CVU - AMEX

Sanjay Hurry - Investor Relations Counsel Douglas McCrosson - President and CEO Vincent Palazzolo - CFO

Ken Herbert - Canaccord Mike Crawford - B. Riley FBR

Hello and welcome to the CPI Aerostructures' Third Quarter 2018 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. And now I would like to turn the conference over to Sanjay Hurry. Please go ahead, sir.

Thank you, operator. Good morning, everyone, and welcome to CPI Aerostructures' 2018 third quarter financial 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 on the Investor Relations section of the CPI Aero website. On today's call are Douglas 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. Including 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 are budgetary constraints change the government are right to spend or borrow 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 turning the call over to management for their prepared remarks, please note that management is available for follow-up calls with institutional investors. Following the conclusion of this call. Please contact my office via a contact details listed in today's press release to schedule a follow-up. With that said, I'd like to turn the call over to Douglas McCrosson President and Chief Executive Officer. Good morning, Doug.

Good morning, Sanjay, and thank you all for joining us on our call. I'll begin this morning with a brief review of our performance for the third quarter, after which Vince will provide a detailed analysis of our financial results. I’ll then conclude with some commentary on market trends and contract opportunities that position us for a multi-year top and bottom-line growth heading into 2019 and beyond. To begin, we are pleased to report another quarter of strong operational performance. Our sixth consecutive quarter of profitability and a return to positive operating cash flow. I'd like to spend a few minutes to put our third quarter performance into a historical context for the benefit of our newest shareholders following our recent public offering of stock. Our quarterly results 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 multi-year contract opportunities. Coming out of a very challenging 2014, we made a series of strategic and operational choices to reorient CPI arrow to the defense market. From 2014 through 2016, we added $225 million to total backlog for programs on numerous military aircraft that included the E2D Advanced Hawkeye, the F-16, T-38 trainer and the F-35. In 2016, we implemented efficiency initiatives to drive operating leverage and improve free cash flow and working capital through cost reduction and process improvements. Fiscal 2017 was a turning point for CPI Aero, during which we returned to annual profitability and positive operating cash flow, while continuing to execute on a defense market growth strategy. Entering 2018 with an efficient infrastructure in place to drive consistent profitability, together with strengthening long-term industry fundamentals we implemented an M&A initiative to supplement our organic growth opportunities. In March, we entered into a definitive agreement with Air Industries Group to acquire its subsidiaries Welding Metallurgy Inc. WMI is a provider of specialty welded products and assemblies, large diameter tube bending and integrated electronic assemblies among other capabilities to a variety of customers predominantly within the defense and aerospace markets. We believe the acquisition of WMI will expand our capabilities, enhance our competitive position in the defense market and build a larger defense portfolio, as industry tailwinds strengthen. On October 2nd CPI entered into a court ordered stipulation with Air Industries Group Inc. With respect to litigation in the Supreme Court of state of New York concerning the acquisition. As part of the stipulation in order, Air Industries has withdrawn its purported termination of the agreement. Among other things the stipulation in order requires Air Industries to deliver to CPI Aero within 45 days audited unqualified financial statements of WMI for 2017 certified by Air Industries auditor. Subject to fulfillment of other conditions to closing set-forth in the agreement, the parties agreed that the acquisition will close within three weeks after CPI Aero receives the audited financial statements. On the heels of the ruling in mid-October, we completed a public offering that generated net proceeds of approximately $16 million. This raise will support working capital needs associated with our growing backlog, as well as potential new wins from our bid pipeline and should limit the leverage increase associated with our anticipated closing of the acquisition of WMI, which we believe will occur before the end of 2018. And bringing you to the present day, we announced this morning that current board member Terry Stinson was unanimously elected by the Board to be as Non-Executive Chairman, replacing Eric Rosenfeld who is unanimously elected to the position of Chairman of Emeritus both actions effective immediately. Terry is a very well-known and respected executive in the global aerospace industry. His impressive history of strategic and operational accomplishments will help guide our strategy to capture the internal and external growth opportunities we have before us and to build scale profitably. Terry has served in various executive management positions in several aerospace companies, including as Chairman and CEO of Bell Helicopter Textron and Executive Vice President of AAR Corporation. On behalf of the Board and the Executive Management team we also thank Eric Rosenfeld for his stewardship as Non-Executive Chairman over the past 13 years. Eric will remain as valuable member of the Board as Chairman of Emeritus. Turning back to our results for the quarter. We are seeing funds flow through the supply chain from OEMs following the passage of the 2018 Omnibus Bill earlier this year and more recently the National Defense Authorization Act for fiscal year 2018. The confluence of winding down of fiscal 2018 spending and a start of spending under an on-time fiscal 2019 budget contributed to high levels of award activity in the quarter. The result as you can see on slide four is that total backlog increased 23% sequentially to $442.2 million. The graph on the right hand side of this slide illustrating continued execution on our defense market strategy. I draw your attention to the sequential increase, which is attributable primarily to modifications of our contracts with Raytheon for the Next Generation Jammer, mid-band pod that greatly expanded our role and content on its electronic warfare system. I would also note that we maintained a base of commercial business where our technical capabilities and supply chain expertise are key competitive advantages. As an example, we secured a long term agreement with Honda Aircraft for its HondaJet Elite, advanced light jet to manufacture the noise attenuating inlet for the aircraft in the third quarter. Turning to slide five, $213 million of total backlog at September 30th is derived from defense contracts announced since 2016. That gives us visibility into defense revenue through at least 2022. As I just noted, the defense backlog increased sequentially due primarily to receiving contract modifications from Raytheon on a Next Generation Jammer mid-band pod that increased the total potential value of that program or CPI to approximately $170 million through the Navy program of record roughly the year 2030. There were other significant awards during the quarter and are waiting customer approvals to announce. These include, on September 11th, we received the first order of what we expect to be a follow on multi-year contract from an existing customer valued at approximately $47.5 million. The initial order has a maximum value of $8.1 million, $1.6 million of which is currently available to begin production of long-lead items. Also on September 11th, we were notified by an existing customer that we have been selected to receive a five year follow on contract valued at more than $8 million over the life of the contract that purchase order was received subsequent to the end of the quarter. On September 20, we received an order from our current customer, valued at approximately $1 million to manufacture an interior structural assembly on a limited production special purpose rotary wing platform. This order represents an expansion of our business with this customer into a new type of aircraft. Subsequent to the end of the quarter, we received the new purchase order from a brand new customer for the manufacture of a wing assembly used on a new missile system currently in development. This order represents an expansion of our business into missiles and other autonomous weapon systems. This is the fast track program, from which we expect to begin recognizing revenue in the current quarter. More details maybe released in the future if we receive approval from the customer to do so. I will now turn the call over to Vince Palazzolo, our CFO to review our financial results for the third quarter in greater detail. Vince?

