Moog Inc (MOG.A) 2016 Q2 法說會逐字稿

Good day everyone, and welcome to the Moog second quarter fiscal year 2016 earnings conference call. (Operator Instructions). At this time, I would like to turn the conference over to Investor Relations Manager, Ms. Ann Luhr. Please go ahead.

Good morning. Before we begin, we 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, uncertainties and other factors is contained in our news release of April 29, 2016, and our most recent Form 8-K filed on April 29, 2016, 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 did not already have a document, a copy of today's financial presentation is available on our Investor Relations investor webcast page at www.moog.com. John?

Thanks, Ann. Good morning. Thanks for joining us. This morning we report on the second quarter of fiscal 2016 and affirm our EPS guidance for the full year. As usual I will start with the headlines before diving into the business.

First, it was good quarter with earnings per share of $0.85, at the high end of our guidance. Second, we took a restructuring charge of $0.14 in the quarter, mostly the result of a decision to exist a product line in our aircraft segment. Third, it was a good quarter for cash flow. Fourth, we purchased over 500,000 shares of our stock in the quarter for $22 million. And finally we are forecasting full year sales of $2.47 billion and earnings per share of $3.35 plus or minus $0.15, unchanged from 90 days ago. Now let me move to the details starting with the second quarter results.

Sales in the quarter of $611 million were down 4% from last year. Approximately one-third of the decline was due to currency effect. Sales were up marginally in aircraft and down marginally in space and defense, industrial and medical. The big drop was in our components group where sales were off 18% compared to Q2 fiscal 2015 but up nicely from the low point last quarter.

Taking a look at the P&L.

Our gross margin was up over 200 basis points from last year. In the second quarter last year we had an accounting correction in one of our space and defense operations which depressed gross margins. R&D was up in the quarter driven by the heavy work load on our major commercial aircraft programs.

Our SG&A expenses were down as we continue our focus on cost management across the Company. We incurred $8 million of restructure in the quarter, which was three-quarters of the expense in our aircraft group. Our effective tax rate was relatively low at 23.9%. And the overall result was net earnings of $31 million and earnings per share of $0.85.

Fiscal 2016 outlook. We are leaving our forecast unchanged from 90 days ago with full year sales of $2.47 billion and full year earnings per share of $3.35 plus or minus $0.15. We are tweaking the margin performance in a couple of our segments as we allocate the restructuring expense we took in the quarter. Otherwise at the halfway mark the year is on track to meet our guidance. As in previous quarters, this outlook does not include any positive impact from further share repurchase activity.

Now to the segments. I'll remind our listeners that we provided a 2 page supplemental data package posted on our webcast site, which provides all the detailed numbers for your modeling. We suggest you follow this in parallel with the text.

Starting with our aircraft segment. Sales in the second quarter of $276 million were up marginally from last year. Commercial sales were up 3% while military sales were down 2%. On the commercial side, strong growth on the A350 program compensated for slightly lower sales to Boeing and the decline in sales on business jet. The commercial aftermarkets were up marginally in the quarter on stronger A350 initial provisioning. As we look to the future we should continue to enjoy increasing OEM sales as our new programs ramp up.

In the military markets work on the F-35 development program slowed to a trickle. We also saw lower sales in the V-22 and backlog program. On a more positive note, our foreign military sales were higher. The military aftermarket was down in the quarter, with slowing C-5 sales partially offset by increasing sales in the B-2 and the F-35 program. We expect our military business to remain fairly stable over the next few years with the growth in the F-35 offsetting the decline in more mature programs.

Fiscal 2016 outlook for aircraft: we are leaving our full year sales forecast unchanged at $1.13 billion. We are also leaving the mix unchanged with 53% commercial and 47% military. Aircraft margin, margins in the quarter were 9.1%, excluding $6 million of restructuring charges. In the quarter we exited an underperforming product line and incurred a series of expenses related to staff reductions, facility closing and various asset writedowns. Of the$6 million expense about three-quarters were non cash charges.

