Woodward Inc (WWD) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your second quarter 2013 earnings call. At this time, all participants will be in a listen-only mode. But later, we will conduct a question and answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference is being recorded. Now I would like to introduce your host for today, Bob Weber.

Thank you, operator. We would like to welcome all of you to Woodward's second-quarter fiscal year 2013 earnings call. In a minute, I'll cover the financial highlights of our second quarter and Tom will comment on our strategies and markets. I will then comment on today's earnings release. And at the end of our presentation, we will take questions. For those who have not yet seen today's earnings release, you can find it on our website at Woodward.com. As noted in today's earnings release, we have included some presentation materials to go along with today's call that are also accessible on our website. An audio replay of this call will be available through April 27, 2013, and the phone number for the audio replay is on the press release announcing this call and will be repeated by the operator at the end of the call. In addition, a replay of this call will be accessible on our website for 14 days.

Before we begin, I would like to summarize our cautionary statement, as shown on Slide 3. In the course of this call, when we present information and answer questions, any statements we make other than actual results or business facts may contain forward-looking statements. Such statements involve risks and uncertainties and actual results may differ materially from those we currently anticipate. Factors that might cause a material difference include, but are not limited to, future sales, earnings, business performance, and economic conditions that would impact demand in the aerospace and energy markets. We caution investors not to place undue reliance on these forward-looking statements as predictive of future results. In addition, the Company disclaims any obligation to update the forward-looking statements made herein. For more information on risks and uncertainties facing Woodward, we encourage you to consult the earnings release and our public filings with the Securities and Exchange Commission, including our Form 10-K for fiscal 2012 and Form 10-Q for the quarter ended March 31, 2013, which we expect to file shortly.

Segment earnings, EBIT, EBITDA, and free cash flow are non-US GAAP operating measures that we use in the earnings release and during this call. A description of these measures and a reconciliation of each to the most comparable US GAAP measure is included in the appendix to our slide presentation and in our earnings release and related schedules, all of which are posted on our website. Management uses this information in monitoring and evaluating the ongoing performance of Woodward and each business segment.

Turning to the quarter, sales for the quarter were $486 million compared to $469 million for the same quarter last year. Earnings per diluted share were $0.61 in the second quarter of 2013 compared to $0.55 for the second quarter of last year. Free cash flow for the first half of 2013 was $46 million, an increase of $64 million from a negative free cash flow of $18 million in the first half of the prior year. Now, I will turn the call over to Tom to comment on our results, strategies, and markets.

Thank you, Bob. And welcome to those joining us today. I'll start with some highlights for the quarter. Operating performance and market share were solid this quarter, reflecting that our lean initiatives are working. Continuing customer concerns regarding future economic strength have affected our first half sales. Airline demand for improved fuel efficiency is driving strong aircraft build rates, and increasing revenue passenger miles support a solid aftermarket business. The market for industrial engines that burn compressed natural gas continues to be strong, but was more than offset by a dramatic drop in the wind market.

Turning to Aerospace, commercial aircraft deliveries showed strong growth in the quarter. Business jets continue to show signs in a slow recovery and rotorcraft and regional jets were stable. Commercial aftermarket sales in the quarter were up sequentially, although down from a strong comparable in 2012. Our Duarte acquisition integration is proceeding as planned. The acquisition is targeted to help our overall strategy, integrated propulsion systems with leading OEMs in the industry. Despite government budget uncertainty, including sequestration, military market segments were solid, notably military aftermarket.

Turning to our Energy markets, compressed natural gas systems, predominantly in Asia, continue to be a bright spot in our Energy business. The need for significant natural gas infrastructure investment in the US and elsewhere remain robust, but the anticipated order growth has been slow to develop. We believe this is still represents of a significant future opportunity for us. The Wind business remains very challenging. In addition to the volatility related to inconsistent US energy policies, we are seeing project delays and inventory management as a result of global economic uncertainty. More broadly speaking, our energy market segments are being impacted by the stagnant global economy. Having said that, though, we are seeing some positive indications across our Energy business for the latter part of this year.

