Overview

Ducommun Incorporated ("Ducommun" or the "Company"), through its subsidiaries designs, engineers and manufactures aerostructure and electromechanical components and subassemblies, and provides engineering, technical and program management services principally for the aerospace industry. These components, assemblies and services are provided principally for domestic and foreign commercial and military aircraft, helicopter, missile and related programs as well as space programs.

Domestic commercial aircraft programs include the Boeing 737NG, 747, 767, 777 and 787. Foreign commercial aircraft programs include the Airbus Industrie A330 and A340 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 and F-22 aircraft, and various aircraft and shipboard electronics upgrade programs. Commercial and military helicopter programs include helicopters manufactured by Boeing (principally the Apache and Chinook helicopters), Sikorsky, Bell, Augusta and Carson. The Company also supports various unmanned space launch vehicle and satellite programs.

In the fourth quarter of 2008, the Company recorded a non-cash charge of $13,064,000 at DTI (relating to its Miltec reporting unit) for the impairment of goodwill. In accordance with SFAS No. 142 - Goodwill and Other Intangible Assets, the Company performed its required annual impairment test for goodwill using a discounted cash flow analysis supported by comparative market multiples to determine the fair values of its businesses versus their book values. The test as of December 31, 2008 indicated the book value of Miltec exceeded the fair value of the business. The impairment charge driven by adverse equity market conditions that caused a decrease in current market multiples and the Company's stock price as of December 31, 2008 compared with the test performed as of December 31, 2007. The charge reduced goodwill recorded in connection with the acquisition of Miltec and does not impact the company's normal business operations. The principal factors used in the discounted cash flow analysis requiring judgment are the projected results of operations, weighted average cost of capital ("WACC"), and terminal value assumptions. The WACC takes into account the relative weights of each component of the Company's consolidated capital structure (equity and debt) and represents the expected cost of new capital adjusted as appropriate to consider risk profiles associated with growth projection risks. The terminal value assumptions are applied to the final year of discounted cash flow model. Due to many variables inherent in the estimation of a business's fair value and the relative size of the Company's recorded goodwill, differences in assumptions may have a material effect on the results of the Company's impairment analysis. Prior to recording the goodwill impairment charge at Miltec, the Company tested the purchased intangible assets and other long-lived assets at the business as required by SFAS No. 144 - Accounting for the Impairment or Disposal of Long-Lived Assets, and the carrying value of these assets were determined not to be impaired.

On December 23, 2008, the Company acquired DynaBil Industries, Inc. ("DynaBil"), DynaBil is a leading provider of titanium and aluminum structural components and assemblies for commercial and military aerospace applications. The operating results for the acquisitions have been included in the consolidated statements of income since the date of the acquisitions. In December 2006, the Company shut down the Ducommun Technologies Fort Defiance, Arizona facility (which employed approximately 46 people at the closure date), and transferred a portion of the business to the Ducommun Technologies Phoenix, Arizona facility. On September 1, 2006, the Company acquired CMP Display Systems, Inc. ("CMP"). CMP manufactures incandescent, electroluminescent and LED edge lit panels and assemblies for the aerospace and defense industries. On May 10, 2006, the Company acquired WiseWave Technologies, Inc. ("WiseWave"). WiseWave manufactures microwave and millimeterwave products for both aerospace and non-aerospace applications. On January 6, 2006, the Company acquired Miltec Corporation ("Miltec"). Miltec provides engineering, technical and program management services, including the design, development, integration and test of prototype products. Engineering, technical and program management services are provided principally for advanced weapons systems and missile defense.

Sales, gross profit as a percentage of sales, selling, general and administrative expense as a percentage of sales, the effective tax rate and the diluted earnings per share in 2008 and 2007, respectively, were as follows:

                                           2008          2007          2006
            Net Sales (in $000's)        $ 403,803     $ 367,297     $ 319,021
            Gross Profit % of Sales           20.3 %        20.6 %        19.6 %
            SG&A Expense % of Sales           12.5 %        12.6 %        13.1 %
            Effective Tax Rate                23.1 %        28.0 %        21.0 %
            Diluted Earnings Per Share   $    1.23     $    1.88     $    1.39

The Company manufactures components and assemblies principally for domestic and foreign commercial and military aircraft, helicopter and space programs. The Company's Miltec subsidiary provides engineering, technical and program management services almost entirely for United States defense, space and homeland security programs. The Company's mix of military, commercial and space business in 2008, 2007 and 2006, respectively, was approximately as follows:

