ManTech International Corporation
Q2 2020 Earnings Call Transcript

Published: 30 Jul 2020

[Operator:]

Ladies and gentlemen, good afternoon and welcome to the ManTech’s Second Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Stephen Vather, Vice President, Corporate Development and Investor Relations.

[Stephen Vather:]

Welcome, everyone. Thanks for participating on ManTech's second quarter call. Joining me today is Kevin Phillips, our President and CEO; Judy Bjornaas our CFO; and Matt Tait, our newly appointed COO. During this call, we will make statements that do not address historical facts, and thus are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to factors that could cause actual results to differ materially from the anticipated results. For a full discussion of these factors and other risks and uncertainties, please refer to the section entitled Risk Factors in our latest Form 10-K, and our other SEC filings. We undertake no obligation to update any of the forward-looking statements made on this call. On today's call we will discuss some non-GAAP financial measures, which we believe provide useful information for investors. These non-GAAP measures should not be evaluated in isolation or as a substitute for GAAP performance measures. You can find a reconciliation of the non-GAAP measures discussed on this call in our second quarter earnings release. With that, let me hand the call over to Kevin.

[Kevin Phillips:]

Thank you, Stephen and good afternoon, everyone. First, it is my hope that you and your families are remaining healthy and safe given the continued impact of the pandemic across our nation and the globe. I will be covering a number of topics. As such I will be structuring my remarks in the following order

[Judy Bjornaas:]

Thanks, Kevin. I'm very pleased with the performance of the business in the first half of 2020. We are finding our footing and navigating through the complexities posed by the pandemic. Overall, the results in the quarter exceeded our expectations across all of our key measures. Revenue for Q2 was $632 million up 18% and nearly 90% of the growth was organic. Sustained customer demand in the form of new contract wins and growth on existing programs served as the major drivers of our growth. Direct labor remains pivotal to our revenue growth. In the quarter, we performed 91% of our work as a prime contractor and our contract mix remains largely unchanged with approximately 69% cost plus, 19% fixed price, and 12% kind of materials. EBITDA for the quarter was $57 million and grew 22% over Q2 of 2019. EBITDA margin of 8.9% outpaced our expectations and represented a 30 basis point improvement year-over-year. Margin in the quarter was driven by a number of factors. The main driver was our robust direct labor growth due to strong hiring in the quarter and was bolstered by reduced lead taken by our workforce. We expect the significantly below average lead trends to normalize in the balance of the year and certainly next year. The second key driver was strong indirect cost management, most of which comes from non-recurring cost containment measures in asset in the face of uncertainty from the pandemic. The more notable items include reductions to executive compensation and a freezing of investment spend, as well as reduced spend on travel, conferences, medical, and other normal spend due to COVID. Also as the quarter progressed we experienced less than anticipated impact from those that were in a mission-ready state as customers began to slowly ease restrictions. Now, that we have a better sense for the actual level of the impact of the pandemic, we are in a position to adjust spending accordingly for the rest of the year. The last noteworthy item that drove stronger margins in the quarter were positive adjustments of our estimates at completion for a couple of contracts that are approaching and end this year. The bottom-line benefited from our higher than expected revenue growth and solid margins as well as a slightly lower than expected tax rate. Net income was $30 million and diluted EPS was $0.74 for Q2, both up meaningfully compared to last year. Strong growth was also evident in our adjusted figures. For the quarter, adjusted net income was $34 million and adjusted diluted EPS was $0.84, up 21% and 20% respectively from last year. Now, on to the balance sheet and cash flow statements. For the quarter, we collected $62 million in cash flow from operations representing 2.1 times net income. Customers continue to pay on a timely basis and our DSO was 63 days at quarter end a three-day improvement from last year and one day better than last quarter. We distributed $13 million in dividends for the quarter. The Board has authorized us to maintaining our quarterly dividend level of $0.32 per share to be paid in September. Given the current rate environment and the quality of our balance sheet we believe the current yield of approximately 2% is quite attractive. At quarter end, we had $30 million in cash and $20 million of debt. Over the course of the quarter, we repaid a majority of the draw against the revolver as thankfully the need for increased liquidity did not materialize given normal payment processing and that the capital markets began to show greater stability. Our stellar balance sheet and strong cash flow continues to afford us flexibility in investing for growth. We are actively reviewing M&A opportunities as we have seen the market return and we will execute on those that are strategically and financially compelling fits for ManTech. Now, on to our revised 2020 guidance. Based on the strength of the performance to-date we are raising and narrowing our ranges for revenue, adjusted net-net income and adjusted diluted EPS as compared to our previously communicated guidance. We now expect revenue to be between $2.45 billion and $2.5 billion, which represents 10% to 12% year-over-year growth. Our backlog continues to provide good visibility for the balance of the year. The five principal drivers of variability in our guide continue to include the timing of contract awards our success in winning new and recompete peak business the pace of hiring and ramping new and recent contract awards, the level of material procurement and whether the Cares Act 3610 coverage is extended for Q4. Turning to margins. Our guidance assumes an EBITDA margin now of 8.8% for the year, representing a 10 basis point improvement over 2019 solidifying the upper range of what we previously communicated. Second half margins will be impacted by the expectation that employee leaves and other indirect costs will normalize, the catch-up of full year investments over a six month period; and lastly, the uncertainty of 3610 coverage for Q4. To clarify the 3610 extension risk, our guidance reflects our best estimates based on our current observed impact in the first half, but should there be material changes in the trajectory of the pandemic there could be incremental impact to the guidance provided. At the bottom line, we are expecting adjusted net income between $127.6 million and $130.3 million. An adjusted diluted EPS between $3.14 and $3.21. Underlying these guidance ranges are an effective tax rate of 24.7% and a fully diluted share count of 40.7 million shares both of which are down slightly from previous guidance. Now to cash flow. We are increasing our expectations for cash flow from operations to be at least $175 million for the year. This represents a 17% increase from our prior guide. We continue to anticipate capital expenditures to be between 3% to 4% of revenue. Now over to Matt to cover over the business development and operational highlights in the quarter.

