Comtech Telecommunications Corp /De/ Q3 FY2024 Earnings Call

Welcome to Comtech's Fiscal Third Quarter 2024 Earnings Conference Call. As a reminder, this conference is being recorded today, Tuesday, June 18, 2024. I would now like to turn the conference over to Mrs. Maria Ceriello of Comtech. Please go ahead, Maria.

Thank you, operator, and thanks to our investors for taking the time to dial in today. Welcome to Comtech Telecommunications Corp.'s conference call for the third quarter of fiscal year 2024. Today, I'm here with Comtech's Chief Executive Officer, John Ratigan. We're also joined today by Mike Bondi, Comtech's CFO. Before we get started today, please note we have a detailed discussion of the quarter in our shareholder letter available on our website. Certain information presented in 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 always 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 SEC filings. Now I'm pleased to introduce Comtech's CEO, John Ratigan. John?

Thank you, Maria. And as you know, I'm relatively new to the role of CEO of Comtech, but I feel that I'm already making a positive difference. Last quarter, during our earnings call, I said that it was clear to me that the foremost concern of all our stakeholders, and certainly our shareholders, was refinancing our balance sheet. I also said that executing a refinancing would be my highest priority. As I'm certain you all saw, we announced the completion of a $222 million refinancing that replaces our bank facility with a new credit facility consisting of a $60 million asset-based lending facility and a $162 million term loan that matures in 2028. The completion of the refinancing is important for Comtech in many ways. First, our balance sheet is stronger and can support the improved performance and growth of our business as we look ahead. We can now conduct our business without the distraction associated with looming debt maturity, which all our stakeholders will benefit from. Our customers, our vendors, and our people are all excited to move forward unencumbered by reservations about liquidity. It also means that my top operational priority is now the acceleration of our cash conversion cycle and managing our unbilled receivables downward by executing against some of our large multiyear contracts. This quarter, we made progress in delivering against our next-generation troposcatter awards with the U.S. Marine Corps and the U.S. Army. With the refinancing completed, the Comtech team is now totally and wholly focused on accelerating execution against these contracts to deliver value to both our shareholders and our customers. This leads me to my second key point. Comtech hasn't been waiting to move forward. We have been winning business this entire time, demonstrating the strength of our technologies and the mission-critical nature of our solutions. I'll give you the most recent obvious example. Following a competitive process on May 16, the Commonwealth of Massachusetts voted to award Comtech a five-year contract with a five-year extension option for the operations and maintenance of their statewide next-generation 911 Public Safety system. The initial value of this contract is in excess of $140 million, with additional upside potential over the 10-year life of the agreement. These wins, combined with our recent $48 million contract extension with the State of Washington, demonstrate the competitive advantage of our people and our technology. Within our Satellite and Space Communications segment, the Comtech team continues to deliver against the next-generation troposcatter awards with the U.S. Marine Corps and the U.S. Army. In addition to completing work against existing contracts, Comtech continues to expand its relationship with the U.S. Army with a recent $13.5 million award for VSAT equipment and related services. This leads me to a higher-level point that I made both publicly and in my direct conversations with investors, and that I want to emphasize here today. Comtech has a long-standing history of providing mission-critical communication solutions to its customers. In this country, for example, it's easy to take a 911 call for granted. But ensuring those calls yield the public safety results they should is an extraordinarily complex problem, and Comtech is at the forefront of the technology that solves it. We play a similar critical role in Satellite and Space markets, providing communications infrastructure that ensures people, businesses, and governments can connect anywhere on earth under any conditions. This mission-critical role and capability is what I want our investors to remember and hope the markets reconsider. The fact is that our ability to develop and deliver superior technology remains fully intact, and Comtech's underlying value as one of just a few businesses in the world that can do what we do remains unchanged. So what has changed? First, we now move ahead with committed financing and a strengthened balance sheet. Second, we can more successfully leverage two underlying businesses that each see growing demand from traditional buyers due to upgrade cycles in Public Safety and Satellite and Space Communications and from opportunities in new end markets. Mike will speak in detail about this quarter's financial performance in a moment. Before I make that hand-off, I do want to make one other point to our shareholders. It says something very positive about our business and our company that we continue to be able to attract exceptional talent. You may have seen these announcements or read our newsletters, but it's meaningful to the capital markets as well that we have done the following: announced Jeff Robertson's appointment as President of our Terrestrial and Wireless business back in April. And it's safe to say that he's hit the ground running. Jeff is a known leader and expert in the 911 and Public Safety space. Even as he and his team have secured the contract win with Massachusetts, he's moving fast to both improve our existing operations and grow into new opportunities. We hired two other senior public safety officials, Tom Guthrie and John Whitehead. And on the Satellite and Space side, we added Roly Rigual as Vice President of Business Development and Sales. Roly is well-known across the industry for his expertise and ability to drive growth, both in terms of top-line sales and also in terms of building teams. I wrote this in our investor letter and will repeat it here. I don't think Comtech has ever had a deeper and stronger bench than it does today. Comtech is a good business that offers mission-critical solutions to the world's most demanding customers. We've got some of the best people and technologies in the market, and the markets we are selling into are themselves growing. Taken together, I remain optimistic about our future and our ability to create value for all our stakeholders. I'm going to turn it over to Mike Bondi now.

