Ducommun Inc (DCO) 2007 Q3 法說會逐字稿

Good day, and welcome to the Third Quarter 2007 Ducommun Earnings Conference Call. My name is Candice, 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 today's conference.

(OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today's conference, Mr. Joe Berenato, Chairman, President, and Chief Executive Officer. Please proceed sir.

Thank you, Candice. 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 third quarter 2007 conference call, and Greg will now review with you our third quarter financial results reported earlier today.

Thanks, Joe. Good morning, everybody. Q3 was a very good quarter for Ducommun. I'll go through the quarter first and then the year-to-date numbers.

Sales in Q3 2007 were $94.7 million. This is a 16% improvement as compared to revenue of $81.6 million in Q3 2006 -- 14.5% of the sales growth is organic. Both our Ducommun AeroStructures and Ducommun Technologies businesses showed year-over-year gains. AeroStructures grew by 21% quarter-over-quarter, while Technologies grew 9%.

The mix of sales in Q3 2007 were 60% military, 38% commercial, and 2% space, as compared to 66% military, 31% commercial, and 3% space in Q3 2006. Total military sales were up $3.3 million quarter over quarter, mostly due to an increase in Apache Helicopter Program sales of $900,000. Our commercial sales grew by $10.5 million quarter over quarter due mostly to 737NG and 777 program sales. That's $2.6 million and $900,000 respectively, as well as increases in commercial helicopter sales of $3 million.

The Company's backlog is approximately $333 million as compared to $321 million at the end of 2006. The gross profit margin increased to 21.7% in Q3 2007 as compared to 20.8% in Q3 2006. The increase is due primarily to improvements in operating performance in both of our businesses, as well as a better sales mix.

Although SG&A expenses increased by $1.4 million year over year, SG&A as a percent of sales in Q3 2007 decreased to 12.5% as compared to 12.7% in Q3 2006. The increase in expenses was due primarily to higher bonus accruals, full-quarter SG&A expenses related to the acquisition of CMP last year, and a variable portion of SG&A expenses that we would expect to grow with the sales growth we experienced.

Operating income was $8.7 million for the quarter and rose by 32% as compared to 2006, reflecting in part the operating performance improvements inside both businesses. Interest expense was $628,000 in Q3 2007, as compared to $704,000 in Q3 2006, mainly due to a decrease in debt.

Income tax expense in Q3 2007 increased to $2.2 million as compared to $1.8 million in Q3 2006. The increase in income tax expense is due to higher pre-tax income, partially offset by a lower tax rate. The effective tax rate in Q3 2007 was 27.7%, as compared to 30.1% in Q3 2006.

Net income, therefore, for the quarter was $5.8 million or $0.55 per diluted share as compared to $4.1 million or $0.40 per diluted share in Q3 2006 or a 42% increase in net income.

On a year-to-date basis, sales were $273.8 million as compared to $231.2 million for the first nine months of 2006 or an 18.4% increase. Approximately 15.5% of this increase was organic. AeroStructures grew by 15.6% and Technologies grew by 22.8%.

Our sales mix for the first nine months was 61% military, 37% commercial, and 2% space as compared to 67% military, 31% commercial, and 2% space in the first nine months of 2006. The increase in sales was due to increases in both military and commercial sales.

Military sales increased by $11.2 million, mostly due to Engineered Services sales, CMP, and additional C-17 sales of $1.5 million. This was partially offset by a decline in Apache sales of $3.8 million period to period.

Commercial sales for the first nine months of 2007 were $102 million or $29.4 million greater than the comparable 2006 period. This increase was due principally to sales of 737NG, an approximately $8 million increase, 777, $3.7 million increase, CMP, and commercial aftermarket sales.

The gross profit margin increased to 21.5% year-to-date 2007, as compared to 20.2% for the comparable 2006 period. The increase is due primarily to improvements in operating performances -- performance at both our AeroStructures and Technologies businesses, as well as a better sales mix.

