Ducommun Inc (DCO) 2007 Q4 法說會逐字稿

Thank you for your patience, and welcome to the Fourth Quarter 2007 Ducommun Earnings Conference Call. My name is Candice, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question and answer session after the prepared remarks.

(OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today's conference, Chairman and Chief Executive Officer Mr. Joseph Berenato. Sir, you may proceed.

Thank you, Candice. Good morning. I'm Joe Berenato, CEO of Ducommun, and I want to welcome you to Ducommun's fourth quarter and year-end 2007 conference call. As reported earlier today, in the fourth quarter of 2007, we had sales of $93.5 million versus a year ago of $87.8 million, a 6% increase. Our gross profit margin was 18.2% versus 18.1% a year ago.

Operating income came in at $7 million, versus $3.6 million in the fourth quarter of '06, which is a 94% increase. Net income of $5.4 million was $1.1 million better than the year-ago number of $4.3 million, and a 27% increase; and EPS of $0.51, $0.10 better than the $0.41 of last year's fourth quarter, a 24% increase.

For the full year of 2007, sales were $367.3 million, versus $319 million a year ago, an increase of 15%. Gross profit margin for the year was 20.6% versus 19.6% a year ago. Operating income of $29.7 million was 44% higher than the $20.7 million in 2006. Likewise, net income of $19.6 million for 2007 was $5.3 million higher than the $14.3 million of 2006, an increase of 37%. And, EPS of $1.88 was 35% higher than the $1.39 from 2006.

Of special note, through the year, we had been lagging in our cash flow from operations for a variety of reasons that were mostly timing. And the timing reversed itself in the fourth quarter. And we ended 2007 with $42.6 million of cash flow from operations, versus $24.3 million from the year-ago period, or an increase of 75%. Our tax rate for the full year was 28%, versus a 21% tax rate for the 2006 year.

So, we end 2007 with the highest net income and the highest cash flow from operations in the 158-year history of the Company, and we're very proud of that. Looking forward, the commercial markets continue to look strong. Build rates for Boeing Aircraft and Airbus Aircraft continue to rise.

The backlog is very strong for both of these major commercial carriers as they've had three-plus years of record orders. And as the CEO of Boeing has said, they expect this cycle to last through the year 2011. So, we see a lot of opportunity in the commercial markets and continue to be actively bidding new work.

On the military side, we've seen the cycle elongated because of the activities in Iraq and Afghanistan. And the military budget continues at a $500 billion a year level. I do think there's some program risk for specific programs within the military budget, so it matters very much which programs you're on. So the military budget is very high, but there are some programs that may get pushed out or cancelled over the next several years.

So, we feel that our two major markets are strong and have significant legs to continue strong for quite awhile, and we have, we believe, growing capacity and capability. We announced in January a reorganization of the Company, which was primarily designed to allow us to grow faster, and to line up our key people with the areas of growth that we needed to control.

So our foundation continues to be operational excellence, profitable growth, and organizational development. And we think we've got good runway as we go forward, and we think we continue to become increasingly capable.

And with that, I'd be happy to answer any questions that people might have. Candice?

Thank you, sir.

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Our first question will come from the line of Troy Lahr of Stifel Nicolaus. Please proceed.

This is actually Hunter Keay filling in for Troy. How are you, Joe?

Hi, Hunter. How are you?

Good. Thanks. I had a question for you. At DAS, can you quantify the impact of some of these environmental accruals to the fourth quarter income? I saw in the K it was -- you have to take a $3.1 million reserve. Was that on DAS all in this quarter? I'm just trying to kind of quantify --

No.

-- the impact on margins.

No, the $3.1 million is the total amount that had been set aside for the particular issue or issues that was being described there.

Okay.

So, it wasn't a $3.1 million reserve in the quarter. I think we took something less than $1 million. With environmental reserves, whenever there is activity that would lead you to adjust your reserves, then you're required to take it at the time. This is not the kind of thing where you can say, well, I need to get to a number and so every quarter I'll take 20% of that or 25% of that. You need to be fully reserved for what you believe the expectation is of what you'll spend to solve that problem.

Now very often, you don't know what that is because investigation hasn't gone along far enough to reach a conclusion. So in the fourth quarter of 2007, we saw in a couple of instances where new information had come to light which allowed us to reduce reserves in one or two instances, but required us to increase reserves in another instance. And it ended out where there was a net increase of something under $1 million for the quarter.

Okay. So what was it exactly at DAS that caused a lower operating income? I mean, it was a bit below our margins and sort of incrementally. Sequentially from last quarter, it came down a bit. Was there anything sort of one time in this quarter that kept margins down below our --?

