Cubic Corporation (NYSE:CUB)
Q1 2017 Earnings Conference Call
February 09, 2017 04:30 PM ET
Diane Dyer - IR
Brad Feldmann - President and CEO
Jay Thomas - EVP and CFO
Paul Ketchum - VP, Accounting
Julian Mitchell - Credit Suisse
Jim Ricchiuti - Needham & Company
Mark Strouse - JP Morgan
Brian Ruttenbur - Drexel Hamilton
Thank you, operator. Hello, everyone, and thank you for joining Cubic's webcast. Today, shortly after market close, we reported our first quarter fiscal year 2017 results. We encourage you to refer to the Company's press release and the 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 website at www.cubic.com, or on the SEC's website.
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 2017 results. Paul Ketchum, Cubic's Vice President of Accounting, 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 9, 2017. 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 also includes 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.
Thank you, Diane. Thank you, everyone for joining us on the call. Today, I will discuss our first quarter results for fiscal year 2017 together with the highlights of the quarter and a brief update on our strategy. I will also address the perceived potential impact of the incoming administration on Cubic's overall business and give an update on our Cubic mission solution C4ISR business. Jay will cover our consolidated operating and financial results.
On slide 3, you will find an overview of our first quarter results. I am pleased to report a growth in sales to $334.7 million for the first quarter of the year, up $20.9 million, or 6.7%, from the same quarter last year despite foreign currency exchange headwinds of $8.7 million. Adjusted EBITDA was $20.1 million, also up by $8.8 million, or 78%, from the same period last year net of $1.7 million foreign currency exchange headwinds and $1.2 million of New York City Fair Payment System pre contract R&D investments. Overall, our performance was in line with our expectations. Our Q4 FY16 results had funding and shipment delays primarily in our defense systems business.
We've made great progress to settle and equitable contract adjustment with the U.S. Navy on our Littoral Combat Ship virtual training contract an expect to complete negotiations soon. In the fourth quarter, we saw some delays and shipment changes to our delivery schedule. We have now resolved these issues, and virtually all of these delayed shipments are on track for completion by our second quarter. Lastly, we experienced funding delays on approximately $20 million in new orders for tactical networking equipment in September. We have now received about 6 million of these orders and expect the balance to be received and shipped in the second half of the fiscal year.
Moving on to slide 4 and turning to the new Trump administration. The outlook for Cubic remains consistent with the assessment provided in our Q4 FY16 call. We believe the initiatives to improve the U.S. military and infrastructure under the new administration will be beneficial for our Company's growth and profitability over the next few years. President Trump's executive order rebuilding the U.S. armed forces places high importance on military readiness. We're also heartened by Senate Armed Services Committee Chair Senator McCain's white paper, Restoring American Power, that calls for significant increase in the defense budget over the next five years. In addition, the impetus to have our allies carry a larger share of the defense cost burden could also open up additional international opportunities for Cubic. In all, we believe these initiatives will increase the demand for Cubic's defense products and services.
With the change in administration, we expect the Budget Control Act and sequestration will be replaced with a long term budget deal that addresses necessary increases in discretionary funding, including much needed increases in defense communications and training. These outcomes would lead to more predictable and stable budget cycles, particularly for the defense department. We also expect lower corporate tax rates and an opportunity to repatriate our offshore cash more tax efficiently. We believe these changes will help accelerate our Cubic 2020 growth strategy.
Moving to slide 5, I will provide a progress update on our strategy. Winning the customer is at the core of everything we do, and innovation is critical to the growth of the Company. Cubic's GATR Technologies received the Most Innovative New Product Award from CONNECT, a nonprofit dedicated to accelerating innovation in San Diego. We are proud of the GATR team's efforts. Cubic has been a CONNECT finalist for five consecutive years and, in fact, won awards four of these years. Another innovation example is our next generation virtual ticketing office, NextAgent, which is currently installed both in the UK and Germany and soon to be provided in Singapore for the Land Transport Authority. Our strong customer relationships continue to generate follow on contract awards in New York, Atlanta, and Maryland to support or upgrade existing systems. And we are pleased with the close alignment between our NextCity strategy and the technology roadmap produced by transport for New South Whales, which is leading to increased opportunities with this very important customer.
