CPI International F4Q07 (Qtr End 9/28/07) Earnings Call Transcript

Dec.13.07 | About: CPI International, (CPII)

CPI International, Inc. (CPII) F4Q07 Earnings Call December 13, 2007 11:00 AM ET

Executives

Joe Caldarelli - CEO, President, Communications & Medical Products

Bob Fickett - President and COO, President, Microwave Power Products

Joel A. Littman - Chief Financial Officer

Analysts

Antonio Antezano - Bear, Stearns & Co. Inc.

Michael Coleman - Wachovia Securities

Andrew Burke - Polk

Operator

Good day, ladies and gentlemen, and welcome to the CPI International Fourth Quarter and Fiscal 2007 financial results conference call. My name is Maria and I will be your coordinator for today.

At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session at the end of today’s conference [Operator instructions]. As a reminder this conference is being recorded for replay purposes.

Before we begin the company has asked me to read the following statement:

Today’s presentation includes forward-looking statements within the meaning of the Securities Exchange Act of 1934. Forward-looking statements provide the company’s current expectations, beliefs or forecasts of future events. Forward-looking statements are subject to known and unknown risks and uncertainties which could cause actual results to differ materially from the results expected, projected or implied by forward-looking statements.

These risk factors include without limitation: competition in the company’s end-market; the company’s debt levels; significant changes or reductions in the U.S. Defense budget; currency fluctuations; U.S. government contracts; laws and regulations; changes in technology; the impact of unexpected cost; the inability to obtain raw materials and components. Further information in these risk factors and additional risks and uncertainties are included in the company’s filings with the Securities and Exchange Commission.

The compensation of EBITDA, adjusted EBITDA, adjusted EBITDA margin, free cash flow and adjusted free cash flow margin that will be discussed on today’s call are non-GAAP financial measures under Securities and Exchange Commission rules. A presentation if the most directly comparable GAAP measures and reconciliations on each of these non-GAAP financial measures to the most directly comparable GAAP measures are available in yesterday’s press release which has been posted on the company’s website. Interested parties can access the press release by going to www.CPII.com and opening the press release entitled CPI International Announces Fourth Quarter and Fiscal Year 2007 Financial Results.

I would now like to turn the presentation over to your host for today’s conference, Joe Calderelli the Chief Executive Officer of COI International. Please proceed, Sir.

Joe Calderelli

Thank you. Good morning and welcome to CPI’s Q4 and Fiscal ’07 call. We appreciate your time this morning and hope that you have had a chance to review yesterday’s 10-K and press release.

I’ll start this morning’s call with an overview of our ’07 results and discuss some of the highlights of the past year. Joel Littman our Chief Financial Officer will discuss certain key financial metrics for the year and our guidance for fiscal ’08. I’ll finish up with further comments by discussing some of the trends we’re seeing in the coming year. At that point we’ll open up the call for your questions and Bob Fickett our President and Chief Operating Officer will join us for the question-and-answer session.

Before I begin our discussion of fiscal ’07 results, I would like to briefly touch on our Q4 performance as well as the Q4 debt refinancing. Q4 ’07 was an exceptionally strong quarter for CPI. We generated $91.6 million in sales the highest quarterly sales in CPI’s history. Even if you exclude the $3.1 million contribution that our new Malibu division made to our sales, our sales for the most recent quarter still remain our highest quarterly sales ever.

In Q4 we grew our sales in five of our six end-markets. We believe that some of the strength of our Q4 sales in part to certain customers requesting accelerated shipments of products earlier than planned. In many cases we were able to fulfill this accelerated demand. For example, at our customers request we shipped approximately 2.3 million of x-ray generators for the second year during Q4 rather than spreading the shipments out into early ’08 as originally planned. We expect that this shifting of some sales from early ’08 to Q4 ’07 will soften our sales for the corresponding programs in the first part of fiscal ’08. In addition, we experienced some delays in the timing of order placement by a few of our defense customers shifting orders from Q4 ’07 to the first part of ’08.

