Ducommun Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 8, 2024

There are 7 speakers on the call.

Operator

Good day, everyone, and thank you for standing by. Welcome to the Second Quarter 2020 4 Ducommun Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

Operator

Now I will pass the call over to Ducommun's Senior Vice President and Chief Financial Officer, Suman Mokherjee. Please go ahead.

Speaker 1

Thank you, and welcome to Ducommun's 2024 Second 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 and 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.

Speaker 1

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 amongst others, the cyclicality of our end use markets, the level of U. S. Government defense spending, our customers may experience delays in the launch and certification of new products, 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 or high interest rates, the ability to attract and retain key personnel and avoid labor disruptions, the ability to adequately protect and enforce intellectual property rights, pandemics, disasters, natural or otherwise, and risk of cybersecurity attacks.

Speaker 1

Please refer to our annual report on Form 10 ks, quarterly reports on Form 10 Q and other reports filed from time to time with the SEC, as well as the press release issued today for a detailed discussion of the risks. 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.

Speaker 1

We filed our Q2 2024 Quarterly Report on Form 10 Q with the SEC today. I would now like to turn the call over to Steve Oswald for a review of the operating results.

Speaker 2

Steve? Okay. Thank you, Samad. Thanks everyone for joining us today for our Q2 conference call. Today and as usual, I'll give an update on the current situation at the company afterwards Saman will review our financials in detail.

Speaker 2

Let me first start off this quarterly call with Ducommun's Vision 2027 game plan for investors. Strategy and vision were developed coming out of the COVID pandemic over the summer and fall of 2022, unanimously approved by the common board in November of 2022 and then presented to investors the following month in New York where

Speaker 1

we got excellent

Speaker 2

feedback. Since that time, the Commons Management has been executing the Vision 2027 strategy by consolidating its facility or rooftop footprint, increasing the revenue percentage of engineered products and aftermarket content, continuing its targeted acquisition program, executing our offloading strategy with defense primes in high growth segments of the defense budget and by expanding content on key commercial aerospace platforms. All of us here have a high level of conviction in the Vision 2027 strategy and financial goals and believe the many catalysts ahead present a unique value creation opportunity for shareholders. The Q2 2024 results were also a very good example of our strategy working. Q2 was a record revenue and gross margin quarter follows up the strong start we experienced in the Q1.

Speaker 2

Revenues were 197,000,000 dollars growing 5.2% over the prior year and this is our 4th consecutive quarter with revenues exceeding 190,000,000 dollars Strong growth in our commercial aircraft business across Boeing, Airbus and Business Jet helped drive revenue during the quarter. We saw significant growth on the A220 program where we make the skins for the entire fuselage along with good growth in twin IO platforms as well. Business Jet revenues were higher driven by work we do for Gulfstream. We also saw an increase in our commercial revenue as we build buffer stock to support the Monrovia facility closure and transfer to DCO's Guaymas, Mexico operation. Q2 was also supported by us building a higher production rate that SPR and BA to allow for efficiencies, workforce retention and level loading of our production.

Speaker 2

Overall, commercial aerospace was up 13% from Q2 2023. We have now grown year over year revenue in our commercial aerospace business for 12 consecutive quarters, demonstrating resilience of our business even in a challenging OEM environment with SPR and BA. The other good news for DCO's commercial aerospace business is the fuselage skin project for the 737 MAX at Spirit, which we have been working on. We now anticipate having the FAI approved in September and shipping the first production set in October. 2025 revenue for the 4 skins should be over $3,500,000 at 15 shipsets a month.

Speaker 2

Keep in mind, this is less than 10% of the fuselage. So stay tuned for more news as we move forward and gain more program share. Our defense business grew 3% year over year with strong demand for the F-fifteen, Black Hawk and radar platform as well as selective naval submarine programs. Growth was partially offset by declines in programs such as the JSF, F-eighteen, which we have discussed in the past, and the F-sixteen. A pause in the TOW missile production contributed as well, but we now have a new PO from RTX and anticipate starting shipments again in July 2025 from Guaymas, Mexico.

