# DUCOMMUN INC /DE/ (DCO) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from DUCOMMUN INC /DE/'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/30305/000162828022003518/dco-20211231.htm
Accession: 0001628280-22-003518
Filing date: 2022-02-23
Report date: 2021-12-31
Extracted from Item 7 to the first post-MD&A boundary after HTML sanitization.
Confidence: high

Company profile: /company/DCO/
All MD&A years: /company/DCO/mda/
Next year: /company/DCO/mda/fy2022/ (FY 2022)

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Ducommun Incorporated (“Ducommun,” “the Company,” “we,” “us” or “our”) is a leading global provider of engineering and manufacturing services for high-performance products and high-cost-of failure applications used primarily in the aerospace, defense, industrial, medical, and other industries. We differentiate ourselves as a full-service solution-based provider, offering a wide range of value-added products and services in our primary businesses of electronics, structures and integrated solutions. We operate through two primary business segments: Electronic Systems and Structural Systems, each of which is a reportable segment.

COVID-19 Pandemic Impact on Our Business

The COVID-19 pandemic has had a significant impact on our overall business during the year ended December 31, 2021. As a result of the COVID-19 pandemic, precautionary measures were instituted by governments and businesses to mitigate its spread, including the imposition of travel restrictions, quarantines, shelter in place directives, and shutting down of non-essential businesses.

The safety of our employees remains our highest priority. The well-being and safety protocols that were already in place at all of our facilities were further enhanced at the onset of the COVID-19 pandemic. We continue to follow safety protocols consistent with guidelines provided by state and local governments and the Centers for Disease Control and Prevention (“CDC”). These measures included social distancing, provision of personal protective equipment, enhanced cleaning, and flexible work arrangements wherever possible. We have also offered enhanced leave and benefits to our employees and provided frequent updates to ensure our workforce continues to be kept apprised of evolving regulations and safety measures.

In March 2020, the U.S. enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) which provides tax relief to individuals and businesses affected by the coronavirus pandemic. We have not requested or accepted any loans or payments that are available under the CARES Act, however, we have utilized the option to defer payment of the employer portion of payroll taxes (Social Security) that would otherwise be required to be made during the period beginning March 27, 2020 to December 31, 2020. One half of the deferred amount was required to be paid and was paid by December 31, 2021, with the remaining 50% to be paid by December 31, 2022. As of December 31, 2021, our remaining deferred amount is $3.1 million and is included as part of accrued and other liabilities on the consolidated balance sheets.

The COVID-19 pandemic has and continues to contribute to a general slowdown in the global economy and most significantly, the commercial aerospace end-use market. While both major large aircraft manufacturers, The Boeing Company (“Boeing”) and Airbus SE, have announced increases in build rates for 2022, it is well below pre-pandemic levels. In its 2021 Annual Report on Form 10-K, Boeing indicated it expects commercial air travel to return to 2019 levels in 2023 to 2024, and a few years beyond that for the industry to return to the long-term trend growth. While the full extent and impact of the COVID-19 pandemic cannot be reasonably estimated with certainty at this time, COVID-19 has had a significant impact on our business, the businesses of our customers and suppliers, as well as our results of operations and financial condition, and may have a material adverse impact on our business, results of operations and financial condition for 2022 and beyond. See Risk Factors included in Part I, Item 1A of this Annual Report on Form 10-K (“Form 10-K”).

Recap for the year ended December 31, 2021:

•Net revenues of $645.4 million

•Net income of $135.5 million, or $11.06 per diluted share

•Adjusted EBITDA of $92.8 million

Non-GAAP Financial Measures

Adjusted earnings before interest, taxes, depreciation, amortization, stock-based compensation expense, Guaymas fire related expenses, gain on sale-leaseback, success bonus related to the completion of sale-leaseback transaction, inventory purchase accounting adjustments, restructuring charges, loss on extinguishment of debt, and other debt refinancing costs (“Adjusted EBITDA”) was $92.8 million and $87.9 million for years ended December 31, 2021 and December 31, 2020, respectively.

When viewed with our financial results prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and accompanying reconciliations, we believe Adjusted EBITDA provides additional useful information to clarify and enhance the understanding of the factors and trends affecting our past performance and future prospects. We define Adjusted EBITDA, explain how it is calculated, and provide a reconciliation to the most comparable GAAP measure in the table below. Adjusted EBITDA and the related financial ratios, as presented in this Annual Report on

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Form 10-K (“Form 10-K”), are supplemental measures of our performance that are not required by, or presented in accordance with, GAAP. They are not a measurement of our financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as an alternative to net cash provided by operating activities as measures of our liquidity. The presentation of these measures should not be interpreted to mean that our future results will be unaffected by unusual or nonrecurring items.

We use Adjusted EBITDA non-GAAP operating performance measures internally as complementary financial measures to evaluate the performance and trends of our businesses. We also present Adjusted EBITDA and the related financial ratios, as applicable, because we believe that measures such as these provide useful information with respect to our ability to meet our operating commitments.

Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as substitutes for analysis of our results as reported under GAAP. Some of these limitations include:

•It does not reflect our cash expenditures, future requirements for capital expenditures or contractual commitments;

•It does not reflect changes in, or cash requirements for, our working capital needs;

•It does not reflect the significant interest expense or the cash requirements necessary to service interest or principal payments on our debt;

•Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;

•It is not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows;

•It does not reflect the impact on earnings or charges resulting from matters unrelated to our ongoing operations; and

•Other companies in our industry may calculate Adjusted EBITDA differently from us, limiting their usefulness as comparative measures.

As a result of these limitations, Adjusted EBITDA and the related financial ratios should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as a measure of cash that will be available to us to meet our obligations. You should compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only as supplemental information. See our consolidated financial statements contained in this Form 10-K.

