CPI International Inc. F3Q09 (Qtr End 03/07/09) Earnings Call Transcript

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About: CPI International, Inc. (CPII)
by: SA Transcripts

CPI International Inc. (CPII) F3Q09 Earnings Call August 13, 2009 11:00 AM ET

Executives

Joe Caldarelli - Chief Executive Officer

Joel Littman - Chief Financial Officer

Bob Fickett - Chief Operating Officer

Amanda Mogin - Director of Investor Relations

Analysts

Gary Liebowitz - Wells Fargo Securities

Chris Quilty - Raymond James & Associates

Andrew Berg - Post Advisory Group

Operator

Good day, everyone and welcome to the CPI International third quarter 2009 financial results conference call. My name is Kelsey and I will be your coordinator for today. At this time, all participants are in a listen-only mode. So we will be facilitate a question-and-answer session at the end of today’s presentation. (Operator Instructions)

Now, it is my pleasure to turn the presentation over to Amanda Mogin, Director of Investor Relations for CPI International, please go ahead Ms. Mogin.

Amanda Mogin

Thank you. Good morning and welcome to CPI International’s conference call for the third quarter of fiscal 2009. With us on today’s call are Joe Caldarelli, our Chief Executive Officer; Joel Littman, our Chief Financial Officer; and Bob Fickett, our Chief Operating Officer, who will join us for the question-and-answer session portion at the end of the call.

Before the call gets underway, there are some administrative details that I’d like to attend to. Please bear in mind that, today’s presentation includes forward-looking statements within the meaning of the Securities and Exchange Act of 1934. These statements are based on our best view of our markets in our business as we see them today and actual results can change as market conditions change. Please interpret these statements in that light.

Further information on risks and uncertainties related to our business are included in the Safe Harbor statement in yesterday’s press release and then our filings with the Securities and Exchange Commission. Today’s presentation under Securities and Exchange Commission will often include non-GAAP financial measures related to EBITDA and cash flow.

A presentation of the most directly comparable GAAP measures and a reconciliation of each of these non-GAAP financial measures to most directly comparable GAAP measures are available in the yesterday’s press release, which have been posted on our website. Interested parties can access the press release by going to www.cpii.com and opening the press release entitled CPI International announces third quarter 2009 financial results.

The agenda for this mornings call is straightforward. First, Joe Caldarelli provide an overview of CPI’s sales and orders results in Q3, then Joel Littman will discuss some of our key financial metrics for the quarter and then Joe, will wrap up our prepared remarks by discussing our expectations for the rest of the year.

Now, here is Joe Caldarelli.

Joe Caldarelli

Good morning. We are encouraged by our Q3 results, which represents the sequential improvement over the first half of the year. Our sales, net income and earnings per share increased in comparison to Q2. Our cash flow remains strong and our backlog is at record levels. Q3 actually committed that better than we had expected, but we are seeing signs of stability in our defense market.

After result, we are encouraged by what we’re seeing for Q4 and anticipating for fiscal year 2010. We believe that the majority of the economic downturn is behind us. We think that our commercial markets may have reached the bottom of their downward trends and we are closely monitoring those markets for signs and improvement.

However, some of our commercial customers particularly in the medical and commercial communications market are still feeling some of the effects of the weak economy and are continuing to delay postpone or suspend programs as the result. The impact of the economic downturn has made for some difficult year-over-year comparisons for 2009 so far, but overall, we are seeing market conditions settling down and our business is strengthening.

In the first nine of months of fiscal ‘09, we booked $271 million in orders at 3% decease from the $280 million we booked last year. Orders in the defense and medical markets actually increase during the most recent nine month period. At approximately $89 million, our orders rate in Q3 was decent, suggesting that our end markets are indeed coming down.

As you may recall, our Q2 orders bookings set a company record at approximately $116 million, because we received the number of previously delayed orders and booked several sizeable orders, whose timing just happens coincide. As a result of the record Q2 orders and comfortable Q3 orders at the end of Q3, we had unusually high orders backlog that totaled in excess of $230 million for the first time in CPI’s history. In comparison, our backlog averaged approximately $200 million in fiscal ‘08.

However, I should point out that a number of the orders currently in backlog are for longer term programs that have delivery schedules extending beyond the next 12 months. We are nevertheless encouraged by the increase in our backlog and the visibility we’ll add for our business over the next couple of years. Our Q3 sales were $82.5 million, a sequential increase from our Q1 and Q2 sales, but approximately 9% lower than our sales in the year ago quarter.

I’d like to discuss CPI’s recent orders and sales in each of our end markets individually, starting with the defense market. In comparison to last year, orders in our defense market rose 7% to $115 million for the first nine months of ‘09. Contributing to this increase was the timing of order receipts for electronic warfare programs as such as the ALE-50 airborne towed decoy system.

In the first month of fiscal ‘09 we also received several large development orders for radar programs such as the APN-245 Automatic Carrier Landing System Beacon, but began shipping at Q3. Some of these are long term programs and shipments are being made over periods extending beyond the next 12 months.

Sales in our defense markets totaled $35.7 million in Q3, 09 of 6% decrease from the same quarter last year. This decrease was primarily due to a $2.3 million drop in shipments of radar products to support the Aegis weapons system. As we stated previously, we expect our fiscal ‘09 sales rate for Aegis system to be approximately half of last year’s sales of $20 million.

With DDG-51 Aegis destroyer program now being restarted, we do expect to book orders to support new ships starting in fiscal 2010. We are continuing to see evidence suggesting that are defense markets are stabilized and the demand is holding fairly steady. Please keep in mind that it takes several quarters for defense orders to be converted into sales, so our defense sales levels may continue to reflect the impact of previously delayed the defense orders for few quarters.

Our second major market is the medical markets. Medical orders increased 2%, $49.5 million in the first nine months of fiscal ‘09 due to higher bookings for MRI and radiation therapy products. Our Q3, medical sales decreased 7% to $15.5 million in comparison to last year. This decrease was entirely due to lower sales of x-ray imaging products.

As a number of other companies in the medical imaging space have reported the markets for imaging products continues to be soft. The recession has diversely impact of the capital equipment budgets of hospitals and health clinics and many of them are delaying their investments and facilities on equipment.

This has temporarily resulted in reduced demand for products, for x-ray imaging application. Once the economic outlook for hospitals and health clinics is a bit better, we expect to see a rebound in demand for x-ray imaging products, but this could take a few quarters yet. Our communications market consisted products for both commercial communications and military communications for mil-comm application.

In the first nine month of fiscal ‘09 overall orders in our communications market decreased 6% to $91 million. This decrease was mainly due to lower demand for products to support commercial communications including direct-to-home broadcast, satellite news gathering and terrestrial broadcast application, all of which have been quite strong performance in recent years.

We believe that this decrease is tied to the soft economy and that demand for commercial communications products will increase as the economy recovers. There is still a strong underlying demand for additional bandwidth suggesting meaningful long term opportunities for growth and commercial communications.

Our military communications business continue to grow as the investments we made in our comparatively new mil-comm business over the past few years are continuing to bear fruit. Orders for mil-comm programs are approximately 75% higher in the first nine months of ‘09 versus the year ago.

A key contributor to this increase was the receipt of two approximately $12 million orders for the Warfighter Information Network Tactical or WIN-T in fiscal ‘09 to-date as compared to one similarly sized orders fiscal ‘08. We have now received in total approximately $38 million in orders for this program and we expect to make shipments against these orders well into fiscal 2011.

Although WIN-T remains the most significant program in our mil-comm business, we’ve also been orders several other mil-comm contracts this year including $1.7 million contracts for multinational defense organization and approximately $3 million upgrade award for the Joint Network Node or JNN program for the U.S. Army, $1 million contract for the U.S. Navy’s Multiband Terminal and several other mil-comm projects.

$24 million our communication sales in Q3 were 15% lower than a year ago quarter. The circumstances for communications sales are similar to those I just mentioned for our orders in this market, namely sales to support commercial communications applications such as direct-to-home broadcast and satellite news gathering have decreased due to economic weakness, while our sales to support military communications program have increased approximately 50%.

Overall our orders and sales were satisfactory in Q3 and there were no real surprises. Our commercial markets continues to feel the impact of the economy, but may have bottomed. Our defense markets have stabilized and our military communications business has continued to grow. We expect to see an improvement in our commercial markets as the economy strengthened. Our backlog is that it’s highest level contributing to long term stability of our business.

