Business context and reporting period
Comtech Telecommunications Corp. provides communications equipment, systems and services to commercial and government customers through its Commercial Solutions and Government Solutions segments. This Form 10-K covers the fiscal year ended July 31, 2017; fiscal Q4 ended on that date. Fiscal 2017 includes 12 months of TeleCommunication Systems (TCS), acquired February 23, 2016, versus approximately five months in fiscal 2016, limiting comparability.
Key financial results
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $550.4 million | $411.0 million |
| Gross profit / margin | $218.2 million / 39.6% | $171.2 million / 41.7% |
| Operating income (loss) | $37.0 million | ($0.6) million |
| Net income (loss) | $15.8 million; diluted EPS $0.67 | ($7.7) million; diluted EPS ($0.46) |
| Adjusted EBITDA (non-GAAP) | $70.7 million; 12.8% of sales | $48.1 million; 11.7% of sales |
| Cash provided by operating activities | $66.7 million | $15.0 million |
| Cash and cash equivalents at year-end | $41.8 million | $66.8 million |
| Working capital at year-end | $96.8 million | $119.5 million |
Fiscal Q4 FY2017 sales were $147.8 million, gross profit $60.4 million, net income $7.3 million and diluted EPS $0.31. The comparable FY2016 quarter reported sales of $152.4 million and net income of $2.7 million.
Fiscal 2017 sales rose 33.9%, primarily because the year included a full year of TCS operations; TCS contributed $298.5 million of sales. The overall gross margin declined mainly from sales mix, particularly lower-margin TCS government solutions. Management reported $12.0 million of favorable adjustments from settled TCS intellectual-property matters and $5.5 million of other favorable legal-cost recovery and reserve adjustments. Excluding $18.8 million of favorable operating-expense adjustments, operating income was $18.2 million, or 3.3% of sales.
Debt, liquidity and capital allocation
At July 31, 2017, debt under the secured credit facility was $196.5 million before deferred financing costs; capital lease obligations were approximately $4.1 million. The company said total debt outstanding excluding deferred financing costs was $200.6 million. It reduced total indebtedness by $63.7 million during FY2017 and by $160.3 million since the TCS acquisition. The facility matures February 23, 2021, is secured by substantially all tangible and intangible assets, and provides up to $400 million of borrowing capacity.
The leverage ratio was 2.84x against a maximum of 3.75x; the maximum declines to 3.00x by FY2018 Q4. Fixed charge coverage was 1.95x against a 1.25x minimum. Cash dividends paid in FY2017 were $18.9 million. The board targeted quarterly FY2018 dividends of $0.10 per share, subject to covenant compliance and board approval.
Year-end backlog was $446.2 million, down from $484.0 million; FY2017 book-to-bill was 0.93. Management expects a significant portion of backlog to convert to FY2018 sales, but contracts are generally subject to modification or cancellation and some commercial-government program funding depends on future budgets.
Outlook, risks and unusual items
- Management expects consolidated FY2018 sales to increase and Adjusted EBITDA to be comparable to FY2017’s $70.7 million despite the absence of a $6.7 million BFT-1 intellectual-property license fee. It expects Adjusted EBITDA margin near 12.8%; stronger market conditions could result in a higher amount.
- Management expects FY2018 Government Solutions sales below FY2017, partly due to the expired BFT-1 license fee and its shift away from large, lower-margin service contracts. Commercial Solutions sales are expected to increase. Management expects operating losses in FY2018 Q1 and Q2, profits in Q3 and Q4, and Q4 to be the peak sales and Adjusted EBITDA quarter.
- FY2018 operating income is targeted at approximately 4%–5% of sales, compared with FY2017’s 3.3% excluding favorable adjustments. Results depend on order timing, contract awards and government funding; management cautions that forecasts are difficult and quarterly results can fluctuate.
- Significant items include the $6.7 million BFT-1 license fee in FY2017 and the $12.0 million favorable net adjustment for settled intellectual-property matters. Adjusted EBITDA is non-GAAP and excludes various costs; the filing cautions that such costs may recur and the measure may not be comparable across companies.
- AT&T disputed performance and usability of legacy TCS 911 call-handling software and sought refunds. The company accrued $5.5 million and expected refunds over 36 months if a settlement is finalized. Separate accrued warranty obligations for the TCS software were $9.9 million.
- OFAC review remains unresolved following the company’s disclosure of modem transactions with a possible Sudan end user; the company cannot predict whether penalties or other action will result. Vehicle IP appealed a judgment of noninfringement; further legal expense and an unfavorable outcome remain possible.
- Other material risks include U.S. and foreign government budget and contract uncertainty, contract cancellation and fixed-price cost overruns, export-control compliance, cyber threats, dependence on partners and suppliers, competition and potential impairment of goodwill and intangibles. Goodwill was $290.6 million and net finite-lived intangibles $261.9 million; the August 1, 2017 impairment test found no impairment.
Important facts for investors to verify
- Reconcile reported FY2017 operating income and Adjusted EBITDA to the $18.8 million favorable adjustments and the $6.7 million BFT-1 license fee; review the non-GAAP reconciliation and definitions.
- Track FY2018 orders, backlog conversion and awards—especially the anticipated Navy SLM-5650B contract, NG911 opportunities, BFT sustainment and the Army SNAP contract—and confirm funding, timing and margins.
- Monitor debt repayment, interest costs and headroom under the tightening leverage covenant, as well as whether dividends remain permitted under facility covenants.
- Review resolution and cash costs of the AT&T software dispute, the OFAC inquiry and the Vehicle IP appeal, including whether existing accruals prove adequate.
- Assess the effect of the new revenue-recognition standard, scheduled for adoption in FY2019, and whether forecast growth and cash generation support goodwill and intangible-asset carrying values.