CPI Aerostructures Inc (CVU) 2013 Q1 法說會逐字稿

Greetings and welcome to the CPI Aerostructures, Inc. first-quarter 2013 conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions).

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Edward Fred, Chief Executive Officer. Thank you. Mr. Fred, you may begin.

Thank you, Kevin. Good morning, and thank you all for joining us for our first-quarter 2013 conference call. If you need a copy of the press release issued this morning, please contact Lena Cati of The Equity Group at 212-836-9611 and she will fax or email a copy to you. Also if you would like to listen to this call again, you can hear a replay on our website's Investor Relations section in about an hour at www.cpiaero.com.

Before we get started, I want to remind investors that 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 is the government's ability to terminate their contracts with us 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 us from doing business with them as well as competition in the bidding price process for both government and subcontracting contracts.

Our subcontracting customers also have the ability to terminate their contracts with us if we fail to meet the requirements of those contracts. Or if their customer reduces or modifies its contracts to them 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 our filings with the SEC.

As has been the case in previous first-quarter conference calls I will provide our new listeners with a brief overview of CPI Aero and our activities. Based on Long Island, CPI Aero is a world-class manufacturer of aerospace structural parts and assemblies. During the last few years, we have substantially grown our business by becoming a subcontractor to some of the largest US aerospace and defense contractors such as Northrop Grumman, Boeing, Sikorsky, Spirit Aerosystems, Lockheed Martin, HondaJet, Cessna, Embraer and Bell Helicopter. We are also a prime contractor to the US Department of Defense.

Since its inception in 1980, CPI Aero is focused on the production of aerospace structural parts and assembly and in developing the required skills and expertise to produce the highest quality products possible. We have carved out for ourselves a niche within the aerospace market and become one of the country's leading suppliers of structural spares for vintage and out of production aircraft, now assemblies for new production planes.

Typical assemblies produced by CPI Aero are skin panels, leading edges, flight control services, engine housing, cowl doors, wingtips, outer wing panels and the sales and [inward] assemblies for military aircraft such as the A-10 Thunderbolt, UH-60 BLACK HAWK helicopter, E-2D Hawkeye, E-3 Sentry, C-5A Galaxy, C-130 Hercules and the B-1 Bomber; and various structural assemblies for commercial aircraft, such as the Gulfstream G650, the HondaJet Advanced Light business jet, the Cessna Citation X, Embraer Phenom 300, and the S-92 helicopter.

So with that prelude, I will now hand the call over to Vince Palazzolo, our CFO, so he can walk you through the financial statement details. And then I will comment on the current business environment and then wrap things up and open the call to questions. Vince?

Thanks, Ed. As reported in this morning's press release, comparing the first quarter of 2013 to the first quarter of 2012, revenue increased slightly from $19,927,433 from $19,721,095. Gross margin was 22.3% as compared to 25.2%. Pretax income decreased to $2,421,276 compared to $2,710,320. Net income decreased to $1,671,276 or $0.20 per diluted share compared to $1,919,320 or $0.27 per diluted share.

Selling, general and administrative expenses were approximately $1,878,000 or 9.4% of revenue compared to approximately $2,105,000 or 10.7% of revenue.

Ed?

Thanks, Vince. The federal budget sequester has resulted in delayed contract decisions by many prime contractors in the aerospace and defense segment including our customers.

As of March 31, 2013, we received approximately $11.5 million of new contract awards compared to a total of $31.7 million of new contract awards in the same period last year. This decrease was anticipated and was already requested in our financial performance expectations of 2013.

Now that sequestration has become a reality and the Company and our customers have more definite information regarding certain key defense programs, the Company expects new orders for military aircraft to accelerate and we expect to have a solid year for new business from both the military and commercial segments.

There is also a real business potential from the bid pipeline of unawarded solicitations outstanding, once these programs either become funded or are awarded.

