Ducommun Inc (DCO) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2016 Ducommun earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would like to introduce you to your host for today's conference, Chris Witty. You may begin.

Thank you and welcome to Ducommun's 2016 second-quarter conference call. With me today are Tony Reardon, Chairman, President and CEO, and Doug Groves, Vice President, Chief Financial Officer 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 and may cause the Company's actual performance to be 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, 2015.

All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are especially 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 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 for our 2016 second-quarter conference call.

I will begin by providing an overview of our operations including some market color after which I will turn the call over to Doug Groves, our Chief Financial Officer, to go through our financial results in detail.

We are very happy to report that our second quarter showed benefits of many constructive changes that we made in this past year from progressively cutting costs and implementing supply chain initiatives to closing facilities, refinancing our debt and divesting non-core operations. Even in the face of the softness in certain elements of our military markets, we achieved 19.6% gross margins and posted earnings of $0.34 per diluted share. We believe our strong performance will continue in the second half of 2016 and I will review that in a minute.

Our balance sheet is strong along with our backlog and we are on track to further delever the Company's balance sheet this year. The bottom line is that our overall financial performance continues to improve as does our growth profile and we believe the Company remains well-positioned for new business opportunities going forward.

Now let me go through the -- give you some additional market color on certain end markets and programs and products. I will start off with our commercial aerospace business where quarterly revenue once again was very solid at $66 million, near all-time record levels and slightly above our 2015 second quarter. Sales rose year-over-year on several large aircraft platforms including with Airbus. This was partially offset by a decline in our helicopter business as well as lower regional and business jet sales. We also saw some timing delays in shipments for the Boeing 737 and 787 platforms but we expect these to be made up during the second half of 2016.

It is worth noting that our Airbus content which is a still relatively small part of our business now accounts for roughly 15% of our total commercial aerospace sales versus virtually nothing just five years ago. So we are quite pleased with our performance in this regard and expect to see additional awards and increased content in the quarters to come.

In total, our commercial aerospace backlog stood at $239 million at the end of the second quarter, down from earlier this year due to seasonal adjustments and program order timing. Last year's second quarter backlog was also the lowest in 2015 at just $194 million. Given such timing issues, we expect the bookings in commercial aerospace to rise during the second half of 2016 because of our strong positions on the 737, 787 and 777 programs along with our content on the Airbus A320, A350 and A330 platforms.

We are also on track with regard to our facility investments to support the higher demand for our titanium composites and electronics product lines and we are targeting new content -- where we are targeting new content and accelerated growth.

Turning to our military and space sector, revenue fell to $51 million this quarter from $77 million last year which again reflects the program cancellations and budget changes we experienced last year along with a slowdown in military helicopter sales due to timing issues and schedule adjustments. In addition, roughly $5 million of our year-over-year variance was tied to our divestiture of Miltec which we completed earlier in 2016.

So our results were definitely not a surprise. We anticipate higher military helicopter sales during the second half of 2016. We also expect stronger shipments of our radar racks during the remainder of the year on platforms such as the F-15 and the F-18 aircraft. In fact our overall defense technology backlog grew to nearly $209 million this quarter, the highest level in over two years due to increased participation on missile platforms and solid radar rack orders.

Our total military and defense backlog now stands at a respectable $268 million so even within the current environment, Ducommun remains well-positioned for our electronics upgrades, cutting edge missile platforms and new structural applications on some of the most popular platforms in the marketplace.

With that, I would like to now turn the call over to Doug to review our financial results.

Thank you, Tony, and good day to everybody.

Revenue for the second quarter of 2016 was approximately $134.4 million compared to $174.8 million for the second quarter 2015. The change in revenue year-over-year reflects $17.1 million in lower sales within the Company's industrial end-use markets and $25.8 million in lower sales within our military and space markets.

The industrial decline was primarily due to the divestiture of our Pittsburgh operation in January of this year and the closure of our Houston operation in December of 2015, both of which serving the non-aerospace markets. The military decline of nearly $26 million year-over-year reflects the Miltec divestiture and the program cancellations and budget changes we experienced last year which impacted the Company's fixed wing and helicopter platforms and pushed out some scheduled deliveries. Commercial aerospace revenue was roughly $66 million during the second quarter up slightly year-over-year and near the record levels.