Again, our revenue and earnings streams tend to be pretty seasonal.

Okay.

And so, Q4 and Q1 tend to be our weakest quarters. And Q2 and Q3 tend to be our stronger quarters. So in any given year, either the first or fourth quarter will probably be our weakest. And the reason for that is really tied around a couple of items. In Q4, first of all, you have the fewest working days of the year in any quarter because of Thanksgiving and Christmas.

Secondly, some of your customers stop taking shipments in mid-December. So that further truncates what you can do in that quarter. Therefore, the month of December, very often you'll have three weeks of revenue but five weeks of overhead. And so, margins get impacted by that.

Likewise, in Q1, people come back from the holidays. And in December, you probably wound down your working capital quite a bit. So the pipeline is kind of lean.

Okay.

And then when you come back in January, the first couple weeks are really spent rebuilding the pipeline. So, January tends to be our either weakest or second weakest month of the year. So it's for those reasons, that Q4 or Q1 tend to be weaker. And so as you saw, we had a gross profit margin of 18.2% in the fourth quarter, but 20.6% for the full year.

Okay. Great. And could you maybe help us frame out 2008 a bit, just for -- from a top-line perspective, and sort of maybe more directionally where you think margins can go from here?

Well, we don't provide guidance. What I have said in the past is that the investments that we made in 2006 were meant to position us so that we could have increasing revenue and profits in '07, '08, and '09. So, I still believe that. So '07 was better than '06. And we think '08 should be better than '07. But other than that, we really haven't talked about the future.

Okay. Sounds good. Thanks a lot.

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

Hi, Joe. Good morning.

Hi, Mike. How are you?

I'm doing okay. Quick question -- in your prepared remarks, you once again stated that there are some programs on military side that you do see at risk. I was wondering if you could elaborate a little bit more on that, and with regard to specific concentration that Ducommun might have on some of these programs.

Sure. Again, I've got now crystal ball, but when you look at the amount of money that's being spent and the deficit, it's pretty clear that something has to give. I think it's possible that, for instance, the F-22 really doesn't go certainly higher than 200 aircraft, even though the Air Force would like to have 383. I think the F-35 might get pushed out a little bit. Future Combat Systems, I think, has the chance to be pushed out.

Certainly, the program that is of interest to us is the C-17. And for the last two years, the Air Force hasn't put any money in the budget for it, and relied on Congress to put the money in. And they don't like doing that, and they've said so.

Actually, 55 congressmen this past year sent a letter to the Secretary of the Air Force saying put it in your budget because we're tired of funding it. And the Air Force promptly did not put it in their budget again for '09. So, Congress is left with the reality that they either have to fund it, or provide for the shutdown of the line.

On the 5th and 6th of March, I'll be in D.C. at a Boeing-sponsored rally of suppliers to get us to visit congressmen all over the Hill to encourage them to support the program yet again. The good news is, we really do need the plane. And it's a really, really good plane. So, we've got two things really going for us in that regard.

There was an interesting piece of news about three weeks ago when the Air Force came out and said that they were canceling the refurbishing of about 60 C-5As and would continue to refurbish only about 50 C-5Bs. That refurbishment of the 110 aircraft was originally budgeted at about $11 billion.

The latest estimate was for $17.5 billion. So in canceling the 60 billion, they brought the program down below that $11-billion original number to something more like--I don't know -- $7 billion or $8 billion. So it frees up some money. I'm sure the Air Force would like to use it to buy F-22s and some C-17s. But, we'll see how it all shakes out.

We're hopeful, of course, that some of that money will go to fund C-17s. The C-17 is on the Air Force unfunded priority list. So, we'll see how all the stars align. As I've said in the past, we hope for the best, we try to prepare for the worst. And sometime between 2010 and 2012, I think the C-17 program will be canceled.

Now maybe it won't, and if it isn't, that's wonderful. But if it is, what we've been doing about it -- that program is worth about $30 million of revenue a year to us. We've been out looking to win three new programs that by the time the C-17 shutdown, would each be in a production range of about $10 million a year in sales.

And so far, we've been successful in winning two of those programs. One is the Eclipse very light jet, where we do nine fuselage skins. And the other is the Carson Helicopter blade, where we're manufacturing that blade for Carson Helicopter. And to our knowledge, it's the only all-composite helicopter blade that a non-OEM is building. And we think that program could have great legs as well.

And we're chasing two other -- actually almost three other programs that also have the potential to get in that $10-million a year range. And we need to land at least one of those in the next couple of years, so it can be up in production rate by the time the C-17 would shut down if in fact it did get canceled.

