Greetings, and welcome, and thank you for joining us for the Vectrus Third Quarter 2018 Earnings Conference Call and Webcast. Today's call is being recorded. [Operator Instructions] And now, I'll pass the call over to your host, Mike Smith, Vice President of Investor Relations and Corporate Development at Vectrus. Thank you. Please begin.

Thank you. Good afternoon, everyone. Welcome to the Vectrus Third Quarter 2018 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 would like to turn the call over to Chuck Prow.

Thank you, Mike. Good afternoon, everyone. Thank you for joining us on the call today. Please turn to slide 3. We had a solid third quarter with double-digit year-over-year improvements in revenue and earnings per share. Additionally, our operating margin increased 80 basis points year-over-year, and we have won new work that will contribute in 2019. I'm especially pleased with our results this quarter, given that our teams were phasing in approximately $130 million of new business. We had the additional responsibility of completing the move to our new Colorado Springs headquarters facility. I'd like to thank our team for their great effort in successfully managing this large corporate relocation while not losing focus on our clients and our business. As mentioned, in the third quarter, our teams were extremely focused on phasing in new programs. Specifically, during the quarter, we successfully phased in our $84 million 7-year firm fixed-price contract for the base maintenance support at Sheppard Air Force Base in Texas. We have done a great job expanding our presence with the Air Force and are currently a trusted provider of facilities and logistics services to this important client in nine countries. Additionally, during the quarter, we successfully phased in our $43 million, 5-year firm fixed-price installation maintenance services contract at the US Army Garrison in Stuttgart. This contract further positions Vectrus as the leading provider of facility support services in Germany while expanding our scope of work in the United States European command. Turning to awards. During the quarter, we were successfully awarded another task order under the AFCAP IV program. This new task is a 1-year, $14 million firm fixed-price effort to support the US Air Force in Europe. Our team was also successful in winning our Air Force Medical Evaluation Support Activity recompete. While small,…

Thank you, Chuck. Good afternoon, everyone. Please turn to slide 5. Our third quarter financial results were solid with revenue of $308 million, up $39 million or 14% year-over-year when compared to the third quarter of 2017. Excluding revenue from SENTEL, our third quarter revenue grew 4% year-over-year. Operating margin in the third quarter was 4.5% and diluted earnings per share were strong at $0.86. Our third quarter operating margins increased 80 basis points year-over-year due to continued program execution. Year-to-date cash provided by operating activities was $8.7 million. We expect net cash provided by operating activities to be strong in the fourth quarter, incrementally generating $26 million to $30 million. Our total backlog is $3 billion. And our year-to-date awards are $1.02 billion, representing a year-to-date book-to-bill of 1.1 times. Furthermore, the additional extension of our K-BOSSS contract will add to backlog once definitized. As a reminder, in January, we acquired SENTEL Corporation for $36 million, and I am pleased to report that the integration is now essentially complete, and the results are tracking ahead of our plan. SENTEL is a great example of how our capital deployment strategy will help transform Vectrus into a higher-value technology-enabled and differentiated platform while continuing to broaden our capabilities and diversifying our client portfolio. As Chuck mentioned, during the quarter, we completed the relocation of our Colorado Springs headquarters to a more modern and high-tech facility. This move has been well received by our employees and, as a reminder, will yield annual cost savings of $1 million. As of September 28, 2018, our leverage ratio was 1.29 times, which is well below our covenant level of 3.0 times. Total debt at the end of the quarter was $76 million, while our cash balance was $40 million resulting in a $36 million of…

[Operator Instructions] Our first question comes from the line of Joseph DeNardi with Stifel.

Chuck, just on the margin profile of the business, can you just talk in aggregate what the margins are for the cost-plus piece versus the fixed-price piece? And then how long does it take for the business by contract type to kind of more resemble your bookings profile so far this year?

It's Matt. Let me start out, and then Chuck can add some more color. Typically, every contract is a little bit different, so cost-plus programs and fixed-price programs kind of can generate similar numbers to our aggregated numbers of the 3.8%. The way we described fixed price is number of opportunities to improve margins as the business shifts to fixed price. So the one thing that we have to be cautious on is, as we phase in and start programs, we typically realize margins a little bit lower than when we finish the contracts. We're real pleased with the last two years of wins. We've won about $1.3 billion of new contracts, $330 million this year that we described in the prepared remarks that are really phasing in this year, and we expect to improve margins into 2019.

The only point that I would add to that, Joe, is that we are seeing increasing receptivity from our clients to do two things. First of all, to allow us to infuse new capabilities into existing fixed-price contracts and under those same contracts, kind of point one, and point two is, even many of our cost type contracts are moving to allowing us to do fixed-price cleanse or fixed-price additional line items. So in aggregate, I mean, this really reinforces our move to a more balanced portfolio than what it is today in terms of the mix between fixed and cost-type contracts.

