Michael Smith - Director of IR Charles Prow - CEO, President and Director Matthew Klein - CFO and SVP.

Brian Ruttenbur - Drexel Hamilton.

Welcome to the Vectrus Incorporated First Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mike Smith, Director of Investor Relations and Corporate Development. Please go ahead..

Thank you. Good afternoon, everyone. Welcome to the Vectrus First Quarter 2017 Earnings Conference Call. Joining us today are Chuck Prow, President and Chief Executive Officer; and Matt Klein, Senior Vice President and Chief Financial Officer. Slides for today's presentation are available on our Investor Relations website, 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 statements in our press release and presentation materials 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.

At this time, I'd like to turn the call over to Chuck Pro..

Thank you, Mike. Good afternoon, everyone. Thank you for joining us on the call. Please turn to Slide 3. Before we get started, I'd like to recognize our veteran workforce. Vectrus has a leading employee of veterans with over 35% of our employees reporting prior military service.

I'm proud of our veterans as they bring valuable leadership skills and a unique understanding of our client's missions. I'm also proud to say that Victory Media once again recognized Vectrus with the 2017 military-friendly employer designation. On a related note, later this month, we will recognize Memorial Day.

As we honor the brave men and women who have given their lives in service of our country, I'd like to thank all of those, past and present, who have served to protect our freedom. Now I'd like to discuss our first quarter 2017 financial highlights.

Revenue for the first quarter was $290 million, down $21 million year-over-year, due to lower revenue from our Afghanistan programs. Operating margin was 4%, up 20 basis points year-to-year.

Diluted earnings per share was $0.60, down $0.01 year-over-year and the first quarter net cash provided by operating activities was strong at $10 million, up $8 million year-over-year.

We were off to a fast start in 2017 and in the first quarter, we have been awarded new business, recompetes and contract modifications and extensions which significantly improve our visibility for 2017 and beyond. In March, we were awarded the extension of our Kuwait-Base Operations and Security Support Services contract known as K-BOSSS.

The K-BOSSS extension has a 1-year base period of performance which extends through March 2018. Additionally, the extension includes 2 option period, the first being 9 months and the second being 3 months which, if exercised by the client, would extend performance through March 2019.

We look forward to continuing to provide our K-BOSSS clients with exceptional value and strong performance on the largest military footprint in the Middle East. Also in March, we were awarded our Operations, Maintenance and Supply-Europe or OPMAS-E contract recompete.

The contract has a total value of $115 million and a period of performance, including options, that extend through January 2022. OPMAS-E provides a full range of IT services to the U.S. Army Europe, U.S. European Command and U.S Africa Command areas of responsibility.

Vectrus has been providing mission-critical support under OPMAS-E contract for over 10 consecutive years and more than 30 years in total, dating back to 1977. We look forward to serving our clients well into the next decade. The OPMAS-E recompete win continues our momentum in the IT and network communication services line.

I'd like to point out that through our current portfolio of contracts, Vectrus provides IT and network communication services throughout the U.S. and 17 countries spanning Western Europe to Southwest Asia. Importantly, we also serve [indiscernible] providing the U.S.

Navy afloat force, a full range of network support services that are integral to the readiness of the U.S. Navy fleet. Next, we were awarded our Maxwell Base Operations and Support recompete contract. The contract had a total value of $278 million and a period of performance, including option period that extends through March 2024.

Originally started by the Wright Brothers in 1910 as the nation's first civilian flying school, Maxwell Air Force Base is currently the headquarters of Air University, a key component of the Air Education and Training Command and is the Air Force Center for professional military education.

We're proud to support this historic and important Air Force Base, home to more than 12,500 after-duty reserve, civilian and contracted personnel. With the OPMAS-E and Maxwell awards, we have successfully retained all our recompete schedule for 2017. I'd like to commend our team for a job well done on both of these important programs.

