Ducommun Inc (DCO) 2016 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Ducommun fourth-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to our moderator for today, Chris Witty. You may begin.

Thank you, and welcome to Ducommun's 2016 fourth-quarter conference call. With me today are Tony Reardon, Chairman of the Board of Directors; Steve Oswald, 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 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 assurances 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 on Form 10-K for the fiscal year ended December 31, 2016.

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 now like to turn the call over to Mr. Tony Reardon for a review of the operating results. Tony?

Thank you, Chris, and thank you everyone for joining us today for our 2016 fourth-quarter conference call. We will do things a little bit different today. I will begin by providing an overview of recent accomplishments and our current market outlook, and then I will hand the call over to our new President and CEO, Steve Oswald, to say a few words, after which Doug Groves will go over our financial results in detail.

But first let me say a few words about Steve. It gives me great pleasure to have Steve take the helm of Ducommun. His appointment follows a total search by our Board of Directors to find a dedicated, experienced executive to take the Company to the next level in its growth trajectory.

Steve has an excellent background in the industry, having previously served in leadership positions at organizations including Capital Safety, United Technology, Hoechst Celanese, and GE. Since joining Ducommun, he has been diligently working to become familiar with our management team, business units, and our unique manufacturing capabilities and applications.

We are proud of all that we have accomplished this past year, as we have strengthened the balance sheet, streamlined our operations, and improved our overall operating results. I believe that Steve will now bring a fresh perspective to running Ducommun, with the passion, capability and experience needed to drive our long-term financial performance. He will continue our focus on growing the top line, expanding our customer base, and leveraging our unique structural and electronics capabilities to enhance shareholder value.

The Board and I are very confident in the future of Ducommun in Steve's hands, as we turn to a new chapter in our history. I will be staying on as the Chairman to help ensure a smooth transition as Steve guides the Company going forward.

Now turning to our recent results, let me just say how pleased we are to report another quarter of strong performance. We paid down an additional $10 million of our debt during the period, which means we eliminated a total of $75 million of indebtedness this year.

These payments were driven by strong operating cash flow of $43.3 million, and along with the proceeds from some appropriate divestitures that served to focus the Company and improve our long-term margin profile. On that note, we again posted strong gross margins of 19.5% in the fourth quarter, at the same time ending the year with the backlog of approximately $600 million, driven by a nice uptick in the commercial aerospace backlog, which now stands at $318 million.

Now let me provide some additional color on our end markets, products, and programs. I'll begin with our commercial aerospace business, certainly a highlight of our operations. As I mentioned, our backlog here again is at record levels, and spans an array of exciting platform serving Boeing, Airbus, and several other OEMs.

Total commercial aerospace revenue in Q4 was approximately $65 million, and the full-year revenue was close to $264 million, up 6% from 2015. We continue to be pleased with our position on the Boeing 737 and the 737 MAX, the 777, and the 787 programs. As well as the Airbus A320, A330, and the A350 platforms.

As you may have seen, we recently announced that the Company has received a multi-year multi-million dollar contract from Airbus to produce additional titanium structures for engine support and engine frames on the A320neo. This award increased our content on the neo, and illustrates of value-added structural solutions that leverage our titanium expertise, the key area of strategic focus for Ducommun.

Our titanium sales are growing fast, and are expected to represent almost 50% of our structures business in the not-too-distant future. We remain on track to expanding our Parsons, Kansas facility to support our titanium operations and increased demand that we see in the quarters to come. In fact, we are developing over 25 new applications in 2017 in the titanium area alone, and expect this to significantly influence our future growth trajectory, as we continue to invest in titanium to support our customers' changing requirements on next generation aircraft.

Turning to our military and space sector, fourth-quarter revenue fell slightly to $65 million from our $69 million last year, reflecting our Miltec divestiture, but results were up sequentially from the third quarter's $54 million, and our backlog held steady at $257 million, versus our $227 million at the end of 2015. Excluding the Miltec impact, military and defense sales actually rose slightly year-over-year, reflecting higher shipments on radar racks and other components on key platforms, such as the F-18 and the F-15 programs.

