UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
For the quarterly period ended September 28, 2013
OR
For the transition period from to
Commission File Number 1-8174
DUCOMMUN INCORPORATED
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code: (310) 513-7200
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of September 28, 2013, there were outstanding 10,780,169 shares of common stock.
INDEX
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 28, 2013 and September 29, 2012
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 28, 2013 and September 29, 2012
Condensed Consolidated Balance Sheets at September 28, 2013 and December 31, 2012
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 28, 2013 and September 29, 2012
Notes to Condensed Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 6. Exhibits and Reports on Form 8-K
Signatures
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Ducommun Incorporated
Condensed Consolidated Statements of Income
(Unaudited)
(In thousands, except per share amounts)
Net Sales
Cost of Sales
Gross Profit
Selling, General and Administrative Expenses
Operating Income
Interest Expense
Income Before Taxes
Income Tax Expense (Benefit)
Net Income
Earnings Per Share
Basic earnings per share
Diluted earnings per share
Weighted-Average Number of Common Shares Outstanding
Basic
Diluted
See accompanying notes to condensed consolidated financial statements.
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Condensed Consolidated Statements of Comprehensive Income
(In thousands)
Other Comprehensive Loss
Amortization of actuarial loss and prior service costs, net of tax benefit of $102 and $306 for the three and nine months of 2013, respectively
Comprehensive Income
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Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
Assets
Current Assets
Cash and cash equivalents
Accounts receivable, net
Unbilled receivables
Inventories
Production cost of contracts
Deferred income taxes
Other current assets
Total Current Assets
Property and Equipment, Net
Goodwill
Intangibles, Net
Other Assets
Total Assets
Liabilities and Shareholders’ Equity
Current Liabilities
Current portion of long-term debt
Accounts payable
Accrued liabilities
Total Current Liabilities
Long-Term Debt, Less Current Portion
Deferred Income Taxes
Other Long-Term Liabilities
Total Liabilities
Commitments and Contingencies
Shareholders’ Equity
Common stock – $0.01 par value; authorized 35,000,000 shares; issued 10,923,469 shares in 2013 and 10,738,065 shares in 2012
Treasury stock – held in treasury 143,300 shares in 2013 and 2012
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
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Condensed Consolidated Statements of Cash Flows
Cash Flows from Operating Activities
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities
Depreciation and amortization
Stock-based compensation expense
Deferred income tax provision (benefit)
Income tax benefit from stock-based compensation
Excess tax benefit from stock-based compensation
Provision for (recovery of) doubtful accounts
Other
Changes in Assets and Liabilities
Accounts receivable (increase) decrease
Unbilled receivables increase
Inventories increase
Production cost of contracts increase
Other assets (increase) decrease
Accounts payable decrease
Accrued and other liabilities decrease
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities
Purchases of property and equipment
Proceeds from the sales of assets
Net Cash Used in Investing Activities
Cash Flows from Financing Activities
Repayments of term loan and other debt
Net cash effect of exercise related to stock options
Deferred financing cost paid
Net Cash Used in Financing Activities
Net Decrease in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Period
Cash and Cash Equivalents at End of Period
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DUCOMMUN INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Ducommun Incorporated and its subsidiaries (“Ducommun”, the “Company”, “we”, “us” or “our”), after eliminating intercompany balances and transactions. The December 31, 2012 condensed consolidated balance sheet data was derived from audited financial statements, but does not contain all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”).
Our significant accounting policies were described in Part II, Item 8. “Note 1. Summary of Significant Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2012. We follow the same accounting policies for interim reporting, with the exception of accounting principles adopted as of January 1, 2013, as discussed below in Recent Accounting Pronouncements. The financial information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012.
In the opinion of management, all adjustments, consisting of recurring accruals, have been made that are necessary to fairly state our condensed consolidated financial position, statements of income, comprehensive income and cash flows in accordance with GAAP for the periods covered by this Quarterly Report on Form 10-Q. The results of operations for the three and nine months ended September 28, 2013 are not necessarily indicative of the results to be expected for the full year ending December 31, 2013.
Certain prior year reclassifications have been made to conform to the current year financial statement presentation.