One of our core strengths is Vectrus' ability to rapidly respond to anywhere across the world in a challenging environment in order to meet our client's contingency mission requirement.

This was demonstrated with a recent half quarter win order under our Air Force contract augmentation program to provide logistic support services at Bagram Air Field in Afghanistan. Total value of the award is $14 million with a period of performance, including options through March of 2021.

This was new work to Vectrus and represents our rapid response logistical capabilities and commitment to serving side-by-side with our clients anywhere and at anytime they need us. A related topic. During the quarter, we were awarded the $31 million 1-year contingency support services contract modification in support of Operation Inherent Resolve.

To provide base maintenance and operation under our Turkey-Spain Base Maintenance contract, I'm pleased to announce that many of the items above helped prepare our total backlog with $2.9 billion in the first quarter, the highest level since being a stand-alone public company.

I would like to note that our backlog does not include the unexercised option period associated with K-BOSSS. Please turn to Slide 4. The wins, modifications and extensions previously described significantly improve our 2017 visibility.

As a result, we're increasing our 2017 guidance for revenue, net income, diluted earnings per share and net cash provided by operating activities. Matt will discuss these changes in greater detail shortly.

Regarding that Thule Base Maintenance Contract discussed on prior calls, our Danish subsidiary have begun the phase-in period with full contract operations to begin on 1 October 2017. We anticipate revenue streams on this firm fixed-price contract to materialize in the later part of 2017.

Overall, we look forward to performing this program with the Air Force in the coming years. Our business momentum has been able to carry into the second quarter. Most recently, on April 11, we were awarded a $97 million firm fixed-price contract to provide base operations support services at Keesler Air Force Base.

The contract period of performance, including options, extend through May of 2024. However, subsequent to the award announcement, a protest was filed with the U.S. Government Accountability Office or GAO. The GAO has up to 100 days to issue a written decision.

Accordingly, we expect the GAO to issue a written decision no later than 3 August 2017 for the Keesler award protest. Keesler was a strategic win and a new contract for Vectrus and we look forward to providing the Air Force client with the same excellent performance we deliver on the Maxwell contract.

With regard to new business, we have approximately $1.5 billion of bid submitted pending award. I'd like to note that this number includes the Keesler award, given its current protest status. Additionally, we plan to submit proposals on almost $4 billion of identified opportunities over the next 12 months, all of which are for new business.

This number is down from the fourth quarter due to the time line changes associated with certain procurements. We expect to hear award decisions running up to $1.5 billion of bids in the next 6 to 9 months. Our balance sheet remains strong. We paid down $3.5 million of debt in the first quarter, ending with a total debt of $81.5 million.

Cash on the balance sheet increased by $6 million to $54 million from $48 million in the fourth quarter of 2016. At 1.61x debt to EBITDA, we're still well below our 2017 covenant level of 3.0x.

During last quarter's call, we introduced a new strategy that we believe will transform Vectrus into a higher value, technology-enabled and differentiated platform. Even though we're in the very early process of executing this strategy, recent contract wins and extensions, inputs from our clients and discussions within investors are encouraging.

As you may recall, each of our core strategies, expand the base, enhance the portfolio and add more value have a series of strategic imperatives. One imperative we discussed on the fourth quarter call was to aggressively and systematically integrate our enterprise operations.

Since that time, we have advanced and are deploying our enterprise program, Enterprise Vectrus to call us Vectrus improvement program known as VIP and other enterprise improvement initiatives into a single enterprise-wide management system.

Although this imperative is still in the beginning stages, we're making solid progress and I look forward to updating you in the future. Now I'd like to turn the call over to Matt, who will go through our financial results and provide updated 2017 guidance, then we will open up the call for questions..

Thank you, Chuck. Good afternoon, everyone. Please turn to Slide 5. Today, I will be discussing our financial results for the 3 months ended March 31, 2017. In the first quarter, revenue was $290 million, reflecting a decrease of $21 million or 6.6% as compared to the 3 months ended April 1, 2016.

