Moog Inc (MOG.B) 2014 Q3 法說會逐字稿

Good day and welcome to the Moog Third-Quarter Earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Investor Relations Manager, Ms. Ann Luhr.

Please go ahead, ma'am.

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 July 25, 2014; our most recent Form 8-K, filed on July 25, 2014; 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?

Thanks, Ann.

Good morning. Thanks for joining us. This morning, we'll report on the third quarter of FY14 and update our guidance for the full year. We'll also provide our first look at FY15.

Let's start with the headlines. First, Q3 was a good quarter. Sales were up modestly on growth in the commercial aircraft business. Operating margins were 11%, and earnings per share of $1.08 were up 44% from last year. We also had a very strong quarter of free cash flow at $72 million.

Second, FY14 is on track to meet our earnings guidance. We're affirming our EPS guidance of $3.65 per share, excluding the effects of our share buyback program. The buyback program is running well, and we're more than halfway through at the end of June. The effect of the buyback will be to add $0.07 per share to this year's earnings.

However, we anticipate the need in the fourth quarter to incur some restructuring charges to set ourselves up to meet our FY15 outlook. We estimate that this restructuring would be about $0.07 per share, canceling out the contribution from the share buyback. The details of the restructuring are still under review. So for the moment, we put a placeholder for the restructuring reserve in our corporate cost.

Turning now to free cash flow, we're increasing our forecast for the year to reflect the strong performance we've seen in the first nine months of the year.

Third, for FY15, we're projecting a 1% increase in sales, a 50-basis-point increase in operating margins to 11.7%, and a 16% increase in earnings per share to $4.25. We're also projecting a cash conversion ratio of over 100%.

While FY15 will be another year of improving performance, the pace of operating margin expansion is slower than we've been anticipating. Excluding our aircraft segment, we're forecasting 90 basis points of margin expansion next year in the other four segments. So that is very positive.

However, we're forecasting flat margins in our Aircraft segment. This is disappointing, but it's the result of the long-term approach we're taking to our investment strategy in the commercial aircraft business. Our major programs are costing us more in the short term than we had anticipated. Long term, however, they will pay off handsomely. Let me provide a little background and some perspective on the future.

Over the last decade, Moog has gone from being a second-tier supplier of hydraulic components to the leading supplier of flight control systems on commercial airplanes. We have won major positions on all the significant new platforms including the 787, A350, C919, Gulfstream business jets and, most recently, the Embraer E2 program. We consolidated the industry through our acquisition of the GE, formally Smiths pilot company, in the UK. We've delivered on all our program commitments and have established an excellent reputation in the market.

Establishing this industry-leading position has required an enormous investment of resources, as well as the dedication and commitment of thousands of staff around the globe. It's been an incredible accomplishment over a ten-year period. Today, we have an enviable position in the market while at the same time, we have an immature book of business when compared to other companies in the industry.

Approximately half our OEM book of business today is on brand-new programs, and our aftermarket is only 20% of our sales. In addition, our R&D expense continues high as we invest in new opportunities by completing out the commitments we've already made. In our segment of the commercial aircraft market, the business is characterized by large upfront investments followed by 20 plus years of production and another 20 years of aftermarkets. Margins suffer in the investment years, recover slightly in the early years of production, and then improve dramatically as we move through the production lifecycle and the aftermarket grows with the fleet size.

Going back a couple of years to FY12, military aircraft made up 60% of our total aircraft sales. In FY15, that ratio will drop below 50% as military sales slow and commercial sales grow. This commercial growth is coming from new platforms.

In addition, our R&D run rate today is $20 million to $30 million ahead of what we anticipated back in 2012. This increased spending is due to our decision to invest in the new Embraer program, as well as higher costs to complete our existing projects. The combination of slowing military sales, early production commercial work, and higher R&D is putting margins under more pressure than we had expected.

We're seeing this effect come through in the second half of FY14. And, based on our latest estimates, we continue to see the pressure for a couple of years to come. As we look out to FY17 and beyond, we'll see margins expand again as our commercial book of business matures and our R&D spending comes down to about 5% of sales.

Our financial goals remain unchanged. We are looking to increase our operating margins into the mid-teens, deliver 100%-plus free cash flow conversion each year, grow organically faster than our markets, and allocate capital prudently to maximize long-term shareholder value. Our revised outlook for aircraft margins does not change our strategy. Rather, it means it will take us a couple of years longer to reach our margin goals than we had planned.

Now let me provide you with some numbers, starting with the third-quarter results. Sales in the third quarter of $684 million were up 2% from last year. Organic growth in the commercial aircraft market of 25% and some nice increases in our Space business, offset a $10 million decline in sales in the Medical Devices segment. Sales in Industrial Systems and Components were more or less flat.

Taking a look at the P&L, our gross margin is unchanged from last year. R&D is down slightly, while G&A costs are up slightly as a result of our SAP startup activities. In Q3 FY13, we had several unusual items, including restructuring costs and the loss on the sale of our Ethox Buffalo operations. This quarter, we had no unusual items. Interest expense in the quarter was down almost $4 million, and we benefited from some favorable tax specials giving us an unusually low rate of 25.6%.

FY14 outlook. We're increasing our full-year sales forecast by $9 million. On the positive side, commercial aircraft sales continue to exceed our expectations; while on the negative side, our medical devices sales are coming in well short of plan.

We're moderating our forecast for operating margins by 30 basis points, to 11.2%, on lower aircraft margins. We're forecasting earnings per share of $3.65, including both the effect of our share buyback and some restructuring costs we anticipate in the fourth quarter. Cash flow is strong, and we're increasing our forecast for the year by $20 million to $185 million.

