Ducommun Inc (DCO) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2010 Ducommun earnings conference call. My name is Jeremy, and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to your host for today, Mr. Chris Witty, title Investor Relations. Please proceed, sir.

Thank you and welcome to Ducommun's second quarter conference call. With me today is Tony Reardon, President and CEO, and Joe Bellino, Vice President and CFO.

I would now like to provide a brief Safe Harbor statement. This conference call may include forward-looking statements that represent the company's expectations and beliefs concerning future events that involve risks and uncertainties and may cause the company's actual performance to be materially different from the performance indicated or implied by such statements. All statements other than statements of historical facts included in this conference call are forward-looking statements.

Although the company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the company's expectations are disclosed in this conference call and in the company's annual report and form 10-K for the fiscal year ended December 31st, 2009.

All subsequent written and oral forward-looking statements attributable to the company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements. Unless otherwise required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this conference call.

I'd like to turn it over now to Ducommun's President and CEO, Tony Reardon for a review of the operating results. Tony.

Thank you, Chris, and thank you everyone for joining us today. I'd like to give you a brief overview of this quarter, after which I'll turn the call over to Joe Bellino to discuss our financial results in detail.

As expected, Ducommun is seeing signs of improvement within our commercial markets and continued stabilization in a large portion of our military markets heading into the second half of 2010. This is setting the stage for growth for next year.

While our overall revenue fell slightly due primarily to lower sales of our Engineering Services Division, we posted 4% growth in our manufactured products and our margins improved across the board.

More importantly, we are very pleased by the number of contract wins this quarter, particularly with regard to the new business development initiatives, which is expected to drive revenue acceleration going forward. These awards show the depth of our partnerships with top tier OEMs as Ducommun is called upon to provide integrated next-generation solutions across the broad spectrum of aerospace applications. Many of these awards have not yet shown a surge in the company's backlog either because they're under development or because the associated purchase orders will take place in specific quarterly installments.

But we are winning long-term development and production contracts with an excellent array of key customers. As an example, Ducommun Technologies received an award from Boeing for the retrofit of the caution light panels on the F-18 cockpits as the U.S. Navy warning system upgrade. DTI was also awarded a contract on the new engine start switches on the next generation Boeing 737. These rotary switches will support all models in production and aftermarket spares, including Boeing classic platforms, and production will begin in 2011.

Likewise, at Ducommun AeroStructures we are awarded several exciting contracts to illustrate our growth in the more complex subassemblies. [Laticore] group selected us for stretch form nose fairing assembly panels in the Airbus A350, and also awarded us contracts to supply fuselage and door skins on the Embraer, or the ERJ 170 and 190 through 2015.

In addition, we received a contract from TigHitco for the upturn exhaust system subassemblies and other components for the Sikorsky Blackhawk helicopter. This is a system that will help lower the helicopter's exhaust IR signature. It will be used in not only in a production but will support a significant retrofit program.

We view these wins as a validation that we're doing what we set out to do, play a greater role in the critical aerospace program, and, in doing so, make Ducommun a leading tier two player, boosting the company's long-term organic growth.

As the year progresses, we expect our backlog to growth due to these program wins and as well as follow-on orders from existing programs, including the F-18, F-15, Apache, C-17, and helicopter -- and Carson helicopter programs. We also expect the commercial market's upward momentum will accelerate the second half of this year, and we see increased rates on a Boeing 737, 747, and 777 programs as well as startup on the 787 program and the Airbus A320. These programs will see higher rates in 2011 and 2012.

At the same time, we do anticipate a modest rebound in demand of the aftermarket spares in the second half of 2010.

Now, before turning the call over to Joe Bellino, let me briefly add some color to our revenue and margins for this quarter. Our AeroStructures business was off about 2% in the second quarter of 2010 versus 2009, due to lower military and commercial helicopter sales partially offset by higher sales through RUAG on a Bombardier 700 and 900 series aircraft and on higher fixed-wing and commercial and military programs.

We were pleased to see our margins within this segment [that grew] sequentially.

