Ducommun Incorporated: Q2 2014 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, as well as industrial, natural resources, medical and other markets. Its two reportable segments are Ducommun AeroStructures (DAS) and Ducommun LaBarge Technologies (DLT). The filing covers the three and six months ended June 28, 2014, compared with the periods ended June 29, 2013. The interim financial statements are unaudited.
Financial performance and key metrics
| Metric | Q2 2014 | Q2 2013 | First six months 2014 | First six months 2013 |
|---|---|---|---|---|
| Net revenues | $186.5 million | $191.5 million | $366.3 million | $367.4 million |
| Gross profit | $37.4 million | $37.3 million | $72.5 million | $70.2 million |
| Gross margin | 20.1% | 19.5% | 19.8% | 19.1% |
| Operating income | $16.6 million | $15.0 million | $30.6 million | $25.3 million |
| Operating margin | 8.9% | 7.9% | 8.3% | 6.9% |
| Net income | $6.5 million | $5.5 million | $11.1 million | $9.2 million |
| Diluted EPS | $0.59 | $0.51 | $1.00 | $0.86 |
| EBITDA | $24.3 million | $22.2 million | $45.7 million | $39.5 million |
| EBITDA margin | 13.0% | 11.6% | 12.5% | 10.8% |
Q2 SG&A was $20.9 million, or 11.2% of revenue, compared with $22.3 million, or 11.6%, in the prior-year quarter. Interest expense was $7.0 million versus $7.4 million. The Q2 effective tax rate increased to 32.5% from 27.6%; the prior-year period benefited from federal research and development tax credits. For the six-month period, the effective tax rate was 32.5% versus 8.6% in 2013, when approximately $3.0 million of R&D tax benefits were recognized.
DAS generated Q2 revenue of $78.6 million, down 6.4%, and segment operating income of $9.8 million, up from $9.0 million. DLT generated revenue of $107.9 million, essentially flat, and segment operating income of $10.8 million, down from $11.2 million.
Cash flow, debt and liquidity
- Six-month operating cash flow was $15.5 million, compared with $6.9 million in the prior-year period.
- Capital expenditures were $6.0 million for the six months, compared with $5.1 million. Management expects approximately $16.0 million of 2014 capital expenditures.
- Cash used in financing activities was $14.6 million, principally reflecting $15.0 million of voluntary term-loan principal payments.
- Cash and cash equivalents were $43.8 million at June 28, 2014, compared with $48.8 million at December 31, 2013.
- Total debt was $317.7 million, including $200.0 million of 9.75% senior unsecured notes and $117.6 million of a 4.75% floating-rate senior secured term loan.
- Unused revolving credit capacity was approximately $58.4 million, after consideration of standby letters of credit. The company reported compliance with all debt covenants and no amounts outstanding that triggered the leverage covenant.
- Management expects total 2014 term-loan paydown of approximately $25 million to $30 million and believes operating cash flow and available borrowing capacity will provide sufficient liquidity for the next twelve months.
Material changes versus the prior comparable period
- Q2 revenue declined 2.6%, while first-half revenue declined 0.3%. Military and space revenue fell approximately 8% in Q2 and 5% year to date, partly offset by stronger commercial aerospace and non-aerospace and defense revenue.
- Profitability improved despite lower Q2 revenue. Gross margin, operating margin and EBITDA margin all expanded, reflecting improved operating performance, favorable product mix, lower SG&A and an approximately $0.8 million workers’ compensation audit refund related to prior years.
- Net income increased 17.6% in Q2 and 20.5% for the first six months; diluted EPS increased to $0.59 from $0.51 in Q2 and to $1.00 from $0.86 year to date.
- Interest expense declined because of lower debt balances and the prior repricing of the term loan.
- Accounts receivable increased to $105.2 million from $91.9 million at year-end, while inventory increased to $142.2 million from $140.5 million.
- Firm backlog was $623.1 million at June 28, 2014, up $3.2 million from December 31, 2013; approximately $498.5 million was expected to be delivered within twelve months.
- Boeing represented 20% of Q2 and first-half revenue, Raytheon represented 9%, and the top ten customers represented 58% of Q2 revenue and 59% of first-half revenue.
Outlook, risks, contingencies and unusual items
Management expects higher 2014 capital spending to support new contract awards and increased tooling and engineering requirements associated with its strategy to become a Tier 2 supplier. Backlog may be affected by delivery delays, program cancellations and customer order timing and may not reliably predict future revenue, particularly because non-aerospace and defense backlog is generally short duration.
The company faces a qui tam False Claims Act lawsuit alleging that unapproved parts were sold to Boeing and installed in aircraft sold to the U.S. government. The government declined to intervene; summary judgment motions were pending. Ducommun stated that it could not estimate potential liability.
Environmental matters include groundwater investigation and remediation at California facilities and liability for certain landfills. Reserves included approximately $1.5 million for groundwater matters and $0.4 million for the West Covina landfill; estimated West Covina exposure was approximately $0.4 million to $3.1 million.
Other considerations include customer concentration, dependence on aerospace and defense programs, contract-cost estimates and potential loss provisions, inventory valuation judgments, interest-rate exposure and substantial debt. Management stated that other litigation and contingencies were not expected to have a material adverse effect, but actual outcomes may differ from estimates.
The federal R&D tax credit had expired for 2014 and no 2014 benefit was recognized. The company adopted ASU 2013-11, reducing deferred tax assets by approximately $0.6 million; it did not expect the other newly issued accounting standards discussed in the filing to have a material impact based on its current assessment.
Most important facts for investors to verify
- Whether improved margins and segment profitability are sustainable after the workers’ compensation refund and other favorable mix or cost items.
- The effect of declining military and space revenue, customer concentration and program timing on future revenue and backlog conversion.
- Progress against expected 2014 term-loan paydown and capital spending, including compliance with debt covenants and available revolver capacity.
- Working-capital trends, particularly the increase in accounts receivable and inventory relative to year-end.
- Potential exposure from the False Claims Act litigation and environmental remediation matters, for which ultimate liabilities were uncertain.
- Future effective tax rates without federal R&D tax-credit benefits.