | | Fourth Quarter | | | 48.94 | | | | 37.93 | | | | | | | | | | | | | Fiscal Year Ended July 31, 2008 | | | | | | | | | | First Quarter | | | 58.00 | | | | 35.45 | | | Second Quarter | | | 56.07 | | | | 43.01 | | | Third Quarter | | | 48.41 | | | | 37.59 | | | Fourth Quarter | | | 51.21 | | | | 38.63 | |
We have never paid cash dividends on our common stock. Although we currently expect to use earnings and cash on hand to finance the development and expansion of our businesses, our Board of Directors reviews our dividend policy periodically. The payment of dividends in the future will depend upon our earnings, capital requirements, financial condition and other factors considered relevant by our Board of Directors.
None.
We did not repurchase any of our equity securities during fiscal 2008.
As of September 12, 2008, there were approximately 787 holders of our common stock. Such number of record owners was determined from our shareholder records and does not include beneficial owners of our common stock held in the name of various security holders, dealers and clearing agencies.
The following table shows selected historical consolidated financial data for our Company. During the fiscal quarter ended January 31, 2005, the Company adopted Emerging Issues Task Force (“EITF”) Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share.” The Company has restated, for comparative purposes, the historical share and per share data, including earnings per share (“EPS”), to reflect the impact of the assumed conversion of the Company’s 2.0% convertible senior notes in calculating diluted EPS. Effective August 1, 2005, we adopted the provisions of SFAS No. 123(R), “Share-Based Payment” using the modified prospective method and, as a result, periods prior to August 1, 2005 do not reflect the recognition of stock-based compensation expense. All share and per share amounts have also been adjusted to reflect the three-for-two stock split of the Company’s common shares that occurred in April 2005. Detailed historical financial information is included in the audited consolidated financial statements for fiscal 2008, 2007 and 2006. | | | Fiscal Years Ended July 31, (In thousands, except per share amounts) | | | | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | | | Consolidated Statement of | | | | | | | | | | | | | | | | | Operations Data: | | | | | | | | | | | | | | | | | Net sales | | $ | 531,627 | | | | 445,684 | | | | 391,511 | | | | 307,890 | | | | 223,390 | | | Cost of sales | | | 296,687 | | | | 252,389 | | | | 232,210 | | | | 180,524 | | | | 135,858 | | | Gross profit | | | 234,940 | | | | 193,295 | | | | 159,301 | | | | 127,366 | | | | 87,532 | | | | | | | | | | | | | | | | | | | | | | | | | Expenses: | | | | | | | | | | | | | | | | | | | | | | Selling, general and administrative | | | 85,967 | | | | 73,312 | | | | 67,071 | | | | 51,819 | | | | 36,016 | | | Research and development | | | 40,472 | | | | 32,469 | | | | 25,834 | | | | 21,155 | | | | 15,907 | | | In-process research and development | | | - | | | | - | | | | - | | | | - | | | | 940 | | | Amortization of intangibles | | | 1,710 | | | | 2,592 | | | | 2,465 | | | | 2,328 | | | | 2,067 | | | | | | 128,149 | | | | 108,373 | | | | 95,370 | | | | 75,302 | | | | 54,930 | | | | | | | | | | | | | | | | | | | | | | | | | Operating income | | | 106,791 | | | | 84,922 | | | | 63,931 | | | | 52,064 | | | | 32,602 | | | | | | | | | | | | | | | | | | | | | | | | | Other expenses (income): | | | | | | | | | | | | | | | | | | | | | | Interest expense | | | 2,683 | | | | 2,731 | | | | 2,687 | | | | 2,679 | | | | 1,425 | | | Interest income and other | | | (14,065 | ) | | | (14,208 | ) | | | (9,243 | ) | | | (4,072 | ) | | | (921 | ) | | | | | | | | | | | | | | | | | | | | | | | | Income before provision for income taxes | | | 118,173 | | | | 96,399 | | | | 70,487 | | | | 53,457 | | | | 32,098 | | | | | | | | | | | | | | | | | | | | | | | | | Provision for income taxes | | | 41,740 | | | | 31,186 | | | | 25,218 | | | | 16,802 | | | | 10,271 | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | $ | 76,433 | | | | 65,213 | | | | 45,269 | | | | 36,655 | | | | 21,827 | | | | | | | | | | | | | | | | | | | | | | | | | Net income per share: | | | | | | | | | | | | | | | | | | | | | | Basic | | $ | 3.17 | | | | 2.81 | | | | 1.99 | | | | 1.69 | | | | 1.03 | | | Diluted | | $ | 2.76 | | | | 2.42 | | | | 1.72 | | | | 1.42 | | | | 0.92 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Weighted average number of common shares outstanding - basic | | | 24,138 | | | | 23,178 | | | | 22,753 | | | | 21,673 | | | | 21,178 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Weighted average number of common and common equivalent shares outstanding assuming dilution – diluted | | | 28,278 | | | | 27,603 | | | | 27,324 | | | | 27,064 | | | | 24,781 | |
(continued)
| | | Fiscal Years Ended July 31, (In thousands) | | | | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | | | Other Consolidated Operating Data: | | | | | | | | | | | | | | | | | Backlog at period-end | | $ | 201,122 | | | | 129,044 | | | | 186,007 | | | | 153,314 | | | | 83,549 | | | New orders | | | 603,705 | | | | 388,721 | | | | 424,204 | | | | 377,655 | | | | 206,797 | | | Research and development expenditures - internal and customer funded | | | 48,224 | | | | 36,639 | | | | 30,243 | | | | 24,156 | | | | 21,656 | |
| | | As of July 31, (In thousands) | | | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | | Consolidated Balance Sheet Data: | | | | | | | | | | | | | | | | Total assets | | $ | 653,120 | | | | 556,342 | | | | 455,266 | | | | 382,403 | | | | 306,390 | | | Working capital | | | 484,451 | | | | 397,083 | | | | 308,986 | | | | 254,690 | | | | 201,218 | | | Convertible senior notes | | | 105,000 | | | | 105,000 | | | | 105,000 | | | | 105,000 | | | | 105,000 | | | Other long-term obligations | | | - | | | | 108 | | | | 243 | | | | 396 | | | | 158 | | | Stockholders’ equity | | | 442,802 | | | | 345,768 | | | | 254,242 | | | | 196,629 | | | | 142,398 | |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We design, develop, produce and market innovative products, systems and services for advanced communications solutions. We believe many of our solutions play a vital role in providing or enhancing communication capabilities when terrestrial communications infrastructure is unavailable or ineffective. We conduct our business through three complementary segments: telecommunications transmission, mobile data communications and RF microwave amplifiers. We sell our products to a diverse customer base in the global commercial and government communications markets. We believe we are a leader in the market segments that we serve.
Our telecommunications transmission segment provides equipment and systems that are used to enhance satellite transmission efficiency and that enable wireless communications in environments where terrestrial communications are unavailable, inefficient or too expensive. Our telecommunications transmission segment also operates our high-volume technology manufacturing center that is utilized, in part, by our mobile data communications and RF microwave amplifiers segments as well as third party commercial customers who outsource a portion of their manufacturing to us. Accordingly, our telecommunications transmission segment benefits from the related increased operating efficiencies. Our mobile data communications segment provides customers with an integrated solution, including mobile satellite transceivers and satellite network support, to enable global satellite-based communications when mobile, real-time, secure transmission is required. Our mobile data communications segment also designs and manufactures microsatellites and related components. Our RF microwave amplifiers segment designs, manufactures and markets satellite earth station traveling wave tube amplifiers, klystron amplifiers and solid-state amplifiers, including high-power, broadband RF microwave amplifier products.
A substantial portion of our sales may be derived from a limited number of relatively large customer contracts, such as our Movement Tracking System (“MTS”) contract with the U.S. Army and our U.S. Army’s Force XXI Battle Command, Brigade and Below command and control systems (also known as Blue Force Tracking (“BFT”)) contract, for which the timing of revenues cannot be predicted. Quarterly and period-to-period sales and operating results may be dramatically affected by one or more of such contracts. In addition, our gross profit is affected by a variety of factors, including the mix of products, systems and services sold, production efficiencies, estimates of warranty expense, price competition and general economic conditions. Our gross profit may also be affected by the impact of any cumulative adjustments to contracts that are accounted for under the percentage-of-completion method. Our contracts with the U.S. government can be terminated at any time and orders are subject to unpredictable funding, deployment and technology decisions by the U.S. government. Some of these contracts, such as the MTS and BFT contracts, are indefinite delivery/indefinite quantity (“IDIQ”) contracts, and as such, the U.S. government is not obligated to purchase any equipment or services under these contracts. Accordingly, we can experience significant fluctuations in sales and operating results from quarter-to-quarter and period-to-period comparisons may not be indicative of a trend or future performance.
Revenue from the sale of our products is generally recognized when the earnings process is complete, upon shipment or customer acceptance. Revenue from contracts relating to the design, development or manufacture of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts is generally recognized in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”). Revenue from contracts that contain multiple elements that are not accounted for under SOP 81-1 are generally accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Revenue from these contracts is allocated to each respective element based on each element’s relative fair value and is recognized when the respective revenue recognition criteria for each element are met.
The Radyne Acquisition In August 2008, and as more fully described throughout this Form 10-K, we acquired Radyne for a preliminary aggregate purchase price of approximately $231.7 million (including estimated transaction costs and payments made for outstanding share-based stock awards). We believe that the acquisition of Radyne resulted in the following strategic benefits:
| - | Strengthened our leadership position in our satellite earth station product lines in our telecommunications transmission segment; |
| - | More than doubled the size of our RF microwave amplifiers segment by expanding our amplifier product portfolio and immediately positioning us as a leader, not only in the solid-state amplifier market, but in the satellite earth station traveling wave tube amplifier market; |
| - | Broadened the number of products and services that our mobile data communications segment can offer by allowing us to market additional mobile tracking products as well as the design and manufacture of microsatellites and related components; and |
| - | Further diversified our overall global customer base and expanded our addressable markets. |
We believe that, over time, we will be able to take advantage of our combined engineering and sales talents to drive further innovation in the marketplace and deliver new and advanced products to our customers in all three of our business segments. In connection with the Radyne acquisition, we also expect that we will be able to achieve operating efficiencies by eliminating redundant functions and related expenses. In order to achieve these efficiencies, on August 1, 2008, we immediately adopted a restructuring plan and are currently in the process of closing Radyne’s Phoenix, Arizona manufacturing facility and integrating that operation into our high-volume technology manufacturing center located in Tempe, Arizona. In addition, Radyne’s corporate functions, which were co-located in Radyne’s Phoenix, Arizona manufacturing facility, are currently being moved to our Melville, New York corporate office. The closing of Radyne’s facility and related integration is expected to be completed in the second half of fiscal 2009. In connection with the realization of operating synergies, we have preliminarily estimated that we may incur up to $9.6 million of restructuring costs, of which, approximately $8.7 million relates to possible exit costs relating to the shut-down of Radyne’s Phoenix Arizona manufacturing facility. We have already incurred approximately $0.8 million of severance costs for Radyne employees who were notified that they were being terminated on August 1, 2008. We are currently in preliminary negotiations with a tenant who subleases, from us, a portion of the manufacturing facility, and is interested in subleasing the remaining portion of this facility from us. If the negotiations with this tenant are successful, our actual net cost related to the shut-down of the manufacturing facility will be significantly lower. We anticipate that we will be able to capitalize all of the aforementioned costs as part of purchase accounting in accordance with Emerging Issues Task Force 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination (“EITF 95-3”). In addition, in connection with the acquisition, during the three months ended October 31, 2008 (our first quarter of fiscal 2009), and in accordance with SFAS No. 141, “Business Combinations,” we expect, based on a preliminary analysis, to record a one-time charge of $6.2 million reflecting the fair-market value of in-process research and development acquired.
From an operational and financial reporting perspective, as of August 1, 2008, Radyne’s satellite electronics and video encoders and decoder product lines are now part of our telecommunications transmission segment, Radyne’s TWTA and KPA amplifier product portfolios are now part of our RF microwave amplifiers segment and Radyne’s microsatellites and SENS products are now part of our mobile data communications segment. Other Tactical and Product Line AcquisitionsIn August 2006, we acquired certain assets and assumed certain liabilities of Insite Consulting, Inc. (“Insite”), a logistics application software company, for $3.2 million, including transaction costs of $0.2 million. Insite has developed the geoOps™ Enterprise Location Monitoring System, a software-based solution that allows customers to integrate legacy data systems with near-real time logistics and operational data systems. This operation was combined with our existing business and is part of our mobile data communications segment.
In February 2007, we acquired certain assets and assumed certain liabilities of Digicast Networks, Inc. (“Digicast”), a manufacturer of digital video broadcasting equipment, for $1.0 million. This operation was combined with our existing business and is part of the telecommunications transmission segment.
In July 2008, we acquired the network backhaul assets and the NetPerformer and AccessGate product lines of Verso Technologies ("Verso") for approximately $3.9 million. This operation was combined with our existing business and is part of our telecommunications transmission segment.
We consider certain accounting policies to be critical due to the estimation process involved in each.
Revenue Recognition on Long-Term Contracts. Revenues and related costs from long-term contracts relating to the design, development or manufacture of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts are recognized in accordance with SOP 81-1. We primarily apply the percentage-of-completion method and generally recognize revenue based on the relationship of total costs incurred to total projected costs, or, alternatively, based on output measures, such as units delivered or produced. Profits expected to be realized on such contracts are based on total estimated sales for the contract compared to total estimated costs, including warranty 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 evident. Long-term U.S. government cost-reimbursable type contracts are also specifically covered by Accounting Research Bulletin No. 43 “Government Contracts, Cost-Plus Fixed-Fee Contracts” (“ARB 43”), in addition to SOP 81-1.
We have been engaged in the production and delivery of goods and services on a continual basis under contractual arrangements for many years. Historically, we have demonstrated an ability to accurately estimate revenues and expenses relating to our long-term contracts. However, there exist inherent risks and uncertainties in estimating revenues, expenses and progress toward completion, particularly on larger or longer-term contracts. If we do not accurately estimate the total sales, related costs and progress towards completion on such contracts, the estimated gross margins may be significantly impacted or losses may need to be recognized in future periods. Any such resulting changes in margins or contract losses could be material to our results of operations and financial position.
In addition, most government contracts have termination for convenience clauses that provide the customer with the right to terminate the contract at any time. Such terminations could impact the assumptions regarding total contract revenues and expenses utilized in recognizing profit under the percentage-of-completion method of accounting. Changes to these assumptions could materially impact our results of operations and financial position. Historically, we have not experienced material terminations of our long-term contracts.
We also address customer acceptance provisions in assessing our ability to perform our contractual obligations under long-term contracts. Our inability to perform on our long-term contracts could materially impact our results of operations and financial condition. Historically, we have been able to perform on our long-term contracts.
Accounting for Stock-Based Compensation. As discussed further in “Notes to Consolidated Financial Statements – Note 1(j) Accounting for Stock-Based Compensation,” we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R) on August 1, 2005 using the modified prospective method.
We have used and expect to continue to use the Black-Scholes option pricing model to compute the estimated fair value of stock-based awards. The Black-Scholes option pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. The assumptions used in computing the fair value of stock-based awards reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. We estimate expected volatility by considering the historical volatility of our stock, the implied volatility of publicly traded stock options in our stock and our expectations of volatility for the expected term of stock-based compensation awards. As a result, if other assumptions or estimates had been used for options granted, stock-based compensation expense that was recorded could have been materially different. Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially impacted in the future.
Impairment of Goodwill and Other Intangible Assets. As of July 31, 2008, our goodwill and other intangible assets aggregated $31.9 million. This amount will materially increase as a result of the Radyne acquisition. In assessing the recoverability of goodwill and other intangibles, we 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, we may be required to record impairment charges for these assets in future periods. Any such resulting impairment charges could be material to our results of operations.
Provision for Warranty Obligations. We provide warranty coverage for most of our products, including products under long-term contracts, for a period of at least one year from the date of shipment. We record a liability for estimated warranty expense based on historical claims, product failure rates and other factors. Costs associated with some of our warranties that are provided under long-term contracts are incorporated into our estimates of total contract costs. There exist inherent risks and uncertainties in estimating warranty expenses, particularly on larger or longer-term contracts. As such, if we do not accurately estimate our warranty costs, any changes to our original estimates could be material to our results of operations and financial condition.
Accounting for Income Taxes. Our deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. The provision for income taxes is based on domestic and international statutory income tax rates in the tax jurisdictions where we operate, permanent differences between financial reporting and tax reporting and available credits and incentives. We recognize interest and penalties related to certain uncertain tax positions in income tax expense. The U.S. Federal government is our most significant income tax jurisdiction.
Significant judgment is required in determining income tax provisions and tax positions. We may be challenged upon review by the applicable taxing authority and positions taken by us may not be sustained. We recognize all or a portion of the benefit of income tax positions only when we have made a determination that it is more-likely-than-not that the tax position will be sustained upon examination, based upon the technical merits of the position. For tax positions that are determined as more-likely-than-not to be sustained upon examination, the tax benefit recognized is the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The development of reserves for income tax positions requires consideration of timing and judgments about tax issues and potential outcomes, and is a subjective critical estimate. In certain circumstances, the ultimate outcome of exposures and risks involves significant uncertainties. If actual outcomes differ materially from these estimates, they could have a material impact on our results of operations and financial condition. As discussed in “Notes to Consolidated Financial Statements – Note 1(h) Income Taxes and Note 9 Income Taxes,” on August 1, 2007 we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”).
Provisions for Excess and Obsolete Inventory. We record a provision for excess and obsolete inventory based on historical and future usage trends. Other factors may also influence our provision, including decisions to exit a product line, technological change and new product development. These factors could result in a change in the amount of excess and obsolete inventory on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if we determine that our inventory was overvalued, we would be required to recognize such costs in our financial statements at the time of such determination. Any such charges could be material to our results of operations and financial condition.
Allowance for Doubtful Accounts. We perform credit evaluations of our customers and adjust credit limits based upon customer payment history and current creditworthiness, as determined by our review of our customers’ current credit information. Generally, we will require cash in advance or payment secured by irrevocable letters of credit before an order is accepted from an international customer that we do not do business with regularly. In addition, we seek to obtain insurance for certain international customers. We monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the allowances established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and the financial health of specific customers. Changes to the estimated allowance for doubtful accounts could be material to our results of operations and financial condition.
The following table sets forth, for the periods indicated, certain income and expense items expressed as a percentage of our consolidated net sales:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | Net sales | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | Gross margin | | | 44.2 | | | | 43.4 | | | | 40.7 | | | Selling, general and administrative expenses | | | 16.2 | | | | 16.4 | | | | 17.1 | | | Research and development expenses | | | 7.6 | | | | 7.3 | | | | 6.6 | | | Amortization of intangibles | | | 0.3 | | | | 0.6 | | | | 0.6 | | | Operating income | | | 20.1 | | | | 19.1 | | | | 16.3 | | | Interest expense (income), net | | | (2.1 | ) | | | (2.5 | ) | | | (1.7 | ) | | Income before provision for income taxes | | | 22.2 | | | | 21.6 | | | | 18.0 | | | Net income | | | 14.4 | | | | 14.6 | | | | 11.6 | |
We expect that fiscal 2009 will be another record year of net sales and net income. We believe we will continue to successfully execute our business strategies, that we will continue to experience organic growth in our existing businesses and that we will generate incremental net sales and net income as a result of the Radyne acquisition. Our outlook by business segment is noted below:
| · | Telecommunications transmission segment - We expect that annual net sales in our telecommunications transmission segment will increase in fiscal 2009. Our acquisition of Radyne has further strengthened our leadership position in our satellite earth station product line and we expect annual sales of our satellite earth station products to increase as we believe we will benefit from ongoing strong demand for our bandwidth efficient satellite earth station modems, including those used to support cellular backhaul applications. Annual sales of over-the-horizon microwave systems are also expected to increase. We continue to be involved in lengthy negotiations and discussions related to a number of large over-the-horizon microwave system opportunities, and, although it is extremely difficult to predict the timing of any potential contract award, we believe that we will be able to renew these leases or find comparable facilities elsewhere.ITEM 3. LEGAL PROCEEDINGS
We are subject to certain legal actions, which arise in the normal course of business. Although the ultimate outcome of litigation is difficult to accurately predict, we believe that the outcome of these actions will not have a material effect on our consolidated financial position or results of operations.
During fiscal 2005, two of our leased facilities located in Florida experienced hurricane damage to both leasehold improvements and personal property. As of July 31, 2006, we have completed all restoration efforts relating to the hurricane damage and have recorded an $0.8 million insurance recovery receivable and accrued a total of $2.2 million for hurricane related costs. Despite a written agreement with the general contractor that we believe limits our liability for the cost of the repairs to the amount of insurance proceeds ultimately received from our insurance company, a dispute has arisen with the general contractor and a certain subcontractor over the subcontractor’s demand for payment directly from us (by virtue of a purported assignment of rights and other grounds) in an amount exceeding the insurance proceeds by $0.8 million, plus late charges, interest, fees, costs and certain treble damages. As a result of this dispute, we deposited approximately $1.4 million, representing the balance of the insurance proceeds received, in our attorneys’ trust account and filed a complaint for declaratory judgment in the 9th Judicial Circuit Court for Orange County, Florida. The general contractor and the subcontractor have filed separate and independent actions against us and our insurance company, all of which have now been consolidated under our original action. The Court has scheduled December 1, 2006 as the discovery cutoff and trial for February 13, 2007; however, these dates are subject to change as the litigation progresses. We do not expect that the outcome of this matter will have a material effect on our consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to our stockholders during the fourth quarter of the fiscal year ended July 31, 2006.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the NASDAQ Stock Market LLC (“NASDAQ”) under the symbol “CMTL.” The following table shows the quarterly range of the high and low sale prices for our common stock as reported by the NASDAQ, as adjusted to reflect the three-for-two stock split effected in April 2005. Such prices do not include retail markups, markdowns or commissions.
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| | | | | Fiscal Year Ended July 31, 2005 | | | | | | | | | | | | First Quarter | | | $ | 19.71 | | $ | 10.85 | | | | | Second Quarter | | | | 25.63 | | | 17.87 | | | | | Third Quarter | | | | 36.65 | | | 22.07 | | | | | Fourth Quarter | | | | 39.70 | | | 31.80 | | | | | | | | | | Fiscal Year Ended July 31, 2006 | | | | | First Quarter | | | | 43.36 | | | 30.60 | | | | | Second Quarter | | | | 45.65 | | | 29.42 | | | | | Third Quarter | | | | 33.44 | | | 27.40 | | | | | Fourth Quarter | | | | 33.80 | | | 25.67 | | |
Dividends
We have never paid cash dividends on our common stock and we intend to continue this policy for the foreseeable future. We expect to use earnings to finance the development and expansion of our businesses. Our Board of Directors reviews our dividend policy periodically. The payment of dividends in the future will depend upon our earnings, capital requirements, financial condition and other factors considered relevant by our Board of Directors.
Recent Sales of Unregistered Securities
We sold 47,370 shares of our common stock to holders of warrants who exercised purchase rights during fiscal 2004. These warrants for the purchase of shares of our common stock were issued in connection with our acquisition of Mobile Datacom Corporation in September 1998 and were issued with an exercise price of $2.92 per share.
On January 27, 2004, we issued $105.0 million of 2.0% convertible senior notes in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. During certain periods, the notes are convertible into shares of our common stock at an initial conversion price of $31.50 per share (a conversion rate of 31.7460 shares per $1,000 original principal amount of notes), subject to adjustment in certain circumstances. The notes may be converted if, during a conversion period on each of at least 20 trading days, the closing sale price of our common stock exceeds 120% of the conversion price in effect. Upon conversion of the notes, in lieu of delivering common stock, we may, in our discretion, deliver cash or a combination of cash and common stock. We may, at our option, redeem some or all of the notes on or after February 4, 2009. Holders of the notes will have the right to require us to repurchase some or all of the outstanding notes on February 1, 2011, February 1, 2014 and February 1, 2019 and upon certain events, including a change in control. If not redeemed by us or repaid pursuant to the holders’ right to require repurchase, the notes mature on February 1, 2024.
The 2.0% interest is payable in cash, semi-annually, through February 1, 2011. After such date, the 2.0% interest will be accreted into the principal amount of the notes. Also, commencing with the six-month period beginning February 1, 2009, if the average note price for the applicable trading period equals 120% or more of the accreted principal amount of such notes, we will pay contingent interest at an annual rate of 0.25%.
The notes are general unsecured obligations of Comtech Telecommunications Corp. (the “Parent”), ranking equally in right of payment with all of its other existing and future unsecured senior indebtedness and senior in right of payment to any of its future subordinated indebtedness. All of the Parent’s wholly-owned subsidiaries have issued full and unconditional guarantees in favor of the holders of Comtech’s 2.0% convertible senior notes (the “Guarantor Subsidiaries”), except for the subsidiary that purchased Memotec, Inc. in fiscal 2004 (the “Non-Guarantor Subsidiary”). Tolt, which was purchased in February 2005, became a guarantor in July 2005. These full and unconditional guarantees are joint and several. Other than supporting the operations of its subsidiaries, the Parent has no independent assets or operations and there are currently no significant restrictions on its ability, or the ability of the guarantors, to obtain funds from each other by dividend or loan. Consolidating financial information regarding the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiary can be found in Note 17 to the consolidated financial statements beginning on page F-29.
The net proceeds of the offering are being used for working capital and general corporate purposes and potentially may be used for future acquisitions of businesses or technologies or repurchases of our common stock. We filed a registration statement with the SEC, which became effective in April 2004, for the resale of the notes and the shares of common stock issuable upon conversion of the notes.
Issuer Purchases of Equity Securities
We did not repurchase any of our equity securities during fiscal 2006.
Approximate Number of Equity Security Holders
As of September 15, 2006, there were approximately 788 holders of our common stock. Such number of record owners was determined from our shareholder records and does not include beneficial owners of our common stock held in the name of various security holders, dealers and clearing agencies.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table shows selected historical consolidated financial data for our Company. During the fiscal quarter ended January 31, 2005, the Company adopted Emerging Issues Task Force (“EITF”) Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share.” The Company has restated, for comparative purposes, the historical share and per share data, including earnings per share (“EPS”), to reflect the impact of the assumed conversion of the Company’s 2.0% convertible senior notes in calculating diluted EPS. No restatement of EPS for periods prior to fiscal 2004 was required since the convertible senior notes were not outstanding during these periods. In addition, effective August 1, 2005, we adopted the provisions of SFAS No. 123(R), “Share-Based Payment” using the modified prospective method and, as a result, periods prior to August 1, 2005 do not reflect the recognition of stock-based compensation expense.
All share and per share amounts have also been adjusted to reflect the three-for-two stock splits of the Company’s common shares that occurred in April 2005 and July 2003. Detailed historical financial information is included in the audited consolidated financial statements for fiscal 2006, 2005 and 2004.
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Operations Data: | | | | | | | | | | | | | | | | | | Net sales | | $ | 391,511 | | | 307,890 | | | 223,390 | | | 174,035 | | | 119,357 | | | Cost of sales | | | 232,210 | | | 180,524 | | | 135,858 | | | 114,317 | | | 78,780 | | | | |
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| | | Gross profit | | | 159,301 | | | 127,366 | | | 87,532 | | | 59,718 | | | 40,577 | | | | |
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| | | | | | | | | | | | | | | | | | | | | Expenses: | | | | | | | | | | | | | | | | | | Selling, general and administrative | | | 67,071 | | | 51,819 | | | 36,016 | | | 28,045 | | | 22,512 | | | Research and development | | | 25,834 | | | 21,155 | | | 15,907 | | | 12,828 | | | 11,041 | | | In-process research and development | | | — | | | — | | | 940 | | | — | | | 2,192 | | | | | | | | | Amortization of intangibles | | | 2,465 | | | 2,328 | | | 2,067 | | | 2,039 | | | 1,471 | | | | | | | | | | |
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| | | | | | 95,370 | | | 75,302 | | | 54,930 | | | 42,912 | | | 37,216 | | | | |
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| | | | | | | | | | | | | | | | | | | | | Operating income | | | 63,931 | | | 52,064 | | | 32,602 | | | 16,806 | | | 3,361 | | | | | | | | | | | | | | | | | | | | | Other expenses (income): | | | | | | | | | | | | | | | | | | Interest expense | | | 2,687 | | | 2,679 | | | 1,425 | | | 2,803 | | | 3,061 | | | Interest income | | | (9,243 | ) | | (4,072 | ) | | (921 | ) | | (275 | ) | | (452 | ) | | | | | | | | Other income, net | | | — | | | — | | | — | | | — | | | (28 | ) | | | |
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income taxes | | | 70,487 | | | 53,457 | | | 32,098 | | | 14,278 | | | 780 | | | | | | | | | | | Provision (benefit) for income taxes | | | 25,218 | | | 16,802 | | | 10,271 | | | 4,569 | | | (368 | ) | | | | | | | | | |
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| | | Net income | | $ | 45,269 | | | 36,655 | | | 21,827 | | | 9,709 | | | 1,148 | | | | |
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| | | Net income per share: | | | | | | | | | Basic | | $ | 1.99 | | | 1.69 | | | 1.03 | | | 0.57 | | | 0.07 | | | | | | | | | | |
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| | | Diluted | | $ | 1.72 | | | 1.42 | | | 0.92 | | | 0.53 | | | 0.07 | | | | | | | | | | |
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shares outstanding - basic | | | 22,753 | | | 21,673 | | | 21,178 | | | 17,168 | | | 16,788 | | | | | | | | | | |
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and common equivalent shares
outstanding assuming dilution —
diluted | | | 27,324 | | | 27,064 | | | 24,781 | | | 18,290 | | | 17,562 | | | | |
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| | | Other Consolidated Operating Data: | | | | | | | | | | | | | | | | | | Backlog at period-end | | $ | 186,007 | | | 153,314 | | | 83,549 | | | 100,142 | | | 44,121 | | | New orders | | | 424,204 | | | 377,655 | | | 206,797 | | | 230,056 | | | 113,384 | | Research and development expenditures
- internal and customer funded | | | 30,243 | | | 24,156 | | | 21,656 | | | 16,504 | | | 13,070 | |
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| | | Consolidated Balance Sheet Data: | | | | | | | | | | | | | | | | | | Total assets | | $ | 455,266 | | | 382,403 | | | 306,390 | | | 164,250 | | | 126,586 | | | Working capital | | | 308,986 | | | 254,690 | | | 201,218 | | | 74,801 | | | 51,577 | | | Long-term debt | | | — | | | — | | | — | | | — | | | 28,683 | | | Convertible senior notes | | | 105,000 | | | 105,000 | | | 105,000 | | | — | | | — | | | Other long-term obligations | | | 243 | | | 396 | | | 158 | | | 393 | | | 1,294 | | | Stockholders’ equity | | | 254,242 | | | 196,629 | | | 142,398 | | | 117,568 | | | 67,288 | |
| ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We design, develop, produce and market innovative products, systems and services for advanced communications solutions. We believe many of our solutions play a vital role in providing or enhancing communication capabilities when terrestrial communications infrastructure is unavailable or ineffective.
We conduct our business through three complementary segments: telecommunications transmission, mobile data communications and RF microwave amplifiers. We sell our products to a diverse customer base in the global commercial and government communications markets. We believe we are a leader in the market segments that we serve.
Our telecommunications transmission segment, which is currently our largest business segment, provides sophisticated equipment and systems that are used to enhance satellite transmission efficiency and that enable wireless communications in environments where terrestrial communications are unavailable, inefficient or too expensive. Our mobile data communications segment, currently our fastest growing segment, provides customers with an integrated solution including mobile satellite transceivers and satellite network support to enable global satellite-based communications when mobile, real-time, secure transmission is required for applications including logistics, support and battlefield command and control applications. Our RF microwave amplifiers segment designs, manufactures and markets solid-state, high-power, broadband RF microwave amplifier products.
A substantial portion of our sales may be derived from a limited number of relatively large customer contracts, the timing of revenues from which cannot be predicted. Quarterly and period-to-period sales and operating results may be significantly affected byawarded one or more of such contracts. In addition, our gross profit is affected by a variety of factors, including the mix of products, systems and services sold, production efficiencies, estimates of warranty expense, price competition and general economic conditions. Our gross profit may also be affected by the impact of any cumulative adjustments to contracts that are accounted for under the percentage-of-completion method. Accordingly, we can experience significant fluctuations in sales and operating results from quarter-to-quarter and period-to-period comparisons may not be indicative of future performance.
Revenue from the sale of our products is generally recognized when the earnings process is complete, upon shipment or customer acceptance. Revenue from contracts relating to the design, development or manufacturing of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts is recognized using the percentage-of-completion method. Revenue from contracts that contain multiple elements that are not accounted for under the percentage-of-completion method are accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple
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Deliverables.” Revenue from these contracts is allocated to each respective element based on each element’s relative fair value and is recognized when the respective revenue recognition criteria for each element are met. | | Our contract with the United States (“U.S.”) Army for the Movement Tracking System (“MTS”) is for an eight-year period ending in July 2007 and revenue recognition is based on the percentage-of-completion method. The gross margin is based on the estimated sales 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. Through the end of ouropportunities during fiscal quarter ended October 31, 2004, we recognized revenue on the portion of such orders that relate to prepaid service time when the time was used by the customer. As a result of changes to the manner in which our technology is being deployed and used, commencing November 1, 2004, we are recognizing service time revenue based on a network availability method which recognizes prepaid service time on a straight-line basis from the date of shipment through the end of the contract term in July 2007. | | Recent Acquisitions
In May 2004, we acquired certain assets and assumed certain liabilities of Memotec, Inc. (“Memotec”), a subsidiary of Kontron AG, and at the same time, purchased related inventory owned by Kontron Canada Inc., for an aggregate purchase price of approximately $5.2 million in cash. Commencing in May 2004, Memotec’s results of operations have been included in our telecommunications transmission segment.
| | In February 2005, we acquired certain assets and assumed certain liabilities of Tolt Technologies, Inc. (“Tolt”) for an aggregate purchase price of $3.7 million, including transaction costs of $0.2 million. In fiscal 2006, we significantly de-emphasized stand-alone sales of Tolt’s turnkey employee mobility solutions, and are focusing our efforts on selling commercial satellite-based mobile data applications. This operation is part of our mobile data communications segment. | | In August 2006, we acquired certain assets and assumed certain liabilities of Insite Consulting, Inc. (“Insite”), a logistics application software company, for $2.7 million, plus certain earn-out payments based on the achievement of future sales targets. The first part of the earn-out cannot exceed $1.4 million and is limited to a five-year period. The second part of the earn-out, which is for a ten-year period, is unlimited and based on a per unit future sales target primarily relating to new commercial satellite-based mobile data communications markets. Insite has developed the geoOps™ Enterprise Location Monitoring System, a software-based solution that allows customers to integrate legacy data systems with near-real time logistics and operational data systems. This operation was combined with our existing business and is part of our mobile data communications segment. | | Critical Accounting Policies
We consider certain accounting policies to be critical due to the estimation process involved in each.
| | Revenue Recognition on Long-Term Contracts. Revenues and related costs from long-term contracts relating to the design, development or manufacturing of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts are recognized using the percentage-of-completion method. Revenue is recognized based on the relationship of total costs incurred to total projected costs, or, alternatively, based on output measures, such as units delivered. Profits expected to be realized on such contracts are based on total estimated sales for the contract compared to total estimated costs, including warranty 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. The impact of any such adjustments discussed in“Management’s Discussion and Analysis of Financial Condition and Results of Operations” represents the cumulative impact of the adjustment on the relevant financial statement amount as of the beginning of the period being discussed. Estimated losses on long-term contracts are recorded in the period in which the losses become evident.
| | Some of our largest contracts, including our MTS contract with the U.S. Army, are accounted for using the percentage-of-completion method. We have been engaged in the production and delivery of goods and services on a continual basis under contractual arrangements for many years. Historically, we have demonstrated an ability to accurately estimate revenues and expenses relating to our long-term contracts. However, there exist inherent risks and uncertainties in estimating revenues, expenses and progress toward completion, particularly on larger or longer-term contracts. If we do not accurately estimate the total sales, related costs and progress towards completion on such contracts, the estimated gross margins may be significantly impacted or losses may need to be recognized in future periods. Any such resulting changes in margins or contract losses could be material to our results of operations and financial position. |
In addition, most government contracts have termination for convenience clauses that provide the customer with the right to terminate the contract at any time. Such terminations could impact the assumptions regarding total contract revenues and expenses utilized in recognizing profit under the percentage-of-completion method of accounting. Changes to these assumptions could materially impact our results of operations and financial position. Historically, we have not experienced material terminations of our long-term contracts. | | We also address customer acceptance provisions in assessing our ability to perform our contractual obligations under long-term contracts. Our inability to perform on our long-term contracts could materially impact our results of operations and financial position. Historically, we have been able to perform on our long-term contracts. | | Accounting for Stock-Based Compensation. As discussed further in“Notes to Consolidated Financial Statements – Note 1(j) Accounting for Stock-Based Compensation,” we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R) on August 1, 2005 using the modified prospective method. Through July 31, 2005, we accounted for our stock option and employee stock purchase plans under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, and as a result no compensation costs had been recognized in our historical consolidated statements of operations.
| | We have used and expect to continue to use the Black-Scholes option pricing model to compute the estimated fair value of stock-based awards. The Black-Scholes option pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. The assumptions used in computing the fair value of stock-based awards reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. We estimate expected volatility by considering the historical volatility of our stock, the implied volatility of publicly traded stock options in our stock and our expectations of volatility for the expected term of stock-based compensation awards. As a result, if other assumptions or estimates had been used for options granted in 2006 and in prior periods, the stock-based compensation expense that was recorded for fiscal 2006 could have been materially different. Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially impacted in the future. | | Impairment of Goodwill and Other Intangible Assets. As of July 31, 2006, our company’s goodwill and other intangible assets aggregated $29.1 million. In assessing the recoverability of goodwill and other intangibles, we 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, we may be required to record impairment charges for these assets in future periods. Any such resulting impairment charges could be material to our results of operations.
| | Provision for Warranty Obligations. We provide warranty coverage for most of our products, including products under long-term contracts, for a period of at least one year from the date of shipment. We record a liability for estimated warranty expense based on historical claims, product failure rates and other factors. There exist inherent risks and uncertainties in estimating warranty expenses, particularly on larger or longer-term contracts. As such, if we do not accurately estimate our warranty costs, any changes to our original estimates could be material to our results of operations and financial position.
Accounting for Income Taxes.Our deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. The provision for income taxes is based on domestic and international statutory income tax rates in the tax jurisdictions where we operate, permanent differences between financial reporting and tax reporting and available credits and incentives. Significant judgment is required in determining income tax provisions and tax positions. We may be challenged upon review by the applicable taxing authority and positions taken by us may not be sustained. We provide tax reserves for tax exposures relating to periods subject to audit. The development of reserves for these exposures requires consideration of timing and judgments about tax issues and potential outcomes, and is a subjective critical estimate. In certain circumstances, the ultimate outcome of exposures and risks involves significant uncertainties. If actual outcomes differ materially from these estimates, they could have a material impact on our results of operations and our financial position.
| | Provisions for Excess and Obsolete Inventory.We record a provision for excess and obsolete inventory based on historical and future usage trends. Several factors may influence the sale and use of our inventories, including decisions to exit a product line, technological change and new product development. These factors could result in a change in the amount of excess and obsolete inventory on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for
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excess and obsolete inventory. In the future, if we determine that our inventory was overvalued, we would be required to recognize such costs in our financial statements at the time of such determination. Any such charges could be material to our results of operations and financial position.
Allowance for Doubtful Accounts.We perform credit evaluations of our customers and adjust credit limits based upon customer payment history and current creditworthiness, as determined by our review of our customers’ current credit information. Generally, we will require cash in advance or payment secured by irrevocable letters of credit before an order is accepted from an international customer that we do not do business with regularly. In addition, we seek to obtain insurance for certain international customers. We monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the allowances established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and the financial health of specific customers. Changes to the estimated allowance for doubtful accounts could be material to our results of operations and financial position.
Results of Operations
The following table sets forth, for the periods indicated, certain income and expense items expressed as a percentage of our consolidated net sales:
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| 2006 | | 2005 | | 2004 | |
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| | | Net sales | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | Gross margin | | | 40.7 | | | | 41.4 | | | | 39.2 | | | | Selling, general and administrative expenses | | | 17.1 | | | | 16.8 | | | | 16.1 | | | | Research and development expenses | | | 6.6 | | | | 6.9 | | | | 7.1 | | | | In-process research and development | | | — | | | | — | | | | 0.4 | | | | Amortization of intangibles | | | 0.6 | | | | 0.8 | | | | 0.9 | | | | Operating income | | | 16.3 | | | | 16.9 | | | | 14.6 | | | | Interest expense (income), net | | | (1.7 | ) | | | (0.5 | ) | | | 0.2 | | | | Income before provision for income taxes | | | 18.0 | | | | 17.4 | | | | 14.4 | | | | Net income | | | 11.6 | | | | 11.9 | | | | 9.8 | | |
| Comparison of Fiscal 2006 and 2005
Net Sales. Consolidated net sales were $391.5 million and $307.9 million for fiscal 2006 and 2005, respectively, representing an increase of $83.6 million, or 27.2%. The increase in net sales was driven by an increase in our telecommunications transmission and our mobile data communications segments, partially offset by lower net sales in our RF microwave amplifiers segment.
Net sales2009. Sales in our telecommunications transmission segment were $197.9 million and $174.5 million for fiscal 2006 and 2005, respectively, an increasecan fluctuate dramatically from period-to-period due to many factors including the strength of $23.4 million, or 13.4%. The growth in this segment resulted primarily from an increase in demand for our satellite earth station productsproduct line bookings and salesthe timing and related to a contract with a third-party commercial customer to outsource its manufacturing. Fiscal 2005 also includes a $4.0 million cumulative adjustment to net sales which resultedreceipt of and performance on, large contracts from lower than anticipated costs on two largethe U.S. government and international customers for our over-the-horizon microwave system contracts. In late fiscal 2006, we announced
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· | Mobile data communications segment –We expect that the U.S. Department of Defense (“DoD”) awarded us a $28.3 million contract to purchase our 16 Mbps troposcatter modem upgrade kits for use on the AN/TRC-170 digital troposcatter. Sales related to this U.S. government program in fiscal 2007 are expected to offset any reduction in sales, both direct and indirect, to a North African country. We believe that sales, both direct and indirect, to this North African country, could be lower in fiscal 2007 as we believe our North African end customer is in between major phases of a large program. Sales in the over-the-horizon microwave systems product line can fluctuate dramatically from period to period based on the receipt of large contracts and our performance thereon. Our telecommunications transmission segment represented 50.5% of consolidatedannual net sales for fiscal 2006 as compared to 56.7% for fiscal 2005. |
Net sales in our mobile data communications segment were $149.5 million and $86.1 million for fiscal 2006 and 2005, respectively, an increase of $63.4 million, or 73.6%. Thewill increase in net sales wasfiscal 2009, primarily due to (i) higher sales onincreased demand for MTS product and services. Through July 31, 2008, we have received $133.6 million in new orders under the MTS contract including $9.5and have now supplied over 20,000 transceivers to the MTS program. There is approximately $184.0 million of sales relatingpotential MTS funding available from the Global War on Terrorism (“GWOT”) funding supplement and $9.0 million from the government’s fiscal 2008 base budget. In addition, there is $142.0 million of potential MTS funding available for the government’s fiscal 2009 budget (including GWOT). Although we do not expect to receive the full amount of the remaining potential MTS funding available in fiscal 2009, we expect orders and related revenue in fiscal 2009 to increase as compared to the gross profit adjustment discussed belowamount we received in fiscal 2008. We also believe that demand for our BFT products and services will remain strong. Through July 31, 2008, we have received $134.8 million in new orders under“Gross Profit,” (ii) higher sales of battlefield command the BFT contract and control applicationshave now supplied over 60,000 transceivers to the U.S. military,BFT program. We continue to be focused on maintaining and (iii)expanding our role in both the MTS and BFT programs by upgrading and enhancing the performance of our satellite network and transceivers. In addition, as a result of the Radyne acquisition, of Tolt in February 2005 which contributed $18.7 million of net sales for fiscal 2006 comparedwe expect to $11.3 million of net sales for fiscal 2005. In the second half of fiscal 2006, we significantly de-emphasized stand-alone sales of Tolt’s low margin turnkey employee mobility solutions to further focus its sales efforts on commercial satellite-based mobile data applications. Stand-alone sales of these low margin turnkey employee mobility solutions during fiscal 2006 were approximately $15.0 million and such salesgenerate incremental revenue in fiscal 2007 are expected to be nominal. Net sales for fiscal 2005 were positively impacted by a favorable cumulative adjustment associated with the change2009 from the usage method to the straight-line methoddesign and manufacture of accounting for MTS prepaid service time revenue, which contributed $3.8 million to net sales. Period-to-period salesmicrosatellites and from mobile tracking products that incorporate SENS technology. Sales and profitability in our mobile data communications segment can fluctuate dramatically from period-to-period due to many factors including unpredictable funding, fluctuations. In fiscal 2006, we began to receive orders under our MTS contract fordeployment and technology decisions by the Army National Guard’s acquisition of MTS equipment, including our MT 2012 transceiver and related services. If we receive additional significant ordersU.S. government as well as risks from the Army National Guard and if we continue to experience strong demand from the U.S. Army, we expectuncertainty of prevailing political conditions.
