CPI Aerostructures, Inc.
Q4 2012 Earnings Call Transcript

Published: 12 Mar 2013

[Operator:]

Greetings, and welcome to the CPI Aerostructures Inc. Fourth Quarter 2012 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Edward Fred, Chief Executive Officer. Thank you, sir. You may begin.

[Edward J. Fred:]

Thank you, Christine. Good morning, and thank you, all, for joining us for our fourth quarter and year-end 2012 conference call. If you need a copy of the press release issued this morning, please contact Lena Cati of the Equity Group, at [phone], and she will fax or email a copy to you. Also, if you would like to listen to this call again, you can hear a replay on our website's Investor Relations section in about 1 hour at www.cpiaero.com. Before we get started, I want to remind investors that 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 us 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 us from doing business with them, as well as competition in the bidding price for both government and subcontracting contracts. Our subcontracting customers also have the ability to terminate their contracts with us if we fail 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 on our filings with the SEC. As announced earlier this morning, for the year ended December 31, 2012, we reported record results with substantial increases in revenue and net income. Specifically, revenue was approximately $89,273,000 compared to approximately $74,136,000 for the year ended December 31, 2011, an increase of approximately 20%, with the G650 and E-2D programs accounting for most of this increase. Gross margin was 27.1% compared to 25.4%. Pretax income was approximately $16,525,000 compared to pretax income of approximately $10,539,000 in 2011, an increase of approximately 57%. Net income for the full year was approximately $11,011,000 or $1.40 per diluted share, compared to net income of approximately $7,417,000 or $1.04 per diluted share for the 2011 full year. Selling, general and administrative expenses for 2012 in absolute dollars and as a percentage of revenue, decreased to approximately $7,323,000 or 8.2% of revenue, compared to approximately $7,932,000 or 10.7% of revenue in 2011. So with that prelude, I will now hand the call over to Vince Palazzolo, our CFO, so he can walk you through the financial statement details for the fourth quarter. Then I will comment on the current business environment and the guidance issued approximately 5 weeks ago. I will then wrap things up and open the call to questions. Vince?

[Vincent Palazzolo:]

Thank you, Ed. As reported in this morning's press release, comparing the fourth quarter of 2012 to the fourth quarter of 2011, revenue increased 15.5% to $27,356,029 from $24,092,200. Gross margin was 28.1% as compared to 27.2%. Pretax income increased 47.8% to $5,765,354 compared to $3,901,020. Net income increased 34.7% to $3,600,354 or $0.43 per diluted share, compared to $2,673,020 or $0.37 per diluted share. Selling, general and administrative expenses were $2,031,631 or 7.4% of revenue, compared to $2,523,313 or 10.5% of revenue. Ed?

[Edward J. Fred:]

Thanks, Vince. New orders for 2012 were approximately $81.6 million, just slightly lower than the 2011 record awards figure of approximately $83.6 million. Given the economic uncertainties that existed throughout the year due to the threat and eventual implementation of sequestration, we are quite pleased that we could still procure a new award amount similar to our previous record year. This award total includes contracts with 3 new customers

[Operator:]

[Operator Instructions] Our first question comes from the line of Mark Jordan with Noble Financial.

[Mark C. Jordan:]

Ed, you mentioned in your press release today a large defense contract was pushed out. You now expected it to be received in 2013. Is that program being delayed by the continuing resolution? Or is this an ongoing program that you're just getting your first award under and it's just delayed because of the general sequestration delays?

[Edward J. Fred:]

I'll say to you that it was delayed because of the sequestration delays, looking at -- the customer looking to see if sequestration was going to occur, what the impacts might be on them. It is our belief now that this contract award is in the system for final approval but it was not part of the continuing resolution at all.

[Mark C. Jordan:]

Okay. Could you -- have you had discussions or gained any clarity as to what 2 of your larger defense programs, the E-2D and the A-10, how sequestration is going to impact both Northrop Grumman and Boeing on those 2 programs?

[Edward J. Fred:]

In any specific conversations we've had with them, it basically is, for our purposes, anyway, does not impact us all that much at this stage. We have not been told to slow down building our product or anything else like that. You can read what I read in the papers about what Boeing says it will do to them in the long term, same thing with Northrop Grumman. But as far as it impacts CPI, other than perhaps not having a release or 2 that we would've expected by now on those programs, it's not slowing us down at all.

