Comtech Telecommunications Corp. — Q3 FY2016 Form 10-Q
Reporting period: Quarter and nine months ended April 30, 2016. The filing is unaudited. Comtech provides communications solutions to commercial and government customers. Comparisons with prior periods are affected by the February 23, 2016 acquisition of TeleCommunication Systems, Inc. (TCS), whose results are included only from the acquisition date.
Business context and acquisition
TCS expanded Comtech into public safety, enterprise applications and additional government solutions. The preliminary accounting purchase price was approximately $340.4 million, with enterprise value of approximately $423.6 million. Comtech reported about $66.0 million of TCS sales in the quarter and nine-month period. The purchase-price allocation remains preliminary, including estimates for taxes, intellectual-property contingencies and goodwill.
Beginning in Q3, Comtech reported Commercial Solutions and Government Solutions as its two operating segments.
Key financial metrics
| Metric | Three months ended April 30 | Nine months ended April 30 |
|---|---|---|
| Net sales | $124.2 million, up 73.5% from $71.6 million | $258.6 million, up 12.5% from $229.8 million |
| Gross profit / margin | $51.4 million / 41.4%, versus $32.3 million / 45.1% | $109.0 million / 42.2%, versus $105.5 million / 45.9% |
| Operating income (loss) | $(13.4) million, versus $7.2 million | $(8.0) million, versus $26.0 million |
| Net income (loss) | $(14.4) million, or $(0.89) per diluted share; prior-year income was $5.0 million, or $0.30 per diluted share | $(10.4) million, or $(0.65) per diluted share; prior-year income was $17.8 million, or $1.08 per diluted share |
| Adjusted EBITDA | $12.5 million, versus $11.6 million | $29.2 million, versus $39.8 million |
| Operating cash flow | Not separately presented for the quarter | $12.3 million, versus $7.7 million |
Adjusted EBITDA is a company-defined non-GAAP measure; Comtech cautions that its definition may not be comparable with similarly titled measures at other companies. Acquisition-plan expenses were $17.0 million in the quarter and $20.7 million year to date. Excluding those expenses, reported operating income would have been $3.6 million for the quarter and $12.7 million year to date; these figures are management’s adjustments, not GAAP results.
Liquidity and debt: Cash and cash equivalents were $69.1 million at April 30, down from $151.0 million at July 31, 2015. Current assets were $298.2 million and current liabilities $151.8 million. The company reported $342.5 million of secured credit-facility debt net of financing costs (approximately $348.8 million of borrowings before those costs), plus $8.7 million of capital lease obligations. The facility matures February 23, 2021; its blended current interest rate was approximately 5.0%. The $150 million revolver had $101.9 million drawn. The facility is secured by substantially all company and guarantor assets and includes financial and other covenants.
Cash used in investing activities was $283.6 million, primarily the $280.5 million net cash paid for TCS. Financing activities provided $189.5 million, including $351.9 million of borrowings and $134.1 million used to repay acquired debt. Cash dividends paid were $14.5 million. The quarterly dividend remained $0.30 per share; future dividends are subject to board approval and credit-facility restrictions.
Material changes versus prior periods
- Reported sales growth primarily reflects TCS; Comtech said lower sales of legacy products partly offset the acquisition contribution. The filing cautions that reported comparisons are not necessarily indicative of underlying trends.
- Gross margin fell in both comparison periods, mainly because TCS government solutions carried lower margins than Comtech’s legacy products and because large legacy over-the-horizon microwave contracts were nearing completion.
- Quarterly operating results were burdened by acquisition expenses and higher acquired-intangible amortization; nine-month adjusted EBITDA declined despite higher consolidated sales.
- International sales represented 22.9% of quarterly sales and 32.2% of nine-month sales, down from 50.6% and 57.8%, respectively, in the prior-year periods. U.S. government sales were 41.9% and 41.8% of sales, respectively.
Outlook, commentary and risks
- Management expected FY2016 consolidated revenue to exceed FY2015 revenue because of TCS, while legacy Comtech sales were expected to be lower than in FY2015. Comtech expected a FY2016 GAAP operating loss, but significant operating income excluding acquisition-plan expenses and positive operating cash flow.
- Management expected approximately $3.9 million of additional acquisition-plan expense in Q4, within an estimated total of about $48 million of transaction and merger-related expenditures. It projected an $8 million annual synergy run-rate over the next several quarters and $12 million of synergies in aggregate in the second year after closing.
- Management expected FY2017 GAAP net sales, operating income and operating cash flow to be significantly higher than FY2016, and estimated a FY2017 effective tax rate of approximately 37.5%. No specific revenue or earnings guidance range was provided.
- Q3 bookings were approximately $139.2 million, a 1.12 book-to-bill ratio. Management expected stronger bookings in Q4 and higher Q4 Adjusted EBITDA than in Q3.
- Risks include successful integration and realization of TCS synergies, customer and employee retention, government budget and funding uncertainty, contract timing and cost estimates, international market and currency conditions, debt service and covenant compliance, and potential impairment of substantial goodwill and intangible assets.
- TCS-related intellectual-property and contract matters were accrued at $4.5 million, but losses and legal costs could exceed estimates and potentially materially affect results or cash flows. Tax audits and uncertain tax positions are also disclosed. Separately, Comtech reported an OFAC inquiry following voluntarily disclosed transactions involving modems ultimately associated with Sudan; the outcome and any penalties were uncertain.
- Management stated disclosure controls were effective. Integration of TCS into internal-control processes was continuing.
Important facts for investors to verify
- Whether TCS integration achieves the projected cost savings and revenue contribution, and how the final purchase-price allocation changes goodwill, intangibles and amortization.
- Whether legacy product demand stabilizes, large over-the-horizon microwave contracts conclude as expected, and government bookings convert to funded orders and revenue.
- Debt repayment capacity, revolver availability, covenant headroom, floating-rate exposure and the sustainability of the dividend.
- Developments in TCS intellectual-property and contract disputes, including whether the $4.5 million accrual remains adequate, and the outcome of the OFAC review and tax audits.
- Potential goodwill impairment, particularly at the next annual test scheduled for August 1, 2016, and any material changes to the preliminary acquisition estimates.