Ducommun Inc /De/ Q1 FY2023 Earnings Call

Good day, ladies and gentlemen, and welcome to Ducommun's First Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we'll hold a Q&A session. As a reminder, this conference call is being recorded today, May 4, 2023. I would now like to turn the conference call over to Ducommun's Senior Vice President, Chief Financial Officer, Controller and Treasurer; Mr. Suman Mookerji.

Thank you, Jeda, and welcome to Ducommun's 2023 first quarter conference call. With me today is Steve Oswald, Chairman, President and CEO. 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 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, among others, the cyclicality of our end-use markets, the level of US government defense spending, timing of orders from our customers, legal and regulatory risks, the cost of expansion and acquisitions, competition, economic and geopolitical developments, including supply chain issues and rising interest rates, pandemics 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 Q1 2023 Quarterly Report on Form 10-Q with the SEC today. I would now like to turn the call over to Steve Oswald for a review of the operating results.

Okay, Suman, thank you. And thanks, everyone, for joining us today for our first quarter conference call. Today, and as usual, I will give an update on the current situation of the company, and Suman will review our financials in detail. Before that though, I'd like to discuss our CFO transition announced yesterday. First, I'd like to say this transition is not related to any issues revolving the company's financial reporting. I would also like to thank Chris Wampler for his contributions and service as CFO. And welcome Suman Mookerji to the call and congratulate him on his new role. Suman and I have known each other for over 12 years, worked together at three different companies and I have full confidence in him and his abilities. As we announced last week, I'm also delighted that we have completed the acquisition of BLR after the end of Q1 as we had a 30-day filing period that ended on April 24. BLR Aerospace is our fifth acquisition and largest since I joined the company in 2017. Its acquisition is 100% in line with the expectations we discussed at the Ducommun Investor Meeting in New York in December. BLR is an industry leader and innovator, providing engineered products and aftermarket services to rotorcraft, fixed-wing business aviation OEM customers and fleet operators. I want to welcome Mike Carpenter, President and the entire BLR team to Ducommun. I’m excited to begin working with them. As for the quarter, we're off to a good start in 2023 with very strong top-line growth, as the company delivered year-over-year revenue growth of 11% to $181.2 million. As mentioned in the press release, our excellent position in narrow-body aircraft was key to driving overall revenue growth and another positive sign of recovery is in good shape. It only gets better in the near and longer term. Turning to the markets, the continued recovery in commercial aerospace is one of the real bright spots in Q1. With Boeing 737 MAX business up 80% year-over-year and the Airbus A320 also showing significant growth of 66% year-over-year. Overall, commercial aerospace with Airbus and Boeing and others was up 35% from Q1 2022. Ducommun’s commercial aerospace business has shown year-over-year revenue growth now for the seventh consecutive quarter, which is an excellent sign as the industry and build rates recover. The company's defense business was down modestly year-over-year in Q1, mainly due to the timing of programs such as the Apache rotor blade and GA UAVs among others. But once again, Ducommun has delivered a solid performance of roughly $96 million in revenue as we prepare for increasing DoD budgets and FMS in the years ahead. The company posted a solid gross profit of 20.3%, which is up year-over-year from 19.9%. These are good results as we work through our restructuring activities. The team also posted adjusted operating income margins of 7.5% and adjusted EBITDA was $23.1 million, an increase of $3 million year-over-year. The company had adjusted EBITDA margins of 12.7% in Q1 as well, and we anticipate adjusted EBITDA to be solid this year, with much stronger numbers in 2024, once the 2023 results are behind us. Quality of earnings was solid with GAAP diluted EPS of $0.42 a share versus $0.66 a share for Q1 2022. However, with adjustments, the diluted EPS of $0.63 a share was comparable to a diluted EPS of $0.67 a share in the prior year. Some key drivers for the lower GAAP diluted EPS include restructuring charges and higher Glamis fire-related expenses. Switching to the company's backlog performance, the commercial aerospace backlog increased sequentially for the eighth consecutive quarter from $266 million at the end of Q1 2021 to $464 million