Ducommun Inc (DCO) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2006 Ducommun earnings conference call. My name is Francis and I will be your coordinator for today. At this time all participants are in listen-only mode; we will conduct a question-and-answer session toward 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 call over to Mr. Joseph Berenato, Chairman, President and Chief Executive Officer. Please proceed, sir.

Thank you, Francis. 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 fourth-quarter and year-end 2006 conference call. Greg will now comment on the fourth-quarter and year-end results reported earlier today.

Good morning, everyone. I'll start with a quarter-to-quarter comparison between Q4 2006 and Q4 2005 and then I'll follow that with a full year-over-year comparison. Sales in Q4 2006 were $87.8 million; this is a 44% improvement as compared to revenue of $60.9 million in Q4 2005. Most of the year-over-year difference is due to the three acquisitions we made during 2006 -- Miltec, CMP and WiseWave -- but we did have 14% of our growth that was organic. The mix of sales in Q4 2006 was 63% military, 34% commercial and 3% space as compared with 67% military, 29% commercial and 4% space in Q4 2005.

The gross profit margin was 18.1% in Q4 2006 which was down 3.1% as compared to Q4 2005. The decrease is primarily due to the acquisition of Miltec, which has a lower gross profit percentage than our gross profit percentages prior to the acquisition, as well as a favorable warranty reserve resolution we had in Q4 2005 that increased gross profit in Q4 2005 by $1.6 million. We also incurred some additional cost in Q4 2006 for the Fort Defiance closure we spoke to you about during our Q3 earnings call.

SG&A as a percentage of sales in Q4 '06 decreased to 14% as compared to 14.6% in Q4 '05. This was due primarily to costs being spread over a higher sales base partially offset by about $3.4 million of additional SG&A costs incurred in Q4 '06 as compared to Q4 '05. The increasing cost was due to our acquisitions, primarily Miltec, and the SG&A that they carry as well as expenses related to the Fort Defiance closure, $500,000 of non-cash amortization of intangibles related to our three acquisitions, and $435,000 of non-cash stock option expense.

Interest expense was $733,000 in Q4 2006 compared to interest income of $200,000 in Q4 '05; the interest expense is a result of the debt incurred on the three acquisitions. Income taxes were a benefit in Q4 2006 of $1.4 million as compared to a tax provision of $694,000 in Q4 '05. This is due to the fact that Congress extended the research and development tax credit in December 2006 that was retroactive for the entire 2006 year. We therefore took the entire 2006 benefit in Q4. We also had a favorable impact on changes to the research and development tax reserves we had established in Q4 '06.

I should note that the R&D tax credit extension now runs through 2007 as well. Net income therefore for Q4 '06 was $4.3 million or $0.41 per diluted share as compared to $3.5 million or $0.34 per diluted share in Q4 '05. For the full year revenues were $319 million in '06; this is an increase of $69.1 million or a 27.7% increase over '05. This is primarily due to the acquisitions, but we also showed organic growth as well. Our largest customers were Boeing, Raytheon and the U.S. government. These three customers represented 56% of sales in 2006.

The gross profit percent for the year was 19.6% in '06 as compared to 20.7% in '05. This decline was primarily due to the Miltec acquisition which, as I said earlier, has a lower gross profit percent than the average gross profit percent Ducommun had prior to the acquisitions. Also we were negatively impacted by $860,000 in inventory reserves related to a canceled contract taken in Q2 2006 and then also the favorable warranty reserve resolution I spoke to you about that was taken in Q4 '05.

SG&A expenses increased to $41.9 million or 13.1% of sales in 2006 as compared to $31.1 million or 12.4% of sales in '05. The change relates to the acquisitions that we made and the associated SG&A that they carry. Miltec in particular carries a higher SG&A percent than Ducommun does in its other businesses. Also amortization of intangibles related to the acquisitions was $1.5 million and stock option expense was $1.5 million. We also incurred additional costs incurred in the closure of Fort Defiance as well as costs associated with the startup of our Thailand operation in the first half of the year.

Interest expense for '06 was $2.6 million as compared to interest income of $522,000 in '05. This is due to the debt incurred on the three acquisitions. The effective tax rate for '06 was 21% as compared to 24.3% in 2005. Net income therefore was $14.3 million or $1.39 per diluted share as compared to $16 million of net income or $1.57 per diluted share in 2005.

Quickly, from a cash flow perspective, our debt to capital percent was 14% at the end of the quarter as compared to 20% at the end of Q3. Q4 was a very good cash generation quarter that allowed us to pay down debt. So now I'll turn it over to Joe.

