CPI Aerostructures, Inc.

Now, I will transfer the call to Douglas McCrosson, CPI Aero's President and Chief Executive Officer.

Good morning. Thank you all for joining us for our 2014 First Quarter Results 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 e-mail 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.

I'd like to begin this conference call by expressing my appreciation to the many shareholders, colleagues, customers and suppliers that have provided support and advice during my transition from Chief Operating Officer to CEO and President. And to my nearly 300 fellow employees, thank you for your support and encouragement during the past 2 months.

I know that, like me, you are prepared to help us achieve our shared vision for CPI to make CPI Aero the most trusted manufacturer of aerostructure in our customer supply chain.

So with that prelude, I will now hand the call over to Vince Palazzolo, our CFO, to discuss our financial results for 2014 first quarter and guidance for the year, then I will comment on the current business environment, backlog and contract awards; expectations for 2015; and new growth opportunities going forward. I will then wrap things up and open the call to questions.

Vince?

Thank you, Doug. As announced earlier this morning, our 2014 first quarter revenue increased by 9.8%, mainly due to a 30% increase in revenue from commercial subcontracts.

Gross margin was 20.5%, which although lower than the 22.3% reported in the first quarter of 2013, is within our expected range for this year. Our selling, general and administrative expenses for the 2014 first quarter decreased as a percent of revenue substantially to 8.4% as compared to 9.4% in the 2013 first quarter, mainly due to steps we took to improve the efficiency of our administrative processes.

As a result, our first quarter 2014 pretax income increased by 3.6% to $2.51 million, and net income increased by 3.4% to $1.73 million or $0.20 per diluted share.

The first quarter of 2014 results, which improved as compared to the first quarter of 2013, were in line with our expectations and support our prior projections for the full year 2014. Specifically, for 2014, we expect total revenue to be higher than 2013.

We are projecting revenue in 2014 to be between $83.5 million and $85 million. This is mainly due to an approximate 25% increase in revenue from our commercial business, partially offset by single-digit decline in our defense business compared to 2013.

We project commercial revenue to be approximately 40% of total revenue in 2014 compared to 32% in 2013. This commercial revenue is provided by a mix of programs with increasing revenue from our newer business jet programs with Embraer, Honda and Cessna.

As our gross profit margins during startup are often lower and improve as the program matures, we expect this program mix to provide headwinds to our gross profit margin for the full year. Therefore, for 2014, we expect gross margin to be in the range of 20% to 21%.

As these newer programs mature into 2015 and beyond, we expect margins to improve.

Furthermore, we will continue to look at ways to lower our administrative costs to minimize the impact of margin fade in the 2014 -- margin fade in 2014 to our bottom line. Recently, we were able to obtain savings from a variety of service providers and have reduced total annual expenses in these areas by $137,000 per year.

These savings begin to benefit the income statement beginning in the second quarter of 2014 and will help to improve our operating margins in future periods.

In 2014, we project product deliveries to surpass our 2013 record year by approximately 10%, mainly due to increased demand for our commercial products. Several of these commercial programs are now ramping up and will transition to full rate production over the course of the next 6 to 12 months.

We expect positive cash flow from operations in the range of $1 million to $1.25 million compared to $3.3 million in 2013, as anticipated investments in new programs starts will offset the cash flow generated from existing production lines.

Now I will hand the call over to Doug, who will comment on the current business environment, backlog and contract awards, expectations for 2015 and new growth opportunities going forward. He will then open the call to questions.

Doug?

Thank you, Vince. As of March 31, 2014, we received approximately $4.7 million of new contract awards, which compares to a total of $11.5 million in new contract awards in the same period last year.

The decrease in new contract awards is predominantly the result of the timing of the release of new awards from our defense customers as they work to finalize contracts with the DoD or other customers. Based on feedback from some of these customers that have been experiencing funding delays, we are confident that CPI Aero's funded backlog at year end 2014 will increase as compared to year end 2013.

