Lionheart Holdings
Q3 2020 Earnings Call Transcript

Published: 7 Aug 2020

[Operator:]

Ladies and gentlemen, welcome to Cubic Corporation's Third Quarter Fiscal Year 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. 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, a friendly reminder that our presentation contains forward-looking statements that are made pursuant to the safe harbor provisions of the 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 of these non-GAAP financial measures 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. Welcome, everyone, and thank you for joining us today. Please turn to slide three. Before we discuss the quarterly results, I want to comment on recent events. The killings of George Floyd, Breonna Taylor and sadly, many others are tragic reminders of the injustice that continues to threaten the black community here in the United States. Recently, we came together as an organization virtually to educate each other and support our fellow cubes, who are hurting from racial injustice. Our employee resource group of black employees led multiple sessions with all of Cubic facilitating open dialogue to discuss recent events, share personal experiences and discuss potential actions to address inequalities. Additionally, we have launched a new training course for all employees to help us identify and mitigate unconscious bias. These are small steps, and there is more to be done. We are committed to listening, learning and improving together. As I've said before, diversity fuels innovation, which is the lifeblood of our company. Cubic is committed to an inclusive workplace, where everyone is respected, supported and empowered and has the opportunity to contribute to innovation. Now let me briefly comment on the current economic environment. Since the onset of COVID-19 pandemic, the health and safety of our employees and customers has been our top priority. At the same time, we focused on ensuring business continuity and effectively managing expenses during this uncertain period. We believe that our resilient corporate culture and adaptable experience teams have enabled us to effectively address these priorities, and our results this quarter demonstrate that. At the same time, we have not taken our eye off of the future and our strategic priorities, specifically building technology-driven, market-leading businesses, and we believe the long-term favorable industry dynamics in both transportation and defense remain intact. Lastly, while we continue to face the near-term dynamics related to COVID-19, we believe Cubic remains well positioned to drive growth, improved cash flow and reduce leverage. Please turn to slide four. Last year, we launched our diversity and inclusion strategy with ambitious goals across three pillars

[Anshooman Aga:]