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| · | RF microwave amplifiers segment - We believe that sales in this segment will increase in fiscal 2007. The MTS contract is not subject to automatic renewal or extension upon its scheduled expiration in July 2007. If the MTS contract is not renewed, extended or if we fail to succeed in a recompete process, it would have a material adverse impact on our business and results of operations. Our mobile data communications segment represented 38.2% of consolidatedannual net sales for fiscal 2006 as compared to 27.9% for fiscal 2005.Net sales in our RF microwave amplifiers segment were $44.1 million for fiscal 2006 compared to $47.3 million for fiscal 2005,will increase. As a decrease of $3.2 million, or 6.8%. The decrease in net sales was due primarily to lower salesresult of our amplifiers that are incorporated into improvised explosive device jamming systems, partially offset by increased demand for other defense-related products in this segment. Ouracquisition of Radyne, we more than doubled the size of our RF microwave amplifiers segment represented 11.3%and immediately positioned ourselves, not only as a leader in the solid-state amplifier market, but as a leader in the satellite earth station traveling wave tube amplifier market and expanded our RF microwave amplifier segment’s product portfolio to include klystron tube power amplifiers. These products are used on U.S. government satellite programs including the Family of consolidated net sales for fiscal 2006 as comparedAdvanced Beyond-Line-of-Sight Terminal and the Wideband Global Satellite Communications programs. Sales of our solid-state high-power broadband amplifiers are expected to 15.4% for fiscal 2005.
International sales (which include sales to U.S. companies for inclusion in products which are sold to international customers) represented 35.6% and 44.0% of consolidated net sales for fiscal 2006 and 2005, respectively. Domestic commercial sales represented 17.1% and 13.9% of consolidated net sales for fiscal 2006 and 2005, respectively. Salesbe comparable to the U.S. government (includinglevels experienced in fiscal 2008. Although we currently expect sales of amplifiers that are used on the Crew 2.1 program to prime contractors to the U.S. government) represented 47.3% and 42.1% of consolidated net sales for fiscal 2006 and 2005, respectively.
One customer, a prime contractor, represented 10.2% of consolidated net sales in both fiscal 2006 and 2005. Direct and indirect sales to a North African country, including certain sales to the prime contractor mentioned above, represented 9.7% and 13.2% of consolidated net sales for fiscal 2006 and 2005, respectively.
Gross Profit. Gross profit was $159.3 million and $127.4 million for fiscal 2006 and 2005, respectively, representing an increase of $31.9 million, or 25.0%. Our gross profit percentage was 40.7% for fiscal 2006 as compared to 41.4% for fiscal 2005.
Excluding the impact of adjustments to both net sales and gross profit in both periods, as discussed below, our gross profit as a percentage of net sales for fiscal 2006 and 2005 would have been 39.8% and 40.5%, respectively. This decrease was primarily due to a higher proportion of our consolidated net sales being in the mobile data communications segment, which typically realizes lower gross margins than sales in our other two segments. In addition, fiscal 2006 includes higher sales relating to Tolt’s turnkey employee mobility solutions, which have lower gross margins than any of our other product lines. The decline in gross margin percentage due to the change in product mix was partially offset by continued increased operating efficiencies associated with increased usage of our high-volume technology manufacturing facility during fiscal 2006.
During fiscal 2006, we recorded favorable cumulative gross profit adjustments of $9.1 million (of which $8.5 million relates to the mobile data communications segment and $0.6 million relates to the RF microwave amplifiers segment). The adjustment in our mobile data communications segment was primarily the result of increased MTS funding from the U.S. Army, as well as improved operating efficiencies. The adjustmentlevels achieved in fiscal 2008, we believe we will experience increased sales of solid-state, high-power, broadband amplifiers used for other defense-related and satellite applications. Sales in our RF microwave amplifiers segment relatedcan fluctuate dramatically from period-to-period due to a military contract that was substantially completed in fiscal 2006. These favorable adjustments were partially offset by a $1.7 million warranty provision in our mobile data communications segment relating to certainmany factors including the receipt of our firmware that needs to be modified. During fiscal 2005, we recorded cumulative adjustments related to twoand performance on, large over-the-horizon microwave system contracts and the MTS contract with an aggregate impact of $5.8 million on gross profit (of which $2.2 million relates to the mobile data communications segment and $3.6 million relates to the telecommunications transmission segment).
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In our mobile data communications segment, we continue to rollout our next generation satellite transceiver, known as the MT 2012, and enhance our network and related software to provide increased speed and performance. We continue to work closely with our customers and currently expect to continue these initiatives through fiscal 2007. If the current funding levels of MTS and battlefield command and control applications are maintained or increased, or if and when we receive additional orders from the Army National Guard, we may experience additional increased operating efficiencies in fiscal 2007. Unrelated to the next generation MTS technology upgrade, we are also continuing to upgrade certain of our firmware that needs to be modified. The ultimate amount of warranty expense could differ from our initial estimate and we may incur additional unanticipated costs or delays.
Included in cost of sales for fiscal 2006 and 2005 are provisions for excess and obsolete inventory of $2.0 million and $2.1 million, respectively. As discussed under“Critical Accounting Policies – Provisions for Excess and Obsolete Inventory,” we regularly review our inventory and record a provision for excess and obsolete inventory based on historical and projected usage assumptions.
| | Selling, General and Administrative Expenses.Selling, general and administrative expenses were $67.1 million and $51.8 million for fiscal 2006 and 2005, respectively, representing an increase of $15.3 million, or 29.5%. The increase in expenses was primarily attributable to (i) the increased level of net sales and activity in our telecommunications transmission and mobile data communications segments, (ii) the recording of $4.6 million of stock-based compensation expense during fiscal 2006, and (iii) a full year of expenses associated with Tolt, which was acquired in February 2005. There was no stock-based compensation expense included in selling, general and administrative expenses in fiscal 2005. As a percentage of consolidated net sales, selling, general and administrative expenses were 17.1% and 16.8% for fiscal 2006 and 2005, respectively.
Research and Development Expenses.Research and development expenses were $25.8 million and $21.2 million for fiscal 2006 and 2005, respectively, representing an increase of $4.6 million, or 21.7%. Approximately $19.0 million and $17.7 million of such amounts, respectively, related to our telecommunications transmission segment, with the remaining expenses primarily related to our mobile data communications segment and, to a lesser extent, our RF microwave amplifiers segment. In addition, during fiscal 2006, we recorded $0.7 million of stock-based compensation expense in research and development expenses. There was no stock-based compensation expense included in research and development expenses in fiscal 2005. As an investment for the future, we are continually 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 fiscal 2006 and 2005, customers reimbursed us $4.4 million and $3.0 million, respectively, which is not reflected in the reported research and development expenses, but is included in net sales with the related costs included in cost of sales.
| | Amortization of Intangibles.Amortization of intangibles for fiscal 2006 and 2005 was $2.5 million and $2.3 million, respectively. The amortization primarily relates to intangibles with finite lives that we acquired in connection with various acquisitions.
Operating Income. Operating income for fiscal 2006 and 2005 was $63.9 million and $52.1 million, respectively. The $11.8 million, or 22.6% increase, was the result of the higher sales and gross profit, discussed above, partially offset by higher operating expenses.
Operating income in our telecommunications transmission segment increased to $49.8 million for fiscal 2006 from $40.2 million for fiscal 2005, as a result of increased net sales and gross profit, partially offset by increased operating expenses. In addition, fiscal 2005 included a $3.1 million positive impact on operating income from the cumulative gross margin adjustments discussed above under “Gross Profit” related to two large over-the-horizon microwave system contracts.
| | Our mobile data communications segment generated operating income of $21.7 million for fiscal 2006 compared to $11.9 million for fiscal 2005 due primarily to the significant increase in net sales and gross profit, partially offset by increased operating expenses, including increased research and development expenses. The operations relating to Tolt, which incurred an operating loss of $5.0 million in fiscal 2006, have been combined into our network operations center facility. In fiscal 2007, although we expect to incur lower expenses relating to our commercial satellite-based mobile data applications, we do expect to increase other operating expenses, particularly research and development expenses, as we continue to position ourselves to win an extension or recompete of the MTS contract that expires in July 2007 and as we develop new technologies for other programs, such as Blue Force Tracking. In addition, fiscal 2006 and 2005 included positive impacts on operating income from the cumulative gross margin |
adjustments, net of the warranty provision in the fiscal 2006 period, discussed above under“Gross Profit”of $5.8 million and $2.0 million, respectively.
Operating income in our RF microwave amplifiers segment increased to $8.3 million for fiscal 2006 from $8.2 million for fiscal 2005. Operating income for fiscal 2006 includes a $0.5 million benefit from a positive gross margin adjustment on a contract discussed above under“Gross Profit.”
Unallocated operating expenses increased to $15.9 million for fiscal 2006 from $8.2 million for fiscal 2005 due primarily to the recording of $5.7 million of stock-based compensation expense associated with SFAS No. 123(R) and increased incentive compensation costs in connection with the significant increase in pre-tax income.
Interest Expense. Interest expense was $2.7 million for both fiscal 2006 and 2005. Interest expense primarily relates to our 2.0% convertible senior notes issued in January 2004.
Interest Income. Interest income for fiscal 2006 was $9.2 million, as compared to $4.1 million for fiscal 2005. The $5.1 million increase was due primarily to an increase in interest rates and additional investable cash, primarily provided by our operating cash flow.
Provision for Income Taxes.The provision for income taxes was $25.2 million and $16.8 million for fiscal 2006 and 2005, respectively. Our effective tax rate for fiscal 2006 was 35.8% as compared to 31.4% for fiscal 2005.
The increase in the effective tax rate was primarily attributable to (i) the increased level of pre-tax profit, (ii) the nondeductibility of stock-based compensation expense in fiscal 2006 relating to incentive stock options, (iii) the expiration, in December 2005, of the Federal research and experimentation credit, and (iv) the scheduled phase-out of the extraterritorial income exclusion which was slightly offset by the scheduled phase-in of the deduction for domestic production activities.
In fiscal 2006, we recorded a net tax benefit of $0.6 million primarily relating to the favorable settlement of a state tax matter. In fiscal 2005, we recorded a $1.1 million tax benefit related to the reduction in the valuation allowance that was established for the extended write-off period of acquired in-process research and development.
We currently expect our effective tax rate for fiscal 2007 to approximate 36.5%. If legislation to extend the Federal research and experimentation credit is not signed into law, our effective tax rate for fiscal 2007 could approximate 38.0%.
In fiscal 2006, we were informed by the Internal Revenue Service that our Federal income tax return for the fiscal year ended July 31, 2004 was selected for audit. The audit is in the early stages and additional income tax returns for other fiscal years may be examined. If the outcome of the audit differs materially from our original income tax provisions, it could have a material adverse impact on our results of operations and financial position.
Comparison of Fiscal 2005 and 2004
Net Sales. Consolidated net sales were $307.9 million and $223.4 million for fiscal 2005 and 2004, respectively, representing an increase of $84.5 million, or 37.8%. The increase in net sales was driven by increased demand for our products in all three business segments.
Net sales in our telecommunications transmission segment were $174.5 million and $141.5 million for fiscal 2005 and 2004, respectively, an increase of $33.0 million, or 23.3%. The growth in this segment resulted primarily from a significant increase in demand for our satellite earth station products and incremental sales of our over-the-horizon microwave systems. In addition, favorable cumulative gross margin adjustments, resulting from lower than anticipated costs on two large over-the-horizon microwave system contracts, contributed $4.0 million and $0.8 million in net sales for fiscal 2005 and 2004, respectively. Memotec, which we acquired in May 2004, contributed $6.3 million and $1.3 million to net sales for fiscal 2005 and 2004, respectively. Our telecommunications transmission segment represented 56.7% of consolidated net sales for fiscal 2005 as compared to 63.3% for fiscal 2004.
Net sales in our mobile data communications segment were $86.1 million and $59.8 million for fiscal 2005 and 2004, respectively, an increase of $26.3 million, or 44.0%. The increase in net sales was due, in part, to increased demand and continued deployment of our MTS system by the U.S. Army and higher sales of battlefield command and control applications to the U.S. military. Tolt, which we acquired in February 2005, contributed $11.3 million of net sales for fiscal 2005. Also, included in net sales for fiscal 2005 is a $3.8 million cumulative adjustment
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associated with the aforementioned change from the usage method to the straight-line method of accounting for MTS prepaid service time revenue. Our mobile data communications segment represented 27.9% of consolidated net sales for fiscal 2005 as compared to 26.8% for fiscal 2004.
Net sales in our RF microwave amplifiers segment were $47.3 million for fiscal 2005 compared to $22.1 million for fiscal 2004, an increase of $25.2 million, or 114.0%. The significant increase in net sales was primarily the result of increased demand for our defense-related products. In particular, we experienced a marked increase in demand for our RF microwave amplifiers that are incorporated into improvised explosive device jamming systems. Our RF microwave amplifiers segment represented 15.4% of consolidated net sales for fiscal 2005 as compared to 9.9% for fiscal 2004.
International sales (which include sales to domestic companies for inclusion in products which are sold to international customers) represented 44.0% and 45.4% of consolidated net sales for fiscal 2005 and 2004, respectively. Domestic commercial sales represented 13.9% and 14.5% of consolidated net sales for fiscal 2005 and 2004, respectively. Sales to the U.S. government (including sales to prime contractors to the U.S. government) represented 42.1% and 40.1% of consolidated net sales for fiscal 2005 and 2004, respectively.
During fiscal 2005, one customer, a prime contractor, represented 10.2% of consolidated net sales. During fiscal 2004, one customer, another prime contractor, represented 12.5% of consolidated net sales. Direct and indirect sales to a North African country, including certain sales to the prime contractors mentioned above, during fiscal 2005 and 2004 represented 13.2% and 14.1%, respectively, of consolidated net sales.
Gross Profit. Gross profit was $127.4 million and $87.5 million for fiscal 2005 and 2004, respectively, representing an increase of $39.9 million, or 45.6%. The increase in gross profit was primarily attributable to the increase in netinternational customers. In addition, sales and the gross profit percentage, which increased from 39.2% for fiscal 2004 to 41.4% for fiscal 2005. Fiscal 2005 includes favorable cumulative gross margin adjustments on two large over-the-horizon microwave system contracts and the MTS contract (including the MTS prepaid service time adjustment as discussed above), which had an aggregate impact of $5.8 million on gross profit compared to favorable cumulative gross margin adjustments during fiscal 2004 of $1.9 million. Excluding the sales and gross profit relating to prior periods from these adjustments, our gross margin percentage still improved significantlyprofitability can fluctuate due to increased operating efficiencies.
As mentioned above, in fiscal 2005, we continued to realize increased operating efficiencies. In our telecommunications transmission segment, such efficiencies were achieved, in part, by our continuing efforts to expand the usage of our high-volume manufacturing facility in Tempe, Arizona. The increased utilization and resulting operating efficiencies were the result of higher demand for our satellite earth station products, as well as the continued use of the facility by our other two segmentslonger than anticipated production times associated with contracts for certain high-volume manufacturing requirements. In addition, as part of our strategy to leverage the high-volume technology manufacturing centercomplex amplifiers and further develop a diversified customer base, we produced and currently have on-hand $1.6 million of inventory relating to a contract from a third-party commercial customer to outsource its manufacturing.
In our mobile data communications segment, operating efficiencies were the result of incremental MTS and battlefield command and control applications funding from the U.S. Army.
Our RF microwave amplifiers segment experienced increased operating efficiencies associated with significant operating leverage driven by the increase in sales and a more favorable product mix.
Included in cost of sales for fiscal 2005 and 2004 are provisions for excess and obsolete inventory of $2.1 million and $1.2 million, respectively.
Selling, General and Administrative Expenses.Selling, general and administrative expenses were $51.8 million and $36.0 million for fiscal 2005 and 2004, respectively, representing an increase of $15.8 million, or 43.9%. The increase in expenses is primarily attributable to (i) the increased level of net sales in all three of our business segments, (ii) expenses associated with the Memotec and Tolt acquisitions in May 2004 and February 2005, respectively, and (iii) costs of compliance with recent corporate governance regulations. As a percentage of consolidated net sales, selling, general and administrative expenses were 16.8% and 16.1% for fiscal 2005 and 2004, respectively.
Research and Development Expenses.Research and development expenses were $21.2 million and $15.9 million for fiscal 2005 and 2004, respectively representing an increase of $5.3 million or 33.3%. Approximately $17.7
high-power switches that employ newer technology. |
Our gross profit, as a percentage of fiscal 2009 net sales, is expected to decline from the percentage achieved in fiscal 2008, primarily due to the inclusion of sales of Radyne’s products which traditionally have been sold at gross margins below those of our existing businesses. In connection with our acquisition of Radyne, on August 1, 2008, we initiated a restructuring plan to achieve operating efficiencies by eliminating redundant functions and related expenses by closing Radyne’s Phoenix, Arizona manufacturing facility and integrating that operation into our high-volume technology manufacturing center located in Tempe, Arizona. We expect this integration to be completed during the second half of fiscal 2009. Our gross margin in fiscal 2009 will also be negatively impacted by amortization of $1.5 million related to the estimated fair value step-up of inventory acquired.
Selling, general and administrative expenses for fiscal 2009, as a percentage of net sales, are expected to be slightly lower than our historical spending pattern over the past three years, as we expect to benefit from synergies associated with the acquisition of Radyne. We are currently in the process of integrating Radyne’s corporate functions, into our Melville, New York corporate headquarters. We expect this integration to be completed by the second half of fiscal 2009.
Research and development expenses for fiscal 2009, as a percentage of net sales, are expected to be comparable to our historical spending pattern over the past three years. During fiscal 2009, we believe that we will begin to take advantage of our combined engineering and sales talents to drive further innovation in the marketplace and deliver new and advanced products to our customers in all three of our business segments. In addition, in connection with the acquisition, during the three months ended October 31, 2008 (our first quarter of fiscal 2009), and in accordance with SFAS No. 141, “Business Combinations,” we expect, based on a preliminary analysis, to record a one-time amortization charge of $6.2 million reflecting the fair value of in-process research and development acquired.
Total amortization of stock-based compensation expense (which is allocated to the cost of sales, selling, general and administrative and research and development expense line items in our consolidated statement of operations) for fiscal 2009, is expected to be similar to fiscal 2008.
Amortization of intangibles is expected to substantially increase in fiscal 2009 due to the Radyne and Verso acquisitions. We are accounting for both the acquisitions of Radyne and Verso in accordance with SFAS No. 141. As of August 1, 2008, and based on our preliminary estimates, we expect incremental amortization of approximately $6.9 million, of which $5.4 million (to be recorded as operating expenses in our consolidated statements of operations) is related to amortization of intangibles and $1.5 million (to be recorded as cost of sales in our consolidated statements of operations) is related to the estimated fair value step-up of Radyne's inventory acquired. Interest income is expected to be significantly lower due to the decline in interest rates as well as the use of cash for the Radyne acquisition. We expect to earn approximately 2.00% to 2.30% on our cash and cash equivalents in fiscal 2009. Interest expense is expected to primarily reflect interest associated with our 2.0% convertible notes. Our estimated tax rate of 35.75% for fiscal 2009 reflects the fact, among others, that the Federal research and experimentation ("R&E") credit has expired as of December 31, 2007. Our tax rate for fiscal 2008 was 35.3%. Based on the aforementioned, we believe our net income will increase from the levels achieved in fiscal 2008 and that fiscal 2009 will be another record year.
Net Sales. Consolidated net sales were $531.6 million and $445.7 million for fiscal 2008 and 2007, respectively, representing an increase of $85.9 million, or 19.3%. The increase in net sales reflects significant growth in both our mobile data communications and RF microwave amplifiers segments, partially offset by lower net sales, as anticipated, in our telecommunications transmission segment.
Net sales in our telecommunications transmission segment were $208.9 million and $219.9 million for fiscal 2008 and 2007, respectively, a decrease of $11.0 million, or 5.0%. Net sales in this segment reflect increased sales of our satellite earth station products which were more than offset by lower sales, as anticipated, of our over-the-horizon microwave systems. Sales of our satellite earth station products for fiscal 2008 were higher than fiscal 2007 as we continue to benefit from the ongoing strong demand for our bandwidth efficient satellite earth station modems, including those used to support cellular backhaul applications. Net sales of our over-the-horizon microwave systems for fiscal 2008 were significantly lower than fiscal 2007 primarily due to lower sales of our 16 Mbps troposcatter modem upgrade kits for use on the U.S. Department of Defense’s (“DoD”) AN/TRC-170 digital troposcatter terminals and lower indirect sales to our North African country end-customer. Net sales in fiscal 2007 include sales of $1.2 million relating to a gross profit adjustment, as discussed below, on a large over-the-horizon microwave system contract. Our telecommunications transmission segment represented 39.3% of consolidated net sales for fiscal 2008 as compared to 49.3% for fiscal 2007.
Sales and profitability in our telecommunications transmission segment can fluctuate from period-to-period due to many factors including the book-and-ship nature associated with our satellite earth station products and the timing of, and our related performance on, contracts from the U.S. government and international customers for our over-the-horizon microwave systems.
Net sales in our mobile data communications segment were a record $261.1 million for fiscal 2008 and $189.6 million for fiscal 2007, an increase of $71.5 million, or 37.7%. This increase in net sales was due to the significant increase in deliveries to the U.S. Army for orders placed under our new MTS and BFT contracts. Deliveries to the Army National Guard, for orders placed under the MTS contract, were significantly lower during fiscal 2008. Net sales for fiscal 2007 included sales of $1.1 million relating to a favorable gross profit adjustment on our original MTS contract. Our mobile data communications segment represented 49.1% of consolidated net sales for fiscal 2008 as compared to 42.6% for fiscal 2007.
Sales and profitability in our mobile data communications segment can fluctuate dramatically from period-to-period due to many factors, including unpredictable funding, deployment and technology decisions by the U.S. government. In addition, both our new MTS and BFT contracts are IDIQ contracts, and as such, the U.S. Army is generally not obligated to purchase any equipment or services under these contracts. In addition, we are aware, that on occasion, the U.S. government has experienced delays in the receipt of certain components that are eventually provided to us for incorporation into our mobile satellite transceivers. If we do not receive these U.S. government furnished components in a timely manner, we could experience delays in fulfilling funded and anticipated orders from our customers.
Net sales in our RF microwave amplifiers segment were a record $61.6 million for fiscal 2008, compared to $36.2 million for fiscal 2007, an increase of $25.4 million, or 70.2%. The significant increase in net sales was due to higher sales of our amplifiers and high-power switches that are incorporated into defense-related systems, primarily sales associated with our participation in the Counter Remote-Control Improvised Explosive Device Electronic Warfare 2.1 (“CREW 2.1”) program. Our RF microwave amplifiers segment represented 11.6% of consolidated net sales for fiscal 2008 as compared to 8.1% for fiscal 2007.
International sales (which include sales to U.S. companies for inclusion in products that are sold to international customers) represented 26.7% and 26.2% of consolidated net sales for fiscal 2008 and 2007, respectively. Domestic commercial sales represented 6.9% and 12.5% of consolidated net sales for fiscal 2008 and 2007, respectively. Sales to the U.S. government (including sales to prime contractors of the U.S. government) represented 66.4% and 61.3% of consolidated net sales for fiscal 2008 and 2007, respectively.
Gross Profit. Gross profit was $234.9 million and $193.3 million for fiscal 2008 and 2007, respectively, representing an increase of $41.6 million, or 21.5%. The increase in gross profit was attributable to the increase in net sales discussed above and related increased operating efficiencies. Gross profit as a percentage of net sales increased to 44.2% for fiscal 2008 from 43.4% for fiscal 2007.
Excluding the impact of adjustments discussed below, our gross profit as a percentage of net sales for fiscal 2007 would have been 41.0%. The increase in the gross profit percentage from 41.0% to 44.2% was driven by an increase in the gross profit percentage in both our mobile data communications and telecommunications transmission segments. These increases were partially offset by the impact of a higher percentage of consolidated net sales occurring within the mobile data communications segment, which typically has a lower gross profit percentage than our telecommunications transmission segment. In addition, in fiscal 2008, we experienced a lower gross profit percentage in our RF microwave amplifiers segment.
Our mobile data communications segment experienced a higher gross profit percentage due to increased operating efficiencies associated with increased sales related to our new MTS and BFT contracts and a more favorable product mix during fiscal 2008 as compared to fiscal 2007. Our telecommunications transmission segment experienced a higher gross profit percentage as it benefited from increased usage of our high-volume technology manufacturing center (including both incremental satellite earth station product sales and use by our two other operating segments) that was partially offset by lower sales of our 16 Mbps troposcatter modem upgrade kits. In addition, in fiscal 2008 our telecommunications transmission segment’s gross profit percentage was favorably impacted by a $0.7 million reduction in our estimated reserve for warranty obligations due to lower than anticipated claims received on contracts whose warranty periods have expired. Our RF microwave amplifiers segment experienced a lower gross profit percentage due to long production times associated with contracts for certain complex amplifiers and high-power switches that employ newer technology.
During fiscal 2007 we recorded favorable cumulative gross profit adjustments of $11.8 million (of which $10.7 million related to the mobile data communications segment and $1.1 million related to the telecommunications transmission segment), resulting from our ongoing review of total estimated contract revenues and costs, and the related gross margin at completion, on long-term contracts. These adjustments were partially offset by a $0.1 million firmware-related warranty provision in our mobile data communications segment.
Included in cost of sales for fiscal 2008 and 2007 are provisions for excess and obsolete inventory of $2.4 million and $4.5 million, respectively. As discussed in our “Critical Accounting Policies – Provisions for Excess and Obsolete Inventory,” we regularly review our inventory and record a provision for excess and obsolete inventory based on historical and projected usage assumptions.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $86.0 million and $73.3 million for fiscal 2008 and 2007, respectively, representing an increase of $12.7 million, or 17.3%. The increase in expenses was primarily attributable to higher payroll-related expenses (including amortization of stock-based compensation and cash-based incentive compensation) associated with the overall increase in our net sales and profits and, to a lesser extent, legal and other professional fees, including costs associated with the Brazil Subpoena and Export Matters, discussed in “Notes to Consolidated Financial Statements – Note (13) Commitments and Contingencies.” As a percentage of consolidated net sales, selling, general and administrative expenses were 16.2% and 16.4% for fiscal 2008 and 2007, respectively.
Amortization of stock-based compensation expense recorded as selling, general and administrative expenses increased to $8.1 million in fiscal 2008 from $5.8 million in fiscal 2007. Research and Development Expenses. Research and development expenses were $40.5 million and $32.5 million for fiscal 2008 and 2007, respectively, representing an increase of $8.0 million, or 24.6%. The increase in expenses primarily reflects our continued investment in research and development efforts across all of our business segments. As a percentage of consolidated net sales, research and development expenses were 7.6% and 7.3% for fiscal 2008 and 2007, respectively.
For fiscal 2008 and 2007, research and development expenses of $24.1 million and $21.0 million, respectively, related to our telecommunications transmission segment, $10.8 million and $7.9 million, respectively, related to our mobile data communications segment, $3.9 million and $2.5 million, respectively, related to our RF microwave amplifiers segment, with the remaining expenses related to the amortization of stock-based compensation expense which is not allocated to our three operating segments. Amortization of stock-based compensation expense recorded as research and development expenses increased to $1.7 million in fiscal 2008 from $1.1 million in fiscal 2007.
As an investment for the future, we are continually 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 fiscal 2008 and 2007, customers reimbursed us $7.8 million and $4.2 million, respectively, which is not reflected in the reported research and development expenses, but is included in net sales with the related costs included in cost of sales.
Amortization of Intangibles. Amortization of intangibles was $1.7 million and $2.6 million for fiscal 2008 and 2007, respectively. The amortization primarily relates to intangibles with finite lives that we acquired in connection with various acquisitions. The decrease in amortization of intangibles for fiscal 2008 is related to certain intangibles that have been fully amortized.
Operating Income. Operating income for fiscal 2008 and 2007 was $106.8 million and $84.9 million, respectively. The $21.9 million, or 25.8%, increase was primarily the result of the higher consolidated net sales and gross margin percentage during fiscal 2008, partially offset by increased operating expenses (including research and development expenses) as discussed above.
Operating income in our telecommunications transmission segment decreased to $56.7 million for fiscal 2008 from $59.2 million for fiscal 2007, primarily driven by lower net sales (at a higher gross margin percentage) and increased operating expenses (including expenses associated with the Brazil Subpoena and Export Matters). In addition, as discussed above under Gross Profit, included in operating income for fiscal 2007 is a cumulative adjustment related to a large over-the-horizon microwave systems contract which favorably impacted operating income by $0.9 million.
Our mobile data communications segment generated operating income of $72.8 million for fiscal 2008 as compared to $45.4 million for fiscal 2007. The increase in operating income was primarily due to the increase in net sales and gross margins achieved during fiscal 2008, partially offset by increased operating expenses. As discussed above under “Gross Profit,” included in operating income in fiscal 2007 is the positive impact from cumulative adjustments, net of the firmware-related warranty provision, of $9.1 million.
Operating income in our RF microwave amplifiers segment increased to $4.4 million for fiscal 2008 from $3.7 million for fiscal 2007 due primarily to the increase in net sales (at a lower gross profit percentage) partially offset by increased spending on research and development activities.
Unallocated operating expenses increased to $27.1 million for fiscal 2008 from $23.3 million for fiscal 2007 due to higher payroll-related expenses (including amortization of stock-based compensation and cash-based incentive compensation) as well as increased other costs associated with growing our business. Amortization of stock-based compensation expense increased to $10.6 million in fiscal 2008 from $7.4 million in fiscal 2007. This increase is primarily attributable to an increase in both the number and related fair value of stock-based awards that are being amortized over their respective service periods for fiscal 2008 as compared to fiscal 2007.
Interest Expense. Interest expense was $2.7 million for both fiscal 2008 and 2007. Interest expense primarily represents interest associated with our 2.0% convertible senior notes.
Interest Income and Other. Interest income and other for fiscal 2008 was $14.1 million, as compared to $14.2 million for fiscal 2007. The decrease of $0.1 million was primarily due to a decline in interest rates partially offset by an increase in investable cash since July 31, 2007. Provision for Income Taxes. The provision for income taxes was $41.7 million and $31.2 million for fiscal 2008 and 2007, respectively. Our effective tax rate was 35.3% and 32.4% for fiscal 2008 and 2007, respectively. Our effective tax rate for fiscal 2007 of 32.4% included discrete tax benefits of approximately $2.6 million (including a $1.0 million tax benefit due to the expiration of applicable statutes of limitations and a $0.6 million tax benefit relating to the retroactive extension of Federal R&E credits in December 2006). Excluding these discrete tax benefits, our effective tax rate for fiscal 2007 was approximately 35.0%. The increase from 35.0% to 35.3% in fiscal 2008 was primarily driven by the expiration of the R&E credit as of December 31, 2007.
Our tax rate for fiscal 2008 reflects an agreement we reached with the Internal Revenue Service (“IRS”) relating to its completion of the audit of our Federal income tax returns for fiscal 2004 and fiscal 2005. The agreement primarily relates to the allowable amount of R&E credits utilized and interest expense relating to our 2% convertible senior notes. The IRS has also informed us that it intends to audit our fiscal 2006 tax return with a focus on the same items it disallowed in fiscal 2004 and fiscal 2005. Our provision for income tax in fiscal 2008, reflects a net discrete tax cost of approximately $0.1 million, primarily related to the agreement with the IRS and our estimate of anticipated future disallowable R&E credits and interest expense.
Although adjustments relating to our fiscal 2004 and fiscal 2005 tax return were immaterial, a resulting tax assessment or settlement for fiscal 2006 and other periods that may be selected for future audit could have a material adverse impact on our results of operations and financial position.
Net Sales. Consolidated net sales were $445.7 million and $391.5 million for fiscal 2007 and 2006, respectively, representing an increase of $54.2 million, or 13.8%. The increase in net sales reflected growth in our telecommunications transmission and mobile data communications segments, partially offset by lower net sales in our RF microwave amplifiers segment.
Net sales in our telecommunications transmission segment were $219.9 million and $197.9 million for fiscal 2007 and 2006, respectively, an increase of $22.0 million, or 11.1%. The increase in net sales in this segment primarily reflected increased sales of our over-the-horizon microwave systems and satellite earth station products. Sales of our over-the-horizon microwave systems for fiscal 2007 were higher than fiscal 2006 due to deliveries of our 16 Mbps troposcatter modem upgrade kits for use on the U.S. Department of Defense’s (“DoD”) AN/TRC-170 digital troposcatter terminals. On the other hand, sales of our over-the-horizon microwave systems, both direct and indirect, to our North African country end-customer were lower during fiscal 2007 as we believe the end-customer is between major phases of a multi-year roll-out of a large project. Net sales in fiscal 2007 include sales of $1.2 million relating to a gross profit adjustment, as discussed below, on a large over-the-horizon microwave system contract. Sales of satellite earth station products in fiscal 2007 were higher than fiscal 2006 as we continued to benefit from demand for our bandwidth efficient satellite earth station modems, including those used to support cellular backhaul applications. Our telecommunications transmission segment represented 49.3% of consolidated net sales for fiscal 2007 as compared to 50.5% for fiscal 2006.
Net sales in our mobile data communications segment were $189.6 million and $149.5 million for fiscal 2007 and 2006, respectively, an increase of $40.1 million, or 26.8%. The increase in net sales was due to an increase in deliveries to the U.S. Army and Army National Guard for ongoing support of MTS program activities and higher sales of battlefield command and control applications to the U.S. military. This increase was partially offset by a decline in net sales of $17.3 million related to the impact of our decision, made in fiscal 2006, to significantly de-emphasize stand-alone sales of low margin turnkey employee mobility solutions. Net sales in fiscal 2007 and 2006 include sales of $1.1 million and $9.5 million, respectively, relating to gross profit adjustments on our original MTS contract, discussed below. Our mobile data communications segment represented 42.6% of consolidated net sales for fiscal 2007 as compared to 38.2% for fiscal 2006.
Net sales in our RF microwave amplifiers segment were $36.2 million for fiscal 2007 compared to $44.1 million for fiscal 2006, a decrease of $7.9 million, or 17.9%. The decrease in net sales was due to lower sales of our amplifiers that are incorporated into improvised explosive device jamming systems, as well as certain orders in the backlog that shipped in fiscal 2008. Our RF microwave amplifiers segment represented 8.1% of consolidated net sales for fiscal 2007 as compared to 11.3% for fiscal 2006.
International sales (which include sales to U.S. companies for inclusion in products which are sold to international customers) represented 26.2% and 35.6% of consolidated net sales for fiscal 2007 and 2006, respectively. Domestic commercial sales represented 12.5% and 17.1% of consolidated net sales for fiscal 2007 and 2006, respectively. Sales to the U.S. government (including sales to prime contractors to the U.S. government) represented 61.3% and 47.3% of consolidated net sales for fiscal 2007 and 2006, respectively.
During fiscal 2007 and 2006, one customer, a prime contractor, represented 5.4% and 10.2% of consolidated net sales, respectively.
Gross Profit. Gross profit was $193.3 million and $159.3 million for fiscal 2007 and 2006, respectively, representing an increase of $34.0 million, or 21.3%. The increase in gross profit was primarily attributable to the increase in net sales discussed above, as well as an increase in the gross profit percentage to 43.4% for fiscal 2007 from 40.7% for 2006.
As discussed further below, we recorded favorable cumulative adjustments relating to certain long-term contracts, which were partially offset by a firmware-related warranty provision in both periods. Excluding the impact of these adjustments and the firmware-related warranty provision, to both net sales and gross profit, our gross profit as a percentage of sales for fiscal 2007 and 2006 would have been 41.0% and 39.8%, respectively. The increase in the adjusted gross profit percentage was primarily due to increased gross margins within our telecommunications transmission segment, primarily due to the benefit of higher sales of our new 16 Mbps troposcatter modem upgrade kits, and increased operating efficiencies in our mobile data communications segment, including the benefit of our decision to significantly de-emphasize stand-alone sales of low margin turnkey employee mobility solutions. The increase in gross margins was offset, in part, by lower gross margins in our RF microwave amplifiers segment primarily due to lower sales and product mix.
During fiscal 2007 and 2006, we recorded favorable cumulative gross profit adjustments of $11.8 million (of which $10.7 million related to the mobile data communications segment and $1.1 million related to the telecommunications transmission segment) and $9.1 million (of which $8.5 million related to the mobile data communications segment and $0.6 million related to the RF microwave amplifiers segment), respectively, relating to our ongoing review of total estimated contract revenues and costs, and the related gross margin at completion, on long-term contracts. Offsetting these adjustments, in our mobile data communications segment and included in cost of sales for fiscal 2007 and 2006, is a firmware-related warranty provision of $0.1 million and $1.7 million, respectively.
The favorable cumulative gross profit adjustments recorded in both periods in our mobile data communications segment resulted from the increase in the estimated gross profit at completion on our original MTS contract. The adjustments are primarily related to increased operating efficiencies and, as it relates to fiscal 2007, the finalization of our total contract costs (including estimates for warranty obligations) relating to the completion of the original MTS contract. The favorable cumulative gross profit adjustment recorded in our telecommunications transmission segment during fiscal 2007 related to an increase in the estimated gross profit at completion on a large over-the-horizon microwave system contract. The favorable cumulative gross profit adjustment recorded in our RF microwave amplifiers segment during fiscal 2006 related to a U.S. military contract that was substantially completed in fiscal 2006.
Included in cost of sales for fiscal 2007 and 2006 are provisions for excess and obsolete inventory of $4.5 million and $2.0 million, respectively. As discussed in our “Critical Accounting Policies – Provisions for Excess and Obsolete Inventory,” we regularly review our inventory and record a provision for excess and obsolete inventory based on historical and projected usage assumptions.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $73.3 million and $67.1 million for fiscal 2007 and 2006, respectively, representing an increase of $6.2 million, or 9.2%. The increase in expenses was primarily attributable to higher payroll-related expenses (including amortization of stock-based compensation) and increased other costs associated with the growth of our business. This increase was offset, in part, by lower expenses in our mobile data communications segment as we continued to de-emphasize stand-alone sales of low margin turnkey employee mobility solutions. As a percentage of consolidated net sales, selling, general and administrative expenses were 16.4% and 17.1% for fiscal 2007 and 2006, respectively.
Amortization of stock-based compensation expense recorded as selling, general and administrative expenses increased to $5.8 million in fiscal 2007 from $4.6 million in fiscal 2006.
Research and Development Expenses. Research and development expenses were $32.5 million and $25.8 million for fiscal 2007 and 2006, respectively, representing an increase of $6.7 million, or 26.0%. Approximately $21.0 million and $19.0 million of such amounts, respectively, related to our telecommunications transmission segment, with the remaining expenses primarily related to our mobile data communications segment and, to a lesser extent, our RF microwave amplifiers segment. As a percentage of consolidated net sales, research and development expenses were 7.3% and 6.6% for fiscal 2007 and 2006, respectively.
As an investment for the future, we are continually 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 fiscal 2007 and 2006, customers reimbursed us $4.2 million and $4.4 million, respectively, which is not reflected in the reported research and development expenses, but is included in net sales with the related costs included in cost of sales.
Amortization of stock-based compensation expense recorded as research and development expenses increased to $1.1 million in fiscal 2007 from $0.7 million in fiscal 2006.
Amortization of Intangibles. Amortization of intangibles for fiscal 2007 and 2006 was $2.6 million and $2.5 million, respectively. The amortization primarily relates to intangibles with finite lives that we acquired in connection with various acquisitions (including the acquisitions of Insite and Digicast that occurred in fiscal 2007).
Operating Income. Operating income for fiscal 2007 and 2006 was $84.9 million and $63.9 million, respectively. The $21.0 million, or 32.9% increase, was primarily the result of the higher sales and gross profit, discussed above.
Operating income in our telecommunications transmission segment increased to $59.2 million for fiscal 2007 from $49.8 million for fiscal 2006, as a result of increased net sales and gross profit, partially offset by increased operating expenses. In addition, as discussed above under “Gross Profit,” included in operating income for fiscal 2007 is a cumulative adjustment related to a large over-the-horizon microwave systems contract which favorably impacted operating income by $0.9 million.
Our mobile data communications segment generated operating income of $45.4 million for fiscal 2007 compared to $21.7 million for fiscal 2006. The increase in operating income was primarily due to the increase in net sales and operating efficiencies achieved, including the benefit of lower selling, general and administrative expenses as we continued to de-emphasize stand-alone sales of low margin turnkey employee mobility solutions. In addition, as discussed above under “Gross Profit,” included in operating income for fiscal 2007 and 2006, are positive impacts from the cumulative adjustments, net of the respective firmware-related warranty provisions, of $9.1 million and $5.8 million, respectively.
Operating income in our RF microwave amplifiers segment decreased to $3.7 million for fiscal 2007 from $8.3 million for fiscal 2006 due primarily to lower net sales and lower gross margins. In addition, as discussed above under “Gross Profit,” included in operating income for fiscal 2006 is a cumulative adjustment which favorably impacted operating income by $0.5 million.
Unallocated operating expenses increased to $23.3 million for fiscal 2007 from $15.9 million for fiscal 2006 due primarily to higher payroll-related expenses (including increased amortization of stock-based compensation), as well as increased other costs associated with growing our business. Amortization of stock-based compensation expense increased to $7.4 million in fiscal 2007 from $5.7 million in fiscal 2006. This increase was primarily attributable to an increase in both the number and related fair value of stock-based awards that are being amortized over their respective service periods for fiscal 2007 as compared to fiscal 2006.
Interest Expense. Interest expense was $2.7 million for both fiscal 2007 and 2006. Interest expense primarily relates to our 2.0% convertible senior notes.
Interest Income and Other. Interest income and other for fiscal 2007 was $14.2 million, as compared to $9.2 million for fiscal 2006. The $5.0 million increase was primarily due to an increase in interest rates and additional investable cash since July 2006.
Provision for Income Taxes. The provision for income taxes was $31.2 million and $25.2 million for fiscal 2007 and 2006, respectively. Our effective tax rate was 32.4% and 35.8% for fiscal 2007 and 2006, respectively.
The decrease in the effective tax rate was primarily attributable to the passage of legislation, in fiscal 2007, extending the Federal research and experimentation credit, including $0.6 million of tax benefits related to the retroactive application of the credit to fiscal 2006, and the approval by our stockholders of an amendment to the 2000 Stock Incentive Plan (the “Plan”) which will permit us to claim tax deductions for cash incentive awards anticipated to be paid under the Plan without limitation under §162(m) of the Internal Revenue Code. In addition, we also recorded incremental tax benefits aggregating $2.0 million during fiscal 2007 including a $1.0 million tax benefit due to the expiration of applicable statutes of limitations. Our tax rate for fiscal 2006 was favorably impacted by the recording of a net benefit of $0.6 million primarily relating to the favorable settlement of a state tax matter. Excluding adjustments, our effective tax rate for fiscal 2007 approximated 35.0%.
Our unrestricted cash and cash equivalents increased to $410.1 million at July 31, 2008 from $342.9 million at July 31, 2007, representing an increase of $67.2 million. None of our cash equivalents include municipal auction-rate securities. On August 1, 2008 (the beginning of our fiscal year 2009), and as more fully described throughout this Form 10-K, we purchased Radyne using a portion of our existing cash and cash equivalents for a preliminary aggregate purchase price of approximately $231.7 million (including estimated transaction costs and payments made for outstanding share-based stock awards).
