CPI Aerostructures, Inc.
Q3 2017 Earnings Call Transcript

Published: 8 Nov 2017

[Operator:]

Good morning and welcome to the CPI Aerostructures’ Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Sanjay Hurry, Investor Relations Counsel. Please go ahead.

[Sanjay Hurry:]

Thank you, Cary. Good morning, everyone, and welcome to CPI Aerostructures’ third quarter 2017 earnings 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 at the Investor Relations section of the CPI Aero website. With us on the call today are Doug 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. Included 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 with the SEC. Before turning the call over to management for their prepared remarks, be advised that management is available for follow-up calls with institutional investors following the conclusion of this call. Please contact me via contact details listed in this morning’s press release to schedule a follow-up. With that let’s turn the call over to Douglas McCrosson, President and Chief Executive Officer. Good morning Doug.

[Douglas McCrosson:]

Good morning Sanjay. And thank you for joining us on our quarterly conference call. I will begin this morning’s call with a brief review of third quarter performance, after which Vince will provide you with greater detail on our financial results and on updated financial guidance for 2017. Then as approach to the end of 2017, I will conclude the call with some initial thoughts on our plans for 2018. Our financial performance for the third quarter reflects continuous solid execution on our defense market strategy that together with higher margins and improved working capital management combined to deliver a second consecutive quarter of both profitability and positive operating cash flow. I’m pleased to report earnings per share of $0.19, that is consistent with the year ago period on revenue that came in slightly below year ago levels. Specifically, our revenue for the quarter was impacted by our push outs across nearly all of our newer, early stage defense programs. While we expect these programs to move to the assembly phase over the next several months, customer-driven design changes in the quarter resulted in delayed activity that limited the amount of revenue we could recognize on the percentage of completion accounting. Turning to Slide 4, you will see that total backlog increased by more than $3 million to about $398 million in the third quarter, for a book-to-bill of 1.15 for the quarter. Funded backlog increase from $90.5 million to $100.6 million at the end of the third quarter and has increased more than $6 million from the end of 2016, a percentage increase of 6.5%. Our commercial products backlog increased by more than $4 million during in the quarter, largely due to new order releases by Triumph for our Gulfstream G650, the leading edge contract from Honda on the HondaJet engine inlet program and from Sikorsky on the S-92 structural kits program. Defense backlog remains very strong at $313.3 million or 79% of consolidated backlog, down just slightly from the end of the second quarter. Noteworthy new defense awards during the quarter were first, a five-year $8.2 million supply agreement with Sikorsky, a Lockheed Martin company, for its Black Hawk helicopter. This is our second award under the multi-year nine contract signed by Sikorsky with the U.S. Army. Second, purchase orders totaling $2 million from the U.S. Air Force for structural modification kits for the T-38C Trainer aircraft, bringing the total firm orders placed under this indefinite delivery/indefinite quantity or IDIQ contract for $13.7 million. As a reminder, we were awarded this IDIQ contract by the Air Force in 2015 and it has total potential value of $49 million. Third, an F-35 award we announced earlier this week. This $15.8 million multi-year contract was awarded to us by Lockheed Martin to manufacture canopy actuation drive shaft assemblies for the F-35 Lightning II, the world’s most advanced multirole fighter. This is our second award for the F-35 and more than doubles the dollar content we supplied for what is our nation's largest ever military aircraft program. It also further strengthens our relationship with Lockheed Martin the largest defense prime contractor in the world. In all three cases these awards are indicators of operation excellence, superior customer service and affordability leading to additional work. Momentum in our defense business was sustained subsequent to the close of the quarter with the award of a follow-on order announced in our earnings press release this morning. Valued at approximately $6 million this follow-on order is in support of a foreign military aircraft sale. While this award is reflected in our total backlog reported at September 30, the orders will be part of the funded backlog we reported year end. We will provide more detail about the customer and aircraft once we receive customer approval of an announcement. Moving on to Slide 5, the momentum in our business – in our defense business is made clear on the slide. With the exception of the one year Tactical Synthetic Aperture Radar or TSAR, pod development project we were awarded earlier this summer all of the recent wins are multi-year programs that offer excellent revenue visibility in the future years and in some cases out to 2022 and beyond. Our involvement in the TSAR project at such an early stage bodes well for our chances to secure a multi-year production award with UTC Aerospace once that program moves out of the development phase into low rate initial production. Let me know turn the call over to see our CFO, Vince Palazzolo who will provide a more detailed review of our third quarter results and our updated 2017 financial guidance.