Our sales and operating income were very strong in Q4. However we did incur $6.3 million of pre-tax charges associated with the refinancing of our debt in Q4. Debt from 7 million of those pre-tax charges were non-cash charges related to the write-off of our unamortized defect issuance cost and 1.9 million was attributable to redemption premiums and other cash expenses associated of the repurchase and redemption of our floating rate senior notes partially offset by approximately 300,000 from the early termination of the interest rate swap related to our floating rate senior notes.

Our Q4 adjusted EBITDA which excludes these charges totaled 19.7 million, while our net income which includes these charges was 2.8 million or $0.16 per diluted share. In short, notwithstanding the charges related to our successful debt refinancing, our strong operating results in Q4 ’07 capped another successful year of profitable growth for CPI.

Let’s now turn to our highlights for fiscal year 2007 as a whole. We enjoyed our fifth consecutive year of sales growth in ’07, increasing sales to a record high 351.1 million. This sales growth is consistent with our expectations for long–term annual sales growth and it’s in line with our previously announced guidance. In fact, we met or exceeded our guidance in all key parameters for fiscal ’07.

Examining our ’07 sales by market, combined sales in our radar/electronic warfare, warfare markets remained virtually unchanged from the previous year of 145.7 million. As usual we continue to see fluctuations in the timing of orders for certain defense programs, resulting in corresponding fluctuations in the subsequent period sales-release programs. We have not seen any indication that the most recent delays in order placement have any systemic cause or are anything out of the ordinary. And we continue to expect low single-digit percentage long-term annual sales growth in the radar and electronic warfare markets.

In the medical market, we again saw double-digit sales increases in ’07 recording sales of 67.6 million. This increase was due primarily to increased sales of our products for x-ray imaging and MRI systems. Our sales of products used for magnetic resonance imaging systems increased 42% in ’07. Our x-ray imaging sales included 5.9 million of shipments for the second year of the Russian tender program an increase of 1.9 million over the 2006 sales for this program. The ’07 Russian demand exceeded our expectations. We shipped more than 700 x-ray generators for this program. We expect that there will be another stage to this program in 2008, but we do not yet have any details regarding the volumes and the product mix.

In the communications market, our sales increased 4% over the prior year to 110.8 million. This increase was driven by increased sales of both newer and traditional satcom amplifiers for a number of applications including broadcast networks and direct-to-home applications outside of North America. In addition, we grew our sales of newer satcom amplifiers for news-gathering and other mobile applications for the growing military satcom market.

In Q4 we won our first major satcom program, Increment One of Win-T. Although we won’t make significant shipments for Win-T until mid-year in fiscal ’08 the size and significance of this program and the opportunity that it represents for CPI merits discussion on this morning’s call. Win-T is a tactical communication system that is intended for use by soldiers in the field to allow them to access the Department of Defense’s information sharing network using satellite, airborne and terrestrial communication systems. Increment One of Win-T seeks the development field of mobile tactical networks that will deliver voice, data and imagery to the war-fighters.

CPI has been selected to be General Dynamics’ sole supplier of Ku-band high-power amplifiers for its specialized satcom terminal for Increment One of Win-T. Each of General Dynamics’ trailers, of which there are expected to be more than 1,200, will contain multiple CPI Ku-band amplifiers. We have received approximately $2 million in initial awards for this four year program which is expected to have a full potential value of more that $50 million to CPI.

This was a hotly contested program and we are very excited to have been selected as the sole provider of Ku-band amplifiers for it. In addition to the monetary value of the program we believe that CPI’s involvement in Win-T goes a long way to establishing our credibility and reputation as a provider of satcom technology in the growing field of military communications.

Let’s briefly discuss our fiscal ’07 orders. More details on orders are available in our 10-K. Orders totaled 344 million in ’07, an increase from 331 million in ’06. Our book-to-build ratio for all of ’07 was .98 as compared to 1.04 after the first three quarters of ’07. The drop in our book-to-build ratio reflects the delays that we saw in the timing of certain defense orders in Q4. We co not believe that these delays were anything other than the usual year-end fluctuations in the timing of defense orders. However these delays did weaken our overall book-to build ratio for the year and will soften our financial results in the first part of ’08. We’ll discuss the ’08 impact more full a little later in the call.