Thank you, Brad, and hello, everyone. Please turn to slide 11 to cover the third quarter financial results. As Brad mentioned, we executed well this quarter, and our results were in line with our expectations. Bookings grew 40% to $453 million, driven by the contract amendment with our Boston customer including additional scope on both the design-build and services portion of the project. Sales in the third quarter were $350 million, down 8% as reported and 9% on an organic basis year-over-year, reflecting the timing of shipments and Mission Solutions and estimated impacts related to COVID-19 as a result of delayed awards, project pauses and slowdowns and lower transit ridership revenue. Adjusted EBITDA was $38.2 million, up 25% year-over-year, reflecting growth in transportation and defense training and benefits from the previously announced company-wide cost management initiative, which was partially offset by a decline in Mission Solutions. We estimate that the unfavorable impacts related to the COVID-19 pandemic totaled up to $41 million for sales and up to $14 million for adjusted EBITDA in the third quarter. Adjusted earnings per share were $0.74, up 12% year-over-year, reflecting higher adjusted EBITDA, partially offset by higher taxes and depreciation expense. Additionally, we delivered strong adjusted free cash flow of $44 million in the third quarter, driven by a payment on the Boston contract with the financial close and the milestone payment on the New York contract. As a reminder, last year's adjusted free cash flow included $45 million of net proceeds from the sale of real estate in June 2019. Moving to our Transportation segment results on slide 12. Bookings more than doubled year-over-year, which reflects the $228 million booking on the Boston contract amendment. Sales were in line with the prior year, reflecting growth from the Boston project, but were offset by impacts from COVID-19, primarily due to delayed bookings in our Intelligent Transport Systems business, project pauses and slowdowns and lower transit ridership. However, adjusted EBITDA increased 71% year-over-year to $41.9 million, while adjusted EBITDA margin increased 790 basis points to 19.4%, driven by the Boston contract reset, cost savings and overall strong performance. As I mentioned, Trafficware and GRIDSMART have experienced some delays this year, due to the pandemic. However, bookings grew year-over-year, and we continue to expect growth in this high-margin business in future periods. Moving to our Mission Solutions segment, on slide 13. Bookings in the third quarter were $79 million, in line with the prior year. Sales declined in the third quarter as compared to the prior year, reflecting lower GATR deliveries, due to the timing of shipments, which had an unfavorable impact on adjusted EBITDA as these products are high margin. Adjusted EBITDA also reflects continued investments in franchise programs. We continue to expect a strong fourth quarter for CMS, which I'll cover in a moment. Turning to slide 14. Bookings in our Global Defense segment were lower than last year, due to program award delays, including delays associated with COVID-19, which, in turn, impacted sales. The top line decline also reflects lower year-over-year sales in ground training, partially offset by growth in air training. Adjusted EBITDA margin of 13.1% increased 320 basis points year-over-year, reflecting strong operational execution and cost management. Turning to slide 15 for some fourth quarter guideposts. We expect to deliver a strong fourth quarter, leading to full year anticipated adjusted EBITDA to be at or slightly above fiscal year 2019, where we delivered $146.6 million. While this is a large fourth quarter ramp, please keep in mind our Mission Solutions business is typically heavily weighted towards the fourth quarter due to the timing of orders. Additionally, the acquisition of Pixia, which is a high-margin software business, generates most of its profit in the fourth quarter since the largest annual license renewal occurs in Q4. And we are pleased to confirm that this order was received at the end of July as expected. I'll touch on some other key drivers. In addition to the meaningful Pixia contribution, we expect strong shipments of GATR in the fourth quarter, driven by the $73 million in backlog. Also, in CMS, we expect strong deliveries of a DTECH product line, supported by current backlog and additional orders expected in the fourth quarter. We also anticipate modest growth in our short-cycle Intelligent Transport Systems business. Lastly, a design-build, fare collection project in CTS continue to be on track, including the manufacturing schedule. Moving to slide 16. We believe our cost savings initiative, which were announced in May are currently on track to generate cumulative net savings of $30 million to $35 million over the course of FY 2020 and 2021. While we feel comfortable with where we are from an expense management perspective, to help mitigate the impacts of COVID-19, we have additional levers should we need to take further action. Our bank net leverage ratio improved to 3.7 times at quarter end, and our credit agreement allows us to have a net leverage ratio of up to 4.75 times through December 2020, as a result of our acquisition of Pixia. We remain focused on cash preservation and lowering our leverage ratio to our target of below three times. As a reminder, the debt issued by the variable interest entity in connection with the Boston contract is non-recourse to Cubic and is not included by our banks in the calculation of our leverage ratio. Our Boston MBTA contract was structured as a public-private partnership, where we formed a joint venture with John Laing, in which we only have a 10% equity stake, but this entity must be consolidated under U.S. GAAP. I'll close by reiterating that we are pleased with our execution this quarter, especially given the challenging environment, and we look forward to delivering a strong fourth quarter to end the fiscal year. Now I'll turn the call back over to Brad.

[Bradley Feldmann:]

Thank you, Anshooman. Turning to slide 17. We are pleased with our performance and strategic progress this quarter and what continues to be a challenging and fast-changing environment. Cubic remains well positioned in our markets and to successfully execute our business strategy, but we are not taking that for granted. We will continue to effectively navigate the current landscape, fine-tune our strategy, mobilize our resources and take actions to best serve our customers and create value for our stakeholders. With that, let's proceed to the Q&A session.

[Operator:]

[Operator Instructions] Your first question comes from the line of Ken Herbert with Canaccord. Your line is open.

[Ken Herbert:]

Yeah, hi, good afternoon. I can, have you drawn pretty good. Brad. Hey, it sounds like you've obviously on good pace with bookings in CMS in the fourth quarter. Can you just provide a little bit more confidence or maybe a little bit more color on sort of fourth quarter and CMS and expectations around, not only the top line, but then to expound upon some of your comments on what we should expect in terms of EBITDA and margin on those products? Because obviously, it's, as you've talked about, historically, such a major swing factor for the segment in the fourth quarter and the full company. But any more detail on confidence around the fourth quarter and CMS would be great.

[Bradley Feldmann:]

Yes. We've remained confident regarding the fourth quarter. From a revenue perspective, we have north of 85% of the orders in backlog through the recent days and more actually regarding the profitability. So at the end of the year, I actually expect them to have higher profits year-on-year than they did last year.

[Ken Herbert:]

Does the revenues in CMS this year surpass what we saw in fiscal 2019?

[Bradley Feldmann:]

It will some. As you know, Pixia was in addition to what we were doing last year.

[Ken Herbert:]

Okay, that's helpful. And then can you just there's a lot of speculation around, and I know you've talked a lot about within CTS, the impact of or the limited impact of ridership on your direct revenues now, but it clearly sounds like it's a bit of a headwind for timing on new contracts and some activity in the segment. Can you just three to nine months, I think, you called out on sort of new contract wins. Is there any way that could get helped if we get more stimulus for state and local governments? And how are you viewing the potential there to maybe speed up some of the activity from a booking standpoint?

