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Saturday, March 29, 2008

CPI Aerostructures (CVU) 10-K

I currently own CPI Aerostructures, which does maintenance on airplanes, mostly military. It was a VIC idea and the guy who recommended it actually changed his mind, while I continue to stick with it. My thinking of why this is a "big move" is due to a few things. First, the planes are in Iraq now and the orders aren't coming in to anyone; it's not just a CVU issue. Second, CVU seems to be well-run and they're gaining business in other areas. They seem to have a very good name at this point. They're well prepared for a large increase in business now (which has increased their costs). The big story, in my opinion, is that the planes will return. Word is that they'll need an enormous amount of maintenance: things have been put off at the same time that the equipment has been put to heavy use.

However, the stock has been a disappointment for the 3-4 years I've owned it. It's still a bit below breakeven. But the business is doing well and doing all the right things.

They did a conference call and thankfully Seeking Alpha has a transcript. It's not perfect (as if I've ever approached that ideal!), but it's a hell of a lot better than typing it myself.

Here's are some key parts of the story for this company.

2003: $27 million
2004: $30 million
2005: $26 million
2006: $18 million
2007: $28 million

Gross Profit:
2003: $9.0 million
2004: $10.3 million
2005: $6.0 million
2006: $1.6 million ...the business was scaled up for increased revenues, but they dropped
2007: $7.4 million

Net Profit:
2003: $8.4 million
2004: $5.1 million
2005: $1.5 million
2006: ($1.3 million) ...the business was scaled up for increased revenues, but they dropped
2007: $1.9 million

(Yahoo, home, sec)

I've been lazy and it's been a long time since I picked apart a financial statement. Let me just pop some caffeine aaaaaand here goes nuthin...

year ending Dec 31, 2007
6 million shares on Mar 20, 2008

CVU acts as a prime contractor directly with the military or else as a subcontractor for another prime. The growth is in the subcontractor area. They've talked a lot about this in the past and some in the conference call.

They provide aircraft skin panels, leading edges, flight control surfaces, etc. etc. C-5A "Galaxy" carge jets, T-38 "Talon" jet trainer, C-130 "Hercules" carge jet, A-10 "Warthog", E-3 "Sentry" AWACS jet.

Also Black Hawk, MH-60S anti-mine helicoptor.

Awarded contracts:
2007: prime $22.7 million, military subcontracts $9.0 million, commercial subcontracts $6.0 million (Sikorsky)
2006: prime $23.0 million, military subcontracts $7.0 million, commercial subcontracts about the same
2005: prime $14.4 million, military subcontracts $2.2 million, commercial subcontracts unknown (any?)

Subcontracting from...
Northrop Grumman
Lockheed Martin
Sikorsky (this is fairly new stuff)
Vought Aircraft

Spirit: March 2008 they were awarded the Spirit (Yahoo) subcontract. ASIDE: Spirit seems to be selling fairly cheap, just based on a cursory check, but not as cheap as CVU from what I can tell. The Spirit subcontract had an initial order of $3.5 million ($3 million to be booked in 2008) and the total multi-year revenue is expected to be $86 million. Details later.

CVU has been in business for 27 years, completed over 2,400 contracts. Most of the managers come from the large aerospace companies. Due to CVU's small size, they can compete for government contracts set aside for "small businesses".


T-38 "Talon": jet trainer intro-ed in 1959. 500 are in service. Air Force has a program to keep them in service till 2020. In 2001, CVU was awarded a 10-year contract to build structural inlets. Total of $61 million over 10 years. 21% of revenue in 2007.

C-5A "Galaxy": this is the mega contract that never seems to actually produce revenue. It's been years now and this was the catalyst for CVU as an investment when I first bought it 3 or 4 years ago. The C-5A is the largest aircraft in the world right now. It's the plane that carries all the stuff to places like the Middle East. Intro-ed in 1970 (the C-5 is from 1969). This plane has been going through upgrades in recent years, but that seems to be on hold right now and CVU hasn't been getting much work on this. Air Force has a program to keep these planes going till 2040, but there's political arguments about a replacement. From Wikipedia:

The C-5 is also known as "FRED" (Fucking Ridiculous Economic/Environmental Disaster) by its crews due to its maintenance/reliability issues and large consumption of fuel. The C-5 requires an average of 16 hours of maintenance for each flight hour based on 1996 data.
I don't expect all that much from this contract. I don't think the stock market does, either. They've gotten $17.9 million from this contract so far and it was 28% of revenue in 2007.

UH-60 "Black Hawk": Long-term agreement with Sikorsky for Hover Infrared Reduction System module assemblies. The initial order was for $4.4 million. In 2008, they've had 3 follow on orders of apparently $8.1 million. CVU thinks there will be perhaps another $7.5 million on this by the end of 2010. This was 27% of revenue in 2007.

Gulfstream G650 business jet: This is the commercial Spirit contract. Structural leading edges, trailing edges, flap assemblies. Potential revenue through 2014 is $86 million.