And I would also just hit, in our prepared remarks, we have 67% of our new contract wins as fixed price. And as we phase those in, the business will shift to more fixed price, which gives us more levers to actually expand margins over time.

Yes, I guess what I was trying to ask was the longer-term goal to get to 7% EBITDA. Does that assume - I mean, what does that assume from a contract mix standpoint? It would seem like if two-thirds of the business is fixed price, you could actually do better than 7%?

I would like to think that, over this kind of journey between now and 2023, that we would see somewhere between a half and slightly more than a half of our business being fixed price. Again, that always depends on mix, and time will tell. Additionally, we also see a move to selling more independent solutions, and those independent solutions will also contribute to improvements on that margin expansion. Last point and really the last pillar of our profit expansion road map is to continue to drive lean principles and other process management improvements across our entire portfolio.

Okay, that's helpful. And then, it seems like the work associated with K-BOSSS is going to continue for a little while longer. I'm wondering, Chuck, if you could just talk about LOGCAP? How many shots on goal do you think you have there to maintain your current book of business? If you don't win CENTCOM, are there other chances there or is that it? What's the best way to think about that?

The best way to think about this - the LOGCAP conversation is in two parts. The government has repeatedly reinforced that they would like to make four to six awards on the LOGCAP V contract. They have also said verbally on countless occasions that their preference is to award closer to six. We are highly confident that, today, there are six competitors. So the likelihood of us receiving a seat on LOGCAP, while nothing is certain in this world, is probable, point one. Point two is that our current footprint in the CENTCOM area of responsibility, as I stated in the prepared remarks, we are the largest incumbent, and we have excellent performance ratings from our clients. So retaining CENTCOM is our first objective, and I think it's an objective that I personally have confidence in. If for some reason we do not win CENTCOM, there is revenue alternative - the revenue opportunities, I should say, across all the areas of responsibility. So if we're fortunate enough to receive - to win a seat on LOGCAP, the likelihood of us going from our current footprint in CENTCOM to zero is de minimis. We will have a revenue base somewhere throughout the world, depending on which area of responsibility they were ultimately awarded. Does that make sense?

It does, Chuck. Can you share what the lowest revenue opportunity for you is within the contract?

I would be speculating at this point and the very nature of LOGCAP being a contingency engagement. I mean, we're one world event away from that being obsolete. I will tell you, though, that both CENTCOM and EUCOM and PACOM, just by reading the press, is where the focus is from the US Military perspective.

Our next question comes from the line of Brian Ruttenbur with Drexel Hamilton.

A couple of questions. First of all, let me start with the macro and then jump into some of the individual more questions digging down. Can you talk a little bit about what you see with budgets going on in '19 and beyond? There's been lots of talk, lots of proposals, talking about everything flattening out. What you guys - even if you won K-BOSSS, let's just say that K-BOSSS becomes LOGCAP, you keep your percentage, what you see going on in the industry, maybe you can talk about that. And then I'll jump into some specific questions.

So I will - at the macro level, having a budget and having budget stability is a good thing maybe as much or more important than the exact levels. With regard to the speculation about reductions in 2020, what I will tell you is, I am as confident as our - in our pipeline as I've been since arriving a couple of years ago. So the visibility that we have into the opportunity stream well into 2020 and beyond is something that is - provides comfort to me. We'll always have to deal with budget ups and downs, but right now, it's really the stability of the budgeting process which we believe to be back to the norm, if you will, as well as the strength of our pipeline is how I think about the macro.

Okay. And then let me jump over and ask Matt some questions about maybe '19, you can talk a little bit about how much is built in, I believe, that K-BOSSS goes through the end of March. Can you talk a little bit about your visibility beyond that for the program? And do you expect any kind of extensions? Or this is actually going to be let the end of March?

Yes. So we are on contract through December of this year formally and got a notice of intent to extend the option period through March. So that's likely. We do know the LOGCAP award is scheduled for an April award. So just that logic, we expect an extension on K-BOSSS into 2019. How far into 2019 is anywhere from 6 to 18 months. So we just - we don't know that as of this time. What I would say, as far as 2019 revenue expectations, assuming K-BOSSS stays at its current level, which is not a guarantee, we would expect with the strong wins this year that we would see approximately about a 3% to 5% organic growth rate into '19, again, assuming K-BOSSS stays at its current level.

Okay, so let me just get this straight. Right now, for sure, you have an extension through the end of this calendar year. I thought there was an extension - you had extension or visibility contract until March, right.