In summary, we continue to invest in technologies and programs that we believe will grow our market share and provide enhanced customer and shareholder value. The global economy presented a challenging first half for Woodward. However, we are beginning to see improved order volumes and other positive signs that we believe hold potential for a significantly stronger second half. Now, let me turn it back to Bob for the financials.

Thank you, Tom. This quarter, I would like to modify our approach somewhat on providing financial information, and focus more on key items of interest, as opposed to largely reciting the press release. I will address my comments as they relate to our two segments, Aerospace and Energy, and then address some Woodward items in total.

Our Aerospace segment's sales for the second quarter of 2013 were favorably impacted by growth in commercial OEM sales and military aftermarket, including the $35 million impact of the Duarte acquisition. Organic sales increased 5% in the second quarter of 2013 compared to the prior year. Aerospace earnings as a percent of segment sales, were 15% this quarter, comparable to the same quarter a year ago. Segment earnings this quarter were positively impacted by the higher sales volumes and lower investments in research and development. Excluding the Duarte acquisition, segment earnings as a percent of sales would have been 17% this quarter. The Duarte business is performing in line with expectations and was slightly accretive in the current quarter.

In our Energy segment, strong sales of compressed natural gas systems in the quarter were offset by a significant decrease of $30 million in wind turbine converter sales. Of this decrease, a portion relates to the impact of the anticipated expiration of the US production tax credit in calendar year 2012. The balance of this decline was unanticipated and reflects general uncertainty with respect to investments in large wind projects. Additionally, softness continued in our reciprocating engine and industrial turbine system sales. As Tom mentioned, we do see some positive signs for the second half. Energy earnings as a percent of segment sales were 11% this quarter compared to 14% in the same quarter a year ago. Segment earnings were primarily impacted by the substantially decreased wind turbine converter sales volume and loss of related operating leverage. This was partially offset by increased pricing and favorable product mix.

Now, I would like to focus on certain specific elements of our consolidated financial statements. Gross margin, defined as net sales less cost of goods sold, was 28.3% of sales in the second quarter of 2013 compared to 31.2% for the second quarter of 2012. Gross margin percent decreased primarily due to the loss in operating leverage associated with the wind turbine converter sales decline. Selling, general, and administrative expenses were $37 million, or 7.6% of net sales this quarter compared to $41 million, or 8.7% of net sales in the same period of 2012, primarily related to the favorable impacts of foreign exchange rates. Research and development costs increased primarily due to the completion of certain programs and lower related material purchases.

Our effective tax rate for the second quarter of 2013 was 15.7% compared to 28.3% for the same quarter last year. After removing the impact of the fiscal 2012 portion of the retroactive R&E credit restatement, the effective tax rate was approximately 26%. Last year's effective tax rate included a reduction related to a repatriation assumption change with respect to China. We expect the full-year effective tax rate to be approximately 27%, which is largely consistent with the prior year.

Looking at the balance sheet and cash flows, free cash flow for the first half of 2013 was $46 million, a significant increase from the prior year when we experienced negative free cash flow of $18 million for the first half. We generated $93 million of cash flow from operations for the first half of 2013 compared to $12 million for the prior year related to higher collection of accounts receivable and lean operational improvements that lowered inventory purchase requirements. Capital expenditures increased to almost $48 million for the first half of 2013 compared to $31 million for the prior year period. We continue to believe capital expenditures for the full year will be about $150 million, but subject to variability as to the timing of major facilities expenditures that can be affected by weather and other factors. We now expect full-year 2013 free cash flow will be approximately $75 million. We had $17 million of share repurchases for the first half of 2013 compared to $14 million in the same period of the prior year. In the first half of 2013, we borrowed an additional $200 million related to the Duarte acquisition and used some of our strong cash flow to repay $40 million of term loan debt during this quarter prior to maturity without penalty.

