Ducommun Inc (DCO) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2014 Ducommun earnings call. My name is Sarah and I will be your operator for today. (Operator Instructions) I would now like to turn the conference over to your host for today, Mr. Chris Witty.

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

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 that 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 31, 2013. 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 would like to turn it over now to Tony Reardon for a review of the operating results. Tony?

Thank you, Chris, and thank you, everyone, for joining us today. I will begin by providing an overview of the quarter, including some market color, after which, I will turn the call over to Joe Bellino to go over our financial results in detail.

The second quarter was characterized by continued strong commercial aerospace shipments, solid cash flow, and higher margins driven by improved operating performance and aided by some nonrecurring items, which Joe will review in a moment. In addition, we have begun to see some resilience in our non-A&D end markets, where our strategic efforts to engage with customers and expand the scope of our business has resulted in a higher backlog and an increase in sales.

We focused on implementing a growth strategy for these segments during the past few quarters and are encouraged by the gains that are being made.

Overall, we are pleased with the quarter's financial results, including our 8.9% operating margin and earning $0.59 per diluted share. We ended June with a backlog of $623 million and once again, paid down $7.5 million of debt.

Now let me provide some color on our end markets, products, and programs. Starting with the military and space, revenue was down approximately 8% year over year, primarily due to lower helicopter shipments and declines in the missile systems and defense technologies.

While the Company continues to support wide variety of key programs and platforms, fluctuations in the quarterly performance will remain a given until -- with the wind down of the overseas deployment operations and overall budget considerations.

In addition, certain helicopter deliveries were pushed into Q3 from Q2. That said, demand is playing out as expected and is in line with our backlog. We expect to see lower overall revenue from this market through the remainder of the year, with electronic upgrades in certain key programs being offset by the impact of overriding budget constraints.

Going forward, our visibility into 2015 will be shaped by the spending priorities in Washington and of course, the geopolitical considerations. Our military and space backlog is roughly $310 million. It remains very solid, but it's clearly down from our robust levels of 2013.

As I've said in the past, this is why Ducommun remains focused, not only on improving the efficiency of our operations, but on securing new business. We cannot simply stand by while the cyclical realities of the military spending impact our business. So we have been working hard on opportunities to grow across all of our end markets and are particularly pleased by what we have seen recently in the non-A&D segments.

Moving into this part of our business, non-A&D sales were up 10%, both year over year and sequentially, from Q1. This is the highest level since the third quarter of 2012. At the same time, our non-A&D backlog at $62 million was also 10% higher than it was at this time last year.

We see these developments as a reflection of increased market demand as well as the result of targeted initiatives to penetrate new customers and expand our portfolio of solutions within the industrial, energy, and medical markets.

I am very pleased by the progress we have shown in these segments and credit our talented workforce in bringing to market the products and services that companies such as John Deere really value. Having our team offer stronger engineering expertise and faster turnaround times drives our ability to solve problems -- customer problems at the best value pricing.

We work hand-in-hand with companies to address real world issues of manufacturability while offering technological enhancements. We strategically review all of our product lines and operations to determine how we can increase our speed to market, drive cost lower, and improve our supply chain performance.

This is a continuous improvement process, which looks both at the high-performing facilities as well as the lower performing operations and products to implement more efficient manufacturing processes and inventory management techniques. The bottom line is that we are doing what is required to drive topline growth and improve margin while addressing underperforming parts of our business.

Now turning to our commercial aerospace operations. I'm proud to say that Ducommun is clearly leveraging its leadership position in structural components and electronics systems to win content and grow our brand in this very important segment. The increased revenue, particularly in our electronic systems group, is a positive indicator of our ability to continue to expand in this market.

Aircraft demand remains strong, supported by the fact that Boeing's latest delivery projections are the highest in their history.

Whether such expectations ultimately prove correct, the industry nevertheless remains a very attractive area and [growth] for us and this quarter was no exception. Our overall commercial aerospace revenue grew slightly over last year's second quarter to approximately $58.5 million, our best level ever.

