Good morning, and welcome to the Third Quarter 2016 CPI Aerostructures' Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Sanjay Hurry, Investor Relations. Please go ahead.

Thank you, Cary. Good morning, everyone, and welcome to CPI Aerostructures' third quarter 2016 results conference call. A copy of the company's earnings press release and accompanying PowerPoint presentation to this call are available for download at the Investor Relations section of the CPI Aero Web site. With us on the call this morning are Doug McCrosson, President and Chief Executive Officer; and Vincent Palazzolo, Chief Financial Officer. At the conclusion of their prepared remarks, management will hold a Q&A session. As a reminder, this conference call 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 contracts 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 their customer reduces or modifies its contracts due to budgetary constraints. Given these uncertainties, listeners are cautioned to not 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 company's filings with the SEC. Please note further that for the purposes of this call and its associated PowerPoint presentation, management will be referring the company's financials on an adjusted basis that excludes the impact of the A-10 program on the third quarter of 2016 and the third quarter of 2015. GAAP financials as well as GAAP to adjusted earnings reconciliation tables can be found in the company's earnings press release as well as at the end of the PowerPoint presentation. With that, I'd like to hand over the call to Douglas McCrosson, President and Chief Executive Officer. Good morning, Doug.

Good morning, Sanjay, and good morning and thank you all for joining us for our third quarter 2016 results conference call. On today's call, I will provide a brief overview of our performance for the third quarter. After which Vince Palazzolo, our CFO, will review our financial results in greater detail and provide you with our updated 2016 financial guidance. I will then share my perspective on how the progress we have made to-date positions us for success in 2017. As part of this, I will offer a high level financial outlook on fiscal 2017. I will then open the call to your questions. To begin, we are reporting another quarter of solid financial and operational performance. We anticipated that the quarter-over-quarter comparison would be difficult as the multiyear E-2D contract awarded to us by Northrop Grumman in late 2014 frontloaded certain program activities that accelerated the timing of revenue from later years into the third and fourth quarters of 2015. This aside, we are pleased to report steady revenue and improving margin from our commercial market and meaningful contributions from our newer multiyear defense contracts, including Wet Outer Wing Panel kits for the E-2D Advanced Hawkeye that Northrop Grumman is manufacturing for Japan, the T-38 Pacer Classic, three aircraft structural modification kits and the F-16 wing components. And what will be a recurring theme in my prepared remarks today; our performance is directly correlated to our strategy of placing greater sales emphasis on the defense market as well as on commercial market opportunities that leverage our technical capabilities. More on both of these markets in a moment. As you can see on the right-hand side of Slide 4 of our Q3 2016 results PowerPoint presentation, our backlog stood at $441.5 million as of September 30, 2016, which is up…

Thank you, Doug. As a reminder, we are referring to our financial results on an adjusted basis that excludes the impact of our A-10 program for the third quarter of 2016 and the third quarter of 2015. GAAP financials as well as GAAP to adjusted earnings reconciliation tables for both the three and nine months ended September 30, 2016 can be found in our press release issued this morning. Turning to Slide 7. For the reason Doug detailed relating to the accelerated timing of revenue recognition of the E-2D Outer Wing Panel kits, revenue for the third quarter of 2016 decreased to $19.4 million as compared to 23.9 million in the third quarter of 2015. Gross profit for the third quarter of 2016 decreased by approximately $600,000 to 5 million as compared to 5.6 million in the third quarter of 2015. Gross margin, however, increased by approximately 240 basis points year-over-year to 25.8% in the third quarter of 2016 from 23.4% due mainly to increased production rates and higher build rates of our newer military programs. SG&A increased by approximately $100,000 in the third quarter of 2016 as compared to the third quarter of 2015 due to higher professional fees as well as costs associated with the adoption of a new executive compensation program. Pre-tax income for the third quarter of 2016 was $2.7 million as compared to pre-tax income of 3.5 million in the third quarter of 2015. Net income for the third quarter of 2016 was $1.7 million or $0.19 per diluted share compared to $2.4 million or $0.28 per diluted share in the third quarter of 2015. Moving to Slide 8. Our balance sheet together with the debt refinancing conducted earlier this year gives us financial flexibility to pursue our growth opportunities. Costs and estimated earnings in…

Thank you, Vince. With recent awards from Embraer, Raytheon and Sikorsky, our momentum is building. As we look to the balance of fiscal 2016, we anticipate that several of the open bids in our pipeline will be decided during the remaining weeks. CPI Aero is the incumbent supplier on a few of these opportunities, and I am optimistic that our past performance will lead to success between now and the end of the year. Turning to 2017. As we have done in the past, we intend to provide detailed 2017 financial guidance on our fourth quarter earnings call in March. As we sit here today given recent wins, our backlog and our bid pipeline, we have enough visibility to offer initial directional guidance for revenue and earnings per share. We are projecting revenue growth in fiscal 2017 over fiscal 2016 of 5% to 10% and a return to positive earnings per share for the year 2017. Let me spend a few minutes discussing the inputs that are shaping our positive outlook for 2017. As you can see on Slide 12, our bid pipeline mirrors our sales emphasis on multiyear opportunities in the defense market where our supply chain management, project management, and final assembly expertise are competitive advantages. I would highlight the concentration of bids in our Aerosystems business segment, which makes up 31% of the bid pipeline. These opportunities contain electronic warfare pods, intelligence, surveillance and reconnaissance pods and similar programs, some of which would be follow-ons of products previously manufactured by CPI Aero. We are putting sales emphasis here because this is a less commoditized market where we feel we have a technical advantage over competitors with similar cost structures. Quite simply, the skills required to manufacture these highly engineered, precision systems are usually resident only in the…

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Mark Jordan of Noble Financial. Please go ahead.

Good morning, gentlemen. A question on gross margins. On an adjusted basis they were in excess of 25% in both the second and third quarters, again, taking out the A-10 revenues and costs. Looking into the next year, you also will have some new programs ramping; T-38, F-16 and the new Jammer Pods. What is a reasonable range of gross margin? Will those new programs be a depressant to the current run rate of roughly 25%, or is that a sustainable rate or should we think that those programs starting up would generate lower margins and gross margin should be in the 22% to 23% range?

I think you were on to it with the latter comment, Mark. We do anticipate that 2017 will be in large part driven by some of these new defense programs that will generate lower margins at the beginning, as you mentioned. I think we’ve benefitted from a very good mix of products without a lot of newer programs in that mix. So I think in that lower range where you said, I think would be a good estimate going forward. When we do our detailed financial guidance in March, we’ll provide more clarity with respect to what we think the gross profit range will be. But I think you should expect it to be lower than we’ve been reporting to-date.

Okay. And in your guidance that you have given relative to revenue next year of plus 5% to 10%, does that – I think if that is based on current programs on-hand, it wouldn’t have any of next potential revenue from say the A-10 award if it were to be received?

That guidance, Mark, has the tail end of the current program that we’re still booking at zero profit. There will be under, say, $2 million worth of revenue next year related to the finalization of the A-10 contract. And there is a small amount in our forecast that’s within the range of the 5% to 10% that envisions some A-10 TUSK program revenue in 2017. I think it’s highly probable it will be awarded and I find it probable that we’ll get a piece of it. Quite honestly, the timing of that would affect the 5% to 10%. It’s almost entirely within the A-10 TUSK, that range of 5% to 10% I mentioned.

Okay. Vince, could you give us an update as to sort of the cash generation you expect in the fourth quarter and therefore how much deleveraging you’ve been able to achieve or should be able to achieve for 2016?

Well, in the third quarter we generated between $400,000 and $500,000 worth of cash. We’re expecting to at least double that in the fourth quarter, actually probably more than that in the range of between 1 million and 1.5 million of cash generation in the fourth quarter.

Okay. Thank you very much.

The next question comes from Ken Herbert of Canaccord. Please go ahead.

Hi. Good morning, Doug and Vince.

Hi, Ken.

Hi.

Just, Vince, first wanted to ask for the guidance in the implied fourth quarter revenues, still a fairly wide range there, can you just go through a couple of the key puts and takes as we think about the fourth quarter from a top line standpoint in terms of what gets you to or what do you need to see to get to the upper end of the guidance range versus the lower end?

This is Doug. The upper end assumes uninterrupted some of our newer programs, particularly the Wet Outer Wing Panel kits program. We experienced a little bit of, I’ll say, a slowdown in that late third quarter that’s kind of over now. That kind of set us back a little bit. I would say that you should be thinking middle of the range rather than the upper end of that range. But of course, if we make good progress in the next two months, we could be also at that higher end. But for your purposes I would think middle.

Okay. And so it sounds like the guidance really doesn’t imply any new programs starts in the calendar fourth quarter which could be at risk assuming the continuation or the continuing resolution?

You mean for '16 or '17?

For '16?

No. Everything’s in that’s going to be in, in terms of anything meaningful, in terms of revenue recognition in this fourth quarter.

Okay. And then same question to your point on '17. I’m expecting we get a defense budget probably early calendar '17. Does the guidance assume fairly quick resolution to the CR and things are – when you think about new programs, things were able to move ahead, or what have you assumed or what’s your thinking around timing on the '17 budget and potential impact on some of the new programs that are embedded or you’re looking for in 2017?

We don’t view the continuing resolution as having a lot to do with our current flow of programs. The A-10 TUSK program as an example is not utilizing the '17 funding. It was funded in 2016, so that should not prevent that award from taking place. So really we’re – it’s not so much as a continuing resolution that changes guidance so much in 2017 as much as it would be the timing and the magnitude of any A-10 TUSK order.

Okay. And then if I could, just finally – I mean really nice growth on the backlog specifically on the defense side as you go through this year. If you look into the end of this year and calendar '17, any reason the backlog there can’t continue to see growth? Maybe, Doug, if you could just talk about what you’re seeing in terms of bid and quote activity at the primes, at your customers, some of the more important ones and maybe how you’re business development pipeline has been growing and how you see it developing over the next few quarters?

There’s no reason to think that the growth in backlog can’t continue through 2017. We’re seeing quite a bit of bid and proposal activity predominately at the tier 1 level for some of the newer military programs, for example T-X and JSTARS and some of the other ones that I mentioned in the prepared remarks. Our bid pipeline now has at the moment, because it’s always – we’ve won a lot of defense programs. So right now, it’s actually kind of evenly balanced between military and commercial. But certainly the pace at which we’re bidding on defense programs is going to grow that as a percentage of the total. The one thing I guess that you see kind of a slow decline to around $100 million level in our commercial that’s largely a result I guess of a softer market but really renewed emphasis on our sales term on the defense opportunity. So it’s really kind of purposeful decline, if you will. And we look forward to 2017 I think you’re going to find the revenue mix to be much greater skewed towards the fence. And so we actually do envision that before we start seeing growth again in the commercial market, we might see revenue decline in our commercial business next year that’s going to be more than offset by increases in our defense.

Okay. It sounds like on the commercial side, Citation X, clearly that’s a headwind there. Are you seeing up revenues from either the Phenom 300 or the HondaJet from '16 into '17? Is that embedded in the guidance?

No. We actually see a flat to decline in both of those programs. The extent of which we’re not clear about we’re working on orders now that have backlog in the G650, for example, through the middle to end of 2017. I would expect pretty soon that we’ll see a new order from Triumph that will give us some clarity into 2017 and '18, which is really why I haven’t provided any more details. But I would say that you should consider those as steady to slightly declining in 2017 just to be conservative.

Okay. Thank you very much.

[Operator Instructions]. Our next question comes from Mike Crawford of B. Riley & Co. Please go ahead.

Thanks.

Hi, Mike.

Hi. Can you just again clarify for me the 6 million potential revenue variance in Q4, which I think you’ve said that’s primarily due just to your OWP work?

The new program that we started up, the Wet Outer Wing is being developed by Northrop for Japan, a lot of the variability is how quickly we can recover in the fourth quarter from what was a, I’ll say, some engineering technical data schedule slips by our customer. So the variability, as you know with revenue recognition, a lot has to do with actually bringing – incurring costs and bringing procurement in. And when we have a delay that results in our – I’ll say a delay in us putting the words out to our suppliers for that program, we experienced delays in the receipt. So there is some variability there. And as I just guided with Ken, if you think in the middle of that range I think that that would get you closer to where we probably will end up given where we are today.

And then for the adjusted revenue initial thoughts for next year, so you’re basically thinking 87 million to 98 million?

Well, if you do the 5% to 10%, yes, as of right today and that assumes an A-10 test program that will not likely be awarded until sometime during the first quarter whose revenue would not be really recognized until late in 2017.

Right, because even if one of the primes, and I guess you’re on both of them, get a TUSK award by March 31, you still need to work out your contract with your prime customer, right, so probably Q3 is the earliest?

I would say Q3 would be the earliest that we could start recognizing revenue on that program, correct.

And yet still you – I think you mentioned there was a 5 million variance just relative to TUSK alone in 2017. So is that from 0 to 5 or 5 to 10 or --?

In the 5% to 10% number, there is not --

I meant million. Are you assuming like – I guess what’s the range of expected TUSK revenue you would be expecting out of that 87 million to 98 million next year, given that you said there was a --?

Under 3 million.

What?

About 3 million or 4 million to get us into the 10% range of growth.

Okay. I guess I’m still unclear because it sounds like you’re expecting some, but it may be --

If we get none, it will be closer to the 5% growth.

I see.

If we get some, we’ll be closer to the 10% growth.

Okay. But there’s still a big delta, 3 million to 4 million versus 9 million on your range, so I guess not entirely clear what the other 6 million --

Keep in mind that we don’t even normally give this level. We’re trying to give directional guidance. I think we have enough clarity to indicate to our investors that we expect an up year next year on the top line, the details of which will be worked out over the next six to eight weeks and we’ll be in a position at the beginning of next year to come out with detailed guidance.

Okay. And then with your new strategic supply agreements, is this something that just makes you more competitive and more likely to win future bids, or is this something that directly translates into gross margin?

It’s both really. We’ve been continuously driving direct costs out of the process. The PPG is just the latest example. Prior to that, we had a similar vendor-managed inventory program on hardware, drill bits, everything in shop and factory supplies. We’ve done lean manufacturing that lowered direct labor costs and automation of course that lowers the direct labor costs. So everything that we’ve been doing over the last two years has really been – if you notice, our peers, a lot of the talk has been about trying to drive cost out to improve competitiveness and lots of pricing pressure as you know in this market. I think that we were ahead of the curve by starting this as many years ago as we did, and I think that what you’re seeing is a slower improvement in our margins and I think one that’s sustainable going forward, as we keep trying to continuously improve our cost position. So yes, it’s making us more competitive but it’s also generating bottom line improvement as well as cash flow improvement.

Okay. That’s good. And then with the A-10, it sounds like it’s just you believe 2 million of revenue on the current ending contract?

Under 2 million.

And that’s going to be in Q1 and probably going steady in Q2?

I would say all – for the most part why don’t we just say Q1. There might be a little run over, because I think our final production goes out the door in the second quarter. But by and large, it’s going to be in the first quarter.

Okay, great. Thank you.

Thank you, Mike.

The next question is a follow up from Mark Jordan of Noble Financial. Please go ahead.

Yes. Two quick questions. Doug, the A-10 award has been – now you’re expecting in the first quarter. We’ve been somewhat expecting it literally for the last year. What gives you a sense that it is finally going to be or is finally a predictable event that’s going to occur in Q1?

I’m just reading what everybody else reads. I don’t have any necessarily insight information. I can tell you that by everything you read and most recently the announcement from the General in charge of the Air Force Materiel Command that they’re making plans to, and their words, maintain this aircraft indefinitely. I think the congressional pressure that has been brought to bear is going to come to the realization that 173 wings, which is all that we were able to produce under the initial contract, is not going to be sufficient to prevent grounding of aircraft in the future. So I think there’s a lot of factors that go into why I believe that, but I don’t think I’m alone in my belief. I think it’s always been a matter of, is the Air Force going to put the funding in? And I think we saw evidence last year that they did in fact put funding in to do A-10 TUSK. If the Air Force were to not do A-10 TUSK, then what it is saying is that there will be no industrial capacity in the world to manufacture new wings for that aircraft should it ever decide to go beyond 173. I think even just from a pure risk management and to hedge your bets, you must maintain an industry capacity to not just manufacture the foot wing, but also to maintain and sustain that aircraft because you do and will have at least 173 aircraft flying with brand new wings that will need new leading edges one day, or new assemblies that are being produced by that contracted team, including CPI. So I think that we’re at a point now where it’s really kind of put up or shut up by the Air Force and I think Congress is going to make them put up.

Okay. Final question for me. You had had some change order protest put into Boeing. What is the status of potentially recouping some of the change order expenses that you’ve had over the years?

I won’t go into too much detail of where we are, because it’s I’ll say an ongoing discussion and negotiation we’re having. There has not been a lot of progress frankly, but I can’t go into detail as to the reasons for that. So probably the last time you may have asked me have been a quarter or two ago is not a lot of movement in those discussions since that time.

Okay. Thank you.

The next question is a follow up from Ken Herbert of Canaccord. Please go ahead.

Hi, Doug.

Hi, Ken.

I just wanted to follow up on the PPG announcement. Are there other – it seems like a pretty nice savings. Are there other opportunities with suppliers as you look across your supply chain and the money you spend outsourced to – is there a robust pipeline here of other things or was this really sort of a one-off opportunity as you look at the supply chain? How should we think about that moving forward?

This is the last of a sequence of similar events that we’ve embarked on over the, say, from the 2014 timeframe now, which together has taken about $3 million of annualized indirect and direct costs out of the company. We’re always looking for those opportunities. Most recently, we entered into a smaller contract but it gives you a sense of the types of activities that we do that even go so far as to try to bulk savings up with office supplies and paper and copying costs and you name it. Pretty much every facet of our cost structure is being attacked by ways to improve it even by a little. The next, I’ll say, big opportunity is in our supply chain, the actual production costs of the components that we use to build our assemblies. We’ve done a very good job I think over the last couple of years in dealing with our suppliers, helping them understand our growth strategy, helping them understand why we would be and should be a favored customer to them in terms of being able to offer us the best possible price. And I think we’ve done collectively a very good job at that. I’d like to see more attention on some of the offshore initiatives that we have going. I’d like to see some progress on that. I think there’s an area particularly within our commercial cost structure where we can go to non-U.S. suppliers and get more savings than we’re seeing right now. We have new relationships started in Brazil, we have one in Mexico. So we’re starting to make progress there. But I think that would be the next major thrust that would see a needle movement in gross margins going into the end of '17, early '18 timeline.

Okay, that’s helpful. And as you look at those opportunities, can you maybe think about another sort of potential 3 million in savings over the next few years or is there any way to quantify the pipeline as it looks like on these new opportunities?

The savings are – because they’re recurring and they’re normally tied to production, so as our production rates increase those savings would generally be greater. But I think that if we’re being realistic, a lot of those low-hanging fruit things we’ve identified and taken care of. I think now we’re looking at just constant refinement of that process. I don’t see anything right now outside of the direct material, which of course is a big number. But I don’t think that we could get another $3 million of savings for just those types of things that we’ve already gotten. So I think the next step function, if you will, in gross margin improvement will come through our supply chain.

All right, thank you very much.

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

Thank you, Cary, and thank you all for participating in today’s call. We look forward to speaking with you again in March when we release our fourth quarter 2016 and full year 2016 results. So thank you. Happy Election Day and go out and vote.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Have a great day.