Earnings Labs

Ducommun Incorporated (DCO)

Q2 2017 Earnings Call· Fri, Aug 4, 2017

$142.61

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Transcript

Operator

Operator

Good day, ladies and gentlemen, and welcome to the Ducommun’s Second 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] And as a reminder, this conference may be recorded. I would now like to introduce Mr. Chris Witty, the moderator for today’s conference. Sir, you may begin.

Chris Witty

Analyst

Thank you, and welcome to the Ducommun’s 2017 Second 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 today 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 therefore, our 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 have been 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. This call includes non-GAAP financial measures. Please refer to our Form 10-Q filed with the SEC for the reconciliation of the non-GAAP measures referenced on this call to the most similar GAAP measures. We have filed our Form 10-Q with the SEC earlier today describing our results for the quarter ended July 1, 2017. You’ll 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 will now like to turn the call over to Mr. Steve Oswald, for a review of the operating results. Steve?

Steve Oswald

Analyst

Thanks, Chris. And thank you, everyone for joining us today for our 2017 Second Quarter Conference Call. I’ll begin by providing an overview of performance, including some market color. After which, Doug Groves will go over financial results in detail. I’m happy report we posted revenues of $141 million this quarter, an increased both sequentially and year-over-year, reflecting $18 million of higher military and defense shipments offsetting lower revenue in some of our commercial aerospace platforms. The weakness on the commercial side was primarily due to a winding down of a regional jet program, which had unattractive margins, and some continued softness in the business jet market, as was discussed last quarter. But as a reminder, the regional business jet markets are a mighty contributor to Ducommun’s growth strategy, and, indeed, we ended the quarter with our highest commercial aerospace backlog ever, some $337 million. We’ve set the stage for revenue acceleration in the quarters to follow as we move into the second half of 2017. I also want to share with you some excellent news that the total backlog at the end of Q2 stood at $611 million, and that’s up $30 million from last quarter. We generated $3 million in cash from operations this quarter, which equates to $16.3 million year-to-date, but did not pay down any additional debt this period as we normally do for a very good reason. As we move forward in time, we’re going to deploy capital for future growth. We invested $9.5 million in the businesses period, roughly twice our normal amount for CapEx. This is largely due to our next generation titanium operations in Parsons, Canada, where we are working diligently preparing for new production for the Boeing 737 MAX, Airbus A320 NEO, Airbus A330 and A350, along with Gulfstream, G500 and…

Doug Groves

Analyst

Thank you, Steve, and good day, everyone. Revenue for the second quarter of 2017 was $140.9 million compared to $133.4 million for the second quarter of 2016. The increase year-over-year reflects $17.6 million of higher sales within our military and space end-use markets, partially offset by $7.7 million of lower commercial aerospace revenue, primarily due to the winding down of a regional jet program and softness in the business jet market, as Steve mentioned. These related areas are not considered strategic to Ducommun, or to our long-term growth plans. Revenue for the quarter was also down within the industrial sector $2.4 million. Ducommun’s backlog was approximately $611 million at the end of the quarter, highlighting the strength and diversity of the platforms we serve. Moving to gross profit. Our gross margin was 18.6% in the second quarter versus 19.6% last year’s comparable period. The decline in gross margin was primarily due to product mix and the continued new program development at ramping up production on certain commercial aerospace programs within the company’s Structural Systems segment. SG&A was $19.7 million in the second quarter versus $18.9 million in 2016 with the primary increase reflecting higher compensation and benefit cost. Operating income for the second quarter of 2017 was $6.5 million or 4.6% of revenue versus $7.3 million or 5.4% of revenue in the prior year period. The decrease in operating income year-over-year primarily reflects the higher SG&A, I just mentioned. Interest expense was flat at $1.9 million in the second quarters of both 2017 and 2016, as a positive impact of a lower outstanding term loan balance was offset by higher utilization of the company’s revolving credit facility. Net income for the second quarter was $3.8 million or $0.33 per diluted share compared to $3.9 million or $0.34 per diluted share…