Speaker 2

Defense business was $100,000,000 in revenue for the 3rd time in the last four quarters and we remain optimistic about the growth ahead. On offloading from RTX, our SPY6 radar circuit card business grew over 100% from Q3 last year, tracking now for over $10,000,000 in revenue in 2024 for just one CCA. We have the next card for the SPY6 program in process and that will be in production next year. Another record highlight in Q2 was gross margin of 26% for the quarter, up 460 bps year over year from 21.4 percent and 140 bps compared to the Q1 as we continue to realize benefits from our strategic value pricing initiatives, productivity improvements, favorable product mix, growing engineered product portfolio with aftermarket and initial restructuring savings. In addition, our Berryville Arkansas facility is now down to less than 10 people to maintain capability on a single platform to receiving until the receiving plan is certified.

Speaker 2

Our Monrovia, California facility also significantly reduced headcount this month with most production activities shut down and the team is down to less than 20 employees. Monrovia plant will be fully closed by the end of September. We will see the cost savings of these moves as the receiving plants ramp up production in 2025. So stay tuned. For adjusted operating income margins in Q2, the team delivered 10.1%, a record performance and well ahead of the 8.1% number in Q2 2023.

Speaker 2

This is a great result driven again by the continued growth in our engineered product businesses, favorable product mix, impact of our strategic pricing initiatives and our restructuring savings beginning to kick in during the quarter. Adjusted EBITDA was another great story in Q2, hitting $30,000,000 for the first time, a big deal, while expanding a robust 130 basis points to 15.2% of revenue compared to 13.9% in Q2 2023. This all provides momentum along with the Q1 results as we work towards the 18% goal in our Vision 2027 plan. The GAAP diluted EPS was $0.52 a share in Q2 2024 versus $0.17 a share for Q2 2023 and with adjustments diluted EPS was an impressive $0.83 a share compared to diluted EPS of $0.54 in the prior year quarter. The higher GAAP and adjusted diluted EPS was driven by improved operating income as well as lower interest costs due to our hedging strategy during the 4th.

Speaker 2

The company's consolidated backlog increased both sequentially and compared to the prior year quarter. Total company backlog ended Q2 at a new record of 1,068,000,000 increasing over $22,000,000 sequentially and almost $58,000,000 year over year. Defense backlog increased $98,000,000 compared to the prior year quarter to the end of at a record of $592,000,000 The commercial aerospace backlog decreased $14,000,000 year over year, primarily due to industry issues with single aisle production rates and the MAX issues with Boeing and Spirit. However, our commercial aerospace backlog still grew on a sequential quarterly basis to $451,000,000 As for the 2024 revenue guidance, despite continued uncertainty surrounding Boeing, Spirit and the FAA on the MAX, we are maintaining our guide of mid single digits for the year with Q3 flattish to last year followed by an uptick again in Q4. While we have seen a significant slowdown in the MAX build rates at the OEM level in Q2 and anticipate the same in Q3, we are positioned for the recovery as the bill rates ramp back up.

Speaker 2

If BA is at 38 by year end for their most recent communications on the MAX, this will be a major lift for DCO. I will also add that despite the challenges in the MAX, we are comforted by continued strength on other programs at BA and Spirit, Airbus and Gulfstream. Now let me provide some color on our markets, products and programs. Beginning with our military and space sector, we experienced revenues at 101,000,000 dollars compared to $97,000,000 in Q2 2023. Growth was driven by the F-fifteen program along with military rotary aircraft, notably the Black Hawk program as well as our radar franchise, again driven by the SPY-six program.

Speaker 2

These are partially offset by weakness in F-thirty five, F-eighteen and F-sixteen revenues. The 2nd quarter military and space revenue represented 51 percent of the common revenue in the period, down from 59% back in 202270% in 2021. We expect these trends we expected these trends and reflect more and it reflects more balance with commercial aerospace, which we like. We also ended the Q2 with a backlog of $592,000,000 an increase of $98,000,000 year over year, representing 55% of the common total backlog. In our commercial aerospace operations, 2nd quarter revenue continued to see double digit growth, increasing 13% year over year to $87,000,000 driven mainly by growth on the A220 platform, twin aisle aircrafts, business jets, as well as buffer build support the closure of our Monrovia facility.

