CPI Aerostructures, Inc.
Q1 2018 Earnings Call Transcript

Published: 15 May 2018

[Operator:]

Good morning and welcome to the First Quarter 2018 CPI Aerostructures' Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn over the conference over to Jody Burfening. Please go ahead.

[Jody Burfening:]

Thank you, Brandon. Good morning, everyone, and welcome to CPI Aerostructures' 2018 First Quarter Financial Results Conference Call. A copy of the Company's earnings press release issued earlier today and the PowerPoint presentation accompanying this call are available for download on the Investor Relations section of the CPI Aero website. With us today are Douglas McCrosson, President and Chief Executive Officer; and Vincent Palazzolo, Chief Financial Officer. At the conclusion of their prepared remarks, they will hold a question-and-answer session. As a reminder, this conference call will contain forward-looking statements which involve known and unknown risks, uncertainties, and other factors that may cause actual results to be materially different from projected results. Including in these risks are the government's ability to terminate their contracts with the company at any time, the government's ability to reduce or modify its contracts if its requirements or budgetary constraints change, the government's right to suspend or bar the company from doing business with them, as well as competition in the bidding process for both government and subcontracting contracts. Subcontracting customers also have the ability to terminate their contracts with the company if it fails to meet the requirements of those contracts or if their customer reduces or modifies its contracts due to budgetary constraints. Given these uncertainties, listeners are cautioned not to place undue reliance on any forward-looking statements made during this conference call. Additional information concerning these and other risks can be found in the Company's filings in the SEC. Before turning the call over to Management, I have a couple of additional notices. First, management is available for follow-up calls with its institutional investors following the conclusion of this call. Please contact Elise [ph] to schedule a follow-up call. Second, management will present at the B. Riley FBR Annual Institutional Investor Conference on May 23 at 4

[Douglas McCrosson:]

Good morning, Jody, and thank you, everyone, joining us on our call. I will begin this morning with a brief update on our planned acquisition of Welding Metallurgy Inc. or WMI before reviewing our performance for the quarter. Vince will then provide you with greater detail on our financial results and I will conclude the call with some thoughts on the balance of the year. We announced a definitive agreement in late March to acquire WMI, a provider of specialty welded products and assemblies, large diameter tube bending and integrated electronic assemblies among other capabilities to a variety of customers, predominantly within the defense and aerospace markets. The acquisition of WMI enables us to expand our capabilities, enhance our competitive position in the defense market, and build a larger defense portfolio. Since announcing the acquisition, we have made excellent progress in working through the customary closing conditions. As we reported in our press release, we have received a commitment of debt financing from our senior lender, BankUnited. We plan to transition WMI staff and equipment and programs to our headquarters by the beginning of the fourth quarter. Over the past several weeks, I have personally spoken with WMI's key customers that collectively account for the majority of its sales. I've been encouraged by these conversations as it has become quite clear that WMI's capabilities are very much in demand by the defense industry. Welding, in particular, is a very specialized process that requires the supplier to be certified by the customer to certain process specifications. WMI holds these valuable certifications from Lockheed, Boeing, Northrop Grumman, Raytheon, Sikorsky, and others. And while the company name implies a core focus on welding, WMI also manufactures other niche products like wiring harnesses, cable assemblies, tubing and ducting that will enable CPI Aero to add more value to our customers for our integrated structures that typically contain many of these components. We're already identifying opportunities that we would not have had access to without WMI, opportunities that combine its capabilities and our expertise in program execution, manufacturing, and supply chain management. Let me give you a few examples of the opportunities we are already seeing. The first is on the A-10. On the A-10 wing replacement program we performed for Boeing, we used WMI for welding services on several assemblies. Other suppliers did so as well because WMI is one of the few approved suppliers for a very special type of welding required on this program. When the A-10 wing replacement program is restarted, as we expect it will in early 2019, we will have the opportunity to capture more content on this platform with these added capabilities. A second is on the F-35 platform for which we manufacture canopy driveshaft assemblies and lock assemblies. WMI does not presently produce components on the F-35, but it is an inactive qualified supplier to the program. We believe that our good standing with Lockheed could enable WMI to become re-certified as an approved welding manufacturer on the F-35, and ready to meet the platform's need for qualified welders. And third, we are seeing strong interest in WMI's integrated electronic assemblies from customers of our EW and ISR pods. Our customers understand the enhanced value proposition of CPI Aero being able to produce its own cables and tubes as opposed to buying these from external sources. In short, we're excited about this new venture and we can't wait to get started. Turning to our performance for the quarter, I'm pleased to report another strong execution quarter and the fourth consecutive quarter of EPS profitability. Revenue for the quarter declined year-over-year as expected and was due to lower revenue from F-16 wing components and E-2D outer wing panel kits that offset higher revenue from our Next Generation Jammer Pod program and our T-38 Pacer Classic III Prime contract. Specifically, lower F-16 revenue is attributable to a timing issue as a large quantity of high value component that shipped in the year-ago period is today being shipped in lower quantities throughout the year. We continue to expect to see revenue growth from this program for the full year. We also saw an expected decline in E-2D revenue as we transition from one multi-year contract to an anticipated new multi-year contract expected this year. I would note that we did receive new awards from Northrop Grumman on structural kits for the E-2D Advanced Hawkeye for Japan in the quarter, a testament to our excellent program execution on the E-2D platform, which gives us confidence that we will secure the new and imminent multi-year contract. Turning to Slide 4, you can see backlog is lower this quarter than at year-end, principally as a result of the drag on orders created by the continuing resolution that did not end until near the end of the first quarter. Consolidated backlog at quarter end stood at $373.3 million with multi-year defense programs accounting for 78% of that total or $292.7 million. With passage of the 2018 Omnibus Spending Bill in March 24, our customers have finally secured major funding for our key defense programs which should start to flow to CPI Aero in the form of new program starts and delivery orders as the year unfolds. The Omnibus bill provides growth on virtually all platforms we provide parts for and covers new aircraft as well as spares and maintenance, and we expect that consolidated and defense backlogs at year-end will both be higher than at year-end 2017. Slide 5 illustrates the many recent successes of our defense market strategy. You can see that $286 million of the total backlog at March 31 is derived from defense contracts announced since November 2014. All but the TacSAR pod structure are on production with periods of performance that extends into 2022 and beyond in some cases, so we have good visibility in annual defense revenue for future years. In addition to the new awards for the third and fourth E-2D from Japan, we also secured a contract extension on our AH-1Z Viper Helicopter program for Bell, bringing the total value of this contract to more than $34 million. I will now turn the call over to Vince Palazzolo, our CFO, to review our financial results for the first quarter in greater detail. I will then come back with some closing comments before opening the call for questions. Vince?

