Ducommun Incorporated (DCO) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon ladies and gentlemen and welcome to the Second 2015 Ducommun Earnings Conference Call. My name is Chris and I’ll be your conference moderator for today. At this time, all participants are in a listen-only mode. Late we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. And at this time I would now like to turn the conference over to your host for today, Mr. Chris Witty. Sir, you may proceed.

Thank you and welcome to Ducommun’s second 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. Now, I’d like to turn the call over now to Mr. Tony Reardon for a review of the operating results. Tony?

Thank you, Chris and thank you everyone for joining us today on our fiscal second 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. We’re facing a slowdown in our military and oil and gas markets –– business growth in our commercial aerospace. We focused on improving bottom line results in streamlining certain operations to ensure that Ducommun is right sized for the current economic environment. The good news is that we accomplished what we set out to this quarter, cutting cost and expanding margins while at the same time evaluating our facilities for rationalization opportunities. In addition I’m pleased to say that our New York facility consolidation bringing three facilities into one newer more advanced and more efficient manufacturing operation is on schedule for completion this year. We’ve also now reduced head count to 10% year-over-year and implemented corporate wide supply chain initiatives. As a result of these actions and as committed to, we’re on track to remove $4 million to $5 million of annualized cost from our operations this year. This is already showing up in terms of our margin expansion. So revenue and income net of onetime items were down compared to last year. We showed vast improvement sequentially versus the first quarter of 2015. Commercial aerospace demand remains strong and other end markets appear to be stabilizing. Another very important element of our focus this quarter was completing our debt refinancing on schedule. We accomplished this goal at very attractive rates that are expected to save the company an estimated $14 million to $15 million in interest annually. It’s a tremendous achievement and one that we are very proud of. So we made progress this quarter on improving both our balance sheet and our operational performance. Now, let me put a little color on our end markets and our products and programs. In the military and space sector we saw some modest growth versus Q1, but we’re still down year-over-year as expected given the legacy programs we’ve discussed in the past. In fact like you already heard from other government contractors, our defense related business is down double digits year-to-date and we’re starting to see some stabilization in terms of run rates across the board, but still anticipate lower revenue on these markets during the second half of 2015. Our military backlog in both AeroStructures and technologies remains just north of 250 million. There was no surprise in this part of the business, but this is an area that remains a core focus in our efforts to right size operations so they’re in line with what we call the new normal of lower defense spending. In fact we’re looking at additional streamline initiatives including cost cutting measures about which I’ll be able bride more color later on this year. I also wanted to mention a recent industry development with regard to our military and space business, specifically the recently announced deal with Lockheed Martin to purchase Sikorsky from the United Technologies. As many of you already know, Sikorsky has been and remains one of our key customers here at Ducommun. The Black Hawk is our largest military program and we have received several prestigious supplier awards from Sikorsky over the past decade. So we now look forward to working with its new owner and believe our relationship with both Sikorsky and Lockheed will continue to strengthen in the years to come. Now, moving to our commercial aerospace operations, I’m pleased to say that once again we posted year-over-year revenue growth on the strength of a diverse number of high profile platforms such as the Boeing 737, the 777 and the 787 programs. Our commercial aerospace backlog remains solid just under 200 million and we expect to see this grow over the next two quarters with revenue expansion as well during the remainder of 2015. We continue to win new content on the new 737 MAX as well as various Airbus aircraft and since May have announced a number of awards in this space including a contract to produce Spirit to produce titanium auxiliary power unit exhaust barring assemblies housing [ph] the Tailcone on the 737 MAX. This adds to our content on the MAX platform which already includes OLS [ph] and other structural assemblies. We also announced at the Paris Air Show a cooperative research agreement with Airbus under which we’ll jointly develop applications using Ducommun’s full matrix technology and advance resin-transfer molding process which brings both weight and cost savings into a higher strength assembly. We see this as the beginning of an entirely new chapter in our collaboration with Airbus. Now, last but not least, we also recently announced a multimillion dollar contract with Gulfstream Aerospace to support the upcoming G500 and 600 aircraft, a new family of large-cabin and long-range business jets. Ducommun will be the sole store supplier of the titanium auxiliary power unit in inlet duct and the cooler duct for these platforms. It’s a great win for Ducommun and it will significantly expand our presence with Gulfstream going forward. And these wins come on top of our previously announced supply agreements with both the United Technologies and Rolls-Royce. So we’re very pleased with our increased visibility and end content within the entire commercial aerospace arena and we currently have 30 to 40 brand new development programs in place. We continue to see plenty of business opportunities with Boeing particularly on the 737 MAX and the 787 and Airbus on A320 NEO, A330 NEO and the A350. Our focus for the balance of the year will be managing these new startup programs and other new development programs that have initial production revenues for 2016. Turning to our non-A&D business, we saw a mixed performance this quarter as anticipated. With our energy related end markets we’re down double digits year-over-year due primarily to the negative impact of the oil market. We saw a modest growth in our industrial end markets and our medical end markets again both versus 2014 and sequentially along with strengthening backlogs. The bottom line though is that we non-A&D areas to remain mixed but stable likely without much meaningful improvement until 2016. As with our military and space markets, we’re using this opportunity to assess our facilities for additional rationalization and take increased steps to increase our asset utilization. With that I’d like to now turn the call over to Joe to go through our financial results. Joe?

