CPI Aerostructures, Inc.
Q1 2015 Earnings Call Transcript

Published: 6 May 2015

[Operator:]

Welcome to the CPI Aero's 2015 First Quarter Results Conference Call. With us today are Douglas McCrosson, President and Chief Executive Officer; and Vincent Palazzolo, Chief Financial Officer. After Management’s prepared remarks, there will be a Q&A 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 contract if 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 to them 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 filings with the SEC. Now, I will transfer the call to Douglas McCrosson, CPI Aero's President and Chief Executive Officer.

[Doug McCrosson:]

Thank you, Kevin. Good morning and thank you to all for joining us for our 2015 first quarter results conference call. I would like to start this call by providing a summary of our achievements for the quarter and then turn the call over to Vince who will discuss our recent financial results. Yesterday after the close of the market, we released our first quarter 2015 financial results. Our reported revenue and earnings per share for the first quarter of 2015 were in line with our internal forecast for the period and we remain on target for the year as a whole. Due to the timing of delivery orders associated with several recently announced major programs, we expect our performance for the second half of the year to be much stronger than the first half and 2015 to be a record year in terms of revenue. We're still projecting full year revenue of $92 to $102 million, surpassing the $89.3 million of revenue we recorded in 2012. Before I turn the call over to Vince, I want to share what I believe to be the three key takeaways as you review our first quarter 2015 performance. First, total backlog at March 31, 2015, increased by $39.9 million to $442.6 million as compared to 2014 yearend. The gross profit margin for the first quarter of 2015 was adversely affected by the change in estimate we made in 2Q '14 for our A-10 Wing Replacement Program. That program was contributing profitable revenue in the first quarter of 2014 and now we're booking A-10 WRP revenue at zero profit. We believe analyzing the gross profit margin for the rest of our products is key to assess how the rest of the business is performing. I am very encouraged to see that gross profit margin for the first quarter of 2015 improve by 200 basis points when compared to the first quarter of 2014 after excluding the contributions of the A-10 WRP during both periods. Clearly we're seeing the results of our various efforts to drive direct and indirect cost out of our production processes. Third, since the beginning of the year through March 31, we received approximately $16.2 million in new contract awards which is approximately $11.5 million of new contract awards received in the same period of 2014 and our best start to the year since 2012. With that prelude, I will now hand the call over to Vince Palazzolo, our CFO to discuss our recent financial results and expectations for 2015. Then I will comment on the current business environment, backlog and contract awards and new growth opportunities going forward. I'll then open the call to questions. Vince?

[Vince Palazzolo:]

Thank you, Doug. Starting with our financial performance for the first quarter of 2015 as shown on Slide 6, for the first quarter of 2015 as compared to the first quarter of 2014, we reported revenue of $19.9 million as compared to $21.9 million. Gross margin of 18.1% as compared to 20.5%, pre-tax income of $1.4 million compared to $2.5 million and net income of approximately $0.9 million or $0.11 per diluted share, compared to $1.7 million or $0.20 per diluted share. Moving to Slide 7, in the first quarter of 2015, approximately 49% of our total revenue or $9.2 million was generated from commercial programs. This compared to approximately $7.3 million reported in the first quarter of 2014, up by $1.9 million, which was due to increased production on our Embraer and Honda programs. As expected revenue generated from military contracts in the first quarter of 2015 decreased, as compared to the same quarter of 2014, due to lower revenues from our E-2D program with Northrop Grumman as work on the new E-2D multi-year award has not yet reached its peak rate. During the quarter, we continued to book revenue for the A-10 Wing Replacement Program at zero margin as compared to 18.6% gross margin for this program in the first quarter of 2014. As a result, as shown on Slide 8, our gross margin for the current quarter was 18.1% compared to gross margin of 20.5% in the quarter ended March 31, 2014. Excluding the effect of the A-10 Program, the first quarter 2015 gross margin on all remaining programs improved 23.1% as compared to 21.1% in the same period in 2014. This increase was primarily the result of higher gross margin on the company's commercial programs as production rates have increased. Slide 9 summarizes our guidance for 2015. As previously mentioned, our performance for the second half of the year is expected to be much stronger than the first half due to the timing of delivery orders associated with several recently announced major programs most notably our E2D outer wing panel kits program for Northrop Grumman. Specifically for 2015, we expect record revenue in the range of $92 million to $102 million. Gross margin for 2015 in the range of 19% to 21% although lower than our historical margin as we will continue to book A-10 Wing WRP revenue at zero profit. Net income in the range of $7.2 million to $8 million. Additionally in 2015, we expect to receive a cash benefit of between $13 million and $15 million due to the recovery of previously paid income taxes and the use of tax loss carry forwards related to our A-10 WRP. Following slides provide 2015 revenue breakdown by market subcontractor role and segment. Starting with revenue breakdown by market, as shown on Slide 10. In 2015, we expect the military commercial split for 2015 to change as compared to the split of approximately 55

