Moog Inc (MOG.A) 2016 Q1 法說會逐字稿

Good day and welcome to the Moog first-quarter FY16 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Investor Relations Manager, Miss Ann Luhr. Please go ahead, ma'am.

Good morning. Before we begin, I'd like to call your attention to the fact 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 and uncertainties and other factors is contained in our news release of January 29, 2016, our most recent Form 8-K filed on January 29, 2016, and certain of our other public body filings with the SEC. We provided some financial schedules to help our listeners better follow along with prepared comments.

For those of you who do not already have the document, a copy of today's financial presentation is on our Investor Relations home page and webcast page at www.moog.com. John?

Good morning. Thanks for joining us.

This morning we report on the first quarter of FY16 and update our guidance for the full year. We had expected a slow start to the year and we came in at the low end of our guidance for the quarter. We also expected a pick up in many of our markets as we moved through the year.

Over the last 90 days, the outlook for Aerospace and Defense markets has held fairly firm. Unexpected macroeconomic developments has caused our view of non A&D energy markets to change significantly. I'll discuss the details as I walk through each of our segments, starting with the headlines.

First, earnings per share on the quarter $0.71 were at the low end of our guidance. Second, we had a net use of cash in the quarter. This was not a surprise as a favorable timing of receipts in our fourth quarter reversed this quarter.

We still expect free cash flow conversion for the full-year to be over 100%. Third, we've reduced our 2016 EPS forecast to $3.35, down from our last forecast of $4.

Our outlook for our non A&D businesses has weakened markedly over the last 90 days. In our energy markets, the outlook for price of oil was directly impacting our FY16 sales forecast. We're also seeing impact from the strong US dollar, slowdown in China, and economic woes in Brazil.

Finally, last month we announced the acquisition of 70% of Linear Mold & Engineering, a small company outside of Detroit with annual sales of about $20 million. This company specializes in additive manufacturing, a technology we view as potentially transformative for many of our markets in the future.

Now let me move through the details, starting with the first quarter results. Deals in the quarter of $568 million, were down 10% from last year.

The stronger dollar accounted for one quarter of the decline. Excluding foreign currency effects, real sales were down in our Aircraft, Space and Defense, and Component segments. Sales in the Industrial segment were up marginally and organic sales in our Medical segment were up 22% over last year.

Taking a look at the P&L, our gross margin is down slightly as a result of the lower sales. Our R&D expenses up on increased Aircraft activity and our SG&A expenses down as a percentage of sales as we continue to reduce our overhead costs.

Our effective tax rate was 26.6%, as we benefited from the reinstatement of the R&D tax credit in the US. Overall result was net earnings of $26 million and earnings per share of $0.71.

FY16 outlook. We're moderating our full-year sales forecast by $100 million, to reflect weakening outlook across many of our markets. This number includes $20 million of additional sales from the acquisition of Linear Molds so the outlook for our organic business is down $120 million versus 90 days ago.

This reduction in sales will result in $35 million of lower operating profit, and corresponds to reduction in earnings per share for the year of $0.65 to $3.35. Given the significant uncertainty we are seeing in our industrial markets, we are putting a range around the $3.35 of plus or minus $0.15.

We're taking an aggressive approach to revising our forecast downwards today, based on what we have seen of the first quarter. It's frustrating to announce this reduction to the market. Over the coming quarters, our team will be working very hard to deliver the best possible results in the face of the changing economic environments.

Now to the segments. I'd remind our listeners, we provided a two-page supplemental data package posted on our website which provides all the detailed numbers for your models. We suggest you follow this in parallel to the text.

Starting with our Aircraft group. Sales for the first quarter up $255 million, were down 4% from last year. Sales were lower on both the military and commercial side of the house.

On the military OEM side, lower sales on the V-22 and F-18 were partially offset by higher F-35 sales. The V-22 benefited last year from a catch up on deliveries but the lower F-18 sales this quarter reflect the slowing production rates.

Sales were also lower in military aftermarket as the C-5 refurbishment closes out. On commercial side, OEM sales were down across the legacy book at both Boeing and Airbus and also in our business jet product line. Higher 8350 sales remained a bright spot as production continues to ramp up. Sales in the commercial aftermarket were up 6% as 787 initial provisioning slowed.

FY16. We are making small adjustment to our sales forecast for the Aircraft group through the year. We're moderating our military forecast by $10 million across a range of programs. And we're also moderating our commercial forecast by $10 million, reflecting the slow start to the year.

On the other hand, we're adding $20 million to our commercial OEM forecasts, as we incorporate the sales of our additive manufacturing acquisition under this segment. [Net-net], no change to the total sales number for our Aircraft segment.

