Earnings Call Transcript - DCO Q2 2024

Operator, Operator

Good day, everyone. And thank you for standing by. Welcome to the Second Quarter 2024 Ducommun Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. Now I will pass the call over to Ducommun’s Senior Vice President and Chief Financial Officer, Suman Mookerji. Please go ahead.

Suman Mookerji, CFO

Thank you. And welcome to Ducommun's 2024 second 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 market, the level of US government defense spending, our customers may experience delays in the launch and certification of new products, 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 or high interest rates, the ability to attract and retain key personnel and avoid labor disruptions, the ability to adequately protect and enforce intellectual property rights, pandemics, disasters, natural or otherwise, and risks of cybersecurity attacks. Please refer to our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and other reports filed from time to time with the SEC, as well as the press release issued today for a detailed discussion of the risks. 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 Q2 2024 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. Steve?

Steve Oswald, CEO

Okay. Thank you, Suman. Thanks everyone for joining us today for our second quarter conference call. Today and as usual, I'll give an update on the current situation of the company, after which Suman will review our financials in detail. Let me first start off this quarterly call with Ducommun’s Vision 2027 game plan for investors. Strategy and vision were developed coming out of the COVID pandemic over the summer and fall of 2022, unanimously approved by Ducommun Board in November of 2022, and then presented to investors the following month in New York where we got excellent feedback. Since that time, Ducommun has been executing the Vision 2027 strategy, by consolidating its facility or rooftop footprint, increasing the revenue percentage of engineered products and aftermarket content, continuing its targeted acquisition program, executing our offloading strategy with defense primes and high growth segments of the defense budget, and by expanding content on key commercial aerospace platforms. All of us here have a high level of conviction in the Vision 2027 strategy and financial goals and believe the many catalysts ahead present a unique value creation opportunity for shareholders. The Q2 2024 results are also a very good example of our strategy working. Q2 was a record revenue and gross margin quarter following a strong start we experienced in the first quarter. Revenues were $197 million, growing 5.2% over the prior year, and this is our fourth consecutive quarter with revenues exceeding $190 million. Strong growth in our commercial aircraft business across Boeing, Airbus, and Business Jet helped drive revenue during the quarter. We saw significant growth on the A220 program where we make the skins for the entire fuselage along with good growth in twin aisle platforms as well. Business Jet revenues were higher driven by work we do for Gulfstream. We also saw an increase in our commercial revenue as we build buffer stock to support the Monrovia facility closure and transfer to DCO's Guaymas Mexico operation. Q2 was also supported by us building a higher production rate than SPR and VA to allow for efficiencies, workforce retention, and level loading of our production. Overall, Commercial Aerospace was up 13% from Q2 2023. We have now grown year-over-year revenue in our commercial aerospace business for 12 consecutive quarters, demonstrating the resilience of our business even in a challenging OEM environment with SPR and BA. The other good news for DCO's commercial aerospace business is the fuselage skin project for the 737MAX at Spirit, which we have been working on. We now anticipate having the FAI approved in September and shipping the first production set in October. 2025 revenue for the four skins should be over $3.5 million at 15 shipsets a month. Keep in mind this is less than 10% of the fuselage. So stay tuned for more news as we move forward and gain more program share. Our defense business grew 3% year-over-year with strong demand for the F-15, Black Hawk, and radar platform, as well as selective naval submarine programs. Growth was partially offset by declines in programs, such as the JSF, F-18, which we have discussed in the past, and the F-16. A pause in the TOW missile production contributed as well, but we now have a new PO from RTX and anticipate starting shipments again in July 2025 from Guaymas, Mexico. Defense business was $100 million in revenue for the third time in the last four quarters, and we remain optimistic about the growth ahead. On offloading from RTX, our SPY-6 radar circuit card business grew over 100% from Q3 last year, tracking now for over $10 million in revenue in 2024 for