Ducommun Inc (DCO) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Ducommun 2007 Second Quarter Earnings Conference Call. My name is Latisha and I will be your coordinator for today.

(OPERATOR INSTRUCTIONS)

At this time, I will turn the presentation over to Joseph Berenato, Chairman, President and Chief Executive Officer. Please proceed, sir.

Thank you, Latisha. Good morning. I'm Joe Berenato, CEO of Ducommun. And with me is our CFO, Greg Hann.

We want to welcome you to Ducommun's Second Quarter 2007 Conference Call. And Greg will review with you our second quarter financial results, reported earlier today.

Good morning, everyone.

As I started out our call last quarter, I can say again that Ducommun Incorporated had a very good quarter. Sales in Q2 2007 were $91.1 million. This is a 17.6% improvement, as compared to revenue of $77.5 million in Q2 2006.

Both our Ducommun AeroStructures and Ducommun Technologies businesses showed year-over-year gains. AeroStructures grew by 11.4% quarter over quarter, while Ducommun Technologies grew 27.4%.

Technologies improvement included the effect of our WiseWave and CMP acquisitions that were made in Q2 and Q3 of 2006. Without the impact of these two acquisitions, organic growth was approximately 14% for Ducommun Incorporated in Q2 2007, as compared to Q2 2006.

The mix of sales in Q2 2007 was 61% military, 37% commercial, and 2% space, as compared with 67% military, 32% commercial, and 1% space in Q2 2006.

Total military sales were up by $4 million quarter over quarter. This occurred despite a small year-over-year decline in C-17 and Apache program sales.

Our commercial sales grew by $8.8 million quarter over quarter, due mostly to 737 NG and 777 program sales, increases in some after-market sales and commercial sales associated with the CMP acquisition.

The Company's backlog is approximately $371 million, as compared to $321 million at the end of 2006.

The gross profit margin increased to 21.7% in Q2 2007, as compared to 19.7% in Q2 2006. The increase is due primarily to improvements in operating performance at both our AeroStructures and Technologies businesses, as well as a better sales mix.

SG&A, as a percentage of sales in Q2 2007, increased to 13.3%, as compared to 12.4% in Q2 2006. This increase was due primarily to higher bonus accruals, and SG&A expenses related to the acquisition of CMP, which was not included a year ago, and has a higher SG&A percent than the average of our other businesses.

Operating income was $7.7 million for the quarter and rose by 36%, as compared to Q2 2006, reflecting, in part, the operating-performance improvement inside both of our businesses.

Interest expense was $765,000 in Q2 2007, as compared to $649,000 in Q2 2006. This increase is due to the debt associated with the CMP acquisition made in Q3 2006, as well as working-capital increases.

Income-tax expense in Q2 2007 increased to $2.2 million, as compared to $1.8 million last year. The increase in income-tax expense is due to higher pre-tax income, partially offset by a lower tax rate.

The effective tax rate this quarter was 33.7%, as compared to 36.3% a year ago. The lower tax rate was due to the applicability of the R&D tax credit, which was not available in Q2 2006.

Net income, therefore, for the quarter was $4.6 million or $0.44 per diluted share, as compared to $3.2 million or $0.31 per diluted share in Q2 2006, a 44% increase in net income.

On a year-to-date basis, sales were $179.2 million -- excuse me -- as compared to $149.6 million for the first six months of 2006, or a 19.7% increase. Approximately 16% of this increase was organic.

AeroStructures grew by 12.9% and Technologies grew by 30.9%. Our sales mix was 61% military, 37% commercial and -- excuse me -- 61% military, 37% commercial and 2% space, as compared to 67% military, 32% commercial, and 1% space in the first six months of 2006.

The increase in sales for the first six months of 2007, as compared to the same period in 2006 was primarily due to an increase in commercial sales. Commercial sales for the first six months of 2007 were $66.6 million, or $18.9 million greater than the comparable 2006 period.

As with the Q2 results, this increase was due to 737 NG and 777 sales.

Military sales increased by $8 million, mostly due to sales from Miltec, our January 2006 acquisition, WiseWave, CMP and additional C-17 sales of $1.3 million. This was partially offset by a decline in Apache sales of $4.7 million period to period.