[Vincent Palazzolo:]

Thank you, Doug. To start on Slide 7, revenue for the third quarter of 2017 was $20.7 million, compared to $22.1 million in the third quarter of 2016. As Doug mentioned in his opening remarks, on several early stage program customer initiated design changes resulted in delayed late activity that limited the amount of revenue we could recognize on the percentage of completion accounting. Also revenue on our E-2D outer wing program decline from the third quarter of 2016 which was an expected cyclical decrease related to timing of new purchase order releases. Gross profit was $4.9 million compared to $5.0 million in third quarter of 2016. We generated very strong gross margin for the quarter of 23.7%, above the 21% to 23% range for 2017 we communicated on prior investor calls. Gross margin was driven by the partial replacement of the zero margin A-10 revenue, with higher margin revenue, as well as ongoing benefit of cost and process initiatives to further wean our manufacturing processes. SG& A of $2.0 million was flat compared to the prior period. Pre-tax income of $2.5 million in the third quarter of 2017 was down $207,000, but a lower effective tax rate resulted in net income and earnings per diluted share to remain unchanged over the prior year quarter at $1.7 million and $0.19 per diluted share respectively. Turning Slide 8, which displays balance sheet highlights, cost and estimated earnings in excess of billings on uncompleted contracts or CEE was $108.4 million, an increase of approximately $9 million compared to December 31, 2016. CEE increase was largely due to increased activity on our new programs especially our Next Generation Jammer Increment 1 Pod program with Raytheon. As you know, we have been working at reducing the amount of cash tied up in working capital, in particular, the amount of inventory we carry. Our total inventory at September 30, 2017 is down $1.5 million from June 30 and $7.2 million from December 31, 2016. To date we are well ahead of our plan to reduce inventory by 10% or more for 2017 on top of the 10% reduction in inventory we realized in 2016. Working capital improvements previously implemented are reflected in our operating cash flow. For the first nine months of 2017 we used $209,000 of cash in operating activities, which is significantly less than the $6.8 million we used for the same period last year. For the quarter, we generated positive operating cash flow of $900,000, compared to positive operating cash flow of $500,000 during the third quarter of 2016, which we used to further pay down the outstanding balance on our revolving line of credit. As a result total bank debt at September 30 of $32.7 million is down $1.3 million in the quarter and compares with a total bank debt of $32.6 million at December 31, 2016. Shareholders' equity stood at $72.1 million at quarter end, with a book value of $8.15. Our debt to capital ratio stood at 0.45. Turning to Slide 9, in light of our third quarter results we have updated our financial guidance for 2017. We now expect revenue to be at the low end of our prior range of $82.5 million to $87 million. Pretax income is still anticipated to be at the high end of the range of $8.1 million to $8.5 million, as we continue to benefit from profitability improvements and from steps previously taken to lean our manufacturing processes. We expect to generate positive operating cash for the fourth quarter and expect to generate approximately $1 million on operating cash for the full year, compared to negative cash flow of $6.6 million in 2016. Our effect the tax rate is now expected to be approximately 35%, which is down from our previous guidance of approximately 37%. This concludes my prepared remarks. I will now turn the cal back to Doug for additional commentary on the quarter and closing remarks. Doug?

