Ducommun Incorporated: Q3 2011 Form 10-Q Summary
Business context and reporting period
Ducommun designs and manufactures structural, electronic and electromechanical components and systems primarily for aerospace and defense customers, with additional exposure to industrial, natural resources, medical and other commercial markets. The filing covers the three and nine months ended October 1, 2011, compared with October 2, 2010.
On June 28, 2011, Ducommun acquired LaBarge, Inc. for approximately $325.3 million net of cash acquired. LaBarge's results were included from the acquisition date and were combined with Ducommun Technologies to form the Ducommun LaBarge Technologies segment.
Financial performance and condition
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $185.1 million | $99.4 million | $392.7 million | $306.6 million |
| Operating income | $9.6 million | $6.2 million | $11.3 million | $22.1 million |
| Net income | $1.0 million | $5.8 million | $0.9 million | $15.6 million |
| Diluted EPS | $0.09 | $0.55 | $0.09 | $1.48 |
| Gross margin | 18.5% | 20.0% | 18.7% | 20.1% |
| SG&A as a percentage of sales | 13.3% | 13.8% | 15.9% | 12.9% |
| Net interest expense | $8.3 million | $0.5 million | $10.0 million | $1.7 million |
Q3 sales increased 86.1%, driven principally by $83.8 million of LaBarge sales and approximately 2% organic growth. Nine-month sales increased 28.1%, including approximately $84.7 million from LaBarge. Ducommun LaBarge Technologies sales rose 245.8% in Q3 and 67.7% for the nine-month period, while Ducommun AeroStructures sales increased 11.0% and 8.7%, respectively.
Profitability declined despite higher sales. Management attributed lower gross margins to product mix, the LaBarge inventory step-up write-off and lower AeroStructures performance. Q3 and nine-month operating results included $3.9 million and $15.3 million, respectively, of acquisition-related expenses. Excluding these expenses, management reported Q3 diluted EPS of $0.34 and nine-month diluted EPS of $1.13.
Reported EBITDA was $18.0 million in Q3 and $28.1 million for the first nine months. Adjusted EBITDA, excluding inventory step-up and merger-related expenses, was $21.8 million and $43.5 million, respectively. These are non-GAAP measures and should not be treated as substitutes for GAAP earnings or operating cash flow.
At October 1, 2011, cash and cash equivalents were $19.4 million, compared with $10.3 million at December 31, 2010. Total assets were $860.8 million, including $216.3 million of goodwill and $190.7 million of intangible assets. Total debt was $392.7 million, consisting primarily of $200.0 million of senior unsecured notes and a $189.5 million senior secured term loan.
Cash used in operating activities was $28.9 million for the first nine months, compared with $2.7 million used in the prior-year period. Cash used in investing activities was $336.5 million, including $325.3 million for the LaBarge acquisition and $11.2 million of capital expenditures. Financing activities provided $374.5 million, primarily from approximately $390.0 million of new borrowings.
Material changes versus the prior comparable period
- LaBarge materially increased sales, assets, goodwill, intangible assets and leverage beginning in the third quarter.
- Operating income fell 48.9% for the first nine months despite 28.1% sales growth, primarily because of acquisition-related costs, higher amortization, increased corporate expenses and substantially higher interest expense.
- Gross margin decreased 150 basis points in Q3 and 140 basis points for the nine-month period.
- Interest expense increased to $8.3 million in Q3 from $0.5 million and to $10.0 million for nine months from $1.7 million.
- Working capital expanded substantially, including inventories of $168.2 million versus $72.6 million at year-end 2010 and accounts receivable of $97.4 million versus $47.9 million.
- Firm backlog increased to approximately $611.7 million from $328.0 million at December 31, 2010, with approximately $172.0 million expected to be delivered during the remainder of 2011.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide formal earnings or revenue guidance. Management expects the LaBarge acquisition to broaden end-market exposure, strengthen the company's Tier 2 supplier position, expand manufacturing and technology capabilities, and provide potential synergies. Management also expects approximately $17.0 million of capital expenditures for 2011 and states that cash from operations and available borrowing capacity are expected to meet obligations over the next twelve months.
Liquidity included $58.4 million of unused revolving credit capacity after $1.6 million of standby letters of credit. The company had no revolver borrowings and was in compliance with its debt covenants at October 1, 2011. The term loan requires quarterly principal payments of $475,000, and the credit agreements include leverage and EBITDA covenants and restrictions on dividends, acquisitions, capital expenditures and additional debt.
- LaBarge integration, retention of key employees, realization of synergies and potential undisclosed liabilities are significant execution risks.
- Substantial leverage increases debt-service requirements and exposure to variable interest rates. The senior unsecured notes carry a 9.75% interest rate and mature in 2018; the term loan matures in 2017.
- Goodwill and intangible assets are significant. An interim impairment review found that reporting-unit fair values exceeded carrying values, but further declines in operating performance or stock price could trigger future impairment charges.
- Sales are concentrated among major aerospace, defense and industrial customers, and are subject to program changes, cancellations, delays, pricing pressure and government funding decisions.
- The company faces fixed-price contract cost-overrun risk, supplier and component shortages, environmental liabilities, regulatory and government-contracting risk, and exposure to cyclical aerospace markets.
- Ducommun is a defendant in putative class actions related to the LaBarge acquisition. A preliminary Delaware settlement remained subject to definitive documentation and court approval; related Missouri actions were stayed.
- A qui tam False Claims Act lawsuit involving alleged unapproved parts sold to Boeing remains pending. A relators' expert estimated alleged government damages at $833 million, but the company stated that it could not estimate its potential liability and that the government declined to intervene.
- Environmental reserves included approximately $1.5 million for groundwater remediation and approximately $0.7 million for the West Covina landfill matter; the estimated West Covina liability range was approximately $0.9 million to $3.3 million.
Most important facts for investors to verify
- Whether LaBarge integration produces sustainable operating margins and the anticipated synergies.
- Whether operating cash flow improves after significant working-capital investment and acquisition-related cash costs.
- Debt covenant compliance, required term-loan amortization, interest-rate exposure and the company's ability to service approximately $392.7 million of debt.
- The final LaBarge purchase-price allocation and any subsequent changes to goodwill or acquired intangible values.
- The outcome and potential cost of the LaBarge merger litigation, False Claims Act litigation and environmental matters.
- Backlog conversion, customer concentration, defense-budget trends and the effect of commercial aerospace production rates on future revenue.