Thanks, John. Before discussing our recent results for Q3, let me first cover the status of our refinancing efforts. Last night, we were very pleased to announce that we entered into a new $222 million credit facility with a new syndicate of lenders, which replaces our prior credit facility and which is expected to be funded today, June 18. With July 31, 2028 as its maturity date, we have significantly pushed out our repayment obligations by about four years. By adding an asset-based revolver component to the facility, we have immediately enhanced our liquidity. As a result of entering this new credit facility, we are able to once again reclassify a major portion of our outstanding debt back to its long-term status. The new credit facility consists of a committed $162 million term loan facility and a $60 million revolver loan facility, backed by our eligible receivables and inventory. Outstanding borrowings at close approximate $187 million, reflecting $25 million drawn on the revolver. At close, our available sources of liquidity approximate $63 million, consisting of qualified cash and cash equivalents and excess availability under the revolver, both as defined under the credit agreement of approximately $28 million and $35 million, respectively. Interest on the term loan facility currently approximates SOFR plus 9.5%, whereas interest on the asset-based revolver currently approximates SOFR plus 5%. Blended, the rate currently approximates 14%. Interest on the term loan is dependent on a pricing grid based on our net leverage ratio, and interest on the revolver is dependent on a pricing grid based on our average revolver usage, both as defined in the agreement. Our first covenant testing period is July 31, 2024. At such date, our maximum net leverage ratio is set at 3.25 times trailing 12 months EBITDA. As for the minimum fixed charge coverage ratio, that is initially set at 1.2 times. The first step-down in the net leverage ratio to 3.15 occurs on July 31, 2025. And the first uptick in our fixed charge coverage ratio to 1.25 occurs on April 30, 2025. Other financial covenants we need to maintain include an initial minimum trailing 12-month EBITDA of $35 million starting in October of 2025 and a minimum average liquidity of $20 million. In connection with entering into the new credit facility, we exchanged our Series B convertible preferred shares for a new series of B-1 convertible preferred shares. The new Series B-1 convertible preferred shares reflect certain changes to consent rights and existing put rights related to payments upon a change of control following specified asset sales, in each case consistent with the terms of the new credit facility. The powers, preferences, and rights of the Series B-1 convertible preferred stock are substantially the same as those of the Series B. We do not receive any cash proceeds from the issuance of the Series B-1 shares, and importantly, as I'm sure some might ask, the preferred holders' conversion price and interest rate did not change. Now the documents themselves are lengthy, so I'm not going to run down each and every term in the agreement. I just covered a good amount of ground on the key terms and strongly urge investors to read these documents, which are being filed in the Form 8-K with the SEC today. Entering into the new credit facility was a key milestone not only for our company but for our customers, our vendors, and our dedicated employees who got this over the finish line. We are very pleased to have finally resolved a significant overhang on our business and expect the new credit facility to contribute significantly to enhancing our liquidity and business prospects. With this refinancing now in the rearview mirror, we can get back to the tasks at hand of growing our business, liquidating our unbilled receivables, and increasing value for our shareholders. Now let's talk about Q3 results. Consolidated net sales were $128.1 million, compared to $134.2 million in the second quarter of fiscal 2024 and $136.3 million in the third quarter of fiscal '23. Net sales during our third quarter of fiscal 2024, primarily in our Satellite and Space Communications segment, continue to reflect challenging business conditions stemming principally from our efforts during the quarter to refinance our prior credit facility, which temporarily slowed down our receipt of components from suppliers and our ability to deliver finished products during the quarter. While we have made significant progress towards resolving such conditions by entering into our new credit facility, net sales related to certain orders in our backlog shifted to future periods. Also, as an important reminder, net sales in our Satellite and Space Communications segment for our third quarter reflect the absence of PST, which was divested on November 7, 2023. For the three months ended April 30, 2024, net sales in our Satellite and Space