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Executives

Joseph Berenato – Chairman and Chief Executive Officer

Anthony Reardon – President and Chief Operating Officer

Joseph Bellino – Vice President and Chief Financial Officer

Analysts

Troy Lahr – Stifel Nicolaus & Company

Edward Marshall – Sidoti & Company

Michael Lewis – BB&T Capital Markets

Ducommun Inc. (DCO) Q3 2009 Earnings Call November 2, 2009 10:30 AM ET

Operator

Welcome to the Third Quarter 2009 Ducommun Earnings conference call. (Operator Instructions). I would now like to turn the presentation over to your host for today's call, Mr. Joe Berenato, Chairman and CEO of Ducommun.

Joseph Berenato

I am Joe Berenato CEO of Ducommun and I would like to welcome you to Ducommun's third quarter conference call. Earlier today we actually issued two press releases. The first announced a $31 million follow-on order for the C-17 program which takes us through 2010, and the second release announced our strong third quarter results. Joining me on the call today are Tony Reardon our President and Chief Operating Officer, and Joe Bellino our Vice President and Chief Financial Officer.

And with that, I would like to turn the call over to Tony Reardon.

Anthony Reardon

I'd like to give a brief market overview and discuss the implications on Ducommun's performance in Q3. I will then review some of the major operating highlights for the quarter before turning the meeting over to Joe Bellino for the financial review.

In the commercial airline industry we're still seeing weak air traffic, although there has been some improvement since the first half of 2009, with continued consolidation of the routes. The domestic airlines have been delaying or pushing out new aircraft purchases and retiring older aircraft, while the international carriers seem to have been experiencing a slightly better trend.

Despite the airline trends, the commercial jetliner market is holding steady because of the robust backlog. And other than the already announced bill rate cuts on the Boeing 777, we expect a major program such as a Boeing 737 and the A320 programs to continue at the current rate, full production rates through 2010.

The regional jet market has been impacted to a greater extent by the airline industry trends, but we've seen some build rates stabilizing. The general aviation market has been hit hard, including being impacted by the lack of equipment leases, and we don't see any meaningful recovery in the near future.

The military defense market remains solid for 2009. We reported earlier today in our press release on the C-17, it will be fully funded through the fourth quarter of 2010, and the recent defense budget adds another ten new aircraft through 2011.

Ducommun's performance for Q3 was pretty strong. We had a shift in the mix as we moved to a higher military versus commercial mix quarter-over-quarter and year-to-date, primarily due to the acquisition of DAS-NY, which has heavy military helicopter mix which has been offset by a drop in our regional jet and general aviation market business.

Our military business remains solid as we increase sales on the C-17, F-18, and the Blackhawk program, although with a slight increase in our engineering services business quarter-over-quarter and year-to-date, these increases were partially offset by the previously disclosed drop in sales in the Apache program

We had a $5 million one-time pickup in revenue during the quarter on the sale of a development program for the Unmanned Combat Air Systems, acronym UCAS, engine components. It's a significant milestone for us in the pursuit of new business. Now we are well positioned on the future work as a result of our efforts on this program.

The commercial fixed-wing and rotary-wing markets were down quarter-over-quarter and year-to-date on lower sales in the regional jet and the general aviation markets despite being partially offset in the quarter by higher sales on the 737 program due to higher volume production spares, and higher sales on the Boeing 777 program achieved as a result of the DAS-NY acquisition. We also had an increase in 787 development and low-rate production work in the quarter.

Ducommun Technology sales were down quarter-over-quarter, but our ability to improve profitability remains strong through our efforts on lean and Six Sigma. We continue to invest in selected internal engineering development programs at DTI which will improve our design engineering product offering and meet customer expectations. We anticipate that some of these projects will be ready for the market in the coming year.

Ducommun AeroStructures had solid performance in the third quarter while managing several new development programs. DAS is investing in a number of new startup and development programs such as the RUAG assembly, the Embraer design and build program, and the UCAS development program and these are all paving the way for our future growth.

Looking ahead, the military markets remain solid through 2011, but we'll have some changes in mix and a possible reduction in the RDT&E spending and that may have an impact on the engineering development and services sector. The military helicopter market remains a bright spot and we continue to build our market presence here. However, we're seeing a lower usage of the Apache helicopter than anticipate and we expect that this will most probably lead to a further drop in production rate next year.

The regional jet and general aviation markets are down and still volatile as the aircraft manufacturers are seeking the proper build rates and their associated inventory levels. The commercial market remains stable and we look for the Boeing 737 program to stay at its current build rate and possible lower rate productions than the Boeing 787 program.

