CVU - AMEX

Sanjay Hurry - IR Doug McCrosson - President and CEO Vincent Palazzolo - CFO

Mike Crawford - B. Riley & Co. Ken Herbert - Canaccord Mark Jordan - Noble Capital Markets

Good morning and welcome to the Second Quarter 2017 CPI Aerostructures Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Sanjay Hurry. Please go ahead.

Thank you, Brian. Good morning, everyone, and welcome to CPI Aerostructures second quarter 2017 earnings 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 the Jefferies Industrial Conference in New York City and at the Canaccord Genuity Annual Growth Conference tomorrow in Boston. Management's presentation at the Canaccord conference will be webcast via the link provided on the Investor Relations section of the CPI Aero website. 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 with a brief overview of our performance for the second quarter. After which, Vince Palazzolo, our CFO, who will review our financial results in greater detail. I will then touch on market and business trends that we expect will place CPI Aero firmly on a growth trajectory. I will then open the call to questions. Let's begin. We delivered solid financial results for the second quarter that demonstrate consistent execution across all facets of the company. I'm especially pleased with our earnings per share for the quarter which are the direct result of the cost reduction and process improvement initiatives that we have put into place over the past three years. Improvements to our ERP inventory systems applied last fall together with tightened operational control reduced our inventory by $3.5 million in the quarter and by $5.7 million year-to-date. As a result, cash flow was positive for the quarter at $1.8 million. This is a substantial turnaround from negative cash flow of $1.6 million in the second quarter of 2016. Year-to-date we have narrowed negative cash flow to $1.1 million compared to negative cash flow of $7.3 million in the first half of 2016. We believe this trend will continue and now expect to have positive cash flow for the balance of the year. Vince will provide some color on this in his prepared remarks. The quarter was all about continued momentum in our business with new awards secured principally in our defense business reflecting our focus on that market. Revenue for the quarter saw an expected sequential decline given the pull forward of F-16 part sales into the first quarter, which we discussed on our last call. Turning to slide four, we will see continued strong execution of our defense market strategy. Defense backlog now comprises 80% of consolidated backlog, which stands at $394.8 million. As you can see in the line graph on the right hand side of the slide, we recorded a defense book-to-bill of about 1 in the quarter. Slide five gives you an idea of our sustained momentum in new defense awards. In June, we were awarded a development contract from UTC Aerospace System for their new TacSAR pod-based surveillance system. This contract demonstrates not only our continued success in expanding our footprint in the advanced pod-based electronics market, it also is a great example of how we have been able to break away from our build-to-print roots and become a value-added Tier 1 supplier. More on this after Vince's review of the financials. We also secured an initial MRO services contract from Sikorsky for tow hook assemblies for its MH-53 Sea Dragon. We previously manufactured new tow hook assemblies for the Sea Dragon, so our expertise greatly reduced program execution risk for Sikorsky and led to our first component MRO contract. You also can see that we have built a robust base of future defense revenue with excellent visibility into 2022 and beyond. Most programs on this slide are early -- are in the early stages of their lifecycle. Several programs originally set to conclude before 2018 have already been extended, including the recently announced contract to provide Aerostructures and kits to Sikorsky on their S-92 commercial helicopter. We have been supporting Sikorsky on the S-92 since 2011. Its new multi-year follow-on order highlights our exceptional program execution, quality, value, and customer service. After the close of the quarter, we also extended our work on the Sikorsky Black Hawk military helicopter with a long-term supply agreement for fuel panel assemblies for that aircraft. I'll now turn the call over to Vince Palazzolo, our CFO, to review our financial results for the second quarter. I will then conclude the call with a discussion on our strategy for the second half of 2017 and the near-term opportunities ahead of us. I'll then open the call to questions. Go ahead, Vince.