Now here is Joel to discuss our financial result.

Joel Littman

Thanks, Joe. In my remarks this morning, I will discuss our EBITDA, adjusted EBITDA, net income, cash, cash flow, and free cash conversion result for the third quarter of fiscal 2009. You can find the definitions in reconciliations of our non-GAAP metrics in the financial tables of the press release we issued yesterday afternoon.

For today’s call, I thought I’d structure my presentation a little differently than I have in the past. As it has for a great many companies the recent economic downturn has adversely impacted CPI sales and therefore profits in fiscal 2009, making our normal discussion of year-over-year comparisons rather uninformative.

Rather than recite the various measures of our profitability and our negative comparison to the year ago periods, I prefer to focus today’s discussion on several key themes that are apparent in our financial results for the most recent period. You can find a year-over-year comparisons in yesterday’s press release and Form 10-Q filing.

The first thing that I’d like to discuss is the sequential improvement that our third quarter results represent in comparison to our results in the first two quarters of fiscal 2009. Most recent quarter with our best quarter in this fiscal year, all measures of CPI profitability improved from the prior two quarters. In comparison to the second quarter, our sales increased modestly.

EBITDA and adjusted EBITDA experienced more substantial growth and both increased by approximately 28%. In addition our adjusted EBITDA margin increased from 13.7% in the second quarter to a respectable 17.5% in the most recent quarter. These improvements in profitability were due to a more favorable product mix in the third quarter and the positive impact of cost savings initiatives that we have implemented this year. I will discuss the cost savings initiatives in more detail in a few moments.

Our third quarter net and net income per share also benefited from the more favorable product mix and recent cost savings measure. As you may recall, we’ve recorded non-recurring discrete tax benefits from the first two quarters of the year, consisting a $5.7 million in the first quarter and $1 million in the second quarter.

Adjusted to exclude these discrete tax benefits, our first quarter net income was $2 million and our second quarter net income was $2.7 million. In comparison, we generated higher third quarter net income of $3.9 million, representing a 45% improvement from our adjusted net income in the second quarter.

On a diluted basis, net income per share in the second quarter, excluding the $0.06 per share of non-recurring discrete tax benefit was $0.15 per share. A $0.22 per share, our net income per share on a diluted basis was 47% higher in the third quarter. These quarter-over-quarter increases in EBITDA, adjusted EBITDA, net income, and net income per share speak to our ability to manage our business in a downturn and to increase our profitability as the economy stabilizes and eventually recovers.

Second thing related to our financial results that I’d like to discuss involves the comparisons of the most recent period to the prior year. Not unexpectedly, our sales and profits are down materially from last year due primarily to the slowdown in the worldwide economy. As I mentioned earlier, we have taken a number of steps this fiscal year to reduce our cost in order to offset the impact of this lower sales volume.

We have been careful to reduce our cost without impacting our ability to serve our customers to the current or higher activity levels, or our ability to continue to develop new and improved products. In fact, our total spending on research and development increased in the third quarter of fiscal 2009 in comparison to the same quarter of last year and we maintained approximately the same level of investment in our company’s sponsored research and development in this year’s third quarter as in last year.

The permanent and temporary cost saving measures that we implemented in fiscal 2009 include headcount reductions, salary freezes, temporary shutdowns of our facilities, work-share program, increased mandatory vacation time, and the number of other initiatives indented to cut our costs both in the near term and in the long term. One additional ongoing cost saving initiatives has been continued to reduce our interest expense by using our free cash flow to pay down our debt.

That brings me to the third and last thing that I’d like to mention regarding our financial results, mainly that despite lower sales volumes and profits in comparisons to last year. CPI continues to generate significant and positive cash flow, which we believe provides financial security and flexibility during a tough economic climate.

At the end of the third quarter, CPI had cash and cash equivalents totaling $35.2 million, an increase in comparison to the $28.7 million that we had at the end of fiscal 2008 and the $26.2 million that we had at this time last year.

For the 12 months periods ending July 3, 2009 our cash flow from operating activities totaled $29.5 million, and our free cash flow totaled $26.2 million, inline with our guidance for adjusted free cash flow of more than $20 million in fiscal 2009. As demonstrated by our ongoing debt reduction program, using our cash to retire debt remains a priority for us.