Communications segment primarily reflect higher net sales of our troposcatter solutions to U.S. government and customers, including progress toward delivering next-generation troposcatter terminals to both the U.S. Marine Corps and U.S. Army, more than offset by lower net sales of high-power solid-state amplifiers related to the PST divestiture, COMET tropo terminals to an international customer, and VSAT SATCOM equipment for the U.S. Army. Our book-to-bill ratio and measures defined as bookings divided by net sales in this segment for the three months ended April 30, 2024 was 0.85 times. During the third quarter of fiscal 2024, this segment was awarded over $13.5 million of funded orders from the U.S. Army for VSAT equipment and related services, over $6 million of funding from the U.S. Army for cyber training-related solutions, over $5.5 million in operational support and maintenance orders from the Japan Aerospace Exploration Agency, over $5 million of funding from a Canadian customer to upgrade a previously deployed troposcatter system, as well as an order from an international military that is evaluating our COMET troposcatter solutions. We believe that this new international customer, along with the two other new international customers that placed orders in our second quarter of fiscal 2024 to evaluate our next-generation modular transportable transmission systems, could lead to larger scale tropo opportunities in the future. As for our Terrestrial and Wireless Network segment, compared to the comparable period of the prior year, Q3 fiscal 2024 reflects higher net sales of our NG-911 and call handling services, offset in part by lower net sales of our location-based solutions. Our book-to-bill ratio in this segment for the three months ended April 30, 2024 was 0.72 times. Key bookings include a multiyear extension for critical NG-911 services for a large county in a Midwestern state valued at over $10 million and an extension of our short messaging service software engineering services to a large international mobile network operator valued at over $7 million, and a multiyear NG-911 call handling services contract aggregating $4 million for PSAPs located in Canada. Additionally, as John referenced before, subsequent to our quarter-end, we entered into a contract with the Commonwealth of Massachusetts for the continued operation and maintenance of the state's NG-911 system. This new contract has an initial five-year term from August 1, 2024 through July 31, 2029, and includes one option to renew for a five-year period through July 31, 2034. Including the option period, the total contract value could potentially exceed $250 million. We are very honored to have been selected again to be a trusted solutions provider to the Commonwealth. This competitive win serves to highlight the strong value proposition of our critical communications infrastructure services and significantly enhances our revenue visibility into the future. Gross margins for the quarter were 30.4%, compared to 32.2% in our second quarter of fiscal 2024 and 31.7% in the third quarter of fiscal 2023. We reported a GAAP operating loss in Q3 fiscal 2024 of $3.5 million, compared to an operating loss of $5.3 million in Q3 of fiscal 2023. While both quarters included restructuring charges, GAAP operating loss in the more recent quarter includes $2.5 million of CEO transition costs. As explained in more detail and reconciled in our Form 10-Q for the quarter, we utilize a non-GAAP measure that we refer to as adjusted EBITDA. For Q3 fiscal 2024, adjusted EBITDA was $11.9 million or 9.3% of related net sales, as compared to $12.5 million or 9.2% that we achieved in Q3 of fiscal 2023. The decrease in adjusted EBITDA in dollars reflects lower research and development expenses in both of our reportable operating segments, more than offset by lower consolidated net sales and lower consolidated gross profit both in dollars and as a percentage of consolidated net sales, and higher unallocated SG&A expenses due to our One Comtech and people strategies initiatives. As we enter the fourth quarter of fiscal 2024, business conditions continue to be challenging and the operating environment is largely unpredictable. In light of these business conditions and resulting challenges, while we are pleased to have successfully closed on our refinancing of the prior credit facility, we do anticipate variability from time to time as we move through our One Comtech transformation and are targeting net sales and adjusted EBITDA for our fourth quarter of fiscal 2024 to be similar to our third quarter of fiscal 2024. Such expectation considers our strong backlog of $653.4 million as of April 30, 2024, our revenue visibility of approximately $1.5 billion, and the timing of our refinancing of the prior credit facility today being so close to our fiscal year-end. Now let me turn the call back over to John.

