Lionheart Holdings (CUB) Q4 2014 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen and welcome to the Cubic Corporation Fiscal Year 2014 Year End Conference Call. At this time, all lines are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Diane Dyer. Please go ahead.

Thank you, operator. Good afternoon, everyone and thank you for being with us today. This afternoon, we announced our results by press release ahead of our 10-K which we expect to file with the SEC by the end of the week. For anyone who hasn’t seen a copy of the results, please look on our website for this information at www.cubic.com. An audio replay of this call will also be posted on our website at the conclusion of the call. I am joined by Brad Feldmann, our President and Chief Executive Officer and Jay Thomas, our Chief Financial Officer. Following prepared remarks by Brad and Jay this afternoon, we will turn the call over to you for your questions. Mark Harrison, Senior Vice President and Corporate Controller of Cubic Corporation will also be available for the Q&A session. Now, I’d like to introduce Jim Edwards, Cubic’s Senior Vice President and General Counsel for the Safe Harbor disclosure.

Okay. I caution listeners that during this call, Cubic management will be making forward-looking statements about future events for Cubic’s future financial and operating performance. 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, November 25, 2014. Cubic undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call. This conference call will also include a discussion of non-GAAP financial measures as that term is defined in Regulation G. Cubic believes this information is useful to investors, because it provides a basis for measuring the company’s available capital resources, the actual and forecasted operating performance of the company’s business and the company’s cash flows. A reconciliation between the GAAP financial measures that correspond to these non-GAAP financial measures is contained in our earnings press release. Any discussion of non-GAAP financial measures is not intended to detract from the importance of comparable GAAP measures. With that said, let me turn the call over to Brad Feldmann, our President and Chief Executive Officer.

Thank you, Jim. Good afternoon, everyone. Thanks for joining us on today’s call. We are having our call today in advance of our 10-K release. We expect our 10-K will be available by Friday, November 28. We finished the year with earnings per share of $2.59, which is at the top end of our revised financial guidance provided on our last call. For the year, we have nearly $1.4 billion in sales, operating income of $92.5 million, and operating cash flow of $114.8 million. Absent the cost issues we had in our third quarter of the Vancouver contract in our transportation segment, our earnings per share would have exceeded the top end of our initial guidance to the last year. Cubic’s fourth quarter was the best quarter in our history in terms of sales, profits and backlog. For the quarter, sales were nearly $400 million and operating income was nearly $40 million with earnings per share of $1.22. In the quarter we had strong contract awards and finished the year with a record total backlog of $3.18 billion. Our Q4 operating cash flow of $75 million was also quite strong. I wish to thank our team for the great fourth quarter performance and our customers for their continued trust. All three operating segments finished the year with strong inflows of contract awards. As mentioned on our last call we won important recompetes in our transportation segment and in our mission support segment. During the year the defense systems segment saw continued strength in orders from international customer for our air and ground training systems. Now let’s briefly review the market position for each of our businesses. Our transportation business CTS continues to be the market leader in intelligent transportation systems and related revenue management and payment systems. We have recently started to rollout next wave our innovative integrated mobile phone application using near field communications or NFC which supports a wide variety of mobile ticketing, mobile top up, contact list mobile payment, account management, real time alerts across multiple modes of transport and advanced trip planning features. We believe the momentum in NFC payments caused by the Apple Pay announcement along with other applications using mobile phones for payments will create demand for CTS’ mobile solutions as new contactless technologies become part of the transit experience. In Sydney the rollout of the new Opal card is progressing and has replaced a number of legacy fair products which were retired by the customer in September. We remain on track to complete the initial rollout of Opal system by calendar year end. In Brisbane we will launch the NextBus real-time passenger application next year. This is an important expansion of this innovative solution for consumers in the Australian market. We successfully deployed an open payment system for the Oyster system in London and for their venture system in Chicago which together represents the next generation of their collection payment systems. In Vancouver, we are resolving technical issues and are working to begin the service phase in the second half of fiscal 2015. Overall, our transportation segment is well positioned with the megatrends of global population growth and urbanization, smart cities and big data. Our team continues to implement our NextCity strategy, which represents how CTS will address these megatrends and apply our technologies in the context of transportation. Our defense systems business CDS continues to be the market leader in live virtual constructive and game-based training systems. We are focused on providing next generation training technologies that will provide our customers greater training fidelity and effectiveness at reduced costs. CDS’ long-term strategy is to build a niche communications business across C4ISR leveraging our expertise in secure communications, data links and network systems. Our initial goal is to build $100 million to $200 million business generating mid-teen EBITDA margins within the next 3 to 4 years. To support this strategy we are making important investments in R&D and actively evaluating a number of acquisitions. In 2014, our mission support services business MSS won all of its major recompetes. As we said in our last call, we believe that MSS reached its revenue trough in fiscal year ‘14. And with the recent wins, we believe revenues and profits will expand from current levels. Bill Cody, who joined us this year has done a great job leading this business through a difficult period and he is focused on building his team to grow across National Intel, Special Forces and MSS core services markets. Recently we launched an initiative to share common processes and systems across all of our businesses known as One Cubic. Our team along with outside consultants has been working hard to develop a time phase implementation plan for global business services model that aligns with our One Cubic strategy. In the next year, we will be implementing a number of initiatives to lower our manufacturing and G&A cost. In fiscal year 2015, we anticipate spending $6 million to $7 million to implement these shared services initiatives. We expect that over time after these initiatives are fully implemented they will generate annual savings of $10 million to $15 million per year. Recently, we hired Jan Marshall, the former CIO of Southwest Airlines, and a proven IT professional, to lead us through a transformation of our business systems. We estimate that transformation to implement a new ERP system will take three years. We are in the process of evaluating vendors for our new ERP system and implementation. We expect that we will begin to implement a new system in fiscal year 2016. The implementation of the new ERP system in conjunction with our global business services rollout, should translate into improved profitability for the company, once it is fully implemented. On future calls, we will address our investment in this new ERP system. I’d now like to turn the call over to Jay Thomas, our CFO. Jay will discuss our guidance for fiscal year 2015, our financial performance, and a plan to increase in our cash dividend.

Thanks Brad. First off, I would like to discuss our guidance for fiscal year 2015 and also announce that our Board has approved a 12.5% increase in our semi-annual dividend to $0.135 per share and expects to declare it at the Annual Meeting in February. For fiscal year 2015, we expect to generate sales in the range of $1.425 billion to $1.465 billion. We expect to generate EPS in the range of $2.60 to $2.85. When I review our results for 2014, I will also address certain items that will impact our sales and profits in 2015. We expect these items will impact EPS by approximately $0.60 when compared to fiscal year 2014. We expect our performance next year will be biased in the second half of the year. Sales from our Cubic Defense Systems business are depended on shipments which are expected to backend loaded next year. And turning to our consolidated results, we had a very strong finish to our fiscal year 2014 from our Transportation and Defense Systems segments, which resulted in record quarterly consolidated sales and profits. For the year, sales were $1.398 billion, up 3% from last fiscal year. Operating income for the year was up 127% to $92.5 million. Last year, our operating income was reduced by a goodwill impairment charge. EBITDA was $122.9 million this year, up 5% over the previous year. SG&A expenses were 13% of sales in fiscal year 2014, up from 12% in the prior year. The increase was primarily due to expenses associated with acquisitions that we made during the year, including transaction-related compensation expenses recorded on the Intific purchase, higher professional fees for consulting services on our One Cubic initiative and $3.4 million of higher stock-based compensation expenses. In fiscal year 2015, we are implementing our cost savings strategies as a part of the One Cubic initiative, and we expect this will reduce pre-tax earnings by $6 million to $7 million next year, but over the long-term will lower our cost. R&D spending in fiscal year 2014, totaled $18 million, down from $24.4 million last year. The largest decrease was in our Defense Systems segment. We expect a $7 million to $8 million increase in R&D for fiscal 2015, as we focus on our C4ISR and NextCity growth initiatives. Our tax rate was 22% in fiscal 2014, reflecting the fact that the majority of our income was from international operations, where tax rates are much lower than the U.S. For fiscal ‘15, we are expecting a higher tax rate in the range of 26% to 27% as our profitability will improve and jurisdictions for tax rates are higher. During fiscal ‘14, we finished it from favorable exchange rates, which increased sales by $6.4 million and operating income by $5.9 million. Our foreign-based operations generate approximately $500 million in annual revenues in currencies other than the U.S. dollars. Subsequent to our year end, we have seen the U.S. dollar strengthened 5% to 6% against the British pound, the Australian dollar and the New Zealand dollar. Our largest exposure is the British pound and this will impact comparable results in our Transportation segment. Now, turning to Transportation or CTS, CTS sales increased $70.2 million or 13% to a record of $599.7 million in fiscal ‘14. Recent acquisitions contributed $53.8 million. Sales were also higher on contracts in Chicago, London, and San Francisco. Sales in ‘14 were reduced by $18.4 million due to a change in estimate on a contract in Vancouver. CTS operating income decreased 1% to $65.9 million for the year. Operating income was reduced by the $18.4 million Vancouver cost increase and startup losses on the Chicago contract. Offsetting these items were higher profits on contracts in the UK and Australia. We expect CTS profitability will increase in fiscal ‘15. Now, turning to Mission Support Services or MSS, this year MSS sales decreased $70.6 million or 15% to $398.1 million. Sales were down due to a reduced activity with MSS primary customer in the U.S. government, which imposed a shutdown with the budget impasse and start to curtail spending. During the year, MSS Special Forces business had decent growth. MSS has won a number of recompetes along with some competitive wins for training and services related work in the last few months. We are cautiously optimistic that MSS will see decent growth from these depressed levels going forward. MSS operating income was $7.8 million in fiscal ‘14. Operating income reflected a $10.4 million of amortization of intangibles last year and $1.7 targeted investment to grow our Special Forces business. We are expecting an increase in operating income for MSS in ‘15 due to a reduction in the amortization of intangibles to $7.7 million. However, operating profit margins are likely to remain low for MSS for the next few years due to market pricing constraints. Now, turning to Cubic Defense Systems or CDS, CDS sales increased 10.4% to $400.6 million in fiscal ‘14 led by an increase in training systems sales. Training systems sales were higher due to recent acquisitions that contributed $17.9 million in sales. We also had higher sales in the Far East and higher sales on littoral combat ship contracts. Secured communication sales were down 5% in ‘14. CDS operating income was $26.8 million for the year, up 89% compared to the prior year. Operating losses from recent acquisitions reduced operating income by $8 million in ‘14, including acquisition-related charges of $3.9 million on the Intific purchase. Overall, training system profits were much higher due to the restructuring that was done in the prior year. Secured communication losses for the year were $3.9 million versus $8.1 million due to cost-cutting efforts on the asset tracking product line. We finished the year with a record total backlog of $3.18 billion, up from $2.65 billion or 20% from the last fiscal year. The largest increase in backlog was in our Transportation segment due to the transport for London contract renewal. We also saw our defense systems backlog increase as a result of key contract awards for training systems. MSS total backlog was down slightly for the year. Now, finally focusing on our balance sheet, cash flow and capital allocation, for the year we generated $114.8 million in operating cash flow with a strong inflow of cash in the fourth quarter from our Transportation and Defense Systems segment. On prior conference calls, we said we expect to finish the year with strong cash flows as we are nearing completion on several development contracts. We are anticipating strong positive operating cash flows for fiscal year ‘15 with our transportation segment providing the bulk of the cash flow as major delivery projects complete. In fiscal year ‘14 we invested $83.5 million for acquisition and $16.6 million for capital expenditures. We anticipate that our capital expenditures will increase from the historical next few years as we invest in a new ERP system and make improvements to our facilities. At year end, we had cash and restricted cash totaling $248.6 million held by our foreign subsidiaries. We also had $37.5 million of cash with our U.S. subsidiaries at year end. Our cash dividend payout is driven by our U.S. profitability and cash flows. We review our dividend once a year in conjunction with our annual meeting. And with that I will let Brad share his closing thoughts.

