Earnings Transcript for CVU - Q1 Fiscal Year 2019

Operator: Good day, and welcome to the First Quarter 2019 CPI Aerostructures Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Sanjay Hurry, Investor Relations Counsel. Please go ahead.

Sanjay Hurry: Thank you, Andrew. Good morning, everyone, and welcome to CPI Aerostructures 2019 First Quarter Financial Results Conference Call. A copy of the company's earnings press release that was issued this morning and the accompanying PowerPoint presentation to this call are available for download on the Investor Relations section of the CPI Aero website. On the call this morning are Douglas McCrosson, President and Chief Executive Officer; and Vincent Palazzolo, Chief Financial Officer. After their prepared remarks, management will hold a Q&A session. As a reminder, this conference call will contain certain 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 the 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 I turn the call over to management, please note that Doug and Vince are available for follow-up with institutional investors. Please schedule a follow-up via the contact details listed in today's press release. With that said, I'd like to turn the call over to Douglas McCrosson, President and Chief Executive Officer. Good morning, Doug.

Douglas McCrosson: Good morning, Sanjay, and thank you all for joining us on our 2019 first quarter results call. I will begin with a brief review of the quarter's performance and our progress in integrating our recently acquired subsidiary, Welding Metallurgy Inc., or WMI. Vince Palazzolo, our CFO, will then review our financial results in detail. I will then conclude the call with some commentary on the implications to CPI Aero of the 2020 defense budget request. And highlight several key contract opportunities that should keep us on a solid growth trajectory over the next several quarters and beyond. Starting with Slide 4. Continued operational execution during the quarter gave us a strong start to the year and advanced our strategic priorities for 2019. We are pleased to report higher revenue, gross profit and net income year-over-year. Our results were driven predominantly by production rate increases on our Next Generation Jammer pod program for Raytheon and revenue from our WMI subsidiary. Reporting financials tell only part the quarter's performance as both CPI Aero and WMI also generated strong bookings. We generated $2 in new firm delivery orders for every dollar of product shipments during the quarter, for a book-to-bill of 2.0. Our consolidated product sales backlog increased by approximately 14% during the quarter, and now stands at approximately $134 million. I'm happy to report that we completed the consolidation of WMI's operations into our facility by the end of March, as planned. Obviously, the quicker we can fully integrate the companies, the faster we realize the expected synergies. We did observe some improved overhead absorption in the first quarter, even when operating from 2 facilities. So we expect continued improvement in cost from this point forward. But I'm most pleased by the strong support and cooperation of our customers during the transition. As we expected, once the acquisition closed, we saw a surge in new orders as customers gained confidence in WMI's future. WMI secured more than $5 million in new orders during the quarter. And it's backlog was $17.4 million at quarter end. As I reviewed on our fourth quarter call, we secured notable additions to backlog in the second half of 2018, including 3 programs which we are starting in 2019. They are, first, the Lockheed Martin F-16V for international markets. Second, an undisclosed and our first missile platform. And third, and unnamed Sikorsky helicopter platform. Given the concentration on new program starts this year, it is crucial that we get off to the right foot and ensure we have the right processes in place today to meet delivery schedule goals for the year. These programs are also critical to our ability to grow our business with these customers over the long term. Therefore, flawless program execution is imperative. I am pleased to report that each of our 3 new program starts is on plan. We have made a first delivery on a Sikorsky platform, first delivery on the developmental missile wing is imminent and we are underway on the F-16V with deliveries slated for later this year. Turning to our backlog at quarter end on Slide 5. Consolidated and defense backlog were mostly unchanged from the fourth quarter's record levels. As a reminder, these figures are inclusive of WMI's backlog. A quick clarifying note here. The backlog reported here is revenue backlog. As you know, on many contracts we recognize revenue as work is performed. The total backlog is potential revenue expected to be recognized over the remaining life of existing contracts. As I mentioned on our fourth quarter 2018 call in March, we are including product sales backlog, which I reported earlier as totaling $134 million. This is the total value of firm open orders on the books and we believe provides additional context for our shareholders to assess our ability to generate cash. Slide 6 lists key defense programs in our backlog. Collectively, these military platforms account for the majority of our $384 million defense backlog. I'll highlight two today. In the bottom row, you see our E-2D program. Last fall, we received a first order valued at $8.1 million from Northrop Grumman for long lead-time items under a contract that could expand to a maximum award of $47.5 million. After the close of the quarter, the U.S. Navy awarded Northrop Grumman a multibillion-dollar contract for 24 E-2Ds, what we refer to as multiyear 2. This award supports our expectations that our contract will approach the full $47.5 million over the next 4 years. We are currently in discussions with Northrop Grumman on securing the full multiyear order, and hope to conclude these negotiations in the third quarter. E-2D is also an important program for WMI and has been for years. Separately, WMI is currently quoting a significant package of welded structure and tube assemblies for multiyear 2 for which they are the current incumbent supplier. I'd also like to point out the Raytheon Sea Sparrow program in the bottom row. This is a legacy WMI contract to build electronic cabinets. We are in the final stages of production and expect to ship these units during the current quarter. Now let me turn the call over to Vince Palazzolo, our CFO, who will take you through our financial results for the quarter and our financial guidance for the year. Vince?