                                       2008     2007     2006
                          Military       59 %     60 %     66 %
                          Commercial     39 %     37 %     32 %
                          Space           2 %      3 %      2 %

                          Total         100 %    100 %    100 %

                                               2008     2007     2006
                  Boeing Commercial Aircraft     15 %     18 %     14 %
                  Boeing C-17 Aircraft            9 %     10 %     10 %
                  Boeing Apache Helicopter       13 %     15 %     18 %
                  All Others                     63 %     57 %     58 %

                  Total                         100 %    100 %    100 %

Net income for 2008 was lower than 2007. The decline in net income in 2008 was driven by non-cash goodwill impairment at Ducommun Technologies, Inc. ("DTI"), (relating to its Miltec reporting unit) of $13,064,000 and an increase in allowance for doubtful accounts, at Ducommun AeroStructures, Inc. ("DAS") due to a customer's bankruptcy. Net income was also affected by lower operating performance at DTI operating segment and a higher effective tax rate in 2008, partially offset by an improvement in operating performance at DAS and a decrease in interest expense due to lower debt and lower interest rates in 2008.

Critical Accounting Policies

Critical accounting policies are those accounting policies 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. For additional accounting policies, see Note 1 of "Notes to Consolidated Financial Statements."

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. Revenue from products sold under long-term contracts is recognized by the Company on the same basis as other sale transactions. The Company recognizes revenue on the sale of services (including prototype products) based on the type of contract: time and materials, cost-plus reimbursement and firm-fixed price. Revenue is recognized
(i) on time and materials contracts as time is spent at hourly rates, which

Provision for Estimated Losses on Contracts

The Company records provisions for estimated losses on contracts in the period in which such losses are identified. The provisions for estimated losses on contracts require management 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. Management's estimate of the future cost to complete a contract may include assumptions as to improvements in manufacturing efficiency and reductions in operating and material costs. If any of these or other assumptions and estimates do not materialize in the future, the Company may be required to record additional provisions for estimated losses on contracts.

Goodwill

The Company's business acquisitions have resulted in goodwill. In assessing the recoverability of the Company's goodwill, management must make assumptions regarding estimated future cash flows, comparable company analyses, discount rates and other factors to determine the fair value of the respective assets. If actual results do not meet these estimates, if these estimates or their related assumptions change in the future, or if adverse equity market conditions cause a decrease in current market multiples and the Company's stock price the Company may be required to record additional impairment charges for these assets. In the event that a goodwill impairment charge is required, it could adversely affect the operating results and financial position of the Company.

Other Intangible Assets

The Company amortizes purchased other intangible assets with finite lives using the straight-line method over the estimated economic lives of the assets, ranging from one to fourteen years. The value of other intangibles acquired through business combinations has been estimated using present value techniques which involve estimates of future cash flows. Actual results could vary, potentially resulting in impairment charges.

Accounting for Stock-Based Compensation

The Company uses a Black-Scholes valuation model in determining the stock-based compensation expense for options, net of an estimated forfeiture rate, on a straight-line basis over the requisite service period of the award. The Company has two award populations, one with an option vesting term of four years and the other with an option vesting term of one year. The Company estimated the forfeiture rate based on its historic experience.

Inventories

Inventories are stated at the lower of cost or market, cost being determined on a first-in, first-out basis. Inventoried costs include raw materials, outside processing, direct labor and allocated overhead, adjusted for any abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) incurred, but do not include any selling, general and administrative expense. Costs under long-term contracts are accumulated into, and removed from, inventory on the same basis as other contracts. 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 can fluctuate significantly caused by factors beyond the control of the Company. The Company maintains an allowance for potentially excess and obsolete inventories and inventories that are carried at costs that are higher than their estimated net realizable values. If market conditions are less favorable than those projected by management, such as an unanticipated decline in demand and not meeting expectations, inventory write-downs may be required.

