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3: EX-10.21 Material Contract HTML 33K
4: EX-31.1 Certification -- §302 - SOA'02 HTML 23K
5: EX-31.2 Certification -- §302 - SOA'02 HTML 23K
6: EX-32 Certification -- §906 - SOA'02 HTML 22K
12: R1 Cover Page HTML 71K
13: R2 Condensed Consolidated Balance Sheets HTML 127K
14: R3 Condensed Consolidated Balance Sheets HTML 32K
(Parenthetical)
15: R4 Condensed Consolidated Statements of Income HTML 90K
16: R5 Condensed Consolidated Statements of Comprehensive HTML 48K
Income
17: R6 Condensed Consolidated Statements of Comprehensive HTML 24K
Income (Parenthetical)
18: R7 Condensed Consolidated Statements of Changes in HTML 100K
Shareholders' Equity
19: R8 Condensed Consolidated Statements of Cash Flows HTML 102K
20: R9 Summary of Significant Accounting Policies HTML 121K
21: R10 Business Combinations HTML 40K
22: R11 Restructuring Activities HTML 42K
23: R12 Inventories HTML 27K
24: R13 Goodwill HTML 35K
25: R14 Accrued and Other Liabilities HTML 27K
26: R15 Long-Term Debt HTML 45K
27: R16 Indemnifications HTML 22K
28: R17 Income Taxes HTML 28K
29: R18 Commitments and Contingencies HTML 28K
30: R19 Business Segment Information HTML 80K
31: R20 Summary of Significant Accounting Policies HTML 74K
(Policies)
32: R21 Summary of Significant Accounting Policies HTML 98K
(Tables)
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34: R23 Restructuring Activities (Tables) HTML 39K
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36: R25 Goodwill (Tables) HTML 35K
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38: R27 Long-Term Debt (Tables) HTML 36K
39: R28 Business Segment Information (Tables) HTML 79K
40: R29 Summary of Significant Accounting Policies - HTML 77K
Narrative (Details)
41: R30 Summary of Significant Accounting Policies - HTML 27K
Supplemental Cash Flow Items (Details)
42: R31 Summary of Significant Accounting Policies - HTML 56K
Weighted Average Number of Shares Outstanding Used
to Compute Earnings Per Share (Details)
43: R32 Summary of Significant Accounting Policies - HTML 23K
Weighted Average Number of Shares Outstanding
Excluded from Computation of Diluted Earnings
(Details)
44: R33 Summary of Significant Accounting Policies - HTML 23K
Contract Assets and Liabilities (Details)
45: R34 Summary of Significant Accounting Policies - HTML 42K
Disaggregated Revenue (Details)
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Liabilities Acquired (Details)
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Intangible Assets Acquired (Details)
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Activities (Details)
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52: R41 Goodwill (Details) HTML 40K
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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. iYesx
No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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). iYesx No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
iAccelerated
filer
x
Non-accelerated filer
¨
Smaller reporting company
i¨
Emerging
growth company
i¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ix
Common
Stock - $ii0.01/ par value; ii35,000,000/
shares authorized; ii12,067,868/ and ii11,925,087/
shares issued and outstanding at July 2, 2022 and December 31, 2021, respectively
i121
i119
Additional
Paid-In Capital
i106,301
i104,253
Retained
Earnings
i389,509
i377,263
Accumulated
Other Comprehensive Income (Loss)
i614
(i7,033)
Total
Shareholders’ Equity
i496,545
i474,602
Total
Liabilities and Shareholders’ Equity
$
i979,048
$
i978,735
See
accompanying notes to Condensed Consolidated Financial Statements.
Amortization of actuarial loss and prior service costs, net of tax of $i35 and $i77
for the three months ended July 2, 2022 and July 3, 2021, respectively and $i71 and $i153
for the six months ended July 2, 2022 and July 3, 2021, respectively
i111
i245
i221
i490
Change
in unrealized gains on cash flow hedges, net of tax of $i777 and izero
for the three months ended July 2, 2022 and July 3, 2021, respectively and $i2,286 and izero
for the six months ended July 2, 2022 and July 3, 2021, respectively
i2,523
i—
i7,426
i—
Other
Comprehensive Income, Net of Tax
i2,634
i245
i7,647
i490
Comprehensive
Income
$
i6,781
$
i8,668
$
i19,893
$
i15,608
See
accompanying notes to Condensed Consolidated Financial Statements.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1. iSummary
of Significant Accounting Policies
Description of Business
We are a leading global provider of innovative, value-added proprietary products and manufacturing solutions for high-performance products and high-cost-of failure applications used primarily in the aerospace and defense (“A&D”), industrial, medical and other industries (collectively, “Industrial”). Our operations are organized into itwo primary businesses: the Electronic Systems segment (“Electronic
Systems”) and the Structural Systems segment (“Structural Systems”), each of which is a reportable operating segment. Electronic Systems designs, engineers and manufactures high-reliability electronic and electromechanical products used in worldwide technology-driven markets including A&D and Industrial end-use markets. Electronic Systems’ product offerings primarily range from prototype development to complex assemblies. Structural Systems designs, engineers and manufactures large, complex contoured aerostructure components and assemblies and supplies composite and metal bonded structures and assemblies. Structural Systems’ products are primarily used on commercial aircraft, military fixed-wing aircraft, and military and commercial rotary-wing aircraft. Both reportable operating segments follow the same accounting principles.
i
Basis
of Presentation
The unaudited condensed 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, 2021 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 IV, Item 15(a)(1), “Note 1. Summary of Significant Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31,
2021. The financial information included in this Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2021.
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, changes in shareholders’ equity, 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 six months ended July 2, 2022 are not necessarily indicative of the results to be expected for the full year ending December 31, 2022.
Our fiscal quarters
typically end on the Saturday closest to the end of March, June and September for the first three fiscal quarters of each year, and on December 31 for our fourth fiscal quarter. As a result of using fiscal quarters for the first three quarters combined with leap years, our first and fourth fiscal quarters can range between 12 1/2 weeks to 13 1/2 weeks while the second and third fiscal quarters remain at a constant 13 weeks per fiscal quarter.
Certain reclassifications have been made to prior period amounts to conform to the current year’s presentation.
iUse
of Estimates
Certain amounts and disclosures included in the unaudited condensed consolidated financial statements require management to make estimates and judgments that affect the amounts of assets, liabilities (including contract 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.
i
Subsequent
Events
Subsequent to our quarter ended July 2, 2022, on July 14, 2022, we completed a refinancing of all our existing debt by entering into a new term loan (“2022 Term Loan”) and a new revolving credit facility (“2022 Revolving Credit Facility”). The 2022 Term Loan is a $i250.0 million senior secured loan that matures on July 14, 2027. The 2022 Revolving Credit Facility is
a $i200.0 million senior secured revolving credit facility that matures on July 14, 2027. The 2022 Term Loan and 2022 Revolving Credit Facility, collectively, are the new credit facilities (“2022 Credit Facilities”). At closing, we utilized the entire amount of the 2022 Term Loan and combined with cash on hand, extinguished the existing 2019 term loan and the existing 2018 term loan. There was no balance outstanding on the 2019 revolving credit facility. At the same leverage
ratio, the interest rate spread in our 2022 Credit Facilities is lower then the interest rate spread in our credit facilities that were in effect as of July 2, 2022.
Subsequent to our quarter ended July 2, 2022, on July 14, 2022, as a result of completing a refinancing of our existing debt, we were required to complete an amendment to our derivative contracts
with an aggregate notional amount of $i150.0 million we had entered into in November 2021. The existing derivative contracts were based on U.S. dollar-one month LIBOR, which was required to be amended to one month Term SOFR, as borrowings using LIBOR are no longer available under the 2022 Credit Facilities. We have elected to apply certain hedge accounting optional expedients under ASC 848 that will allow us to continue the method of assessing hedge effectiveness as documented in the original
hedge documentation and allows the reference rate on the hypothetical derivative to match the reference rate on the hedging instrument. These derivative contracts are forward interest rate swaps, all with an effective date of January 1, 2024 and terminating on January 1, 2031.
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 is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding, plus any potentially dilutive shares that could be issued if exercised or converted into common stock in each period.
iThe net income and weighted-average common shares outstanding
used to compute earnings per share were as follows:
Weighted-average
number of common shares outstanding
Basic weighted-average common shares outstanding
i12,070
i11,878
i12,029
i11,834
Dilutive
potential common shares
i263
i370
i308
i414
Diluted
weighted-average common shares outstanding
i12,333
i12,248
i12,337
i12,248
Earnings
per share
Basic
$
i0.34
$
i0.71
$
i1.02
$
i1.28
Diluted
$
i0.34
$
i0.69
$
i0.99
$
i1.23
/
iPotentially
dilutive stock awards, as shown below, were excluded from the computation of diluted earnings per share because their inclusion would have been anti-dilutive. However, these awards may be potentially dilutive common shares in the future.
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 the 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.
We have money market funds which are included as
cash and cash equivalents. We also have forward interest rate swap agreements and the fair value of the forward interest rate swap agreements was determined using pricing models that use observable market inputs as of the balance sheet date, a Level 2 measurement.
