Welcome to the Vectrus, Inc. Third Quarter 2014 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Cindy Frothingham, Director of Investor Relations. Please go ahead.

Good morning, everyone. I would like to welcome you 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. 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 security laws. Please review our Safe Harbor statement in our earnings 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 will 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 reconciliations and other disclosures required by the SEC included in our earnings release and in our presentation slides, which are publicly available on our Vectrus website at investors.vectrus.com. Please turn to Slide 3. At this time, I'd like to turn the call over to Ken.

Thank you, Cindy. Good morning, everyone. Thank you for joining us on the call today. As we all know, today is Veterans Day, and I cannot think of a better day for Vectrus to deliver its first earnings call. In our line of business, we are proud to serve side-by-side with the men and women who wear the cloth of our nation. Today is our day to give them thanks. I recently had the opportunity to visit these men and women as well as our employees in the Middle East. Each visit reminds me of the dedication, sacrifice and hard work required to conduct operations there. Happy Veterans Day to all who have worn or continue to be in uniform. Thanks for your service. As you know, our spinoff was completed as of September 27. And today, we are pleased to lead Vectrus as a publicly traded company. Last month, during our Investor Day briefing, I spoke about what makes Vectrus unique and why we believe we are positioned to provide critical support to our customers while delivering compelling shareholder return. Before I dig into the details of the quarter, I would like to review those highlights. Vectrus primarily provides mission-critical operations and maintenance services to U.S. Government customers around the world. Our customers continue to have requirements for infrastructure asset management, information technology and network communication services and logistics and supply chain management. Our history of delivering superior performance, creating long-term value and sustaining enduring customer relationships creates our foundation for future growth. Looking at our future as an independent company, we believe we have a significant opportunity in the market as a result of our proven ability to win and execute large-scale, mission-critical global services. With proven performance and enduring customer relationships, we are solidly positioned to capture…

Thank you, Ken. Good morning, everyone. Please turn to Slide 7 to review our financial performance. On September 27, Vectrus completed a spin transaction from Exelis and became an independent company. Although Vectrus was a business unit under Exelis during the reported period, the following results reflect Vectrus as an independent company. During our discussion today, I will address our third quarter results on an adjusted basis, which excludes the historical revenue and operating income for the Tethered Aerostat Radar System business, which we refer to as TARS, as well as the impact of separation costs to become a standalone public company. If you will recall, the TARS business was retained by Exelis as part of the separation. You can reference the Appendix of this presentation for the reconciliation of our adjusted results to GAAP. For the third quarter, funded orders were $703 million. This is a significant quarter for us and provides visibility into expected revenue and cash flows for 2015. Orders were down compared to the third quarter of 2013, which is the reflection of declining Afghanistan contract base and reflects timing of awards on Middle East programs. For the balance of 2014, 100% of the remaining expected revenue is currently in backlog. Current funded orders do not include the 3 recent wins, ACE-IT, Turkey Spain and Thule Base Maintenance Contracts, which are expected to be added to backlog in the fourth quarter. Adjusted revenue for the quarter was $288 million. Afghanistan programs were down $56 million compared to prior quarter, while the base business grew by $2 million. This demonstrates that our existing non-Afghanistan contracts provide a strong revenue base going into 2015. Third quarter adjusted operating income was $9 million or 3.1% of sales, which was in line with our internal expectations and supportive of the…

[Operator Instructions] And we will take our first question from Brian Ruttenbur with CRT Capital.

First question. Adjusted gross profit amount attributed to TARS, what was that in the period?

Brian, it's Matt. So we didn't provide any adjustments to gross profit, but I think you can think of it very simply: all the spin costs really fall out in G&A, and then you can just take a little bit out for TARS from what we have in the adjustments in the reconciliation to GAAP as it relates to G&A to get back to gross profit.

Okay. So we take all the spin costs out of G&A, and then we add what back into the gross profit?

So just take a little bit out for G&A for TARS, 5%, 6%, and the rest goes into gross profit.