Thanks, Mike, and thanks again to those of you who dialed in today. To recap, our balance sheet is strong. We have made excellent additions to our leadership team. Our people, technology, and equipment are best-in-class, evidenced by our continuing success in winning new business. As I said, my top near-term priority is ensuring that we manage our unbilled receivables downward, improving our cash conversion cycle. There's a lot ahead of us to look forward to, and we're exiting the quarter with significant positive momentum. Some of what's to come is challenging, but I remain confident, and we'll get to where we need to be. I'm excited to lead Comtech forward at this moment in time, and I expect it won't be long before the markets come to appreciate and properly value our business. In closing, I would like to thank our dedicated employees, customers, and suppliers for their continued commitment to Comtech. Thank you very much.

We'll take our first question from Joe Gomes with Noble Capital. Please go ahead.

Good morning, John and Mike, congrats on the refinancing. A couple of quick questions on the refinancing, just during the call scanning the 8-K. And I was wondering, you said with a new group. Did White Hat, Magnetar, did they contribute any additional funds over and above what they had done previously? Also saw there's about 1.4 million warrants that were attached to the deal. I was wondering who those warrants went to. And you gave us a kind of a blended 14% rate, if you could just remind us how that compares to what it was under the old facility.

Sure. There's a lot to cover here, but please remind me if I miss anything. Regarding the warrants, they were allocated to the lenders as part of the deal, not to Magnetar or White Hat. Magnetar and White Hat did not contribute any new cash to their investment, but they were very supportive throughout the process. Currently, our rate is about 10% lower than what it was under the old agreement, reflecting the terms of the deal we are finalizing.

Thank you for the clarification. You mentioned the challenges with the supply chain and completing products, which has delayed some revenue. I'm trying to understand how long it will take to resolve these supply chain issues and return to a normalized rate.

Yes. So as you might imagine, going through the period we went through where our liquidity was low, we weren't able to get everything to the suppliers that we needed. They weren't able to supply equipment and certainly pushed things to the right. We are hopeful that within a three-month time frame, we can reset the supply chain and return to a kind of a rate of normal production of all our facilities. Does that answer the question?

Thank you for that. Regarding the global field services contract, I understand it has faced some protests, and I believe some of those protests have been denied. Could you provide us with an update on the current status of that contract?

Yes. So as of last Thursday, we got a note from Army Contract Command that the stop work order had been lifted. And so we are anticipating taking over that contract.

Okay. And when do you think you might start seeing revenues out of that then?

Our view at this point, Joe, is with the stop work order lifted, we would get going pretty quickly. We do have a ramping up, but the Army has already expressed the desire to get going. So we will get ramped up. It's probably going to start contributing meaningfully in 2025.

I think that timing is about right. By the time we transition all the employees, I would expect August 1.

Okay. And then one last one for me and I'll jump back in queue. So John, a lot of great news here with the refinancing done and continue to move forward on adding new people, some major contract wins like Massachusetts. Any timeframe as to when they're going to remove the temporary tag?

Well, unfortunately, I would give you one answer, but it's the Board of Directors who, of course, have the fiduciary responsibility to do a search, and that is ongoing. You'd have to talk to our Chairman, Mark Quinlan, about that. But as I told the Board, I'm going to make it very difficult for them to take me out of this job. And if they can find somebody better, then more power to them. But I'm loving performing under the job and with the team that we've got in place and others to be added, I couldn't think of a better place to be.