This decrease in revenue was attributed to lower revenue from Afghanistan programs of $20.2 million and our European programs of $3.2 million, partially offset by an increase of $2.8 million from our U.S. and Middle East programs.

Operating income for the 3 months ended March 31, 2017 was $11.6 million which was $200,000 or 1.4% lower compared to the first quarter of 2016. The operating margin for the 3 months ended March 31, 2017 was 4% compared to 3.8% operating margin in the first quarter of 2016.

We recorded a net favorable cumulative catchup in the first quarter of 2017, up $2.7 million compared to $2.8 million in the same period of 2016. There are many factors that drive this performance, including successful contract modifications and extensions of current contracts.

Adjustments can be positive or negative, are normal part of this business and our guidance contemplates this reality. As you will see in our 2017 guidance discussed later in the presentation, we're holding our full year operating margin at the previously communicated midpoint of 3.5%.

This implies a lower run rate for the balance of the year relative to the 4% we reported in the first quarter. The potential change from the first quarter performance is the reflection of the potential temporary pressures of phasing in several new contracts and the implementation of our new strategic imperative.

We believe the new programs, successful recompete wins, contract extensions, along with the successful implementation of our strategic imperatives, will result in a sustainable annual margin above our historical performance. Net income for the quarter ended March 31, 2017, was $6.7 million, compared to $6.6 million in the first quarter of 2016.

The increase in the first quarter 2017 net income is due to lower interest expense of $200,000, offset by lower operating income of approximately $200,000.

In addition, tax expense decreased approximately $100,000 in the first quarter of 2017 compared to the same period in 2016, related to a slight change in the tax rate of 36.6% from 37.2% in the first quarter 2016.

Diluted earnings per share for the first quarter of 2017 were $0.60 compared to diluted earnings per share of $0.61 in the first quarter of 2016. The decline is primarily associated with the increase in the weighted average diluted shares outstanding as of March 31, 2017 compared to April 1, 2016.

Net cash provided by operating activities was $9.9 million for the 3 months ended March 31, 2017 which was an improvement of $8.2 million versus the first quarter of 2016.

Days sales outstanding for the first quarter 2017 was 54 days which was an improvement of 3 days compared to the first quarter of 2016 due to the continued work of our teams in managing cash collection. Please turn to Slide 6.

During the first quarter of 2017, we paid $3.5 million of mandatory debt payments, lowering the total debt balance to $81.5 million, representing the total debt-to-trailing 12 months consolidated EBITDA leverage ratio of 1.61x.

The total debt-to-trailing 12-month consolidated EBITDA leverage ratio covenant level for 2017 is 3x and it will drop to 2.75x in the first quarter of 2018. We've worked diligently to improve our financial position. And as you can see from the chart, since the third quarter of 2014, we have significantly reduced our leverage profile.

Our improved financial position and increased visibility through recent contract momentum increases our flexibility to make future capital allocation decisions. With that said, our current credit facility was initiated in 2014 under a different set of circumstances and a very different market environment.

We're currently evaluating options to improve the terms of our credit facility, working with our lending partners to increase our capital allocation options in the future. We remain committed to a methodical and thoughtful capital allocation strategy with emphasis on improving shareholder returns.

We look forward to updating you on our progress in the future. Please turn to Slide 7. For the first quarter 2017, contract awards were over $800 million, total backlog was $2.9 billion and funded backlog was approximately $900 million.

Total backlog includes both funded and unfunded backlog and represents firm orders and potential options on multiyear contracts. Total backlog excludes potential orders under indefinite delivery and indefinite quantity contracts and contracts under protest.

During the first quarter of 2017, the K-BOSSS extension and OPMAS-E and Maxwell recompete awards were included in total backlog.

I would like to point out that because the K-BOSSS options represents a further extension beyond the period of performance originally contemplated by the K-BOSSS contract, the unexercised option periods associated with K-BOSSS are not included in backlog at this time.

