Lionheart Holdings
Q2 2020 Earnings Call Transcript

Published: 9 May 2020

[Operator:]

Ladies and gentlemen, welcome to Cubic Corporation's Second Quarter Fiscal Year 2020 Earnings Conference Call. [Operator Instructions]. Now I would like to turn the call over to Kirsten Nielsen, Vice President of Investor Relations. You may begin.

[Kirsten Nielsen:]

Hello, everyone, and thank you for joining Cubic's webcast. I'm joined today by Brad Feldmann, Chairman, President and Chief Executive Officer; and Anshooman Aga, Executive Vice President and Chief Financial Officer. Before we begin, I'll remind everyone that our presentation contains forward-looking statements that are made pursuant to the safe harbor provisions of federal securities laws. Our most recent SEC filings include risk factors that could cause the company's actual results to differ materially from our expectations. In addition, we have included non-GAAP financial measures in our discussion. Reconciliations to the most directly comparable GAAP financial measures can be found in today's press release and in the appendix to today's presentation. With that, I'll turn the call over to Brad.

[Bradley Feldmann:]

Thank you, Kirsten. Thank you, everyone, for joining us today. Before we talk about the quarterly results and business trends, it is important to underscore that our top priority in dealing with COVID-19 pandemic has been to protect the health and safety of our people and our communities, while at the same time, serve our customers and ensure business continuity. I want to thank all our employees who have kept our businesses operational during these unprecedented times. I am grateful to you and incredibly proud of your commitment to serving our customers. For today's call, I'll start with a brief summary of our performance for the second quarter, and I'll discuss the notable trends and developments we're seeing and address how Cubic is navigating the current environment and preparing for the future. Anshooman will discuss the financials and our cost savings initiatives in more detail, and we'll finish with Q&A, as usual. Please turn to Slide 3. We have a lot to cover today, so let me start with some key points upfront. While we are experiencing some customer-driven delays and impacts as a result of COVID-19, our businesses are deemed essential, and we believe that we are fully prepared to meet customer commitments and execute our substantial backlog. We are also repurposing our capabilities to support our customers and communities. Later in this presentation, we'll discuss the actions we've taken to navigate in this challenging environment, including measures to safeguard our employees, which is our top priority, while ensuring business continuity and mitigating the impacts and risks associated with COVID-19. Regarding the current business dynamics, as many of you know, our transportation business is not driven by transit ridership today. The vast majority of our transportation revenue is recognized through project delivery on fare collection systems as well as the maintenance and operations of those systems. Our transportation customers, however, continue to experience significant pressure on their operating budgets. In Mission Solutions, while we are seeing some short-term order delays, the national defense strategy continues to drive robust demand, and we are writing more proposals than ever. In our training business, force-on-force ground training exercises have slowed, but we are very encouraged by our customer engagements regarding Cubic's programs for the United States Army's Synthetic Training Environment. We continue to prioritize reducing leverage. Anshooman will discuss our cost savings initiatives and our recently completed debt restructuring, which enhances our financial flexibility. Lastly, the underlying fundamentals of our business are strong. We believe the industry dynamics in both transportation and defense remain favorable in the long term, which I'll discuss later in the presentation. Turning to Slide 4. Our book-to-bill ratio through the first half was 1.33, and our backlog remains strong at $3.6 billion, which represents more than 2 years of future sales. Second quarter sales of $321.5 million decreased 5% year-on-year as growth in defense training was offset by a decline in Mission Solutions, primarily driven by 2 factors

[Anshooman Aga:]