Aircraft margins. Margins in the quarter were 7.1%, down from 9.2% last year. The lower margin in the quarter is a combination of higher R&D expense and the anticipated unfavorable mix, including lower aftermarket sales in both military and commercial.

R&D in the first quarter ran a couple of million dollars ahead of our plan and we anticipate this spend rate will continue through the year. We're therefore increasing our full-year forecast for R&D by $5 million.

The net impact is a reduction in our full-year margin forecast to 9%. From the slow start in Q1, margins will improve as we move through the year, due to stronger foreign military sales.

Turning now to the Space and Defense segment, sales in the quarter of $83 million were 17% lower than last year. Sales were down in both the Space and the Defense markets. Our Space business is going through a down cycle. We closed down several programs over last year and the follow-on business has not yet begun. That will improve as we go through this year and we anticipate sales recovering to the run rate of last year by the second half.

On the Defense side, the sales production was all in our security business. Last year, we went through some significant restructuring of the security business, as we rationalized the product portfolio to concentrate on our key customers.

Space and Defense FY16, we believe the last three quarters will be in line with our sales forecast from 90 days ago, but we will not recover the slight sales shortfall in the first quarter. As a result, we're moderating our full-year forecast by $10 million to $375 million.

Margins. Space and Defense margins in the quarter were 14.3%, up from 8.7% last year. This is particularly impressive results given the lower level of sales in the quarter.

Last year, we had a drag of 200 basis points as we wrote down some inventory in our security -- (technical difficulty). This year, we some one time benefits as we closed out (technical difficulty).

More importantly however, this quarter, the benefits of the restructuring activities last year came through in the margin. Given the strong first quarter, we are increasing our full-year margin forecast to 12% on slightly lower sales.

Industrial systems, Q1. Sales in the quarter of $125 million were 6% lower than last year. The reduction is all due to the strengthening of the US dollar over the course of the last 12 months. Excluding foreign currency effects, sales were actually up marginally from last year.

The real increase was all in the simulation and test business across a range of programs. Real sales were slightly lower in our industrial automation markets, and were down 70% in our oil and gas markets.

Industrial systems FY16. Although first quarter sales were more or less flat with last year on a constant currency basis, we saw a slowdown in incoming orders which suggest sales could weaken as we go through the year.

The continued decline in the price of oil has had a direct impact on our sales into the onshore exploration markets. We have also seen a direct impact from the economic woes in Brazil, as $12 billion of planned wind energy sales have evaporated.

In addition, we believe we're now seeing second order effects from the strong dollar and the slowdown in China. Industrial automation sales in Europe are slowing, and our industrial aftermarket activity is below plan.

At the moment, there does not seem to be any macroeconomic indicator which would suggest a global recovery anytime soon. We are therefore moderating our full-year sales forecast by $30 million, in an attempt to capture the effects of this new reality on our business. The reductions are all in our energy and industrial automation markets.

Industrial Systems margins. Margins in the quarter were 10.9%. As in our Space and Defense segments, we are seeing the benefits of last year's restructuring coming through. We continue to adjust capacity to demand over the coming year as the sales picture unfolds. However, given the challenging outlook, we've reflected in sales forecasts, we're moderating full year margins to 9.2%.

Components, Q1. Normally, my report on the Components segment is very boring and boring is good. It's always been another quarter of strong sales and great margins.

Well, to say our Components segment experienced a perfect storm this quarter would not be an exaggeration. Sales in the quarter of $80 million were down 26% from last year. Sales were down in every market we serve, ranging from 11% reduction in Space and Defense to a 56% reduction in energy.

In our A&D markets, we saw some slowing in our aftermarket parts business, as well as unfortunate timing on a range of customer programs. In our energy markets, the continuing decline price of oil is reflected in our sales.

In our industrial automation market, we are seeing the same effects as in our Industrial Systems segment. The strong dollar, slowdown in investment in energy sector, and slowing economy in China, are filtering down to the lower tiers of industrial suppliers like us.

Finally in our Medical markets, our customer for sleep apnea equipment is introducing a new product to the market. We continue to be their primary supplier for motors, but the price point for new motor is lower than in the previous product generation.

Components, FY16. Despite the slow start to the year, our A&D backlog is healthy. We anticipate these markets will recover significantly as we move through the year to yield full-year sales close to our FY15 total.

In our non Aerospace and Defense markets, the story is very different. We anticipate continued weakness in our energy, automation, and medical markets, and we're adjusting our forecast for the full-year in each of these markets to align them with the run rates of the first quarter. The result is full-year sales for the Component segment of $365 million, down $60 million from our forecast 90 days ago.

Components margins. Margins in the quarter are 5.9%, reflecting a significant shortfall in sales. Let me put this performance in context.

We acquired the Components segment in 2003. And in the last 12 years, margins have average mid-teens, and have never dropped below double digits in any one quarter. This quarter was truly an outlier.