Not only does this reflect continued strong shipments to the large aircraft OEM, but also moderate rebound in our regional and business jet markets, as noted in the last quarter. Overall, we remain very positive about our position in the commercial aerospace arena and have recently noted many positive developments, including several wins in the Boeing 737 MAX program.

We expect additional awards in the near future on key aircraft such as this and with Airbus as well, particularly on the A320, as we continue to offer more complex value-added solutions across a broad array of products, increasing our penetration on a variety of new and existing platforms.

Our commercial aerospace backlog, at over $250 million, is the highest in our corporate history. The quarter in total demonstrated that Ducommun is making progress in winning new business, improving operational performance, and increasing margins. We believe the steps being taken today will help offset some of the variability in the defense spending that will surely continue into the near future.

We never underestimate the challenges ahead and we never stop focusing on ways to make Ducommun the best it can be. Our vision is to become our customers' number one provider of innovative electronics and customer solutions. And we are really not going to stop until we prove that case.

With that, I would like to now just turn the call over to Joe to review the financial results in detail. Joe?

Thank you, Tony. And good day, everyone. After the market closed today, we reported results for the second quarter of 2014, which reflected the continuation of improved financial results this year.

In looking at a review of second quarter results, net sales for the quarter were approximately $187 million, roughly 3% down from last year's $192 million. The revenue decline year over year was primarily driven by the 8% decrease in military and space sales, but they were partially offset by a 10% increase in our non-aerospace and defense markets.

Our commercial aerospace sales remain solid as we continue to benefit from the increased airframe production rates, which climbed to the highest levels since early 2013. While there remains softness in our military and defense sectors, we have seen significant growth in commercial aerospace and the non-A&D end-use markets since the beginning of the year.

Ducommun's net income for the second quarter of 2014 increased nearly 18% to $6.5 million, or $0.59 per diluted share, compared to $5.5 million, or $0.51 per diluted share, for the second quarter last year. As further detailed in the earnings release, pre-tax income expanded 26% to $9.6 million for the quarter from $7.6 million in last year's second quarter.

The second quarter net income this year was negatively impacted by a 32.5% effective tax rate, which reflected no federal R&D tax credits, while the second quarter of 2013 included $0.5 million of such credits, resulting in an effective tax rate of 27.6%. We do expect for the second half of the year an approximate 31% tax rate in 2014.

We are pleased to report 10% higher operating income of nearly $17 million, up $2 million from the $15 million last year. The improvement was due to a variety of factors, including a favorable product mix, better operating performance, and a $0.8 million Worker's Compensation audit refund related to prior years.

Our gross margin expanded 60 basis points to 20.1% of revenue and SG&A expenses fell 40 basis points to 11.2% of revenue, resulting in an overall 100 basis points increase in our operating margin to 8.9%.

EBITDA expanded to $24 million, or 13% of revenues, in the second quarter from $22 million, or 11.6% of revenue, in the comparable period last year.

In reviewing results by business segment, first beginning with the Ducommun AeroStructures segment, DAS, the DAS reported a 6% decrease in net sales to $79 million in the second quarter as compared to $84 million for last year's comparable period. DAS sales were down primarily due to an 11% decline in military aircraft sales. In the commercial aerospace sector, we saw a slight decrease, mainly attributable to timing differences with customer shipments.

We were pleased to report that DAS operating income expanded to $9.8 million, or 12.5% of revenue, in this year's second quarter compared to $9 million, or 10.7% of revenue, last year. The segment operating income benefited from an improved product mix, better operating performance on various programs, and the previously mentioned benefit related to the Worker's Compensation refund.

DAS's EBITDA was $13.4 million, or 17% of revenue, compared to $11.4 million, or 13.6% of revenue, for the comparable period last year. The DAS EBITDA margin expanded 340 basis points year over year.

Next in reviewing our Ducommun LaBarge Technologies DLT segment, net sales for the quarter were approximately flat at $108 million. That said, we have seen a sales shift mix occurring as non-A&D revenue rose 10% and commercial electronic aerospace products increased nearly 25%. And this offset a 7% decline in our defense electronics sales.