Thank you, Brad, and hello, everyone. Please turn to Slide 14. In response to the rapidly evolving COVID-19 pandemic, we've undertaken many cost reduction and cash preservation initiatives. We've reduced discretionary expenses, optimized overhead and made tough decisions to reduce and defer select R&D projects, while continuing to focus on critical investments to drive growth. Our Board of Directors and Brad have taken a 15% reduction in cash compensation for the remainder of the fiscal year and I've taken a 7.5% reduction. We've also made some changes to employee compensation, including a temporary suspension of the 401(k) match for the remainder of this fiscal year as well as a salary freeze through fiscal year 2021. We expect these cost saving actions to result in cumulative net savings of more than $30 million through fiscal year 2021. Additionally, we are focused on improving our cash flow and lowering our net leverage ratio to under 3x. As a reminder, our credit agreement permits us to maintain a net leverage ratio of up to 4.75x for a period of 12 months in connection with the acquisition of Pixia in January. And given our typical seasonality and expectation for a stronger second half, we currently expect to be within compliance with this covenant for the next 2 quarters. Near-term drivers to improve cash flow include recent actions to reduce CapEx, the expected financial close on the Boston contract in Q3, the conversion of the $17 million buildup in CMS inventory in Q2 to cash later this fiscal year and renegotiation of certain milestone payments with customers. For example, with the pause on installation in New York in late March and April, we have worked with our customer to get paid for the scope completed related to this milestone versus waiting for full completion of the milestone. Turning to Slide 15. As previously announced in March, we recently strengthened our financial flexibility by entering into a new $450 million unsecured term loan and by upsizing our existing revolver from $800 million to $850 million. Part of the proceeds from the new term loan were used for the early prepayment of our outstanding private placement. Our capacity increased by 30% to a total of $1.3 billion, improving our financial flexibility due to more flexible covenants, interest savings and a better debt maturity profile. This extends the average life of our debt by approximately 1.4 years and decreases principal amortization over the next 24 months by approximately $49 million. Additionally, in April, we swapped $550 million of 1-month LIBOR to a 74 basis points fixed rate, increasing the expected interest savings. Please turn to Slide 16 to cover the second quarter financial results. Sales in Q2 were $321 million, down 5% as reported and 4% on an organic basis, reflecting growth in defense training, which was offset by a decline in Mission Solutions due to lower GATR and DTECH shipments, as Brad discussed, while transportation systems was roughly flat as a result of project timing. Adjusted EBITDA for the quarter was $4.5 million, which reflects growth in both transportation and defense training, offset by Mission Solutions as a result of lower high-margin sales as well as higher investments, including R&D and investment on franchise programs. The COVID-19 pandemic negatively impacted adjusted EBITDA by approximately $5 million versus our prior expectations for the quarter. Adjusted loss per share was negative $0.12, reflecting lower adjusted EBITDA and higher interest and depreciation expense, partially offset by discrete tax benefits. Our GAAP effective tax rate for Q2 was 27%, which differs from the second quarter 2019 effective tax rate of 29% and the U.S. statutory rate of 21%. We recognized a onetime $13.5 million tax benefit recorded through purchase accounting related to the acquisitions of Pixia and Delerrok. As a reminder, tax benefits recorded through purchase accounting are not included in adjusted EPS. Adjusted free cash flow was negative $37 million in the second quarter, reflecting higher inventory in CMS for products that are expected to ship in the second half as well as unbilled receivables from Boston and the Bay Area. Moving to our Transportation segment results on Slide 17. Sales declined 2% as reported and were flat excluding FX impacts, primarily reflecting project timing on our fare collection project and a $4 million impact due to COVID-19. Adjusted EBITDA margins increased 200 basis points, driven by higher margins on services and cost management. The COVID-19 pandemic negatively impacted adjusted EBITDA by approximately $1 million as a result of declines in transit ridership and delays of Trafficware and GRIDSMART awards. We expect growth to accelerate in the second half of the year, driven by the Boston contract reset and the timing of development work on our other fare collection projects in addition to growth from Trafficware and GRIDSMART. Moving to our Mission Solutions segment on Slide 18. Bookings included a GATR order on the T2C2 program for $49 million, and we expect to ship in the second half. We've largely addressed CMS performance already, which reflects 2 key drivers. First, orders and shipments of GATR were lower year-over-year as the prior year benefited from orders and support of a U.S. Army Urgent Operational Need. The second primary impact was related to the timing of orders for DTECH, which we expect to book and ship in the second half of this fiscal year. These 2 items were the largest driver of the lower adjusted EBITDA in Q2. Second quarter adjusted EBITDA also included additional investments in Mission Solutions in addition to higher bid and proposal expenses. As a reminder, if you look back at prior years, Cubic's typical seasonality reflects Q4 weighted adjusted EBITDA. Turning to Slide 19. Bookings in our Global Defense segment grew 121%, reflecting ground training wins, while sales grew 13% as reported and 14% organically, driven by air training. Adjusted EBITDA margin of 9.2% increased 50 basis points, reflecting continued strong project execution and cost management. Turning to Slide 20. I'd like to briefly remind everyone of our revenue recognition policies and payment terms for each of our businesses. In transportation, our product sales are mainly cost-to-cost percentage of completion, while payments are tied to milestones, and our service sales are primarily fixed price with certain variable elements and are billed monthly. In Mission Solutions, revenue is primarily recognized when products are delivered and accepted by the customer with cash collection typically occurring 30 days after shipment. In defense training, our product sales are primarily cost-to-cost percentage of completion, while our service sales are generally recognized based on billable amount. Our U.S. government customers pay us as costs are incurred and our international customers place a down payment at the beginning of the contract for product sales with remaining payments tied to milestones, while service sales are billed and collected a month in arrears. Turning to Slide '21. While we are suspending our previously issued guidance, we wanted to provide some information around potential low-end scenarios for the third quarter and the full year. For the third quarter, we expect adjusted EBITDA to be at or better than our Q3 fiscal '19 performance of $30.6 million. We have provided our key assumptions, including the completion of the Boston contract reset, which was approved by the MBTA Board on April 27 as well as continued delivery of CTS projects, and expected orders and shipments on our short-cycle DTECH and Intelligent Transport Systems businesses. For the full year, at the low end, we expect adjusted EBITDA to be at or better than fiscal 2019, where we delivered $146.6 million. Compared to our previous expectations, we believe there is approximately $15 million at risk in the CTS business related to COVID-19, including ridership and project delays, which will be offset by our cost savings program. We continue to expect performance in Mission Solutions to be weighted to the fourth quarter, driven by the timing of high-margin orders and shipments in Mission Solutions, including GATR, DTECH and Pixia's largest software renewal. We also expect continued growth in our Intelligent Transport Systems business. There are potential upsides to this low end scenario including timing of shipment and customer acceptance for GATR as well as upsides in our transportation business, should our customers recover faster than expected. Currently, our expectation is that public transit ridership will be a slow U-shaped recovery as lockdown restrictions are gradually eased through the calendar year. Public transit is a critical service that people rely on, and we expect ridership to return to near normal levels. We expect roads usage, which drives demand for our traffic management solutions, to return faster than mass transit. It's important to note that there continues to be significant uncertainty related to the COVID-19 pandemic, including the potential impact to timing of orders and customer acceptance, manufacturing and supply chain risk and the full extent and duration of the revenue declines experienced by our transportation agency and municipality customers. We are aggressively managing what is within our control to mitigate risk and achieve the best possible results. Now I'll turn the call back over to Brad.

