V2X Inc (VVX) 2014 Q3 法說會逐字稿

Good day and welcome to the Vectrus Incorporated Third Quarter 2014 Earnings Conference Call.

Today's conference is being recorded.

At this time I would like to turn the conference over to Cindy Frothingham, Director of Investor Relations.

Please go ahead.

Good morning, everyone.

I would like to welcome you to the Vectrus Third Quarter Earnings Conference Call.

Joining us today are Ken Hunzeker, Chief Executive Officer and President and Matt Klein, Senior Vice President and Chief Financial Officer.

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 earnings press release 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.

Also we will be making reference to non-GAAP financial measures during this call.

We remind you that these non-GAAP financial measures are not a substitute for their comparable GAAP measures.

You can find the non-GAAP reconciliations and other disclosures required by the SEC included in our earnings release and in our presentation slides which are publicly available on our Vectrus website at investors.vectrus.com.

Please turn to slide 3. At this time I'd like to turn the call over to Ken.

Thank you, Cindy.

Good morning, everyone.

Thank you for joining us on the call today.

As we all know today is Veteran's Day and I cannot think of a better day for Vectrus to deliver its first earnings call.

In our line of business we are proud to serve side by side with the men and women who wear the cloth of our nation.

Today is our day to give them thanks.

I recently had the opportunity to visit these men and women as well as our employees in the Middle East.

Each visit reminds me of the dedication, sacrifice and hard work required to conduct the operations there.

Happy Veteran's Day to all who have worn or continue to be in uniform.

Thanks for your service.

As you know our spinoff was completed on September 27th and today we are pleased to lead Vectrus as a publicly traded company.

Last month during our Investor Day briefing I spoke about what makes Vectrus unique and why we believe we are positioned to provide critical support to our customers while delivering a compelling shareholder return.

Before I dig into details of the quarter I would like to review those highlights.

Vectrus primarily provides mission critical operations and maintenance services to US Government customers around the world.

Our customers continue to have requirements for infrastructure asset management, information technology and network communication services and logistics and supply chain management.

Our history of delivering superior performance, creating long-term value and sustaining enduring customer relationships creates our foundation for future growth.

Looking at our future as an independent company we believe we have a significant opportunity in the market as a result of our proven ability to win and execute large scale, mission critical, global services.

With proven performance and enduring customer relationships we are solemnly positioned to capture our share of the approximately $100 billion in the addressable market we serve.

Our pipeline of potential new opportunities over the next three years is more than $10 billion and our track record is solid with $2.4 billion of new awards and seven new IDIQ contracts in the last 20 months.

A solid pipeline with a winning track record and good financial fundamentals provides with an excellent opportunity to increase shareholder value.

Please turn to slide 4. Third quarter highlights include the successful spin from Exelis on September 27th.

This required a great deal of work resulted in a smooth transition to a standalone company.

I believe we have good financial fundamentals, a manageable debt level and an experienced management team working together to deliver increased shareholder value.

In the past few months we were awarded three key contracts in our base business which are consistent with our strategy and expected to add $1.4 billion of backlog as well as approximately $200 million of annualized revenue.

This is significant because these contracts run beyond 2020 and mitigate our declining Afghanistan revenue.

I will talk about each one of these wins in detail on the following slides.

Third quarter results are in line with what we communicate during the investor day briefing and are consistent with our full-year projections.

As we discussed at investor day, revenue and earnings were lower relative to prior year as our support US troops and the Afghan military continues to draw down.

We expect our Afghanistan contracts to gradually come to a conclusion by the end of 2016.

This assumes the administration remains on its current course to remove all combat troops within that timeframe.

Matt will provide you details on the financials later in the presentation.

Please turn to slide 5. And I will discuss these three wins in more details.

The three recently awarded contracts all align with our strategy of expanding our geographic footprint while broadening our customer base.

The strategy has been in place for some time and these recent wins demonstrate our ability to execute on our strategy.

First, on August 15th, Vectrus was awarded the US Corps of Engineers Enterprise Information Management and Information Technology contract, referred to in this presentation as ACE-IT, totaling $517 million and running five years.

This program has been protested.

