V2X Inc (VVX) 2016 Q2 法說會逐字稿

Good day and welcome to be Vectrus Incorporated second-quarter 2016 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Michael Smith, Director of Investor Relations and Corporate Development. Please go ahead, sir.

Thank you, Eric. Good morning, everyone. Welcome to the Vectrus second-quarter 2016 earnings conference call. Joining us today are Ken Hunzeker, Chief Executive Officer and President, 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 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 in our earnings release and in our presentation slides, which are publicly available on the Vectrus website at investors.vectrus.com.

At this time, I would like to turn the call over to Ken Hunzeker.

Thank you, Mike. Good morning everyone, and thank you for joining us on the call. Today, we are reporting second-quarter 2016 financial results. Before we get started, I would like to discuss a couple of items. First, last month, I visited our programs in the Middle East. I saw multiple customers, met with employees and connected several town hall meetings.

These trips always remind me of the tough and challenging environments our employees and service members endure in the region. They confirmed for me that our mission is absolutely critical to the United States' efforts overseas. As the active duty force structure is reduced, Vectrus will continue to be our government's partner living and working in very demanding and tough conditions. I'm exceptionally proud of our work force.

The second item I would like to discuss is related to our Vectrus Improvement Projects, also known as VIPs, which are the centerpiece of our operational excellence initiatives. As you may recall, VIPs are deliberate, thoughtful and lean-based approaches that are a key component of how we support the customer and increased stakeholder value. There is true excitement within Vectrus to initiate and implement these projects and since initiating the VIP Program, the number of submissions we are receiving from employees is increasing. Importantly, the feedback we're getting from customers regarding VIPs has been overwhelmingly positive.

I'd like to highlight one of our recent VIP of the Quarter winners to provide a sense of the results that they produce. This particular VIP, on one of our IT programs, implemented advanced automation of processes, optimized schedules, and streamlined staffing.

The improvement project resulted in a 25% reduction in employee turnover and a significant cost savings to our customer. Our VIP initiatives are creating significant value. We plan to issue a VIP of the Year award in October, and look forward to sharing the story and results of the winning project with you later.

Please turn to slide 3, where I will discuss some of our second-quarter highlights. Second-quarter results were solid. Revenue was $308 million, down slightly from last year. Our operating margin in the second quarter was 3.7%, up 20 basis points compared to the prior year.

Diluted earnings per share were $0.55, down a $0.01 from last year. Our team's continued focus on cash collections resulted in a $20 million improvement in free cash flow compared to the prior year. Our days sales outstanding, or DSOs, reached a Company record of 52 days in the second quarter.

Our strong cash collections enabled us to make a voluntary debt payment of $2 million in the quarter. Additionally, I would like to note that subsequent to the end of the second quarter, we made another voluntary debt payment of $3 million. Including this amount, we have made $17 million of voluntary debt payments since September of 2014 and reduced our total debt by 27%.

I am proud to announce that during the second quarter, Vectrus successfully underwent an ISO 20000 surveillance assessment, where IT service management systems processes were reviewed for compliance and effectiveness. Additionally, Vectrus completed the standard CMMI Appraisal Method for Process Improvement. Vectrus is currently appraised for development at maturity level 3 and plans to work towards achieving increased appraisal levels.

These two certifications demonstrate the Vectrus IT commitment to the industry-leading standards that strengthen our ability to deliver imaginative, compliant and affordable solutions to our customers. Additionally, subsequent to the second quarter, we received a two-year re-certification of ISO 9001.

To become ISO 9001 certified, an organization must demonstrate a quality management system with the ability to consistently meet statutory, regulatory and customer requirements. These internationally recognized credentials are important, as they ensure we maintain competitive qualifications in support of our current programs and new business pursuits.

Please turn to slide 4 where we'll provide an operational update on Vectrus. First, on July 15, 2016 there was an attempted coup in Turkey. During this event, Turkish officials stopped all flights in and out of Incirlik Air Base. Vectrus provides the full spectrum of day-to-day base operations and maintenance service at Incirlik Air Base as part of our Turkish paying Base Maintenance Contract.

I'm happy to report none of our employees were injured during this event. During this uncertain time, our employees delivered exceptional support to our customer. Facing restricted base access, no commercial power, workdays exceeding 20 hours a day in some cases, our teams were able to continue the mission without interruption.