Use of Estimates
Certain amounts and disclosures included in the condensed consolidated financial statements required management to make estimates and judgments that affect the amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
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Description of Business
We are a global provider of engineering and manufacturing products and services primarily to the aerospace and defense industry through a wide range of products and services in the primary businesses of electronics, structures and integrated solutions. Our subsidiaries are organized into two strategic businesses, each of which is a reportable operating segment. Ducommun AeroStructures (“DAS”) designs, engineers and manufactures large, complex contoured aerospace structural components and assemblies and supplies composite and metal bonded structures and assemblies. Ducommun LaBarge Technologies (“DLT”) designs, engineers and manufactures high-reliability products used in worldwide technology-driven markets including aerospace and defense, natural resources, industrial and medical and other end-use markets. DLT’s product offerings range from prototype development to complex assemblies. Each reportable operating segment follows the same accounting principles.
Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss, as reflected on the condensed consolidated balance sheets, was composed of cumulative pension and liability adjustments of $7.0 million and $7.5 million, net of tax, at September 28, 2013 and December 31, 2012, respectively.
Earnings per Share
Basic earnings per share are computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding in each period. Diluted earnings per share are computed by dividing the sum of income available to common shareholders plus income associated with dilutive securities by the weighted-average number of common shares outstanding, plus any potential dilutive shares that could be issued if exercised or converted into common stock in each period.
The net earnings and weighted-average number of common shares outstanding used to compute earnings per share were as follows:
Net earnings (a)
Weighted-average number of common shares outstanding
Basic weighted-average common shares outstanding (b)
Dilutive potential common shares
Diluted weighted-average common shares outstanding (c)
Earnings per share
Basic (a/b)
Diluted (a/c)
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Potentially dilutive stock options and stock units to purchase common stock, as shown below, were excluded from the computation of diluted earnings per share because their inclusion would have been anti-dilutive. However, these shares may be potentially dilutive common shares in the future.
Stock options and stock units
Cash Equivalents
Cash equivalents consist of highly liquid instruments purchased with original maturities of three months or less. These assets are valued at cost, which approximates fair value, which we classify as Level 1. See Fair Value below.
Out of Period Adjustments
During the third quarter of 2013, we determined that approximately $1.1 million of inventory had not been valued correctly at our DLT operating segment for periods originating in 2010 through the second quarter of 2013. The errors were attributed to the following quarters; $0.3 million in Q2 2010, $0.5 million in Q2 2011, $0.1 million in Q4 2012, $0.1 million in Q1 2013 and $0.1 million in Q2 2013. We assessed the materiality of these errors and concluded they were immaterial to currently forecasted annual amounts and previously reported annual and interim amounts. We corrected the errors in the third quarter of 2013 and recorded a $1.1 million charge for inventory reserves for the DLT operating segment.
During the first quarter of 2012, we determined that approximately $0.4 million of engineering research and development costs had been capitalized in error in inventory in prior periods. We assessed the materiality of this error and concluded it was immaterial to currently reported annual and previously reported annual and interim amounts. We corrected the error in the first quarter of 2012 and did not restate our condensed consolidated financial statements for the prior annual or interim periods.
Fair Value
Assets and liabilities that are measured, recorded or disclosed at fair value on a recurring basis are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value. Level 1, the highest level, refers to the values determined based on quoted prices in active markets for identical assets. Level 2 refers to fair values estimated using significant observable inputs. Level 3, the lowest level, includes fair values estimated using significant unobservable inputs.
Recent Accounting Pronouncements
New Accounting Guidance Adopted in 2013
In February 2013, the Financial Accounting Standards Board (the “FASB”) issued guidance to improve the reporting of reclassifications out of accumulated other comprehensive income/loss. The new guidance requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income/loss on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, cross-reference to other disclosures that provide additional detail is required. Early adoption is permitted. We adopted this new guidance effective January 1, 2013. This guidance affects disclosures only.
