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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 3, 2004
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 1-8174
DUCOMMUN INCORPORATED
(Exact name of registrant as specified in its charter)
| Delaware | 95-0693330 | |
(State or other jurisdiction of incorporation or organization) | I.R.S. Employer Identification No. | |
111 W. Ocean Boulevard, Suite 900, Long Beach, California | 90802 | |
| (Address of principal executive offices) | (Zip Code) | |
(562) 624-0800
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes x No ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of April 3, 2004, there were outstanding 9,962,162 shares of common stock.
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FORM 10-Q
INDEX
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PART I - FINANCIAL INFORMATION
DUCOMMUN INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
| April 3, 2004 | December 31, 2003 | |||||||
Assets | ||||||||
Current Assets: | ||||||||
Cash and cash equivalents | $ | 109 | $ | 3,832 | ||||
Accounts receivable (less allowance for doubtful accounts of $467 and $503) | 29,784 | 26,275 | ||||||
Inventories | 45,080 | 40,003 | ||||||
Deferred income taxes | 6,699 | 6,217 | ||||||
Prepaid income taxes | 1,593 | 1,593 | ||||||
Other current assets | 4,256 | 4,277 | ||||||
Total Current Assets | 87,521 | 82,197 | ||||||
Property and Equipment, Net | 56,945 | 56,929 | ||||||
Goodwill (Net of Accumulated Amortization of $10,996 and $10,996) | 57,201 | 57,201 | ||||||
Other Assets | 1,536 | 1,714 | ||||||
| $ | 203,203 | $ | 198,041 | |||||
Liabilities and Shareholders’ Equity | ||||||||
Current Liabilities: | ||||||||
Current portion of long-term debt | $ | 2,185 | $ | 2,185 | ||||
Accounts payable | 15,338 | 14,200 | ||||||
Accrued liabilities | 34,150 | 36,152 | ||||||
Total Current Liabilities | 51,673 | 52,537 | ||||||
Long-Term Debt, Less Current Portion | 3,400 | 400 | ||||||
Deferred Income Taxes | 5,313 | 5,313 | ||||||
Other Long-Term Liabilities | 2,041 | 2,041 | ||||||
Total Liabilities | 62,427 | 60,291 | ||||||
Commitments and Contingencies | ||||||||
Shareholders’ Equity: | ||||||||
Common stock — $.01 par value; authorized 35,000,000 shares; issued 9,962,162 shares in 2004 and 9,901,965 shares in 2003 | 100 | 99 | ||||||
Additional paid-in capital | 39,188 | 38,394 | ||||||
Retained earnings | 103,529 | 101,298 | ||||||
Accumulated other comprehensive loss | (2,041 | ) | (2,041 | ) | ||||
Total Shareholders’ Equity | 140,776 | 137,750 | ||||||
| $ | 203,203 | $ | 198,041 | |||||
See accompanying notes to consolidated financial statements.
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DUCOMMUN INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
| For Three Months Ended | ||||||||
April 3, 2004 | April 5, 2003 | |||||||
Net Sales | $ | 58,247 | $ | 55,041 | ||||
Operating Costs and Expenses: | ||||||||
Cost of goods sold | 47,833 | 43,028 | ||||||
Selling, general and administrative expenses | 6,790 | 6,983 | ||||||
Total Operating Costs and Expenses | 54,623 | 50,011 | ||||||
Operating Income | 3,624 | 5,030 | ||||||
Interest Expense | (138 | ) | (321 | ) | ||||
Income Before Taxes | 3,486 | 4,709 | ||||||
Income Tax Expense | (1,255 | ) | (1,601 | ) | ||||
Net Income | $ | 2,231 | $ | 3,108 | ||||
Earnings Per Share: | ||||||||
Basic earnings per share: | $ | 0.22 | $ | 0.31 | ||||
Diluted earnings per share: | $ | 0.22 | $ | 0.31 | ||||
Weighted Average Number of Common Shares Outstanding: | ||||||||
Basic | 9,922 | 9,873 | ||||||
Diluted | 10,192 | 9,894 | ||||||
See accompanying notes to consolidated financial statements.
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DUCOMMUN INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| For Three Months Ended | ||||||||
| April 3, 2004 | April 5, 2003 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net Income | $ | 2,231 | $ | 3,108 | ||||
Adjustments to Reconcile Net Income to Net Cash (Used in) Provided by Operating Activities: | ||||||||
Depreciation and amortization | 1,877 | 1,886 | ||||||
Deferred income tax benefit | (482 | ) | (533 | ) | ||||
Income tax benefit related to the exercise of nonqualified stock options | 334 | 7 | ||||||
Recovery of doubtful accounts | (36 | ) | (79 | ) | ||||
Net provision for (recovery of) contract cost overruns | 1,796 | (276 | ) | |||||
Recovery of warranty reserves | (63 | ) | (18 | ) | ||||
Gain on sale of assets | (5 | ) | — | |||||
Changes in Assets and Liabilities: | ||||||||
Accounts receivable | (3,473 | ) | (3,183 | ) | ||||
Inventories | (5,077 | ) | (1,002 | ) | ||||
Other assets | 199 | 295 | ||||||
Accounts payable | 1,138 | 1,280 | ||||||
Accrued and other liabilities | (3,735 | ) | 4,501 | |||||
Net Cash (Used in) Provided by Operating Activities | (5,296 | ) | 5,986 | |||||
Cash Flows from Investing Activities: | ||||||||
Purchase of property and equipment | (1,893 | ) | (1,436 | ) | ||||
Proceeds from sale of assets | 5 | 2 | ||||||
Net Cash Used in Investing Activities | (1,888 | ) | (1,434 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Net borrowings (repayment) of long-term debt | 3,000 | (4,527 | ) | |||||
Net cash effect of exercise related to stock options | 461 | 123 | ||||||
Net Cash Provided by (Used in) Financing Activities | 3,461 | (4,404 | ) | |||||
Net (Decrease) Increase in Cash and Cash Equivalents | (3,723 | ) | 148 | |||||
Cash and Cash Equivalents - Beginning of Period | 3,832 | 174 | ||||||
Cash and Cash Equivalents - End of Period | $ | 109 | $ | 322 | ||||
Supplemental Disclosures of Cash Flow Information: | ||||||||
Interest Paid | $ | 12 | $ | 208 | ||||
Income Taxes Paid | $ | 93 | $ | 16 | ||||
Supplemental information for Non-Cash Investing and Financing Activities: | ||||||||
See Note 2 for non-cash investing activities related to the acquisition of business. | ||||||||
See accompanying notes to consolidated financial statements.
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DUCOMMUN INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Consolidation
The consolidated balance sheets, consolidated statements of income and consolidated statements of cash flows are unaudited as of and for the three months ended April 3, 2004 and April 5, 2003. The consolidated financial statements include the accounts of Ducommun Incorporated and its subsidiaries (“Ducommun” or the “Company”), after eliminating inter-company balances and transactions. The financial information included in the quarterly report should be read in conjunction with the Company’s consolidated financial statements and related notes thereto included in its annual report on Form 10-K for the year ended December 31, 2003.