Lastly, let me turn to our outlook. As Tom mentioned, our first half was challenging and the global economy remains uncertain. Given this backdrop, we now believe fiscal 2013 sales will be between $1.9 billion and $2.0 billion, and earnings per share will be between $2.22 and $2.35 per share for fiscal 2013. This concludes our comments on the business and results for the second quarter of fiscal 2013, and our full-year 2013 outlook. Operator, we are now ready to open the call to questions.

(Operator Instructions)

Julie Yates Stewart, Credit Suisse.

Good afternoon.

Hi, Julie.

So on the outlook, I'm a little surprised that the sales guidance's range did not come down after the first two quarters were disappointing, especially in Energy. Is there an offset elsewhere? And then can you update us on your growth expectations by segment?

On the sales outlook, if you recall on the first quarter when we added Duarte into the mix. I think the comment was made then that must mean you were a little less bullish on the other parts of liver. I think that was true and that's kind of where we're at again at this quarter. The first half, as we said, has been overall challenging.

We mentioned there are some potential bright spots that we're seeing in the second half, and if you look at the mix of the first half to the second half, there's a significant improvement in the second half, which is largely in line with our historical patterns. So not a lot of change from historical pattern standpoint.

We have some -- wind has obviously been the biggest issue for the first half. And you can tell that $40 million for the first half, $30 million of which were in the second quarter. So substantial impact there. There are some potential bright spots that may cause that to come back a little bit. We talked a little bit about the extension of the production tax credit might allow some fourth quarter impacts there and we're hopeful for that.

On a lot of the other areas, I think the Aerospace side of the equation has been growing largely in line in most areas. Commercial after-market, we saw strength in prior quarters. That has modified a bit, but we're seeing good, strong after-market sales in the military side of the equation.

In the Energy side, outside of Wind, we've seen kind of a delay, a pause. The infrastructure growth is a little bit slower than maybe originally anticipated, but we do see that coming on a little bit stronger in the second half.

Okay.

Hopefully that gives you some color there.

Bob, can you quantify how much the commercial after-market was down in the quarter and maybe update us on your outlook for the year, specifically for that market?

Overall, just if we looked at the total, so Commercial Aero, year-over-year was up roughly the 9%. I think we've called out numbers similar to that in the past. And overall, we're at a 3%, growth in Commercial side of Aerospace. So you can kind of work from there, the math on being slightly down, low single-digits sort of range, on commercial after-market.

Okay. Thank you.

Tyler Hojo, Sidoti & Company.

Yes, hi. Good evening, guys.

Hi, Tyler.

I just wanted to follow up to Julie's question. Maybe I can ask it like this. Basically over the last couple of days, we've heard from GE, who lowered their outlook for large gas turbine. Caterpillar lowered their outlook, predicated on mining. And Textron lowered their business jet outlook. And they are all customers of you.

So I, I guess what I'm wondering is, how do we think about that? Were you just being a little bit more conservative? Any comments you could provide would be helpful.

Yes, Tyler, this is Tom. You did see the reports, and obviously those are three of our big customers. I think what we have to look at is that we have factored that type of data into our outlook, and as always, you got to break it down by the market, then by application.

I think what you maybe can pick up from our customers' announcements, as well as ours, the first half of our fiscal year, so the fourth quarter last year and this first calendar quarter, the economy didn't really follow the economic models that we use. And we saw pull-backs. And I think our customer base did, too. And you see a lot of comments that it was pulled back strong, more than anticipated. And I think that, that was the case.

We saw hesitancy, you know, that started in the fourth calendar quarter and I think it was due to fiscal policy, uncertainty around the world, China changing governments, our election in this country, tax policy. We just saw people pull back. And it kind of rolled into the first quarter.

The Wind market, we knew was going to be down, but it's down more than we thought. And we're still continuing. There may be some chance for the end of this year, a pickup. But it was down more than we anticipated.