Thanks very much Jay. Again I would like to thank our customers and team for a superb fourth quarter. Our businesses are in very strong global market leading positions. Additionally our management team opportunity pipeline and balance sheet are quite strong. We are working to improve our execution, reshape our portfolio, invest in innovation, grow the company, rationalize our back office and expand our margins. We believe our strategies and growth plans combined with our internal cost improvement initiatives will continue to increase shareholder value. I thank you for your support. With that I would like to open the call for our Q&A session.

Thank you. [Operator Instructions] Our first question comes from the line of Paul Coster with JPMorgan. Please proceed with your question.

Yes. Thanks very much. In your prepared remarks I think you mentioned that there may be $0.60 impact to ‘15 guidance, so in other words that the numbers are a little bit higher that you have suggested on a normalized basis, now $67 million it sounds like it’s associated with an investment required to get to sort of One Cubic, but what else is – can you sort of basically step us through $0.60 adjustment?

Yes. Paul, this is Jay Thomas. So there is probably four – about four areas that are impacting us. One is FX, so the translation difference on currencies this year versus fiscal ’14 got a 5% to 6% difference. So it will have the effect of reducing our profits. The R&D increase we talked about that’s probably in the range of sort of like $0.19 and then the investments that you just mentioned on our Cubic One initiatives. And then the last part is the increase in our effective tax rate.