Cash Equivalents
Cash equivalents consist of highly liquid instruments purchased with original maturities of three months or less. The cost of these investments approximates fair value.
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, the price is fixed or determinable, collection is reasonably assured and delivery of products has occurred or services have been rendered. The Company records provisions for estimated losses on contracts in the period in which such losses are identified.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses from the inability of customers to make required payments. The allowance for doubtful accounts is evaluated periodically based on the aging of accounts receivable, the financial condition of customers and their payment history, historical write-off experience and other assumptions.
Inventory Valuation
Inventories are stated at the lower of cost or market, cost being determined on a first-in, first-out basis. The Company assesses the inventory carrying value and reduces 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 Company’s customer demand is highly unpredictable, and can fluctuate significantly caused by factors beyond the control of the Company. The Company maintains an allowance for inventories for potentially excess and obsolete inventories and gross inventory levels that are carried at costs that are higher than their market values. If market conditions are less favorable than those projected by management, such as an unanticipated decline in demand not meeting expectations, inventory write-downs may be required.
Property and Depreciation
Property and equipment, including assets recorded under capital leases, are recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives and, in the case of leasehold improvements, over the shorter of the lives of the improvements or the lease term. The Company evaluates long-lived assets for recoverability, when significant changes in conditions occur, and recognizes impairment losses, if any, based upon the fair value of the assets.
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Goodwill
The Company’s business acquisitions have typically resulted in goodwill, which affects the amount of possible impairment expense that the Company will incur. The determination of the value of goodwill requires management to make estimates and assumptions that affect the Company’s consolidated financial statements. The Company performs a goodwill impairment tests annually in its fourth quarter and between annual tests, in certain circumstances, whenever events may indicate an impairment may have occurred. In assessing the recoverability of the Company’s goodwill, management must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets.
Warranty Liability
The Company quantifies and records an estimate for warranty related costs based on the Company’s actual historical and projected return and failure rates and the current repair costs. Should the Company experience actual return and failure rates, or repair costs that are higher than the estimates used to calculate the provision, the Company’s operating results for the period or periods in which such returns or additional costs materialize will be adversely impacted.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards, No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
Litigation and Commitments
In the normal course of business, the Company and its subsidiaries are defendants in certain litigation, claims and inquiries, including matters relating to environmental laws. In addition, the Company makes various commitments and incurs contingent liabilities. Management’s estimates regarding contingent liabilities could differ from actual results.
Environmental Liabilities
Environmental liabilities are recorded when environmental assessments and/or remedial efforts are probable and costs can be reasonably estimated. Generally, the timing of these accruals coincides with the completion of a feasibility study or the Company’s commitment to a formal plan of action.
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Earnings Per Share
Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding in each year. Diluted earnings per share is computed by dividing income available to common shareholders plus income associated with dilutive securities by the weighted average number of common shares outstanding plus any potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock in each period. For the three months ended April 3, 2004 and April 5, 2003, income available to common shareholders was $2,231,000 and $3,108,000, respectively. The weighted average number of common shares outstanding for the three months ended April 3, 2004 and April 5, 2003 were 9,922,000 and 9,873,000, and the diluted shares associated with stock options were 270,000 and 21,000, respectively.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”), requires that certain items such as foreign currency translation adjustments, unrealized gains and losses on certain investments in debt and equity securities and minimum pension liability adjustments be presented as separate components of shareholders’ equity. SFAS No. 130 defines these as items of other comprehensive income and as such must be reported in a financial statement that is displayed with the same prominence as other financial statements. Accumulated other comprehensive income, as reflected in the Consolidated Statements of Shareholders’ Equity, was comprised of a minimum pension liability adjustment of $2,041,000, net of tax, at April 3, 2004 and December 31, 2003. No items of other comprehensive income were recorded during the quarters ended April 3, 2004 and April 5, 2003.
Recent Accounting Pronouncements
In January 2003, FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN No. 46”), was issued. This Interpretation, as revised in December 2003, requires an investor with a majority of the variable interests (primary beneficiary) in a variable interest entity (“VIE”) to consolidate the entity. It also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling interest, or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from other parties. The adoption of FIN No. 46 in 2004 did not have any impact on the Company’s financial position, results of operations or cash flows.
Use of Estimates
Certain amounts and disclosures included in the consolidated financial statements required management to make estimates and judgments that affect the amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the
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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 under different assumptions or conditions.
Note 2. Acquisition
In August 2003, the Company acquired the assets of DBP Microwave, Inc. (“DBP”), a privately held company based in Azusa, California for $2,322,000 in cash and a $400,000 nonnegotiable promissory note. DBP is a manufacturer of electromechanical RF and microwave switches for both aerospace and nonaerospace applications, and is now part of the Company’s Ducommun Technologies, Inc. (“DTI”), subsidiary. The acquisition was accounted for under the purchase method of accounting and, accordingly, the operating results for this acquisition have been included in the consolidated statements of income since the date of the acquisition. The cost of the acquisition was allocated on the basis of the estimated fair value of the assets acquired and liabilities assumed. This acquisition accounted for approximately $1,669,000 of the excess of cost over net assets acquired at April 3, 2004 and December 31, 2003. The acquisition was funded from internally generated cash, notes and other accounts payable to sellers, and borrowings under the Company’s credit agreement (see Note 5 for additional information). This acquisition strengthened the Company’s position in the aerospace industry and added complementary lines of business. Pro forma results for the three months ended April 3, 2004 and April 5, 2003, assuming the acquisition of DBP at the beginning of the period, would not have been materially different from the Company’s historical results for the period presented.
Note 3. Inventories
Inventories consist of the following:
| (In thousands) | ||||||
April 3, 2004 | December 31, 2003 | |||||
Raw materials and supplies | $ | 12,382 | $ | 10,994 | ||
Work in process | 37,807 | 36,794 | ||||
Finished goods | 1,323 | 1,484 | ||||
| 51,512 | 49,272 | |||||
Less progress payments | 6,432 | 9,269 | ||||
Total | $ | 45,080 | $ | 40,003 | ||
Work in process inventories include amounts under long-term fixed price contracts aggregating $26,118,000 and $25,342,000 at April 3, 2004 and December 31, 2003, respectively.
Note 4. Goodwill
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No. 141”) and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). Pursuant to the nonamortization provisions of SFAS No. 142, there was no goodwill amortization expense in 2004 and 2003. There was no change in goodwill during the first quarter of 2004.
