Comtech Telecommunications Corp. (CMTL) Earnings Call Transcript

Good afternoon, everyone. Good morning for some of you. For those of you I haven't met, my name is Asiya Merchant. I'm part of Citi's Tech Hardware, Tech Supply Chain and Networking Team at Citi Research. Just a quick housekeeping item. We have disclosures available on the conference registration side and you can e-mail me myself at asiya.merchant@citi.com if you need another copy or if you have any questions. This session is only intended for Citi clients and is close to the media. With that, I'd like to welcome Mike Porcelain, who is the COO and President of Comtech; as well as Michael Bondi, who's the CFO of Comtech. Welcome, gentlemen. Hope you guys are doing well.

Good afternoon, and good morning to everybody as well.

Great. All right. So I'm just going to kick it off first and ask about Comtech. I mean, obviously, those who are heavily invested in your stock, they probably understand. But Comtech does offer a lot of complex solutions. It's in the telecom equipment space, but you do have various solutions for end markets. So if you can just kind of give a broader reference to what you guys are? What the major business segments are? If you can simplify it, that would be even greater. And sort of while you talk about that, if you can talk a little bit about the demand drivers for the various solutions that you offer?

Sure. Yes. So look, let me try to simplify things because I do agree with you at times, for a new investor, Comtech could certainly look complicated for a $700 million-ish type revenue company. But things are pretty simple, though, and I'll start out with we do provide complex solutions. That is the company. It's one of the things that we charge from our heritage that we don't provide commodity type services to consumers. We are really a thought leader in what we call secure wireless communications, and we are known for solving complex problems. We have probably 400 or so top engineers, experts in their field, from satellite communications, troposcatter communications and location technologies, all with a goal of delivering cutting-edge technologies, which provide or enhance secure wireless communications. That's the key thing, secure. A lot of our customers want extra security. We're very focused on the wireless side. We don't -- we're not into fiber or telephone line. It's sort of an advanced type of technology. And when you boil it down, the company's revenue streams, there's really 3 key demand drivers. We do report our business in 2 segments, but these 3 demand drivers that I'm going to talk about really overlay both our commercial segment and our government segment. So let me talk about the first driver is demand for satellite cellular backhaul solutions. So if you think about the number of mobile telephone operators in the world, whether it would be AT&T, Verizon, Embratel, ChinaSat mobile or Orange, which is a large mobile company in Africa. There is a tremendous demand and growth in wireless mobile solutions for end customers in foreign locations. They're rolling out 3G and 4G and 5G solutions. And in simple terms, what we provide is satellite ground station infrastructure that is used to amplify, transmit and receive cellular data over satellites. When you first hear the words satellite, everyone usually thinks about the satellite that's in the space, ignore it, we provide all the equipment that is behind the antenna, and in some cases, the antenna itself. So this is the equipment on the ground, which is why we call it satellite ground infrastructure. And we are true leader in that marketplace, 70% market share. And given the growth in 4G and 5G solutions that's going to occur over the next 5 years, we do believe we are in the early stages of a multiyear growth period. Taking a step back in simple terms, given the growth of voice, video and data that's expected to occur over cellular networks around the world, we do believe that the end market will grow nicely for the foreseeable future. And this will benefit not only our commercial customers that are in our commercial segment, but also our military customers and our government customers who use cellular services overseas. So this demand is broad-based and will benefit both of our segments. The next demand driver, if you will, we call next-generation 911 upgrades or public