As mentioned earlier, the $97 million Keesler Air Force Base contract is currently under protest. As a result, we do not plan to add the contract to backlog until it successfully clears the protest. Please turn to Slide 8 and we will discuss 2017 updated guidance and assumptions.

We're updating our 2017 financial guidance to reflect the full year contribution from the K-BOSSS contract. For reference, our prior guidance assumed K-BOSSS contributed well into the third quarter. The prior guidance included the assumption of successful awards on the Maxwell Base Operations Support and OPMAS-E contract recompete.

In addition, Thule was included in the previous guidance with full performance to begin on October 1, 2017. We have updated 2017 guidance to reflect the extension of K-BOSSS and are now estimating annual revenues to be in the range of $990 million to $1.09 billion, up from the previously guided range of $910 million to $1.01 billion.

The updated revenue guidance midpoint of $1.04 billion is $151 million lower when compared to 2016 actuals, due primarily to the completion of the APS-5 Kuwait contract. As a reminder, for the full year 2016, the APS-5 Kuwait contract contributed approximately $181 million in revenue.

The guidance range for operating margin remains unchanged at 3.4% to 3.6%. As a result, the midpoint for operating margin is 3.5%.

The operating margin remains unchanged from prior guidance and is lower than our first quarter 2017 financial results due to the potential of increased startup cost, phasing in new contracts and the launch for new strategic imperatives.

Looking forward, we believe we will create a higher sustained margin profile with the successful implementation of these initiatives. Net income is now expected to be in the range of $18.7 million to $22.3 million, up from $17 million to $20.5 million.

As a result, the range for diluted earnings per share increases to $1.68 to $2, from $1.53 to $1.83 per share. The updated midpoint of diluted earnings per share is $1.84, up from $1.68. This assumed an estimated $11.1 million weighted average diluted shares outstanding.

2017 net cash provided by operating activities is now expected to be in the range of $22 million to $28 million, up from $20 million to $26 million. Capital expenditures for 2017 are expected to be approximately $1 million. Depreciation and amortization is expected to be $2.3 million for 2017. 2017 mandatory debt payments are $15.8 million.

Interest expense is forecasted at $4.2 million and we're currently estimating a 36.4% tax rate for the full year. Now I'd like to turn the call over for questions..

[Operator Instructions]. The first question comes from Brian Ruttenbur with Drexel Hamilton..

So couple of quick questions on Keesler.

Is this assumed in your projections that you're giving in your guidance that you're giving for '17 that Keesler is in there or not in there?.

Brian, this is Matt. We have very little new business in our new guidance. If you notice, if we roll it from the prior guidance, we increased it about $80 million. Most of that change has to do with K-BOSSS. We slightly changed our new business assumption from prior guidance. So very little has to do with new business in 2017.

Keesler will roll into 2018 in a full run rate..

Okay.

So how big is Keesler on a run-rate basis?.

That's $97 million over 5 years -- over 7 years -- I'm sorry, corrected. Need to correct the period of performance..

Okay. 7 years.

$97 million over 7 years, so not that big of a needle mover versus Maxwell or K-BOSSS?.

Correct, correct..

Okay. A couple of other.

The K-BOSSS program, you've got a 1 year contract with a 1 year or is it a 9-month and a 3-month extension? Is it -- can you remind me of that?.

Sure. We're extended for 12 months. It takes us through March of next year and then we have 2 option periods, 1 for 9 months and then another one for 3 months. So it could complete all the way through March of 2019..

Okay. And then your net debt is roughly $28 million and you're talking about generating $22 million to $28 million on the year.

It seems like you could be net cash positive maybe by this time next year?.

Yes. We have -- with the contract revenue visibility, we have many more options as it relates to capital allocations. I think our current focus is really to focus on the strategic imperatives, make sure those are implemented effectively and really phasing in these contracts.