So you can combine those. We weren't the only ones that, if you want to say, were surprised by the severity or the pullback. But I think there was a lot of non-normal business-cycle type things that were occurring.

Going forward, we still see some pressure on our reciprocating engine business and we have pockets of bright spots, as Bob highlighted, the compressed natural gas area is doing well. But, we serve those mining industries and others, and those are down. The marine market's still down. If you're tracking global logistics and, the marine freight market, you'll see that it's down. So we're feeling that. So those ones came in.

And then on the energy side, it's a couple things. Power generation was down some, but you see oil and gas was flat. And, we expect, as we said in our prepared remarks, we expect to start seeing that order volume, which we are starting to get the orders, picking up in second half of the year and going into 2014.

The Aerospace side, which was interesting, the OEM side was strong, and it's really driven by good programs that we're on and increasing line rates. We saw some pull-back in the after-market -- and I wouldn't call it pull-back. I would call it airlines being conservative on when they were spending their maintenance and repair budgets.

We did get impacted by some of the new aircraft and delays of getting into service. So our initial provisioning sales were down below our plan. Those didn't disappear. They are just pushed out as the aircraft start to be delivered. We expect those initial provisioning sales to materialize.

So that's why we're starting to see second half pick up. So the Aerospace side, we feel is in strong shape. The Energy side, the orders are starting to come in. It will be the latter half of the second half, more like fourth quarter and into 2014, as we start seeing these orders coming back.

Okay. Yes, that's very helpful, Tom. Thanks for that.

Just two quick follow-up questions. In regards to wind inverters, I think you said in the prepared remarks, down $30 million in the first half?

$30 million in the quarter. $40 million in the half.

Okay, and I thought we were talking about down $50 million for the year.

We were. And we're expecting maybe now somewhere closer to $80 million down.

Okay.

So that's a substantial change. And it's just along with, the pull-back because of the -- if you want to say, the acceleration of orders last year to catch the PTC, the lack of orders and getting things online. And then as things dried up, customers are burning off their inventory or they are resisting to take any inventory.

So it's a timing effect, but in our fiscal year, we're getting the brunt of it, beyond -- I think if you want to say, where's the surprise? We knew the production tax credit was going away. We knew we were going to be down. The surprise was the pullback in inventory and how much inventory was spread around the world by some of our customers, that they have actually just backed down on that.

So it won't be until the production goes up that we start seeing orders. And that, as Bob said, we're really thinking fourth quarter and into next year.

Okay. Very helpful. And just lastly for me, I'm just curious if you could give a quick update on the conversion of locomotives that you guys have talked about quite a bit over the last 6 months to 12 months.

There was some press in the Journal about BNSF running a pilot program. Just curious, do you play on that? And have you gotten more optimistic over the last several months?

Well, we play, in all those applications. So we will be present as those materialize. The case for going to LNG locomotive is really compelling. The amount of savings per year for the railroads is huge, and the emission reduction is huge. So, they have a very compelling case to go this way.

The big issue for them is that I think the technology's coming along. The ability to show that the locomotives can be converted is being proven. But there's a lot of regulatory issues the industry still needs to work through and they are working through it quickly.

So we're active in that market. We're going to participate. And it's going to be how quick they can get through all the regulatory issues. And then the major OEMs are going to be -- are preparing for that and I would expect to start seeing it next year.

Perfect. Thanks so much, guys. Appreciate it.

Thanks, Tyler.

Peter Skibitski, Drexel Hamilton.

Hi, guys.

Hi, Peter.

Just on Energy again in the second half of the year, are you expecting it down again in the second half of the year? Just maybe low single-digits instead of high single-digits? What's your thoughts there?

Yes, but on a more moderated scale. So you're right, it won't be down as significantly as in the first half. We are expecting some uptick from this level, but possibly still down from the prior year.

We had a very strong fourth quarter last year and, that is our pattern. And so we're going to be hopeful for that same strong fourth quarter. But we'll see how that goes.