Thank you, Tony, and good day everyone. We reported net income of 1.8 million or $0.16 per diluted share for the current quarter, compared to net income of 6.6 million or $0.60 per diluted share in the second quarter of 2014. I’ll get into the details in a moment, but directionally it shows considerable improvement from the first quarter’s results and also includes certain debt extinguishment expenses incurred related to our new credit agreement which we finalized during the quarter. Net sales for the quarter of 2015 were approximately $175 million that was 6% down from last year’s comparable quarter. As we bridge the revenue decline, it’s reflecting a continuing shift in demand for our products, including a nearly $16 million decrease in military and space sales and an approximate $2 million decline in non-Aerospace and Defense revenue partially offset by an approximate $6 million increase in commercial aerospace revenue. In the military and space sector, we have seen reduced demand for both structural solutions and technology applications, reflecting lower aggregate demand in the government defense spending sector. Within the commercial aerospace arena by contrast, we continue to experience growing revenues as we benefit air frame build rates and increased content. We expect these mix shift trends to continue throughout the remainder of 2015 and into 2016. Overall, the macro environment reflects softer demand as compared to historic levels. We have previously indicated that the first half of 2015 would be a transition period as we work through this mix shift and other short-term issues. During the second quarter, we began to see benefits from actively managing this transition and from our efforts to reduce manufacturing expenses. This resulted in a 17.8% gross margin which although down from last year’s 20.2%, the 17.8% gross margin was a significant improvement from the 2015 first quarter’s gross margin of 15.5%. We continue to work to address the issues in front of us to return the company to profitability levels of which we’re capable. This could include further headcount reductions, lowering of indirect labor costs and improving our manufacturing performance as well as our execution on certain new programs. In addition we’ve launched a companywide supply chain improvement process during the quarter and we expect the supply chain improvement efforts to contribute to enhancing our profitability beginning in the fourth quarter of this year. Operating income for the current quarter was approximately 11 million or 6.2% of revenue, as compared to approximately 17 million or 9% of revenue on last year’s comparable quarter. The actions taken during the quarter are improving operating margins which are now returning to levels similar to those in the second half of 2014. In addition to the focus on gross margin improvement we’ve worked to lower our SG&A expenses which were 11.6% of revenues in the current second quarter as we continue to right size our overall cost structure. The second quarter 2015 pretax results include two items on separate lines in our statement of operations. The first being a $2.8 million loss on the extinguishment of debt related to our new credit agreement which I’ll discuss in a bit and the second a $1.5 million insurance recovery listed as other income. Our effective tax rate during the quarter was nearly 42% compared to 32.6% for the comparable period last year. The higher rate reflects the lower levels of pretax income this year compared to last and the associated limitations on certain deductions. We expect the effective tax rate for the balance of 2015 to average approximately 37% excluding any potential benefit from the federal research and development tax credits. These federal R&D tax credits are gaining traction in congress for approval and this would benefit us - it would be a benefit to us in the - could be a three year or so and impact us favorably in 2015 and 2016. EBITDA was approximately $19 million or 10.8% of revenues in the second quarter of 2015. Our effective working capital execution continued in the quarter resulting in cash flow from operations of $14 million and for the year-to-date six months $17.6 million versus $15.5 million during the comparable six month period of 2014. Now, reviewing the results by business segment. First Ducommun AeroStructures or DAS, DAS posted revenues of approximately 76 million for the quarter down nearly 3 million versus 79 million in the second quarter of 2014. In addition to the previously mentioned sun setting of long cycle defense programs, we have seen some reductions in revenue across our military helicopter platforms due to lower defense spending. This resulted in a revenue decrease in military and space structural products year-over-year of a total of nearly $8 million. This was partially offset by a $5 million increase in the sales of commercial aerospace structured applications primarily on the Boeing and Airbus large commercial air frame applications. DASs operating income was approximately 7 million or 9% of revenues versus operating income of approximately 10 million or 12.8% of revenues for the second quarter of 2014. The negative margin comparison year-over-year was primarily the result of an unfavorable mixed shift, higher forward loss reserves, the loss of efficiencies from slightly lower manufacturing volume and lower overall volume which was partially offset by lower compensation and benefit costs. Although still below 2014 results, DASs operating income improved significantly from the first quarter of 2015 as the benefits of our cost cutting efforts began to take effect. We continue to aggressively address our manufacturing efficiency issues and expect the sequential improvement in operating margins throughout the second half of 2015. EBITDA was approximately $11 million or 13.8% of revenue as compared to nearly 14 million or 17.3% of revenue in the second quarter of 2014. We expect military and space demand to remain soft throughout 2015. On the other hand commercial aerospace orders remained solid with most of the growth coming from existing contracts. Going forward, we expect commercial aerospace demand to continue to rise over the next several years at a 3% to 5% annual rate which would be accompanied by expansion of margins as we right size our cost structure. Ducommun LaBarge Technologies results or DLT segment sales for the second quarter decreased 8.5% to approximately $99 million as compared to approximately 108 million in the comparable period last year. The lower revenue reflects a nearly 13% decline in military and space electronics revenue and an almost 30% increase in oil and gas applications. This was due to a modest shift as defense electronics