Comtech Telecommunications : Q2 2022 Shareholder Letter

Comtech Second Quarter Fiscal Year 2022 Shareholder Letter

Fellow Shareholders:

The second quarter of fiscal year 2022 was transformative for Comtech. I took on a new role as CEO, we welcomed new independent members to our Board of Directors, furthered plans to deploy the proceeds of our $100 million strategic growth investment, and continued to solidify our position as a leading solutions provider in our two key end-markets: 1) Next Generation 911 Public Safety and 2) Satellite and Space Communications. Both are at the beginning of a long-term investment and upgrade cycle and are expected to significantly grow over the next four and seven years, respectively.

We see these two end-markets as part of what Comtech will now call the "Failsafe Communications Market." This market includes the critical communications infrastructure that people, businesses, and governments know they can rely on, no matter where they are - on land, at sea, or in the air - and no matter what's going on outside - from armed conflict to natural disaster.

As defined in independent market studies and forecasts produced by NSR and Frost & Sullivan dated December 2020 and May 2021, respectively.

For more than 40 years, Comtech's DNA was developing and manufacturing highly reliable communications equipment. As markets changed, so did Comtech. Our customers, who are Next Generation 911 ("NG-911") and Public Safety providers, mobile network operators, governments and defense agencies and other enterprises, require communications and data transmission solutions that work every time, under the most demanding conditions. As such, over the past several years, our DNA has evolved to include more secure and sophisticated wireless technologies, cyber training, and public safety software solutions. With new leadership in place and added flexibility to invest significantly in our strategic initiatives, our company will continue evolving, confident in its ability to seize enormous opportunities ahead.

Comtech is a natural, dependable and highly valued partner. Our satellite network equipment enables broadband connectivity in underserved communities and geographies, by permitting our customers to leapfrog legacy network requirements and deliver robust data transmission anywhere on the globe.

Although we are optimistic about the future, we know that we face short-term challenges and continued uncertainties in the second half of our fiscal 2022.

The repercussions of the military conflict between Russia and Ukraine are significant. It has been said that war follows the Law of Unintended Consequences. Large-scale military engagements can profoundly dislocate political, economic and social conditions. They produce not only immediate change, but have the capacity to create extraordinary, and often unforeseen longer-term transformations.

For Comtech, the current conflict is directly impacting short-term elements of our sales pipelines. Certain customers have paused procurement and deployment of satellite and troposcatter communication systems, and instead began purchasing war-fighting equipment, such as anti-tank missiles and other "lethal equipment." The U.S. defense budget, and defense budgets worldwide, are now being adjusted in real-time to reflect the priorities of war and changing European geopolitics.

Given the economic sanctions against Russia and the daily evolution of the situation on the ground, we are assuming no new sales in Russia for the remainder of fiscal 2022, which translates into roughly a $5.0 million reduction in order flow. We are actively hiring new employees to replace certain support activities previously conducted in Russia. In addition, we have asset exposure (primarily cash and accounts receivables) of approximately $1.5 million.

On the other hand, our experience suggests that Comtech will benefit from an up-tick in demand as conflict and uncertainties create new and different opportunities for the types of communication solutions we supply. Once rockets and missiles are purchased and deployed, communication equipment deployments usually follow. We are seeing this play out live right now, but the magnitude and timing of demand is not yet predictable.

And, like many other companies around the world, we are working around supply chain constraints that include component shortages and quality issues as well as delays. Additionally, we are dealing with inflation. Freight costs were already impacted by COVID-19 issues and higher oil prices have not helped. Component prices are up approximately 10% in the past several months and freight costs, in some cases, have doubled.

Finally, while we are a stronger and more powerful organization for it, we are only just emerging from a drawn-out proxy contest, and the distraction of an unsolicited acquisition offer. These events required time and focus from leadership and slowed strategic execution, while competitors used this short-term uncertainty to their advantage. We experienced a higher level of employee stress and turnover, some bookings and contract wins were delayed, and in some cases, we lost them.

Nevertheless, we are incredibly proud that despite the cumulative challenges Comtech faced during our second quarter of fiscal 2022, we achieved a solid quarter of financial performance that exceeded our bottom-line expectations.