R&D was up sharply in the quarter on increased B-2 and A350 activity, but a good sales mix resulted in solid overall margins. For the full year we are increasing our planned R&D spend by $5 million to account for higher activity on the E2 program. However we are anticipating a slightly better sales mix and are therefore maintaining our full year margin forecast, adjusted for restructuring, at 9%. Including the restructuring this quarter full year margins declined to 8.5%.

Aerospace and defense sales in the quarter of $89 million were down 4% from last year. The weakness was all on the space side of the business as we had less work on various satellite programs than last year. Over the last 12 months we've closed out several space contracts and therefore our business has been temporarily down as we awaited the follow-on orders. These orders are now starting to materialize and our satellite business is up from the first quarter. We are anticipating it will continue to improve as we move through the second half of the year, so we believe the low point of the present cycle may be behind us.

In the defense market we had higher sales on military vehicles. In general we're seeing a recovery in our vehicle businesses both in the U.S. and Europe as spending increases from a low point a couple years ago. Space and defense fiscal 2016: we are maintaining our full year sales forecast at $375 million. This forecast assumes a slightly stronger second half with higher sales on satellite, military vehicles and in our naval product line.

Space and defense margin, margins in the quarter were 15%, up from 5.3% last year. Second quarter margins last year included an accounting correction which depressed margins by 840 basis points. Even adjusting for this correction, margins for this quarter were above last year on lower sales, a very strong performance. Last quarter we forecasted full year margins in this segment of 12%. This margin projection included over $2 million of restructuring which we anticipated would occur in the second half of the year. Based on our incoming order rates we no longer believe this restructuring will be necessary and hence we are increasing our forecast for full year margins to 12.7%.

Turning now to our industrial systems. Our industrial systems business is driven by three very different end market dynamics. The simulation business is strong as investment in new airplanes and more extensive pilot training continues. Our industrial automation business is holding its own in a soft economy both in Europe and Asia but there is little or no growth. Finally, our energy business is suffering as the result of the price of oil and the volatility in our wind market. Looking out a year or two we anticipate our investment in new products for our wind business will drive a recovery in our energy sector.

Sales in the quarter of $128 million were essentially flat with last year. Our simulation and test business was up nicely on strong sales to our major flight simulation customers. We also had higher sales for our components used on gas and steam turbines. In our energy markets we had lower wind sales in both Europe and Brazil as well as lower sales in the oil and gas exploration market. Industrial automation sales were slightly lower on reduced sales to steel mills.

Industrial systems fiscal 2016: our forecast for full year fiscal 2016 sales is unchanged at $495 million. Margins: margins in the quarter were 10.3%, which included $1 million of restructuring charges. For the full year we are maintaining our margin forecast at 9.2%.

Turning now to our components group. Our components group is slowly coming out of the perfect storm that hit in Q1. There is still a lot of work to do and it will probably be sometime in fiscal 2017 before the business is back to full health, but Q2 was a step in the right direction. Even though sales in Q2 were down relative to a year ago, they were up nicely over Q1.

Component sales in the quarter of $94 million were 18% lower than last year. Comparing to the same quarter a year ago, sales were down in every market segment. It is a similar picture to what we described in our call 90 days ago.

In our A&D markets we continue to see lower sales in our aftermarket businesses and in helicopter program. In our energy markets sales were down almost 50% from last year while our industrial sales are lower on a general slowdown across a range of programs. Finally our medical sales are lower as our customer [per seat at the] equipment moves to a lower cost next generation product. On a positive note, sales in the second quarter were up nicely from our first quarter with improvements in every market we serve. As we move through the remainder of this year, we believe we will continue to see further improvements from the low point in the first quarter.

Looking to fiscal 2016, we are keeping our full year forecast unchanged from 90 days ago at $365 million. Second half sales should be up from the first half driven by some specific aircraft and defense vehicle programs.

Components margins: margins in the quarter of 8.9% included $1 million of restructuring charges. These margins were significantly lower than last year but up from the first quarter. We believe the first quarter was the low point for this business and we are slowly recovery as we resize the operations and see a gradual recovery in the sales. For the full year we are maintaining our margin forecast of 10%.

