Lionheart Holdings (CUB) Q4 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Cubic Corporation Fourth Quarter and Full Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to turn the call over to Kirsten Nielsen, Vice President of Investor Relations. You may begin.

Hello, everyone, and thank you for joining Cubic's webcast. I'm joined today by Brad Feldmann, Chairman, President and Chief Executive Officer; and Anshooman Aga, Executive Vice President and Chief Financial Officer. Before we begin, a friendly reminder that our presentation contains forward-looking statements that are made pursuant to the Safe Harbor provisions of the federal securities laws. Our most recent SEC filings include risk factors that could cause the company's actual results to differ materially from our expectations. In addition, we have included non-GAAP financial measures in our discussion. Reconciliations of these non-GAAP financial measures 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. Welcome, everyone, and thank you for joining us. I hope you and your loved ones remain healthy and safe. On today's call, I'll discuss the highlights for our fourth quarter and full year performance for fiscal 2020, followed by an update of our strategy. Anshooman will cover the financial results in more detail and discuss the outlook for fiscal 2021. Please turn to slide three. As you saw from our announcement this afternoon, our fourth quarter performance reflects strong execution and a solid finish to the fiscal year. This year brought unprecedented changes with the COVID-19 pandemic altering the way we work and live. Against the backdrop of economic challenges and uncertainty, our 6,000 talented cubes have done an exceptional job delivering mission-critical solutions to our customers, while safeguarding the health of their fellow team members. We are excited about the future as we embark on our recently announced NextCUBIC strategy, which we expect will drive strong organic sales growth and increase adjusted EBITDA margins to the mid-teens by fiscal 2025. Finally, to support long-term sustainable value, we have advanced our ESG priorities this year and reporting on our progress will continue to be an increasingly important area of focus for Cubic. Across the company, we remain guided by our common purpose. Our teams innovate to make a positive difference in peoples' lives. Turning to slide four. I'll briefly cover a few highlights of our results. As we communicated to you on the last earnings call, we expected to see a strong fourth quarter, and we delivered against that expectation by achieving record quarterly sales of $475.4 million, an increase of 1% year-on-year and record adjusted EBITDA of $104.2 million, an increase of 36% year-on-year. We also delivered robust adjusted free cash flow of $87.5 million in the quarter, and we continued to reduce our net leverage ratio, which was 3.4 times at the end of the quarter. Our fourth quarter performance was driven by the Mission Solutions segment, which delivered significant growth across all key metrics. While adjusted EBITDA doubled year-on-year in this segment, the full-year adjusted EBITDA was below our expectations, reflecting significant investments in franchise programs, which enhanced our wideband SATCOM modem system and line-of-sight common data link solution set. Performance was also impacted by delayed orders for GATR in support of the United States Army Urgent Operational Need, which we expect to book in fiscal 2021. For the year, the book-to-bill ratio was greater than one in all segments. Our backlog remained strong at $3.7 billion, and we have an additional $1.3 billion of available capacity on our sole source IDIQs, which is not reflected in backlog. While full year sales decreased slightly versus fiscal 2019, adjusted EBITDA for the full year increased 8% to a company record of $158 million and adjusted EBITDA margin expanded 90 basis points to 10.7%. Overall, we are very happy with our execution and financial performance for the fiscal year considering the ongoing COVID-19 pandemic and its impact on our customers and our businesses. Before we move to the next slide, let me comment on the U.S. Federal budget environment. We are pleased that Congress and the Administration agreed to a continuing resolution that funds the government through December 11, which supports our U.S. Military programs, including T2C2 and Federal transportation funding under the extended FAST Act. We're hopeful that Congress and the Administration will quickly complete the FY 2021 appropriations process and reach an agreement on the new COVID-19 bill, which includes transit and highway funding. We believe there is strong bipartisan support for National Security funding, as indicated by the $740 billion FY 2021 defense appropriation, and we believe that our portfolio is well-aligned to support the United States National Defense strategy. The expected outcome of a split Congress in 2021 is unlikely to result in a reversal of corporate tax cuts or result in significant changes to the established top lines for the defense budget. There is also bipartisan support for transportation infrastructure spending, including intelligence transportation and congestion management systems in the next surface transportation reauthorization act. Turning to slide 5. We have made a lot of progress this year, and I'll share a few key milestones. Starting with transportation, we are pleased that our major projects remain on track. In New York, we are on schedule to deploy the OMNY readers at every subway station and on all New York City buses by year-end. Next, we made good progress in Los Angeles, Washington, D.C., and Chicago with our mobile apps and virtual card functionality, providing travelers with a safer way to pay for their journeys, while also delivering a seamless customer experience. While our public transportation agency customers continue to face financial challenges operating in this unprecedented environment, our transportation backlog of $3.1 billion is largely insulated from the impacts of COVID-19, due to the critical importance of fare collection and fare collection modernization, including contactless payments. We have not assumed a change in the operating environment in the near term, but we are encouraged by the initial reports on the efficacy and availability of a potential vaccine. As we discussed on prior earnings calls, we have experienced some delays of new awards, but our pipeline remains robust. We continue to work closely with our customers, and we are well positioned to help them solve for current and future challenges such as; building trust in public transportation and creating safe environments for staff and travelers; accelerate contactless technologies, removing physical touch points, and improving safety through real-time data; improving journey planning to shift the peak of travel; adapting systems to be more flexible and scalable; limiting congestion and improving throughput for alternate modes of transportation; and shaping equitable, sustainable, and economically viable transport networks that promote prosperity. Turning to Defense. One of our key achievements was our recent award by the United States Air Force to deliver the high-capacity backbone demonstration. During the last week of October, Cubic flew 3 flight tests of our HALO system. As we have previously discussed, HCB is a critical element of the joint aerial layer