CPI Aerostructures, Inc.
Q2 2018 Earnings Call Transcript

Published: 12 Aug 2018

[Operator:]

Good morning and welcome to the CPI Aerostructures' Second Quarter 2018 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 Sanjay Hurry, Investor Relations Council. Please go ahead.

[Sanjay Hurry:]

Thank you, Kate. Good morning, everyone, and welcome to CPI Aerostructures' 2018 Second Quarter Financial Results Conference Call. A copy of the Company's earnings press release that was issued earlier today and the accompanying PowerPoint presentation to this call are available for download on the Investor Relations section of the CPI Aero website. On the call this morning are Douglas McCrosson, President and Chief Executive Officer; and Vincent Palazzolo, Chief Financial Officer. At the conclusion of their prepared remarks, management 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 contained in this conference call. Additional information concerning these and other risks can be found in the Company's filings in the SEC. With that said, I would now like to turn the call over to Doug McCrosson, President and Chief Executive Officer. Good morning, Doug.

[Douglas McCrosson:]

Good morning, Sanjay, and thank you, everyone, joining us on our call. I will begin this morning with a brief review of our performance for the quarter. Vince will then provide a more detailed review of our financial results, including our full-year financial guidance published this morning that address for the WMI acquisition which did not close in the second quarter. I will then conclude the call with some color on the second half of the year and offer some early perspective on 2019. Before I begin, let me touch on the status of our acquisition of WMI. As you are aware, we are now in litigation to compel WMI Parent Air Industries Group to provide information required to proceed with the closing of the acquisition. Last week, we filed a preliminary conjunction motion that issues the court order directing Air Industries to furnish CPI Aero with all previously requested financial, operating and other data and information relating to WMI. The court has scheduled oral arguments for the preliminary conjunction motions for August 13. As we are currently in litigation, these will be the extent to my comments on WMI today. We are reporting another quarter of strong operational performance, highlighted by a fifth consecutive quarter of profitability in both sequential and year-over-year growth in revenue. Those of you who have followed our progress over the years, are well aware that we have worked hard to put in place an efficient infrastructure to drive consistent profitability. We are therefore very proud of our earnings per share with the EPS up for the second quarter and first half of the year 56% and 22% respectively over the comparable periods last year. We have also been focused on improving cash flow from operation. While we expect that 2018 will have positive cash flow from operations as was the case in 2017, we did experience timing issues with billing on three programs that resulted in negative cash flow from operations through June 30th. We fully expect to have these issues resolved in the second half of the year. Vince will provide additional details as part of his review. We are especially pleased with our revenue performance for the quarter and first half of the year given the uncertainty and defense budgets at the beginning of the year. That was only resolved with the passage of the 2018 Omnibus Appropriations Bill in March. Second quarter revenue increased 21% year-over-year and was driven principally by defense programs such as our Next Generation Jammer pod for Raytheon and our T-38 Pacer Classic III program. We also secured a long-term agreement in our commercial segments with Honda Aircraft Company for the manufacturer of the noise attenuating engine inlet for its recently debuted HondaJet Elite advanced light jet. We have manufactured products for the HondaJet Aircraft since 2011. And this award testifies to our strategy to innovate and pursue state-of-the-art manufacturing processes that continue to set us apart from our competition. The passage of the appropriations bill in March has removed budgetary uncertainty surrounding fiscal 2018. While it provides funding for almost all our customers key programs, we saw orders begin to pick up at the beginning of Q2 as net effect on backlog is not yet evidence. You will see this on Slide 4 of consolidated backlog at quarter-end was $360.2 million of this amount 79%, but $284.6 million relates to multi-year defense opportunities. This is a sequential decline as compared to the March quarter. However, with defense budget for 2018 now set. We expect backlog at year-end to be higher than at the end of the second quarter. I will provide additional color around this expectation after Vince’s review. Turning to Slide 5. $277 million of the total backlog at June 30th is derived from defense contracts announced since November of 2014, illustrating continued execution on a defense market strategy. You will also know that with the exception of the tax R-Pod Structure that is in the early stage of development. We have substantial visibility over defense revenue through 2022, and in some cases beyond. We also have multiple opportunities for replenishment through follow-on contracts. During the second quarter, we received additional purchase orders for T-38C Pacer III Classic modification kits. With these purchase orders, we have received orders totaling $18.1 million under a potential $49 million IDIQ contract that we want in 2015 from the Air Force. I will now turn the call over to Vince Palazzolo, our CFO to review our financial results for the second quarter in greater detail. Vince.