We have the same team, serving the same markets, for over a decade and they really know their business. That team is very focused on getting their business back on track and they are taking all the necessary steps to align their cost structure with the sales outlook. However, given the reduction in the sales forecast for the year, combined with the soft margins in the first quarter we're moderating our full-year margins to 10%.

Turning now to our Medical Devices segment. Sales in the first quarter, it was another good quarter for our Medical Devices. Sales in the quarter of $26 million were up 13% from last year.

In the first quarter last year, we had almost $2 million in sales from our Life Sciences operations which we subsequently divested in the second quarter. Excluding these life sciences sales shipments of pumps and sets were up 22% in first quarter. Gains were fairly evenly spread across both our enteral and IV product lines.

Medical FY16. We're keeping our sales forecast for the full-year unchanged at $102 million, which corresponds to 7% organic growth for the year. Margins. Medical margins in the quarter were 12.5%, a good start to the year. We're keeping our full-year margins unchanged at 11.4%.

Last quarter, I reported we had a couple of open items left to complete in our Medical Devices segment before restarting our strategic review process. These items included some further process improvements as well as a review of our channel partners. In the next 90 days we believe we'll get these items behind us and be able to conduct a review of the strategic options for the segment.

The objective of our review will be to identify the best options for this business to maximize long-term shareholder value. We hope to report [out] next quarter on our progress.

Summary guidance. We've gotten off to a slow start in the first quarter. But we had expected as much. What we had not expected was the significant deterioration in the outlook for our non A&D businesses in the space of 90 days.

The stock market turmoil over the last four weeks may be a reflection of what we're seeing in the real world. As I described in the text, the macroeconomic climate for our industrial and energy business has weakened significantly. We are experiencing first-order effects from the low oil prices and the economic meltdown in Brazil with lost business in each market.

We're also experiencing second-order effects from the strong dollar and the slow down in China, as our industrial automation businesses in both Europe and the US slow. We're moderating our sales forecast for the year by a $100 million to $2.47 billion and we're moderating our EPS forecast by $0.65. We're now forecasting full-year EPS of $3.35 with a range of plus or minus $0.15.

Comparing this total with our forecast of $4 from 90 days ago, there are three major items which explain the $0.65 change. A $0.35 reduction in our outlook for the Component segment, a $0.20 reduction in our outlook for the Industrial Systems segment, and the $0.10 reduction from higher R&D in our Aircraft segment.

As usual, our forecast does not include any projections for future acquisitions or further share buyback activity. Earnings in the second quarter should be in the range of $0.75 to $0.85, with the last two quarters averaging just over $0.90.

On the surface, it might appear as FY16 is similar to the past two years, and one might conclude that our internal actions to improve our performance have not been very effective. However, it's helpful to look at the influence of market forces over the recent past to see how much headwind they've generated, and then to look at how our internal actions have helped shape our results.

Looking at our FY16 forecast, our Military Aircraft business is down 11% from 2013 as a result of slowing defense spending in the US. Our industrial systems business is down 16% in just two years, while our oil and gas businesses are off 60% over the same period. Our sales in Space market are down almost 20% since 2014 as well as our sales the Medical Device market.

While our commercial OEM sales are up 25% since 2013, our commercial aftermarket has remained flat. Unfortunately, each one of these sales changes has had a negative impact on our margins over the last two years.

As the sales picture has evolved, we've gone through multiple rounds of restructuring to adjust our cost structure proactively. We've continually reviewed our portfolio of businesses to ensure we are focusing on the most promising areas for the future. We're promoting lean processes in all our operations and investing in the long-term future across all our markets.

As a result, we see positive developments in several segments. Both our Medical Devices segments and Space and Defense segments are showing significant improvement in profitability over the last few years, even in the face of declining sales.

Our industrial and energy businesses continue to wrestle with slowing demand across many markets. But in time, markets will stabilize, and eventually start to grow again, and the impact of our internal actions will come through.

Finally, the Aircraft business is a long-term play. Over the coming years, the military business will improve as the JSF ramps up and the associated aftermarket kicks in.

Commercial R&D will come down gradually as the A350 and E-Jets move into full production. Commercial OEM profitability will continue to improve as we come down the cost curves on the new platforms, and finally, the commercial aftermarket will start to benefit as the size of the 787, A350, and later, E2 fleets expand.

Over the last few years, our internal initiatives have yielded strong cash flow, and in the absence of strategic acquisitions, we have return significant value to shareholders through our share buyback program. Most importantly, for the long-term, we continue to invest in innovation across all of our businesses.