just one CCA. We have the next card for the SPY-6 program in process and that will be in production next year. Another record highlight in Q2 was gross margin of 26% for the quarter, up 460 bps year-over-year from 21.4% and 140 bps compared to the first quarter, as we continue to realize benefits from our strategic value pricing initiatives, productivity improvements, favorable product mix, growing engineered product portfolio with aftermarket, and initial restructuring savings. In addition, our Berryville, Arkansas facility is now down to less than 10 people to maintain capability on a single platform until the receiving plan is certified. Our Monrovia, California facility also significantly reduced headcount this month with most production activities shut down, and the team is down to less than 20 employees. The Monrovia plant will be fully closed by the end of September. We will see the cost savings of these moves as the receiving plants ramp up production in 2025. So stay tuned. For adjusted operating income margin in Q2, the team delivered 10.1%, a record performance and well ahead of the 8.1% number in Q2 2023. This is a great result driven again by the continued growth in our Engineered Products businesses, favorable product mix, impact of our strategic pricing initiatives, and our restructuring savings beginning to kick in during the quarter. Adjusted EBITDA was another great story in Q2, hitting $30 million for the first time, a big deal, while expanding a robust 130 basis points to 15.2% of revenue compared to 13.9% in Q2 2023. This all provides momentum along with the Q1 results as we work towards the 18% goal in our Vision 2027 plan. The GAAP diluted EPS was $0.52 a share in Q2 2024 versus $0.17 a share for Q2 2023. And with adjustments, diluted EPS was an impressive $0.83 a share compared to diluted EPS of $0.54 in the prior year quarter. The higher GAAP and adjusted diluted EPS was driven by improved operating income as well as lower interest costs due to our hedging strategy during the quarter. The company's consolidated backlog increased both sequentially and compared to the prior year quarter. Total company backlog ended Q2 at a new record of $1.68 billion, increasing over $22 million sequentially and almost $58 million year-over-year. Defense backlog increased $98 million compared to the prior year quarter to end at a record of $592 million. The commercial aerospace backlog decreased $14 million year-over-year, primarily due to industry issues with single aisle production rates and the MAX issues with Boeing and Spirit. However, our commercial aerospace backlog still grew on a sequential quarterly basis to $451 million. As for the 2024 revenue guidance and despite continued uncertainty surrounding Boeing, Spirit, and the FAA on the MAX, we are maintaining our guide of mid single digits for the year with Q3 flattish to last year followed by an uptick again in Q4. While we have seen a significant slowdown in the MAX build rates at the OEM level in Q2 and anticipate the same in Q3, we are positioned for the recovery as the build rates ramp back up. If BA is at 38 by year-end for their most recent communications on the MAX, this will be a major lift for DCO. I will also add that despite the challenges in the MAX, we are comforted by continued strength on other programs at BA and Spirit, Airbus, and Gulfstream. Now let me provide some color on our markets, products, and programs. Beginning with our military and space sector, we experienced revenues at $101 million compared to $97 million in Q2 2023. Growth was driven by the F-15 program along with military rotary aircraft, notably the Black Hawk program, as well as our radar franchise, again driven by the SPY-6 program. These were partially offset by weakness in F-35, F-18, and F-16 revenues. The second quarter military and space revenue represented 51% of Ducommun's revenue in the period, down from 59% back in 2022 and 70% in 2021. We expected these trends and it reflects more balance with commercial aerospace, which we like. We also ended the second quarter with a backlog of $592 million, an increase of $98 million year-over-year, representing 55% of Ducommun's total backlog. Within our commercial aerospace operations, second quarter revenue continued to see double-digit growth, increasing 13% year-over-year to $87 million, driven mainly by growth on the A220 platform, twin aisle aircraft, business jets, as well as buffer build to support the closure of our Monrovia facility. As mentioned earlier, we believe a much better story is ahead for BA and MAX by the end of Q4 and in 2025. The backlog within our commercial aerospace business was $451 million at the end of the second quarter, increasing almost $9 million sequentially and a solid number given the temporary weakness in the commercial aerospace market. Now with that, I'll have Suman review our financial results in detail. Suman?

