Comtech Telecommunications Corp. (CMTL) Q3 2018 Earnings Report, Transcript and Summary

Welcome to Comtech Telecommunications Corp.’s Third Quarter Fiscal 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Thursday, June 7, 2018. I'd like now to turn the conference over to Ms. Maria Ceriello of Comtech Communications. Please go ahead, ma’am.

Thank you, and good morning. Welcome to the Comtech Telecommunications Corp. conference call for the third quarter of fiscal year 2018. With us on the call this morning are Fred Kornberg, Chief Executive Officer and President of Comtech; and Michael D. Porcelain, Senior Vice President and Chief Financial Officer. Before we proceed, I need to remind you of the company’s Safe Harbor language. 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 involve certain 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'm pleased now to introduce the Chief Executive Officer and President of Comtech, Fred Kornberg. Fred?

Thank you, Maria. Good morning, everyone, and thank you for joining us on this call. As announced yesterday afternoon, we reported our third quarter results of $147.9 million in revenues and operating profit of $14 million; adjusted EBITDA of $23.5 million and bookings of $164.3 million. We finished the quarter with a near record backlog of $583.7 million, which is close to the company's record high. Our results for the third quarter exceeded our expectations and based on our pipeline of opportunities, our strong year-to-date performance, and our positive business momentum, we believe that fiscal 2018 will be a very successful year. As such, we're maintaining our fiscal 2018 revenue target of $570 million to $585 million, increasing our GAAP diluted EPS target to a new range of $1.17 to a $1.23, and increasing our adjusted EBITDA target to a new range of $73.5 million to $76.5 million. Obviously, I am very pleased with our performance and numerous accomplishments this quarter. I will talk more about that later in this call. But first let me turn it over to Mike Porcelain, our CFO, who will provide a discussion of our third quarter financial results and our updated fiscal 2018 guidance in more detail. Then I will comeback before opening it up to questions and answers. Mike?

