Cubic's (CUB) CEO Brad Feldmann on Q1 2016 Results - Earnings Call Transcript

| About: Cubic Corporation (CUB)

Cubic Corporation (NYSE:CUB)

Q1 2016 Earnings Conference Call

February 04, 2016 01:00 PM ET

Executives

Diane Dyer - Director, IR

Brad Feldmann - President & CEO

Jay Thomas - EVP & CFO

Analysts

Julian Mitchell - Credit Suisse

Brian Ruttenbur - BB&T

Mark Strouse - JPMorgan

Jim Ricchiuti - Needham & Company

Josephine Millward - The Benchmark Company

[Call Starts Abruptly] Cubic's Director of Investor Relations. Please go ahead.

Diane Dyer

Thank you, operator. Hello everyone and thank you for joining Cubic's webcast. Today, before market open, we've reported our First Quarter Fiscal Year 2016 Results. We encourage you to refer to the Company's press release and most recent reports filed with the SEC as well as today's presentation slides. You can access these documents on the Investor Relations tab of Cubic's Web site at www.cubic.com or on the SEC's Web site.

On today's call, Brad Feldmann, Cubic's President and CEO and Jay Thomas, Executive Vice President and CFO will comment on Cubic's first quarter 2016 results. Mark Harrison, Cubic's Senior Vice President and Corporate Controller will join us for the Q&A session. Please note that certain information discussed on the call today is covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act. I caution listeners that during this call Cubic management will be making forward-looking statements about future events or Cubic's future financial and operating performance. Actual results could differ materially from those stated or implied by these forward-looking statements due to risks and uncertainties associated with the Company's business. These forward-looking statements should be considered in conjunction with and are qualified by the cautionary statements contained in Cubic's earnings press release and SEC filings including its annual report on Form 10-K and quarterly reports on Form 10-Q.

This conference call contains time-sensitive information that is accurate only as of the date of this broadcast, February 4, 2016. Cubic undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call. This conference call will also include a discussion of non-GAAP financial measures as that term is defined in Regulation G. Cubic believes this information is useful to investors because it provides a basis for measuring the Company's available capital resources, the actual and forecasted operating performance of the Company's business, and the Company's cash flows. Any discussion of non-GAAP measures is not intended to detract from the importance of comparable GAAP measures.

With that said, I'll turn the call over to Brad Feldmann, our President and CEO.

Brad Feldmann

Thank you, Diane. Good morning, everyone. Thank you for joining us on the call today. Today, I'll review our Q1 FY '16 results and discuss some key items related to our segment and strategy updates and then Jay will cover our financial results and non-GAAP reconciliations in more detail.

On Slide 3, you will find an overview of our first quarter operating results. Sales in the first quarter for fiscal 2016 were $313.8 million, down 1% from the first quarter of last year. Without currency headwinds of $9.5 million, sales were actually up 1% year-over-year. Historically, the first quarter has been slow for us regarding profitability and this year has been no exception. This quarter, a combination of low margin mix and volume of systems work across transportation and defense segments was further impacted by the accelerated OneCubic ERP investment of $6.5 million and acquisition-related expenses of $4.3 million resulting in a net loss of 5.4 million or $0.20 per share.

Based on our current forecast, sales, profit, and operating cash flow will greatly improve in the second half of fiscal 2016 and with a much greater concentration of higher margin system shipments, revenue in both defense systems and transportation segments. In fact, we expect fiscal year '16 overall to have higher sales and adjusted EBITDA compared to last year. Our OneCubic efficiency investments to implement SAP and Workday starting this fiscal year remain on track. The first phased roll out of the ERP system will take place in the third quarter of this fiscal year and we are confident that we will see savings of additional $10 million in fiscal year 2017 growing to over $30 million annually by fiscal year 2019. We have completed two very significant C4ISR acquisitions, TeraLogics and GATR Technologies, which will greatly propel our sales and profitability expansion going forward.