[Vincent Palazzolo:]

Thank you, Doug. Before I review our second quarter results, I want to remind you that effective January 1, 2008, we adopted a new revenue recognition standard known as ASC Topics 606. Following the adoption of ASC606, our revenue recognition on all of our current contracts has not changed materially over the life of those contracts. As a further reminder, and as a consequence of our adoption of ASC606, the asset previously called costs and estimated earnings in excess of billings on uncompleted contracts is now under ASC606 called contract assets. And the liability previously called billings in excess of cost and estimated earnings on uncompleted contracts is now under ASC606 called contract liabilities. Starting on Slide 7. Revenue for the second quarter 2018 increased 21% to $20.3 million from $16.7 million for the second quarter of 2017. As Doug mentioned in his opening remarks, we recognized higher revenue from our next generation jammer pod program and T-38 Pacer Classic III Prime contract that offset lower revenue from our E2D program. Over the past several quarters we have seen lower revenue from E2D as we transition from the current multi-year program to expected new multi-year contract that Doug will mention later. Gross profit increased 24.5% to $4.6 million, from $3.7 million in the year ago period. Gross margin for the quarter was 22.6% an improvement for 60 basis points compared to the year ago period. Selling, general and administrative expenses increased by approximately $556,000 for the second quarter compared to the same period last year, primarily reflecting an increase in professional fees, salaries and compensation related expenses. The increase in professional fees is predominantly the result of work performed for financial and legal due diligence and transition planning for our proposed acquisition of WMI. Pretax income for the second quarter increased 32.4% to $1.6 million from $1.2 million in the year ago period. The increase was due predominantly to higher military revenue. Net income for the second quarter of 2018 was $1.3 million or $0.14 per diluted share compared to $776,000 or $0.09 per diluted share in the year ago period. Turning to Slide 8, which displays balance sheet highlights. Contract assets were $115.2 million an increase of $4 million compared to the December 31, 2017. The increase is the result of work performed, but not yet build on newer programs such as the next generation jammer pod and the new design of Honda Jet Engine Inlet for which we have not yet begun to bill on a steady rate. Further we experienced some delays in shipping on the G-650 program. As you know, we have been working on reducing the amount of cash tied up and working capital and particular the amount of inventory we carry. While we have a lower inventory through the first six months of 2018, we had a slight increase in inventory this quarter as we built up units related to these three programs that did not shipped until early July. We ended the with working capital of $80.6 million, compared to $78.1 million at December 31, 2017 an increase of $2.5 million. The increase is predominantly the result of the increase in contract assets. We used $1 million in cash to support operations in the second quarter of 2018 as compared to positive cash flow of $1.8 million during the same period last year. As was the case last year, we expect cash flow to improve in the later portion of the year. At June 30, 2018 total long term debt stood at $6.2 million compared to $7 million at December 31, 2017. We had $27.3 million outstanding on our revolving line of credit at quarter end. The $2.5 million increase in the revolving line of credit was the result of timing differences between cash received from customers on certain programs and payments we made to suppliers on these programs. We have resolved some of these timing issues with our customers already and expect to have these issues fully resolved by year-end. Shareholders equity improved to $77.3 million at quarter end with a book value of $8.65 per share. Our debt to capital stood at $30.46. Finally, we received a commitment letter from BankUnited to amend our BankUnited facility to extend the term of the revolving loan through June 30, 2020. Turning to Slide 9, our prior 2018 financial guidance included contributions from WMI and assumed that we would close this acquisition in the second quarter. This is not the case unit as Doug noted. We are currently in litigation with WMI's parent company. We are there for providing standalone financial guidance for 2018 that excludes the acquisition of WMI. For fiscal 2018, we now expect the revenue in the range of $82.0 million to $85 million with pre-tax income anticipated to be in the range of $8.0 million to $8.2 million. We are maintaining our expected effective tax rate range of 19% to 21%. 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. Looking ahead to the second half of 2018 with defense budgets funded, customers are starting to order off our nearly $300 million defense backlog. As reflected in our financial guidance, we expect a stronger second half to the year in terms of revenue, profitability and cash flow from operations and expect to be cash flow positive for the year. The certainty defense budgets moreover, extends beyond the current year that together with our bid pipelines and with program opportunities on the horizon across both domestic and foreign military sales, gives us multiyear line of sight to sustain top and bottom line growth. The appropriations bill raises discretionary spending caps imposed by sequestration for two years, reversing years of decline and uncertainty and defense program funding. This comes at a time when we are increasingly intertwined in our partner supply chains on longer-term programs. Last week, the House of Representatives approved a compromise defense policy bill that would authorize a wave of significant defense department increases for 2019. This compromise bill prioritizes among other things, rebuilding military readiness and modernization efforts. These favorable tailwinds are further supported by the administration and Congress indicating their preference for further increased spending on defense together with increasing spending internationally, and increasing operating tempos for U.S. and Allied air forces. Last week, the Senate approved its annual defense authorization bill that is above the administration's request. The bill which is expected to become a law in a few weeks, allocates $40.8 billion to overcome what it terms as a "crisis in military aviation". The positive implications for CPI Aero are across multiple platforms. I will provide more insight into our opportunity