Key leadership at Incirlik Air Base recognized our employees' contributions and thanked them for their efforts during this event. In my view, this is a remarkable demonstration of how Vectrus remains true to its mission and consistently works towards its vision of being the customer's first choice and most trusted partner.

Regarding our major recompetes, our largest recompete on a revenue basis is the K-BOSSS program. We continue to operate under a $329 million modification of the contract, which runs through December 28, 2016. Every day we operate the K-BOSSS contract, we look for ways to improve our already exceptional performance and the value that we bring to the customer.

K-BOSSS has the largest US military footprint in the Middle East and we are seeing increased activity associated with this contract. Rapid response to varying customer requirements is a core strength of Vectrus. We believe the current off-tempo in the Middle East allows Vectrus to demonstrate its ability to respond quickly and without fail in order to meet the complex and challenging needs of our customer.

Turning to our recompete on APS-5 Kuwait/Qatar. We continue to operate under extensions for both contracts which has the potential to run through February of 2017. As we've noted in the past, the contracts will be combined and awarded under the Eagle indefinite delivery/indefinite quantity, or IDIQ contract. Eagle is a very competitive contract vehicle and we believe the consolidation of our prior contracts make this program even more compelling to competitors.

Although our past performance on APS-5 has not been the same as K-BOSSS or Maxwell, we have made tremendous progress on APS-5 since our initial award and we look forward to demonstrating our unique solutions and VIPs on the new contract. It is currently our best estimate to both K-BOSSS and APS-5 will be awarded in the latter part of the third quarter.

Regarding our Maxwell-based operations support program, during the second quarter, Vectrus was awarded a three-month modification that extends into August. Subsequent to the second quarter, Vectrus was awarded a second three-month option that extends to November 2016.

Our past performance on Maxwell remains strong and these option periods provide an opportunity for Vectrus to continue our excellent performance and increase our track record of success for this customer. Hopefully, we will have some additional clarity on our recompetes by the time we report our third-quarter 2016 results in November.

Turning to our IT and Network Services business, we have successfully recruited some of the best and brightest individuals in the industry and have reached full capacity in our Reston, Virginia office. This talented team is working hard to deliver our unique and differentiated solutions to customers.

Our team plans to leverage our existing past performance, customer relationships, global footprint and solid financial position to effectively compete with our peers in this market. We are already seeing solid progress by our Reston-based team and expect our efforts to produce results over the next 18 months.

Turning to the status of new business, we currently have over $1 billion of proposal for new business submitted and awaiting award. Additionally, we plan to submit proposals on almost $7 billion of identified opportunities over the next 12 months, all of which are new business. I'd like to point out that these numbers do not include potential IDIQ contracts.

Our new business pipeline has been impacted by various factors. While we have been submitting proposals, we have reported about $1 billion of business awaiting award for several quarters now with no recent award announcements. This means there have been some unsuccessful bids. We believe there is always an opportunity to get better and that continuous improvement is an essential part of our culture.

Based on some recent organizational change, our teams are now better aligned, staffed and resourced in order to improve probability of win on new opportunities. Regarding the $411 million Thule Base Maintenance Contract, on June 26, 2016, the US Court of Appeals for the Federal Circuit ruled in favor of our Danish subsidiary and issued a decision that reversed the decision of the Court of Federal Claims.

Since then, however, two of the protesters have filed petitions for a re-hearing with the full court. We remain confident that our position is strong.

Now I'd like to turn the call over to Matt and he will go through our financials, results and provide details regarding our updated 2016 guidance and then we'll open the call up for questions.

Thank you, Ken. Good morning, everyone. Please turn to slide 5. Today, I will be discussing our financial results for the three and six months ended July 1, 2016. I'd like to start with the second-quarter financial results reflected in the chart at the top of slide 5. For the second quarter, funded orders were $304 million, down $29 million compared to the same period of 2015. This change is primarily driven by timing of contract modifications.

Our funded book-to-bill ratio was 1.0 times in the quarter. In the second quarter, revenue was $308 million, down less than 1%, or $2 million compared to the same period of 2015. This change was primary driven by a $31 million decrease in revenue from our Afghanistan, US, and European programs and partially offset by an increase from our Middle East programs of $29 million when compared to the second quarter of 2015.

Operating income was $11 million, or 3.7% operating margin, in the second quarter of 2016, $500,000, or 20 basis point improvement compared to the second quarter of 2015. Net cumulative catch-ups added $300,000 to operating income in the second quarter compared to a negative impact of $1.2 million in the second quarter of 2015.

Cumulative catch-ups are a natural part of our business and are driven by changes in contract terms, program performance, customer scope changes, and changes to estimates in the reported period. These changes can be positive or negative depending on the dynamics of program, and we're pleased with the net favorable results this quarter.

Importantly, during the quarter, we witnessed an increase in interest expense related to the fees incurred for the renegotiation of the credit agreement covenants. Interest expense in the second quarter of 2016 was $1.7 million versus $1.4 million in the prior-year period. Diluted earnings per share for the second quarter were $0.55 compared to $0.56 per share in the second quarter of 2015. It is important to note EPS was negatively impacted by the credit agreement amendment and equity expense acceleration. Both items total approximately $400,000 in the quarter.

Now I'd like to turn your attention to the year-to-date 2016 financial results, shown on the lower half of slide 5. Our funded orders were $909 million, an increase of $433 million compared to the same period in 2015, primarily due to timing of funded award and contract extensions. Year-to-date 2016 revenue was $619 million, an increase of $48 million, or up 8% when compared to the same period of 2015. The increase was driven by our growth on our Middle East programs of $85 million and partially offset by the decline in revenue from our Afghanistan, US, and European programs of $37 million.

Operating income was $23 million year to date in the second quarter of 2016, or 3.7% operating margin, which is $2.9 million, or 20 basis points favorable when compared to the same period in 2015. Year-to-date 2016 diluted earnings per share were $1.16 compared to $1.02 per share in the prior period. Year-to-date 2016, we generated $19 million of free cash flow, which is an improvement of $19.9 million when compared to the prior period.

Continuous improvement in the collections process helped us reach a Company record 52 days sales outstanding during the quarter. For our current mix of contracts, 52 days is superior performance. However, we do not expect to sustain this level as we grow our business and start up new contracts. We believe a more sustainable DSO is in the low-60s range.

Our strong cash collections enabled us to voluntarily pay down $2 million of debt in the second quarter of 2016. Our debt as of July 1, 2016, was $105 million, representing a total debt to trailing 12-month consolidated EBITDA ratio of 2.0 times. Also of note, subsequent to the second quarter, on July 28, Vectrus paid $3 million in additional voluntary debt payments, bringing the total payments to $5 million for the year.

Please turn to slide 6. For the second quarter, total backlog was $2.3 billion. Total backlog represents firm orders and potential options on multi-year contracts, which exclude the ceiling values of IDIQ contract vehicle awards. Our funded backlog was $975 million. We expect total backlog levels to increase once recompete contracts are awarded and new business pursuits are won.

Please turn to slide 7. As a result of our improved visibility and outlook for the remainder of the year, we are increasing the previously communicated ranges for revenue, diluted EPS, and free cash flow for 2016. We increased the ranges for revenue to $1.18 billion to $1.2 billion, from $1.15 billion to $1.19 billion. The new midpoint for 2016 revenue is $1.19 billion.

We increased the estimated range for diluted earnings per share to $2.07 to $2.32. The new midpoint for diluted earnings per share is $2.20. We also increased the range of free cash flow. We now estimate free cash flow to range from $28 million to $32 million, with a midpoint of $30 million. We are maintaining the range of operating margin at 3.6% to 3.9% with a midpoint of 3.75%.

Debt management remains a focus in 2016. Given the $5 million of voluntary debt payments made so far this year, and our strong free cash flow, we increased the lower end of our anticipated voluntary payment range and now expect payments of $8 million to $10 million. This should bring our debt leverage ratio to below 2 times EBITDA by the end of 2016.

Depreciation and amortization is expected to be $2 million in 2016, a change from $4.1 million as previously reported due to recent contract closures. Interest expense is forecasted at $5.8 million. We currently estimate a 36.7% tax rate for the full year.

Now I would like to turn the call over for questions.

(Operator Instructions)

Bill Loomis with Stifel.

Thank you. Good morning. Just --

Hey Bill.

Looking at the backlog, it looks like the backlog was down sequentially almost a couple hundred million, and -- but yet a 1.0 book to bill. Was there any type of revaluation or anything in the backlog?

No, what we're seeing is really the backlog come down as we earned the revenue in this quarter and what we're really waiting for is the recompetes to be awarded as we said in the prepared remarks. We expect those announcements, really, by the end of the third quarter, early fourth quarter, latest.

Once that happens, backlog levels will bump up again. So funding is strong on our current contracts. We reported $975 million of funded orders; what that really does is it gives us visibility to our cash collections in the next 60 to 90 days or so.

Okay, so just to be clear, the $307 million in orders you had in wins you had in the quarter, that didn't add into backlog?

That was funded backlog. That does not add into total backlog. The way we report our backlog is in two chunks. Total backlog of $2.3 billion includes unfunded elements. The reason why we do that is it's really kind of a better reflection of revenue streams going out into the future.

Funding for us is not in jeopardy per se. As far as -- I'm sorry, the options for us if they are partially funded. They are not in jeopardy of realizing the full option year because of the way our contracts work. So funding really is visibility in our cash flows.

The shorter our funding, the lower our funding, the tighter our cash collections will be and so, really, the way to look at it, $2.3 billion is our revenue streams in the next couple of years. $975,000 of funded orders really gives us an idea of how the next couple quarters will play out and how our collections will result.

Okay. So the $975,000 is not a part of the $2.3 billion?

$975,000 is part of the $2.3 billion.

The $300 million in awards did go into the $2.3 billion billing calculation?

It goes into the funded chunk of it, it breaks out the $2.3 billion. Correct.

I understand. So if we look at the total, you burned off your revenue in the quarter which was about roughly $300 million, $308 million. You had awards of about the same, which replaced that in backlog. So I'm just wondering why backlog went down sequentially.

No I think we're talking past through each other. So the way it would work is let's start from the second -- or the first quarter, we had $2.5 billion. Okay? So we burned $300 million of revenue. So that would bring that down to $2.2 billion. We received another $100 million of contract extension, nothing to do with funding at this point. So that gets us to the $2.3 billion, okay? Part of that $2.3 billion in any given quarter is funded or unfunded. So the $300 million that we realized in the quarter really breaks out that $2.3 billion.

Okay. So what would the -- the $300 million in awards you had in the quarter in funded awards, what would the amount that would have gone into total backlog be, including the unfunded part of your $300 million?

So we saw an extension on our [on dex walker] program that added to our total backlog; if that helps.

Okay. I need to get -- I'm confused on this so I'll talk to off-line on that one. And then on the -- let's see, the pipeline went from $6 billion to $7 billion. What was the -- was it a series of smaller awards or was it a big one that boosted that sequentially that you are eyeing?

Bill, this is Ken. It's really a combination of both. As we expand what capabilities we have in the IT networks business as I look at the pipeline and we look at it going forward, the IAM/Log has stayed pretty much standard and hasn't increased that much. But because we're expanding in the DIT networks business, that's where we see most of the expansion in our pipeline.

Okay, so it's a series of $100 million type jobs or a lot smaller jobs? Just trying to understand the concentration on that sequential increase.

So we have today, our current pipeline is made up of some larger contracts. I will say the AFCAP contract vehicle, we're seeing a lot of activities and those are lower volumes. But it's a mix. I think as we mature the IT solutions, you'll start to see those coming in smaller increments as far as TCVs. But our pipeline is made up of just roughly maybe five to ten pursuits in any given quarter.

But the IT networks has really shown a better mix going forward of small and large contracts.

Okay. And then just on the $400,000 in cost you had with the credit negotiation, equity acceleration. Was that a pre-tax number so it would be -- I'm calculating about $0.02 per share after tax?

We are on the same page. That is a pre-tax number.

That's exactly right.

Okay, and then just one last one on the Thule contract. So what is the -- how could that -- how could this play out and over what time frame now they have filed these two other petitions?

Well, quite candidly, we are waiting for the government response and in one case, we've been asked for our response and we are preparing that. And then as it goes to a decision of whether or not it's heard by the entire federal court, then that carries it forward. If that doesn't take place, and the only next option would then be to basically go to the Supreme Court, which really hasn't been done much in the past.

So we are really waiting to see if there is another -- if a third competitor actually files. We only have two right now and see what is the Court's decision going forward. But quite candidly, if this all comes to play, I think we'll know by the end of September or early October how this all will play out in the future.

The likelihood of seeing revenue streams, if the award -- if it's re-awarded to Vectrus this year is probably expiring. But we sure would like to get this decision behind us and get a full run rate next year.

Okay, great. Thank you.

Thank you, Bill.

Michael French with Drexel Hamilton.

Good morning, Mike.

Hi. Good morning, gentlemen. Congratulations on the strong results.

Thank you, Mike.

Ken, I'd like to ask you to follow-up on actually a couple on Turkey. So you mentioned guys working 20 hours. I feel sorry for them working that hard under those conditions. But the financial question is, does that result in any uptick for you guys, if there is more work being done there. Was that just a temporary situation?

Well, as you know, that contract and the work that is taking place in Turkey has been modded several times based upon an increased activity at the base. So we actually have that in our numbers for this year, and is already reflected. What we're seeing right now is a very small surge, really not that impactful on our revenue income.

But what's incredible is that our employees have really performed exceptionally during this period. You couldn't get them to go home. They were all about the mission. They were all about getting everything taken care of and the passion that they showed was really recognized by the customer.

And so I think it really showed that Vectrus is up to the task and can basically execute under any condition and so it really was -- if you could make a good news story out of something that was in a very trying time, that's what the good news was.

Okay, thank you and perhaps a more difficult question, I'd like to ask your take on the political situation there, and how stable this is as a piece of business for you guys.

Well, I will tell you my personal opinion here is that when it comes to national interest, President Erdogan is really a realist and when you look at their partnership with NATO and that relationship, they very much value that. And so I think that our relationship as a nation will continue with Turkey.

I've talked to Turkish officials in the past, they love their relationship with NATO and the United States, so I think that bond is strong and I think as long as we have a common enemy, which we do, which is ISIS or Daesh, we will continue to be partners of that going forward. I think their relationship will stand the test of what the internal struggles within Turkey that are taking place now.

Okay, very well and shifting gears on the new contracts at IT networks, the mix of large and small. I was wondering if you could provide more color. Did some of these contracts result of the -- from your new facility in Reston? And do these contracts you're talking about, do they differ from previous contracts in any material way, the size, margin, structure, scope of work or any other color you could add there would be helpful.

That's a great question, Mike. So when you think about the IT networks, in many cases, not a lot of people recognized that, that was really one of our business platforms in the past based upon when we worked with Exelis. So the fact that we've actually come out and told everybody that we want to build out the office and we want to do that. We're actually getting into partnerships with some of our peers in the group and we're actually bidding contracts with them now and working those kind of opportunities.

But it also alerts the -- our customer base that we're a player here and based upon the number of folks that we've hired and they have identified future opportunities going forward, it's really given us a refresh on our look on our pipeline. That's the biggest change, is it's that refresh, new set of eyes and how we want to work it with the talent that we've been able to hire in the last six months.

The near-term of our pipeline looks very untraditional; contracts we're performing on now, ASA being the most relevant. As we move through the year, in the next 12 to 18 to 24 months, that pipeline will strengthen. We will have -- the intent is to be on some IDIQ contracts. So as I discussed earlier, those values will be smaller increments, but hopefully, a larger and a number of task orders.

And the idea here is obviously we have 20-plus contracts in our current portfolio. We would like to have less contract concentration in any one contract. So looking forward in the next three to five years, if we could have 50 contracts and no contract mix of the K-BOSSS type volume of 30% would be ideal.

Going back to your question on profitability, yes, we are hopeful that this investment gives us some more margin improvement. We think there is some opportunities to where we are today roughly as an organization at the 3.7% versus what we think our peers are earning in the 7%, 8%, 9% range. So we feel like we have an opportunity to take some business away, improve our margins but not outprice ourselves in this initiative.

Okay. Very good. Thank you, and good luck.

Thanks, Mike.

(Operator Instructions)

With no questions in the queue, I'll turn the call back over to Mr. Hunzeker for any additional remarks.

Thanks, Eric. Thank you for joining us on the call today. The first half of 2016 has seen great performance by our team. Our execution and Improved visibility have allowed us to increase our 2016 revenue, diluted earnings per share and free cash flow guidance.

We continue to execute on these three pillars of our strong, long-term strategy that is include -- which is continue to execute on the three pillars: enhancing a solid foundation, balancing our portfolio, and providing more value.

We thank you for your interest and look forward to updating you on our progress next quarter.

This concludes today's call. Thank you for your participation. You may now disconnect.