Ducommun Inc (DCO) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter 2006 Ducommun earnings conference call. My name is Lisa and I'll be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of this conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to Mr. Joe Berenato, Chairman, President and CEO. Please proceed, sir.

Thank you, Lisa. Good morning, I'm Joe Berenato, CEO of Ducommun and with me is Greg Hann our CFO. We want to welcome you to Ducommun's third quarter 2006 conference call and Greg will now comment on the Q3 results which were reported earlier today.

Good morning, everybody. Q3 2006 sales were 81.6 million, Q3, 2005 was 63 million. This is a 29% increase. By comparison, Q2, the prior period was 77.5 million. The increase in sales for Q3 is mainly due to the acquisitions we had of Miltec, WiseWave and CMP during 2006 as well as improvement with our Ducommun AeroStructures business. Our mix during Q3 was 66% military, 31 commercial and 3% space, as compared to Q3, 2005, of 54% military, 42% commercial and 4% space, this is a result of the Miltec acquisition which is military-based.

Gross profit percent, as a percent of sales for Q3, 2006 was 20.8%, this compares with Q3, 2005 at 20.7%, and Q2, 2006 at 19.7. The increase in gross profit percentage was mainly a result of operating improvements at our Ducommun AeroStructures business. Sales SG&A as a percentage of sales is 12.7% in Q3, 2006, compared to Q3, 2005 of 12% even and Q2, 2006 of 12.4%. This increase in SG&A is mainly due to the Miltec acquisition, which has a higher percent of SG&A than our other businesses. So it pulls the SG&A percentage up.

Operating income for the current quarter was 6.6 million, this compares to Q3, 2005 of 5.5 million, and last quarter, Q2, 2006 of 5.6 million. Interest expense was 700,000 for the current quarter, as compared to Q3, 2005, which was 400,000 of income, interest income. This is due to the acquisitions we made during the year and we expect to use the cash flow from our business to pay down our debt and lower our interest expense going forward.

Net income for the quarter was 4.1 million or $0.40 per diluted share. This compares with Q3, 2005 at 4.3 million or $0.42 per diluted share. Last quarter was $0.31 per diluted share.

For the nine months ending in the third quarter, sales were 231.2 million, this compares with 2005 for the first nine months of 188.8 or 22% increase. Once again, this is a result mainly of the Miltec, WiseWave and CMP acquisitions as well as AeroStructures improvement. The mix for the nine months in 2006 was 67% military, 31 commercial, 2% space. Last year, year-to-date, 59% military, 37 commercial, 4% space. Once again, due to the Miltec acquisition.

Our gross profit percentage for the first nine months of 2006 is 20.2%, versus last year at 20.5%. SG&A for the first nine months was 12.8%, last year was 11.8% as I mentioned earlier, this is a full result of the Miltec acquisition. Operating income for the first nine months, 17.1 million, in 2005, 16.6 million. Income taxes, the effective rate of our income taxes is 34.1% in 2006, versus 26.2% in 2005, this is a result of mostly R&D tax credits that expired at the end of 2005 and Congress has not yet renewed these credits. Net income for the first nine months of 2006 is ten million or $0.97 per diluted share. In 2005, 12.5 million or a $1.22 per diluted share.

Thank you, Greg. Looking forward, the commercial markets continue to look strong. We have a good position on the 737. We anticipate additional awards on the 787 and the Eclipse very light jet will in 2007 start ramping up production as they receive full certification earlier this month.

When the military side spending continues at a very high level but we are seeing some tightening based on the needs of funding the activities in Iraq and Afghanistan and so I think what we'll see on the military side is that the level of spending will remain high, aftermarket and repair type expenditures will remain very high. Some new OEM programs may get squeezed or pushed out in order to find the funds to continue the Iraq activity. So in that sense, we're beneficiary and have a potential risk going forward to the C-17 has been highlighted a lot. We were happy to see ten additional aircraft and I think each year we'll continue to have that same activity, trying to get additional aircraft to continue to push out the potential closure of the line. Right now we have aircraft orders or anticipated orders that would take production through the end of 2009 and we would look each year to continue to push that out.

We continue to integrate our three acquisitions, Miltec made in January, WiseWave in May and our newest acquisition of CMP which closed on September 1st. That's our biggest challenge right now as we bring these new folks and their skills into our organization and position them for the best chance of success within the Ducommun family.

Our Thailand operation which started production in July is up and running, making commercial microwave switches and we see production there ahead of our anticipated schedule and we're looking at other appropriate activities that we can put into the Thailand facility.