[Douglas McCrosson:]

Thank you, Vince. Turning to Slide 11, our bid pipeline is almost exclusively weighted to defense opportunities. While reflective of our business development focus on defence, we're also benefiting from our growing reputation in the military supply chain as a high quality, lower cost alternative to in-house assembly work. We inhabit the unique position when industry supply chain grounded in decades of manufacturing to the defense industry. Industry recognition of our technical capabilities as a Tier 1 supplier, the most recent example of which was when CPI Aero was selected as a finalist for 2017 Aviation Week Program Excellence Award. It’s raising our profile with prospective customers and generating new opportunities with the complexity and work scope that could command higher prices and better margins. As I look at midst of the bid pipeline by product category on the right side of this slide, I would draw your attention to the Kitting and Aerosystems segments, which together account for 58% of the bid pipeline and have higher potential margins than our Aerostructures segment. As a result, we have dedicated more of our sales focus to those segments. This quarter also saw improved bid activity on our Sikorsky Seahawk stabilator maintenance repair and overhaul program that drove an increase in our MRO segment quarter-over-quarter. You will see some of the opportunities in bid pipeline listed on Slide 12. One of these opportunities, the follow on order we announced today has already converted to a firm order. I also noted on our second quarter conference call that we are pursuing a follow-on contract to our existing multi-year DB-110 reconnaissance pod program with UTC Aerospace Systems. We expect to hear about this opportunity before the end of the year. Turning to Slide 13, our long-term defense and commercial programs have the potential to generate approximately $398 million over the remainder of their periods of performance. As we near the end of 2017 and look ahead to a very favorable defense environment for the foreseeable future, we are pleased to be in a strong position to take advantage of the opportunities for excellent suppliers like CPI Aero. Over the past three years we have executed on a defense market strategy building our backlog to give us revenue foundation for the long-term. Over the past two years we've learned our manufacturing processes and have become much more efficient as an organization and we are seeing the benefits of that with positive operating cash flow. There's always more to do in this area and we will continue to further lean operations and improve productivity. However, our goal has never been to solely lower our cost, rather we viewed this as a necessary step in driving revenue growth. With so many operational improvements accomplished over the past few years, we can now look forward to a renewed emphasis on increasing topline growth with an improved cost structure and better competitiveness. We will look to continue taking advantage of the current up cycle in defense spending through internal and external growth initiatives that expand our opportunity set across all business segments. This concludes my prepared remarks. I like to thank you for your participation in today's call and your continued support of CPI Aero. Operator you can open the call to questions please. Thank you.

[Operator:]

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

[Mike Crawford:]

Thank you. Doug could you…

[Douglas McCrosson:]

Good morning.

[Mike Crawford:]

Good morning. Could you provide us some little more detail on the customer-initiated design changes during the quarter that led to some changes in revenue recognition.

[Douglas McCrosson:]

I would just say that they were normal, iterative design steps that customers make during the early stages – during the design stages of a major weapon system. The impact to us when something like that change happens is as an example, if we have a design change that affects the part that we have out at a subcontractor for machining. And they and they have to stop work as a result while the change is implemented. And they don't deliver their product say in September and it slips into October that is less revenue we can recognize in September. So it was nothing I would say necessarily one thing that was major, but a cumulative effect of multiple drawings being changed after the time at which we've already placed orders with our supply chain. And that just put a little bit of disruption into the supply chain and thus our material receipts were down for the quarter than we would have expected.

[Mike Crawford:]

Okay, thank you. And just may be a two- part question. One, how would you postulate your chances of getting more content on the F-35. And then separately maybe you could provide us with a update on what may or may not happen with future A-10 Wing Replacement order and even the ability to get some early preparatory work in this year before even a new order would go to Boeing and from Boeing to you if that happened.