We continue to believe that there is solid long-term demand for our defense products from both U.S. and international customers. With that I’d like to turn the call over to Joel to discuss some of our key financial highlights for the year.

Joel Littman

Thanks, Joe.

This morning I will focus my discussion on CPIs fiscal 2007 results on several of our key financial metrics, including EBITDA, adjusted EBITDA, net income, cash and cash flow. Joe has already discussed our sales and orders for the year.

Before I go into the details of our historical results, I would like to mention a few important points. First a reminder, our financial results for fiscal 2007 includes the benefit if the cost reductions and productivity improvements that were implemented as a result of the fiscal 2006 relocation of our I-mac operations. In fiscal 2007 our commitment to operational excellence programs combined with the savings realized from the integration of our I-mac operations into our microwave power products division has helped us to overcome some of the headwind resulting from the weakening of the U.S. dollar as compared to the Canadian dollar, and to achieve our goal of maintaining the adjusted EBITDA margin.

As you know we have two divisions based in Ontario, Canada. We incurred approximately 55 million in Canadian dollar denominated expenses in 2007. We used rolling hedges to stabilize the impact of the fluctuations in the U.S. dollar to Canadian dollar exchange rate, though we were not fully able to insulate ourselves against the dramatic weakening of the U.S. dollar in ’07.

Our fiscal 2006 average exchange rate including our hedging was approximately $0.84 to $1 Canadian. In fiscal 2007, our average effective exchange rate increased to approximately $0.89 U.S. for every Canadian dollar. As a result of this increase in our average effective exchange rate, our EBITDA was unfavorably impacted by 2.6 million in fiscal 2007 as compared to the prior year. This currency headwind negatively impacted our fiscal 2007 net income by 1.6 million or $0.09 per share.

The third and last factor that I want to mention before I address the details of our key financial metrics is our successful debt refinancing a few months ago. As Joe mentioned, while we incurred 6.3 million in refinancing expenses in fiscal 2007 we expect this refinancing will result in $2 million of annual interest expense savings in future years. The impact of the refinancing in fiscal 2007 was to reduce our net income by 2.9 million or $0.22 per share on a diluted basis.

Overall fiscal 2007 was another strong, stable year for CPI and we again enjoyed profitable growth. In fiscal 2007 CPI generated EBITDA of 64.3 million or approximately 18% of sales. This was a 9% increase form the 59.1 million or approximately 17% of sales generated in the prior year. Our EBITDA in 2007 benefited from a number of cost reduction and operational excellence initiatives that contributed to the increase in our year-over-year EBITDA.

These initiatives include: the integration of our I-mac operations into our Palo Alto based division; the continued implementation of lean manufacturing programs that reduced our production and support costs while maintaining our excellent production rates; supplier performance programs which decreased the cost of purchasing raw materials and components; and a number of other cost-cutting initiatives. In addition, in fiscal 2007 we benefited from higher sales levels than in the previous year, as well as a more profitable mix of products sold.

In fiscal 2007 adjusted EBITDA includes two significant adjustments to EBITDA. First our fiscal 2007 adjusted EBITDA does not include the aforementioned 6.3 million in debt extinguishment costs. Second, adjusted EBITDA excludes 1.2 million in stock-based compensation expenses. We generated adjusted EBITDA of 71.3 million or approximately 20% of sales in fiscal 2007, which is in line with our guidance of average long-term adjusted EBITDA margins of 20%.

Please note that for the seven weeks that Malibu was part of CPI in fiscal 2007 its impact on earnings was slightly positive.

Now let’s take a look at our net income results for the year. In fiscal 2007 our net income totaled 22.5 million or $1.27 per share on a diluted basis. Our net income increased from 31% from 17.2 million generated in fiscal w006 while our net income per share of $1.27 increased 17% from the $1.09 generated a year ago.

In comparison to the previous year our fiscal 2007 net income was positively impacted by the same factors that impacted our fiscal 2007 EBITDA: namely integration of our I-mac operations into our Palo Alto based division; continued implementation of operational excellence initiatives; higher sales volume; and a more profitable mix of products. These positive factors were partially offset by: the 3.9 million in after-tax charges, or $0.22 on a diluted basis; cost related to our recent debt refinancing and the 1.6 million after taxes, or $0.09 per share on a diluted basis; and currency headwind that I discussed earlier.