We have new business opportunities across the board in all of our business sectors. We're working hard to improve our development and R&D spending efforts so that we can reach productions levels, and we continue to pursue complementary acquisitions that will help us grow this business.

So with that, I'd like to turn the meeting over to Joe Bellino for our financial review.

Joseph Bellino

We are pleased to report solid results this morning of $0.59 per diluted share for the quarter compared to $0.59 a year ago. There is a few major themes that we'll be covering today. One is in the third quarter our sales increased sequentially by 7%. Our Ducommun or DCO operating margins improved to 9%. Our Ducommun AeroStructures or DAS margins expanded to 13.5% from 11.5% the previous quarter. And our DTI or Ducommun Technologies business, our DTI margins of 8.6% continued higher than the 5.5% range that we experienced in 2008.

With that, the sales for the quarter were $110 million. Those were up 9% year-over-year, and as I mentioned more important, they expanded sequentially by 7% from what we call same-store sales. We experienced most of the year-over-year growth from our DAS-NY acquisition so that in our DAS or AeroStructures segment business we were up 19% year-over-year. We also had in that segment, we had very solid growth in our military fixed wing and helicopter segments, which have helped offset somewhat the declines in our Apache helicopter blade program.

And although DTI realized a 5% decline in sales, a portion of this had been planned since we exited certain unprofitable lines from a year ago. We were pleased to see that our F-18 sales of replacement radar racks increased significantly as we're now seeing the benefits of the $105 million contract that we announced last October. We take a look at operating income by business segment for the quarter, overall DCO's operating income was $9.9 million, or as I mentioned earlier, 9% of sales and that was compared to $9.3 million a year ago.

In DAS's operating income, it improved to $10.1 million compared to $9.6 million a year ago as a result of higher sales and cost reductions which more than offset some of the reduced sales levels from the Apache helicopter blades and the business in regional jets, which Tony mentioned earlier. We were pleased that the DAS operating margins in the third quarter did expand to 13.5% compared to an adjusted 11.5% operating margin that we had in the first two quarters of this year.

DTI's operating income also increased to $3.9 million compared to $2.3 million a year go as a result of Six Sigma activities and lean manufacturing, as well as an improved product mix. The operating margins there were 8.6% and they have been consistently in that area for the last three quarters.

Our selling, general and administrative expenses overall increased slightly and they were a primary result of the acquisition of DAS-NY and they included in the quarter about $700,000 or so of amortization of intangible assets. Otherwise, we did a god job of holding our SG&A expenses in check and they reflect the actions that we had taken earlier in the year to defer management's salary increases, to reduce bonus accruals and to lower other controllable administrative expenses.

If you look at the year-to-date results, for the nine months we reported net income of $13.4 million or $1.27 per fully diluted share that compares to $17.3 million or $1.63 per diluted share a year ago. The first half of 2009, as previously reported, included an after-tax charge of $0.33 per diluted share for the Eclipse inventory reserve and an inventory adjustment.

Our year-to-date sales were $325 million, including $32 million from DAS-NY. Sales overall were up 7.5% compared to $302 million in the comparable nine months of '08. If we look at it by sector, DAS or Ducommun AeroStructures sales increased to $142 million from $129 million and DTI's year-to-date sales were up slightly over the previous year.

Taking a look at year-to-date operating income by business segment, overall DCO's operating income was $22 million compared to $27.5 million a year ago. The first nine months of 2009 reflect a pre-tax $5.1 million of Eclipse reserve and inventory valuation. As I mentioned earlier, that was $0.33 after-tax but the $5.1 million is a pre-tax number. In breaking this down year-to-date for the Ducommun AeroStructures, we reported operating income of $21.1 million that compares to $29.7 million, but on an adjusted basis the result would have been $26.2 million versus $29.7 a year ago.

DTI's nine-month operating income increased to $9.3 million compared to $6 million a year ago. Overall selling, general and administrative expenses are running about 5% higher this year than they were last year and they primarily reflect the additional cost of DAS-NY, including the amortization of intangible assets. And those were set off somewhat by the cost reductions I mentioned earlier in the quarterly report.

Taking a look at our business mix and backlog in this kind of economic environment, which is impacting a certain amount of our commercial sales, we have seen our business mix continue to shift toward more military so that as of October 3 our business was comprised of 62% military, 36% commercial and 2% space. So our backlogs stand at about $382 million. They're just down about 5% from the July 4 levels.

