Ducommun Inc (DCO) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2008 Ducommun Earnings Conference Call. My name is Jasmine and I'll be the operator for today.

(OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today's call, Mr. Joe Berenato. You may proceed.

Thank you, Jasmine. Good morning. I'm Joe Berenato, CEO of Ducommun. I want to welcome you to Ducommun's first quarter 2008 conference call. As reported earlier today, sales for the first quarter were $98,658,000 versus $88,052,000. That's in increase of 12%. Gross profit margins for the quarter were 21.2% versus 21% in the year-ago quarter.

Operating income was $8.5 million versus $6.3 million a year ago, an increase of 36%. And net income was $5.3 million versus $3.8 million a year ago, an increase of 38%. EPS for the quarter was $0.49 fully diluted versus $0.37 from the year ago quarter. The mix was, for the quarter, pretty stable with a year ago, 59% Military, 39% Commercial and 2% Space versus 59% Military, 38% Commercial and 3% Space.

Our tax rate for the quarter was 36.8% versus 32.1% from the year-ago quarter. The R&D tax credit has not been extended thus far for 2008 and that would give us a somewhat higher tax rate for the year if it doesn't get extended. In the last several years, Congress has extended it late in the year and we've seen an anomaly in the fourth quarter with low tax rates and a more normalized rate for the full year.

We've started off 2008 with a solid performance and, as we look forward, the commercial markets continue to look strong. Build rates are high, the OEM backlog for Boeing and Airbus, Embry Air and Bombardier are all very strong.

Our own backlog for the end of the first quarter was $392 million versus $353 million at year end. And according to the comments from the CEO of Boeing and others, we look for this commercial cycle to last through 2011.

On the Military side, Military activity remains high. While the budget is over $500 billion per year and looks like it'll stay there for a number of years, there is program risk within that. We will see programs be successful and accelerate, others be slowed down or cancelled. So it's very much an issue of which programs you're on as to how strong the Military cycle looks for you going forward. And from our perspective, we think we're in pretty good shape.

Our reorganization has gone well. We announced it in early January and so far it has been helping us drive common policies and procedures across Ducommun, which in turn will help us grow faster and help us be better integrators of future acquisitions.

Our foundation continues to rest on the three prime concepts of operational excellence, driven by our LEAN Six Sigma initiatives, profitable growth driven by internal growth through R&D and capital expenditures and external growth through acquisition and organizational development, driven by our restructuring and our growing efforts in education and training through Ducommun University.

So even though we've seen some tremors to the economy at large, we still see our future as pretty bright. And although it's filled with some risks, we think predominantly it's filled with opportunity. We've had a good first quarter and we look forward to a strong year. And with that, Jasmine, I'd be happy to take questions.

(OPERATOR INSTRUCTIONS)

And your first question comes from Michael Lewis. You may proceed.

Hi, good morning, Joe, how are you sir?

Hi, Mike.

Okay, can we get an update on the CFO search?

We continue to interview candidates. Because of the strength in that area between both myself and our General Counsel, Jim Heiser, both of us have served for a number of years as the CFO of Ducommun in prior assignments.

We continue to look for the right guy and not trying to make it as fast as possible. We've seen several good candidates and we're taking them into the second and third round of interviews. And I would hope that we'd be successful in the second quarter of announcing a successor.

Are they going to come from industry? Or are you opening it up to wherever?

We've seen candidates both from within aerospace and outside, but we are looking for people who have had strong experience with manufacturing operations.

Okay. I'll ask one more question and then get back in the queue so others can ask. I was wondering if you could just go to 30,000 feet and kind of talk about what the implications for Ducommun is based on the KC Tanker deal going to Northrop versus Boeing. And my understanding is that it's really a zero sum game for you because you would have received business either with Boeing or with EADS. Can you talk a little bit about that?

Sure. The Tanker deal, first of all, let's frame it in context. The number $40 billion has been tossed about a lot. But it's essentially going to be about ten to 12 planes a year when it starts and go for a long time. So while we would love work on ten to 12 planes a year, unless you have very significant content, this program by itself is not going to be material to anybody.