Having completed our short-term C4ISR expansion initiatives as outlined on our January 8 conference call, we have already expanded our addressable market with these acquisitions. Overall, we expect to achieve record sales and adjusted EBITDA for the corporation in fiscal year '17. Jay will cover the details financial results in the call.

Moving to Slide 4, I'd like to update you on our business segments. In Cubic Transportation Systems, we have successfully proceeded to service commencement on the Vancouver project with over 500,000 daily riders and we are in the process of modifying the contract to improve our profitability going forward. We continue to have success implementing our NextCity vision. With the New Hampshire tolling win and multiple demos in Europe of our NextAgent intelligent ticketing vendor which enables transit operators to provide customer support at a dramatically reduced cost. In Chicago, the launch of the Ventra Mobile App that we announced last quarter is going extremely well.

We're seeing increased demand for similar mobile solution across much of our customer base. We are actively pursuing opportunities to expand our Intelligent Transport Management Systems ITMS presence in North America as well as offering our full transport capabilities in the Middle East. We expect a strong second half due to pending system upgrades in London and the delivery of higher margin work across our customer base. Finally, we have a number of opportunities that we are well positioned to win. We have been shortlisted for fare collection systems in Melbourne and Brisbane and for the M50 tolling system and operations in Dublin. We expect the New York City fare collection upgrade RFP later this year and there are multiple new fare collection opportunities that we're pursuing particularly in North America.

In Cubic Global Defense Systems, we closed three acquisitions since our last earnings call with the two C4ISR acquisitions as well as niche training acquisition in the UK, H4 Global. H4 is a software company that supports the UK Army and is in fact a great investment as they just won a contract to provide ISR synthetic RAFT to the UK's army training range that Cubic has operated for many years. We believe we are well positioned on key long-term priorities for the U.S. Department of Defense and our international allies. These include such programs as the Joint Strike Fighter and the Littoral Combat Ship and critical capabilities for expeditionary communications and wide virtual constructive game-based training. International defense markets are seeing demand for air, ground, and live fire training systems due to uncertainty and instability around the globe.

Our bid pipeline remains strong with many opportunities for security training in the Middle East and the ability of the new Cubic Global Defense team to compete at the prime level for major programs. For instance, the Air Force is currently in the selection process for the large KC-46 trainer, operations, and maintenance program where we believe we have proposed a superior value solution for the customer.

In Cubic Global Defense Services, we are pleased to report an improved program win rate particularly with our U.S. Army customers. We expect improved profitability this fiscal year with further margin expansion next fiscal year. The large share JRTC re-compete will come out this fiscal year and we believe we are well positioned as we have been delivering superior value to this critical customer since 2001. There is also a large opportunity set of ground-based services, which we will bid and therefore expect resulting growth. We're winning re-competes and competitive bids as well as strategic wins such as a three-year, $15 million task order to support the United States Army's Force 2025 and beyond initiative.

Moving to Slide 5, I'd like to provide a strategy update. For several quarters now, we have shared our intent and focus on expanding our C4ISR offerings as part of our broader strategy. We are pleased to report that we have successfully completed the short-term implementation of the strategic initiative by completing acquisitions of DTECH, TeraLogics, and GATR Technologies. These companies greatly enhance our Cubic Global Defense C4ISR portfolio and will allow us to build scale with increased shareholder returns in high-growth and higher margin markets anchored by expeditionary communications capability. TeraLogics is a leading provider of real-time full-motion video processing, exploitation and dissemination for the Department of Defense, a capability which is complementary to our existing tactical communications portfolio and establish Cubic as a key player in the ISR full motion video market.

GATR Technologies is a manufacturer of next-generation deployable satellite communication terminal solutions, which expands Cubic's technology leadership and satellite communications and network applications. GATR's line of portable inflatable satellite and C4ISR terminals supports mission-critical requirements for tactical communications in harsh and forward or remote deployed environments. Both of these acquisitions bring established customer bases and strong intellectual property portfolios to CGD Systems.