We continue to drive Lean in Six Sigma. This has really been an activity that has helped us significantly over the last several years and as we any activity, as you get better at is, you get better results with it and so we continue to drive it and we continue to see good results from it.

As we look forward to the fourth quarter and to the coming year, historically at Ducommun what we find is that from an absolute point of view, Q2 or Q3 tend to be our big -- best quarters and Q1 and Q4 tend to be our weaker quarters and this is all tied around the holidays. The Q4 period is the shortest period in terms of number of working days, because of Thanksgiving and Christmas. In fact, some of our customers will actually shut down for the last two weeks of December and not accept any orders. Likewise in the first quarter, that first week of January is a slow period of ramp-up because most people have shipped the floor at the end of the year and so the beginning of the year you have to refill the pipeline and get people back from vacation, so January is actually the weakest month of the year for us every year and Q1 and Q4 vie for whether they're the weakest quarter. This is seasonal and happens every year and is nothing unusual. It's just the way it works in our business. We would expect 2007 to be a year of improvement as we have mentioned earlier, the 2006 would be a year of transition and transformation. So we expect to start reaping the benefits of that next year. With that I'd be happy to answer any questions that people might have. Lisa?

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Mike Lewis with BB&T Capital Markets. Please proceed, sir.

Good morning, Joe, Greg, how you guys doing?

Good.

Hey, Joe, just a quick question with regard to the closing of Fort Defiance. What was the increase in the cost? Have you been able to quantify that and can you provide us what the breakout was and basis points as part of the SG&A?

I'll let Greg talk to that a little bit too, but the general observation is that from a couple years ago, the accounting treatment has changed. It used to be when you would close a facility you would estimate all of your costs and take them as a one-shot hit and then as you actually expensed it over the time that the closure took place, you would just go against the reserve that you took. The accounting mavens didn't like the fact that big companies were taking enormous charges and then bleeding the benefit back in the profits in later quarters. So what's happened now is that there's really very little that you can take an upfront charge for and instead you're required to expense it as you go, largely, that's not true for some categories and Greg will talk to that, but for -- in most instances you no longer take a large charge and then bleed against it. So the closure of the Fort has been an ongoing expense that we've been recognizing during the course of the year. We do expect the Fort to close in the fourth quarter and at that point any charges for severance and other things will be taken and I don't think we're going to see that these numbers are really meaningful to our financials, but I'll let Greg speak to that. Yeah, Mike, the Fort Defiance, the main issue is the severance cost as Joe mentioned, having to spread that out and the impact on Q3 is about a tenth of a point on the SG&A line, about $100,000.

Okay. That will be recurring into next quarter as well?

That's correct.

Okay. Joe, can you just talk a little bit about where you're seeing the majority of your bid proposal activity? Are you seeing it in defense or commercial and can you offer some color into what opportunities you have going into next year?

Yes, I think it's fair to say that we're seeing that across the board, but to give some color to it, on the structure side of the business, I'd say that we're seeing a majority of our bid and proposals on the commercial side. And a lot of this has to do with either the primes and Tier 1s looking to offload work so that they can create more space on their floors for newer product, whether it's 787 for Boeing related suppliers or new versions of helicopters or helicopter blades in that arena, or whereas on the engineering services side, necessarily, we see most of the bid and proposal work on the military side, because those businesses are primarily military. So from a macro point of view, we're seeing a lot of activity, both commercial and military. But on the structure side, it seems to be predominantly commercial. On the Ducommun Technologies side it seems to be primarily military.

Okay, thanks. I'll just hop back in the queue.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Alex Hamilton with the Benchmark Company. Please proceed.

Good morning, yes. How are you?

Hi, Alex.

Just a few questions, first kind of on just a for modeling purposes, can you break out cash debt and shareholder's equity at the end of the quarter? I don't think that was in the press release.

No, it wasn't in the press release, it will be in the 10-Q which we hope to have out, Greg, tomorrow. So the actual numbers will be there. But roughly speaking, there's probably about -- and again, these are rough numbers. It was probably about 45 million of debt and 180 of equity.

That's correct.

And the cash flow number is positive in the third quarter. It's a seasonality thing, which I can't really explain why it's the case that we tend to collect most of our cash for the year in the second half of the year. Now, I do know that there are some expenses in the first half of the year, again, which are seasonal cash bonuses, there are more tax payments in the first half of the year than there are in the second half, that kind of thing. But we historically over the 15 years I've been here, tended to collect most of our cash in the second half.

