BigBear.ai Holdings, Inc. Q3 FY2022 Earnings Call

Good afternoon, everyone, and welcome to BigBear.ai's 2022 Third Quarter Earnings Conference Call. I'm here with Mandy Long, our new CEO; and Julie Peffer, our Chief Financial Officer. During the call today, we may make certain forward-looking statements. Listeners are cautioned not to put undue reliance on the forward-looking statements. BigBear.ai specifically disclaims any obligation to update the forward-looking statements that may be discussed during this call. Many factors could cause actual events to differ materially from the forward-looking statements made on the call. These statements are based on current expectations and assumptions, and as a result, are subject to risks and uncertainties. For more information about these risks and uncertainties, please refer to the forward-looking statements section of the earnings press release issued today and our SEC filings. We will also discuss some non-GAAP financial measures during the call today. These non-GAAP financial measures should not be considered a replacement for and should be read together with GAAP results. You can find the GAAP and non-GAAP reconciliations within our earnings release. Now I'd like to turn the call over to Mandy.

Thank you, Josh, and thank you all for joining today's call. I'm thrilled to be here for the first time as CEO. And 30 days into the job, I can see very clearly that we have the right investment thesis, talent, and technology to thrive as a software and services business. We had a solid third quarter with total revenue of $40.7 million, our highest quarterly revenue to date representing 8% quarter-over-quarter growth. We also made significant progress on our cost savings initiatives and expect these initiatives to result in more than $20 million in annualized savings as we move into Q4. We made some mistakes earlier in the year around how we were managing spend, and we lacked the necessary operational rigor. I'm committed to addressing these in my new role in collaboration with my leadership team. BigBear.ai is building a better world through better choices. And our superpower is working with some of the most complex information to find and reveal what really matters. We support decisions, often in an incredibly dynamic and high-stakes environment, and our customers depend on our technology and expertise to achieve critical missions from shipyards to hospitals to battlefields. I'm focused on a comprehensive review of our talent and our portfolio. And I'm defining the path to unlock the value that exists here through focused, disciplined growth to drive shareholder value over the long term. The three main objectives that we're rolling out this week to guide our path forward are as follows: repeatable pattern, good housekeeping, and find rare earth. Let's talk a little bit about what each of these means. Repeatable patterns refer to how we'll leverage the assets we have today to continue to solve real customer problems. With the challenging macroeconomic environment and the geopolitical factors we face as a global society, we're going to prioritize an area of core strength, earning and maintaining the trust of our clients and partners as we solve difficult information challenges and provide decision-making support in a highly complex environment. We're going to be more methodical about identifying what works and replicating that with our robust prospects. We have a strong backlog, and we are going to lean in on the areas where we have established skill to drive engagement forward to success. Our new Global Force Information Management, or GFIM, win is a perfect example of our ability to deliver value to a customer by deriving actionable insights from complex, highly divergent data to drive operational decisions based on force readiness worldwide. The GFIM award began generating revenue in September and will be a primary driver of our fourth-quarter growth. Additionally, we're seeing opportunities with children's hospitals to provide digital twin simulation solutions to enhance decision-making. For example, an early 4Q win successfully led to an implementation