Suman Mookerji, CFO

Thank you, Steve. As a reminder, please see the company's Q2 10-Q and Q2 earnings release for a further description of information mentioned on today's call. As Steve discussed, our second quarter results reflected another period of strong performance with growth in both our commercial aerospace and military end markets, as well as continued improvement in our margins. We remain encouraged by the continued strength in domestic and global travel, which would support higher long-term demand for aircraft as we work through some of the industry issues impacting single aisle production rates. In addition, we also made good progress on our facility consolidation efforts during the quarter, which will drive savings in 2025 and beyond. With all this, we feel like 2024 is showing good momentum that will continue to drive our performance towards our Vision 2027 goals. Now turning to our second quarter results. Revenue for the second quarter of 2024 was $197 million versus $187.3 million for the second quarter of 2023. The year-over-year increase of 5.2% reflects growth in both commercial aerospace and military and space, highlighted by $9.9 million of growth across our commercial aerospace platform and $3.2 million of growth in our military and space platform. We posted total gross profit of $51.2 million or 26% of revenue for the quarter versus $40.1 million or 21.4% of revenue in the prior year period. We continue to provide adjusted gross margins as we have certain non-GAAP cost of sales items in the current and prior period relating to inventory step-up amortization on our recent acquisitions, restructuring charges, and the impact from the Guaymas fire on our operations. On an adjusted basis, our gross margins were 26.6% in Q2 2024 versus 23.1% in Q2 2023. The improvement in gross margin was driven by our growing engineered products portfolio as well as favorable product mix in our manufacturing services businesses, strategic pricing initiatives, productivity improvements, and some initial restructuring savings. We continue to make progress working through a difficult operating environment with supply chain and labor. Through our proactive efforts, including strategic buys on our inventory investments, we have been able to avoid any significant impacts thus far on our business. During the second quarter of 2024, we reduced our inventory by $7.1 million from Q1 while still keeping our performance centers positioned to meet our 2024 delivery commitments and ready for a ramp-up in commercial aerospace build rates. We grew our contract assets by $13 million versus Q1. This was partly due to a buffer build of product to support the Monrovia facility closure as well as some modest build ahead in our commercial aerospace structures business to level load production. We continue to look for opportunities to unwind our working capital investments to improve our cash flow. Ducommun reported operating income for the second quarter of $13.9 million or 7.1% of revenue compared to $5 million or 2.7% of revenue in the prior year period. Adjusted operating income was $19.9 million or 10.1% of revenue this quarter compared to $15.2 million or 8.1% of revenue in the comparable period last year. The company reported net income for the second quarter of 2024 of $7.7 million or $0.52 per diluted share compared to net income of $2.4 million or $0.17 per diluted share a year ago. On an adjusted basis, the company's reported net income of $12.5 million or $0.83 per diluted share compared to net income of $7.3 million or $0.54 in Q2 2023. The higher net income and adjusted net income during the quarter were driven by higher operating income and adjusted operating income. Additionally, our interest rate hedge helped reduce our year-over-year interest expense. Now let me turn to our segment results. Our Structural Systems segment posted revenue of $95.6 million in the second quarter of 2024 versus $80.2 million last year. The year-over-year increase reflected $10.4 million of higher sales across our commercial aerospace applications, including the A220 and select twin aisle platforms, in addition to regional business jets and buffer build to support the Monrovia facility closure. In addition, we maintained commercial aerospace build rates for selected products to help level load production and maintain production efficiencies. The $5 million of higher revenue within the military and space markets was driven by strength in Black Hawk and other military programs. Structural Systems’ operating income for the quarter was $10.6 million or 11% of revenue compared to $5.4 million