Business context and reporting period
Comtech Telecommunications Corp. filed this unaudited Form 10-Q for its first quarter of fiscal 2019, the three months ended October 31, 2018. The company provides communications technology to commercial and government customers through its Commercial Solutions and Government Solutions segments.
Financial performance and liquidity
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Net sales | $160.8 million | $121.6 million |
| Gross profit; gross margin | $57.8 million; 35.9% | $47.7 million; 39.3% |
| Operating income; operating margin | $7.3 million; 4.5% | $0.2 million; 0.2% |
| Net income (loss) | $3.5 million; $0.14 diluted EPS | $(1.7) million; $(0.07) diluted EPS |
| Adjusted EBITDA (non-GAAP) | $18.0 million; 11.2% of sales | $9.6 million; 7.9% of sales |
| Cash from operating activities | $(14.1) million | $6.5 million |
- Cash and cash equivalents were $42.9 million at October 31, down from $43.5 million at July 31. Operating cash use reflected working-capital movements, particularly receivables and inventory.
- Current assets were $304.9 million and current liabilities $142.6 million. Long-term debt was $193.4 million; capital lease and other obligations totaled $2.2 million. Total debt and those obligations were approximately $195.6 million.
- Capital expenditures were $1.6 million. Backlog was $627.3 million; consolidated book-to-bill was 0.98.
Material changes versus the prior comparable period
- Sales rose 32.2%, driven mainly by Government Solutions, up 82.2% to $82.9 million. Commercial Solutions increased 2.5% to $78.0 million.
- Government Solutions benefited from stronger command-and-control and over-the-horizon microwave systems sales. About $10 million of sales were accelerated from later quarters because of customer fielding schedules. Management said Q1 was expected to be the segment’s peak quarter for FY2019.
- Gross margin fell from 39.3% to 35.9%, largely because Government Solutions, which typically has lower margins than Commercial Solutions, made up a greater share of sales. The prior-year quarter also included a $0.7 million favorable warranty settlement.
- Operating income improved substantially, but included $1.4 million in facility exit costs, $1.1 million in acquisition-plan expenses and a $3.2 million write-off of deferred financing costs. The quarter also included a $2.4 million net discrete tax benefit. Excluding the specified facility and acquisition costs, the financing-cost write-off and discrete tax benefit, management presented non-GAAP operating income of $9.8 million, net income of $5.5 million and diluted EPS of $0.22.
- ASC 606 was adopted using the modified retrospective method; management said its impact was not material.
Outlook, management commentary and risks
- Management raised FY2019 targets: revenue of $625–$640 million, GAAP diluted EPS of $0.95–$1.08, and Adjusted EBITDA of $84–$88 million. These targets include specified facility exit costs, acquisition-plan expenses, financing-cost write-off and discrete tax benefits, as applicable. Adjusted EBITDA is non-GAAP.
- Management expected Q2 sales, operating income and Adjusted EBITDA to be nearly in line with Q1; Q3 results to improve on Q2; and Q4 to be the peak consolidated quarter. It expected full-year gross margin below FY2018, while operating income was targeted to exceed FY2018’s 6.2% of sales. The effective tax rate excluding discrete items was expected to be about 22.75%.
- Management cited strong demand and bookings, while noting that results depend on order timing, customer deliveries and government funding. U.S. government contracts may be terminated for convenience, and IDIQ contracts do not guarantee purchases. Quarterly results can fluctuate materially.
- On October 31, the company replaced its prior facility with a senior secured credit facility of up to $550 million, including a $300 million revolving facility and a $250 million accordion. It matures October 31, 2023; $193.4 million was drawn at quarter-end. The company reported a secured leverage ratio of 2.25x against a 3.75x maximum and interest coverage of 11.31x against a 3.25x minimum. The facility is secured by substantially all tangible and intangible assets. Management expected operating cash flow to turn positive for the rest of FY2019 and borrowings to decline.
- Management disclosed ongoing efforts to acquire a small technology solutions company, with no assurance of success; it expected about $1.0 million of additional related expenses in Q2. A Tampa manufacturing facility was consolidated into the Orlando facility.
- Contingencies include a pending appeal in the legacy Vehicle IP patent matter; an OFAC investigation concerning historical shipments involving Sudan, with a tolling agreement through December 31, 2019; and a Commerce Department review of six potentially noncompliant export transactions. No accrual was recorded for a possible export penalty. The filing says legal costs or outcomes could materially affect future results or cash flows.
- Other risks include customer and government spending delays, contract cost-estimate revisions, interest-rate exposure, warranty and inventory estimates, possible goodwill impairment if business assumptions deteriorate, and covenant limits on dividends. Goodwill was not impaired in the August 2018 annual test.
Important facts for investors to verify
- Whether the accelerated $10 million of Government Solutions sales and the expected quarterly segment cadence are reflected in subsequent results.
- Whether the raised FY2019 revenue, EPS and Adjusted EBITDA targets were achieved; review the non-GAAP definitions and reconciliations.
- Whether operating cash flow improved as management expected, and whether working capital, debt and interest costs changed materially.
- Progress, costs and any announced outcome of the contemplated acquisition, plus the effects of facility consolidation.
- Developments in the Vehicle IP appeal, OFAC and export-control matters, and any resulting accruals or penalties.
- Customer concentration, government funding and order timing, credit-facility covenant headroom, and the continued ability to pay dividends.