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Note 5. Long-Term Debt
Long-term debt is summarized as follows:
| (In thousands) | ||||||
| April 3, 2004 | December 31, 2003 | |||||
Bank credit agreement | $ | 3,000 | $ | — | ||
Notes and other liabilities for acquisitions | 2,585 | 2,585 | ||||
Total debt | 5,585 | 2,585 | ||||
Less current portion | 2,185 | 2,185 | ||||
Total long-term debt | $ | 3,400 | $ | 400 | ||
In December 2002, the Company and its lenders amended the Company’s credit agreement. The amended credit agreement provides for a $75,000,000 unsecured revolving credit line gradually declining to $60,000,000 at maturity on September 30, 2005. Interest is payable monthly on the outstanding borrowings based on the bank’s prime rate plus a spread based on the leverage ratio of the Company calculated at the end of each fiscal quarter (4.25% at April 3, 2004). A Eurodollar pricing option is also available to the Company for terms of up to six months at the Eurodollar rate plus a spread based on the leverage ratio of the Company calculated at the end of each fiscal quarter (2.59% at April 3, 2004). At April 3, 2004, the Company had $70,578,000 of unused lines of credit, after deducting $3,000,000 of loans outstanding and $1,422,000 for outstanding standby letters of credit. The credit agreement includes minimum interest coverage, maximum leverage, minimum EBITDA (earnings before interest, taxes, depreciation and amortization) and minimum net worth covenants, an unused commitment fee based on the leverage ratio (0.40% per annum at April 3, 2004), and limitations on future dispositions of property, repurchases of common stock, outside indebtedness, capital expenditures and acquisitions.
Note 6. Shareholders’ Equity
At April 3, 2004 and December 31, 2003, no preferred shares were issued or outstanding. The Company did not repurchase any of its common stock during 2004 and 2003.
Note 7. Stock Options
The Company has three stock option or incentive plans. Stock awards may be made to directors, officers and key employees under the stock plans on terms determined by the Compensation Committee of the Board of Directors or, with respect to directors, on terms determined by the Board of Directors. Stock options have been and may be granted to directors, officers and key employees under the stock plans at prices not less than 100% of the market value on the date of grant, and expire not more than ten years from the date of grant. The option price and number of shares are subject to adjustment under certain dilutive circumstances. At April 3, 2004, 107,271 common shares were available for future grants and 696,226 common shares were reserved for the exercise of outstanding options.
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In accordance with the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), the Company applies APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its plans and does not recognize compensation expense for its stock-based compensation plans based on the fair value method. If the Company had elected to recognize compensation expense based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed by SFAS No. 123, the Company’s net income and earnings per share would be reduced to the pro forma amounts indicated below:
| (In thousands) Three Months Ended | ||||||||
| April 3, 2004 | April 5, 2003 | |||||||
Net Income: | ||||||||
As reported | $ | 2,231 | $ | 3,108 | ||||
Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (173 | ) | (99 | ) | ||||
Pro forma | $ | 2,058 | $ | 3,009 | ||||
Earnings per common share: | ||||||||
As reported: | ||||||||
Basic | $ | .22 | $ | .31 | ||||
Diluted | .22 | .31 | ||||||
Pro forma: | ||||||||
Basic | $ | .21 | $ | .30 | ||||
Diluted | .20 | .30 | ||||||
These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future years.
Note 8. Employee Benefit Plans
The Company has an unfunded supplemental retirement plan that was suspended in 1986, but which continues to cover certain former executives. The accumulated benefit obligations under the plan at April 3, 2004 and December 31, 2003 were $514,000 and $516,000, respectively, which are included in accrued liabilities.
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The Company sponsors for all of its employees, a 401(k) defined contribution plan under which employees can make annual voluntary contributions not to exceed the lesser of an amount equal to 25% of their compensation or limits established by the Internal Revenue Code. The Company generally provides a match equal to 50 percent of the employees’ contributions up to the first 4 percent of compensation, except for union employees who are not eligible to receive the match. The Company matching contributions for the periods ended April 3, 2004 and April 5, 2003 were approximately $173,000 and $177,000, respectively.
The Company provides certain health care benefits for retired employees. Elgibility for additional employees to become covered by retiree health benefits was terminated in 1988. Employees became eligible for these benefits if they met minimum age and service requirements and were eligible for retirement benefits. The Company accrues postretirement health care benefits over the period in which active employees become eligible for such benefits. The accrued postretirement benefit cost under these plans is included in accrued liabilities. The components of net periodic post retirement benefits cost for these plans are as follows:
| (In thousands) Three Months Ended | ||||||||
| April 3, 2004 | April 5, 2003 | |||||||
Service cost | $ | — | $ | — | ||||
Interest cost | 18 | 20 | ||||||
Expected return on plan assets | — | — | ||||||
Amortization of net transition obligation | 21 | 21 | ||||||
Amortization of actuarial gain | (5 | ) | (5 | ) | ||||
Net periodic post retirement benefits cost | $ | 34 | $ | 36 | ||||
Certain hourly employees at one location of the Company are covered by a defined benefit plan. Pension plan benefits are generally determined on the basis of the retiree’s age and length of service. Assets of the defined benefit plan are composed primarily of fixed income and equity securities.
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The components of net periodic pension cost for this plan is as follows:
| (In thousands) Three Months Ended | ||||||||
| April 3, 2004 | April 5, 2003 | |||||||
Service cost | $ | 127 | $ | 112 | ||||
Interest cost | 156 | 134 | ||||||
Expected return on plan assets | (182 | ) | (140 | ) | ||||
Amortized losses | 40 | 43 | ||||||
Net periodic pension cost | $ | 141 | $ | 149 | ||||
On December 31, 2003, the Company’s annual measurement date, and April 3, 2004, the accumulated benefit obligation, related to the defined benefit plan, exceeded the fair value of the plan assets. Such excess is referred to as an unfunded accumulated benefit obligation. In accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions,” the Company recognized a minimum pension liability at April 3, 2004 and December 31, 2003 of $2,041,000, net of tax, which decreased shareholders’ equity and is included in other long-term liabilities. This charge to shareholders’ equity represents a net loss not yet recognized as pension expense. This charge did not affect reported earnings, and would be reversible if either interest rates increase or market performance and plan returns improved or contributions cause the pension plan to return to fully funded status. There were no charges during the quarters ended April 3, 2004 and April 5, 2003.
Amounts recognized in the statement of financial position consist of:
| (In thousands) | |||||||||||||||
| Pension Benefits | Other Benefits | ||||||||||||||
| April 3, 2004 | December 31, 2003 | April 3, 2004 | December 31, 2003 | ||||||||||||
Prepaid benefit cost | $ | 407 | $ | 547 | $ | — | $ | — | |||||||
Accrued benefit cost | — | 638 | (1,234 | ) | (1,256 | ) | |||||||||
Accumulated other comprehensive income, net of tax | — | (638 | ) | — | — | ||||||||||
Net amount recognized | $ | 407 | $ | 547 | $ | (1,234 | ) | $ | (1,256 | ) | |||||
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The deferred benefit plan assets consist primarily of listed stocks and bonds. The Company’s funding policy is to contribute cash to its pension plans so that the minimum contribution requirements established by government funding and taxing authorities are met. The Company was not required to make any contributions to the pension plan in 2003, but plans to contribute as much as $1,300,000 in 2004.
