Ducommun Incorporated 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, and medical markets. Operations are reported through Structural Systems and Electronic Systems. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2018, compared primarily with the periods ended July 1, 2017.
Ducommun adopted ASC 606 on January 1, 2018 using the modified retrospective method. Accordingly, 2018 results and 2017 comparative results are reported under different revenue-recognition standards, which limits direct comparability.
Financial performance and position
| Metric | Three months ended June 30, 2018 | Three months ended July 1, 2017 | Six months ended June 30, 2018 | Six months ended July 1, 2017 |
|---|---|---|---|---|
| Net revenue | $154.8 million | $140.9 million | $305.3 million | $277.2 million |
| Gross profit | $32.0 million | $26.3 million | $58.8 million | $51.3 million |
| Gross margin | 20.7% | 18.6% | 19.3% | 18.5% |
| Operating income | $5.6 million | $6.6 million | $10.9 million | $10.9 million |
| Net income | $1.6 million | $3.8 million | $4.2 million | $5.9 million |
| Diluted EPS | $0.14 | $0.33 | $0.36 | $0.51 |
| Adjusted EBITDA | $18.7 million | $13.7 million | $33.2 million | $25.6 million |
| Adjusted EBITDA margin | 12.1% | 9.7% | 10.9% | 9.2% |
Reported quarterly revenue increased approximately 9.9%, while six-month revenue increased approximately 10.1%. Growth was led by commercial aerospace, partially offset by lower industrial revenue. Commercial aerospace revenue increased $16.1 million in the quarter and $29.6 million for the six-month period. Military and space revenue increased modestly.
Quarterly gross margin improved by 210 basis points, and six-month gross margin improved by 80 basis points, primarily from higher manufacturing volume and favorable product mix. Operating income was broadly flat year over year because restructuring charges, higher interest expense, and higher corporate and selling expenses offset the gross-profit improvement.
Structural Systems revenue increased to $70.3 million in the quarter from $59.1 million, and segment operating income increased to $5.0 million from $2.1 million. Electronic Systems revenue increased to $84.5 million from $81.8 million, while segment operating income declined to $8.7 million from $8.9 million.
At June 30, 2018, cash and cash equivalents were $3.5 million, total assets were $631.9 million, total liabilities were $381.9 million, and shareholders’ equity was $250.0 million. Total debt was $232.7 million, consisting of a $160.0 million term loan and $72.7 million drawn on the revolving facility. The weighted-average interest rate was 4.31%.
| Cash flow metric | Six months ended June 30, 2018 | Six months ended July 1, 2017 |
|---|---|---|
| Operating cash flow | $26.2 million | $16.2 million |
| Investing cash flow | $(38.4) million | $(16.2) million |
| Financing cash flow | $13.6 million | $(0.1) million |
| Capital expenditures | $7.5 million | $16.2 million |
The company had $127.0 million of unused revolving-credit capacity after borrowings and standby letters of credit. It reported compliance with all debt covenants. The term loan and revolving facility mature June 26, 2020; no mandatory term-loan payments were due before maturity because required prepayments had been made.
Material changes versus the prior comparable period
- Revenue increased, principally due to higher commercial-aircraft build rates and related customer demand.
- Net income declined 58% in the quarter and 29% for the six-month period, primarily because of restructuring charges and higher interest expense.
- Restructuring charges were $5.2 million in the quarter and $7.4 million for the six-month period; additional restructuring-related costs of $0.2 million were included in cost of sales.
- Management finalized a plan to close the Phoenix Electronic Systems operation by December 31, 2018. The company estimates total pre-tax restructuring charges of $20.0 million to $22.0 million through 2018, including $8.8 million recorded in 2017.
- Ducommun acquired Certified Thermoplastics Co., LLC on April 23, 2018 for approximately $30.5 million net of cash acquired, funded through the revolving credit facility. The preliminary allocation included $18.6 million of goodwill and $8.0 million of identifiable intangible assets.
- Goodwill increased to $136.1 million from $117.4 million, primarily from the CTP acquisition. Total goodwill and intangible assets were $253.5 million.
- ASC 606 increased opening retained earnings by $8.7 million and created $81.7 million of contract assets and $15.2 million of contract liabilities at June 30, 2018. It also materially changed reported inventory and revenue timing.
- Backlog increased to $823.0 million from $726.5 million at December 31, 2017; $558.0 million was expected to be delivered over the following 12 months.
Guidance, outlook, risks and unusual items
- Management expects 2018 capital expenditures of $15.0 million to $17.0 million, primarily to support new Structural Systems and Electronic Systems programs.
- Restructuring actions are expected to generate annualized savings of approximately $14.0 million beginning in 2019, although additional 2018 charges were expected.
- Management stated that operating cash flow and available borrowing capacity should provide sufficient liquidity for the next 12 months.
- Interest-rate exposure is the principal disclosed market risk. The company uses interest-rate cap hedges covering an aggregate $135.0 million of debt; management indicated that a hypothetical 10% rate change would have an immaterial effect.
- Customer concentration is significant: the top ten customers represented 65.4% of quarterly revenue and 63.5% of six-month revenue. Boeing represented 16.1% and 17.1%, respectively.
- Revenue and profit depend on estimates of contract costs, productivity, material availability, subcontractor performance, and contract profitability. Changes in estimates may cause cumulative catch-up adjustments or loss recognition.
- Environmental matters include groundwater remediation at El Mirage and Monrovia, California, with a $1.5 million accrual, and a West Covina landfill matter with an estimated exposure range of $0.4 million to $3.1 million and a $0.4 million accrual. Management did not expect these matters to have a material adverse effect.
- The company had $5.4 million of unrecognized tax benefits at June 30, 2018, of which $3.6 million would affect the effective tax rate if recognized.
- Management reported no material changes to the risk factors disclosed in the 2017 Form 10-K and stated that disclosure controls were effective.
Most important facts for investors to verify
- Reconcile 2018 revenue, margins, contract assets, contract liabilities, inventory, and retained earnings under ASC 606 against the non-comparable 2017 presentation.
- Track execution of the Phoenix closure, remaining restructuring charges, cash payments, asset impairments, and the projected $14.0 million of annualized savings.
- Assess leverage, interest-rate exposure, covenant compliance, and the June 2020 maturity of the term loan and revolving facility.
- Evaluate whether the $823.0 million backlog and $524.3 million of remaining ASC 606 performance obligations convert into revenue as expected, recognizing that orders may be delayed or cancelled.
- Monitor commercial aerospace build rates, customer concentration, industrial-market weakness, and segment-level profitability.
- Review the final purchase-price allocation and operating contribution of Certified Thermoplastics, including goodwill and intangible-asset valuations.
- Confirm the ultimate cost and timing of environmental remediation, tax contingencies, and other legal or contractual obligations.