[Bradley Feldmann:]

Thank you, Anshooman. Turning to Slide 22. To conclude, I'll reiterate that our top priority during the COVID-19 pandemic is the safety of our employees. We have repurposed our capabilities to support our customers and communities, and we have taken necessary actions manage through the current environment and to mitigate the impacts of COVID-19. Our strategic priorities and the long-term tailwinds of our businesses remain intact. While we some uncertain and the challenges in the near term, we are well positioned to continue to drive growth, delivering innovative solutions that solve our customers' hardest challenges. This concludes our prepared remarks for today. Let's proceed to the Q&A session.

[Operator:]

[Operator Instructions]. And our first question comes from Ken Herbert from Canaccord.

[Kenneth Herbert:]

Brad, I just wanted to follow up on CMS. And obviously, the drop there. And it sounds like a lot of it's timing, but -- and I know you -- appreciate all the detail, but can you just go through, again, the key drivers and the confidence sort of in the back half fiscal fourth quarter, which I know is typically very big seasonally for this business? But where do you see the risks that some of this could slip into fiscal '21 or confidence around CMS and the fourth quarter and second half numbers?

[Bradley Feldmann:]

We expect CMS actually to do better this fiscal year than last. We see some margin expansion. As you could tell, we booked the $50 million T2C2 contract towards the end of the quarter. And so that will get shipped out in the second half. There are a number of orders in DTECH that are "in the contracting officer's typewriter" that will get in their short shipment cycles. We're also -- you remember, we won that large tropo order with the Marine Corps in the first quarter, and that is ramping up as well. And then finally, you'll remember we bought Pixia, which is a commercial software company, and they have a few orders that are software licensing kinds of agreements that have very high margin. So net-net, I'm very confident that CMS will -- that this is timing and that CMS will actually have a better year than we did last.

