Lionheart Holdings (CUB) Q3 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to Cubic Corporation's Third Quarter Fiscal Year 2017 Earnings Conference Call. At this all time, all participants are in a listen-only mode. Today's webcast includes a slide presentation as part of the formal presentation followed by a question-and-answer session. You can advance the slide deck by using the left and right arrows located at the top of your screen. [Operator Instructions]. As a reminder, this conference is being recorded. If anyone has any objections, you may disconnect at any time. Now, I'd like to turn the call over to Diane Dyer. Cubic's Director of Investor Relations. Thank you. You may begin.

Thank you, operator. Hello, everyone, and thank you for joining Cubic’s webcast. Today, after market closed, we reported our third quarter fiscal year 2017 results. We encourage you to refer to the company's press release and the most recent reports filed with the SEC as well as today's presentation slides. You can access these documents on the Investor Relations tab of Cubic's Web site at www.cubic.com, or on the SEC's Web site. On today’s call, Brad Feldmann, Cubic's President and CEO; and Jay Thomas, Executive Vice President and CFO will comment on Cubic’s third quarter 2017 results. 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 about future events or 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, August 3, 2017. 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 also includes 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. Any discussion of non-GAAP financial measures is not intended to detract from the importance of comparable GAAP measures. Having that said, I'll turn the call over to Brad Feldmann, our President and CEO.

