Moog Inc (MOG.B) 2015 Q2 法說會逐字稿

Good day, welcome to the Moog second quarter FY15 earnings conference call. As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Investor Relations Manager, Ms. Ann Luhr. Please go ahead.

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 May 1, 2015, our most recent Form 8-K filed on May 1, 2015, 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.

Good morning. Thanks for joining us. This morning we'll report on the second quarter of FY15 and update our guidance for the full year. As usual, I'll start with the headlines before diving into the numbers.

First, earnings per share of $0.80 in the quarter include a couple of one-time charges. Excluding these charges, EPS of $0.96 in the quarter is up 17% over last year on slightly lower sales. The EPS growth is a combination of slightly higher operating profit, a more favorable tax rate and a lower share count.

Second, we had an accounting correction in the quarter. We recorded an $8 million non-cash charge to earnings or $0.13 per share. This correction related to an error which accumulated over the last 3 years, but was not material to the results of any prior periods. I'll provide a little more color when I get to the Space and Defense segment in a few minutes.

Third, during the quarter we completed the sale of two small operations in our Medical Devices segment. These were part of the Ethox acquisition, which we completed in 2009. The operations had combined sales of just over $7 million in FY14 and were about break even.

We received approximately $3 million in cash for these assets and took a non-cash charge of $1.2 million, or $0.03 per share. The sale of these operations continues the restructuring of our Medical Devices segment.

Fourth, it was a mixed margin quarter with strong performance in both Space and Defense and Medical Devices, but lower margins in Aircraft. Fifth, it was another good quarter for free cash flow. We continued to return this free cash to our shareholders through our share buyback program.

Finally, we continue to see weaknesses in several segments as we look out over the next two quarters. Consequently, we're adjusting our full year sales forecast down by $28 million.

In response, we're planning some restructuring over the balance of the year. From an EPS perspective, the combination of the Q2 write downs, the future restructuring charge and the impact of the softer business outlook results in full year earnings per share of $3.55.

Now, let me move to the details starting the second quarter results. Sales in the quarter of $637 million were down marginally from last year. Adjusting for the effect of the stronger US dollar, sales were up slightly over 2014.

Sales were up nicely in our Medical and Components segments. Sales in Aircraft were unchanged while Space and Defense sales were down marginally. Sales in our Industrial segment were sharply lower, mostly the effect of foreign currency translation.

Taking a look at the P&L, our gross margin is down about 300 basis points. About one-third of this reduction is due to the accounting correction we made in the quarter. The remainder is the result of lower margins in our Aircraft segment.

R&D is down due to lower aircraft activity on our new commercial programs. Our SG&A expenses are also down as a result of past restructuring and our ongoing focus on expense reduction.

Our effective tax rate was unusually low at 22%, a combination of some one-time benefits and the changing mix of earnings projected for the year. The overall result was net earnings of $32 million and as I said earnings per share of $0.80.

The FY15 outlook, we're moderating our sales forecast for the year by $28 million. $4 million of this reduction relates to medical operations we sold in the quarter. The remainder is due to a weaker sales outlook in our Space and Defense and Components segments. The result is full year sales of $2.54 billion. And as I said we're also moderating our full-year earnings outlook.

We're reducing our full year EPS from $3.85 last quarter to $3.55. The reduction is made up of the following items: $0.13 for the accounting correction in Q2; $0.03 for the disposal of the medical operations, also in Q2; an $0.08 restructuring reserve for anticipated costs in the second half; and, $0.06 due to all other impacts including operational headwinds, offset by a more favorable tax rate and the benefit of a lower share count.

As in previous quarters, this outlook does not include the positive impact of further share repurchases over the coming two quarters. Should we continue our buyback program on a pace to conclude our 9 million share authorization by the end of this fiscal year, then earnings per share would be $3.60.

Now to the segments. I would remind our listeners that we've 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 the aircraft segment. Sales in the quarter of $274 million were flat with last year. The mix shift continued its familiar pattern, with stronger commercial sales and weaker military sales.

Total commercial sales were up 5% in the quarter, driven by healthy increases on the OEM book. Sales to Boeing, Airbus and on business jets were all up nicely over last year. The commercial aftermarket was down in the quarter, as the pace of initial provisioning on the 787 slowed.

In the military market, sales were down 5% from last year. F-35 production continued to grow and we had a pick up on our major helicopter programs. Some of our other military OEM programs were lower,, and in particular the KC-46 Tanker development work is winding down from last year. The military aftermarket was also down in the quarter as a result of slightly lower sales across a wide range of programs.

Aircraft in FY15, we're leaving our full year forecast unchanged at $1.09 billion. We're also leaving the mix unchanged, with 52% commercial and 48% military.

Aircraft margins, margins in the quarter of 8.1% were disappointing. The challenge is all in the gross margin line, as R&D was relatively low this quarter. There are three effects driving the lower gross margin in the quarter.

