MOG.A (MOG.A) Q4 2018 Earnings Report, Transcript and Summary

Good day, and welcome to the Moog Fourth Quarter and Year-end Earnings Conference Call. Today's conference is being recorded. [Operator Instructions] And at this time, I'd 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 November 2, 2018, our most recent Form 8-K filed on November 2, 2018, and in certain of our other public filings with the SEC. We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our Investor Relations website at www.moog.com/investors. John?

Thanks, Ann. Good morning. Thanks for joining us. This morning, we will report on the fourth quarter of fiscal '18 and reflect on our performance for the full year. We'll also provide our initial guidance for fiscal '19. As usual, let me start with the headlines for the quarter. First, it was a good quarter for our operations, with sales up 8% versus a year ago and adjusted earnings per share of $1.28, up 20% from last year and above the high end of our guidance from 90 days ago. Free cash flow conversion was approximately 80% in the quarter. Second, our portfolio refinements continued this quarter. We completed the exit from the wind pitch control business and took a net charge of $4 million. We also took a $2 million charge associated with the sale of a small European operation in our Space and Defense group. And third, we're providing a first look at fiscal '19 today. We anticipate sales growth of 6% to $2.88 billion and earnings per share of $5.25, plus or minus $0.20, a 15% increase over our adjusted numbers for fiscal '18. As we reflect back on fiscal '18, the following headlines stand out: First, it was another year of technical achievements in a variety of end markets. Examples include the successful first flights of the Bell V-280 Valor helicopter, the entry into service of the Embraer E2 airplane and the success of our new reconfigurable turret system in several military vehicle programs. It was also a good year for our operations. Sales were up 8%; and earnings per share, adjusted for tax reform and the wind restructuring, came in at $4.57, ahead of our adjusted guidance of $4.40 coming into the year. Third, we completed the strategic review of our wind pitch control business, and after several years of investments, decided to exit the business. Fourth, we made 2 bolt-on acquisitions during the year, adding a large motor company in the Czech Republic to our industrial group and a UAV tracking software company to our Space and Defense group. Combined annual sales of these acquisitions in fiscal '19 will be about $50 million. Fifth, we initiated a quarterly dividend in the second quarter, the next step in our strategy of ensuring improvements in the management of our shareholders' capital. This decision reflects our confidence in the long-term future of the business. And finally, we fully funded and derisked our U.S. DB pension plan. We should not have to make any further cash payments into this plan for the foreseeable future. Overall, fiscal '18 was a good year for our company. Each of our operating groups grew in sales, and the adjusted operating margin was up nicely. As I do at this time each year, I'd like to express my thanks for the dedication and commitment of our 12,000-plus employees around the world that made all this happen. Now let me provide some more details on the quarter. Sales in the quarter of $701 million were 8% higher than last year, and sales were up in each of our operating groups. Taking you through the P&L, our gross margin was down on an adverse mix in our aircraft business. R&D was down on lower spending in commercial aircraft programs, and our SG&A expense was also down as a percentage of sales. We incurred $9 million of restructuring expense in the quarter, mostly due to the close-out of our wind exit strategy. Interest expense was up slightly on higher rates. Our effective tax rate in the quarter of 26.7% included some residual adjustment for U.S. tax reform. Including the restructuring charges and the tax adjustments, the overall result was net earnings of $41 million, up 5%; and earnings per share of $1.14, up 7%. Excluding restructuring and the onetime tax adjustments related to tax reform, net earnings were $46 million and earnings per share were $1.28. For the full year of fiscal '18, sales of $2.71 billion were up 8% over last year. The story for the year is similar to the story for the quarter, with sales up in each operating group. Underlying organic growth was $160 million. Acquisitions, net of divestitures, contributed about $20 million, and stronger foreign currencies added another $30 million or so. As we've discussed in the past, the results for fiscal '18 are complicated by the change in the U.S. tax law and the restructuring expense associated with the exit from the wind business, and exclusive of these onetime effects, operating margin was up 90 basis points and net earnings and earnings per share were each up 17%. Free cash flow for the year of $8 million included $85 million of accelerated contributions to our U.S. DB pension plan. For fiscal '19, we're projecting continued organic growth, with sales of $2.88 billion, up 6%. Sales will be up in Aircraft, and growth will be particularly strong in Space and Defense. Industrial sales will be about flat with fiscal '18, but adjusting for the lack of wind sales, it will be up 4% organically. We're anticipating full year operating margins of 11.7% and earnings per share of $5.25, plus or minus $0.20. Free cash flow next year should could come in at 100% conversion. Now to the segments. I'd remind my -- our listeners that we've 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 fourth quarter of $304 million were 7% higher than last year, with all of the increase on the military side of the house. Sales on the F-35 program were up almost 50%, a combination of increased volumes on LRIP-11 and the timing of some deliveries. Sales in the military aftermarket were also higher across the range of programs, in particular, the B-1B, the F-18 and the V-22. On the commercial side, OEM sales on the 787 and the 350 were in line with last year, while newer OEM sales to Boeing on the 777 were partially compensated by higher aftermarket sales on the A350 program. Full year fiscal '18 sales for Aircraft were up 6% to $1.19 billion. Military aircraft was up 10% year-over-year. We saw strong growth in the F-35 program as Lockheed Martin continues to ramp up production. Sales were also higher on the KC-46 Tanker and in our navigation aids business as well as in some foreign platforms. We also enjoyed increased work on funded development programs. The military aftermarket was marginally higher, as additional F-18 repairs and spares activity compensated for lower B-2 sales. On the commercial side, OEM sales were 3% lower. 