FY15 outlook. For next year, we are projecting sales of $2.69 billion, up 1% from FY14. We anticipate commercial aircraft will continue to grow and that we'll see some recovery in our industrial markets. Defense sales will be up slightly from FY14.

Operating margins in FY15 are forecasted to be 11.7%, up from 11.2% this year. We are projecting earnings per share of $4.25. Cash flow next year is projected at $190 million or 105% of net income.

Turning to the segments. I'd remind our listeners that 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 with the text.

Starting with Aircraft, Q3. Sales in the quarter were up 8% from last year to $294 million. The familiar pattern continues, strong organic growth in the commercial side compensating for slowing defense sales.

Commercial sales were up 25% in the quarter, with strength in both the OEM and aftermarket segments. Sales to Boeing and Airbus maintain their upward trajectory led by the continued 787 ramp and the startup of production on the A350s. Commercial aftermarket also had a strong quarter, driven by continued strong initial provisioning from the 787. In the military markets, sales were down 5% from last year.

Sales on OEM platforms were down 11%, with lower sales in both the V-22 and the F-35 platforms. In our third quarter last year, we received a long-awaited order for the F-35 LRIP 6 resulting in an unusual pop in sales in that quarter. This quarter, the F-35 sales were running at a more normal level. The military aftermarkets was up in the quarter, ironically the result of higher sales on both the V-22 and F-35 platforms.

Aircraft FY14. Given the strong sales in the third quarter, we're increasing our full-year FY14 sales forecast by $38 million to just over $1.1 billion. Military sales will be $13 million higher, and commercial sales will be $25 million higher . On the military side, the increase is on the F-35 production contracts and across the range of aftermarket programs. On the commercial side, the increase is in both the OEM and aftermarket categories, driven by the 787 program.

Aircraft FY15. We're projecting a minimal sales change between FY14 and FY15, although the mix will continue to shift from military to commercial. Military OEM sales will be $17 million lower, the reduction split evenly between domestic and foreign military sales. The military aftermarkets will be about $5 million lower.

Commercial OEM sales will be $35 million higher as the A350 production ramps up. On the other hand, the commercial aftermarkets is forecasted to be down $17 million next year on a significant slowdown in the 787 initial provisioning, up almost $20 million from our forecasted FY14 total. In FY14, we enjoyed abnormally strong initial provisioning on the 787, as various customers put large amounts of hardware on the shelf in anticipation of their future fleet sizes.

Aircraft margins. Margins in the quarter were 10.3%. This was below our forecast. Given the results of the third quarter, we're moderating our margin forecast for the year to 11.1%, down 100 bps from our forecast 90 days ago. One-third of this margin reduction is due to higher R&D costs, and the other two-thirds are due to higher early production costs on our commercial programs.

Given the margin challenges in FY14, we've taken a hard look at FY15 and beyond. In FY15, we're forecasting full-year margins of 11.1%, in line with FY14. On the military side, we're seeing margin pressure on some domestic programs and lower sales on a variety of foreign military platforms.

On the commercial side, the initial production ramp up on the A350 program, combined with $20 million lower 787 initial provisioning sales, are further margin headwinds. Balancing these out, we'll see some relief on the R&D expenditures as the A350 develops and slows down.

As I said in my opening comments, when we look beyond FY15, we believe we'll continue to see margin headwinds for another year or so before R&D starts to ease up and the new commercial production programs mature.

Turning now to Space and Defense, Q3. Sales in the quarter were up 2% from last year, to $103 million. Strong growth in the space market compensated for lower sales in the defense market. Within our space market, we had higher sales of components on both satellites and launch vehicles.

We benefited from several large production orders for fuel components for satellites, and our work on the NASA Soft Capture System was up nicely from last year. In the defense markets, the lower sales were the military vehicle applications. Last year, we enjoyed a very strong quarter of spare sales for the LAV-25 vehicle; and this quarter those sales did not repeat.

Space and Defense, FY14. We're moderating our sales forecast for the year by $10 million, down to $410 million. The change is all in the defense markets, but the military vehicle business continues to be softer than we were forecasting. The softness is in both the domestic and foreign military markets. We're keeping our space forecast unchanged from 90 days ago.

Space and Defense, FY15. For FY15, we're projecting a 2% increase in segment sales, to $418 million. We're forecasting a stronger defense business as the military vehicle market recovers from the low point in 2014. In the US, our military vehicle sales have dropped from $50 million in 2012 to less than $15 million in FY14.

We anticipate a modest recovery in the US vehicle sales in FY15, as well as stronger foreign military vehicle sales. We should also see slightly higher sales in both naval and security applications. Space sales in FY15 will be slightly lower than 2014, the combination of lower satellite component sales compensated partially by higher-launch vehicle sales.

Space and Defense margins. Margins in the quarter were 8.5%, up from 6.7% a year ago. Margins continue to improve as we move through FY14 and get some of the challenges with new acquisitions from FY13 behind us. We're maintaining our FY14 full-year margin forecast at 9.1%. And for FY15, we're forecasting further margin improvements to 10.3%.

Now to Industrial Systems, Q3. Sales in the quarter of $148 million were flat with last year, but the mix was quite different. We had higher wind energy sales as our new applications in Brazil for our AC systems continue to ramp up. Overall, the winds business has stabilized this year, at between $18 million and $19 million in sales each quarter. The non-winds energy business was off in the quarter as we shipped fewer products for steam and gas turbines.

In industrial automation, we had another good quarter with sales up 9% from last year. We continue to see modest improvements in almost every submarket within this category.

Finally, simulation and test sales continue to be relatively weak compared to last year, as our major simulation customers complete out their inventory adjustment process. We anticipate these sales will start to improve in the coming quarters.