First, the mix was particularly adverse with lower aftermarket content on both the commercial and military sides of the house. Second, we had a quality issue with a vendor supplied part which slowed production and resulted in higher costs. This issue is now behind us.

And third, we continue to experience adverse cost variances on our new commercial programs. Margins in the second half will improve due to a more favorable mix of sales, particularly on some foreign military programs. However, given the cost challenges we've seen in the first half on the commercial OEM book, we're moderating our full year margin forecast to 10%.

Turning now to Space and Defense, sales in the quarter of $93 million were down 2% from last year. The weakness was all on the Space side of the business.

We had lower activity on various satellite programs as existing contracts wound down, compensated partially by additional work on NASA programs. In the defense market, we had higher sales on our missile, vehicle and naval programs, but lower sales in our security markets.

Space and Defense, FY15, we're reducing our full year forecast by $14 million. The change is all in the outlook for our security business. This is a business which has struggled with profitability over the last few years.

As a result of a deep dive into the business this quarter, we're refocusing the portfolio to ensure the operations are profitable going forward. The result is that we anticipate $14 million of lower sales as we stop some of our less profitable activities.

Separately, we're adjusting the mix in the remainder of the Space and Defense business to better align with the experience of the first half. We're reducing our Space forecast by $10 million and increasing our Defense forecast, exclusive of security, by the same amount.

Space and Defense margins, margins in the quarter were 5.3%. This margin includes the effect of the accounting correction this quarter.

During the quarter, we identified that some working capital balances, including inventories, receivables and payables had not been appropriately accounted for in one of our business units over a period of 3 years. The accumulated accounting correction this quarter totaled $8 million.

This was a non-cash charge to earnings as we corrected the relevant working capital accounts. Exclusive of this charge, margins in the quarter were a healthy 13.7%. From an operational perspective, the restructuring activities of the past years are bearing fruit and we're getting the program challenges on some of our smaller acquisitions behind us.

For the year, we're adjusting our margin forecast to include the impact of the accounting correction in Q2. This will result in full year margins of 9.1%.

Industrial systems Q2, sales in the quarter of $129 million were 15% lower than last year. The decline was primarily driven by the stronger US dollar. In addition, we're seeing a general weakness across many of our global industrial markets.

We had lower activity in each of our major market categories - energy, industrial automation and simulation & test. In each of these markets, the change in exchange rates was the dominant factor, but we also experienced a small real sales decline in each market. On a positive note, wind energy sales into Brazil continue to grow driven by the adoption of our new AC platform.

Industrial systems FY15, you will remember that in our first quarter call, we reduced our full year forecast by $70 million down to $530 million. This quarter, we're leaving our full-year sales forecast unchanged. We believe this forecast already captures the combined effects of currency shifts and the softening macro-economic picture.

Margins in the quarter were 9.8%. We continue to adjust our cost structure to align with the lower sales outlook. We anticipate that second half margins will improve to an average of 11.5% to yield full year margins of 10.7%.

Now to our Components group, sales in the quarter of $109 million were 7% higher than last year. Within our A&D markets we saw some nice increases on missile programs and various military vehicle applications, a similar trend to our Space and Defense segment.

In the non-A&D markets we had an increase in our energy market as we finished up a couple of large projects and completed shipments as anticipated. We also had increased sales in our general industrial markets where our acquisition of Aspen Motion Technologies in 2013 continues to perform well.

Components FY15, we're moderating our forecast for the year by $10 million to $410 million. We're reducing our A&D outlook by $3 million as several programs which we had anticipated booking in Q2 have moved to the right. We're reducing our non A&D forecast by $7 million, a combination of further anticipated weakness in the energy market and slower growth in our general industrial business.

Components margins, margins in the quarter were 12.8%. These relatively soft margins are a result of higher costs on a new military development program and negative impacts from the stronger US dollar.

Through the first six months of the year, margins are 13.7%. Looking out to the balance of the year, we anticipate some margin headwinds as sales into the energy market slow down.

In response, we will continue to adjust our cost structure and believe we can more or less maintain the margin performance of the first half. We're now forecasting full year margins of 13.6%.

Medical Devices Q2, this was another good quarter for our Medical Devices segment. Sales were up 16%, with strong gains in both pumps and sets.

We're seeing a pickup in demand for our IV pumps as other players remove some older products from the market. In our sets business, our enteral volumes have returned to more normal levels after a year of inventory destocking by a major customer in 2014.

FY15, we're adjusting our sales forecast down by $4 million. The reduction relates to the operations we sold in the quarter.

Medical margins, operating profit in the quarter of $2.7 million includes $1.2 million of loss associated with the divestiture. Exclusive of this loss, margins in the quarter were 12.1%, another very strong performance for this segment.

We're adjusting our operating profit forecast for the year down by $1 million to account for the Q2 divestiture loss. The result is full year margins of 10.4%.

