Ducommun Incorporated 10-Q Summary
Business Context and Reporting Period
Ducommun provides engineering and manufacturing services for high-performance, high-cost-of-failure products, primarily in aerospace and defense, with additional industrial and medical exposure. Operations comprise Electronic Systems and Structural Systems. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared primarily with the three months ended April 1, 2017.
Effective January 1, 2018, the company adopted ASC 606 using the modified retrospective method. Accordingly, 2018 results reflect the new revenue standard while 2017 results remain under ASC 605 and are not directly comparable in certain areas.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenues | $150.5 million | $136.3 million | Up 10.4% |
| Gross profit | $26.8 million | $25.0 million | Up $1.8 million |
| Gross margin | 17.8% | 18.3% | Down 0.5 percentage points |
| Operating income | $5.3 million | $4.3 million | Up $1.0 million |
| Operating margin | 3.5% | 3.1% | Improved |
| Net income | $2.6 million | $2.1 million | Up $0.5 million |
| Diluted EPS | $0.22 | $0.18 | Up $0.04 |
| Adjusted EBITDA | $14.5 million | $11.9 million | Up 22.3% |
| Adjusted EBITDA margin | 9.6% | 8.7% | Improved |
| Net cash provided by operations | $10.3 million | $13.2 million | Down $2.9 million |
Revenue growth was driven mainly by commercial aerospace and defense electronics, partially offset by lower industrial and defense structures revenue. Structural Systems revenue increased 18.2% to $68.0 million, while Electronic Systems revenue increased 4.7% to $82.4 million.
Structural Systems segment operating income increased to $4.4 million from $2.8 million. Electronic Systems segment operating income declined to $5.7 million from $7.1 million, primarily due to unfavorable product mix, restructuring charges and higher manufacturing costs.
At March 31, 2018, cash and cash equivalents were $1.8 million, compared with $2.2 million at December 31, 2017. Total debt was $211.5 million, net debt was approximately $209.7 million after debt issuance costs, and unused revolving credit capacity was $148.2 million. The weighted-average debt interest rate was 4.09%, compared with 3.73% at year-end 2017. The company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue increased $14.2 million, although approximately $12.0 million of reported 2018 revenue was attributable to the ASC 606 adoption effect relative to an ASC 605 presentation.
- Gross margin declined to 17.8% from 18.3%, primarily because of higher manufacturing costs, partially offset by higher production volume.
- SG&A expense decreased $1.4 million, primarily from lower compensation and benefits, partly offset by higher professional services costs.
- Interest expense increased $1.2 million because of higher revolving debt balances following the LDS acquisition and higher interest rates.
- Restructuring charges were $2.2 million in Q1 2018 versus none in Q1 2017.
- The effective tax rate changed from a 15.6% expense rate to a 10.3% benefit rate, primarily reflecting the lower U.S. corporate tax rate and additional research and development tax credits.
- Operating cash flow declined despite higher net income, mainly because of working-capital effects associated with the new revenue recognition model and inventory levels.
Accounting, Outlook, Risks and Unusual Items
ASC 606 changed the majority of revenue recognition from point-in-time recognition to recognition over time. At adoption, retained earnings increased by $8.7 million. At March 31, 2018, contract assets were $78.2 million and contract liabilities were $15.7 million. The new model also materially reduced reported inventory and introduced greater reliance on estimates of contract costs, progress and profitability.
The company’s broader backlog was $819.8 million at March 31, 2018, up from $726.5 million at December 31, 2017, with $547.0 million expected to be delivered within 12 months. Separately, ASC 606-defined backlog was $590.8 million. Management cautions that backlog can be affected by delivery delays, order timing, program cancellations and concentration in several programs.
Management estimates total pre-tax restructuring charges of $20.0 million to $22.0 million through 2018, including $2.2 million recorded in the first quarter. Beginning in 2019, the restructuring plan is expected to generate approximately $14.0 million of annualized savings.
Capital expenditures are expected to be $15.0 million to $17.0 million in 2018, primarily to support new contract awards. Management expects operating cash flow and available credit facilities to provide sufficient liquidity for the next 12 months.
On April 23, 2018, after quarter-end, the company acquired Certified Thermoplastics Co., LLC for $30.5 million net of cash acquired, paying $31.1 million at closing with a draw on the revolving credit facility. The acquisition increased post-quarter-end leverage and reduced available borrowing capacity.
Key risks include aerospace and defense program concentration, customer concentration, contract estimate changes and potential losses, reliance on government and commercial aerospace demand, interest-rate exposure, execution of restructuring activities, acquisition integration, environmental matters and litigation. Environmental accruals totaled $1.9 million for groundwater and landfill matters, with an estimated West Covina landfill liability range of $0.4 million to $3.1 million.
The company maintains interest-rate cap hedges covering $135.0 million of debt through June 2020. Management stated that a hypothetical 10% change in interest rates would have an immaterial effect on financial condition and results of operations.
Important Facts for Investors to Verify
- Reconcile reported 2018 revenue, profit and segment results with an ASC 605 presentation because the prior-year comparison was not restated.
- Assess the sustainability of the 17.8% gross margin and the decline in Electronic Systems operating income.
- Review contract assets, contract liabilities and management’s estimates of costs to complete long-term contracts under ASC 606.
- Monitor restructuring charges, execution of the plan and whether projected annualized savings materialize in 2019.
- Recalculate leverage and revolving-credit availability after the April 2018 CTP acquisition.
- Evaluate cash conversion, inventory requirements and the company’s limited cash balance relative to debt service and capital expenditures.
- Review backlog definitions and distinguish the $819.8 million broader backlog from the $590.8 million ASC 606-defined backlog.
- Consider customer concentration: the top ten customers represented 62.7% of Q1 2018 revenue.
- Follow unrecognized tax benefits of $8.9 million and the pending accounting-method treatment expected to affect subsequent reporting.