Ducommun Inc (DCO) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2012 Ducommun earnings conference call. My name is Jeff and I'll be your coordinator for today. At this time, all participants are in a listen-only mode.

(Operator instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Chris Witty. And you have the floor, sir.

Thank you and welcome to Ducommun's second quarter conference call. With me today is Tony Reardon, Chairman, President, & CEO and Joe Bellino, Vice President & 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 belief concerning future events that involve risks and uncertainties, and may cause the company's actual performance to be materially different from the performance indicator or implied by such statements. All statements other than the 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, we 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 the company's annual report and form 10-K for the fiscal year ended December 31, 2011. All subsequent written and for -- oral forward-looking statements attributable to the company, or persons acting on its behalf, are expressly qualified in their entirety by the cautionary statement. 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 would now like to turn the call over to Tony Reardon for a review of the operating results. Tony?

Thank you, Chris, and thank you everyone for joining us today. I'll begin by providing an update on the quarter and some market color, after which I'll turn the call over to Joe Bellino to review the financial results in detail.

Ducommun continued to make steady improvements sequentially this quarter. We saw better operational performance in our aero structures business, margin expansion within our DLT business unit, and benefited from overall strong commercial aerospace demand.

We posted revenue of $184.7 million in our earnings, excluding any tax adjustments, rose sequentially to $0.37 per share from $0.23 in the first quarter, while we generated $10.5 million in cash flow from operation. Adjusted EBITDA also rose to 11.6% of sales, from 10.3% in both the second quarter of last year and the first quarter of 2012. Our operations are clearly benefiting from increased build rates across a number of key commercial platforms, particularly the 747 and 737, as well as higher shipments from military helicopters like the Black Hawk Chinook programs.

However, within our non aerospace markets, we once again saw softness in demand, such that our industrial and natural resources areas posted revenue that was down slightly sequentially in aggregate versus the first quarter. We expect these end markets to remain flat for the rest of the year, and with return to a growth likely in 2013. Year-to-date we generated nearly $6 million in cash, compared to an $11 million usage of cash last year, testimony to our focus on sound working capital management. As Joe will discuss in a moment, we plan to pay down a portion of our debt in third quarter, in line with our goals to deliver the balance sheet.

At the end of the second quarter, we had a backlog of approximately $640 million which does not include roughly $18 million of follow on orders from the Chinook helicopter booked just after June 30, 2012. In addition we have received approximately $50 million in radar rack orders for the F-15, F-16 and F-18 programs year-to-date, leading to our best backlog on these important programs in over a year. Overall, we were pleased with this quarter and further sequential increases in both margins and earnings, and we continue to focus on improved shareholder returns.

Now, let me step back and take a look at the current market fundamentals. As already stated, the commercial aerospace demand is fueling growth in both of our aero structures and our DLT operations. We are pleased with the increase in build rates of our customers across-the-board, and the strength of air passenger miles worldwide.

In addition, as I'll come back to in a few moments, we are excited about the increased confidence provided to us by our major OEMs, who are coming to value the synergies and technologies offered by combining our traditional aero structures business with our new DLT. We're seeing more opportunities for increased electronic content, higher ended assemblies, and more complex Tier 2 modules going forward.

Within the regional jet and the general aviation market the picture is still mixed, with some platforms showing while others exhibit an uptick, particularly with regard to the larger general aviation aircraft. However our commercial helicopter business continues to post strong solid growth year-over-year.

Moving to the defense side of our business the story hasn't changed much since last quarter, as I'm sure our listeners are all aware. There remains a great deal of uncertainty with regard to fiscal 2013 funding given the overhang of sequestration. While we are pleased with the potential of the continuing resolution discussions taking place on Capital Hill, we have seen little planning to date by the government that would allow us and/or our customers to predict what will play out in the coming months.