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In January 2013, the FASB issued guidance clarifying the scope of disclosures about offsetting assets and liabilities and requires retrospective application for all periods presented. We adopted this new guidance effective January 1, 2013. The adoption of this new guidance did not have any effect on our condensed consolidated financial statements. In December 2011, the FASB issued guidance enhancing disclosure requirements about the nature of an entity’s right to offset and related arrangements associated with its financial instruments and derivative instruments. The new guidance requires the disclosure of the gross amounts subject to rights of set-off, amounts offset in accordance with the accounting standards followed, and the related net exposure. The new guidance requires retrospective application for all comparable periods presented. We adopted this new guidance effective January 1, 2013. The adoption of this new guidance did not have any effect on our condensed consolidated financial statements.
New Accounting Guidance Not Yet Adopted
In July 2013, the FASB issued guidance that requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. This guidance will be effective for fiscal years beginning after December 15, 2013, which will be our fiscal year 2014, with early adoption permitted. We currently expect the adoption of this guidance will reduce deferred tax assets by approximately $2.2 million.
In February 2013, the FASB issued guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date, except for obligations addressed within existing guidance in GAAP. The new guidance will be effective for us beginning January 1, 2014. Early adoption is permitted. We do not expect the adoption of this guidance to have a material impact on our condensed consolidated financial statements.
Note 2. Inventories
Inventories consisted of the following:
Raw materials and supplies
Work in process
Finished goods
Less progress payments
Total
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Note 3. Goodwill
Goodwill was as follows:
Gross goodwill
Accumulated goodwill impairment
Balance at December 31, 2012
Balance at September 28, 2013
Note 4. Long-Term Debt
Long-term debt and the current period interest rates were as follows:
Senior unsecured notes (fixed 9.75%)
Senior secured term loan (floating 4.75%)
Promissory note (fixed 5.0%) and other debt (fixed 5.41%)
Total Debt
Less Current Portion
Total Long-Term Debt
Weighted-average interest rate
We made voluntary principal prepayments of $7.5 million each on our senior secured term loan on September 27, 2013, April 30, 2013 and March 28, 2013.
On March 28, 2013, we executed an amendment to our Credit Agreement dated June 11, 2011 (“Credit Agreement”) which completed a repricing of our senior secured term loan and revolving credit facility. The repricing reduced the interest rate spread on the senior secured term loan and revolving credit facility by 50 basis points and the interest rate floor by 25 basis points. In connection with this repricing, we recognized $0.5 million of financing and legal costs which were included in selling, general and administrative expenses in the first quarter of 2013.
At September 28, 2013, we had $58.4 million of unused borrowing capacity under the revolving credit facility, after deducting $1.6 million for standby letters of credit.
At September 28, 2013, we were in compliance with all covenants required by the Credit Agreement. At September 28, 2013, there were no amounts outstanding that would have triggered the leverage covenant under the Credit Agreement. However, we would have been in compliance with such leverage covenant. Under the terms of the
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Credit Agreement, if, during a given fiscal quarter, (i) the sum of (a) any amounts outstanding under the revolving credit facility plus (b) the amount drawn under any letters of credit exceeds $1.0 million; or (ii) the aggregate amount of outstanding letters of credit exceeds $5.0 million, the revolving credit facility will be subject to a maximum total leverage ratio.
On October 18, 2013, we executed an amendment to our Credit Agreement, which increases the maximum leverage ratio, as defined, by 0.75 in all future periods.
The carrying amount of long-term debt approximates fair value, except for the senior unsecured notes for which the fair value was $223.5 million. Fair value was estimated using Level 2 inputs, based on the terms of the related debt, recent transactions and estimates using interest rates currently available to us for debt with similar terms and remaining maturities.
Note 5. Shareholders’ Equity
We are authorized to issue five million shares of preferred stock. At September 28, 2013 and December 31, 2012, no preferred shares were issued or outstanding.