However, upon successful resolution it will significantly expand our footprint within the continent of the United States.

The contract calls for us to provide information management and information technology support services to more than 37,000 Army Corp.

of engineer customers.

In addition, this contract expands to work in our IT and network communication line of service.

Our network infrastructure support capability is well developed and well tested.

We're thoroughly committed to providing this important customer with superior performance.

As of September 18th we were awarded the Turkey-Spain Base Maintenance contract by the US Air Forces in Europe.

It has a total contract value of $458 million and runs through September of 2021.

Support services include the full spectrum of day-to-day base operations and maintenance as well as contingency and exercise support to the DOD, the Joint Chiefs, the US Air Force and other Allied Operations.

Work will be performed in multiple locations in Turkey as well as in Spain at Moron Air Force Base.

We're happy to be selected as the successful bidder.

We're committed to supporting the customer's mission at these strategic locations.

We expect this contract to be fully operational in second quarter of 2015.

On slide 6 is our most recent win.

On October 31st, a Danish company owned by Vectrus received notice of award of the Thule Base Maintenance Contract.

It has a total contract value of $411 million and runs through 2022.

The operations and maintenance work will be performed at Thule Air Base in Greenland.

These three contracts add approximately $1.4 billion or additional 64% to our existing $2.2 billion of recorded backlog.

We expect to continue growing our base business with $10 billion of identified potential new opportunities in the pipeline including $1 billion of proposals submitted and pending award.

Additionally, we have another $1.5 billion of bids expected to be submitted for consideration in the next 68 to 90 days.

At this time I would like to turn the call over to Matt to go through the details of third quarter and full-year performance and then we'll open up the line for your questions.

Thank you, Ken.

Good morning, everyone.

Please turn to slide 7 to review our financial performance.

On September 27th Vectrus completed a spin transaction from Exelis and became an independent company.

Although Vectrus was a business unit under Exelis during the reported period, the following results reflect Vectrus as an independent company.

During our discussion today I will address our third quarter results on an adjusted basis, which excludes the historical revenue and operating income for the Tethered Aerostat Radar Systems business, which we refer to as TARS as well as the impact to separation costs to become a standalone public company.

If you recall, the TARS business was retained by Exelis as part of the separation.

You can reference the appendix of this presentation for the reconciliation of our adjusted results to GAAP.

For the third quarter, funded orders were $703 million.

This is a significant quarter for us and provides visibility into expected revenue and cash flows for 2015.

Orders are down compared to the third quarter of 2013 which is the reflection of declining Afghanistan contract base and reflects timing of awards on Middle East programs.

For the balance of 2014 100% of the remaining expected revenue is currently in backlog.

Current funded orders do not include the three recent wins, ACE-IT, Turkey Spain, and Thule Base Maintenance Contracts which are expected to be added to backlog in the fourth quarter.

Adjusted revenue for the quarter was $288 million.

Afghanistan programs were down $56 million compared to prior quarter while the base business grew by $2 million.

This demonstrates that our existing non-Afghanistan contracts provide a strong revenue base going into 2015.

Third quarter adjusted operating income was $9 million or 3.1% of sales which was in line with our internal expectations and supportive of the full year projections we laid out during our investor day briefing.

Adjusted operating income excludes $7 million of pre-tax cost associated with the spinoff from Exelis and $1 million of pre-tax income from the TARS program.

Please turn to slide 8.

Let's talk about our performance on a year-to-date basis.

While year-to-date orders are $384 million unfavorable compared to 2013, the orders of $1.2 billion represents a year-to-date book to bill of 1.3 times, again, providing strong visibility into expected revenue and cash flows going into 2015.

Adjusted revenue through September was $887 million which is $272 million unfavorable to prior year.

Afghanistan programs were down $200 million with service level reductions on Middle East programs making up the difference.

Year-to-date adjusted operating income was $41 million or 4.6% of sales which was in line with our internal expectations and consistent with the full-year projections we laid out during our investor day briefing.

As you can see from the third quarter results our operating margin for the last few quarters is lower than our annual guidance.

This is due largely to adjustments on Afghanistan contracts as a result of lower service level requirements and temporary cost inefficiencies around separation activities.

