Ducommun - 10-Q quarterly report FY

Item 1.  Financial Statements

See accompanying notes to consolidated financial statements.

Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding in each period. Diluted earnings per share is computed by dividing income available to common shareholders plus income associated with dilutive securities by the weighted average number of common shares outstanding plus any potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock in each period. For the three months ended June 29, 2002 and June 30, 2001, income available to common shareholders was $2,647,000 and $3,265,000, respectively. The weighted average number of common shares outstanding for the three months ended June 29, 2002 and June 30, 2001 were 9,802,000 and 9,667,000, and the diluted shares associated with stock options were 238,000 and 96,000, respectively. For the six months ended June 29, 2002 and June 30, 2001, income available to common shareholders was $3,877,000 and $6,290,000, respectively. The weighted average number of common shares outstanding for the six months ended June 29, 2002 and June 30, 2001 were 9,753,000 and 9,641,000, and the dilutive shares associated with stock options were 160,000 and 89,000, respectively.

Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No. 141”) and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). Pursuant to the impairment recognition provisions of SFAS 142, a pre-tax goodwill impairment loss of $3,633,000 ($2,325,000 after-tax) was recognized related to the Company’s Brice Manufacturing reporting unit during the first quarter of 2002. The fair value of the Brice

Manufacturing reporting unit was estimated by an independent valuation expert using the expected present value of future cash flows in accordance with SFAS 142.

The following sets forth a reconciliation of net income and earnings per share information for the three months and six months ended June 29, 2002 and June 30, 2001 as adjusted for the non-amortization provisions of SFAS 142:

Changes in the carrying amount of goodwill for the six month periods ended June 29, 2002 and June 30, 2001 are as follows:

The Company’s credit agreement provides for a $100,000,000 unsecured revolving credit line declining to $60,000,000 at maturity on September 30, 2005. Interest is payable monthly on the outstanding borrowings based on the bank’s prime rate plus a spread based on the leverage ratio of the Company calculated at the end of each fiscal quarter (4.75% at June 29, 2002). A Eurodollar pricing option is also available to the Company for terms of up to six months at the Eurodollar rate plus a spread based on the leverage ratio of the Company calculated at the end of each fiscal quarter (3.12% at June 29, 2002). At June 29, 2002, the Company had $63,089,000 of unused lines of credit, after deducting $36,000,000 of loans outstanding and $911,000 for outstanding standby letters of credit. The credit agreement includes minimum interest coverage, maximum leverage, minimum EBITDA and minimum net worth covenants, an unused commitment fee based on the leverage ratio (0.25% per annum at June 29, 2002), and limitations on future dispositions of property, repurchases of common stock, outside indebtedness, capital expenditures and acquisitions.

At June 29, 2002 and June 30, 2001, no preferred shares were issued or outstanding. The Company did not repurchase any of its common stock during 2002 or 2001.

Ducommun’s subsidiary, Aerochem, Inc. (“Aerochem”), is a major supplier of chemical milling services for the aerospace industry. Aerochem has been directed by California environmental agencies to investigate and take corrective action for groundwater contamination at its El Mirage, California facility (the “Site”). Aerochem expects to spend approximately $1 million for future investigation and corrective action at the Site, and the Company has established a provision for such costs. However, the Company’s ultimate liability in connection with the Site will depend upon a number of factors, including changes in existing laws and regulations, and the design and cost of the construction, operation and maintenance of the corrective action.

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, the Company makes various commitments and incurs contingent liabilities. While it is not feasible to predict the outcome of these matters, the Company 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 or results of operations.

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

CRITICAL ACCOUNTING POLICIES

Revenue Recognition

Allowance for Doubtful Accounts

Inventory

Goodwill

Taxes

Litigation and Commitments

FINANCIAL STATEMENT PRESENTATION

RESULTS OF OPERATIONS

Second Quarter of 2002 Compared to Second Quarter of 2001

Six Months of 2002 Compared to Six Months of 2001

Net sales increased 16% to $114,317,000 in the first six months of 2002 as a result of the acquisitions of Composite Structures and Fort Defiance. Excluding the acquisitions, sales decreased 11%. The sales decrease, excluding acquisitions, resulted primarily from lower sales for Boeing commercial aircraft, various regional jet and space programs, and lower sales at Brice Manufacturing, partially offset by higher sales for military programs.

