Ducommun Incorporated (DCO) on Q1 2022 Results - Earnings Call Transcript
Operator: Good day and thank you for standing by. Welcome to the Q1 2022 Ducommun Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chris Wampler, Vice President, Chief Financial Officer, Controller and Treasurer.
Chris Wampler: Thank you and welcome to Ducommun 2022 first quarter conference call. With me today is Steve Oswald, Chairman, President and CEO. I'm going to discuss certain limitation to any forward-looking statements regarding future events, projections or performance that we may make during the prepared remarks or the Q&A 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 Private Securities Litigation Reform Act of 1995 and are, therefore, 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 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, amongst other things, the cyclicality of our end-use markets, the impact of COVID-19 on our operations or customers, the level of U.S. government defense spending, timing of orders from our customers, legal and regulatory risks, management changes, the cost of expansion and acquisition, competition, geopolitical developments and disasters, natural or otherwise. 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 also includes non-GAAP financial measures. Please refer to our filings with the SEC for a reconciliation of the GAAP to non-GAAP measures referenced on this call. We filed our 2022 first quarter Form 10-Q with the SEC today. I would now like to turn the call over to Mr. Steve Oswald, for a review of the operating results. Steve?
Steve Oswald: Okay, thank you, Chris and thanks everyone for joining us today for our first quarter conference call. Today and as usual, I give an update of the current situation of the company, after which Chris will review our financials in detail. The company remains focused first and foremost on the health and safety of our employees. The team has done an excellent job with the safety protocols put in place since March 2020. We continue to follow our best practices aligning with health authorities. Within the company, we had 287 cases of Omicron in Q1 of 2022, with 263 of them occurring in January. Turning to the Q1 financial results. Ducommun's first quarter performance is very solid. The company delivering year-over-year revenue growth of 4%. This was excellent in light of the significant amount of COVID cases mentioned previously among the workforce in January. The commercial aerospace market recovery was a real bright spot in Q1 and Boeing 737 MAX business was up over 100% year-over-year and the Airbus A320 family also had a significant increase of over 80% year-over-year. The company's defense business, after a great progress in the past two years, was down but still delivered a solid performance. Finally, our overall commercial aerospace business showed good year-over-year revenue growth for the third consecutive quarter. We also posted solid gross profit of 19.9%, along with an adjusted EBITDA of 12.3%, despite the challenging start to the year. Team also posted adjusted operating income margins of 7.5% which is good progress for the start of the year, as we continue to build our track record of effective operational leadership and cost management in any environment. The quality of earnings was solid as well. The company reaching GAAP diluted EPS of $0.66 a share versus $0.55 a share for Q1 2021 and adjusted diluted EPS of $0.67 a share versus $0.66 in 2021. First quarter revenue was higher due to Ducommun's overall commercial aerospace growth, up 53% year-over-year, along with continued solid defense business versus prior year though down on a fairly strong Q1 2021 number. The military and space program that had growth in Q1, included the F-18, F-16, near missile programs and other military rotary wing aircraft programs. Our continued approach to the defense market continues to be innovative products and processes, as a Tier 1 supplier that provide significant value to the customer, although it's striving for a consistent high level of service. Raytheon Technologies as well, was again our number one customer in Q1. We continue to benefit from the strategic supplier agreement signed with the missile and defense business over two years ago. We've been hard at work with current and new programs, offloading and share shift with Raytheon Technologies and look forward to continuing to leverage that relationship in 2022 and 2023. I mentioned in the last call about the offloading for defense products and the future benefits for the company. The work is progressing with Raytheon, GA, Northrop Grumman and others and will be over $45 million in 2022 for strictly offloading, up from roughly $31 million in 2021. We then expect to double it to $90 million plus in 2023, the great deal of that in our circuit card business. A long term run rate of programs already commercialized or in development will be over $125 million by 2025. These opportunities