The Company's overall backlog rose to $537 million versus $524 million at this time last year. The quarter saw a nice uptick in orders for defense technologies where the backlog rose to nearly $209 million. It is the highest level it over two years as Tony mentioned. However, we saw a decline in our commercial aerospace backlog sequentially versus Q1 which was primarily related to just timing issues.

Moving onto gross profit, our gross margin was 19.6% in the second quarter as compared to $17.8 million in last year's comparable quarter. This once again reflects improved product mix, the various cost initiatives we have undertaken over the past year including supply chain cost savings and other efficiency improvements. SG&A fell slightly year-over-year to $18.9 million from $20.4 million in 2015. This reflects our divestitures and cost-cutting initiatives somewhat offset by some increased personnel costs and the timing of certain R&D costs related to new program wins.

Operating income for the second quarter of 2016 was $7.3 million or 5.4% of revenue compared to $10.8 million or 6.2% of revenue in the comparable period last year. The decrease in operating income was primarily due to the lower revenues.

Interest expense decreased to $1.9 million in the second quarter of 2016 compared to $6.4 million last year primarily due to lower outstanding debt and reduced interest rates as a result of the Company's refinancing in July 2015.

Our effective income tax expense during the quarter was $1.5 million or 28% compared to $1.3 million or 42% for the comparable period last year. The decrease in the tax rate was primarily due to the US Federal Research and Development Tax Credit that was permanently extended in the fourth quarter of 2015. Going forward, the tax rate for the full-year still expected to be approximately 29%.

We reported net income of $3.9 million or $0.34 per diluted share for the second quarter of 2016 compared to $1.8 million or $0.16 per diluted share last year. The increase was primarily due to the lower interest expense of approximately $4.5 million and the improved operating performance. Adjusted EBITDA for the second quarter of 2016 was approximately $13.7 million or 10.3% of revenue compared to $19.7 million or 11.3% of revenue for the comparable period in 2015.

Now let me turn to the segment results. Our structural systems segment posted revenue of $60.7 million in the second quarter of 2016 versus $76.1 million in the prior year period. The decline was primarily due to $10.8 million in lower military and space sales reflecting the program cancellations and budget changes we experienced last year which impacted the Company's fixed wing and helicopter platforms and pushed out some scheduled deliveries. Overall the structure system revenue also was impacted by a $4.6 million decrease in commercial aerospace sales and this was just related to the timing of certain large airframe shipments and the wind-down of a regional jet program last year.

Structural systems operating income for the second quarter was $4.7 million or 7.8% of revenue compared to $6.9 million or 9% of revenue last year. The decrease in operating income and margin was primarily due to the lower sales level.

Adjusted EBITDA was $6.5 million for the current quarter or 10.7% of revenue compared to $10.5 million or 13.8% of revenue last year.

Now turning to the electronics segment, we posted revenue of $72.7 million in the second quarter of 2016 versus $98.8 million in the prior period. Revenue from our industrial markets was down $17.1 million mainly due to the divestiture of our Pittsburgh operation and closure of our Houston facility. In addition, there was a $15 million decrease in military and space revenue mainly due to our Miltec divestiture along with the budget changes we experienced last year which impacted both the fixed and helicopter platforms as previously discussed. The impact of these items was partially offset by a $6.1 million increase in the segment's commercial aerospace revenue where we continued to gain traction.

Electronic systems posted operating income for the second quarter of $6.8 million or 9.3% of revenue compared to $7.7 million or 7.8% of revenue for the second quarter of 2015 with the decrease in operating income again due to lower revenue.

Adjusted EBITDA was $10.5 million for the quarter or 14.4% of revenue compared to 12.1% or 12.2% of revenue for the comparable quarter last year.

Corporate, general and administrative expenses for the second quarter of 2016 were $4.2 million or 3.2% of total revenue compared to $3.7 million or 2.1% of total revenue last year.

Now turning to liquidity and capital resources, we generated $6.6 million of cash from operations in the second quarter of 2016 compared to $14.1 million in 2015. We remain diligent in effective working capital management and expect our net cash profile going forward to reflect the historical seasonal patterns. We previously had used net proceeds from divesting of Miltec in Pittsburgh of approximately $55 million to pay down debt and continue toward our goal of delevering to targets of 2.25 to 2.5 times debt to EBITDA over the next few years. While debt did not decrease this quarter, we expect to pay down another $10 million to $20 million of debt by fiscal year-end.

CapEx for this quarter was $3.8 million and we continue to expect CapEx to be approximately $18 million to $22 million for the full year as we continue to invest in new programs and prepare for the next generation platforms ramping up later this year.

In closing, we are very pleased to see the fruits of our efforts in terms of higher performance and bottom-line results from the cost-cutting measures taken over the past year along with initiatives to exit non-core businesses, and focus on our growth strategy going forward. We expect higher levels of revenue in the second half along with even better returns.

I will now turn it back over to Tony for his closing remarks. Tony?

Thank you, Doug. Before turning the call over to questions, I wanted to once again say that we are pleased to see the ongoing transformation of our business and bottom-line results even with some changes in our end market requirements. The commercial aerospace industry remains strong. However, there is a degree of weakness that remains within the regional and business jet markets as well as in with the commercial helicopter market. We are well-positioned on some very solid platforms including the 737 MAX and the A320 neo. We have right-sized the Company to better manage the varying production levels and we are investing for growth in the next generation titanium and composite technologies.

At the same time, we are seeing some stabilization in the defense market where our backlogs have risen.

We continue to believe that the worst is behind us there. In addition, we have closed certain facilities and sold others having transformed the remaining organization into a leaner, more nimble and more results driven enterprise so the management team is upbeat about Ducommun and what our future holds. We have reduced the Company's debt, strengthened our balance sheet, cut costs and focused our attention on the core markets where our technologies and capabilities have the highest impact.

Our continued focus will be on the growth of our business and on increasing our shareholder value.

With that, Glenda, I would like to open up the call for questions please.

(Operator Instructions). Edward Marshall, Sidoti & Company.

Listen, I got a question for you on the margin of the two businesses -- both have recovered nicely. And I am curious as you build on that for the remainder of the year, what has to happen? Is it volume? Is it program mix or learning curve? Kind of walk me through maybe how we see incremental margin maybe this year or into next?

Ed, it is really a combination of all of those things you described. There is certainly a product mix component to it. We continue to work our supply chain initiative that we have talked about for the last couple of quarters and that continues to gain traction and certainly volume as we get more volume, it helps cover that overhead. So I think we continue to see certainly in the structures business some nice momentum coming out of the end of last year sequentially through the first quarter into the second quarter and seeing that business as we have said in the past getting back to that 8% to 9% operating income margin level that we know the business is capable of.

Which of the three do you think is the biggest lever, volume, mix and learning curves?

I think it is the learning curves, it. I think that what you see right now as we have talked in the past, we have a number of brand-new development programs that we have that are going through right now and we expect to start shipment on those in the next couple of quarters, primarily more in the fourth quarter and into the first quarter of next year. So as we see that roll out and as we see the businesses improving on the learning curves, then we expect especially on the structure side to see some pickup in the margins. But you know suffice to say and I think we talked about this last quarter, we are investing heavily in the growth businesses and we are putting ourselves in a position where I think that we will be more successful going forward next year.

Got it. You talked about anticipating higher military sales in the second half of 2016 and I am curious what that reference is toward? Is it year-over-year or is it quarter over quarter?

It should be quarter over quarter. I think you will still see a decline from the year-over-year, Ed, because of the shutdown of the C-17 program as well as the Apache. But as we see quarter-over-quarter I think we will see a pickup in the helicopter programs as well as in the radar systems.

And that brings me to the next question I guess. The missile programs and the radar racks are typically higher-margin and you said they are entering backlog now. Can you give me a sense as to the impact from the margin perspective from those businesses as we move forward?

I think they should be in the range of where we are close to where we are right now. They will have some impact with regards to adding the volume to the business but it is in businesses right now that are in the development process in some case on some of the programs and ramping up in other cases.

I think it was three quarters ago you said the missile programs were -- or maybe it was radar racks are extremely high margin for you guys. Does that still hold true or has there been a change into the pricing structure of that?

I don't think we said the radar racks were high margin but I think on the missile programs they have typically been good margin programs for us and I think the comment was in particular I would have to go back and look at it but I think the comment was in reference to generally on the longer production or the major production programs that we had in the military side, they were higher-margin than the commercial. So having said that, the missile platforms that we are entering into in the second half are essentially new development programs.

