Ducommun Incorporated 2019 Q1 Form 10-Q Summary
Business context and reporting period
Ducommun provides engineering and manufacturing services for high-performance, high-cost-of-failure products, primarily for aerospace and defense, with additional industrial and medical applications. Operations are reported through Electronic Systems and Structural Systems. This unaudited Form 10-Q covers the three months ended March 30, 2019, compared with the three months ended March 31, 2018.
Financial performance and key metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net revenue | $172.6 million | $150.5 million | 14.7% increase |
| Gross profit | $35.7 million | $26.8 million | 33.4% increase |
| Gross margin | 20.7% | 17.8% | Up 290 basis points |
| Operating income | $12.8 million | $5.3 million | Increase |
| Operating margin | 7.4% | 3.5% | Up 390 basis points |
| Net income | $7.5 million | $2.6 million | Increase |
| Diluted EPS | $0.64 | $0.22 | Increase |
| Adjusted EBITDA | $21.7 million | $14.5 million | 49.7% increase |
| Adjusted EBITDA margin | 12.6% | 9.6% | Up 300 basis points |
Revenue growth was driven by $13.1 million of higher military and space revenue, primarily from missile platforms, and $11.9 million of higher commercial aerospace revenue from additional content and higher aircraft build rates. Industrial revenue declined by $2.9 million.
- Electronic Systems revenue increased 2.2% to $84.2 million; segment operating income increased to $9.2 million from $5.7 million.
- Structural Systems revenue increased 29.9% to $88.4 million; segment operating income increased to $10.5 million from $4.4 million.
- SG&A increased $3.5 million to $22.8 million, primarily due to higher compensation and benefit costs.
- No restructuring charges were recorded in Q1 2019, compared with $2.2 million in Q1 2018.
- Interest expense increased to $4.4 million from $2.9 million, reflecting higher debt-related costs and interest rates.
Cash flow, balance sheet, debt and liquidity
- Cash used in operating activities was $1.7 million, compared with $10.3 million of cash provided in Q1 2018. The decline primarily reflected decreases in accrued and other liabilities.
- Capital expenditures were $3.2 million on the cash flow statement; segment disclosures report $4.5 million, including $2.1 million of property and equipment purchases not yet paid.
- Cash used in financing activities was $1.6 million, including $3.0 million of term-loan principal repayments. Revolver borrowings and repayments were $61.9 million and $58.7 million, respectively.
- Cash and cash equivalents declined to $3.7 million from $10.3 million at December 31, 2018.
- Total debt was $233.2 million, compared with $233.0 million at year-end. The weighted-average interest rate was 6.84%, versus 4.71% at December 31, 2018.
- The company had $96.6 million of unused revolving credit capacity and was in compliance with all credit-facility covenants.
- Total assets were $660.7 million and shareholders’ equity was $263.8 million at March 30, 2019.
- Management expects 2019 capital expenditures of $15 million to $17 million and states that operating cash flow and available borrowing capacity should provide sufficient liquidity for the next twelve months.
Material changes, outlook and unusual items
- Ducommun adopted ASC 842 lease accounting on January 1, 2019. The adoption added operating lease right-of-use assets of $18.4 million and operating lease liabilities of $20.0 million at March 30, 2019, and reduced opening retained earnings by approximately $0.3 million. Prior-year comparative information was not recast.
- The 2017 restructuring plan was completed by December 31, 2018. Q1 2019 included $2.2 million of restructuring cash payments and no current-period restructuring charge.
- Remaining performance obligations were $697.5 million at March 30, 2019, with approximately 70% expected to be recognized as revenue during the next twelve months.
- Backlog was $883.8 million, up from $864.4 million at December 31, 2018; $625.0 million was expected to be delivered within twelve months. Backlog is subject to delivery delays and program cancellations.
- The company expects continued investment in tooling, equipment and facilities to support aerospace and defense programs and may pursue acquisitions as part of its growth strategy.
- Interest-rate exposure remains material because debt bears variable rates tied to LIBOR or base rates. The company has interest-rate cap hedges covering $135.0 million of debt through June 2020.
- Top-ten customers represented 67.1% of Q1 revenue. Boeing alone represented 19.9%, indicating customer and program concentration.
Risks, contingencies and controls
- Environmental matters include groundwater investigation and remediation obligations at El Mirage and Monrovia, California, with a recorded accrual of $1.5 million, and a West Covina landfill matter with an estimated future liability range of $0.4 million to $3.1 million and a $0.4 million accrual.
- The company reported $5.4 million of unrecognized tax benefits at March 30, 2019, of which $3.4 million would affect the effective tax rate if recognized.
- Management stated that other litigation, claims and contingencies are not currently expected to have a material adverse effect, although outcomes cannot be predicted.
- Management identified no material changes to the risk factors in the 2018 Form 10-K.
- Disclosure controls were deemed effective. Internal controls were materially affected by the ASC 842 implementation, including new policies, training, processes and lease-accounting software.
Important facts for investors to verify
- Whether improved margins and segment operating performance are sustainable after the absence of restructuring charges in Q1 2019.
- Conversion of the substantial backlog and remaining performance obligations into revenue and operating cash flow.
- Working-capital requirements, particularly the $93.3 million contract-asset balance and $104.0 million inventory balance.
- Debt refinancing, variable-rate exposure, covenant compliance and the effect of higher interest expense on future earnings and cash flow.
- Customer concentration and the potential effect of aerospace production changes, program delays or cancellations.
- Progress and ultimate cost of environmental remediation and other contingent liabilities.
- The comparability of 2019 results with 2018 following adoption of ASC 842 and the company’s use of non-GAAP Adjusted EBITDA.