safety technologies. In simple terms, we provide a variety of software-based solutions to cell phone companies such as Verizon, states such as the Commonwealth of Massachusetts and local agencies that can help modernize their antiquated 911 systems. We do everything from routing 911 calls on smartphones, to providing software to the 911 operator, who's on the other end of the emergency call. So in broad strokes, when somebody dials 911 on their mobile phone, approximately 50% of all calls made in the United States are routed on a Comtech network. We basically provide the caller ID information and more critically location data. And we refer to it as trusted location technologies. And although I'm sure most people have a view, they call Uber or DoorDash and they order dinner or something like that, I'm sure you understand sometimes the driver gets lost. Well, maybe they show up in the wrong house. In our business, that's not good enough. Good enough is -- close enough is not good enough. So we provide very accurate information to the 911 agencies and every call that we transmit, we provide that data. It's not only in the United States, but we do it in Canada, and we also do it in Australia. That business is growing because there's a huge demand to upgrade to what we call Next Generation 911 systems. Many of you out there, certainly in the United States, you can't send a text message to the 911 operator. You can't send a picture to the 911 operator. You can't send a video. There's a variety of reasons why, but mostly it has to do with antiquated systems on the police agency side. And what we're in the business of doing is upgrading that technology and effectively creating what I call 911 on the cloud. And the state or the local agency pays us, they hire us to build them a new system, host and maintain it. And it's a recurring revenue stream for many years. And it's just a really good business to be in. And we call it Next Generation 911. That business, we report in our commercial segment that roughly represents about half of that segment's revenue. The third demand driver I call it relates to the modernization of military communications. It's not just the U.S. military, which compromises about 35% of our global revenue, but it's military communications around the world regardless of government. Most of our equipment is commercial. It's available to most governments around the world. And like everywhere else, governments around the world want to communicate with high-data transmission requirements, large files, high-definition video and the highest levels of security. As such, we focused on providing mission-critical technologies that are crucial to the success of the operation for that particular government. Many of these solutions, and we talked about it being complicated or unique or many is because we uniquely design the solution for the end customer. So we'll do everything from supplying and maintaining VSAT satellite terminals used for special operation troops around the world. We also provide troposcatter modems or what we call COMET, the world's smallest troposcatter system, that provides midrange communications for governments without the need for satellite. And of late, we're designing and manufacturing, what we call XY antennas that will be used on next-generation LEO and MEO satellite systems, which, of course, I'm sure everybody is reading in the Wall Street Journal. There's just billions of billions of dollars being sent on the launching of thousands of satellites around the world that are going to provide next-generation, high throughput speeds around the world via satellite. And again, that's not just for consumers, the military and the governments around the world are going to use that. And so although a large portion of this business is reported in our government segment, in some cases, we just provide certain hardware to the U.S. government, and that business will be reported in the commercial segment. But the key thing is there's 3 key kind of products or demand drivers and that the end markets are clearly going -- excuse me, clearly growing. And in a very simplistic way, we provide the hardware and the software for those 3 trends, the adoption of 5G technology, the growing 911 business and the insatiable demand by U.S. -- by the governments around the world for high-quality and more data transmission.

