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Comtech Telecommunications Corp. (CMTL)

Q3 2020 Earnings Call· Wed, Jun 3, 2020

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Transcript

Operator

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Comtech Telecommunications Corp. Third Quarter Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, June 3, 2020. I would now like to turn the conference over to Mr. Jason DiLorenzo of Comtech Telecommunications. Please go ahead, sir.

Jason DiLorenzo

Analyst

Thank you. Welcome to the Comtech Telecommunications Corp. conference call for the third quarter of fiscal year 2020. With us on the call today are Fred Kornberg, Chief Executive Officer and Chairman of the Board of Comtech; Michael D. Porcelain, President and Chief Operating Officer; and Michael Bondi, Chief Financial Officer. Before we proceed, I need to remind you of the company’s Safe Harbor language. Certain information presented on this call will include, but not be limited to, information relating to the future performance and financial condition of the company, the company’s plans, objectives and business outlook and the plans, objectives and business outlook of the company’s management. The company’s assumptions regarding such performance, business outlook and plans are forward-looking in nature and involve significant risks and uncertainties. Actual results could differ materially from such forward-looking information. Any forward-looking statements are qualified in their entirety by cautionary statements contained in the company’s Securities and Exchange Commission filings. I am pleased now to introduce the Chief Executive Officer and Chairman of the Board of Comtech, Fred Kornberg. Fred?

Fred Kornberg

Analyst

Thank you, Jason, and good afternoon everyone, and thank you for joining us on this call. Let me start this call by saying a few words about the COVID-19 pandemic. As you would expect, our top priority in dealing with the pandemic has been to protect the health and safety of our employees, suppliers, customers, and partners. Also, I hope that everyone that is listening to this call is healthy and staying safe. No doubt, the current quarter was challenging and you could say it was a surprise to us on how difficult the quarter turned out to be. The last time we spoke was on March 4, 2020. We discussed the modest effect on our Q2 performance due to the coronavirus situation, but we felt we had a strong pipeline and that the situation from what we thought we saw was temporary. Well, we were wrong. One week later, on March 11, the coronavirus situation was characterized by the World Health Organization as a pandemic. Thereafter, there was a sudden and unexpected deterioration in business conditions caused by COVID-19 throughout the world. On March 31, just 20 days later, we went through our fiscal 2020 guidance. Although, I could never have imagined what has occurred over the past few months, it had, and we saw how our Comtech employees would rise quickly to the challenge. I have never been prouder of our employees for their dedication and commitment to our customers and to our company. I’m also exceedingly grateful for the trust our customers continue to place on Comtech’s leading industry technology and expertise. And as you will hear about in this call, I remain enthusiastic about our business. Despite our Q3 performance occurring through the worst part of the pandemic crisis, we stayed focused, we generated a positive…

Michael Bondi

Analyst

Thank you, Fred. Our net sales for the third quarter of fiscal 2020 were $135.1 million. From a geographic perspective, net sales in the third quarter to U.S.-based customers were 75.7% of total net sales, with 24.3% to international customers. Bookings during the third quarter were $137.5 million and our consolidated book-to-bill ratio was 1.02. We finished Q3 with backlog of $640.7 million, and when you factor in the total unfunded value of some multiyear contracts that we have received and which we expect future funding, we have visibility into approximately $1 billion worth of total potential future revenue. Our gross profit percentage in Q3 was 39.2%. GAAP SG&A expense in Q3 was $32.3 million or 23.9% of consolidated net sales. Turning to research and development expense. We spent $12.3 million in the third quarter or 9.1% of consolidated net sales. Of this amount, $10.8 million was spent in our Commercial Solutions segment and $1.4 million was spent in our Government Solutions segment, with the remainder representing amortization of stock-based compensation. Total stock-based compensation expense was $1 million for the quarter. Q3 amortization of intangibles of $5.5 million reflects a full quarter of amortization related to our January 2020 acquisition of CGC. For fiscal 2020, we are expecting amortization to approximate $22 million. Such amount does not include the impact of the pending UHP or Gilat acquisitions. Our consolidated GAAP operating loss for the third quarter of fiscal 2020 was $3.1 million. Our GAAP operating costs include $6 million of acquisition expenses – acquisition plan expenses and $0.5 million of estimated contract settlement costs. Excluding these costs, our consolidated operating income would have been $3.3 million or 2.5% of consolidated net sales. Our adjusted EBITDA was $12.5 million or 9.2% of consolidated net sales for the third quarter. On a…