Net cash provided by operating activities was $77.8 million for fiscal 2008 compared to $89.2 million for fiscal 2007. The decrease in cash provided by operating activities, during fiscal 2008 as compared to fiscal 2007, was driven by an increase in working capital requirements associated with the significant increase in sales activity in our mobile data communications and RF microwave amplifiers segments. The increase in working capital requirements (primarily for inventory) was driven by the timing of shipments to our customers, as well as the necessary investment in inventory in support of current backlog.
Net cash used in investing activities for fiscal 2008 was $20.5 million, of which $14.1 million was for purchases of property, plant and equipment including expenditures relating to ongoing equipment upgrades as well as enhancements to our high-volume technology manufacturing center in Tempe, Arizona. In fiscal 2008, we purchased the network backhaul assets and the NetPerformer and AccessGate product lines of Verso Technologies for approximately $3.9 million. Through July 31, 2008, we incurred approximately $3.2 million of acquisition costs associated with the purchase of Radyne, of which approximately $2.1 million were paid.
We currently expect capital expenditures for fiscal 2009 to be approximately $20.0 million to $22.0 million.
Net cash provided by financing activities was $9.8 million for fiscal 2008, due primarily to the proceeds from stock-option exercises and employee stock purchase plan shares aggregating $7.6 million and a $2.4 million excess income tax benefit from the exercise of stock awards.
We have historically met both our short-term and long-term cash requirements with funds provided by a combination of cash and cash equivalent balances, cash generated from operating activities and financing transactions. Based on our anticipated level of future sales and operating income, we believe that our existing cash and cash equivalent balances and our cash generated from operating activities will be sufficient to meet both our currently anticipated short-term and long-term cash requirements. In addition, should our short-term or long-term cash requirements increase beyond our current expectations, we believe that we would have sufficient access to credit from financial institutions and/or financing from public and private debt and equity markets.
As of July 31, 2008, our material short-term cash requirements primarily consisted of working capital needs and the $231.7 million of cash and cash equivalents necessary to complete the acquisition of Radyne. In addition to the aggregate purchase price, the acquisition of Radyne also triggered certain liabilities associated with Radyne’s change-in-control and professional fee agreements, which we assumed, aggregating $4.1 million.
Our material long-term cash requirements primarily consists of the possible use of cash to repay $105.0 million of our 2.0% convertible senior notes due 2024, including any interest accreted into the principal amount of the notes after February 1, 2011, and contractual non-cancellable lease obligations aggregating $14.8 million. We are currently in preliminary negotiations with a tenant who subleases, from us, a portion of Radyne’s Phoenix, Arizona facility. If these negotiations are not successful, we intend to perform an assessment on whether or not we will be able to sublease the Phoenix, Arizona facility for the remaining duration of the lease, and at what rent, if any, we might be able to receive, given the poor real estate market conditions in the Phoenix, Arizona area as well as uncertainties relating to the local economic environment.
As of July 31, 2008, $105.0 million of our 2.0% convertible senior notes were outstanding. As discussed further in “Notes to Consolidated Financial Statements – Note (8) - 2.0% Convertible Senior Notes due 2024,” we could be obligated to repurchase these notes in the short-term (i) if all or a portion of the outstanding notes are converted during a conversion period and we elect to deliver cash to the converting noteholders, (ii) if we elect to redeem some or all of the outstanding notes on or after February 4, 2009 using cash, or (iii) upon the occurrence of certain events, including a change in control of our company.
Financing Arrangement
On January 27, 2004, we issued $105.0 million of our 2.0% convertible senior notes in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. For further information concerning this financing, see “Notes to Consolidated Financial Statements – Note (8) - 2.0% Convertible Senior Notes due 2024.”
Commitments
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 July 31, 2008, will materially adversely affect our liquidity.
At July 31, 2008, we had contractual cash obligations to repay our 2.0% convertible senior notes, operating lease obligations (including satellite lease expenditures relating to our mobile data communications segment contracts) and the financing of a purchase of proprietary technology. Payments due under these long-term obligations, excluding interest on the 2.0% convertible senior notes, are as follows:
| | | Obligations Due by Fiscal Years (in thousands) | | | | | Total | | | 2009 | | | 2010 and 2011 | | | 2012 and 2013 | | | After 2014 | | | | | | | | | | | | | | | | | | | | 2.0% convertible senior notes | | $ | 105,000,000 | | | | - | | | | - | | | | - | | | | 105,000,000 | | | | | | | | | | | | | | | | | | | | | | | | | Operating lease commitments | | | 38,781,000 | | | | 25,095,000 | | | | 7,385,000 | | | | 2,911,000 | | | | 3,390,000 | | | | | | | | | | | | | | | | | | | | | | | | | Other obligations | | | 113,000 | | | | 113,000 | | | | - | | | | - | | | | - | | | | | | | | | | | | | | | | | | | | | | | | | Total contractual cash obligations | | $ | 143,894,000 | | | | 25,208,000 | | | | 7,385,000 | | | | 2,911,000 | | | | 108,390,000 | | | | | | | | | | | | | | | | | | | | | | | |
On August 1, 2008 (the beginning of our fiscal year 2009), and as more fully described throughout this Form 10-K, we purchased Radyne using a portion of our existing cash and cash equivalents for a preliminary aggregate purchase price of approximately $231.7 million. The acquisition of Radyne also triggered certain liabilities associated with Radyne’s change-in-control and professional fee agreements aggregating $4.1 million. In addition, on August 1, 2008, we immediately adopted a restructuring plan and are currently in the process of closing Radyne’s Phoenix, Arizona manufacturing facility and integrating that operation into our high-volume technology manufacturing center located in Tempe, Arizona. Radyne’s corporate functions, which were co-located in Radyne’s Phoenix, Arizona manufacturing facility, are currently being moved to our Melville, New York corporate office. In connection with the realization of operating synergies, we have preliminarily estimated that we might incur up to $9.6 million of restructuring costs. Such amounts are not included in the above table.
As further discussed in “Notes to Consolidated Financial Statements – Note (8) - 2.0% Convertible Senior Notes due 2024,” we may, at our option, redeem some or all of the notes on or after February 4, 2009. Holders of our 2.0% convertible senior notes will have the right to require us to repurchase some or all of the outstanding notes on February 1, 2011, February 1, 2014 and February 1, 2019 and upon certain events. The notes can be converted, at the option of the noteholders, during the conversion period of September 15, 2008 through December 15, 2008. Upon receiving notification of a noteholder’s intent to convert, we, in accordance with the provisions of the indenture, will inform the noteholder of our intention to deliver shares of common stock or cash, or a combination thereof.
We have entered into standby letter of credit agreements with financial institutions relating to the guarantee of future performance on certain contracts. At July 31, 2008, the balance of these agreements was $2.7 million.
Brazil Subpoena and Export Matters In October 2007, our Florida-based subsidiary, Comtech Systems, Inc. (“CSI”), received a customs export enforcement subpoena from the U.S. Immigration and Customs Enforcement (“ICE”) branch of the Department of Homeland Security. The subpoena relates to CSI’s $2.0 million contract with the Brazilian Naval Commission (the Brazil contract) and it required the production of all books, records and documents, including copies of contracts, invoices and payments related to agreements between CSI, its agent, its subcontractor and the Brazilian government. We believe that the ICE investigation is focused primarily on whether or not CSI was in compliance with export-related laws and regulations, including the International Traffic in Arms Regulations (“ITAR”) and the Export Administration Regulations. CSI produced documents in response to the subpoena request. Customs officials have detained certain inventory related to the Brazil contract pending resolution of this matter.
We engaged outside counsel to assist CSI in its response to the subpoena and related matters and to conduct our own investigation. Based on our ongoing investigation into this matter, we believe that the detained inventory, which consists of commercial satellite equipment, was not modified or adapted in any way to meet Brazilian military requirements and was only subject to the jurisdiction of the Department of Commerce and not the jurisdiction of the U.S. Department of State. In addition, in order to provide certain defense services, including conducting factory acceptance testing at CSI’s Florida facility, we obtained a license (referred to as a Technical Assistance Agreement (“TAA”)) from the U.S. Department of State. We believe that the TAA authorized all activities under the Brazil contract that were subject to the jurisdiction of the U.S. Department of State.
We believe that CSI made a good faith effort to comply with applicable regulations; however, we believe that CSI made inadvertent administrative errors resulting in a TAA that did not become effective on a timely basis. The administrative errors relate primarily to the execution of non-disclosure agreements (“NDA”) with certain third country national employees of CSI’s agent. These individuals have now signed appropriate NDAs, and, in December 2007, CSI filed an amended TAA with the U.S. Department of State. CSI has requested that the U.S. Department of State confirm CSI’s and our view that the Brazil contract does not require any other State Department license.
In March 2008, the Enforcement Division of the U.S. Department of State informed us that they were reviewing our amended TAA. In May 2008, the U.S. Attorney’s Office in the Middle District of Florida informed us that, based on its conversations with the ICE agent who initiated the subpoena, it was closing its investigation into the Brazil matter. In June 2008, the ICE agent informed us that he would recommend that the detained inventory be released back to us upon the U.S. Department of State confirming our position that a State Department license for the hardware shipped was not required. In August 2008, the ICE agent informed us that the U.S. Department of State wanted to clarify certain technical matters and, on its behalf, the ICE agent was going to interview one of our engineers. This interview occurred in September of 2008. We continue to remain cautiously optimistic that we will be able to shortly reship the Brazil inventory to our customer.
In addition to their review of the Brazil contract, in March 2008, the Enforcement Division of the U.S. Department of State informed us that they sought to confirm our company-wide ITAR compliance for the five-year period ended March 2008. In response, we expanded the scope of our own ongoing investigation. In June 2008, we provided detailed information and a summary of our findings to the U.S. Department of State. In July 2008, the U.S. Department of State requested supplemental information and we responded to their request. Our findings to date indicate that there were certain instances of exports and defense services during the five-year period for which we did not have the appropriate authorization from the U.S. Department of State; however, none of those instances involved Proscribed Countries as defined by ITAR. We are awaiting additional feedback from the U.S. Department of State as it relates to all of the aforementioned matters.
Since the receipt of the original Brazil subpoena in October 2007, we have engaged outside counsel and export consultants to help us assess and improve, as appropriate, our internal controls with respect to U.S. export control laws and regulations and laws governing record keeping and dealings with foreign representatives. In addition, in connection with our August 1, 2008 acquisition of Radyne, we are expanding our export internal control assessment to include our newly acquired subsidiaries. To date, we have noted opportunities for improving our procedures to comply with such laws and regulations, including at our newly acquired Radyne subsidiaries. During fiscal 2008, we have taken numerous steps to significantly improve our export control processes, including the hiring of additional employees who are knowledgeable and experienced with ITAR and the engagement of an outside export consultant to conduct additional training. We are also in the process of implementing enhanced formal company-wide ITAR control procedures, including at our newly acquired Radyne subsidiaries. Because our assessments are continuing, we expect to remediate, improve and enhance our internal controls relating to exports throughout fiscal 2009.
Because the above matters are ongoing, we cannot determine the ultimate outcome of these matters. Violations of U.S. export control-related laws and regulations could result in civil or criminal fines and/or penalties and/or result in an injunction against us, all of which could, in the aggregate, materially impact our business, results of operations and cash flows. Should we identify a material weakness relating to our compliance, the ongoing costs of remediation could be material. In addition, inventory related to the Brazil contract (including the inventory that has been detained) had a net book value of $1.1 million as of July 31, 2008. If this inventory is permanently seized or not returned to us timely, or we can not resell the inventory to other customers, we would be required to write-off the value of this inventory in a future accounting period.
Other Legal Proceedings The Company is party to certain other legal actions, which arise in the normal course of business. Although the ultimate outcome of litigation is difficult to accurately predict, the Company believes that the outcome of these actions will not have a material effect on its consolidated financial condition or results of operations.
In June 2008, the Financial Accounting Standards Board (“FASB”) issued a Staff Position (“FSP”) on Emerging Issues Task Force (“EITF”) Issue No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.” This FSP requires share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents prior to vesting be accounted for as participating securities for purposes of calculating and presenting earnings per share. We are required to adopt this FSP, retroactively, beginning in the first quarter of our fiscal 2010 year. Early adoption is prohibited. As we have not historically issued share-based payment awards that contain such rights, the adoption of this FSP will have no impact on our consolidated financial statements. In June 2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). This EITF provides guidance on whether or not a freestanding financial instrument or embedded contract feature must be accounted for as a derivative instrument. We are required to adopt this EITF beginning in the first quarter of our fiscal 2010 year. Early adoption is prohibited for those entities that already elected an alternative accounting policy. Since we only have freestanding financial instruments or embedded features that are either indexed to our stock and that would be classified as equity if they were a freestanding instrument, the adoption of this EITF will have no impact on our consolidated financial statements. In May 2008, the FASB issued FSP Accounting Principles Board (“APB”) 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”), which clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.” In addition, FSP APB 14-1 indicates that issuers of such instruments generally should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. We must adopt FSP APB 14-1 beginning in the first quarter of fiscal 2010 and will be required to retroactively present prior period information. FSP APB 14-1 is applicable to our 2.0% $105.0 million convertible senior notes. With respect to the impact of adoption, the FSP will require us to retroactively separate the liability and equity components of such debt in our consolidated balance sheets on a fair value basis. The FSP will also result in lower reported net income and basic earnings per share since our historical reported interest expense will be retroactively recorded at our nonconvertible debt borrowing rate, which is higher than the stated 2.0% convertible debt rate. Due to the fact that we have historically included the common shares issuable upon conversion of the 2.0% notes and adjusted our net income to reflect our nonconvertible debt borrowing rate in diluted earnings per share, the adoption of FSP ABP 14-1 will not impact our historically reported diluted earnings per share.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 162”) which defines the category and order of authority of accounting principles that are generally accepted, including rules and interpretations of the Securities and Exchange Commission (“SEC”). SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” Adoption of SFAS No. 162 will not have a material affect on our consolidated financial statements.
In April 2008, the FASB issued FSP 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP 142-3 applies prospectively to intangible assets that are acquired, individually or with a group of other assets, after the effective date in either a business combination or asset acquisition. FSP 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. We must adopt FSP 142-3 beginning in the first quarter of fiscal 2010. Adoption of FSP 142-3 will not have a material affect on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures of how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption permitted. We adopted the provisions of SFAS No. 161 effective May 1, 2008. The adoption had no impact on our consolidated financial statements and disclosures.
In February 2008, the FASB issued FSP 157-2, “Effective Date of FASB Statement No. 157,” which delays the effective date of FASB Statement No. 157, “Fair Value Measurements,” for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The delay is intended to allow the FASB and constituents additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of SFAS No. 157. For items within the scope of FSP 157-2, the FSP defers the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. We must adopt FSP 157-2 beginning in the first quarter of fiscal 2010. Adoption of the SFAS No. 157 will not have a material effect on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose all of the information required to evaluate and understand the nature and financial effect of the business combination. This statement is effective for acquisition dates on or after the beginning of the first annual reporting period beginning after December 15, 2008. Early adoption is prohibited. We must adopt SFAS No. 141R beginning in the first quarter of fiscal 2010. Adoption of SFAS No. 141R will not have a material affect on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS No. 160”) to change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method significantly changes the accounting for transactions involving minority interest holders. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008. Early adoption is prohibited. We must adopt SFAS No. 160 beginning in the first quarter of fiscal 2010. We currently do not have any noncontrolling interests recorded in our financial statements; accordingly, we do not expect that the adoption of SFAS No. 160 to have a material effect on our consolidated financial statements. In December 2007, the FASB ratified the consensus in Emerging Issues Task Force Issue No. 07-1, “Accounting for Collaborative Arrangements” (“EITF 07-1”), which defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF 07-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We must adopt EITF 07-1 beginning in the first quarter of fiscal 2010. EITF 07-1 is generally to be applied retrospectively to all periods presented for all collaborative arrangements existing as of the effective date. We currently do not participate in collaborative arrangements as defined by EITF 07-1; accordingly, we currently do not expect the adoption of EITF 07-1 to have a material effect on our consolidated financial statements.
In February 2007, the FASB released SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”) to provide companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. We adopted the provisions of SFAS No. 159 effective August 1, 2008. The adoption had no impact on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”) to clarify the definition of fair value, establish a framework for measuring fair value and expand the disclosures on fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 also stipulates that, as a market-based measurement, fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability, and establishes a fair value hierarchy that distinguishes between (a) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (b) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). Except for the deferral imposed by FSP 157-2 for non-financial assets and non-financial liabilities discussed above, SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We adopted the provisions of SFAS No. 157 applicable to financial assets and liabilities effective August 1, 2008. The adoption had no impact on our consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our earnings and cash flows are subject to fluctuations due to changes in interest rates primarily from our investment of available cash balances. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. If the interest rate we receive on our investment of available cash balances (excluding approximately $231.7 million that was used in connection with our Radyne acquisition) were to change by 10%, our annual interest income would be impacted by approximately $0.5 million.
Our 2.0% convertible senior notes bear a fixed rate of interest. As such, our earnings and cash flows are not sensitive to changes in interest rates on our long-term debt. As of July 31, 2008, we estimate the fair market value of our 2.0% convertible senior notes to be $164.8 million based on recent trading activity.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reports of Independent Registered Public Accounting Firm, Consolidated Financial Statements, Notes to Consolidated Financial Statements and Related Financial Schedule are listed in the Index to Consolidated Financial Statements and Schedule annexed hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Annual Report on Form 10-K, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out by the Company under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures have been designed and are being operated in a manner that provides reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. A system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
Management’s Report on Internal Control Over Financial Reporting
Management of Comtech is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accounted accounting principles.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of July 31, 2008. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on our assessment, we determined that, as of July 31, 2008, the Company’s internal control over financial reporting was effective based on those criteria.
KPMG LLP (“KPMG”), our independent registered public accounting firm, has performed an audit of the Company’s internal control over financial reporting as of July 31, 2008 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). This audit is required to be performed in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our independent auditors were given unrestricted access to all financial records and related data. KPMG’s audit reports appear on pages F-2 and F-3 of this annual report.
Changes In Internal Control Over Financial Reporting There have been no changes in our internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act that occurred during our fiscal quarter ended July 31, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Not applicable.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Certain information concerning directors and officers is incorporated by reference to our Proxy Statement for the Annual Meeting of Stockholders to be held December 5, 2008 (the “Proxy Statement”) which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
Information regarding executive compensation is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information regarding securities authorized for issuance under equity compensation plans and certain information regarding security ownership of certain beneficial owners and management is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information regarding certain relationships and related transactions is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information regarding principal accountant fees and services is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
million and $14.2 million of such amounts, respectively, related to our telecommunications transmission segment. As an investment for the future, we are continually 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 fiscal 2005 and 2004, customers reimbursed us $3.0 million and $5.7 million, respectively, which is not reflected in the reported research and development expenses, but is included in net sales with the related costs included in cost of sales.
In-Process Research and Development Expense.In connection with the purchase of certain assets and liabilities of Memotec in fiscal 2004, we recorded a charge of $0.9 million for the write-off of in-process research and development. There was no in-process research and development expense in fiscal 2005.
Amortization of Intangibles.Amortization of intangibles for fiscal 2005 and 2004 was $2.3 million and $2.1 million, respectively. The increase was attributable to the Memotec and Tolt acquisitions.
Operating Income. Operating income for fiscal 2005 and 2004 was $52.1 million and $32.6 million, respectively. The $19.5 million, or 59.8%, increase was the result of the higher sales and gross profit, discussed above, partially offset by higher operating expenses.
Operating income in our telecommunications transmission segment increased to $40.2 million for fiscal 2005 from $29.2 million for fiscal 2004 as a result of increased sales and associated operating efficiencies. Fiscal 2005 operating income included favorable cumulative gross margin adjustments on two large over-the-horizon microwave system contracts which aggregated $3.1 million, compared to $0.6 million in 2004.
Our mobile data communications segment generated operating income of $11.9 million for fiscal 2005 compared to $9.5 million for fiscal 2004 as a result of increased sales and associated operating efficiencies. In addition, fiscal 2005 operating income included a $2.0 million favorable impact of the cumulative MTS contract adjustments discussed above in“Gross Profit,” compared to $1.0 million in fiscal 2004. This was partially offset by increased operating costs, including expenses associated with Tolt and our continued initiation of commercial marketing efforts.
Operating income in our RF microwave amplifiers segment increased to $8.2 million for fiscal 2005 from $0.3 million for fiscal 2004 primarily as a result of the significant increase in net sales and improved operating efficiencies.
Unallocated operating expenses increased to $8.2 million for fiscal 2005 from $6.4 million for fiscal 2004, due primarily to increased compensation expense and increased costs in connection with recent corporate governance regulations.
Interest Expense. Interest expense increased from $1.4 million for fiscal 2004 to $2.7 million for fiscal 2005. Interest expense primarily represents interest expense associated with our 2.0% convertible senior notes issued in January 2004.
Interest Income. Interest income for fiscal 2005 was $4.1 million, as compared to $0.9 million for fiscal 2004. The $3.2 million increase was due primarily to a higher average cash position resulting from the proceeds received from the issuance of our 2.0% convertible senior notes in January 2004 and cash provided by our operating activities, as well as an increase in interest rates.
Provision for Income Taxes.The provision for income taxes was $16.8 million and $10.3 million for fiscal 2005 and 2004, respectively. The increase was the result of the significant increase in pre-tax profit in fiscal 2005. The effective tax rate was 31.4% and 32.0% in fiscal 2005 and 2004, respectively. The fiscal 2005 provision for income taxes was offset by a tax benefit of $1.1 million primarily relating to the reduction in the valuation allowance that was established for the extended write-off period of acquired in-process research and development. During fiscal 2005, it became more likely than not that the related deferred tax asset would be recoverable. Excluding the tax benefit, the effective tax rate for fiscal 2005 was 33.5%.
Liquidity and Capital Resources
Our unrestricted cash and cash equivalents increased to $251.6 million at July 31, 2006 from $214.4 million at July 31, 2005, representing an increase of $37.2 million.
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Net cash provided by operating activities was $44.3 million for fiscal 2006. Such amount reflects net income of $45.3 million, the impact of depreciation and amortization and the provisions for doubtful accounts and inventory reserves aggregating $12.0 million and stock-based compensation expense of $5.7 million, offset by changes in working capital balances, most notably an increase in accounts receivable and inventory associated with the increase in net sales.
Net cash used in investing activities for fiscal 2006 was $13.5 million, primarily representing capital expenditures including expenditures related to the continued expansion of our high-volume technology manufacturing center located in Tempe, Arizona, as well as continued enhancements to our network operations facility in Germantown, Maryland. We currently expect capital expenditures for fiscal 2007 to be between $12.0 million and $14.0 million.
Net cash provided by financing activities for fiscal 2006 was $6.4 million, due primarily to proceeds from stock option exercises and employee stock purchase plan shares aggregating $2.5 million and a $4.1 million excess income tax benefit from the exercise of stock options.
Financing Arrangement
On January 27, 2004, we issued $105.0 million of our 2.0% convertible senior notes in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. The net proceeds from this transaction were $101.2 million after deducting the initial purchaser’s discount and other transaction costs. For further information concerning this financing, see“Notes to Consolidated Financial Statements – Note 8 - 2.0% Convertible Senior Notes due 2024.”
Commitments
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 July 31, 2006 will materially adversely affect our liquidity.
At July 31, 2006, we had contractual cash obligations to repay our 2.0% convertible senior notes, capital lease and operating lease obligations (including satellite lease expenditures relating to our mobile data communications segment contracts) and the financing of a purchase of proprietary technology. Payments due under these long-term obligations, excluding interest on the 2.0% convertible senior notes, are as follows:
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| Obligations Due by Fiscal Years | |
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| Total | | 2007 | | 2008
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2009 | | 2010
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2011 | | After
2011 | |
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| | Maturity of our 2.0% convertible
senior notes | $ | 105,000,000 | | — | | — | | — | | 105,000,000 | | | | | | | | | | | | | | | | Operating lease commitments | | 17,956,000 | | 8,565,000 | | 5,325,000 | | 3,268,000 | | 798,000 | | | | | | | | | | | | | | | | Other obligations | | 443,000 | | 180,000 | | 263,000 | | — | | — | | | | | | | | | | | | | | | |
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| | | | | Total contractual cash obligations | $ | 123,399,000 | | 8,745,000 | | 5,588,000 | | 3,268,000 | | 105,798,000 | | | |
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| As further discussed in“Notes to Consolidated Financial Statements – Note 8 - 2.0% Convertible Senior Notes due 2024,” we may, at our option, redeem some or all of the notes on or after February 4, 2009. Holders of our 2% convertible senior notes will have the right to require us to repurchase some or all of the outstanding notes on February 1, 2011, February 1, 2014 and February 1, 2009 and upon certain events.
We have entered into standby letter of credit agreements with financial institutions relating to the guarantee of future performance on certain contracts. At July 31, 2006, the balance of these agreements was $2.8 million. Cash we have pledged against such agreements aggregating $1.0 million has been classified as restricted cash in the consolidated balance sheet.
We believe that our cash and cash equivalents will be sufficient to meet our operating cash requirements for the foreseeable future. In the event that we identify a significant acquisition that requires additional cash, we would seek to borrow funds or raise additional equity capital.
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Legal Proceedings
We are subject to certain legal actions, which arise in the normal course of business. Although the ultimate outcome of litigation is difficult to accurately predict, we believe that the outcome of these actions will not have a material effect on our consolidated financial position or results of operations.
During fiscal 2005, two of our leased facilities located in Florida experienced hurricane damage to both leasehold improvements and personal property. As of July 31, 2006, we have completed all restoration efforts relating to the hurricane damage and have recorded an $0.8 million insurance recovery receivable and accrued a total of $2.2 million for hurricane related costs. Despite a written agreement with the general contractor that we believe limits our liability for the cost of the repairs to the amount of insurance proceeds ultimately received from our insurance company, a dispute has arisen with the general contractor and a certain subcontractor over the subcontractor’s demand for payment directly from us (by virtue of a purported assignment of rights and other grounds) in an amount exceeding the insurance proceeds by $0.8 million, plus late charges, interest, fees, costs and certain treble damages. As a result of this dispute, we deposited approximately $1.4 million, representing the balance of the insurance proceeds received, in our attorneys’ trust account and filed a complaint for declaratory judgment in the 9th Judicial Circuit Court for Orange County, Florida. The general contractor and the subcontractor have filed separate and independent actions against us and our insurance company, all of which have now been consolidated under our original action. The Court has scheduled December 1, 2006 as the discovery cutoff and trial for February 13, 2007; however, these dates are subject to change as the litigation progresses. We do not expect that the outcome of this matter will have a material effect on our consolidated financial position.
Recent Accounting Pronouncements
On September 13, 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. (“SAB 108”) which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The guidance is applicable for our fiscal 2007. We are not yet in a position to determine what, if any, effects SAB No. 108 will have on our consolidated financial statements.
In July 2006, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law and prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 prescribes a two-step evaluation process for tax positions. The first step is recognition based on a determination of whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is to measure a tax position that meets the more-likely-than-not threshold. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements. FIN 48 is effective beginning in our first quarter of fiscal 2008. The cumulative effects, if any, of applying FIN 48 will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. We have commenced the process of evaluating the potential effects of FIN 48 on our consolidated financial statements and are not yet in a position to determine what, if any, effects FIN 48 will have on our consolidated financial statements.
In June 2006, the EITF reached a consensus on EITF 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (“EITF 06-3”). EITF 06-3 provides that taxes imposed by a governmental authority on a revenue producing transaction between a seller and a customer should be shown in the income statement on either a gross or a net basis, based on the entity’s accounting policy, which should be disclosed pursuant to APB Opinion No. 22, “Disclosure of Accounting Policies.” If such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. EITF 06-3 will be effective beginning with our third quarter of fiscal 2007. We are currently evaluating the impact EITF 06-3 will have on the presentation of our consolidated financial statements.
In June 2006, the EITF reached a consensus on EITF 05-1, “Accounting for the Conversion of an Instrument that Becomes Convertible Upon the Issuer’s Exercise of a Call Option” (“EITF 05-1”). This guidance requires that the issuance of equity securities to settle an instrument (pursuant to the instrument’s original conversion terms) that becomes convertible upon the issuer’s exercise of a call option should be accounted for as a conversion if the debt instrument contained a substantive conversion feature as of its issuance date (i.e., no gain or loss should be recognized related to the equity securities issued to settle the instrument). The guidance is effective for all conversions within its scope that result from the exercise of call options in interim or annual reporting periods beginning after June 28, 2006. In the future, if we issue common stock pursuant to the conversion terms to settle our 2% convertible senior notes, we would not recognize a gain or loss because our notes have substantive conversion features as defined by EITF 05-1.
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In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the requirements for the accounting and reporting of a change in accounting principle (“SFAS No. 154”). SFAS No. 154 applies to all voluntary changes in accounting principles, as well as to changes required by an accounting pronouncement that does not include specific transition provisions. SFAS No. 154 eliminates the requirement to include the cumulative effect of changes in accounting principle in the income statement and instead requires that changes in accounting principle be retroactively applied. A change in accounting estimate continues to be accounted for in the period of change and future periods if necessary. A correction of an error continues to be reported by restating prior period financial statements. SFAS No. 154 is effective for our first quarter of fiscal 2007.
In March 2005, the FASB issued interpretation FIN No. 47, “Accounting for Conditional Asset Retirement Obligations (“FIN 47”). FIN 47 clarifies that the term conditional asset retirement obligation as used in SFAS 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. We adopted FIN 47 in fiscal 2006 and it had no material effect on our consolidated financial condition or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our earnings and cash flows are subject to fluctuations due to changes in interest rates, primarily from our investment of available cash balances. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. If the interest rate we receive on our investment of available cash balances were to change by 10%, our interest income would be impacted by approximately $1.1 million.
Our 2.0% convertible senior notes bear a fixed rate of interest. As such, our earnings and cash flows are not sensitive to changes in interest rates on our long-term debt.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reports of Independent Registered Public Accounting Firm, Consolidated Financial Statements, Notes to Consolidated Financial Statements and Related Financial Schedule are listed in the Index to Consolidated Financial Statements and Schedule annexed hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Annual Report on Form 10-K, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out by the Company under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures have been designed and are being operated in a manner that provides reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
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Management’s Report on Internal Control Over Financial Reporting
Management of Comtech is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accounted accounting principles.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of July 31, 2006. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on our assessment, we determined that, as of July 31, 2006, the Company’s internal control over financial reporting was effective based on those criteria.
KPMG LLP (“KPMG”), our independent registered public accounting firm, has performed an audit of our assessment of the effectiveness of the Company’s internal control over financial reporting as of July 31, 2006. This audit is required to be performed in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our independent auditors were given unrestricted access to all financial records and related data. KPMG’s audit reports appear on pages F-2 and F-3 of this annual report.
Changes In Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act that occurred during our fiscal quarter ended July 31, 2006, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Certain information concerning directors and officers is incorporated by reference to our Proxy Statement for the Annual Meeting of Stockholders to be held December 5, 2006 (the “Proxy Statement”) which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information regarding securities authorized for issuance under equity compensation plans and certain information regarding security ownership of certain beneficial owners and management is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
|
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal accountant fees and services is incorporated by reference to the Proxy Statement, which will be filed with the Securities and Exchange Commission no more than 120 days after the close of our fiscal year.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) (1) The Registrant’s financial statements together with a separate index are annexed hereto.
| | (2) The Financial Statement Schedule listed in a separate index is annexed hereto. | | (3) Exhibits required by Item 601 of Regulation S-K are listed below. | | |
| | Exhibit Number | | Description of Exhibit | | Incorporated By
Reference to Exhibit | | Exhibit Number |
Description of Exhibit | |
| |
| Incorporated By Reference to Exhibit | | 3(a)(i) | | Restated Certificate of Incorporation of the Registrant | | | Exhibit 3(a)(i) to the Registrant’s 2006 Form 10-K | | | | | | | | | 3(a)(ii) | | Amended and Restated By-Laws of the Registrant | | Exhibit 3(c)3(ii) to the Registrant’s 1998 Form 10-K | 8-K dated December 6, 2007 | | | | | | | | | 4(a) | | Rights Agreement dated as of December 15, 1998 between the Registrant and American Stock Transfer and Trust Company, as Rights Agent | | Exhibit 4(1) to the Registrant’s Form 8-A/A dated December 23, 1998 | | | | | | | | | | 4(b) | | Indenture by and between the Registrant and The Bank of New York, as trustee, dated as of January 27, 2004, including form of Note | | Exhibit 4.2 to the Registrant’s Form S-3 (File No. 333-114268) | | | | | | | | | | 4(c) | | Registration Rights Agreement dated as of January 27, 2004, between the Registrant and Bear, Stearns & Co. Inc., as Initial Purchaser | | Exhibit 4.4 to the Registrant’s Form S-3 (File No. 333-114268) | | | | | | | | | | 10(a)* | | | | Exhibit 10(a) to the Registrant’s Form 10-Q for quarter ended April 30, 2003 | | | | | | | | | | 10(b)* | | | | Exhibit 10(b) to the Registrant’s Form 10-Q for quarter ended April 30, 2003 | | | | | | L. McCollum and Michael D. Porcelain and certain non-executive officers | | | | 10(c) | | Lease | | Exhibit 10(k) to the Registrant’s 1992 Form 10-K | | | | | | Registrant and certain non-executive officers | | | | 10(d)10(c)* | | Amended and restatedRestated 1993 Incentive Stock Option Plan | | Appendix A to the Registrant’s Proxy Statement dated November 3, 1997 | | | | | | | | | | 10(e) | | Movement Tracking System Contract between Comtech Mobile Datacom Corp. and U.S. Army’s CECOM Acquisition Center dated June 24, 1999 (certain portions of this agreement have been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment) | | Exhibit 10(g) to the Registrant’s 1999 Form 10-K | | | | | | | | | | 10(f)(1)10(d)* | | Amended and restated 2000 Stock Incentive Plan | | Appendix AExhibit 10 to the Registrant’s Proxy Statement dated November 8, 1999 | | | | | | | | | | 10(f)(2)* | | Amendment to the 2000 Stock Incentive Plan | | Appendix A to the Registrant’s Proxy Statement dated November 6, 2000 | | | | | | | | | | 10(f)(3)* | | Amendment to the 2000 Stock Incentive Plan | | Exhibit 10(g)(3) to the Registrant’s 2002 Form 10-K | | | | | | | | | | 10(f)(4)* | | Amendment to the 2000 Stock Incentive Plan | | Exhibit 10(h)(4) to the Registrant’s 2003 Form 10-K | | | | | | | | | | 10(f)(5)* | | Amendment to the 2000 Stock Incentive Plan | | Exhibit 10(g)(5) to the Registrant’s 2004 Form 10-K | | | | | | | | | | 10(f)(6)* | | Amendment to the 2000 Stock Incentive Plan | | Exhibit 10.1 to the Registrant’s Form 8-K filed December 12, 2005 | 6, 2007 | | | | | | | | | 10(f)(7)10(e)* | | Form of Stock Option Agreement pursuant to the 2000 Stock Incentive Plan | | Exhibit 10(f)(7) to the Registrant’s 2005 Form 10-K | | | | | | | | | | 10(f)(8)* | | Form of Stock Option Agreement for Non-employee Directors pursuant to the 2000 Stock Incentive Plan | | | Exhibit 10(f)(8) to the Registrant’s 2006 Form 10-K | | | | | | | |
| Exhibit Number | | Description of Exhibit | | Incorporated By
Reference to Exhibit | |
| |
| |
| | | 10(g)* | | 2001 Employee Stock Purchase Plan | | Appendix B to the Registrant’s Proxy Statement dated November 6, 2000 | | | 10(h)* | 21Lease and amendment thereto on the Melville, New York Facility | | Exhibit 10(k) to the Registrant’s 1992 Form 10-K |
| Exhibit Number | Description of Exhibit | | Incorporated By Reference to Exhibit | | 10(i) | Movement Tracking System Contract between Comtech Mobile Datacom Corporation and the U.S. Army’s Contract Agency dated August 31, 2007… | | Exhibit 10(j) to the Registrant’s 2007 Form 10-K | | 10(j) | Blue Force Tracking System Contract between Comtech Mobile Datacom Corporation and the U.S. Army CECOM dated August 31, 2007… | | Exhibit 10(k) to the Registrant’s 2007 Form 10-K | | 10(k) | Form of Indemnification Agreement between the Registrant and Richard L. Burt, Fred Kornberg, Robert L. McCollum, Michael D. Porcelain and certain non-executive officers | | Exhibit 10.1 to Registrant’s 8-K filed on March 8, 2007 | | 10(l) | Agreement and Plan of Merger, dated May 10, 2008, among the Company, Purchaser and Radyne | | Exhibit 2.1 to the Registrant’s Form 8-K filed May 12, 2008 | | 10(m) | Amendment to Agreement and Plan of Merger, dated as of July 11, 2008, among the Company, Purchaser and Radyne | | Exhibit 2.1 to the Registrant’s Form 8-K filed July 14, 2008 | | | | | | | | | | | | | | 23 | | | | | | | | | | | | | | 31.1 | | | | | | | | | | | | | | 31.2 | | | | | | | | | | | | | | 32.1 | | | | | | | | | | | | | | 32.2 | | | | |
* Management contract or compensatory plan or arrangement. … Certain portions of this agreement have been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.
Exhibits to this Annual Report on Form 10-K are available from the Company upon request and payment to the Company for the cost of reproduction. The information is also available on our Internet website at www.comtechtel.com.
Pursuant to the requirements of Section 13 or 15 (d) of the Securities and 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. | | | | September 17, 2008 | By: /s/Fred Kornberg | | (Date) | Fred Kornberg, Chairman of the Board | | and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| September 17, 2008 | /s/Fred Kornberg | Chairman of the Board | *
(Date) | Management contract or compensatory plan or arrangement.
Fred Kornberg |
| Exhibits to this Annual Report on Form 10-K are available from the Company upon requestChief Executive Officer and payment to the Company for the cost of reproduction. The information is also available on our Internet website atwww.comtechtel.com.
| |
SIGNATURES | | Pursuant to the requirements of Section 13 or 15 (d) of the Securities and 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.President(Principal Executive Officer) | | | | | | | | | September 20, 200617, 2008 | /s/Michael D. Porcelain | By: /s/Fred KornbergSenior Vice President and | | (Date) | Michael D. Porcelain | Fred Kornberg, Chairman of the Board | | | Chief Financial Officer (Principal Financial and Chief Executive OfficerAccounting Officer) | | | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. | |
| | Signature | | Title | | | | | | September 20, 200617, 2008 | /s/Richard L. Goldberg | /s/Fred Kornberg | | Chairman of the BoardDirector | | (Date) | Richard L. Goldberg | Fred Kornberg | | Chief Executive Officer and President | | | | | | (Principal Executive Officer) | | | | | | September 20, 200617, 2008 | /s/Edwin Kantor | /s/Michael D. Porcelain | | Senior Vice President andDirector | | (Date) | Edwin Kantor | Michael D. Porcelain | | Chief Financial Officer | | | | | | (Principal Financial and Accounting Officer) | | | | | | September 20, 200617, 2008 | | /s/George Bugliarello | Ira Kaplan | Director | | (Date) | Ira Kaplan | George Bugliarello | | | | | | | | | | | | | | | | September 20, 200617, 2008 | | /s/Richard L. Goldberg | Gerard R. Nocita | Director | | (Date) | Gerard R. Nocita | Richard L. Goldberg | | | | | | | | | | | | | | | | September 20, 200617, 2008 | | /s/Edwin Kantor | Robert G. Paul | Director | | (Date) | | Edwin Kantor | | | | | | | | | | | | | September 20, 2006 | | /s/Ira Kaplan | | Director | (Date) | | Ira Kaplan | | | | | | | | | | | | | September 20, 2006 | | /s/Gerard R. Nocita | | Director | (Date) | | Gerard R. NocitaRobert G. Paul | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Index to Consolidated Financial Statements and Schedule
| |
Index to Consolidated Financial Statements and Schedule
| | Page | |
| | | | F-2, F-3 | | | | | | | | | | | F-4 | | | | | | F-5 | | | | | | F-6 | | | | | | F-7, F-8 | | | | | | F-9 to F-36F-38 | | | Additional Financial Information Pursuant to the Requirements of Form 10-K: | | | | | | | | S-1 | | | | Schedules not listed above have been omitted because they are either not applicable or the required information has been provided elsewhere in the consolidated financial statements or notes thereto. |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Comtech Telecommunications Corp.:
We have audited the accompanying consolidated balance sheets of Comtech Telecommunications Corp. and subsidiaries as of July 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended July 31, 2008. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in the accompanying index. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Comtech Telecommunications Corp. and subsidiaries as of July 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended July 31, 2008, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Notes 1(j) to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” effective August 1, 2005.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Comtech Telecommunications Corp.’s internal control over financial reporting as of July 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated September 17, 2008 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Melville, New York September 17, 2008
Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of Comtech Telecommunications Corp.:
We have audited Comtech Telecommunications Corp. and subsidiaries internal control over financial reporting as of July 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Comtech Telecommunications Corp. and subsidiaries' management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Comtech Telecommunications Corp. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of July 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Comtech Telecommunications Corp. and subsidiaries as of July 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended July 31, 2008, and our report dated September 17, 2008, expressed an unqualified opinion on those consolidated financial statements.