I know you guys have been pretty proactive in knowing that at some point the C-17 does end, apparently at this point we're talking about the '09, 2010 event that I think you guys have talked about having to replace it with probably about three programs to equal the size of the C-17. I know you currently have one that looks like it's going to be one of those three. Have there been any other opportunities that potentially in the last few months that have appeared that look promising for that?

Yes. There have. They're still pretty early stage and it is a situation where we are competing with others, so I don't want to highlight what they are, but we are right now looking at three or four opportunities that would come to fruition in terms of at least order placement, I think by the middle of next year that would fall in the category of being equivalent to the Eclipse work and therefore be a candidate to be one of the three that we would need to replace the C-17.

Are they military or commercial or --

They're both.

And then I guess just lastly, I guess in terms of kind of the growth that we should -- that we're going to see this year in '07, how much of that is organic versus acquired growth? Half or less than half?

That's interesting. When you say organic versus acquired, you mean not counting the growth we would expect from Miltec, WiseWave and CMP? Or --

Correct.

Or do you mean future acquisitions in '07?

Excluding the three acquisitions.

I would say that on a percentage basis, the majority of our growth would come from the Miltec acquisition, only because it's been growing at a double-digit rate.

Okay.

And so if it continues to grow at a double-digit rate, it would be growing faster than the rest of our businesses, but we would expect all of our businesses to have internal growth during 2007.

On the DAS side, the single biggest thing that's going to pop for us of course will be the revenue stream on the Eclipse, which is a commercial program. We'll continue to see strong sales there on the military side because of Apache. But Apache is not going up, per se. And C-17 is not going up. Although they are our two biggest programs but they will continue at a high rate. So I would think a lot of our growth in '07 would come off of the incremental acquisitions, especially because in the case of WiseWave and CMP, we only had them for part of the year.

Okay. I'll let somebody else get in queue. Thank you.

[OPERATOR INSTRUCTIONS] There are no additional questions at this time. I would now like to turn the presentation back to Mr. Joe Berenato. I'm sorry you do have a follow-up that just pulled of from Mr. Mike Lewis with BB&T Capital Markets. Please proceed, Mr. Lewis.

Hey, Joe. If you could just -- I just wanted to go further on Alex's question with regard to internal growth. Now, what are you seeing in the M&A market for next year? Are you currently looking at some opportunities for acquisition or is the pipeline kind of flatlined there and you guys are focusing on the business and current acquisitions? Can you talk a little bit about that?

Sure. I mean, obviously we're very busy integrating the three acquisitions we made this year and Greg as an example has been chairing a committee that meets on a weekly basis to look at the integration activities of these businesses as we go forward. But we haven't stopped continuing to look for acquisitions and the areas of our primary focus is still the same. We're looking for engineered product acquisitions that are complimentary to the things that we already do in lighted products and microwave/millimeter wave and we also continue to look for additional engineering services business that's would be complimentary to what we already have in Miltec. So different customers, different technologies. So that we could add more scale, if you will, to our existing business. We're not looking to acquire the fraternal twin, if you will, of Miltec, but rather a business that would be complimentary to it to broaden our offerings and access us to new markets that we're not already in. So while I wouldn't anticipate an acquisition on January 1st, we're going to continue looking and if you look at our history over the last 13 years, we've made 13 acquisitions. But they haven't come one a year. There have been dry periods and then there's been periods of pretty intense activity, as '06 was for us. But it doesn't mean that we've turned off our efforts on and offer like a light switch. We have been continuous in our efforts, just a matter of when you bring things to fruition. So as we go into '07 we're not in any way lessening our efforts to find additional acquisitions.

Just to circle back to some of those financial numbers, you said you had about 45 million in debt right now?

Right.

Okay. And you said were you free cash flow positive or was this operating cash flow?

Both.

If I could get one more number for you. Do you have an approximate cash number.

For the --

For wherever it stands right now on the balance sheet.

Cash flow from ons for the third quarter will be approximately $13 million.

Okay. Okay. Thank you very much.

Your next question is from the line of Chris McDonald with Kennedy Capital Market. Please proceed.

Good morning, Joe and Greg, how are you?

Good morning, Chris.

A question on Eclipse. Could you just refresh my memory on the content that the company has on that aircraft and then I don't know if you ever quantified it as a revenue per plane but if you're willing to do that I'd be interested in that as well.

We haven't quantified it as a revenue per plane. What we do in the Eclipse is we make nine fuselage skins, which essentially is all of the fuselage from the nose to the beginning of the tail section, which is referred to as the empennage, so everything in front of the empennage and behind the nose is made up of nine skins and we make all nine of those.

