Moog Inc (MOG.B) 2018 Q3 法說會逐字稿

Good day, everyone, and welcome to the Moog Third Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to 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 July 27, 2018, our most recent Form 8-K filed on July 27, 2018, and in certain of our other public filings with the SEC. We 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, thank you for joining us. This morning, we report on the third quarter of fiscal '18 and update our guidance for the full year.

Our business continues to perform well, and we remain on track to meet our original full year EPS targets.

Last quarter, we recalibrated our listeners to our target of $4.40 per share, a number which excludes the wind restructuring and the onetime impact of tax reform but includes the effect of the ongoing lower tax rates. This quarter, we have a relatively simple story, a relief after a couple of quarters of major tax and restructuring adjustments.

As usual, let me start with the headlines. First on the technical front, the Embraer E2 jet entered service in April of 2018 equipped with the Moog primary flight control system. This event represents another milestone achievement in our commercial aircraft growth strategy.

Second, it was another good quarter with double-digit sales growth and earnings per share of $1.13, slightly ahead of our guidance of $1.10 from 90 days ago. Free cash flow was light in the quarter, the result of strong sales growth and higher pension contributions.

Third, we paid our first quarterly dividend since the 1980s on June 1. And today we announce our second quarterly dividend of $0.25 per share.

Fourth, we fully funded our U.S. DB pension plan this quarter. This plan was closed to new entrants but not frozen back in 2008. Now a decade later, we've achieved a funding level, which should eliminate the need to further fund the plan in the foreseeable future.

Finally, across the portfolio, our markets continue to perform well. Talk of trade wars and a hard Brexit are concerns, but for the moment, business conditions remain positive.

Now let me move to the details, starting with the third quarter results.

Sales in the quarter of $692 million were 11% higher than last year. Stronger foreign currencies, combined with sales from acquired businesses, made up about 1/3 of the increase, with underlying organic growth running over 7%. Sales were up in each of our operating groups, with particularly strong organic growth in the Space and Defense group.

Taking a look at the P&L, our gross margin was lower than last year on the negative sales mix and increasing pricing pressure across our military book of business. R&D was lower, as our major aircraft programs continued to ramp down. And similar to last quarter, SG&A expense is running higher this year on additional selling activity, acquisition-related expenses and higher employee health care costs.

Earnings before taxes are up 14% from last year, but our tax rate was almost 900 basis points higher than an unusually low quarter last year.

The overall result was net earnings of $41 million and earnings per share of $1.13, up from $1.11 last year, and as I said, slightly above the midpoint of our guidance for the quarter of $1.10.

Fiscal '18 outlook. With 1 quarter left to go, we are adding $20 million to our sales forecast to bring our full year projection to $2.7 billion. Excluding the impacts of the wind restructuring and tax reform, we're increasing our adjusted EPS forecast slightly to $4.42, plus or minus $0.10. That's $0.02 ahead of what we said 90 days ago. Unadjusted, our full year GAAP EPS is unchanged at $2.67, plus or minus $0.10.

Now to the segments, and I'd remind our listeners that we provided a 3-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. Sales in the third quarter of $300 million were 6% higher than last year. On the military side, sales on the F-35 are almost 40% higher and accelerating production activity associated with LRIP-11. Sales in other OEM programs were up slightly from the same quarter last year, while the military aftermarket was up on higher F-18 and V-22 activity.

On the commercial side, sales to both Boeing and Airbus were down from last year. Sales for the 787 program were in line, but 777 deliveries are down 30% as legacy aircraft deliveries wind down. Airbus sales were down slightly on the A350 associated with the timing of deliveries.

Overall, sales to business jet customers were in line with last year. The commercial aftermarket continues to show strength with sales up over 20%, driven primarily by continued strength and initial provisioning for the A350.

Aircraft, fiscal '18. We are keeping our full year sales forecast unchanged from 90 days ago at $1.2 billion, but we are refining the mix in the commercial sector slightly. We anticipate sales on OEM programs will be about $10 million lower than our forecast from 90 days ago, while sales into the commercial aftermarket will be about $10 million higher.

Aircraft margins. Margins in the quarter were 11.1%, up 80 basis points from the same quarter last year. Increased margins were the result of lower R&D, partially offset by a lower gross margin and higher SG&A expenses. Our gross margin was down from last year on a less favorable sales mix in commercial OEM and pricing pressures across the military book. SG&A expenses were up as we invest additional resources to find new avenues of growth, both organic and acquired. For the full year, we are lowering our forecast for R&D by $7 million, and increasing our operating margin forecast to 10.8%.

Turning now to Space and Defense. Sales in the quarter of $150 million were up 17% from last year. This quarter, we recorded nice increases in both our Space and Defense portfolios. On the space side, it's a similar story to last quarter. Sales of avionics products were almost double the level of Q3 fiscal '17. Over the last 2 years, we've won significant avionics content on new military platforms as the DoD places increased emphasis on space capabilities. We also continued to see strength in our launch products, and particularly activity at NASA for the SLS and Orion programs.