We attribute the decrease in defense technologies or electronics to timing differences and softer backlogs. We were really pleased to see higher demand for our commercial aerospace electronics as well as non-A&D offerings, which are experiencing modest growth as our marketing development efforts are beginning to show positive results.

DLT's operating income for the second quarter was $10.8 million, or 10% of revenue, compared to $11.2 million, or 10.4% of revenue, in last year's second quarter. The slight shortfall reflects the unfavorable impact of lower defense revenues. EBITDA was $14.8 million in the quarter, or 13.7% of revenue, compared to $15.8 million, or 14% of revenue, in last year's period.

Addressing corporate, general, and administrative expenses for the quarter, they were $4 million, or 2.2% of revenue, down from $5.1 million, or 2.7% of revenue, last year. It was due to really -- or the improvements are result of the effective cost management as well as lower professional fees and benefit expenses compared to last year.

Our overall backlogs have increased since last year and remain a solid at $623 million. Despite a decline in backlog for our defense technologies products, we were pleased to see that this was more than offset by increased bookings within our commercial aerospace and non-aerospace and defense markets.

We expect to finalize additional orders on various commercial aerospace and defense technology platforms in the near future, as we continue to see numerous growth opportunities. Our non-A&D markets are also showing modest improvement, reflecting in our growing backlogs, and recent activities suggest that an uptick in some of these end-use markets may be underway.

Next in discussing liquidity and capital resources, as Tony mentioned during the quarter, we continue to de-lever our balance sheet. We prepaid another $7.5 million of our debt, reducing it to $318 million at quarter end, and our net debt was reduced to $274 million.

While trailing 12-month EBITDA as defined in our loan agreements of $85 million, this equates to 3.2 times net funded debt to EBITDA. During the balance of 2014, we continue to plan to voluntary prepay our debt of approximately $7.5 million per quarter. We remain committed to achieving our goal of deleveraging to the 2.75 to 3 time range by the end of 2015.

During the first half of 2014, we generated nearly $15.5 million in cash from operations. This is roughly $8 million more than the comparable period last year. We remain diligent in effective working capital management and expect our net cash generation for the balance of the year to be similar to historic seasonal patterns.

We anticipate CapEx for the year to be in the range of $16 million and we are using our CapEx to support the expansion of our manufacturing capabilities and new contract awards.

In closing, we continue to focus on achieving sustainable operating and EBITDA margins, which, along with diligent expense management and continued focus on working capital efficiencies, should permit the Company to generate adequate cash flow going forward.

I will now turn back the program to Tony for his closing remarks. Tony?

Thank you, Joe. Before opening the call to questions, I would just like to again emphasize how proud we are of everything Ducommun has accomplished so far this year. We have re-energized our non-A&D business, won new contracts within our expansive commercial aerospace operations, driven margin growth, and continue to execute on manufacturing improvement initiatives to increase cash flow and return on equity.

We are encouraged by the steady rebound in our industrial end markets, demonstrating both the nature of the overall economic conditions as well as the strategic investments we have made to grow this business. Similarly, our commercial aerospace expansion has many new wins on important programs, illustrating our drive to be a leader in the industry and our strong relationship with our key OEMs.

While the military and defense markets remain unpredictable, it is one where we have long-standing positions on key platforms and programs such that as budget priorities are defined, we should win our fair share of technology-driven upgrades and awards. Even here, there is room to penetrate new platforms and selectively grow the business.

We remain focused on improving bottom-line results, our balance sheet, and our growth trajectory. Which all go hand-in-hand with building and maintaining a solid reputation in the marketplace. We owe this to our customers, our employees, and most of all, to our shareholders.

With that, Sarah, I will turn -- or open up the call for questions.

(Operator Instructions) Patrick McCarthy, FBR Capital Markets.

Good afternoon. My first question is on the DAS margins. You highlighted that you benefited from a pretty decent mix shift in the quarter. I'm just wondering how transitory that is over the next couple of quarters. Is the margin we saw this quarter relatively sustainable?

Our DAS margins, Patrick, of 17% for the quarter and 16.3% for the year tell us that because of some -- as I talked about, we had improvements on program, performance, on a variety of programs, and a little bit of a shift in mix plus the aforementioned $0.8 million. But we believe that the [16.5%] EBITDA, the year to date, almost, is a fairly sustainable rate the way we are operating today.

Okay. Perfect. And then the --

Patrick, let me add a little something to that. I think that one of the things that, as you look forward, you just have to remember that some of these key military programs, which are higher margin-driven programs in the third quarter and fourth quarter, will slow down quite a bit.

Okay, fair enough. And then on the non-A&D business, I think in the past, before the strategy shift a couple of quarters ago, it looked like the backlog in that business has turned about 50% into the next quarter to revenues. Is that still a fairly decent proxy, given the change in strategy? Has anything changed there?

No, that's still a pretty good proxy. The non-A&D customers, generally, let's say, don't manage the inventory as effectively as the aerospace and military customers. And so, that 50% ratio I talked about is about the same. We are really pleased to see our backlogs from a year ago increase about 10%. And they have been trending up in the last couple quarters.

Yes. We turn at about 90 to 120 days, generally.

Okay, great. Great. Thanks for taking my questions.

Ken Herbert, Canaccord.

Good afternoon, nice quarter.

Thanks, Ken.

Thanks, Ken

First, I just wanted to ask on the DLT segment -- again, a similar question. I mean, really nice step up sequentially in the operating profit from the first to second quarter. Is this, Joe, is this a run rate now at sort of 10%, at least from an operating profit standpoint, we should expect to the second half of the year or how should we think about that for the second half?

Well, the GAAP operating income of 10% and it compares to 8.6% for the first 6 months. As I talked about, we are having this mix shift and we are selling less of the higher-margin defense electronics products.

So although we have been very diligent in managing our costs and improving our mix of business in the non-A&D business, and we have added some significant commercial aerospace business, this overall shift should result in somewhere between those -- the 8.6% and the 10% for the balance of the year.

Okay. That's helpful. And I wanted to ask you about that. I know you have done a lot in terms of specifically on the commercial aerospace side within the electronics business that really came through this quarter. I know you have talked publicly about driving a better mix through, maybe, dropping some customers.

Can you talk, specifically within the electronics segment, where you are in terms of your commercial aerospace push? I mean, some great numbers this quarter. Are you early on in the process? Is there more we should expect or how would you characterize that in terms of where you are in that process?

Ken, I think we are actually in the beginning of it. I think we are seeing -- we got good traction. We had real nice pickup quarter over quarter and year over year on the commercial side. We have got more opportunities in front of us.

I will tell you that between the commercial aerospace and the pickups in companies such as John Deere, we are really churning through. So we have got a little work in front of us, a lot of new programs that we have in place that we are working through. So we may see a flattening before we step back up, but I think there's a lot more business there for us to garner. So we are seeing a nice pick up there.

And then we are working with customers that maybe looking for much lower costs than the value-added that we think we are bringing. And so we are changing out some of those lower margin customers and working with them to find better solutions for them on new product lines.

So -- and I think that some of this is attributed that effort as well. But I think that we are doing it in the sense that we really want to help the customers get to the level where they understand the value we are bringing and the changing in the marketplace. And if they are just looking for cost, then maybe we are not the right guys.

Okay, great, that's helpful. And if I could then just -- you are taking on a lot of new customers within, obviously, within the electronics segment. You have had a lot of new wins, like you highlighted on the Boeing 737 within aerostructures.

Can you give us comfort that either from a contracting or execution standpoint, as you take on these new projects, that maybe the risk profile relative to some earlier issues is better today or is there something we should be concerned about as you take on this new business?

That's a great question, Ken. I think that we have changed business. I think that one of the things that Joel Benkie and his team has done is realign the businesses. So there's been a major change in our new product introduction.

That is not to say that we don't have more work to do there. Also, we have got a much more focused effort on our supply chain management, both of which have been attributable to some of the issues that we faced in the past on our new product development.

That is not to say that we don't have more work to do, but I think we are comfortable that we have a lot of work to do and really trying to pace ourselves with the customers so that we don't overpromise and underdeliver.

