Ducommun Incorporated (NYSE:DCO) Q1 2023 Earnings Conference Call May 4, 2023 1:00 PM ET
Company Participants
Suman Mookerji – Senior Vice President, Chief Financial Officer, Controller & Treasurer
Steve Oswald – Chairman, President & Chief Executive Officer
Conference Call Participants
Ken Herbert – RBC
Mike Crawford – B. Riley Securities
Michael Ciarmoli – Truist Securities
Operator
Good day, ladies and gentlemen, and welcome to Ducommun’s First Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, we’ll hold a Q&A session. [Operator Instructions] As a reminder, this conference call is being recorded today, May 4, 2023.
I would now like to turn the conference call over to Ducommun’s Senior Vice President, Chief Financial Officer, Controller and Treasurer; Mr. Suman Mookerji.
Suman Mookerji
Thank you, Jeda, and welcome to Ducommun’s 2023 first quarter conference call. With me today is Steve Oswald, Chairman, President and CEO.
I’m going to discuss certain limitations to any forward-looking statements regarding future events, projections or performance that we may make during the prepared remarks or the Q&A Session that follows.
Certain statements today that are not historical facts, including any statements as to future market conditions, results of operations and financial projections are forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are therefore, prospective. These forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. In addition, estimates of future operating results are based on the company’s current business, which is subject to change.
Particular risks facing Ducommun include, among others, the cyclicality of our end-use markets, the level of US government defense spending, timing of orders from our customers, legal and regulatory risks, the cost of expansion and acquisitions, competition, economic and geopolitical developments, including supply chain issues and rising interest rates, pandemics and disasters, natural or otherwise. These risks and others are described in our Annual Report on Form 10-K filed with the SEC, and our forward-looking statements are subject to those risks. Statements made during this call are only as of the time made, and we do not intend to update any statements made in this presentation, except if and as required by regulatory authorities.
This call also includes non-GAAP financial measures. Please refer to our filings with the SEC for a reconciliation of the GAAP to non-GAAP measures referenced on this call. We filed our Q1 2023 Quarterly Report on Form-10Q 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
Okay, Suman, thank you. And thanks, everyone, for joining us today for our first quarter conference call. Today, and as usual, I will give an update of the current situation of the company and for which Suman will review our financials in detail.
Before that though, I’d like to discuss our CFO transition announced yesterday. First, I’d like to say this transition is not related to any issues revolving the company’s financial reporting. I would also like to thank Chris Wampler for his contributions and service as CFO. And welcome Suman Mookerji to the call and congratulate him on his new role. Suman and I have known each other for over 12 years, worked together at three different companies and I have full confidence in him and his abilities.
As we announced last week, I’m also delighted that we have completed the acquisition of BLR after the end of Q1 as we had a 30-day filing period that ended on July — I’m sorry, ended on April 24. BLR Aerospace is our fifth acquisition and largest since I joined the company in 2017. And its 100% in line with the expectations we discussed at the Ducommun Investor Meeting in New York in December.
BLR is an industry leader and innovator, providing engineered products and aftermarket services to rotorcraft, fixed-wing business aviation OEM customers and fleet operators. I want to welcome Mike Carpenter, President and the entire BLR team to Ducommun. I’m excited to begin working with them.
As for the quarter, we’re off to a good start in 2023 with very strong top-line growth, as the company delivered year-over-year revenue growth of 11% to $181.2 million. As mentioned in the press release, our excellent position in narrow-body aircraft was key to driving overall revenue growth and another positive sign of recovery is in good shape. It only gets better in the near and longer term.
Turning to the markets. The continued recovery in commercial aerospace wants to get a real bright spot in Q1. With Boeing 737 MAX business up 80% year-over-year and the Airbus A320 also have significant growth of 66% year-over-year.
Overall, commercial aerospace with Airbus and Boeing and others was up 35% from Q1 2022. Ducommun’s commercial aerospace business has shown year-over-year revenue growth now for the seventh consecutive quarter, an excellent sign as the industry and build rates recover.