sales fell by 8 million, commercial aerospace electronics grew almost 1 million and non-aerospace and defense revenues declined by nearly 2 million. The decrease in defense technologies revenue primarily reflects reduced demand for F-15 and F-18 modernizations affecting our radar rack applications and softness in military helicopter demand. Offsetting this trend somewhat, we continue to see slightly higher demand for missile defense electronics applications. The recent market development activities, we continue to enjoy increased demand for our commercial aerospace electronics applications with new customers. Going forward in the DLT segment, we expect to see stabilization in our defense electronics backlog with trends similar to those that we have reported in the last four quarters and a solid commercial aerospace backlog. In our non-A&D offerings we have a pronounced decline in demand for energy related products reflecting the efforts and impact of a combination of lower oil prices and lower rig counts. Offsetting this we’re experiencing strong growth in other areas including medical and industrial applications resulting in higher backlogs in those segments. DLTs operating income for the second quarter of 2015 was approximately 8 million or 7.8% of revenue compared to approximately 11 million or 10% of revenue in last year’s comparable period. This decrease reflects a loss of efficiencies resulting from lower manufacturing volume and lower revenue. We continue to reduce operating expenses and are aggressively pursuing additional cost reduction activities while also expecting our supply chain initiatives to contribute in operating margin beginning in the fourth quarter of 2015. EBITDA was approximately 12 million in the quarter or 12.2% of revenue compared to approximately 15 million or 13.7% of revenue in last year’s comparable period. Looking at corporate general and administrative expenses, they ran at the rate of 3.7 million for the quarter or 2.1% of revenue and it was a decrease from $4 million or 2.2% of revenue in last year’s comparable period primarily due to lower compensation and benefit expenses. Next, looking at our backlog overall at the end of the quarter backlog tallied 524 million. This equates to essential decrease of 35 million versus the end of 2014, but is mostly within the DAS business segment related to large commercial air frames. The backlog decline in our DAS commercial aerospace sector reflects a change for our large air frame manufacturing customers in placing their orders with us on a quarterly rather than our traditional annual basis. This is more of a timing difference accounting for about 25 million of the lower commercial aerospace bookings and does not reflect the strong underlying long term demand trends for large air frame products. As a result of early backlogs even if we look at it on our long-term programs tend to be shorter in duration and lower demands than was previously the case. We continue to work diligently to win additional orders across both our diverse commercial aerospace end markets and defense technology platforms. Liquidity in capital resource is very important to us and in the first half of 2015 as I mentioned, we generated 17.6 million of cash flow from operations, $2.1 million more than the comparable first half of last year. We remain diligent in effective working capital management and expect our net cash profile going forward to reflect historic seasonal patterns. At the end of the quarter our net to adjusted EBITDA as defined was approximately 3.4 to 1. Our financial highlight of the quarter involved entering into a new five year $475 million secured credit facility which we announced on June 26. The new credit facility consists of $200 million revolving credit and $275 million term loan with mandatory prepayments both of which mature in June of 2020. With the new credit facility in place prior to quarter end, we refinanced the existing 80 million outstanding term loan that was due in 2017. In Q3 we redeem all 200 million of senior notes to 2018. During the second quarter we incurred $2.8 million loss on the extinguishment of debt related to the unamortized differed financing cost in connection with the prior financing that was retired. On June 29, we initiated a call notice to retire all the $200 million senior notes. As previously announced this transaction closed on July 27. The notes were redeemed by paying $9.75 million call premium and we’ll record an additional $2.1 million loss on the extinguishment of this debt. The total aggregate amount related to retiring the senior notes of approximately 11.9 million will be recorded in the third quarter. On completion of the refinancing on July 27, we now have $275 million outstanding on the term loan and a nine years balance on the revolving credit facility resulting in approximately $198 million of liquidity under the new credit agreement. The refinancing resulted in very favorable economics for Ducommun as the initial effective interest rate will be approximately 3.5% per annum compared to the average prior rate of approximately 9% on our old debt. We expect interest savings annually to be approximately 14 million to 15 million as compared to our prior debt. We estimate that interest expenses will be approximately $3.5 million for the third quarter which has blended interest rates of old debt and new debt and in the fourth quarter with all new debt, we estimate interest expenses will be approximately $2.5 million. This compares favorably to the $6.7 million of expenses that we incurred in the second and first quarters of this year. We’re very pleased with the execution of this new credit agreement and subsequent refinancing as it provides us significantly reduced expenses and greater financial flexibility to pursue strategic objective and in addition create shareholder value. At this stage we continue toward our goal of deleveraging to targets of 2.25 to 2.5 over the next years. Capital expenditures year-to-date were 8 million and we expect to spend a total of $15 million in CapEx in 2015 similar to historic levels. In closing we continue to focus on managing the changing mix in our business and work to realize lower manufacturing cost throughout our operations. We also expect to see annualized cost savings of $4 million to $5 million beginning in the fourth quarter through our supply chain initiatives to help drive higher operating margins and higher EBITDA margins. In addition we remain diligent with regard to expense management and working capital efficiencies, which along with significant lower interest rates should generate meaningful free cash flow going forward. I like to now turn it back over to Tony for his closing remarks. Tony?

