Lionheart Holdings
Q4 2018 Earnings Call Transcript

Published: 15 Nov 2018

[Operator:]

Greetings, and welcome to the Cubic Corporation Fourth Quarter and Full Year 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Kirsten Nielsen, Vice President of Investor Relations. Please go ahead.

[Kirsten Nielsen:]

Thank you. This morning we reported our fourth quarter and full year results for fiscal 2018. I’m joined by Brad Feldmann, Chairman, President and Chief Executive Officer; and Anshooman Aga, Executive Vice President and Chief Financial Officer. I’ll remind everyone that statements made on today’s call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. You can find risk factors that could cause the company’s actual results to differ materially from our expectations listed in our most recent SEC filings. 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’d like to turn the call over to Brad.

[Brad Feldmann:]

Thank you, Kirsten. Thank you, everyone, for joining us today. On today’s call, I will start with a start with a brief overview of our financial results followed by a strategy update. Then I'll hand the call over to our CFO, Anshooman Aga who will cover the financial results and next year's guidance in more detail. Starting with Slide three, we had a great year and I want to begin by thanking my teammates for their strong performance and continued focus on winning the customer. In the fourth quarter, we achieved record sales of $379.7 million, a 9% increase compared to the fourth quarter last year. Adjusted EBITDA was also a quarterly record at $49.1 million, an 8% increase compared to the fourth quarter of last year. For the full year, we achieved our financial guidance, delivering record sales of $1.2 billion, a 9% increase over last year and full year adjusted EBITDA of $104.6 million, an increase of 20% compared to last year. Our backlog continues to grow and is now over $4 billion, another record in Cubic's history. Turning to Slide four, we recently closed the acquisition of Trafficware to expand our operational and analytics capabilities as part of our NextCity vision. Trafficware is a technology-driven market-leading intelligent transportation solutions company. They provide a fully integrated innovative suite of software Internet of things devices and hardware solutions that optimize the flow of vehicles and pedestrian traffic through intersections and arterial roads. As part of their solution, they provide smart infrastructure that will support smart cars in the future. I warmly welcome the Trafficware team to Cubic. We expect revenue synergies going forward as we advance our NextCity strategy together and reduce congestion for our customers. Anshooman will discuss the financial impact of the Trafficware acquisition in fiscal 2019. Turning to Slide five, with our recent Bay Area transportation win, we are pleased to have successfully achieved all six growth catalysts that we had strategically targeted several quarters ago including winning New York, Boston, Brisbane and the Bay Area achieving the T2C2 full rate production and completing our ERP implementation. These wins represent $1.8 billion in new business awarded with $2 billion in potential follow-on business. Moving to Slide six, along with our major wins, we continue to make progress with our Winning the Customer initiative. As the result show, Cubic's NextCity strategy continues to win customers and improve our execution. We continue to see very strong demand for Cubic's compelling solutions to provide full motion video to the edge of the battlefield and we continue to make progress combining live virtual and constructive simulation techniques to provide efficient performance-based training to our customers. Lastly, we're working to deliver keener insights to our customers through digitization and developing our platform capabilities in NextCity 2.0 ISR as a service and Training-as-a-Service. Turning the Slide seven, in NextCity we are celebrating our Bay Area Transportation Award to deliver our next-generation fare payment system to the Metropolitan Transportation Commission. We are honored to continue our long-term relationship with the MTC. Cubic will leverage the investments the MTC and the regional operators have made to deliver new features such as mobile and new bus devices early, while completing longer-term upgrades to the back office. Our solution will offer the full range of payment and account management features we are delivering to major cities around the world including London, New York, Boston, Brisbane, Sydney, Vancouver and Chicago. Each of these new technologies will be powered by Cubic's real-time communications and data analytics, supporting the company's account-based architecture. This technology model opens a variety of new potential partnerships between transit, bike share, ride share, card share, parking and other vertical transportation services, falling under NextCity our mobility-as-a-service strategy. We also won the Sydney Integrated Congestion Management Program, a first of its kind program to reduce congestion in the city. The new