[Doug McCrosson:]

Thank you, Vince. Since the beginning of the year through March 31, 2015 we received approximately $16.2 million in new business which included approximately $7.5 million of military orders and approximately $8.7 million of commercial orders compared to a total of $4.7 million in new contract awards for both military and commercial programs in the same period of last year. As Slide 16 shows, at March 31, 2015, our total backlog increased to $442.6 million as compared to $403.7 million at December 31, 2014. Funded backlog was $120.4 million similar to funded backlog at December 31, 2014 and non-funded backlog comprised 73% of total backlog and increased to $322.2 million with 44% related to our long-term commercial aerospace programs. Slide 17 shows our largest contracts currently in progress including our recently won contracts, which collectively have the potential to generate revenue of $438 million during the remainder of their performance periods. Of note, the three most defense related programs wins for work on the F-16, T-38 and E-2, C-2 collectively added over $188 million in backlog recognizable through 2022. Slide 18 provides an update of a few of our programs currently in progress in the three recent wins I just mentioned. Starting with our multiyear contract for E-2D/C-2A outer wing panel kits, this contract added more than $63 million in new funded backlog. We will begin to recognize revenue from the multiyear order for the second quarter of ’15 and significant revenue is expected to occur in both third and fourth quarter of this year as we received purchased detailed parts from our suppliers. Our Phenom 300 engine inlet assembly program with Embraer continues to perform well and we have successfully ramped the full rate production of more than 10 ship sets per month. This is up sharply from the two ship sets per month rate of early 2014. HondaJet one of the newest most technologically advanced light jets on the market is another important program for CPI. In late March, Honda Aircraft received FAA provisional type certification for its business jet and it is expecting to receive its final type of certification in the new few months. Honda has publicly stated that it has booked orders for more than 100 aircrafts and that they expect to deliver at least this many aircrafts during the first 24 months following the final type certification. We look forward to ramping to full rate production over the coming months. We have a potential $53.5 million contract with the Defense Logistics Agency to provide structural wing components and logistical support for global F-16 aircraft maintenance, repair and overhaul operations. We will not use percentage of completion revenue recognition on this program and will record revenue when we deliver product to the customer. Due to supplier lead times and a delayed start resulting from an unsuccessful protest of this contract by a competitor, we now expect that 2015 will be spent acquiring inventory and obtaining the approvals needed to begin product deliveries in the first quarter of 2016. While some product sales may in fact start this year, we do not project this program to have meaningful revenue this year. Our newest long-term program was awarded in February this year and it’s a $49 million contract to provide structural modification kits for the T-38 Pacer Classic II program. This contract is part of a larger air force effort to enhance operational capability while improving flight safety, reliability and maintainability of the T-38 trainer. Along with the contract, we received a firm delivery order that added $5.6 million for funded backlog. In addition to these contracts, we were recently awarded to follow-on awards. The first one is $1.21 million contract by Northrop Grumman to manufacture part structural housings for their airborne laser mine detection system called ALMDS. The contract includes options which if exercised would bring the cumulative value for $6.75 million. Deliveries for this contract are scheduled to commence in early 2016 in the period of performance including option periods is through 2021. CPI aero has participated on the ALMDS program since 2005 and since this time we have delivered a total 18 ALMDS pod structural housing. The second award is a $3 million purchase order from the Cessna Aircraft Company to supply wings part assemblies on their flagship aircraft the new Citation X+. This purchase order is a follow on to the long-term agreement announced in October 2012 and brings the total value of firm orders to approximately $12.2 million and extends production backlog through late 2016. Moving to Slide 19, this slide summarizes our bid pipeline and breakdown by segment and position within the supply chain. We’ve submitted several proposals for high value programs for both the commercial and defense aerospace markets. These opportunities span across all segments of our business at both the Tier 1 and Tier 2 level. Over the years we've successfully competed for a number of opportunities in both commercial and defense markets. The commercial defense mix within the bid pipeline changes as the function of the timing of proposals submitted and awards. At the present time, most of our submitted bid is around 63% by value happen to be for military aircraft structure and aero systems including the F35 Fighter and pod-based electronic systems. We have submitted or will soon be submitting several high value proposals for regional and large commercial airline or assembly program. For example on Slide 20, you will note that we have bids for structural assemblies on aircrafts such as the Boeing 787 Dreamliner, the Embraer E2 Regional Jet and the Bombardier C-Series airliner. These proposals are for both Tier 1 and Tier two applications. While timing of the review and evaluation of proposals by the potential customer and final decisions remain out of control. I would like to emphasize that our guidance of 2015 does not include revenue from a potential win for large commercial airliner. Moving to Slide 21, our strategy is clear. One, focus on gaining market share at the Tier 1 level particularly within high mix, lower volume markets such as defense, business aviation and regional airliner. Two, invest in new manufacturing technologies that increase capacity and lower unit cost to improve margins on current products and to better position CPI Aero as a Tier 1 or Tier 2 manufacturer within higher volume markets such as the large commercial airline market. Three, develop new sales channels and service offerings for our aftermarket and MRO Services business to provide a better balance between long cycle and short cycle sales. With regard to item two above, the automated riveter we acquired late last year is operational about two months ahead of plan. We are expecting to see considerable labor savings compared to a fully manual riveting process. In this first actual use the riveting operation that took 3.5 hours was reduced to a little more than an hour. Likewise, our new 3D printer is already producing tooling details as significantly less cost of the machine to tool details and with greatly reduced lead time. We are on pace to pay back the investment in around 12 or 13 months. As important as the cost savings, these investments have shown our customers that CPI Aero was serious about continuous improvement, plane manufacturing and increasing our capacity. We are now able to credibly compete for larger and more complex programs especially large scale high production rate applications by commercial airliners from both domestic and international customers. Our efforts in this area were recently recognized by Frost & Sullivan's Manufacturing Leadership Council as we named the winner of the 2015 Manufacturing Leadership Award. The Manufacturing Leadership Awards recognize world-class manufacturing companies that distinguish themselves by embracing breakthrough innovation. CPI Aero was selected as the winner in the Engineering and Production Technology Leadership Category for improving and streamlining the manufacturing process for improved productivity. We're very proud to be part of a very selective list of winners in this category, including companies such as General Motors, GKN Aerospace and Lockheed Martin. In the coming quarters, we plan to use a portion of the $13 million to $15 million in cash benefit we expect to receive from the recovery of previously paid income taxes and the use of tax loss carry forward related to our A-10 WRP to further invest in advanced technologies, program risk sharing to help capture new long-term commercial contracts, our infrastructure and in skills training. Moving to Slide 22, our efforts have well positioned CPI Aero for even greater success in this future. Our belief is supported by our large and diversified backlog of over $440 million, our growing bid pipeline, new opportunities for both the defense and commercial markets, the ability to perform on larger and more complex programs due to investments and advanced technologies and invest in growth opportunities arising from the developments in both commercial aerospace and the military defense sector. Before opening the lines for questions, I would like to mention that we will be presenting at three conferences in the following week; The B Riley Conference on May 14 in Los Angles, The Benchmark 101 Conference on May 28 in Milwaukee and the Drexel Hamilton A&D Conference on June 11 in New York City. I am sure we’ll see some of you there. This concludes our prepared remarks. At this point, I would like to open the floor to questions. Kevin, please allow the callers to place questions?

