Comtech Telecommunications Corp (CMTL) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Comtech Telecommunications Corp's second-quarter fiscal 2017 earnings conference call. At this time all participants are in a listen only. Later we will conduct a question and answer session. (Operator Instructions)

As a reminder, this conference is being recorded Thursday, March 9, 2017. I would now like to turn the conference over to Ms. Maria Ceriello of Comtech Telecommunications. Please go ahead, ma'am.

Thank you and good morning. Welcome to the Comtech Telecommunications Corp's conference call for the second-quarter of fiscal 2017. With us on the call this morning are Fred Kornberg, Chief Executive Officer and President of Comtech; Michael D. Porcelain, Senior Vice President and Chief Financial Officer; and Michael Galletti, our Chief Operating 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, including among others, the risk that Comtech's and TCS's businesses will not be integrated successfully.

Actual results could differ materially from such forward-looking information. Any forward-looking statements are qualified in their entirety by cautionary statements contained in the Company's Securities and Exchange Commission filings.

I am pleased now to introduce the Chief Executive Officer and President of Comtech, Fred Kornberg. Fred?

Thank you, Maria. And good morning, everyone, and thank you for joining us on this call.

As announced yesterday afternoon, we reported our second-quarter results of $139 million in revenues and operating profit of $12.8 million, and an adjusted EBITDA of $13.5 million.

Consolidated backlog as of January 31, 2017 was $453.3 million and during the second-quarter, we achieved bookings of approximately $130.4 million with particular strength in our Commercial Solutions segment.

When I resumed the CEO role in September of 2016, the first task or first priority that I gave to our management team was to increase shareholder value. To do that, we must be more profitable, we must be more competitive and we must grow. Today, I can state that I'm pleased at the progress that we are making on all three fronts. First, I have updated our fiscal 2017 revenue target to a range of $570 million to $580 million. This new range reflects an updated reflection and assessment of our decision to focus less on bidding on large U.S. government contracts with low margin conditions and focus more on pursuing U.S. government contracts for our niche products with higher margins.

Second, we have been hard at work initiating and achieving cost reductions across the company. As such, we believe we will be able to mitigate the bottom-line impact of this strategy change and are maintaining our Adjusted EBITDA goal for the year of approximately 12.0% of revenues or $70 million.

Although, there is still work to do, I believe we are on the right path forward. I will talk more about our implemented changes in our Government Solutions segment and our overall business in a few minutes.

But first, let me turn it over to Mike Porcelain, our CFO, to discuss our financial results in more detail. Then I'll come back and provide some additional comments. Mike?

Thanks, Fred, and good morning, everyone. Consolidated net sales for Q2 were $139 million. These sales include approximately $75.9 million of sales as a result of the TCS acquisition. Of the $139.0 million, approximately 32.1% were generated from US government end customers, 32.1% from international end customers, and 35.8% from domestic commercial end customers. Net sales in our Commercial Solutions segment were $82.1 million or 59.1% of total net sales.

During Q2, this segment benefited from sales of our location and messaging-based platforms and safety and security technology solutions that we now offer as a result of the TCS acquisition. Sales of TCS products in this segment during Q2 were approximately $37.4 million.

The remainder of the segment sales in Q2 consist of Comtech legacy products which we now refer to as Communication Technology Solutions such as our satellite earth station products and traveling wave tube amplifiers. Our book-to-bill in this segment during the quarter was 1.22. Bookings for our safety and security technologies and enterprise technologies solutions were particularly strong. This quarter included incremental orders for existing next-generation 9-1-1 contracts and renewals of long-time customers for some of our mapping applications.

In addition, we received significant bookings during the quarter for our amplifiers that are used in the growing in-flight connectivity market. Shipments of these amplifiers and related revenue recognition are expected to occur in the second half of fiscal 2017. We are also expecting additional orders for the in-flight connectivity market in our Q4.

Backlog in this segment is the highest it has been at any quarter end since our acquisition of TCS. Based on potential orders in our pipeline, and the anticipated release of our next version of our Heights Networking platform, which is expected to result in an increase in future satellite earth station sales, we ultimately believe that bookings in this segment will remain strong for the second half of fiscal 2017.