Moving to Ducommun Technologies, we saw sales increase 2% year-over-year despite a 29% decline in our Engineering Services business. A 25% increase occurred within manufactured technology products boosted by deliveries of Radar Racks and other electronic components. We're pleased to see DTI operating margins expand both year-over-year and sequentially from the first quarter, reflecting a more favorable revenue mix and continued productivity enhancements.

As with our AeroStructures units, we are investing in new programs that will lead to higher growth and improved operating performance.

Now I'd like to turn the call over to Joe Bellino. Joe.

Thank you, Tony, and good morning everyone. Yesterday we reported solid results in the second quarter, posting net income of $5.7 million or $0.53 per fully diluted share, compared to $4.6 million or $0.44 per diluted share a year ago.

Now let me give some color. Some of the financial highlights I will touch upon are the following. Operating income and margin improved both sequentially and year-over-year. We generated $12 million in cash flow from operations during the quarter and we expect our backlogs to increase in the second half of 2010.

Terms of sale, second-quarter sales of $102 million were down 1% year-over-year. We experienced a 2% decline in sales within our Ducommun AeroStructures segment, DAS, primarily from softer sales in military and commercial helicopter products, while our large fixed-wing commercial and fixed-wing military aircraft programs showed solid growth.

In the technology segment, we saw a 2% increase in revenues despite a 29% decrease in Engineering Services revenues as a result of reduced government funding. Our manufactured products posted a 25% increase with higher shipments in replacement Radar Racks and electric -- electronic components.

Looking at our operating income by segment, Ducommun's operating income for the quarter rose 19% to $9 million or 8.8% of revenue from $7.6 million or 7.3% of revenue as we experience operating margin improvements in both segments. The 8.8% overall margin for the quarter marked an up-tick not only year-over-year but also sequentially from the first quarter's 6.6%.

As noted in our release, we had a favorable adjustment during the period of approximately $1.1 million related to the reversal of certain accounts payables accruals recorded in prior periods. In addition, we absorbed a $1.1 million expense in startup and development costs for several new programs which generated sales during the quarter of $2.8 million, and these programs were started and we reported on them in the first quarter of 2010. The amount of these costs were down from the first quarter and we expect them to be reduced sequentially through the balance of the year.

Operating income for the second quarter of 2009 was adversely impacted by an inventory valuation adjustment of $0.8 million. Excluding these items, adjusted operating income for the second quarter of 2010 would have been $9 million or 9% of revenues compared to an adjusted $8.4 million or 8% of revenues in 2009.

While gross margins improved, operating income was adversely impacted by an increase of $0.6 million in amortization expenses and higher accrued compensation compared to last year's second quarter.

DAS's operating income improved to $9.2 million and resulted in 13.5% of revenue compared to $7 million or 10.2% of revenue a year ago. This higher operating income reflects a more favorable product mix driven by increases in the commercial aerospace sector and military fixed-wing products and continued operating efficiencies.

DTI operating income increased to $3.4 million or 9.7% of sales versus $2.9 million or 8.4% last year. This improvement of a margin of 130 basis points year-over-year was primarily a result of increased shipments of Radar Rack products and increases in technology products and continuing efficiencies that we are benefiting from our [leading] manufacturing activities.

In terms of looking at our business mix and backlog, in the current economic environment, we saw our business mix shift slightly to a greater percentage of commercial sales such that the end of the second quarter our mix of business was 58% military, 40% commercial, and 2% space, compared to last year's 58% military, 39% commercial, and 3% space.

At quarter end, the backlog stood at $306 million. We have had no major program losses but we have experienced some delays, as Tony reported on, on follow-on orders for the F-18, F-15, the Apache, C-17, and the Carson helicopter programs. We expect the follow-on orders for these programs to be booked in the third or fourth quarters.

We are also optimistic with regard to additional new program wins and with the recent new programs ramping up in 2010, we expect increased backlog levels going forward.

Now if I may comment on the first half 2010 results. Ducommun's net income was $9.9 million or $0.94 a share per fully diluted share in fiscal 2010 versus $7.2 million or $0.69 per fully diluted share a year ago. Our first-half sales decreased 4% to $207 million from $215 million in 2009, primarily as a result of a 31% decrease in Engineering Services revenues while our manufacturing products revenues increased slightly for the first six months.