Now let’s move on to the changes in our cash and cash flow in the past 12 months. As you know we continue to manage our business to generate solid cash flow. Our cash position as of the end of fiscal 2007 was 9.7 million lower than at the end of the prior year. During 2007 the following items increased our cash position: we generated approximately 23 million in adjusted free cash flow which was in line with our guidance; we received an additional 2 million of proceeds including the tax benefit from the exercise of stock options and from our employee stock-purchase plan; and we received 1 million of net proceeds from our refinancing after paying expenses.

Offsetting these increases, the following items decreased our cash position during the year: we used approximately 22 million of the initial payment for the acquisition of our Malibu division; we used 5 million in excess cash from the first fiscal quarter to make a term-loan pre-payment; and we used approximately 9 million for two non-recurring items, the expansion of our Canadian facility and an income tax payment related to the gain on the sale of our San Carlos property.

The net result of these increases and decreases in our cash position was that we ended fiscal 2007 with 20.5 million in cash and cash equivalents. In summary, we had an excellent fiscal 2007. We met or exceeded all of our previously issued guidance for the year. We increased our sales for the fifth consecutive year, while maintaining our adjusted EBITDA margins. We believe that CPIs profitable growth in 2007 positions us well for fiscal 2008.

Our guidance for 2008 which is laid out in yesterday’s press release forecasts continued growth in our sales, net income, EBITDA and free cash flow. We intend to continue CPI’s pattern of generating profitable growth. Let me start the discussion of our 2008 guidance with some of the assumptions that are behind our financial projections. More detailed information regarding these assumptions is available in yesterday's press release.

First we are assuming an ongoing overall effective cash rate of approximately 38%. Second we are basing our financial projections on an assumed average effective exchange rate of $0.95 U.S. for every Canadian dollar which includes the effect of our current and expected future hedging. In fiscal 2008, we intend to continue of employing rolling hedges. As of the end of November, we have entered into hedges for 23.4 million Canadian, representing approximately 80% of our estimated Canadian expenses through March 2008. The average rate of these hedges is approximately $0.95 U.S. for every $1 Canadian.

As our Canadian-based expenses are growing for fiscal 2008 we estimate that every $0.01 change in the exchange rate will negatively impact our EBITDA by approximately $600,000 and our net income by approximately $370,000 annually, or by 2.1 cents per share on a diluted basis.

Let’s turn now to our sales projections for the upcoming year. In fiscal 2008, we expect to generate total sales in the range of 382 million to 390 million. This sales growth is in keeping with our expectations of 4% to 6% annual organic sales growth over the long-term. We are reaffirming our long-term guidance in this respect.

As Joe mentioned earlier our sales in the second half of 2008 are expected to include sales for the 2008 Russian tender program as well as our first sales for the Win-T military satcom program that we recently won. We also expect our Malibu division to contribute approximately $20 million in sales in fiscal 2008 which will be that division’s first full year as part of CPI.

We are assuming that our weighted average share count for fiscal 2008 will be approximately 17.9 million shares. We are also estimating that our stock-based compensation expenses for fiscal 2008 will total approximately 2 million and that amortization of intangibles related to the Malibu acquisition will add approximately 900,000. In total we expect to generate net income of 25 to 26 million or $1.40 to $1.46 per share on a diluted basis. This diluted net income per share range represents growth of approximately 10% to 15% from this year’s diluted net income per share results.

Moving on to adjusted EBITDA, we expect to generate adjusted EBITDA in the range of 72.5 million to 74.5 million in fiscal 2008, or between 18.6% and 19.5% of sales. Our adjusted EBITDA projection excludes stock-based compensation expenses of approximately 2 million. We expect our adjusted EBITDA margins will be slightly below our long-term guidance of 20% due in part to the effect of lower projected first year margins from Malibu. Those margins are expected to steadily increase in the following several years. Lastly, we expect to generate between 24 to 28 million in free cash flow.