Our acquisition of a majority stake in Linear Mode this quarter is a further demonstration to commitment to the future. We believe that additive manufacturing is potential to disrupt many of our markets over the next 5 to 10 years and we intend to lead that disruption. Let me finish by reiterating our commitment to our investors to deliver the best possible results against the backdrop of the challenging macroeconomic climate we're in.

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

Thank you, John. Good morning, everybody.

Three months ago we enjoyed a record quarter for free cash flow that approached 400% conversion. As referenced, the [fortune] timing of certain cash receipts and disbursements that contributed to this unsustainable accomplishment, and I know that accordingly, we expected to get off to a slow start in FY16.

Well, we have gotten off to a slow start in FY16. Our free cash flow in first quarter was a net use of funds totalling $13 million. We enjoyed really strong free cash flow performance over the past three fiscal years, averaging over 150% conversion. We expect to continue to report respectable results as we look ahead.

We expect to achieve better than 100% free cash conversion [for all of 2016]). Net debt increased $44 million, primarily as a result of acquisition of Linear Mode. For the full FY16, we're modifying our previous free cash flow forecast to $130 million, down from the last forecast of $150 million, reflecting the decline in our earnings outlook that John just discussed.

During the first quarter, we did not repurchase any Moog shares under our share repurchase program. At the end of the quarter we were expecting a soft quarter for free cash flow and in addition, our leverage was 2.4 times to start the quarter, which was at higher end of our optimal range of between 2 and 2.5 times levered. This ratio was forecasted to increase during first quarter before considering any M&A activity such as the Linear deal.

And at the end of the quarter, our leverage did indeed increase to 2.6 times. Accordingly, we decided it would be best to refrain from using our capital to buy back any Moog shares for the time being. We have about 4.2 million shares remaining under the outstanding Board authorization.

Our projections for 2016 do not factor in any impact of any share buyback activity. We will report on any further activity next quarter.

With respect to M&A, we were excited to announce the December acquisition of Linear Mold, an additive manufacturing company located outside of Detroit. If you were fortunate enough to have listened and attended the annual meeting. We spent fair amount of time describing additive manufacturing in general, the acquisition of Linear and what we think it will mean to Moog.

The Linear transaction resulted in Moog owning 70% of the business and included an initial cash payment of $11 million plus assumption of about $12 million of debt. Beyond Linear, we continue to look for strategic opportunities as we consider M&A an important compliment to our organic growth objectives.

Capital expenditures in the quarter were $12 million, and depreciation and amortization totaled $25 million for all of 2016. We're lowering our CapEx forecast to $80 million. Depreciation and amortization in 2016 will be about $103 million.

Cash contributions to our global retirement plan totaled $22 million in the quarter, compared to last year's first quarter of only $14 million. For all of 2016, we're planning to make contributions to our global retirement plans totaling $95 million, unchanged from our forecast three months ago.

Global retirement plan expense in first fiscal quarter 2016 was $16 million, up slightly from a year ago. In 2016 our expense for retirement plans is projected to be $66 million, compared to $61 million in 2015, up largely because of the effects of updated mortality assumptions.

Our effective tax rate in the quarter -- I am sorry, in the first quarter was 26.6% compared to last year's 28.7%. During the first quarter of this year, Congress enacted tax legislation that included the permanent reinstatement of R&D tax credit. This had a beneficial impact on the quarter's results of $1.5 million due to the catch-up of last year's credit.

For all of 2016, we're forecasting effective tax rate of 28.3%, essentially unchanged from our forecast 90 days ago. As I mentioned, our leverage ratio, which is net debt divided by EBITDA, increased 2.6 times at the end of the quarter, compared with 2.1 times a year ago.

Net debt as a percentage of total cap was 44.6%, up from 36.5% last year. At quarter-end we had $268 million of available unused borrowing capacity on our $1.1 billion revolver that terms out in 2019.

With that, I would like to turn it back to John for any questions you may have.

Thanks, Don. Ebony, if you have people in the queue we would be happy to take their questions.

Thank you.

(Operator Instructions).

Robert Spingarn, Credit Suisse.

Good morning.

Good morning, Robert.

John, at a high level I wanted to ask you how comfortable you are that this guide truly de-risks the forward outlook? I understand and appreciate the fact, especially on the industrial and energy side, where none of us really know what we are looking at. But I was a little surprised that while you characterized the aerospace as kind of stable, there were several moving parts in there. It looks like some organic decline was offset with acquired revenue. Just a high level question on the confidence of the outlook?

It's a really good question and obviously the benefit of hindsight I'd be able to tell you how confident it was. I can tell you this, last year we went through a series of quarterly earnings calls. Each quarter, I would say the picture unfolded. And as it did, we had to guide lower. I can assure you it's not our intention or our desire to guide the market lower one step at a time. I hope this quarter, we did spend a lot of time saying what did we learn from last year? Can we make sure that as we guide lower that hopefully we guide to a level that we can make sure that we will do at least as well as that. We will be working very hard, I can assure you entirely, to do better.