Okay, and I guess it sounds like Wind doesn't really help you in the second half at all. So I guess what you're seeing is a little bit of incremental order flow from the other end markets, maybe you see Power Gen coming back a little bit and Mining a little bit, is that the way to think about it?

That's true. We are kind of holding out hope that Wind may actually show some signs of life in that fourth quarter. But that would be a wild card. So otherwise, I think you're accurate.

Okay, okay. And then I want to ask you about, you had previously stuck with a 14% margin rate guidance for the year in Energy. Is that still the expectation? Or is that kind of pulled in here?

Yes, that would be pulled in a bit. So you can see where we ended up for the year-to-date and the quarter now. We do anticipate an improvement from there.

And I would like to point out that when you take out the impact of the Wind decline and the, I'll call it reverse leverage, that that's giving us, there is, some nice pockets of profit improvement going on in the rest of the business. We do anticipate that will come back a little bit. And we won't be that far off of that target by the time we get to the end of the year.

Okay. So pretty close to 14% for the full year? Not for the full year, but for the second half of the year?

No, for the full year, pretty close to that number.

Okay, okay. Got it. Got it.

And then, guys, the other thing I wanted to ask about, we had this military sequestration that's happened now for fiscal 2013. It sounds like you're not feeling it at all, as of yet. Do you get any indications at all that, that you may be impacted in the second half of the year from sequestration? And maybe you could give us a sense of what your expectations are for growth in military in H2.

Yes, I don't think you're going to see a huge impact. It will probably be relatively flat. But it may surprise everyone on the call, but overall, for the year, we'll probably be up low single-digits year-over-year.

A lot of that is, it's how the budgets are put in place, the repair and overhaul of the fleet that's going on, those type of things are still coming through. Our long-term belief is that Military will be hovering around flat as we look out over the next number of years. You know, it could go plus or minus a little bit over flat, a couple points. But that's our expectation with the portfolio we have.

And what we see in the defense budgets and the activities that we participate in. I think you can just kind of plan for that this year. A little up this year, but basically flat going into the next couple of years.

Tom, is precision guidance, in maybe both US and international, has that been a big pocket of strength for you this quarter and going forward?

You know, that's been good still, but I have to tell you, one of the biggest areas for us was Military after-market. And when we say that, what that really means is getting, especially Rotor Craft, they had heavy use in the wars that are still going on, and that's been probably the biggest pocket of strength.

Okay, great. Thanks, guys.

William Bremer, Maxim Group.

Good evening, Gentlemen.

Good evening, Bill.

Most of my questions have already been answered. You've provided some very good color.

You mentioned increased pricing across both segments. Can you elaborate on that? Where are you seeing some pricing there?

Well, Bill, when we can get price realization, we try to accomplish that. At the same time, there's a lot of pressure from customers trying to work you the opposite direction. So it's a combination of just working value and ensuring that where we can get price, we get it. So it's kind of that general. So we do what we can and we did accomplish some in first half.

And what type of look-through do you have in terms of your Energy segment right now? How far out are you starting to see some things percolate? You mentioned the back half of this year, but how does 2014 look?

My belief is that you'll see our Energy segment improving through the second half of this year and then continuing to improve as we go into 2014.

Okay. That's all I got. Thank you.

Great.

Peter Lisnic from Robert W. Baird.

Good afternoon, Gentlemen.

Good afternoon.

I guess first question on Energy, if I look at the op margin, at least on a sequential basis, revenue up, but margin down, so can we ascribe all that to the wind absorption hit? Is that right? Or is there something else in the mix? I would have thought margin would have been a little bit stronger if it was just Wind, and if the mix from Wind is negative.

Well, I think we've said from time to time that the Wind mix isn't as negative as, I think from time to time, has been ascribed to it. So it is, largely that's the impact.