system will enhance monitoring and management of the road network across New South Wales, coordinate the public transport network across all modes, improve management of clear ways and improve incident clearance times, while providing real-time information and advice to the public about disruptions. This win together, with the Trafficware acquisition, represents significant momentum for the operation and analytics pillar of the NextCity strategy. We also are expecting customer upgrades to continue. The latest in Los Angeles where we will support two innovative service enhancements planned for progressive launch over the next 18 months. These include an integrated mobile app and Tab Force a cloud-based account. Emission Solutions as we discussed on the last earnings call, we had been awarded a $500 million transportable tactical command communications T2C2 contract increase doubling the total potential value to $950 million with approximately $750 million unused ceiling. We booked and delivered $55 million in Q4. We continue to expand our secured networking business and we're selected for a new fifth generation technology insertion for the United States Army command post upgrade. We are preparing for build and delivery of our first pilot order of this fielding. We're now receiving orders from AT&T and their partners for our interoperability gateway in support of the FirstNet program. In Q4, we received approximately $2 million in new orders for this program. In defense training, we led successful joint US Air Force and Navy Advanced Technology demonstration of next-generation live virtual constructive air combat large force exercise flights at Nellis Air Force Base. Finally we received a $13 million instrumented tactical engagement simulation systems spares contract as a result of a recent US Marine Corps NexGen training platform demo at Twentynine Palms. Moving to Slide eight, we are laser focused on meeting our commitments. We are in a fortunate position in that are sizable backlog and program of record visibility is driving strong growth for the company. We must deliver to our customers efficiently and effectively, while continuing to improve our infrastructure to support future growth. In transportation, this means delivering on our major projects, further expanding into attractive adjacencies and leveraging our leadership position in the fare collection market with our One Account Technology advantage. In C4ISR we will successfully field T2C2 to full rate production and delivery FirstNet for AT&T, our radio-over-Internet protocol RoIP solution that will allow first responders across the US to use radios with cell phones over the mandated FirstNet network. We will also integrate and grow our recent acquisitions. In defense training, we will turn SLATE ATD into a program of record, win select synthetic training environment awards and grow our international business. We remain focused on living One Cubic. We are implementing product lifecycle management through fiscal 2019 to standardize our engineering tools and workflows. A priority of ours is to develop enhanced analytics capabilities, We are especially pleased with our One Cubic teamwork and the value that our transportation and defense engineering teams deliver as they work together to develop innovative technology solutions. We recently held a data analytics and machine learning summit to further our collaboration in these areas. Lastly, due to our ongoing efforts to reduce supply chain and overhead costs, we expect to further expand margins in FY 2019. Turning to Slide nine, I couldn't be happier with the transformation progress Cubic has made, but our journey continues. In the mid-term, we plan to capitalize on our competitive advantages in transportation to win AFC upgrades with existing customers pursue new opportunities in cities such as San Diego, Paris, Toronto and Montreal and continue to expand our presence in adjacent markets of surface transport management, tolling and congestion charging and our NextBus 2.0 midmarket entry. We will successfully deliver on our recent mobile solution wins and leverage these launches to further monetize NextCity. In Mission Solutions, we are ramping up on FirstNet with AT&T and preparing for SATCOM convergence as the U.S. army considers common solutions as U.S. Army considers common solutions. In defense training, we continue to develop our Synthetic Virtual and Live Multi-Domain Training Environment, part of the Army's modernization priorities. We strongly believe Cubic is well-positioned for its next wave of value creation by building technology driven market leading businesses. We will consolidate across the value chain to create integrated offerings and extend into new and attractive markets leveraging our core capabilities. We will transform our way of doing business and leverage new digitally enabled business models to help drive top quartile shareholder returns. We believe that one Cubic platforms will allow us to provide keener, valuable insights to our customers. Next, I'll ask and Anshooman to describe our financial results in more detail.