I’ll turn the call back over to Joe now to discuss our expectations for the shape of fiscal 2008.

Joe Calderelli

Thanks, Joel.

As I mentioned earlier we had an exceptionally strong Q4 ’07. In part the strength of our Q4 was due to customers requesting shipment of their products earlier than we had originally expected. We were able to ramp up our production and meet those shipment schedules resulting in sales and profitability levels well above our expectations in Q4. As a result of these accelerated shipments we believe our sales and profitability will be correspondingly softer in the first several months of fiscal ’08 than they otherwise would have been.

In addition, a number of defense programs have delayed the timing of placing their orders with us in recent months, moving these orders out of fiscal ’07.We still expect to receive these orders and have in fact recently received a previously delayed 35 million IDIQ contract to support the aged radar system. The receipt of these orders is shifted to arrive by a few months. We have also seen a delay in orders to provide support the radar system for the hawk missile system. Initial indicators point to orders for this years hawk radar program surpassing the average annual orders we’ve received for the program in the last 10 years and we expect tot see the first of this year’s hawk orders very soon.

Earlier this week, the government announced that our Malibu division has been awarded a 5.6 million U.S. Air Force contract for antennae refurbishment. This was another delayed contract. Again these delays in orders are not unusual as the timing of defense programs often fluctuates, especially in the first and last quarters of the government fiscal year.

The combined effect of the accelerated shipments in Q4 and the delayed placement of defense orders which in turn will delay the timing of shipments in early ’08 is why we expect our sales and profit in the first half of ’08 to be lower than our sales and profit in the second half of the year. This is purely a short-term timing issue and we do not believe it will have a long term impact on our business. We continue to see strong, stable demand for our defense and commercial products and continue to expect average organic long-term growth in the 4% to 6% range.

We expect to generate Q1 earnings of between $0.23 and $0.27 per share on a diluted basis. We expect our Q2 earnings to be stronger, ranging between $0.30 and $0.35 per diluted share. Our third and fourth quarters are expected to be our strongest quarters in ’08. We estimate that our diluted EPS in Q3 will be approximately equal to our diluted EPS in Q4.

That concludes our prepared remarks this morning. I’d like to thank you for your time and attention. Operator, please open up the call for questions.

Question-and-Answer Session

Operator

[Operator instructions] Your first question on the line comes from Antonio Antezano from Bear, Stearns. Please go ahead.

Antonio Antezano - Bear, Stearns & Co. Inc.

Good morning. I was wondering as we get into 2008, the first quarter is almost completed now, does your guidance include what you see so far for the first quarter of fiscal ’08. And in terms of the conversion for the Canadian dollar, what other initiatives are you undertaking to offset that headwind that you mentioned in your guidance?

Joe Calderelli

The first part of your question, yes our guidance reflects what’s happened so far, of course, in Q1 ’08 and reflects the fact that there are a couple of orders that could still happen and which we may still be able to get some shipments on this quarter. That’s getting tighter and tighter, of course.

With respect to the Canadian dollar, we really continue our pattern of the previous years, of recognizing that we have the headwind. We simply continue to look at how we manage our business, and the operational excellence initiatives, working with our vendors, look at our design and see how we can take costs out of product services and of operations in total. Last year we had a significant net benefit from the first year of the full integration of I-mac.

Going forward I think we will continue to benefit from some of the work we’re doing with some of the outsourcing initiatives. For example, we’re looking at moving certain of the components and products that we buy in Canadian or maybe even U.S. dollars over to other parts of the world such as the Far East. We’re ramping up our efforts in that respect. We’ve had some reasonable early results and I think there’s still a lot of opportunity for us to reduce cost and materials by sourcing them elsewhere.

Antonio Antezano - Bear, Stearns & Co. Inc.

A follow-up in the medical sector, you mentioned that there was some acceleration in demand for the x-ray in Russia. Outside Russia, what are the trends that you see in the medical sector for fiscal year ’08?

Joe Calderelli

They continue to be quite strong. The medical sector shows now sign of any issues geographically or economic in nature. We just see continued good demand all around the world for the products. I don’t see any predibations to our medical products historical performance.