Yes, our net debt will be much more positive into next year, but as we move into the next couple of quarters, we'll take a look at our credit agreement and we'll work with our lending partners to make improvements there. And then as our capital allocation strategy change and evolve, we'll communicate it at the appropriate time..

Yes. It seems like it's time to do given how strong you are in the cash flow and the visibility, a much better credit agreement needs to happen.

I assume you want to get that done in the next quarter or 2, is that what you're saying?.

Yes. So when we originally signed up for the credit agreement, it was in a much different time in 2014 with much more risk. So it was very restricted and we communicated that over the course of the last couple of years. We're looking to expand our capital allocation options with the new credit agreement. How that plays out, we're not exactly sure.

We're looking to proceed this year with those decisions and discussions and we'll communicate at the right appropriate time..

Okay. And then a couple other questions. SG&A.

is this the right level around $14 million kind of moving forward? Or was there anything abnormal in that quarter, up or down?.

Nothing abnormal. We did have some savings as it relates to our actions in October. If you kind of benchmark to where we ended in '16 which was about $64 million of SG&A and we were projecting about $8 million of annual savings, we would be in maybe $55 million to $56 million in SG&A assumptions in 2017.

I think the important thing is we're going to leverage our enterprise Vectrus and we're going to leverage consistency in what we do everyday. So as the business starts to grow, we don't think proportionally SG&A will need to grow with it. So we'll get to natural phasing that way..

Okay.

And then in terms of -- I know you're not giving guidance for '18, but where do you sit right now? And you didn't win any new business and just were on a run-rate going forward, you would be flattish in '18 or would you be up slightly?.

Yes. So with the recent awards, we have clarity on 2017, so we're really pleased with that and we feel good about our prospects in 2018. We have not been specific around 2018 guidance. There are some levers that you need to think about when you're modeling this. It's really around the K-BOSSS extension. We're on contract through March of '18.

If that extends to its full period of performance with all the options, that could extend all the way through 2019. We have the APS-5 Kuwait year-over-year change which will be about $48 million going into '18.

You have things like a full run rate of Thule and then really the success around our current pipeline, Keesler being the nearest term award that would fill in any potential gaps..

Looks like '18 would be -- if everything just came through including just Keesler, you getting through the protest period, you would have 3% or 4% growth off of '17 to '18, as I just do back of the envelope.

Is that ballpark right?.

We're going to see how '17 plays out. If everything stays stable, we see consistency on K-BOSSS and we realize the Keesler contract to clear protest, we could see some growth. Anything more than that, I don't -- I want to stay away from specifics..

Understood. And then maybe 1 macro question about the CR going away, budget going in place.

Was there anything specifically that helped you out? Or is it just all up-tempo activity in the Middle East that is helping you out internally?.

Brian, I would break it down this way. I think the kind of the fundamental point is actually just yielding on our existing pipeline. We've talked about that in prior quarters as well. We do see the stability of the budget is the helpful item to not only ourselves, but the entire industry.

And other than that, again, I would just market up to good execution by the teams..

Okay. And then final question on -- you talked recently about putting technology into bids. Was Keesler one of those situations where you added some technology and to a bid that helped you? Or -- and maybe you can elaborate on that..

Well, I think, in general, we're applying technology to our existing contracts wherever we can as well as to new bids. You know the life cycle of these programs.

I mean, that bid was bid quite a while ago, but in terms of executing against our base of business, again, we have several initiatives underway by the teams to infuse technology wherever possible, point one.

And point two, I have been very pleased with the conversations we've had with not only clients -- potential clients, but with the investor community as well as partners in terms of strategy. Still very early into strategy, but encouraging..

Ladies and gentlemen, we have reached the end of the question-and-answer session and I would like to turn the call back to Chuck Prow for closing remarks..

Thank you. Appreciate it and thank for joining the call today. And I look forward to updating you as to the progress and we'll see you on next quarter's call. Thank you very much..

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..