Note 6. Employee Benefit Plans
The components of net periodic pension expense were as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of actuarial loss and prior service costs
Net periodic pension cost
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The components of the reclassifications from accumulated other comprehensive loss to net income during the three and nine months ended September 28, 2013 were as follows:
Amortization of actuarial loss and prior service costs-total before tax (b)
Tax benefit
Net of tax
Note 7. Indemnification
We have made guarantees and indemnities under which we may be required to make payments to a guaranteed or indemnified party, in relation to certain transactions, including revenue transactions in the ordinary course of business. In connection with certain facility leases, we have indemnified our lessors for certain claims arising from the facility or the lease. We indemnify our directors and officers to the maximum extent permitted under the laws of the State of Delaware. However, we have a directors and officers insurance policy that may reduce our exposure in certain circumstances and may enable us to recover a portion of future amounts that may be payable, if any. The duration of the guarantees and indemnities varies and, in many cases, is indefinite but subject to statute of limitations. The majority of guarantees and indemnities do not provide any limitations of the maximum potential future payments we could be obligated to make. Historically, payments related to these guarantees and indemnities have been immaterial. We estimate the fair value of our indemnification obligations as insignificant based on this history and insurance coverage and have, therefore, not recorded any liability for these guarantees and indemnities in the accompanying condensed consolidated balance sheets.
Note 8. Income Taxes
We recorded an income tax benefit of $0.1 million (an effective tax benefit of 1.9%) in the third quarter of 2013, compared to an income tax expense of $0.9 million (an effective tax rate of 14.9%) in the third quarter of 2012. We recorded an income tax expense of $0.8 million (an effective tax rate of 5.4%) in the first nine months of 2013, compared to an income tax expense of $2.4 million (an effective tax rate of 15.6%) in the comparable period of 2012.
The effective tax rate in the nine months ended September 28, 2013 included $2.0 million of 2012 federal research and development tax credit benefits recognized in the first quarter of 2013 as a result of the American Taxpayer Relief Act of 2012, passed in January 2013. This Act includes an extension of the federal research and development tax credit for the amounts paid or incurred after December 31, 2011 and before January 1, 2014. We recognized total federal research and development tax credit benefits of $2.5 million in the first quarter of 2013, $0.5
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million in the second quarter of 2013, and $0.7 million in the third quarter of 2013. We expect to recognize approximately $0.5 million for these benefits in the fourth quarter of 2013. The effective tax rate for the three and nine months ended September 29, 2012 included no federal research and development tax credit benefits. The effective tax rate for the third quarters of both 2013 and 2012 benefitted from expiring statutes and other favorable tax adjustments. In addition, the first nine months of 2012 included a tax benefit of $1.6 million as a result of the 2011 acquisition of LaBarge Inc., which allowed us to file state consolidated tax returns in certain states.
Our unrecognized tax benefits were $2.5 million and $1.7 million at September 28, 2013 and December 31, 2012, respectively. Most of these amounts, if recognized, would affect our annual income tax rate.
Note 9. Contingencies
Ducommun is a defendant in a lawsuit entitled United States of America ex rel Taylor Smith, Jeannine Prewitt and James Ailes v. The Boeing Company and Ducommun Inc., filed in the United States District Court for the District of Kansas (the “District Court”). The lawsuit is a qui tam action brought by three former Boeing employees (“Relators”) against Boeing and Ducommun on behalf of the United States of America for violations of the United States False Claims Act. The lawsuit alleges that Ducommun sold unapproved parts to the Boeing Company (“Boeing”), which were installed by Boeing in aircraft ultimately sold to the United States Government and that Boeing and Ducommun submitted or caused to be submitted false claims for payment relating to 21 aircraft sold by Boeing to the United States Government. The lawsuit seeks damages in an amount equal to three times the amount of damages the United States Government sustained because of the defendants’ actions, plus a civil penalty of $10 thousand for each false claim made on or before September 28, 1999, and $11 thousand for each false claim made on or after September 28, 1999, together with attorneys’ fees and costs. The Relators claim that the United States Government sustained damages of $1.6 billion (the contract purchase price of 21 aircraft) or, alternatively, $851 million (the alleged diminished value and increased maintenance cost of the 21 aircraft). After investigating the allegations, the United States Government has declined to intervene in the lawsuit. Ducommun and Boeing have filed motions for summary judgment to dismiss the lawsuit. The motions for summary judgment are pending before the District Court. Ducommun intends to defend itself vigorously against the lawsuit. Ducommun, at this time, is unable to estimate what, if any, liability it may have in connection with the lawsuit.