Okay, great. The next question I have is on guidance. Your guidance -- for the first 9 months, you did $2.54. And earnings per share, your guidance is $2.70 to $2.90. That implies a $0.16 to $0.36 fourth quarter adjusted EPS number, is that correct?

That is correct. So the things that we're thinking about in the fourth quarter are, as the business has come down, we have a very scalable cost structure, and we work on that every day. And part of that will be a slight severance charge in the fourth quarter. And then we have some equity grants that will kind of put some pressure on our income as a new company.

Okay. So there will be a severance charge in the fourth quarter under G&A, I assume?

Correct.

And what was the other charges?

We have some equity grants as a new company that we have to record in the fourth quarter.

Okay, will that change your share count?

It was slightly, and we've disclosed that our fully diluted share count will be 10,000,600 shares.

Okay, great. And then, free cash flow, I did not catch what -- I heard $23 million to $26 million is the free cash flow number for the year. What is the year-to-date free cash flow?

Our free cash flow year-to-date is $38 million.

Okay. So you expect to be $15 million, roughly, negative free cash flow in the fourth quarter, is that right?

Yes. The way I look at it, too, is we were $17 million-plus positive in the third quarter with early collection. So we are just kind of coming back to what we normally would receive or realize, and that's about 100% of net income.

Okay, that makes sense. Let me move on to Thule Greenland Air Force Base and understanding that contract a little bit. It's $411 million over 7 years. Who did you guys win that from?

This is Ken. It was a Greenland-based company.

Okay. So it wasn't another defense prime? It was a local company that only had this?

Correct, it was a local base company.

Okay, and when does that start?

So on all of our contracts, that's kind of why we didn't record any of our new contracts in the backlog, they have to clear the protest period, which Thule has not cleared the protest period at this point. And then, we work with the customer on start dates and phase-in dates, so that's still in play. And as we described in -- when we give 2015 guidance early next year, we'll give you some more color around the start dates and the revenue realized or expected in 2015.

Ideally, it would be in the February/March time frame, but that's the time frame we're looking at, Brian.

Okay, good. That's helpful. Okay, so other awards that you're going after, you mentioned $1 billion of bids in, another $1.5 billion in the next 60 to 90 days that you're putting in. That's a lot of award activity, potentially, down the road. Is this primarily base management? Can you talk about the makeup of those? Not anything specific, I don't need specific bases. I'm just trying to understand the makeup of what you're going after.

Well, it's just like, as we put together the plan, these have been in the plan for a while. They are basically across all 3 business areas. So it's a really healthy mix to help us in all 3 areas. We have couple of pursuits on the IT side, a couple on the base operations and what we do on infrastructure management and a couple on logistics. So it really is a nice mix going forward.

Okay. And then, in terms of the continuing resolution, do you see any near-term impact? I know you have a lot of awards out there. Seems to be a lot of award activity happening right now. Is the continuing resolution slowing you down, or do you see them, the CR, slowing you down?

We normally are not affected by CR. We don't expect it now. A CR really affects new starts. Almost everything we do is existing work and is just a recompete, so it's not considered a restart. So on the services side, we have not been affected in the past on continuing resolutions.

Okay. And then, how about the Republican win? This is a macro question. I have to hit you with it. The Republican win and potential for sequestration, does that get avoided or not? I know you can't predict the future, but just give me your opinion on is this good or bad, having the Republicans in, and potential for avoiding or having a sequestration, in your opinion?

Brian, the discussion on sequestration is just getting started. My opinion is it will be a great dialogue as we come together as a nation. I'll tell you, in the past on sequestration, what I find interesting is that we never -- in all the different scenarios that took place in the past, we never had any of our employees laid off. We didn't have any of our employees that were furloughed because a lot of the work -- most of the work we do is mission-critical. So sequestration and what takes place there, based upon the kind of contracts we have in the operating areas that we have, we're not affected.

At this time, we have one question remaining in the queue. [Operator Instructions] We will take our next question from Bill Loomis with Stifel.