[Operator:]

[Operator Instructions] Our first question today is coming from Mark Jordan from Noble Financial. Please proceed with your question.

[Mark Jordan:]

Yes, good morning, gentlemen. A question relative to your guidance of bond in the range of $92 million, if you exclude A-10 revenue, what percent of that $92 million is currently in funded backlog?

[Doug McCrosson:]

It's little over 95% of that.

[Mark Jordan:]

And what do you expect of the balance of that to be nailed down? Is that something that -- is that business you have to find or is that just existing relationships that haven't been funded yet?

[Doug McCrosson:]

The latter Mark.

[Mark Jordan:]

Okay. A question relative to the A-10, how do you see that playing out this year in terms of funded backlog that you have currently and when is the decision point if another option or more work gets committed?

[Doug McCrosson:]

Our backlog does not contain any more releases on A-10. The current political situation is rapidly changing. If people are aware maybe some of you follow it for other reasons the budget process down in Washington. Right now, the only thing that we know for sure is that the House Armed Services Committee has put funding into keep the A-10 in the fleet to provide maintenance and upgrade funding for that program and we believe that you also include a new release of wings beyond the current order that we have now with Boeing. How that plays out over the coming months during this budget process is anybody's guess. We are internally functioning that we've been operating under frankly for over a year now, which is that we will continue to produce A-10 assemblies shipped to our customer probably now for the balance of the year although there has been a -- roughly the same number of aircraft that will be delivering, where spreading it out if you will. So that our assumptions are all valid, the assumptions we made back in 2014 remain valid today. If the Congress ultimately does fund the wings that are currently in the house version of the budget, then I would expect Boeing would receive an order later this year and then we would receive an order some time after that. The economics are going to be different on any subsequent order because we're no longer under the terms of our long-term agreement we negotiated back in 2007, 2008. So in a way, I am kind of neutral on it. I am going to wait and see, but there is a potential upside if the Congress fully funds the A-10 including new wings.