Vincent Palazzolo: Thank you, Doug. Starting on Slide 8, I'll begin my review of the first quarter results. Revenue increased approximately 41% year-over-year to $25.6 million from $18.2 million for the first quarter of 2018, due primarily to continued production activity on the Next Generation Jammer pod program that we have with Raytheon and the contribution of our WMI subsidiary. During the quarter, certain WMI technical certifications did not transfer to CPI Aero by March 31. And this resulted in some push outs of shipments until May and June. We expect the balance of WMI certifications to transfer to us by the end of Q2 2019. Gross profit increased to $5.4 million in the first quarter of 2019 from $4 million for the first quarter of 2018. Gross margin declined modestly to 21.1% compared to 21.9% in the prior period due to an unfavorable contract mix of CPI jobs as well as low gross margin on WMI jobs as a result of business combination purchase accounting. SG&A increased by approximately $800,000 for the first quarter compared to the same period last year. The increase reflects cost incurred in the quarter related to WMI and professional fees associated with expanded audit and reporting requirements. Pretax income for the first quarter increased by approximately $500,000 to $2.1 million from $1.6 million for the same period last year. Net income for the first quarter of 2019 was $1.7 million, an increase of 32% compared to $1.3 million for the same period last year. Taking into account the higher share count following our equity offering in October 2018, EPS was $0.14 for both periods. Turning to our balance sheet highlights on Slide 9. Cash and restricted cash at March 31 was $2.6 million. $2 million of the cash on hand at quarter end is held in escrow, pursuant to the acquisition of WMI. Contract assets were $120.7 million, an increase of $7.4 million compared to December 31, 2018. The increase in contract assets was the result of materials and processing cost associated with the new design on the HondaJet inlet, for which we have not yet begun billing at a steady rate and the Raytheon Next Generation Jammer pod and the T-38 Pacer Classic program. Total long-term debt stood at $3.6 million compared to $3.9 million at December 31, 2018. Our outstanding balance on our revolving line of credit at quarter end was essentially flat at $24 million. Shareholders' equity at quarter end stood at $95.3 million compared to $93.4 million at December 31, 2018. Effective January 1, 2019, we adopted ASC 842, which sets out the accounting treatment of leases. As a result, on January 1, 2019, we recognized operating lease assets of $5.3 million and operating lease liabilities totaling $5.8 million. In accordance with the accounting standard, we elected not to recast the prior comparative balance sheet periods. The adoption of ASC 842 will not have a material impact on our income statement. On Slide 10, we are reaffirming our 2019 financial guidance. We expect revenue in the range of $98.0 million to $102 million. Pretax income is anticipated to be in the range of $11.0 million to $11.3 million. Cash flow from operations is expected to be in excess of $3.5 million. Our effective tax rate is expected to be in the range of 20% to 22%. This concludes my prepared remarks. I will now turn the call back to Doug for additional commentary on the quarter and closing remarks. Doug?

