Thank you for joining the BigBear.ai Second Quarter 2022 Conference Call. This call is being recorded. And at this time, all participants are in a listen-only mode. And a question-and-answer session will follow the formal presentation. [Operator Instructions] I will now turn the call over to Josh Kinley of BigBear.ai. Please go ahead, Mr. Kinley.

Good afternoon, everyone, and welcome to BigBear.ai's 2022 second quarter earnings conference call. I'm Josh Kinley, the former CFO and now Chief Corporate Development Officer of BigBear.ai. I'm here with Dr. Reggie Brothers, CEO; and Julie Peffer, our new CFO, who joined the company in June. During the call today, we may make certain forward-looking statements. Listeners are cautioned not to put undue reliance on the forward-looking statements, and BigBear.ai specifically disclaims any obligation to update the forward-looking statements that may be discussed during this call. Many factors could cause actual events to differ materially from the forward-looking statements made on the call. These statements are based on current expectations and assumptions, and as a result, are subject to risks and uncertainties. For more information about these risks and uncertainties, please refer to the Forward-looking Statements section of the earnings press release issued today and our SEC filings. We will also discuss some non-GAAP financial measures during the call today. These non-GAAP financial measures should not be considered a replacement for, and should be read together with GAAP results. You can find the GAAP and non-GAAP reconciliations within our earnings release. Now I'd like to turn the call over to Reggie.

Thank you, Josh, and thank you all for joining the call. BigBear.ai is in the early stages of a transformation. We're involving our successful services led business into a high growth, high margin, technology led company that empowers customers to make the right decisions at the right time using AI-powered analytics. This is a multi-year process that requires aggressive investments in people, products and infrastructure to achieve scalable growth. It also requires maturation to operate as a public company effectively and efficiently. Despite some challenging circumstances affecting our second quarter results and outlook for the rest of the year, we continue to have a strong foundational business with significant backlog. And we remain confident in our ability to transform and deliver on our vision. As you likely have seen in the earnings announcement issued today, our second quarter performance did not propel us forward at the pace we had anticipated. Externally, the war in Ukraine and the slowing US economy created delays in revenue we are expecting in the quarter. Internally, we increased spend in Q2 to support our growth as well as governance requirements as a public company, both of which reduced our operating margins and cash reserves. Based on these circumstances and their expected impact on our 2022 financial model, we are taking a more conservative approach to our revenue forecast and operating expenses for the remainder of the year, and recalibrating our guidance accordingly. Julie will provide more details on these changes later in the call. First, I'd like to provide more color on our customer engagements and how we are responding to market dynamics, starting with our government contracts. The flow of funds from the appropriations bill signed in March continues to work its way through individual agencies and projects, but we have also experienced delays…

Thank you, Reggie. I'm excited to be here on my first earnings call as the Chief Financial Officer of BigBear.ai, and to help guide the company for exciting transformation. As Reggie said, our aggressive growth strategy must be balanced by disciplined investments, operational efficiency and diligent governance, and these are all areas where I believe my experience and expertise can help accelerate the company's maturation and improve our financial performance. Now let's turn to the results for the second quarter. Revenue for the quarter was $37.6 million compared to $36.3 million in the second quarter of 2021, driven by execution of the contracts in our backlog and growing commercial engagement. Approximately $19 million of revenue from our analytics segment compared to $16 million in the prior year, the 18% increase is largely attributable to an expansion of key programs from awards won in 2021, as well as commercial revenue growth from the addition of ProModel. While the slowing economy has elongated sales cycles, with current and new customers we expect the portion of our revenue attributed to higher margin analytics to continue growing, and this quarter is a great reflection of the shift in our business model. $18.6 million of revenue came from the Cyber & Engineering or C&E business, compared to $20.3 million in the prior year period. The lower revenue was largely the result of the lumpy procurement activity that Reggie mentioned earlier. In general, services contracts are especially susceptible to priority changes underscoring our need to sharpen our focus on more reliable, long-term software related engagements. Our backlog remains healthy coming in at $325 million at the end of the quarter. This reduction versus prior quarter reflects two changes in our approach to backlog reporting, not a loss in contractual work. Previously, our backlog included five categories:…

Thanks, Julie. As you heard in Julie's report, we are still growing despite the challenging current climate. We are focused on rigorously managing our expenses and cash position as we make the disciplined investments needed to accelerate our growth. We also have made substantial progress in our transition to become a more scalable, profitable, technology first company. And we have high confidence in the recalibrated guidance we presented today. While we expect Ukraine aid to continue to be a priority for the federal government in the near-term, we do anticipate increased government award and contract activity in the back half of the year. We are also ramping our commercial business with ProModel, establishing footholds in our strategic markets and growing our pipeline of opportunities substantially. Across both government and commercial, we continue to see tremendous market opportunity on the horizon. So while the changes to our near-term outlook are necessary given the macroeconomic factors at play right now, our revised 2022 guidance is not representative of our successful track record, evidenced by our strong backlog or our unique ability to solve some of the most complex, intelligence and risk mitigation needs in the world. We have much to offer that the market needs and we're in it for the long-term. We continue to be confident in our future growth trajectory. Now I will turn it over to the operator for Q&A, where Josh, Julie and I will be joined by Jeff Dyer, President of Commercial, who has been leading our ProModel integration and growth plan.

