Ducommun Incorporated (DCO) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ducommun First Quarter 2017 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 call is being recorded. I would now like to introduce your host for today's conference, Mr. Chris Witty. You may begin.

Thank you, and welcome to Ducommun's 2017 First Quarter Conference Call. With me today are Steve Oswald, 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 future market conditions, results of operations and financial projections, are forward-looking statements under the federal Private Securities Litigation Reform Act of 1995 and are therefore, perspective. These forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. Although we believe that expectations reflected in our forward-looking statements are reasonable, we can give no assurance 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. This call includes non-GAAP financial measures. Please refer to our Form 10-Q filed with the SEC for a reconciliation of the non-GAAP measures referenced on this call to the most similar GAAP measures. We filed our Form 10-Q with the SEC earlier today discussing our results for the quarter ended April 1, 2017. You will find a link to the company's SEC filings, including our Form 10-K, 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 2017 First Quarter Conference Call. I'll begin by providing an overview of our performance, including some market color. Afterwards, I'm going to have Doug Groves go over our financial results in detail. We posted revenue of 136 million for the quarter, up slightly year-over-year adjusted for the divestitures. That's reflecting a nice rebound on our military business and stable shipments across our large commercial platforms even as some of the platform transitions take place. We also generated 13 million in cash flow from operations, which was the best Q1 performance over the best 10 -- over the last 10 years and more than double that of 2016. The company did pay down an additional 5 million of debt in the quarter as well. And with a backlog of 581 million, I believe the company is positioned well for a solid performance this year. But before providing more color on our markets and platforms, let me just step back and talk about the past few months. Since joining the company in late January, I spent a great deal of time reviewing all aspects of our operations, meeting staff, touring factories, assessing financial performance and visiting with our customers. I believe Ducommun has a good portfolio of products and serves a broad array of key aerospace and defense platforms. But I also believe we have a potential to be much better. Even as we've accomplished a good deal these past 12 months resulting in a more focused organization and improved cost structure. I see room for higher operating performance, including margin expansion going forward. And I like, I'm assessing all areas of the organization for new ways to streamline manufacturing, further increase margins and enhance return on capital. I've also hired some key talent to help us achieve our near-term goals, including bringing on Suman Mookerji, a UTC executive, as VP of Strategy, Acquisitions and Integration. Suman was previously a senior Director of Strategy at United Technologies Aerospace, and I've known him nearly a decade in several capacities. He's a critical thinker and a seasoned executive, who will help us develop a vision, along with myself and the rest of the team, to run our business more effectively as well as lead our acquisition process as well as also the all-important integration. My priorities for the second half of 2017 is to execute on initiatives designed to bolster our long-term growth trajectory while strengthening bottom line performance. The overall goal, and my overall goal, is to build a culture focused on value, driving excellence, cost performance and most importantly, results. I'll have more to say on this in the coming quarters as we craft a plan to leverage Ducommun's technology, its applications and its long-standing customer relationships to take advantage of the current attractive economic environment. Now let me provide some color on our end markets, products and programs. Beginning with our commercial aerospace business, our overall sales were $60 million, down from roughly $66 million last year. This slight decline versus 2016 was primarily due to ongoing weakness within the regional and business jet markets, a relatively small portion of operation, and includes the wind-down of one program in particular, which had margins below our expectations. Our large commercial fixed-line business was stable, reflecting the timing of shipments across the various platforms we serve. We saw strong deliveries to Boeing for the 737 and 787 platforms as well as some very nice growth on the Airbus 320 and Airbus 330 aircraft. We ended the quarter with a commercial aerospace backlog of $310 million, which remains near record levels, and are pleased with the outlook for growth across our core Boeing and Airbus platforms as they transition to next-generation aircraft this year. In addition, we remain on track with regards to expanding our Parsons, Canada facility to support our titanium operations and platform requirements. This is a major investment for Ducommun and drove our CapEx spending in Q1 to more than double that of last year. We're supporting and driving dozens of new applications this year, which will significantly impact our growth going forward. Turning to our military and space sector, we posted first quarter revenue of 63 million, up nearly 6 million from last year, though down slightly from Q4, reflecting order timing. The fact that shipments improved year-over-year even net of the Miltec divestiture is a very good sign. I remain cautiously optimistic about the outlook going forward, particularly given the potential for budget increases in Washington. We also saw a nice uptick this quarter in sales of radar racks for the F-15 and F-18, along with a rebound in Black Hawk shipments. In addition, while overall defense backlog fell to $244 million from $256 million at the end of Q4, we believe we'll continue to see military revenue of around $60 million plus or minus going forward with some upside potential under the current administration. We also believe there is a pent-up demand for many military programs as well as missile defense programs. This would include general modifications and upgrades, which will potentially lead to higher bookings in revenue as the year plays out. Overall, I believe the company is on solid financial footing for the rest of 2017 even as we look to bolster top line growth, invest for the future and continue to de-lever the balance sheet. Our structural and economic capabilities have already resulted to Ducommun being a trusted supplier on some of the world's top OEM platforms using our unique titanium composite technology as well as our electronic capabilities. But I believe we can further streamline our production capacity and improve our customer relationships to increase content on these and other commercial and military aircraft. Myself and the whole team must remain, and will, significant -- singularly focused on being a trusted value-added provider of innovative applications for the end use markets we serve. Finally, we're committed to driving excellence in all areas and everything we do here at Ducommun for the betterment of our customers, employees, suppliers and shareholders. With that, I'll now have Doug review our financial results in detail. Doug? Thank you.