Melville, New York September 17, 2008
AND SUBSIDIARIES Consolidated Balance Sheets As of July 31, 2008 and 2007
| Assets | | 2008 | | | 2007 | | | Current assets: | | | | | | | | Cash and cash equivalents | | $ | 410,067,000 | | | | 342,903,000 | | | Accounts receivable, net | | | 70,040,000 | | | | 73,585,000 | | | Inventories, net | | | 85,966,000 | | | | 61,987,000 | | | Prepaid expenses and other current assets | | | 5,891,000 | | | | 6,734,000 | | | Deferred tax asset – current | | | 10,026,000 | | | | 9,380,000 | | | Total current assets | | | 581,990,000 | | | | 494,589,000 | | | | | | | | | | | | | Property, plant and equipment, net | | | 34,269,000 | | | | 29,282,000 | | | Goodwill | | | 24,363,000 | | | | 24,387,000 | | | Intangibles with finite lives, net | | | 7,505,000 | | | | 5,717,000 | | | Deferred financing costs, net | | | 1,357,000 | | | | 1,903,000 | | | Other assets, net | | | 3,636,000 | | | | 464,000 | | | Total assets | | $ | 653,120,000 | | | | 556,342,000 | | | | | | | | | | | | | Liabilities and Stockholders’ Equity | | | | | | | | | | Current liabilities: | | | | | | | | | | Accounts payable | | $ | 31,423,000 | | | | 26,137,000 | | | Accrued expenses and other current liabilities | | | 49,671,000 | | | | 47,332,000 | | | Customer advances and deposits | | | 15,287,000 | | | | 20,056,000 | | | Current installments of other obligations | | | 108,000 | | | | 135,000 | | | Interest payable | | | 1,050,000 | | | | 1,050,000 | | | Income taxes payable | | | - | | | | 2,796,000 | | | Total current liabilities | | | 97,539,000 | | | | 97,506,000 | | | | | | | | | | | | | Convertible senior notes | | | 105,000,000 | | | | 105,000,000 | | | Other obligations, less current installments | | | - | | | | 108,000 | | | Income taxes payable – non-current | | | 1,909,000 | | | | - | | | Deferred tax liability – non-current | | | 5,870,000 | | | | 7,960,000 | | | Total liabilities | | | 210,318,000 | | | | 210,574,000 | | | | | | | | | | | | | Commitments and contingencies (See Note 13) | | | | | | | | | | | | | | | | | | | | Stockholders’ equity: | | | | | | | | | | Preferred stock, par value $.10 per share; shares authorized and unissued 2,000,000 | | | - | | | | - | | | Common stock, par value $.10 per share; authorized 100,000,000 shares; issued 24,600,166 shares and 24,016,329 shares at July 31, 2008 and 2007, respectively | | | 2,460,000 | | | | 2,402,000 | | | Additional paid-in capital | | | 186,246,000 | | | | 165,703,000 | | | Retained earnings | | | 254,281,000 | | | | 177,848,000 | | | | | | 442,987,000 | | | | 345,953,000 | | | Less: | | | | | | | | | | Treasury stock (210,937 shares) | | | (185,000 | ) | | | (185,000 | ) | | Total stockholders’ equity | | | 442,802,000 | | | | 345,768,000 | | | Total liabilities and stockholders’ equity | | $ | 653,120,000 | | | | 556,342,000 | | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
AND SUBSIDIARIES Consolidated Statements of Operations Fiscal Years Ended July 31, 2008, 2007 and 2006
| | | 2008 | | | 2007 | | | 2006 | | | | | | | | | | | | | | Net sales | | $ | 531,627,000 | | | | 445,684,000 | | | | 391,511,000 | | | Cost of sales | | | 296,687,000 | | | | 252,389,000 | | | | 232,210,000 | | | Gross profit | | | 234,940,000 | | | | 193,295,000 | | | | 159,301,000 | | | | | | | | | | | | | | | | | Expenses: | | | | | | | | | | | | | | Selling, general and administrative | | | 85,967,000 | | | | 73,312,000 | | | | 67,071,000 | | | Research and development | | | 40,472,000 | | | | 32,469,000 | | | | 25,834,000 | | | Amortization of intangibles | | | 1,710,000 | | | | 2,592,000 | | | | 2,465,000 | | | | | | 128,149,000 | | | | 108,373,000 | | | | 95,370,000 | | | | | | | | | | | | | | | | | Operating income | | | 106,791,000 | | | | 84,922,000 | | | | 63,931,000 | | | | | | | | | | | | | | | | | Other expenses (income): | | | | | | | | | | | | | | Interest expense | | | 2,683,000 | | | | 2,731,000 | | | | 2,687,000 | | | Interest income and other | | | (14,065,000 | ) | | | (14,208,000 | ) | | | (9,243,000 | ) | | | | | | | | | | | | | | | | Income before provision for income taxes | | | 118,173,000 | | | | 96,399,000 | | | | 70,487,000 | | | Provision for income taxes | | | 41,740,000 | | | | 31,186,000 | | | | 25,218,000 | | | | | | | | | | | | | | | | | Net income | | $ | 76,433,000 | | | | 65,213,000 | | | | 45,269,000 | | | | | | | | | | | | | | | | | Net income per share (See Note 1(i)): | | | | | | | | | | | | | | Basic | | $ | 3.17 | | | | 2.81 | | | | 1.99 | | | Diluted | | $ | 2.76 | | | | 2.42 | | | | 1.72 | | | | | | | | | | | | | | | | | Weighted average number of common shares outstanding – basic | | | 24,138,000 | | | | 23,178,000 | | | | 22,753,000 | | | | | | | | | | | | | | | | | Weighted average number of common and common equivalent shares outstanding assuming dilution – diluted | | | 28,278,000 | | | | 27,603,000 | | | | 27,324,000 | | | | | | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity and Comprehensive Income Fiscal Years Ended July 31, 2008, 2007 and 2006 | | | Common Stock | | | Additional Paid-in | | | Retained | | | Treasury Stock | | | Stockholders’ | | | Comprehensive | | | | | Shares | | | Amount | | | Capital | | | Earnings | | | Shares | | | Amount | | | Equity | | | Income | | | Balance July 31, 2005 | | | 22,781,678 | | | $ | 2,278,000 | | | $ | 127,170,000 | | | $ | 67,366,000 | | | | 210,937 | | | $ | (185,000 | ) | | $ | 196,629,000 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Equity-classified stock award compensation | | | - | | | | - | | | | 5,742,000 | | | | - | | | | - | | | | - | | | | 5,742,000 | | | $ | - | | | Proceeds from exercise of options | | | 244,737 | | | | 24,000 | | | | 1,839,000 | | | | - | | | | - | | | | - | | | | 1,863,000 | | | | - | | | Proceeds from issuance of employee stock purchase plan shares | | | 26,178 | | | | 3,000 | | | | 671,000 | | | | - | | | | - | | | | - | | | | 674,000 | | | | - | | | Excess income tax benefit from stock award exercises | | | - | | | | - | | | | 4,065,000 | | | | - | | | | - | | | | - | | | | 4,065,000 | | | | - | | | Net income | | | - | | | | - | | | | - | | | | 45,269,000 | | | | - | | | | - | | | | 45,269,000 | | | | 45,269,000 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance July 31, 2006 | | | 23,052,593 | | | | 2,305,000 | | | | 139,487,000 | | | | 112,635,000 | | | | 210,937 | | | | (185,000 | ) | | | 254,242,000 | | | | 45,269,000 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Equity-classified stock award compensation | | | - | | | | - | | | | 7,408,000 | | | | - | | | | - | | | | - | | | | 7,408,000 | | | | - | | | Proceeds from exercise of options | | | 938,000 | | | | 94,000 | | | | 9,441,000 | | | | - | | | | - | | | | - | | | | 9,535,000 | | | | - | | | Proceeds from issuance of employee stock purchase plan shares | | | 25,736 | | | | 3,000 | | | | 755,000 | | | | - | | | | - | | | | - | | | | 758,000 | | | | - | | | Excess income tax benefit from stock award exercises | | | - | | | | - | | | | 8,612,000 | | | | - | | | | - | | | | - | | | | 8,612,000 | | | | - | | | Net income | | | - | | | | - | | | | - | | | | 65,213,000 | | | | - | | | | - | | | | 65,213,000 | | | | 65,213,000 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance July 31, 2007 | | | 24,016,329 | | | | 2,402,000 | | | | 165,703,000 | | | | 177,848,000 | | | | 210,937 | | | | (185,000 | ) | | | 345,768,000 | | | | 65,213,000 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Equity-classified stock award compensation | | | - | | | | - | | | | 10,595,000 | | | | - | | | | - | | | | - | | | | 10,595,000 | | | | - | | | Proceeds from exercise of options | | | 559,681 | | | | 56,000 | | | | 6,640,000 | | | | - | | | | - | | | | - | | | | 6,696,000 | | | | - | | | Proceeds from issuance of employee stock purchase plan shares | | | 24,156 | | | | 2,000 | | | | 902,000 | | | | - | | | | - | | | | - | | | | 904,000 | | | | - | | | Excess income tax benefit from stock award exercises | | | - | | | | - | | | | 2,406,000 | | | | - | | | | - | | | | - | | | | 2,406,000 | | | | - | | | Net income | | | - | | | | - | | | | - | | | | 76,433,000 | | | | - | | | | - | | | | 76,433,000 | | | | 76,433,000 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance July 31, 2008 | | | 24,600,166 | | | $ | 2,460,000 | | | $ | 186,246,000 | | | $ | 254,281,000 | | | | 210,937 | | | $ | (185,000 | ) | | $ | 442,802,000 | | | $ | 76,433,000 | |
See accompanying notes to consolidated financial statements. AND SUBSIDIARIES Consolidated Statements of Cash Flows Fiscal Years Ended July 31, 2008, 2007 and 2006
| | | 2008 | | | 2007 | | | 2006 | | | Cash flows from operating activities: | | | | | | | | | | | Net income | | $ | 76,433,000 | | | | 65,213,000 | | | | 45,269,000 | | | Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | | | Depreciation and amortization of property, plant and equipment | | | 9,196,000 | | | | 7,536,000 | | | | 6,242,000 | | | Amortization of intangible assets with finite lives | | | 1,710,000 | | | | 2,592,000 | | | | 2,465,000 | | | Amortization of stock-based compensation | | | 10,640,000 | | | | 7,401,000 | | | | 5,681,000 | | | Amortization of deferred financing costs | | | 546,000 | | | | 546,000 | | | | 546,000 | | | Loss on disposal of property, plant and equipment | | | 6,000 | | | | 203,000 | | | | 36,000 | | | Provision for (benefit from) allowance for doubtful accounts | | | 723,000 | | | | (375,000 | ) | | | 748,000 | | | Provision for excess and obsolete inventory | | | 2,414,000 | | | | 4,491,000 | | | | 2,030,000 | | | Excess income tax benefit from stock award exercises | | | (2,374,000 | ) | | | (7,990,000 | ) | | | (4,065,000 | ) | | Deferred income tax (benefit) expense | | | (2,736,000 | ) | | | (147,000 | ) | | | 832,000 | | | Changes in assets and liabilities, net of effects of acquisitions: | | | | | | | | | | | | | | Restricted cash securing letter of credit obligations | | | - | | | | 1,003,000 | | | | 31,000 | | | Accounts receivable | | | 2,822,000 | | | | (3,163,000 | ) | | | (14,743,000 | ) | | Inventories | | | (25,038,000 | ) | | | (4,818,000 | ) | | | (17,909,000 | ) | | Prepaid expenses and other current assets | | | 49,000 | | | | 492,000 | | | | (2,791,000 | ) | | Other assets | | | 39,000 | | | | 73,000 | | | | (260,000 | ) | | Accounts payable | | | 5,361,000 | | | | (2,200,000 | ) | | | 4,760,000 | | | Accrued expenses and other current liabilities | | | 1,235,000 | | | | 5,608,000 | | | | 7,733,000 | | | Customer advances and deposits | | | (4,769,000 | ) | | | 16,512,000 | | | | (1,738,000 | ) | | Deferred service revenue | | | - | | | | (9,896,000 | ) | | | 1,686,000 | | | Income taxes payable | | | 1,519,000 | | | | 6,156,000 | | | | 7,777,000 | | | Net cash provided by operating activities | | | 77,776,000 | | | | 89,237,000 | | | | 44,330,000 | | | | | | | | | | | | | | | | | Cash flows from investing activities: | | | | | | | | | | | | | | Purchases of property, plant and equipment | | | (14,064,000 | ) | | | (12,075,000 | ) | | | (12,327,000 | ) | | Purchases of other intangibles with finite lives | | | (193,000 | ) | | | (38,000 | ) | | | (197,000 | ) | | Payments for business acquisitions | | | (6,194,000 | ) | | | (3,937,000 | ) | | | (1,000,000 | ) | | Net cash used in investing activities | | | (20,451,000 | ) | | | (16,050,000 | ) | | | (13,524,000 | ) | | | | | | | | | | | | | | | | Cash flows from financing activities: | | | | | | | | | | | | | | Principal payments on other obligations | | | (135,000 | ) | | | (154,000 | ) | | | (234,000 | ) | | Excess income tax benefit from stock award exercises | | | 2,374,000 | | | | 7,990,000 | | | | 4,065,000 | | | Proceeds from exercises of stock options | | | 6,696,000 | | | | 9,535,000 | | | | 1,863,000 | | | Proceeds from issuance of employee stock purchase plan shares | | | 904,000 | | | | 758,000 | | | | 674,000 | | | Net cash provided by financing activities | | | 9,839,000 | | | | 18,129,000 | | | | 6,368,000 | |
(Continued)
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) Years ended July 31, 2008, 2007 and 2006
| | | 2008 | | | 2007 | | | 2006 | | | Net increase in cash and cash equivalents | | $ | 67,164,000 | | | | 91,316,000 | | | | 37,174,000 | | | Cash and cash equivalents at beginning of period | | | 342,903,000 | | | | 251,587,000 | | | | 214,413,000 | | | Cash and cash equivalents at end of period | | $ | 410,067,000 | | | | 342,903,000 | | | | 251,587,000 | | | | | | | | | | | | | | | | Supplemental cash flow disclosure | | | | | | | | | | | | | | Cash paid during the period for: | | | | | | | | | | | | | | Interest | | $ | 2,120,000 | | | | 2,150,000 | | | | 2,142,000 | | | | | | | | | | | | | | | | | Income taxes | | $ | 43,843,000 | | | | 24,778,000 | | | | 16,573,000 | | | | | | | | | | | | | | | | | Non cash investing activities: | | | | | | | | | | | | | | Accrued business acquisition payments | | $ | 1,169,000 | | | | 290,000 | | | | - | |
See accompanying notes to consolidated financial statements.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting and Reporting Policies
 | | (a) | | | KPMG LLP | | Suite 200 | | 1305 Walt Whitman Road | | Melville, NY 11747-4302 | | |
Report of Independent Registered Public Accounting Firm | | The Board of Directors and Stockholders of Comtech Telecommunications Corp.:
We have audited the accompanying consolidated balance sheets of Comtech Telecommunications Corp. and subsidiaries as of July 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended July 31, 2006. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in the accompanying index. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Comtech Telecommunications Corp. and subsidiaries as of July 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended July 31, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Notes 1(j) and 10 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” effective August 1, 2005.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Comtech Telecommunications Corp.’s internal control over financial reporting as of July 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated September 19, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, the Company’s internal control over financial reporting.
|
| | |  | | | Melville, New York
September 19, 2006 |
| | | | KPMG LLP | | Suite 200 | | 1305 Walt Whitman Road | | Melville, NY 11747-4302 | | |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Comtech Telecommunications Corp.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Comtech Telecommunications Corp. maintained effective internal control over financial reporting as of July 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Comtech Telecommunications Corp.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Comtech Telecommunications Corp. maintained effective internal control over financial reporting as of July 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Comtech Telecommunications Corp. maintained, in all material respects, effective internal control over financial reporting as of July 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Comtech Telecommunications Corp. and subsidiaries as of July 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended July 31, 2006, and our report dated September 19, 2006, expressed an unqualified opinion on those consolidated financial statements. Our report, dated September 19, 2006, refers to the Company’s adoption of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”, effective August 1, 2005.
| | | | | | | Melville, New York
September 19, 2006 |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Consolidated Balance Sheets
As of July 31, 2006 and 2005
| |
| Assets | 2006 | | 2005 | | |
| |
| | | Current assets: | | | | | | | | Cash and cash equivalents | $ | 251,587,000 | | | 214,413,000 | | | Restricted cash | | 1,003,000 | | | 1,034,000 | | | Accounts receivable, net | | 70,047,000 | | | 56,052,000 | | | Inventories, net | | 61,043,000 | | | 45,103,000 | | | Prepaid expenses and other current assets | | 7,178,000 | | | 4,387,000 | | | Deferred tax asset – current | | 7,591,000 | | | 8,092,000 | | |
| |
| | | Total current assets | | 398,449,000 | | | 329,081,000 | | | | | Property, plant and equipment, net | | 24,732,000 | | | 18,683,000 | | | Goodwill | | 22,244,000 | | | 22,244,000 | | | Intangibles with finite lives, net | | 6,855,000 | | | 9,123,000 | | | Deferred financing costs, net | | 2,449,000 | | | 2,995,000 | | | Other assets, net | | 537,000 | | | 277,000 | | |
| |
| | | Total assets | $ | 455,266,000 | | | 382,403,000 | | |
| |
| | | | | Liabilities and Stockholders’ Equity | | | | | | | | | Current liabilities: | | | | | | | | Accounts payable | $ | 28,337,000 | | | 23,577,000 | | | Accrued expenses and other current liabilities | | 41,230,000 | | | 34,497,000 | | | Customer advances and deposits | | 3,544,000 | | | 5,282,000 | | | Deferred service revenue | | 9,896,000 | | | 8,210,000 | | | Current installments of other obligations | | 154,000 | | | 235,000 | | | Interest payable | | 1,050,000 | | | 1,050,000 | | | Income taxes payable | | 5,252,000 | | | 1,540,000 | | |
| |
| | | Total current liabilities | | 89,463,000 | | | 74,391,000 | | | | | Convertible senior notes | | 105,000,000 | | | 105,000,000 | | | Other obligations, less current installments | | 243,000 | | | 396,000 | | | Deferred tax liability – non-current | | 6,318,000 | | | 5,987,000 | | |
| |
| | | Total liabilities | | 201,024,000 | | | 185,774,000 | | | | | Commitments and contingencies (See Note 13) | | | | | | | | | | Stockholders’ equity: | | | | | | | Preferred stock, par value $.10 per share; shares authorized
and unissued 2,000,000 | | — | | | — | | Common stock, par value $.10 per share; authorized 100,000,000
shares and 30,000,000 shares at July 31, 2006 and July 31, 2005,
respectively; issued 23,052,593 shares and 22,781,678 shares at
July 31, 2006 and 2005, respectively | | 2,305,000 | | | 2,278,000 | | | Additional paid-in capital | | 139,487,000 | | | 127,170,000 | | | Retained earnings | | 112,635,000 | | | 67,366,000 | | |
| |
| | | | | 254,427,000 | | | 196,814,000 | | | | | Less: | | | | | | | | Treasury stock (210,937 shares) | | (185,000 | ) | | (185,000 | ) | |
| |
| | | | | Total stockholders’ equity | | 254,242,000 | | | 196,629,000 | | |
| |
| | | Total liabilities and stockholders’ equity | $ | 455,266,000 | | | 382,403,000 | | |
| |
| |
| See accompanying notes to consolidated financial statements.
|
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Consolidated Statements of Operations
Fiscal Years Ended July 31, 2006, 2005 and 2004
| |
| 2006 | | 2005 | | 2004 | |
|---|
|
| |
| |
| |
|---|
| |
|---|
| Net sales | $ | 391,511,000 | | | 307,890,000 | | | 223,390,000 | | | Cost of sales | | 232,210,000 | | | 180,524,000 | | | 135,858,000 | | |
| |
| |
| |
|---|
| Gross profit | | 159,301,000 | | | 127,366,000 | | | 87,532,000 | | |
| |
| |
| |
|---|
| |
|---|
| Expenses: | | | | | | | | | | | Selling, general and administrative | | 67,071,000 | | | 51,819,000 | | | 36,016,000 | | | Research and development | | 25,834,000 | | | 21,155,000 | | | 15,907,000 | | | In-process research and development | | — | | | — | | | 940,000 | | | | | | | Amortization of intangibles | | 2,465,000 | | | 2,328,000 | | | 2,067,000 | | | | | | |
| |
| |
| |
|---|
| | | 95,370,000 | | | 75,302,000 | | | 54,930,000 | | |
| |
| |
| |
|---|
| |
|---|
| Operating income | | 63,931,000 | | | 52,064,000 | | | 32,602,000 | | | |
|---|
| Other expenses (income): | | Interest expense | | 2,687,000 | | | 2,679,000 | | | 1,425,000 | | | | | | | Interest income | | (9,243,000 | ) | | (4,072,000 | ) | | (921,000 | ) | |
| |
| |
| |
|---|
| |
|---|
| Income before provision for income taxes | | 70,487,000 | | | 53,457,000 | | | 32,098,000 | | | | | | | Provision for income taxes | | 25,218,000 | | | 16,802,000 | | | 10,271,000 | | | | | | |
| |
| |
| |
|---|
| Net income | $ | 45,269,000 | | | 36,655,000 | | | 21,827,000 | | | | | | |
| |
| |
| |
|---|
| |
|---|
| Net income per share (See Note 1(i)): | | | | | | | | | | | Basic | $ | 1.99 | | | 1.69 | | | 1.03 | | | | | | |
| |
| |
| |
|---|
| Diluted | $ | 1.72 | | | 1.42 | | | 0.92 | | | | | | |
| |
| |
| |
|---|
| |
|---|
Weighted average number of common shares
outstanding – basic | | 22,753,000 | | | 21,673,000 | | | 21,178,000 | | | | | | |
| |
| |
| |
|---|
| |
|---|
Weighted average number of common and common
equivalent shares outstanding assuming dilution – diluted | | 27,324,000 | | | 27,064,000 | | | 24,781,000 | | |
| |
| |
| |
|---|
| See accompanying notes to consolidated financial statements.
|
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
Fiscal Years Ended July 31, 2006, 2005 and 2004
| |
| Common Stock | | Additional
Paid-in
Capital | | Retained
Earnings | | Treasury Stock | | Deferred
Compensation | | Stockholders’
Equity | | Comprehensive
Income | |
|---|
| |
| | | |
| | | | |
|---|
| Shares | | Amount | | | | Shares | | Amount | | | | |
|---|
| |
| |
| |
| |
| |
| |
| |
| |
| |
| | | Balance July 31, 2003 | 21,031,153 | | $ | 2,103,000 | | $ | 106,872,000 | | $ | 8,884,000 | | | 210,937 | | $ | (185,000 | ) | $ | (106,000 | ) | $ | 117,568,000 | | $ | 9,709,000 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Amortization of deferred
compensation | — | | | — | | | — | | | — | | | — | | | — | | | 106,000 | | | 106,000 | | | — | | Issuance of shares - stock options
exercised and related income
tax benefit | 450,210 | | | 45,000 | | | 2,470,000 | | | — | | | — | | | — | | | — | | | 2,515,000 | | | — | | Issuance of shares - employee
stock purchase plan | 28,269 | | | 3,000 | | | 352,000 | | | — | | | — | | | — | | | — | | | 355,000 | | | — | | Issuance of shares - warrants
exercised | 47,370 | | | 5,000 | | | 22,000 | | | — | | | — | | | — | | | — | | | 27,000 | | | — | | | Net income | — | | | — | | | — | | | 21,827,000 | | | — | | | — | | | — | | | 21,827,000 | | | 21,827,000 | | | |
| |
| |
| |
| |
| |
| |
| |
| |
| | | | | Balance July 31, 2004 | 21,557,002 | | | 2,156,000 | | | 109,716,000 | | | 30,711,000 | | | 210,937 | | | (185,000 | ) | | — | | | 142,398,000 | | | 21,827,000 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Issuance of shares - stock options
exercised and related income
tax benefit | 1,209,799 | | | 121,000 | | | 17,012,000 | | | — | | | — | | | — | | | — | | | 17,133,000 | | | — | | Issuance of shares - employee
stock purchase plan | 28,827 | | | 3,000 | | | 517,000 | | | — | | | — | | | — | | | — | | | 520,000 | | | — | | Termination of unvested restricted
shares issued pursuant to
employee stock award
agreement | (13,950 | ) | | (2,000 | ) | | (75,000 | ) | | — | | | — | | | — | | | — | | | (77,000 | ) | | Net income | — | | | — | | | — | | | 36,655,000 | | | — | | | — | | | — | | | 36,655,000 | | | 36,655,000 | | | |
| |
| |
| |
| |
| |
| |
| |
| |
| | | | | Balance July 31, 2005 | 22,781,678 | | | 2,278,000 | | | 127,170,000 | | | 67,366,000 | | | 210,937 | | | (185,000 | ) | | — | | | 196,629,000 | | | 36,655,000 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Stock-based compensation
programs | — | | | — | | | 5,742,000 | | | — | | | — | | | — | | | — | | | 5,742,000 | | | — | | Issuance of shares - stock
options exercised and related
income tax benefit | 244,737 | | | 24,000 | | | 5,904,000 | | | — | | | — | | | — | | | — | | | 5,928,000 | | | — | | Issuance of shares - employee
stock purchase plan | 26,178 | | | 3,000 | | | 671,000 | | | — | | | — | | | — | | | — | | | 674,000 | | | — | | | Net income | — | | | — | | | — | | | 45,269,000 | | | — | | | — | | | — | | | 45,269,000 | | | 45,269,000 | | | |
| |
| |
| |
| |
| |
| |
| |
| |
| | | | | Balance July 31, 2006 | 23,052,593 | | $ | 2,305,000 | | $ | 139,487,000 | | $ | 112,635,000 | | | 210,937 | | $ | (185,000 | ) | $ | — | | $ | 254,242,000 | | $ | 45,269,000 | | | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| See accompanying notes to consolidated financial statements. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Fiscal Years Ended July 31, 2006, 2005 and 2004
| |
| 2006 | | 2005 | | 2004 | |
|---|
| |
| |
| |
| | | Cash flows from operating activities: | | | | | | | | | Net income | $ | 45,269,000 | | 36,655,000 | | 21,827,000 | | Adjustments to reconcile net income to net cash provided by
operating activities: | | | | | | | | | Depreciation and amortization of property, plant and equipment | | 6,242,000 | | 5,315,000 | | 4,341,000 | | | Amortization of intangible assets with finite lives | | 2,465,000 | | 2,328,000 | | 2,067,000 | | | Amortization of stock-based compensation | | 5,681,000 | | — | | — | | | Amortization of deferred compensation | | — | | — | | 106,000 | | | Amortization of deferred financing costs | | 546,000 | | 546,000 | | 280,000 | | | Loss on disposal of property, plant and equipment | | 36,000 | | 284,000 | | 91,000 | | | Write-off of in-process research and development | | — | | — | | 940,000 | | | Provision for allowance for doubtful accounts | | 748,000 | | 287,000 | | 147,000 | | | Provision for excess and obsolete inventory | | 2,030,000 | | 2,098,000 | | 1,193,000 | | | Income tax benefit from stock option exercises | | — | | 9,896,000 | | 1,001,000 | | | Excess income tax benefit from stock option exercises | | (4,065,000 | ) | — | | — | | | Deferred income tax expense | | 832,000 | | 2,768,000 | | 2,079,000 | | Changes in assets and liabilities, net of effects of
acquisitions: | | Restricted cash securing letter of credit obligations | | 31,000 | | 3,020,000 | | 234,000 | | | Accounts receivable | | (14,743,000 | ) | (13,337,000 | ) | (16,453,000 | ) | | Inventories | | (17,909,000 | ) | (7,236,000 | ) | (5,152,000 | ) | | Prepaid expenses and other current assets | | (2,791,000 | ) | (2,373,000 | ) | 284,000 | | | Other assets | | (260,000 | ) | 69,000 | | 44,000 | | | Accounts payable | | 4,760,000 | | 14,011,000 | | (1,961,000 | ) | | Accrued expenses and other current liabilities | | 7,733,000 | | 12,532,000 | | 6,915,000 | | | Customer advances and deposits | | (1,738,000 | ) | (2,008,000 | ) | 4,799,000 | | | Deferred service revenue | | 1,686,000 | | (5,506,000 | ) | 2,556,000 | | | Interest payable | | — | | (23,000 | ) | 1,073,000 | | | | | | | Income taxes payable | | 7,777,000 | | (3,272,000 | ) | (2,133,000 | ) | | |
| |
| |
| | | Net cash provided by operating activities | | 44,330,000 | | 56,054,000 | | 24,278,000 | | | |
| |
| |
| | | | | Cash flows from investing activities: | | | | | | | | | Purchases of property, plant and equipment | | (12,327,000 | ) | (9,532,000 | ) | (6,591,000 | ) | | Purchases of other intangibles with finite lives | | (197,000 | ) | (75,000 | ) | — | | | | | | | Payments for business acquisitions | | (1,000,000 | ) | (2,735,000 | ) | (5,187,000 | ) | | |
| |
| |
| | | Net cash used in investing activities | | (13,524,000 | ) | (12,342,000 | ) | (11,778,000 | ) | | |
| |
| |
| | | | | Cash flows from financing activities: | | | | | | | | | Net proceeds from issuance of convertible senior notes | | — | | — | | 101,179,000 | | | Principal payments on other obligations | | (234,000 | ) | (271,000 | ) | (900,000 | ) | | | | | | Excess income tax benefit from stock option exercises | | 4,065,000 | | — | | — | | | Proceeds from exercises of stock options and warrants | | 1,863,000 | | 7,160,000 | | 1,541,000 | | | | | | | Proceeds from issuance of employee stock purchase plan shares | | 674,000 | | 520,000 | | 355,000 | | | |
| |
| |
| | | Net cash provided by financing activities | | 6,368,000 | | 7,409,000 | | 102,175,000 | | | |
| |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended July 31, 2006, 2005 and 2004
| |
| 2006 | | 2005 | | 2004 | |
|---|
| |
| |
| |
| | | | | Net increase in cash and cash equivalents | $ | 37,174,000 | | | 51,121,000 | | | 114,675,000 | | | | | | | Cash and cash equivalents at beginning of period | | 214,413,000 | | | 163,292,000 | | | 48,617,000 | | | |
| | |
| | |
| | | Cash and cash equivalents at end of period | $ | 251,587,000 | | | 214,413,000 | | | 163,292,000 | | | | | | | |
| | |
| | |
| | | Supplemental cash flow disclosure | | | | Cash paid during the period for: | | Interest | $ | 2,142,000 | | | 2,156,000 | | | 55,000 | | | |
| | |
| | |
| | | | | Income taxes | $ | 16,573,000 | | | 7,456,000 | | | 9,324,000 | | | |
| | |
| | |
| | | Non cash investing activities: | | | | | | | Purchase of proprietary technology through financing
obligation | $ | — | | | 509,000 | | | — | | | | | | | |
| | |
| | |
| | | Accrued business acquisition payments (See Note 2) | $ | — | | | 1,000,000 | | | — | | | |
| | |
| | |
| |
| See accompanying notes to consolidated financial statements.
|
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting and Reporting Policies
| |
| (a) | Principles of Consolidation | | | |
The accompanying consolidated financial statements include the accounts of Comtech Telecommunications Corp. and its subsidiaries (“the Company”), all of which are wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation.
| (b) | The accompanying consolidated financial statements include the accounts of Comtech Telecommunications Corp. and its subsidiaries (“the Company”), all of which are wholly owned. All significant intercompany balances and transactions have been eliminated in consolidation. | | |
| | The Company designs, develops, produces and markets innovative products, systems and services for advanced communications solutions. |
| | | | | The Company’s business is highly competitive and characterized by rapid technological change. The Company’s growth and financial position depends, among other things, on its ability to keep pace with such changes and developments and to respond to the sophisticated requirements of an increasing variety of electronic equipment users. Many of the Company’s competitors are substantially larger, and have significantly greater financial, marketing and operating resources and broader product lines than the Company. A significant technological breakthrough by others, including smaller competitors or new companies, could have a material adverse effect on the Company’s business. In addition, certain of the Company’s customers have technological capabilities in the Company’s product areas and could choose to replace the Company’s products with their own. |
| | | | | International sales expose the Company to certain risks, including barriers to trade, fluctuations in foreign currency exchange rates (which may make the Company’s products less price competitive), political and economic instability, availability of suitable export financing, export license requirements, tariff regulations, and other United States (“U.S.”) and foreign regulations that may apply to the export of the Company’s products, as well as the generally greater difficulties of doing business abroad. The Company attempts to reduce the risk of doing business in foreign countries by seeking contracts denominated in U.S. dollars, advance or milestone payments, credit insurance and irrevocable letters of credit in its favor. |
| | | | | PursuantThe Company currently provides mobile data communications products and services to a contract award issued in July 1999, the Company is currently the sole provider of the U.S. Army logistics community’s Movement Tracking System (“MTS”). The contact expires in July 2007,government under contracts which can be terminated at any time and isare not subject to automatic renewals or extension. The loss of the MTS contractthese contracts would have a material adverse effect on the Company’s future business, results of operations and financial condition. | | | |
| | Revenue is generally recognized when the earnings process is complete, upon shipment or customer acceptance. Revenue from contracts relating to the design, development or manufacturing of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts is recognized using the percentage-of-completion method. Revenue recognition using the percentage-of-completion method is based on the relationship of total costs incurred to total projected costs, or, alternatively, based on output measures, such as units delivered. Provision for anticipated losses on uncompleted contracts is made in the period in which such losses become evident. | | | | The Company has historically demonstrated an ability to estimate contract revenues and expenses in applying the percentage-of-completion method of accounting. However, there exist risks and uncertainties in estimating future revenues and expenses, particularly on larger or longer-term contracts. Changes to such estimates could have a material effect on the Company’s consolidated financial position and results of operations.Recognition |
Revenue is generally recognized when the earnings process is complete, upon shipment or customer acceptance. Revenue from contracts relating to the design, development or manufacture of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts is generally recognized in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”). The Company primarily applies the percentage-of-completion method and generally recognizes revenue based on the relationship of total costs incurred to total projected costs, or, alternatively, based on output measures, such as units delivered or produced. Profits expected to be realized on such contracts are based on total estimated sales for the contract compared to total estimated costs, including warranty 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. Provision for anticipated losses on uncompleted contracts is made in the period in which such losses become evident. Long-term, U.S. government, cost-reimbursable type contracts are also specifically covered by Accounting Research Bulletin No. 43 “Government Contracts, Cost-Plus-Fixed-Fee Contracts” (“ARB 43”), in addition to SOP 81-1. COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company has historically demonstrated an ability to estimate contract revenues and expenses in applying the percentage-of-completion method of accounting. However, there exist risks and uncertainties in estimating future revenues and expenses, particularly on larger or longer-term contracts. Changes to such estimates could have a material effect on the Company’s consolidated financial condition and results of operations.
Revenue recognized in excess of amounts billable under long-term contracts accounted for under the percentage-of-completion method are recorded as unbilled receivables in the accompanying consolidated balance sheets. Unbilled receivables are billable upon various events, including the attainment of performance milestones, delivery of hardware, submission of progress bills based on time and materials, or completion of the contract.
In the case of the Company’s mobile data communications segment’s Movement Tracking System (“MTS”) and Force XXI Battle Command, Brigade and Below command and control systems (also known as Blue Force Tracking (“BFT”)) contracts with the U.S. Army, the Company utilizes the percentage-of-completion method. The Company does not recognize revenue, or record unbilled receivables, until it receives fully funded orders.
Almost all of the Company’s U.S. government revenues in fiscal 2008, 2007 and 2006 are derived from firm fixed-price contracts. Under these types of contracts, the Company performs for an agreed-upon price and derives benefits from cost savings, but bears the risk of cost overruns. The Company’s cost-plus-fixed-fee contracts, which to date have been insignificant, typically provide for reimbursement of allowable costs incurred plus a negotiated fee.
Most government contracts have termination for convenience clauses that provide the customer with the right to terminate the contract at any time. Historically, the Company has not experienced material contract terminations or write-offs of unbilled receivables. The Company addresses customer acceptance provisions in assessing its ability to perform its contractual obligations under long-term contracts. Historically, the Company has been able to perform on its long-term contracts.
Revenue from contracts that contain multiple elements that are not accounted for under the percentage-of-completion method are accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Revenue from these contracts is allocated to each respective element based on each element’s relative fair value, if determinable, and is recognized when the respective revenue recognition criteria for each element are met.
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| Revenue recognized in excess of amounts billable under long-term contracts accounted for under the percentage-of-completion method are recorded as unbilled receivables in the accompanying consolidated balance sheets. Unbilled receivables are billable upon various events, including the attainment of performance milestones, delivery of hardware, submission of progress bills based on time and materials, or completion of the contract. | | | | In the case of the Company’s mobile data communications segment’s MTS contract with the U.S. Army, the Company utilizes the percentage-of-completion method and estimates total contract revenues, which are subject to annual funding appropriations. However, the Company does not recognize revenue, or record unbilled receivables, until it receives fully funded orders. MTS service-time revenue is recognized based on a network availability method which recognizes prepaid service time on a straight-line basis from the date of shipment through the end of the contract term in July 2007. | | | | Most government contracts have termination for convenience clauses that provide the customer with the right to terminate the contract at any time. Historically, the Company has not experienced material contract terminations or write-offs of unbilled receivables. The Company addresses customer acceptance provisions in assessing its ability to perform its contractual obligations under long-term contracts. Historically, the Company has been able to perform on its long-term contracts. | | | | Revenue from contracts that contain multiple elements that are not accounted for under the percentage-of-completion method are accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Revenue from these contracts is allocated to each respective element based on each element’s relative fair value and is recognized when the respective revenue recognition criteria for each element are met. | | |
| (d) | Cash, Cash Equivalents and Restricted Cash | | | |
| | Cash equivalents are temporary cash investments with a maturity of three months or less when purchased.and Cash equivalents, primarily U.S. treasury securities with a maturity of three months or less, at July 31, 2006 and 2005 amounted to $231,261,000 and $205,527,000, respectively. These investments are carried at cost, which approximates fair market value. Restricted cash as of July 31, 2006 and 2005 represents the amount the Company has pledged against guarantees of performance on certain of its contracts. | | Equivalents |
The Company’s cash equivalents are short-term, highly liquid investments that are both readily convertible to known amounts of cash and that have insignificant risk of change in value because of changes in interest rates. The Company’s cash and cash equivalents, as of July 31, 2008 and 2007, amounted to $410,067,000 and $342,903,000, respectively, and primarily consist of money market funds and U.S. Treasury securities (with maturities at the time of purchase of three months or less). None of the Company's cash equivalents include municipal auction-rate securities. Cash equivalents are carried at cost, which approximates fair market value.
Work-in-process inventory reflects all accumulated production costs, which are comprised of direct production costs and overhead, and is reduced by amounts recorded in cost of sales as the related revenue is recognized. These inventories are reduced to their estimated net realizable value by a charge to cost of sales in the period such excess costs are determined.
Raw materials and components and finished goods inventory are stated at the lower of cost or market, computed on the first-in, first-out (“FIFO”) method.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| (f) | Work-in-process inventory reflects all accumulated production costs, which are comprised of direct production costs and overhead, and is reduced by amounts recorded in cost of sales as the related revenue is recognized. These inventories are reduced to their estimated net realizable value by a charge to cost of sales in the period such excess costs are determined. | | | | Raw materials and components and finished goods inventory are stated at the lower of cost or market, computed on the first-in, first-out (“FIFO”) method. | | Long-Lived Assets |
The Company’s machinery and equipment, which are recorded at cost, are depreciated or amortized over their estimated useful lives (three to eight years) under the straight-line method. Capitalized values of properties and leasehold improvements under leases are amortized over the life of the lease or the estimated life of the asset, whichever is less.
Goodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired. In accordance with the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized. The Company periodically, at least on an annual basis, reviews goodwill, considering factors such as projected cash flows and revenue and earnings multiples, to determine whether the carrying value of the goodwill is impaired. If the goodwill is deemed to be impaired, the difference between the carrying amount reflected in the financial statements and the estimated fair value is recognized as an expense in the period in which the impairment occurs. The Company defines its reporting units to be the same as its segments.
The Company assesses the recoverability of the carrying value of its other long-lived assets, including identifiable intangible assets with finite useful lives, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates the recoverability of such assets based upon the expectations of undiscounted cash flows from such assets. If the sum of the expected future undiscounted cash flows were less than the carrying amount of the asset, a loss would be recognized for the difference between the fair value and the carrying amount.
| The Company’s machinery and equipment, which are recorded at cost, are depreciated or amortized over their estimated useful lives (three to eight years) under the straight-line method. Capitalized values of properties and leasehold improvements under leases are amortized over the life of the lease or the estimated life of the asset, whichever is less. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| Goodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired. In accordance with the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized. The Company periodically, at least on an annual basis, reviews goodwill, considering factors such as projected cash flows and revenue and earnings multiples, to determine whether the carrying value of the goodwill is impaired. If the goodwill is deemed to be impaired, the difference between the carrying amount reflected in the financial statements and the estimated fair value is recognized as an expense in the period in which the impairment occurs. The Company defines its reporting units to be the same as its segments. | | | | The Company assesses the recoverability of the carrying value of its other long-lived assets, including identifiable intangible assets with finite useful lives, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates the recoverability of such assets based upon the expectations of undiscounted cash flows from such assets. If the sum of the expected future undiscounted cash flows were less than the carrying amount of the asset, a loss would be recognized for the difference between the fair value and the carrying amount. | | |
| (g) | Research and Development Costs | | | |
The Company charges research and development costs to operations as incurred, except in those cases in which such costs are reimbursable under customer funded contracts. In fiscal 2008, 2007 and 2006, the Company was reimbursed by customers for such activities in the amount of $7,752,000, $4,170,000 and $4,409,000, respectively.
| The Company charges research and development costs to operations as incurred, except in those cases in which such costs are reimbursable under customer funded contracts. In fiscal 2006, 2005 and 2004, the Company was reimbursed by customers for such activities in the amount of $4,409,000, $3,001,000 and $5,749,000, respectively. | | |
| | Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. | | Taxes |
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company’s policy is to recognize interest and penalties related to uncertain tax positions in income tax expense.
In July 2006, the FASB released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law and prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 prescribes a two-step evaluation process for tax positions. The first step is recognition based on a determination of whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is to measure a tax position that meets the more-likely-than-not threshold. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements. The Company adopted FIN 48 on August 1, 2007 and its adoption had no material impact on the Company’s consolidated results of operations or financial condition.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| (i) | (i) | 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 dilution from potential common stock issuable pursuant to the exercise of equity-classified stock-based awards and convertible senior notes, if dilutive, outstanding during each period. Equity-classified stock-based awards to purchase 601,000, 706,000 and 712,000 shares for fiscal 2008, 2007 and 2006, respectively, were not included in the EPS calculation because their effect would have been anti-dilutive.
Liability-classified stock-based awards do not impact and are not included in the denominator for EPS calculations. In accordance with EITF Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share,” the Company includes the impact of the assumed conversion of its 2.0% convertible senior notes in calculating diluted EPS.
The following table reconciles the numerators and denominators used in the basic and diluted EPS calculations:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | Numerator: | | | | | | | | | | | Net income for basic calculation | | $ | 76,433,000 | | | | 65,213,000 | | | | 45,269,000 | | | Effect of dilutive securities: | | | | | | | | | | | | | Interest expense (net of tax) on convertible senior notes | | | 1,667,000 | | | | 1,667,000 | | | | 1,662,000 | | | Numerator for diluted calculation | | $ | 78,100,000 | | | | 66,880,000 | | | | 46,931,000 | | | | | | | | | | | | | | | | | Denominator: | | | | | | | | | | | | | | Denominator for basic calculation | | | 24,138,000 | | | | 23,178,000 | | | | 22,753,000 | | | Effect of dilutive securities: | | | | | | | | | | | | | | Stock options | | | 807,000 | | | | 1,092,000 | | | | 1,238,000 | | Conversion of convertible senior notes | | | 3,333,000 | | | | 3,333,000 | | | | 3,333,000 | | | Denominator for diluted calculation | | | 28,278,000 | | | | 27,603,000 | | | | 27,324,000 | |
| (j) | 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 dilution from potential common stock issuable pursuant to the exercise of stock options, warrants and convertible senior notes, if dilutive, outstanding during each period. Stock options to purchase 712,000, 49,000 and 105,000 shares for fiscal 2006, 2005 and 2004, respectively, were not included in the EPS calculation because their effect would have been anti-dilutive. | | | | In accordance with EITF Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share,” the Company has (i) included the impact of the assumed conversion of its 2.0% convertible senior notes in calculating diluted EPS commencing in the fiscal quarter ended January 31, 2005 and (ii) restated prior periods’ diluted EPS for comparative purposes. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| The following table reconciles the numerators and denominators used in the basic and diluted EPS calculations: | | |
| | |
| |
|---|
| | | Fiscal Years Ended July 31, | |
|---|
| | |
| |
|---|
| | | 2006 | | 2005 | | 2004 | |
|---|
| | |
| |
| |
| | | | Numerator: | | | | | | | | | | Net income for basic calculation | $ | 45,269,000 | | 36,655,000 | | 21,827,000 | | | | Effect of dilutive securities: | | | | | | | | | | Interest expense (net of tax) on
convertible senior notes | | 1,662,000 | | 1,817,000 | | 925,000 | | | | |
| |
| |
| | | | Numerator for diluted calculation | $ | 46,931,000 | | 38,472,000 | | 22,752,000 | | | | |
| |
| |
| | | | | | Denominator: | | | | | | | | | | Denominator for basic calculation | | 22,753,000 | | 21,673,000 | | 21,178,000 | | | | Effect of dilutive securities: | | | Stock options | | 1,238,000 | | 2,058,000 | | 1,890,000 | | | | Conversion of convertible
senior notes | | 3,333,000 | | 3,333,000 | | 1,713,000 | | | | |
| |
| |
| | | | Denominator for diluted calculation | | 27,324,000 | | 27,064,000 | | 24,781,000 | | | | |
| |
| |
| |
| | | | (j) | Accounting for Stock-Based Compensation | | | |
Effective August 1, 2005, the Company adopted the provisions of SFAS No. 123(R), “Share-Based Payment,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No. 123(R), stock-based compensation for both equity and liability-classified awards is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant). The fair value of liability-classified awards is remeasured at the end of each reporting period until the award is settled, with changes in fair value recognized pro-rata for the portion of the requisite service period rendered. The Company used the modified prospective method upon adopting SFAS No. 123(R).
Under the modified prospective method, SFAS No. 123(R) applies to new awards and to awards outstanding on the effective date that are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service had not been fully rendered as of July 31, 2005 is being recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under SFAS No. 123. Through July 31, 2007, the Company valued graded vesting awards based on vesting tranches. Effective August 1, 2007, the Company values graded vesting awards based on the entire award. The Company amortizes the fair value of all awards on a straight-line basis over the total requisite service period. Cumulative compensation expense recognized at any date will at least equal the grant date fair value of the vested portion of the award at that time. Additionally, the Company includes the excess hypothetical tax benefit related to stock-based awards which were fully vested upon adoption of SFAS No. 123(R) when calculating earnings per share. COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued The Company recognized stock-based compensation for awards issued under the Company’s Stock Option Plans and the Company’s 2001 Employee Stock Purchase Plan (the “ESPP”) in the following line items in the Consolidated Statements of Operations:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | Cost of sales | | $ | 777,000 | | | | 539,000 | | | | 385,000 | | | Selling, general and administrative expenses | | | 8,129,000 | | | | 5,793,000 | | | | 4,585,000 | | | Research and development expenses | | | 1,734,000 | | | | 1,069,000 | | | | 711,000 | | Stock-based compensation expense before income tax benefit | | | 10,640,000 | | | | 7,401,000 | | | | 5,681,000 | | | Income tax benefit | | | (3,648,000 | ) | | | (2,394,000 | ) | | | (1,312,000 | ) | | Net stock-based compensation expense | | $ | 6,992,000 | | | | 5,007,000 | | | | 4,369,000 | |
Of the total stock-based compensation expense before income tax benefit recognized in fiscal 2008, 2007 and 2006, $220,000, $170,000 and $163,000, respectively, relates to stock-based awards issued pursuant to the ESPP. Of the total stock-based compensation expense before income tax recognized in fiscal 2008, 2007 and 2006, $154,000, $38,000 and $0, respectively, related to awards of stock appreciation rights (“SARs”). The Company’s liability-classified SARs are remeasured at fair value at the end of each reporting period.