[Matt Tait:]

Thanks Judy. I'm excited to join the call today as ManTech's Chief Operating Officer and share some business development and operational highlights. Bookings totaled $663 million resulting in a little over 1.0 book-to-bill. Sole source expansions and extensions with classified customers drove the majority of bookings in the quarter. New business awards represent over half of the bookings over the past 12 months. Our total backlog was $9.2 billion and funded backlog stood at $1.4 billion both holding steady. We are seeing contract consolidations continue to occur in segments of our market, and over the last few years ManTech has strongly benefited from this trend. However, this quarter we experienced a mixed outcome on a couple of efforts. Most of this work would have been new for ManTech, but I wanted to note that there were components of the overall awards where we were an incumbent. Our success rates will not be perfect on these consolidations, but overall we expect it will remain strong. Exiting the quarter, our proposal's outstanding figure stood at a healthy level of approximately $6 billion. I am confident that we have the right team, differentiated capabilities and competitive pricing to drive bookings consistent with our record over the last few years. We continue to see ample opportunities for continued growth and I look forward to leveraging ManTech's strong capabilities across the federal market. On the operational front, our ramp-up of the Navy NPRA program is going well and at a steady gradual pace. The time line is holding to 18 to 24 months to fully ramp the program. As touched upon earlier, we are seeing very strong hiring in the quarter and certainly higher-than-anticipated despite the pandemic. This as well as the reduced employee leave and less than expected impact from individuals in a mission-ready state are all driving factors in the robust level of direct labor in the quarter. With that, let me hand the call back over to Kevin for closing remarks.

[Kevin Phillips:]

Thanks, Matt. In closing, let me leave you with a few thoughts before we take questions. The business has shown incredible resilience and remains focused on growth even amidst a more uncertain macro and budget environment. I want to emphasize that ManTech enjoys customer and contract diversity with differentiated capabilities in cyber, analytics, in IT and systems modernization, where we expect demand to remain steady. Demand is being bolstered by the persistent elevated global threat environment, change in customer operating postures brought out on by the pandemic and the broader trend of cyber and digital transformation across the federal government. We are working at the heart of critical customer missions and our focus on technology to enable customer missions is favorable. Our continued commitment to shareholders is to drive value through growth both organically and through M&A. Before we turn to questions, I want to offer my continued thanks to those who are operating on the front lines in fighting this pandemic. We are genuinely grateful for all your efforts over the past few months and for the foreseeable future. Operator, please open the line for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Tobey Sommer with SunTrust. Your line is now open.

[Jasper Bibb:]

Hey, good afternoon. This is Jasper Bibb filling in for Tobey. I was hoping you could update us on the Space Range program and some of the opportunities you're seeing on that front?

[Matt Tait:]

So, yes for the space range, we actually are having a lot of very good conversations with customers. We actually have built up a very significant pipeline. So we're excited about that. I'd say more details to come on that in the future. But we're very excited about the traction we're getting there.

