Ducommun Inc (DCO) 2005 Q1 法說會逐字稿

Welcome to the first-quarter earnings release conference for Ducommun Inc. At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session at the end of the conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded. I would like to now turn the presentation to your host, Chairman and Chief Executive Officer, Mr. Joe Berenato.

Good morning. I'm Joe Berenato, CEO of Ducommun, and I want to welcome you to Ducommun's first-quarter 2005 conference call. As reported earlier today, sales for the first quarter of 2005 were 63.8 million, up 10% from the 58.2 million of the first quarter of 2004. Operating income was 4.7 million versus 3.6 million from the year ago quarter, a gain of 30%. Net income was 4.1 million versus 2.2 million from the first quarter 2004 which was an increase of 83%. And diluted EPS was $0.40 a diluted share versus $0.22 from a year ago, also an 82% increase.

On the breakdown, military was 61% of our sales for the first quarter of '05 as it was in the first quarter of '04. Commercial was 36% versus 35% from a year ago. And space was three% versus 4% from a year ago. We're making good progress on our 2005 goals which include -- one, drive to the one Company as we make our transition from being a holding company to an operating company; two, improving operations through lean and Six Sigma; three, driving strategic growth through internal program development and seeking acquisitions; and four, driving organizational development both through structure and people.

And as I talked in the annual report, we have brought in a number of new folks, but the good news is that as we continue to evaluate our personnel we're seeing more and more opportunity to develop our existing folks and less and less of a need to continue to go outside to hire new people. These goals are communicated frequently through our all hands meetings at each of our sites and through the Ducommun company newsletter.

Every person in our Company is eligible for cash bonuses if annual operating plan goals for profits and free cash flow are met. Last year we didn't meet these goals and no bonuses were paid. We believe our pay for performance policy drives the right behavior and keeps all employees focused on the right metrics. The good news is that we're on plan through the first quarter of this year.

Our team members are working very hard to improve operations and bring in more work which we can deliver on time with high-quality and at a reasonable cost. So what I can say is that we are improving, that both military and commercial cycles should be positive for the next two to three years, and that we have a strong balance sheet to fund our growth both internally through capital expenditure or program buy in or developing offshore capability and externally through acquisitions for our Ducommun Technologies business.

Today we have no net debt and would expect to continue to build cash until we make the next acquisition. So with that I'd be happy to take some questions.

(OPERATOR INSTRUCTIONS). Adam Hurwitz (ph), Celine Management.

Could you just give us a sense by program -- platform program where you might be seeing additional strength going forward?

Certainly we would expect going forward that we'll see gradual growth on the Boeing 737 and 777 programs. Right now, depending on the particular component or subassembly, we're building anywhere between 18 to 21 per month for the 737 and would expect during the course of this year to see that number go up. On the military side the growth would be on the Apache helicopter blade because of the usage in the Middle East. Most of the helicopter blades for the Apache that we build are replacement blades and not for OEM helicopters. So those would be the two prime areas in our existing business. We continue to look for new opportunities and if we were successful in landing a significant new contract that, of course, would be additive to what we're currently doing.

Do you think there's going to be -- there's been a lot of talk about currency movements in the Far East; it doesn't sound to me like that should be enough to have an impact one way or the other.

No, I don't think in the Far East. What we hope is that the continued strong euro will cause Airbus to look to outsource more work into the United States. Because they sell their product in dollars and, to the extent that the work is being done in Europe, they're incurring euro cost and so that's probably a pretty good squeeze on their profitability.

Thank you very much.

(OPERATOR INSTRUCTIONS). David Napgatser (ph), RBC.

Just wondering, your last answer -- you talked about 737 and 777. Are you already in or already out on the 787 or just no contract slated yet?

Not on the program yet and the reason is because the -- I guess there are about seven tier one contractors who divide up the aerostructures on that aircraft. The design isn't set yet so until they have a firm design that has been accepted by the first tier guys they can really start offloading work to second and third tier subcontractors because they have no engineering to give them. So on the aerostructures side the wait really is to see the engineering stabilize. On the electromechanical side work can be outlet on that side, again to the extent that the engineering is done, and we're actively talking to some first-tier folks about doing some work that would be on the 787.

Okay. This may be a little bit technical, but did the increase in your -- I'm trying to get this right -- you had a 10 million increase in your raw material and work in progress at the end of the year and you had a decrease in your progress payments. That seemed kind of odd that you would have less progress payment and yet more work in progress.

It's strictly a matter of timing because what happens is progress payments or other incremental payments are made based on certain milestones. As an example, when you buy raw material you submit the bills and you get the progress payments. So at a given point in time it just depends what's left on the books of the progress payments that you've already received. So if I got the progress billing on December 20th it was a big number and that same billing if it took place in November some portion of it would have shipped and so there would be less progress billings on my books.

