Earnings Call Transcript - PKE Q2 2020

Operator, Operator

Good morning. My name is Shannon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Park Aerospace Corp Second Quarter Fiscal Year 2020 Earnings Release Conference Call and Investor Presentation. All lines have been placed on mute to prevent any background noise. After the speakers’ remark, there will be a question and answer session. Thank you. At this time, I will turn today's call over to Mr. Brian Shore, Chairman and Chief Executive Officer. Mr. Shore, you may begin your conference.

Brian Shore, Chairman and CEO

Thank you, operator. Welcome everybody to our second quarter call. This is Brian, and with me as usual is Matthew Farabaugh, our CFO. We have a presentation we prepared for you and for this call, it's been posted on our website and also there is a link that's referred to in the earnings news release. You probably want to get a copy of that in front of you because Matt and I will be going through the presentation. There's also some supplemental financial information that's attached to the presentation. I think it's Appendix 1. We're not going to read through it, but it's something you might want to take a look at at some point. Obviously, you know the news release is out. The earnings release is out as of earlier this morning. So there is a lot to cover and I'm going to try to cover some more complex topics to give you some perspective on the quarter. So please just try to bear with us, but why not we get started. So on Slide 2, we have our forward-looking disclaimer. We're not going to read through that, of course, but if you have any questions about it, please give us a call. Thanks on that. Slide 3, Matt, why don't you pick up on Slide 3, talking about the expansion spending and also top five customers.

Matthew Farabaugh, CFO

Sure. Thanks, Brian. Just as a reminder, we had announced that we are doing a major expansion at our Newton Kansas facility and we made that announcement back in December. This slide is really just to give you a quick update on where we're at and the spending on that expansion. So our estimated budget for the expansion was $20,500,000. So far through the end of Q2, we've spent $3,900,000, a little short of $4,000,000 on that and the remaining to be spent for that expansion is about $16,600,000. That expansion is expected to be completed by next summer, so that's the summer of 2020. The top five customers for the quarter are AAE Aerospace, AAR Corp, Kratos Defense and Security Solutions, Meggitt PLC, and of course, MRAS, including its subcontractors. Just a reminder that MRAS is now a subsidiary of ST Engineering Aerospace.

