V2X, Inc. (VVX) Q3 2017 Earnings Report, Transcript and Summary

Welcome to the Vectrus, Inc. Third Quarter 2017 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Michael Smith, Director of Investor Relations and Corporate Development. Please go ahead.

Thank you. Good afternoon, everyone. Welcome to the Vectrus Third Quarter 2017 Earnings Conference Call. Joining us today are Chuck Prow, President and Chief Executive Officer; and Matt Klein, Senior Vice President and Chief Financial Officer. Slides for today's presentation are available on our Investor Relations website investors.vectrus.com. Please turn to Slide 2. During today's presentation, management will be making forward-looking statements pursuant to the safe harbor provisions of the Federal Securities laws. Please review our safe harbor statement in our press release and presentation material for a description of some of the factors that may cause actual results to differ materially from the results contemplated by these forward-looking statements. We assume no obligation to update our forward-looking statements. At this time, I'd like to turn the call over to Chuck Prow.

Thank you, Mike. Good afternoon, everyone. Thank you for joining us on the call today. Please turn to Slide 3. I'm pleased to announce that our momentum has continued into the second half of 2017 and has contributed to our solid third quarter financial results. In terms of new business, I'm excited to report that during the quarter, we were awarded a significant, almost $400 million, 16 years subcontract in support of the Air Force Range Support Services II, or RSS II program. This was our largest new business contract win over the past 12 months. Additionally, we have made great progress in negotiating commitment letters and a term sheet for our new credit agreement, which will allow for greater flexibility regarding capital allocation decisions that align with our corporate strategy. Now, I'd like to discuss our third quarter 2017 financial results and highlights. Revenue for the third quarter was $270 million, down $14 million year-over-year, but up $10 million, sequentially. As a reminder, the year-over-year decline was primarily due to the closure of the APS-5 program, which contributed $49 million in the third quarter of 2016. Operating margin was 3.7% compared with 3.9% last year and was also up 20 basis points sequentially. During the third quarter, we phased a new contract wins, transitioned successful recompetes to new structures and continued the implementation of our strategic imperatives. All of which would generally result in margin pressure. However, we believe the margin level achieved in the third quarter in light of these activities is a testament to our team and lays the foundation for future margin expansion. Diluted earnings per share were $0.51 down from $0.60 in the third quarter of 2016. Year-to-date net cash provided by operating activities were $22 million with a DSO of 57 days, which is in line with our expectations. Regarding new business, as I've previously mentioned, during the quarter, we were awarded an almost $400 million cost-plus subcontract to support the Air Force's RSS II program. This long-term program is expected to extend into the first quarter of 2034, and provide an annual revenue stream in excess of $20 million over the term. The contract structure is similar to other government contracts, which include the base period performance and several option year periods. As with any government contract there is no guarantee that the government will exercise the option period. Importantly, the RSS II contract win combined with our Maxwell, Keesler and Thule awards as well as our ongoing Turkey-Spain base maintenance contract, strengthens our position as a trusted provider of facilities and logistics services to the Air Force, while further increasing our footprint in the continental United States. Our team has started phasing in the RSS II contract and is making great progress. We expect to reach full operating capability in the fourth quarter. This was a major win for the RSS II team and we're proud to be a part of this important mission. Regarding the phase-ins of Keesler and Thule, I'm happy to report that both contracts were successfully phased in during the third quarter. Phasing in over $0.5 billion of new contracts is no small undertaking, but our team did a phenomenal job, and I'd like to recognize their hard work in this great accomplishment. We continue to make progress growing our business base in 2017, which is demonstrated by our year-to-date bookings of $1.3 billion and record-high backlog. Currently, our backlog covers almost 3x our 2017 midpoint for revenue. We continue to reduce our balance sheet leverage and ended the quarter with $74.5 million in debt, which is down $10.5 million from the fourth quarter of 2016. Additionally, we continue to generate strong cash flows and ended the quarter with $63 million