Even with the limitations above, we believe that Adjusted EBITDA is useful to an investor in evaluating our results of operations as this measure:

•Is widely used by investors to measure a company’s operating performance without regard to items excluded from the calculation of such terms, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors;

•Helps investors to evaluate and compare the results of our operations from period to period by removing the effect of our capital structure from our operating performance; and

•Is used by our management team for various other purposes in presentations to our Board of Directors as a basis for strategic planning and forecasting.

The following financial items have been added back to or subtracted from our net income when calculating Adjusted EBITDA:

•Interest expense may be useful to investors for determining current cash flow;

•Income tax expense may be useful to investors because it represents the taxes which may be payable for the period and the change in deferred taxes during the period, and may reduce cash flow available for use in our business;

•Depreciation may be useful to investors because it generally represents the wear and tear on our property and equipment used in our operations;

•Amortization expense may be useful to investors because it represents the estimated attrition of our acquired customer base and the diminishing value of product rights;

•Stock-based compensation expense may be useful to our investors for determining current cash flow;

•Guaymas fire related expenses may be useful to our investors in evaluating our core operating performance;

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•Gain on sale-leaseback may be useful to our investors in evaluating our core operating performance;

•Success bonus related to completion of sale-leaseback transaction may be useful to our investors in evaluating our core operating performance;

•Purchase accounting inventory step-ups may be useful to our investors as they do not necessarily reflect the current or on-going cash charges related to our core operating performance;

•Restructuring charges may be useful to our investors in evaluating our core operating performance;

•Loss on extinguishment of debt may be useful to our investors for determining current cash flow; and

•Other debt refinancing costs may be useful to our investors in evaluating our core operating performance.

Reconciliations of net income to Adjusted EBITDA and the presentation of Adjusted EBITDA as a percentage of net revenues were as follows:

[[GREPCENT_TABLE]]
[["","","(Dollars in thousands) Years Ended December 31,"],["","","2021","","2020","","2019"],["Net income","","$","135,536","","","$","29,174","","","$","32,461"],["Interest expense","","11,187","","","13,653","","","18,290"],["Income tax expense","","34,948","","","2,807","","","5,302"],["Depreciation","","14,051","","","13,824","","","13,519"],["Amortization","","14,338","","","15,026","","","14,786"],["Stock-based compensation expense","","11,212","","","9,299","","","7,161"],["Guaymas fire related expenses","","2,486","","","1,704","","","\u2014"],["Gain on sale-leaseback","","(132,522)","","","\u2014","","","\u2014"],["Success bonus related to completion of sale-leaseback transaction (1)","","1,451","","","\u2014","","","\u2014"],["Inventory purchase accounting adjustments (2)","","106","","","\u2014","","","511"],["Restructuring charges","","\u2014","","","2,424","","","\u2014"],["Loss on extinguishment of debt","","\u2014","","","\u2014","","","180"],["Other debt refinancing costs","","\u2014","","","\u2014","","","77"],["Adjusted EBITDA","","$","92,793","","","$","87,911","","","$","92,287"],["% of net revenues","","14.4","%","","14.0","%","","12.8","%"]]
[[/GREPCENT_TABLE]]

(1)2021 included $1.3 million of success bonus related to the completion of the sale-leaseback transaction that was recorded as part of cost of sales.

(2)2021 and 2019 included inventory purchase accounting adjustments of inventory that was stepped up as part of our purchase price allocation from our acquisitions of Magnetic Seal LLC (f/k/a Magnetic Seal Corporation, “MagSeal”) and Nobles Worldwide, Inc. (“Nobles”) on December 16, 2021 and in October 2019, respectively, and both are a part of our Structural Systems operating segment.

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RESULTS OF OPERATIONS

2021 Compared to 2020

The following table sets forth net revenues, selected financial data, the effective tax rate and diluted earnings per share:

[[GREPCENT_TABLE]]
[["","","(Dollars in thousands, except per share data) Years Ended December 31,"],["","","2021","","% of Net Revenues","","2020","","% of Net Revenues"],["Net Revenues","","$","645,413","","","100.0","%","","$","628,941","","","100.0","%"],["Cost of Sales","","502,953","","","77.9","%","","491,203","","","78.1","%"],["Gross Profit","","142,460","","","22.1","%","","137,738","","","21.9","%"],["Selling, General and Administrative Expenses","","93,579","","","14.5","%","","89,808","","","14.3","%"],["Restructuring Charges","","\u2014","","","\u2014","%","","2,424","","","0.4","%"],["Operating Income","","48,881","","","7.6","%","","45,506","","","7.2","%"],["Interest Expense","","(11,187)","","","(1.7)","%","","(13,653)","","","(2.1)","%"],["Gain on Sale-Leaseback","","132,522","","","20.5","%","","\u2014","","","\u2014","%"],["Other Income, Net","","268","","","\u2014","%","","128","","","\u2014","%"],["Income Before Taxes","","170,484","","","26.4","%","","31,981","","","5.1","%"],["Income Tax Expense","","34,948","","","nm","","2,807","","","nm"],["Net Income","","$","135,536","","","21.0","%","","$","29,174","","","4.6","%"],["Effective Tax Rate","","20.5","%","","nm","","8.8","%","","nm"],["Diluted Earnings Per Share","","$","11.06","","","nm","","$","2.45","","","nm"]]
[[/GREPCENT_TABLE]]

nm = not meaningful

Net Revenues by End-Use Market and Operating Segment

Net revenues by end-use market and operating segment during 2021 and 2020, respectively, were as follows:

[[GREPCENT_TABLE]]
[["","","","","(Dollars in thousands) Years Ended December 31,","","% of Net Revenues"],["","","Change","","2021","","2020","","2021","","2020"],["Consolidated Ducommun"],["Military and space","","$","30,989","","","$","453,848","","","$","422,859","","","70.3","%","","67.2","%"],["Commercial aerospace","","(12,411)","","","155,731","","","168,142","","","24.1","%","","26.8","%"],["Industrial","","(2,106)","","","35,834","","","37,940","","","5.6","%","","6.0","%"],["Total","","$","16,472","","","$","645,413","","","$","628,941","","","100.0","%","","100.0","%"],["Electronic Systems"],["Military and space","","$","19,235","","","$","327,911","","","$","308,676","","","79.5","%","","78.6","%"],["Commercial aerospace","","2,886","","","48,903","","","46,017","","","11.8","%","","11.7","%"],["Industrial","","(2,106)","","","35,834","","","37,940","","","8.7","%","","9.7","%"],["Total","","$","20,015","","","$","412,648","","","$","392,633","","","100.0","%","","100.0","%"],["Structural Systems"],["Military and space","","$","11,754","","","$","125,937","","","$","114,183","","","54.1","%","","48.3","%"],["Commercial aerospace","","(15,297)","","","106,828","","","122,125","","","45.9","%","","51.7","%"],["Total","","$","(3,543)","","","$","232,765","","","$","236,308","","","100.0","%","","100.0","%"]]
[[/GREPCENT_TABLE]]

Net revenues for 2021 were $645.4 million compared to $628.9 million for 2020. The year-over-year increase was primarily due to the following:

•$31.0 million higher revenues in our military and space end-use markets due to higher build rates on military fixed-wing aircraft platforms and higher build rates on various missile platforms; partially offset by

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•$12.4 million lower revenues in our commercial aerospace end-use markets due to lower build rates on large aircraft platforms.

Net Revenues by Major Customers

A significant portion of our net revenues are from our top ten customers as follows:

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2021","","2020"],["Boeing Company","","7.8","%","","10.5","%"],["Lockheed Martin Corporation","","4.4","%","","5.0","%"],["Northrop Grumman Corporation","","7.1","%","","9.1","%"],["Raytheon Technologies Corporation","","24.4","%","","20.9","%"],["Top ten customers(1)","","61.1","%","","61.1","%"]]
[[/GREPCENT_TABLE]]

(1) Includes The Boeing Company (“Boeing”), Lockheed Martin Corporation (“Lockheed Martin”), Northrop Grumman Corporation (“Northrop”), and Raytheon Technologies Corporation (“Raytheon”).

The revenues from Boeing, Lockheed Martin, Northrop, and Raytheon are diversified over a number of commercial, military and space programs and were generated by both operating segments.

Gross Profit

Gross profit consists of net revenues less cost of sales. Cost of sales includes the cost of production of finished products and other expenses related to inventory management, manufacturing quality, and order fulfillment. Gross profit margin increased to 22.1% in 2021 compared to 21.9% in 2020 primarily due to favorable product mix and lower other manufacturing costs.

Selling, General and Administrative (“SG&A”) Expenses

SG&A expenses increased $3.8 million in 2021 compared to 2020 primarily due to higher professional services fees of $2.2 million, a portion of which was related to the MagSeal acquisition, and higher compensation and benefits costs of $1.6 million.

Restructuring Charges

Restructuring charges decreased $2.4 million in 2021 compared to 2020 primarily due to the 2020 restructuring plan being completed by the end of 2020. See Note 1 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information on restructuring activities.

Interest Expense

Interest expense decreased in 2021 compared to 2020 primarily due to a lower amount of debt outstanding and lower interest rates. See Note 8 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information on our long-term debt.

Gain on Sale-Leaseback

Gain on sale-leaseback increased in 2021 compared to 2020 due to the Gardena performance center located in Carson, California, sale-leaseback transaction we entered into on December 16, 2021. See Note 5 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information on our sale-leaseback transaction.

Income Tax Expense

We recorded an income tax expense of $34.9 million (an effective tax rate of 20.5%) in 2021, compared to $2.8 million (an effective tax rate of 8.8%) in 2020. The increase in the effective tax rate for 2021 compared to 2020 was primarily due to higher pre-tax income for 2021, which included the gain on the sale-leaseback transaction we entered into on December 16, 2021, compared to 2020. The higher pre-tax income in 2021 caused the research and development tax credits to have a lower income tax benefit impact on the effective tax rate. The increase in the effective tax rate was also due to lower discrete income tax benefits recognized from the release of uncertain tax positions in 2021 compared to 2020.

Our unrecognized tax benefits were $4.4 million and $4.1 million in 2021 and 2020, respectively. We record interest and penalty charges, if any, related to uncertain tax positions as a component of tax expense and unrecognized tax benefits. The amounts accrued for interest and penalty charges as of December 31, 2021 and 2020 were not significant. If recognized, $2.6

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million would affect the effective income tax rate. As a result of statute of limitations set to expire in 2022, we expect decreases to our unrecognized tax benefits of approximately $0.7 million in the next twelve months.

We file U.S. Federal and state income tax returns. We are subject to examination by the Internal Revenue Service (“IRS”) for tax years after 2017 and by state taxing authorities for tax years after 2016. While we are no longer subject to examination prior to those periods, carryforwards generated prior to those periods may still be adjusted upon examination by the IRS or state taxing authority if they either have been or will be used in a subsequent period. We believe we have adequately accrued for tax deficiencies or reductions in tax benefits, if any, that could result from the examination and all open audit years.

