Mike Smith - Director, IR Ken Hunzeker - CEO and President Matt Klein - SVP and CFO.

Morey Marcus - Sidoti.

Good day, everyone and welcome to the Vectrus Incorporated Third Quarter 2015 Earnings Conference Call. Today’s call is being recorded. For opening remarks and introductions, I’ll turn the conference over to Mike Smith. Mike, please go ahead..

Thank you, Debbie. Good morning, everyone. Welcome to the Vectrus third quarter earnings conference call. Joining us today are Ken Hunzeker, Chief Executive Officer and President; and Matt Klein, Senior Vice President and Chief Financial Officer. Slides from today’s presentation are available on our Investor Relations website at investors.vectrus.com.

Please turn to Slide 2. During today’s presentation, management will be making forward-looking statements pursuant to the safe harbor provisions of the federal securities laws.

Please review our safe harbor statement in our press release for a description of some of the factors that may cause actual results to differ materially from the results contemplated by these forward-looking statements. We assume no obligation to update our forward-looking statements.

Also, we’ll be making reference to non-GAAP financial measures during this call. We remind you that these non-GAAP financial measures are not a substitute for their comparable GAAP measures.

You can find the non-GAAP reconciliation and other disclosures in our earnings release and in our presentation slides, which are publicly available on the Vectrus website at investors.vectrus.com. At this time, I would like to turn the call over to Ken Hunzeker..

Thank you, Mike. Good morning, everyone and thank you for joining us on the call today. We are excited to be here to discuss our third quarter results. Please turn to slide 3.Before we get started, I would like to point out that Vectrus completed its full year as a publicly traded pure-play government service company.

There was a tremendous amount of effort put into this achievement and like to thank all of our employees for their contributions. Turning to results. I'm pleased to announce that the third quarter, our core business revenue, which excludes Afghanistan continue to grow and increased 17% year-over-year to $260 million.

This is a second consecutive quarter of year-over-year core business growth. Our Army Corps of Engineers Information Technology contract reached full operational capability in the third quarter and helped drive core business growth. Total revenue was $299 million in the third quarter, up 4% year-over-year on an adjusted basis.

Contracts based in Afghanistan contributed $39 million in revenue. Our adjusted operating margin in the third quarter was a solid 3.9%, highest we've seen in over a year. Our steadfast commitment to operational excellence is bearing fruit as is demonstrated in our improved operating margin.

Overall, we are continuing to execute and make progress towards realizing our 4% to 5% normalized operating margin goal. Adjusted EPS was $0.65 per share in the third quarter, up 10% from the prior year. We generated $10 million of free cash flow in the quarter and made a voluntary debt payment of $3 million.

The strength of our free cash flow has enabled us to make over $9 million in voluntary debt payments year-to-date. During the third quarter, we’ve recorded a favorable settlement on uncertain tax positions associated with our former parent. Please turn to slide 4. We’ve had some recent developments that I would like to discuss.

First, within our IT and network service line, we're seeing opportunities to expand our market share. We've been gaining traction in this market and believe it would be an area of future growth for Vectrus. In order to help achieve our growth objectives in this market, we’ve recently made a key strategic hire.

We're delighted that Chico Moline has joined us as Vice President of our IT and Network Communication service line. Chico has a strong track record of strategic growth, profit and loss experience and operational excellence within the IT and network communication space.

Overall we believe expanding our footprint and presence in the IT and network market aligns with our long-term strategy of enhancing the foundation, balancing the portfolio and providing more value. Second, as you may know, we have some upcoming major re-competes that we've discussed in prior calls that I’d like to briefly touch-base on those.

Our largest re-compete on a revenue basis is the Kuwait Base Operations and Security Support Services program also known as K-BOSSS. This quarter we were awarded a $221 million extension to the current contract that runs into March of 2016. We submitted our proposal for the K-BOSSS re-compete in May.

As it stands, bids are under evaluation and the process is ongoing. Turning to our re-compete on outside Kuwait, in Qatar, the request for proposal has been released and the award is expected in 2016.

Regarding our Maxwell Base Operations Support program, we’re currently performing under a bridge contract that runs into May of 2016 and has the potential for an additional two, three-month option periods. We believe we earn the right to win re-competes every day beyond on the current contract.