or 6.7% of revenue for the prior year quarter. Excluding restructuring charges and other adjustments in both years, the segment operating margin was 15.4% in Q2 2024 versus 16% in Q2 2023. The slight decline was from higher costs due to the transition of production from Monrovia to Guaymas, partially offset by strategic pricing initiatives and operating leverage from higher revenues at other performance centers within the segment. Our Electronic Systems segment posted revenue of $101.4 million in the second quarter of 2024 versus $107.1 million in the prior year period. The decline is attributable to lower revenues from in-flight entertainment to electronics F-18 and F-35 platforms, along with a reduction in our industrial business as we chose to selectively prune non-core business. The declines were partially offset by strength on select military platforms, including the F-15, SPY-6 radar, and naval and submarine programs, along with business jets with Gulfstream and on the A220 platform with Airbus. Electronic Systems operating income for the second quarter was $16.8 million or 16.6% of revenue versus $9.5 million or 8.9% of revenue in the prior year period. Excluding restructuring charges and other adjustments in both years, the segment operating margin was 16.9% in Q2 2024 versus 11.4% in Q2 2023. The year-over-year increase was primarily due to shifting mix with higher growth in revenues and profitability in our engineered product businesses along with strategic value pricing initiatives as well as savings from the restructuring program. Restructuring savings were driven by the transition of product lines from our Berryville performance center to other facilities. Next, I would like to provide an update on our ongoing restructuring program. As a reminder and as discussed previously, we commenced a restructuring initiative back in 2022. These actions are being taken to better position the company for stronger performance in the short and long term. This includes the shutdown of our facilities in Monrovia, California and Berryville, Arkansas, and the transfer of that work to our low-cost operation in Guaymas, Mexico and to other existing performance centers in the United States. We continue to make progress on these transitions with excellent employee retention and engagement and are also working diligently with our customers, Boeing and RTX, to obtain the requisite approval. During Q2 2024, we recorded $2.1 million in restructuring charges. The majority of these charges were severance and related benefits as we continue to wind down the two operations. We expect to incur an additional $3 million to $4 million in restructuring expenses through the end of 2024 and early 2025 as we complete the program. Upon the completion of our restructuring program, we expect to generate $11 million to $13 million in annual savings from our actions and are already beginning to see some realization of savings from these actions this year. We anticipate selling the land and building at both Monrovia, California and Berryville, Arkansas. Turning next to liquidity and capital resources. Year-to-date Q2 2024, we generated $1.8 million in cash flow from operating activities, which was an improvement compared to year-to-date Q2 2023, which had a usage of $9.7 million. The improvement was due to higher net income of $7 million as well as improvements compared to the prior year in accrued and other liabilities. As of the end of the second quarter, we had available liquidity of $205.4 million comprising of the unutilized portion of our revolver and cash on hand. Our existing credit facility was put in place in July 2022 at an opportune time in the credit market, allowing us to reduce our spread, increase the size of our revolver, and allowing us the flexibility to execute on our acquisition strategy. Interest expense was $4 million compared to $5.7 million in Q2 of 2023. The year-over-year improvement in interest costs, despite a higher debt balance, was due to the interest rate hedge going into effect. In November 2021, we put in place an interest rate hedge that went into effect for a seven-year period starting January 2024 and pegged the one-month term SOFR at 170 basis points for $150 million of our debt. The hedge resulted in interest savings of $1.4 million in Q2 2024 and will continue to drive significant interest cost savings in 2024 and beyond. To conclude the financial review for Q2 2024, I would like to say that the second quarter results continued our momentum from Q1 and positions us well for the rest of 2024. I'll now turn it back over to Steve for his closing remarks.

