Ducommun Incorporated (DCO) Q1 2015 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Q1 2015 Ducommun Earnings Conference Call. My name is Alex and I’ll be your operator for today. At this time, all participants are in listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to our moderator for today, Mr. Chris Witty. Please proceed, sir.

Thank you and welcome to Ducommun’s first quarter conference call. With me today is Tony Reardon, Chairman and CEO; and Joe Bellino, Vice President, CFO and Treasurer. I would now like to provide a brief Safe Harbor statement. This conference call may include forward-looking statements that represent the company’s expectations and beliefs concerning future events that involve risks and uncertainties and may cause the company’s actual performance to be materially different from the performance indicated or implied by such statements. All statements other than statements of historical facts include in this conference call are forward-looking statements. Although the company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the company’s expectations are disclosed in this conference call and in the company’s Annual Report in Form 10-K for the fiscal year ended December 31, 2014. All subsequent written and oral forward-looking statements attributable to the company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements. Unless otherwise required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this conference call. I’d like to turn it over now to Tony Reardon for a review of the operating results. Tony?

Thank you, Chris, and thank you everyone for joining us today on our fiscal first quarter conference call. I’ll begin by providing an overview of the quarter, including some market color after which I’ll turn the call over to Joe Bellino to go over our financial results in detail. Let me start off by saying that we are extremely disappointed with our financial and operational performance this quarter. While we continued to benefit from robust growth in our commercial aerospace operations and experienced modest decline in overall revenue year over year, this was accompanied by a significant decline in margins. The margin compression was particularly acute in our AeroStructures segment, primarily due to weak military and space demand which negatively impacted our operating leverage at a faster rate than we were able to counteract with our cost cost reduction efforts. Bottom line results were further impacted by production inefficiencies on certain legacy programs and one-time development costs of new technologies. But having said that, our performance for this quarter was simply unacceptable. We’ve talked in the past about the pressure on margins that would come from lower defense spending as some very attractive programs wind down or go through period of lower demand, these platforms like the C-17, F-15, Apache and the Blackhawk. During the quarter, total military shipments were down 22% year over year. While we expected a fall off in defense revenue, the actual decline was greater than anticipated due to scheduled softness on some ongoing programs and we’re not able to reduce costs as quickly as necessary to counteract the revenue decline. We’re taking aggressive actions to offset the lower profitability performance and bolster cost reduction initiatives already underway. We’ve identified the root causes of the inefficiencies and are working on specific plans to mitigate them. On top of those actions already taken to reduce expenses, we’ve reevaluated our structural cost drivers and enacted measures to further streamline operations and reduce additional headcount, all in an effort to bring our overhead structure more in line with the lower than projected military sales. We anticipate that these cost reduction efforts will improve operating profit through the year by approximately $4 million to $5 million. In those areas where we’re already planning major manufacturing efficiency improvements, we’re redoubling our efforts to get the job done more quickly. We will also continue to reduce our working capital. We have also enacted plans to further streamline our supply chain, improving cost and performance from our suppliers and we expect the initial benefits to positively impact the second half of 2015. Overall, we’re taking action to resolve or mitigate the factors that impeded our execution during the first quarter and position us for stronger second half of the year. Let me provide some color on our end markets and products and programs. In the military and space sector, which is now about 41% of our total business, revenue was down significantly both year over year and sequentially from Q4. And our backlog here also declined to approximately $249 million versus nearly $318 million at the same time last year. Our AeroStructures and Technology segments have each been impacted with lower backlogs, reflecting lower government spending in this sector. We expect on a year over year basis revenue comparisons will get better as 2015 progresses, as will the margins. We continue to work through this transition and anticipate the second quarter will be an improvement over the first and through our actions the second half of 2015 will show further sequential improvements. Now, moving to some brighter news, let me talk for a moment about the commercial aerospace operations where revenue rose to $68 million, up 20% over the same quarter of 2014. We continued to benefit from higher build rates and additional content across the board, particularly on the 737 and 787 platforms as well as on the Airbus A320 and A350 platforms. We remain very well positioned for further growth in this area, particularly on the large fixed-wing aircraft platforms with Boeing and with Airbus. We’re bidding on additional electronic and structural content and believe our strong relationship with these customers as well as with Spirit and with the major engine OEMs form the basis for a higher top line growth going forward. Our recently announced long term supply agreement with United Technologies and Rolls-Royce strengthen our outlook for growth with these strategic partners on major commercial platforms. We see no reason to believe that our commercial aerospace business shouldn’t continue to expand in 2015 and for the next several years based on our business development efforts and solid aircraft demand. While additional content and higher build rates are obviously something we applaud, the company has experienced lower margins near term because of the investments in new product development and program roll out. Therefore, our new product introduction process is another specific area we are targeting for improvement. We will shorten our learning curve on new products and reduce upfront development costs. Turning to our non-A&D business, we are generally pleased with our performance this quarter. Revenue rose 8% year over year to approximately $34 million. What this equates to is pretty strong growth trends across our industrial offerings, offsetting the softer demand within our energy markets as anticipated. Low oil prices continued to negatively impact the drilling market in North America and resulted in reduced shipments and lower backlog in this area for us. We expect such trends to continue for the balance of 2015. However, our industrial backlog is at the highest level it’s been in years and we anticipate growth here will largely offset any energy related weaknesses for the foreseeable future. Finally, as stated in our previous call, we’re looking to refinance the company’s debt, market conditions permitting, which will lower interest expense and help improve our profitability going forward. With that, I’ll now turn the call over to Joe Bellino to go through our financials. Joe?