[Kenneth Herbert:]

Is it fair to assume -- appreciate that, that margins in the fourth quarter of this year for CMS during the second half will be better than what we saw last year as well?

[Bradley Feldmann:]

I think we'll do a little better, Ken.

[Kenneth Herbert:]

Okay. Okay. That's great, Brad. And if I could, just one final question on CTS. I mean I appreciate that not a lot tied to ridership right now. But how do you view the risks, especially in New York City and Boston as things do start to reopen and people ideally start to increase ridership, budget constraints on your customers and what are your conversations like today with timing? And do you see any risk as they face budget pressure on either timing or potential changes in scope to the projects you're on right now?

[Bradley Feldmann:]

Yes. So as you know, we have near record backlog in our transportation business. We had a slow -- a pause for a month, as we talked about, in New York City. We're now putting OMNY validators. We started a few days ago. We'll pick up lots of schedule there. So that contract is on track. And you might note also, I was tremendously impressed by our team's ability to have agility and create face coverings, and we're providing over 300,000 face coverings to the MTA. So we're very proud of that. We also commented that there was a public board meeting in the last week or so in Boston, where they approved the restructure, the contract value going up near a couple hundred million dollars. And so we're moving out on that as well. In Brisbane, we're moving along. That -- Brisbane -- obviously, Australia is different than we've experienced in the U.S., and we don't anticipate slowdowns in installation later this year. San Francisco is moving out as well. So over the next -- and I don't see cancellations or reductions in contract. I mean, if these agencies are -- and these agencies are short revenue, obviously, our business is to help them to get revenue. And so we're essential for that. And we see opportunities, quite frankly, in our traffic business. As we rebound some, I think there'll be more people in cars for a while. And there'll be more congestion. And as you might remember, we bid that congestion management job in New York City using our OMNY back office, and there's inherent advantages for that. So Ken, I don't see major impacts. I see this continuing. The issue is mass transit is subsidized by governments. We expect that to continue. And so just out of abundance of caution, while our customers are experiencing, obviously, revenue issues that's why we withdrew guidance.

[Operator:]

Our next question comes from Jon Raviv from Citi.

[Jonathan Raviv:]

Brad and Anshooman, just a question about the FY '20 guide. I know you pulled it back here. But just give us a sense. Were you on path to achieve that without coronavirus? Or perhaps some of the higher CMS investments and higher BNP you mentioned, which I assume are not coronavirus related, perhaps threw things a bit off track there?

[Bradley Feldmann:]

No, we were on track to be within the range.

[Jonathan Raviv:]

Okay. And then another question here. Of the higher bid and proposal stuff that you're mentioning at CMS, so the first thing. Can you characterize some of those projects that you're seeing? It seems like they kind of came out of nowhere. You mentioned $1 million of excess spending in the quarter. That's a pretty big number. And then also, what's your perspective on when that kind of bid and proposal writing is going to translate to positive EBITDA growth, margin expansion, sort of see that CMS business really pick up?

[Bradley Feldmann:]

Yes, I think, overall, our country has the national defense strategy. And given COVID and discussions on where that started or whatever, I see the country doubling down. We see the Department of Defense trying to speed up activities. And so that very much is in the sweet spot for Mission Solutions. And you might also remember, our Nuvotronics acquisition that we did gives us opportunities for commercial bids as well, particularly in 5G and commercial space. And so we had invested in a technology called HALO, which allows wideband network pipes. We put out a bid related to that. We put out some bids related -- actually a couple of bids on HALO. We put out some bids in space. We've done some stuff on 5G related to base stations. And you might remember, we have this unified video dissemination system in that with the Pixia and other things, we're bidding C2ISR platform. So an awful lot of activity. In terms of timing on when that turns into revenue and EBITDA, I would say it's possible to get some awards later this year, but it's probably more probable during the first half of next year.

[Operator:]

And our next question comes from Michael Ciarmoli from SunTrust.