Thank you, Diane. Thank you everyone for joining us on the call. Today, I’ll begin with highlights of a year-to-date financial performance, review of the increased investments in our transportation business and an update on our strategy. Following that, Jay Thomas, our CFO will discuss our quarterly financial results in greater detail. Starting with Slide 3. Sales for the first three quarters were $1.040 billion, up $6 million on a constant currency basis. Adjusted EBITDA was $55.4 million compared to $82.3 million last year, net of $3 million foreign currency exchange headwinds. I will summarize the incremental investments we have made to grow our transportation business on the next slide. Following the approval of the DoD budget in May, we look forward to a strong finish this fiscal year driven by increased C4ISR product sales in mission solutions and approved financial performance in our transportation business. We remain very confident in our bid for the New York City New Fare Payment System. The New York MTA has recently expanded the scope of the contract to include both Long Island Railroad and Metro North. And we expect an award decision in the near term. As announced, October 1 Jay Thomas, our Chief Financial Officer will transition to an executive advisory role focused on corporate growth initiatives. Jay has had an enormous impact on the success of the corporation during his nearly four decades of service, and I want to thank Jay for his valuable insights and for his counsel. Thank you, Jay. Anshooman Aga, who recently joined us from AECOM will succeed Jay as CFO. We are very pleased to Anshooman on board and we welcome him to the Cubic senior leadership team. Turning to Slide 4. I want to outline the significant investments we have made in our transportation business. These core investments position us for strong organic growth, driven by our competitive advantages and global customer demand for fare system upgrades. All amounts are year-on-year comparisons. We invested $9.4 million in R&D to advance our next-generation solutions in mobile, revenue collection and real-time passenger information. These investments enable us to increase speed to market, reusability and margins. With the next investment of $6.6 million, we entered the toll market. We also invested $6.4 million in pre-contract engineering to reduce our delivery risk on the New York City bid. Lastly, we have had higher bid and proposal cost related to our larger bids in New York and Boston. These opportunities exceed $2 billion. After adjusting for these investments and foreign currency exchange headwinds, the operating performance for CTS is comparable year-on-year. Moving on to Slide 5. I would like to update you on our five key priorities. The first of these is winning customers. I believe that if we keep winning the customer, revenue growth, penetration of new markets, repeat business, longer contracts and improved employee engagement will follow. I am often impressed at the many ways in which the Cubic team makes a difference in our customers’ lives. In San Francisco, we helped our BART customers support a spike in transit ridership during the Warriors’ victory parade and quickly met the demand for 30,000 additional fare cards. This quarter, we renewed our contract with the Bay Area operators for two years with options to extend to 2024. In mission solutions, TeraLogics’ Unified Video Dissemination System, UVDS, was identified by the Defense Information Security Agency as an important contributor to the agency’s effectiveness and thus to global security. UVDS provides secure, reliable transmission of full motion video to combat commands increasing real-time situational awareness and mission effectiveness. Our Defense Services business received an outstanding after-action review for support of the recent Marine Expeditionary Force exercise. Cubic Global Defense had a strong presence at the recent Paris Air Show where we displayed emerging air combat training technology such as the iPad-based Bandit Board. As we continue building NextCity globally, we have implemented the first phase of Miami’s update to a cloud-based back office. In Los Angeles, we are proposing innovative mobile solutions to help the fourth largest transit authority in the United States and we expect to finalize the deal soon. We have also successful launched EMV contactless technology with our customer transport for New South Wales in Australia. At the end of May, we announced along with our customer RMV in Frankfurt, Germany that the Cubic Deutschland mobile app had passed the milestone of 10 million tickets sold. Other major milestones saw the 2 million Compass Card in Vancouver, and the billionth contactless transaction in London. Elsewhere, following the successful launch of the back office for the New Hampshire Department of Transportation, we are selectively pursuing other traffic management and tolling opportunities in North America, the United Kingdom and Australia. In mission solutions, we continue to see accelerating growth with a successful operational test for T2C2 and expect a full rate production decision at the end of the fiscal year. The technology was demonstrated with great success to the 82nd Airborne Division. And we have recently delivered our first foreign military sale in New Zealand. We received an additional order for 80 Personnel Locator Systems, PLS, with bookings of $6 million. PLS provides a critical airborne solution to enable combat search and rescue, and we anticipate delivering most of these units this fiscal year. The DoD recently approved the MOD Land Joint Capability Technology Demonstration, JCTD, that will leverage our ongoing investment in our wideband communications solution that enables the Joint Aerial Layer Network. Our selection validates a multiyear investment in this capability and the JCTD offers expanded sales opportunities once the demonstration phase is completed in the next three years. This technology is expected to transition to Navy, the United States Marine Corps and the United States Air Force platforms. Additionally, we are partnering with a platform provider to offer a new Intelligence as a Service business model to support the DoD’s expanding needs for real-time intelligence. In realization of our next training priority, we supported the United States Navy in activating the first Littoral Combat Ship Training Facility in San Diego. The successful delivery of the Mission Bay Trainer and the initial Immersive Virtual Ship Environment, IVSE, courseware will help train thousands of sailors to gain competency in their shipboard duties. We are confident there will be further demand for our virtual courseware. Finally, Cubic Global Defense acquired Deltenna, a UK communications company that delivers advanced mobile LTE capabilities. We envision this capability initially being offered in support of our ground training systems business, although a key factor in our decision to acquire the company was the broader applicability for these technologies across all of our businesses. An important factor in achieving our One Cubic priority is to streamline our supply chain and procurement costs. I am happy to report year-to-date savings of $9.6 million which will translate into improved gross margins going forward, part of which can be attributed to last year’s decision to reduce our supplier base by around 50%. We continue to push forward with our ERP implementation which is scheduled for completion in the first half of FY '18. Our employee engagement scores continue to improve and there are now noticeably above the norm of comparable companies. I would now like to ask Jay Thomas, our CFO, to describe our third quarter results in more detail.

