Comtech Telecommunications Corp. — Q2 FY2020 Form 10-Q
Reporting period: Three and six months ended January 31, 2020. The filing was signed March 4, 2020. Comtech provides communications technologies to commercial and government customers through its Commercial Solutions and Government Solutions segments.
Key financial results
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Net sales | $161.7 million | $164.1 million | $331.9 million | $325.0 million |
| Gross profit | $60.6 million | $61.2 million | $124.2 million | $119.0 million |
| Gross margin | 37.5% | 37.3% | 37.4% | 36.6% |
| Operating income | $6.2 million | $12.4 million | $15.5 million | $19.7 million |
| Net income | $3.5 million | $7.8 million | $9.9 million | $11.3 million |
| Diluted EPS | $0.14 | $0.32 | $0.40 | $0.47 |
| Adjusted EBITDA (non-GAAP) | $21.2 million | $23.2 million | $41.8 million | $41.2 million |
Quarterly operating margin was approximately 3.9% versus 7.6% a year earlier; six-month operating margin was approximately 4.7% versus 6.1%. Quarterly Adjusted EBITDA margin was 13.1% versus 14.1%; six-month margin was 12.6% versus 12.7%. Management’s non-GAAP adjustments include acquisition-plan expenses and other specified items; it cautions that these measures are not substitutes for GAAP results.
Liquidity, debt and cash flow
- Cash and cash equivalents were $46.5 million at January 31, 2020, up from $45.6 million at July 31, 2019. Current assets were $289.6 million and current liabilities $163.2 million.
- Six-month operating cash flow was $31.3 million, compared with $13.0 million in the prior-year period. Investing cash outflow was $13.7 million, including $11.2 million paid for CGC net of acquired cash; financing cash outflow was $16.7 million. Cash dividends paid were $5.1 million.
- Debt under the existing secured credit facility was $158.0 million, down from $165.0 million at July 31, 2019. The facility matures October 31, 2023; $2.6 million of standby letters of credit were outstanding.
- At January 31, the secured leverage ratio was 1.60x, compared with a 3.75x maximum; interest coverage was 14.51x, compared with a 3.25x minimum. Management expected continued covenant compliance.
Period changes and operating drivers
- Q2 sales declined 1.5% year over year. Commercial Solutions sales rose 10.8% to $96.1 million, while Government Solutions sales fell 15.4% to $65.5 million. For the first six months, Commercial Solutions grew 15.6% and Government Solutions declined 11.7%.
- Management attributed Commercial Solutions growth mainly to public safety and location technology, including the contribution from prior-year Solacom and GD NG-911 acquisitions. Government Solutions weakness reflected lower mission-critical technology sales, including reduced U.S. Army mobile satellite transceiver sales and timing of large contracts.
- Quarterly operating income and net income fell despite a slightly higher gross margin. Higher acquisition-plan expenses, lower Government Solutions sales, and the absence of a prior-year $3.2 million intellectual-property litigation benefit were important comparisons. Q2 acquisition-plan expense was $6.0 million; the prior-year quarter included $1.8 million of such expense and $3.9 million of contract-settlement costs.
- Backlog was $638.3 million at January 31. Q2 consolidated book-to-bill was 0.94; management targeted a full-year FY2020 ratio above 1.0. A substantial portion of backlog was expected to be recognized over the following 24 months.
Outlook, transactions and risks
- FY2020 targets: Net sales of approximately $712 million and Adjusted EBITDA of approximately $99 million, narrowed from prior ranges. Management expected GAAP operating margin of approximately 6.0%, or approximately 7.5% excluding specified acquisition and settlement items; interest expense of approximately $7 million; and an effective tax rate of approximately 23%, excluding discrete items.
- Near-term outlook: Management forecast Q3 sales of $150–155 million and Adjusted EBITDA of $16–18 million, followed by a substantial Q4 rebound. The outlook assumed coronavirus-related deterioration was temporary and conditions would improve in the second half. Management said satellite ground station technologies were already experiencing order delays and travel constraints; continued disruption could shift deliveries and pipeline opportunities into FY2021. Pending UHP and Gilat acquisitions were excluded from FY2020 targets.
- Acquisitions: Comtech completed its CGC Technology acquisition on January 27 for a preliminary accounting purchase price of $23.7 million, partly paid in 323,504 Comtech shares. It had agreed to acquire UHP for approximately $40 million, with a possible additional earn-out of up to $10 million. The pending Gilat merger had an announced enterprise value of approximately $532.5 million and consideration of $7.18 cash plus 0.08425 Comtech share per Gilat share. Closing required customary conditions, including Gilat shareholder and regulatory approvals. Comtech had a commitment for a new $800 million secured facility to finance the transaction; estimated related transaction expenses were $28.6 million. Management cited only approximately $2 million of expected cost synergies and warned of integration, financing and execution risks.
- Other exposures include a TCS legacy 911 customer lawsuit seeking, among other relief, a refund exceeding $14 million; the parties had reached an agreement in principle, but final settlement terms were still being negotiated. Comtech also disclosed ongoing OFAC review of a historical Sudan-related shipment and a Commerce Department export-compliance review; no accrual was recorded for a possible export penalty.
- Management reported no goodwill impairment in its August 2019 annual test, but noted that deterioration in business conditions, lower projected cash flows or a significant stock-price decline could lead to future impairment. It also identified contract-estimate, warranty, customer demand, government funding, integration, and covenant/debt-service risks. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- Whether coronavirus-related order delays and travel restrictions persisted, and whether the forecast Q4 rebound and FY2020 targets were achieved.
- Conversion of backlog and bookings into funded orders, particularly the timing and profitability of the U.S. Army support contract and troposcatter IDIQ awards.
- Final terms, financing, approvals, closing, costs, dilution and integration results for the Gilat and UHP transactions; the $800 million facility’s final terms and resulting leverage are especially important.
- Resolution of the TCS legacy customer lawsuit and the OFAC/export-compliance matters, including any settlement, penalty or insurance recovery.
- Performance against debt covenants and the assumptions underlying non-GAAP Adjusted EBITDA and management’s full-year guidance.