include Raytheon SPY-6, products for GA, TOW missile electronic harnesses and circuit cards and the next generation jammer which would be a major driver for revenue. The defense backlog was also a bright spot in Q1 that ended the quarter at $509 million. The commercial backlog also showed strong signs of recovery, increasing sequentially for the third consecutive quarter from $276 million at the end of Q2 2021, to $377 million at the end of Q1 2022, a very good sign. The book-to-bill ratio for Q1 was 1.2. We are thrilled that the total backlog for Q1 reached an all-time high of $943 million for the company. The company's cost actions and lead organization are also continuing to pay dividends. Even before the pandemic, the company was working on initiatives to offset the 737 MAX beginning in Q4 2019. The effectiveness of our operational leadership and action since then and through two years of COVID will provide meaningful benefits as we move forward and gain scale across our businesses. SG&A spending in particular is a contributor, especially at the corporate level which is among the industry leaders. In regards to the outlook, our continued good momentum in commercial aerospace, along with our significant backlog in defense, will result in high single-digit revenue growth for the full year 2022 which we're very pleased with. We estimate that revenue remain solid in defense but over the quarters ahead, we will see more and more commercial aerospace volume return. Our high narrow-body to wide-body ratio for the business will also help us based on current challenges facing wide-body aircraft. The other bright spot for Ducommun is our business aviation portfolio which is up 70% in revenue year-over-year with a strong backlog, especially with GS. As mentioned in previous calls, we have the capacity, supply chain and strong operating team ready to deliver the forecasted rate increases ahead and we look forward to every opportunity. Another area for the companies and investors to discuss is M&A. We continue to be actively looking for companies that fit our model and believe this will only be accelerated to higher results now and in the future. We had a significant win with the acquisition of MagSeal in December. I'm happy to report that the numbers are already ahead of plan and the integration has been excellent. I also want to mention that all of our acquisitions completed since 2017 have been integrated well, are leaders in their space. The financial numbers are ahead of expectations and have added much needed high-margin aftermarket revenue for the company. We will delve deeper into this performance at our upcoming investor meeting planned for the second half of this year and stay tuned for the date. Before I move to the market commentary, we announced today a restructuring initiative which commenced subsequent to Q1 2022. Our team has taken this action to accelerate the achievement of our strategic goals to better position the company for a stronger performance. We are still finalizing details as of the timing, certain actions and operations effectively; including facility repositioning related expenses, impairment of long-lived assets, severance and write-down of inventory. We currently anticipate this initiative will result in approximately $10 million to $14 million in total pre-tax restructuring charges over the next 12 months. The company anticipates these restructuring actions will result in estimated annual cost savings of approximately $3 million to $4 million beginning in 2023. Now let me provide you with some color on our markets, products and programs. Beginning with our military and space sector, we posted first quarter revenue of $99.3 million, a decrease versus 2021. In spite of being down, this was a solid showing for the business in Q1. As mentioned earlier, we saw increases in demand for our F-18, F-16, near missile program and other military rotary wing aircraft. First quarter military and space revenue represented about 70% of Ducommun's revenue in the period and this will be changing over time to reflect more balance with commercial aerospace. We offset in the first quarter with solid backlog of $509 million which represents 54% of Ducommun's total backlog. In our commercial aerospace operations, first quarter revenue increased year-over-year to $54.1 million, driven mainly by bill rate increases on large aircraft platforms, business aviation and in-flight products for Viasat. Ducommun expects a meaningful improvement in the commercial aerospace markets overall for the rest of 2022 and 2023. And the future is very bright across our product offerings, including our industry-leading titanium structural business. The backlog within our commercial aerospace sector stands at roughly $376 million at the end of the first quarter. Significant increase sequentially, compared to Q4, 2021; and the third consecutive quarter of growth. With that, I'll have Chris review our financial results in detail, Chris.