Stock-based compensation that was capitalized and included in ending inventory at July 31, 2008, 2007 and 2006 was $215,000, $106,000 and $61,000, respectively.
The Company estimates the fair value of stock-based awards using the Black-Scholes option pricing model. The Black-Scholes option pricing model includes assumptions regarding dividend yield, expected volatility, expected option terms and risk-free interest rates. The assumptions used in computing the fair value of stock-based awards reflect the Company’s best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of its control. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive stock-based awards.
The per share weighted average grant-date fair value of stock-based awards granted during fiscal 2008, 2007 and 2006 was $15.66, $10.85 and $14.03, respectively. In addition to the exercise and grant-date prices of the awards, certain weighted average assumptions that were used to estimate the fair value of stock-based awards in the respective periods are listed in the table below:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | Expected dividend yield | | | 0 | % | | | 0 | % | | | 0 | % | | Expected volatility | | | 43.15 | % | | | 45.14 | % | | | 51.44 | % | | Risk-free interest rate | | | 4.44 | % | | | 4.87 | % | | | 4.20 | % | | Expected life (years) | | | 3.56 | | | | 3.63 | | | | 3.63 | |
Stock-based awards granted during fiscal 2008, 2007 and 2006 have exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of five years and a vesting period of three years. All stock-based awards granted through July 31, 2005 had exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of ten years and generally a vesting period of five years. The Company settles employee stock option exercises with new shares. All SARs granted through July 31, 2008 may only be settled with cash.
The Company estimates expected volatility by considering the historical volatility of the Company’s stock, the implied volatility of publicly traded stock options in the Company’s stock and the Company’s expectations of volatility for the expected term of stock-based compensation awards. The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. The expected option term is the number of years that the Company estimates that share-based awards will be outstanding prior to exercise. The expected life of the awards issued after July 31, 2005 and through July 31, 2007 was determined using the “simplified method” COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following table provides the components of the actual income tax benefit recognized for tax deductions relating to the exercise of stock-based awards:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | Actual income tax benefit recorded for the tax deductions relating to the exercise of stock-based awards | | $ | 3,368,000 | | | | 9,366,000 | | | | 4,065,000 | | | Less: Tax benefit initially recognized on exercised stock-based awards vesting subsequent to the adoption of SFAS No. 123(R) | | | (962,000 | ) | | | (754,000 | ) | | | - | | | Excess income tax benefit recorded as an increase to additional paid-in capital in the Company’s Consolidated Statements of Stockholders’ Equity and Comprehensive Income | | | 2,406,000 | | | | 8,612,000 | | | | 4,065,000 | | | Less: Tax benefit initially disclosed but not previously recognized on exercised equity-classified stock-based awards vesting prior to the adoption of SFAS No. 123(R) | | | (32,000 | ) | | | (622,000 | ) | | | - | | | Excess income tax benefit from exercised equity-classified stock-based awards reported as a cash flow from financing activities in the Company’s Consolidated Statements of Cash Flows | | $ | 2,374,000 | | | | 7,990,000 | | | | 4,065,000 | |
At July 31, 2008, total remaining unrecognized compensation cost related to unvested stock-based awards was $10,698,000, net of estimated forfeitures of $701,000. The net cost is expected to be recognized over a weighted average period of 1.7 years.
In August 2008, the Company authorized, in accordance with the Company’s 2000 Stock Incentive Plan, 554,100 stock-based awards (including 10,000 SARs). Total unrecognized stock-based compensation, net of estimated forfeitures, related to these awards was approximately $8,205,000. These awards have exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of five years and a vesting period of three years.
| (k) | Effective August 1, 2005, the Company adopted the provisions of SFAS No. 123(R), “Share-Based Payment,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No. 123(R), stock-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant). The Company adopted SFAS No. 123(R) using the modified prospective method and, as a result, periods prior to August 1, 2005 have not been restated. | | | | The Company recognized stock-based compensation for awards issued under the Company’s Stock Option Plans and 2001 Employee Stock Purchase Plan (the “ESPP”), in the following line items in the Consolidated Statement of Operations: | | Financial Instruments |
| |
| | |
|---|
| Fiscal Year Ended
July 31, 2006 | | |
|---|
| | |
| | | | | Cost of sales | $ | 385,000 | | | | | Selling, general and administrative expenses | | 4,585,000 | | | | | Research and development expenses | | 711,000 | | | | | |
| | | | | Stock-based compensation expense before income tax benefit | | 5,681,000 | | | | | Income tax benefit | | (1,312,000 | ) | | | | |
| | | | | Net compensation expense | $ | 4,369,000 | | | | | |
| | |
The Company believes that the book value of its current monetary assets and liabilities approximates fair value as a result of the short-term nature of such assets and liabilities. The Company further believes that the fair market value of its capital lease obligations does not differ materially from the carrying value. As of July 31, 2008, the Company estimates the fair market value of its 2.0% convertible senior notes to be approximately $164,829,000 based on recent trading activity.
| (l) | | | Of the $5,681,000 of stock-based compensation expense before income tax benefit, $163,000 relates to awards issued pursuant to the ESPP. Stock-based compensation that was capitalized and included in ending inventory at July 31, 2006 was $61,000. | | | | During fiscal 2005 and 2004 (and for periods prior to August 1, 2005), the Company recorded compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Since the exercise price for such options was equal to the fair market value of the Company’s stock at the date of grant, the stock options had no intrinsic value upon grant and, therefore, no expense was recorded in those respective Consolidated Statements of Operations. | | | | Stock-based compensation expense, net of the related income tax benefit, resulted in a decrease of $0.19 and $0.14 in basic and diluted earnings per share, respectively, for fiscal 2006. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| Had the compensation cost of the Company’s employee stock award plans for fiscal 2005 and 2004 been determined in accordance with SFAS No. 123, the Company’s pro forma net income and net income per share would have been: | | |
| | |
| | |
|---|
| | | Fiscal Years Ended July 31, | | |
|---|
| | |
| | |
|---|
| | | 2005 | | 2004 | | |
|---|
| | |
| | | | | Net income, as reported | $ | 36,655,000 | | 21,827,000 | | | | | Less: Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects | | (4,236,000 | ) | (1,615,000 | ) | | | | |
| |
| | | | | Pro forma net income | $ | 32,419,000 | | 20,212,000 | | | | | |
| |
| | | | | Net income per share: | | | | | | | | | | As reported | Basic | $ | 1.69 | | 1.03 | | | | | | Diluted | $ | 1.42 | | 0.92 | | | | | | Pro forma | Basic | $ | 1.50 | | 0.95 | | | | | | Diluted | $ | 1.28 | | 0.85 | | | | | | |
| | | Under the modified prospective method, SFAS No. 123(R) applies to new awards and to awards outstanding on the effective date that are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service had not been rendered as of July 31, 2005 is being recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under SFAS No. 123. The Company has elected to value graded vesting awards based on vesting tranches. Prior to the adoption of SFAS No. 123(R), the Company valued graded vesting awards based on the entire award for purposes of pro forma disclosure. The Company amortizes the fair values of all awards on a straight-line basis over the total requisite service period. Cumulative compensation expense recognized at any date will at least equal the grant date fair value of the vested portion of the award at that time. Additionally, the Company includes the excess hypothetical tax benefit related to stock options which were fully vested upon adoption of SFAS No. 123(R) when calculating earnings per share. | | | | The Company estimates the fair value of stock options using the Black-Scholes option pricing model. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of the Company’s stock options granted during fiscal 2006. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards. | | | | The per share weighted average fair value of stock options granted during fiscal 2006, 2005 and 2004 was $14.03, $8.52 and $6.59, respectively. In addition to the exercise and grant date prices of the awards, certain weighted average assumptions that were used to estimate the fair value of stock option grants in the respective periods are listed in the table below: | | |
| |
| | | | | Fiscal Years Ended July 31, | | | |
| | |
|---|
| | 2006 | | 2005 | | 2004 | | | | | | | | |
| |
| |
| | | | | Expected dividend yield | | | | 0 | % | 0 | % | 0 | % | | | | Expected volatility | | | | 51.44 | % | 64.83 | % | 53.67 | % | | | | Risk-free interest rate | | | | 4.20 | % | 3.70 | % | 3.31 | % | | | | Expected life (years) | | | | 3.63 | | 5.00 | | 5.00 | | |
| | | Options granted during fiscal 2006 have exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of five years and a vesting period of three years. All options granted through July 31, 2005 had exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of ten years and generally a vesting period of five years. As of July 31, 2006, the weighted average estimated forfeiture rate was 8.2%. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| The Company estimates expected volatility by considering the historical volatility of the Company’s stock, the implied volatility of publicly traded stock options in the Company’s stock and the Company’s expectations of volatility for the expected term of stock-based compensation awards. The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. The expected option term is the number of years that the Company estimates that options will be outstanding prior to exercise. The expected term of the awards issued after July 31, 2005 was determined using the “simplified method” prescribed in SEC Staff Accounting Bulletin (“SAB”) No. 107. | | | | The actual income tax benefit recorded relating to the exercise of stock option awards was $4,065,000 for fiscal 2006 and is classified as a financing cash inflow in the Company’s Consolidated Statement of Cash Flows. Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits related to stock-based compensation as an operating cash inflow. The actual income tax benefit recorded relating to the exercise of stock option awards was $9,896,000 and $1,001,000 for fiscal 2005 and 2004, respectively. The Company settles employee stock option exercises with new shares. | | | | At July 31, 2006, total remaining unrecognized compensation cost related to unvested stock-based payment awards was $12,541,000, net of estimated forfeitures. That cost is expected to be recognized over a weighted average period of 2.4 years. | | | | On August 1, 2006, the first day of the Company’s 2007 fiscal year, the Company authorized, in accordance with the Company’s 2000 Stock Incentive Plan, the award of stock options to purchase a total of 635,100 shares of common stock. Total unrecognized compensation cost, net of estimated forfeitures, related to this award was $6,359,000. The compensation cost related to these options will be recognized on a straight-line basis over the related three-year service period. | | |
| The Company believes that the book value of its current monetary assets and liabilities approximates fair value as a result of the short-term nature of such assets and liabilities. The Company further believes that the fair market value of its capital lease obligations does not differ materially from the carrying value. As of July 31, 2006, the Company estimates the fair market value of its 2.0% convertible senior notes to be $109,000,000 based on recent trading activity. | | |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management 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 financial statements and the reported amounts of revenues and expenses during the reported period. The Company makes significant estimates in many areas of its accounting, including but not limited to the following: long-term contracts, stock-based compensation, intangible assets, provision for excess and obsolete inventory, allowance for doubtful accounts, warranty obligations and income taxes. Actual results may differ from those estimates.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued | (m) | The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management 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 financial statements and the reported amounts of revenues and expenses during the reported period. The Company makes significant estimates in many areas of its accounting, including but not limited to the following: long-term contracts, stock-based compensation, intangible assets, provision for excess and obsolete inventory, allowance for doubtful accounts, warranty obligations and income taxes. Actual results may differ from those estimates. | | Comprehensive Income |
The Company has adopted SFAS No. 130, “Reporting Comprehensive Income,” which requires companies to report all changes in equity during a period, except those resulting from investment by owners and distribution to owners, for the period in which they are recognized. Comprehensive income is the total of net income and all other non-owner changes in equity (or other comprehensive income) such as unrealized gains/losses on securities classified as available-for-sale, foreign currency translation adjustments and minimum pension liability adjustments. Comprehensive income was the same as net income in fiscal 2008, 2007 and 2006.
| (n) | (m) | Comprehensive Income | | | Reclassifications |
Certain reclassifications have been made to previously reported consolidated financial statements to conform to the fiscal 2008 presentation.
(2) Acquisitions
In August 2006, the Company acquired certain assets and assumed certain liabilities of Insite Consulting, Inc. (“Insite”), a logistics application software company, for $3,203,000, including transaction costs of $232,000. In addition to the guaranteed purchase price, the Company may be required to make certain earn-out payments based on the achievement of future sales targets. The first part of the earn-out cannot exceed $1,350,000 and is limited to a five-year period. The second part of the earn-out, which is for a ten-year period, is unlimited and based on a per unit future sales target primarily relating to new commercial satellite-based mobile data communication markets. As of July 31, 2008, no earn-out payments have been made. Insite has developed the geoOps™ Enterprise Location Management System, a software-based solution that allows customers to integrate legacy data systems with near-real time logistics and operational data systems. Sales and income relating to the Insite assets acquired have not been material to the Company’s results of operations. This operation was combined with the Company’s existing business and is part of the mobile data communications segment.
In February 2007, the Company acquired certain assets and assumed certain liabilities of Digicast Networks, Inc. (“Digicast”), a manufacturer of digital video broadcasting equipment, for $1,000,000. Sales and income related to the Digicast assets acquired were not material to the Company’s results of operations. This operation was combined with the Company’s existing business and is part of the telecommunications transmission segment.
In July 2008, the Company acquired certain assets and assumed certain liabilities of Verso Technologies (“Verso”), a manufacturer of digital video broadcasting equipment, for $3,917,000. Sales and income related to the Verso assets acquired were not material to the Company’s results of operations. This operation was combined with the Company’s existing business and is part of the telecommunications transmission segment.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The Company allocated the purchase price of these acquisitions as follows:
| | | Insite | | | Digicast | | | Verso | | Estimated Useful Lives | | Fair value of net tangible assets acquired | | $ | 335,000 | | | | 408,000 | | | | 1,338,000 | | | | | | | | | | | | | | | | | | | Adjustments to record intangible assets at fair value: | | | | | | | | | | | | | | | Existing technology | | | 447,000 | | | | - | | | | 2,579,000 | | 7 years | | Other intangibles | | | 302,000 | | | | 592,000 | | | | - | | 1 to 10 years | | Goodwill | | | 2,119,000 | | | | - | | | | - | | Indefinite | | | | | 2,868,000 | | | | 592,000 | | | | 2,579,000 | | | | Aggregate purchase price | | $ | 3,203,000 | | | | 1,000,000 | | | | 3,917,000 | | |
The allocation of the Verso purchase price is preliminary and is expected to be completed within one year of the acquisition. The valuation of technology was based primarily on the discounted capitalization of royalty expense saved because the Company now owns the asset. The valuation of other intangibles was primarily based on the value of the discounted cash flows that the related assets could be expected to generate in the future.
(3) Accounts Receivable
Accounts receivable consist of the following at July 31, 2008 and 2007: | | | 2008 | | | 2007 | | | Billed receivables from the U.S. government and its agencies | | $ | 34,911,000 | | | | 38,773,000 | | | Billed receivables from commercial customers | | | 31,758,000 | | | | 33,859,000 | | | Unbilled receivables on contracts-in-progress | | | 4,672,000 | | | | 1,638,000 | | | | | | 71,341,000 | | | | 74,270,000 | | | Less allowance for doubtful accounts | | | 1,301,000 | | | | 685,000 | | Accounts receivable, net | | $ | 70,040,000 | | | | 73,585,000 | |
Unbilled receivables on contracts-in-progress include $2,854,000 and $1,308,000 at July 31, 2008 and July 31, 2007, respectively, due from the U.S. government and its agencies. There was $145,000 and $0 of retainage included in unbilled receivables at July 31, 2008 and July 31, 2007, respectively. In the opinion of management, substantially all of the unbilled balances will be billed and collected within one year.
(4) Inventories
Inventories consist of the following at July 31, 2008 and 2007: | | | 2008 | | | 2007 | | | Raw materials and components | | $ | 41,047,000 | | | | 32,669,000 | | | Work-in-process and finished goods | | | 53,120,000 | | | | 37,822,000 | | | | | | 94,167,000 | | | | 70,491,000 | | | Less reserve for excess and obsolete inventories | | | 8,201,000 | | | | 8,504,000 | | Inventories, net | | $ | 85,966,000 | | | | 61,987,000 | |
Inventories directly related to long-term contracts, including the Company’s MTS and BFT contracts with the U.S. Army, were $29,081,000 and $6,547,000 at July 31, 2008 and July 31, 2007, respectively. At July 31, 2008 and July 31, 2007, $4,336,000 and $2,286,000, respectively, of the inventory balance above related to contracts from third party commercial customers to outsource their manufacturing.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Property, Plant and Equipment
Property, plant and equipment consist of the following at July 31, 2008 and 2007:
| | | 2008 | | | 2007 | | | Machinery and equipment | | $ | 75,800,000 | | | | 64,562,000 | | | Leasehold improvements | | | 6,275,000 | | | | 5,185,000 | | | Equipment financed by capital lease | | | 52,000 | | | | 243,000 | | | | | | 82,127,000 | | | | 69,990,000 | | | Less accumulated depreciation and amortization | | | 47,858,000 | | | | 40,708,000 | | Property, plant and equipment, net | | $ | 34,269,000 | | | | 29,282,000 | |
Depreciation and amortization expense on property, plant and equipment amounted to approximately $9,196,000, $7,536,000 and $6,242,000 for the fiscal years ended July 31, 2008, 2007 and 2006, respectively.
(6) Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following at July 31, 2008 and 2007:
| | | 2008 | | | 2007 | | | Accrued wages and benefits | | $ | 23,680,000 | | | | 20,695,000 | | | Accrued warranty obligations | | | 12,308,000 | | | | 9,685,000 | | | Accrued commissions and royalties | | | 4,882,000 | | | | 6,751,000 | | | Accrued business acquisition payments | | | 1,169,000 | | | | 290,000 | | | Other | | | 7,632,000 | | | | 9,911,000 | | Accrued expenses and other current liabilities | | $ | 49,671,000 | | | | 47,332,000 | |
The Company provides warranty coverage for most of its products for a period of at least one year from the date of shipment. The Company records a liability for estimated warranty expense based on historical claims, product failure rates and other factors. Some of the Company’s product warranties are provided under long-term contracts, the costs of which are incorporated into the Company’s estimates of total contract costs.
Changes in the Company’s product warranty liability during the fiscal years ended July 31, 2008 and 2007 were as follows:
| | | 2008 | | | 2007 | | | Balance at beginning of period | | $ | 9,685,000 | | | | 10,468,000 | | | Provision for warranty obligations | | | 8,131,000 | | | | 5,417,000 | | | Reversal of warranty liability | | | (1,026,000 | ) | | | (1,056,000 | ) | | Charges incurred | | | (4,482,000 | ) | | | (5,144,000 | ) | | Balance at end of period | | $ | 12,308,000 | | | | 9,685,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Other Obligations
Other obligations consist of the following at July 31, 2008 and 2007: | | | 2008 | | | 2007 | | | Obligations under capital leases and for technology purchase | | $ | 108,000 | | | | 243,000 | | | Less current installments | | | 108,000 | | | | 135,000 | | | | | $ | - | | | | 108,000 | |
Other obligations in fiscal 2007 related to certain equipment and a technology license. Other obligations at July 31, 2008 only related to a technology license. The net carrying value of assets acquired under these obligations was $348,000 and $589,000 at July 31, 2008 and 2007, respectively.
Future minimum lease payments under other obligations as of July 31, 2008 are $108,000, net of $5,000 representing interest at a rate of 8.0%, all of which is current.
(8) 2.0% Convertible Senior Notes due 2024
On January 27, 2004, the Company issued $105,000,000 of its 2.0% convertible senior notes in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. The net proceeds from this transaction were $101,179,000 after deducting the initial purchaser’s discount and other transaction costs of $3,821,000.
The notes bear interest at an annual rate of 2.0% and, during certain periods, the notes are convertible into shares of the Company's common stock at an initial conversion price of $31.50 per share (a conversion rate of 31.7460 shares per $1,000 original principal amount of notes), subject to adjustment in certain circumstances. The notes may be converted if, during a conversion period on each of at least 20 trading days, the closing sale price of the Company’s common stock exceeds 120% of the conversion price in effect. Upon conversion of the notes, in lieu of delivering common stock, the Company may, in its discretion, deliver cash or a combination of cash and common stock. The notes can be converted, at the option of the noteholders, during the conversion period of September 15, 2008 through December 15, 2008. Upon receiving notification of a noteholder’s intent to convert, the Company, in accordance with the provisions of the indenture, will inform the noteholder of its intention to deliver shares of common stock or cash, or a combination thereof. The Company may, at its option, redeem some or all of the notes on or after February 4, 2009. Holders of the notes will have the right to require the Company to repurchase some or all of the outstanding notes on February 1, 2011, February 1, 2014 and February 1, 2019 and upon certain events, including a change in control. If not redeemed by the Company or repaid pursuant to the holders’ right to require repurchase, the notes mature on February 1, 2024. The notes have substantive conversion features as defined by EITF 05-1, “Accounting for the Conversion of an Instrument that Becomes Convertible Upon the Issuers Exercise of a Call Option.” Accordingly, the Company will not recognize a gain or loss if it issues common stock upon the conversion and settlement of these notes.
The 2.0% interest is payable in cash, semi-annually, through February 1, 2011. After such date, the 2.0% interest will be accreted into the principal amount of the notes. Also, commencing with the six-month period beginning February 1, 2009, if the average note price for the applicable trading period equals 120% or more of the accreted principal amount of such notes, the Company will pay contingent interest at an annual rate of 0.25%.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The notes are general unsecured obligations of the Company, ranking equally in right of payment with all of its other existing and future unsecured senior indebtedness and senior in right of payment to any of its future subordinated indebtedness. All of Comtech Telecommunications Corp.’s (the “Parent”) wholly-owned subsidiaries have issued full and unconditional guarantees in favor of the holders of the Company’s 2.0% convertible senior notes (the “Guarantor Subsidiaries”), except for the subsidiary that purchased Memotec, Inc. in fiscal 2004 (the “Non-Guarantor Subsidiary”). These full and unconditional guarantees are joint and several. Other than supporting the operations of its subsidiaries, the Parent has no independent assets or operations and there are currently no significant restrictions on its ability, or the ability of the guarantors, to obtain funds from each other by dividend or loan. Consolidating financial information regarding the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiary can be found in Note 16 to the consolidated financial statements beginning on page F-30.
The net proceeds of the offering are being used for working capital and general corporate purposes and potentially may be used for future acquisitions of businesses or technologies or repurchases of the Company’s common stock. The Company filed a registration statement with the Securities and Exchange Commission (“SEC”), which has become effective, for the resale of the notes and the shares of common stock issuable upon conversion of the notes.
(9) Income Taxes
Income before provision for income taxes consists of the following:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | U.S. | | $ | 115,782,000 | | | | 97,215,000 | | | | 68,024,000 | | | Foreign | | | 2,391,000 | | | | (816,000 | ) | | | 2,463,000 | | | | | $ | 118,173,000 | | | | 96,399,000 | | | | 70,487,000 | |
The provision for income taxes included in the accompanying consolidated statements of operations consists of the following:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | Federal – current | | $ | 39,799,000 | | | | 29,388,000 | | | | 22,085,000 | | | Federal – deferred | | | (1,627,000 | ) | | | (628,000 | ) | | | 854,000 | | State and local – current | | | 4,375,000 | | | | 2,091,000 | | | | 1,539,000 | | | State and local – deferred | | | (1,045,000 | ) | | | 509,000 | | | | 85,000 | | | | | | | | | | | | | | | | | Foreign – current | | | 302,000 | | | | (146,000 | ) | | | 762,000 | | | Foreign – deferred | | | (64,000 | ) | | | (28,000 | ) | | | (107,000 | ) | | | | $ | 41,740,000 | | | | 31,186,000 | | | | 25,218,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The provision for income taxes differed from the amounts computed by applying the U.S. Federal income tax rate as a result of the following:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | | | Amount | | | Rate | | | Amount | | | Rate | | | Amount | | | Rate | | | Computed “expected” tax expense | | $ | 41,361,000 | | | | 35.0 | % | | | 33,740,000 | | | | 35.0 | % | | | 24,670,000 | | | | 35.0 | % | | Increase (reduction) in income taxes resulting from: | | | | | | | | | | | | | | | | | | | | | | | | | | Nondeductible compensation | | | 26,000 | | | | 0.1 | | | | 51,000 | | | | 0.1 | | | | 961,000 | | | | 1.4 | | | State and local income taxes, net of Federal benefit | | | 2,165,000 | | | | 1.8 | | | | 1,678,000 | | | | 1.8 | | | | 922,000 | | | | 1.3 | | | Nondeductible stock-based compensation | | | 585,000 | | | | 0.5 | | | | 529,000 | | | | 0.5 | | | | 615,000 | | | | 0.9 | | | Extraterritorial income exclusion/ domestic production activities deduction | | | (1,817,000 | ) | | | (1.5 | ) | | | (1,472,000 | ) | | | (1.5 | ) | | | (1,372,000 | ) | | | (1.9 | ) | | Research and experimentation credits | | | (1,174,000 | ) | | | (1.0 | ) | | | (3,400,000 | ) | | | (3.5 | ) | | | (415,000 | ) | | | (0.6 | ) | | Change in the beginning of the year valuation allowance for deferred tax assets | | | (50,000 | ) | | | (0.1 | ) | | | (50,000 | ) | | | (0.1 | ) | | | (111,000 | ) | | | (0.2 | ) | | Other | | | 644,000 | | | | 0.5 | | | | 110,000 | | | | 0.1 | | | | (52,000 | ) | | | (0.1 | ) | | | | $ | 41,740,000 | | | | 35.3 | % | | | 31,186,000 | | | | 32.4 | % | | | 25,218,000 | | | | 35.8 | % |
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at July 31, 2008 and 2007 are presented below.
| | | 2008 | | | 2007 | | | Deferred tax assets: | | | | | | | | Allowance for doubtful accounts receivable | | $ | 484,000 | | | | 210,000 | | | Intangibles | | | 329,000 | | | | 715,000 | | | Inventory and warranty reserves | | | 6,922,000 | | | | 5,871,000 | | | Compensation and commissions | | | 1,558,000 | | | | 2,632,000 | | | State research and experimentation credits | | | 1,162,000 | | | | 1,162,000 | | | Stock-based compensation | | | 5,623,000 | | | | 3,057,000 | | | Other | | | 1,963,000 | | | | 1,134,000 | | | Less valuation allowance | | | (1,262,000 | ) | | | (1,312,000 | ) | | Total deferred tax assets | | | 16,779,000 | | | | 13,469,000 | | Deferred tax liabilities: | | | | | | | | | | Convertible senior notes | | | (9,672,000 | ) | | | (8,899,000 | ) | | Plant and equipment | | | (2,951,000 | ) | | | (3,150,000 | ) | | Total deferred tax liabilities | | | (12,623,000 | ) | | | (12,049,000 | ) | | Net deferred tax assets | | $ | 4,156,000 | | | | 1,420,000 | |
The Company provides for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires an asset and liability based approach in accounting for income taxes. In assessing the realizability of deferred tax assets and liabilities, management considers whether it is more likely than not that some portion or all of them will not be realized. As of July 31, 2008 and 2007, the Company’s deferred tax asset has been offset by a valuation allowance primarily related to state research and experimentation credits which may not be utilized in future periods. The Company must generate approximately $48,800,000 of taxable income to fully utilize its deferred tax assets. Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Effective August 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN No. 48”). Except for additional disclosures included in the Notes to Consolidated Financial Statements, there was no material impact and the Company did not record any cumulative-effect adjustment to the opening balance in retained earnings. In accordance with FIN No. 48, there was no retrospective application to any prior financial statement periods.
At August 1, 2007 (the date of adoption of FIN No. 48) and July 31, 2008, the total unrecognized tax benefits, excluding interest, were $3,955,000 and $4,467,000, respectively. At August 1, 2007 and July 31, 2008, the amount of unrecognized tax benefits that would impact the Company’s effective tax rate, if recognized, was $3,955,000 and $2,714,000, respectively. Unrecognized tax benefits result from income tax positions taken or expected to be taken on the Company’s income tax returns for which a tax benefit has not been recorded in the Company’s financial statements. Of the total unrecognized tax benefits, $2,801,000 and $1,909,000 were recorded as non-current income taxes payable in the Consolidated Balance Sheets of the Company at August 1, 2007 and July 31, 2008, respectively. The following table summarizes the activity related to the Company’s unrecognized tax benefits:
| Balance as of August 1, 2007 | | $ | 3,955,000 | | | Increase related to prior periods | | | 826,000 | | | Decrease related to prior periods | | | (123,000 | ) | | Increase related to fiscal 2008 | | | 678,000 | | | Settlements with taxing authorities | | | (756,000 | ) | | Expiration of statute of limitations | | | (113,000 | ) | | Balance as of July 31, 2008 | | $ | 4,467,000 | |
The Company’s policy is to recognize interest and penalties relating to uncertain tax positions in income tax expense. At August 1, 2007 and July 31, 2008, interest accrued relating to income taxes was $462,000 and $301,000, respectively, net of the related income tax benefit.
Tax years prior to fiscal 2003 are not subject to examination by the U.S. Federal tax authorities. In fiscal 2008, the Internal Revenue Service (“IRS”) completed its audit of the Company’s Federal income tax returns for fiscal 2004 and fiscal 2005. In addition, it has informed the Company that it will audit the Company’s Federal income tax return for fiscal 2006. The IRS audits for 2004 and 2005 were focused on the allowable amount of R&E credits utilized and interest expense relating to the Company’s 2% convertible senior notes.
If the final outcome of the fiscal 2006 audit differs materially from the Company’s original income tax provision, the Company’s results of operations and financial condition could be materially impacted.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Stock Option Plans and Employee Stock Purchase Plan
The Company issues stock-based awards pursuant to the following plans:
1993 Incentive Stock Option Plan – The 1993 Incentive Stock Option Plan, as amended, provided for the granting to key employees and officers of incentive and non-qualified stock options to purchase up to 2,345,625 shares of the Company’s common stock at prices generally not less than the fair market value at the date of grant with the exception of anyone who, prior to the grant, owns more than 10% of the voting power, in which case the exercise price cannot be less than 110% of the fair market value. In addition, it provided formula grants to non-employee members of the Company’s Board of Directors. The term of the options could be no more than ten years. However, for incentive stock options granted to any employee who, prior to the granting of the option, owns stock representing more than 10% of the voting power, the option term could be no more than five years.
As of July 31, 2008, the Company had granted stock-based awards representing the right to purchase an aggregate of 2,016,218 shares (net of 428,441 canceled awards) at prices ranging between $0.67 – $5.31 per share, of which 675 are outstanding at July 31, 2008. To date, 2,015,543 shares have been exercised. Outstanding awards have been transferred to the 2000 Stock Incentive Plan. The terms applicable to these awards prior to the transfer continue to apply. The plan was terminated by the Company’s Board of Directors in December 1999 due to the approval by the shareholders of the 2000 Stock Incentive Plan.
2000 Stock Incentive Plan – The 2000 Stock Incentive Plan, as amended, provides for the granting to all employees and consultants of the Company (including prospective employees and consultants) non-qualified stock options, SARs, restricted stock, performance shares, performance units and other stock-based awards. In addition, employees of the Company are eligible to be granted incentive stock options. Non-employee directors of the Company are eligible to receive non-discretionary grants of nonqualified stock options subject to certain limitations. The aggregate number of shares of common stock which may be issued may not exceed 6,587,500 plus the shares that were transferred to the Plan relating to outstanding awards that were previously granted under the 1982 Incentive Stock Option Plan and the 1993 Incentive Stock Option Plan. The Stock Option Committee of the Company’s Board of Directors, consistent with the terms of the Plan, will determine the types of awards to be granted, the terms and conditions of each award and the number of shares of common stock to be covered by each award. Grants of incentive and non-qualified stock options may not have a term exceeding ten years or no more than five years in the case of an incentive stock option granted to a stockholder who owns stock representing more than 10% of the voting power.
As of July 31, 2008, the Company had granted stock-based awards representing the right to purchase an aggregate of 5,441,222 shares (net of 590,078 canceled awards) at prices ranging between $3.13 – $51.65 of which 2,518,998 are outstanding at July 31, 2008. As of July 31, 2008, 2,922,224 stock-based awards have been exercised. All stock-based awards granted through July 31, 2005 had exercise prices equal to the fair market value of the stock on the date of grant and a term of ten years. All stock-based awards granted since August 1, 2005 have had exercise prices equal to the fair market value of the stock on the date of grant and a term of five years.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The following table summarizes certain stock option plan activity during the three years ended July 31, 2008:
| | | Number of Shares Underlying Stock-Based Awards | | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Term (Years) | | Aggregate Intrinsic Value | | Outstanding at July 31, 2005 | | | 2,566,882 | | | $ | 9.87 | | | | | | Granted | | | 706,000 | | | | 35.30 | | | | | | Expired/canceled | | | (108,903 | ) | | | 16.00 | | | | | | Exercised | | | (244,737 | ) | | | 7.61 | | | | | | Outstanding at July 31, 2006 | | | 2,919,242 | | | | 15.99 | | | | | | Granted | | | 716,600 | | | | 27.91 | | | | | | Expired/canceled | | | (197,825 | ) | | | 14.90 | | | | | | Exercised | | | (938,000 | ) | | | 10.17 | | | | | | Outstanding at July 31, 2007 | | | 2,500,017 | | | | 21.67 | | | | | | Granted | | | 622,000 | | | | 42.47 | | | | | | Expired/canceled | | | (42,663 | ) | | | 27.38 | | | | | | Exercised | | | (559,681 | ) | | | 11.96 | | | | | | Outstanding at July 31, 2008 | | | 2,519,673 | | | $ | 28.87 | | 3.79 | | $ 51,058,000 | | Exercisable at July 31, 2008 | | | 722,533 | | | $ | 22.33 | | 3.86 | | $ 19,361,000 | | Expected to vest at July 31, 2008 | | | 1,754,661 | | | $ | 31.63 | | 3.76 | | $ 30,700,000 |
Included in the number of shares underlying stock-based awards outstanding at July 31, 2008, in the above table, are 26,000 SARs with an aggregate intrinsic value of $291,000.
The total intrinsic value of stock-based awards exercised during the years ended July 31, 2008, 2007 and 2006 was $21,125,000, $27,302,000 and $6,602,000, respectively.
2001 Employee Stock Purchase Plan – The ESPP was approved by the shareholders on December 12, 2000, and 675,000 shares of the Company’s common stock were reserved for issuance. The ESPP is intended to provide eligible employees of the Company the opportunity to acquire common stock in the Company at 85% of fair market value at date of issuance through participation in the payroll-deduction based ESPP. Through fiscal 2008, the Company issued 284,743 shares of its common stock to participating employees in connection with the ESPP.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(11) Customer and Geographic Information
Sales by geography and customer type, as a percentage of consolidated net sales, are as follows:
| | | Fiscal Years Ended July 31, | | | | | 2008 | | | 2007 | | | 2006 | | | United States | | | | | | | | | | | U.S. government | | | 66.4 | % | | | 61.3 | % | | | 47.3 | % | | Commercial customers | | | 6.9 | % | | | 12.5 | % | | | 17.1 | % | | Total United States | | | 73.3 | % | | | 73.8 | % | | | 64.4 | % | | | | | | | | | | | | | | | | International | | | 26.7 | % | | | 26.2 | % | | | 35.6 | % |
International sales include sales to U.S. domestic companies for inclusion in products that will be sold to international customers. One customer, a prime contractor, represented 3.1%, 5.4% and 10.2% of consolidated net sales in fiscal 2008, 2007 and 2006, respectively.
(12) Segment 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 decisions about resources to be allocated and assessing their 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 operating segments: (i) telecommunications transmission, (ii) mobile data communications and (iii) RF microwave amplifiers. Telecommunications transmission products include satellite earth station products (such as analog and digital modems, frequency converters, power amplifiers, and voice gateways) and over-the-horizon microwave communications products and systems. Mobile data communications products include satellite-based mobile location, tracking and messaging hardware and related services. RF microwave amplifier products include solid-state, high-power, broadband amplifier products that use the microwave and radio frequency spectrums.
Unallocated expenses result from such corporate expenses as legal, accounting and executive compensation. In addition, for fiscal 2008, 2007 and 2006, unallocated expenses include $10,640,000, $7,401,000 and $5,681,000 of stock-based compensation expense, respectively. Interest expense (which includes amortization of deferred financing costs) associated with the Company’s 2.0% convertible senior notes is not allocated to the operating segments. Depreciation and amortization includes amortization of stock-based compensation. Unallocated assets consist principally of cash, deferred financing costs and deferred tax assets. Substantially all of the Company's long-lived assets are located in the U.S.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Corporate management defines and reviews segment profitability based on the same allocation methodology as presented in the segment data tables below.
| | Fiscal Year Ended July 31, 2008 | | (in thousands) | Telecommunications Transmission | | | Mobile Data Communications | | | RF Microwave Amplifiers | | | Unallocated | | | Total | | | Net sales | | $ | 208,994 | | | | 261,057 | | | | 61,576 | | | | - | | | $ | 531,627 | | | Operating income (expense) | | | 56,688 | | | | 72,796 | | | | 4,410 | | | | (27,103 | ) | | | 106,791 | | | Interest income and other | | | 156 | | | | 4 | | | | - | | | | 13,905 | | | | 14,065 | | | Interest expense | | | 25 | | | | 12 | | | | - | | | | 2,646 | | | | 2,683 | | | Depreciation and amortization | | | 7,362 | | | | 2,139 | | | | 1,201 | | | | 10,844 | | | | 21,546 | | | Expenditure for long-lived assets, including intangibles | | | 11,834 | | | | 3,705 | | | | 1,588 | | | | 99 | | | | 17,226 | | | Total assets at July 31, 2008 | | | 145,290 | | | | 40,519 | | | | 42,363 | | | | 424,948 | | | | 653,120 | |
| | Fiscal Year Ended July 31, 2007 | | (in thousands) | Telecommunications Transmission | | | Mobile Data Communications | | | RF Microwave Amplifiers | | | Unallocated | | | Total | | | Net sales | | $ | 219,935 | | | | 189,575 | | | | 36,174 | | | | - | | | $ | 445,684 | | | Operating income (expense) | | | 59,205 | | | | 45,403 | | | | 3,658 | | | | (23,344 | ) | | | 84,922 | | | Interest income and other | | | (59 | ) | | | 22 | | | | - | | | | 14,245 | | | | 14,208 | | | Interest expense | | | 48 | | | | 37 | | | | - | | | | 2,646 | | | | 2,731 | | | Depreciation and amortization | | | 6,995 | | | | 1,556 | | | | 1,392 | | | | 7,586 | | | | 17,529 | | | Expenditure for long-lived assets, including intangibles | | | 8,616 | | | | 5,858 | | | | 1,298 | | | | 114 | | | | 15,886 | | | Total assets at July 31, 2007 | | | 118,300 | | | | 48,275 | | | | 34,993 | | | | 354,774 | | | | 556,342 | |
| | Fiscal Year Ended July 31, 2006 | | (in thousands) | Telecommunications Transmission | | | Mobile Data Communications | | | RF Microwave Amplifiers | | | Unallocated | | | Total | | | Net sales | | $ | 197,891 | | | | 149,463 | | | | 44,157 | | | | - | | | $ | 391,511 | | | Operating income (expense) | | | 49,797 | | | | 21,730 | | | | 8,311 | | | | (15,907 | ) | | | 63,931 | | | Interest income and other | | | 48 | | | | 2 | | | | - | | | | 9,193 | | | | 9,243 | | | Interest expense | | | 38 | | | | - | | | | 3 | | | | 2,646 | | | | 2,687 | | | Depreciation and amortization | | | 6,086 | | | | 1,193 | | | | 1,317 | | | | 5,792 | | | | 14,388 | | Expenditure for long-lived assets, including intangibles | | | 8,914 | | | | 1,545 | | | | 1,477 | | | | 588 | | | | 12,524 | | | Total assets at July 31, 2006 | | | 134,567 | | | | 45,641 | | | | 24,588 | | | | 250,470 | | | | 455,266 | |
Intersegment sales in fiscal 2008, 2007 and 2006 by the telecommunications transmission segment to the RF microwave amplifiers segment were $16,005,000, $6,495,000 and $7,512,000, respectively. In fiscal 2008, 2007 and 2006, intersegment sales by the telecommunications transmission segment to the mobile data communications segment were $123,767,000, $78,319,000 and $55,667,000, respectively. Intersegment sales have been eliminated from the tables above.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13) Commitments and Contingencies
(a) Operating Leases
The Company is obligated under noncancellable operating lease agreements, including satellite lease expenditures relating to its mobile data communications segment contracts. At July 31, 2008, the future minimum lease payments under operating leases are as follows:
| 2009 | | $ | 25,095,000 | | | 2010 | | | 4,211,000 | | | 2011 | | | 3,174,000 | | | 2012 | | | 1,692,000 | | | 2013 | | | 1,219,000 | | | Thereafter | | | 3,390,000 | | | Total | | $ | 38,781,000 | |
Lease expense charged to operations was $4,668,000, $3,871,000 and $3,379,000 in fiscal 2008, 2007 and 2006, respectively. Lease expense excludes satellite lease expenditures incurred of approximately $22,632,000, $15,456,000 and $13,382,000 in fiscal 2008, 2007 and 2006, respectively, relating to the Company’s mobile data communications segment. Satellite lease expenditures are allocated to individual contracts and expensed to cost of sales.
In December 1991, the Company and a partnership controlled by the Company’s Chairman, Chief Executive Officer and President entered into an agreement in which the Company leases from the partnership its Melville, New York production facility. The lease was for an initial term of ten years. In December 2001, the Company exercised its option for an additional ten-year period. For financial reporting purposes, the lease for the extension period is an operating lease. The annual rentals, of approximately $570,000 for fiscal 2008, are subject to annual adjustments equal to the lesser of 5% or the change in the Consumer Price Index.
(b) United States Government Contracts
Certain of the Company’s contracts are subject to audit by applicable governmental agencies. Until such audits are completed, the ultimate profit on these contracts cannot be determined; however, it is management’s belief that the final contract settlements will not have a material adverse effect on the Company’s consolidated financial condition or results of operations.
(c) Legal Proceedings
In October 2007, the Company’s Florida-based subsidiary, Comtech Systems, Inc. (“CSI”), received a customs export enforcement subpoena from the U.S. Immigration and Customs Enforcement (“ICE”) branch of the Department of Homeland Security. The subpoena relates to CSI’s $1,982,000 contract with the Brazilian Naval Commission (the Brazil contract) and it required the production of all books, records and documents, including copies of contracts, invoices and payments related to agreements between CSI, its agent, its subcontractor and the Brazilian government. The Company believes that the ICE investigation is focused primarily on whether or not CSI was in compliance with export-related laws and regulations, including the International Traffic in Arms Regulations (“ITAR”) and the Export Administration Regulations. CSI produced documents in response to the subpoena request. Customs officials have detained certain inventory related to the Brazil contract pending resolution of this matter.
The Company engaged outside counsel to assist CSI in its response to the subpoena and related matters and to conduct its own investigation. Based on the Company’s ongoing investigation into this matter, it believes that the detained inventory, which consists of commercial satellite equipment, was not modified or adapted in any way to meet Brazilian military requirements and was only subject to the jurisdiction of the Department of Commerce and not the jurisdiction of the U.S. Department of State. In addition, in order to provide certain defense services, including conducting factory acceptance testing at CSI’s Florida facility, COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued the Company obtained a license (referred to as a Technical Assistance Agreement (“TAA”)) from the U.S. Department of State. The Company believes that the TAA authorized all activities under the Brazil contract that were subject to the jurisdiction of the U.S. Department of State.