So I think that the program management situation -- we talked earlier and know you've had - we've had some previews with regards to what we are doing in our area of operational excellence, but really putting together the office of operational excellence and combining our supply chain management with our operational excellence with our product development or program management, new product development as well as our engineering team and product integrity has really proven so that we come through on our full circle of execution. And are really working the new programs hard.

So we have got a lot of new things going on. We are very focused on the program management side of the business and I think we are making real nice strides there.

Great. Thank you very much.

Mark Jordan, Noble Financial.

Good afternoon, gentlemen. Question relative to depreciation and amortization by segment. And I am looking at this sequentially. If you look at DAS, you were up $1.1 million sequentially after it had been in previous quarters pretty flat, at about $2.5 million per quarter.

And then at DLT, sequentially, D&A -- or D&A went down $1 million to $4 million from $5 million. Net net, obviously, D&A is roughly the same quarter over quarter, but there's some significant shifts. Is there any unique things that happened in the quarter to cause those shifts and what is our run rate moving forward?

Mark, I think where we are in the quarter is pretty much the run rate, with a nominal increase, because we continue to make investments equal to our depreciation every year. Why we saw $1 million -- $1.1 million -- in the DAS sector was they are a function of we began to amortize tooling, which is associated with new contract awards on the commercial side.

And so as we build out those projects and start shifting product, which we did in the second quarter, we are able to amortize that tooling.

On the DLT side, we have some legacy assets, where the depreciation dropped off -- primarily, it is not so much the amortization component of that relates to the purchase price, but we have been very modest in -- as you know, it is not a very highly capital intensive. And so after the normal depreciation timelines, those assets are still in play and useful and yet, we have fully depreciated some.

Thank you. I looked at it and it just looked odd. Thank you for the explanation.

Secondly, we are now getting within striking distance, I guess, of July 2015, when you would have the opportunity, if you so chose, to refinance your debt. Obviously, that the 9.75% debt is expensive.

Do you have an estimate of a range of annualized interest savings, if you were to look, at right now, in the second quarter, you're at $28 million annualized interest expense. If you were to refinance your overall debt structure in July 2015, what range of potential interest savings you might be able to realize on an annual basis?

Given that the chairman of the Federal Reserve has indicated intermediate-term, short- and intermediate-term rates will stay modest for another 12 to 15 months, we believe that we can refinance our $317 million, which will be down by another $15 million if we keep paying them down.

We believe that we can save $8 million to $10 million of interest a year and our all-in rate would be closer to 5% versus 8% today.

Okay. Thank you very much.

(Operator Instructions) J.B. Groh, DA Davidson.

You have obviously done a great job winning these new Boeing 737 deals. Can you sort of give us a frame of reference on that? At the current rates, does that new content make up for what you are losing on C17 -- [217]?

Not exactly, J.B., but it is a good start. Right? So it is, as you look across the C17, you know that was running at a rate in the $25 million a year range, something in that nature in the last couple of years.

And although these will add at the highest run rates for the 737, give us double-digit growth, it won't quite make up that avenue. But we do have other programs that we are working on to fill that gap, both on the commercial side as well as the military.

Yes. And then, Joe, maybe you could talk about cash deployment strategy. Obviously, paying down the debt at a pretty good clip here. Any other thoughts on other cash deployment (technical difficulty) acquisition?

Our strategy and the commitment we made to the credit agencies and to ourselves is to continue to pay down debt so we can get to that leverage, J.B, at 2.75 to 3. We are really pleased to see that we've had some acceleration this quarter, down to a 3.2 net debt to EBITDA, which was driven by a combination of EBITDAS going north and the debt is going south.

We feel that it will give us really good leverage if we are at 2.75 to 3 when we refinance ours. And as I didn't explain before, but the trigger is our $200 million high-yield bonds are first callable at an affordable price in January -- July 15 of 2015, and that has really been our trigger point to refinance it. So we have another four quarters to go.