At several recent defense industry trade shows, we demonstrated our portfolio of NextTraining and next generation air combat technologies. We are pleased with the broad customer interest in these solutions. As the market leader, we are delivering the state of the art training and simulation systems that keep our warfighters ready to engage in combat and successfully fulfill their missions. We are continuing to build NextCity globally by the success of OneAccount that is enabling the introduction of new forms of card and mobile based payment and information in transforming customer experience. There is a rise in demand for open payment across our transportation customer base. For example, we received an award from Miami Dade's Department of Transit to upgrade the EZ card to a mobile and open payment system. A growing number of customers are seeking to improve traveler experience by using the cloud, open payments, and mobile applications. Moreover, near field communications continues to mature as a core technology following the launch of Apple Pay and Samsung Pay. We anticipate that the growth of the NFC will propel mobile payments in our core markets, and we are delighted to be the world leader in these transformational changes for our transportation customers.
We remain focused on ensuring success for the New York City bid and the potential for significant upgrades to adjoining customers in the New York City area who will adopt next generation fair collection payment technologies. The CTS addressable market exceeds $12 billion with a CAGR of between 5% to 7%. I am confident our transportation team with the NextCity strategy can meet our Goal 2020 revenue target of $900 million. We're also working to grow our C4ISR Cubic mission solution business. During the quarter, we acquired Vocality International in the UK, which develops and deploys technology that optimizes and bridges information flow among communications networks. Their software technology now integrated into the detect offerings optimizes communications paths and shows great promise for all of Cubic's business. The acquisition of Vocality has enhanced our communications capabilities while simultaneously opening up new opportunities for a range of Cubic solutions across the European market.
GATR's Air Transportable Tactical Command Communications, or T2C2, program, has continued success with developmental testing this quarter, and will enter operational testing soon. We anticipate the customer will proceed with a full rate production decision later this fiscal year. We are encouraged to have received product communication bookings this quarter aggregating approximately $9 million, supporting Fire Scout MQ-8C A10 personal locator system and several tactical network programs. Further contributing to our strategy is building our NextTraining capability, developing and delivering innovative and integrated systems that facilitate and provide performance based training for U.S. and allied nation militaries. I am pleased to report that Micro SCOPIC, Cubic Global Defense's Synthetic Wrap solution, was demonstrated with full operational capability at the Salisbury plane training area in the United Kingdom. Synthetic Wrap integrates live and virtual environments.
We continue to make great progress on our air combat training live virtual constructive contract with the Air Force Research Lab that represents the future of the air combat maneuvering instrumentation market. This allows synthetic entities to be played in the cockpit and enhances the training effectiveness and efficiency of fighter pilots. Given the new administration's focus on defense training and readiness, we believe this policy shift should benefit our defense services business in the near term. We believe that our next training and LBC technologies will increase our defense training systems business over the medium term.
Finally, we will succeed through living OneCubic. We continue to make progress with our phased rollout of SAP in our North American defense business. As with any new system, there are challenges. But our team is working very hard to make the rollout a success. Having a common system across all of Cubic will enable us to hit our cost savings goals in FY19. We also continue to improve our culture to support our Goal 2020 objectives.
Moving to slide 6, I would like to describe the Cubic mission solutions integrated C4ISR systems capabilities that have been created with four recent acquisitions and our legacy communications products. We can now provide our expeditionary communications customer a single integrated system that provides intelligence by enabling the processing exploitation and dissemination process. This capability helps our customers see in real time the same picture from the warfighter to the operations center, therefore improving mission effectiveness. We have developed and shipped a new product, the Atlas full motion video dissemination system, which integrates these new capabilities. Our addressable C4ISR market is now over $2 billion with a 10% to 15% CAGR. We continue to believe that our shift into the C4ISR market will greatly increase shareholder value.
I will now turn the call over to our CFO, Jay Thomas.