of our first emergency room customer in October, and we will discuss this in more detail on our next earnings call. We're also continuing to build our pipeline in the discrete manufacturing space, focused on use cases such as optimizing process performance via increased product throughput, reducing cycle time, and rightsizing inventory levels. With existing customers, we're looking to grow our relationship by bringing additional capabilities to the table through a land-and-expand motion. We're establishing repeatable patterns based on lessons learned, experimenting with new concepts, and putting those that validate into scale. The second objective we're focused on is good housekeeping. This refers to comprehensively improving how we operate and adopting a no-shortcut mentality. We will continue to integrate and drive efficiencies in our core business functions. These opportunities will allow us to more closely monitor the business and pivot if necessary, and will also empower our team members and create a culture of pervasive excellence and accountability. So we're going back to the beginning, and we're doing a full review of the systems, tools, and methods we're using. This includes rigorous cost and expense control as well as financial contingency planning. It includes how we communicate and create transparency throughout the organization so that team members have the information they need to make decisions quickly and effectively. And it includes how we build and deliver technology, ensuring that we're leveraging best practices and continuously learning from our community as new methods emerge. This work never stops and will be a part of our DNA from here on out. I'd like to note that we've made progress, and I'm grateful for the team's hard work over the third quarter and moving the ball forward. As one example, this quarter, we held a 2.5-day Finance Transformation Summit with leaders from each of our departments as well as outside advisers. The outcome of this exercise was a roadmap of objectives and actions that are designed to accelerate our close process, eliminate unnecessary redundancies, ensure that we're maximizing the value of our IT infrastructure, and shorten the cycle time for our leaders to receive critical information to guide strategic decisions. We'll make future improvements to our operating efficiency in the coming quarters, and we will communicate those as we harden plans. The third objective we're focused on is find rare earth. This refers to the implementation of a continuous discovery process across the organization to encourage thoughtful experimentation by all of our creators at BigBear.ai and to establish the way we'll uncover and validate potential software and services solutions to foster a forever innovation pipeline. This isn't just about new things. Innovation also represents the application of existing things in new areas. And we're all tilting our heads and looking at the amazing portfolio we have with new eyes as we think about servicing our markets. I'll have more information to share on our progress here as we complete an atomic global technology assessment and get to work. By framing the work that needs to be done into these three objectives, we're organizing ourselves and our path forward. And as I shared at the beginning of my comments, our investment thesis is sound, and we have the right technology, the right people, and the support of our extraordinary customers and partners. I'm confident we'll achieve meaningful, sustainable growth at BigBear.ai, and I will continue to share our progress openly and transparently. We won't be perfect, but we will learn, we will listen, and we will get better every day. Today, we are reaffirming our financial outlook for 2022 and plan to provide an outlook for 2023 when we report our 4Q and year-end financials. We're grateful for the continued support and confidence from our investors and look forward to keeping you updated as we drive towards profitable and sustainable growth. With that, I'll turn the call over to Julie for a detailed review of our financials and specifics on our cost savings initiatives.