The Company had substantial sales to Boeing, Raytheon and Lockheed Martin. During the first six months of 2002 and 2001, sales to Boeing were approximately $54,834,000 and $40,259,000, respectively; sales to Raytheon were approximately $14,569,000 and $6,535,000, respectively; and sales to Lockheed Martin were approximately $5,469,000 and $5,592,000, respectively. The sales relating to Boeing, Raytheon and Lockheed Martin are diversified over a number of different commercial, space and military programs.

The Company’s commercial business is represented on virtually all of today’s major commercial aircraft. Sales related to commercial business were approximately 41% of total sales in the first six months of 2002, compared to 54% in the first six months of 2001.

Military components manufactured by the Company are employed in many of the country’s front-line fighters, bombers, helicopters and support aircraft, as well as many land and sea-based vehicles. The Company’s defense business is widely diversified among military manufacturers and programs. Sales related to military programs were approximately 55% of total sales in the first six months of 2002, compared to 38% in the first six months of 2001. This substantial shift in business mix is due to sales at the Company’s Composite Structures unit and increased military procurement spending, as well as a difficult commercial aerospace environment. The shift in the Company’s business mix from commercial to military is expected to continue, particularly in the area of military spare parts.

In the space sector, the Company produces components for the expendable fuel tanks which help boost the Space Shuttle vehicle into orbit. Components are also produced for a variety of unmanned launch vehicles and satellite programs. Sales related to space programs were approximately 4% of total sales in the second quarter 2002, compared to 8% in the first six months of 2001. In the first six months of 2002 sales related to space programs were lower due to timing differences in production scheduling for the space shuttle program and lower sales for other space launch vehicles.

At June 29, 2002, backlog believed to be firm was approximately $282,080,000 compared to $308,400,000 at December 31, 2001 and $322,400,000 at June 30, 2001. Approximately $85,000,000 of backlog is expected to be delivered during the remainder of 2002.

Gross profit, as a percentage of sales, was 23.0% for the first six months of 2002 compared to 26.4% in 2001. The decrease in gross profit margin was primarily the result of changes in sales mix, pricing

pressures from customers, higher costs relating to certain new production contracts which commenced in the second quarter of 2002, and higher overhead expenses as a percentage of sales due to lower sales excluding acquisitions. In addition, gross profit was negatively impacted by costs related to the ongoing integration of Ducommun Aerostructures into a single operating unit, and front-end investment and expense necessary to improve operating efficiencies.

Selling, general and administrative expenses, as a percentage of sales, were 13.7% for the first six months of 2002 compared to 13.6% in 2001. The increase in these expenses as a percentage of sales was primarily the result of approximately $1,020,000 of consulting and other related costs related to assistance received in the second quarter of 2002 from a management consulting firm to review the Company’s strategic opportunities for growth and enhancing shareholder value, and approximately $733,000 of severance and facility consolidation expenses related to the closure of the Company’s Chatsworth, California facility.

Goodwill amortization expense decreased to $0 in the first six months of 2002 compared to $1,588,000 in 2001. Effective January 1, 2002, the Company adopted, Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No. 141”) and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). As a result of the adoption of SFAS 141 and SFAS 142, goodwill and intangible assets with indefinite useful lives are no longer amortized but rather tested at least annually for impairment.

Interest expense increased to $982,000 in the first six months of 2002 compared to $906,000 for 2001. The increase in interest expense was primarily due to higher debt levels, partially offset by lower interest rates in 2002 compared to 2001.

Income tax expense decreased to $3,489,000 in the first six months of 2002 compared to $3,855,000 for 2001. The decrease in income tax expense was primarily due to the lower income before taxes and a lower tax rate of 36% in 2002 compared to 38% in 2001. Cash paid for income taxes was $5,739,000 in the first six months of 2002, compared to $4,609,000 in 2001.

In the first quarter of 2002, the Company recorded a non-cash, pre-tax charge of $3,632,000 for goodwill impairment at its Brice Manufacturing reporting unit in accordance with SFAS 142. This charge is reflected as a cumulative effect of accounting change, net of taxes, of $2,325,000, or $0.24 per diluted share.

Net income for the first six months of 2002 was $3,877,000, or $0.39 diluted earnings per share, compared to $6,290,000, or $0.65 diluted earnings per share, in 2001. Net income for the first six months of 2002 included after-tax charges totaling approximately $1,442,000, or $0.15 per diluted share, for consulting fees, severance and facility consolidation discussed above. Net income for the first six months of 2001 included an after-tax charge of $501,000, or $0.05 per diluted share, for a lawsuit filed by Com Dev Consulting Ltd. and $985,000, or $0.10 per diluted share, for goodwill amortization expense.