Great. Well, congrats again on getting the refinancing done. Look forward to getting back to business as normal. And I will allow someone else to ask some questions. Thank you.

And we will move next with Mike Crawford with B. Riley Securities. Please go ahead.

Thank you. With the win in Massachusetts, does that whole $140 million go into bookings already in this July fourth quarter?

That would be a fourth quarter booking, yes. We would not put the option year in at this point. The option year would not be in backlog.

And then regarding the unbilled receivables and how those will be declining in the next year, can we just walk through some of the mechanisms regarding that? Maybe starting with troposcatters, for example, timeline from order to delivery to acceptance on the tropo product? And maybe what relative contribution that kind of section of unbilled receivables is on the balance sheet? And maybe kind of a similar walk-through on the other major items there.

Sure. Hey Mike. This quarter, looking at our footnote, you probably will notice that, while the total headline number stayed about the same, we did have a shift in our unbilled receivables with the U.S. Government towards billed receivables. So I take that as a sign that we are starting to get the components in, starting to make the deliveries that we need to in order to clear the unbilled. So we always felt around this time of the year we would start to see this liquidation. I think now with the refinancing behind us and supporting our balance sheet, we can lean in on the supply chain to get components in faster and out the door sooner. I think that's probably the number one thing to do: just get the supply chain, get the manufacturing, and get those deliveries out as planned on both the Army tropo order as well as the Marine tropo order. So I think we're in the thick of it right now, and we do expect to see a nice liquidation in those two particular contracts over the next couple of months.

Yes, I would also add that we started significant deliveries at the end of May. We'll be delivering throughout June, July, and August. I believe the last delivery is being pushed to August, but I think the final deliveries will occur at the beginning of September.

Okay. That's great for the tropo. And what about sort of things like software delivered to telecom customers where you've been waiting for acceptance after it's been delivered?

Yes. I think we're doing what we need to do for our deliveries. Some of these milestones were out in fiscal '25, so we haven't yet approached those milestones. I think you're probably going to see a more dramatic drop in the Satellite and Space unbilleds. The T&W unbilleds, I think, will be a little bit of a longer tail. But I think we're moving along doing what we need to do working with our customers, and we expect to recover that as planned.

Yes. Some of those contracts in that space, which are indicative of that market, have long times between milestones. And so as we catch up to those, and I believe in fiscal year '25, we'll start to roll those off. In the future, we will try to make sure that we put in place contracts with a little bit better milestones.

Yes, that would be good. And then just to be clear, this $11.9 million adjusted EBITDA number for 3Q with a similar expectation for 4Q, are those the numbers that will be used for the leverage covenant in your new bank facility?

Yes. Regarding how we arrived at that figure, this reflects our current perspective following the refinancing. We are monitoring various risks and opportunities, and we believe it is appropriate to provide this guidance given the proximity to year-end. With the refinancing secured, we will aim to expedite processes. However, we must remain cautious since we are just starting. Our focus is to begin executing on servicing the supply chain. Concerning the covenants, we included sensitivities in our models and are confident that our initial setup will allow us to remain compliant.

Great. Well, thank you very much.

We will move next with Greg Burns from Sidoti. Please proceed.

Good morning. Just a follow-up on that last comment. When you look at staying in compliance with those covenants, obviously this run rate would imply either a step down in the level of debt or EBITDA growing from these levels. What is your view on that? And how you're going to, I guess, stay in compliance? Are you expecting to liquidate those receivables and reduce the level of lending? Do you have a view on EBITDA maybe stepping up with some of these contracts kicking in, in 2025? How should we think about that?

I think you nailed it on the last point, certainly, the unbilled receivables and liquidating the unbilled is a key driver to this. We are expecting those, as I said earlier, to unwind over the summer and generate cash flows for us. We have grown our backlog and we're on pace to have record backlog if we keep this up. Things are trending in the right direction, and now that we have the refinancing secured, we feel comfortable about making those investments to move forward on bringing whatever we can to the left and maximizing our EBITDA. The #1 item is definitely the unbilled that's going to drive our compliance.