Thanks, Brad. Please turn to Slide 6, and I will discuss our consolidated operating highlights. Sales were virtually flat for the nine months ended June 30 compared to last year after consideration of FX headwinds totaling 20.3 million. Sales increased in defense systems but were down slightly in our defense services and transportation segments. Consolidated adjusted EBITDA was 55.4 million year-to-date, down from 82.3 million last year. The biggest impact to profitability was a 20.6 million increase in R&D spending led by major investments in transportation. Our year-to-date expense for our new ERP system was 23.6 million compared to 24.4 million last year. We expect to complete the implementation phase on this new system by midyear FY '18. Our operating income has been impacted by our investment in our new ERP system over the last few years and from recent acquisitions. These investments have mostly impacted our U.S. income and we’ve had three years of U.S. GAAP losses, which has resulted in a U.S. deferred tax valuation allowance. Because of the deferred tax valuation allowance, we are not showing tax benefit for U.S. GAAP losses in our tax expense line. Current U.S. cash taxes are virtually nil. In Q3, due to the sensitivity of tax expense to small changes in our forecasted U.S. GAAP income, we changed to a discrete provision method to calculate our U.S. income taxes and this resulted in a net expense of 17.8 million or $0.66 per share. Year-to-date, we’ve recorded a 5.7 million tax expense against a pre-tax GAAP loss of 18.6 million which includes income tax on our foreign income and no tax benefits from our U.S. GAAP losses. Now please turn to Slide 7. Transportation sales were flat year-over-year after adjusting for FX headwinds of 21.6 million. Q3 sales were down compared to last year on lower comparable sales in Vancouver and Sydney. Adjusted EBITDA was 23.6 million year-to-date compared to 50.9 million last year. As Brad discussed earlier, this year we are making substantial investments in R&D, transformation and in B&P to support our New York and Boston bids along with strong expected demand across our installed base for next-generation fare collection technologies. We believe these investments, while negatively impacting our short-term profits, will generate fare profitability in this segment once these new contracts are in backlog. Transportation profitability has also been impacted by a 6.6 million loss year-to-date on our first toll system contract. We are leveraging this investment to expand our footprint in this $1 billion plus market. Now please turn to Slide 8. Defense systems sales increased 6% year-over-year to 350.7 million led by growth in C4ISR. C4ISR was up 59% year-over-year led by higher sales from our GATR business which we acquired in February of 2016. Ground and immersive training sales were lower this year while air combat sales were slightly higher. Defense systems adjusted EBITDA increased to 29.7 million, up 29% over last year and an almost 100% increase in R&D spending. The increase in R&D spending which totaled 8.3 million year-to-date was offset by an $8 million REA claim that we recovered on the LCS program in Q3. The higher R&D spend was for growth initiatives for our datalink, wideband antennas and NextTraining product areas. Subsequent to the quarter end, we made a small acquisition of Deltenna, which is a UK-based company that provides next-generation LTE solutions. Now please turn to Slide 9. Defense services sales were 281.7 million year-to-date, down 4% year-over-year. Due to late approval of the FY '17 DoD budget, we’ve experienced general slowness in the defense services market this year. Adjusted EBITDA was lower this year on lower volume, higher B&P costs due to security delays and lower margins on re-competed contracts. We remain positive on our outlook for FY 2018 with the proposed DoD budget showing higher spending in our core focus areas of training and readiness and also with the plan for increased troop levels. Now turning to Slide 10, we’ll focus now on the balance sheet and cash flow. During the third quarter, we made substantial changes to our balance sheet. We’ve paid down our short-term debt by 146 million using our offshore cash. The reduction in debt outstanding reduced our annual interest cost by approximately $4.5 million per year. During the quarter, we had 28.3 million of negative operating cash flow and year-to-date, we had 16.5 million in negative operating cash flow. Year-to-date, our cash and equivalents decreased by approximately 200 million and we had approximately 85 million on hand as of June 30. Capital expenditure levels remained elevated based on historical standards, due to our ERP system implementation and improvements to our other facilities that will generate cost effectives going forward. With the completion of the ERP in FY '18, we expect our capital expenditures to trend lower over time. In closing, we are expecting our fiscal year sales and adjusted EBITDA to be at the low end of our guidance range due to the timing issues we had discussed on our last call. These timing issues relate to the award of the New York City Fare Collection contract and delays related to the late approval of the FY '17 budget. And with that, I will turn it back over to Brad for his closing thoughts.

