Ducommun Incorporated 10-Q Summary
Business Context and Reporting Period
Ducommun provides engineering and manufacturing services primarily for aerospace and defense customers, with additional industrial, natural resources, medical and other exposure. Operations are reported through Structural Systems and Electronic Systems. This unaudited filing covers the three months ended April 2, 2016, compared with the three months ended April 4, 2015.
Financial Results and Key Metrics
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net revenue | $142.1 million | $172.9 million |
| Gross profit / margin | $27.0 million / 19.0% | $26.8 million / 15.5% |
| Operating income / margin | $4.3 million / 3.0% | $3.6 million / 2.1% |
| Net income (loss) | $13.6 million | $(2.0) million |
| Diluted EPS | $1.21 | $(0.18) |
| Adjusted EBITDA | $11.1 million / 7.8% of revenue | $12.2 million / 7.0% |
| Cash flow from operations | $5.5 million | $3.5 million |
Revenue declined 17.8% year over year, while gross profit increased slightly because of lower material costs, favorable product mix and manufacturing efficiencies. SG&A declined to $22.7 million from $23.1 million. Interest expense fell to $2.4 million from $6.7 million following debt refinancing and principal repayments.
Net income included an $18.8 million pretax gain from the Pittsburgh and Miltec divestitures. Excluding the gain, reported profitability was materially lower than the GAAP result. Income tax expense was $7.2 million, representing an effective rate of approximately 35%.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $6.4 million at April 2, 2016, compared with $5.5 million at December 31, 2015.
- Total debt was $190.0 million, net of approximately $4.0 million of debt issuance costs, versus $245.0 million at year-end 2015.
- The company made $55.0 million of voluntary term-loan principal repayments during the quarter.
- Approximately $198.5 million of revolving credit capacity was unused, after approximately $1.5 million of standby letters of credit.
- The senior secured term loan and revolving facility mature June 26, 2020. The company reported compliance with all debt covenants.
- Operating cash flow was partly offset by $3.8 million of property and equipment purchases. Cash provided by investing activities was $51.5 million, primarily from $55.3 million of divestiture proceeds, while financing activities used $55.9 million.
- Management expects 2016 capital expenditures of approximately $18 million to $22 million, principally to support new contract awards and tooling requirements.
Material Changes Versus the Prior Comparable Period
- Structural Systems revenue decreased 11.2% to $64.0 million, while segment operating income increased to $2.7 million from $2.1 million.
- Electronic Systems revenue decreased 22.5% to $78.1 million, primarily because of the Pittsburgh divestiture, the Houston facility closure and lower military and space demand. Segment operating income increased to $7.1 million from $6.3 million.
- Industrial revenue decreased approximately $18.0 million, and military and space revenue decreased approximately $13.2 million. Commercial aerospace revenue increased modestly.
- Management expects Electronic Systems revenue to be approximately $20 million lower per quarter going forward as a result of the Houston closure and the Pittsburgh and Miltec divestitures.
- Backlog increased to $563.5 million from $545.8 million at December 31, 2015; approximately $450.8 million was expected to be delivered within 12 months. Management cautions that backlog is subject to delays, cancellations and concentration in several programs.
- The company completed the Pittsburgh sale on January 22, 2016, for preliminary cash proceeds of approximately $38.5 million, and the Miltec sale on March 25, 2016, for preliminary cash proceeds of approximately $14.6 million.
- Restructuring actions continued, including closure of the St. Louis facility in April 2016. Approximately $1.5 million of restructuring liabilities remained accrued at quarter-end, and the company did not expect additional accruals for the stated plans.
Outlook, Risks, Contingencies and Unusual Items
- Management expects operating cash flow and available revolver capacity to provide sufficient liquidity for the next 12 months.
- Demand is exposed to U.S. government defense spending, shifting defense priorities, delayed platform deliveries, commercial aerospace program changes and industrial-market weakness.
- Customer concentration is significant: the top ten customers represented 59% of first-quarter revenue; Boeing represented 19% and Raytheon 7%.
- Interest-rate exposure remains material because the $190.0 million term loan carries variable-rate pricing. Interest-rate cap hedges cover approximately $135.0 million of debt and mature in June 2020.
- Goodwill and intangible assets totaled approximately $190.9 million at April 2, 2016. Management concluded that no goodwill impairment triggering event occurred, but stated that a sustained decline in market capitalization or other adverse developments could require testing.
- Forward-loss reserves were approximately $10.2 million. Contract-loss estimates depend on future revenue, completion costs, manufacturing efficiencies and the resolution of customer claims.
- Environmental reserves included approximately $1.5 million for groundwater matters and approximately $0.4 million for the West Covina landfill; estimated future West Covina exposure was between $0.4 million and $3.1 million.
- A previously dismissed False Claims Act lawsuit involving Boeing and Ducommun remained on appeal. Relators had alleged damages of up to $1.6 billion, but the filing states that the company did not expect its litigation matters to have a material adverse effect.
- Disclosure controls were ineffective because a material weakness in internal control over financial reporting related to labor-hour classification and monitoring for percentage-of-completion contracts had not been remediated. Management expected to complete remediation during 2016 but provided no assurance that it would do so.
Most Important Facts to Verify
- Whether the $18.8 million divestiture gain is clearly separated from recurring operating performance in valuation analyses.
- Whether the projected $20 million quarterly reduction in Electronic Systems revenue is offset by backlog conversion, new awards or additional commercial aerospace content.
- The sustainability of the improved 19.0% gross margin despite lower revenue and ongoing program and defense-spending pressures.
- Progress toward remediation of the material weakness and any resulting effects on contract estimates or forward-loss reserves.
- Compliance with term-loan covenants, required principal amortization and variable-rate debt exposure.
- Realization of the $563.5 million backlog, including customer concentration, delivery timing and cancellation or delay risk.
- Final purchase-price and working-capital adjustments for the Pittsburgh and Miltec divestitures, as the reported proceeds and gains were preliminary.