[Vincent Palazzolo:]

Thank you, Doug. For our review of first quarter results, I want to bring to your attention a change in our accounting policies. Effective January 1, 2018, we adapted a new revenue recognition standard known as ASC Topic 606. For those of you who aren't familiar with ASC 606, it requires sales and gross profit to be recognized over the contract period as work is performed based on the relationship between actual cost incurred and total estimated cost at the completion of the contract. Following the adaption of ASC 606, our revenue recognition on all of our contracts has not changed materially for both first quarter and over the life of those contracts. The one change to point out are the names of two related balance sheet line items. The asset previously cost an estimated earnings in excess of billings on completed contracts is now under ASC 606 called Contract Assets and the liability previously called Billings and Excessive Cost and Estimated Earnings on Completed Contract is now under ASC 606 called Contract Liabilities. To start on Slide 7, revenue for the first quarter of 2018 was $18.2 million compared to $20.0 million for the first quarter 2017. As Doug mentioned in his opening remarks, we recognized lower revenue for our F-16 and E-2D programs that offset higher revenue from our Next Generation Jammer Pod program and our T-38 Pacer Classic III Prime contract. Specifically, lower F-16 revenue is attributable to a timing issue as high value components that shipped in the year-ago period are today shipped in lower quantities and on a more regular schedule. Decline in E-2D revenue reflects the lower rate of activities near the end of the current multi-year contract. Gross profit was $4.0 million compared to $4.5 million for the first quarter of 2017. Gross margin for the quarter was $0.22 and flat with the year-ago period. SG&A decreased by approximately $100,000 for the first quarter compared to the same period last year, primarily reflecting lower professional fees and reduced compensation-related expenses. Pre-tax income for the first quarter was $1.6 million compared to $2.0 million in the year-ago period, the result of lower growth revenue and lower growth profit. Net income for both first quarter 2018 and 2017 was $1.25 million. EPS for the quarter was unchanged from the year-ago period of $0.14. Turning to Slide 8, which displays balance sheet highlights. Contract assets were $114.0 million, an increase of $2.8 million compared to December 31, 2017. The increase is the result of work performed, but not yet built on the Next Generation Jammer Pod. We ended the quarter with working capital of $79.6 million, compared to $78.1 million at December 31, 2017, an increase of $1.5 million. The increase is predominantly the result of the increase in contract assets. We used $2.6 million in cash to support operations in the first quarter of 2018 as compared to $2.9 million used for operations during the same period last year. As was the case last year, we expect cash flow to improve in the latter portion of the year. Additionally, we expect the operations of Welding Metallurgy to be positively accretive to cash flow over once the acquisition has been completed. At March 31, 2018, total long term debt stood at $8.6 million compared to $10 million at March 31, 2017. We had $24.8 million outstanding on our revolving line of credit at quarter end. Subsequent to the quarter, we received a commitment letter from BankUnited to amend our banking facility, extending the term of the revolving loan for an additional two years to May 31, 2021, as well as amending the payments under the term loan through May 31, 2021. In addition, BankUnited has agreed to finance the company's acquisition of WMI to a new $9 million term loan. The amendments to the BankUnited facility are subject to the lender's due diligence and the preparation and execution of formal documentation. Shareholders' equity improved to 75.9 million at quarter end with a book value of $8.51 per share. Our debt to capital stood at $0.44. Turning to Slide 9, given the passage of the 2018 Omnibus bill and its funding of our major programs into fiscal 2019 and assuming we close the WMI transaction during the second quarter, we are reaffirming our financial guidance for 2018 of revenue in the range of $92 million to $96 million with pre-tax income anticipated to be in the range of $9.1 million to $9.6 million. We have lowered the expected effective tax rate to range to 19% to 21% as the details of the newly enacted tax law are now more clear. This concludes my prepared remarks. I will now turn the call back to Doug for additional commentary on the quarter and closing remarks. Doug?

