Ducommun Inc (DCO) 2015 Q1 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Q1 2015 Ducommun earnings conference call. My name is Alex, and I will be your operator for today.

(Operator Instructions)

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 included 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 and 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 for 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 continue to benefit from robust growth in our commercial aerospace operations and experience 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 reduction efforts.

Bottom line results were further impacted by production inefficiencies on certain legacy programs and one-time development costs of new technologies. 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 lowered defense spending as some very attractive programs wind down or go through a period of lower demand, these platforms like the C-17, F-15, Apache and the Black Hawk. 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 were not able to reduce costs as quickly as necessary to counteract the revenue decline.

We are 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 have 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 costs 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 Technologies 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, 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 about for a moment about the commercial aerospace operations where revenue rose to $68 million, up 20% for the same quarter in 2014. We continue 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 programs.

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 are 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 higher top-line growth going forward.

Our recently announced long-term supply agreements 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 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 its 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 has 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 will now turn the call over to Joe Bellino to go through our financials. Joe?

Thanks Tony, and good day everyone. After the market close today we reported our earnings and our loss of -- 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 will go into the details in a moment, but clearly we were disappointed with our current quarter financial results.

Net sales for the quarter -- 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 an $11 million increase in commercial aerospace sales and a slight uptick of $2 million in 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 continue to benefit from a combination of higher airframe build rates and increased content. We expect these mix shift trends to continue throughout the balance of 2015.

We have previously indicated 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 accrued 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 of 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're 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 Company-wide 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 revenue, as compared to approximately $15 million, or 8.2% of revenue in the first quarter of 2014. Our gross margin was 15.5%. This 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 efforts will have a positive impact on our second-half financial performance.

Higher accrued 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 of 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.

And looking at 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 (sic - see Press Release "$4.7 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 the 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 had mentioned the sunsetting of two long-cycled 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 remain 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 our commercial aerospace electronics applications and a nearly 8% increase in our 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 F15 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 have seen a slightly higher backlog in our industrial sector, but a pronounced decline in demand for our 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 action 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 accrued compensation and benefit expenses and higher professional services expenses.

Now turning to backlog. Our overall backlog at quarter's end was $538 million. This equates to a sequential decline of $21 million from the December 2014 period, broken down by an $11 million decline in our military and space backlog, a $9 million decrease in commercial aerospace products. For clarification purposes, we report backlogs based on firm purchase orders from our customers.

The backlog decline in commercial aerospace sector reflects a change by our customers in recent quarters, in that they place their orders with us on a quarterly basis rather than traditionally where they placed them on an annual basis. As a result of and an upshot of this is that 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 continue 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 in last year's first quarter.

We remain diligent ineffective 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 fund to 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 FY15. 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 improved 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'd like to turn the program back over to Tony for his closing remarks. Tony?

Thank you, Joe. I'll make my closing comments brief so that we can get right to the Q&A. Let me just say once again that our shortfall this quarter was unacceptable.

We knew that certain military programs were being dramatically scaled back, and we anticipated 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 caused 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 are taking the disciplined proactive approach to improve bottom-line results for 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 would like to open up the call for questions, please.

(Operator instructions)

Edward Marshall, Sidoti & Company.

Evening, guys.

Ed.

Hi, Ed.

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

Ed, this is Joe. 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 is, we look at the closing -- we look at, in trueing up our books, we looked at the amount of relative indirect costs and we expensed those. And those were, 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 -- and we're investing in those, but the way the accounting is, we expense 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, Ed. I think that the big issue was some of these outstanding areas that we were stilling running down. We clearly knew that we were short of expectations, but as -- we don't forecast earnings, right?

So we don't give any guidance. And it's awful 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 is about as much as that we could get without detailing the numbers, which we did not have finalized, as Joe just indicated.

Okay. So when you look at, I guess, the term indirect costs were used quite often, what is -- what are indirect costs? I'm not sure that I (multiple speakers)

Indirect costs in the manufacturing operation as compared to direct costs, those are non-direct labor-related activities that remain throughout a manufacturing facility. And as we are 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 costs show up in the prior -- in the current period, but the benefits begin in the subsequent period.

Got you. All right. So can we talk about maybe some of the list of costs that you had there? You mentioned quite a few. You had the professional fees, which I assume are the audit.

You talk about the higher indirect costs, the product inefficiencies, and one-time development costs in new technologies. So can we put numbers to this, so I kind of have an idea maybe if you want to do it as an EBIT number or if you want to do it as an EPS number, whatever's 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 can give you is between the $20 million-some last year and the $10 million, about $4 million was related to some non-rate things and 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 costs and they're going away.