Thank you, Doug. To start, on slide seven, revenue for the second quarter of 2017 was $16.7 million compared to $22.3 million in the second quarter of 2016. The decrease in revenue was due in part to an acceleration of our F-16 MRO program that pulled what had been expected revenue and margin from Q2 and Q3 into Q1. In addition, the expected winding down of our A-10 Wing Replacement Program and a normal cyclical decrease in revenue from our E-2D program contributed to the decline in revenue. Gross profit for the second quarter of 2017 was $3.7 million compared to $5 million in the second quarter of 2016. Gross profit margin was 22.5% and near the upper end of our expected range for all of 2017 of between 21% and 23%. SG&A increased by approximately $130,000 in the second quarter of 2017 compared to the second quarter of 2016. This increase reflects modest increases in marketing and compensation partially offset by lower bank fees. Pretax income for the second quarter of 2017 was approximately $1.2 million compared to $2.8 million in the second quarter of 2016. The $1.6 million decrease in pretax income reflects primarily lower gross profit due to lower revenue as well as slightly higher SG&A expenses and increased interest expense. Net income for the second quarter of 2017 was $800,000 or $0.09 per diluted share exceeding our goal. This compared to $1.8 million or $0.21 per diluted share in the second quarter of 2016. Turning to slide eight, our balance sheet. Costs and estimated earnings in excess of billings on uncompleted contracts, CE&E, were $101.7 million, an increase of approximately $2.2 million compared to December 31st, 2016. As you know, we've been working at reducing the amount of cash tied up in our working capital, in particular the amount of inventory we carry. In the second quarter, we reduced inventory by $3.5 million and for year-to-date by $5.7 million. We are ahead of plan to reduce inventory by 10% during 2017. Total debt stood at $33.9 million at June 30 compared to $35 million at March 31. Shareholders' equity stood at $70.3 million at quarter end with a book value of $7.96. Our debt to capital stood at 0.66. Our working capital improvements are becoming evident in our cash flow. For the first six months of 2017, we have used $1.1 million of cash in operating activities, which is significantly less than last year's first half when we used a total of $7.3 million. For the quarter, we generated positive operating cash flow of $1.8 million, which gave us the resources to pay down some of our outstanding balance on the revolving credit line. We also expect to generate positive operating cash for the third and fourth quarters and as a result, we expect to generate approximately $1 million in positive operating cash flow for the full year compared to negative cash flow of $6.6 million in 2016. Turning to slide nine, given the recent program wins, business momentum as we enter the second half of the year and improved operational performance. We are reaffirming our financial guidance for 2017 of revenue in the range of $82.5 million to $87 million with pretax income anticipated to be at the high end of our range of $8.1 million to $8.5 million for the year. This concludes my prepared remarks. I will now turn the call back to Doug.

