CPI Aerostructures, Inc. (CVU) Q3 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the CPI Aerostructures Inc. Third 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 third 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 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 the 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 process 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, the 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 announced earlier this morning, our 9 months results were in line with our expectations, if not slightly better. Revenue for the first 9 months of 2013 was approximately $61,703,000 compared to approximately $61,917,000 in first 9 months of 2012. Gross margin was 21.3% compared to 26.7%. Pretax income was approximately $7,778,000 compared to pretax income of approximately $10,760,000 for the same period last year. Net income for the first 9 months of 2013 was approximately $5,367,000, or $0.63 per diluted share, compared to net income of approximately $7,411,000, or $0.96 per diluted share, in the first 9 months of 2012. Selling, general and administrative expenses for the first 9 months of 2013 were approximately $4,883,000, or 7.9% of revenue, compared to approximately $5,291,000 or 8.5% of revenue for the same period of 2012. With that prelude, I will now hand the call over to Vince Palazzolo, our CFO, who can walk you through the financial statement details for the third quarter. Then I will comment on the current business environment, our guidance for the current year and new opportunities going forward. I will then wrap things up and open the call for questions. Vince?

Thank you, Ed. As reported in this morning's press release, comparing the third quarter of 2013 to the third quarter of 2012, revenue was $20,664,645 compared to $21,340,831. Gross margin was 21.7% as compared to 27.2%. Pre-tax income was $2,772,100 compared to $4,025,437. Net income was $1,911,100 or $0.23 per diluted share compared to $2,795,437 or $0.33 per diluted share. Selling, general and administrative expenses were approximately $1,509,000 or 7.3% of revenue compared to approximately $1,616,000 or 7.6% of revenue. Ed?

Thanks, Vince. As we've discussed for what seems like 6 or 7 quarters now, the federal budget sequester resulted in delayed contract decisions by many prime contractors in the aerospace and defense sector, including our customers. However, even with the federal budget sequester, we have recently seen acceleration in new order releases for military aircraft, as our customers have received more definitive information regarding certain key defense programs. In that regard, we received a $47 million long-term agreement from Sikorsky for the production of BLACK HAWK fuel panel, a program for which CPI Aero has provided assembly labor since 2010, among some others, as of yet unannounced contracts that we have received. Including these orders, new contract awards as of October 31, from all customers, were approximately $83 million or 30% higher than the approximately $64 million in new contract awards reported for the same period in 2012, and just slightly below our record of $83.6 million on new contract awards reported for full year 2011. We expect additional contracts to be released before the 2013 year-end and have a record year for new business from both the military and commercial segments. There is also real business potential from our current bid pipeline of unawarded 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 experience on the important programs that we are working on and the exposure we have had and the contacts we've made at various aerospace and defense institutional investment conferences. We are now in the midst of establishing relationships with additional prime manufacturers, including other helicopter and business jet manufacturing companies, who have come to recognize CPI Aero as a premier supplier of aircraft structure. Among the unawarded bids outstanding are contract opportunities with these potential customers, including multiple opportunities to perform work on commercial jetliners. We look forward to reporting on our progress of turning solicitations with these prospects into awards and contracts in the near future. Our total backlog at September 30, 2013 increased slightly to approximately $392.7 million as compared to approximately $391.9 million at December 31, 2012. This increase was attributable to a $29.5 million increase in backlog on commercial programs, offset by a $28.7 million decrease in backlog for military programs. Funded backlog at September 30, 2013 increased to $102.5 million from $52.3 million at December 31, 2012, which was a result of increases in funded backlog for both military and commercial programs. Specifically, at September 30, 2013 as compared to December 31, 2012, funded backlog for military programs increased by $30.4 million to $73.6 million and funded backlog for commercial programs increased by $19.8 million to $28.9 million. Our third quarter and 9-month results were in line with our expectations. Our 2013 guidance has 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 to 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 startup cost associated with new contracts and a declining -- and decline in nonrecurring expenses on our maturing programs, could result in a positive cash flow from operations of approximately $3 million. We expect our gross margin for the full 2013 year to be within the range of 23% to 24%, which is lower than our projected range of 25% to 27%. Of note however, we intend to compensate for this shortfall by continued reductions in selling, general and administrative expenses, which should allow us to achieve the net income target we projected for 2013. The year-to-date gross margin was affected by adjustments to our long-term contracts with Spirit, Northrop Grumman and Boeing, as well as our C-5 TOP program as follows: the adjustment for the Spirit program is the result of price reductions given in part as part of the agreement to increase the program value and extend its life until 2019. The Northrop Grumman adjustment is a result of price reductions that were necessary upon completion of a government price analysis. The Boeing adjustment is due to negotiations for engineering changes. We are working with Boeing to lower procurement and labor costs; however, our gross margin was adjusted by 200 basis points to reflect our best estimate of future costs on the A-10 program. Of note, due to these engineering changes, we expect our revenue over the life of this program to increase by approximately $1.5 million. We anticipate our SG&A expenses to be lower than last year's, as we have taken a cost-conscious approach to spending in 2013 to account for the reduction in revenue this year. To support our increased delivery requirements in 2013 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 270 people. From a cash flow perspective, our 9 months operating cash flow was in line with expectations. We anticipate a significant improvement in the fourth quarter of the year, which should result in positive cash flow from operations of approximately $3 million for 2013 full year, as we have projected at the end of 2012. Additionally, our cash flow is expected to improve due to the completion of our contract negotiations with Boeing. On a separate note, CPI Aero will continue to tell its story as often as possible and share the message with our shareholders and potential investors that the effects of sequestration upon CPI Aero's operations were a temporary setback and that we are once again receiving awards and follow-on releases, as we had in the past, that enabled us to grow this company from an $8 million entity to one that reached nearly $90 million last year. To that end, we will participate in the D.A. Davidson Aerospace and Industrial Conference in Boston on December 10 and the Benchmark Micro Cap Discovery Conference in Chicago on December 11. Additionally, we have already accepted an invitation to present at the Noble Financial 10th Annual Equity Conference in January in Florida. We look forward to our immediate and long-term future with great anticipation. We realize that 2013 has tested the mettle of both the management of CPI and our shareholders. But we are well-prepared for this challenge as over the last years, we have taken steps to diversify our customer base and focused our efforts on commercial programs. For the remainder of 2013, we will continue to execute on our current contracts, delivering unprecedented amount of product to our customers, work to become a cash-flow-positive company, and also continue our efforts to develop new customers. We expect to have a record year of new contract awards, and we believe that 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, please?