We expected this decline which is incorporated and consistent with our prior guidance of annual adjusted operating margin range of 4% to 4.5% for 2014.

Our free cash flow through September was strong at $38 million.

While we were pleased with our cash flow generation year-to-date, it was partially impacted by early cash receipts which will put pressure on fourth quarter incremental cash flows.

If you recall in the information statement Vectrus and Exelis executed a contribution agreement containing a two-way adjustment mechanism relating to working capital and cash levels of Vectrus and its subsidiaries prior to spinoff.

Pursuant to that agreement and as a result of strong cash collections Vectrus received an initial payment of $17 million from Exelis on September 26.

A final payment of approximately $2.6 million is expected before year-end.

This will close the working capital two-way adjustment mechanism.

Please turn to slide 9.

Through the third quarter backlog was $2.2 billion with approximately $400 million moving from unfunded to funded backlog.

Backlog represents firm orders and potential options on multi-year contracts excluding IDIQ contracts.

The year-to-date backlog excludes ACE-IT, Turkey Spain, and Thule contracts.

The $1.2 billion of year-to-date orders represents a book to bill of 1.3 times through 9 months until September 30th.

We expect our book to bill to exceed one for the full year.

September backlog adjusted to include the three recent awards would represent $3.6 billion.

The recently awarded ACE-IT and Turkey Spain contracts were not included on our formal backlog due to our conservative process to record contracts once offered as a resolve and the relevant protest period had passed.

The Turkey Spain contract was awarded on September 18th for $458 million.

The award is now protested and the contract is expected to begin phase-in around the first of the year.

ACE-IT was awarded on August 15th for $570 million.

However, a protest was filed with the GAO on September 2nd.

Generally a GAO decision on a protest is due within 100 days of the protest submission.

Subsequent to the quarter's end we were notified that a Danish company owned by Vectrus was awarded the Thule Base Maintenance Contract for $411 million.

We expect to add these three programs to backlog in the fourth quarter.

In total these three contracts will add approximately $1.4 billion to our existing backlog.

Turning to slide 10.

As we look forward we have a lot to be excited about in the quarter and we have made significant progress on our strategic initiatives.

Orders in the quarter were strong.

As previously mentioned, we also won two major strategic programs during the period as well as an additional program in October.

These three recent awards are expected to add approximately $1.4 billion of total backlog in the fourth quarter.

With just the fourth quarter remaining we are able to refine our 2014 guidance.

First, we are narrowing our full-year adjusted revenue guidance to range from $1.15 billion to $1.2 billion for the full-year.

Our adjustment to the higher end of the range reflects anticipated stability on Middle East programs and predictable decline on Afghanistan contracts over the next three months.

We continue to estimate the full-year adjusted operating margin to range from 4% to 4.5%.

Our free cash flow guidance is expected to range from $23 million to $26 million.

As we noted cash receipts in the third quarter were very strong and much of the uncertainty and the timing of our expected receivables has been removed for the balance of the year.

Lastly, year-end 2014 adjusted earnings per share is estimated between $2.70 and $2.90 and the expected tax rate for 2014 is estimated to be 35.7%.

As for 2015 we are currently working through our financial planning process.

Our intent is to provide 2015 guidance during our fourth quarter earnings call early next year.

Now, I'd like to turn the call over for questions.

Thank you.

(Operator Instructions) And we'll take our first question from Brian Rutenberg with CRC Capital.

Great.

Well, congratulations first quarter out the gate.

First question, adjusted gross profit amount attributed to TARS, what was that in the period?

Hey, Brian, it's Matt.

Hi, good morning, Matt.

Good morning.

We didn't provide any adjustments to gross profit but I think you can think of it very simply.

All of the spin costs really fell out in G&A and then you can just take a little bit out for TARS from what we have in the adjustments in the reconciliations to GAAP as it relates to G&A to get back to gross profit.

Okay.

So, we take all the spin cost out of G&A and then we add what back in to the gross profit?

So, just take a little bit out for G&A for TARS, 5%, 6% and the rest goes into gross profit.

Okay.

Great.