Steve Oswald

Analyst

Thanks, Doug. I’ll just add a few final comments before opening it up to questions. I want to close my remarks today, and just say that I think we’ve started to make some real progress, especially on the customer side, along with posting some good top-line growth due to diversity of our products on a variety of key commercial and military platforms. We and I are also encouraged by the increase in our backlog, which means customers like what they see and continue to trust us with additional orders. And also, progress in our next generation titanium operations. We also had an expanded presence and great series of meetings, again, like I mentioned, with important customers at the Paris Airshow, which I think will positively impact our prospects going forward. As I view opportunities and I mentioned earlier, we clearly fell short in terms of margins on our structures business. However, the addition of Jerry Redondo, who I trust and is a top A-player to lead the structures group will make a clear difference in the future. I’ve also many instituted many changes throughout the company to increase our focus on efficiency and asset allocation, rewarding customers responsiveness as well, a drive and a passion for excellence, and assessing ways to increase top-line growth and overall performance. In this regard, the Ducommun team has responded well to the challenges I’ve implemented. I’m optimistic about the future. To our investors and the investor community, I say stay tuned. We’ll have many more initiatives to discuss as the year progresses. And I strongly believe the company will be in excellent shape as we take on the opportunities to outperform and over deliver in terms of service to our customers and also returns to shareholders. This will all happen in the quarters to come. With that, operator, let’s now open up for questions.

Operator

Operator

Thank you. [Operator Instructions] And our first question will come from the line of Edward Marshall with Sidoti. Your line is now open.

Edward Marshall

Analyst

Good afternoon, Steve and Doug. How are you?

Steve Oswald

Analyst

Hi, Ed.

Doug Groves

Analyst

Ed, good to hear from you.

Edward Marshall

Analyst

So the structures – walk me through what’s going on. I guess last quarter, you talked about operation margins within the segment of between a 5% to 8% range near term, what you defined as the next couple of quarters as you ramp up some new platforms and the impact that related investments in 2017, I’m reading from the transcript. So I’m curious, what kind of underperformed your expectations since you were below the earnings?

Steve Oswald

Analyst

Well, just couple of things. I’ll chime in here first. We’ve got a lot of activity in Structures. So we’re definitely working on many programs and then we’re also expanding Parsons. So frankly, we’re having some growing pains. And you know – but as I mentioned, I’m not sure you know Jerry is a top operator and he is now in charge. And I think we’re going to definitely see better days ahead. So that’s one of the challenges are some growing pains and just getting the plant finished, so its some pressure on there. Also, we’re still working on lots of programs that we have to just use our factory utilization better. We have to drive the kinds of changes that I’m planning on in the future. And as I mentioned in our meeting in the fall, just stay tuned, we’ll have some more comments as we move forward.

Edward Marshall

Analyst

Is there a way to quantify the drag that you’re seeing from the ramp up in the titanium business?

Doug Groves

Analyst

Not specifically, Ed, because there’s so many moving parts with, you know the utilization of the equipment as well as the training of the new people, we’ve increased the staff there almost 35% over the last year to accommodate the 50% footprint expansion. So there’s an element of inefficiency with that many new people added to the organization. So I think as Steve said, stay tuned. We’ve got Jerry on it as well as a number of other senior people deployed out to Parsons to get this to where it needs to be.

Edward Marshall

Analyst

Got it. And just to be clear, this is a top line rating for the programs to come in with heavy staff there that would be the drag at least for the titanium piece?

Doug Groves

Analyst

Yes. absolutely and I would just say in closing this is an absolute runway in structures, so stay tuned.

Edward Marshall

Analyst

Right. Right. Okay, moving on. So SG&A Doug, was there any accelerated compensation expense in this particular quarter that might have driven that number slightly higher this quarter, will that continue into 3Q, 4Q?