In the past several years, our reputation has been elevated in our industry, thanks to our impressive list of customers; the success we have experienced on the important programs we are working on; and the exposure we have had and contacts we have made at various aerospace and defense institutional investor conferences.

We are now in the midst of establishing relationships with additional prime manufacturers, including other helicopter and business private jet companies who have come to recognize CPI Aero as the premier supplier of structural aircraft. Among the unawarded bids outstanding are contract opportunities with these potential customers, including our first serious opportunities to perform work on multiple commercial jetliners. We look forward to reporting on our progress of turning solicitations with these prospects into awards on contracts in the very near future.

Our total backlog at March 31, 2013, increased by $28.4 million from approximately $420.3 million as compared to approximately $391.9 million at December 31, 2012. This increase was attributable to a $42.3 million increase in backlog on commercial programs offset by a $13.9 million decrease in backlog for military program.

Funded backlog increased to $81.9 million at March 31, 2013, from $52.3 million at December 31, 2012, which was predominantly the result of a $31.8 million increase in funded backlog on commercial programs.

Our first-quarter results were in line with our expectations. Our 2013 guidance is factored in the current defense budget environment and reflects the cuts mandated by the Budget Control Act of 2011.

For 2013, we continue to expect revenue and earnings to be lower than 2012 and more similar to those of 2011, commercial programs to generate a larger percentage of our overall revenue as compared to 2012, product shipments to be greater than in 2012, or any other year, as many of our programs have transitioned from development to production, increased shipments combined with less spending for startup costs associated with new contracts and a decline in nonrecurring expenses on our maturing programs to result in positive cash flow from operations of approximately $3 million. We still expect our gross margins for the 2013 full year to be within our projected range of 25% to 27%.

The first-quarter gross margin was affected by adjustments to our long-term programs with Spirit and Boeing. The adjustments of the Spirit program was a result of price reductions given as part of the negotiations to increase the program value and extend its life until 2013, while the Boeing adjustment was due to negotiations for program changes.

We anticipate our SG&A expenses to remain as low as possible as we take a cost-conscious approach to spending in 2013 to account for the reduction in revenue this year. To support our increased delivery requirements and expected growth in the future, we have amended and increased our credit line to a borrowing capacity of $35 million and we have increased our workforce to approximately 225 people.

On a separate note, CPI Aero will continue to tell its story as often as possible and demonstrate to our shareholders and potential investors that the effects of sequestration upon CPI Aero's operations are a temporary setback which we had no control over.

To that point, we will participate in the B. Riley 14th Annual Investor Conference presenting at 1 PM Eastern time, 10 AM Pacific time on May 21.

Our presentation will be webcast and I encourage all of you that can't attend the conference to watch it either live or replay it on the CPI website.

Also, CPI will have a presence at the 2013 Paris Air Show in June where we previously made inroads with companies that we are now able to call customers. And through a grant given to CPI by New York State we are able to attend at a reduced rate and have a presence at the New York State Department of Economic Development booth located in the US International Pavilion.

We look forward to our immediate and long-term future with great anticipation. We realize that 2013 is testing the mettle of both the management of CPI and our shareholders while we are excited and well-prepared for this challenge, as we execute on our current contracts, delivering unprecedented amount of product to our customers, develop new customers, and work to become a cash flow positive company.

We are well-positioned to resume growth in 2014 and beyond. Our new business opportunities remain strong and we are bidding on larger and more complex contracts including those for large commercial aircraft parts.

At this point, I would like to open the floor to questions. Kevin, can you allow callers to place questions now?

Certainly, sir. (Operator Instructions). Mark Jordan, Noble Financial.

Good morning. Ed, I would like to delve in and get a little better explanation of your discussion of new orders and how it relates to backlog. New orders used to top at $11.5 million but backlog in the quarter went up $28 million. Is that a distinction between potentially an expansion of the Spirit contract in the first quarter which increased backlog but wasn't reflect -- that was not reflected in your total of new business awards?