Michael D. Porcelain

Analyst

Thanks. As Fred stated, COVID-19 was present right from the start of our third quarter. And as a result, we experienced significant order delays, lower sales and implemented a variety of cost-saving measures. Let me give you some detailed color by segment and product line of what is happening. Our Commercial Solutions segment achieved a book-to-bill ratio of 0.73 or bookings of $57.4 million. Net sales in this segment were $78.3 million this quarter compared to $89.6 million last year, a decrease of 12.6%. Here, you can see that our satellite ground station technology product line which has historically required significant in-person meetings to generate new business and finalized sales orders has been most impacted by restrictions on business travel. With our recent deployment of new video sales channel methods and the partial resumption of business activities in some places around the world, we believe this product line has started to slowly recover as we enter Q4. Importantly, we have been awarded multiple satellite ground station technology solution contracts to support several U.S. Department of Defense end customers, and we have received initial funding for these critical projects that we expect will generate revenues for 2021 and for several years beyond. Although our U.S. government business was always important, given the increased uncertainty of the international business and commercial markets right now, it is even more so. Here, we are well positioned and recently announced two contracts. First, we announced a $1.7 million order for engineering services to support the Data Link Modernization or DLM contract by providing new advanced Satcom systems for the U.S. Army’s Gray Eagle Unmanned Aircraft System. Under the development and prototype phase, we will provide advanced engineering services, including porting of waveforms to the prime’s airborne and ground-based satellite modems and supporting the stringent Army…

Fred Kornberg

Analyst

Thanks, Mike. As I mentioned previously, in these unprecedented times, we are very pleased with how we are performing. We have an extremely dedicated and talented workforce, and I’m confident that our current approach will support sustained growth for years to come. We have a strong, diversified customer base, selling to government customers and commercial customers, and having a good business mix and a diversified product line has protected Comtech in the past, and we believe it is a significant source of strength today. We remain determined to extend our market-leading positions and are firmly focused to achieve growth in fiscal 2021, as market conditions approve. Given our business outlook, our Board of Directors declared a dividend once more for the third quarter of fiscal 2020 of $0.10 per common share, payable on August 14, 2020 to shareholders of record at the close of business on July 15, 2020. We still continue to believe our dividend program is a great way to return capital to our shareholders as we grow our business over the long term. Now I’d like to proceed to the question-and-answer part of our conference. Operator?

Operator

Operator

[Operator Instructions] We will take a question from Joe Gomes from NOBLE Capital. Please go ahead.

Joe Gomes

Analyst

Good afternoon. Thanks for taking my question. On the…

Fred Kornberg

Analyst

Hi, Joe. How are you?

Joe Gomes

Analyst

Good. We’re doing well here. Hope you guys are doing the same. Quick question on the Next Generation 911. Last quarter, you mentioned and also this one that you’re in negotiations for some large multiyear orders, and I know as part of the NG911, Inc. acquisition, you received a $15 million order from Northern Illinois. Is that one of the contracts that you’re talking about? Are you talking about additional ones to that one also, as there’s even a bigger target market out there that we’re looking to get some awards from?

Fred Kornberg

Analyst

Yes. So, that’s a good question, Joe. That’s not the contracts that we’re referring to. There’s a number of contracts that are very near to finalization. A couple of them are certainly multi-million – double-digit millions and the high double multi-million-dollar number range. I can even tell you that during the quarter, with the coronavirus we had folks running around one state in the car getting signatures, and that’s how close it is to being finalized. So, we feel pretty good that things are going to get finalized, but we need to get all the paperwork done and announce the contract soon.

Joe Gomes

Analyst

Okay. Great. That sounds fantastic. And on the COMET, again, you got the Marines, the one, and now you’re talking about that the special ops have ordered – placed an order. But last year, we had lost the Army contract. Does this potentially give you the opportunity to go back there and maybe get some other Army business also?