Turning to our Government Solutions segment, net sales were $56.9 million or 40.9% of total net sales. During Q2, our Government Solutions segment benefited from a variety of new advanced communication solutions that we now offer as a result of the TCS acquisition. These solutions include field support, space components and cyber-training. Sales of TCS products in this segment during Q2 were approximately $38.5 million with the remainder of the sales in the segment being derived from Comtech legacy products which includes sales of our over-the-horizon microwave products, solid-state amplifiers and BFT-1 sustainment support services. As Fred will discuss in more detail, we are continuing with our tactical strategy shift in this segment.

In this regard, our book-to-bill ratio during Q2 in this segment was 0.53 and reflects: the impact of implementing our strategy; a delay in the receipt of a $20 million plus order that we still expect to receive during the second half of fiscal 2017; and a temporary and brief lull in ordering by the US government that we believe occurred as a result of the change in the US presidential administration.

Based on the opportunities in our order pipeline, we believe that order flow in our Government Solutions segment during the third and fourth quarters of fiscal 2017 will significantly increase from the level we achieved in our second-quarter of fiscal 2017.

Now let me give you some color on our operating metrics. Our gross profit in Q2 of fiscal 2017 as a percentage of consolidated net sales was 38.3% which was similar to what we achieved in Q1. Although there may be some quarterly fluctuations for the rest of the year, we believe that gross margins for the second half and aggregate will be similar to the level we achieved in Q2.

As discussed on prior calls, as a result of the full year impact of the TCS acquisition, anticipated mix changes and lower year-over-year BFT-1 intellectual property licensing fees, we expect our fiscal 2017 gross margin percentage to be lower than the level we achieved last year. On the operating side, SG&A expenses were $31 million in Q2 of fiscal 2017 or 22.3% of consolidated sales.

Research and development expenses were $13.3 million or 9.6% of consolidated net sales. Our spending consisted of $11 million of spending in the Commercial Solutions segment, $2.2 million of spending related to the Government Solutions segment, with the rest constituting amortization of stock-based compensation, which is not allocated to our two operating segments.

Total stock-based compensation expense, which is recorded as unallocated operating expenses, was $1 million for the second-quarter of fiscal 2017 and we still expect that amortization for the year to approximate $5 million. Amortization of intangibles was $6 million in Q2 of fiscal 2017.

Before discussing our operating income and adjusted EBITDA metrics, let me bring you up-to-date on several TCS IP litigation matters that have been hanging over our heads for a while. During the quarter, there were several positive events.

First, we did settle a large TCS litigation case for a non cash settlement of approximately $10.0 million that benefited our operating income. Cash payments related to the settlement are expected to occur in the second half of fiscal 2017 and are expected to be immaterial.

Second, we did settle a second case in principal with another party who had sued us for patent infringement. The cash payments associated with this settlement are also expected to be immaterial.

Third, we have entered a final settlement negotiation in regards to another TCS litigation matter. This TCS case went back to 2012 and there have been many court motions going back. Ultimately, we have decided to settle the matters on terms indicated by the court and are negotiating a final settlement as we speak. Like the other settled lawsuits, this settlement is expected to result in an immaterial amount of cash payments.

We are really pleased with the progress we have made on the TCS intellectual property matters and hope to avoid such in the future.

On a GAAP basis our consolidated operating income was $12.8 million in Q2 of fiscal 2017. Excluding the impact of this non cash settlement, operating income would have been $2.8 million or 2.0% of sales.

On a segment basis, operating income in our Commercial Solutions segment was $5.9 million or 7.2% of related segment net sales and operating income in the Government Solutions segment was $2.3 million or 4.0% of related segment net sales. Our adjusted EBITDA, which excludes the $10.0 million favorable settlement, was $13.5 million or 9.7% of consolidated net sales. Adjusted EBITDA in our Commercial Solutions segment was $12.7 million or 15.5% of related sales and our Government Solutions segment was $4.7 million or 8.3% of related net sales.

Given our overall sales and spending plans for the remainder of fiscal 2017, we expect that adjusted EBITDA in dollars and as a percentage of net sales will increase in Q3 and Q4 as compared to Q2, with Q4 still expected to be the highest quarter by far.

