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Edited Transcript of MOG.A earnings conference call or presentation 26-Jan-18 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2018 Moog Inc Earnings Call

EAST AURORA Feb 1, 2018 (Thomson StreetEvents) -- Edited Transcript of Moog Inc earnings conference call or presentation Friday, January 26, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ann Marie Luhr

Moog Inc. - Manager of IR

* Donald R. Fishback

Moog Inc. - VP, CFO & Director

* 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 and Senior Research Analyst

* Kristine Tan Liwag

BofA Merrill Lynch, Research Division - VP

* Michael Frank Ciarmoli

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* 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 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Ann Luhr. Please go ahead, ma'am.

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Ann Marie Luhr, Moog Inc. - Manager 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 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 26, 2018, our most recent Form 8-K filed on January 26, 2018, and in 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 a document, a copy of today's financial presentation is available on our Investor Relations' 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 '18 and affirm our operational guidance for the full year. Overall, it was a good quarter and a healthy start to our new fiscal year.

Let me start with the headlines. First, we celebrated another first flight this quarter when the V-280 Valor took off for the first time on December 18. This helicopter is 1 of the 2 candidates for the Army's Future Vertical Lift program, a replacement for the Blackhawk. And we're delighted to be teamed with Textron on this incredible vehicle.

We also received the Development Supplier of the Year award from Embraer for our work on the E2 flight controls program, honoring the hard work, dedication and skill of our engineering team.

Second, our underlying operations performed well this quarter. Excluding the effects of tax reform, our underlying business delivered $0.93 per share, above the high end of our guidance from 90 days ago. Free cash flow in the quarter of $23 million was in line with our expectations.

Third, we took some charges this quarter in connection with the new tax legislation in the U.S. Tax reform will be a longer-term benefit for Moog but was a drag on earnings this quarter.

Finally, macroeconomic forecasts for each of our major markets of commercial aerospace, defense and industrial continue to be bullish. Commercial delivery rates continue at record levels, and OEM backlogs remain strong. Defense spending is poised to accelerate in the U.S. in response to years of budget tightening and increased global security threats.

In addition, GDP growth is healthy in most of our major industrial markets. Sustained periods of GDP growth eventually translate into accelerating capital investment, which in turn, trickles down to increased demand for our products. This bullish outlook for our major markets gives us confidence in our forecast for this year and optimism about our longer-term outlook.

Now let me move to the details, starting with the first quarter. Sales in the quarter of $628 million were 6% higher than last year. About 1/4 of the increase was due to stronger foreign currencies relative to the dollar. Sales were up in each of our 3 operating segments.

Taking a look at the P&L. Our gross margin was unchanged from last year, but R&D expense was down on lower spending in the Aircraft group. SG&A was up as a percentage of sales as a result of the timing of various expenses and plans higher selling expense in select growth markets.

There's a lot of movement in the tax rate this quarter, which Don will explain in more detail later. Including the impact of tax reform, net income was $1 million and earnings per share were $0.04. Excluding the impact of tax reform, net income was $34 million and earnings per share were $0.93, up 11% from last year.

Fiscal '18 outlook. We're keeping our sales guidance for fiscal '18 unchanged from 90 days ago. We anticipate full year sales of $2.62 billion. Excluding the impact of tax reform, we're also keeping our projected EPS unchanged at $4.10, plus or minus $0.20. Adjusting for the tax impact, the new range for EPS is $3.43, plus or minus $0.20.

Now to the segments. You remember that at the end of last fiscal year, we split our Components group into 2 major markets and integrated them with the Space and Defense and Industrial segments. As a result, our reporting going forward covers 3 segments. I'd also remind our listeners that we provided a 2-page supplemental data package posted on our website, which provides all the detailed numbers for your models. We suggest you follow this in parallel with the text.

Starting with the Aircraft group, sales in the first quarter of $279 million were 4% higher than last year. On the commercial side, sales to Boeing were about flat with last year, but sales to Airbus were up nicely on the continued ramp-up of the A350 program. Sales in the commercial aftermarket were up in the quarter also on strong initial provisioning for the A350.

On the military side, sales were down 3% on a slow start to the F-35 program as well as a soft aftermarket. The relatively low military aftermarket was driven by lower B-2 activity as that program winds down and some technical challenges on the V-22, which are now behind us. We anticipate the V-22 aftermarket will recover as we move through the year.

Aircraft's fiscal '18. Given the experience of the first quarter, we're tweaking the sales mix slightly. The F-35 sales will accelerate as we move through the year and start work on LRIP-11. But given the slow start in Q1, we're moderating the full year forecast by $10 million.

On the commercial side, we're updating our production rates for both Boeing and Airbus, resulting in $5 million higher sales to Boeing and $5 million lower sales to Airbus. Finally, given the strong start to the year for the commercial aftermarket, we're increasing that forecast by $10 million for the full year. The net result is full year sales of $1.18 billion, unchanged from 90 days ago.

Aircraft margins. Margins in the quarter of 11% were up nicely from last year. Our gross margin was up on a more favorable sales mix, and we had 170 basis points lower R&D than last year. The first quarter R&D of $18 million is below our projected run rate of $20 million per quarter this year. The lower spend in the quarter was the result of material receipts for development programs that pushed into Q2. We still anticipate full year R&D spend in the Aircraft group will be $80 million as projected 90 days ago. For the full year, we're anticipating margins of 10.6%, unchanged from last quarter.

Longer-term outlook. Our aircraft markets remain strong. As production rates continue to ramp on both the commercial and military sides, we remain focused on execution and margin expansion. We're working to strengthen our supply chain and exploit lean techniques to reduce the cost of our OEM book.