After a relatively slow first half of the year, defense sales were up 15% this quarter. We enjoyed higher component sales across a broad range of applications. In addition, sales of security products were more than double the level of a year ago. This increase was a combination of higher sales on legacy pan and tilt systems including after-market activity on the [DBD] program, as well as sales from the acquisition of Electro-Optical Imaging, which we completed early in the quarter.

Electro-Optical Imaging is a small company located in Florida which has developed UAV, unmanned area vehicle tracking systems. Their technology adds to our growing capability in tracking and eliminating the threat of UAV systems in the field. The acquisition added $4 million of sales in the quarter.

Space and Defense, fiscal '18. With 1 quarter remaining, we are increasing our forecast for defense sales by $20 million, while keeping our space forecast unchanged from last quarter. Defense sales will be higher as a result of the Q3 acquisition and a recent win on a new military vehicle program.

Space and Defense margins. Margins in the quarter of 11% were up 100 basis points from last year. For the full year, we are increasing our margin forecast slightly to 11.8% on the higher sales forecast.

Turning now to Industrial Systems. Sales in the quarter of $243 million were up 13% from last year. The increase is roughly 40% acquired sales, 40% organic growth and 20% ForEx driven. At the end of the second quarter, we closed on the acquisition of VUES Brno, a company located in the Czech Republic that specializes in large motors. Large motors are a key component in helping our customers in certain markets transition from hydraulic to electric motion control solutions. The acquisition of Brno gives us a complementary capability to our in-house products and brings a cost-effective manufacturing capability in Eastern Europe. For the fiscal year, the acquisition adds about $20 million in sales.

In total, we saw strong growth in 3 of our 4 major markets: energy, industrial automation and medical.

In the energy markets, sales into nonrenewable applications were up as higher oil prices drove a modest recovery in exploration investment. We also saw a nice increase in products sold to makers of power generation equipment in the Pacific. Wind sales were up marginally from last year, as we ship our backlog of customer orders before the end of this fiscal year.

Industrial automation sales were up as the global economies continue to invest in new capital. And sales into medical markets were up for both our pumps and component product lines.

Finally, simulation and test sales were down from an unusually strong quarter in fiscal '17.

Industrial Systems, fiscal '18. We are keeping our sales forecast for the full year unchanged from 90 days ago at $934 million. Some of our simulation and test customers have pushed out their demand into next fiscal year, but these sales will be compensated by slightly higher sales in each of our other 3 markets.

Margins. Margins in the quarter of 10% were about in line with last year. In the quarter, we took a charge on a long-running program in our simulation and test business which depressed margins by 100 basis points. And in addition, we added $1 million to the restructuring reserve for our wind exit plan. For the full year, we're moderating our margin forecast to 6.7% to take account of slightly higher anticipated costs to exit the wind pitch control business. We are on schedule to complete our facility wind down by the end of our fiscal year. And we'll true up the final numbers when we report out in Q4.

Full year margins, exclusive of restructuring, will be 10.2%, more or less in line with fiscal '17.

Summary guidance. Q3 continues our pattern of good performance this year, with earnings per share coming in above the midpoint of our guidance. In our aircraft business, military programs are showing signs of strength and the commercial aftermarket is ahead of our expectations. Commercial OEM deliveries are level with last year, although the mix is moving against us as sales on new programs replace more profitable legacy production programs, particularly the 777. Company-funded commercial R&D continues to moderate, replaced in large part by customer-funded military R&D. Our Space and Defense business is enjoying the increased new investment -- U.S. investment in space assets, identified as the next military battlefield. And we are gaining traction on some new military vehicle programs, which bode well for the future. Finally, our industrial markets continued strong on the back of good GDP growth in the major economies around the globe. Trade wars and a potential hard Brexit are concerns on the horizon, but as yet we have not seen a significant impact. Our wind exit strategy is on schedule to be essentially completed by the end of next quarter. And finally, Q3 was the first quarter of sales for both our Brno acquisition and our Electro-Optical Imaging acquisition. Both of these bolt-on acquisitions bring us key technologies in select growth markets, large motors and UAV tracking, respectively.

Full year fiscal '18 earnings per share are projected to be $2.67, plus or minus $0.10, unchanged from last quarter. This now includes $0.74 of negative impact for the wind restructuring and $1.01 negative impact from the onetime impact of tax reform. Adjusting for these effects, our EPS forecast is up slightly just $0.02 from 90 days ago at $4.42, plus or minus $0.10.

For the fourth quarter, we anticipate earnings per share of $1.12, plus or minus $0.10.

Now let me pass you to Don to provide more details on our cash flow and balance sheet as well as additional color on our pension funding and tax rate.

Thank you, John, and good morning. Free cash flow for Q3 was at use of funds totaling $26 million. Year-to-date, our free cash flow was a use of funds of $24 million. Included in these numbers are year-to-date contributions of $175 million to our global pension plans compared with last year's $74 million. You'll recall our strategy to accelerate U.S. DB pension funding because of the December 2017 changes in U.S. tax law which fit nicely with our pension derisking strategy. We're forecasting a much stronger Q4, which will result in free cash flow for all of 2018 of $55 million. This is a reduction of $20 million from our forecast last quarter due primarily to tax-related estimates.