Note 9. Indemnifications and Warranty Liability
Indemnifications
The Company has made guarantees and indemnities under which it may be required to make payments to a guaranteed or indemnified party, in relation to certain transactions, including revenue transactions in the ordinary course of business. In connection with certain facility leases the Company has indemnified its lessors for certain claims arising from the facility or the lease. The Company indemnifies its directors and officers to the maximum extent permitted under the laws of the State of Delaware. However, the Company has a directors and officers insurance policy that may reduce its exposure in certain circumstances and may enable it 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 the Company could be obligated to make. Historically, payments related to these guarantees and indemnities have been immaterial. The Company estimates the fair value of its indemnification obligations as insignificant based on this history and insurance coverage and has, therefore, not recorded any liability for these guarantees and indemnities in the accompanying consolidated balance sheets. However, there can be no assurances that the Company will not have any future financial exposure under these indemnification obligations.
Warranty Liability
The Company quantifies and records an estimate for warranty related costs based on the Company’s actual historical and projected return and failure rates and the current repair costs. Should the Company experience actual return and failure rates, or repair costs that are higher than the estimates used to calculate the provision, the Company’s operating results for the period or periods in which such returns or additional costs materialize will be adversely impacted.
Information regarding the changes in the Company’s aggregate warranty liability is as follows:
| (In thousands) | ||||||||
| April 3, 2004 | December 31, 2003 | |||||||
Warranty liability at beginning of period | $ | 1,759 | $ | 1,697 | ||||
Accruals for warranties during the period | 29 | 184 | ||||||
Adjustments relating to pre-existing warranties | (92 | ) | (122 | ) | ||||
Warranty liability at end of period | $ | 1,696 | $ | 1,759 | ||||
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Note 10. Leases
The Company leases certain facilities and equipment for periods ranging from 1 to 9 years. The leases generally are renewable and provide for the payment of property taxes, insurance and other costs relative to the property. Rental expense for the periods ended April 3, 2004 and April 5, 2003, was $744,000 and $799,000, respectively. Future minimum rental payments under operating leases having initial or remaining noncancelable terms in excess of one year at April 3, 2004 are as follows:
| (In thousands) Lease Commitments | |||
2004 | $ | 1,687 | |
2005 | 1,647 | ||
2006 | 886 | ||
2007 | 883 | ||
2008 | 696 | ||
Thereafter | 1,603 | ||
Total | $ | 7,402 | |
Note 11. Contingencies
The Ducommun AeroStructures, Inc. (“DAS”) facility located in El Mirage, California has been directed by California environmental agencies to investigate and take corrective action for groundwater contamination. Based upon currently available information, the Company has established a provision for the cost of such investigation and corrective action. DAS expects to spend approximately $1 million for future investigation and corrective action for groundwater contamination at its El Mirage location. However, the Company’s ultimate liability in connection with the contamination will depend upon a number of factors, including changes in existing laws and regulations, and the design and cost of the construction, operation and maintenance of the corrective action.
The Company’s subsidiary, Composite Structures, LLC (“Composite”), and several other companies have been ordered by a California environmental agency to investigate and clean up soil and groundwater contamination at its Monrovia, California facility. Composite has filed a petition for review of the order.
In the normal course of business, Ducommun and its subsidiaries are defendants in certain other litigation, claims and inquiries, including matters relating to environmental laws. In addition, the Company makes various commitments and incurs contingent liabilities. While it is not feasible to predict the outcome of these matters, the Company does not presently expect that any sum it may be required to pay in connection with these matters would have a material adverse effect on its consolidated financial position, results of operations or cash flows.
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Note 12. Major Customers and Concentrations of Credit Risk
The Company provides proprietary products and services to most of the prime aerospace and aircraft manufacturers. As a result, the Company’s sales and trade receivables are concentrated principally in the aerospace industry.
The Company had substantial sales to Boeing, Raytheon and Lockheed Martin. During the first quarter of 2004 and 2003, sales to Boeing were $27,799,000 and $29,143,000, respectively; sales to Raytheon were $7,649,000 and $7,111,000, respectively; and sales to Lockheed Martin were $3,345,000 and $3,117,000, respectively. At April 3, 2004, trade receivables from Boeing, Raytheon and Lockheed Martin were $12,989,000, $4,212,000 and $1,143,000, respectively. The sales and receivables relating to Boeing, Raytheon and Lockheed Martin are diversified over a number of different commercial, space and military programs.
Note 13. Business Segment Information
The Company supplies products and services to the aerospace industry. The Company’s subsidiaries are organized into two strategic businesses, each of which is a reportable operating segment. Ducommun AeroStructures, Inc., manufactures aerospace structural components and subassemblies. Ducommun Technologies, Inc., manufactures aerospace electromechanical components and subsystems. The accounting policies of the segments are the same as those of the Company, as described in Note 1, Summary of Significant Accounting Policies.
Financial Accounting Standards Board Statement No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS No. 131”) establishes standards for reporting information about segments in financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available and that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
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Financial information by operating segment is set forth below:
(In thousands) Three Months Ended | ||||||||
| April 3, 2004 | April 5, 2003 | |||||||
Net Sales: | ||||||||
Ducommun AeroStructures, Inc. | $ | 39,526 | $ | 35,805 | ||||
Ducommun Technologies, Inc. | 18,721 | 19,236 | ||||||
Total Net Sales | $ | 58,247 | $ | 55,041 | ||||
Segment Operating Income (1): | ||||||||
Ducommun AeroStructures, Inc. | $ | 1,775 | $ | 3,550 | ||||
Ducommun Technologies, Inc. | 3,017 | 3,289 | ||||||
| 4,792 | 6,839 | |||||||
Corporate General and Administrative Expenses | (1,168 | ) | (1,809 | ) | ||||
Total Operating Income | $ | 3,624 | $ | 5,030 | ||||
Depreciation and Amortization Expenses: | ||||||||
Ducommun AeroStructures, Inc. | $ | 1,530 | $ | 1,535 | ||||
Ducommun Technologies, Inc. | 343 | 313 | ||||||
Corporate Administration | 4 | 38 | ||||||
Total Depreciation and Amortization Expenses | $ | 1,877 | $ | 1,886 | ||||
Capital Expenditures: | ||||||||
Ducommun AeroStructures, Inc. | $ | 1,618 | $ | 1,231 | ||||
Ducommun Technologies, Inc. | 275 | 203 | ||||||
Corporate Administration | — | — | ||||||
Total Capital Expenditures | $ | 1,893 | $ | 1,434 | ||||
| (1) | Before certain allocated corporate overhead. |
Segment assets include assets directly identifiable with each segment. Corporate assets include assets not specifically identified with a business segment, including cash.