DAS's sales decreased about 2.5% to $138 million from $142 million the first six months, as solid growth in fixed-wing products, both large commercial and military aircraft, were not enough to offset lower revenue from military helicopter products and regional and business jets.

DTI's first-half revenues were down about 6%, reflecting shortfalls in aftermarket sales and engineering services revenues despite significant growth in Radar Rack products. DTI posted 13% growth in manufactured technology products and that more than offset the 31% drop in the Engineering Services revenues.

Our first-half operating income for Ducommun showed an increase in -- by 31% to $15.9 million, or 7.7% of revenues compared to $12 million or 5.6% of revenues a year ago. First-half results included a favorable inventory adjustment of $1.1 million, which I mentioned earlier, offset by approximately $2.9 million in cumulative startup and development costs which generated nearly $6 million in sales in the first half. About 90% of the 2010 startup and development costs can be attributable to the DAS business segment.

First half 2009 results were negatively impacted by $5.1 million or 2.4 percentage points due to an inventory reserve of $4.3 million report -- related to the Eclipse bankruptcy filing and an inventory valuation adjustment of $0.8 million that I mentioned in the second quarter's report.

On an adjusted basis, operating income for the first half would have been $17.7 million or 8.8% of revenues contrasting that to $17.3 million or 8% of revenues in the prior six months.

DAS's first-half 2010 reporting operating income was $16.6 million or 12% of revenues compared to the reported results of $11 million or $7.8 million -- 7.8% of revenue a year ago. On a pro forma basis, if we back out the first-half development costs in 2010, it's related sales of $5.9 million, and the inventory adjustments in both 2010 and 20 -- 2009, DAS's operating income would have been $18 million or 13.5% of revenue compared to $16.2 million or 11.4% of revenue in 2009.

We were pleased to see that DAS's operating margins have improved over 200 basis points on an adjusted basis year-over-year.

For DTI, despite the favorable revenue shift and higher margin technology products compared to Engineering Services revenues, first half 2010 operating income of $5.8 million, which was 8.4% of revenues, was lower as compared to the $6.3 million or 8.6% of revenues in 2009. You will note in my earlier comments that DTI's operating margins in the second quarter of 2010 was 9.7%, up sequentially both from this year's first quarter and higher than the comparable 2009 quarter. We have significant momentum going there and we expect to continue this momentum in operating margin improvement throughout the balance of 2010.

Selling, general, and administrative expenses over the first six months are running at 12.4% as compared to 11.6% for the first half of 2009, and they're largely as a result of expenses related to amortization of intangible expenses and slightly higher compensation accruals. Cost controls remain in effect.

Commenting now on liquidity and capital resources. During the quarter, we generated nearly $12 million in cash flow from operations, bringing our year-to-date cash from operations to a negative $9 million, which is $6 million better than the comparable period last year. The improvements during the quarter were the result of increased amounts of operating income, depreciation, and amortization, as well as improved receivables management. Typically we are a cash user in the first six months of the year, as we're seeing this year and in the past, and in the second half of the year we are a cash generator.

We continue to focus on effective working capital management by improving inventory turns and increasing accounts receivable management.

We also continue to maintain a low leverage position. At quarter end, our net debt to capital ratio was 9%. We feel that given the current static economic environment and uncertainty in the credit markets, this is an excellent position for us to be in. We expect CapEx in 2010 to be approximately $9 million and compares to slightly less than $8 million a year ago.

Now I would like to ask Tony Reardon to make some additional remarks. Tony.

Thank you, Joe. Before turning the call over to question, let me just hit a few key points. First, our operating margins continue to improve and we will take every measure necessary to ensure optimum asset utilization. In that vein, we're currently evaluating additional facility consolidations and capacity rationalization as part of our productivity enhancement initiatives.