at the end of Q1 2023, an increase of 74%. This was led by the 737 MAX and ViaSat for in-flight entertainment, the A320, A220 and Gulfstream, all of which you would expect after a slower-than-expected recovery during 2022. The defense backlog decreased modestly sequentially from Q2 2022, but remained solid at the end of Q1 as well and ended the quarter at $444 million. I also want to share with you some great news on the 737 MAX. We recently received our first order ever from Spirit AeroSystems for MAX fuselage skins similar to what we manufacture for the A220. This is an initial order for four skin sections, which comprise roughly 5% of the total fuselage. We expect this to grow as we move forward. The initial four skin order is projected to be $4 million in revenue yearly, and we're excited about what is ahead. Keep in mind; we provide close to 100% of the skins for the A220 fuselage as a sole source or a 50-50 split with Spirit for certain areas. So we are ready to do a lot more after this initial order. The four skin sections will be fully commercialized by year-end. For offloading for defense prime, the work continues. We're expecting roughly $90 million for the full year, as committed to with a great deal of that in our circuit card business for Raytheon at such sites as Appleton, Wisconsin and Tulsa, Oklahoma. The long-term run rate of these defense programs, already commercialized or in development for off-flowing, will be over $125 million for the company by 2025. One item to note is that there are lags with these types of projects. We would not only have to transfer legacy or buy test equipment, etc., but we do have an initial headwind on revenue with the OEM supplying material from their on-hand stock. So the numbers with these large OEMs do take some time. The company's actions and lean organizational structure are also continuing to pay dividends. Our team delivered another excellent quarter in Q1, managing the supply chain, and this is shown not only in our financials but we cannot be in better shape with our customers regarding our on-time delivery and quality. In addition, we were honored in March by Airbus with an award for being a top-performing supplier for hot form and superplastic form titanium products. Ducommun put out a press release on this, and we are very proud of our work. For context, we did not have any business with Airbus before 2016. It has been a great success and Airbus sets a very high global standard for these awards. It is a select group. For revenue guidance for the year, we're happy to update it to mid-to-high single digits for 2023 based on better news on commercial aerospace along with a very successful win with BLR and the acquisition. Just a few comments on our win. These are never easy and require a great deal of effort and excellence. I'm happy to report that the seller, due to our approach, went exclusive with Ducommun early on and this provides beneficial benefits for everyone. On the commercial aerospace side, the recovery will continue to lead the way, and revenue will be very good for the rest of 2023 as we see more and more volume return with defense also being solid. The two plant closings later this year will also have some limited headwinds on revenue as we seek to prove non-strategic and low-volume business, but we feel very confident in our much-improved guidance for 2023 revenue. Now, let me provide some additional insights on our markets, products, and programs. Beginning with our military and space sector, we posted first-quarter revenue of $96.4 million, a modest decrease versus Q1 2022. Despite being down, as mentioned earlier, it was a solid showing for the business in Q1. We still saw increases in demand for our other military and space platforms such as MIRV missile systems, other military rotary aircraft platforms, and other military fixed-wing aircraft platforms. In the first quarter, military and space revenue represented 53% of the company's revenue in the period, down from 61% last year and this trend will continue to reflect more balance with commercial aerospace, which we like. We also ended the first quarter with a solid backlog of $444 million, while also down modestly sequentially, it still represents 46% of Ducommun's total backlog. In our commercial aerospace operations, first-quarter revenue increased 35% year-over-year to $73.1 million, driven mainly by bill rate increases at Boeing, Airbus, and others. Ducommun expects this to continue to gain momentum in 2023, and the future is very bright across our product offerings. Our delivery and quality also continued to stand out as we move ahead. The backlog within our commercial aerospace sector stands at $464 million at the end of the first quarter, an increase of $87 million or 23% year-over-year from Q1 2022. With that, I'll have Suman review our financial results in detail.

