Lionheart Holdings (CUB) Q1 2013 Earnings Report, Transcript and Summary

Welcome to Cubic Corporation's First Quarter Fiscal 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. At this time, I would like to turn the conference over to Diane Dyer, Director of Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone. Thank you for joining us as we discuss Cubic's results for the first quarter of 2013. Today, after the market closed, we issued a press release reporting the company's financial results for the quarter ended December 31, 2012. A copy of the press release is available on the Investor Relations section of our website at www.cubic.com. We encourage everyone to read today's press release and refer to our most recent reports on Form 10-Q and 10-K. These documents are available from the SEC and from our website. An archive of this call will be available later today on Cubic's website at the Investor Relations tab under Webcast and Events. On the call today are William Boyle, Chief Executive Officer; John D. Thomas, Executive Vice President and Chief Financial Officer; Mark Harrison, Senior Vice President and Corporate Controller; and James Edwards, Senior Vice President and General Counsel. Now I'll turn the call over to Jim Edwards for the Safe Harbor disclosure.

Thank you, Diane. Please note that certain information discussed on the call today is covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act. I caution listeners that during this call, Cubic management will be making forward-looking statements. Actual results could differ materially from those stated or implied by these forward-looking statements due to risks and uncertainties associated with the company's business. These forward-looking statements should be considered in conjunction with and are qualified by the cautionary statements contained in Cubic's earnings press release and SEC filings, including its annual report on Form 10-K and quarterly reports on Form 10-Q. This conference call contains time-sensitive information that is accurate only as of the date of this broadcast, February 11, 2013. Cubic undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call. Also, please note that management will discuss certain non-GAAP financial measures. A reconciliation between the GAAP financial measures that correspond to these non-GAAP financial measures is contained in our earnings press release and our SEC Form 10-Q report for the quarter ended December 31, 2012. Any discussion of non-GAAP measures is not intended to detract from the importance of comparable GAAP measures. With that said, let me turn the call over to Bill Boyle, our Chief Executive Officer.

Thanks, Jim. Good afternoon, and thank you all for joining Cubic's first conference call. Before talking about our first quarter 2013 results, I'd like to touch just a bit on the current environment for our business units. Cubic has a somewhat unique business model, segment on across Transportation and Defense markets and products and services, with a strong international penetration on both businesses. At one time, defense was 100% of Cubic's business. But today, it represents less than half of our profits, with much of that coming from its international business. It's widely known at the moment that defense industry faces uncertainties in the U.S. due to ongoing pressures within the Department of Defense and the prospect for sequestration, which may be implemented on March 1. Like most companies who have exposure to the defense industry, we've been preparing for the effects of this legislation to mitigate its potential adverse impact on our shareholders, as well as our customers, suppliers and employees. Cubic's U.S. Defense business is focused in training, intelligence, surveillance and reconnaissance, areas that we believe are essential and should be priorities, especially in context of the constrained budgets and allowing our customers to preserve the nation's force readiness and intelligence superiority in a cost-effective way. Nevertheless, we will continue to monitor the situation closely and make adjustments to our business as required. Moving onto the Transportation segment, CTS, which accounts for more than half of our operating profit. As transit authority seek to optimize their operations by outsourcing bundled systems and services, CTS has transformed itself from a provider of automated fare collection systems into a systems integrator and services company focused on the intelligent transportation market. As a result, CTS has seen strong growth over the past several years, reflecting our launch contract wins for turnkey solutions in major cities throughout the world. Now to our consolidated first quarter fiscal year 2013 results. Net sales for the quarter were $313.4 million, which were down $3.4 million or about 1% compared to the first quarter last year. The decrease in the quarter was from our product sales, while our service-related sales actually grew by $14.2 million. The sales decrease was primarily the result of less activity on the Vancouver project in our Transportation business because much of the hardware production was completed and the project has moved into the latter stages of systems delivery. Operating income was $18.2 million on our first quarter compared to $27.8 million in the comparable quarter last year, a decrease of $9.6 million. The decrease to our operating income was attributable to several factors. We realized $3.3 million of lower gross profit due to the sales mix between products and services. In addition, we incurred higher SG&A expenses of $5.8 million and higher R&D expenses of $900,000. SG&A expenses increased in all business segments primarily due to higher selling and marketing cost, increased information technology cost, acquisition-related expenses and higher professional service cost related to the restatement of our financials. During the first quarter, we incurred $1.5 million in professional fees associated with the restatement of our financials and acquisition-related cost. During the last 2 quarters, we've noticed a slowdown in U.S. contract awards in our 2 defense segments, while at the same time seeing an increase in proposal activity. While we expect new contract awards to approve in subsequent periods, we're carefully monitoring our ongoing expense levels and will adjust if contract awards continue to slip. Majority of our research and development expenditures involve new defense technologies and mobile home -- and, I'm sorry, mobile phone connectivity and payment-related fare collection applications for our Transportation segment. We anticipate during the current fiscal year we'll continue to invest in R&D at levels consistent with recent years, as continuing innovation has been a key factor in our recent successes. Net income for the quarter was $12.4 million, $0.47 per share, compared to $20.7 million or $0.77 a share in 2012. Net income for the quarter was lower due to the drop in operating income and a drop in other income for the quarter. Last year included a foreign exchange gain of $1.2 million. And this year, we incurred interest expense and other cost of $650,000 related to the conclusion of a long-standing dispute with the government of Iran. Our effective tax rate for the quarter was 30%. Subsequent to the quarter-end, the American Taxpayer Relief Act of 2012 reinstate the U.S. federal research and development tax credit retroactively from January 1, 2012 to December 31, 2013. The new legislation will be reflected in our estimated effective tax rate commencing with the second quarter. Additionally, we will record a discrete tax benefit of approximately $1.7 million in the second quarter related to the reinstatement of federal R&D tax credit for fiscal 2012. We're estimating our annual effective income tax rate for fiscal year 2013 will be approximately 26% versus the 30% recorded in the first quarter. We had an operating cash outflow of about $26 million in the first quarter and a cash outflow of $38 million for the quarter after borrowing $25 million under our revolving credit agreement. The bulk of the cash outflow was the net cash we paid to acquire NEK and capitalized cost on the Chicago transportation contract. I will now turn the call over to Jay Thomas, our Chief Financial Officer, who will review the specific segment results and also discuss some of our recent acquisitions.