We do not take our incumbency for granted and we believe we are well positioned to win. I would also like to provide an update on the status of the $411 million Thule Base maintenance contract. As you know, there are several protests surrounding the award. In May, the Court of Federal Claims edited judgment in favor of the protesters.

Our Danish company as well as United States Air Force appealed the Court of Federal Claims decision. The matter is scheduled to be briefed - fully briefed in mid-December with earrings to be scheduled shortly thereafter. As we have stated in the past, this appeal could take a while, but we believe we have a strong case.

Turning to awards, we have solid funded orders in the third quarter totaling $444 million, which represent 1.5 funded book to bill ratio. We remain laser focused on building our business development pipeline and positioning Vectrus from future opportunities.

Additionally, we are encouraged to see some past quarter come up for bid on the IDIQ contract vehicles wins that we reported last quarter. With that being said, the timing of awards remains hard to predict and contract awards continue to be impacted by protests and other delays.

We have approximately $1 billion of bids submitted awaiting potential award and over the course of the next 12 months; we plan to submit proposals on approximately $6 billion of new pursuits with $3 billion expected in the remainder of 2015. I would like to briefly discuss the global environment in which we operate.

Regarding the Middle East as we've stated previously, there is no question that it continues to be a dangerous place with rapidly changing and emerging threats. This was reflected in the President’s most recent decision regarding sustaining current US troop levels in Afghanistan through most of 2016.

In 2015, we are forecasting $160 million of revenue with some potential favorability associated with Afghanistan operations. Regarding our 2016 outlook for Afghanistan. Matt will discuss our initial forecast in just a few moments.

What we can say with certainty is Vectrus is well-positioned in the Middle East and Central Asia to respond quickly and efficiently to the needs of our customers. Just as a reminder, Vectrus provided the full spectrum of day-to-day based operations and maintenance services in several locations across Turkey and at the Morón Air Base in Spain.

We achieved full operational capability on our Turkey Spain Base Maintenance Contract last quarter, and I've seen recent activity on that contractor in particular. As you may know, the United States is flying manned counter-ISIL missions from Incirlik Air Base in Turkey.

And in the third quarter, we were awarded a nearly $12 million modification to our Turkey Spain Base Maintenance Contract to provide contentious port associated with Operation Inherent Resolve. This is an excellent example of how Vectrus stands ready to service customers any time and any place.

To summarize, there is a lot of activity occurring in places where Vectrus is positioned. We stand ready to sponsor our customers’ needs; it’s the opportunity for Vectrus is to expand our current positioning through continued focus of being our customers’ first choice and most trusted partner.

Now I’d like to turn the call over to Matt, and he will go through the details of the third quarter, then we’ll open up the call for questions..

Thank you, Ken. Good morning, everyone. Please turn to slide 5. Today, I will be discussing our results for three and nine months period ended September 25, 2015. The table of the top of pages 5 and 6 reflect the generally accepted accounting principles financial results of Vectrus.

The table at the bottom of page 5 and 6 reflects adjusted financial results to exclude the Tethered Aerostat Radar System program and separation costs to become a standalone company, and one-time favorable settlements of tax liabilities.

The TARS program was retained by our former parent as part of the spin and separation costs and favorable tax settlements are a non-recurring part of the business. I will address the financial results on an adjusted basis, which we believe better reflect the ongoing business trends.

You can reference the appendix of this presentation for the reconciliation of our adjusted results to GAAP. I'd like to turn your attention to the table shown on the lower half of slide 5, which reflects the adjusted financial results for the third quarter of 2015.

Before I proceed, I would like to explain the adjustments we made to the 2015 financial results. In the third quarter, two uncertain tax liabilities were effectively settled with the IRS, which had impacts to G&A and a tax provision account.

These transactions are non-recurring and non-cash in nature and as such we have made adjustments to our results to better describe the underlying results of the quarter. Please refer to the appendix in this presentation or the 10-Q for further detail. Funded orders were $444 million.

Orders were $259 million compared to the third quarter of 2014 but up from $332 million in the second quarter of 2015. Revenue for the quarter was $299 million, $11 million higher when compared to the same period of 2014. We succeeded in achieving positive year-over-year revenue growth of 4% in the quarter.