We continue to be conservative in our outlook and in our working capital management, while actively reviewing planning scenarios for the potential implementation of the budget control act. In the absence of sequestration, there still will be a focus on reducing defense expenditures. However, as discussed in the past, Ducommun has a significant presence on a diverse set of key platforms that are unlikely to see material cuts near term. Increased electronics content, upgrades to existing aircraft, and robust foreign military sales are anticipated to remain solid in demand for our programs, and leading platforms such as the Black Hawk, F-15, C-17, & the F-18 continue to be sought after both here and over -- in the overseas marketplace.

Within our non aerospace markets some softness remains. We expect the revenue within the industrial natural resources area will be relatively flat during the remainder of 2012, but we're actively investing in new business initiatives, while being aggressive on managing costs and working capital.

These are important marks Ducommun that can turn around quickly, but they are overly dependant on a few large customers in the past. We are positioning them for improved performance as we look to secure a more diverse base of clients going forward. Our medical markets, however, are -- remain steady, as showing growth in both backlog and revenue, which we expect to continue. We remain positive about the future and confident that Ducommun has taken the right steps to improve shareholder value. See significant opportunities to both accelerate and expand our margins going forward and expect further sequential gains in our performance during the second quarter -- or, second half of 2012.

Now I would like to turn the call over to Joe Bellino for a more detailed financial review. Joe?

Thank you, Tony, and good day, everyone. After the market closed this evening, we reported results for the second quarter of 2012.

Net income grew to $5.5 million, or $0.52, per fully diluted share. That compares with $4.8 million, or $0.45, per fully diluted share last year, excluding acquisition related expenses that we incurred in 2011. The 2012 second quarter results include a tax benefit of $0.15 per fully diluted share, reflecting a lot of hard work and analysis we have done, and further integration benefits that we are realizing from the LaBarge acquisition, which, in this case, relates to our ability to file consolidated state income tax returns for the combined entity, another win in the integration goals that we've set.

Importantly, and as Tony noted, we saw sequential gains in financial performance, including improvements in operating margins, net income, and cash flow. While Ducommun's year-over-year returns are available in our earnings report in the 10-Q, we thought it would be more meaningful to you, given the LaBarge acquisition, to discuss this -- these sequential improvements in our results. During the second quarter of 2012, as compared to the first quarter of 2012, we expanded our gross margin to 19.5% from 18.7%, we reduced our SG&A expenses to 11.9% of sales from 12.3% of sales, and in the process, we expanded our operating margins to 7.6% from 6.4% in Q1 2012.

These gains reflect the expansion of margins in both of our business segments, with cost synergies realized at DLT, and absorption of new development expenses at DAS. During our previous earnings call in May we discussed our higher operating margin expectations and we're pleased to report we are headed in the right direction. In addition, during the second quarter we generated $21 million in adjusted EBITDA, or 11.4% of revenues, and this compares favorably with $18 million in adjusted EBITDA, or 10.3% margin, in the first quarter of 2012. Both business segments realized sequential expansion in adjusted EBITDA and in operating margin.

Our backlog remains solid at $640 million, which is now 10% higher than we closed the LaBarge transaction in June of 2011. The backlog was down just slightly, approximately $7 million, from the March backlogs, and they primarily reflect the timing of new orders which we now have received during the current quarter. In addition, as Tony commented on, some of our non aerospace and defense markets reflect slightly lower backlog sequentially for March.

In this recent quarter, sales increased 71% to nearly $185 million, including $81 million in sales from the nearly acquired DLT assets. On a pro forma basis, sales were about 1% ahead of last year's second quarter, with the main driver being increases in commercial aerospace, and Military and space revenues. Primarily in that latter sector, it was primarily the Military electronics sector, which continues to receive significant market acceptance, and they were somewhat offset by softer sales in the industrial and natural resources markets.

We look at results by business segments starting with Ducommun AeroStructures, or DAS, first. DAS' sales for the quarter increased sequentially from the first quarter by slightly less than 4% to $77 million, as the segmented -- benefited from increased sales in large commercial aircraft, reflecting rising build rates. Adjusted EBITDA increased to $9.8 million, or 12.8% of revenues, up from $8.7 million, or 11.7% of revenues, in the first quarter of 2012. The increase in adjusted EBITDA and margin percentages is attributable to reductions in development costs for the new programs as compared to the first quarter of 2012. We expect margin expansion to continue sequentially through the balance of this year.