network, and our innovations help ensure aerial layer network availability and resiliency in all environments to accelerate data delivery to increase decision speed. During our testing, we achieved a significant technical milestone by validating multiple concurrent common data link beams from a common RF source. We further proved mature functionality and other related requirements of this effort such as air to air and air to ground communication nodes, interoperability with other fielded terminals, and auto link establishment. This achievement positions HALO as the best solution for the joint area layer network connectivity as a key enabler to DoD's high priority joint all domain command and control initiative. Our solution integrates capabilities across our protected communications and C2ISR portfolio. We will demonstrate the entire air and ground system, including network and active cyber defense during calendar year 2021. We anticipate that our successful execution on this effort will drive growth over time, as we deliver on the HCV program and transition the capability to platforms, addressing a $4 billion market opportunity. In recent years, we launched several initiatives to improve our performance and we believe that our results demonstrate that. We improved our One Cubic culture and infrastructure while reshaping the company as a technology-driven market leading business. We have a strong track record of achievement, and our teams have a lot to be proud of. Over the last three years, we have grown sales at 10% CAGR and expanded margins more than 280 basis points, while we've made significant investments to support future growth. Turning to Slide 6. NextCUBIC is the next chapter in our transformation, which has been underway for more than a year as part of our strategic planning process. The COVID-19 pandemic led us to reassess the risks and opportunities across the organization, accelerate our efforts, reimagine the way we work and take action to further improve the company. NextCUBIC is underpinned by our strong foundation of customer-centric innovation, market-leading positions and exceptional diverse talent. Our growth initiatives remain largely unchanged. And our NextCUBIC efforts are aimed at maximizing these opportunities and delivering on them with efficiency. In transportation, we will continue to deliver on our big five CTS projects. Maximizing reusability and capitalizing on our best-in-class position to capture opportunities across existing and new customers internationally. We anticipate strong growth in our intelligent transportation management business, where we have invested in investor breed solutions and are growing our sales force this year to support our strategy to expand both domestically and internationally. In defense, our recent franchise wins are a testament to our strategy and investments in technology. We have focused on delivering these programs effectively and generating strong margins upon entering the recurring production phase. We also capitalized on the broader pipeline associated with these wins, leveraging our market-leading size, weight and power swap and our holistic approach to mission effectiveness. We're also focused on expanding dual use technology for defense and commercial markets, such as space, 5G and game-based training. Across all of our businesses, we are creating product-oriented information-rich platform businesses that generate new recurring revenue streams. We are especially excited about our digital platform in transportation, where we are advancing our strategic shift from being a provider of payment solutions to a provider of information and platform applications. We are on track for the platform's first release at the end of 2020, partnering with Moovit to combine their journey planning solution with Cubic's multi-agency, cloud-based fare payment solution. In the near term, we expect this to drive more users and transaction fees, and over time, drive more agency wins and create value through Mobility-as-a-Service offerings. Overall, our NextCUBIC strategy aims to drive a step change in value creation and deliver sustainable financial improvement through both functional and cultural transformation. Turning to slide seven, as you can see here, NextCUBIC is driving us towards a longer term financial objective to achieve mid to high single-digit sales growth and increase our adjusted EBITDA margins and return on invested capital to the mid-teens by 2025, supported by improved scale and operating leverage as well as new high-margin revenue streams. We are building on Cubic's existing software and cloud-focused solutions that include our mobile suite and transportation, which is at the forefront of our Mobility-as-a-service platform as well as our full-motion video platform and expertise in game-based training. Turning to slide eight, this is a summary of the significant near-term opportunities for improvement that we have identified to drive better execution on key growth initiatives and transform the way we work. This spring, we partnered with a leading consulting firm to perform a comprehensive outside in assessment. Coming out of that effort, we developed performance improvement targets for each area of the business. We have completed the specific implementation plans and are now in the execution mode. The first key action was the combination of our Mission Solutions and defense training segments which we announced at the end of August. Another key initiative underway is in the transportation business, where we are optimizing our global footprint and growing our engineering workforce in India to drive engineering excellence and cost savings. Overall, we are targeting meaningful financial improvements within the businesses and across G&A, external spend, manufacturing and engineering. A lot of work has gone into identifying the scope of opportunity, and we've identified between $50 million and $75 million of incremental adjusted EBITDA, and we expect to achieve run rate by the end of fiscal 2023. Turning to slide nine for a few updates on ESG. This month, our Chief Human Resources and Diversity Officer, Grace Lee was named among the 2020 Top 50, Chief Diversity Officers by the National Diversity Council. Grace leads our diversity and inclusion strategy which drives innovation across the organization with clear priorities related to recruiting diverse talent, expanding unconscious bias education, engaging an inclusive workforce, strengthening community outreach, and supporting supplier diversity. Additionally, we are very honored to be named as one of San Diego Union Tribune's Top Workplaces, which is an employee nominated program. Our San Diego employees took the initiative to share their perspective around our culture, work environment, diversity, benefits, recognition programs, ethics, and leadership. We have been working hard to make meaningful strides at our company, and we are thrilled to receive this award. Additionally, our recent progress on key environmental and social topics reflects our support of the 10 principles of the UN Global Compact, including the publication of Cubic's global human rights policy and living wage statement. These new disclosures can be found on our website. We also completed an HSE assessment in North America as part of our effort to accurately measure and monitor HSE performance on a global scale. With that, I'll ask Anshooman to discuss the financial results.

