Lionheart Holdings (CUB) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to Cubic Corporation's First Quarter Fiscal Year 2018 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 slides by using the left and right arrows located in the upper right-hand corner of your window. [Operator Instructions]. As a reminder, this conference is being recorded. If anyone has any objections, you may disconnect at this time. Now, I'd like to turn the call over to Kirsten Nielsen, Vice President of Investor Relations. Thank you. Please begin.

Hello, everyone, and thank you for joining Cubic’s webcast. Today, after the market closed, we reported our first quarter fiscal year 2018 results. I am joined by Brad Feldmann, Chief Executive Officer and Anshooman Aga, Executive Vice President and Chief Financial Officer. I would like to reminder everyone that statements made on today's call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. You can find factors that could cause the company's actual results to differ material from our expectations listed in today's presentation, press release and most recent SEC filings. In addition, we've included some non-GAAP financial measures in our discussion. Reconciliations to the most directly comparable GAAP financial measures can be found in today's press release and in the appendix of today's presentation. With that, I'd like to turn the call over to Brad.

Thank you, everyone for joining us today. Thank you, Kirsten. I want to start by welcoming Kirsten, our new Vice President of Investor Relations. Kirsten is an experienced financial executive who joined our team from Arconic, formerly Alcoa, where she was Director of Investor Relations. Kirsten has already made significant contributions and enhanced our dialogue with our shareholder base. We're excited to have her on Board. On today's call, I will start by discussing our first quarter results for fiscal year 2018 and the highlights of the quarter. Then I'll hand the call over to our CFO, Anshooman Aga, who will cover our financial results in more detail. Starting with Slide 3, you will find an overview of our first quarter results. As you can see, strong execution on our Winning the Customer initiative has led to the highest backlog in the company's history totaling $3.64 billion. We won all of the major opportunities we're pursuing including our major transportation wins in New York and Boston. An Air Force Datalink Enterprise ID/IQ Award and an important defense training wins for continued support of the Joint Readiness Training Center in Fort Polk Louisiana and at OASIS-EUCOM for training support, as well as a training support services enterprise mission support services ID/IQ. This accelerated award momentum generated a book-to-bill ratio of 2.44 for the quarter, providing us substantial organic growth in the future. Sales for the quarter were $340.7 million, a 2% increase compared to last year. Adjusted EBITDA was $17 million in line with our expectations and slightly lower than last year's $20.1 million. R&D increased roughly $3 million due to our investment in CMS Technologies and our acceleration of development of innovative training technologies. We remain hopeful that the president and congressional leadership will reach a new 2018-2019 bipartisan budget agreement with DOD funding tax increased. President Trump is now expected to ask for an all-in military budget request of $716 billion for fiscal 2019, which would be roughly 7% over his 2018 request and 13% over 2017. We think this level of defense spending and potential topline growth in the out years will allow for steady organic growth in the future. Turning to Slide 4, with our many key recent wins and the T2C2 full rate production decision, we are in a strong path to goal 2020. On Slide 5, you will see that our investments are paying off. Along with our transportation award in New York, in November Cubic was selected by the Massachusetts Bay Transportation Authority to design, build, operate and maintain a next-generation fare payment system. With the Boston win, we're now providing fare payment systems for the top five metro agencies in the United States. In January, our Cubic Mission Solutions GATR team received a full material release and a full rate production decision from our United States Army Customers Milestone Decision Authority PEO C3T for the Transportable Tactical Command Communications Program. The T2C2 full rate production decision authorizes our customers to procure and field over 800 satellite communications terminals to US Army units worldwide. The growing success of our efforts on U.S. programs of record like T2C2 could lead to fleetwide adoption by the Army and other services, while positioning us for large international opportunities. Additionally, because of our strong customer relationship with the United States Army, we continue to support exercises at the Joint Readiness Training Center. This follows our recent Combat Training Center Award in Asia-Pacific and numerous task orders for our superior gaming training solution to support the Littoral Combat Ship program. Moving to Slide 6, we continue to make investments in technology. We are investing in MotionDSP, a Silicon Valley-based artificial intelligence software company specializing in real-time video enhancement and computer vision analytics. We will now be able to detect and track entities in near real time augmenting our existing full motion video dissemination capability. On Slide 7, we're making significant progress on our growth initiatives. Under NextCity, we continue to introduce new forms of mobile based payment systems. Our most recent award is with the Los Angeles County Metropolitan