CPI Aerostructures, Inc. (CVU) Q1 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the CPI Aerostructures, Inc. First Quarter 2013 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, Mr. Fred. You may begin.

Thank you, Kevin. Good morning, and thank you all for joining us for our First Quarter 2013 Conference Call. If you need a copy of the press release issued this morning, please contact Lena Cati of the Equity Group at (212) 836-9611, and she will fax or e-mail 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 an 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 process 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 in our filings with the SEC. As it's been the case in previous first quarter conference calls, I will provide our new listeners with a brief overview of CPI Aero and our activities. Based on Long Island, CPI Aero is a world-class manufacturer of aerospace structural parts and assemblies. During the last few years, we have substantially grown our business by becoming a subcontractor to some of the largest U.S. aerospace and defense contractors, such as Northrop Grumman, Boeing, Sikorsky, Spirit Aerosystems, Lockheed Martin, Honda Jet, Cessna, EMBRAER and Bell Helicopter. We are also a prime contractor to the U.S. Department of Defense. Since its inception in 1980, CPI Aero is focused on the production of aerospace structural parts and assembly, and is developing the required skills and expertise to produce the highest quality products possible. We have carved out for ourselves a niche within the aerospace market and become one of the country's leading suppliers of structural spares for vintage and out-of-production aircraft, and now assemblies for new production plans. Typical assemblies produced by CPI Aero are skin panels, leading edges, flight control services, engine housings, cowl doors, wing tips, outer wing panels, nacelles and inlet assemblies for military aircraft, such as the A-10 Thunderbolt, UH-60 BLACK HAWK helicopter, E-2D Hawkeye, E-3 Sentry, C-5A Galaxy, C-130 Hercules and the B-1 Bomber. And various structural assemblies for commercial aircraft, such as the Gulfstream G650, the Honda Jet advanced light business jet, the Cessna Citation X, the EMBRAER Phenom 300 and the S-92 helicopter. 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. Then I will comment on the current business environment and then wrap things up and open the call to questions. Vince?

Thanks, Ed. As reported in this morning's press release, comparing the first quarter of 2013 to the first quarter of 2012, revenue increased slightly to $19,927,433 from $19,721,095. Gross margin was 22.3% as compared to 25.2%. Pretax income decreased to $2,421,276 compared to $2,710,320. Net income decreased to $1,671,276 or $0.20 per diluted share compared to $1,919,320 or $0.27 per diluted share. Selling, general and administrative expenses were approximately $1,878,000 or 9.4% of revenue compared to approximately $2,105,000 or 10.7% of revenue. Ed?

Thanks, Vince. The federal budget sequester has resulted in delayed contract decisions by many prime contractors in the aerospace and defense segment, including our customers. As of March 31, 2013, we received approximately $11.5 million of new contract awards compared to the total of $31.7 million of new contract awards in the same period last year. This decrease was anticipated and was already reflected in our financial performance expectations for 2013. Now that sequestration has become a reality and the company and our customers have more definite information regarding certain key defense programs, the company expects new orders for military aircraft to accelerate, and we expect to have a solid year for new business for both the military and commercial segments. The results are real business potential from the bid pipeline of unwanted solicitations outstanding once these programs either become funded or are awarded. In the past several years, our reputation has been elevated in our industry, thanks to our impressive list of customers, the success we've experienced on the important programs we are working on and the exposure we have had and contacts we've made at various aerospace and defense institutional investor conferences. We are now in the midst of establishing relationships with additional prime manufacturers, including other helicopter and business private jet companies who have come to recognize CPI Aero as a premier supplier of structural aircraft. Among the unawarded bids outstanding are contracts opportunities with these potential customers, including our first serious opportunities to perform work on multiple commercial jetliners. We look forward to reporting on our progress of turning solicitations with these prospects into awards and contracts in the very near future. Our total backlog in March 31, 2013, increased by $28.4 million from approximately $420.3 million, as compared to approximately $391.9 million at December 31, 2012. This increase was attributable to a $42.3 million increase in backlog on commercial programs, offset by a $13.9 million decrease in backlog for military programs. Funded backlog increased to $81.9 million at March 31, 2013 from $52.3 million at December 31, 2012, which is predominantly the result of a $31.8 million increase in funded backlog on commercial programs. Our first quarter results were inline with our expectations. Our 2013 guidance is factored in the current defense budget environment and reflects the cuts mandated by the Budget Control Act of 2011. For 2013, we continue to expect revenue and earnings to be lower than 2012 and more similar to those of 2011; commercial programs that generate a larger percentage of our overall revenue as compared to 2012; product shipments to be greater than in 2012 or any other year as many of our programs have transitioned from development to production; increased shipments, combined with less spending for start-up cost associated with new contracts and a decline in nonrecurring expenses on our maturing programs to result in positive cash flow from operations of approximately $3 million. We still expect our gross margin for the 2013 full year to be within our projected range of 25% to 27%. The first quarter gross margin was affected by adjustments to our long-term programs with Spirit and Boeing. The adjustment for the Spirit program was the result of price reductions given as part of the negotiations to increase the program value and expand its life until 2019, while the Boeing adjustment was due to negotiations for program changes. We anticipate our SG&A expenses to remain as low as possible, as we take a cost-conscious approach to spending in 2013 to account for the reduction in revenue this year. To support our increased delivery requirements and expected growth in the future, we have amended and increased our credit line to a borrowing capacity of $35 million, and we have increased our workforce to approximately 225 people. On a separate note, CPI Aero will continue to tell the story as often as possible and demonstrate to our shareholders and potential investors that the effects of sequestration upon CPI Aero's operations are a temporary setback, which we had no control over. To that point, we will participate in the B. Riley 14th Annual Investor Conference, presenting at 1 p.m. Eastern time, 10 a.m. Pacific time on May 21. Our presentation will be webcast, and I encourage all of you that can't attend the conference to watch it either live or replay it on the CPI website. Also, CPI will have a presence at the 2013 Paris Airshow in June, where we previously made inroads in companies that we are now able to call customers. And through a grant given to CPI by New York State, we're able to attend at a reduced rate and have a presence at the New York State Department of Economic Development booth, located in the U.S. International Pavilion. We look forward to our immediate and long-term future with great anticipation. We realize that 2013 is testing the mettle of both the management of CPI and our shareholders. While we are excited and well prepared for this challenge as we execute on our current contracts, deliver an unprecedented amount of product to our customers, develop new customers and work to become a cash flow positive company. We are well positioned to resume growth in 2014 and beyond. Our new business opportunities remain strong, and we are bidding on larger and more complex contracts, including those for large commercial aircraft parts. At this point, I would like to open the floor to questions. Kevin, can you allow callers to place questions now?

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

Ed, I'd like to just delve in, get a little better explanation of your discussion of new orders and how it relates to backlog. New orders, you talked at $11.5 million, but backlog in the quarter went up $28 million. Is that a distinction between potentially an expansion of, say, the Spirit contract in the first quarter, which increased backlog but was not reflected in your total of new business awards?

That's a pretty good synopsis of what it is, yes. Now what was included in the new business awards, obviously, is just that amount that we were released for out of the long-term contract, yet backlog increased by a substantial piece of that contract that goes out to 2019. So yes, that is correct.

Okay. Second question relative to, obviously, a very strong jump in funded backlog. Would you talk about the expected delivery cycle for that $81 million in funded backlog?

Most of what you see in our funded backlog at this stage in our business cycle as a company will be liquidated within the 12-month period of time. To that end, we'll obviously be adding to backlog over the next 12 months, so that it's not to be read that, okay, once they're done with their $81 million, they have no future revenue stream. Not the case, obviously.

Okay. I'd like to talk for just a second about the E-2D program, possibly the example of how sequestration is impacting your order flow. It's my understanding that the Department of Defense has defunded one of the 4 planes for the E-2D program in the 2013 budget. In that budget, it's my understanding, E-2D was in its LRIP or low rate production, and that it was expected, historically, that, that would go into volume production and lift to potentially 6-plus planes per year for an extended period of time. Do you know that, while you may have -- we have had a defunding of one plane this year, what are the plans for the program? Has there been any change in the program in terms of progressing to a volume production rate meaningfully in excess of where you are today?

Okay. That reduction had nothing to do with CPI, just so you know. Remember that we're anywhere from 12 to 15 to 18 months ahead of the schedule or behind the schedule, depending on how you want to look at it. So that one plane reduction would come in a future release that we would have received from Northrop Grumman. So it does not impact us at all for this year or next year's build. However, the one point you left out of there is that the DoD did give permission for long-rate reduction on the E-2D. It is leaving its low-rate production mode and going into a full production mode, albeit with sequestration staring us in the face. So while one plane may drop out of the given year's budget because there's a dollar reduction required, the program itself is the strongest it's ever been. So we now know that the government has said, we're funding a 75-airplane program along with funding a 25-airplane modification program on the C-2A. So from our perspective, I think, from Northrop Grumman's perspective, though I won't speak for them, I think we all look at this as probably the most vibrant program any one of us is dealing with right now.

Final question, if I may. What was depreciation and amortization in the quarter?

$163,500.

Our next question is coming from Joe Bess from Roth Capital Partners.

Ed, can we talk a little bit more about gross margins and your expectations for the rest of the year? And really, with your expectations for it still to be between the 25% and 27%, is this a function of contract mix that you have in the pipeline right now? Or can you give me a little bit of better understanding of where this margin expansion is going to be coming from on a sequential basis?

Well, yes. All right. Be careful about calling it margin expansion, Joe, because we don't give quarterly margin projections, estimates or anything else. We do it based on a given year. Now as we wrote in our press release and I mentioned here in the script, we had to take some adjustments to gross margin, yes. One of them was the fact that we had to -- while we're off pricing to Spirit to get the long-term contract extension that we got. And when you do that, you have to adjust the gross margin you've taken so far. I think that should give an indication that the pricing reduction wasn't so severe that we have a 5-year program, and the gross margin in the entire company dropped less than 3%. So given that and the fact that, that's a 1 quarter adjustment, if we run our normal 26%, 27% over the next 3 quarters, we will fall right into that 25% to 27% range. So I think that's the way you want to look at this.

Okay, great. And then thinking about the contract that got pushed out from kind of being in the December timeframe potentially into 2013, can you give us a status update on that contract?

We don't have it yet. We're expecting it. All indications are that we will be getting it. Unfortunately, we're just caught up in the bureaucracy of the company's approval cycle at the moment. But as I stated again in my conference call, we expect this to be an incredibly solid award year, and that contract will be a very big piece of that. And there is no reason nor any indication that CPI will not have that contract this year. And since we've already accounted for the fact that we didn't have it in our 2013 numbers, while I would love to see it sooner rather than later, if I got it in June versus September versus November, it would not impact my 2013 numbers.

Okay, great. And then thinking a little bit more about the funded backlog and what you said about majority that will be recognized over the next 12 months, are you able to give a little bit more color on what you guys are expecting for that to be for the next 9 -- or the next 9 months for the 2013 number?

I would say that you subtract $19 million from $74 million, and that number is what will come out of the backlog for the next 9 months. It's not -- our number for 2013, our projected number, which we said would be very similar to 2011, that number was $74 million. We will be right around that number. Very little can change that number downward. And unless we get a major surprise or get something very early that we're not expecting yet, it probably won't go up, either.

Your next question is coming from Michael Callahan from Topeka Capital Markets.

First thing just on cash flow, negative cash flow in the first quarter even while, I guess, sales were flat. At some point, I guess, as sales are declining throughout 2013, I guess you'd expect shipments to be in excess of work completed on these contracts, could you guys give us any sense as to when that inflection point might take place? And to what magnitude the swing might be when it does?

I think you'll see a move towards positive cash flow for the second quarter, and then you will experience positive cash flow in the third and fourth as we deliver high, high rates. The reason, obviously, or at least it should be obvious to a lot of people, I know it is to you, Mike, is that the first quarter would be negative cash flow because the fourth quarter of 2012 was the best quarter we ever had revenue-wise since our driven, our revenue is driven by procurement. The first quarter is when we pay the bills on all of the procurement we bought in, in the fourth quarter. So that said, you should start to see a marked decrease and negative cash flow. We're hoping to approach break-even cash flow at the end of the second quarter, might be slightly negative, might be slightly positive. Nothing dramatic in either case. And then the third and fourth, especially the fourth, is where you will see the major turnaround in cash flow that will get us to a $3 million positive year.

Okay. That's helpful. I guess just on the revenue number. So if you just take first quarter and then kind of annualize it, you come out to, I guess, a higher -- significantly higher rate than what you're adding in 2011. Does that suggests that there are contracts that will be completed in the second and third quarter, and it'll actually flip negative on a sequential basis, or how should we be thinking about that? And is that specifically related to the fixed-wing contracts with the Department of Defense?

I'm trying to figure out how to answer you here. The question was a little confusing. But yes, you will see decreases in revenue as we pull people, we would for the entire year this year. It's not that programs will be completed, it will simply be the ordering necessary given the slowdown in programs for the time being. You'll probably see most of that in the second and third quarters, I would think. And then assuming we've won the awards we expected to, things have gone the way we expect them to go this year and 2014 to be a good year, you would see the fourth quarter start a major pickup. The third quarter is a quarter you're looking at as being the worst of the 4.

Okay, that's helpful as well. I guess, just the last thing I'd want to ask here. You mentioned some negotiations with Boeing, and then that contributed to the lower margins in the first quarter. Can you give us any color as to what the status of the receivable with Boeing and then how close that is to being resolved?