There is a natural ebb and flow of backlogs toward year end and we would expect follow-on purchases, new program wins and new programs coming online in 2010, all of which will favorably impact our backlog levels. As Tony noted earlier, beginning in 2010 we expect the production rates for the Apache to be reduced somewhat from current levels.

In terms of liquidity and capital resources, we generated net positive cash during the quarter, although for the year-to-date we're a net user of about $8 million. This is a normal seasonality pattern that we have seen in the past. A part of this usage this year in 2009 is different from other years as a result of some significant planned investments we've made in new programs, such as the Embraer and the RUAG programs, which require additional tooling costs and are carried on our books as inventory.

In terms of the credit environment, we continue to see a restrictive credit environment which had a short-term impact on some of our customer's credit availability. As a result, we have seen a number of days in receivables outstanding expand about five to six days. We are taking aggressive actions to try to reverse this trend.

Along with our new credit facility, we continue to maintain a low leverage position and at quarter's end our debt to cap was about 17%. Our leverage ratio target is really about 30% to 35% but we feel given the economy environment that we're in and the uncertainty in the credit markets, we have left ourselves in a very good position from a leverage standpoint and the ability of available funding to pursue our strategic incentives.

Our CapEx for the year will be about $9 million that compares to $12 million for last year. These numbers change from time-to-time based on new program awards and the investments that are required with those.

So as we close our 2009, we feel very confident that our strong financial position will allow us to take advantage of several market opportunities and enable us to benefit from our strong credit risk profile. And with that, I'd like to ask Tony Reardon to make some concluding remarks.

Anthony Reardon

Ducommun had a solid quarter in a very tough market. Over the course of the year, we've enacted some very prudent cost cutting measures all across the board, while we continue to invest in new business development programs and some specific IR&D programs. We have a number of new business proposals that we're working on and our businesses are concentrated on winning contracts with more engineering content and higher level assemblies.

We also have a targeted and we are pursuing some very complementary acquisitions. We've had several challenges in front of us in the some of the unknowns that we will be working through so we continue to manage our business as prudently as we have in the past and we look forward to the additional growth opportunities that we're working on.

So with that, I'll turn it over for any questions.

Question-and-Answer Session

Operator

(Operator's Instructions). Your first question comes from Troy Lahr – Stifel Nicolaus.

Troy Lahr – Stifel Nicolaus & Company

Just two questions on backlog, can you run through and just kind of give us an update on the Carson Helicopter backlog? Its looks like that's kind of been down about three quarters in a row now sequentially. Should that start ramping up soon again?

Anthony Reardon

Troy, this is Tony Reardon. With the Carson backlog, what's actually happening there is got a pretty solid backlog on the commercial and we're working through a development program on the military helicopter blades, and I think I've talked about that in the past. We have development program that we're working on for the presidential helicopter and we're into the final phases of that development program. We actually have three spires that we're delivering on this quarter.

So we would anticipate an additional follow-on order late to first quarter of next year or early the second quarter, which will bolster that backlog. So I think we're in pretty solid shape going forward, we're waiting for the military portion to pickup.

Troy Lahr – Stifel Nicolaus & Company

Can you help me understand the backlog for the Boeing 737? It looks like that backlog was up pretty significantly. I think about 10% yet Boeing's backlog was up on, I think it maybe was actually down about 1%. Why is a significant change quarter-over-quarter on the 737 backlog?

Anthony Reardon

Well, we picked up an additional order from Spirit on our work in Parsons, Kansas, which picks up some of the offload work that they had. Also what Boeing is now doing Troy, is they're releasing quarter-over-quarter as opposed to we use to have a lumpy release on the 737 and we'd get a large order towards the end of the year.

Now what they're doing is they'll be releasing at the end of this quarter for the fourth quarter and maybe the first quarter or next year. So instead of having one release a year they're going to quarter-over-quarter releases, so the backlog has grown a lot bit and we expect that to continue.

Troy Lahr – Stifel Nicolaus & Company

Was it a significant amount of work you picked up from Spirit? So your dollar content is ramping up or has had increased on the –

Anthony Reardon

It was actually just a follow-on order. It was actually just a follow-on order.

Troy Lahr – Stifel Nicolaus & Company

The last question on the Northrop Grumman program, the X47 I guess it is. What should the revenue profile look like for that program over the next kind of six quarters? Does it ramp up or should we kind of think about that as like a $5 million revenue run rate?

Anthony Reardon

We have a little bit more to produce on that, and then they go into their development test program. So we would expect that program, Troy, to not produce any revenue next year, but it has some pretty solid opportunities going forward for us and possibly receive an order toward the end of next year, which will be for production in 2011.

Operator

Your next question comes from Edward Marshall – Sidoti & Company.

Edward Marshall – Sidoti & Company

My first question has to do with your gross margin, which was up in the quarter. I would have assumed with the new programs rolling on which are, I'm assuming, lower margin and then replacing some of the legacy business, which I would assume is higher margin, we would have seen a little bit of pressure on the gross margin. It was the opposite. Is pricing up? Is there something else that's going on? Materials maybe down? Can you kind of comment?

Joseph Bellino

Ed, I think some of it has to do with, as I talked about earlier, how we expanded our margins to 13.5% in the past structure that helped our DCO margins go to 9%. Those were a result of sequentially increasing sales and we've been tightening our belt in terms of our costs in more lean manufacturing. So we're in an environment where it's not real robust for price increases, so we're having to get it from additional business.

And I understand your question when we talk about some of the newer programs coming on in some of the more well developed and mature programs dropping, but we have counter measures to do those things in terms of our operating performance, as well as the sales incentives that we benefited from during the quarter

Anthony Reardon

The new program development, the sales will start picking up in the fourth quarter so you'll start seeing the lower margins, if you will, on those programs impacting slightly in the fourth quarter. So we had a pretty solid favorable mix in the third quarter and we're able to solidify some of the run rates on some of the programs that we had going forward, and our lean program had some nice pickup in the third quarter as well.

Edward Marshall – Sidoti & Company

Then my second question has to do on the Apache program, which was slated to be down about 50% for this year. I think you're looking at in your Q somewhere north of 30% for next year, 31% I guess. The 50% didn't materialize this year. How should we look at this 31% going into next year? Is this your rough guess or is this what you expect, kind of comment in that direction.

Joseph Bellino

In terms of the historic numbers, Ed, I think we talked about there's both main rotor blades and tail rotor blades. Starting in the second quarter we saw our sales go from an average of about $12.5 million of sales a quarter down to $8.5 million a quarter. Its because the main rotor blades were sliced in half from 50 blades a month to 25, but the tail rotor blades and other components didn't decrease that much. So that's why we only saw about a 30% to 35% reduction in our revenues year-over-year. I'll have Tony report on looking forward about the Apache program.

Anthony Reardon

Ed, what we're seeing on the Apache is because of the way the Iraq war is going and lower usage in Afghanistan, the aircraft actually has a lot lower flight hours. So we're anticipating a drop in the main rotor production in particular for the foreseeable future. So we would expect that rate to drop going forward in the next year.

Edward Marshall – Sidoti & Company

Is it based on the projected 50% reduction this year or should we take it off of the raw numbers that you actually produce for this year, because I think you're down 20% year-over-year for the first nine months. It all takes it down 50% which was expectation.

Anthony Reardon

If you would take the last two quarters, that would be more representative. The first quarter was a pickup from sales last year, so when we went into first quarter last year we're actually still building at the higher production rate. So if you look at the last two quarters and then we would anticipate a drop from there from the last two quarters.

Edward Marshall – Sidoti & Company

Then on the 787 program, you talked about doing some developmental work. Is that composite structure is it metal structure. What are you referring to?

Anthony Reardon

We had some work at the composite facility on the consoles, engine consoles, and then it was primarily work for engine switch out of our super plastic forming house in Parsons, Kansas. So they put more emphasis on the Rolls Royce engine and we picked up additional in sell work there.

Edward Marshall – Sidoti & Company

What's the potential of that program going forward, as far as the sales dollar value?

Joseph Bellino

I think we've talked in the past that as it matures it ought to be one of our five or six largest programs.

Operator

(Operator Instructions) Your next question comes from Michael Lewis – BB&T Capital Markets.

[Jeremy] for Michael Lewis – BB&T Capital Markets

This is Jeremy in for Mike. Looking at possible OCI issues at Ducommun Technologies, with the new management team at that subsidiary, what steps are you taking to mitigate any future issues?

Anthony Reardon

Great question, Jeremy, what we've done there is first of the only OCI issues in our situation is primarily related to the Missile Defense Agency and we're working on a large contract, so we've done quite a bit of work to make sure that we don't step into a zone. We've given Midas significant information in terms of the production programs that we currently manufacture in all parts of our business.

And we've gotten a nod in order first of all to be able to bid on the Midas service contract, which is an RDT&E type contract. So we've worked hard on the OCI mitigation issues and we're very aware of it and we're very keen on putting ourselves in a position to shift the business away from any possible conflicts.