In March 2020, the U.S. enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) that provided tax relief to individuals and businesses affected by the coronavirus pandemic. We considered the provisions of the CARES Act and determined they do not have a material impact to our overall income taxes. We utilized the option to defer payment of the employer portion of payroll taxes (Social Security) that would otherwise be required to be made during the period beginning March 27, 2020 to December 31, 2020. See COVID-19 Pandemic Impact on Our Business included in Part II, Item 7 of this Form 10-K. As such, as of December 31, 2020, we deferred payment of income tax deductions related to payroll taxes of $6.1 million and recorded the related deferred tax asset of $1.4 million, which was included as part of the net deferred income taxes on the consolidated balance sheet. We were required to and made the payments for 50% of the deferred payroll taxes by December 31, 2021. As of December 31, 2021, the remaining unpaid deferred income tax deductions related to payroll taxes is $3.1 million and the related deferred tax asset of $0.7 million is included as part of the net deferred income taxes on the consolidated balance sheet.

In December 2020, the U.S. enacted the Consolidated Appropriations Act, 2021 (the “Appropriations Act”) that provided additional tax relief to individuals and businesses affected by the coronavirus pandemic. We considered the provisions of the Appropriations Act and determined they do not have a material impact to our overall income taxes.

On March 11, 2021, the U.S. enacted the American Rescue Plan Act of 2021 (“Rescue Plan”). The amendment to Section 162(m) expanding the definition of covered employee to also include the next five highest compensated employees in the limitation will apply to us effective January 1, 2027. We do not expect any tax impacts to be material. We considered other provisions in the Rescue Plan and determined they have no or minimal impact to our overall income taxes.

The Tax Cuts and Jobs Act of 2017 (“TCJA”), which was signed into U.S. law in December 2017, eliminated the option to immediately deduct research and development expenditures in the year incurred under Section 174 effective January 1, 2022. The amended provision under Section 174 requires us to capitalize and amortize these expenditures over five years. Although there is proposed legislation to temporarily reinstate the current deduction of the expenditures after 2021 through 2025, we must consider the changes under the TCJA. If the provision is not deferred, modified, or repealed, with retroactive effect to January 1, 2022, it may result in a material impact on cash from operating activities and the balance of our deferred taxes. The actual impact will depend on if and when this provision is deferred, modified, or repealed by Congress, including if retroactively to January 1, 2022, and the amount of research and development expenditures incurred in 2022. We are monitoring legislation for any further changes to Section 174 and the impact to the financial statements in 2022.

Net Income and Earnings per Diluted Share

Net income and earnings per diluted share for 2021 were $135.5 million, or $11.06 per diluted share, compared to net income and earnings per diluted share for 2020 of $29.2 million, or $2.45 per diluted share. The increase in net income in 2021 compared to 2020 was primarily due to a gain on sale-leaseback of $132.5 million, $4.7 million of higher gross profit as a result of higher revenues, lower interest expense of $2.5 million, and lower restructuring charges of $2.4 million, partially offset by higher income tax expense of $32.1 million and higher SG&A expenses of $3.8 million.

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Business Segment Performance

We report our financial performance based upon the two reportable operating segments: Electronic Systems and Structural Systems. The results of operations differ between our reportable operating segments due to differences in competitors, customers, extent of proprietary deliverables and performance. The following table summarizes our business segment performance for 2021 and 2020:

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[[GREPCENT_TABLE]]
[["","","%","","(Dollars in thousands) Years Ended December 31,","","% of Net Revenues","","% of Net Revenues"],["","","Change","","2021","","2020","","2021","","2020"],["Net Revenues"],["Electronic Systems","","5.1","%","","$","412,648","","","$","392,633","","","63.9","%","","62.4","%"],["Structural Systems","","(1.5)","%","","232,765","","","236,308","","","36.1","%","","37.6","%"],["Total Net Revenues","","2.6","%","","$","645,413","","","$","628,941","","","100.0","%","","100.0","%"],["Segment Operating Income"],["Electronic Systems","","","","$","57,629","","","$","51,894","","","14.0","%","","13.2","%"],["Structural Systems","","","","20,234","","","19,584","","","8.7","%","","8.3","%"],["","","","","77,863","","","71,478"],["Corporate General and Administrative Expenses (1)","","","","(28,982)","","","(25,972)","","","(4.5)","%","","(4.1)","%"],["Total Operating Income","","","","$","48,881","","","$","45,506","","","7.6","%","","7.2","%"],["Adjusted EBITDA"],["Electronic Systems"],["Operating Income","","","","$","57,629","","","$","51,894"],["Other Income","","","","196","","","\u2014"],["Depreciation and Amortization","","","","13,823","","","14,038"],["Restructuring Charges","","","","\u2014","","","596"],["Success Bonus Related to Completion of Sale-Leaseback Transaction (2)","","","","970","","","\u2014"],["","","","","72,618","","","66,528","","","17.6","%","","16.9","%"],["Structural Systems"],["Operating Income","","","","20,234","","","19,584"],["Other Income","","","","72","","","\u2014"],["Depreciation and Amortization","","","","14,331","","","14,559"],["Restructuring Charges","","","","\u2014","","","1,828"],["Inventory Purchase Accounting Adjustments","","","","106","","","\u2014"],["Guaymas Fire Related Expenses","","","","2,486","","","1,704"],["Success Bonus Related to Completion of Sale-Leaseback Transaction (2)","","","","475","","","\u2014"],["","","","","37,704","","","37,675","","","16.2","%","","15.9","%"],["Corporate General and Administrative Expenses (1)"],["Operating Loss","","","","(28,982)","","","(25,972)"],["Other Income","","","","\u2014","","","128"],["Depreciation and Amortization","","","","235","","","253"],["Stock-Based Compensation Expense","","","","11,212","","","9,299"],["Success Bonus Related to Completion of Sale-Leaseback Transaction (2)","","","","6","","","\u2014"],["","","","","(17,529)","","","(16,292)"],["Adjusted EBITDA","","","","$","92,793","","","$","87,911","","","14.4","%","","14.0","%"],["Capital Expenditures"],["Electronic Systems","","","","$","7,471","","","$","5,037"],["Structural Systems","","","","8,463","","","8,570"],["Corporate Administration","","","","\u2014","","","\u2014"],["Total Capital Expenditures","","","","$","15,934","","","$","13,607"]]
[[/GREPCENT_TABLE]]

(1)Includes costs not allocated to either the Electronic Systems or Structural Systems operating segments.