Speaker 2

As mentioned earlier, we believe a much better story is ahead for BA and MAX by the end of Q4 and in 2025. The backlog within our commercial aerospace business was $451,000,000 at the end of the second quarter, increasing almost $9,000,000 sequentially and a solid number given the temporary weakness in the commercial aerospace market. Now with that, I'll have Sumant review our financial results in detail. Sumant?

Speaker 1

Thank you, Steve. As a reminder, please see the company's Q2 10Q and Q2 earnings release for a further description of information mentioned in today's call. As Steve discussed, our 2nd quarter results reflected another period of strong performance with growth in both our commercial aerospace and military end markets as well as continued improvement in our margins. We remain encouraged by the continued strength in domestic and global travel, which would support higher long term demand for aircraft as we work through some of the industry issues impacting single aisle production rates. In addition, we also made good progress on our facility consolidation efforts during the quarter, which will drive savings in 2025 beyond.

Speaker 1

With all this, we feel like 2024 is showing good momentum that will continue to drive our performance towards our Vision 2027 goals. Now turning to our 2nd quarter results. Revenue for the Q2 of 2024 was $197,000,000 versus $187,300,000 for the Q2 of 2023. The year over year increase of 5.2% reflects growth in both commercial aerospace and military and space, highlighted by $9,900,000 of growth across our commercial aerospace platforms and $3,200,000 of growth in our military and space platforms. We posted total gross profit of $51,200,000 or 26 percent of revenue for the quarter versus $40,100,000 21.4 percent of revenue in the prior year period.

Speaker 1

We continue to provide adjusted gross margins as we have certain non GAAP cost of sales items in the current and prior period relating to inventory step up amortization on our recent acquisitions, restructuring charges and the impact from the Guaymas fire on our operations. On an adjusted basis, our gross margins were 26.6 percent in Q2 2024 versus 23.1% in Q2 2023. The improvement in gross margin was driven by our growing engineered products portfolio as well as favorable product mix in our manufacturing services businesses, strategic pricing initiatives, productivity improvements and some initial restructuring savings. We continue to make progress working through a difficult operating environment with supply chain and labor. Through our proactive efforts, including strategic buys on our inventory investments, we have been able to avoid any significant impact thus far on our business.

Speaker 1

During the Q2 of 2024, we reduced our inventory by $7,100,000 from Q1, while still keeping our performance centers positioned to meet our 2024 delivery commitments and ready for a ramp up in commercial aerospace build rates. We grew our contract assets by $13,000,000 versus Q1. This was partly due to buffer build of product to support the Monrovia facility closure as well as some modest build ahead in our commercial aerospace structures business to level load production. We continue to look for opportunities to unwind our working capital investments to improve our cash flow. Ducommun reported operating income for the Q2 of $13,900,000 or 7.1 percent of revenue compared to $5,000,000 or 2.7 percent of revenue in the prior year period.

Speaker 1

Adjusted operating income was 19,900,000 10.1 percent of revenue this quarter compared to $15,200,000 or 8.1 percent of revenue in the comparable period last year. The company reported net income for the Q2 of 2024 of $7,700,000 or $0.52 per diluted share compared to net income of $2,400,000 or $0.17 per diluted share a year ago. On an adjusted basis, the company's reported net income of $12,500,000 or $0.83 per diluted share compared to net income of $7,300,000 or $0.54 in Q2 2023. The higher net income and adjusted net income during the quarter were driven by higher operating income and adjusted operating income. Additionally, our interest rate hedge helped reduce our year over year interest expense.

Speaker 1

Now let me turn to our segment results. Our Structural Systems segment posted revenue of $95,600,000 in the Q2 of 2024 versus $80,200,000 last year. The year over year increase reflected $10,400,000 of higher sales across our commercial aerospace applications, including the A220 and select twin aisle platforms, in addition to regional business jets and buffer build to support the Monrovia facility closure. In addition, we maintained commercial aerospace build rates for selected products to help level load production and maintain production efficiencies. The $5,000,000 of higher revenue within the military and space markets was driven by strength in Black Hawk and other military programs.