across these platforms in a moment. Our strategy to support key existing and new defense platforms is aligned with a new defense authorization bill and presents an opportunity for continued growth and our competence is founded in our competitive advantage. We offer large contractor capabilities with the flexibility and responsiveness of a small company while staying competitive in costs and delivering superior quality products. As you can see on Slide 11, 89% of our bid pipeline is cited on defense platforms. Virtually all bids are at the primer for Tier 1 level. Our growing reputation as an efficient supply chain partner for the aerospace and defense industry positions us well to take increasing share of work on any platform with a Department of Defense or Tier 1 is looking to improve supply chain efficiency. This quarter, you will notice substantial variance in kitting and Aerostructures relative to Q1. Kitting decreased as a percentage of our bid pipeline following the award of the F-16 Service-Life Extension Program contract to a competitor. However, CPI Aero is an approved source of supply for several components on the F-16 SLEP, so we are eligible to supply parts to the chosen prime contractor. In fact, we recently received an RFP for certain of these components. Aerostructures increase as a percentage of the bid pipeline sequentially due to largely to the A-10 re-wing program. Previously, the big value reflected the first four aircraft only. The bid pipeline now includes the value for the full program of 110 aircraft following submission of our proposal to the prime contractors that will be volume for the re-wing contract. Turning to Slide 12. Overtime, we have extended our capabilities, particularly within our manufacturing operation, supply chain and program management functions. Intern we now possess the ability to supply more complex aerostructure assemblies, and aero systems in support of our defense based programs. Our capabilities have also allowed us the opportunity to pursue higher margin MRO and kitting opportunities. On Slide 12, you will see some opportunities ahead and each of the segments that we operate in. On today’s call, I want to provide some color and timing around some of the programs that put us on a path to continued growth, many of which are new starts expected to be funded in the 2019 defense budget. For our Aerostructures segment, we see a restart of the A-10 Wing Replacement Program. The 2019 National Defense Authorization Act that was sent to the President as $144 million beyond the $103 million already earmarked for the program in the 2018 defense budget. That is approximately a quarter of a $1 billion that is expected the flow to industry starting as early as March of 2019. As we have previously discussed, we know of only two prime contractors bidding on work and we are uniquely positioned to support either winner. While agreements prevent me from disclosing their potential value of the A-10 effort to CPI, it is expected to be among our largest potential new programs. We also have near-term potential on various Black Hawk components and structural repairs, as well as for flight control services on a light attack fixed wing aircraft for an international customer. In our kitting and supply chain management segment, we see opportunities and sales of F-16 wing components for both domestic and international customers. We see a new supply agreement with Northrop Grumman for outer wing panel kits for its E-2D Advanced Hawkeye for both U.S. and Japan variants. The 2019 Defense Authorization Bill gives a green light for a new multiyear procurement of E-2D Advanced Hawkeye and authorizes long lead funding. We are currently in discussion with Northrop Grumman on the terms of a five year contract to continued supply the same case we have been supplying for more than a decade. And we have open bids for the supply of structural components for various other military helicopters. Within our Aero system segments, near-term opportunities include systems for reconnaissance pods, electronic warfare pods and structure for an advanced antenna. I was recently in England attending the Farnborough International Air Show, where I held dozens of meetings with senior leaders of our customers and potential customers. The message was clear. Product demand for both commercial and defense platforms is likely to make OEMs more reliant on a supply chains, and the companies that are system integrators and have the experience to manage complex programs will be an asset to them. I of course, believe CPI Aero was such a Company. To that end in addition to working to close on the several near-term opportunities in front of us, our business development activities focused on next generation aircraft and systems such as T-X Trainer, B-21 Long Range Strategic Bomber the F-16 as well as new model business jets. Likewise, we see potential and leveraging along experience and manufacturing increasingly more complex aero systems such as the next-generation jammer electronic warfare system we built for Avion to fine success in the autonomous systems market. On our Investor Call last quarter, I spoke about the skill set we maintained in-house that lends itself to being the supplier of subassemblies of potentially even complete autonomous systems. We have made progress since our last call in positioning our capabilities in front of manufacturers of such systems. Who we expect will require outsourced capabilities to meet the projected future demand. Turning to Slide 13. Our focus on multi-year defense awards gives us excellent long term revenue visibility. Our defense and commercial programs has a potential to generate approximately $360 million over the remainder of their periods of performance. In summary, over the past several years, we have put in place an efficient organization, we redirected our business development efforts towards the defense market and pursue the multi-year program that offer a significant visibility into annual revenue. We have a stable business at numerous near term opportunities that we expect to yield new program starts as well as follow-on awards. And we have established a track record and reputation as a valued supply chain partner and enables us to be in the mix on future aircraft and systems that will drive future growth. And with current and projected near term U.S. and foreign defense spending as a tailwind, we are on a trajectory for higher and sustainable growth. This concludes my prepared remarks. Thank you for your participation on the call. And Kate, could you please open the call to questions? Thank you.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question is from Mike Crawford of B. Riley FBR. Please go ahead.