In parallel, our commercial R&D is coming down as we slowly wind up development programs and transfer our engineers to funded military programs. Our aftermarket is showing signs of improving with a lot of runway to go as fleets grow and our targeted initiatives to win share bear fruit.

Turning now to the Space and Defense group. Sales in the first quarter of $133 million were 9% higher than last year. Sales into the defense market were 11% higher on continued strength in ground vehicle programs, both in the U.S. and Europe, as well as higher sales on the Guardian program. Sales into the space market were up 5% on robust sales of avionics products for satellite applications.

We're leaving our forecast for the full year fiscal '18 unchanged for Space and Defense. We anticipate full year sales of $547 million, up 3% from last year. The sales total is a combination of approximately $200 million in the space market and $350 million in the defense market.

Space and Defense margins. Margins in the quarter of 12.2% are a healthy start to the year. In the first quarter last year, margins in this business included a $9 million write-off associated with the divestiture of our European space facilities. Exclusive of that impact, margins this quarter are actually down from its very strong performance last year. The exceptional performance last year was a result of a very unusual and favorable sales mix in the quarter. For the full year fiscal '18, we're keeping our margin forecast unchanged at 11.5%.

Longer-term outlook for Space and Defense. Over the last 2 years, we've refocused our Space business to concentrate on the U.S. market, and we're now seeing benefits in our win ratio for avionics and new military platforms. A major long-term focus for us in this segment is to win a significant position on the GBSD program, the modernization of the ground-based nuclear deterrence capability. We're encouraged by the recent commentary coming out of Washington and the Department of Defense, which suggests accelerating funding to this initiative and to defense programs in general.

Overall, our Defense business is showing encouraging signs. One example of note is that after several years of investment, this quarter, we won a first order for our remote integrated weapons platform, a product which we believe has significant potential for the future.

Turning now to Industrial Systems. It was a good start to the year for Industrial businesses with sales of $216 million, up 9% from last year. One-third of the growth is due to stronger foreign currencies relative to the U.S. dollar.

We organized our Industrial sales into 4 major markets. In the energy market, sales were up nicely on higher shipments of products for onshore drilling applications, while sales to our wind customers were flat with last year. Sales were also up in our industrial automation market across a broad range of our traditional customers. Simulation and test sales were up double digits as we shipped several systems for auto test applications and enjoyed strong sales of simulation systems for entertainment purposes.

Finally, sales into the medical market were up on higher component sales into a variety of end-market applications. Sales of pumps and sets were about flat with last year.

Fiscal '18 outlook. We're leaving our full year sales forecast unchanged from 90 days ago at $894 million, a 6% increase from fiscal '17.

Margins. Industrial margins in the quarter of 8.9% are a slow start to the year but in line with our expectations. In this quarter, we had a couple of onetime charges which will not repeat in future quarters. Our margin forecast for the full year is unchanged at 11.2%.

Longer-term outlook. Most of our traditional industrial markets around the globe are strengthening. Wind remains a challenge, but even our exploration business, which is tied to the price of oil, is marginally up from the low point in fiscal '17. Our broad approach to the industrial markets is to work closely with our customers to solve their problems and create value in their applications. We're investing to grow both our traditional hydraulics business as well as our electric drive business with new technologies and products.

We believe advanced automation has a bright future in applications ranging from service robots to autonomous systems. Moog has deep expertise in motion technology, and our experience across markets, from the far reaches of outer space to the depths of the ocean, position us ideally to create advanced technical solutions that the average supplier of motion products is unable to match.

Summary guidance. Q1 was a good start to the new fiscal year. Earnings per share adjusted were above the high end of our guidance and cash flow was in line with our expectations. Our Aircraft business is strong and margins are on the rise. Space and Defense is also doing well after a couple of years of portfolio cleanup. Our Industrial businesses are off to a slow start, but our book-to-bill is firmly above 1 and our backlog continues to build.

The macroeconomic outlook for our major markets is bullish, and we're pleased to affirm our guidance from 90 days ago. Tax reform is a real positive for the long term but a drag this quarter and for the year. All in all, a quiet quarter on the operational front but a good -- a quarter of good news on the macroeconomic front and great news on the tax front.

I like to finish my remarks each quarter by offering some thoughts on the upside opportunities and the downside risks associated with our forecast. On the positive side, the Aircraft business is doing well, and we could see upside in both the commercial and military aftermarkets. On the negative side, our wind business continues to be a challenge. Our new products are meeting their technical and cost goals, but increased price pressures in the broader market for wind turbines continue to put stress on our business model.

As always, we try to provide the market with a forecast which balances these pluses and minuses. Exclusive of tax reform, adjusted full year earnings remain unchanged at $4.10, plus or minus $0.20. For the second quarter, we anticipate earnings per share of $1.10, plus or minus $0.10.

Now let me pass it to Don, who'll provide more details on the tax reform impact and some color on our cash flow and balance sheet.

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [4]

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Thank you, John, and good morning, everybody. It's certainly a complicated quarter with the impact of the enactment of the Tax Cuts and Jobs Act on December 22. I'll do my best to reconcile reported EPS and free cash flow to our adjusted results that are exclusive of tax-related effects from the Tax Act. Despite the nearer-term earnings and cash impacts, the Tax Act is beneficial to us over the longer term.

At a macro level, adjusted EPS and free cash flow were better than our expectations coming into the quarter. As John said, adjusted EPS was $0.93 a share, above the high end of our guidance range from 3 months ago. With only 1 quarter behind us, we're affirming the midpoint of our 2018 full year adjusted EPS guidance at $4.10 a share.