Industrial Systems, FY14. We're keeping our forecast for the full year unchanged, at $590 million. We're changing the mix slightly, however, increasing our industrial automation sales by $5 million while reducing our simulation sales by the same amount.

FY15. Looking to next year, we're anticipating 3% sales growth to $608 million. Wind energy sales should be up on sales growth in South America. Industrial automation sales will be about flat with this year. And finally, we're anticipating a recovery in our sales to the simulation market, as our customers return with more normal buying pattern after their periods of inventory adjustments in FY14.

Industrial Systems margins. Margins in the quarter were up nicely, to 11.4%. We continue to see the benefits of the restructuring actions we took in FY13, as well as an improving mix in the business. We're anticipating further margin improvement in the fourth quarter to yield full-year margins of 10.5%. We believe we will see further margin improvement in FY15, to 12%, on slightly higher sales.

Now to the Component segments, Q3. Sales in the quarter were down 2% from last year. In the A&D arena, we continue to see weakness in both the aircraft and space and defense markets relative to last year. In general, the reductions were across a wide range of platforms reflecting the general slowdown in military spending. On a more positive note, over the first three quarters of FY14, our A&D sales have stabilized at a run rate of $45 million per quarter.

In the non-A&D markets, sales into the Energy sector were 12% higher than last year, driven by continued strength in offshore exploration applications. In this Energy sector, our Tritech acquisition, which we completed in August 2012, had a very nice quarter and is performing ahead of original expectations. Sales into the medical and general industrial markets were within $1 million of last year.

Components, FY14. We're moderating our sales forecast a little this quarter as we include the results of Q3. We think both our A&D and non-A&D markets will be weaker than our April forecast. The net impact is a downward sales revision of $9 million. This resulted in full-year sales of $429 million, a 3% increase over last year.

FY15. We're projecting a modest sales increase of 3% in FY15 to $440 million. Component sales into the A&D markets will be up slightly from FY14, based on slightly higher sales in the space market and an improved foreign military vehicle business. Sales into industrial applications should also be slightly higher as the US economy continues to improve.

Components margins. Margins in the quarter were 15.3%, up nicely from Q2. The margin shift in this business quarter to quarter is primarily a function of the sales mix. Given the stronger third quarter, we're increasing our margin forecast for the full year to 15%. For FY15, we're projecting margins of 14.8%.

Medical Devices. Sales in the third quarter of $29 million were down $9 million from last year. About $3 million of the difference is due to the sale of the Buffalo Ethox operations at the end of the third quarter last year. The other $6 million is due to lower sales into the enteral feeding market.

In Q2 FY13, we entered into a new distribution agreement with a large distributor of enteral products in the US. The agreements result in lower average selling prices for Moog, but also lower selling and overhead costs. Since the agreement has come into place, we've experienced some sales volatility quarter to quarter as our partner works to size their inventory correctly. Looking past this volatility, there is the opportunity for significant volume increases as we look out to the future.

Medical FY14. Given the weak sales in the third quarter, we're revising our full-year forecast down by $10 million, to $117 million. The reduction is across all our subsegments. The intense divestiture exercise we went through during the first six month of this year resulted in significant management distraction that has taken its toll on the sales outlook for the year.

Medical FY15. Full-year sales in FY15 are projected to be $120 million, up slightly from FY14. We should see improving pump and set sales balanced by slightly lower component sales in our Other category.

Medical margins. Margins in the quarter were 8.2%. Given the low level of sales in the quarter, this margin performance is particularly encouraging.

We continue to manage our costs prudently and focus our attention on positioning the business for sales. Given the strong third quarter, we're increasing our full-year margin forecast from 6.9% to 8.3%. For FY15, we're projecting full-year margins of 8.8%.

Before leaving our Medical segment, let me reiterate what I said last quarter about our strategic direction. We've determined that the medical pump business is not core long term. As we move forward, we're continuing our process of seeking a suitable buyer for the full segment and also broadening our process to consider options of each of the product lines as appropriate. We'll provide the market with updates as events unfold

So let me provide a summary. After all of the various tweaks, our FY14 sales forecast is now $9 million higher than our forecast from 90 days ago. Total sales for FY14 should be $2.65 billion, up 2% from last year. The change in the forecast is a combination of higher aircraft sales balanced by lower space and defense, components, and medical sales. Our operating margin for the full year will be 11.2%, and earnings per share $3.65.

Our share buyback program will contribute an additional $0.07 per share to this total, but will be canceled out by $0.07 per share in restructuring costs which we anticipate in the fourth quarter. In FY15, we're projecting a small sales increase on the double-digit increase in earnings per share.

Sales in FY15 will be $2.69 billion, up 1% higher than this year. Aircraft sales are projected to be flat with FY14, but with a continuing shift in the mix from military to commercial. Sales in each of the other four segments will be up between 2% and 3%.

We're projecting earnings per share of $4.25. Net earnings will be $181 million. Net margins will improve to 6.7%, and earnings per share will be up 16% over FY14.

So what do we see as the risks and opportunities associated with our forecast for FY15? I look at the events of FY14 as perhaps best guide. On the risk side, slowing defense spending combined with cost challenges in the early stages of new commercial aircraft programs remain the major concerns. On the opportunity side, we're assuming very modest growth in our industrial businesses and that our space business will be soft next year. Both of these assumptions could prove to be conservative.

As always, we try to provide a forecast which balances these pluses and minuses.

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

Thanks, John.

Good morning, everyone. As John noted, free cash flow in our third quarter was $72 million. This compares with an increase in our net debt over the last 90 days of $53 million. The difference relates to $121 million of cash used to repurchase company stock during the quarter.