Yes. We are on contract formally through December of this year, and we have - there's an option to extend through March, which the government, our customer, has exercised a notice of intent to extend. So that will extend through March.

Okay. And then, on top of that, you anticipate - or you think it's probable, maybe I can help - you can help me without the words, that this extends throughout all of '19?

So what we have today is we have a belief that the extension will range from anywhere from 6 months to 18 months. For our internal planning purposes, I mean, we are thinking about the existing K-BOSSS revenue stream through the entire 2019 period. And there are no guarantees, and we would hope to have somewhere in the first quarter of next year a kind of a firm understanding from the government about how long that extension period will be. Again, the conversation has been anywhere from 6 to 18 months.

And Brian, you just have to think about a LOGCAP award in April. There has to be some time to kind of socialize the award and then phase in task orders, so that's why we came up with that belief and that estimate.

Okay, very good. That's encouraging. And then final question. Your strong bookings. Are you displacing any competitors or is this just the rising tide lifting all boats?

I am very heartened by the success in, not just retaining our existing business but in actually displacing entrenched incumbents. In fact, I believe, Matt, you can correct me, I don't believe in our bookings so far this year. Other than SENTEL, we've had any recompetes. So everything that we have won that had been in our pipeline has actually been displacing a competitor somewhere else.

[Operator Instructions] Our next question comes the line of Lucy Guo with Cowen and Company.

So a couple of follow-ups. One is, would you have visibilities to other extensions besides K-BOSSS and maybe the timing of those?

We do have one contract - one material contract that we disclosed in our Q that will extend likely in the fourth quarter, and it's OMDAC-SWACA, so we believe our bookings will pick up in the fourth quarter and really in the first quarter with the K-BOSSS extension as well.

Okay, that's good to know. And when - so I noticed the submits pending decision decreased from $1.4 billion to $1 billion. Were there any pushouts in that pipeline or did some move into the two bids submitted?

The bids submitted pending award kind of changes over time. Some contracts are won. Guantanamo Bay is a good example. So that comes out, but it goes into our new wins category. Some contracts, we're not successful on. So not every contract we propose on, we win. So that changes over time. I would say, since we've been reporting that, which is really probably for four years now, we've been over $1 billion. And that kind of shows the health of our pipeline. If we can have roughly about $1 billion pending award in any given time, we feel like that's a good level at this point, and so we really start to see some additional growth.

Got it. And would you have the rough mix of both new business and fixed-price contracts within the backlog and the pipeline?

I would say, generally, with the exception of LOGCAP, LOGCAP is a cost-responsive or cost-plus program. It's currently constructed but, as a general rule, what's within our new business pipeline is typically at least 50-50 fixed price, maybe 60% fixed price, 40% cost-plus. And the reason why there's always a cost-plus element for most of our contracts, there's a consumable requirement that the contract needs to have some flexibility for. So very rarely is it all fixed price, but occasionally it is. But in general, just to answer your question with the exception of LOGCAP, the business is shifting more 60% fixed price, 40% cost-plus.

Right. And the associate - I'm assuming, that you still see a pretty good new business mix in your pipeline as well besides LOGCAP?

We do. Our pipeline is strong now both in the bids that are under evaluation and the $7 billion in the pipeline. Again, as I mentioned to Brian, the budget stability has really helped, if you will, our clients' confidence and make new awards, point one. And point two, we are seeing our clients really gravitating towards kind of infusing both technical and operational activities in the contracts. So in essence, we have access at potentially greater contracts now than historically. So a longwinded answer to your question, but we do see confidence from our clients' perspective, and we are aggressively building and maturing our pipeline across our core businesses.

That's helpful. And then a follow-up on LOGCAP V, which is - what would it take for Vectrus to switch to another geography if CENTCOM doesn't happen to come through in terms of personnel and costs, maybe just talk briefly on that?

Well, as he - and we talked this year that we had successfully phased in 100 - in this call, phased in $130 million worth of new business here in the last quarter. What that would entail is essentially winding down our K-BOSSS operations, and we do much more of in K-BOSSS as we've indicated in CENTCOM, so that would be a program wind-down. And then we would have several program start-ups in another area of responsibility. So it would not be trivial, obviously, but we have demonstrated to ourself an ability to successfully transition in new contracts.

And just to kind of connect it financially. There's no really stranded cost in that transition. Those phase-in and phase-outs are usually covered in contractual requirements of both the closing out contract and the start-up contracts.

Thank you. We have reached the end of our Q&A session. I'd now like to turn the call to Mr. Prow for closing remarks.

First of all, thank you all for your thoughtful questions. We enjoyed the call today, and we look forward to updating you on our progress in our next call. Have a nice day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.