So it's very much a point in time issue. It doesn't mean that we have in aggregate fewer progress billings available to us this year than last. It's just what was on the books on that cutoff date. In fact, we continue to -- progress billings are available primarily on government contracts and we continue -- as we get more government work, primarily military, we continue to try to get more progress billings. And so just depending on the timing of when those are received matters whether it will show up as 2 million, 3 million, 6 million or 8 million.

And just one last area. What's your status on the joint strike fighter? Is that still something that could be near future?

Yes, we have a little bit of work on the joint strike fighter now and would expect to get some more work going forward. My guess on the joint strike fighter is that we're going to see it pushed out. And so whereas we originally thought there would be revenue, toward the end of this decade there probably still will be but probably less than we had originally imagined. The corollary to that is that that should give extended life to things like the F-15 and the F-18 where we also have positions so that would be a good thing for us.

Thank you.

(OPERATOR INSTRUCTIONS). Tom Spiro, Spiro Capital.

I remember, Joe, last year we had some problems on the Apache helicopter blade program. And I know you spent a lot of time and effort making some changes. How's it going?

So far so good. The program has run to our plan essentially since October of last year, so that makes seven months in a row. We obviously want to keep on extending that streak. We continue to put in improvements in operating procedures working closely with Boeing to make the manufacturing process more robust. But every 100 helicopter blades we do a destructive test and if we find anything in that we report it to the customer and to the Army and if they believe there's an issue there, that could disrupt production. So what we always say is that we're only as good as our last destructive test. And those tests are taking place probably about once every two months now.

Thanks. I also recall from last year's results that we had some problems with lost contracts and as a consequence you and your team were going to put in some new bidding processes and procedures and I wondered if those are all pretty much now in place and you're comfortable with the way you are approaching new business?

They are in place. We brought in an outside consultant with experience at senior defense contractors and he helped us redesign our estimating process which we then flowed through the entire Company. And so we feel pretty comfortable that we know what we're doing. It doesn't mean the pricing is much better, but we know what we're doing in terms of what we're pricing.

The lost contracts are something that you revisited every quarter. At the end of every quarter we're required to look at all of our contracts and re-evaluate whether they are contributors or whether they're lost contracts and if they're a lost contract to what extent. Now most quarters you don't hear anything about it because the changes are too minimal to comment on whether they're up or down. And it's only when you have a significant lost contract that it gets mentioned which we did both in the first and fourth quarters of last year.

So our goal obviously is not to have any more lost contracts than are noticeable. But such contracts exist in our industry continuously. It's just that normally they're not of a size that are worth making comment about.

Thanks, Joe. Good luck.

(OPERATOR INSTRUCTIONS). Peter Arment, JSA Research.

You mentioned in the release lower -- there was some offsetting impact on lower gross margins at the aerostructures -- to common aerostructures. Could you give me a little more color on just whether that's new development programs or exactly what might be going on there?

It was really talking to newer programs, whether they were a loss contract or not. So that when you take on the new program, especially if it has an extended term to it, three to five years in nature, typically the way it gets bid is that you accept a firm fixed-price for the full five years and it's targeted off of the should cost halfway through the contract. Typically new contracts run at lower margins in the beginning and then if you are coming down the learning curve the way you thought or perhaps even better than the margins get better and better as the contract goes forward. That's why when a contract runs out it typically has its highest margins and the challenge then is to replace it with work that can have similar margins and that's a tough hurdle because new work, again, tends to start with skinny margins and then work your way forward.

So the good news about winning lots of new contracts is that you've got more work and you've got more overhead absorption going on in the factory. The bad news is that you typically start out with lower than average margins and then you have to come down the learning curve. When we have a loss contract as we did last year it's because we didn't come down the learning curve as quickly as we had projected in our estimate.

So you've got three potential issues. One is that you estimated it wrong and that happened to us a couple times last year and that's why we went through and redid our entire estimating process. The second is you may have estimated it correctly but you just couldn't get the operating efficiencies that you thought you were going to get and that can give you lower margins or possibly even a loss contract. And the third is that you estimated it correctly and that your performance is on the curve or even better than the curve and therefore the margins are better.

So they comment there was trying to explain that with an 18.2% gross profit margin in the first quarter it was because of a reduction in accrued loss contract provision, and that was a good benefit for us, partially offset by the fact that we had some newer contracts that were running at lower than average margins. So those netted out to a gross profit margin that was I think three tense of a percentage point higher than the year ago.

But your sales volume was up a little higher than I was estimating. Is that just a function of some of these new development contracts coming through or are you seeing the benefits on just both the higher airliner, OEM deliveries and the tick-up in military?

I don't think we've seen much benefit on the commercial build rate cycle yet. I think those will come gradually and we don't expect them to be big, but hopefully they'll last for a while. On the commercial side it was really some of these newer programs that have now moved from tooling and first article parts into production. Our commercial sales increase was primarily because of other commercial programs that are now moving into production, not Boeing or Airbus programs.