Chris Wampler: Thank you, Steve and good afternoon again, everyone. As a reminder, please see the Company's 10-Q and Q1 earnings release for further description of information mentioned on today's call. As Steve discussed, our first quarter results reflected another period of solid performance. The first quarter results saw a strong increase in commercial aerospace revenue. We are pleased to see their continued strength and overall travel demand which should drive higher shipments going forward. We are off to a decent start in 2022 and are looking forward to building on our Q1 2022 results and are in a position to do so. Now turning to our first quarter results. Let me review some of the highlights. Revenue for the first quarter of 2022 was $163.5 million versus $157.2 million for the first quarter of 2021. The year-over-year increase reflects $18.7 million of growth across our commercial aerospace platforms, partially offset by $14.8 million of lower revenue within the military and space sector. A portion of the year-over-year increase is directly attributable to MagSeal which we acquired in December of 2021. Thus our overall growth was a combination of organic and inorganic. Ducommun's overall backlog at the end of the first quarter was approximately $943 million, an all-time high, reflecting recent growth across our commercial aerospace platforms, setting up the Company for strong topline performance for the rest of 2022 and beyond. Our defense backlog remains strong at $509 million and has us positioned for another strong year for our defense business. As a reminder, we define backlog as potential revenue based on customer purchase orders and long-term agreements with firm fixed prices and expected delivery dates of 24 months or less. We posted total gross profit of $32.5 million for the quarter versus $33.1 million in the prior year period, while gross margins were 19.9% and 21.1% in 2022 and 2021, respectively. The decrease in margin year-over-year reflects unfavorable product mix, partially offset by lower compensation and benefit costs. During the first part of Q1, our workforce availability was impacted by the COVID Omicron variant, as well as harsh winter weather in the Midwest. The ripple effects of these items slowed production in some performance centers. Also, while we are not immune to supply chain issues, we were able to manage through another quarter without significant supply chain impacts due to our proactive supply chain efforts, executing strategic buys, leveraging our performance center flexibility and utilizing inventory that we had invested in. SG&A was $23.4 million in the first quarter versus $22.5 million last year, the increase largely reflects one-time severance charges. Ducommun reported operating income for the first quarter of $9.1 million or 5.6% of revenue, compared to $10.6 million or 6.8% of revenue in the prior year period. Adjusted operating income was $12.3 million or 7.5% of revenue this quarter, compared to $12.3 million or 7.8% of revenue in the comparable period last year. Our definition of adjusted income now includes an add back for acquisition-related amortization expense. As result of this change, we have recast comparable numbers with this methodology. Interest expense was $2.4 million for the first quarter of 2022 versus $2.8 million in the prior-year period. The company reported net income for the first quarter of 2022 of $8.1 million or $0.66 per diluted share, compared to net income of $6.7 million or $0.55 per diluted share a year ago. The increase year-over-year includes other income of $3 million -- $3.0 million for the insurance recoveries related to business interruption related to our Guaymas recovery. On an adjusted basis, the company reported net income of $8.3 million or $0.67 per diluted share, compared to net income of $8 million or $0.66 in 2021. Both the adjusted net income and adjusted diluted EPS amounts include the aforementioned add-back of acquisition-related amortization expense. Adjusted EBITDA for the first quarter was $20.1 million or 12.3% of revenue, compared to $21.1 million or 13.5% of revenue for the comparable period in 2021. Now, let me turn to the segment results. Our structural segment -- segment posted revenue of $66 million in the first quarter of 2022 versus $58 million last year. The year-over-year increase reflects $12.8 million of higher sales across our commercial aerospace applications, partially offset by $4.9 million of lower revenue within the company's military and space markets. Structural segment's operating income for the quarter was $4.9 million or 7.4% of revenue compared to $5.1 million or 8.8% of revenue last year. The year-over-year operating margin decrease was primarily due to unfavorable product mix, partially offset by favorable manufacturing volume and lower compensation and benefit costs. Excluding inventory purchase accounting adjustments and other adjustments in