FINANCIAL CONDITION

Liquidity and Capital Resources

Cash flows from operating activities for the six months ended June 29, 2002 was $8,457,000, compared to $1,728,000 for the six months ended June 30, 2001. The increase in cash flow from operating activities resulted principally from a decrease in accounts receivable in 2002 compared to an increase in accounts receivable in 2001, partially offset by a decrease in trade payables and a smaller decrease in accrued and other liabilities in 2002 than in 2001. During the first six months of 2002, the Company repaid $9,867,000 of principal on outstanding borrowings. The Company continues to depend on operating cash flow and the availability of its bank line of credit to provide short-term liquidity. Cash from operations and bank borrowing capacity are expected to provide sufficient liquidity to meet the Company’s obligations for the next twelve months. The Company’s bank credit agreement provides for a $100,000,000 unsecured revolving credit line declining to $60,000,000 at maturity on September 30, 2005. At June 29, 2002, the Company had $63,089,000 of unused lines of credit, after deducting $36,000,000 of loans outstanding and $911,000 for outstanding standby letters of credit. See Note 5 to the Notes to Consolidated Financial Statements for additional information.

The Company spent $1,493,000 on capital expenditures during the first six months of 2002 and expects to spend less than $6,000,000 in the aggregate for capital expenditures in 2002. During the second quarter of 2002 the Company retained a management consulting firm to assist in a review of strategic opportunities for growth and enhancing shareholder value. As a result of this review the Company’s management and the Board of Directors have reaffirmed that substantial opportunities exist for the Company to enhance shareholder value by playing an expanded role in the aerospace industry supply chain through the offering of higher value added products and services, particularly in view of the anticipated increase in defense procurement spending and the consolidation of defense subcontractors. The Company believes that acquisitions in areas which focus on highly engineered products in aerospace and related non-aerospace markets are important components of the Company’s future growth. Accordingly, the Company plans to continue to seek attractive acquisition opportunities and to make substantial capital expenditures for manufacturing equipment and facilities to improve and restructure its existing operations.

Ducommun’s subsidiary, Aerochem, Inc. (“Aerochem”), is a major supplier of chemical milling services for the aerospace industry. Aerochem has been directed by California environmental agencies to investigate and take corrective action for groundwater contamination at its El Mirage, California facility (the “Site”). Aerochem expects to spend approximately $1 million for future investigation and corrective action at the Site, and the Company has established a provision for such costs. However, the Company’s ultimate liability in connection with the Site will depend upon a number of factors, including changes in existing laws and regulations, and the design and cost of the construction, operation and maintenance of the corrective action.

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, the Company makes various commitments and incurs contingent liabilities. While it is not feasible to predict the outcome of these matters, the Company 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 or results of operations.

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

Any forward-looking statements made in this Form 10-Q involve risks and uncertainties. The Company’s future financial results could differ materially from those anticipated due to the Company’s dependence on conditions in the airline industry, the level of new commercial aircraft orders, the production rate for Boeing commercial aircraft, the C-17 and Apache helicopter rotor blade programs, the level of defense spending, competitive pricing pressures, technology and product development risks and uncertainties, product performance, risks associated with acquisitions and dispositions of businesses by the Company, increasing consolidation of customers and suppliers in the aerospace industry, availability of raw materials and components from suppliers, cost of electricity in California, and other factors beyond the Company’s control.

Item 3    Quantitative and Qualitative Disclosure about Market Risk

Not applicable.

Item 4.    Submission of Matters to a Vote of Security Holders

The 2002 annual meeting of shareholders of the Company was held on May 1, 2002. At the meeting, Robert C. Ducommun and Thomas P. Mullaney were elected as directors of the Company to serve for three-year terms expiring at the annual meeting of shareholders in 2005. In the election of directors, the shareholder vote was as follows: Robert C. Ducommun, For-8,084,898, Abstain-22,931, Thomas P. Mullaney, For-8,083,656, Abstain-24,173. The other directors whose terms of office continued after the annual meeting are: Norman A. Barkeley, Joseph C. Berenato, Eugene P. Conese, Jr., H. Frederick Christie, Ralph D. Crosby, Jr., and Kevin S. Moore.

Item 6.    Exhibits and Reports on Form 8-K.

(a)  No exhibits are filed with this report.

(b)  No reports on Form 8-K were filed during the quarter for which this report is filed.

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.

Date:    July 23, 2002