Thanks, Bill. I will give a brief discussion of the quarterly results for each of our 3 operating segments and also discuss 2 of our recent acquisitions that we had made since our fiscal year end. First, I will discuss Cubic Transportation Systems or CTS. Sales for the first quarter were $118.6 million versus $125.8 million in the comparable quarter in fiscal year 2012 or a decrease of 6%. The primary reason for the decrease in sales is from the Vancouver project mentioned previously, as we are now moving into the later stages of system delivery. Operating profits in CTS for the first quarter were $13.2 million or 11.1% on sales versus $17.9 million or 14.2% of sales for the comparable quarter in 2012. The major contributing factors causing the decrease in operating profits were higher costs in Sydney, providing services on certain equipment prior to full operations and lower margins on current work being performed for U.K. transit customers. We highlighted in our year-end 2012 earnings release that 2013 would be a transitional year in terms of completing major new transit projects, which could cause some pressure on operating profits. Additionally, we believe that the U.K. markets post Olympics may experience a slowdown or deferral on some fare collection for the quarters. Total backlog for the CTS segment was virtually unchanged from our prior quarter ended September 30, with approximately $1.7 billion. We continue to make progress on the Chicago open payments project. We're not recognizing revenue on this project until we achieve system acceptance, which we would expect to occur by the second quarter of fiscal year 2014. Through December 31, 2012, we had capitalized $40.1 million in cost associated with developing this new fare collection system, including $13.3 million in the current quarter. SG&A costs are not being capitalized but are being expensed as incurred. After the quarter end, we announced the acquisition of NextBus, as well as certain contracts from its parent company, Webtech Wireless. The purchase consideration was approximately $21 million. NextBus provides real-time passenger information system using a Software-as-a-Service solution. NextBus' acquisition is part of our Nextcity vision and it expands CTS business potential market beyond fare collection to information-based solutions. For fiscal year 2013, we expect that NextBus will be slightly dilutive to our earnings per share after consideration of cost for transaction integration, retention and the amortization of purchased intangibles. In fiscal year 2014, this acquisition should be accretive. NextBus should contribute $10 million to $11 million of sales on an annualized basis. Next, I'll discuss Mission Support Services or MSS. Sales for the first quarter were $113.4 million versus $107.5 million in the comparable quarter of 2012 or an increase of 5%. During the quarter, we completed the acquisition of certain assets of NEK. The results from this acquisition had an immaterial impact on our sales for the quarter. The increase in sales was attributable to activities associated with our training contract at the Joint Readiness Training Center at Fort Polk and higher sales associated with our national security customers. Operating profits in MSS for the first quarter were $4.2 million or 3.7% on sales versus $4.5 million or 4.2% of sales for the comparable quarter in fiscal year 2012. MSS has made 3 acquisitions in recent years, including Omega Training, Abraxas Corporation and NEK Special Programs Group. We believe it is important to review the operating results after adding back the amortization of intangibles and the acquisition cost as being more indicative of operating results. Consequently, adjusted MSS operating results after adding back the amortization of intangibles and transaction-related expenses were $7.5 million or 6.6% of sales in our first quarter versus $7.8 million or 7.3% of sales in the comparable quarter last year. Management of MSS took steps to reduce overhead in SG&A cost by over $1 million per year after the quarter end to address ongoing competitive pricing pressures. MSS total backlog was $746 million at December 31, including funded backlog of $257.3 million. Total backlog and funded backlog at December 31 included $19.5 million related to the NEK acquisition. During the quarter, as we previously discussed, we acquired select assets of NEK for $53 million in total consideration. NEK provides special forces training related services to the U.S. Army and other national security related customers. As part of the acquisition, we hired 200 employees with substantial experience in the special forces community. MSS has been focused on diversifying its business over the last few years to the national security market. NEK will provide a platform to expand its worth both in the U.S. and to key foreign allies. For fiscal year 2013, we expect NEK will be slightly dilutive to our earnings per share after consideration of cost for transaction, integration, retention and the amortization of purchased intangibles. In fiscal year 2014, we expect this acquisition to be accretive. We anticipate NEK will contribute on an annualized basis $45 million to $50 million in sales. Shifting now to Defense Systems or CDS. Sales for the first quarter were $81.2 million versus $83.3 million in the comparable quarter in 2012, or a decrease of 3%. The primary reason for the decrease in CDS sales in the quarter related to a decrease in sales of secured communication products, partially offset by slightly higher training and other advanced technology sales. Operating profits in CDS for the quarter were $1.2 million or 1.5% of sales versus $6 million or 7.2% of sales for the comparable quarter in 2012. Operating profits were lower due to cost growth on a secure communications contract and lower margins on training-related sales during the quarter. Total backlog for CDS was $404.5 million as of December 31, down from $430.9 million at September 30. As discussed earlier, we have experienced delays by our U.S. Defense customers in awarding contracts, which has cost our backlog for this segment to decrease. Subsequent to the quarter end, we were notified that we had been selected as a single source awardee on 3 Indefinite Delivery Indefinite Quantity, or IDIQ contracts, aggregating $298.5 million from the U.S. Navy. We expect that period of performance to be over 5 years and the contracts involve developing virtual training related technology and curriculum for the U.S. Navy littoral combat ships. In closing, we would expect CDS's operating performance to improve during the balance of the year. And I will now let Bill Boyle provide some closing thoughts.

