Good day, ladies and gentlemen, and welcome to the Q4 2018 Ducommun Earnings Conference Call. [Operator Instructions]. As a reminder, this call is being recorded. I'd like to introduce your moderator for this call. Sir, you may begin..

Thank you, and welcome to Ducommun's 2018 Fourth Quarter Conference Call. With me today are Steve Oswald, Chairman, President and CEO; and Doug Groves, Vice President, Chief Financial Officer 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 question-and-answer session that follows.

Certain statements today that are not historical facts, including any statements as to future market conditions, results of operations, our restructuring plans and financial projections, are forward-looking statements under the Federal Private Securities Litigation Reform Act of 1995 and, therefore, are prospective.

These forward-looking statements are subject to risks, uncertainties and other factors that 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 assurances that such expectations will prove to be correct. In addition, the 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 U.S. government defense spending, legal and regulatory risks, management changes, the cost of expansion and acquisitions, and competition.

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.

In addition, all comparisons on today's call recognize the implementation of the FASB Accounting Standards Codification, or ASC, topic 606, covering revenue recognition policies on current results. Please see the company's filings for a further description of this change and a comparison to the prior policy, ASC 605.

This call also includes non-GAAP financial measures. Please refer to our filings with the SEC for a reconciliation of the non-GAAP measures referenced on this call to the most similar GAAP measures. We have filed our Form 10-K with the SEC today, and you will find a link to all our filings on the company's website under the Investor Relations tab.

I would now like to turn the call over to Mr. Steve Oswald for a review of the operating results.

Steve?.

Okay, thanks, Chris, and thank you, everyone, for joining us today for our 2018 fourth quarter conference call. As usual, I'll begin by providing an overview of recent developments of the company, after which Doug will review our financial results in detail.

First, I'm happy to report that Ducommun had a strong finish to 2018 with very good results which I believe are indicative of the many actions and initiatives implemented to improve the company's operating performance.

Fourth quarter revenue grew a robust 15% year-over-year to $164 million to reflect higher shipments across both commercial and military platforms. In addition, full year sales rose to $629 million from $558 million in 2017, an increase of over 10%.

At the same time, we ended the year with a record backlog of $864 million, up more than $125 million year-over-year. This clearly demonstrates and shows the company's success in leveraging innovation, technology as well as our commitment to customer value.

Ducommun is also fully engaged on winning new business and penetrating further into existing client platforms. At the same time, the company also generated $46 million in cash from operations and strengthened our financial flexibility by refinancing our debt, as Doug will review in a moment.

Our restructuring action in 2018 were to streamline our operations, improve capacity utilization and increase margins, and the team delivered in all three areas. We removed almost 16% of total manufacturing floor space and eliminated about $14 million of annualized costs going forward, all without any customer disruptions.

We also flattened our organizational structure and reduced costs while hiring new talent and investing in employee development. The team rationalized the product portfolio as well, removing low-performing programs from the company.

In addition to the restructuring, Ducommun successfully integrated two accretive acquisitions that strengthened our margins, enhanced our proprietary technology and bolstered our growth profile. All these activities position the company very well for the future.

As shareholders who attended the company Investor Day in November, along with comments on previous quarterly calls, the team was also focused on operational excellence and higher returns in 2018 particularly within our structures business.

The results, through a lot of hard work, were significant, with structures adjusted operating margins, in particular more than doubling to 10.7% in the fourth quarter from 4.9% a year earlier, an outstanding improvement within a short period. And everyone is proud of what we've been able to achieve.

As we look forward to the future, the team is continually focused on product innovation, differentiation in the marketplace to ensure continued top line growth and solid margins.

Whether it's our proprietary VersaCore composite technology or the company's expanding array of engineered products, Ducommun is committed to niche applications that provide high value to the industry. The company is in excellent shape as we begin 2019, and we're working on improving every day.

Now let me provide you some additional color on our end markets, products and programs. Beginning with our military and space sector, we posted fourth quarter revenue of $73 million, up 13% from last year, reflecting strong sales across a variety of missile applications.

For the total year, revenue was $277 million for the sector, representing growth of roughly 3% over 2017, driven by key platforms such as the F-18, F-35, Apache helicopter, along with the Patriot and other missile-related programs. We anticipate continued strong results within this portion of our business based on the outlook for military spending.

I might note that the initial DoD budget for fiscal 2020 is anticipated to be at least $720 billion which is above the current budget. But Ducommun, we ended the year with military, space backlog just above - or excuse me, just under $340 million, and that's near record levels.