There were no numbers -- I mean, can you tell me how much the audit cost?

Yes, the audit cost, it is 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, we -- there were some that were made valuable, and that's probably another $500,000 to $600,000.

I see. And the indirect costs? I mean, what were the fees there?

On the development side, look. If you just take the pick-up in the cost increase in the SG&A and the development costs, you're talking about, like Joe said, about 30% of last year. It's about $3 million is what those had. The inefficiencies and the product mix kind of developed the rest of it.

There were schedule slides in there that caused, and this is where it is very difficult and this is why we don't break these numbers down because when you're inefficient you increase higher overhead cost. 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 -- well, suffice it to say we have taken out a significant number of headcount at the end of the year last year, the last two quarters of last year. And now it is 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 costs that were impacted by the shift in revenue base and the product mix shift.

Okay. So are you saying in the $10 million delta from this year's to last year EBITDA, I guess, roughly one-third of that was your professional fees and the remainder was the inefficiencies? Is that what you're saying?

I would put it in buckets. Some was the mix shift. As I commented earlier, we typically generated higher gross margins 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 at a lower margin, I think product mix you can quantify that, ex the labor inefficiencies. So I think you want to do your own modeling and make some assumptions.

No, correct. You called the inefficiencies out in the quarter, you called the professional fees and the indirect costs. And from the investment community, to the shareholders of the -- that own the stock, to give us some kind of understanding to kind of how to look at the business on a go-forward basis, I mean, that's what I'm trying to get at.

Sure.

How much of this is actual water under the bridge and how much, as we progress into future quarters, that we kind of -- and to the timing of that, that we can kind of see that step off? That is what I'm kind of asking and trying to get to.

Let me see if I can help I was little bit. All right. So when you look at product inefficiencies, you also have to take into consideration that in the first quarter of last year there was a significant number of dollars in revenue on the Apache and the C-17, which generated a pretty solid profit. Now that is gone.

And then remember as we looked at it, that dissipated over the years. 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? We didn't quite get back to all of the 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 and all of that, 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 the C-17 and Apache, that's coming down and we should be picking up efficiency on those programs. You had inefficiency due to schedule slides. You had some non-recurring with regards to the SG&A, the expenses, the development costs for the new technology within the area of about $1 million.

So those are maybe about a $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 see. I guess if we can kind of move onto maybe cash flow. Joe, did I hear you say that you expect to return to normalized seasonal cash flow patterns on a go-forward basis?

Yes.

As we look kind of year over year, do you anticipate very similar numbers to what we put up the last two years, maybe on average? Is that an 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 it's -- 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 $10 million.

Historically since the acquisitions in 2012 we've used anywhere from $6 million to $10 million in the first quarter. Really diligent about collections.

Yes, the seasonal patterns, we expect will continue, where 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 fourth quarter, or even the first quarter of this year, have they impeded that or caused any kind of disruption to the timing, or even the rates that you anticipate that you receive on any refinancing that may occur?

Well, we don't see it until a third quarter event. 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, it looks like the fed won't increase rates until the second half of this year.

We're feel pretty -- we're very positive about the whole project, and our experience and our ability to generate cash flow and pay down debt. And 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 dialog over probably the last year in anticipation of this. We were very proactive in looking at it.

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.

Right. And so there is no change to that based on the hiccups that you had in Q1?

No, in fact the market has 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 than a quarter.

Sure, sure, sure, sure. I guess what I'm getting at is this just -- 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 the operations improve, the margins return, maybe regress to potentially a lower mean than historically. But again, moving towards a mean. And this is just kind of a blip on the screen. Is that a fair assumption?

That is a fair assumption. That is the way that we're looking at it. And like I said in my remarks, I mean, 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 we will be better results than the first quarter.

And like I said in the 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.

Okay. Thank you.

That's not an excuse, though, by the way. That is not an excuse for the performance.

Right, right. Thank you.

Thank you.

Thank you, Ed.

Mark Jordan, Noble Financial.

Good afternoon, gentlemen. Question on--

Hello, Mark.

About DAS in terms of what you might view, given a structural shift in mix of 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.

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

We look at for being 33% to 35%. Probably model 33%.

Okay. DAS, also given the weakness in the first quarter and the push-out of -- 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 kind of looking at it as a 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.

Yes. I mean, the phenomenon that occurred in the first quarter, it was both the exit of the C-17 completely and a reduction in requirements for the Apache. But our other military helicopter programs declined too. In the Chinook and the Black Hawk, and it's a trickle-down effect from a couple years before. Less troop support in [Elco] and those kind of things.