As we look ahead into 2019, we expect free cash flow conversion to be closer to our longer-term target of 100% of net earnings.

Net debt increased $51 million compared to free cash flow usage of $26 million. The $25 million difference relates to 3 things: first, the payment in June of our first quarterly dividend, consuming $9 million of cash; second, $5 million used to acquire the small counter UAS business, mentioned previously by John, that complements our security business strategy; and third, the effects of currency translation on our cash balances.

Net working capital, excluding cash and debt was 25.2% of sales at the end of Q3, comparable with last year's 24.7%.

Our Q3 effective tax rate was 25.8%, close to the 27.4% tax rate that we forecasted last quarter for the second half of 2018, and it compares with last year's Q3 tax rate of 17%. Last year's unusually low rate was affected by tax benefits associated with the disposition. Year-to-date, our 2018 effective tax rate is 56.4%. When we remove the onetime tax reform and wind restructuring effects, our year-to-date Q3 effective tax rate related to our core operations was 26.5%. We're now forecasting our GAAP tax rate to be 47.7% for all of 2018 with everything included, essentially unchanged from last quarter's forecast. Our 2018 adjusted effective tax rate related to core operations, again, after removing the onetime effects of tax reform and wind will be 26.8%.

Similar to our comments last quarter, our updated preliminary look at 2019 suggests that our effective tax rate will be in the 25.5% realm as we benefit from a full 12 months of the lower U.S. corporate tax rate.

Capital expenditures in the quarter were $27 million, while depreciation and amortization totaled $23 million. Year-to-date CapEx was $71 million, while D&A was $68 million.

For all of 2018, our CapEx forecast remains unchanged at $95 million.

We've got a couple of facility expansion projects this year that are driving a slight increase in CapEx relative to recent years. D&A in 2018 will be about $90 million.

Cash contributions to our global pension plans totaled $75 million in the quarter compared to last year's third quarter of $33 million. For all of 2018, we're planning to make global retirement plan contributions totaling $183 million, nearly unchanged from our forecast 90 days ago. We've described how we've accelerated a total of $85 million of contributions into our U.S. DB pension plan from future years into this year, $35 million of which happened in Q3. This results in a total 2018 contributions for our U.S. DB plan of $145 million, all of which has happened as of the end of Q3. Our U.S. DB plan is now fully funded relative to our projected benefit obligation. Accordingly, we won't be making any further cash contributions to this U.S. DB plan for the foreseeable future.

Global retirement plan expense in the quarter was $15 million compared to last year's $16 million. Our global expense for retirement plans is projected to be $59 million for 2018, down from last year's $64 million.

Our leverage ratio, net debt divided by EBITDA, increased to 2.18x at the end of Q3 compared to 1.92 at this time a year ago. Net debt as a percentage of total cap was 35.8%, almost unchanged from a year ago.

At quarter end, we had approximately $450 million of available unused borrowing capacity on our $1.1 billion revolver that terms out in 2021.

At the end of the first quarter, we had just under $400 million of cash in our balance sheet, and most of that was offshore, so that's just 6 months ago. At the end of Q3, our cash balance is down to $157 million. $144 million of this decrease results from the repatriation of offshore cash to the U.S., which has been used to pay down our outstanding revolver, and we used $64 million of cash for our second quarter acquisition of VUES Brno headquartered in the Czech Republic that John just mentioned. Our plan is to repatriate an additional $100 million by the end of calendar 2018, and this cash repatriation has no impact on our leverage as our net debt position is unchanged.

With respect to capital deployment, we announced on March 15 that we would be initiating a quarterly dividend of $0.25 per share starting on June 1 with a yield of about 1.2%. And today, we announced that we are paying our second quarterly dividend of $0.25 per share on September 4 to shareholders of record on August 15. The quarterly cash cost is about $9 million.

Top line growth and margin expansion continue to be a priority, including acquisitive growth, and we remain active and disciplined as we evaluate acquisition opportunities that will complement our business strategies.

In summary, despite all the noise in 2018 year-to-date numbers from tax reform and restructuring activities, our core business is performing well and consistent with our earnings forecast at the start of the year.

So with that, I'd like to turn you back to John and open it up for any questions that you may have. John?

April, do you want to queue questions for us, please?

(Operator Instructions) And we'll first hear from Kristine Liwag of Bank of America.

John, in your prepared remarks, you highlighted pricing pressure in your military business. Can you discuss more about what's driving that and how long you think that pressure would continue for?

I can -- yes, let me give you a little bit of context on it, Kristine. Over the last year or 2, we've seen -- and particularly this year, we've seen our R&D come down. And we've been watching that margin has been getting better, but not -- and what we have seen is we've seen a little bit of an erosion in the gross margin even as the R&D is coming down. Now some of that is because that R&D expense has gone up into cost of sales for our cost-plus development work on the military side, which typically carries very low margins with it, so you get a little bit of a dilution there. But the other impact that we're starting to see, and I think we're starting to recognize a little bit of a pattern is that the military book in general, and it's not just in aircraft but it's also in the Space and Defense area, is just seeing additional pricing pressures. And I guess it's the better buying power, it's the focus of the government on improving their performance. And I think we are just starting to see that broadly across the portfolio take an impact, particularly on the gross margin line and of course that falls down then to the bottom. So that's the way I would describe it, Kristine. It's one of those effects that you start to see a little bit here, a little bit there. And then eventually you start to say, well, it actually looks like it's a broad pattern. And that's the effect that we are starting to see.

