Business context and reporting period
Comtech Telecommunications Corp. filed this Form 10-K for the fiscal year ended July 31, 2016. The requested fourth quarter ended on that date. The company provides communications technologies and services to commercial and government customers through Commercial Solutions and Government Solutions.
Comtech completed its acquisition of TeleCommunication Systems (TCS) on February 23, 2016. Fiscal 2016 includes about five months of TCS operations, so comparisons with prior years are not fully comparable. The acquisition’s preliminary purchase price was $340.4 million; stated enterprise value was approximately $423.6 million.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales | $411.0 million | $307.3 million |
| Gross profit / margin | $171.2 million / 41.7% | $138.9 million / 45.2% |
| Operating income (loss) | $(0.6) million | $34.1 million |
| Net income (loss) | $(7.7) million; $(0.46) per diluted share | $23.2 million; $1.42 per diluted share |
| Adjusted EBITDA, non-GAAP | $48.1 million | $51.8 million |
| Cash from operating activities | $15.0 million | $21.7 million |
Revenue rose 33.7%, primarily because of TCS, which contributed $151.4 million in sales after acquisition; lower sales from legacy Comtech products partly offset that contribution. Gross margin declined mainly from the acquired business and sales mix. Fiscal 2016 operating results included $21.3 million of acquisition-plan expenses; excluding those expenses, reported operating income would have been $20.7 million, or 5.0% of sales. Adjusted EBITDA fell despite the added TCS contribution, as legacy-business earnings declined.
| Fourth-quarter metric | FY2016 Q4 | FY2015 Q4 |
|---|---|---|
| Net sales | $152.4 million | $77.5 million |
| Gross profit / margin | $62.2 million / approximately 40.8% | $33.4 million / approximately 43.1% |
| Net income (loss) | $2.7 million | $5.5 million |
| Diluted EPS | $0.14 | $0.34 |
At July 31, 2016, cash and cash equivalents were $66.8 million, working capital was $119.5 million, total assets were $921.2 million, and stockholders’ equity was $470.4 million. Debt including capital leases was $258.6 million. The company reported $256.5 million of gross borrowings under its secured credit facility, before deferred financing costs; the facility matures February 23, 2021. Operating cash flow was $15.0 million; investing cash outflow was $286.2 million, including $280.5 million net cash paid for TCS; financing cash inflow was $187.1 million, including facility borrowings and a $95.0 million net equity-offering contribution.
Backlog was $484.0 million at fiscal year-end, versus $117.7 million a year earlier. Management said a significant portion was expected to convert to fiscal 2017 sales, while warning that orders may be changed or canceled.
Outlook, management commentary, and material risks
- Management expected significant year-over-year increases in fiscal 2017 sales, operating income, and Adjusted EBITDA. The outlook was not quantified and depended in part on orders from international customers and the U.S. government.
- Management expected fiscal 2017 gross margin percentage to be below fiscal 2016, citing acquisition-related mix and lower expected BFT-1 intellectual-property license revenue. It anticipated acquisition synergies of about $8 million at annual run rate over the next several quarters and $12 million in aggregate for fiscal 2018.
- Fourth-quarter bookings were strong across nearly all product lines; the quarterly book-to-bill ratio was 1.33. Management described the business as at a turning point and reported progress integrating TCS. Leadership changes announced in fiscal 2017 included the Chairman resuming the CEO and President roles and appointment of a Chief Operating Officer.
- Debt covenants require a maximum net leverage ratio of 2.75x Adjusted EBITDA by fiscal 2017 year-end. Management cautioned it might not meet the covenant even if expected results were achieved, and said it believed lender waivers could be obtained if necessary. Dividends remained subject to covenants and Board approval; the stated fiscal 2017 target was $1.20 per share, but the Board was reassessing the appropriate level.
- Key exposures include U.S. government funding and contract timing, international demand and customer financing, foreign exchange and geopolitical conditions, integration and synergy execution, fixed-price contract cost overruns, component availability, cybersecurity, and potential impairment of goodwill and intangibles. Goodwill was $287.6 million and net finite-lived intangibles were $284.7 million; the August 1, 2016 impairment test found no impairment, but the Commercial Solutions cushion was narrower under the income-only sensitivity analysis.
- Contingencies include TCS intellectual-property matters, for which a preliminary acquisition-date liability of $28.1 million was recorded; an AT&T dispute over 911 call-handling software, with a $7.2 million preliminary liability; and an unresolved OFAC review following disclosures concerning modem shipments ultimately routed to Sudan. The filing states that outcomes and potential penalties remain uncertain.
- Management reported effective internal control over financial reporting for the assessed operations, and the auditor issued an unqualified opinion. TCS, acquired during the year, was excluded from the internal-control assessment.
Important facts for investors to verify
- Whether TCS integration delivers the stated synergies and whether acquired-business margins support the fiscal 2017 outlook.
- Fiscal 2017 covenant compliance, debt repayment capacity, interest costs, and the sustainability of the targeted dividend.
- Conversion, timing, funding, and profitability of the $484.0 million backlog, including government and customer cancellation exposure.
- Final TCS purchase-price allocation and the resolution or revised valuation of intellectual-property and 911 software contingencies.
- Any OFAC determination, potential sanctions-related penalties, and the adequacy of export-compliance controls; also monitor goodwill and intangible-asset impairment assumptions.