Business Context and Reporting Period
Ducommun Incorporated provides engineering and manufacturing services for high-performance, high-cost-of-failure products, primarily serving aerospace and defense markets, with additional exposure to industrial, natural resources, medical and other markets. Operations are reported through Ducommun AeroStructures (DAS) and Ducommun LaBarge Technologies (DLT). This unaudited Form 10-Q covers the three and nine months ended September 27, 2014, compared with the periods ended September 28, 2013.
Financial Performance and Position
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net revenue | $188.2 million | $181.3 million | $554.4 million | $548.7 million |
| Gross profit | $33.4 million | $32.3 million | $105.9 million | $102.5 million |
| Gross margin | 17.7% | 17.8% | 19.1% | 18.7% |
| Operating income | $10.3 million | $12.0 million | $40.9 million | $37.3 million |
| Operating margin | 5.5% | 6.6% | 7.4% | 6.8% |
| Net income | $2.6 million | $4.6 million | $13.7 million | $13.8 million |
| Diluted EPS | $0.24 | $0.42 | $1.23 | $1.28 |
| EBITDA | $18.6 million | $19.2 million | $64.3 million | $58.7 million |
Net revenue increased 3.8% in the quarter and 1.0% year to date. Commercial aerospace revenue increased approximately 21% in the quarter and 10% year to date, while military and space revenue declined approximately 3% and 5%, respectively. Q3 revenue was $81.4 million for DAS and $106.8 million for DLT. Year-to-date revenue increased for DAS by 3.1% but declined for DLT by 0.5%.
Q3 gross margin was essentially flat. Year-to-date margin improved primarily from favorable product mix and an approximately $0.8 million prior-year workers’ compensation audit refund, partly offset by higher compensation and benefit costs. Q3 operating income declined because higher revenue and lower interest expense were more than offset by higher compensation costs, supplier-delay costs, and increased corporate expenses.
The Q3 effective tax rate was 47.2%, compared with a 1.9% tax benefit rate in the prior-year quarter. The nine-month rate was 35.9%, compared with 5.4% in the prior-year period, mainly because the federal research and development tax credit had expired and was not recognized in 2014. Q3 also included approximately $0.9 million of additional tax expense related to a lower Qualified Domestic Production Activities Deduction.
Cash Flow, Debt and Liquidity
- Operating cash flow was $20.9 million for the first nine months of 2014, compared with $14.7 million in the prior-year period.
- Investing cash flow used $7.6 million, including $9.3 million of property and equipment purchases and $1.6 million of insurance recoveries.
- Financing cash flow used $21.2 million, primarily from $22.5 million of term-loan repayments.
- Cash and cash equivalents declined to $40.9 million at September 27, 2014, from $48.8 million at December 31, 2013.
- Total debt was $310.2 million, including $200.0 million of 9.75% senior unsecured notes and $110.1 million of senior secured term-loan borrowings at a 4.75% rate. The weighted-average debt rate was 7.97%.
- Approximately $58.5 million of revolving-credit capacity remained available after standby letters of credit. The Company reported compliance with all debt covenants and no borrowings that would trigger the leverage covenant.
- Accounts receivable increased to $104.4 million and inventories increased to $145.5 million from $91.9 million and $140.5 million, respectively, at year-end 2013.
Material Changes, Outlook and Unusual Items
- Management expected total 2014 term-loan paydowns of $30 million to $40 million, including $22.5 million paid through the first nine months.
- Management expected approximately $16 million of 2014 capital expenditures, financed by operating cash flow, primarily to support new contract awards and tooling requirements.
- Approximately $455 million of backlog was expected to be delivered over the next 12 months. Total backlog declined to $568.7 million at September 27, 2014 from $620.0 million at December 31, 2013, primarily reflecting reductions in defense technologies, defense structures and commercial aerospace backlog.
- A major outside supplier’s delivery delay increased Q3 costs and pressured DAS operating income.
- Q3 and year-to-date results included $1.6 million of insurance recoveries related to property and equipment. These recoveries increased other income and are not necessarily recurring.
- Customer concentration remained significant: Boeing represented 21% of Q3 revenue and 20% of year-to-date revenue; the top ten customers represented 61% and 59%, respectively. Boeing and Raytheon represented 17% and 8% of accounts receivable at quarter-end.
- A previously disclosed qui tam False Claims Act lawsuit was dismissed by summary judgment on October 8, 2014, after the quarter-end; the decision remained subject to appeal. The relators had alleged damages of $851 million to $1.6 billion, plus treble damages and penalties.
- Environmental reserves included approximately $1.5 million for groundwater remediation and $0.4 million for the West Covina landfill. Estimated West Covina exposure was approximately $0.4 million to $3.1 million.
- Management stated that operating cash flow and revolving-credit availability should provide sufficient liquidity for the next twelve months. The filing provided no specific revenue or earnings guidance.
Most Important Facts for Investors to Verify
- Whether the backlog reduction translates into lower future revenue, particularly in defense programs and DAS commercial aerospace programs.
- The recoverability and timing of $145.5 million of inventory and $104.4 million of receivables, given working-capital use and customer concentration.
- Whether supplier delays, compensation costs and elevated corporate expenses continue to pressure operating margins.
- The sustainability of cash generation after capital expenditures, required debt amortization and planned voluntary term-loan repayments.
- Future tax rates and the potential effect of any reinstatement or continued expiration of the federal R&D tax credit.
- The outcome of any appeal in the dismissed False Claims Act litigation and changes in environmental remediation obligations.
- The effect of the $319.6 million of goodwill and intangible assets on future impairment risk, particularly in DLT.