And is that pattern mostly on newer military programs? Because I mean, the first piece that you mentioned seems like more of a sales mix, but the second piece in terms of the better buying power, is this on new programs like the F-35 or classified programs? Or are these also from legacy programs like F-18 and things like that?

It's across the board. It's across the board, Kristine.

And would you be able to quantify how much you think that would pressure your business going forward? Is this the beginning? Or will there be more pressures?

Well, we'll give guidance for '19 when we get together again in 90 days' time, and we can give an indication at that stage of what we think is the outlook for that. It's not changing our outlook for this business year.

I see. Okay, that's fair. And switching gears to the dividend. How do you think about your long-term dividend policy? Is there a payout ratio that you are targeting going forward?

I think it's a little early yet. I mean we are committed to a long-term dividend, but of course, it's on a quarterly basis determined by the board. But we got into it with a view to this is a long-term dividend commitment and in line with what normal dividend commitments might be from companies, but we have not set a long-term target for that. And of course part of it, Kristine, is you want to be careful that you are able to respond to economic changes. Sitting here today, it's hard to imagine something that would have a significant impact on us. But on the other hand, I don't want to commit to a dividend policy that somebody banks on, and then for some strange reason in a couple of years' time, there is a set of conditions that maybe change that. And so no, I don't want to make a long-term commitment to what that dividend yield might be or what the dividend increase might be year-on-year. Apart from saying we got into paying a dividend with a view to this is a very long-term commitment, and that we'd like to make sure that we are rewarding our investors on a regular basis.

Bob Spingarn of Credit Suisse.

Wanted to ask you about R&D in general, particularly the company funded. Now that it's winding down for the big aerospace programs, you've talked about that quite a bit, where are you spending company-funded R&D money?

Well, so I'm not sure I fully understand your (inaudible)...

Well, I want to understand where your -- where are the opportunities now. The big programs are paid for. You mentioned before some of the government stuff is up in cost-plus type development work. So where are you putting, which of the various businesses are you putting the money you are spending into? Where are the opportunities going forward for some new product?

Okay. So let me do it this way. First of all, let me do our industrial business. Industrial business is about $1 billion in sales. And historically and on a present basis, we kind of run 4% to 5% of R&D as a percentage of sales there. And that's just -- it's continuously updating the product portfolio,

it's investing in new technologies, the next-generation motors, the next-generation valves, the next generation set of applications. So that's kind of a fairly standard run rate of 4% to 5% that we've been doing for forever, and I would anticipate that we would continue at roughly at that level. In the Space and Defense business, if you go back a couple of years, we actually had very low R&D, it was running kind of in the 1% to 2% range. And over the last year or 2 and probably as we look to the future, we are going to ramp that up a little bit again into the 3% to 4% range. The big opportunities that we see there that are driving some of that, one of it is military vehicles and in particular looking at opportunities for counter UAV type of systems. We talked a little bit in the past about [terror] type applications. And so that's one area that we're spending our own R&D. And then the other area is in some of the space applications, particularly the GBSD, the ground-based strategic deterrents that's follow-up for the Minuteman. It's probably out a decade before it turns into real production, but it could be a big program for us and so we're choosing to spend some of our R&D on that right now. I would say on the defense world, one of the things that's happening in the defense business is that there is a shift from, we come up, the defense -- Department of Defense and one of the services comes up with the requirements, there is a big long spec period, there's a bid, there is an EMD phase, the development phase and eventually gets to production. To where for a lot of urgent needs, they're going out and saying, "Well, do you have something? And if you have something, maybe we can move very quickly." And so there is an opportunity to spend some of our own money, putting some of these military platforms or elements of platforms in place so that we're able to respond quickly to opportunities that are coming up in defense. And I mentioned on the call that we won a position on a new military vehicle, and that was essentially that. That's a couple of million dollars that we spent over the last few years putting a system in place, and now that system has actually won a program, and we are moving quickly into production. Historically, that same set of activities would have taken 5 to 10 years before we would get there. So there is a spend that we're doing on the defense side, which is putting some stuff together in anticipation, working with our customers and with the DoD with the services trying to understand their needs and then being able to respond quickly to the opportunities that come up. And then on the aircraft side, we have a total spend for this year of some -- about $70 million, a little bit less, in the $67 million, $68 million range. Of that, about, still about $40 million of it is what I call the existing platforms. So there is any of these big platforms like the 87 or 350 , you have an ongoing spend rate of several million dollars a year just to update them, continue (inaudible) changes, et cetera. So it's not as if that goes ever away. So you've got the 87, which a no more mature; 350 is still maturing. We're still working the E2. There is the C919, that's a program that's not even -- that's still in the development phase. And we've got some Gulfstream activity. So you put all that together and that's over -- well over half of our spend on the aircraft side. So there is still kind of a tail to that and there will continue to be a tail to that, that just won't go away completely. Then the other, I call it 40%, 30% to 40% of the aircraft spend is a couple of things. A significant piece of it is again a bit like on the defense side that I talked about, as we get involved in new military programs, what we want to do is make sure that we are spending some of our own R&D in order to develop the key IP that we want to retain ownership of. And so in addition to a funded development, we will also spend some of our own R&D to make sure that we are keeping -- we are developing the key IP on our own nickel, and that's important for the long-term control of the product. We're also a bit like the defenses as I described, spending some money on getting ahead of some potential opportunities. So we are doing a little bit of speculative R&D within aircraft. And then finally the thing that we are doing, and we are doing this across the company, is we're identifying new potential future growth opportunities, and we are spending a little bit of money in those areas. So think of 5% to 10% of your total R&D budget, you really want to be spending on what I'd call speculative long-term opportunities that could turn out to be the next wave of opportunity. And we are starting to do that, which historically we weren't doing as much of because we were so focused on the big R&D projects that we just had to get done. So that's how it breaks down, Rob. I don't know if that gives you a picture, but that (inaudible)...