In our commercial aerospace operations, fourth quarter sales rose approximately 27% year-over-year to $80 million. We once again saw significant growth across large, fixed-wing, narrow-body aircraft, reflecting higher build rates for the Boeing 737 platforms and the Airbus A320 family.

We are also very pleased to see a nice uptick in business with Viasat for electronics tied to in-flight connectivity. For 2018, as a whole, we posted commercial revenue of $304 million, representing growth of nearly 29% year-over-year. Our 737 business grew 30% in 2018, and for the first time ever, topped $100 million in sales.

At the same time, we continue to ramp up content on the A320, which is a terrific story with Airbus being a fairly new commercial customer. We're optimistic about continued growth in 2019 once again being driven by Boeing 737 Max and Airbus A320 programs as well as our business with Gulfstream and other Boeing platforms such as the 787.

As a reminder, Boeing plans to increase 737 production to 57 a month this year from 52 in 2018 and 787 production to 14 a month from 12 last year, a real benefit for Ducommun.

I'd also like to mention our VersaCore technology is growing in popularity, and we're on track with regards to our 10-year $200 million contract to supply and to sell components for a leading aircraft engine OEM. We will complete the industrialization plan this year with manufacturing in Guaymas, Mexico and expect to begin full production in 2020.

The backlog within our commercial aerospace sector grew to $487 million at year-end, representing another record for the company. While bookings converted quarter-to-quarter due to order timing, we're upbeat about the outlook for 2019 based on the platforms we serve and continued operating improvement.

In summary, this should all result in mid-single-digit growth or better this year, along with strong margins and solid bottom line performance. Before I turn the call over to Doug, I want to mention that in January, Ducommun initiated an employee stock purchase plan which provides all employees an opportunity to purchase Ducommun shares.

Having employees' interest aligned with those of shareholders result in a win-win environment where our growth and improving operating results reward all stakeholders now and in the future. With that, I'll have Doug review our financial results in detail.

Doug?.

Thank you, Steve, and good day, everyone. As a reminder, my comparisons on today's call are on a year-over-year basis and recognize the implementation of the FASB Accounting Standards Codification, or ASC, topic 606 covering revenue recognition policies on current year results.

Please see the company's filings and today's 10-K and press release for further description of this codification versus the prior policy ASC 605. Revenue for the fourth quarter of 2018 was $164.2 million versus $142.3 million in the fourth quarter of 2017.

This performance primarily reflects $17 million of higher sales to the company's commercial aerospace customers and $8.1 million of greater revenue within the military and space sector. This was due to increased shipments for key platforms such as the Boeing 737, the Airbus A320 and various missile defense programs.

Ducommun's overall backlog was approximately $864 million at the end of the year versus $780 million in Q3, and as Steve mentioned, it represents a new record for the company.

Just as a reminder, the company does define backlog as potential revenue and is based upon customer-placed purchase orders and long-term agreements with firm fixed prices and firm delivery dates of 24 months or less.

We completed our transition to ASC 606 in 2018, so in 2019 we will also be referring to our remaining performance obligations versus our historical backlog definition. Moving to gross profit. Our gross margin was 19.9% in the fourth quarter versus 18.1% in the prior year's comparable period.

The increase year-over-year was primarily due to higher production volumes, favorable product mix, along with lower compensation benefit costs. SG&A was $22.5 million in the fourth quarter versus $20 million in 2017, with the increase primarily reflecting $0.7 million in debt refinancing fees and higher compensation and benefit costs.

The company reported operating income for the fourth quarter of $6.3 million or 3.8% of revenue compared to an operating loss of $2.6 million or negative 1.8% of revenue in the prior year period.

The year-over-year improvement was due to higher revenue and gross profit as well as the impact of $4.9 million in lower restructuring charges partially offset by higher SG&A expenses.

On an adjusted basis, operating income was $11.8 million or 7.1% of sales and $7.3 million or 5.1% of sales for the fourth quarters of 2017 - excuse me, 2018 and 2017, respectively.

Our 2018 fourth quarter restructuring activities included approximately $1.1 million of charges within our Structural Systems segment, $2.4 million within Electronic Systems and $0.3 million at the corporate level. As Steve mentioned, the restructuring program achieved the stated objectives and is set to deliver the benefits previously discussed.

Interest expense was $3.8 million in the fourth quarter of 2018 versus $2.8 million last year. This was due to higher utilization of our credit facility for recent acquisitions along with higher interest rates.

