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Edited Transcript of MOG.A earnings conference call or presentation 28-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 Moog Inc Earnings Call

EAST AURORA May 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Moog Inc earnings conference call or presentation Friday, April 28, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ann Marie Luhr

* Donald R. Fishback

Moog Inc. - CFO, VP and Director

* John R. Scannell

Moog Inc. - Chairman and 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

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Presentation

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Operator [1]

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Good day, and welcome to the Moog Second Quarter Fiscal Year 2017 Earnings Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to today's speaker, Ms. Ann Luhr. Please go ahead, ma'am.

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Ann Marie Luhr, [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 April 28, 2017, our most recent Form 8-K filed on April 28, 2017, 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 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 and CEO [3]

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Thanks, Ann. Good morning. Thanks for joining us. This morning, we report on the second quarter of fiscal '17 and affirm our guidance for the year. It was another good quarter for both earnings and cash flow and in line with our full year guidance.

Let me start with the headlines. First, it was another milestone quarter for successful first flight using Moog flight controls. On March 29, the Embraer 195-E2 took to the sky for the first time. And on the 31st of March, the 787-10 completed its maiden voyage.

Second, earnings per share in the quarter of $0.88 was above our guidance from 90 days ago and up 4% from last year. Sales were up 3%, and operating profit for the quarter was up 15% from last year. Halfway through the year, we remain on target to meet our full year guidance.

Third, free cash flow in the quarter of $56 million was particularly strong.

Fourth, we announced the acquisition of the Rotary Transfer Systems slip ring business in Europe. This transaction closed on April 2, the first day of our third quarter. This business adds to our global leadership in slip ring technology and opens new industrial markets for our products in the heart of Europe. We anticipate sales of $10 million in the second half of fiscal '17 from the acquisition and no impact on earnings per share.

In the quarter, we also acquired the remaining 30% stake in Linear Mold, which allows us to integrate this additive manufacturing technology into the rest of Moog.

Fifth, we continued our portfolio cleanup in the Space and Defense group. We adjusted the accounting reserve on the European space businesses held for sale and decided to divest the nonstrategic product line, which we acquired as part of our additive manufacturing acquisition 15 months ago. This product line is now classified as held for sale. We took a $4 million charge in the quarter associated with these future divestitures.

And finally, we're affirming our full year guidance for fiscal '17 and tightening the range slightly. We anticipate earnings per share in the range of $3.50, plus or minus $0.15.

Now let me move to the details, starting with the second quarter results. Sales in the quarter of $632 million were 3% higher than last year. Sales were up in Aircraft, Space and Defense and Components. Taking a look at the P&L, our gross margin is in line with last year. R&D expense is down 70 basis points, while our SG&A is up 30 basis points on acquisition and divestiture-related fees.

Last year, we incurred $8 million of restructuring expenses, which were absent this year. But this year, we incurred $4 million of charges associated with product lines in our Space and Defense segment which are held for sale.

Earnings before taxes were up 19%, but we had an unusually high effective tax rate of 34.3%, which Don will describe later in the call. The overall result is net earnings of $32 million and earnings per share of $0.88.

Fiscal '17 outlook. We're adjusting our sales forecast to account for the addition of $10 million in sales from the Rotary Transfer Systems acquisition. This shows up in our Components segment. We're also increasing our sales forecast in our Space and Defense segment by $20 million to reflect a strengthening defense book of business. We're keeping our sales forecast for the other operating segments unchanged from 90 days ago. We're adjusting the sales mix slightly in some of the groups to reflect the experience of the first 6 months of the year. And we're maintaining our full year midpoint EPS guidance at $3.50 per share.

Now to the segments. I'd remind our listeners that we've 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 Aircraft, Q2. Sales in the quarter of $290 million was 6% higher than last year. Similar to last quarter, sales were up in both our military and commercial markets. On the military side, sales of the F-35 program were sharply higher as production volumes continued to ramp up. We also saw continued strong sales on funded development programs. The military aftermarket was down on lower B-1B and C-5 repair activity.

On the commercial side, OEM sales on the A350 program continued to increase, but sales to Boeing and to our business jet and components customers remained relatively flat. Sales in the aftermarket were down $1 million from last year on reduced activity on some legacy programs.