Transportation Authority for which we will be delivering innovative traveler and merchant apps for the transient access pass tap regional contact list fare system, the largest regional smartcard system in the United States. The app will be on our Software as a Service Cloud platform enabled by our collaboration with Microsoft and will securely allow third-party services such as ride or bike sharing parking and fare subsidy programs. With Chicago, L.A., New York, and Boston we now have mobile solutions in four of the top five U.S. transit agencies representing 52% of U.S. ridership. We're very excited about these mobility as a service wins as they provide us with the opportunity to accelerate our growth with new revenue streams and are the foundational platforms for the user interface to NextCity. There is a rise in demand for open payment systems across our transportation customer base and we are well-positioned on our next two big fare collection opportunities in Brisbane and San Francisco. In Brisbane, we submitted our proposal in late 2017 and expect the customer to complete their evaluation and announce a decision later in 2018. In the San Francisco Bay Area, our bid is due in March with a planned award in 2019. We remain extremely confident that our One Account platform leads the market’s demand for technologically advanced cloud-based back office systems and we are well positioned for several other opportunities in large cities, such as Toronto, Montreal, Paris, Dublin, Houston an Detroit. In addition, we see many state of good repair and upgrade opportunities with our existing customers. We’re also bidding on multiple adjacent opportunities related to our tolling, Intelligent Transportation Systems and NextBus businesses. Overall, we expect CTS to deliver 7% to 10% organic growth in line with our goal 2020 targets. In mission solutions, we have been awarded multiple data link contracts including the research and development of Next-Generation Communication Systems under an air force data link IDIQ vehicle. Secure common data link support on the joint surveillance targeting and reconnaissance system. Radio and waveform development for the Marine Corps, small unmanned air force system and an upgrade to the aircraft Carrier common data link using the Navy’s shark link system. Our halo wideband communications solution that will enable the joint area layered network is maturing and expanding in scope. We continue to mature the halo solution through our selection on the mod land Joint Capability Technology Demonstration contract. This technology is expected to transition to multiple U.S. Navy Marine Corps and Air Force platforms. In CMS, we are working with motion DSP our next-generation solutions that integrate enterprise solutions and machine learning with our improving processing dissemination and exploitation end products. By capitalizing on the T2C2 full rate production decision and ever-increasing demand for enhanced head solutions we expect Mission Solutions to deliver a growth rate in the 10% to 15% range in line with our goal 2020 targets. In Defense Training systems, the United States Navy has joined our existing secure LVC advanced training environment, advanced technology demonstration contract, the future multi-level encrypted live virtual constructive ACMI. We continue to build our next training capability to provide performance-based training for the United States and allied nation militaries. We’re providing fully integrated multi-domain training architecture using LTE communications, augmented reality and enhanced exercise control data visualization to several key customers. Building upon our prior successes, the United States navy recently ordered new engineering watch team training combat systems and IT maintenance training courseware to support the Littoral Combat Ship. We’re also awarded the option for a third year of supplying the British Army with our SCOPIC synthetic wrap technology. The technology provides an expeditionary LTE network infrastructure with tactically deployable emulated equipment and personnel to support collective and machine rehearsal training exercises. Additional options are expected to extend the program support for several years. We have received a notification of intent to award a sole-source contract for a newly developed non-line of sight targeting training system for the United Kingdom's 105 M.M. howitzers which will be used by the UK Royal School of Artillery to provide precision targeting to support of simulated live training exercises. We expect our training systems business to grow approximately 5% in line with our goal 2020 targets. In addition to winning our JRTC a read competes, we won two large training services, ID/IQ vehicles, mission training complex contract support with a ceiling of $975 million and the training services support enterprise with a value of $150 million. We have already been awarded the first task order of the TSSC valued at $15 million. Our team continues to do an outstanding job for our customers keeping us abreast of future training requirements and consistently winning. Finally, on Slide 8, we continue to make significant progress on our One Cubic initiative. We completed the major milestones of our ERP system back office implementation and are on schedule to finish soon in fiscal year 2018. We will now implement a common engineering tool suite and workflows through fiscal year 2019. A key goal of our Living One Cubic priority is to increase employee engagement. We believe when our employees are all-in, our company performs better and better. Next, I will ask Anshooman Aga, our CFO to describe our first quarter results in more detail.

