Earnings Transcript for CVU - Q2 Fiscal Year 2020

Operator: Good day and welcome to the Q2 2020 CPI Aerostructures 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. Please note this event is being recorded. I would now like to turn the conference over to Mr. Jody Burfening, LHA Investor Relations Council. Please go ahead.

Jody Burfening: Thank you, Sarah, and good morning, everyone. Welcome to CPI Aerostructures’ second quarter 2020 earnings conference call. With me on the call this morning are Doug McCrosson, President and Chief Executive Officer; and Tom Powers, acting Chief Financial Officer. The earnings press release was issued after the market closed yesterday evening. For today’s call, a PowerPoint presentation accompanying management’s prepared remarks is available for download in the Investor Relations section of the company’s website at www.cpiaero.com. At the conclusion of their prepared remarks, management will hold a Q&A session. As a reminder, this conference call will contain forward-looking statements that are based on current expectations of management and certain assumptions that are subject to risks and uncertainties. There can be no assurance that such risks and uncertainties will not affect the accuracy of the forward-looking statements or that actual results will not differ materially from the results anticipated in the forward-looking statements. Including – included in these risks are risks associated with the restatement of the company’s prior period consolidated financial statements and the material weaknesses in the company’s internal controls, including the substantial costs and diversion of management attention and resources, which will be required to remediate the material weaknesses; any adverse developments in existing legal proceedings or the initiation of new legal proceedings; the effect of economic conditions in the industries and markets where the company operates, including financial market conditions; the impact of the COVID-19 pandemic, including its impact on global supply, demand and distribution capabilities at the outbreak – as the outbreak continues; the financial condition of the company’s customers and suppliers; the cyclicality of the aerospace market; the level of U.S. government defense spending, including shifts or changes in defense spending due to budgetary constraints; spending cuts resulting from sequestration; the allocation of funds to government responses to COVID-19 or changing political conditions and uncertain funding of programs; the ability of the government and the company’s other customers to terminate contracts anytime; production rates for commercial and military aircraft programs; competitive pricing pressures; start-up costs for new programs; technology and product development risk and uncertainties; product performance and costs resulting from changes to and compliance with applicable regulatory requirements; level of indebtedness and cash flow from operations. Additional information concerning these and other risks can be found in the company’s filings with the Securities and Exchange Commission. Because the risks, assumptions and uncertainties referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements, listeners are cautioned not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made. The company has no obligation to update any forward-looking statements to reflect events or circumstances after the date hereof. With that, I would now like to turn the call over to Douglas McCrosson, President and Chief Executive Officer. Good morning, Doug.