Looking forward our outlook really remains unchanged from what we discussed at the Q3 conference call. The commercial markets look strong; build rates we expect to remain stable to up and that should continue through 2010 as the U.S. and European major carriers still have not made major orders of their own. As we reported earlier, we booked an eight-year extension to our 737 spoiler contract which is a strong revenue and profit generator for us in this space. We started work on the 787 programs and would expect to have some announcements in the near future about that work. And the Eclipse program, the very light jet, is going into ramp up production in 2007.

On the military side spending should continue at a high-level for the next several years, but we do expect to see some tightening especially with respect to big-ticket programs which probably will get squeezed and stretched out. So we have a strong commercial and a strong military market and we're continuing to pursue a number of opportunities for growth. It is a market where there are opportunities and we're actively pursuing them.

As we look at the issues for us over the next several years we need to prepare for the eventual slowdown in sales for our Apache helicopter blade as activities in Iraq will eventually wind down. And we also expect over the next several years a significant reduction in the C-17 program. So we're actively pursuing programs and markets to replace this work and still continue to grow internally. Eclipse is the first of these significant wins and we expect to announce similar significant wins this year and next.

As Greg mentioned earlier, Q4 benefited from R&D tax credits and reserves and we saw that full-year impact in the fourth quarter. Our tax rate for 2006 was about 21%, which is similar to where it's been the last two years. However, we would expect somewhat higher tax rates going forward. Also the Company's results tend to be seasonal. The Q1 or Q4 periods tend to be our weaker quarters and Q2 and Q3 our stronger quarters and it's really tied to the same thing.

At the end of the year a number of our customers shut down in mid December and so sales for the fourth quarter tend to be a little weak. And likewise the startups in January tend to start from an empty floor as you've shipped everything you can possibly make at the end of the year, you have to start building work in process and finished goods when you come back in January. So typically January is the worst month of the year for us and the first quarter tends to be our weakest quarter as well and then Q2 and Q3 tend to be our strongest.

We expect 2007 and beyond to benefit from the foundation that we laid in 2006. A year ago we said '06 was going to be a busy year, that we had a lot to do. And the good news is that we've accomplished pretty much everything we set out to do in 2006 and made substantial investment in the Company. And all of that foundation is really based on our efforts in operational excellence and increasing our technical capabilities.

So as we sit here today we think we're well-positioned for 2007 and beyond and we've got good markets. So we expect to be able to really make some benefit from the investment in '06. And with that, Francis, I'd be happy to answer any questions that people might have.

(OPERATOR INSTRUCTIONS). Alex Hamilton, The Benchmarks Co.

Good morning, gentlemen. Where do I begin? Lots of questions. Let me ask a few and then I'll let some other people jump on the line. The first thing is you talked about organic growth of 14%. That is highly exceptional for you guys and that seems to be faster than what the underlying commercial cycle is doing. Can you talk about what added to that?

Once again, this was Q4 to Q4. We're experiencing a lot of growth on the DAS side of our business. If you looked at DAS and DT, both for the quarter showed organic growth but it was stronger on the DAS side. I think it's a reflection of the capabilities, the improvement in productivity that we're seeing on the DAS side of the business and their ability to take on new work. And I would also add that both Eclipse is ramping up toward the end of the year, which wasn't there a year ago, and the 737 build rates are higher.

This wasn't my second question but I'll interject on that. Can you talk about the Eclipse run rate? I know you said it's going to start really ramping in '07; do you have any build rates associated with that? And also, can you comment? Is that program running better than you expected or kind of in line?

I would say the program is running in line. The Eclipse has taken over 2200 orders and got their certification so that they can start delivering aircraft. And of course with any new program you've always got the issue of startup and I think they've managed this really extraordinarily well in trying to bring this plane to market. We expect to see somewhere in the 500 to 600 unit of delivering during the '07 period, and we saw the beginnings of that starting in the fourth quarter of '06. So in that sense that's all incremental revenue because a year ago there wasn't any Eclipse revenue in our sales.

Great, and then I'll ask a question and then I'll let somebody else ask. In terms of the R&D retroactive benefit that you're seeing, can we talk about that? If we were to allocate that evenly across the quarters what would that have been, about $0.02 a quarter that it added?

Just about, yes.

Okay. And what's the actual dollar amount I guess?

The R&D benefit that we -- the R&D benefit for the year would typically be approximately $700,000.

Okay, great. I'll let someone else jump in. Thank you.

(OPERATOR INSTRUCTIONS). Michael Lewis, BB&T Capital Markets.