Medical devices, it was another good quarter for our medical devices business continuing the trend of the last two years of organic growth and healthy margins. Sales in the quarter of $24 million were down 5%. However in the second quarter last year we had almost $2 million in sales from our life sciences operation which we divested in March 2015. Including these life sciences sales, shipments of pumps and sets were about flat with last year. Through the first six months of the year excluding sales from our life sciences operation, sales are up 11% organically over the same period last year.

For the full year we are maintaining our forecast at $102 million. This forecast assumes a second half very similar to the first. Margins in the quarter were 10.6%. Margins for the first six months of the year were 11.6%. For the full year we are maintaining our margin forecast at 11.4%.

Summary: after a significant revision to our forecast 90 days ago, we are pleased to report a quarter where we came in at the high end of our guidance and are maintaining our sales and EPS forecast for the full year. To reiterate we are forecasting full year sales of $2.47 billion.

90 days ago we forecasted $5 million of restructuring for the full year. We are now forecasting $9 million of total restructuring of which we took over $8 million in the second quarter. This higher restructuring expense is compensated by a lower tax rate and slightly lower share count. The net result is no change in our EPS forecast of $3.35 plus or minus $0.15. At the halfway mark we have a $1.56 in the bank. We anticipate the third and fourth quarters will be in the range of $0.85 to $0.95. As usual this forecast does not assume any impact from further share buyback activity.

Before I pass it to Don, I would like to inform our listeners of a change we are making in our timing of providing forward looking guidance to the Street. Traditionally we have provided a first look at the next fiscal year when we reported our results at the end of our third quarter. This year we are changing that practice to align it with most of our peers and we will provide our first look at fiscal 2017 at the end of our fourth quarter. Now let me pass it to Don who will provide some color on our cash flow and balance sheet.

Thank you, John, and good morning everybody. Free cash flow in our second quarter was $64 million bringing our year-to-date free cash flow to $51 million or a cash conversion ratio of 89%. Net debt decreased by $52 million and for the full year 2016 we are affirming our previous free cash flow forecast of $130 million or a conversion ratio of 106%.

During the second quarter we repurchased 526,000 shares under our share buyback program for about $22 million. We have 3.7 million shares remaining under the outstanding Board authorization. As we have previously described if our leverage ratio -- which is defined as net debt divided by EBITDA -- exceeds 2.5 times our bank covenants constrain our share repurchase activity to 30% of our prior year's net earnings. We monitor our leverage weekly to ensure our compliance.

As of the end of the quarter, we had $17 million of our carryover basket remaining for when our leverage exceeds 2.5 times. We'll continue to report our repurchasing activity at the end of each quarter.

Capital expenditures in the quarter were $15 million and depreciation and amortization totaled $25 million. Capital expenditures for the first six months of 2016 was $28 million compared with D&A of $50 million. For all of 2016 we are leaving our capital expenditure forecast at $80 million. In the second half of 2016 our projected CapEx spend will increase largely due to expected tooling and test equipment investments on major commercial aerospace programs. Depreciation and amortization in 2016 will be about $103 million.

Cash contributions to our global retirement plans totaled $24 million in the quarter compared to last year's $23 million. For all of 2016 we are planning to make contributions to our global retirement plans totaling $95 million, unchanged from our forecast three months ago.

Global retirement plan expense in the quarter was $16 million up just 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 assumption.

Our effective tax rate in the second quarter was 23.9% compared with last year's 22.5%. These relatively low tax rates in both years reflect a reversal of accruals for certain tax exposures outside of the United States where the statutes of limitations have now expired. This was a discrete item in the second quarter that will not repeat in the balance of 2016. For all of 2016 we are forecasting an effective tax rate of 27.6%, down slightly from our forecast 90 days ago and from 2015's tax rate of 28.3%.

Our leverage ratio increased to 2.5 times at the end of the quarter compared to 2.3 times a year ago because of our share repurchase activity over the last 12 months. Net debt as a percentage of total capitalization was 42% versus 40% last year and at quarter end we had $324 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 that you might have.

Thanks. Kim, we are open for questions please.

(Operator Instructions). We'll take our first question from Robert Spingarn with Credit Suisse.

Good morning.

Good morning, Rob.

John, you talked about or put it in the release that the aftermarket I think was up a couple of percentage points and A350 provisioning was cited. Could you parse this out a little bit, provisioning versus spares?

Provisioning versus spares. So we have provisioning on the -87 and the A350 and that was up a little bit from last year. That's the difference. The rest of our underlying aftermarket business there wasn't a lot of change from last year. So I'm not sure; the difference between last year and this year is only about $1 million and it is really driven by $1 million of combined IP between the -87 and the 350; that is what has picked up a little bit. The rest of it is pretty much flat.

So spares activity flat. Do you have any sense as to --

I'm sorry. One sec. I think you are mixing two things. I would call IP as really spares and then the rest of our business is a combination of parts, repair and overhaul spares activity. So I don't know that the split that you are making there that I would agree with. We have IP which is really spares into the airline for new programs and then we have the traditional aftermarket which is all the other stuff. It is parts, repairs, spares, everything.

Yes, I want to separate the initial provisioning from the run rate spares from the higher flying activity, et cetera.

So of the kind of the $30 million in the quarter about $6 million is initial provisioning across the major programs.

Okay. Would you say that the destocking that so many suppliers have been talking about is starting to thin, and the demand for spare parts and MRO is beginning to strengthen?

No, I don't think I would say that. And I think if you look at our forecast, our projection for the year is actually down a little bit from what we said last year. We are looking at a forecast on the commercial aftermarkets for the year of $112 million versus $118 million last year. And there is a little bit of that is in the IP side, but that is less than half. We are still assuming the underlying business will be a little bit softer than it was last year.

Okay. All right. Just a higher level question while we are on this. Boeing has talked about taking a greater role in the total life cycle of its aircraft and increasing its share, which it calls about 6% of the aftermarket if you will. Have you started to see any impact from this, and how do you think about this from a strategic perspective?

I think there are -- let me break that into two pieces. There is the new programs at Boeing, the 787 for us; and then there is the legacy business. On the 787 we described -- and the same is true on the A350 -- we have described that because of the level of content we have on it, it becomes interesting for the airlines to consider a power-by-the-hour type of contract. Essentially there is a variety of those contracts ranging from availability of spares through forward stocking locations to full service power-by-the-hour type of contracts. And we have developed a set of in-house offerings that we have worked with a variety of the major airlines to provide that opportunity.

We of course also provide the same -- Boeing provides a similar set of opportunities through their GoldCare on the 787, and for that we support Boeing. We are a supplier into Boeing on that.

In the more traditional business, the older programs, it is still a standard business in terms of spares, repairs, et cetera, and I can imagine and I understand that Boeing's interest going forward is to perhaps change that relationship. We haven't had any specific conversations around that, and of course that changes some of the economics of how these programs work. I think you are all aware that the majority of the income for these types of programs has traditionally been in the aftermarket and that's the model that we have used as well.

Should I infer from that maybe some of the return then shifts to the original equipment in a scenario like that?

I don't think I understood. Can you say that again because I'm not sure I understood what you said.

In other words, if you have to give up a little bit more on the aftermarket side of the equation.

Yes, but again programs that are already in production have agreements around OEM pricing, around aftermarket pricing, all that stuff. I think that is more relevant as you look forward to the next set of programs.

Understood.

That will be when negotiations start.

Understood. It is a long-term process. Lastly you have this strength in the second quarter; your revenues look like they bottomed for most segments in Q1 now. You did hold the guidance, you talked about the $2.47 billion. Did you move any business to the left, or might it be now that your second half guide perhaps has a little more cushion than it has in the past?

The quarter came in stronger than we had anticipated and there was a little bit of some stuff happened in the second that we had anticipated in the third. So there is a little bit of that.

If you back out the restructuring halfway through the year we're at about, close to $1.70, multiply that by two you are at $3.40. We are sticking with our $3.35.

That anticipates that our aircraft business gets better in the second half. We do have, as we said last quarter, we have got some foreign military business we think will help with that. On the other hand, we saw R&D pick up in this quarter and we are ticking it up for the year so that remains a little bit of a wild card as we go through the qualification and certification programs in some of the big programs we are running.

So I would say there is nothing in the industrial world that says anything is going to get better, so we are forecasting a little bit flat maybe to down there. We have been surprised on the components side. I would say we are feeling comfortable, that half way through year we are not anticipating a big pickup in the second half. On the other hand, I don't think there's any signs that there should be a big pick up. We are comfortable that we are holding with our guidance. It is too early to say that there is an upside at this stage.

Okay. Thank you for taking my questions, John.

You're welcome.

Moving on, we have a question from Michael Ciarmoli from KeyBanc Capital Markets.

Good morning, Michael.

Thanks for taking the questions. Maybe just to follow up on Rob there with the aftermarket. So second half is going to be down over first half. I would have thought maybe you would have seen maybe a little bit more provisioning on the A350 or as more airlines start to take deliveries of the 787s. Anything we can look into? You kind of said the destocking is not ending but the outlook implies it gets a little bit worse in the second half.

Yes, I think we have found it notoriously difficult Michael, to forecast the initial provisioning. Which is kind of strange because you would say, well, for every five airplanes delivered don't you supply one actuator, or whatever it is. But it turns out that that is not typically the way the airlines seem to order.

And you may remember that in 2014 we had an enormous year of initial provisioning on the -87, which was totally unanticipated, and essentially pulled forward a lot of provisioning that we might have anticipated that would come with the natural growth in the fleet. So we are anticipating in the second half that the IP on the -87 will slow down and that the A350 will kind of keep at the pace we are going.

Is there potential upside to that? I would say, yes, just given the fact that as I say it has been very difficult to anticipate how the airlines will actually stock their locations.

The other thing I would say though is what I mentioned to Rob, which is we are focused very much on also signing long-term agreements with the airline customers to provide some level of guaranteed spare turnaround time, perhaps fly-by-the-hour type of contracts. There's various offerings and different airlines are interested in different things.

As you do that you get fewer IP sales; of course you get more long-term sales, so it's a different equation. But you see less of the initial IP sales and that is also playing a little bit into this. So tough to forecast. Primarily the difference between the first half and the second half is we are not anticipating that the level of -87 IP will continue at what we saw in the first half.

Got it. And then maybe shifting to the OE side. The A350, Airbus clearly having challenges. I think they have got 40 planes in final assembly there. What is your assessment there; what is your read?

I mean do you expect to continue shipping at this same rate on the A350 for a longer period of time before you see that next jump in rate as maybe it takes Airbus a little bit longer to address those situations? I mean, how are you planning for those different scenarios?

Well, we have not changed our outlook for the year on the A350. Our outlook is that we will ship about $80 million of content. Through the first half if you do a run rate on the first half, it works out at about $65 million, so we are anticipating that will continue to ramp. And if I look back over the last four quarters, it ramps quarter after quarter. It is up a couple $2 million, $3 million, $4 million one quarter after another, and we anticipate that that will continue.

I think, Michael, oftentimes even if the OEM has some challenges -- and if you'll remember I think it was a couple years ago, there was a Boeing strike for a couple of months and people were wondering. They typically do not want -- at least in our experience, they do not want to slow down the supply chain. They want the supply chain to continue working at a steady pace and a steady ramp and assume that they will find their way through the challenges that they have got, and that is essentially where we are.

So we have no information from Airbus that says slow down, change your outlook and stuff, and we are progressing down that path. Now perhaps next quarter or the following quarter there may be a little bit of a slowdown in that. But right now we are anticipating that we will do about $80 million for the year and there is no change from what we thought 90 days ago.

Got it. Than just a last one for me, can you elaborate a little bit more on the product line that you exited and just maybe the rationale there?

This is a technology product line that came along with an acquisition years back in the aircraft group. It was a business we thought had some potential. We invested in it for a few years.

Given the situation we find ourselves in, in terms of the other challenges in the aircraft business in terms of getting through the programs, getting through the work load we have, we have been doing as we mentioned before a continuance portfolio review across all of our businesses. And if you look back over the last few years, every other quarter there is a little bit of change here or there.

We've stepped out of a product line. It was a product line that we took a step back on said, is it worth continuing to invest in, do we see light at the end of the tunnel, is it worth continuing. And we decided, no, it is not, so we stepped out of it.

And there wasn't a huge number of people. It was 20 or so people, it was a small facility involved. But there was some inventory and other intangibles that went with it. Of the $6 million charge 75% of it was a non cash charge. So just part of the portfolio cleanup and continuing to make sure we are focusing on the businesses that we think have long term potential and concentrating our efforts on the major opportunities we see.

Got it. Thanks a lot guys. I'll turn it back to the queue.

Thanks, Michael.

(Operator Instructions). We'll go next to Ronald Epstein with Bank of America, Merrill Lynch.

Good morning. It is actually Kristine Liwag calling in for Ron this morning.

Hello, Kristine.

John, this is following up on a question that was already asked before. The OEMs have been pretty vocal about reducing supply chain costs. With your long term agreements with the OEMs are there any material contract expirations that are coming up that we should watch?

Not anything in the next couple years, Kristine, that I think will have any significant impact. As you go out further of course as you get into the 2020s and stuff typically you have renegotiations, renegotiation with some of the OEMs around some of the programs, but not in the next year or two.

And then in the next year or two when we think about volume is there some sort of pricing escalation or pricing stepdown tied to that, or maybe pricing protection?

There is a little bit of both if I look across the portfolio of major programs. Some of them have some minor pricedowns; some of them have some potential for adjustments based on pricing escalation. But it gets into the noise Kristine in terms of the effect on the overall business and as we -- when we will provide guidance for 2017, we will bake that in. It is not a significant impact in terms of the overall programs.

Great. And then for -- if I could do a second one, your business outlook for the full year assumes a 4% decline, and I think from what I remember this is mostly Gulfstream. And my question has to do with more mix. Do you have more content on the 500 and 600 versus the Gulfstream 450 and 550?

The 650 is a reasonable sized program for us. We have -- I mean, the major Gulfstream programs for us are the 500, the 280, and the 650.

So does that mean that the 500 and 600 you have more content there versus the 450 and 550? So when we transition to the newer Gulfstreams does that mean that should be a step up for you?

I think we anticipate that the Gulfstream business will continue to be positive over the coming years; of course it depends a lot on the overall business jet market. But we have developed a fairly strong position with Gulfstream over the last few years. And we are optimistic that that will continue to be a nice contributor for us in the future. So, yes, I think you can -- our business jet business will be more tied to Gulfstream than if we go back a few years.

Great. Thank you very much.

You're welcome.

(Operator Instructions). I do have another question that comes from Cai von Rumohr from Cowen and Company.

Good morning, Cai.

Yes, hello. Thank you very much. So your R&D was a little higher than expected in the quarter. Where was aircraft R&D and where do you expect it for the year?

Aircraft R&D for the quarter was about $28 million and for the year we are anticipating that it is going to be around the $90 million mark. And that is up, Cai. We have also revised our forecast up by about $5 million. And it is really driven -- we are in the certification stage on the E2; we are in the same on the A350 1000, so there is just more work as we go through that.

Some of it, as you will also notice there, the gross margin got better. It is not as if we have hired a whole new team of engineers that drive these costs. There is a portion of it that moves between the gross margin and the R&D line depending on whether folks are working on production related stuff or they are working on the R&D line.

So what you will notice is we have bumped up R&D for the year, but we haven't changed the outlook for aircrafts for the year. That really has to do with a little bit of a better mix but also a little bit of a movement of cost between cost of sales and R&D.

Okay. So this is a fairly big change in the estimate. Is this reflective of a technical problem or why is the number so much larger than you initially estimated the R&D number?

As we have gone through the qualification program, Cai, there have been some technical challenges that have emerged that require some redesign work and that's what's driving the higher costs.

Are those higher costs likely to be recouped from the customer?

No. No.

Okay.

There is no recourse on the R&D.

Are you pretty much beyond this? Because your estimate for the year kind of looks like the R&D goes from $28 million down to an average of $20 million in the third or fourth quarter. So is that what you look for, or is there risk that this number could be higher?

That is the outlook as we see it right now, Cai. But there is clearly risk on these sorts of development programs. And I think we have seen that over the years that as you go through that certification program, the qualification and certification, there are always things that can crop up despite the best efforts early on in the program to design for the set of requirements. And typically those costs it is hard to -- you can put some kind of reserve around assuming that; but typically when something like that comes up it ends up causing more costs than we have anticipated and that we planned for.

And given --

Cai, this is Don. Just to add a little, one other piece. We do have a forecast out there that does in fact as you describe show that the R&D is projected to be coming down in the second half. That does assume that things are going to go according to plan and we have had challenges with that as we have reported every quarter.

But I would also offer a perspective on the SG&A run rate. We have got SG&A looking like it is going to be up quite a bit in the second half. And probably when you put the two buckets together, SG&A and R&D, we're probably feeling pretty good about that total number.

Okay. So are you relatively close to the certification so you can say the risk is behind you? And what are the implications that these higher numbers have? And the come-down in the second half for next year, should we finally at long last get some relief at the aircraft R&D line?

I think you asked me the same question which is: is there risk in the second half? And the answer is clearly, yes, there is risk as long as you keep going through these programs. And even after you get into the initial units to the customer there is oftentimes -- once stock gets into fleet there is wringing out of the last pieces of it.

I think we have seen that on the -87, we have seen it on the 350, we are seeing it on the E2. So clearly there is risk, Cai. And we have anticipated that our engineering costs will come down earlier than they have.

I don't want to speculate yet on 2017. I think it will depend on how far we get through the balance of 2016, how good we are feeling about all of that, and we'll provide that guidance when we're providing our 2017 outlook.

So I think I would prefer not to provide you that guidance at this stage. I think it is a little bit premature for us to do that.

Thank you. Then one last one on the product that was discontinued, could you tell us what were the sales and losses on that product? And are you looking -- do you have any others in your sights of other products that you might also terminate?

So it was sales in the single-digits, Cai, and I don't want to go into product line profitability, that takes us down a path that I think is not fruitful. But you can assume that it wasn't making money. That is probably the best I would like to say on it.

It was not a contributor. But the sales were very small. So it really was more of a development effort. And it was stopping due to that investment in the development.

And, yes, there continue to be product lines that we are looking at on a continuance basis across the Company and seeing do these product lines fit. They are typically smaller product lines. They are small $2 million, $3 million, $4 million, $5 million product lines. But typically they are carrying some significant amount of engineering investments.

And some of them are good businesses we believe. Some of them are worth the investment. I talked to you in the past about the wind business; that is a larger business but that is a business we continue to invest in and believe that in a year or two's time we'll be glad that we did that.

But yes, we are going through a continuous process of looking at all of our businesses on a quarterly basis and if there are ones that don't seem to fit and don't seem to have a future we'll continue to do the necessarily restructuring and focus on the businesses that we think are better for the long-term.

Got it. And just a last one back on the R&D. Is that pretty much all on the E2 or is it also the A350 1000?

Yes, well, the increase is on the E2.

Thank you.

The additional $5 million that we are anticipating for the year is essentially on the E2 program.

Thank you very much.

Thank you.

And I have a follow-up question from Michael Ciarmoli from KeyBanc Capital Markets.

Thanks for taking this guys. I may have missed this, second half space and defense margins running lower than the first half; is that just due to -- you talked about closing out a lot of programs, is that just the normal startup and mix that is going to occur as you ramp up some activities?

There is a bit of that, Michael, we also have not been running on the R&D line in space and defense. We kind of have been running at below what we feel is a nice normal sustainable rate. So we anticipate there will be a little bit of extra R&D in the second half so we will be adding some engineering there.

It is a little bit of both. It is kind of early phase contract and a little bit more R&D, and we think that will push the margin performance down a little bit.

Got it. Thanks guys.

(Operator Instructions). And it appears there are no further questions. At this time, speakers I will turn the conference back to you for any additional or closing remarks.

Thank you very much indeed. We feel it was a pretty quiet quarter. We look forward to providing you with an update in 90 days. Thank you.

That does conclude our conference call today. Thank you all for your participation. The replay information is on the webcast. We thank you for joining us.