Looking at the sequential revenue -- so when I'm looking at your guidance and towards the upper end of that guidance, I get sequential flat or even growth. But it's not going to have the contribution from the 3 new wins, which you expect to ramp up next year. So -- and Afghanistan work is going to continue to come down. So what is going to show -- towards the upper end of your guidance, what programs are showing growth in fourth quarter?

So I think what we're seeing on our Middle East programs is really stability and maybe slight growth, not a tremendous growth, with the activity that's going on in the region. Afghanistan is kind of leveling off. We saw some pretty steep declines in the first 3 quarters, and we'll a see little bit of pressure in the fourth quarter, but overall, I think we're seeing stability across our programs. And like you said, correct, the new contract wins won't begin until next year at various points in time during the next year, and we will give guidance on that early next year.

So if the Afghanistan is leveling off, but you still think it's going to be gone by end of 2016, what -- in the third quarter, what was your Afghanistan revenue overall for the -- as a percent of revenue?

Afghanistan revenue was $66 million in the third quarter, which was down $56 million. So the prior year was $122 million. And it's trending about 50% compared to last year, 50% decline.

Okay. So and you expect that -- I know at the analyst meeting, I think you said you expected that in '15, if I recall, one of the comments you said, that kind of decline in '15 for your Afghanistan work, down about 50%?

Yes, so I mean -- so we have $250 million that we're projecting through '14. It might be a little bit higher than that depending on how the last few months go. What we said was, in the next 2 years, the Afghanistan business will align with combat troop levels. And what we've seen this year is a 50% decline. I think, at the worst case for next year in 2015, we may see another 50% decline. I think that's worst case at this point, but that's all dependent on what happens with troop levels.

Okay. So with the $200 million of revenues from just the 3 wins you talked about, your base programs are stable based on what you're saying for fourth quarter and the growth you saw in third quarter or stability in third quarter. So I mean, in 2015, you're not giving guidance, but I mean, it sounds like it's -- I mean, the revenues will grow. I mean, is that a fair statement?

Well, there's a lot of moving parts on the 3 recent wins, right? The things you have to contemplate as we work with our customers that aren't completely known now is when do we start and then how long is the phase-in. And those kind of can change through the course of negotiations. So that's the one variable. You can't assume that the $200 million is going to start January 1. So that's the one variable that we have to work on.

Okay, but if -- okay. But is it reasonable to think, as I think Ken mentioned earlier, February, March, that we could get these things -- all 3 of them going, assuming that nothing happens there?

It's -- I would say that it's reasonable to have clarity around where we are on all 3 of them with the protest and the pending protest period expiring. And then, we'll know when the phase-in starts. So we'll definitely be able to give guidance on what we think the revenue trend is for these 3 programs. In '16, I would expect to get a full complement of annualized revenue.

And we did it on Turkey Spain. We had our post -- preperformance conference with them last week, and we will start that at the end of March. So we do know that one.

Okay. And then on the 3 wins only, what type of margin are on those programs? Are they kind of in the 4% range? Or what guidance can you give on that?

Yes, we're not going to talk about individual programs. We do feel we're very excited about winning these contracts and replacing our declining Afghanistan contracts. And the good thing is, when these resolve through the protest periods and we start executing, we have full control of operating margins, and that's a good place to be.

Okay. But no kind of above corporate average, below corporate average guidance on the 3 wins?

Yes, we're not really ready to give guidance until next year on overall corporate operating margins.

And then, just on your debt going forward, what's the full-in interest rate, including fee amortization and everything like that?

We're really trending towards -- we closed September at about 2.99%. So the annual interest expense, depending on where LIBOR goes is in the $4 million to $6 million in the first couple of years.

Okay. And then, in third quarter, on the adjusted margins, so with that 3.1% adjusted margin, was there any onetime items in there that kind of dragged that down and/or boosted it like potential fee awards or anything, or is that a good figure?