Free cash flow in Q1 was $23 million, slightly better than the slow start we were expecting, and we're affirming our forecast for adjusted free cash flow for all of 2018 at $135 million, representing an adjusted conversion ratio of about 90%. The business is performing well.

Starting with EPS. The $0.89 per share difference between the Q1 reported GAAP EPS of $0.04 a share and our adjusted EPS of $0.93 per share is comprised of 5 tax-related elements.

First, the transition tax on our offshore cash and earnings results in a charge to our Q1 earnings of $0.85 per share. We have in excess of $350 million of offshore cash. This transition tax results from applying the Tax Act's statutory rate of 15.5% and 8.0% on cash and noncash assets, respectively, offset by level foreign tax credits.

Second, our plan is to repatriate to the U.S. as much of our existing offshore cash as possible and our future earnings. This results in a Q1 charge for estimated withholding taxes of $0.41 per share.

Third, we have a rather minor charge to our Q1 earnings for the revaluation of our deferred taxes of $0.03 per share. This reflects deferred tax assets and liabilities that were remeasured at the old rates -- that were measured at the old rates, sorry, and must now be revalued.

Fourth, the reduction of the corporate tax rate to 21% from 35%, per the Tax Act, reduces our effective tax rate for 2018 and results in a Q1 tax benefit of $0.07 per share. For all of 2018, our estimated adjusted effective tax rate, reflecting the lower statutory corporate tax rate, is 26.2% compared to last quarter's forecast of 31.0%. The 26.2% reflects 3 quarters of the reduced statutory rate because our fiscal year ends in September. This lower 2018 tax rate, in isolation, increases our projected EPS for 2018 to $4.40 a share from our current adjusted guidance of $4.10 a share.

Fifth and last, we had the opportunity to manage contributions to our U.S. defined benefit pension plan in a tax-efficient manner. We're planning to accelerate contributions into the DB plan that we were otherwise planning to make in 2019 and 2020 and receive an incremental tax benefit of $0.33 per share. All of that benefit gets recorded in Q1 of 2018.

So in the first quarter of 2018, our effective tax rate computes to just under 100%. Removing the effects of the new legislation, the adjusted effective tax rate in Q1 is 29.6%. This compares with last year's first quarter, where we had a very low tax rate of 17.6%, and that was because of divestitures. Stripping out the effect of the divestitures, the clean effective tax rate last year, Q1 of '17, was 28.7%. Accordingly, the adjusted tax rate for Q1 this year versus a year ago is pretty consistent.

For all of 2018, we're now forecasting an adjusted effective tax rate of 26.2%, inclusive of the ongoing benefits of a lower corporate statutory rate. And a very preliminary look at 2019 suggests that our effective tax rate will be in the 25% realm as we benefit from a full 12 months of the lower U.S. corporate tax rate.

In summary, the important takeaway is that after removing the tax effects of the new legislation, our adjusted EPS in Q1 was $0.93 a share, and we're still forecasting adjusted EPS for all of 2018 at $4.10. More concisely, our operations remain on track, as John described.

Now let me turn to free cash flow, which will also be affected by the Tax Act. Free cash flow in our first quarter was $23 million compared to our projection for all of 2018 of $135 million. We expected a slow start to the year. However, cash flow came -- actually came in a bit stronger than we expected due to the timing of some cash advances. For the year, we expect our adjusted free cash flow to still come in at $135 million, unchanged from our forecast from 3 months ago. This represents an adjusted cash conversion ratio of about 90%. Our free cash flow from operations is on track.

However, as we report our future results, we'll end up reporting free cash flow of $85 million for the year. So what's causing the $50 million difference between adjusted and the unadjusted free cash flow? As I referenced earlier, we're accelerating $85 million of cash contributions into our U.S. DB pension plan in 2018, and those accelerations will come from 2019 and 2020 as we otherwise had planned, for which there's an offsetting cash tax savings. This accelerated pension funding strategy generates an economic savings of $12 million as we will receive the benefit of a tax deduction on our 2017 tax return at 35% instead of the newer -- or instead of the new lower rates.

I'm hoping that our description of the effects of the new legislation on EPS and free cash flow is helpful. As John noted early on, we have provided supplemental financial data on our website that may be useful in understanding this busy quarter. Allow me to move on, so we can get to your Q&A.

Net debt decreased $22 million compared to free cash flow of $23 million. Net working capital, excluding cash and debt, as a percentage of sales increased to 26.7% at the end of Q1 compared to 25.4% a year ago. And this increase is largely due to timing of product shipments, mostly in our Industrial group, and we're expecting to show a year-over-year decrease in this metric as we report out at the end of this fiscal year.

Capital expenditures in the quarter were $21 million, and depreciation and amortization totaled $22 million. For all of '18, we're -- our forecast for CapEx remains unchanged at $95 million. D&A in 2018 will be about $90 million.

Cash contributions to our global pension plans totaled $19 million in the quarter compared to last year's first quarter of $17 million. For all of 2018, we're now planning to make contributions totaling $181 million, up about $85 million from our previous forecast. By accelerating these contributions into 2018, our U.S. DB pension plan will be close to fully funded by the end of 2018. As a result, we don't expect to be making any significant cash contributions to this plan over the subsequent few years. Our recent historical norm has been about $60 million of annual contributions into the U.S. DB plan.

Global retirement plan expense in the first quarter of '18 was $15 million, similar to last year. Our global expense for retirement plans is projected to be $58 million in 2018, down from last year's $64 million.