[Anshooman Aga:]

Thank you, Brad. Please turn to slide 10 to cover a few highlights for the quarter. As Brad mentioned, we delivered record results this quarter, and our backlog has reached another record at $4.1 billion. At the beginning of the quarter, we were awarded a $500 million increase to the ceiling on our T2C2 contract vehicle, leading to approximately $750 million of unused capacity, which is not included in our backlog figures. We successfully delivered the first tranche of T2C2 at full rate production and execution across all major projects which remain on track. On a constant currency basis, fourth quarter sales grew 10% year-on-year driven by transportation and machine solutions and adjusted EBITDA grew 9%. Free cash flow was positive $29.8 million in the fourth quarter. As a reminder, the milestone payments from the special purpose entities related to the Boston project are not reflected as operating cash flow. If we were to adjust for this, free cash flow would have been positive $36.4 million in the fourth quarter. Turning to Slide 11, we were pleased that we achieved our full year financial guidance for fiscal 2018 delivering strong growth in both sales and adjusted EBITDA, while expanding margins by 80 basis points due to sales growth, strong execution and One Cubic initiatives. At the same time, we grew the backlog by $1.5 billion to secure future growth and we improved our portfolio through disciplined capital allocation decisions to drive long-term shareholder value. We believe our success in 2018 provides a clear path to goal 2020. Going forward, we will continue to assess M&A opportunities that are in line with our strategy and acquisitive to shareholders. On slide 12, we provided an overview of the consolidated fourth quarter results, which we have largely covered on the prior slide. As Brad mentioned, we achieved a record backlog, record sales and record adjusted EBITDA in Q4. Net income from continuing operations attributable to Cubic was $22 million or $0.80 per share compared to $9.6 million or $0.35 per share in the fourth quarter of last year. A year-on-year increase was driven by higher adjusted EBITDA, lower ERP related expenses and a lower effective tax rate. Turning to Slide 13. For the full year, all three segments achieved strong growth in bookings. As Brad mentioned, we achieved a company record to sales at $1.2 million up 8% on a constant currency basis governed by transportation and emission acquisition. We grew adjusted EBITDA by an impressive 17% on a constant currency basis with margins increasing by 80 basis points. Net income from continuing operations attributable to Cubic was $8.1 million or $0.29 per share in 2018 compared to a net loss of $25.7 million or $0.95 per share in 2017. The year-over-year comparison of EPS reflects higher operating income, lower interest expense and a lower effective tax rate. Moving to the segment results on slide 14. Cubic transportation systems delivered excellent results. Fourth quarter bookings were driven by the Bay Area award, but $394 million while the full year also includes New York, Boston and Brisbane award. Sales increased 14% in both the fourth quarter and for the full year on a constant currency basis reflecting strong growth in both products and services. It's worth mentioning that the fourth quarter of last year included a pickup from a favorable contract resolution. Full year adjusted EBITDA margin increased significantly due to higher sales, operational cost reductions, lower R&D spend and solid execution. Moving to Slide 15. Our Mission Solutions business had impressive results with strong increases in all key metrics both for the quarter and the year. As expected we delivered on the first tranche of T2C2 at full rate production. Robust growth was led by Gator, although CMS recorded growth in all sub-segments. Margins improved by roughly 900 basis points in Q4 and 400 basis points for the full year due to higher sales, favorable mix and strong execution which more than offset higher R&D spend. Turning to slide 16, Cubic Global Defense delivered 20% growth in bookings in 2018, while sales and adjusted EBITDA declines year-on-year driven by the completion of various programs. As Brad mentioned, we have been investing in the next generation live virtual constructive technologies and had a successful demonstration in Q4 and expect this to turn into a program of record. Full year adjusted EBITDA was comparable to last year excluding the impact of higher R&D spend. The legal arbitration in Q4 of this year and favorable REA impact in 2017. Turning to Slide 17 for our fiscal 2019 guidance. We expect another year of strong growth in sales and adjusted EBITDA driven by the ramp up of our transportation projects and continued growth in C4ISR. We expect sales in the range of $1.37 billion to $1.45 billion and we expect adjusted EBITDA to be in the range of $135 million to $155 million. The midpoint of our guidance reflects 13% organic sales growth and 24% organic adjusted EBITDA growth. Our guidance range includes the Trafficware acquisition which closed on October 24. We expect Trafficware to contribute approximately $50 million in sales and $14 million to $15 million of adjusted EBITDA and to be accretive to earnings per share. Lastly, we expect seasonality to be in line with last fiscal year. You can expect Q1 adjusted EBITDA to be slightly higher year-on-year and ramping sequentially thereafter driven by the continued ramp in CTS projects, the timing of discretionary government spend, which impacts our CMS business and fewer working days in Q1. Now I'll turn the call back over to Brad.