DAS has been directed by California environmental agencies to investigate and take corrective action for groundwater contamination at its facilities located in El Mirage and Monrovia, California. Based on currently available information, Ducommun has established a reserve for its estimated liability for such investigation and corrective action of approximately $1.5 million at September 28, 2013, which is reflected in other long-term liabilities on its condensed consolidated balance sheet.
DAS also faces liability as a potentially responsible party for hazardous waste disposed at landfills located in Casmalia and West Covina, California. DAS and other companies and
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government entities have entered into consent decrees with respect to these landfills with the United States Environmental Protection Agency and/or California environmental agencies under which certain investigation, remediation and maintenance activities are being performed. Based on currently available information, Ducommun preliminarily estimates that the range of its future liabilities in connection with the landfill located in West Covina, is between approximately $0.4 million and $3.1 million. Ducommun has established a reserve for its estimated liability, in connection with the West Covina landfill of approximately $0.4 million at September 28, 2013, which is reflected in other long-term liabilities on its condensed consolidated balance sheet. Ducommun’s ultimate liability in connection with these matters will depend upon a number of factors, including changes in existing laws and regulations, the design and cost of construction, operation and maintenance activities, and the allocation of liability among potentially responsible parties.
In the normal course of business, Ducommun and its subsidiaries are defendants in certain other litigation, claims and inquiries, including matters relating to environmental laws. In addition, Ducommun makes various commitments and incurs contingent liabilities. While it is not feasible to predict the outcome of these matters, Ducommun does not presently expect that any sum it may be required to pay in connection with these matters would have a material adverse effect on its consolidated financial position, results of operations or cash flows.
Note 10. Business Segment Information
We supply products and services primarily to the aerospace and defense industries. Our subsidiaries are organized into two strategic businesses, DAS and DLT, each of which is a reportable operating segment.
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Financial information by reportable segment was as follows:
DAS
DLT
Total Net Sales
Segment Operating Income
DLT (2)
Corporate General and
Administrative Expenses (1) (2) (3)
Total Operating Income
Depreciation and Amortization
Expenses
Corporate Administration
Total Depreciation and
Amortization Expenses
Capital Expenditures
Total Capital Expenditures
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Segment assets include assets directly identifiable with each segment. Corporate Administration assets include assets not specifically identified with a business segment, including cash.
Goodwill and Intangibles
Total Goodwill and Intangibles
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OVERVIEW
Ducommun Incorporated (“Ducommun”, the “Company”, “we”, “us” or “our”), through its subsidiaries, is a leading global provider of engineering and manufacturing services for high-performance products and high-cost-of-failure applications used primarily in the aerospace, defense, industrial, energy, and medical industries. Ducommun differentiates itself as a full-service provider, offering a wide range of value-added products and services in our primary businesses of electronics, structures and integrated solutions. We operate through two primary business units: Ducommun AeroStructures (“DAS”) and Ducommun LaBarge Technologies (“DLT”).
Third quarter 2013 highlights were as follows:
Earnings before interest, taxes and depreciation and amortization (“EBITDA”) and Adjusted EBITDA for the three months ended September 28, 2013 were both $19.2 million. See Non-GAAP Financial Measures below for certain information regarding EBITDA and Adjusted EBITDA, including reconciliations of EBITDA and Adjusted EBITDA to net income.
Non-GAAP Financial Measures
When viewed with our financial results prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and accompanying reconciliations, we believe EBITDA and Adjusted EBITDA provide additional useful information to clarify and enhance the understanding of the factors and trends affecting our past performance and future prospects. We define these measures, explain how they are calculated and provide reconciliations of these measures to the most comparable GAAP measure in the tables below. EBITDA, Adjusted EBITDA and the related financial ratios, as presented in this Form 10-Q, are supplemental measures of our performance that are not required by, or presented in accordance with, GAAP. They are not a measurement of our financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as an alternative to net cash provided by operating activities as measures of our liquidity. The presentation of these measures should not be interpreted to mean that our future results will be unaffected by unusual or nonrecurring items.