We believe these new offerings will be complementary to our existing Cubic product lines from DTECH as well as our cross-domain and data link solutions and other C4ISR capabilities. The combination of these products will allow us to provide an integrated end-to-end offering and expand sales in both domestic and international customers. We believe we have now established a market leadership position in expeditionary communications by combining Cubic's legacy capabilities with the technological leadership of these recent acquisitions. The transformation of Cubic Global Defense is well underway.

We anticipate by the end of fiscal '16, our C4ISR portfolio will be generating 200 million in annual sales and EBITDA margins in the high teens excluding non-recurring acquisition and integration costs. Our near-term focus in CGD Systems will be on integrating TeraLogics and GATR. We have taken powerful steps to achieve our growth strategy and we are excited to welcome TeraLogics and GATR teams to the Cubic family. We remain very excited about our future growth as we are well positioned in our markets. I will now turn the call over to Jay Thomas, our CFO.

Jay Thomas

Thanks Brad. As Brad noted, the GATR transaction closed on Tuesday. We will update our guidance after our Q2 close to reflect the impact of this acquisition. Our fiscal year '16 guidance, which we gave on our November earnings call is reaffirmed including the impacts of the TeraLogics and H4 Global acquisitions for the balance of the current fiscal year.

Moving to Slide 6, I will discuss our consolidated operating highlights. First quarter sales of 313.8 million were 1% lower than sales of 318.5 million in the corresponding quarter last year primarily due to foreign currency headwinds of 9.5 million. Adjusted EBITDA for the quarter was 11.2 million, down from 18.8 million in the same quarter last year. Adjusted EBITDA and other profit metrics including operating income and EPS were lower due to lower shipments in the air combat training and lower margins and transition costs under new London transport contract in the quarter. Adjusted EBITDA for the quarter includes an add-back of 4.4 million for acquisition-related costs and 6.5 million for ERP expenses. Included in the acquisition expenses was 1.3 million of compensation expense related to the TeraLogics acquisition and 800,000 related to an increase of contingent consideration for an earnout. Operating activities used 49.6 million in the quarter compared to cash provided by operating activities of $8.3 million in the same quarter last year.

Now turning to Slide 7, I'd like to provide an update regarding our businesses starting with Cubic Transportation Systems. CTS backlog remains high at more than three times annual sales. Q1 sales totaling 125.8 million were down 4% compared to last year reflecting the impact of currency headwinds of 6.8 million. Profits were primarily down due to the transition to the new London fare collection services contract. Now that we have transitioned, we expect margin expansion will be further enhanced with additional system upgrades and change orders during the course of FY16 and with further improvement in FY '17.

So, now turning to Cubic Global Defense Systems on Slide 8. Backlog remains strong at 577.5 million. Sales totaling 95.9 million were down 2% from last year, being impacted by decreased air combat shipments in the quarter. Defense Systems had an operating loss in the quarter of 3.4 million. The loss reflects 4.4 million of acquisition-related costs and losses on recently acquired businesses. We are confident that Defense Systems profitability will markedly improve in the subsequent quarters as we ship higher margin products and we see a contribution from the recent acquisitions, apps, and transaction related charges.

Now turning to Defense Services on Slide 9. Backlog grew year-over-year to 490.2 million from 485.6 million. Sales totaling 92.1 million increased 3% over last year's first quarter in a very tough but stabilizing DoD services market driven primarily by increased demand for special operation services at the Joint Readiness Training Center. Operating margins remain constrained due to the impacts of LPTA in the services market.

Finally, turning to Slide 10, I will review key items on the balance sheet, cash flow, and capital allocation and provide an update to our borrowing arrangements reflective of the GATR transaction, which we closed this week. At the end of Q1, we had 266.6 million in cash, restricted cash, and marketable securities compared to 318.3 million at September 30. Our foreign subsidiaries held 248.1 million in cash, restricted cash, and marketable securities as of the end of the quarter. The aggregate cash balances of 266.6 million, decreased 51.7 million in the quarter. Total debt at the end of the quarter was 236.5 million compared to 186.7 million at September 30th, or an increase of 49.8 million. The decrease in cash and increase in debt which aggregated 101.5 million in the quarter was used to fund negative cash flows from operation totaling 49.6 million, capital expenditures of 10.4 million, consideration for the acquisitions of TeraLogics and H4 Global aggregating 29.7 million, the impact of exchange rates on cash totaling $8.2 million, a reduction in the earnout obligation for the DTECH acquisition totaling 1.7 million and finally a repurchase of stock of $1.7 million. The negative cash flows from operations of 49.6 million reflected an increase in net working capital and the net loss. As Brad noted, we expect operating cash flow to improve during the balance of the fiscal year. Capital expenditures of 10.4 million included 7.3 million of capitalized cost related to the new ERP system. Capital expenditures this year will be higher than prior years as we are implementing this new system.