Thank you, Brad, and hello, everyone. Please turn to slide 10 to cover the fourth quarter financial results. We executed very well this quarter with strong year-over-year growth across bookings, adjusted EBITDA, adjusted EPS and adjusted free cash flow. Sales for the fourth quarter were $475.4 million, which was comparable to the prior year and down 4% on an organic basis, reflecting robust growth in Mission Solutions, offset by lower sales from transportation and defense training, which I'll discuss in more detail when we get to the segment results. We continue to experience impacts related to the COVID-19 pandemic, including delayed new orders across all segments and the impact of lower ridership on certain CTS operations and maintenance contracts. Bookings increased 47% to $368 million, driven by Mission Solutions and transportation. Adjusted EBITDA was $104.2 million, up 36% year-over-year, reflecting strong performance in Mission Solutions, including the enterprise license renewal at Pixia and benefits from company-wide cost management initiatives. Adjusted earnings per share were $2.82, up more than 50% year-over-year, primarily reflecting higher adjusted EBITDA and lower tax expense. Adjusted free cash flow was strong at $87.5 million in the fourth quarter, driven by working capital management. Turning to the full year results on slide 11. As Brad mentioned, our book-to-bill ratio was greater than 1 across all segments, with the major drivers of bookings growth being the contract reset with the Boston MBTA and the Chicago upgrade award in transportation as well as air training programs in defense. Backlog grew to $3.7 billion, up 8% year-over-year, and we have an additional $1.3 billion of unused capacity on our key sole source IDIQ contracts. For the full year, sales decreased 1% as reported and 3% on an organic basis. We estimate that the impacts related to COVID-19 totaled up to $73 million for the full year, primarily reflecting delayed orders and lower transit ridership. Adjusted EBITDA increased 8% to $158.3 million. And adjusted EBITDA margin increased 90 basis points to 10.7%, as strong performance in transportation, coupled with the contribution of the high-margin Pixia acquisition and company-wide cost management initiatives more than offset significant investments in Mission Solutions and the impacts related to COVID-19. Adjusted earnings per share were $3.32, up 6% year-over-year, reflecting higher adjusted EBITDA and lower taxes, partially offset by higher depreciation and interest expense. Adjusted free cash flow increased to $60.5 million, compared to $14.1 million in the prior year, reflecting receipts of milestone payments on certain long-term development contracts. Moving to the Transportation segment on slide 12. Bookings in the fourth quarter were $142 million and include the NextBus award for San Francisco Muni and Atlanta maintenance award and bookings in Trafficware and GRIDSMART. For the full year, bookings were more than double, driven by the Boston reset and the Chicago upgrade. Fourth quarter sales decreased 6% as reported and 8% on an organic basis to $239 million, leading to full year sales of $841 million, down 1% from fiscal year 2019. Both fourth quarter and full year sales reflect the timing of development work, which reflects lower sales on the New York contract, partially offset by an increase in development work on other projects. Both fourth quarter and full year sales were negatively impacted by COVID-19 due to delays on new awards and lower transit ridership. The estimated full year impact of COVID-19 on sales was up to $46 million. Fourth quarter adjusted EBITDA for the transportation segment decreased 1% to $45.7 million as the impact of lower sales was mostly offset by cost savings, resulting in a higher adjusted EBITDA margin. Full year adjusted EBITDA increased 21% to $134 million, reflecting the Boston contract amendment, strong execution on services contracts and cost savings, which offset unfavorable impacts related to COVID-19. Moving to our Mission Solutions segment on slide 13. As we have communicated throughout the year, we