Ducommun Incorporated: Q3 2012 Form 10-Q Summary
Business context and reporting period
Ducommun supplies engineered products and services primarily to the aerospace and defense industries through Ducommun AeroStructures (DAS) and Ducommun LaBarge Technologies (DLT). The filing covers the three and nine months ended September 29, 2012, compared with October 1, 2011. Results include the LaBarge acquisition completed June 28, 2011, which materially affects year-over-year comparability.
Financial performance and key metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net sales | $184.1 million | $185.1 million | $553.1 million | $392.7 million |
| Operating income | $14.2 million | $9.6 million | $40.1 million | $11.3 million |
| Net income | $5.1 million | $1.0 million | $13.0 million | $0.9 million |
| Diluted EPS | $0.48 | $0.09 | $1.23 | $0.09 |
| Gross margin | 19.3% | 18.5% | 19.2% | 18.7% |
| Effective tax rate | 14.9% | 30.2% | 15.6% | 27.2% |
| Adjusted EBITDA | $21.9 million | $19.8 million | $62.3 million | $39.9 million |
Third-quarter sales declined 0.5%, as lower DLT revenue offset higher DAS revenue. Operating income increased 47.8%, primarily from improved product mix, lower SG&A, integration synergies and the absence of significant 2011 merger-related expenses. Nine-month sales increased 40.9%, primarily reflecting $160.8 million of incremental LaBarge-related sales.
- DAS Q3 sales increased 2.1% to $76.7 million; operating income increased to $7.4 million from $6.5 million.
- DLT Q3 sales decreased 2.3% to $107.4 million; operating income increased to $10.5 million from $7.3 million.
- Q3 SG&A declined to $21.3 million, or 11.6% of sales, from $24.6 million, or 13.3%.
- Nine-month interest expense increased to $24.7 million from $10.0 million because of acquisition-related debt.
- Cash provided by operating activities was $11.4 million for the nine months, compared with cash used of $28.9 million in the prior-year period.
- Capital expenditures were $12.3 million for the nine months; management expected approximately $15.0 million for full-year 2012.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $28.9 million at September 29, 2012, down from $41.4 million at December 31, 2011.
- Total debt was $380.8 million, consisting primarily of $200.0 million of senior unsecured notes and $177.6 million of senior secured term debt.
- The company made a voluntary $10.0 million term-loan prepayment on September 28, eliminating required quarterly principal payments going forward.
- Unused revolving credit capacity was $58.4 million after $1.6 million of standby letters of credit; no revolver borrowings were outstanding.
- The weighted-average borrowing rate was 7.73%, and the company was in compliance with debt covenants.
- Total assets were $795.3 million and shareholders’ equity was $219.0 million at September 29, 2012.
Material changes, outlook and risks
- Firm backlog was $642.2 million at quarter-end, up from $636.4 million at December 31, 2011; approximately $162.0 million was expected to be delivered during the remainder of 2012.
- Backlog increased in military and space and commercial aerospace but declined in natural resources, industrial and medical/other markets. Management cautioned that backlog may not predict future sales because of order timing, program concentration, delays and cancellations.
- Management expected operating cash flow and available bank capacity to provide sufficient liquidity for the next twelve months.
- Goodwill totaled $161.9 million and goodwill plus intangible assets totaled $341.2 million. An interim DLT impairment test found fair value exceeded carrying value by 9%; no impairment was recorded. Future impairment could result from sustained stock-price declines, weak performance, failure to win business or increased competition.
- The company remains exposed to aerospace and defense spending, commercial aircraft production rates, customer concentration, program changes, competitive pricing and performance requirements.
- A False Claims Act lawsuit involving alleged unapproved parts supplied to Boeing remained outstanding. The government declined to intervene, but one relator’s expert estimated government damages at $833 million. Ducommun could not estimate any potential liability.
- Environmental reserves included approximately $1.5 million for groundwater matters and $0.6 million for the West Covina landfill; estimated West Covina exposure was approximately $0.6 million to $3.3 million.
- The company identified no material market-risk disclosures, and management concluded disclosure controls were effective as of September 29, 2012.
Important facts for investors to verify
- Reconcile the nine-month diluted EPS: the financial statements report $1.23, while the MD&A narrative refers to $1.27.
- Assess debt-service capacity, refinancing requirements and the effect of the 7.73% weighted-average borrowing cost.
- Monitor DLT goodwill, given the reported 9% fair-value cushion and sensitivity to forecast sales, margins, growth and discount rates.
- Evaluate the potential financial and reputational impact of the False Claims Act litigation, for which no liability estimate was recorded.
- Verify backlog conversion, customer and program concentration, and the sustainability of reported integration synergies and improved margins.
- Consider the temporary nature of tax benefits that reduced the 2012 effective tax rate.