[Douglas McCrosson:]

Thank you, Vince. With an efficient infrastructure in place to drive consistent profitability, together with strengthening long-term industry fundamentals and near-term spending certainty because of the Omnibus bill, we are focused on driving top line growth from the defense sector in the current fiscal year and beyond. Our initiatives spend several fronts. While WMI represents growth through M&A, we're also driving organic growth opportunities. Let me spend a few minutes on what we are doing to materially change our growth profile. I noted on our year-end investment call in March that we brought on board Jay Mulhall as Senior Director of Business Development and Strategy for Defense Markets. Jay leads our business development efforts in areas that stand to benefit from increased DOD spend particularly in the areas of electronic warfare, intelligence, surveillance and reconnaissance and autonomous systems -- all areas where we enjoy significant competitive advantage. Jay brings deep industry experience that is integral to our strategy of pursuing the emerging growth opportunities and expanding our aerosystems business. I'll speak more on this in a moment. Turning to Slide 11, you can see that Kitting and aerosystems, two growth segments for us comprised 80% of our bid pipeline. In these areas we believe we are well-positioned to take increasing shared work on any platform with the Department of Defense, our prime contractor is looking to improve supply chain efficiency. On the left side of the slide, the pie chart underscores our ongoing sales emphasis on multi-year opportunities in the defense market. On Slide 12, you will see some of the opportunities in our big pipeline. On today's call, I want to spend some time talking about aerosystems and specifically our ability to manufacture sophisticated pod structures for electronic warfare and ISR applications. Over the past several years, our structural pod business has evolved and matured. From our earliest contracts as a bill-to-print manufacturer of simple pod structure to now providing full manufacturing engineering and systems integration design support, we have become a valued partner in this growing partner in this growing market to the leading developers of ISR and EW pods in the aerospace industry. For example, the experience and expertise we developed was leveraged to secured contract with Raytheon, the manufacturer of structural pod housings for the Next Generation Jammer Pod, one of the country's most important electronic warfare programs. I'm happy to report that the pod deliveries have commenced and we hope to see new opportunities within the EW space in the near future. The evolution of this business took another step when we are engaged by United Technologies Aerospace systems for a one year development project for its technical synthetic aperture radar or TacSAR pod that took us from being viewed as a build-to-print shop for parts and assemblies to having a higher value, trusted design and integrated role with UTAS. While still a pre-production program, TacSAR fills the capabilities gap in the ISO market and we are projecting initial orders sometime soon, possibly in 2018. I noted earlier that WMI's capabilities in wire harness manufacturing complements our pods expertise. Adding WMI's electrical wire cabling, integrated electronics and wire harnesses capabilities not only gives us greater control over content for integration work, it also represents the next stage of evolution for our pods business. On a fundamental level with a vertical integration potential afforded by the addition of WMI's capabilities, we can now offer customers a lower cost integrated solution that elevates our standing as a key partner in their production processes, allows us to bid on larger work packages and expanse content share on current programs. WMI also has a long standing relationship with Raytheon on the Seasparrow Missile Program that we can leverage to transfer our pods expertise for the first time in naval defense program. Jay's background, together with increased defense spending in this area naturally lends itself to a greater business development focus on this segment of the market. At a more aspirational level, the combination of CPI and WMI's capabilities lends itself to the manufacturer of even more sophisticated aerostructures and perhaps even complete unmanned or autonomous system. In fact, I believe this will be the next logical evolution in our integrated assembly strategy. Our manufacturing expertise with electronic warfare parts are transferable to the manufacturer of unmanned autonomous systems whether in the air, on the ground or under the sea. This will be a key focus area for us as we seek to leverage our reputation as an efficient supply chain partner to the defense industry to penetrate a segment of the defense market growing faster than the whole. Turning to Slide 13, our focus on multi-year defense awards gives us excellent long-term revenue of visibility. Our defense in commercial programs have the potential degenerate approximately $373 million over the remainder of that periods of performance. I hope my prepared remarks have given you a sense of the breadth and depth of our opportunity set both organically into acquiring companies like WMI. And we demonstrated our ability to drive consistent profitability and given our business development and sales efforts across current and perspective customers and platforms, we believe we are firmly on the path to higher and sustainable growth. This concludes my prepared remarks. I'd like to thank you all for your attendance and continuing support of CPI Aero. Operator, please open the call for the questions. Thank you.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Ken Herbert with Canaccord. Please go ahead.