Summary, coming into the quarter, we were forecasting earnings per share of $0.90, excluding any additional buyback activity. During the quarter, our buyback continued, adding $0.06 per share to the total. So our revised expectation for the quarter was $0.96.

We did not anticipate the impact of the accounting correction of $0.13. And, while we were optimistic that we would complete the sale of our two small medical operations in the quarter, we did not include the $0.03 impact of that transaction in our guidance either.

When we add these adjustments back, our quarter came in pretty much on plan. We enjoyed an unusually low tax rate in the quarter, which compensated for softer margins in several of our segments. In particular, our aircraft business continues to be impacted by margin headwinds from a shifting mix and challenges in meeting our cost reduction goals on our new commercial OEM programs.

These challenges are not going to be overcome in a quarter or two. However, as we look out a few years, the OEM programs will mature, R&D will abate and the aftermarket will grow to give us mid teen margins.

On a positive note, our Medical segment continues to perform well and we're seeing some real gains in our Space and Defense segment. In addition, it was another quarter of good cash flow and we're maintaining our cash flow forecast for the full year despite the reduction in our projected net income.

We're now forecasting full year sales of $2.54 billion and earnings per share of $3.55. At the halfway mark, we have $1.66 in the bank. The last two quarters will average $0.95, but the exact EPS will be based on when the projected restructuring charges hit the P&L.

As in previous quarters, our forecast of $3.55 per share does not include any impact from further share buyback activity over the next 6 months. Should we continue our buyback program on a pace to conclude our 9 million share authorization by the end of this fiscal year, then earnings per share would be $3.60.

Over the last year, it might seem as if our business is going through a period of one step forward and one step back. Macroeconomic forces have combined with a shifting mix to dilute the impact of the internal improvement initiatives we're pursuing. We've taken steps forward with our Medical and Space and Defense segments and we are seeing some nice improvements in those businesses.

In our Industrial segment, our wind energy business continues to be a drag on margins but another recent deep dive into this business has convinced us that we should stay the course for the next few years. If all goes to plan, the rewards will be worth it. Our Components segment has always been a strong performer and continues to do well.

Finally, our largest segment, the Aircraft segment, is going through significant growing pains as we evolve into the number one supplier of flight controls in the world. This journey is taking longer and is more expensive than we had ever anticipated, but most of the major investment is now behind us, and in the long term, we'll all be glad we stayed the course. Day to day, we continue to focus on operational improvements and cash flow generation through our LEAN activities, while deploying capital to maximize shareholder value.

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

Thanks, John. Good morning. Free cash flow in the quarter came in at $35 million, bringing our six-month total to $94 million against year-to-date net earnings of $67 million, or a conversion ratio of 139%. Despite the FY15 earnings challenges that John's described, we're reaffirming last quarter's forecasted free cash flow of $190 million for all of 2015 which will result in a conversion ratio of 134%.

Our net debt increased by $58 million during the quarter to $769 million. The $93 million difference between our positive free cash flow and the increase in net debt outstanding is principally the result of our share buyback program.

Working capital as a percentage of sales continued its recent downward trend. Our increasing attention to LEAN is having a positive effect on the amount of capital we have invested in the balance sheet.

Over the last two years, our trading net working capital as a percentage of sales has steadily declined by over 400 basis points. Our 9 million share repurchase program that we initiated in January of 2014 continued during Q2. During the three months ended March 2015, we acquired an additional 1.1 million shares for $82 million at an average price of $74.

At the end of March, we have 2.4 million shares remaining under our outstanding Board authorization. Our present plan is to continue buying back these shares programmatically on the open market throughout the duration of 2015.

Capital expenditures were $18 million and depreciation and amortization totaled $27 million in the quarter. Our forecast for CapEx and depreciation and amortization for all of 2015 is now $90 million and $109 million, respectively.

Cash contributions to our global defined benefit pension plans totaled $18 million in the second quarter. We're still forecasting $61 million of global DB plan cash contributions for all of FY15.

Our effective tax rate in the second quarter was 22.5%, down from last year's 29.6%. There are a number of items that, when added together, affect this rate considerably.

First and most significantly, we are benefiting from a more favorable mix of taxable earnings due to the updated forecasts that we've described. More specifically we're now forecasting less US taxable income taxed at higher marginal rates.

Second, we recorded an incremental R&D tax credit benefit related to FY14 based on some additional work that our tax team performed during the quarter. Lastly, we had an accrual for a tax exposure at a foreign subsidiary which expired during the quarter. For all of FY15, we're now projecting our effective tax rate to be 29.2%, down from our last forecast of 31.4%.

Our financial ratios at the end of the quarter reflect the continuation of our strategy to return capital to our shareholders via our share buyback program. Net debt as a percentage of total cap was 40%, up from 24% in last year's second quarter. Our leverage ratio, net debt divided by EBITDA, was 2.28 times at the end of the quarter.