both years, the segment operating margin was 11.7% in 2022 versus 11.1% in 2021. As a reminder, the recently acquired MagSeal business results are a part of the structures business. Our Electronic systems segment posted revenue of $97.5 million in the first quarter of 2022 versus $99.1 million in the prior year period. These results reflect $9.9 million of lower revenue across the company's military and space customers, partially offset by $5.9 million of higher commercial aerospace revenue. Electronic systems operating income for the first quarter was $9.4 million or 9.7% of revenue versus $12.5 million or 12.6% of revenue in the prior year period, primarily reflecting unfavorable manufacturing volume and product mix. As mentioned earlier, the impacts of COVID and the winter weather presented challenges in Q1 for us. The challenges were more prevalent in the mid-western portion of the country which is where the majority of our electronics business operates. Corporate, general and administrative expenses. CG&A expense for the first quarter of 2022 was $5.2 million or 3.2% of revenue versus $7 million or 4.5% of revenue in 2021, the year-over-year decrease was primarily due to lower compensation and benefit costs. Turning to liquidity and capital resources, we have available liquidity of $119 million, we used $18.9 million of cash from operations this quarter, compared to cash used of $23.4 million in the prior year period. The first quarter typically results in a cash outflow from operations as we pay our annual incentives and invest in working capital support -- to support expected business growth. We made voluntary paydowns on our term loans of $30 million in the current quarter. Our 12 month debt-to-adjusted EBITDA ratio was 2.6 and remains amongst the lowest in the last several years. As a reminder, during Q4 of 2021, we increased retained earnings and shareholders' equity by over $115 million which was an increase of over 30%. This was as a result of the gain related to our successful sale-leaseback project, it was a great outcome. In terms of capital expenditures, we spent $4.8 million during the quarter. Going forward, we anticipate spending between $16 million to $18 million for the full year 2022 for sustaining capital and ongoing product development. As Steve mentioned earlier, subsequent to our quarter-end, we approved and commenced a restructuring plan. The details and timing of certain actions are being finalized but we are -- currently anticipate this initiative will result in approximately $10 million to $14 million in total pre-tax restructure charges over the next 12 months. We'll provide additional details in future calls. In conclusion, in the first quarter, we posted solid results while growing our commercial aerospace backlog, setting us up for continued strong performance for the rest of 2022 and beyond. We expect to see our topline and bottom line pick up momentum from Q1 as we move through the year. We significantly improved our gross debt position by paying down $30 million on our term loans. We'll continue to look at our operations for opportunities to accelerate our growth, as we look to deliver stronger operating results and returns for our investors going forward. I'll now turn it back over to Steve for his closing remarks. Steve?
Steve Oswald: Okay. Thanks, Chris. Okay. So in closing, it's a very good start to the year despite a few temporary challenges. I'd like to take this time again this quarter to thank our Ducommun employees, along with our investors, suppliers and other stakeholders for their continued support. We've done a great job managing the business and maintaining a level of excellence in 2020 and 2021. And all of our hard and smart work will now pay off in full over the next few years ahead. So we're very optimistic. We thank you for listening and we'll now open up for questions. Operator?
Operator: Our first question comes from Pete Osterland from Truist Securities.
Pete Osterland: This is Pete on for Mike Ciarmoli. First, I just wanted to ask, where you are on production rates for the 737 MAX, are you currently aligned with underlying OEM build rates or are there any differences for your current production rates due to leadx or inventories in the system. And just what are your expectations for where production rates will be going throughout the rest of the year?
Steve Oswald: Well, look, we're right aligned with Boeing and right aligned with Airbus, as far as the bill rates. One of the, I think, the bright spots for Ducommun is, we're in very good position with our titanium inventories. We have -- we feel very good about where we are, we're sort of shoulder-to-shoulder with both companies as well as with Gulfstream and other manufacturers. So we feel great about where we are with inventory. We are pretty much aligned and I'll mention Spirit as well, because they are a big customer of ours. So I think we're in very good shape.
