CPI Aerostructures, Inc.
Q4 2017 Earnings Call Transcript

Published: 22 Mar 2018

[Operator:]

Good morning and welcome to the Q4 2017 CPI Aerostructures’ 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 over the conference to Sanjay Hurry. Please go ahead, sir.

[Sanjay Hurry:]

Thank you, Keith. Good morning, everyone, and welcome to CPI Aerostructures’ 2017 fourth quarter and full-year 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 Web site. On the call today 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. 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, please note that management is available for follow-up calls with institutional investors following the conclusion of this call. Please contact me via details listed in today’s press release to schedule a follow-up. With that said, I’d like to turn the call over to Douglas McCrosson, President and Chief Executive Officer. Good morning Doug.

[Douglas McCrosson:]

Good morning and thank you, Sanjay. And good morning and thank you all for joining us on our call. I will begin this morning with a review of our performance for the fourth quarter and full-year 2017 before offering some thoughts on 2018, and an overview of our plan to acquire Welding Metallurgy or WMI, which we announced this morning. Vince will then review our financial results for both periods, the financial considerations of our acquisition of WMI, and introduce our financial guidance for 2018. I will then conclude our prepared remarks. Let's begin. I’m pleased to report another quarter of solid financial performance, the result of our continued focus on operational excellence and program execution. We continue to advance our defense market strategy, winning a $15.8 million multiyear contract from Lockheed Martin for the manufacture of multiple canopy actuation drive shaft assemblies on the F-35 Lightning Aircraft. This is our second contract for the F-35 in effect doubling the value of our content on this program. Equally significant, this new order speaks to our strong relationship with Lockheed Martin and our ability to leverage superior program execution to secure additional work from the largest defense prime contractor in the world. Our financial results for 2017 attest to how far we've progressed since we undertook a series of operational and strategic initiatives in 2014 to return to the company -- to return the company to its defense market roots. Since then we have placed greater focus on multiyear opportunities, expanded and diversified our revenue base and implemented profitability improvement initiatives. As a result, this year we restored annual profitability and positive operating cash flow. Key financial highlights for the year includes

[Vincent Palazzolo:]

Thank you, Doug. Start, revenue for the fourth quarter of 2017 was $23.8 million compared to $24.3 million for the fourth quarter of 2016. As Doug mentioned in his opening remarks, we experienced order push outs from newer defense programs which resulted in limiting our fourth quarter revenue. Also revenue on our E-2D outer wing program declined from the fourth quarter of 2016, which was an expected cyclical decrease related to the timing of new purchase order releases. Gross profit was $5.5 million compared to $5.9 million for the fourth quarter of 2016. We sustained a strong gross margin for the quarter of 23.1%, above the range of 21% to 23% for 2017 that we had previously shared with you. Gross margin was driven by an ongoing benefit of cost and process initiatives to further lean our manufacturing processes. SG&A increased by ₤200,000 for the fourth quarter compared to the same period last year, the result of higher health insurance costs in 2017. Pre-tax income was $2.8 million for the fourth quarter compared to $3.4 million for the fourth quarter of last year, predominantly the result of the lower revenue in Q4 2017 compared to 2016. Because of the new tax laws signed by the President in December, we recognize the lower tax rate in Q4 2017 which resulted in net income that was unchanged from last year have $2.1 million. EPS for the quarter was $0.23 compared to $0.24 for the same period last year. Turning to the balance sheet, which is -- balance sheet highlights. Cost and estimated earnings in excess of billings on uncompleted contracts or CE&E was $111.2 million, an increase of approximately $11.6 million compared to December 31, 2016. As was the case in Q3 2017, the CE&E increase was largely due to increased activity on our newer programs especially the next generation jammer increment one pod program with Raytheon and our new weapons pylon assembly program with Sikorsky. We ended the year with working capital of $78.3 million compared to $70.6 million at December 31, 2016, an increase of $7.7 million. During 2017, we implement -- implemented several initiatives to improve operating cash flow. As a result of these efforts, we generated operating cash of $1.6 million with 2017 whereas in 2016 we used cash of $6.7 million to support operations. At December 31, 2017 total long-term debt stood at $9 million compared to $10.2 million at December 31, 2016. We had $22.8 million outstanding on our $30 million revolving line of credit at the end of 2017. Shareholder's equity improved to $74.3 million at quarter end and year-end with a book value of $8.38 per share. Our debt to capital stood at 0.43. We expect our -- for 2018, we expect revenue in the range of $92 million to $96 million compared to $81.3 million for 2017. Pretax income is anticipated to be within the range of $9.1 million to $9.6 million compared to $8.5 million for 2017. Our effective tax rate for the year is expected to be 23% to 24%. Our guidance includes the results of the acquisition of Welding Metallurgy Inc., assuming we close the transaction during the second quarter. This concludes my prepared remarks. I will now turn the call back to Doug for additional commentary and closing remarks. Doug?

[Douglas McCrosson:]

Thank you, Vince. Let me offer some concluding thoughts before opening our call to questions. We’ve meaningful long-term growth opportunities ahead of us. One of our strong defense portfolio and a focus on the defense market, that is today yielding a large and diversified backlog and growing bid pipeline of new opportunities. Over the past three years, we've leaned out our manufacturing processes and have become much more efficient as an organization, the benefits of which we began to realize in 2017. Now with an efficient infrastructure, we're focused on increasing revenue both organic and inorganic to propel earnings growth. The acquisition of WMI is reflective of the strategy. With greater capabilities and increasingly competitive offering in the marketplace and singular focus on execution we are extremely well situated for long-term success. I'd like to thank you for your attendance and continuing support of CPI Aero. Keith, you can open the call to questions. Thank you.

[Operator:]

Yes, thank you. We will now begin the question-and-answer session [Operator Instructions] And today’s first question comes from Ken Herbert with Canaccord.

[Kenneth Herbert:]

Hi. Good morning, Doug and Vince.

[Douglas McCrosson:]

Hi, Ken.

[Vincent Palazzolo:]

Hi, Ken.

[Kenneth Herbert:]

Hi. Congratulations on WMI. Just wanted to ask a first question, Doug, on the -- your backlog, I think the guidance for 2018, I think you indicated that you do not include some programs that are maybe a timing risk from some defense programs. How do you -- assuming we get the omnibus deal signed and worked out this week, how do you see the impact on the backlog, and is there perhaps any change we should think about and timing related to some of these programs as part of the fiscal '18 guidance?

[Douglas McCrosson:]

Yes, a significant change in our guidance is resulting from the A-10 push out. There are others that are related to some programs that are new start programs that have yet to be started. I think we are anticipating that the impact of 2018 moved us maybe a few million dollars of organic growth out of the year, largely compensated and increased by the acquisition. But, yes, there was several million dollars worth of timing related revenue that that probably would've been in 2018, that is now in 2019.

[Kenneth Herbert:]

Okay. Okay. That's helpful. And for -- on the acquisition, it looks like obviously it fits very well just in terms of the proximity in the geography. Does this change longer-term what you’ve talked about potentially or move the needle in terms of our gross margin. What you think the company could from gross margin standpoint not just maybe in '18 obviously, but you think out in '19 and '20 and beyond?

[Douglas McCrosson:]

Yes, this was a an excellent acquisition for us in many ways. One of the key ways is that we believe that our scale will enable the good products that we're bringing over with -- acquiring with the transaction to expand greatly. We believe that the margin profile of the Welding Met product line in our facility with our overhead structure and our efficient manufacturing systems will benefit greatly. That said, they also have a very nice mix of electronics programs that that are, I say, higher than our average margin. So I think in the long run you will definitely see margin expansion from CPI. The other thing that's really important to recognize is we're bringing over a lot of work and a lot of direct hours and we're really going to have a high facility utilization and a much lower factory overhead make us more competitive on future programs as well as to lower the future cost of all of our current programs that we were running before the acquisition. So it's -- I would say a huge economic plus for the combined businesses.

[Kenneth Herbert:]

Okay. That’s great. And can you just remind me, again, I just missed it, your expected revenue contribution from WMI? What’s embedded in the guidance for '18?

[Douglas McCrosson:]

You didn’t miss it, we didn’t say it.

[Kenneth Herbert:]

Oh, okay.

[Douglas McCrosson:]

So -- and we won't be saying that. The …

[Kenneth Herbert:]

Okay.

[Douglas McCrosson:]

… what is -- the range in the revenue guidance is really largely related to the timing of the closing of that transaction.

[Kenneth Herbert:]

Okay. Okay. What is it -- maybe what are the business due in '17? Can you comment on that?

[Douglas McCrosson:]

I can't. There will be audited financial statements filed within 75 days after closing. I can tell you that on an annualized basis the revenue that we're acquiring is about 15% higher than what it was in 2017.

[Kenneth Herbert:]

Okay. Okay. And then just finally it sounds like the F-16 SLEP program and the TacSAR program with United Technologies could both be -- timing of those could both be pretty significant for this year? It sounded like F-16 is maybe sooner or rather than later. Can you give a little more detail, Doug, on expectations on timing there and what you're thinking of that particular program and your chances in this as well as on the TacSAR opportunity? I know you’re on a 1-year contract, but the chances and timing of maybe looking at extending that or moving forward on that?

[Douglas McCrosson:]

I will start with the F-16. As you know, we are doing work right now, very similar work on the F-16 on -- with DLA and we're 2 to 3 years into that program. Many of the components that are on -- that contract and similar components will be on the F-16 service life extension program. The -- so it's a supply chain management, obsolescence management, I will say a fairly complex kitting and logistics support type of contract. That program should, it's a small business set aside, so we qualify for that. There is -- there are probably about seven or eight competitors to that. We feel that we have probably a stronger position than most on that list with our experience on the F-16 to date and our -- in a good past performance on similar programs in the past. I’m not going to handicap it, but it would be a -- clearly the winner of that program, no matter what size you are, it will be a game changer type program, should you be successful. We are hopeful. I think we put in a very good competitive proposal. We priced it to win. We have a good deal of experience. We know what our costs are going in. So I think we did an excellent job on the proposal, but I won't handicap our percentage chance right now. As far as the TacSAR program, that program is very similar to our DB-110 program that we also do with United Technologies. We will be the -- in that case we will be the sole-source provider of the structure once they get launch customers. Our customer, which is UTC Aerosystems has not announced yet a launch customer. We're optimistic that we will get turned on to start production within 2018 timing is again largely related to the FMS process, because the foreign military sales opportunities for United Technologies and we can't necessarily control that.

[Kenneth Herbert:]

Okay. That’s helpful. Congratulations obviously on the acquisition and a great end to '17. I will pass it back there. Thank you.

[Operator:]

Thank you. And the next question comes from Mike Crawford with B. Riley.

[Mike Crawford:]

Thanks. Doug, is it fair to …

[Douglas McCrosson:]

Hi, Mike.

[Mike Crawford:]

Hi. Is it fair to say that WMI within Air Industries Group was not profitable in 2017?

[Douglas McCrosson:]

I think you just need to be careful when you -- if you try to deduce what WMI was from the Air Industries public filings. There are plenty of adjustments that are intercompany adjustments that aren't necessarily clear in there. We're comfortable that it is a profitable business in 2016 and '17. And it's more so profitable when we bring it in to our own facility.

[Mike Crawford:]

Once you bring it in by the fourth quarter of 2018, what will your footprint look like in terms of ability to take on new work and/or ramp back up the A-10 at some point potentially?

[Douglas McCrosson:]

Right now the floor space plan that we have keeps our A-10 line compressed a little bit, but still intact. So when the A-10 does come online we have availability and we feel that we'd have adequate space within this facility to take on more programs as well. We will be, I would say, we would probably be at 10% to 15% free floor space not including any kind of mezzanine operations -- any kind of mezzanine that we could do to take some things up and make a quasi second story. We feel very confident that this building will be high floor space station, very efficient much more efficient than it is currently and still has room to grow.

[Mike Crawford:]

Okay. Thanks. And then, is that 23% to 25% tax rate something that you think continues beyond 2018?

[Vincent Palazzolo:]

I do. The reason we are kind of giving a little bit of a range is because the details of the new -- how the new tax law is actually going to exactly run through our financial statements is not perfectly -- perfect science yet. But the new tax law plus state taxes with the -- with a significantly lower federal tax rate should keep us in that 23%, 24%, 25% range for the foreseeable future.

[Mike Crawford:]

Okay. Thank you. And then last question is on the cost and estimated earnings account that grew about ₤11 million in 2017, including a few million in the fourth quarter. So do you have visibility as to what might happen to that account in 2018 and/or beyond?

[Vincent Palazzolo:]

A lot of that growth in the fourth quarter was related to Next-Generation Jammer. The first fully complete pod didn’t shipped until the first quarter of 2018. So that was what a lot of the run-up was in the fourth quarter of 2017. Now that we are shipping that, the CE&E should kind of stabilize for the remainder of this year. While I don't -- I’m going to say I don't foresee that would go up, however, with that being said starting in the first quarter you’re not going to see CE&E on the balance sheet anymore. The new revenue recognition standard that took effect January 1, will change the presentation of contract assets and contract liabilities to different line items and there will be more description in the notes. So on a gross level it's not going to be materially different, but presentation is going to be different.

[Mike Crawford:]

Okay. Just given that answer and Vince, if I could just extend my final question to you. From say a free cash flow perspective, but for an accounting change you don't expect much of a change on the old CE&E accounting, but we’re going to have to look at the numbers differently by the time you file the Q1 report, is that fair paraphrase of what you said?

[Vincent Palazzolo:]

Yes.

[Mike Crawford:]

Okay. All right. Thank you.

[Vincent Palazzolo:]

Yep.

[Operator:]

Thank you. [Operator Instructions] And the next question comes from Mark Jordan with NOBLE Capital.

[Mark Jordan:]

Good morning, gentlemen. Question is related to the expenses with the acquisition. In your slide you say there will be about $600,000 of expenses. Will that be expensed in the first or second quarter? How does that breakdown? And then I assume with the synergies then you will earn that back, so basically the expenses and synergies are a wash for the year? Is that the way we look at it?'

[Vincent Palazzolo:]

Yes. Well there is $900,000 of …

[Douglas McCrosson:]

Yes, it's more.

[Vincent Palazzolo:]

… it is definitely more synergy than transaction expense.

[Mark Jordan:]

Okay. But from a modeling standpoint that $600,000 of expenses, is that in the first or second quarter or how is it split, so that we can -- I get surprised little bit on that non-operating expense in a quarter?

[Vincent Palazzolo:]

It will be in both.

[Mark Jordan:]

Okay.

[Vincent Palazzolo:]

It is spread between the two.

[Mark Jordan:]

Okay. And going back to the margin question for WMI. Could you say, what were their gross margins historically again prior to any enhancements or synergies that you -- the combination should bring?

[Douglas McCrosson:]

I can characterize the margin profile as very -- I’m not going to say exactly what it was, but it is consistent with companies in that industry and maybe slightly lower than our own. At times it's been higher, at times, it's been lower. But we feel that it's why don’t we say in the mid 20s similar to like ours is.

[Mark Jordan:]

Okay.

[Douglas McCrosson:]

The -- and that’s pre-synergy. So the -- what we -- and that’s historically over a period of time. The one thing I did want to kind of highlight and maybe I didn’t make clear it is we expect to close this transaction as soon as possible and -- in the second quarter, hopefully early second quarter. And during a roughly 3 months period of time while we own the company, we will be operating from our location as well as their location. And when I said we will move all of the personnel and equipment over to our facility, that will be at the start of the fourth quarter. So the true post closing synergies where we get the advantage of not having duplicate of rent expensed will be starting in the fourth quarter, but we will own the company in the second quarter.

[Mark Jordan:]

Right. The -- what are your expectations for cash flow from operations this year and what is your expectations for CapEx for 2018?

[Douglas McCrosson:]

What I will say for the cash flow is when we close and we may -- we will probably update everybody on that, we will maybe fine-tune the guidance, because we will know exactly when we close and we will update cash flow guidance of the combined end -- of the combined entity at that time. I can tell you that preacquisition, our standalone guidance would be more positively -- more positive cash flow than we had in 2017.

[Mark Jordan:]

Okay. Comment on CapEx?

[Douglas McCrosson:]

CapEx is in -- within our normal range. We will definitely have some that are related to facilitization [ph] particularly of -- with the acquisition, but nothing that is outside of some historical as -- we ebb and flow sometimes with CapEx. Vince, you have any -- it's under a $1 million still.

[Vincent Palazzolo:]

Yes, I mean, in the last three years we’ve averaged around $200,000 a year -- $250,000 a year.

[Douglas McCrosson:]

Maybe double that.

[Vincent Palazzolo:]

Maybe we will double that.

[Douglas McCrosson:]

Right.

[Vincent Palazzolo:]

Roughly maybe a little bit more, but it's still going to be we anticipate it being under $1 million.

[Mark Jordan:]

Okay. Final question for me. The go forward combined financing package you will have in place, is there any comments on the incremental interest rates there. Will it be consistent with what you are paying or what’s your outlook?

[Vincent Palazzolo:]

That is still being negotiated. But that is still being negotiated, but we are working to make the rates similar to what we're -- we have now.

[Mark Jordan:]

Okay. Thank you very much.

[Operator:]

Thank you. [Operator Instructions] Okay, as there is nothing else at the present time, I would like to return the call to Mr. McCrosson for any closing comments.

[Douglas McCrosson:]

Thank you, Keith, and thank you everyone for attending our call today. It was exciting announcements today and we’re looking forward to what the future brings here. Vince and I look forward to speaking you again in May, when we report our 2018 first quarter results. Thank you very much.

[Operator:]

Thank you. This conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.