CPI Aerostructures, Inc. (CVU) Q4 2014 Earnings Report, Transcript and Summary

Welcome to the CPI Aero's 2014 Fourth Quarter and Year-End 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 SEC. During this conference call, there will be references to adjusted revenue and adjusted gross margin, which are non-GAAP financial measures as defined by Regulation G promulgated under the Securities Act of 1933 as amended. A reconciliation of these non-GAAP financial measures to relevant GAAP financial measures can be found on the company's website at cpiaero.com. Now, I will transfer the call to Douglas McCrosson, CPI Aero's President and Chief Executive Officer.

Thank you, Ralph. Good morning, and thank you to all for joining us for our 2014 fourth quarter and year-end results conference call. Before I turn the call over to Vince who will discuss our recent financial results, I would like to start this call by summarizing our achievements for 2014. We ended the year with a funded backlog of $120.6 million, up $10.2 million for the year. We received $92.9 million in new contract awards for both commercial and defense programs. This figure includes several defense contracts, a particularly important achievement during this difficult defense budget environment. Finally, we expanded our commercial business, which generated $36.9 million of revenue in 2014, up 37.6% as compared to 2013 commercial revenue. These achievements set us up well for 2015 and we are reaffirming our guidance that revenue in 2015 will reach an all-time high. 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 will then open the call to questions. Vince?

Thank you, Doug. Our 2014 financial performance was affected by a one-time non-cash charge of $44.7 million related to revised estimates of a significantly shorter life and lower production quantity for the A-10 Wing Replacement Program. Although we expect this program to end sometime in 2015, we continue to book revenue for the A-10 Wing Replacement Program at zero margin. As shown on Slide 6, for the fourth quarter 2014 as compared to the fourth quarter of 2013, we reported on revenue of $20.1 million compared to $21.3 million. Gross margin was 21.3% compared to 24.8%. Pre-tax income was $2.1 million compared to $3.4 million. Net income was $1.7 million or $0.20 per diluted share compared to $2.4 million or $0.28 per diluted share. Slide 7 shows that our revenue and gross margin for the fourth quarter of 2014 and 2013 what would have been if revenue generated from the A-10 Program were excluded from both reporting periods. So, excluding the A-10 Program, adjusted revenue for the fourth quarter of 2014 would have been 17.5 million as compared to 16.9 million in the fourth quarter of 2013, an improvement of 3.5%. At the same time, adjusted gross margin for the fourth quarter of 2014 would have been 24.5% slightly improved as compared to 24.4% for the fourth quarter of 2013. Moving to Slide 8. For the full year 2014 versus full year 2013, revenue was $39.7 million as compared to $83 million in 2013. Again, 2014 results included one-time non-cash $44.7 million adjustment to revenue related to revised estimates of a significantly shorter life and lower production quantity A-10 Wing Replacement Program. Revenue generated from commercial contracts in 2014 accounted for approximately $36.9 million, up $10 million or 37.6% as compared to $27 million of revenue generated from commercial contracts in 2013. This increase was mainly due to ramp up production for our newer business jet programs, which we won during the 2011-2012 timeframe, especially our Cessna Citation X+ program with Textron Aviation, our Phenom 300 program with Embraer and our HondaJet program. As a result of the A-10 Program adjustment, gross margin for the full year 2014 was negative 74.9% compared to positive 22.2% in 2013. We recorded a pre-tax loss of $37.7 million compared to pre-tax income of $11.2 million in 2013, and our net loss for 2014 was $25.2 million or a loss of $2.98 per share compared to net income of $7.7 million or $0.91 per diluted share in 2013. Slide 9 provides additional details about the effect of the shorter life of the A-10 Program, but I want to point out that due to the GAAP loss recorded in the second quarter of 2014, in 2015 we will be able to claim a tax refund of approximately $9 million from prior years’ tax payments and over $5 million tax loss carry forwards that we expect to utilize in 2015. Slide 10 summarizes our guidance for 2015, which calls for revenue to be in the range of 92 million to 102 million, the highest revenue in our history. Gross margin for 2015 is expected to be in the range of 19% to 21%, lower than our historical gross margin as we will continue to book A-10 Wing Replacement revenue at zero profit. Net income is expected to be in the range of $7.2 million to $8 million. We have good visibility for 2015 as approximately 94% of revenue is expected to be generated from programs currently in our backlog. That said, we expect performance for the second half of the year to be much stronger than the first half due to the timing of delivery orders associated with several recently announced major programs. The following slides provide 2015 revenue breakdown by market, subcontractor role and segment. Starting with revenue breakdown by market, as shown on Slide 11. In 2015, we expect military commercial split for 2015 to change as compared to approximately 45 split in 2014 with military revenue to account for approximately 65% of total revenue growing by 25% year-over-year, due to recent contract wins. Commercial revenue is expected to decline year-over-year as the majority of the new contract wins in 2014 were for military programs. As I previously mentioned, we expect approximately 94% of revenue to be generated from programs currently in our backlog, which provides us a good visibility for the year. Regarding our revenue breakdown by subcontractor role, as shown on Slide 12. The majority of our revenue, over 80% is expected to be generated from programs which we have a Tier 1 role. Our revenue generated from prime and Tier 1 type contracts are expected to substantially grow in 2015 as compared to 2014. Slide 13 shows the breakdown within our three main segments. Kitting to account for 37% of total revenue and is expected to grow by 30% year-over-year. Aerosystems to account for 11% of total revenue and is expected to double year-over-year. And total non-Aerostructures business is expected to increase to approximately 48% of total revenue with Aerostructures to account for approximately 52% of revenue. Moving on Slide 14. We have several initiatives to improve our financial position. These initiatives include the following. We will continue to pay down debt and reduce interest expense. We will continue to invest in automation, which should favorably impact operating efficiencies. We will continue to drive production cost down to improve cash flow from operations. We will further reduce overhead and SG&A, which currently are at historically low rates. Doug will provide additional details regarding our efforts to improve our technical capabilities, investments in new programs and our marketing efforts going forward. But I just want to summarize our sources of capital needed to make such investments. As per Slide 15, those sources are $13 million to $15 million refunds, loss carry forwards related to the change in estimate on the A-10 Wing Program recorded in the second quarter of 2014. We have a $35 million revolving credit facility, which is expandable to 50 million of which approximately 10 million was available at December 31, 2014. We also have a $4.5 million term loan. Now I will hand the call over to Doug who will comment on the backlog, contract awards, current business environment and new growth opportunities going forward. He will then open the call to questions. Doug?