Doug Groves

Analyst

Well, no there wasn’t any acceleration in this quarter, as there was like last quarter, but our stock-based compensation as you’ll see in our 10-Q is going to be running higher this year than it has in the past due to a number of different reasons, but I mean that’s a noncash charge. So the stock-based comp this year through the first half is about $1.5 million higher than it was through the first half of last year.

Edward Marshall

Analyst

And what will it be for the full year higher?

Doug Groves

Analyst

Well, we don’t really forecast that, Ed, but you could probably take the second quarter as a somewhat normal run rate.

Edward Marshall

Analyst

Okay. And what are the reasons?

Doug Groves

Analyst

Primarily just has to do with the nature of some of the performance awards as well as the award for Steve bringing him on Board as we disclosed in our 8-K.

Edward Marshall

Analyst

All right. Okay. And then looking at CapEx, you said roughly $20 million to $26 million for full?

Doug Groves

Analyst

That’s right.

Steve Oswald

Analyst

Yes. That will be less next year.

Doug Groves

Analyst

Yes. Absolutely it’s a huge the step down as we complete Parsons.

Edward Marshall

Analyst

Right. So most of that is going to be spent in third quarter?

Doug Groves

Analyst

I would say not most of it, I mean probably 60% third quarter, 40% in the fourth quarter.

Edward Marshall

Analyst

Got it. Thanks very much. I appreciate it guys.

Doug Groves

Analyst

Okay, thank you.

Steve Oswald

Analyst

Thank you, Ed.

Operator

Operator

Thank you. And the next question comes from Mark Jordan with NOBLE Capital. Your line is now open.

Mark Jordan

Analyst · NOBLE Capital. Your line is now open.

Good afternoon, Steve and Doug.

Steve Oswald

Analyst · NOBLE Capital. Your line is now open.

Hi, Mark.

Mark Jordan

Analyst · NOBLE Capital. Your line is now open.

I like to talk a little bit about the titanium initiative, could you size what that is from a volume standpoint before you started to add this capacity. And then I assume, I believe you said that the step up in the 50% footprint should be completed by next spring? And what does that incremental expansion give you in terms of step up in annualized capacity versus what you have now?

Doug Groves

Analyst · NOBLE Capital. Your line is now open.

Sure, well, so from a footprint standpoint, we’re adding roughly 50%. So the new factory’s going to be about 170,000 square feet. And again, as we mentioned, it’s going to be completed in the spring. And so the volume there, obviously, is going to increase not exactly in proportion to that, but significantly, and as you know, we don’t disclose volume in any of the businesses below the segment in our reporting. So needless to say, if you look at our commercial aerospace backlog and where it’s at, at $337 million, there’s a very significant piece of that in our titanium business.

Mark Jordan

Analyst · NOBLE Capital. Your line is now open.

Okay. And you couldn’t throw out some in terms of the Structures business, just crudely, roughly a range of X%?

Doug Groves

Analyst · NOBLE Capital. Your line is now open.

No, I mean, we don’t give that kind of guidance, but if you look at our commercial aerospace backlog as a percentage of the total, you’ll see how that has grown quarter-over-quarter to give you a sense of what that future could look like.

Mark Jordan

Analyst · NOBLE Capital. Your line is now open.

Okay. The Systems – Electronic Systems business had a phenomenal quarter. I guess question over the near-term is that run rate and margin sustainable?

Doug Groves

Analyst · NOBLE Capital. Your line is now open.

Well, that moves around, as we’ve said in the past, somewhere between 9% and 10% this quarter, it was 10.8%. So it’s really a function of the product mix, there’s a lot of different things that we do there. So we would expect it to not sustain a 10.8%, but certainly, somewhere between 9% and 10% as we move forward and that’s historically where that business is running. Just depends upon the quarter and the products and that volume.

Mark Jordan

Analyst · NOBLE Capital. Your line is now open.

Okay. You mentioned a regional jet program that’s been problematic for a while. As I remember, last year you made a charge against that, so I’m assuming you’re executing on that program on a 0 gross margin basis? When is that program gone?