(2)2021 included $1.3 million of success bonus related to the completion of the sale-leaseback transaction that was recorded as part of cost of sales.

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Electronic Systems

Electronic Systems’ net revenues in 2021 compared to 2020 increased $20.0 million primarily due to the following:

•$19.2 million higher revenues in our military and space end-use markets due to higher build rates on military fixed-wing aircraft platforms, partially offset by lower build rates on various missile platforms; and

•$2.9 million higher revenues in our commercial aerospace end-use markets due to higher build rates on other commercial aerospace platforms.

Electronic Systems segment operating income in 2021 compared to 2020 increased $5.7 million primarily due to favorable product mix and lower other manufacturing costs.

Structural Systems

Structural Systems’ net revenues in 2021 compared to 2020 decreased $3.5 million primarily due to the following:

•$15.3 million lower revenues in commercial aerospace end-use markets due to lower build rates on large aircraft platforms; partially offset by

•$11.8 million higher revenues in military and space end-use markets due to higher build rates on various missile platforms.

The Structural Systems operating income in 2021 compared to 2020 increased $0.7 million primarily due to lower other manufacturing costs, partially offset by unfavorable product mix.

In June 2020, a fire severely damaged our performance center in Guaymas, Mexico, which is part of our Structural Systems segment. There were no injuries, however, property and equipment, inventory, and tooling in this leased facility were damaged. We have insurance coverage and expect the majority, if not all, of these items will be covered, less our deductible. The full financial impact cannot be estimated at this time as we are currently working with our insurance carriers to determine the cause of the fire. Our Guaymas performance center is comprised of two buildings with an aggregate total of 62,000 square feet. The loss of production from the Guaymas performance center is being absorbed by our other existing performance centers. See Note 14 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for additional information.

Corporate General and Administrative (“CG&A”) Expenses

CG&A expenses in 2021 compared to 2020 increased $3.0 million primarily due to higher professional services fees of $1.9 million, a portion of which was related to the acquisition of MagSeal, and higher compensation and benefits costs of $1.8 million.

Backlog

We define backlog as customer placed purchase orders (“POs”) and long-term agreements (“LTAs”) with firm fixed price and expected delivery dates of 24 months or less. The majority of the LTAs do not meet the definition of a contract under ASC 606 and thus, the backlog amount disclosed below is greater than the remaining performance obligations amount disclosed in Note 1 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K. Backlog is subject to delivery delays or program cancellations, which are beyond our control. Backlog is affected by timing differences in the placement of customer orders and tends to be concentrated in several programs to a greater extent than our net revenues. Backlog in industrial markets tends to be of a shorter duration and is generally fulfilled within a three month period. As a result of these factors, trends in our overall level of backlog may not be indicative of trends in our future net revenues.

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The increase in backlog was primarily in the commercial aerospace end-use markets and industrial end-use markets. $628.0 million of total backlog is expected to be delivered over the next 12 months. The following table summarizes our backlog for 2021 and 2020:

[[GREPCENT_TABLE]]
[["","","","","(Dollars in thousands) December 31,"],["","","Change","","2021","","2020"],["Consolidated Ducommun"],["Military and space","","$","4,882","","","$","520,278","","","$","515,396"],["Commercial aerospace","","64,781","","","333,107","","","268,326"],["Industrial","","27,783","","","51,802","","","24,019"],["Total","","$","97,446","","","$","905,187","","","$","807,741"],["Electronic Systems"],["Military and space","","$","10,125","","","$","400,002","","","$","389,877"],["Commercial aerospace","","91","","","56,810","","","56,719"],["Industrial","","27,783","","","51,802","","","24,019"],["Total","","$","37,999","","","$","508,614","","","$","470,615"],["Structural Systems"],["Military and space","","$","(5,243)","","","$","120,276","","","$","125,519"],["Commercial aerospace","","64,690","","","276,297","","","211,607"],["Total","","$","59,447","","","$","396,573","","","$","337,126"]]
[[/GREPCENT_TABLE]]

2020 Compared to 2019

See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Annual Report on Form 10-K filed with the SEC on February 11, 2021, which is incorporated by reference herein.

LIQUIDITY AND CAPITAL RESOURCES

Available Liquidity

Total debt, the weighted-average interest rate, cash and cash equivalents and available credit facilities were as follows:

[[GREPCENT_TABLE]]
[["","","(Dollars in millions) December 31,"],["","","2021","","2020"],["Total debt, including long-term portion","","$","287.7","","","$","320.6"],["Weighted-average interest rate on debt","","3.27","%","","3.59","%"],["Term Loans interest rate","","3.22","%","","3.81","%"],["Cash and cash equivalents","","$","76.3","","","$","56.5"],["Unused Revolving Credit Facility","","$","99.8","","","$","74.8"]]
[[/GREPCENT_TABLE]]

In December 2019, we completed the refinancing of a portion of our existing debt by entering into a new revolving credit facility (“2019 Revolving Credit Facility”) to replace the existing revolving credit facility that was entered into in November 2018 (“2018 Revolving Credit Facility”) and entering into a new term loan (“2019 Term Loan”). The 2019 Revolving Credit Facility is a $100.0 million senior secured revolving credit facility that will mature on December 20, 2024 replacing the $100.0 million 2018 Revolving Credit Facility that would have matured on November 21, 2023. The 2019 Term Loan is a $140.0 million senior secured term loan that will mature on December 20, 2024. We also have an existing $240.0 million senior secured term loan that was entered into in November 2018 that will mature on November 21, 2025 (“2018 Term Loan”). The original amounts available under the 2019 Revolving Credit Facility, 2019 Term Loan, and 2018 Term Loan (collectively, the “Credit Facilities”) in aggregate, totaled $480.0 million. We are required to make installment payments of 1.25% of the original outstanding principal balance of the 2019 Term Loan amount on a quarterly basis, on the last day of the calendar quarter and thus, paid $7.0 million during 2021. In addition, if we meet the annual excess cash flow threshold, we are required to make an annual additional principal payment based on the consolidated adjusted leverage ratio. During the first quarter of 2021, we