Aircraft fiscal '17. We're keeping our sales forecast unchanged from 90 days ago at $1.11 billion. We're adjusting the mix slightly based on the experience of the first half. We're increasing our F-35 sales by $10 million and increasing our commercial after-market sales by $5 million. At the same time, we are reducing our commercial OEM sales by $15 million, spread across each of our major customers.

Aircraft margins. Margins in the quarter of 10.8% were up sharply from 7.3% last year. In the second quarter last year, we incurred $6 million of restructuring charges, which were absent this year. In addition, this year, we had lower R&D expense. At the halfway mark of the year, Aircraft margins are 9.7%, and we're maintaining our full year margin forecast at 9.5%.

Overall, our Aircraft business is performing nicely to plan this year, with R&D in line with budget and our commercial OEM programs coming down to production cost curves in line with our projections. Our military book of business is strong, and our level of funded developments on new military platforms is probably what it was last year.

Turning now to Space and Defense. Sales in the second quarter of $106 million were up 14% from last year. The strength was on the Defense side of the business. Strong sales on both U.S. and European vehicle programs, in combination with higher naval and security sales, contributed to a 26% overall Defense increase from last year. On the Space side, higher sales on satellite components compensated for lower sales to NASA.

Space and Defense fiscal '17. Given the strong first half of the defense market, we're increasing our full year forecast for Defense by $20 million while keeping our Space forecast unchanged. The result is full year sales of $387 million.

Margins. Margin in the quarter of 9.9% included 2 unusual items. First, we increased our product reserves by $3 million from the investigation of an engineering issue on some of our satellite components. And second, we incurred $4 million of charges associated with business lines held for sale. For the full year, we're increasing our operating profit by $2 million to reflect the increased sales forecast while keeping our margin forecast unchanged at 10.7%.

Our underlying Space and Defense operations are performing extremely well this year. Over the last 2 to 3 years, we've restructured our operations and reshaped our portfolio of this business, and the operating results are now showing the fruits of this hard work.

Turning now to Industrial Systems. It was another challenging quarter in our Industrial Systems segment, with sales in the quarter of $115 million, down 10% from last year. We saw declines in each of our major markets, although we believe the business is stabilizing. Sales into the energy market were down 15% from last year, with lower sales in both renewable and nonrenewable markets. On the positive side, however, our new pitch control system is slowly getting traction with our wind customers.

In the industrial automation market, sales were down 8%, but we believe we hit bottom and are starting to see signs of improving orders in some of our core markets in Europe.

Finally, simulation and test sales were 9% lower in the quarter. But we recently secured new multiyear agreements with our major flight simulation customers and anticipate sales in flight simulation to be higher in the second half of the year.

Industrial Systems fiscal '17. We're keeping our full year sales forecast unchanged at $470 million. Based on the performance in the first half, we're adjusting the mix slightly by increasing our simulation test sales by $10 million, while reducing our industrial automation sales by the same amount.

Margins. Industrial Systems margins in the quarter were 10.7%, up from 9.5% in the first quarter. 6 months into the year, margins are 10.1%. We anticipate margins will continue to strengthen through the second half to yield full year margins of 10.4%, in line with our forecast from 90 days ago.

Components. Sales in the second quarter of $121 million were up 3% from last year, with the growth coming in our medical markets. Sales of medical pumps and sensors increased double digits over last year. Sales into the A&D sector were about flat with last year, with stronger sales on missiles and military vehicles compensating for lower sales of components and military aircraft. Finally, sales in the industrial market were slightly lower than last year, driven by further weakness in our energy markets.

Components fiscal '17. We're adding $10 million of sales for the full year to reflect the additional revenue from our acquisition of the Rotary Transfer Systems business in Europe. The additional sales are all in our industrial markets. Moog is the largest producer of slip rings in the world, and the addition of Rotary Transfer Systems further strengthens our market-leading position while also giving us new application opportunities in the heart of Europe. We're keeping our sales forecast in the other markets unchanged from last quarter, so we're now forecasting full year sales of $487 million.

Margins. Margins in the quarter were 8.9% and for the first half were 9.4%. We're now forecasting full year margins of 10.2%, down slightly from last quarter's forecast as a result of the $10 million of additional acquisition sales.

