Business Context and Reporting Period
Ducommun Incorporated is an aerospace and defense engineering and manufacturing company with two reportable segments: Electronic Systems and Structural Systems. The unaudited Form 10-Q covers the three and nine months ended September 28, 2019, compared with September 29, 2018. The company also serves industrial, medical and other markets, although aerospace and defense are the primary markets.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net revenues | $181.1 million | $159.8 million | $534.2 million | $465.1 million |
| Gross profit | $38.3 million | $31.1 million | $112.1 million | $89.9 million |
| Gross margin | 21.2% | 19.5% | 21.0% | 19.3% |
| Operating income | $14.6 million | $6.8 million | $41.1 million | $17.6 million |
| Operating margin | 8.1% | 4.3% | 7.7% | 3.8% |
| Net income | $8.3 million | $4.2 million | $23.6 million | $8.4 million |
| Diluted EPS | $0.70 | $0.36 | $2.00 | $0.72 |
| Adjusted EBITDA | $23.6 million | $18.1 million | $67.1 million | $51.3 million |
| Adjusted EBITDA margin | 13.1% | 11.3% | 12.6% | 11.0% |
Revenue growth was driven principally by higher commercial aerospace and military and space volumes. Q3 revenue increased 13.3% year over year, while nine-month revenue increased 14.8%.
- Electronic Systems revenue was $90.6 million in Q3 and $264.0 million for the first nine months; segment operating income was $9.7 million and $28.8 million, respectively.
- Structural Systems revenue was $90.5 million in Q3 and $270.1 million for the first nine months; segment operating income was $12.9 million and $35.2 million, respectively.
- Commercial aerospace represented $88.9 million, or 49.1%, of Q3 revenue; military and space represented $80.5 million, or 44.4%.
- Net cash provided by operating activities was $20.1 million for the first nine months, compared with $33.4 million in the prior-year period. Capital expenditures were $14.7 million in cash-flow reporting, or $14.9 million in segment reporting.
- Cash, cash equivalents and restricted cash totaled $6.7 million at September 28, 2019, including $6.4 million of unrestricted cash.
- Total debt was $226.4 million, consisting primarily of a term loan; the weighted-average interest rate was 6.87%. The company had $99.8 million of unused revolving credit capacity after standby letters of credit.
Material Changes Versus the Prior Comparable Period
- Gross margin improved 170 basis points in Q3 and 170 basis points for the first nine months, reflecting favorable volume, product mix and manufacturing efficiencies.
- Operating income increased $7.8 million in Q3 and $23.4 million for the first nine months. The improvement included the absence of restructuring charges recorded in the comparable periods: $3.4 million in Q3 2018 and $10.8 million in the first nine months of 2018.
- SG&A increased $2.8 million in Q3 and $9.6 million for the first nine months, primarily due to higher compensation, benefits and corporate expenses; the nine-month period also included $1.7 million of one-time severance charges.
- Interest expense increased to $4.4 million in Q3 and $13.1 million for the first nine months, primarily because of higher interest rates.
- Operating cash flow declined despite higher earnings because of increases in contract assets, accounts receivable and inventories.
- Backlog declined to $835.2 million at September 28, 2019, from $864.4 million at December 31, 2018. The decrease was concentrated in commercial aerospace and industrial markets; $574.0 million was expected to be delivered over the next 12 months.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2019 capital expenditures of $16.0 million to $18.0 million, primarily to support new contract awards. The filing does not provide formal revenue or earnings guidance.
- Remaining performance obligations were $682.2 million at September 28, 2019, with approximately 70% expected to be recognized as revenue within the next 12 months. These obligations and backlog remain subject to delivery delays, order timing and program cancellations.
- On October 8, 2019, after quarter end, Ducommun acquired Nobles Worldwide for $77.0 million net of cash acquired and paid $77.3 million using the revolving credit facility. This transaction increased post-quarter-end leverage and reduced available revolver capacity; the filing does not provide post-acquisition debt or liquidity balances.
- The company depends on operating cash flow and borrowing capacity for short-term liquidity. It was in compliance with all credit-facility covenants at September 28, 2019 and stated that liquidity was expected to be sufficient for the next 12 months.
- Interest-rate exposure is material because the term loan and revolver bear variable rates, although the company stated that a hypothetical 10% change in interest rates would have an immaterial impact. Interest-rate cap hedges covered $135.0 million of debt and had maturities through June 2020.
- Environmental contingencies include a $1.5 million accrual for groundwater investigation and corrective action and a $0.4 million accrual for the West Covina landfill. The estimated range of potential West Covina liabilities was $0.4 million to $3.1 million.
- The company adopted ASC 842 lease accounting in 2019, recording $18.6 million of operating lease right-of-use assets and $20.1 million of operating lease liabilities at September 28, 2019. Opening retained earnings decreased by $0.3 million.
- Goodwill totaled $136.1 million and intangible assets totaled $104.0 million. The Structural Systems goodwill impairment test performed in April 2019 indicated fair value exceeded carrying value by 85%.
- Top ten customers represented 61.5% of Q3 revenue and 64.6% of nine-month revenue, creating customer and program concentration risk. Boeing, Raytheon and Spirit accounted for significant portions of revenue and accounts receivable.
Investor Verification Checklist
- Verify the financing impact of the Nobles acquisition, including pro forma leverage, interest expense and remaining revolver capacity.
- Assess whether backlog and remaining performance obligations convert to revenue as expected, particularly in commercial aerospace.
- Monitor contract assets, receivables and inventory for further working-capital pressure and cash-flow conversion.
- Review variable-rate debt exposure, covenant compliance and the expiration of interest-rate caps in 2020.
- Evaluate customer concentration, program delivery schedules and potential cancellations or delays.
- Reconcile Adjusted EBITDA to GAAP results and consider the effects of stock compensation, amortization, taxes and other excluded items.
- Track environmental liabilities, contract-loss estimates and goodwill or intangible-asset impairment indicators.