Thank you, Doug. Before I review our third quarter results, I want to remind you that effective January 1, 2018, we adopted a new revenue recognition standard known as ASC Topic 606. Following the adoption of ASC 606 our revenue recognition on all of our current contract has not changed materially over the life of those contracts. As a further reminder, and as a consequence of our adoption of ASC 606, the asset previously called cost and estimated earnings in excess of billings on uncompleted contracts is now under ASC 606 called contract assets. And the liability, previously called billings in excess of cost and estimated earnings on uncompleted contracts is now called contract liabilities. Starting on slide seven, revenue for the third quarter of 2018 was $19.9 million compared to $20.7 million for the third quarter of 2017. Revenue for the quarter reflected the anticipated wind down of our current Northrop Grumman E-2D multi-year program as we begin to transitioning to a new multi-year contract. Partially offset by increased revenue from direct from our prime contracts with the U.S. government for F-16 components and T-38 kits. Gross profit and margin was essentially unchanged at $4.8 million and 24.1% respectively, as compared to the year ago period. SG&A increased by approximately $600,000 for the third quarter compared to the same period last year, primarily reflecting increases in legal fees for the WMI litigation, salaries and IT related expenses. Pre-tax income for the third quarter was $2.2 million compared to $2.9 million in the year ago period. The decrease was due to higher SG&A expenses. Net income for the third quarter of 2018 was $1.3 million or $0.15 per diluted share, compared to $1.7 million or $0.19 per diluted share in the year ago period. We estimate that the incremental costs associated with the WMI litigation totaled $305,000 or $0.03 per share in the quarter. Turning to slide eight, which displays balance sheet highlights. Contract assets were $114.1 million, an increase of $2.9 million compared to December 31, 2017. The increase in contract assets was the result of timing issues in the second quarter related to billing on three programs that were resolved in the third quarter. Although contract assets has increased as compared to December 31, 2017, they have declined in Q3 as compared to Q2. So as we continue to ship on programs, contract assets should continue to decline. As Doug, mentioned at the start of his remarks, we returned to positive operating cash flow in the third quarter. This was the result of improved shipping on the programs I mentioned a moment ago. We ended the quarter with working capital of $81.5 million compared to $78.1 million at December 31, 2017, an increase $3.4 million. The increase was predominantly the result of the increase in contract assets. We generated $533,000 in cash for operations in the third quarter 2018, as compared to positive cash of $905,000 during the same period last year. We expect cash flow to continue to improve in the fourth quarter of 2018. At September 30, 2018, total long-term debts stood at $5.7 million compared to $7 million at December 31, 2017. We had $27.5 million outstanding on our revolving line of credit at quarter end. Shareholders’ equity improved to $78.8 million at September 30th, with a book value of $8.80 per share. Our debt to capital ratio stood at $0.45. We completed a public offering on October 19th to raise proceeds of $16.1 million after deducting the underwriting discount and other customary expenses. Of this amount subsequent to quarter end, we have applied $4.1 million to long-term and revolving debt and expect the balance to be used for the acquisition of WMI, working capital and additional debt repayment. Turning to slide nine, we are reaffirming our 2018 financial guidance. As a reminder, our financial guidance does not include contributions from WMI. For fiscal 2018, we expect revenue in the range of $82 million to $85 million, with pre-tax income anticipated to be in the range of $8.0 million to $8.2 million. We have lowered our expected effective tax rate to 19% to 21% as a consequence of the Tax Cuts and Jobs Act. This concludes my prepared remarks. I will now turn the call back to Doug for additional commentary on the quarter and closing remarks. Doug?

Thank you, Vince. As reflected in our financial guidance, we expect a strong fourth quarter in terms of revenue, profitability, and cash flow from operations. We expect this will be driven by our next generation Jammer mid-band pod program, our new agreement on the Honda Jet Elite, and continued production of T-38 kits and F-16 wing components. As we look ahead to 2019, we see opportunities for multi-year top and bottom line growth, reflecting very favorable long-term defense spending trends. A growing backlog and a bid pipeline with several multi-year program awards on the horizon that will leverage our cost efficient infrastructure. As you can see on slide 11, 82% of our bid pipeline is cited on defense platforms. Virtually all bids are at the Tier 1 level. I noted earlier that we saw high award activity in the third quarter that drove backlog growth. With the 2019 budget passed on time, we are currently bidding on programs funded with fiscal 2019 moneys and therefore we expect our business development activity to maintain its high cadence through the rest of this year and into 2019. On slide 12 you'll see some opportunities ahead in each of the segments that we operate in. These are opportunities born not only of the expanded capabilities we have developed over the past several years that enable us to supply more complex aerostructure assemblies and aerosystems in support of our defense based programs, but also a market dynamics that very much favor CPI Aero. On today's call I want to provide some color around some of these trends and how the strengthening defense spending environment is serving to enhance our competitive advantage in the marketplace. We believe years of sequestration created a capabilities gap within our customers organization, skills such as produceability engineering, manufacturing engineering, tool design and supply chain development and management are all required in a typical program's lifecycle. Faced with this gap while defense spending is increasing OEMs are outsourcing more of their higher level work to suppliers that can provide the value added skills that they require. They are turning increasingly to CPI Aero, because we offer these skills at a time when many of our peers cannot. Our program teams are increasingly becoming integrated into our OEM partners platform teams. In effect, they view us as a force multiplier and we are the beneficiaries of more work. The contract modification we received from Raytheon on the Next Generation Jammer pod is the most recent example of the success we have with this strategy. Two of the opportunities shown in this slide a multi-year programs that we expect will be awarded next year. The first is the A-10 for which the 2019 defense budget adds $144 million beyond the $103 million already year marked for the program from the 2018 defense budget to re-wing the initial 12 aircraft of what is envisioned to be a five year program to provide 112 A-10 aircraft with new wings. We have submitted proposals to two competing prime contractors who in turn have submitted their proposals to the Air Force. The Air Force expects program award in March 2019. The second is the outer wing panels for the E-2D Multi Year 2 Contract both for the U.S. Navy and for Japan. I mentioned at the start of my prepared remarks that we are in the process of winding down the Multi-Year 1 Contract and the 2019 budget also gives a green light for a new multi-year procurement of E-2D advanced Hawkeyes and authorizes long lead funding. We are currently in discussion with Northrop Grumman on the terms of a five year contract to continue to supply the same kits we have been supplying now for more than a decade. Turning to slide 13 our focus on multi-year defense award gives us excellent long-term revenue visibility. Our defense and commercial programs have the potential to generate over $442 million over the remainder of their periods of performance. So in conclusion, market tailwinds are strengthening and with spending certainty over the near-term, we are positioning ourselves to win a bigger slice of that spend both through business development initiatives that leverage our capabilities and through M&A. We are executing on all cylinders with the capital necessary to execute on our growth strategy through the consistent and hardworking efforts of our management team and especially our employees, we have never been positioned better to succeed. That concludes my prepared remarks, like to thank you each for participating on today's conference call. And Keith you can open the call to questions. Thank you.

Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Ken Herbert with Canaccord.

Hi. Good morning, Doug and Vince.

Hi, Ken.

Hi, Ken.

Hey, Doug. I just wanted to first clarify, did you provide a date as to when you expect to sign the next multi-year for the E-2D?

No. That was one what I just mentioned there at the end that we believe will be the early part of next year for the multi-year.

Okay. But everything is on track with that process and I know obviously you've had a bit of a deep here near-term as the first multi-year has wind down. But when you think about the second multi-year, how does it compared to the current contract that's winding down? Are you seeing any increased content perhaps on a ship set basis or is the broader contract meaningfully different?

No, it's virtually the same in terms of content, there have been price adjustments now as it's later than the original contract was signed. But the physical contents of what we are providing will remain the same. The multi-year is envisioned to be five year program and it is also envisioned to include not just what is required from the U.S. Navy, which I believe is another 25 aircraft or so, but also anticipated sales of internationals E-2Ds for example for Japan. So the exact I'll say form the contract is yet to be decided by our customer and that's what's going to take another couple of months to kind of figure out.

Okay. No, that's great. Thanks for the color there. And if could, Vince or Doug, the gross margins in the quarter were obviously very good. And I know it's consistent with what we've seen in the last few years with the third quarter. Was there anything unique this quarter or was it really just what you're able to ship in the quarter?

I think it was a favorable mix even though the revenue might be down from the third quarter, it was -- of last year, the mix was favorable. And also it reflects the -- I'll say the increased content on the Raytheon program in particular.

Okay, that's helpful. And then just finally, when I look at your -- the bid activity and the bid pipeline. You've had some recent success obviously with HondaJet, but you're clearly putting more resources into the defense market and I think that's reflected of course in the backlog and the success you're seeing. How do you think strategically about commercial opportunities? Now when I say commercial specifically business jet for you. And is that an area you think you might start to see turn in the backlog there with pursuits of bid activity or really should we just think about defenses as the key source of upside for the next couple of years?

No, I don't think that's true at all actually. The -- you've reported on and others about the -- we'll speak at least now for the business jet segment. It's definitely strengthening market. We've made considerable I'll say investments in relationships with the major manufacturers of business jets, including some of our current customers. But we have before is now within the bid pipeline several large aerostructures programs for newer business jet that we expect to be awarded to -- hopefully to us. But it will be awarded by our customers into say the next four to six months called it. So we're very happy about the -- about seeing increased opportunities in that. And we are currently exploring opportunities to help I'll say outsourced production for some of the higher rate commercial programs such as maybe something new for us. But as these rates, particularly on the narrow body planes increases, we feel that there are maybe some potentially and we’re going to kind of pursue that a little bit over the next several months to see if there is any truth to our theory that there might be those opportunities for outsource production for higher rate aircraft. So we'll see. But right now, no, I wouldn't say that that defenses exclusive in a bid pipeline. I think we have a fairly good mix. And I think long-term you shouldn't expect to see this to be a 95% or 90% military company. I think we need to strike a good balance. So -- but clearly the backlog success of the last two years has been from the military environment.

Great. Well, thank you very much for the color. Really nice quarter.

Thank you.

Thank you. [Operator Instructions] And the next question comes from Mike Crawford with B. Riley FBR.

Thanks. Given that you…

Hi.

Hi. Given that you embarked on M&A strategy in 2018, and then agreed to this acquisition and that you said you are going to acquire with credit, why did you not do so and instead issue equities?

But we had the credit lined up as we reported previously. And the plan what event to finance this with the debt. That kind of changed as the bank commitment expired as the closing moved beyond and then went into litigation. And with the new ruling from the court that we have basically a three week time period, after which we have to close the original agreement was more open ended in terms of a financing contingency. We felt it was the prudent course to make sure that that opportunity didn't elude us and we wanted to secure the financing and we did so with equity.

So your credit agreement lapsed that's what happens?

The commitment lapsed, because all of these commitments have a certain period of time.

Okay. All right, thank you.

Thank you. And that does conclude the question-and-answer session. I would like to turn the floor Douglas McCrosson for closing comments.

All right. Thank you all again for participating on today's call. Vince and I look forward to speaking with you all again in March, when we announce our year-end 2018 results. Thank you.