Lionheart Holdings (CUB) Q3 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cubic Corporation Third Quarter Fiscal Year 2018 Earnings Results Conference Call. At this time, all participants 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. It’s now my pleasure to turn the call over to Kirsten Nielsen, Vice President of Investor Relations for Cubic. Please go ahead, Kirsten.

Thank you. I’d like to welcome everyone to our third quarter fiscal 2018 earnings conference call. I’m joined today by Brad Feldmann, Chairman, President and Chief Executive Officer; and Anshooman Aga, Executive Vice President and Chief Financial Officer. I’ll remind 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 materially from our expectations listed in today’s press release and most recent SEC filing. In addition, we have 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 to today’s presentation. With that, I’ll turn the call over to Brad.

Thank you, Kirsten. Thank you, everyone, for joining us today. On today’s call, I will start by discussing our third quarter and year-to-date results for fiscal year 2018 followed by a strategy update. Then I’ll hand the call over to our CFO, Anshooman Aga, who will cover the financial results in more detail. Starting with Slide 3. You will find an overview of our financial results from continuing operations as we closed on the sale of our non-original equipment Manufacturer Training Services business in May. Sales for the third quarter were $296 million, an 11% increase compared to the third quarter last year. Sales for the first nine months were $823 million, a 9% increase over prior year. Adjusted EBITDA for Q3 was $28.2 million, a 123% increase compared to the third quarter of last year and $55.5 million for the nine months, an increase of 32% compared to last year. Our backlog continues to grow and is now at $3.7 billion, another record in Cubic’s history. Following the sale of the Defense Services business, we have revised our Goal 2020 revenue target to $1.55 billion to $2 billion in revenue, including 10% annualized organic growth, with 11% to 12.5% adjusted EBITDA margins. Turning to Slide 4. We are pleased to have successfully achieved five of the six growth catalysts that we had strategically targeted several quarters ago, including win in New York, Boston and Brisbane, achieving the T2C2 full rate production decision and completing our ERP implementation. With strong confidence of our perspective win in the Bay Area, all six of the catalysts will be achieved. Looking forward, our upcoming growth catalysts in transportation include AFC upgrades with existing customers as well as competitive opportunities in cities such as San Diego, Paris, Toronto and Montreal and the expansion of our presence in adjacent markets of Surface Transport Management, tolling and congestion charging and our NextBus 2.0 market entry. In Mission Solutions, we are ramping up on our FirstNet program with AT&T and preparing for SATCOM convergence as the U.S. Army considers common solutions. In defense training, we continue to develop our synthetic training environment solution, part of the Army’s modernization priorities. Moving to Slide 5. Along with our major wins, we continue to make overall progress with our Winning the Customer initiative. In Q3, we completed our defense services divestiture, and we’ll deploy cash from its proceeds to further drive our market-leading, technology-driven strategy. To better serve our small- and mid-market transportation customers with an appropriately scaled fare collection solution, we have made an investment in Delerrok, an automated fare collection company that has focused on this market segment. By combining Delerrok solutions with NextBus 2.0, initially through a reseller agreement, we believe we can offer subscription-based applications to small and mid-market, combining market-leading payment and real-time information functionality at an affordable and profitable price point. We are pleased to strengthen our relationship with AT&T and Verizon as an exclusive FirstNet Radio over Internet Protocol interoperability provider. Our RoIP solution will allow first responders across the U.S. to use radios with cellphones over the mandated FirstNet network. Finally, we had a successful flight test of the Secure Live, Virtual, Constructive Advanced Training Environment Advanced Technology Demonstration, SLATE ATD. As the sole integrator of the program, we will provide next-generation Live, Virtual, Constructive Air Combat Maneuvering Instrumentation to the SLATE ATD program. This successful test flight moves us well along the path to revolutionize Air Combat Maneuvering Instrumentation with combined secure LVC simulation techniques. Turning to Slide 6. We recently announced that Cubic has acquired the assets of Shield Aviation unmanned systems. As a result, Cubic will provide an affordable airborne intelligence surveillance and reconnaissance, ISR, capability with expanded range and payload over other existing systems in its class. We have been working with Shield for many months, and we’ll integrate our C4ISR capabilities into this unique platform. This entry into the ISR market fits our strategy of focusing on technology-driven growing markets, where we can provide niche or market-leading capability. The DoD demand for ISR is growing and continues to be underserved. We are combining our capabilities so that we can offer ISR as a service to meet this demand. The Autonomous Aerial systems, AAS, market, which is roughly $5.7 billion today, is expected to more than double by 2024. Turning to Slide 7. In NextCity, we are making tremendous progress on our three strategic pillars: One Account, mobile and customer experience and operations and analytics. We are celebrating our recent Brisbane next-generation ticketing system award to upgrade the current system to incorporate the most advanced ticketing technologies, including contactless payments and next-generation real-time passenger information. The new system will enable Queensland commuters to use bankcards, mobile phones and personal electronic devices across four different modes of public transport: bus, ferry, rail and light rail. We are confidently awaiting the outcome of our best and final offer for the Sydney Integrated Congestion Management program, which will significantly advance the operations and analytics pillar of our NextCity vision to the next level as our system will provide a complete situational understanding of the entire transportation system to reduce congestion. Additionally, the top five U.S. transit agencies are committed to our mobile solution. And this last quarter, we’ve added Brisbane to the mobile customer list and have also launched the next generation of our mobile app in London. Together, these wins demonstrate that our investments in R&D are paying off and providing a competitive advantage. In addition to these competitive wins, we continue to work with our broad customer base on upgrade strategies aligned to NextCity for their existing systems. By way of example, this quarter, we received two significant orders from the Washington Metropolitan Area Transit Authority, one for our mobile solution and another for the fare collection solution for the Silver line. We expect this trend of customer upgrades to continue in support of Goal 2020. In Mission Solutions, we’re expecting an increase to our Transportable Tactical Command Communications ID/IQ contract, which would roughly double the ceiling from where it is today, bringing the total potential value to just under $1 billion. As we’ve discussed on previous calls, we expect shipments on the T2C2 full rate production order by the end of this fiscal year. We were also awarded an increase to our unified video dissemination contract from DISA to expand our nation’s global airborne ISR dissemination capability. In Defense Systems, the F-35 Joint Strike Fighter lot 12 through 14 order for $65 million is now in backlog. Cubic’s training capability is now in over 1,000 F-35s in a fleet that will eventually reach over 3,000. We were awarded the Canada Urban Operations Training program valued at more than $27 million from the Canadian Department of National Defence. We will deliver urban operations training capability into the Canadian weapon effect simulation sea west environment. Under this contract, Cubic will fully instrument urban operation sites at Canadian forces base Gagetown and the Canadian maneuver training center Wainwright, satisfying the force-on-force training capability requirements of the Canadian Army. We also conducted a very successful demonstration in late May at the United States Marine Corps’ premier live training site at Twentynine Palms, California. We demonstrated two important technologies we’ve invested in: the mobile LTE and virtual constructive in addition to live training. The customer was very happy as they saw value of improved training. We expect to see several Training-as-a-Service contract opportunities with the Marine Corps in 2019. Finally, moving to Slide 8. We continue to make significant progress on our Living OneCubic initiative. We finished our major ERP system back-office implementation in Q2 and are working on optimizing all global processes and workflows. We’re also implementing product life cycle management to standardize our engineering tools and workflows through fiscal year 2019. A priority of ours is to develop enhanced analytics capabilities using our new tools. We are especially proud of our OneCubic teamwork new solutions. The Tri-Reader 4, the heart of our future transportation payment solutions, and our defense artillery training offerings were collaboratively developed by transportation and defense engineers. Due to the reducing supply chain and overhead costs, we expect to further expand profit margins in FY2019. Now I’ll ask Anshooman to describe our financial results in more detail.

Thank you, Brad. Please turn to Slide 9 to cover a few of the highlights for the quarter. We had strong financial performance in all three segments with execution on crack across our major projects. Adjusted EBITDA from continuing operations was $28.2 million, more than double the third quarter of last year and slightly ahead of our expectations, driven by the accelerated timing of some shipments. Free cash flow was negative $42 million and impacted by inventory buildup in support of Q4 shipments and burn-down of customer advances. Also, as a reminder, the milestone payments from the special purpose entity related to the Boston project, which I’ll discuss in a moment, are not reflected as operating cash flow. If we were to adjust for that, free cash flow would have been negative $26.1 million in the third quarter. On May 31, we completed the previously announced sale of the non-OEM services business. Lastly, we are maintaining our full year guidance. Turning to Slide 10. I’ll take a moment to go over the Boston contract. As we’ve discussed on previous calls, this was structured as a public-private partnership. Cubic formed a joint venture with John Laing, where we have a special purpose entity in which Cubic has a 10% equity stake. The special purpose entity raises non-recourse debt and subcontract the design board and operations and maintenance to Cubic. Cubic receives progress payments from the special purpose entity during the design-build portion of the contract. The cost of special purpose entity meets the definition of a variable interest entity under U.S. GAAP that Cubic being deemed the primary beneficiary, Cubic must consolidate the special purpose entity. As a result, you won’t see progress payments from special purpose entity reflected in free cash flow. We will be providing an adjusted free cash flow. Adjusted outflow to special purpose entity was not consolidated so that you can better understand the underlying performance from a cash perspective. Additionally, the nonrecourse debt issued by the special purpose entity will be reflected as debt on our books. This debt is not included by our banks in the calculation of our leverage ratio. Finally, since this is a multiple element arrangement contract, that payment for the design-build element is tied to the operations and maintenance portion of the contract. Under current U.S. GAAP, we cannot recognize revenue during the design-build phase in fiscal 2018, and project costs are capitalized. This will change starting in fiscal 2019 when we adopt ASC 606 and recognize revenue as a standard design-build contract. Turning to Slide 11 for an overview of the consolidated financial results. As Brad mentioned, our backlog is at another all-time high of $3.7 billion with the Brisbane booking. Third quarter sales increased 10% on a constant currency basis, and adjusted EBITDA more than doubled to $28.2 million, driven by growth in transportation and Mission Solutions. Net income from continuing operations attributable to Cubic was $0.9 million or $0.03 per share compared to a net loss of $78.2 million or $2.89 per share in the third quarter of last year. The year-over-year comparisons of EPS reflects significant swings in the quarterly effective tax rates on continuing operations, which were significantly impacted by the application of the FASB guidelines requiring the allocation of total tax expense to continuing operations, discontinuing operations and other comprehensive income. Compared to last year, the total earnings per share attributable to Cubic, which includes discontinued operations, increased significantly. Moving to the segment results on Slide 12. Cubic Transportation Systems delivered strong performance in the third quarter. Sales increased 19% in the third quarter on a constant currency basis, reflecting strong growth in both products and services. Adjusted EBITDA and margin increased significantly due to higher sales, lower R&D spend and solid project execution. Moving to Slide 13. Our Mission Solutions business had a good quarter. Sales were up 5% year-on-year due to higher C2ISR deliveries in the period. Margins improved by more than 500 basis points due to higher sales and favorable mix, which more than offset higher R&D spend. As we’ve discussed on previous calls, we expect a strong fourth quarter in CMS, driven by T2C2 shipments. Turning to Slide 14. As we said on our last earnings call, Cubic Global Defense systems bookings were covered in the third quarter and were up significantly year-over-year, driven by the F-35 and Canada Urban Operations Training System award. The year-over-year comparisons of bookings, sales and adjusted EBITDA were significantly impacted by an $8 million equitable contract adjustment recognized in the third quarter of 2017. Normalizing for this, sales would have been up $8 million or 10% year-over-year, adjusted EBITDA up $3 million and margin up approximately 260 basis points. In summary, we are very pleased with our Q3 performance and are executing well on our strategy, building momentum towards our Goal 2020 targets. Now I’ll turn the call back over to Brad.