Ducommun LaBarge Technologies, or DLT, posted sales for the quarter of nearly $108 million, it was down slightly from the first quarter, due primarily to softer, non aerospace and defense revenues. But, adjusted EBITDA grew sequentially to $15.2 million, or 14% of sales, from $13 million, or 11.8% of sales, in the first quarter of 2012. We benefited from a variety of factors including a combination of a richer product mix, solid management of the DLT operations, and cost savings associated with our continuing integration efforts.

Overall corporate, general, and administrative expenses, CG&A, which are not identifiable or attributable to the business segments, were 2.1% of revenues for the quarter, compared to 1.7% of revenues in the first quarter. The small difference is attributable to increased accrued compensation expenses.

Moving to backlog, as we mentioned earlier, our backlog continues to remain steady and solid with growth primarily in the commercial aero s pace and Military electronics businesses. We saw the sequential drop in our backlog more as a result of order timing, particularly given the F-15 and F-18 orders we have recently booked, as Tony mentioned. We continue to see solid underlying demands for our products and services, and believe the softness in some of our non aerospace and defense markets is more short-term in nature.

Another important area is liquidity in capital resources. At the end of the second quarter we had $391 million in debt outstanding, and $354 million in net debt when we consider the amount of cash we have in our balance sheet. Given our trailing 12 month adjusted EBITDA of $83 million, this equates to 4.25 times net funded debt to adjusted EBITDA.

We continue to focus on debt reduction, along with selective capital investments in our business, as the use of our cash flow from operations. From a cash flow perspective in the second quarter, as Tony mentioned also, we generated nearly $10.5 million in cash from operations, and our year-to-date generation of cash is nearly $6 million. This compares to an $11 million usage of cash at this time last year, which also excludes 2011 acquisition costs. We now had about -- at the quarter end, we had about $37 million of cash on our balance sheet.

What we plan to do in the second half of the year coincident with what we said in our May earnings call was to pay down $25 million in the second half of 2012. We see this most likely being prepayments of around $10 million in the September quarter, and we'll look into the fourth quarter with -- and have prepayment plans of approximately $10 million to $15 million in that quarter to achieve the $25 million that we have been discussing.

As we look at it, with our cash flows, even during the quarter here, and the third quarter, we remain on track to do so. We are driving cash flow generation through a combination of working capital initiatives in other areas to achieve these goals, and we expect that our $60 million revolving credit line will remain unused for the foreseeable future. We anticipate capital expenditures for the entire 2012 to be in the range of $16 million, that is down from our original estimate in our 10-K earlier this year of $21 million.

We initiated several growth projects earlier in the year, and now we see a slight slow down in the level of CapEx spending through the balance of the year. Further expenditures will continue to be targeted till growth of our manufacturing capabilities and selected increases in expansion of our facilities to support our strategic initiatives. So in closing, we are very pleased to see sequential gross margin and operating margin improvements during the quarter, as we benefit from new program cost performance and synergies realized from our integration efforts.

I now would like to turn the program back over to Tony for his closing remarks.

Thanks, Joe, and before opening the call to questions, I would like to expand on the point I made earlier about Ducommun's evolving relationship with our customers. A few weeks ago we exhibited at the Farm Bureau air show, where we had the opportunity to meet with many of our A&D customers, and heard on a number of occasions just how interested they were in our expanded offerings and capabilities since the LaBarge transaction.

It's one thing for us to say that we're a much better, more capable company, but it means a great deal more coming from our customers. The OEM market is increasingly using more integrated electronic content on their platforms, and they now understand our business model, with our combined DLT, and aero structures operations, can provide more advanced assemblies, sub assemblies, and modules going forward. With this in mind, we are working to deliver more value added solutions and deepen our customer relationships.