Great. And actually, that leads directly to my next question. So obviously, demand was impacted from COVID-19 because you referenced that in your call, and that makes sense because you couldn't go out and book deals and this equipment is pretty complex to set up. And so you can't book the revenues associated with those orders. But now as we recover from the pandemic here, Mike, if you can just talk about what the demand driver -- you already talked about the demand, but what was the growth profile in these -- under these 3 categories, pre-pandemic? And then just as a pandemic, have the drivers been impacted positively or perhaps negatively because of certain macro factors, which have expanded your book of revenue and the growth that you were expecting from each of these 3 categories?

Sure. Let me try to address it by the individual pieces. First, big picture, I will say to you that we believe that we are well past the worst impact from COVID-19. We do feel that business conditions are, I use the phrase, slowly improving. Maybe it's going to come rapidly. But I feel that when you look at global business conditions, they're on, what I call a slow improvement. But even in this COVID-19 world or slow-growing world, slow improvement, I think our long-term fundamentals that existed pre-COVID, generally remain intact and generally are probably more positive. And I think we're starting to see that. We -- look, we -- I think like oil companies. We've faced lockdown, social distancing, companies and our customers have learned to go virtual. And whether it's heightened civil or political unrest for our 911 customers, virtualization, we think, is a trend that's going to be here. We think our customers have adopted that trend on a permanent basis and because that will result in higher video requirements and a more demand for, let's say, 5G overseas, it's going to accelerate things that have sort of been delayed for a while. So I think we believe that there was this sort of huge shift to the right of all of our markets during COVID. It's a question of how fast does it come back to us, we'll see that month-by-month. I think taking it by markets, the only business -- the only market that I feel is still a negative is the IFEC business, which we've never really were big in any way. So the IFEC business, where we did sell some equipment to -- for some of these airlines and mostly on the amplifier side, I don't think that, that's coming back for at least another year. I think that that's going to be a slow area for satellite connectivity to come back as it was pre-COVID. But everything else, I think, is a net positive. Your -- in our market, in the satellite world, the LEO satellites that are being launched today, I think there's an acceleration of that because they're being launched by very big companies, big companies who survived the COVID situation. So they are planning to move forward with these investments, whether it be LEO satellites or 5G investments or the Internet of Things. We're starting to see a lot more interest almost every day and a lot more things coming back to where they were, call it, pre-COVID. So we're excited about what we're hearing and what we're seeing. And of course, we'd like to see it result in tangible order flow. But net-net, I think it's resulted in an acceleration of time line in for whatever was going to happen. The key -- the ability to communicate and connect is clear, and I think you jumped right into the 911 business. Certainly in the 911 business, I would describe it as a little bit of a tale of 2 cities. First, I think that there's a reality out there that exists today, state governments are under pressure dealing right now with delivery of vaccines to their citizens. But on the other hand, there's many local agencies and state governments that have realized that they have needed to accelerate the upgrade of their 911 systems. I think it was Time Magazine perhaps, but so many newspapers reported that 2020 was the year of the first responder. And so whether it was dealing with COVID-19 relief efforts or dealing with protest, communication networks for first responders became a top priority. So although state and local budget governments in some parts of the United States and elsewhere are under pressure, we think just the heighten attention to it in some areas of the world is offsetting it. So in the heart of COVID-19 in the United States, for example, we were awarded $100 million-plus contract from the state -- from the Commonwealth of Pennsylvania. We were awarded a $50 million contract from the state of South Carolina who made -- both customers made unequivocal statements that deploying upgraded 911 systems was a top priority, and they found the necessary funds to move forward. And we continue to see a large number of states that we are working with, and we are hopeful to announce additional awards over the next 12 months. It is definitely a tale of 2 cities. There are some states that are saying, well, take a step back, we have no money. We're rolling out vaccine. But when we add it up, we think there's more positive change in the near term, which is good because projects that might have occurred 4 years from now, now may be coming in 3 years or 2 years, and it takes some time for the state and local governments to come forward. So again, a tale of 2 cities, but we think it's net positive as demonstrated by the 2 awards we received with South Carolina and Pennsylvania. And then I guess, finally, you have to -- when you talk about COVID, you have to talk about the recent change in the Presidential administration. I think this current administration is very focused on passing some type of infrastructure bill, and the infrastructure bill should bode well for industrial and technology companies such as Comtech. We think and we're hearing it from our constituents and our customers that providing upgraded 5G systems and providing upgraded 911 systems, seems like a perfect win-win for the politicians to come together for, for infrastructure spending. So ultimately, we're watching it from the side. We don't -- it's not like we have our lobbyist down at the White House or in Congress. But we're letting the bigger companies do the lobbying because we fit right into what this new administration is trying to come up with. And if it does happen, we think we will benefit from that, and it will be, again, an acceleration of the trends that we think are out there. Adding it all up, we think we survived COVID. We're probably stronger than we were back in January because some of our smaller competitors really struggled, really had to cut spending. We kept forward. We did our reductions, but we did turn down the dime on R&D. And so we think we're emerging from this a stronger, better company and with more opportunity as a leader.

Excellent. If I can just ask a financial guidance question before we dig deeper into each of these demand drivers. Guidance for fiscal '21, when I look at absolute kind of revenue expectations level, it is below where you were guiding pre the pandemic for fiscal '20. And so if you can just talk a little bit about the puts and takes. Clearly, the backlog looks good. You guys talk about that every -- when you guys report. Why the guidance, is it just conservatism? Is it you guys are still waiting for a few of these people to come back and operations to resume? If you can just kind of high-level talk about on an absolute level, '21 fiscal versus pre-pandemic fiscal '20 expectations.

