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Edited Transcript of MOG.A earnings conference call or presentation 24-Jan-20 3:00pm GMT

Q1 2020 Moog Inc Earnings Call

EAST AURORA Jan 29, 2020 (Thomson StreetEvents) -- Edited Transcript of Moog Inc earnings conference call or presentation Friday, January 24, 2020 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ann Marie Luhr

Moog Inc. - Head of IR

* Jennifer Walter

Moog Inc. - VP & CFO

* John R. Scannell

Moog Inc. - Chairman & CEO

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Conference Call Participants

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* Cai von Rumohr

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Kristine Tan Liwag

BofA Merrill Lynch, Research Division - VP

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

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Presentation

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Operator [1]

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Good day and welcome to the Moog First Quarter Fiscal Year 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would now like to turn today's conference over to Ms. Ann Luhr. Please go ahead, ma'am.

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Ann Marie Luhr, Moog Inc. - Head of IR [2]

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Good morning. Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance and are subject to the risks, uncertainties and other factors that could cause actual performance to differ materially from such statements. A description of these risks, uncertainties and other factors is contained in our news release of January 24, 2020, our most recent Form 8-K filed on January 24, 2020, and certain of our other public filings with the SEC. We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our Investor Relations home page and webcast page at www.moog.com. John?

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John R. Scannell, Moog Inc. - Chairman & CEO [3]

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Thanks, Ann. Good morning. Thanks for joining us. This morning, we report on the first quarter of fiscal '20 and fine tune our guidance for the full year. Overall, it was a strong start to our new fiscal year in terms of both sales and operating performance. This quarter, I'm adopting a new approach to the headlines, first, offering some macroeconomic comments followed by some macroeconomic thoughts and then focusing on what's going on inside our company. First, from a macroeconomic perspective, there's more clarity around both Brexit and the U.S. trade dispute with China than there was a quarter ago. While neither situation has significant direct impact on our business, the additional clarity should help stabilize the global economy and be positive for both our industrial and commercial aircraft businesses longer term. On the defense side, the continued unrest in the Middle East suggests a reduction in overseas -- U. S. overseas activities is not imminent, which supports our thesis for continued strong defense spending.

Second, within our industry sectors, there have been developments in both our commercial aircraft and industrial markets. The uncertainty around the Boeing 737 MAX return to service has increased, while the potential addition of simulator training requirements for MAX pilots has also emerged. On the industrial side, the economic climate in Europe has continued to weaken, particularly in Germany, and our team there believes we've not yet seen the bottom. In the defense markets, excluding developments in the Middle East, the underlying narrative concerning near-peer rivals in China and Russia has not changed and spending priorities remain stable.

Third, it was a good quarter for our business. Sales were up 11%. Operating profit was up 14% and earnings per share were up 18%. During the quarter, we witnessed the first flight of the Embraer E2 175, using all Moog flight controls, and our medical manufacturing facility in Costa Rica received a prestigious national award for operational excellence. We completed the acquisition of an industrial manufacturing company in Germany, which further strengthens our market leadership position in rotating devices. We refinanced our debt structure, reducing our interest rates and providing additional capital deployment flexibility. Our balance sheet is now nicely set up for the next several years and provides us with tremendous flexibility in how we allocate capital to create value for our shareholders.

Finally, in the quarter, we repurchased 670,000 shares under our outstanding authorization. And then lastly, our colleague and friend, Don Fishback, decided to retire at the end of our first quarter. Don spent 38 years with our company in various finance functions, spending the last 9 years of his career as CFO. He was a wonderful CFO, great business adviser and personal friend. I will miss him as well many of our listeners who have known Don. He'll continue as a Director of Moog. Our new CFO is Jennifer Walter, who's been with Moog almost 20 years as Controller, and more recently, as Vice President of Finance. She'll do an excellent job taking over from Don.

Now let me move to the details, starting with the first quarter results. Sales in the quarter of $755 million were 11% higher than last year, driven by strong organic growth, particularly in our A&D portfolio. Sales were up in each of our operating groups, with Space and Defense up 19%, aircraft up 12% and industrial up 4% over last year.

Taking a look at the P&L. Our gross margin was down from last year on a less favorable mix. R&D was down on lower aircraft spend, while SG&A was lower as a percentage of sales. Interest expense is up slightly on higher debt levels. In other income, we had a benefit of about $2 million last year as a result of the sale of a small product line. Excluding this unusual item, the other income line is flat with last year. The effective tax rate this quarter was 25.2%, resulting in net income of $50 million, up 17% from last year and earnings per share of $1.44, up 18% on a slightly lower share count.