SG&A expenses were $36.2 million year-to-date 2007, an increase of $6.6 million as compared to the first nine months of '06. SG&A as a percentage of sales year-to-date 2007 increased to 13.2% as compared '02 12.8% in '06. This was due mainly to higher bonus accruals in '07 and SG&A expenses related to the Q2 acquisition of WiseWave -- Q2 2006 acquisition of WiseWave, and the Q3 2006 acquisition of CMP, which also had high SG&A costs at a higher percent than our other businesses.

Operating income was $22.6 million year to date and rose by $5.5 million or 32% as compared to the same 2006 period, once again, reflecting in part the operating performance improvements inside those businesses. Interest expense was $2 million in 2007 as compared to $1.9 million in '06.

Income tax expense for the first nine months of '07 was $6.4 million, as compared to $5.2 million for the comparable 2006 period. The increase is due to higher pre-tax income, partially offset by a lower effective tax rate. The effective tax rate for the first nine months of '07 was 30.9%, as compared to 34.1% for the first nine months of 2006. The lower rate was due primarily to the applicability of the R&D tax credit, which was not available to us during the first nine months of '06.

Net income therefore, year-to-date 2007, was $14.2 million or $1.36 per diluted share, as compared to $10 million or $0.97 per diluted share for the comparable period in 2006 or a 42% increase in net income.

Net cash provided from operations for the first nine months was $1 million. Inventories have increased $10.7 million during the year, related primarily to work in process for new production. Accounts payable have decreased by $12 million due to the timing of vendor payments, and receivables have increased by $4.9 million due to an increase in sales. As a note, our depreciation and amortization year to date is $7.6 million.

Our total debt at the end of Q3, 2007, was $34.3 million, which equates to a 14.2% debt-to-capital ratio as compared to 14% at the end of Q4 2006. This is still well below our target of 30%. The change is primarily due to working capital increases. And finally, we have incurred $8.4 million in capital expenditures during the first nine months of the year. We expect to spend no more than $11 million for capital expenditures during 2007.

I guess I'd say in summary, the quarter as well as the first nine months of 2007 has been very strong for us. Joe?

Thanks, Greg. As you can see, we have reported another strong quarter for both revenue and profit. Looking forward, we see opportunity to continue to grow in both our commercial and military market segments.

On the commercial side, we still see build rates rising, especially for the 737 and 777 programs for Boeing. The Boeing Chairman McNerney recently stated that they view the aerospace commercial jet cycle continuing into 2012, which is a year longer than previously mentioned. And we see more outsourcing opportunities from Tier Ones.

On the military side, we see a continued high level of activity because of the Iraq and Afghanistan conflicts, but as I've said before, I think we will see winners and losers in this space, based on what programs there are. And there will be programs that'll get pushed out. There will be others that'll get pulled in. And while the overall defense budget will stay large, there'll be real winners and losers within that framework.

Our focus is to continue trying to increase our design engineering content, in moving and migrating to higher-level assemblies and on the Dash side, focusing on the titanium and composite opportunities that exist in the marketplace. So, as we continue to drive our key initiatives, one Company, operational excellence, profitable growth and organizational develop, I think we have a -- an exciting runway ahead of us.

And with that, Candice, I'd be happy to take any questions.

Our first question will come from the line of Michael Lewis of BB&T Capital Markets.

Good morning, great quarter.

Hi, Mike.

Hi, Mike.

Thank you.

Okay. So Joe, I just wanted to ask a quick question about the M&A market. The changes that we've seen in the credit markets, how do you think that's impacted the relative pricing throughout the industry? And do you think that you're seeing some rationalization on the M&A side on pricing?

Not as much as I would like, I think the rationalization is taking place at the high end. And by that, I mean the big-ticket end of the market where the ability to lever up seven and a half times EBITDA with no covenants has gone away. And you've seen a number of those deals try to get restructured.

At the size of deal that we're looking at, these deals are usually financed with bank credit. And the banks will continue to lend for these transactions, although with more covenants and not quite as high leveraged. But, we've never been one of those who was willing to go to the extreme and leverage.

You might remember that I mentioned, a banker came in and offered us a financing to go after somebody. And I said, "You're willing to give us more money than we ought to take." So, I think while there has been some dampening of the pricing in the market, I wish I could say that there was more than we've seen so far. Greg, do you have any comment on that?