As announced, our total backlog at March 31, 2014, was $410.3 million, of which funded backlog was $96.2 million. Unfunded backlog of $314.1 million was primarily comprised of the long-term contracts that we received from Boeing, Spirit and Northrop Grumman during 2008; from Honda and Bell during 2011; and from Cessna, Sikorsky and Embraer during 2012, for which we expect to receive funded orders in the future.

Starting with our 2008 contract with Spirit AeroSystems to manufacture the leading edges of the Gulfstream G650 wing, our strategy to diversify into non-military aerospace and our demonstrated ability to execute in this competitive marketplace have been the catalyst of our growth. In 2011, 14% of our revenue, or approximately $10.3 million, was derived from commercial aerospace.

In 2013, the percentage grew to 32% of revenue or $26.4 million. In 2014, we expect this trend to continue and we project greater than $33 million in revenue from commercial aerospace products.

Our business plan calls for continued investments and efforts to capture new business from existing and new customers for our commercial programs. Going forward, our commercial programs are anticipated to generate a higher percentage of total revenue, and our intention is to have about 42% of our revenue derived from commercial aircraft by the end of 2015.

Currently, all of our commercial programs are within business jets and civilian helicopters. We have developed an excellent reputation among business jet manufacturers and we are getting opportunities to bid for work on many current and future business jet aircraft, including offerings from Cessna, Bell Stream [ph], Embraer and Bombardier.

The next logical progression in our growth strategy is to capture business on a large commercial airliner. While this is not an easy path as it takes time for entry into this market, we are confident that entry into the large commercial airliner market is a question of when and not if.

Our current skills and capabilities position us to compete today on a number of Tier 2 applications, and we are. However, our ultimate goal in this market is to manufacture larger value-added assemblies direct to the OEM or to their largest Tier 1 partners.

Therefore, our business strategy includes new investments in automation technologies and continued investment in production floor software that will increase output, improve quality and lower production costs compared to our current methods. For example, we will install automation equipment that will enable us to have enhanced capability for new commercial airliner products and greater efficiency for current long-term programs.

This automation will require total CapEx of approximately $500,000 in 2015.

Additionally, our global supply chain is developing offshore and nearshore sources, which we estimate can reduce cost and increase our competitiveness. We will continue our efforts to prioritize operational excellence and to make the appropriate investment in lean manufacturing to improve productivity.

And last but not least, we increased our workforce and skills training programs to ensure that our workers are the best trained and the best prepared in the industry.

We have submitted a number of proposals at the Tier 2 level for structure for airliners manufactured by Airbus and Boeing. Our business development team is currently targeting opportunities on several commercial airliner programs at both the Tier 1 and Tier 2 levels, including the Boeing 787, 737 MAX, the Airbus A320neo, as well as the next generation of Embraer E-JETS.

I hope to be able to report a win from these proposals in the months ahead.

military helicopters, maintenance repair and overhaul and the ISR, intelligence, surveillance and reconnaissance pods. So our 2014 will be a down year for our defense sector as a whole, there are many national security platforms for which we provide product that are well supported in the DoD's budget plans that point to a brighter future beginning in 2014 -- 2015.

For example, we have strong positions in military helicopters such as the BLACK HAWK from Sikorsky, the AH-1Z ZULU from Bell, and the recently rolled out CH-53 King Stallion from Sikorsky.

Our largest program in terms of potential value, the E-2D Outer Wing Panel kits, stands to benefit from the current multi-year procurement negotiation currently taking place between Northrop Grumman and the United States Navy. CPI Aero's share of the multi-year buy is anticipated to be more than approximately $30 million.

Northrop Grumman is also leveraging the fact that the E-2D shares a wing with the C-2A Greyhound aircraft and is pursuing a similar multi-year procurement of new wings for the C-2A. If successful, CPI Aero's share of Northrop Grumman's C-2A contract with the Navy would be an additional $40 million for Outer Wing Panel kits.