Thank you, Vince. During 2014, we received several new long-term contracts both military and commercial programs totaling approximately $93 million. This total included approximately $67 million for defense programs and approximately $25 million of commercial programs. Slide 17 shows the breakdown of our backlog at December 31, 2014. Our total backlog was $403.7 million with approximately $149 million for commercial aerospace contracts. Our funded backlog increased to $120.6 million, which was $10.2 million higher than funded backlog at December 31, 2013. The value of the unfunded backlog was approximately 283 million with 51% related to our long-term commercial aerospace program. Moving to Slide 18, this shows our largest contracts currently in progress including our recently won contracts, which collectively had a potential to generate revenue of $445 million during the remainder of their performance periods. I will provide an update for each of these programs starting with the programs currently in progress, as highlighted on slides 19 and 20. Slide 19 provides 2014 highlights from our defense programs. Of particular note is that near the end of 2014, our outer wing panel kits program for the E-2D Advanced Hawkeye and C-2A Greyhound aircraft was extended through 2019 adding new funded backlog of $63.6 million. We finalized the contract with Sikorsky to manufacture fuel panel assemblies for the BLACK HAWK. Deliveries started in 2014 but 2015 will be the first full year of production. 2014 also saw the first delivery of our most technologically complex product, the pod structure for the DB110 Reconnaissance System produced by UTC Aero Systems. Moving to our commercial programs, 2014 was a great year for our Phenom 300 engine inlet assembly program with Embraer. Last year, we successfully ramped production from two ship sets per month to more than 10 ship sets per month, exceeding our customers’ expectations. As many of you that follow the aerospace industry know, as of January 1 of this year, Spirit Aero Systems sold its Gulfstream G280 and G650 wing production programs to the Triumph Group. We have manufactured the fixed leading edge assemblies for the G650 since they started the G650 program. All of the open purchased orders with Spirit as well as the master ordering agreement that is in a [Technical Difficulty] new orders from Triumph with deliveries established through the middle of 2016. We view this transition as a means to grow our relationships with both companies, two of the most important Tier 1 aerospace structures companies in the world. And finally in 2014, we delivered engine inlets and flaps for the HondaJet manufactured by Honda Aerospace Company that will fly on the first HondaJet delivered to customers in the very near future. The HondaJet is one of the most exciting groundbreaking light jets on the market. With FAA type certification expected any week now and with a reported backlog of two years in production, we look forward to ramping this program up to full rate production over the coming months. Moving on to Slide 21, our recently won programs. During the last several years, we have taken steps to diversify our business and have won several multimillion-dollar long-term commercial aerospace contracts, but we never abandon the defense sector, which has been and will continue to be an important part of our business. We believe that our defense business is coming back. As I mentioned during the third quarter call, not since the mid-2000s when we were one of DODs leading small business prime contractors of structure had we seen government RFPs with this much potential. We had two major prime contract proposals sent to the government for evaluation at that time and I am excited to report that we were successful on both. Defense is an incredibly large market with great potential for CPI in certain segments. With the notable exception of the A-10 Program, the national security platforms for which we provide product are well supported in the DOD’s budget plans, for example, the BLACK HAWK helicopter and the E-2D Advanced Hawkeye. We continue to see strong bid activity in our defense business both at the Tier 1 level as well as some additional opportunities as the prime contractor, although these are much smaller than the T-38 and F-16 contracts. As highlighted on Slide 21, we recently won three contracts for military programs, which added over $188 million in backlog