Comtech Telecommunications Corp. — Q3 FY2018 Form 10-Q
Reporting period: Three and nine months ended April 30, 2018; filed June 6, 2018. Results are unaudited. Comtech provides communications solutions through Commercial Solutions and Government Solutions.
Financial performance and liquidity
- Q3 revenue: $147.9 million, up 15.7% year over year. Gross profit was $62.4 million, with a 42.2% gross margin versus 41.1%. Operating income was $14.0 million versus $10.2 million; net income was $8.2 million versus $4.4 million. Diluted EPS was $0.34 versus $0.19.
- Q3 Adjusted EBITDA: $23.5 million, up from $18.1 million; margin was 15.9% versus 14.2%. This is a non-GAAP measure.
- Nine-month revenue: $403.2 million, essentially flat with $402.6 million in the prior-year period. Gross profit was $161.0 million versus $157.8 million; gross margin was 39.9% versus 39.2%. Operating income declined to $19.1 million from $22.3 million. Net income rose to $22.3 million from $8.5 million, and diluted EPS to $0.93 from $0.36.
- Nine-month Adjusted EBITDA: $47.7 million versus $41.6 million; margin was 11.8% versus 10.3%. Prior-year results included a $12.0 million favorable intellectual-property litigation adjustment; FY2018 results did not.
- Cash flow: Nine-month operating cash flow was $30.6 million, down from $43.9 million, chiefly reflecting working-capital timing, including a $19.6 million inventory cash outflow. Capital spending was $5.3 million. Q3 operating cash flow was $21.4 million, according to management.
- Balance sheet at April 30: Cash and equivalents were $44.2 million; current assets were $261.9 million and current liabilities $152.5 million. Total liabilities were $336.3 million and equity $497.8 million. Inventory rose to $76.6 million from $60.6 million at July 31, 2017.
- Debt and covenants: Total indebtedness was $186.4 million, down from $235.4 million at April 30, 2017. The secured facility had a February 2021 maturity. Leverage was 2.43x against a 3.10x maximum (to decline to 3.00x in Q4 FY2018); fixed-charge coverage was 2.36x against a 1.25x minimum. Management expected continued covenant compliance.
- Shareholder returns: Quarterly dividend was $0.10 per share. A further $0.10 dividend was declared June 6, payable August 17, subject to covenant compliance and board approval.
Material changes and business drivers
- Q3 sales increased in both segments: Commercial Solutions rose 13.2% to $89.9 million; Government Solutions rose 19.6% to $57.9 million. Commercial Solutions benefited from stronger demand and favorable product mix, including earlier-than-planned U.S. Navy modem shipments.
- For the nine months, Commercial Solutions sales grew 6.0% to $251.9 million, while Government Solutions sales fell 8.2% to $151.3 million. Government Solutions was affected by lower over-the-horizon microwave sales, the absence of $6.7 million of BFT-1 intellectual-property license fees, and the shift away from large, lower-margin service contracts.
- Q3 consolidated book-to-bill was 1.11 and funded, firm backlog was $583.7 million, near a record. The $59.0 million Navy IDIQ award had received $8.2 million in initial funding; the total award is not equivalent to funded backlog.
- Tax reform drove an estimated $14.1 million discrete tax benefit in the nine-month period, contributing to the increase in reported net income. The company expects to finalize the estimate during the remainder of FY2018.
Outlook, risks, and contingencies
- Management’s FY2018 targets were revenue growth close to 5%, operating margin of approximately 5.2%, Adjusted EBITDA growth close to 6%, and Adjusted EBITDA margin close to 13%. Targets exclude certain favorable FY2017 adjustments when comparing operating margins. Management said Q4 should be the peak quarter for sales and Adjusted EBITDA, while Q3 was expected to be the peak for operating income.
- Management expected FY2018 Government and Commercial Solutions sales to exceed FY2017 levels, but noted that shipment timing, product mix, government funding and customer decisions can cause significant period-to-period swings. Lower expected Q4 sales of higher-margin cyber training software could weigh on Government Solutions margins.
- For FY2019, management initially estimated an effective tax rate of 23.5%–25.0%, before discrete items. Tax-law interpretation and finalization of the FY2018 tax benefit could change estimates.
- Material exposures include the Vehicle IP patent appeal and related legal costs; an ongoing Commerce Department export-compliance review involving six transactions valued at less than $100,000 in aggregate, with no penalty accrual recorded; and an OFAC review of historical transactions involving Sudan. Potential outcomes and penalties were uncertain.
- Other risks include customer and government-contract concentration, contract termination and funding uncertainty, estimation of long-term contract costs and warranties, inventory obsolescence, and possible goodwill impairment if forecasts or market conditions deteriorate. The company reported no material change to previously disclosed risk factors and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether Navy and other government orders receive funding and ship on the timetable assumed in FY2018 guidance; only $8.2 million of the $59.0 million Navy award was initially funded.
- How much of Q3 and nine-month earnings growth reflects recurring operating performance versus tax reform, the prior-year litigation adjustment, the warranty settlement benefit, and shipment or product-mix timing.
- Progress converting the $583.7 million funded backlog and strong bookings into revenue and cash, particularly given the inventory build and lower year-to-date operating cash flow.
- Debt repayment, borrowing costs, covenant headroom, and the ability to sustain dividends while meeting facility requirements.
- Developments in the Vehicle IP appeal, export-control reviews, tax audit and tax-benefit finalization, and any resulting financial exposure.