Fred Kornberg

Analyst

I guess, I’ll answer that one. The COMET is really a, what you could call a thin line tropo terminal. It’s extremely small. It’s extremely low power, but very, very employable in special ops operations. So, it’s a special – it’s really a special product line. That – notwithstanding that, it is almost equivalent to the large tropo systems that we have supplied in the past. So, to answer your question, yes, I certainly believe that the COMET will effectively be used by the Army, as they see the performance that we will show – we actually demonstrated it to them and that we will show in actual field operations.

Joe Gomes

Analyst

That’s good news. And one last one for me, and I’ll jump back in the line. Again, last quarter, you guys had talked about, especially in the satellite stations that you couldn’t get into offices and no one was there to receive product, et cetera, but it still sounds like there’s some of that going on. But you’ve been releasing a fair number of awards lately in your press releases. I mean, how close to normal would you think we are to business at this point in time?

Michael D. Porcelain

Analyst

I think it’s just starting, I guess, is the reopening is the way I would characterize it. Earlier in the quarter, we started to see some increased activity with China, and China opened up first around the world. But there are many places around the world that are not placing orders right now. There are customers that are still opposed, but at the same time, we are seeing a pickup in activity. And that’s what we’re seeing. And I guess, I would say it’s a slow, and I’d like to think we’re in the early stages of that. I can’t tell you right now, is it going to be a V recovery for us or U or an L, it’s difficult for us to say that at this point. But the one comment that I think we feel pretty strongly about is, given the markets that we have strength in the 5G, the cellular backhaul market and the types of end applications that we sell, we do think that there’s a tremendous need for them and, let’s say, other markets, they should come back relatively quickly.

Joe Gomes

Analyst

Great. Thanks for taking the questions.

Operator

Operator

We will take a question from Chris Quilty from Quilty Analytics. Please go ahead.

Chris Quilty

Analyst

Hi, guys. Just wanted to follow up on that COMET product line. Was that a cost development – internal development product line or do you have any customer funding from it?

Fred Kornberg

Analyst

No. It’s been totally developed by Comtech clients. Taken us a couple of years, but we actually demonstrated it to the Army and to the Marines just in the past few months.

Chris Quilty

Analyst

And is there a separate contract vehicle that might be available for that product line or since it’s something entirely new, do we prospectively have to go through some kind of a long contracting and specification period or can it just be tagged on?

Fred Kornberg

Analyst

I think we’re dealing at the moment with the special forces, obviously. But I think both the Marines and the Army have expressed interest in actually getting, I guess, an ordering number to be a large program for the Army.

Michael D. Porcelain

Analyst

Chris, importantly and not to deemphasize this point. Right now, there is a -- we think, a very big market with the special operations command. And I think you know that they have ways to do business. Our initial orders that we’re getting is through rapid acquisition modes, through all other companies that have contracts, that allow for quick turn communication equipment to be purchased. So, we’re not seeing an obstacle, I guess is the main point here. There’s not an obstacle of not having a contract vehicle out there. There’s ways that the government can procure this and they’re doing so and we’re talking to them about more orders.

Chris Quilty

Analyst

Great. And one other tropo-related question. Are you seeing any kind of a slowdown with your international customers, given the fact that, I believe, some or many of those customers are dependent upon energy markets for funding a lot of their defense expenditures?

Fred Kornberg

Analyst

Certainly, the international market is very, very similar to the satellite international market. We are seeing delays. We – as Mike mentioned and as I mentioned, these are usually contracts that get placed with personal face-to-face meetings and negotiations. So, I think it’s very, very similar to the satellite area.

Michael D. Porcelain

Analyst

And it would Chris to be – it would be a mistake to use oil, as the reason, the lower oil prices here to be the cause of these delays. But we think that these delays are strictly related to the coronavirus and the markets that we’re serving. Most of our end customers are not in the oil-producing side of the business. There’s other companies out there that sell a lot of their equipment into it. We don’t. Our key customers are in the mobile network operations space. So again, the over-the-horizon business that we previously sold to Algeria, we’re in between phases of a contract. So, it’s not – oil is not driving any of the delays for us at the moment.

Chris Quilty

Analyst

Got you. And a question on the Heights product line. I mean, given everything going on, I don’t know that we should expect any developments around that product line, but any commentary on customer acceptance, either on the historic product. I forget the name of the new lower-cost version?