From our perspective, on the A330 aircraft, we do the leading edges of the wings. And on the 767 Boeing aircraft we do a variety of structural components. So for us, while we might get slightly more revenue from one program over the other, it's not really going to have any kind of noticeable impact for us, whichever party prevails.

Okay, thank you.

And your next question comes from Ed Marshall. You may proceed.

Hi, Joe.

Hi, Ed, how are you?

Not bad. Listen, Military segment growth was up 11% or so, which looks to be, best of my number there. Can you kind of talk about that? And is that sustainable going forward?

I don't think 11% is sustainable on the Military side, mainly because the budget itself is probably going to grow, over time, in the 3% to 5% range. So unless you're winning new programs to add to what you already have, you can figure that you wouldn't expect to grow materially larger than the budget as a whole.

For us to have swings in any given quarter wouldn't be unusual just because of the timing of deliveries. So while we were 11% up on Military in the first quarter, I would not expect that we'd be up 11% for the year.

So the 3% to 5% growth that we've talked about for quite a while would be the growth rate going forward in that particular business.

I think from a high level that's right. You know, we could get a rush of orders, let's say, for abrasion strips for helicopter blades that would cause a jump in any particular quarter, but it wouldn't be sustainable in that sense.

And the blades that you're sending to Carson is going through your Commercial space, that's not going through the Military segment. Is that right?

I believe right now that they're all counted as commercial blades, although we will have military blades with Carson because they're also selling to the Ministry of Defense in England.

I see.

The blade is currently being used in Afghanistan with good results.

Now on the C-17 program, it looks like Boeing self funding 30 planes. Can you talk about how long the supply line may go on there for you? You know, my feeling is probably 2010, or at least through the end of 2010, maybe even into 2011. Can you kind of talk about that for a second?

Yes. What I've said consistently for the last couple years is that what we're planning for is that our production on the C-17 program, which stops somewhere between 2010 and 2012. We're hopeful that it'll go longer but we're planning for it to end in that time frame.

So our Plan B is to win three programs which, when in full production, would generate at least $10 million a year in sales so that, taken together, they would replace the roughly $30 million a year that we currently make on the C-17.

Now I was in Washington last month as part of the Boeing Supplier conference, speaking to Congressmen and women and asking them to continue to support the program. Hopefully Boeing is getting some good vibrations out of that kind of thing. And that may have been part of the reason why they were willing to invest their own money to start building the additional 30 planes.

I don't view that as pushing out to 2010 to 2012 horizon. We really would need more orders from the U.S. Air Force or the Defense Department to extend that time horizon.

You wouldn't care to comment on what Congress's decision's going to be, would you?

No. You know the good news here is that the C-17 is built in 42 States with 30,000 people. And so there is a strong incentive for a number of Congress people, even if they are not what you would classically view as pro military, to vote for the continuation of this plane. The primary reason to vote for the continuation of this plane, however, really isn't to preserve jobs, it's the fact that it's a really good plane and we actually really need it.

The C-17s are being used at a very high tempo in the Middle East and some of the early aircraft are starting to wear out. And so the initial notion that we could run a fleet with 180 and be sufficient, I think, is being rethought in the Pentagon. And so -- but as I said earlier, there's a lot of squeeze on different aspects of the budget.

So we'll see where this all plays out. We said we had to win three programs, so far we've already won two. Of course in helicopter blade we talked about, and the skins for the Eclipse, the very light jet. And we have three other programs that we're working that any one of which would be that third program, hopefully we get all three of them. But I think that if the C-17 were to shut down, we'll be covered. And if the plane were to continue it would be good for the country.

Sounds like you're warming back up to the fact that the Eclipse could be one of the top programs for Ducommun.

I think it can. I don't know that the higher build rates that have been suggested over the last several years are something that can be achieved and be sustainable. But they continue to have a very strong backlog and the taxi jet concept is being tested right now. I think there's a firm called Bayjet down in Florida that has about 20 Eclipses and is up and running.