Doug McCrosson: Good morning. And thank you, Jody, and good morning, everyone. I hope that you, your families, your friends and your neighbors are all healthy and well. Today we are reporting our second quarter 2020 results as we continue to catch up on our reporting this year since completing the restatement of fiscal 2018 financials, as well as the first three quarters of fiscal 2019 in the filing of our Form 10-K for fiscal 2019. We remain hopeful that we will be current with the SEC reporting requirements with the filing of our third quarter results sometime in late-December. This reporting first quarter results only five weeks ago. The fundamentals of the business are still strong, our liquidity has improved, our outlook for a strong finish to 2020 is unchanged, and our optimism heading into 2020 remains high. It’s only a short time has passed since our last call. We are going to keep our comments brief this morning, focused on second quarter results, backlog figures and our outlook for 2020 and 2021. I’ll start with a recap of recent highlights. And Tom will provide you with a detailed review of our financial results for the second quarter and the status of our Paycheck Protection Program loan. And then I will offer some concluding remarks before opening the line to questions. Turning to Slide 4. We posted solid results for the second quarter as we continue to execute on programs and our funded defense backlog. Revenue was flat compared to the second quarter of 2019 with increases from our defense business offset by ongoing weakness in our commercial aviation business. Gross profit margin rebounded from the first quarter as expected. Sequentially, gross margin percentage increased nearly 900 basis points from the first quarter and by nearly 200 basis points from the year ago period. We continue to expect that the first quarter margin will prove to be the low point of 2020, and that full year 2020 gross margin percentage will be higher than it was in 2019. Our net loss for the quarter narrowed relative to last year’s second quarter, despite the addition of non-recurring professional fees related to the restatement, and we generated operating cash flow for the quarter. Reflecting an intense focus on improving working capital management, we improved cash flow from operations relative to last year by approximately $1.7 million for the quarter, while absorbing $800,000 of non-recurring cash outflows for professional fees. For the first half of 2020, our cash flow from operations has improved by approximately $2.5 million versus last year. Liquidity, which we are defining as unrestricted cash on hand plus revolver availability, that’s also increased significantly from approximately $1 million as of June 30, 2019 to $7 million as of June 30, 2020. The strategic steps we took earlier this year to prioritize cash flow are starting to show in our financial performance. As a result of these steps, plus the receipt of the Paycheck Protection Program loan during the second quarter which enabled us to sustain our workforce throughout the COVID-19 pandemic. We are in a stronger position as we have been in years to execute on our growing backlog, creating welcome news for our workforce, our customers and ultimately for our shareholders. On the first quarter call, we highlighted $77.4 million in new firm orders. Since then we have announced $1.4 million in orders from Turkish aerospace industries for our work on the Turkish Utility Helicopter program. As a reminder, since the beginning of the year, we have also received $52.1 million in firm orders from Northrop Grumman for work on the E-2D Advanced Hawkeye, both for the U.S. Navy version as well as for the international variant. $14 million in new purchase orders from Boeing in support of the A-10 Thunderbolt II aircraft rewinging effort, $10.1 million in purchase orders from the U.S. Air Force for T-38 modification kits, and $1.2 million follow-on order from Lockheed Martin for F-16 structural assemblies. We ended the second quarter with a total backlog of $546.4 million and $491.1 million defense backlog. First quarter book-to-bill ratio was unusually high. So the second quarter ratio of 0.9 was still higher than we expected. And our trailing 12-month book to bill ratio as of June 30, 2020 is a very robust 2.13. We ended the quarter with a funded defense backlog of $205.6 million, up $68.8 million or 50% since December 31 of 2019. This supports a sustainable business for CPI Aero in the near-term and growth over the longer term. As a reminder, the largest programs in this funded backlog are the E-2D wing panel kits we supplied to Northrop Grumman, the A-10 assemblies we built for Boeing and our next generation Jammer pod program we performed for Raytheon. Turning to Slide 5. You can see it from the line chart on the right side of the slide, our backlog of multi-year defense contracts is stable, offering CPI Aero multiple attractive long-term growth opportunities as we continue to deliver consistently strong performance on the military programs we support. In addition, we believe that the defense spending for the foreseeable future will not be impacted by the recent presidential election. Our defense backlog contains a broad array of high value defense platforms from legacy aircraft like the A-10, F-16 and T-38 to technologically advanced weapons systems like the F-35, the Next Generation Jammer and other undisclosed pod and missile platforms. As such, we believe we’re well positioned relative to DoD’s spending priorities, regardless of which parties in the majority come January. The commercial portion of our backlog continues to reduce due to headwinds from the global COVID-19 pandemic and from order cancellations and deferred deliveries. As of June 30, our funded backlog stood at $209.0 million, of which $205.6 million consisted of orders from our defense industry customers. The current defense backlog is scheduled to convert to revenue through the end of 2022, and is expected to generate in the aggregate positive operating margins and cash flow. Near-term, as we ramp up production on newer defense programs, we expect to accelerate revenue and margin improvement for the second half of 2020 compared to the first half of the year. Now I’ll turn the call over to Tom Powers, our acting CFO, who will walk you through our financial results for the quarter, as well as on the status of the Paycheck Protection Program loan. Tom?