Thanks, Brad. Please turn to slide 7, and I will discuss our consolidated operating highlights. Sales increased $20.9 million, or 6.7%, to $334.7 million in the quarter compared to last year. The increase was due to higher sales in our defense systems and transportation segments, somewhat offset by lower sales in defense services. FX headwinds impacted sales by $8.7 million in the quarter primarily in our transportation segment due to continued unfavorable comparisons in the British pound. Consolidated adjusted EBITDA increased 78% over last year to $20.1 million with the increase being in our higher margin defense systems and transportation businesses, somewhat offset, again by FX headwinds totaling $1.4 million.
R&D expense increased this year to $9 million from $3.5 million last year for new technologies and pre contract costs in our defense systems and transportation segments. For the quarter, we had an operating loss of $4.1 million, which was a 49% improvement over last year's operating loss of $8.1 million. In the quarter, we expensed $8.7 million related to the OneCubic ERP cost compared to $6.5 million last year. We had a net loss in the quarter of $2.9 million compared to $5.4 million last year. Interest expense was $3.5 million in the quarter compared to $1.3 million last year. The higher interest cost is related to borrowings made last year for recent acquisitions.
Please turn to slide 8. Transportation sales were up 5% over last year and 12% on a constant currency basis to $131.9 million. During the quarter, we had FX headwinds of $9.2 million. The sales increase was attributable to higher sales on our contract in Sidney for additional systems and services work somewhat offset by lower FX impacted UK sales and slightly lower U.S. sales. Adjusted EBITDA increased 79% to $12 million over last year's depressed first quarter on improved margins in Australia and the UK despite much higher R&D expenses. For the quarter, R&D expenses increased 243% to $5.5 million. The higher spend was for new technologies related to our NextCity initiatives and included pre contract expenses for the pending New York City Transit Systems contract totaling $1.2 million.
As Brad noted, we are expecting an award of this contract in the second half of the fiscal year. We expect to have higher R&D and pre contract expenses this year for transportation to take advantage of a significant growth cycle we see unfolding as our transit customers upgrade to open payments, mobile, and cloud technologies.
Now turn to slide 9. Defense systems sales were 112.4 million, or a 17% increase over last year's first quarter. The sales increase included 24.7 million from the recent acquisitions of GATR and TeraLogics, which did not have any comparable sales in last year's first quarter.
Air combat had higher sales in the quarter, some of which was related to the delayed shipments in our Q4 '16. Ground combat, virtual and immersive training systems all had slightly lower sales in the quarter.
Defense systems generated adjusted EBITDA of 9.9 million, which was up 154% over the last year. The major reason for this increase were sales of higher margin C4ISR and air combat-related products and systems, somewhat offset by lower profits and ground training virtual and immersive systems. R&D expenses totally 3.5 million in the quarter, or an increase of 94% over last year. The higher R&D expense related to pre-contract spend on an army ground training contract and higher spending on next generation data links and NextTraining-related technologies.
Now turn to Slide 10. Defense services sales decreased 2% in the quarter to 90.3 million. The decrease was related to lower activity on readiness and training-related contracts primarily with the U.S. Army. As Brad noted, we expect the new administration's proposed initiatives and finalization of the FY17 budget could improve the prospects for this segment in the second half of the year. Adjusted EBITDA was 600,000 in the quarter, down from 2.3 million last year. The decreased profitability was due to less activity on higher margin contracts and lower margins from contracts that were recently re-competed.
Finally, turning to Slide 11, I will discuss the balance sheet and cash flow. For the quarter, we generated operating cash flow of 7.1 million. All three operating segments had positive operating cash flows. This was a significant improvement over last year's first quarter, where we had operating cash outflows of approximately 50 million.
In Q4 '16, we noted increase in AR days on certain Middle East contracts. This quarter we had good cash collections on these, and overall we saw good improvement in net AR balances across all business segments.
Somewhat offsetting this improvement, inventory levels increased in our defense systems segments primarily for work and IDIQ-related contracts where we will be making shipments later in the fiscal year.
Our gross debt of 442.4 million was virtually unchanged from year end. Total cash, restricted cash, and marketable securities at the end of the quarter totaled 258.5 million. Virtually all of this was held in our offshore subsidiaries.
CapEx in the quarter was 6.7 million down from 10.4 million last year. This year we capitalized about 2 million related to our new ERP system. Outside of the ERP systems implementation, we are spending CapEx this year on facility modernization expenses. We expect to continue these expenditures over the next few fiscal years as we upgrade and consolidate our operations as part of our OneCubic initiative.