Thank you, Joe. Before turning the call over for questions, let me just reiterate that while we accomplished a good deal this quarter, we are by no means done with our performance improvement initiatives. As I mentioned earlier we’ve already cut headcount 10% year-over-year and will continue to look at the potential for further reductions while strengthening our operations. We’re evaluating our facilities for additional rationalization opportunities and given the current outlook for lower defense spending and reduced demand in certain industrial end markets particularly the oil and gas, we think that we have an opportunity to really take a look at the asset utilization that we’ll significantly improve going across the board. We’ve begun the process of right sizing our operations for the new normal and are on target to achieve our $4 million to $5 million cost savings this year, which should be evident and improve margin sequentially during the second half even with the revenue headwinds previously discussed. Our supply chain initiatives are also expected to reduce cost beginning in the fourth quarter, leading to improve bottom line results heading into 2016. And our commercial aerospace business remains very robust and we’re looking at our other end markets that we believe are now sable and have stable run rates. This continues to be a transition year for Ducommun and as we stated at the beginning of 2015, we’re evaluating the business in all stages to resize the business for a long-term growth and margin expansion. Given current demand dynamics it is essential that we stay focused on asset utilization across our facilities and our product lines. We intend to update our investors on future calls with regards to our initiatives. In the mean time we continue to make progress towards achieving improved financial results and I’m pleased that we closed that $475 million credit agreement refinancing that will significantly reduce interest expense Ducommun going forward. This is something that we’re very proud of as Joe indicated and it improves our financial profile and benefits our shareholders. We’re now a more nimble and faster moving company than just a few quarters ago and we’re transforming Ducommun into an organization that is liner and able to rapidly adapt to fluctuations in the market. Overtime, this will lead to more consistent results, increase customer satisfaction and we believe we’re going to be delivering higher returns to our shareholders. With that Chris, I’ll turn the call over to questions. Please.