We continue to believe that the Company is now operating at a baseline rate of approximately $60 million, plus or minus per quarter, for our military programs and foresee the possibility of higher defense spending under the new administration. It's too early to say how things will play out with the budget in Washington, but we are cautiously optimistic about revenue growth within this part of our business going forward. We anticipate higher shipments of radar racks for the F-15 and F-18 in 2017, along with solid missile systems revenue.

At the same time, we continue to target additional opportunities for innovative solutions, as well as platform modifications and upgrades within the defense arena. Overall, we believe the results in the fourth quarter illustrates the type of operating results we're targeting throughout 2017. However as a reminder, our first quarter is usually our softest from a top line perspective, due to the seasonality, and we expect Q1 for 2017 to be in line with the first quarter of 2016 after adjusting for the divestitures.

Gross margins could be down slightly in the 18% range, due to the number of new programs currently under development that are projected to come online in the second half. Our improved balance sheet and our margin profile should drive solid earnings, as our top line benefits from platform growth and new applications later this year.

Given our position on a number of leading programs ramping up in 2017, most notably the 737 and the A320, and the prospect of slightly higher defense spending, we look forward to another year of strong performance and returns to our shareholders. We did exactly what we said we would do in 2016, and we're pleased with how well the Company is positioned as we begin 2017.

With that, I'm happy to turn the call over to Steve Oswald, Ducommun's new President and Chief Executive Officer. Steve?

Thanks Tony, it's great to be on board at Ducommun, where I see a lot of potential as I begin my tenure as President and CEO. It's been a busy, albeit short time since joining the Company, and I've been focused on meeting with operational management, traveling to the many sites, reviewing program rollout plans, and generally becoming familiar with every asset of the business.

What I have found is an organization of talented individuals who are dedicated, know the aerospace industry extremely well, and are excited about the important role we play on a number of leading platforms. These people, as well as the potential, is why I joined Ducommun, and I will lay out more of my vision in the months to come for the Company.

As you know, a number of measures were already taken to reinvigorate and focus Ducommun even before I arrived, and I want everyone to know we will continue to follow a path that increases both top line growth and bottom line results. The fact that margins are solid, expenses are down, and the balance sheet is strong will provide the flexibility and foundation for us to focus in on innovation, business development, and of course having a world-class team on the field.

As Doug will review in a moment, we posted strong margins and cash flow again this past quarter. We believe the outlook for 2017 and beyond looks promising, given our large book of business and attractive applications on many leading aerospace platforms. It's certainly an exciting time to be joining the Company.

With that, I'll now have Doug review our financial results in detail. Doug?

Thank you, Steve, and good day to everybody. We will review the financial results in a little different order today, by starting with net income, since we had two non-recurring items in the fourth quarter related to the finalization of our Miltec divestiture. Net income was $2.8 million or $0.25 per diluted share, compared to a net loss of $65.2 million or $5.88 per share in the fourth quarter of 2015.

The fourth quarter of 2016 included a negative $1.2 million pretax net working capital adjustment, for which there was no related tax benefit, and a $1 million tax adjustment related to the tax basis of Miltec, both negatively impacting net income. The effect of these two nonrecurring items was $2.2 million after-tax, or $0.20 per diluted share.

Aside from these items, the change in net income year over year reflects two charges recorded in the fourth quarter of 2015, a $57.2 million non-cash pretax goodwill impairment charge within our structural systems segment, and $32.9 million non-cash pretax impairment charge related to an indefinite-lived trade name within our electronic systems segment, partially offset by a higher tax provision this year.

Revenue for the fourth quarter of 2016 was $142.5 million, compared to $156.6 million for the fourth quarter of 2015. The decline year over year primarily reflects $17.5 million of lower revenue within the Company's industrial end markets, due to the divestiture of our Pittsburgh facility in January of 2016, the closure of our Houston operation in December 2015.

We also saw $4.5 million of lower revenue within the Company's military and space markets, mainly due to the divestiture of our Miltec business last March, but we posted $7.8 million higher revenue within our commercial aerospace markets, reflecting new awards and increased content. Ducommun's backlog improved to some $600 million at year-end, the highest level since 2012, excluding divested operation, and a rise of nearly $34 million from Q3's $566 million. This was again driven by an increase in our commercial aerospace business, once more illustrating our strong position in an expanding market.

Moving to gross profit, our gross margin was 19.5% in the fourth quarter versus 14.6% in last year's comparable period. The higher gross margin was primarily due to improved product mix, the Company's ongoing supply chain initiatives, and improved overall operating performance.

SG&A fell in Q4 to $18.8 million from $21.2 million in 2015. This reflects our divestitures and cost-cutting initiatives, as well as a decrease in compensation and benefit cost. For 2017, we do expect SG&A to run slightly higher at closer to 14.5% of revenue, primarily the result of some nonrecurring executive transition costs.

Operating income for the fourth quarter of 2016 was $9 million or 6.3% of revenue, compared to an operating loss of $88.6 million in the prior period. The increase in operating income year-over-year primarily reflects the 2015 impact from the impairment charge, as I previously mentioned. Excluding these, the improvement in 2016 reflects higher overall operating performance.

Interest expense decreased to $2 million in the fourth quarter of 2016, compared to $2.2 million last year, primarily due to lower outstanding debt as a result of net voluntary principal pre-payments on the Company's credit facilities. Our effective tax rate expense during the quarter was $3 million or 51.3%, compared to a benefit of $25 million or 27.7% in the comparable period last year.

The tax rate in the fourth quarter of 2016 was a result of the one-time nonrecurring items that I noted while discussing our net income. The number $2 million pretax negative working capital adjustment reduced our pretax income, but there was no corresponding tax benefit, and the $1 million tax adjustment was related to a true-up in the tax basis on the Miltec divestiture, which is now finalized.

Lastly the higher year-over-year tax rate also reflects the 2015 impairment charge as previously mentioned. Going forward, the tax rate for 2017 is expected to be approximately 30% to 31%. Adjusted EBITDA for the fourth quarter of 2016 was $15.1 million or 10.6% of revenue, compared to $11 million or 7.1% of revenue for the comparable period in 2015.

Now, let me turn to our segment results. Our structural systems segment posted revenue of $60.8 million in the fourth quarter of 2016, versus $61 million last year. The slight decline was primarily due to $2.9 million in lower military and space sales, reflecting program delays, budget changes that impacted deliveries on certain of our platforms. The reduced military revenue was almost entirely offset by $2.8 million of higher commercial aerospace sales.

Structural systems operating income for the fourth quarter was $3.2 million or 5.2% of revenue, compared to an operating loss of $56 million last year. The increase in operating income year over year primarily reflects 2015's $57.2 million goodwill impairment charge, as I previously mentioned.

The fourth quarter of 2016 also included the impact of an additional investment in new programs, which reduced margins when compared to the third-quarter year-to-date figure of 7.2%. Note that due to the ramp-up of platforms and impact of related investments in 2017, we see operating margins for structural systems trending in the 5% to 8% range in the very near term.

Turning to the electronic systems segment, our electronic systems segment posted revenue of $81.7 million in the fourth quarter, versus $95.6 million in the prior-year period. These results reflect the $17.5 million decrease across our industrial end markets due to the divestiture of our Pittsburgh facility and closure of our Houston operation, as I previously mentioned. In addition, electronic systems saw a $1.5 million decline in military and space revenue, reflecting the divestiture of our Miltec operations. These negative factors were partially offset by a $5.1 million increase in commercial aerospace revenue, reflecting added content with existing customers.

Electronic systems posted operating income for the fourth quarter of $9.2 million, or 11.3% of revenue, compared to an operating loss of $27 million in the prior period. The increase in operating income year-over-year primarily reflects 2015's $32.9 million impairment charge as I previously mentioned, slightly offset by the impact of lower revenue in 2016 due to the divestitures and plant closures discussed.