Okay. And when you look at the disruptions in your business that you saw last quarter and this quarter, and I guess probably into the next quarter a little bit, how much of that is just timing with the supply chain and getting the products out the door versus maybe lost business?

I would say the majority of the issue is related to key components needed for manufacturing. It only takes one part to cause delays. During the refinancing process, we expected to complete it back in March, so we had to operate under the previous agreement for another three months, which affected our operations. Now that we have more liquidity from our new asset-based loan, we are in a better position to address the supply chain. Our partners have been very supportive in recent months, and I believe it's time to reciprocate by prioritizing factory production and keeping Maria's team engaged.

Yes. I would also add that I'm not sure that we were losing orders, but that there were orders that were being delayed with some of the customer base worried a bit about our financial stability. Completing and resolving the refinancing will solve all of those problems regarding our perception in the market and will give us a boost into business for the next year.

Okay. When considering alternative solutions, if a customer is postponing their decision and evaluating their options, how feasible would it be for them to switch to another supplier? I'm trying to gauge if they might find another option.

Yes. In the troposcatter market, we have very few competitors and we are the leading provider of technology in that area. The decision for customers often hinges on whether they want to opt for equipment that is less capable than ours. On the satellite front, there are competitors in both the digital and RF segments, but we continue to maintain a strong backlog. While there are competitors, they haven't significantly diverted to other options yet. What we are experiencing is a delay in some customer activities as well as challenges in our production and shipment processes. We are eager to improve our performance in these areas in the coming months.

Great. And with the 911 renewals, what was the pricing like on those? Was there a step down in pricing? Or how did those renegotiations go?

Yes. I don't think we'll get specific as to how we price the opportunity, but I would say we have good relationships with our customers. These were competitive awards that we won. There were folks out there that we were competing with, and we outbid them, I guess, if you will. The pricing and the jobs themselves, this is a lot of work that we've been doing for years and the continuation of that work. We were not seeing like massive discounts to win the opportunities. I think the customers are at the point in their life cycles where they're also looking to do upgrades of the technologies, particularly in the 911 space. That gives us opportunities to have margin expansion while we secure the base and then bring in other opportunities on top of that.

Okay, great. Thank you.

We do have a follow-up from Mike Crawford with B. Riley Securities. Please go ahead.

Thank you. Regarding growth and other growth drivers, is the global field services representative contract still expected to generate up to $100 million in annual revenue for the company over the coming years?

Yes. That was a four-and-a-half-year contract. It's staffing over 200 positions globally. Once you have them in place, it's pretty stable, steady work.

Okay. Thank you. And then the other one that we've been maybe more excited about is this EDIM modem that you're developing that really is the next generation of this EBIM modem that FISAT, I think, has generated about $1 billion of revenue on over the last decade. And I believe you're building the first articles there. Or what's the timeline on EDIM?

The first articles and prototypes are due in September. We don't expect significant revenue from that until likely the end of our 2025 fiscal year. However, it will be the first digital modem available in the market, and we are quite excited about it. This aligns with our strategy of digitalizing the satellite industry. We're getting a head start on this with the Army regarding that modem. Additionally, we are involved in other modems. There have been three major programs from the military, and Comtech has participated in all of them. These include the WANs, the A3M, which is the Army-Air Force anti-jam modem, and the EDIM. We anticipate that the A3M will soon enter production, which should generate significant revenue for us in fiscal year 2025.

Okay, great. Thank you.

And we show no further questions at this time. I will turn the call back to our presenters for any closing or additional remarks.

Thanks, everybody, for calling in and being with us today. Mike and I and his entire team of financial professionals are very proud of the work we did to complete the refinancing, and we're happy to move forward. We're excited about the future. We think there are lots of good things ahead for Comtech. We expect to continue to bring on additional leaders in the industry and expect great things out of both our Public Safety and Satellite and Space businesses. Thank you.

And this does conclude today's program. Thank you for your participation. You may disconnect at any time.