Speaker 1

Structural Systems operating income for the quarter was $10,600,000 or 11% of revenue compared to 5,400,000 or 6.7 percent of revenue for the prior year quarter. Excluding restructuring charges and other adjustments in both years, the segment operating margin was 15.4% in Q2 2024 versus 16% in Q2 2023. The slight decline was from higher costs due to the transition of production from Monrovia to Guaymas, partially offset by strategic pricing initiatives and operating leverage from higher revenues at other performance centers within the segment. Our Electronic Systems segment posted revenue of $101,400,000 in the Q2 of 2024 versus $107,100,000 in the prior year period. The decline is attributable to lower revenues from in flight entertainment to electronics, F-eighteen and F-thirty five platforms, along with the reduction in our industrial business as we chose to selectively prune non core business.

Speaker 1

The declines were partially offset by strength on select military platforms, including the F-fifteen, SPY-six radar and naval and submarine programs along with business jets with Gulfstream and on the A220 platform with Airbus. Electronic Systems operating income for the Q2 was $16,800,000 or 16.6 percent of revenue versus $9,500,000 or 8.9 percent of revenue in the prior year period. Excluding restructuring charges and other adjustments in both years, the segment operating margin was 16.9% in Q2 2024 versus 11.4% in Q2 2023. The year over year increase was primarily due to shifting mix with higher growth in revenues and profitability in our engineered product businesses along with strategic value pricing initiatives as well as savings from the restructuring program. Restructuring savings were driven by the transition of product lines from our variable performance center to other facilities.

Speaker 1

Next, I would like to provide an update on our ongoing restructuring program. As a reminder and as discussed previously, we commenced a restructuring initiative back in 2022. These actions are being taken to better position the company for stronger performance in the short and long term. This includes the shutdown of our facilities in Monrovia, California and Berryville, Arkansas and the transfer of that work to our low cost operation in Guaymas, Mexico and to other existing performance centers in the United States. We continue to make progress on these transitions with excellent employee retention and engagement and are also working diligently with our customers Boeing and RTX to obtain the requisite approval.

Speaker 1

During Q2 2024, we recorded $2,100,000 in restructuring charges. The majority of these charges were severance and related benefits as we continue to wind down the 2 operations. We expect to incur an additional $3,000,000 to $4,000,000 in restructuring expenses through the end of 2024 and early 2025 as we complete the program. Upon the completion of our restructuring program, we expect to generate $11,000,000 to $13,000,000 in annual savings from our actions and are already beginning to see some realization of savings from these actions this year. We anticipate selling the land and building at both Monrovia, California and Berryville, Arkansas.

Speaker 1

Turning next to liquidity and capital resources. Year to date Q2 2024, we generated $1,800,000 in cash flow from operating activities, which was an improvement compared to year to date Q2 2023, which had a usage of $9,700,000 The improvement was due to higher net income of $7,000,000 as well as improvements compared to prior year in accrued and other liabilities. As of the end of the Q2, we had available liquidity of $205,400,000 comprising of the unutilized portion of our revolver and cash on hand. Our existing credit facility was put in place in July 2022 at an opportune time in the credit markets, allowing us to reduce our spread, increase the size of our revolver and allowing us the flexibility to execute on our acquisition strategy. Interest expense was $4,000,000 compared to $5,700,000 in Q2 of 2023.

Speaker 1

The year over year improvement in interest costs despite a higher debt balance was due to the interest rate hedge going into effect. In November 2021, we put in place an interest rate hedge that went into effect for a 7 year period starting January 2024 and pegs the 1 month term so far at 170 basis points for $150,000,000 of our debt. The hedge resulted in interest savings of $1,400,000 in Q2 2024 and will continue to drive significant interest cost savings in 2024 and beyond. To conclude the financial review for Q2 2020 4, I would like to say that the 2nd quarter results continued our momentum from Q1 and positions us well for the rest of 2024. I'll now turn it back over to Steve for his closing remarks.

Speaker 1

Steve?

Speaker 2

Okay. Thanks, Shimon. And just in closing, Q2 was vision 2027, especially around margin expansion. For the Vision 2027, especially around margin expansion. Our first half position us well to deliver strong performance in 2022 despite some of the current constraints.

Speaker 2

The progress on gross and EBITDA margin expansion has been excellent. We're not surprised and feel right on schedule. In addition, on 2 key tenets of our 2027 game plan, we're tracking well against the goals of 18% EBITDA margins and 25% or more of engineered product and aftermarket revenues. With commercial aerospace build ramps still ahead of us and the benefits from our facility consolidation expected to kick in starting in 2025, I'm excited about what lies ahead for us at Ducommun and our shareholders in the years ahead. Stay tuned.

Speaker 2

Okay. With that, let's please go to questions.

Operator

Thank you. One moment for our first question. And it comes from the line of Jason Gerske with Citi. Please proceed.

Speaker 3

Yes. Hello there, everybody. Thanks for taking the question. Steve, maybe we start with you and talk a little bit about the pipeline of new opportunities and maybe just kind of give us a flavor of how things have evolved year to date, starting at the beginning of the year, where you are today and what you see in the pipeline. I'm just curious if anything kind of new and interesting has popped up for you here over the last 6, 7 months?

Speaker 3

And when you look out over the next couple of years, what you think the pipeline conversion might look like and book to bills on just kind of the general demand flavor as well? Thanks. Sure.

Speaker 2

Okay. Thank you. Good to be with you. So first, let me just tackle commercial aerospace. I talked about the skins and that's though not a huge number starting next year about $3,000,000 or $4,000,000 I mean we're only doing less than 10% of the fuselage for the MAX.

Speaker 2

We do 100% of fuselage for the A220. So we can do it, right? We have the capacity, we have the machine. So that's something in the pipeline. We're very, very excited about.

Speaker 2

We're also and just can't disclose it today. We're also working on opportunities more on the commercial aerospace side and specifically around share shift from some of our competitors and won't get into it today, but we have some nice things happening there. We're going to pick up, I can disclose this, we're going to pick up also on the 787 a good amount of business starting in January 2025. And the 787 gets to 5 or 10 that's real money for DCO. So on that side it's good.

Speaker 2

We just met with Airbus at the air show. We're in a very good position with Airbus. They're going on the way up and we're going to go on the way up with them. So I think on the commercial side, it's all looking very positive and there'll be more news coming. On the defense side, we certainly work on sort of the hypersonic and the other sort of things that we probably can't discuss on the call too much, but I'll just give you one example.

Speaker 2

This offloading program has been great for us. We're really getting heavy into radar. We make one card so far on the S3Y6 and year to date it's been over $5,000,000 for one card. So we're going to bring on another card next year. So we've got some very nice things happening at the fence not only organically but obviously with share shift as well.

Speaker 2

And we just met with Raytheon at the air show and had a great meeting and the Tomahawks are going to go to Glimus, which is going to be a great boost for us from where we are now in Berryville. That's a major program. We've had that since the 80s. Right now, obviously, we built all the buffer to move it. So, but we have some wonderful margin expansion happening there as well as we go to Guaymas and the TOW.

Speaker 2

So the TOW is also coming back. We talked about that already in my remarks coming back mid year. We have already have the PO for that in Guaymas. So both on the commercial and defense side looking good to very good. And then also obviously the build rates, which I think are going to go up eventually, that's going to be some nice tailwind as well.

Speaker 3

Okay, great. And then just a quick follow-up. Saman, you mentioned maybe some additional liquidity or capacity, and I think you mentioned M and A on the same sentence. So I'm just kind of curious to get an update just on the pipeline of potential M and A and have you further opened the aperture on potentially doing something larger where we'd be bringing in more revenue than what you had targeted for Vision 2027?

Speaker 1

So we continue to look at a number of opportunities. I would say that in terms of us being able to meet and exceed the target we set forth in Vision 2027, which is a $75,000,000 placeholder for revenue from acquisitions. We feel very good about being able to meet and exceed that. So I would agree. Are we looking to do something bigger than or something more transformational at this time?

Speaker 1

No, we're looking to continue our strategy of doing these tuck in acquisitions of niche product lines in kind of a more manageable size range and be prudent with our leverage at this time. So we aren't looking to change the aperture on size of deals. But we feel good about being able to exceed the Vision 2027 target for acquisition revenue.

Speaker 3

Okay, great. I'll pass the line. Thanks.

Speaker 2

Thank you, Jason.

Operator

Thank you. Our next question comes from the line of Mike Crawford with B. Riley Securities.

Speaker 4

Thank you. So Suman, you benefited from absorption as you built some buffered stock now. Can you just walk us through how margins are affected by the ramp up at Guaymas? And as you work through this buffer that you've built out and get into a more normalized cadence?

Speaker 1

Right. So, great question, Mike. And we did have a significant improvement in our Structures segment margins on a sequential quarter basis. And to the point you just made, it was driven to a large extent by Monrovia having better absorptions. Actually, Mondrovia had significantly lower revenues in Q1 versus Q4 of last year and Q1 of last of 2023.

Speaker 1

So we saw a very low revenue base kind of trying to handle higher fixed cost base in Q1, which led to and higher one time costs related to the transition in Monrovia in Q1. We had lower costs. We had double the revenue in Monrovia as we built up buffer stock and look to close out operations. We had doubled the revenue in Q2 Monrovia facility. That helped with absorption again to the point you made, right.

Speaker 1

And we also had some slightly better mix. So we feel like the improvement that we're seeing in that structure segment margin in Q2, which is in line with where structures margins have been historically is sustainable, if that's kind of where you're getting to.

Speaker 4

Okay. Thank you. And just, excuse me, related, you're getting near the end of this, I guess, 2nd restructuring program since you guys joined the company and put it on its current trajectory. But I know there's $11,000,000 to $13,000,000 cost savings target, but I imagine a chunk of that has already been realized.

Speaker 1

That is correct. So I would say that from our Berryville and Joplin facility, we are right now tracking at a run rate of, I would say, dollars 2,000,000 to $3,000,000 of savings annually. So an annual run rate of $2,000,000 to $3,000,000 I would say is where we are right now from the shutdown of Berryville. Of course, that will ramp up later in 2025 when we actually start production of some of those product lines in Guaymas, Mexico. So that hasn't started yet.

Speaker 2

Yes, I wouldn't say a good chunk, Mike. I would say it's I think 2 to 3 is fair. Okay. There's a lot more coming.

Speaker 4

Okay, great. Thank you very much.

Speaker 2

Thanks, Mike.

Operator

Thank you. Our next question is from Michael Ciarmoli with Truist Securities.

Speaker 5

Hey, good afternoon guys. Thanks for taking the questions. Good results. Hey, Steve or Sumant, the buffer stock, I think coupling that with maybe I think you said you're building ahead right now. How should we sort of calibrate ourselves just on the revenue?

Speaker 5

I think you said 3Q would be down a little bit, but do we have to go through an unwind period here as we look out over the second half of the year even into early 2025 just depends I mean, I don't think we have a crystal ball with Boeing's rates or Airbus is for sure, but how should we think about maybe the impact of the build ahead and buffer on revenues?

Speaker 1

Yes. Hi, Mike. Great question. So we during Q2, we had about, I would say, between the buffer build and the build ahead, somewhere between $5,000,000 to $6,000,000 in revenue that you could say was pulled ahead from Q3 and Q4. And so that's kind of how I would think about how Q3 comes out in line with what Steve said a little earlier, Q3 being flattish on a year over year basis and then seeing improvement in Q4.

Speaker 1

So that's kind of all in all, we come out at that mid single digit guidance for the full year. Yes.

Speaker 2

Mike, I think that's the right way to think about it. I think overall it's light. The impact is light.

Speaker 1

Okay.

Speaker 2

So it's not anything I'm very concerned about. But just everyone on the call, I mean, we're a little Parsons is a big manufacturer for both Spirit and for BA and we just don't want to have to lay off 40 people and then 4 months later hire them again.

Speaker 5

Right, right. Yes, of course.

Speaker 2

There's a little as I said, there's some retention, employee retention in there that I think investors I think hopefully will agree it's smart.

Speaker 5

Got it. And then just on the aerospace, I mean, I know we can kind of see it in our models. You've got the slide out there, highest quarterly revenue rate since 3Q 2019. Is there any way to measure that on a same store sales basis? I mean, you've obviously had some acquisitions in there.

Speaker 5

You've picked up some new programs like the A220. But just knowing that MAX had been one of the biggest programs, just trying to get a sense as to if I were looking at that same store sales versus that 3Q, how much runway do you still have? Because I mean we're still well below prior peak production rates here?

Speaker 2

Yes. I think we have a lot. I think when you go back that long, I mean, if you think about us now, it's a lot more defense business than we had back then. So that's one thing to think about. And also and which is extremely important, we have a good deal more engineered product and aftermarket.

Speaker 2

So that could also fall into commercial, right, Mike? Yes.

Speaker 1

Okay.

Speaker 2

Much more we're certainly different back then. And so you're right that we have the I think the right kind of base and then we have good balance and I think that we're very anxious. I know it's Kelly's first day. So we're going to cheer for him And we certainly feel like things are going to get better. We're going to ride the ramp up.

Speaker 2

And I think that's going to be great for our revenue.

Speaker 5

Got it.

Speaker 1

Got it. One thing I'll add there, Mike, as you help as you think about modeling our commercial aerospace revenues relative to where we were in 2019, A little over half of our revenues come from our commercial aerospace revenues come specifically from Boeing and Airbus platforms. So you couldn't apply build rates directly to our entire commercial aerospace revenues. There are other elements including business jets, commercial helicopters, and other in flight entertainment stuff and things that we do. So if you were looking really at build rates across Boeing and Airbus platforms, a little more than half is from yes.

Speaker 5

Got it. Yes. Okay.

Speaker 1

Of course, that will grow higher. But right now, it's that much.

Speaker 5

Okay. And then just the last one. Any thoughts, Suman, on free cash generation? I know you kind of mentioned that inventory being down sequentially, but just I know you've got the guidance out there on the top line. Talked a little bit about the margins and where we should be, but how should we think about cash generation second half of the year here and into 2025?

Speaker 1

Yes. That's an important focus area for us, Mike, as a company. And Q2, as you noted, was impacted by buildup in contract assets as we did some of these buffer builds. We did some amount of build ahead on commercial aerospace platforms. We do expect that Q4 will be really strong for us in terms of cash flow to end out the year on a much more positive note and that is a priority for us.

Speaker 1

I mean, I would expect Q3 to be marginally better, but not significantly, but with a real ramp up in cash flow towards the end of the year.

Speaker 5

Okay. Perfect.

Speaker 1

I'll jump back in the queue.

Speaker 5

Okay. Perfect.

Speaker 1

I'll jump back in the queue.

Speaker 2

Okay. Mike, thanks.

Operator

Thank you. Our next question is from the line of Noah Poponak with Goldman Sachs.

Speaker 6

Hey, good afternoon.

Speaker 2

Yes, Noah.

Speaker 6

Jiman, maybe just picking up there, how should we think about where free cash to net income conversion or EBITDA conversion go over the medium term if you kind of think about more normal times where you're not having to build ahead and you don't have so much uncertainty at the customers and things are kind of coming along a little bit more visibly?

Speaker 1

Yes. Excellent question. Thanks, Noah. In the longer run, we do want to get our free cash flow closer to the net income number. We're not going to get there here in the next few quarters or next year as we continue to have significant amount of inventory and contract assets in the balance sheet and supply chain pressures while they have eased are still significant.

