Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1. Summary of Significant Accounting Policies
Description of Business
We are 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”). Our operations are organized into two 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.
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, 2020 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, 2020. 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, 2020.
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 nine months ended October 2, 2021 are not necessarily indicative of the results to be expected for the full year ending December 31, 2021.
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.
Use 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.
Supplemental Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
Nine Months Ended
|
|
|
October 2,
2021
|
|
September 26,
2020
|
Interest paid
|
|
$
|
7,672
|
|
|
$
|
8,825
|
|
Taxes paid, net
|
|
$
|
3,082
|
|
|
$
|
2,559
|
|
Non-cash activities:
|
|
|
|
|
Purchases of property and equipment not paid
|
|
$
|
1,698
|
|
|
$
|
1,059
|
|
Earnings Per Share
Basic earnings per share are computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding in each period. Diluted earnings per share 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.
The net income and weighted-average common shares outstanding used to compute earnings per share were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands,
except per share data)
|
|
(Dollars in thousands,
except per share data)
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
October 2,
2021
|
|
September 26,
2020
|
|
October 2,
2021
|
|
September 26,
2020
|
Net income
|
|
$
|
9,584
|
|
|
$
|
6,501
|
|
|
$
|
24,702
|
|
|
$
|
19,521
|
|
Weighted-average number of common shares outstanding
|
|
|
|
|
|
|
|
|
Basic weighted-average common shares outstanding
|
|
11,920
|
|
|
11,703
|
|
|
11,862
|
|
|
11,660
|
|
Dilutive potential common shares
|
|
322
|
|
|
256
|
|
|
386
|
|
|
226
|
|
Diluted weighted-average common shares outstanding
|
|
12,242
|
|
|
11,959
|
|
|
12,248
|
|
|
11,886
|
|
Earnings per share
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.80
|
|
|
$
|
0.56
|
|
|
$
|
2.08
|
|
|
$
|
1.67
|
|
Diluted
|
|
$
|
0.78
|
|
|
$
|
0.54
|
|
|
$
|
2.02
|
|
|
$
|
1.64
|
|
Potentially 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
(In thousands)
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
October 2,
2021
|
|
September 26,
2020
|
|
October 2,
2021
|
|
September 26,
2020
|
Stock options and stock units
|
|
9
|
|
|
341
|
|
|
6
|
|
|
340
|
|
Fair Value
Assets and liabilities that are measured, recorded or disclosed at fair value on a recurring basis are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine 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 and they are included as cash and cash equivalents. We also had interest rate cap hedge agreements for which the fair value of the interest rate cap hedge agreements was determined using pricing models that use observable market inputs as of the balance sheet date, a Level 2 measurement, however, those agreements expired during our second quarter of 2020.
There were no transfers between Level 1, Level 2, or Level 3 financial instruments in the three months ended October 2, 2021.
Cash 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, which we classify as Level 1. See Fair Value above.
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. As of October 2, 2021, we had no derivative instruments as our cash flow hedges matured in the second quarter of 2020.
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.
Restructuring Charges
In May 2020, management approved and commenced a restructuring plan in the Structural Systems segment mainly to reduce headcount in response to the impact from the COVID-19 pandemic on commercial aerospace demand outlook. We completed the restructuring plan as of December 31, 2020. We recorded an aggregate total of zero and $1.1 million for severance and benefits costs which were charged to restructuring charges during the three months ended October 2, 2021 and September 26, 2020, respectively. We recorded an aggregate total of zero and $1.8 million for severance and benefits costs which were charged to restructuring charges during the nine months ended October 2, 2021 and September 26, 2020, respectively.
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.
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 nine months ended October 2, 2021 and September 26, 2020.
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.
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 October 2, 2021 and December 31, 2020, provision for estimated losses on contracts were $2.2 million and $2.3 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 October 2, 2021 and December 31, 2020, production cost of contracts were $7.6 million and $7.0 million, respectively.
Contract Assets and Contract Liabilities
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.
Contract assets and contract liabilities from revenue contracts with customers are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
October 2,
2021
|
|
December 31,
2020
|
Contract assets
|
|
$
|
182,759
|
|
|
$
|
154,028
|
|
Contract liabilities
|
|
$
|
23,274
|
|
|
$
|
28,264
|
|
The increase in our contract assets as of October 2, 2021 compared to December 31, 2020 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 October 2, 2021 compared to December 31, 2020 was primarily due to a net decrease of advance or progress payments received from our customers in the current period. We recognized $16.5 million of the contract liabilities as of December 31, 2020 as revenues during the nine months ended October 2, 2021.
