Ducommun Incorporated — 2017 Third-Quarter Form 10-Q Summary
Business context and reporting period
Ducommun provides engineering and manufacturing services primarily for aerospace and defense, with additional industrial and medical exposure. Its reportable segments are Electronic Systems and Structural Systems. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with October 1, 2016.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net revenues | $138.7 million | $132.6 million | $415.9 million | $408.2 million |
| Gross profit / margin | $26.0 million / 18.8% | $25.2 million / 19.0% | $77.1 million / 18.5% | $78.4 million / 19.2% |
| Operating income / margin | $7.2 million / 5.2% | $8.1 million / 6.1% | $17.8 million / 4.3% | $19.6 million / 4.8% |
| Net income | $4.7 million | $5.0 million | $10.6 million | $22.4 million |
| Diluted EPS | $0.41 | $0.44 | $0.92 | $1.99 |
| Adjusted EBITDA | $14.5 million | $14.9 million | $39.7 million | $39.8 million |
Q3 revenue increased 4.6%, while net income declined 7.2% and Adjusted EBITDA declined 2.8%. For the first nine months, revenue increased 1.9%, but net income declined 52.8%, primarily because 2016 included an $18.8 million pretax gain on divestitures. Adjusted EBITDA margin was 10.4% in Q3 and 9.6% for the first nine months.
- Electronic Systems revenue increased 10.3% in Q3 and 7.7% year to date; segment operating income increased to $8.2 million in Q3 and $24.2 million year to date.
- Structural Systems revenue decreased 2.0% in Q3 and 5.0% year to date; segment operating income decreased to $3.5 million in Q3 and $8.1 million year to date.
- Military and space revenue increased $8.1 million in Q3 and $31.9 million year to date, while commercial aerospace revenue declined $2.8 million and $16.8 million, respectively.
Cash flow, liquidity and debt
- Operating cash flow was $27.4 million for the first nine months of 2017, essentially unchanged from $27.6 million in the prior-year period.
- Capital expenditures were $24.6 million in the consolidated cash flow statement, or $22.2 million in segment reporting; management expects full-year capital expenditures of $26 million to $30 million.
- Investing cash flow was a use of $83.5 million, driven principally by the $59.2 million net cash purchase of Lightning Diversion Systems, compared with $42.6 million of investing cash inflow in the prior-year period, which included divestiture proceeds.
- Cash and cash equivalents declined to $3.7 million from $7.4 million at December 31, 2016.
- Total debt was $224.7 million, compared with $170.0 million at year-end 2016. Debt consisted of a $160.0 million term loan and $64.7 million drawn on the revolving facility. The weighted-average interest rate was 3.43%.
- Unused revolving-credit capacity was $134.5 million after borrowings and standby letters of credit. The credit facilities mature June 26, 2020, and the company reported compliance with all covenants.
Material changes, transactions and outlook
- On September 11, 2017, Ducommun acquired Lightning Diversion Systems, a provider of aerospace and defense lightning-protection systems, for $60.0 million net of cash acquired. The preliminary allocation included $34.9 million of goodwill and $22.4 million of identifiable intangible assets.
- Backlog increased to $655.3 million from $607.0 million at December 31, 2016; $427.0 million was expected to be delivered within 12 months. Management cautioned that backlog is subject to delivery delays, cancellations and program concentration.
- In November 2017, after the quarter ended, management approved a restructuring plan expected to generate $22 million to $25 million of pretax charges through 2018, including approximately $10.5 million in the fourth quarter of 2017. Estimated annualized savings beginning in 2019 are $14.0 million.
- Management expects operating cash flow and available borrowing capacity to provide sufficient liquidity for the next 12 months.
- The company was implementing the new revenue-recognition standard effective January 1, 2018. Management expected most revenue to be recognized over time, with a significant reduction in work-in-process and finished-goods inventory and an increase in unbilled receivables. The company planned to use the modified-retrospective transition method.
Risks, contingencies and unusual items
- Gross margins declined because of unfavorable product mix, although manufacturing cost reductions provided partial offset. Structural Systems results were pressured by new-program development, lower manufacturing volume, the wind-down of a regional-jet program and business-jet softness.
- Customer concentration remained significant: the top ten customers represented 64.3% of Q3 revenue and 62.8% of nine-month revenue. Boeing represented 17.1% of Q3 revenue and Raytheon 14.3%.
- The company’s previously disclosed material weakness in income-tax accounting and disclosures had not been remediated as of September 30, 2017. Consequently, management concluded that disclosure controls and procedures were not effective.
- Environmental liabilities included a $1.5 million accrual for groundwater matters and a $0.4 million accrual for the West Covina landfill; estimated future liability for that landfill ranged from $0.4 million to $3.1 million.
- The company had $3.7 million of unrecognized tax benefits, of which $2.4 million would affect the effective tax rate if recognized. The IRS was auditing the 2014 and 2015 tax years.
- Interest-rate exposure is material because debt bears variable rates, although management stated that a hypothetical 10% rate change would have an immaterial effect on financial condition and results of operations.
Investor verification checklist
- Verify the final purchase-price allocation, operating contribution and integration performance of Lightning Diversion Systems.
- Monitor restructuring charges, cash payments and whether the projected $14.0 million of annual savings are achieved beginning in 2019.
- Assess debt paydown, revolving-facility utilization, interest costs and covenant headroom following the acquisition.
- Evaluate the impact of ASC 606 adoption on revenue timing, inventory, contract assets, retained earnings and internal controls.
- Confirm remediation of the income-tax internal-control material weakness.
- Track commercial-aerospace demand, regional-jet program runoff, business-jet softness and the concentration of backlog and revenue among major customers.