There were no transfers between Level 1, Level 2, or Level 3 financial instruments in the three months ended July 2, 2022.
iCash and 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, and we classify as Level 1. See Fair Value above.
i
Derivative Instruments
We recognize derivative instruments on our condensed consolidated balance sheets at their fair value. On the date that we enter into a derivative contract, we designate the derivative instrument as a fair value hedge, a cash flow hedge,
or a derivative instrument that will not be accounted for using hedge accounting methods. In November 2021, we entered into forward interest rate swap agreements, all with an effective date of January 1, 2024 (“Forward Interest Rate Swaps”) to manage our exposure to interest rate movements on a portion of our debt. As such, we have made the following cash flow hedging relationship elections to qualify for hedge accounting treatment related to the Forward Interest Rate Swaps as our current term loans mature before the expiration of the Forward Interest Rate Swaps: 1) Probability of forecasted transactions, and 2) Assessment of effectiveness. See Note 7. As of July 2, 2022, all of our derivative instruments were designated as cash flow hedges.
We record changes in the fair value of a derivative instrument that is highly
effective and that is designated and qualifies as a cash flow hedge in other comprehensive income (loss), net of tax until our earnings are affected by the variability of cash flows of the underlying hedged item. We report changes in the fair values of derivative instruments that are not designated or do not qualify for hedge accounting in current period earnings. We classify cash flows from derivative instruments in the condensed consolidated statements of cash flows in the same category as the item being hedged or on a basis consistent with the nature of the instrument. Since the Forward Interest Rate Swaps are not effective until January 1, 2024, in both the three and six months ended July 2, 2022, we only recorded the changes in the fair value of the derivative instruments that were highly effective and that were designated and qualified as cash flow hedges of $i3.3
million and $i9.7 million, respectively, in other long term assets, other long term liabilities, and accumulated other comprehensive income (loss). During the three and six months ended July 3, 2021, we had no derivative instruments.
When we determine that a derivative instrument is not highly effective as a hedge, we discontinue hedge accounting prospectively.
In all situations in which we discontinue hedge accounting and the derivative instrument remains outstanding, we will carry the derivative instrument at its fair value on our condensed consolidated balance sheets and recognize subsequent changes in its fair value in our current period earnings.
/i
Inventories
Inventories are stated at the lower of cost or net realizable value with cost being determined using a moving average cost basis for raw materials
and actual cost for work-in-process and finished goods. The majority of our inventory is charged to cost of sales as raw materials are placed into production. Inventoried costs include raw materials, outside processing, direct labor and allocated overhead, adjusted for any abnormal amounts of idle performance center expense, freight, handling costs, and wasted materials (spoilage) incurred. We assess the inventory carrying value and reduce it, if necessary, to its net realizable value based on customer orders on hand, and internal demand forecasts using management’s best estimates given information currently available. The majority of our revenues are recognized over time, however, for revenue contracts where revenue is recognized using the point in time method, inventory is not reduced until it is shipped or transfer of control to the customer has occurred. Our ending inventory
consists of raw materials, work-in-process, and finished goods.
i
Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss, as reflected on the condensed consolidated balance sheets under the equity section, was comprised of cumulative pension and retirement liability adjustments, net of tax, and change in net unrealized gains and losses on cash flow hedges, net of tax.
i
Revenue
Recognition
Our customers typically engage us to manufacture products based on designs and specifications provided by the end-use customer. This requires the building of tooling and manufacturing first article inspection products (prototypes) before volume manufacturing. Contracts with our customers generally include a termination for convenience clause.
We have a significant number of contracts that are started and completed within the same year, as well as contracts derived
from long-term agreements and programs that can span several years. We recognize revenue under Accounting Standards Codification 606, “Revenue from Contracts with Customers” (“ASC 606”), which utilizes a five-step model.
The definition of a contract for us is typically defined as a customer purchase order as this is when we achieve an enforceable right to payment. The majority of our contracts are firm fixed-price contracts. The deliverables within a customer purchase order are analyzed to determine
the number of performance obligations. At times, in order to achieve economies of scale and based on our customer’s forecasted demand, we may build in advance of receiving a purchase order from our customer. When that occurs, we would not recognize revenue until we have received the customer purchase order.
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account under ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, control is transferred and the performance obligation is satisfied. The majority of our contracts
have a single performance obligation as the promise to transfer the individual goods or services are highly interrelated or meet the series guidance. For contracts with multiple performance obligations, we allocate the contract transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate the standalone selling price is the expected cost plus a margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service.
We manufacture most products
to customer specifications and the product cannot be easily modified to satisfy another customer’s order. As such, these products are deemed to have no alternative use once the manufacturing process begins. In the event the customer invokes a termination for convenience clause, we would be entitled to costs incurred to date plus a reasonable profit. Contract costs typically include labor, materials, overhead, and when applicable, subcontractor costs. For most of our products, we are building assets with no alternative use and have enforceable right to payment, and thus, we recognize revenue using the over time method.
The majority of our performance obligations are satisfied over time as work progresses. Typically, revenue is recognized over time using an input measure (i.e., costs incurred to date relative to total estimated costs at
completion, also known as cost-to-cost plus reasonable profit) to determine progress. Our typical revenue contract is a firm fixed price contract, and the cost of raw materials could make up a significant amount of the total costs incurred. As such, we believe using the total costs incurred input method would be the most appropriate method. While the cost of raw materials could make up a significant amount of the total costs incurred, there is a direct relationship between our inputs and the transfer of control of goods or services to the customer.
Contract estimates are based on various assumptions to project the outcome of future events that can span multiple
months or years. These assumptions include labor productivity and availability; the complexity of the work to be performed; the cost and availability of materials; and the performance of subcontractors.
As a significant change in one or more of these estimates could affect the progress completed (and related profitability) on our contracts, we review and update our contract-related estimates on a regular basis. We recognize such adjustments under the cumulative catch-up method. Under this method, the impact of the adjustment is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using
the adjusted estimate.
The impact of adjustments in contract estimates on our operating earnings can be reflected in either operating costs and expenses or revenue.
Net cumulative catch up adjustments on gross profit recorded were not material for both the three and six months ended July 2, 2022 and July 3, 2021.
Payments under long-term contracts may be received before or after revenue is recognized. When revenue is recognized before we bill our customer, a contract asset is
created for the work performed but not yet billed. Similarly, when we receive payment before we ship our products to our customer, a contract liability is created for the advance or progress payment. When a contract liability and a contract asset exist on the same contract, we report it on a net basis.
We record provisions for the total anticipated losses on contracts, considering total estimated costs to complete the contract
compared to total anticipated revenues, in the period in which such losses are identified. The provisions for estimated losses on contracts require us to make certain estimates and assumptions, including those with respect to the future revenue under a contract and the future cost to complete the contract. Our estimate of the future cost to complete a contract may include assumptions as to changes in manufacturing efficiency, operating and material costs, and our ability to resolve claims and assertions with our customers. If any of these or other assumptions and estimates do not materialize in the future, we may
be required to adjust the provisions for estimated losses on contracts. The provision for estimated losses on contracts is included as part of contract liabilities on the condensed consolidated balance sheets. As of July 2, 2022 and December 31, 2021, provision for estimated losses on contracts were $i3.6 million
and $i2.8 million, respectively.
Production cost of contracts includes non-recurring production costs,
such as design and engineering costs, and tooling and other special-purpose machinery necessary to build parts as specified in a contract. Production costs of contracts are recorded to cost of sales using the over time revenue recognition model. We review the value of the production cost of contracts on a quarterly basis to ensure when added to the estimated cost to complete, the value is not greater than the estimated realizable value of the related contracts. As of July 2, 2022 and December 31, 2021, production cost
of contracts were $i6.0 million and $i8.0 million, respectively.
Contract assets consist of our right to payment for work performed but not yet billed. Contract assets are transferred to accounts receivable when we bill our customers. We bill our customers when we ship the products and meet the shipping terms within the revenue contract. Contract liabilities consist of advance or progress payments received from our customers prior to the time transfer of control occurs plus the estimated losses on contracts.
When a contract liability and a contract asset exist on the same contract, we report it on a net basis.
The
increase in our contract assets as of July 2, 2022 compared to December 31, 2021 was primarily due to a net increase of products in work in process in the current period.
The decrease in our contract liabilities as of July 2, 2022 compared to December 31, 2021 was primarily due to a net decrease of advance or progress payments received from our customers in the current period. We recognized $ii16.1/ million
of the contract liabilities as of December 31, 2021 as revenues during the six months ended July 2, 2022.
Performance obligations are defined as customer placed purchase orders (“POs”) with firm fixed price and firm delivery dates. Our remaining performance obligations as of July 2, 2022 totaled $i879.4 million.
We anticipate recognizing an estimated i70% of our remaining performance obligations as revenue during the next i12 months with the remaining
performance obligations being recognized in the remainder of 2023 and beyond.
In November 2021, we were awarded an Aviation Manufacturing Jobs Protection Program grant from the U.S. Department of Transportation (“AMJPP Grant”) of $i4.0 million. As part of the award, we had to meet certain requirements over a six month performance period from November 15, 2021 to May 14, 2022, and as of our quarter ended July 2, 2022, we have completed all such requirements. As of July 2,
2022, we have received $i2.0 million of the AMJPP Grant, all during 2021, with the remaining $i2.0 million expected to be received during 2022 and included as other current assets.
