Ducommun Incorporated 2018 Third-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 serving aerospace and defense, industrial, medical and related markets. Operations are organized into Electronic Systems and Structural Systems. This unaudited Form 10-Q covers the three and nine months ended September 29, 2018, compared with September 30, 2017.
Ducommun adopted ASC 606 on January 1, 2018 using the modified retrospective method. Accordingly, 2018 and 2017 revenue results are not fully comparable because the prior-year amounts remain under ASC 605. ASC 606 increased opening retained earnings by $8.7 million and created $88.1 million of contract assets and $15.1 million of contract liabilities at September 29, 2018.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net revenues | $159.8 million | $138.7 million | $465.1 million | $415.9 million |
| Gross profit | $31.1 million | $26.1 million | $89.9 million | $77.4 million |
| Gross margin | 19.5% | 18.8% | 19.3% | 18.6% |
| Operating income | $6.8 million | $7.3 million | $17.6 million | $18.2 million |
| Operating margin | 4.3% | 5.3% | 3.8% | 4.4% |
| Net income | $4.2 million | $4.7 million | $8.4 million | $10.6 million |
| Diluted EPS | $0.36 | $0.41 | $0.72 | $0.92 |
| Adjusted EBITDA | $18.1 million | $14.6 million | $51.3 million | $40.2 million |
| Adjusted EBITDA margin | 11.3% | 10.5% | 11.0% | 9.7% |
Revenue increased 15.3% in the third quarter and 11.8% for the first nine months. Commercial aerospace revenue increased $16.3 million in the quarter and $45.9 million year to date; military and space revenue increased $6.8 million and $5.2 million, respectively. Industrial revenue declined $2.0 million in the quarter and $1.9 million year to date.
At September 29, 2018, cash and cash equivalents were $3.6 million, compared with $2.2 million at December 31, 2017. Total debt was $230.7 million, including $160.0 million of term debt and $70.7 million drawn on the revolving facility; debt net of issuance costs was $229.4 million. Unused revolving capacity was $129.0 million. The weighted-average debt interest rate increased to 4.50% from 3.73% at December 31, 2017, and the company was in compliance with its credit covenants.
For the first nine months, operating cash flow was $33.4 million, compared with $27.4 million in the prior-year period. Investing cash outflow was $43.4 million, including $30.7 million for the acquisition of Certified Thermoplastics Co., LLC and $12.8 million of capital expenditures. Financing activities provided $11.4 million, resulting in a $1.4 million increase in cash.
Material Changes Versus the Prior Comparable Period
- Gross margin improved by 70 basis points in the quarter and 70 basis points year to date, primarily from favorable product mix and manufacturing volume.
- Operating income and net income declined despite higher revenue because restructuring charges increased by $3.3 million in the quarter and $10.7 million year to date, while interest expense and SG&A also increased.
- Electronic Systems revenue increased 8.5% in the quarter and 5.4% year to date; nine-month segment operating income declined to $23.5 million from $24.4 million.
- Structural Systems revenue increased 24.2% in the quarter and 20.5% year to date; nine-month segment operating income increased to $13.4 million from $8.4 million.
- Backlog increased to $780.1 million from $726.5 million at December 31, 2017, with $552.0 million expected to be delivered within 12 months. Remaining ASC 606 performance obligations were $523.7 million, of which approximately 70% was expected to be recognized within 12 months.
- Ducommun acquired Certified Thermoplastics for approximately $30.8 million in cash on April 23, 2018, funded through the revolving credit facility. The preliminary allocation included $18.3 million of goodwill and $8.0 million of intangible assets.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2018 capital expenditures of $15.0 million to $17.0 million, primarily to support new aerospace and defense contract awards.
- The restructuring plan was expected to generate approximately $14.0 million of annualized savings beginning in 2019. Total pre-tax restructuring charges were estimated at $21.0 million to $23.0 million through 2018; cumulative charges were $19.8 million through September 29, 2018, with additional charges expected in the remainder of 2018.
- Management stated that operating cash flow and available borrowing capacity should provide sufficient liquidity for the next 12 months. Term loan maturity and revolving facility maturity are both June 2020; no mandatory term-loan prepayments were due before maturity after required payments had been made.
- Key risks include customer and program concentration, dependence on aerospace and defense markets, potential delivery delays or cancellations, contract-estimate changes and anticipated contract losses, restructuring execution, leverage and variable interest rates, and environmental remediation obligations.
- The top ten customers represented 62.0% of third-quarter revenue and 62.9% of nine-month revenue. Boeing represented 17.0% of third-quarter revenue and 17.1% year to date.
- Environmental liabilities included a $1.5 million accrual for groundwater investigation and remediation and a $0.4 million accrual for the West Covina landfill; estimated potential West Covina liabilities ranged from $0.4 million to $3.1 million.
- The company early adopted certain accounting standards in 2018 and expected to adopt the new lease standard in 2019. The precise balance-sheet impact of lease adoption was not yet determinable.
Important Facts for Investors to Verify
- Reconcile 2018 results under ASC 606 with 2017 results under ASC 605 before assessing growth, margins or earnings trends.
- Evaluate whether the restructuring program delivers the projected $14.0 million of annualized savings and whether further charges remain within the estimated range.
- Monitor debt balances, interest rates, covenant compliance and the June 2020 maturity profile.
- Assess conversion of the $780.1 million backlog and $523.7 million of ASC 606 remaining performance obligations into revenue and cash flow.
- Review customer concentration and exposure to commercial aerospace build rates, defense programs and potential program cancellations.
- Track the final purchase-price allocation for Certified Thermoplastics, including goodwill and intangible-asset valuations.
- Confirm the eventual effect of ASC 842 lease adoption and the resolution or escalation of environmental contingencies.