[Jasper Bibb:]

Thanks. And then just on the update of revenue guidance, how much of a top line headwind is assumed for COVID billing impact?

[Judy Bjornaas:]

Really not that much. It's – we got most of everything covered in Q2. It's been dropping as Kevin talked about in Q3 and then depending on what happens in Q4, we feel like the guidance range is broad enough to cover most reasonable possibilities around what might happen with that.

[Jasper Bibb:]

Great. Thank you very much.

[Operator:]

Thank you. And our next question comes from Gautam Khanna with Cowen. Your line is now open.

[Gautam Khanna:]

Yes. Judy I was wondering if you could first, give us some color on the margins. How much of a benefit was there from the EAC adjustments in the quarter?

[Judy Bjornaas:]

I would say a little bit more than we usually see from quarter-to-quarter. But probably, it was offset -- it was enough that offset basically the lost fee on the COVID labor so it kind of washed out.

[Gautam Khanna:]

Okay. And then just stepping in back and looking into next year based on what you've booked this year and what's in the pipeline, do you see a case for margins to expand next year?

[Judy Bjornaas:]

I think it's a little premature right now to talk about 2021. There's a lot to happen in the next six months. We're outperforming this year. And I think the Q3 call maybe we'll be in a position to give a little more color on 2021.

[Gautam Khanna:]

Okay. And you did talk a little bit about the M&A pipeline starting up again. I was wondering if you could talk about just the types of things you're seeing. Are you seeing smaller acquisition opportunities? Or are they -- are you seeing some big ones as well? Sort of what characterizes the pipeline, if you can characterize it?

[Kevin Phillips:]

It's Kevin. It's fairly broad. I mean there was a pause based on uncertainty as you know in terms of financing and just the overall environment in early Q2. And it's a fairly broad range of businesses and assets. So I'd say, it's the normal plus a little bit heavier flow on smaller to mid-size, but some of them are fairly attractive and it's good to be able to get back in the group of looking at opportunities and seeing how they fit into the business.

[Gautam Khanna:]

Thank you very much.

[Kevin Phillips:]

Thanks, Gautam.

[Operator:]

Thank you. Ladies and gentlemen, our next question comes from Brian Kinstlinger with Alliance Global Partners. Your line is now open.

[Brian Kinstlinger:]

Thanks so much. 2Q is not seasonally a strong awards quarter. I'm wondering how COVID is impacting. And I think you talked about it last quarter as a potential risk the sales cycle and the procurement cycle. So do you think that in spite of COVID the third quarter will still be as typically seasonally strong as it usually is in terms of awards? And then how do you think COVID impacts if at all contractors' ability to displace incumbents on existing programs?

[Matt Tait:]

So I think what we're seeing is we're expecting to see choppiness for the rest of the year just because there is so much variability with COVID. We thought our 1.0 book-to-bill was pretty reasonable given all the circumstances that were going on there. And then on terms of -- I think you asked a question about transitioning work from an incumbent or to an incumbent. And I think that's really -- that's very specific to each program and to each customer in terms of how they're dealing with it. I mean, you have to remember a lot of our workforce actually is their day did not change. They are still out in the field, still in a lab, still in a care. So we still have a lot of folks that are still going to government places every day.

[Brian Kinstlinger:]

When you talk about bookings spreading, are you saying that the typical third quarter seasonal strength may slip into the fourth quarter and the third quarter might not make up as high a percentage of bookings as it typically does?

[Kevin Phillips:]

Yes. Look there's a lot of proposal activity that's picking back up. But the timing what we're seeing is it's uncertain. We don't know when the government will be awarding those based on these conditions. So yes, it's uncertain. Can't tell you either way.

[Brian Kinstlinger:]

And then, did I hear correctly? Did ManTech lose some meaningful contracts? Was that what you were trying to say? And if so, can you size those losses on an annual basis in terms of revenue?

[Matt Tait:]

No that -- sorry that was not, what we're trying to say is just that look in the past consolidations have helped us. But this quarter we were just less successful. We have a very diverse business and we have no large contracts or anything like that that we are concerned about.

[Brian Kinstlinger:]

Great. Last question, I have. Can you talk about what percentage of your billable staff is working remotely versus which ones are able to work at the program site, and/or what percentage of your programs may be more frozen or delayed?