Our leverage ratio, net debt divided by EBITDA, decreased to 1.85x at the end of Q1 compared to 2.1x a year ago. Net debt as a percentage of total capitalization was 31.7%, down from 41% a year ago. At quarter-end, we had $516 million of available unused borrowing capacity on our $1.1 billion revolver that terms out in 2021.

I'd like to wrap up by commenting on 2 more topics: global cash management and capital deployment. At the end of the quarter, we had just under $400 million of cash on our balance sheet. Most of this cash is offshore. As a result of this -- of the tax legislation, we're planning to bring back to the U.S. as much offshore cash as possible and as soon as practicable. We are targeting to repatriate approximately $250 million by the end of 2018, and we'll manage the rest of it timely and appropriately. Our current plan is to pay down our outstanding revolver. This will increase the unused available capacity under our revolver but has no impact on our leverage as our net debt position is unchanged.

Lastly, capital deployment. We've shared previously, our target leverage is between 2 and 2.5x. That's net debt divided by EBITDA. We're currently below our target range and are forecasting solid cash flow from operations, excluding this year's revised pension funding strategy. Over the last 5 years, we've had very little to report with respect to acquisitions. However, we continue to see a lot of pipeline activity. We believe that we can provide attractive returns for our shareholders by growing the business strategically.

We remain disciplined and are focused on both organic and acquisitive growth. Organically, we're increasingly optimistic that the headwinds we've discussed over the past number of years are finally shifting to tailwinds. And we're looking forward to the time when we can report on strategic acquisitions that will complement our overall growth strategy. Growing the company both organically and through acquisitions will provide optimal returns over the long term.

With that, I'd like to turn you back to John and answer any questions that you may have.

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

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Thanks, Don. Cody, we'll take questions now, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Cai Von Rumohr with Cowen and Company.

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

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So with the pull-forward of R&D from the push-forward from the first to the second quarter, how big was that? That was -- and that's an earnings plus $2 million, correct or not?

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

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Yes. Well, our projected R&D in Aircraft for the year, Cai, is $80 million, so that's a run rate of $20 million a quarter. We did about just under $18 million of R&D expense in the first quarter. But the difference was that there was material and receipts. So when you do development programs, the materials for the development programs, prototype systems, first systems that we typically deliver to customers, that gets booked on the R&D line.

And we anticipated some significant material receipts in the quarter in the order of a couple of million dollars. They didn't come in, but they just come in the second quarter. So we think that the second quarter is maybe a little bit north of the $20 million, but for the year, we're sticking with the $80 million. So yes, a positive impact on the P&L in the first, but for the year, we don't think it'll have any change.

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

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Got it. Okay. And then so why -- with the E2 looking like it's doing very well and going to deliver in the next couple of months, how come it's still an $80 million number and it's not coming down?

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

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Well, I think we worked our way through that at the end of last quarter. Typically, what we've seen -- I mean, we're still running R&D, Cai, on the 87, and that's been in delivery for -- at this stage, it's probably close to 7 or 8 years. We still have derivatives on the A350.

For the E2, I think the first -- it's the first model that's being delivered, but there are derivatives that we will be working on. And typically, our R&D profile is that it runs several years past first deliveries of an airplane. So it's not that -- there's typically multiples. The A350 we're doing the 1000, the 787 with the -10.

So it starts to wind down, but it takes a little bit longer than you think. And even after first delivery, typically, there's final tweaking, there's experience that's coming in from the actual flight hours. And typically, that absorbs R&D that you might say, well, it's delivered so we're done, and that's typically not the case.

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Cai Von Rumohr, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [6]

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Got it. So I guess I'm a little confused on -- so the total pension contribution you mentioned, $181 million. Is that both the U.S. and the foreign plans (technical difficulty)?

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [7]

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Yes, yes, that would be everything included. That's correct.

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Cai Von Rumohr, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [8]

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Okay. And that number goes to what in 2019 -- to zero?

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [9]

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(inaudible) give that number, but it's going to be down -- we've got $85 million of surge in '18, and my remarks said that what we had otherwise been planning in the future is -- well, yes, $60 million was our run rate. So I guess you can say the $85 million increment plus the total that we're making; otherwise, is about $45 million. So it'll be down about -- I'm doing this math in my head, about $130 million or so.

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Cai Von Rumohr, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [10]

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Okay. So that's a pretty significant cash flow plus as we look to next year. Okay. Great. And -- okay, terrific. And then maybe if you look at Industrial, I guess, from what you said, the margins looked like -- the margins looked a little light in this quarter and then looks like they come back like gangbusters in the next quarters. Maybe give us a little more color there.

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John R. Scannell, Moog Inc. - Chairman & CEO [11]

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So you're right, Cai. That is the case. There were a couple of onetime issues this quarter that -- there was a technical issue on a program that we had to take a little bit of a charge for, and there was some other expensing that came through. So there were a couple of things that were pushing the margin down.

We also see -- as we go through the year, though, we see, I think, the sales pick up a little bit as we move through the year. We've seen the backlog improve. We've seen the book-to-bill ratio improve. And so we're feeling comfortable that margins will pick up.

If you ask me, where do you see the upside and downside, I think there's a stretch maybe on the Industrial side to get to the margins. On the other hand, the Aircraft margins are coming down through the year based on the first quarter. So again, it's some puts and takes. But we have the backlog. We think there's a -- as I say, there were some specials in the first quarter, so we're optimistic that those margins will improve as we go through the year.

