Ducommun Incorporated: 2017 First-Quarter 10-Q Summary
Business Context and Reporting Period
Ducommun provides engineering and manufacturing services primarily for aerospace and defense, with additional industrial and medical exposure. Operations are reported through the Structural Systems and Electronic Systems segments. The filing covers the three months ended April 1, 2017, compared with the three months ended April 2, 2016. Financial statements are unaudited.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $136.3 million | $142.1 million | Down 4.1% |
| Gross profit | $24.9 million | $27.0 million | Down 7.6% |
| Gross margin | 18.3% | 19.0% | Down 70 basis points |
| Operating income | $4.1 million | $4.3 million | Down 4.5% |
| Operating margin | 3.0% | 3.0% | Approximately flat |
| Net income | $2.1 million | $13.6 million | Down 84.4% |
| Diluted EPS | $0.18 | $1.21 | Down $1.03 |
| Adjusted EBITDA | $11.7 million | $11.1 million | Up 5.0% |
| Adjusted EBITDA margin | 8.6% | 7.8% | Up 80 basis points |
| Cash flow from operations | $13.2 million | $5.5 million | Up $7.8 million |
Interest expense was $1.6 million, compared with $2.4 million in the prior year. The effective tax rate was 15.6%, compared with 34.6% in Q1 2016. The prior-year results included an $18.8 million pretax gain from divestitures, which materially inflated prior-year pretax income and earnings.
Financial Position, Debt and Liquidity
- Cash and cash equivalents were $7.1 million at April 1, 2017, compared with $7.4 million at December 31, 2016.
- Total debt was $165.0 million, down from $170.0 million at year-end 2016. Net debt, using reported cash, was approximately $157.9 million.
- The company made $5.0 million of voluntary principal prepayments during the quarter. The term loan and revolving facility mature June 26, 2020.
- Unused revolving credit capacity was $199.0 million, after $1.0 million reserved for standby letters of credit. The company reported compliance with all debt covenants.
- Current assets were $227.6 million and current liabilities were $91.4 million, implying reported current ratio of approximately 2.5x.
- Inventory increased to $127.2 million from $119.9 million at year-end, while accounts receivable declined to $71.6 million from $76.2 million.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because of lower commercial aerospace revenue, including the wind-down of a regional jet program and transition of a large aircraft program, and lower industrial revenue following facility closure and prior divestitures.
- Military and space revenue increased by approximately $5.9 million due mainly to resumed scheduled U.S. Department of Defense deliveries.
- Structural Systems revenue decreased 10.1% to $57.6 million; segment operating income was broadly flat at $2.6 million.
- Electronic Systems revenue increased 0.8% to $78.7 million; segment operating income increased to $7.1 million from $6.4 million.
- Gross margin declined because of unfavorable product mix, while SG&A declined $1.8 million, partly reflecting divestitures and facility closures.
- Operating cash flow improved despite lower net income, primarily because of lower accounts receivable and higher deferred income taxes.
- Investing cash flow changed from $51.5 million of inflow in Q1 2016 to $6.8 million of outflow in Q1 2017 because the prior year included approximately $55.3 million of divestiture proceeds.
Guidance, Outlook, Risks and Unusual Items
- Management expects 2017 capital expenditures of $22 million to $26 million, principally to support the Parsons, Kansas facility and new contract awards.
- Backlog was $580.9 million at April 1, 2017, down from $600.3 million at December 31, 2016; $464.7 million was expected to be delivered within the next 12 months. Management cautions that backlog is subject to delays, cancellations and program concentration.
- Management expects operating cash flow and available borrowing capacity to provide sufficient liquidity for the next 12 months, but the company depends on both sources to meet obligations.
- Revenue recognition standard ASC 606 is expected to affect reported revenue, cost of sales and related items. The company anticipated adopting the modified retrospective method in the first quarter of 2018 and expected that most revenue would be recognized over time rather than at a point in time.
- A material weakness in internal control over financial reporting related to income-tax accounting and disclosures remained unremediated. Management concluded that disclosure controls and procedures were ineffective as of April 1, 2017, although remediation efforts were underway.
- Environmental liabilities included $1.5 million accrued for groundwater matters and $0.4 million accrued for the West Covina landfill; estimated West Covina exposure ranged from $0.4 million to $3.1 million.
- Goodwill was $82.6 million net, all associated with Electronic Systems. Management did not identify a triggering event requiring an interim impairment test but noted that a sustained decline in market capitalization or other adverse developments could change that conclusion.
- Customer concentration is significant: the top ten customers represented 63.3% of Q1 revenue, compared with 58.2% in the prior-year quarter.
- Interest-rate exposure exists on variable-rate debt, although management stated that a hypothetical 10% rate change would have an immaterial effect on financial condition and results.
Most Important Facts for Investors to Verify
- Whether the decline in commercial aerospace and industrial revenue stabilizes and whether defense delivery activity remains strong.
- Whether backlog conversion supports revenue growth despite the $19.4 million sequential backlog decline.
- Progress and final remediation of the income-tax internal-control material weakness.
- Actual 2017 capital expenditures and their effect on free cash flow and leverage reduction.
- The effect of ASC 606 adoption on revenue timing, backlog conversion and opening retained earnings.
- Customer concentration, program transitions and potential cancellations or delays affecting the largest aerospace and defense contracts.
- Changes in goodwill impairment indicators, environmental obligations and forward-loss reserves.