Acquisitions

On December 23, 2008, the Company acquired DynaBil Industries, Inc. ("DynaBil"), a privately-owned company based in Coxsackie, New York for $45,986,000 (net of cash acquired and excluding acquisition costs). The purchase price for DynaBil remains subject to adjustment based on a closing balance sheet. DynaBil is a leading provider of titanium and aluminum structural components and assemblies for commercial and military aerospace applications. The acquisition was funded from internally generated cash, notes to the sellers, and borrowings of approximately $10,500,000 under the Company's credit agreement. The operating results for this acquisition have been included in the consolidated statements of income since the date of the acquisition. The consolidated financial statements reflect preliminary estimates of the fair value of the assets acquired and liabilities assumed and the related allocation of the purchase price for DynaBil. The principal estimates of fair value have been determined using expected net present value techniques utilizing a 15% discount rate. Customer relationships are valued assuming an annual attrition rate of 3%. Management does not expect adjustments to these estimates, if any, to have a material effect on the Company's consolidated financial position or results of operations.

On September 1, 2006, the Company acquired CMP, a privately-owned company based in Newbury Park, California for $13,804,000 (net of cash acquired and excluding acquisition costs). CMP manufactures incandescent, electroluminescent and LED edge lit panels and assemblies for

On May 10, 2006, the Company acquired WiseWave, a privately-owned company based in Torrance, California for $6,827,000 (net of cash, including assumed indebtedness and excluding acquisition costs). WiseWave manufactures microwave and millimeterwave products for both aerospace and non-aerospace applications. The acquisition broadens the Company's microwave product line and adds millimeterwave products to its offerings. The cost of the acquisition was allocated on the basis of the estimated fair value of the assets acquired and liabilities assumed. The acquisition was funded from notes to the sellers, and borrowings of approximately $5,100,000 under the Company's credit agreement. The operating results for this acquisition have been included in the consolidated statements of income since the date of the acquisition.

On January 6, 2006, the Company acquired Miltec, a privately-owned company based in Huntsville, Alabama for $46,811,000 (net of cash, including assumed indebtedness and excluding acquisition costs). Miltec provides engineering, technical and program management services (including design, development, integration and test of prototype products) principally for aerospace and military markets. The acquisition provided the Company a platform business with leading-edge technology in a large and growing market with substantial design engineering capability. The cost of the acquisition was allocated on the basis of the estimated fair value of the assets acquired and liabilities assumed. The acquisition was funded from internally generated cash, notes to the sellers, and borrowings of approximately $24,000,000 under the Company's credit agreement. The operating results for this acquisition have been included in the consolidated statements of income since the date of the acquisition.

Results of Operations

2008 Compared to 2007

Net sales in 2008 were $403,803,000, compared to net sales of $367,297,000 for 2007. Net sales in 2008 increased 10% from 2007 primarily due to increases in both military and commercial sales. The Company's mix of business in 2008 was approximately 59% military, 39% commercial, and 2% space, compared to 60% military, 37% commercial, and 3% space in 2007. Foreign sales were approximately 8% of total sales in both 2008 and 2007. The Company did not have sales to any foreign country greater than 4% of total sales in 2008 or 2007.

The Company had substantial sales, through both of its business segments, to Boeing, the United States government, and Raytheon. During 2008 and 2007, sales to Boeing, the United States government, and Raytheon were as follows:

                   December 31,                 2008        2007
                   (In thousands)
                   Boeing                     $ 130,783   $ 126,484
                   United States government      33,335      32,622
                   Raytheon                      33,248      30,007

                   Total                      $ 197,366   $ 189,113

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 sea-based applications. Engineering, technical and program management services are provided principally for United States defense, space and homeland security programs. The Company's defense business is diversified among military manufacturers and programs. Sales related to military programs were approximately $238,309,000, or 59% of total sales in 2008, compared to $219,248,000, or 60% of total sales in 2007. The increase in military sales in 2008 resulted principally from an $8,224,000 increase in sales to the Chinook program and a $3,790,000 increase in sales to the Blackhawk program at DAS, a $5,404,000 increase in sales to the Phalanx program at DTI and a net increase in all other military programs at DAS and DTI, partially offset by a $3,121,000 reduction in sales to the F-18 program at DAS. The Apache helicopter program accounted for approximately $52,480,000 in sales in 2008, compared to $53,681,000 in sales in 2007. The C-17 program accounted for approximately $36,714,000 in sales in 2008 compared to $35,535,000 in sales in 2007. The F-18 program accounted for approximately $17,542,000 in sales in 2008, compared to $20,663,000 in sales in 2007. The F-15 program accounted for approximately $9,940,000 in sales in 2008, compared to $8,798,000 in sales in 2007.