Fiscal '20 outlook. Our forecast for operating performance is unchanged from 90 days ago. However, we're making 2 minor adjustments to our full year outlook to reflect events in the first quarter, which we had not forecasted. First, we're increasing our sales forecast by $35 million to account for the sales of the GAT acquisition in our industrial group. Given first year acquisition accounting impacts, we're modeling this business to be breakeven in fiscal '20. Second, we're adjusting our EPS forecast to include the combined impact of calling our high yield bonds and the first quarter share buyback activity. The net impact is a $0.05 reduction in our EPS forecast. The overall result is full year sales of $3.05 billion and earnings per share of $5.50, plus or minus $0.20.

Now to the segments. I'd remind our listeners that we provided a 2-page supplemental data package posted on our webcast site, which provides all of the detailed numbers for your models. We suggest you follow this in parallel with the text. Beginning with aircraft, Q1. Sales in the quarter of $340 million were 12% higher than last year. On the military side, we enjoyed good growth in both the OEM and aftermarket portfolios. OEM sales on foreign platforms were up nicely in the quarter, while F-35 sales to Lockheed were down slightly after a very strong first quarter last year. For the full year, we anticipate OEM sales on the F-35 will be up 17% over last year. In the military aftermarket, sales in the quarter were up across much of the portfolio led by strong F-35 growth. As the fleet of F-35 airplanes in service continues to grow, our aftermarket activity will grow accordingly. In fiscal '20, we're forecasting the F-35 aftermarket to be more than twice the level it was just 2 years ago.

On the commercial side, sales were up nicely from last year, albeit less than on the military side. OEM sales to both Boeing and Airbus were up double digits. Our Boeing book of business was up on higher 788 -- 787 sales, the result of timing of orders. Sales on the 737 platform were down marginally from last year. Sales to Airbus were up on the A350 program, with the remainder of the Airbus programs down slightly. Sales into the commercial aftermarket were more or less in line with last year, with slightly higher 787 activity, compensating for slightly lower A350 sales.

Aircraft fiscal '20. We're keeping our full year sales forecast unchanged from 90 days ago at $1.33 billion, up 2% from fiscal '19. We're planning for 7% growth in the military portfolio, led by strong F-35 activity, but slightly lower commercial activity on reduced 787 and A350 OEM sales. Given the present uncertainty around the 737 MAX production rates, we're not adjusting our sales forecast for that program as yet until we know more.

Aircraft margins. Margins in the quarter of 11.4% were a good start to the year. This quarter, we benefited from the unusually high level of sales on foreign programs as well as relatively low expenses. These effects will normalize as we move through subsequent quarters, so we're maintaining our full year margin forecast at 10.5%. Our Operations 2.0 initiative continues to make steady progress. And as we've said in the past, we should start to see the impact on both cash flow and margins towards the back half of fiscal '20.

Turning now to Space and Defense. Sales in the first quarter of $186 million were 19% higher than last year, driven by strong growth across both our Space and Defense markets. Sales into space applications were up 25% in the quarter as that market returns to healthy growth in fiscal '20. Sales were up at each of our core markets of launch, satellites and special missions. The growth was led by our development programs for Thrust Vector Control and launch vehicles as well as work on various NASA programs. In the Defense markets, sales continue to be strong across most of the portfolio. Missiles sales were up on continued high levels of production on our legacy platforms and increased development work on hypersonics. Vehicle sales were up on stronger domestic and European activity, while sales of our general components into a wide variety of end applications were up over 20%.

Space and Defense fiscal '20. We're leaving our forecast for the year unchanged from 90 days ago. Full year sales of $770 million will be up 13% from last year, a combination of 16% growth in Space and 11% growth in Defense sales, all organic.

Margins. Space and Defense margins in the quarter of 13.6% were strong and a good start to the year. Compared to last year, higher sales, a slightly improved gross margin and some favorable timing of certain expense lines resulted in almost 200 basis points of margin expansion. Over the next 3 quarters, spending in R&D and selling will gradually increase. So for the full year, we're keeping our margin forecast unchanged at 13%.

Now to Industrial Systems. Sales in the first quarter of $229 million were up 4% from last year. We had strong sales growth into medical applications on higher enteral pump and set activity. Sales into our other 3 markets of energy, industrial automation and simulation tests were more or less in line with last year. Energy sales were marginally up on offshore oil production activity, while sales into industrial automation applications were slightly lower. As anticipated, we're seeing weakness in this business in Central Europe as the German economy continues to struggle.

Finally, sales into flight simulation applications were up but sales into the test market were down in both auto and aero applications. At the end of November, we completed the acquisition of GAT, a privately owned German company, which specializes in fluid rotary units or FRUs. These are devices, which are used to carry fluids across rotating interfaces and are used in a wide range of industrial applications for machine tools to offshore oil exploration. We're already the world's leader in slip ring technology, which are devices used to carry electrical power and signals across rotating interfaces.

Slip rings and fluid rotor unions are complementary technologies and are often used in the same applications. The acquisition of GAT opens new markets to Moog and enhances our competitive position at some of our existing slip ring customers. GAT sales for fiscal '20 should be $35 million.

Industrial Systems fiscal '20. We're adjusting our full year sales forecast to account for the acquired sales of GAT. These additional sales are within the industrial automation market. We're also refining our outlook for both simulation and test and medical. Given the slowing global economy, we believe our test sales will be $10 million lower, while the strength in our medical end markets, particularly for our enteral products will deliver $10 million of additional sales. The net result is full year sales of $950 million. Industrial margins in the quarter of 11.7% were down from last year but in line with our plans for the full year. In the first quarter of fiscal '19, we completed the small -- the sale of a small product line, which contributed just over 100 basis points of operating margin. The acquisition of GAT will contribute $35 million of additional sales, but given the impact of first year accounting adjustments, we're modeling no additional operating profit. Therefore, for the full year, we're keeping our forecast for operating profit unchanged at $106 million but moderating the margin forecast slightly for the higher sales to 11.1%.

Summary guidance. Q1 was a strong start to fiscal '20. Sales were up 11% against the plan of 5% growth for the full year. Operating margin is ahead of our full year forecast, and earnings per share were above the high end of our guidance. Our defense business continues to show real strength across the complete portfolio, and our space business is back to strong growth after a flat year in 2019. Space is benefiting from the additional U.S. defense spending as well as the ramp-up of activities at NASA to get back to the moon in the next 4 years.

Commercial aircraft had nice growth in the quarter at our major OEM customers, although the aftermarket was up slightly from last year. Uncertainty around the MAX return to service increased during the quarter, but it's too early for us to model the impact yet on our full year results. Overall, commercial is on track for the year in which we're modeling a slight decrease in total sales from fiscal '19 due to the slowdown in some of our legacy programs.

Finally, industrial sales in the quarter of almost $230 million are in line with the run rate for the year, excluding the impact of the acquired sales from GAT. We've been modeling a flat year for industrial compared to fiscal '19, but should now see about 3% growth from the acquisition. We believe the pattern of the first quarter will repeat over the coming quarters with strong medical sales compensating for continuing softness in our industrial automation business.

Taken all together, we're pleased with our first quarter start to the year. We're keeping our outlook for the full year unchanged with minor adjustments for the acquired sales of GAT and the impact of our financing activities. Our first quarter benefited from some positive timing on various defense contracts as well as a slower ramp-up of expense spending than we had anticipated. As our hiring catches up with our growth plans, expenses should come back into line with our forecast. And in addition, the favorable timing of orders and shipments we enjoyed in the first quarter will unwind somewhat over the balance of the year. Opportunities to do better include further growth in our defense business, although the availability of talents to meet the needs remains a constraint.

In addition, our operational initiatives at aircraft could show positive results ahead of plan. Risks include the uncertainty around the MAX return to service as well as a further deterioration in the industrial climate. As always, we try to provide a balanced view, which weighs both the upside opportunities and the downside risks. For the second quarter, we expect earnings per share of $1.30, plus or minus $0.10. Now let me pass you to Jennifer, who'll provide more color on our cash flow and balance sheet.

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Jennifer Walter, Moog Inc. - VP & CFO [4]

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Thank you, John. Good morning, everyone. It was an excellent quarter for our balance sheet. We refinanced the debt portion of our capital structure in the first quarter, and we are now very nicely positioned to deploy capital that will create value for our shareholders in the coming years. During October, we extended the term of our $1.1 billion U.S. revolving credit facility through October 2024 and obtained more favorable terms. This facility also has an accordion feature to facilitate up to $400 million of expansion should we be looking for that capacity in the future. We also extended our securitization program through October of 2021. This program effectively increases our borrowing capacity and lowers our interest rate on up to $130 million of borrowing.

