Vectrus' (VEC) CEO Chuck Prow on Q3 2021 Results - Earnings Call Transcript

Nov. 09, 2021 7:39 PM ETVectrus, Inc. (VEC)
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Vectrus, Inc. (NYSE:VEC) Q3 2021 Earnings Conference Call November 10, 2021 4:30 PM ET

Company Participants

Mike Smith – Director-Investor Relations and Corporate Development

Chuck Prow – President and Chief Executive Officer

Susan Lynch – Chief Financial Officer

Conference Call Participants

Joe Gomes – NOBLE Capital

Operator

Hello, and welcome to Vectrus, Inc. Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note today’s event is being recorded.

I now will like to turn the conference over to Mike Smith, Director of Investor Relations and Corporate Development. Mr. Smith, please go ahead.

Mike Smith

Thank you. Good afternoon, everyone. Welcome to the Vectrus third quarter 2021 earnings conference call. Joining us today are Chuck Prow, President and Chief Executive Officer; and Susan Lynch, 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 statements in our press release and presentation materials 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. The company assumes no obligation to update its forward-looking statements.

Additionally, I would like to point out that we will be discussing and reporting adjusted non-GAAP metrics, including adjusted operating income and margin, adjusted EBITDA and margin, adjusted net income and adjusted diluted earnings per share. The definition of these non-GAAP measures can be found in our presentation materials and press release.

At this time, I would like to turn the call over to Chuck Prow.

Chuck Prow

Thank you, Mike. And good afternoon, everyone. Thank you for joining us on the call today.

Before we get started, I would like to thank all of our employees for their dedication and remarkable contributions in supporting the recent evacuation of thousands of Afghan refugees, third country nationals and Americans from Afghanistan. This undertaking was the largest non-combatant evacuation in U.S. history and our team’s commitment to the mission and performance was exceptional.

I recently visited our overseas locations in CENTCOM and met with our teams and clients that directly supported this major humanitarian effort. The accomplishments, stories and the feedback I received from clients regarding the contributions of our employees was outstanding. I'll discuss some noteworthy highlights shortly.

Please turn to Slide 3. Our third quarter results were strong, driven by a 30% year-over-year increase in revenue. Organic growth was also strong increasing 13% year-over-year, reflecting expansion and our core business, new wins and phase-ins.

The ability to generate substantial cash from operations remains an important characteristic of our business and during the quarter we delivered $39 million of operating cashflow.

Adjusted EBITDA margin in the quarter was 4.5%.

And adjusted diluted earnings per share increased 19% year-over-year to $1.15.

We are continuing to grow and expand our presence in the Pacific or INDOPACOM. For example, just last month, we were awarded a task order with an eight-year performance period to provide logistics and support in the Philippines. In addition, we recently completed the pre-transition site survey for a LOGCAP V quadrant task order, and we anticipate the phase in to start by the end of the year and to reach full operational capability and revenue run rate by mid-2022.

Importantly, our revenue INDOPACOM now makes up approximately 5% of our total revenue versus 1% in the same period last year. We believe INDOPACOM will be a key long-term growth driver for Vectrus, given the DoD’s intent to improve posture in the region. Our prime position under LOGCAP V enables us to support our clients throughout the full range of operations in the region over the next decade.

Our client campaigns remain instrumental to our growth and diversification strategy. During the third quarter, we continue to build on our Navy campaign and recorded several notable technology-enabled wins that further our position as a premier, converged, infrastructure company. We also continued to advance our leadership in 5G and our supporting cutting-edge testing and experimentation for the DoD. For example, we recently supported the successful demonstration of a 5G network for Smart Warehouse and see significant applications for our clients converged infrastructure operations.

We ended the quarter with a total backlog of approximately $5 billion and pro forma total backlog of $5.1 billion.

Given our solid year-to-year results, we are reiterating our 2021 guidance ranges.