On a year-to-date basis, free cash flow was $152 million, reflecting a 129% cash conversion ratio. Free cash flow has been strong this year. A number of variants, when added together, are contributing to this progress. We're having some success with more favorable contract terms including milestone payments, improved inventory turns, and lower spending on capital expenditures.

As a result, we've seen our working capital, excluding cash and debt, as a percentage of trailing 12-month sales decline by about 150 basis points in the last 12 months. Because of our performance to date, we're increasing our free cash flow outlook for the full year 2014 to $185 million, compared to our last forecast of $165 million, reflecting a cash conversion ratio of 110%. For 2015, our initial forecast for free cash flow is $190 million, or a cash conversion ratio of about 105%.

Our 4 million share repurchase program that we announced in January of this year continued in earnest during the third quarter. Year to date through the end of June, we have repurchased approximately 2.1 million shares, representing about 4.5 % of our average weighted shares outstanding, at an average price per share of about $67. Our plan is to complete this buyback program by the end of the calendar year.

Capital expenditures in the quarter were $22 million, and depreciation and amortization totaled $27 million. For the nine months ended June, CapEx is $58 million, while G&A was $82 million. We are reducing our 2014 forecast for CapEx to $90 million, which compares with projected G&A of $109 million. For 2015, we're forecasting CapEx of $100 million, and depreciation and amortization of $112 million.

Cash contributions to our defined benefit pension plans totaled $18 million in the quarter. We have increased our projected contributions for all of 2014 by $15 million to $70 million. We are now planning to contribute $14 million to our German defined benefit plan, putting some of our excess overseas cash to work. For 2015, we're planning to increase the pace of contributions into our US defined benefit plan as a result of the persistence of low discount rates. As a result, our contributions to our global DB plans will be approximately $80 million in 2015.

Despite the increased contributions to our DB plans over the last few years, we've been able to show strong improving free cash flow results. Global pension expense for our DB plans in 2015 is projected to be $46 million, compared with $36 million in 2014. This $10 million increase is equivalent to a $0.15-per-share drag on 2015 EPS compared to 2014.

Our effective tax rate in the third quarter was a very favorable 25.6% compared with last year's 28.1%. The low tax rate in the quarter resulted from a tax-deductible loss associated with the sale of the Ethox medical operations in June of last year, 2013. As a result, we've lowered our projected effective tax rate for all of 2014 to 29.6%. For 2015, we're forecasting an effective tax rate of 31.0%.

Our financial ratios at the end of the quarter are solid, even after considering the effects of the stock repurchase program. Net debt as a percentage of total cap was at 26.9%, down from 30.8% in last year's third quarter. Our leverage ratio is 1.6 times.

During our third-quarter, we announced that we amended and extended our revolving credit facility. We increased the total bank commitment by $200 million to $1.1 billion with our existing 13 banks, and we refreshed the five-year term to mature now in May of 2019. We also have an accordion option for an additional $200 million. All other terms of the credit agreement are materially the same. And at quarter end, we had $416 million of unused borrowing capacity on this revolver.

So in summary, as John described, we're projecting 2014 EPS of $3.65, including the effects of our share buyback program. And we're forecasting 2015 EPS to increase 16%, to $4.25, and 1% sales growth.

With that, I'd like to turn you back to John for any questions you may have. And we'll ask Aaron to help us out with that.

Aaron?

(Operator Instructions)

Cai von Rumohr.

Yes. Thank you very much. Great performance on the cash flow.

So could you give us a little more color on the aircraft R&D, where it was, where you expect it to go and some of the aircraft challenges? Is this the A350? Where are you seeing the bigger challenges? Thanks.

Let me just clarify your question. Is the question related to 2014, 2015, or both?

Both.

Okay. The broad story in aircraft is that the R&D remains elevated. Now in the quarter, R&D came in at -- in the Aircraft segment, it's down sequentially.

It's down at about $20 million and so for the year, we're forecasting it to come in at about $90 million. For next year, we anticipate that the R&D will be down about $8 million or $9 million off of that so you will have that tailwind.

But on the other hand, you have three headwinds. You've got the military business is continues to soften and is seeing some margin compression that we hadn't anticipated. The commercial ramp up on the 87 and then particularly next year the 350 gets into gear, is more extensive than we were anticipating. And next year the commercial aftermarket in particular will be down fairly significantly because we had a very unusual year of IP provisioning on the 787 this year which won't repeat next year.

It's a combination of all those factors that's leading to compressed margins in the second half of this year and therefore the reduction for the full year and we're seeing that continue into next year. That is the combination of all those things is how that plays together.

Thanks a lot. You have the aftermarket in your forecast down below FY15 -- FY13, excuse me, and yet Boeing is saying that expect to have 16 to 18 new customer intros this year and the same number next year. And the A350 presumably also will be generating some initial provisioning. So help me understand why you have such a sharp decline projected for aircraft commercial aftermarket.

If I do FY14 to FY15, the big shift is in the 87 initial provision. This year, we're forecasting it to be in the $27 million to $28 million range and next year, we're thinking that will be in the $8 million to $9 million range. That is slightly below what we saw in FY12 and FY13 but given that the initial provisioning is an accumulation based on the fleet size, the outsized results in FY14, we think that that will have a negative impact on FY15.

Now when we came into this year, we had no idea that the IP would be as strong as it turned out to be, and perhaps that's a little bit conservative. I am not sure. As they say, if you get a boom year, it's like there's an inventory buildup and I think we feel that it would be a little imprudent to assume that anything like that would happen again.