Thanks, Tony, and good day everyone. After the market closed today, we reported our earnings and our net loss of $2 million, or $0.18 per share for the current quarter that compares to $5.2 million, or $0.46 per diluted share in last year’s first quarter. I’ll go into the details in a moment, but clearly we’re disappointed with our current quarter financial results. Net sales for the first quarter of 2015 were approximately $173 million, that’s 4% lower than last year’s first quarter. The revenue decline reflected a continuing shift in demand for our products, including a $20 million decrease in military and space sales, offset by a $11 million increase in commercial aerospace sales and a slight uptick of $2 million on our non-A&D revenue. In the military and space sector, we have seen reduced demand for both structural solutions and technology electronics platforms, reflecting lower aggregate government defense spending. Within the commercial aerospace arena by contrast, we have seen increases in both our AeroStructures commercial business as well as our electronic solutions as we continued to benefit from a combination of higher air frame build rates and increased content. We expect these mix shift trends to continue throughout the balance of 2015. We have previously indicated that in the first half of 2015 it would be a transition period and we will work through this mix shift and other short-term issues. During the quarter, in addition to the unfavorable product mix, we experienced a loss of efficiencies from lower manufacturing volumes as well as higher crude compensation and benefit costs along with higher professional services fees. Partially offsetting these factors were a 35% income tax rate benefit as compared to an income tax rate of 33% in last year's first quarter. We believe that while a portion of the first quarter 2015 results were an anomaly; we need to swiftly address the issues in front of us and return the company to profitability levels for which we are capable. This includes taking headcount reductions, lowering of indirect labor costs and improving our manufacturing performance as well as our execution on certain new programs. In addition, we have launched a companywide supply chain improvement process which will contribute to our profitability enhancement initiatives beginning in the third quarter. Operating income for the current quarter was $4 million or 2.1% of revenues compared to approximately $15 million or 8.2% of revenue in the first quarter of 2014. Our gross margin was 15.5% as compared to 20% in the first quarter of 2014. The actions we are taking and the improvements we are seeing in the second quarter already indicate that gross margins are headed in the direction of the levels we experienced in the second half of 2014 and we believe that through additional work they will continue to improve sequentially. We expect the supply chain initiatives currently being implemented and the realization of our business development effort will have a positive impact on our second half financial performance. Higher crude compensation and benefit costs and higher professional services costs year over year resulted in SG&A running at 13.4% of revenue as compared to a more normalized rate we experienced in last year's first quarter of 11.7%. EBITDA for the current quarter was $10.5 million or approximately 6.1% of revenue this quarter. Our working capital execution during the quarter resulted in cash flow from operations of $3.5 million as compared to a cash usage of just under $10 million in the first quarter of 2014. As a result of continued solid cash flow generation, we made a voluntary prepayment on our term loan of $10 million and we have reduced our outstanding total debt to approximately $280 million. Looking on our results by business segment, first the Ducommun AeroStructures or DAS business segment, that segment faced most of the challenges during the current quarter as operating income was approximately $2 million or 3% of revenues compared to last year's first quarter where operating income was approximately $11 million or 13.6% of revenues. EBITDA was approximately $5.5 million or 6.5% of revenues this quarter as compared to nearly $14 million or 16.5% of revenues in last year's first quarter. The unfavorable results year over year were primarily a result of an unfavorable product mix shift, lower revenue, the loss of efficiencies from lower manufacturing volume and higher development costs of new technologies. DAS reported revenue for the current quarter of approximately $72 million, down nearly $10 million from the $82 million recorded in last year's first quarter. In previous calls, we have mentioned that the sun setting of two long cycle defense programs would impact us in early 2015. In addition, we have seen some reductions in revenue across our military helicopter applications. This resulted in a revenue decline in military and space structural products year over year of approximately $15 million which were offset by a $5 million increase year over year in sales of our commercial aerospace structured applications. Historically, our gross margins have been somewhat higher in our military and space products as compared to commercial aerospace applications. And the unfavorable product mix is reflected in this quarter's results. In addition, we saw a greatly reduced operating leverage due to reduced overall volumes that we were not able to offset through our current cost structure reduction initiatives. We are aggressively addressing these manufacturing issues and expect sequential improvement in operating margins in the DAS segment beginning this quarter and continuing through the second half of 2015. Commercial aerospace orders remained solid paralleling the growth that we see in both Boeing and Airbus, with most of the