At the end of March, we had $1.031 billion of total debt outstanding with about half of that either priced or hedged at fixed interest rates. Also, as of the end of March, we had over $400 million of unused capacity on our $1.1 billion revolver.

Similar to many global companies, we've been challenged in recent years by soft organic growth. We're using this time to focus on operational improvements. They're hard to see as we're fighting against the headwinds that John's described, but they're real nonetheless.

For example, over the past 9 months our total staffing has declined by nearly 5% while sales have been flat. Additionally, we believe we're in the early stages of embracing the principles of LEAN throughout the Company where the mindset is, everybody improving every day, and we know we have plenty of opportunities for further improvements.

Despite our near-term challenges, we remain focused on creating shareholder value. Our strong cash flow continues to afford us the opportunity to return capital to our shareholders through our share buyback program.

Acquired growth remains an important complementary strategy for value creation along with our organic growth even though we haven't reported an acquisition in over two years. We are working on ways to increase our deal flow while increasing the likelihood of getting the right transactions across the finish line and remaining true to a disciplined approach.

In summary, John noted that our EPS for FY15 is now $3.55 including the negative effect of $0.24 of specials that we hadn't been anticipating in our last forecast. These specials include the accounting correction, the loss on the disposal of the medical operations, and some additional restructuring costs in response to softer business conditions.

After adding back the effect of these specials, our FY15 EPS would be $3.79 a share. This would reflect an 8% increase over last year's EPS of $3.52. With that, I'd like to turn you back to John for any questions that you may have. And, Alan, can you help us out?

(Operator Instructions)

Cai von Rumohr, Cowen and Company

This is Lucy dialing in for Cai. Good morning.

First there is a clarification question on your outlook revision to the $0.06 weaker operations. It sounds like you have some weaker aircraft ops in the first half, and you're expecting production challenges in the second half. Your industrial margins are expected to improve in the second half, but you have some headwind at components.

Can you just maybe clarify how much of the $0.06 is in the first half versus the second half?

Good morning, Lucy.

The way I described it was I described the change from $3.85 last quarter to $3.55. As Don mentioned, of that $0.30 change, $0.24 is specials. And then the way I described it was the remaining $0.06 is due to all other impacts, which includes operational headwinds and thereafter by the more favorable tax rate Don described and the benefit of the lower share count. So there are a couple of different moving parts in that $0.06.

If I look at the margin projection first half/the second half across the businesses, in the Aircraft business, the margin improves first half to second half quite substantially; that is a mix issue. We anticipate some foreign military sales that we have already got in the backlog in the second half, which will accrue the mix of military to commercial.

So we'll see a pickup in the Aircraft margin in the second half. In Space and Defense, we see a pickup in the margins in the second-half. And that is really driven by the fact that we have this big correction in the first half; otherwise, we are keeping the margins there fixed.

Industrial, we also anticipate a little of pick up in the second half. That is not really driven by a sales increase; it's more driven by the fact that we continue to focus on costs across that business. Components, first-half/second-half margin is about the same. The issue there is in the second half we are seeing some slower sales on our Marine side of the business, which is a nice contributor. And we compensate for that by keeping the costs down. So first half/second half, similar margins.

And in our Medical business, it's also somewhat first half/second half similar margins. Medical had the hit at the one point, just over $1 million from the last this quarter. So if you take that out, Medical gets a little better.

So it's a mixed picture, I would say, Lucy -- the second half stronger than the first half, but it varies across the different groups.

That's really helpful. Thank you.

And then just on Commercial, aftermarket it was down 16% on tough comps on the 787 provisioning from last year. Can you maybe talk about how much it was in terms of growth or decline ex provisioning and what you're expecting for the rest of the year?

I can. Ex provisioning, it's essentially pretty much flat. And when you ask what we're anticipating for the rest of the year -- so let me just pull up the actual numbers here. Provisioning on the 787 in the second quarter last year was about over $9 million; this year, it was under $5 million. So that kind of really is driving the difference. It's about a $5 million difference in the provisioning, and that's essentially the difference almost to the bottom line. So much of the rest of it is kind of puts and takes, but it's pretty much the same.

I know if you look at provisioning for the total this year, we're anticipating about $13 million or $14 million this year. And that's down from about $30 million last year. And I think, again, if you look at the total for the year in Commercial aftermarket, last year it was about $130 million. This year, we're forecasting $115 million. It is essentially all initial provisioning, the shift in initial provisioning -- ex-initial provisioning of the 787. The commercial aftermarket actually for the last two or three years has been almost flat year on year.

At about a $100 million.

Yes. It's a $100 million plus IP as really what you see.

Wonderful.

And one more follow-up, and I'll pass it on. Restructuring -- just wondering how you're thinking about the cadence of spending in the second half. How should we kind of think about in our modeling? And maybe also how much benefit you're expecting going forward from your actions this year?