[Bradley Feldmann:]

Yes. So obviously, if there's stimulus that comes from governments that helps the situation. As you know, we've seen stimulus provided around the world to mass transit. Mass transit is essential. And just to point out that we provide contactless, i.e., safe, fare collection methods. And so having said all that, the delays could be shorter if there were stimulus. I think you'll note that we're working on lots of proposal activity, I think, we said north of $1 billion of activity in various cities around the world. And the ridership around the world

[Ken Herbert:]

Okay. And just finally, aside from the MBTA contract reset, was there anything else that directly impacted margins positively in CTS in the quarter?

[Bradley Feldmann:]

Just really good go ahead, Anshooman, sorry.

[Anshooman Aga:]

So as Brad was saying, we had very good execution across the board, both on the design-build and the services side. And then also, as I pointed out, we had the cost savings initiative company-wide, which also impacted CTS positively.

[Operator:]

The next question comes from the line of Jon Raviv with Citi. Your line is open.

[Jon Raviv:]

Thank you very much. So a question to sort of carrying on Ken's first point about CMS margin. How are you thinking about that business going forward? You're building backlog. You've gotten the nice position. You're investing. But when should we be able to see some of that positive EBITDA margin going forward? Goal 2020, I assume, that's pegged at 14% to 15%. Is there some kind of inflection point that we should be looking out for over the next year or two? Any help on any perspective on that time would be much appreciated.

[Bradley Feldmann:]

Yes. I think this year, there will be margin expansion. And we would expect that to continue the next year or two to the levels that you suggested. We're in a cycle now where we've been winning a lot of programs that have nonrecurring engineering in them. Recurring obviously follows. Those recurring jobs were bid at much higher margins. So the mix will change quite a bit in the next few years.

[Jon Raviv:]

And just to clarify, the mix being those nonrecurring engineering to production?

[Bradley Feldmann:]

That's right. So the mix going from nonrecurring engineering to production. The production, just to reiterate, was bid at much higher margins.

[Jon Raviv:]

Understood. And then on the CTS side, talking about this almost an air pocket or a delay in some of those other projects you outlined. Is there a chance that some of the roads or non-public transit stuff will be able to accelerate and fill in some of that hole? Or should we be prepared for CTS growth to decelerate here based on pandemic?

[Bradley Feldmann:]

No. We'll see growth next year and the year after. But your question has good insight. Roads are coming back much faster. And the acquisitions that we have done, we believe, we have the best technology, and we believe, we'll see expansion there from those products.

[Jon Raviv:]

Right.

[Operator:]

Your next question comes from the line of Louie DiPalma with William Blair. Your line is open.

[Bradley Feldmann:]

Hey Lori.

[Louie DiPalma:]

Hi, Brad Anshooman and Kirsten. Good afternoon.

[Bradley Feldmann:]

Good afternoon. Louie

[Louie DiPalma:]

What is the time line on launching Cubic Interactive? I know you had a pilot in Miami right before the Super Bowl, and you made a couple of announcements during the quarter. But I'm interested in what are your expected investments to launch Cubic Interactive in the Delerrok markets and later potentially the New York, Boston, San Francisco and other Tier one markets?

[Bradley Feldmann:]

Yes. So we're working very hard on our partnership with Moovit. As you all recall, Moovit has, from my perspective, the best information regarding mass transit in the world. And I would argue that we have the best payment technology and so to deliver that experience to users or patrons that use mass transit is a tremendous opportunity. And so by the end of the calendar year, we will have a product that amalgamates both capabilities. And that will also have Cubic Interactive with it as well. So you'll see some momentum at the end of this calendar year and into next to see those digital products take hold.

[Louie DiPalma:]

That's helpful. And for Anshooman, you discussed the reduction of leverage is a major priority. During the quarter, you reduced net debt by around $50 million. But there's a lot of work left. What do you expect net leverage to be by the end of the year? And do you have any sense on when the leverage ratio can fall back below three times?

[Anshooman Aga:]

Thanks, Louie. So yes, we had a strong quarter in Q3 with $54 million of net leverage reduction and our leverage ratio went down to 3.7 times versus 3.96 times in Q2. For the fourth quarter, we expect positive free cash flow again, which will and again, adjusted EBITDA will be stronger than last year's adjusted EBITDA, just given the full year guidepost that we have provided, which will further help leverage ratios go down. We continue to work through the fiscal year and next year also to continue to lower leverage. Regarding the exact timing of three times, we're still working through our business plans. And also, there's a little bit of uncertainty because of the pandemic. But we will continue to make progress towards the three times target.