Tom Powers: Thank you, Doug. Good morning, everyone. I’ll start my remarks on Slide 7. As a reminder, results for the second quarter of 2019 are restated values as found on Form 10-Q/A filed with the SEC on August 25. Revenue for the second quarter of 2020 was $19.7 million compared to $20.1 million for the same period last year. Overall, revenue from military contracts increased $2.6 million while revenue from commercial aviation contracts decreased $3 million. Within our defense business, the revenue increases related primarily to our previously announced multi-year award from the Northrop Grumman on the E-2D program and work performed on the T-38 Pacer program, which were offset by decreases in our commercial programs and the Raytheon pod program. As in the first quarter, the lower revenue from the Raytheon program was expected and reflects timing differences as it transitions from one development phase to the next. Finding revenue from our commercial programs reflects lower revenue from the G650 program and the Embraer program. Gross profit was $2.6 million compared to $2.2 million reflecting favorable product mix. SG&A expenses were $2.8 million compared to $2.5 million and included approximately $514,000 in non-recurring accounting and legal expenses related to the restatement and the ongoing litigation resulting from the restatement. Despite the increase in professional fees, the increase in gross profit resulted in a narrowing of a net loss to $0.6 million or $0.05 a share compared to $0.9 million for $0.07 per share for the second quarter of 2019. Turning to Slide 8. Slide 8 presents balance sheet highlights. Cash and restricted cash stood at 8.1 million as of June 30, compared to 5.4 million at December 31, 2019. Net contract assets and liabilities were 10.6 million compared to 11.7 million as of December, 31. The decrease reflects higher contract liabilities due to increased contract financing received from customers. Total debt was 34.5 million including 26.7 million outstanding under our revolver and the $4.8 million loan we received on April 10, under the Paycheck Protection Program provision of the CARES Act. The outstanding balance under our revolver is unchanged as of June 30, compared to March 31, and December 31, 2019. With respect to the PPP loan, we applied for full forgiveness of the loan on October 16, and our lender has submitted our application to the SBA for review and final approval. Upon receipt of proper approvals, the loan forgiveness will be included in other income in our income statement. Debt in the balance sheet will be reduced accordingly. And I’ll turn the call back to Doug.

Doug McCrosson: Thank you, Tom. Turning now to Slide 10. This is a slide we included in our first quarter presentation. And as you can see, three of the four near-term opportunities that we were bidding on as the incumbent supplier have now been decided in our favor. More details will be provided once we receive permission from the customer. None of these new contracts are in the reported backlog as of June 30. Collectively, we estimate that these will add more than $20 million to our total backlog. Customer decisions on most of the other opportunities on this slide are expected within the next 90 days. Slide 11, on the first quarter call I shared with you our priorities for 2020 and 2021 including a sharpened focus on liquidity, our balance sheet and margin expansion. We are continuing to implement working capital improvement initiatives that are designed to compress the cash flow cycle for each program by shortening bill time and more closely managing the flow of materials into operations. We are also continuing to examine our operations to enhance capital efficiency by re-engineering key manufacturing and production control processes. Already, these initiatives along with careful inventory management are allowing us to meet, if not slightly exceed our internal operating cash flow plan objectives for the first half of 2020. Using these new tools also enabled us to generate operating cash flow of approximately $0.6 million for the second quarter, which we applied to the repayment of approximately $0.6 million of long-term debt. We are committed to paying down debt through disciplined adherence to liquidity enhancement measures. With respect to margin expansion, we still expect production ramp up of our new defense programs over the latter part of 2020, will improve profit margins across our portfolio of products. Longer-term, we continue to see opportunities to lower our bill of material costs. Collectively these operational priorities position CPI Aero for higher revenue, improved profitability and cash flow for 2021 compared to 2020. Our goal, which we are now closer to – now than at any point in our recent history is to have more consistently positive operating cash flow. We expect to use any increased cash flow to delever the balance sheet even more in 2021 to give us a solid foundation for 2022 and beyond. On Slide 12, I want to give you a quick recap of our growth outlook for the three-year period, 2018-2021 in each of our business areas using restated 2018 as a baseline. In Aerostructures which accounted for 26% of total backlog at June 30, new contracts with Lockheed for F-16 assemblies and with Boeing for the A-10 places on our path to grow this business in the range of 12% to 14% through 2021. As a reminder, the bulk of our commercial revenue are in this aerostructures business area. Aerosystems, 44% of total backlog remains our fastest growing area driven by our electronic warfare pods and electronic systems programs, ones that we believe can generate growth across all the programs indicated at a three-year compound annual growth rate in the range of 22% to 26%. This has largely driven off expected increased production of the various electronic warfare and intelligence reconnaissance and surveillance pods, we built for Raytheon and Northrop Grumman as well as increased orders for certain BLACK HAWK systems from Sikorsky. Kitting and supply chain management, which is 30% of total backlog led by key platforms such as the E-2D, T-38 and F-16 will produce a compound annual growth rate in the range of 8% to 10%. In summary, our second quarter results demonstrate continued solid execution of our funded defense backlog and the business stability our high-quality backlog affords us. I’d like to take the opportunity to recognize the hard work and talent of our workforce during what has been unprecedented times. While some worked from the office and others worked from home, each group had to endure extremely challenging circumstances and their results exceeded my expectations. There’s no finite group of aerospace professionals in the industry and they have my respect and my thanks. I’m sure they have yours. The results also support our expectation that ramping production of newer programs and our defense backlog will fuel a stronger half of the year and position us to end 2020 with higher revenue and operating income in 2019. Our preliminary outlook for 2021 is for growth in revenue, operating income and operating cash flow compared to 2020. We expect to share more insights into 2021, when we announce our third quarter results sometime in late December. Harry, you can open the line for questions now. Thank you.