If you can learn the past, we have learned from the past. Have we learned enough? Or is the instability in the outlook more than we've tried to bake in? Impossible to say. I will say we've done the very best we can and we've taken the aggressive approach as I've said in the text to revising our guidance downwards, in one step, in the hope that we don't have to do that again. However, if circumstances change dramatically, unfortunately we will be subject to that. (multiple speakers).

The aircraft business, that's a very long term business. The [slight] guide change in the first quarter was a couple of tweaks. It was $20 million, $10 million in our defense business, $10 million in our commercial, not really anything of significance, a little bit of a tweak here and a tweak there. No change in the aftermarket on the commercial side. I think that business is pretty solid. We expected a slow start. As we go through the year, there are foreign military sales that we know about, we've had every year, we've got them in the backlog. We're fairly comfortable that business is in good shape.

Space and Defense, similar story. It's a long-term business. We know that the backlog is there. That should be pretty good. It's all really on the industrial side, in both the Components group and in our Industrial business, that we have seen the change and it is driven by industrial markets and the energy prices. Both the direct impact of energy and a second order effect, which is hard to quantify, but it's the reduction in overall investment that we are seeing. That's filtering through to us.

Okay and I think that's all. It makes a ton of sense and it's reasonable. I was actually looking at what happened in 2015 as well and it was each quarter. So what you are saying, John, is that this time you built in more cushion?

I hope we are more conservative this time than before. Yes. As I said, Robert, our objective is not to under promise -- or over promise and under deliver. That is absolutely at any stage -- every single guidance we have given has always been to try and be somewhat conservative. This time I think we've learned from past years to try and be more conservative.

No, we as a market understand it's certainly not your intention. Really the question is, have you changed the process of forecasting somewhat to be more conservative and it sounds like you have, or at least that's what you have attempted to do here.

Yes.

Okay and then a quick one. I've asked you about aftermarket on prior calls, but you mentioned, you made the comment that commercial aftermarket has essentially been flat, I think since 2013 if I heard that correctly?

Yes.

Ex provisioning, what would that number be? (multiple speakers) Has it grown with traffic?

No. Ex-provisioning, if you look over the last three years and you take out the provisioning, sales have been about $100 million per year. That's the run rate. Provisioning in 2013 was about $12 million, sales were $112 million, provisioning in 2014 was about $30 million, sales were about [$113 million.] Provisioning last year was a little bit higher, underlying sales were a little bit lower. But it's in that kind of $90 million to $100 million and it has not grown, and I think, what that is, Rob, is it's a reflection of the fleets that we're on. You have 57, 67, we're on 777 as well. It's just a reflection of, some of those are getting retired and it's a relatively old set of airplanes, and therefore the underlying aftermarket has been slowed slightly down.

On the 777, with the weakness in Asia with the 200s, are you seeing particular weakness there on the aftermarket side?

Not that it's a significant -- we typically don't get into that level of detail by individual airplane because our $100 million is made up of a lot of different platforms.

And you see quarter-to-quarter, I have explained in the past, our commercial aftermarket was very plus or minus 20%, from $18 million, $19 million, to $23 million, $24 million, one quarter to the next, and therefore it's a little bit difficult to extract a pattern from that. The multi-year pattern shows what we are seeing across the fleet and I think it's probably a better indicator than a specific individual airplane in a specific region.

Okay and then a final question. You may have mentioned this earlier but I did not catch it. Your guidance, does it accommodate the latest Boeing production cuts? I realize the 777 is in 2017 but I'm wondering if some of that -- you have some lead time there and the 747 to the extent that you are there.

747 has a very small amount of content on it, so that's kind of negligible. The 777, we anticipate that probably we'll get through all of FY16 in line with forecasts, it will be more of a FY17 [event].

Okay, thanks John.

Thank you.

Cai von Rumohr, Cowen and Company.

Yes, thank you very much. Your tax rate didn't change for the year, your guidance, even though you had picked up $1.5 million in the first quarter. Basically, I assume it's basically $300,000 or $400,000 in each of the next three quarters. So how come the tax rate is still where it is?

Cai, this is Don. The reason is we had a shift in our forecasted earnings that has an impact in the way we project what our effective tax rate is going to be. We had been forecasting some benefit based on historical patterns, that we were going to get some impact of benefit of R&D coming through into our FY16 numbers. It wasn't material but that's why you're not seeing -- your assumptions are reasonable based on what you just described. But what we did see in this quarter, a bump to our benefit, as I described, to the tune about $1.5 million. That was the outlier but that's being offset by the mix of earnings and the impact on how that comes together on the tax rate.

Okay, and if we turn to aircraft, your R&D was higher than expected. You've basically said its $5 million higher for the year. Can you walk us through what programs it's higher on?

In the first quarter, really this is a reflection of the E2 coming into production. We start to see additional stuff, and the rest of it is spread across a whole series of programs. It's not one individual program that I would single out, and say that's a $5 million increase. You've got the 350, the E-Jets, the B-280, we've got the B-525, we've got a whole series of other programs. It's just a -- across a whole range of programs that there is a little bit of an uptick in it; it's not a single program. In the quarter, higher R&D spend was really driven by the E2 program, and that really has to do with where it is in terms of getting initial hardware to the customer.

Okay, that's supposed to be about $32 million or so for the year?

Yes, in that range, yes.

And then, you talked about the mix going forward but as I do the math, from what you are saying, the R&D stays pretty close to $22 million. Pretty much all of the incremental growth is in commercial OE, A350, 787 where you have been complaining that the margins are not very good. Walk us through why they get better and how big is -- I know you don't want to identify these FMS sales, but basically, how big are they in terms of revenues and when should we see them occur?

I think your question -- Let me see if I got the question right. How do margins get better from 7% plus in the first quarter to 9% average through the year? It's a combination of getting -- the commercial business we continue to come down the cost curve, so we'll continue toward that.

And it is that the military [boat] business gets better as we go through the year. We're forecasting increased sales as we go through the year. Some of that, a portion of that is FMS sales and that seems to have a better margin. We have seen that in the past years. We've seen that type of margin change from one quarter to the next. It's a pattern we have seen before.

The margins that we did last year, we did 10.5% in the third quarter versus 8% in the second quarter. We see that type of margin shift. It's not unusual. It has to do with the way the business flows through. As I say, a lot of it is related to specific FMS stuff and continuing improvements on the OE side.

Last year you had the problem on commercial, the new commercial programs of lots of supplier issues in Asia where you would have to shift from suppliers. Can you update us, where is that supplier issue? Why should we at this point feel comfortable, though, you should come down those cost curves when you had so much trouble last year?

A little bit like the answer I gave Rob, which is, you learn from experience. Over the last several quarters, we have been tracking to what our plans have been, and we are tracking this year so far in the first quarter from what our plans have been. It's not that everything is perfect. We continue to work our way through building that supply chain. We continue to ramp-up the 350. We have the E2 behind that.

But we are seeing that the models we have to predict future costs have taken into account some of the effects I described last year. That's part of learning by experience, I would say, and as a result we are kind of on track for the cost [downs] that we have anticipated. Our forecast includes continuing to meet those cost curves and on the basis that we have become more accurate over the last several quarters in our ability to predict, that's what gives us the confidence to say hopefully we will continue to meet the cost curves.

Can you give us, and this is my last question, I apologize. Can you give us some color on how you're doing cost wise on both the 787 and the A350? Do either of those two programs have price step downs as other suppliers have?

I am not sure, when you say color on cost?

Basically, how you are doing? You say you were coming down. Do you feel equally comfortable with the 787, the A350 obviously is a lot earlier, and I would think there would be less certainty, but we've basically done more than 300 87s. How comfortable do you feel and is that something that could be challenged because of price step downs. So, just, general description of how comfortable are you on those?

I would say our progress on the cost down curves on the A350 is much, much better than it was on the 787. Again, that's both learning from experience and having the infrastructure with the 787 supply chain that we can tap into. As we look at the E2, which is not yet even in production, we see already that we are much faster at getting down that cost curve than we have been on the 350. There's no question there has been significant learning as we have gone 87 to 350 to the E2.

In terms of the level of confidence, it's the best confidence we can provide. That is not to say there cannot some kind of a supply chain hiccup or issue with a supplier. We have baked in the experience we have had in the past in order to try and capture that. As I say, over the last four, five to six quarters we have started to see ourselves tracking to our new cost curves in line with what we expect. I can't guarantee that there won't be a supply chain disruption somewhere along the way as we go through it. I can only guarantee that the models we have are a lot better, folks have learned from experience and we're working real hard to meet all those costs.

Thank you, very much.

Thanks.

(Operator Instructions)

Michael Ciarmoli, KeyBanc.

Good morning, thanks for taking the question. Maybe, John, just to stay on where Cai was going in recovery on aircraft margins, can we walk through a similar exercise here for components? You're going to have to average over double-digit margins for the remaining three quarters. I would imagine the environment having gotten better the first month here of the second quarter. Again, similar, how do we have confidence in the margin rebound in the components, if seemingly some of these end-markets are showing further weakness?

Yes, I can tell you, Michael, we have gone through that ourselves in great detail over the last several weeks as we have been doing this conversation. Let me give you this perspective on it. The first thing you got to look at is that the components this quarter was an outlier across all of their markets. Everything, all of the A&D stuff, all of the industrial businesses, everything was significantly down.