We recorded $i0.9 million and $i2.7 million as a reduction of cost of sales during the three and six months ended July 2, 2022, respectively, and $i0.1 million
and $i0.3 million as a reduction of general and administrative expenses during the three and six months ended July 2, 2022, respectively. Cumulative through July 2, 2022, we have recorded $i3.6 million
and $i0.4 million as a reduction of cost of sales and selling, general and administrative expenses, respectively.
i
Recent Accounting Pronouncements
New
Accounting Guidance Adopted in 2022
In August 2020, the FASB issued ASU 2020-06, “Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40) - Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” (“ASU 2020-06”), which simplifies reporting or provides clarification on various topics, including clarification that an entity should use the weighted-average share count from each quarter when calculating the year-to-date weighted-average share count. The new guidance is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years, which
was our interim period beginning January 1, 2022. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.
Recently Issued Accounting Standards
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2020-04”), which provides optional guidance for a limited time for contracts that reference London Interbank Offered Rate (“LIBOR”), to ease the potential burden in accounting for, or recognizing the effects, of reference rate reform on financial reporting as a result of the cessation of LIBOR. The new guidance is effective at any time after March
12, 2020 but no later than December 31, 2022. We have made the following elections related to our current cash flow hedging relationships as our current term loans mature before the expiration of the Forward Interest Rate Swaps: 1) Probability of forecasted transactions, and 2) Assessment of effectiveness. See Note 7.
In December 2021, we acquired i100.0% of the outstanding equity interests of Magnetic Seal LLC (f/k/a Magnetic Seal Corporation, “MagSeal”), a privately-held leading provider of high-impact, military-proven magnetic seals for critical systems in aerospace and defense applications, offering sealing solutions that are engineered to perform in high-speed, high-vibration, and other challenging environments. MagSeal is located in Warren, Rhode Island. The acquisition of MagSeal will
continue to advance our strategy to diversify and offer more customized, value-driven engineered products with aftermarket opportunities.
The original purchase price for MagSeal was $i69.5 million, net of cash acquired, all payable in cash. We paid a gross aggregate of $i71.3 million
in cash upon the closing of the transaction. Subsequent to the closing of the transaction, during the three months ended July 2, 2022, as part of finalizing the working capital adjustment, we received $i0.4 million back from the seller which lowered the purchase price to $i69.1 million,
net of cash acquired. We allocated the final gross purchase price of $i70.9 million to the assets acquired and liabilities assumed at their estimated fair values. The excess of the purchase price over the aggregate fair values of the net assets was recorded as goodwill.
i
The
following table summarizes the final estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):
Estimated Fair Value
Cash
$
i1,821
Accounts
receivable
i2,093
Inventories
i4,546
Other
current assets
i98
Property and equipment
i482
Operating
lease right-of-use assets
i1,533
Intangible assets
i30,100
Goodwill
i32,577
Total
assets acquired
i73,250
Current liabilities
(i907)
Other
non-current liabilities
(i1,408)
Total liabilities assumed
(i2,315)
Total
purchase price allocation
$
i70,935
/
i
Useful
Life (In years)
Estimated Fair Value (In thousands)
Intangible assets:
Customer relationships
i19
$
i24,800
Backlog
i2
i600
Trade
name
Indefinite
i4,700
$
i30,100
/
The
intangible assets acquired of $i30.1 million were determined based on the estimated fair values using valuation techniques consistent with the income approach to measure fair value, which represented Level 3 fair value measurements. The useful lives were estimated based on the underlying agreements or the future economic benefit expected to be received from the assets. The value for customer relationships
and backlog were estimated based on a multi-period excess earnings approach, while the value for trade name was assessed using the relief from royalty methodology. Inputs to the income approach models and other aspects of the allocation of the purchase price require judgment. The more significant inputs used in the customer relationships intangible asset valuation include (i) future revenue growth rates, (ii) projected gross margins, (iii) the customer attrition rate, and (iv) the discount rate.
The goodwill of $i32.6 million arising from the acquisition is attributable to
the benefits we expect to derive from expected synergies from the transaction, including complementary products that will enhance our overall product portfolio, opportunities within new markets, and an acquired assembled workforce. All the goodwill was assigned to the Structural Systems segment. The MagSeal acquisition, for tax purposes, is deemed an asset acquisition and thus, is deductible for income tax purposes.
Acquisition related transaction costs were not included as components of consideration transferred but have been expensed as incurred. Total acquisition-related transaction costs incurred by us were $i0.9 million
during 2021 and charged to selling, general and administrative expenses.
MagSeal’s results of operations have been included in our condensed consolidated statements of income since the date of acquisition as part of the Structural Systems segment and were immaterial since the date of acquisition. Pro forma results of operations of the MagSeal acquisition have not been presented as the effect of the MagSeal acquisition was not material to our financial results.
Note 3. iRestructuring
Activities
Summary of 2022 Restructuring Plan
In April 2022, management approved and commenced a restructuring plan that will better position us for stronger performance. The restructuring plan will mainly reduce headcount and consolidate facilities. As a result of this restructuring plan, we analyzed the need to write-down inventory and impair long-lived assets, including operating lease right-of-use assets. During the three months ended July 2, 2022, we recorded total charges of $i3.2
million. As of July 2, 2022, we estimate the remaining amount of charges related to this initiative will be $i3.0 million to $i5.0 million
in total pre-tax restructuring charges through 2023. Of these charges, we estimate $i2.0 million to $i3.0 million to be cash
payments for employee separation and other facility consolidation related expenses, and $i1.0 million to $i2.0 million to
be non-cash charges for impairment of long-lived assets.
In the Electronics Systems segment, we recorded $i1.3 million during the three months ended July 2, 2022 for severance and benefits that were classified as restructuring charges.
In the Structural Systems segment, we recorded $i0.5
million, $i1.1 million, and $i0.3 million during the three months ended July 2, 2022 for inventory write down that was classified as cost of sales,
severance and benefits that were classified as restructuring charges, and impairment of property and equipment that were classified as restructuring charges, respectively.
i
Our restructuring activities during the six months ended July 2, 2022 were as follows (in thousands):
Property
and equipment impairment due to restructuring
i—
i304
i—
(i304)
i—
i—
Inventory
write down
i—
i528
i—
(i528)
i—
i—
Ending
balance
$
i—
$
i3,231
$
(i948)
$
(i832)
$
i—
$
i1,451
/
The
restructuring activities accrual for severance and benefits of $i1.5 million as of July 2, 2022 was included as part of accrued and other liabilities.
We perform our annual goodwill impairment test as of the first day of the fourth quarter. If certain factors occur, including significant underperformance of our business relative to expected operating results, significant adverse economic and industry trends, significant decline in our market capitalization for an extended period of time relative to net book value, a decision to divest individual businesses within a reporting unit, or a decision to group individual businesses differently, we may be required to perform an interim impairment
test prior to the fourth quarter.
15
We may use either a qualitative or quantitative approach when testing a reporting unit’s goodwill for impairment. The qualitative approach for potential impairment analysis to determine whether it is more likely than not that the fair value of a reporting unit was less than its carrying amount.
The quantitative approach for potential impairment analysis is performed by comparing the fair value of a reporting unit to its carrying value, including goodwill. Fair value is estimated by management using a combination of the income approach (which is based on a discounted cash flow model) and market approach. Management’s cash flow projections include significant judgments and assumptions, including
the amount and timing of expected cash flows, long-term growth rates, and discount rates. The cash flows used in the discounted cash flow model are based on our best estimate of future revenues, gross margins, and adjusted after-tax earnings. If any of these assumptions are incorrect, it will impact the estimated fair value of a reporting unit. The market approach also requires significant management judgment in selecting comparable business acquisitions and the transaction values observed and its related control premiums.
While our business continues to be negatively impacted during the three and six months ended July 2, 2022 as a result of the COVID-19 pandemic, no material adverse factors/changes have occurred since the fourth quarter of 2021 that would require us to perform another qualitative or quantitative assessment. As such, for the second quarter of 2022, it was also
not more likely than not that the fair values of the reporting units were less than their carrying amounts and thus, the respective goodwill amounts were not deemed to be impaired.
iThe carrying amounts of our goodwill were as follows:
Subsequent to our quarter ended July 2, 2022, on July 14, 2022, we completed a refinancing of all our existing debt by entering into a new term loan (“2022 Term Loan”) and a new revolving credit facility (“2022 Revolving Credit Facility”). The 2022 Term Loan is a $i250.0 million
senior secured loan that matures on July 14, 2027. The 2022 Revolving Credit Facility is a $i200.0 million senior secured revolving credit facility that matures on July 14, 2027. The 2022 Term Loan and 2022 Revolving Credit Facility, collectively are the new credit facilities (“2022 Credit Facilities”). At the same leverage ratio, the interest rate spread in our 2022 Credit Facilities is lower then the interest rate spread in our
credit facilities that were in effect as of July 2, 2022. See Note 1 for further information.
In December 2019, we completed the refinancing of a portion of our existing debt by entering into a new revolving credit facility (“2019 Revolving Credit Facility”) to replace the then existing revolving credit facility that was entered into in November 2018 (“2018 Revolving Credit Facility”) and entered into a new term loan (“2019 Term Loan”). The 2019 Revolving Credit Facility is a $i100.0 million
senior secured revolving credit facility that matures on December 20, 2024 replacing the $i100.0 million 2018 Revolving Credit Facility that would have matured on November 21, 2023. The 2019 Term Loan is a $i140.0 million
senior secured term loan that matures on December 20, 2024. We also have an existing $i240.0 million senior secured term loan that was entered into in November 2018 that matures on November 21, 2025 (“2018 Term Loan”). The original amounts available under the 2019 Revolving Credit Facility, 2019 Term Loan, and 2018 Term Loan (collectively, the “Credit Facilities”) in aggregate, totaled $i480.0 million.