Then in December, we issued $500 million of 4 1/4% senior notes with an 8-year maturity. In conjunction with the issuance, we called our outstanding $300 million, up 5 1/4% senior notes and incurred a call premium of $4 million. We completed this redemption in January. We're pleased to have the solid debt structure fully in place. We expect our interest expense in 2020 to be $39 million, the same amount we had in 2019 as higher outstanding borrowings are offset by lower interest rates.

As of quarter end, we had both types of senior notes outstanding and just $50 million outstanding on the U.S. revolving credit facility. We also had $127 million of cash at quarter end compared to $93 million a quarter ago. The increase resulted from the timing associated with our debt refinancing activity. Free cash flow in the first quarter was $15 million. That's a conversion ratio of 30%. We had expected a slow start for free cash flow generation in the first half of 2020. We are still forecasting a full year conversion ratio of 80% or $152 million of free cash flow. We'll pick up in the back half of the year as we start to see the benefits associated with our efforts to improve our operational processes.

Net working capital, excluding cash and debt as a percentage of sales at the end of Q1, was 28.8% compared with 27.9% a quarter ago. The increase largely reflects the growth in physical inventories we've experienced. Capital expenditures in the first quarter were $27 million, while depreciation and amortization totaled $22 million. We're forecasting a slight ramp-up in both capital expenditures and depreciation and amortization as we've progressed through the year.

For all of 2020, we're forecasting $120 million of capital expenditures and $91 million of depreciation and amortization. Capital expenditures in 2020 will be about 4% of sales, which is at the high end of our historical spending range. We're working on various facility expansion projects, and we're investing in machinery and test equipment as part of our operational improvement activities. The $15 million of free cash flow for Q1 compares with an increase in our net debt of $110 million. The $125 million difference includes share repurchases.

During the first quarter, we repurchased 670,000 shares at an average price of $88 for a total of $59 million. As is our typical practice, we'll report on any future share repurchase activity when we report out on our next earnings call. We also paid $54 million for the acquisition of GAT and $9 million for the quarterly dividend. Our leverage ratio, which is net debt divided by EBITDA, increased to 2.3x from 2.1x a quarter ago. Net debt as a percentage of total capitalization was 39%, up from 36% last quarter.

Shifting over to taxes. Our effective tax rate was 25.2% in the first quarter compared to 24.3% in the same period a year ago. The lower rate a year ago included the benefit associated with utilizing tax loss carryforwards associated with the gain on a divested business. Cash contributions to our global retirement plans totaled $10 million in the quarter compared to $9 million in the first quarter of 2019. We plan to make contributions of $42 million in 2020, up from $37 million in 2019. Global retirement plan expense in the first quarter was $18 million, up from $17 million in the first quarter of 2019. Total expense for 2020 is expected to be $74 million compared to $72 million in 2019.

We made an accounting change in the first quarter that reduces our pension expense volatility. The change relates to how we value certain assets in our U.S.-defined benefit plan. In 2018, we made significant contributions and fully funded that plan. Accordingly, we rebalanced the investment portfolio such that we had 80% liability hedging securities, providing an economic hedge. The changes in fair value of these assets will now flow through the income statement annually rather than being smooth over time. And this reduces the volatility we're exposed to in our income statement.

Our previous guidance for 2020 already considered this new principle. This change does require retroactive application, so we've updated our 2019 numbers. It affects nonservice pension costs, so operating profit is not affected. First quarter 2019 earnings per share are now $0.03 lower than previously reported. For all of 2019, our earnings per share will be $0.15 lower than previously reported in our 10-K. We're in really good shape from a capital perspective, having completed the refinancing activities in the first quarter. Regarding capital deployment, we will continue to take a disciplined approach towards strategic acquisitions and returning capital to shareholders through opportunistic share repurchases and dividends.

This morning, we announced our quarterly cash dividend of $0.25 per share payable to our shareholders. As John described, we're off to a strong start for the year, and we're looking forward to the rest of 2020. We expect to top the $3 billion mark in sales this year and achieve double-digit growth in earnings per share. With that, we'll turn it back to John for any questions you may have.

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John R. Scannell, Moog Inc. - Chairman & CEO [5]

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Thanks, Jennifer. Carrie, we're open for questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will be from Cai von Rumohr with Cowen.

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Cai von Rumohr, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [2]

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So John, MAX, are you still running at 42 per month? And given it's likely that you, as along with all the others, are going to see something of a dip, what can you do to kind of mitigate the fact that if the rate goes down, do you keep the people? Or do you let them go, try to hire them again? And alternatively, maybe some comment on the potential benefit to test and -- to the simulation business.