So, we're hoping that it won't, and we're doing something to replace it if it does. But that's about the only significant program that we think has risk in the next several years.

Okay. And if I can just circle back on the new programs that you're chasing right now, you said there's three. Are they all commercial, a mix of commercial-military? Can you give us an idea?

Yes, it's a mix of commercial and military.

Is it like two commercial, one military, exactly where? Okay. Well, that's very helpful. And just again on your remarks about the C-5, I know we talked about this last week. And it does look like the Air Force is going to try to use as much of their newly released funds on a 22.

But do you think a big push that you're going to make during your time in D.C. is that some of those dollars should be funneled back in the C-17 refurb, or the outright reproduction of new vehicles?

Yes, I think the push is to have the money allocated to buying new aircraft. The C-17 has proven to be such a workhorse that they're using it at a higher rate of intensity than was ever planned for when it was first designed. So what they're seeing is that some of the early C-17s are really absorbing a lot of wear and tear.

So, the Air Force would certainly like to have more of them. They just don't want to pay for them, because their top priority is the F-22. And the Congress is frustrated that in the last couple of years they've been required to fund it.

One fact that exists is that the C-17 is built in 40 states. And so, there's a lot of constituencies around the country who have a vested interest in the aircraft. If it weren't such a good aircraft, that might not matter. But the fact is that the country really needs it. We have insufficient lift. And doing away with the 60 old C-5As that really weren't very useful does create a window where the government can fund some very capable C-17s. So, we'll wait to see what happens.

Okay. Then just two quick questions, I'll get out of the way. Tax rate, again, we were at 28%, and you came in at 19%. Can you at least help us out on what you think the expectation will be for tax in 2008? Are we looking at north of 30%? Or, should we assume that you come in around 28% again next year?

When you look at our tax rate over the last four years for the full-year period, it's been trending higher. And that's because we've been using us R&D tax credits from prior years. And of course, recently with FIN 48, there's been a change in the way the tax positions are treated. And so, we got a bit of a boost from that in '07. So, our guess is that the tax rate will be above 30% next year.

Okay. And then just with regard to the Lockheed settlement, we'd modeled $1 million into our number, it came in at $1.2 million. But could you help me out with regard to where that was additive to, both direct costs and indirect costs, so we can kind of figure out what the normalized margin should've been in the quarter pulling that out?

Yes -- actually I don't know off the top of my head. I think most of it if not all of it was in SG&A. So when you look at the SG&A number for the year, it's lower than the prior year. And that's primarily because of the Lockheed settlement. So for the quarter, SG&A was $10 million.

And a year ago, the fourth quarter was $12.2 million. But when you look at the full year, it was $46.2 million versus $41.9 million. So you can see that the fourth quarter was unusually low. And that was because the $1.2 million must have all gone against SG&A, but if not, virtually all of it did.

Okay. Very helpful. Thanks a lot, Joe.

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

Hey, Joe. How are you?

Hi. Alex. How are you?

Good. Couple questions -- and if you mentioned it, I apologize -- organic growth for the quarter?

Well, it was 6% because in '06 our acquisitions were in January, May, and September.

And that implies what for the year? So we're still a little -- it'd be 20% or so? I'm sorry.

No, what we've always said about growth is that we're about 60% military and 37% commercial. Commercial's been growing double digit. Military grows single digit. So, we've said that organic growth ought to be in that 6% to 8% range.

And as you mentioned, cash flow was very strong. Can we talk about what the moving items were there? And is this kind of a run rate we should be looking at going forward? Since you have been lagging, it's been a little hard to model that going forward.

Yes, actually, I think what happened was the reverse. We've been lagging all year. And not only did we catch up, but in a sense we were prepaid. And I don't mean literally prepaid. But the money came in earlier than would've been anticipated. And all I can think of is that some of our major customers had some reason why they wanted to make those payments before the end of the year. It might've impacted, for instance, how they got paid themselves by their customers.

But we expected the fourth quarter to be a strong cash flow quarter. But it exceeded all expectations. And my guess is that it will starve us for the first part of '08. But believe me, I'd rather have the cash in my checking account rather than waiting for receipt of it.

Great. I know you said that we should expect to start seeing benefits from the Mexican facility in the second quarter. Can you talk about anything that you've seen there, any benefits or detriments?

Only that the facility is up and running and we're looking to create first-article parts for the spoilers that we do for the 737. And once those first-article parts are accepted by Boeing, then we'll go into production. So as of yet, we haven't generated any revenue in Mexico because we put the tooling in place.