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We use EBITDA and Adjusted EBITDA non-GAAP operating performance measures internally as complementary financial measures to evaluate the performance and trends of our businesses. We present EBITDA, Adjusted EBITDA and the related financial ratios, as applicable, because we believe that measures such as these provide useful information with respect to our ability to meet our future debt service, capital expenditures, working capital requirements and overall operating performance.
EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation or as substitutes for analysis of our results as reported under GAAP. Some of these limitations are:
Because of these limitations, EBITDA, Adjusted EBITDA and the related financial ratios should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. You should compensate for these limitations by relying primarily on our GAAP results and using EBITDA and Adjusted EBITDA only supplementally. See our condensed consolidated financial statements contained in this Form 10-Q report.
However, in spite of the above limitations, we believe that EBITDA and Adjusted EBITDA are useful to an investor in evaluating our results of operations because these measures:
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EBITDA and Adjusted EBITDA provide meaningful information about the operating performance of our businesses apart from amortization, merger-related expenses, as well as interest and tax expenses.
The following financial items have been added back to our net income when calculating EBITDA and Adjusted EDITDA:
Reconciliations of net income to EBITDA and Adjusted EBITDA and the presentation of Adjusted EBITDA as a percentage of net sales were as follows:
Net income
Interest expense
Income tax expense (benefit)
EBITDA
Merger-related expenses (1)
Adjusted EBITDA
% of net sales
Adjusted EBITDA decreased for the three- and nine-month periods of 2013 compared to 2012 primarily due to decreased net sales, mainly in non-aerospace and defense end-use markets, while also reflecting lower gross profit dollars and higher inventory reserve charges.
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RESULTS OF OPERATIONS
Third Quarter and Year to Date 2013 Compared to Third Quarter and Year to Date 2012
The following table sets forth net sales, selected financial data, the effective tax rate and diluted earnings per share:
Selling, General and
Administrative Expenses
Effective Tax Rate (Benefit)
Diluted Earnings Per Share
nm = not meaningful
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Net Sales by End-Use Market and Operating Segment
Net sales by end-use market and operating segment during the three- and nine-month periods of 2013 and 2012, respectively, were as follows:
%of Net Sales
Consolidated Ducommun
Military and space
Defense technologies
Defense structures
Commercial aerospace
Natural resources
Industrial
Medical and other
The net sales for the three- and nine-month periods of 2013 reflected growth in the aerospace and defense end-use markets, which were more than offset by lower sales in the non-aerospace and defense end-use markets.
Net Sales to Major Customers
Boeing and Raytheon each exceeded ten percent of net sales for the third quarter of 2013. Net sales to Boeing and Raytheon and the related accounts receivable are diversified over a number of different commercial, military and space programs and were made by both operating segments. Net sales to our top ten customers, including Boeing and Raytheon, represented the following percentages of total net sales:
Boeing
Raytheon
Top ten customers
Boeing and Raytheon represented the following percentages of total accounts receivable:
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Gross profit dollars decreased for the three- and nine-month periods of 2013 due to lower net sales and a $1.1 million inventory reserve charge, as discussed below. Gross profit margins as a percentage of net sales decreased for both the three- and nine-month periods of 2013 due to unfavorable product mix and the impact of the lower net sales in the non-aerospace and defense end use markets and the inventory reserve charge.
During the third quarter of 2013, we determined that approximately $1.1 million of inventory relating to prior periods had not been valued correctly at our DLT operating segment. We corrected these errors in the third quarter of 2013 and recorded a $1.1 million charge for inventory reserves for the DLT operating segment. This charge reduced the third quarter of 2013 gross margins by 60 basis points and the first nine months of 2013 gross margins by 20 basis points.
The SG&A expenses for the third quarter of 2013 decreased primarily due to lower accrued compensation and benefits costs. Year-to-date 2013 SG&A expenses decreased due to lower accrued compensation and benefits costs and lower intangible asset amortization, partially offset by a charge of $0.5 million related to the debt repricing and professional fees. Year-to-date 2012 SG&A expenses included a charge of $0.4 million for engineering research and development cost that were capitalized in error in inventory in prior periods.