As our domestic defense market contracts, our OEM customers are seeking to grow their international business via direct commercial sales to foreign governments and foreign military sales. We have contracts with Northrop Grumman and United Technologies Aerospace Systems, or UTAS, where our products are used to support our customers' international sales.

For example, in January of this year, we announced on order received in 2013 from Northrop Grumman for Outer Wing Panel kits that would be used to manufacture an E-2C wing for Japan, and 2 of our pod structures, the DB-110 reconnaissance pod for UTAS and the ALMDS mine detection pod for Northrop Grumman, both are marketed internationally. Additionally, we have pending pursuits for work on other high-priority weapon systems such as the F-16, the F-35 and the CH-53K.

We continue to see increasing demand from Sikorsky for our maintenance repair and overhaul services. So while there are many prospects within defense on the horizon that bode well for CPI Aero in the future, the fate of our one of our important defense platforms, the A-10 Warthog, is currently being debated in Congress.

As I mentioned in March during our 2013 year end conference call, the Air Force is requesting that the entire fleet of A-10s be retired starting in government fiscal year 2015. But just last night, during a markup session on the National Defense Authorization Act, or the NDAA, the House Armed Services Committee adopted a bipartisan amendment that would continue to fund the A-10 through fiscal 2015.

The next test in Congress comes May 21, when the Senate Armed Services Committee releases its markup of the 2015 NDAA. Powerful senators from both sides of the aisle are on the record in support of the A-10, but the outcome is still uncertain.

For our part, I have gone to D.C. to personally advocate for the A-10 with Congressman Peter King, our representative in the house, and with New York Senators Schumer and Gillibrand.

We continue to perform under our contract with Boeing and envision we will continue to do so throughout the remainder of 2014 as the legislative process continues. Notwithstanding the above uncertainties surrounding the A-10, we have sufficient visibility to provide our expectations for 2015.

We see continued strength in production rates of our newer business jet programs, particularly our Embraer Phenom 300 and the Cessna 10 program. We see steady demand in 2015 for our G650 leading edges.

We are confident that we will receive follow-on funding from our long-term military programs such as the E-2D and C-2A, the DB-110 pod and the Bell AH-1Z helicopter. We are optimistic that our bid pipeline is large and diverse enough to obtain new commercial and military contracts, including work on a large commercial airliner.

We, therefore, project 2015 will produce the highest revenue in our history. Specifically, revenues are expected to be in the range of $90.5 million to $94 million.

We project single-digit growth in military revenue and double-digit growth in commercial revenue in 2015 as compared to 2014. Gross profit margin is expected to be higher than in 2014 at a range of 22.0% to 23.5%, mainly driven by higher production rates and lower unit costs.

The B. Riley Investor Conference on May 20 in Santa Monica California; the Benchmark Company One-on-One Investor Conference on May 29 in Milwaukee; the UBS Aerospace and Defense One-on-One Conference on June 5 in New York; the Drexel Hamilton's Aerospace & Defense Conference on June 12 in New York; and the Jefferies Industrial Conference on August 14, also in New York City.

At these conferences, Vince and I will be meeting with many of our largest shareholders and other institutional investors. We hope to see some of you there.

This concludes our prepared remarks. At this point, I would like to open the floor to questions.

Operator, can you allow callers to place questions now?

A question on cash flow for the year. You've obviously stated that with the higher level of deliveries, you're going to be cash flow positive.

Borrowings increased in the quarter. Can you talk about your cash flow on a quarterly basis through the year?

Are you going to have a strong delivery fourth quarter like last year or how does that work out?

We do expect the deliveries to ramp up through the year so I would expect slightly -- expect better cash flow in each quarter going forward similar to what happened last year that the fourth quarter was the big quarter. I don't expect it to be as dramatic as was the case last year so the second quarter cash flow should be better than the negative cash flow that we had in the first quarter.

The third quarter should be better than that, the fourth quarter should be the best, it should be a little bit flatter than last year's big spike-up, but yes, it should improve throughout the year.

Okay. A question relative to the bids that -- I guess, that you have or the conversations you've had on the larger Tier 1, Tier 2 opportunities on the commercial side for larger aircraft.

Could you add a little more color as to how definitive those opportunities are and what might be the decision cycles on some of the nearer-term opportunities? And then finally, what kind of lead time is there with regards to ramping revenues once the relationship is signed?

I can tell you that one of the more near-term commercial opportunities we expect to close within, I'll say, the next 90 days, this is an application that we have been working with a customer since the beginning of last year. We were notified near the end of last year that we were being considered and we entered negotiations that got kind of stalled due to some management changes within the customer.

So I would define one commercial opportunity as more likely, although not guaranteed. We are in discussion actively with this customer and those discussions are ongoing and I won't comment as to how close we are or how far apart we are, but one of those opportunities we will know one way or the other within the next, say, 90 days.

The others are in various stages. I would not, as my notes read, probably we'll hear between 6 and 18 months on some of them.

I would call -- other than the one that we're in discussion with, I would call them mid- to longer-term opportunity. And as far as lead time, we would expect -- because we do percentage completion accounting, we would expect shortly after contract award to be able to start booking revenue on these newer commercial opportunities.

Okay. Final question for me.

In your guidance for revenue for 2015, at the lower end, what level of new business or new relationships do you assume to achieve that bottom end number of $90.5 million?

Well, I won't really comment on how much brand new we expect to win. It is -- we expect the follow-on programs that I mentioned in the -- in my remarks, particularly on the E-2D and the C-2A and the DB-110, those will be required to meet the projection given in 2015.

We have, I'll say, a normal amount of anticipated probability-weighted new awards factored in for 2015, which, because again the accounting system, the revenue recognition system, we have typically until the middle part of 2015 to win to affect revenue in calendar year 2015, so there is no significant win among them but there is always some factor for new awards and particularly, when you're talking about 1.5 years from now, almost 2 years from now.

In, I believe, each of the last 4 quarters, the company's actual revenue has come in higher than we have modeled, and I believe consensus as well, yet the forward guidance always seems to be tamped down a little bit. And so I guess the question is how can you give such a tight revenue guidance range for a year given the -- what seems to be greater variance each quarterly period?

I'm not sure I quite get the question but...

So for the year, Doug, you're saying revenues are going to be within a $1.5 million range, yet this quarter, you already -- you beat consensus by $3 million or $4 million in revenue, which is great, but there seems to -- but there's a lot of variance in your...

Variance from the consensus and maybe the individual analysts, but not from our internal plan. The statement I'm trying to make is that we are on our plan and the fact that we recognize that a lot of people had our first quarter as being somewhat low, my internal plan is that by the midpoint we're going to be more or less where we were in 2013, at the half.

So we're beating last year but we're not beating it by $5 million, $10 million.

No, that's -- I understand. So I guess it's -- I guess how much of a standard deviation would you put on that range?

It's a very tight range of expected revenue for the year's as your operational production schedule and delivery schedule, such that you really can see with that degree of precision to what you might do this year?

Well, I'd like to say, yes, it is. I mean the -- as we get -- we're already in May and we use models like you all do, and right now, the model is in that range.

If -- I don't know how to answer your question, Mike, I'm sorry, I'm not being -- starting any trouble, I'm just having a hard time. We look at our numbers and that's what we come up with.

In the past we've given too broad a range and people have said, "Well, how can you have such a broad range when you're almost halfway through the year?" So what I wanted to do, and I think I did, is in November of last year, we talked about where it could be as high as 2012.

And I really felt that a lot of good things have to happen for that to still be the case and I'm not sure that I'm hedging my bets that they -- that some of these might not happen or it might not happen in the timeframe to generate that upper end revenue and so we guided towards something that is coming off of that $89 million number.

That's very helpful, Doug. And then just the last question, just to kind of continue in the same vein.

So for next year, you've given also what I would consider to be a very tight range although you gave yourself a couple more million of range, it's a $3.5 million range. Now could you just maybe talk about the 1, 2 or 3 things either way that could really drive you outside of that range for 2015?

