Comtech Telecommunications Corp. — Q2 Fiscal 2019 10-Q
Reporting period: Three and six months ended January 31, 2019; filed March 6, 2019. The quarter is the second quarter of fiscal 2019. Comtech supplies communications technologies to commercial and government customers through its Commercial Solutions and Government Solutions segments.
Financial performance and liquidity
| Metric | Three months ended Jan. 31, 2019 | Prior-year quarter | Six months ended Jan. 31, 2019 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $164.1 million | $133.7 million | $325.0 million | $255.3 million |
| Gross profit / margin | $61.2 million / 37.3% | $50.8 million / 38.0% | $119.0 million / 36.6% | $98.5 million / 38.6% |
| Operating income | $12.4 million | $4.9 million | $19.7 million | $5.1 million |
| Net income | $7.8 million | $15.8 million | $11.3 million | $14.1 million |
| Diluted EPS | $0.32 | $0.66 | $0.47 | $0.59 |
| Adjusted EBITDA (non-GAAP) | $23.2 million | $14.5 million | $41.2 million | $24.1 million |
Quarterly sales rose 22.7%; year-to-date sales rose 27.3%. Government Solutions drove most of the growth: segment sales increased 61.6% in the quarter and 71.6% year to date. Commercial Solutions sales were up 1.1% and 1.7%, respectively. Consolidated gross margin declined as the higher-growth Government Solutions segment generally has lower margins than Commercial Solutions.
Net income fell despite higher operating income, chiefly because the prior-year periods included a substantial tax benefit from U.S. tax reform. Fiscal 2018 Q2 included a $14.0 million discrete tax benefit; the current-year quarter had a 23.0% effective tax rate excluding discrete items. Current-year year-to-date net income also includes a $3.2 million financing-cost write-off, partly offset by a $3.2 million favorable litigation-related benefit.
Cash and debt at January 31: Cash and equivalents were $46.0 million; long-term debt under the new credit facility was $174.5 million, and total debt including capital leases and other obligations was $176.3 million. Current assets were $285.8 million and current liabilities $129.7 million. For the six months, operating cash flow was $13.0 million (versus $9.2 million), capital expenditures were $4.2 million, and financing cash outflow was $6.3 million. Management separately reported second-quarter operating cash flow of $27.2 million.
The October 2018 senior secured credit facility provides up to $550 million, including a $300 million revolver and an accordion feature. It matures October 31, 2023, has no scheduled principal payments before maturity, and is subject to financial covenants. At quarter-end, the secured leverage ratio was 1.85x against a 3.75x maximum; interest coverage was 12.16x against a 3.25x minimum. Management expected to remain in compliance.
Notable changes and unusual items
- Commercial Solutions recorded $3.9 million of estimated contract settlement costs as it withdrew certain enterprise technology offerings to focus on higher-margin solutions.
- Comtech recorded $1.4 million of facility exit costs for consolidating its Tampa manufacturing facility into its Orlando facility.
- A favorable appellate ruling in a legacy TCS intellectual-property matter led to a $3.2 million benefit from reducing accrued legal costs.
- Comtech recorded $2.9 million of acquisition-plan expenses for the first six months and wrote off $3.2 million of deferred financing costs when replacing its prior credit facility.
- On February 28, 2019, after quarter-end, Comtech completed its Solacom acquisition, a provider of next-generation 911 solutions. Preliminary purchase price was $31.5 million: $25.9 million cash and $5.6 million in shares. The cash portion was funded principally with credit-facility borrowings.
Outlook, commentary, and risks
Management raised fiscal 2019 targets to net sales of $645–$660 million and Adjusted EBITDA of $85–$89 million, including a nominal Solacom contribution. Its diluted GAAP EPS target was $0.86–$0.98. Management expected third-quarter sales to approximate the second quarter, with operating income of about $9 million and Adjusted EBITDA of about $20 million; the fourth quarter was expected to be the fiscal-year peak for Adjusted EBITDA. It expected full-year operating margin to be similar to fiscal 2018’s 6.2%, and the adjusted effective tax rate to be about 23%.
Quarterly consolidated book-to-bill was 0.75 and backlog was $586.4 million. Management still targeted a full-year book-to-bill ratio of 1.0 and expected second-half bookings to improve, while noting that timing of large opportunities and government awards is difficult to predict. Fiscal 2019 guidance excludes potential revenue from the SeaPort-NxG IDIQ award and new MT-2025 orders. Government Solutions sales in each remaining quarter were expected below Q2 levels. Management anticipated lower consolidated gross margin for fiscal 2019 than in fiscal 2018, reflecting segment mix and growth in lower-margin HEIGHTS products.
- A TCS 911 software customer sought a refund of approximately $14.3 million through February 28, 2019, citing outages and alleged incomplete failover features. Comtech disputed the claim, had agreed to non-binding mediation, and had accrued no costs. The outcome could materially affect future results or cash flows.
- Comtech disclosed ongoing export-control reviews by OFAC and the Department of Commerce. It had not accrued potential penalties; sanctions or export violations could result in penalties and reputational harm.
- Other key risks include variable government funding and award timing, contract cost-estimate changes, customer concentration, acquisition integration and execution, interest-rate exposure, and possible goodwill or intangible-asset impairment. The filing reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether bookings recover from the quarter’s 0.75 book-to-bill and support management’s full-year targets.
- How the $3.9 million enterprise-contract settlement charge affects the repositioning’s future revenue and margins.
- Solacom’s integration, purchase-price finalization, financing impact, and contribution to results.
- Developments in the 911 customer dispute and export-control reviews, including any claims, accruals, or penalties.
- Cash generation, borrowing levels, covenant headroom, and the sustainability of dividends under the credit facility.
- Adjusted EBITDA is a company-defined non-GAAP measure; compare it with GAAP results and review the company’s stated adjustments.