Let me now talk about our taxes, interest, expense and our balance sheet. Looking forward, the company currently expects that its fiscal 2017 effective tax rate, excluding discrete items, will approximate 35.5%. Interest expense was $2.9 million in the second quarter of fiscal 2017 and principally reflects interest on our secured credit facility. Based on the type, terms, and amount of outstanding debt, including capital leases that we currently expect, we estimate that our effective interest rate, including amortization of deferred financing costs will range from 4.5% to 5.0% of total debt. On a cash basis the interest rate percentage is lower.

At January 31, 2017, we had $63.1 million of cash and cash equivalents and we generated cash flows from operating activities of $17.7 million. I want to point out here, that the $10.0 million non-cash operating income pick up that we took in Q2 did not result in cash proceeds to us. The cash flows of $17.7 million were all organic. Clearly, this was a spectacular quarter of cash flow generation and reflects a concentrated effort across our company to better manage working capital.

Total debt, as of January 31, 2017, excluding unamortized deferred financing costs was $253.8 million. Looking forward, we continue to expect to generate cash flows from our operating activities during the second half of the year, however, because our revenue and adjusted EBITDA will be somewhat back-end loaded we may see some working capital increases towards the end of the year.

Given our business outlook and our strong cash flows from operating activities, we maintained compliance with our senior credit facility and we believe we will do so for the remainder of the year. As a point of reference, our leverage ratio of trailing twelve months adjusted EBITDA to net debt was 2.57x as compared to a maximum allowable amount for Q2 of 3.0x, so we have some flexibility. This maximum allowable ratio of 3.0x will not change in Q3 and will decrease to 2.75x for Q4.

We are, in order to obtain increased flexibility and other enhancements, continue to have substantive discussions with our financial lenders. We believe we are on track to obtain additional flexibility not only for 2017, but 2018 and beyond, and hope to announce some enhancements to our credit facility soon. Adding it up, all in all, it was a really good quarter. On the bottom line, we delivered GAAP diluted EPS of $0.28 per share in Q2 of fiscal 2017. Excluding the $10.0 million non-cash adjustment related to the litigation settlement our EPS would have been a penny.

Now, let me turn it back to Fred who will discuss our business and further details. Fred.

Thanks, Mike. As I mentioned on our last earnings call in December 2016, we believe our business is at a turning point and I'm really excited about the growth opportunities that are ahead of us. Let me give you some color on what is happening in each of our segments.

In our Commercial Solutions segment, we are a leading provider of satellite communications networks and products such as satellite earth station modems, up and down frequency converters, and solid-state and traveling wave tube amplifiers. We are also a leading provider of public safety systems such as the next-generation 9-1-1 technologies and enterprise application technologies such as messaging and trusted location based technologies.

The Commercial Solutions segment, on a long-term basis, should approximate about 50% of our revenues and is aligned with several large growing end markets. Our satellite-based communications products participate in the satellite back-haul and network services market. In the satellite modem area we remain the undisputed leader in single channel per carrier, driven primarily by our proven ability to deliver the most bandwidth efficient modems. In the last few years we have also focused on marketing and research and development of our new Heights Network solution for use with the new high through-put satellites.

Just this week, we announced our next version of our Heights Dynamic Network Access technology or H-DNA at the satellite 2017 exhibition in Washington, D.C. At the show we introduced our new H-DNA technology, which we believe offers an uncompromised step change in performance and exceptional end-user qualities of experience. Heights or H-DNA is intended to meet the demands of today's traditional fixed satellite services or FSS while providing distinct advantages for those already using or considering migrating to high through-put satellite systems.

This HTS is an entirely new market for us but one which is much larger than our traditional SCPC market. As I said, we have been developing Heights now for a couple of years and believe that we will begin to see tangible rewards for this effort in the second half of fiscal 2017 and beyond as more and more users start to operate over the new HTS or high through-put satellites.

Another area we're excited about is the in-flight satellite based connectivity market. Our solid-state power amplifiers help enable commercial airlines to provide inflight connectivity services to their passengers. Here, we are a qualified supplier on the GoGo system. This is a new and growing market for us and we believe this area will be a significant revenue contributor for Comtech as we rev up shipments in fiscal 2018. On the public safety side, our solutions include 9-1-1 call routing for wireless, 9-1-1 routing over voice or over Internet networks, and the next-generation 9-1-1 solutions for state and local public safety operations.