of cash on the balance sheet, up $16 million from the fourth quarter of 2016. That puts us in a favorable financial position and I'll talk more about our future plans for capital allocation shortly. Please turn to Slide 4. Our year-to-date results provide visibility for us to increase our 2017 guidance for revenue, net income, diluted earnings per share and net cash provided by operating activities. Matt will discuss the guidance ranges in greater detail shortly. Turning to new business. Our prospects remain solid with over $6 billion of identified opportunities, which we plan to submit over the next 12 months. This number is up from $4 billion last quarter due to continued refinements we've made in our pipeline, in alignment with our corporate strategy. I'd also like to point out that the $6 billion does not currently include any value associated with the LOGCAP V program. We also have approximately $400 million in bids submitted pending award. This number is down from $1 billion last quarter, due primarily to the RSS II contract win and the removal of a smaller unsuccessful bid. I would like to now provide an update on our Kuwait Base Operation and Security Support Services contract known as K-BOSSS, and the Logistics Civil Augmentation Program V or LOGCAP V competition. As it relates to K-BOSSS, our client plans to incorporate our current K-BOSSS contract as a task order into the LOGCAP V competition. Our current K-BOSSS contract is operating under an extension, which has a base period of performance due March of 2018. Additionally, the extension includes 2 option periods, the first being 9 months, the second being 3 months, which, if executed by the client would extend our performance through March of 2019. In terms of the LOGCAP V competition, there are expected to be up to 6 indefinite delivery, indefinite quantify contract awards. Awards will be for a 10-year ordering period, and based upon a best value trade-off. It is currently anticipated that with the award of the LOGCAP V IDIQ, there will also be a series of task orders that will simultaneously be awarded. Each Army Service Component Command, or ASCC, will have a 10-year task order for set the theater. It's also anticipated that there will be nine 5-year task orders simultaneously awarded with the IDIQ contract. For example, the K-BOSSS task order is expected to be awarded under the CENTCOM ASCC. Recently, the government held a LOGCAP V Industry Day at the Army Contracting Command in Rock Island, Illinois. Our team attended the event and showcased our qualification and differentiated approach to the competition. As a reminder, Vectrus is intimately familiar with the LOGCAP mission and requirements, as we've generated in excess of $1 billion performing as a significant subcontractor under the current LOGCAP IV program. Additionally, we're incumbent on the largest CENTCOM task order and our past performance is at the highest achievable level. We believe Vectrus is well-positioned for LOGCAP V, as our capability is strongly aligned to our clients' requirements and the emerging operational environment. Vectrus is well-known for its ability to rapidly respond anywhere across the world in challenging and austere environments to meet our clients' contingency mission requirements. For almost 70 years, Vectrus has provided exceptional results for our clients ranging from the sub-zero Arctic and Antarctic climates to the desert heat in the Middle East. The most recent information from the government regarding the LOGCAP V time line, has proposals due in January of 2018, and a contract award in August of 2018. As has been widely reported on Friday, the government issued a statement indicating a delay in the issuance of the final request for proposals. We will update you on our next call as to effect this delay has, if any, on the target award dates. Over the past couple of quarters, we discussed potentially improving the terms of our credit agreement to enhance our ability to make future capital allocation decisions. We have made significant progress on this front, and our current expectation is that the new credit agreement will close in the fourth quarter of 2017, subject to negotiation of definitive agreements and market conditions. In terms of our capital allocation strategy, to date, we have allocated capital to organic activities and reducing our leverage profile. Our current financial position provides us a flexibility to pursue, both organic and inorganic growth opportunities, while maintaining conservative leverage. Overall, our capital deployment strategy will help transform Vectrus into a higher value, technology-enabled and differentiated platform, while continuing to broaden our capabilities and diversify our client portfolio. I look forward to updating you as your progress in the future. Now, I'd like to turn the call over to Matt. He will go through our financial results for 2017. Then we'll open the call up for questions.