777 deliveries were off almost 50% from fiscal '17, and we also saw lower volumes on legacy 737 platforms. On the positive side, 787 sales were up as we prepare to increase the rate to 14 chipsets per month, while A350 sales were in line with last year. The commercial aftermarket had a great year, driven by strong A350 initial provisioning, retrofit activity on some aging platforms and an increased focus on capturing market share. For fiscal 19, we're projecting sales of $1.27 billion at Aircraft, a 6% organic increase over '18. Similar to this year, most of the growth is on the military side, with continued ramp-up on the F-35 program and higher sales in some foreign platforms, compensating for a softer helicopter book of business. The military aftermarket should also be up on increased F-35 and V-22 activity. We're forecasting higher commercial OEM sales, driven by our flagship programs, the 787 and A350. And we'll also see the initial ramp on the Embraer E2 program. Sales on the legacy Boeing book will continue to decline as the older models are gradually phased out. We anticipate that the commercial aftermarkets will be lower as initial provisioning declines from a boom year from fiscal '18. Margins in the quarter were 10.2%, and for the full year, were 10.8%. These margins are up 70 basis points from fiscal '17. We anticipate a further increase in margins by 60 basis points in fiscal '19 to 11.4%. This continues the trend of expanding margins over the last few years. The margin improvement in fiscal '18 was driven by lower R&D spending on commercial jobs, but this benefit was eroded somewhat by higher investment in new business capture as well as a lower gross margin on the negative mix. As we look out to fiscal '19, R&D will be down slightly from fiscal '18, as it continues to converge on our 5% long-term target. Switching now to Space and Defense. Sales in the fourth quarter of $154 million were up 10% from last year. We had nice increases in both the Space and Defense markets. Space sales were up on increasing work on NASA programs, both the Space Launch System and the Orion Crew Vehicle; while defense sales were up on strong, tactical missile work, good growth in Navy programs and acquired sales from our acquisition of EOI, a small UAV tracking company. The story for fiscal '18 in total is similar to the story for the quarter, with overall growth of 10%. Our space avionics had another great year, with sales up over 60%. Sales in this product line have more than doubled in the last 2 years as we gained positions on new defense satellites. Sales across the full range of launch vehicles were also very strong. On the Defense side, the bright spots were missiles, included -- including funded development work on new hypersonic opportunities; security systems, including acquired sales from EOI; and various components for a range of end users. Our military ground vehicles was a tale of two cities. Lower sales on legacy platforms were mostly compensated by increased sales of our new reconfigurable turret system. Our initial forecast for fiscal '19 projects strong growth. Defense sales will be up 25%. Sales on missile programs will be up over 30%, a combination of higher rates on existing programs and initial production on new platforms. We'll also increase naval sales on the Virginia-class submarine. Sales on military vehicles will be significantly higher, driven by our new turret offering. This is a new product for us and is part of our strategy to meet the needs of the forces directly, with tailored products for specific requirements as part of our agile prime strategy: to invest selectively internally, to develop capability and then respond quickly to urgent needs in the field. This product has been in development for about 5 years and had initial sales of about $3 million in fiscal '17. In fiscal '19, we're projecting sales of over $50 million. On the Space side, sales next year will be up 3%, with slight increases in our work on a range of launch vehicle systems. Margins in the quarter were 11.2%, and for the full year, 11.5%. And for fiscal '19, we're projecting an increase in margins to 11.8% on the higher sales. Turning now to Industrial Systems. Sales in the fourth quarter of $243 million were up 8% over last year. The increase is split approximately 50-50 between organic and acquired growth. Our energy market was about flat with last year, and we've essentially completed the wind-down of our wind pitch control business and shipments of those products will be negligible next year. Industrial automation was up nicely in the quarter as our major markets around the globe continue to invest in new capital equipment. Sales into simulation and test applications and for medical applications were up modestly from last year. Full year fiscal '18 sales of $935 million were up 11% over last year. About half of the gain is organic growth and the remainder is split evenly between acquired growth from our 2 acquisitions over the last 18 months and stronger foreign currencies relative to the dollar. Our energy markets were strong this year, with increases in both exploration and generation. Industrial