More specifically, reviewing the implementation of a plan to move certain operations and in doing so improved facility utilization in support of our growth for many new programs. We see this starting in the second half of 2010, to be completed no later than the first quarter of 2011. While total expenses and payback scenarios are still being analyzed, we envision the cost to be around $1 million to $1.5 million spread over the next three quarters, with significant positive ROI beginning in 2011.

Second, we're winning new business programs which will fuel growth for 2011. We will continue to invest in the development programs as a means to broaden our product offering and drive our internal growth objectives. As Joe mentioned, we have a number of follow-on contracts which we anticipate will be booked in the second half of 2010, increasing our backlog for this year.

And third, we're optimistic that the commercial aerospace recovery is taking hold and that the impact will position Ducommun for higher revenue in the quarters to come.

In summary, 2010 is playing out as expected and we're pleased that our business units are improving their operating performance as demand trends begin to turn in our favor.

Now, Jeremy, I'd like to turn the call open -- or open up the call for questions, please.

(Operator Instructions) Our first question comes from Michael Lewis from BB&T. Please proceed.

Thank you, and good morning.

Morning, Michael.

Good morning.

Okay. Can we talk about the startup costs for a second? In Q1, the revenue was $3.1 million, Q2 it came in at $2.8 million. So I'm wondering what -- why the revenue was down. And is this more as a result of seasonality or --

Those are just timing difference in terms of getting deliveries out at quarter and, Michael. It's -- we're really at the same run rate and that will continue for the balance of the year.

And we're seeing that the cost impact to EBIT is progressively coming down quarter-over-quarter. And should you expect to see that trend continue here through the remainder of this year?

We expect to continue to have the startup costs and development costs throughout the balance of the year, although we think they're going to abate a bit. That being said, we still have some additional new programs coming on in the second half of the year. I mean, we were pleased that the cost came down from $1.8 million to $1.1 million. And down the learning curve, we should continue to show progress. We've done some things in terms of more accountability from our suppliers, doing [ties-in] events and [lien] things. So we're very active in reducing those costs and we should be at a much more manageable level come the first quarter of 2011.

Okay. Joe. Thanks for that. And let me ask you another question about the -- Tony had talked about the $1 to $1.5 million in additional costs from facility rationalization costs, things like that. Are there any other additional costs or charges that we can expect? Over the last few quarters we've witnessed some costs that we did not expect between the line items. So I'm just trying to understand the cost, the cost of the business here over the next few quarters and what we can expect in addition to what our model is currently showing.

Michael, this is Tony. We don't see any additional costs. I mean, obviously, we had the discussion in the first quarter with regards to the startup costs on these programs, which we tried to forecast last year. But as we progress through the year, I think Joe forecasted that we will have investments going forward on new programs. And we anticipate that as we go forward because as we step into the tier two, it's more and more of a requirement to be a player in that market.

We anticipate that coming down the learning curve on some of these programs will be faster. We've got programs in place to be able to enhance that.

The reason that we mentioned the facility consolidation was exactly to give you the information that we are anticipating some costs going forward. It has the significant payback. It's part of our program to take a look at how best to utilize the capital assets that we have in place and to support the growth programs that we have in front of us.

So I think that as we look at the business, we're doing everything that we possibly can to optimize the growth of the business as well as optimize the profitability of the business. And to us, this is a prudent move. But in terms of moving forward and -- we don't see any other extraneous costs that are in front of us that we would anticipate, other than those costs associated with development of new programs.

Okay. I got it. I'm going to ask one more question then let my peers take over. With regard to backlog expectations in fiscal year '10, you've already talked about that you expect that we will see some type of reacceleration in the metric. But I think my -- the most important question here is in the second half of the year, would you anticipate a book-to-bill of around 1.1 times in order to equate a full year book-to-bill of around one times?

Yes.

Thank you.

Yes, pretty close to that. We do have some issues with regards to Ducommun Technologies that you know that we have shorter booking periods. But we anticipate some of these major programs would come in and the comfort would be there that the backlog is closer to the one times.

Yes. It looks like you're getting some more book-to-[billed]-type contracts in there which does impact the total backlog.