In the third quarter, we repurchased another $5 million of CPI’s 8% senior subordinated note. In the first nine months of the year, we have retired a total of $12.75 million of the principal amount of our debt. In coming quarters, we will continue to evaluate the best use of our cash and the most appropriate debt to retire.

For the 12 month period that ended on July 3, 2009, our free cash flow equaled $26.2 million and our net income equaled $21.2 million. As a result, our free cash flow conversion ratio was a 124%, illustrating CPI’s continuing ability to generate positive cash flow in excess of our net income.

In summary, our third quarter financials were an improvement from those of the first and second quarters of fiscal year. Our book-to-bill ratio, calculated as year-to-date orders divided by our year-to-date sales is 1.12 for the first nine months of this fiscal year. This is a positive measure that speaks well for our future sales. In conclusion, CPI remains a dependably profitable company. We continue to generate positive cash flow and to use our cash flow to reduce our debt.

Now, I’ll turn the call back over to Joe to discuss our expectations for the remainder of the fiscal year.

Joe Caldarelli

Thanks, Joel. In general, market conditions were improving. For the most part, delays in defense orders have abated and demand in our defense markets is holding steady. Demand has grown for our products in the mil-comm part of our communications market. Some of our commercial customers continue to feel the effects of the tough economic conditions, but we are seeing evidence that certain of our commercial communications customers are ready to start buying again.

It may take longer for our medical customers to work equipment purchases back into their budgets, given the longer and more ridged budgeting cycles in hospital, but we are confident that the underlying demand is still there for our imaging products once the time something right.

As a result of these combined factors, we believe our fourth quarter will be the strongest quarter of fiscal ‘09. We expect the top and bottom lines to improve in comparison to the previous three quarters. We continue to expect to generate adjusted the free cash flow of more than $20 million for the year.

In the last couple of years, a new seasonal pattern has emerged for us. The fourth quarter has become our strongest quarter of the year and the first quarter has become the weakest. Following this pattern, we expect the Q4 will be the strongest quarter of fiscal 2009. We believe that fiscal 2010 will start with a Q1 that is similar to Q1 ‘09 and then will improve in subsequent quarters with Q2, Q3, and Q4 all coming in stronger than the corresponding quarters of fiscal ‘09.

Overall, we expect fiscal 2010 to be an improvement for fiscal 2009, as market conditions continued to improve and we turn a record backlog into sales and we continued to realize benefits from our cost savings initiatives. We are currently in the midst of our budgeting and planning process for 2010, therefore we cannot provide detailed projections for the year at this time. We plan to provide update our financial guidance for fiscal 2010 on our Q4 call in December.

I want to thank all of you for your time and attention this morning, let’s begin the question-and-answer portion of our call.

Question-and-Answer Session

Operator

Your first question comes from Gary Liebowitz - Wells Fargo Securities.

Gary Liebowitz - Wells Fargo Securities

Joe, you mentioned that the orders for WIN-T are coming in pretty nicely. I guess you’re not seeing any of the effects of, I think there is the talk of possibly restructuring part of that program in connection with the future Combat systems restructure, or maybe emphasizing certain elements of the program, but you are not seeing any impact of that on your business?

Joe Caldarelli

No, we haven’t. With the orders that we currently have, and these are firm orders and releases, it carries us out into the 2011 timeframe. So any restructure would impact us beyond that period, but we’re pretty secure for the next nearly two year period.

Gary Liebowitz - Wells Fargo Securities

Also I was wondering, if you could quantify what some of the cost saving measures, what that benefit might have been in the quarter, because you attributed the strong margin improvement sequentially to both the cost initiatives and also the mix of sales apparently and I’m just trying to get a sense of how much of the margin improvement is sustainable because they’re due to the cost saving measures as opposed to the mix issues which could fluctuate quarter-to-quarter?

Joe Caldarelli

Well, we’ve estimated the annualized cost savings in the $10 million range. So we haven’t specifically tried to calculate the impact on this quarter, but it’s reasonable to assume, a couple of million plus at these rates and of course as the sales rate increases we expect to see incremental benefits. So that’s probably a reasonable way to model it.