automation was also strong on the foundation of strong global GDP. Sales of simulation and test systems were about flat with last year, while sales into medical applications, both components and pumps, were up nicely. Looking to fiscal '19. We're projecting flat top line sales as we move into next year. This is a result of 4% organic growth compensating for the loss of about $40 million in wind energy sales. Sales into industrial automation markets and for medical applications should be up about 5%, while we anticipate a flat year for simulation and test. Adjusted margins in our Industrial Systems business in the quarter were 12.1%. That excludes the restructuring expense associated with our exit from the wind business of about 200 basis points. Margins for the full year, excluding the wind exit charges, were 10.6%. And for fiscal '19, we're forecasting margins to increase to 12%. About 100 basis points of this improvement is a result of the decision to exit the wind business in '18. Summary guidance. So fiscal '18 was a good year operationally, and we're looking forward to building on that performance as we move into fiscal '19. We're forecasting full year sales of $2.88 billion, up 6%. Our Aircraft group should see nice growth on the military side as the F-35 continues to ramp and the aftermarket recovers. The commercial OEM business will also grow, fueled by the A350 ramp, but we anticipate the commercial aftermarket will be down from a bumper year in fiscal '18. In Space and Defense, we're seeing strong growth in our military sales. And finally, the headline sales number in Industrial is flat with last year, as 4% organic growth compensates for the lack of wind pitch control sales. We're forecasting earnings per share of $5.25, plus or minus $0.20, a 15% increase over our adjusted '18 results. As always, our forecast does not include any projection for future acquisitions or share buyback activity. We anticipate strong free cash flow generation in fiscal '19, and we'll continue to manage the shareholder capital prudently. We continue to look for bolt-on acquisitions, which support our organic growth strategies, but we remain disciplined in our evaluation and will not acquire top line growth at a price level that prohibits earning an acceptable return on our capital. Our dividends and buyback policies provide ample opportunities to return capital to shareholders, should we not find the right acquisition opportunities. We're patient and believe that growth is an essential ingredient to long-term value creation. And as our R&D spend winds down on large commercial programs, we're redirecting some of our resources to exploring new, innovative solutions to the technical challenges our customers will face tomorrow. From additive manufacturing to next-generation robotics to autonomous systems, we're exploring the next generation of opportunities for our capabilities. As always, our focus will remain on driving long-term value for our shareholders. I'll finish my comments as I've done in previous years, by looking at our business through the lens of the end markets we serve. These are defense, industrial, commercial, energy, space and medical. Defense is our largest market, over 1/3 of our sales. Over the last year, we've seen the benefit of the increasing U.S. Defense budget as sequestration has been temporarily put on hold. We anticipate continued strength in fiscal '19 in both existing programs like the F-35 and in new application areas such as our reconfigurable turrets and counter-UAV systems. Our funded military development work in fiscal '18 was over $150 million as we work on the next generations of weapons platforms across the portfolio. Despite the short-term worries in the industry about defense budgets dropping significantly beyond fiscal '19, this funded development work demonstrates that we're well positioned for the very long run. Sales into various industrial markets represent our second largest market at about 1/4 of our sales. This market has recovered significantly over the last 18 months or so as global GDP has strengthened. We believe this strength will continue in fiscal '19, despite the increasing interest rate environment in the U.S. and the threat of tariffs. Longer term, our industrial markets are cyclical, and we remain vigilant in these good times to continue to structure the business and control costs to ensure maximum returns throughout the cycle. Commercial aircraft is also about 1/4 of our sales and has been an engine for organic growth over the last 15 years as we invest in the 787, A350 and E2. Over the last 5 years, the primary focus of this business has shifted from R&D spending to certifying new airplanes to operational execution as deliveries have ramped up. Fiscal '19 will continue this trend as R&D again falls as a percentage of sales and volumes of new programs continue to build. This trend should continue for several years to come, and the aftermarkets of these new programs will continue to grow. We're experiencing a margin headwind as volume on some of our older platforms, in particular the 777, wind down. This will continue until the program comes to an end in the next few years. We don't anticipate any major new wins in the foreseeable future and are therefore confident that the R&D load will continue to abate, resulting in continued margin expansion. Our energy, space and medical markets each represent less than 10% of our sales. Putting aside our wind challenges, fiscal '18 was actually a positive year for our energy markets. In particular, our exploration sales improved from a low point in fiscal '17 and are forecast to see further modest improvements in fiscal '19. The recovery in the price of oil over the last couple of years has helped put this business back on a solid footing. Our space business was up a healthy 15% in fiscal '18, and we're projecting modest growth into fiscal '19, driven by increasing sales on a variety of launch platforms. Sales of