[Brad Feldmann:]

Thank you, Anshooman. Turning to Slide 18, in summary, we finished the year on a strong note with record quarterly sales and adjusted EBITDA leading to record annual sales. We have achieved all six near-term growth catalysts with our ward in the Bay Area. We believe we have a clear path to Goal 2020 and have made great progress executing our strategy demonstrated by our recent wins, historical high backlog, reshaped portfolio, and the absolute focus on technology. We expect our upcoming fiscal year 2019 to be another year of strong growth and we will be focused on meeting our commitments and delivering excellence to our customers. Finally I'd like to welcome Prith Banerjee, who recently joined Cubic’s Board of Directors. Prith brings to Cubic an extensive background in academia, engineering, disruptive technology, and research and development. Prith is currently the Chief Technology Officer for ANSYS, a leading engineering simulation provider. I look forward to his leadership and insight as we continue to work adjacency expansion and the digitization of our offering to provide keener insights to our customers In closing, I’d like to thank my Cubic teammates for their strong performance and commitment to driving long-term value for our customers and shareholders. Now, let’s proceed to the Q&A session.

[Operator:]

Thank you. Now we’ll be conducting a question-and-answer session. [Operator Instructions] One moment please, while we poll for questions. Our first question today is coming from Mark Strouse from JPMorgan. Your line is now live.

[Mark Strouse:]

Yeah. Hey, good morning. Thanks for taking our questions and congrats on the results here. So I just wanted to …

[Brad Feldmann:]

Good morning.

[Mark Strouse:]

Hey Brad. So on the transportation business, you guys have done a pretty phenomenal job over the last year, 1.5 year with these – this big contracts win, contract wins that you've had. Just looking forward, I think, I get the message that there's going be higher volume of maybe smaller deals especially with the potential synergies with traffic where. But are there any kind of the larger contracts you know of maybe nothing's equivalent to New York. But looking forward, any larger deals over the next couple of years that we should keep our eyes on?

[Brad Feldmann:]

Yeah, I think there's a few of them. Paris is a fairly large deal. Montreal and Toronto are large deals as well. I would also expect that I think we suggested in the previous call that we had 61% market share regarding mobile ticketing and we would expect for instance in the City of Los Angeles where we’re putting the cap card in the phone that will start getting recurring revenue streams using that card. So I would expect with re-usability, mobility some of these bigger contract areas we will continue to grow the business and expand margins.

[Mark Strouse:]

Brad, okay. And then let's see, you’ve announced our legacy flows, the acquisition of the Trafficware and you've got a lot of the large contracts yes. It sounds great. And so, sorry Brad.

[Brad Feldmann:]

No please.

[Mark Strouse:]

Oh, sorry Brad, okay. So in closed Trafficware you got a lot of these big contracts that you’re executing on. Can you just kind of talk about your ability or your appetite for further M&A over the next year or so. Just from a management bandwidth perspective if nothing else?

[Brad Feldmann:]

Yeah. We continue to look at acquisitions that are in line with our strategy. And there are a number of women that – that we’re looking at. And so, I would expect us to continue to be acquisitive going forward.

[Mark Strouse:]

Okay. I’ll hop back in queue. Thank you very much Brad.

[Operator:]

Thank you. Thanks you. Our next question today is coming from Jim Ricchiuti from Needham & Company. Your line is now live.

[Jim Ricchiuti:]

Hi. Congratulations in the year. I had a couple of questions on the segment margins, you showed significant improvement in margins in the CMS business and I’m just wondering just given the seasonality that you see in the business, how should we think about and I’m just wondering you know just given the seasonality that you see in the business how should we think about those margins in fiscal 2019.

[Brad Feldmann:]

Hi, Jim. So the margins reflect our continued growth in the business along with our strong execution. So while the seasonality will remain in the business as the volume is backend loaded you'll see higher margins at the end of the quarter but the margins aren't a one-time thing, we expect the margins to continue to be in line with what you're seeing and potentially grow as the volume grows.