Thank you, Brad. Please turn to slide nine to cover a few of the highlights for the quarter. Our financial results for Q1 were in line with our expectations. Adjusted EBITDA of $17 million was down $3 million year-on-year primarily due to higher R&D investments in our technology and products that will deliver long-term returns for our shareholders and the timing of shipments and mix from our defense business. While Q1, R&D spend was $3 million higher than prior year, full year R&D expense is expected to be slightly below fiscal year 2017 levels. As Brad already mentioned, we ended the quarter with a record backlog of $3.64 billion, which now reflects the $554 million contract for New York signed in October. We continue to expect the financial close and booking for Boston in fiscal Q2. Free cash flow was negatively impacted by the timing of collections in the Middle East, higher unbilled AR and defense services, timing of the mobilization payment from New York and an increase of inventory in transportations for delivery scheduled in the coming months. Going forward, we expect cash flow to improve as we collect on these receivables. As you are aware, the recently enacted tax legislation significantly revises the U.S. corporate income tax system by reducing the corporate’s income rate to 21% adopting a territorial regime and then posing a one-time transition tax on deemed repatriated foreign earnings. As a result of proactive tax planning, our current estimate is that no material impact or results from the deemed repatriation of our offshore earnings. Additionally, we expect to benefit from the lower corporate tax rate once we get passed past our investment in the ERP and deliver on the planned growths in the U.S. We will continue to analyze the impact of the Tax Act and provide updates in future quarters. Turning to Slide 10. First quarter sales were flat on a constant currency basis as growth and Transportation and Defense Services was offset by lower sales, primarily in Defense Systems compared to the prior year. I'll talk more about this at the segment level. As I discussed adjusted EBITDA and cash flow on the previous slide, I just mentioned that's the most significant item contributing to the decrease in earnings per share in the first quarter versus the prior year for the change in our tax provision. In the first quarter of 2017, we had computed an annual effective tax rate using a worldwide blended methodology giving us a tax benefit of $5.1 million against the pre-tax loss of $7.9 million. However, in the first quarter of 2018 we computed discreet domestic and foreign annual effective rates to arrive at a total projected rates for the year resulting in a tax expense of $517,000 on top of our pre-tax loss of $9.3 million. The difference in methodology only impacts timing of the tax provision within the fiscal year. Lastly the earnings per share, includes costs associated with our ERP and supply chain initiatives of approximately $8 million as well as acquisition related expenses of $1.4 million. Turning to Slide 11, the Transportation business delivered strong sales growth of 8% on a constant currency basis, primarily driven by system engineering on the New York City project. Adjusted EBITDA margin was in line with the prior year at 9.1%. Moving to Slide 12. We are now presenting Mission Solutions as a separate reporting segment. Q1 adjusted EBITDA and margin reflect higher year-on-year R&D expense of $3.5 million to develop next generation protected communications solution as well as a change in mix primarily due to the timing of gated sales. In terms of the year-on-year comparison, it's also worth pointing out again that the prior year was favorably impacted by the funding delays in Q4 fiscal 2016 which forced some shipment into Q1 fiscal year 2017. Last month, the Army’s T2C2 program received approval to move to full rate production. We expect this program to help deliver year-on-year performance improvement for CMS. Also, I think it's important to take a moment to emphasize the seasonality of this business. As we have communicated in the past, due to the CR and the timing of discretionary spend from our main customer, the majority of our adjusted EBITDA in the segment generated in Q4. For example, last fiscal year CMS delivered $11.8 million in Q4 versus as full year adjusted EBITDA of $14.8 million. We expect similar year on concentration in fiscal year 2018. But the defense systems segment on slide 13, bookings were impacted by delayed orders. Recovery is expected in Q2. Sales are lower than Q1 of last year due to the timing of shipment. Adjusted EBITDA and margins reflect lower sales and higher R&D spending compared to last year. Turning to Slide 14, the services segment is off to a strong start. Higher bookings reflect key wins with the U.S. army customer and the funding of the JRTC bridge program. Sales grew 2% driven by additional training rotations at JRTC. Adjusted EBITDA improved due to strong execution and business realignment efficiencies. Moving to slide 15, we’re maintaining our full year guidance for fiscal 2018 based on strong order activity in Q1 including the New York win, the full rate production decision on T2C2 along with our expectation for strong fourth quarter shipments for our CMS business. We continue to expect sales to be between $1.51 and $1.56 billion and adjusted EBITDA to be between $110 million and $135 million. As indicated during the last earnings call, we anticipate that adjusted EBITDA seasonality will be similar to fiscal year 2017. We are hopeful that we will have a signed Defense Appropriations bill in the coming weeks. Additionally, the timing of the U.S. government discretionary spend favors us a strong final quarter for our CMS business and the ramp up of the New York contract will reflect the bell curve during the duration of the design build contract with a steeper ramp in fiscal year 2019. Therefore, Q2 adjusted EBITDA is expected to reflect a gradual sequential improvement over Q1. We expect more accelerated EBITDA improvement in the second half of the fiscal year particularly in Q4. Now, I'll turn it back over to Brad to wrap things up.