Please turn to Slide 4. Vectrus is well-known for its ability to provide rapid response, convert solutions across all time zones and operating environments, which was demonstrated in full by our team during the recent mission to evacuate various populations from Afghanistan Supporting our client's mission this was a historical undertaking that our teams tackled with a highest level of skill, precision and dedication.

In one case our team received a LOGCAP V task to bill out living space that could accommodate several thousand Afghan refugees in 45 days. Our teams worked around the clock under extreme weather conditions to design construct and operate over 250,000 square feet of living space. This was a remarkable achievement. And while we have one example shown on this slide, several Vectrus locations in [indiscernible], including Qatar and Bahrain, supported this important humanitarian effort. I like to commend our entire team for going above and beyond to support this critically important mission.

Please turn to Slide 5. Our client campaigns remain instrumental to our growth and diversification of our business. The momentum associated with our Navy Campaign continued in the third quarter with several noteworthy technology-based wins that further our position as a premier, converged, infrastructure company.

First, Vectrus was awarded a prime OTA contract to provide automation and the receipt and tracking and materials for the Naval Air Warfare Center Aircraft Division. Under this small but important contract, we will provide a solution that utilizes RFID technology to automate the receiving and distribution processes while providing readily available metrics and reporting indicating material delivery, location, and quantities.

Secondly, Vectrus was awarded a contract to further develop the Real-Time Spectrum Operation software for the Navy's fleet. RTSO is a capability integration effort, responsible for providing spectrum planning, sensing, monitoring, prediction, and maneuvering capabilities to support electromagnetic spectrum operations. This award was based on our decades of experience providing leading edge electromagnetic environmental effects engineering and spectrum operations.

Finally, Vectrus was awarded a position on a $93 million five-year multiple award IDIQ contract to provide R&D, engineering, integration, test, cybersecurity, upgrade, and sustainment for various tactical threat systems for the Navy. This award represents both a new client and an expansion in our capabilities.

The result of our Navy campaigns are seen in our financial results, with Navy revenue increasing 180% year-over-year, driven by organic wins and M&A, and now comprises 11% of our total revenues versus 5% last year. We believe that based on the opportunities in our pipeline, and client demand signals, our work with the Navy will continue to expand over the next several years.

Please turn to Slide 6. We are continuing to build Vectrus’ position as a leader and innovator in 5G and converged infrastructure enablement by utilizing our operational expertise and solutions in support of the largest full-scale 5G test for dual use applications in the world.

You may recall that a year ago, it was announced that Vectrus was awarded two contracts as part of the DoD’s 5G experimentation and testing at five U.S. military test sites, which was earmarked as $600 million. Recently, the DoD completed its first 5G project demonstration of a smart warehouse from Marine Corps Logistics Base, Albany. Vectrus supported the successful demonstration and as a subcontractor assisted in the design, development and installation of a radio area network test bed.

The network will enable a broad set of smart warehouse use cases, such as warehouse robotics, and holographic augmentation and virtual reality applications as part of a modernizing Marine Corps operations.

We also recently demonstrated the Vectrus converged infrastructure, 5G, 3D logistics hologram at the Army's Annual Industry Conference AUSA last month. The Vectrus use case is unique in that it shows the hologram guiding the user through a warehouse to find a specific item. After finding the item, this system can then scan a code to display a 3D image of the items’ contents. The ability to be directed to a specific item, and then visually confirm the item in real time adds an incredible value to the warehouse operators.

Our second 5G contract is a three-year prime contract for the Naval Base Coronado Smart Warehouse under which we will provide industry-leading inventory management, network security, robotic material moving and environmental sensing capabilities. We are currently working on Phase 1 of that prototyping effort. And our team recently demonstrated how augmented reality and RFID location services can assist clients.

We believe there is a significant long-term growth opportunity associated with the enablement of 5G and our clients’ migration to convert it to infrastructure operations. That gives us the investing to capture the expected future growth as part of the 5G initiative. For example, we recently launched the Vectrus 5G Network for Integration, connectivity, and experimentation, or the Vectrus 5G NICE lab that includes a mock up warehouse to be used for development, testing and demonstration purposes.