The
2019 Term Loan bears interest, at our option, at a rate equal to either (i) the Eurodollar Rate (defined as the London Interbank Offered Rate [“LIBOR”]) plus an applicable margin ranging from i1.50% to i2.50%
per year or (ii) the Base Rate (defined as the highest of [a] Federal Funds Rate plus i0.50%, [b] Bank of America’s prime rate, and [c] the Eurodollar Rate plus i1.00%)
plus an applicable margin ranging from i0.50% to i1.50% per year, in each case based upon the consolidated total net adjusted leverage ratio, typically payable
quarterly. In addition, the 2019 Term Loan requires installment payments of i1.25% of the original outstanding principal balance of the 2019 Term Loan amount on a quarterly basis, on the last day of the calendar quarter. For the three and six months ended July 2, 2022, we made the required quarterly payments of $i1.8
million and $i3.5 million, respectively.
The 2019 Revolving Credit Facility bears interest, at our option, at a rate equal to either (i) the Eurodollar Rate (defined as LIBOR) plus an applicable margin ranging from i1.50%
to i2.50% per year or (ii) the Base Rate (defined as the highest of [a] Federal Funds Rate plus i0.50%, [b] Bank of America’s prime rate, and [c] the Eurodollar
Rate plus i1.00%) plus an applicable margin ranging from i0.50% to i1.50%
per year, in each case based upon the consolidated total net adjusted leverage ratio, typically payable quarterly. The undrawn portion of the commitment of the 2019 Revolving Credit Facility is subject to a commitment fee ranging from i0.175% to i0.275%,
based upon the consolidated total net adjusted leverage ratio. However, the 2019 Revolving Credit Facility does not require any principal installment payments.
The 2018 Term Loan bears interest, at our option, at a rate equal to either (i) the Eurodollar Rate (defined as LIBOR plus an applicable margin ranging from i3.75% to i4.00%
per year or (ii) the Base Rate (defined as the highest of [a] Federal Funds Rate plus i0.50%, [b] Bank of America’s prime rate, and [c] the Eurodollar Rate plus i1.00%)
plus an applicable margin ranging from i3.75% to i4.00% per year, in each case based upon the consolidated total net adjusted leverage ratio, typically payable
quarterly. In addition, the 2018 Term Loan required installment payments of i0.25% of the outstanding principal balance of the 2018 Term Loan amount on a quarterly basis.
Further, under the Credit Facilities, if we exceed the annual excess cash flow threshold, we are required to make an annual additional principal payment based on the consolidated adjusted leverage ratio. The annual mandatory excess cash flow payment is based on (i) i50%
of the excess cash flow amount if the adjusted leverage ratio is greater than i3.25 to 1.0, (ii) i25%
of the excess cash flow amount if the adjusted leverage ratio is less than or equal to i3.25 to 1.0 but greater than i2.50 to 1.0, and (iii) izero
percent of the excess cash flow amount if the consolidated adjusted leverage ratio is less than or equal to i2.50 to 1.0. We did not exceed the annual excess cash flow threshold for 2021 and thus, no annual excess cash flow payment was required to be paid during the first quarter of 2022. As of July 2, 2022, we were in compliance with all covenants required under the Credit Facilities.
In conjunction with entering into the 2019 Revolving Credit Facility and the 2019 Term
Loan, we drew down the entire $i140.0 million on the 2019 Term Loan and used those proceeds to pay off and close the 2018 Revolving Credit Facility of $i58.5 million,
paid down a portion of the 2018 Term Loan of $i56.0 million, paid the accrued interest associated with the amounts being paid down on the 2018 Revolving Credit Facility and 2018 Term Loan, paid the fees related to this transaction, and the remainder available for general corporate purposes. The $i56.0 million
pay down on the 2018 Term Loan paid all the required quarterly installment payments on the 2018 Term Loan until maturity.
However, since we were paying down on the term loans during the three months ended April 2, 2022, we were required to pay down on the 2019 Term Loan and 2018 Term Loan on a pro-rata basis and thus, we paid down $i13.0 million and $i17.0 million
on the 2019 Term Loan and 2018 Term Loan, respectively, for an aggregate total pay down of $i30.0 million. We made iino/
voluntary prepayments on either the 2019 Term Loan or the 2018 Term Loan during the three months ended July 2, 2022.
The 2019 Term Loan and 2018 Term Loan were considered a modification of debt and thus, no gain or loss was recorded. Instead, the new fees paid to the lenders of $i0.6 million
were capitalized and are being amortized over the life of the 2019 Term Loan. The remaining debt issuance costs related to the 2018 Term Loan of $i1.5 million as of the modification date will continue to be amortized over its remaining life.
The 2019 Revolving Credit Facility that replaced the 2018 Revolving Credit Facility was considered an extinguishment of debt except for the portion related to the creditors that were part of both the 2019 Revolving Credit Facility and the 2018 Revolving Credit Facility and in which case, it was considered
a modification of debt. As a result, we expensed the portion of the unamortized debt issuance costs related to the 2018 Revolving Credit Facility that was considered an extinguishment of debt of $i0.5 million. In addition, the new fees paid to the lenders of $i0.5 million
as part of the 2019 Revolving Credit Facility were capitalized and are being amortized over its remaining life. Further, the remaining debt issuance costs related to the 2018 Revolving Credit Facility of $i1.1 million as of the modification date will also be amortized over its remaining life.
As of July 2, 2022, we had $i99.8
million of unused borrowing capacity under the 2019 Revolving Credit Facility, after deducting $i0.2 million for standby letters of credit.
The Credit Facilities were entered into by us (“Parent Company”) and guaranteed by all of our domestic subsidiaries, other than itwosubsidiaries that were considered minor (“Subsidiary Guarantors”). The Subsidiary Guarantors jointly and severally guarantee the Credit Facilities. The Parent Company has no independent assets or operations and therefore, no consolidating financial information for the Parent Company and its subsidiaries is presented.
In November 2021, we entered into derivative contracts, U.S. dollar-one month LIBOR forward interest rate swaps designated as cash flow hedges, all with an effective date of January 1, 2024, for an aggregate total notional amount of $i150.0 million,
weighted average fixed rate of i1.8%, and all terminating on January 1, 2031 (“Forward Interest Rate Swaps”). The Forward Interest Rate Swaps mature on a monthly basis, with fixed amount payer payment dates on the first day of each calendar month, commencing on February 1, 2024 through January 1, 2031. The Forward Interest Rate Swaps were deemed to be highly effective upon entering into the derivative contracts
and thus, hedge accounting treatment was utilized. Since the Forward Interest Rate Swaps are not effective until January 1, 2024, we only recorded the changes in the fair value of the Forward Interest Rate Swaps that were highly effective and that were designated and qualified as cash flow hedges. As such, we recorded the change of $i3.3 million in other long term assets, other long term liabilities, and
other comprehensive income (loss) for the three months ended July 2, 2022. See Note 1 for further information.
Subsequent to our quarter ended July 2, 2022, on July 14, 2022, as a result of completing a refinancing of our existing debt, we were required to complete an amendment of our derivative contracts with an aggregate notional amount of $i150.0 million
we had entered into in November 2021. The existing derivative contracts were based on U.S. dollar-one month LIBOR, which was required to be amended to one month Term SOFR, as borrowings using LIBOR are no longer available under the 2022 Credit Facilities. See Note 1.
Note 8. iIndemnifications
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. Additionally, we indemnify our directors and officers to the maximum extent permitted under the laws of the State of Delaware and 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. Moreover, in connection with certain performance center leases, we have indemnified our lessors for certain claims arising from the performance center or the lease.
The duration of the guarantees and indemnities varies and, in many cases is indefinite but subject to applicable statutes of limitations. The majority of guarantees and indemnities do not provide any limitations on 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 9. iIncome
Taxes
The provision for income taxes is determined using an estimated annual effective tax rate, which is generally less than the U.S. Federal statutory rate, primarily due to research and development (“R&D”) tax credits. Our effective tax rate may be subject to fluctuations during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as expected utilization of R&D tax credits, valuation allowances against deferred tax assets, recognition or derecognition of tax benefits related to uncertain tax positions, and changes in or the interpretation of tax laws in jurisdictions where we conduct business. Also, excess tax benefits and tax detriments related to our equity
compensation recognized in the condensed consolidated income statement could result in fluctuations in our effective tax rate period-over-period depending on the volatility of our stock price, number of restricted or performance stock units that vests, and stock options exercised during the period. We recognize deferred tax assets and liabilities, using enacted tax rates, for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities along with net operating loss and tax credit carryovers.
We record a valuation allowance against our deferred tax assets to reduce the net carrying value to an amount that we believe is more likely than not to be realized. When we establish or reduce our valuation allowances against our deferred tax assets, the provision for income taxes will increase or decrease, respectively, in
the period when that determination is made.
We recorded income tax expense of $i1.0 million for the three months ended July 2, 2022 compared to $i1.8
million for the three months ended July 3, 2021. The decrease in income tax expense for the second quarter of 2022 compared to the second quarter of 2021 was primarily due to lower pre-tax income for the second quarter of 2022 compared to the second quarter of 2021. The decrease in income tax expense was partially offset by lower discrete income tax benefits recognized in the second quarter of 2022 for net tax windfalls related to stock-based compensation.