Thank you, Anshooman. Turning to Slide 15. In summary, we are very pleased with our year-on-year sales and adjusted EBITDA growth as well as growing record backlog. We have achieved five of our six near-term growth catalysts and expect to complete the sixth one, an award in the Bay Area in FY2019. We have made great progress executing our strategy, demonstrated by the recent wins, historical high backlog, reshaped portfolio with recent divestiture and the absolute focus on technology. The Shield acquisition is a great opportunity for us to enter a new growing market with a differentiated solution. Our absolute focus on Winning the Customer, delivering best-of-breed technology solutions, will continue to drive organic growth. Finally, with our ERP back-office system in place, we have a solid scalable foundation for first-class processes and efficiency to support the company’s expected growth while expanding margins. On the next earnings call, I will provide some perspective beyond Goal 2020. In closing, I’d like to thank my Cubic teammates for their strong performance and commitment to driving long-term value for our customers and shareholders. Now let’s proceed to the Q&A session.

Thank you. Now we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Louie Dipalma from William Blair. Your line is now live.

Good morning, Brad, Anshooman and Kirsten. How are you, guys?

Hey, Louie. How are you doing?

Not bad. I was wondering how your recently announced Delerrok partnership will help your strategy as you pursue small and mid-sized transportation customers.

Sure. Delerrok has been serving small-market customers for a number of years and have built up a subscription-based model, where the fare rules are very easily changeable from city to city. And we think by combining that platform, if you will, with our NextBus 2.0 enhanced real-time passenger information system, and in the future some CAD/AVL capability, we’ll be able to provide subscription-based offering to midsized – small and midsized cities, if you will, allowing them to exchange CapEx for OpEx. And so we would get, if you will, a piece of the fare. And so we’re very excited about this opportunity. And as you know, traditionally, we’ve served larger cities, and this is a great opportunity to increase our addressable market.