[Mark C. Jordan:]

Okay. Final question relative to, I guess, your relationship with Sikorsky. Do you feel that the changing -- the tighter budgets we're facing in the future will change Sikorsky's view of the attractiveness of outsourcing and the ability to look for subcontractors that can lower costs and increase -- and deliver good quality? Do you have a sense that they're pulling in their horns? Or -- and again, this is longer term, not short -- not over the next -- this year.

[Edward J. Fred:]

Yes, we're not hearing anything like that and I get asked that question an awful a lot. Will -- based on what's going on in the economy, will companies start to pull work back in-house versus subcontract it out? And my only answer to that is -- I'm not in the boardroom of Sikorsky to hear what they're doing but I think there's a logic that applies that says if we can offload work and get it done more cheaply than we can have it done in-house or maybe it's break even but we can create space so we can bring in more profitable work from some of the platform, then you continue to do that. No one has -- none of our customers, not one, has given us any indication that there's even a thought of pulling work back in due to the economic situation that exists right now. We have not heard that one time.

[Operator:]

Our next question comes from the line of Joe Bess with Roth Capital Partners.

[Joseph Bess:]

Ed, can you talk a little more about your main E-2D, A-10 and G650 contracts and the purchase orders there? And are we anticipating revenue growth from these contracts in 2013?

[Edward J. Fred:]

Joe, I have not given specific information out to the public on what each of those programs is going to do separately. What I can tell you is that you saw at the beginning of January that we announced an E-2D contract award for either 5 or 6. Doug, E-2Ds, 5?

[Douglas J. McCrosson:]

5.

[Edward J. Fred:]

5 new E-2Ds that we had actually received in December but we weren't given approval to put out a press release till January. So I think you should see that, that's not really being impacted at this stage. You can take a look at G650 and the ordering and the public information General Dynamics puts out about their program, the Gulfstream 650, and see that, that plane is all set for delivery and they're starting to make the deliveries on them, et cetera, and there's no discussions about that slowing down in any way, shape or form. A-10, I'm not going to tell you it's slowing down. I'm not going to tell you it's speeding up. It is a little bit stagnant right now. We have not gotten the next round of releases. That said, we are still working on the releases that we have, so I think the impact will be somewhat negligible there. I don't know that, that program would suffer any more than any other one if sequestration were to continue. But for us, our 2013 revenue is pretty much in place, if you will.

[Joseph Bess:]

Okay, great. And then thinking about revenue on a quarterly basis, how should we be thinking about the growth -- or just be thinking about it on quarterly? Because you're seeing quite a bit of fluctuation over the last few quarters. And just kind of get a better idea on how this streamlines through the year?

[Edward J. Fred:]

Well, we don't give quarterly guidance. We never have. That's a tricky game, especially when you use percentage-of-completion method accounting. But I think if you look at us historically, the first quarter is always the lowest and that's usually because our customers want to build up for year end, for their financial statement purposes and their deliveries to their customers, et cetera. So the first is always the lowest. The second and third can flip-flop with each other. They're usually but not always bigger than the first quarter. But one can be -- like for example, it's not always the first is x, the second is x plus 1, the third is x plus 2 and the fourth is x plus 4. It doesn't always work that way but that tends to be the cycle of CPI's revenue stream. So first quarter will be our lowest, may or may not be down from the first quarter of 2012. We know somewhere along the way during 2013 that the quarters have to be down from the previous year's quarters because we're doing $15 million less in revenue but that's kind of the trend you will see here.

[Joseph Bess:]

Okay, great. And then I was hoping that you can just give a little bit more color on your forecast and what do you see as some of the inherent downside risks and upside potential that can be derived from your guidance?

[Edward J. Fred:]

I'm going to be very careful here because our number is our number right now, which you just have to go and look at 2011 and see that we're saying we're basically going to have the same kind of year. I don't know that there's a lot of downside risk to that number because we've taken into account the fact that not only were we hit with the threat of sequestration but now we're full-blown into sequestration. So I'm not sure there's much downside risk to it. Upside, I don't want to get crazy here and tell you it's unlimited. Right now, there isn't a big trend by anybody to start looking to give out awards to people because they're all in the same boat, from a military standpoint, of not knowing what's coming, when sequestration ends; if it ends, what kind of budget cuts are we facing, what platforms, what programs. We don't worry a whole lot about our platforms. We think we're on 3 fantastic platforms even with budgetary cuts. And then also, Joe, we're constantly working the commercial market right now. Now could we be awarded something in 2013 that changes the projection upward because we won a major commercial program? Of course. I'm not telling you we're doing that, though. We are finding, and maybe it's part of growing pains as a company, I don't know, but we are finding it's much harder to predict both size and timing of commercial programs than it was to do military programs. And so I think our outlook for 2013 or projection or whatever you want to call it, is pretty solid at this moment. I don't look for downside. Is there potential for upside? Of course.

[Joseph Bess:]

Okay, great. And then Vince, just one housekeeping item. What was the D&A in the quarter?

[Vincent Palazzolo:]

165,000.

[Operator:]

Our next question comes from the line of Bhakti Pavani with CK Cooper.

[Bhakti Pavani:]

My question is related to the commercial side of the business. As we know, the [indiscernible] side is getting impacted because of sequestration. But what kind of opportunities are you seeing in the commercial side, especially the business jet market? And is there any growth potential in 2013 or any new orders expected? If you could share some color.

[Edward J. Fred:]

Well, I can say to you that, as I have said from the beginning of last year, the commercial sector, if you will, is on the upswing, where we've have left the bottom of the trough. We're starting to head north, if you will, into the 8 to 10 to 11 to 12-year cycle of commercial buildup. There are numerous opportunities out there. We see more and more everyday. We're pursuing an awful lot of them. As far as what I can expect this year, I can't project anything that I expect. We're very hopeful of opportunities with what I'll call the big 3

[Bhakti Pavani:]

Okay, fair enough. It's kind of preliminary but I can just see that CPI has grown its top line in 2008 through 2012 in the range of about 8%, with an exception of 2010 and now 2013. Now that the sequestration has become certain, that there is going to be sequestration, there is going to be cuts, what is the probability -- what kind of growth can we expect in 2014? Is it going to be similar to the 20% growth that CPI has historically had? Or any kind of guidance on what should we expect.

[Edward J. Fred:]

Now, Bhakti, you know I can't give you that answer. CPI has not projected 2014 at all. I can't tell you what to project at this moment. Do we believe 2014 should see a resumption in growth? Yes, I said that in my script. But as far as quantifying that, I'm not in a position to do that right now. You see the world situation. So for me to do that would be absolutely foolish.

[Bhakti Pavani:]

Okay. Just a last question. What kind of tax rate assumption would be appropriate for 2013?

[Edward J. Fred:]

Bhakti, you broke up when you asked the question. Could you repeat it? What kind of...

[Bhakti Pavani:]

Oh, I'm sorry. The tax rate assumption for 2013?

[Edward J. Fred:]

For 2013, what's the model?

[Vincent Palazzolo:]

Use 31%.

[Edward J. Fred:]

You hear him, Bhakti? 31%.

[Bhakti Pavani:]

Yes, I heard him.

[Operator:]

[Operator Instructions] Our next question comes from the line of Mike Crawford with B. Riley.

[Michael Crawford:]

Mike Crawford with B. Riley & Co. In the past, you talked about efforts to rein in the costs in excess of billings and that's a huge number relative to your enterprise value in particular.

[Edward J. Fred:]

Yes.

[Michael Crawford:]

And so what can you do structurally to reduce this number both this year and going forward?

[Edward J. Fred:]

Well, it'll come down this year -- 2013, if we're saying this year, simply because we will be delivering a lot more product than we will be booking revenue. So that account is going to start to come down that way. And it would continue that way if we continue to decrease in revenue, which obviously is not our goal here. The other thing, though, is as our programs all start to reach maturity phases, it will naturally eat away at that number because you will be billing out higher amounts than you'll be incurring in costs and delivering on those products. So I think 2013 is the start of the eating away at that number. 2013 will have a significant erosion of that number and then can continue into the future. Now I give you a caveat with that. Were we to land some major work, and I'm not talking about a $5 million contract or a $10 million contract, but if we were to land $30 million or $40 million per year in let's just say commercial work, we're going to build that account back up again. It's the nature of the business because we would then be starting up brand-new programs, where you incur costs, incur tooling, incur a lot of things that you don't get to bill out right away. And, for example, that account will never come down rapidly as long as we have the Boeing tooling in there that we have to amortize over the number of units that we're delivering. In our old days, we used to -- a lot of our customers, and I guess that's probably because it was the U.S. government, we were able out to bill out tooling immediately and that would help reduce the cost in excess account every time. With our newer customers, they like it amortized. And I understand why but the fact that you're amortizing it means amounts sit in, in that CE&E [ph] account a lot longer than they would if you were allowed to just bill out the tooling. So in answer to your question, what can we do? We can deliver more than we have been delivering, which we will do for 2013. That'll eat away at the number. Then as we continue to be in mature programs or programs that are going into their production phases, that too will continue to eat away at that, which will also generate cash flow. And then we'll see where we go as far as new programs go and what it does to that account.