Innovative technologies that we demonstrated include RFID tags and portals, small and large autonomous movers, smart shelving, smart lockers, and augmented reality, mixed reality pickup and pull technologies.

Please turn to Slide 7. We are making great progress advancing our IoT, sensor integration, machine learning and data analytics offerings, which are allowing us to deliver a more integrated and comprehensive suite of solutions. We are also extending our differentiated solutions to new clients to markets. For example, as part of the CVRN OTA contract, our team recently deployed nine newly designed, integrated early warning Dropbox sensor enclosures at the 2021 Indianapolis 500. The sensors were designed to detect and notify stakeholders of a potential bioweapon release.

Security units utilized the newly developed IEW dropboxes that incorporated various bio threat, chemical and meteorological sensors with Vectrus’ Sensor Management System software. This unique combination of sensors and software allowed for the integration and processing of sensor data from multiple sources and well as data analytics and visualization at the local command center. The Vectrus software there was inside the sensor enclosure enabled fast data processing and a user-friendly interface, allowing local police energy and public health departments to view real-time data for the event. We are proud to have supported this important operation with a new client and a new market.

Please turn to Slide 8. Our new business pipeline at approximately $11 billion with $2.1 billion, a bid submitted awaiting award and $8.7 billion that we plan to submit over the next 12 months. As you can see on the page, our new business pipeline reflects our continued focus on executing targeted growth campaigns to diversify our portfolio. There is also a greater concentration of higher margin solutions-based opportunities in our pipeline, which are driven by the organic and inorganic investments we've made in the business.

I like to note that the withdrawal from Afghanistan resulted in a slight erosion of our pipeline, but we have since redeployed those business development resources to other pursuits. Lastly, our pipeline does not currently include any LOGCAP V related opportunities and only an immaterial amount of international client opportunities, given the flu timing associated with those efforts.

Overall, we remain confident in our ability to successfully compete and win our fair share of new business.

Now I'd like to turn the call over to our Chief Financial Officer, Susan Lynch for a review of the financials.

Susan Lynch

Thanks, Chuck. And good afternoon, everyone.

Please turn with me to Slide 9. Third quarter 2021 revenue grew 30% or approximately $107 million year-on-year to $459 million. Exploiting the contribution from our 2020 acquisitions, organic revenue grew 13%. Organic revenue was driven by expansion INDOPACOM ramped to full operational capability on LOGCAP V Iraq and expansion in our core business, including support of the humanitarian refugee mission.

Adjusted EBITDA for the third quarter of 2021 was $20.5 million or 4.5% margin compared to 4.8% in a prior year's quarter. Margin in the third quarter was influenced by the timing and phase in of new awards, program completions and increasing volume of material and passthrough content, which carries a lower fee.

Third quarter 2021 interest expense was $2 million approximately $1 million a year-on-year to the company's two acquisitions.

Diluted earnings per share for the third quarter of 2021 was $0.87.

Adjusted, diluted EPS, adding back amortization from acquisitions, M&A and integration costs and removing the benefit associated with prior year's tax credits was a $1.15.

Relative to last year, adjusted diluted EPS increased at 19% due to the company's organic revenue growth, income from our two acquisitions, a lower tax rate offset by higher M&A related interest expense.

Operating cash flows were $39.4 million for the quarter compared to $3.3 million in the same period last year, an impressive result that was driven by our teams to focus on cash collections and process improvement. Operating cash flows were $53.4 million for the nine-month period compared to $37.7 million in the prior year's period.

Excluding the prior year benefit of the CARES Act payroll tax deferrals, year-to-date cash flow from operations improved 92% over last year.

Please turn to Slide 10. We continue to focus on diversifying our portfolio through organic and inorganic investments. Our recent results with the Navy have been outstanding with revenue growing 180% year-on-year, and now representing 11% of total revenue compared to 5% during the same period last year.

