Ducommun Incorporated — Q2 2020 Form 10-Q Summary
Business context and reporting period
Ducommun provides engineering and manufacturing services for high-performance, high-cost-of-failure products used primarily in aerospace and defense, industrial, medical and related markets. Operations comprise Electronic Systems and Structural Systems. This unaudited filing covers the three and six months ended June 27, 2020, compared with the periods ended June 29, 2019.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net revenues | $147.3 million | $180.5 million | $320.8 million | $353.1 million |
| Gross profit / margin | $32.7 million / 22.2% | $38.1 million / 21.1% | $69.5 million / 21.7% | $73.8 million / 20.9% |
| Operating income / margin | $10.0 million / 6.8% | $13.6 million / 7.5% | $23.7 million / 7.4% | $26.5 million / 7.5% |
| Net income / margin | $5.1 million / 3.5% | $7.8 million / 4.3% | $13.0 million / 4.1% | $15.3 million / 4.3% |
| Diluted EPS | $0.43 | $0.66 | $1.10 | $1.30 |
| Adjusted EBITDA | $20.3 million / 13.8% | $22.4 million / 12.4% | $43.5 million / 13.6% | $43.5 million / 12.3% |
Cash and cash equivalents were $70.8 million at June 27, 2020, compared with $39.6 million at December 31, 2019. Six-month operating cash flow was negative $3.4 million, versus positive $8.1 million in the prior-year period, primarily reflecting increases in contract assets and inventories and lower accounts payable. Investing cash flow was negative $4.8 million, including $5.0 million of property and equipment purchases. Financing cash flow was positive $39.4 million, primarily reflecting net revolving-credit borrowings.
Total debt was $350.9 million, up from $310.0 million at year-end 2019. The weighted-average interest rate declined to 4.04% from 6.87%. The company had $49.8 million of unused revolving-credit capacity, after standby letters of credit, and was in compliance with all debt covenants. Total assets were $841.6 million and shareholders’ equity was $309.6 million at June 27, 2020.
Material changes versus the prior comparable period
- Quarterly revenue declined 18.4%, and six-month revenue declined 9.1%, primarily because commercial aerospace revenue fell $51.6 million in the quarter and $76.2 million year to date due to lower large-aircraft build rates.
- Military and space revenue increased $17.4 million in the quarter and $43.2 million year to date, partially offsetting commercial aerospace weakness.
- Electronic Systems revenue increased 3.0% in the quarter and 9.6% year to date; segment operating income increased to $10.4 million from $9.9 million in the quarter and to $25.6 million from $19.1 million year to date.
- Structural Systems revenue decreased 39.3% in the quarter and 27.2% year to date; segment operating income declined to $6.2 million from $11.8 million in the quarter and to $11.6 million from $22.3 million year to date.
- Gross margin improved because of lower compensation and benefit costs and favorable product mix, but operating and net margins declined because of lower revenue and unfavorable manufacturing volume.
- The company recorded $0.7 million of restructuring charges for severance and benefits under a Structural Systems headcount-reduction plan responding to weaker commercial aerospace demand.
- Backlog declined to $830.7 million from $910.2 million at December 31, 2019, primarily due to commercial aerospace. Approximately $552.0 million was expected to be delivered within 12 months. Remaining performance obligations were $732.2 million, with approximately 70% expected to be recognized as revenue within 12 months.
Guidance, outlook, risks and unusual items
- Management stated that COVID-19 materially affected operations, customers and suppliers, particularly commercial aerospace, and could have a material adverse effect for part or all of 2020. No full-year revenue or earnings guidance was provided.
- Management expected 2020 capital expenditures of $12.0 million to $14.0 million, excluding restoration-related spending for the Guaymas facility; some planned spending could be delayed because of COVID-19.
- On June 29, 2020, after quarter-end, a fire severely damaged the 62,000-square-foot Guaymas, Mexico performance center in Structural Systems. Inventory and property and equipment were damaged. Insurance is expected to cover most or all losses less the deductible, but the financial impact was not yet estimable. Production was expected to shift to other facilities.
- In October 2019, Ducommun acquired Nobles Worldwide for approximately $76.8 million net of cash acquired, adding $34.9 million of goodwill and $37.2 million of identifiable intangible assets. The acquisition was included in Structural Systems and was not material to consolidated results on a pro forma basis.
- Goodwill impairment indicators were evaluated in the first and second quarters; management concluded that goodwill was not impaired.
- Environmental liabilities included a $1.5 million accrual for groundwater matters and a $0.4 million accrual for the West Covina landfill. Management preliminarily estimated potential West Covina exposure at $0.4 million to $3.1 million.
- Unrecognized tax benefits totaled $5.8 million; approximately $4.2 million would affect the effective tax rate if recognized. The company expected approximately $2.0 million of reductions over the next 12 months due to expiring statutes of limitation.
- Customer concentration remained significant: the top ten customers represented 60.4% of second-quarter revenue and 56.8% of six-month revenue.
Investor verification checklist
- Verify the extent and timing of insurance recoveries, restoration costs and production effects from the Guaymas fire.
- Monitor commercial aerospace build rates, customer shutdowns, Boeing 737 MAX-related demand and COVID-19 effects on backlog conversion.
- Assess liquidity, leverage, mandatory amortization and covenant compliance as operating cash flow remains negative and debt increased.
- Reconcile reported Adjusted EBITDA with GAAP results; it is a non-GAAP measure and excludes interest, taxes, depreciation, amortization, stock compensation and restructuring charges.
- Track Structural Systems profitability, restructuring benefits and potential goodwill or asset impairments.
- Review environmental contingencies, tax exposures, customer concentration and the recoverability of contract assets and inventories.