Comtech Telecommunications Corp. — Q1 FY2017 Form 10-Q
Reporting period: Three months ended October 31, 2016; unaudited. Comparisons are with the three months ended October 31, 2015. Results include TeleCommunication Systems (TCS), acquired February 23, 2016, so year-over-year comparisons are materially affected by the acquisition.
Financial results
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Revenue | $135.8 million | $64.1 million |
| Gross profit / margin | $52.1 million / 38.4% | $28.2 million / 44.0% |
| Operating income (loss) | $(0.7) million | $2.2 million |
| Net income (loss) | $(2.5) million; $(0.11) per diluted share | $1.4 million; $0.09 per diluted share |
| Adjusted EBITDA (non-GAAP) | $10.0 million; 7.4% of revenue | $7.5 million; 11.7% of revenue |
| Cash provided by operating activities | $7.6 million | $5.1 million |
Revenue rose 111.9%, including approximately $78.0 million from TCS, partly offset by lower sales of legacy Comtech products. Commercial Solutions revenue was $76.2 million and Government Solutions revenue was $59.6 million. Gross margin declined principally because acquired TCS government business had lower margins and product mix shifted. Higher acquired-business amortization and interest expense contributed to the quarterly net loss.
At October 31, 2016, cash and cash equivalents were $62.7 million, down from $66.8 million at July 31. Current assets were $292.9 million and current liabilities were $177.9 million. Investing activities used $2.1 million, principally for property and equipment; financing activities used $9.6 million, including $7.1 million of dividends. Cash decreased by $4.1 million overall.
Long-term debt under the secured credit facility was $255.3 million before unamortized financing costs ($250.1 million net carrying value); capital lease obligations were $6.7 million. The facility matures in February 2021 and had a blended interest rate of approximately 5.0% during the quarter.
Material changes and management outlook
- Sales increased substantially with TCS, but the gross margin, operating result and Adjusted EBITDA margin weakened versus the prior-year quarter. Adjusted EBITDA increased in dollars, reflecting TCS contributions, partly offset by lower legacy-business contributions and higher unallocated costs.
- Management expected Q2 FY2017 revenue and Adjusted EBITDA to be approximately level with Q1, with both increasing in Q3 and Q4. It cited $461.9 million of backlog at October 31 and expected the FY2017 book-to-bill ratio to exceed 1.0. These are expectations, not guaranteed results; no specific full-year revenue or earnings target is provided.
- Management expected FY2017 gross margin to be below FY2016, reflecting the full-year TCS impact, anticipated product mix and lower BFT-1 intellectual-property license revenue. It expected Q2 gross margin to decline from Q1 before improving later in the year.
- The company was shifting Government Solutions toward smaller, higher-margin niche-product contracts and planning facility and other cost reductions. Management noted near-term sales and marketing costs associated with the repositioning.
- The credit facility requires a maximum net leverage ratio of 2.75x Adjusted EBITDA by fiscal year-end 2017. Management said compliance could be difficult even if expected results are achieved and reported substantive discussions with lenders to modify terms, particularly the leverage covenant. Dividends are subject to covenant compliance and Board approval; the Board targeted quarterly dividends of $0.10 per share for the remainder of FY2017, down from the $0.30 declared for the quarter.
Risks, contingencies and unusual items
- TCS legacy intellectual-property matters and related indemnification disputes were recorded at a preliminary estimated fair value of $27.0 million. Management cautioned that actual outcomes and legal costs could differ materially. Related proceedings included Vehicle IP and TracBeam patent cases; the TracBeam trial was scheduled for January 2017.
- A customer dispute concerning TCS’s 911 call-handling software contributed an estimated $6.8 million warranty liability. A separate Mississippi lawsuit alleged improper routing of 911 calls and sought $20 million in compensatory and $25 million in punitive damages; the company said it would defend the matter.
- OFAC was reviewing disclosed modem shipments potentially reaching Sudan, including a transaction with approximately $288,000 in sales. The company could not predict whether enforcement action or penalties would result.
- Customer demand and government-contract funding, international economic and political conditions, foreign exchange, oil prices, contract execution and customer concentration may affect orders and results. The company also warned that goodwill, particularly Commercial Solutions goodwill, could be at risk if projected sales and cash flows are not achieved; its August 1, 2016 annual test found no impairment.
- Disclosure controls were deemed effective, but the evaluation excluded TCS while its internal controls were being integrated.
Most important facts for investors to verify
- Whether the company and lenders amended or waived the leverage covenant, and whether the company remains compliant.
- Whether backlog converts into the forecast second-half revenue and Adjusted EBITDA growth, including the timing and funding of government and international orders.
- Whether TCS integration, synergies and acquired-business margins develop as expected, and whether lower consolidated gross margins persist.
- Developments and potential cash exposure in the TCS intellectual-property, 911 software warranty and 911 call-routing matters, as well as the OFAC review.
- Whether cash generation supports debt service and the targeted $0.10 quarterly dividend, subject to lender covenants and Board approval.