Douglas McCrosson: Thank you, Vince. Looking ahead, the DOD recently published its 2020 defense budget request that indicates significant growth and proposed funding levels for key programs in our bid pipeline. On today's call, I want to provide some color and timing around some of the programs that are keeping us on a path to continued growth. The market's military budget is set to grow for the fifth consecutive year to near historic highs in 2020. The U.S. government is expected to spend more on our military this year than at any point since World War II, except for a handful of years at the height of the Iraq War as the military moves to rebuild and retool for competition against other great powers. The budget also includes funding for technologies and capabilities that CPI Aero has been making strategic business development priorities, including electronic warfare, intelligence reconnaissance and surveillance, advanced missiles and autonomous systems. In sum, the 2020 defense budget request appears to be a positive for CPI Aero. We will be actively monitoring the budget as it winds its way through the approval process. Within our product categories as shown in the pie chart on the right side of Slide 12, our Aerosystem segment is up 8% sequentially and consistent with our business development priorities I just mentioned. We also remain true to our Tier 1 strategy, where we believe we represent a compelling value for our prime contractor customer. Fully 85% of our bids by dollar value are direct to the OEM of the aircraft or weapon system. Let me spend a few minutes on Slide 13 that illustrates key programs within our bid pipeline. At the top side of this slide, in the first section, Aerostructures, you'll see the A-10 is the first bullet. It is intentionally placed at the top of the list and is one of the largest potential awards in our 2019 bid pipeline. With the publication of the 2020 budget request we see funding support to the A-10 for the third fiscal year in a row. Prior budget secured approximately $247 million in funding for the rewinging program that has not yet been obligated. The 2020 budget request is seeking an additional $169 million to support the rewing effort. The Air Force is a month or 2 away from selecting winner in this competition. As we've previously discussed, we're uniquely positioned with the contractors vying for the A-10 rewinging contract, and believe that our history of program excellence on this airframe will earn us the honor to continue working on this program for many years to come, no matter which prime contractor is awarded the contract. You will note that there are other many exciting opportunities before us. In particular, we are seeing demand for our Aerosystems manufacturing capability, and support of many of the emerging technologies that are strategic priorities for the DOD as reflected by the 2020 budget request. For example, we have proposed new work for newly developed electronic warfare pods as well as for subassemblies on next generation missile systems. It is our belief that most of the opportunities on this page will be awarded within the next 12 months. Turning to Slide 14. Our focus on multiyear defense awards gives us excellent long-term revenue visibility. Our defense and commercial programs have the potential to cumulatively generate approximately $453 million over the remainder of their periods of performance. As we look to the balance of 2019, we see revenue catalysts on horizon, the E-2D Next Generation Jammer and the A-10, being but a few arising out of the 2020 budget request. Defense prime contractors favor companies with broader set of capabilities that have experience managing large programs and a competitive pricing environment. Our acquisition of WMI provides new avenues for revenue growth with new customers and expanded work content for our current customers. For the balance of the year, we will be focused on maximizing manufacturing efficiency of the acquired WMI operations as well as continuing to drive down cost of legacy CPI Aero programs that will improve our cash flow heading into 2020. Before I ask the operator to open the line for questions, I'd like to also take a moment to publicly recognize and thank the nearly 300 hard-working men and women team members at CPI Aero and WMI for their support and positive attitude these past months since the closing of the acquisition. They've had to endure unavoidable disruptions to their daily work lives as they either moved from their former workplace or had to make room for the new arrival. The transition has gone extremely well due to their cooperation and support, and I thank them for that. Together, we are better than we were separately. And I cannot be more proud to lead this fine group of aerospace and defense professionals. This concludes my prepared remarks. Andrew, please open the line for questions.

Operator: [Operator Instructions]. The first question comes from Ken Herbert of Canaccord.

Kenneth Herbert: Doug and Vince, really nice quarter.

Vincent Palazzolo: Thank you, Ken.

Douglas McCrosson: Thanks, Ken.

Kenneth Herbert: Just wanted to first start off. Can you quantify, Doug, what the revenue contribution was for WMI in the quarter? And then specifically, what the - maybe what some of the onetime cost were associated with WMI and the impact on the gross margin or SG&A in the quarter?

Douglas McCrosson: I'll let Vince answer that.

Vincent Palazzolo: The revenue for WMI was $2.1 million in the quarter. The margin, because of the nature of purchase accounting, was only 10% on the WMI work because their inventory, when it came over to us is revalued at fair value, which is closer to the sales price than it is to the manufacturing price. So it's kind of depressed the margin by a little bit. We also had a couple of hundred thousand dollars' worth of moving cost that - one invoice just for the moving of the heavy equipment that was like $126,000 on its own. And then extra cost related to expand and audit was another $50,000 or $60,000.

Kenneth Herbert: Okay. But is it fair to say that the higher inventory cost are going to - I mean that's going to be burdened for WMI sales for this year? Or was it part of that...

Vincent Palazzolo: Further and further away from the acquisition date, and we are doing more and more work on the inventory here, as CPI, we gain the benefit of that margin. So we're only 10% in the first quarter, you should expect it to go 12%, 13%, 14%, 15% in the second quarter. And then by the time we get to the third quarter, almost be at a normal margin rate for them.