The gross profit percentage increased to 21.4% year-to-date 2007, as compared to 19.9% for the comparable 2006 period. The increase was due primarily to improvements in operating performance at both our AeroStructures and Technologies businesses, as well as a better sales mix.

SG&A as a percentage of sales year-to-date 2007 increased to 13.6%, as compared to 12.9% in 2006. This was due primarily to higher bonus accruals and SG&A expenses related to the Q2 2006 acquisition of WiseWave and the Q3 2006 acquisition of CMP, which had SG&A costs at a higher percent than our other businesses.

Operating income was $13.9 million year-to-date 2007 and rose by 32.4%, as compared to the same 2006 period, once again reflecting, in part, the operating performance improvement inside both of our businesses.

Interest expense was $1.4 million year-to-date 2007, as compared to interest expense of $1.2 million in 2006. This increase is due to the debt associated with the CMP acquisition, as well as working-capital increases.

Income-tax expense for the first six months of 2007 was $4.1 million, as compared to $3.4 million in 2006. The increase is due to higher pre-tax income, partially offset by a lower effective tax rate.

The effective tax rate for the first six months of 2007 was 33%, as compared to 36.6% for the first six months of 2006. The lower tax rate is due to the applicability of the R&D tax credit, which was not available during the first six months of 2006.

Net income, therefore, year-to-date 2007 was $8.4 million, or $0.80 per diluted share, as compared to $5.9 million or $0.58 per diluted share or the comparable period in 2006, or a 41.2% increase in net income.

Net cash used from operations for the first six months was $7.7 million, mostly due to increases in inventories and decreases in payables.

Inventories increased by $10.3 million during the year, primarily due to work-in-process for new productions scheduled to ship during 2007.

Accounts payable went down by $10.9 million due to the timing of vendor payments. And accounts receivable went up slightly by $3 million, mostly due to an increase in sales.

Our total debt at the end of Q2 2007 was $41.8 million, which equated to a debt-to-capital ratio of 17.4%, as compared to 14% at the end of Q4 2006. This is still well below our target of 30%. The change was primarily due to working-capital increases.

And finally, we incurred $5 million in capital expenditures during the first six months of the year.

I guess, in summary, I could say that the first half of 2007 has been very strong for us. Joe?

Thank you, Greg.

As you can see, we've reported another strong quarter for both revenue and profit. Looking forward, we see a lot of opportunity for us to grow in both our commercial and military segments.

In the commercial markets, the commercial-jet build rates are continuing to rise. Boeing has commented that they think this cycle will go into 2011. And it's really -- the length of it is really being driven by the fact that most of the U.S. majors have not yet, or they're just starting to buy aircraft, after having been through several years of hard times.

We're seeing more outsourcing from the primes and the tier-ones as build rates go up. And even with our very-light-jet Eclipse program sliding a little bit to the right, as you can see by our revenues, we've been able to fill that gap with other new work.

On the military side, we continue to see a high level of activity. Here, I think, risk is program-specific. Some programs will get pushed to the right and others will be trimmed back because of the squeezing of funds for Iraq. But the programs that we're on seem to be very solid. And we're finding new opportunities developing, which we're bidding on.

So as we look forward, our focus continues to be on enhancing our design-engineering content, both for product and services, striving to develop more higher-level assembly capability, focusing on titanium and composites on our AeroStructures side of the business, and we're seeing the opportunity for contracts in all of these areas coming in our future. So we're pretty optimistic on our ability to drive growth internally.

So we'll continue to push our key initiatives of one Company, operational excellence, and profitable growth, which are really fueled by the talent and the effort of our people.

And so we think the runway looks good ahead of us. And with that, Latisha, I'd be happy to take any questions that people might have.

(OPERATOR INSTRUCTIONS). And your first question comes from the line of Michael Lewis with BB&T Capital Markets. Please proceed.

Hey, good morning.

Hi, Mike.

Good morning, Mike.

Okay. Hey, Joe, I just wanted to ask you -- in late May, you received the small CLV contract for $1.9 million.

Right.

But the key takeaway was that this is a Miltec engineering win and it was tied to the AeroStructures business for the production side.

And I guess my question is, can you discuss some other areas that could, potentially, lead to larger contract awards over the next few quarters as a result of tying both of these businesses together for the engineering capabilities?

I can talk to the general areas of where we're looking.