Thank you. [Operator Instructions] Our first question comes from the line of Ken Herbert with Canaccord. You may proceed.

Hi, Tony, Joe, good afternoon.

Good afternoon, Ken.

First, congratulations on getting the refinancing done. Just wanted to ask first off on the gross margins Joe, really nice improvement this quarter, did your comments imply that we continue to see sequential improvements in the gross margin through the second half of the year and are you going to end the year close to the sort of 19, 19.5 number you’ve talked about or what’s cadence on the gross margin we should expect?

We believe it’s going to move in that northeastern direction that the first quarter wasn’t normally, but they should be returning back to more historic levels. We’re really working hard on the margins with the all the things, product mix and cost and then towards fourth quarter we’ll start to see some supply chain improvements kicking in and so we do see sequential improvement in the third quarter over the second and potentially the fourth quarter over the third.

Okay, that’s helpful. And then is it fair to assume that as you start to anniversary some of the tougher comps on the defense business that you could see growth in that business in the first quarter of ‘16 or what should we expect from a timing standpoint for the defense portfolio to start to see some positive growth?

I think it will be later in the year in ‘16, Ken because we have a couple of new applications that we’re working on in ‘16. I think we’re seeing some stabilization. The tough call for us is in the helicopter market and how that’s going to behave. So we’re seeing some fluctuation in that market because we have both OEM and then spares within that flow, so that’s a little bit more difficult for us to project, but we believe that ‘16 will - it’s much more stable today than it was two months ago, but we think that towards the second quarter to third quarter of ‘16 we have to see that start to stabilize and they pick up a little bit for us.

We updated in our investor relations our three year growth outlook and as we do we see a slight growth in defense technologies, those backlogs although there’s been a mix shift [indiscernible] have been relatively flat for the last four quarters which portends [ph] what’s going to be out there 9 to 12 months from now. On the structure side we see a 2% to 3% drop with comments that Tony made in the helicopter business. We still don’t think it’s totally hit bottom.

Okay, that’s helpful. And then if I could I just wanted to make sure I understood, you had a really significant drop both within each segment within the commercial aero backlog, was that really just timing of how your customer is placing orders or was there anything else perhaps in there?

No, it’s purely timing Ken. So we’re looking for a few orders to be coming in this quarter that should bolster for that backlog and it’s just a function of timing on the quarter releases particularly for the 737 or 777 programs.

Okay and then just finally again on the backlog, a really nice step up in the quarter in the backlog for the medical and other markets and I know they’re smaller, but anything in particular that drove that or any particular range you might want to comment on?

Yeah, I think we had a real nice pick up in the medical and we were able to replace a supplier for one of our key customers and support them as one of the suppliers was having a lot trouble. So I thought that - we’ve implemented a significant R&D effort for our customers in one of our - in our [indiscernible] business and I think that that has really helped us to get into the customers and get closer to the customers and this pickup in the medical business has been a result of real good customer relationships and moving fast and getting them products in a hurry. So we got a nice jump in the backlog there.

Yeah, that’s nice. Well, thanks and a nice quarter.

Thank you, Ken.

The next question comes from the line of Mark Jordan with Noble Financial. You may proceed.

Good afternoon, gentlemen. First question relative to the tax rate, you did give us guidance obviously of 37% for the second half of this year. As I remember we started off the year looking at a potential tax rate in the low 30% range, around 33% I believe. With this move for the - in guidance for the second half of 37%, if you were to look into, say, 2016, what ballpark should be expected tax rate assuming that there is investment tax credit initiated and what would be if you were to get one?