Doug Groves

Analyst · NOBLE Capital. Your line is now open.

We will be done with that program in the spring of 2018.

Mark Jordan

Analyst · NOBLE Capital. Your line is now open.

Okay. And a final question for me, you talked about strength in number of helicopter programs sort of runs counter was initially at least in some of the budgets for fiscal – governmental budgets for fiscal 2017, what has caused the uptick there versus baseline funding in the 2017 budget, which was down for units?

Doug Groves

Analyst · NOBLE Capital. Your line is now open.

Well, we’ve got to – a couple of dynamics. First is foreign military sales, so you know the big, big order from...

Steve Oswald

Analyst · NOBLE Capital. Your line is now open.

Black Hawk.

Doug Groves

Analyst · NOBLE Capital. Your line is now open.

Exactly. As well as some other foreign military sales orders and then we’re also seeing with the new – no one knows where the budget is going to land exactly, but the numbers that are being tossed around in the latest round of the budget, do have the build rate certainly on the Black Hawk as well as the Apache refurbished increasing, so we’re seeing some uptick there, at least for now.

Steve Oswald

Analyst · NOBLE Capital. Your line is now open.

A lot of it is, this is Steve, a lot of it’s – but everybody is pretty positive about the next few years.

Mark Jordan

Analyst · NOBLE Capital. Your line is now open.

Okay. Thank you very much.

Steve Oswald

Analyst · NOBLE Capital. Your line is now open.

Thank you.

Doug Groves

Analyst · NOBLE Capital. Your line is now open.

Thanks.

Operator

Operator

Thank you. [Operator Instructions] And the next question will come from the line of Mike Crawford with B.Riley & Company. Your line is now open.

Mike Crawford

Analyst

Thank you. Regarding the record commercial aerospace backlog, particularly the Structural Systems backlog that increased $17 million to $296 million, isn’t that kind of seasonal? I thought Q2 was usually the weakest period for commercial aerospace structures?

Doug Groves

Analyst

In terms of backlog, Q1 is usually the lightest booking quarter that we have, I mean this quarter if you just look at the bookings, it was an excellent quarter almost $170 million. So no, the first quarter is usually like the lightest quarter for bookings for us. And again, most of these things are timing issues.

Mike Crawford

Analyst

Okay. And then related to commercial structures, so next year your top customer Boeing plans to step up production of 737 from 40 to 42 units a month and then to 48. Yes, from 42 to 48 and then 53. But the 777 line will get cut as the prepare for the 77x, so is that something that you’re working at?

Doug Groves

Analyst

No, definitely is, the good news is we have some new content on the 777x, but we definitely will see those build rates decrease 7, 5 down to as low as potentially 3. That will obviously be offset by the 737, which is the largest program we have in the company. So it’s fully our expectation that with Boeing and the large airframes that we’re going to see continued strong growth there. So the 777 program much, much smaller in terms of content for us.

Mike Crawford

Analyst

And then also Raytheon was almost as large of a customer as Boeing in the current quarter, the revenue is up over 100% year-over-year, is that something sustainable? And is that – what’s driving those particular gains?

Doug Groves

Analyst

Sure, Well there are several things we do for Raytheon, there’s a radar racks that go on the F-15 and the F-18, and then, of course, the various missile platforms that they’ve got. So some of that was just timing of the orders on the F-15 and F-18 but it does appear that the missile platforms have a very healthy backlog if you looked at Raytheon’s backlog when they reported, still continues to be over $11 billion with really strong quarter-over-quarter sales in missile. So I think we’re optimistic with what we can see at least preliminarily in the budget that there’s going to be good demand for those products, which at some point trickle down to us obviously.

Steve Oswald

Analyst

And again, part of that is [indiscernible] so I was just – I was with Raytheon not too long ago, visiting them and their leadership. So it’s sort of a mix, and again, just like with the Apache and Black Hawk folks pretty upbeat.