But if you take that out, Cai, it's up -- it's down significantly from FY14. It's down even a little bit from FY12 and FY13, but if you took a run rate across the four years, it's probably in line with the growth on the fleet side. And the A350 next year, it's only a couple of million dollars. It's not a big number so it doesn't really drive it next year.

Okay, great. And then you mentioned the restructuring. Approximately, what is that for? And it's all in corporate expense. Is that correct?

What we've done is we've put a place holder on corporate expense, Cai, and we have reserved a number, $4 million to $5 million, in that area. We have not gone through all of that internally yet. There's a lot of discussions that still has to happen. Nothing has been announced so we would prefer not to go into it at this stage because there needs to be some internal discussions before that happens.

Normally we wouldn't mentioned this type of thing on a call until it was after the event. But given that part of meeting the 2015 numbers, wanted to make sure that we weren't surprising the market at the end of next quarter if we had a number for it.

And two quick ones. Your R&D, what assumption, if any, are you making regarding R&D on the 777X? That's the first question.

We have -- the 777X, we have not yet got into the bidding process of that. Boeing is -- our packages are later coming out than some of the other packages. And we have some possibility of there's some money reserved in next year's number for what I might call new programs on unplanned activities. But it's not a significant number and even if we were to win something on the 777X, typically in the first year it's not a very large number.

But given that we haven't seen the details of it, et cetera, I don't have -- I can't be exact on that, Cai. I think if we -- if we were to win a package on the 777X, I'm guessing there will be a slight revision in the R&D spend, one way or another. I'm not sure that it will be a very significant revision.

Okay. And then the last one. You mentioned still having a mid teens margin target. Is that just for the Aircraft sector or the total Company? And approximately when might we hope that you might reach that target?

That's our target for the whole Company. It's also the target for the Aircraft business.

As I said I said a couple of years ago that our objective was to get the mid teens by mid teens, and clearly that's not now what we are achieving. That is a disappointment for us internally. If I go back a couple of years, and if I look at what assumptions we -- and we had models out five years at the time that supported that type of margin growth. I have what assumptions were in those versus to what's actually happened.

I would say there's a couple of things. One is that the higher investment in R&D, which as I mentioned on the call, is $20 million to $30 million higher than what we -- in FY15 than what we had projected a couple years ago. And that's completing out the work that we have on the A350 in particular but also the addition of the Embraer program so it's an investment decision that we made plus higher costs on some of the other programs.

It's higher costs associated with the initial ramp up as programs move from development into production. The 87 and now the A350 coming on behind us and behind that we will have the E2 jet. It's the military side slowing down I think a little bit more than we had anticipated, and then the fact that there's no real growth on the industrial side of our business. You take all of those together and you can -- in fact, a couple of years versus where we are now, those are the things that have actually been headwinds versus what we originally said.

Given the reset, I would say, of the aircraft margins that we don't anticipate that the headwinds there will change for the next couple of years. We're probably out a few years and I would say it's a delay of probably towards the back end of late teens before we would see those mid-teen margins. I'm hesitant to say it, Cai, because I said something before and now I can explain all the reasons that it didn't quite work out, but based on what we look at now, that's the outlook that we see.

Terrific. Thank you very much.

Thank you.

Tyler Hojo.

Good morning. So first question just relates to the FY15 guidance. I guess what I'm wondering is what is the assumption in regards to share count? Are you assuming that the remainder of the share repurchase authorization gets sold by the end of the year?

Tyler, this is Don Fishback. Yes, we are expecting that the remaining -- I think I mentioned in the call about 2.1 million shares were purchased in the third quarter, or through the third quarter. So we've got a little under 2 million left to go.

We're forecasting that by the end of the calendar year, where there's a little bit of a straddle in the answer to your question. So by the end of the calendar year, we'll have finished the $4 million buyback.

Okay. Got it. All right, that's helpful.

And then just a follow-up to Cai's question on the 777X. Maybe you could share with us what your thoughts are in terms of timing on some of the supplier decisions that you're going after.

I wish I could, Tyler but we don't know that yet. We have been involved in RFIs, request for information, and stuff but my last information as of a couple of days ago is that we haven't fully -- we haven't received RFPs and details and schedules associated with that. I'm afraid that's a question that you'll have to ask Boeing. I don't -- we don't know exactly what their schedule is.

Fair enough. Maybe just a broader question as it relates to the wind market. Nice to see some of the progress there but I guess what I'm curious about is just I know part of your strategy is to move from DC to AC power within the wind product line. How is that going? And is there any sort of time frame associated with transitioning there?

I would say that's a transition that's happening, it's the customer base that's determining how quickly they want to do that. So some new customers like our business in South America is on the new system. In Europe, we're focused and in China, we're focused on selling the newer systems, but the adoption rate is really based on the consumers. And I think as we look to the future, customers will -- the vast majority of them will take the AC system.

There are both cost and reliability benefits associated with it. But each customer will be in a different phase of their development cycle, and if they have an existing turbine, it's highly unlikely that they will change the pitch system on an existing kind of approved or certified turbine. So they'll probably wait until they come out with their next generation.

So typically a technology shifts like this in any of our markets. It's something that probably takes two to three, four years depending on what the adoption rate will be. So it's not an overnight, we're shipping you a DC system yesterday, I'll ship you an AC system tomorrow. A lot of it is you introduce to the customer, they do some tests, then they get it into their development cycle, and typically it's a couple of year process before there is a full transition.

Okay. Thanks for that color. And just lastly for me.

Just in regards to simulation and tests, you've talked now for I guess the last couple of quarters about seeing some inventory adjustments with customers. I guess you're a little bit more optimistic over the next several quarters that that starts to rebound. I guess what I'm wondering is what gives you that confidence?