[Jim Ricchiuti:]

Okay. And just turning to the CTS margins, EBITDA margins, down a bit certainly from Q3 and I wonder if you could talk to that a little bit?

[Anshooman Aga:]

Sure, Jim. So if you remember last year we had disclosed that in Q4 we had a favorable contract resolution with the customer which had driven the margins up significantly in Q4 last fiscal year. The cost had been incurred during the course of the year and some in the prior year and in fiscal 2016. So when you look at margins I think the better comparison is year-over-year margins where the CTS margins, adjusted EBITDA margins have increased from 8.4% to 10.9%, so almost a 250 basis point improvement in margins. And again we're tracking well towards our Goal 2020 target of being between 13% and 15%.

[Jim Ricchiuti:]

Okay. And, Brad you may not be able to talk specifically about the size of some of these larger deals in the transportation but I'm wondering can you aggregate the Paris, Toronto, and Montreal opportunities just give us a sense as to you know maybe collectively what they could represent?

[Brad Feldmann:]

Larger opportunities and in general, Jim, our – are you know in the hundreds of millions of dollars range. I don’t know the aggregate number, but that's generally what they are.

[Jim Ricchiuti:]

Okay, now that's helpful. That's helpful. And then final question from me and I'll jump back in the queue, your range of revenues and EBITDA for fiscal 2019 and you know not that wide. But I'm just wondering, what the various puts and takes might be getting to the high end of that range? Thank you.

[Brad Feldmann:]

So Jim part of our CMS business, which you can tell is higher gross margin is tied to getting the orders and getting it shift in time, while we do have appropriations this year, it's the timing of some of the order entry in the CMS business. On our CGD business, you know we've made great progress with the live, virtual, constructive, we’re the only one who's been able to demonstrate this technology. We expect to start seeing orders, but again it comes down to timing of some of these orders. For CTS it’s a – you know most of the revenue is in backlog, it's just about a – it continue to execute as they have been doing this. There's a strong focus on execution that will remain in all our businesses, but for CTS, it's more about executing on the projects in backlog.

[Jim Ricchiuti:]

Okay. Thanks very much.

[Brad Feldmann:]

Thank you.

[Operator:]

Thank you. Our next question is coming from Ken Herbert from Canaccord. Your line is now live.

[Ken Herbert:]

Hi. Good morning, everybody.

[Brad Feldmann:]

Hi, Ken.

[Ken Herbert:]

Brad and Anshooman, I just wanted to take a little further if we could into the 2019 EBITDA guidance. I mean, when I look at the midpoint and I back out the acquisition, it's about $25 million. Are you – should I assume or can we assume that all of that increase obviously comes from CMS and CTS. And I wondered if you could give a little more granularity on the assumptions for sort of the EBITDA growth in those two businesses. And then as a second part of that obviously global defense, is that down again in terms of its EBITDA contribution in 2019 or what does that guidance imply really on a more segment level if you could?

[Brad Feldmann:]

Ken I’ll talk in generality since we don't breakdown our guidance at the segment level but just looking at the fundamentals of the business CTS has a strong backlog, it's going to continue to grow more than in terms of revenue and adjusted EBITDA margins. When you look at CMS with our T2C2 contract and network convergence that Brad talked about our potential growth we're the first net part of the business with our Radio over IP gateway. We will continue to see growth in that business. We also continue to invest in that business in terms of R&D. So our revenue and adjusted EBITDA will grow in that business. On the CGD side that's a little earlier in the technology inflection point. If you think of our three businesses with CTS, with the one account, with CMS gate and on the CGD side the live, virtual, constructive, so we've demonstrated that very successfully. There's a lot of excitement around our technology. And now it's getting to a program of record and driving growth through that business, the international pipeline remains strong. So while there won't be significant growth in that business it's not going to continue to decline. I think you'll see more of a stabilization in that business with that upward tech coming in the future years. Can all businesses are growing top line and bottom line.

[Ken Herbert:]

Okay, Brad that's helpful. And then if I could just within obviously CMS you've had great strong end of the year, and I think it's very consistent with what you were talking about. Can you just remind us either on one sort of gate or C2T2 or on obviously the network, the work you're doing with AT&T maybe a couple of the next milestones or how we should think about sort of key potential events as we go through fiscal 2019 in that business?