After the end of the quarter, we increased our revolving credit facility to 400 million from the prior facility size of 200 million. In addition, we revised the note purchase agreement pursuant to which we had previously issued long-term, unsecured notes aggregating 125 million and borrowed an additional 75 million at a fixed interest rate of 3.93% that will have a final maturity of 2026. As part of the bank amendment and revision to our note purchase agreements, we modified certain debt covenants and definitions that increase our leverage capacity. On February 2nd, when we completed the GATR Technologies, we used proceeds from the amended revolving credit facility and the funding from the issuance of the new 75 million of note purchase agreements. As of February 2nd, we had total debt outstanding of approximately 447 million.

And now with that, I will turn it back over to Brad for his final thoughts.

A - Brad Feldmann

Thank you, Jay. Now turning to Slide 14, our summary slide, we are confident that fiscal year 2016 sales and adjusted EBITDA will be better than last year. Our efficiency enhancing OneCubic ERP implementation is on track. We had many large opportunities for which we are well positioned to win. We are thrilled with our new acquisitions, TeraLogics and GATR Technologies, which position us as the expeditionary communications market leader. We believe our C4ISR strategy is a game changer for Cubic. FY16 is a pivotal year for us during which we will improve our performance as well as our overall growth prospects and set a foundation for fiscal year '17. Together, our team continues its intense focus on implementing our strategy and providing superior value to our shareholders and customers. We are very excited for the future and appreciate your partnership in the Company and your continued support.

Now, let's proceed to the Q&A session.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Julian Mitchell with Credit Suisse. Please state your question.

Julian Mitchell

Just a question maybe firstly on the mix impact that you call out in Q1. So your adjusted EBITDA margin was 3.6% in the quarter. Is it possible for you to quantify how much of that was really mix within that number. How much was weighed down by mix?

Jay Thomas

I don't have a really good specific response to that other than the higher margin stuff that we have in transportation and in defense systems specifically air combat and in the C4ISR side, as we said I think on the last call, we're going to have a little more volatility. So we definitely will have higher shipments of that into the third and fourth quarters of this year. So the first quarter compared to last year, we had much higher air combat shipments. So it's going to vary quarter-to-quarter, Julian.

Brad Feldmann

And this is Brad. Hi Julian, I'll just add to that. I've met with our team and we have lots of shipments particularly in the third and fourth quarter and we'll see the numbers greatly improve.

Julian Mitchell

And then just on the cash flow -- the free cash flow in Q1 was an outflow of about 60 million. Any sort of rough parameters you can give us for the full-year in terms of conversion or operating cash flow or free cash flow where that could end up?

Brad Feldmann

Yes, we'll definitely see a rebound obviously in the next couple of quarters. So we don't typically give specific guidance on operating cash flow, but it will dramatically improve in the next couple of quarters. First quarter for us is normally seasonally weak.

Operator

Our next question comes from Mark Strouse with JPMorgan. Please state your question.

Mark Strouse

So I guess, just starting with transportation, the operating margins were down quite a bit year-over-year. I'm just wondering if you can quantify how much of that was because of the new TSO contract and how much was from these one-time transition cost?

Jay Thomas

I'd say the majority of the issue was from the London contract in the first quarter. It is a services contract that we have. So whatever expenses we have we expense and so the expenses were higher because of some transition cost and then we have a sort of a set amount of revenues. So going forward, we won't have these transition costs and then we'll start to see some higher margins on change orders.