We recorded income tax expense of $i2.6
million for the six months ended July 2, 2022 compared to $i2.9 million for the six months ended July 3, 2021. The decrease in income tax expense for the first six months of 2022 compared to the first six months of 2021 was primarily due to lower pre-tax income for the first six months of 2022 compared to the first six months of 2021 and higher income tax benefits recognized in the first six months of 2022 related to the U.S. Federal research and development tax credit. The
decrease in income tax expense was partially offset by lower discrete income tax benefits recognized in the first six months of 2022 for net tax windfalls related to stock-based compensation.
Our total amount of unrecognized tax benefits was $i4.6 million and $i4.4
million as of July 2, 2022 and December 31, 2021, respectively. If recognized, $i2.8 million would affect the effective tax rate. We record interest and penalty charges, if any, related to uncertain tax positions as a component of tax expense and unrecognized tax benefits. The amounts accrued for interest and penalty charges as of July 2, 2022 and December 31,
2021 were not significant. As a result of statute of limitations set to expire in the fourth quarter of 2022, we expect decreases to our unrecognized tax benefits of approximately $i0.7 million in the next twelve months.
We file U.S. Federal and state income tax returns. We are subject to examination by the Internal Revenue Service (“IRS”) for tax years after 2017 and by state taxing authorities for tax years after 2016. While we are no longer subject to examination
prior to those periods, carryforwards generated prior to those periods may still be adjusted upon examination by the IRS or state taxing authorities if they either have been or will be used in a subsequent period. We believe we have adequately accrued for tax deficiencies or reductions in tax benefits, if any, that could result from the examination and all open audit years.
The Tax Cuts and Jobs Act of 2017 (“TCJA”), which was signed into U.S. law in December 2017, eliminated the option to immediately deduct research and development expenditures in the year incurred under Section 174 effective January 1, 2022. The amended provision under Section 174 requires us to capitalize and amortize these expenditures over five years (for U.S.-based research). Although there is proposed legislation to temporarily reinstate the current deduction of the expenditures after 2021 through
2025, we must consider the changes under the TCJA. As of July 2, 2022, we recorded an increase to current income taxes payable by approximately $i5.3 million and a decrease to net deferred tax liabilities by a similar amount. We are monitoring legislation for any further changes to Section 174 and the impact to the financial statements in 2022.
Note 10.
iCommitments and Contingencies
In December 2020, a representative action under California’s Private Attorneys General Act was filed against us in the Superior Court of California, County of San Bernardino. We received service of process of this complaint on January 28, 2021. The complaint alleges violations of California’s wage and hour laws relating to our current and former employees and seeks attorney’s fees and penalties. We vigorously refuted and defended
these claims, and reached a tentative settlement of $i0.8 million during the fourth quarter 2021, which is subject to court approval. Thus, we recorded accrued liabilities of $i0.8 million as of December 31,
2021. During the three months ended July 2, 2022, additional factual information was identified resulting in an increase in the amount of the tentative settlement to $i0.9 million. Therefore, we recorded an additional accrued liabilities of $i0.1 million
for a total accrued liabilities amount of $i0.9 million as of July 2, 2022. We are awaiting final court approval of this settlement.
Structural Systems has been directed by California environmental agencies to investigate and take corrective action for groundwater contamination at our facilities located in El Mirage and Monrovia, California. Based on currently available information, we have established an accrual for its estimated liability for such investigation and corrective action of $ii1.5/
million at both July 2, 2022 and December 31, 2021, which is reflected in other long-term liabilities on our condensed consolidated balance sheets.
Structural Systems also faces liability as a potentially responsible party for hazardous waste disposed at landfills located in Casmalia and West Covina, California. Structural Systems and other companies and 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, we preliminarily estimate that the range of our future liabilities in connection with the landfill located in West Covina, California is between $i0.4 million and $i3.1
million. We have established an accrual for the estimated liability in connection with the West Covina landfill of $ii0.4/
million as of both July 2, 2022 and December 31, 2021, which is reflected in other long-term liabilities on our condensed consolidated balance sheets. Our 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 June 2020, a fire severely damaged our performance center in Guaymas, Mexico, which is part of our Structural Systems segment. There were no injuries, however, property and equipment, inventories, and tooling in this leased facility were damaged. Our Guaymas performance center is comprised of itwo
buildings with an aggregate total of i62,000 square feet. The loss of production from the Guaymas performance center was being absorbed by our other existing performance centers, however, we have reestablished and are in the process of ramping up manufacturing capabilities in a different leased facility in Guaymas. A neighboring, non-related manufacturing facility, also suffered fire damage during the same time as the fire that severely damaged our Guaymas performance center. The cause of the fire is still undetermined and as such, there is no amount of loss that is probable
and reasonably estimable at this time. If we are ultimately deemed to be responsible or partly responsible, it is possible we could incur a loss in excess of our insurance coverage limits, which could be material to our cash flow, liquidity, or financial results.
Our insurance covers damage, up to a capped amount, to the facility, equipment, unfinished inventory, and other assets at replacement cost, finished goods inventory at selling price, as well as business interruption, third party property damage, and recovery related expenses caused by the fire, less our per claim deductible. The anticipated insurance recoveries related to losses and incremental costs incurred are recognized when receipt is probable. The anticipated insurance recoveries in excess of net book value of the damaged operating assets and business interruption will not be recorded until all contingencies related to our claim have been resolved. During the
year ended December 31, 2020, $i0.8 million of revenue and $i0.5 million
of related cost of sales were reversed for revenue previously recognized using the over time method as the revenue recognition process for these items were deemed to be interrupted as a result of these inventory items being damaged. Also during the year ended December 31, 2020, we wrote off property and equipment and tooling with an aggregate total net book value of $i7.1 million and inventory on hand of $i3.4 million
that were damaged by the fire. The related anticipated insurance recoveries were also presented within the same financial statement line item in the condensed consolidated statements of income resulting in no net impact, with the anticipated insurance recoveries receivable included as part of other current assets on the condensed consolidated balance sheets. During the three and six months ended July 2, 2022, we received insurance recoveries of izero and $i3.0 million,
respectively, for business interruption and since the contingencies related to this amount are deemed to be resolved, we recorded this amount as other income. In addition, as of July 2, 2022, we have received $i13.5 million of general insurance recoveries, all during 2020. The timing of and the remaining amounts of insurance recoveries, including for business interruption, are not known at this time.
In the normal course of business, Ducommun and its subsidiaries
are defendants in certain other litigation and claims, and receive certain demands and inquiries, in both cases, including but not limited to matters relating to environmental laws. In addition, Ducommun makes various commitments, grants indemnities, and incurs contingent liabilities in the ordinary course of business. 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 condensed consolidated financial position, results of operations or cash flows.
We supply products and services primarily to the aerospace and defense industries. Our subsidiaries are organized into itwo
strategic businesses, Electronic Systems and Structural Systems, each of which is a reportable operating segment.
i
Financial information by reportable operating segment was as follows:
(1)Includes
assets not specifically identified to or allocated to either the Electronic Systems or Structural Systems operating segments, including cash and cash equivalents.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Ducommun Incorporated (“Ducommun,”“the Company,”“we,”“us” or “our”) 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 and defense (“A&D”), industrial, medical and other industries (collectively, “Industrial”). We differentiate ourselves as a full-service solution-based 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 segments: Electronic Systems and Structural Systems, each of which is a reportable segment.
COVID-19 Pandemic Impact on Our Business
The COVID-19 pandemic has had a significant impact on our overall business during both the three and six months ended July 2, 2022 and July 3,
2021. As a result of the COVID-19 pandemic, precautionary measures were instituted by governments and businesses to mitigate its spread, including the imposition of travel restrictions, quarantines, shelter in place directives, and shutting down of non-essential businesses.
The safety of our employees remains our highest priority. The well-being and safety protocols that were already in place at all of our facilities were further enhanced at the onset of the COVID-19 pandemic. We continue to follow safety protocols consistent with guidelines provided by state and local governments and the Centers for Disease Control and Prevention (“CDC”). These measures included social distancing, provision of personal protective equipment, enhanced cleaning, and flexible work arrangements wherever possible. We have also offered enhanced leave and benefits to our employees and provided frequent updates to ensure our workforce is
kept apprised of evolving regulations and safety measures.
In March 2020, the U.S. enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) which provides tax relief to individuals and businesses affected by the coronavirus pandemic. We have not requested or accepted any loans or payments that are available under the CARES Act, however, we have utilized the option to defer payment of the employer portion of payroll taxes (Social Security) that would otherwise be required to be made during the period beginning March 27, 2020 to December 31, 2020. One half of the deferred amount was required to be paid and was paid by December 31, 2021, with the remaining 50% to be paid by December 31, 2022. As of July 2,
2022, we have deferred $3.1 million, which is included as part of accrued and other liabilities on the condensed consolidated balance sheets.
The COVID-19 pandemic has and continues to contribute to a general slowdown in the global economy and most significantly, the commercial aerospace end-use market. While both major large aircraft manufacturers, The Boeing Company (“Boeing”) and Airbus SE, have announced increases in build rates for 2022, it is well below pre-pandemic levels. In its 2021 Annual Report on Form 10-K, Boeing indicated it expects commercial air travel to return to 2019 levels in 2023 to 2024, and a few years beyond that for the industry to return to the long-term trend growth. While the full extent and impact of the COVID-19 pandemic cannot be reasonably estimated with certainty at this time, COVID-19 has had a significant impact on our business, the businesses of our customers and suppliers, as
well as our results of operations and financial condition, and may have a material adverse impact on our business, results of operations and financial condition for 2022 and beyond.