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John R. Scannell, Moog Inc. - Chairman & CEO [3]

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So let me answer one piece of that. It's really -- we're not going to be letting anybody go in this context, Cai. As we've said before, the MAX is -- it's a nice piece of business for us, but it's in that $30 million to $40 million a year range. And so it's not an enormous part of our business. And we have plenty to do for our folks that make that stuff. So there's no question that we'll be reducing staff or anything like that.

We are still producing, Cai, and I would say it's a very fluid situation at the moment, which is why we decided not to guide to something in our numbers. We'll do that at the end of the next quarter when we know for definite. We have received notification from our customer about potentially moving some stuff out, but they've not necessarily changed orders. We also have the issue around that they -- we can still continue to produce. We will probably -- even if they stop taking deliveries produced at a lower rate to build some safety stuff, and it's still very fluid as to what the reramp-up is. And so at this stage, I think there's no question, it will be a hit to both the sales. And it is a profitable program, so you can assume on the margin contribution, it's perhaps similar to the average of the aircraft business. So I've no doubt that there will be some negative impact for us. But exactly what that looks like will depend on exactly what Boeing would like to do and then, well, our response to that in terms of how much we continue to produce versus how much we slow down. But we have plenty of other things for folks to do. So that's not a concern.

The simulation piece, I just don't know, Cai. I -- so they've announced that they -- I believe that Boeing is now saying that they believe that some additional simulator training would be useful. But myself and Jennifer were at a defense conference -- or commercial and defense conference a couple of weeks ago and listening to the pilot unions at the time, they didn't know anything about it, and they couldn't size it. I gather from what I've heard that there are somewhere in the mid-30s, high 30s MAX simulators on the planet at the moment. And so you could imagine that there could be a need for additional simulators. Our own forecast for flight simulation this year was up just marginally from last year, and our folks believe that actually some of the big flight simulator folks built some white tails last year because we had some accelerated sales towards the back half of 2019 in anticipation of perhaps some additional training. And so they may already be a little bit ahead of that curve and it -- so far, we've not heard anything.

But I could imagine that, that could be a little bit of a pickup. The type of stuff we make is not the type of thing you can suddenly double production in a quarter. So it would be -- you'd have to ramp that up over a few quarters. Our total simulation, flight simulation business, put in context, is about a $70 million to $80 million piece of business in total. So if there was a nice pickup there, you could imagine that might compensate for some of the MAX. But at this stage, again, we just haven't seen it. And I think it's all very fresh.

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Cai von Rumohr, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [4]

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And maybe on the big question, your aircraft process overhaul, maybe update us in terms of what you've done, what people you still need to hire, where you are in process changes and why you said you thought you might do a little bit better at the bottom line than you thought previously.

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John R. Scannell, Moog Inc. - Chairman & CEO [5]

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Well, I was very careful in what I said, Cai. I said potential upsides could be if it was faster than we are planning. So I didn't say we would be better. I said it could be (inaudible) but I just want to be careful on that. I don't want to get ahead of myself as I've done in the past.

So when we're looking at the performance on our operational improvement, let me break it down into 4 categories: people, processes, capabilities and then results. So on the people side, we have continued to add additional talent into the operations. And in the last quarter, we have brought in 2 new leaders on 2 of our major sites, again, just strengthening the bench there in terms of our operational performance. And coming out of the initial supply chain review with our consultants, we're looking at how best to organize our supply chain to reflect both the geographical distribution of it and the way we work together to ensure the planning, buying is combined. And so that's in process. So there's kind of organizational adjustments. None of this is losing people. It's just reorganizing how we work to make sure it's as streamlined as possible. So additional skill -- upskilling, additional talent and reviewing how we're organized to get the best out of it on the people side.

From a processes side, I'd say there's 4 major things that I'd talk about. We've talked about supplier improvement processes. Last time we talked, we said the first initial 3 to 6 months was really about analysis and then piloting, and we are definitely moving into the rolling it out across the supplier community. But keep in mind, as I described in the past, this is a -- because of the fact that you are locked in with suppliers, the time to change suppliers, the time to adjust things take so long, from the time you're rolling out something until you actually see the results, it just takes months and quarters. So -- but we are rolling out those processes. We feel very good about the processes and we've slowed the amount of consulting activity on that because we feel like we're moving from the design it and try it to now we just have to roll it out ourselves. That's on the supplier side.

We've done a lot of work in refining and improving our sales and operations planning process, which is very much around making sure we've got all of the demands, matching it to the operational side. And that itself has shown up that we had some gas in it, which in the past have contributed to misalignments between what we thought we were going to have to produce and what our capabilities were. So we're finding that. Planning processes internally, we're working to improve.