[Kevin Phillips:]

Yeah. I'll speak to the latter. If we take about the number of people that were put into a mission-ready state, at the beginning of this crisis maybe 12%, 13% of our population had some number of hours that they had to spend not on-site, because the adjustments customers were making for social distancing and things like that. Not full-time, on the COVID chart, but part of that time. Now that number is closer to 8% of our population is on some number of hours, but those number of hours that are dependent on this mission-ready state coverage is declining as well. So it's declining, it's not a huge number, but for companies in our sector, it's still a large number of people, that are needing to use some of that mission-ready time, until our customers are fully operational or have a good safe way. Now I will also note that, there are a lot of stringent measures at federal facilities and our facilities that are really making a difference in preventing COVID spread. If there is any COVID spread happening that we're seeing recently, it's more for people that are kind of working. So I'm very optimistic about what we're seeing with the customer sites. And our facilities about the security measures and safety measures in place.

[Brian Kinstlinger:]

Great. Thanks so much for your time.

[Kevin Phillips:]

Yeah. Thank you, Brian.

[Operator:]

Thank you. Our next question comes from Joe DeNardi with Stifel. Your line is now open.

[Unidentified Analyst:]

Hey guys this is John on for Joe. Good quarter. I want to first just touch on the labor market. You guys are up about 300 employees, this quarter. Can you guys just give us some color on, what you're seeing broadly in the labor market? And kind of, talk to your success in ramping up the number of employees given that six months ago we were in such a tight labor market?

[Matt Tait:]

Yeahs. Well look, I think that first of all the labor market is still competitive for sure. But one of the things that we feel that, we've done a great job of is we already had some full virtual onboarding programs, to start with just because of us being in 30 different countries. And that has really been something we were able to scale very quickly to continue to hire without really, having any dip whatsoever. So we felt -- so we've actually found that that was something that I would say was a program we just leaned into, to accelerate the hiring for us.

[Kevin Phillips:]

I'll add to that briefly. The infrastructure and investments, we've put in place over the last few years to help grow the business. But also to make sure that our workforce can securely work, any location is really paid off as well as the national structure for teleworking is really strong too. So I think that, things really worked out well. It was uncertain, but they've really worked out well in terms of our ability to bring on a remote workforce. And also support our remote work force.

[Unidentified Analyst:]

Thanks, guys. Good color. I want to just pivot now to the M&A environment. You guys have always been very disciplined about your approach. I just want to get your thoughts around how your approach now going into a very different election year than we've seen in prior years. Are you starting to kind of place in that political risk? And how does that kind of affect your decisions when it comes to defense versus civilian customers?

[Kevin Phillips:]

Yes, that's a great question. We appreciate that. If you look at the general, I'd say view of platforms of administrations it's hard to see ultimately what the overall discretionary budgets will be and how they allocate that. But just the macro would suggest that there's going to be a lot of focus on less spend. That said there's a continuing prioritization to focus around space, around cyber, around all things digital. And we believe that within whatever that budget framework is going to be we're in a good space to be able to continue to compete and grow the business. Once elections are over and determinations are about who's going to be in what role both in the executive branch and legislative branch then we'll look at the federal budget trends and be able to move quickly about that and see what we want to do just like we have for the last 50 years. We'll adjust on the fly as things start looking. But we still are focused on -- in defensive DHS, Department of State, Federal Health those continue to be areas of focus for us on that side of the equation regardless.

[Unidentified Analyst:]

Awesome. And then just lastly if you guys could kind of talk to your two different customer sets again defense and civilian. Are you seeing a difference in their awards approach thus far in third quarter? Specifically, are certain customer sets opting to do more sole source or extensions? Is that kind of what's driving the choppiness? Or is it simply more a function of working remotely and not being able to perhaps team with the members as effectively as they did last year?

[Matt Tait:]

This is Matt. I'll probably give you the answer of all of the above, right? I mean I think all of those things are contributing and tell what we're talking about in terms of choppiness moving forward.

[Unidentified Analyst:]

Thank you, guys.

[Operator:]

Thank you. Next question comes from Louie DiPalma with William Blair. Your line is now open.

[Louie DiPalma:]

Kevin, Judy, Matt and Steven, thank you for picking my questions. And Matt congratulations on your promotion.

[Matt Tait:]

Thank you, sir. Appreciate it.

[Louie DiPalma:]

So there has been a lot of investor discussion about election risk. And Kevin you just addressed the topic a little bit and during the defense downturn in 2012 and 2013 in which Kevin you were the CFO ManTech had its MRAP S3 and mobile cell tower contracts that were heavily tied to Oppo funding in Afghanistan and the wind down of these programs obviously pressured revenue back then. Am I correct to assume that things are different now and you don't have these types of transitory contracts today in your revenue base?