Historically, they've gone after small contracts of less than $200K. Typical sales cycle (RFP to delivery) is 6 months to 2 years, but some of these big ones are longer.

Currently CVU has $220 million in bids outstanding. Generally about 40 to 50 contract bids per week. They've been winning 14% of bids in the past 3 years.

72% of contract awards were those made under the US Gov "small business" award program. This doesn't make me happy. If the thing ends, does CVU become uneconomical?

2006 had the Quadrennial Defense Review (QDR), with a commitment to cargo transportibility etc., including modernizing the C-5.

However, there has been a slowdown in contract awards and releases due to the ongoing war etc. CVU has expanded operations as a subcontractor to other primes.

2006: $26.8 million funded, $21.4 million unfunded
2007: $29.6 million funded, $5.5 million unfunded (about $24 million is expected to be revenue in 2008)

About 87% of the backlog is government contracts.

The usual regulations apply to the company.

We believe that our competitive advantage lies in our ability to offer large contractor capabilities with the flexibility and responsiveness of a small company, while staying competitive in cost and delivering superior quality products. While the larger prime contractors compete for significant modification awards and subcontract components to other suppliers, they generally do not compete for awards in smaller modifications, spares and replacement parts, even for aircraft for which they are the original manufacturer.
65 full time employees, plus various temporary specialized personnel as needed.

Notable risks:

1.2 million stock options

Assume 7.5 million totally diluted shares.

Revenue increased about $10 million or 56% in 2007, but it had simply recovered from a drop in 2006 (see list of revenue numbers above). But we need to look closely at this recovery to see some important things. First, the increase in traditional government contracts caused only about 25% of the revenue increase. Subcontracts (a new market for CVU) caused about 80% of the revenue increase. Only a small part of the increase was due to commercial work. But notice that the big Spirit contract is commercial.

According to the contract numbers, Spirit will probably contribute an average $13 million per year to revenue through 2014, but only $3 million in 2008.

Only $5 million of the C-5 TOP contract was released in 2007. I don't expect much from this going forward.

Gross margins were 26.4% for 2007. In the conference call, Ed Fred said (hehe) that they will "Absolutely" get back to "those 30% plus gross margin levels." They would have been close to that this year, but not with the Spirit contract, which during the early phases pulls margins down. They talk about getting to the mid 30s gross margins 3 to 4 years from now.

They're doing all the normal things to improve margins (according to the 10-K), but they had ramped up for higher volumes. This hurts things now, but will help later as revenues apparently will be ramping up (in my opinion).

SG&A was up 22.6% mostly due to consulting fees for bids, bonuses earned by officers.

Aug 2007, new 2 year revolver. $2.5 million. Secured by all assets. lower of LIBOR+2 or bank prime.
$1.1 million in debt, but $500K was repaid just after New Years.

Auditors added a note about accounting for stock based compensation based on adopting SFAS 123(R). Seems like a respectable auditor. They audit 50 public companies.

Balance sheet looks solid, similar to last year.

I've already dealt with the income statement.

Cash flow in this sort of business tends to be timing sensitive. But if we look at three years cumulative, we see roughly (only) $2.2 million in net income and operations burned up $3 million. The total amount is about the same as the cumulative costs and estimated earnings in excess of actual billings. So we've had three years of earnings that have yet to be billed to the customers. Let's hope these guys are honest. They seem to be, based on what I've observed over the past 3 or so years.

Capex has been less than depreciation.

Cash flows have been maintained in the past 3 years by depleting existing cash, by stock options, and the line of credit.

As of Dec 31, 2007, costs and est earnings in excess of billings:
Government: costs are $57.5 million, est earnings are $36.5 million, billings to date are $64.8 million, leaving $29 million
Commercial: costs are $16.6 million, est earnings are $7.2 million, billings to date are $21.9 million, leaving $2.0 million

Costs tend to be up-front and earnings tend to be down the road. Inflation risk.

Depreciation schedule seems reasonable.

In compliance with all bank covenants.

They've granted about 100K stock optons per year. None forfeited in the last 3 years.


This is a case where the initial investment was a mistake, but I believe it's currently a good investment. The correct course of action would have been to buy it at $5 back in 2006. Oddly enough, I still think it's worth around $18, which was my initial estimate when I first bought it. That's not a case of anchoring, it's a bottom-up result.

UPDATE March 31, 2008: CVU just announced that they won another contract, this time for $1.5 million on the C-5A Galaxy as part of the C-5 TOP contract. All right! Said Ed Fred...

With this award, we end the first quarter of 2008 with a total of $10.6 million
in new contract awards, compared to $1.1 million for the same period last year.

This increase is due to "our continued efforts to diversify our customer base and increase the proportion of work" as a subcontractor.

Hi Bruce,

I've been reading various parts of your blog over the last few days - very nice job!

However, I've looked at CVU myself recently and I have to admit that I'm baffled as to why you think it's worth $18. In my view, it's close to fair value (maybe even somewhat overvalued) at about $8 right now. Would you care to expand on your valuation for CVU, or can you point me to it in your blog in case I missed it?

Many thanks.
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