Thank you, Chuck. Good afternoon, everyone. Please turn to Slide 5. Today, I'll be discussing our financial results for the 3 and 9 months ended September 29, 2017. In the third quarter of 2017, revenue was $270 million, down $14 million or 5% as compared to the third quarter of 2016, but up $10 million sequentially. Of note, the APS-5 programs contributed approximately $49 million in the third quarter of 2016. Importantly, $35 million of growth in our new and existing programs partially offset the negative comparison. For the third quarter, Middle East programs declined $14.1 million and U.S. programs declined $2.9 million. This was partially offset by increases from our European programs up $2.3 million, and from our Afghanistan programs up $0.5 million. Operating income for the third quarter of 2017 was $10.1 million, down $1.1 million or 9.6% compared to the third quarter of 2016, and up 20 basis points sequentially. Operating margin for the third quarter of 2017 was 3.7% compared to 3.9% operating margin in the third quarter of 2016. I'd like to recognize our teams for effectively phasing in over $500 million of new programs and for successfully transitioning our recompete wins to new contract structures. Our enterprise Vectrus approach on these phase ins proved valuable and positions us for solid performance and margin expansion in the future. Operating income for the third quarter of 2017 was lower when compared to the same period of 2016, primarily due to the reduction in revenue, partially offset by a decrease in SG&A cost. During the third quarter of 2017, we recorded net favorable cumulative adjustments to operating income of $3.7 million compared to $1.2 million in the same period of 2016. There are many factors that drive contract performance, including successful contract modifications and extension of current contracts. Cumulative catch-up adjustments can be positive or negative are a normal part of this business and our guidance contemplates this reality. Interest expense for the third quarter of 2017 was $1.1 million or $0.3 million lower than the same period of 2016. The decrease in interest expense was due to a lower debt balance. Net income for the quarter ended September 29, 2017 was $5.8 million compared to $6.6 million in the third quarter of 2016. The decrease was due to lower operating income of $1.1 million, partially offset by lower interest expense of $0.3 million, when compared to the third quarter of 2016. Diluted earnings per share for the third quarter of 2017 were $0.51 compared to diluted earnings per share of $0.60 in the third quarter of 2016. The decrease was due to lower net income and the higher number of shares outstanding in the third quarter of 2017. Now I would like to discuss year-to-date 2017 financial results, reflected on the right hand side of the Slide 5. Year-to-date 2017 revenue was $819 million, a decrease of $83.4 million or 9.2% as compared to the same period in 2016. The decrease in revenue was attributed to lower activity from our Afghanistan programs of $36.5 million, our Middle East programs of $38.1 million and our U.S. programs of $10.1 million, partially offset by an increase from our European programs of $1.3 million. Year-to-date, 2017 operating income was $30.9 million, down $3.3 million or 9.7% when compared to the same period in 2016. This change is due to the impact of lower revenue, partially offset by a decrease in SG&A cost. Net favorable adjustments to operating income for year-to-date 2017 and year-to-date 2016 were $8.6 million and $4.2 million, respectively. Operating income as a percentage of revenue was 3.8% year-to-date for 2017 and 2016. As you will see in our 2017 guidance discussed later in the presentation, we increased our full year operating margin to the midpoint of 3.6%. This implies a lower run rate for the fourth quarter of the year, relative to the 3.8% we reported through year-to-date September. The change from current performance is a reflection of the potential temporary pressures of phasing in several new contracts and the implementation of our new strategic imperatives. We believe the new programs, successful recompete wins, contract extensions, along with a successful implementation of our strategic imperatives will result in a sustainable annual margin above our historical performance. Net income for the 9 months ended September 29, 2017, was $17.9 million compared to $19.2 million for the same period of 2016. The decrease was due to lower