Well, only to say that I agree with Joe. We continue to look, and we think there are some opportunities out there, Mike. We are constantly pursuing those. And as Joe say, it's tough. But, we're continuing to look hard and hopefully, we'll be successful.

Okay. And I'll ask two more questions and then get back in the queue for -- so someone else can get in. But, noticed in the Q, the NASA/Lockheed Martin agreement had come about and so, you're going to have a $1 million pre-tax adjustment next quarter. And how should we account for that? Is that's something that's going to come out of like SG&A or direct costs? How should we --?

It's going to be about half and half between COGS and SG&A, Mike.

Okay. And then just one final question, Joe, with regard to -- the EBIT margin in Technologies was significantly weaker than I was forecasting. I think I was looking for about a 10% margin in that business. Maybe I was overshooting a little bit, but based on the numbers I ran, they came in around 6.3%.

But at the same time, AeroStructures was up a few hundred basis points versus my projection. So it -- really, I guess what I want to do is square away in the model here what you think the sustainable longer-term growth rate is in each one of the sectors, or segments. Could you kind of help me reel this in a little bit?

Well, what I would say is that in the quarter, AeroStructures have had a very solid quarter, strong sales. And so, that helped their margins. On the DTI side, we had a couple of smaller but profitable segments where the sales weren't quite as high as we thought they would be. We think it's -- it was temporary in nature, but because they -- the sales were a little soft and their margins are so good, I think that impacted them a little bit for the quarter.

So, it's not something that we're -- should be repeated, say, in the next quarter or in '08? It's just something that happened in the third quarter, isolated?

Well, they've got to recover, of course, but the intention is that they will recover.

Okay, that's fair. Okay, thanks guys.

(OPERATOR INSTRUCTIONS). Our next question will come from the line of Troy Lahr of Stifel Nicolaus. Please proceed.

Thanks. Just one question regarding -- kind of piggybacking on the last one there, with AeroStructures, so it sounds like 15% operating margins could be achievable kind of if you can sustain that level of sales. Is that what you're saying?

Yes. I think if we can get the volume. That's -- that side of the business is more capital intensive, so you've got a lot of fixed costs that you've got to carry. So, the key there is volume.

Okay. And then, I think Greg mentioned a favorable sales mix this quarter that really helped. Can you kind of drill down on that a little bit?

Well, we're really -- if you look at program by program and just do a comparison quarter to quarter, you just see that the sales volume in some programs that had a little bit higher gross profit margins, we had higher volume in.

We also are starting to see in a couple of programs where -- a couple of start-up programs where we're starting to get into a little bit higher productions. Those programs are now more profitable, typically. A lot of our new start-ups, we lose money as we go down the learning curve, and we're starting to get better. So, I'd say that those were really the two reasons.

Okay. And how do you see that going forward, say, over the next year? Do you see that favorable mix still staying in your favor or kind of swinging back? I guess the start-up settles, but what about the other side of the equation?

I would think that the gains -- in our mature programs where we get the gains is by our lean and Six Sigma activities. So, we still think we have a culture of lean and Six Sigma in our organization that helps drive operational improvements. And for most of our programs, that's where we'll see it. We also would expect to get some gains from our -- on the Dash side from our New Mexico operation as we go forward.

So, there's a constant process of new programs that we go down the learning curve, and then we get better and better and better. They begin to mature, and then it's about all lean and Six Sigma from our perspective.

Yes. And let's not forget that if we're doing it right, we've always got new programs. If we're going to be growing and adding new customers and new content, we're always going to have some programs in -- at the front end of that learning curve.

Okay. And then lastly, just trying to understand the sales to Boeing commercial aircraft, I guess year over year probably up about 50%. But, if you look at Boeing's build rates, maybe they're up 15%, 20%, given certain product lines, but mostly if you look at 737 and 777, I think they're up around that range. But, your sales are increasing at a much faster rate. Is that 787? Or, are you actually gaining content on 777 and 737s?

Well, I think it's a little bit of all of the above. The build rates on 37 and 777 have been going up. We are getting some work on 787, but it's not significant yet. But, we are winning contracts on that program. And we are getting work on the 747 Dash 8, which probably doesn't show up individually. So, that's why the sales of total Boeing commercial aircraft looks like its growing faster. So, it's a combination of rising build rate and new programs and new content on existing programs.