This won't happen overnight, but it is already taking place in terms of technical decisions, collaboration, high content opportunities, and a broader breadth of RFPs that we are receiving. It was very exciting to hear about the future of our customers, and we are working very hard to secure our position in that future. Overall, we are pleased with the progress to date, and with our sequential improvements in the operating results, and we remain positive about the focus that we have in terms of ensuring our margin expansion and our earnings increases going forward. Given our backlog of strong mix of programs, I believe the second half of 2012 will bring a convergence of positive factors across our business, positioning Ducommun for solid results in the quarters to come.

Lastly, before closing, I would like to welcome Joel Benkie, who joined Ducommun on June 18 as the Executive Vice President and Chief Operating Officer. Joel comes from a distinguished career at Parker Aerospace, a unit of Parker-Hannifin, and has a strong strategic and operational background. He has already proven to be a great addition to the team, and will make a positive impact on our future results.

As always, we appreciate our investor's patience and interest, and we remain confident that we are on the right path to increasing shareholder returns. With that, Jeff, I would like to open the call for questions, please.

Thank you very much.

(Operator Instructions)

James Lebenthal, Lebenthal Asset Management.

I apologize because I'm going to ask you a question I think you have answered before, I know you have answered before. But looking at the debt pay down, could you just remind me and others which particular debt instruments you are looking to pay down in the second half?

We are looking to pay down on our term loan B.

And what is the interest rate on that? Sorry to ask you to remind me.

It is $190 million of aggregate. We are paying it 1% down quarterly, principal and interest, but the all in rate right now is 5.5%. The other piece that we have is a $200 million unsecured senior debt that is a non call four that is pretty onerous for us to prepay before we get to the -- 2015.

And would I assume that in 2015, that all things being equal, obviously, none of us can predict what the world will look like. But if you had the cash in 2015, you would try to pay that down instead right?

That's a correct statement, yes. Yes. I mean, because our all in cost of interest is about 7.75%, so we are trying to drive that down, both from a reduction of the amount of outstanding debt, as well as a change in the mix.

Thank you gentlemen. Excellent execution.

J.B. Groh, D.A. Davidson.

Thanks for taking my call, congratulations on the quarter. I had to hop on a little late. The backlog was down a little bit sequentially which I'm assuming is timing related. Could you talk about orders subsequent to the quarter end, and how those have progressed?

Yes, sure. I just, J.B., we had a large order from Boeing Philly on the Chinook program for about $18 million which we've subsequently booked. We have a couple of other orders that are in the -- that are finalized, we are just waiting to get through the DCAA audit process. But, suffice to say $25 million to $30 million or $40 million of those orders that are on the military side waiting.

And then every quarter we pick up an order on the Boeing 737, so that increases on a quarterly basis on that program. So I think that we are pretty well positioned. Of the major programs that we have, in particular on the military side, we are starting to see in the bookings on the Black Hawk program coming through now. So, we should see relatively good pick up in the second half of the year.

And then on the 737, what -- the order flow you are getting now, what build rate does that reflect?

It is about 34 to 35 shipsets a month.

Okay, so there is still room to go there?

Yes. We don't expect to see anything in that larger area increasing until late in the year, to get to the 38, if they do that.

Okay. And then, just from your comments, it seems like you guys have a relatively high degree of confidence that your military portfolio is pretty stable even in the face of sequestration. How do you -- how are you doing that?

Hopefully I didn't give the impression that it was stable in the face of sequestration. It's stable, and I think there are opportunities out there. So I think that what we are seeing, I don't think anybody is stable in the face of sequestration, so if I gave that impression, I -- that was not correct. But the, because everybody's going to take a hit on that, the way that is set up right now, unless there are some things that are worked out between now and the end of the year. But I do think that there are a number of programs that we have that are not impacted by sequestration. So, the C-17 for example is a perfect program. Most of those sales, like I say, 95% of those sales are foreign military sales that we have, so that backlog is loaded with foreign military sales and the current US government sales, I don't see them cutting any of those from sequestration.

F-15 and F-18 programs, they are both loaded with foreign military sales, F-15 is all foreign military. So we have got a good size of our backlog on the defense side that is posted for military sales, and so we do not expect those to be impacted by the -- by sequestration. So, it would reduce the impact on us by some margin because of that.

How do we -- any way to, can you give us an indication as to what percentage of your military or military business would be foreign? Is there a way to do that?

It's very tough to do that. But, it's -- if you just took a look at the percentage of defense business that we had, and then said that somewhere between 25% and 30% of that was devoted to foreign military, then that would be --

Okay. That is perfect. Hey thank you.

J.B., I might add, though, when you look at the at the Q that we filed that has been posted, a breakdown of those backlogs, I think, are really telling. Because in the DLT military electronics sector, since the beginning of the year, those backlogs have grown from $212 million to $251 million. There is good underlying growth of that, that includes some of the bookings of F-15 & F-18. But it is mostly to wiring interconnectivity solutions, which are smaller applications per order.

Where we see flatness and some shrink is our Ducommun AeroStructure military portfolio, where at the beginning of the year it was $141 million, we'd booked some orders on the C-17 for two years in there it shrunk to $115 million. But when we add in the $18 million of the Chinook, it is $134 million to $135 million. We expect 3% to 4% shrink coincident with the decline in the defense budget on just the structure side, but our underlying military electronics business looks very, very solid, positive, and growing.

And the DLT, stuff is mostly retrofit, correct?

No, it's actually new build and some retrofit markets.

And defense, missile defense.

Heavy on the missile defense side, so I think that is an area that, even when you looked at [Tenada's] budget, we looked at what the government is doing, both the House and Senate are doing, both those budgets look pretty stable on -- and consistent with what Tenada's doing on the (inaudible).

And some of the drivers of those, again, are the macro drivers, are like more electronic content in cockpits and other parts of the aircraft that requires more complex solutions to benefit from.

Okay great. Thanks for your time.

Alex Hamilton, Early Bird Capital.

Hi. Good evening. Joe, you had mentioned that you highlighted how margins sequentially improved this quarter, and I believe you had said that you expect sequential improvement to continue. Can you talk about the low hanging fruit, and what gives you the confidence to get there? And then can we talk about a longer-term profile that we should expect?

I'll go back and say from the fourth quarter, when we had an unacceptable 17.2% gross margin and that we expected that range to be between 17.8% and 18.4%, and we hit 18.7%, we were pleased to show that we exceeded that. And we said that we continue to make improvements, and that the improvements will come on the DAS side as we continue to drive down the costs of delivering some of these new programs that we have been dealing with over the last 16, 18 months. That's the primary driver of seeing the margins improve. On the -- when you look at the numbers on the DLT side, you'll see sequentially our sales are down because we had softness in the non A&D portfolio over there. But we have managed that business well to maintain the margins and take some costs out. So in terms of -- we look to keep working continuous improvement to nominally improve those margins, and hopefully we'll get a pick up in sales at some point in time that will improve our operating margins a bit.

Okay. Thank you.

Carter Leake, BB&T Capital Markets.

Good evening, thanks for taking my call. So, I'll be taking up for Jeremy, so bear with me as I get up to speed like he was. Start with weakness in the RJ market, can you give some color on that? What were you seeing there?

Weakness in which market?

Regional jets.

Oh, the regional jets. Yes, I think that we are heavy on the Bombardier 700 & 900 series, so they have cut back on the build rates from last year. So, they have gone from -- they were at roughly four through most of last year and cut back to about two shipsets a month. But we see some of that picking up, actually now, and then that was the biggest part of the softness on the RJ side.

But do you see that picking back up? How would that pick back up?

Well, I think we are seeing some spares pick up on their side of the business, but it's not -- I don't think the build rate itself --.

Okay. You mentioned some platforms. Any A350 impact this quarter, or is that too early for you?

We have some A350 sales but it is not -- it's still in the development side.

You mentioned 737s & 74s, any color on 777s & 78s in the quarter?

Well, they were up, both of them, quarter over quarter, and, actually, year to date, both programs are up. 747-8 is starting to come into its own, so we have got pretty good content on there, that aircraft. So it's -- we saw an increase in revenue on that as well.

And I'm not sure if you guys do this, but I have a June presentation that -- it's your annual expected growth rates. Do you update that on the quarter, is that something that --?

Yes we do. Those growth rates that we post on our website, we review those quarterly and even sometimes monthly. We justify posted ours today that reflects updated financial information, in that we haven't changed those growth rates because we think they're really more applicable to two to three years out, rather than just quarter to quarter.

Okay. But these are the new -- the ones I'm seeing in the June presentation are the current annual expected growth rates?

Yes, and we have an August presentation out now on the web.

You do? Okay, great. Okay thanks.

Bhakti Pavani, C.K. Cooper & Company.

Hi Joe, hi Tony. You guys touched on the sequential margin expansions for the gross margins and operating income. Would you share some color on the top line on what part sort of sequential growth are you expecting for the second half?

Well, on the -- as you trend it, we have been ranging in the last four or five months -- quarters, excuse me, between $182 million and $188 million a quarter, we've been averaging $185 million. As we looked at the second half of the year, we see continued growth in our military electronics business, and we see increased shipments in our commercial aerospace business. Offsetting those, we are going to just be seeing softer sales, either flat or sequentially down a little bit, in the industrial sectors and in the natural resources sectors. So we are looking for a measured improvement in growth sequentially.

Okay. Talking about the tax benefit that you guys received for Q2, is that something that is one time, or do you expect that continuing going forward?

No, that's a permanent change, we expect that. We spend a lot of time in terms of tax planning and tax strategy, and because we were able to file consolidated returns with all the entities involved, it translates to a lower effective state tax rate, really a permanent change in the future.

But it won't be that size. So, we were able to pick up, first quarter and second quarter, in that reduction. So going forward, it will be, it will have an impact of somewhere between 1% and 3% on the overall tax rate.

Okay. Last week you received a contract from Bell Helicopter for the AH-1Z Cobra program. Could you shed some light on what does that mean for Ducommun, and what kind of a growth opportunity do you have there? If you could share some color.

Well, the actual program that we received is significant in a couple of ways. I think that it's a development program that -- this is a brand new helicopter development program. So as we go forward, it is a combination of two of our business units, so it's driven through both our engineering division as well as our structures division, and it has some significant growth opportunities. We have a couple of nice applications on the ducting system for this helicopter. We don't -- I think we gave some dollars output in the release, but we are actually limited what we can say about the program from our customer.

Okay. Perfect. Yes that's it for my side. Thank you very much.

(Operator instructions)

Mike Crawford, B. Riley & Co.

Thank you. First, regarding next year, you have some trepidation regarding if there is actual sequestration. But if there is a six month continuing resolution that averts that worst case scenario, what kind of impact would you see that having on your business?

Mike, this is Tony Reardon. I don't believe that the continuing resolution has any impact on sequestration. Sequestration is part of the Budget Control Act, and so what the continuing resolution does is allow the budget to go forward for six months, so it gives the government the ability to go spend on the things that they need. But the impact, the sequestration would impact the funds available for the continuous -- continuing resolutions. So you would be impacted by sequestration no matter what.

Okay. And then just on the expected margin expansion. I think it's a little bit of several factors. One just getting more experienced on some of the new programs. Two, maybe working on more value added, complex sub systems, and then reduction of R&D expenses. But if you tried to weight the importance of each of those factors, what's giving you the most bang for the buck?

I think, clearly, the biggest bang for the buck is the reduction of the development costs. So, we have got a very aggressive operational excellence program running in the facilities that are in brand new development. And we have been successful quarter over quarter in hitting the targets that we placed before the operations, so we are going to continue to do that. I think that there are also opportunities to expand margins on some of these higher level assemblies that we are looking at. So we have a number of opportunities out there. Again, we haven't captured those and I'm sure that there will be some start up development costs related to those. But I think, as we go along, I think the biggest bang for the buck is going to come from moving the AeroStructures margins north, and reducing the overall exposure on the development costs.

Thank you.

Ladies and gentlemen, since there are no further questions in queue, I would now like to turn the call over to Mr. Reardon for closing remarks.

Okay, I would again like to thank everybody for joining us today. And again, thank you for your continued interest and support, and we look forward to speaking with you next quarter. Thank you very much.

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