Thank you, Jay, and thank you once more for your great contributions to Cubic as a counselor to several CEOs, including our legendary founder. Now turning to Slide 11. In summary, our strategy is sound and we remain confident that our investments will yield accelerating growth and expanding margins for the company. We expect a very strong finish to our fiscal year led by C4ISR product shipments, improved transportation business performance and strong order intake. Our ERP implementation is advancing on pace and will provide us with a solid foundation for first-class processes and efficiency. We anticipate solid growth throughout FY '18 with the expected New York City Fare Payment System award, further expansion in the fare collection market with our OneAccount advantage and with the transition of the T2C2 program to full rate production. We are satisfied with our progress toward achieving goal 2020. In closing, I’d like to thank my Cubic teammates for their hard work and many contributions, increasing shareholder value and to the investor community for our ongoing partnership as we continue to grow Cubic. Now, let’s proceed to the Q&A session.

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Julian Mitchell from Credit Suisse. Please go ahead.

Hi. Thank you. Thanks, Jay, for all the help down the years and good luck in the new role.

Thank you.

Just a first question I guess around the toll market entry costs. I think people understand that a lot of the year-on-year headwinds are investment related but it can be difficult from the outside to see the sort of path and scale of the returns on those investments. So maybe on the toll market one specifically, give us an update of how quickly we should see a return on that investment and what the addressable opportunity is?

Julian, this is Brad. How are you?

Good. Thank you.

There are a number of opportunities both in the U.S. and Australia that we have proposals now and the number of opportunities is hundreds of millions of dollars. So I would expect in the next couple of years we’ll get our money back.

Understood. Thank you. And then maybe a second around the – it looks like the free cash flow for the year as a whole may end up coming in negative. How do we think about the pace of what that can rebound over 12 or 18 months?

So you can see what’s kind of happened here is as we get sort of backend loaded, so we’ve got a lot of stuff sitting in inventory that will ship in the fourth quarter. So that should translate into positive cash flow as we move into Q1 of '18. So I think it’s just the cycle quarter-to-quarter based on the backend loading for a lot of shipments that we’re seeing with this DoD.

Thanks. And lastly I guess for me just defense services, obviously the margins have been under pressure partly because of the top line trend. Are there any measures you can enact to improve profitability in defense services, or it’s really just a question now of waiting for that top line to turn up?

Yes, I think it was mostly a top line issue. There are some contracts that we’re specifically working at improving the profitability. But I’d say overall it’s a top line issue and it’s a scale issue.

We’ve just seen bid cycles on contracts take anywhere from six to nine months. There’s a lot of protesting going on, on jobs where you’re competing against others.

Understood. Thank you.

Our next question comes from the line of Ken Herbert from Canaccord Genuity. Please go ahead.

Hi, Brad. And congratulations as well, Jay.

Thank you.

Hi, Ken.

Hi. Just wanted to start off first on New York City opportunity. It seems like the scope is expanding. First, can you maybe help quantify that for us in terms of – obviously you’re making some additional investment as you talked about 2 billion for both New York and Boston combined I think. But how much individually has New York expanded?

The total contract I believe will be over 1 billion and I think it will expand further. So it is increasing. Boston is a key opportunity. We’re also working hard in Brisbane which could be also another $1 billion. There’s an opportunity in San Francisco where we’re the incumbent. So in the short to midterm we see very good organic growth within CTS. The investments we’re making, some of them have to do with moving the company from a program simplicity to product simplicity and we believe by increasing our reusability, we’ll be able to drive margin going forward as well.

Okay. That’s helpful. And specifically for New York in the investments, do the inbound on investments partially – obviously you’ve talked about the reorganization there. Are there at all reflective of maybe incremental competitive pressure and maybe incremental cost you didn’t anticipate to win the bid or is it really just the organization and then maybe just obviously being able to deal with an expanded scope. How would you help characterize the additional investments putting into the bid process?

