CPI Aerostructures, Inc.
Q2 2015 Earnings Call Transcript

Published: 7 Aug 2015

[Operator:]

Welcome to the CPI Aero's 2015 Second 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 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 the 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 Securities and Exchange Commission. Please note today’s conference is being recorded. Now, I will transfer the call to Douglas McCrosson, CPI Aero's President and Chief Executive Officer.

[Doug McCrosson:]

Thank you, Amy. Good morning and thank you to all for joining us for our 2015 second quarter and first half results conference call. I will start this call by providing a summary of our achievements for the periods 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 second quarter and first half 2015 financial results. Before I turn the call over to Vince, I would like to point out the following items. First for the second quarter of 2015 we reported EPS of $0.12 compared to a loss of $3.50 per diluted share in the second quarter of ’14. As compared to the first quarter of ’15 we reported improvements in both revenue and net income in the second quarter of 2015. We expect these sequential quarter improvements to continue over the next two quarters. 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 major programs received in late 2014 to early 2015. For this reason, we are projecting full year revenue $92 million to $102 million, surpassing the $89.3 million of revenue we recorded in 2012. Second, we continue to focus our efforts on improving our production margin and have taken steps to drive direct and indirect costs down. Our gross margin for the first half of 2015 was affected by the profit adjustment we made last year related to revised estimates for the A-10 Wing Replacement Program or WRP. As a result, we continued to record revenue on this program with zero gross margin. Excluding the effect of the A-10 WRP first half 2015 gross margin in all remaining programs improved to 23.4% compared to 20.3% in the same period of 2014. Gross margin for the second quarter of 2015 improved by over 30 basis points when compared to the first quarter of 2015, after excluding the contributions of the A-10 WRP during both periods. We expect our margins to further improve during the second half of the year as we continue to focus on driving costs down during program execution, especially as it pertains to labor, supply chain and shipping cost. Third, in the second quarter we received tax refunds of approximately $8.1 million related to our 2014 change in estimate with respect to the A-10 Wing Replacement Program. As a result we generated $2.4 million in cash flow from operations for the first six months 2015 compared to a negative $9.5 million during the same period in 2014. Additionally, we expect our cash flow to sequentially improve the remaining two quarters of the year as we expect to generate more than $6.1 million in cash from operation in the second half of 2015. Furthermore, we have approximately $4.3 million in net operating loss carry forward available, which offset future federal and state income taxes. Fourth, from the beginning of the year through June 30, 2015, we received approximately $24.2 million of new contract awards, approximately $5 million higher as compared to a total of $19.2 million in new contract awards received in the same period last year. Finally at June 30 2015 our backlog reached a record level of $446.6 million, which is up $43 million from 2014 year-end. 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 second quarter and first half of 2015 as shown on Slide 6, for the second quarter of 2015 as compared to the second quarter of 2014, we reported revenue of $21.9 million compared to negative $23.8 million. Gross profit $3.9 million compared to negative $43 million. Pre-tax income of $1.5 million compared to a pre-tax loss of $44.9 million and net income of approximately $1 million or $0.12 per diluted share, compared to a net loss of $29.7 million or $3.50 per diluted share. Comparing the first half of 2015 versus the first half of 2014, we recorded revenue of $41.8 million compared to negative revenue of $1.9 million. Gross profit of $7.5 million compared to negative margin of $38.5 million. Pre-tax income of $2.9 million compared to a pre-tax loss of $42.4 million and net income of $1.9 million or $0.22 per diluted share, compared to a net loss of $28 million or $3.31 per diluted share. Moving to Slide 7, in the first half of 2015, approximately 47% of our total revenue or $19.8 million was generated from commercial programs mainly from our Gulfstream, Embraer and Honda programs. Defense programs generated approximately $22 million during the first half of the year of which $21.7 million was from tier one military subcontracts with OEMs and $300,000 was from government prime contracts. As shown on Slide 8, our gross margin for the first half of 2015 was affected by the change in estimate for the A-10 Wing Replacement Program as we continue to record revenue on this program with zero gross margin. Excluding the effect of the A-10 Wing Replacement Program, first half 2015 gross margin on all remaining programs improved to 23.4% compared to 20.3% in the same period in 2014. This increase is primarily the result of higher gross margin on certain of the company's commercial programs as production rates have increased and is within the historical expected range of gross profit percentage based on the company’s current mix of programs. 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. 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 gross margins as we will continue to book A-10 WRP revenue at zero profit. Net income in the range of $7.2 million to $8 million. The 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 to change as compared to the split of approximately 55%

[Doug McCrosson:]

Thank you, Vince. Since the beginning of the year through June 30, 2015 we received approximately $24.2 million of new contract awards, which included approximately $6.4 million of government prime contract awards, $6.1 million of government subcontract awards and approximately $11.7 million of commercial subcontract awards. This compares to a total of $19.2 million of new contract awards from all types in the same period of last year. As Slide 16 shows, at June 30, 2015, our total backlog increased to a record $446.6 million as compared to $403.7 million at December 31, 2014. Funded backlog was increased to $130.6 million, up $10 million as compared to funded backlog at December 31, 2014. Unfunded backlog comprised 71% of total backlog and increased to $316 million with 40% related to our long-term commercial aerospace programs. Moving to Slide 17, this shows our largest contracts currently in progress including our recently won contracts, which collectively have the potential to generate revenue of $447 million during the remainder of their performance periods. Slide 18 provides an update of a few of our programs currently in progress. Starting with our Phenom 300 engine inlet assembly program with Embraer we have successfully ramped production from two ship sets per month to more than 12 ship sets. We plan to ramp up production to 14 ship sets per month by year-end. HondaJet one of the newest and most technologically advanced light jets on the market is another important program for CPI. In late March of this year, 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 aircraft and that they expect to deliver at least this many aircrafts during the first 24 months following final type certification. Also we recently won four large defense programs, which added close to $200 million to our backlog. These programs are expected to ramp up in late 2015 and to generate continuous revenue for several years. I would like to start with our newest program, the F-35 aircraft. Just last month we were awarded a multi-year contract by Lockheed Martin Company to manufacture four lock assemblies for the arresting gear door on 289 F-35A Conventional Takeoff and Landing, or the CTOL aircraft. This contract which has an estimated value of $10.6 million, was an important win for CPI, as it was our first on the F-35, an aircraft that is expected to be one of the most vital systems for global security for decades. It also represents for us a new customer, Lockheed Martin’s aeronautics division, based in Fort Worth, Texas. Currently we are projecting to deliver the initial part to our customer in the last quarter of 2016. Regarding the other three programs, first our contract for the E2D C2A outer wing panel kit. While we have recognized some revenue in the second quarter of ’15 from our multi-year contract for the E2D outer wing panel kits, we expect significant revenue to occur in both the third and fourth quarters of this year as we receive purchased detailed parts from our suppliers. Regarding our $53.5 million contract for the F-16 aircraft, currently we are acquiring inventory and establishing a small satellite location within the F-16 wing overall shop at Hill Air Force Base, in Northern Utah. We are on track to begin product deliveries to support foreign military sales in very late 2015. Product sales for the US Air Force should begin in early 2016. Another long-term program for CPI Aero is the $49 million contract to provide structural modification kits for the T-38 Pacer Classic program. We have already received an initial $5.6 million from delivery orders. Based on the current developments and discussions with our customer the plan is to deliver the first article in mid-2016, and start production in the first quarter of 2017. 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 and also opportunities as a prime contractor with the government. We continue to successfully compete for a number of opportunities in both defense and commercial markets. This commercial defense mix within the bid pipeline changes as the function of the timing of proposals submittals and awards. Recently we submitted several high value proposals for large commercial airliner and regional airliner applications. these programs are typically for higher complexity assemblies and of long duration, and therefore can have high potential value. The submission of these bids for commercial programs combined with taking the F-35 military bid out of the pipeline after we won, accounted for a shift towards commercial programs rather than military programs. As a result, around 72% of our total bids are for commercial aircraft structure, while 28% are for military aerostructures and military aerosystems. We have submitted or will soon submit proposal for both Tier 1 and Tier 2 applications on the aircraft shown on Slide 20. As I have mentioned a few times in the past, the timing of the review and evaluation of proposals by the potential customer and final decisions remain out of our control. However, our 2015 guidance does not include revenue from a potential new win on a large commercial or regional airliner. Moving to Slide 21, our focus areas for the balance of 2015. We remain focused on gaining market share at the Tier 1, particularly within high mix, lower volume markets such as defense, business aviation and regional airliner. We will begin to utilize our recently deployed manufacturing technologies that increase capacity and lower unit cost. In so doing, we expect to improve margins on current products and to better position 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 airliner market. Our business development team has been focusing its efforts on further diversifying our customer base and sources of revenue. We seek ways to be less dependent on new aircraft production by developing products and services that take advantage of the anticipated growth in aircraft usage. Just a small fraction of our 2015 revenue is expected to come from our aftermarket services. We want to grow this segment of the business aggressively over the next couple of years. We are seeking to 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. On the commercial side, we will undertake to become a FAA certified repair station so that we can perform structural overhaul and repair of the various assemblies we currently manufacture as well as provide other services for the installed base of commercial aircraft. On the military side we are looking to increase our scope of work beyond our existing programs, such as the one we performed for Sikorsky for the repair of Black Hawk [Indiscernible]. For example, we are competing for both fixed wing and helicopter structural repair contracts in addition to our typical new manufacture programs. Moving to Slide 22, our efforts have well positioned CPI Aero for even greater success in the future. Our belief is supported by our large and diversified backlog of approximately $447 million, our growing bid pipeline, with new opportunities for both the defense and commercial markets, the ability to perform on larger and more complex programs due to investments we have made in advanced technologies and invest in growth opportunities arising from developments in both commercial aerospace and within the military and defense sectors. Before opening the lines for questions, I would like to mention that we will be presenting at two conferences next week; The Jefferies Industrial Conference on August 12 in New York; Canaccord Genuity Conference on August 13 in Boston. Vince and I hope to see some of you there. This concludes our prepared remarks. At this point, Amy please open the floor to questions.

[Operator:]

[Operator Instructions] Our first question is from Mark Jordan and Noble Financial.

[Mark Jordan:]

Good morning gentlemen. A question relative to how the A-10 program winds down, when are the final shipments scheduled, and I believe that you had stated last year that in your business plan you had a base case of about 3 million in A-10 revenue, is that still the case?

[Doug McCrosson:]

Mark, the delivery schedule will run at least until the middle of next year, perhaps even into the latter half of next year, the amount of ship sets that we are delivering on a monthly basis. As for the revenue, the original comment that we had made about the 3 million to 4 million [worth of] revenue from last year was based upon the assumption that the program would get terminated and we would stop working on it on September of this year. Well, obviously we are at August 6 of this year and we haven’t been terminated yet. So we are going to have to continue to book revenue beyond where we currently – where we currently are. We still have about $5 million to $6 million worth of revenue to run on that program through the end of the cycle, which they say is going to run at least until mid next year, maybe until the latter half of next year.

[Mark Jordan:]

Okay. That ties in to a question of, your balance sheet line of cost and estimated earnings in excess of billings being about $90 million, how much of that relates to the A-10 and I would assume under the scenario you just outlined of deliveries running through midyear to the fall of 2016 that those would be converted – that would be converted to cash over time. But what exposure there is that – of that 90 million is A-10 that should eventually be converted to cash?

[Doug McCrosson:]

It is about 12% of that number, yes, about 12% of that number is the A-10.

[Mark Jordan:]

Okay.

[Doug McCrosson:]

It is of course offset. There is also a $1.7 million liability on the liability side of the contract, loss liability. That is also A-10. So the net number might be closer to around $9 million net.

[Mark Jordan:]

Okay. Given that line down that you have and that [Indiscernible] generating cash as it comes to completion, should the company therefore be meaningfully cash flow positive from operations in 2016?

[Doug McCrosson:]

Mark we haven’t done the forecast for 2016, but whatever gain we make on that side we lose on building up inventory on our recent wins, particularly the F-16 and T-38. so when we provide our guidance on 2016, we will provide some cash flow guidance as well, but yes, if there weren’t those $200 million of new orders that we put into the backlog starting about seven or eight months ago.

[Mark Jordan:]

Okay, final question from me obviously you outlined a rich bid pipeline and the fact that you have no incremental awards in your outlook for this year, while there is nothing in your outlook do you expect meaningful decisions on some of the bids that are out there between now and the end of the year?

[Doug McCrosson:]

Yes. There is one military. I’m not talking about some of the smaller ones, but there is a military one that we expect our customer is going to make a decision on during the third quarter, this current quarter, and there is one larger commercial that we expect not a final decision, but a downselect decision probably during the early fourth quarter. I’m not sure if the downselect process will result in a final decision in 2015, but we will know in the fourth quarter if we are part of the two companies that get downselected.

[Mark Jordan:]

Okay, thank you very much.

[Doug McCrosson:]

Thank you Mark.

[Operator:]

[Operator Instructions] Our next question is from Mike Crawford of B. Riley & Company.

[Mike Crawford:]

Thank you. going back to the A-10, is there – what is the likelihood that the government might have to go back to Boeing, Boeing might have to come back to you to actually order additional wings, which then would put you in a position of actually making margin on some of this production.

[Doug McCrosson:]

I hate to handicap this because I have already been wrong once on this. But I would have thought that the Congress would have already stopped it. That said, there is money for the A-10 to continue flying. What is uncertain still is whether or not that necessarily means the government will continue with the wing program and I feel that there is still some possibility that we will be asked to stop or at least drastically slow down that program within the next several months as the situation in Washington kind of unfolds. That said I find that scenario may be more likely than the scenario that gets us to beyond the current amount on order, which is 173 aircraft. So in order of likelihood, I would say we have likely – it is more likely that the program gets scaled back and or terminated and then the second most likelihood would be we run it to the 173, and the least likely is that they do more and order more.

[Mike Crawford:]

Okay. Thank you and then on another defense program you have been long-running prior to UTC Aerospace Systems, and on the DB-110 sensor and now the company – that company is looking to get a smaller pod to accomplish what that product does, now is that something that you would be capable of working on with them or will it be more of a build-to-print situation, how closely would you work with a customer like that on?

[Doug McCrosson:]

We are working actually very closely with United Technologies’ Aerospace Systems at the earliest stages of their design and development. We are not under contract I should say for any derivative pods of the DB-110, but our relationship is such that we are part of the process at least on a informal basis providing some producibility tips and some kind of ROM estimates of what this structure may cost. So our relationship is excellent with UTAS. We are looking to extend our current DB-110 contract with a multi-year agreement, which is an ongoing discussion we are having with the customer and that agreement would also lend itself to derivative pods and entirely new pods as well.

[Mike Crawford:]

Okay, but that is separate from this other military pod form you are expecting..?

[Doug McCrosson:]

I’m not sure exactly what you want, you are referring to [Indiscernible], then we are intimately involved. If you are referring to one that I’m not aware of I can’t answer that.

[Mike Crawford:]

Okay. Thank you.

[Doug McCrosson:]

Thank you Mike.

[Operator:]

[Operator Instructions] Seeing no further questions, this concludes our question-and-answer session and I would like to turn the conference back over to Doug McCrosson for closing remarks.

[Doug McCrosson:]

Thank you, and thank you to all of you for participating in this call. We look forward to speaking to you again in early November when we announce our 2015 third quarter results. Thank you. Goodbye.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.