[Louie DiPalma:]

Thanks.

[Operator:]

Your next question comes from the line of Michael Ciarmoli with SunTrust. Your line is open.

[Michael Ciarmoli:]

Hey guys, good evening. Thanks for taking the questions here. Brad, just maybe on the contract you called out, the High Capacity Backbone. I mean, it sounds like a great opportunity. And I'm just I think, Jon, was hitting on this about the mix. I mean, clearly, this sounds like it will be a little bit of a margin headwind in the near term. I mean, are there going to be, just trying to, I guess, level set expectations in CMS? You've got the Advanced Battle Management System. Is there a little bit more margin pressure in the near term on some of these wins before we get to that mix shift?

[Bradley Feldmann:]

Yes. So overall, we've been doing a lot of nonrecurring from major wins that we had last year

[Michael Ciarmoli:]

Okay. And then maybe dovetailing into that, the $30 million to $35 million of cost savings, Anshooman, can you just give us a sense of what hit in the current quarter, maybe what segment we're seeing at most? And as we look forward into the, I guess, the full realization of that savings, should we expect to see that drop right through to EBITDA margins in 2021?

[Anshooman Aga:]

Yes. So it's a cumulative $30 million to $35 million. So far, we've, in Q3, we had a little over $8 million hit the books. Obviously, CTS has majority of the people, so majority of the savings would go to CTS. And then we'll have additional savings in Q4 and then the remaining to get to the cumulative $30 million to $35 million would be next fiscal year. And yes, straight to the bottom line.

[Michael Ciarmoli:]

Straight to the bottom line. Okay...

[Anshooman Aga:]

Yes. It's offsetting some of the impacts from COVID that we had.

[Michael Ciarmoli:]

Right. I mean, the COVID impact, too, I guess, my last one, the $41 million of revenue headwinds, I don't have that number in front of me, I think the $13 million or $14 million of EBITDA, do you pick that up in the fourth quarter or 2021? Or how should we think about that from a modeling standpoint?

[Anshooman Aga:]

Well, a lot of these were project delays. And as Brad mentioned, we're seeing a three to nine month delay in projects. So ultimately, maybe in two years or three years, there's a catch-up where a lot of pent-up demand comes. But there is delay in projects. A couple of the projects, we had pauses or slowdowns. For example, New York, we had announced last quarter that they had a one month pause. We're catching up on the installation on that. We had a project in Los Angeles, where installing the readers was put on hold for the safety of employees. That's back on track, and we're trying to catch up. But the delay and then the ridership impact obviously doesn't come back because we have certain part of our revenue tied to ridership, which just doesn't come back.

[Michael Ciarmoli:]

Got it, got it. And maybe just one more. Just taking into consideration some of these pauses, delays, I guess, more on your current projects, any changes to the that you see from COVID with if I were to think about that, that sort of three year free cash flow profile that you've guided us to, does anything slide out further to the right in terms of cash collections here as we're thinking about? I know you called out a strong fourth quarter for cash. But anything we should be aware about cash collections with some of these delays?

[Anshooman Aga:]

No. Our three year target remains on track. The projects remain on track. Wherever the couple of projects that I mentioned where we had a pause, they were temporary pauses, and the customers are interested in us actually catching up. And further to the point where in New York, actually paused the project, we worked with the customer to break the milestone payment into three milestone payments, and we got the first one in Q3. So it talks to the testament of our employees and our relationship with the customer and the good work our employees are doing to serve our MTA customer.

[Operator:]

[Operator Instructions] Your next question comes from the line of Mike Cikos with Needham & Company. Your line is open.

[Mike Cikos:]

Hi team you have Mike Cikos here, for Jim Ricchiuti. I wanted to ask you with respect to the COVID-19 impact that we saw in fiscal Q3. Could you help us unpackage, I guess, what was specific maybe to CTS, sort of, I'm thinking about what's coming from the reduced transit ridership? And I guess what I'm ultimately trying to do is unpackage that and get a better sense of what we might anticipate impacting Cubic in fiscal Q4? Or to what extent any COVID-19 impact has been contemplated in the guidepost we've been provided today?

[Anshooman Aga:]

Sure. So of the $41 million that we talked about, just under $30 million was tied to CTS. About a little less than one third of that was based on ridership and then the rest was delays and slowdowns.