Interest expense decreased in both the three- and nine-month periods of 2013 mainly due to lower outstanding debt balances and a lower interest rate on the term loan beginning in April 2013.
Income Tax Expense
The effective tax rate in the nine months ended September 28, 2013 included $2.0 million of 2012 federal research and development tax credit benefits recognized in the first quarter of 2013 as a result of the American Taxpayer Relief Act of 2012, passed in January 2013. This Act includes an extension of the federal research and development tax credit for the amounts paid or incurred after December 31, 2011 and before January 1, 2014. We recognized total federal research and development tax credit benefits of $2.5 million in the first quarter of 2013, $0.5 million in the second quarter of 2013, and $0.7 million in the third quarter of 2013. We expect to recognize approximately $0.5 million for these benefits in the fourth quarter of 2013. The effective tax rate for the three and nine months ended September 29, 2012 included no federal research and development tax credit benefits. The effective tax rate for the third quarters of both 2013 and 2012 benefitted from expiring statutes and other favorable tax adjustments. In addition, the first nine months of 2012 included a tax benefit of $1.6 million as a result of the 2011 acquisition of LaBarge Inc., which allowed us to file state consolidated tax returns in certain states.
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Net Income and Diluted Earnings per Share
Net income and earnings per diluted share for the third quarter of 2013 were $4.6 million, or $0.42 per diluted share, compared to $5.1 million, or $0.48 per diluted share, in the third quarter of 2012. Diluted earnings per share for the three-month period of 2013 included a federal research and development tax benefit of $0.7 million while the 2012 period included no such benefit. Diluted earnings per share for the third quarters of both 2013 and 2012 included tax benefits from expiring statutes and other favorable tax adjustments.
Net income and earnings per diluted share for the nine-month period of 2013 were $13.8 million, or $1.28 per diluted share, compared to $13.0 million, or $1.23 per diluted share, in the comparable period of 2012. Diluted earnings per share for the nine-month period of 2013 also included a federal research and development tax benefit of $3.7 million while the 2012 period included no such benefit. Diluted earnings per share for the nine-month period of 2012 included a state tax benefit of $1.6 million. Diluted earnings per share for the nine-month periods of both 2013 and 2012 included tax benefits from expiring statutes and other favorable tax adjustments.
Business Segment Performance
We report our financial performance based on the following two reportable segments; Ducommun AeroStructures (DAS) and Ducommun LaBarge Technologies (DLT). The results of operations differ between our reportable operating segments due to differences in competitors, customers, extent of proprietary deliverables and performance.
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The following table summarizes our business segment performance for the third quarters and first nine months of 2013 and 2012:
EBITDA (1)
Operating Loss
Merger-related expenses (2)
Ducommun AeroStructures (DAS)
DAS’ net sales in the three-month period of 2013 increased 1.4% due to higher net sales of large commercial aircraft products, and slightly higher net sales of military aircraft, partially offset by lower sales of commercial helicopter products. DAS’s net sales for the nine-month period of 2013 increased 2.9% due to higher net sales of large commercial aircraft products, partially offset by lower net sales of commercial helicopter products.
The DAS segment operating income and EBITDA increased in the three-month period of 2013, reflecting higher operating margin from improved product mix. The DAS segment operating income and EBITDA for the nine-month period of 2013 also reflect improved operating efficiencies.
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Ducommun LaBarge Technologies (DLT)
DLT’s net sales in the three-month period of 2013 decreased 3.6%. The year-over-year decline reflects a 24.7% decrease in non-aerospace and defense revenue, partially offset by an 8.9% increase in defense electronics and commercial aerospace revenue. Net sales for the nine-month period of 2013 decreased 3.4%. The lower revenue reflects a 27.5% decline in non-aerospace and defense sales, partially offset by a 12.3% increase in defense electronics and commercial aerospace revenue.
DLT’s segment operating income and EBITDA decreased in the three-month period of 2013 primarily due to lower operating margin from reduced sales and a $1.1 million charge for inventory reserves. In addition, for the nine-month period of 2013, lower operating income and EBITDA were partially offset by the realization of cost synergies achieved during the latter part of 2012 following the LaBarge acquisition.