It’s probably a range of 32% to 34%, Mark. The R&D tax credit, which I’m getting comfortable with the things that are going on there, last year it’s terribly impacted our tax rate by 7% and we’ve had those in the past experience. So certainly that’s a boon to us of 2.5 million a year, but we don’t project given the proper GAAP accounting treatment of them until that becomes law. So we look at that as an upside potential and it’s happened every year for the last 30 years or so except for one year. So we’re fairly confident it will pass.

Okay, Tony you’ve talked about sequential improvement in AeroStructures in the second half with regards to segment operating margin. If you were to look out into the second half of 2016, all of your initiatives from cost cutting to supply chain should be fully reflected in the operational characteristics, plus more volume on the commercial side. What kind of operating margin would you think would be a normal range that DAS should deliver?

Well, the operating margin as we look at it today, we’ve honestly struggled through the change in the defense side, so in looking at 2016 and the second half, it’s kind of a tough call for me right here without understanding the product mix. But looking at what we’re doing with the initiatives that we have in place, we expect that business to replace - to return to its normal operating margins into 11%.

The operating margins overall for the company, as I mentioned, let’s put a frame on it. We had operating [indiscernible] 0.8% and as I mentioned, those - that was about what the level of the third and fourth quarter of last year, where certainly our targets are higher than the 62 and the 10.8 respectively. And to the extent, we could do all these things and get supply chain. We haven’t quantified it exactly, but certainly our goals are to be higher than where they are today by some amount.

Okay. Thank you very much.

Thank you.

Our next question comes from the line of Edward Marshall with Sidoti & Company. You may proceed.

Good afternoon, Tony and Joe, Chris. How are you guys doing?

Good, we are good.

Hi, Ed.

So, question, what was the loss reserves in the quarter, loss reserve expense?

What we - we’ve put a variety of things in there, Ed. As you know, it’s probably similar to what we’ve had in historic patterns with, it was more of a qualitative discussion as you can see to communicate to the investment community and to the analyst community, the number of things, the moving parts that we’re dealing with, but they were not substantial relative to the whole body of work of things. And as you know, back in ‘12, ‘13, ‘14, we quantified more on an annual basis and as we got through a lot of program in ‘12 and when we’ve got to ‘13, we said normally its $3 million to $4 million a year annually and you could use those same times of the functions for the year. But by quarter-to-quarter, there is timing differences.

Right, so you’re just booking the change in quarter, correct? So are you saying it’s less than $1 million in the quarter?

We have - we have - I didn’t say that. It’s - they vary by quarter. And what we have is all these other things to quantify, so we want to take out of context. Although there is more than one program, there is three or four and we change our estimates each quarter based on our manufacturing experience, which could be both better or worse.

Just so I understand the accounting, though, when - to hit the P&L is the change in the expense in the particular quarter that hits the P&L on a quarterly basis, isn’t that right?

Here is the way we do it. We do our estimates to complete and we walk through it, Ed, we estimate what that, most of these are in - all these are in development programs. There is one that’s in production, but the programs that are in development, we estimate to complete. So as we look at it, we actually true up that estimate and that’s what costs the reserve, so, if you are going - and they can go the other way of course. But as you look at it, you’re looking at what’s it going to cost to complete this and then we’ll take a reserve to cover all the costs that will overrun the program if you will and try to take that up to the completion of the contract or the development contract if you will, so that we cover the cost and we don’t revisit that. So with a number of development programs, you have around two here that [ph] there’s some opportunities in the preproduction phase that we look at. So we stop our estimates to complete and we’re paying close attention to that and I would have to say we’re very conservative. So there are just opportunities on both sides of defense and reserves if you will.

Sure. Are you just - so basically you are just saying that it’s an insignificant expense in the quarter?

Yes.

Okay. So what stands up to me is the tax rate, I just see if I can get more clarity on it and I think if you look at a similar tax rate for 2Q that gets the kind of the 37% range for the full year and I’m curious is there anything to do with some of the expenses that you took, maybe the extinguishment of debt that’s not tax deductible or tax deductible at a higher rate?