Thank you, Vince. As we look ahead, our growth trajectory is supported by a robust bid pipeline of multi-year defense opportunities. Recent successes, especially within our Aerosystems segment, have served to raise our profile with customers and are starting to generate new business development activity. Let me spend a few minutes sharing with you how our manufacturing and engineering expertise is helping to drive new opportunity. Our defense market focus is underpinned by our decades' long roots in manufacturing for the defense industry. We have historically been a build-to-print shop and a very good one. Today, I'm proud and gratified that we have earned a reputation to provide capabilities at the high end of the production value chain. Customers now turn to CPI Aero as a true partner from the earliest stages of the program life cycle, no longer waiting for their design to be completed and often for our expertise beyond the work scope of traditional aerostructures companies. Customers now seek us out for our exceptional manufacturing engineering, innovative tooling expertise, and increasingly for our experience in subsystem installation, test, and integration. They benefit from our expertise, but at a much lower cost than doing it themselves. In turn, our Tier 1 capabilities makes us more a valuable -- makes us more valuable to our customers, enables us to generate revenue and profits during more of the product's lifecycle and will typically provide us with better financial returns than we would otherwise expect from performing only as a build-to-print manufacturer. It also gives us a meaningful competitive advantage in increasing our statement of work with a given customer on a particular project given our greater participation at the earliest stages of the product lifecycle. There is no better example of the success of this strategy than our TacSAR award from United Technologies Aerospace Systems that we announced at this year's Paris Air Show. This new contract led directly from our prior work task on the DB-110 Reconnaissance pod allowing CPI Aero to go wider across the key customer's product portfolio. Now, the preproduction work we are undertaking as part of the TacSAR contract is expected to lead to a production contract once they launch customer and secure it. If this program is as successful as DB-110 has been, CPI Aero could be building systems for years to come. Our door lock assembly program for Lockheed Martin's F-35 also reflects our high value engineering work. We began to deliver product under this program in the second quarter, which included developing functional test procedures and specialized equipment to ensure required performance. Recent successes are also serving to raise our profile with prospective customers. Having recently attended the Paris Air Show, our growing reputation in the marketplace made this our most productive show to date. This is development conversation centered on our capabilities for the defense market and particularly on our Aerosystems business. Turning to slide 11, interest generated in Paris is evident in our bid pipeline. Defense opportunities represent 88% of the total value of our bid pipeline. We continue to prioritize our new business activity in Kitting and Aerosystems given the strong customer demand, our track record of success and the positive financial results we can generate in these segments. These two segments now total 57% of our bid pipeline and could grow. For example, in Paris we were told by several existing customers that they each have a new pod-based system in development. Given our solid execution to-date on similar programs for these customers, we believe we have a role to play in those future systems well. On slide 12, you will see representative opportunities in our bid pipeline. Touching briefly on the A-10 Wing Replacement Program opportunity, we continue to be optimistic for a restart of the Wing Replacement Program in calendar year 2018 if not sooner. Both the House and Senate have authorized $103 million within the 2018 defense budget for new wings for the A-10. This amount is in addition to the $20 million that has already been appropriated by Congress for new wings within the 2017 Omnibus Appropriations Act. We are exploring ways to get on to contract before the end of this year for certain restart activities using some of the $20 million in funds from the current fiscal year that ends September 30th. We are also starting to see the 2017 Omnibus Appropriations Act catalyze some opportunities on this slide. I noted earlier that we were awarded a five-year $21 million supply agreement by Sikorsky for fuel panel assemblies for the Black Hawk after the close of the second quarter. This award follows the signing of the U.S. Army's Multi-Year IX Black Hawk contract with Sikorsky in June. We expect another Multi-Year IX contract to be awarded to us by Sikorsky within the next couple of months. With regard to Reconnaissance pod opportunities, we are also pursuing a follow-on to our existing multi-year DB-110 Intelligence Surveillance and Reconnaissance pod program with UTC Aerospace. Recent foreign military sales that have been announced by the State Department are very likely to lead the UTC obtaining orders for their DB-110 system. We expect that orders will flow down to CPI Aero for additional pods this calendar year. The DB-110 was also a platform we heard a lot about in Paris so we are very excited about its future demand. Turning to slide 13. Our long-term defense and commercial programs have the potential to generate over $394 million over the remainder of their periods of performance. As I noted previously, we have secured new agreements on several programs set to end by 2018, and on the remaining one, the DB-110, as I noted moments ago, we have reason to be very optimistic. In summary, we are starting to see the benefits of our profitability improvement initiatives, improving defense fundamentals together with our defense market exposure, backlog and multi-year opportunities and a robust bid pipeline. We believe we have never been in a better position to succeed. This concludes my prepared remarks. I'd like to thank you all for your attendance and continuing support of CPI Aero. Brian, please open the call for questions. Thank you.

We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Mike Crawford with B. Riley & Co. Please go ahead

Thanks Doug and Vince.

Hi Mike.

You said you're exploring ways to get on to further re-wing work for the A-10 by year end and there's already $20 million appropriated. Obviously there's request for -- to re-kit the whole the remaining 110 units in the fleet. What -- what types of explorations are you doing and what are the probabilities this might happen?

Well, I can't really go into too much detail about the exploration, but I can tell you that they are with the prime contractor Boeing, in concert with them and with the Air Force. And there are several things that the -- there are plenty of assemblies within the A-10 that are no longer in production we've completed the order for. So, there are a lot of what I would call engineering, paperwork, cleanup, tool calibration, manufacturing procedures that have to be I think incorporated, any changes or learning experiences that we may have uncovered during the original production. So, there are definitely activities that we can do to get ready that would not consume all of the money that they have already appropriated, the $20 million. So, those are the types of things that we're looking to do right now.

Okay. And then if you take it a step further to if we can make a hypothesis that there is funding authorized to re-wing the whole fleet, then how might that play out for CPI Aero? That would be a contract that you would expect to get what -- around the first quarter of 2018 perhaps or -- and then run for a couple of years or what?

Well, right now my guess would be that we were going -- that the FY 2018 budget -- the government fiscal year budget 2018 won't come in on time because it rarely does. So, I would say that it will be at least the first quarter of 2018 before that budget is officially signed. Then Boeing has to get on contract or the Air Force has to put a contractor, presumably Boeing, on contract and then that would flow to us. So, I think the first quarter you could see the prime contract being let and maybe in the early second quarter the subcontracts being let after that. As far as how the program would wind up, the government has put out a -- the only thing I can go by is what they've publicly stated in one of their RFQs, which was to build roughly two new sets of wings every month, which would be about 20 to 24 a year and so probably be about a four or five year program, 24 a year type of program.