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made the required 2020 annual excess cash flow payment of $0.9 million. Further, the undrawn portion of the commitment of the 2019 Revolving Credit Facility is subject to a commitment fee ranging from 0.175% to 0.275%, based upon the consolidated total net adjusted leverage ratio. As of December 31, 2021, we were in compliance with all covenants required under the Credit Facilities. See Note 8 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information.

We drew down $50.0 million on the 2019 Revolving Credit Facility during the first quarter of 2020 to hold as cash on hand, $25.0 million of which was repaid during the fourth quarter of 2020 with the remaining $25.0 million repaid during 2021, thus, we made no net aggregate voluntary prepayments during 2021.

In November 2018, we completed credit facilities to replace the then existing credit facilities. The November 2018 credit facilities consisted of the 2018 Term Loan and the 2018 Revolving Credit Facility (collectively, the “2018 Credit Facilities”). We were required to make installment payments of 0.25% of the outstanding principal balance of the 2018 Term Loan amount on a quarterly basis, however, in conjunction with the 2019 refinancing where we paid down $56.0 million on the 2018 Term Loan, it paid all the required quarterly installment payments on the 2018 Term Loan until maturity.

On November 29, 2021, we entered into derivative contracts, U.S. dollar-one month LIBOR forward interest rate swaps designated as cash flow hedges, all with an effective date of January 1, 2024, for an aggregate total notional amount of $150.0 million, weighted average fixed rate of 1.8%, and all terminating on January 1, 2031 (“Forward Interest Rate Swaps”). The Forward Interest Rate Swaps mature on a monthly basis, with fixed amount payer payment dates on the first day of each calendar month, commencing on February 1, 2024 through January 1, 2031. See Note 1 and Note 8 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information.

In October 2015, we entered into interest rate cap hedges designated as cash flow hedges with a portion of these interest rate cap hedges maturing on a quarterly basis, and a final quarterly maturity date of June 2020, in aggregate, totaling $135.0 million of our debt. We paid a total of $1.0 million in connection with entering into the interest rate cap hedges. The interest rate cap hedges matured during our second quarter of 2020 and as such, all remaining amounts related to the interest rate cap hedges were fully amortized and unrealized gains and losses recorded in accumulated other comprehensive income were also realized at that time. See Note 1 and Note 8 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information.

On December 16, 2021, we acquired MagSeal for a purchase price of $69.5 million, net of cash acquired, all payable in cash. Upon the closing of the transaction, we paid a gross total aggregate of $71.3 million in cash, a portion of which was by drawing down on the 2019 Revolving Credit Facility. This draw down on the 2019 Revolving Credit Facility was paid off by December 31, 2021. See Note 2 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information.

In October 2019, we acquired Nobles Parent Inc., the parent company of Nobles Worldwide, Inc. (“Nobles”) for an original purchase price of $77.0 million, net of cash acquired, all payable in cash. Upon the closing of the transaction, we paid a gross total aggregate of $77.3 million in cash by drawing down on the 2018 Revolving Credit Facility.

On December 16, 2021, we entered into a sale-leaseback transaction for the building and related land for our Gardena performance center located in Carson, California (“Sale-Leaseback Agreement”). The building and related land was sold for $143.1 million and we recognized a gain of $132.5 million. As part of the Sale-Leaseback Agreement, we entered into an initial five year lease for the usage of the just sold building and related land. The future minimum base monthly lease payments during the initial five year period in aggregate total $19.6 million. See Note 5 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for further information.

We expect to spend a total of $16.0 million to $18.0 million for capital expenditures in 2022 (excluding capital expenditures we will spend to restore the manufacturing capabilities related to our Guaymas performance center that was severely damaged by fire in June 2020), financed by cash generated from operations, principally to support new contract awards in Electronic Systems and Structural Systems. As part of our strategic plan to become a supplier of higher-level assemblies and win new contract awards, additional up-front investment in tooling will be required for newer programs which have higher engineering content and higher levels of complexity in assemblies. However, some portion of the expected capital expenditures in 2022 could be delayed as a result of the COVID-19 pandemic.

We believe the ongoing aerospace and defense subcontractor consolidation makes acquisitions an increasingly important component of our future growth. We will continue to make prudent acquisitions and capital expenditures for manufacturing equipment and facilities to support long-term contracts for commercial and military aircraft and defense programs.

We continue to depend on operating cash flow and the availability of our Credit Facilities to provide short-term liquidity. Cash generated from operations and bank borrowing capacity is expected to provide sufficient liquidity to meet our obligations during the next twelve months from the date of issuance of these financial statements.

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Cash Flow Summary

2021 Compared to 2020

Net cash used in operating activities during 2021 was $0.6 million, compared to net cash provided by operating activities of $12.6 million during 2020. The lower cash provided by operating activities during 2021 was primarily due to higher contract assets, higher inventories, and higher accounts receivable, partially offset by higher net income and higher contract liabilities.

Net cash provided by investing activities during 2021 was $57.8 million compared to net cash used by investing activities of $5.5 million during 2020. The higher cash provided by investing activities during 2021 was primarily due to proceeds from sale-leaseback, partially offset by the payments for the acquisition of MagSeal.

