Ducommun Incorporated 10-Q Summary
Business Context and Reporting Period
Ducommun provides engineering and manufacturing services for high-performance, high-cost-of-failure applications, primarily in aerospace and defense, with additional industrial and medical exposure. Operations are reported through Electronic Systems and Structural Systems. This unaudited Form 10-Q covers the three and nine months ended October 1, 2016, compared with October 3, 2015.
Financial Performance and Key Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net revenues | $132.6 million | $161.7 million | $408.2 million | $509.4 million |
| Gross profit / margin | $25.2 million / 19.0% | $20.0 million / 12.4% | $78.4 million / 19.2% | $78.0 million / 15.3% |
| Operating income | $8.1 million | $(1.2) million | $19.6 million | $13.3 million |
| Net income (loss) | $5.0 million | $(9.5) million | $22.4 million | $(9.7) million |
| Diluted EPS | $0.44 | $(0.86) | $1.99 | $(0.88) |
| Adjusted EBITDA | $14.9 million | $6.6 million | $39.8 million | $38.5 million |
| Adjusted EBITDA margin | 11.2% | 4.1% | 9.7% | 7.5% |
Net cash provided by operating activities was $27.5 million for the first nine months, compared with $12.1 million in the prior-year period. Investing activities provided $42.6 million, primarily from $55.3 million of divestiture proceeds, partially offset by $12.7 million of capital expenditures. Financing activities used $66.1 million, principally due to $65.0 million of term-loan repayments. Capital expenditures totaled $11.9 million through nine months; management expected full-year 2016 capital expenditures of $18 million to $22 million.
At October 1, 2016, cash and cash equivalents were $9.5 million, total debt was $180.0 million, and unused revolving-credit capacity was $198.5 million after standby letters of credit. The weighted-average debt interest rate was 3.35%, and the company was in compliance with its credit-facility covenants. Debt matures in 2020, subject to mandatory amortization and voluntary prepayments.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue declined 18.0% and nine-month revenue declined 19.9%, primarily because of the Pittsburgh and Miltec divestitures, the Houston facility closure, program cancellations, budget changes and delayed deliveries.
- Commercial aerospace revenue increased by $4.5 million in the quarter and $6.4 million year to date, reflecting additional content with existing customers.
- Gross margin improved materially because the prior-year periods included $10.0 million and $12.2 million forward-loss reserves on a regional-jet program, while material-cost ratios also improved through supply-chain initiatives and operating improvements.
- Structural Systems quarterly revenue decreased 5.0% to $60.9 million, but segment operating income improved to $5.9 million from a $6.0 million loss. Electronic Systems revenue decreased 26.5% to $71.6 million and segment operating income declined to $6.6 million from $8.6 million.
- Interest expense declined to $1.9 million from $3.4 million in the quarter and to $6.3 million from $16.5 million year to date, reflecting lower debt balances and refinancing completed in 2015.
- Nine-month results included an $18.8 million pretax gain from the Pittsburgh and Miltec divestitures. The prior-year periods included debt-extinguishment losses of $11.9 million in the quarter and $14.7 million year to date.
Guidance, Outlook, Risks and Unusual Items
- Backlog increased to $566.3 million at October 1, 2016, including $453.0 million expected to be delivered over the following 12 months. Management cautioned that backlog is concentrated, subject to delivery delays and program cancellations, and may not reliably predict revenue.
- Management expected operating cash flow and available revolver capacity to provide sufficient liquidity for the next 12 months and planned capital spending primarily to support new contract awards and higher-complexity programs.
- The company remains exposed to aerospace and defense program cancellations, budget changes, delayed deliveries, customer concentration and commercial aerospace softness. The top ten customers represented 57.7% of third-quarter revenue; Boeing represented 17.8%.
- Contract profitability depends on estimates of future revenue, costs, manufacturing efficiency and customer claims. Additional forward-loss reserves could be required if assumptions do not materialize.
- Goodwill of $82.6 million, all in Electronic Systems, was not impaired. Management noted that a sustained decline in market capitalization, adverse industry trends or operating underperformance could trigger an interim impairment test.
- A material weakness in internal control over financial reporting relating to labor-hour accuracy and classification for percentage-of-completion contracts remained unremediated at October 1, 2016. Management therefore concluded that disclosure controls and procedures were not effective at that date.
- Environmental matters include groundwater remediation at El Mirage and Monrovia, California, for which $1.5 million was accrued, and a West Covina landfill matter with estimated future exposure of $0.4 million to $3.1 million; $0.4 million was accrued.
- The IRS commenced an audit of the 2014 tax year. Unrecognized tax benefits were $2.9 million, of which $2.0 million could affect the annual tax rate if recognized.
- The company used interest-rate caps covering $135.0 million of debt through June 2020. Management stated that a hypothetical 10% interest-rate change would have an immaterial impact.
Important Facts for Investors to Verify
- Whether revenue declines from divestitures, defense-program changes and facility closures stabilize, and whether commercial aerospace growth continues.
- Whether improved gross margins are sustained after the absence of prior-year forward-loss charges.
- Progress and final effectiveness of remediation for the material internal-control weakness.
- Debt repayment capacity, mandatory amortization requirements, covenant compliance and available revolver liquidity.
- Conversion of the $566.3 million backlog into revenue, particularly the $453.0 million expected within 12 months.
- Potential additional contract-loss reserves, goodwill impairment indicators, environmental costs and tax-audit exposure.