And then the last one I would say is just in terms of metrics and reporting and visibility. We've put quite a lot of time and effort on the IT side to get better, more real-time reporting to understand exactly what's going on. And of course, that's one of the first steps in understanding how you get better. And so we're seeing that. We've got much better dashboards, much better real-time information.

In terms of capabilities, I'd say both from the people and the equipment side, Jennifer mentioned, we are spending more on capital, and we'll continue to do that as we upgrade equipment from where we are, some older equipments or add equipments to free up bottlenecks. And also on the people side, as you go through better planning process, you identify the bottleneck and turns out that in some of these because of demographics, we've lost capability to run the equipment as efficiently and effectively and in the times that we want. And so we're adding staff and capabilities. But again, these are difficult skills of getting a grinder and some of these high-end machining things, it's difficult to find them and then it takes time to bring those people onboard. But we're systematically doing that.

And then finally, in terms of results, Cai, at the moment, we're not seeing it. And we -- this is what we predicted in either cash or margins. I would say our customers are feeling it, though, because part of when you run into some of these supply chain initiatives and internal planning issues is you just start to struggle with making sure you're keeping up with all your customer demands. And we definitely know that our customers are starting to feel better about that. So that's -- we're seeing it there. I think in time, we'll see it. The second thing we should see it on the cash flow as inventory starts to level out and then hopefully as the percentage of sales start to come down and then eventually it will work its way into the P&L. But as we've said, that's the back end of this fiscal year just given the length of time it takes to do these things. So we're on plan. We're working our way through it. It's going to be a continuous month after month, a lot of hard work for people. But we're feeling good about -- we're doing the right things and in time, we'll start to see the results.

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Operator [6]

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Our next question will be from Robert Spingarn with Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [7]

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Just on the MAX, you've been very clear actually. You have a relative advantage, I guess, because you're not very exposed. And based on what you said earlier, it sounds like your profit exposure is maybe $1 million or $2 million if your margin is as you said. Is that about right?

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John R. Scannell, Moog Inc. - Chairman & CEO [8]

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Yes. I did -- but be careful, Rob, I didn't say that. I said you might want to think of it as the average of our aircraft business. But keep in mind, it's marginal contribution. So just keep that in mind.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [9]

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Okay. Fair enough. And on -- about, you said, $30 million to $40 million in revenue exposure there.

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John R. Scannell, Moog Inc. - Chairman & CEO [10]

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Yes, that's our annual revenue. So if it all went away -- I mean we've already got 1 quarter down. So it's -- $10 million-ish a quarter type of number. So it depends on what the rest of the quarters look like.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [11]

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So with this being the case, is there a chance that if this situation disrupts some other suppliers more exposed, weakens them, smaller folks, could they be attractive M&A targets for you?

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John R. Scannell, Moog Inc. - Chairman & CEO [12]

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That's an interesting thought. I think we're always looking for potential acquisitions that are adjacent to what we do. Sometimes adjacency is one step to the left or one step to the right. Sometimes it could be vertical integration. We do some components sensor type of stuff ourselves internally. And obviously, we've got some significant suppliers that own IP on 37, but more on the bigger ones that perhaps they will become available. I'm not sure that, that's going to happen. I think it would be an odd situation that, I think everybody, if you were selling your business, would you sell it now, and even if you did, you'd just look through the MAX situation and say, hey, this is a hiccup, and I want to value it on MAX, a run rate of 50 plus a month. So I'd be surprised. And right now one of the things that we know -- everybody sees is multiples seem to have -- we're on a whole new level. I mean it seems like if you're not in the 13, 14, 15 range, that just -- you're just not paying up. And as I said in the past, we find it very hard unless it's incredibly strategic to justify those types of levels. So if the right thing came along, absolutely. We are constantly looking for acquisitions, and we'd be delighted if something adjacent, similar technologies came along. So we'd be open to that. I think we've got a very strong balance sheet. But I'm not sure anybody's selling is going to say I'm just selling out unless it's a fire sale, which I...

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [13]

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I'm thinking somebody who's distressed because they can't manage this the way you can because they're more exposed.

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John R. Scannell, Moog Inc. - Chairman & CEO [14]

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Yes. That's a good question. We've not really thought about it, a good question.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [15]

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Okay. All right. Now well, just switching over to the defense side of the business. There was a point, maybe it was a year ago, you talked about some pricing pressure. You'd experienced some DoD and some margin impact there. Is there any update to those trends? Anything that's happened since then? And if there are any pressures, how you're managing through that?