That is correct. We have seen a significant inventory adjustment this year. The reason for that is a couple of our customers, one in particular went through a system -- an ERP system conversion and I think they did like many companies do, they built up some inventory in advance of that in anticipation that they might have some challenges as they went through the conversion. They've done that and they are coming out the far side of that.

And the confidence is just based on the conversations with our customers and starting to receive some orders for some new product from them. So we think the fourth quarter will probably be -- won't be a big recovery but we're anticipating that next year we'll see a little bit. We will see some recovery of that as well as inventory levels have come down and they start to re-order in line with their production rates. So it's based on detailed discussions with the customers.

Great. That's all I had. I really appreciate all the color.

Thank you.

Stephen Chow.

I think that's me from Royal Bank of Canada. Thank you.

My first question is just on the Aircraft programs. You talked a little bit about the new programs coming in with higher cost. Can you maybe give us some more color as to what some of those cost buckets are?

Is this a little bit more challenges on the learning curve? Is this supplier input cost? And as you look forward to the E2, are there things that you've learned from 787 and A350 that will allow you to maybe keep the cost a bit more in line as you get further down in your development trajectory?

Yes. So let me sort of -- two questions. Let me answer the second one first which is have we learned something.

I sure hope so. As you go through any of these, you learn a lot of things and you try to apply it on the next one. These are, particularly the 87 and the A350, these are very, very large systems jobs, and as I described in my text, we've gone from being a components, a second-tier components supplier to a first tier large integrated systems supplier, and that has proven to be, of course, a very large challenge over the last decade.

On the 87, we learned a lot on the 87. We're applying it on the A350 and the E-Jets will be the next one after that, and hopefully we'll have learned each step along the way so that we get better.

The way we do our costs for these programs is we have an estimate for the initial production, and then we have ramp down costs curves for the cost as the production increases as we get down the learning curve,. But also as we transition from low rates initial production where typically we will be doing that perhaps in the west where we've got the engineering staff, all of the product engineering folks. And then we start to transition that out of our facilities in the west and ramp up production in our Asian facilities and also ramp up production with our Asian supply chain. And there are a lot of assumptions associated with that that go with the transfer, how the transfer will work, and particularly how suppliers in the supply chain, how their costs will turn out.

As we've gone through some of the programs, what we've learned is that it's taken -- the learning curve has taken longer to come down the learning curve. The supply-chain response has been a little bit slower, it hasn't -- the costs haven't all come in exactly where you had anticipated, and therefore that cost curve moves out to the right. In the end, there's still plans in place that get us to the cost levels that we want to get to but there's just a shift that takes longer to get there and more volume has to go through before you actually achieve that. And that's what's happened.

It's a combination of supplier challenges, transition challenges, and just the fact that these are very large jobs that are new to us as a company. Now I'd also point out that although there is clearly learnings from a large -- one large systems jobs to the next, the technology and some of the manufacturing challenges with each job are different because the flight control systems of an A350 are different from the flight control systems on a 787, which is different from an E2.

So it's not that they're more of the same, it's just make more of them. There are unique challenges associated with each one.

So there's always that challenge. Yes, you learn about the systems job but there are individual challenges because they're different piece parts, perhaps some of them are different suppliers, and each thing brings a new challenge with it.

That's great color. On the 787, have you fully made that transition from the low rate production in the west to the factory and then where are you in that transition on the A350 here?

On the 787, all of our manufacturing is done. We have a facility in the Philippines, which by the way, we've had since 1984, so this is not a new facility for us, and all of the 787, essentially all of it is now coming out of our operations in the Philippines. So that transition happened over the last couple of years, but we've also, of course, ramped the 787 at the same time from 20, 30, 40 units to where we are doing 10 a month now, 120 a year, and continuing to look at potentially ramping up from there.

We're building up the supply chain associated with that, but there is the challenge as you bring new suppliers on board that if for some reason the supplier hiccups, you end up going back to your higher cost western supplier in order to make sure that you're guaranteeing your supply. And you put that and you buy from them, that stuff goes into inventory and, of course, you have to work down your way down through that inventory. And that stays in the cost once you get past that and you bring the other supplier on board.

So I'd say the 787, from an internal factory perspective, is in Asia. In terms of the supply chain, that's maturing, and we'll probably -- we then continue down that learning curve.

The A350 is in the transition process. It's essentially very early production we've done. In order to minimize risks, we do those early production units, goes to the engineering design teams in the west. That's obviously a lot more expensive, low volume, western rates, and then we start moving it to Asia, and it is in the process of moving. Next year as we ramp up, we will see a lot of that ramp-up happening in Asia.

But typically to do that, it's one to two-year transition process because you have to do it very carefully that you're making sure that you're maintaining the quality, meeting all of the certifications. We've done it very successfully. We've never announced there's been a major hiccup -- we can't deliver products. So we have done it very successfully. The challenge always is, do the costs come in, in line with what you had anticipated.

That's very helpful. And then just a final one on -- maybe on cash. You've talked a lot about having more inward investment focus. Maybe a little bit less focus on M&A. With such strong free cash flow, is there any directional change there?

And I know you're not going to talk specifically on what you're doing with Medical, but if you were to find a buyer for something, does maybe the cash that comes in from that gets sorted out differently than the free cash flow that you're are generating on an ongoing basis in terms of deployment? Thanks.

So we are engaged in the buyback program. That's new for us as a company. That's not something that we've done in the past, and is a reflection of the fact that we find ourselves in an environment where we've got strong cash flow, and there are fewer interesting acquisition opportunities than in the past.

Now we still see ourselves definitely in the acquisition game, we just haven't seen opportunities that we found compelling enough and we wanted to make sure that we were giving cash back to shareholders in a way that was rewarding them for long-term holding of the stock. What I'd like to suggest is let's get past that share buyback program.

We're conscious of the fact that we are relatively to our history under-levered and then we get through this share buyback program. And then we look at, so what will be the next step in terms of returning -- either returning capital to shareholders or reinvesting capital to provide for long-term shareholder growth. So, we'd like to get through the present buyback, which as Don said, is probably going to take us another quarter or two, and then we'd like to address that again.

Very good. Thank you.

And in terms of the Medical, if there are receipts for Medical, I think that's probably a ways out. I don't know if that's something that we -- given how long it took us to get the process underway and the fact that we've had to take a little bit of a reset in it, I don't think that's something that we have to worry about too soon. If we manage to sell some or all of the Medical business, we'll obviously come back and we can answer that question at that time.

Very good. Thank you.

Julie Yates.

Good morning. Organic growth for next year is little bit below where most of us were expecting and you did a nice job of explaining why. But just think big picture beyond FY15, how should we think about the pace of organic growth as some of these new programs ramp up?

I think maybe there's two questions in there. One is new programs which are an aircraft phenomenon, and it's the commercial side of aircraft and it's -- that's just based, Julie, on the quantities of airplanes that they're going to actually make. And the new programs that will be -- we can see the A350. If you assume ballpark it's a $1 million of content, you can run that out.

87, you can assume roughly the same. You can run that out if Boeing's rates go up, we'll see that go up. And then the rest of the book of business you can kind of look at that versus the average rates that Boeing and Airbus are predicting.

So I think in terms of looking at the growth rate on the commercial OEM side, that's literally program by program driven. And I'm thinking you probably have a better outlook or at least as good an outlook of what Boeing and Airbus are going to do as we do, and therefore, I think you can bake that in. So there will definitely continue to be growth on the commercial side unless the cycle slows down and Boeing and Airbus were to slow down production rates, but I don't think anybody's predicting that just yet.

So we'll see growth on the OEM side. We said that the aftermarket next year was down, but as I said, that's really a reflection of the fact that we had an enormous IP year this year on the 87, and we think that's going to tail off next year. I hope that we start to see that aftermarket grow after that as the 87 comes back up to a more normal level, and clearly we will see the 350 kicking in after that and then the E-Jets after that again.

And then as the fleet size grows, you move from IP into the normal aftermarket. So over the next decade, we should definitely see that aftermarket start to ramp up and continue to ramp up.

The rest of the businesses, obviously the headwind is on the defense side of the business and we're not projecting any significant differences from the military budget except for the F-35 where we have a big position on the F-35, and we would see that obviously ramping up. So that's clearly a growth program over the next few years and the hope is that that will compensate at least in part for the wind down of some of the other V-22 Black Hawk, all of the other programs, the vehicle programs that we've already talked about.

And then on the industrial side, we've seen some nice steady, albeit very small improvement in the industrial automation business, which for us really is comparable with GDP growth. As you see GDP growth, you see capacity utilizations going up. Eventually the capital investment cycle kicks up, and you start to see that in our business.

But until you really see GDP picking up and big investment in capital, we won't see our business shoot up. And I don't think we've seen any evidence in Europe or Asia or the US that says, yes, we are really now -- now the consumer is really starting to take off and we're really going to see that capital investment the folks as retool and try to drive productivity.

So we're forecasting a little bit of an improvement next year but nothing too spectacular. And the out years, again, just looking at the organic side of it, Julie, really is based on how you get back into a significant growth cycle on the industrial automation business. And in the Space business, that's -- relatively speaking, that's relatively small. It's only about 10% of our business.

We think that's got good long-term growth opportunities, particularly on the commercial space side. But that will go up and down year-to-year as you get involved in new development programs, move into production, you get through this 6 or 8 or 10 satellites, that winds down, the next development. So there's a little bit of a cycle up and down in that that's hard to predict.

So I'd love to see significant organic growth opportunities outside of commercial, but that's the big one right now. And I don't think there's another huge driver.

The one other one that I would mention is the marine business, the whole energy business. That has the upside potential. The marine business has continued to be very strong. We've acquired some additional businesses there to broaden our footprint, and we think that continues that up opportunity.

And wind business, we said we're sticking with the wind business despite the challenges we've had because we believe that we can develop products that offer superior performance at a better price point and offer significant growth if we can re-establish a very strong position in that market. So that should be a growth market. If it turns out not to be, then I think we're going to have to take a step back and decide whether or not we think we can be as successful in it as we thought.

So we clearly have an organic investment strategy around wind right now that we would like to see pay off over the next three to four to five years. But it will take a couple of years to get the new products established in the market and then start to see the growth. That's a long answer to a short question, Julie.

Okay. Thank you.

And one for you, Don. What are the assumptions for equity based comp and for corporate in 2015?

Equity based comp is around $8 million. Let me just double check here. Yes, $8 million in 2015, and what was the other one? Corporate expense?

Yes.

Corporate expense, we've got going up to about $29 million in 2015, from about $27.5 million in 2014.

Okay. And then is there any risk that some of the restructuring charges anticipated in the fourth quarter bleed over into FY15 because you're still in early stages in shaping the program?

Yes. That's definitely a possibility, Julie.

Okay. Is that embedded in guidance?

No. The way we've done it at the moment is we've said that we reserved some restructuring bucket in the fourth quarter. But whether or not that will all -- whether or not we'll be able to work our way through all of that or not in the fourth quarter, we don't know at this stage. But the 2015 guidance assumes this.

Okay.

Assumes that we'll -- on the other side, what we're going to do in 4Q and get that behind us.