This represents our second consecutive quarter of positive year-over- year growth. Afghanistan contracts contributed $39 million of revenue, down $26 million or 40% compared to the prior year's quarter.

Our core business revenue which excludes Afghanistan contracts from our adjusted revenue equated to $260 million, up 17% compared to prior year’s quarter. Due to the stabilization of existing programs and the ramp up of new contract revenue, we anticipate growth in our core business to continue in the fourth quarter.

Third quarter adjusted operating income was $11.8 million or 3.9% operating margin, which is $2.3 million or 60 basis point improvement when compared to the same period in 2014. Afghanistan contracts contributed $2 million in the quarter which were down $1.3 million compared to the prior year.

The adjusted diluted earnings per share for the third quarter was $0.65 cents per share compared to $0.59 per share in the third quarter of 2014, largely due to the mix of the business as we diversify our business base and replace the decline in Afghanistan contract activity.

Our third quarter tax rate, excluding one-time cash settlements, was 30%, which was lower than we expected due to true-ups with our filing of our annual tax return. For the fourth quarter, we anticipate to return to a more normalized tax rate of 36%. Please turn to slide 6.

I'd like to draw your attention to the table shown on the lower half of slide six, which reflects the adjusted financial results for the nine month period ended September 25, 2015. Our adjusted funded orders were $920 million. Orders are lower by $248 million compared to the prior year due primarily to timing of funded awards.

Year-to-date adjusted revenue was $870 million, $17 million or 2% lower when compared to the same period of 2014. The reduction was driven by lower requirements and associated revenue in our Afghanistan based programs. Afghanistan contracts contributed $128 million of revenue, down $91 million or 41% compared to the prior year.

Our core business revenue was $741 million, up $74 million or 11% when compared to the same period of 2014. Revenue in the period saw stabilization on our existing core business as well as contributions from our new contracts.

Adjusted operating income was $32.1 million year-to-date or 3.7% operating margin, which is $9.3 million or 100 basis points unfavorable when compared to the same period in 2014. Afghanistan contracts contributed $8.2 million year-to-date, which were down $12.8 million compared to the prior year.

We generated $10 million of free cash flow in the third quarter. Free cash flow was $9.3 million year-to-date. Our cash collections enabled us to pay down $6 million of debt in the third quarter. Our debt now stands at $121 million representing a total debt to trailing 12 months consolidated EBITDA ratio below 2.5 times.

Year-to-date adjusted diluted earnings per share were $1.69 per share compared to $2.54 per share in the prior period. Please turn to slide 7. For the third quarter, total backlog was $2.4 billion with approximately $900 million funded.

Total backlog represents firm orders and potential options on multi-year contracts which excludes the ceiling values of ID/IQ contract vehicle awards. We expect total backlog levels to replenish once re-compete contracts are awarded and new business pursuits are successfully won. Please turn to slide 8.

We are increasing our full-year 2015 adjusted operating margin and adjusted EPS ranges. We now expect adjusted operating margin, which excludes minimal spin cost and certain one-time tax benefits, to be 3.5% to 3.7%. This is up from our prior range of 3.2% to 3.6%.

The midpoint of our adjusted operating margin guidance increased 20 basis points to 3.6% from 3.4%. We now forecast adjusted diluted EPS at $2.10 to $2.28 per share, which is up from $1.85 to $2.23 per share. As a result, the midpoint of EPS increased by $0.15 to $2.19 per share from $2.04 per share.

We tightened our revenue guidance range and maintained the midpoint of our guidance at $1.175 billion. We also increased the midpoint of our free cash flow guidance by $1 million to $18 million. As previously mentioned, we have made $9 million in voluntary debt payments to-date.

This is at the high-end of our previously communicated range of $5 million to $10 million in voluntary payments expected for 2015. Given our solid cash collections, we now anticipate voluntary debt payments to be between $10 million to $12 million for the year.

Finally, regarding Afghanistan, although the announcement regarding troop levels could result in this revenue stream contributing longer than previously thought, we still expect to experience declines in 2016.

In previous discussions we communicated that it would be reasonable to assume that in 2016 Afghanistan revenue would be above half of the 2015 estimated amount or roughly $80 million. With 2016 nearing, we believe projected revenue will be in the $100 million to $120 million range with lower margins expected due to the loss of contract volume.