Yes. It's a slower growth and it's a sequential, so you don't see the big impact like we had in the past. But as we mentioned in the Q, and I think that's on page 21 in the Q, we talked about the backlog. I think that we've got a pretty good understanding of where we're at with the backlog and what we anticipate going forward. And every one of these major programs is in final negotiations now.

What is the proportion of your revenue that is now attributable to contracts that are -- you book the revenue and you pretty much immediately ship it out?

That's about -- I don't have the number right off the top of my head. I hate to guess. It's probably less than 20%.

And what's that in comparison to say two years ago?

About the same.

Okay. Thank you.

(Operator Instructions) Our next question comes from Edward Marshall from Sidoti and Company. Please proceed.

Morning, guys.

Morning, Ed.

Good morning, Ed.

Thanks for taking my call. I don't know if you already went through this. I'm kind of on multiple calls here. But I, for one, appreciate and look at the startup costs in the quarter and I like that you're incurring them at this point. You haven't hit this kind of operating margin at this revenue base since we were kind of in the cycle of 2008. So it kind of looks like to me the drop-through from these programs is a little bit higher margin than some of your maybe legacy programs. Can you kind of help me work with that a little bit?

Actually, we're getting more efficiency out of some of the legacy programs, and that's what I think you're seeing. And then we're getting good growth on some of the startup programs and moving faster on some of those. So the 747-8 program, for example, is accelerating through at a nicer rate than we anticipated earlier.

But I would say overall you're -- we're getting the margins we anticipate on startup programs versus legacy programs. I don't think there's any big shift there.

Okay. And then clearly, the commercial cycle is improving, Tony, and you were just informed, and I don't know if you commented on this in your prepared remarks, but could you -- I mean, obviously we all saw the order activity and so forth. But could you comment on kind of the pulse, if you will, that you saw at the show? Obviously order rates being good.

Yes, I think that overall, I think that we saw on the commercial side a very, very positive swing. I'm not sure if a lot of the orders that we saw come out of [Farmboro] were more acknowledgment of existing orders that Boeing and Airbus had.

Sure.

But clearly we're seeing a pretty solid backlog that came through. The real buzz was around whether or not Boeing and Airbus were going to either re-engine or new aircraft on the single (inaudible) to replace 737 and A320. But having said that, they both announced higher rates, talked about higher rate production on their commercial aircraft program.

The military side was more conversations around higher requirements for foreign military sales. That's where I think they see their markets growth opportunities, which we encourage, obviously, and will support. And then not much talk on the space side, obviously, with the budget influx.

So the big push was on the commercial side. I think probably the biggest disappointment was no major orders on the C series aircraft announcements from the show. But primarily on the commercial side, I think we saw a big push there.

And working so close with Boeing, I mean, your thoughts on kind of the 737. Where would you stand in line if we did kind of re-design that aircraft? Obviously, probably [re-engining] is probably better off in the near-term for you. But any comments you could add to that.

Well, I think we would look to participate heavily on that aircraft. We are a major player on the 737 right now in terms of our current [ship-set] value and we would look to play a role in that aircraft. And as we grow more toward tier two, hopefully we'll be able to expand that. So we see lots of opportunities coming out now as they expand their production rate or get ready to do that. So we would look to enhance our roles there.

Okay. And then finally, this is a question I've asked several times before and I'm going to -- I'm not going to hold out on this call either. But can you comment kind of on acquisitions and what you're thinking about? And what you can kind of give comfort to maybe the investor base about, not making just an acquisition just for the sake of making an acquisition?

We have four criteria that we've really been focusing on and they are, they have to be a strategic fit, it has to be inline with our -- as part of that, just in line with our strategic goals of getting to more complex assemblies and positioning us stronger in the supply chain as a tier two, that's one key point.

The other one is that we have to be able to effectively integrate these and see the synergies that make sense. The next one is obviously it has to be complementary products, whether it's another leg to the stool here or whether it fits in well with our existing product offerings. And then finally, fourth, the way we look at it as fair value. If we do the three things that precede that, then we'll know by definition it will be fair value. Tony.