When we do our full year provision, our estimates which incorporate the 11 million plus that I spoke about, the 11.9 million I spoke about that we’ll record in the third quarter is that lots of extinguishment of debt, plus the 2.8 from this, those are all - most of the - those are all deductible. And what it does is it lowers our pretax income. So that precludes us from taking certain deductions like the manufacturer deductions which is about 9% and also may have caused us to carry forward some of our investment tax credits, research and development tax credit on the federal or even on some state level. So when you get into the blended ones of those, but had we reported the similar amount that we did in the second quarter of last year, you would have seen the effective tax rate would have gone to what we reported then.

Got you, so the difference of change there and the tax rate relative to what you said the guidance for 2016 is essentially just the way you have to recognize some tax, unrecognizing tax deductibles regarding - related to somewhat of the extinguishment of debt I guess.

Yeah, and it’s such a small amount as you noted from our pretax number. It was 3 million, last year it was almost 10 million, last year 10 million, the effective tax rate was 32.6%.

And just to be clear, the 1.3 million net extinguishment of debt lest the insurance recoveries was a gain, so roughly $0.07 after tax, is that about right?

Well, for modeling purposes, you can use an effective incremental tax rate of 37% over 11.3 million shares.

I’m talking about specifically for the quarter for 2Q though.

Yeah, that’s how you can do it.

Okay, using third [Indiscernible]

Even though the effective tax rate was almost 42%, the incremental tax rate after a certain level is really 37%.

Got you, it’s a good query. The debt, did you say that there was going to 275 million on the balance sheet as of July and so as we look into September quarter, I assume you don’t pay anything down, be roughly 275 million plus any working capital adjustments on the debt line?

Yeah, if you look at the balance sheet at the end of June, it was 265 million and then we had some cash and all that that’s when we borrowed [ph] 275. We used some of that to true that up. But we actually do on that term portion of the 275, the first year we have to pay 5% of the principal which is about 13.75 million. We’ll pay a quarter of that in the September quarter and so we are at 171 million in change - 271 million in change is what our balance will be at the end of the third quarter assuming we don’t prepay any additional debt.

Got you and so you’ve gone - I mean that’s the reason to the next question I guess. There is going to be, well, I guess, 14 to 15 million less tax of incremental cash flow is coming into the business and I’m just curious, I mean, you’ve been paying debt down pretty steady pace and this is a term loan. So I’m kind of curious to get your sense as to what pace do you think you’ll continue and more importantly is that still the motivation with excess cash flows?

Okay, so that’s a good question, Ed. So what we’re going to do is we’re going to - right now we’re coming on this quarter leverage of about 3.4 and what we’d like to do is get that down to the 275, 25 to 275 range. So we’ll look at the debt and then starting next year, we’ll start to look potentials for acquisitions as we want to bolster the target line. I think that we want to use this year and probably into the first quarter to really make sure that we’ve got our cost reduction programs well managed and well under control and then some of these new development programs on pace. So as we look at the cash and try to drive the cash through, I would say that the remainder of this year, we have cash in the balance sheet right now and we are not into the revolver. So we’ll use that to churn the debt.

So are you saying that you are going to pay debt down faster and chunkier than the 30 million a year that you’d been paying it down?

We actually - if we just use the 30 million, we’ll probably be there, but it’s a good possibility that we pay more, yeah.

Okay. And then finally you mentioned some cost saving plans and I just wanted to get some clarity. First, what did you see in 2Q from that $4 million to $5 million annual expense savings? And then secondarily, you mentioned supply chains, is that part of the $4 million to $5 million on the savings or is that incremental over the 4 to 5?

Okay, so let me answer both questions. So first question, essentially do we see some of that in the second quarter? The answer is yes. I can’t give you the number on that, because of the way that works. You pick it up as the quarter is going on. So we have pretty detailed cost reduction initiatives and as we walk through the initiatives, we implement the initiatives in the early part of the Q2. You pick up some benefit then you continue to pick up benefits in three and four. Does that make sense to you? And then, with regard to - I lost my train of thought on your second question.

Supply chain part, is that four to?

Yeah, the supply chain part, we don’t expect to see any of that until Q4. So we implemented that in the second quarter and as you can imagine, the implementation takes time. So we have agreements. We have targets. We understand what we need to be doing, but now we have to flush through backlog and flush through the purchase and then the shipments out the door before we realize any saving. So we think that by the fourth quarter we have to start realizing some savings and I would say the major portion of the initiative will take effect in 2016.