So I think we’re very confident on our ability to win that job because we’re being incumbent. So really what we’re doing is we’re building some of the technologies in advance so that we get a jumpstart on the schedule, which takes off risk once we’re under our way. So when we get that contract, we have a team in place and they’re already going and they’re working hard and we’ll have the chalks [ph] very well on that job and reduce risk for everyone.

Okay, great. Just finally on the C4ISR business, it seems like you’re seeing good growth there and you acquired GATR a few years ago and TeraLogics and DTECH. You were talking high margin potential businesses with 20% growth. Are they hitting your targets there, maybe exceeding your targets and how has the pipeline expanded specifically within C4ISR now that we’ve got a '17 budget in place?

We’re doing well in those businesses. I talked about the T2C2 program going in the full rate production. We expect that decision in the coming months. That program itself has objective quantity of around 1,000 terminals. It turns out that the Army has other nets as well. And it turns out you can use this technology for other applications; one for instance Troposcatter. And so I think we’ll sell 1,000 of these antennas. DTECH is doing well. They had some international sales also. They’re on key programs at SOCAR. Quite frankly we’re waiting for contracts to be awarded in some of the areas. We have very good visibility but it’s hard for me always to predict how long contracting officers take to do their jobs. But we remain very savvy about what we’ve done. And if linked a mission chain of capability for our customers and have actually sold products that include all of those capabilities that we’ve required. So I’m seeing certainly some revenue synergy as well.

Okay, that’s helpful. And just finally it sounds like on adjusted EBITDA, the guidance implies a very strong – or your commentary a very strong fourth quarter, maybe 45 million to 55 million in adjusted EBITDA. Is there high confidence in that level or is there solely recent timing risk around some of the programs?

We’re confident, of course, as I mentioned. We don’t have all the orders in backlog yet. But we are very confident. And our team is pushing the process very, very hard.

If you kind of look at our past couple of years, you’ll see the fourth quarter has always come in a – it’s our largest quarter of the year. So we’ve just seen more phenomena shipments in the fourth quarter.

Okay, great. Thank you very much.

Thank you. [Operator Instructions]. Our next question comes from the line of Brian Ruttenbur from Drexel Hamilton. Please go ahead.

Yes. Thank you very much. So it sounds like the MTA, is this still going to happen by the end of August or are we pushing the timing out?

So the next Board meeting is in September. We don’t have Board meetings apparently in August. So we anticipate that that’s when we’ll learn the good news.

Okay. And then what’s the next Board meeting after that if it doesn’t get voted on in September?

October.

Okay, so it’s immediately after that. Okay.

[Indiscernible]

That’s nice of them because they’re working hard. That was supposed to be funny. But it looks like you kitchen-sinked the quarter. Is that what I would regain on this is that you – the change in CFO and some other things that you put everything that you possibly could in this quarter and that’s why things are going to be a lot easier going forward, or am I being too blunt and reading something into this?

Yes, I think you maybe over reading. I don’t think there was timing all related to that. I think we shared the bridge of year-to-date investments within CTS. We expect CTS to do very well going forward.

Okay. And do you have a breakout of – I’m looking through the slide deck as well as the press release, a breakout in the quarter. How much were the charges to just try and back out to what a normalized quarter would be if we backed out new bid expense, FX for the quarter, incremental R&D just for the quarter? Do you have those numbers broken out?

If you go into the MD&A and the 10-Q, you should see the detail in there.

Okay. I just didn’t get into the Q yet. Perfect. Thanks very much and good luck. And the guidance for fourth quarter was as I heard, adjusted EBITDA 45 million to 50 million, is that correct, backing into it?

Yes, if you look at the low end of our range for the year and back into, that’s where we’re at. Correct.

Okay. Thank you very much.

Great.

Thank you. Ladies and gentlemen, there are no further questions in Q&A at this time. I would like to turn the floor back over to CEO, Brad Feldmann, for closing comments.

Thank you for joining us on the call today. We remain optimistic about Cubic’s future. Thank you very much for your support of our great company.