Thank you, Steve. As a reminder, please see the company's Q1 10-Q and Q1 earnings release for a further description of the information mentioned on today's call. As Steve discussed, our first quarter results reflect another period of strong performance. Once again, we saw a significant increase in our commercial aerospace revenues. We remain encouraged by the continued strength in domestic and global travel, which supports higher long-term demand for aircraft and are also encouraged by the build rate outlook from our key customers that should drive continued growth in our shipments. During the quarter, we also continued to make progress on our restructuring program. And as Steve mentioned, we announced the acquisition of BLR Aerospace in Q1 and subsequently closed on the transaction on April 25th. With all this, we feel like we have laid a strong foundation for the year in the first quarter. Now turning to our first-quarter results, revenue for the first quarter of 2023 was $181.2 million versus $163.5 million for the first quarter of 2022. The year-over-year increase reflects $19 million of growth across our commercial aerospace platforms, partially offset by $2.9 million of lower revenue within the military and space sector. Ducommun's overall backlog at the end of the first quarter was approximately $961 million, similar to the level at the end of Q4 2022 and $18 million higher than at the end of Q1 2022. This reflects recent growth across our commercial aerospace platforms. Our defense backlog was $444 million, and we remain positioned for continued solid performance as we move through the remainder of 2023. 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 a total gross profit of $36.8 million or 20.3% of revenue for the quarter versus $32.5 million or 19.9% of revenue in the prior year period. We continue to show adjusted gross margins as we have a higher amount of non-GAAP related cost of sales this year, mainly driven by our fire-related impact. On an adjusted basis, our gross margins were 21.1% in Q1 2023 versus 20.8% in Q1 2022. We continue to work through a difficult operating environment with supply chain and labor challenges. However, through our proactive efforts including strategic buys and our inventory investments, we have been able to avoid any significant impacts on the business. Ducommun reported operating income for the first quarter of $6.4 million or 3.5% of revenue, compared to $9.1 million or 5.6% of revenue in the prior year period. Adjusted operating income was $13.6 million or 7.5% of revenue this quarter compared to $12.3 million or 7.5% of revenue in the comparable period last year. The company reported net income for the first quarter of 2023 of $5.2 million or $0.42 per diluted share compared to net income of $8.1 million or $0.66 per diluted share a year ago. On an adjusted basis, the company reported a net income of $7.9 million or $0.63 per diluted share, compared to a net income of $8.3 million or $0.67 in Q1 2022. The lower net income relative to operating income was driven by higher interest costs during the period. Adjusted EBITDA for the first quarter of 2023 was $23.1 million or 12.7% of revenue, compared to $20.1 million or 12.3% of revenue for the comparable period in 2022. Now, let me turn to our segment results. Our Structural Systems segment posted revenue of $75.6 million in the first quarter of 2023 versus $66 million last year. The year-over-year increase reflects $14 million of higher sales across our commercial aerospace applications, partially offset by $4.4 million of lower revenue within the company's military and space markets. Structural Systems operating income for the quarter was $4.7 million or 6.3% of revenue compared to $4.9 million or 7.4% of revenue last year. The year-over-year operating margin decrease was primarily due to higher restructuring charges. Excluding restructuring charges and other adjustments in both years, the segment operating margin was 12.9% in Q1 2023 versus 11.7% in Q1 2022. This is a solid operating performance from the Structural Systems segment. Our Electronic Systems segment posted revenue of $105.6 million in the first quarter of 2023 versus $97.5 million in the prior year period. These results reflect $5 million of higher commercial aerospace revenue and $1.5 million of higher revenue across the company's military and space customers. Electronic Systems' operating income for the first quarter was $10 million or 9.5% of revenue versus $9.4 million or 9.7% of revenue in the prior year period. The lower operating income as a percentage of revenue was primarily due to higher restructuring charges. Excluding restructuring charges and other adjustments, in both years the segment operating margin was 11.6% in Q1 2023 versus 10% in Q1 2022. Now, an update on our restructuring. As a reminder, we commenced a restructuring initiative back in Q2 2022. These actions are being taken to accelerate the achievement of our strategic goals and to better position the company for stronger performance in both the short and long-term. This includes the shutdown of our facilities in Monrovia, California and Berryville, Arkansas, and transferring a majority of that work to our low-cost operation in Guaymas, Mexico, with the remainder going to other existing performance centers in the United States. We are progressing well on these transitions both with employee retention and engagement and with customer alignment. During Q1 2023, we incurred $4.2 million in restructuring charges. The majority of these charges were severance and benefits-related. We expect to incur an additional $8 million to $12 million in restructuring expenses during the rest of 2023. Upon the completion of our restructuring program, we expect to generate $11 million to $13 million in annual savings from our actions. Once we wind down production at Monrovia and Berryville, we anticipate selling the associated land and buildings at both locations. Turning to liquidity and capital resources, we have available liquidity of $217 million at the end of the first quarter. The first quarter of each year is typically our largest net usage of cash in operations, primarily due to the payout of year-end accrued incentives. This year we also made an estimated tax payment of approximately $8 million to cover changes in tax rules for R&D expenses, which now need to be capitalized and amortized. Thus, we used $18.9 million in cash flow from operating activities during the quarter. This was similar to the prior year, which also saw net cash used in operations of $18.9 million. Our 12-month debt-to-adjusted EBITDA ratio was 2.5 and is among the lowest in the last several years. However, going forward, as a result of the completion of the BLR acquisition in Q2, we expect our debt-to-adjusted EBITDA ratio to increase. While our debt refinancing during 2022 was timely and beneficial, the rising interest rate environment drove the increase in interest costs to $4.2 million in the quarter versus $2.4 million in Q1 2022. This was expected. In November 2021, we installed an interest rate hedge for $150 million, which goes into effect in January 2024, and will help with our interest costs. To conclude the financial overview, we are off to a good start in 2023, and with the BLR acquisition now completed in Q2 and the expected completion of the restructuring program later this year, there is much to look forward to for the rest of 2023 and beyond. I'll now turn it back over to Steve for his closing remarks.