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Cai Von Rumohr, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [12]

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Terrific. And lastly, your Space and Defense margin was particularly strong, and sort of your guide assumes it's not going to be quite as strong as we move through the year. Kind of help us understand that pattern.

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John R. Scannell, Moog Inc. - Chairman & CEO [13]

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I think that's just -- it was a good start to the year. We're maybe being -- again, maybe being a little bit conservative on that. But right now, the business is looking solid, but the growth in the first quarter is kind of ahead of what we anticipate the growth for the year to be. So for the first quarter, we had growth of 9%. For the year, we're forecasting growth of 3%.

So we're not anticipating that it's going to keep going quite as well as that. The first quarter was stronger than we anticipated. Actually, the Space business, if you take out the impacts of the divestitures we made last year and the last sales of those, the Space business was up in the double digits growth as well. It was very nicely up. So we're just not anticipating that that's going to continue.

Some of the vehicle stuff that's been really strong over the last year-or-so, we think that's going to come down a little bit as we move through the year. So it's -- again, it's a little bit of a balance -- good start to the year, feeling comfortable about it, but as you pointed out, Industrial has a bit of a hill to climb. The other 2 businesses maybe don't have so much of a hill to climb. I think if you put it together, it's probably a pretty balanced outlook.

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Operator [14]

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We'll now take our next question from Rob Spingarn with Credit Suisse.

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

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Some very good numbers here, some really good growth rates in the first quarter. I wanted to ask you, just to follow up on what Cai was talking about a moment ago and how you were answering him, is there any area where it was just timing? Because on the Space and Defense, John, it sounded like that was not the case. It's just you don't want to rely on it to continue necessarily, and if it does, it does.

In other words, if you could just review where you did have pull-forwards and where you didn't so we get an idea which business lines actually do have upside.

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

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Well, so let me kind of walk you through some of them. So we definitely see sales upside on the F-35 as we move through the year. We had a slow start to the year. I think I mentioned LRIP-11. That should start to kick in in the second quarter. So we see the F-35 ramping up as we move through the year from the run rate of the first quarter.

We think the military aftermarket will ramp up as we move through the year from a pretty slow start in the first quarter. Run rate in the first quarter was about 170. We're anticipating almost 190 or a little bit above it for the year. So both of those were kind of slow starts.

On the aftermarket side, we had a very nice -- well, we tweaked the OEM book. But the OEM book, we think, is kind of running pretty much on plan. The A350, of course, will continue to ramp as we move through the year, so you'd see a ramp-up on that.

And on the commercial aftermarket side, we had a very strong start to the year. We were surprised at how strong the A350 initial provisioning was, and we're not anticipating that that's going to continue. So you look at the run rate for the commercial aftermarket, it's 135 on the base of the first quarter, but we're thinking we're going to be closer to 120.

Maybe that's a little bit conservative. On the other hand, as I say, we were surprised by how much IP we had, particularly on the A350 as that -- as the fleet starts to grow there. So that's on the Aircraft side.

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

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Okay. Before you go on, can I just ask a question or 2 on that? Was all of this outperformance in commercial aftermarket A350? You've been very clear that that was the strength. Is there anything else going on there? Was there any offset, any strengths or weaknesses elsewhere?

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

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I'd say the IP on the 87 -- well, the aftermarket on the 87 was also a little bit stronger. One of the things that we have learned, which, I guess, we didn't anticipate, Rob, is that we were using traditional IP models to predict how much IP we would have.

So when I say traditional models, the 87 -- sorry, the 777 historical-type numbers, where you typically have the hub-and-spoke type of business model. But the 87 is a point-to-point model, and therefore, what we discovered is that there's more IP going into the market because they're positioning it at airports that wouldn't be long to admit -- so you wouldn't necessarily do that if you were flying hub-and-spoke type of routes.

And so that seems to have driven more IP on the 87 because for the last couple years, we've reported again and again that the 87 IP is above what we thought, so we kept thinking it's coming down. It may well be that we start -- we'd see something similar on the A350. So that was -- I've said the IP both the 87 and 350 were strong.

We also have a -- not a retrofit, a kind of -- I don't know how we exactly describe it. But in the 757 campaign that's going on that we've worked with some of our airline customers for some retroactive work there, and that gave us a shot in the arm as well in the first quarter that is beyond what we anticipate for the full year.

So a little bit of a specialty campaign on the 57; A350, 87 IP doing a little bit better than planned. So -- but for the year, we're -- we don't want to get too far ahead. Last year, we did $118 million in our commercial aftermarket. Previous year, we did $113 million. This year, we're forecasting about $123 million.

So it's up from last year, from the last 2 years. It's just the run rate in the first quarter was particularly strong, and we don't want to bank on that keeping going. So...

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

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Okay. Okay. And then if I could let you go back to where you were about to go.

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John R. Scannell, Moog Inc. - Chairman & CEO [20]

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Yes. So the Space and Defense. If I look at the Space run rate for the first quarter versus the run rate for the year, it's about in line. First quarter was pretty much -- it was about a $50 million [total] in the first quarter. That gives you $200 million for the year, and that's pretty much what we're forecasting.

On the Defense side, run rate in the first quarter was about $335 million, $340 million. We're forecasting a little bit of an uptick in that as you go through the year.

The big thing that you have to keep in mind, Rob, in our Space and Defense business is it's the mix of developments versus production programs. And so if I go back a year, we had a blowout first quarter last year in terms of margins. And it just happens that a series of contracts -- contract close up, some of the profit rates were higher than we had anticipated, and we had a nice mix between production, that means higher production, and relatively low-cost plus development-type work, or cost reimbursed development work.

