Comtech Telecommunications Corp. — Q2 FY2018 10-Q
Reporting period: Three and six months ended January 31, 2018. Unaudited results; fiscal year ends July 31. Comtech operates Commercial Solutions and Government Solutions segments.
Financial performance
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Net sales | $133.7m | $139.0m | $255.3m | $274.8m |
| Gross profit / margin | $50.8m / 38.0% | $53.2m / 38.3% | $98.5m / 38.6% | $105.3m / 38.3% |
| Operating income | $4.9m | $12.8m | $5.1m | $12.1m |
| Net income | $15.8m | $6.6m | $14.1m | $4.1m |
| Diluted EPS | $0.66 | $0.28 | $0.59 | $0.17 |
| Adjusted EBITDA (non-GAAP) | $14.5m | $13.5m | $24.1m | $23.5m |
Q2 sales fell 3.8%; first-half sales fell 7.1%. Government Solutions weakness outweighed growth in Commercial Solutions. Q2 commercial sales rose 4.5% to $85.8m, while government sales fell 15.8% to $47.9m. For six months, commercial sales increased 2.3% to $161.9m; government sales declined 19.8% to $93.4m.
Q2 operating income was lower than the prior year, which included a $10.0m favorable intellectual-property litigation adjustment. The first-half comparison likewise reflects that prior-year benefit. Net income increased substantially, principally because of a $14.0m estimated discrete tax benefit from U.S. tax reform—not stronger operating income. Q2 Adjusted EBITDA margin was 10.9%, versus 9.7%; first-half margin was 9.5%, versus 8.6%.
For the six months, operating cash flow was $9.2m, down from $25.6m, mainly due to working-capital timing, including inventory investment. Capital spending was $2.8m, and cash declined $1.4m to $40.5m. Management reported Q2 operating cash flow of $2.7m.
Liquidity, debt and capital
- At January 31, 2018, total indebtedness was $198.3m, compared with $253.8m a year earlier. Secured Credit Facility debt, net of financing costs, was $191.4m; the facility matures February 2021.
- Cash was $40.5m; the revolving facility had $66.8m outstanding. The company reported leverage of 2.78x against a 3.35x maximum, and fixed-charge coverage of 2.09x against a 1.25x minimum. The leverage ceiling steps down to 3.00x by Q4 FY2018. Management expected continued covenant compliance.
- Six-month dividends paid were $4.8m. The board declared a further $0.10-per-share dividend payable May 18, 2018, subject to covenant compliance and board approval.
- Contractual cash obligations totaled $260.7m, including $195.5m facility principal, $43.4m operating leases, and $2.9m capital leases.
Business developments and outlook
- Commercial Solutions won a $134.0m multiyear E911 contract with a major U.S. wireless carrier. The company also cited $96.2m of AT&T contracts in the first half.
- Government Solutions won a three-year $123.6m U.S. Army sustainment contract and an initial $11.7m order for MT-2025 transceivers supporting BFT-2; initial shipments were expected in Q4. It also received two international microwave-system awards.
- Backlog was $567.3m, near a record, and Q2 consolidated book-to-bill was 1.57. Backlog includes only funded, firm orders, not unfunded portions of multiyear contracts.
- Management raised its FY2018 targets to approximately 5% revenue growth and 5% Adjusted EBITDA growth versus FY2017, with Adjusted EBITDA margin comparable to FY2017’s 12.8%. Management expected Q4 to be the peak quarter; Q3 sales and Adjusted EBITDA were projected approximately 10% above Q2, with Q3 operating margin near 4% and Adjusted EBITDA margin near 11%. These are forward-looking, non-GAAP targets; the filing did not provide a quantitative reconciliation to GAAP.
- Management expects fiscal 2018 gross margin to be slightly below fiscal 2017, while targeting operating income near 5% of sales. Fiscal 2018 Government Solutions sales were revised to slightly above fiscal 2017; Commercial Solutions sales were also expected to grow.
Risks, contingencies and unusual items
- The tax reform remeasurement generated an estimated $14.0m discrete tax benefit; the estimate remained subject to finalization and possible IRS guidance. Management estimated a 27.75% FY2018 effective tax rate excluding discrete items and a 24.5%–26.0% FY2019 rate before discrete items.
- The $4.4m present value of AT&T warranty credits was recorded following a settlement concerning TCS 911 call-handling software. The settlement reduced cost of sales by $0.7m in the first half. Warranty and inventory estimates remain sensitive to claims, product demand and contract performance.
- Vehicle IP appealed a noninfringement judgment; the appeal outcome and further defense costs were uncertain and could materially affect results, financial position or cash flows. OFAC was reviewing disclosed historical Sudan-related transactions; potential enforcement and penalties were uncertain.
- Other key risks include variable government-contract funding and termination rights, timing of large awards and deliveries, international sales exposure, execution of the Government Solutions strategy, interest-rate exposure, and potential goodwill impairment if forecasts or market conditions deteriorate. The company reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether awarded multiyear contracts convert into funded orders and revenue on the expected schedule, particularly the $134.0m E911 award and Army contracts.
- Whether backlog, book-to-bill and second-half deliveries support the FY2018 growth and margin targets, especially the anticipated Q4 peak.
- How much of the earnings increase reflects the one-time tax benefit versus recurring operating performance, and whether the tax estimate changes.
- Whether operating cash flow improves as working capital normalizes, and whether debt reduction and covenant headroom remain adequate as limits tighten.
- Developments in the Vehicle IP appeal, OFAC review and remaining warranty obligations, including any effects on cash requirements.