CPI Aerostructures, Inc. (CVU) Q4 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the CPI Aerostructures' Fourth Quarter and Full Year 2016 Results 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, Andrew. Good morning, everyone, and welcome to CPI Aerostructures' fourth quarter and full year 2016 results conference call. A copy of the company's earnings press release that was issued earlier today and the accompanying PowerPoint presentation to this call are available for download at the Investor Relations section of the CPI Aero website. 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 question-and-answer 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 – will refer to the company's financials on a GAAP to basis, GAAP to adjusted earnings reconciliation tables can be found in the company's earnings press release as well as the end of the PowerPoint presentation. As a reminder, adjusted earnings exclude the impact of the A-10 program on the company's results. With that, I'd like to hand the call over to Douglas McCrosson, President and Chief Executive Officer. Good morning, Doug.

Good morning. And thank you for joining us on our call. I will begin this morning with a brief review of our performance for the fourth quarter and full year 2016. After which Vince will provide a detailed analysis of our financial results for both periods and update you on our financial guidance for fiscal 2017. I will then conclude with our perspective on market forces that have shaped our financial guidance relative to the initial directional guidance we provided one quarter ago, as well as the opportunity set in front of us this year. To begin, we are pleased to report another quarter of solid financial performance. The result of our continued focus on operational excellence and program execution. We continue to execute on our defense market strategy. As evidenced by awards from Bell Helicopter and Sikorsky that drove backlog to $416.3 million at year-end. The Sikorsky award in particular was notable for being our first with Sikorsky as a Lockheed Martin company. Both awards illustrate our ability to leverage customer satisfaction to secure additional work. Our financial results for fiscal 2016 reflect continued successful execution on our strategy to drive growth and profitability by leveraging our roots in the defense market and placing greater sales emphasis on multiyear contract opportunities. To fully appreciate of performance in 2016, we must take a step back to 2014 to when we first laid the foundation for the strategy. During a very challenging 2014, we made a series of strategic and operational choices to reorient CPI Aero to the defense market, a market we know very well and one in which we have historically achieved great success. We placed greater focus on multiyear opportunities, start to expand and diversify our revenue base and operate with the financial discipline to drive growth to both our top and bottom-line. In the commercial market, we opted to narrow our focus to the business and executive jet segments. Our performance in 2015 validated these choices. Our defense market focus drove record revenue for the year, and we generated positive pretax income and EPS for the full year, itself a substantial turnaround from the losses reported in 2014. In 2016 business headwinds from sequestration gave way to greater defense spending certainty, following the signing of the 2016 Omnibus Appropriations bill. Accordingly, we sought opportunities to expand our footprint on current programs and simultaneously increased our business development efforts for new program. Turning to slide four. Our sales focus on multiyear defense opportunities resulted in defense backlog at 2016 year-end expanding to reach 77% of total backlog. As of December 31, 2016 defense backlog was $321.7 million, up 26% from year-end 2014 and up 16% from year-end 2015. This is a testament to the hard work and dedication of our employees and the operational excellence demonstrated by our customer focused program teams over these past several years. Total backlog at year-end included four new programs awarded in the second half of 2016 that together added approximately $85 million, with each program expected to contribute meaningful revenue in 2017 and beyond. I noted a moment ago, that a component of our strategy includes the narrowing of focus on the commercial market to the business in regional jet segment. This segment is better aligned with our corporate capabilities, capital structure and return on investment goals. As you can also see on slide four, our commercial backlog over the several years has declined, correlating to our strategy to place greater sales emphasis on defense opportunities. In addition to say that we're not seeking and winning opportunities in this market of the four programs one in the second half of 2016, one was with our long-standing customer Embraer for a contract on their second generation E series regional jet. The many successes of our defense market strategy are evident on slide five. This slide illustrates that approximately $254 million of the total backlog at 2016 year-end is derived from defense contracts announced only since November of 2014. These contracts are estimated to provide a strong base of annual defense segment revenue in future years, you can also see that most of the programs on this slide are in the early stages of their life cycle, which affords us revenue visibility into 2022 and beyond. I will now turn the call over to Vince Palazzolo, our CFO, to review our financial results for the fourth quarter and full year in greater detail and provide you with our financial expectations for fiscal 2017. I will then conclude the call with my thoughts on the strategies and opportunities that should drive growth in 2017 and beyond. I will then open the call to your question. Vince?