Yes. So what we've said is we've reserved about $5 million, taken our reserve in the second half for restructuring. We haven't described where or how that will take place. And I don't want to speculate on when that restructuring charge might come through. What I said is I think that the second half we'll average about $0.95 a quarter. And then depending on when that restructuring hits, that will obviously be the adjustments then in the third or fourth quarter.

And in terms of the benefits, we won't see any benefit in this fiscal year from that restructuring. The costs of the restructuring will not be recovered that fast. I would say this though. Normally our restructuring has the benefit of somewhere between 1 to 2 times in the following year. But what we do anticipate is some of that restructuring will be structural changes to some contractual relationships that we have, which our relationships will have a tail on them of a couple of years.

So the normal impact that we would have seen on typical restructuring will probably not be what plays out on at least a portion of that restructuring. And as this happens, we will describe it to the market; and we will explain the benefits that we anticipate in FY15.

That's terrific. Thank you very much.

Thank you.

Next we'll go to Steven Cahall with Royal Bank of Canada.

Good morning, Steven.

Steven Cahall - Royal Bank of Canada Yes. Thank you good morning.

Maybe a first question on the aircraft controls margin. I was wondering if you could quantify what the quality issue impact was on the quarter. Just to give us a sense of kind of what a more normalize run rate, since you said that's behind you.

Because what I am kind of getting at here is if we just look at the second half of the year, certainly it looks like we're going to see some underlying margin improvement. The last few quarters, going back into FY14, we've certainly seen that margin start to track down. What gives you additional confidence then it's going to start to pick up?

The quality issue rounded is about 100 basis points in the quarter. And then the improved margins in the second half are totally a mix issue. And we have various problems, particularly on the military side, which tend to vary quarter over quarter and year over year. And some of those foreign military sales can be significant drivers of margin performance.

We've booked -- we have it in the backlog from business that we anticipate shipping over the next couple of quarters. And that's what gives us confidence that the second half will be better than the first half.

And I think you mentioned that there was some cost growth on new programs. Is this primarily -- I am guessing it's not so much stuff that's in development because we didn't see R&D go up; you said it was more in the gross margins. So is this the transition -- for instance, the 787 or early A350 -- into your lower cost production, or is this something else?

No, it is. It's the new aircraft -- 87s, 350. And it's not so much that I would describe it is cost growth as that I would describe that our anticipation of how quickly we will down the cost curve -- that's proving to be the challenge. So costs are coming down; they're just not coming down as fast as we were anticipating and were building into our forecast for the year. And that's essentially the effect that we're seeing.

Okay. Thank you.

And then just a final one -- a bit of a clarification on the tax rate. If I quickly take a look at that, the new implied tax rate for the year, it suggests to me that we kind of a go back to that 31.5% in the back half. So how come we don't get that mix of earnings outside the US that's favorable repeating in HQ as it did in the second quarter?

Yes, this is Don. Thanks for the question, Steven.

You're right; the second half is forecasted to be little bit above 31% effective tax rate. In the accounting world, we're obligated and have estimated what we think that mix is going to look like as we look out for the balance of the year. And there is essentially a cumulative catch-up that happens in the second quarter. So we've captured that impact for the most part all in the second quarter, and we've normalized it in the second half.

Thank you. I'll get back in the queue.

Thanks.

(Operator Instructions)

We'll next go to Ron Epstein with Bank of America Merrill Lynch.

Just a couple of questions. In the Aircraft segment, can you talk more about the quality issue you had with the vendor? Does this just kind of bounce back? I remember -- what was it, maybe two or three quarters ago, John, where you were talking about you were having Asia supply chain issues. Is this related to that?

No, it's not Ron.

This is - it's a very small part that just cut across all of our products that was a mix up at the vendor. The quality issue was not visible. We discovered it when some stuff was in production. There was a big scramble to say, okay, we've got to replace all those parts. And it was long-standing vendor. It was just a lot issue which we ended up having to clean up.

But the cleanup was kind of expensive and difficult. It happened in the quarter; it's behind us. It won't happen again because we know now the fault mechanism as the vendor. It was just one of those kind of unusual events. Nothing to do with new vendors or agents actually -- nothing to do with that.

Okay. And then also you mentioned in the prepared remarks how R&D spending was down in the quarter. Can you quantify how much it was down in the quarter, what drove it, and how we should think about R&D for the rest of the year?

Yes, so for the rest of the year we were at a forecast of $135 million for the year. And we've moderated that down to about to $130 million. And the $5 million reduction is in Aircrafts, and it's really on the A350 that we're seeing the spending coming down. The A350 spending was down about $4 million $5 million in the quarter.

So that's what's driving it. Now, I have to temper that by saying the way the spending of the A350 and E-Jets goes is that you have quarters where it fluctuates quite a lot. And the reason is when you get into the point of the program where you are building hardware, you go from having kind of a fixed number of engineers working on it; and then suddenly you're engaging in material purchases, you're engaging the machine shop, you're actually making stuff. So the R&D spend goes up significantly in those particular quarters.