Corporate, general, and administrative expenses, CG&A, for the fourth quarter were $3.4 million or 2.4% of Company revenue, compared to $5.6 million or 3.6% of revenue last year. The decrease in CG&A expenses was primarily due to lower professional fees of $1.7 million, and lower compensation and benefit cost of $0.5 million.

Turning to liquidity and capital resources, we generated $15.8 million of cash from operations in the fourth quarter of 2016, compared to $11.6 million in 2015. For the full year, we generated $43.3 million in cash flow from operations, compared to $30.5 million in the prior-year period which would exclude the use of $9.8 million for the redemption of the senior notes that were redeemed that year.

We remain diligent in working capital management, and expect our net cash profile going forward to reflect historical seasonal patterns. We also paid down an additional $10 million of debt this quarter, as Tony mentioned, and reduced our debt in total by $75 million in 2016. We expect to pay down approximately $25 million of debt during 2017, as we continue towards our goal of deleveraging to a target of 2.25 to 2.5 times debt to EBITDA.

Capital expenditures were $4.3 million in the quarter, and we expect CapEx to be approximately $22 million to $26 million for 2017, driven by the expansion of our Parsons facility and continued investment in new programs, as we prepare for the next-generation platforms ramping up later this year, as Tony mentioned.

In closing, the quarter played out much as we expected, and benefited from the many steps taken in 2016 to streamline our operations and focus our core business. As Tony discussed, we expect our Q1 2017 revenue to follow historical seasonal patterns, and then grow 2% to 3% sequentially this quarter throughout the year. With our strong cash flow and solid bottom-line results, we will continue to pay down debt as appropriate.

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

Thank you, Doug. With Ducommun's leadership now in Steve's hands, I just wanted to thank our Board of Directors, our investors, our employees, and our customers with the many years I've had the pleasure working with you. The Company has changed dramatically since I became CEO in 2010, and my goal was to leave Ducommun in a better position than when I started, which hopefully I have been able to accomplish for our shareholders.

As the Chairman of the Board, I want to continue to work with and to support Steve and his leadership team, to achieve our goals of improving shareholder value. Ducommun could not be the company it is today without our entire team coming together to serve our customers and shareholders, in a way that has dramatically improved our competitiveness and our market position.

I'm proud to turn over the reins to Steve at this pivotal time in our history, where the next stage of Ducommun's growth trajectory is clearly at hand. With our company in solid shape operationally, a strong backlog and platform expansion right around the corner, I firmly believe that Ducommun, under Steve's capable leadership is in a sound footing for 2017 and beyond. With that, Sonja, I'd like to open up the call for questions.

(Operator Instructions)

Edward Marshall, Sidoti & Company.

I just wanted, the first question I had was you gave some outlook into the Q1, and you referenced. I'm just curious, could you parse out what the divestitures were in the first quarter of 2016, or the revenue that you accumulated from the divestitures?

Sure, that's about $9 million in the first quarter for the divestitures in 2016.

Got it. Okay, and you talked about the higher costs associated with the CEO transition. Did you quantify what that would be, that you experienced in 2017?

No Ed, we don't quantify that specifically, other than to say our SG&A will be running a little bit higher this year, as noted in the remarks, probably closer to 14.5% than the 14.1% we were at this year.

Would you break that out as far as each quarter or is this -- my understanding is that would be looked at as somewhat one-time in nature?

No, some of it spreads across the year, so I would say it's probably heavily weighted in the first quarter, but there will be some that comes to the second half of the year.

Got it. And you said the neo, you talked about the neo content, but I don't know that you ever quantified it. Could you talk about what you have on the neo today, and maybe where you anticipate that program might be, as you have some bids out, I'm assuming?

We have a number of different applications on the neo today. We don't really quantify ship set value as we go forward, especially on new programs that we are developing for competitive reasons. But suffice to say that we have won a number of applications on the neo, primarily in the titanium area, but we have been very successful and continue to be successful in our bid processes, so we expect that to be a solid program for us going forward.

Okay, and you said radar racks and missile systems are coming through in 2017. I think that was a negative for you in 2016, as those programs weighted on some budgets. Could you talk about maybe what you anticipate to happen in 2017 from a numbers perspective, from those two programs?

I think that we will see a pick up on the military side, but I think that when you look at our total military business, it's going to stay in that $60 million total revenue range, with the pick up. We are trying to get a steady-state on the F-18 and the F-15. If you noticed over the last couple of years, it's been up and down due to late lead time issues from our customer, but we are trying to get that smoothed out this year so that you see more of a steady state as that goes along, and that gives us the confidence to say that we're going to be in that $60 million-ish range going forward quarter over quarter.

But it's a richer mix?

It's a good mix, yes.

And then finally, as I look at your backlog and we're near record levels, I'm curious as to if you look at it this way, I'm not sure. But the new programs and new awards that you have won over the last couple of years, how much of that as a percentage of your backlog, or any clarity that we can look at? Maybe your success rate, or your batting average that you have in backlog, based on what you've done over the last couple of years from new awards, new programs, bids on the neo, bids on the 737 MAX, et cetera?

I think we've done well in both of those areas. We don't like to quantify that data because of competitive reasons, Ed, but suffice to say the pick up between the third quarter and the fourth quarter was all commercial programs, and primarily new applications.

Got it. Thanks.

Ken Herbert, Canaccord Genuity.

I wanted to first ask, that you gave some guidance, and considering the new programs and the impact for margins within the structures segment. As I look at electronics systems, is it fair to assume now, since we saw a really nice uptick in the fourth quarter that for 2017, we should assume double-digit margins in that business? Or maybe any color around that, like you provided on the structures side, would be helpful?

Ken, this is Doug. We have historically said it was a really nice quarter, 11.3% margin for the year at 9.5%, so I think that range of 9% to 10% is where we see that business. It will bounce around in between quarters because of our product mix, but probably be within that range as we move through 2017.

We had a nice mix in the fourth quarter and that's what gave us the uptick.

Okay, so clearly a bit of a nice mix, but the mix maybe isn't as good in 2017?

I wouldn't say not as good, I would just say that is going to bounce around. The quarterly operating margins for that business the first quarter was a 8.2%, the fourth quarter was 11.3%, so it does move around from quarter to quarter depending upon the products that are getting shipped within the quarter.

Okay.

We're really comfortable in that 9% to 10% range, and look for the uptick, and we are working for that.

Okay, and the step-down in margins in structures, was that 100% due sequentially, 100% due to the introduction of the new content you have won and the mix there, or was there anything else that happened in the quarter?

I think it's twofold. One is some of the step-down, as we talked about in the third quarter, is really from the military side, the lower military revenue, which was a little bit richer. But we are investing heavily in the new programs, and we have a number of new programs on the titanium side, as well as on the composite side, where we have invested heavily in the programs and continue to do that. So we saw that little higher investment in the fourth quarter, as Doug talked about in his remarks, but we continue to see investment going forward in the first quarter, and probably in the second and third quarter not as high an extent.

Okay, that's helpful. And then if I could, the backlog question a different way. You obviously added about a $36 million, $37 million sequential step-up in the backlog, and as you indicated, it was virtually all on the commercial aerospace side. Is it fair to assume that step-up is virtually all narrow body, which is where it seems to have been, you have been winning significant content on the titanium side?

Absolutely, that's correct.

All right, that's helpful. And finally, Doug, sorry if you mentioned this, but what's the assumption for D&A for 2017?

The A stays about the same, the run rate where we're at now, amortization about $9 million. And then the depreciation will step up with the additional CapEx, probably $1 million to $2 million off of what our run rate was this year, primarily driven by the investment in the Parsons facility.

Okay, that's helpful. And then if I could, one final question maybe for Steve. I know obviously, you have just settled in, you are going to be hitting your leverage targets depending upon how fast the EBITDA ramps mid to second half of this year. Anything, Steve, you would care to say around capital deployment, or any thoughts you might have, that as you think about the free cash flow generation and as that continues to increase, as you look to use capital?

Yes, thank you for the question. We have still got some work to do in the first half of the year to pay down some debt, but my view is the second half of the year, we're going to start looking for effective acquisitions, what I call them, to really increase our value portfolio. I think more to come on that, but the first half is pay down debt, and then we will start moving forward.

Okay. Helpful. Thank you very much.

(Operator Instructions)

Mark Jordan, Noble Financial.

A question which is more longer-term on the structures side. Once we get through this bubble of investment in new programs, and late in 2017 or into 2018, what should be the normalized operating margin in the structures group again, once we get past this wave of investment in new programs?

Mark, I think that after we run through these investments, we should be returning to that 8% to 9% range, and driving towards the 9%, if you will. But we do have a number of new program developments going on, as we indicated. But that's our goal, is to get it back to that range, and that path.

Okay. Could we talk, just a little bit, you teased us with a little bit of detail on the titanium business, as far as its contribution to structures, moving towards half of the business. Where are you, where were you at the end of 2015, and a snapshot where are you now in terms of sizing that as the overall piece of the business?

At the end of 2015, I would say that the titanium was approximately 40% of the base, and we have three businesses that actually are working in titanium, forming and super plastic forming. So we get a combination of it. So a lot of the helicopter work, if you remember in 2015, we were still pretty heavy in the helicopter, military helicopter sales were up, and there's a lot of titanium products that are on those programs.

As they came down, we replaced a lot of that with the new commercial narrow body program. So we're moving towards that 50%, and I would say as you move into the first half of 2018, as the rates ramp up, that should be pretty close to what that number is. Now we are working on some other new programs on the composite side that could put a dent in that, but we are in the right direction there.

Okay, final question for me, relative to you mentioned some contract delays on the military side. Are those issues related to a delay in the approval of 2017 budget, or is this just generic DoD moving slowly?

It's a little bit of both. The budget, we're still under a CR, and hopefully that gets replaced by the budget, so some of it is just moving the contracts over, and other is exactly what you said, just slower movement.

Okay, thank you very much.

Mike Crawford, B. Riley & Co.

Further to the helicopter side of your business, it looks like the House has requested in its appropriations bill a much larger number than the prior administration initially put out for the year, and I think earlier you had said you expected that number to move more towards 60 to 65 for Black Hawks, for example, but what's your opinion overall of where that business is headed for Ducommun?

I think right now, Mike, the best thing for us to do is remain in that 65 to 70 ship sets, but I think that we saw the same data that you saw, in terms of the budget, and there's a good possibility that could go up a little bit, but we're on the wait and see on that, so from a forecasting standpoint, we're staying at the 60 to 65.

Okay, thank you, and then you are investing in Parsons in 2017, and is that expansion expected to be substantially completed by 2017, and then CapEx comes back down a little bit, or what do you see?

Yes, that's exactly right, Mike. The expansion is largely completed as we exit 2017, so the CapEx comes back down to what I would call our historical range, $15 million or so per year, once we exit 2017 and go into 2018.

We are expecting to continue to grow, so we will spend the capital as needed.

Right, as long as you get a good return on investment on it. Final question, just touching back on M&A, where you said you might have some room to start looking again in the second half of 2017, but what effect, if any, are you seeing on your business now, given some of the other recent consolidation in your space?

Mike, not much so far. Obviously there's been some recent activity, but we haven't seen that as either a positive or a negative. We are pretty well entrenched with our customer base and the unique solutions that we offer, so it really hasn't been an impact on us thus far.

Okay, great. Thank you.

Thank you and there are no other questions in queue. I would now like to turn the call back over to Tony Reardon for any further remarks.

Thank you Sonja, and thank you everyone for joining us today. We really appreciate your continued interest and support, and we look forward to speaking to you next quarter. Thank you, everybody. Goodbye, now.

Ladies and gentlemen thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.