Steve Oswald, CEO

Okay. Thanks, Suman. Just in closing, Q2 was an excellent quarter and a record in some cases with many highlights for the company and our shareholders. We start to realize some of the gains we all expect for the Vision 2027, especially around margin expansion. Our first half positions us well to deliver strong performance in 2022 despite some of the current constraints. The progress on gross and EBITDA margin expansion has been excellent. We're not surprised and feel right on schedule. In addition, on two key tenets of our 2027 game plan, we're tracking well against the goals of 18% EBITDA margins and 25% or more of engineered product and aftermarket revenues. With commercial aerospace build ramps still ahead of us and the benefits from our facility consolidation expected to kick in starting in 2025, I'm excited about what lies ahead for us at Ducommun and our shareholders in the years ahead. Stay tuned. Okay. With that, let's please go to questions.

Operator, Operator

Thank you. One moment for our first question. And it comes from the line of Jason Gursky with Citi.

Jason Gursky, Analyst

Steve, maybe start with you and talk a little bit about the pipeline of new opportunities, and maybe just kind of give us a flavor of how things have evolved year-to-date starting at the beginning of the year where you are today and what you see in the pipeline. I'm just curious if anything kind of new and interesting has popped up for you here over the last six, seven months. And when you look out over the next couple of years, what you think the pipeline conversion might look like and book-to-bills, just kind of general demand flavor as well?

Steve Oswald, CEO

Let me address commercial aerospace first. Regarding the skins, while it's not a large number, we expect to see around $3 million to $4 million starting next year. We're only responsible for less than 10% of the MAX fuselage, but we handle 100% of the A220 fuselage. So we have the capacity and the machinery needed for this, and we are genuinely excited about what's in the pipeline. Additionally, we are exploring opportunities in commercial aerospace, particularly in gaining market share from competitors, which we'll elaborate on later. We anticipate picking up a significant amount of business related to the 787 beginning in January 2025, which could translate into substantial revenue for us. Our discussions with Airbus at the Air Show were positive, and we feel we are well-positioned to grow alongside them. Overall, the outlook for the commercial sector appears promising, with further updates to come. On the defense side, we are working on advanced projects, including hypersonics, although we can't share too many details right now. One noteworthy example is our offloading program, which has been beneficial for us. We produce a card for the SPY-6 radar, and so far, it has earned us over $5 million. We plan to introduce another card next year. There are several exciting developments in defense, both from organic growth and by capturing market share. Our meeting with Raytheon at the Air Show was productive, and the Tomahawks transitioning to Guaymas will greatly enhance our operations from Berryville. This has been a major program for us since the 80s. We have established the necessary infrastructure to facilitate this transition, and we anticipate significant margin expansion as we progress with Guaymas and the TOW program, which is also re-establishing itself midyear. We have already received a purchase order for that in Guaymas. Overall, both the commercial and defense sectors are looking quite strong, and we expect an eventual increase in build rates to provide added momentum.

Jason Gursky, Analyst

And then just a quick follow-up. Suman, you mentioned maybe some additional liquidity or capacity, and I think you mentioned M&A in the same sentence. So I'm just kind of curious to get an update just on the pipeline of potential M&A and have you further opened the aperture on potentially doing something larger where we'd be bringing in more revenue than what you had targeted for Vision 2027?

Suman Mookerji, CFO

So we continue to look at a number of opportunities. I would say that in terms of us being able to meet and exceed the target we set forth in Vision 2027, which is a $75 million placeholder for revenue from acquisitions, we feel very good about being able to meet and exceed that. So I would agree. Are we looking to do something bigger than or something more transformational at this time? No, we're looking to continue our strategy of doing these tuck-in acquisitions of niche product lines in a kind of a more manageable size range and be prudent with our leverage at this time. So we aren't looking to change the aperture on the size of deals. But we feel good about being able to exceed the Vision 2027 target for acquisition revenue.

Operator, Operator

Our next question comes from the line of Mike Crawford with B. Riley Securities.

Mike Crawford, Analyst

So Suman, you benefit from absorption as you built some buffered stock now. Can you just walk us through how margins are affected by the ramp-up at Guaymas, and as you work through this buffer that you've built up and get into a more normalized cadence?

Suman Mookerji, CFO

We saw a notable improvement in our structures segment margins compared to the previous quarter. This was largely due to Monrovia achieving better absorption rates. Specifically, Monrovia's revenues in the first quarter were significantly lower than both the fourth quarter of last year and the first quarter of 2023. Consequently, we faced a low revenue base that struggled with higher fixed costs in the first quarter, which, combined with one-time costs associated with the transition in Monrovia, impacted our margins. However, we managed to cut costs and doubled Monrovia's revenue as we built up our buffer stock and prepared to close operations there. In fact, revenue in the second quarter was twice that of the first quarter for the Monrovia facility, which improved absorption rates. Additionally, we experienced a slightly better product mix. Therefore, we believe that the improvements we are seeing in the structures segment margin for the second quarter, which aligns with historical margins, are sustainable going forward.

Mike Crawford, Analyst

And just related, you're getting near the end of this, I guess, second restructuring program since you guys joined the company and put it on its current trajectory. But I know there's an $11 million to $13 million cost savings target, but I imagine a chunk of that has already been realized.