expected performance for the Mission Solutions segment to be back-end weighted. Fourth quarter sales were $170 million, an increase of 21% on an organic basis, reflecting higher sales of rugged Internet of Things products. Full year sales of $337 million decreased 6% on an organic basis as growth from rugged Internet of Things products was offset by lower deliveries on GATR, including delays associated with COVID-19 and other delays, such as urgent operation needs order. Fourth quarter CMS, adjusted EBITDA was an impressive $59 million, more than double the prior year period. This primarily reflects higher sales of rugged Internet of Things products, and the contribution from the high-margin Pixia acquisition. Full year adjusted EBITDA decreased to $28.2 million, compared to $34.4 million in 2019, driven by significant investments of $18.8 million in franchise programs and higher research and development expense. These impacts were partially offset by the contribution of Pixia. Turning to slide 14. Fourth quarter bookings, sales and adjusted EBITDA in our global defense segment were lower than last year due to program award delays, including delays associated with COVID-19. Fourth quarter CGD sales declined to $66.4 million, compared to $91 million in the prior year period, leading to full year sales of $298 million, a decrease of 6%, compared to the last year. Both the fourth quarter and full year reflect lower sales in ground training due to delays in new awards and exercise delays, primarily due to COVID-19. Fourth quarter CGD adjusted EBITDA decreased to $9 million, compared to $13.2 million in the prior year period, while the full year adjusted EBITDA was essentially flat at $33 million, reflecting continued focus on cost management. Moving to Slide 15, I'd like to remind everyone that we combined our Defense businesses to form a new segment called Cubic Mission and Performance Solutions, CMPS. This was our first key NextCUBIC action and allows us to leverage our talent and common technologies to enhance collaboration and customer intimacy, while improving our organizational and operational efficiency. Beginning in the first quarter of fiscal 2021, we will report our results on the 2 segments: Cubic Transportation Systems and Cubic Mission and Performance Solutions. Proforma financial results for CMPS are included in the appendix of the presentation. Moving to Slide 16. We continue to have a strong focus on liquidity and maintaining a healthy balance sheet. Our net leverage ratio decreased to 3.4x as a result of strong EBITDA performance and continued reduction of net debt during the quarter, and we remain focused on lowering our net leverage ratio to our target of below 3x. We ended the fiscal year with adjusted free cash flow of $60.5 million. And we are reaffirming our 3-year adjusted free cash flow conversion target of over 100% of net income. Turning to Slide 17. We are pleased to reinstate annual guidance. For fiscal year 2021, we expect sales in the range of $1.55 billion to $1.6 billion, which reflects 6.7% growth at the midpoint. For adjusted EBITDA, we expect a range of $170 million to $190 million, reflecting our continued focus on margin improvement as part of NextCUBIC. We expect adjusted EPS in the range of $3 to $3.60 based on our assumption for a higher effective tax rate. Our confidence in the full year is supported by good visibility with roughly 80% of our anticipated sales planned either in backlog or high probability orders, including those supported by existing contract vehicles and expected follow-ons. As a reminder, the seasonality of our business and cadence of order activity for higher-margin product drives the majority of a profit to the back end of the year and we expect a similar dynamics in fiscal 2021, including our expectation for adjusted EBITDA for Q1 to be flat or slightly higher than Q1 of fiscal 2020. In closing, we are very happy with our execution in the fourth quarter, especially given the challenging environment, and we expect to deliver solid growth and margin expansion in fiscal 2021. Now I'll turn the call back over to Brad.