Michael D. Porcelain

Analyst

Yes. Chris, you are referring to the Heights Pico line, but I think it’s kind of lumped into the slowdown that we’re seeing. I think one of the things that we are hearing from our sales team is that it’s allowing customers to test the product a lot more. So that is what’s happening is this – a lot of the folks that instead of actively rolling out networks, they’re spending much more time testing it, which ultimately will bode good if those tests go good. So again, I don’t think there’s anything – we have nothing big to announce right now on the Heights stuff, but the opportunities are still there, and they’re just waiting for things to improve.

Chris Quilty

Analyst

Switching gears over to the NG911 area. Lots of government money being thrown around. Are there any specific government grants or outlays or whatnot that you can identify that might benefit your customers’ ability to either expand or accelerate their purchasing decisions?

Michael D. Porcelain

Analyst

I guess, I would say there’s a yes and no. Many of the projects that we’re talking with our end customers, there’s this 911 charms that already appears on everybody’s phone bill. So there is some 911 money. On the other hand, we do recognize that some of the states that are out there are now have budget constraints. They spent a lot of money on coronavirus, they’re having some reductions of state income tax revenue. So, we’re cognizant of that. I think when we sit back and the feedback we’re hearing from our customers is there’s going to be most likely a federal infrastructure budget that will be passed, and they’ll have access to spend on equipment and upgrades and things that will boost the local economy. So if anything – if an infrastructure bill is passed, it will help solidify some things that are out there and also potentially get things moving faster. Upgrading 911 equipment definitely increases employment, definitely provides a tangible benefit to the citizens. And I think most – everyone has – continues to go through this pandemic and realize how important 911 system is, and if anything, we think big picture, it’s going to drive more money to the market.

Chris Quilty

Analyst

Understand. And final question, you mentioned some cost-cutting initiatives. Can you help quantify perhaps where they fall, either by government or commercial or just from a P&L perspective, were these folks out of sales and marketing? Or was it more heavily on production side or evenly split across the board?

Michael D. Porcelain

Analyst

I would say it’s more broad-based. I mean, obviously, as Fred and I both discussed, our satellite earth station product line bore the brunt of the coronavirus. So you could assume that a higher percentage was in that group, but we don’t want to get into specifics. Doing cost reductions during this time is not easy and it wasn’t a fun activity to do, but it was pretty broad-based.

Chris Quilty

Analyst

Understand. Thank you, gentlemen.

Operator

Operator

We will take a question from Mike Latimore from Northland Capital. Please go ahead. Your line is open.

Mike Latimore

Analyst

Yes. Great. Thank you. On the 911 or NG911, Inc. acquisition, can you just talk a little bit about the assets you’re acquiring there? Is it – what technology, what sort of services are you getting there?

Michael D. Porcelain

Analyst

Yes. The NG911 as we mentioned in the prepared remarks is really was a small distributor with local know-how. And local know-how means who do you know and how do you get stuff done in the town. And it also means where do you do the installations and what kind of the local system. So a lot of it was intangibles rather than hard technology or hard equipment. And that’s why it was, I would say, a very nominal investment for us to make, which really resulted in those $15 million contract awards that we subsequently received.

Mike Latimore

Analyst

Got it. And then I think during the quarter, you closed some of your – like your Santa Clara facility for a few weeks. I guess, is everything back up and running? And then what kind of, I don’t know, revenue effect does that have on the quarter?

Michael D. Porcelain

Analyst

Yes. I mean, it definitely did. We – from both of production side and in order side. But we were – when the Santa Clara announcement, I think, came out, that was one of the first counties in the United States to issue any sort of shutdown mode. And eventually, shortly thereafter, I think, about a week later, the U.S. Department of Defense issued this essential definition company and that sort of overrode some of these local ordinances. So I would say we lost a couple of weeks of production, really. Almost all of our facilities are impacted by the coronavirus in some way, shape or form. We were implementing self-quarantine, not self-quarantine, we’re separating people, doing social distancing, as we best can implement them at the facility. But I think also at the same time, since order flow is suppressed at the moment, we’ve been able to accommodate that lower order flow, and we’re not operating at full capacity. That is certainly the case.

Mike Latimore

Analyst

Okay, clear. And then you talked a little bit about, I think, some pushouts in orders from the U.S. government, I believe, but the demand is there, the pipeline is there. I mean, are you expecting a little bit more of a fiscal year-end spike in kind of federal spending this year, at least on the projects you’re looking at?