Okay. Thanks, Suman. In closing, it was a very good quarter to begin the year. The Bell acquisition is another step in the right direction and certainly meets the expectations we communicated at our Investor Day in December. In addition, all the meetings I've been attending now that we're meeting in person again with top customers and all the industry news that I read, just show some great opportunities over the next several years, and the Ducommun team is ready to capture the upside. My thanks, as always, to our employees and investors for their support as we embark on the new year and build momentum throughout 2023, toward an even stronger 2024. I will now open up for questions. Thank you for listening.

Thank you. At this time, we will conduct the question-and-answer session. Our first question comes from Ken Herbert of RBC. Your line is now open.

Yes. Hey, good morning Steve, and congratulations to Suman.

Thank you.

Good morning, Ken.

Hey, Steve maybe to start off, you called out some pretty significant growth in the first quarter for the MAX, and it sounds like you've taken some share on that program, which is nice, but there's been a lot of headlines recently about this program and some issues with Spirit. Can you maybe level set us here in terms of what bill rate you're currently going in on the MAX, maybe how you see that progressing over this year? And then maybe the revenue contribution this year. How much do we expect it to grow across the full year? Because it sounds like you haven't been impacted by some of the slowdown that we're seeing in Spirit.

Thanks, Ken, that's a good question. I was recently at the Boeing supplier meeting. We started at a modest rate of 31 a month. Despite some challenges with Spirit, which we hope they resolve soon, we believe we're still at the beginning of this process. We anticipate a slight bump in the road, but we expect to increase from 31% to 38% by the end of the year. We are well-prepared for this growth and will need to hire a bit more staff, but we're feeling optimistic. There is concern regarding the necessary repairs Spirit needs to address, but we've made significant progress on the skins development with them after working on it for over 16 months. We already have a strong position in fuselage skins for the A220 and believe we will improve our rates. While some challenges exist right now, we aim to reach 38% or close to it by year-end. Additionally, we are optimistic about gaining a larger share of the program as we move forward with Spirit, indicating good prospects ahead for us.

Okay. That's helpful. Thank you. And I guess as you think about that to segue into the better outlook for revenues this year being mid to high single-digit. Is that predominantly the BLR acquisition, or is there any assumption in there about sort of better performance out of aerospace? I mean, it looks like BLR could add maybe three to four points of growth this year.

Yes, it's a mix. Certainly, BLR will contribute. We acquired them at the end of April, so we won't see a full year of revenue, but we expect to receive some nice revenue. At the beginning of the year, we started with a low single-digit outlook and were feeling somewhat cautious. However, we have a more positive view on our prospects as well as those of Airbus, Gulfstream, and the other companies we support. BLR is projected to be at the lower end of the range you mentioned, but there is significant organic growth in the outlook.

Okay. Great. And Suman, just finally I think the cash use this quarter was probably consistent with expectations, but can you reset us on maybe an expectation for full-year 2023 free cash flow?

So, we expect to have a better free cash flow year this year than we did last year. There are some headwinds as we do these facility transitions and have to build up some inventory to support those moves. But we're looking at ways to offset some of those headwinds and come out net positive versus where we did on working capital and cash flow last year.

Yes, Ted, we received the Apache back late, and we are dealing with the MAX spoilage. These are significant industry impacts that we need to manage. It's important for us to prioritize customer care and ensure we have sufficient buffers for these changes. Additionally, there are some other factors to consider.

Great. All right guys. Thanks a lot.

Thanks, Ken.