Summary guidance. At the halfway mark in fiscal '17, we're pleased to report that we remain on track for our full year guidance. The first 2 quarters came in stronger than planned despite some one-time expenses associated with operations which are held for sale in our Space and Defense segment.

Our Aircraft segment is performing nicely to plan, with the military side of the business strengthening on the F-35 production and new funded classified development programs. On the commercial side, we're coming down the production cost curves on our major OEM programs, and we're starting to see R&D decline in line with our forecast for the year.

In Space and Defense, underlying operations are performing very nicely, and we're seeing an uptick in our military programs. The Industrial segment continues to be challenged, but there are signs that the declines of the last several years are bottoming out.

Finally, our Components segment continues to wrestle with soft market demand but has some bright spots, particularly in the medical markets. Cash flow continues to be very strong, and we added Rotary Transfer Systems to our slip ring business. We're keeping our forecast for the full year unchanged from last quarter at $3.50 a share, but tightening the range to plus or minus $0.15.

As always, there are both opportunities and risks to the forecast. On the opportunity side, the Aircraft and Space and Defense segments are performing ahead of plan. But on the risk side, our industrial businesses in both the Industrial Systems and Components segments continue to operate in challenging markets. We expect the third quarter to be in the range of $0.80 to $0.90.

Now let me pass it to Don, who will provide some color on our cash flow and balance sheet.

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

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Thank you, John, and good morning, everyone. As John highlighted at the start of the call, we had a strong quarter for free cash flow, $56 million, and that brings our year-to-date free cash flow to $91 million or a conversion ratio of 148%. We expect that our cash flow in the second half of 2017 will be softer than the first half due to the timing of various cash receipts and disbursements as well as somewhat higher spending levels for capital expenditures. Our projection suggests that this cash flow softness will be most pronounced in our Q3 due to our planned timing in contributions to our domestic-defined benefit pension plan.

In addition, customer advances are projected to begin to climb in the second half of 2017 after reaching their current high levels, partly due to payment terms associated with our commercial aircraft growth programs. In the end, we expect to achieve over 100% free cash flow conversion for all of 2017 or $130 million, unchanged from our last forecast. Net debt decreased $57 million, in line with our free cash flow of $56 million.

John also mentioned that we announced during the second quarter the acquisition of the Rotary Transfer Systems business with -- or I should say from Morgan Advanced Materials with operations in Germany and France. Rotary Transfer Systems designs and manufactures products that are similar to our industrial slip rings and opens up the opportunity for us to expand our business throughout Europe. The business will be managed as part of our Components segment. We closed this transaction on April 2, which was the first day of our third quarter, so our financial statements will reflect this acquisition in the third quarter.

Net working capital, excluding cash and debt, as a percentage of sales, was down to 24.4% at the end of the second quarter compared to the 26.5% a year ago, continuing the downward trend that we've been reporting over the past few years.

Our capital deployment focus is on smart top line acquisitive growth. It was nice to report on the acquisition of Rotary Transfer Systems this quarter as our M&A activity has been admittedly quiet over the past few years. And although it's a relatively small transaction, we are pleased to have closed on this strategic target.

Capital expenditures in the quarter were $15 million, and depreciation and amortization totaled $22 million. For all of 2017, our CapEx forecast remains unchanged at $80 million, while depreciation and amortization will be about $94 million.

Cash contributions to our global retirement plans totaled $24 million in the quarter, the same as a year ago; while year-to-date, we made $41 million of contributions. For all of 2017, we're planning to make contributions into our global retirement plans totaling $92 million, unchanged from our forecast 3 months ago. Global retirement plan expense in the second quarter of '17 was $16 million, similar to last year. Our global expense for retirement plans is projected to be $63 million in '17 compared with $65 million in '16.

In the second quarter of 2017, we had a high effective tax rate, as John mentioned. It was 34.3% compared with last year's 23.9%. This high Q2 tax rate was influenced by the effects of charges associated with the divestitures in our Space and Defense segment, fortunately there was no tax cover as well as a less favorable mix of global taxable earnings due to a relatively more -- due to relatively more profits being generated in the U.S. Also, last year's low rate reflected the reversal of accrual for certain tax exposures outside of the U.S. for which the statute of limitations had expired.

Year-to-date, our 2017 tax rate was 27.1% compared to last year's 25.2%. For all of 2017, we've slightly adjusted our outlook and are now forecasting an effective tax rate of 29.6%, up 110 basis points from our forecast last quarter. This compares with our tax rate in 2016 of 28.5%.

Our leverage ratio, net debt divided by EBITDA, decreased to 1.91x at the end of the quarter compared with 2.47x a year ago. Net debt as a percentage of total cap was 37.4%, down from 42.3% a year ago. And at quarter-end, we had $532 million of available unused borrowing capacity at our $1.1 billion revolver that terms out in 2021.

So with that, I'd like to turn it back to John, and we'll take any questions you may have. Kerry, can you help us, 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 first, your Boeing and Airbus sales forecast went down. What programs were those? Were those the 777 and the A330?

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

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Yes, it was across the portfolio, Cai. It was a little bit on the 87, it's a little bit on the 350. So just we -- but keep in mind that the way that, that slows is not exactly in line with the way their production flows, and there's a lot of inventory movement and stuff. So we moderated both of them slightly.

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

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Okay. And then your R&D was a little bit higher than we were looking for. Where -- how much of that was in the Aircraft area and kind of what programs?

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

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Well, so I think -- and when you say your R&D, you're talking about total R&D for the company?

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

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Yes, the $37 million was up -- was down year-over-year, but up sequentially. How much of that was Aircraft?

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John R. Scannell, Moog Inc. - Chairman and CEO [7]

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Aircraft was down $6 million over -- from the quarter last year. And that was, as you might expect, that was 350 and E2 stuff. But we did see a little bit of an increase in some of the other segments. There was a little bit of a couple of million in the Space, then there's a couple of million in the Industrial business. So that was the -- that was what was going up.

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

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So for the year, what is the R&D target and how much is Aircraft?

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John R. Scannell, Moog Inc. - Chairman and CEO [9]

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Yes. So that hasn't changed. None of that has changed. The target for the year is still about -- is $140 million, and our forecast for Aircraft is just under $90 million. So that's not changed. We're on track for the year, we think.

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

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Okay. And then -- so walk us through the Space because those margins look sensational if we take out the divestiture and the product loss. Walk us through that and give us a little more background on that, if you could.

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

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Well, as I said on the call, we spent the last 2 or 3 years, Cai, if you go back 3 years or so, we were struggling in that business. So there's a combination of things. One is, I would say, a focused restructuring. We've taken restructuring over the last years in that. We've been cleaning up the portfolio. I mean, the held-for-sale stuff, we got rid of Bradford in the first quarter. We've been cleaning that up over the last couple of years as well. So that's kind of an underlying improvement in the business. And then on top of that, I think the first half of the year, we had some favorable contract stuff that happened, a very nice mix. So we're not forecasting that strength will continue in the second half, although it continues to be a nice double-digit business. But it's just, as I say, it's a series of activities over multiyear periods that we're starting to see some very nice performance from. Now we did have, as you say, we had a product reserve issue. And it's always easy to back those out. We're obviously a little bit cautious though because there's always somewhat something rather that tends to pop up in these types of businesses, whether in the aerospace and defense side of the business. So that was unusual in the quarter. But typically, you have some unusual item as you go through the year. But it is, the business is performing nicely. The Defense side is doing nicely. We've got very solid missile programs. We've got nice vehicle programs. And the Space business, I think if you go back a year or so, I was kind of saying what basically continues to come up, that seems to have leveled out and seems to be start improving. We've won some nice positions on new classified satellite programs. So we're feeling that the Space business is also starting to take off. So the business is doing well. Now I would say there's been a lot of focus on -- because of the contract, a lot of production stuff, and over the next few quarters and even in this quarter, we're seeing a little bit more of a pickup in R&D. There are some long-term programs we've talked in the past, so those GBSD that we're going to start to spend a little bit more money on. So those kinds of high-teen margins that excludes some of those [expressions] , we don't anticipate that that's sustainable over a long period of time. But we do think that the business is nicely positioned. It's got some nice programs, and it's performing well.

