Ducommun Inc (DCO) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ducommun Third Quarter Conference Call. (Operator Instructions) As a reminder, this call is being recorded. And I'd like to introduce your host for today's conference, Chris Witty, moderator. Sir, you may begin.

Thank you, and welcome to Ducommun's 2018 Third Quarter Conference Call. With me today are Steve Oswald, Chairman, President and CEO; and Doug Groves, Vice President, Chief Financial Officer and Treasurer.

I'm going to discuss certain limitations to any forward-looking statements regarding future events, projections or performance that we may make during the prepared remarks or the question-and-answer session that follows. Certain statements that are not historical facts, including any statements as to the future market conditions, results of operations, our restructuring plans and financial projections, are forward-looking statements under the Federal Private Securities Litigation Reform Act of 1995 and are, therefore, prospective. These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we can give no assurances that such expectations will prove to be correct. In addition, estimates of future operating results are based on the company's current business, which is subject to change. Particular risks facing Ducommun include, among others, the cyclicality of our end-use markets, the level of U.S. government defense spending, legal and regulatory risks, management changes, the cost of expansion and acquisitions and competition. These risks and others are described in our annual report on Form 10-K filed with the SEC, and our forward-looking statements are subject to those risks. Statements made during this call are only as of the time made, and we do not intend to update any statements made in this presentation except if and as required by regulatory authorities.

In addition, all comparisons on today's call recognize the implementation of the FASB Accounting Standards Codification, or ASC Topic 606, covering revenue recognition policies on current results. Please see the company's filings for further description of this change and a comparison to the prior policy, ASC 605.

This call also includes non-GAAP financial measures. Please refer to our filings with the SEC for a reconciliation of non-GAAP measures referenced on this call to the most similar GAAP measures.

We filed our Form 10-Q with the SEC today, and you'll find a link to all our filings on the company's website under the Investor Relations tab.

I would now like to turn the call over to Mr. Steve Oswald for a review of the operating results. Steve?

Thanks, Chris, and thank you, everyone, for joining us today for our 2018 third quarter conference call. As usual, I'll begin by providing an overview of recent developments of the company, after which Doug will review our financial results in detail.

As with the second quarter in 2018, the third quarter again demonstrated the ongoing benefits of many actions we've taken over the past 18 months to improve Ducommun's growth trajectory and overall financial results. Effective restructuring strategy, record backlogs, new program wins and a leaner, more efficient organization is now starting to be realized in our financial performance.

Revenue rose 15.3% year-over-year to $159.8 million. The double-digit growth reflects the continued strength across a number of programs, both commercial and defense-related, which Ducommun is benefiting from a significant shipset amount per platform and rising bill rates. The company is also known as a lead provider of advanced structural and electronic components for many large, narrow-body aircraft, and our share gains to this market is growing quarter-by-quarter.

At the same time, we recently announced a $200 million long-term contract producing nacelle components using our new proprietary VersaCore Composite technology for a leading engine OEM. While we cannot name the customer for competitive reasons, the contract, which runs through 2029, is an excellent example of the company leveraging its manufacturing expertise, proprietary materials along with process technology and composites. Ducommun will complete the nacelle product design in 2019 and then begin full production in 2020. For background, the VersaCore Composite technology enables the manufacture of lightweight aircraft structures at much lower cost without compromising durability.

We also again posted stronger gross margins this quarter of 19.8% after purchase accounting adjustments and the impact of ASC 606 versus 18.8% last year, and our adjusted op margins rose 90 basis points to 6.2% from 5.3% in 2017. Our structures adjusted operating margin, which has been a major focus, climbed to 9.1% from 6% last year, an increase of 300 basis points or 50%. And this is due to many initiatives implemented to drastically improve our operating efficiency and capacity utilization.