And on the A350, the spends came down. Last year, it was over $11 million; this year in the same quarters, it was closer to $5 million. That's the big difference. And we see that picking up, actually, over the next couple of quarters. And then at start the next year, as we do the A350-1000, then it starts to roll out again.

So that's really what is happened, Ron. It was heavy expense last year in the same quarter on the A350 as we were building a lot hardware. That hardware went through this year. But for the year, we also anticipate that the 350 will be more than we had anticipated.

Okay. And then maybe one more if I can.

On the Asia supply chain issue. How is that going? How is that proceeding? Can give us any color on how much better it is, or what's going on there?

Let me offer you a kind of a broader perspective on it. And that is that our move to [four stuff] in Asia, that continues. We continue down that path. We have our own facilities in Asia. We've transferred and [A7] production is essentially all in our own facilities in Asia. A350 is not yet there; we're starting that transfer. We tend to build the initial units here in the US, and then we start moving into the sum of things as we've matured our ability to do that. And then the buildup of an Asian supply chain, that all continues.

The broader issue that we're challenged with is just our anticipation of how fast we will come down the cost curve across a whole range of our parts, suppliers, internal yields -- all the things that go into that overall cost cart. And it's just proving to take longer than we had anticipated.

Costs do continue to come down; quarter on quarter, we're seeing the cost coming down. But it's coming down slower than we had forecasted; and therefore we end up adjusting our cost structure, and we adjust our forecast for the year. And that's really what's happening, Ron.

It's costing us more. The new OEM problems on the commercial side are costing us more than we were forecasting and that's what we're trying to identify as we look out when we were forecasting for the rest of the year.

Got it. And then just one observation if I could just get your take on this. When I look at the margins in the quarter, it looks like Medical devices actually had higher margins than both Aircraft systems and Space and Defense controls. It's kind of weird right?

That's not quite right. Let me tell you why. But you're right. Aircraft -- if you back out the effect of the disposal, then Medical was just over 12%. But if I back out the effect of the accounting correction in Space and Defense, Space and Defense was up close to 14%. They actually were coming out of a lot of tough things there. But, yes, Medical is doing very well.

Actually if you look at Medical on an EBITDA basis, it's coming close to 20% because of the heavy amortization in our Medical segments because of the purchase prices that we paid a few years ago. So it's actually done a lot better. Now, we've described in the past -- part of when we couldn't do the sale, and one of the things I mentioned was that we had a kind of a collection of different pieces of business that buyers valued at a different rate, depending on the type of buyer you were.

So the sale of the two operations this quarter -- although they were small -- that continues down this path of trying to separate out the pieces of the business so that when we go back out and seek a buyer for it, we've got a cleaner story. And hopefully the market will value that at a price that we feel is commensurate with the value that it will have within (inaudible). So we'll continue down that process. And our plan right now is in the second half of this year that we will go back out to the market and test the market's appetite of the property.

Having said that, our anticipation of value now is significantly higher from what it was two years ago. We started this process when we were kind of maybe -- we didn't have a good track record of making real steady earnings with that business.

Got it. Got it. Thanks.

You're welcome.

(Operator Instructions)

We'll next go to Michael Ciarmoli with KeyBanc Capital Markets.

Just on the Aircraft margins, I mean you still are talking about getting back to a mid-teen level. How realistic is that? We haven't seen mid-teens since 2004. You're going to have -- I would imagine -- dilutive mix issues going forward when the Embraer program ramps up, the 777X. Is it really realistic to think we can see mid-teen margins just given maybe a consistent string of new programs coming in?

Well, I think, Michael, it's more a question of timing rather than if. It's not an if; it's a when. And what I would say is the when is what changed significantly in our outlook over the last few years. So there are three things that will drive the margin over time. There is the mix and how strong or weak the Military side of the business is because that's a very nice margin contributor. There is the R&D spends and how quickly that will come down or not. And then there is how quickly we can, on the commercial side, get the costs down on the OEM side until the aftermarket starts to ramp up.

The military mix, obviously, there's not a lot we can do about that. We're on the major programs -- at 35, long term that's going to be a great program. There is no aftermarket in that. Yes, that will kick in. That will be a great program. V-22, that's real solid program for us. And we continue to look for new military opportunities. But there are not a lot of big programs on the military side. So we'll go to some extent with the budget spends and, in particular, with how the F35 fares.

On the R&D side, the R&D will come down. That will probably take another couple of years before we really see it falling off. And the reason for that is Embraer will continue over the next year or two. And, as I mentioned, the A350, we've got the A350-1000 variance. So we don't think that next year we'll see much of a change in R&D perhaps. But then as you get out to 2017, 2018, 2019, R&D will come down.