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(In thousands) Three Months Ended | ||||||
| April 3, 2004 | December 31, 2003 | |||||
Total Assets | ||||||
Ducommun AeroStructures, Inc. | $ | 138,446 | $ | 135,257 | ||
Ducommun Technologies, Inc. | 52,473 | 46,603 | ||||
Corporate Administration | 12,284 | 16,181 | ||||
Total Assets | $ | 203,203 | $ | 198,041 | ||
Goodwill | ||||||
Ducommun AeroStructures, Inc. | $ | 36,785 | $ | 36,785 | ||
Ducommun Technologies, Inc. | 20,416 | 20,416 | ||||
Total Goodwill | $ | 57,201 | $ | 57,201 | ||
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Ducommun designs, engineers and manufactures aerostructure and electromechanical components and subassemblies principally for the aerospace industry. The Company manufactures components and assemblies principally for domestic and foreign commercial and military aircraft and space programs. Domestic commercial aircraft programs include the Boeing 737NG, 747, 757, 767 and 777. Foreign commercial aircraft programs include the Airbus Industrie A330, A340 and A340-600 aircraft, Bombardier business and regional jets, and the Embraer 145 and 170/190. Major military programs include the Boeing C-17, F-15 and F-18 and Lockheed Martin F-16, various Sikorsky, Bell, Boeing Apache and Augusta helicopter programs, and various aircraft and shipboard electronics upgrade programs. Space programs include the space shuttle external fuel tank, and various commercial and military space launch and satellite programs.
Critical Accounting Policies
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, the price is fixed or determinable, collection is reasonably assured and delivery of products has occurred or services have been rendered. The Company records provisions for estimated losses on contracts in the period in which such losses are identified.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses from the inability of customers to make required payments. The allowance for doubtful accounts is evaluated periodically based on the aging of accounts receivable, the financial condition of customers and their payment history, historical write-off experience and other assumptions.
Inventory Valuation
Inventories are stated at the lower of cost or market, cost being determined on a first-in, first-out basis. The Company assesses the inventory carrying value and reduces 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 Company’s customer demand is highly unpredictable, and can fluctuate significantly caused by factors beyond the control of the Company. The Company maintains an allowance for inventories for potentially excess and obsolete inventories and gross inventory levels that are carried at costs that are higher than their market values. If market conditions are less favorable than those projected by management, such as an unanticipated decline in demand not meeting expectations, inventory write-downs may be required.
Property and Depreciation
Property and equipment, including assets recorded under capital leases, are recorded at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives and, in the case of leasehold improvements, over the shorter of the lives of the improvements or the lease term. The Company evaluates long-lived assets for recoverability, when significant changes in conditions occur, and recognizes impairment losses, if any, based upon the fair value of the assets.
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Goodwill
The Company’s business acquisitions have typically resulted in goodwill, which affects the amount of possible impairment expense that the Company will incur. The determination of the value of goodwill requires management to make estimates and assumptions that affect the Company’s consolidated financial statements. The Company performs a goodwill impairment test annually in its fourth quarter and between annual tests, in certain circumstances, whenever events may indicate an impairment may have occurred. In assessing the recoverability of the Company’s goodwill, management must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Standards, No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
Acquisition
In August 2003, the Company acquired the assets of DBP Microwave, Inc. (“DBP”), a privately held company based in Azusa, California for $2,322,000 in cash and a $400,000 nonnegotiable promissory note. DBP is a manufacturer of electromechanical RF and microwave switches for both aerospace and nonaerospace applications, and is now part of the Company’s Ducommun Technologies, Inc. (“DTI”), subsidiary. The acquisition was accounted for under the purchase method of accounting and, accordingly, the operating results for this acquisition have been included in the consolidated statements of income since the date of the acquisition. The cost of the acquisition was allocated on the basis of the estimated fair value of the assets acquired and liabilities assumed. This acquisition accounted for approximately $1,669,000 of the excess of cost over net assets acquired at April 3, 2004 and December 31, 2003, respectively. The acquisition was funded from internally generated cash, notes and other accounts payable to sellers, and borrowings under the Company’s credit agreement (see Note 5 for additional information). This acquisition strengthened the Company’s position in the aerospace industry and added complementary lines of business.
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Results of Operations
First Quarter of 2004 Compared to First Quarter of 2003
Net sales in the first quarter of 2004 were $58,247,000, compared to net sales of $55,041,000 for the first quarter of 2003. Net sales in 2004 benefited by approximately $1,260,000 in sales from the August 2003 acquisition of DBP Microwave. The Company’s mix of business in the first quarter of 2004 was approximately 61% military, 35% commercial, and 4% space, compared to 65% military, 31% commercial, and 4% space in the first quarter of 2003.
The Company had substantial sales to Boeing, Raytheon and Lockheed Martin. During the first quarter of 2004 and 2003, sales to Boeing were $27,799,000 and $29,143,000, respectively; sales to Raytheon were $7,649,000 and $7,111,000, respectively; and sales to Lockheed Martin were $3,345,000 and $3,117,000, respectively. At April 3, 2004, trade receivables from Boeing, Raytheon and Lockheed Martin were $12,989,000, $4,212,000 and $1,143,000, respectively. The sales and receivables relating to Boeing, Raytheon and Lockheed Martin are diversified over a number of different commercial, space and military programs.
The Company’s commercial business is represented on virtually all of today’s major commercial aircraft. During the first quarter of 2004, sales related to commercial business were approximately $20,162,000, or 35% of total sales, compared to $17,091,000, or 31% in the first quarter of 2003. The Boeing 737/737NG program accounted for approximately $8,611,000 in sales in the first quarter of 2004, compared to $6,315,000 in sales in the first quarter of 2003.
Military components manufactured by the Company are employed in many of the country’s front-line fighters, bombers, helicopters and support aircraft, as well as many sea-based vehicles. The Company’s defense business is widely diversified among military manufacturers and programs. Sales related to military programs were approximately $35,797,000, or 61% of total sales in the first quarter of 2004, compared to $35,625,000, or 65% of total sales in the first quarter of 2003. In the first quarter of 2004, the C-17 program accounted for approximately $7,455,000 in sales, compared to $9,802,000 in sales in the first quarter of 2003, and the Apache helicopter program accounted for approximately $10,362,000 in sales, compared to $7,609,000 in sales in the first quarter of 2003.
In the space sector, the Company produces components for the expendable fuel tanks which help boost the Space Shuttle vehicle into orbit. Components are also produced for a variety of unmanned launch vehicles and satellite programs. During the first quarter of 2004, sales related to space programs were approximately $2,288,000, or 4% of total sales, compared to $2,374,000, or 4% of total sales in the first quarter of 2003.
At April 3, 2004, backlog believed to be firm was approximately $271,757,000, compared to $283,901,000 at December 31, 2003. The backlog decrease from December 31, 2003 was primarily due to lower bookings for commercial programs. Approximately $150,000,000 of the total backlog is expected to be delivered during 2004.
Gross profit, as a percentage of sales, decreased to 17.9% in the first quarter of 2004 from 21.8% in the first quarter of 2003. This decrease was primarily the result of initial losses on several new contracts at Ducommun AeroStructures during the first quarter of 2004, partially offset by the impact of spreading fixed overhead costs over a greater sales volume. The decline in gross profit margins also included a provision of $1,894,000 established during the first quarter of 2004 for estimated cost overruns on certain of the new contracts at Ducommun AeroStructures. The provision for estimated cost overruns
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is based on currently available information and various assumptions, including customers’ future production rates and delivery schedules and the Company’s future cost structure and learning curve assumptions.