Performance obligations are defined as customer placed purchase orders (“POs”) with firm fixed price and firm delivery dates. Our remaining performance obligations as of October 2, 2021 totaled $736.0 million. We anticipate recognizing an estimated 70% of our remaining performance obligations as revenue during the next 12 months with the remaining performance obligations being recognized in the remainder of 2022 and beyond.
Revenue by Category
In addition to the revenue categories disclosed above, the following table reflects our revenue disaggregated by major end-use market:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
(Dollars in thousands)
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
October 2
2021
|
|
September 26,
2020
|
|
October 2
2021
|
|
September 26,
2020
|
Consolidated Ducommun
|
|
|
|
|
|
|
|
|
Military and space
|
|
$
|
113,622
|
|
|
$
|
111,058
|
|
|
$
|
340,757
|
|
|
$
|
307,479
|
|
Commercial aerospace
|
|
41,150
|
|
|
30,731
|
|
|
114,104
|
|
|
130,948
|
|
Industrial
|
|
8,455
|
|
|
8,582
|
|
|
25,709
|
|
|
32,728
|
|
Total
|
|
$
|
163,227
|
|
|
$
|
150,371
|
|
|
$
|
480,570
|
|
|
$
|
471,155
|
|
|
|
|
|
|
|
|
|
|
Electronic Systems
|
|
|
|
|
|
|
|
|
Military and space
|
|
$
|
81,365
|
|
|
$
|
80,209
|
|
|
$
|
243,853
|
|
|
$
|
223,692
|
|
Commercial aerospace
|
|
14,901
|
|
|
14,679
|
|
|
37,060
|
|
|
37,120
|
|
Industrial
|
|
8,455
|
|
|
8,582
|
|
|
25,709
|
|
|
32,728
|
|
Total
|
|
$
|
104,721
|
|
|
$
|
103,470
|
|
|
$
|
306,622
|
|
|
$
|
293,540
|
|
|
|
|
|
|
|
|
|
|
Structural Systems
|
|
|
|
|
|
|
|
|
Military and space
|
|
$
|
32,257
|
|
|
$
|
30,849
|
|
|
$
|
96,904
|
|
|
$
|
83,787
|
|
Commercial aerospace
|
|
26,249
|
|
|
16,052
|
|
|
77,044
|
|
|
93,828
|
|
Total
|
|
$
|
58,506
|
|
|
$
|
46,901
|
|
|
$
|
173,948
|
|
|
$
|
177,615
|
|
Recent Accounting Pronouncements
New Accounting Guidance Adopted in 2021
In October 2020, the FASB issued ASU 2020-10, “Codification Improvements” (“ASU 2020-10”), which affects a wide variety of Topics in the Accounting Standards Codification (“Codification”). ASU 2020-10, among other things, contains amendments that improve the consistency of the Codification by including all disclosure guidance in the appropriate Disclosure Section (Section 50). Many of the amendments arose as the FASB provided an option to give certain information either on the face of the financial statements or in the notes to financial statements and that option only was included in the Other Presentation Matters Section (Section 45) of the Codification. Those amendments are not expected to change current practice. The new guidance is effective for fiscal years beginning after December 15, 2020, which was our interim period beginning January 1, 2021. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes” (“ASU 2019-12”), which removes certain exceptions and provides guidance on various areas of tax accounting. The new guidance is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years, which was our interim period beginning January 1, 2021. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.
In August 2018, the FASB issued ASU 2018-14, “Compensation - Retirement Benefits - Defined Benefit Plans - General (Topic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans” (“ASU 2018-14”), which removes disclosures that no longer are considered cost-beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. The new guidance is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years, which was our interim period beginning January 1, 2021. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.
Recently Issued Accounting Standards
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 will be our interim period beginning January 1, 2022. Early adoption is permitted. We are evaluating the impact of this standard.
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 are evaluating the impact of this standard.
Note 2. Inventories
Inventories consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
October 2,
2021
|
|
December 31,
2020
|
Raw materials and supplies
|
|
$
|
122,752
|
|
|
$
|
107,983
|
|
Work in process
|
|
17,312
|
|
|
15,895
|
|
Finished goods
|
|
4,115
|
|
|
5,345
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
144,179
|
|
|
$
|
129,223
|
|
Note 3. Goodwill
We perform our annual goodwill impairment test as of the first day of the fourth quarter. If certain factors occur, including significant under performance 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.