[Brad Feldmann:]

Yeah, I think one good thing we have just in terms of the environment is we've returned to regular order. We haven't had a budget before the fiscal year starts for more than 10 years. And so we think orders will come to us sooner as a result of that. And although it will be back end loaded it, it won't be quite as back end loaded. We've started to see a convergence other customers buying this T2C2 gate or solution. And so we'll see some expansion there. We've just really started with the FirstNet expansion and AT&T and Verizon. We hope we'll sell this like gangbusters for us, and those products have terrific margins. And so those are key things we have some key proposals out that we hope we'll win which will even drive further growth.

[Ken Herbert:]

Okay, that's great. And if I could just one final question Anshooman, as we look at free cash flow into fiscal 2019 I know obviously it’s little messy with Boston and how you roll that up, but how should we think about free cash flow. We either maybe as a conversion or any other sort of metric you will provide as part of the guidance into 2019?

[Anshooman Aga:]

So we continue to remain very focused on improving our free cash flow. If we exclude Boston, you should see some gradual improvement on free cash flow. One of the things that impacted our cash flow this year was having all the CMS revenue very, very backend loaded. So given that as Brad mentioned, we're moving towards more of a normal order if we can start getting some of the shipments out in Q3 and earlier in Q4 we'll be able to convert that into cash. So we continue to remain focused I think you'll start seeing improvements in 2019 going into 2020 further in terms of free cash flow conversion.

[Ken Herbert:]

Great. Thank you very much.

[Brad Feldmann:]

Thank you, Ken.

[Operator:]

Thank you. [Operator Instructions] Our next question is coming from Brian Ruttenbur from Drexel Hamilton. Please proceed with your question.

[Brian Ruttenbur:]

Thanks very much, good quarter. So Anshooman, if you could help me out a little bit on the quarterly breakdown you mentioned I think earlier in your commentary about profitability in the first quarter should be you made a statement that profitability is going to start off low then work high something along that lines. Can you talk a little bit about maybe revenue how will work from first quarter to fourth quarter and it will look the same way as this fiscal year and will you be profitable in terms EPS this last first quarter you had a negative start off with kind of in the whole then work your way out?

[Anshooman Aga:]

Hi Brian. Let me try and cover some of your questions in there. So seasonality, yes, similar to last year Q1 from adjusted EBITDA slightly higher than Q1 last year and revenue seasonality will be in line with that also. Given the fact that when you think of our CMS business being back end loaded, it drives significant gross margin on at the back end of the year, but when you look at the overheads in terms of SG&A, R&D those are linear, so that impacts the seasonality. When you think of transportation a lot of engineering going on, on our projects right now with the four large wins and Q1 has the least number of working days, which means our cost-to-cost percentage of completion to lease revenue and lease profit. So seasonality, similar to last year, EPS, we don't give guidance in terms of EPS, but you could probably translate last years into this year or next year also.

[Brian Ruttenbur:]

Okay. So by translating last year's into this year and looking at a similar EBITDA, we would – we would start off then just going logically with a negative going to a very big positive, is that the way you're thinking in terms logical?

[Brad Feldmann:]

Typically, yes, we also …

[Brian Ruttenbur:]

Okay.

[Brad Feldmann:]

We have made an acquisition of projects, where …

[Brian Ruttenbur:]

Right.

[Brad Feldmann:]

…we haven't done the purchase price accounting at this stage, so I can't comment on what the impact on taxes will be. But if you keep in mind that we have deferred tax assets, which we had to put a valuation allowance again, so we don’t show that deferred tax asset on our books. This acquisition does create deferred tax liabilities and when we have deferred tax liabilities, I can release some of the valuation allowance to cover the deferred tax liabilities. So we should see some pickup in taxes in Q1, given the fact we haven't done a purchase accounting yet, I can’t quantify that number.

[Brian Ruttenbur:]

Okay. And then just as a follow-up another financial question, sorry, is about SG&A. As a dollar amount we should be seeing a drop because of ERP implementation in 2019, even with this acquisition and all the moving parts is that correct?