[Mike Crawford:]

Thanks. Doug, I know you said you couldn’t comment on the WMI acquisition any further, but I mean why is this thing in court didn’t Air Industry sign contract to sell these assets to you?

[Douglas McCrosson:]

Yes. And they backed out of the deal. So we had to litigate.

[Mike Crawford:]

So I mean is just management or is it the board of directors or who is liable here?

[Douglas McCrosson:]

I'm not going to comment on that Mike. And I'm not sure if you are referring to their board of directors or mine?

[Mike Crawford:]

Yes, their board of directors. They are the ones that are breaching the contract. So anyway, what is the E2D in transition? It if takes a while to get this extended five year contract with Northrop Grumman. Does that mean there is any risk to the guidance you provided today?

[Douglas McCrosson:]

No. Because the guidance today assumes completion of the current multi-year and we have good insight as to when we expected multi-year two will start and that is reflected as well. And we believe there is no risk in that number.

[Mike Crawford:]

And given that this NDAA on that you mentioned on Trump's desk is poised to say we are the first on time budget in 22 years knock on wood. But does that mean would that accelerate ability to get jump start on the A-10 rewinging?

[Douglas McCrosson:]

That is always possible, Mike. Our expectation though is that the current calendar for that award is still March of 2019. Could that accelerate? Sure. There was some good news recently the government - the original government request it had the 110 or so aircraft in there but they were only going to put four on contract. That number has been increased up to 12 with the expectation that the new money is coming to 2019. So, we are already seeing signs that there they have increased their commitment to the industry on how many aircraft they initially want? We view that as a very good sign.

[Mike Crawford:]

Okay, great. Thank you very much.

[Douglas McCrosson:]

Thank you, Mike.

[Operator:]

The next question is from Ken Herbert of Canaccord. Please go ahead.

[Kenneth Herbert:]

Hi. Good morning, Doug.

[Douglas McCrosson:]

Good morning Ken.

[Kenneth Herbert:]

Hey, I just wanted to follow-up on the comments you made around some of the further opportunities are pursuing, whether it be T-X, B-21 some F-16 obviously it sounds like there is incremental opportunities on the NexGen Jammer. What is the time frame we should think about in maybe you would be in a position to announce sort of initial or significant new program starts I guess, as we think about the budget firming, we think about, obviously, your business development efforts and the pipeline growing? What is maybe a couple of the next catalyst we should think about as we head into 2019 of incremental programs that could be significant to the Company?