We put the process and the procedures in place. The capital equipment's in place. Now we're creating the first-article parts, which have to be specially tested and inspected and signed off on by Boeing on site, which would then allow us to go into actual production.

And then just last question, if you will -- I know that the Eclipse program's been pretty slow to start, I think to everybody a disappointment. One big difference I guess is you used to breakout the backlog in your K. It looks like this year, you didn't. Can we kind of talk about the changes that you've seen in that program, if any?

Basically, they've been making their statements publicly and privately to us at the same time, which is to say how many aircraft they expect to build. So when we entered 2007, these numbers may not be exactly right. But we entered 2007 with, I believe, Eclipse saying they were going to build north of 450 aircraft.

And as we were coming through the year because of a variety of delays and both -- well, from suppliers primarily, not us, but from other suppliers -- they repetitively reduced that number. So by the time they got into the fourth quarter, they said they were going to deliver somewhere around 150 or 160 aircraft for '07. I think they came in a little over 100.

For '08, they've said that they anticipate building, I think, it's between 450 and 550 aircraft. And it largely resides on whether the supply chain delivers, because their business model has been doing essentially final assembly. So, virtually everything comes from somebody else. And it only takes a few suppliers to cause a ripple in the production stream, but once they get the thing humming, then it should be a very efficient way of delivering aircraft.

Now based on that uncertainty, is that why you took it out of the K, I guess, in terms of disclosing it in your backlog?

No, I didn't realize that it was out. It could be that in the K we only disclosed the larger backlogs.

Okay.

And so, maybe it didn't qualify in the top four or five backlogs.

Okay. Great. Thanks, Joe.

Our next question will come from the line of Edward Marshall of Sidoti & Company. Please proceed.

Hi, Joe.

Hi, Ed. How are you?

Not bad. Listen, any update on the CFO?

We are continuing the process. In fact, I'm interviewing a candidate tomorrow. Our goal, of course, is to find somebody terrific. And so, we're not in a big rush between Jim Heiser, who was the CFO before Greg came, and myself, who was the CFO before Jim Heiser. We think we've got the position pretty well covered on an interim basis.

Now what we want to find is a terrific CFO. And so, we're using a search firm, and we're searching nationally. This kind of position we're told by the recruiters is a hot area right now. So, these folks are in high demand, and we want to make sure we find somebody who's a good fit for us.

Original expectation was March or first quarter. Any delays expected on that?

I think it would have to move pretty quickly for us to have somebody on the ground before the end of March. But I don't feel like it has slid very far either. We've interviewed a number of people so far. And we're going to start bringing some people back for second interviews.

Excellent. You mentioned in the release about the 787 and a couple programs that you're working on there with the titanium components, the composite panels, and the wiring harnesses. My question is -- are the delays that Boeing is seeing there helping you with winning new business from Boeing for that plane?

I don't know that the delay itself is helping. Certainly as the primes in the first tiers get the engineering for whatever components or assemblies that they're doing firmed up, then their in a position to subcontract the work out.

What's very difficult, but happens anyway, is that a primer first tier subcontracts work out, and then they keep on making engineering changes. Now that happens all the time anyway, but you'd like to have the majority of the engineering done before you subcontract it out to somebody else.

So, in the sense that time has passed and they've been able to settle more of the engineering, then that work is eligible to be put outside. So, I don't think that the delay itself has improved our opportunity to win business. It's just as the engineering solidifies, then it becomes a candidate for outsourcing.

It's just that -- the composite panels and the wiring harnesses, were you the original supplier on those particular programs?

Well, again, the guy who won it won a major assembly.

Okay.

And he put the wiring harnesses as an example out. Now we've had that contract for over a year, but we weren't producing anything because the design wasn't stabilized.

I see.

So, we're just now providing first articles on some of those harnesses in order to be able to go into production.

Okay. Now I think Alex touched on backlog. I'm looking at this Sikorsky Helicopter program -- as well as the Carson Helicopter program, which has entered the backlog for the first time. The Sikorsky Helicopter program looks about $36 million. Can we look at that as possibly breaking into the top five? Or, is that a program that will not make the top five overall for Ducommun?

It's possible that the Black Hawk could get into the top five just because of rates. But when things go into the backlog, it's strictly a function of purchase orders. And if somebody gives you a purchase order for one year -- well, a great example would be the spoilers.

We got an eight-year order for that, but only one year was a purchase order. So we can only put the one year in the backlog, even though we know we've got that build rate for eight years. So, it's very much a function of when you get the purchase order and how much the purchase order covers. So the Black Hawk could possibly break into the top five, yes.

And that's a program that lasts until about 2012, I think, for you. Is that right?