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 is performed to determine whether it is more likely than not that the fair value of a reporting unit is 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.
For our most recent annual goodwill impairment test of our Electronic Systems reporting unit as of the first day of the fourth quarter of 2020, we used a qualitative assessment and determined it was not more likely than not that the fair value of the reporting unit was less than its carrying amount. For our most recent annual goodwill impairment test of our Structural Systems reporting unit as of the first day of the fourth quarter of 2020, we performed a step one goodwill impairment test where the fair value of our Structural Systems reporting unit exceeded its carrying value by 69% and thus, goodwill was not deemed to be impaired. While our business continues to be negatively impacted during the three and nine months ended October 2, 2021 as a result of the COVID-19 pandemic, no material adverse factors/changes have occurred since the fourth quarter of 2020 that would require us to perform another qualitative assessment. As such, for the third quarter of 2021, 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.
The carrying amounts of our goodwill were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
Electronic
Systems
|
|
Structural
Systems
|
|
Consolidated
Ducommun
|
Gross goodwill
|
|
$
|
199,157
|
|
|
$
|
53,395
|
|
|
$
|
252,552
|
|
Accumulated goodwill impairment
|
|
(81,722)
|
|
|
—
|
|
|
(81,722)
|
|
Balance at December 31, 2020
|
|
$
|
117,435
|
|
|
$
|
53,395
|
|
|
$
|
170,830
|
|
|
|
|
|
|
|
|
Balance at October 2, 2021
|
|
$
|
117,435
|
|
|
$
|
53,395
|
|
|
$
|
170,830
|
|
Note 4. Accrued and Other Liabilities
The components of accrued and other liabilities were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
October 2,
2021
|
|
December 31,
2020
|
Accrued compensation
|
|
$
|
21,715
|
|
|
$
|
28,432
|
|
Accrued income tax and sales tax
|
|
453
|
|
|
80
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
13,126
|
|
|
12,014
|
|
Total
|
|
$
|
35,294
|
|
|
$
|
40,526
|
|
Note 5. Long-Term Debt
Long-term debt and the current period interest rates were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
October 2,
2021
|
|
December 31,
2020
|
Term loans
|
|
$
|
289,462
|
|
|
$
|
295,638
|
|
Revolving credit facility
|
|
10,000
|
|
|
25,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
299,462
|
|
|
320,638
|
|
Less current portion
|
|
(7,000)
|
|
|
(7,000)
|
|
Total long-term debt, less current portion
|
|
292,462
|
|
|
313,638
|
|
Less debt issuance costs - term loans
|
|
(1,424)
|
|
|
(1,716)
|
|
Total long-term debt, net of debt issuance costs - term loans
|
|
$
|
291,038
|
|
|
$
|
311,922
|
|
Debt issuance costs - revolving credit facility (1)
|
|
$
|
1,231
|
|
|
$
|
1,515
|
|
Weighted-average interest rate
|
|
3.24
|
%
|
|
3.59
|
%
|
(1) Included as part of other assets.
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 matures 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 matures on December 20, 2024. We also have an existing $240.0 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 $480.0 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 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, typically payable quarterly. In addition, the 2019 Term Loan requires 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. For the three and nine months ended October 2, 2021, we made the required quarterly payments totaling $1.8 million and $5.3 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 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, typically payable quarterly. 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. 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 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, typically payable quarterly. In addition, the 2018 Term Loan required installment payments of 0.25% 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) 50% of the excess cash flow amount if the adjusted leverage ratio is greater than 3.25 to 1.0, (ii) 25% of the excess cash flow amount if the adjusted leverage ratio is less than or equal to 3.25 to 1.0 but greater than 2.50 to 1.0, and (iii) zero percent of the excess cash flow amount if the consolidated adjusted leverage ratio is less than or equal to 2.50 to 1.0. During the first quarter of 2021, we made the required 2020 annual excess cash flow payment of $0.9 million. As of October 2, 2021, we were in compliance with all covenants required under the Credit Facilities.
During the three and nine months ended October 2, 2021, we made net voluntary prepayments totaling $5.0 million and $15.0 million, respectively, on the 2019 Revolving Credit Facility.