[Kenneth Herbert:]

Doug, I just wanted to first ask on the backlog. I mean, it sounds encouraging and you’re expected to be above one, sort of or up year-over-year by the end of the year. Are you comfortable seeing backlog growth year-over-year starting in the second or third quarter or how should we think about timing of when you start to see a real sort of inflection on the backlog?

[Douglas McCrosson:]

I'd say by the end of the third quarter and certainly more so in the fourth quarter. But the second quarter in terms of new bookings was better than the first quarter. So while it's not going to reverse the first quarter negative trend by the full year, it will -- both the defense business backlog and the total backlog should be over where it was at the beginning of the year.

[Kenneth Herbert:]

Just how would you characterize conversations with customers now that we have a budget? It sounds like maybe the time from netting contracts is taking a little longer than people have expected. Just what would be your thoughts now from your customers on the defense side in particular, with the budget in place, and what should be more certainty, timing, and maybe the nature of those conversations?

[Douglas McCrosson:]

Yes, I'd have to say that right now, all of the customer conversations have been, I'll say, very optimistic in terms of -- and frequent. So, if you measure future delivery orders by the amount of activity and calls and communication, I would say we're in for a period of good backlog growth, like I said going beyond this quarter into the fourth quarter. Timing, as you know, particularly with our customer base being large bureaucratic customers that have a lot of rules and regulations upon them before they award contracts, the timing is sometimes hard to predict, but I would say that the optimism and the level of activity is as high as I can remember, actually.

[Kenneth Herbert:]

Just finally, I wanted to follow up on your comments on sort of the autonomous opportunity. It sounds like it is an area you are starting to put some resources in, you're starting to invest in, is it too early or can you start to talk about how you view this market in terms of maybe the total opportunity or importance down the road or relative to maybe on the aerosystems or the Kitting side, and how you see this evolving and is this something that we should maybe look for, maybe something as early as this year or the evolution of this opportunity for you?

[Douglas McCrosson:]

So, this journey began many years ago with the beginning of work on our Aerosystems segment before we even had a system called aerosystems, and all along, the belief has been that we need to demonstrate a capability and an aptitude for quality work, on time, at a highly complex level and over a long period of time. And I think that we have gotten to the point where we can begin to start talking about what is next beyond these integrated structures, and we look at the autonomous market as everybody does, and I know it's that scenario for growth. There's a lot of activity both in air, under sea, some are in the early development program, some a little further, and it continues to be our belief that the model that a lot of the prime contractors followed back in the day that created a need for CPI in the first place in terms of outsourced production work, I think we're going to see the same thing from the OEMs for that segment of the market, particularly where cost, affordability, and lead times are going to be differentiators in that market. So while I think it is too early to talk about specific opportunities, and I can say that the interest in CPI for products that would fit that bill is high, and we're pursuing them fairly aggressively and I'm not going to rule out that such an award could happen in 2018.