And last question, I know you were doing some developmental work on the titanium ductwork for the JSF. First, did anything come of that? And as we see the program start to swell a little bit, do you see that entering backlog and do you see that as a second half or even 2017 driver for you?

We are still in the process of working through that right now, Ed, so I don't see any big pickup going into next year at all, no.

Got it. Thank you.

Ken Herbert, Canaccord.

It is actually John on for Ken. So a quick question on the shipments that you said slid to the right some of which was if I -- correct me if I'm wrong -- was the 787. Did it have anything to do with Boeing's change in payment terms, sort of that PFS initiative?

No, no, it didn't at all.

And what other program was it? You mentioned 787 and --?

The 737 program and both of those were programs where it was just primarily a timing issue with regards to shipments out at the end of the month.

Got it, got it. And then you mentioned the electronic segment there was a $6.1 million benefit. What platforms was that on and what should we expect going forward?

On the increase in the commercial aerospace?

Yes, yes.

That was primarily on the A350 program and some of it on the A320.

Okay, and then going back to some of the gross margin benefits that were asked before, so you mentioned learning curve is really number one and volume mix being number two because I guess what I was trying to get at as well is, did you really benefit this quarter from mix or was it primarily just a learning curve and some of the cost initiatives?

I think it was primarily, there are two major factors in the margins in this quarter and some of it was not so much coming down the learning curve that I think we are going to see more of that in the second half of the year. But in terms of this quarter, it was really about the cost-cutting measures as well as the improvement in our supply chain.

Got it. Okay, thanks very much, guys.

(Operator Instructions). Mark Drucker, B. Riley.

Hi, Tony. Appreciate the time. I've got one question. So it seems like there has been bifurcation between your backlog and the revenue streams which we are seeing in commercial and defense and the backlog actually grew quite significantly in defense and it is almost kind of right in line with the commercial backlog. Just kind of wanting to understand also with respect to revenue coming in at $51 million in military, are you kind of I guess -- are you taking a step back from the $60 million to $70 million run rate in the military business that you stated last quarter?

No, it is really just a timing issue as we referred to in the comments particularly in the military helicopter businesses that we have. So the commercial backlog while it was down this quarter, again was really just a timing issue. If you went back in time and looked at the backlog a year ago for the commercial aerospace, it was about $195 million against the $240 million that we have right now. So it really is just a timing issue for commercial and on the sales side for military again just (multiple speakers).

It is at timing issue as far as -- it will pick up in second half.

Okay. With respect to your initiatives to cut cost, I see that SG&A went down in this quarter and quarter-over-quarter it is down over the last quarter. But it is kind of, it is in line with Q4 2015 and it seems kind of comparable to what we saw across the board actually in 2015. What do you think is the optimal level of SG&A to maintain your projected revenues?

We have historically ran SG&A somewhere around 13% to 13.5% of revenue and certainly it was down this quarter because we benefited from not having Miltec in the operations and the impact of some of the cost-cutting that we were doing like the closure of our St. Louis office that completed right here at the beginning of the second quarter. So we are seeing the benefits of that but I mean we are looking at somewhere in that range of revenue in the kind of $19 million a quarter kind of range as we look out through the rest of the year.

That is helpful. Thank you. Two quick questions and you touched on one of them on the call. So leverage coming down to 2.5 times EBITDA, would that -- are you projecting maybe 2017 when that would occur?

No, that is over the next year and a half to two years. So we expect to be able to repay debt somewhere in the $10 million to $20 million range this year and that will bring the leverage down with what we hope will be increased EBITDA as well.

Okay. And last question for me, do you have any more visibility into 2017 Black Hawk production?

You know, I think it is as forecasted. So I think we are expecting a slight drop in the Black Hawk and the size of that drop I think is still being bounced around in Congress so it's kind of hard for us to report on it but I would say it is going to be somewhere around 80 aircraft a year as opposed to the 120 they are at right now.

Okay, thank you.

(Operator Instructions). There are no other callers in queue. I would like to turn the call back over to Mr. Reardon for closing remarks.

Thank you, Glenda. Thank you everyone for joining us today and we look forward to talking to you at the end of the third quarter. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.