Business Context and Reporting Period
Ducommun Incorporated is a global manufacturer of engineered products and manufacturing solutions primarily for 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 September 30, 2023, compared with October 1, 2022.
In April 2023, Ducommun acquired BLR Aerospace for approximately $117.0 million in cash, including $41.2 million of goodwill and $55.5 million of identifiable intangible assets. BLR is included in Structural Systems from the acquisition date.
Key Financial Metrics
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Net revenue | $196.3 million | $186.6 million | $564.8 million | $524.3 million |
| Gross profit | $44.6 million | $38.6 million | $121.5 million | $105.7 million |
| Gross margin | 22.7% | 20.7% | 21.5% | 20.2% |
| Operating income | $8.6 million | $13.2 million | $20.0 million | $30.1 million |
| Operating margin | 4.4% | 7.1% | 3.5% | 5.7% |
| Net income | $3.2 million | $8.5 million | $10.8 million | $20.7 million |
| Diluted EPS | $0.22 | $0.69 | $0.79 | $1.68 |
| Adjusted EBITDA | $29.3 million | $26.0 million | $78.5 million | $70.2 million |
| Adjusted EBITDA margin | 14.9% | 13.9% | 13.9% | 13.4% |
Net cash provided by operating activities was $4.6 million in the first nine months of 2023 versus $0.6 million in the prior-year period. Capital expenditures were $15.8 million, and total cash used in investing activities was $130.0 million, principally reflecting the BLR acquisition.
At September 30, 2023, cash and cash equivalents were $27.2 million, total debt was $272.6 million, and unused revolving credit capacity was $171.0 million. The weighted-average interest rate on debt was 7.43%, compared with 4.36% at December 31, 2022. Management stated that the company was in compliance with all credit-facility covenants.
Total assets were $1.14 billion and shareholders’ equity was $635.4 million at September 30, 2023. Inventories increased to $215.2 million from $171.2 million at year-end 2022, while contract assets remained broadly stable at $191.2 million.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue increased 5.2%, driven by higher commercial aerospace revenue and higher military and space revenue. Nine-month revenue increased 7.7%, primarily from commercial aerospace growth, partially offset by lower military and space revenue.
- Structural Systems revenue increased 16.9% in the quarter and 18.5% year to date, supported by commercial aerospace build rates and the BLR acquisition. Electronic Systems revenue declined 2.4% in the quarter but increased 0.9% year to date.
- Gross margin improved by 200 basis points in the quarter and 130 basis points year to date, reflecting favorable product mix and manufacturing volume, partly offset by unfavorable other manufacturing costs.
- Operating income and net income declined despite higher revenue and gross profit. SG&A increased by $7.4 million in the quarter and $16.4 million year to date, while restructuring charges increased by $3.2 million and $9.5 million, respectively. Interest expense increased by $2.4 million in the quarter and $7.3 million year to date due primarily to higher interest rates.
- The company issued 2.3 million common shares in May 2023 for net proceeds of $85.1 million. The proceeds and cash on hand were used to repay approximately $85.2 million of revolving debt.
- Shares outstanding increased to 14.6 million at September 30, 2023 from 12.1 million at December 31, 2022, primarily due to the public offering.
Guidance, Outlook, Risks, and Unusual Items
- Management expects 2023 capital expenditures of $18.0 million to $20.0 million, primarily supporting new contract awards and tooling requirements.
- The restructuring program is expected to generate annualized cost savings of $11.0 million to $13.0 million. Remaining pre-tax restructuring charges through 2024 are estimated at $7.0 million to $9.0 million, including $6.0 million to $8.0 million of expected cash costs.
- Remaining performance obligations were $947.9 million at September 30, 2023; management expects approximately 70% to be recognized as revenue over the following 12 months. Backlog was $958.5 million, of which $638.0 million was expected to be delivered within 12 months.
- Management cited slower-than-expected commercial aerospace production ramp-ups, customer and industry concentration, aircraft production rates, defense spending, supply-chain constraints, inflation, geopolitical conditions, rising interest rates, cybersecurity requirements, contract execution, and potential goodwill or asset impairments as material risks.
- Insurance recoveries contributed $7.9 million of other income during the first nine months, including $3.8 million related to the Guaymas fire and $0.3 million related to a separate April 2023 fire. These recoveries are unusual items and should not be treated as recurring operating performance.
- The company estimates $1.5 million of environmental remediation liabilities for the El Mirage and Monrovia facilities and has accrued $0.4 million for the West Covina landfill matter; the estimated potential West Covina exposure ranges from $0.4 million to $3.1 million.
- A previously settled California wage-and-hour representative action was reopened by the court. Ducommun is appealing, and the filing states that any additional liability is not currently probable or reasonably estimable.
- Interest-rate swaps with a $150.0 million notional amount become effective January 1, 2024. Unrealized hedge gains of $5.5 million were recorded in other comprehensive income during the first nine months.
- Management stated that operating cash flow and available borrowing capacity are expected to provide sufficient liquidity for the next 12 months. The filing does not provide formal revenue or earnings guidance.
Investor Verification Checklist
- Verify whether commercial aerospace production-rate increases translate into sustained revenue growth and whether military and space volume stabilizes.
- Monitor restructuring execution, the remaining $7.0 million to $9.0 million of expected charges, and whether projected annualized savings of $11.0 million to $13.0 million are realized.
- Assess BLR’s contribution, integration costs, aftermarket opportunity, and the recoverability of acquisition-related goodwill and intangible assets.
- Track debt balances, interest rates, revolver utilization, covenant headroom, and the effect of the January 2024 interest-rate hedge commencement.
- Evaluate cash conversion, particularly the substantial inventory balance, $191.2 million of contract assets, and low nine-month operating cash flow relative to earnings.
- Reconcile Adjusted EBITDA to GAAP results and separately consider the effect of restructuring, stock compensation, purchase-accounting adjustments, fire costs, and insurance recoveries.
- Review customer concentration, backlog quality, remaining performance obligations, contract-loss estimates, environmental liabilities, and the reopened wage-and-hour proceeding.