Thank you, Doug. Before I begin, as you are aware in prior quarters we have referred to our financial results on an adjusted basis that excludes the impact of our A-10 wing replacement program, so as to offer a clearer view of our performance. As we approach the end of the A-10 Wing Replacement Program, effective with our fourth quarter and year-end report today we will refer to our financial performance on a GAAP basis. The presentation of the 2016 results compared to the 2015 results, excluding the impact of our A-10 program can be found in schedules at the end of the presentation that accompanies our earnings and within the Form 10-K for 2016 that is expected to be filed later this week. To start on slide seven, revenue for the fourth quarter of 2016 decreased to $24.3 million compared to $31.6 million in the fourth quarter 2015. We purport [ph] program revenue as work is performed towards completion, we had anticipated accomplishing more work during the fourth quarter of 2016 on two our new defense programs then we actually were able to, as we waited necessary information from our customer. This reduced our internal revenue projection on these two programs in the quarter by about $1.5 million. Gross profit for the fourth quarter of 2016 increased by approximately $2.3 million to $5.9 million, compared to $3.6 million in the fourth quarter of 2015. Gross margin increased by more than double year-over-year to 24.3% in the fourth quarter 2016 from a 11.3% in the fourth quarter 2015. Selling, general and administrative expenses increased by approximately $300,000 in the fourth quarter 2016, compared to the fourth quarter 2015, due to higher compensation costs which were largely non-cash expenses associated with a new long-term incentive compensation plan adopted by the company during 2016. Pretax income for the fourth quarter of 2016 was $3.5 million, compared to $1.6 million in the fourth quarter of 2015. Net income for the fourth quarter 2016 was $2.1 million or $0.24 per diluted share, compared to 700,000 or $0.08 per diluted share in the fourth quarter of 2015. For the year, revenue decreased to $81.3 million in 2016, compared to $100.2 million in 2015. Gross profit in 2016 decreased by $12.3 million to $4.3 million, compared to $16.6 million in 2015. Gross margin decreased to 5.3% in 2016 from 16.6% in 2015 due to the change in estimate on our A-10 program. Selling, general and administrative expenses increased by approximately $1 million in 2016, compared to 2015, due primarily to three separate items that are not expected to recur in future periods. One, certain non-recurring accounting and legal fees associated with our year-end 2015 order. Two, a reserve against our accounts receivable for certain old amounts which realization is uncertain and three, the adoption of a new executive compensation plan that better aligns the incentives for management with the interests of shareholders. Pretax loss for 2016 was $5.7 million, compared to pretax income of $8 million in 2015. Net loss for 2016 was $3.6 million or a loss of $0.42 per diluted share, compared to net income of $5 million or $0.58 per diluted share for 2015. Moving to slide eight. Our balance sheet, together with the debt refinancing we completed in early 2016 gives us the financial flexibility to pursue our growth opportunities. Costs and estimated earnings in excess of billings on uncompleted contracts CE&E was $99.6 million, a decrease of approximately $3 million, compared to December 31, 2015. As expected, total debt at December 31, 2016 was $32.6 million, up approximately $7.4 million over the end of 2015, as