Thank you, Anshooman. Turning to Slide 18. We are pleased with our performance and strategic progress this year. We believe that Cubic remains well positioned in our markets to successfully execute our NextCUBIC strategy with clear priorities and significant opportunities to drive growth and operational excellence. Before turning to questions, I want to make one clarification. As you probably know, the Cubic Board adopted a shareholder rights plan in September in response to the rapid accumulation of our stock by Elliott management. At that time, Elliott also expressed an interest in acquiring Cubic. We will not be providing any information on this topic today. We ask that you keep your questions focused on our earnings results and outlook. Thanks for your cooperation in that regard. With that, let's proceed to the Q&A session. Operator?

[Operator Instructions] Our first question comes from Jim Ricchiuti with Needham. Your line is open.

Hi, good afternoon. Good to hear from you, Brad. Just with respect to the seasonality, the revenues in fiscal 2021. I'm wondering, how we should be thinking about the CTS business? I think we all understand how back-end loaded the defense business can be. But is there any color you can give us on how we might think of the CTS business next year or this year I should say?

Jim, I'll let Anshooman address that.

Hi, Jim, So seasonality for our transportation business also indicates a lower Q1. We have the Thanksgiving holidays and we have the Christmas holidays, so less working days than we are an engineering company. So Q1, typically a little bit lower from a revenue and profit perspective in CTS. They also ramp up in Q3 and Q4. Also given that, we expect a slow gradual recovery in ridership and the seasonality of our intelligent traffic management business, Trafficware and GRIDSMART is also more summer focused.

Got it. That's helpful. And just with respect to that, the color you gave on Q1 adjusted EBITDA, anything unusual in that number being roughly flat with the year-ago period? Is there increased COVID headwinds that you're now anticipating for that? Any color on that?

Yes, Jim. So obviously, last year, Q1 we had no COVID impact. Going into Q1 of this fiscal year, we have lower ridership and some impacts of COVID. Despite these COVID impacts in Q1, we believe our adjusted EBITDA would be flat to slightly above last year, which shows strong execution across our business and initial benefits from our NextCUBIC initiative.

Okay. Thanks. I’ll jump back in queue. We can follow up. Thanks.

Our next question comes from Jon Raviv with Citi. Your line is open.

Thanks. Good afternoon, everyone. On NextCUBIC, can provide a little more – I know a lot of slides there, but just sort of a big picture, like what – with NextCUBIC, what are some of the things that you're going to start doing that you were not doing before? At the same token, what are some of the things you're going to stop doing than maybe you were doing before? And sort of in that conversation, what's the linearity of that path in mid-teens. You talked about margin growth in FY 2022 – in the year ahead. What’s the linearity of that mid-teens over time? Could we see some step back if you choose to enhance investments in a given year or do you expect it to be relatively linear? Thank you.

Yes. Hi, this is Brad. We expect the margin expansion to be linear year-on-year over the next five years. So, some of the things that we're focused on, as you noted, we completed the first step already and that was combining the two defense organizations. We did that in September. We're looking at all kinds of things, things like geo-shifting, some of our engineering workforce in CTS. We're looking at rationalizing factories even more. We're looking at reducing cost in the supply chain. We have about 175 initiatives that we're working on over the next two to three years. About half of them are cost related and half of them are revenue-expansion related. And what we're trying to do is make sure that we get the cost savings and do that dovetail with the investments. So, we're very, very excited about the possibility and very savvy about improving the margins of the company while continuing to grow it, and I'll also note that it's not just financial, it also has to do with our culture. You'll note on one of the charts, we talked about cultural transformation, and so there's an organizational health index that we took as a baseline. I might add, we were very high in the second quadrant, and we're going to work our way into the first quadrant. So, we're very excited about this, and appreciate the question.

Thanks Brad. Those were my one and my follow-up right there. Thank you.

Our next question comes from Mark Strouse with JPMorgan. Your line is open.

Good afternoon. Thank you very much for taking our questions. So, good to hear that the big five CTS contracts continue to track expectations. Can you give an update, though, to your commentary, I think from the last call, where you talked about some delays in your pipeline projects. Are you seeing any thawing in those conversations with those customers? And kind of a related follow-up to that, in your guidance for fiscal 2021, you've got about 80% visibility from your backlog and your high probability wins. I guess, can you compare that to entering fiscal year 2020? What was that number? And what gives you the confidence that, that other 20% will come in to hit your guidance?

Yes. So, in transportation, as we talked about on the previous call, there were some delays in orders. We continue to see about the same, not much change there. With regard to confidence in the forecast, we're very confident. So, the 80% and I'll let Anshooman talk about if he knows the number of percentage year on year. But we're in a continuing resolution now and as you know, after the election, the Senate Appropriations Committee marked up their bill and we understand people are meeting now to come up with a bill. I don't know if it will be done by December 11 or we'll have another CR, but I expect it will be done in the near term. And so, as you know, we have orders that are connected to that. So, we're pretty confident that we'll have a full budget fairly quickly. Anshooman, do you want to add color on -- more color on confidence, please?

Sure. Thanks, Mark. So on the 80% in backlog and high probability, the high probability are mainly renewals, follow-ons and program of records where we already have the capacity, a lot of those in the defense side. You can trace them back to the President's budget. The remaining 20%, we have a very strong pipeline, not to say those aren't high probability. Those are also high probabilities, but there are a lot of smaller book-to-bill orders, for example, our Trafficware and Gridsmart. The time from a booking to shipment could be four to six weeks. And that's a $100 million business right there. So there's very strong visibility. And actually this year, the visibility is slightly higher than we had last year at this time. Given the fact that we were in the process of certain renegotiations of the Boston contract, et cetera, where the timing was a little to be determined. So we feel very strongly going into next year about our prospects.