[Jeremy] for Michael Lewis – BB&T Capital Markets

Then looking at the 787 program and how that is unfolding, what opportunities are on the board for you in terms of new contracts over the next say 6 to 12 months?

Anthony Reardon

Well I think, Jeremy, there was about three or four programs or three or four applications that we're looking at in addition to the ones that we currently have. And what we're seeing from the OEMs from Boeing and from the Japanese heavies, as well as from some work coming out of [Vault] is opportunities to start picking up support on the production contract as we go forward.

So we're working on a number of applications in both the composite arena, as well as our titanium hot forming and hot [brake] areas, and we're looking at a couple of structural applications as well. So we've got, I would say, three to five applications that we're looking at right now and nothing has been brought in new to the current workload, but we're pursuing a number of them.

[Jeremy] for Michael Lewis – BB&T Capital Markets

One last if I can before I hop back in queue here. Did you receive any milestone payments in the quarter and if not when are you expecting any?

Anthony Reardon

Actually no, we did not receive any milestone payments and there is a possibility that we'll pick up a milestone payment albeit about less than half of what we received in the fourth quarter of last year on the Raytheon 15 contract. We're working hard to pull that in. There was a late order release on that so we're working hard to meet the requirements for the milestone payment class. So it's in our sights but it will be a challenge.

Operator

Your next question comes from Edward Marshall – Sidoti and Company.

Edward Marshall – Sidoti & Company

The 737 program you talked quite a bit about how it looks pretty steady through at least 2010 I think is what your comments were. Please clarify if not. But I'm curious of how you're handling the working capital requirements for that program kind of going forward as there is a lot of anticipation that we may eventually see a cut in that program.

Anthony Reardon

Well, that's another very good question. So we have a couple of things going on there, Ed. We've gone to a [con-bon] system with our supply base. Actually we have our suppliers in meetings in the next two weeks to discuss this flow through the program. There are a lot of skeptics out there on the 737 program as far as there is a rate reduction.

What we've talked about in the past and what is absolutely true is we have changes clause in the contract which requires about six months notice for a de-sell and we're working to that. However, we were just up at Boeing in the last few weeks and we have some pretty good data that says that the backlog is pretty solid in light even in view of some of the changes that they've had through 2010.

But we're very aware of the working capital issues in terms of inventory carrying and the supply base. So we're working close with our supply base to make sure that the flow is proper and as we see a de-sell we react immediately.

Edward Marshall – Sidoti & Company

So essentially if the OE schedule stays relatively stable the only thing we really need to be careful of on the commercial side is the regional and private aircraft or small commercial aircraft. I mean is that really where the pockets of weakness is coming from at this time on the commercial side?

Anthony Reardon

Yes, absolutely. That's the big hits we're taking on our wing led programs and our general aviation and regional jet business and we're still working through that. We're still seeing a lot of adjustments in terms of schedule because of the inventory that they have on hand across the board. So we're working through that and that's where a lot of the working capital issues are that we're working through right now.

Edward Marshall – Sidoti & Company

I think I know this, but what is percent of that program to your overall sales that regional and private aircraft.

Anthony Reardon

That's roughly about 10% total revenue 10 to 15 somewhere in there.

Edward Marshall – Sidoti & Company

Joe, the tax rate that we should be using going forward.

Joe Bellino

The tax rate that we used for the first three quarters has been 33%. We'll end up the year it depends on the resolution of some outstanding tax issues with the state authorities. For the year, we ought to end up with about 30% to 32%, which assumes in the fourth quarter we're somewhere between 25% and 28% tax rate.

Edward Marshall – Sidoti & Company

And that's R&D tax credits.

Joe Bellino

That's all-in. There's a myriad of factors but certainly the R&D tax credit, both the federal and state levels come into play that affect the rate lower than the normal statutory federal rate and state.

Edward Marshall – Sidoti & Company

Do you think 33 is good for next year too?

Joe Bellino

Yes, for now 33 is good and then we give more color as we get into the year and look at our situation, particular circumstances.

Operator

I would now like to turn the call over to Mr. Tony Reardon, President and Chief Operating Officer for closing remarks.

Anthony Reardon

Again, Ducommun had a very solid quarter. We continue to pursue new business applications. We continue to invest in the business with regards to RD&T and we're working hard to control the cost as we go forward. We also have some selected gap fillers, if you will, with regards to acquisitions and we're targeting acquisitions to grow this business. So with that, I would like to thank you for your participation in this call and have a good day.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: Ducommun Inc. Q3 2009 Earnings Call Transcript
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