Okay. Thank you. And then--

And we would need further funding beyond what is already in 2018 to accomplish that.

Okay. Thank you. Then Doug, you mentioned that you expected the foreign military sales that have occurred to likely lead to DB-110 systems orders, but I mean what would happen for those -- for that not to lead to orders or is there someone else that's manufacturing these as well?

No, there's nobody manufacturing them. But the deals have to get -- they're announced deals, they are not fully executed and so that has to happen. So, that would be the only way it wouldn't happen.

Okay. Thank you. And then last question maybe more for Vince is how might we think about the C and any line item on the balance sheet that's at $102 million today. Is that something that might come down first or is there any directional move on that line item?

Yes. As we continue to lower the inventory, that number should begin to chip down. It's not a one-for-one, but it is should start to come down. It did actually come down. We mentioned in the presentation that it went up from the beginning -- from the end of last year. But what I didn't mention in the presentation is it actually went down from the end of the first quarter. So, that should begin to start to come down the rest of the way through the year -- through the rest of this year as we continue to lower inventory levels.

Okay, great. Thank you very much.

Thank you, Mike.

Next question comes from Ken Herbert with Canaccord. Please go ahead.

Hi, good morning Doug and Vince.

Hi Ken.

Hi Ken.

Hi Doug. I just wanted to ask the guidance for the full year on the topline implies sort of flat sales relative to last year. From a cadence standpoint, do you see a nice sequential uptick in revenues from the second to the third quarter or is this really back-end loaded into the fourth quarter to hit the lower end of the guidance range?

No. We do see a strong third quarter in revenue and a stronger quarter in the fourth quarter from the topline standpoint. Part of the revenue component quite honestly shorter than -- lower than we had planned for the second quarter was because of the inventory reduction just as we fine-tune our manufacturing process and we can accept delivery of our component materials much closer to when they're actually going to be used to build the assembly. We're just buying less material and we did appreciably less material in the early part of the second quarter, which was why we had a very good cash flow quarter this year. But what that does is if you're not bringing in new material and incurring new cost, you actually are lowering your revenue on the percentage of completion accounting method. So, on the one hand, we were very, very happy to see the cash generation for the quarter and the inventory reduction, but it did put a little bit of a temporary kind of hit to the topline in this quarter. We feel now we have a good cadence. The rest of the quarter is kind of buying in accordance -- strict accordance with our ERP plan and so that's reflected in our second half guidance. So, we have a pretty good handle on the timing of our component receipts. We're going to continue to burn down inventory a little bit, but the revenue I think is going to be strong in the second half.

Okay. That's helpful. So, the inventory impact on revenues in the second quarter was maybe in the range of $1 million to $2 million?

It was probably just under $1 million.

Okay. Okay, that's helpful. And then on the cost front, obviously seems like the ERP system and the investments there have certainly been helpful in the gross margin trend you're seeing, it sounds like you're going to end the full year well within the guidance range, maybe at the upper end of the range. How much more would you say opportunity there is either within inventory or as a result of the ERP spend as you go into the second half of this year, maybe specifically on inventory, but then into 2018 as well? I mean obviously there's a lot of low hanging fruit so to speak you're able to pick, but do you see incremental opportunity moving forward or how should we think about that?

I think the best way to think about that is we are at a fairly I'll say mature on some of our particular commercial product lines like Embraer and Gulfstream and Honda where -- so in other words there's really not a lot of I'll say major opportunities other than fine-tuning on those particular programs. But where you should see some margin expansion is as our defense programs, the newer ones in particular, start to accelerate through the third and fourth quarter this year and more significantly in 2018, things like the Raytheon Next Generation Jammer program as one example. I think that's where you'll see the opportunity for gross margin expansion is as the newer defense programs start hitting more of their full production strides and get out of the -- I'll say the development phase of their programs.