Our organic growth and strategic acquisitions have also further diversified our geographic portfolio. In the third quarter, our revenue in INDOPACOM or Asia were approximately $19 million year-on-year, and now represents 5% of total revenue. Our targeted focus on increasing our capabilities and presence in the region, as well as the phase in of LOGCAP V is now visible in our results. Our footprint in INDOPACOM will continue to increase as we ramp up the Kwajalein task order and our recently awarded work in the Philippines.

Additionally, our U.S.-based based revenue composition grew to 30% of total revenue as compared to 25% of the same period last year.

Lastly, our contract mix has shifted to a greater percentage of cost type revenue compared to the third quarter of 2020. This is partly due to COVID-19 impacts on revenue last year and the ramp of LOGCAP V this year.

Please turn to Slide 11. Third quarter 2021 total backlog was $4.9 billion compared to $3.7 billion in the third quarter of 2020. Total pro forma backlog was $5.1 billion and includes contract wins currently under protest. Funded backlog was $1.2 billion.

The company's trailing 12-month pro forma book-to-bill ratio was 1.4 times compared to 1.5 times in Q3 of 2020.

Please turn now to Slide 12. Cash at quarter end was $53.4 million.

Total debt with $128 million and net debt was $71.8 million. Both net debt and total debt were up due to the acquisitions of Zenetex and HHB on December 31, 2020. Strong cash generation further strengthened our balance sheet and provided the ability to pay down an additional $45 million of debt in a quarter. Total and net debt were down sequentially from Q2 2021 by $47 million and $33 million respectively.

The company's total leverage ratio was 1.33 times, well below its covenant level of 3.5 times.

We plan to utilize our strong balance sheet to enhance Vectrus’ position in the market through organic and inorganic investments that align to our strategy.

Finally, we are nearing the maturity of our current credit facility and plan to leverage the significant advancements in our business and strong balance sheet to introduce a larger, more favorable, flexible, and lower cost facility that supports our growth plan.

Please turn to Slide 13. Given our strong year-to-date performance, we are reiterating our previous 2021 guidance ranges. Revenue guidance is $1.745 billion to $1.78 billion or 25% to 28% growth. Adjusted diluted earnings per share guidance is $4.76 to $5.07 or 42% to 51% growth. The adjusted EBITDA margin range is 4.8% to 5%. We expect net cash provided by operating activities to remain in the range of $58 million to $65 million. Capital expenditures are expected to be approximately $8 million. And as a reminder, program-related capital expenditures are considered in contract pricing and will be recouped all or in part over the performance of the contract.

Now I'd like to open the call to questions. Operator?

Question-and-Answer Session

Operator

Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Joe Gomes with NOBLE Capital.

Joe Gomes

Good evening, Chuck and Susan. Thanks for taking the questions.

Susan Lynch

You bet.

Chuck Prow

Hey Joe.

Joe Gomes

Great. Another really nice quarter. Just seem to be putting them – stringing them together here. On INDOPACOM, awesome job there. Is any kind of way to size the potential opportunity there. I know a lot of these things come about based on the contracts, everything. But I don't know where if you can give us any kind of more detail our color of what the potential for INDOPACOM could actually mean to Vectrus?

Chuck Prow

Hi, Joe this is Chuck. How are you? A great question. INDOPACOM is an increasing portion of our overall pipeline. We don't really talk about the composition of the pipeline per se, but it is rapidly increasing, point one.

Point two, as you know, Kwajalein was one of the tasks that we were awarded during LOGCAP. And Kwajalein is currently, as we stated in the prepared remarks, currently beginning to phase in and should be fairly phased in, fairly well phased in, excuse me, by the middle of next year. We do expect that contract to be more than 10% of our revenue. So, we will begin to report that as that comes online.

In the last part, as you hear from a geopolitical perspective, quite often that this pivot to Asia is real from both a military and foreign policy perspective and our results both in this quarter as well as the prior quarter were favorably impacted by the Pacific Defender activity. And that activity was a contingency operation to support an exercise. And we expect to see that type of activity continue and in fact, increase over the coming years.