The revenue reduction, while significant, is higher than roughly half of our 2015 estimated amount. As you know, the decision regarding troop levels was made fairly recently and the situation in Afghanistan remains dynamic.

It is difficult to forecast with exact precision how 2016 might play out, but we continue to work closely with our customers to meet the requirements on the ground and will have greater clarity on this projection early next year. Now, I’d like to turn the call over for questions..

Thank you. [Operator Instructions] And we’ll go to Corey Allen with B&T [ph]..

Hey, guys. Good morning. Thank you for taking my question. I just wanted to ask about the modification in Turkey and Spain, what’s the expiration of that, I didn’t catch that..

So, the $12 million that’s received this quarter and it expires March of 2016..

Okay.

And if there is a need from the customer for ongoing work, would you expect that to be awarded in another modification?.

Absolutely. Based upon the dynamic situation that’s taking place on the ground, we communicated with the customer already to adapt any modifications they would need and that would be for a future work based upon what’s taking place on the ground..

Okay. And just on the Afghanistan business, as you look forward into 2016, you said you’d expect margins to come down, given the volume of work there.

Could you give us the margin profile of the existing business as it stands today?.

Sure. So Afghanistan, we positioned at the beginning this year about 7%. If you go back a couple of quarters, first quarter, we were around 6%, the second quarter, we were a little bit stronger at 7% and that was because the site visibility was consistent and we can control our cost in that period.

This quarter, we came down to about 5%, because we’re seeing some changes on the ground that’s causing a little bit of stress on the program. I would expect the full year to be a little bit different than what we guided to and probably more like 6% as we finish out the year.

On a positive note, we’re seeing some favorability on the remaining programs and non-Afghanistan programs that will make up the difference. So I’m not concerned about hitting our overall margin target as a matter of fact, because we’re very comfortable with where we’re right now, we raised our guidance..

All right, great. Thank you for taking my questions..

Thanks, Corey..

[Operator Instructions] We’ll go next to Morey Marcus with Sidoti..

Sorry, I was on mute. Thanks for taking my call. My question is just on the IT side, just given the timing of the hiring of Chico, can you just talk about like what you guys are seeing in that environment from the DoD and the government. Just is it better visibility on RFPs and the award environment.

I’m just kind of curious on that side because you talked about on the RFP side, it’s still kind of unclear..

Well, I’d say Morey, what’s really interesting is that we really have a strong foundation when you look across our infrastructure and logistic services lines, where we have talked about opportunity is really on the IT network space.

What we’re really focusing on is over the next year, 18 to 24 months, there is multiple IDIQ vehicles that we’re going after that are on our pipeline, which we have not been on in the past, and there are several single award contracts with our new capabilities, our abilities to execute in this area and our past performance that we really see is potential growth.

So that’s why the focus, that’s why the hire of Chico. Additionally, we’ve supplemented our IT service line with more business development and operations personnel to accommodate what we think will be the new work going forward..

And I would say that we also view this as an area that we can increase our margins, not massively, but it would help kind of get us up to the 4% to 5% that we think this business is sustaining longer-term..

Okay. Yeah. Okay, that’s the only question I have. Thanks..

Thanks, Morey..

With no other questions at this time, I’ll turn the conference back to Ken Hunzeker for closing remarks..

Before we conclude the call, I’d like to take a minute to recognize our veterans. On Wednesday November 11th, we’ll pause for a moment to remember the dedication and sacrifices made by those men and women that served in armed forces.

We did our last earnings call as a publicly traded company on Veterans Day last year, our first earnings and during that call, I told you that not only are we proud to serve side by side with the men and women who were or who have the worn the uniform, but that it is also important to recognize and thank them for their service on this day.

These men and women have endured hardship and separation from loved ones in the name of liberty and freedom. So as we close, I’d like to kindly ask each of you to personally seek out veteran on your travels next Wednesday.

And for all those veterans that are on this call, let me personally and on behalf of the global workforce at Vectrus, thank you for your service. We thank you for your interest and look forward to updating you on our progress next quarter..

Ladies and gentlemen, thank you for your participation. This does conclude today’s conference..