The Company believes that CSI made a good faith effort to comply with applicable regulations; however, the Company believes that CSI made inadvertent administrative errors resulting in a TAA that did not become effective on a timely basis. The administrative errors relate primarily to the execution of non-disclosure agreements (“NDA”) with certain third country national employees of CSI’s agent. These individuals have now signed appropriate NDAs, and, in December 2007, CSI filed an amended TAA with the U.S. Department of State. CSI has requested that the U.S. Department of State confirm CSI’s and the Company’s view that the Brazil contract does not require any other State Department license. In March 2008, the Enforcement Division of the U.S. Department of State informed the Company that they were reviewing CSI’s amended TAA. In May 2008, the U.S. Attorney’s Office in the Middle District of Florida informed the Company that, based on its conversations with the ICE agent who initiated the subpoena, it was closing its investigation into the Brazil matter. In June 2008, the ICE agent informed the Company that he would recommend that the detained inventory be released back to the Company upon the U.S. Department of State confirming the Company’s position that a State Department license for the hardware shipped was not required. In August 2008, the ICE agent informed the Company that the U.S. Department of State wanted to clarify certain technical matters and, on its behalf, the ICE agent was going to interview one of the Company’s engineers. This interview occurred in September of 2008. The Company remains cautiously optimistic that it will be able to shortly reship the Brazil inventory to the end-customer.
In addition to its review of the Brazil contract, in March 2008, the Enforcement Division of the U.S. Department of State informed the Company that it sought to confirm the Company’s company-wide ITAR compliance for the five-year period ended March 2008. In response, the Company expanded its ongoing investigation. In June 2008, the Company provided detailed information and a summary of its findings to the U.S. Department of State. In July 2008, the U.S. Department of State requested supplemental information and the Company responded to its request. The Company’s findings to date indicate that there were certain instances of exports and defense services during the five-year period for which it did not have the appropriate authorization from the U.S. Department of State; however, none of those instances involved Proscribed Countries as defined by ITAR. The Company is awaiting additional feedback from the U.S. Department of State as it relates to all of the aforementioned matters.
Since the receipt of the original Brazil subpoena in October 2007, the Company has engaged outside counsel and export consultants to help it assess and improve, as appropriate, its internal controls with respect to U.S. export control laws and regulations and laws governing record keeping and dealings with foreign representatives. In addition, in connection with the Company’s August 1, 2008 acquisition of Radyne, the Company is expanding its export internal control assessment to include its newly acquired subsidiaries. To date, the Company has noted opportunities for improving its procedures to comply with such laws and regulations, including at its newly acquired Radyne subsidiaries.
During fiscal 2008, the Company has taken numerous steps to significantly improve its export control processes, including the hiring of additional employees who are knowledgeable and experienced with ITAR and the engagement of an outside export consultant to conduct additional training. The Company is also in the process of implementing enhanced formal company-wide ITAR control procedures, including at its newly acquired Radyne subsidiaries. Because the Company’s assessments are continuing, the Company expects to remediate, improve and enhance its internal controls relating to exports throughout fiscal 2009. COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued Because the above matters are ongoing, the Company cannot determine the ultimate outcome of these matters. Violations of U.S. export control-related laws and regulations could result in civil or criminal fines and/or penalties and/or result in an injunction against the Company, all of which could, in the aggregate, materially impact its business, results of operations and cash flows. Should the Company identify a material weakness relating to its compliance, the ongoing costs of remediation could be material. In addition, inventory related to the Brazil contract (including the inventory that has been detained) had a net book value of $1,110,000 as of July 31, 2008. If this inventory is permanently seized or not returned to the Company timely, or the Company can not resell the inventory to other customers, the Company would be required to write-off the value of this inventory in a future accounting period.
(d) Employment and Change of Control Agreements
The Company has an employment agreement with its Chairman of the Board, Chief Executive Officer and President. The employment agreement generally provides for an annual salary and bonus award. The Company has also entered into change of control agreements with certain of its officers. All of the agreements may require payments, in certain circumstances, in the event of a change in control of the Company.
(14) Stockholder Rights Plan
On December 15, 1998, the Company’s Board of Directors approved the adoption of a stockholder rights plan in which one stock purchase right (“Right”) was distributed as a dividend on each outstanding share of the Company’s common stock to stockholders of record at the close of business on January 4, 1999. Under the plan, the Rights will be exercisable only if triggered by a person or group’s acquisition of 15% or more of the Company’s common stock. If triggered, each Right, other than Rights held by the acquiring person or group, would entitle its holder to purchase a specified number of the Company’s common shares for 50% of their market value at that time. Unless a 15% acquisition has occurred, the Rights may be redeemed by the Company at any time prior to the termination date of the plan.
This Right to purchase common stock at a discount will not be triggered by a person or group’s acquisition of 15% or more of the common stock pursuant to a tender or exchange offer which is for all outstanding shares at a price and on terms that the Company’s Board of Directors determines (prior to acquisition) to be adequate and in the best interest of the Company and its stockholders. The Rights will expire on December 15, 2008.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(15) Intangible Assets
Intangible assets with finite lives arising from acquisitions as of July 31, 2008 and 2007 are as follows:
| | | July 31, 2008 | | | | | Weighted Average Amortization Period | | | Gross Carrying Amount | | | Accumulated Amortization | | | Net Carrying Amount | | | Existing technology | | | 6.95 | | | $ | 16,401,000 | | | | 11,897,000 | | | $ | 4,504,000 | | | Proprietary, core and licensed technology | | | 8.31 | | | | 5,851,000 | | | | 3,189,000 | | | | 2,662,000 | | | Other | | | 5.61 | | | | 975,000 | | | | 636,000 | | | | 339,000 | | | Total | | | | | | $ | 23,227,000 | | | | 15,722,000 | | | $ | 7,505,000 | |
| | | July 31, 2007 | | | | | Weighted Average Amortization Period | | | Gross Carrying Amount | | | Accumulated Amortization | | | Net Carrying Amount | | | Existing technology | | | 7.22 | | | $ | 12,903,000 | | | | 11,168,000 | | | $ | 1,735,000 | | | Proprietary, core and licensed technology | | | 8.31 | | | | 5,851,000 | | | | 2,326,000 | | | | 3,525,000 | | | Other | | | 5.61 | | | | 975,000 | | | | 518,000 | | | | 457,000 | | | Total | | | | | | $ | 19,729,000 | | | | 14,012,000 | | | $ | 5,717,000 | |
Amortization expense for the years ended July 31, 2008, 2007 and 2006 was $1,710,000, $2,592,000 and $2,465,000, respectively. The estimated amortization expense for the fiscal years ending July 31, 2009, 2010, 2011, 2012 and 2013 is $2,072,000, $1,957,000, $1,545,000, $631,000 and $524,000, respectively.
The changes in carrying amount of goodwill by segment for the years ended July 31, 2008 and 2007 are as follows:
| | | Telecommunications | | | Mobile Data | | | RF Microwave | | | | | | | | Transmission | | | Communications | | | Amplifiers | | | Total | | | Balance at July 31, 2006 | | $ | 8,817,000 | | | | 5,005,000 | | | | 8,422,000 | | | $ | 22,244,000 | | | Acquisition of Insite | | | - | | | | 2,143,000 | | | | - | | | | 2,143,000 | | | Balance at July 31, 2007 | | | 8,817,000 | | | | 7,148,000 | | | | 8,422,000 | | | | 24,387,000 | | | Acquisition of Insite (See Note 2) | | | - | | | | (24,000 | ) | | | - | | | | (24,000 | ) | | Balance at July 31, 2008 | | $ | 8,817,000 | | | | 7,124,000 | | | | 8,422,000 | | | $ | 24,363,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Consolidating Financial Information
The consolidating financial information presented below reflects information regarding the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiary of the Company’s 2.0% convertible senior notes. Tolt is included in the guarantor column for all periods presented. The Parent’s expenses associated with supporting the operations of its subsidiaries are allocated to the respective Guarantor Subsidiaries and Non-Guarantor Subsidiary. The consolidating financial information presented herein is not utilized by the chief operating decision-maker in making operating decisions and assessing performance.
The following reflects the consolidating balance sheet as of July 31, 2008:
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | Assets | | | | | | | | | | | | | | | | | Current assets: | | | | | | | | | | | | | | | | | Cash and cash equivalents | | $ | 408,065,000 | | | | - | | | | 4,056,000 | | | | (2,054,000 | ) | | $ | 410,067,000 | | | Accounts receivable, net | | | - | | | | 67,777,000 | | | | 2,263,000 | | | | - | | | | 70,040,000 | | | Inventories, net | | | - | | | | 84,032,000 | | | | 1,934,000 | | | | - | | | | 85,966,000 | | | Prepaid expenses and other current assets | | | 1,953,000 | | | | 3,209,000 | | | | 1,404,000 | | | | (675,000 | ) | | | 5,891,000 | | | Deferred tax asset – current | | | 1,243,000 | | | | 8,783,000 | | | | - | | | | - | | | | 10,026,000 | | | Total current assets | | | 411,261,000 | | | | 163,801,000 | | | | 9,657,000 | | | | (2,729,000 | ) | | | 581,990,000 | | | | | | | | | | | | | | | | | | | | | | | | | Property, plant and equipment, net | | | 740,000 | | | | 32,763,000 | | | | 766,000 | | | | - | | | | 34,269,000 | | | Investment in subsidiaries | | | 318,292,000 | | | | 5,721,000 | | | | - | | | | (324,013,000 | ) | | | - | | | Goodwill | | | - | | | | 23,416,000 | | | | 947,000 | | | | - | | | | 24,363,000 | | | Intangibles with finite lives, net | | | - | | | | 4,388,000 | | | | 3,117,000 | | | | - | | | | 7,505,000 | | | Deferred tax asset – non-current | | | - | | | | - | | | | 206,000 | | | | (206,000 | ) | | | - | | | Deferred financing costs, net | | | 1,357,000 | | | | - | | | | - | | | | - | | | | 1,357,000 | | | Other assets, net | | | 3,266,000 | | | | 352,000 | | | | 18,000 | | | | - | | | | 3,636,000 | | | Intercompany receivables | | | - | | | | 171,277,000 | | | | - | | | | (171,277,000 | ) | | | - | | | Total assets | | $ | 734,916,000 | | | | 401,718,000 | | | | 14,711,000 | | | | (498,225,000 | ) | | $ | 653,120,000 | | | | | | | | | | | | | | | | | | | | | | | | | Liabilities and Stockholders’ Equity | | | | | | | | | | | | | | | | | | | | | | Current liabilities: | | | | | | | | | | | | | | | | | | | | | | Accounts payable | | $ | 1,597,000 | | | | 30,874,000 | | | | 1,006,000 | | | | (2,054,000 | ) | | $ | 31,423,000 | | | Accrued expenses and other current liabilities | | | 12,241,000 | | | | 36,551,000 | | | | 879,000 | | | | - | | | | 49,671,000 | | | Customer advances and deposits | | | - | | | | 13,254,000 | | | | 2,033,000 | | | | - | | | | 15,287,000 | | | Current installments of other obligations | | | - | | | | 108,000 | | | | - | | | | - | | | | 108,000 | | | Interest payable | | | 1,050,000 | | | | - | | | | - | | | | - | | | | 1,050,000 | | | Income taxes payable | | | - | | | | - | | | | 675,000 | | | | (675,000 | ) | | | - | | | Total current liabilities | | | 14,888,000 | | | | 80,787,000 | | | | 4,593,000 | | | | (2,729,000 | ) | | | 97,539,000 | | | | | | | | | | | | | | | | | | | | | | | | | Convertible senior notes | | | 105,000,000 | | | | - | | | | - | | | | - | | | | 105,000,000 | | | Income taxes payable – non-current | | | 1,909,000 | | | | - | | | | - | | | | - | | | | 1,909,000 | | | Deferred tax liability – non-current | | | 3,437,000 | | | | 2,639,000 | | | | - | | | | (206,000 | ) | | | 5,870,000 | | | Intercompany payables | | | 166,880,000 | | | | - | | | | 4,397,000 | | | | (171,277,000 | ) | | | - | | | Total liabilities | | | 292,114,000 | | | | 83,426,000 | | | | 8,990,000 | | | | (174,212,000 | ) | | | 210,318,000 | | | | | | | | | | | | | | | | | | | | | | | | | Commitments and contingencies | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Stockholders’ equity: | | | | | | | | | | | | | | | | | | | | | | Preferred stock | | | - | | | | - | | | | - | | | | - | | | | - | | | Common stock | | | 2,460,000 | | | | 4,000 | | | | - | | | | (4,000 | ) | | | 2,460,000 | | | Additional paid-in capital | | | 186,246,000 | | | | 81,410,000 | | | | 5,187,000 | | | | (86,597,000 | ) | | | 186,246,000 | | | Retained earnings | | | 254,281,000 | | | | 236,878,000 | | | | 534,000 | | | | (237,412,000 | ) | | | 254,281,000 | | | | | | 442,987,000 | | | | 318,292,000 | | | | 5,721,000 | | | | (324,013,000 | ) | | | 442,987,000 | | | Less: | | | | | | | | | | | | | | | | | | | | | | Treasury stock | | | (185,000 | ) | | | - | | | | - | | | | - | | | | (185,000 | ) | | Total stockholders’ equity | | | 442,802,000 | | | | 318,292,000 | | | | 5,721,000 | | | | (324,013,000 | ) | | | 442,802,000 | | | Total liabilities and stockholders’ equity | | $ | 734,916,000 | | | | 401,718,000 | | | | 14,711,000 | | | | (498,225,000 | ) | | $ | 653,120,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Consolidating Financial Information (continued)
The following reflects the consolidating balance sheet as of July 31, 2007:
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | Assets | | | | | | | | | | | | | | | | | Current assets: | | | | | | | | | | | | | | | | | Cash and cash equivalents | | $ | 340,617,000 | | | | 983,000 | | | | 1,303,000 | | | | - | | | $ | 342,903,000 | | | Accounts receivable, net | | | - | | | | 66,240,000 | | | | 7,345,000 | | | | - | | | | 73,585,000 | | | Inventories, net | | | - | | | | 61,337,000 | | | | 650,000 | | | | - | | | | 61,987,000 | | | Prepaid expenses and other current assets | | | 1,868,000 | | | | 4,311,000 | | | | 555,000 | | | | - | | | | 6,734,000 | | | Deferred tax asset – current | | | 645,000 | | | | 8,735,000 | | | | - | | | | - | | | | 9,380,000 | | | Total current assets | | | 343,130,000 | | | | 141,606,000 | | | | 9,853,000 | | | | - | | | | 494,589,000 | | | | | | | | | | | | | | | | | | | | | | | | | Property, plant and equipment, net | | | 844,000 | | | | 27,796,000 | | | | 642,000 | | | | - | | | | 29,282,000 | | | Investment in subsidiaries | | | 248,952,000 | | | | 4,755,000 | | | | - | | | | (253,707,000 | ) | | | - | | | Goodwill | | | - | | | | 23,440,000 | | | | 947,000 | | | | - | | | | 24,387,000 | | | Intangibles with finite lives, net | | | - | | | | 4,972,000 | | | | 745,000 | | | | - | | | | 5,717,000 | | | Deferred tax asset – non-current | | | - | | | | - | | | | 190,000 | | | | (190,000 | ) | | | - | | | Deferred financing costs, net | | | 1,903,000 | | | | - | | | | - | | | | - | | | | 1,903,000 | | | Other assets, net | | | 56,000 | | | | 386,000 | | | | 22,000 | | | | - | | | | 464,000 | | | Intercompany receivables | | | - | | | | 126,210,000 | | | | - | | | | (126,210,000 | ) | | | - | | | Total assets | | $ | 594,885,000 | | | | 329,165,000 | | | | 12,399,000 | | | | (380,107,000 | ) | | $ | 556,342,000 | | | | | | | | | | | | | | | | | | | | | | | | | Liabilities and Stockholders’ Equity | | | | | | | | | | | | | | | | | | | | | | Current liabilities: | | | | | | | | | | | | | | | | | | | | | | Accounts payable | | $ | 374,000 | | | | 25,616,000 | | | | 147,000 | | | | - | | | $ | 26,137,000 | | | Accrued expenses and other current liabilities | | | 10,340,000 | | | | 36,378,000 | | | | 614,000 | | | | - | | | | 47,332,000 | | | Customer advances and deposits | | | - | | | | 15,189,000 | | | | 4,867,000 | | | | - | | | | 20,056,000 | | | Current installments of other obligations | | | - | | | | 135,000 | | | | - | | | | - | | | | 135,000 | | | Interest payable | | | 1,050,000 | | | | - | | | | - | | | | - | | | | 1,050,000 | | | Income taxes payable | | | 3,283,000 | | | | - | | | | (487,000 | ) | | | - | | | | 2,796,000 | | | Total current liabilities | | | 15,047,000 | | | | 77,318,000 | | | | 5,141,000 | | | | - | | | | 97,506,000 | | | | | | | | | | | | | | | | | | | | | | | | | Convertible senior notes | | | 105,000,000 | | | | - | | | | - | | | | - | | | | 105,000,000 | | | Other obligations, less current installments | | | - | | | | 108,000 | | | | - | | | | - | | | | 108,000 | | | Deferred tax liability – non-current | | | 5,363,000 | | | | 2,787,000 | | | | - | | | | (190,000 | ) | | | 7,960,000 | | | Intercompany payables | | | 123,707,000 | | | | - | | | | 2,503,000 | | | | (126,210,000 | ) | | | - | | | Total liabilities | | | 249,117,000 | | | | 80,213,000 | | | | 7,644,000 | | | | (126,400,000 | ) | | | 210,574,000 | | | | | | | | | | | | | | | | | | | | | | | | | Commitments and contingencies | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Stockholders’ equity: | | | | | | | | | | | | | | | | | | | | | | Preferred stock | | | - | | | | - | | | | - | | | | - | | | | - | | | Common stock | | | 2,402,000 | | | | 4,000 | | | | - | | | | (4,000 | ) | | | 2,402,000 | | | Additional paid-in capital | | | 165,703,000 | | | | 81,410,000 | | | | 5,187,000 | | | | (86,597,000 | ) | | | 165,703,000 | | | Retained earnings (deficit) | | | 177,848,000 | | | | 167,538,000 | | | | (432,000 | ) | | | (167,106,000 | ) | | | 177,848,000 | | | | | | 345,953,000 | | | | 248,952,000 | | | | 4,755,000 | | | | (253,707,000 | ) | | | 345,953,000 | | | Less: | | | | | | | | | | | | | | | | | | | | | | Treasury stock | | | (185,000 | ) | | | - | | | | - | | | | - | | | | (185,000 | ) | | Total stockholders’ equity | | | 345,768,000 | | | | 248,952,000 | | | | 4,755,000 | | | | (253,707,000 | ) | | | 345,768,000 | | | Total liabilities and stockholders’ equity | | $ | 594,885,000 | | | | 329,165,000 | | | | 12,399,000 | | | | (380,107,000 | ) | | $ | 556,342,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Consolidating Financial Information (continued)
The following reflects the consolidating statement of operations for the year ended July 31, 2008: | | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | | | | | | | | | | | | | | | | | | Net sales | | $ | - | | | | 513,430,000 | | | | 18,671,000 | | | | (474,000 | ) | | $ | 531,627,000 | | | Cost of sales | | | - | | | | 288,737,000 | | | | 8,424,000 | | | | (474,000 | ) | | | 296,687,000 | | | Gross profit | | | - | | | | 224,693,000 | | | | 10,247,000 | | | | - | | | | 234,940,000 | | | | | | | | | | | | | | | | | | | | | | | | | Expenses: | | | | | | | | | | | | | | | | | | | | | | Selling, general and administrative | | | - | | | | 79,355,000 | | | | 6,612,000 | | | | - | | | | 85,967,000 | | | Research and development | | | - | | | | 37,660,000 | | | | 2,812,000 | | | | - | | | | 40,472,000 | | | Amortization of intangibles | | | - | | | | 1,503,000 | | | | 207,000 | | | | - | | | | 1,710,000 | | | | | | - | | | | 118,518,000 | | | | 9,631,000 | | | | - | | | | 128,149,000 | | | | | | | | | | | | | | | | | | | | | | | | | Operating income | | | - | | | | 106,175,000 | | | | 616,000 | | | | - | | | | 106,791,000 | | | | | | | | | | | | | | | | | | | | | | | | | Other expense (income): | | | | | | | | | | | | | | | | | | | | | | Interest expense | | | 2,646,000 | | | | 37,000 | | | | - | | | | - | | | | 2,683,000 | | | Interest income and other | | | (13,905,000 | ) | | | (85,000 | ) | | | (75,000 | ) | | | - | | | | (14,065,000 | ) | | | | | | | | | | | | | | | | | | | | | | | | Income before provision for benefit from income taxes and equity in undistributed earnings of subsidiaries | | | 11,259,000 | | | | 106,223,000 | | | | 691,000 | | | | - | | | | 118,173,000 | | | Provision for (benefit from) income taxes | | | 4,166,000 | | | | 37,849,000 | | | | (275,000 | ) | | | - | | | | 41,740,000 | | | Net earnings before equity in undistributed earnings (loss) of subsidiaries | | | 7,093,000 | | | | 68,374,000 | | | | 966,000 | | | | - | | | | 76,433,000 | | | Equity in undistributed earnings of subsidiaries | | | 69,340,000 | | | | 966,000 | | | | - | | | | (70,306,000 | ) | | | - | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | $ | 76,433,000 | | | | 69,340,000 | | | | 966,000 | | | | (70,306,000 | ) | | $ | 76,433,000 | |
The following reflects the consolidating statement of operations for the year ended July 31, 2007: | | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | | | | | | | | | | | | | | | �� | | | Net sales | | $ | - | | | | 436,075,000 | | | | 10,045,000 | | | | (436,000 | ) | | $ | 445,684,000 | | | Cost of sales | | | - | | | | 247,364,000 | | | | 5,461,000 | | | | (436,000 | ) | | | 252,389,000 | | | Gross profit | | | - | | | | 188,711,000 | | | | 4,584,000 | | | | - | | | | 193,295,000 | | | | | | | | | | | | | | | | | | | | | | | | | Expenses: | | | | | | | | | | | | | | | | | | | | | | Selling, general and administrative | | | - | | | | 69,613,000 | | | | 3,699,000 | | | | - | | | | 73,312,000 | | | Research and development | | | - | | | | 30,633,000 | | | | 1,836,000 | | | | - | | | | 32,469,000 | | | Amortization of intangibles | | | - | | | | 2,415,000 | | | | 177,000 | | | | - | | | | 2,592,000 | | | | | | - | | | | 102,661,000 | | | | 5,712,000 | | | | - | | | | 108,373,000 | | | | | | | | | | | | | | | | | | | | | | | | | Operating income (loss) | | | - | | | | 86,050,000 | | | | (1,128,000 | ) | | | - | | | | 84,922,000 | | | | | | | | | | | | | | | | | | | | | | | | | Other expense (income): | | | | | | | | | | | | | | | | | | | | | | Interest expense | | | 2,646,000 | | | | 73,000 | | | | 12,000 | | | | - | | | | 2,731,000 | | | Interest income and other | | | (14,245,000 | ) | | | 76,000 | | | | (39,000 | ) | | | - | | | | (14,208,000 | ) | | | | | | | | | | | | | | | | | | | | | | | | Income (loss) before provision for benefit from income taxes and equity in undistributed earnings (loss) of subsidiaries | | | 11,599,000 | | | | 85,901,000 | | | | (1,101,000 | ) | | | - | | | | 96,399,000 | | | Provision for (benefit from) income taxes | | | 4,292,000 | | | | 27,253,000 | | | | (359,000 | ) | | | - | | | | 31,186,000 | | | Net earnings (loss) before equity in undistributed earnings (loss) of subsidiaries | | | 7,307,000 | | | | 58,648,000 | | | | (742,000 | ) | | | - | | | | 65,213,000 | | | Equity in undistributed earnings (loss) of subsidiaries | | | 57,906,000 | | | | (742,000 | ) | | | - | | | | (57,164,000 | ) | | | - | | | | | | | | | | | | | | | | | | | | | | | | | Net income (loss) | | $ | 65,213,000 | | | | 57,906,000 | | | | (742,000 | ) | | | (57,164,000 | ) | | $ | 65,213,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Consolidating Financial Information (continued) The following reflects the consolidating statement of operations for the year ended July 31, 2006: | | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | | | | | | | | | | | | | | | | | | Net sales | | $ | - | | | | 377,003,000 | | | | 14,971,000 | | | | (463,000 | ) | | $ | 391,511,000 | | | Cost of sales | | | - | | | | 227,042,000 | | | | 5,631,000 | | | | (463,000 | ) | | | 232,210,000 | | | Gross profit | | | - | | | | 149,961,000 | | | | 9,340,000 | | | | - | | | | 159,301,000 | | | | | | | | | | | | | | | | | | | | | | | | | Expenses: | | | | | | | | | | | | | | | | | | | | | | Selling, general and administrative | | | - | | | | 61,467,000 | | | | 5,604,000 | | | | - | | | | 67,071,000 | | | Research and development | | | - | | | | 24,392,000 | | | | 1,442,000 | | | | - | | | | 25,834,000 | | | Amortization of intangibles | | | - | | | | 2,288,000 | | | | 177,000 | | | | - | | | | 2,465,000 | | | | | | - | | | | 88,147,000 | | | | 7,223,000 | | | | - | | | | 95,370,000 | | | | | | | | | | | | | | | | | | | | | | | | | Operating income | | | - | | | | 61,814,000 | | | | 2,117,000 | | | | - | | | | 63,931,000 | | | | | | | | | | | | | | | | | | | | | | | | | Other expense (income): | | | | | | | | | | | | | | | | | | | | | | Interest expense | | | 2,646,000 | | | | 41,000 | | | | - | | | | - | | | | 2,687,000 | | | Interest income and other | | | (9,193,000 | ) | | | (60,000 | ) | | | 10,000 | | | | - | | | | (9,243,000 | ) | | | | | | | | | | | | | | | | | | | | | | | | Income before provision for income taxes and equity in undistributed earnings of subsidiaries | | | 6,547,000 | | | | 61,833,000 | | | | 2,107,000 | | | | - | | | | 70,487,000 | | | Provision for income taxes | | | 2,435,000 | | | | 22,133,000 | | | | 650,000 | | | | - | | | | 25,218,000 | | | Net earnings before equity in undistributed earnings of subsidiaries | | | 4,112,000 | | | | 39,700,000 | | | | 1,457,000 | | | | - | | | | 45,269,000 | | | Equity in undistributed earnings of subsidiaries | | | 41,157,000 | | | | 1,457,000 | | | | - | | | | (42,614,000 | ) | | | - | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | $ | 45,269,000 | | | | 41,157,000 | | | | 1,457,000 | | | | (42,614,000 | ) | | $ | 45,269,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Consolidating Financial Information (continued)
The following reflects the consolidating statement of cash flows for the year ended July 31, 2008:
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from operating activities: | | | | | | | | | | | | | | | | | Net income | | $ | 76,433,000 | | | | 69,340,000 | | | | 966,000 | | | | (70,306,000 | ) | | $ | 76,433,000 | | | Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | | | | | | | | | | | Depreciation and amortization of property, plant and equipment | | | 203,000 | | | | 8,766,000 | | | | 227,000 | | | | - | | | | 9,196,000 | | | Amortization of intangible assets with finite lives | | | - | | | | 1,503,000 | | | | 207,000 | | | | - | | | | 1,710,000 | | | Amortization of stock-based compensation | | | 4,377,000 | | | | 6,106,000 | | | | 157,000 | | | | - | | | | 10,640,000 | | | Amortization of deferred financing costs | | | 546,000 | | | | - | | | | - | | | | - | | | | 546,000 | | | Loss on disposal of property, plant and equipment | | | - | | | | 6,000 | | | | - | | | | - | | | | 6,000 | | | Provision for allowance for doubtful accounts | | | - | | | | 663,000 | | | | 60,000 | | | | - | | | | 723,000 | | | Provision for excess and obsolete inventory | | | - | | | | 2,402,000 | | | | 12,000 | | | | - | | | | 2,414,000 | | | Excess income tax benefit from stock award exercises | | | (2,374,000 | ) | | | - | | | | - | | | | - | | | | (2,374,000 | ) | | Deferred income tax benefit | | | (2,524,000 | ) | | | (196,000 | ) | | | (16,000 | ) | | | - | | | | (2,736,000 | ) | | Equity in undistributed earnings of subsidiaries | | | (69,340,000 | ) | | | (966,000 | ) | | | - | | | | 70,306,000 | | | | - | | | Intercompany accounts | | | 49,391,000 | | | | (51,282,000 | ) | | | 1,891,000 | | | | - | | | | - | | | Changes in assets and liabilities, net of effects of acquisitions: | | | | | | | | | | | | | | | | | | | | | | Accounts receivable | | | - | | | | (2,200,000 | ) | | | 5,022,000 | | | | - | | | | 2,822,000 | | | Inventories | | | - | | | | (24,988,000 | ) | | | (50,000 | ) | | | - | | | | (25,038,000 | ) | | Prepaid expenses and other current assets | | | (85,000 | ) | | | 301,000 | | | | (355,000 | ) | | | 188,000 | | | | 49,000 | | | Other assets | | | 1,000 | | | | 34,000 | | | | 4,000 | | | | - | | | | 39,000 | | | Accounts payable | | | 1,224,000 | | | | 5,333,000 | | | | 858,000 | | | | (2,054,000 | ) | | | 5,361,000 | | | Accrued expenses and other current liabilities | | | 732,000 | | | | 462,000 | | | | 41,000 | | | | - | | | | 1,235,000 | | | Customer advances and deposits | | | - | | | | (1,935,000 | ) | | | (2,834,000 | ) | | | - | | | | (4,769,000 | ) | | Deferred service revenue | | | - | | | | - | | | | - | | | | - | | | | - | | | Income taxes payable | | | 1,032,000 | | | | - | | | | 675,000 | | | | (188,000 | ) | | | 1,519,000 | | | Net cash provided by operating activities | | | 59,616,000 | | | | 13,349,000 | | | | 6,865,000 | | | | (2,054,000 | ) | | | 77,776,000 | | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from investing activities: | | | | | | | | | | | | | | | | | | | | | | Purchases of property, plant and equipment | | | (100,000 | ) | | | (13,739,000 | ) | | | (225,000 | ) | | | - | | | | (14,064,000 | ) | | Purchase of other intangibles with finite lives | | | - | | | | (193,000 | ) | | | - | | | | - | | | | (193,000 | ) | | Payments for business acquisitions | | | (2,042,000 | ) | | | (265,000 | ) | | | (3,887,000 | ) | | | - | | | | (6,194,000 | ) | | Net cash used in investing activities | | | (2,142,000 | ) | | | (14,197,000 | ) | | | (4,112,000 | ) | | | - | | | | (20,451,000 | ) | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from financing activities: | | | | | | | | | | | | | | | | | | | | | | Principal payments on other obligations | | | - | | | | (135,000 | ) | | | - | | | | - | | | | (135,000 | ) | | Excess income tax benefit from stock award exercises | | | 2,374,000 | | | | - | | | | - | | | | - | | | | 2,374,000 | | | Proceeds from exercises of stock options | | | 6,696,000 | | | | - | | | | - | | | | - | | | | 6,696,000 | | | Proceeds from issuance of employee stock purchase plan shares | | | 904,000 | | | | - | | | | - | | | | - | | | | 904,000 | | | Net cash provided by (used in) financing activities | | | 9,974,000 | | | | (135,000 | ) | | | - | | | | - | | | | 9,839,000 | | | | | | | | | | | | | | | | | | | | | | | | | Net increase (decrease) in cash and cash equivalents | | | 67,448,000 | | | | (983,000 | ) | | | 2,753,000 | | | | (2,054,000 | ) | | | 67,164,000 | | | Cash and cash equivalents at beginning of period | | | 340,617,000 | | | | 983,000 | | | | 1,303,000 | | | | - | | | | 342,903,000 | | | Cash and cash equivalents at end of period | | $ | 408,065,000 | | | | - | | | | 4,056,000 | | | | (2,054,000 | ) | | $ | 410,067,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Consolidating Financial Information (continued)
The following reflects the consolidating statement of cash flows for the year ended July 31, 2007:
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from operating activities: | | | | | | | | | | | | | | | | | Net income (loss) | | $ | 65,213,000 | | | | 57,906,000 | | | | (742,000 | ) | | | (57,164,000 | ) | | $ | 65,213,000 | | | Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | | | | | | | | | | | | | | | Depreciation and amortization of property, plant and equipment | | | 185,000 | | | | 7,129,000 | | | | 222,000 | | | | - | | | | 7,536,000 | | | Amortization of intangible assets with finite lives | | | - | | | | 2,415,000 | | | | 177,000 | | | | - | | | | 2,592,000 | | | Amortization of stock-based compensation | | | 2,932,000 | | | | 4,430,000 | | | | 39,000 | | | | - | | | | 7,401,000 | | | Amortization of deferred financing costs | | | 546,000 | | | | - | | | | - | | | | - | | | | 546,000 | | | Loss on disposal of property, plant and equipment | | | - | | | | 201,000 | | | | 2,000 | | | | - | | | | 203,000 | | | Benefit from allowance for doubtful accounts | | | - | | | | (308,000 | ) | | | (67,000 | ) | | | - | | | | (375,000 | ) | | Provision for (benefit from) excess and obsolete inventory | | | - | | | | 4,519,000 | | | | (28,000 | ) | | | - | | | | 4,491,000 | | | Excess income tax benefit from stock award exercises | | | (7,990,000 | ) | | | - | | | | - | | | | - | | | | (7,990,000 | ) | | Deferred income tax expense (benefit) | | | 562,000 | | | | (693,000 | ) | | | (16,000 | ) | | | - | | | | (147,000 | ) | | Equity in undistributed (earnings) loss of subsidiaries | | | (57,906,000 | ) | | | 742,000 | | | | - | | | | 57,164,000 | | | | - | | | Intercompany accounts | | | 70,268,000 | | | | (70,861,000 | ) | | | 593,000 | | | | - | | | | - | | | Changes in assets and liabilities, net of effects of acquisitions: | | | | | | | | | | | | | | | | | | | | | | Restricted cash securing letter of credit obligations | | | - | | | | 1,003,000 | | | | - | | | | - | | | | 1,003,000 | | | Accounts receivable | | | - | | | | 93,000 | | | | (3,256,000 | ) | | | - | | | | (3,163,000 | ) | | Inventories | | | - | | | | (4,196,000 | ) | | | (622,000 | ) | | | - | | | | (4,818,000 | ) | | Prepaid expenses and other current assets | | | (767,000 | ) | | | 1,302,000 | | | | (43,000 | ) | | | - | | | | 492,000 | | | Other assets | | | - | | | | 73,000 | | | | - | | | | - | | | | 73,000 | | | Accounts payable | | | (16,000 | ) | | | (1,881,000 | ) | | | (303,000 | ) | | | - | | | | (2,200,000 | ) | | Accrued expenses and other current liabilities | | | 3,657,000 | | | | 3,116,000 | | | | (1,165,000 | ) | | | - | | | | 5,608,000 | | | Customer advances and deposits | | | - | | | | 11,687,000 | | | | 4,825,000 | | | | - | | | | 16,512,000 | | | Deferred service revenue | | | - | | | | (9,896,000 | ) | | | - | | | | - | | | | (9,896,000 | ) | | Income taxes payable | | | 7,467,000 | | | | - | | | | (1,311,000 | ) | | | - | | | | 6,156,000 | | | Net cash provided by (used in) operating activities | | | 84,151,000 | | | | 6,781,000 | | | | (1,695,000 | ) | | | - | | | | 89,237,000 | | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from investing activities: | | | | | | | | | | | | | | | | | | | | | | Purchases of property, plant and equipment | | | (115,000 | ) | | | (11,618,000 | ) | | | (342,000 | ) | | | - | | | | (12,075,000 | ) | | Purchase of other intangibles with finite lives | | | - | | | | (38,000 | ) | | | - | | | | - | | | | (38,000 | ) | | Payments for business acquisitions | | | - | | | | (3,937,000 | ) | | | - | | | | - | | | | (3,937,000 | ) | | Net cash used in investing activities | | | (115,000 | ) | | | (15,593,000 | ) | | | (342,000 | ) | | | - | | | | (16,050,000 | ) | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from financing activities: | | | | | | | | | | | | | | | | | | | | | | Principal payments on other obligations | | | - | | | | (154,000 | ) | | | - | | | | - | | | | (154,000 | ) | | Excess income tax benefit from stock award exercises | | | 7,990,000 | | | | - | | | | - | | | | - | | | | 7,990,000 | | | Proceeds from exercises of stock options | | | 9,535,000 | | | | - | | | | - | | | | - | | | | 9,535,000 | | | Proceeds from issuance of employee stock purchase plan shares | | | 758,000 | | | | - | | | | - | | | | - | | | | 758,000 | | | Net cash provided by (used in) financing activities | | | 18,283,000 | | | | (154,000 | ) | | | - | | | | - | | | | 18,129,000 | | | | | | | | | | | | | | | | | | | | | | | | | Net increase (decrease) in cash and cash equivalents | | | 102,319,000 | | | | (8,966,000 | ) | | | (2,037,000 | ) | | | - | | | | 91,316,000 | | | Cash and cash equivalents at beginning of period | | | 238,298,000 | | | | 9,949,000 | | | | 3,340,000 | | | | - | | | | 251,587,000 | | | Cash and cash equivalents at end of period | | $ | 340,617,000 | | | | 983,000 | | | | 1,303,000 | | | | - | | | $ | 342,903,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(16) Consolidating Financial Information (continued)
The following reflects the consolidating statement of cash flows for the year ended July 31, 2006:
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiary | | | Consolidating Entries | | | Consolidated Total | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from operating activities: | | | | | | | | | | | | | | | | | Net income | | $ | 45,269,000 | | | | 41,157,000 | | | | 1,457,000 | | | | (42,614,000 | ) | | $ | 45,269,000 | | | Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | | | | | | | | | | | Depreciation and amortization of property, plant and equipment | | | 111,000 | | | | 6,019,000 | | | | 112,000 | | | | - | | | | 6,242,000 | | | Amortization of intangible assets with finite lives | | | - | | | | 2,289,000 | | | | 176,000 | | | | - | | | | 2,465,000 | | | Amortization of stock-based compensation | | | 2,176,000 | | | | 3,495,000 | | | | 10,000 | | | | - | | | | 5,681,000 | | | Amortization of deferred financing costs | | | 546,000 | | | | - | | | | - | | | | - | | | | 546,000 | | | Loss on disposal of property, plant and equipment | | | - | | | | 35,000 | | | | 1,000 | | | | - | | | | 36,000 | | | Provision for allowance for doubtful accounts | | | - | | | | 556,000 | | | | 192,000 | | | | - | | | | 748,000 | | | Provision for excess and obsolete inventory | | | - | | | | 1,981,000 | | | | 49,000 | | | | - | | | | 2,030,000 | | | Excess income tax benefit from stock award exercises | | | (4,065,000 | ) | | | - | | | | - | | | | - | | | | (4,065,000 | ) | | Deferred income tax expense (benefit) | | | 1,013,000 | | | | (74,000 | ) | | | (107,000 | ) | | | - | | | | 832,000 | | | Equity in undistributed earnings of subsidiaries | | | (41,157,000 | ) | | | (1,457,000 | ) | | | - | | | | 42,614,000 | | | | - | | | Intercompany accounts | | | 7,876,000 | | | | (9,822,000 | ) | | | 1,946,000 | | | | - | | | | - | | | Changes in assets and liabilities, net of effects of acquisition: | | | | | | | | | | | | | | | | | | | | | | Restricted cash securing letter of credit obligations | | | 31,000 | | | | - | | | | - | | | | - | | | | 31,000 | | | Accounts receivable | | | - | | | | (11,775,000 | ) | | | (2,968,000 | ) | | | - | | | | (14,743,000 | ) | | Inventories | | | - | | | | (17,860,000 | ) | | | (49,000 | ) | | | - | | | | (17,909,000 | ) | | Prepaid expenses and other current assets | | | (213,000 | ) | | | (2,262,000 | ) | | | (316,000 | ) | | | - | | | | (2,791,000 | ) | | Other assets | | | (56,000 | ) | | | (195,000 | ) | | | (9,000 | ) | | | - | | | | (260,000 | ) | | Accounts payable | | | 39,000 | | | | 4,392,000 | | | | 329,000 | | | | - | | | | 4,760,000 | | | Accrued expenses and other current liabilities | | | 1,181,000 | | | | 5,271,000 | | | | 1,281,000 | | | | - | | | | 7,733,000 | | | Customer advances and deposits | | | - | | | | (1,780,000 | ) | | | 42,000 | | | | - | | | | (1,738,000 | ) | | Deferred service revenue | | | - | | | | 1,686,000 | | | | - | | | | - | | | | 1,686,000 | | | Income taxes payable | | | 6,953,000 | | | | - | | | | 824,000 | | | | - | | | | 7,777,000 | | | Net cash provided by operating activities | | | 19,704,000 | | | | 21,656,000 | | | | 2,970,000 | | | | - | | | | 44,330,000 | | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from investing activities: | | | | | | | | | | | | | | | | | | | | | | Purchases of property, plant and equipment | | | (587,000 | ) | | | (11,387,000 | ) | | | (353,000 | ) | | | - | | | | (12,327,000 | ) | | Purchase of other intangibles with finite lives | | | - | | | | (197,000 | ) | | | - | | | | - | | | | (197,000 | ) | | Payments for business acquisition | | | - | | | | (1,000,000 | ) | | | - | | | | - | | | | (1,000,000 | ) | | Net cash used in investing activities | | | (587,000 | ) | | | (12,584,000 | ) | | | (353,000 | ) | | | - | | | | (13,524,000 | ) | | | | | | | | | | | | | | | | | | | | | | | | Cash flows from financing activities: | | | | | | | | | | | | | | | | | | | | | | Principal payments on other obligations | | | - | | | | (234,000 | ) | | | - | | | | - | | | | (234,000 | ) | | Excess income tax benefit from stock award exercises | | | 4,065,000 | | | | - | | | | - | | | | - | | | | 4,065,000 | | | Proceeds from exercises of stock options | | | 1,863,000 | | | | - | | | | - | | | | - | | | | 1,863,000 | | | Proceeds from issuance of employee stock purchase plan shares | | | 674,000 | | | | - | | | | - | | | | - | | | | 674,000 | | | Net cash provided by (used in) financing activities | | | 6,602,000 | | | | (234,000 | ) | | | - | | | | - | | | | 6,368,000 | | | | | | | | | | | | | | | | | | | | | | | | | Net increase in cash and cash equivalents | | | 25,719,000 | | | | 8,838,000 | | | | 2,617,000 | | | | - | | | | 37,174,000 | | | Cash and cash equivalents at beginning of period | | | 212,579,000 | | | | 1,111,000 | | | | 723,000 | | | | - | | | | 214,413,000 | | | Cash and cash equivalents at end of period | | $ | 238,298,000 | | | | 9,949,000 | | | | 3,340,000 | | | | - | | | $ | 251,587,000 | |
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Unaudited Quarterly Financial Data
The following is a summary of unaudited quarterly operating results (amounts in thousands, except per share data):
| Fiscal 2008 | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | | | Total | | | Net sales | | $ | 115,055 | | | | 152,030 | | | | 138,068 | | | | 126,474 | | | | 531,627 | | | Gross profit | | | 50,478 | | | | 66,325 | | | | 60,532 | | | | 57,605 | | | | 234,940 | | | Net income | | | 14,694 | | | | 25,469 | | | | 19,305 | | | | 16,965 | | | | 76,433 | | | Diluted income per share | | $ | 0.54 | | | | 0.91 | | | | 0.70 | | | | 0.61 | | | | 2.76 | |
| Fiscal 2007 | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | | | Total | | | Net sales | | $ | 97,070 | | | | 111,383 | | | | 119,417 | | | | 117,814 | | | | 445,684 | | | Gross profit | | | 39,375 | | | | 49,850 | | | | 51,575 | | | | 52,495 | | | | 193,295 | | | Net income | | | 10,827 | | | | 18,171 | | | | 19,128 | | | | 17,087 | | | | 65,213 | | | Diluted income per share | | $ | 0.41 | | | | 0.68 | | | | 0.71 | | | | 0.63 | | | | 2.42 | * |
| Fiscal 2006 | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | | | Total | | | Net sales | | $ | 106,567 | | | | 95,741 | | | | 88,997 | | | | 100,206 | | | | 391,511 | | | Gross profit | | | 40,204 | | | | 41,091 | | | | 34,213 | | | | 43,793 | | | | 159,301 | | | Net income | | | 11,464 | | | | 13,304 | | | | 8,722 | | | | 11,779 | | | | 45,269 | | | Diluted income per share | | $ | 0.43 | | | | 0.50 | | | | 0.33 | | | | 0.45 | | | | 1.72 | * |
| The Company has adopted SFAS No. 130, “Reporting Comprehensive Income,” which requires companies to report all changes in equity during a period, except those resulting from investment by owners and distribution to owners, for the period in which they are recognized. Comprehensive income is the total of net income and all other non-owner changes in equity (or other comprehensive income) such as unrealized gains/losses on securities classified as available-for-sale, foreign currency translation adjustments and minimum pension liability adjustments. Comprehensive income was the same as net income in fiscal 2006, 2005 and 2004. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| Certain reclassifications have been made to previously reported consolidated financial statements to conform to the fiscal 2006 presentation. |