Kenneth Herbert: Okay. That's great. And then if I could just, Doug, obviously really strong bookings in the quarter and you've called out a number of programs. Can you maybe just provide a little bit more commentary on what you're hearing from customers? And was there anything really sort of onetime in the strong bookings in the quarter? Or do you think we could really see continued sort of visibility on book-to-bill ratio across the rest of 2019 and how that could look?

Douglas McCrosson: Yes. No, we're very optimistic that the quarter - while the quarter was particularly strong on a kind of a lagging 12-month basis. Our book-to-build is still higher than 1.15. And we expect that kind of trend to continue for the balance of the year. We're seeing very strong, not just in our proposal activity, but also in increasing production rates of some of the other programs, particularly Honda and - as well as the Raytheon Next Generation Jammer, we expect some more work out of there. No, we don't see any real slow down. There were no real big, say, monster programs that kind of weighted the book to bill this quarter. I think we're going to see a fairly consistent and strong booking for the rest of the year.

Kenneth Herbert: Okay. Great. That's helpful. And if I could, just finally, you specifically highlighted three important starts for you in the quarter. The F-16V, obviously, an undisclosed missile wing program and, of course, a Sikorsky helicopter program. 2 of those 3 obviously with Lockheed or Sikorsky, how are you - can you maybe just size up these opportunities for us a little bit? But I guess more importantly as you look to execute on these, any risk that - on these programs we should be aware of? Or how are the pieces in place for you to ensure that on the new starts you're bringing in, you're able to maintain, obviously, the margin levels and the timeliness and expectations from an execution standpoint?

Douglas McCrosson: So on the F-16V, we are just now - we have received the engineering, our nonrecurring engineering effort is underway. And we have every expectation that we're on target for the early stage in terms of the nonrecurring work associated with the new program start. We are in the process now of going out to the supply chain community in negotiating contracts individually with suppliers, so that we can be prepared to deliver that later at the very end of this year. So, so far in the early stages, a month or 2 into it, we seem to be on budget and on schedule. The delivery of the undisclosed work for a Sikorsky helicopter, that equally is on track to hit on margin assumptions. But more importantly there was - time was of the essence with this particular assembly and we're happy to say not only did we deliver the first unit but we're already 4 or 5 units in. So both those efforts, with an extremely important customer in Lockheed, have gone exceedingly well. And the undisclosed customer and undisclosed missile program has - we had the team from our customer in this week for final inspection on the product. And we anticipate shipping that as early as the end of this month. So couldn't be more excited about the work that the team did here to get these 3 programs in good shape. And all these three programs, collectively, are meaningful for the second half of - even now, but for the second half, in particular, of 2019.

Kenneth Herbert: Great. And if I could just one final question. How much does - how much A-10 contribution is factored in the revenue guidance for the full year, if any? Can you just provide some color around that?

Douglas McCrosson: Yes. Our assumption is that an award to a prime contractor would happen in the - say, June time frame that we would get a - hopefully able to win a negotiated contract with the winning contractor maybe within 2 months after that. And we're budgeting about $1 million or $1.5 million in revenue recognition, no shipments but revenue recognition in this calendar year.

Operator: [Operator Instructions]. The next question comes from Art Winston of Pilot Advisors.

Arthur Winston: Great quarter, guys. I didn't pick up the number of the contribution for the A-10 for those months. And if a contract goes through, what could be the annualized contribution for revenue in 2020?

Douglas McCrosson: Okay. So I mentioned there was about $1 million to $1.5 million, assuming timing of our contract in the, say, August, September time frame. I would rather not, Art, talk about annual run rate because it is a competitive proposal. But I can - I'll bound it a little bit by - it's probably in the, say, $9 million to $12 million per year type of opportunity for the first couple of years. It could be higher than that if it goes into the full 110 aircraft that still are left to be rewinged.

Arthur Winston: Excellent. I don't have a question. But it sounds like our new man who came in, in the middle of last year to help us with marketing is doing a great job. So I just wanted to thank him.

Douglas McCrosson: I'll thank him too.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Doug McCrosson for any closing remarks.

Douglas McCrosson: Thank you, Andrew, and thank you all for listening today's call. Vince and I look forward to speaking with you all again in early August, when we announce our second quarter results. Thank you, and have a great day.

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