growth coming from existing contracts. Going forward, we expect commercial aerospace demand to continue to rise at a 3% to 5% annual growth rate which would be accompanied by an expansion of margins as we right size our cost structure. Now, turning to the Ducommun LaBarge Technologies or DLT business segment, net sales for the first quarter of 2015 increased nearly 3% to approximately $101 million as compared to approximately $98 million in last year's first quarter. The higher revenue reflected a solid increase in commercial aerospace electronics applications and a nearly 8% increase in non-A&D revenue, partially offset by a 10% decrease in military and space electronics revenue. This corresponds to modest mix shift as defense electronics sales declined by $6 million, commercial aerospace electronics grew by a similar $6 million and non-A&D revenues increased by $2 million. The decrease in defense technologies revenue primarily reflects reduced demand for S-15 modernizations which affects our radar rack applications and softness in military helicopter demand. Offsetting this trend somewhat, we continue to see slightly higher demand for our missile defense electronics applications. Through recent marketing development activities, we also saw increased demand for our commercial aerospace and industrial electronics applications with new customers. Going forward, we expect to see further sequential reductions in our defense electronics backlog, with an increase in our commercial aerospace backlog. In our non-A&D offerings, we've seen a slightly higher backlog in our industrial sector, but a pronounced decline in demand for energy related products where the backlog declined sequentially in the natural resources area by $7 million since the end of 2014, primarily reflecting the adverse impact of lower oil prices. DLT's operating income for the current quarter was approximately $6 million or 6.2% of revenue. This compares to $7 million or 7.2% of revenue in last year's comparable period. The decrease reflects an unfavorable product mix that was partially offset by higher revenue. We are currently addressing and taking actions on the level of manufacturing expenses within this business segment and are aggressively pursuing cost reduction activities and supply chain initiatives aimed at improving operating performance. EBITDA was approximately $11 million or 10.6% of revenues, compared to $12 million or 12.3% of revenues in the 2014 comparable period. Corporate general and administrative expenses for the first quarter were $4.8 million or 2.8% of revenue compared to $3.3 million or 1.8% of revenue in last year's comparable period. They were primarily due to higher crude compensation and benefit expenses and higher professional services expenses. Now turning to backlog, our overall backlog at the quarter's end was $538 million. This equates to a sequential decline of $21 million from the December 2014 period, broken down by $11 million decline in our military and space backlog, $9 million decrease in commercial aerospace products. For clarification purposes, we report backlog based on firm purchase orders from our customers. The backlog decline in commercial aerospace sector reflects a change by our customers in recent quarters and that they placed their orders with us on a quarterly basis rather than traditionally where they place them on an annual basis. As a result and an upside of this is our quarterly backlogs, even on our long-term programs tend to be shorter in duration and in lower amounts than was previously the case. We continue to work diligently to win new orders across both our diverse commercial aerospace end markets and our defense technology platforms. Commenting on liquidity and capital resources, during the quarter we continued to delever our balance sheet. In the first quarter of 2015, as I mentioned, we generated $3.5 million in positive cash from operations compared to a usage of cash of just under $10 million last year's first quarter. We remain diligent in effective working capital management and expect our net cash flow profile going forward to reflect historic seasonal patterns. We ended the quarter with sufficient cash balances and expect to continue deleveraging the balance sheet going forward. During the first quarter of 2015, we also made another $10 million voluntary prepayment on our debt, reducing our funded debt to $280 million. At the end of the quarter, our net debt to adjusted EBITDA was approximately 3.3 to 1. At this stage, we are on schedule with regard to our goal of deleveraging to targets of net debt to EBITDA of 2.75 to 3 by the end of 2015. In addition, we recognize that we have the opportunity this year subject to market conditions to refinance our debt and reduce interest expenses significantly going forward as well as increase our ability to execute on strategic growth initiatives. CapEx for the quarter was approximately $5 million and we forecast approximately $15 million of CapEx in fiscal 2015. Our CapEx is used to support the expansion of our manufacturing capabilities and to support new contract awards. In closing, we continue to focus on managing the changing mix in our business and are working diligently to lower manufacturing costs throughout our operations. We also intend to realize an annual cost savings of $4 million to $5 million as well as improve quality and cycle times through supply chain initiatives to support our goals of higher operating income and higher EBITDA margins. In addition, we remain diligent with expense management and a focus on working capital efficiencies, which along with the prospect of lower interest expenses from a potential refinancing of our debt should generate meaningful cash flow going forward. Now, I would like to turn the program back over to Tony for his closing remarks. Tony?