The company’s defense business was down modestly year-over-year in Q1, mainly due to the timing of programs such as the Apache rotor blade and GA UAVs among others. But once again, Ducommun has delivered a solid performance of roughly $96 million in revenue as we prepare for increasing DoD budgets and FMS in the years ahead. The company posted a solid gross profit of 20.3% up year-over-year from 19.9% good results, we work through our restructuring activities.
The team also posted adjusted operating income margins of 7.5% and adjusted EBITDA was $23.1 million, an increase of $3 million year-over-year. The company had adjusted EBITDA margins of 12.7% in Q1 as well and we anticipate adjusted EBITDA to be solid this year with much stronger numbers in 2024. Once the plant — 2023 are behind us.
Quality of earnings was solid with GAAP diluted EPS of $0.42 a share versus $0.66 a share for Q1 2022. But with adjustments the diluted EPS of $0.63 a share was comparable to a diluted EPS of $0.67 a share in the prior year. Some key drivers for the lower GAAP diluted EPS include restructuring charges and higher Glamis fire-related expenses.
Switching to the company’s backlog performance the commercial aerospace backlog increased sequentially for the eighth consecutive quarter from $266 million at the end of Q1 2021 to $464 million at the end of Q1 2023 an increase of 74%. This was led by the 737 MAX ViaSat for in-flight entertainment the A320, A220 and Gulfstream, all of which you would expect after a slower-than-expected recovery during 2022.
The Defense backlog decreased modestly sequentially from Q2 2022, but remained solid at the end of Q1 as well and ended the quarter at $444 million. I also want to share with you some great news on the 737 MAX. We recently received our first order ever from Spirit AeroSystems for MAX fuselage skins similar to what we made currently for the A220. This is an initial order for four skin sections, which comprised of roughly 5% of the total fuselage.
So we expect this to grow as we move forward. The initial foreskin order is projected to be $4 million in revenue yearly and we’re excited about what is ahead. Keep in mind, we provide close to 100% of the skins for the A220 fuselage as a sole source or a 50-50 split with Spirit for certain areas. So we are ready to do a lot more after this initial order.
The four skin sections will be fully commercialized by year-end. For offloading for defense prime the work continues. We’re expecting roughly $90 million for the full year as committed to with a great deal of that in our circuit card business for Raytheon at such sites as Appleton Wisconsin and Tulsa Oklahoma. The long-term run rate of these defense programs already commercialized or in development for off-flowing will be over $125 million for the common by 2025.
One item to note is that there are lags with these types of projects. I would not only have to transfer a legacy or buy test equipment et cetera, but we do have an initial headwind on revenue with the OEM supplying material from their on-hand stock. So the numbers with these large OEMs do take some time.
The company’s actions and lean organizational structure are also continuing to pay dividends. Our team delivered another excellent quarter as well in Q1 managing the supply chain and this is not only shown in our financials but also we cannot be in better shape with our customers regarding our on-time delivery and quality.
In addition, we were honored in Telos in March by Airbus with an award for being a top-performing supplier for hot farm and superplastic form titanium products. Ducommun — put out a press release on this and we are very proud of our work. For context, we did not have any business with Airbus before 2016. It has been a great success and Airbus is a very high global standard for these awards. It is a select group.
For revenue guidance for the year we’re happy to update it to mid-to-high single digit for 2023 based on better news on commercial aerospace along with a very successful win with BLR and the acquisition.
Just a few comments on our win. These are never easy and require a great deal of effort and excellence. I’m happy to report that the seller due to our approach went exclusive with Ducommun early on and this provides beneficial benefits for everyone.
On the commercial aerospace side, the recovery will continue to lead the way and revenue will be very good for the rest of 2023 as we see more and more volume returns with defense also being solid. The two plant closings later this year will also have some limited headwinds on revenue as we seek to prove non-strategic and low-volume business but feel very confident in our much-improved guidance for 2023 revenue.
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 $96.4 million a modest decrease versus Q1 2022. Despite being down as mentioned earlier, it was a solid showing for the business in Q1. We still saw increases in demand on our other military and space platforms MIRV missile other military rotary aircraft platforms and other military fixed-wing aircraft platforms.
