Ducommun Incorporated: 2016 Q2 Form 10-Q Summary
Business Context and Reporting Period
Ducommun provides engineering and manufacturing services for aerospace, defense and industrial applications through its Structural Systems and Electronic Systems segments. The unaudited filing covers the three and six months ended July 2, 2016, compared with July 4, 2015; balance-sheet comparisons are to December 31, 2015.
Key Financial Metrics
| Metric | Q2 2016 | Q2 2015 | Six Months 2016 | Six Months 2015 |
|---|---|---|---|---|
| Revenue | $133.4 million | $174.8 million | $275.6 million | $347.8 million |
| Gross profit / margin | $26.2 million / 19.6% | $31.2 million / 17.8% | $53.2 million / 19.3% | $58.0 million / 16.7% |
| Operating income / margin | $7.3 million / 5.4% | $10.8 million / 6.2% | $11.6 million / 4.2% | $14.5 million / 4.2% |
| Net income (loss) | $3.9 million | $1.8 million | $17.4 million | $(0.2) million |
| Diluted EPS | $0.34 | $0.16 | $1.55 | $(0.02) |
| Adjusted EBITDA | $13.7 million | $19.7 million | $24.9 million | $31.9 million |
| Adjusted EBITDA margin | 10.3% | 11.3% | 9.0% | 9.2% |
Six-month operating cash flow was $12.1 million, compared with $17.6 million in the prior-year period. Capital expenditures were $7.6 million in the cash-flow statement, or $7.3 million in segment reporting. Divestiture proceeds were $55.3 million, producing $47.7 million of investing cash flow. Financing cash flow was $(56.0) million, primarily reflecting $60.0 million of voluntary term-loan repayments.
At July 2, 2016, cash and equivalents were $9.2 million, total debt was $190.0 million, and net debt was approximately $180.8 million. Unused revolving-credit capacity was $193.5 million after standby letters of credit. The weighted-average debt rate was 3.14%, and management reported compliance with all debt covenants. The credit facilities mature June 26, 2020.
Inventory increased to $127.6 million from $115.4 million at year-end, while total assets declined to $520.3 million from $557.1 million, largely reflecting completed divestitures. Shareholders’ equity increased to $205.4 million from $187.3 million.
Material Changes Versus the Prior Comparable Period
- Revenue declined 23.7% in the quarter and 20.8% for the six-month period. Management attributed the decline primarily to the Pittsburgh and Miltec divestitures, the Houston facility closure, program cancellations and budget changes affecting military and space programs, and delayed deliveries.
- Structural Systems revenue declined 20.2% in the quarter and 15.8% year to date. Electronic Systems revenue declined 26.3% and 24.4%, respectively.
- Gross margin improved to 19.6% from 17.8% in the quarter and to 19.3% from 16.7% year to date, driven principally by lower material costs, supply-chain initiatives, improved operating performance and product mix.
- Interest expense fell by $4.5 million in the quarter and $8.8 million year to date, reflecting lower debt balances and refinancing benefits.
- Six-month net income included an $18.8 million pretax gain from selling the Pittsburgh and Miltec operations. The divestitures generated $55.3 million of cash proceeds.
- Backlog was $537.2 million at July 2, 2016, down from $545.8 million at December 31, 2015; $429.7 million was expected to be delivered within the next 12 months. The filing cautions that backlog is subject to delivery delays and cancellations.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2016 capital expenditures of $18 million to $22 million, funded primarily by operating cash flow, to support new contract awards and tooling requirements.
- Management stated that operating cash flow and revolving-credit availability should provide sufficient liquidity for the next 12 months.
- The company is exposed to aerospace and defense program changes, customer concentration, delivery delays, cancellations, commercial aerospace softness, industrial-market weakness and contract-estimate risk. The ten largest customers represented 56% of quarterly revenue and 56% of six-month revenue; Boeing represented 17% and 18%, respectively.
- Forward-loss reserves were $8.0 million at July 2, 2016. Estimates depend on future revenue, costs to complete, manufacturing efficiencies, cost reductions and customer claims resolution.
- Goodwill of approximately $82.6 million was concentrated in Electronic Systems. No impairment was recorded, but management stated that sustained market-capitalization declines, underperformance or adverse industry conditions could trigger an impairment review.
- A previously reported material weakness in controls over labor-hour classification and monitoring for percentage-of-completion contracts had not been remediated. Consequently, management concluded that disclosure controls and procedures were ineffective as of July 2, 2016, although remediation was in progress.
- Environmental liabilities included a $1.5 million accrual for groundwater matters and a $0.4 million accrual for the West Covina landfill; estimated potential West Covina exposure ranged from $0.4 million to $3.1 million. Management did not expect other litigation or contingencies to have a material adverse effect.
- Restructuring activities produced $0.2 million of 2016 charges, with $1.1 million of restructuring liabilities remaining at July 2, 2016. Management did not expect additional charges under the disclosed plans.
- New revenue-recognition guidance was scheduled to become effective for Ducommun on January 1, 2018; the company was evaluating its impact. The company also expected new lease accounting guidance to affect its financial statements beginning January 1, 2019.
Most Important Facts for Investors to Verify
- Whether revenue weakness from divestitures, program changes and delayed deliveries stabilizes and whether backlog converts to revenue as scheduled.
- Whether improved gross margins are sustainable after accounting for lower volume, mix, material costs and potential contract-loss adjustments.
- Progress and independent validation of remediation of the material weakness in internal controls.
- Debt repayment capacity, mandatory term-loan amortization, variable-rate exposure and continued covenant compliance.
- Inventory growth, forward-loss reserves and contract-cost estimates, particularly for percentage-of-completion contracts.
- Potential goodwill impairment triggers and the ultimate cost of environmental and other contingent liabilities.