Thank you, Joe. I will make my closing comments brief so that we can get back to the Q&A. So let me just say once again that our shortfall this quarter was unacceptable. We knew that certain military programs are being dramatically scaled back and we anticipate the potential impact to margins. However, cost reduction efforts put in place last year were unable to offset the loss of operating leverage caused by the large drop in shipments. In addition, the change in mix across some of the legacy programs cause inefficiencies that were simply inexcusable. Having said that, we are working on specific plans to reduce costs, lower headcount where required, streamline operations, increase asset utilization and lower working capital. Some of these goals will take a little longer to achieve due to lower military volumes and the change in product mix, but we envision better results for the second half of 2015 based on cost savings initiatives already underway. As I said earlier, we anticipate that our cost reduction efforts will improve our operating profit by $4 million to $5 million this year. Our commercial aerospace operations will continue to benefit from strong demand and our industrial business is also expected to post further growth. And lastly, as Joe mentioned, we have an opportunity to realize lower interest expenses by refinancing our debt by Q3. Overall, we're taking the disciplined proactive approach to improve bottom-line results in the remainder of 2015 and we believe the company is still well positioned for long-term growth and higher returns for our investors. With that Alex, I’d like to open up the call for questions, please.

[Operator Instructions] Your first question comes from the line of Edward Marshall with Sidoti & Company.

You delayed the fourth quarter call and that report was done in mid-April. And I'm just curious as to why, considering the first quarter was closed, what went into not actually alerting us at that time to the inefficiencies and the disruptions that occurred in Q1?

As you know, we spent considerable time in the first quarter with getting the year end closed. And as we always do, we true up the quarters similar to what we do year end. And for example, on the SG&A expenses that I spoke about, we had higher professional costs related to getting the books closed as well as we recognized some PSUs, performance share units, which is in our proxy, that contributed to some of them. Some of the others, we look at the closing, we look at in truing up our books, we looked at the amount of relative indirect costs and we expensed those and as well as the costs that went into our development during the quarter of new product technologies and we recognized all those costs, whereas you can make a case that some of those would be capitalizable but the – we are investing in those, but the way the accounting is we expensed those amounts. So those contributed probably to 30% to 40% of the delta between last year's first quarter and this year's first quarter. The balance of that was as we did see the changing mix and we analyzed, as I commented in my statements, the lower margins we generate from commercial aerospace and the higher margins from the declining military and space sales, those numbers did have an impact on our performance.