Speaker 1

We continue to have close to 2 years of lead time on inventory. We have fluctuations in build rates, which often means we are stuck with raw material inventory we have ordered 2 years in advance sitting on our balance sheet. So as those supply chain pressures ease, there is more predictability in production rates. We will be able to continue to wind down our strategic inventory that we have been holding for the past few years. And it will get us over the next couple of years in closer to that target of getting our free cash flow in line with our net income.

Speaker 2

Yes. And Noah, this is Steve. I also think that some of the restructuring is going to help. I mean, there's other things, bigger rocks of the market and troubled companies and strategic buying and everything, but it also is going to help us on the manufacturing services side to have a shorter a smaller footprint and I think better management of our inventory and our processes.

Speaker 6

Okay. That's helpful. Appreciate that. On the margins, the segment margins, I guess, would it be possible to just speak to how you expect each segment's margin in the second half to kind of directionally compare to the first half? Just electronic systems has had this pretty sizable increase year over year.

Speaker 6

Structurally, you talked about the difference between 1Q and 2Q, but that's a pretty big difference. How do each of those shape up second half or first half?

Speaker 1

Yes. So I'll take that. So we don't give guidance at the segment level for margins. I can give you some comments which are kind of directionally help you. So if you look at the our Electronics margins, they have jumped in Q1 of this year and they've kind of stayed in the ballpark here in Q2 and that was driven by a shift in the mix within our Electronic Systems portfolio towards more engineered product revenue and growth in the profitability as well as those engineered product revenues on a year over year basis.

Speaker 1

That was a significant driver for the Electronics segment margins. And we I would say, would expect margins to stay in the ballpark of where you're seeing them here in Q2 for the rest of the year, right? There is always a range of, I would say, 50 to 75 basis points within which they may fluctuate based on product mix in a particular quarter, but they're in that ballpark. On the structure side, you saw margins this quarter get back to historical levels. We had an unusual situation with Monrovia, which had unusually low revenue and other one time costs as we were shutting down the facility in Q1, which subdued the overall structure segment margins.

Speaker 1

That got back to normal here in Q2, helped the Structures business improve. We also had some better mix in there, which helped in Q2 get the structures margins up. Now with Monrovia costs being further cut down in Q3 and as Steve mentioned, we have less than 20 people now in that facility, we do believe that we will have similar levels of structures margins for the second half. And of course, margins will continue to improve in 2025 as the restructuring savings start to kick in and other initiatives take hold. So lots of trajectory margins improved.

Speaker 1

2nd half, I would say margins are expected to stay in the same ballpark. Q2 margins, I would say, probably have about 75 basis points of favorable mix in them, just overall at the DCO level. And but that's typical for us and we expect to stay in that right now.

Speaker 2

We are on hold serve for the most part.

Speaker 6

Okay. Super helpful. Last one I had was, just your defense revenue had a bit of a, I guess, transition with F-eighteen and the timing of missile, I think, was how you described it. And it looks like maybe you've now lapped the former and then have had some orders on the latter. Should we expect your defense revenues to kind of be stable going forward here or can the growth rate accelerate?

Speaker 1

We're probably flattish here in the rest of 2024 as we continue to face tough compares on the F-twenty 18, in particular, as well as the TOW missile program. But with TOW coming back in 2025 as well as other programs such as the SPY-six ramping up in 2025, we should have better times than defense starting next year. Yes.

Speaker 2

It was better next year, for sure.

Speaker 6

Okay. Super helpful. Thank you.

Speaker 2

Thanks Noah. Thanks for calling in. Thank you.

Operator

Thank you. And there appears to be no further questions. I will turn the call back to Stephen Oswald for closing remarks.

Speaker 2

Okay. Thank you very much and just wanted to thank everyone for joining us. Obviously, we're very enthusiastic about our numbers, about our performance as we close the Q2. We feel great about where we are and we look forward to continuing to build a performance story as we move to our vision 2027 financial goals. So again, we appreciate all the support and wish you a good day.

Speaker 2

Thank you.

Operator

And thank you all for participating in today's conference. You may now disconnect.

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Earnings Conference Call
Ducommun Q2 2024
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