Operator: Thank you. [Operator Instructions] Our first question comes from Ken Herbert with Canaccord. Please go ahead.

Ken Herbert: Yes. Hi, good morning.

Doug McCrosson: Good morning, Ken.

Ken Herbert: Hey, Doug. Just wanted to see if you can provide any more detail on the – your expectation for the pace of gross margin improvement into the second half of the year, I know you indicated you expect it to be better for the full year than last year, but you put up a very nice sort of sequential improvement from the first of the second quarter. How do we think about the improvement into the third and fourth quarters?

Doug McCrosson: Well, again, we’re still doing all of the estimates and preparing the third quarter results, but my sense is that the third quarter gross margin percentage will be higher than the second quarter and that we will end the year. Second half of the year will obviously be much higher in gross margin percentage than the first half. How much higher than it was in the second quarter, will depend on our program estimates that are ongoing right now, but based on what I’m seeing now, I would say they are sequentially higher again in the third quarter compared to the second quarter.

Ken Herbert: Okay. And do you infect – sort of, do you have a positive earnings quarter this year or does that look like it’s more into 2021?

Doug McCrosson: Yes, we do have positive earnings quarters this year.

Ken Herbert: Okay. And I think you just called out the – on the pod, the Next Gen Jammer slightly down in the quarter, I think if I remember while you’re transitioning on that program, can you maybe just level set us on revenues this year and if there was anything unusual in the quarter on that program and how we should think about it moving forward?

Doug McCrosson: Yes. So we are now in full swing on what is called the SDTA phase of that program, system development and test phase. There was a lot of activity in the third quarter on that job. It continues pretty much through 2021. The run rate on an annual basis is at least equal to if not greater than the previous phase. So we would expect that to be once again, one of our key contributors of revenue going forward.

Ken Herbert: Okay. And just finally, on the defense side in general, really good growth in the backlog, are you seeing any sort of increased pricing pressure or can you talk about dynamics from your customers from a pricing standpoint and if there’s been any more sort of risk or pressure there and how the backlog reflects any of that?

Doug McCrosson: Well, the backlog would be priced at mostly fixed price contract. So those are not going to as Tom, remind me all fixed price contracts. So there’s no way for, I’ll say customers to put pressure on those selling prices that we’ve negotiated already, at least on the defense side. And, I’m not really seeing any of that. I mean, the defense industry has always been, there’s always price sensitivity for everything, right. There’s only so much budget dollars and the government wants to get a good price for the good value for what they’re getting. And we think we of course delivered that. And second, in some cases, when we go to a bid on a new system, maybe we’ve had efficiencies the last time we run it and we could lower price without giving margin. And in some cases we show that, our margin wasn’t at our normal standard and we were able to get better pricing, the next time we bid on the job. So it’s kind of all over the board. I wouldn’t say that there’s pricing pressure to the extent that the commercial aviation business is known to have pricing pressure.

Ken Herbert: Great. Thank you very much. I’ll pass it back there.

Doug McCrosson: Thank you, Ken.

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

Doug McCrosson: Okay. Thank you, everyone for participating in today’s call. And Tom and I look forward to speaking to you in late-December when we report on the third quarter results. Thank you.

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