Thank you, Anshooman. Turning to slide 16. In summary, we are very pleased with our start to fiscal year 2018 led by our major transportation wins in the New York and Boston. Our Mission Solutions Air Force data links IDIQ award and the defense training JRTC win in Fort Polk. We expect CMS revenue and profitability to increase due to the recent T2C2 full rate production decision. We will continue to make technology investments to drive revenue growth and margin expansion. Finally, our ERP back office implementation is nearing project completion and will provide us with a solid foundation for first class processes and efficiency. We are standardizing our engineering tool sets and workflows to drive further consistency and efficiency. In closing, I'd like to thank my Cubic teammates for their hard work in 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. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Ken Herbert with Canaccord Genuity. Please proceed.

Hi good afternoon.

Hey, Ken, how are you doing?

Hi, pretty good. Brad and Anshooman. I just wanted to start off first within transportation systems, can you just provide an update on what the contribution was in the quarter perhaps from the New York City contract and how we should think about that contract maybe and the contribution on a full-year basis from a top line and maybe from an EBITDA basis?

Thanks, Ken. As we don't break out individual revenue and profitability of individual contracts, I'll remind you that the revenue is in the form of bell curve. We will see some ramp in the quarters to come in this fiscal year from a revenue perspective and then fiscal '19 and fiscal '20 will be the steeper ramp in terms of New York revenue. From a profitability perspective, while we don't disclose individual contract profitability as we mentioned in the past we are committed to our goal 2020 targets and see this contract contributing towards our goal 2020 margin.

Okay. Okay. Now that's helpful. And then if I understand correctly, due to the accounting and how you count for the contract, as the revenue ramps from '18 to '19, do you see any expansion of the margins or are you booking the revenues now at a consistent margin?

It's cost to cost completions so the margins during the duration of the design book contract will remain slight assuming we deliver on time in terms of profitability.

Okay. Okay. Thanks for that. And then if I could just on the specifically within mission solutions, I can appreciate the investment in support of GATR and T2C2 as you think about this business, I just want to clarify you talked about this business as maybe 10% to 15% sort of growth business across the cycle I guess or as part of your 2020 goal. Do we start to see that growth this year? Is that more of 2019-2020, as we get the full benefit of T2C2? Or how do we think about the growth ramp here moving forward within Mission Solutions?