| In May 2004, the Company acquired certain assets and product lines and assumed certain liabilities of Memotec, Inc. (“Memotec”), a subsidiary of Kontron AG, and at the same time, purchased related inventory owned by Kontron Canada Inc., for an aggregate purchase price of $5,187,000, including transaction costs of $161,000. Sales and income for fiscal 2004 relating to the Memotec assets acquired would not have been material to the Company’s results of operations for that period. | | | | In February 2005, the Company acquired certain assets and assumed certain liabilities of Tolt Technologies, Inc. (“Tolt”). Sales and income for fiscal 2005 and 2004 relating to the Tolt assets acquired would not have been material to the Company’s results of operations for those periods. The purchase price of the business was $3,735,000, including transaction costs of $235,000. Of the total purchase price excluding transaction costs, $2,500,000 was paid at closing and the remaining $1,000,000 was paid in fiscal 2006. | | | | The Memotec and Tolt purchase prices were allocated as follows: | | |
| | | Memotec | | Tolt | | Estimated Useful Lives | | | | |
| |
| |
| | | | Fair value of net tangible
assets acquired | $ | 1,990,000 | | | 4,000 | | | | | | | | Adjustments to record
intangible assets and
liabilities at fair value: | | | | | | | | | | | In-process research and
development | | 940,000 | | | — | | — | | | | Proprietary and core
technology | | 820,000 | | | — | | 8-9 years | | | | Existing technology | | 190,000 | | | — | | 7-9 years | | | | Other intangibles | | 410,000 | | | 160,000 | | 6 months to 10 years | | | | Goodwill | | 947,000 | | | 3,571,000 | | Infinite | | | | Deferred tax liability | | (110,000 | ) | | — | | | | | | |
| |
| | | | | | | | 3,197,000 | | | 3,731,000 | | | | | | |
| |
| | | | | | Aggregate purchase price | $ | 5,187,000 | | | 3,735,000 | | | | | | |
| |
| | | |
| | | For Memotec, the valuation of the in-process research and development, existing technology and most other intangibles was based on the value of the discounted cash flows that the assets could be expected to generate in the future. The valuation of the core technology was based on the discounted capitalization of the royalty expense saved since the Company owns the asset. For Tolt, the purchase price was substantially allocated to goodwill (which includes assembled workforce). |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| The value ascribed to the Memotec in-process research and development acquired was expensed in fiscal 2004. The following table includes the specific nature and fair value allocated to each significant in-process research and development project acquired, as well as significant appraisal assumptions used as of the acquisition date and the current project status. | | |
| | | | As of the Acquisition Date | | | | | | | |
| | | | | | Specific Nature
of R&D Projects | | Fair Market
Value
Allocated | | % of
Estimated
Efforts
Complete | | Original
Anticipated
Completion
Date | | Discount
Rate | Fiscal Year
Cash Flows
Projected To
Commence | | Project
Status as of
July 31,
2006 | | | |
| |
| |
| |
| |
|
| |
| | | | Technology for bandwidth
optimization #1 | | $ | 680,000 | | 78% | | January 2005 | | 35% | 2005 | | Complete | | | | | | Technology for bandwidth
optimization #2 | | | 260,000 | | 24% | | August 2005 | | 40% | 2006 | | Cancelled | | | | | |
| | | | | | | | | | | | | Total | | $ | 940,000 | | | | | | | | | | | | | | |
| | | | | | | | | | |
| | | Our purchased in-process research and development efforts are complex and unique in light of the nature of the technology, which is generally state-of-the-art. The Company does not believe that the failure to complete the cancelled Memotec project will have a material impact on the Company’s consolidated results of operations. | | | | As discussed in Note 18, in August 2006, the Company acquired certain assets and assumed certain liabilities of Insite Consulting, Inc. (“Insite”), a logistics application software company, for $2.7 million, plus certain earn-out payments based on the achievement of future sales targets. |
| Accounts receivable consist of the following at July 31, 2006 and 2005: | | |
| | | 2006 | | 2005 | | | | |
| |
| | | | Accounts receivable from commercial customers | $ | 36,700,000 | | | 30,967,000 | | | | Unbilled receivables (including retainages) on contracts-in-progress | | 10,361,000 | | | 8,811,000 | | | | Amounts receivable from the U.S. government and its agencies | | 24,362,000 | | | 16,910,000 | | | | |
| |
| | | | | | 71,423,000 | | | 56,688,000 | | | | Less allowance for doubtful accounts | | 1,376,000 | | | 636,000 | | | | |
| |
| | | | Accounts receivable, net | $ | 70,047,000 | | | 56,052,000 | | | | |
| |
| |
| | | There was no retainage included in unbilled receivables at July 31, 2006. There was $2,684,000 of retainage included in unbilled receivables at July 31, 2005. | | | | As of July 31, 2006, a prime contractor represented 16.6% of total net accounts receivable which primarily relates to a large over-the-horizon microwave system contract in our telecommunications transmission segment. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4)Inventories
Inventories consist of the following at July 31, 2006 and 2005:
| |
| | | | 2006 | | 2005
| | | | | |
| |
| | | | Raw materials and components | | $ | 35,835,000 | | | 26,816,000 | | | | Work-in-process and finished goods | | | 31,331,000 | | | 24,796,000 | | | | | |
| |
| | | | | | | 67,166,000 | | | 51,612,000 | | | | Less reserve for excess and obsolete inventories | | | 6,123,000 | | | 6,509,000 | | | | | |
| |
| | | | Inventories, net | | $ | 61,043,000 | | | 45,103,000 | | | | | |
| |
| |
| | | Inventories directly related to long-term contracts were $8,349,000 and $8,925,000 at July 31, 2006 and 2005, respectively. At July 31, 2006, $3,406,000 of the inventory balance above related to a contract from a third party commercial customer to outsource its manufacturing. The decrease in the reserve from July 31, 2005 to July 31, 2006, primarily related to the write-off of previously reserved inventory during fiscal 2006, largely offset by the fiscal 2006 provision for excess and obsolete inventory. | | | (5)Property, Plant and Equipment | | | | Property, plant and equipment consists of the following at July 31, 2006 and 2005: |
| | | | | | | | | | | | 2006 | | 2005
| | | | | |
| |
| | | | Machinery and equipment | | $ | 54,305,000 | | | 43,060,000 | | | | Leasehold improvements | | | 4,338,000 | | | 3,715,000 | | | | Equipment financed by capital lease | | | 522,000 | | | 522,000 | | | | | |
| |
| | | | | | | 59,165,000 | | | 47,297,000 | | | | Less accumulated depreciation and amortization | | | 34,433,000 | | | 28,614,000 | | | | | |
| |
| | | | Property, plant and equipment, net | | $ | 24,732,000 | | | 18,683,000 | | | | | |
| |
| |
| | | Depreciation and amortization expense on property, plant and equipment amounted to approximately $6,242,000, $5,315,000 and $4,341,000, for the fiscal years ended July 31, 2006, 2005 and 2004, respectively. | | | (6)Accrued Expenses and Other Current Liabilities | | | | Accrued expenses and other current liabilities consist of the following at July 31, 2006 and 2005: |
| | | | | | | | | | | | 2006 | | 2005
| | | | | |
| |
| | | | Accrued wages and benefits | | $ | 17,361,000 | | | 14,439,000 | | | | Accrued commissions | | | 5,745,000 | | | 5,049,000 | | | | Accrued warranty | | | 10,468,000 | | | 7,910,000 | | | | Accrued hurricane related costs (See Note 13(c)) | | | 2,240,000 | | | 2,331,000 | | | | Accrued business acquisition payments | | | — | | | 1,000,000 | | | | Other | | | 5,416,000 | | | 3,768,000 | | | | | |
| |
| | | | Accrued expenses and other current liabilities | | $ | 41,230,000 | | | 34,497,000 | | | | | |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| The Company provides standard warranty coverage for most of its products for a period of at least one year from the date of shipment. The Company records a liability for estimated warranty expense based on historical claims, product failure rates and other factors. Changes in the Company’s product warranty liability during the fiscal years ended July 31, 2006 and 2005 were as follows: | | |
| | | | 2006
| | 2005
| | | | | |
| |
| | | | Balance at beginning of period | | $ | 7,910,000 | | | 4,990,000 | | | | Provision for warranty obligations | | | 7,260,000 | | | 5,958,000 | | | | Acquired obligations | | | — | | | 450,000 | | | | Charges incurred | | | (4,702,000 | ) | | (3,488,000 | ) | | | | |
| |
| | | | Balance at end of period | | $ | 10,468,000 | | | 7,910,000 | | | | | |
| |
| |
| (7)Other Obligations
Other obligations consist of the following at July 31, 2006 and 2005:
| |
| | | | 2006
| | 2005
| | | | | |
| |
| | | | Obligations under capital leases and for technology purchase | | $ | 397,000 | | | 631,000 | | | | Less current installments | | | 154,000 | | | 235,000 | | | | | |
| |
| | | | | | $ | 243,000 | | | 396,000 | | | | | |
| |
| |
| | | Other obligations in both years related to certain equipment and a technology license. The net carrying value of assets under these obligations was $830,000 and $864,000 at July 31, 2006 and 2005, respectively. |
| | | Future minimum lease payments under other obligations as of July 31, 2006 are as follows: | | |
| | Fiscal years ending July 31, | | | | | | | | 2007 | $ | 180,000 | | | | | | 2008 | | 150,000 | | | | | | 2009 | | 113,000 | | | | | |
| | | | | Total minimum lease payments | | 443,000 | | | | | Less amounts representing interest (at rates ranging from 6.90% to 8.0%) | | 46,000 | | | | | |
| | | | | | | 397,000 | | | | | Less current installments | | 154,000 | | | | | |
| | | | | Other obligations, net of current installments | $ | 243,000 | | | | | |
| | |
| (8)2.0% Convertible Senior Notes due 2024
| |
| On January 27, 2004, the Company issued $105,000,000 of its 2.0% convertible senior notes in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. The net proceeds from this transaction were $101,179,000 after deducting the initial purchaser’s discount and other transaction costs of $3,821,000. | | | | The notes bear interest at an annual rate of 2.0% and, during certain periods, the notes are convertible into shares of the Company’s common stock at an initial conversion price of $31.50 per share (a conversion rate of 31.7460 shares per $1,000 original principal amount of notes), subject to adjustment in certain circumstances. The notes may be converted if, during a conversion period on each of at least 20 trading days, the closing sale price of the Company’s common stock exceeds 120% of the conversion price in effect. Upon conversion of the notes, in lieu of delivering common stock, the Company may, in its discretion, deliver cash or a combination of cash and common stock. The Company may, at its option, redeem some or all of the notes on or after February 4, 2009. Holders of the notes will have the right to require the Company to repurchase some or all of the outstanding notes on February 1, 2011, February 1, 2014 and February 1, 2019 and upon certain events, including a change in control. If not redeemed by the Company or repaid pursuant to the holders’ right to require repurchase, the notes mature on February 1, 2024. | | | | The 2.0% interest is payable in cash, semi-annually, through February 1, 2011. After such date, the 2.0% interest will be accreted into the principal amount of the notes. Also, commencing with the six-month period |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| beginning February 1, 2009, if the average note price for the applicable trading period equals 120% or more of the accreted principal amount of such notes, the Company will pay contingent interest at an annual rate of 0.25%. | | | | The notes are general unsecured obligations of the Company, ranking equally in right of payment with all of its other existing and future unsecured senior indebtedness and senior in right of payment to any of its future subordinated indebtedness. All of Comtech Telecommunications Corp.’s (the “Parent”) wholly-owned subsidiaries have issued full and unconditional guarantees in favor of the holders of the Company’s 2.0% convertible senior notes (the “Guarantor Subsidiaries”), except for the subsidiary that purchased Memotec, Inc. in fiscal 2004 (the “Non-Guarantor Subsidiary”). Tolt, which was purchased in February 2005, became a guarantor in July 2005. These full and unconditional guarantees are joint and several. Other than supporting the operations of its subsidiaries, the Parent has no independent assets or operations and there are currently no significant restrictions on its ability, or the ability of the guarantors, to obtain funds from each other by dividend or loan. Consolidating financial information regarding the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiary can be found in Note 17 to the consolidated financial statements beginning on page F-29. | | | | The net proceeds of the offering are being used for working capital and general corporate purposes and potentially may be used for future acquisitions of businesses or technologies or repurchases of the Company’s common stock. The Company filed a registration statement with the Securities and Exchange Commission (“SEC”), which has become effective, for the resale of the notes and the shares of common stock issuable upon conversion of the notes. |
| The provision for income taxes included in the accompanying consolidated statements of operations consists of the following: | | |
| | | |
| | | | | | Fiscal Years Ended July 31,
| | | | | |
| | | | | | 2006 | | 2005
| | 2004 | | | | | |
| |
| |
| | | | Federal – current | | $ | 22,085,000 | | | 13,135,000 | | | 7,664,000 | | | | Federal – deferred | | | 854,000 | | | 2,605,000 | | | 2,122,000 | | | | | | | | | | | | | | | | | State and local – current | | | 1,539,000 | | | 931,000 | | | 504,000 | | | | State and local – deferred | | | 85,000 | | | 163,000 | | | 133,000 | | | | | | | | | | | | | | | | | Foreign – current | | | 762,000 | | | (32,000 | ) | | 24,000 | | | | Foreign – deferred | | | (107,000 | ) | | — | | | (176,000 | ) | | | | |
| |
| |
| | | | | | $ | 25,218,000 | | | 16,802,000 | | | 10,271,000 | | | | | |
| |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| The provision for income taxes differed from the amounts computed by applying the U.S. Federal income tax rate as a result of the following: | | |
| |
| | | | Fiscal Years Ended July 31, | | | | 2006 | | 2005 | | 2004 | | | |
| |
| |
| | | | Amount | | Rate | | Amount | | Rate | | Amount | | Rate | | | |
| |
| |
| |
| |
| |
| | | Computed “expected” tax expense | $ | 24,670,000 | | | 35.0 | % | | 18,710,000 | | | 35.0 | % | | 11,234,000 | | | 35.0 | % | Increase (reduction) in income taxes
resulting from: | | | | | | | | | | | | | | | | | | | | Nondeductible compensation | | 961,000 | | | 1.4 | | | 906,000 | | | 1.7 | | | — | | | — | | State and local income taxes,
net of Federal benefit | | 922,000 | | | 1.3 | | | 711,000 | | | 1.3 | | | 414,000 | | | 1.3 | | Nondeductible stock-based
compensation | | 615,000 | | | 0.9 | | | — | | | — | | | — | | | — | | Extraterritorial income
exclusion | | (726,000 | ) | | (1.0 | ) | | (1,862,000 | ) | | (3.5 | ) | | (856,000 | ) | | (2.7 | ) | Domestic production activities
deduction | | (646,000 | ) | | (0.9 | ) | | — | | | — | | | — | | | — | | Research and experimentation
credits | | (415,000 | ) | | (0.6 | ) | | (694,000 | ) | | (1.3 | ) | | (454,000 | ) | | (1.4 | ) | Change in the beginning of the
year valuation allowance for
deferred tax assets | | (111,000 | ) | | (0.2 | ) | | (1,189,000 | ) | | (2.2 | ) | | (350,000 | ) | | (1.1 | ) | | | | | | | | | Other | | (52,000 | ) | | (0.1 | ) | | 220,000 | | | 0.4 | | | 283,000 | | | 0.9 | | | |
| |
| |
| |
| |
| |
| | | | $ | 25,218,000 | | | 35.8 | % | | 16,802,000 | | | 31.4 | % | | 10,271,000 | | | 32.0 | % | | |
| |
| |
| |
| |
| |
| | | | | | | | |
| | | The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at July 31, 2006 and 2005 are presented below. | | |
| | | | 2006 | | 2005 | | | | | | |
| |
| | | | | Deferred tax assets: | | | | | | | | | | | Allowance for doubtful accounts receivable | | $ | 404,000 | | | 236,000 | | | | | Intangibles | | | 675,000 | | | 848,000 | | | | | Inventory and warranty reserves | | | 5,025,000 | | | 4,930,000 | | | | | Compensation and commissions | | | 2,049,000 | | | 1,925,000 | | | | | State research and experimentation credits | | | 1,162,000 | | | 1,158,000 | | | | | Stock-based compensation | | | 1,312,000 | | | — | | | | | Other | | | 1,245,000 | | | 1,001,000 | | | | | Less valuation allowance | | | (1,362,000 | ) | | (1,470,000 | ) | | | | | |
| |
| | | | | Total deferred tax assets | | | 10,510,000 | | | 8,628,000 | | | | | | | | | | | | | | | | Deferred tax liabilities: | | | | | | | | | | | Convertible senior notes | | | (6,374,000 | ) | | (3,836,000 | ) | | | | Plant and equipment | | | (2,863,000 | ) | | (2,687,000 | ) | | | | | |
| |
| | | | | Total deferred tax liabilities | | | (9,237,000 | ) | | (6,523,000 | ) | | | | | |
| |
| | | | | Net deferred tax assets | | $ | 1,273,000 | | | 2,105,000 | | | | | | |
| |
| | |
| | | The Company provides for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires an asset and liability based approach in accounting for income taxes. In assessing the realizability of deferred tax assets and liabilities, management considers whether it is more likely than not that some portion or all of them will not be realized. As of July 31, 2006 and 2005, the Company’s deferred tax asset has been offset by a valuation allowance primarily related to state research and experimentation credits which may not be utilized in future periods. The Company must generate approximately $32,000,000 of taxable income to fully utilize its deferred tax assets. Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| In fiscal 2006, the Company’s Federal income tax return for the fiscal year ended July 31, 2004 was selected for audit by the Internal Revenue Service. The audit is in the early stages and additional income tax returns for other fiscal years may be examined. If the outcome of the audit differs materially from our original income tax provisions, the Company’s results of operations and financial position could be materially impacted. |
| In April 2005, the Company completed a three-for-two stock split, which was effected in the form of a 50% stock dividend. All share and per share information in the consolidated financial statements and notes thereto has been adjusted to reflect the stock split. | | |
| (b) Stock Option, Stock Purchase and Warrant Agreements | | |
| The Company has stock option and stock purchase plans and warrant agreements as follows: | | | | 1993 Incentive Stock Option Plan – The 1993 Incentive Stock Option Plan, as amended, provided for the granting to key employees and officers of incentive and non-qualified stock options to purchase up to 2,345,625 shares of the Company’s common stock at prices generally not less than the fair market value at the date of grant with the exception of anyone who, prior to the grant, owns more than 10% of the voting power, in which case the exercise price cannot be less than 110% of the fair market value. In addition, it provided formula grants to non-employee members of the Company’s Board of Directors. The term of the options could be no more than ten years. However, for incentive stock options granted to any employee who, prior to the granting of the option, owns stock representing more than 10% of the voting power, the option term could be no more than five years. As of July 31, 2006, the Company had granted stock options representing the right to purchase an aggregate of 2,070,218 shares (net of 374,441 canceled options) at prices ranging between $0.67 - $5.31 per share, of which 207,262 are outstanding at July 31, 2006. To date, 1,862,956 shares have been exercised. Outstanding awards have been transferred to the 2000 Stock Incentive Plan. The terms applicable to these awards prior to the transfer continue to apply. The plan was terminated by the Company’s Board of Directors in December 1999 due to the approval by the shareholders of the 2000 Stock Incentive Plan.
| | | | 2000 Stock Incentive Plan – The 2000 Stock Incentive Plan, as amended, provides for the granting to all employees and consultants of the Company (including prospective employees and consultants) non-qualified stock options, stock appreciation rights, restricted stock, performance shares, performance units and other stock-based awards. In addition, employees of the Company are eligible to be granted incentive stock options. Non-employee directors of the Company are eligible to receive non-discretionary grants of nonqualified stock options subject to certain limitations. The aggregate number of shares of common stock which may be issued may not exceed 5,737,500 plus the shares that were transferred to the Plan relating to outstanding awards that were previously granted under the 1982 Incentive Stock Option Plan and the 1993 Incentive Stock Option Plan. The Stock Option Committee of the Company’s Board of Directors, consistent with the terms of the Plan, will determine the types of awards to be granted, the terms and conditions of each award and the number of shares of common stock to be covered by each award. Grants of incentive and non- qualified stock options may not have a term exceeding ten years or no more than five years in the case of an incentive stock option granted to a stockholder who owns stock representing more than 10% of the voting power. As of July 31, 2006, the Company had granted stock options representing the right to purchase an aggregate of 4,692,700 shares at prices ranging between $3.13 - $41.51 of which 403,590 options were canceled and 2,711,980 are outstanding at July 31, 2006. As of July 31, 2006, 1,577,130 stock options have been exercised. All options granted through July 31, 2005 had exercise prices equal to the fair market value of the stock on the date of grant and a term of ten years. All options granted since August 1, 2006 have had exercise prices equal to the fair market value of the stock on the date of grant and a term of five years.
|
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| The following table summarizes stock option activity during the three years ended July 31, 2006: | | |
| | | Number of
Shares | | Weighted
Average
Exercise Price
| | Weighted
Average
Remaining
Contractual
Term (Years) | | Aggregate
Intrinsic
Value
| | | | |
| | | | Outstanding at July 31, 2003 | | 2,602,281 | | | $ | 4.18 | | | | | | | | | | | Granted | | 988,875 | | | | 13.07 | | | | | | | | | | | Expired/canceled | | (35,025 | ) | | | 5.88 | | | | | | | | | | | Exercised | | (450,225 | ) | | | 3.36 | | | | | | | | | | | |
| | |
| | | | | | | | | | | | | Outstanding at July 31, 2004 | | 3,105,906 | | | | 7.11 | | | | | | | | | | | Granted | | 732,750 | | | | 15.20 | | | | | | | | | | | Expired/canceled | | (61,975 | ) | | | 10.25 | | | | | | | | | | | Exercised | | (1,209,799 | ) | | | 5.98 | | | | | | | | | | | |
| | |
| | | | | | | | | | | | | Outstanding at July 31, 2005 | | 2,566,882 | | | | 9.87 | | | | | | | | | | | Granted | | 706,000 | | | | 35.30 | | | | | | | | | | | Expired/canceled | | (108,903 | ) | | | 16.00 | | | | | | | | | | | Exercised | | (244,737 | ) | | | 7.61 | | | | | | | | | | | |
| | |
| | | | | | | | | | | | | Outstanding at July 31, 2006 | | 2,919,242 | | | $ | 15.99 | | | 5.9 | | | $ | 34,373,000 | | | | |
| | |
| | |
| | |
| | | | | | Exercisable at July 31, 2006 | | 732,692 | | | $ | 9.68 | | | 6.4 | | | $ | 13,246,000 | | | | |
| | |
| | |
| | |
| | | | | | Expected to vest at July 31, 2006 | | 2,008,425 | | | $ | 18.10 | | | 5.7 | | | $ | 21,127,000 | | | | |
| | |
| | |
| | |
| |
| | | The total intrinsic value of stock options exercised during the years ended July 31, 2006, 2005 and 2004 was $6,602,000, $32,590,000 and $7,164,000, respectively. | | | | Warrants Issued Pursuant to Acquisition– In connection with an acquisition in fiscal 1999, the Company issued warrants to the acquiree’s owners and creditors to purchase 337,500 shares of the Company’s common stock at an exercise price of $2.92. All warrants were exercised as of July 31, 2004.
| | | | 2001 Employee Stock Purchase Plan – The ESPP was approved by the shareholders on December 12, 2000, and 675,000 shares of the Company’s common stock were reserved for issuance. The ESPP is intended to provide eligible employees of the Company the opportunity to acquire common stock in the Company at 85% of fair market value at date of issuance through participation in the payroll-deduction based ESPP. Through fiscal 2006, the Company issued 234,851 shares of its common stock to participating employees in connection with the ESPP.
|
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(11) Customer and Geographic Information
Sales by geography and customer type, as a percentage of consolidated net sales, are as follows:
| |
| | |
| | | | | | Fiscal Years Ended July 31, | | | | | |
| | | | | | 2006 | | 2005 | | 2004 | | | | | |
| |
| |
| | | | | United States | | | | | | | | | | | | | U.S. government | | 47.3 | % | | 42.1 | % | | 40.1 | % | | | | Commercial customers | | 17.1 | % | | 13.9 | % | | 14.5 | % | | | | |
| |
| |
| | | | | Total United States | | 64.4 | % | | 56.0 | % | | 54.6 | % | | | | | | | | | | | | | | | | | International | | | | | | | | | | | | | North African country | | 9.7 | % | | 13.2 | % | | 14.1 | % | | | | Other international customers | | 25.9 | % | | 30.8 | % | | 31.3 | % | | | | |
| |
| |
| | | | | Total International | | 35.6 | % | | 44.0 | % | | 45.4 | % | |
| | | International sales include sales to U.S. domestic companies for inclusion in products that will be sold to international customers. One customer, a prime contractor, represented 10.2% of consolidated net sales in both fiscal 2006 and 2005. In fiscal 2004, one customer, another prime contractor, represented 12.5% of consolidated net sales. |
| 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 decisions about resources to be allocated and assessing their 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 operating segments: (i) telecommunications transmission, (ii) mobile data communications and (iii) RF microwave amplifiers. Telecommunications transmission products include satellite earth station products (such as analog and digital modems, frequency converters, power amplifiers, and voice gateways) and over-the-horizon microwave communications products and systems. Mobile data communications products include satellite-based mobile location, tracking and messaging hardware and related services. RF microwave amplifier products include solid-state, high-power, broadband amplifier products that use the microwave and radio frequency spectrums. | | | | Unallocated expenses result from such corporate expenses as legal, accounting and executive compensation. In addition, for fiscal 2006, unallocated expenses include $5,681,000 of stock-based compensation expense. There was no stock-based compensation expense recorded for fiscal 2005 or 2004. Interest expense associated with the Company’s 2.0% convertible senior notes is not allocated to the operating segments. Unallocated assets consist principally of cash, deferred financing costs and deferred tax assets. Substantially all of the Company’s long-lived assets are located in the U.S. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| Corporate management defines and reviews segment profitability based on the same allocation methodology as presented in the segment data tables below. | | |
| |
| |
|---|
| Fiscal Year Ended July 31, 2006 | |
|---|
| |
| |
|---|
| (in thousands) | Telecommunications
Transmission | | Mobile Data
Communications | | RF Microwave
Amplifiers | | Unallocated | | Total | |
|---|
| | | Net sales | $ | 197,891 | | | 149,463 | | | 44,157 | | | — | | $ | 391,511 | | | Operating income (expense) | | 49,797 | | | 21,730 | | | 8,311 | | | (15,907 | ) | | 63,931 | | | Interest income | | 48 | | | 2 | | | — | | | 9,193 | | | 9,243 | | | Interest expense | | 38 | | | — | | | 3 | | | 2,646 | | | 2,687 | | | Depreciation and amortization | | 6,086 | | | 1,193 | | | 1,317 | | | 111 | | | 8,707 | | Expenditure for long-lived assets,
including intangibles | | 8,914 | | | 1,545 | | | 1,477 | | | 588 | | | 12,524 | | | Total assets at July 31, 2006 | | 134,567 | | | 45,641 | | | 24,588 | | | 250,470 | | | 455,266 | |
| |
| |
|---|
| Fiscal Year Ended July 31, 2005 | |
|---|
| |
| |
|---|
| (in thousands) | Telecommunications
Transmission | | Mobile Data
Communications | | RF Microwave
Amplifiers | | Unallocated | | Total | |
|---|
| | | Net sales | $ | 174,488 | | | 86,084 | | | 47,318 | | | — | | $ | 307,890 | | | Operating income (expense) | | 40,194 | | | 11,848 | | | 8,224 | | | (8,202 | ) | | 52,064 | | | Interest income | | (2 | ) | | 1 | | | 3 | | | 4,070 | | | 4,072 | | | Interest expense | | 22 | | | — | | | 11 | | | 2,646 | | | 2,679 | | | Depreciation and amortization | | 5,497 | | | 796 | | | 1,262 | | | 88 | | | 7,643 | | Expenditure for long-lived assets,
including intangibles | | 6,962 | | | 5,344 | | | 1,604 | | | 65 | | | 13,975 | | | Total assets at July 31, 2005 | | 99,197 | | | 32,827 | | | 25,320 | | | 225,059 | | | 382,403 | |
| |
| |
|---|
| Fiscal Year Ended July 31, 2004 | |
|---|
| |
| |
|---|
| (in thousands) | Telecommunications
Transmission | | Mobile Data
Communications | | RF Microwave
Amplifiers | | Unallocated | | Total | |
|---|
| | | Net sales | $ | 141,514 | | | 59,784 | | | 22,092 | | | — | | $ | 223,390 | | | Operating income (expense) | | 29,210 | | | 9,526 | | | 261 | | | (6,395 | ) | | 32,602 | | | Interest income | | 4 | | | 3 | | | — | | | 914 | | | 921 | | | Interest expense | | 33 | | | — | | | 22 | | | 1,370 | | | 1,425 | | | Depreciation and amortization | | 4,832 | | | 413 | | | 1,082 | | | 187 | | | 6,514 | | Expenditure for long-lived assets,
including intangibles | | 6,473 | | | 1,552 | | | 652 | | | 494 | | | 9,171 | | | Total assets at July 31, 2004 | | 88,629 | | | 21,276 | | | 22,934 | | | 173,551 | | | 306,390 | |
| | Intersegment sales in fiscal 2006, 2005 and 2004 by the telecommunications transmission segment to the RF microwave amplifiers segment were $7,512,000, $8,579,000 and $3,598,000, respectively. In fiscal 2006, 2005 and 2004, intersegment sales by the telecommunications transmission segment to the mobile data communications segment were $55,667,000, $19,466,000 and $12,776,000, respectively. Intersegment sales have been eliminated from the tables above. In fiscal 2004, operating income in the telecommunications transmission segment includes an in-process research and development charge of $940,000. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13)Commitments and Contingencies
| |
| The Company is obligated under noncancellable operating lease agreements, including satellite lease expenditures relating to its mobile data communications segment contracts. At July 31, 2006, the future minimum lease payments under operating leases are as follows: | | |
| | 2007 | $ | 8,565,000 | | | | 2008 | | 2,901,000 | | | | 2009 | | 2,424,000 | | | | 2010 | | 2,061,000 | | | | 2011 | | 1,207,000 | | | | Thereafter | | 798,000 | | | | |
| | | | Total | $ | 17,956,000 | | | | |
| |
| | | Lease expense charged to operations was $3,379,000, $3,018,000 and $2,866,000 in fiscal 2006, 2005 and 2004, respectively. Lease expense excludes satellite lease expenditures incurred of approximately $13,382,000, $11,854,000 and $11,233,000 in fiscal 2006, 2005 and 2004, respectively, relating to the Company’s mobile data communications segment. Satellite lease expenditures are allocated to individual contracts and expensed to cost of sales. | | | | In December 1991, the Company and a partnership controlled by the Company’s Chairman, Chief Executive Officer and President entered into an agreement in which the Company leases from the partnership its Melville, New York production facility. The lease was for an initial term of ten years. In December 2001, the Company exercised its option for an additional ten-year period. For financial reporting purposes, the lease for the extension period is an operating lease. The annual rentals, of approximately $532,000 for fiscal 2006, are subject to annual adjustments equal to the lesser of 5% or the change in the Consumer Price Index. | | |
| (b)United States Government Contracts | | |
| Certain of the Company’s contracts are subject to audit by applicable governmental agencies. Until such audits are completed, the ultimate profit on these contracts cannot be determined; however, it is management’s belief that the final contract settlements will not have a material adverse effect on the Company’s consolidated financial position or results of operations. | | |
| The Company is subject to certain legal actions, which arise in the normal course of business. Although the ultimate outcome of litigation is difficult to accurately predict, the Company believes that the outcome of these actions will not have a material effect on its consolidated financial position or results of operations. | | | | During fiscal 2005, two of the Company’s leased facilities located in Florida experienced hurricane damage to both leasehold improvements and personal property. As of July 31, 2006, the Company has completed all restoration efforts relating to the hurricane damage and has recorded an $816,000 insurance recovery receivable and accrued a total of $2,240,000 for hurricane related costs. Despite a written agreement with the general contractor that the Company believes limits its liability for the cost of the repairs to the amount of insurance proceeds ultimately received from its insurance company, a dispute has arisen with the general contractor and a certain subcontractor over the subcontractor’s demand for payment directly from the Company (by virtue of a purported assignment of rights and other grounds) in an amount exceeding the insurance proceeds by $816,000, plus late charges, interest, fees, costs and certain treble damages. As a result of this dispute, the Company deposited $1,422,000, representing the balance of the insurance proceeds it has received, in its attorneys’ trust account and filed a complaint for declaratory judgment in the 9th Judicial Circuit Court for Orange County, Florida. The general contractor and the subcontractor have |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| filed separate and independent actions against the Company and its insurance company, all of which have now been consolidated under the Company’s original action. The Court has scheduled December 1, 2006 as the discovery cutoff and trial for February 13, 2007; however, these dates are subject to change as the litigation progresses. The Company does not expect that the outcome of this matter will have a material effect on its consolidated financial position. | | |
| The Company has employment agreements with its Chairman of the Board, Chief Executive Officer and President (the “Chairman”), and its Executive Vice President and Chief Operating Officer (the “Chief Operating Officer”). | | | | The Chairman’s agreement which was amended and restated in June 2003 provides, among other things, for his employment until July 31, 2008 at a current base compensation of $625,000 per annum and incentive compensation equal to 3.5% of the Company’s pre-tax income, not to exceed his base salary, plus such additional amounts, if any, as the Board of Directors may from time to time determine. The employment period is automatically extended for successive two-year periods unless either party gives notice of non-extension at least six months in advance of the scheduled termination date. The agreement also provides for payment to the Chairman in the event of a change in control of the Company. Such payment, as defined in the employment agreement, would include, among other items: (i) at least three times the Chairman’s Base Salary then in effect; plus, (ii) the amount of any unpaid Incentive Compensation, plus (iii) an amount equal to the number of shares of Common Stock of the Company subject to unexercised options (whether or not then exercisable) held by the Chairman multiplied by the intrinsic value of the options, in lieu of exercising such options. | | | | The Chief Operating Officer’s agreement which was amended and restated in June 2003 provides, among other things, for his employment until July 31, 2007 at a current base compensation of $370,000 per annum and incentive compensation equal to 1.5% of the Company’s pre-tax income, not to exceed his base salary, plus such additional amounts, if any, as the Board of Directors may from time to time determine. The employment period is automatically extended for successive one-year periods unless either party gives notice of non-extension at least three months in advance of the scheduled termination date. The agreement also provides for payment, in certain circumstances, to the Chief Operating Officer in the event of a change in control of the Company. Such payment would be equal to 299% of the Chief Operating Officer’s Annual Base Salary then in effect. |
| (14)Stockholder Rights Plan
| |
| On December 15, 1998, the Company’s Board of Directors approved the adoption of a stockholder rights plan in which one stock purchase right (“Right”) was distributed as a dividend on each outstanding share of the Company’s common stock to stockholders of record at the close of business on January 4, 1999. Under the plan, the Rights will be exercisable only if triggered by a person or group’s acquisition of 15% or more of the Company’s common stock. If triggered, each Right, other than Rights held by the acquiring person or group, would entitle its holder to purchase a specified number of the Company’s common shares for 50% of their market value at that time. Unless a 15% acquisition has occurred, the Rights may be redeemed by the Company at any time prior to the termination date of the plan. | | | | This Right to purchase common stock at a discount will not be triggered by a person or group’s acquisition of 15% or more of the common stock pursuant to a tender or exchange offer which is for all outstanding shares at a price and on terms that Comtech’s Board of Directors determines (prior to acquisition) to be adequate and in the best interest of the Company and its stockholders. The Rights will expire on December 15, 2008. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(15)Intangible Assets
| |
| Intangible assets with finite lives arising from acquisitions as of July 31, 2006 and 2005 are as follows: | | |
| | 2006 | | 2005 | |
|---|
| | | |
| |
| |
|---|
| Weighted Average
Amortization Period | | Gross
Carrying
Amount | | Accumulated
Amortization | | Gross
Carrying
Amount | | Accumulated
Amortization | |
|---|
| |
| |
| |
| |
| |
| | | Existing technology | 7.23 | | $ | 12,456,000 | | | 9,494,000 | | | 12,456,000 | | | 7,741,000 | | Proprietary, core and
licensed technology | 8.57 | | | 5,145,000 | | | 1,554,000 | | | 4,948,000 | | | 1,032,000 | | | Other | 5.23 | | | 834,000 | | | 532,000 | | | 834,000 | | | 342,000 | | | | | |
| |
| |
| |
| | | Total | | | $ | 18,435,000 | | | 11,580,000 | | | 18,238,000 | | | 9,115,000 | | | | | |
| |
| |
| |
| |
| | | Amortization expense for the years ended July 31, 2006, 2005 and 2004 was $2,465,000, $2,328,000 and $2,067,000, respectively. The estimated amortization expense for the fiscal years ending July 31, 2007, 2008, 2009, 2010 and 2011 is $2,213,000, $978,000, $952,000, $837,000 and $712,000, respectively. | | | | The changes in carrying amount of goodwill by segment for the fiscal year ended July 31, 2005 is as follows: | | |
| | | Telecommunications
Transmission | | Mobile Data
Communications | | RF Microwave
Amplifiers | | Total | |
|---|
| | |
| |
| |
| |
| | | | Balance at July 31, 2004 | $ | 8,865,000 | | | 1,434,000 | | | 8,422,000 | | $ | 18,721,000 | | | | Acquisition of Tolt | | — | | | 3,571,000 | | | — | | | 3,571,000 | | | | Memotec adjustment | | (48,000 | ) | | — | | | — | | | (48,000 | ) | | | | | | | | | |
| |
| |
| |
| | | | Balance at July 31, 2005 | $ | 8,817,000 | | | 5,005,000 | | | 8,422,000 | | $ | 22,244,000 | | | | |
| |
| |
| |
| |
| | | There were no changes in the carrying amount of goodwill in fiscal 2006. |
| (16)Recent Accounting Pronouncements
| |
| On September 13, 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”) which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The guidance is applicable for the Company’s fiscal 2007. The Company is not yet in a position to determine what, if any, effect SAB No. 108 will have on its consolidated financial statements. | | | | In July 2006, the FASB released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law and prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 prescribes a two-step evaluation process for tax positions. The first step is recognition based on a determination of whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is to measure a tax position that meets the more-likely-than-not threshold. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements. FIN 48 is effective beginning in the Company’s first quarter of fiscal 2008. The cumulative effects, if any, of applying FIN 48 will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The Company has commenced the process of evaluating the potential effects of FIN 48 on our consolidated financial statements and is not yet in a position to determine what, if any, effects FIN 48 will have on its consolidated financial statements. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| |
| In June 2006, the EITF reached a consensus on EITF 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (“EITF 06-3”). EITF 06-3 provides that taxes imposed by a governmental authority on a revenue producing transaction between a seller and a customer should be shown in the income statement on either a gross or a net basis, based on the entity’s accounting policy, which should be disclosed pursuant to APB Opinion No. 22, “Disclosure of Accounting Policies.” If such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. EITF 06-3 will be effective beginning with the Company’s third quarter of fiscal 2007. The Company is currently evaluating the impact EITF 06-3 will have on the presentation of its consolidated financial statements. | | | | In June 2006, the EITF reached a consensus on EITF 05-1, “Accounting for the Conversion of an Instrument that Becomes Convertible Upon the Issuer’s Exercise of a Call Option” (“EITF 05-1”). This guidance requires that the issuance of equity securities to settle an instrument (pursuant to the instrument’s original conversion terms) that becomes convertible upon the issuer’s exercise of a call option should be accounted for as a conversion if the debt instrument contained a substantive conversion feature as of its issuance date (i.e., no gain or loss should be recognized related to the equity securities issued to settle the instrument). Additionally, the issuance of equity securities to settle an instrument that, as of its issuance date, does not contain a substantive conversion feature should be accounted for as a debt extinguishment and the fair value of the equity securities issued should be considered a component of the reacquisition price of the debt. The guidance is effective for all conversions within its scope that result from the exercise of call options in interim or annual reporting periods beginning after June 28, 2006. In the future, if the Company issues common stock pursuant to the conversion terms to settle its 2% convertible senior notes, it would not recognize a gain or loss because the notes have substantive conversion features as defined by EITF 05-1. | | | | In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the requirements for the accounting and reporting of a change in accounting principle (“SFAS No. 154”). SFAS No. 154 applies to all voluntary changes in accounting principles, as well as to changes required by an accounting pronouncement that does not include specific transition provisions. SFAS No. 154 eliminates the requirement to include the cumulative effect of changes in accounting principle in the income statement and instead requires that changes in accounting principle be retroactively applied. A change in accounting estimate continues to be accounted for in the period of change and future periods if necessary. A correction of an error continues to be reported by restating prior period financial statements. SFAS No. 154 is effective for the Company’s first quarter of fiscal 2007. | | | | In March 2005, the FASB issued interpretation FIN No. 47, “Accounting for Conditional Asset Retirement Obligations (“FIN 47”). FIN 47 clarifies that the term conditional asset retirement obligation as used in SFAS 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The Company adopted FIN 47 in fiscal 2006 and it had no material effect on the Company’s consolidated financial condition or results of operations. |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| | (17) Consolidating Financial Information | |