Okay. And on that subject of larger cities, you’ve won a lot of them recently with your mobile wins in L.A. and D.C., along with your…

Mostly all, Louie.

Yes. I was just wondering if there’s been any change in competitive behavior just because I’m under the impression that there are a lot of economies of scale in this industry. And as you win more cities, it helps your margins and your competitors have less scale. So I was wondering if you’ve witnessed competitors being any less aggressive in the – than they have been in the past for these contracts and whether you get any sense that competitors may want to retrench from the industry.

We have to compete on each and every one of them. I’m not sure I would note overall trends. I think, as you pointed out, as the snowball continues, we have an advantage in terms of getting the nonrecurring done and, if you will, getting that done earlier and reducing risk and allowing us, thus, to have better solutions for our customers.

Okay. And that makes sense. And last question. At the Analyst Day, you referenced the Joint Aerial Layer Network as an organic growth driver. And I was just wondering if you could go over the time line for the commercialization of that product and potential customers that may be interested.

Yes. So we have a contract today with AFRL, and we’re maturing that solution and have a demo next year, where we’ll be able to demonstrate, if you will, a high-capacity backbone amongst various participants in the air. We hope and expect that, that will lead to excitement, and there has been a concept of the Joint Aerial Layer Network out there for some time. We believe that the upcoming PALM, the FY2020 PALM, where the department will allocate resources aligned with the new national security policy, I think that will be telling think that will be telling.

Thanks.

Thank you. [Operator Instructions] Our next question is coming from Brian Ruttenbur from Drexel Hamilton. Your line is live.

Yes, thank you very much. Sorry for the background noise. I’m in an airport. Can you talk a little bit about the growth going forward?

Hey, Brian. How are you doing?

Pretty, good. Can you hear me?

We can. Thanks for calling.

Okay. So I apologize for any background nose. So I wanted to understand your long-term growth plans for transportation. It appears that the next three to five years, you’re going to be on extremely rapid rate. You’re winning everything. You’re going to have a ramp period. Can you talk a little bit about what you see down the road? What is kind of a steady-state model after all of these projects ramp? Or they’re just add on, add on, add on, on to the transportation?

Well, I’ll comment broadly, and I’ll let Anshooman talk about economics. So broadly, as you know, we’re very interested in this vision that Matt Cole has laid out called NextCity at the analyst conference. As you know, he talked about NextCity 3.0. So NextCity is the – if you will, the transformation of a payment business across many of the modes, and we’re trying to transform that to a payment and information technology business that is across all of the modes in the city such that we’re helping cities reduce congestion by providing them real-time information about what’s going on in the transportation network. And by having that information, patrons will – commuters will be able to make choices about what mode to take. In addition to that, operators perhaps will be able to have congestion pricing ideas to move people off of peak demands. And so we think there’s lots of growth in implementing the strategy. And we’ve been very fortunate, as you’ve noted, at the early, early days of that.

So Brian, adding on, as we mentioned in the past, we are very deliberate to spend our innovation R&D dollars in short-term and long-term opportunities. And we – so as the design-build contract that we want move into services, obviously, there are additional cities that we mentioned like Paris, Toronto, Montreal that we compete with but then also the adjacent markets for tolling and congestion charging. With the One Account strategy, we can expand into those markets in a cost-effective way for our customers and provide a great solution. We’re looking at intelligent traffic management systems. And then with the Delerrok investment and partnership that we announced today, we are looking at entering into the small and mid-market. So we have a good market share in the large fare collection systems, but we’re also ripe to expand into these other markets based on the technology that we’ve been building. So we expect that we should continue to see growth long term in our transportation business.

Okay, thank you very much. So it sounds like you’ve got near-term rapid growth, and longer term, you think that you can maintain a very high rate of growth off this new technology. My next question about is capital deployment. You’re hitting all your goals, and the priority in the near term on capital deployment, can you rank order it for me? And how has it changed? Is it M&A first? Is it buybacks? Is it – just rank order it, and tell me if it’s changed at all.

It really hasn’t changed from what we talked about during the Investor Day. We’re continuously evaluating all options. We look at organic growth via investment in innovation short term, long term, dividing it between incremental and game changer. We also look at accretive M&A transactions. So again, as long as it fits in our strategy of being market-leading, technology-driven and being accretive second year cash, EPS accretive second year, we look to make additions to our portfolio, and we continuously are monitoring that and evaluating those.

Okay, thank you very much.

Brian, thank you.

We’ve reached the end of our question-and-answer session. I’d like to turn the floor back over to Brad for any further closing comments.

Thank you for joining us today. Cubic had a solid quarter, and we remain very optimistic about the future. We look forward to you joining us on the next call.