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Ducommun(DCO) - 2021 Q4 - Annual Report

Part I Business Ducommun Incorporated provides engineering and manufacturing services for high-performance products, primarily serving the aerospace and defense industries General and Acquisitions Ducommun operates through Electronic Systems and Structural Systems segments, with acquisitions like MagSeal being a key growth strategy - Ducommun operates through two primary business segments: Electronic Systems and Structural Systems, providing solutions for aerospace, defense, and industrial markets1821 - On December 16, 2021, the company acquired Magnetic Seal LLC (MagSeal) for $69.5 million, net of cash acquired, to enhance its engineered product offerings within the Structural Systems segment20 Products and Services The company's Electronic Systems segment offers high-reliability electronic products, while Structural Systems manufactures complex aerostructure components - Electronic Systems provides a range of products including complex cable assemblies, printed circuit board assemblies, electromechanical systems, and engineered products like switches, filters, and motors for motion control2225 - Structural Systems manufactures large, complex contoured aerostructure components and assemblies from materials like aluminum, titanium, and Inconel, as well as composite and metal bonded structures27 End-Use Markets Overview In 2021, 94% of Ducommun's revenue derived from aerospace and defense markets, with commercial aerospace recovering and defense spending influenced by government budgets 2021 Revenue by End-Use Market | End-Use Market | Percentage of 2021 Net Revenues | | :------------- | :------------------------------ | | Military and Space | 70% | | Commercial Aerospace | 24% | | Industrial | 6% | - The commercial aerospace market is recovering from the COVID-19 pandemic, with Boeing projecting a return to 2019 air travel levels between 2023 and 20242932 - The defense market is subject to U.S. government defense spending levels, with the FY 2022 NDAA authorizing approximately $25 billion more than the President's budget request, though future appropriations remain uncertain33 Sales, Marketing, and Major Customers Sales are tied to aircraft production and defense programs, with the top 10 customers accounting for 61% of 2021 net revenues Net Revenues by Major Customer (as % of Total) | Customer | 2021 | 2020 | | :-------------------------- | :------ | :------ | | Raytheon Technologies Corp. | 24.4% | 20.9% | | The Boeing Company | 7.8% | 10.5% | | Northrop Grumman Corp. | 7.1% | 9.1% | | Lockheed Martin Corp. | 4.4% | 5.0% | | Top 10 Customers (Total) | 61.1% | 61.1% | Remaining Performance Obligations and Backlog As of December 31, 2021, remaining performance obligations totaled $814.1 million, with backlog increasing to $905.2 million driven by commercial aerospace and industrial markets Backlog Comparison (Year-End) | Metric | Dec 31, 2021 | Dec 31, 2020 | | :-------------------------- | :---------------- | :---------------- | | Remaining Performance Obligations | $814.1 million | Not Provided | | Total Backlog | $905.2 million | $807.7 million | - The increase in backlog from 2020 to 2021 was primarily driven by the commercial aerospace and industrial end-use markets54 Human Capital As of December 31, 2021, Ducommun employed 2,480 people, focusing on safety, diversity, and talent retention through competitive compensation and benefits - The company had 2,480 employees as of December 31, 2021, with 465 subject to collective bargaining agreements62 - Key human capital initiatives include promoting diversity and inclusion, ensuring employee safety (highlighted by COVID-19 response), and talent retention through competitive compensation and an Employee Stock Purchase Plan (ESPP)585960 Risk Factors The company faces significant risks related to its capital structure, business operations, regulatory environment, and general market conditions Capital Structure Risks Ducommun's $287.7 million in outstanding debt limits financing options and operational flexibility, with variable interest rates partially mitigated by forward interest rate swaps - As of December 31, 2021, the company had $287.7 million of outstanding long-term debt under its Credit Facilities, primarily resulting from past acquisitions67 - The debt level could limit the ability to obtain additional financing, require cash flow to be dedicated to debt service, and restrict strategic acquisitions70 - The company entered into forward interest rate swaps for an aggregate notional amount of $150.0 million, effective January 1, 2024, to mitigate risk from rising interest rates on its variable-rate debt7586 Business and Operational Risks Ducommun's business is vulnerable to cyclical markets, high customer concentration, U.S. government defense spending fluctuations, and challenges in integrating acquisitions - The company has high customer concentration, with its top ten customers representing 61% of total 2021 net revenues95 - A significant portion of business depends on U.S. Government defense spending, making the company vulnerable to changes in government appropriations, national defense policies, and budgetary constraints98101 - The growth strategy includes