And so this quarter, even though it was a very good start, it was down from a blowout quarter, the first quarter last year. But if you looked last year, at the first quarter relative to the rest of the year, you got to take out the fact that we had a $9 million divestiture charge. But you would have seen those margins come way down from -- I think they were in the 16%, 17% for just our Space and Defense group, x the Components group at the start of last year, and then they moderated down.

So it is true that in the Space and Defense business, depending on the mix, depending on the production versus development, depending on the programs that actually watch you ship, et cetera, we do tend to see fairly large fluctuations in the margins, which (inaudible) a reflection of kind of major changes in the underlying business. It's just the mix.

And so as we move through the year, we had a nice start in the first quarter, nice mix, but that mix we anticipate is not going to stay at that level. Now it's not a dramatic shift as we move through the year. For the quarter, we had margins that were coming in at 12.2%. We're forecasting 11.5% for the year. So it's kind of -- it's a little bit of a softening of margins on a similar run rate but not something that I would take much away from.

So -- and then Industrial is the one where we do anticipate a margin pickup as we go through the year. And that's partially sales driven -- a lot of it is sales driven. And as I said, we had a couple of onetime charges in the first quarter that we're hoping and anticipating don't repeat as we go through the year. So...

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

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Right. And then back to Defense for a moment, is there any sensitivity in your business to this lingering budget situation?

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

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I'd say our entire Defense business is susceptible to what they decide to do with the DOD budget and in Washington, or at least a very large proportion of it. Having said that, we've been operating under this -- both sequestration and continuing resolutions for quite a few years. And our Defense outlook, we have not assumed that there's going to be a major pickup in defense spending.

I mean, we're optimistic, whether it's the budgets coming out of the Senate or the House or the White House. Everybody says we got to spend more on defense. And the fleet availability is not what it needs to be and more missile-defense, et cetera. So we're optimistic that that could have a pickup, but we're not baking that into what we've got forecasted. We're baking in the programs that we see at the funding rates that we believe are already pretty much in place. So...

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

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Okay. I guess I was just getting at -- I should have asked it more clearly. Is there any new program that relies on a big funding increase here that you'd be exposed to if the CR extends and that increase is delayed?

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John R. Scannell, Moog Inc. - Chairman & CEO [24]

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I don't think so. There are a couple of initiatives that we've got going where we anticipate potential opportunities in what I'd call special ops type of things. I mean, they're not the big programs that anybody would call out. But there are various things that we do with the special ops side folks where they're looking for a particular system or a couple of systems, and we probably have some of that baked in.

But I wouldn't say that's out of the ordinary. It's what we've seen in the past. It's not the type of stuff that gets CR -- that the CR is affected by, I think, it's different. It's not a huge number, but perhaps there's a little bit of that baked in in the out quarters, assuming some special [op] or small volume type of response to particular threat type of issues, but not something, I think, that gets caught up in the broader budget in Washington.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [25]

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Okay. And just last thing, you may have already talked about this. You said Boeing, I think this was OE, $5 million above initial plan; and Airbus, the opposite.

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John R. Scannell, Moog Inc. - Chairman & CEO [26]

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Yes.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [27]

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Did I catch that? What were those again? What was behind that?

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John R. Scannell, Moog Inc. - Chairman & CEO [28]

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Well, it's Boeing is just -- so we do long-term contract accounting, Rob, so a little bit of this is how the inventory and unbilled receivables flow as you go through the year. Some of it, of course, is actual run rates that we're seeing on the book of business that we have.

So the first quarter, on the Boeing book of business, we did just over $60 million. That gives you a run rate of just north of $240 million for the year. But our run rate for the year, we were down in the kind of the $230 million range. So we just bumped that up a bit on the evidence of the first quarter.

And then on the Airbus side, it actually is. The 350, we anticipate that there'll be slightly lower volume than we were anticipating coming into the year. I think we think there's 4 or 5 shifts that kind of floated into the following year.

So -- again, keep in mind that -- our -- we're probably 3 to 6 months ahead in terms of our billings and our -- what's on our sales line versus what the airline is doing. So it's difficult to connect it exactly one-for-one, but we're just seeing a little bit of a slower ramp on the A350 than we thought.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [29]

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All right. And then just, Don, you were very clear that the cash flow adjustment, operating cash flow, that's entirely the pension contribution, the $50 million after tax. Are there any moving pieces that we don't see? Any changes in how you think working capital will flow? I think CapEx holds as is.

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [30]

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No. The -- I think the quick answer is no. Just to be a little bit more specific, maybe -- this may be behind your question. But the Tax Act effects from a cash perspective in 2018 are negligible. So...

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [31]

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I meant fundamentally. Anything outside of tax that moves around but doesn't change the net guidance?

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [32]

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The answer is no. We're still focused on -- that's why I was trying to convey that $135 million adjusted free cash flow target before you get into the pension and the related tax issue, and we're still on track.

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Operator [33]

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We'll now move on to Kristine Liwag with Bank of America Merrill Lynch.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [34]

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John, in your prepared remarks, you discussed some opportunities in industrial automation. Can you provide more color on which industries are driving growth? And also, how much of the growth that you're seeing today can be attributed to return of manufacturing in the U.S.? I know that's a topic that we've discussed in the past. And how much of that is really just related to recovery right now?

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John R. Scannell, Moog Inc. - Chairman & CEO [35]

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So your first -- the first part of your question was -- I'm trying to remember the first part of your question, Kristine. Was it specific to...

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [36]

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Industrial?