Second quarter 2022 recap:
•Net revenues of $174.2 million
•Net income of $4.1 million, or $0.34 per diluted share
•Adjusted EBITDA of $24.1 million, or 13.8% of revenues
Non-GAAP Financial Measures
Adjusted earnings before interest, taxes, depreciation, amortization, stock-based compensation expense, restructuring charges, Guaymas fire related expenses, insurance recoveries related to business interruption, and inventory purchase accounting adjustments (“Adjusted
EBITDA”) were $24.1 million and $23.4 million for the three months ended July 2, 2022 and July 3, 2021, respectively.
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 Adjusted EBITDA provides additional useful information that clarifies and enhances the understanding of the factors and trends affecting our past performance and future prospects. We define this measure, explain how it is calculated and provide a reconciliation of this measure to the most comparable GAAP measure in the table below. Adjusted EBITDA and the related financial ratios, as presented in this Quarterly Report on Form 10-Q (“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.
We use Adjusted EBITDA as a non-GAAP operating performance measure internally as a complementary financial measure to evaluate the performance
and trends of our businesses. We present 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 operating commitments.
Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations include:
•It does not reflect our cash expenditures, future requirements for capital expenditures or contractual commitments;
•It does not reflect changes in, or cash requirements for, our working capital needs;
•It does not reflect the significant interest expense or the cash requirements necessary
to service interest or principal payments on our debt;
•Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;
•It is not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows;
•It does not reflect the impact on earnings of charges resulting from matters unrelated to our ongoing operations; and
•Other companies in our industry may calculate Adjusted EBITDA differently from us, limiting its usefulness as a comparative measure.
As a result
of these limitations, 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 Adjusted EBITDA only as supplemental information. See our condensed consolidated financial statements contained in this Form 10-Q.
Even with the limitations above, we believe that Adjusted EBITDA is useful to an investor in evaluating our results of operations as this measure:
•Is widely used by investors to measure a company’s operating performance without regard to items excluded from the calculation of such terms, which can vary substantially from company to company depending upon accounting methods and
book value of assets, capital structure and the method by which assets were acquired, among other factors;
•Helps investors to evaluate and compare the results of our operations from period to period by removing the effect of our capital structure from our operating performance; and
•Is used by our management team for various other purposes in presentations to our Board of Directors as a basis for strategic planning and forecasting.
The following financial items have been added back to or subtracted from our net income when calculating Adjusted EBITDA:
•Interest expense may be useful to investors for determining current cash flow;
•Income tax expense may be
useful to investors because it represents the taxes which may be payable for the period and the change in deferred taxes during the period, and may reduce cash flow available for use in our business;
•Depreciation may be useful to investors because it generally represents the wear and tear on our property and equipment used in our operations;
•Amortization expense may be useful to investors because it represents the estimated attrition of our acquired customer base and the diminishing value of product rights;
•Stock-based compensation may be useful to our investors for determining current cash flow;
•Restructuring charges may be useful to our investors in evaluating our core operating performance;
•Guaymas
fire related expenses may be useful to our investors in evaluating our core operating performance;
•Insurance recoveries related to business interruption may be useful to our investors in evaluating our core operating performance; and
•Purchase accounting inventory step-ups may be useful to our investors as they do not necessarily reflect the current or on-going cash charges related to our core operating performance.
Reconciliations of net income to Adjusted EBITDA and the presentation of Adjusted EBITDA as a percentage of
net revenues were as follows:
Insurance
recoveries related to business interruption
—
—
(3,000)
—
Inventory purchase accounting adjustments
637
—
1,274
—
Adjusted
EBITDA
$
24,118
$
23,379
$
44,193
$
44,519
% of net revenues
13.8
%
14.6
%
13.1
%
14.0
%
(1)
Both three and six months ended July 2, 2022 included $0.5 million of stock-based compensation expense for awards with both performance and market conditions that will be settled in cash.
(2) Both three and six months ended July 2, 2022 included $0.5 million of restructuring charges that were recorded as cost of sales.
Net Revenues by End-Use Market and Operating Segment
Net revenues by end-use market and operating segment during the fiscal three and six months ended July 2, 2022 and July 3, 2021, respectively, were as follows:
Net
revenues for the three months ended July 2, 2022 were $174.2 million, compared to $160.2 million for the three months ended July 3, 2021. The year-over-year increase was primarily due to the following:
•$19.5 million higher revenues in our commercial aerospace end-use markets due to higher build rates on large aircraft platforms, other commercial aerospace platforms, and regional and business aircraft platforms; partially offset by
•$6.3 million lower revenues in our military and space end-use markets due to lower build rates on military rotary-wing aircraft platforms and various missile platforms, partially offset by higher build rates on other military and space platforms.
Net revenues for
the six months ended July 2, 2022 were $337.7 million, compared to $317.3 million for the six months ended July 3, 2021. The year-over-year increase was primarily due to the following:
•$38.2 million higher revenues in our commercial aerospace end-use markets due to higher build rates on large aircraft platforms, other commercial aerospace platforms, and regional and business aircraft platforms; partially offset by
•$21.1 million lower revenues in our military and space end-use markets due to lower build rates on military rotary-wing aircraft platforms, various missile platforms, and military fixed-wing aircraft platforms.
Net Revenues by Major Customers
A
significant portion of our net revenues are from our top ten customers as follows:
(1)Includes The Boeing Company (“Boeing”),
General Dynamics Corporation (“GD”), Northrop Grumman Corporation (“Northrop”), Raytheon Technologies Corporation (“Raytheon”), and Spirit AeroSystems Holdings, Inc. (“Spirit”) for the three and six months ended July 2, 2022 and July 3, 2021.
Boeing, GD, Northrop, Raytheon, and Spirit represented the following percentages of total accounts receivable:
The
net revenues and accounts receivable from Boeing, GD, Northrop, Raytheon, and Spirit are diversified over a number of commercial, military and space programs and were generated by both operating segments.
Gross Profit
Gross profit consists of net revenues less cost of sales. Cost of sales includes the cost of production of finished products and other expenses related to inventory management, manufacturing quality, and order fulfillment. Gross profit as a percentage of net revenues decreased year-over-year with the three months ended July 2, 2022 of 19.9%, compared to the three months ended July 3, 2021 of 23.0% primarily due to unfavorable product mix, partially offset by favorable manufacturing volume and lower compensation and benefits costs.
Gross
profit as a percentage of net revenues decreased year-over-year with the six months ended July 2, 2022 of 19.9%, compared to the six months ended July 3, 2021 of 22.0% primarily due to unfavorable product mix, partially offset by lower compensation and benefits costs and favorable manufacturing volume.
Selling, General and Administrative (“SG&A”) Expenses
SG&A expenses increased $0.5 million year-over-year in the three months ended July 2, 2022 compared to the three months ended July 3, 2021 primarily due to higher other general and administrative expenses of $0.9 million, partially offset by lower compensation and benefits costs of $0.3 million.
SG&A
expenses increased $1.4 million year-over-year in the six months ended July 2, 2022 compared to the six months ended July 3, 2021 primarily due to higher other general and administrative expenses of $1.6 million.
Restructuring Charges
Restructuring charges increased $3.2 million (of which $0.5 million was included in cost of sales) year-over-year in both the three and six months ended July 2, 2022 compared to both the three and six months ended July 3, 2021 primarily due to the restructuring plan that was approved and commenced in April 2022 that is expected to better position us for stronger performance. See Note 3 for further information.
Interest
Expense
Interest expense decreased $0.2 million and $0.6 million year-over-year in the three and six months ended July 2, 2022 compared to the three and six months ended July 3, 2021, respectively, primarily due to a lower outstanding debt balance, partially offset by higher interest rates.
Income Tax Expense
We recorded income tax expense of $1.0 million for the three months ended July 2, 2022, compared to $1.8 million for the three months ended July 3, 2021. The decrease in income tax expense for the second quarter of 2022 compared to the second quarter of 2021 was primarily due to lower pre-tax income for the second quarter of 2022 compared
to the second quarter of 2021. The decrease in income tax expense was partially offset by lower discrete income tax benefits recognized in the second quarter of 2022 for net tax windfalls related to stock-based compensation.
We recorded income tax expense of $2.6 million for the six months ended July 2, 2022, compared to $2.9 million for the six months ended July 3, 2021. The decrease in income tax expense for the first six months of 2022 compared to the first six months of 2021 was primarily due to lower pre-tax income for the first six months of 2022 compared to the first six months of 2021 and higher income tax benefits recognized in the first six months of 2022 related to the U.S. Federal research and development tax credit. The decrease in
income tax expense was partially offset by lower discrete income tax benefits recognized in the first six months of 2022 for net tax windfalls related to stock-based compensation.
Our total amount of unrecognized tax benefits was $4.6 million and $4.4 million as of July 2, 2022 and December 31, 2021, respectively. If recognized, $2.8 million would affect the effective tax rate. We record interest and penalty charges, if any, related to uncertain tax positions as a component of tax expense and unrecognized tax benefits. The amounts accrued for interest and penalty charges as of July 2, 2022 and December 31, 2021 were not significant. As a result of statute of limitations
set to expire in the fourth quarter of 2022, we expect decreases to our unrecognized tax benefits of approximately $0.7 million in the next twelve months.