As I mentioned, I think from the rest of the business, we've actually seen some profit improvement. I'm not going to use grandiose terms, but some nice movement in profits on both the Industrial Turbine side and the Reciprocating Engine side. But that was totally offset by the Wind.

Okay. All right. As you look to the back half, I may have missed this, but sounded like you said around that 14% margin is maybe not going to be there, but kind of close. But that would require a pretty significant step-up in the face of another $40 million volume headwind that you've got in the back half from Wind. How do we reconcile the margin acceleration off of the first half and then the back half with still another big hit from Wind in the back half?

So a lot of the efforts, and we've been talking about them from time to time. You heard us last year talking about a lot of investments in manufacturing and lean and everything else. Obviously, those are gaining strength.

So as we saw some impact in the first half and largely in the second quarter, we expect that to continue now and see more benefit relative to the first half in the second half. So we also, as Tom mentioned, just a couple of areas where we hope for some increased natural gas infrastructure sales, et cetera, and so that may counteract some of that Wind decline.

Okay. All right. If I could switch to Aero, on the biz jet side, it sounded like the commentary there was modestly positive signs of recovery, I guess. Could you give us a little bit more flavor as to where that is occurring?

Pete, I'll highlight. One thing to recognize is, we are on substantially all the major large biz jets. And the large cabin biz jets are doing okay.

And then you start going into the super-mid-size and they are recovering. It's really the light jet market -- the light, and they are called light-, small-, and then the mid-, are under the most pressure. And so it's, again, the split of the market.

So if you get super-mid-size and above, the market is doing, recovering well. Below that mid-size are still under a lot of pressure and the small- and light- are really under pressure. So that's the mix. We have good representation and that's where we're starting to see some recovery.

Got it. Okay, that's helpful there. Last one, going back to Energy, I understand, it may be picking up or signs that 2014's going to look better, back half's going to look better. Could you give us a little bit of color or flavor as to what's happening in the backlog?

I'm wondering if you're seeing any sorts of things get pushed out, any sorts of significant cancellations? Just kind of the quality of the backlog, if there's any commentary you could give along those lines, I think it would be helpful.

Sure. I look at why I feel, why we feel that way on the book of business, and also as it ties to the margin, is we're starting to see on our turbo machinery business, we're starting to see orders picking up. And those have a long lead time, we're getting the orders coming in. We see some very large projects, come have been announced, some are going to be announced shortly, that have real good content for us, real good potential. So we start seeing that pick up. And those will kick in towards the latter part of this year and roll into next year.

We're starting to see some improvement in our Large Reciprocating Engine business. We had quite a drop-off in the first half of the year that we talked about, some beyond our expectations. We are starting to see some of the orders come in. We're use our faster-cycle businesses are starting to see orders pick up. So that's a good indication of how the longer-cycle businesses follow.

So we do believe the outlook for 2014, in our mind, has changed a little bit and it's actually improving. So in some ways, as we said, some of the issues in the economy occurred earlier than people had planned, earlier than we had planned and now we're starting to see things coming back.

And the order book, you asked about backlog, but the order book is supporting the increase. The one that's the most volatile is the Renewable business and that one we're being very cautious on, looking forward. But I do expect going into 2014 that to pick up as well. But that one's been very volatile, as you all know.

Okay. And then what about the Electrical business, within Energy?

Electrical is also down. You know, the power management controls were a little soft in the first half. We're starting to see orders increasing there as well. So it's kind of following the same pattern that I just discussed. And it was down below our expectations first half, starting to get the orders filling in. I would anticipate that those will continue and ramp into 2014.

All right. I got it. Thanks for the color. I appreciate it.

Sure.

Thanks, Pete.

Sheila Kahyaolglu, Jefferies.

Good afternoon.

Hi, Sheila.

Can you provide an update on the Duarte acquisition and maybe where you are in finalizing the contents, content per aircraft there?

Sure. We're actually very happy with where we are at this stage. We've had, we've owned it for maybe, what, 105, 110 days?