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John R. Scannell, Moog Inc. - Chairman & CEO [16]

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I wouldn't say there's any updates. This was a curious thing for me a year ago because, as everybody knows, the defense department is very focused on better buying power, trying to get the best value for their dollar, which is, of course, a completely sensible thing. No, I don't think there's any update on it. I think it's -- we're continuing to operate the business as we do and that pressure we have seen and nobody else seems to see it. Our defense business is doing fine. I said at the time, Defense is still a great business. It's not to suggest defense isn't a good business. But I think across the portfolio, whether it's industrial products, commercial products or defense products, there continues to be additional focus around how all our customers can get the best possible value for their dollar. And that's not changed. And I think that will continue as the defense spending continues to be strong, I think that trend will continue. But it's not something -- I guess I learned my lesson not to say it openly because that caused a lot of concerns at the time. So...

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [17]

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One thing that we have seen from DoD is maybe some effort to change the acquisition approach so that they can own more of their IP and perhaps control more of their sustainment. Have you seen any effort from them or from your customers to change the IP dynamic where you'd have less?

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John R. Scannell, Moog Inc. - Chairman & CEO [18]

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I don't know that we've explicitly seen anything from our customers. But we are very clear, Rob, we're an IP company. And so we spend R&D as part of some of these defense programs to make sure that the key IP is ours, and we've done it on our nickel and it's ours to keep. And so we are very diligent in understanding the IP component of everything that we do and making sure that we are not a build to print, design it -- you guys just design it for us and then we shop it around. That's just not what we do. We have core technologies, and we keep them. And in anything that we do in the defense world, there's an enormous amount of background IP that we've been developing for decades. And so we spend R&D. I think you may notice that in some of these things, I would say we've got a lot of funded development. But we're also spending more of our own R&D dollars on the military side, and that's the kind of -- in parallel with funded development work to make sure that the IP -- the key IP pieces are stuff that we're spending on ourselves and that we're keeping ownership of.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [19]

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Okay. Last one for Jennifer. On the working capital and cash flow, you mentioned H1 is going to be under a little bit more pressure than H2. Are there any negative free cash flow or very low free cash flow quarters we should anticipate? Or really talking about Q2, I suspect. But do you dip negative at any point?

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Jennifer Walter, Moog Inc. - VP & CFO [20]

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Yes. I'm hoping that we will be in good shape for continuing on as we are right now. Certainly, the first half, so Q2 will be under more pressure than the second half of the year. There's -- we look at it all together, inventory, our receivables, our customer advances as we progress through the year. So we don't have a specific number out there for Q2 as far as our free cash flow. But again, we'll have a slower start as we did in Q1 for next quarter. And as we get towards the back end of the year, that's when we still should be able to see some of the benefits associated with our operational improvements.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [21]

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Let me maybe ask it...

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John R. Scannell, Moog Inc. - Chairman & CEO [22]

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We have noticed, Rob, that cash tends to be very volatile. I mean it depends on -- you can get significant receipts the last day of the quarter or they can push into the next quarter. And so that's why we're always very cautious about giving a specific quarterly number because it can move around quite a lot in the space of a week or even a couple of days just based on people actually paying or not paying. So...

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [23]

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Right. And I was noticing you had a couple of negative quarters out over the last 2, 3 years, but they're random. And so I just wanted to be prepared for that if that was the case in Q2.

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Jennifer Walter, Moog Inc. - VP & CFO [24]

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Yes. When we typically -- like John said, we do have these random quarters. And so when we look at our cash, we typically look at it over a few quarters in a row so that we eliminate that randomness for when we're actually looking at it from an operational perspective.

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Operator [25]

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Our next question will be from Kristine Liwag from BAML.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [26]

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Your margins in Q1 across all 3 segments were trending higher than your expected full year outlook for fiscal year '20. What are the headwinds that you're expecting that full year margins will be lower than where you are this quarter?

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John R. Scannell, Moog Inc. - Chairman & CEO [27]

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Okay. So let me walk through them. So if I take aircraft, we did 11.4% in the first. We're guiding to 10.5% for the year, Kristine. I think I mentioned that we had a relatively positive mix. We had some good foreign military stuff in the first quarter, and we had relatively lower expenses. And as we go through the rest of the year, that mix will not be as positive because we just shipped a bunch of stuff in the first quarter because of the timing based on what our customer wanted. So that we kind of unwind. It was -- it is forecasted in the year. We just happen to get it in the first. And then the expenses in the first were just lower than what we're anticipating for the year, both on some of the G&A stuff and on the R&D, and we continue to add some staff to try and meet the goals that we have until we should see those expenses creep up as well. So that's why first quarter was better in aircraft, but we're guiding to slightly lower for the year.