So you’re saying you didn’t know in mid-April?

We didn’t know everything in mid-April and I think that the big issue was some of these outstanding areas that we were still running down. We clearly knew that we were short of expectations. But as – we don’t forecast earnings, right, we don’t give any guidance and it’s also difficult to be in that position. We knew that the quarter was going to be very hard and I think when we talked in the first – at the end of the year, in April, we talked about a soft first half of the year and a soft first quarter. So that’s about as much as that we could give without detailing the numbers which we did not have finalized as Joe just indicated.

So when you look at, I guess the term indirect cost was used quite often, what are indirect costs, I’m not sure?

Indirect costs in the manufacturing operation as compared to direct costs. Those are non-direct labor related activities that remained throughout a manufacturing facility and as we’re in the process of reducing those non-direct labor hours within our manufacturing operations to right size the business. There’s a lag effect in that though, Ed, in terms of when the volume declines and we make a determination that the volume is not going to recover quickly, then we immediately go into headcount reductions and other layoffs. So there is a lag effect in terms of severance costs and other things that we incur that those cost show up in the current period but the benefits begin in the subsequent period.

So can we talk about maybe some of the list of costs that you had there, because you mentioned quite a few. The professional fees which I assume with the audit, you talked about the higher indirect cost, the product inefficiencies and one-time development cost in new technology, so can we put numbers to this so I can have an idea maybe if you want to do as an EBIT number or if you want to do it as an EPS number, whatever is easier for you, but I’m assuming you have those numbers prepared?

We haven’t broken those out, we really don’t break those out. I think the best assistance I could give you is between 20-some million last year and the $10 million, about $4 million was related to some non-rate things and the other $6 million delta was in mix change and the delay in – not the delay, but the taking out of the indirect labors which we incurred the cost and they’re going away.

So there are no numbers, I mean, can you tell me how much the audit cost?

Yes, the audit cost, it’s in the proxy, the audit fees excluding taxes were about $2.4 million versus last year’s cost, they were about $1.6 million. There were also legal expenses and there were income tax expenses. And so that was fairly significant and the PSUs again, the proxy shows that because of our strong performance in 2014, the PSUs, there were some that were made valuable and that’s probably another $500,000 to $600,000.

And the indirect costs, what was the...

On the development side, look if you just take the pickup in the cost increase in SG&A and the development cost you’re talking about, like Joe said about 30% last year, it’s about $3 million is what those had. The inefficiencies in the product mix developed the rest of it, but there were scheduled slides in there that caused – and this is where it’s very difficult and this is why we don’t break these numbers down because it becomes – when you’re inefficient, you increase higher overhead costs, so you put yourself in a position where the overhead is driven higher because you’re not performing at the labor rate requirements that you need. And so with additional schedule slides on some major programs on the military side that were not anticipated, we were not able to catch up, trust me when I tell you that we had a pretty solid cost reduction program. We’ve taken out probably – suffice it to say, we’ve taken out a significant number of headcount at the end of the year last year, last two quarters last year and no one has anticipated that we had some early in this first quarter, but they did not come out fast enough in order to be able to offset the overhead cost that were impacted by the shift in revenue base and the product mix shift.

So are you saying the $10 million delta from this year to last year EBITDA, roughly a third of that was your professional fees and the remainder was the inefficiencies, is that what you’re saying?

I’d put it in buckets, so some was the mix shift. As I commented earlier, we typically generated higher gross margin on the military business and more modest margins on the commercial business. So when you do a delta, if you work through the numbers of the loss in military business year over year at X margin and add back the delta increase in commercial aerospace with a lower margin, I think product mix can quantify that, X the labor inefficiencies. So I think you want to do your own modeling and make some assumptions.