It's on plan. The integration's progressing. We talked about the significant narrow body orders of the future that we have, those programs. We're getting our arms around the development efforts and some of the activities there.

The final configurations are still being worked out, but what I will do is we'll commit to you that at our December investor meeting, we will provide dollar content per application for all the narrow body programs, the new ones, and the new aircraft. I think at that point, I think things will be a little bit more stable in the development programs and we can have some confidence to give those numbers to you. So we will be providing.

But right now, what I can tell you is that programs are going well, development, we're really heavy in development right now in all the narrow body, but as well in Duarte. Integration is progressing well. So far, we're on the plan we laid out when we bought it. So we're feeling good after a little over 100 days. We still got a lot to do, but it's progressing well.

Got it. Thanks. And then I might have missed this, but in terms of your revenues grew 4% in the quarter, but CGS grew 8%. What drove that increase?

Well, a lot of that is the impact of that reverse leverage. So the big -- if you kind of take a, call it a standard flow-through on the $40 million and assume most of that all takes place at the gross margin level, you will find, and I think we commented on this, that it's largely in line. There really isn't that big a difference in the overall gross margin percentage when you back out that impact.

Thanks.

Really it was almost entirely related to that.

Okay, got it. My last one for me is, after-market utilization within Energy. Can you maybe provide some color on what you saw there? And any geographic color would be great, too.

I would say on that, the big, I think if you want to say, the after-market driver, has been a large increase in the utilization of the installed natural gas turbines and natural gas engine fleet. So we put more hours on it. We are seeing more spare parts being ordered and we are seeing some replacement.

So definitely a higher utilization of the install base, and that's been a positive. I would have to say that's one of those pockets of bright spots that we had. And I anticipate that's still going to continue with the price of natural gas. You're seeing a much higher utilization and higher percent of the total power generation market. So we are seeing that flow through in parts.

Great, thanks.

Michael Ciarmoli, KeyBanc Capital.

Hey, good evening. Thanks, guys. Thanks for taking the questions.

Sure.

Just to maybe follow up on the Duarte. I think you said ex- the acquisition margins were at 17%. How should we think about the Aerospace margins?

I that a function of just digesting some of the purchase accounting and step-ups still? Or are we looking at margins in and around this 15% range going forward?

One comment I'll make, and I'll turn it back to Bob. I just want to highlight that for the last couple of years we talked about improved margins occurring in our Airframe Systems business. If you set aside the acquisition, and we had a lot of step-ups, and other things that occurred in the second quarter.

But if you take a look at it, we are seeing improvements. Airframe Systems is continuing to prove its profitability, and our Turbine Group is continuing to manage a huge R&D load while keeping profits up. And so we anticipate this to continue as we go forward. And we still support our higher, longer-term target of 20% for the segment.

So what I would say is that's the progress occurring. Obviously having Duarte in the quarter and the like, and the first quarter as you're working through all the accounting, it impacted us there. But it looks like a solid contributor to our Aerospace segment.

We didn't, as Tom mentioned, we did have the inventory step-up issue that you always have in the first quarter. It was not anywhere near as significant as some of the past. So we chose not to highlight it. But it did absorb that and was still accretive in the quarter. That's a good sign and portends well for the remainder of the year for us.

I'm just looking at that back half guidance and the margin assumptions at the corporate level. I mean, if Energy stays kind of pressured, it seems like Aerospace should be able to get into the 16.5% range fourth quarter. Is that the right way to think about this?

Yes, without commenting specifically on the number, it will improve, yes.

Okay.

That's true.

Fair enough. Perfect.

And then, Bob, on the tax rate, I guess you had been looking at 28%, 29% for the year. Now you're at 27%. Was that just a function of the R&D tax credit being a little bit better than anticipated, or is there anything else going on there with taxes?

Largely, that is true. There's always a US, non-US, where's the income earned, kind of impacts to those things. That's what causes it to move around a bit. We were really trying to highlight that when you took out that retroactive impact, we're largely in line with where we are most of the years here.