No, that's a fantastic overview, that's what I was looking for. I have a couple of questions on some of it, though. One is on GBSD, would you be aligned with both teams? How do we think about that?

Yes, we are working with both teams.

Yes? Okay. And then as you mentioned looking toward the future in Defense and so forth, sixth gen aircraft has been a topic these days at the show, the Tempest, and then of course the U.S. is working on stuff, and there's the Franco-German program. So I would imagine motion control is pretty important there with these stealthy airplanes. Is that something you're starting to get into?

Well, let me put it this way, the stealth airplanes in the U.S. right now are the B-2 and the JSF is a stealth airplane.

No, of course, fifth gen.

Yes, I understand, and we have all the flight controls on those. I think any next generation jet is still going to use the same basic kind of flight control technologies. And over the last couple of years, as we've described in the past, we've won major positions on essentially every U.S. military application that we found of significant interest. And so if there's a sixth generation fighter in the U.S., I think we would be a strong contender for the type of hardware that would go on it. I'm not sure even if there is, or were, that we would be able to talk about it, Rob, so I can't give you any more than that, except to say that we've got the stuff, we've got a very nice job of winning military positions, we know how to do [stuff] on stealth, and so I think we're well positioned for that opportunity. But keep in mind that's probably -- before something like that it turns into a production program, I'm guessing you and I will be retired, so it's a long ways out. I think the bigger opportunity on the military side is Future Vertical Lift, and we're working that. We're working on the Textron team on that. And so that one I think is a bigger, nearer-term opportunity if it goes. But again, that's probably in the middle of the 2020s before that turns into production.

Rob, this is Don. Another indirect answer to your question is, and we've said this before, but our spend on classified programs for R&D has amped up a fair amount. Now this is funding development, but from a couple years ago, it was $25 million and this year we've estimated that it's approximately $60 million. So there is a lot of increased activity that we've got going on, and you can put the dots together, but it's classified business that we are working on.

I have one word on that -- hypersonics. Does that resonate?

Yes. Hypersonics is a theme that is big. As I said on the call, space is a big theme right now. I think there's a sense that the next war could be fought in space. And then of course hypersonics is a big theme and the U.S. has a perceived -- they've fallen behind the Chinese and the Russians, I think that's what we think. And so there is a big focus on spending more money on hypersonics. And again, we do missile fin control and actuation systems, and hypersonics kind of falls between what we would traditionally think of defense missiles and space because I think they go up into the 100,000 feet type of range. And so yes, we are engaged with our customers and working opportunities in hypersonics as well. But again, think of that at this stage as it's investigative, it's not that we are shipping products yet, and I don't think any of our customers are either.

Michael Ciarmoli of SunTrust.

I just wanted to go back to the pricing pressure in sort of the defense sector there. Can you just shed maybe a little bit more light. Are you seeing pressure across the board on all of your products, even some of the content that might be sole-sourced proprietary? And maybe even some color, I mean on the negotiations, do you have any leverage? Is this -- is the pressure more relegated to direct sales to the DoD at the depot level? Or are you feeling this from your prime contractor customers? Are they pushing on pricing as well? Maybe just a little bit more color at the product level.

