Chris Witty - IR Stephen Oswald - Chairman, President & CEO Douglas Groves - VP, CFO & Treasurer

Edward Marshall - Sidoti & Company Michael Crawford - B. Riley FBR, Inc.

Benjamin Klieve - NOBLE Capital Markets

Thank you, and welcome to Ducommun's 2018 Second 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 for the question-and-answer -- 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, or restructuring plans and financial projections, are forward-looking statements under the Federal Private Securities Litigation Reform Act of 1995 and, therefore, our perspective.

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 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 the call are only as of the time made, and we do not intend to update our -- 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 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 non-GAAP measures referenced on this call to the most similar GAAP measures. I would now like to turn the call over to Mr.

Steve Oswald for a review of the operating results. Steve?

Thanks, Chris, and thank you, everyone for joining us today for our 2018 Second 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.

Q2 performance is certainly a very good step forward for the company. The significant progress clearly shows the impact from many initiatives put in place since my arrival in January 2017 to enhance top line growth, expand margins and generally produce more consistent, positive financial results.

Revenue for the quarter rose nearly 10% year-over-year to $154.8 million as we benefited from strong demand across nearly every aspect of our business. It's great to see the benefits of our efforts as growth on key platforms and recent wins drive top line performance.

In addition, the strong focus on operational excellence, advanced technology and our two acquisitions are strengthening Ducommun's position as the unique provider of a broader array of electronic and structural applications for the aerospace and defense industry. Ducommun grew margins nicely this quarter and as expected.

The company's gross margin rose 210 basis points to 20.7% from 18.6% last year, reflecting higher volumes and improved mix. And our adjusted operating margin climbed 100 basis points to 5.7% from 4.7% in 2017.

Notably, and I'm pleased to tell you, our structure's adjusted operating margin, which has been a key focus for us since I arrived, rose sequentially 440 basis points, 10.2% this quarter from 5.8% in Q1 and 540 basis points from 4.8% in Q4. I'm sure you'll agree that the progress is very encouraging and was helped by favorable product mix and increased volume.

We also took another $5.4 million of restructuring charges this quarter, on top of the $11 million previously booked, in connection with our various streamlining initiatives that cut across all facets of our organization. We remain on track to eliminate roughly 16% of our forward space by year-end and reduce that by 6%, which will result in savings previously announced of about $14 million annual cost going forward.

We've already completed many of the efficiency improvements within our structures group, including excess capacity in California. And most of the remaining restructuring will target our electronic segment.

During the quarter, we announced the closure of our Phoenix,, Arizona plant, and we're moving that capability to our Huntsville, Arkansas facility by fiscal year-end. I also want to take this time to recognize our Phoenix team for their professionalism.

We ended the quarter, once again, with strong backlog of $823 million, leaving the company well positioned for growth and further performance improvement heading into 2019. In addition, we generated $15.9 million in cash from operations during the period, resulting in $26.2 million of cash flow year-to-date.

At the same time, our acquisitions of LDS and CTP are fully integrated, contributing financially and broadening Ducommun's technology portfolio. Regarding our acquisitions, I'd also want to emphasize to investors that Fortune 100 executive-level talent is leading this important process and driving acquisition decisions.

Overall, our team is keenly focused on taking the company to the next level in terms of operating excellence. I'm very positive about what we've had accomplished and where we stand on transformation of the company.

Now let me provide you some color on our end markets, products and programs. Beginning with our military and space sector, we've posted second quarter revenue of $70.3 million, up slightly from last year, reflecting higher shipments for the F-16 and F-18 programs as well as increased deliveries for certain missile and defense programs.

Please keep in mind that we are always -- also always reviewing and rationalizing poor-performing programs. We anticipate continued growth across our key platforms going forward and expect strong by-products and support for defense spending on Capitol Hill as budget priorities are formulated from fiscal 2019.

Our military and space backlog grew as well to roughly $323 million during the quarter, up modestly from Q1. Then our commercial aerospace operations, second quarter sales rose approximately 29% year-over-year to $71.8 million.

We once again saw significant growth across large, fixed-wing aircraft applications, driven by high build rates for the Boeing 737 platforms and Airbus A320 family. As I mentioned earlier, these increased levels of production, combined with our restructuring measures and better operational performance, are generating benefit shown in margin expansion, typically within our structures group.

We expect further operating leverage in the future as we continue our restructuring program, although quarter-over-quarter results can vary due to overall product mix. Backlog within commercial aerospace remains solid at $460 million, down slightly from Q1's record levels.