In addition, we booked $3.4 million of restructuring charges this past quarter, which Doug will review further in a moment. We remain on track to eliminate roughly 60% of our floor space by year-end and reduce staff by 6%, resulting in annual savings of approximately $14 million starting in 2019. We ended the quarter with a solid backlog of $780 million, still near record levels and reflecting strong orders of both commercial and defense-related platforms. We generated $7.2 million in cash from operations, which equates to roughly $33.4 million of cash flow year-to-date. Given the strength of our balance sheet, accelerating top line growth and improving margins, Ducommun is on track as we turn the corner on 2018.

Now let me provide you some additional color on end markets, products and programs. Beginning with our military and space sector, we posted third quarter revenue of $71.5 million, up over 10% from last year, reflecting higher shipments for the F-16, F-18 and F-35 programs along with other military aircraft. In fact, sales to fixed-wing defense platforms rose 35% year-over-year. It's a great performance and shows the enduring value of these planes and the integral content Ducommun provides, such as radar racks and cockpit electronics. We anticipate continued strong revenue going forward based on the outlook for military spending this year and next. Our military and space backlog was just under $300 million at the end of the quarter, remaining near-record levels.

Within our commercial aerospace operations, third quarter sales rose approximately 27% year-over-year to $76.3 million we once again saw significant growth across our large fixed-wing aircraft applications, reflecting higher build rates for the Boeing 737 platforms and the Airbus A320 family. We are clearly benefiting from having a greater presence on these aircrafts and increasing demand for narrow-body platforms in general. Our content per shipset is over 15% higher on the Boeing 737 Max than it was on the 737 NG. While with Airbus, Ducommun's total sales are up 34% year-over-year, and our A320 business has more than doubled in the last 12 months. As mentioned in the past, Airbus became a new customer in 2016, and we're now seeing the benefits of significant runway ahead. The backlog within our commercial aerospace sector stands at $442 million, down slightly from Q2 in recognition of order timing. We're confident that our position across such platforms will remain strong, driving continued higher revenue heading into 2019.

Before turning the call over to Doug, I wanted to mention 2 other important matters: First, we recently announced that Shirley Drazba joined Ducommun board as an independent director. I'm delighted to have Shirley as part of our Ducommun team, and her appointment expands the number of directors to 8, 7 of whom are independent. In addition, Shirley will be a member of the company's new Innovation Committee, which is designed to oversee our ongoing forward activities in developing additional technologies for aerospace and defense customers. She also brings years of product innovation experience from leading positions at IDEX and Honeywell, and we're very happy to have a person of her expertise and background at Ducommun.

I'd also like to remind our listeners that Ducommun will host its first ever Investor Day in New York this Friday morning, November 9. We've already heard from over 50 analysts, institutional investors, financial advisers who plan to attend. We look forward to a productive day of presentations and meetings. Besides myself and Doug, we'll also have in attendance, Dave Wilmot, our Vice President of Electronics and Engineered Products; Jerry Redondo, Senior Vice President of Operations and Vice President of Structures; and Suman Mookerji, Vice President of Strategy and M&A. We hope you can attend this important meeting.

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

Thank you, Steve, and good day, everyone. As a reminder, my comparisons on today's call are on a year-over-year basis and recognize the implementation of FASB Accounting Standards Codification, or ASC Topic 606, covering revenue recognition policies on current year results. Please see the company's filings with the SEC in today's press release for further description of this codification versus the prior policy, ASC 605.

Revenue for the third quarter of 2018 was $159.8 million versus $138.7 million in the third quarter of 2017. This performance primary reflects $16.3 million of higher sales to the company's commercial aerospace customers and $6.8 million of greater revenue within the military and space sector. The increase in both of these markets were due to higher shipments for fixed-wing platforms, such as the Boeing 737, Airbus A320, Lockheed Martin F-16, F-35, and Boeing F-18, as Steve just mentioned. Ducommun's overall backlog was about $780 million at the end of the quarter, down slightly from $823 million in Q2 just due to order timing. However, it remains at near-record levels.

Moving to gross profit. Our gross margin was 19.8% after purchase accounting adjustments and the impact of ASC 606 versus 18.8% in the prior year's comparable period. The increase year-over-year was primarily due to higher production volumes, lower manufacturing overhead cost and favorable product mix.

SG&A was $21 million in the third quarter versus $18.7 million in 2017, with the increase primarily reflecting higher compensation and benefit costs and professional service fees.

The company reported operating income for the third quarter of $6.8 million or 4.3% of revenue versus operating income of $7.3 million or 5.3% of revenue in the prior year period. On an adjusted basis, operating income for 2018 was $9.6 million or 6.2% of sales, up 90 basis points year-over-year. Our restructuring activities included approximately $1.6 million of charges within the Structural Systems segment, $1.2 million within Electronic Systems and $0.6 million at the corporate level, which in aggregate equaled $3.4 million. As mentioned previously, by year-end, we expect to be operating with 16% less manufacturing square footage and 6% fewer staff, eliminating approximately $14 million in annualized expenses by 2019. We expect to incur additional restructuring charges of approximately $2 million to $3 million in the fourth quarter, bringing the total program to $21 million to $23 million since starting in Q4 of 2017.

Interest expense was $2.5 million in the third quarter of 2018 versus $2.2 million last year due to higher utilization of our revolving credit facilities for recent acquisitions.

The company reported net income for the third quarter of $4.2 million or $0.36 per diluted share compared to net income of $4.7 million or $0.41 per diluted share for the third quarter of 2017. Adjusted net income was $6.2 million or $0.53 per diluted share with an effective tax rate of 2.8% in the current quarter. Our expected tax rate will be approximately 17% to 18% before any restructuring charges in the fourth quarter and as we head into 2019.

Adjusted EBITDA for the third quarter was $18.1 million or 11.3% of revenue compared to $14.6 million or 10.5% of revenue for the comparable period in 2017.

Now let me turn to our segment results. Turning to Electronic Systems segment. Our Electronic Systems segment posted revenue of $85.7 million in the third quarter of 2018 versus $79 million in the prior year period. These results reflect the $6.7 million increase in sales to our commercial aerospace customers and $2 million higher shipments within the military and space market. Electronic Systems posted operating income for the third quarter of $9.1 million or 10.6% of revenue versus $8.3 million or 10.5% of revenue in the prior year period. Excluding restructuring charges, the impact of ASC 606, the electronics adjusted operating margin was 10.5% for the 2018 third quarter.

The Structural Systems segment posted revenue of $74.1 million in the third quarter of 2018 versus $59.7 million last year. The year-over-year increase was due to $9.6 million of higher sales across our commercial aerospace applications, particularly on the large-jet, single-aisle platforms as well as $4.9 million of increased revenue within the military and space markets due to increased shipments on helicopter platforms. Structural Systems posted operating income for the quarter of $4 million or 5.3% of revenue compared to operating income of $3.5 million or 5.9% of revenue last year. Excluding restructuring charges, purchase accounting adjustments and the impact of ASC 606, the structures adjusted margin was 9.1% for the third quarter compared to 6% last year, a 50% increase.

Corporate, general and administrative expenses for the third quarter were $6.2 million or 3.9% of total company revenue, compared to $4.5 million or 3.2% of revenue last year. The higher CG&A expense was primarily due to higher compensation and benefit costs of $0.8 million, restructuring charges of $0.6 million and higher professional service fees of $0.6 million.

Turning to liquidity and capital resources. We generated $7.2 million of cash for operations in the third quarter of 2018 versus $11.1 million in 2017. However, on a year-to-date basis, we've generated $33.4 million in cash from operations compared to $27.4 million in the prior year comparable period. We also paid down $2 million of debt during the quarter, bringing the year-to-date total to $18 million, and we expect to pay off approximately $25 million for the full year.

In terms of CapEx, we spent $5.3 million during the third quarter. On a year-to-date basis, we spent $12.8 million compared to $24.6 million in the prior year. We still anticipate spending approximately $15 million to $17 million in 2018 to support new program wins, such as the ones Steve previously mentioned.

We're pleased with our overall improved operating performance this year. Our restructuring plan is on track to be completed this year, and our results reflect our continued focus on operational excellence as well as strong top line growth, and we're optimistic of our continued higher returns in the quarters to come.

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

Okay. Thanks, Doug, okay. Before turning the call over to questions, I'd like just to once again reiterate that Ducommun is -- we're now really seeing the benefits of all the actions and activities in 2017 and 2018. In addition, as a leader across the markets, we're continuing to move the company, I believe, in a very positive direction and the future has a great amount of runway for both revenue growth and margin expansion. I also want to take this time as we wrap up here to let our investors know we appreciate their patience and their continued interest in our success.

So with that, operator, we'll now open the call for questions.

(Operator Instructions) Our first question comes from Edward Marshall from Sidoti.

The 15.3% revenue growth, I kind of -- I know there's been some price initiatives that you've been kind of thinking to implement. When you kind of look at that growth, could you kind of talk about price volume and maybe even market share, kind of how that breaks out and what's been driving that growth rate?

Sure, Ed. Well, I think I can answer part of the question. If you look on the appendix of the earnings release, we did pick up about $5 million in revenue from the adoption of ASC 606. So that definitely drove the growth and the revenue a little bit higher over last year, which, of course, is a 605 number. And the pricing initiatives that we've talked about the last few quarters continue as contracts come up for renewal. And of course, the volume side of things is really, we see, on the single aisle, which was denoted in the comments. So it's a combination of those 3 things that drove the growth. But certainly, we're pleased to see that all the work we put in is meaningful.

Got it. And when I look at the structures margin, in particular, I'll note the continued improvement on a year-over-year basis. When I look at the incremental margins, it has kind of have been all over the place this year. And I'm wondering what you might think about either, you call, incremental or combination -- or a contribution margin. What do you think the normalized number might look like for that business on a go-forward and specific to the structures?

Well, we've been consistent in our messaging that we're going to exit this year on high single digit. We're roughly 8.5% on an adjusted basis through 3 quarters. So we're well on track. Do we think we can get it to double digits? We're certainly going to work towards that, but we're going to stick to the high single as we exit this year with certainly more [to come and change as we see the top line growing] particularly on the single-aisle platforms.

Yes, this is Steve. I'd say the same thing. There's more to come, okay?

Right. I guess what I'm talking about is the additional -- the incremental revenue over a certain threshold, right, the incremental margin that might be dropping through. What's the rate? I mean, once you've covered your fixed cost, what's the rate of drop-through there as opposed to just kind of a guesswork on my own?

Sure. Well, on an operating margin perspective, it's probably about, I'll say, 100 basis points of pure incremental once you get to a certain level of volume at the operating margin level.

Got it. And the final question, if I may. Looking at the nacelle program, first, I'm assuming that -- is that composites? Or is that titanium?

Yes, that's composites. That's our -- so we have a new composite process called VersaCore. So that's a straight-up composite work from [that] nacelle.

Right. Who pays for the tooling? Does the customer pay for the tooling? Or do you kind of incur those costs and then that's reimbursed as part of revenue as you kind of build to that in the new program as you ramp up? How's the tooling work associated with composite work?

Sure. It's similar to the other structures businesses that we have. We're under a development contract right now as we're building out the processes as well as the tooling and getting ready to industrialize this in the latter part of 2019.

Got it. So should I think of that as a typical run rate initially or see a little bit of compression in the margin? And ultimately, as that program gets up to run rate, it should be contributing according to the -- at the typical level?

That's correct. That's generally the way the structures programs work. There's a learning curve when you get in the initial production. And then obviously, with volume and experience, the margins come up.

Got it. And is there any specific -- is there a -- is this a significant amount of tooling in -- as opposed to some of the metalwork that you do? Or is this more complex? Or just kind of trying to think about the cost curve there.

No, no. It's probably actually less than the other structures businesses that we've got because this is out-of-autoclave technology.

Our next question comes from Ken Herbert from Canaccord.

I just wanted to first start off. You talked several quarters now, and it clearly seems like you're winning more business on the narrow-bodies, the 737 in particular. Can you just talk sort of -- can you frame that in terms of the overall contribution of that program to your business as sort of part 1? And then second, are there any -- as you step up to 57 a month, is there any sort of incremental investments from a capital standpoint you need to make to support that rate moving forward?

Do you want to...

Sure. So the -- let me start with the easy part of the question, which is certainly the capital investment required. So I think as we've talked about, we've made that capital investment over the last few years. So going from 52 to 57 and higher, we've got the footprint in place to be able to support those rate increases. The -- a lot of the new business wins that we've gotten on the MAX have come from the titanium part of the structures business, which has been a big focus for us. We like that business a lot, and we're seeing a lot of opportunity with Boeing as well as with Spirit as we look at new applications and share gain.

Yes. I've been -- just so everybody on the call -- the main 2 titanium operations are Coxsackie, New York near Albany and Parsons. And [I have visited] -- that both facilities in the last couple of months, and we're all working towards this 57. For the most part, we've got all the capital and all the machines in place. It's just about driving the supply chain and get to a higher level. So we're comfortable, and we're looking forward to the rising rate.

Okay. That's helpful. And are you seeing any risk or any pressure points in your particular supply chain on the 737?

This is Steve again. Not really. I mean, we -- a lot of our gain on this is titanium sheet, and we have a good flow of that. We certainly manage our inventory appropriately to make sure that we always are covered. And on the other suppliers, which are more minor, we're in very good shape. So for -- at least from the Ducommun side, it's a good story.

Okay. And I guess, it would be -- is it fair to say that sort of the sequential growth in inventory we've seen this year -- I know, obviously, it's down from a year ago but as it stepped up each quarter, could be just reflecting some of the longer lead times on titanium? Or is that maybe related to other programs?

Yes, it's probably that. I mean, you've got these long-cycle orders, and so that's -- definitely, a part of it is the ramp-up and the order ahead of it.

Okay, okay. And then if I could, just on the defense side, obviously, you called out a few programs. You've seen some really nice growth in the quarter. What's your view on sustainability? Are we sort of early as you look at the opportunities within your defense portfolio? Do you view some of this growth as maybe tapering off into '19? Maybe what's your -- not fourth quarter view but the next sort of 2- to 3-year view on the defense business?

Both Doug and I will weigh. I just -- I guess, a couple of things. First, obviously, we have a budget. So we're happy with that. So we have some certainty. So we feel good about the next 2 or 3 years. The other thing I'll say is that we, obviously, have some strategic customers. But we have other customers where our share of market or share of account is fairly low, okay. So we're also -- as we look forward, it's not only, okay, the defense budget and things are up, but it's also that it's still early innings for Ducommun, okay, across the industry certainly with some of the other big clients.

And Ken, I would add. I mean, as we look at the defense portfolio, the -- we've got multiple missile programs largely with Raytheon but some also with Northrop Grumman. And given what we see with 4 military sales and just the way the budget is being funded and characterized that there should be good longer-term growth there. The F-35 is emerging as a big program for the company as we gain more share there, primarily in the electronics part of the business. And then we've got the F-18 and the Apache, which -- again, both have good, strong funding for the next couple of years from what we can see.

So I guess just finally, Steve, if I interpreted your comments, it sounds like there's a nice opportunity. You're seeing some share gain with some of your, obviously, customers [or in] some opportunities as well as certainly just the volume growth.