In the first quarter military and space revenue represented 53% of the common revenue in the period, down from 61% last year and this trend will continue to reflect more balance with commercial aerospace and we like that. We also ended the first quarter with a solid backlog of $444 million, while also down modestly sequentially still represents 46% of Ducommun’s total backlog.
In our commercial aerospace operations, first quarter revenue increased 35% year-over-year to $73.1 million, driven mainly by bill rate increases at Boeing Airbus and others. Ducommun expects this to continue to gain momentum in 2023 and the future is very bright across our product offerings. Our delivery and quality also continued to stand out as we move ahead. The backlog within our commercial aerospace sector stands at $464 million at the end of the first quarter and was $87 million higher or had a 23% increase year-over-year from Q1 2022.
With that, I’ll have Suman review our financial results in detail. Suman?
Suman Mookerji
Thank you, Steve. As a reminder, please see the company’s Q1 10-Q and Q1 earnings release for a further description of the information mentioned on today’s call.
As Steve discussed, our first quarter results reflect another period of strong performance. Once again, we saw a significant increase in our commercial aerospace revenues. We remain encouraged by the continued strength in domestic and global travel, which would support higher long-term demand for aircraft and are also encouraged by the build rate outlook from our key customers that should drive continued growth in our shipments.
During the quarter, we also continued to make progress on our restructuring program. And as Steve mentioned we announced the acquisition of BLR Aerospace in Q1 and subsequently closed on the transaction on April 25th. With all this, we feel like we have laid a strong foundation to the year in the first quarter.
Now turning to our first quarter results. Revenue for the first quarter of 2023 was $181.2 million versus $163.5 million for the first quarter of 2022. The year-over-year increase reflects $19 million of growth across our commercial aerospace platforms, partially offset by $2.9 million of lower revenue within the military and space sector. Ducommun’s overall backlog at the end of the first quarter was approximately $961 million similar to the level at the end of Q4 2022 and $18 million higher than at the end of Q1 2022. This reflects recent growth across our commercial aerospace platforms. Our defense backlog was $444 million and we remain positioned for continued solid performance as we move through the remainder of 2023.
As a reminder, we define backlog as potential revenue based on customer purchase orders and long-term agreements with firm fixed prices and expected delivery dates of 24 months or less. We posted a total gross profit of $36.8 million or 20.3% of revenue for the quarter versus $32.5 million or 19.9% of revenue in the prior year period.
We continue to show adjusted gross margins as we have a higher amount of non-GAAP related cost of sales this year, mainly driven by our Guaymas fire related impact. On an adjusted basis our gross margins were 21.1% in Q1 2023 versus 20.8% in Q1 2022. We continue to work through a difficult operating environment with supply chain and labor. However, through our proactive efforts including strategic buys and our inventory investments, we have been able to avoid any significant impacts on the business.
Ducommun reported operating income for the first quarter of $6.4 million or 3.5% of revenue, compared to $9.1 million or 5.6% of revenue in the prior year period. Adjusted operating income was $13.6 million or 7.5% of revenue this quarter compared to $12.3 million or 7.5% of revenue in the comparable period last year. The company reported net income for the first quarter of 2023 of $5.2 million or $0.42 per diluted share compared to net income of $8.1 million or $0.66 per diluted share a year ago.
On an adjusted basis the company reported a net income of $7.9 million or $0.63 per diluted share, compared to a net income of $8.3 million or $0.67 in Q1 2022. The lower net income relative to operating income was driven by higher interest costs during the period. Adjusted EBITDA for the first quarter of 2023 was $23.1 million or 12.7% of revenue, compared to $20.1 million or 12.3% of revenue for the comparable period in 2022.
Now, let me turn to our segment results. Our Structural Systems segment posted revenue of $75.6 million in the first quarter of 2023 versus $66 million last year. The year-over-year increase reflects $14 million of higher sales across our commercial aerospace applications, partially offset by $4.4 million of lower revenue within the company’s military and space markets.
Structural Systems operating income for the quarter was $4.7 million or 6.3% of revenue compared to $4.9 million or 7.4% of revenue last year.
