Ducommun Incorporated (DCO) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ducommun Third Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. And I 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 today that are not historical facts, including any statements as to 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, our prospective. 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 the 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 the 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 [Audio gap] 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 to 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 of the second quarter of 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 backlog, new program wins and a leaner more efficient organization is now starting to be realized in our finance 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 benefiting from the significant ship set amount for platform and rising bill rates. The Company is also known as a leading provider of advanced structural 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 the $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 costs 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% points 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, 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 reflecting stronger orders in 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 improving margins, Ducommun is on track as you 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. This is a great performance and shows the enduring value of these planes and the integral content Ducommun provides, such as radar access and cockpit electronics. We anticipate continued strong revenue going forward based on the outlook from military spending this year and next. Our military and space backlog was just under $300 million at the end of the quarter remaining at their record levels. Within our commercial aerospace operations, third quarter sales rose approximately 27% year-over-year, $76.3 million. We once again saw some dividend 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 benefitting from having a greater presence on these aircrafts and increasing demand for narrow-body platforms in general. Our content per ship set is over 15% higher on 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 the significant runway ahead. The backlog within our commercial aerospace sector stands at $442 million down slightly from Q2 a recognition of order timing. We're confident that our position across such platforms will remain strong, driving continued higher revenue heading into 2019. Before I turn the call over to Doug, I want to mention two other important matters. First, we recently announced that Shirley Drazba joined the 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 eight several 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 in 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 9th. We already heard from over 50 analysts, institutional investors, financial advisors who plan to attend. And we look forward to a productive day of presentations and meetings. Beside myself and Doug, we'll also have in attendance Dave Wilmot, our Vice President of Electronics 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 to 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 as the Accounting Standards Codification or ASC Topic 606 covering revenue recognition policies on current year results. Please see the Company’s filings with the SEC and 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 primarily 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 these markets were due the 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 which primarily due to higher production volumes, lower manufacturing overhead costs and favorable product mix. SG&A was 21 million in the third quarter versus 18.7 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 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 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 of 16% last 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 a 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% or 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 system segment our electronic system segment posted revenue of $85.7 million in the third quarter of 2018 versus $79 million in the prior year period. These results reflect a $6.7 million increase in sales to our commercial aerospace customers and $2 million higher shipments within the military and space market. Electronic system 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 structure's adjusted margin was 9.1% for the third quarter compared to 6% last year, a 50% increase. Corporate, general and administrative expenses for the quarter $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 cost 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 from 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 one 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 with our continued higher returns in the quarters to come. I'll now turn it back over to Steve for his closing remarks. Steve?

Thanks Doug. Before turning the call to the questions, I'd like just 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 I look 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. Also I take this time to wrap up here to let our investors know we appreciate their patience and their continued interest in our success. So with that, operator, why not open the call for questions?

Thank you [Operator Instructions]. Our first question comes from Edward Marshall from Sidoti. Your line is now open.

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

Ed, well, I think I can answer part of the question if you look on the appendix to the earnings release, we did pick up about $5 million in revenue from the adoption of ASC 606. So that definitely drove the growth in the revenue a little bit higher over last year, which of course is a 605 numbers. In the pricing initiatives that we 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 in the comments. So, it’s a combination of those three things that drove the growth. But certainly, we’re pleased to see that all the work we put in is reading through.

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’s been all over the place this year. And I’m wondering what you might think about, either you call it incremental or contribution margin. What you think the normalized number might look like for that business on a go forward, and this is specific to the structures?

Well, we’ve been consistent in our messaging that we’re going to exit this year in high single-digit. We're roughly 8.5% on an adjusted basis through three 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 as we see the top line growing, particularly on the single out platforms.

This is Steve. I'd say the same thing. There's more to come.

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

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

And the final question, if I may. Looking at the nacelle program, first, I’m assuming that -- is that’s composites or is that titanium?

Yes, that’s composite. So we have a new composite process called VersaCore. So that’s a straight up composite work from that nacelle.

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

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, the latter part of 2019?

So should I think of that as a typical run-rate, initially you'll see a little bit of a compression in the margin and then ultimately if that program gets up to run-rate, it should be contributing a core into the -- at the typical level?

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

And is there any specific -- is this a significant amount of tooling as opposed to some of the metal work that you do, or is this more complex or just trying to think about the cost curve there?

No, it's probably actually less than some of the other structures businesses that we've got, because this is out of autoclaved technology.

Thank you. Our next question comes from Ken Herbert from Canaccord. Your line is now open.

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

So that the let me start 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 and 57 and higher, we've got the footprint in place to be able to support those rate increases. 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 lot of opportunity with Boeing as well as with Spirit as we look at new applications and share gain.

And I've been just so everybody on the call -- the main two titanium operations are operations are Coxsackie, New York near Albany and Parsons. And I believe that both facilities in the last couple of months and were all working towards the 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 getting to a higher level. So we're comfortable and we're looking forward to the rising rate.

And are you seeing any risk or any pressure points in your particular supply chain on the 737?

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

And I guess would be -- is it fair to say that the sequential growth in inventory we've seen this year. I know obviously it's down from a year ago. But is 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 that the ramp up and the order had a bit.

And then if I could just on the defense side. Obviously, you called out few programs. You’ve seen some really nice growth in the quarter. What’s your view on sustainability? Are we 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 two to three year view on the defense business?

I guess 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 two or three years. The other thing I’d say is that we obviously have some strategic customers but we have other customers where share of market or share of account is fairly low. So we're also -- as we look forward, it’s not only, okay, the defense budget and things are up, it’s also that it’s still early innings for Ducommun across the industry certainly with some of the other big primes.

And Ken, I would add. I mean, as we look at the defense portfolio, we’ve got multiple missile programs largely with Raytheon but some also with Northrop Grumman. And given what we see with four military sales and just the way the budgets 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 some opportunities as well as certainly just the volume growth?

Absolutely, yes. So like I said, there’s -- we’re happy with the volume and it’s done a good thing for the Company. And obviously our customers are very busy and we’re very busy. But I think there’s also the whole term and 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. Your line is now open.

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

They’re really fully integrated. I mean, these were smaller companies. We were able to successfully integrate them. And as we’ve talked about in previous calls, we’ve got some great experienced people in the Company now that 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.

And then my second question was regarding the Boeing 737 from by Raytheon air 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 look at what we do for the aircraft and our quality and records in Boeing standards, we don't have any concern that there is anything that’s a threat to Ducommun.

And my last question was regarding your restructuring charges. How much more additional restructuring charges do you expect to incur?

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 Crowford with B. Riley FBR. Your line is now open.

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

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

But I think the other thing is certainly we believe there is a good amount of opportunity in those top five but then to your point, there is also as well in the next five. 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 growing numbers of cash paid and to Ducommun and payables to Ducommun. So, can you say what it is make for Viasat or whether there is 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.

Well, I thought it's worth a try since you're mentioned in there filings. And then just final question on M&A front. Is there any change in the number 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. So we have a good process, we have good discipline. We have Suman Mookerji running it. We have a faith on him and he's already made the difference with those two acquisitions. So I'd say the profile is pretty much the same.

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

Okay, great. Well, let me wrap up here. Again, I want thank everybody for their time this afternoon. We're upbeat and we're really proud of our team and proud of this workthe last two 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’ve 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, thanks for participating in today’s conference. This concludes today’s program, you may all disconnect. Everyone have a great day.