operating income of $3.3 million, partially offset by lower interest expense of $1.1 million and lower tax expense of $0.9 million. Year-to-date 2017 diluted earnings per share were $1.61 compared to diluted earnings per share of $1.76 for the same period in 2016. The variance is due to decrease in revenue, lower SG&A, interest expense and a lower tax expense, associated with lower taxable income, and the higher number of shares outstanding in 2017. Year-to-date net cash provided by operating activities was $22.4 million, which is $11.1 million lower compared to the same period in 2016. Day sales outstanding as of the third quarter of 2017 was 57 days compared to 55 in the third quarter of 2016. The unfavorable impact is associated with temporary timing of invoice collection. Please turn to Slide 6. During the third quarter of 2017, we made $3.5 million of mandatory debt payments, lowering the total debt balance to $74.5 million, representing a total debt to trailing 12 months, consolidated EBITDA leverage ratio of 1.58x. We have worked diligently to improve our financial position. And as you can see from the chart, since the third quarter of 2014, we have significantly reduced our leverage profile. The commitment to voluntarily pay down debt has allowed us to negotiate commitment letters and a term sheet for a new credit agreement, which will allow for greater financial flexibility to support our business growth objectives and capital allocation strategy. We anticipate the closing date for the new agreement to occur in the fourth quarter of 2017, subject to negotiation of definitive agreements and market conditions. Please turn to Slide 7. For the third quarter of 2017, total backlog was $3.1 billion and funded backlog was approximately $800 million. Total backlog includes the newly awarded approximately $400 million Range Support Services II contract. Total backlog includes both funded and unfunded backlog and represents firm orders and potential options on multiyear contracts. Our contracts are multiyear contracts and the right to exercise an option period is at the sole discretion of the U.S. Government who are the prime contractor when we're a subcontractor. Total backlog excludes potential orders under indefinite delivery and indefinite quantity contracts, and contracts under protest. Please turn to Slide 8, where I will discuss 2017 guidance assumptions. Our year-to-date financial results and contract extensions provide visibility to update our full year 2017 guidance for revenue, operating margin, net income, diluted EPS and net cash provided by operating activities. We increased the range for revenue to $1.08 billion to $1.1 billion from $990 million to $1.09 billion. The new midpoint for 2017 revenue is $1.09 billion. We now expect the operating margin to be in the range of 3.5% to 3.7%. As a result the new midpoint for operating margin is 3.6%. Net income will be in the range of $21.1 million to $23 million. This takes into consideration the impact of unamortized bank fees related to the existing agreement. Diluted earnings per share will be in the range of $1.87 to $2.03. The midpoint for diluted earnings per share is $1.95. The range for diluted EPS assume an estimated $11.3 million weighted average diluted shares outstanding. 2017 net cash provided by operating activities is expected to be in the range of $24 million to $30 million. Capital expenditures for 2017 are expected to be approximately $2 million. Depreciation and amortization is expected to be $2.3 million for 2017. 2017 mandatory debt payments are expected to be $11.5 million. Interest expense is forecasted at $5.1 million and we're currently estimating a 35.5% tax rate for the full year. Now I'd like to provide some insight into 2018 revenue. As we spoke last quarter, we anticipate K-BOSSS to continue through 2018. The new contract awards RSS II, Keesler and Thule are expected to contribute approximately $65 million of incremental revenue. While we were successful in winning all of our recompetes during 2017, some contracts will undergo a pricing factor reduction versus their historical run rates. Additionally, in 2017, we generated $63 million of revenue from the APS-5 contracts that will not reoccur in 2018. We remain positive on our pipeline and the successful execution of our pipeline could drive additional revenue. Finally, we anticipate contracts up for recompete to be about 10% of our revenue in 2018. Now I'd like to turn the call over for questions.