We file U.S. Federal and state income tax returns. We are subject to examination by the Internal Revenue Service (“IRS”) for tax years after 2017 and by state taxing authorities for tax years after 2016. While we are no longer subject to examination prior to those periods, carryforwards generated prior to those periods may still be adjusted upon examination by the IRS or state taxing authorities if they either have been or will be used in a subsequent period. We believe we have adequately accrued for tax deficiencies or reductions in tax benefits, if any, that could result from the examination and all open audit years.
The Tax Cuts and Jobs Act of 2017 (“TCJA”), which was signed into U.S. law in December 2017, eliminated
the option to immediately deduct research and development expenditures in the year incurred under Section 174 effective January 1, 2022. The amended provision under Section 174 requires us to capitalize and amortize these expenditures over five years (for U.S.-based research). Although there is proposed legislation to temporarily reinstate the current deduction of the expenditures after 2021 through 2025, we must consider the changes under the TCJA. As of July 2, 2022, we recorded an increase to current income taxes payable by approximately $5.3 million and a decrease to net deferred tax liabilities by a similar amount. We are monitoring legislation for any further changes to Section 174 and the impact to the financial statements in 2022.
Net Income and Earnings per Share
Net income
and earnings per share for the three months ended July 2, 2022 were $4.1 million, or $0.34 per diluted share, compared to $8.4 million, or $0.69 per diluted share, for the three months ended July 3, 2021. The decrease in net income for the three months ended July 2, 2022 compared to the three months ended July 3, 2021 was primarily due to lower gross profit of $2.1 million and higher restructuring charges of $3.2 million.
Net income and earnings per share for the six months ended July 2, 2022 were $12.2 million, or $0.99 per diluted share, compared to $15.1 million, or $1.23 per diluted share, for the six months ended July 3, 2021.
The decrease in net income for the six months ended July 2, 2022 compared to the six months ended July 3, 2021 was primarily due to lower gross profit of $2.8 million and higher restructuring charges of $3.2 million, partially offset by higher other income of $3.0 million.
We report our financial performance based upon the two reportable operating segments: Electronic Systems and Structural Systems. The results of operations differ between our reportable operating segments due to differences
in competitors, customers, extent of proprietary deliverables and performance. The following table summarizes our business segment performance for the three and six months ended July 2, 2022 and July 3, 2021:
(1)Includes
costs not allocated to either the Electronic Systems or Structural Systems operating segments.
Electronic Systems
Electronic Systems net revenues in the three months ended July 2, 2022 compared to the three months ended July 3, 2021 increased $6.9 million primarily due to the following:
•$6.7 million higher revenues in our commercial aerospace end-use markets due to higher build rates on other commercial aerospace platforms and large aircraft platforms; partially offset by
•$0.6 million lower revenues in our military and space end-use markets due to lower build rates on military fixed-wing aircraft platforms and various missile platforms, partially offset by higher build rates on other military and space platforms.
Electronic Systems net revenues in the six months ended July 2, 2022 compared to the six months ended July 3, 2021 increased $5.3 million primarily due to the following:
•$12.5 million higher revenues in our commercial aerospace end-use markets due to higher build rates on other commercial aerospace platforms, large aircraft platforms, and regional and business aircraft platforms; partially offset by
•$10.5
million lower revenues in our military and space end-use markets due to lower build rates on other military and space platforms, military fixed-wing aircraft platforms, and various missile platforms.
Electronic Systems segment operating income in the three months ended July 2, 2022 compared to the three months ended July 3, 2021 decreased $0.8 million primarily due to unfavorable product mix, partially offset by favorable manufacturing volume.
Electronic Systems segment operating income in the six months ended July 2, 2022 compared to the six months ended July 3, 2021 decreased $3.8 million primarily due to unfavorable product mix.
Structural
Systems
Structural Systems net revenues in the three months ended July 2, 2022 compared to the three months ended July 3, 2021 increased $7.1 million primarily due to the following:
•$12.8 million higher revenues in our commercial aerospace end-use markets due to higher build rates on large aircraft platforms; partially offset by
•$5.8 million lower revenues in our military and space end-use markets due to lower build rates on military rotary-wing aircraft platforms and various missile platforms.
Structural Systems net revenues in the six months ended July 2, 2022 compared to the six months ended July 3,
2021 increased $15.0 million primarily due to the following:
•$25.7 million higher revenues in our commercial aerospace end-use markets due to higher build rates on large aircraft platforms and regional and business aircraft platforms; partially offset by
•$10.6 million lower revenues in our military and space end-use markets due to lower build rates on military rotary-wing aircraft platforms and various missile platforms.
The Structural Systems segment operating income in the three months ended July 2, 2022 compared to the three months ended July 3, 2021 decreased $4.3 million primarily due to unfavorable product mix.
The Structural Systems segment
operating income in the six months ended July 2, 2022 compared to the six months ended July 3, 2021 decreased $4.6 million primarily due to unfavorable product mix, partially offset by lower compensation and benefits costs and favorable manufacturing volume.
In June 2020, a fire severely damaged our performance center in Guaymas, Mexico. We have insurance coverage and up to a capped amount, expect these items will be covered, less our deductible. The full financial impact cannot be estimated at this time as we are currently working with our insurance carriers to determine the cause of the fire. The loss of production from the Guaymas performance center was being absorbed by our other existing performance centers, however, we have reestablished and are in the process of ramping up our manufacturing capabilities in a different
leased facility in Guaymas. A neighboring, non-related manufacturing facility, also suffered fire damage during the same time as the fire that severely damaged our Guaymas performance center. The cause of the fire is still undetermined and as such, there is no amount of loss that is probable and reasonably estimable at this time. If we are ultimately deemed to be responsible or partly responsible, it is possible we could incur a loss in excess of our insurance coverage limits, which could be material to our cash flow, liquidity, or financial results. See Note 8 and Note 10 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q.
Corporate General and Administrative (“CG&A”) Expenses
CG&A expenses increased $0.2 million for the three months ended July 2, 2022 compared to the three
months ended July 3, 2021.
CG&A expenses decreased $1.6 million for the six months ended July 2, 2022 compared to the six months ended July 3, 2021 primarily due to lower compensation and benefits costs of $1.6 million.
Backlog
We define backlog as customer placed purchase orders (“POs”) and long-term agreements (“LTAs”) with firm fixed price and expected delivery dates of 24 months or less. The majority of the LTAs do not meet the definition of a contract under ASC 606 and thus, the backlog amount disclosed below is greater than the remaining performance obligations amount disclosed
in Note 1 to our condensed
consolidated financial statements included in Part I, Item 1 of this Form 10-Q. 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 revenues. Backlog in industrial 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 revenues.
The
increase in backlog was primarily in the commercial aerospace end-use market, partially offset by a decrease in the military and space end-use market. $686.0 million of total backlog is expected to be delivered over the next 12 months. The following table summarizes our backlog as of July 2, 2022 and December 31, 2021:
Subsequent
to our quarter ended July 2, 2022, on July 14, 2022, we completed a refinancing of all our existing debt by entering into a new term loan and a new revolving credit facility. At the same leverage ratio, the interest rate spread in our new credit facilities is lower then the interest rate spread in our credit facilities that were in effect as of July 2, 2022. See Note 1 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
In December 2019, we completed the refinancing of a portion of our existing debt by entering into a new revolving credit facility (“2019 Revolving Credit Facility”) to replace the then existing revolving credit facility that was entered into in November 2018 (“2018 Revolving Credit Facility”)
and entered into a new term loan (“2019 Term Loan”). The 2019 Revolving Credit Facility is a $100.0 million senior secured revolving credit facility that will mature on December 20, 2024, replacing the $100.0 million 2018 Revolving Credit Facility that would have matured on November 21, 2023. The 2019 Term Loan is a $140.0 million senior secured term loan that will mature on December 20, 2024. We also have an existing $240.0 million senior secured term loan that was entered into in November 2018 that will mature on November 21, 2025 (“2018 Term Loan”). The original amounts available under the 2019 Revolving Credit Facility, 2019 Term Loan, and 2018 Term Loan (collectively, the “Credit Facilities”) in aggregate, totaled $480.0 million. We are required
to make installment payments of 1.25% of the original outstanding principal balance of the 2019 Term Loan amount on a quarterly basis, on the last day of the calendar quarter. We made the mandatory quarterly principal prepayment under the 2019 Term Loan during the three and six months ended July 2, 2022 of $1.8 million and $3.5 million, respectively. In addition, if we meet the annual excess cash flow threshold, we are required to make an annual additional principal payment on the 2018 Term Loan based on the consolidated adjusted leverage ratio. We did not exceed the annual excess cash flow threshold for 2021 and thus, no annual excess cash flow payment was required to be paid during the first quarter of 2022. Further, the undrawn portion of the commitment of the 2019 Revolving Credit Facility is subject to a commitment fee ranging from 0.175% to 0.275%, based upon the consolidated total net adjusted leverage ratio. As
of July 2, 2022, we were in compliance with all covenants required under the Credit Facilities. See Note 7 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
In November 2018, we completed credit facilities to replace the then existing credit facilities. The November 2018 credit facilities consisted of the 2018 Term Loan and the 2018 Revolving Credit Facility (collectively, the “2018 Credit Facilities”). We were required to make installment payments of 0.25% of the outstanding principal balance of the 2018 Term Loan amount on a quarterly basis, however, in conjunction with the 2019 refinancing where we paid down $56.0 million on the 2018 Term Loan, it paid all the required quarterly installment payments on the 2018 Term Loan until maturity.