Gary Liebowski - Wachovia Capital Markets

Just one last one for Joel, I mean cash flow was a bit stronger than I had expected, and it seems like you’ve almost met your full year guidance for free cash flow through nine months. What were the working capital changes that led to such strong cash flow in the quarter?

Joel Littman

There’s a variety of items, but some of the items include receivables, we had good collections in the quarter. Our receivables are running about 45 day sales outstanding, and I consider that an excellent level of receivables, that’s one of the impacts. We continue to perhaps and are able to collect advance payments from customers, that’s also a big helper on cash flow.

Gary Liebowski - Wachovia Capital Markets

Just looking at the balance sheet, doesn’t look like there was significant changes in those two balance sheet balances compared to the end of March or maybe something that I can pursue offline, I’m not seeing in the balance sheet where the cash came from?

Joel Littman

I’ll look at it, Gary and if you want to give me a call later we can talk about it.

Operator

Your next question comes from Chris Quilty - Raymond James & Associates.

Chris Quilty - Raymond James & Associates

A question for you, on the commercial communications side of the business and I guess specifically for the DTH side of things. Any indications that you’re losing market share or customers there just really delaying orders because most of what you should be seeing on demand side, is it really all that optional in terms of their need for spending?

Joe Caldarelli

On the DTH side there has been a shift in the technology used by one key customer that has had some impact on us. I think the impact is relatively modest.

Chris Quilty - Raymond James & Associates

Is that a Ka-band move or…?

Joe Caldarelli

No. It’s moving from indoor based amplifiers to outdoor based amplifiers at the conventional frequencies, and that’s a modest impact. The other I think is just really, just people being cautious. So if I mean the quarter that just ended, we actually had reasonably good bookings in commercial communications applications at the bookings level, but these things are fairly lumpy, so I’m reluctant to sort of call it that it’s all over, but on the base level one quarter trend, it seems pretty good.

Chris Quilty - Raymond James & Associates

On the military communications side relative success story, can you remind us to the degree that you can of any major programs that we should keep our eyes on and in the pipeline for announcements or potential wins?

Joe Caldarelli

Since, I don’t know that I’d get them right if I tried to do that. So there’s so many acronyms beyond and there’s got to be 15 or 20 that we’re following at any onetime so.

Chris Quilty - Raymond James & Associates

No single program that really sticks out like the WIN-T?

Joe Caldarelli

No, single program, I think there’s a pretty good variety of million dollar to multimillion dollar range programs, but there’s no single one like WIN-T for example, that we’re following that is a must-win.

Chris Quilty - Raymond James & Associates

Malibu, is it still a drag or are you getting the expected contribution there yet?

Joe Caldarelli

They’re kind of at the breakeven level at this point here. So we’re still very encouraged by the desirability of their technology and key customers reactions to their technology and I’m hoping actually in the not-too-distant future to have some positive announcements about that, but on an operating basis, we’re still supporting the transition of Malibu from an engineering house to a production houses. They are relatively breakeven at this point.

Joel Littman

They are making a very small process so far this year, so they’re slightly better than breakeven.

Gary Liebowski - Wachovia Capital Markets

You are still funding the development in terms of future products there at an appropriate level?

Joe Caldarelli

There is some customer funding involved as well they do a fair bit work that’s developmental in natures with customer funding. Our investment in them is captured and it’s new state as slightly better than breakeven. Other words, we are little bit better than breakeven in spite of our investments.

Gary Liebowski - Wachovia Capital Markets

Just for the accurate advent Varian acquisition shouldn’t have any impact on you, should it?

Joe Caldarelli

No impact.

Operator

Your final question comes from Andrew Berg - Post Advisory Group.

Andrew Berg - Post Advisory Group

Just a clarification in your last comment, you said first quarter 2010 should be similar to 2009. Where you referring to absolute dollar amount of EBITDA or order of magnitude declines from fourth quarter to first quarter?

Joe Caldarelli

Overall performance in Q1 ‘10 will be very comfortable to Q1 ‘09. So I guess you are taking dollar I guess it.

Operator

While we have no further question at this time, so Mr. Caldarelli I will turned it back to you for closing or additional remarks.

Joe Caldarelli

Thank you very much for listening in and I’ll talk to you all in December. Have a good day.

Operator

That’s conclude, our conference for today. We thank you all for your participation.