That's a pretty good synopsis of what it is, yes. Now what was included in the new business awards obviously is just that amount that we were released for out of the long-term contract. Yet backlog increased by a substantial piece of that contract that goes out to 2019. So yes, that is correct.

Second question relative to, obviously, a very strong jump on the backlog. Would you talk about the deliver -- the expected delivery cycle for that $81 million in funded backlog?

Most of what you see in our funded backlog at this stage in our business cycle is the Company will be liquidated within a 12-month period of time. To that end, we will obviously be adding to backlog over the next 12 months so that it is not to be read that, okay, once they are done with their $81 million they have no future revenue stream. Not the case, obviously.

Okay. Would like to talk for just a second about the E-2D program possibly as an example of how sequestration is impacting your order flow. It is my understanding that the Department of Defense has defunded one of the four planes for the E-2D program in the 2013 budget. In that budget it is my understanding that E-2D was in its LRIP, or low rate production and that it was expected historically that that would go into volume production and left to potentially six plus planes for a year for an extended period of time.

You know that while you may have -- we have had a defunding of one plane this year, what are the plans for the program -- has there been any change in the program in terms of progressing to a volume production rate meaningfully in excess of where you are today?

Okay. That reduction had nothing to do with CPI, just so you know. Remember that for anywhere from 12 to 15 to 18 months ahead of the schedule or behind the schedule, depending on how you want to look at it. So, that one plane reduction would come in a future release that we would receive from Northrop Grumman. So it does not impact us at all for this year or next year's build.

However, the one point you left out of there is that the DOD did give permission for long rate production on the E-2D. It is leaving its low rate production mode and going into a full production mode albeit with sequestration staring us in the face. So while one plane may drop out of a given year's budget, because there is a dollar reduction required, the program itself is as strong as it has ever been, that we now know that the government has said we are funding a 75 airplane program along with funding at 25 airplane modification program on the C-2A.

So, from our perspective, I think from Northrop Grumman's perspective, though I won't speak for them, I think we all look at this as probably the most vibrant program any one of us are dealing with right now.

Final question, if I may. What was depreciation and amortization in the quarter?

$163,500.

He was ready for you, Mark.

Thank you very much.

Joe Bess, ROTH Capital Partners.

Good morning, gentlemen. Ed, can we talk a little bit more about gross margins and your expectations for the rest of the year? And really with your expectations for it still to be between the 25% and 27%, is this a function of contract mix that you have in the pipeline right now? Or can you give me a little bit better understanding of where this margin expansion is going to be coming from on a sequential basis?

Yes, all right. Be careful about calling it margin expansion, because we don't give quarterly margin projections, estimates, or anything else. We do it based on a given year.

Now as we wrote in our press release and I mentioned here in the script, we had to take some adjustments to gross margin. Yes, one of them was the fact that we had to lower our pricing to Spirit to get the long-term contract extension that we got. And when you do that you have to adjust the gross margins you have taken so far.

I think that should give an indication that the pricing reduction wasn't so severe that -- we have a five-year program and the gross margin for the entire Company dropped less than 3%. So given that and the fact that that is a one quarter adjustment, if we run our normal 26%, 27% over the next three quarters, we will fall right into that 25% to 27% range. So I think that is the way you want to look at this.

Okay, great. Then thinking about the contract that got pushed out from kind of the end of December timeframe potentially into 2013, can you give us a status update on that contract?

We don't have it yet. We are expecting it. All indications are that we will be getting it.

Unfortunately, we are just caught up in the bureaucracy of the Company's approval cycle at the moment. But as I stated again in my conference call, we expect this to be an incredibly solid award year and that contract will be a very big piece of that. And there is no reason nor any indication that CPI will not have that contract this year.

And since we have already accounted for the fact that we didn't have it in our 2013 numbers, while I would love to see it sooner rather than later, if I got it in June versus September versus November, it would not impact my 2013 numbers.