through 2022. It is important to note that securing a long-term defense contract in today’s budgetary environment is a direct result of the exceptional program execution and superior product quality provided by CPI Aero’s dedicated and professional employees. The three newest defense wins are; a multiyear contract for E-2D/C-2A outer wing panel kits, which accounted for most of the new defense business both in 2014 and added more than $63 million in new funded backlog. A $53.5 million contract received in November 2014 from the Defense Logistics Agency to provide structural wing components and logistical support of global F-16 aircraft maintenance, repair and overall operations. And finally, we started 2015 with a $49 million contract for the T-38 Pacer Classic III program, which added $5.6 million to the funded backlog. The following slides provide additional details for each of these contracts. Moving past these program slides to Slide 26, this slide summarizes our bid pipeline and breakdown by segment and position within the supply chain. Over the years, we have built a strong reputation for quality, performance, value and world-class customer service. We have positioned CPI Aero to successfully compete for a number of Tier 1 opportunities in both defense and commercial markets. At the present time, most of our submitted bids, around 70% by value, happen to be for military aircraft structures and pod-based systems. The current bid pipeline does include large airline or assembly proposals that are under evaluation by our customers. And also, we have a recent surge of demand from a couple of perspective customers for Tier 2 opportunities for large commercial aircraft. We will be submitting several proposals over the weeks and months ahead. We cannot control the customer proposal review process and we cannot predict when or even if decisions will be made regarding awards for bids we’ve already submitted or will submit in the future, but while there is a potential win for large commercial airline contracts in 2015, our guidance does not include revenue from a win in this market. We are bidding for programs such as the Lockheed Martin F-35, the Boeing 787 Dreamliner, the Embraer E2 regional jet and the Bombardier C-series airliner. Moving to Slide 28, our focus areas for 2015. For 2015, we’ll continue to execute our strategy focused on gaining market share at the Tier 1 level. We will continue to improve on the qualities and attributes that our customers have come to expect from CPI; quality, value and world-class program performance. We recognize a need to continue to make investments in new automated manufacturing technologies that should further increase output, improve quality, lower production costs and sustain the cost effective performance into the future. In December of 2014, we received our first automatic drilling and riveting machine as well as our first 3D printer. We are very likely to order additional equipment during 2015. The 3D printer is already producing details we used on our assembly fixtures and tooling. The automatic riveter is expected to be transitioned to the production floor during the second quarter of this year. The continued investments and technology and facility improvements will support our marketing efforts to organically grow our business. We are now able to credibly compete for larger and more complex programs, especially large-scale, high production rate applications like commercial airliners from both domestic and international customers. In addition to making investments to grow organically, we remain open to acquisition opportunities, which could enable us to gain scale and/or enter new markets quicker. So before I open the call to questions, I want to conclude my remarks on some reasons why my management team and I believe that CPI is well positioned for even greater success in the future. First, our large and diversified backlog currently more than $400 million; our stellar reputation within the industry and our focus to continuously expand and improve our capabilities; the demand for the types of products and services we offer arising from market dynamics in both commercial aerospace and the military defense sector; and our significant bid pipeline for both defense and commercial markets. This concludes our prepared remarks. At this point, I’d like to open the floor to questions. Ralph, can you allow the callers to place questions now? Thank you.

Yes. Thank you. [Operator Instructions]. Our first question comes from the line of Mark Jordan with Noble Financial. Please proceed with your questions.

Good morning, gentlemen.

Good morning, Mark.

First question is on the booking numbers that you give. You said you had government contracts to 67.1, but you also mentioned the E-2D program at 86 million, the F-16 at 53. Was there de-booking relative to the A-10 counted in there? And if so, what was the gross number of incoming awards and what was de-booked and how do we get to that 67.1?

The 67.1 is I’ll say the funded amount. We don’t – for example, the F-16 order, we won’t consider that as an award until we get delivery orders for it. It’s not the total value of the contracts won, it’s the amount that was put on purchase order.

Okay. So the gross amount of awards was exceptionally larger than that, it was just what you have that is funded in coming quarters.

Correct.

Okay.

The three programs I believe I’d say were added up to something like $188 million or something like that, the three newest government programs.

Okay. Thank you. What is the timing of – when should you actually receive the $9 million tax refund?

We are hoping to get that back in the third quarter of 2015. Given the size of it, it may be somewhat delayed because it may get reviewed by the IRS, so that would push it into the fourth quarter. But our hope at this point is that will be a third quarter receipt.

Okay. Could you talk a little bit – obviously there’s sometimes a long gestation period from the time a contract is awarded until revenue starts to flow in volumes, as evidenced by the ramp from the commercial relationships. With the F-16 and the T-38C, when do you expect first revenues and how should they ramp? And how much meaningfully will it fall into 2015 or are they really 2016 from a volume standpoint?

The one thing of importance is that each of those programs is going to be – the revenue recognition is different on both. For the T-38 that will be, I’ll say, our normal percentage completion accounting. On the F-16, it will only be as we deliver the product. So I’ll start with the F-16 first. We have a contractual requirement that within a year we will be in a position to supply the air force with product on a 24-hour turnaround time. That said, not all of those 400-some-odd different components we will be supplying will not be available until a year from now. Some will be available as early as this year. So there is some amount of revenue in our guidance that will be for product that we ship to the air force to support the F-16 wing line in calendar year 2015, a small amount. On the T-38 Pacer Classic program, we will begin recording revenue primarily associated with the start-up functions of labor, supply chain management program, program management, engineering, so we will be booking some revenue on that probably starting in the second quarter of this year and maybe ramping up a little further, a little higher in the fourth quarter this year as we begin to make a receipt of some of the purchased items. I would expect the T-38 to ramp up to what I would call a regular run rate in the 12 to 15-month range, maybe middle of 2016 and on to be a regular contributor, a monthly contributor to revenue.

All right. Two final questions. One, you said that you have a strategy to decrease SG&A and overhead. As you mentioned, you’re relatively lean historically. What’s the strategy there? And secondly, what are your capital expenditure plans for 2015?

I’ll let Vince start with the capital expenditure plan.

The capital expenditure plan actually is a little bit more aggressive than we’ve had in the past few years. We’ve budgeted historically under $1 million per year for capital expenditures. For this year we’re budgeting in the $1 million to $1.5 million range and closer to the top number.

And as far as the SG&A and overhead – Vince, stop me if I say something really dumb here. We’re talking about lowering our rates as a percentage of sales. So the overhead number, the physical overhead number may actually go up but as a percentage of output it’s coming down as a percentage. I think that’s really what we mean to say.

That is correct. There are certain cost cutting efficiencies that will take place in this year. Particularly, there was an announcement actually that New York State had made that we were eligible for an Excelsior start-up New York power program. We only started drawing power off of that program in the fourth quarter of 2014. This will be the first year that we have fallen out, so that will save us some money. But Doug is correct, it’s the rate that’s going to improve even if overall costs are flat or slightly higher in absolute dollars.

So what you’re doing is, is you will be growing SG&A at a lesser rate than you’re growing revenues moving forward?

Correct, much less.

All right. Thank you very much.

Thank you, Mark.

Our next question comes from the line of Mike Crawford with B. Riley & Company. Please proceed with your questions.

Thank you. When we talk – why are the commercial revenue expected to decline given that major programs like HondaJet are just starting to ramp up in 2015?

A lot of it is based on our revenue recognition. We’re just – we have some inventory particularly on the Honda program, so even though we’re shipping product, we’re not incurring any new, necessarily not a lot of material receipt costs. So in our system, revenue could actually be lower even though product deliveries is a little bit higher for the year. Similarly, on the G650 program, in 2015 we had a step-down pricing with our customer as a result of the multiyear we signed a couple of years ago. The overall price reductions that we negotiated took place over two periods of time and that kicked in starting in '15 that contributes a little bit to that as well.

Okay. Thanks, Doug. And then with all things considered including new funds and maybe some future claim regarding to A-10 work, do you think it would be better or worse for CPI Aero today if you were just able to stop working on A-10 new winging or if you actually kept it a little busy by continuing to work on A-10 new winging even though that the revenue is being booked at cost?

There is no question in my mind that the overall financial performance of CPI would be better the earlier we stop the A-10 program. And it isn’t just the fact that if the government terminated it for convenience, we would be entitled to recoup some of the cash investments we made at the start of the program. What it is also doing is it’s deferring our ability to reassign personnel who are building those assemblies on the floor and where we could be putting them over to Honda and Embraer and some of our commercial programs that are going gangbusters right now. So, we need and I’m trying and maybe with the new Congress and the new budget, we still expect to be out of our program at the end of the current fiscal year, which ends September 30 of this year.

Okay. Thank you. And then just if you can clarify guidance. Can you say what your expected GAAP tax rate will be in 2015? And also what your expected cash taxes with the exclusive potential 9 million refund?

Cash taxes is going to be zero in 2015. We won’t be paying any taxes because of the NOL carry forward.

Right. And so when you’re providing a net income guidance, what GAAP tax rate are you contemplating on that net income guidance?

It’s actually – call it slightly higher than our historic rate. Our historic rate the last few years has been around the 31-ish range, 31.5. While we’re using the NOLs up, it’s probably going to be closer to 33, because there’s a couple of things particular. We did the carry back. There’s a couple of permanent differences that we can’t take in lost years, so it will be just figure 33% for this year, for 2015.

Okay. So in other words, you’re expecting closer to 11 million or so on income before taxes?

Yes.

Okay, great. Thank you very much.

Thank you, Mike.

Thank you. [Operator Instructions]. The next question comes from the line of Alex Silverman with Special Situations Fund. Please proceed with your questions.

Good morning, gentlemen.

Hi, Alex.

Since your Q or your K is not out yet, can you help us with what your year-end EBITDA was?

Sorry, we’re really not supposed to do that but I don’t – that is a non-GAAP measure and we don’t have a reconciliation for that. I know it’s a lawyer-ish answer, but --

No, that’s fair. Okay, guys. Thank you.

All right.

Thank you. [Operator Instructions]. Gentlemen, it appears we have no additional questions at this time. Would you like to make some closing comments?

Yes. Thank you, Ralph. Thank you all for participating in this call. We look forward to speaking with you again in early May when we announce our 2015 first quarter results. Thank you.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time and we thank you for your participation.