CPI Aerostructures Inc (NYSE: CVU) Q3 2020 Earnings Call Jan. 06, 2021
Corporate Participants:
Jody Burfening — Investor Relations
Douglas McCrosson — President and Chief Executive Officer
Thomas Powers — Acting Chief Financial Officer
Analysts:
Ken Herbert — Canaccord Genuity — Analyst
Art Winston — Pilot Advisors — Analyst
Presentation:
Operator
Good morning and welcome to the Third Quarter 2020 CPI Aerostructures Earnings Conference Call. [Operator Instructions]
I would now like to turn the conference over to Jody Burfening. Please go ahead.
Jody Burfening — Investor Relations
Thank you, Jason, and good morning everyone and welcome to CPI Aerostructures third 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 before the market opened on December 31. And for today’s call, management will refer to a PowerPoint presentation during their prepared remarks, which has been filed with the SEC and will be posted shortly to 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 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’s attention and resources, which will be required to remediate the material weaknesses. In the 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 COVID-19 pandemic including its impact on global supply, demand and distribution capabilities as the outbreak continues; the financial conditions of the company’s customers and suppliers; the cyclicality of the aerospace market; the level of US 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 uncertainty — 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, startup costs for new programs, technology and product development risks 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 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 Doug McCrosson, President and Chief Executive Officer. Good morning, Doug.
Douglas McCrosson — President and Chief Executive Officer
Thank you Jody and good morning everyone. A very Happy New Year to you all. Thank you for joining us on short notice after holiday week. As we start the New Year, I hope that you, your family and friends are doing well. When we held the earnings call to report our second quarter results this past November. We were hopeful that we would be able to report third quarter results before year-end and I’m very happy that we’ve met that goal. More importantly with the filing of our Form 10-Q for the third quarter on December 31, we are now current with SEC reporting requirements and have regained compliance with the New York Stock Exchange’s timely filing criteria. With the restatement of financial reports for periods — for prior periods now behind us as of August 25, this is the third quarterly results report for fiscal 2020, since, we released our first quarter results on September 30. Those results have demonstrated strengthening fundamentals in 2020 based on our record funded defense backlog and success of our strategy to win long-term defense contracts aligned with current and future US military priorities.
Our third quarter results, which we are reviewing on today’s call, bolster our outlook for a strong finish to 2020 and our continuing optimism for 2021. I’ll start with a recap of recent highlights. Then Tom will provide you with a detailed review of our financial results for the third quarter. And I will offer some concluding remarks before opening the line to question.
Turning to Slide 4. Our third quarter results demonstrates the benefits we have expected from ramping up production of new defense programs and from continued effective execution on our funded defense backlog. Compared to the second quarter, revenue surged 30% to $25.6 million and revenue from defense programs increased to 38%. Gross profit rose 62.1% and gross margin expanded 330 basis points to 16.4%. Net income improved $1.4 million to $0.8 million. Since the end of September, we have won or have been selected for three awards totaling approximately $20 million. Because we have not yet received customer approval to announce these awards, we can’t share details about these programs other than to say that these are follow-on contracts with existing customers.
Lastly, I want to touch on three significant events, which have occurred since September 30. Each of these events is described in detail in our 10-Q filing for the third quarter. First, we have resumed work on the Gulfstream G650 program. As a reminder, in April, we were asked by our customer Triumph Group to stop work on our contract to produce certain fixed leading-edge assemblies on the wing of the G650 business jet, and in May Triumph canceled nearly all our open orders on this program. Triumph has since sold the G650 Wing program to Gulfstream. And earlier this month we received new — I’m sorry, earlier in December, we received new purchase orders from Gulfstream totaling approximately $3.6 million. Importantly, we are now working directly with Gulfstream for the first time since inception of the G650 program over a decade ago. We have already put back into production all of the products that Triumph had cancelled. In fact, we delivered about 10% of the order in December, with the balance due to ship during the first three quarters of 2021. With this restart, we expect to improve overhead absorption, reduce inventory and generate incremental operating cash flow over the remaining life of the contract.