Mark Strouse

And those change orders that will lead to higher margins this year and next year. Can you just remind us if those are already contracted or is that something that's still under negotiation?

Jay Thomas

Some of them are already under contract and we were expecting to get more here in the near-term.

Brad Feldmann

As we've stated in previous calls, we knew that our customers slowed down on change orders given that they were going through a re-compete on the London contract. Of course, that's done and there's pent up demand for things to be added.

Mark Strouse

And then just one more simple one, Jay. I think the last TfL contract every fiscal second quarter, the March quarter, the margins would get an uplift from some, I think they were usage payments that you would get. Should we expect the same thing under this new contract, same seasonality?

Jay Thomas

No. We won't -- we do not have that aspect in the current contract and we -- I think we planned that out in the 10-K last year. So it's a different style of contract this time.

Operator

Our next question is comes from Jim Ricchiuti with Needham & Company. Please state your question.

Jim Ricchiuti

Jay, you referenced the guidance in November. I missed what you were saying. Can you just go over that one more time?

Jay Thomas

Yes. So what we've said on the call here is that we're reaffirming our fiscal year '16 guidance and that, that guidance is inclusive of the two small acquisitions that we've completed, which is TeraLogics and H4.

Jim Ricchiuti

So, I guess back in November, you were talking about 1% to 5% or so revenue growth?

Jay Thomas

I think the midpoint on the guidance for revenues was about 1.460 billion, so --

Jim Ricchiuti

And I guess and EPS you were suggesting at that time about 1.30-1.55?

Jay Thomas

Yes. That was the range.

Jim Ricchiuti

So as we think about the current quarter and I know you got a lot of moving parts here, but how back-end loaded do you anticipate this year, it sounds like you're still -- there'll still be some unusual costs in the current quarter?

Jay Thomas

In the next quarter obviously, the GATR transaction will close and we'll have to go through our purchase accounting. So that's why we're going to revise full-year guidance for that after the end of Q2. So, it will have it and we had said on that call on January 8 that both GATR and TeraLogics, primarily GATR, I should say, will have a dilutive impact on GAAP EPS, but it'll have an uplift into our adjusted EBITDA.

Brad Feldmann

And Jim, this is Brad. There are lots and lots of shipments in Q3 and Q4 with superior margins and our team is on track to get those done.

Jim Ricchiuti

One other as you talk -- as we look out at fiscal '17, clearly you're expecting a significant improvement in EBITDA, adjusted EBITDA next year. I don't know if you're in a position yet where you can give us a sense of what EBITDA, adjusted EBITDA margins you might be targeting next year?

Jay Thomas

No, I would say we're in a position, but I think the things to focus on is that the acquisitions will have this year, a partial year and so we have heavier expenses like on the TeraLogics, part of the purchase price got expensed because it's related to options and so next year, we'll have reduced, obviously won't have the transaction expenses and then won't have to reduce the ERP expense. So we'll update our or we'll provide our fiscal year '17 guidance on our year-end call.

Brad Feldmann

Jim, suffice it to say, we'll do better than in the history of Cubic next fiscal year.

Jim Ricchiuti

And the ERP investments, the quarter just ended 6.5 million?

Jay Thomas

Yes.

Jim Ricchiuti

And just if you can remind us Jay how we should think about those expenses going forward over the next couple of quarters?

Jay Thomas

Be pretty consistent quarter-to-quarter.

Operator

Our next question comes from Brian Ruttenbur with BB&T. Please state your question.

Brian Ruttenbur

A couple of questions, some of them have already been asked. So I'm going to hit you with an easy one, the plans for capital deployment. It sounds like you're going to be paying down debt. Is that the plan over the next two years, any buybacks in addition or additional acquisitions planned?

Jay Thomas

So yes we're going to -- at this point our focus is to pay down debt. Post the GATR transaction, we did lever up on a net debt basis if you offset the foreign cash, we're not highly levered, but the intent is that we will be paying down the leverage, probably not be doing any acquisitions in the U.S. We do have some capacity to do some acquisitions outside of the U.S., but I think near-term slowdown on acquisitions while we digest GATR and TeraLogics.