[Michael Ciarmoli:]

Glad to hear everybody is safe and healthy. Brad, just on CTS. Given all the strain being applied to some of your larger customers, how do you think that's going to impact your receivables, collection of milestone? Should we think about the COVID environment here changing anything regarding free cash flow? I know you guys have kind of directed us to think about cash over a 3-year period. But how should we think -- again, is there -- they're financially strained, and we've seen the MTA ask for bailout and maybe reorganizing and reshuffling some of their projects. How are you thinking about sort of cash?

[Bradley Feldmann:]

May I have Anshooman answer that question, please?

[Anshooman Aga:]

Sure. Mike, so from a cash perspective, I would say, the 3-year guidance we've given, so that remains intact. We don't see any risk related to payment from our customers. We've been working with our customers. And actually, as I mentioned in the prepared remarks, we had -- we worked with our customer in New York to actually move forward some payments, which are tied to a milestone when the work was stopped. We worked with them for a partial milestone payment based on work already completed, and they agreed to that, reflecting our strong relationship with the customer and, obviously, the strong progress we've made on this OMNY system for them.

[Michael Ciarmoli:]

Okay. And what about -- you talked about the kind of revenue, your total revenue exposure to kind of ridership. What are you thinking about sort of the maintenance exposure? And do you expect across your transportation customer base that you're kind of -- if there is sort of a predictable annual revenue stream you get there. Do you think there's any impact on sort of maintenance revenues?

[Bradley Feldmann:]

We don't see that.

[Anshooman Aga:]

So the $25 million readership risk that we talk about, that's part of the operations and maintenance bucket. It's not tied to the design build.

[Michael Ciarmoli:]

Okay. Okay. And then I guess the other one I had, just on -- back to the broader, whether it's Global Defense or Mission Systems, can you give any color as to what you might be seeing from some of your international customers? I mean, obviously, everyone's dealing with the same issues here. I know you had some delays. How are projects and programs on the international front tracking right now in the defense landscape?

[Bradley Feldmann:]

Yes. There's quite a few international opportunities that we're close on. Some of these countries, like us, are gradually opening up. But we have been in discussion with the customer and -- particularly in the training area, these are things that they vitally need and they're funded and it's close to actually being in the contracting officer's typewriter. So we expect good order inflow. In fact, we had some. You saw that in the prepared remarks in Cubic Global Defense, and we expect that to continue. I'd say there's been a slight pause, but people are eager to get back to work and get on with it.

[Michael Ciarmoli:]

Okay. Okay. The last one I had. Just as you guys look at your supply chain, probably across all the segments, procurement of technology-related smaller components. I mean, how are you sizing up or thinking about the potential risks as you look to procure raw materials, other inventory? Is there any required prebuying, where you might see potential tightness in certain product lines or what have you? I mean, have you guys given some thought to that area as well?

[Bradley Feldmann:]

As you might expect, we're micromanaging the heck out of that. We have all parts for the third and fourth quarter anticipated shipments either in-house or we have extreme visibility on it. In general, we don't buy many parts offshore. I think it was less than a handful, but my manufacturing and procurement guy is working on like that no tomorrow. The best way to preclude all this is to get ahead. And so we're working very hard on that.

[Operator:]

And our next question comes from Mike Cikos from Needham & Company.

[Michael Cikos:]

Just wanted to follow up on the cost savings plan that you guys have in place. So that $30 million to $35 million that we should be seeing over the next couple of quarters. Trying to get a sense, how much of that is being implemented on a permanent basis, go forward versus temporary? And I guess as a follow-up to that is how much should we expect to be following through in the COGS versus in OpEx?

[Anshooman Aga:]

Sure. So the $30 million to $35 million is not over the next couple of quarters, it's over fiscal -- remainder of fiscal '20 and '21, so over the next 6 quarters. The large -- some of the large drivers on there are temporary actions. We basically have a salary freeze through the next fiscal year, fiscal 2021. We suspended the 401(k) match. But part of those drivers in terms of optimizing overhead costs and really looking at present position, this is probably more of a permanent, but a large part of it is temporary based on the current conditions. From COGS versus SG&A perspective, a large part will show up in our cost of goods sold. Probably a little more than half of it will or 60% plus will show up in cost of goods sold as that's our employee base and the remainder goes in SG&A and other line items.

[Michael Cikos:]

Okay. And then, I guess, the follow-up I have to you is on the CGD segment. Can you describe, I guess, the customer conversations you're having there? And I guess, I'd just like to get some more color on the customer budgets being largely in place and the fact that these orders should be coming, so.