Okay. For 2015, the -- certainly, a commercial airliner win that comes near to the mid-year of this year will provide upside in our forecast.

We have certain of these awards coming in late third quarter. With the lead time and the ramp-up, that would take some revenue out of '15.

So if it happens sooner, that's better for us. Clearly, the -- probably the biggest driver, if you will, for 2015 is our work on C-2 and E-2, and clearly, a multi-year procurement that allows us to go out and start working on what would be 4 years’ worth of requirements on the E-2D and the C-2A would be impactful to our '15 -- to '15 as well.

And again, our Sikorsky businesses is ramping up as is our MRO business. So we do have some -- there is some degree of visibility in our military notwithstanding the A-10.

And we also have now our backlog and our delivery date set for Embraer and Cessna. So as we move along and our ability to see with our -- and work with our customers and see their forecast and see their delivery demand, we're in a position today where we felt that we could go out in 2015 and provide some level of guidance.

Any time you're talking about something this far away or that far away, there are some upside and there are some downside. I think my conservative nature is that's more of, I'll say, the low end of what could happen.

If you start seeing our new business awards coming on stronger than they have in the first quarter, you see multi-year procurements on E-2D, multi-year on C-2A, a contract with UTAS that follows up on the DB-110 and some positive news out of Embraer and Cessna, then we could be talking about upside increasing the top end guidance.

So you talked about the commercial being 42% of the business. I just want to understand if that's kind of an average or a peak because I know that business is more cyclical.

No, we project -- in our model and in our guidance, the $90.5 million to $94 million is -- includes 42% commercial revenue.

Okay. So I'm sorry I misunderstood that.

I guess what I'm asking is what you think the potential is for the commercial as a percentage of revenue then, not giving specific guidance, but long term.

Oh, long -- beyond '15? We are looking at somewhere in the maybe 55%/45% range.

I think the reality is because we're still working on several long-term programs and I mentioned a couple on that E-2D. And we have others that we're bidding on, I alluded to some of our bid pipeline being for the military.

I think that's still going to be a very large percentage of our business going forward, which is fine if they are the right programs and if things that are happening with A-10 don't happen to those. So I mean that's the risk of the military market, I guess.

But right now we don't see a pendulum swing to us becoming a commercial aerospace company within the 2016 timeframe.

I appreciate that. And just going back to winning some the Tier 1, Tier 2 product -- projects.

You mentioned training and I just want to clarify, are there any other things you're doing -- I guess hardware, that's probably the wrong word, but structurally to compete in those projects? Or are you waiting until you get more visibility?

No, no, no. We have been doing it -- the steps that we've been taken in the past, say, I'll go back maybe 2 or 3 years in terms of bringing up our workforce and our training, the skill set within our manufacturing floor management, the improvements and investments we've made in our IT area, those are all bearing fruit in terms of we are now in a position where we can bid and compete on a global basis to win this work at the, say, the Tier 2 level, which are typically like smaller subassemblies, not major sections of the aircraft.

What we are looking to do now is we have a number of opportunities in the pipeline that fall into that area. We would like to position ourselves 1 to 2 years, 3 years down the road to be a Tier 1-capable company, where a Boeing or an Airbus or an Embraer could come directly to CPI for a large section of aircraft.

And those are the things that we're taking steps beginning later this year and into 2015 in terms of bringing automation equipment, automatic drilling, potentially looking at some robotics, this is a 2- or 3-year business plan with the strategy being get some of the Tier 2 work now over the next 6 to 12 months and then build on that by executing well on those and then allowing ourselves to be in a position to bid on bigger chunks of aircraft in the future.

In order to do that, is there much CapEx you're going to need spend or these are -- I guess that's what I wanted to know.

We're looking at about $0.5 million in 2015 if -- and that's for a limited capability, I'll call it, where in 2016, we'll have to see. But right now the current plan is that -- is about $0.5 million investment next year.

