Business context and reporting period
Comtech Telecommunications Corp. filed this unaudited Form 10-Q for the quarter and nine months ended April 30, 2017 (fiscal 2017). It operates through Commercial Solutions and Government Solutions. Results include the TeleCommunication Systems (TCS) business, acquired February 23, 2016; consequently, nine-month year-over-year comparisons reflect a partial period of TCS in 2016 and are not fully comparable.
Financial performance and liquidity
| Metric | Three months ended April 30, 2017 | Three months ended April 30, 2016 | Nine months ended April 30, 2017 | Nine months ended April 30, 2016 |
|---|---|---|---|---|
| Net sales | $127.8 million | $124.2 million | $402.6 million | $258.6 million |
| Gross profit / margin | $52.5 million / 41.1% | $51.4 million / approximately 41.4% | $157.8 million / 39.2% | $109.0 million / 42.2% |
| Operating income (loss) | $10.2 million | $(13.4) million | $22.3 million | $(8.0) million |
| Net income (loss) | $4.4 million | $(14.4) million | $8.5 million | $(10.4) million |
| Adjusted EBITDA (non-GAAP) | $18.1 million; 14.2% of sales | $12.5 million; 10.0% | $41.6 million; 10.3% | $29.2 million; 11.3% |
Third-quarter sales rose 2.9%. Commercial Solutions sales increased 10.3% to $79.4 million, while Government Solutions sales decreased 7.3% to $48.4 million. Nine-month sales rose 55.7%, primarily reflecting the inclusion of additional TCS sales. The nine-month gross margin declined, which management attributed mainly to product mix, including lower-margin TCS Government Solutions sales.
Operating cash flow was $18.3 million in the third quarter and $43.7 million for the nine months, versus $12.3 million for the prior-year nine-month period. Nine-month capital expenditures were $6.2 million. Cash declined to $58.8 million at April 30, 2017 from $66.8 million at July 31, 2016. Debt outstanding was $235.4 million, excluding deferred financing costs; the company reported reducing total indebtedness by $28.8 million during the nine months. Current assets were $266.2 million and current liabilities $151.9 million.
At April 30, the $400 million secured facility had $164.9 million outstanding under the term loan and $65.6 million under the revolver. The facility matures in February 2021. The company reported compliance with covenants, including under a June 6, 2017 amendment that applies retroactively to April 30.
Material changes and unusual items
- Third-quarter operating results included a $2.0 million favorable intellectual-property litigation adjustment. Nine-month results included $12.0 million of favorable adjustments from settlements of TCS intellectual-property matters. These items lifted GAAP operating income; Adjusted EBITDA excludes settlement effects.
- The prior-year quarter and nine-month period included $17.0 million and $20.7 million, respectively, of acquisition-plan expenses, primarily related to TCS. There were none in the 2017 periods.
- Government Solutions’ third-quarter sales and profitability were affected by lower sales and the expiration, on March 31, 2017, of a BFT-1 intellectual-property license contract. The U.S. Army has no further payment obligation under that license.
- Accrued warranty obligations were $18.2 million, including $10.2 million for estimated costs related to pre-acquisition TCS 911 call-handling software issues.
Outlook, risks and contingencies
Management expected fourth-quarter fiscal 2017 sales and Adjusted EBITDA to be the highest quarterly levels of the fiscal year, with fourth-quarter operating income also expected to increase from the third quarter. It expected fiscal-year Adjusted EBITDA to approximate 12% of consolidated sales. Management forecast fourth-quarter gross margin slightly below the third-quarter rate and fiscal 2017 gross margin below fiscal 2016. These are expectations, not guarantees.
Backlog was $461.3 million at April 30, with a large portion scheduled for delivery in the fourth quarter. Third-quarter consolidated book-to-bill was 1.06; Government Solutions book-to-bill improved to 1.39 from 0.53 in the preceding quarter, while Commercial Solutions’ ratio was 0.86. Management cited significant prospective contracts and anticipated HEIGHTS opportunities, but noted awards and timing could slip. It viewed fiscal 2018 as the expected breakout year for HEIGHTS because initial sales cycles were longer than anticipated.
The June 2017 credit amendment changed covenant calculations and dividend treatment, reduced the term-loan balloon payment by $22.5 million through increased revolver borrowings, and did not change committed capacity, maturity, or stated interest rates. Under amended calculations, leverage was 3.89x against a 4.25x maximum and fixed-charge coverage was 1.70x against a 1.25x minimum. The maximum leverage threshold tightens to 3.75x in fiscal Q4 2017 and declines to 3.00x by fiscal Q4 2018. Management anticipated continued covenant compliance; failure to meet covenants could constrain operations, acquisitions, or dividends.
Key risks include uncertain government funding and contract awards, termination-for-convenience provisions, execution of the Government Solutions shift toward higher-margin niche products, long-term contract cost estimates, international business conditions, and potential goodwill impairment. The company reported no impairment indicators during the quarter, but noted that weaker business results or a sustained share-price decline could put goodwill and intangibles at risk. The Vehicle IP litigation remained unresolved; a favorable May 30, 2017 claim-construction order led the parties to seek cancellation of the scheduled trial, but an appeal was possible. OFAC continued reviewing a disclosed export matter involving equipment ultimately used in Sudan; penalties and timing were uncertain.
Important facts for investors to verify
- Whether fourth-quarter sales, Adjusted EBITDA, and backlog conversion met management’s expectations, and whether large prospective awards were booked on schedule.
- How much reported profit and cash generation depended on litigation recoveries, working-capital movements, or other nonrecurring factors; review GAAP results alongside the company-defined non-GAAP measure.
- Progress in Government Solutions margins and the impact of the expired BFT-1 license fees and the strategy shift.
- Compliance with tightening amended debt covenants, debt repayment, revolver usage, and the company’s capacity to sustain dividends.
- Developments in the Vehicle IP case, the $10.2 million 911 software warranty exposure, OFAC’s review, and goodwill impairment assumptions.