And Boeing has not -- I think our understanding is that Boeing has awarded the primary package on the 777X to another supplier. So that's not going to be, at least in our R&D going forward, the highlight. We're not sure what Boeing's position on that is. But we'll have to see how that plays out.

But in any event, we would anticipate that R&D will come down over the next several years. And then as I mentioned, it's getting down the cost curve on the OM business. And there are a lot of plans in place, a lot of work being done on that. We have the low cost facility offshore that we've had offshore for the last 30 years. So this is not a Greenfield site that we've just established over the last couple of years and are working our way through that.

So that will happen. It's just that it will take awhile. And there will be the headwind of -- as the A7 gets into better shape, the A350 will be already saved. And then as that gets into better shape, the E-jets will be early stage. However, we do believe the learning curve. 787 was the first major systems job that we've done; A350, we learned a lot, and E-Jets, we've learned even more. So we would anticipate that we would be able to come down that cost curve faster from the 787 to the 350 and the 350 to the E-jets.

Got it.

Plus the infrastructure around an agent supply chain -- we'll have built that through the 787 period; we'll optimize it on 350; and we'll hopefully be able to the plug the E-jets in a lot quicker.

Got it. That's helpful.

And then what about you held the industrial revenue outlook. So is it safe to say that some of your oil-exposed businesses have -- maybe stabilized isn't the right word. But have you fairly contemplated that weakness when you looked at the outlook last quarter? I mean, can you tell us if those businesses have gotten better or worse, or are they just kind of hanging in there?

Well, so let me split that into two. In our Industrial segments, we have a little bit of oil and gas exposure; but it's not a big piece of business. It's kind of a $20 million piece of business. So that's up a little bit; it's down hold exploration. But that's kind of holding reasonably steady -- probably weaker than last year, but that's not the big piece.

The bigger piece is in our Component segment, where we have our energy piece is really what we call the Marine business. And that's the business that did $75 million last year, and we're now forecasting that's going to do about $55 million this year. So that's coming up quite significantly. And it's really in the second half that's coming up because through the first half, the run rate is about 70%.

So we're seeing a significant drop in the second half, which is what we -- I think we were projecting over the last couple of quarters where we said the drop in the price of oil, it will take a little bit of awhile before that filters through just because capital projects are already approved and in gear. And we did in the quarter -- we took that down by $3 million from what we said three months ago. So we're anticipating it will be even softer.

So, yes, we figured down a little bit more. I think in our guidance of 90 days ago, we tried to capture most of that. There was just another little tweak downwards in the components group this quarter.

Got it.

The bigger effect on our Industrial Systems business is more around the ForEx impact that we described last quarter.

Okay. And on that Marine, is that more offshore production? Or is it more exposed to exploration, or it is just a mix of both?

It's really a mix of both. There are two major processes. One is [slip rings] that go on remotely-operated vehicles, which I think are used both for maintenance. So these are vehicles that go down to the seabed. They're used both for maintenance and for, I think, installing new systems.

And then the other big piece of it is what are called FPSOs, which are very large - think of the multi-million dollar type of sales that are used on floating production and storage offloading systems which essentially are shift that have a kind of that platform on them, and that's more the production side of the business. So, it's a bit of a combination of both and it is all offshore, it's all offshore oil exploration.

Got it. And then just a last one from me. I have may have gone distracted during the call, but you guys said you were keeping the medical segment now. And I am just wondering if you could walk me through those internal discussions. I mean, it was at one point announced for sale, applauded by shareholders, your stock went up. At was seemingly out the door the deal fell apart and now all of a sudden we've done the 180 on it. I mean, can you just give us a sense of kind of the internal dialog and analysis and how you guys have come full circle?

Yes. Michael, I definitely did not say that in the call.

Okay.

What I said, and I think I've been consistent with this over the last year or so, is that we are restructuring our medical segments because as we went through the sale process, it turns out that we have -- the primary focus was on pumps and sets. But because we did five acquisitions, we also ended up -- product lines since what I would call it components product line within medical. We call it sensors and hand pieces.

And then we also had some stuff like the lab services stuff. And when you went to sell it you had a piece -- you had 40% of it a PE guy was interested in because it was a cash based business. Another 40% you had a strategic that was interested because they were interested in the pump business, and then another 20% that really was kind of nobody was that interested in. So nobody was really willing to give you, you couldn't get the strategic to give you full value, you couldn't get the PE guys to give you full value and the other stuff was essentially discounted.

So over the last 12 months since the deal fell through, which is 12 months ago now, what we've been doing as we've been trying to divide it up into logical product line that are more suitable for sale and that we could offer to the right type of buyer. And a piece of that was the sale of the two lab services facilities this quarter. So we've got that over the picture now, $7 million of sales is not a big piece.

And we are continuing down the path of trying to make sure that what we would offer to the market is attractive to the right set of buyers. And what I said consistently is that we will go out in the second half of this year so, probably after the third quarter results, and we will test the markets appetite for what we're then offering.

