UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 _________________________________________________________

FORM 10-Q

(Former name, former address and former fiscal year, if changed since last report)

(Unaudited)

(InDollars in thousands, except share and per share data)

See accompanying notes to Condensed Consolidated Financial Statements.

(Unaudited)

(InDollars in thousands, except per share amounts)

(Unaudited)

(InDollars in thousands)

 

(Unaudited)

(InDollars in thousands)

 

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 subsidiariesoperations are organized into two strategic2 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 aerospace, defense, industrialA&D and medical and otherIndustrial end-use markets. Electronic Systems’ product offerings primarily range from prototype development to complex assemblies. Structural Systems designs, engineers and manufactures large, complex contoured aerospace structuralaerostructure 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. BothAll 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, 20162020 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, 2016. We followed the same accounting policies for interim reporting.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, 2016.2020.

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 September 30, 2017April 3, 2021 are not necessarily indicative of the results to be expected for the full year ending December 31, 2017.2021.

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 ends 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 requiresrequire management to make estimates and judgments that affect the amounts of assets, liabilities (including forward loss reserves)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.

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 areis computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding, plus any potentialpotentially dilutive shares that could be issued if exercised or converted into common stock in each period.

The net income and weighted-average number of common shares outstanding used to compute earnings per share were as follows:

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.

There were no transfers between Level 1, Level 2, or Level 3 financial instruments in the ongoing operating results in the condensed consolidated income statements for all periods presented. Preliminary net assets sold were $24.0 million, net liabilities sold were $4.0 million, and direct transaction costs incurred were $0.2 million, resulting in a preliminary gain on divestiture of

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, a hedge of a net investment in a foreign operation, or a derivative instrument that will not be accounted for using hedge accounting methods. As of September 30, 2017, all of ourApril 3, 2021, we had no derivative instruments were designated as our cash flow hedges.

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, with units being relieved andgoods. The majority of our inventory is charged to cost of

sales on a first-in, first-out basis.as raw materials are placed into production and the related revenue is recognized. Inventoried costs include raw materials, outside processing, direct labor and allocated overhead, adjusted for any abnormal amounts of idle facilityperformance center expense, freight, handling costs, and wasted materials (spoilage) incurred. Costs under long-term contracts are accumulated into, and removed from, inventory on the same basis as other contracts. 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.

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.

ProvisionOur 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 Estimated Lossesconvenience clause.

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 Contractsour 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.

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 improvementschanges in manufacturing efficiency, reductions in 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 record additionaladjust 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 April 3, 2021 and December 31, 2020, provision for estimated losses on contracts were $2.0 million and $2.3 million, respectively.

In December 2016,October 2020, the FASB issued ASU 2016-19, “Technical Corrections and2020-10, “Codification Improvements” (“2016-19”ASU 2020-10”), which coveraffect a wide variety of Topics in the Codification. TheAccounting Standards Codification (“Codification”). ASU 2020-10, among other things, contains amendments in ASU 2016-19 represent changes to make corrections or improvements tothat 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 have a significant effect onchange current accounting practice or create a significant administrative cost to most entities.practice. The new guidance wasis effective for usfiscal years beginning after December 15, 2020, which was our interim period beginning January 1, 2017.2021. The adoption of this standard did not have a significantmaterial impact on our condensed consolidated financial statements.

In March 2016,December 2019, the FASB issued ASU 2016-09, “Compensation - Stock Compensation2019-12, “Income Taxes (Topic 718): Improvements to Employee Share-Based Payment Accounting”740), Simplifying the Accounting for Income Taxes” (“ASU 2016-09”2019-12”), which is intended to improve the accounting for employee share-based payments.removes certain exceptions and provides guidance on various areas of tax accounting. The new guidance wasis effective for usfiscal years beginning after December 15, 2020, including interim periods within those fiscal years, which was our interim period beginning January 1, 2017.2021. The adoption of this standard did not have a significant dollarmaterial impact on our condensed consolidated financial statements.