Thank you, Steve, and good day to everyone. Revenue for the first quarter of 2017 was 136.3 million compared to 142.1 million for the first quarter of 2016. Adjusting for the divestitures and plant consolidations, revenue rose 2% year-over-year. On an adjusted basis, there was a decline year-over-year of 6 million in lower revenue within the company's commercial aerospace markets, primarily due to the wind-down of a regional jet program and the transition to new models across the large airframe platform, along with 5.8 million of lower revenue within our industrial markets, which was due to the divestiture of our -- the company's Pittsburgh facility in January of 2016 and closure of one of our Tulsa operations last June. The negative impact of such items was partially offset by 5.9 million of higher revenue within Ducommun's military and space markets, reflecting stronger deliveries even with the negative impact of our Miltec divestiture last March. Ducommun's backlog was approximately $581 million at the end of the first quarter, down slightly from year-end, primarily reflecting the timing of certain commercial orders. The backlog remains near record levels, as Steve mentioned, and once again, underscores our strong position within a rather healthy aerospace market. Moving to gross profit. Our gross margin was 18.3% in the first quarter versus 19% in last year's comparable period. The decline in gross margin was primarily due to product mix and the continued ramping of production on certain commercial programs within the company's Structural Systems segment. SG&A was $20.8 million in the first quarter versus $22.7 million in 2016. This primarily reflects our divestitures as well as cost-cutting initiatives. The first quarter of 2017 also included approximately $1 million of nonrecurring executive transition costs. Operating income for the first quarter of 2017 was $4.1 million or 3% of revenue versus $4.3 million, also 3% of revenue in the prior year period. Interest expense decreased to $1.6 million in the first quarter of 2017 compared to $2.4 million last year, primarily due to lower outstanding debt as a result of net voluntary principal prepayments on the company's credit facilities. Net income was $2.1 million or $0.18 per diluted share compared to $13.6 million or $1.21 per diluted share in the first quarter of 2016. The first quarter of 2016 did include an $18.8 million gain on divestitures, the net effect of which was $12.2 million after-tax or $1.08 per diluted share. Our effective income tax expense during the quarter was $0.4 million or 15.6% compared to 17, excuse me, $7.2 million or 34.6% in the comparable period last year, again reflecting the divestiture gains I just mentioned. The income tax rate for 2017 first quarter was reduced due to higher-than-expected tax benefits related to share-based compensation. Going forward, the tax rate for 2017 is expected to be approximately 29% to 30%. Adjusted EBITDA for the first quarter of 2017 was $11.7 million or 8.6% of revenue compared to 11.1% or 7.8% of revenue for the comparable period in 2016. Now let me return to the segment results. Our Structural Systems segment posted revenue of $57.6 million in the first quarter of 2017 versus $64 million last year. The decline was primarily due to $7.2 million of lower sales within our commercial aerospace markets, reflecting a wind-down of a regional jet program and the ongoing transition of a large aircraft platform. This was partially offset by $0.8 million of higher revenue in our military and space end use markets. Structural Systems operating income for the first quarter was $2.6 million or 4.6% of revenue compared to $2.7 million or 4.3% of revenue last year. The first quarter of 2017 included the impact of additional investment we're making in new programs. As noted on last quarter's earnings call, we see operating margins for the Structural Systems trending in the 5% to 8% range near term due to the ramp-up of platforms and impact of related investments in 2017. Turning to the Electronic Systems segment. Our Electronic Systems segment revenue posted revenue of $78.7 million in the first quarter versus $78.1 million in the prior year period. These results reflect $5.2 million of higher shipments within our military and space end use markets, partially offset by the impact of divesting our Miltec operation in March 2016. We also saw 1.2 million of higher revenue across our commercial aerospace platforms but a 5.8 million sales decline within the industrial arena, again, due to the closure of one of our Tulsa operations in June 2016 and divestiture of our Pittsburgh facility in January 2016. Electronic System posted revenue income for the first quarter of 7.1 million or 9% of revenue, up from 6.4 million or 8.2% in the prior period. Corporate, general and administrative expense for the first quarter was 5.6 million or 4% -- 4.1% of company revenue compared to 4.8 million or 3.4% of revenue last year. The increase was primarily due to higher compensation benefit cost of $1.1 million, partially offset by lower professional fees. Turning to liquidity and capital resources, we generated 13.2 million of cash from operations in the first quarter of 2017 compared to 5.5 million in 2016, and we remain diligent in effective working capital management. We also paid down an additional $5 million of debt this quarter, as Steve mentioned, and 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 6.8 million in the quarter, and we expect CapEx to be approximately 22 million to 26 million for 2017, primarily due to 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. In closing, the quarter played out as expected and reflected the various dynamics of our end markets. We continue to expect that revenue will likely grow 2% to 3% sequentially for the next few quarters. And with our strong for cash flow, we'll pay down more debt as appropriate. I'll now turn it back over to Steve for his closing remarks. Steve?

Thanks, Doug. I'll just add a few final comments before we open it up to questions. As I said in the beginning, Ducommun has come a long way these past few years, leaving us a more focused provider of key technologies to the aerospace and defense industry. But there are other opportunities to strengthen both our growth outlook and bottom line results. I, as well as the team, want to take the company to the next level. As mentioned earlier, I've already hired some individuals to help us do so as well as making sure we set clear expectations for everyone on the team. I'll provide updates in the coming quarters on the steps we're taking to increase margins, further streamline our operations, improve customer satisfaction and drive higher returns on capital. With that, operator, let's now open the call for questions.

[Operator Instructions] And our first question comes from the line of Ed Marshall from Sidoti. Your line is open.

Welcome to the call, Steve.

Thank you very much, Ed.

Yes, absolutely. So I guess the first question, you've mentioned the unprofitable mix. And I would have figured, with some of the divestitures that you had and then the increased shipments of the F-15, F-18 and Black Hawk, which are typically higher-margin on the gross margin level, that would have been a positive mix shift for you. Can you kind of walk me through maybe some of the puts and takes to the unprofitable mix that you saw in Q1?

Well, Ed, if you look at the segment results, it's really driven more by the structures business. Our electronic segment operating income was 9% for the quarter. So as we said last quarter, that's going to move around a little bit, but it stays in that 9% to 10% range. In the structure segment, the operating margin was only 4.6%. So it really had more to do with, as we said on the last call, the 25 development programs we have underway in structures that are creating a little bit of drag on the margins that we expect to get back later this year as we get through that development work and all those programs come online.

Right. And you talked about the 5% to 8% operating margin in that business near term. I'm curious, what's your definition of near term? And as we look into the second half of the year with the next-generation ramp-up, do we continue to see that weigh on the margin as well?