Sure. One thing to point out to everybody, especially if you're new to Comtech is that contact has a fiscal year that ends in July. And so it's really important when you're talking about fiscal years, the way we talk about it is COVID-19 impacted both our fiscal year 2020 and our fiscal 2021. So when we're talking about the numbers that we're thinking about, we've been in COVID for the last 6 months of 2020. And really, we're still into the 6th month or probably now 7th month into in 2021. So it's not only impacted last year, but it's carried forward into the first year of fiscal '21. So to your point, I don't like to use the words conservatism because it implies we're holding something back. I put it in the camp of realistic. What we tried to do is we kind of be -- we're mindful of the overall macroeconomic environment that we're in. Europe is still in shutdown in some cases. You still can't get on planes. There's still part shortages that exist out there. So I think on the one hand, you're seeing a lot of press releases that we're putting out there that really show the volume of business that we're seeing. And I'm not going to comment on our guidance that we issued back in December. Clearly, we're getting orders, there's no doubt about it. And we'll obviously update you on where our guidance may be when we announce new things, but we're being very mindful. There's still delays. This still takes a lot of time to get into the customer's office, if you will, to do installation. So we were conservative back in December. And sitting here today, I'm still conservative to use your word, but I'm more realistic. I don't know when I can deliver stuff. I'm certainly getting orders right now. And as we look at fiscal year '21, we think in light of everything, it's very respectable. But right now, we're sitting here mid of February. We're in our Q3. And I can tell you, Mike Bondi and my's and Fred's eyes, we're very focused on fiscal 2022, which starts our fiscal year August 1, '21. We have lots of new contracts, a pipeline of opportunities that appear to be growing. And although I can't give you an updated guidance for '21 or I can't give you guidance for 2022, I can say I think it's going to be better than '21. But that's a story to come, and we're feeling pretty good about ourselves.

When I -- I've got a question from an investor who e-mails me through the portal. Basically saying, how do you guys realize the revenues on very large contracts? Is it ratable? Is it percentage of completion? Maybe you can dig a little bit what's the difference between your commercial and government segments. And then as it relates to the profitability of these contracts, obviously, the goal there is to continue to improve profitability. Are there specific things that investors should keep in mind on what you guys are doing to improve the underlying profitability of these large contracts?

Hey, Mike, do you want to take that?

Sure, Mike. In terms of the revenue recognition, it really -- we have a really diverse business with a lot of different programs that we're on. It's not like a one-size-fits-all kind of answer. But generally speaking, when you look at our commercial business, especially the satellite ground station business, that's more prone to being at the time of shipment, we'll take the revenue as opposed to maybe in the 911 business, which -- those are nice recurring contracts with nice maintenance tail. So that's more over time. And then in the government business, it's a hodgepodge. It could be cost-plus type contracts. It could be delivery, could be cost-to-cost type models. So it definitely varies. So I would answer it that way.

Okay. And then for the profitability, are there specific things that you're doing, whether it's OpEx efficiencies or even specifically on the gross margin side between, let's say, the commercial contracts versus the government contracts or the next-gen 911 versus the ground station equipment?

Yes. So I think put it in -- let me answer the question in 2 ways on the margin side. First, and this does get a little bit back to your question on 2021's guidance. We are incurring extra costs right now because of COVID. We're taking a lot of safety-related initiatives and cost through our P&L to make sure that our employees are safe and our customers are safe. So that cost we're doing. So we're not sure how long that's going to last. Hopefully, as the vaccine becomes effective around the world, that cost would go away. So that piece -- it's not material, but it is certainly something that's suppressing our margins at the moment. But more importantly, as we get more volume, we definitely think margins will improve. And we're taking it on -- we're taking as a step-by-step basis. If you look at some of the margin profile that Comtech has done in the past, I'd like to get to 15% adjusted EBITDA margins sort of as a goal, if you will. I'm not going to say I can do that in the next 12 months. Maybe I can, I don't know yet. But we're -- some of these programs that we get, you try to be very careful and cautious on. So you try to make sure that you don't have any hiccups upfront. You may not have the same margin initially as you do later on in that contract. So when you get into the second, third or fourth year of the contract, the margin by itself should increase so long as everything goes okay. And again, we plan prudently, not conservatively but prudently. These are complex projects. So as we get into the second and third year, the margin by itself should go up. And given the growth and the volume that we are seeing, we think we have a path pretty easily so for increased margins, but it's up to us to execute to that. And that's what we're focused on today.

And is that on both the commercial and the government side? Or is the government -- I know it tends to be a little bit more customizable. And there is -- the margin profile tends to be lower than your commercial segment.

Yes. Absolutely. The comments that I just gave to you do apply to both the commercial segment and the government segment. But as you just appropriately pointed out, our Government Solutions segment does have lower margins because in many cases, the government is funding the R&D. So they're not going to pay you the same type of gross margin that you would get if you funded the R&D investment yourself. So those margins are closer to, let's say, the 10% adjusted EBITDA margin profile. And the commercial segment, Mike, I don't remember what it was in our last go around, but it's close to the 14%, 15%. And something that we obviously -- we've gotten close to 20%, in some cases, based on volume. So we know we can do it. It's a question of mix, function, execution and certainly volume.