Thank you, Mandy. Let's turn to our third quarter results. Revenue for the third quarter was $40.7 million compared to $40.2 million in the third quarter of 2021, about 1% year-over-year growth and 8% quarter-over-quarter growth driven primarily by the September award of the GFIM OE Phase 2 contract. Our Analytics segment drove $22.7 million of revenue this quarter compared to about $21 million over the same period last year, which is 8% year-over-year growth, largely attributable to the addition of ProModel and the GFIM award in September. As we stated last quarter, we expect our Analytics segment, which drives higher margins, to continue to grow faster than C&E, which will improve our overall margins as our business mix shifts. Revenue in C&E was $18 million this quarter compared to $19.2 million in Q3 of last year. The decrease was primarily the result of lower volumes on certain procurement programs. Backlog was $288 million at the end of Q3, which is down 11% compared to last quarter. This was largely driven by contracts converting into Q3 revenue as well as a few contracts with expired periods of performance at the end of the federal government fiscal year. For these time and material contracts, the customer did not spend to their contractual limits, so our backlog was reduced for any remaining funds when the period of performance was completed. This is a result of the ongoing shifting priorities we've seen throughout the year. We are continuing to review our backlog in detail to ensure we have integrated a common methodology and practical application across all of our acquired businesses as we move forward. As a reminder, we revised our backlog calculation methodology in the second quarter to more accurately depict awarded contracts from five categories into four: funded, unfunded, priced unexercised options, and unpriced unexercised options. Even with this quarter's reduction, our firm backlog comprised of funded, unfunded, and priced unexercised options is still up 54% since December 2020. In the third quarter, our unadjusted gross margin was 29%, up from 27% for Q3 2021 driven primarily by increased margins on analytics contracts. Our adjusted gross margin was 34% compared to 36% year-over-year due to the impact of less development work in Q3 2022 compared to last year. This also reduced year-over-year adjusted gross margin in analytics from 49% in Q3 2021 to 43% in Q3 2022. Segment adjusted gross margin for C&E was 22% compared to 21% in Q3 2021. Now turning to operating expenses. For Q3, operating expenses were $24 million, including R&D expenses of $1.8 million and SG&A expenses of $20.2 million. We also booked $1.6 million of restructuring costs and $600,000 of transaction costs in our Q3 operating expenses that are categorized as nonrecurring, although Q3 operating expenses were higher than the same period last year due to public company and infrastructure costs as well as integration-related expenses. When you exclude the $2.2 million of nonrecurring expenses, Q3 is a sequential decrease of approximately $7.5 million or a 25% reduction versus Q2. This reduction was largely driven by the actions we are taking to right-size our cost structure to better align expenses and cash flow with our revised revenue expectations for the year. As part of the rightsizing actions initiated in Q3, we elected to slow some of our internal investments, which required the difficult decision to execute a reduction in force at the end of August. This was a contributing factor in our sequential operating expense decline. In addition, we reassigned a significant number of G&A and R&D employees from internal projects to open billable roles, which reduced our G&A expense while fulfilling existing and new contractual obligations without additional hiring. We also reduced vendor expenses, including facilities expenses associated with reduced office space in several locations where we expect to realize additional savings in Q4. In total, we've identified more than $20 million of annualized savings in both labor and vendor reductions. This work continues, and we expect to be operating at this new annualized run rate during Q4, which will enable us to meet our previous guidance commitment of a negative single-digit loss in the second half of 2022. Going forward, as Mandy described, we will continue to identify repeatable patterns that allow us to run our business as efficiently as possible, and we will continue to take a more disciplined approach to managing operational expenses and growth investments. With rigorous cost management and good housekeeping, we will efficiently deploy capital for targeted investments that yield sustainable growth. Overall, we posted a net loss of $16.1 million for the third quarter of 2022, which included $2.2 million of stock-based compensation expense, $1.6 million of restructuring-related expense, $1.2 million of D&O insurance, and $600,000 related to transaction fees. Our adjusted EBITDA loss was $3.9 million, which is nearly a 50% improvement from Q2 with only one month of realized cost savings. Additionally, we made a year-to-date adjustment in our management bonus accrual to align with full-year projected performance. Now turning to the balance sheet. We ended the quarter with cash and cash equivalents of approximately $22 million. This represents an $8 million burn since Q2, but also includes $2.2 million of nonrecurring expenses for severance and transaction fees. The structural cost reductions we have made will allow us to minimize our cash burn going forward. Just this week, we are finalizing our credit facility amendment with Bank of America to better align with our current business needs. The revised facility will give us access to up to $25 million of liquidity upon fulfillment of the agreement covenants. As I've just described, we anticipate substantially lower cash burn going forward, and we believe our solid liquidity position enables us to target our growth investments judiciously. Now turning to our financial outlook. Today, we are reaffirming our guidance of expected 2022 revenue in the range of $150 million to $170 million. We anticipate strong year-over-year growth in commercial revenue, comprising approximately 8% to 10% of second half revenue. Following our successful cost reduction initiatives, we continue to expect adjusted EBITDA to be in the negative single-digit million range for the second half of 2022. Looking ahead, we continue to expect gross margins to expand as revenue shifts towards software and our backlog remains strong. Our product strategy and go-to-market efforts remain core to our growth, and we will focus on driving efficiencies as we continue to find rare earth opportunities and ramp up in a sustainable way.