And if we see repetitive successes across the country of the air taxi concept, I think that will be a model that business can be built around. And there's strong support from individuals who are buying this aircraft because, at slightly over $1 million, you can get a jet that can take you 500 miles or more. And there are more people than you would think who want to be able to do that.

And I guess, I don't want to take up too much time, so one last question and then I'll jump off here. Mexico operations with the 737?

We opened our Mexico operation last October and the first contract in there is to do final assembly and paint of the spoilers for the 737 program. We have the facility up and running, the tooling is in place and we are right now going through first-article manufacture and acceptance from Boeing. So once that is completed, which should be in the second quarter, we will start, in essence, supplying the spoilers that are finished in Guaymas through our Monrovia facility to do quality checks.

And once we think we have the procedure secure for quality, then we'll ship directly from Guaymas to the customer. So it's an evolutionary thing but, as we go through the second quarter, we should be producing that product for final assembly and paint out of Mexico.

Excellent, thank you.

And your next question comes from Alex Hamilton. You may proceed.

Hi, Joe. How are you?

Hi, Alex.

Good. Two just questions in relation to the model. Interest expense seemed lower than I had forecast anyway. Should I look at that $200,000 or so as the run rate going forward?

Well we have two things going on. When you look at the 10-Q, which I'm very proud to say came out this morning as well, so we've achieved our goal of producing the Q and the press release on the same day, you'll note that we have an interest rate swap in place. So our payments on the $20 million in debt is pretty fixed.

What will drive the variable on the interest rate expense, because that's a net number, is how much cash on hand we have and how much interest we're earning on that cash on hand. And so the interest expense net of the interest earned on the cash balances will be that net number. And because we started Q1 with a very high cash balance, I think that was a major driver of the net interest expense. I would expect it to be higher in later quarters than it was in Q1.

Okay, thank you. And then also operating margins, you had terrific year-over-year and even sequential growth in the operating margins. How should we look at that run rate going forward? Is that a sustainable rate?

Are you speaking of gross margin or operating income or --?

I'm talking about operating income.

You know, our goal, we've said before, is that, over the next several years -- to get that back up into double-digits and last year I think we ran at just under 8%. So we're not going to get there all in one leap, and -- but I would think that, year-over-year, we should see gradual improvement in those operating margins so that we can achieve that goal of getting it over 10%.

There will be variability in quarters, depending on sales mix in a given quarter and also what the SG&A costs are in a given quarter. But I wouldn't expect to see wide swings. But if we were below 8% last year, we should do a little better this year and a little better in '09.

Okay, thank you.

And your next question comes from Troy Lahr. You may proceed.

Hey, Joe. I'm just wondering if you can drill down a little bit specifically on aero structures. I mean, you did 9% in the fourth quarter and even first quarter last year you did 12.5%. I mean, how do you get up to the margin level that you're seeing now? I mean, is it mixed? Is it efficiencies? I guess I really just don't understand that.

Well you have a variety of things going on. Certainly mix is a big deal. Efficiency should be gradually getting better all the time. You do have the impact of pricing. And so the timing of pricing increases or decreases are going to have an impact as well.

So you've got all these things that go into determining what these margins are. As I said, I thought that in any given quarter, you can have unusually high or unusually low margins, but year-over-year we ought to see gradual improvement.

Yes. I mean, that's a pretty big increase though. I mean, 400 basis points year-over-year. I mean, can you maybe kind of parse this out? I mean, how much of this is mix versus pricing and some of this other stuff that could hold up a little better than kind of just a lumpy product mix?

I think in the first quarter, especially, we had a positive anomaly of some pricing on a contract that was ending.

Okay.

And has repriced going forward and we won't have the same level of margin that we had in that end-of-contract situation.

Was that like a contract close out?

It was just the end of one term of the contract and the contract continues to go forward with renegotiated pricing.

Okay. So it wasn't kind of like a catch up or anything like that for margins as you closed out the contract?

There might have been a little bit of that, but it was just favorable pricing.

Favorable pricing.

Yes.

Okay. And then --

So while I think we will continue to see a gradual improvement in our margins, it isn't going to be lock-step every quarter. But it'll trend -- it should continue to trend better.