But we've seen a pickup in orders for the Gulfstream G500 and 600 and 650 platforms, which is a good indicator for production trends on this business going forward. Our structures business, particularly within commercial aerospace, is not only benefiting from the steps we've taken to increase asset utilization return on capital but also from our investments, as you know, in core technologies and processes.

For example, both our titanium operations, in Parsons, Kansas and Coxsackie, New York, are building strong capabilities and operation's efficiency for the future. This is important to point out as we are not only cost-cutting but also investing for stronger, long-term value for both Ducommun customers and shareholders.

In summary, I'm pleased the company is moving forward and it has developed a solid track record of results. With that, I'll now 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 press release for further description of this codification versus the prior policy, ASC 605. Revenue for the second quarter of 2018 was $154.8 million versus $140.9 million in the second quarter of 2017.

This performance primarily reflects $16.1 million of higher sales to the company's commercial aerospace customers due to increased shipments for large, fixed-wing platforms, such as the Boeing 737 and the Airbus A320, as Steve mentioned. Ducommun's backlog rose to $823 million at the end of the quarter, up slightly from $820 million in Q1.

And moving to gross profit. Our gross margin was 20.7% in the second quarter versus 18.6% in the prior year's comparable period.

This increase year-over-year was primarily due to higher manufacturing volumes and favorable product mix as noted. SG&A was $21.2 million for the second quarter versus $19.6 million in 2017, with the increase primarily reflecting higher compensation and benefit costs and an increase in professional service fees, which included about $300,000 of acquisition cost for CTP in the second quarter.

The company reported operating income for the second quarter of $5.6 million or 3.6% of revenue versus operating income of $6.6 million or 4.7% of revenue in the prior year period. On an adjusted basis, operating income for 2018 was $8.8 million versus 5 -- excuse me, was about 5.7% of sales, up 33% year-over-year.

Our Q2 restructuring activities included approximately $3.6 million of charges within our Structural Systems segment, $0.7 million within Electronic Systems and $1.1 million at the corporate level, which in aggregate equaled to $5.4 million. As mentioned previously, by year-end, we expect to be operating with about 16% less manufacturing square footage and 6% fewer staff as we work to eliminate approximately $14 million in annualized expenses by 2019.

Additional restructuring will take place during the rest of this year, and we expect to incur restructuring charges of about $5 million to $6 million in the second half of 2018, bringing the total program to $20 million to $22 million since we began in Q4 of '17. Interest expense was $3.8 million in the second quarter of 2018 versus $2.1 million last year, primarily due to higher utilization of our revolving credit facility for the acquisitions of LDS and CTP along with higher interest rates.

The company reported net income for the second quarter of $1.6 million or $0.14 per diluted share, compared to $3.8 million or $0.33 per diluted share for the second quarter of 2017. Adjusted net income was $4.2 million or $0.37 per diluted share in the current year second quarter.

And our tax rate was 13%. Our expected tax rate will be approximately 17% to 18% before any restructuring charges going forward.

Adjusted EBITDA for the second quarter of 2018 was $18.7 million or 12.1% of revenue compared to $13.7 million or 9.7% of revenue for the comparable period in 2017. Now let me turn to our segment results.

Our Electronic Systems segment posted revenue of $84.5 million in the second quarter of 2018 versus $81.8 million in the prior year period. These results reflect $5.4 million of higher sales to our commercial aerospace customers, offset by some slight declines in shipments within our industrial and military end markets.

Electronic Systems posted operating income for the second quarter of $8.7 million or 10.3% of revenue versus $8.9 million or 10.9% of revenue in the prior year period. Excluding restructuring charges, the impact of ASC 606, the electronics adjusted operating margin was 10.2% for the second quarter of 2018.

Our Structural Systems segment posted revenue of $70.3 million in the second quarter of 2018, versus $59.1 million last year. The year-over-year increase was due primarily to $10.7 million of higher sales across our commercial aerospace applications, particularly, on the large-jet, single-aisle platforms.

Structural Systems posted operating income for the quarter of $5 million or 7.1% of revenue compared to operating income of $2.1 million or 3.6% of revenue last year. Excluding restructuring charges, purchase accounting adjustments and the impact of ASC 606, structures adjusted operating margin was 10.2% for the 2018 second quarter.

As Steve discussed, while we're pleased with the improved performance that reflects our restructuring program as well as the increased build rates, margins can vary quarter-to-quarter due to product mix and platform timing. We continue to focus on producing consistently better margins across our entire business enterprise.