Michael D. Porcelain

Analyst

Yes. In the short-term, yes, some of the government bases that we do work on have actually made public announcements that they’re not letting folks on the grounds until at least July 1. So again, there’s an inability to do certain field support and services that we normally would do. So we definitely saw delays there. But it’s going to get shifted to the right. And so some of that stuff is in backlog already. We can’t do. Some of the stuff is – government has money. It’s not a question of money. And at the end of the day, the government doesn’t like to lose funded money. So, what they’re trying to figure out is the logistics behind how to do the work in every state and every county has its own rules and regulations. And we’re working through that with the customer. But in short, yes, we do expect to receive some nice orders in Q4 of this year, and we’re expecting to do some deliveries in Q4 as well as continuing that in 2021.

Mike Latimore

Analyst

Got it. And then I guess just last one. It seems like there’s been a lot more just text messaging activity, given people staying at home, communicating more. Has that had any influence on some of your kind of messaging business?

Michael D. Porcelain

Analyst

Yes. No doubt. Like I said, we had – the messaging that we’ve been processing on our system is twice than what is normal. And right down in there, there’s some revenue opportunities for us, that I would categorize in the millions and very high-margin type work. But in connection with the FCC’s Keep America connected pledge, we decided that we didn’t want to pass on cost to our cell phone mobile network operators who were not passing cost on to the end user, trying to make sure that people had this very critical capability. Now, I think what’s happening is you start to see these reopenings and some people work at home, some people come back to the office. That number will probably drop at some point. But I think most importantly, there’s going to be increased messaging, and there’s going to be an opportunity for us to get incremental revenue from these customers. And most importantly, I think – and it’s something that I’ve always felt that text messaging is not a dead technology. It’s a critical piece of the network infrastructure. It’s going to be needed around, and it certainly proved its worth during this crisis. And I guess, I don’t think it’s going anywhere for a long time.

Mike Latimore

Analyst

Great. Thanks a lot.

Operator

Operator

We will take a question from Chris Sakai from Singular Research. Please go ahead. Your line is open.

Chris Sakai

Analyst

Hi, everyone. Just had a question. I know you mentioned that the states are running into some budgetary issues. Has that affected you guys at all? I mean, how have you dealt with that?

Michael D. Porcelain

Analyst

I joke, we drove around the county in a particular state to try to get some signatures. So funding, obviously, the states need to provide funding to do 911 services. So, it’s a part of getting an order. We have seen some delays. We don’t have those orders at the moment. That’s why we haven’t announced them. And hopefully, those states will deal with their funding issues and allocate their budgets and move forward with the projects in the short term. These projects, Chris, are safety orientated. So I think as you’re seeing states sort of wind down the mobilization of hospitals, the purchasing of these masks for healthcare responders and so forth, I think you’ll see a shifting of money back to the 911 space to try to get the networks and computers ready for the next wave.

Chris Sakai

Analyst

Okay, great. And then I don’t know if you can shed some light on this. But – so for the Commercial Solutions segment, your – the book-to-bill ratio was 0.73. Just was wondering, in the current quarter, can you guys give an idea or in the ballpark, where this book-to-bill ratio might land?

Michael D. Porcelain

Analyst

For Q4, we think it’s going to be higher. Our satellite earth station business, we’d like to get it back to 1.0 on a trailing 12 months. We think it’s a growth business market for us, given the cellular backhaul requirements that mobile network operators have. So this is a business that the book-to-bill, we would like to believe is 103, 105 on a short-term basis. So that’s kind of where we like to go. But obviously, given the coronavirus, just things just didn’t happen in Q3. So, the best I can say is, we think it’s going to be higher than it currently was in Q3.

Chris Sakai

Analyst

Okay, all right. Well, thanks for that. Yes.

Michael D. Porcelain

Analyst

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Operator

Operator

And we do not have any further questions at this time. I will turn it back over to the speakers.

Fred Kornberg

Analyst

Well, thank you again for joining us today. And we certainly look forward to speaking with you again in the call to discuss our full-year fiscal 2020 results. Thank you very much.

Operator

Operator

This concludes today’s program. Thank you for your participation. You may disconnect at any time.