In conjunction with entering into the 2019 Revolving Credit Facility and the 2019 Term Loan, we drew down the entire $140.0 million on the 2019 Term Loan and used those proceeds to pay off and close the 2018 Revolving Credit Facility of $58.5 million, paid down a portion of the 2018 Term Loan of $56.0 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 $56.0 million pay down on the 2018 Term Loan paid all the required quarterly installment payments on the 2018 Term Loan until maturity.
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 $0.6 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 $1.5 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 $0.5 million. In addition, the new fees paid to the lenders of $0.5 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 $1.1 million as of the modification date will also be amortized over its remaining life.
As of October 2, 2021, we had $89.8 million of unused borrowing capacity under the 2019 Revolving Credit Facility, after deducting $0.2 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 two subsidiaries 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 are presented.
In October 2015, we entered into interest rate cap hedges designated as cash flow hedges with a portion of these interest rate cap hedges maturing on a quarterly basis, and a final quarterly maturity date of June 2020, in aggregate, totaling $135.0 million of our debt. We paid a total of $1.0 million in connection with entering into the interest rate cap hedges. The interest rate cap hedges matured during our second quarter of 2020 and as such, all remaining amounts related to the interest rate cap hedges were fully amortized and unrealized gains and losses recorded in accumulated other comprehensive income were also realized at that time.
Note 6. Indemnifications
We have made guarantees and indemnities under which we may be required to make payments to a guaranteed or indemnified party, in relation to certain transactions, including revenue transactions in the ordinary course of business. In connection with certain performance center leases, we have indemnified our lessors for certain claims arising from the performance center or the lease. We indemnify our directors and officers to the maximum extent permitted under the laws of the State of Delaware.
However, we have a directors and officers insurance policy that may reduce our exposure in certain circumstances and may enable us to recover a portion of future amounts that may be payable, if any. The duration of the guarantees and indemnities varies and, in many cases is indefinite but subject to statute of limitations. The majority of guarantees and indemnities do not provide any limitations of the maximum potential future payments we could be obligated to make. Historically, payments related to these guarantees and indemnities have been immaterial. We estimate the fair value of our indemnification obligations as insignificant based on this history and insurance coverage and have, therefore, not recorded any liability for these guarantees and indemnities in the accompanying condensed consolidated balance sheets.
Note 7. Income 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 $1.2 million for the three months ended October 2, 2021 compared to $0.8 million for the three months ended September 26, 2020. The increase in income tax expense for the third quarter of 2021 compared to the third quarter of 2020 was primarily due to higher pre-tax income for the third quarter of 2021 compared to the third quarter of 2020. The increase in income tax expense was partially offset by higher income tax benefits recognized in the third quarter of 2021 related to the U.S. Federal research and development tax credit.
We recorded income tax expense of $4.1 million for the nine months ended October 2, 2021, compared to $3.4 million for the nine months ended September 26, 2020. The increase in income tax expense for the first nine months of 2021 compared to the first nine months of 2020 was primarily due to higher pre-tax income for the first nine months of 2021 compared to the first nine months of 2020. The increase in income tax expense was partially offset by higher income tax benefits related to the U.S. Federal research and development tax credit and higher discrete income tax benefits related to net tax windfalls from stock-based compensation.
On March 11, 2021, the U.S. enacted the American Rescue Plan Act of 2021 (“Rescue Plan”) aimed at mitigating the continuing effects of the COVID-19 pandemic. We considered the provisions of the Rescue Plan and determined they do not have a material impact on our income taxes.
Our total amount of unrecognized tax benefits was $4.5 million and $4.1 million as of October 2, 2021 and December 31, 2020, 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 October 2, 2021 and December 31, 2020 were not significant. We do not expect the total amount of unrecognized tax benefits to increase or decrease by a material amount 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 2016 and by state taxing authorities for tax years after 2015. 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.
Note 8. Commitments 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 believe these claims are baseless, are without merit and intend to vigorously defend against them. We do not currently have enough information to make a reasonable estimate as to the likelihood or amount of loss, or a range of reasonably possible losses as a result of this claim, so there has been no related accrual for estimated liability recorded as of October 2, 2021.
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 $1.5 million at both October 2, 2021 and December 31, 2020, 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 $0.4 million and $3.1 million. We have established an accrual for the estimated liability in connection with the West Covina landfill of $0.4 million as of both October 2, 2021 and December 31, 2020, 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 two buildings with an aggregate total of 62,000 square feet. The loss of production from the Guaymas performance center is being absorbed by our other existing performance centers. 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.