Selling, general and administrative expenses, as a percentage of sales, were 11.7% in the first quarter of 2004, compared to 12.7% in the first quarter of 2003. Selling, general and administrative expenses in the first quarter of 2004 included severance costs of approximately $559,000, and did not include accruals for incentive compensation. Selling, general and administrative expenses in the first quarter of 2003 included approximately $279,000 of severance costs and $654,000 of accrued incentive compensation.
Interest expense decreased to $138,000 in the first quarter of 2004 compared to $321,000 for the first quarter of 2003. The decrease in interest expense was primarily due to lower debt levels and lower interest rates in 2004 compared to 2003.
Income tax expense decreased to $1,255,000 in the first quarter of 2004, compared to $1,601,000 in the first quarter of 2003. The decrease in income tax expense was primarily due to the decrease in income before taxes partially offset by a higher effective income tax rate. The Company’s effective tax rate for the first quarter of 2004 was 36.0%, compared to 34.0% in the first quarter of 2003, the difference primarily attributed to higher research and development tax credits in 2003. Cash expended to pay income taxes increased to $93,000 in the first quarter of 2004, compared to $16,000 in the first quarter of 2003.
Net income for the first quarter of 2004 was $2,231,000, or $0.22 diluted earnings per share, compared to $3,108,000, or $0.31 diluted earnings per share in the first quarter of 2003.
Financial Condition
Liquidity and Capital Resources
Net cash used in operating activities for the first quarter of 2004 was $5,296,000, compared to $5,986,000 of net cash provided by operating activities in the first quarter of 2003. Major elements of the net cash used in operating activities for the first quarter of 2004 included a $5,077,000 increase in inventory primarily due to a reduction in progress payments from customers and delays in shipments, a $3,473,000 increase in accounts receivable due to timing of shipments and billings to customers, a decrease in accrued and other liabilities of $3,735,000, due mainly to payment of accrued bonuses, partially offset by $2,231,000 of net income, $1,877,000 of depreciation, a $1,138,000 increase in accounts payable due to timing of payments of vendors invoices and a net increase of $1,796,000 in the provision for cost overruns.
Net cash used in investing activities for the first quarter of 2004 consisted primarily of $1,893,000 of capital expenditures.
Net cash from financing activities in the first quarter of 2004 of $3,461,000 included $3,000,000 of net borrowings by the Company and $461,000 of net cash received from the exercise of common stock options.
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The Company continues to depend on operating cash flow and the availability of its bank line of credit to provide short-term liquidity. Cash from operations and bank borrowing capacity are expected to provide sufficient liquidity to meet the Company’s obligations during 2004. In December 2002, the Company and its lenders amended the Company’s credit agreement. The amended credit agreement provides for a $75,000,000 unsecured revolving credit line gradually declining to $60,000,000 at maturity on September 30, 2005. Interest is payable monthly on the outstanding borrowings based on the bank’s prime rate plus a spread based on the leverage ratio of the Company calculated at the end of each fiscal quarter (4.25% at April 3, 2004). A Eurodollar pricing option is also available to the Company for terms of up to six months at the Eurodollar rate plus a spread based on the leverage ratio of the Company calculated at the end of each fiscal quarter (2.60% at April 3, 2004). At April 3, 2004, the Company had $70,578,000 of unused lines of credit, after deducting $3,000,000 of loans outstanding and $1,422,000 for outstanding standby letters of credit. The credit agreement includes minimum interest coverage, maximum leverage, minimum EBITDA (earnings before interest, taxes, depreciation and amortization) and minimum net worth covenants, an unused commitment fee based on the leverage ratio (0.40% per annum at April 3, 2004), and limitations on future dispositions of property, repurchases of common stock, outside indebtedness, capital expenditures and acquisitions.
The weighted average interest rate on borrowings outstanding was 4.32% and 5.69% at April 3, 2004 and December 31, 2003, respectively.
The carrying amount of long-term debt approximates fair value based on the terms of the related debt, recent transactions and estimates using interest rates currently available to the Company for debt with similar terms and remaining maturities.
Aggregate maturities of long-term debt during the next five years are as follows: 2005, $3,400,000; 2006, $0; 2007, $0; 2008, $0.
Certain hourly employees at one location of the Company are covered by a defined benefit plan. Pension plan benefits are generally determined on the basis of the retiree’s age and length of service. Assets of the defined benefit plan are composed primarily of fixed income and equity securities. On December 31, 2003, the Company’s annual measurement date, the accumulated benefit obligation, related to the Company’s defined benefit plan, exceeded the fair value of the pension plan assets. Such excess is referred to as an unfunded accumulated benefit obligation. In accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions,” the Company recognized minimum pension liability of $2,041,000, net of tax, which decreased shareholders’ equity and is included in other long-term liabilities at April 3, 2004 and December 31, 2003. Pension expense will be approximately $562,000 in 2004. The Company was not required to make any contributions to the pension plan in 2003, but plans to contribute as much as $1,300,000 in 2004.
The Company expects to spend less than $10,000,000 for capital expenditures in 2004. The Company believes that the ongoing subcontractor consolidation makes acquisitions an increasingly important component of the Company’s future growth. Accordingly, the Company plans to continue to seek attractive acquisition opportunities and to make substantial capital expenditures for manufacturing equipment and facilities to support long-term contracts for both commercial and military aircraft and space programs.
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The Company has made guarantees and indemnities under which it may be required to make payments to a guaranteed or indemnified party, in relation to certain transactions, including revenue transactions in the ordinary course of business. In connection with certain facility leases the Company has indemnified its lessors for certain claims arising from the facility or the lease. The Company indemnifies its directors and officers to the maximum extent permitted under the laws of the State of Delaware. However, the Company has a directors and officers insurance policy that may reduce its exposure in certain circumstances and may enable it 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 the Company could be obligated to make. Historically, payments related to these guarantees and indemnities have been immaterial. The Company estimates the fair value of its indemnification obligations as insignificant based on this history and insurance coverage and has, therefore, not recorded any liability for these guarantees and indemnities in the accompanying consolidated balance sheets. However, there can be no assurances that the Company will not have any future financial exposure under these indemnification obligations.
As of April 3, 2004 the Company had the following categories of contractual obligations (in thousands):
| Payments due by period | |||||||||||||||
Contractual Obligations | Total | Less than 1 year | 1 - 3 years | 3 - 5 years | More than 5 years | ||||||||||
Long-term debt | $ | 5,585 | $ | 2,185 | $ | 3,400 | $ | — | $ | — | |||||
Operating leases | 7,402 | 2,152 | 2,290 | 1,497 | 1,463 | ||||||||||
Other long-term liabilities | 2,041 | 1,306 | 735 | — | — | ||||||||||
Total | $ | 15,028 | $ | 5,643 | $ | 6,425 | $ | 1,497 | $ | 1,463 | |||||
The DAS facility located in El Mirage, California has been directed by California environmental agencies to investigate and take corrective action for groundwater contamination. Based upon currently available information, the Company has established a provision for the cost of such investigation and corrective action. DAS expects to spend approximately $1 million for future investigation and corrective action for groundwater contamination at its El Mirage location. However, the Company’s ultimate liability in connection with the contamination will depend upon a number of factors, including changes in existing laws and regulations, and the design and cost of the construction, operation and maintenance of the corrective action.