Now what I do want to say is that we will sell that what we've got at all cost in a fire sale, because what we have now is actually a nicely profitable business. And I think I said in the call, it's actually a 20% EBITDA margin business in our medical segment right now.

We want to make sure that we get the right value for that that reflects on our shareholders what the value of the actual business is worth. If we can find somebody that's willing to pay the right price for it, we would be happy to sell it. If we can't, we'll have to consider what the alternatives might be. But we will not -- the whole focus is on where we're standing right now, what's the optimum shareholder value creation option with that business.

So, our plan is go back out and see what we've go. It's not a 180, but I would also say that our situation today is very different from two years ago where we were looking in getting out of this business. We found to way to make it a much, much stronger business that has nice financials so the price that we would expect is a significantly different number from what we would have been hoping to get two years ago.

Great, I am definitely glad I asked that for that clarity. I'll jump back in the queue.

Thanks, Michael.

(Operator Instructions)

That we have one question left in the queue. We'll take that from Robert Spingarn from Credit Suisse.

Just wanted to ask you again about commercial aftermarket, why it isn't, ex the provisioning, why isn't it actually trending up this year?

Yes, we've got this question at various times through the years and what I have to do is, is I've got to tell you that the number is fixed. And I've got to explain to you what I think the number is to way it is. But I cannot give you exact detail as to why it's not doing some different.

The fact that it's about $100 million ex the provisioning and what you have got to think about a couple of things. Our stuff, first of all is not on scheduled maintenance. It essentially is, when stuff leaks, it comes back and we fix it. So it's not that you can tie it directly to passenger seat miles or number of airplane flights or number of legs.

Now it is true that those obviously a correlations that the more they fly the airplane the more our stuff gets used and the more comes back. But it's not like brake pads where for every landing or every ten landings we got to have the new spare. So that's one thing.

The second thing is that it's the mix of airplanes that we're on or anybody is on and how much those airplanes are flying and or how much those airplanes are being retired. And in our case we've got some older 57, 67, 47 business and that's obviously tailing up.

Now we've got some newer platforms obviously 37, 87 and some of the Airbus businesses- but it's that combination. If you've got older platform and they're starting to slow down, you see that drop-off. On the other hand you're seeing newer platform ramps up.

The end result is, it's flat. It's not a loss of market share or anything like that, it's the combination of old/new, how many flight hours et cetera. Does that help?

It does help. Do you have some sense of what might be moving into a sweet spot then? Or maybe another way to ask the question is that we look at the $100 million, what percentage of that is on out-of-production versus in-production models, is there a way to look at it that way?

No. We don't typically provide that level of breakdown.

I mean because the way you explained it John, it sounds like if we're talking 57, 67 and 47, that's at some point going to go down to zero. There is a little bit of a renaissance with the 57. But if you have a good position on 37 for example, or somewhere, an Airbus, maybe we start to see that growth at some point?

I think that our anticipation is that major future in our aftermarket business, it would be obviously the introduction airplanes, 777, 37. But then particularly that's the 350 and 87 starts to go on. And clearly we will see the older platforms drop off. We look out a few years, we think our aircraft aftermarket business will definitely grow. But there will be that -- there will be the headwind of the older platforms as they do that.

Now let me offer you this thought. If you look at a 67 versus in 87, a comp which is the factor of 3, 4, 5 higher. If you look at it 330 versus a 350 it's a multiple higher. So you have that impact going on that we just have more content on the newer airplanes.

The other thing that we've done on the newer platforms is we actually are engaging in long-term contracts with some of the major airlines that have fly by our type of contracts you may see [transfer leases] of different times when we signed up for long-term deals. So a key future focus is making sure we've got long-term contracts in place and therefore you get out of the potential competition you have with job shops that are trying to just replace parts with reworked parts.

So just to tie the loop here on 78, you're clearly saying nice ships at content there. Is it about five, six years into the program where you'll start to see you'll get through the provisioning maybe seven to eight years and you'll see a nice bow wave?

Yes because there is also a four or five year warranty periods in all of these airplanes. So you have to get through that period of times. So what happens is you get into production, you get an initial shot in the arm for provisioning that you'll probably get a little bit of slowdown and then gradually airplanes are coming out of warranty and you start to do that. And actually I think the first 87 is coming off warranty kind of in the next quarter or two. So we're actually very early stages starting to get into that stage of the program.

Alright sounds like you're couple of years away. Thank you.

Very welcome. Any other questions, Alan?

No sir, we have no further questions at this time.

Thank you very much, indeed Thank you for all for joining us, and we look forward to catching up again in the 90 days' time. Thanks, Alan.

You're welcome, sir, and that does conclude today's conference. We thank everyone for their participation. If you'd like to access the replay of today's event, you can do so starting at noon today using the number 719-457-0820 or toll free 1-888-203-1112. That replay will last until May 6, once again, at noon.

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