In March 2016,August 2018, the FASB issued ASU 2016-05, “Derivatives and Hedging2018-14, “Compensation - Retirement Benefits - Defined Benefit Plans - General (Topic 815)715-20): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships”Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans” (“ASU 2016-05”2018-14”), which clarifieswill remove disclosures that a change inno longer are considered cost-beneficial, clarify the counter party to a derivative instrument designatedspecific requirements of disclosures, and add disclosure requirements identified as a hedging instrument does not require dedesignation of that hedging relationship, provided that all other hedge accounting criteria are met.relevant. The new guidance wasis effective for usfiscal years beginning after December 15, 2020, including interim periods within those fiscal years, which was our interim period beginning January 1, 2017.2021. The adoption of this standard did not have a significant impact on our condensed consolidated financial statements.

In August 2017,2020, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging” (“ASU 2017-12”), which intends to improve and simplify accounting rules around hedge accounting. ASU 2017-12 refines and expands hedge accounting for both financial (i.e., interest rate) and commodity risks. In addition, it creates more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes. The new guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, which will be our interim period beginning January 1, 2019. Early adoption is permitted, including adoption in any interim period after the issuance of ASU 2017-12. We are evaluating the impact of this standard.

permitted. We are evaluating the impact of this standard and currently anticipate it will impact our condensed consolidated financial statements.standard.

In May 2014,March 2020, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers2020-04, “Reference Rate Reform (Topic 606)”848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2014-09”2020-04”), which outlinesprovides optional guidance for a new, single comprehensive modellimited time for entitiescontracts that reference London Interbank Offered Rate (“LIBOR”), to useease the potential burden in accounting for, revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new revenue recognition model providesor recognizing the effects, of reference rate reform on financial reporting as a five-step analysis in determining when and how revenue is recognized. It requires entities to exercise judgment when considering the termsresult of the contract(s) which include (i) identifying the contract(s) with the customer, (ii) identifying the separate performance obligations in the contract, (iii) determining the transaction price, (iv) allocating the transaction price to the separate performance obligations, and (v) recognizing revenue when each performance obligation is satisfied. Thus, it depicts the transfercessation of promised goods or services to customers in an amount that reflects the consideration an entity expects to receive in exchange for those goods or services. Companies have the option of applying the provisions of ASU 2014-09 either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying this guidance recognized at the date of initial application. In August 2015, the FASB issued ASU 2015-14, “Revenue From Contracts With Customers (Topic 606)” (“ASU 2015-14”), which deferred the effective date of ASU 2014-09 by one year to annual periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.LIBOR. The new guidance is effective for us beginning January 1, 2018 and provides us additionalat any time to evaluateafter March 12, 2020 but no later than December 31, 2022. We are evaluating the impact that ASU 2014-09 will have on our condensed consolidated financial statements. We are in the process of completing the implementation phase of the project. We have noted that under ASU 2014-09, the percentage of completion, unit of delivery method of recognizing revenue is no longer a viable method for us and production costs will generally not be deferred. Instead, revenue will be recognized as the customer obtains control of the goods and services promised in the contract (i.e., performance obligations). Given the nature of our products and terms and conditions in the majority of our contracts, our customer obtains control as we perform work under the contract. As such, most of our revenues will be recognized sooner as a result of changing to an over time method (i.e., cost-to-cost plus a reasonable profit) from a point-in-time method, which is our current method for recognizing revenue. This will result in eliminating the majority of our work-in-process and finished goods inventory and a significant increase in unbilled accounts receivables (i.e., contract assets). This change will also impact our information technology systems, systems of internal controls over financial reporting, and certain accounting policies, requiring the usage of more judgement in determining our revenue recognition. Further, we have selected a software solution and are in the process of implementing the software solution to comply with this new accounting standard. Finally, we will adopt the new accounting standard using the modified retrospective method, under which the cumulative effect of initially applying the new guidance is recognized as an adjustment to certain captions on the balance sheet, including the opening balance of retained earnings in the first quarter of 2018.

Inventories consisted of the following:

The carrying amounts of our goodwill all in our Electronic Systems segment, were as follows:

The components of accrued and other liabilities were as follows:

Long-term debt and the current period interest rates were as follows:

The Credit Facilities bear2019 Term Loan bears interest, at our option, at a rate equal to either (i) the Eurodollar Rate (defined as LIBOR)the London Interbank Offered Rate [“LIBOR”]) plus an applicable margin ranging from 1.50% to 2.75%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 1.75%1.50% per year, in each case based upon the consolidated total net adjusted leverage ratio.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 months ended April 3, 2021, we made the required quarterly payment of $1.8 million.