[Operator Instructions] Our first question today is coming from Joe Bess from Roth Capital Partners.

What percentage of the funded backlog should convert to revenue before the end of 2014?

The end of 2014?

Yes.

What percentage of funded backlog should convert to revenue by the end of 2014?

We don't have [ph] answer because we're not giving guidance [indiscernible].

Yes, that's a good point. Okay, Joe, I don't know if you heard Vince but the fact that we haven't given guidance yet for next year, [indiscernible] us from giving you that answer.

Okay. How much should convert in '13? Is that possible?

Well, I mean, if you take the fact that we've done $60 million round numbers, and we anticipate doing $74 million or $75 million-ish, you're looking at $50 [ph] million, $60 [ph] million converting.

Okay. And then -- and given the government shutdown in October, have you experienced any delays in funding your projects, and has this impacted your guys' production rates in Q4?

We have not done any reduction... We have not had any -- we do not have any reduction in our production rates due to the government shutdown. We had about a 4-day lag in some shipments, but those have been caught up already. So there was no impact for our operations.

Okay, great. And when we're looking at the revenue mix on the military side by $6 million [indiscernible] positive, how do you see this mix changing in 2014 and which product lines do you think will be growing faster?

Hey, Joe, this is Doug. Right now, we're looking at our business jet line in 2014 growing. We still expect some softness in the military market that we've been seeing a little bit this year, primarily in the fixed wing market. Our helicopter business is pretty strong for next year. We anticipate, at the Investor Day within a couple of weeks, to give a breakout of that like we had in the past. But in general, our defense fixed wing is kind of soft, military rotary wing pretty strong, as well as our business jet.

Okay, great. What percent of your bids outstanding now are with contractors that you have yet to work with? Do you guys have an idea on that? Just trying to get a feel for what the potential is with new customers.

There is a -- there are some sizeable, I would say, more than 10% and under 50%. I don't have that number handy. We don't look at it that way. But I would say it's in the 25% range.

Okay, great. And last question. Are you able to quantify the potential value of the purchase orders your customers have received that you have not yet had translate to purchase orders for you at this point in time?

Yes. I can't tell you what that is, but yes, we know what that is.

Okay, you know what it is. But are you able to kind of ballpark it at all?

No, let's put it this way, Joe. We're not going to go out with nonpublic information on this call. However, you've heard us say already, now granted we only have to go up about $400,000 in awards to make it the record year. But we would not have said twice in my script and once in the press release that we anticipate receiving more awards that will make this a record year if we were going to close the year at $84 million. Okay. This will be a significant year, a significant increase in our record number, we believe, based on the information we have on those purchase orders themselves. So I think, obviously, I can't lead you to the pond on this one, but the number will be, I think, pleasing to all. It's certainly pleasing to us.

Your next question today is coming from Mark Jordan from Noble Financial.

Let's talk a little bit about the balance sheet. I think, year-to-date, that's up a little over $7 million. You're talking about $3 million in cash flow generation. Should we assume that there is a very -- an exceptionally high level of deliveries relative to revenue this quarter and that you generate something like $8 million to $10 million in cash. Is that what [indiscernible] be expecting?

Correct.

Okay. So that would explain why you -- from a revenue standpoint you would be, if you stay at $74 million to $75 million, you'd be implying something like $13 million top line, but yet deliveries and cash flow generation would be at record levels. Is that correct?

100% correct, Mark. You categorized it exactly the way we would.

Okay. Another question that I would have relative to, I guess, the commercial opportunities. You've talked about for probably over 1 year now some larger opportunities on the commercial jet side. Are those still out there and percolating, or has -- have the opportunities changed over the last 12 months versus when we first started talking about this?

There are still numerous opportunities. I think I have stated this publicly a few times. I've certainly stated it at all the presentations I make. I said there are [ph] being approximately 24, I'll stretch it and say maybe 30-month window where there will still be numerous opportunities to win large commercial programs. At that point, I think they would all have been basically given out, and the only way you'll get large things is somebody messes up, to be honest with you. So there are still significant opportunities out there. On Investor Day, I believe you'll be here, Mark; if not, I know you'll be listening in, we'll add a little more color to that for you and the entire investing public, expand on some of the opportunities and some of the past opportunities, et cetera.

Okay. Final question from me relative to the E-2D. Could you talk about how that aircraft program was impacted by sequestration in terms of the work that you were doing? Obviously, you didn't have much visibility coming in through the year. What you've learned in terms of -- what you did realize this year and what's in the offing for 2014-2015?

Hey, Mark. This is Doug again. I'll address that. On the E-2D, it's really just a shift of 1 airplane in the immediate near term. But I guess the bigger effect is in the long-term, multiyear contract that was being negotiated between Northrop Grumman and the Navy. There were several aircraft, I believe, a total of like 8 over the 5- to 7-year timeline. So there has been definitely an impact in, say, the -- to us in the in '15 -- beyond '15, probably '16, '17, '18 timeframe, but nothing really material in the near term.

Well, let me just add that it affects what I'll call current revenue, meaning what Doug just said, not this year necessarily, not '14. It affects current revenue, but not the value of the current program. The requirement, even with all the budgetary issues that there are, the requirement for 75 new E-2Ds has been approved by the Department of Defense, and hence Congress, and everyone else. So this is just the matter of some planes pushing out further into the cycle and not dropping out of the cycle altogether.

Okay. So the only way planes would drop out is just if Navy decides they are going to have pure carriers longer term?

Something to that effect, exactly.

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

Regarding the A-10, what are your concerns regarding that platform being -- continuing to be the primary close-air support platform versus some using the -- that they were trying [ph] to using these joint strike fighters for that role?

Right. My concern is that, obviously, it's a possibility that they will do that. Now that said, the DoD just funded, as you know, just funded Boeing for another 51 aircraft, I think it was, back on the 177 or something to that extent. Yes, 174. So while that's all being talked about, they have agreed to fund through 177, and it's only at 240-plane program at this point, even though there are 360 planes in the fleet. So I am not overly concerned. I'm not going to lose sleep over it yet. I believe there is an awful lot of posturing going on over it. There are some who want it, some who don't. I don't believe that if you don't fund enough F-35s, you can take the A-10 out of service. Therefore, you need to fix the wings. So I think there is a bit of a Catch-22 here, because if you read, they are also, I won't say defunding completely, reducing the funding on F-35. So you can't have both things happen; reducing that and reducing the A-10, because then you absolutely weaken the fleet, and no matter which side of the argument you are listening to, neither one agrees with that. So we're not overly concerned in the short term. As I've stated publicly, if you know Boeing got their release for their 15X [ph] , 51 planes or 54 planes, whatever it was, you haven't seen us announce ours yet, which mean ours should be coming. That's kind to take us to 177, that's going to fund us for a long period of time. So again, here in size, short term, meaning next 1 year or 2, we don't see any impact, whatsoever. Long term, could it happen if they reduce the number they have fixed and buy? Absolutely. To be candid with everyone, I said Northrop Grumman, when there was no way anybody in the world wanted the F-14 to go, except for a few people, everybody said it's posturing, it'll never happen, et cetera, the F-14 went away. So anything is possible. But as of right now, it's not a major concern to us. Obviously, we're keeping our eyes and ears on the issue. But again, it's not anything imperative. It's not happening this moment. And there is so much going on with budgets, et cetera, that I don't think this is truly on the top of their list.

Okay. Yes, I think it was -- I think it's 56 replacement wings, that's the contract they won in September?

Okay. That could be, yes.

What do you and/or your customers think would be the probability that the fiscal -- government fiscal '14 turns out to be a bottom in the defense budget? You've been operating under some uncertainty for several years. Do you think -- what do you think are the prospects that things look actually a little bit better in FY '15 versus '14?

You know what, Mike, that would strictly be a personal opinion. I don't think everybody has a clue. Each budget battle gets worse. I mean, we saw a government shutdown because the two sides couldn't agree to meet on anything and then at 11:30 at night they decide, okay, we'll do something, and all they've done is push it to January. And I can almost guarantee you, in January or early February, we'll start to talk about another government shutdown because they haven't accomplished a thing. So for me to say, we hit bottom. I honest to god, don't know. Again, I think we are on the right platforms in a decreasing defense budget. So in that respect, I think we're a little bit safer than some, but overall, I mean, none of us want to see a decrease in defense budget. It doesn't help any of us in this industry.

Okay. And then last question relates to Spirit. So earlier in the year you got these leading-edge assembly orders for the 650, and then more recently, you got on the Super Stallion. And this is at a time when Spirit itself is looking to cut back suppliers and also maybe push for some streamliner work. So how would you characterize your relationship with Spirit today and maybe count your probability of winning more, getting on more programs with that customer?

Well, I mean, I think you kind of just made my case for me. They had the option earlier this year of not awarding CPI for follow-on wings, leading edges. They could have gone to someone else in what, I would call, a very friendly price negotiation. We came to a price that we could afford to build it for and make a substantial profit, and they reduced to number they needed to get to. So I think that proves the relationship worked well there. And then in the midst of saying that they're trying to shrink their supply base, they award CPI a second contract on the second platform. I think that indicates -- and nobody run out and post on a board somewhere that Ed Fred said Spirit loves them, but I think it would indicate that we are on that list of companies that they want to continue to work with because we do provide a high-quality product, on-time delivery and have proven over and over again that we should be a supplier of choice. So in general, I think the relationship with them is fantastic, and of course, Mike, that then leads us to market to them the fact that they've got pretty much a piece of every Boeing program that there is and things that they are looking to offload, CPI would love to do the work for them. And if you are thought of as a major customer or a major supplier, too, for them, then I would hope they'd be thinking about you when it came time to offload, torque [ph], et cetera. Now, we'll have more discussions with people, not just with Spirit, but all of the aerospace companies in the United States. Doug and I are going out to the AIA Conference, the annual conference is the biggest one they have. Every CEO, pretty much every major aerospace company in the country will be out there, and these will be the kind of discussions that occur for the future: what kind of work can we ask for, what kind of can we looking for; what can we do to get more work from you? So with Spirit especially, I think we're well-positioned to at least bid on more work.

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

Thanks, Kevin. Before I close the call, I'd just like to let people know, if you'd like to see our facility first-hand, we produced a 2.5-minute video that will give you a flavor of what we do here and what the inside of this facility looks like. It's posted on the company's website and will also be used on our business development presentations going forward. Additionally, we have finalized our plans for CPI's first ever Investor and Analyst Day, which will be held at our facility on Monday, November 18. The interest level has been extremely high, and we currently have over 40 confirmed attendees. These attendees will be representing our larger shareholders, major institutional investors and analysts from various research firms. The day will consist of presentations from CPI's senior management, as well as the heads of all functional areas. All slides used will be available for the general public and the company's website and the entire day, with the exception of the shop floor tour and lunch periods, will be webcast, including live presentations. Press release will be issued that will provide the log-in information necessary for you to watch the webcast live. For additional details, interested investors and analysts may contact Lena Cati at the Equity Group at (212) 836-9611. I'd like to thank all of you for participating in this call, and look forward to speaking to you again in early 2014. Thank you.

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