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [37]

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Yes. For industrial automation, which industries and markets are driving that growth?

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John R. Scannell, Moog Inc. - Chairman & CEO [38]

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Yes. So I think we've described in the past, a lot of our industrial automation business is to large European OEMs. And that business -- a lot of it is hydraulics, and that business is actually doing very well.

I mean, if you think of German GDP and German machine builders, they're all doing pretty well, and we're seeing some nice pickup in the markets -- all of those markets, plastic injection moldings, blow molding, the steel mill type stuff. All those markets that we traditionally serve with our hydraulics business, that's looking pretty well.

We've also got -- now that we've integrated the Components business with the Industrial business, there's a major part of that industrial automation which is providing motors and slip rings here in the U.S., and that's also doing pretty well.

It's across a very broad range, Kristine, because there are hundreds of customers that we serve with our types of products. And so the indicator I use is GDP growth translating into investment and capital expenditures, and that's what we're seeing. We're seeing a nice book-to-bill, nicely north of 1 for the last couple of quarters, and we think that's going to play out as we move through the year.

So it's not a specific end market or a specific application in industrial automation. I think it's a very broad range of customers serving products into all kinds of machine builders across both the U.S. and Europe and, indeed, into Asia as well.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [39]

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So it sounds like it's really GDP-related growth. So I guess, does that mean that if we see more manufacturing in the U.S. that's in excess of global GDP-driven-type growth, that we should see incremental pickup in your U.S. business as well?

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John R. Scannell, Moog Inc. - Chairman & CEO [40]

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I don't know, Kristine. I think that's a hard line to draw and given -- for this reason. Typically -- so more manufacturing in the U.S. So you build a factory and now you got to install automation equipment. And that automation equipment is typically not coming from U.S manufacturers.

There are no U.S. OEMs -- or almost none that make machine tools, that make large industrial equipment. That stuff is typically coming out of Germany. It's coming out of China. It's coming out of Korea. It's coming out of Japan. And so I think the capital that goes into many of those factories is actually coming from somewhere else.

Now that's -- now we would still end up selling our products to those OEMs that are making that machinery, but for us, it might look like sales in Europe or in Asia, not necessarily sales directly into the U.S.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [41]

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I see. And for the GBSD program, do you have content difference in the Boeing team versus the Northrop team?

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John R. Scannell, Moog Inc. - Chairman & CEO [42]

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I don't think we'll go into specifics on either team. I'd say we're working with all teams, and we're looking for -- we're working all kinds of opportunities, Kristine, and it's going to be a long haul. This is going to take -- we've got a very small initially kind of study-type contracts, but we're trying to make sure that we are working with both teams to try and find opportunities to work over the long term.

So as I described -- it's an investment for us. It's an investment in, particularly, bids, proposal. We're putting in our own money to make sure our facilities and our capabilities are ready to do it, and we're keen to work with both teams to try and make sure we bring product to them that they feel serves their needs.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [43]

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And maybe lastly from me, a follow-up question for Don. Don, you mentioned that the tax benefit would push the midpoint of your fiscal year '18 EPS outlook to $4.40 from $4.10. I was wondering, why not just bake the tax benefit directly into your outlook?

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [44]

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You can fit whatever numbers from the menu you choose, and that would be appropriate. I do think that if the only thing we captured was the impact of the lower, new U.S. corporate tax rate from 35% down to 21%, which is not 21% for us in '18, it's 24.4% because of the 3 quarters, you're right, our EPS would be $4.40 a share.

But it's a sea of numbers, and you can pick and choose whatever you want. But I do think that in reality, the substantive earnings and earnings per share have just incremented with that in isolation from $4.10 to $4.40 a share.

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John R. Scannell, Moog Inc. - Chairman & CEO [45]

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Our GAAP number, though, Kristine, is going to be $3.43. As Don says, it all depends on which number that you want to use. I mean, we've gone round and round on this as well. I think the one that we want to be clear to the market with is we're affirming the $4.10 guidance. From an operational perspective, the operations are doing just fine, good, solid start, feeling good for the year. We're not changing that guidance. So that was the one that we wanted to try and hone in on.

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Operator [46]

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(Operator Instructions) We'll take our next question from Michael Ciarmoli with SunTrust.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [47]

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Just a housekeeping on that tax rate. Did I catch it, beyond 2018, you're going to look at something around a 25% tax rate going forward?

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [48]

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That's correct. That's our early estimate right now. That's right. I used the 25% realm. That's right.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [49]

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Okay. And then just on the Industrial margins, can you guys specify what the magnitude of the charges were this quarter just to get an idea of kind of what that incremental spend was that weighed on margins?

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John R. Scannell, Moog Inc. - Chairman & CEO [50]

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It was -- I don't want to go into it in too much detail, but it was in the kind of the 100 to 200 basis point type hit.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [51]

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Okay. Okay. So just thinking about the -- you sound very optimistic on the broad industrial macro environment. Over the years, I think there's been a lot of cost takeout, a lot of restructuring in Industrial. What should we think about either from -- or how should we think about incremental margins going forward?

Or if I look back on a trailing basis, I think when things were moving in the right direction, Industrial had the potential to do 13%, 14%. Has there been any change to your mindset about the margin potential in Industrial? Should we kind of continue to see broad-based volume increases and recoveries in a lot of your end markets?