[Mike Cikos:]

And then I did want to come back to the HCB contract as well. Just wanted to get a sense because, again, this $4 billion addressable opportunity over 10 years is obviously just a large number. But for Cubic itself, are you guys actively pursuing that entire $4 billion? Are you actively addressing that entire $4 billion? Or do you get there through partnerships or additional acquisitions and internal R&D? Just curious how much of that Cubic can how much of that wallet Cubic can actually grab with its product portfolio.

[Bradley Feldmann:]

100%. We'll attack that $4 billion hard with the technology that we've come up with, we've been working on a number of years. And what it allows, in essence, is to put Ethernet in the sky, so that all the participants in the sky can have a common secure picture. And so after we do the development and demonstrate the air and ground pieces, then we'll start putting that on platforms. We called out a couple on the charts. But I think that will continue to expand. It's a key priority of the Department of Defense, the Joint All Domain Command and Control system and our HALO product is in the middle of that. We're thrilled. We beat many prime contractors and our team did a great job. We've been investing and developing that technology that we think is very, very unique. The last five years, not only internally with company monies, but also in partnering with the Air Force Research Lab. So this is a tremendous win for us, and we're thrilled.

[Mike Cikos:]

That's helpful. And one more on the cost savings, if I may. I'm just thinking about the cumulative net savings of this $30 million to $35 million with $8 million hitting the books in fiscal Q3, which was obviously impacted by the COVID-19. But curious, has that I guess, the $8 million that did hit fiscal Q3, was this was there anything onetime in there or faster than we anticipated? Because again, I'm just looking at this stretching over the next five quarters into fiscal 2021 to get a sense of how these savings layer in?

[Anshooman Aga:]

Yes. I won't say it was unanticipated, it was right according to our plan. There are some onetime actions in there. For example, we stopped the 401(k) match for the rest of this fiscal year. We've put a freeze on salaries. So no merit increases through end of next fiscal year. Obviously, travel and trade shows and stuff like that and discretionary spending is down. And then there are certain actions that are more permanent in nature in terms of organization.

[Mike Cikos:]

Great, thank you guys.

[Operator:]

You our next question comes from the line of Jon Raviv with Citi. Your line is open.

[Jon Raviv:]

Hi, thanks for the follow-up. Brad, I appreciate the perspective on where CMS margins can go and some of the shape around that. But this question is on CTS, CTS margin opportunity as some of those higher-margin solutions ramp up, maybe this is the kind of thing that would have been covered at the Investor Day that never was. But any thoughts on how you're thinking about long term there and maybe any preview for Goal 2025, if you will.

[Bradley Feldmann:]

Well, we're not previewing Goal 2025 today. And Kirsten will let us know when we're going to have the Investor Day. But what I would say, and your question is very insightful. What I would say is that we get these digital products out into the marketplace, they're at much higher margins. And what I also will say is that we're driving down the risk quite a bit as we're delivering these big five contracts. And so I would expect margins to continue to improve. Anshooman was very clear that we were helped by the Boston contract this quarter. But margins in CTS, I think, we had given sort of a guidepost of middle double-digit margins. And so we're headed there.

[Jon Raviv:]

Yes, thanks. Thought I'd try. Thanks again.

[Operator:]

Your next question comes from the line of Louie DiPalma with William Blair. Your line is open.

[Louie DiPalma:]

Thanks for the follow-up Regarding the Joint All Domain Command and Control on $950 million IDIQ, should investors think of that IDIQ similar to your like $962 million IDIQ for T2C2 and that like do you expect to realize most of that $950 million? Or is that amount expected to be split between the several awardees for that program?

[Bradley Feldmann:]

Yes. It's a multiple-award IDIQ in contrast to the T2C2, which was single award. So and they awarded a lot of contracts. What I would say is, again, the High Capacity Backbone win, that technology is very relevant to that multi-award IDIQ. And we think our technology is unique.

[Louie DiPalma:]

Okay. So is that was that High Capacity Backbone is that not a task order under this $950 million?

[Bradley Feldmann:]

It's not. It's not.

[Louie DiPalma:]

Okay. So it's completely separate.

[Bradley Feldmann:]

It's a separate contract and was very competitive and fortunately, we beat lots of household names.

[Louie DiPalma:]

Sounds Good. That's helpful. Thanks, Brent.

[Operator:]

There are no further questions at this time. I will turn the call back over to Brad Feldmann.

[Bradley Feldmann:]

Thank you for joining us today. Before we sign off, I want to thank the Cubic team for their ongoing commitment to serving our customers and keeping our businesses safely operational during the ongoing pandemic. We appreciate your support and interest in our great company. Thanks so very much.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.