Okay, got it. And can you just repeat for me what the R&D investment is again I didn’t quite catch that?

So, this is Brad Feldmann, how are you?

Hi Brad.

We are increasing our investment in C4ISR and NextCity. We see opportunities in the market. And so we are playing for the long haul and therefore made some investments.

And how much was it going to increase by if you can just repeat that amount?

It’s something in the range of around $6 million to $7 million. I think $7 million to $8 million next year.

Okay. This year, now you also talked Brad enhancing about the impact of NFC and Apple play and how this might promote contactless deployment. So, there is an upgrade cycle coming perhaps through some of your installations in the transportation division, under what timeline do you think this might develop and are there any particular contracts that you can call out as opportunities?

There are some obvious ones in the near-term. We are working in Chicago and LA, but there will be others as well. I would expect them to roll out over the next few years.

And then what about New York, it has been many years since that system has been upgraded, is that within striking distance?

We believe that will be within the next two years, the RFP has been delayed and the customers asking questions, but we believe the RFP cycle will continue and we’ll be winning that contract and working on upgrades within the next two years.

Very good. Thank you very much.

Thank you. [Operator Instructions] It appears there are no further questions at this time, I’d like to turn it back to management for closing comments. Oh! I’m sorry. We do have a question from John Ricchiuti with Needham & Company. Please proceed. John Ricchiuti-Needham & Company: Hi, good afternoon. Just looking at your operating margins, it looks like your Transportation Systems operating margins really snapped back nicely. I don’t have the K yet obviously, but where the operating margins around 18% in the Transportation business in Q4?

They were very high. I don’t know the exact – I don’t have the exact margins in front of me Jim, but yes, it was a very strong quarter obviously. Obviously that’s the function of the reduced losses in Chicago and lack of any big charges in Vancouver. John Ricchiuti-Needham & Company: So going forward, should we assume that operating margins in the Transportation Systems business can remain at these elevated levels as early as high as Q4, but just trying to get a sense as to how you’re thinking about operating margins in that business?

We – probably we talk that in terms of EBITDA margins, because of the amortization charges, but we have been sort of saying that the business has been sort of in this 12% to 14% range year-over-year, that’s probably still holding, we may refresh that as the year goes through. John Ricchiuti-Needham & Company: Okay. And you made a reference to training systems and if I understood you correctly, I think you suggested that it would be more of a backend loaded year for training systems. Is that correct?

Yes, so a lot of that is shipped, this is Brad. John Ricchiuti-Needham & Company: Hi Brad.

A lot of that is shipped – hi, a lot of that is shipment based and our shipments are towards the end of the year. John Ricchiuti-Needham & Company: Okay. So looking at the other two businesses, is there any flavor you can give us in terms of how we might think of the mission support services, MSS business in the early part of fiscal 2015?

Oh! Boy, that’s a tough one, because we don’t get down to quarterly guidance at that level. But historically our first quarter is probably a weakest quarter, because we probably have more holidays. The second quarter, obviously we easily start to see a little bit of a boost in transportation. This year, obviously the fourth quarter finished really strong, because of the – we had a lot of shipments based revenues. So I kind of think that that pattern will probably kind of happen again in 2015. John Ricchiuti-Needham & Company: Okay, that’s helpful. And this will – you provided a loss number associated with the transportation contracts, and I wonder if you could just remind us again for the full fiscal year, was the losses were associated with Vancouver and Chicago?

Mark Harrison. This is Mark Harrison. John Ricchiuti-Needham & Company: Hi.

The Vancouver contract loss was just over $18 million. John Ricchiuti-Needham & Company: Okay.

And Chicago was just north of $28 million. John Ricchiuti-Needham & Company: Okay. And I’m not sure if you made any reference in your introductory remarks regarding Sydney. Did you provide any update on how that’s going?

It’s – we are hopefully having a nice Thanksgiving generally, I think we are putting some of the equipment on the last set of buses here in the next couple of days. So it’s pretty well on target for crossing the finish line on the first phase. But there will be some follow-on work in Sydney for more systems in addition to services.

Our team has been in Sydney and the customer is very happy with the progress that we have made. John Ricchiuti-Needham & Company: Okay, terrific. Thanks. That’s it from me.

Thank you. And I’d like to turn it back to management for any closing comments.

Thank you all for participating in the call today. As always, we appreciate your continued support and interest in our company. If any one has any further questions, please do not hesitate to contact Diane Dyer, our Director of Investor Relations. That concludes our call today, and we thank you for your interest in Cubic Corporation.