[Douglas McCrosson:]

Okay, with regard to F-35, the award we announced earlier this week, as I mentioned in my remarks, more than doubles the dollar content on the F-35 platform. It was a significant award for us. So for now I would say that we don't have any current bid on the F-35 that we won the one that we had. What I'd like to say about that though is as this F-35 moves into the higher rates that are expected over the next several years, the – I guess the strategy will be by Lockheed kind of seems to be for many of these major components like the type that we bid on, they are dual sourcing. The one that we just won was one such example. We certainly will be going after more and I think there will be more and more opportunities on the F-35 as the production ramp comes into effect in 2018 and going forward into 2019. So I do expect an increase amount of F-35 activity. To be honest, we don't have one currently, but we do expect more in the future. As far as A-10 goes the current thinking seems to be that we have to wait now till the continuing resolution is replaced by a 2018 defense budget. There was around $20 million of funding that was appropriated by Congress in 2017 for the A-10 new production wing program. My belief is that the Air Force is hesitant to start work on that contract with the $20 million that they do currently have until there’s clarity with respect to future years regarding – on the 2018 budget. I believe you know that there is more than $100 million, I think, its $103 million that has been authorized by Congress for new wings in the 2018 fiscal year. But that money has yet to be appropriated while we are under a continuing resolution. As far as hedging our bets, there are two main ways that the Air Force can keep A-10s flying, which is really mandated by prior legislation. The first way of course is to continue with the manufacture of new wings similar to what we've been doing with Boeing for the past seven or eight years. And at that’s the main way in my opinion and the best way in my opinion. An alternative to that in the meantime is to repair wings that they currently have and strengthen them and extend the life of them. That way we believe that the Air Force is looking at that as an option, it has a solicitation out to the primes for work to help them develop a strategy to repair the wings of A-10. And I'd like to think that we can participate on that. We have a bid in with one of the primes on that effort to do just that. So we're looking to benefit from the continued life of the A-10 either by new manufacture which are what we've been doing for the past seven years or eight years. And as well as we're looking to participate if the airforce should decide that in parallel with that new wing effort they also what to repair some.

[Mike Crawford:]

Okay. Great, thank you.

[Operator:]

The next question will come from Mark Jordan of Noble Capital. Please go ahead.

[Mark Jordan:]

Thank you. First question relates around some of the T-38 and F-16 replacement part programs. Could you talk about how those have been ramping through the year and what’s your expectations for those would be for 2018?

[Douglas McCrosson:]

The F-16 contract is, I would say, underperforming what I would have hopped for. After we won the award we had a series of awarders and we benefitted from those earlier this year. The issue with F-16 is that the government itself has inventory that they kind of found which is duplicative of what we are on contract for. We did recently receive some orders we have a backlog currently somewhere in the $4 million range of undelivered orders on that, which is good. But frankly I hoped it would have been better. T-38 is the opposite story. T-38 is doing better than we expected. And we had a press release earlier this year, couple of million dollars extra in delivery orders already up to close to $14 million and firm commitment. That aircraft will be in service for a long time even though the T-X Trainer is expected to replace the T-38 one day. That hasn't even been awarded jet, so the longer that the T-X – I’m sorry the longer the T-38 flies, the more opportunities there are to ramp that program even faster. So it's kind of a mixed news to F-16 not as great as we hope T-38 better than we hoped.

[Mark Jordan:]

Okay. On your – one of the last slides you pointed out for military sales opportunities for the F-16, how do you market that? I mean does that go through the air force and through the same channel or is that a sort of a separate conduit?

[Douglas McCrosson:]

No we're looking at two different ways on that. One is we are developing a network of relationships direct to foreign operators of F-16s, for example, each year they hold an international conference at Hill Air Force Base for the F-16 worldwide community. And we are marketing our approved product directly to these foreign operators. We are also looking at a couple of already in the market third-party distributors and aftermarket resellers to establish if that is a faster way into those markets. So we're exploring both, working with people that companies that already sell into these markets directly and trying to do it ourself.

[Mark Jordan:]

Okay. Doug I think in your comments you alluded that the agenda would include some preliminary comments on 2018. Did you omit those or are you going to be making those?

