Earnings Call Transcript - DCO Q1 2021

Operator, Operator

Welcome to the First Quarter 2021 Ducommun Earnings Conference Call. My name is Anna, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I will now turn the call over to the investor relations advisor, Chris Witty. Chris, you may begin.

Chris Witty, Investor Relations Advisor

Thank you, and welcome to Ducommun's 2021 first quarter conference call. With me today are Steve Oswald, Chairman, President, and CEO; and Chris Wampler, Vice President, Chief Financial Officer, Controller, and Treasurer. I'm going to discuss certain limitations to any forward-looking statements regarding future events, projections, or performance that we may make during the prepared remarks or the 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 be correct. In addition, estimates of future operating results are based on the Company's current business, which is subject to change. Particular risks facing Ducommun include, among others, the cyclicality of our end-use markets, the impact of COVID-19 on our operations and 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 acquisitions, competition, and disasters, natural or otherwise. These risks and others are described in the 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 authority. 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 2021 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, Chairman, President and CEO

Okay. Thank you, Chris, and thanks everyone for joining us today for our first quarter conference call. As in our prior quarterly calls, I hope you and your families are healthy, and for those that have received vaccines, that things are going well. Today, I will give an update on the current situation at the Company, after which Chris Wampler will review our financials in detail. Company ratings focus 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 work with authorities on best practices throughout our operations. Currently, the cases at Ducommun are roughly 200. Since the beginning of the pandemic, we have seen a significant drop-off starting in February of this year, and we remain diligent on communication with weekly updates through our human resources team. As mentioned in the press release, the first quarter results are strong despite the continued challenges in the commercial aerospace markets, which we're all aware of. All the actions, initiatives, and hard work since we began this journey in 2017 have shown strong operating results, especially since last March and again, in Q1. Our defense business continues to be the major contributor as we build out this important segment of the Company for scale, which includes having the right product portfolio and strong operating metrics by leveraging our lean, highly focused performance center concept. This is particularly evident in the continued margin strength for gross profit and adjusted EBITDA, despite the significant year-over-year headwind. The team also posted adjusted operating income margins of over 7%. The quality of earnings was very high, with the Company reaching GAAP diluted EPS of 55 cents a share versus 67 cents a share for Q1 2020 and adjusted diluted EPS of 58 cents a share versus 67 in 2020. These numbers are noteworthy despite overall revenue being down 9% from Q1 last year. It's a job well done. This is also a great story for our investors. We are looking forward to revenue growth overall in 2021 with commercial aerospace recovering, solid results in Q1 will benefit the rest of the year. The Company's first quarter revenue was lower due to the commercial aerospace markets. However, Ducommun's business again showed a strengthening of 12% versus the prior year. This was the result of many improvements starting back in 2018. We never want to show negative growth. The overall revenue numbers are impressive despite the pandemic's impact on commercial aerospace in the quarter, and we're looking forward to Q2 and posting year-over-year growth for the first time in a while. Ducommun's defense business revenues continue to show excellent progress on shipments and robust business development. The majority of gains in Q1 include the Raytheon TOW program, radar systems for Northrop Grumman, UAVs at General Atomics, and other missile programs. Again, as we have stated in the past, we are thrilled to be a strategic supplier with GA and reached $1 million in revenue in March this year for the first time. Shipments in 2021 will be able to increase over 4X compared to 2020. I also want to mention Raytheon Missile and Defense, and the progress we made in signing the strategic supplier agreement with them in July of 2019. We've been hard at work with new programs and share shifts where we can provide value, and I'm happy to report that 2021 will be a record year overall with the legacy Raytheon businesses growing from less than $90 million in 2020 to over $125 million in 2021, which is an increase of almost 40%. Regarding the defense backlog, it remains strong, ending Q1 with a backlog of $516 million. The total backlog for the Company was $810 million, which is a great number based on the environment. The