The year-over-year operating margin decrease was primarily due to higher restructuring charges. Excluding restructuring charges and other adjustments in both years, the segment operating margin was 12.9% in Q1 2023 versus 11.7% in Q1 2022. This is a solid operating performance from the Structural Systems segment.
Our Electronic Systems segment posted revenue of $105.6 million in the first quarter of 2023 versus $97.5 million in the prior year period. These results reflect $5 million of higher commercial aerospace revenue and $1.5 million of higher revenue across the company’s military and space customers.
Electronic Systems’ operating income for the first quarter was $10 million or 9.5% of revenue versus $9.4 million or 9.7% of revenue in the prior year period. The lower operating income as a percentage of revenue was primarily due to higher restructuring charges. Excluding restructuring charges and other adjustments in both years the segment operating margin was 11.6% in Q1 2023 versus 10% in Q1 2022.
Now an update on our restructuring. As a reminder and as discussed previously, we commenced a restructuring initiative back in Q2 2022. These actions are being taken to accelerate the achievement of our strategic goals and to better position the company for stronger performance in both the short and long-term. This includes the shutdown of our facilities in Monrovia, California and Berryville, Arkansas and transferred a majority of that work to our low-cost operation in Guaymas, Mexico, with the remainder going to other existing performance centers in the United States. We are progressing well on these transitions both with employee retention and engagement and with customer alignment.
During Q1 2023, we incurred $4.2 million in restructuring charges. The majority of these charges were severance and benefits related. We expect to incur an additional $8 million to $12 million in restructuring expenses during the rest of 2023. Upon the completion of our restructuring program, we expect to generate $11 million to $13 million in annual savings from our actions. Once we wind down production at Monrovia and Berryville, we anticipate selling the associated land and building at both locations.
Turning to liquidity and capital resources. We have available liquidity of $217 million at the end of the first quarter. The first quarter of each year is typically our largest net usage of cash in operations, primarily due to the payout of year-end accrued incentives. And this year we also made an estimated tax payment of approximately $8 million to cover changes in tax rules for R&D expenses, which now need to be capitalized and amortized and thus used $18.9 million in cash flow from operating activities during the quarter. This was similar to the prior year, which also saw net cash used in operations of $18.9 million.
Our 12-month debt-to-adjusted EBITDA ratio was 2.5 and is among the lowest in the last several years. However going forward as a result of the completion of the BLR acquisition in Q2, we expect our debt-to-adjusted EBITDA ratio to increase. While our debt refinancing during 2022 was timely and beneficial, the rising interest rate environment drove the increase in interest costs to $4.2 million in the quarter versus $2.4 million in Q1 2022. This was expected. In November 2021, we put in an interest rate hedge for $150 million, which goes into effect in January 2024 and will help with our interest costs.
To conclude the financial overview, we are off to a good start in 2023 and with the BLR acquisition now completed in Q2 and the expected completion of the restructuring program later this year, there is much to look forward to for the rest of 2023 and beyond.
I’ll now turn it back over to Steve for his closing remarks. Steve?
Steve Oswald
Okay. Thanks, Suman. In closing, it was a look a very good quarter to begin the year. The Bell acquisition is another step in the right direction and certainly meets the expectations we communicated at our Investor Day in December. In addition, all the meetings I’ve been attending now that we’re meeting in person again with top customers and all the industry news that I read, just show some great opportunities over the next several years and the common team be ready to capture the upside. My thanks as always to our employees and investors for the support as we embark on the New Year, and build momentum throughout 2023, toward an even stronger 2024.
I will now open up for questions. Thank you for listening.
Question-and-Answer Session
Operator
Thank you. At this time we will conduct the question-and-answer session. [Operator Instructions] Our first question comes from Ken Herbert of RBC. Your line is now open.
Ken Herbert
Yes. Hey, good morning Steve, and congratulations to Suman.
Suman Mookerji
Thank you.
Steve Oswald
Good morning, Ken.
Ken Herbert
Hey, Steve maybe to start off, you called out some pretty significant growth in the first quarter for the MAX, and it sounds like you’ve taken some share on that program, which is nice, but there’s been a lot of headlines recently about this program and some issues with Spirit. Can you maybe level set us here in terms of what bill rate you’re currently going in on the MAX, maybe how you see that progressing over this year?