[Anshooman Aga:]

As a percentage you'll see a significant drop in terms of total SG&A our ERP related expense will be down. We were at $24 million in fiscal 2018 versus guidance of $25 million so just under of what we told you. But if you go to the appendix of our slide deck, you’ll see it’s about $10 million next year. We have also mentioned there'll be some restructuring and business optimization charges, which will lead to savings and One Cubic initiative. So – but as a percentage it be down.

[Brian Ruttenbur:]

Okay. Thank you very much.

[Anshooman Aga:]

Thank you, Brian.

[Operator:]

Thank you. Our next question today is coming from Louie DiPalma from William Blair & Company. Your line is now live.

[Louie DiPalma:]

Good morning.

[Brad Feldmann:]

Hey Louie.

[Louie DiPalma:]

A lot has been made about a lack of formidable competition for Cubic and public transit payment. I'm playing devil's advocate, CapEx believe that the reason there weren't more bidders for San Francisco and Boston is because the margins are low? Can you provide your perspective on why there weren't more bidders for some of these large contracts? And related to this [indiscernible] in London and Chicago?

[Brad Feldmann:]

I missed that last part Louie, can you repeat that second part please.

[Louie DiPalma:]

Yeah I was wondering how significant has it been, the fact that you already have in – some of these automated fare collection contracts.

[Brad Feldmann:]

Yeah, Louie, I think I got most of that all, if I didn't you know please help me. But what I would say Louie, is a few years ago when I changed jobs we significantly increased our R&D investment. I think we were below $20 million and now we're in the $50 million range. And in addition to that, we put a lot more emphasis on co-development with our customers. So we're getting R&D investments, we’re co-developing with our customers to significant amounts above that. And one of the things that we “invented” is this thing called one account and One Account is where transactions are done in the back office as opposed to with a closed loop card, prepaid touching a reader and doing the math and letting you through. The reason that’s significant is because it will allow a city to have one account for all transportation needs within the city and it will allow the operators in the city to have congestion based pricing because you’ll have visibility over potentially all the modes of transport. And so we made a bet on that and invested in that and invented that and implemented that in Chicago and in London and in Vancouver. And so when these four big cities came up this current year they called out One Account and we just had invented it and had already made the investments. So another bidder who isn’t in that position, their costs go up significantly. So for them their margins are lower because they have more cost. For us, we're going to make very good money. And I think are you know I call it our legalization strategy of instead of building bespoke systems we’re reusing these code sets. And so there was a lot of momentum gained as you know when we you know when we won New York, and Boston, and in Brisbane. And what happened in San Francisco was you know publicly is no one else bid. And so I don't think it was – it's not our margin profile but I think your question is quite insightful. They had a huge non-recurring bill to pay to compete.

[Louie DiPalma:]

Thanks, Brad. And can you discuss in a little more detail of the potential revenue synergies associated with Trafficware and you think Trafficware where has value in terms of your ability to cross-sell your transit payment solutions to the Trafficware customer base and potentially go after the middle market that is.

[Brad Feldmann:]

Again insightful questions, Louie. Thank you. So you might also notice on the call we won a job in Sydney called integrated congestion management program and this is sort of like a command center that will take all the feeds of the various transportation networks and help the city deal with congestion. To control congestion in a city just very simply, it's really helpful to control the traffic lights. And so, you can kind of see that there's a command center and traffic whereas ability to control the traffic lights is you know sort of like ham and eggs and then on top of that Trafficware has been doing some experimentation and has actually delivered product to test beds for instance in Las Vegas where they're dealing with autonomous cars. And so the autonomous cars if you will the smart cars needed smart infrastructure and Trafficware is providing that. When you take a step back even broader to the NextCity vision you know surface transport is absolutely in the middle of the fair way of trying to reduce congestion under our NextCity strategy. So we think it perfectly aligns and quite frankly we'll open up in a bigger way adjacencies and we for sure we'll see revenue synergy going forward.

[Louie DiPalma:]

Okay and last one on defense training. Do you have any estimate as the potential size of a program of records that slate could be and some are related to this. Do you expect that for defense training that the overall growth rate over the next three years will resemble your– the 3% to 5% growth rate that you articulated in the 2020 goal presentation?