Chris Wampler: Let me add one thing. Just to add, Pete, just add real quickly too. Your other part of your question on the inventory that they have. I mean that's the wrinkle we're still, like everybody working through as we've come out of the pandemic, is where -- their rate is with the rate we've got in the plan, that's what we're working towards. But what we see, we're still working back to the sort of published rates. We're still as I work through their inventory, we see some of that come from their inventory, some of that come from us.
Pete Osterland: All right. And then just -- I also had a question on margins. Just given the year-over-year drop in electronic systems, I understood that some of the impacts were you called out was from COVID and weather and they seem like they'd be contained over to the first quarter but you're expecting that the product mix headwinds that you called out will continue impacting the segment in the second quarter and are you seeing any meaningful inflation from labor or other input costs that might be an additional headwind heading into 2Q?
Chris Wampler: No, I wouldn't say significant. I'd say, certainly we're working with a lot of the dynamics that everybody is in terms of inflationary pressures with you see from labor or what you see from the supply chain but we're covered and feel like we're in a good spot, especially as we move forward on that. But the margin itself, Q1 tends to be sort of the toughest margin quarter for us, really across the board but particularly with electronics and as we look forward, we're planning on the mix coming back to a more normal state and so we can do that. We'll look forward to snapping back from where we're at here in Q1.
Pete Osterland: Okay, great. And then just one, one last one, if I could.
Steve Oswald: This is Steve. Let me just say I want some more color on that. So obviously a lot of manufacturers struggled in January. Sure, you've heard it from other companies. We had to certainly work very hard in February and March and make for some absenteeism which I think we did but I think one of the bright spots going forward on the margins and those type of things, we have our all-time record backlog. So that's going to help a lot as we go forward through the next few quarters.
Pete Osterland: Understood. Makes sense. And then just one last one if I could, just on the defense side, are you seeing any demand signals from your defense prime customers suggesting that there might be any additional opportunities or volume increases as a result of the Russia-Ukraine situation and just what is your overall outlook for the global defense spending environment moving forward?
Steve Oswald: Yes, we look, we've built really built our defense business. So we feel really good about it. Yes, there is more activity, absolutely with the threats going on and continued threats just legacy and in general, so the competition with Russia, competition with China, Ukraine. So we absolutely are seeing activity that we're working on and we feel good about. The other thing, just mentioned again in my remarks, is that outside of programs and other things, I mean, customers are eager to work with us on sort of non-core manufacturing as these defense primes were looking at things and saying, do we really want to make circuit cards in our factories at the kind of costs an OEM has, or do you want to send it to Ducommun, so I think not only this year but certainly next year, we're going to have some nice tailwind with that off-loading on top of the order activity now.
Operator: Our next question is from Ken Herbert with RBC Capital Market.
Unidentified Analyst: This is Keith on for Ken Herbert. I was hoping, you guys could just discuss some of the weakness we saw in military and space, in terms of the programs?
Steve Oswald: Yes, I think a couple of things, Keith. And I'll let Chris jump in too, is that a lot of it was timing of orders. As we took a look at some missile programs that we've had, there tends to be some movement, when you have military sales and our TOW missile cases as well, those things kind of going a little bit of variable as far as orders go. So overall, again, I thought it was a very solid quarter for us. Cards were good, harnesses were good but I think in just top level markets, a little lightness in missiles and then on TOW case.
Chris Wampler: Yes, no, I think on the military side, just on the fixed wing F-35, down a little bit was a part of it but I'd say the other theme really is the volume is a matter too of what we can produce. And one was the issues that we sort of pointed to with Q1 with working through COVID and working through weather, that's just a constraint on what we're able to produce on the military side. So I'll point that back to the strong backlog at over $500 million, we feel really good about, where we're at but that's a little bit about why Q1 played out the way it did.
Unidentified Analyst: And then do you kind of expect that could be a bit more positive in 2Q? And then just if I could, just kind of a full year outlook for defense as well?