Key Second Quarter 2022 Financial Highlights:

• Consolidated net sales were $120.4 million, up 3.1% sequentially from Q1 2022;
• GAAP net loss attributable to common stockholders was $23.5 million, and included $13.6 million of CEO leadership transition charges (of which $7.4 million related to amortization of stock-based awards) and $9.1 million related to our settled proxy contest;
• GAAP EPS loss of $0.89 and Non-GAAP EPS loss of $0.03;
• Adjusted EBITDA was $9.8 million, a 76.7% sequential increase from Q1 2022. Adjusted EBITDA and Non-GAAP EPS are Non-GAAP financial measures that are reconciled to the most directly comparable GAAP financial measure and are more fully defined in the Appendix below;

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• New bookings, also referred to as orders, were $102.9 million, a 19.2% sequential increase from Q1 2022, resulting in a quarterly book-to-bill ratio of 0.86x (a measure defined as bookings divided by net sales);
• Q2 2022 ending backlog was $611.1 million compared to $628.5 million as of the end of Q1 2022;
• Our revenue visibility is approximately $1.2 billion. We measure this revenue visibility as the sum of our $611.1 million backlog plus the total unfunded value of certain multi-year contracts that we have received and from which we expect future orders; and
• We generated $4.8 million of cash flows from operating activities despite making $2.8 million of cash payments for our settled proxy contest.

Additional discussion of our Q2 fiscal 2022 results including discussion of comparative amounts in Q2 fiscal 2021 is set forth below and in our Form 10-Q filed today with the Securities and Exchange Commission. Also, we have provided comparative condensed consolidated Statements of Operations and Balance Sheets in the Appendix to this letter. Our investor relations section at www.comtechtel.com(and our new web site coming soon at www.comtech.com) also contains an updated shareholder presentation.

Key Contract Wins

The following were ten key contract wins (including extensions and follow-on orders) awarded to us during Q2 fiscal 2022:

$38.3M

IN KEY WINS

1. $7.4 Million Order for X-Band Satellite Ground Station Equipment for the U.S. Government
2. $5.1 Million of Ka-Band Amplifiers for a Trailer-based Satellite Communications Ground System
3. $4.7 Million of Contracts to Supply Amplifiers for an Electronic Warfare System
4. $4.4 Million of Mobile Satellite Equipment to the U.S. Army
5. $3.8 Million of Amplifiers for In-Flight Communication Applications
6. $3.2 Million Renewal for 911 Trusted LocationTM Software
7. $2.7 Million Contract to Deploy NG-911 Call Handling Software
8. $2.6 Million Contract to Deploy NG-911 Call Handling Software
9. $2.4 Million Order for Satellite Ground Station Equipment for an International Mobile Network Operator
10. $2.0 Million Order for High-PowerSolid-State Amplifiers

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Product News

In January 2022, we announced the launch of our new very small aperture terminal ("VSAT") platform, ELEVATE™, a scalable, reliable, software-defined satellite communications solution. ELEVATE™ enables our customers to create private VSAT networks of any size and topology, with infinite scalability. We are incredibly excited about ELEVATE™, as it will offer any user the opportunity to build data and communications networks with full functionality on land, at sea or in the air, using next-generation satellite constellations, that are completely private, fast and reliable.

The use cases for our ELEVATE™ technology span multiple industries because it works everywhere: aerospace, agriculture, land mobile, maritime, energy, and any other application or geography where a community, government or enterprise needs reliable, secure Failsafe Communications. In a future defined by the increasing proliferation of so-called "edge devices" comprising the Internet of Things, we believe ELEVATE™ will give Comtech - and our customers - a competitive edge.

In March 2022, we announced that our new SmartResponse™ solution is now compatible with the RapidSOS platform. SmartResponse™ is a cloud-native solution for emergency communications centers that combines the most accurate location data available with caller information, live traffic, weather, routing, points of interest, and Department of Transportation camera feeds into a single Common Operating Picture ("COP"). This product is being offered to our NG-911 Public Safety and Security customers, is data agnostic and can interface with any call handling or dispatch platforms through its use of flexible application programming interfaces ("APIs"). RapidSOS is an emergency response data platform that securely links life-saving data directly to emergency service providers and first responders. Together, these solutions arm emergency communication professionals with the most accurate information available, improving response times and performance in any situation.