The Company's commercial business is represented on many of today's major commercial aircraft. Sales related to commercial business were approximately $156,689,000, or 39% of total sales in 2008, compared to $137,864,000, or 37% of total sales in 2007. During 2008, commercial sales were higher, principally because of a $16,379,000 increase in commercial aftermarket sales at DAS and DTI, a $5,582,000 increase in sales to the Carson helicopter program, partially offset by a decrease in all other commercial sales at DAS and DTI. Sales to the Boeing 737NG program accounted for approximately $38,259,000 in sales in 2008, compared to $39,558,000 in sales in 2007. The Boeing 777 program accounted for approximately $10,400,000 in sales in 2008, compared to $11,796,000 in sales in 2007. The Company estimates that the strike of Boeing by the International Association of Machinists and Aerospace Workers, which began in the third quarter of 2008 and ended in the fourth quarter of 2008, reduced the Company's sales in 2008 by approximately $7,479,000.

In the space sector, the Company produces components for a variety of unmanned launch vehicles and satellite programs and provides engineering services. Sales related to space programs were approximately $8,805,000, or 2% in 2008, compared to $10,185,000, or 3% of total sales in 2007. The decrease in sales for space programs resulted principally from a decrease in engineering services at DTI.

                                                 Backlog
                                              (In thousands)
                      737NG                  $         57,507
                      Sikorsky Helicopters             53,343
                      Apache Helicopter                50,311
                      F-18                             42,342
                      C-17                             29,528
                      Chinook Helicopter               26,038
                      Carson Helicopter                25,710
                      777                              22,299

                                             $        307,078

Trends in the Company's overall level of backlog, however, may not be indicative of trends in future sales because the Company's backlog is affected by timing differences in the placement of customer orders and because the Company's backlog tends to be concentrated in several programs to a greater extent than the Company's sales. Beginning in January 2009, the production rate and the Company's sales for the Apache helicopter program are expected to be reduced by approximately one-half from the rate in 2008. Current program backlog will be shipped over an extended delivery schedule.

Gross profit, as a percent of sales, decreased to 20.3% in 2008 from 20.6% in 2007. The gross profit margin decrease was primarily attributable to lower operating performance at DTI, partially offset by an improvement in operating performance at DAS. The Company estimates that the strike at Boeing negatively impacted the Company's gross profit by approximately $1,942,000. Gross profit in 2008 was also negatively impacted by a write-off of $166,000 of software cost that was capitalized in error in prior periods.

Selling, general and administrative ("SG&A") expenses increased to $50,548,000, or 12.5% of sales in 2008, compared to $46,191,000, or 12.6% of sales in 2007. The increase in SG&A expenses was primarily due to higher people related costs, and a $1,130,000 increase in the allowance for doubtful accounts due to a customer's bankruptcy filing. The Company continues to provide product to this customer when paid in advance and has approximately $4 million in inventory with this customer on its balance sheet. SG&A also increased due to a

In the fourth quarter of 2008, the Company recorded a non-cash charge of $13,064,000 at DTI (relating to its Miltec reporting unit) for the impairment of goodwill. In accordance with SFAS No. 142 - Goodwill and Other Intangible Assets, the Company performed its required annual impairment test for goodwill using a discounted cash flow analysis supported by comparative market multiples to determine the fair values of its businesses versus their book values. The test as of December 31, 2008 indicated the book value of Miltec exceeded the fair value of the business. The impairment charge was primarily driven by adverse equity market conditions that caused a decrease in current market multiples and the Company's stock price as of December 31, 2008 compared with the test performed as of December 31, 2007. The charge reduced goodwill recorded in connection with the acquisition of Miltec and does not impact the company's normal business operations. The principal factors used in the discounted cash flow analysis requiring judgment are the projected results of operations, weighted average cost of capital ("WACC"), and terminal value assumptions. The WACC takes into account the relative weights of each component of the Company's consolidated capital structure (equity and debt) and represents the expected cost of new capital adjusted as appropriate to consider risk profiles associated with growth projection risks. The terminal value assumptions are applied to the final year of discounted cash flow model. Due to many variables inherent in the estimation of a business's fair value and the relative size of the Company's recorded goodwill, differences in assumptions may have a material effect on the results of the Company's impairment analysis. Prior to recording the goodwill impairment charge at Miltec, the Company tested the purchased intangible assets and other long-lived assets at the business as required by SFAS No. 144 - Accounting for the Impairment or Disposal of Long-Lived Assets, and the carrying value of these assets were determined not to be impaired.

Interest expense was $1,242,000 in 2008, compared to $2,395,000 in 2007, . . .