Chris Wampler: Yes, I mean, I'll start and Steve can jump in here but I mean we definitely, yes, we don't anticipate the same type of complexities on the workforce with COVID, weather, things like that. In Q2, usually is where we can start to stretch our legs a little bit just as we operate. So we feel good about that part of it, getting to utilize what we have out there in the backlog. And from a full year, I mean we knew, we've come through a couple of really strong years of defense growth. And so, this year with the story as we have a business now that we certainly flex hard toward defense coming from '19 through 2021, seeing commercial tick back up is going to be really helpful. Defense, we've got a strong business now. There we're going to continue to make some inroads like Steve mentioned but overall it's the good commercial business is what's going to drive a lot of the high-single growth, that Steve talked about.
Operator: Our next question is from Mike Crawford with B. Riley Securities.
Mike Crawford: Regarding the latest restructuring initiative, how much is that related to M&A integration? Do you still think of these acquired entities like LDS, CTP, Nobles and MagSeal, separate subsidiaries or they are more integrated into structural and electric systems?
Steve Oswald: Yes, Mike. So look, they are definitely more integrated. This really is sort of outside of those companies and much more into some of our legacy footprint that I've been dealing with since I've been here. And I think just for on the call, I mean, we did the only other restructuring in November 2017 when I first started and I felt that now in five years into the job, I talk to the team. We have some opportunities. I'll give you one example on the calls, I think it is important is that we have a facility in Thailand that really does have -- doesn't really fit for us as far as strategic value. It's very far away, tough for governance and those types of things. So that's an opportunity, we're going to move forward on. So it's those types of things, Mike, we're getting ready for the next five years here, we're trying to get things right and get to our long-term goals.
Mike Crawford: Okay. And then, further regarding your footprint, what's the current capacity is following the fire you had there earlier?
Steve Oswald: Well, they have a brand new building and I'm proud of the team. So we're, by the end of Q2, we're going to be right back where we are as far as production for background. We had to move all that work up to Gardena, our Gardena facility and we did. And we built a new building. We feel really good about it. All the work is being transferred back in Q1 and in Q2. So we'll be ready to go. I think on our capacity, Mike, I think right now we've got a lot of runway, we're certainly looking to double that business, we're looking at other opportunities, because as I mentioned in previous calls, the LEAP engine block door is now fully commercialized in Middle River. We have closed out panels, we have the faring. So we'll look to do more in that space. We like themselves a lot, we think VersaCore could do a good job there. So more to come.
Mike Crawford: Okay. Just one last one. You mentioned, things like the SPY-6 radars and NGJ for commercial offloading. But what about like captive titanium operation at Airbus that you could, work to do. Has there been any progress on that or?
Steve Oswald: Yes, nice. I wish now as it came, Mike. Look, we have our place to play, our lane with Airbus. We're certainly interested if there is more opportunity there. I don't see, we've benefited from higher volume when Airbus gets busier which they will. We certainly anticipate. We're going to see more share, okay. That's sort of what's happened in the past, now that we're coming out of COVID. So we think that's more of the play for Ducommun titatium, is that we --whereas they go higher and other suppliers may struggle. We have -- we've been on time with Airbus over two years now. So, straight. So we feel good about our position there. We're going to benefit once we keep going on these bill rates, so again stay tune on that too.
Operator: I am showing no further questions at this time. I would like to turn the conference back to Mr. Oswald.
Steve Oswald: Okay. Thank you very much and thanks everybody for your time today. We feel obviously we had a bit of a tough start, as I mentioned in January, a lot of absenteeism and that was just our reality. But I think we had a very good start to the year. We're very optimistic about the next few quarters. So that's a good feeling among our team here and the all-time backlog number is something that obviously we're proud of. I mean customers, they vote for orders, okay, that's how they vote. So our customers are behind us. We have the team. We have the footprint. We have the supply chain. So I think more good things ahead. Again as I've always said in my calls, thank you for your support. Have a nice afternoon or evening.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect.