One moment for our next question. Our next question comes from Mike Crawford of B. Riley Securities. Your line is now open.

Thank you. Just to make sure, are you not comfortable talking about the rough annual revenue run rate of BLR as well as the added working capital that that's going to put on the balance sheet the next time we see a print?

We'll have more to say, I think, at the end of the Q2 call, okay? Mike, we'll just get started here. Obviously, BLR is an engineered product with an aftermarket. So it's going to be accretive to the P&L and to our current business. So we're excited about it. I think earlier with Ken's comments, it's a couple of points for this year for us on the revenue side, and more to come.

Okay and then regarding the mid-to-high single-digit growth guidance implying some high hundred millions of revenue versus your 12-month backlog which is closer to $650 million-ish. So where is the main book and ship business that makes up that difference?

So we see book and ship in a lot of our engineered product businesses. And so that is a big driver of that. And then, we may see some incremental growth in our structural business as well and some drop in orders in our electronic manufacturing services business from time to time, although their typical lead times are longer. But mainly in our engineered products businesses is where we have more book and ship business.

Okay. Great. Thank you. And then, I don't know, I guess on the last call you weren't really prepared to talk about this, but once you do get out of Monrovia and the other factory like, do you have any more sense you can share on the potential timing of the sale of the real estate underlying these facilities and ….

Yeah.

… perhaps what you might get from it?

I think it's a bit challenging at the moment, as we have some significant moves to make, and customers are feeling uneasy. We need to ensure that we are making the right decisions upfront. We aim to relocate one if not both properties, likely by the end of the year or possibly by the first quarter. While we're not rushed, it's important that we do what's best for the market, and we prefer to address this soon rather than later.

Okay. All right. Thank you very much.

Thanks Mike.

Our next question comes from Michael Ciarmoli of Truist Securities.

Taking my question…

Your call is now…

Hey, can you hear me guys?

Yes. We can hear you.

We can hear you Michael. How are you?

Hey. Maybe just going back to the facility transitions, I think you talked about the MAX spoilers and the Apache blades.

Yeah.

Is there any sort of requalification risk needed to shift that work or any sort of technical challenges that we should be aware of there?

No, Mike. We've been producing that for a long time. We're just relocating production to a different site. There's no issue with that, but we will need to collaborate with the customer since it will be going into a new facility. There's always a delay with defense primes or major OEMs in the commercial sector. However, we're confident about our current position. I want to highlight that at Berryville, we announced this last November and still maintain a nearly full workforce. The team is dedicated to completing the job and ensuring a smooth transfer. So, from a technical standpoint, the answer is no.

Okay.

We will be relocating production to another site, and while there may be some delays due to the transition into a new facility, we are confident in our current position. I want to acknowledge the dedication of our team at Berryville. Since we announced this change last November, we have maintained a nearly full workforce, which shows their commitment to completing the project and ensuring a smooth transfer. Therefore, from a technical standpoint, I can confirm that there are no concerns.

Okay. And then, just back to the MAX, can you just circle back a little bit more about the content? You talked about the $4 million. Does that assume a specific run rate? Are you on every plane? I know the MAX was your biggest program pre-pandemic but just trying to get a sense of how much content this adds.

Yes. As I said, it's a good start. Let's put it that way. It's going to sort of increase our ship rates so roughly around 15 ship sets a month for those skins. We're pretty happy with that.

Okay.

Spirit makes it internally too. So.

Got it.

But that's the big deal. We're in the game.

Perfect, that's what I was looking for. Suman, regarding the restructuring, you mentioned the annualized savings starting in the second half of 2023. How should we think about that? Is it around $5.5 million in savings? What are your thoughts on how this will impact margins? Should we expect to see a significant increase in operating income and margins as we move into the third and fourth quarters?

I think you're going to see it more towards the end of the year.

Okay.

And yes, I think you're going to see the benefit more pronounced in 2024.

Okay. Got it. Perfect. Okay, perfect guys. That's all I had. Thanks.

Okay. Thanks, Michael.

There appears to be no further questions. I would now like to turn it over to Mr. Oswald for closing remarks.

Okay. Thank you very much. Again, I think it's a very good start to the year. We have a lot going on here, but I think all very positive for our customers, our company and our shareholders. It should be a consequential year to comment on the upside. And again, my thanks for attending today, and I wish you a good afternoon.

Thank you for attending today's conference. This does conclude the program. You may now disconnect.