Net cash used by financing activities during 2021 was $37.3 million compared to net cash provided by financing activities of $9.7 million during 2020. The lower cash provided by financing activities during 2021 was primarily due to higher net repayments of borrowings on the Credit Facilities.

2020 Compared to 2019

See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Annual Report on Form 10-K filed with the SEC on February 11, 2021, which is incorporated by reference herein.

Off-Balance Sheet Arrangements

Our off-balance sheet arrangements consist of operating and finance leases not recorded as a result of the practical expedients utilized, right of offset of industrial revenue bonds and associated failed sales-leasebacks on property and equipment, and indemnities, none of which we believe may have a material current or future effect on our financial condition, liquidity, capital resources, or results of operations.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical accounting policies and estimates are those accounting policies and estimates that can have a significant impact on the presentation of our financial condition and results of operations and that require the use of subjective estimates based upon past experience and management’s judgment. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Below are those policies applied in preparing our financial statements that management believes are the most dependent on the application of estimates and assumptions. See Note 1 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for additional accounting policies.

Revenue Recognition

Our customers typically engage us to manufacture products based on designs and specifications provided by the end-use customer. This requires the building of tooling and manufacturing first article inspection products (prototypes) before volume manufacturing. Contracts with our customers generally include a termination for convenience clause.

We have a significant number of contracts that are started and completed within the same year, as well as contracts derived from long-term agreements and programs that can span several years. We recognize revenue under ASC 606, “Revenue from Contracts with Customers” (“ASC 606”), which utilizes a five-step model.

The definition of a contract for us is typically defined as a customer purchase order as this is when we achieve an enforceable right to payment. The majority of our contracts are firm fixed-price contracts. The deliverables within a customer purchase order are analyzed to determine the number of performance obligations. In addition, at times, in order to achieve economies of scale and based on our customer’s forecasted demand, we may build in advance of receiving a purchase order from our customer. When that occurs, we would not recognize revenue until we have received the customer purchase order.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account under ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, control is transferred and the performance obligation is satisfied. The majority of our contracts have a single performance obligation as the promise to transfer the individual goods or services are highly interrelated or met the series guidance. For contracts with multiple performance obligations, we allocate the contract transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate the standalone selling price is the expected cost plus a margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service.

We manufacture most products to customer specifications and the product cannot be easily modified for another customer. As such, these products are deemed to have no alternative use once the manufacturing process begins. In the event the customer invokes a termination for convenience clause, we would be entitled to costs incurred to date plus a reasonable profit. Contract

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costs typically include labor, materials, overhead, and when applicable, subcontractor costs. For most of our products, we are building assets with no alternative use and have enforceable right to payment, and thus, we recognize revenue using the over time method.

The majority of our performance obligations are satisfied over time as work progresses. Typically, revenue is recognized over time using an input measure (i.e., costs incurred to date relative to total estimated costs at completion, also known as cost-to-cost plus reasonable profit) to measure progress. Our typical revenue contract is a firm fixed price contract, and the cost of raw materials could make up a significant amount of the total costs incurred. As such, we believe using the total costs incurred input method would be the most appropriate method. While the cost of raw materials could make up a significant amount of the total costs incurred, there is a direct relationship between our inputs and the transfer of control of goods or services to the customer.

Contract estimates are based on various assumptions to project the outcome of future events that can span multiple months or years. These assumptions include labor productivity and availability; the complexity of the work to be performed; the cost and availability of materials; and the performance of subcontractors.

As a significant change in one or more of these estimates could affect the progress completed (and related profitability) on our contracts, we review and update our contract-related estimates on a regular basis. We recognize such adjustments under the cumulative catch-up method. Under this method, the impact of the adjustment is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate.

The impact of adjustments in contract estimates on our operating earnings can be reflected in either operating costs and expenses or revenue. See Note 1 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for the net impact of these adjustments to our consolidated financial statements for 2021.

Payments under long-term contracts may be received before or after revenue is recognized. When revenue is recognized before we bill our customer, a contract asset is created for the work performed but not yet billed. Similarly, when we receive payment before we ship our products to our customer and have met the shipping terms, a contract liability is created for the advance or progress payment. When a contract liability and a contract asset exist on the same contract, we report it on a net basis.

We record provisions for the total anticipated losses on contracts, considering total estimated costs to complete the contract compared to total anticipated revenues, in the period in which such losses are identified. The provisions for estimated losses on contracts require us to make certain estimates and assumptions, including those with respect to the future revenue under a contract and the future cost to complete the contract. Our estimate of the future cost to complete a contract may include assumptions as to changes in manufacturing efficiency, operating and material costs, and our ability to resolve claims and assertions with our customers. If any of these or other assumptions and estimates do not materialize in the future, we may be required to adjust the provisions for estimated losses on contracts. The provision for estimated losses on contracts is included as part of contract liabilities on the consolidated balance sheets.

Production cost of contracts includes non-recurring production costs, such as design and engineering costs, and tooling and other special-purpose machinery necessary to build parts as specified in a contract. Production costs of contracts are recorded to cost of sales using the over time revenue recognition model. We review the value of the production cost of contracts on a quarterly basis to ensure when added to the estimated cost to complete, the value is not greater than the estimated realizable value of the related contracts.

Business Combinations

When a business is acquired, we allocate the purchase price by recording the assets acquired and liabilities assumed at their estimated fair values as of the acquisition date, with the excess cost recorded as goodwill. A preliminary fair value is determined once a business is acquired, with the final determination of fair value be completed no later than one year from the date of acquisition.

To determine the estimated fair value of assets acquired and liabilities assumed requires significant judgment and estimates, including the selection of valuation methodologies, estimates of future revenues, costs and cash flows, discount rates, and selection of comparable companies. We engage the assistance of valuation specialists in concluding on fair value measurements in determining the fair value of assets acquired and liabilities assumed in business combinations.