No, what I said in the dialogue is really inefficiencies around spin activities. So there is a slight pressure on that margin just to kind of have overlap people to be ready for day one, to have certain TSAs and prep for those to get through the transaction, to stand up software requirements. So our costs, probably, were a little bit high in the third quarter, and we'll work on those in the coming quarters to kind of lean out operations. So we should see a little bit of improvement on our cost structure going forward.

Okay. And then in the fourth quarter, when you -- on your adjusted margin that you will report in the fourth quarter, would that be a kind of run-rate margin going forward? Or is there going to be some pressures on that, too?

We would expect it to be similar to Q3.

Similar in size or similar in that it's going to have some onetime kind of temporary costs in there?

There would be -- as I described, there will be severance costs as we roll into next year and we adjust our cost structure, and there will be equity grants that we have to contemplate and record in the fourth quarter as a new company that will put pressure on the margins.

So when you report adjusted margins, you're not adding that back to get your adjusted margin?

We do not plan on adding anything other than spin cost and TARS at this point.

Okay. And then, just seasonality, generally speaking, in terms of your revenues, how -- is that -- do you have much seasonality in the business, apples-to-apples? Is fourth quarter generally going to be stronger than first quarter, for example?

We don't, typically. If everything were to start at the same time, it would be very predictable, but with one exception: if things change on a base and the customer directs either increases or decreases, that could change it. But overall, if things are pretty straightforward and consistent, you would see, quarter-over-quarter, pretty consistent revenue.

The next question is from Jim Foung with Gabelli & Company.

[indiscernible] call late, so I apologize if you answered this earlier, but I wanted to ask -- at your Investor Day, you talked about $1.5 billion of potential new businesses under evaluation and then overall, $25 billion over a 3-year period. And I was kind of curious, was this Army Corps of Engineers award that you won, was that part of this $1.5 billion of potential new business? And then, could you just talk a little bit more broadly of where you are in terms of maybe potentially getting more of that $1.5 billion of new business coming up?

Jim, this is Matt. Let me start you with reconciliation. At the Investor Day, we had $1.5 billion. In that number included Thule. So we were recently awarded Thule. That's why it came down to about $1 billion pending. And then, I'll turn it over to Ken for some color around what's still to go.

And what's really interesting is we're obviously putting together our op plan to go to the board and working this draft plan going forward. I'm really excited about what I see on the number of opportunities we have. So we have always run a robust pipeline within the organization, and it's continued as we go to the future, very excited about all the different opportunities and our ability, with our past performance, to really put a lot of good bids in. And that's what in you're seeing the results of. So that's why we're -- within the next 60 to 90 days, we'll have $1.5 billion of new awards turned in, which just keeps the flow going.

So in terms of your opportunity, there's still another $1 billion in the near term, right, and then $25 billion over 3 years?

Yes, let me step you back a little bit. So roughly, there's $10 billion in our pipeline that kind of averages over 3 years. So if you just kind of do simple math, $3 billion or $4 billion in any given year that we kind of pursue and submit. And you move down from that, $1 billion of it is pending awards. So it's all the way through its acquisition life cycle and ready for award. Another $1.5 billion is just normal rhythm of the business that we're ready to submit and that will start to go through its acquisition life cycle in consideration. So I wouldn't get too confused on the $1.5 billion and the $1 billion. The $1 billion is ready for award. We've been quite successful in this pool recently, and we're hopeful that we're successful in this what's due to be awarded, but really, the rhythm of the business is $10 billion pipeline with about $3 billion that we pursue in any given year that kind of whittles down to active pending award bids of $1 billion.

It appears there are no further questions at this time. Mr. Hunzeker, I would like to turn the conference back to you for any additional or closing remarks.

Thanks, Eric. Thank you, everybody, for joining us on the call today. As we discussed during our prepared remarks, we're really excited to be a new company. The recent wins align directly to our strategy and help mitigate the declining Afghanistan revenue base. We look forward to providing 2015 guidance next year when we report fourth quarter results. And I think I will end as I started today with a comment on Veterans Day. Please take a moment to thank a Veteran for their service. Thanks.

This concludes today's call. Thank you for your participation.