We have built partnerships with key system integrators, such as Motorola and General Dynamics and we're actively participating in multiple RFP responses. We believe we're seeing the benefit of our overall strategy as our pipeline is full and we've moved into the last stages of the selection process for several states.

At the same time, we continue to drive our multi-year next-generation ESInet deployment for the state of Washington and are continuing to deploy the next-generation systems in California, Tennessee, Indiana, and Florida. We believe that this market will continue to grow for many years ahead and that the current political environment will be helpful to facilitate such growth.

In fact, just a few weeks ago, two US senators, Senator Bill Nelson of Florida and Senator Amy Klobuchar of Minnesota, introduced the draft bill called the next-generation 9-1-1 Act of 2017. This draft bill addresses critical needs for the 9-1-1 community and recognizes that a modernized 9-1-1 system is a national public safety and Homeland Security priority. If this bill is passed, additional federal grants would become available to local communities across the United States. No doubt, this could be very helpful to our growth plans.

Turning to our enterprise and trusted location solution product line, here, our solutions include GPS-enabled software which we provide for Verizon's navigator services which makes it easier for users to find, locate, and get directions to various points of interest. We also offer text-messaging solutions and we believe we are one of the leading providers of text-messaging in North America, providing such service to Verizon and other carriers.

We offer carrier grade platforms and high-performance short messaging services or SMS routing, including Application Programming Interfaces or API's for cloud messaging centers, wireless intelligent gateways and a feature rich operator grade messaging platform. We also believe that we can also bring certain of these technologies to international mobile carriers.

We continue to market products and solutions and are pleased with our customer feedback from our newly released location studio trademark system, which was recognized recently by the Cellular Telecommunications Industry Association, or CTIA, as a winner for the Industrial Internet of Things product of the year. Looking forward, we anticipate future location studio-enabled applications for us in the connected car, the mobile OEM and data analytics domain.

At this point, let me address the government markets within our Government Solutions segments where we serve large government end users that require mission-critical technologies and systems. Our government solutions are primarily sold to US Department of Defense agencies and primarily consist of C4ISR. Our solutions include satellite, line-of-site and troposcatter ground terminals, management and sale of bandwidth and RF power and switching technologies that are used in the electronic warfare applications and identification friend-or-foe applications.

As we announced back in October, we continue to implement the tactical shift in strategy to focus less on larger commodity service contracts with more emphasis on winning contracts for our niche products with higher margins. Earlier in the week, we announced that Michael Atcheson has joined our company and will now oversee the TCS legacy Command and Control Technologies group. Mike will be leading this tactical shift in strategy going forward. Rising to the rank of Colonel in the U.S. Marine Corps, Mike brings more than 25 years of military and civilian contractor experience and has led a large team of deploying complex high-tech defense systems. I'm pleased that Mike has joined our company.

Mike's immediate focus is on the number of large opportunities that we're working on, including the SNAP VSAT program. The U.S. Army intends to purchase new SNAP equipment and maintain their fielded SNAP systems for the next several years. We are the incumbent on this contract and are getting ready to bid on the next large contract award. Additionally, on the BFT-1 front, we continue to work with the U.S. Army and ultimately expect to receive additional sustaining contract work to continue to perform services beyond March 2017.

Based on customer feedback we're getting, we believe the extension of our contract could be in the range of $20 million to $40 million over five years. This contract is expected to be placed by March 31st or this month to ensure continued service for the U.S. Army. We also believe that the U.S. Army will ultimately purchase a next-generation system. Our primary goal here is to continue to provide the U.S. Army with outstanding support, doing so should position us well to participate in their next-generation platform.

In our Space Components technology group, we have several opportunities supporting the Japanese Exploration Agency or otherwise known as JAXA. We're expecting an award for $20 million plus during the second half of fiscal 2017 for the upgrade of JAXA's Christmas Island and Guam Down Range Tracking Stations to accommodate their upgrade of existing fleet of launch vehicles.

On the cyber front we continue to see interest from the DoD and select national intelligence entities for our cybertraining performance score--scoring tool which enables real time performance-based training. As it relates to our over horizon microwave or troposcatter solutions, there is no doubt that the U.S. Army now and the Marines have large and critical needs for troposcatter terminal replacements, which we refer to as the TRC-170 replacements. There is now finally a program of record. We have been waiting for this opportunity for a long time and given the size of the program, the U.S. military intends to seek proposals from industry.