Thanks, Jay. We hope that instituting these quarterly earnings calls will give all of you greater visibility and clarity into the company. We're well aware of the current issues facing us and are fortunate to have the continuity of a proven and experienced management team throughout the company and strong financial resources to support them. We're pursuing a broad array of opportunities for which we feel we're well positioned, such as the almost $300 million defense contract that was awarded to us after the close of the first quarter. For the past number of years, we've been successful in substantially increasing our International business and increasing the service component of our overall business. In addition, recent acquisitions in the intelligence and special forces areas into our defense services company, MSS, should serve us well in the current DoD environment. As many of you may well have noted, Aviation Week and their annual study of companies in our industry noted Cubic as the second highest performer over the past 5 years for companies with sales between $1 billion and $5 billion. And last year, the Petrusky report put out by a professor at the University of Chicago gave Cubic the only perfect score out of all public companies and their rating of companies in 9 separate financial measurements. We intend to stay in the ranks of these top-performing companies. And though our first quarter was disappointing, we believe that going forward with the wide diversity and nature of our markets, we feel well equipped to address the current economic conditions and will continue to deliver superior value to our shareholders. With that and with the remaining time available, we'd be happy to address any questions you may have.

[Operator Instructions] Our first question comes from the line of Jeremy Devaney with BB&T Capital Markets. Jeremy W. Devaney - BB&T Capital Markets, Research Division: First question I wanted to address is you comment that you anticipate improved profitability on some of the transit contracts as they move from transition fees to full operations. Can you give us a sense of the timing for those margin gains to take hold? When are you planning on transitioning from development to operations on Sydney, Vancouver and Chicago? And how are...