The Company’s subsidiary, Composite Structures, LLC (“Composite”), and several other companies have been ordered by a California environmental agency to investigate and clean up soil and groundwater contamination at its Monrovia, California facility. Composite has filed a petition for review of the order.
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In the normal course of business, Ducommun and its subsidiaries are defendants in certain other litigation, claims and inquiries, including matters relating to environmental laws. In addition, the Company makes various commitments and incurs contingent liabilities. While it is not feasible to predict the outcome of these matters, the Company does not presently expect that any sum it may be required to pay in connection with these matters would have a material adverse effect on its consolidated financial position, results of operations or cash flows.
Off-Balance Arrangements
The Company’s off-balance sheet arrangements consist of operating leases and capital commitments as described above.
Recent Accounting Pronouncements
In January 2003, FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN No. 46”), was issued. This Interpretation, as revised in December 2003, requires an investor with a majority of the variable interests (primary beneficiary) in a variable interest entity (“VIE”) to consolidate the entity. It also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling interest, or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from other parties. The adoption of FIN No. 46 in 2004 did not have any impact on the Company’s financial position, results of operations or cash flows.
Additional Risk Factors
The Company’s business, financial condition, results of operations and cash flows may be affected by known and unknown risks, uncertainties and other factors. Any of these risks, uncertainties and other factors could cause the Company’s future financial results to differ materially from recent financial results or from currently anticipated future financial results. In addition to those noted elsewhere in this report, the Company is subject to the following risks and uncertainties:
Aerospace Markets Are Cyclical
The aerospace markets in which the Company sells its products are cyclical and have experienced periodic declines. The market for the Company’s products sold for new commercial aircraft production is currently experiencing a decline, the depth and duration of which is unknown. The Company’s sales are, therefore, unpredictable and tend to fluctuate based on a number of factors, including economic conditions and developments affecting the aerospace industry and the customers served. If the current downturn in commercial aircraft production were to continue for an extended period or if conditions in the commercial aircraft market were to worsen, the negative impact on the Company’s business, financial condition and operating results could be further exacerbated.
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Commercial Aircraft Production Rates Are Declining
The Company estimates that, in the first quarter of 2004, approximately 20% of its sales were for Boeing commercial aircraft and approximately 15% of its sales were for other commercial aircraft and miscellaneous nonaerospace commercial applications. The production rate for new commercial aircraft is expected to decline at least through 2004, and the timing of any rebound in new commercial aircraft production is unknown. These reductions in commercial aircraft production are expected to affect adversely the Company’s result of operations and cash flows.
Military and Space-Related Products Are Dependent Upon Government Spending
The Company estimates that, in the first quarter of 2004, approximately 65% of its sales were derived from military and space markets. These military and space markets are largely dependent upon government spending, particularly by the United States government. Changes in the levels of spending for military and space could improve or negatively impact the Company’s prospects in its military and space markets. The tragedy involving the Space Shuttle Columbia may further affect government spending for space programs, which could adversely affect the Company.
The Company Is Dependent on Boeing Commercial Aircraft, the C-17 Aircraft and Apache Helicopter Programs
The Company estimates that, in the first quarter of 2004, approximately 20% of its sales were for Boeing commercial aircraft, 13% of its sales were for the C-17 aircraft, and 18% of its sales were for the Apache helicopter. The Company’s sales for Boeing commercial aircraft and the C-17 aircraft are principally for new aircraft production; and the Company’s sales for the Apache helicopter program are principally for replacement rotor blades. Any significant change in production rates for these programs would have a material effect on the Company’s results of operations and cash flows. In addition, there is no guarantee that the Company’s current significant customers will continue to buy products from the Company at current levels. The loss of a key customer could have a material adverse effect on the Company. For example, the Company manufactures the spoilers for the Boeing 737NG aircraft (the “737 Spoilers”), which contributed approximately $12,062,000 to sales in 2003. The Company has been informed that a competitor has been awarded a contract to produce the 737 Spoilers. Although the precise timing and amount of any transition of work to the competitor is presently unknown, such a transition of work may occur as early as late 2004.
Terrorist Attacks, Such As Those That Occurred on September 11, 2001, Have Adversely Impacted the Company’s Operations and May Do So Again in the Future
The terrorist attacks that occurred on September 11, 2001 have had a negative impact on commercial air travel and, consequently, on the manufacture of commercial aircraft and the demand for the Company’s commercial aircraft products. There can be no assurance that the current world political and military tensions, or the United States military actions, will not lead to further acts of terrorism and civil
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disturbances in the United States or elsewhere. These attacks may strike directly at the physical facilities of the Company, its suppliers or its customers. Such attacks could have an adverse impact on the Company’s domestic and international sales, supply chain, production capabilities, insurance premiums or ability to purchase insurance, thereby adversely affecting the Company’s financial position, results of operations and cash flows. In addition, the consequences of terrorist attacks and armed conflicts are unpredictable, and their long-term effects upon the Company are uncertain.
The Company Is Experiencing Competitive Pricing Pressures
The aerospace industry is highly competitive and competitive pressures may adversely affect the Company. The Company competes worldwide with a number of United States and international companies that are larger than it in terms of resources and market share. The Company is experiencing competitive pricing pressures, particularly in its Ducommun AeroStructures business. These competitive pricing pressures have had, and are expected to continue to have, a material adverse effect on the Company’s business, financial condition and operating results.
The Company Faces Risks of Cost Overruns and Losses on Fixed-Price Contracts
The Company sells its products under firm, fixed-price contracts providing for a fixed price for the products regardless of the production costs incurred by the Company. As a result, mistakes in bidding on contracts, underestimation of the scope of work required under contracts, manufacturing inefficiencies and start-up costs and other factors may result in cost overruns and losses on contracts. The cost of producing products also may be adversely affected by increases in the cost of labor, materials, outside processing, overhead and other factors. In many cases, the Company makes multiyear firm, fixed-price commitments to its customers, without assurance that the Company’s anticipated production costs will be achieved.
As discussed above, in the first quarter of 2004, the Company established a provision of $1,894,000 for estimated cost overruns on certain of the new contracts at Ducommun AeroStructures. The provision for estimated cost overruns is based on currently available information and various assumptions, including customers’ future production rates and delivery schedules and the Company’s future cost structure and learning curve assumptions. The Company could incur additional losses or be required to establish additional provisions for cost overruns if actual results should differ from the estimates under these assumptions.
The Company’s Products and Processes Are Subject to Risks from Changes in Technology
The Company’s products and processes are subject to risks of obsolescence as a result of changes in technology. To address this risk, the Company invests in product design and development, and for capital expenditures. There can be no guarantee that the Company’s product design and development efforts will be successful, or that the amounts of money required to be invested for product design and development and capital expenditures will not increase materially in the future.