In summary, over the course of years, if successful in this program, we could generate a couple of hundred million dollars of revenue for Comtech. Based on feedback we have received, we understand the draft RFP will be sent to industry shortly with the final RFP in May 2017. The ultimate award would be sometime in 2018. Given our market leadership and proven history of working with the Army and the Marines, we believe we are well positioned to win this project.

With that, let me remind you that yesterday our Board of Directors declared a dividend for the third quarter of fiscal 2017 with $0.10 per common share payable on May 19, 2017 to shareholders of record at the close of business on April 19th, 2017. Future dividends remain subject obviously to compliance with financial covenants under our secured credit facility as well as Board approval.

Now, I finally would like to close with-- that I am very pleased with our progress and performance to-date, I'm excited about Comtech's future, and I believe our best years are ahead of us. Now, I'd like to proceed to the question-and-answer period. Operator?

(Operator Instructions). We will take your first question from Tim Long of BMO Capital Markets. Please go ahead.

Thank you. Two questions, if I could. First, the change in strategy on the government side focused a little bit more on profitability, I get you for the 12% EBITDA-- adjusted EBITDA margin this year. But when should we start to see a gross margin benefit and could there be more margin leverage as that strategy plays out into the next few years? That's number one. And then secondly, Fred, I think you mentioned commercial should ultimately be about 50% of revenues. It's running higher than that now and the government seems like there will be some more focus on profitability. So how does that 50/50 split work? Is that incumbent on some of these really large troposcatter deals you're talking about or what else is going to help offset the strategy change in government to bring that up to closer to half the business? Thank you.

Okay. As far as the strategy, as I mentioned in our last call and prior to that, we're really focusing now on government programs more so for our niche products, which carry a very good margin. We're obviously not participating in some programs that we -- let's say the TCS company would have -- would have participated in the low margin service contracts. So I think what you're seeing is our -- our downdraft in the government business revenues will really occur during 2017.

At the same time that we're downdrafting in that area, not participating, we are -- we are looking and participating in programs that will start in or be placed in 2018. So I think as far as gross margin improvement and revenue improvement, I think we'll start to see the government improvement in that side starting in 2018. As far as the revenue being 50/50, I think our strategy is to try to maintain that revenue at 50/50. Obviously, today we've had much more success with the Commercial Satellite Solutions segment than we have in the Government Solutions segment.

But I think we see that -- although we see it that segment growing in 2018 as well, we see government -- the government business catching up, specifically in the area. -- One area that you mentioned is obviously the troposcatter business. We've been -- we've been participating with the army and the Marines in the troposcatter area for years and it's never -- never been fully funded. Well, there is now a program on record and the funding associated with it and it will get into two hundred to three hundred million dollars for us over five years. Will the immediate -- immediate impact be that great? Probably not. I think more -- more likely we'll see 2018 maybe to the tune of $30 million to $35 million. And then the rest of the years to follow.

Okay. Thank you.

And we'll take our next question from Mark Jordan from Noble Financial. Please go ahead.

Good morning gentlemen, one question on tropo. You're talking RFPs being out near term here. Do you know if they're going to specify or require backward compatibility of the TRC-170?

That's a good question, Mark. I think we're certainly -- we're certainly hoping that they do because we've supplied our modems and into the TRC-170. I believe that the government because it's a large -- large program will try to not make specific -- specific bandwidth solutions available, similar to what we had with the BFT-2 situations. So it's something that we're looking at. I think as far as the RFP coming out, I can add more color for you. We expect it almost momentarily but then we also know that things do slip. We do think that in May the RFP should be out. What will happen is, as the RFP comes out, the Army has decided to request all bidders to supply two tropo terminals for actual field-testing to make sure that the tropo terminals will work.

I think that probably puts us at a very good advantage because we already have fielded tropo systems with the Marines and with the Army that we've supplied before. And some of our systems are actually nomenclature. So we feel pretty good about that. But after a field testing trial of about eight weeks, the Army will then, I suspect -- and this is just my speculation -- they will come back with kind of a best and final and go on from there with a -- a project contract probably in 2018.

Okay. Michael, you talked about working with the banks to gain greater flexibility which could allow you to do other type of acquisitions, etcetera. On last quarter's call you also said that you thought that getting that agreement was fairly imminent. What seems to have been the slip? Is this an issue that's not quite as pressing now? Or is there some specific sticking point?