When we acquired Miltec, we acquired the business that had engineering services, but no manufacturing capability. And as I've said before, the real attraction of Miltec for us was the influx of a large number of engineers into our organization.

And on the AeroStructures side, we are largely built-to-print. So the focus has been on trying to meld the engineering capabilities on the Miltec side with the manufacturing capabilities in the rest of our business so that as Miltec finds opportunities to get on real production programs, they could also provide the manufacturing of the work that they provide to that program.

In the past, that manufacturing had to go to others because Miltec didn't have that kind of opportunity.

So it -- especially in the area of missile defense, where Miltec works on a variety of programs in guidance, lethality and other segments like sensors, we are looking to win contracts on production programs as a partner to larger companies and to provide that manufacturing.

So I can't say to you that it will happen in the next quarter or two, but we are comfortable that we're making progress and that we should see contracts that will lead us to providing manufacturing support and services for the engineering technology that Miltec has, as they win contracts on production programs.

Okay, yes. And that was, I think, what's important there -- is that the opportunities tied with missile defense are still out there?

Yes, very much so.

Okay. And then I'll just ask one more question and get in the queue again. Internal growth is surprisingly strong. The first two quarters averaged about 15% combined.

Joe, I mean, what should our expectation be for the second half of the year? Will we expect to see a deceleration of the internal growth or is this sustainable in the low-to-mid teens?

Well, I think what you see going on in the marketplace is double-digit growth on the commercial side and low-single-digit growth on the military side.

The size of our growth overall in the first six months, I think, was aided, in part, by favorable comparisons. In the second half of 2006, we were starting to see the kinds of growth on commercial that we have continued to enjoy in the first half of this year.

So I think the growth will moderate in terms of year-over-year comparisons, but it is still true that we're seeing double-digit growth on commercial side, which will allow us to continue to grow internally. It might not be at 15% plus year-over-year comparisons, but it still should be a favorable growth.

Okay, thanks. I'll hop back in.

(OPERATOR INSTRUCTIONS). And your next question comes from the line of Chris McDonald with Kennedy Capital. Please proceed.

Hi. Good morning, Joe and Greg.

Hi, Chris.

Good morning.

Greg, you mentioned Apache being down a little bit, year over year. And I'm wondering if one of you can just give us an outlook for that program. I know you've had unusually high replacement business on the blades, and I'm just wondering if you've got contracts winding down there or if it's just a timing issue.

No. I'm -- we don't have contracts winding down.

I think, as we've talked about before, at some point in time, Apache sales are going to decline as you go forward. It's not going to go away, but it's going to eventually get to a place where it was, perhaps, a few years ago.

I wouldn't say that we would expect it, in the third quarter and fourth quarter -- to see, necessarily, declines, compared to the prior quarters. But over time, I think it is safe to say that Apache sales will continue to go down.

Is this the kind of business when you -- when we start bringing equipment back from Iraq, where you'd have reset work or refurbishment-type work that might get the growth rate going again? Or is it just kind of a constant upgrade? I just don't know how quickly the blades wear out on --

Right. This is Joe.

Let me say that since the overwhelming majority of the blades that we build are spares, it's driven very much by the tempo of activity that's going on in Iraq. And last year, there was a bit of a surge, as they were concerned about the blades in their pipeline. We're running at a more normal rate for the level of activity that exists in the Middle East today.

As they start bringing equipment back, we would not expect to see a surge of activity for the equipment being brought back. What we would expect is that the rate will stay -- continue to stay high, because even as we take troops out of Iraq, we'll continue to support the Iraqi Army and police with Apache Helicopter support.

So while, let's say, a year and a half or two years from now, our troop levels may be down, the level of activity from Apaches will probably not be down because of support for the indigenous pro-government forces.

When we acquired this business in 2001, we were running about $20 million to $25 million a year on Apache. We're up around $50 million a year now. At some point in time in the future, we will gradually, I think, go back to that $20 million to $25 million. But we don't see it for the next several years.

What we are doing, though, is we're targeting programs to win to fill the gap and replace any cyclical sales that we lose because of the drop in activity. So by the time we get out there, we should have in place other programs to pick up the slack.

Okay, excellent.

And then, just lastly, could you comment on expectations relative to Eclipse, maybe, in the second half of the year? You mentioned "move to the right a little bit." Maybe just talk about timing and then, potentially, magnitude of the opportunity there.