Okay. And then on that point, just one final question. How would you characterize the pricing environment with the new work you're winning today and then obviously your pipeline of defense work? It seems like on one hand there is budget relief and maybe a little more opportunity there, but on the other hand certainly pricing I know can be tight. Would you say that you're seeing more pricing pressure with the new work or you think you're able to maintain or even maybe get pricing as part of the backlog and the work there? Thank you.

Okay. I'll kind of repeat a little bit what I said in my prepared remarks relative to the newest contract with United Technologies. And keep in mind the pricing pressure that you hear most often is certainly on the large commercial and even to some extent the business jet area. And while affordability is key in every market and is more so in defense than ever before, the area that we compete is really against the prime manufacturer, his own internal capability or a very large Tier 1. The types of assemblies that we're building and the types of work now that we're doing by way of example is the DB-110 Reconnaissance pod, the Raytheon Next Generation Jammer. These are very sophisticated non-commodity major weapon systems that require and will value our skill. So, you can hold a better price than you would otherwise, particularly in the commercial market, but you're still affordable to the government and to the taxpayer because the organization that would have done that work is a much higher cost structured company. So, I think that these large electronic system, particularly our pod systems, are the types of things that the government and our primes are looking to do. They're looking to have a high level of complexity and skill, but at a more affordable price. And I'd argue that we're one of the very few companies of our size in the country that can do that type of work.

Great. Thank you very much.

Next question comes from Mark Jordan with Noble Capital Markets. Please go ahead.

Good men gentlemen. One question relative to gross margin is the -- was the -- in the second quarter, was the legacy A-10 work all finished or was there still some residual 0 profit revenue in the quarter?

There is still some zero profit revenue for the A-10. That number is getting relatively small right now. I think that for the remainder of the job, we're under -- certainly under $1 million down close to $0.5 million for the remainder of the job. So, it's getting to be a pretty small number at this point.

Okay. In your presentation, you said that there was potential for incremental awards to provide upside to the revenue expectations for the year. Is that primarily the potential for some quick turnaround A-10 work if it was to be appropriated because usually there's a little bit of a lag between award and starting to realize revenue?

There is a little bit of that, Mark, not a lot. Bigger would be more quickly finalizing negotiations on a second Multi-Year IX contract with Sikorsky as well as a more timely closing of some of the DB-110 opportunities with our -- with United Technologies. That's really what I'm addressing when I say that.

Have there been any substantive change in the relationship with Sikorsky subsequent towards your sale to Lockheed Martin? Obviously there's been a better flow of contracts there recently and expect some good things. Is there any change in terms of their use of subcontractors versus in-house as a result of ownership change?

No, not at all. And we have two -- we've actually increased. Within the last year say year, we've increased our presence with Sikorsky by getting both the Canadian helicopter weapon pylon system and the -- and most recently the MH-53 tow hook assembly repair contract. So, no, our relationship with Sikorsky has been strong since the mid-2000s and it's as good as it's ever been right now.

Okay. Final question for me or a couple of questions, it's around your F-16 business. Could you please sort of scale that in terms of what that should be sort of for this year and next year? And secondly, also with your opportunities like you list MRO F-16 service life extension as an opportunity, so what incremental business are you looking for off of that platform?

So, our current program with the F-16 is -- I don't know -- I'm looking at Vince now, is that $3 million to $4 million a year.

We're in the high $2 million already.

So, why don't we say between $3.5 million and $5 million is probably a good number.

Yes.

We would actually anticipate that program stepping up because similar to what we did this year with inventory, they discovered some inventory that they had within the depots that have -- so we haven't seen the order -- the new orders as strong as we would expect to see in this year. But as they wind through that inventory, we anticipate that turning around and that's a multi-year program, I don't have the exact years, but there's at least three or four more years on the program. The next program down the line, which is a small business set aside, is even larger than the one that we have now. Very similar type of program where we would be providing kitted components and the government estimates that to be around I think what the number was $150 million over 10 years. So, you can see that's quite a bit different than that. We feel that we're going to put in a very good proposal, we're working hard on it right now and we hope that a winner is selected in the first quarter of 2018.

Okay. Thank you very much.

[Operator Instructions] At this time, there are no more questions in the queue. So, I'd like to turn the conference back over to Doug McCrosson for any closing remarks.

Thank you, Brian and thank you all again for listening to today's call. Vince and I look forward to speaking with you again in November when we expect to announce our third quarter 2017 financial results. Good bye for now.