[Douglas McCrosson:]

No I think the comments that I won't be as our normal is we will issue 2018 guidance along with our fourth quarter results in early March. But I can tell you that my remarks implying to 2018 are that

[Mark Jordan:]

Okay. And a final question from me, just a point of clarification on the F-35. You said that the current order you just received on the canopy actuators was a move to obtain a second source you were that second source. And that it’s your belief as volumes you have 35 grow that Lockheed as – we’ll move to four more used second sources to increase competition as volume justifies it. Is that the strategy Lockheed is taking?

[Douglas McCrosson:]

That is my interpretation based on my discussions with them, as well as seeing some of the bid documents that come across our desk.

[Mark Jordan:]

Okay. Thank you very much.

[Operator:]

[Operator Instructions] The next question will come from Michael Potter of Monarch Capital Group. Please go ahead.

[Michael Potter:]

Hi guys.

[Douglas McCrosson:]

Hi Mike.

[Michael Potter:]

I just have one follow-up to, I guess, the first question and one of the points in the script. How many new programs did the design changes effect?

[Douglas McCrosson:]

It was – I would say 2.5, I would say three.

[Michael Potter:]

Okay. So it affected three programs, okay. And will we make up for this delay in Q4?

[Douglas McCrosson:]

Yes we….

[Michael Potter:]

It sounded like from the guidance though.

[Douglas McCrosson:]

The majority of the change activity for both – for the two primary programs that were impacted are complete. And we're executing back one hundred percent, meaning all of our suppliers are back turned on. Whether that hits in the fourth quarter, or very early in next year is kind of uncertain. At the moment there's opportunity, but we are expecting a big fourth quarter as you can tell from the guidance and doing the makeup math that's left. We are expecting a good fourth quarter, but maybe not all of the change activity will have wrung itself out this year. It may continue into next year.

[Michael Potter:]

Got it. Okay so that’s an anomaly for three new programs to be affected in one quarter.

[Douglas McCrosson:]

Yes and collectively my guess is it was in the under $2 million of top line probably like $1.8 million-ish, $2 million something like that. And I like I said, I think, most of that will be in the fourth quarter.

[Michael Potter:]

Okay terrific. And a follow-up question on the pod business as well. Where do we currently stand, I'm not sure if you broke it out in regards to our backlog, but have we seen an increase activity in potential pod sales to foreign governments.

[Douglas McCrosson:]

Yes there were several announced foreign military sales by our government to other governments and for F16s and F15s. And a few of those do include the DB-110 reconnaissance pod system. So there is definitely – those have not been fully executed by the countries in our country. So we're still kind of waiting for that. And now is what I refer to it in my remarks about the DB-110. We expect our customer to have a decision on when they can put sub contractors on the order and who those subcontractors are by the end of December. So we feel that the foreign military sales that have been kind of held up for really a couple years now are starting to flow through and we should know before the end of the year where we stand on that. As far as the other programs TacSAR is a good program, our customer indicates that there is a high level of interest from foreign governments for that system. We’re in the early stages of helping them complete the development and design of that system from the structure side. And we certainly hope within say the next 90 days or so to get some positive news about starting a production program for TacSAR. We're seeing other increased demand from Northrop Grumman on a couple of POD systems we do for them. Some are in production now and others we’re waiting to hear. And of course we have our biggest Pod program now which is the Raytheon next-generation jammer pod, which is doing great and is the I'll say as of right now the highest profile electronic warfare system that the government has right now. So all in all, I'm very happy with both our program execution on the I’ll say the electronic aero system, the electronic warfare reconnaissance systems. I'm very happy with our customer satisfaction and the fact that our work on those programs are opening doors that were not open to us two or three years ago.

[Michael Potter:]

Alright, terrific. Thanks guys I’ll get back in queue.

[Operator:]

[Operator Instructions] Seeing no further questions, this concludes our conference Q&A Session for today. I'd like to turn the conference back over to Doug McCrosson for any closing remarks.

[Douglas McCrosson:]

Thank you Cary. And thank you all again for listening today. We look forward to speaking with you all again in early 2018 when we report our fourth quarter and full year 2017 results. Thank you. Good bye.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day