Okay. That's very helpful. Thank you. And then just one quick follow-up Anshooman. A lot of moving parts in CTS this year. With New York transitioning from design-build into O&M, can you just talk about the revenue profile? I mean, you've already talked about the seasonality, I guess, to Jim's question, but do you expect growth in that segment this year?

Yes, we expect growth in both our CTS and our new CMPS segments this year from a top line perspective.

Okay. Simple enough. Thank you very much.

Our next question comes from Ken Herbert with Canaccord. Your line is open.

Hi. Good afternoon.

Hi, Ken.

Hey, Brad. I just wanted to follow-up on that question on the 2021 outlook. The guidance implies at the midpoint, sort of 6.5% to 7% top line growth. CTS was, obviously, basically flattish this year. Is it fair to assume that while it may grow in 2021, we continue to see stronger growth out of the new CMPS segment, or how should we think about that growth by segment next year or in fiscal 2021?

As Anshooman said, there'll be growth in both segments. And as you know, we have very large backlog. So it's just a function of where those contracts are in the -- their percent complete path. Anshooman, do you want to add to that?

Yes. Ken, we don't give segment guidance, but we do expect good growth in our CTS business this year. And I think both our businesses will perform well from a growth perspective this year.

Okay. And has the conversation with your CTS customers changed at all, just in terms of the timing of the sort of a ridership recovery, when I think about the major metropolitan areas and incremental risk to the capital spending. I mean, I know your -- obviously, your revenues are not driven by ridership, but eventually, we have to catch up. And I'm just curious if you're sensing any change from your customers in their outlook or on CTS, and sort of confidence near and mid-term on their ability to continue to fund the programs?

Yeah, I think ridership has been down. We also know that there's been discussion regarding vaccines coming in the mid-term in terms of the distribution of those. We anticipate that there will be growth next year and that CTS in terms of orders and the like, we'll have good book-to-bill next year. And then it will grow even more than that, the year following.

All right. Thanks, Brad.

Our next question comes from Michael Ciarmoli with Truist. Your line is open.

Hey good evening guys. Thanks for taking the questions. Brad, I guess, just to maybe stay on that CTS and the ridership. You said a couple of times lower ridership creating some headwinds. I know I think you guys have called out ridership is less than 2% of total annual revenues. The ridership pressure, I mean, should we think of that as pressuring your customers and the municipalities in creating delays, or again just trying to reconcile ridership delays because it's clearly not a big piece of your revenue, but is it just creating some constipation with execution on the programs you're working on?

No. The programs are going along fine. So stuff that's in backlog, we're executing. And as you pointed out, unfortunately, we have a backlog north of $3 billion in that business. So that's moving along buying. There's a small sliver that's ridership focus. I think it depends upon the time frame. As we know, these municipalities are funded either through government grants or fair box revenue or sales tax, and it depends what part of the planet you're on. So that is delaying some CapEx a little bit, which are growth initiatives a few years from now. So – and we anticipate that the COVID is not going to last forever, thank God. And that the order flow will pick up. Having said that, next year, we expect good order flow. And then we expect it to pick up quite a bit to year following.

Okay, okay. And then just as we look at the guidance framework for 2021, I think there's news out today about the New York MTA meeting probably $12 billion bail out. That -- everything, the pressure that's being incurred on the MTA and potential timing of revenues, all that seems to be in the scope of how you guys are thinking about pacing for 2021.

Yeah. That's all encapsulated in our guidance. What I would say is we have considerable backlog with our customer in the MTA. And we'll burn that backlog off. And there's been no discussion about anything different than that. In fact, we've been encouraged to speed up and so we're speeding up. You might remember, we were slowed down for about 6 weeks in the spring time due to COVID. And then after they stopped us and that was just on the installation, they said, hey can you speed up and get done by calendar year-end. And we're tracking every day the -- how many buses we're wiring, where those validators are going, and we're on track to finish that across all of New York City, this calendar year. So things are on track, and we have clean visibility on that revenue.

Got it. Got it. And maybe just the last one, you guys -- you touched on it a couple of times about the expectation for good bookings next year and even layering in the kind of 2025 kind of target you've got out there. I think on one of the slides you threw out a $37 billion plus pipeline. Can you give some color on that pipeline? And how you think that can maybe convert on that pipeline? I'm assuming it's more skewed heavily towards CTS, but maybe just even give us some of the bigger programs or opportunities are tracking? And maybe what should we be looking for as you guys maybe try and execute on that opportunity?