[Operator:]

Our next question comes from Mike Crawford with B. Riley FBR. Please go ahead.

[Mike Crawford:]

Can you provide your updated thoughts on the A-10 wing replacement given this favorable HASC markup we saw last week with $65 million plus up recommendation for the base budget?

[Douglas McCrosson:]

Yes. I mean that still has to be matched by the Senate, and we're certainly going to try to make that happen. But yes, the A-10 has been -- I think the uncertainty surrounding the A-10 has largely gone if not entirely gone. I think that with the increased spending really across the board in defense, there is no longer a zero-sum game, and a lot of programs are going to get funding that were among the margins, and I think that the A-10 and the strength of the funding behind it is one such program. The timing is still unchanged from when we spoke last. We are responding to RFPs right now, and so I can't really talk too much about where we are in that progress, but the endgame is still early next Spring in the first quarter to have a prime contract awarded to one of the competitors on that procurement.

[Mike Crawford:]

Which would then put potential contract from that time [ph] to you in the Fall of '19 time frame?

[Douglas McCrosson:]

I would put it more on the second quarter of '19.

[Mike Crawford:]

And then given the reiterated revenue guidance for this year, is there any E-2D timing risk related to when you get your new multi-year? Is that one of the bigger gating factors on that $4 million revenue range?

[Douglas McCrosson:]

Well, there's two gating factors. That certainly is one, but I view the E-2D multi-year 2, which is what they're calling it as low-risk and I would expect soon to be able to talk about that. The timing risk more, I will say back when we did it, the timing of the WMI close, we're projecting it to close in the second quarter. I think we left some room in there in case it does not, but we fully expect that it will.

[Mike Crawford:]

Okay.

[Douglas McCrosson:]

Probably when we do get the closing certainly by the next conference call, we will tighten up that guidance range.

[Mike Crawford:]

Is that WMI something that you expect that you're trying to time like on the very last day of the month of the quarter? Or it could be any day?

[Douglas McCrosson:]

No. When it happens, it happens.

[Mike Crawford:]

The last question is when you were talking about WMI, possibly getting on to the F-35, did you say re-certified as in they were certified and then they are not certified now? Or would this be an initial certification?

[Douglas McCrosson:]

Early on they did have some welding work on the program in its early days and they are now inactive. We're discussing with Lockheed as part of this closing process, their willingness to come back in and re-certify the process.

[Operator:]

Our next question comes from Ben Cleave with Noble Capital Markets. Please go ahead.

[Ben Cleave:]

First, a quick follow-up from Mike's question and your comments, Doug, on the E-2D. In your prepared remarks plus-plus and your follow-up to Mike, you seem pretty optimistic that that contract closures can be pretty imminent. Do you believe that on this call next quarter, that we're going to have a lot more visibility here? Is this something that you think could be pushed out to the second half of the year?

[Douglas McCrosson:]

No. We should have it by the time we talk again.

[Ben Cleave:]

And then one question I have -- a program-specific here is regarding the F-16 extension. I'm wondering if you can discuss how you view the potential from this program today versus before the passage of the budget at the start of the year. And how has that program evolved both in terms of the near term potential and the longer term potential for you guys?

[Douglas McCrosson:]

For F-16 program currently has what I would describe as a healthy backlog. We are seeing an increased level of activity in terms of what could be delivered in 2018. So I think we have a, I'll say, more visibility into what we can actually sell for that particular program in coming year 2018. Unlike many of our other programs, that revenue is booked as we ship product. We feel that we're going to have a strong second half with regard to F-16 because of recent orders that we received.

[Ben Cleave:]

Just one more for me. If I remember correctly, the WMI acquisition you had from contingent consideration, variables that you expected to have news on really soon and during this quarter. Is there any update on the contingent consideration payments to WMI? If there's going to be a plus up from the $9 million that wasn't up last quarter?

[Douglas McCrosson:]

I can tell you as of today, neither contingent program win has been booked by Welding Met. I can't talk to that, I mean when it will. But as of right now, there is no contingent payment to be made.

[Operator:]

[Operator Instructions] At this time I'm seeing no further questions. I would like to turn the conference back over to Doug McCrosson for any closing remarks.

[Douglas McCrosson:]

Thank you, Brandon, and thank you, everyone for attending our call today. Vince and I look forward to speaking with you all again in August when we report our 2018 second quarter results. Thank you.