No, correct. But there are – you called the inefficiencies on the quarter, you called the professional fees and the indirect costs, and from the investment community, to the shareholders of – that own the stock, to give us some kind of understanding to how to look at the business on a go forward basis, that’s what I’m trying to get at, how much of this is actual water on to the bridge and how much, as we progress into future quarters that we can – and to the timing of that that we can see the step-off, that’s what I’m asking and trying to get to.

Okay, let me see if I can help you a little bit. When you look at product inefficiencies, you also have to take into consideration that in the first quarter last year there was a significant number of dollars in revenue in the Apache and the C-17, which generated pretty solid profit. Now that has gone and then remember, as we looked at it and anticipated over the year. So those programs second quarter was less than the first quarter. So we lost the revenue, but we also lost the margins that went with that, but then we tried to make up margins by the cost cutting, right. So we didn’t quite get back to all those cost cutting. So some of the profitability would have been down regardless just because of the loss of those two major programs. But when you look at the existing programs where we had lower inefficiency that was another factor and another 20% off those numbers if you look at it. So when you base these numbers together, you had the loss of C-17 and Apache that’s coming down and we should be picking up efficiency on those programs. We had inefficiency due to schedule slides, we had some non-recurring with regards to the SG&A, the expenses, the development cost for the new technology within the area of about $1 million. So those maybe about $1.8 million when you add in some of the other aspects of it. So those are areas where the adjustments would not return.

I guess if we can move on to maybe cash flow, I mean, Joe, did I hear you say that you expect to return to normalized seasonal cash flow patterns on a go forward basis?

Yes.

So as we look year over year, do you anticipate very similar numbers to what we’ve put up in the last two years maybe on average, is that accurate?

Yes, I think we can even improve upon that if we complete our financing in the third quarter, that will generate more cash flow. But we were pleased, we had record collections in the first quarter even though our sales from the fourth quarter were similar to the previous year. We generated cash, where last year we used historically since the acquisitions in 2012, we’ve used anywhere from $6 million to $10 million in the first quarter. We’re really diligent about collections. And yes, the seasonal patterns we expect will continue. Generally, the fourth quarter is the largest net generator, between quarters one, two and three, typically cumulatively we’re about slightly positive on cash flow through three quarters and I think with the projected lower interest expenses that will improve our cash flow even a little bit more.

And on the refi, I’m assuming you’ve talked to your banks, is any of the actions that occurred in the fourth quarter or even the first quarter this year, have they impeded that or caused any kind of disruption to the timing or even the rates that you anticipate that you’ll receive on any refinancing that may occur?

We don’t see it till the third quarter events. So we’re just having discussions right now internally analyzing that, but we know that the markets are very favorable both in the term loan B markets and in the commercial banking markets, there is capacity there, there are many borrowers like us that are doing refis during this time and the climate is very good, especially with the looks like the Fed won’t increase rates till the second half of this year. So we feel pretty – we’re very positive about the whole project and our experience and our ability to generate cash flow and pay down debt. We feel we have very good support from the lending community.

So you have or you have not spoke to the bank group?

Well, we have continuing dialog, Ed. We have had a dialog over probably last year in anticipation of this. We’re very proactive in looking at it.

And so what kind of rate are you assuming for the debt?

As I said on our April 8 call, we’re looking at 5.25% to 5.75%, which would come down from 8.32% which is our blended average interest rate today.

So there is no change that based on the hiccups that you had in Q1?

No, in fact, the markets got improved since April as interest rates have tightened. So perhaps we get to the lower end of that 5.25%.

Ed, I think the banks will look at us over a longer period in the quarter.

Sure. I guess what I’m getting at is this is typically – Ducommun has some of these hiccups from time to time and I’m wondering if this is just one of those hiccups and as we move forward throughout 2015, your operations improve, the margins return maybe [indiscernible] potentially a lower mean than historically. But again, moving towards a mean, and this is just a blip on the screen, is that a fair assumption?

That’s a fair assumption, that’s the way that we’re looking at it. And like I said in my remarks, we have plans in place operationally, trust me when I tell you the operations are embarrassed by the performance and we’re going to put this thing back on track. So it is a hiccup, there are some one-time expenses in there that will not recur and we feel comfortable that we will be on track, second quarter we anticipate better results than the first quarter. And like I said in year-end comments, we anticipate that the second half will be stronger. We did say that this is a transition year, so we got a lot of moving parts going on and obviously we didn’t anticipate the issues that delayed the year-end results and unfortunately that took up a lot of resources in order to be able to get that accomplished. That’s not an excuse though, by the way. That’s not an excuse for the performance.