Okay.

So it's pretty consistent from that standpoint.

Okay. Perfect. And then just one last one, on the after-market, Tom.

Looking at some of the trends that surface at the MRO Americas Conference last week, the influx of surplus parts from all these aircraft retirements seem to be putting some pressure on after-market activity at the new-part level. I mean, how are you guys looking at that?

You've got a lot of content on the engines. What would be considered some of the high-valued resalable content that comes off those retired aircraft? Is that creating headwinds in your business? Creating more difficulties forecasting the business?

Well, it definitely will have a little impact on forecasting. Probably the fleet that we're most closely monitoring and watching is the 737 classics.

Okay.

It's a very large fleet. We derive good revenue from that fleet. They are starting to park in part some of those, but not in great numbers yet. So as we move forward, not compared to, if you're looking at the old McDonnell Douglas aircraft or the MD 80s and the like.

Sure.

We're monitoring that very closely and watching and trying to build that into all our forecasts. What I would tell you is our incoming repair and overhaul pipeline, the volume of incoming units, has been increasing in the last month and moving forward. We're forecasting good after-market, or repair and overhaul incoming.

We have had some pressure. Just going on the after-market, some pressure, and I want to highlight sales, the initial provisioning, as there has been some difficulty with the 787.

Right.

-- 47, A380, those aircraft are going to get into service. They are going to need their initial provision spares. It's just they have -- airlines aren't spending the money until they really have those aircraft in their fleet. So that's been a little of the pressure as well.

We have to really watch that 737 classic fleet. That's where we'll see potential problems with parting out aircraft and what that will do to our after-market. But we're monitoring it.

Okay. Perfect. That's helpful. Thanks a lot, guys.

Thank you.

(Operator Instructions)

Peter Skibitski, Drexel Hamilton.

Hey guys, just a few short follow-ups. On Duarte, the $35 million in revenue for the quarter, is that kind of a run rate for this firm? Is it kind of a $140 million business? I feel like I've been up and down in terms of what the level of that business should be.

Yes, we had, I think, a little confusion over the three quarters of a year that will be included this year for us. So, yes, the annual is roughly that $140 million. Not to hold that too tight.

And I think then everybody kind of focused on $110 million would be included in our fiscal year this year, and roughly $35 million in the quarter. So you can see subject to normal quarterly variability, it's largely on track with that.

I see, okay. Okay.

And then the SG&A and the R&D spend down for this quarter, was that deliberate? Trying to be disciplined on those two fronts? Or was it all what you said in SG&A? I think you mentioned some FX -- ?

Yes, clearly, we have talked about initiatives to watch, obviously, the spending. When you're not delivering the same level of sales that you originally anticipated, you're kind of watching how things go towards that. So that was an element of it. But the foreign exchange, also an element there. We will continue that as we go into the second half.

On the R&D, conscious, from the standpoint of programs do fall off from time to time. And a lot of times there's material purchases that go into those programs that you're also not purchasing anymore. And so the cost comes down a bit.

All right.

So nothing that we anticipate will be a continuing trend. I think we're still within a reasonable range of where we targeted for the full year. So, more quarterly variation than anything.

Okay. Got it, got it. And then as the last one.

Bob, did you say you bought back about $17 million worth of shares this quarter? Did I hear you right?

Yes, I did.

Okay, and should we see share count then decline in the third quarter? Or is that just offsetting options creep?

Very hard to say. We do not have a formal standard program. So it's more opportunistic, so we'll kind of watch the way the market plays out and go from there. Impossible to say at this point.

Okay, okay. Thanks, guys.

Okay. Thank you. Mr. Gendron, there are no further questions at this time. I will now turn the conference back to you.

Okay. Thank you. Well, appreciate everybody joining us today, and appreciate your questions. Look forward to seeing you over the next quarter. Thank you.

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