Comtech Telecommunications Corp. — Form 10-Q Summary
Reporting period: Second quarter and six months ended January 31, 2017. Unaudited results. Comparisons are substantially affected by the February 2016 acquisition of TeleCommunication Systems (TCS): the 2017 periods include TCS, while the comparable 2016 periods do not.
Financial performance
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Net sales | $139.0 million | $70.3 million | $274.8 million | $134.4 million |
| Gross profit / margin | $53.2 million / 38.3% | $29.4 million / 41.8% | $105.3 million / 38.3% | $57.6 million / 42.9% |
| Operating income | $12.8 million | $3.2 million | $12.1 million | $5.4 million |
| Net income | $6.6 million | $2.5 million | $4.1 million | $3.9 million |
| Diluted EPS | $0.28 | $0.15 | $0.17 | $0.24 |
| Adjusted EBITDA (non-GAAP) | $13.5 million | $9.3 million | $23.5 million | $16.8 million |
- Q2 sales increased 97.7%; management attributed the increase principally to $75.9 million of TCS sales. Six-month sales increased 104.5%, including $153.9 million from TCS.
- Q2 operating margin was 9.2%, but included a favorable $10.0 million adjustment from resolving a legacy TCS intellectual-property matter. Excluding it, operating income was $2.8 million, or 2.0% of sales. Six-month operating income excluding the adjustment was $2.1 million.
- Lower consolidated gross margin reflected product mix, particularly TCS Government Solutions, whose margins were below Comtech’s legacy products. TCS also increased amortization expense and interest costs.
- Segment sales in Q2 were $82.1 million for Commercial Solutions and $56.9 million for Government Solutions. Segment book-to-bill was 1.22 and 0.53, respectively.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $25.4 million, versus $23.4 million a year earlier; Q2 operating cash flow was $17.7 million. Capital expenditures were $4.1 million for the six months.
- Cash and equivalents were $63.1 million at January 31, down from $66.8 million at July 31, 2016. Six-month financing cash outflow was $24.9 million, including $14.2 million of dividends and debt and lease repayments.
- Current assets were $278.5 million and current liabilities $156.9 million. Total assets were $883.5 million and total liabilities $417.0 million.
- Secured Credit Facility debt was $248.0 million gross at January 31: $168.2 million term loan and $79.8 million revolver. The balance-sheet debt amount, net of deferred financing costs, was $243.1 million. Capital lease obligations totaled $5.8 million.
- Leverage ratio was 2.57x against a 3.00x maximum; the maximum is scheduled to decline to 2.75x by fiscal year-end. Management anticipated covenant compliance for at least the remainder of FY2017, while noting future compliance is not assured and discussing possible facility modifications with lenders.
Outlook, commentary and risks
- Backlog was $453.3 million at January 31. Management expected FY2017 consolidated book-to-bill to exceed 1.0 and anticipated sales and Adjusted EBITDA growth in the second half, supported by backlog and expected orders.
- Management expected Q3 sales to be slightly below Q2, but Q3 Adjusted EBITDA to exceed Q2; Q4 sales and Adjusted EBITDA were expected to be the highest of FY2017. The company targeted full-year Adjusted EBITDA of approximately 12% of expected sales. These are expectations, not guarantees.
- Management lowered its sales expectations for FY2017, citing a delayed U.S. government order exceeding $20 million, a government-wide ordering lull, and its strategic shift toward higher-margin niche Government Solutions contracts. It expected mix improvements and efficiencies to offset the anticipated sales decline’s effect on operating income.
- Management expected FY2017 gross margin to be below FY2016, partly due to TCS mix and lower BFT-1 license-fee revenue. BFT-1 license fees ended after March 31, 2017; further sustainment-support work was anticipated but depended on a contract award.
- Key exposures include execution and integration of TCS, uncertain government funding and order timing, international demand and currency effects, contract-estimation and warranty risks, and potential goodwill impairment. Commercial Solutions goodwill was particularly sensitive to achieving projected sales and cash flows.
- Legal and contingency matters include the unresolved Vehicle IP patent case scheduled for trial in July 2017; a CallWave settlement under negotiation; an accrued $10.6 million for TCS 911 software warranty issues; and an OFAC review concerning equipment potentially routed to Sudan. The TracBeam matter was settled, producing the $10.0 million favorable operating-income adjustment; management described the net cash outflow from the related settlements as immaterial.
Most important facts for investors to verify
- Whether anticipated large Government Solutions orders arrive and book-to-bill improves, particularly given Q2’s 0.53 segment ratio.
- Underlying profitability excluding the one-time $10.0 million litigation adjustment, and whether the targeted second-half improvement materializes.
- Compliance with increasingly restrictive debt covenants, lender discussions, debt repayment capacity and the effect of dividends on liquidity.
- Resolution and potential cash costs of the Vehicle IP, CallWave, 911 software warranty and OFAC matters, plus impairment sensitivity of goodwill.
- That reported year-over-year growth is not directly comparable because of the TCS acquisition and resulting changes in business mix.