| The consolidating financial information presented below reflects information regarding the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiary of the Company’s 2.0% convertible senior notes. Tolt is included in the guarantor column for all periods presented. The Parent’s expenses associated with supporting the operations of its subsidiaries are allocated to the respective Guarantor Subsidiaries and Non–Guarantor Subsidiary. The consolidating financial information presented herein is not utilized by the chief operating decision-maker in making operating decisions and assessing performance. | | | | The following reflects the consolidating balance sheet as of July 31, 2006: | | |
| | | Parent | | | Guarantor
Subsidiaries
| | | Non-Guarantor
Subsidiary
| | | Consolidating
Entries
| | | Consolidated
Total
| |
|---|
| |
| |
| |
| |
| |
| | | Assets | | | | | | | | | | | | | | | | | Current assets: | | | | | | | | | | | | | | | | | Cash and cash equivalents | $ | 238,298,000 | | | 9,949,000 | | | 3,340,000 | | | — | | $ | 251,587,000 | | | Restricted cash | | — | | | 1,003,000 | | | — | | | — | | | 1,003,000 | | | Accounts receivable, net | | — | | | 66,025,000 | | | 4,022,000 | | | — | | | 70,047,000 | | | Inventories, net | | — | | | 61,043,000 | | | — | | | — | | | 61,043,000 | | | Prepaid expenses and other current assets | | 1,101,000 | | | 5,565,000 | | | 512,000 | | | — | | | 7,178,000 | | | Deferred tax asset - current | | 551,000 | | | 7,040,000 | | | — | | | — | | | 7,591,000 | | | |
| |
| |
| |
| |
| | | Total current assets | | 239,950,000 | | | 150,625,000 | | | 7,874,000 | | | — | | | 398,449,000 | | | | | Property, plant and equipment, net | | 914,000 | | | 23,295,000 | | | 523,000 | | | — | | | 24,732,000 | | | Investment in subsidiaries | | 191,046,000 | | | 5,496,000 | | | — | | | (196,542,000 | ) | | — | | | Goodwill | | — | | | 21,297,000 | | | 947,000 | | | — | | | 22,244,000 | | | Intangibles with finite lives, net | | — | | | 5,933,000 | | | 922,000 | | | — | | | 6,855,000 | | | Deferred tax asset – non-current | | — | | | — | | | 174,000 | | | (174,000 | ) | | — | | | Deferred financing costs, net | | 2,449,000 | | | — | | | — | | | — | | | 2,449,000 | | | Other assets, net | | 56,000 | | | 459,000 | | | 22,000 | | | — | | | 537,000 | | | Intercompany receivables | | — | | | 59,824,000 | | | — | | | (59,824,000 | ) | | — | | | |
| |
| |
| |
| |
| | | Total assets | $ | 434,415,000 | | | 266,929,000 | | | 10,462,000 | | | (256,540,000 | ) | $ | 455,266,000 | | | |
| |
| |
| |
| |
| | | | | Liabilities and Stockholders’ Equity | | | | | | | | | | | | | | | | | Current liabilities: | | | | | | | | | | | | | | | | | Accounts payable | $ | 390,000 | | | 27,497,000 | | | 450,000 | | | — | | $ | 28,337,000 | | | Accrued expenses and other current liabilities | | 6,683,000 | | | 32,806,000 | | | 1,741,000 | | | — | | | 41,230,000 | | | Customer advances and deposits | | — | | | 3,502,000 | | | 42,000 | | | — | | | 3,544,000 | | | Deferred service revenue | | — | | | 9,896,000 | | | — | | | — | | | 9,896,000 | | | Current installments of other obligations | | — | | | 154,000 | | | — | | | — | | | 154,000 | | | Interest payable | | 1,050,000 | | | — | | | — | | | — | | | 1,050,000 | | | Income taxes payable | | 4,428,000 | | | — | | | 824,000 | | | — | | | 5,252,000 | | | |
| |
| |
| |
| |
| | | Total current liabilities | | 12,551,000 | | | 73,855,000 | | | 3,057,000 | | | — | | | 89,463,000 | | | | | Convertible senior notes | | 105,000,000 | | | — | | | — | | | — | | | 105,000,000 | | | Other obligations, less current installments | | — | | | 243,000 | | | — | | | — | | | 243,000 | | | Deferred tax liability – non-current | | 4,707,000 | | | 1,785,000 | | | ��� | | | (174,000 | ) | | 6,318,000 | | | Intercompany payables | | 57,915,000 | | | — | | | 1,908,000 | | | (59,823,000 | ) | | — | | | |
| |
| |
| |
| |
| | | Total liabilities | | 180,173,000 | | | 75,883,000 | | | 4,965,000 | | | (59,997,000 | ) | | 201,024,000 | | | | | Commitments and contingencies | | | | | | | | | | | | | | | | | | | Stockholders’ equity: | | | | | | | | | | | | | | | | | Preferred stock | | — | | | — | | | — | | | — | | | — | | | Common stock | | 2,305,000 | | | 4,000 | | | — | | | (4,000 | ) | | 2,305,000 | | | Additional paid-in capital | | 139,487,000 | | | 81,410,000 | | | 5,187,000 | | | (86,597,000 | ) | | 139,487,000 | | | Retained earnings | | 112,635,000 | | | 109,632,000 | | | 310,000 | | | (109,942,000 | ) | | 112,635,000 | | | |
| |
| |
| |
| |
| | | | | 254,427,000 | | | 191,046,000 | | | 5,497,000 | | | (196,543,000 | ) | | 254,427,000 | | | | | Less: | | | | | | | | | | | | | | | | | Treasury stock | | (185,000 | ) | | — | | | — | | | — | | | (185,000 | ) | | |
| |
| |
| |
| |
| | | Total stockholders’ equity | | 254,242,000 | | | 191,046,000 | | | 5,497,000 | | | (196,543,000 | ) | | 254,242,000 | | | |
| |
| |
| |
| |
| | | Total liabilities and stockholders’ equity | $ | 434,415,000 | | | 266,929,000 | | | 10,462,000 | | | (256,540,000 | ) | $ | 455,266,000 | | | |
| |
| |
| |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| | (17) Consolidating Financial Information (continued) | |
| The following reflects the consolidating balance sheet as of July 31, 2005: | | |
| | | Parent | | | Guarantor
Subsidiaries
| | | Non-Guarantor
Subsidiary
| | | Consolidating
Entries
| | | Consolidated
Total
| | | |
| |
| |
| |
| |
| | | Assets | | | | | | | | | | | | | | | | | Current assets: | | | | | | | | | | | | | | | | | Cash and cash equivalents | $ | 212,579,000 | | | 1,111,000 | | | 723,000 | | | — | | $ | 214,413,000 | | | Restricted cash | | 31,000 | | | 1,003,000 | | | — | | | — | | | 1,034,000 | | | Accounts receivable, net | | — | | | 54,807,000 | | | 1,245,000 | | | — | | | 56,052,000 | | | Inventories, net | | — | | | 45,103,000 | | | — | | | — | | | 45,103,000 | | | Prepaid expenses and other current assets | | 888,000 | | | 3,303,000 | | | 196,000 | | | — | | | 4,387,000 | | | Deferred tax asset - current | | 592,000 | | | 7,500,000 | | | — | | | — | | | 8,092,000 | | | |
| |
| |
| |
| |
| | | Total current assets | | 214,090,000 | | | 112,827,000 | | | 2,164,000 | | | — | | | 329,081,000 | | | | | Property, plant and equipment, net | | 474,000 | | | 17,925,000 | | | 284,000 | | | — | | | 18,683,000 | | | Investment in subsidiaries | | 149,889,000 | | | 4,040,000 | | | — | | | (153,929,000 | ) | | — | | | Goodwill | | — | | | 21,297,000 | | | 947,000 | | | — | | | 22,244,000 | | | Intangibles with finite lives, net | | — | | | 8,024,000 | | | 1,099,000 | | | — | | | 9,123,000 | | | Deferred tax asset – non-current | | — | | | — | | | 66,000 | | | (66,000 | ) | | — | | | Deferred financing costs, net | | 2,995,000 | | | — | | | — | | | — | | | 2,995,000 | | | Other assets, net | | — | | | 265,000 | | | 12,000 | | | — | | | 277,000 | | | Intercompany receivables | | — | | | 53,591,000 | | | 50,000 | | | (53,641,000 | ) | | — | | | |
| |
| |
| |
| |
| | | Total assets | $ | 367,448,000 | | | 217,969,000 | | | 4,622,000 | | | (207,636,000 | ) | $ | 382,403,000 | | | |
| |
| |
| |
| |
| | | | | Liabilities and Stockholders’ Equity | | | | | | | | | | | | | | | | | Current liabilities: | | | | | | | | | | | | | | | | | Accounts payable | $ | 351,000 | | | 23,105,000 | | | 121,000 | | | — | | $ | 23,577,000 | | | Accrued expenses and other current liabilities | | 5,502,000 | | | 28,534,000 | | | 461,000 | | | — | | | 34,497,000 | | | Customer advances and deposits | | — | | | 5,282,000 | | | — | | | — | | | 5,282,000 | | | Deferred service revenue | | — | | | 8,210,000 | | | — | | | — | | | 8,210,000 | | | Current installments of other obligations | | — | | | 235,000 | | | — | | | — | | | 235,000 | | | Interest payable | | 1,050,000 | | | — | | | — | | | — | | | 1,050,000 | | | Income taxes payable | | 1,540,000 | | | — | | | — | | | — | | | 1,540,000 | | | |
| |
| |
| |
| |
| | | Total current liabilities | | 8,443,000 | | | 65,366,000 | | | 582,000 | | | — | | | 74,391,000 | | | | | Convertible senior notes | | 105,000,000 | | | — | | | — | | | — | | | 105,000,000 | | | Other obligations, less current installments | | — | | | 396,000 | | | — | | | — | | | 396,000 | | | Deferred tax liability – non-current | | 3,735,000 | | | 2,318,000 | | | — | | | (66,000 | ) | | 5,987,000 | | | Intercompany payables | | 53,641,000 | | | — | | | — | | | (53,641,000 | ) | | — | | | |
| |
| |
| |
| |
| | | Total liabilities | | 170,819,000 | | | 68,080,000 | | | 582,000 | | | (53,707,000 | ) | | 185,774,000 | | | | | Commitments and contingencies | | | | | | | | | | | | | | | | | | | Stockholders’ equity: | | | | | | | | | | | | | | | | | Preferred stock | | — | | | — | | | — | | | — | | | — | | | Common stock | | 2,278,000 | | | 4,000 | | | — | | | (4,000 | ) | | 2,278,000 | | | Additional paid-in capital | | 127,170,000 | | | 81,410,000 | | | 5,187,000 | | | (86,597,000 | ) | | 127,170,000 | | | Retained earnings (deficit) | | 67,366,000 | | | 68,475,000 | | | (1,147,000 | ) | | (67,328,000 | ) | | 67,366,000 | | | |
| |
| |
| |
| |
| | | | | 196,814,000 | | | 149,889,000 | | | 4,040,000 | | | (153,929,000 | ) | | 196,814,000 | | | | | Less: | | | | | | | | | | | | | | | | | Treasury stock | | (185,000 | ) | | — | | | — | | | — | | | (185,000 | ) | | |
| |
| |
| |
| |
| | | Total stockholders’ equity | | 196,629,000 | | | 149,889,000 | | | 4,040,000 | | | (153,929,000 | ) | | 196,629,000 | | | |
| |
| |
| |
| |
| | | Total liabilities and stockholders’ equity | $ | 367,448,000 | | | 217,969,000 | | | 4,622,000 | | | (207,636,000 | ) | $ | 382,403,000 | | | |
| |
| |
| |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| | (17) Consolidating Financial Information (continued) | |
| The following reflects the consolidating statement of operations for the year ended July 31, 2006: | | |
| | | Parent | | | Guarantor
Subsidiaries
| | | Non-Guarantor
Subsidiary
| | | Consolidating
Entries
| | | Consolidated
Total
| | | |
| |
| |
| |
| |
| | | Net sales | $ | — | | | 377,003,000 | | | 14,971,000 | | | (463,000 | ) | $ | 391,511,000 | | | Cost of sales | | — | | | 227,042,000 | | | 5,631,000 | | | (463,000 | ) | | 232,210,000 | | | |
| |
| |
| |
| |
| | | Gross Profit | | — | | | 149,961,000 | | | 9,340,000 | | | — | | | 159,301,000 | | | | | Expenses: | | | | | | | | | | | | | | | | | Selling, general and administrative | | — | | | 61,467,000 | | | 5,604,000 | | | — | | | 67,071,000 | | | Research and development | | — | | | 24,392,000 | | | 1,442,000 | | | — | | | 25,834,000 | | | Amortization of intangibles | | — | | | 2,288,000 | | | 177,000 | | | — | | | 2,465,000 | | | | | | | | | |
| |
| |
| |
| |
| | | | | — | | | 88,147,000 | | | 7,223,000 | | | — | | | 95,370,000 | | | |
| |
| |
| |
| |
| | | | | Operating income (loss) | | — | | | 61,814,000 | | | 2,117,000 | | | — | | | 63,931,000 | | | | | Other expense (income): | | | | | | | | | | | | | | | | | Interest expense | | 2,646,000 | | | 41,000 | | | — | | | — | | | 2,687,000 | | | Interest (income) | | (9,193,000 | ) | | (60,000 | ) | | 10,000 | | | — | | | (9,243,000 | ) | | |
| |
| |
| |
| |
| | | | Income before provision for income taxes and equity
in undistributed earnings of subsidiaries | | 6,547,000 | | | 61,833,000 | | | 2,107,000 | | | — | | | 70,487,000 | | | Provision for income taxes | | 2,435,000 | | | 22,133,000 | | | 650,000 | | | — | | | 25,218,000 | | | |
| |
| |
| |
| |
| | Net earnings (loss) before equity in undistributed
earnings of subsidiaries | | 4,112,000 | | | 39,700,000 | | | 1,457,000 | | | — | | | 45,269,000 | | | Equity in undistributed earnings of subsidiaries | | 41,157,000 | | | 1,457,000 | | | — | | | (42,614,000 | ) | | — | | | |
| |
| |
| |
| |
| | | | | Net income | $ | 45,269,000 | | | 41,157,000 | | | 1,457,000 | | | (42,614,000 | ) | $ | 45,269,000 | | | |
| |
| |
| |
| |
| |
| | | The following reflects the consolidating statement of operations for the year ended July 31, 2005: | | |
| | | Parent | | | Guarantor
Subsidiaries
| | | Non-Guarantor
Subsidiary
| | | Consolidating
Entries
| | | Consolidated
Total
| | | |
| |
| |
| |
| |
| | | Net sales | $ | — | | | 301,749,000 | | | 6,334,000 | | | (193,000 | ) | $ | 307,890,000 | | | Cost of sales | | — | | | 178,099,000 | | | 2,618,000 | | | (193,000 | ) | | 180,524,000 | | | |
| |
| |
| |
| |
| | | Gross Profit | | — | | | 123,650,000 | | | 3,716,000 | | | — | | | 127,366,000 | | | | | Expenses: | | | | | | | | | | | | | | | | | Selling, general and administrative | | — | | | 48,710,000 | | | 3,109,000 | | | — | | | 51,819,000 | | | Research and development | | — | | | 20,261,000 | | | 894,000 | | | — | | | 21,155,000 | | | Amortization of intangibles | | — | | | 2,076,000 | | | 252,000 | | | — | | | 2,328,000 | | | | | | | | | |
| |
| |
| |
| |
| | | | | — | | | 71,047,000 | | | 4,255,000 | | | — | | | 75,302,000 | | | |
| |
| |
| |
| |
| | | | | Operating income (loss) | | — | | | 52,603,000 | | | (539,000 | ) | | — | | | 52,064,000 | | | | | | | | | | | | | | | | | | | | Other expense (income): | | | | | | | | | | | | | | | | | Interest expense | | 2,646,000 | | | 33,000 | | | — | | | — | | | 2,679,000 | | | Interest (income) | | (4,070,000 | ) | | (14,000 | ) | | 12,000 | | | — | | | (4,072,000 | ) | | |
| |
| |
| |
| |
| | | | Income (loss) before provision (benefit) for income
taxes and equity in undistributed earnings (loss)
of subsidiaries | | 1,424,000 | | | 52,584,000 | | | (551,000 | ) | | — | | | 53,457,000 | | | Provision (benefit) for income taxes | | 530,000 | | | 16,318,000 | | | (46,000 | ) | | — | | | 16,802,000 | | | |
| |
| |
| |
| |
| | Net earnings (loss) before equity in undistributed
earnings (loss) of subsidiaries | | 894,000 | | | 36,266,000 | | | (505,000 | ) | | — | | | 36,655,000 | | Equity in undistributed earnings (loss) of
subsidiaries | | 35,761,000 | | | (505,000 | ) | | — | | | (35,256,000 | ) | | — | | | |
| |
| |
| |
| |
| | | | | Net income (loss) | $ | 36,655,000 | | | 35,761,000 | | | (505,000 | ) | | (35,256,000 | ) | $ | 36,655,000 | | | |
| |
| |
| |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
| | (17) Consolidating Financial Information (continued) | |
| The following reflects the consolidating statement of operations for the year ended as of July 31, 2004: | | |
| Parent | | Guarantor
Subsidiaries | | Non-Guarantor
Subsidiary | | Consolidating
Entries | | Consolidated
Total | |
|---|
| |
| |
| |
| |
| |
| | | Net sales | $ | — | | | 222,132,000 | | 1,258,000 | | — | | $ 223,390,000 | | | Cost of sales | | — | | | 135,418,000 | | 440,000 | | — | | 135,858,000 | | | |
| |
| |
| |
| |
| | | Gross Profit | | — | | | 86,714,000 | | 818,000 | | — | | 87,532,000 | | | | | Expenses: | | | | | | | | | | | | | | Selling, general and administrative | | — | | | 35,472,000 | | 544,000 | | — | | 36,016,000 | | | Research and development | | — | | | 15,709,000 | | 198,000 | | — | | 15,907,000 | | | In-process research and development | | — | | | — | | 940,000 | | — | | 940,000 | | | Amortization of intangibles | | — | | | 1,998,000 | | 69,000 | | — | | 2,067,000 | | | | | | | | | | |
| |
| |
| |
| |
| | | | | — | | | 53,179,000 | | 1,751,000 | | — | | 54,930,000 | | | |
| |
| |
| |
| |
| | | | | Operating income (loss) | | — | | | 33,535,000 | | (933,000 | ) | — | | 32,602,000 | | | | | Other expense (income): | | | | | | | | | | | | | | Interest expense | | 1,370,000 | | | 61,000 | | (6,000 | ) | — | | 1,425,000 | | | Interest (income) | | (914,000 | ) | | (7,000 | ) | — | | — | | (921,000 | ) | | |
| |
| |
| |
| |
| | | | Income (loss) before provision (benefit)
for income taxes and equity in
undistributed earnings (loss) of
subsidiaries | | (456,000 | ) | | 33,481,000 | | (927,000 | ) | — | | 32,098,000 | | | Provision (benefit) for income taxes | | (146,000 | ) | | 10,702,000 | | (285,000 | ) | — | | 10,271,000 | | | |
| |
| |
| |
| |
| | Net earnings (loss) before equity in undistributed
earnings (loss) of subsidiaries | | (310,000 | ) | | 22,779,000 | | (642,000 | ) | — | | 21,827,000 | | Equity in undistributed earnings (loss) of
subsidiaries | | 22,137,000 | | | (642,000 | ) | — | | (21,495,000 | ) | — | | | |
| |
| |
| |
| |
| | | | | Net income (loss) | $ | 21,827,000 | | | 22,137,000 | | (642,000 | ) | (21,495,000 | ) | $ 21,827,000 | | | |
| |
| |
| |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Consolidating Financial Information (continued)
| |
| The following reflects the consolidating statement of cash flows for the year ended July 31, 2006: | | |
| | | Parent | | | Guarantor
Subsidiaries
| | | Non-Guarantor
Subsidiary
| | | Consolidating
Entries
| | | Consolidated
Total
| | | |
| |
| |
| |
| |
| | | Cash flows from operating activities: | | | | | | | | | | | | | | | | | Net income | $ | 45,269,000 | | | 41,157,000 | | | 1,457,000 | | | (42,614,000 | ) | $ | 45,269,000 | | Adjustments to reconcile net income to net cash
provided by operating activities: | | — | | | — | | | — | | | — | | | — | | Depreciation and amortization of property, plant
and equipment | | 111,000 | | | 6,019,000 | | | 112,000 | | | — | | | 6,242,000 | | | Amortization of intangible assets with finite lives | | — | | | 2,289,000 | | | 176,000 | | | — | | | 2,465,000 | | | Amortization of stock-based compensation | | 2,176,000 | | | 3,495,000 | | | 10,000 | | | — | | | 5,681,000 | | | Amortization of deferred financing costs | | 546,000 | | | — | | | — | | | — | | | 546,000 | | | Loss on disposal of property, plant and equipment | | — | | | 35,000 | | | 1,000 | | | — | | | 36,000 | | | Provision for doubtful accounts | | — | | | 556,000 | | | 192,000 | | | — | | | 748,000 | | | Provision for excess and obsolete inventory | | — | | | 1,981,000 | | | 49,000 | | | — | | | 2,030,000 | | Excess income tax benefit from stock option
exercises | | (4,065,000 | ) | | — | | | — | | | — | | | (4,065,000 | ) | | Deferred income tax expense (benefit) | | 1,013,000 | | | (74,000 | ) | | (107,000 | ) | | — | | | 832,000 | | | Equity in undistributed earnings of subsidiaries | | (41,157,000 | ) | | (1,457,000 | ) | | — | | | 42,614,000 | | | — | | | Intercompany accounts | | 7,876,000 | | | (9,822,000 | ) | | 1,946,000 | | | — | | | — | | Changes in assets and liabilities, net of effects of
acquisition: | | | | | | | | | | | | | | | | | Restricted cash securing letter of credit obligations | | 31,000 | | | — | | | — | | | — | | | 31,000 | | | Accounts receivable | | — | | | (11,775,000 | ) | | (2,968,000 | ) | | — | | | (14,743,000 | ) | | Inventories | | — | | | (17,860,000 | ) | | (49,000 | ) | | — | | | (17,909,000 | ) | | Prepaid expenses and other assets | | (213,000 | ) | | (2,262,000 | ) | | (316,000 | ) | | — | | | (2,791,000 | ) | | Other assets | | (56,000 | ) | | (195,000 | ) | | (9,000 | ) | | — | | | (260,000 | ) | | Accounts payable | | 39,000 | | | 4,392,000 | | | 329,000 | | | — | | | 4,760,000 | | | Accrued expenses and other current liabilities | | 1,181,000 | | | 5,271,000 | | | 1,281,000 | | | — | | | 7,733,000 | | | Customer advances and deposits | | — | | | (1,780,000 | ) | | 42,000 | | | — | | | (1,738,000 | ) | | Deferred service revenue | | — | | | 1,686,000 | | | — | | | — | | | 1,686,000 | | | Interest payable | | — | | | — | | | — | | | — | | | — | | | | | | | | | Income taxes payable | | 6,953,000 | | | — | | | 824,000 | | | — | | | 7,777,000 | | | |
| |
| |
| |
| |
| | | Net cash provided by operating activities | | 19,704,000 | | | 21,656,000 | | | 2,970,000 | | | — | | | 44,330,000 | | | |
| |
| |
| |
| |
| | | | | Cash flows from investing activities: | | | | | | | | | | | | | | | | | Purchases of property, plant and equipment | | (587,000 | ) | | (11,387,000 | ) | | (353,000 | ) | | — | | | (12,327,000 | ) | | Purchase of other intangibles with finite lives | | — | | | (197,000 | ) | | — | | | — | | | (197,000 | ) | | | | | | | | Payments for business acquisition | | — | | | (1,000,000 | ) | | — | | | — | | | (1,000,000 | ) | | |
| |
| |
| |
| |
| | | Net cash used in investing activities | | (587,000 | ) | | (12,584,000 | ) | | (353,000 | ) | | — | | | (13,524,000 | ) | | |
| |
| |
| |
| |
| | | | | Cash flows from financing activities: | | | | | | | | | | | | | | | | | Principal payments on other obligations | | — | | | (234,000 | ) | | — | | | — | | | (234,000 | ) | Excess income tax benefit from stock option exercises
| | 4,065,000 | | | — | | | — | | | — | | | 4,065,000 | | | Proceeds from exercises of stock options | | 1,863,000 | | | — | | | — | | | — | | | 1,863,000 | | Proceeds from issuance of employee stock purchase
plan shares | | 674,000 | | | — | | | — | | | — | | | 674,000 | | | |
| |
| |
| |
| |
| | | Net cash provided by (used in) financing activities | | 6,602,000 | | | (234,000 | ) | | — | | | — | | | 6,368,000 | | | |
| |
| |
| |
| |
| | | | | Net increase in cash and cash equivalents | | 25,719,000 | | | 8,838,000 | | | 2,617,000 | | | — | | | 37,174,000 | | | Cash and cash equivalents at beginning of period | | 212,579,000 | | | 1,111,000 | | | 723,000 | | | — | | | 214,413,000 | | | |
| |
| |
| |
| |
| | | Cash and cash equivalents at end of period | $ | 238,298,000 | | | 9,949,000 | | | 3,340,000 | | | — | | $ | 251,587,000 | | | |
| |
| |
| |
| |
| |
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Consolidating Financial Information (continued)
| |
| The following reflects the consolidating statement of cash flows for the year ended July 31, 2005: | | |
| Parent | | Guarantor
Subsidiaries | | Non-Guarantor
Subsidiary | | Consolidating
Entries | | Consolidated
Total | |
|---|
| |
| |
| |
| |
| |
| |
|---|
| Cash flows from operating activities: | | | | | | | | | | | | | | | | | Net income (loss) | $ | 36,655,000 | | | 35,761,000 | | | (505,000 | ) | | (35,256,000 | ) | $ | 36,655,000 | | Adjustments to reconcile net income (loss) to net
cash provided by operating activities: | | | | | | | | | | | | | | | | Depreciation and amortization of property,
plant and equipment | | 145,000 | | | 5,087,000 | | | 83,000 | | | — | | | 5,315,000 | | | Amortization of intangible assets with finite lives | | — | | | 2,076,000 | | | 252,000 | | | — | | | 2,328,000 | | | Amortization of deferred financing costs | | 546,000 | | | — | | | — | | | — | | | 546,000 | | Loss on disposal of property, plant and
equipment | | — | | | 284,000 | | | — | | | — | | | 284,000 | | | Provision for doubtful accounts | | — | | | 287,000 | | | — | | | — | | | 287,000 | | | Provision for excess and obsolete inventory | | — | | | 2,081,000 | | | 17,000 | | | — | | | 2,098,000 | | | Income tax benefit from stock option exercises | | 9,896,000 | | | — | | | — | | | — | | | 9,896,000 | | | Deferred income tax expense | | 2,164,000 | | | 604,000 | | | — | | | — | | | 2,768,000 | | Equity in undistributed earnings (loss) of
subsidiaries | | (35,761,000 | ) | | 505,000 | | | — | | | 35,256,000 | | | — | | | Intercompany accounts | | 33,407,000 | | | (34,162,000 | ) | | 755,000 | | | — | | | — | | Changes in assets and liabilities, net of effects
of acquisition: | | | | | | | | | | | | | | | | Restricted cash securing letter of credit
obligations | | 10,000 | | | 3,010,000 | | | — | | | — | | | 3,020,000 | | | Accounts receivable | | — | | | (12,674,000 | ) | | (663,000 | ) | | — | | | (13,337,000 | ) | | Inventories | | — | | | (7,267,000 | ) | | 31,000 | | | — | | | (7,236,000 | ) | | Prepaid expenses and other assets | | (478,000 | ) | | (1,731,000 | ) | | (164,000 | ) | | — | | | (2,373,000 | ) | | Other assets | | — | | | 74,000 | | | (5,000 | ) | | — | | | 69,000 | | | Accounts payable | | 22,000 | | | 13,914,000 | | | 75,000 | | | — | | | 14,011,000 | | | Accrued expenses and other current liabilities | | 1,884,000 | | | 10,385,000 | | | 127,000 | | | 136,000 | | | 12,532,000 | | | Customer advances and deposits | | — | | | (2,008,000 | ) | | — | | | — | | | (2,008,000 | ) | | Deferred service revenue | | — | | | (5,506,000 | ) | | — | | | — | | | (5,506,000 | ) | | Interest payable | | (23,000 | ) | | — | | | — | | | — | | | (23,000 | ) | | | | | | | | Income taxes payable | | (3,272,000 | ) | | — | | | — | | | — | | | (3,272,000 | ) | | |
| |
| |
| |
| |
| |
|---|
| Net cash provided by operating activities | | 45,195,000 | | | 10,720,000 | | | 3,000 | | | 136,000 | | | 56,054,000 | | | |
| |
| |
| |
| |
| |
|---|
| | | Cash flows from investing activities: | | | | | | | | | | | | | | | | | Purchases of property, plant and equipment | | (64,000 | ) | | (9,263,000 | ) | | (205,000 | ) | | — | | | (9,532,000 | ) | | | | | | | | Purchase of other intangibles with finite lives | | — | | | (75,000 | ) | | — | | | — | | | (75,000 | ) | | Payments for business acquisition | | (2,735,000 | ) | | (2,735,000 | ) | | — | | | 2,735,000 | | | (2,735,000 | ) | | |
| |
| |
| |
| |
| |
|---|
| Net cash used in investing activities | | (2,799,000 | ) | | (12,073,000 | ) | | (205,000 | ) | | 2,735,000 | | | (12,342,000 | ) | | |
| |
| |
| |
| |
| |
|---|
| | | Cash flows from financing activities: | | | | | | | | | | | | | | | | | Proceeds from issuance of stock in subsidiary | | — | | | 2,735,000 | | | — | | | (2,735,000 | ) | | — | | | Principal payments on other obligations | | — | | | (271,000 | ) | | — | | | — | | | (271,000 | ) | Proceeds from exercises of stock options and
warrants | | 7,160,000 | | | — | | | — | | | — | | | 7,160,000 | | | | | | | | Proceeds from issuance of employee stock
purchase plan shares | | 520,000 | | | — | | | — | | | — | | | 520,000 | | | |
| |
| |
| |
| |
| |
|---|
Net cash provided by (used in) financing
activities | | 7,680,000 | | | 2,464,000 | | | — | | | (2,735,000 | ) | | 7,409,000 | | | |
| |
| |
| |
| |
| |
|---|
| | Net increase (decrease) in cash and cash
equivalents | | 50,076,000 | | | 1,111,000 | | | (202,000 | ) | | 136,000 | | | 51,121,000 | | | | | | | | | Cash and cash equivalents at beginning of period | | 162,503,000 | | | — | | | 925,000 | | | (136,000 | ) | | 163,292,000 | | | |
| |
| |
| |
| |
| |
|---|
| Cash and cash equivalents at end of period | $ | 212,579,000 | | | 1,111,000 | | | 723,000 | | | — | | $ | 214,413,000 | | | |
| |
| |
| |
| |
| |
|---|
COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Consolidating Financial Information (continued)
| |
| The following reflects the consolidating statement of cash flows for the year ended July 31, 2004: | | |
| Parent | | Guarantor
Subsidiaries | | Non-Guarantor
Subsidiary | | Consolidating
Entries | | Consolidated
Total | |
|---|
| |
| |
| |
| |
| |
| |
|---|
| Cash flows from operating activities: | | | | | | | | | | | | | | | | | Net income (loss) | $ | 21,827,000 | | | 22,137,000 | | | (642,000 | ) | | (21,495,000 | ) | $ | 21,827,000 | | Adjustments to reconcile net income (loss) to
net cash provided by operating activities: | | | | | | | | | | | | | | | | Depreciation and amortization of property, plant
and equipment | | 97,000 | | | 4,236,000 | | | 8,000 | | | — | | | 4,341,000 | | Amortization of intangible assets with finite
lives | | — | | | 1,997,000 | | | 70,000 | | | | | | 2,067,000 | | | Amortization of deferred financing costs | | 280,000 | | | — | | | — | | | — | | | 280,000 | | | Amortization of deferred compensation | | 106,000 | | | — | | | — | | | — | | | 106,000 | | Loss on disposal of property, plant and
equipment | | — | | | 91,000 | | | — | | | — | | | 91,000 | | Write off of in process research and
development | | — | | | — | | | 940,000 | | | — | | | 940,000 | | | Provision for doubtful accounts | | — | | | 147,000 | | | — | | | — | | | 147,000 | | | Provision for excess and obsolete inventory | | — | | | 1,193,000 | | | — | | | — | | | 1,193,000 | | | Income tax benefit from stock option exercises | | 1,001,000 | | | — | | | — | | | — | | | 1,001,000 | | | Deferred income tax expense (benefit) | | 1,600,000 | | | 655,000 | | | (176,000 | ) | | — | | | 2,079,000 | | | Equity in undistributed earnings (loss) of subsidiaries | | (22,137,000 | ) | | 642,000 | | | — | | | 21,495,000 | | | — | | | Intercompany accounts | | 7,276,000 | | | (6,471,000 | ) | | (805,000 | ) | | — | | | — | | Changes in assets and liabilities, net of effects
of acquisition: | | | | | | | | | | | | | | | | Restricted cash securing letter of credit
obligations | | 4,247,000 | | | (4,013,000 | ) | | — | | | — | | | 234,000 | | | Accounts receivable | | — | | | (15,871,000 | ) | | (582,000 | ) | | — | | | (16,453,000 | ) | | Inventories | | — | | | (6,903,000 | ) | | 1,751,000 | | | — | | | (5,152,000 | ) | | Prepaid expenses and other assets | | (189,000 | ) | | 146,000 | | | 327,000 | | | — | | | 284,000 | | | Other assets | | — | | | 51,000 | | | (7,000 | ) | | — | | | 44,000 | | | Accounts payable | | 65,000 | | | (2,072,000 | ) | | 46,000 | | | — | | | (1,961,000 | ) | | Accrued expenses and other current liabilities | | 1,097,000 | | | 5,953,000 | | | 1,000 | | | (136,000 | ) | | 6,915,000 | | | Customer advances and deposits | | — | | | 4,799,000 | | | — | | | — | | | 4,799,000 | | | Deferred service revenue | | — | | | 2,556,000 | | | — | | | — | | | 2,556,000 | | | Interest payable | | 1,073,000 | | | — | | | — | | | — | | | 1,073,000 | | | Income taxes payable | | (2,133,000 | ) | | — | | | — | | | — | | | (2,133,000 | ) | | |
| |
| |
| |
| |
| |
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| Net cash provided by operating activities | | 14,210,000 | | | 9,273,000 | | | 931,000 | | | (136,000 | ) | | 24,278,000 | | | |
| |
| |
| |
| |
| |
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| | | Cash flows from investing activities: | | | | | | | | | | | | | | | | | Purchases of property, plant and equipment | | (493,000 | ) | | (6,092,000 | ) | | (6,000 | ) | | — | | | (6,591,000 | ) | | Payments for business acquisition | | — | | | (5,187,000 | ) | | (5,187,000 | ) | | 5,187,000 | | | (5,187,000 | ) | | |
| |
| |
| |
| |
| |
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| Net cash used in investing activities | | (493,000 | ) | | (11,279,000 | ) | | (5,193,000 | ) | | 5,187,000 | | | (11,778,000 | ) | | |
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| | | Cash flows from financing activities: | | | | | | | | | | | | | | | | | Proceeds from issuance of convertible senior notes | | 101,179,000 | | | — | | | — | | | — | | | 101,179,000 | | | Proceeds from issuance of stock in subsidiary | | — | | | — | | | 5,187,000 | | | (5,187,000 | ) | | — | | | Principal payments on other obligations | | — | | | (900,000 | ) | | — | | | — | | | (900,000 | ) | Proceeds from exercises of stock options and
warrants | | 1,541,000 | | | — | | | — | | | — | | | 1,541,000 | | Proceeds from issuance of employee stock
purchase plan shares | | 355,000 | | | — | | | — | | | — | | | 355,000 | | | |
| |
| |
| |
| |
| |
|---|
Net cash provided by (used in) financing
activities | | 103,075,000 | | | (900,000 | ) | | 5,187,000 | | | (5,187,000 | ) | | 102,175,000 | | | |
| |
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| |
| |
| |
|---|
| | Net increase (decrease) in cash and cash
equivalents | | 116,792,000 | | | (2,906,000 | ) | | 925,000 | | | (136,000 | ) | | 114,675,000 | | | Cash and cash equivalents at beginning of period | | 45,711,000 | | | 2,906,000 | | | — | | | — | | | 48,617,000 | | | |
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| Cash and cash equivalents at end of period | $ | 162,503,000 | | | — | | | 925,000 | | | (136,000 | ) | $ | 163,292,000 | | | |
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COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(18) Subsequent Event
| |
| In August 2006, the Company acquired certain assets and assumed certain liabilities of Insite, a logistics application software company, for $2.7 million, plus certain earn-out payments based on the achievement of future sales targets. The first part of the earn-out cannot exceed $1.4 million and is limited to a five-year period. The second part of the earn-out, which is for a ten-year period, is unlimited and based on a per unit future sales target primarily relating to new commercial satellite-based mobile data communication markets. Insite has developed the geoOps™ Enterprise Location Monitoring System, a software-based solution that allows customers to integrate legacy data systems with near-real time logistics and operational data systems. This operation was combined with the Company’s existing business and is part of the mobile data communications segment.
| | |
(19) Unaudited Quarterly Financial Data
| |
| The following is a summary of unaudited quarterly operating results (amounts in thousands, except per share data): | | |
| | Fiscal 2006 | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Total | |
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|
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| |
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| | | Net sales | $ | 106,567 | | | 95,741 | | | 88,997 | | | 100,206 | | | 391,511 | | | | | Gross profit | | 40,204 | | | 41,091 | | | 34,213 | | | 43,793 | | | 159,301 | | | | | Net income | | 11,464 | | | 13,304 | | | 8,722 | | | 11,779 | | | 45,269 | | | | | Diluted income per share | $ | 0.43 | | | 0.50 | | | 0.33 | | | 0.45 | | | 1.72 | * | | | | | | | | |
| Fiscal 2005 | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Total | |
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|
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| | | Net sales | $ | 56,122 | | | 78,087 | | | 75,388 | | | 98,293 | | | 307,890 | | | | | Gross profit | | 27,121 | | | 32,290 | | | 29,478 | | | 38,477 | | | 127,366 | | | | | Net income | | 7,076 | | | 10,182 | | | 8,372 | | | 11,025 | | | 36,655 | | | | | Diluted income per share | $ | 0.28 | | | 0.39 | | | 0.32 | | | 0.42 | | | 1.42 | * | | | | | | | | |
| | | | | * | Income per share information for the full fiscal year may not equal the total of the quarters within the year as a result of rounding. |
(18) Subsequent Events
In August 2008, the Company acquired Radyne Corporation (“Radyne”) for a preliminary aggregate purchase price of approximately $231,684,000 (including estimated transaction costs and liabilities assumed for outstanding share-based awards). Radyne designs, manufactures, sells, integrates and installs products, systems and software used for the transmission and reception of data and video over satellite, troposcatter, microwave and cable communication networks. The acquisition will be accounted for in the first quarter of fiscal 2009.
The Company believes that the acquisition of Radyne resulted in the following strategic benefits:
F-36
- | Strengthened its leadership position in its satellite earth station product line in its telecommunications transmission segment; |
Schedule II- | | COMTECH TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
ValuationMore than doubled the size of its RF microwave amplifiers segment by expanding its amplifier product portfolio and Qualifying Accounts and Reserves
Fiscal Years Ended July 31, 2006, 2005 and 2004
| | immediately positioning it as a leader, not only in the solid-state amplifier market but also in the satellite earth station traveling wave tube amplifier market; |
Column A
| | Column B
| | | Column C Additions
| | | Column D
| | | Column E | |
|
| |
| |
| |
| | Description
| | Balance at
beginning
of period
| | | Charged to
cost and
expenses
| | Charged to
other accounts
- describe
| | | Transfers
(deductions)
- describe
| | | Balance at
end of
period
| |
|
| |
| |
| |
| |
| | | | | | | | | | | | | | | | | | Allowance for doubtful accounts —
accounts receivable: | | | | | | | | | | | | | | | | Year ended July 31, | | | | | | | | | | | | | | | | | 2006 | $ | 636,000 | | | 748,000 (C) | | — | | | (8,000) (D) | | $ | 1,376,000 | | | | 2005 | | 732,000 | | | 287,000 (C) | | — | | | (383,000) (D) | | | 636,000 | | | | 2004 | | 912,000 | | | 147,000 (C) | | — | | | (327,000) (D) | | | 732,000 | | | | | | | | | | | | | | | | | | | Inventory reserves: | | | | | | | | | | | | | | | | Year ended July 31, | | | | | | | | | | | | | | | | | 2006 | $ | 6,509,000 | | | 2,030,000 (A) | | — | | | (2,416,000) (B) | | $ | 6,123,000 | | | | 2005 | | 5,622,000 | | | 2,098,000 (A) | | — | | | (1,211,000) (B) | | | 6,509,000 | | | | 2004 | | 5,099,000 | | | 1,193,000 (A) | | — | | | (670,000) (B) | | | 5,622,000 | |
| - | Broadened the number of products and services that its mobile data communications segment can offer by allowing it to market additional mobile tracking products as well as design and manufacture microsatellites and related components; and |
- | Further diversified its overall global customer base and expanded its addressable markets. |
In connection with the acquisition, the Company immediately adopted a restructuring plan and is currently in the process of closing Radyne’s Phoenix, Arizona manufacturing facility and integrating that operation into the Company’s high-volume technology manufacturing center located in Tempe, Arizona. In addition, Radyne’s corporate functions, which were co-located in Radyne’s Phoenix, Arizona manufacturing facility, will be moved to the Company’s Melville, New York corporate office.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued In connection with the realization of operating synergies, the Company preliminarily estimates that it will incur approximately $9,600,000 of restructuring costs, of which approximately $8,700,000 relates to possible exit costs related to the shut-down of Radyne's Phoenix, Arizona manufacturing facility. The Company has already incurred $800,000 of severance costs for Radyne employees who were notified that they were being terminated on August 1, 2008. The Company is in preliminary negotiations with a tenant who subleases, from it, a portion of the manufacturing facility, and is interested in subleasing the remaining portion of this facility from the Company. If the negotiations with this tenant are successful, the Company’s actual net costs related to the shut-down of the manufacturing facility will be significantly lower. If the negotiations with this tenant are not successful, the Company intends to perform an assessment of whether or not it will be able to sublease the Phoenix, Arizona facility for the remaining duration of the lease, and at what rent, if any, it might be able to receive, given the poor real-estate market conditions in the Phoenix, Arizona area as well as uncertainties relating to the local economic environment. The Company anticipates that it will be able to capitalize these costs as part of purchase accounting in accordance with Emerging Issues Task Force 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination (“EITF 95-3”).
From an operational and financial reporting perspective, as of August 1, 2008, Radyne’s satellite electronics and video encoders and decoder product lines are now part of the Company’s telecommunications transmission segment, Radyne’s TWTA and KPA amplifier product portfolios are now part of the Company’s RF microwave amplifiers segment and Radyne’s microsatellites and SENS product lines are now part of the Company’s mobile data communications segment.
The Company accounts for business combinations in accordance with FASB Statement No. 141, "Business Combinations" (“SFAS No. 141”). In accordance with SFAS No. 141, the preliminary aggregate purchase price for Radyne was allocated to amortizable intangible assets and acquired in-process research and development ("IPR&D") based upon their respective preliminary estimated fair values as of August 1, 2008, as set forth below:
| | | Preliminary Fair Value | | Estimated Useful Lives | | Preliminary fair value adjustments to amortizable intangible assets and IPR&D: | | | | | | Inventory step-up | | $ | 1,520,000 | | 6 months | | IPR&D | | | 6,200,000 | | Expensed immediately | | Customer relationships | | | 29,600,000 | | 10 years | | Core technologies | | | 19,900,000 | | 7 to 15 years | | Trademarks and other | | | 5,600,000 | | 2 to 20 years | | Total | | $ | 62,820,000 | | |
The preliminary estimates in the above table are based on available information, certain assumptions and preliminary valuation work and may change upon finalization. The primary areas of the purchase price allocation that are not yet finalized relate to the specifically identifiable intangible values (including IPR&D), goodwill, income taxes, and restructuring costs. The Company expects the allocation will be finalized within one year.
Based on this preliminary allocation, the annual amortization of the above fair value adjustments will approximate $6,600,000 in the Company’s fiscal 2009 consolidated statements of operations, of which $5,100,000 (to be recorded as operating expenses) is related to amortization of intangibles and $1,500,000 (to be recorded as cost of sales) is related to the estimated fair value step-up of inventory acquired. In addition, in August 2008 (the start of the Company’s fiscal 2009) and in accordance with SFAS No. 141, the Company expects to record the $6,200,000 of amortization associated with IPR&D.
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
Valuation and Qualifying Accounts and Reserves
Fiscal Years Ended July 31, 2008, 2007 and 2006
| Column A | | Column B | | | Column C Additions | | | Column D | | | Column E | | | Description | | Balance at beginning of period | | | Charged to cost and expenses | | | Charged to other accounts - describe | | | Transfers (deductions) - describe | | | Balance at end of period | | | Allowance for doubtful accounts - | | | | | | | | | | | | | | | | | accounts receivable: | | | | | | | | | | | | | | | | | Year ended July 31, | | | | | | | | | | | | | | | | | 2008 | | $ | 685,000 | | | | 723,000 | (A) | | | - | | | | (107,000 | ) (B) | | $ | 1,301,000 | | | 2007 | | | 1,376,000 | | | | (375,000 | )(A) | | | - | | | | (316,000 | ) (B) | | | 685,000 | | | 2006 | | | 636,000 | | | | 748,000 | (A) | | | - | | | | (8,000 | ) (B) | | | 1,376,000 | | | | | | | | | | | | | | | | | | | | | | | | | Inventory reserves: | | | | | | | | | | | | | | | | | | | | | | Year ended July 31, | | | | | | | | | | | | | | | | | | | | | | 2008 | | $ | 8,504,000 | | | | 2,414,000 | (C) | | | - | | | | (2,717,000 | ) (D) | | $ | 8,201,000 | | | 2007 | | | 6,123,000 | | | | 4,491,000 | (C) | | | - | | | | (2,110,000 | ) (D) | | | 8,504,000 | | | 2006 | | | 6,509,000 | | | | 2,030,000 | (C) | | | - | | | | (2,416,000 | ) (D) | | | 6,123,000 | |
| (A) | Provision for (benefit from) doubtful accounts. |
| (B) | Write-off of uncollectible receivables. |
| (C) | Provision for excess and obsolete inventory. | | | (B) | Write-off of inventory. | | | (C) | Provision for doubtful accounts. | | |
| (D) | Write-off of uncollectible receivables.inventory |
|