These are the business programs you announced?

They could be business jet, it could be Eclipse, it could be helicopter blades for Carson. They're all commercial programs but they're not tied to Boeing or Airbus. And on the military side we saw a little bit of pickup on our deliveries on Apache.

And you mentioned also about your tax rate. I guess you had a lower tax rate this first quarter but you're expecting the year to be more in the 25% to 30% range. Any particular reason why you're seeing that jump around so much?

Yes, what happened several years ago is that we did a forensics study of R&D. Traditionally when we were mostly bill to print we never captured R&D expense. But the definition of R&D expense for tax purposes is more liberal than what you or I would think of R&D. It includes certain types of process improvements. So we went back about ten years and recaptured a lot of information, to the extent wd could, and amended tax returns. They run out -- once you file them the federal I think have three years to expiration and the state has four.

So when we filed the amended return we did not take the entire benefit of what we were asking for because there was the possibility of audit. So as those returns expire or when we are audited and pass audit, we then take the remaining benefit, if there is any, on that return. So each year we have a return of these historic returns that should roll-off in the third quarter. And last year you'll note that in the third quarter we had a big drop in tax rate for that reason. This year what happened was for whatever reason the state of California finished their review early and gave us a finding letter which basically accepted our return.

The benefit, if any, that we would have planned to have received in the third quarter came in the first quarter. It was literally a surprise to us; the letter was dated March 25th. And so we should not see a big drop in tax rate in the third quarter even if we were successful because it's happened early. So we would anticipate that for the full year our tax rate will be in the 26% to 30% range which is lower than our statutory rate which is around 40%. And as a result of these are indeed tax credits, both the forensic ones where we look back ten years and the benefit of the existing tax credits that we file now on an annual basis.

And just one final one. I don't know if I missed it or not -- did you give out like a cash from operations number or give us a little color on working capital?

No, I don't think we've put anything out, but the Q was filed today too.

Oh, okay. That's fine.

It will be in the Q. And what it will show is that we had positive cash for the first quarter and we'll expect to see that continue throughout the rest of the year.

Thanks, Joe. Congratulations on the progress.

(OPERATOR INSTRUCTIONS). Adriano Ahmada (ph), DGHM.

I was just wondering on -- you mentioned that you didn't have really any impact -- noticeable impact from higher build rates. Do you have enough visibility on the deliveries from the OEMs and Boeing in particular that would let you at least gauge a type of direction of volumes?

Yes, they give us a multiyear chart which isn't really -- you wouldn't hang your hat on it, but they give you a multiyear chart to show you where they think rates are going. But then they give you a chart also for the next year. That one is closer to being on the money and then ultimately they give you a purchase order which is usually for a year so you can see what the build rate is for the next 12 months. Now that doesn't mean that they won't come to you during the 12-month period and ask you to raise or lower rates as conditions warrant, and it may not be that everything you make runs at the same rate.

For instance on the Boeing 737 as we speak today there are some aerostructures components that we make that are called bear straps that when you walk through the door of the aircraft on the inside of the wall there's this tick-tac-toe pattern where the door is that center of the tic-tac-toe and that's used to strengthen the fuselage because they've cut a whole in it for the door. So you have multiple of these bear straps in the wall and we're building those currently at about 18 a month.

We also build the spoilers on the wings and we're building those at 21 a month. The reason for that may well be that they may have some spare needs for the spoilers, but they obviously don't for the bear straps. Or their inventory in the bear straps just is higher than it is on the spoilers, but it's possible to be building at different rates for these same airplane at the same time. So that's why they give you this kind of waterfall chart to let you know where you are. It looks like later in the year, on both programs, we'll be ramping to about 24 a month. Now that's subject to change but that's kind of how it works.

So on these two specific products, but as a general rule these build rates are building up through 2005, right?

Yes.

And if you had to characterize just where the incremental growth would come from would you say there's more of this type of recovery growth than new business growth going forward in terms of mix?

I guess it's perhaps more in timing. Right now we're seeing more growth coming out of new business that's not bowing related. Later in the year we'll start to see the kick-up of Boeing build rates. So the incremental addition probably would be more from Boeing build rates later in the year than now where the incremental addition is primarily from new programs.

Okay. And it's fair to assume that that kind of mix coming from just the build rate has a higher contribution margin, right?

Yes, because now you're spreading overhead over longer runs.

That's what I thought, but we haven't seen that mix improvement take place yet.

No.

Okay, thanks, Joe.

(OPERATOR INSTRUCTIONS). Sir, I'll hand the call back to you for your closing comments; that was the final question.

Thank you all for participating on this call. I look forward to speaking with you again in July to report on the second quarter. Thanks, again.

Ladies and gentlemen, that does conclude your conference call. You may now disconnect.