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The Company Faces Risks Associated with Acquisitions and Dispositions of Businesses
A key element of the Company’s long-term strategy has been growth through acquisitions. The Company is continuously reviewing and actively pursuing acquisitions, including acquisitions outside of its current aerospace markets. Acquisitions may require the Company to incur additional indebtedness, resulting in increased leverage. Any significant acquisition may result in a material weakening of the Company’s financial position and a material increase in the Company’s cost of borrowings. Acquisitions also may require the Company to issue additional equity, resulting in dilution to existing stockholders. This additional financing for acquisitions and capital expenditures may not be available on terms acceptable or favorable to the Company. Acquired businesses may not achieve anticipated results, and could result in a material adverse effect on the Company’s financial condition, results of operations and cash flows. The Company also periodically reviews its existing businesses to determine if they are consistent with the Company’s strategy. The Company has sold, and may sell in the future, business units and product lines, which may result in either a gain or loss on disposition.
The Company’s acquisition strategy exposes it to risks, including the risk that the Company may not be able to successfully integrate acquired businesses. The Company’s ability to grow by acquisition is dependent upon, among other factors, the availability of suitable acquisition candidates. Growth by acquisition involves risks that could have a material adverse affect on the Company’s business, financial condition and operating results, including difficulties in integrating the operations and personnel of acquired companies, the potential amortization of acquired intangible assets, the potential impairment of goodwill and the potential loss of key employees of acquired companies. The Company may not be able to consummate acquisitions on satisfactory terms or, if any acquisitions are consummated, to satisfactorily integrate these acquired businesses.
Goodwill Could Be Impaired in the Future
In assessing the recoverability of the Company’s goodwill at December 31, 2003, management was required to make certain critical estimates and assumptions. These estimates and assumptions, with respect to the Company’s Ducommun AeroStructures, Inc. (“DAS”), reporting unit, included that during the next several years DAS will make improvements in manufacturing efficiency, achieve reductions in operating costs, and obtain increases in sales and backlog. If any of these or other estimates and assumptions are not realized in the future, the Company may be required to record an impairment charge for the goodwill of DAS. The goodwill of DAS was $36,785,000 at April 3, 2004.
Significant Consolidation in the Aerospace Industry Could Adversely Affect the Company’s Business and Financial Results
The aerospace industry is experiencing significant consolidation, including among the Company’s customers, competitors and suppliers. Consolidation among the Company’s customers may result in delays in the award of new contracts and losses of existing business. Consolidation among the Company’s competitors may result in larger competitors with greater resources and market share, which could adversely affect the Company’s ability to compete successfully. Consolidation among the Company’s suppliers may result in fewer sources of supply and increased cost to the Company.
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The Company’s Manufacturing Operations May Be Adversely Affected by the Availability of Raw Materials and Components from Suppliers
In some cases, the Company’s customers supply raw materials and components to the Company. In other cases, the Company’s customers designate specific suppliers from which the Company is directed to purchase raw materials and components. As a result, the Company may have limited control over the selection of suppliers and the timing of receipt and cost of raw materials and components from suppliers. The failure of customers and suppliers to deliver on a timely basis raw materials and components to the Company may adversely affect the Company’s results of operations and cash flows.
Environmental Liabilities Could Adversely Affect the Company’s Financial Results
The Company is subject to various environmental laws and regulations. The Company is investigating and taking corrective action for groundwater contamination at its DAS subsidiary’s El Mirage, California site. The Company is also a potentially responsible party at certain sites at which it previously disposed of hazardous wastes. There can be no assurance that future developments, lawsuits and administrative actions, and liabilities relating to environmental matters will not have a material adverse effect on the Company’s results of operations or cash flows.
The DAS chemical milling business uses various acid and alkaline solutions in the chemical milling process, resulting in potential environmental hazards. Despite existing waste recovery systems and continuing capital expenditures for waste reduction and management, at least for the immediate future, this business will remain dependent on the availability and cost of remote hazardous waste disposal sites or other alternative methods of disposal.
The DAS facility located in El Mirage, California has been directed by California environmental agencies to investigate and take corrective action for groundwater contamination. Based upon currently available information, the Company has established a provision for the cost of such investigation and corrective action. DAS expects to spend approximately $1 million for future investigation and corrective action for groundwater contamination at its El Mirage location. However, the Company’s ultimate liability in connection with the contamination will depend upon a number of factors, including changes in existing laws and regulations, and the design and cost of the construction, operation and maintenance of the corrective action.
The Company’s subsidiary, Composite Structures, LLC (“Composite”), and several other companies have been ordered by a California environmental agency to investigate and clean up soil and groundwater contamination at its Monrovia, California facility. Composite has filed a petition for review of the order.
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Product Liability Claims in Excess of Insurance Could Adversely Affect the Company’s Financial Results and Financial Condition
The Company faces potential liability for personal injury or death as a result of the failure of products designed or manufactured by the Company. Although the Company maintains product liability insurance, any material product liability not covered by insurance could have a material adverse effect on the Company’s financial condition, results of operations and cash flows.
Damage or Destruction of the Company’s Facilities Caused by Earthquake or Other Causes Could Adversely Affect the Company’s Financial Results and Financial Condition
Although the Company maintains standard property casualty insurance covering its properties, the Company does not carry any earthquake insurance because of the cost of such insurance. Most of the Company’s properties are located in Southern California, an area subject to frequent and sometimes severe earthquake activity. Even if covered by insurance, any significant damage or destruction of the Company’s facilities could result in the inability to meet customer delivery schedules and may result in the loss of customers and significant additional costs to the Company. As a result, any significant damage or destruction of the Company’s properties could have a material adverse effect on the Company’s business, financial condition or results of operations.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 4. Controls and Procedures
The Company’s chief executive officer and chief financial officer have concluded, based on an evaluation of the Company’s disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(c)), that such disclosure controls and procedures were effective as of the end of the period covered by this report. No change in the Company’s internal control over financial reporting occurred during the period covered by this report that has materially affected, or is reasonable likely to materially affect, the Company’s internal control over financial reporting.
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Item 6. Exhibits and Reports on Form 8-K.
| (a) | Exhibits |
3 Bylaws as amended and restated on March 25, 2004.
11 Reconciliation of the Numerators and Denominators of the Basic and Diluted Earnings Per Share Computations.
31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002.
31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002.
32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002.
| (b) | The Company filed a report on Form 8-K, dated March 3, 2004 reporting under Item 12 that the Company issued a press release dated March 1, 2004 regarding fourth quarter and year ended December 31, 2003 results. |
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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.
DUCOMMUN INCORPORATED | ||
| (Registrant) | ||
By: | /s/ James S. Heiser | |
James S. Heiser | ||
Vice President, Chief Financial Officer | ||
And General Counsel | ||
(Duly Authorized Officer of the Registrant) | ||
By: | /s/ Samuel D. Williams | |
Samuel D. Williams | ||
Vice President and Controller | ||
(Chief Accounting Officer of the Registrant) | ||
Date: May 10, 2004
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