we financed the startup inventory for our E2D multiyear kitting program and our F-16 components contract. Shareholders equity stood at $67.6 million at year-end with a book value of $7.74 per share. Our debt to capital ratio stood at 0.48. Tuning to slide nine. We are refreshing our initial 2017 financial guidance provided on our third quarter conference call. Our guidance today reflects uncertainty surrounding defense appropriations for 2017 that are impacting the timing of awards. Doug will discuss in greater detail in his prepared remarks to follow. For fiscal 2017, we expect revenue in the range of $82.5 million to $87 million. Starting with commercial revenue in 2017, this segment will be affected by a reduction in production rates for our Embraer, Phenom 300 engine Inlet program, as a major spares and retrofit effort has now ended and we are returning to a normal production rhythm. Weakness in the overall business jet market is also leading to lessen demand for our socket Citation X+ program. These and other factors are estimated to result in a marked reduction in commercial revenue for 2016. The decline in commercial revenue in 2017, however, will be more than offset by an increase in defense revenue. For 2017, we are expecting defense revenue to be close to 70% of total revenue, driven largely by increased revenue for our Aerosystems product lines, such as the Next Generation Jammer Increment 1 Pod and the DB-110 ISR pod structures. Defense revenue expectations for the year include approximately $3 million from our A-10 program, the majority of which will be recognized in the first half of 2017. As a reminder, A-10 WRP revenue is booked at zero gross margin. With regard to gross margin, while we are not providing guidance at the gross margin level, we do anticipate that 2017 revenue will be in large part driven by newer defense awards that carry lower gross margins at the beginning of their project lifecycles. As such, gross profit margin for the full 2017 is expected to be on the lower end of our historical range between 22% and 24%. Continuing along this slide, pretax income is expected to be in the range of $8.1 million to $8.5 million. Our projected effective tax rate continues to be approximately 37%. As a reminder, we have $14.6 million of net operating loss carry forwards and therefore expect no cash tax expense. As Doug will discuss shortly, certain multiyear defense opportunities that may be awarded this year could offer upside to our revenue guidance. Moving to slide 10. We remain focused on maximizing cash flow from operations through a multi-pronged approach. First, we are focused on inventory reduction. We reduced inventory by roughly 10% during 2016, and we expect to reduce it again another 10% in 2017, despite increased revenue and several new programs that will require us to build inventory prior to production. Second, we have an unrelenting focus on improving productivity. As an example, we entered 2017 with a lower fixed cost base with 7% fewer employees than a year ago period and expect to generate 10% more revenue per employee than we did in 2016. And third, we are continuing to seek ways to reduce overhead expenses. The strategic supply agreement we entered into during the fourth quarter of 2016 with PPG for shop floor perishable and consumable that is projected to save hundreds of thousands of dollars in overhead expenses is but one example, and of course with greater productivity comes less employee benefit cost or employees which greatly overhead lowers overhead expense. This concludes my prepared remarks, I will now turn the call back to Doug.