If I take 12 years of history and the associated 50 quarters that they have been with us, where they have never had a quarter under double digits, and average mid teens, that is a starting point to say, this quarter, clearly, there was a set of unusual circumstances. As we look to the rest of the year, as you say, to average 10% they've got to get back into the low teens. We've never had a business that was in the low teens, I would think that would be a good concern to have.

On the other hand, it's the same team of folks, the guy who is leading that business has been leading it for the last 12 years since they joined us. He and his team have been there that whole time; they really know their business. It has diversified across all of those markets. In terms of the team, the folks who have done it and have delivered in the past, that's the first thing I would offer you. And these are their numbers in terms of the opportunity to get better.

The A&D side of the business, there was a series of weaknesses in the first quarter which were unusual. There is backlog, there are problems in terms of some of the aircraft, electro-optical infrared stuff, that with the missile businesses, some of the vehicle businesses in Europe, where we've won positions. So we see that improving as we go through the second half of the year.

Generally speaking, our military business was soft in the first quarter. If you look across all of our military businesses, it's not as if the military defense budgets have taken a dramatic step down between the fourth and the first quarter. On the A&D side, we see a recovery, we have a whole series of programs that we anticipate will do better. A lot of that is already in the backlog and I can see an improvement. For the non-A&D side, the industrial, oil, and the medical segment, what we have done, is forward forecasted at the run rate of the first quarter.

We can ask ourselves the question, could it get worse from there? Perhaps, but I think the oil business is down, as I said, 60% from what it was a couple of years ago. We believe we are now at the maintenance level in that oil business. Therefore, we think the rest of the year should be similar to the first.

Much lower than last year, if you remember this time last year, as oil started to drop, we said we thought we would make our way through 2015 because we had a lot of stuff in the backlog that was these large FPSO orders which were multibillion dollar programs that our customers had already invested in, and therefore, that wouldn't stop. And that's what happened. That essentially has all flushed through now. We're hopeful that our forecast for our oil-related business at the same run rate as the first quarter is realistic.

We've done the same with the Industrial business. That's taking it down significantly from what we said only 90 days ago. It's down $20 million. We've come down from $100 million to $80 million. We're taken a 20% cut in that business after seeing what happened in the first quarter. By the way, that's down 20% from what we did last year.

We've done something similar with our medical business. We taken that down by 15%. That's off $20 million from what we did in 2015. Each of those is significantly below than what we did in 2015, it's in line with the run rate of the first quarter.

Could it get worse? Sure, it could get worse. It sure feels like we're trying to re-baseline this way lower than 2015, in line with what we have seen in the first quarter, and the pick up is on the A&D side of the business, which we are much more confident in. We've seen that business, those programs in the past, we know what the programs are, we feel comfortable that will come back.

Got it. I think you quickly referenced in there some of the floating offshore production. On your offshore, it seems like that's hit bottom or really bottomed, or do you think there's any further weakness in some of that offshore energy exposure that you have?

In 2014 -- I'm sorry, in FY14 we had $85 million of that business. This year we're forecasting $35 million. Last year we did $60 million. We just took it down from what we thought 90 days ago. We took it down by $15 million. That's a 30% decline from what we said 90 days ago.

We're working real hard to try and find the bottom of it and say this seems like a number we should be able too meet and, perhaps do a little bit better than. As you can imagine, what are internal folks are saying is they think they can do more. We are trying to make sure that we put in whatever necessary reserves we think are sensible to get us to a bottom. That's what we've done, and it's as good as we can make it, Michael. I wish I could guarantee it to you but even if I did, I don't think I would believe it if I were you.

No, no, I appreciate the challenges out there forecasting it. Maybe just a shift, too. The one area I thought you would have seen some strength and I think you referenced in your Space and Defense, your security was a bit weaker, and it seems like there's a prevailing sentiment out there that since the Paris terrorist attacks, some of these sensors, surveillance systems, border security would have seen some strength. Can you give us some color on what is happening in that business?

I can. That's an interesting question. If you remember, last year we had some significant challenges in that business. We took a couple of million dollar write-offs in the first quarter. In the second quarter we had an accounting adjustment for challenges in that business. It was a business that was significantly challenged and went through some dramatic restructuring over the course of the last 12 months. As a result of that, the other thing we have been moving, we combined two facilities, that's now completed. We have been working very hard to restructure that business.