Second, we have exited our program with Honda Aircraft company to manufacture the engine inlet assemblies for their Honda jet aircraft. This program was in the early stages of a life of program agreement. In January 2020, the company requested a modification to the recurring sales price, and a few months later, Honda denied the company’s request. We commenced discussions with Honda for the purpose of CPI Aero exiting the program and transitioning our work back to Honda. This discussion concluded on December 23 when we signed an agreement that terminated the Honda long-term agreement and canceled all remaining purchase orders placed with CPI Aero. Honda has agreed to purchase approximately $600,000 of inventory and assume responsibility for certain purchase orders we have placed with the suppliers. We are responsible for any remaining termination liability to suppliers that they did not choose to continue buying from. In any event this is a very positive outcome for us. We expect the net cash to CPI between now and the end of the first quarter of 2021 to be around several $100,000 even after paying termination claims to suppliers if there are any, but the greater value comes from no longer having to produce product at a significant recurring loss. The impact of this contract termination is expected to have a positive effect in our fourth quarter 2020 as we unwind the loss reserve we took to cover potential future losses.
And third, as announced this past Monday, we reached a settlement of the post closing working capital dispute with Air Industries and the entire $1.4 million that had been held in escrow was paid to us on December 28, adding to our liquidity position as we begin 2021. These more recent developments combined with our solid third quarter results, supports our expectations for a strong finish to 2020 and positive momentum heading into 2021.
Turning to Slide 5. As you can see from the line chart on the right side of the slide, we ended the quarter with a total backlog of $536.9 million and a backlog of multi-year contracts with our defense industry customers of $480.2 million. Of our defense backlog, $183.6 million consisted of funded orders, primarily with Northrop Grumman for E-2D Outer Wing Panel kits with Raytheon for next generation Jammer mid-band electronic warfare pods with Boeing for A-10 structural assemblies for their rewind program, and direct orders with the US Air Force for T-38 life extension program components. We expect our funded defense backlog in aggregate to convert to revenue through the end of 2022, and to generate positive operating margins and cash flow. Our book-to-bill ratio for the 12 months ended September 30 was a strong 1.4 times.
I’ll now turn the call over to Tom Powers, our acting CFO who will walk you through our financial results for the quarter. Tom?
Thomas Powers — Acting Chief Financial Officer
Thank you, Doug. I will start my remarks on Slide 7. As a reminder, results for the third quarter of 2019 are the restated values as filed with the SEC this past August. Revenue for the third quarter of 2020 increased 12.7% to $25.6 million, compared to $22.7 million for the same period last year. Revenue from military contracts increased $6.8 million or 38%, while revenue from commercial aviation contracts decreased $3.9 million. Within our defense business, revenue increases were primarily related to the art of the recent multi-reward for the Northrop Grumman E-2D program, and were performed on the T-38 Pacer program. These increases were offset by a decrease in revenue on the Raytheon pod program. As in the first and second quarters, the lower revenue from the Raytheon program was expected and reflects timing differences as that program transitions from one development phase to the next.
The decline in revenue from our commercial programs reflects lower revenue from the G650 and Embraer business jet programs. Gross profit more than doubled to $4.2 million, compared to $1.9 million reflecting higher revenue and a favorable program mix. SG&A expenses were $3.1 million, compared to $2.8 million a year ago. 2020 had legal and accounting expenses that were approximately $600,000 higher than a year ago, primarily attributable to the restatement and the ongoing litigation resulting from the restatement. As a result of the increase in gross profit, our net income improved $2.1 million versus last year, improving to $800,000 or $0.07 per share, versus a net loss of $1.3 million or $0.11 per share for the third quarter of 2019.
Turning to Slide 8. Slide 8 presents a few of our key balance sheet accounts at September 30, 2020 compared to December 31, 2019. Cash and restricted cash stood at $5 million at September 30, compared to $5.4 million at December 31, 2019. Key difference between these values being that as recently announced the $1.4 million of restricted cash related to the WMI Working Capital dispute is now unrestricted. Net contract assets and liabilities stood at $15.9 million, compared to $11.7 million as of December 31. The increase reflects higher contract assets as we ramp up production on newer defense programs, and a return of approximately $3.2 million in over advanced funds returned to a key customer. Total debt was $33.9 million, including $20.7 million outstanding under our revolver. Debt includes the $4.8 million PPP loan we received on April 10 under the Paycheck Protection Program provision of the CARES Act. Excluding this increase in debt, we have otherwise reduced debt by approximately $1.9 million over the first nine months of fiscal 2020.
As a reminder, we apply for full forgiveness of the PPP loan, and on November 2, our lender notified us that our application had been approved and submitted 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 and the debt in the balance sheet will be reduced accordingly.
I’ll now turn the call back to Doug.
Douglas McCrosson — President and Chief Executive Officer
Well, thank you, Tom. Please turn to Slide 10, and I will reiterate our priorities for 2020 and 2021 delivering a sharpened focus on liquidity, our balance sheet, and margin expansion. I have mentioned previously that we have implemented working capital improvement initiatives that are designed to compress the cash flow cycle for each program by shortening build time and more closely managing the flow of materials into our operations, and enhancing capital efficiency.
To illustrate the point, for the first nine months of 2020, we reduced the cash used in operations to $3.3 million, or $700,000, lower than the same period in 2019 on around $2 million less revenue. This was achieved despite more than $800,000 of extraordinary legal and accounting expenses, as well as paying back the approximately $3 million in overpayments by a customer received in 2019 that Tom mentioned a few moments ago. Without these items, cash flow from operations would have been approximately $1 million positive during the first nine months of 2020, which would have been a swing of approximately $5 million compared to the same period a year ago. We are closer now to realizing our goal of delivering more consistently positive operating cash flow than at any point in our recent history. We expect to use the improved cash flow in 2021 to deliver the business even more, and to improve our financial profile for 2022 and beyond. We’re paying down our term loan by $2.1 million in 2020 in accordance with the terms of our amended credit agreement. And finally as our third quarter results demonstrate, ramping up our newer programs in our defense backlog is in fact improving fixed cost absorption and profitability. And we are increasingly confident that we will achieve our stated expectation for accelerated revenue growth and margin improvement across our portfolio of products for the second half of 2020 compared to the first half.
We have a lot to look forward to over the next 12 months. We’ll be making first deliveries of a number of defense programs, including major assemblies for the A-10 and F-16. We will start work on our newest reconnaissance pod, the Tactical Synthetic Aperture Radar or TacSAR, and we are expecting the Raytheon Next Generation pod Mid Band electronic warfare pod to again be a very prominent component of our business in 2021.
We have also made strategic moves in late 2020 to eliminate an unprofitable business and to settle a long standing dispute, both of which diverted management and financial resources during 2020. So while we did well in 2020, despite the challenges of a multi-year financial restatement and a global pandemic, I see an even greater 2021. The momentum in our business these past several months combined with our strong funded defense backlog gives us a high degree of confidence to affirm our initial outlook for 2021. Namely, we expect higher revenue, operating income, and operating cash flow for 2021, compared to 2020.
Before opening to Q&A session, I would like to express my heartfelt appreciation for the dedication and commitment of our workforce who have worked tirelessly through the challenges presented by the pandemic, and the extra effort involved with the financial restatements. We set the bar high at the beginning of 2020 to execute flawlessly on our programs, particularly the ramp up of production of our newer defense programs, and we have succeeded. Our strong defense backlog, demonstrated ability to win new contracts, and ongoing business development efforts, position CPI Aero for attractive long-term growth.
Thank you for participating in the call, and operator, you can open up the line for questions now. Thank you.
Questions and Answers:
Operator
[Operator Instructions] Our first question is from Ken Herbert from Canaccord. Please go ahead.
Ken Herbert — Canaccord Genuity — Analyst
Hi. Good morning, Doug and Tom.
Thomas Powers — Acting Chief Financial Officer
Good morning.
Douglas McCrosson — President and Chief Executive Officer
Good morning. Happy New Year.
Ken Herbert — Canaccord Genuity — Analyst
Yes. Happy New Year, Doug and Tom. Nice quarter. Doug, I wanted to see first of all, if you can talk about really strong revenue growth in the third quarter, was there anything unusual there or anything that maybe was pulled out of the fourth quarter? And how should we think about the top line in the fourth quarter?
Douglas McCrosson — President and Chief Executive Officer
No, the answer — the short answer is no. There was nothing pulled forward from the fourth quarter. We knew from the beginning, that the second half of 2020 would be very strong compared to the first half, and we’ve been indicating that on the various previous calls. So, I think a lot was Northrop Grumman E-2D. We had a little bit of Raytheon Mid Band pod come back in the third quarter that was relatively dormant in the first two. And also, as we mentioned in prior calls, our focus really has been in working capital management, and with percentage of completion accounting, as you align your incoming materials more closely to when you actually need it on the factory floor and you compress that build cycle, you’re actually taking revenue that would have been booked and putting it closer to the actual point of sale, which is what we’ve been doing. And so, I think you saw a lot of that in the first quarter and the second quarter as well. And now that everything is aligned, you’re seeing the true ramp up of our — primarily our defense programs.
Ken Herbert — Canaccord Genuity — Analyst
Okay, very helpful. As we — I think you alluded to, as we look at your defense backlog where you’ve had some really nice growth, funded defense backlog of $184 million, I think you said on the call that you expect most of that to convert to revenues if not all by the end of ’22. Can you just talk about the sort of the revenue cadence into ’21, and maybe even ’22, or is the quarterly rate you’re at now a good quarterly run rate to assume into ’21?
Douglas McCrosson — President and Chief Executive Officer
As you know, we haven’t given guidance for 2020, and we probably won’t for 2021. I can tell you that the level of activity, which is generally aligned with revenue that we’ll post is increased in the fourth quarter over the third quarter. And going into the first quarter of 2021, we expect that to kind of continue. I haven’t measured the full impact of the defense backlog and when it flows out over 2021, we’ll do that in the coming days and weeks as we — we’re just about to start our fourth quarter close. So, I can tell you that the business going into 2021 is as strong as it’s ever been in my, almost 17 years here. So, feeling very good about 2021.
Ken Herbert — Canaccord Genuity — Analyst
Okay, that’s great. And if I could just one final question, I think you commented that, excluding the, sort of the one-time charges this year you would have been positive $1 million in cash from operations through the first nine months. I just wanted to make sure I got that correctly to clarify that. And then second, I know obviously you’re not giving guidance, but I think you’re expecting cash generation to improve in ’21 over ’20, I’m just wondering if you can provide any color around magnitude or expectations around that, and maybe just a couple of the moving pieces.
Douglas McCrosson — President and Chief Executive Officer
Okay. So let me start with your first point. So back in 2019, we had advanced payments we were getting from a significant customer. And as it turns out, when ultimately the negotiation was completed, and it was on a not to exceed contract, the — our true costs really were lower than what they’d actually paid us. And so over the first nine months of 2020, we in fact we’re billing this customer, and they were not paying us the cash for it, because we were paying it back, you know, roughly $3.2 million. So that alone would have almost turned us into a breakeven on a cash flow basis, had we collected that $3.2 million, instead of basically paying it back to the customer. So, you did hear that right. And then the other component is the extraneous, above and beyond legal and accounting associated with the restatement. And legal costs associated with the restatement. So, you did get that correct.
Going forward into 2021, we don’t have that — we don’t have as much headwind as we did in — certainly in the first nine months of 2020. And so, I think that you’ll see a much improved company from a cash flow perspective, in full-year 2021. I’m not ready to say what that will be. We’re expecting to be less negative at the end of the fourth quarter. I don’t know that will be a breakeven company in the fourth quarter from a cash flow perspective. But certainly, that would be the goal in 2021.
Ken Herbert — Canaccord Genuity — Analyst
Perfect. Thanks a lot, Doug. Happy New Year. Nice quarter.
Douglas McCrosson — President and Chief Executive Officer
Thank you.
Operator
[Operator Instructions] The next question is from Art Winston from Pilot Advisors. Please go ahead.
Art Winston — Pilot Advisors — Analyst
Happy New Year, Doug.
Douglas McCrosson — President and Chief Executive Officer
Hi, Art.
Art Winston — Pilot Advisors — Analyst
My question is really on the A-10. Can you give us any sense about what to anticipate in terms of revenue and shipments and cash flow and operating profit? I know you can’t give numbers, but what’s it on the A-10 going forward in 2021?
Douglas McCrosson — President and Chief Executive Officer
So, thank you Art, and good to hear from you and Happy New Year. So the A-10 program has a significant backlog. I don’t have the number handy, but it’s in the close to $18 million to $20 million range. And that is funded, which is roughly half of what the program might become. The expectation is that it is a normal profit here, which is, you know, when the — say the 20% range or so. So, we expect the A-10 to be profitable in 2021 and it will be of all of the programs that are growing, because we did have some small amount of revenue in the fourth quarter of 2020 for A-10. We expect it to grow by around $4 million, $4 million or $5 million in 2021. So, it’ll be a pretty sizable component of our ’21 sales, and more so in 2022.
Art Winston — Pilot Advisors — Analyst
Okay, thanks, Doug. Thanks. Good job. Thank you.
Douglas McCrosson — President and Chief Executive Officer
Bye Art. Thank you.
Operator
[Operator Instructions] There are no more questions in the queue. This concludes our question-and-answer session. I’d like to turn the conference back over to Doug McCrosson for any closing remarks.
Douglas McCrosson — President and Chief Executive Officer
Thank you, Jason. And again, thank you all for participating in today’s call. And Tom and I will be speaking to you again when we report the fourth quarter and full-year 2020 results later this year. Thank you.
Operator
[Operator Closing Remarks]