Corporate general and administrative expenses. CG&A expense for the second quarter was $8.1 million or 5.2% of total company revenue compared to $4.4 million or 3.1% of revenue last year.

The higher CG&A expense was primarily due to the $1.1 million restructured charge previously mentioned, increased compensation and benefits costs as well as higher professional service fees. Coming to liquidity and capital resources.

We generated $15.9 million of cash from operations in the second quarter of 2018 versus $3 million in 2017. We also paid down $9.3 million of debt during the quarter and expect to pay off $25 million to $30 million in debt for 2018, absent any additional acquisitions.

In terms of CapEx, we spent $4.2 million during the second quarter. And we still anticipate spending approximately $15 million to $17 million in 2018 to support new program wins.

Once again, I'd like to reiterate that we're pleased with our improving performance this year, which reflects the execution of a well-thought-out restructuring strategy and the implementation of streamlining initiatives across the company. Through careful planning and a passion to serve our customers, we're optimistic about continued higher returns in the quarters to come.

I'll now turn it back over to Steve for his closing remarks. Steve?

Okay, thanks, Doug. And before we go to questions, just a few final comments.

Basically, what we've accomplished since my coming on board in January of 2017, I'm happy to announce that Ducommun will host an Investor Day, it's our first in many years, on November 9 in New York. So November 9 in New York.

Invitations to analyst, institutional investors and other key stakeholders will be coming in near future. And we really look forward to showcasing, obviously, some of our achievements but, most important, our plans for the future.

So I just wanted to share that with you. And finally, looking forward to completing many initiatives, we've discussed, later this year and see -- seeing even more significant results in 2019.

The investors in the company, our people and customers think it's really paying off. And we're positioning Ducommun, I think, well for higher growth and a stronger future.

With that, operator, why don't we open the line for questions?

So I want to talk about the structures business for a second. And I want to [indiscernible] if I could, I think it's a little early to see the restructuring benefits.

I think you've been calling for the back half of '18 into '19 for the majority of that. Maybe we can look at [indiscernible]?

What's behind the improvement there in structures?

Yes, Ed. Certainly the people piece of the restructuring is reading through.

Some of the excess capacity that we've taken out will need a few more quarters to read through 100%. And as Steve mentioned, pricing is a part of the improvement in the business as we review programs that aren't meeting the [indiscernible] rates that we're expecting.

Those are getting exited out of the portfolio. So we've been fortunate with the increase in demand, on the single-aisle particularly, that any of those revenue -- share gains that we've -- we're giving back to customers, we're compensating for with the single-aisle volume increases.

So that's probably the two biggest pieces that help us see the margin. Then there was a product mix improvement as well in this quarter that we didn't have in the last quarter.

I'll take that, Doug. And one other -- obviously, Parsons now is pretty much finished with their work and getting things online as well.

As you know, we're just better. Okay?

We're better operationally. We're producing less scrap.

Well, we're doing lots of things, I think, that are benefiting the margin improvements. And so, I think I'm happy to report that we're not there fully yet, things are coming together.

I think, Doug, in your prepared remarks, you said that they can be lumpy and volatile quarter-to-quarter. Do you see this as the baseline for the business now?

I mean is it something that you're going to improve upon for the remainder of the year into next? Or how do you look at the structures businesses?

What's your vision for the structures businesses? You'll continue to build on this restructuring program and the other get-better-kind-of initiatives?

Sure. Well, clearly, we're very pleased with this quarter.

But we're still marching towards high single-digit exiting this year. We're 8.1% at the halfway mark here.

So that's certainly within our striking distance to -- for the full year, be at a high single-digit. But I don't think that the double-digit that we saw this quarter on an adjusted basis is the new baseline as you quoted.

That was just the benefactor of some of the things we've been working on along with some of the product mix.

Got it. I just want to be clear too on the corporate expense line.

Was there any adjustments or moves from the segment level down to the corporate level? I know the 3: kind of restructuring, compensation and professional service fees that you noted in that.

But with the increase in that business and then the increase in the individual segments, I wonder if there's any kind of adjustment on that line?

No, no, there were no reclassifications. The SG&A was a little higher than normal this quarter, but that's some acquisition-related costs in it as well as some other professional fees for some of the projects we're working on.

And restructuring at corporate. Yes, I mean, so it's all the same bucket, Ed.

So what was the professional service fees? Could you quantify that number for me?

Well, sure, well, there was about $300,000 related to the acquisition of CTP. And then we had some other professional service fees for some of the special projects that we're working on.