Absolutely, yes, yes. So like I said, there's -- look, we're happy with the volume and it's been a good thing for the company. And obviously, our customers are very busy and we're very busy. But I think there's also, in the whole term, the early innings. I think there's more to come also on the share side.

Our next question comes from Christian Herbosa from NOBLE Capital Market.

I have a couple of questions. First, could we get an update on the integration of the -- of your recent LDS and CTP acquisitions? Should we expect to see any additional marginal enhancement coming from these acquisitions? Or are they fully integrated at this point?

Thanks for the question, Christian. They're really fully integrated. I mean, these were smaller companies. We were able to successfully integrate them. And as we talked about in previous calls, we've got some very experienced people in the company now that know how to do this. So we're looking forward to now really helping those businesses grow as they're part of the Ducommun portfolio. So the integration is behind us, and we're really focused on growing those businesses now that we own them.

Okay, great. That's good to hear. And then my second question was regarding the Boeing 737 owned by Lion Air that crashed in Indonesia recently. Do you have any concerns about how any of the possible outcomes of the investigation into that incident might impact your business?

No, we don't have any concerns, Christian. I mean, while a tragedy, we're -- we look at what we do for the aircraft and [our quality records and] Boeing standards. We don't have any concern that there's anything that's a threat to Ducommun.

Okay. And my last question was regarding the -- your restructuring charges. How much -- how many more -- how much more are the additional restructuring charges do you expect to incur?

Sure. So as mentioned in the comments, we're looking at probably $2 million to $3 million in the fourth quarter, and we'll have this wrapped up as we exit this year. The transfer of our Phoenix facility to our Huntsville, Arkansas facility is well underway and should be done as we exit this year.

(Operator Instructions) We have Mike Crawford from B. Riley FBR.

It's nice to see the sales -- 17% of sales to Boeing. I did notice that if you take your top 5 customers and then the next 5 and the top 10 that's -- whereas it's almost 47% of revenue from the top 5, it's only 15% from the next 5 thereafter. So I mean, is it those 5 or others beyond that where you say it's still early innings and you expect to get more business from? Or do you expect to see more growth just from kind of the big 5 you're currently serving?

Well, Ken (sic) [Mike], I think a great example is Lockheed, who's an important customer of ours. Most of the work we do there is on the Black Hawk, where we've got a tremendous opportunity to take what we've done with Raytheon and their missile business and apply some of the same capability to Lockheed. So I think there's a lot more opportunity with some of those customers that were not -- that we're getting after but sort of haven't captured yet.

But I think the other thing -- this is Steve, is there's certainly -- we believe there's certainly a good amount of opportunity in those top 5. But then to your point, there's also -- as well in the next 5, okay. So I think overall, I think it looks very positive.

And then maybe outside of that, Viasat, another company I cover, has been disclosing in its SEC financials the growing numbers of cash paid in -- to Ducommun and payable to Ducommun. So can you say what it is you're making for Viasat or whether there's growth opportunity there?

No, we don't disclose that customer information unless we have their consent other than to say they are customer of ours. Good customer.

I thought it's worth a try since you're mentioned in their filings, okay. And then just final question on the M&A front. Is there any change in the number or -- of companies or quality of companies that you're finding in your pipeline or how you're progressing through them?

No, I think it's steady as it goes, right. So we have a good process. We have good discipline. We have Suman Mookerji running it. We've got a lot of faith in him, and he's already made a difference with those 2 acquisitions. So I'd say the profile is pretty much the same. You, Doug, as well...

Yes.

Agree with that? Yes.

At this point, there appears to be no further questions in queue, and I'd like to turn the call back over to Steve Oswald for any closing remarks.

Okay, great. Well, let me just wrap up here again. I want to thank everybody for their time this afternoon. We're upbeat and we're really proud of our team and proud of their work the last 2 years. It's showing in the numbers. And we're -- again want to thank those who cover the company and, most of all, investors who have been patient and committed to these new changes. So I'll leave it there, and I want to wish you a good evening. Thank you.

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.