And at this time, we'll be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Louie DiPalma with William Blair. Please proceed with your questions.

Good afternoon, Reggie, Julie, Josh and Jeff.

Hi, Louie.

Hi, Louie, how are you doing?

How are you doing?

Great. Reggie, you mentioned how you won a contract for one of the largest health care or hospital systems in the US. What is the addressable opportunity for additional wins for other health care systems in the United States? And do you have an already established health care offering that could be plug and play for other health care opportunities? Or do you need to still invest more in order to realize the market potential for your health care data analytics products?

So, Louie, thank you very much for the question. Yes, we do have an offering, and I'll let Jeff Dyer, who is the President, Commercial answer that in greater detail.

Thanks, Reggie, and thanks for the questions, Louie. I'll try to tackle each of those that you addressed. ProModel has a very established product called FutureFlow Rx. It's already had significant success that we've been able to leverage and accelerate in our go-to market. The product offering has lots of potential use cases that we're accelerating through our advanced or predictive analytics capabilities, leveraging our algorithms and machine learning that's rich in our federal side of the business. There is over 6,000 hospitals in the United States alone that creates a logical addressable market for us to go invest as we build out our commercial strategy in our commercial sales force to focus on selling the product that already has success with ProModel, but also bringing additional ideas that we believe are going to be significant in helping hospital customers be more efficient with respect to their general operations, their emergency room and operating room aspects of the business, as well as more visibility and transparency into their day-to-day operations. So we're excited about the opportunity. We're still young in our integration of ProModel, but we're encouraged that the early success that we're seeing. And we're certainly encouraged by the feedback that we're getting from the customer base that's excited about the innovations that we're now accelerating in the roadmap.

Thanks, Jeff. And for Julie, you referenced how you are investing in certain prototype contracts that have large upfront costs, that are depressing your EBITDA margins right now. What is the long-term margin potential for BigBear as prototype contracts shift to production?

Yes, thanks for the question, Louie, and great to meet you. Yes, we are currently on some prototype contracts that we are making those investments in. We do have some follow on kind of prototype projects that we're still working on for the rest of this year. But next year we are expecting to get in 2023 some larger, much more profitable production contracts as it relates to this. So we don't necessarily see a very short-term impact from the standpoint of our margins getting significantly better in the short-term, because we are continuing for the rest of the year to work on some of those prototype contracts. But we are expecting that those are going to be fixed price contracts. And we think the margins are going to be definitely higher than our typical spend in those areas from a gross margin perspective, much more typical of what you would normally see for our analytics business in the range of 50% to 60% gross margin levels.

Great. And are you able to share what types of verticals do these prototypes relate to?

Yes. Sure, Louie. There is a couple ones we can talk about. One has to do with cyber concerns, so we have something we call it Spacecraft. And Spacecraft is a collaboration with one of our partners, Redwire Space. And in this collaboration, we have developed a system that enables us to uncover cyber vulnerabilities in satellite constellations. And as you know with the proliferation of commercial LEO satellites and this is an extremely needed capability and this has led to several including funded - several opportunities including one funded at this point. So we're excited about that. So that's one area. Another really has to do with special target identification and behavior forecasting, that's one of our fortes, that's another one. And then we have one that has to do with our data-as-a-service. One has to do with the computer vision as a service and several others. So I think it's - what we're doing is we're leveraging the cross-pollinating, the skill sets we have inside - in our cyber side as well as our analytics side to create these prototypes. And as you probably know that we do. The government is starting to work contract based on, show me, right? So it's no longer just based on past performance, but they're requiring you to show them something. And that requires us to make an upfront investment, and that's what these prototypes are all about. And these prototypes have allowed us, as I said, to gain entry into other customer bases, have allowed us to actually having a great win with US Cyber Command, as we're really excited about this opportunity. But as Julie has brought up and you questioned, it does have challenge in the near-term with respect to margin. So we see these as strategic investments, one that can open up additional opportunities for us to show off our advanced capabilities in cyber and in analytics and cross-pollinate, both those areas.

Great. That makes sense, Reggie. And also in your prepared remarks, you referenced how there actually were headwinds associated with the Ukraine more, at least, you mentioned near-term headwinds. And ultimately, do you feel that the Ukraine war should be a long-term positive for BigBear in terms of your pipeline opportunities?

Yes, that's a great question and thanks, Louie. So this issue with Ukraine, I think we saw early interest and continuing interest in our analytic products and services. I think one of the challenge we've run into them is that investment has taken away unexpectedly from already funded programs, as well as from some of the lumpiness - and contributed to the lumpiness that Julie was talking about earlier. So in the near-term it is actually giving us some headwinds. I think in the long-term, because of the need for advanced intelligence, predictive capabilities, not only in Ukraine, but also we have to think about the change in geopolitical climate, particularly in the South Asia, right? We see what's going on. There is tremendous need for that kind of intelligence and so that's where we see longer-term value as well. Now that said, because of the longer government contracting delays which can take 12, 18, 24 months, these are not necessarily things that we're going to see immediate return on, but are things that are strategically placed for us to take advantage of. So I think Ukraine, the tensions in South Asia all contribute to strategic success for BigBear.ai.