The next question I have is on guidance.

Your guidance for the first nine months you did $2.54 in earnings per share, your guidance is $2.70 to $2.90, that implies a $0.16 to $0.36 fourth quarter adjusted EPS number; is that correct?

That is correct.

Okay, great.

The things that we're thinking about in the fourth quarter are, as the business has come down we have a very scalable cost structure and we work on that every day.

And part of that will be as a slight severance charge in the fourth quarter and then we have some equity grants that will kind of put some pressure on our income as a new company.

Okay.

So, there'll be a severance charge in the fourth quarter under G&A I assume?

Correct.

And what was the other charges?

We have some equity grants as the new company that we have to record in the fourth quarter.

Okay.

Will that change your share count?

It will slightly and we disclosed that our fully diluted share account will be 10,600,000 shares.

Okay.

Great.

And then free cash flow, I did not catch what -- I heard $23 million to $26 million is the free cash flow number for the year.

What is the year-to-date free cash flow?

Free cash flow year-to-date is $38 million.

Okay.

So, you expect to be $15 million, roughly, negative free cash flow in the fourth quarter; is that right?

Yes.

The way I look at it too is we were 70 million plus positive in the third quarter with early collection.

So we're just coming back to what we normally would receive or realize and that's about 100% of net income.

Okay.

That makes sense.

Let me move on to the Thule Greenland Air Force Base and understanding that contract a little bit.

It?s $411 million over seven years.

Who did you guys win that from?

Hi.

This is Ken.

It was -- it was a Greenland based company.

Okay.

So it wasn't another defense prime; it was -- it was a local company that only had this?

Correct.

It was a local based company.

Okay.

And when does that start?

So all of our contracts -- it's kind of why we didn't record any of new contracts into backlog.

They have to clear the protest period which Thule has not cleared the protest period at this point.

And then, we work with the customer on start dates and phase-in dates, so that's still in play.

And as we described in 2000 -- when we give 2015 guidance early next year, we'll give you some more color around the start dates and the revenue realized or expected in 2015.

Okay.

Ideally, it would be in the February, March timeframe.

But that's the time frame we're looking at, Brian.

Okay, good.

That's helpful.

Okay, so other awards that you're going after, you mentioned $1 billion of bids in, another $1.5 billion in the next 60 to 90 days that you're putting in.

That's a lot of award activity potentially down the road.

Is this primarily base management?

Can you talk about the makeup of those?

Not anything specific; I don't need specific basis.

I'm just trying to understand the makeup of what you're going after.

Well, it's just like our -- as we put together the plan -- these have been in the plan for awhile.

They are basically across all three business areas.

So it's a really healthy mix to help us in all three areas.

We have a couple of pursuits on the IT side, a couple in the base operations and what we're doing in the infrastructure management and a couple on logistics.

So it really is a nice mix going forward.

Okay.

And then, in terms of the continuing resolution, do you see any near term impact?

I know you have a lot of awards out there.

It seems to be a lot of award activity happening right now.

Is the continuing resolution slowing you down or do you see them -- the CRs slowing you down?

We normally are not affected by CR.

We don?t expect it now.

A CR really affects new starts.

Almost everything we do is existing work and it's just to re-compete, so it's not considered a restart.

Still, on the services side, we have not been affected in the past on continuing resolutions.

Okay.

And then, how about the Republican win, this is a macro question.

I have to hit you with it.

The Republican win and potential for sequestration, does that get avoided or not?

I know you can?t predict the future, but just give me your opinion on is this good or bad having the Republicans in and potential for avoiding or having a sequestration, in your opinion?

Brian, the discussion of sequestration is just getting started.

My opinion is that it would be our great dialog as we come together as a nation.

I will tell you in the past on sequestration, what I found interesting is that we never and all the different scenarios that took place in the past, we never -?

in all the different scenarios that took place in the past, we never had any of our employees laid off.

We didn't have any of our employees that were furloughed because a lot of the work, we -- most the work we do is mission critical.

So sequestration and what takes place there based upon the kind of contracts we have in the operating areas that we have, we're not affected.

Great.

Thank you.

At this time, we have one question remaining in the queue.