Suman Mookerji, CFO

That is correct. So I would say that from our Berryville and Joplin facility, we are right now tracking at a run rate of I would say, $2 million to $3 million of savings annually. So an annual run rate of $2 million to $3 million, I would say, is where we are right now from the shutdown of Berryville. Of course, that will ramp up later in 2025 when we actually start production of some of those product lines in Guaymas, Mexico. So that hasn't started yet.

Steve Oswald, CEO

I wouldn't say a large amount, Mike. I believe two to three is reasonable. There's much more on the way.

Operator, Operator

Our next question is from Michael Ciarmoli with Truist Securities.

Michael Ciarmoli, Analyst

Steve or Suman, regarding the buffer stock, I believe you mentioned that you are currently building ahead. How should we adjust our expectations for revenue? You indicated that Q3 might see a slight decline. Should we anticipate a period of unwinding here? As we look towards the second half of the year and into early 2025, it seems uncertain considering the rates from Boeing and Airbus. How should we evaluate the potential effects of the build ahead and buffer on revenues?

Suman Mookerji, CFO

During Q2, we had approximately $5 million to $6 million in revenue that was pulled ahead from Q3 and Q4 due to the buffer build and the build ahead. This reflects how Q3 will align with what Steve mentioned earlier, with Q3 being relatively stable on a year-over-year basis, followed by improvements in Q4. Overall, we aim to meet that mid-single-digit guidance for the full year.

Steve Oswald, CEO

Mike, I think that's the right way to think about it. I think overall it's light, the impact is light. So it's not anything I'm very concerned about. But just for everyone on the call, I mean, Parsons is a big manufacturer for both Spirit and BA. And we just don't want to have to lay off 40 people and then four months later hire them again.

Michael Ciarmoli, Analyst

Right. Yes, of course.

Steve Oswald, CEO

So there's some employee retention in there that I think investors will hopefully agree is smart.

Michael Ciarmoli, Analyst

Regarding aerospace, I see that reflected in our models, and the slide shows it has the highest quarterly revenue rate since the third quarter of 2019. Is there a way to assess that on a same-store sales basis? You've had acquisitions and new programs like the A220, but considering that the MAX has been one of the largest programs, I want to understand how that compares to same-store sales from the third quarter. How much growth potential is still available, especially since we are still significantly below the previous peak production rates?

Steve Oswald, CEO

I believe we have a lot to consider. Looking back, we have a significantly larger defense business now than we did at that time. Additionally, it's important to note that we offer much more in terms of engineered products and aftermarket services. This could also relate to the commercial aspect. We are certainly different from how we were then. I believe we have a solid foundation and we maintain a good balance. We're actively moving forward, and even though it's Kelly's first day, we're optimistic about the improvements ahead. We expect to see a positive trajectory, which will be beneficial for our revenue.

Suman Mookerji, CFO

Just one thing I'll add, Mike, as you consider modeling our commercial aerospace revenues compared to 2019. A little over half of our commercial aerospace revenues come specifically from Boeing and Airbus platforms. Therefore, you can’t apply build rates directly to our entire commercial aerospace revenue. There are other elements including business jets, commercial helicopters, and various in-flight entertainment services that we offer. If you focus on build rates for Boeing and Airbus platforms, a little more than half will grow higher. But for now, that's the situation.

Michael Ciarmoli, Analyst

And then just the last one. Any thoughts, Suman, on free cash generation? I know you kind of mentioned that inventory being down sequentially, but just I know you've got the guidance out there on the top line, talked a little bit about the margins and where we should be. But how should we think about cash generation second half of the year here and into 2025?

Suman Mookerji, CFO

Yes, that's an important focus area for us, Mike, as a company. And Q2, as you noted, was impacted by buildup in contract assets as we did some of these buffer builds. We did some amount of build ahead on the commercial aerospace platforms. We do expect that Q4 will be really strong for us in terms of cash flow to end out the year on a much more positive note. And that is a priority for us. I mean, I would expect Q3 to be marginally better but not significantly, but with a real ramp-up in cash flow towards the end of the year.