Thank you, Vince. We entered 2017 with a broader base of business, a deep backlog and a robust bid pipeline underpinned again by our defense market strategy. As Vince noted however, we have refreshed our 2017 directional guidance we provided a few months ago to reflect a more conservative outlook we have today for revenue growth, principally as a consequence of near-term uncertainty and defense appropriations, following the presidential election. While the president and congress have both indicated a preference for increasing defense spending, we are mindful that we are today five months into the government fiscal year without a signed 2017 Defense Appropriations bill. The Defense Department is operating on a continuing resolution that is estimated to be in place through April, if not longer. On a more optimistic note, we will soon learn the detail of President Trumps 2018 defense budget request and has joint address to Congress on February 28, he proposed a $15 billion increase over the 2017 defense budget. It is anticipated that this additional funding will address readiness, and if so we will really believe this to be incrementally positive for us. For instance, this could lead to an increase in demand for the structure we provide for older aircraft, such as the A-10 Thunderbolt, UH-60 Black Hawk, F-16 Falcon and the T-38 Trainer. Let me spend a few minutes now discussing the inputs that are shaping our perspective on 2017. As you can see on slide 12, our bid pipeline aligns with our sales emphasis on multiyear opportunities in the defense market. I want to draw particular attention to our Aerosystems business, which now comprises 48% of our bid pipeline. Specifically our integrated pod structures capability supports a growth niche within the defense sector in which we enjoy significant competitive advantage. We have the reputation for manufacturing these complex systems, with the quality and precision of an OEM, but in a much lower cost. We have established an excellent reputation with some of the world's leading developers of such systems, such as Northrop Grumman, United Technologies, and Raytheon. Turning to slide 13, you will see a sampling of some of the opportunities in our bid pipeline. We have a good distribution of opportunities among the three product segment. We had a mix of new programs with potential new customers. We have new programs with current customers and we are seeing opportunities to expand our footprint on current programs. These opportunities are weighted to our defense. However, the bid pipeline does include new programs with current customers in the commercial helicopter space and for business jet. Let me focus on one specifically, the A-10 TUSK program. We are now more positive on an A-10 follow-on order, known as A-10 TUSK. At the news at the Air Force Chief of Staff announced at the A-10's retirement would be deferred until at least 2021, in our opinion, an extension in service life would necessitate new wings beyond the 173 aircraft that will have received new wings by the conclusion of our current A-10 wing replacement program later this year. However, the continuing resolution and the expected release of the 2018 presidential budget request sometime after April makes it unlikely that there will be definitive path forward on the A-10 TUSK program until sometime after May. We have been in regular contact with Senate minority leader and New York State senator, Chuck Schumer and Congressman Peter King of New York to make the case for the A-10 aircraft in a bit encouraged by their support. Given the amount of uncertainty surrounding the A-10 weapon system, however, we have not included any revenue or profit contribution from an A-10 follow-on order in our 2017 financial guidance. Any follow-on order this year could be additive to our financial guidance. Turning to slide 14. Our long-term defense and commercial programs have the potential to generate over $416 million over the remainder of their periods of performance. Several of these contracts run beyond 2022 and very few are expected to end before 2018. Our new Raytheon Jammer pod and Embraer E1-75 wins each run past 2022. Turning to slide 15. You will see evidence of our defense market sales strategy again at work. Aerospace sales cycles can be quite long and some of these opportunities may extend well into 2018. But we will be spending a lot of time this year trying to secure opportunities on these platforms and others. For 2017, probably the largest potential contract on this page is the F-16 Service Life Extension Program or F-16 SLEP, which is set aside for US small businesses and is estimated by the government to be valued at over $150 million over 10 year period. This is a similar program to our F-16 wing component contract with the same end customer Hill Air Force Base. The current plan calls for cementing a proposal near the end of 2017 with the winners selected in early 2018. To conclude, as we enter fiscal 2017 we will begin to see the results of defense programs won over the past two years. To supplement our organic growth, we have begun a process of identifying acquisition targets that are principally focused on the defense market to complement and enhance our current capabilities and enable us to more quickly gain scale. We believe this is an important attribute that should enhance our competitive position and permit us to more rapidly gain a larger defense portfolio. To that end, we seek targets that leverage our existing customer base and platforms and or give us establish relationships and access to new customers and new platform. This concludes my prepared remarks. I'd like to thank you for your attendance and continuing support at CPI. Operator, please open the call to questions.