And with that, I will turn it back over the Brad for his closing comments.
Thank you, Jay. Now turning to Slide 12, our summary slide, we believe our Goal 2020 strategy is sound, and we are making great progress on winning the customer, NextCity, C4ISR, NextTraining, and OneCubic. We are pleased with the revenue growth in the first quarter. We expect strong organic growth in FY18 with the anticipated New York City air system win, further expansion in the fair collection market with our unique OneAccount technology, and with the transition of the T2C2 program to full rate production.
We continue to be successful with our ERP implementation and will complete this project early next fiscal year. Having the data in one place with common processes will drive the efficiency and effectiveness of the Company resulting in additional earnings growth.
The combination of transportation organic growth, our reshaped portfolio with higher growth, higher margin C4ISR business and anticipated OneCubic ERP efficiencies, accelerated with new business-friendly policies from President Trump will drive shareholder values strongly in FY18 and beyond. 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.
Now let's proceed to the Q&A session.
Thank you. Ladies and gentlemen, at this time, we will be conducting our question and answer session. [Operator Instructions] Our first question comes from the line of Julian Mitchell from Credit Suisse. Please go ahead.
I guess my first question would be around the defense systems business. You had a very good margin expansion there in the quarter. I just wondered if you thought that was driven more by a special sort of one-time mix boost because of what you saw in C4ISR and also air combat, or do you think we should see the margins overall in that segment this year up versus 2016?
We expect the margins to continue to be good throughout the remainder of the year. As you know, our acquisitions in C4ISR are in the mid-teens, and that's very helpful to increase the margin overall. And quite frankly, we're working hard at running the business better.
Understood. Thank you. And then within transportation, a better result there than we'd expected. If you look at the UK business in particular, would you anticipate that profits there should be up over the balance of the year, year-on-year assuming no big currency move from here?
This is Jay Thomas. Yes, we would. And part of that is last year's -- if you remember last year, the first quarter was really depressed because we had some extra cost in that quarter. So you take that out, and I think year-over-year, it'll definitely be up.
Understood. And I'm assuming, as I didn't see much comments around it, but the full year overall firm-wide targets you'd laid out on the Q4 call, are you reiterating all of those today?
Great. Thank you very much.
Thank you. Our next question comes from the line of -- I am sorry, excuse me -- our next question comes from the line of Jim Ricchiuti from Needham & Company. Please go ahead.
Maybe just to follow up on that last question, Jay, is there any change in the cadence in terms of how we see the year unfolding? I mean, you talked about your prior full-year guidance being pretty heavily back-end loaded, so I assume that's still the case, correct?
Yes, that is still the case.
Okay. Brad, I wanted to just ask you a question. We're, what, at a one-year anniversary on the acquisitions, and I wanted to just get your perspective on how they've performed relative to your expectations for GATR and TeraLogics when you acquired both companies a year ago.
TeraLogics is doing extremely well. It's exceeding expectations. GATR is in line with expectations. And you'll remember that the big boost there is this program of record, T2C2, so we're in development testing now, and that will proceed to full rate production. The government is projected to buy hundreds of terminals, and some people are talking larger numbers than that over the next few years.
Okay, so it sounds like it's performed on the margin, looking at both of them together, a little better than expected?
Yes, as you put the two together, yes.
Okay. Any update with respect to the timing on the New York City contract? It sounds like you're expecting second half of the fiscal year. Is there any risk that that gets pushed out, the award?
I don't see any risk in it not happening this fiscal year. I think there's certainty on that. They're adding requirements to the contract as we speak, so we're working through that. It's a good thing. I think the reason we said the second half is it's hard for us to predict if it's June or it slides into July or whatever. But we're very savvy about the award this year.
Okay. And Jay, with respect to pre-contract expense, anything we should be thinking about over the next couple of quarters as you get closer to this award that spending might be higher?
Yes, I think we built into our guidance a fairly big bump in our R&D, so we would give an update if that's going to change. I think right now we're well within -- we're going to be within kind of what we've projected. So if this slips into the fourth quarter, then we might have to readdress the number.