(Operator Instruction) We'll take our next question from Bill Loomis with Stifel.

Hi.

Thank you.

Good morning.

Good morning, Bill.

Great.

Looking at the sequential revenue, so when I'm looking at your guidance and towards the upper end of that guidance I get sequential flatter, even growth.

But it's not going to have the contribution from the three new wins which you expect to ramp up next year, so in Afghanistan work is going to continue to come down.

What is going to show towards the upper end of your guidance -- what programs are showing the growth in fourth quarter?

So I think what we're seeing on our Middle East programs is really stability and maybe a slight growth, not a tremendous growth with activity that's going on in the region.

Afghanistan is kind of leveling off.

We saw some pretty steep declines in the first three quarters and we'll see a little bit of a pressure in the fourth quarter.

But overall, I think we're seeing stability across our programs.

And like you said correctly, new contract wins won't begin until next year at various points in times during the next year and we'll give guidance on that early next year.

So if Afghanistan is leveling off, but you still think it's going to be gone by the end of 2016, what was it -- in the third quarter what was your Afghanistan revenue overall for the -- as a percent of revenue?

Afghanistan revenue was $66 million in the third quarter, which was down $56 million.

So the prior year was $122 million and it's trending about 50% compared to last year, 50% decline.

Okay.

So and you would expect that -- I know at the analyst meeting I think you said you expected that in '15, if I recall.

One of the comments you said that kind of decline in '15 for your Afghanistan work down about 50%?

Yes.

So I mean -- so we have $250 million that we're projecting through '14 and might be a little bit higher than that depending on how the last few quarters -- few months go.

What we said was in the next two years, the Afghanistan business will align with combat troop levels and what we've seen this year is a 50% decline.

I think at the worst case for next year in 2015, we may see another 50% decline.

I think that's the worst case at this point, but that's all dependent on what happens with troop levels.

Okay.

So with the $200 million of revenues from just the three wins you talked about, your base programs are stable based on what you're saying for fourth quarter and the growth you saw in third quarter or stability in third quarter.

So I mean, in 2015, you're not giving guidance, but I mean it sounds like it's -- I mean, revenues will grow.

I mean, is that a fair statement?

Well, there are a lot of moving parts on the three recent wins, right?

The things you have to contemplate is we work with our customers that aren't completely known now is when do we start and then, how long is the phase-in.

And those can change through the course of the negotiations.

So that's the one where we can assume that the $200 million is going to start January 1. So that's the one variable that we have to work on.

Okay, but if -- okay.

But is it reasonable to think, as I think Ken mentioned earlier, February, March that we could get these things -- all three of them going assuming that (inaudible) happens there?

It's a -- I would say that it's reasonable to have clarity around where we are on all three of them with the protest and the pending protest period expiring and then, we'll know when the phase-in starts .

So we'll definitely be able to give guidance on what we think the revenue trend is for these three programs.

In '16, I would expect you get a full complement of annualized revenue.

And we do know on Turkey Spain we had our post -- pre-performance conference with them last week and we will start that at the end of March so we do know that one.

Okay.

And then on the three wins only, what types of margin are on those programs?

Are they kind of in the 4% range or what guidance can you give on that?

We're not going to talk about individual programs.

We do feel -- we're very excited about winning these contracts and replacing our declining Afghanistan contracts.

And the good thing is, is when a win is resolved through the protest periods and we start executing, we have full control of operating margins and that's a good place to be.

Okay.

But no above corporate average, below corporate average guidance on the three wins?

Yes.

We're not really ready to give guidance until next year on overall corporate operating margins.

And then just on your debt going forward, what's the full-in interest rate including fee amortizations and everything like that?

We're really trending towards -- we closed September at about 2.99% so the annual interest expense depending on where LIBOR goes is in the $4 million to $6 million in the first couple of years.

Okay.

And then on third quarter, on the adjusted margins, so with that 3.1% adjusted margin, was there any one-time items in there that dragged that down and/or boosted it like potential fee awards or anything or is that a good figure?

What I said in the dialogue is really inefficiencies around spin activities.