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John R. Scannell, Moog Inc. - Chairman & CEO [52]

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Well, no, I don't think there's any change, Michael, in terms of our belief and the potential in the market, but let me offer you a couple of perspectives. So keep in mind that our Industrial business, as we're now talking about it, includes a major part of what used to be our Components group. And if you go back 3 or 4 years ago when oil was at $100-plus a barrel, that business was very, very profitable. And then you saw in '16, in particular, and even in '17 what was kind of a high-teen business dropping into the kind of the low double digits, actually, even to single digits in some quarters.

So that oil business is now within the Industrial business. It's a good business that we believe is there for the long term, but that's dropped from $100 million to about $30 million over the last 3 years. So that's a drag on margins relative to what it would have been 2 or 3 years ago.

The other piece of the business that we talked about over the last couple of years that has been an investment is our wind business. And as I've said, that continues to be challenged, the pricing -- the outlook that we're seeing is accelerating down faster than we thought. And so we're looking at that business as how we convert it from a focused-on-growth investment to grow to focus on profitability and a return.

And so I think if oil were to get better you could see some very nice upside, even absent that. Switching the wind business from invest and grow to return focus, I think, there, we'd start to see some nice margin improvement. And you -- definitely, as you start to see the sales grow, you'll see an improvement in that business. So I think it's a -- I do think it's a good business.

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [53]

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[We have kind of], John, about mid-teens objective still?

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John R. Scannell, Moog Inc. - Chairman & CEO [54]

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Yes, I mean, that business can -- we believe that it's a business that can definitely get into the mid-teens. It's going to take a few years, but part of it is continuing to make sure that we're cleaning up the portfolio and focusing on the businesses that have real returns.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [55]

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Got it. And then, Don, I think you gave some pretty good color about capital deployment and seemingly talking about wanting to grow strategically through M&A. Can you guys give a little bit more color maybe what markets you would be targeting?

I would presume you're not looking to add any additional leg to the stool. But is something in your view a little bit more attractive, whether it's military, commercial aero, on the Industrial side? And you're talking about the challenges of wind, is there any potential opportunities for pruning of the portfolio?

I mean, does anything not quite fit? I know we've -- I've been around following you guys, and wind has kind of been dragging for quite some time. But any color on either target markets or maybe something that doesn't quite fit in the portfolio?

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Donald R. Fishback, Moog Inc. - VP, CFO & Director [56]

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Let me start with the last, so pruning the portfolio. I think we've actually demonstrated over the past number of years that we have pruned the portfolio where we had a business that didn't have a solid, long-term strategic future.

Right now, I think we look at all of our businesses in that light that we're -- all of our folks are determined to make those businesses into a long-term strategic success. So I don't want to comment about are we targeting anything at this point in time to think about divesting, but we're constantly looking at -- so are our businesses operating as we look ahead over the longer term in a fashion that we think will provide a solid return to our shareholders. So let's leave that at that.

And then with respect to acquisitions, the -- as I referenced, the pipeline is much more, much more robust for us than it was a couple years ago. We -- as demonstrated by our behavior, we got kind of quiet and sequestered, I guess, back a couple years ago because we were focused on how can we improve what we have and not get distracted with more acquisitive growth.

And we had -- as we reported over the past few years, we've had some challenges with some of the acquisitions that we've done or had done, and so we continue to work on the internal performance, organic performance of the company. And John referenced some of that with some of the wind activities we have going on, constantly trying to improve margins.

But a couple years ago, we reinvigorated ourselves with a renewed focus on let's rebuild the pipeline, let's get some increased focus on options. And to go to your question about so are we targeting any particular markets or the like, the answer is we've got 3 general markets that we're serving now if we think of the 3 segments that we've got.

We've got the Aircraft business, the Space and Defense business and the Industrial business. And all 3 of them are out looking for growth opportunities that would be complementary to their already increasingly optimistic organic growth picture that I think is pretty solid.

There is no plan at this juncture for us to do something way off the fairway. So it would be, I would say, strategically positioned, complementary growth within the -- generally within the 3 segments that we're serving now.

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John R. Scannell, Moog Inc. - Chairman & CEO [57]

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The only other thing I'd add to that, Michael, is it's got to be at the right price. And so if you look at commercial over the last several years, people are paying very expensive prices that every time we look at it -- we've looked at a couple of deals, and what we're willing to pay is way below what ends up getting paid. So we can't make those numbers work.

So we're trying to make sure that we're remaining very disciplined. But if it's -- as Don said, if it's a strategic asset that fits within an existing strategy, it has to complement a strategy that we're already pursuing, then we're interested in it. And over the long term, we think that's a combination of acquisitive and organic growth.

We've demonstrated that if there isn't interesting things to do and we got excess capital, we're willing to give it back to shareholders through a buyback. We did that for quite a few years. Right now, we think there's more opportunity on the acquisition side, and so we're looking at that. But staying disciplined and making sure that we're looking at returns over the long term is key to what we're doing.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [58]

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Got it. Helpful. Last quick one on the initial provisioning. Given the content, should we expect to see anything material on the MAX or the Neo for you guys?

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John R. Scannell, Moog Inc. - Chairman & CEO [59]

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No. We don't have any -- we have a small amount of content on the MAX and on the Neo, but it's nothing unusual, and it's common with what was on the previous generation of airplanes. So I don't anticipate any bump on either of those airplanes.

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Operator [60]

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And at this time, it appears there are no further questions in the queue. I'd like to turn the conference back over to management for any additional or closing remarks.

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John R. Scannell, Moog Inc. - Chairman & CEO [61]

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Thank you, Cody. Thank you to all our listeners. And we look forward to reporting out again in 90 days time. Thank you.

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Operator [62]

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Thank you. And that does conclude today's conference. Thank you all for your participation. And you may now disconnect.