The last part point on Pacific Defender is that as a real example of how the contingency operations portion of the LOGCAP contract will increasingly affect our financial, making our financials that in many cases, a bit more lumpy, because that kind of revenue really doesn't show up in backlog. In the case of Pacific Defender, the opportunity was identified, it was book and it was billed in less than two quarters. So, it’s a great question. And to your point we will consider, and we are considering, I should say, providing a bit more color to our pipeline in the future so we can demonstrate where we think we have emerging demand.

Joe Gomes

Okay. Thank you for that. Much appreciated. And one of the recurring themes here on a lot of the companies, at least that I follow is the very difficult labor market and difficulty in finding staffing and combined with the vaccine mandates that have been issued by the Biden administration, especially for federal contractors, was just wondering how you guys are dealing with, or are finding staffing ability – or availability, excuse me here? And where do you guys, I guess, on the spectrum of being, getting the workforce vaccinated? Are you having issues with that? Is that something that's moving smoothly here? Just curious as if it could be a potential hiccup down the road here.

Chuck Prow

So, a lot of questions in your one question. So, let me kind of break them down piece by piece. Like other companies we continue to face challenges in terms of identifying and deploying resources. As you know, a big part of our business model is the use of foreign national and local labor. So, in terms of keeping our programs staffed COVID has been difficult, but as you can see by our results, we've been able to find the right types of people in the right location to continue to drive revenue.

With regard to the vaccine mandate. First of all, we take very seriously. We've been tracking both COVID effects and COVID mandates from the beginning. We and most of our other businesses have been affected by COVID and we look to get our staffs vaccinated per the order as quickly as possible. It's important to note, however, that as you know, 80% of our business approximately comes outside the continental United States. And the current executive order is really focused on U.S.-based employees. So, we have while the need exists, they get people mandated as quickly as possible to keep our people and our clients safe, the mandate effect itself really affects our corporate office and our U.S.-based contracts more directly.

Joe Gomes

Okay, thanks for that insight. And one more, if I may again really nice quarter here but you did raise the guidance that you kept it the same one would have thought that showing such a nice quarter, maybe you would have increased a little bit, or was just kind of the thought process as to are we just being a little more conservative here? I know that we're operating under a continuing resolution, does that have a play in your thought process of maintaining guidance where you had it at the end of the second quarter? Thank you.

Chuck Prow

It's really a three full answer to your question. First of all, we're going to have a very solid year this year at the mid-point well over 25% growth, total growth, I should say. We are, I wouldn't call it being conservative, but we are being mindful of three things. Thing one is like everyone else we did have – not everyone, like many other companies in our industry, we did have some effects from Afghanistan that were not overall material as we talked about in our last call, but there were some effects from Afghanistan, point one. Point two, is we do have a number of contracts in transition and close out between prior contract structures and new contract structures such as LOGCAP. And the final point is, is that we were greatly benefited in quarter two and quarter three from the contingency work that I described earlier.

And so, one of the areas that we need to continue to work with you and your colleagues and our investors that with the blessing of LOGCAP comes a bit of reeducation in terms of how our revenue can be a bit lumpy if you will quarter-to-quarter.

Having said all of that, we are not prepared and we're not going to give 2022 guidance yet. But I do see, as I look into 2022 at organic business base that will lead again to growth in growth in 2022.

Joe Gomes

Great. Thanks for that Chuck. And much appreciated again, really nice quarter.

Chuck Prow

Thank you, Joe. Good talking to you.

Susan Lynch

Thanks, Joe.

Operator

Thank you. And this concludes the question-and-answer session. I would like to return the floor to Chuck Prow for any closing comments.

Chuck Prow

Thank you. And thanks for everyone for joining the call today. We look forward to catching you up on our full year performance the next time we get together. Thanks a lot, and have a good day.

Operator

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.

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