The company reported net income for the fourth quarter of $0.7 million or $0.06 per diluted share compared to net income of $9.5 million or $0.82 per diluted share for the fourth quarter of 2017. The year-over-year decrease was primarily due to a tax benefit of $14.5 million in the prior year period as a result of the 2017 Tax Cuts and Jobs Act.

Adjusted net income was $5.2 million or $0.44 per diluted share in the 2018 fourth quarter versus $4.6 million or $0.40 per diluted share in the prior year period.

Adjusted EBITDA for the fourth quarter of 2018 was $19.4 million or 11.8% of revenue, which is an increase of 210 basis points compared to $13.8 million or 9.7% of revenue for the comparable period in 2017. Now let me turn to the segment results. Turning to the Electronic Systems segment.

Electronic Systems segment revenue - posted revenue of $85.3 million in the fourth quarter of 2018 versus $77.2 million in the prior year period. These results reflect a $4.5 million increase in sales to our military and space customers and $6.8 million higher shipments within the commercial aerospace market.

Electronic Systems posted operating income for the fourth quarter of $7.5 million or 8.7% of revenue versus $6.9 million or 8.9% of revenue in the prior year period. Excluding restructuring charges and the impact of ASC 606, electronics posted operating income - operating margin of 10.6% for the 2018 fourth quarter and 11.9% in the prior year period.

Our Structural Systems segment posted revenue of $78.9 million in the fourth quarter of 2018 versus $65.1 million last year.

The year-over-year increase was due to $10.2 million of higher sales across our commercial aerospace applications, particularly large airframe single-aisle platforms and $3.6 million of increased revenue within the company's military and space markets.

Structural Systems posted operating income for the quarter of $5.7 million or 7.2% of revenue compared to an operating loss of $2.6 million or negative 4% of revenue last year. Excluding restructuring charges and the impact of ASC 606, structures adjusted operating margin more than doubled to 10.7% for the 2018 fourth quarter versus 4.9% in 2017.

This reflected the higher operating efficiencies, improved pricing and impact of our just completed restructuring program.

Corporate general and administrative expenses, CG&A, for the fourth quarter was $6.9 million or 4.2% of revenue and essentially flat year-over-year due to lowering restructuring charges, partially offset by $0.7 million in debt restructure costs and higher compensation and benefit costs. Turning to liquidity and capital resources.

We generated $12.8 million of cash from operations in the fourth quarter of 2018 versus $8.1 million in 2017. For the full year just ended, operating cash flow was $46.2 million versus $35.4 million in 2017.

The improvement in cash flow reflects the improved earnings, continued diligence in managing working capital, and our balance sheet is in solid shape going forward. In November, we've refinanced our credit agreement, providing for a new seven year, $240 million senior secured term loan facility and a five year $100 million senior secured revolver.

The new credit facilities will also allow us greater flexibility to execute our strategic initiatives but will increase our borrowing weight by about 150 to 175 basis points depending upon our leverage. Net of any unforeseen acquisitions, we anticipate using operating cash flow to further reduce the company's leverage in 2019.

In terms of CapEx, we spent $4.8 million during the fourth quarter and $17.6 million for the year which was down from $27.6 million in 2017. We anticipate spending approximately $15 million to $17 million in 2019 to support new program wins.

In closing, we're very pleased with the results of our restructuring program and other initiatives designed to streamline the company and improve top line growth. Ducommun is on sound footing for continued strong operating performance in fiscal 2019. I'll now turn it back over to Steve for his closing remarks.

Steve?.

Okay, thanks, Doug. Before turning the call over for questions, let me just once again reiterate how pleased I am with our many accomplishments in 2018. As I look forward to 2019, both the commercial and defense markets again will provide another year of great opportunities for the company.

In Ducommun, we're focused on where we can bring the most value to the marketplace while continuing to improve our internal operations. Our structure and electronic manufacturing capabilities, along with engineered products, serve the best large narrow-body platforms in the industry.

We also have very strong relationships with key customers such as Boeing, Airbus, Raytheon, Spirit Aerosystems, Lockheed Martin and United Technologies Corporation. In addition, the company's balance sheet is strong, and I believe the team is aligned as we prepare for another year of success.

So again, I'm very proud of everything we achieved in 2018, and in closing, I want to thank our investors for their continued support. With that, operator, we'll now open up the call to questions..

[Operator Instructions]. Our first question comes from Edward Marshall from Sidoti & Company..

So I guess, I'll start with restructuring, you've done a pretty good job there, obviously.

Is there additional restructuring that you're planning for 2019? And if so, do you mind sharing kind of what areas of the business that restructuring may be coming through with?.