Thank you, Julie. As I shared in my earlier comments, we have the right investment thesis, talent, and technology to thrive as a software and services business. We know that we still have work to do. And my leadership team and I are committed to improving how we manage our business and choosing new and existing investments that will lay the foundation for our long-term success. We shared several steps that we've already taken today, and we'll keep you updated as we implement additional measures to achieve these goals. We're now happy to take your questions.

Mandy, congrats on your appointment as CEO.

Thank you very much.

For Mandy or Julie, last quarter, BigBear.ai's FutureFlow Rx health care simulation platform won a significant deal. And the Shipyard AI platform also gained some traction as it relates to supply chain. Did the commercial momentum continue in the third quarter even as the macro environment has globally deteriorated?

I'll begin and then I’ll invite Jeff Dyer to share some additional insights. We've seen some interesting developments, particularly as a result of the factors you mentioned. We secured an early deal and have implemented our first emergency room use case. Our prospect pipeline looks promising, both directly and indirectly, thanks to our emerging channel relationships. Overall, I have a positive outlook for our commercial business. Jeff, I’ll turn it over to you for more details.

Thanks, Mandy, and thanks for the question. Louie, good to hear from you. She said it well. We're continuing to make investments in our sales pursuit, building only quality pipeline and differentiating with our existing clientele with expanded offerings. Mandy alluded to our first emergency room department customer. Again, lots of exciting progress that we're making with both new clients, direct and indirect as well as bringing new products and new innovations to our existing customer base, which is allowing us to expand those relationships.

Great. And for the GFIM contract that you referenced on the earnings call, this has been a contract that investors have had their eye on. You discussed in your press release about how you are partnering with Palantir. Can you provide more details in terms of what aspects of the solution you will provide versus what aspects Palantir would provide? And potentially any detail on what the economic implications are in terms of you partnering with Palantir versus if you were to do the contract entirely yourself?

It's a great question. So I think it probably makes sense, Louie, to set the table a little bit on the deal itself. So the GFIM contract win, it's a 9-month contract valued at $14.8 million. And that award builds on the previous work, and we talked about this in other reports, and the successful delivery of a prototype platform; that's what we did during Phase 1. So where we are is entering Phase 2 and getting into the contract phase for production, right, that's where we're headed into 2023. I think from a relationship standpoint with Palantir, we have a great relationship with them. I think the short answer is that we are, frankly, still doing work around exactly where some of the areas where we have superpowers, right, and where our partner does. I'll ask Tony Barrett, who runs our federal business. Tony, do you want to add a little bit of additional color there?

Thanks, Mandy. And thanks for the question. I would say the relationship between us and Palantir is complementary. It's not competitive in this particular offering. In fact, we have several partners that we're going into this solution with, including Appian. So what we've done is we're leading the way with a multi-member team approach, which answers all of the government's questions and allows them to get the best solution.

Sorry to interrupt, Mandy or Julie. I'm under the impression that eventually when the contract shifts from the prototyping phase to the production phase that the annual revenue will step up to around $30 million per year. Is that a good estimate?

Yes, I'm happy to. I think that's a good estimate. Obviously, it's not a completely firm number yet, but we expect it to be a 5-year contract, and we think it will be roughly $30 million a year. We anticipate that it will be a fairly quick follow-on to the Phase 2 contract.

Great. And a final one from me. You mentioned, Julie, at the end of your prepared remarks that you're making an amendment with your Bank of America credit facility; what is the total liquidity position now with that amendment?

Yes. So we just finalized actually yesterday our new restructured credit facility with Bank of America. The new agreement, we're going to have access to roughly $25 million of the credit facility going forward, and it's going to be related and based on our really strong government receivables. We're going to provide more of the details on the terms of that agreement within our Q. But again, we are really happy to get that locked back in. It's going to be $25 million. We don't expect to need that access to that in the near term, but really happy that we were able to get this finalized and back in place.

Okay. So with that in your cash on the balance sheet, there's about $47 million of liquidity, is that...?

That's right. That's right.

I'm Vivek on behalf of Mike Latimore. I have a couple of questions with me here. The first one is, have you seen more hesitancy among corporate prospects given the macroeconomic environment?

Vivek, thank you for the question. Yes, I just want to make sure that I understood. Was your question in relation to the commercial pipeline that we're seeing? I just want to make sure I understand it.

Yes.

Got you. So what we're seeing in general is that when we look at the second half of this year, we expect that part of our business will represent about 8% to 10% of our revenue. Looking ahead to 2023, one of the initiatives we're focusing on is the idea of finding rare earth. We believe we have many technological capabilities that are certainly applicable to commercial enterprises, and we need to put in the effort to understand and validate those use cases in the field. Additionally, within our current portfolio, we have products that are highly relevant and have a devoted customer base, and we are working increasingly to make them available.

And do you expect to be EBITDA positive in FY '23?

It's a great question. I think as we talked about, Mandy has been here now about a month, less than a month, but we are continuing to work toward our 2023 budget as we speak, and that process is ongoing. We haven't completed that process. But once we do, we're planning to announce our guidance as we announce our completion of Q4. So we'll let you know how that plays out, but we're not making commitments yet on 2023.

All right. One last question. Are you foreseeing any enhancements in the sales strategy?

I want to make sure that I understand your question there, Vivek. So you asked whether we were foreseeing any enhancements in our sales strategy? Are you talking about in terms of how we do our mix of go-to-market? Or maybe you could help me understand a little bit more.

On the go-to-market part.

Got it. I'll focus on the commercial business since that seems to align with your questions, but we can definitely discuss more if needed. On the commercial side, we built a high-caliber enterprise sales team throughout 2022, which is part of Jeff Dyer's organization. We are already seeing positive results from this in both direct and indirect channels. I touched on some initiatives we’re pursuing with our ecosystem and partners, where we see significant opportunities moving forward, and we are dedicating efforts there. Our current focus is on refining our market approach and messaging to increase clarity and make it easier for customers to discover and understand the products we offer for the various personas we serve.

This is Harshil on for Ittai. I just wanted to ask about the cost-cutting program, just how far along are you? And how much more in terms of savings do you think you still have to realize?

Thank you very much. We have made significant progress on our cost-saving initiatives, and I am very proud of what we accomplished in the third quarter. Achieving over $20 million in annualized savings as we approach Q4 is a major milestone. Looking ahead, there is still more work to be done. As I am just a month into this role, I am currently conducting a thorough analysis concerning our tools, spending, talent, and overall operations. In short, we will continue to seek opportunities for greater efficiency wherever possible. We have effectively managed and stabilized the near-term liquidity challenges we previously discussed. Julie, would you like to provide any additional insights?

Sure. Let me elaborate on some of the cost-saving initiatives we've implemented and what we have planned. We have identified over $20 million in annual savings, coming from both labor and vendor reductions. We focused on these areas starting in August and September. We've essentially captured one month of these cost savings initiatives in Q3, but you'll see the full impact in Q4, which will positively affect our run rate. During our August call, we committed to a thorough review of all expenses, which unfortunately led to a difficult decision to reduce our workforce at the end of August. We also reassigned some talented team members to billable roles in both general administration and research and development for current and new contracts, which diminished our need to hire additional staff. Additionally, we discovered significant opportunities to lower vendor spending, including reducing several office locations. These cost reductions will help us meet the guidance we provided regarding a slight loss in the second half of the year. As we develop our full-year budget for 2023, we will leverage the savings we've achieved this year. While there will be areas needing investment and focus, we will remain prudent in how we allocate resources and continue to drive efficiencies with a disciplined approach. Thank you for the question, and I appreciate the chance to explain our cost-saving efforts.

Thank you, John. I just wanted in conclusion to say a big thank you to everyone who joined today. We are incredibly fortunate to have a group of customers and partners and investors who believe deeply in the mission of this organization and the path that we're on. I have no doubt that we are right now on the path and at the beginning of what is going to be an incredibly successful transformation. We are, frankly, sitting on one of the most exciting things I've seen in my career, and it's a privilege to be able to be the CEO. We are excited about talking to you about some of the things that we're going to be doing in the coming quarters, and we appreciate the questions. I hope that everyone has a wonderful rest of their day. Take care and stay safe.

This now concludes today's conference. Thank you for joining the BigBear.ai earnings call. Have a great rest of the day.