And, Ed, I think in response to the question of just doing it to do it, we're not doing that. I mean, we're out actively looking. We have identified on the structure side of the business gaps that we would like to fill in order to enhance our product offering along the engineering, more engineering growth and larger assemblies. And on the technology side, we're looking for consolidation of the solid platform to grow from. So we're looking to grow this business and we believe that acquisitions will play a role in that.

By looking at kind of the valuations in the space, do you think -- I mean, will it be a year dilutive, maybe two years dilutive? Obviously, that's a tough question to say at this stage, but kind of just --

It's difficult to answer until we have the acquisition in play and have had the ability to analyze it.

Maybe I ask it a different way. How long would you be willing to dilute the earnings for an acquisition that made sense?

I really can't say without having the specific acquisition in front of me and how that plays into the strategic growth of the company. I think I would gladly answer that question once I've identified and we've honed in and closed on an acquisition, and I'll clearly address that issue going forward. But without having that, the ability to analyze that and understand the strategic positioning of that business within our business, I think it would be imprudent to try and speculate.

Yes. Okay. That's fair. I appreciate it. Thanks, guys.

Thank you, Ed.

(Operator Instructions) Our next question comes from Michael Lewis with BB&T. Please proceed.

Sorry about that. I was on mute. Okay. Let me just ask a quick follow-up here with regard to the third quarter typically plays out as one of the stronger revenue and margin quarters. And, Joe, you had offered some commentary on March and I think I missed it a little bit. Did you say that you anticipated that margin would continue the current positive trends that we've witnessed over the prior few quarters?

I think the question relates to how sustainable are second quarter margins. And we were very pleased that they were up year-over-year and they were improved sequentially from some things we've done.

I think when we look at the modeling, we have to factor in the startup and development costs plus the spread of this million to 1.5 million cost over the next three quarters for our capacity expansions and rationalizations and better asset utilization. So that being said and the environment still is somewhat stabilized in some sectors, as we've talked about. I'm giving you a little backdrop on it. What we do expect in the third quarter in terms of overall deliveries, we expect a good, continued, modest increase in the large aircraft segment and some nominal growth in the regional and business aircraft segment and also in the fixed wing military, which is C-17 is stable, but F-15 and F-18 -- so we do see some nominal growth there.

We still have the issue of where the Apache now did about $7 million this quarter, we're still looking at $6 to $6.5. And without going into all the programs, we see a slight improvement in sales here in the third quarter, but not robust or a step change yet.

So as we manage through our psychology, as we recognize the cost we're going to incur, we continue to work on improving our revenue mix and also continue focus on operating efficiencies to try to keep these margins not only where they are, but modestly expand them in this environment.

Joe, is that a slight improvement in revenue in Q3 year-over-year or sequentially?

I think sequentially.

Okay. And then what is -- the company has talked about this in the past. But what is the margin goal core, company wide, say two to two and a half, three years out. Are we looking at mid- 9% levels, closer to 10%?

When I look at the -- when I look at those margins, I just want to give a little historic perspective, if I may, where we were. At one time in '08 for the first three quarters, we were averaging about 9.5%. And at that time we had said 10. I think those have been modified. I mean, I think our goal is still to get at above 10. I think what our conversation has been recently in this environment, since the fourth quarter of '08 is that it will take us a little longer to get there, but within the context of our current environment, where during the quarter we 8.8, in the intermediate term, we certainly look to exceed that nominally, the 9% to 9.25% for now and eventually get to 10% as these newer products and new programs mature.

So if I were to define intermediate term, you're talking two years there on the --

Well, I think intermediate term the next three quarters or so.

I'm sorry. Say that again.

Next three quarters.

Okay. So you do think that possibly, let's say a 9.5% margin is attainable sometime in the '12 period, 2012 period?

Yes. And we always said it will coincide with the expansion of the large commercial aircraft increases in builds and those kinds of things.

Got you. Thank you so much.

(Operator Instructions) Mr. Reardon, there are no more questions queued at this time.

Okay. Thank you, Jeremy. And I would like to thank everybody for joining us this morning. And we'd like to thank you for your continued interest and support, and we look forward to speaking to you in the next quarter. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.