Brian Ruttenbur

So what level of debt are you comfortable with, it sounds like you're comfortable with this level or are you wanting to bring it down. You've historically had a lot of cash.

Jay Thomas

Yes, I would say from a kind of a debt-to-adjusted EBITDA I think the range for us is probably going to be in, over the long-term sort of 1.5% to 2%. So we're obviously north of 3% at this point. So we'll be bringing it back in debt to the normal ranges and then it becomes, if we find something that's sort of in our strategy range, obviously, we have the financial capacity to do it. We've just been waiting for the right opportunities and obviously we had put together this C4ISR strategy and we found the right set of opportunities and so we deployed the balance sheet.

Brian Ruttenbur

And then another question along the lines of guidance, but the 1.45 billion to 1.5 billion revenue guidance was before these acquisitions as I recall and is there any kind of update that what the -- at least the revenue change would be with these two acquisitions for this fiscal year. I know it's partial years.

Jay Thomas

Yes, so we'll update that in May, but I think on that January 8, call, we said that the GATR -- we gave sort of a range for GATR and we gave a range for TeraLogics for the year because we have to go through the purchase accounting it's probably a bit premature for us to give you the GATR number today, but I think TeraLogics number is probably in the range of sort of 12 million to 15 million for the year.

Operator

[Operator Instructions] Our next question comes from Josephine Millward with The Benchmark Company. Please your question.

Josephine Millward

I just want to clarify on your EPS guidance. Is that a GAAP number or adjusted EPS excluding restructuring, acquisition-related charges?

Jay Thomas

Yes. This is Jay. The EPS stuff that we gave is adjusted EPS.

Josephine Millward

And I wanted to get back to margin on transportation. Are you guys profitable on Vancouver and Chicago right now?

Jay Thomas

We are not, but as Brad noted in his comments, we're working through a resolution of a contract change in Vancouver.

Brad Feldmann

And in fact, last night in the middle of the night, Josephine, we cupped that deal we signed it. So Vancouver will improve.

Josephine Millward

And when you talk about margin improvement in the second half, could we see transportation margin returning to double-digit or what are we looking at, what have kind of -- can you help us quantify?

Brad Feldmann

Yes, it'll certainly be -- it will certainly return to double-digit, Josephine.

Jay Thomas

And Josephine, I just want to clarify when you asked me that question about EPS guidance. So if you go back and look at our November guidance, we did give a GAAP EPS range which we've reaffirmed.

Josephine Millward

That's what I was referring to the $1.30 and $1.55, that that was a GAAP number, right?

Jay Thomas

Right, that is correct.

Josephine Millward

In terms of Defense Systems, you also talked about much higher shipments and better product mix in the second half. Could we see Defense Systems returning to your normalized profitability in the high-single digits in the second half?

Brad Feldmann

Yes.

Josephine Millward

That's good to hear, Brad. That's good to know and I was wondering if you can give us an update on the timing of some of these key opportunities, when they might be awarded such as New York, Melbourne, and KC-46 and the JRTC re-compete as well.

Brad Feldmann

So, Melbourne, we think will be awarded this fiscal year, Josephine. New York, we think we'll see the RFP this fiscal year and it will be awarded next year. We think KC-46 will be awarded this year.

Jay Thomas

JRTC.

Brad Feldmann

Forgive me. And on JRTC, we anticipate the RFP later this fiscal year with an award next fiscal year.

Josephine Millward

So, none of these major opportunities are real contributors to '16. They are more likely geared for '17?

Jay Thomas

That is correct. So the key thing would be winning them and then they'll have a revenue and profit impact in '17.

Operator

Ladies and gentlemen, there are no further questions. At this time, I will turn the call back to Brad Feldmann to conclude. Thank you.

Brad Feldmann

Thank you all for joining us this morning. As always, we appreciate your continued support and interest in our great company. We're available if you have any further questions.

Operator

This concludes today's call. All parties may disconnect. Have a good day.

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