Yes. So let me offer a couple of thoughts, Michael, and then you can tell me if I helped you or if you want to [form] your question. First thing I'd say is this is what I would describe it as a trend that I would say where we've seen a bit here and a bit there, and then you kind of -- but eventually you see enough and you start to say, this seems like it's an emerging trend. We have not changed our guidance for this year. We have not changed, so business is doing well, and we come out with guidance for '19 in 90 days' time. So I'm not trying to announce this as there's a major cliff in terms of defense profitability. But what I would say is that we are starting to see this as more of a broad-based trend across a lot of the defense book rather than just well, we had one renegotiation or one particular contract that we saw a little bit of pricing pressure on. And it really is, I mean, I think for those of you who are very involved in the defense side of the world, there has been an enormous push by the Pentagon on their better buying power on looking for opportunities to reduce costs and working with the suppliers. And so we are seeing some of that, it's pressure in terms of the margins that they are comfortable that you make, et cetera. All of these are cost-based negotiations, Michael, so it's almost always a negotiation around about what your past costs were and what you project future costs to be. But in general, I would say there's additional pressure from the defense related stuff. And it comes either directly from the services or through the OEMs that are putting some gradual margin pressure that we would probably play out, continue to play out over the coming years. Again, we are not changing guidance on the basis of this. I'd say it's more giving more a heads up to, this seems like it's an emerging activity, and we wanted to just say, look, gross margins in aircrafts are a little bit lower than we might expect. And what we are starting to see is, yes, we are seeing that pricing pressure. So have you got opportunities? I mean, it depends. There's -- we typically are paid for development work. So we own some of the IP, the government of course has paid for a large amount of it. But they're cost-based negotiations, and so it's not as if -- unless you have what they call commercial terms and stuff, then the pricing opportunity is restricted by the cost base negotiation.

Is this relegated to OE? Are you seeing any pressure on some of your legacy aircraft aftermarket parts in the military market?

It would be across both, actually, Michael.

Okay, okay. That's helpful. And then if I can just one more. You mentioned, I think you called out simulation and test with some customers maybe opting to push out some business into -- presumably into your next fiscal year, or did that move into the calendar year? Can you kind of quantify what maybe the magnitude of the slide out is and maybe what specific programs or product lines?

Yes. So we adjusted, if you plug our numbers into your model, we adjusted the simulation and test forecast for the full year down by $20 million, and we said we'll absorb that elsewhere. Almost -- a big chunk of it, Michael, turns out that when we bought this acquisition, we mentioned an acquisition that's adding $20 million of sales to the full fiscal year. And last quarter, we allocated their sales to our various markets, to industrial automation, simulation, test, medical and energy. And we, this quarter, we essentially did a bit of a correction on that. So of that $20 million reduction, about $7 million or $8 million of it was just a reallocation of sales just based on a better understanding of the business that we bought. So that's a good piece of it, call it 40% of it. And then the rest of it is there's a couple of programs that have pushed out, nothing really significant. I mean, the simulation business is going really well. We have a very strong position at Flight Safety and CAE. I mean they're our biggest customers. Their businesses are doing well. There continues to be a lot of requirement for pilot training. And on the test business, typically, this is a lumpy business. You get a -- you ship a big test system for several million dollars, and you take the sales. And then if for whatever reason that moves out a quarter, you lose that. So this is a little bit of a reallocation based on better knowledge of an acquisition we had closed just before the end of last quarter and a little bit of some stuff just shifting to the right, but nothing that we are concerned about, not a fundamental shift in the underlying business. And if you think about it, the key drivers are simulation, which is mostly commercial pilot training; and then test, which is a lot of auto test, aero test, a lot of it is auto test systems. And there continues to be significant investment in that. Now if we get auto tariffs and all that type of stuff, I'd worry a little bit about that. But there is a push to move to electric vehicles and that shift in the kind of the portfolio we think creates opportunities for car companies to invest more in new test equipment because it's just different test equipment. So right now, we still think it's a real solid business and the movement of the sales is partly a reclassification and then partly just some stuff moving out.

Got it. Helpful. And you mentioned Flight Safety and CAE. I mean are you working with L3 as well?

Yes, I believe so.

Next, we'll hear from Cai Von Rumohr of Cowen and Company.

So refresh my memory, how big is the wind energy business this year in terms of sales and operating losses excluding restructuring? And will there be any carryover next year? Or will it just be a 0 next year?

So we've got 2 pieces of our wind business. We have the pitch control systems and then we have other Wind Energy products, which are some hydraulic servovalves, slip rings in particular. And so if you look at our total wind business this year, it's about a $60 million business, of which maybe about $40 million of it is what I'd call the pitch control systems, Cai. And so that $40 million of the $60 million, next year essentially goes away. So we think next year instead of having $60 million in what we call wind, it will be down to maybe about $20 million. And it will all go away. I mean, we are on a schedule to ship all of our backlog by the end of this quarter into the fourth quarter and actually close the facilities that do those. So there will be no additional shipments. The only hangover that will remain is we will have, because we're shipping products there will be receivables that we will have to collect over the course of the next fiscal year. And a lot of our receivables in this business, as we've described in the past, is in China and typically our friends in China take quite a while to pay. So that's the only hangover that would be there as we move into next year, but it should be a balance sheet issue and we shouldn't see anything through the P&L. And in terms of margin change, I'd stick with what I said the last time, it's about 100 basis points of margin lift, all other things being equal next year versus this year. So if you say you'll do $940 million of sales this year, you can assume it's about a $9 million to $9.5 million loss this year that goes away next year.

So maybe help me understand. So on the $60 million this year, is that [a loss]? Because I assume the slip rings and the valves are basically you make some money, but on the $40 million pitch controls, excluding the restructuring, how much is that losing?

What I just described, so $9 million.