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

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And last one. So you bought in the minority interest in the additive manufacturing business. Is that basically now at breakeven? Is that contained so that, that won't be a problem going forward?

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

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So what we're doing, Cai, is we bought the minority in it, as you heard on the call as well, it was a product line within that, that we're divesting. So when we bought it, there was 2 pieces there. There was the additive piece and there was a piece that was essentially a mold -- a tool and die molding type business that came with it, which was the original business that the founder started with, and then he got into additive. And we were never planning to keep that. So we've also arranged for that to be held for sale. So now as we move forward, we see this more as a technology that we feel is critical for the company in the long term as against a stand-alone business that we think has got its own P&L. So it's integrated with the other segments. It's within our Space and Defense segment, but it's a technology and a capability that we will be sharing across the whole corporation. So rather than talk about it as a P&L, we see this is a critical technology that would be used by all of our businesses in the coming years. And so that's the way we're starting to see it. So it's probably more on the R&D type of line than a sales and profitability line.

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Operator [14]

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And we'll take our next question from Kristine Liwag with Bank of America Merrill Lynch.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [15]

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John, in your prepared remarks, you mentioned growth in classified programs and defense, and I understand you're limited in what you can say. But are these programs in general dilutive or accretive to margins? Or are they in line with segment margins?

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

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So typically, Kristine, when you have military defense programs like that, they are cost-plus type programs, but they will be low-margin programs. So they would be dilutive to margins. However, one of the nice things that's happening is, as the commercial R&D starts to come down, we have the opportunity to redeploy those engineers into these types of programs. And so essentially you gain all of the expense because it becomes sales and the type that covers. So as we shift from R&D, from commercial where it's all on your R&D line into military, you have an improving situation in margins, but it's because your R&D line has essentially come down. Does that help?

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [17]

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That helps. And would you be able to quantify the size of classified for you?

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

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No. But what I would say is we have funded R&D -- I said this last -- I think in the previous call. Last year, our funded R&D in Aircraft was about $25 million. And this year, it's about $50 million of sales.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [19]

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Great. And then maybe switching gears, the Boeing middle-of-the-market aircraft seems to be becoming more topical. If the aircraft becomes a reality, how should we think about R&D for you if this is a program that you end up pursuing?

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

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I prefer not to speculate on that because I think the aircraft hasn't yet been approved. There's been absolutely no conversations yet in terms of what it might look like. I think Boeing's procurement strategy is kind of changing as they move from the 87 to the next generation of airplanes. Our position, our potential opportunity on it, we would have to see. It's a combination of what Boeing might be interested in, what we might have to offer the competition. So I think it's too early to speculate on that, Kristine. I just couldn't really give you a picture of it. And I think, in any event, I think no matter what, it's probably a couple of years out in terms of when you'd actually see any kind of a significant R&D spend, where we to be part of that program. So I think it's a little bit too early to speculate on what that might look like.

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Operator [21]

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(Operator Instructions) And 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 [22]

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Just back to Space and Defense, x the charges, you had 17% plus in the first quarter, 16.5%, I get it. It sounds like there were some one-time items in there. What sort of -- I mean, do you have very good visibility? I mean, because that would be quite a falloff in second half margins. And clearly, it sounds like you're getting some uptick in the Defense side, which may be offsetting some of the weakness. But I mean, do you have very good line of sight into, I guess, the profit potential of what's going to come through the backlog or what's going to come through from the order book?

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John R. Scannell, Moog Inc. - Chairman and CEO [23]