Mike Crawford

Analyst

Okay. And then last question relates to strategies. So you talked about investing internally for growth. You also talked about CapEx stepping back down and once you finished with Parsons next spring, so is this a case where there might be new capital projects as yet undefined? Or how are you thinking among those lines?

Steve Oswald

Analyst

I’d say that’s the fair statement. I’d say that there is definitely new programs that are yet undefined. This year as you know with those levels of investment, we’re going pretty hard at Parsons, and I think for all the right reasons. So just stay tuned on that as well and we’ll have more for you next year.

Mike Crawford

Analyst

All right. Thank you very much.

Steve Oswald

Analyst

Thank you.

Doug Groves

Analyst

Thank you.

Operator

Operator

Thank you. We have a follow-up question from the line of Edward Marshall with Sidoti. Your line is now open.

Edward Marshall

Analyst

Just wanted to go back to a previous question. You talked about 50% footprint growth in the titanium business. I’m curious what’s your expectation year 1, maybe year 2 with regards to utilization?

Doug Groves

Analyst

Well at this point, Ed, we’re building for the future and as we think about the rates going on the single aisle up to potentially 60, we’re definitely going to have capacity to be able to function at that level when we get out there. But I don’t think we’re prepared to give an exact percentage of the utilization today versus next year versus the following year other than to say we’ve made the expansion to support the growth that we do see coming on the single aisle.

Edward Marshall

Analyst

I guess what I’m getting at is there a need for additional capital to be put back in the titanium business or your putting yourself in a position where you can kind of hit peak demand?

Steve Oswald

Analyst

It’s a fair question. This is Steve. We’re in good shape, I think a lot of – before I showed up a lot of thought went into that as far as footprint and capacity utilization of what we’re looking at. So we’re comfortable where we are.

Edward Marshall

Analyst

Good to hear. Thanks.

Operator

Operator

Thank you. And our next question comes from the line of Ken Herbert with Canaccord.

Unidentified Analyst

Analyst · Canaccord.

Hello, this is [indiscernible] calling in for Ken. Just wanted to know if you guys could just give an update on some of the Airbus opportunities and kind of any potential positions on any new programs.

Doug Groves

Analyst · Canaccord.

Well, we don’t really go out with that competitive information on specific platforms and programs and content other than to say that as we’ve communicated in the past Airbus is a growing customer for us with a lot of opportunity, particularly with this titanium capability that we’ve got.

Steve Oswald

Analyst · Canaccord.

I’d only add, this is Steve. The only thing I’d add is that I had my first meeting with the Airbus leadership in March, then we again met in Paris and my overall description of the meeting in Paris was upbeat.

Unidentified Analyst

Analyst · Canaccord.

Okay. Fair enough. And as far as you’ve seen the automation opportunity seems to be getting more investment by some of the larger structure firms such as Boeing and Spirit. Have you seen that – any effect on that? What’s your thoughts and views on that increase of investment roughly?

Doug Groves

Analyst · Canaccord.

Well I think its something we’re always evaluating, I mean there’s a cost-benefit of automation and we go through that as we look at our internal processes, and then particularly, when we’re adding footprint like we did in Parsons and certainly introductions of certain levels of automation makes some sense in some cases, but not at all. So it’s really a case-by-case evaluation that we do.

Unidentified Analyst

Analyst · Canaccord.

Okay. Thank you. I appreciate that. That’s all I had.

Doug Groves

Analyst · Canaccord.

Thank you.

Operator

Operator

Thank you. And I’m not showing further questions at this time. I would now like to turn the call back over to Steve Oswald for closing remarks.

Steve Oswald

Analyst

Thanks, very much. Again I want to thank everybody for joining us this afternoon. I guess the headline again is I thought we had a good quarter, it’s my first full quarter as a CEO, and I feel like some of the things I’m putting in place are definitely starting to move forward. I think the Jerry Redondo appointment is a big one for us. And I’ll have more to share with you in the fall. So I look forward to our next meeting. And thank you again for your support of Ducommun.

Operator

Operator

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

Steve Oswald

Analyst

Thank you.