So we, of course, like a lot of companies use a methodology to measure the size of the pipeline, -- pipeline adequate to drive growth. So – and we look at a factor of north of 20 to 1 of the pipeline of the revenue that we need. And so we watch those metrics, and we're above those metrics. In terms of some big things that we're working on, there's a big fair collection job, for instance, in New Zealand -- across the country of New Zealand. We've chatted about Vancouver, there's opportunities in Dublin, there's opportunities in Prague. And we're seeing pretty good growth in our small to mid market expansion. You might remember, we bought Bill [indiscernible] at the beginning of the calendar of the year. And we've combined that with some Cubic capabilities as well as some movement capabilities. You'll hear some announcements in coming days, but that as well. And in our traffic business, we've seen good growth, and we expect that. So -- and you might also remember that in our defense business, we are very thrilled to win the high-capacity backbone. And I think in the last call, we mentioned that, that had opened up an addressable market of about $4 billion. So get that capability on lots of platforms. So there's growth across the business.

Got it. Got it. Helpful. Thanks a lot guys. I will turn back in the queue.

I'll also point out that we talk about the $1.3 billion of unused capacity on sole source IDIQ. That's not in backlog. So those will materialize into bookings and into backlog, too.

Got it.

Our next question comes from Louie DiPalma with William Blair. Your line is open.

Brad, Anshooman and Kirsten, good afternoon.

Hello Louie.

You have addressed this topic several times in the past. But in terms of a refresher, could you discuss the synergies between your transportation and defense division and how having both of those divisions fits into your 2025 plan? And whether you plan greater synergies and cross-fertilization between having surveillance capabilities for transportation and surveillance capabilities for defense? Thanks.

I think your question is insightful, Louie. So thanks for that. What I would say, as you know, we went down this One Cubic path and what that – what we've done with that is, that's a hybrid sharing strategy, where on the one hand, things that are in the businesses that are customer-facing are decentralized, things like program management, engineering, marketing and so forth. But things that are not customer-facing or more support back office, if you will, are shared. And so we're working hard at improving that sharing even more so things like factory, things like supply chain, things like our legal department contracts, accounting. So all kinds of, if you will, support functions. And we do that so we can scale them. And you might also remember, we made a significant investment in SAP, so that we could have one platform across the globe to share common data. And so we're continuing to leverage that more and more. What I'd also say is there are vivid examples of technology and know-how that are shared across the business. So some examples. The guys in defense are actually better at doing thermal analysis than the folks in transportation. So they're helping them now as we speak in Brisbane. Also, all of the sort of user interface for the smart apps that we're rolling out for transport, that front-end was done in defense by NCPT [ph]. They have a bunch of gamers there who are expert on front ends. And C4ISR, some of the mapping capability and the like comes from transportation. So there are many, many things that we share across the business.

Indeed. And then I only want to say it was just surveillance. I know there's data analytics, capabilities and the engineering and gaming capabilities that you mentioned. One more question, Brad. Last year or it might have been the year before, you acquired Nuvotronics. And at the time, you highlighted a Nuvotronics PolyStrata technology for like 5G applications and millimeter wave. And I was wondering, does Cubic expect to play a large role in terms of the Department of Defenses, rollout of 5G applications or those Nuvotronics mostly focused on no commercial applications, or I'm just wondering, what's your outlook in terms of monetizing the Nuvotronics asset? Thanks.

Yes. So we're using – we believe Nuvotronics makes the best RF componentry in the world at millimeter wave type frequencies. And so we're in the base station designs of some key suppliers for 5G. And we're partnering them to bring those offerings to the Department of Defense. Also because the parts -- normal RF parts, you see with your eyes, these things you need jewelers classes with they're one-hundred the size and so they're really terrific for space applications. So, we have some bids out for LEO constellations and the like and we're pretty savvy that we're going to expand our role in space using Nuvotronics. Those are a couple of examples.

Thanks Brad and thanks Anshooman. That's all that I have.

Our next question comes from Michael Eisen with RBC Capital Markets. Your line is open.

Hey good evening everyone. Thanks for squeezing me in the end. I'm looking at some of the early results in defense and you had a few big wins in the fourth quarter and strong profitability at CMS. When thinking about the potential of the combined business going forward, is there enough synergy you can drive in this business to be profitable throughout the course of the year? And how should we think about the cadence of profitability going forward?

So, the profitability will improve year-on-year and will continue to improve year-on-year, and we expect margin expansion. The timing, there is seasonality. There's products in the defense business that tend to get shipped out in the fourth quarter and they have very good margin. So that will continue. But we're very pleased by combining the two businesses. One vivid example, we're today doing ISR simulation for exercises, and we're doing ISR for real and so we think there's synergies between those two capabilities as one vivid example.