Brian Shore, Chairman and CEO

Okay. Thanks, Matt. I'll take it back to. Let's move to Slide 4, everybody please. Here are the quarterly results which you've seen presumably. The sales for the quarter, second quarter, I'm talking about $13.723 million gross profit -- gross margin 27.8%, obviously way down, and EBITDA $2.406 million also down. So let's talk about what we told you would happen or what we said -- we believe would happen during our first quarter conference call that was on July 11. We gave you a sales estimate of $14.5 million to $15.5 million and EBITDA estimate at $3.1 million to $3.7 million. The shortfalls both top and bottom line, the sales shortfall is to the lower end of the forecast range, not the middle. The lower end is $777,000 and the EBITDA shortfall of $694,000. So obviously, if we go to Slide 4, the question is what happened? Why did this happen? What the heck happened in Q2? As I've already mentioned at the beginning of this explanation -- the explanation is complex. It's multifaceted. We're going to go into some details because I think it would be helpful for you to understand and get the perspective. These are things we probably haven't discussed with some in the past. So just try to bear with me, please. Why don't we start with some background perspective. We've discussed this before, but I just want to remind you that in fiscal '19 Q4, that was December of last year, in January and February of this year, the sales for the GE/MRAS programs were three times the sales of the first quarter that same year, just nine months later. That's a very steep ramp for a very complicated and challenging customer to support. We got the job done and we did not disappoint them in Q4 with the ramp they asked us to handle. We did it mostly with brute force, and that's what we had at that point. We did not have the systems in place to operate at that level, especially for such demanding customer. I want to be clear, I'm not saying it in a bad way. We love MRAS. In fact, they are much more challenging than the other customers. They ramped three times during the nine-month period, which put a lot of pressure on our system. I got to tell you, I think we're the exception to the rule because there are a lot of suppliers in the supply chain right now. They have real trouble keeping up and are causing real challenges for supply chain managers in the aerospace industry. We're in a process of transitioning from brute force to sustainability. You can't do brute force forever; at some point, it's just kind of wears people out. Some important and painful progress is being made. We're not there yet in terms of transitioning from brute force to sustainability. Maybe we got a little burned out in Q2 from the brute force efforts in Q4 and Q1; maybe we let down a little bit, maybe our discipline slipped a little bit. If that's true, I think our heads are back in the game now. Another thing I want to bring to your attention is the practice we've had in the last few quarters, particularly Q4 and Q1 of making the quarter last few weeks. I think we got complacent about it, thinking don't worry, we will make the quarter last few weeks. In other words, total stops in production, we would just push everything through and get anything shipped by the end of the quarter; but we got burned by that in Q2. We got behind and we couldn't catch up for reasons I explain in the next few slides. We didn't even see the sales and EBITDA shortfall coming in the last few weeks of the quarter, because again, over the prior two quarters we were used to making the quarter last few weeks. It's a bad practice; we're not doing that anymore. Some things we learned the hard way and -- but I think one good thing about us is that we do learn, even though sometimes it's the hard way. Let's move to Slide 6 please. This is going to be complicated, but bear with me. We obviously just report our revenues and profits. We don't report production plans. So in Q2, our plan was to produce $2.9 million more product than we actually produced in Q2. That's a huge difference. The fiscal '20 Q2 sales shortfall obviously had a negative bottom line impact. That’s straightforward. But the larger impact was from the production shortfall because when you produce product, some of that drops to the bottom line when the product is converted to inventory. This $2.9 million is in sales values. That’s the value of the product when it's sold. Okay, so why did that significant production shortfall happen in Q2? There were three discrete, unrelated events that were all unexpected by us and that caused us significant difficulty in Q2. This is where I need to explain a little bit about some of our raw materials and our processes. Normally, we don't go into this detail, but I think it’s crucial for us to be transparent. There is something called polyurethane film that's used in our process. It stabilizes the product in customer operations, and it also prevents the product from sticking to itself when rolled up because it's sticky. We did a change of the polyurethane film style for the MRAS programs, and that caused wrinkles. The film wasn't sticking to the product in a flat way, it was wrinkled. This was not something we were able to pick up on. It was picked up by the customer and they sent the product back to us for rework. Polyurethane is applied in the original process fully automatically on the machine, but when you have to rework, it's a semi-manual process. We had used this other solid style poly for other applications that worked very well. We thought, let's just use it here without trials, which was a mistake. That was something, an example of, maybe our discipline wasn't as good as they should have been. So we didn’t do it and we got burned because we had done an enormous amount of product and say we have wrinkles; you got to send all back. Now we're doing the rework. The second item was an unrelated but serious quality issue from a different supplier of polyurethane film. We did not realize it in our factory. It was the customer that realized it when they received the product and again, it caused significant rework. This is time-consuming; not only do you pay for the rework labor, but that labor is not producing product to ship and sell. A third item, also unrelated, was when we received some carbon fabric for an MRAS program that was distorted and could not be used. We had to send it back to the weaver for rework. The issue with carbon fiber supplier is they would supply the forecast but not one pound extra. So we could call them up and say, look, we have a problem; can you send us more fiber? There is no more fiber. With very little slack in our system, we didn’t have room to recover from these issues, which is why we’re telling you about it. Those two things together, the discrete events and the tightness in our system conspired against us in Q2. Next, the major rework related to polyurethane film resulted in significant expense. Our production workers were consumed with rework, diverting them from producing products. The bigger impact was not just the cost to do the rework but the production value shortfall of approximately $3 million. And we are not blaming the suppliers. We think our suppliers are very good and support us well. It's crucial to explain what happened because normally we deal with problems without them significantly affecting performance, but this time we had a major impact in our Q2 performance. Moving on to Slide 8, hot-melt manufacturing capacity constraints. You're probably surprised to hear this, because until now we felt we have enough capacity. When we did our capacity analysis, we were learning as we went and we've had to adjust our capacity concepts. To relieve and open up the hot-melt capacity, we implemented fourth tape line manufacturing shifts. The tape line is now running 24/7. We believe our capacity is $45 million, but that does not include the capacity from the 24-inch line. Until the expansion comes online, we have enough capacity to serve our needs and to take on other opportunities. Let's discuss our forecast. For Q3, we're projecting revenue of $14.75 million to $15.75 million, down from our previous forecasted EBITDA. For Q4, we see revenue of $15.25 million to $16.25 million and EBITDA of $3.25 million to $3.75 million. Our salespeople need to be out there getting orders. We need to build ourselves a cushion for things that might happen at the end of the quarter. We're bringing EBITDA numbers down due to several factors: outside testing costs related to new product development, additional costs from the manufacturing trials for the GE9X program, ongoing rework related to polyurethane film and push out of delivery schedules for the GE9X program. These all have an impact on the bottom line, but they don't affect our long-term prospects. All our major jet engine company programs, except the B747-8, are ramping or in development. There are setbacks in development or ramping and issues with supply chain. There’s more risk in the system with most key programs that are in development or ramping. Let's move on to Slide 12. We previously indicated long-term forecasts only once a year, so we will update this forecast next January. There is nothing unusual included in our long-term forecast, just a baseline from MRAS and the GE programs. We aim for organic growth, and we do not include acquisitions in our forecasts. Now regarding acquisition opportunities, we haven't seen significant changes since our last quarter. We identified a number of companies, but these are not companies that have been put up for sale. We're continuing our efforts there. It’s a tedious process. We'll see what happens, but there haven't been any significant updates.

Christopher Hillary, Analyst

Great. I just wanted to ask, you mentioned in your comments that we could ask about your long-term forecasts. I just wanted to ask if you could provide more insight into what you have included in some of those longer-term forecasts?

Brian Shore, Chairman and CEO

For the long-term forecast, we've cut the MRAS and GE programs to some extent, just to be a bit conservative. The GE9X program has been a significant factor. We think what will happen is based upon all the assumptions we're making. We’re not inclined to give you a conservative forecast simply to be heroes. Last quarter, there were unexpected events that impacted us, but they do not affect the long term.

Christopher Hillary, Analyst

Okay. And then one more, just a follow-up. You have a material cash balance and in previous calls, I believe you expressed some confidence that there are some acquisition opportunities. Is there any updated color on that front?

Brian Shore, Chairman and CEO

No significant change since the last quarter. We're focused on avoiding auctions run by investment bankers that often lead to overpricing. We're continuing to identify companies in various product categories and have reached out to them. We'll see where it takes us.

Operator, Operator

[Operator Instructions] I'm currently showing no further questions at this time. I will turn the call back over to Brian Shore for any closing remarks.

Brian Shore, Chairman and CEO

Okay, well thank you very much, operator, and thank you all for listening today. I appreciate you hanging in there. I know it was a lengthy discussion, but we thought it was necessary for perspective. Have a good day. If you have any additional questions, we're available. Thank you again. Goodbye.

Operator, Operator

Ladies and Gentlemen, this concludes today’s conference call. Thanks for participating. You may now disconnect.