But our cash deployment strategy -- we pay that down, we get this financing targeted at 5% that we can with the variety of financial instruments. And then after that, then we can go back and look at some strategic initiatives of growing the business, possibly by some modest acquisitions that we can fill some gaps.

Okay. Thank you. Great job on the markets, guys. Thank you.

Thank you.

Thank you.

(Operator Instructions). Mike Crawford, B Riley and Company.

I know you were recently at the Farm Bureau show and I am wondering if you could share what kind of conversations you had with partners at the show and how they feel about performance metrics, like on-time delivery and quality metrics versus what you are targeting. Thank you.

Well, I think that we are targeting the same thing, Mike, as the customers are requesting with regards to on-time delivery and quality. But I think we had real good meetings at the show. We met with every one of our major customers. We met with most of our prospective customers. We met with potential partners for growth.

We also had some pretty in-depth operational reviews with a few of our customers. But as we look at where the marketplace is, I think that everybody is bullish on the commercial side of the business. And I think there's still some opportunities on the not -- or, excuse me, on the military side of the business as well.

However, when you look at the expectations with regards to the customers, I think we are driving the same expectations that they have. If you look at United Technologies, for example, we have got -- we are a Gold supplier on three of our divisions and driving for full Ducommun Gold supplier. We want to be Gold suppliers across all of our customers and that means improving our on-time delivery and our quality.

Year to date, we have driven down our past due deliveries to our customers significantly and we are in line with our targets on that. On that aspect of our business. So we have really improved our operating performance across the board as well as driving the working capital.

So when you look at the things that we talk to our investors about, in terms of how we are going to manage the business, as we started this process, we said we're going to drive our debt down and we have done that. We are going to improve our working capital and we have done that.

We are going to grow our business and we are in the process of doing that. And the aspects of growing the business are driven primarily around our ability to improve our on-time delivery, offer really solid solutions to customer problems, and put ourselves in a position where we deliver 100% quality every time we ship product out the door.

Okay, thanks, Tony. And then just further to that point, clearly, you are growing the commercial aerospace business with more content and in higher build rates by the industry itself. That non-A&D stuff looks good as well.

Now on the military and space, we do know that this backlog is down some nearly $50 million-ish year over year. And I think, just given the slowdown in military spending to pull out from overseas, et cetera, that that business has to be down next year.

But given the positive things happening in the other aspects of Ducommun's business, do you think that it would be possible to grow the overall business in 2015 versus 2014, given the headwinds in the military and space side?

We think we can, Mike. We think there's opportunities. I think it is going to be a very small growth, but I think that you'll see somewhere in the 1% to 2%, we think that's manageable, given the things that are falling out.

Now, with the C-17 down, that is a big program for us. Apache. Boeing has robust sales on the CH-47 and the Apache, but it is not really translating to large sales for us because of the pull back from the war. So you get accommodation there. But we think the military helicopter business is solid.

There are a couple of missile-defense systems that we are working with Raytheon, that if they win, we should be in good shape on some new business there. We do have some nice opportunities with Raytheon on the military side to shore up a couple of programs there.

But there are some headwinds with regards to some other programs that we are on. But we are really on some really nice platforms and I think that sustainability of those platforms, going forward, is very good. Albeit they may be at lower rates.

So our goal is to continue to drive the growth platforms that we see and then put ourselves in a position to pick up 1% or 2% next year. But we are still in the process of evaluating that right now, to be quite frank with you.

Okay, thank you. Then final question just relates to what you were talking about with Raytheon. So you said your -- if they win some missile-defense systems work. Now demand if they win the protest of the awards that were already issued, but are under protest. Is that what you mean?

Well, they have a couple of programs that they are working on right now that I don't think they have announced. But some of them are the ones under protest as well, yes.

Okay, great. Thank you very much.

All right, great. Well, it looks like there are no further questions in queue. So I will turn the call back over to Mr. Tony Reardon for closing remarks.

Okay, thank you, Sarah. And thank you everyone for joining us today and we look forward to talking to you next quarter. So thank you for joining us. Bye now.

Great. This does conclude today's conference. Thanks for your participation. You can disconnect and have a wonderful day.