Yes. I think we would define near term as the next couple of quarters.

Okay. And does that include the next-generation ramp? Or we'd see another ship lower on that?

No, that would include the ramp. We're looking at that 5% to 8% range for the next few quarters. So you've got new programs coming on. And as you know, with new program ramps, there's inefficiency until you get to the full rate.

Right. Steve, I know that you have, you've had only a short period of time, so maybe this is an unfair question, but I'll give it a shot anyway.

Thank you.

You talked about the next quarter conference calls, the following conference calls, you'll talk more about maybe some of the plans that you have. But maybe I could ask it, maybe I can ask a little bit of a forward-looking question about, what do you think the appropriate margin for Ducommun is based on what your assessment has been over the last couple months?

Well, certainly, I'll just say this. Look, I'm still going through the process, right? And as I said on my note, I will be following up the next few quarters. I'll give a lot more color to it. But I certainly believe that the margins are in a great position to expand, all right? I think that we, as I get involved in this, we got a lot of work to do operationally. We also have to make sure that when we're looking at our portfolio mix, that we're really driving to the programs that we add the most value.

Okay. Doug, just curious. Tax benefit, the windfall tax in the quarter, if you could just clear that up for me. What was the dollar amount, the absolute value?

Sure. So our rate benefited almost 10 full points from the new accounting standard that came into effect due to share-based compensation. So you could take the reported rate of 15.6% and add back to that. So it would have been closer to 27% without that benefit.

And our next question comes from the line of Christopher Van Horn from FBR.

This is Dan Drawbaugh on the line for Chris. So if I could start with the line you mentioned in the press release related to strategic initiatives potentially driving inorganic growth. Can you talk a little bit about the opportunities that you're looking at there and maybe what you're seeing in the marketplace?

Sure. Well, I think as Steve mentioned in his remarks, we have hired Suman to help us look at several different initiatives to help drive inorganic growth. He's just getting onboarded as we speak. So as we get into later this year, as we've said in previous calls, looking at things that would help supplement the organic growth will be largely what he's going to be focused on.

Okay, that's fair. And in terms of balancing that against repaying debt and working towards your leverage target, how are you thinking about that going forward?

Sure. So we've been pretty straightforward for quite a while that we want to get the leverage down to that 2.5, 2.25 level. We think that's the right place for our company, and that also gives us the flexibility to start looking at potential bolt-on acquisitions as we get into the second half of this year and beyond.

Okay, fair enough. And then last one for me. Can you talk a little bit about the conversations that you're having with customers as they sort of begin getting positioned for the next budget negotiation? I guess we've got the omnibus going through now, but September is only a few months away.

Well, Dan, I think the conversations are -- the similar ones we've had in the past, we're very cautiously optimistic that we're going to see an increase in defense spending. And certainly, what was released the first part of this week gives us that optimism when we saw the number of units being funded for the Black Hawk, which, of course, is one of our major programs as well a few of the others, the Apaches, spending for missile platform. So once all the dust settles, we'll see. But we're remaining very, as I said, cautiously optimistic about what the budget holds for us.

Yes. This is Steve. Yes, [indiscernible] so...

[Operator Instructions] Our next question comes from the line of Aman Gulani from B. Riley & Co.

So my question is in terms of backlog. It got me a little bit. How do you see you executing on your backlog for the remainder of the year?

Sure. Well, we're optimistic, as I just said, about the defense part of our business as well as commercial aerospace. I mean, the first quarter, typically, is a lower quarter for backlog in terms of timing of orders. So we've got a lot of good things in the works, so we would expect that we're going to be able to materialize on that and see the backlog continue to be sound for where we're at with the platforms that we've got.

At this time, I'm showing no further questions. I would like to turn the call back over to Steve Oswald for closing remarks.

Yes, okay. Well, thank you. And I want to thank everybody again for joining us. As I mentioned, as we move forward here in time, I guess, more experience and activity with the team and the facilities, we'll continue to update you on further developments on changes and things we're driving to increase our performance. So I'll leave it there. Thank you again.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.