Operator, Operator

Our next question is from the line of Noah Poponak with Goldman Sachs.

Noah Poponak, Analyst

Suman, maybe just picking up there. How should we think about where free cash to net income conversion or EBITDA conversion go over the medium term if you kind of think about more normal times where you're not having to build ahead and you don't have so much uncertainty at the customers, and things are kind of coming along a little bit more visibly?

Suman Mookerji, CFO

In the longer run, we do want to get our free cash flow closer to the net income number. We're not going to get that here in the next few quarters or next year as we continue to have significant amounts of inventory and contract assets on the balance sheet. And supply chain pressures, while these are still significant, we continue to have close to two years of lead time on inventory. We have fluctuations in build rates, which often means we're stuck with raw material inventory. We've ordered two years in advance sitting on our balance sheet. So as those supply chain pressures ease, there is more predictability in production rates. We will be able to continue to wind down our strategic inventory that we have been holding for the past few years. And it will get us, over the next couple of years, closer to that target of getting our free cash flow in line with our net income.

Steve Oswald, CEO

I believe that some of the restructuring will be beneficial. There are also larger challenges in the market, along with troubled companies and strategic acquisitions. However, this restructuring will assist us on the manufacturing services side by allowing for a smaller footprint, leading to improved management of our inventory and processes.

Noah Poponak, Analyst

Could you discuss how you anticipate the margins for each segment in the second half will compare directionally to the first half? Notably, the electronic systems segment has seen a significant year-over-year increase. You mentioned the structural differences between the first and second quarter, which are quite substantial. How do these segments perform in the second half compared to the first half?

Suman Mookerji, CFO

We don't provide guidance at the segment level for margins, but I can offer some insights that might help. Our electronics margins increased in Q1 this year and have remained steady in Q2. This improvement was due to a shift in our electronic systems portfolio towards more engineered product revenue and profitability growth, along with a year-over-year increase in engineered product revenues. Therefore, we anticipate margins will stay around the same level in Q2 for the remainder of the year. There's normally a fluctuation range of 50 to 75 basis points depending on product mix in any given quarter, but they will remain in that range. For the structures segment, margins returned to historical levels this quarter. We had a unique situation with Monrovia, where low revenue and one-time costs related to the facility shutdown in Q1 impacted overall margins. However, this returned to normal in Q2, enhancing the structures business. We also improved the product mix in Q2, which helped raise margins for structures. With further cost reductions for Monrovia in Q3 and fewer than 20 employees remaining at that facility, we believe structures margins will remain consistent for the second half. Additionally, margins are expected to improve in 2025 as we realize restructuring savings and implement further initiatives. In the long term, we expect margins to increase. For the second half, we anticipate that margins will stay similar to the levels seen in Q2, which likely included around 75 basis points of favorable mix at the DCO level. This is typical for us, and we expect to maintain that range.

Steve Oswald, CEO

We're on hold serve for the most part.

Noah Poponak, Analyst

Last one I had was just your defense revenue had a bit of a, I guess, transition with F-18 and the timing of the missile, I think, was how you described it. And it looks like maybe you've now lapped the former and then have had some orders on the latter. Should we expect your defense revenues to kind of be stable going forward here or can the growth rate accelerate?

Suman Mookerji, CFO

We're probably flattish here in the rest of 2024 as we continue to face tough compares on the F-18 in particular as well as the TOW missile program. But with TOW coming back in 2025, as well as other programs such as the SPY-6 ramping up in 2025, we should have better times in defense starting next year.

Steve Oswald, CEO

And we better next year, for sure.

Operator, Operator

Thank you. And there appears to be no further questions. I will turn the call back to Stephen Oswald for closing remarks.

Steve Oswald, CEO

Okay, thank you very much. And just wanted to thank everyone for joining us. Obviously, we're very enthusiastic about our numbers, about our performance as we close the second quarter. We feel great about where we are and we look forward to continuing to build a performance story as we move to our Vision 2027 financial goals. So again, we appreciate all the support and wish you a good day. Thank you.

Operator, Operator

And thank you all for participating in today's conference. You may now disconnect.