So we're not going to talk about what those projects are or how much we're spending on them, just -- other than they are important to our go-forward plans.

Got it. And did you quantify the benefit [indiscernible] and maybe profit line from CTP?

No, not anything further than what we said in the last quarter call, when we talked about CTP, which is -- it's a small business, about 4% of the revenues of our structures business, with a margin profile, that is about 3x better than the existing structures business, in that high single-digit area. So that's ...

And performing well.

Yes, it's doing well, because look only in the -- we only had a 2.5 months here, so more to come on that.

Good news.

Relative to your commercial fixed-wing business, there's been some reports that of 737 is kind of piling up in Washington. Has this been some maybe slow deliveries from some suppliers?

Is that affecting the growth rate that you're seeing with any of your customers?

I'll say no, we haven't seen that. We're still marching to the rates.

We haven't heard any communication from anyone as far as any issues or slowing down. So we're 110% running.

Okay, great. And then on your M&A pipeline.

So you've done a great job of acquiring these businesses with proprietary mix of products and higher margins. How would you characterize the pipeline the way you're looking at today?

Well, it's Steve again. I think it certainly it's good.

Obviously, had a lot of discipline around that. I mentioned earlier, we have some excellent people working this.

So it's good we have -- we're constantly, as you know, acquisitions opportunistic, right? So properties come on when they come on.

So -- but rest assured that we're looking at everything, we're scrubbing detail and just seeing where possibly down the road things can add some value.

All right, thanks and then final question, is: It looks like there was a particular jump in your Industrial backlog. So is that kind of a -- just a timing thing?

Or is that business actually improving?

No, it's just a timing thing. Those are generally pretty short order purchase orders we get in that part of the portfolio, so they -- it does jump around a little bit from a backlog perspective as well as even from a revenue perspective.

First question about that business development effort on the back of the two acquisitions. Have you been able to gain traction with your legacy customers such as you think revenue from the 2 acquired product lines you can grow faster than the overall growth rate of the company here in the back half of the year or in 2019?

Or is this still kind of too early to really -- you'll be able to quantify the traction of those efforts?

Yes, so there is some overlap in the customers, but part of our value proposition for these companies is to be able to get them into maybe some of the OEMs that they weren't in before. So we're actively working that, but I would say it's too early to say it's going to read through on the top line yet other than, for example, at our booth at the Farmborough Air Show a few weeks ago, we had nice representation from both CTP and our LDS business there at the air show with us.

So they are getting exposed to our customers as well.

And then there are a few questions I have regards to cash flow. First, you touched on CapEx expectations with $15 million to $17 million, I believe, you said for 2018.

At this point, do you think that's a reasonable level for 2019 or do you see that picking up at all next year?

No, it's probably staying within that range. I mean, that's been our historical average absent any big initiatives like we had over the last couple of years with the Parsons facility expansion, but it generally runs right in that range.

Obviously, if we can get some more big wins, we're going to certainly spend the capital to support those.

Right. Okay, perfect.

And then with regards to the cash [indiscernible] on restructuring activities. Given that the structures side is -- seems to be pretty much complete, do you expect that you'd have a cash impact from the structuring and the electronics side to be roughly the same?

Or do you think it will be less here in the second half of the year than you've seen so far?

Yes, I think it will be about the same, particularly with the exit of the Phoenix facility because there's a lease there that we're going to get out of, and then obviously, the employees that are impacted by it.

Okay, perfect. And then one last question from me, again, on cash flow here.

Given the ramp that you're looking at, especially in the commercial side, do you -- where do you see your working capital position today relative to where it will be over the next, say, 12 to 18 months? Do you think it's going to grow along with revenue growth?

Or do you think maybe it will grow a bit slower? Kind of how do you see working capital expansion here coming up?

Sure. well certainly, as we're moving facilities, there's a buildup of inventory, right, because we're always going to be sure we've got enough safety stock to protect our customers during the moves.

And as rates ramp, particularly in structures, we do, from time to time, have min-max requirements that we're going to have to keep up with. So the inventory probably increases a little bit, but we've got a lot of initiatives in place to try and manage that to a moderate level, so that our historical 23%, 24% of revenue working capital number stays intact.

Okay. Okay.

Again, let me just wrap it up. Certainly, as I mentioned in my opening remarks, certainly a step forward for the company.

I really like what I'm seeing throughout: all the activity, the intensity, the focus, all those things that you need to create value for the customer and for the shareholders. So I'm pleased where we are.

I just want to, again, thank our investors, analysts and everyone else for their continued support, and have a nice rest of the day and evening.