[Bradley Feldmann:]

Yes. So as we know, the Department of Defense budget is at a high watermark. So the budgets are pretty solid. And overseas, we see the things that we're chasing funded. And we have, as I stated, very good chances. And there are some orders that are, we believe, actually in the typewriter when people come back from COVID. So they're pretty high probability stuff. As we know, internationally, timing is always an issue. But we will get these intended orders.

[Operator:]

[Operator Instructions]. Our next question comes from Jim Ricchiuti from Needham & Company.

[James Ricchiuti:]

I joined the call a little bit late, but I did have a couple of questions just on the decision to withdraw the guidance. It sounds like it was mainly in the transportation business. And I'm assuming, is it mainly as a result of the uncertainty with the New York contract, Brad?

[Bradley Feldmann:]

Jim, it's mostly -- it is on transportation. That's a fact. We're seeing lower ridership across all the properties. And our customers have less revenue coming in by quite a bit. So it was not a New York thing. That contract is funded. We're continuing on it. It was out of abundance of caution of things getting delayed and so forth is they're lower on revenue. But to be clear, there have been no canceled contracts nor do I anticipate any.

[James Ricchiuti:]

Okay. And yes, maybe to turn it around a little bit. If we put aside New York for a moment, in aggregate, if you look at the rest of the transportation contracts that you have, what's your level of confidence and the predictability of that business? New York's high profile. New York, chances are it's going to get the funding that's required. But just looking at the rest of the business and the various systems that you're dealing with out there with authorities, how confident are you about that part of the business?

[Bradley Feldmann:]

Yes. So overall, very confident. As we stated in the call, Jim, that only 2% of our revenue, it's actually a little less than that, is tied to quantity of people riding mass transit around the world. The issue is I don't know what else might happen, right? So -- but I'm very confident that we're going to finish the year strong and so forth. There may be delays of new orders, but I'm very confident that -- and as you know, we have high visibility because it's all in backlog.

[Operator:]

And our next question comes from Jon Raviv from Citi.

[Jonathan Raviv:]

I know we're running a little bit long here almost. Just a question on the covenants. I know you're below the 4.75% on the net ratio. With EBITDA being flat this year, again, I'm not asking you for guidance per se in FY '21, but it's fair to assume that we'd get some of that EBITDA growth in '21 that we otherwise would have seen this year based on essentially a recovery, if you will?

[Anshooman Aga:]

Yes, Jon, just a couple of ways to think about our EBITDA -- our leverage ratio. Our EBITDA half 1 is down versus half 1 last year. And we've said at the low end, we expect EBITDA to be flat to last year, which means a stronger second half. So that's going to help our leverage ratio as second half EBITDA is going to be stronger. The second thing, we will have better cash flow in the second half, positive cash flow in the second half, which will help our leverage ratio. And then again, 2021, if there's the U-shaped recovery that we expect in mass transit, we should start seeing some growth out there. So we feel pretty comfortable with our leverage ratio and where we are, and we're very focused on paying down debt and have a very keen eye on our balance sheet.

[Jonathan Raviv:]

And then just a question on the repurposing of facilities. I understand the social imperative to do that and bravo for doing that. I'm just curious, are the facilities that you're purposing, are they things that were not particularly busy at the time or because of delayed orders, you have some downtime? I'm just kind of wondering where you're getting the capacity to repurpose facilities, including on something like GATR.

[Bradley Feldmann:]

Jon, we went to more shifts.

[Operator:]

And that clears the queue of questions at this time. I'll turn the call back to Brad Feldmann for closing remarks.

[Bradley Feldmann:]

Thank you, everyone, for joining us today. Before we sign off, I want to provide an update on our previously announced plans for an Investor Day scheduled for June 18, 2020 in New York. As a result of the COVID-19 pandemic and recommendations from public health care authorities to restrict travel and group gatherings, we have decided to postpone our event. Our highest priority is the safety of our people and communities, and we believe that postponing this event is the right thing to do considering the circumstances. We will announce a new date for this event soon, as soon as feasible and look forward to remaining engaged with our analysts and investors. Thank you so very much. We appreciate your time and interest in Cubic.

[Operator:]

Thank you, ladies and gentlemen. This concludes our call today. You may now disconnect.