Great. Then thinking a little bit more about the funded backlog and what you said about majority that will be recognized over the next 12 months, are you able to give a little bit more color on what you guys are expecting for that to be for the next nine -- or the next nine months for the 2013 number?

I would say to you subtract $19 million from $74 million and that number is what will come out of the backlog for the next nine months. It's not -- our number for 2013, our projected number which we said would be very similar to 2011, that number was $74 million. We will be right around that number. Very little can change that number downward and unless we get a major surprise or get something very early, but we are not expecting it, it probably won't go up either.

Okay, great. Thank you.

Michael Callahan, Topeka Capital Markets.

Good morning, guys, and thanks for taking my question. First thing just on cash flow, negative cash flow in the first quarter even while, I guess, sales were flat, at some point, I guess as sales are declining throughout 2013, I guess you would expect shipment to be in excess of work completed on these contracts. Can you guys give us any sense as to when that inflection point might take place and to what magnitude the swing might be when it does?

I think you'll see a move towards positive cash flow for the second quarter and then you will experience positive cash flow in the third and fourth as we deliver high, high rates. The reason obviously -- or at least it should be obvious to a lot of people, I know it is to you, Mike, is that the first quarter would be negative cash flow because the fourth quarter of 2012 was the best quarter we ever had revenuewise. Since we are driven, our revenue is driven by procurement, the first quarter is when we paid the bills on all of the procurement we brought in in the fourth quarter.

So that said, you should start to see a marked decrease in negative cash flow. We are hoping to approach breakeven cash flow at the end of the second quarter, might be slightly negative, might be slightly positive, nothing dramatic in either case. And then the third and fourth especially the fourth is where you will see the major turnaround in cash flow. That will get us to a $3 million positive year.

Okay, thanks. That's helpful. Then, just on the revenue number, so if you take first quarter and annualize it, you come out to a higher, significantly higher rate than what you are adding in 2011. Does that suggest that there are contracts that will be completed in the second, third quarter and that it will actually flip negative on a sequential basis? Or how should we be thinking about that? And is that specifically related to the fixed wing contract then with the Department of Defense?

I am trying to figure out how to answer you here. The question was a little confusing. But, yes you will see decreases in revenue as we have told people we would for the entire year this year. It is not that programs will be completed, we will simply be -- the ordering necessary given the slowdown in programs for the time being. You will probably see most of that in the second and third quarters, I would think.

And then assuming we have won the awards we expected to, things have gone the way we expect them to go this year and 2014 to be a good year, you would see the fourth quarter start a major pickup. The third quarter is the quarter you are looking at as being the worst of the four.

That's helpful as well. Lastly I wanted to ask you on the -- you mentioned some negotiations with Boeing and that contributed to lower margins in the first quarter. Can you give us any color as to what the status is of the receivable with Boeing and how close that is to being resolved?

Sure. What I can give you right now is we have as we have stated in the press release, had negotiations with them. We are reaching points of agreement on various issues. Subsequent to March 31, we received a major payment for items that were old in the receivable category. So you would see a reduction of that in next quarter's financial statement.

So while it has taken a very, very long time for both companies to work out these matters, significant progress is being made.

Okay. Thank you, guys.

Bhakti Pavani, C.K. Cooper & Co.

My question was related to the price negotiations that you talked about in your prepared remarks with Spirit. In the fourth quarter you received a contract from Spirit. So my question is, is the pricing fixed on that contract or is there a probability for their price negotiation going into the future?

It is a fixed price contract like all of our contracts are.

Okay. The other question was on the Boeing. You mentioned that there were negotiations on program changes. Would you provide some color on the current negotiations and also on the A-10 program? How is that looking and are you guys shipping any kind of shipments for this year?

Okay. First, we have been shipping all along on the A-10 program. I think people have a misconception about the Boeing program.

The Boeing program is a wonderful program and they are a fantastic customer and we have a very good relationship with them. We have been negotiating a couple of things -- older receivables, changes in the program pricing based on engineering changes, production changes, material changes, things like that.