[Kevin Phillips:]

Yes. So we have a much more diverse set of contracts both in revenue size, as well as the type of work we do. And over the last five or six years, we've been very focused on investing in areas where we think the long-term growth will be supporting our expansion and is worked out. And if you -- again if you look at the overall platforms and priorities we think that those are going to continue to be within whatever that framework is in terms of the budget positive. So we have done a lot to reposition the business and we're very positive about that.

[Louie DiPalma:]

Great. And Kevin and for the team I guess you highlighted in your press release how a large portion of your $667 million of bookings this quarter came from extensions of classified contracts. And ManTech is generally unique in that. You don't have a lot of these mega contracts. But I was wondering for your revenue base are you able to share like the general split breakdown between classified revenue and revenue that comes from non classified contracts? And related to this would you say that classified contracts have the same like degree of stickiness as like general IT and cyber contracts?

[Kevin Phillips:]

So yes the answer is we -- if you look at our investor information about 40% to 45% of our business is supporting the intelligence community. It is sticky in that and you do have to have approval to support the government on those and the people have to have clearances. But if you look at the business, whether it's in the intelligence community or outside of it, we're over half of our businesses in cyber and in IT today. Those are going to continue to be a priority. And again the need for the types of technology is across all the different customer sets we have is going to continue to grow just based on the overall global environment and the press.

[Louie DiPalma:]

Thanks.

[Operator:]

[Operator Instructions] Our next question comes from Mariana Perez Mora with Bank of America. Your line is now open.

[Mariana Perez Mora:]

Good afternoon, everyone. So I will follow-up on the elections and budget questions. Because there are increased like investor concerns on the flattening defense budget. And the defense services contractors are being punished the most as everyone sends them on shorter-term expos versus the defense primes. So could you please discuss how is ManTech positioned now with the set of capabilities and with the backlog and the longer and larger contracts you have in backlog how are you exposed to this flattening defense budget?

[Kevin Phillips:]

Yes. So if you look at – this is great question. If you look at the $9 billion backlog we have the term of contracts is on average five years. So that gives you some visibility. And those are already kind of baked in, in terms of the demand signals. If you look at the FY '21 appropriations in NDAA that's already fairly set in terms of the amount. So most of the discussions that we view with the end of '22 forward view of how funding would be prioritized and re-appropriated if need be. But again, everything we're seeing is states or suggest that the technology use in different customer sets is going to continue if not go faster. And it's going to be more dynamic based on what's happening in the market. So we're – again, we're fairly comfortable with where we are recognizing that it's a fluid situation and we have to look at a broader set of outcomes in our industry.

[Matt Tait:]

And I would add just to Kevin's point is that the threat environment is not changing. And so we still see where we are focused is where those demand signals we believe will continue.

[Mariana Perez Mora:]

Yes, makes sense. Then it is related to taxes. According to the last tax reform starting in 2022, research and development deductions will have had to start being amortized over five years instead of like the one year. How is that going to impact your cash taxes in 2022?

[Judy Bjornaas:]

They'll be a little bit higher. We don't have -- we had a big pickup from the R&D credit that will start being amortized in 2022 over five years, but the per year amount of that was not big. We basically had a big pickup for re-filing multi-years. And then we'll have to pay the payroll taxes that we're not paying right now because of the CARES Act also in 2021 and 2022, but that doesn't flow through the tax line.

[Mariana Perez Mora:]

Okay. But those are not expected to be a significant headwind to...

[Judy Bjornaas:]

Yes. If we especially continue on our M&A front our tax cash rate is significantly lower than our book tax rate.

[Mariana Perez Mora:]

Okay. And last one could you please remind us the recompetes risk for the remainder of the year and next year?

[Judy Bjornaas:]

So next year we're expecting a normalized recompete year of about 20% to 25%. There's not a lot of recompete risk in the 2020 guidance. The recompetes that we have are kind of spread over the next six months and not a significant amount. So kind of worked through a lot of the 2020 recompete risk and the normal 2021 recompete risk.

[Mariana Perez Mora:]

Okay. Thank you very much.

[Judy Bjornaas`:]

Thank you.

[Matt Tait:]

Thank you.

[Operator:]

Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back to Stephen Vather for any closing remarks.

[Stephen Vather:]

Thank you all for your participation on today's call and your interest in ManTech. As usual members of our senior team will be available for any follow-up questions. Have a good evening and please stay safe.

[Operator:]

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude your program and you may now disconnect.