Good morning, Joe and Greg. Nice quarter. Joe, can we just focus on Miltec for a second? The government services space, it's been subject to some various difficulties tied to the ongoing shifts in funding due to the war; we're seeing pricing pressures starting to really come into the fold here; we have high multiples in the M&A marketplace. I was hoping you could talk about what you're witnessing on the Miltec side. Are you seeing any of these types of pressures? Is the business running at, below or above your internal plan? Because I'm just trying to get my arms around what we can expect on the SG&A with regard to your costs coming through the business because I was a little bit surprised of what the impact was this quarter.

On the Miltec side of the business it's interesting because I've read a lot about revenue pressures and pricing pressures in the defense IT space. While we've seen some programs stretch out, generally we've continued to see good growth in Miltec, so we haven't seen as much of an impact as what I've been reading about. From an SG&A point of view, remember this is how we generate our revenue.

We're in a sense renting expertise to the government and that expense shows up in our SG&A line. The business has been pretty much on plan -- our internal plan for the first year and as we work to integrate more fully that business into the rest of Ducommun Inc. we're expecting to see some faster growth in revenue and some higher profitability as we start to shift, incrementally at least, our mix of contracts away from cost-plus and more toward fixed price.

So our feeling about Miltec is pretty optimistic right now, even with the pressures that we're seeing in the marketplace on the defense IT side. When we acquired the business we thought it would take us a year to get organized, a year to convince the customers and a year to actually book orders where we were combining Miltec's expertise and old Ducommun's manufacturing expertise. And as we sit here today I think we're pretty close on some contracts where we're doing that, combining the engineering expertise with the manufacturing expertise.

So in that sense I think we're about a year ahead of our original schedule. So despite the pressures that the defense IT side is seeing, I'm pretty optimistic of where Miltec and Ducommun Technologies are headed.

Okay, that's helpful. With regard to the $3.4 million in additional cost in the quarter, Greg, I was wondering, can you break that out with regard to the cost related to Fort Defiance versus what you saw in the Miltec SG&A line?

Yes, we had indicated, Mike, in Q3 at the time that we had about $100,000 in costs related to Fort Defiance and that we expected -- and that was for the month of September and we had expected about the same amount per month during Q4 and I would say that we were about on plan. So approximately $300,000 on the Fort Defiance side. From a Miltec perspective, is your question the amount of cost associated with Miltec?

Yes, we can look at it that way.

We don't break that out separately. I will tell you that typically what we see from Miltec SG&A, that it's a couple of points higher than what our normal business is.

Okay. And do you have a current turnover rate that you're seeing in Miltec right now or has that been fully integrated?

Fully integrated.

Okay. I'll jump back in the queue and let someone else go.

(OPERATOR INSTRUCTIONS). Alex Hamilton, The Benchmark Co.

D&A for the year was -- I know A was 1.5, what was the D part?

It's probably around $8 million.

Oh, $8 million? Okay.

Round number.

And what was free cash flow in the quarter?

I don't know the exact number. The 10-K will probably be out tomorrow and it will have all that detail in it. But it was a very strong cash flow quarter. As Greg mentioned earlier, debt earlier in the year was at $49 million and we ended the year at $30 million. And a lot of that cash came in in the fourth quarter.

I think one thing that is changing is probably in terms of my forecast. It looks like your -- I know you don't forecast so I'm trying to ask -- I know I'm trying to ask this question, but it looks like you are no longer going to be growing mid single-digits; it looks like probably low double digits is probably a fair assumption going forward.

I would say that when you look at our performance in '06, it is so intermingled between what internal growth was and the timing of the arrival of the acquisitions. Again, we're in a market where the military side is going to show very little growth because it's at a very high level but doesn't have a lot of upside. And that's almost two-thirds of our business. So even with double-digit growth on the commercial side I think it would be hard for us over the course of a full year to be growing double digits overall when two-thirds of the business is military.

Okay, that's helpful. Thank you very much.

Chris McDonald, Kennedy Capital.

Good morning. I was a little bit surprised at how strong the top line came in and I know you mentioned the 737 build rate and the Eclipse initial deliveries. Was there anything else in there? Was there a big Apache blade delivery or anything else unusual that drove that really strong revenue number this quarter?

I'd say we were pleased with the growth in Miltec. I mean, it was where we expected it to be, but it was nice to see them actually get there.

Okay. And on the gross margin line, even if I bake in some Fort Defiance closure costs, it seems like it was a little weaker than I anticipated. Is that -- I don't know if that's tied to just the ramp up in Eclipse and learning curve there or maybe you can just comment on some of the levers that drove gross margin in the quarter?