Antonio Antezano - Bear, Stearns & Co. Inc.

Thank you.

Operator

Your next question is a follow-up on the line with Antonio Antezano with Bear Stearns. Please proceed.

Antonio Antezano - Bear, Stearns & Co. Inc.

In the military sector of the business you mentioned this order you got. What type of other opportunities in the military satcom do you see in fiscal year ’08?

Joe Calderelli

Actually there are almost countless opportunities. It’s really quite remarkable the number of programs that are being pursued and explored and that parallel. Frankly there are so many of them I’m not sure if I could even intelligently mention them by name, especially if they all have three letters. But there are a lot.

We think there’s a reasonable opportunity for follow-on programs of very good size, from millions to 10s of millions per program, sometimes one year, sometimes multi-year. I think we’ve graduated now to being a full-fledged participant in that business. Remember that historically we’ve concentrated primarily on the commercial business until two or three years ago when we decided that it was inappropriate for us, and we focused more effort on the military side. So we had to pay our dues to get back into that business, to reestablish our credibility.

I believe we’ve done that and I believe we’re a full-fledged participant. I believe going forward there are significant opportunities for us, with some being comparable in size to the Win-T program over the next several years.

One thing that’s unique about that side of the business that’s worth pointing out, of course, is that you tend to partner with one or two others in these programs and your partner needs to win in order for you to win. It’s very difficult to predict going forward how many of those will come our way. But I think I can say safely that we’re partnered with a number of people that are in a good position and we expect to continue to be able to make announcements about our growing participation in that business.

Antonio Antezano - Bear, Stearns & Co. Inc.

That would be outside for this fiscal year, I guess, nothing of that is explained in your guidance.

Joe Calderelli

We have some assumptions. Remember that for military programs, shipments don’t start immediately. The take a while before you start shipments. We think in our general forecast for the future we have assumed continued success in defense communications. But certainly if one or more of the significant programs were to come in, it would definitely be outside potential. From a revenue perspective that probably would be late in the year, or next fiscal year, because it invariable involves several months before you actually ship meaningful products to them

Antonio Antezano - Bear, Stearns & Co. Inc.

Thank you.

Operator

Your next question comes on the line from Michael Coleman of Wachovia Securities. Please proceed.

Michael Coleman – Wachovia Securities

Good morning. I’m wondering if you guys are seeing any additional delays, or of there are any potential additional delays to defense orders from the budget problems that have been ongoing. Specifically if additional hold back or orders from the prime contractors that you supply may result in second half sales being somewhat short. Is there any color you can add on that?

Joe Calderelli

It’s very difficult from where we sit in the supply chain for us to tell cause and effect. Undoubtedly as we see every year there are delays in approvals of budgets, it causes a certain amount of constipation in the system, frankly. I'm not sure that I could cause a direct attribution to specific issues.

This is not al all uncommon. Every year in Q4 and Q1 we go through this. I think as I said before it’s very difficult to tell if there’s anything different about this year. We’re tight right now but to our understanding we have lost no orders and all of the products that we’re waiting to get orders for are still very much needed. In some cases, the service actually would like the product so we try to get prepared so that when the order arrives we can ship it in a much shorter time frame than we traditionally would.

We think it’s a typical beginning of the year situation. In regard to your question about the second part of the year, I don’t think so but clearly if the situation drags on for a few ore months, then yes of course, it would start affecting the second half. That’s not the way it looks now. There are a number of them on the cusp, and we hope to book them in December and early January.

Michael Coleman – Wachovia Securities

Thank you.

Operator

Your next question comes on the line from

Andrew Burke – Polk

Hi, guys, I may have missed this. It’s just a housekeeping item. What’s CAPEX expected to be this year?

Joe Calderelli

It’s approximately $6 million for fiscal ’08.

Andrew Burke – Polk

Okay, thank you.

Operator

At this time there are no further calls in the queue. I will now turn the call back over to Mr. Joe Calderelli for final remarks.

Joe Calderelli

Thank you very much for joining us this morning. We look forward to chatting with you at the end of Q1. Have a good day.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you all for participating. You may now disconnect, enjoy your day.

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