Our insurance covers damage 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, $0.8 million of revenue and $0.5 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 $7.1 million and inventory on hand of $3.4 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. As of October 2, 2021, $13.5 million of general insurance recoveries have been received to date. 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, claims and inquiries,
including matters relating to environmental laws. In addition, Ducommun makes various commitments 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.
Note 9. Business Segment Information
We supply products and services primarily to the aerospace and defense industries. Our subsidiaries are organized into two strategic businesses, Electronic Systems and Structural Systems, each of which is a reportable operating segment.
Financial information by reportable operating segment was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
Three Months Ended
|
|
(Dollars in thousands)
Nine Months Ended
|
|
|
October 2,
2021
|
|
September 26,
2020
|
|
October 2,
2021
|
|
September 26,
2020
|
Net Revenues
|
|
|
|
|
|
|
|
|
Electronic Systems
|
|
$
|
104,721
|
|
|
$
|
103,470
|
|
|
$
|
306,622
|
|
|
$
|
293,540
|
|
Structural Systems
|
|
58,506
|
|
|
46,901
|
|
|
173,948
|
|
|
177,615
|
|
Total Net Revenues
|
|
$
|
163,227
|
|
|
$
|
150,371
|
|
|
$
|
480,570
|
|
|
$
|
471,155
|
|
Segment Operating Income
|
|
|
|
|
|
|
|
|
Electronic Systems
|
|
$
|
15,319
|
|
|
$
|
14,867
|
|
|
$
|
42,185
|
|
|
$
|
40,427
|
|
Structural Systems
|
|
4,457
|
|
|
1,769
|
|
|
15,177
|
|
|
13,373
|
|
|
|
19,776
|
|
|
16,636
|
|
|
57,362
|
|
|
53,800
|
|
Corporate General and Administrative Expenses (1)
|
|
(6,413)
|
|
|
(6,371)
|
|
|
(20,297)
|
|
|
(19,884)
|
|
Operating Income
|
|
$
|
13,363
|
|
|
$
|
10,265
|
|
|
$
|
37,065
|
|
|
$
|
33,916
|
|
Depreciation and Amortization Expenses
|
|
|
|
|
|
|
|
|
Electronic Systems
|
|
$
|
3,547
|
|
|
$
|
3,492
|
|
|
$
|
10,396
|
|
|
$
|
10,591
|
|
Structural Systems
|
|
3,599
|
|
|
3,528
|
|
|
10,540
|
|
|
10,956
|
|
Corporate Administration
|
|
58
|
|
|
58
|
|
|
176
|
|
|
194
|
|
Total Depreciation and Amortization Expenses
|
|
$
|
7,204
|
|
|
$
|
7,078
|
|
|
$
|
21,112
|
|
|
$
|
21,741
|
|
Capital Expenditures
|
|
|
|
|
|
|
|
|
Electronic Systems
|
|
$
|
1,964
|
|
|
$
|
586
|
|
|
$
|
3,865
|
|
|
$
|
3,518
|
|
Structural Systems
|
|
1,598
|
|
|
1,796
|
|
|
6,154
|
|
|
4,400
|
|
Corporate Administration
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total Capital Expenditures
|
|
$
|
3,562
|
|
|
$
|
2,382
|
|
|
$
|
10,019
|
|
|
$
|
7,918
|
|
(1)Includes costs not allocated to either the Electronic Systems or Structural Systems operating segments.
Segment assets include assets directly identifiable to or allocated to each segment. Our segment assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
October 2,
2021
|
|
December 31,
2020
|
Total Assets
|
|
|
|
|
Electronic Systems
|
|
$
|
496,616
|
|
|
$
|
448,606
|
|
Structural Systems
|
|
325,165
|
|
|
325,604
|
|
Corporate Administration (1)
|
|
16,002
|
|
|
63,137
|
|
Total Assets
|
|
$
|
837,783
|
|
|
$
|
837,347
|
|
Goodwill and Intangibles
|
|
|
|
|
Electronic Systems
|
|
$
|
194,111
|
|
|
$
|
201,077
|
|
Structural Systems
|
|
91,703
|
|
|
94,497
|
|
Total Goodwill and Intangibles
|
|
$
|
285,814
|
|
|
$
|
295,574
|
|
(1)Includes assets not specifically identified to or allocated to either the Electronic Systems or Structural Systems operating segments, including cash and cash equivalents.