Ducommun Incorporated 10-Q Summary
Business Context and Reporting Period
Ducommun designs and manufactures aerospace structural components, electronic and electromechanical systems, and provides engineering and program-management services, primarily for aerospace, defense, space and selected commercial markets. The filing covers the three and six months ended July 2, 2011, compared with July 3, 2010, and the balance sheet as of July 2, 2011.
On June 28, 2011, Ducommun acquired all outstanding shares of LaBarge, Inc. for $325.3 million, net of cash acquired and excluding acquisition costs. LaBarge was consolidated beginning June 29, 2011; therefore, its contribution to reported second-quarter sales was only $0.9 million.
Financial Performance and Position
| Metric | Q2 2011 | Q2 2010 | Six Months 2011 | Six Months 2010 |
|---|---|---|---|---|
| Net sales | $108.0 million | $102.9 million | $207.6 million | $207.2 million |
| Operating income/(loss) | $(2.6) million | $9.0 million | $1.7 million | $15.9 million |
| Net income/(loss) | $(3.0) million | $5.7 million | $(0.1) million | $9.9 million |
| Diluted EPS | $(0.28) | $0.53 | Not meaningful due to loss | $0.94 |
| Gross margin | 19.4% | 21.7% | 19.0% | 20.1% |
| SG&A as a percentage of sales | 21.8% | 12.9% | 18.2% | 12.4% |
Q2 sales increased 5.0%, driven by regional-jet and large commercial-aircraft programs, partly offset by lower military-aircraft and engineering-services revenue. Six-month sales were essentially flat. Commercial sales increased to 47% of Q2 sales from 40% in the prior-year quarter, while military and space sales declined to 53% from 60%.
Margins declined primarily because of a higher mix of lower-margin programs and slightly weaker operating performance at Ducommun AeroStructures. Prior-year margins also benefited from a $1.1 million reversal of prior-period accounts-payable accruals. SG&A included $10.1 million of LaBarge acquisition-related expenses in Q2 and $11.5 million for the six-month period. Interest expense included an $831,000 write-off of unamortized financing costs related to acquisition financing.
At July 2, 2011, total assets were $872.9 million, including $216.9 million of goodwill and $193.5 million of intangible assets. Total liabilities were $617.8 million and shareholders’ equity was $255.1 million.
Six-month operating cash flow was negative $22.9 million, compared with negative $9.3 million in the prior-year period. The outflow reflected higher accounts receivable and inventory, payments of previously accrued liabilities and acquisition-related expenses. Investing cash flow was negative $331.1 million, principally due to the LaBarge acquisition and $5.8 million of capital expenditures.
Cash and cash equivalents increased to $31.4 million from $10.3 million at December 31, 2010, primarily because financing activities provided $375.0 million. Total debt was $393.4 million, consisting principally of $200.0 million of senior unsecured notes and a $190.0 million senior secured term loan. The weighted-average borrowing rate was 7.66%. The company had no revolver borrowings, $58.4 million of unused revolving capacity after standby letters of credit, and was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- LaBarge was acquired and added substantial assets, goodwill, intangible assets and debt to the balance sheet.
- Q2 operating results shifted from $9.0 million of operating income to a $2.6 million operating loss; six-month operating income declined from $15.9 million to $1.7 million.
- Q2 net income of $5.7 million became a net loss of $3.0 million, while the six-month period moved from $9.9 million of net income to a $50,000 net loss.
- Gross margin fell 230 basis points in Q2 and 110 basis points for the six-month period.
- SG&A increased substantially because of acquisition-related costs and organizational changes.
- Backlog increased to $581.6 million at July 2, 2011, from $328.0 million at December 31, 2010; approximately $272.2 million was expected to be delivered during the remainder of 2011. The increase included $237.6 million of LaBarge backlog.
Guidance, Outlook, Risks and Unusual Items
Management expected operating cash flow and available bank capacity to provide sufficient liquidity for the next twelve months. It expected approximately $16.0 million of capital expenditures in 2011, primarily to support new contract awards, LaBarge operations and offshore manufacturing expansion. No formal earnings or revenue guidance was provided.
Management expected the LaBarge acquisition to expand aerospace and defense capabilities, diversify end markets, increase value-added manufacturing content, broaden the technology portfolio and create potential synergies. The filing cautions that integration costs, employee retention, customer retention, unidentified liabilities and failure to realize synergies could adversely affect results.
Key risks include substantial leverage, variable-rate debt, restrictive debt covenants, dependence on major customers and government spending, aerospace-market cyclicality, fixed-price contract cost overruns, competitive pricing pressure, supply-chain constraints, program delays or cancellations, goodwill impairment and environmental liabilities.
Ducommun was defending five putative class actions related to the LaBarge acquisition. A Delaware settlement memorandum was subject to a definitive agreement and court approval, while related Missouri actions were stayed. The company also faced a False Claims Act qui tam action involving alleged unapproved parts supplied to Boeing; the government declined to intervene, and Ducommun could not estimate potential liability. Environmental reserves included approximately $1.5 million for groundwater matters, $120,000 for the Casmalia landfill and $843,000 for the West Covina landfill.
The company disclosed total contractual obligations of $622.3 million, including $393.4 million of long-term debt and $198.8 million of future interest. Management stated that the disclosed contingencies were not expected to have a material adverse effect, although outcomes remained uncertain.
Important Facts for Investors to Verify
- Whether LaBarge integration delivers expected revenue, margin and synergy benefits after the limited post-acquisition contribution in this filing.
- Debt covenant compliance, cash generation and the company’s ability to service approximately $393.4 million of debt.
- Whether gross-margin pressure and elevated SG&A were temporary or represent a continuing deterioration in operating performance.
- Backlog conversion, customer order timing and exposure to Boeing, Raytheon, United Technologies and government programs.
- The ultimate resolution and financial impact of the LaBarge shareholder litigation and the False Claims Act case.
- Potential changes to preliminary LaBarge purchase-price allocations, including goodwill and acquired intangible assets.
- Future environmental remediation costs and potential goodwill impairment if operating results do not meet projections.