Okay. And then can you just update us on the 787? Is it still three different systems that you have there? Or can you just kind of clarify that a little bit?

We've got work in three of our facilities that relate to 787. Most of it's on hold. The work is not for Boeing directly, it's for first tier subcontractors. And so we will turn back on when they turn us back on and I wouldn't expect it to be uniform.

Okay.

So someone will turn us on and the others won't and then the others will. It won't be like a single switch.

Sure. And I mean are you still -- is there still bid proposal activity out there on [Obertech] systems on the 787 that you can go after?

I think there will be. I think there's been kind of a bit of a freeze for a while.

Okay.

As people are trying to make sure that what they've got is in fact what the customer wants.

Okay.

The problem has a subcontractor wanting to flow the work down. If you flow it down too early, then you just go through a whole series of engineering changes. Now that happens anyway. But you don't want it to be so crazy that you've put an out-of-control assembly or component in the hands of a third-party and then you're constantly telling them, no, that's not what I want. So if you're a prime or a first tier, you want to have a pretty good understanding that you've got pretty much what the final product ought to be before you give it to somebody else to make for you.

Sure. And then with that being said, on the A350, I mean, are we still a couple of years away before you would start seeing more outsourcing opportunities on that program? Or do you think you could start kind of capturing some systems there?

I don't think we've seen much in the way of A350 work yet. I think Airbus is still in the process of trying to line up its risk sharing partners. And you know they've been looking to sell some of their facilities in Europe and as part of the sale of those facilities, I'm not intimately familiar with it, but it's my understanding that as part of the sale of one of those facilities to a company, you have to agree to be a risk sharing partner on the A350 for what that facility could make. Which means that you have to agree to the investment conditions, et cetera.

Sure.

So I think the reason why some of these sales haven't taken place yet is because of how aggressively Airbus is trying to drive the risk sharing partner concept on the A350 to the buyers of the facilities.

To my knowledge, none of the sales have actually closed yet, although maybe one has, but I know they're close on some. But I think the argument is still primarily around the notion of what the nature of the commitment is on the A350 if you buy one of these facilities.

Okay. Okay. Sounds good. Thanks.

(OPERATOR INSTRUCTIONS)

We have a follow-up question from Michael Lewis. You may proceed.

Hey, Joe. If I could just jump on the back of Troy's question on 787, could you remind us what specific areas you're providing on that?

Well, we haven't put the press releases out yet, so I -- I'd rather leave it to that. But it's mostly in the arena of components. And it's titanium or electromechanical in nature.

Would you offer whether this is just a small portion of the business or a few million dollars a year in revenue right now, with the ability to ramp in future years? Any --?

I wouldn't even say right now it's that much. I mean, as I said, we're on hold for most of it. So -- and the build rate on the 787 will go up over the next several years. But right now, it's not very substantial, nor will it be next year either.

Okay. And then if I recall, you looked back at the K, you were projecting around $14 million in CapEx. In the Q this morning, you brought this down to around $11 million for '08.

Yes.

So kind of what's going on there?

When we approve an annual operating plan, for the coming year, there are a lot of projected capital expenditures. We probably run around $3 million or $4 million a year of what I'd call maintenance CapEx. And then the rest of the CapEx would be tied to particular programs that you hope to win.

And so if you've put sales into your projections for a particular program, you're also required to put the capital expenditures required for that program. So as you come forward, you find out, A, whether you win such a program or not. Or B, you see that the timing of the potential for winning such a program has slid out.

So we're constantly re-assessing where we think the capital expenditures for the year would be. And as you come forward, you see that number -- if you look back at our Ks and Qs from, let's say, the prior three or four years, you'll see that number starts -- always starts out higher and then comes down somewhat during the course of the year. We try to be very careful with the way we spend money, so we're not anxious to spend CapEx unless we think we can get a good return on the investment and/or we think the investment is strategic for us.

So opening Thailand and Guaymas were examples of some capital expenditures we made where there might not have been a return in the year where the expenditure was made, but where we thought it was strategic.