But look at Space and Defense. It just had a very strong first quarter. I mean if you look at their number, the 13.6% in the first quarter versus 11.8% last year, I mean, there was just some nice orders, nice business, nice could be profitable mix. For the year, we're guiding to 13%. We did 13% last year. So I think, again, we see expenses picking up a little bit as we move through the year. As we try to add engineering talent and some sales and operations folks to meet the ramp in terms of production. So I think that's in the -- it's in the ballpark.

And with industrial, we're guiding -- we did 11.7% in the first, and we're going to 11.1%. Now the 11.1% is down from, I think, what we said last quarter, which was 11.4%. And the reason for that is we've added $35 million to the top line for the GAT acquisition, and we're not adding any operating profit because we've got first year accounting adjustments. And so that of itself takes out about 30 basis points of margin. And so if you put that back in -- because in the first quarter, it had negligible sales. It only had a couple of million dollars. So it wasn't really there. You get -- you're in the 11.7% in the first, 11.4% for the year, kind of there or thereabouts. So it's not -- there's not a big shift in that. And the worry there, as I mentioned, is softening industrial automation in Europe, and that's typically a higher margin piece of business for us.

So I think there -- it's a nice start to the year. But there's reasons why the first was a little bit better than we had anticipated. Some of it was timing of various things. Some of it was slower buildup of expense, and some of that I think will normalize as we go through the year. So for the moment, we feel like we don't want to get ahead of what we said before.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [28]

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That's helpful, John. And when you think about your EPS range for fiscal year '20, what are the 1, 2 or maybe 3 things that has to go your way to get to the upper end of your EPS outlook?

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John R. Scannell, Moog Inc. - Chairman & CEO [29]

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So at the end of my comments, I tried to give a couple of possible upsides and downsides. I think the upside is defense spending is going -- is very strong, and it continues to be strong. And so I could see that, that may be stronger than we're anticipating. And the operational activities in aircraft, maybe we start to see some benefits from that until the back end of the year sooner than we had anticipated. So those -- I think those are the big 2 that I'd say -- maybe simulator training, maybe there's some additional orders that come in there. We talked about that earlier for flight simulators. So that could be positive upsides. But I temper that with the fact that the industrial economies in Europe are weakened -- weakening, and our folks there are feeling like we're not -- we're still not seeing the bottom, and so there's a worry that, that could get worse than we're anticipating. And the MAX, we've not built into our outlook at this stage any potential impact on the MAX because, as I said, there's too much movement around at the moment to be able to say this is what we think it looks like, and rather than guide to something -- guide the market to something and then say in 90 days, well, no, that wasn't that we changed it around. We're essentially -- we left the MAX in at the rate that we were asked through the first quarter, which is the 42 a month. And so that is clearly optimistic. And so there's some amount of downside associated with that. We just haven't quantified it yet. So you got pluses and minuses, Kristine.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [30]

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That's really helpful. And maybe last question for me, and it's for Jennifer. Jennifer, how are you thinking about the incremental share buybacks? And what would you have to see in the market to buy back more shares at this point?

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Jennifer Walter, Moog Inc. - VP & CFO [31]

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So Kristine, thanks for the question. We're -- we do look at all of these things in deploying capital on kind of a full basis. So we do consider what's going on in the M&A pipeline. When we're looking at deploying capital, we do look at our share repurchases on an opportunistic basis. Obviously, we've got the dividend as part of our capital deployment strategy as well. We consider where we are from a leverage standpoint. So right now, we're at the 2.3x levered position. So we really look at all of that together in a comprehensive way when we're making those decisions. We don't -- we haven't historically shared what we are doing until after we would execute at the quarter. So if we do any share repurchases, we'll report back on a quarter from now.

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Operator [32]

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(Operator Instructions) I'm showing no further questions at this time.

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John R. Scannell, Moog Inc. - Chairman & CEO [33]

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Thank you, Carrie. Thank you all for listening in. I hope in 90 days' time, I hope the MAX will actually be recertified. I mean, I think that's in all of our interests. And hopefully, there'll be additional clarity around Brexit, and we won't have a trade dispute with Europe. And now we look forward to reporting out in 90 days' time. Thank you all for your time. Thanks, Carrie.

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Operator [34]

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Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.