Okay. And last question. Just -- Brad, as they add components to this and have additional requests, does this change your expectations for the size of this contract? How has that changed as you entered into the pursuit of this business? Has it gotten larger? Are you expecting this now, this award, to be potentially bigger than you thought a year or two ago?
I think it'll be about the same. When we talk about New York City, it's everything within the region. So over time, it'll be $1 billion. I can't tell you exactly what year that revenue will happen, but that's what we think about.
Okay. Thanks very much.
Thank you. Our next question comes from the line of Mark Strouse from JP Morgan. Please go ahead.
So kind of a follow-up to Jim's question, not necessarily in regards to NYC, but just in general in transportation market, are you seeing any delays in the bidding or the RFP processes because of the new administration and their push for infrastructure? I'm just thinking, for example, a certain municipality might delay implementing a system a quarter or two just with the hope of getting some federal funds to help them.
Yes, in the case of New York, they've teed up their funding already. There is one large bid that we're working on that we don't expect to have a decision this year. Well, we could get a decision, but it'll look like it'll have some funding, and that's Boston. Most of the other ones are really in our pipeline, say, when you look out into fiscal years '19 and '20 that might get a benefit from anything out of the new administration.
But in general, we haven't seen any delays and we're very savvy about -- we think we have a technological edge with one account, and we think that will help us greatly. And we hope we win them all.
Got it. Okay, thank you. And then for the C4ISR business, should we still think of that as approximately an $200 million run rate business? And what is the impact from Vocality to that number?
Yes, so it's around $200 million, maybe a little bit more. Vocality was $10-ish million, and we expect that to grow.
Got it, okay. Thank you very much, guys.
Thank you. [Operator Instruction] Our next question comes from the line of Brian Ruttenbur, Drexel Hamilton. Please go ahead.
Yes, thank you very much. Couple of follow-up questions on defense services, the margins were weak in the quarter. Is that a seasonal weakness, or do you expect services to come back? And is that services going to come back dependent on moves within the Trump administration on readiness?
Yes, so I would say historically the first quarter in that business is the weakest quarter. Part of that's seasonality because you have more holidays that quarter. I would say, and generally speaking, they do have some cost pressures in that business because of the LPTA. So if we start to see more work coming through, then we could see some margin improvements. But there's no eminent change here for the next couple quarters.
Okay. And just to better understand on the services side at least, the defense services, should we see better profitability in the second quarter because of seasonality then if nothing else changes?
Okay. And then about cadence -- this was asked a little bit already -- but we should see from where we are in terms of earnings, the negative GAAP earnings, we should start seeing profitability from second quarter on? Is that correct?
Yes, I'm not -- because we don't give quarter-by-quarter guidance, I won't kind of answer that specifically. A lot of it has to do with as we're -- if you think about what's happening is if we have a good shipment quarter on the product businesses, that really drives the EPS. Kind of offsetting that is this ERP spend, which is obviously impacting our EPS. So if we have a really large shipment of sort of IDIQ-related stuff, you're going to have one quarter look better than the other quarter.
Okay. In terms of backlog, it was down, is that just because of seasonality, or is there -- we've been hearing about some delays or some concerns out there just because of a new administration coming in and maybe a slowdown in awards. Was any of that impacting you guys in the period?
So backlog -- transportation business, you saw a really strong, really positive fourth quarter. Theirs is very lumpy. In the defense systems business, we're seeing more and more IDIQ, so you're getting task orders, so you're not getting multiyear, longer-term contracts. And then in services, it's definitely been impacted by the budget because there are contracts that, once they have a budget, they can give us a multiyear contract. It won't be fully funded, but we can at least get the award underway. So it's a bunch of things.
And Brian, by the end of the year, we expect a book-to-bill ratio to be above 1.
Great, so the end of the fiscal year, 1 or better. And then the guidance is unchanged, the 1.5 billion to 1.55 billion, EPS GAAP of 40 to 80. Is that still a right ballpark?
Great. Thank you very much.
Thank you. Ladies and gentlemen, we have no further questions in queue at this time. I would like to turn the floor back over to Mr. Brad Feldmann for closing comments.
Thank you for joining us on the call today. We remain optimistic about Cubic's future. Thank you very much for your support of our great company.
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