No, it's exactly -- it's a good question, Mark. It's the latter, given the strong performance that we had during the quarter, there's not -- there's not an urgent need for us to go out and rush and do an amendment. So we want to get the right agreement for us, not just for the short-term, but for 2018 and beyond. So our conversations have been almost on a week to week basis with the banks as we try to come up with an agreement that makes sense for them and makes sense for us. We think that we're pretty close to doing that and the banks have their own approval requirements that they got to go through so our hope is that we would announce something soon that will give us better flexibility than what we were just thinking even three months ago.

Okay. Final question from me. Obviously good news on the three litigation cases that seem to be settled with sort of nominal cash impact. Are those the major cases that were outstanding? What other litigation do you have out there that could be meaningful?

Yeah. The we did -- we did resolve three cases this quarter, including the Mississippi case where there was a family that got involved with a 9-1-1 situation. So we have one outstanding case that we are continuing to work towards an aggressive settlement position where -- when I say aggressive, we want to do it quick. We obviously need the other party to do so but I think ultimately we don't think that a settlement would have a material impact on our -- on our financial statements. So we kind of -- we kind of think we have it bounded but we haven't been able to come to an exact settlement with the third party yet. But our hope is soon but we need that third party to agree.

Thank you very much.

And we'll take our next question from Stanley Kovler of Citi Research. Please go ahead.

Hi, good morning, and thanks taking my question. I just wanted to ask you if we should be thinking about any potential impact on your business from the new FirstNet program that's currently being rolled out, particularly on the 9-1-1 piece if there will be any pull-through from that buildup on the wireless side and then I have a follow-up. Thank you.

Yeah. So in terms of the FirstNet program, I think we kind of view it as ancillary or tangent to our business. We should get pull-through and it's not going to change our existing business and obviously as the system becomes more important overall, all of the systems need to connect and so we do think there will be pull through. The FirstNet program in totality is something that's been talked about for years and years and years and it's extremely complicated. It's an extremely long sales cycle. So, although there are other companies talking about it having some immediate impact to their numbers, we still see our best case for growth is on the Next-Gen 9-1-1 side whereas companies want to go to a test messaging video over 9-1-1 and an overall Next-Gen 9-1-1 system. That's where we see the immediate growth but FirstNet over all should benefit us.

Thanks. And could you just provide a little bit more detail on the second half gross margins? Obviously, we previously expected gross margins to come back in the second half of your fiscal year, more so related to the government business, but what should we think about as far as gross margins on the commercial side and with the new programs that you have in place for 2018 potentially with troposcatter and other programs. Could we start to see gross margins get back to over 40% at some point? Thank you.

Sure, Stanley. So I would tell you to think about our gross margins more in aggregate than by segment because we do have some inter-company manufacturing that goes on between the segments.

Just a couple of comments. On the Government Solutions segment side, we are actually likely to see a downdraft in gross margins because of the wind down of the BFT intellectual property thing, which by Q4 will no longer be in our financial results. So that's a $2.5 million drop, if you will. That's the negative. On the good hand, we think we'll be able to absorb it in the numbers given the growth in the other areas and bookings and margin profiles that we're seeing in our backlog. We would love to get to 40% gross margins in total. That's certainly a near term target for us, and we obviously need the bookings and execution to come in, but we did do 38% and change this quarter, so it's not such a stretch for us to get to 40%. In our Commercial Segment, Stanley, we have pretty good contribution margins. So when we get incremental revenue it's even possible that we can pick up almost 45% to 50% contribution margins most of that does appear in the gross margin line.

So the way to think about our business model is incremental revenue drops to the bottom line real quickly and, if you think about the way we're giving you our projections, you kind of see that in Q4 is that in incremental revenue we expect our Q4 revenue to be the peak quarter of revenue for this year and resulting adjusted EBITDA margin for the most part is coming from that incremental revenue.

Thank you. I guess if I could just follow up. Could you give us an update on some of your other verticals, like the manufacturing or energy verticals and what you're seeing in those areas? Thank you very much.

Yeah, I mean, I think when you say the energy side Stanley, I'm assuming that you're seeing what we're seeing on the international market side in our satellite earth station business. We do see some continued challenging conditions in the international markets. Although, oil prices have rebounded, the dollar continues to be strong overseas. So from that perspective our international market is still struggling.