It's losing $9 million, so that $9 million goes to 0, is that correct?

Yes.

Yes.

Got it. Okay, great. And then so you'd mentioned you started to see some pickup in offshore oil. I assume that's the Halifax facility. What's the order flow like there? And sort of like roughly how big is that likely to be this year versus last and the momentum going forward?

So I -- if you go back, Cai, I think we've described this in the past, that this is probably about an $80 million business, it dropped into the low 30s, $32 million, $33 million this year. We're starting to see a modest pickup and orders are looking a little bit healthier again, coming off a very low point. So this year we're thinking it's in the kind of the high 30s, so maybe it's $5 million, $6 million better than it was last year on a $33 million, 30 -- low 30s book of business. So that gives you some [perspective] of it. And next quarter, we'll give you guidance for '19. I'd be optimistic that, that pattern could continue, oil companies just came out with some pretty good results, I think. So they've got money, although I think they're still pushing on the fact that they want to return a lot of it to shareholders and not maybe invest it. But given oil prices in the $70 a barrel region, I think we've always said that $70 is the kind of that tipping point that we think the -- above that, you start to invest in more offshore capacity. Who knows what's going to happen with Iran, who knows whether that's going to cause a further squeeze on oil prices or oil supply and then you start to see price creep up. But we are hopeful that the signs that we get, now we supply the oilfield services guys, so think of the Schlumbergers, the Halliburtons. And it would seem as if they're looking to start reinvesting a little bit of the money that they took out of that pool over the last few years. But it's early days, and as I say, it's a little bit of an uptick from where we were, but it's not yet -- it's not anything very significant.

Got it. And then so Don, you'd mentioned that you're going to bring back $100 million in cash in the fourth quarter. You had $150 million. On an ongoing basis, now that you have the ability to bring cash back, what should -- what kind of cash level are you likely to run, all in, for the company?

Cash balances, Cai?

Yes, on an ongoing basis now that you can -- it's not just trapped cash?

Yes, my ideal world would be as close to 0 as possible, but I don't think that's practical. So probably in the $50 million range plus or minus is a reasonable estimate. And just to clarify, the $100 million of repatriation that's yet to go, just to make sure it is clear what I said, it's by the end of calendar 2018. So over the next couple of quarters is what I tried to convey.

(Operator Instructions) And we'll hear from Rob Spingarn from Credit Suisse.

Okay. So I have a couple more. Just going back to some of the new things you are doing, the acquisition, the Electro-Optical Imaging acquisition, I wanted to understand there the tracking. Is that a motion control product? Or is it beyond that? Is it more of a vertical system?

So let me give you, and again I'm not sure I -- let me answer what I think it is, and then you can tell me -- I'm not sure what you mean by a vertical system. But EO optical -- or EO Imaging, that's kind of short for the Electro-Optical Imaging, is a very small company. It's a -- measured in the kind of a dozen people in Florida. We paid $5 million, which is why we didn't announce it, it's just a small acquisition. But what they do is that they have video tracking for drones. When I talk about UAVs and UAV threats, I'm really thinking of the kind of the drone stuff. And of course nowadays you can spend $1,000 on Amazon and you will get an incredibly capable drone. And if you have ill intent, you can put lots of nasty things on the drones. And so there's a growing worry. It's an issue, I think, in the theater in places like Afghanistan and Iraq and places, it's just a big issue there. It's more of concern, of course, domestically because it potentially enables all kinds of terrorist activity that's not been possible before. And so there is a growing interest in how do you both track these and how do you destroy them? Now domestically, you cannot knock anything out of the sky, as far as I know, according to FAA rules. Even if you've got something, you find that you can't knock it out of the sky. But there is an interest to say well, we want to be able to track it. So if you've got major sports events, major activities, you want to be able to set up a system that says, I can spot and track these things and see if I can quickly understand what that is and how I might to respond to it. This is if you are one of the government agencies. And so we've been -- we've worked with a couple of the government agencies, and we've developed some capabilities around that. And what you want to think of is that there's 2 elements to these types of tracking systems. One is I got to be able to spot it and then I've got to be able lock onto it with digital -- with software that allows me to track this thing. And of course the second piece is I need a highly responsive motion control system, thinking about pan and tilt system, that is going to be able to move with the tracking. So it's the detect and capture, and then I've got motion system that moves with it. And so what we've done is we've said, well, we have the motion systems and what we'd like to do is we'd like to be able to have a more complete solution so we could offer, here is a tracking system. Now it does not -- this EO optical doesn't have anything associated with let's try to destroy it, because again, that's kind of a different application. But on the military side of our business, the defense side of our business, we have also been talking with the forces at developing the [terror type] systems, which would allow you to actually take something like that out of the sky. So we just see -- one of the -- we talked about hypersonics, we talked about the next frontier of space, we talked about GBSD. But one of the other areas that is a growing opportunity, we think, is just unmanned aerial systems, tracking and potentially knocking them out of the sky and so we've been spending some R&D money there.