So there's a slight pressure on that margin just to have overlap people to be ready for day one, to have certain TSAs and prep for those to get through the transactions, to stand up software requirements.

So our costs probably are a little bit high in the third quarter and we'll work on those in the coming quarters to kind of lean out operations.

So we should see a little bit of improvement on our cost structure going forward.

Okay.

And then in the fourth quarter -- on your adjusted margin that you will report in the fourth quarter, would that be a run-rate margin going forward or is there going to be some pressures on that too?

We would expect it to be similar to Q3.

Similar in size or similar that it's going to have some one-time temporary costs in there?

There would be -- as I described, there will be severance costs as we roll into next year and we adjust our cost structure.

And there will be equity grants that we have to contemplate and record in the fourth quarter as a new company.

That will put pressure on the margins.

So when you -- for adjusted margins, you're not adding that back to get your adjusted margin?

We do not plan on adding anything other than spin costs and TARS at this point.

Okay.

And then just seasonality, generally speaking, in terms of your revenues, do you have much seasonality in the business, apples to apples?

Is fourth quarter generally going to be stronger than first quarter for example?

We don't typically.

If everything were to start at the same time, it would be very predictable, but with one exception.

If things change on a base and the customer directs either increases or decreases, that could change it.

But overall, if things are pretty straightforward and consistent, you would see quarter-over-quarter pretty consistent revenue.

Okay, great.

Thank you.

Thanks, Bill.

The next question is from Jim Fung with Gabelli & Company.

I called late, so I apologize if you answered this earlier, but what do these -- at your investor day you talked about $1.5 billion of potential new businesses under valuation and then overall at $25 billion is now over a three-year period.

I was curious, was this Army Corps of Engineers award that you won, was that part of this $1.5 billion of potential new business?

And then could you just talk a little bit more broadly of where you are in terms of maybe potentially getting more of that $1.5 billion of new business coming up?

Hi, Jim, this is Matt.

Let me start you with the reconciliation.

At the investor day we had $1.5 billion in that number included Thule.

So we were recently awarded Thule that's why it came down to about $1 billion pending.

And then I'll turn it over to Ken for some color around what's still to go.

Okay.

And what's really interesting is we're obviously putting together our plan to go to the board and working the strategy plan going forward.

I'm really excited about what I see in the number of opportunities that we have.

So we've always wanted a robust pipeline within the organization and it has continued as we go to the future.

I'm very excited about all the different opportunities and our ability with our past performance to really put a lot of good bids in.

And that's what you're seeing the results of.

That's why within the next 60 to 90 days, we?ll have $1.5 billion of new awards turned in.

It just keeps the flow going.

So in terms of your opportunity, there's still another $1 billion in the near-term and then $25 billion over three years?

Yes.

Let me step you back a little bit.

Okay.

So roughly there's $10 billion in our pipeline that averages over three years.

So if you just do some math, $3 billion or $4 billion in any given year that we pursue and submit.

And you move down from that, $1 billion of it is pending award.

So it's all the way through its acquisition life cycle and ready for award.

Another $1.5 billion is just normal rhythm of the business that we're ready to submit and then we'll start to go through its acquisition life cycle on consideration.

So I wouldn't get too confused on the $1.5 billion and the $1 billion.

The $1 billion is ready for award.

We've been quite successful in this pool recently and we're hopeful that we're successful in this -- what's due to be awarded.

But really the rhythm of the business is $10 billion pipeline with about $3 billion that we pursue in a given year that whittles down to active pending award bids of $1 billion.

Right.

Okay, great.

Terrific.

Thank you.

Thanks, Jim.

It appears there are no further questions at this time.

Mr. Hunzeker, I would like to turn the conference back to you for any additional or closing remarks.

Thanks, Eric.

Thank you everybody for joining us on the call today.

As we discussed during our prepared remarks, we're really excited to be a new company.

The recent wins align directly to our strategy and help mitigate the declining Afghanistan revenue base.

We look forward to providing 2015 guidance next year when we report fourth quarter results.

And I think I'll end as I started today with a comment on Veterans Day.

Please take a moment to thank a veteran for their service.

Thanks.

This concludes today's call.

Thank you for your participation.