This contract. But of course --

Right.

-- the program will go beyond that.

Excellent. Okay. Thank you very much, Joe.

Our next question is a follow up from the line of Michael Lewis of BB&T Capital Markets. Please proceed.

Joe, just a few quick follow ups. Per the last question, is that a top-five revenue program that you were talking about for Black Hawk?

It could be, yes.

Okay. And we talked about 787. You talked about some of the titanium components. Can you give us examples of some of the areas that you're focused in? Are they on the skin? Is it winglets? Can you give an idea where you'll be --

Sure.

-- [bidding] most attention?

Yes, the fuselage, of course, are major panels that are being created by people like [Vaude] and Finnmecanica. So the skin of the fuselage is probably not an area that we're going to participate in. That's very capital intensive, very large equipment, and these guys are creating science and magic as they go.

So, we'll see the opportunity on the structural side to be in smaller components, primarily titanium, because titanium and composites work very well together. And we have a strong titanium house in our Parsons, Kansas facility. So we've been winning titanium components and small assemblies there. And any of the composite work would come to our Monrovia facility.

Is it price in effect on all pricing on these contracts right now?

We always try to do that.

Okay.

I can't say that we are 100% successful. But we are routinely successful, so that we tend not to have much raw material exposure.

Okay. So most of the time, you can move that cost onto the customer if indeed the titanium prices continue to grow, right?

Well, it really depends on his willingness. What we do is, we quote firm prices for purchase orders. But if he gives me a five-year contract, and only gives me purchase order for a year, I may be able to guarantee him titanium pricing out a year or two, but no further.

Once he gives me a purchase order, I'll guarantee him the price for that purchase order, and it's usually price in effect at the time that he gives me the purchase order. So if he wants to give me a three-year purchase order, I can lock in pricing for three years. But if he only gives me a one-year purchase order, I can only lock in the pricing for the one year. And he retains the risk for what that is until he gives me a purchase order.

Okay. That's very helpful. Can you just go over what your long-term plan or goals are for revenues? Are you still at the $1-billion level? And, what's your expectation for margin over that same period?

Well, in our vision statement, we said that we want to get to $1 billion by 2012. So, that's not something that would change quarterly, or even annually unless we saw a major change in the market. So that means, not only that we have to have substantial internal growth, but we have to make some significant acquisitions over the next four years as well.

In terms of margins, what we've said is that we want to get our operating income as a percentage of sales back into the double-digit range. Right now, it's a little bit below 8%. So over the next several years, we'd like to see that move up.

Okay. And how's the pricing? Are the prices more rational in the M&A market right now?

No.

Okay.

But to me, the issue isn't what the price is ironically. The issue is what am I going to do with that business after I own it? If I see how I'm going to change the way that business works so that the price I paid is a reasonable price, then I could pay a double-digit multiple. And people would say, that's expensive. But if I know I can take cost out, if I know I can grow sales, then that multiple one year out is much lower.

But knowing is different from hoping. And a lot of people make acquisitions with the assumption that, well, once I own it, I'll figure it out. Or they'll say, jeez, I've walked around the facility. There's tons of opportunity here to reduce cost. But if you don't actually put real plans in place before you close the transaction of what you're going to do after you own it, all of that is just a wish and hope. And, I think the majority of acquisitions that don't work out don't work out because people haven't figured out what they're going to do with it after they own it.

If I buy a business from somebody, I'm pretty sure that I've overpaid for it in terms of what it's worth to the guy who sold it to me, because if I haven't overpaid, then he would've kept it. So if I've overpaid for it in terms of what it's worth to him, then I can't run it the same way he ran it, or else, I will have paid too much. So, I have to know what I'm going to do with it that will make it a more valuable property to me than it was to him. And that's the risk and the challenge of acquisitions.

Well, we're looking forward to another strong '08. Thanks a lot, Joe.

Thank you.

(OPERATOR INSTRUCTIONS)

I have no further questions in the queue at this time, sir.

Well, Candice, thank you. Just one final comment at the end. All the Ducommun team members are incredibly proud of the year that we had in 2007 -- record sales, record earnings, record cash flow in the 158-year history of the Company. What really excites us, though, is that we think we can do better going forward.

So, we've got the wind at our back and filling our sales, and our hope is that we can continue making progress. And the reorganization that we did in January was designed to align our talents with the things that have to be done going forward to grow the Company faster than we have in the past. So, I look forward in the not-too-distant future of getting together with you to talk about the first quarter of 2008.

And with that, Candice, I'll turn it back over to you.

Thank you, sir. And thank you for your participation in today's conference. You may now disconnect. Have a great day.