Well, and that's why I asked the question, and you did answer it. Normally I would think of Moog as being the motion control, the pan and tilt piece of that and somebody else doing the tracking software and whatever other technologies are associated with that. With this acquisition, you are now doing an integrated, what -- I used the word vertical before, more of a vertical system, and I think that is notable even if it is small. Or is this not really -- one of the earlier -- do you have other examples of this elsewhere in the business that we just haven't focused on -- where you've gone beyond motion control?

Yes. Absolutely. I mean so if I give you an example of 15 years ago we used to supply hydraulic servovalves to the manufacturers of flight training simulators. They -- we would provide the servovalves, they would buy the actuator, they would do all of the control electronics and then they would to sell the motion control system. And over a period of about 4 or 5 years, we worked with one of the major customers and we developed an all-electric solution. And we went from supplying a servovalve, call it tens of thousands of dollars of content per simulator to motors, actuators, drives and the control electronics, the huge panel of control electronics all around that and essentially multiplied our content by 10x. And so Aerospace is the same, we used to supply servovalves, then we supplied actuators and then we supplied flight control systems. And so we have had a consistent theme over the decades of building on our motion capability and looking to try and find larger integrated systems, while not forgetting that underlying physics around motion control. So there's many examples of this in the past. I'd say this is just the latest one, and we feel that there is a lot of folks out there, if you go to any of the shows, that are doing lots of tracking systems and various capture systems for drones, but not many of them are what I would call significant substantial companies with real capabilities. Lot of startups, a lot of kind of activity going on. It's not clear how it will shake out, and we think a company with our set of capabilities can actually work directly with some of the larger organizations in the DoD and the domestic 3 letter acronym groups to actually supply a system that really has capability, so.

Okay. Two other quick things. Back to Michael's question on pricing in defense and your point that DoD is very active here trying to get its cost structure in order. Have you seen any kind of -- well, first of all, are you fully priced and contracted on LRIP-11? Or is that still something that is being negotiated, because we do see that with some other folks?

Yes, LRIP-11, we are definitized on.

You are definitized on that. Okay. And are there -- are you seeing any opportunities for recompetes on any systems or components on F-35? Again, as they try to reduce the cost structure of that program, there are a variety of systems that have come into -- that are being reviewed and recomputed and so forth. Have you seen any opportunities there?

Nothing of significance, I would say. Because if you think of the type of stuff we do, it's the flight control actuation, and we're partnered with Parker on it. We are the only 2 companies really that have capability in that area, and we are partnered. And we have a partnership agreement that goes through the life of the program. And so -- and then our capabilities, you might think, well, actuation, well landing gear is similar and it turns out landing gear is very different. So we have not seen much, if any opportunities on that. And again, I want to caution you, the LRIP-11, so we've got that pricing. This is not a precipitous change. It's a gradual change that we've seen and if we look at our average defense margins, we're just starting to see those moderate down a little bit. And I wanted to try and get that initial sense out to the community, not that this is again, not change this year's forecast, we are not announcing anything for '19 yet. But it's a trend that we are starting to see and therefore, I wanted to provide that heads up.

No, no. That makes sense. Last question, on A350, you talked about the provisioning numbers moving around and so there is a slight drop-off there. What's a steady-state type of number for A350 going forward? Or I guess you guided it for Airbus, but I wanted to get an idea of when we're going to be at a steady state on these larger programs like an A350, 787 where they are not fluctuating around just because of the timing of things like provisioning?

Yes. So I may have misguided you a little bit. So the 350 OE production is down a little bit this quarter relative to what we saw a year ago. But if I look at the full content for a year, it's right on, it's exactly the same as it was last year. So you go back to -- let me give you kind of round numbers. You go back to '16, we did about $75 million on it. Last year, we did about $110 million, $115 million. This year we're going to do about $110 million, $115 million. Next year, based on the production rates, we think it's going to ramp up a little bit. And the way to do it, Rob, is just look what that Airbus is saying they're going to ship because that's what we base this off of, and kind of pull that forward 6 to 9 months. So what I did say is that the provisioning, that has been a little bit stronger than we had anticipated it would be. And so the provisioning has been up and down from what we thought. Now part of that is just that as you get more of them into the market. But if you go back to '16, provisioning was 10, 11. Last year was down to 7. This year it's back up again into the high-teens. And so that [purposes] around based on who's taking them, if it's new airlines, how many they want to put in place, and that's what we've had difficulty forecasting with any accuracy and typically has come in little bit ahead. And I think that will continue even on the 87. We've been surprised at how strong that's been for the last couple of years relative to what we thought. And I think I mentioned last quarter, one of the -- our model for initial provisioning was historically based on what I'd call traditional airplane hub-and-spoke type models. And part of what we're thinking now is because the 87 and the 350 are point to point, they are going to more secondary airports. They're not just going into Heathrow and Chicago and Tokyo. And as a result, the airlines are putting more spares into more remote locations and that may be driving some of this additional IP over and above what we historically had thought.

Any last questions?

(Operator Instructions) It appears there are no further questions at this time.

Thank you very much indeed to all our listeners. We look forward to talking to you again at the end of next quarter. Thank you.

That does conclude today's conference. Thank you all for your participation. You may now disconnect.