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We have reasonably good line of sight on it, Michael. So as we're sitting at this point, typically, as you go into a quarter in the Space and Defense business, you're probably in the 90s booked in terms of what you're going to ship that quarter; and out 6 months, maybe you're in the 70% to 80%. So it's not like an industrial business where you're waiting to receive orders as you go through the quarter with 4- to 6-week lead times. However, in some of those businesses, particularly in the Space business, depending on how a contract shows us out, you can have fairly significant swings in the profitability. And the reason I say that is because typically the space stuff, you put it all together with all of the engineering capability and the processes and everything, but if that -- I said the final test, you discover that there's some nuances, for whatever reason, in the product or the functioning, and you have to do some rework. Typically, that could be expensive. So what we find in that business is if the product sales threw very nicely, you make very nice margins. If you've got a hiccup, and these types of things happen when you do very highly engineered products, you'd end up going back, and that could have a significant impact on the margin. So we will always try to be conservative in our margin forecast and hopefully do a little bit better. I think our second half margins are in the north of 12% to reach the full year numbers that we've quoted. So yes, it's down from the 16%, 17% that we did in the first half. But that 12% is, if you compare that with the run rate over the last several years, it's not -- it's a pretty good performance. I said at the end of my call, in terms of opportunities and risks, that both Space and Defense and Aircraft are performing well. So maybe there's some upside there. On the flip side, our Industrial business has continued to be challenged, and that may be where we might have some challenges. So we're trying to do a balanced outlook on this. We have looked at the first half, second half in the Space and Defense business. There will be additional R&D, as I mentioned. We're putting money into a couple of particular military programs that we think have a long-term opportunity. GBSD is a program that we think has long-term potential for us. So there's a mix across the various programs. But right now, we're pleased with the way it's done through the first half, and we hope that we continue to do that -- or do what we forecasted for the second half.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [24]

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No, great, that's helpful. That's helpful, I get that. And then what about Aircraft margins? With the revised forecast, aftermarket being increased a little bit, I'm assuming that carries higher margins. I think you guys tweaked, obviously, some of the OE work. But it still seems like -- and I get the R&D, no change there. Why aren't we seeing any better lift or more favorable mix, maybe, on the aftermarket controls into the second half of the year?

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John R. Scannell, Moog Inc. - Chairman and CEO [25]

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Yes. The aftermarket, you're right, I mean, we tweaked some of the military side, the F-35. So that's -- F-35 in production, and then commercial aftermarket, we tweaked up a little bit. So that had some contribution. And we reduced some of the commercial OE side, which typically is not as high a margin thing. Halfway through the year, we're at 9.7%. We got full year margin of 9.5%. Maybe we'll do a little bit better. Mix changes as you go through the year. R&D is going to be up a little bit in the second half relative to the first half. So a couple of million dollars, that means meets the target of getting to the $89 million, $90 million that I talked about. So it's -- again, I think there may be some upside there. But we've seen also in the past, R&D can spike. I've described that in the past where we're going through a [quaffle], something comes up, and then there's a rework of something. And because of the amount of hardware that goes through when something like that happens, it's never a couple of hundred thousand dollars, it's always a 7-figure number. So again, I think we're trying to be a little bit cautious and conservative and not get ahead of ourselves. But we're feeling -- halfway through the year, we're nicely on track for the full year, and that's different from we were sitting a year ago or a couple of years ago. So we're feeling more comfortable with the year, this year, than I'd say that we felt at last year or the previous year.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [26]

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Got it. And then just last one from me. Maybe, Don, on the free cash flow, I think you mentioned the customer advances and payment terms. Is that stemming from Boeing's change in how they're paying suppliers?

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Donald R. Fishback, Moog Inc. - CFO, VP and Director [27]

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No. It's totally unrelated to that specific topic. This is -- contractual goes back quite a few years and the terms that we negotiated. And with -- I won't single out volume, but terms, we're negotiating with a couple of our commercial aircraft customers. And we knew this was going to be happening where we had built up a real nice customer advance, and we'll have to repay that. So that's going to happen over the next 3 years or so. And it's not a huge number, but it's going to have some impact on cash flow, as we reported, as we look ahead. And I was just kind of teeing up expectations that that's partly why the second half is starting to come off. And boy, we've had a great first half of free cash flow. And I was just trying to tip you guys that it's not going to continue.

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Operator [28]

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It appears there are no further questions. At this time, I'd like to turn the conference back over to our speakers for any additional or closing remarks.

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

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Thanks, Kerry. Thanks for your attention. Thank you for your questions, and we look forward to reporting out again in 90 days' time. And hopefully, folks will have a nice summer. The weather here in Buffalo is just starting to improve, so things are looking good. Thank you.

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Operator [30]

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This concludes today's call. Thank you for your participation. You may now disconnect.