Ducommun Incorporated 2017 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Ducommun provides engineering and manufacturing services for high-performance, high-cost-of-failure products, primarily for aerospace and defense, as well as industrial and medical markets. Its reportable segments are Electronic Systems and Structural Systems. The filing covers the quarter and six months ended July 1, 2017, compared with the periods ended July 2, 2016. The financial statements are unaudited.
Key Financial Metrics
| Metric | Three Months Ended July 1, 2017 | Three Months Ended July 2, 2016 | Six Months Ended July 1, 2017 | Six Months Ended July 2, 2016 |
|---|---|---|---|---|
| Revenue | $140.9 million | $133.4 million | $277.2 million | $275.6 million |
| Gross profit | $26.2 million | $26.2 million | $51.1 million | $53.2 million |
| Gross margin | 18.6% | 19.6% | 18.4% | 19.3% |
| Operating income | $6.5 million | $7.3 million | $10.6 million | $11.6 million |
| Net income | $3.8 million | $3.9 million | $5.9 million | $17.4 million |
| Diluted EPS | $0.33 | $0.34 | $0.51 | $1.55 |
| Adjusted EBITDA | $13.6 million | $13.7 million | $25.3 million | $24.9 million |
Six-month operating cash flow was $16.2 million, compared with $12.1 million in the prior-year period. Capital expenditures were $15.9 million versus $7.3 million, primarily supporting the Parsons, Kansas expansion and new program awards. Cash and cash equivalents were $7.4 million at July 1, 2017.
Total debt was $172.2 million, consisting primarily of a $160.0 million term loan and $12.2 million drawn on the revolving credit facility. The weighted-average interest rate was 3.12%. Unused revolving capacity was $186.8 million, and the company reported compliance with all debt covenants. The credit facilities mature June 26, 2020.
Total assets were $535.8 million and shareholders’ equity was $218.9 million at July 1, 2017. Accounts receivable were $82.0 million, inventories were $129.4 million, and current liabilities were $97.5 million.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue increased 5.6%, driven by a $17.6 million increase in military and space revenue, partly offset by lower commercial aerospace and industrial revenue.
- Six-month revenue increased only 0.6% because military and space growth was largely offset by lower commercial aerospace and industrial revenue, including effects from prior-year divestitures.
- Electronic Systems revenue increased 12.5% in the quarter and 6.4% for the six-month period; segment operating income increased to $8.8 million and $15.9 million, respectively.
- Structural Systems revenue declined 2.6% in the quarter and 6.4% for the six-month period; segment operating income declined to $2.0 million and $4.7 million, respectively, due primarily to lower manufacturing volume and new program development.
- Gross margin declined by 100 basis points in the quarter and 90 basis points for the six-month period, primarily because of unfavorable product mix.
- Six-month net income and diluted EPS decreased substantially because the prior-year period included an $18.8 million pretax gain from the Pittsburgh and Miltec divestitures. No divestiture gain was recorded in 2017.
- Interest expense declined year over year due mainly to voluntary term-loan prepayments, partially offset by increased revolving-facility usage.
- Backlog increased to $610.6 million from $600.3 million at December 31, 2016; $426.0 million was expected to be delivered within 12 months.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expects 2017 capital expenditures of $22 million to $26 million, funded by operating cash flow, principally for the Parsons expansion and new aerospace and defense programs.
- Management stated that operating cash flow and available borrowing capacity should provide sufficient liquidity for the next 12 months. The filing does not provide formal revenue or earnings guidance.
- Defense demand remains subject to congressional appropriations, the federal debt ceiling, Budget Control Act spending limits, sequestration, changing government priorities, and potential program reductions, delays, or cancellations.
- Backlog is subject to delivery delays and program cancellations and may not reliably indicate future revenue because of timing and program concentration.
- The company remains exposed to commercial aerospace softness, including the winding down of a regional jet program and weaker business-jet demand, as well as customer and end-market concentration. The top ten customers represented 62.2% of second-quarter revenue.
- The company had a material weakness in internal control over financial reporting related to income-tax accounting and disclosures. It was not remediated as of July 1, 2017, and management concluded disclosure controls were ineffective at that date.
- Environmental contingencies include a $1.5 million accrual for groundwater investigation and corrective action and a $0.4 million accrual related to the West Covina landfill. Estimated potential West Covina liabilities range from $0.4 million to $3.1 million.
- The company recorded $498,000 for remaining lease-termination obligations associated with prior restructuring activities.
- Management anticipated that adoption of the new revenue standard in 2018 would materially affect revenue, cost of sales, related balance-sheet captions, systems, and opening retained earnings. The company expected to use the modified retrospective method and anticipated that most revenue would be recognized over time.
- A July 14, 2017 technical amendment to the credit facilities provided greater flexibility for certain qualified acquisitions.
Most Important Facts for Investors to Verify
- Whether military and space growth can offset continuing commercial aerospace and industrial declines.
- Whether Structural Systems can recover from lower volume, unfavorable mix, and new-program development costs.
- Progress in remediating the income-tax internal-control material weakness during 2017.
- Cash conversion, inventory growth, capital-expenditure requirements, and the ability to reduce or refinance $172.2 million of debt.
- The effect of the 2018 revenue-recognition adoption on reported revenue, margins, contracts, and retained earnings.
- Backlog quality, customer concentration, delivery timing, and exposure to defense-budget changes or program cancellations.
- Potential exposure from environmental matters, tax examinations, forward-loss reserves, and other litigation or indemnification obligations.