The fair value of the intangible assets is estimated using several valuation methodologies, including the income based or market based approaches, which represent Level 3 fair value measurements. Inputs to fair value analyses and other aspects of the allocation of the purchase price require judgment. The value for customer relationships is typically estimated based on a multi-period excess earnings approach. The more significant inputs used in the customer relationships intangible asset valuation include (i) future revenue growth rates, (ii) projected gross margins, (iii) the customer attrition rate, and (iv) the discount rate. The useful lives are estimated based on the underlying agreements or the future economic benefit expected to be received from the assets.

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Acquisition related costs are not included as components of consideration transferred but instead, expensed as incurred and are included in selling, general and administrative expenses in our consolidated statements of income. See Note 2 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K.

Goodwill

Goodwill is evaluated for impairment on an annual basis on the first day of the fourth fiscal quarter. If certain factors occur, including significant under performance of our business relative to expected operating results, significant adverse economic and industry trends, significant decline in our market capitalization for an extended period of time relative to net book value, a decision to divest individual businesses within a reporting unit, or a decision to group individual businesses differently, we may be required to perform an interim impairment test prior to the fourth quarter.

We may use either a qualitative or quantitative approach when testing a reporting unit’s goodwill for impairment. The qualitative approach for potential impairment analysis is performed to determine whether it is more likely than not that the fair value of a reporting unit was less than its carrying amount.

The quantitative approach for potential impairment analysis is performed by comparing the fair value of a reporting unit to its carrying value, including goodwill. Fair value is estimated by management using a combination of the income approach (which is based on a discounted cash flow model) and the market approach. Management’s cash flow projections include significant judgments and assumptions, including the amount and timing of expected cash flows, long-term growth rates, and discount rates. The cash flows used in the discounted cash flow model are based on our best estimate of future revenues, gross margins, and adjusted after-tax earnings. If any of these assumptions are incorrect, it will impact the estimated fair value of a reporting unit. The market approach also requires significant management judgment in selecting comparable business acquisitions and the transaction values observed and its related control premiums.

In the fourth quarter of 2021, the carrying amount of goodwill at the date of the most recent annual impairment evaluation for Electronic Systems and Structural Systems was $117.4 million and $53.4 million, respectively.

We acquired 100% of the equity interests of MagSeal on December 16, 2021, for a purchase price of $69.5 million, net of cash acquired. We recorded preliminary goodwill of $32.9 million in our Structural Systems segment, which is also our reporting unit. See Note 2 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K.

As of the date of our 2021 annual evaluation for goodwill impairment for the Structural Systems segment, which is also our reporting unit, we performed a step one goodwill impairment analysis as of the first day of the fourth quarter of 2021. The fair value of our Structural Systems segment exceeded its carrying value by 72% and thus, was not deemed impaired.

As of the date of our 2021 annual evaluation for goodwill impairment for the Electronic Systems segment, which is also our reporting unit, we performed a qualitative assessment as of the first day of the fourth quarter of 2021, which considered each of the following: 1) margin of passing most recent step one analysis, 2) earnings before interest, taxes, depreciation, and amortization, 3) long-term growth rate, 4) analyzing material adverse factors/changes between valuation dates, 5) general macroeconomic factors, and 6) industry and market conditions. Based upon our qualitative assessment, we concluded that it was more likely than not that the fair value of the reporting unit exceeded its carrying amount and thus, goodwill was not deemed impaired.

Other Intangible Assets

We amortize acquired other intangible assets with finite lives over the estimated economic lives of the assets, ranging from 2 years to 19 years, generally using the straight-line method. The value of other intangibles acquired through business combinations has been estimated using present value techniques which involve estimates of future cash flows. We evaluate other intangible assets for recoverability considering undiscounted cash flows, when significant changes in conditions occur, and recognize impairment losses, if any, based upon the estimated fair value of the assets.

Accounting for Stock-Based Compensation

We measure and recognize compensation expense for share-based payment transactions to our employees and non-employees at their estimated fair value. The expense is measured at the grant date, based on the calculated fair value of the share-based award, and is recognized over the requisite service period (generally the vesting period of the equity award). The fair value of stock options are determined using the Black-Scholes-Merton (“Black-Scholes”) valuation model, which requires assumptions and judgments regarding stock price volatility, risk-free interest rates, and expected options terms. Management’s estimates could differ from actual results. The fair value of unvested stock awards is determined based on the closing price of the underlying common stock on the date of grant except for market condition awards for which the fair value was based on a Monte Carlo simulation model.

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Inventories

Inventories are stated at the lower of cost or net realizable value with cost being determined using a moving average cost basis for raw materials and actual cost for work-in-process and finished goods. The majority of our inventory is charged to cost of sales as raw materials are placed into production and the related revenue is recognized. Inventoried costs include raw materials, outside processing, direct labor and allocated overhead, adjusted for any abnormal amounts of idle performance center expense, freight, handling costs, and wasted materials (spoilage) incurred. We assess the inventory carrying value and reduce it, if necessary, to its net realizable value based on customer orders on hand, and internal demand forecasts using management’s best estimates given information currently available. The majority of our revenues are recognized over time, however, for revenue contracts where revenue is recognized using the point in time method, inventory is not reduced until it is shipped or transfer of control to the customer has occurred. Our ending inventory consists of raw materials, work-in-process, and finished goods.

Income Taxes

Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized, using enacted tax rates, for the expected future tax consequences of temporary differences between the book and tax bases of recorded assets and liabilities, operating losses, and tax credit carryforwards. Deferred tax assets are evaluated quarterly and are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Tax positions taken or expected to be taken in a tax return are recognized when it is more-likely-than-not, based on technical merits, to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement, including resolution of related appeals and/or litigation process, if any.

Recent Accounting Pronouncements

See Note 1 to our consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for a description of recent accounting pronouncements.