[Operator Instructions] The first question comes from Ben Klieve of Noble Cap Markets. Please go ahead.

All right. Thank you, guys. Few questions for you. First of all regarding the new award grants and that kind of more narrow near-term gross margins, can we expect for all these various program that that once they are fully ramped - that through the historic 24% gross margin range will return for all of these or is there any expected – or is it expected that that kind of 22% range will kind of you know exist for quite a while I guess?

I would say Ben, that the gross margins on these newer defense programs within a year, and certainly by the second year will return to those mid-20% level. The fourth quarter of last year we had a good product mix. Not a lot of brand new starts in our margin was on an adjusted basis in the 25% range. So I would say given a year or so they should - those program should meet our normal range.

Okay. Thank you. And a question relative to your 2017 revenue estimates, you briefly described the possibility of upside from certain defense programs. And I'm wondering are those programs that are – does the upside come from programs that are in your current pipeline or just from you know potential accelerated ramping of existing awards?

I think it's a combination actually Ben. There are indications that you know certain programs could see accelerated funding with increasing defense budgets. For example, our F-16 program and our T-38 program which are largely in support of legacy platforms. So that could be an upside. But the largest single catalyst for any changed guidance would be the timing of any follow-on A-10 program.

Okay. And then I am sorry if I missed this during your commentary, but when you were describing the SG&A for this year and with regards to rest of outlook on 2017, you know, given those various kind of one-time expenses that you saw this year, where do you guys kind of tract SG&A for 2017, either you know, on a kind of quarterly run rate or percent of revenue or anything to that context?

We – yes, it actually is changes quarter-to-quarter because of the amortization of certain non-cash charges, particularly for stock expense that runs through - runs through the SG&A. So year-over-year we expect totals [ph] to be flat or slightly down from the 2016 year. But the quarter-over-quarter will actually decline as we go throughout the year. First quarter should be the highest SG&A and then it runs down.

Perfect. Thank you. That’s all I got. Thanks a lot gentlemen.

Thank you, Ben.

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

Hi, good morning.

Hi, Ken.

Hey, Doug, does that $1.5 million you highlighted as was pushed out in the fourth quarter, does that all on the couple of d defense programs, does that all hit in the first quarter or is that spread throughout the year, what's the timing on that?

I would say most of that is during the first half of this year. But I'm not going to rule out that some of that is into the third quarter.

Okay. Okay, that’s helpful. And then…

As it could certainly be – it’s reflected that all of that turns to revenue in this calendar year.

Okay. That was my questions. So it’s all reflected in the guidance.

Correct.

Can you quantify for '17 and the guidance, two questions around it. One what do you expect the mix to be between defense and commercial? And the second for 2017 on the defense sales what percentage of your sales in '17 on defense are expected to be from contracts that you've signed in the last 12 months? I am just trying to get a sense as to the mix this year within defense of legacy versus new to - just to better understand that flow through?

Okay. To answer your first question, we are projecting about 70% defense weighted total revenue for the year. So this year we ended up with about 50-50, next year it’s going to closer to 70% defense, 30% commercial. As far as the mix of a relatively new versus legacy, I would - I'm just kind of guessing because I haven't looked at it that way, but its probably somewhere between 25% and 30% of total spending will be from these newer contracts, might even be slightly higher than that.

Okay, okay, so a pretty significant part of the mix this year.

That's correct.

Okay. That's helpful. And can you provide a quick update on the E2D specifically for Japan and has there been any changes in timing or schedules on that program?

There haven’t really been any major schedule changes. There were you know, intra quarter and intra year there's been some slides that may take certain activities out of the quarter, but by and large, that program is on schedule. The, pardon me, as far as the macro program goes is we hope that Northrop Grumman receives additional contracts from Japan this year that will allow us to expand our work on onto those aircraft as well. You know, part of the range in our forecast actually is you know, near the upper end of the range where we're making an assumption that we do get follow-on work beyond what's currently on order for the E2D for Japan. So we have indications that that will happen, but again because of timing uncertainties, particularly now the added complexity of a foreign government sale you know, that's factored into our guidance as well. If that comes sooner and more of them, then we had in our forecast that is another program that could potentially offer upside to our guidance.

Okay. Okay, that's helpful. And then just finally, I just wanted to follow up on your common regarding M&A, can you just help us again with – I mean, it looks like now on a pro forma '17 basis, you give or take sort of 3 times leveraged in terms of EBITDA. What kind of leverage are you comfortable with, and any more specifics around either size of opportunities you are looking at or I know, obviously you talked about within the defense areas of focus, but any more color around that as you at opportunities and maybe what's more attractive to you versus maybe what's not as attractive would be helpful?. Thank you.

Okay. First of all of this would be my first acquisition if we were to make one. So the approach is very disciplined and it’s very much in consideration of the impact it would have to current shareholders. We are looking at things that are very complementary to our current business, something that we have knowledge of, markets that we have knowledge of, the government markets or specifically aerospace markets. They are going to be smaller in size, you know, something that in some case it might be done with our current capital structure and others might not. But I think you know, it’s very early, but we are looking for companies - I like companies that would have exposure for example, on F-35 or B-21 or some of the newer of platforms. I like companies that have product lines and unmanned aircraft and a market that where we're trying to get into, but haven't yet. And I like companies that do work in the military aftermarket space, particularly for those companies that are supporting American Aircraft that are located overseas. I think that's a big opportunity. So again, we're in the early stages of that, but those are the types of - on a broad level the types of companies that we would be interested in.

That’s helpful. And then just finally from a leverage standpoint, what you view as or what's a range you're comfortable with?

I am comfortable at the three, maybe a little higher. I don't think we would want to do anything higher than say, 3.5, but right now are – we are looking to keep the leverage in the three range.

Okay. Great. Thank you very much.

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

Thanks. How much floor [ph] space are you reserving for the A-10 in 2017, which otherwise could be used for productive purposes?

Right now we have, I am going to guess around somewhere under 10,000.

Square feet.

Square feet and the – we're currently using or finishing up that contract now, we're only building of the of the 50 or 60 some odd different assemblies that we actually provide, we're only down to a handful that we haven't yet completed the full 173 aircraft order. So that's only taking up now you know, a third of that floor. The rest we're going to keep the tools on the floor. We have no plans to move them hopefully by the time we're done with the last assemblies we'll have more clarity as to what the future holds for that program. But we're behaving here internally as though we will continue to build the same statement of work that we've been building and the timing of that start might be later this year or next year. But we're hauled [ph] onto hat floor space and don't really see any other use for it at the moment.

So you don't see any other used for that space at the moment?

No, I mean, we shouldn’t reserve it. I mean, we're keeping it reserved for A-10.

All right. And then when you are evaluating perspective acquisition targets, do you expect that any potential deal would be forged on a basis of a EBITDA multiple?

I do.

What was your EBITDA, you didn’t any provide any D&A information in this – all those information today?

I don't know, we don’t ever disclose EBITDA, you…

Because of the loss this year, the 2016 on a GAAP basis, you like a funky result that’s even for our bank agreement is an add back because of the A-10 adjustments. So its all - the 2016 is hard to quantify realistically, you know, 2017…

So last year, I think you had depreciation, amortization of 854,000, you had 524,000 of stock-based comp, through Q3 you got 582,000 of D&A and 622,000 of stock-based comp, and what was that at year end?

Its 662 depreciation, and 540 stock comp.

Okay. Thank you. So do you - with CVU shares trading at a closer to 8 or 9 times EV EBITDA ratio, when you like to issue - to do some of these acquisitions using year end stock currency, assuming you could acquire some of these operations with F-35 exposure or some of the other target exposure for lesser multiple?

Well, I think the - with the answer to Ken's question earlier in terms of these deals that we would be - companies that we feel that would be good fit for us with our current structure and capital structure, is figure between $1 million and $3 million or so of EBITDA and so those will I think just naturally carry lower selling multiples. So - but right now, I think we're open to all structures, but we're opting for smaller companies so that we can keep our - you know, the financial structure of the deal with the least amount of risk.

Okay, great. Thank you.

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

Thank you, Andrew. And thank you to those on the line and those who would listen later. Vince I look forward to speaking with you all again in early May when we expect to release our first quarter '17 financial results. Bye for now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.