Corporate General and Administrative (“CG&A”)
The CG&A expenses decreased in the third quarter 2013 due to lower accrued compensation and benefits costs. In addition, the CG&A expenses for the first nine months of 2013 increased primarily due to a workers’ compensation insurance payroll audit charge of $0.6 million and $0.5 million related to our debt repricing transaction and professional fees, partially offset by lower accrued compensation and benefits costs.
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Backlog
Backlog is subject to delivery delays or program cancellations, which are beyond our control. Backlog is affected by timing differences in the placement of customer orders and tends to be concentrated in several programs to a greater extent than our net sales. Backlog in non-aerospace and defense markets tends to be of a shorter duration and is generally fulfilled within a three-month period. As a result of these factors, trends in our overall level of backlog may not be indicative of trends in our future net sales. Approximately $152 million of total backlog is expected to be delivered during the remainder of 2013.
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LIQUIDITY AND CAPITAL RESOURCES
Available Liquidity
Total debt, including long-term portion
Weighted-average interest rate on debt
Term loan interest rate
Unused revolving credit facility
In the third quarter of 2013, we made a voluntary principal prepayment of $7.5 million on our term loan, bringing the total such payments in 2013 to $22.5 million. We expect to pay down up to $30 million on the term loan in 2013.
The revolving credit facility and term loan covenants require EBITDA of more than $50.0 million and a maximum leverage ratio under certain circumstances, as well as annual limitations on capital expenditures and limitations on future disposition of property, investments, acquisitions, repurchase of stock, dividends, and outside indebtedness. At September 28, 2013, we were in compliance with all covenants. At September 28, 2013, there were no amounts outstanding that would have triggered the leverage ratio covenant.
On October 18, 2013, we executed an amendment to our Credit Agreement dated June 11, 2011, which increases the maximum leverage ratio, as defined, by 0.75 in all future periods.
We expect to spend a total of approximately $11 million in 2013, compared to $16 million in 2012, for capital expenditures mainly for investment in tooling to support new contract awards at DAS and DLT, financed by cash generated from operations.
We continue to depend on operating cash flow and the availability of our revolving credit facility to provide short-term liquidity. Cash generated from operations and bank borrowing capacity is expected to provide sufficient liquidity to meet our obligations during the next twelve months.
Cash Flow Summary
Net cash provided by operating activities for the first nine months of 2013 and 2012 was $14.5 million and $11.4 million, respectively. The higher cash provided by operating activities in the first nine months of 2013 reflects improved working capital management, partially offset by utilization in 2012 of income tax prepayments from 2011.
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Net cash used in investing activities of $7.2 million for the first nine months of 2013 included capital expenditures, principally to support new contract awards at DAS and DLT.
Net cash used in financing activities for the first nine months of 2013 of $21.2 million included $22.5 million of voluntary principal prepayments on our term loan, offset by $1.2 million from stock option exercises.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist of operating leases and indemnities.
For a discussion of new accounting guidance affecting Ducommun, see “Ducommun Incorporated and Subsidiaries—Notes to Condensed Consolidated Financial Statements—Note 1. Summary of Significant Accounting Policies—Recent Accounting Pronouncements.”
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Our main market risk exposure relates to changes in U.S. interest rates on our outstanding long-term debt that is subject to variable interest rates. At September 28, 2013, we had borrowings of $140.1 million under our term loan, with an interest rate of 4.75%.
Disclosure Controls and Procedures
The Company’s chief executive officer and chief financial officer have concluded, based on an evaluation of the Company’s disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)), that such disclosure controls and procedures were effective as of the end of the period covered by this report.
Internal Control Over Financial Reporting
There has been no change in the Company’s internal control over financial reporting during the three months ended September 28, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Item 3 of our Annual Report on Form 10-K for the year ended December 31, 2012 for information on legal proceedings.
ITEM 1A. RISK FACTORS
See Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012 for a discussion of risk factors.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Joseph P. Bellino
/s/ Douglas L. Groves
Date: October 28, 2013
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