Jay, do you want to...

Yes, I'll go ahead and answer that question. Thanks, Jeremy. We will be completing majority of the work on the 3 projects that you mentioned probably by the first and second quarter of 2014. So between now and then we'll be really in kind of a transition mode. Jeremy W. Devaney - BB&T Capital Markets, Research Division: And any anticipated level of margin improvement as you transition to the operation side of that?

We don't really give guidance. But I would think once we get through the system completion phase, then we should see an improvement from where we are now back to probably some of the levels that we've had in the prior years. Jeremy W. Devaney - BB&T Capital Markets, Research Division: Sure. Two other quick ones for you. Do you anticipate seeing annual or quarterly guidance now that you're increasing investor communications?

Well, we're taking one step at a time. I -- we don't have any immediate plans to give guidance, but it's something we'll be discussing between now and the end of the next quarter. So we're not going to -- we have not yet decided to do that. Jeremy W. Devaney - BB&T Capital Markets, Research Division: And then you mentioned the recent Navy award that you took down on training missions for Navy systems for littoral combat ship. There's been some press out that Lockheed might protest this bid. Has there been any formal indication to you folks that, if this is actually going to protest status?

Okay. We've not heard of anything official on protest status, but I think we've all seen the industry statistics that says something high percentage of large bids do get protested. So it's not something that would be unusual to happen.

Our next question comes from the line of Jim Ricchiuti with Needham & Company. James Ricchiuti - Needham & Company, LLC, Research Division: You alluded to some, in the -- I believe it was in the training area, some cost overruns on a secure communications contract. Can you talk a little bit about that? It may not have been in the training area. Can you size that? I'd assume that goes away. So would you anticipate some of the margins in that portion of the business to begin to improve in the current quarter?

Yes, Jim, this is Jay Thomas. In the quarter, specifically, we took a cost -- we had a cost growth of about $1.2 million on one of our communications programs. And then when you look at the comparison to last year, we had extremely high profitability because we had a really favorable mix. So the comparison was fairly distorted between the 2 years for 2 different factors. James Ricchiuti - Needham & Company, LLC, Research Division: Got it. And, Jay, you also -- I think the other component of the margin decline that you called out was in the mix of training revenues. How does that look over the next 1 to 2 quarters?

Well, we're not going to give guidance by quarter. But I would say that our expectation is we'll see an improvement probably towards the latter part of the year on -- just based on mix coming out of backlog. James Ricchiuti - Needham & Company, LLC, Research Division: Okay. And just shifting gears a little bit to Transportation. I recognize you're not giving guidance. Would you still be -- would some of the costs you're incurring and the investments you're making, does that begin to ease somewhat? Or is this still -- are you still in a pretty heavy spending mode over the next couple of quarters? You gave us some sense as to when we'll see that business kind of return to margins of your -- some of your historical margins. But just in the near term, what should we expect in terms of some of the expense you're incurring?

I would say that the next few quarters, we'll probably see some improvement on -- in Sydney because that project is a little further along. We won't see -- well, in Chicago, we're just simply -- we're incurring SG&A expenses. So I think the biggest thing that we're kind of preparing ourselves for is we have 3 major projects that have been going into long-term services. So we have sort of this increase going on to build our infrastructure to get ready for that. So that's increasing expenses in the short term.

Our next question comes from the line of Ken Herbert with Imperial Capital.

Jay, just wanted to first talk about NEK. And I know you alluded to probably dilutive in '13, accretive in '14. Can you just talk about the ramp of that business? And specifically, without getting maybe granular quarter-by-quarter in terms of the timing, but what should we be looking for in that business from a backlog standpoint or anything else to help with sort of gauging the progress there?

The business itself, when we bought it, had a funded backlog. I think it's about $20 million. It has a substantial unfunded backlog because they hold a couple of IDIQ contract vehicles. So they get funding incrementally as they're doing tasks. And our sense is that, just based on what you're seeing in the media, there's a quite a bit of a discussion about special forces training and increasing the size of the force. So we could have some positive things happen in that business during the year.

Okay, okay. And it sounds like from your commentary, I mean there was some one-time items in the quarter. But it looks like margins over the next few quarters within, broadly speaking, the defense part of the business, defense and mission, MSS, we may see some improvement. But I guess it's fair to say that most of the improvement we might see as we go through the year would be in CTS from Sydney, as you mentioned, as that transitions. Is that a fair statement?