I think you hit on some of it. Some of the -- what we see typically in some of the major -- when we have a new program is that there is a learning curve, there are costs associated with that and certainly we saw that in '07 with Eclipse for instance. We would certainly expect to see gross profit percentages associated with that major program in particular increasing in '07 versus '06. I think you nailed it on the head with that and we had that situation with most new programs. Joe, do you have anything else to add on that?

Yes, I'm disappointed with where the gross profit margin was in the fourth quarter and I think we can do better.

Okay. And then just two more. One, SG&A at the around $12 million level, was there anything unusual fourth quarter there or is that kind of the run rate that you'd expect going forward?

I would say that that is probably close to the run rate going forward other than the cost associated with the Fort Defiance. Because when you look at it, a big piece of our growth has to do with the stock option expense and the amortization of intangibles as well as in the fourth quarter we had the full impact of all three acquisitions. So I would say that the SG&A costs were probably pretty close.

Okay. And then lastly, sometimes you'll identify what your top five programs are. Have those changed at all over the course of the last couple orders?

No, I think it's all the same ones. It's Apache, C-17, 737, F-18, F-15. Yes, the F-18 and F-15 especially is benefiting from the [AESA] radar racks that we make for Raytheon, because you wouldn't expect OEM builds to be very much for those two programs. So the majority of the sales on those two programs is coming from the upgrade radar rack programs.

Maybe you could comment on profitability on those. I know it's a do new rack and you've been at it now for a couple quarters at least. How comfortable are you with profitability on those programs?

We'd like it to be higher. The profitability there is pretty tight and we're using lien and Six Sigma techniques to try to get enhancements.

Okay. Thanks, thanks a lot.

Michael Lewis, BB&T Capital Markets.

With regard to the extensions you saw on your top five contracts, what is the average extension term?

Let's see, the Apache extension was I think two years, the C-17 of course was a year -- but that's going to be an annual affair. We're ginning up to go back to Washington D.C. next month to lobby again. The 737, as I said, was eight-year. The F-15 and F-18 contracts, I don't have the exact number of years but I'd say it's probably in the four- to five-year range because they're LTAs, long-term agreements, and so the volume -- ultimate volume depends on both domestic and foreign air force purchase of racks.

Would you say that the 737 program is the most profitable one right now? Setting aside the Apache blade business?

No, but it's close.

Okay. Can you break out your revenue by segment for us, DAS, DT and technologies? It would be very helpful.

Again, I don't have the 10-K in front of me. I think what I would say, Mike, is that when you look at our businesses, we continue to see a shift between the two businesses as a percentage of sales. When you look back over time at the beginning of the year, in 2005 I think the DAS versus DT percentage was somewhere in the neighborhood of 70, now we're seeing it move to 60/40 now, so we would continue to see that shift.

I would say for the full year of '06 it's roughly -- these are rough numbers -- about $190 million DAS and $130 million --.

$130 million, exactly.

Okay, that's helpful. And with regard -- if you could just give us a little more information with regard to what your expectations are for tax. Should we assume low 30% range, you think? Would that be safe, 31, 32?

Yes, I think that that's fair.

Okay. And you said you didn't have your free cash flow handy?

No, but it will be out in the K either --

In the morning.

Yes.

Okay. And then just one more question and I'll jump off. Greg, with regard to amortization should we assume an accelerated rate here or are we going to look and see around $500,000 per quarter over the next 12 months?

That's about right.

Okay. Thank you, guys.

There are no further audio questions at this time.

Okay. Let me just conclude by saying we felt that Q4 was a good quarter for us, that our commercial and military marketplaces are in the positive mode and will continue to be so for the foreseeable future. In terms of growth, we're going to continue to look for acquisitions. As we mentioned in the press release, our debt to capital is below 15% now and we will continue to look for acquisitions which expand our technical capabilities in either DAS or DTI. We would expect to continue to increase our offshore activities.

In the area of internal growth we will look to invest with both CapEx and R&D. 2006 was really the first year that we had a real R&D budget for our business, primarily at Miltec, but in '07 we have an R&D budget across the Corporation, so we're looking to do more of that kind of development work internally. Lean Six Sigma continues to be the basis by which we are attacking improving quality, improving delivery and driving the competitive price.

And in fact Greg and I and a number of senior managers were at a Six Sigma class for two days last week. Greg and I have both committed to become green belts and we're going to drive that here in 2007. So thank you for participating on this call and we look forward to discussing Q1 with you in April. Francis, back to you.

Again, thank you, ladies and gentlemen, for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.