So the risk/reward is pretty high then in terms of what you put out?

Yes, our internal projections are -- is that, that investment would pay itself back in about 2.5 years.

Could you guys characterize the bid pipeline as things stand today, what percentage of opportunities are coming from commercial versus military? And is there any way you could characterize the percent of the pipeline that's associated with large commercial?

I can give you the most -- we will -- when we present that at the B. Riley conference later this month, we'll update all of the metrics.

So I can tell you where we were a couple of months back, is we were at around about 44%, 45% of our bid pipeline was for commercial. And of that, about 30% of that was for a large commercial aircraft.

That number I can tell you has gone up as some bids have gone in recently. So in rough numbers, Matt, I would say about 1/2 of our bid pipeline is for commercial markets and probably maybe 30%, 40% of that is for large commercial airliner.

Okay. That's helpful.

And then just on a higher level, Doug, could you discuss the move in the large commercial in greater detail? In particular, how does the RFP process compare to a smaller Bizjet-type contract?

Talk about the competitive landscape if you could as well, can you characterize the typical competitors in the space and how they differ from the smaller commercial competitors?

Okay. I'll try to -- that could take a while so I'll try to summarize it.

Many of the opportunities that we see are where we are, I'll call them, outsourced production, meaning these aircrafts are flying, there's somebody making an assembly, maybe the OEM themselves or maybe the Tier 1 partner itself, and for one reason or another, the customer is deciding that they would like to look outside to see if they could reduce cost or if they can try to make room on their factory floor for something else. And so that process does take time and it takes time because they are -- you're currently making it yourself, you have to develop a plan that shows that the -- go out to the market and go to CPI and our competitors and say, "Okay, well, what would it cost you to make the same assembly?"

Then they have to compare it to their internal estimates. We have to all understand, are we comparing apples-to-apples.

Then there might be some discussion going back. Then they have to figure out, "Okay, well now, how are we going to keep production flowing because we have a production line to make?"

So maybe that requires a second set of tooling. And it's kind of an interim process that requires a lot of operational planning in addition to the bidding part.

So I guess the perfect example is that one that I mentioned was our farthest along that we were optimistic at the end of last year to announce last year, that started back, I believe, in February of 2013 and we're still talking about it. And so when all is said and done, from the time that we were invited to participate until the time that we hopefully will win is 18, 20 months.

So the process is not a short one and -- but I don't think that it's untypical or atypical of all of our bids, quite honestly. That's just the nature of the work these days, is the selling cycle is longer and longer.

Okay. That's fairly helpful.

And then just if you could touch on -- a bit of the competitive landscape and then I'll take the rest offline.

Well, right now, we're at a great advantage in the market because we're typically competing against companies that are much larger than us, have a higher cost structure and we have those same capabilities. So we do compete against companies like Triumph, we compete against companies like Command, GKN, the -- we compete now against some of the Precision Castparts, product of companies.

There's a variety of our competitors out there in the structure space. I guess the good news though is that there is a lot of structures work to be had.

The build rates are really tackling the capacity at the moment and we're very optimistic in our customers that we're filling a need that our customers, or the OEMs have. The OEMs need more manufacturers that make structure, not less.

And so we are seeing opportunities, and in some cases, quite honestly, we could be the third manufacturer to build the same identical assembly and all 3 of us might be making it at the same time to keep up with the rate. So the competitive landscape right now, I think, favors smaller, more adaptable, more nimble companies that are like us and I think the OEMs are real excited that they have such a company with CPI and they get great pricing and great responsiveness and not to mention the great capability, which is often only found in companies about 2x to 3x our size.

So the fact that our bid pipeline is growing, the fact that these customers are finding newer -- new opportunities for us to bid and they're becoming increasingly larger and more complex, I think holds a lot of promise for us in the '15 and '16 timeframe.

Okay. I'd like to thank all of you for participating in this call and look forward to speaking to you again in early August when we announce our second quarter 2014 results.

Thank you.