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 portionsportion of the commitmentscommitment of the 2019 Revolving Credit Facilities areFacility is subject to a commitment fee ranging from 0.175% to 0.300%0.275%, based upon the consolidated total net adjusted leverage ratio. However, the 2019 Revolving Credit Facility does not require any principal installment payments.

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 prepaymentsexcess cash flow payment is based on (i) 50% of amounts outstanding under the Term Loan. The mandatory prepayments will be made quarterly,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 5.0% per year3.25 to 1.0 but greater than 2.50 to 1.0, and (iii) zero percent of the original aggregate principalexcess cash flow amount duringif the first two

In addition,conjunction with entering into the 2019 Revolving Credit Facility and the 2019 Term Loan, we incurred $4.8drew 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 issuance costs relatedand thus, no gain or loss was recorded. Instead, the new fees paid to the Credit Facilities and those costslenders of $0.6 million were capitalized and are being amortized over the five year life of the Credit Facilities.

The 2019 Revolving Credit Facility. The remaining $0.6 million was paid in October 2017 in cash, also by drawing down onFacility that replaced the 2018 Revolving Credit Facility. See Note 2Facility was considered an extinguishment of debt except for further information.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 September 30, 2017,April 3, 2021, we had $134.5$79.8 million of unused borrowing capacity under the 2019 Revolving Credit Facility, after deducting $64.7 million for draw down on the Revolving Credit Facility and $0.8$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 one subsidiary2 subsidiaries that were considered minor (“Subsidiary Guarantors”) that was considered minor.. The Subsidiary Guarantors jointly and severally guarantee the Credit Facilities. The Parent Company has no independent assets or operations and the Subsidiary Guarantors jointly and severally guarantee, on a senior unsecured basis, the Credit Facilities. Therefore,therefore, no condensed 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 datesdate of June 2020, and 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. See Note 5 for further discussion.

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 facilityperformance center leases, we have indemnified our lessors for certain claims arising from the facilityperformance 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 varyvaries and, in many cases areis indefinite but subject to statutesstatute 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 onin the accompanying condensed consolidated balance sheets.

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 $0.9$1.1 million (effective tax rate of 16.8%) for the three months ended September 30, 2017April 3, 2021 compared to $1.2$1.5 million (effective tax rate of 19.8%) for the three months ended October 1, 2016.March 28, 2020. The decrease in income tax expense for the effectivefirst quarter of 2021 compared to the first quarter of 2020 was primarily due to lower pre-tax income for the first quarter of 2021 compared to the first quarter of 2020 and higher discrete tax ratebenefits recognized in the first quarter of 2021 for net tax windfalls related to stock-based compensation.

We evaluated the amendments in ASU 2019-12 for the three months ended September 30, 2017 compared toApril 3, 2021 and determined they do not have an impact on our income taxes.

On March 11, 2021, the three months ended October 1, 2016 was primarily due to tax benefits recognized from additional U.S. Federal researchenacted 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 development tax credits. FASB ASU 2016-09 became effective beginning January 1, 2017 and required all the tax effects related to share-based payments be recorded through thedetermined they do not have a material impact on our income statement. This could result in fluctuations in our effective tax rate from period to period, depending on the number of awards exercised and/or vested in the quarter as well as the volatility of our stock price. During the current year three month period, we recognized tax benefits from deductions of share-based payments in excess of compensation cost recognized for financial reporting purposes of $0.1 million, which decreased our effective tax rate by 0.6%.

Our total amount of unrecognized tax benefits was $3.7 million and $3.0$4.1 million as of September 30, 2017both April 3, 2021 and December 31, 2016, respectively.2020. If recognized, $2.4 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 April 3, 2021 and December 31, 2020 were not significant. We do not reasonably expect significant increases or decreases to ourthe total amount of unrecognized tax benefits to increase or decrease by a material amount in the next twelve months.

In 2016,We file U.S. Federal and state income tax returns. We are subject to examination by the Internal Revenue Service (“IRS”) commenced an audit of our 2014for tax years after 2016 and 2015by state taxing authorities for tax years. Althoughyears 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 outcome of tax examinations cannotIRS or state taxing authority if they either have been or will be predicted with certainty, weused 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.

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 2 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.

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.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.

Financial information by reportable operating segment was as follows: