CPI Aerostructures, Inc. (CVU) Q1 2017 Earnings Report, Transcript and Summary

Good morning and welcome to the First Quarter 2017 CPI Aerostructures Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now turn the conference over to Sanjay Hurry. Please go ahead.

Thank you, Amy. Good morning, everyone, and welcome to CPI Aerostructures First Quarter 2017 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 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 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 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 company's filings with the SEC. Before starting the call I'd like to inform you that management will attend and present at several investor conferences over the next two months in both New York and California. Event details will be posted to the CPI Aero website on the Investor Relations page for your reference. 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. On today's call I will provide a brief overview of our performance for the first quarter, after which Vince Palazzolo, our CFO, will review our financial results in greater detail. I will then offer insight into our business outlook for the year, especially in the context of the 2017 Omnibus Appropriations Act that was passed into law last week. I'll then open the call to questions. So let's begin. I'm very pleased to report a solid start to the year that demonstrates across the board operational and financial execution. Revenue in the quarter was driven by several of our newer multiyear defense programs such as the Northrop Grumman E-2D produced for Japan and our F-16 wing component MRO program. In addition, we had meaningful contributions from programs we performed for key commercial platforms, principally the Gulfstream G650 and the HondaJet. Our revenue and gross margin performance benefited from shipments of F-16 components that the customer requested earlier than planned. Coupled with strong operational and cost control, we are very pleased to report a $0.14 profit per share for the quarter. Turning to Slide 4, our backlog reflects effective execution on our business plan since we pivoted the company back toward the defense market in 2014. Defense programs today comprise 78% of total backlog, which stood at $400.8 million at quarter end. We have a compelling track record of winning multiyear defense contracts. As shown on Slide 5, approximately $251 million of total backlog at quarter end is derived from defense contracts we have announced since 2014. As you can see, we have built a robust base of future defense revenue with excellent visibility into 2022 and beyond. Most programs on this slide are also in the early stages of their lifecycle. I'll now turn the call over to Vince Palazzolo to review our financial results for the first quarter. I'll then conclude the call with my thoughts on the balance of 2017 and how the 2017 defense budget is likely to impact our financial performance. I will then open the call to questions. Vince.

Thank you, Doug. To start on Slide 7, revenue for the first quarter of 2017 increased to $20 million compared to 12.7 million in the first quarter of 2016. The $7.3 million increase in revenue was predominantly the result of the change in estimate on the A-10 program in the 2016 quarter that lowered the Q1 2016 revenue by $6.8 million. Gross profit for the first quarter of 2017 increased by approximately $16.1 million to $4.5 million compared to a loss of $11.6 million in the first quarter of 2016. Gross profit margin was 22.5% which gives a strong start to the year. We expect the gross profit margin will remain in the 21% to 23% range for all of 2017. SG&A expenses decreased by approximately $577,000 in the first quarter of 2017 compared to the first quarter of 2016. This decrease was primarily the result of a decrease of approximately $270,000 in professional fees related to our extended audit in 2016, and a decrease of approximately $395,000 on loss on unrealized receivables in 2016. Pretax income for the first quarter of 2017 was approximately $2 million compared to a pretax loss of 14.6 million in the first quarter of 2016, an increase of approximately $16.6 million. The increase was the result of the change in estimate on the A-10 program that reduced the Q1 2016 pretax income by approximately $15.3 million, also improving gross profit margins on certain programs and product shipments on our F-16 program that contributed no revenue or profit in the first quarter of 2016. Net income for the first quarter of 2017 was $1.2 million or $0.14 per diluted share compared to a net loss of $9.2 million or a $1.07 per diluted share in the first quarter of 2016. The $1.21 per share improvement in EPS was the result of the change in estimate on the A-10 program in the first quarter of 2016 that reduced the EPS by $1.12. Improving gross margins on certain programs, some positive earnings contribution from our F-16 program that generated no revenue or profit in the first quarter of 2016 partially offset by a higher diluted share count in the first quarter of 2017. Moving to Slide 8, our balance sheet together with the debt refinancing we completed in early 2016 gives us the financial flexibility to pursue our growth opportunities. Cost and estimated earnings and excessive billings on uncompleted contracts, CE&E, was $101.9 million, an increase of approximately $2.4 million compared to December 31, 2016. Total debt increased by $2.4 million to $35 million. Shareholders equity stood at $69.3 million at quarter end with a book value of $7.86 per share. Our debt to capital ratio stood at 0.51. Turning to Slide 9. We believe that the combination of our better than expected performance in the first quarter coupled with the passage of the 2017 federal budget into law now offers a path to the high end of our pretax income range of $8.1 million to $8.5 million for the year that we provided in our fourth quarter earnings report. Doug will discuss this in greater detail. This concludes my prepared remarks. I now turn the call back over to Doug.

Thank you, Vince. As Vince just noted, our better than expected performance in the first quarter has improved our outlook for the year as a whole and we anticipate pretax income to be at the high end of the guidance range for the year. In addition, our more positive outlook is due to the recent signing of the 2017 Omnibus Appropriations Act that provides nearly $600 billion to fund the Department of Defense through September 30th of this year. Let me spend a few minutes now discussing our current expectations for 2017 now that we have a signed defense spending bill. During last quarter's call we provided a conservative fiscal outlook for 2017 largely due to defense spending uncertainty as there was no 2017 budget and the Defense Department was operating with funds provided by a continuing resolution. We view the signing of the Omnibus Appropriations Act as very positive for CPI for a number of reasons. It provides more than $15 billion in funds over and above what was expected with added funding for spare parts and maintenance. It fully funds programs that are key platforms for CPI Aero such as the E-2D Advanced Hawkeye, the Next Generation Jammer electronic warfare system, the F-35 Joint Strike Fighter and the AH-1Z helicopter. It increases the number of Black Hawks that will be purchased. And for the first time since 2013 it provides funding to the U.S. Air Force for installing new wings on the A-10. More on this later. Under a continuing resolution, program budgets are kept at the prior year's amount and new programs can start only under very special circumstances. Now that the continuing resolution is superseded with the spending bill, we should see new awards start to flow. And we would likewise expect to see a pickup in bid and proposal activity with the OEMs as well as from our government customers. With the spending bill now law we believe this will result in some of the defense opportunities in our bid pipeline converting to new long term agreements in time to contribute to our financial performance for the year. We expect to hear soon on some bids that are the basis for a more positive outlook. As you can see on Slide 11, our bid pipeline reflects our sales emphasis on multiyear opportunities in the defense market. Defense now represents 94% of the total value of our bid pipeline. I want to draw particular attention this quarter to our Aerosystems and Kitting segments that together now comprise almost two thirds of our potential new business. As a reminder, our Kitting segment provides kitted components and related supply chain management services. This segment contains such programs as the E-2D outer wing panel kits and F-16 wing components on the defense side and on the commercial side S-92 helicopter kits and structural panels for the second generation E175 regional jet. Our Aerosystems products include structural pod assemblies such as the Next Generation Jammer and a DB-110 surveillance system as well as specialized assembly such as the F-35 door lock assembly and fueling systems for the Black Hawk helicopter. We have been very successful in developing new opportunities in these markets based on our excellent performance record. And as evidenced by the slide, we are prioritizing our new business activities in these areas. Turning to Slide 12, you will see representative opportunities in our bid pipeline. I draw your attention to a few of these. First, the A-10. The 2017 defense budget has two pieces of good news for the A-10. It includes language that prevents the U.S. Air Force from using fiscal 2017 funds to retire or take steps to retire the A-10 aircraft. And perhaps, more importantly, it includes a $20 million program increase line item for A-10 wing replacement. The last time there was funding for new A-10 wings was in fiscal 2013, so we consider this to be a major change in air force strategy and bodes well for the continuation of our efforts on this aircraft under new terms that should result in a profitable opportunity for CPI Aero. While this is a nominal amount of funding for 2017, in our estimation, this will be increased in the 2018 defense budget. We believe that it would not be fiscally responsible of the Air Force to effectively restart a program that is near its end if it was not the intent to continue the wing replacement program in a meaningful way in 2018. While we project that the timing of a potential new A-10 contract will have limited affect on this year's results, the A-10 could be a catalyst for continued defense revenue growth for us in 2018. On the F-16, we are moving to leverage our existing contract with a defense logistics agency in support of Hill Air Force Base to generate foreign sales for F-16 wing components. We are now an approved source of supply on close to 200 different components. We are seeking to establish distribution partners with direct sales channels into the foreign governments that operate F-16s. There are nearly 1,900 F-16s flown by 25 nations, about 2x the amount that is in the active inventory of the United States. Same with the F-16, probably the largest potential contract on this page is the F-16 service life extension program which is set aside for U.S. small businesses and is estimated by the government to be valued at over $150 million over a 10 year period. This effort would be similar to work performed by CPI Aero under both the F-16 wing component contract and the T-38 Kitting contract for the same end customer, Hill Air Force Base. The government has moved up its original schedule and we now expect an RFP in the next couple of months. We expect to submit our proposal during the third quarter and the government intends to make an award very late in 2017 or early 2018. Turning to Slide 13. Our long-term defense and commercial programs have the potential to generate over $400.8 million over the remainder of their periods of performance. As I noted previously, several of these contracts run beyond 2022 and very few are expected to end before 2018. We are actively working with our customers to extend the long-term agreements on the Black Hawk S-92 and DB-110 that each would otherwise end in 2018 and we hope to be able to secure new agreements with these customers in the near term. To conclude, we have had a very good start to the fiscal year. The result of past strategic and operational decisions made that continue to pay dividends. The 2017 Omnibus Appropriations Act should serve to catalyze some opportunities in our bid pipeline that together with our better than expected performance in the first quarter gives us the opportunity to achieve the high end of our pretax income range for the year. This concludes my prepared remarks. I would like to thank you for your attendance and continuing support of CPI Aero. Amy, you can open the call to questions.

Thank you. Doug, also when President Trump signed the Appropriations Bill he also issued a signing statement asserting a issue with the constitutionality, if I can speak, of limiting his ability to stop programs like the Global Hawk or the A-10. So do you think that's just more of a question of asserting presidential prerogative or do you think there's some lingering concern about the A-10 program?

No, I no longer think there is lingering concern about the A-10 program and programs like that that are aging aircraft that need to be modernized to meet the future demands and in a more cost effective way than perhaps some of the newer aircraft would. So no, I think the -- with this bill and the language in the act, I would say that it bodes very well for the A-10 and programs like it, for example our F-16, which also is heavily relied on new maintenance and repair overhaul funding to have growth in that area.

And then when you look at the mission, what does it cost the government to refurbish and then field an A-10 for close air support versus applying a $150 million F-35 jet for the same mission?

Well, I don't know the exact number, Mike. I think that could be found in some of the white papers that are on the internet on the subject. But clearly it's a fraction of fielding a brand new weapon.

And then last question is on these programs that are currently [Indiscernible] in the Black Hawk, the ISR Pods and the Helicopter. What are the risks and opportunities with getting -- associated with getting extensions on any of these programs?

Okay. I'll start with the S-92. The S-92 we have been doing for Sikorsky for a number of years now and our most recent five year long term agreement is expiring this year and we are already, I will say, in fairly advanced stages of that negotiation right now. So I would view the risk of maintaining that statement of work as negligible if not zero. On the Black Hawk work statement where we are doing work right now on fuel panels and on the gunner window door assembly, we are about a year away from finishing up our requirements under the multiyear eight contract. Sikorsky has previously announced that it's gotten a go ahead on multiyear nine. The new budget just increased the actual quantity of Black Hawks that will be bought under Multi-Year 9. And so I would also characterize our discussions in an advanced stage with Sikorsky to lock up Multi-Year 9. And finally on the DB-110. The DB-110 is a system that's reliant solely on foreign military sales contracts, and so while I view that risk as maybe slightly higher than the Black Hawk or F-92. We are engaged with the customer now. There seems to be an increased level of demand from their international customers for the type of system that this is. And I'm pretty optimistic that we will be able to conclude those negotiations in fairly short order and have some positive news on that within the next several months.

The next question is from Ken Herbert at Canaccord.

Just wanted to first start out, you provided some pretty positive commentary in reference to the guidance for the pretax income. How are you thinking about the revenue line and the guidance there? And how should we think about maybe coming in it at the upper end of the range or any commentary around on the top line in terms of the guidance?

Well, I think you should still be within the middle to upper end of the guidance of the revenue line, but where we saw the big advantage in the first quarter this year was on the bottom line. To provide a little bit of extra information on the better than-expected performance in the first quarter. Some of that, around $600,000 or so of pretax income was as a result of us actually being able to ship some product on the F-16 earlier than the original plan, some of which was in the second quarter and some of which was in the third quarter. So all told, we are still ahead of plan on a pretax income line, but some of it was a shift from the second and third quarters into the first quarter. But we feel pretty confident that that is going to continue through the remainder of the quarters, to end up on the high end of the pretax range. So I guess we're more bullish on the bottom line performance for the year and we're unwilling to go out and say that we're going to be at -- also at the high end or above the revenue range. But margins are improving and ultimately that's the thing that we're most focused on.

Yes. No, I can appreciate that. And when I looked at the gross margin in the quarter, was the pull-forward on some of the higher margin F-16 parts probably the biggest driver there of the benefit or was there anything else in organization you'd point to?

Well, I would say that it was the dominant factor. But we also saw some margin increases in some of the newer programs that are becoming more mature and some of the risks that are being taken out. And so we did see some gross margin growth in some of our military programs as well.

And let me just ask you this, Doug. You have really nice growth on the defense side both in terms of the backlog, but then also in terms of the bid pipeline and obviously that's you know 94% of the pipeline now in terms of opportunities. And you specifically highlighted Kitting and some other parts of that. As I look at the mix of the bid pipeline at Kitting, Aerostructures systems and MRO, is there an area there you'd specifically highlight as maybe offering better margin opportunity, or I'm just thinking as you execute on these opportunities or maybe prioritize these opportunities, how should we think about the margin profile between the different areas and what the implications might be, obviously not just this year but into '18 and '19.

Well, we won't break out individual product or segment margins, but I can tell you that the Kitting and the Aerosystems both have what I would -- higher potential margins than do our Aerostructures, which is dominated I guess with a bit of a commercial profile, with our Gulfstream product, the HondaJet and Embraer and Cessna. So I know it's a broad statement, but generally speaking we are seeing better margins in our Aerosystems segment and in our Kitting segment. But maybe more importantly is the cash flow profiles of those programs are better. For example, in some of our Aerosystems product we can seek milestone payments, so as we reach key milestones during the program, we can receive payments from our customers prior to delivery. And likewise on the Kitting, we are also getting progress payments from most of our defense customers. But also the lead times are somewhat less than in a traditional Aerostructures program where you would have to develop tooling, put the tooling on the floor and wait for the parts to come in. So the turn time between revenue or I should say between contract award and starting to develop good cash flows on a Kitting program are shorter than an Aerostructures program. So all of that combined really points to why we prioritize those two segments, which is not to say we've abandoned Aerostructures. At the end of the day we're an assembly house here, but it is definitely something that we think that we can do very well, do very profitably with good cash flows and we're going to continue to find those opportunities.

Okay, now that's very helpful, I appreciate that. And just finally there's been a number of mix signals on the business jet side and maybe without going into specific programs, over the last quarter or since the first of the year, has your outlook there or level of optimism maybe changed, are you seeing any scheduled increases from any of your customers there, or four to five months into the year, is it pretty much as expected?