Your next question comes from the line of Mark Jordan with Noble Financial.

Question about DAS in terms of what you might view, given the structural shift in mix towards commercial versus defense where historically you would have looked at a good quarter being in the 11% and 12% operating profit range. With the higher mix of commercial, are we looking at a business that when things are tuned appropriately should be a 9% to 10% operating margin business going forward?

At this stage in transition that seems reasonable, Mark.

Secondly, do you look at the tax rate to be 35% for the balance of the year?

We look at it for being 33% to 35%, probably model 33%.

DAS, also given the weakness in the first quarter and the push out, the slowness of orders you've seen on the military side, is it reasonable to assume that DAS revenue is down year over year 7% to 8%, I think I was looking at 3% to 4% type decline, but is it more reasonable to assume a little bit higher single digit decline?

If you’re looking at the full year business versus the next three quarters?

Full year

You’re looking for next three quarters, the phenomena that occurred in the first quarter was both the exit of the C-17 completely and a reduction in requirements for the Apache, but our other military helicopters programs declined too, in the Chinook and the Blackhawk and it’s a trickledown effect from a couple of years before, less troop support, and outcall, and those kind of things. So from a number standpoint, when we look at our first quarter $81 million versus $72 million, that bridge, our structures, defense structures shrunk from $34 million to $20 million and our commercial aerospace expanded from $48 million to $53 million. So we continue to expect, as I mentioned, 3% to 5%, maybe even 6% on the top side of commercial. But it does look like overall we’re going to be down 10% in the defense structures through the year and then it will level off sequentially because we look like we’ve hit the trough area by the end of the second half of this year of the defense structure business. And we expect to start seeing year over year growth in 2016 in the DAS segment driven by the commercial aerospace, which should be almost 50% of our business going forward.

Finally, what would you tie to – what is the drivers for the strength of the industrial side of DLT?

I think what we found is we’ve taken a segmented marketing approach through an SBU analysis that Joel Benkie headed up and we’ve looked on the electronics side is where the industrials are, as you know, some focused market development areas in customers in the farm equipment, electronic controls is one area. There are some other industrial market application customers that we have been working on that are ready to roll out some products. And so I think it’s been just a focus that we saw after a lot of research and analysis that that was longer term a really attractive market niche for us.

Specifically, Mark, we’re seeing some growth in the heavy industrial. We’re also seeing some nice pickup on the medical side. But I think that the real growth area, as we’ve done some new product development and we’re on some new applications there, so I think that from our prototyping capability, it’s opened up new markets for us. Along with that Joe said, I mean, we’re very – rightful approach in terms of the growth in that business and we have an excellent marketing strategy, so we’re getting to more customers, we’ve got new customer development that’s happening in that business, but the heavy industrial, some pickup in the medical and a lot of new development for new customers.

[Operator Instructions] Your next question comes from the line of Ken Herbert with Canaccord.

Just to maybe to look at it from a different perspective and make sure I understand your commentary, so is it fair to say that in the second quarter, gross margins are similar to first quarter levels and then in the second half of the year sort of get up to similar levels as we saw in the second half of 2014?

We believe the gross margins will expand sequentially in the second quarter from the unacceptable 15.5%. As I talked about it, alluded to it, I think last year’s second half, Ken, we had 17.9% margins. So we’re moving from that 15.5% to 17.9%. Where they shake out, it’s still preliminary, but we’re headed in the northeast direction, as I call it.

And I think based on your comments, probably second half this year gets to sort of those 17.9% or second half 2014 levels?

That’s right, we’ll run them a little bit to get there.

And you talked about supply chain a little bit, is that part of the $4 million to $5 million incremental in operating profit you expect to see or is that maybe above and beyond what you’ve talked about?