[Mark Jordan:]

So just to reiterate that if there was an additional lot authorized that would not -- that would be economically be positive event for you versus a neutral to negative?

[Doug McCrosson:]

That is correct. It would be positive for us.

[Mark Jordan:]

Okay. Final question for me, I noticed in the 8-K filed yesterday that there was amendment to the bank lines, could you summarize the changes that we're implementing with that amendment?

[Doug McCrosson:]

The change basically related to one specific financial covenant that the leverage ratio covenant, we increased the maximum leverage ratio from 2.75 to 1, to 3.75 to 1 for the first quarter of 2015 and then having a sliding scale for the remainder of the year. Mostly that's related was necessary because we were not really comparing apples to apples. We were comparing income in the first quarter of 2015 with zero margin A-10 revenue compared to last year's positive margin A-10. So the kind of through the ratio out of wack and we just fixed up the amount so that for the remainder of this year that will level itself out until all of the periods become comparable again.

[Mark Jordan:]

Okay. Thank you very much.

[Doug McCrosson:]

Thank you, Mark.

[Operator:]

[Operator Instructions] Our next question today is coming from the Mike Crawford from B. Riley & Company. Please proceed with your question.

[Doug McCrosson:]

Good morning, Mike.

[Mike Crawford:]

Thank you. Good morning. So it's nice you’re expecting this near-term acceleration of Tier 2 opportunities for large commercial platforms. What do you mean by that and how many of these bids have already been submitted would you say?

[Doug McCrosson:]

What we've seen, and I’m going to say stating in the late last year into early this year is we've seen increased opportunities for the large commercial airliners primarily on 787 and the Embraer E2. And there is a couple of factors that go into that. I think we’re getting those Tier 2 in one case, I’m sorry it’s a Tier 1 application, but we’re getting these opportunities now for combination of past performance with these customers and in both cases their existing customers. And we’re getting our investments in the technologies are convincing them that this -- that we could actually perform this if we’re successful at the rates that they would be expecting. We have submitted some smaller ones and then we have two large ones that we’re putting in that have to go in, in the May-June timeframe.

[Mike Crawford:]

Okay, thank you and then as for Embraer today, I think you are doing like 12 ship sets per month attending a ramp to 14, with that make that just about the highest volume program you worked on so far.

[Doug McCrosson:]

That is the Embraer right now is our highest delivery rate program by quite a large measure actually and we expect that rate to continue at least through the first quarter of '16 possibly longer. That rate doesn’t go on forever of course, but that is what the rate is currently.

[Mike Crawford:]

So has that been one of the stumbling box just being able to demonstrate the ability to produce at a high rate. So if you take 737 words, 30 or 35 ship sets a month.

[Doug McCrosson:]

Yeah, there is that Mike and it's both the rate and our ability to meet delivery schedules as we increase the ramp and we were very successful on Embraer program in doing both while maintaining the quality. I think this past actually about two weeks ago Embraer had a supplier summit done in Brazil where they bring in their top suppliers and we were asked to actually be one of the keynote the voice of the supplier for that conference because of our success on the ramp up and the increase in our production rate. So we have a very happy customer with Embraer and I think we were able to demonstrate to the larger audience during that presentation that we’re making the right investments to be I'll say, I'll call it a credible Tier 1 supplier to these -- for these larger applications.

[Mike Crawford:]

Great. Thank you. And then last question is you're nicely two for two on these logistic supply chain management bids, are there others that you have submitted or will be submitting that are similar?

[Doug McCrosson:]

The one that -- yes, the one that we're looking at now is during the RFI stage which is pre-RFQ is F-16 service life extension program that's been publicly announced by the air force and we believe pretty strongly that we will be able to offer a very competitive bid piggybacking if you will on our recent win that supports the wing production line out at floor space.

[Mike Crawford:]

Great. Thanks very much.

[Doug McCrosson:]

Okay Mike.

[Operator:]

[Operator Instructions] If there are no further question, at this time, I would like to turn the floor back over to management for any further or closing comments.

[Doug McCrosson:]

All right. Thank you. Thank you all for participating in this call. We look forward to speaking to you again in early August when we announce our 2015 second quarter results. Thank you.

[Operator:]

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.