[Brad Feldmann:]

So the way I’d answer that question is if you look at air combat maneuvering instrumentation market in the previous generation called P5 that was on fourth generation airplanes, as well as there is a box on the Joint Strike Fighter, all of those pods and infrastructure and so forth was worth well over a $1 billion. And so what will happen is this live virtual constructive improvement upgrade next generation will replace all of that. And so it will be well north of a $1 billion over time. And the reason it's so significant is that we can now efficiently and effectively stress fighter pilots more, and the way we do that is by putting synthetic threats in the cockpit. Here to for the cockpit would only speak to the pod out. Now the pod speaks into the cockpit, and we can synthetically create enemy forces if you will such that and every time air forces fly a sortie, fly an airplane, it's at least $20,000, the JSF is up to $50,000. So if you can synthetically create these entities you can save the government an awful lot of money.

[Louie DiPalma:]

Sounds good. Thanks Brad.

[Brad Feldmann:]

Louie, thank you.

[Operator:]

Thank you. Our next question is a follow up from Ken Herbert from Canaccord. Your line is now live.

[Ken Herbert:]

Just a quick follow-up, Anshooman if you could, you just talk about expectations or your assumptions in the guide for FX in 2019. I know obviously the UK continues to be I think about 20% of your sales. Are you doing anything different in terms of your currency exposure and what are you seeing or how, what are the assumptions in the guide around FX.

[Anshooman Aga:]

From FX perspective guidance assumes constant or constant FX. In terms of managing our FX risk we do manage it in the sense that we try and see local revenue, local currency cost, if we don't have local currency cost, we do hedges, do hedge foreign currency risks over a certain amounts of, so we do manage a foreign currency exposure but just from a conversion perspective to U.S. dollars we're using constant currency.

[Ken Herbert:]

Okay. Great and sorry if I missed it but what should we assume as a tax rate for fiscal 2019?

[Anshooman Aga:]

Again we haven't given tax rate guidance. There are a couple of things to think about though from a tax perspective. One as we've said in the past we're basically investing in the U.S. with our ERP investments, our R&D investments. So we're in a cumulative loss position in the U.S. making most of our money overseas. What happens is we're paying taxes overseas but any deferred tax assets, we don't put it on the books in the U.S. we put a valuation allowance. So when thinking 2020 and beyond we turn profitable, we'd be able to release these deferred tax assets. So temporarily our tax rate is higher. On the flip side, what I mentioned, we haven't done a purchase accounting yet but we will see some valuation allowance released on those deferred tax assets based on this acquisition we did because it does generate deferred tax liabilities. So I think you’ll see some clarity on – the impact of the acquisition in Q1.

[Ken Herbert:]

Okay. Thank you.

[Operator:]

Thank you. Our next question is a follow-up from Brian Ruttenbur from Drexel Hamilton. Your line is now live.

[Brian Ruttenbur:]

Yes. This is for Brad. Just a real quick follow-up, maybe a little macro on 2020 DOD budgets. Can you talk about – there’s been a whole lot of talk from a lot of my companies about budget fight going on already for 2020. Can you talk about what you see going on with the training budgets with the peers that the military is getting larger, training can be more, but I want to hear what you have to say about your budget and the battles to come.

[Brad Feldmann:]

So as you know we returned to regular order this year and the sec def was expecting increases. And in 2020 and you also know that recently there has been chatter out of the White House and we have more divided government. What I would say is that the first comment I'd make is that $700 billion is a lot of money will continue to be invested in the readiness of the work of their – of the forces. I’d also say that we’re in good areas within the budget, I don’t see C4ISR, I see continued growth. So and I all see growth in training readiness. And then taking a step back, having said all that as you know there's been tremendous pressure on our NATO allies to increase their defense span in line with their GDP. So, I don't see it as a significant issue for us given that $700 billion is a lot of money and we have many customers outside the U.S.

[Brian Ruttenbur:]

Okay. Thank you.

[Operator:]

Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to Brad for any further closing comments.

[Brad Feldmann:]

Thank you for joining us today. Cubic had a tremendous year, and we remain very optimistic about the future. We look forward to you joining us on the next call.

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.