The 737 and 777, are you gaining content there also?

A little bit, yes.

And on 787, you said winning contracts. I think before, you said wire harnesses. Have you kind of added metal sheet assemblies to that as well?

Well, we haven't put out any press releases yet on other things, so I think I have to wait until we do that.

I think that there was a newspaper article out there where I thought somebody mentioned metal sheet assemblies, one of you guys.

Yes.

But maybe, I'm incorrect.

Yes. You're probably right.

Okay. All right, thank you.

Our next question will come from the line of Alex Hamilton. Please proceed.

Hi, good morning gentlemen.

Good morning.

Good morning, Alex.

Just a few question, you guys had a pretty detailed conference call this time. I -- and once again, I'm still getting used to you guys filing the Q, and I appreciate that. In terms of the Mexico facility, you had talked about it a little bit.

When should we expect to see contribution from that and then, if we can talk about what that contribution's going to be? You talked about a learning curve. My guess is, you're going to see more contribution on the top line than you are maybe to EBIT. Can we talk about that a little bit and kind of how you see that going forward?

Yes. The -- we're putting some assembly content on the 737 spoilers in Mexico where they're going to do final assembly and paint. And they'll start gearing up here in the fourth quarter.

Okay.

So sometime in the first quarter, once we get Boeing approvals, we would go live with doing some portion of that production down in Mexico. So I'd say, probably second quarter going forward, we ought to start seeing some benefit from it.

So, since that's already existing work, my guess is more of that will get more lift to EBIT potentially?

Well, the -- we won an eight-year contract for those spoilers. And the way we were able to do it was by putting in the Mexico facility. So, while it's work that we were doing before, we got the renewal because of Mexico. So in the sense, I view it as new business. But, we have to train a staff down there to do this work. So, some of the learning curve knowledge that we already had will be lost initially, and then we have to build it back up.

And it also seems like your wing business seems to -- I'm not necessarily quantifying it, but if I were to guess, it seems like it's gaining some momentum.

Well, we're --.

Is that's work that's going to be -- that's work that's done in Monrovia? Is that correct?

Right. We're -- we think we're good at it, and so we're out aggressively marketing it to a variety of primes in the first-tier guys. And as we win business, it just supports our position in that niche. But it's an airfoil, and we've got plenty of experience on leading edges of wings and on helicopter airfoils. So, this is another type of airfoil. So, it's not completely foreign to us. It's just a different application.

And I guess this is kind of a twofold question, and then I'll end and let everybody else jump in. I appreciate the time. I'm -- I guess what I'm trying to do is gauge. I know a big focus has been increasing engineering content. Do you have a gauge of what that is in the quarter relative to what it's been before? Do you see this increasing? Or, are we going to expect to see the benefits going forward?

I guess kind of where I'm going is, we've done a great job. We have a great cycle. Execution has been fantastic. Kind of on the margin, where should we see the changes going forward?

My sense on the engineering side as we bid new contracts and also bid existing contracts, we try to get some more content. But, from the internal growth side of the house, the increase in engineering content will be kind of incremental. Where we would see a significant increase in engineering content is through acquisition. If we buy a business that is -- has a design engineered product, let's say, because then we're bringing in-house, a whole new set of sales that have that kind of content already embedded in it.

Thank --.

So, I think it'll be incremental from our existing business. But, step-function increases would be acquisition should we buy a business with engineering content.

Great, thank you.

(OPERATOR INSTRUCTIONS). Our next question will come from the line of [Craig Roth]. Please proceed.

Hello, guys.

Hi, Craig.

Hi, Craig.

Craig Roth at Axiom Asset Management, just a little color on new customers and new products, the advent of the affordable super-light jets, I believe you have an existing contract with one of these manufacturers, which is Eclipse. Could you give us an idea of what you did for Eclipse this quarter, if anything, and what you think this new industry or this new space means to you guys longer term?

The -- on the Eclipse, we make nine fuselage skins, which is most of the body of the airplane. The future for these very light jets, I think, is tied very closely to the whole notion of air taxi. And we're about to witness the launch of that as Eclipse has just delivered about a dozen jets to a Company down in Florida that is just starting service. So, we'll see how it grows.