Would you expect that program -- I'm just trying to get a handle on expectations relative to growth. Does that break into the top five for Ducommun any time in the next couple years?

The projections for this program can vary widely. If you talk to the -- if you talk to the customer, he has a very high expectation of where this program goes. And we would love to believe that. We've been more conservative in our own projections but it still becomes a substantial program for us. Whether it breaks into the top five in the next couple of years really depends what happens with some of our other new programs. Because we've got some other new programs coming on-board that we think have the potential to break into the top five as well. But I would say that whether it's in the top five or not, what we're trying to do as an organization is spread out the concentration so whereas today our top five programs make up 50% of or sales, I'd like the top five programs five years from now to make up 20% of our sales, just have a lot more programs that are significant to us. So we would expect eclipse to be significant to us but I can't tell you that it would be in the top five. If we're successful in doing what we're trying to do, which is to spread out the concentration.

Okay. Could you give a little more detail on some of those other new growing programs that may have a chance to make it into the top five?

Well, on our DAZ side of the business, what you find is that we're continuing to develop ourselves as a center of excellence for airfoils for helicopters, which is a fancy way of saying helicopter blades. So we see potential activity of significant growth in the helicopter blade market, both for OEM blades and for aftermarket in the sense where we take offload production from primes and produce those blades for them. So on the AeroStructures side we would see it there.

On the technology side, it's more likely to come from our engineering services business, as they get involved in programs with primes that have sufficient legs to them to make them a significant program.

Okay. That's helpful. And one last question. On Miltec, could you just give an update on how the integration there is going and what degree that you might see some real synergy in the form of maybe the Ducommun businesses actually building products that are engineered as part of Miltec or just maybe a minute or two on the overall strategy for how Miltec fits in at Ducommun overall.

What we really see Miltec becoming over time is the engineering center of excellence for all of Ducommun. So that if -- what Miltec were to do is continue doing what they do at the time of the acquisition, that would be good but that by itself quite frankly wouldn't justify the reason that we bought it. The reason we wanted it was to bring us substantial numbers of engineers who could help us in the design engineering activity to -- in a variety of our product areas where we were primarily build to print. Now, I don't think in the next three years this is going to be the major driver of the company, but it's the direction in which we're headed. So we want to get involved more and more with engineered product and service where we can differentiate ourselves through the brain power that we can bring to the activity and make ourselves more valuable to our customer.

So the real measurement of this of course over time will be as we win contracts, which demonstrate that the Miltec side of the business is providing engineering content to manufacturing contracts that we've won. So when we bought this business, I thought this would be a three-year process, the first year to organize ourselves, the second year to convince our customers, third year to win contracts and actually get into a production phase. What I'm happy about is that we're already making proposals with this kind of integrated process in place where we're bidding work with Miltec engineering and other Ducommun elements manufacturing as part of our proposal.

Now, the proof of the pudding is if we start winning such contracts and I don't expect to win the initial ones because we're kind of the new kid on the block and we need to develop a little bit of pedigree and get people convinced. But the very fact that we're being able to bid on such contracts this quickly I find encouraging. But again, the proof of the pudding will come when we put out press releases that describe that this has gone from vision to reality.

Thank you. Appreciate it.

Your next question is a follow-up from the line of Alex Hamilton with the Benchmark Company. Please proceed.

Hi, gentlemen. Two quick follow-up questions. The first is in terms of the Thai facility in terms of utilization, how would you categorize that running on plan, above plan or below plan?

And then the second question I have we talked about higher G&A expenses related to the Miltec business. I assume that's kind of the nature of that business. How do you expect that to be offset, that drag on margins being off set in the future? I would assume that's going to come from volume?

On the Thailand activity, in terms of what's being produced there, we're on-plan because we said we would put commercial microwave components in there and that's what's there. In terms of the volume of what's being produced, we're ahead of plan because they're delivering more units than what we had anticipated they would. And so what we've done is we've stepped up the timetable in terms of looking to introduce additional product there. So we're looking at other direct labor, heavy activity that we can move in and it's not that we're suddenly running around scrambling for it. We have a queue in mind and now we're looking at the next two elements and going through the planning to accelerate when we would put it over there. The facility itself is about 20,000 square feet, with the ability to expand substantially. I mean, the land is around us.

Our Thai partner built the facility and leases it to us and when we're ready for more, he'll build the next stage of the facility and we'll sign the lease for that. So I don't anticipate we will need to build the additional segment any time soon, but I do expect that we'll start filling up the first segment of the facility faster than we had had originally planned. So so far we're very pleased with what's going on there, both in terms of the production and the quality of the workforce.