[Operator:]

Our next question comes from the line of Russ Silvestri with SKIRITAI.

[Russell Reed Silvestri:]

I was trying to understand, what was the cash flow for 2012 from operations?

[Edward J. Fred:]

You have it here?

[Vincent Palazzolo:]

I don't have it in front of me.

[Edward J. Fred:]

We don't have it here yet, Russ. We haven't published it yet. It will be published when?

[Vincent Palazzolo:]

Tomorrow.

[Edward J. Fred:]

Tomorrow.

[Russell Reed Silvestri:]

Okay. I guess, is it going to be -- could you just tell me then, I guess, relative to what you're forecasting in the $3 million for 2013 in cash flow from operations. Is it going to be -- how much?

[Edward J. Fred:]

It was significantly negative, Russ, significantly.

[Russell Reed Silvestri:]

Right. So I guess I'm just trying to understand, as you go forward in -- a little bit on the earlier question was, what are you explaining to spend in terms of CapEx next year? So if I look at your free cash flow for 2013, what are your cash investments that you're going to be making in plant, property, equipment, I guess?

[Edward J. Fred:]

Next year? $1 million? It's about $1 million in CapEx for 2013.

[Russell Reed Silvestri:]

Okay. So going forward, you didn't talk about your gross margins I think in 2013.

[Edward J. Fred:]

We have not projected them. Don't forget, we really haven't talked about -- I never actually gave out the top and bottom line numbers for 2013, either. But if you look at us historically over the last 5 years and as you'll see on a chart when I see you next Tuesday, we expect gross margins to be in the same range that they've been, somewhere between 25 and 27. Last 2 years, they've run a little bit higher in that range. And so we would kind of expect that to continue, as well.

[Russell Reed Silvestri:]

But with the costs in excess accounting, shouldn't the gross margins continue to improve if you -- if things stay slow here in the near term?

[Edward J. Fred:]

I wouldn't -- I know where you're going with this. I wouldn't say they should improve. I think we're pretty much banging the top of where they can and should be with the customer base we have and the programs we're on. I don't think they can get a whole lot better. Just don't forget now, the programs we're talking about are in their mature phases. They're all in production, E-2D, G650, A-10, the 3 big ones, and BLACK HAWK, obviously, are all in production phases. So you're not going to get a whole lot better until you wind down those programs. And for that, we're not talking till '15, '16 and '18 on some of them.

[Russell Reed Silvestri:]

Okay. And then last question. If you look at your turns in terms of business that you could potentially turn within a quarter that wouldn't come from backlog, historically, what's been a high number and what's been a -- I guess 0 would be the low number. But can you talk a little bit about what kind of turns opportunity you have within a given quarter?

[Edward J. Fred:]

In a given quarter, you're basically looking at 0 because there is nothing we get in-house that we can even start on before the 3 to 6-month mark.

[Russell Reed Silvestri:]

So how about 6 months then?

[Edward J. Fred:]

It's so hard to throw a dart at.

[Douglas J. McCrosson:]

[indiscernible]

[Edward J. Fred:]

Yes, but that depends on what the contract value is.

[Douglas J. McCrosson:]

Oh, yes.

[Edward J. Fred:]

Yes. So I mean, Doug is saying 5% to 10% of the contract value but that's not going to help you with what you're trying to do here and the modeling you're trying to do because if a contract is $40 million, it's very different if it than if it's $400,000.

[Operator:]

[Operator Instructions] Mr. Fred, it appears we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

[Edward J. Fred:]

Thank you, Christine. Okay, I'd like to thank all of you for participating in this call. If we don't see you out at Roth we look forward to speaking to you again in May for our first quarter earnings call. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.