defense business grew year-over-year by 8.8%, bolstered by strong revenues from key defense platforms, which included the TOW missile, UAV, and other programs as part of what Ducommun continues to deliver. Obviously, this strength helps offset commercial aerospace order pressure, but we anticipate that to start increasing in the second half of 2021. The press results also show great opportunities as we leverage our structural product lines with defense OEMs. As mentioned previously, we have wins now on the TOW missile, which was a share shift from another supplier, and other new programs such as the Standard Missile dorsal fin assembly. Along with our acquisitions, this part of the business will be worth $110 million in revenue for 2021, compared to under $80 million in 2019. I also want to mention that we are optimistic about defense going forward, despite concerns regarding the budget and changes in administration. Ducommun's defense segment has been under-managed in the past, but now its structural applications are going full speed ahead, along with a long track record and value from any of our electronic systems business. We see a strong future. One other very important metric is that our defense portfolio currently has 48 programs at the end of Q1, each with over a million in yearly revenue, up from 34 in 2017, which represents a 40% increase. The Company's cost actions through Q1 2020 are also paying dividends. You can certainly see the effect of our actions in the continued strong gross profit margins year-over-year, and the solid operating income percentage along with diluted EPS. The team did a great job on costs in 2020 and is now extending this success into 2021 in Q1. In regards to the outlook, our significant backlog in defense and the many growth programs mentioned earlier will provide strong revenue for the remainder of 2021. We estimate that revenue will be led by defense, but over the quarters and years ahead, we see more commercial aerospace volume returning to the Company. We have the capacity, a strong operating team, and are prepared for the rate increases, especially in single-aisle aircraft. We stand ready as well with our strong narrow-body platform positions, with Ducommun's titanium businesses leading the way. As I've mentioned in the past, we are the world leader in this area and have strong positions already at Airbus, Boeing, Spirit AeroSystems, Gulfstream, and among other OEMs. Ducommun is now recognized as included in Boeing's Premiere Bidder Program, meeting all of the OEM's criteria. I also want to congratulate our team supporting Airbus by reaching 100% on-time delivery performance for two years straight in April 2021. That is a real achievement. As mentioned in our last call, we will return to growth in 2021, with the first quarter being down year-over-year, but now that is behind us. The other three quarters will see good momentum compared to 2020. We anticipate overall revenue for the year to grow in low to mid-single digits. Ducommun also has a great mid-term and long-term future. This will be accomplished by leveraging our newly built-out defense business and strong position in commercial aerospace, especially on narrow-body revenues, where we have a 2:1 ratio versus double-aisle aircraft. Our engineered products portfolio and recent acquisitions will provide opportunities as well. Finally, we also remain active in the market for M&A and believe this will only accelerate higher results in the future. Now let me provide some additional color on our markets, products, and programs. Beginning with our military and space sector, we posted first-quarter revenue of $114.1 million, once again representing strong growth versus 2020, up 12%, driven by revenue from key defense platforms I mentioned earlier. We saw increases in demand for our TOW missile, UAV, and other missile programs. First quarter military and space revenue represented 73% of Ducommun's revenue in the period. We also continue to be very well positioned for further growth across our defense platforms over the next several quarters in all sectors, especially at Raytheon and GA. Again, we ended the first quarter with strong backlog totaling $516 million, which is up 8.8% year-over-year and represents almost 64% of Ducommun's backlog. Our commercial aerospace operation saw first-quarter revenue decline year-over-year to $35.4 million, as expected, driven by build rate declines on several commercial aerospace platforms impacted by the COVID-19 pandemic. Ducommun has effectively adjusted costs and managed the downturn, and we are well positioned for when rates stabilize and increase over the long term. We expect a recovery in this market in the second half of 2021. As mentioned earlier, the future looks bright. The backlog within our commercial aerospace sector stands at roughly $266 million at the end of the first quarter, largely due to the 737 Max program. We do, however, stand ready with the team, processes, and capital in place to support bill rate increases in the coming years. We're eager to get started. With that, I will have Chris review our financial results in detail. Chris?