Ed, we're compete with the restructuring. There's no further restructuring anticipated in the near term at this point in time..

Okay. And you've taken all the charges, I guess, for that.

And what was the incremental improvement on the earnings that we're anticipating in 2019 versus 2018?.

So it'll be about half of what we had set out of the $14 million. So we realized about half of it in '18 and the other half will start reading through in '19..

Okay. All right. And so I'm thinking about the incremental margin here now. I guess, specifically in structures being that it's kind of your heavier manufacturing type of business.

And I'm curious, as we see the ramp on the 737, we see the ramp on the 787, with the cost that - and other programs as well, with the cost reductions that you've had, how do I think about kind of the incremental - the contribution margin from your businesses, specifically in the structures, if you don't mind commenting?.

Well, as you can see, we've made great strides in improving the margins this year in structures for the year ending at 9.1% operating margins. As we think, moving forward, with the contribution margin and pricing, we could see another 40 to 50 basis points in 2019 in the operating margin..

For structures specifically or for....

Yes..

Okay. Could you elaborate a little bit more on the Viasat, the in-flight connectivity. I guess what are you doing? Maybe who held the contract beforehand and anything else that you might want to elaborate..

Yes. So we don't disclose revenue. So it's 5% or more, so I'll have to - I can't share that with you. But Viasat is - it's a great opportunity for us. It's really around box builds and making cards, so it's all on our electronic systems side of the business. So we're working with them closely. They're based in San Diego.

And we've had a nice relationship with them. It's only getting better. So it's mostly around cards, assembly, and more to come on Viasat.

But they're a new customer as well, I'd say, last two years, right, roughly?.

Yes..

And there's been a bit of jockeying for who's going to win out on certain contracts.

What is it about Viasat that you think has the advantage over some of the other key players in the market for in-flight connectivity?.

Yes. That's difficult for us to answer. Viasat's our customer not our competitor. They know their competitive landscape better than we do..

Our next question comes from Michael Ciarmoli from SunTrust..

It's actually Les in for Michael. Could you talk about - just perhaps give a little bit of a breakdown on the backlog. Is any of the new business are legacy, potential new programs coming from Airbus, Lockheed Martin? I know you mentioned they're kind of underweight now. Just give us a little bit of a breakdown of that backlog number, if you could..

Well, a good percentage of it is recurring business. I mean there are some new business in there, but it's a smaller percentage than the repeat business that we have. And what we saw was obviously, with the rates increasing, we're getting POs from, particularly Boeing, but also from Airbus to be sure that we're ready to meet their rate demands.

And for what we're doing is mostly structures work in both of those areas. So we've got long lead time on, particularly titanium, so it's a lot of - Airbus, it's largely a new business that we haven't done, and Boeing, it's a lot of regarding business that we already have..

Okay. I guess on the Airbus and the Lockheed question, too. I mean, it's still a relatively new customer, too.

Were there any potential discussions around future work? I mean has - do you see kind of double-digit growth coming in '19 of new business tieing to titanium work?.

Yes. I think that we're now a real supplier to Airbus, right? It's been a great thing the last couple of years for the company and really around titanium products. And we continue to have conversations with them, and we feel good about our growth prospects for 2019..

Okay. You mentioned on the Investor Day about the defense CAGRs, around 2% to 4%. I mean would you say that's maybe conservative on your end given the opportunities you've called out in missiles, maybe even potential hypersonics. Not sure if you're on the potential there.

Will that growth rate be somewhat conservative, looking out the next three years?.

You'll see in our investor presentation out on our website later today that we did pull that up to 3% to 5% for those reasons. So as we've gotten more visibility in some of the new business wins that we've had and - we'll see that probably pump up a little bit than where we had at the 2% to 4%..

Got it. Okay, great. And just last one for me on the supply chain. I mean the industry's kind of been seeing pressures.

Any incremental pick up of work for you guys from the bottlenecks in the supply chain?.

No, not really. I mean we're - it's a competitive marketplace, but I wouldn't say that we're grabbing a lot of new business for nonperformance..

Yes, yes..

And our next question comes from Ken Herbert from Canaccord..

First, just wanted to see, Doug, specifically, as we think about margins in '19, is there anything sort of incrementally positive or negative from tariffs or material costs or anything else you'd specifically highlight, either that could be a tailwind or a headwind?.

Not really. It's a lot of, in the structures business, material that we're buying is coming off of Airbus and Boeing contracts. And then on the electronics side of our business, that's mostly U.S. supply base because it's mostly defense business.