Sure. And, you know, everything I say is what I believe Eclipse has been saying publicly. They, originally, were looking to ship over 400 aircraft this year.

And because of some delays of certifications and, therefore, a slower assembly rate, I think they're looking more in the range of 200 aircraft this year. But then they expect the build rate to continue to climb because they've received all of their certifications now. And so they will gradually ramp up.

They certainly would like to get past the 550-aircraft-per-year level. To me, the constraint will be how effective their supply chain is. We don't expect to be the bottleneck. But so much of the aircraft is outsourced, people have to demonstrate they can get to the higher build rates.

We're comfortable that we can get there. And Eclipse, I'm sure, is working hard with all of its suppliers to make sure they can get there. But if there's any issue with whether they can get to, let's say, 700 or 800 planes a year, I think it will be whether the supply chain can support that or not.

Okay. And if the program were to get to, let's say, a 500-[ships-set]-per-year type program for you, does that make it large enough to crack your top five, or would it still be outside of that group?

I think it would probably get into the top five at that point, yes.

Okay. Thanks a lot.

(OPERATOR INSTRUCTIONS). Your next question comes as a follow up from the line of Michael Lewis with BB&T Capital Markets. Please proceed.

Okay. Greg?

Yes?

Amortization fell off a bit in Q2 versus Q1.

Right.

Should we expect to see the amortization flow through for the next few quarters at below $500,000? Or could --?

Yes, I think so, Mike. I mean, as is typical when we amortized a couple of the areas, whether it's backlog, et cetera, typically they amortize relatively quickly.

Other parts of amortization that we do related to acquisitions, whether it's customer relationships, non-competes, things like that, tend to flatten out over time. So you -- typically, you'll see a decline over a couple-year period and then the amortization will flatten out.

So what, specifically, fell off between the two quarters?

I think it was backlog.

Okay. And, if you could just offer what your expectations would be for depreciation and amortization, stock-option expense and tax, that would be very helpful to our modeling.

I would say that from a depreciation standpoint, you could expect to see a relatively consistent $2 million a quarter, that's what we've been showing.

From an amortization standpoint, we'll probably -- we've been averaging about $500,000 a quarter. I think it would probably be about that going forward, and then slight declines, maybe, in Q3 and Q4, but still around the $400,000, $500,000 level -- no big change.

And then our stock-option-related expenses -- probably in the -- we averaged -- we did about $600,000 in Q2. I would say that that number would be relatively consistent in Q3 and Q4 as well.

Okay? And tax?

The tax rate? We've been at -- we're at 33%. I would say that the big influence last year and the reason we had big swings in tax rates last year was because in Q4 we were finally able to utilize the R&D tax credit.

We are taking advantage of that now, quarter over quarter. So I would not see any big swings going forward. That's the biggest -- that was the biggest area of concern a year ago and that's not an issue this year.

So just keep it kind of at the current rate?

I would think so.

And then, just one more. I'm sorry. Expectations for free-cash-flow yield in '07 -- are we going to see this thing approach one times net?

Well, let me just say that we -- as is typical in the business, we typically use cash. In the first part of the year, we generate cash. In the second part of the year, I would hope -- or I would expect -- that that would continue this year.

Okay. And I just wanted to thank you guys, by the way, for having your Q out. It was very helpful to read before the call.

Great. Thanks.

Ladies and gentlemen, at this time, there are no further questions. I will now turn the call over to Joseph Berenato for closing remarks.

Latisha, thank you.

In summary, our markets are strong. We're performing. And we intend to continue to look for complementary acquisitions.

We've seen, in the marketplace lately, prices that have been what we felt were too high. And so while we have been actively involved both in auctions and also developing acquisition targets on our own, the marketplace has been willing to give people so much money that prices have gone to a level that we've stepped back.

And the recent issues we've seen with credit-tightening over the last month, I hope, continue, because my hope is it will help bring the price of acquisition down into a more realistic realm. But the fact that we haven't done an acquisition in the first six months of this year doesn't mean that we're not looking just as hard as we did last year when we made three.

So I'm looking forward to speaking with all of you after our third quarter results. And thank you for attending this conference call.

Latisha, back to you.

Ladies and gentlemen, thank you for you participation in today's conference. This concludes the presentation. You may all disconnect and have a good day.