It’s actually in our existing programs. So we brought it up and we think that there is potential for above and beyond the $4 million to $5 million there. And it’s been a program that was initiated last year, Joel is driving the supply chain to reduce our number of suppliers in all areas and we’ve had some success. We’re moving in that direction right now, just for an example, I think we deal with like 65 different machine jobs out there and we’re going to take that down to low double digit number. So we’ve got a lot of things that are in play there and some of those are already been forecasted, but in addition to that $4 million to $5 million, we think there’ll be some pickup from the supply chain, yes.

And I can appreciate the philosophy that you don’t want to give annual guidance, but over the last year to two, you’ve had a lot of volatility around some of the quarters with some programs and with issues like this, is that something you might ever start to think differently about, you might ever start to think you might get to a point where you have confidence to start to maybe put some numbers out there or think about guidance in a more structured way?

Yes, we have talked about it, Ken, and it’s on our radar screen. We certainly would like to get to where we’re more steady state performance and our forecasting has really improved significantly. So we are looking at that as being something that we hopefully would initiate next year, we can start giving you some annual guidance. As we feel very comfortable about where we are taking the programs, we had a terrible first quarter. I think we will regroup on that and then climb out of this one. So Ken, we dug a big hole for ourselves.

And then just finally, I mean, obviously really nice growth on the commercial aerospace side within each of the segments, but when I specifically look with AeroStructures on commercial aero, backlog was down a little bit sequentially and sort of down year over year, is there any concern there or is that just for the timing on some of these programs?

That’s essentially timing. So it’s about the way that the quarter releases are coming out. So we’re very comfortable. I think that we will see some comparative changes as we go through the year, so even on the military and the Blackhawk side, that’s being released quarter over quarter. So all the commercial aircraft programs are quarter over quarter. So this is the lag there, but we’re comfortable on that side of defense.

Just to add to that, Ken, we track what both Boeing and Airbus do. And in Boeing’s report, they showed modest growth, 5% or 6%, in their first quarter deliveries of 737s and a nice growth in Dreamliners from 17% to 30%. And we parallel that pretty much, there was a little extra 767 shipment. So those 8% to 10% growth rates that we experienced between 2008 and 2014 in the industry are going to slow down to 3% to 5% and we feel real comfortable that we could hit the top end of that range on a sustainable basis with growing with the market and increase content for some of the contracts announcement we’ve released recently.

And then just finally within DLT, on the margin, I mean, it sounds like the comments you sort of step up again to high single digits second quarter for the rest of the year, is that the right way to think about this business now?

Probably in the second half, we’re still transitioning. There are some relatively higher indirect costs there that we’re addressing. And we believe that supply chain initiatives which we’re completing a lot of this consolidation during the quarter will start to flow through in the third quarter. So we’re probably looking at a similar GP in OI in this quarter and there is certainly improvement, sequential improvement in the second half of next year in DLT margins.

Your next question comes from the line of J.B. Groh with D.A. Davidson.

Just sort of a housekeeping issue on the gross margin goal for the second half, that includes the $4 million to $5 million cost savings, correct?

Yes.

So that would show up in gross margin and not so much in G&A?

Correct.

And then just my last question, can you give us an indication of how much content gain you’re going to have on NEO or MAX versus current generation, if that’s been established?

On the MAX, I think the pickup is going to be 4% to 5%, somewhere in that range, might be higher. We’re working on some stuff right now, but from our current base. And on the NEO, of course, we’re just getting into the A320, so lot of the programs we’re working on and some of the new technology that we invested in in the first quarter is gaining us wins on the NEO. So I think that it’s kind of difficult to say what that growth is going to be, but let’s put it this way, anything we pickup there is incremental.

So I’m just trying to establish maybe that once we transition to these new aircraft, you have the ability to grow little bit faster than just the production rate would indicate?

I think we do, yes. And on both of them, specifically, so when you look at the growth rate, we’d look at the 737 MAX and that will not be – that maybe 4% to 5%. The A320 I think will be higher than that, just based on the fact that where our base line is right now.

At this time, there appears to be no further questions in queue. I would now like to turn the call over to Tony Reardon for closing remarks.

Again, we’d like to thank everybody for joining us and we look forward to having a much stronger second quarter. So we’ll talk to you then. Thank you very much.