On the other hand there's been this huge pent up in demand that's being built as a result of the Heights product so we hope that the Washington, D.C. satellite show, which is really, it's one of the premiere shows in our specific space, will ultimately result in the orders and based on the feedback we're hearing, we seem to be on track for that to occur. In terms of the manufacturing vertical, I'm assuming you're referring to somewhat of the connected car market that we're involved in with the enterprise space. And, again, it's a longer term play, the manufacturing vertical using that phrase is not a material portion of our business, but it is a growth area that we are focusing in on and that will take some time to play out.

Thank you.

And we'll take our next question from Mike Latimore from Northland Capital. Please go ahead.

Hey, thanks. Very nice quarter there, guys. Just looking at the commercial segment for a second on the 9-1-1 services within that, is that revenue area growing? And then second, did you say you had kind of a big renewal contract in the quarter?

Sure. Yeah. The revenue in the 9-1-1 portion of the business that we call safety and security is growing and it's growing very nicely. During the quarter, in addition to some contract renewals that occurred during the quarter, we actually did get some additional work related to the state of Washington as that contract scope continues to increase, which is one of the nice things about these large contracts. As you get more deeply involved with the customer, things become bigger and more important and you can get to pick up some additional work. So yeah, the revenue is growing and the opportunities are growing and we see some good things ahead of us.

And on the Washington deal, do you expect -- how is deployment going there? Do you expect kind of an uptick in deployment in the fourth-quarter?

The answer is yes, and it is reflected in our -- in our guidance and our thinking. So yeah, you'll see that really in our Q4, which is one of the reasons that the Q4 revenue and adjusted EBITDA is expected to be higher. But you know that's stuff that we have in our backlog and based on the timing of the deployment and the way the revenue recognition works, we should see that benefit in Q4.

And then Mike, did you say you expect EBITDA to grow sequentially throughout the last two quarters.

Yeah. We are expecting -- I mean, we did $13.5 million of EBITDA in Q2. We're expecting just a few million dollar increase in Q3 with significant, significant EBITDA in our Q4 as the revenue comes in.

And just last, with these -- with the litigation settlements, do you see a notable drop in legal costs next quarter?

Yes. Absolutely true. It's one of the reasons why our EBITDA in the second half is going to be a little bit better. We still have that one case that's out there where spending still continues but yeah exactly. As a result of the settlements of these lawsuits, we are expecting our legal spend to drop, absolutely.

All right. Thank you.

And we'll take our next question from Glenn Mattson of Ladenburg. Please go ahead.

Hi. Thanks for taking the question. You used to quantify that in the past, the litigation expense what it would be for the rest of the year do you do that still or --

Well, we've kind of thrown out numbers, Glen, of somewhere between $5 million and $10 million and we've not been specific about it because we obviously didn't want the other party to get a sense of how we were looking at the cases. So we are -- we are down to sort of one case. And it obviously will be on the lower side of that -- that number is the way to think about it. But there's definitely a drop in spending from the first half to the second half.

Okay, great. And then on the Next-Gen 9-1-1 interesting comment that you're in the late stages of selection for several states. I guess can you talk about some of the dynamics that are going on, I mean, perhaps your partnerships with Motorola and GD are helping, but maybe some of the reasons why you think you're going to win or combat competitive landscape is as you look to choose those deals?

I think generally -- generally I think we're partnered with, as you mentioned, partnered with Motorola and GD. And typically, the third -- the third bidder is usually someone like AT&T. So we kind of have two-thirds -- two-thirds of a chance of winning these contracts. I think and all of these areas in the pipeline, you can assume that all three of those prime contractors are still involved.

Okay. Great. So is it -- are the service levels about the same and you're competing on price in some cases? Or is there competitive advantage you have, you think?

There are competitive advantages and they're different for each of our partners. But I think it's not a -- it's not a total let's say qualified bid and then low price. It is -- each bid is different.

Okay. Great. And then I guess, on the -- still on the commercial, did you say you signed some or a renewal for mapping and was that with your largest customer?

Yes.

Okay. Is it a multi-year, does that go year do year? How does that work?

There really is optional renewals and it's really on a year-to-year basis.

