Ducommun Incorporated 10-Q Summary
Business context and reporting period
Ducommun supplies engineered and manufactured structural, electronic, electromechanical and interconnect products primarily to the aerospace and defense industries, with additional exposure to natural resources, industrial, medical and other commercial markets. Its two reportable segments are Ducommun AeroStructures (DAS) and Ducommun LaBarge Technologies (DLT). This unaudited filing covers the quarter and six months ended June 30, 2012, compared with July 2, 2011.
The results include the LaBarge acquisition, completed June 28, 2011. LaBarge contributed approximately $80.3 million of second-quarter sales and $164.6 million of six-month sales in 2012.
Financial performance and key metrics
| Metric | Three months ended June 30, 2012 | Three months ended July 2, 2011 | Six months ended June 30, 2012 | Six months ended July 2, 2011 |
|---|---|---|---|---|
| Net sales | $184.7 million | $108.0 million | $369.0 million | $207.6 million |
| Operating income/(loss) | $14.0 million | $(2.6) million | $25.9 million | $1.7 million |
| Net income/(loss) | $5.5 million | $(3.0) million | $7.9 million | $(0.05) million |
| Diluted EPS | $0.52 | $(0.28) | $0.75 | Approximately $0.00 |
| Gross margin | 19.5% | 19.4% | 19.1% | 19.0% |
| SG&A as a percentage of sales | 11.9% | 21.8% | 12.1% | 18.2% |
| Adjusted EBITDA | $21.3 million, or 11.6% of sales | $11.1 million, or 10.3% of sales | $40.4 million | $20.2 million |
- Second-quarter sales increased 71.0%; six-month sales increased 77.8%.
- Product sales drove the increase, rising to $177.1 million in the quarter and $354.6 million year to date. Service revenues were $7.6 million and $14.4 million, respectively.
- Interest expense increased to $8.2 million in the quarter and $16.5 million year to date, compared with $1.5 million and $1.8 million in the prior-year periods, primarily because of acquisition-related debt.
- The effective tax rate was 4.7% for the quarter and 16.0% year to date. State combined-reporting benefits related to LaBarge reduced the 2012 tax provision by approximately $1.55 million, although management expected the benefit to be lower in future periods.
- Operating cash flow was $10.5 million in the second quarter and $5.7 million for the first six months, compared with $(22.9) million for the first six months of 2011.
- Capital expenditures were $8.8 million year to date. Management expected approximately $16.0 million of 2012 capital expenditures.
Liquidity, debt and balance sheet
| Balance-sheet item | June 30, 2012 | December 31, 2011 |
|---|---|---|
| Cash and cash equivalents | $37.3 million | $41.4 million |
| Total assets | $804.6 million | $808.1 million |
| Total debt | $391.3 million | $392.2 million |
| Total shareholders’ equity | $213.4 million | $204.3 million |
- Debt consisted principally of $200.0 million of 9.75% senior unsecured notes and $188.1 million of senior secured term debt, plus acquisition-related liabilities.
- The company had $58.4 million of unused revolving credit capacity after $1.6 million of standby letters of credit, no outstanding revolver borrowings, and compliance with all debt covenants.
- The weighted-average interest rate on borrowings was 7.67% at June 30, 2012.
- The revolving facility matures in 2016, the term loan in 2017, and the senior unsecured notes in 2018, when the full principal is due.
- Management stated that operating cash flow and available bank capacity were expected to provide sufficient liquidity for the next twelve months.
Material changes versus the prior comparable period
- DLT sales increased 242.6% in the second quarter and 270.4% for the first six months, largely from the LaBarge acquisition. DAS sales were essentially flat in the quarter and increased 1.6% year to date.
- DAS operating income declined to $7.6 million from $8.8 million in the quarter and to $14.2 million from $15.9 million year to date, reflecting a greater mix of lower-margin products.
- DLT operating income increased to $10.5 million from $2.7 million in the quarter and to $18.8 million from $4.8 million year to date.
- Corporate general and administrative expense declined materially because prior-year periods included significant LaBarge acquisition transaction costs and because integration synergies were realized.
- Gross margins were broadly stable, while SG&A leverage improved substantially. The improvement in reported earnings was partly offset by materially higher interest expense.
- Firm backlog was $639.6 million at June 30, 2012, compared with $636.4 million at December 31, 2011; approximately $277.0 million was expected to be delivered during 2012.
Guidance, outlook, risks and unusual items
- Management expected 2012 capital expenditures of approximately $16.0 million and continued to emphasize manufacturing capacity, tooling, offshore expansion and support for new contracts.
- Management cited potential long-term benefits from LaBarge, including broader aerospace and defense capabilities, end-market diversification, expanded platform content, additional value-added manufacturing and potential synergies.
- Backlog may not predict future sales because of order timing, program concentration, delivery delays and possible cancellations. Approximately 57% of reported backlog was attributable to military and space programs and approximately 30% to commercial aerospace.
- Goodwill was $161.9 million at June 30, 2012. Because of a stock-price decline, the company performed an interim DLT impairment test; DLT fair value exceeded carrying value by 9%, and no impairment was recorded. Future impairment could result from sustained stock-price declines, failure to win new business, underperformance or increased competition.
- A qui tam False Claims Act lawsuit involving alleged unapproved parts supplied to Boeing remained unresolved. The government declined to intervene; one relators’ expert estimated government damages at $833 million, but the company stated that it could not estimate its potential liability.
- Environmental reserves included approximately $1.5 million for groundwater matters and $0.6 million for the West Covina landfill. The estimated potential West Covina liability ranged from approximately $0.6 million to $3.3 million.
- The company identified operating leases and indemnities as off-balance-sheet arrangements and stated that historical payments under indemnities had been immaterial.
- The company corrected an immaterial prior-period error involving approximately $379,000 of engineering research and development costs improperly capitalized in inventory.
Investor verification priorities
- Verify the sustainability of LaBarge-driven revenue and earnings contributions, including customer, market and program concentration.
- Assess whether DAS margin pressure from lower-margin products persists and whether DLT growth converts into operating cash flow.
- Reconcile reported operating cash flow with working-capital movements and monitor cash generation relative to required debt service and capital expenditures.
- Review debt maturities, mandatory term-loan amortization, covenant headroom and the 2018 senior-notes maturity.
- Evaluate the sensitivity of DLT goodwill to sales, margin, growth and discount-rate assumptions, given the 9% fair-value cushion.
- Monitor developments in the False Claims Act litigation and environmental matters, for which ultimate exposure was not fully estimable.
- Confirm the recurring versus nonrecurring nature of the state tax benefit and acquisition-related expense reductions.