Thanks, Fred, and good morning, everyone. Consolidated net sales for Q3 were $147.9 million, of which approximately 37.4% were generated from U.S government end customers, 24.6% from international end customers, and 38% from domestic commercial end customers. During Q3, we achieved bookings of approximately $164.3 million with strong order flow across many of our product lines. We achieved a consolidated book-to-bill ratio of 1.11. As a reminder, this quarter does not include the type of contracts we received in Q2, such as the large ones from AT&T and Verizon. So the 1.11 was strong and a good data point for the type of market demand we're seeing across our product lines. As Fred mentioned, our third quarter finished with a consolidated backlog of $583.7 million, which was higher than what we finished Q2 at and close to a company record high. As I mentioned during our last conference call, when you think about the strength of our backlog, you should be mindful that the total contracts that we have in-house are actually higher. As promised, if you download our Q3 investor presentation from our Web site, we have included a new table that shows a summary of certain contracts that we have been awarded and which indicates that we have visibility to over 500 million of potential orders from existing contracts. Alternatively stated, between backlog and contracts in place, we have over $1 billion of visibility because we were the sole provider for many of these contracts, funding is generally assured and likely to occur. As you know, although timing of receipt of new orders and funding is always difficult to predict, I believe that our overall visibility has never been higher and clearly shows we are positioned for growth in fiscal [technical difficulty] and beyond. Let me turn back to sales now and give a sense by segment of what is happening. Net sales in our Commercial Solutions segment for Q3 were $89.9 million as compared to Q3 of last year, which were $79.4 million, an increase of $10.5 million or 13.2%. Sales in the segment represented approximately 60.8% of total net sales. This was a solid quarter for bookings in our Commercial Solutions segment, which achieved a book-to-bill ratio of 0.93. Net sales of our satellite earth station products, which include our HEIGHTS product line or SCPC satellite modems and solid-state power amplifiers were higher this quarter as compared to Q3 of last year. This was the third quarter in a row of sequential sales growth for our satellite earth station product line. After several years of difficult end market conditions and challenges, it is really nice to see this product line finally showing what we believe to be sustainable growth. During Q3, we received a large strategic multiyear contract award from the U.S. Navy in the amount of $59 million and received funding of approximately $8.2 million. Given the U.S. Navy's pressing operational needs, we shipped most of the $8.2 million of orders during Q3, which positively impacted our operating income. We originally expected to begin shipments of this equipment during our fourth quarter, so we did have a positive change in product mix during the quarter. Although timing for additional orders is difficult to predict, we are optimistic that we will receive and ship additional orders for this equipment during our fourth quarter of fiscal 2018, in fiscal 2019, as well and in future years. Turning to our Enterprise Technology Solutions and Safety and Security Technology Solutions Groups, sales were higher this quarter as compared to Q3 of fiscal 2017. On the Safety and Security Solutions side, we were awarded a 2-year multimillion dollar contract to provide next generation text to 911 emergency services for the State of Maryland. And on the Enterprise Solutions side, we were awarded a $10.1 million multiyear contract to provide one of the largest wireless carriers in the United States with a hosted advanced location services platform, which leverages existing technology including our position determining engine. Given the year-to-date performance of these product lines in recent contract awards, we believe that fiscal 2019 will be a year of revenue growth for these product lines. Now let me turn to our Government Solutions segment were net sales were $57.9 million as compared to $48.4 million in Q3 of fiscal 2017. This represents an increase of approximately 19.6%. Sales in the segment represented approximately 39.2% of total net sales. Bookings for this segment were strong and reflect continued strength in almost all of our government solutions product lines. During Q3, we achieved a book-to-bill ratio of 1.40, the fifth quarter in a row that our book-to-bill ratio in our Government Solutions segment exceeded 1.0. We believe this trend validates the strategy we previously initiated. In fact, backlog for our Government Solutions segment is the highest it has been since our acquisition of TCS back in February 23, 2016. This is quite an accomplishment and we are optimistic about the future. Sales of for Command & Control Solutions, which include the design installation and operation of secure wireless communication networks, cyber intelligence training, and Blue Force Tracking solutions were higher this quarter as compared to last year's Q3. Additionally, we ship certain troposcatter equipment to support U.S. Army activities throughout the Korea and Peninsula, and we believe that long-term demand for our over the horizon microwave systems within the U.S. Army and all the military commands will increase. Looking forward to Q4, we have updated our product mix expectations for the segment and we are now expecting higher Q4 sales of Command & Control Solutions and lower Q4 sales of new high-margin cyber training software solutions. We have experienced longer than expected sales cycles for our new cyber training software solutions, and we continue to invest in R&D to meet market needs and expect that orders for this product line will begin to grow in 2019. However, overall, given year-to-date order flow and expected new orders, we anticipate that fiscal 2019 net sales for our Government Solutions segment will be higher than the amount we achieved in fiscal 2017. Now let me give you some color on our operating metrics. Our gross profit in Q3 of fiscal 2018 as a percentage of consolidated net sales was 42.2% as compared to 41.1% in Q3 of fiscal 2017. For the year, we still expect gross profit as a percentage of consolidated net sales to be slightly lower when compared to 2017. On the operating expense side, SG&A expenses were $30.4 million in Q3 of fiscal 2018 or 20.6% of consolidated net sales, which is similar to the 20.3% last year. As a reminder, SG&A expenses last year included a recovery of legal expenses. So our SG&A expenses for the most recent quarter reflects the benefit of cost reduction actions previously initiated and obtained. For the year, given our current spending and investment plans and revenue growth assumptions for the balance of fiscal 2018, we do expect SG&A expenses as a percentage of revenue to be comparable to the 21.1% we achieved in fiscal 2017. R&D expenses were $12.8 million in Q3 of 2018 or 8.7% of consolidated net sales that were comprised of a $11.3 million of spending in the Commercial segment and 1.4 of spending related to the Government Solution segment with the rest constituting amortization of stock-based compensation. We feel our historical and current R&D spending continues to pay off and is contributing to the recent contract awards that we have announced. As such, we continue to invest significantly in new technologies across our entire product line and expect R&D expenses as a percentage of consolidated net sales to be comparable to the amount in fiscal 2017. Total stock-based compensation was $1.1 million for Q3 of fiscal 2018 as compared to $1 million for Q3 2017. As we did last year, we intend to pay certain fiscal 2018 non-equity incentive awards in the form of fully vested, but restricted share units which will result in an increase in amortization of stock-based compensation in our fourth quarter of fiscal 2018 as compared to Q3. As such, given the increase in our stock price, the type of awards that are currently outstanding and awards expected to be issued during Q4, we believe that total amortization of stock-based compensation expense will be several million dollars higher than the $8.5 million recorded in fiscal 2017. Amortization of intangibles was $5.3 million in Q3 of fiscal 2018 and we expect the run rate to be the same for Q4. On a GAAP basis, our consolidated operating income was $14 million or 9.5% of net sales in Q3 of fiscal 2018. For the year, we're targeting to achieve operating income as a percentage of consolidated net sales of approximately 5.2%. This range compares favorably to the 3.3% achieved in fiscal 2017, which excludes $18.8 million of favorable operating income adjustments that we generated last year. We believe that adjusted EBITDA is an important metric. And in this regard, our adjusted EBITDA was $23.5 million in Q3 of fiscal 2018 or 15.9% of consolidated net sales. Adjusted EBITDA on our Commercial Solutions segment was $20 million or 22.3% of related net sales, and in our Government Solutions segment was $7.5 million or 12.9% of related net sales. Let me now talk about our interest expense, taxes and our balance sheet. Interest expense was $2.5 million in the third quarter of fiscal 2018. Our total interest expense, which includes amortization of deferred financing cost is expected to reflect an effective rate of approximately 5.4% in fiscal 2018 or actual cash borrowing rate currently approximates 4.3%. On the tax side, our effective tax rate was 27.2% for the Q3, excluding discrete tax items, we currently expect our fiscal 2018 effective income tax to approximate 27% as compared to our prior estimate of 27.75%. Our estimated effective tax rate of 27% reflects seven months of benefit related to tax reform. Looking forward to fiscal 2019, before any discrete items we expect our effective tax rate to now range from 23.5% to 25%. On the balance sheet at April 30, 2018, we had $44.2 million of cash and cash equivalents. This was a strong quarter for cash flow generation and in fact was better than our internal expectations. We continue to achieve operating and working capital efficiencies, and in Q3 of fiscal 2018, we generated cash flows from operating activities of $21.4 million and reduced our total debt by approximately $12 million. We have a number of one-time payment schedules for Q4 and based on timing we do expect positive cash flows in Q4, but at a lower amount than what we achieved in Q3. All in all, fiscal 2018 is expected to be a strong year of cash flow generation. As of April 30, 2018, we had total debt excluding unamortized deferred financing cost of $186.4 million. This is a leverage ratio of 2.43x as compared to a maximum allowable of 3.1x EBITDA. So you can see we have pretty good balance sheet flexibility at the moment, and given our future outlook, we anticipate being in compliance with our credit facility for the remainder of its term. Given our improved balance sheet and the strength of our operating results, we have started to renegotiate with our commercial bank lenders to reduce the facility cost and obtain additional flexibility or even look at other debt structures. In short, we think we can reduce cost and obtain better terms than what we have today. If we are successful in achieving such results, we will report them back to you. At the end of the day, it was a really good quarter for Comtech, and it surpassed our original expectations. On the bottom line, GAAP diluted EPS was $0.34 per diluted share in Q3. Now let me give you some color on the guidance. We are maintaining our revenue target range of $570 million to $585 million. We have some puts and takes in our product mix during Q3 and Q4, and even some moving into next year. So as of today, we feel this is about the right range for fiscal 2018. Despite the absence of $6.7 million of BFT-1 intellectual property licensing fee that we earned in fiscal 2017 supporting the U.S. Army's Blue Force Tracking program, the midpoint of this revenue target range represents a year-over-year growth rate close to 5%, which we think is pretty impressive. In addition, and despite product mix changes, we are increasing our adjusted EBITDA target to a new range of $73.5 million to $76.5 million as compared to our prior range of $72 million to $76 million. Again, given the absence of the $6.7 million of BFT-1 intellectual property fees the midpoint of this EBITDA target range represents an annual growth rate close to 6%. Adjusted EBITDA as a percentage of net sales is expected to be close to 13%. Again, we think that is pretty impressive. On a GAAP basis, we are updating our GAAP diluted EPS target to a new range of a $1.17 to a $1.23 as compared to a prior range of a $1.08 to $1.23. This new target range reflects better than expected operating performance. As a reminder, our fiscal 2018 GAAP EPS target does include the Q2 benefit from tax reform, which approximated $0.59 per share. From a timing perspective and consistent with our original business outlook for fiscal 2018, on a consolidated basis, our fourth quarter of fiscal 2018 is still expect to be the peak quarter for both consolidated net sales and adjusted EBITDA. However, given the more favorable product mix, our third quarter of fiscal 2018 is expected to be the peak quarter of operating income. Based on our backlog and expected deliveries, we currently expect fourth quarter consolidated net sales and adjusted EBITDA to be higher than the amounts achieved in the third quarter of fiscal 2018. We expect consolidated GAAP operating income and adjusted EBITDA as a percentage of consolidated fourth net sales -- fourth quarter net sales to approximate 6% and 15%, respectively. We expect GAAP EPS to approximate in the range of $0.24 to $0.30 per diluted share in Q4 as compared to the $0.34 per share we achieved in Q3. Finally, our Board of Directors declared a dividend for the fourth quarter of fiscal 2018 of $0.10 per common share payable on August 17, 2018 to shareholders of record at the close of business on July 16, 2018. Future dividends remain subject to Board approval as well as compliance with financial covenants under our secured credit facility as amended. Now let me turn it back to Fred, who will discuss our businesses in further detail. Fred?

Thank you, Mike. Let me give you some color on what is happening in each of our segments. First, let me discuss our Commercial Solutions segment, which is focused on several large growing markets. Here, we are a leading provider of satellite communications networks and products, such as satellite modems, up-and-down frequency converters, and solid-state and traveling wave tube power amplifiers. We are also a leading provider of public safety systems, such as next generation 911 networks and enterprise applications such as messaging and trusted location-based technologies. In the satellite modem area, we continue to be the undisputed leader in single channel per carrier or SCPC systems, driven primarily by our proven ability to deliver the most bandwidth efficient modems. We do not take our market-leading position lightly, and we continue to invest in R&D to not only support existing customers, but to expand our addressable markets. One such example is that just this week we announced a collaboration with Kepler Communications to advance rapidly deployable, low-cost, low-latency communications via low Earth Orbit or LEO satellites. We've developed a flexible on-board satellite waveform processing technology to operate software defined satellite payloads for this application. We believe that LEO constellations will bring forth new opportunities and new technology demands to the satellite community. This collaboration is just one example of how we're targeting this market. We are also focusing on expanding our total addressable satellite ground station market and are continuing our development and marketing of our new HEIGHTS network solution as well as investing in other R&D new product developments. The Height solution is intended to not only meet the demands of traditional fixed Geo satellite systems, but also to provide distinct advantages for those system uses considering migrating to high throughput Geo satellite systems and MEO and LEO orbiting satellite systems. To date, customer reaction has been and continues to be very positive. HEIGHT sales for the nine months in fiscal 2018 have already exceeded what we achieved during fiscal 2017 and fiscal 2019 is starting to look very, very strong. As you recall, last quarter we mentioned that we were selected by Carnival Cruise Lines to provide our HEIGHTS network solution. While during this third quarter, Orange Business Services, one of the largest telecommunications operations and IT services companies in the world also selected HEIGHTS to help them support projects in two African countries. We believe this order bodes well for the future, given the purchasing influence that Orange Business Services has in other countries. As I’ve discussed in our last conference call, the U.S government business continues to be very -- the U.S government continues to be very interested in our continuing development and extension of our commercial SCPC product line. To that interest, we’ve received during this past quarter a $59 million contract award from the U.S. Navy Space and Naval Warfare systems command for our model SLM-5650B satellite modems and related services. This IDIQ sole-source contract has a 5-year ordering period. During the third quarter, we received initial funding of $8.2 million. And as Mike mentioned earlier, given the U.S. Navy's pressing operational needs, we shipped most of these initial orders during our third quarter. We’re also seeing continued demand for our satellite communications amplifiers, specifically for our series of high-powered GaN solid-state power amplifiers that operate in the top frequency spectrum end of our industry SSS SSPA product line. During the third quarter, we introduced our new compact highly efficient GaN-based KU band solid-state power amplifier. This amplifier packs a tremendous amount of power into a compact low-weight antenna mounted outdoor unit. We believe this is the lightest and most efficient 200 watt linear KU band SSPA available in the marketplace. With a linear performance equal to or better much more expensive -- than much more expensive larger and heavier competitive products. We also recently announced the new breakthrough 250 watt V band amplifier for use with a high throughput satellite gateway service. This product is targeted towards the V band ecosystem, which is expected to grow significantly at this higher frequency spectrum. Now turning to our Safety and Security Technology product line where our solutions include 911 call routing for wireless, 911 routing for voice-over-Internet networks, and next generation 911 solutions for state and local public safety operations. During this quarter, we announced that we were awarded a 2-year multimillion dollar contract to provide next generation text to 911 emergency services for the State of Maryland. Through this contract award, 911 call centers located across the State of Maryland will be outfitted to receive and respond to 911 text messages. As a reminder, during the second quarter, we were awarded a large strategic multiyear contract valued at approximately $134 million to provide one of the largest wireless carriers in the U.S with enhanced E911 services, supporting both current 911 infrastructure and next generation or NG911 networks, which enable text messaging, image, data and video processing. This was a major contract win for Comtech, which increased our market share significantly. As a result of this contract win more than 150 million U.S mobile cell phone users will benefit from a more reliable 911 call routing solution. We believe that the Safety and Security market will grow for many years ahead, and that the current political environment will be helpful in facilitating this growth. Turning to our Enterprise and Trusted Location product line, here our solutions include GPS enabled software where we support products such as Verizon's Navigator Services and Text Messaging Solutions. This product line have showed positive momentum with our location and mapping services being increasingly integrated into new virtual platform offerings. We believe the importance of both location and messaging for the mobile network operator and large enterprise markets is increasing, as exemplified by deployment of business models in machine-to-machine and industrial Internet of Things or IoT applications. We believe this market is poised for growth not only in the U.S., but also internationally. During the quarter we were awarded a $10.1 multimillion contract from one of the largest wireless carriers in the U.S. As Mike mentioned, this contract provides this major network operator with a hosted advanced location services platforms. To deliver precise location information of devices, for applications such as turn-by-turn navigation, family finder, and remote workforce management. At this point, let me talk about our Government Solutions segment where we served a large government end user requirement mission critical technologies and systems. Like our Commercial segment, our Government Solutions segment is showing positive momentum. During the third quarter, we received $16.9 million of initial funded orders from the U.S. Army pursuant to a 3-year $123.6 million IDIQ contract to provide ongoing sustainment services for the AN/TSC-198A SNAP terminals. SNAP terminals provide quick and mobile satellite communications capability. During the third quarter, we were also awarded a $14.2 million of orders to supply the U.S. Army with advanced VSAT equipment. And just this past week, we announced that in the third quarter we were awarded additional funding of $3.7 million to port additional waveforms onto the current BFT-2 transceivers. And to the final objective of this requirements is the ability to quickly change to different waveforms based on changing operational environments. We also continue to work with the U.S. Army on our $11.7 million contract to provide several thousand of our next generation MT-2025 mobile satellite transceivers to support the U.S. Army's BFT-2 system. The BFT-2 system provides global real-time situational awareness and networking capabilities for U.S war fighters and is the successor to the Blue Force Tracking, BFT-1 system. We're pleased that our efforts over the years have resulted in the U.S. Army now selecting our transceiver to meet their immediate future BFT operational needs. Our transceiver meets the original BFT-2 protocols, provides best-in-class reliability and is fully backward compatible with our BFT-1 system. Initial shipments of transceivers are expected to start during our fourth quarter and additional orders for our transceivers are expected in fiscal 2019. As you know, we previously shipped over 100,000 BFT-1 transceivers. And we believe that this current BFT-2 opportunity is likely at least that large or more. Additionally, we are also working on a more long-range successor program with the U.S. Army referred to as BFT-3. That said, our pipeline of Government segment opportunities is clearly growing. We are also working on many large multiyear solicitations for the supply of tropospheric communications equipment, which will replace hundreds of the AN/TSC-170 troposcatter terminals in the Army's inventory. This multiyear opportunity, we believe it's literally going to be valued in the hundreds of millions of dollars over a range of 10 to 20 years. As you know, we've been a supplier of over-the-horizon troposcatter systems to the U.S government agencies and to international customers for many years. We’ve a large worldwide installed base and our systems can transmit video and other broadband voice and data applications at throughputs of over 50 megabits per second. Although an award of the troposcatter program, we believe it will not affect our fiscal 2018 or even 2019 revenues. We would expect to make significant contributions to revenues in subsequent years starting in fiscal 2020. In the near-term, business activity in our over-the-horizon microwave systems product line is starting to pick up. During the quarter -- third quarter, we received $8.5 million in contract awards from two international customers to supply our modular transportable transmission system, our MTTS troposcatter terminals, and expect more contract awards of this product line to increase in the fourth quarter. In this regard, I am pleased to say that we're also in late negotiations with at least two new end customers and I’m optimistic that we will be able to close at least one of these opportunities very shortly. All in all, we continue see to see very positive signs and broad opportunities for future growth across all of our business segments. Fiscal 2018 is expected to be a strong year in all fronts and given the opportunities and the pipeline we see ahead, I'm confident that 2019 will even be better. Now, I’d like to proceed to the question-and-answer part of our conference call. Operator?

Thank you. [Operator Instructions] And we will go first to the line of Ben Klieve from NOBLE Capital. Please go ahead.

All right. Thank you. Couple of questions. So, Mike, you talked about the government backlog being at a high since the TCS acquisition. I’m curious to what the benefit of HEIGHTS? Can you talk about how that backlog has shifted towards higher-margin work? And are you able to quantify kind of what the mix was two years ago versus today of higher-margin work versus more commoditized work?

Sure, Ben. I don’t think I can put it in terms of the percentage of backlog, but I do think it's fair to say that when we purchased TCS back in February of '16, that they were really chasing a lot of large commodity type service contracts and at some point we put the number out there that maybe it was $80 million to $100 million of business that we either decided not to go after or just short of wound down. And so, I don’t know, I think it's certainly better than where it was. There's still some work to do. We need to win the higher-margin stuff and that’s where our concentration is. So, we’ve got I think the product line pretty stabled. We are focusing in the Government Solution segment now on the BFT-2 program, which we think would be higher-margin than the commodity service. We are focusing on the over-the-horizon troposcatter program, which we think would be higher. So, now it's up for us to get the orders and bring them in and then we will see that improvement in the margin.

Okay, very good. Thank you. And kind of along the line to the BFT-2, I’m curious with the transceivers that you’re shipping now, do you know how quickly -- how quickly that will be kind of deployed after you ship? I'm curious how long maybe before the customer is able to judge the performance of these initial shipments of transceivers, once you’ve actually deliver them?

We’ve actually delivered a very small order a while back to the Army of about a 100 transceivers for exactly that some initial testing on their part to make sure that this transceiver does the job for them. So I don't anticipate any problems in terms of getting future orders. I think it's just a matter of when they decide to fund. As far as your questions of fielding, I think the Army is interested in fielding it almost immediately after we deliver.

Got it. I didn’t realize that the 100 had shipped for analysis, that’s great. Okay, perfect. And one more question for me here, with regards to the lower sales of the cyber training solutions that you talked about, can you kind of talk about the dynamics that are coming into play here? And the -- kind of lower than expected revenue in the third quarter, do you think that this a matter of orders just getting pushed to the right or are seeing -- are these awards that are kind of lost in the near-term?

It's a brand new product line. Most of the traditional cyber training business that we’ve done was really, I will call it human based. And this is a software-based product that we’ve been developing for the last couple of years. So what we're doing now is we're going out to customers and I think we mentioned some of them, Booz Hamilton, JPMorgan and even the military in the past. And we are going to them, there's number of opportunities that we are actively talking with them. We are taking feedback based on what they're telling us to that we need to do to the software to meet their needs and we're doing it. So I don't think any of these things from a big picture perspective are lost, but it has certainly taken us longer to get the product out the door than what we'd like. And so during our last business outlook assessment we made the decision to sort of just pull them out of our sales pipeline and when they close, they close and we will report them to you and we will be pretty happy because as you know with software it is a more profitable sale, because you’re expensing the R&D as you do the development.

Perfect. Very good. Thank you both Mike and Fred. Congrats on a good quarter and I will get back in queue here.

Thank you. And we will go next to the line of Mike Latimore from Northland Capital. Please go ahead.

Great. Thanks a lot. Excellent quarter there. On the government EBITDA margins, nice to see that improve some here. Is this kind of a good range to think about going forward or do you see kind of further improvement in government EBITDA margins?

We would love to hit 12.9% from an EBITDA margin every quarter in that segment. I don't think that is reasonable. You can see -- we mentioned some of the troposcatter stuff that we shipped to the Korean Peninsula and that really helps to the bottom-line. I think for the year, as I said on prior calls, we’re probably shooting for 7% to 8% for the year and on a very normalized basis that’s where I would expect government business to be until we start to get some of the BFT-2 hardware transceivers and volume going and even some of the troposcatter stuff. So we were on the path of increasing margins. It's just a question of how fast we can get there.

Got it. And you obviously, you mentioned that your -- I think you said your visibility is never been higher, and you expect growth and there is a good chance of growth in fiscal '19. Maybe as you look to fiscal '19, what would be sort of may be the top couple revenue driver at this point? So you have a lot in the mix, but which ones would be the most impactful [indiscernible]?

Mike, it really is across almost all of our product lines at the moment. Our satellite earth station business is doing good and showing signs as you know that’s a book-to-ship business. And we’ve been fooled in the past on when that rebound will come, but we’ve now seen a couple of quarters of sustainable growth is what we're using the term, and given the HEIGHTS business we are seeing that as Fred mentioned, sales this year have exceeded what we did in fiscal 2017. And so that -- I mean that's just a really good sign. The government side of the business, it's a question of timing of funding on a lot of things. So that’s very difficult to predict. But again, we're seeing growth there. So, in short, it really is everywhere and we're still thinking about in aggregate sort of around 5% or so next year until we get more orders. And I think it would be imprudent to think otherwise, but we think that's about the number when you look up everything in aggregate.

Got it. Great. And then on the -- just on the 911 and next-gen 911 deal, you mentioned with the large wireless operator. Have you started to deploy that? How long does that take to deploy? If you’ve started, how is the process going [ph]?

Yes, we’ve started to deploy it and its approximately over a 12-month period.

Okay, great. Thanks a lot. Excellent quarter.

Thank you. And we will go next to the line of Asiya Merchant from Citigroup. Please go ahead.

Good morning, everyone and congratulations on a strong quarter. I guess my questions were more along the lines of as you look out into fiscal '19, you provided some color on the -- how to think about top line. If you could also help us understand about the margins, the EBIT -- adjusted EBITDA margin, how are you thinking about that across the two individual segment? And then I have a question more on the modem side, satellite modem side and on the HEIGHTS platform, like what kind of competitive dynamics are going on there? Is there any pricing pressures that you’re seeing? Some of the stuff that I’ve been reading about is pressure is on the end customer on the satellite services. Are you feeling any of that on the equipment side from your customers? Thank you.

Let me kind of split your -- the answers to your questions. So as we think about EBITDA in total even for next year, I think if we put a 5% growth target for the moment now, I think that’s about the right way to look at the business. We see and you can see it in our P&L today, we've -- our biggest challenge right now is where do we invest because we have tons of growth opportunities out there and we’re continuing to invest pretty significantly in R&D activities. That even includes in the government segment, the BFT-2, and the BFT-3 opportunities that we see. It includes the troposcatter opportunities that we see. So we were investing in R&D there. In our satellite -- in our commercial side, the HEIGHTS platform, I mean, we are talking about a business that we hope will double if not triple out over the next couple of years, and it's a question of how fast that business will grow. So, again, we were taking the position, now we’re going to invest significantly in that business and we have and expect to continue to do so. On the 911 side of the camp, there's just tons of opportunity out there on the next generation side with text, video, voice, call handling and so forth. And so plenty of places for us to invest and actually result in incremental returns in the outer years and same thing on the location side, it's just out there. So when -- we look at '19, yes, we’re going to be continuing our R&D investments. So, but - yes, ahead of the revenue growth and everything and given I will call not conservatism, just prudency of product mix assumptions, we think about 5% adjusted EBITDA is probably the right way. And so I think when you add that all up, if FY019 should -- could we beat the 13% we’re targeting in 2018, I would like to, but we need to kind of flush that out with product mix because there is some sensitivity between the two segments which is why we couldn't get anything more specific until we see how the new order pipeline and timing comes in because we do have fluctuations from quarter-to-quarter.

As far as answering your question in terms of the effect on the HEIGHT solution of let's say pressure on bandwidth costs, I really don't see that at all affecting our HEIGHT sales. It's really two different cross parameters. HEIGHTS is a network product as compared to our previous products which were the SCPC products, which were really modems for the most part. This is a network solution and it's really intended to replace not only our high-end SCPC product line, but also the low-end TDMA product lines that are being offered by some of our competitors. So this is -- our HEIGHTS product line is essentially a modified SCPC solution that is a network oriented product line that should replace most of the TDMA applications because of their latency problems. So we look forward to having a pretty strong market, but it is a much longer sales than just selling boxes.

Fair enough. Thank you for the opportunity.

Thank you. And we will go next to the line of Kyle McNealy from Jefferies. Please go ahead.

Hi, guys. Thanks a lot for the question. A few here, if I may. So the commentary about the Q4 being the peak for adjusted EBITDA, Q3 for operating income, just curious if you could clarify that a bit what the driver of the difference is considering that there's not much between one than other. Is that GAAP versus adjusted or what are the big drivers there?

Yes, actually -- the latter part is exactly what you hit the nail on the head for. That is the difference between the GAAP and the non-GAAP measure. GAAP net income does reflect the stock-based compensation award that we do in Q4. So if you look at last year, you'll see a very similar metric. For purposes of adjusted EBITDA we pull the stock-based compensation out of that, given that's really not a cash item. So given in Q3, we had the Navy modem shipment. That contributed to the GAAP operating income, but when we look at Q4 that's not going to be in the GAAP operating income. So we will see a decline there, but on adjusted EBITDA we’re going to see a lot more stock-based compensation in Q4.

Okay, great. Thanks. And then on international revenue, it's improving, but still down at year-over-year. Is there anything additional you can give us on -- what trends are looking like internationally? And also remind us of your us dollar impact for international sales is, how much of the stronger dollar impacting trends internationally?

Yes, I mean, international sales are lower than been last year and we will probably finish the year with that trend. I would say two things to be mindful of. Number one, that doesn't include any international troposcatter stuff for the most part. So that’s where that lumpiness comes in. And from a dollar perspective, although the dollar has strengthened recently, there's the political issues that exist out there. We haven't been able to see anything, what I would call, material customers not purchasing our product, but we do kind of know it's out there. But the number one driver I think is just lack of international over-the-horizon opportunities more than anything.

Okay, great. Thanks. And then it looks like the third quarter was impacted pretty positively for U.S government sales by the satellite modem contract with the U.S Navy. Just wanted to see if you have any kind of color that you can provide on how lumpy that might be coming in going forward? Is there particular quarter or time throughout the year that the Navy is more inclined to make purchases against that IDIQ based on their fiscal year and trending there?

I think the answer to that really is a matter of -- it's up to the U.S. Army. However, we do understand that they are -- let's say, expecting to place orders relatively quickly. And as Mike mentioned during his presentation, we not only get the initial funding order, but we actually shipped most of the units in the third quarter. The Navy does want to have those shipped pretty quickly. So I anticipate that the orders will come pretty quickly. It's a 5-year program, if I were to bet on it. It would probably be over a 3-year period, not a 5-year period.

Okay, thanks. And one last one on the tropo contract there, that’s currently out with the U.S. Army. We understand there's another -- you’re not the only bidder on that contract. Can you give us a little bit about what competition is looking like? How you think you’re positioned with your product competitively in there?

I guess the only thing we can tell you is the bids were submitted back in May. And we did supply a couple of terminals for the Army to test to their specifications, which has now finished. We certainly know that we did very well. We did better, much better than the performance requirements of the RFP. We do not know what the competition has or has not done. So we really can't tell, but our bids are in. We expect the Army to come back to us soon hopefully, but I would say we don't look for any information for at least 30 to -- and it could be as long as 60 days.

Okay. All right, great. That’s it for me. Thanks a lot. Congrats on the quarter.

Thanks.

[Operator Instructions] We will go next to Chris Quilty from Quilty Analytics. Please go ahead.

Mike, I think you had said you expected the Q3 operating cash flows be kind of similar to Q2 and it turned out much better than expected. Is that just timing related issues or something that you’re looking at a better cash flow outlook for the year?

I would say it's mostly operational efficiencies that we're able to achieve. We are pulling stuff out -- you can call it, off the balance sheet, right? We are improving our AR turns and our inventory turns. We did have a buildup in inventory and so we tried to -- there managed the payable cycle a little bit. I would -- I don’t know, 60% of the benefit was operational, 40% could be timing. But I think as we’ve said, Chris, in our prior conference call, 2018 was expected to be a cash flow -- free cash flow perspective little bit the same or lower than 2017. It's sort of what we’re thinking and based on how things play out in Q4, that’s going to make that -- that will decide what will happen and then it's just really timing. But if you look at another to 2019, 2019 should be the same or possibly stronger than 2018.

Got you. Thank you for the guidance. And so a question just on the earth station business in general, it sounds like obviously you feel you’re taking share with the HEIGHTS platform, but where do you see the overall health in the market as you look forward next 12 to 24 months, given down trend in GEO orders, you’ve got LEO changes. How does that all mix together to impact you?

I think we see the satellite market really kind of turning around. I think it's had a rough period for the last, let's say, five years and we see even with the bandwidth pressure on cost and so forth, there's lots of satellites being programmed to be shot up there and lots of systems in the development stages. So we actually look forward to much better times in the satellite industry, specifically for us with our HEIGHTS platform which I think our HEIGHTS platform we believe really answers the questions and the requirements, technology requirements for the LEO and MEO orbiting satellites. Not only the GEO HEIGHTS throughput satellites, but also the LEO and MEO, because those are different, those are tracking systems and HEIGHTS has to address that. Having said that, our HEIGHT solution has been long time in the making and we have started to get market share and we hope to kind of increase our revenue in that area from year-to-year and I think we are just getting started.

And are there any big solicitations that you're actually looking at currently?

There are a number of big solicitations, as you say, big can be, it's a matter of definition what’s big. We normally have -- in that business it's mostly book to ship business. As such, I think there's lots of development programs out there in terms of future systems.

Very good. Thank you.

And at this time, I would like to turn it back over to the company for closing remarks.

Okay. Thank you again for joining us today and we look forward to speaking with you again in September. Thank you very much. Bye.

We would like to thank everybody for their participation on today’s conference call. Please feel free to disconnect your line at any time.