acquisitions, which entail risks such as integration difficulties, loss of key employees or customers, and failure to achieve anticipated synergies110111 - The company faces risks associated with its international manufacturing facilities in Thailand and Mexico, including political instability, pandemics, and trade restrictions116 Legal, Regulatory, Tax, and Accounting Risks The company is subject to extensive government regulation, environmental liabilities, product liability claims, and potential impairment of its $345.5 million in goodwill and intangible assets - Business with the U.S. Government is subject to extensive regulation and audit, with non-compliance potentially leading to severe penalties including contract termination and suspension from future business126129 - The company faces environmental liabilities for groundwater contamination at certain California sites and has accrued for these potential costs134136 - Goodwill and other intangible assets totaled $345.5 million (35% of total assets) as of December 31, 2021, which are subject to impairment risk if business performance declines143 General Risks The COVID-19 pandemic continues to adversely affect the business, particularly commercial aerospace, while the company also faces cybersecurity threats and natural disaster risks in Southern California - The COVID-19 pandemic continues to have a material adverse effect on business, results of operations, and financial condition, with the commercial aerospace industry being significantly disrupted153155 - The company is exposed to risks from cybersecurity attacks and system failures that could disrupt business, cause data loss, and damage its reputation161 - A significant portion of operations are located in Southern California, an area subject to earthquake activity, and the company does not carry earthquake insurance165 Unresolved Staff Comments The company reports no unresolved staff comments from the SEC - None166 Properties The company's headquarters are in Santa Ana, California, with various owned and leased facilities deemed suitable for current operations - Headquarters are located in Santa Ana, California, with additional owned and leased facilities in the U.S. and abroad167 Legal Proceedings Information regarding the company's legal proceedings is provided in Note 14 to the consolidated financial statements - Details on legal proceedings are available in Note 14 of the consolidated financial statements168 Mine Safety Disclosures This item is not applicable to the company - Not applicable170 Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Ducommun's common stock trades on the NYSE under DCO, with 144 holders of record as of December 31, 2021, and no dividends paid since Q1 2011 - Common stock is listed on the NYSE under the symbol DCO173 - The company has not paid dividends since Q1 2011 and does not expect to in the foreseeable future173 Management's Discussion and Analysis of Financial Condition and Results of Operations In 2021, Ducommun's net revenues increased to $645.4 million, with net income surging to $135.5 million primarily due to a $132.5 million sale-leaseback gain, maintaining strong liquidity Results of Operations For 2021, net revenues increased by 2.6% to $645.4 million, driven by military and space sales, while net income surged to $135.5 million due to a significant sale-leaseback gain Key Financial Results (2021 vs. 2020) | Metric | 2021 | 2020 | | :------------------------- | :---------------- | :---------------- | | Net Revenues | $645.4 million | $628.9 million | | Gross Profit | $142.5 million | $137.7 million | | Operating Income | $48.9 million | $45.5 million | | Net Income | $135.5 million | $29.2 million | | Diluted Earnings Per Share | $11.06 | $2.45 | - The year-over-year revenue increase was primarily due to $31.0 million higher revenues in military and space markets, partially offset by a $12.4 million decrease in commercial aerospace markets192194 - The significant increase in net income was primarily driven by a $132.5 million gain on a sale-leaseback transaction201210 Business Segment Performance In 2021, Electronic Systems revenue grew 5.1% to $412.6 million due to military and space sales, while Structural Systems revenue declined 1.5% to $232.8 million despite increased operating income Segment Net Revenues (2021 vs. 2020) | Segment | 2021 | 2020 | % Change | | :----------------- | :---------------- | :---------------- | :------- | | Electronic Systems | $412.6 million | $392.6 million | +5.1% | | Structural Systems | $232.8 million | $236.3 million | -1.5% | Segment Operating Income (2021 vs. 2020) | Segment | 2021 | 2020 | | :----------------- | :---------------- | :---------------- | | Electronic Systems | $57.6 million | $51.9 million | | Structural Systems | $20.2 million | $19.6 million | - Electronic Systems' revenue growth was driven by a $19.2 million increase in military and space end-use markets215 - Structural Systems' revenue decline was due to a $15.3 million drop in commercial aerospace, partially offset by an $11.8 million increase in military and space217 Liquidity and Capital Resources As of December 31, 2021, liquidity was strong with $76.3 million in cash and $99.8 million available credit, supported by a $143.1 million sale-leaseback transaction that reduced total debt to $287.7 million Liquidity Position (as of Dec 31) | Metric | 2021 | 2020 | | :------------------------- | :---------------- | :---------------- | | Total Debt | $287.7 million | $320.6 million | | Cash and Cash Equivalents | $76.3 million | $56.5 million | | Unused Revolving Credit Facility | $99.8 million | $74.8 million | - In December 2021, the company completed a sale-leaseback transaction for its Gardena, CA facility, generating proceeds of $143.1 million74225 - Net cash used in operating activities was $0.6 million in 2021, compared to net cash provided by operating activities of $12.6 million in 2020, with the decrease primarily due to higher contract assets and inventories227 Critical Accounting Policies and Estimates Management identifies revenue recognition, business combinations, and goodwill impairment as critical accounting policies requiring significant judgment and estimates - Revenue Recognition: The majority of revenue is recognized over time using a cost-to-cost input measure, which requires significant estimates regarding labor, materials, and subcontractor performance231233 - Business Combinations: The company uses significant judgment and estimates, including valuation specialists, to allocate purchase prices to assets and liabilities at fair value, particularly for intangible assets like customer relationships234325 - Goodwill Impairment: Goodwill is tested annually for impairment using either a qualitative or quantitative approach, with the quantitative test relying on assumptions about future revenues, margins, and discount rates to estimate fair value237326 Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate changes on its $287.7 million variable-rate debt tied to LIBOR, with the planned LIBOR cessation posing a potential impact on borrowing costs - The main market risk is interest rate changes on its $287.7 million in outstanding long-term debt, which bears interest at variable rates based on LIBOR244 - The company acknowledges the risk associated with the planned phase-out of LIBOR, which could impact future borrowing costs85244 Controls and Procedures Management, including the CEO and CFO, concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2021 - The CEO and CFO concluded that disclosure controls and procedures were effective at a reasonable assurance level as of December 31, 2021247 - Management concluded that the company maintained effective internal control over financial reporting as of December 31, 2021, based on the COSO framework248 Part III Directors, Executive Officers and Corporate Governance Information regarding the company's directors, executive officers, audit committee, and code of business conduct is incorporated by reference from the 2022 Proxy Statement - Required information is incorporated by reference from the 2022 Proxy Statement253254257 Executive Compensation Information regarding executive and director compensation is incorporated by reference from the company's 2022 Proxy Statement - Required information is incorporated by reference from the 2022 Proxy Statement259 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information on security ownership is incorporated by reference from the 2022 Proxy Statement, with a table detailing securities authorized for issuance under equity compensation plans Securities Authorized for Issuance under Equity Compensation Plans | Plan Category | Securities to be Issued Upon Exercise (a) | Weighted-Average Exercise Price (b) | Securities Remaining for Future Issuance (c) | | :---------------------------------------- | :---------------------------------------- | :---------------------------------- | :------------------------------------------- | | Equity Plans Approved by Security Holders | 819,624 | $35.30 | 113,579 | | Employee Stock Purchase Plan | — | — | 609,670 | | Total | 819,624 | N/A | 723,249 | Certain Relationships and Related Transactions, and Director Independence Information regarding certain relationships, related transactions, and director independence is incorporated by reference from the company's 2022 Proxy Statement - Required information is incorporated by reference from the 2022 Proxy Statement264 Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the company's 2022 Proxy Statement - Required information is incorporated by reference from the 2022 Proxy Statement265 Part IV Exhibits and Financial Statement Schedules This section lists the financial statements, schedules, and exhibits filed as part of the Form 10-K, including the Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP issued an unqualified opinion on Ducommun's consolidated financial statements and internal control effectiveness, identifying customer relationships valuation as a critical audit matter - The auditor, PricewaterhouseCoopers LLP, issued an unqualified opinion on both the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2021272 - A critical audit matter was identified concerning the valuation of the customer relationships intangible asset acquired in the Magnetic Seal LLC acquisition, due to the significant judgment required for assumptions like future revenue growth, gross margins, customer attrition, and discount rates281282 Form 10-K Summary This item is not applicable - Not applicable470