And then maybe the revenue contribution this year. How much do we expect it to grow across the full year? Because it sounds like you haven’t been impacted by some of the slowdown that we’re seeing in Spirit.
Steve Oswald
Yes. Well, thanks, Ken. Good question. I guess a couple of things. First, I was up at the Boeing supplier meeting not too long ago. So it’s Stan Deal and the team there. So, a couple of things. First, we came out of the gate pretty much in a modest way at 31 a month. But we do — despite some of the issues in Spirit, and we wish them all the best to get that cleared up, we’re more on the front end and front end of this thing.
We think that, okay, there will be a little bit of a hiccup, but we still see things heading up from 31% to 38% by the end of the year. We’re further confident in that. We’re all capitalized for that. We’ve got a little bit of hiring to do, but we’re optimistic. So, certainly, it’s an issue certainly the repairs. I mean, there’s a lot of things that the Spirit has to get done there. But also as I mentioned we have a major development with them on the skins and that was a long time coming.
We worked very hard on that for over say, 16 months at least. So we got that across the finish line just recently. So we already do for roll form and stretch form. We’re already big players in fuselage skins on the A220. So we think that not only we’re going to see better rates, I mean, okay, we’ll have a little bit of a headwind right now, but we’re planning to get to 38% or very close by the end of the year. But we’re also very optimistic that as we go forward with Spirit, we’re going to pick up more of the program share. So I think good things ahead for us.
Ken Herbert
Okay. That’s helpful. Thank you. And I guess as you think about that to segue into the better outlook for revenues this year to up mid to high single-digit. Is that predominantly the BLR acquisition, or is there any assumption in there about sort of better performance out of aerospace? I mean, it looks like BLR could add maybe three to four points of growth this year.
Steve Oswald
Yes. So, it’s a mix, okay? So, it’s certainly BLR is going to contribute. We just picked them up at the end of April, right? So we’re not going to get a full year of revenue, but we’re going to pick up some nice revenue. And then also, again, when we started the year at low single, we’re still obviously a little — I wouldn’t say, nervous, but just being a little more modest at the beginning of the year.
But we feel better about our prospects as well as Airbus and Gulfstream, and the other companies we support. I would say, BLR is kind of on the lower end of the range that you suggested, Ken, and so there is substantial organic growth in the outlook.
Ken Herbert
Okay. Great. And Suman, just finally I think the cash use this quarter was probably consistent with expectations, but can you reset us on maybe an expectation for full-year 2023 free cash flow?
Suman Mookerji
So, we expect to have a better free cash flow year this year than we did last year. There are some headwinds as we do these facility transitions and have to build up some inventory to support those moves. But we’re looking at ways to offset some of those headwinds and come out net positive versus where we did on working capital and cash flow last year.
Steve Oswald
Yes. Ted we got some — just on that we got the Apache back late, we have the MAX spoilage. So we got some major industry impact moves here. So we got to make sure we’re taking care of first the customer and making sure we got enough buffer for these moves. So, a little over that too.
Ken Herbert
Great. All right guys. Thanks a lot.
Steve Oswald
Thanks, Ken.
Operator
One moment for our next question. Our next question comes from Mike Crawford of B. Riley Securities. Your line is now open.
Mike Crawford
Thank you. Just to make sure are you not comfortable talking about the rough annual revenue run rate of BLR as well as added working capital that that’s going to put on the balance sheet the next time we see a print?
Steve Oswald
We’ll have more to say, I think at the end of the Q2 call, okay? Mike, we’ll just get started here. I mean, obviously BLR is an engineered product with an aftermarket. So it’s going to be accretive to the P&L and to our current business. So we’re excited about it. I think earlier with Ken’s comments it’s a couple of points for this year for us on the revenue side and more to come.
Mike Crawford
Okay and then regarding the mid-to-high single-digit growth guidance implying some high hundred millions of revenue versus your 12-month backlog which is closer to $650 million-ish. So where is the main book and ship business that makes up that difference?