Sure. What I can give you right now is we have, as we've stated in the press release, had negotiations with them. We are reaching points of agreement on various issues. Subsequent to March 31, we received a major payment for items that were old in the receivable category, so you would see a reduction of that in next quarter's financial statement. So while it has taken a very, very long time for both companies to work out these matters, significant progress is being made.

Our next question is coming from Bhakti Pavani from C. K. Cooper & Company. Bhakti Pavani - C. K. Cooper & Company, Inc., Research Division: My question was related to the price negotiations that you talked about in your prepared remarks with Spirit. In the fourth quarter, you received the contract from Spirit. So my question is, is the pricing fixed on that contract, or is there a probability of order price negotiations going into the future?

It's a fixed price contract, Bhakti, like all of our contracts are. Bhakti Pavani - C. K. Cooper & Company, Inc., Research Division: Okay. The other question was on the Boeing. You mentioned that there were negotiation on program changes. Would you provide some color on the current negotiation? And also on the A-10 program, how is that looking? And are you guys shipping any kind of shipments for this year?

Okay. First, we have been shipping all along on the A-10 program. I think people have a misconception about the Boeing program. The Boeing program is a wonderful program and they are a fantastic customer, so we have a very good relationship with them. We have been negotiating a couple of things, all the receivables, changes in the program pricing based on engineering changes, production changes, material changes, things like that. When you're dealing with a customer that big and on a program this big, this takes an awful lot of time. More time than any of us would like, but that's the nature of the beast, if we want to work with a company the size of Boeing. So with that said, I'll say to you that the negotiations that have taken place have resulted in a slightly lower gross margin were simply the negotiation on us saying a change in engineering was worth $2 and them saying no, baloney, that change is worth $1.25, and us coming to a price somewhere at $1.61 that we both agreed to. And this will be an ongoing process, sometimes we'll have to come down in price, sometimes they'll have to come up in price and we will eventually have all of these issues ironed out. Other than that, we are delivering all year, we would anticipate a release on this program, the next release now that sequestration is in place and Boeing knows what their customer is willing to give them from a budgetary standpoint, so we don't see any problem with this program nor with this customer. And anything people think to the contrary would be incorrect, so I hope I've clarified that today. Bhakti Pavani - C. K. Cooper & Company, Inc., Research Division: No, that's really helpful. My next question was other than the price negotiations with Spirit, have you received any kind of request on price negotiation on the existing deals that you have in place from any of your other customers?

No, none. Bhakti Pavani - C. K. Cooper & Company, Inc., Research Division: Okay. My last question was related to the tax rate. What kind of tax rate assumption should be taken into consideration going forward?

We anticipate the tax rate for the whole year to be between 30% and 31%.

[Operator Instructions] Our next question is coming from Mike Crawford from B. Riley & Co.

Just going back to the statement about revenue driven by procurement, can you just walk through exactly what happens to the balance sheet given that you don't hold inventories? So what exactly are the uses of cash in Q1 after you take in a bunch of orders like in Q4?

When you buy product as we did in quarter 4, which was the most product we ever bought, was the highest procurement quarter we've had in our history, that product is going into the build for this year. Now when we book it in the fourth quarter because of percentage of completion, that procurement by generates revenue of whatever gross margin each of those programs have. The entry would be to credit revenue and new debit cost an estimated earnings in excess of billings on uncompleted contracts. As we begin to deliver product, whenever that is on each of these items, you then debit receivable and credit cost and estimated earnings on excess of billings. Over the year, you should see cost and estimated earnings go down somewhat because we anticipate delivering significant -- I'll call it significant, although I'll be careful with the word. Let's just say more than I expect to book in revenue, okay. So my deliverables and, therefore, my true receivables will outpace the amount I'm adding to cost and estimated earnings and excess of billings, so that number should come down as the year goes on. Does that answer it?

Okay. Well, yes, but is there -- there's no footnotes or any other disclosure where we can see the amount of product -- I don't want to call it inventory, that you're holding over time. Is there a way to track that more closely?

Not publicly, no. No. You just have to know that if CE&E, [ph] as we call it, is going up, then the company is buying product and building accordingly. If the number is going down, it means we're buying less than we're building, and therefore, true inventory, if you will, and again, percent of completion does not have an item called inventory. But to go to the layman's terms, the items that we're buying that we're going to assemble, if you want to phrase that as inventory, if that the CE&E [ph] account is going down, that means we have less of that material in the facility to use to build an assembly with.

Okay. And so you buy product, which may be somewhere in your books, you call them inventory, but we just see it as one line item, and then you book and assume gross margin. But then if you have a price negotiation, then you'll go back and there'll be a one-period adjustment so -- to a gross margin, so in other words, based on that Spirit renegotiation, you have maybe debook some assumed gross margin that on product that have been worked on already, but now, going forward, you're expecting the revenue to come in closer to that 25% to 27%? Well, to get to that endpoint.

Right. In theory, that's correct. We're not necessarily debooking revenue, and this doesn't occur that often. This occurred because we had a contract that production-wise was expiring at the end of '13. I think everybody can take a look at what platform that is and realize that the number of planes, including in our contract, was nowhere near the number of planes that the prime contractor was forecasting it was going to sell, et cetera. And so in order to get the extended life contract, which basically says we will build those parts for that plane for as long as the plane exists, there had to be some price negotiation. And anybody who is following this industry knows that there have been cost pressures on Spirit on its programs. That's not new, that's not giving away a customer secret. They've published numerous times that they've had cost pressures on a few programs. This was one of those programs. In order to participate in it for the next 6 years and build, who knows, how many more planes, 100, 200, 300, who knows, there had to be some price concessions, and some of those concessions involve planes that we still have yet to be delivered. So there was a slight reduction, and I do mean slight. I mean, when you consider we had 2 adjustments to programs and the gross margin for a quarter is less than 3%. I think if you think at the light of the program, the fact that was out there 5 years, this is not what I would call a major adjustment. This is not an accounting change, where we had to disclose it and book a different one. This is simply a tweaking, if you will, of a gross margin over a program that's going to eventually be about 11 to 12 years.

Our next question is coming from Mark Jordan from Noble Financial.

I'd like to follow-up a little bit, Ed, on your comment about saying that you're well positioned for seeing growth in 2014. I'd like to just talk about the various pieces of your business and what level of optimism you have in each of those pieces. And first, I would say, the incremental new business, both defense and commercial, then do you see the defense -- your existing defense customer base rebounding in '14 versus '13? And then finally, do you continue to expect to see your commercial business growing in '14 versus '13? Could you address sort of each of those 4 pieces?

Okay. First, current military business rebounding, yes. We do see that because sequestration or the threat thereof created tremendous uncertainty for our customers, for ourselves, for everyone, not knowing what it would do, what programs would be affected, et cetera. We've had sequestration; we know what each of the customers are getting dollar-wise funding for their programs; there's a 2014 budget out on the Street, if you will. So I think it creates clarity that wasn't there. So when you say it's going to rebound, yes, we expect to get releases on contracts that we have that we didn't get in '13 or '12, I should say, that were expected and would have made '13 a better year than '12. That didn't happen. So we do expect those to come back based on inputs from the customers and just the fact that the budgets are clear now. So that's one. Two, we've got some new programs, Citation X, the Honda Jet, the EMBRAER Phenom 300, those should all pick up in volume in 2014, again, leading to growth. Now as far as what's in my pipeline, both militarily and commercially, we are going to go with this comment to you. We are always pretty accurate on what we can anticipate in the way of new business, not always accurate on what the program will be internally, but we have always been able to guess at the kind of percentage we will get of new business in a given year. And given that our gross margins are pretty much the same now, yes, they can vary 3 or 4 points high or low from that 25% number. But in general, when you compile our new business awards every year, they will come in on programs that will generate the 25%, 26%, 27% gross margins. They may not do that in day 1 in the early stages as we've all seen with any new program startup. But as a program and over the life of that program, they will generate those same margins. So it's that combination of knowing that the commercial business will pick up in 2014; knowing that we will receive releases on military programs on 2014 that we didn't in '12 that affected the 2013 revenue and of course, net income; knowing that we are bidding on a variety of commercial programs for a variety of commercial parts, and when I say commercial, I mean jetliners not business jet; and knowing we're going to win a certain percentage of the new business awards that are out there, that's what gives us the confidence about 2014. How confident are we? That I will not quantify yet. But I think you can see just by all of those factors that 2013 was an aberration.

That does conclude our question-and-answer session. I'd like to turn the floor back over to management for any further closing comments.

Thank you, Kevin. Before I close the call, I'd just like people to know that for the many of you who are unable to travel to CPI or see our facility first hand, we have produced a 2.5 minute video that will give you a flavor of what we do here and what the inside of the facility looks like. It will be posted on the company's website this week, and will also be used in our business development presentations going forward. I'd like to thank all of you for participating in this call and look forward to speaking to you again in early August for our second quarter earnings call. In addition, please remember that our Annual Shareholders Meeting will be held on Tuesday, June 11, in New York City, and you are welcome and invited to attend. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day. We thank you for your participation today.