So, I guess, my question is, is that included in the $4 million to $5 million in cost saving initiatives that you’ve already put in place or is that incremental?

No, that’s incremental. That would be incremental.

And what do you think happens from a margin perspective with that supply chain initiative?

So, it will actually give me a couple of quarters to be able to work through that. So we don’t have that - we have the data, but we are trying to see how it flows through, but we should see increases in the margin and we have projections on it, but we want to make sure that as we allocate through that it’s - we are truing up those margins. So I prefer that -

You don’t want me to hold you accountable for it?

I don’t mind anybody hold me accountable. I can’t manage like that right now.

I’m joking. Hey, listen, real quick - Airbus, what’s the amount of revenue or maybe percent of your revenue from that business Airbus now? And you’ve been making some growth there, where do you expect it to go?

Well, Airbus, there’s a tale of a couple of things, Ed. It was just two, three years ago where the Airbus business was relatively small and it was like $4 million to $5 million. We look at it now as it’s probably 14 million to 15 million, some directly to them and some on Airbus platforms. And we see that growing to in excess of 20 million to 25 million run rate by the second half of ‘16.

So about two-thirds of what Boeing I guess is for you?

Right now, yeah.

Okay, great, thanks, guys. I really appreciate it.

Thank you, Ed.

[Operator Instructions] Our next question comes from the line of Mike Crawford with B. Riley & Company. You may proceed.

Thanks. Just to continue with the Airbus, I mean, that would be kind of your organic path with some of the development programs you are on and are pursuing, but wouldn’t it be attractive given your stronger balance sheet and maybe others weakness to pick up something opportunistically on the M&A front, even now you are not all the way down your target leverage ratios yet?

I think we would do that, Mike, if something jumps out at us and it’s in the right range for what we think we can handle, but we haven’t seen that. We are looking in the marketplace now and putting together a strategy, but yes, we certainly would look to pick up something that has more Airbus content. There is no doubt about that.

And further in M&A, I mean, given the defense market weakness overall and all the headaches doing in that sectors, I’m sure there are some competitors that are starting to hurt more, but would you not be interested in getting more defense exposure because of all those headaches or is that something do you think is a core competence that you would like to take on?

I think that when you look at the defense market, given that there may be some jewels and diamonds in the rough, if you will and we would certainly not shy away from it. At this point in time, we are not actively pursuing that market, but we believe that the - obviously the multiples would be more attractive in that marketplace and we think that given the business, the technology, our capability will enhance our technology and/or bring us some IP, I think we would definitely look into that marketplace.

Particularly on the defense electronics or technology side of it with the modernization programs going on, with demand from foreign allies of ours and those kinds of things, it’s particularly attractive long-term and we see going into the ‘17 budget and expansion of the budget here domestically and so I mean strategically we find those very attractive markets and margins.

As I’ve stated though I think, Mike, I just want to make it clear that we are not actively pursuing acquisitions at this time.

Right and then maybe just to summarize on all of these operational supply chain improvements and program maturation on the commercial front where you are getting better margins on more productive builds, do you think that - what are the odds you can get up to a 20% gross margin in 2016 or is that a bridge too far?

The way we look at it is we have had in the last eight quarters - we’ve had a couple of quarters where they were 20. The key is to get sustainable margins at these levels of demand from our customers that are certainly higher than the 17.8 now and certainly - we’ve talked before a year ago that we wanted to get those sustained at 19, 19 at core. I think we’ve to have an interim look of doing all the things we can and then further refinement and change in our product mix to continue to enhance it. So it’s a journey.

But I think it’s truly a target, Mike. It’s not something that’s too far and it’s something that we think we can achieve as a company and we have the initiatives that we think in place to help us get as close as possible if not there.

Okay, great, thank you very much.

Okay, Mike, thank you.

And we have no further questions at this time. I would now like to pass the call over to Mr. Reardon for any closing remarks.

Thank you and I would like to thank everybody for joining us today and we sincerely thank you for your interest and your support and we look forward to talking to you next quarter. Thank you very much.