Ducommun Incorporated 2019 Q2 Form 10-Q Summary
Business context and reporting period
Ducommun provides engineering and manufacturing services for high-performance, high-cost-of-failure products, primarily serving aerospace and defense markets, with additional industrial and medical applications. Reportable segments are Electronic Systems and Structural Systems. The filing covers the three and six months ended June 29, 2019, compared with June 30, 2018. The financial statements are unaudited.
Ducommun adopted ASC 842, Leases, on January 1, 2019 using the additional transition method. Prior-period results remain reported under ASC 840 and are not directly comparable for certain lease-related balance sheet items.
Financial performance and key metrics
| Metric | Q2 2019 | Q2 2018 | First six months 2019 | First six months 2018 |
|---|---|---|---|---|
| Net revenues | $180.5 million | $154.8 million | $353.1 million | $305.3 million |
| Gross profit | $38.1 million | $32.0 million | $73.8 million | $58.8 million |
| Gross margin | 21.1% | 20.7% | 20.9% | 19.3% |
| Operating income | $13.6 million | $5.6 million | $26.5 million | $10.9 million |
| Operating margin | 7.5% | 3.6% | 7.5% | 3.6% |
| Net income | $7.8 million | $1.6 million | $15.3 million | $4.2 million |
| Diluted EPS | $0.66 | $0.14 | $1.30 | $0.36 |
| Adjusted EBITDA | $22.4 million | $18.7 million | $43.5 million | $33.2 million |
| Adjusted EBITDA margin | 12.4% | 12.1% | 12.3% | 10.9% |
Commercial aerospace revenue increased $20.1 million in Q2 and $37.8 million year to date, primarily from higher build rates and additional content on large aircraft platforms. Military and space revenue increased $6.9 million in Q2 and $14.2 million year to date. Industrial revenue declined $1.3 million in Q2 and $4.2 million year to date.
Electronic Systems revenue increased 5.6% in Q2 and 3.9% year to date, while segment operating income increased to $9.9 million from $8.7 million in Q2 and to $19.1 million from $14.4 million year to date. Structural Systems revenue increased 29.7% in Q2 and 29.8% year to date, while segment operating income increased to $11.8 million from $5.0 million in Q2 and to $22.3 million from $9.4 million year to date.
Six-month net cash provided by operating activities was $8.1 million, compared with $26.2 million in the prior-year period. The decline reflected increases in contract assets and inventories, partly offset by higher net income. Capital expenditures were $7.6 million in the quarter and $10.4 million year to date.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $3.3 million at June 29, 2019, compared with $10.3 million at December 31, 2018. Including restricted cash, ending cash was $4.0 million.
- Accounts receivable were $69.4 million, contract assets were $100.5 million, and inventory was $109.3 million at quarter end.
- Total debt was $229.5 million, including a $227.0 million term loan and $2.5 million drawn on the revolving facility. Total debt was $233.0 million at year-end 2018.
- The weighted-average interest rate on debt increased to 6.91% from 4.71% at December 31, 2018. Interest expense was $4.4 million in Q2 and $8.8 million year to date.
- The company had $97.3 million of unused revolving credit capacity, after borrowings and standby letters of credit, and was in compliance with all debt covenants.
- The term loan matures in November 2025 and the revolving credit facility matures in November 2023. Interest-rate cap hedges cover an aggregate $135.0 million of debt and mature through June 2020.
- Management expects 2019 capital expenditures of $16 million to $18 million and believes operating cash flow and available borrowing capacity will provide sufficient liquidity for the next twelve months.
Material changes versus the prior comparable period
- Revenue increased 16.6% in Q2 and 15.7% for the first six months, driven primarily by commercial aerospace and military and space demand.
- Gross margin expanded 40 basis points in Q2 and 160 basis points year to date due to favorable volume, product mix and manufacturing efficiencies, partly offset by higher manufacturing costs.
- Operating income benefited from the absence of restructuring charges recorded in 2018. Restructuring charges declined by $5.4 million in Q2 and $7.6 million year to date; the 2017 restructuring plan was completed as of December 31, 2018.
- SG&A increased $3.3 million in Q2 and $6.8 million year to date, including one-time severance charges and higher compensation and benefit costs.
- Interest expense increased because of higher interest rates and borrowings associated primarily with the Certified Thermoplastics acquisition.
- Backlog declined to $852.7 million from $864.4 million at year-end 2018. Approximately $601.0 million was expected to be delivered during the next twelve months.
- Remaining performance obligations were $666.5 million at June 29, 2019, with approximately 70% expected to be recognized as revenue over the following twelve months.
Guidance, outlook, commentary, risks and unusual items
Management did not provide explicit revenue or earnings guidance in the filing. The company expects to continue investing in tooling, equipment and facilities to support new aerospace and defense programs and stated that acquisitions may remain an important component of future growth.
Key risks include customer concentration, dependence on aerospace and defense programs, potential delivery delays or program cancellations, contract estimate changes and anticipated losses on fixed-price contracts, working-capital requirements, interest-rate exposure, and reliance on operating cash flow and credit facilities. The ten largest customers represented 66.1% of Q2 revenue and 66.6% of year-to-date revenue; Boeing, Raytheon and Spirit were particularly significant customers.
Environmental contingencies include a $1.5 million accrual for groundwater investigation and corrective action and a $0.4 million accrual for the West Covina landfill matter. The estimated range of potential West Covina liabilities was $0.4 million to $3.1 million. Management did not expect these or other litigation and environmental matters to have a material adverse effect, although ultimate liabilities may change.
The company recorded operating lease right-of-use assets of $19.1 million and related operating lease liabilities of $20.8 million at June 29, 2019. Adoption of ASC 842 reduced opening retained earnings by approximately $0.3 million. The filing also reported $5.4 million of unrecognized tax benefits, of which $3.5 million would affect the effective tax rate if recognized.
Management stated that disclosure controls were effective as of June 29, 2019 and that there were no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue growth and backlog conversion remain concentrated in a limited number of commercial aerospace platforms and customers.
- Whether contract assets and inventory continue to consume cash and constrain operating cash flow.
- The effect of higher variable interest rates on interest expense, debt service and covenant compliance.
- Progress toward the stated $16 million to $18 million 2019 capital expenditure plan and the related return on investment.
- Whether the improved margins are sustained after the completion of the restructuring plan and despite higher SG&A and manufacturing costs.
- Potential changes in environmental liabilities, contract-loss estimates, tax positions and other contingencies.
- The comparability of 2019 and 2018 results given the adoption of ASC 842 and the absence of 2018 restructuring charges in 2019.