[Operator Instructions] Our first question comes from Brian Ruttenbur of Drexel Hamilton. Please go ahead.

So, very strong. Couple of quick questions. On book-to-bill in the quarter, I didn't hear that number. And then I've got a couple of other follow-on if you just answer that one first.

Brian, it's Matt. So our quarterly bookings is over $500 million. Most of that comes as a result of the RSS II contract that we talked about in the prepared remarks. And then we did see additional contract extension and contract add-ons in the quarter to get us to our total bookings.

So what was the total book-to-bill or total bookings in the quarter, you said over $500 million, I just got to do the calculation then.

Book-to-bill was close to 2x. And it was over $500 million, it was about $560 million and a quarter.

$560 million. Okay. And then you're sitting on a lot of cash. And I know you're looking at doing a refi. What kind of cash do you need going forward to operate the business? Do you need $10 million, $20 million. Help me out with trying to understand your cash needs moving forward?

So when we spun in 2014, we had about $25 million of starting cash. That was a little tight for this kind of business at about $1 billion, all over. I would say a more comfortable range would be in the $35 million to $40 million as a normal run rate. Now as the business grows, which we expect to grow in the future, that number would proportionately go up. But for where we are today, $40 million -- $35 million to $40 million is about right.

Okay. So you're sitting on extra $20 million, $25 million right now?

We ended the quarter at $63 million of cash in the bank and -- as we talked about in the last quarter, we were focused -- are focused on adjusting our current credit facility to give us more flexibility in our capital allocation options going forward.

And so with this new credit facility, do you anticipate using some of that cash to pay down some of your debt? And post the credit facility will only be sitting on roughly $40 million of cash?

We still need to close out the credit facility. So we have some work to do there. We'll decide what the right cash levels are. And based on the opportunities in front of us, that will determine the cash balance that we'll have in any given quarter. Right now, it's a little bit too early to make that determination until we get through this final stage.

And then the last question is on K-BOSSS LOGCAP. Do we have any update on timing? I know you mentioned it during the prepared remarks, but it sounds like nothing has really changed. It still sounds like it's going to be mid-to-late 2018 when the decision is made. Is that kind of the correct timing in what I heard?

Brian, it's Chuck. That is correct. We are currently expecting proposals -- delivery in early 2018 and an award in mid-2018.

And you still feel extremely well positioned on that one?

Tell you what, Brian, our team is doing a great job; our performance continues to be very strong, kind of the op tempo in the way we are supporting the op tempo and the programs that we do support, where we support the programs has been very, very good. So I can't feel any better right now than how we're positioned.

[Operator Instructions] Our next question comes from Ben Klieve of NOBLE Capital Markets. Please go ahead.

So first apologies, I got on a few minutes late. So Chuck I'm going to ask you questions that I'm sure you discussed here at the beginning. But did I hear you say that the RSS contract is going to be at a full run rate during the fourth quarter. Did I hear that correctly?

Yes, Ben, this is Matt. That's correct.

Congratulations on really a solid quarter overall, particularly on the bookings front. We've seen a pretty weak quarter in bookings with a lot of other IT service providers reporting a lot of delays and even excluding the RSS order, it looks like you guys had a pretty decent quarter. So I'm guessing -- I'm wondering if you can comment a bit on the current bidding proposal environment? And kind of how it's evolved over the past couple of quarters? And then also are you noting any kind of meaningful difference in the environment on awards that are kind of more purely IT versus heavier on the facilities and logistic side?

What I will say, as we all know the government contracting cycle is a bit episodic. Where we see our greatest strength is in the aspect of our missions that we support, that are most, I'll call it, forward-deployed. So as the op tempo in the Middle East increases, as an example, we see opportunities to expand our business base. So the short answer to your question is that, the cycles continue to be episodic. But the areas of our business that we feel best about are those aspects that are most tied -- closely tied to our clients' missions.

And then one question, Matt, on your commentary on the quarterly revenue comparison. You noted that Afghanistan activity was up $0.5 million this quarter. Did you give that same number for the first 9 months? I don't think I caught it if you did?

For Afghanistan revenue?

Yes.

Yes, I can give you the quarterly numbers, let me see...

I think it was up $0.5 million during the quarter, but I didn't hear it during -- for the 9 months period.

Yes, the nine months, Afghanistan revenue is $39.5 million.

And where does that stand on a year-over-year comparison?

Year-over-year comparison is down $36.6 million. And it's principally due to -- we were on the LOGCAP IV contract last year and for half the year. So that decline is basically driven by that, that change in 2017.

And the last question from me, and I'll jump back in queue here. Do you guys have any opportunities that are sitting in protest right now?

We do not. At this point in time, we are not awaiting any protest decisions.

[Operator Instructions] This concludes the question and answer session. I would like to turn the conference back over to Chuck Prow, Vectrus Incorporated President and Chief Executive Officer for any closing remarks.

Thank you, Kyle, and thank you, Brian and Ben, for your questions. This concludes our call for today, and I look forward to updating you next quarter as we close the year in the fourth quarter of 2017. Thank you very much.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.