Second Quarter 2022 Financial Discussion

In our December 9, 2021 earnings call, I discussed the reasons we believed fiscal 2022 was starting to shape up in-line with our expectations for our second quarter and fiscal 2022. Immediately following, the Omicron COVID-19 strain surged across Europe and the U.S, causing further delays in an already strained supply chain. Certain suppliers were forced to shut-down production and ceased deliveries of expected parts. Other parts, which did arrive, fell below our quality standards and we declined to use them. As a result, we were unable to get several million dollars of shipments out the door. Nevertheless, in line with our thinking at the time, our second quarter results showed improvements in sales, bookings, and Adjusted EBITDA versus Q1 fiscal 2022.

For Q2 fiscal 2022, we recorded $120.4 million of consolidated net sales, of which $81.3 million were reported in our Commercial Solutions Segment, and $39.1 million were reported in our Government Solutions Segment. Both segments reported slightly higher sales than achieved in Q1 fiscal 2022, but lower sales than Q2 of fiscal 2021.

Of the $120.4 million in consolidated net sales, 74.7% were to U.S. based customers (including 27.1% to the U.S. government) with the remaining 25.3% to international customers. Compared to the year ago quarter, our consolidated Q2 net revenues declined $40.9 million or a 25.4% drop, the large majority of which related to lower revenue from field support activities associated with the withdrawal of U.S. troops in Afghanistan and other program changes.

Gross margins were 38.1% reflecting an improvement from the 35.7% we achieved in the first quarter of fiscal 2022. This improvement related to a more favorable product mix, as well as lower than expected warranty costs in our NG-911 product line. Gross margins in Q2 2021 were 34.5%.

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Our selling, general and administrative expenses ("SGA") of $29.8 million, or 24.8% of sales, reflect tight labor markets and our decision to continue to invest in both existing and new talent. SGA costs also include $1.7 million of restructuring costs to move and streamline our operations. SGA expenses in Q2 2021 were $29.5 million or 18.3% of sales. We are actively seeking new engineers and software developers, as well as marketing and sales professionals, across every single one of our product lines. If you know of someone looking for an exciting place to work, please ask them to visit our job postings at LinkedIn and our new career pages at www.comtech.com.

While we have been judicious, we have been investing in our future and will continue to do so. This includes making significant capital expenditures and building out cloud-based computer networks to support our previously announced NG-911 contract wins for the states of Pennsylvania, South Carolina and Arizona.

We will also continue investments in capital equipment and building improvements in connection with the opening of a new 146,000 square-foot facility in Chandler, Arizona, and the establishment of a new 56,000 square-foot facility in Basingstoke, United Kingdom. Although COVID-19 and supply chain issues have extended our original build-out schedule, both manufacturing centers are expected to support production of next-generation broadband satellite technology and should be operational by early fiscal 2023. With respect to capital investments for these and other initiatives, we expect to spend approximately $30.0 million in fiscal 2022. In the first half of fiscal 2022, we have spent $8.8 million in property, plant and equipment.

On the R&D side, we continue to make long-term investments. R&D investments in Q2 2022 were $12.6 million or 10.5% of sales. Although it would be easy to improve short-term profits by delaying projects and/or reducing staffing, this would directly impair our ability to achieve our long-term business plan. R&D in Q2 2021 was $12.7 million or 7.9% of sales.

Operating loss in Q2 2022 was $24.6 million and includes charges of $24.8 million, including $13.6 million of CEO leadership transition costs (including $7.4 million of amortization of stock-based awards), $9.1 million related to our settled proxy contest, $1.7 million of restructuring costs and $0.4 million of COVID-19 incremental operating costs. As a result of these and other costs, our GAAP net loss attributable to common stockholders was $23.5 million and GAAP EPS was a loss of $0.89. Our GAAP results also reflect $5.3 million of amortization of intangibles, $2.3 million of depreciation expense, $2.0 million of amortization of stock- based compensation, and other costs such as interest and taxes.

We utilize a Non-GAAP measure we refer to as Adjusted EBITDA (see table of reconciliation below) as an additional measure of our results. During Q2 fiscal 2022, Adjusted EBITDA was $9.8 million, a 76.7% sequential increase. As a percentage of net sales, it was 8.1%, an improvement from the 4.7% we achieved in Q1 fiscal 2022. Our Q2 2022 Adjusted EBITDA does reflect a decrease from the $18.1 million (or 11.2% of sales) we achieved in Q2 2021. This decrease primarily reflects the impact of lower sales in our Government Solutions segment that were largely driven by significantly lower sales of global field support services and advanced VSAT products as a result of the U.S. government's April 2021 decision to withdraw troops from Afghanistan, and other program changes.

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