Yes, I think it is. I don't know if we need to elaborate on it, but yes, that's correct.

Okay, great. And just finally, can you comment on the sort of the acquisition pipeline and maybe what you're looking at now or sort of what you're seeing from an opportunity standpoint?

Well, Jay handles our acquisitions, so he can answer this.

Well, we've just -- I mean, we've completed 2 transactions and a small -- very small transactions. So I would say for the next couple of months, things might slow down. Pipeline activity of opportunities we're looking at has slowed down in the last 90 days. But we're kind of sensing that that's probably related to these -- what's the debate on sequestration. So once that is resolved, then we would expect the pipeline of opportunities to pick back up again.

Plus we need a little bit of time to absorb what we've done over the last several months.

Our next question comes from the line of Josephine Millward with Benchmark.

Given the strength in your Transportation backlog, I know you don't give guidance, but can you comment on the outlook view, still anticipate growth in the Transportation business in the coming year? And also in '14 based on the 3 projects completing, the hardware part of the projects?

Yes, Josephine, I'll answer that question. As you know, that's a very lumpy business because when we win these large projects, they can really skew our backlog quarter-to-quarter or year-over-year. So right now, there's only a couple of major bids that are sort of moving into our pipeline. One is in Washington. And we're not sure that that's going to come to some sort of decision sometime this fiscal year. There's some other projects that we're looking at in some newer markets in the Middle East, in South America, in Rio de Janeiro, and then we're looking at trying to do some expansion outside of fare collection. We recently started bidding on some work on the toll market to do back-office services. So I would say this year, there's probably going to be a lot more bidding activity than lots of big changes just because these procurements tend to last for a long period of time.

Okay, that's helpful. And you have also announced a few nice orders in the global asset tracking business. Can you talk about how that's ramping and whether you expect that to break even this year?

Yes, we don't expect to make a lot of money in it this year, but we anticipate breaking even this year.

And we've recently -- we're getting some work, a lot of it has to do with sort of the logistics side of what the DoD is doing. So as they start to bring back a lot of the equipment that's over in Afghanistan, they'll be using some of our equipment. So there'll be some things like that, that could give us some short-term sales increase.

Our next question is a follow-up from Jeremy Devaney with BB&T Capital Markets. Jeremy W. Devaney - BB&T Capital Markets, Research Division: In your 10-K release in December, you commented that you may enter debt markets and try to monetize some of these transportation contracts. Can you explain how this might proceed the impacts on the cash flows and your position on the contracts following any relevant financing?

Well, we're in discussions actually. We may possibly do a long-term debt deal in the next month or so. Jeremy W. Devaney - BB&T Capital Markets, Research Division: And how would this affect your position on those contracts? Would you then be the owners of the equipment and operate the equipment going forward?

Wait a minute, I might have misunderstood your question. Was this in general or with regard to Chicago? Jeremy W. Devaney - BB&T Capital Markets, Research Division: The Chicago contract that you referenced in 10-K.

Okay, that will probably be done next year. But Jay is working on it. Let me have him talk.

Yes. So Jeremy, what we would do in Chicago is the way that we structured the payment terms is that we have the ability to securitize the payments. And so what we would do is we would work on some sort of securitized financing. And we've been in some discussions with a financial institution who's working with us on that. So if we were to do something like that, we would probably get it done once we've gotten system acceptance, which would be towards the end of this calendar year or early part of '14. Jeremy W. Devaney - BB&T Capital Markets, Research Division: All right, excellent. And just to clarify on Bill's comment, you'll be in the debt market in the next couple of months?

We could be. We're looking at it very seriously at the moment. Jeremy W. Devaney - BB&T Capital Markets, Research Division: And then lastly for me. Can you provide any sort of forecast of your annual D&A going forward now that you've executed these last few acquisitions?

In our 10-K, Jeremy, we do give some sort of forward-looking commentary on what the depreciation and amortization is going to be. I'm not sure that we updated the 10-Q for the impact of any K. It might -- it may be in there, so something we could follow up with you directly on.

Thank you. There are no further questions at this time. I would like to turn the call back over to Bill Boyle for closing comments.

Okay. Well, I'd like to thank all of you for joining us today. If anyone has any further questions or comments, please contact Diane Dyer, who is our Director of Investor Relations or even any advice you may have, this is our first time at this, as to how we could improve it. So if you could direct those questions or comments to Diane, we'd appreciate it. So this concludes our call then for today, and we thank you all for your interest in Cubic. Thank you.