When you win a program like Carson or Eclipse, you have to make some capital expenditure for tooling or facility enhancements and you get the benefit of that as the programs come online. So as the timing of things move around or we decide, no, that isn't a good thing to be pursuing. That would change our view of what capital expenditures should be.

So, Joe, if I -- with regard to the delta, the $3 million delta, would that imply that you lost the contract or is this a contract that would move to the right that you point out?

It's not any one particular contract, but it would be either things have slid to the right or it's a contract that we may have decided not to pursue because, as we got further into it, we didn't think that there was a reasonable return.

A great example might be that several years ago, we would have had CapEx in a given year for Eclipse. But we lost that contract. So we didn't spend the money. And then when it was recompeted, we didn't get it either. And so we didn't spend that money.

And then they came back to us and asked us to take on the nine skins because we could make the hard ones, and we did. And then we spent the money.

Yes.

So in a sense, the CapEx for Eclipse initially appeared in probably three different years. But it was only spent in one.

Got you. Okay. Should we anticipate steady state moving in 2009? $11 million and $12 million in CapEx? Or --?

When you look back at our CapEx over the last three or four years, it seems to run in that $7 million to $11 million range in terms of what we have actually spent. So --

Okay.

Now it could go higher, if we won a very significant program, where -- which required significant up-front capital expenditure.

Yes.

So if we had a year where capital expenditures were unusually high, I would hope that it would mean that we've created an opportunity for significant revenue and profits on the particular program.

Yes. Two questions with regard to technologies. The EBIT margin came in below what we were looking for, pretty significantly, so I was just wondering what's going on there? What do you think the sustainable level of margin should be in that business going forward? And then just a final comment, you had the ORS win in February, $69 million for Miltech. What does the ramp look like and -- well I guess that's it. What does the ramp look like on that contract?

You know, I actually don't know. That's a multi-year contract and for planning purposes, I just kind of divide it by, I think, it's five years.

Yes.

And thinking that the first year won't meet the average and the middle years will be above the average and then the last year won't meet the average either.

Yes.

Kind of -- just kind of the notion of how those things work.

Yes. Okay.

What was the -- the middle question?

With regard to the corollary performance of the -- I take it [you have] 3.5% margin -- or EBIT margin in the quarter.

Yes. Yes. Certainly that's not where we want to see it go. We want to see DTI be eventually above double-digits on the operating income as a percentage of sales.

We had a particularly bad mix at one of our facilities and we think that will not be repeated as the year goes on. But the -- we had expected a bad quarter for DTI in the first quarter because of the timing of events and, as hard as this is to believe, they actually came in a little bit ahead of our plan in the first quarter and the next three quarters are anticipated to be better than the first quarter.

Okay. Okay. And just one more question, I promise. Cash expectations. With the R&D tax credit not playing out right now, should we go up to, say, 35%, 36% for the remainder portion of the year? How would you guide? Because you were guiding 31% to 35% range originally?

Yes. I think we'd be at the higher end of that range, unless they extend the R&D tax credit. We're hopeful that they will. Both parties seem to think that it's a good thing and it's a little frustrating that each year they leave it in limbo as opposed to creating a long-term fix here.

But they always seem to leave it until the end, if you will. And given where the economy is, et cetera, I can't imagine that they wouldn't extend it. But who knows? It's an election year, crazy things can happen. I'll just be happy when -- if and when they do extend it.

All right. So adjust it up and we'll see what happens for -- to take it down later in the year?

Yes. I mean, I don't like doing this, but the -- until they extend it, we can't --

No, that's fair.

-- adjust our tax rates.

Well thanks, Joe. Keep up the great work.

Thank you.

All right.

And you have no questions at this time.

Okay. Well if there are no other questions, I'll conclude. I'd like to say that we had a good quarter. We think the cycles of the markets that we operate in are positive and look to remain strong. We're driving growth through capital expenditure, R&D and acquisitions.

And those growth elements are driven by our policy deployment and lean Six Sigma efforts. So thank you for participating in this conference call. And we look forward to discussing Q2 with you in July. Jasmine, that's it.

Thank you attending today's conference. This concludes your presentation. You may now disconnect. Good day.