[Douglas McCrosson:]

Somewhere in the near-term I meaning within the next say, 30 to 60 days, in terms of some of the current products that we are doing that we expect follow on that will take us over the next several years. Some of those programs include the current Raytheon mid-band program that we are doing with them now. Of course, E-2D multiyear that we expect too. There are some spares and aftermarket contracts that we are looking at with Lockheed Martin, Sikorsky's division for Black Hawk. Those are fairly near-term, certainly within the next 60 to 90 days for all of those. Then for the new pursuits, we stood up a new business development leadership team. So some of the longer term like B-21 and T-X, certainly T-X won't happen until a winner is selected on the prime contract. But we are making our case and our value proposition to many of the partners that have already been announced for Trainer and for the B-21.

[Kenneth Herbert:]

Okay, that is helpful. And as we think about incremental work, we are starting up the A-10 work again. Obviously, you have done a lot of work on that in the past, and you had some issues with your customer on the contracts and in getting profitability on that contract as to where you would like it to be. Is there anything we should be concerned about moving forward on this program? Or do you feel like you have made sufficient changes to a potential contract here and how you structure things moving forward on this program that, assuming it does start next year and you are on a relatively accelerated path that it will obviously be incrementally positive and de-risked relative to prior work on this program?

[Douglas McCrosson:]

Yes. You know the engineering data is stable now, both the prime contractor whoever that is, and their teammates have essentially worked out all of the technical challenges and inspection challenges and quality issues that had kind of create a lot of uncertainty when the program was originally let out. We have accounted for all of that basically in that we have eight years of cost data both internal cost with labor as well as external costs with the supply chain, and our bid is based on those actual costs suggested for the various quantities that they would like to buy. So we view the, I would say that the performance risk as negligible because we have been making a quality product for a long time now and really we view the financial risk and in terms of being able to achieve our estimates as equally low.

[Kenneth Herbert:]

Great. Thank you very much.

[Douglas McCrosson:]

Thank you Ken.

[Operator:]

[Operator Instructions] The next question comes from Ben Klieve of Noble Capital Markets. Please go ahead.

[Ben Klieve:]

Just a couple of quick ones for me. First of all, quick question regarding the guidance provision. I just want to be clear that 100% of the guidance provision was tied to WMI. I mean, was there any kind of revision either upward or downward coming from internal performance here, you know you either performance today or the outlook for the remainder of the year?

[Douglas McCrosson:]

No. The only change was stripping out WMI projections from the full-year.

[Ben Klieve:]

Perfect. Thank you. And then, Doug in your comments on the kind of near-term opportunities. I’m wondering if you can elaborate a bit on the potential in the UAV market. Both from a capability standpoint and then kind of when you anticipate development from that space, you may transpire here. How should we really look at as a potential in that space for you over the next couple years?

[Douglas McCrosson:]

So one of the things that we have tried to do over the last several years and really kind of culminating with the next generation Jammer pod where we showed the value that a small business with our type of complex skill in terms of complex structural assemblies can add to these prime contractors. I think that with that contract, we have been able to show others manufacturers of similar systems, as well as autonomous systems that the types of work that they need can be done by a small affordable manufacturer. So we have put ourselves and what our cost structure and our capability to be able to compete I think, in meeting the objectives of what would be the longer term UAV market. So we see the lighter, smaller, more affordable type systems that will be fielded. We think we will benefit from our type of skills with our type of cost structure. So I think we answer industries need for a capable manufacturer that can develop and integrate all of these components at a lower cost than our peers could do. Because right now, when we compete in highly complex systems, we are competing against large multi-billion dollar aerospace companies that have a very high cost structure and so we are able to develop the same types of skills around a lower cost structure. So I think that while we don't have necessarily anything identified right now. Certainly the key objective of our business development team is to find those opportunities where affordability and high quality and complexity aligned to meet our customers' need.

[Ben Klieve:]

That is perfect. Thanks Doug. I appreciate the color and I will get back in queue.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Douglas McCrosson for closing remarks.

[Douglas McCrosson:]

Well thank you again for participating on today's call. And Vince and I look forward to talking to you again when we issue our third quarter 2018 financial performance press release. Thank you and have a good day.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.