However, since
we were paying down on the term loans during the three months ended April 2, 2022, we were required to pay down on the 2019 Term Loan and 2018 Term Loan on a pro-rata basis and thus, we paid down $13.0 million and $17.0 million on the 2019 Term Loan and 2018 Term Loan, respectively, for an aggregate total pay down of $30.0 million. We made no voluntary prepayments on either the 2019 Term Loan or the 2018 Term Loan during the three months ended July 2, 2022.
During the three months ended July 2, 2022, in April 2022, management approved and commenced a restructuring plan that will position us for stronger performance. The restructuring plan will mainly reduce headcount and consolidate facilities. As a result of this restructuring plan, we analyzed the need to write-down inventory
and impair long-lived assets, including operating lease right-of-use assets. As of July 2, 2022, we estimate the remaining amount of charges related to this initiative to be $3.0 million to $5.0 million in total pre-tax restructuring charges through 2023. Of these charges, we estimate $2.0 million to $3.0 million to be cash payments for employee separation and other facility consolidation related expenses, and $1.0 million to $2.0 million to be non-cash charges for impairment of long-lived assets. On an annualized basis, we anticipate these restructuring actions will result in total cost savings of $3.0 million to $4.0 million. See Note 3 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
In November 2021, we entered into derivative contracts,
U.S. dollar-one month LIBOR forward interest rate swaps designated as cash flow hedges, all with an effective date of January 1, 2024, for an aggregate total notional amount of $150.0 million,
weighted average fixed rate of 1.8%, and all terminating on January 1, 2031 (“Forward Interest Rate Swaps”). The Forward Interest Rate Swaps mature on a monthly basis, with fixed amount payer payment dates on the first day of each calendar month, commencing on February 1, 2024 through January
1, 2031. See Note 1 and Note 7 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
Subsequent to our quarter ended July 2, 2022, on July 14, 2022, as a result of completing a refinancing of the Credit Facilities, we were required to complete an amendment of our derivative contracts with an aggregate notional amount of $150.0 million we had entered into in November 2021. The existing derivative contracts were based on U.S. dollar-one month LIBOR, which was required to be amended to one month Term SOFR, as borrowings using LIBOR are no longer available under the New Credit Facilities.
See Note 1 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
In December 2021, we acquired MagSeal for a purchase price of $69.5 million, net of cash acquired, all payable in cash. Upon the closing of the transaction, we paid a gross total aggregate of $71.3 million in cash, a portion of which was by drawing down on the 2019 Revolving Credit Facility. This draw down on the 2019 Revolving Credit Facility was paid off by December 31, 2021. See Note 2 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
In December 2021, we entered into a sale-leaseback transaction for the building and related land for our Gardena performance center located in Carson, California (“Sale-Leaseback Agreement”).
The building and related land was sold for $141.3 million and we recognized a gain of $132.5 million. As part of the Sale-Leaseback Agreement, we entered into an initial five year lease for the usage of the just sold building and related land. The future minimum base monthly lease payments during the initial five year period in aggregate total $19.6 million.
We expect to spend a total of $17.0 million to $19.0 million for capital expenditures in 2022 (excluding capital expenditures we will spend to restore the manufacturing capabilities related to our Guaymas performance center that was severely damaged by fire in June 2020), financed by cash generated from operations, principally to support new contract awards in the Electronic Systems and Structural Systems segments. As part of our strategic plan to become a supplier of a wider range
of higher-level assemblies and win new contract awards, additional up-front investment in tooling will be required for newer programs which have higher engineering content and higher levels of complexity in assemblies.
We believe the ongoing aerospace and defense subcontractor consolidation makes acquisitions an increasingly important component of our future growth. We will continue to make prudent acquisitions and capital expenditures for manufacturing equipment and facilities to support long-term contracts for commercial and military aircraft and defense programs.
We monitor our asset base, including the market dynamics of the properties we own, and we may sell such properties and/or enter into sale-leaseback
transactions. Such transactions would provide cash for various capital deployment options.
We continue to depend on operating cash flow and the availability of our Credit Facilities 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 from the date of issuance of these financial statements.
Cash Flow Summary
Net cash provided by operating activities for the six months ended July 2, 2022 was $6.1 million, compared to net cash used in operating activities of $17.8 million for the six months ended July 3, 2021. The higher net cash provided by operating activities during the first six months of 2022 was mainly
due to higher accounts payable, partially offset by higher contract assets, higher accounts receivable, and lower net income.
Net cash used in investing activities was $8.7 million for the six months ended July 2, 2022, compared to $6.8 million in the six months ended July 3, 2021. The higher net cash used during the first six months of 2022 compared to the prior year period was mainly due to higher purchases of property and equipment.
Net cash used in financing activities was $36.3 million for the six months ended July 2, 2022, compared to $19.8 million for the six months ended July 3, 2021. The
higher net cash used in financing activities during the first six months of 2022 was mainly due to the $30.0 million pay down on term loans during the six months ended July 2, 2022.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist of operating and finance leases not recorded as a result of the practical expedients utilized, right of offset of industrial revenue bonds and associated failed sales-leasebacks on property and equipment, and indemnities, none of which we believe may have a material current or future effect on our financial condition, liquidity, capital resources, or results of operations.
The preparation of our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States requires estimation and judgment that affect the reported amounts of net revenues, expenses, assets and liabilities. For a description of our critical accounting policies, please refer to “Critical Accounting Policies” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2021 Annual Report on Form 10-K. There have been no material changes in any of our critical accounting policies during the three months ended July 2, 2022.
Recent Accounting Pronouncements
See “Part I, Item 1.
Ducommun Incorporated and Subsidiaries—Notes to Condensed Consolidated Financial Statements—Note 1. Summary of Significant Accounting Policies—Recent Accounting Pronouncements” for further information.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our main market risk exposure relates to changes in U.S. and U.K. interest rates on our outstanding long-term debt. At July 2, 2022, we had total borrowings of $254.2 million under our Credit Facilities.
The 2019 Term Loan bears interest, at our option, at a rate equal to either (i) the Eurodollar
Rate (defined as the London Interbank Offered Rate [“LIBOR”]) plus an applicable margin ranging from 1.50% to 2.50% per year or (ii) the Base Rate (defined as the highest of [a] Federal Funds Rate plus 0.50%, [b] Bank of America’s prime rate, and [c] the Eurodollar Rate plus 1.00%) plus an applicable margin ranging from 0.50% to 1.50% per year, in each case based upon the consolidated total net adjusted leverage ratio.
The 2019 Revolving Credit Facility bears interest, at our option, at a rate equal to either (i) the Eurodollar Rate (defined as LIBOR) plus an applicable margin ranging from 1.50% to 2.50% per year or (ii) the Base Rate (defined as the highest of [a] Federal Funds Rate plus 0.50%, [b] Bank of America’s prime rate, and [c] the Eurodollar Rate plus 1.00%) plus an applicable margin ranging from 0.50% to 1.50% per year, in each case based upon the consolidated total net adjusted leverage ratio.
The
2018 Term Loan bears interest, at our option, at a rate equal to either (i) the Eurodollar Rate (defined as LIBOR plus an applicable margin ranging from 3.75% to 4.00% per year or (ii) the Base Rate (defined as the highest of [a] Federal Funds Rate plus 0.50%, [b] Bank of America’s prime rate, and [c] the Eurodollar Rate plus 1.00%) plus an applicable margin ranging from 3.75% to 4.00% per year, in each case based upon the consolidated total net adjusted leverage ratio.
A hypothetical 10% increase or decrease in the interest rate would have an immaterial impact on our financial condition and results of operations.
Subsequent to our quarter ended July 2, 2022, on July 14, 2022, we completed a refinancing of all our existing debt by entering into a new term loan and a new revolving credit
facility. See Note 1 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
Subsequent to our quarter ended July 2, 2022, on July 14, 2022, as a result of completing a refinancing of all our existing debt, we were required to complete an amendment of our derivative contracts with an aggregate notional amount of $150.0 million we had entered into in November 2021. The existing derivative contracts were based on U.S. dollar-one month LIBOR, which was required to be amended to one month Term SOFR, as borrowings using LIBOR are no longer available under the New Credit Facilities. See Note
1 to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for further information.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Company’s chief executive officer (“CEO”) and chief financial officer (“CFO”) have conducted an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934), and concluded that such disclosure controls and procedures were effective as of the end of
the period covered by this report.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the three months ended July 2, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
See Note 10to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q for a description of our legal proceedings.
Item 1A. Risk Factors
See Part I, Item 1A of our Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2021 for a discussion of our risk factors. There have been no material changes during the three months ended July 2, 2022 to the risk factors disclosed in our Form 10-K for the year ended December 31, 2021.
10.28 Form of Indemnity Agreement entered with all directors and officers of Ducommun. Incorporated by reference to Exhibit 10.8 to Form 10-K for the year ended December 31, 1990. All of the Indemnity Agreements are identical except for the name of the director or officer and the date of the Agreement:
101.INS Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are
embedded within the Inline XBRL
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.