We'll see some growth this year, but next year we'll see even better and better growth.

Okay. So next year we should be in that sort of long-term target range?

Indeed.

Okay. Perfect. And if I could just one final question. Within Mission Solutions, again do you expect to have incremental investments to support GATR and T2C2 that we should maybe keep in mind as we think about the margin? Or does this step up or the spend this quarter does that position you or is there going to be more you think you're going to have to invest to support those in those programs?

So, Ken in terms of R&D, what I mentioned was our R&D expense for fiscal '18 will be slightly below the fiscal '17 levels. Last year, we had lower R&D investment in Q1 with significant ramps in Q2, Q3, Q4. This year, it's a little flatter in terms of the R&D spend. So, there's no significant R&D expense ramp up planned from current levels.

In addition to that Ken, we're expanding our facility in Huntsville, so that we can rapidly produce terminals for the army and associated customers.

Okay. Great. Thanks a lot. And obviously great work on these contracts.

Ken, thanks so much.

Thank you. Our next question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed.

Hi. Thank you. Good afternoon. Just wanted to go back to your full year guidance and your reaffirmation of sales and adjusted EBITDA. I’m wondering as I look at the range for adjusted EBITDA to get to the upper end of the range, does that assume a bigger contribution from the defense portion of the business. I'm just trying to get a better feel for what may get you to the high end of that range?

That’s -- hi Jim, definitely a larger contribution for the high end of the range would come from a Defense business. As we mentioned the timing of the discretionary spend from the U.S. government and also the duration of the CR are big determinant factors of the range. So, Defense is the bigger variable in our range.

And Anshooman, looking at that, that would be probably more weighted again toward Q4, is that your sense?

Yes, as you can look at our previous results, Q4 was a significant contribution in profitability last year and the trend this year will continue especially with CR, we’re sitting through half year with the -- almost half year through with the CR, so the timing is again going to be backend loaded.

Okay. And I wonder if you could perhaps talk a little bit more about the investment in motion DSP and what that may bring to you going forward?

Yeah. This is Brad. We made an investment in the company, a partial investment. We plan in the future to buy the whole company out. We'll do that in n number of weeks. So, I suspect, the real reason we interested in that technology, again is that mission chain that we’re creating as you know, we have the ability to disseminate full motion video and we wanted to add processing in real time, so this artificial intelligence company in Silicon Valley is a great find to be to -- help us add greater value for our customers.

This is a company that you’ve had a relationship with or?

Indeed, in fact indeed and we’re currently working with them and have been working with them for months. We’ve tended to follow a pattern of working with folks before we buy them.

Okay. And last question for me, I just wanted to go back to the overall pipeline in transportation, you had a pretty high win rate certainly. But going forward as you look at some of the contracts that are in the pipeline or let’s say the programs that are in the pipeline that you’re targeting. What’s your sense in terms of looking at some of these identified Brisbane it sounds like you feel very confident about that as well as San Francisco. You also alluded to some other ones that you haven’t talked about before. What’s your sense on some of those other deals?

The technology that we’ve developed with open account and you know you’ve probably heard from that called increased acceleration in winning mobile payment contracts. We think that gives us a formidable advantage. We think that our customers that’s what they want and so you know Jim, I would want. And so, Jim, I would expect us to do very well going forward. We're not going to bid a dollar for these things. We're going to bid our costs and so forth. But I would expect us to have a very good advantage. And also, as you think about it, as we do New York, we are getting non-recurring done, as we add Boston; we're getting engineering done as we get Brisbane and the story goes. So, we'll have a lot of engineering already done before these contracts come out so we think we're in a great place.

Okay. Thanks very much, Brad.

Thank you. Our next question comes from the line of Mark Strouse with JPMorgan. Please proceed.

Yeah. Hi. Good afternoon. Thanks for taking my questions.