Well, the -- there are some good programs in our portfolio and some challenged programs. We do have a -- the Cessna Citation X+ is a slow seller, wasn't like it was four to five years ago. We have a, I'll call a steady program on our Gulfstream. And we have an increasing program on the Honda and a kind of a steady program on Embraer. So it's kind of ups and downs, I would say that the real growth driver going forward through the rest of 2017 and certainly into '18 and '19 is the HondaJet. Getting some very positive signs coming out of Honda about future build rates. So I'm optimistic about the longer term success of Honda. Gulfstream G650 remains a very steady and solid program and as does Embraer. Where we're starting to see a little bit of new activity it's not reflected in the current bid pipeline because these bids are just now received, but we are starting to see some Aerostructures work or at least opportunities coming from some of our current customers, as well as some new customers, for large pieces of structure on some of the newer aircraft that are in development, without getting into any specifics. So while the production rate is fairly steady and not necessarily growing, in fact revenue from our commercial businesses is going to be down quite a bit in '17 versus '16. But we are seeing some light at the end of the tunnel with regard to new opportunities that we will be preparing proposals on for the balance of this year into 2018.

The next question is from Mark Jordan at Noble Capital Markets.

Good morning gentlemen. First question is about the distribution of revenue and profitability for the year. Traditionally you've had a weaker first quarter build and through the year had a strong fourth quarter, given the first quarter strength in pulling in some of the business from the second and third quarters, would it be reasonable to assume sequentially a modest decline in revenue and pretax profitability in the second quarter, than a build in the third and then a stronger fourth quarter, would that be a reasonable way to look at the distribution of performance expected here.

Exactly right, Mark.

Okay, second question relative to your free cash flow outlook for the year, what's your expectations there and what are your CapEx plans for this year and first quarter D&A and full year, depreciation and amortization?

I'll let Vince address the second part of your question. The first part of your question is for when we file the Q there will be a statement of cash flows, which will be tomorrow. I believe the cash flow from operations was a use of cash of around 2.9 million.

Correct, yes.

In the first quarter. That compared to roughly five point something million in the first quarter of 2016. First quarter is usually a heavier cash usage quarter for us as we pay the bills from products we received and work performed in the fourth quarter of the prior year. We look to have a fairly good remainder of the year from a cash flow standpoint, we do envision paying down some of our debt through operations, through cash flow from operations for the balance of the year. So while we don't provide cash flow guidance, it's certainly better than it was in '16.

And related to your question on depreciation and amortization, the depreciation in the first quarter was 150,000, should remain relatively stable in that range for the remainder of the year on a quarterly basis, maybe it'll tick up a little bit as we do some PP&A acquisitions later in the year. But it'll certainly remain below 200,000 per quarter, we did have about $420,000 worth of charges for stock compensation which was a non cash and that actually trailed down as we go quarter over quarter. So the first quarter is by far the largest charge and then it drops $100,000 or so per quarter till the end of the year.

Okay. Final question, relative to HondaJet, there's been some talk that they might go with a larger second design for a slightly larger plane. Could you talk about your opportunities of gaining content either on the initial platform that's out there now and/or future designs?

I would say that we have a good prospect of getting additional work, be it on any next plane or even the current one. In fact we're responding to a proposal right now for some work on the current job which is new to what we've done previously. In our track record with Honda in terms of providing value to our OEM customers in terms of our engineering skill and our manufacturing capabilities and the level of work that we're able to -- the complexity of the work that we're able to perform, I think that's our overarching business philosophy is to just do a bang-up job on the work that we do for these customers and then go deeper and wider into their portfolios and I do not see Honda being any different to that.

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

Thank you, Amy and thank you all again for listening today's call. Vince and I look forward to speaking with you again in August when we expect to announce our second quarter 2017 financial results. Goodbye for now.

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