Sounds good. Thanks, Reggie, Julie, Josh and Jeff. That's it from me.

Thanks, Louie.

Thank you.

Our next question comes from the line of Mike Latimore with Northland Capital Markets. Please proceed with your question.

Great. Thanks. Yes, good afternoon, everybody.

Hi, Mike.

Hi, Mike.

Hello. On the - so the backlog change, you highlight the procurement services. Are those mostly in the Cyber & Engineering category, so we should see analytics kind of increase as a percent here? How should we think about that, I guess?

Yes, that's - it's a great call out. Yes, it would be mostly in Cyber & Engineering segment.

Yes. And then I think at one point you had given backlog coverage of future revenues. Under the new backlog calculation, do you have a kind of rough percent of what - how much of the second half revenue that covers?

How much of the second half revenues is already in backlog?

How much of the second half revenues is already in backlog? Is that your question?

Yes, yes.

Yes. I don't have that specific calculation, but I would suggest that most of it is already in backlog. We have - we had some growth coming in that we anticipate because we're starting to get signals of those are getting closer, but most, if not a significant amount of it is already in backlog.

Okay. Great. And then you talked about just OpEx improvements here. I guess, what was the headcount at the end of the second quarter? And kind of where you're thinking that might end by year-end?

So our headcount, I think at the end of the second quarter was about 750 people. But in terms of really looking, I would say, just to give you a bit - let's talk about headcount in general in terms of SG&A costs, I would say a lot of the investments that we've been making in headcount, specifically around our growth strategy, as well as around our corporate structure that we're creating because we're a public company, we were continuing to invest in that growth strategy and in the investments in public company because we felt like we were in a pretty good place after the first quarter. But when the softness kind of continued into the second quarter, that's when we feel like we need to step back and really take a harder look at all those SG&A expenses and make sure that we're investing at the right pace and continuing to focus on the right things in terms of the investment strategy, and maybe we take a step back and look at that in a broader perspective.

Yes. And then just on the federal vertical. I guess, is - are the deals that are out there and is your view, they're still out there in general, it's just they're not - they're a lower priority now or have you seen kind of projects outright cancelled here, I guess?

No, we actually haven't seen any projects that have been cancelled. What we've seen is just an elongation of the cycle. I will tell you there is kind of general frustration across the board, both on the customer side, to be honest, as well as obviously on our side. I think these - the contracting offices are just backlogged and they're getting reprioritize to focus on opportunities to send money to the Ukraine war function. So, we are trying to make sure that we understand where they are in the cycle, but they've just been slower. So nobody is giving us any indication that things have changed. It's just taking longer to get them under contract.

Okay. Well, thanks a lot. Good luck rest of the year.

Thank you.

Thanks, Mike.

Thanks, Mike.

[Operator Instructions] Our next question comes from the line of Michael Cho with Marathon Asset Management. Please proceed with question.

Hi guys. Thanks for taking my call. There seems to be a $16.5 million increase year-over-year in SG&A, and also $5 million increase sequentially this quarter. What's the kind of the right run rate according the SG&A number going forward, especially in the light of your cost reduction plan? And my second question is, internally, do you have a reasonably expected reward time line that - for those delayed rewards? Or is it still kind of hard to predict? Thank you.

I'm sorry. I couldn't catch the second question. Could you say the second one, again?

Yes. So those delayed rewards, do you have an expected time line that it's kind of - that it's a reasonable internally?

We want to take that first.

So we have one delayed rewards we expect by hopefully next month. So we've got awards delayed almost a year. So - but some of those we expect to be coming in at the end of this coming quarter and beyond. So, yes.

So to give - to go back your first question. Let's talk about the SG&A function. I mean, yes, you're right. We've seen significant increases in SG&A. And again, some of those - big picture on SG&A is we've had increases year-over-year for sure related to our stock comp, which we didn't have in our business last year. We have a lot of public company expenses that we didn't have last year. So there is some significant growth in there that we understand. But back to the point about run rate, we are - I'm pretty new to the company, I've been here now about seven weeks and I'm doing a deep dive with the team right now to really dive into where have our investments been made. Where do we need to focus on adding to streamline? How can we get efficiencies in our cost operating model? So I guess, I wish I had a clear answer for you as to how to factor in the run rate. I do expect in Q3 and Q4, it to be lower. But I have - I can't give you a number on that exactly yet, but I do expect it to be lower than it has been in the past. We also had some onetime cost in our third step of the year as it related to transactions, our ProModel transaction as well as some of the costs is related to our legal cost for some of those activities as well.

Thank you.

And we have reached the end of the question-and-answer session. And also, this concludes today's conference. And you may disconnect your lines at this time. We do thank you for your participation.