Great. Nice quarter. Thanks.

(Operator Instructions) We'll take our next question from Kyle McNealy from Jefferies. Please go ahead.

Hi. Thanks, this is Kyle for George Notter. Just wanted to ask a little bit more about your segments and how they may track for the rest of the year for you specifically in light of your revised guidance. Would a majority of that revision come out of the Government Solutions segment given your commentary about transitioning away from the lower margin revenue? And I guess, could there also be some additional growth in (inaudible) Commercials Solutions so the step down in government might be even more than the $25 million difference in your guidance?

Sure. So, Kyle, yeah most of the revenue assessment change that we've made is really in the government side of the camp. We are expecting our sales in Q3 to be slightly lower than Q2 and that will be in the government segment. We are expecting our commercial segment to be the same or slightly higher in Q3 with incremental increases in Q4, most of that coming from the Heights products that we are expecting to deliver in Q4, along with the in-flight entertainment amplifiers that we have in our backlog.

So the backlog is sort of supporting a trajectory, if you will, of our commercial business sort of being slight -- similar to what we did in Q2, slightly higher in Q3 with significant increase in Q4. Our government side is kind of staying slightly lower in Q3 with a big pick up in Q4. Again, a lot of that is supported in backlog already, given that we have $453 million in our backlog at the moment. We expect obviously incremental bookings in Q3, that $20 million we're expecting shortly, and there's other stuff that we expect to occur in 2017 that will also result in revenue in Q4.

Okay. Thanks. And then just I believe you mentioned earlier that the Government Solutions segment may actually have lower margin in the back half of the year than the beginning because of specifically the -- because of the BFT license revenue coming out. I'm just trying to reconcile the lower revenue versus the reconfirmation of your EBITDA guidance and are there any other items at play that we should be thinking about?

Sure. Again, same comment and, again think about it from an EBITDA perspective. Our EBITDA in our Government Segment will be impacted as that IP fee sort of rolls off but offsetting that will be the incremental revenue from these contracts in Q4. So again from a segment perspective, we're expecting a drop in the EBITDA in our Government Segment in Q3 before it increases to Q4 with Q4 being our peak. On the commercial side, we are expecting sequential, sequential growth in EBITDA. So even though we're expecting our revenue in our commercial segment to be the same or slightly higher in Q3, with increase further if Q4 and EBITDA will follow along that same trajectory.

During the quarter, we've also made various cost reductions and so those cost reductions are not yet reflected in our Q2 results and you'll see that come into play in Q3 and Q4 which is why, I think I said earlier in the call, if you think about our Q3 in total, we did $13.5 million of EBITDA in Q2, you can think about Q3 being higher by a couple million on the EBITDA line in aggregate with the rest coming in Q4, Supported by our backlog and the timing of the stuff that we've been talking about.

Okay. Thanks. Can you give us a sense once you got into a normalized steady state of your business (inaudible) lower margin government revenue comes out, how much of a gross margin impact that might be in the longer term? Is it like 200 basis points? Is it more? Is it less?

Well, I think the way I would say it this way is we still need some time for it to shake out. We are targeting as Fred mentioned 12% adjusted EBITDA margins in total. If you look at it by segment, our Commercial Segment did 15.5% adjusted EBITDA in Q2. We think with incremental revenue and incremental profit, we can get that close to 20%. And that's not a crazy number because if you look at what we did in Q4 of 2016, we did 19.3% adjusted EBITDA margins. We do need the revenue to come in to achieve that. But that's the way we're thinking about it.

In the Government Solutions segment, and, again there's lots of blended mix, could we get to a 10% margin in the long-term basis? That's not unreasonable. And so obviously on a longer term basis, we would -- we would be -- we would certainly say we would like to be higher than 12% but we're not going to put out a number at this point. We just need some of these contracts to come in and kind of still work through our cost reductions before we get more specifically. But in aggregate, we have a longer term plan to achieve higher than 12% adjusted EBITDA margins but that's the number we're shooting for right now and we'd like to achieve that first.

Okay. Thanks a lot.

And there appears to be we have no further questions at this time. I would like to turn the call back over to the Company.

I'd like to thank everyone for joining us today and we look forward to speaking with everybody again in June. Thank you very much.

This concludes your teleconference. Thank you for your participation. You may now disconnect.