My guess is that the marketplace does exist but that it'll grow much more slowly than people might imagine at first. The guy in Florida, by the way, says that he doesn't think he's competing with airlines. He thinks he's competing with a guy who chooses to drive his car or to take a ride on a very light jet.

So, there's all sorts of structural issues, how many pilots are there in the world, how many airports are there in the world, how dense the sky gets with airplanes. So, I think this market is real, but I think it comes a little more slowly than some of the proponents or advocates might suggest, which is probably better for us.

But, we do make these fuselage skins for Eclipse, and we are talking to others in this space to see what opportunities exist for us to do some work for them as well.

A little -- can -- in this space, can this industry -- or in that space, can it move the needle for you guys?

I don't think so. I think that we could get a couple of very nice programs that could be in the, let's say, $10 million a year range. But, I don't see it being like a major segment that rivals the commercial jet market or anything like that.

Okay. One last quarter, are you at liberty to say how many deliveries you made of Eclipse last quarter?

I actually don't know, but we're in the beginning stages of delivery. Certainly, they've said that they were going to try to deliver about 170 planes this year. So, we would have made at least that many deliveries.

Okay, thank you for your time.

Our next question will come from the line of Michael Lewis. Please proceed.

Joe, can I -- can you just talk a little bit about -- I understand with Eclipse, some of the issues that we saw there was due to this supply chain build-up on their side. And that Ducommun was set to go with any potential ramp that they brought into the base here, so any additional information on the Eclipse issues that they had with the supply chain?

I don't know a lot of it. I know that they are changing out the flight management system in the cockpit. But, I believe they're making that change as a retrofit to planes that they ship. So, I don't think that's slowing down initial deliveries. So, the -- they must be having problems with other suppliers for particular components in the aircraft. But, I know that we're not the problem, so it's somebody else or some other people who aren't delivering on schedule.

The problem is, when you -- Boeing, in a sense, has the same issue with the 787. When you sub-contract so much of the plane away from yourself, you're at the mercy of your supply chain. And here at Eclipse, virtually everything is sub-contracted out. And the 787 has more sub-contracted out than any other Boeing aircraft. So in both instances, you just have a greater probability of an issue with a sub-contractor that doesn't deliver on time.

What you do try to do, of course, is be very robust in building your supply chain. And Eclipse has tried to dual source most of its suppliers. I believe that the only people who aren't dual sourced are ourselves for the skins, Pratt & Whitney for the engine, and whoever's providing the flight management system in the cockpit. I think everything else in the airplane is dual sourced.

Okay, that's helpful. Just to switch gears here, the recent $25 million contract for Falcon, what would you anticipate the ramp on that contract playing out in '08? Are we looking at a $5 million business there, or is it north of $5 million?

I think it's probably north of $5 million, because we're ramping pretty quickly. We have product due before the end of the year.

Okay. And then, if I could just get a few housekeeping items here, Greg, you had given that year-to-date internal growth. What was that again?

The year-to-date number?

Yes.

Was 15.5%.

Okay. And then, could you help us out with D&A and CapEx, because CapEx $11 million potential this year --.

Right.

Would you expect a step down next year since Mexico will up and running?

You know, Mike, I hope not. And the reason that I say that is that a lot of our CapEx is contingent on new programs --.

Yes.

That we win, so if we're successful in winning some new programs that we're going after, there's probably going to be some associated CapEx with it. So, I would like to tell you that our CapEx spending will be higher next year.

All right.

And you asked about the D&A?

Yes. Just D&A, what your expectation will be for this year and next year? But just to follow up on CapEx, so if I run around, say, a $12 million number for next year, that should be a safe assumption?

I would think so.

Okay, thanks.

And as far as D&A, we're about $7.6 million year to date. I think -- I don't see any reason that that's going to change dramatically over the next couple of quarters. Our amortization will probably drop a little bit, but with our CapEx spending, depreciation will probably offset it by about the same amount.

Okay, so just maintain?

Yes.

Okay. And then just with regard to ARs and inventories, so we saw the inventory spike --

Right.