Got it. And then thinking of CTS, a lot of conversation around the pressure on your customers and there have been a few comments throughout the year about delays to new business wins. And so when thinking about the budget shortfalls that a lot of the customers are having, and clearly, there is expected growth next year for your business. When we think of the bookings, can we expect backlog to continue to grow into 2021 or is there a potential to see a step down before things normalize with consistent ridership?

We expect the book-to-bill ratio to be good next year and for backlog to be slightly up as we exit the year

Perfect. And then one quick one for Anshooman. Free cash flow was really strong in the year and it seemed that working capital was a key driver here. Can you talk to if there's still room for working capital improvements? And what the outlook is for free cash flow as we look out to next year?

Sure. So, the cash flow, as you said, was really good for the end of the year. We expect cash flow for the full year fiscal 2021 to be positive, less than this year, and then 2022 to be an extremely positive year for cash. We have about $80 million of payments tied to certain milestones on certain projects in fiscal 2022, which would significantly drive our working capital down that year. But again, next year will be positive, probably less than this year and then a very strong 2022.

Very helpful. Thanks for all the information today.

Our next question comes from Jim Ricchiuti with Needham & Company. Your line is open.

Anshooman, I may have missed it. But did you -- you gave a number, was it $46 million that you think was the fiscal 2020 impact from COVID? Was that for CTS?

Yes. The $46 million is the total impact for CTS that we estimated that include delayed opportunities, ridership and a little bit of slowdown for the overall company with $73 million that we estimated.

Okay. And that was my next question. I wanted to just get a better idea of how you're sizing the impact on the defense business. And just get in light of what's been happening with the spike around the country. Is that outlook for the defense business as it relates to the training business? Say, are you seeing more of an impact in Q1 from that?

The spike just happens, so we're evaluating that, but there is general acceptance among a lot of the nations that readiness is suffering and they’re trying to start some of the exercises in Q1, Q2. So we -- hopefully, we’ll see a recovery in the near term for some of the training exercises.

Okay. And one final question for me is, just with respect to R&D, you guys have clearly made some investments and won some programs as a result of it. And I'm just wondering if there's any way we should think about R&D expense for fiscal 2021? Do we see that tapering a bit? I don't know how you want to discuss it. If there's any color you can give, either as a percent of revenue or just anything you may want to call out on that?

Yes. So R&D for next year or for fiscal 2021 will be up to fiscal 2020, where you'll be in the 50 million-ish range from R&D perspective next year.

Terrific. Thanks very much.

Our next question comes from Ken Herbert with Canaccord. Your line is open.

Hey, thanks. Brad or Anshooman, just a quick follow-up. You're still talking about the $50 million to $75 million in incremental EBITDA by 2023 from NextCubic initiatives. Should we think about that as roughly -- I think you indicated sort of 50% through -- 50% due to the sort of top line and the organic initiatives and 50% from a cost standpoint. Is that the right framework to think about that $50 million to $75 million?

Yes. That is, Ken.

Okay, great. That’s it. Thank you.

Our next question comes from Jon Raviv with Citi. Your line is open.

Hi. Thanks for the follow-up here. Just a question on organic growth. So you said down 3% this year. With the guidance for next year, can you just clarify for us what you're expecting in terms of organic growth in that guide for the fiscal year ahead?

Yeah. So our number for next year is all organic, the sales guide of 1.55 to 1. 6 is all organic. There is, I guess, one extra quarter of Pixia and Delerrok, but that's not material.

Okay. Thanks. And then in terms of COVID impact on the defense businesses, at least in this current fiscal year. Can you talk about how much of that is timing? And just, therefore, how much pickup we're getting in FY 2021 versus FY 2020? I guess, I just would have expected the organic growth number to be maybe a little bit higher if you're truly having -- given that this year is down 3%, maybe that's a really easy comp heading into next year.

Yeah. So a couple of things. One, on the transportation side, the ridership impact or the negative impact of COVID still exists. We haven't solved for COVID, we are hopeful with a couple of vaccines that we've read about with high efficacy, we'll start seeing some pickup in ridership, but that probably won't happen until spring or summer. And then on the defense side of our business, there were some delayed orders. These are two, especially on the defense training side, if they're a couple year program. The revenue just starts later and continues on later. So it's not a one-for-one acceleration into the fiscal year.

Okay. No, I understand Anshooman. Thanks for the clarification.

I think what I would say is a bumper sticker, we expect growth to top line in both businesses and bottom line growth at an accelerated rate.

Much appreciated that. Thank you.

There are no further questions at this time. I'll now turn the call back to Brad for closing remarks.

Thank you for joining us today. Before we sign off, I want to thank our Cubic team for their ongoing commitment to serving our customers and keeping our businesses safely operational during the ongoing pandemic. We appreciate your support and interest in Cubic. Thanks so very much.

This concludes today's conference call. You may now disconnect.