And in terms of Miltec and the margins there, the drag created by SG&A?

In one sense it sounds like a drag because the percentage of sales is higher than in our other businesses. But this is the nature of an engineering service business. They get paid in engineering services by the hour, if you will. So as they grow, we'll have more SG&A expense related to that business because that's where some of the engineers are categorized and as they -- as we get more engineers and we build more hours, we bill more hours, there'll be more expense there. But it's not a drag on earnings. It could be a drag on margins in the sense that the Miltec business is not a high margin business in the same way that our product business is, but it's in many respects a lower risk business because there's most of their contracts are Cost Plus or time and material type contracts. So and they carry no inventory. So the -- all that inventory on our balance sheet is everywhere but Miltec and we're focussed on trying to drive that inventory down to enhance our cash flow. But I don't view the increased percentage as a drag in earnings so much as the changing nature of our business composition. And we will be happy to have that business add more and more people because that's how it grows. When we bought the business, it was 224 people and about two months in, we had some people leave to -- out of the system side to start up their own little business and that number dropped to about 200 today we're about 254, so we've recouped not only everybody who left, but we've continued to grow and add. So we feel very positive about the prospects for this business, but the nature of the business is that the SG&A tends to be higher. And that's true for DTI in general, compared to Ducommun AeroStructures. In Ducommun AeroStructures you see a relatively low SG&A to sales because there are relatively fewer engineers because there are a lot more engineers, we have a higher SG&A to sales.

Great. Thank you.

Your next question is a follow-up from the line of Mike Lewis with BB&T Capital Markets. Please proceed.

Final question. I've noticed that there's been a big acceleration of the Army shifting resources to the Huntsville area. Have you seen any upticks with regard to the Miltec business from this renewed interest in that area?

We haven't seen any immediate benefit from it but it's kind of like a tsunami that we know is coming. That's both good news and bad news. The missile defense agency is moving from Washington, D.C. and the primary beneficiary of that move over the next three to four years -- so it's not like over the weekend we're moving, but over the next three to four years, that whole missile command moves to both Huntsville, Alabama and Colorado Springs, virtually all of the jobs go to those two places. So that's going to create some stress and some challenges in terms of finding enough engineers to fill all the jobs that are coming. So that's the good news and the bad news. The fact is there's a lot of work coming over the next four years. The Army is moving a three star billet to Huntsville and that command therefore is significant and it will require significant civilian support in the engineering services area. So one of the things that attracted us to Miltec in the very beginning was precisely this transfer of work out of Washington, D.C. and it's coming but it will come over the next three to four years and we should see that as a positive hedge, if you will, against a downturn in military sales three and four years out.

Thank you, sir.

There are no additional questions at this time. I would now like to turn the presentation back to Mr. Joe Berenato.

In conclusion, what I'd like to say is that Q3 was a good quarter for us. A lot of things went right and we were able to take advantage of it. And that we think the commercial military cycles will remain positive over the next several years with commercial growing and military staying at a high level of revenue. We want to continue to grow as I said earlier in terms of some of the questions that were asked. Our acquisition focus is on engineered product and services. But from an internal growth perspective, we're looking to grow both our Ducommun AeroStructures and Ducommun Technologies business and will do that through capital expenditure to support new programs and capabilities and we will see increased R&D spending as we go forward. Our R&D spending historically has not been very large and we will gradually grow it over the next three to four years as our people develop good projects with good likelihood of strong returns and we will fund those to be able to grow on the engineered side internally.

We will continue our offshore activities. I think we will continue to look for opportunities to move direct labor, heavy direct labor activities offshore, but not with the intention of creating a million square foot contract manufacturing facility somewhere in Asia. What we want to do is use our offshore activities to allow us to be more competitive in pricing more complicated and complex contracts so that if we can get some reduction in cost on the direct labor side, we can give a more attractive price for a sub system or a sub assembly for our customer where a lot of the design engineer and skill work will still be done here in the United States. This is not a let's move the company to South America type activity.

We find that Lean and Six Sigma continue to make us more competitive on price and help us improve quality and delivery. This goes hand in hand with what I just said about our pricing strategy and where we intend to do the work. And so I think '06 is panning out as the year of transform medication and transition that we expected going into it. And we expect to continue bringing to bear our brother capabilities as we go forward into '07, '08 and '09.

So I'd like to thank you for participating in this conference call and we look forward to discussing the full year results with you in February. Lisa, back to you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.