When you are dealing with a customer that big and on a program this big, this takes an awful lot of time. More time than any of us would like, but that is the nature of the beast if we want to work with a company the size of Boeing.

So with that said, I will say to you that the negotiations that have taken place that resulted in the slightly lower gross margin was simply the negotiation on us saying a change in engineering was worth $2.00 and then saying no, baloney, the change is worth $1.25. And us coming to a price somewhere at $1.61 that we both agreed to.

And this will be an ongoing process. Sometimes we will have to come down in price, sometimes they will have to come up in price. And we will eventually have all of these issues ironed out.

Other than that, we are delivering all year. We would anticipate a release on this program, the next release now that sequestration is in place and Boeing knows what their customer is willing to give them from a budgetary standpoint. So we don't see any problem with this program, nor with this customer. And anything people think to the contrary would be incorrect.

So I hope I have clarified that today.

No, that is really helpful. Thank you. My next question was other than the price negotiations with Spirit have you received any kind of request on pricing negotiation on existing [LPs] that you have in place? From any of your other customers?

No. None.

My last question was related to the tax rate. What kind of tax rate exemption should be taken into consideration going forward?

We anticipate the tax rate for the whole year to be between 30% and 31%.

Okay, that is it from my side. Thank you very much.

(Operator Instructions). Mike Crawford, B. Riley & Co.

Just getting back to the statement about revenues driven by procurement, can you walk through exactly what happened to the balance sheet, given that you don't hold inventory so what exactly are the uses of cash in Q1 after you take in a bunch of orders like in Q4?

When you buy for product as we did in quarter 4, which was the most product we ever bought, it was the highest procurement quarter we had in our history, that product is going into the build for this year. Now when we book it in the fourth quarter because of percentage of completion, that procurement buy generates a revenue of whatever gross margin each of those programs have.

The entry would be to credit revenue and you debit cost and estimated earnings in excess of billings on uncompleted contracts. As we begin to deliver product, whenever that is on each of these items, you then debit receivables and credit cost and estimated earnings on excess of billings. Over the year, you should see cost and estimated earnings go down somewhat because we anticipate delivering a significant -- I will call it significant, although I will be careful with the word. Let's just say more than I expect to book in revenue. So my deliverables and therefore my true receivables will outpace the amount I am adding to cost and estimated earnings in excess of billing.

So that number should come down as the year goes on.

Okay, thank you —

Did that answer it completely?

Well, yes, but is there -- there's no footnotes or any other disclosure where you can see the amount of product. I don't want to call it inventory that you are holding over time. Is there a way to track that more closely?

Not publicly, no. (multiple speakers). You just have to know that if CE and E, as we call it, is going up, then the Company is buying product and building accordingly. If the number is going down it means we are buying less than we are building and therefore true inventory, if you will, and, again, percentage of completion does not have an item called inventory, but to go to layman's terms, the items that we are buying that we are going to assemble, if you want to phrase that as inventory. If the CEE in account is going down, that means we have less of that material in the facility to use to build an assembly with.

So, you buy a product which, maybe somewhere in your books you call inventory, but we just see it as one line item. And then you book an assumed gross margin, but then if you have a price negotiation then you will go back and there will be a one period adjustment to gross margin, so in other words, based on the Spirit renegotiation, you had to maybe debook some assumed gross margin that on product that had been worked on already, but now going forward you are expecting the revenue to come in closer to that 25% to 27%? (multiple speakers).

We are not necessarily debooking revenue. And this doesn't occur that often. This occurred because we had a contract that productionwise was expiring at the end of 2013. I think everybody can take a look at what platform that is and realize that the number of planes including in our contract was nowhere near the number of planes that the time contract that was forecasting it was going to sell, et cetera. And so in order to get the extended life contract which basically says we will build those parts for that plane for as long as the plane exists, there had to be some price negotiation.

And anybody who is following this industry knows that there have been cost pressures on Spirit on its programs. That is not news. That is not giving away a customer's secrets. They have published numerous times that they had cost pressures on a few programs. This was one of those programs.

In order to participate in it for the next six years and build who knows how many more planes, 100 to 200, 300, who knows, there had to be some price concession. And some of those concessions involved planes that we still have yet to be delivered.

So, there was a slight reduction. And I do mean slight. I mean, when you consider we had two adjustments to programs and the gross margin for a quarter is less than 3%, I think if you think of the life of the program, the fact that it was out there five years, this is not what I would call a major adjustment. This is not an accounting change where we had to disclose it and book it differently. This is simply a tweaking, if you will, of a gross margin over program that is going to eventually be about 11 or 12 years.

Thank you very much.

Mark Jordan, Noble Financial.

I would like to follow up a little bit, Ed, on your comment about saying that you are well-positioned for seeing growth in 2014. I would like to just talk about the various pieces of your business and what level of optimism you have in each of those pieces. And first, I would say the incremental new business, both defense and commercial, then do you see the defense -- your existing defense customer base rebounding versus -- in 2014 versus 2013?

And then, finally, do you continue to expect to see your commercial business growing in 2014 versus 2013? Could you address each of those four pieces?

Okay. First, current military business rebounding. Yes, we do see that. Because sequestration or the threat thereof created tremendous uncertainty for our customers, for ourselves, for everyone. Not knowing what it would do, what programs would be affected, et cetera.

We have had sequestration. We know what each of the customers are getting dollarwise, funding for their programs. There is a 2014 budget out on the Street, if you will.

So I think it creates clarity that wasn't there. So when you say is it going to rebound, yes.

We expect to get releases on contracts that we have that we didn't get in 2013 or 2012, I should say, that were expected and would have made 2013 a better year than 2012. That didn't happen.

So we do expect those to come back based on inputs from the customers and just the fact that the budget is all clear now. So that is one.

Two, we have got some new programs, Citation X, the HondaJet, the Embraer Phenom 300. Those should all pick up in volume in 2014, again, leading to growth. Now, as far as what is in my pipeline, both militarily and commercially, we are going to go with this comment to you. We are always pretty accurate on what we can anticipate in the way of new business. Not always accurate on what the program will be internally, but we have always been able to guess at the kind of percentage we will get of new business in a given year.

And given that our gross margins are pretty much the same now, yes, they can vary 3 or 4 points high or low from that 25 number, but in general when you compile our new business awards every year, they will come in on programs that will generate another 25%, 26%, 27% gross margins.

They may not do that in day one in the early stages as we have all seen with any new programs start-up. But as a program and over the life of that program they will generate those same margins.

So it is that combination of knowing that the commercial business will pick up in 2014; knowing that we will received releases on military programs on 2014 that we didn't in 2012 that affected the 2013 revenue and of course net income; knowing that we are bidding on a variety of commercial programs for a variety of commercial parts. And when I say commercial I mean jetliners not business jets, and knowing we are going to win a certain percentage of the new business awards that are out there, that is what gives us the confidence about 2014.

How confident are we? That I will not quantify yet. But I think you can see just by all of those factors that 2013 was an aberration.

Okay. Thank you very much.

Thank you. That does conclude our question-and-answer session. I would like to turn the floor back over to management for any further or closing comments.

Thank you, Kevin. Before I close the call, I would just like people to know that for the many of you who are unable to travel to CPI or see our facility firsthand, we have produced a two and half minute video that will give you a flavor of what we do here and what the inside of the facility looks like. It will be posted on the Company's website this week and will also be used in our business development presentations going forward.

I would like to thank all of you for participating in this call and look forward to speaking to you again in early August for our second-quarter earnings call.

In addition, please remember that our annual shareholders meeting will be held on Tuesday, June 11, in New York City and you are welcomed and invited to attend. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.