So I mean there's a little bit but not compared to probably what others may be experiencing in other industries. So we don't think it's a big headwind..

Okay. And as I look at the margin improvement, I mean we've got the restructuring, which I think it's fairly well understood. Is it fair to say then that volume would be the biggest sort of opportunity that you'd expect to see? And I'm specifically thinking of the structural segment.

Or is there anything else from a margin standpoint that you'd highlight that could be a tailwind to margins in '19?.

I think volume would be the single biggest driver as we spread that overhead across higher volumes that will drop through. But most of the other things, material costs and such are neutral from a margin expansion standpoint..

Okay. And just finally, if I could, on the 737, in particular, I know you've taken some share gain. I know, obviously, the MAX represents an increase for you in content.

Are you seeing other - either across that program or maybe with your Airbus customer, are there other sort of opportunities to take share? Are you seeing any opportunities where maybe either your customers are looking to derisk the supply chain, where you could maybe step in, or there's opportunities through technology or titanium or something else? I mean maybe - can you just talk about your ability to continue to grow better than sort of the aerospace volume through share gains?.

Well, look, I guess, a couple of things. I think first, on the Boeing side, with what we're doing right now and they're focused on rate, we're pretty much locked in. So we think it's sort of steady as you go with Boeing. I think Airbus is a little bit more on a program perspective.

We might do a share of the part for 320, and we think that we could see some upside taking over a higher percentage of that part for the program. So I think there's a little bit there for Airbus. I think again you know our customers, and we're pretty much locked in this year for what we have..

[Operator Instructions]. Our next question comes from Christian Herbosa from NOBLE Capital Markets..

I have a couple of questions. So this one's a follow-up to some of the earlier questions.

But so where are you seeing the most potential for market share gain at Airbus in terms of titanium or composites or aluminum?.

Well, I think for us, it's largely in the titanium area, I mean, because that's a very specialized science and technology. And we've been in talks with Airbus about gaining more share from both things they may be doing internally as well as other suppliers. So I would say that's probably the single biggest opportunity when we think about share gains.

And to Steve's comments, not as much on the aluminum side of what we do. And you'll hear more about composites and VersaCore as we move forward. That's really an exciting new area for us that we talked about a few calls ago.

We had a great contract to participate on a high-volume sell program, and we've got a lot of good things working there as we bring that to market in 2020..

All right.

So on VersaCore, are you seeing other opportunities outside of the missile contract coming up? And maybe can you provide us any metrics to give us an idea of the size of the addressable market for VersaCore?.

We're not there yet..

Yes. The size of the addressable market is hundreds and hundreds of millions, if not billions. And I think, for us, we're really targeting, as talked about in our Investor Day with our TRL6 certification from Airbus opportunities, specifically with them on a number of different flight control surfaces, but we're still in early innings on that..

It's early, it's early. We'll be following up..

And our next question comes from Aman Gulani from B. Riley FBR..

So you mentioned you should be realizing another 50% to 60% in cost savings from restructuring initiatives.

How quickly will that be realized in 2019?.

Well, it'll be a ramp. It won't be a January 1. It's going to be phase in over the first half of the year and bleed into the second half. A lot of those initiatives are still being worked through, whether it's plant consolidation and other things that we did in terms of taking out capacity. So it's going to spread across the year..

Got it. And you mentioned on previous calls that you're looking to grow your missile business with Lockheed.

How should we think about that going into fiscal '19? Are you on track to secure some missile programs with them while also growing your existing opportunity with Raytheon?.

Well, I think it is a work in progress. I mean we do have dedicated resource now within the organization looking at Lockheed. But these are pretty long sales cycles with these programs, so it's something that we're continuing to work on but it's not....

Not yet, no..

Not yet..

We have a follow-up question from Edward Marshall with Sidoti & Company..

Guys, I just wanted a quick follow-up on the Viasat.

Where they a customer of LDS? And did LDS have anything to do with maybe cementing that award?.

It's good question, Ed. No, they were not, and they were not involved..

And there appears to be no further questions in queue. I would now like to turn the call over to Steve Oswald, Chairman, President and CEO for further remarks..

Okay, let me just wrap it up here. Again, I want to thank everybody for calling in today. We're certainly pleased with the results and where we are. We're certainly looking forward to 2019 and what that can bring for us and for our investors and for shareholders.

So again, I just wanted to settle all my thanks for your support as we go through the last two years together, and look forward again to 2019. So all the best to you, and I'll leave it there. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day..

Thank you..

Thank you..