As a result, some of the things that have happened is we ended up because it was not profitable, increasing prices, doing a lot of stuff. You look at what we had a year ago. We had about $14 million or $15 million of sales in our security product line. This quarter we had $10 million. Now, as you went through the year, in our second quarter last year we had only $6 million, $7 million, and then $10 million. This quarter is on that recovery path. It's a much better set of customers, much better pricing, and it's much better structure. From a profitability perspective, it's way better than it was a year ago. This is one of those, you've got to fix the portfolio where you got problems. A year ago, this business was in significant trouble. It's now a smaller business but it is much healthier.

We'd be optimistic that there might be an opportunity going forward, but we've forecasted the full year at about $40 million, which is the run rate of the first quarter. It's still coming out of a significant period of restructuring and the forecast said that it would pick up too quickly would be maybe overly optimistic.

The Paris type of thing, it could have a positive -- you know, we do pan and tilt systems, [it is security systems]. Typically that would take a little bit of time, Michael, a lot of that is, the type of stuff we sell, is government driven type stuff. You end up going through the whole government procurement cycle, which is a lot of work associated with proposals. It's not as if you suddenly start selling these things off the shelf and start to see it pop in your sales.

Got it.

We may see an improvement as we go through the year but I can tell you at $40 million of sales, I'm a heck of a lot happier with that business than I was two years ago at $50 million of sales. It is in much better shape. If you look at the margins in our Space and Defense segment I think you start to see that reflection. They had a very strong quarter on significantly lower sales.

Got it. That's helpful, and just last one. Buyback, you guys have been buying back pretty aggressively, higher stock prices, stock down where it is. You guys are going to be patient. Just maybe a little more color on maybe the hesitation in proceeding with the buyback?

Michael, this is Don. Yes, I tried to address that in the remarks. We came into the quarter at a leverage that was just under 2.5 times, it was 2.4 times. Our comfort zone, what we believe to be optimal cost to capital gets us in the range of 2 to 2.5 times levered. We're looking at a soft start to the cash flow which actually didn't happen and we thought with some of the M&A activity that was going on, being levered where we were, we thought it was best to hold off and not deploy the capital in that way at that point in time.

We have, as I said, about 4.2 million shares left in the authorization. We will continue to take a look at them and how best to deploy our capital but then, we're not forecasting if we're going back in the market or anything like that. We will actually know in three months what we've done.

Mike, the other thing is that there are certain restrictions as our leverage (multiple speakers) as our leverage gets over two times our bank confidence, it doesn't completely preclude us. It doesn't allow us to go at the pace we have done in the past. It's a combination of there are certain constraints as you start to get over 2.5 times levered, and as Don said, we've said all along that 2 to 2.5 times is where we feel is a good area. It allows us some comfort in terms of a rainy day, but also some margin if the right strategic acquisition comes along and we want to take advantage of that. And therefore I would say our behavior in the quarter was consistent with what we've described over a quite a period of time.

Got it. That's helpful.

(Operator Instructions).

Ron Epstein, Bank of America, Merrill Lynch.

Good morning, everyone. It's Kristine Liwag, not Ron.

Hello, Kristine.

So, guys, extrapolating from your second half recovery expectation in FY16, should we think about FY17 as an improvement over that? Should we think about overall FY16 should be trough earnings for you? If not, what are long-term puts and takes that we should consider?

Kristine, as much as I would like to get into FY17, I don't want to talk about FY17 today. Our objective has always remained the same, which is to get this business into a double digit mid-teens margin business. Our focus is on trying to grow. And our focus is on strong cash flow.

If you look over the last few years, we've done well on the cash flow, but the growth clearly has not been there. I've described some of the headwinds, described 10% reduction in military aircraft, 16% reduction in a couple of years in our industrial businesses, 70% reduction in our oil businesses, 20% reduction in space and medical. None of that is related to losing customers or losing shares, it's to do with the markets we seem to be serving. Despite the diversity that over the years has served us so well, unfortunately, that has not been a great addition in terms of margin. The commercial OE has done great, it's up 25% over the last [three] years, but as we've described on many occasions it's a very immature book of business and from a margin perspective, it's not contributing at a level that it will in years to come.

Our objectives have not changed. If there was some underlying organic growth we would see significant improvement in margins. Despite the challenges, we continue to restructure, continue to focus the portfolio on the most profitable businesses. We continue to work to get those margins into the mid-teens. What that looks in FY17 would be premature for me to say now, because we don't do that process until later this year, and we provide that guidance on our July conference call.

Sure, and switching gears to commercial aerospace, when there are production cuts from Boeing and Airbus, is there adjustment to your pricing?

No. Typically, not. Typically, in all of these contracts, its fixed pricing independent of volume.

Great, thank you.

You are welcome, thanks.

There are no further questions at this time. I would like to turn the call back over to today's presenters for any additional and closing remarks.

Thank you, Ebony. Thank you all for listening in. Tough quarter to report, we hope to come back to you in 90 days time with more positive news.

That does conclude today's conference.