Okay. And then just one last one. I think historically you guys have given some color on the cadence of EPS throughout the year. I didn't see that in the supplemental data. Is there any color on EPS by quarter?

Typically we do that in our fourth quarter, Julie, but the assumption is that like most other years, it tends to be a little bit lower in the first half of the year and then pick up a little bit more in the second half of the year. But $4.25, you're probably in the kind of the high $0.90s, $1 in the first half of the year and then you get a little bit better in the second half. But we'll be a little bit more specific in 90 days.

Understood. Thank you very much.

Thanks, Julie.

Kristine Liwag.

John, you mentioned earlier that quality and on-time delivery issues you're facing when you bring in new suppliers to your system is part of the reason for the margin headwind. Should we think of this shift to lower cost suppliers as part of your strategy in Boeing's Partnering For Success?

Let me caution you a little bit, Kristine. I think what I said is that there are challenges -- there's always challenges with bringing on new suppliers, and I think the way you phrased it is that new suppliers have quality and delivery problems, and I wouldn't put it like that. I think with each new supplier, there's always a learning curve. There's an initial getting to know each other, some test parts, and all that type of stuff.

So there are always challenges as you go through that. I wouldn't like somebody to feel like I said new suppliers deliver poor quality and they don't come in on time.

But in terms of the broader question, we've been working to develop a low-cost supply chain for the last five years or so in anticipation of the 787 ramp-up, and of course the A350 and the other programs after that. And it is the key part of our internal strategy.

It was not something that was specifically triggered by the Boeing Partners For Success because that's a more recent program. This was something that we anticipated when we originally got into the 787 back a decade ago. And as I say, we've been working intently on it over the last five or more years as the 787 has moved into production and started to ramp up.

So it's not new. It's an ongoing process. It's a key element of our overall ability to compete in the commercial aircraft business is having that Asian supply chain.

Great. Thank you.

(Operator Instructions)

Michael Ciarmoli.

Good morning, guys. Thanks for sticking around and taking my questions.

I guess the one thing I'm struggling with here, you brought down the aircraft control margins, I guess, by 100 basis points in the second half of the year. What really changed between last quarter and this quarter?

I mean, is it military being under pressure, commercial ramping, the R&D? It seems like all that was really known. So I'm just struggling with what really surprised you or what happened that was entirely new that wasn't in your plan?

Michael, that's a great question because that's the question of when do you actually recognize something. When does it go from -- with the value of hindsight, you could always say, and we've said it internally, well we couldn't we have known, shouldn't we have known, was there something, were there signs there.

So it's one of those where each quarter we go through a detailed review. We look at how are the costs, again on the early production, how are the costs coming in versus what we had anticipated versus what we had modelled.

And then the other thing that's happened is that the rates on those programs are higher than we had anticipated. So the difference in the second half of the year, the margin adjustment that I said is two things. It's about -- 30 basis points of it is higher R&D than we had forecasted, and we've seen this phenomenon before where it takes a little bit more costs than we had anticipated. So that's about 30 basis points of it. And the other 50 to 70 basis points are higher costs on initial production runs than we had been anticipating.

As I say, you forecast out what those are going to be and then when you look back in the quarter, turned out that we didn't quite meet the targets that we had set for ourselves, and when we roll that forward into the fourth quarter, we say it's going to continue to be a challenge in the fourth quarter. And on top of that, the rates on those commercial ramp-up are higher, so you've got more sales on those things with lower margin than you had anticipated.

Okay.

So it's always one of those, yet with our signs, could we have known, and you say, well yes, with the value of hindsight we should have, could have, we didn't. You wake up one day, you go through it all again and you say, oh I guess it's a little bit different from what we thought and we're going to have to do a little bit of a reset on the margin outlook. I'm afraid that's the best I can tell you.

No. That's helpful. That's helpful, I get it. And with your experience with the Neo and with the MAX, do you anticipate any spending related to the A330 new engine option?

We don't have we any position on the Neo or the MAX, Michael. I don't -- so that's not a program for us.

Okay. And so I'm just trying to think given that the A330 shouldn't really have much of an impact then either?

Well, I don't think we know enough -- a lot about the A330neo yet. I think -- my understanding is they are going to re-engine it and they're probably going to try and minimize everything else. We have ailerons on the A330 and we've got some other valve component stuff on it, but not a lot of content on an A330.

If they keep all the flight controls the same, the chances are we could hopefully keep our position with the aileron but it's not a -- it's just a single actuation position on the airplane. If they decided to change out all of the actuation, of course, that opens up the market for all of us to re-bid stuff, but that seems like that would be a challenge to do that. That would be a big job.

It means changing a lot on the wing and for the volumes that they are anticipating, it seems like it would be hard to justify the [annerly] for anybody to do that, including Airbus. So I don't think we think of the A330neo as a big mover one way or the other for us at this stage.

Okay, perfect. And then just the last one.

I know you guys talked about the F-35 aftermarket given flight hours. I know there's obviously been a brief pause here in flying hours there, but what are kind of the expectations? Any changes for F-35 aftermarket provisioning content given where that fleet is trending?

Yes, so, again, I just have to put it into perspective, though. I mean, what I said in the text was there was a little bit of improvement on the F-35 aftermarket.

This year, it's about a $5 million, $6 million piece of business. Next year, it's actually get up into the $7 million, $8 million size. So we're not talking huge numbers yet. That will be in time as the fleet grows, a very interesting piece of business for us, but it's a -- we are anticipating a kind of a slow ramp for the next couple of years.

Okay. Perfect. Thanks a lot. Thanks for sticking around, guys, for my question.

There are no questions in the queue at this time.

Thank you very much. Thank you to everybody for listening in, and we look forward to doing it again in 90 days. Thank you.

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