Hey, Mark. How are you doing?

Hey, Brad. Good. How are you? So, appreciate you breaking out the mission solutions business. Can you just, would you mind going back to the goal 2020 targets and just talk about the, you've already laid out the revenue targets but can you just remind us of the EBITDA margin targets for that segment as well as the heritage defense systems business?

We haven't given out the targets as but you'd expect the CMS business to be in the mid-teens margin range and the defense CGD training systems business to be high single digits to maybe double-digit range.

Right. Okay. Okay. That makes sense. And then after a few years now, you are on the cusp with some pretty material savings ERP upgrade both in the efficiency gains, but also from the longer investing in that line item. Can you just talk about how much of that will be, how much of those savings will be you reinvested into the business versus how much could go to other thing such as additional M&A or a potential buybacks that kind of thing?

So, you know as we finish our ERP implementation roughly mid-year, this year, the remainder part of this fiscal year we’re going to work to make the system a little more efficient, and improve the processes around SAP. And then, we should start seeing some of the savings dropped to our bottom line next fiscal year. In terms of what we do with the savings at the end of the day, we continuously evaluate best uses of our capital, whether it’s dividends whether it’s M&A, whether it’s investments in organic growth, and we’ll continue to do that. We remain to be committed to make stringent capital allocation decisions that drive the long-term shareholder return and we will just continue to evaluate that as we return – deliver higher returns.

Mark, we’ve stated publicly that we think that the ERP project successfully implemented more well along the way. We will raise the tide by 2% to 2.5%. And we and we stay committed to that right.

All right, okay. Okay. That makes sense. Thank you very much.

Thank you. Our next question comes from the line of Brian Ruttenbur with Drexel Hamilton. Please proceed.

Yes. Thank you very much.

Hi, Brian, how are you doing?

Good. Very good. Thank you very much for taking my call. So, on the R&D side, you basically said, you know the first quarter is going to be the trend around $12 million a quarter, is that right so roughly $48 million on the year, be down roughly $4 million year over year?

In the ballpark, there’ll be slightly below last year Q1 with the holidays et cetera is probably a little below run rate so you can say roughly $50 million.

Okay. And then if you could give us similar kind of guidance on G&A?

G&A…

And tell us what earnings are in three years, no -- just help me out with G&A.

I'll answer the second one first. Earnings in three years, they are much better than this year. But G&A should be down slightly. One of the reasons is going to be the fact that last year we had higher ERP costs. This year, it's $25 million and then we're starting to make certain investments in terms of delivering some of the savings that Brad mentioned and I mentioned earlier so it will be slightly below the last year's levels.

Okay. And then tax rate in fiscal 2019. You talked about the tax rate dropping but what is it going to be on a run rate basis beyond this year. I know this year has got a little bit of the old, little bit of the new but on a run rate basis what do you think the mix will be when you're profitable and generating cash, what kind of tax rate you’ll be paying?

Brian, we're still going through a lot of the analysis so I won't commit to a tax rate this quarter. We'll continue to give updates but just thinking out maybe a couple of years from now you know our earnings predominantly would be in the U.S., UK and Australia and if you start thinking out three, four years potentially the mid-to-high 20s would be the potentially the mid to high 20s would be rate to look at.

A mid to high 20s is that we said?

Right.

Okay. And then finally -- go ahead sorry.

And next -- I won't commit to it next year because, we're still going through all the implications of the Tax Act and there might be some pluses and minuses as we go through all of that.

Okay. And then final question on timing of repatriation of dollars, I guess they're primarily in pounds is that correct? You have roughly £200 million primarily in pounds?

No, we repatriated a lot of that money last year so and part of it was as we were looking at our tax planning with the new Tax Act we were a little preemptive and the key thing one of the things I mentioned was the transition of the toll tax. We expect our liability to -- tax liability to be next to nothing. It was related to a lot of the repatriation and moving the money that we did last year.

Okay. Thank you very much.

Thank you. We have reached the end of our Q&A session. Allow me to return the call for closing remarks.

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