Steve Oswald
So we see book and ship in a lot of our engineered product businesses. And so that is a big driver of that. And then, we may see some incremental in our structures business as well and some drop in orders in our electronic manufacturing services business as well from time-to-time though their typical lead times are longer. But mainly in our engineered products businesses is where we have more book and ship business.
Mike Crawford
Okay. Great. Thank you. And then, I don’t know I guess on the last call you weren’t really prepared to talk about this, but once you do get out of Monrovia and the other factory like, do you have any more sense you can share on the potential timing of the sale of the real estate underlying these facilities and ….
Steve Oswald
Yeah.
Mike Crawford
…perhaps what you might get from it?
Steve Oswald
Yeah. I think it’s a little tricky right now, because we’ve got some major things to move, right? And customers they get nervous. So we have to make sure that we’re doing the right things on the front-end. We would like to move one if not both properties, probably by the year-end if not, by Q1, Mike. So it’s not something we’re going to — we’re in a hurry a bit here, but we’ve got to make sure we do the right things for the market, but sooner than later.
Mike Crawford
Okay. All right. Thank you very much.
Steve Oswald
Thanks Mike.
Operator
Our next call comes from Michael Ciarmoli of Truist Securities.
Michael Ciarmoli
Taking my question…
Operator
Your call is now…
Michael Ciarmoli
Hey, can you hear me guys?
Operator
Yes. We can hear you.
Steve Oswald
We can hear you Michael. How are you?
Michael Ciarmoli
Hey. Maybe just going back to the facility transitions, I think you talked about the MAX spoilers and the Apache blades.
Steve Oswald
Yeah.
Michael Ciarmoli
Is there any sort of requalification risk needed to shift that work or any sort of technical challenges that we should be aware of there?
Steve Oswald
No Mike. We’re making that stuff forever. So…
Michael Ciarmoli
Okay.
Steve Oswald
So we’re just going to make it somewhere else. So no issue about that, but obviously we have to work with the customer because it’s going into a new facility, right? So there’s always a lag with defense prime or a major OEM on the commercial side. But we feel good about where we are.
The one thing I’d say too just for investors is that — and I give a lot of people credit at Berryville [indiscernible]. I mean, we announced this in November last year and we still have a pretty much a full workforce. So people are committed to finishing the job and getting it transferred properly. So I would say at least on the technical side the answer is no.
Michael Ciarmoli
Okay. And then, just back to the MAX, can you just circle back a little more time on the content? You talked about the $4 million. Does that assume a specific run rate? Are you on every plane? I know the MAX was your biggest program pre-pandemic but just trying to get a sense of how much content this adds.
Steve Oswald
Yes. So like I said I mentioned about formula. It’s a good start. Let’s put it that way. It’s going to sort of increase our ship rates so roughly around 15 ships sets a month for those skins. We’re pretty happy with that.
Michael Ciarmoli
Okay.
Steve Oswald
Spirit makes it internally too. So..
Michael Ciarmoli
Got it.
Steve Oswald
But that’s the big deal. We’re in the game.
Michael Ciarmoli
Okay. Perfect. That’s what I was looking for. And then maybe Suman on the restructuring, you called out the — and I think you have done this the annualized savings starting in the second half of 2023. How should we think about that? I don’t know, if it’s call it $5.5 million or so of savings. How should we think about the margin? Should we expect to see a significant up-tick in operating income and margins as we get into 3Q and 4Q?
Suman Mookerji
I think you’re going to see it more towards the end of the year.
Michael Ciarmoli
Okay.
Suman Mookerji
And yeah, so I think you’re going to see the benefit really more pronounced in 2024.
Michael Ciarmoli
Okay. Got it. Perfect. Okay, perfect guys. That’s all I had. Thanks.
Suman Mookerji
Okay. Thanks, Michael.
Operator
There appears to be no further questions. I would now like to turn it over to Mr. Oswald, for closing remarks.
Steve Oswald
Okay. Thank you very much. Look, again, I think it’s a very good start to the year. We have a lot going on here, but I think all very positive for our customers, our company and our shareholders. It should be a consequential year to comment on the upside. And again, my thanks for attending today and I wish you a good afternoon.
Operator
Thank you for attending today’s conference. This does conclude the program. You may now disconnect.
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