Chris Wampler, CFO

Thank you, Steve. Good afternoon, everyone. As a reminder, please see the Company's 10-Q and Q1 earnings release for further description of the information mentioned on today's call. As Steve discussed, our first quarter results were very solid. During Q1, we continued to demonstrate our ability to perform well at reduced volume levels, which we've had since the onset of the COVID-19 pandemic over one year ago. We're looking forward to leveraging the expected increase in demand for our commercial aircraft components and systems, as well as the strength of our defense business, as we return to growth in 2021. Now turning to our first quarter results, let me review some of the highlights. Revenue for the first quarter of 2021 was $157.2 million versus $173.5 million in the first quarter of 2020. The year-over-year decline reflects a $25.2 million drop in revenue across our commercial aerospace platforms and a decrease in our industrial business, partially offset by $12.2 million of higher sales within the military and space sector. Ducommun's overall backlog at the end of the first quarter was approximately $810 million. 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 $33.1 million for the quarter versus $36.8 million in the prior year period. While gross margins were essentially flat year-over-year at 21.1% in Q1 2021 versus 21.2% last year, the headwind from significantly lower manufacturing volumes was largely offset by improved product mix and lower compensation and benefit costs. SG&A was $22.5 million in the first quarter versus $23.2 million last year, reflecting the Company's ongoing cost controls with streamlined operations. Ducommun reported operating income for the first quarter of $10.6 million, or 6.8% of revenue, compared to $13.6 million or 7.8% of revenue in the prior year period. Adjusted operating income, excluding expenses related to the previously reported Guaymas fire, was $11.1 million or 7.1% of revenue, with the year-over-year performance largely reflecting the impact of lower volumes. Interest expense was $2.8 million for the first quarter of 2021 versus $4.2 million in the prior year period, as the lower interest rates more than offset the impact from higher debt levels. The debt outstanding rose due to the Company's cash drawdown of $50 million last year, which was kept on hand as we worked through the impact of the pandemic. Of this amount, we paid back $25 million during the fourth quarter of 2020 and another $5 million in Q1, leaving $20 million outstanding. The Company reported net income for the first quarter of $6.7 million or 55 cents per diluted share, compared to net income of $7.9 million or 67 cents per diluted share for the first quarter of 2020. Excluding one-time expenses, adjusted EPS for the first quarter of 2021 was 58 cents. Adjusted EBITDA for the first quarter was $21.1 million or 13.5% of revenue, compared to $23.2 million or 13.4% of revenue for the comparable period in 2020, reflecting the items I just discussed. Let me turn to our segment results. Our electronic systems segment posted revenue of $99.1 million for the first quarter of 2021 versus $98.1 million in the prior year period. These results reflect a $7.4 million increase in sales with the Company's military and space customers, somewhat offset by a $3.1 million decrease in revenue across our commercial aerospace platforms along with lower industrial sales. Electronic systems operating income for the first quarter was $12.5 million or 12.6% of revenue versus $15.1 million or 15.4% of revenue in the prior year period. The lower margin was primarily a result of unfavorable product mix, partially offset by lower compensation and benefit costs. Our structural systems segment posted revenue of $58 million in the first quarter of 2021 versus $75.4 million last year. The year-over-year decrease reflects $22.1 million of lower sales across our commercial aerospace applications, partially offset by $4.8 million of higher revenue within the Company's military and space markets. Structural systems operating income for the quarter was $5.1 million or 8.8% of revenue compared to $5.4 million or 7.2% of revenue last year. The year-over-year operating margin increase was primarily due to favorable product mix, and excluding the Guaymas charges, the first quarter adjusted operating margin was 9.7% in 2021. Corporate general and administrative expense for the first quarter of 2021 was $7 million or 4.5% of revenue compared to $6.9 million or 4% of revenue in 2020. Turning to liquidity and capital resources, we have $17 million in cash on hand and $80 million available on our revolver, resulting in available liquidity of $97 million. We utilized $23 million of cash from operations this quarter compared to utilizing $12 million in the prior year period. The first quarter typically results in a cash outflow from operations as we pay annual incentives and invest in working capital to support expected business growth. We expect to return to historical cash flow generation levels as we move through the rest of 2021. Our 12-month debt to adjusted EBITDA ratio was 3.4 at the end of the first quarter. In terms of capital expenditures, we spent $4.5 million during the first quarter, reflecting a return to more normal investment levels and aligned with our return to growth in 2021. We anticipate spending between $16 million to $18 million in 2021 to support ongoing product development and sustaining capital. In conclusion, we believe our performance this quarter was solid and stable, reflecting the Company's lean operations, diverse customer base, and strong military demand. For 2021, we continue to be cautiously optimistic about a return to growth in commercial volumes during the second half, as Steve indicated. We'll discuss these trends further at our upcoming investor day on May 26. I'll now turn it back over to Steve for his closing remarks.

Steve Oswald, Chairman, President and CEO

Okay. Thanks, Chris. I'm certainly proud of the results this quarter, and we look obviously forward, as everyone does, to better market conditions in commercial aerospace later this year. We've met our commitments despite some very difficult headwinds. And this is really due to our people and leadership at the end of the day. I would add that we have the right footprint, operating system, cost structure, and discipline. We intend to perform at a high level and feel very confident about the future. As in the Q4 call, I also want to thank our customers, shareholders, and all our business partners for their continued support as we work through these difficult times together, both last year and in Q1. I'll take this opportunity, as Chris mentioned, to let you know that the investor day I mentioned earlier in the year will take place on Wednesday, May 26 and start at 9 a.m. Pacific Time. I'd like to invite everyone to this important meeting, where we will discuss our plans for the future, and appreciate your support in attending. In closing, I'd like to again take this time to thank the Ducommun employees, and I'm proud of them and all their efforts in dealing with the many challenges from the pandemic that began in 2020 and now will continue in Q1 2021. Our team never faltered, and though it was stressful, they got the job done for our customers, our nation, and for one another. So with that, let's go to questions, please. And thank you.

Operator, Operator

Thank you. We will now begin the question-and-answer session. And we have a question from Pete Osterland from Truist Securities. Please go ahead.

Peter Osterland, Analyst

This is Pete Osterland on for Mike Ciarmoli. So it looks like your operating margins took a step back versus the fourth quarter in structural systems, despite sales being pretty flat there on a sequential basis. So I was just wondering if you could give some color on what drove this, if there was anything specific in the first quarter, or just a change in mix or any help you can give there.

Chris Wampler, CFO

Yes, Pete. No. Q1 is really with structures, it's all about the mix. Again, year-over-year, it was a nice change favorably, but sequentially, yes, that's what caused us a little bit of headwind there.

Peter Osterland, Analyst

Okay. And then it looks like your backlog has stabilized in commercial aerospace over the course of the last couple of quarters. So I was just wondering how order flow is trending there and if you could be expecting to see any meaningful increase in commercial aero sales on a sequential basis in the second quarter, or if you think it's really just going to be in the second half before that materializes.

Steve Oswald, Chairman, President and CEO

Pete, this is Steve Oswald, and welcome to the call, by the way. We are optimistic about our order flow the rest of the year, probably more leaning towards the second half of 2021, but we definitely anticipate seeing orders go up. I think the overall story is going to be a very good one, not only in the near term, but also mid-term.

Peter Osterland, Analyst

Great. And then just one more. I was wondering if you could comment on how your M&A pipeline is looking, if there are any areas you'd call out that are currently a priority and just what you're seeing in terms of available opportunities and valuations.

Steve Oswald, Chairman, President and CEO

Sure. Well, look, we're active. We've been active. When I came in and took this role, we established our business development team, and we have some excellent people running that function. We are highly engaged in the market, looking at opportunities. There's certainly a little bit less on the commercial side compared to the defense side, but we like what we see, as we've done three deals since I started here in 2017. I think they've all been real winners. So we're careful about what we do, but we are leaning in, and we hope to find something significant this year as we continue to work hard at it.

Operator, Operator

And we have a question from Mike Crawford from B. Riley. Please go ahead.

Mike Crawford, Analyst

Steve, what, if any, program capture goals do you have in '21 similar to what you did with TOW missiles in 2020?

Steve Oswald, Chairman, President and CEO

Yes. Can you say that again? I'm sorry, I need to turn the phone up a little bit in this room. Can you repeat that, please? I apologize.

Mike Crawford, Analyst

Yes. Just as you captured the TOW missile program from another competitor in 2020, do you have any goals you can share regarding additional program captures this year?

Steve Oswald, Chairman, President and CEO

Yes. I can't share specifics, but I can tell you that there are opportunities for us to achieve share shifts, albeit we will only pursue where we can really add value. That's a case with the TOW missile program. The days of competing solely on price are over, as that has generally led to unsatisfactory outcomes. I will say we are active, not only in share shifts but also in offloading opportunities. This is another key theme we expect to see more of at Ducommun, particularly relating to offloading from defense primes that we can capture. We successfully made the TOW missile opportunity happen, and it's a significant project requiring specialized capabilities. Everything is pointing in the right direction. When we have more material or significant updates, we will definitely share that with you.

Mike Crawford, Analyst

Okay. And then as your commercial line spins back up, is there a delay on when margins pick up as well? Or is it just primarily just a function of scale?

Chris Wampler, CFO

Yes, Mike, it's primarily a function of scale. I mean, there shouldn't be a delay. We are going to pick up efficiency as we increase our operations, and we're looking forward to that, as we're recovering from a significant decline in Q1 and Q2 of last year.

Mike Crawford, Analyst

Great. And this last question is, excuse me?

Chris Wampler, CFO

Go ahead. No, just say with that, I mean, it's not happening just yet. So as we work through this year, as Steve and I mentioned, that's what we're looking to see as we progress.

Mike Crawford, Analyst

Okay. And then just the final question is how many different programs are you on with GA? Is it just one unmanned platform? Or is it multiple…

Chris Wampler, CFO

I can only say so much, because I've got to be respectful of GA. They asked me to keep matters high level. However, we are involved with multiple core ramps.

Operator, Operator

And we have a question from Ken Herbert from Canaccord Genuity. Please go ahead.

Ken Herbert, Analyst

Yes. And Chris, I just wanted to first ask about cash in the quarter. I know the first quarter is typically seasonally soft, but free cash flow was a little bit lower this quarter than we'd expected, and it looked like working capital had some significant investments. Can you just talk about any particular programs that may have been driving the use of cash in the quarter, or if there was anything in particular that stood out in the quarter from a cash standpoint?

Chris Wampler, CFO

Yes. Thanks, Ken. It's Chris. When you look at the cash, I mean, you are hitting on the right themes for sure. It all relates to supporting our growth as we look towards the next few quarters. We're trying to align our build capacity with our ability to meet customer demand and achieve the sales growth we're discussing as we advance quarter by quarter. This is where the investment in inventory and the unbilled comes into play, so that we can manage through these challenges while preparing for expected stronger demands in the next couple of quarters.

Ken Herbert, Analyst

Can you comment, Chris? Is it maybe more on the commercial side in anticipation of the 737 Max bill rates or is it still predominantly on the defense side?

Chris Wampler, CFO

Yes, no, more on the defense side. If you think about, in the structure area, we certainly had a quick stop to a lot of the builds last year. That's what left us with a little more inventory on that side of the business. So we've got a good starting point as we begin to push for growth. Defense-wise is where we've seen a little more of that build-up, therefore we need to stay ahead of that demand.

Steve Oswald, Chairman, President and CEO

Yes. Ken, this is Steve. It's definitely leaning towards defense. I mean, we're busy building things up. We've got plenty of new programs coming online, and we're quite active, so yes, it is leaning a bit towards that as the cash flows move forward.

Ken Herbert, Analyst

Okay. And Steve, you made a comment early in your prepared remarks about building defense towards the right scale. Can you share what you view as the minimum threshold in terms of scale for your defense business? I mean, you clearly have impressive growth numbers, but how do we think about what you regard as the right scale for this business to achieve optimal leverage from the model?

Steve Oswald, Chairman, President and CEO

Yes. Look, I think I'll provide more context on this at our investor day in May. However, we do have a performance center concept, where we have dedicated centers for different operations, such as harnesses, assemblies, and cards. We have a solid plan to scale these centers effectively, which, I believe, will be highly beneficial for both our investors and our margins moving forward. So stay tuned for more discussion in May, I promise.

Ken Herbert, Analyst

Okay. Well, just one final question from me. If we look at electronic systems segment margins, you were down quite a bit from the first quarter of last year. I know last year's Q1 was particularly strong, but can you remind us if there was anything notable compared to a year ago, and how we should think about the margins in that segment getting back to the run rate here in the second quarter, or if it may take a couple of quarters?

Chris Wampler, CFO

Ken, this is Chris. Yes. You're right. When you look at last year's Q1, everything sort of aligned perfectly, getting us to margins north of 15% in the electronic segment for that quarter. In this latest quarter, we haven't hit the mark due to a less favorable mix, but we also had some significant weather events in the Midwest during February that resulted in downtime, impacting our overall results. Therefore, as we move forward, I would suggest thinking about a margin expectation of 11% to 13% for the electronic segment as the recovery continues. And as we've spoken earlier, small shifts can make a big difference, which is why we have that range in mind.

Steve Oswald, Chairman, President and CEO

Yes. Ken, this is Steve. So the polar vortex did indeed have a real impact on Ducommun, particularly in February. That certainly affected many of our operations.

Ken Herbert, Analyst

So I guess there is some trade-off when you think about Kansas and other locations relative to Southern California.

Steve Oswald, Chairman, President and CEO

Yes, there are certainly a few different factors at play, Ken.

Operator, Operator

And at this time, there appear to be no further questions in the queue. So I'll turn it back to Mr. Oswald for any closing remarks.

Steve Oswald, Chairman, President and CEO

Okay. Well, let me wrap it up here. First again, I want to thank everyone for joining us for the first quarter call. We are certainly looking forward to better days, and we know they are coming. Our focus, throughout this whole process, has been employee safety first and foremost. I believe we’ve done an exceptional job overall. Thank you for your support. We are working hard at Ducommun, and we look forward to better days ahead. We appreciate your interest and your time today on the phone.

Chris Wampler, CFO

Thanks, everyone.

Steve Oswald, Chairman, President and CEO

Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.