So from a numbers standpoint when we look at our first quarter, $91 million -- excuse me, $81 million versus $72 million, that bridge, we took -- our 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 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 50% of our business going forward.

Okay. Finally, what would you tie the -- what is the drivers for the strength in the industrial side at 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 focus market development areas in customers in the farm equipment electronic controls is one area.

There is 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 has 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 pick-up on the medical side. But I think that the real growth areas that we've done some new product development and we're on some new applications there.

And so I think from our prototyping capability, it has opened up some new markets for us. Along with what Joe said. I mean, we're very -- a 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 got new customer development to tapping in that business. But the heavy industrial, some pick up in the medical, and a lot of new development for new customers.

Okay. Thank you very much.

Thanks, Mark.

(Operator instructions)

Ken Herbert, Canaccord.

Good afternoon.

Hi, Ken.

Hi, Tony and Joe. Hey, just so I maybe to look at this from a different perspective and make sure I could 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 in 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 is still preliminary, but we're headed in a northeast direction, as I call it.

I think based on your comments, you applied second half this year gets to those -- that 17.9%, or second half 2014 levels?

That's right. We'll have to overrun them the a little bit to get there.

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

It's actually in our existing program. So we brought it out, but we think that there is potential for above and beyond the $4.5 million, the $4 million to $5 million that we put in there. And it's been a program that was initiated last year.

Joel has 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 shops out there, and we're going to take that down to low double-digit number.

Okay.

So we've got a lot of things that are in play there. And some of those are already been forecasted. But addition to that $4.5 million -- or $4 million to $5 million, we think there'll be some pick-up from the supply chain, yes.

I can appreciate the philosophy that you don't want to give annual guidance. But over the last year to two you have 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 is 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.

We feel very comfortable about where we are taking the programs. We had a terrible first quarter, but I think that we'll regroup on that and climb out of this one. But we kind of dug a big hole for ourselves.

Yes, okay. All right. No, that is fair enough. Finally, I mean, obviously really nice growth on the commercial aerospace side within each of the segments, but when I specifically look within -- with AeroStructures on commercial aero, backlog was down a little bit sequentially. Is there, -- and sort of down year over year. Is there any concern there, or is that just reflect timing on some of these programs?

That is essentially timing. So it's about that 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 Black Hawk side, that is being released quarter over quarter.

So all the commercial aircraft programs are quarter over quarter. So there is just a lag there. But we're comfortably there on that side of the fence.

Just add to that, Ken, we track with both Boeing and Airbus, too. And in Boeing's report they showed modest growth, 5% or 6% in their first quarter delivers of 737s and a nice growth in Dreamliners from 17 to 30. And we parallel that pretty much.

There was little extra 767 shipments. So as those 8% to 10% growth rates that were experienced between 2008 and 2014 in the industry are going to slow down to 3% to 5%, and we feel real comfortable that we can hit the top end of that range on a sustainable basis, with growing with the market and increased content per some of the contracts announcement we've released recently.

Yes. Okay. That's helpful. And then just finally within DLT on the margin. I mean, it sounds like with the comments you sort of step up again to sort of high single digits second quarter and for the rest of the year. How do you -- is that the right way to think about this business now, or (multiple speakers)

Probably in the second half. We're still transitioning through the -- there is some still relatively higher indirect costs there that we're addressing. And we believe the 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 and OI in this quarter. But then certainly improvements, sequential improvement in the second half of next year in DLT margins.

Okay. Great. Well, thank you very much.

Thanks, Ken.

J.B. Groh, with D.A. Davidson.

Good afternoon, guys.

Hey, J.B.

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.

Okay. And then just finally on that last question. Can you sort of 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?

That as good question. On the MAX, I think the hiccup is going to be 4% to 5%, somewhere in that range, might be higher. We're working on some stuff right now, but from the -- our current base.

And on the Neo, of course we're just getting into the A320. So lots of programs we're working on.

Some of the new technology that we invested in in the first quarter is getting us wins on the Neo. I think that it's kind of difficult to say what that growth is going to be. Let us put this with, anything we pick up there is incremental, right?

Right. I'm trying to establish maybe that once we transition to these new aircraft, you have the ability to grow a 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 look at the 737 MAX. And that will not be -- that may be 4% to 5%. The A320 I think will be higher than that, just based on the fact back of where our baseline is right now.

Right. Okay. Thanks, that's all I had left.

Thanks, J.B.

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

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

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.