-- due to work in process, will that move out? What's your timing with regard to the inventory build-up? How -- when will we see that come back down? And then on the AR side, do you have a number of -- has any of that converted to cash since you closed the quarter? That's -- I guess that's the question.

Oh, sure. Yes. Let me talk about AR first. I mean, the A -- if you looked at our days sales outstanding, you'd see that AR is, I would think, in some pretty good shape. And what you're seeing here is just kind of the normal AR rise that you would see with sales at our terms.

From an inventory perspective, we had a big build-up in the first half of the year. Really in the third quarter, our inventories were flat. And typically, we tend to see them come down over the second half of the year. So, I would expect that trend to continue through December.

Okay, that's helpful.

Mike, the only other comment I'd make is that the inventory level is unacceptably high. And it's been too high for most of the year, largely because we went out and bought a lot of inventory to support some of our big programs. And we've had delays in getting progress billings, so our hope is to see the inventory to come down significantly from where it is at the end of the third quarter.

That's very helpful, thank you very much.

Sure.

Our next question will come from the line of Alex Hamilton. Please proceed.

Hi. Just a quick follow-up housekeeping, tax rate for the year, what should weak anticipate? What should we model?

I would say somewhere right around 30%.

Okay, thank you.

Our next question will come from the line of Troy Lahr. Please proceed.

On the 787, given the delays, are you guys still continuing to produce your product, whatever those may be? Is that how you're looking at it?

Yes. Yes, we haven't been told by anybody to stop work. Let me say -- well, that's not quite true. I think on the wiring harnesses, we've been slowed up a little bit. But on everything else, we've been told to keep going.

Okay. And then, is there a cash impact? It sounds like Boeing's not going to be paying their suppliers until they get paid. I think they said they would make some exceptions, but do you see that being an impact for you guys? I know it's still relatively small.

It doesn't flow down to us, the -- they may have worked out such arrangements with risk-sharing partners, but we haven't agreed to anything that says that we don't get paid until the airplane's delivered. We've never agreed to anything like that.

So, you get paid on delivery when you deliver to Boeing?

Well, we bill them on delivery and then, it's a struggle to get the receivable collected as soon as we would like.

Okay.

But, we are typically 30 days in terms.

Okay. And again, your content, the programs that you have on 787, is it more than three, three different types of --?

I think it is three right now.

Three, okay. And then on the Carson Helicopter, have they been gaining traction on selling those blades elsewhere?

Yes. I think they just recently announced that they had sold the blades to the Presidential Helicopter as a replacement blade.

Okay.

Which I view that as a huge vote of confidence in the blade.

Right. And then, any change to your build rate on that particular blade?

It's been moving up, and we've been trying to achieve the rates that we've been asked to achieve. But, it has moved up a little bit since the first half of the year.

Oh, good. Do you want to say how many you're doing a quarter or from a dollar standpoint, or maybe kind of quantify it for us?

No, not at this point.

Yes, I figured. All right, guys. Thanks.

(OPERATOR INSTRUCTIONS). Our next question will come from the line of Chris McDonald. Please proceed.

Hi, Joe and Greg, good morning.

Hi, Chris.

Hi, Chris.

Can you just comment on where you're seeing the most outsource opportunities? Is it direct to the tier ones, the primes, biz jets, just kind of walk through where the opportunities are? Thanks.

The primes have been doing their best to get out of manufacturing. So, we're seeing more and more outsourcing opportunities from the tier ones. We're also seeing, and by primes I mean the big jets.

We're also seeing opportunities in the business jet and very light jet marketplaces where they're trying to keep a lid on their investments by getting risk-sharing partners or failing that, outsourcing as much content as possible so they don't have to have the infrastructure. So, we've seen the opportunities really across the board from tier ones, business jet, and very light marketplaces on the commercial side.

Okay, thanks.

I have no further questions in the quarter at this time, gentlemen.

Okay. Well, let me just say in summary that we think our markets are strong. We think that we're becoming increasingly more capable. We're continuing to look for complementary acquisitions that will support the businesses that we already have. And I look forward to speaking with you in February to report on the full year. Thank you, very much.

Thank you.

Thank you for your participation. You may now disconnect. Have a great day.