our avionics products have doubled over the last 2 years and are set to continue strong into next year. Finally, our medical market grew 9% in fiscal '18 and should grow an additional 6% in fiscal '19. We anticipate stronger sales for both our pump products as well as components sold to medical OEMs. In summary, as we close out fiscal '18, the majority of our key markets are healthy, and we're looking forward to a strong fiscal '19. Our fundamental strategy remains unchanged. We work closely with our customers to solve their more difficult technical challenges. We look for applications where performance really matters, where the cost of failure is high and where our technology offers real differentiation for our customers. We continue to serve a diverse range of markets, with a focused set of technologies built around precision motion and fluid control. We look for adjacent acquisitions to complement our organic growth strategy, and we remain focused on 3 corporate-wide initiatives: talent, lean and innovation. Our key financial measures are sales growth, margin expansion and free cash flow generation. We look to invest our shareholders' capital wisely, always with a view to long-term value creation. Our preference is to invest in organic growth, first; followed by strategic acquisitions; and lastly, on returning capital to shareholders through dividends or buying back shares. We continue to operate with a conservative balance sheet, using leverage prudently to balance returns with financial resilience and flexibility. As I said before, in fiscal '19, we anticipate sales of $2.88 billion and earnings per share of $5.25, plus or minus $0.20. And as usual, we anticipate a somewhat slow start to the year, with Q1 earnings per share of $1.15, plus or minus $0.10. Now let me pass you to Don, who will provide more color on our cash flow and balance sheet.

Thank you, John, and good morning, everyone. Free cash flow in the quarter was $32 million. For all of 2018, free cash flow was $8 million, and that includes $85 million of incremental funding to our U.S. defined-benefit pension plan. This compares with net earnings in 2018 of $97 million. To keep this in perspective, I'd like to share 2 points. First, despite a relatively soft 2018, our free cash flow conversion has averaged 114% into 2012. And second, we'll see a noticeable rebound in 2019. Coming into Q4, we were forecasting a better free cash flow finish to the year. The shortfall is explained by a combination of net working capital demands and tax refunds. Our net working capital as a percentage of sales actually came down 30 basis points from 90 days ago. In hindsight, we were simply too optimistic in forecasting a more significant reduction. We were also expecting that certain tax refunds would be received before year-end, but they slipped into 2019. As we look ahead to 2019, we're expecting free cash flow of $185 million or a conversion ratio of 100%. Our forecast is helped by lower ongoing pension contributions because of our accelerated funding strategy and by the tax refund that we thought we'd receive in 2018. However, our long -- our outlook is tempered by an anticipated decline in customer advances, in addition to more working capital needed to support our top line growth. Our year-end net working capital, and that excludes cash and debt, as a percentage of sales was 24.9% compared with 25.2%, both last quarter and a year ago. Over the better part of the last decade, we've reported a rather steady decline in this working capital metric since we peaked at almost 34% of sales in 2009. In 2019, we believe we'll see a continuation of this trend. The $8 million of free cash flow for the year compares with an increase in net debt of $148 million. The $156 million difference relates primarily to the following: We repurchased 1 million shares of Moog stock at $75.74 per share from our DB pension plan, completing our de-risking strategy. We've spent $70 million for acquisitions that we completed earlier in the year. And we paid $18 million for 2 quarterly cash dividend payments that began in June. Capital expenditures in the fourth quarter were $24 million, and depreciation and amortization totaled $20 million. For all of 2018, CapEx was $95 million, while D&A was $89 million; and in 2019, it will look nearly identical to 2018 as we're forecasting $95 million in CapEx and D&A of $89 million. We believe that our normal sustaining level of CapEx is between 3% and 4% of sales, and in 2019, our spend rate will be within that range. Cash contributions to our global retirement plans totaled $6 million in the quarter, resulting in $181 million of contributions for all of 2018. This compares with $93 million in '17. We've described how we accelerated a total of $85 million of contributions into our U.S. DB plan from future years into 2018. This resulted in total 2018 contributions to our U.S. DB plan of $145 million. 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 plan for the foreseeable future. For 2019, we're planning to make contributions into our global retirement plans totaling $34 million. Global retirement plan expense in 2018 was $57 million compared with $64 million in '17, and in 2019, our expense for retirement plans is projected to be $62 million. I'd like to explain why we're expecting our global pension expense for '19 to increase compared to '18, after having accelerated $85 million of funding to the U.S. DB plan. This may sound counterintuitive since having more assets in the plan should, in isolation, result in a greater return, and therefore, less expense. However, we contemporaneously pursued a derisking investment strategy that resulted in more of our planned assets being invested in lower-risk instruments with lower returns. This liability-driven investment strategy lowers the overall return on all plan assets and offsets the benefit of having more assets in the plan. The derisking strategy was absolutely the right thing to do, particularly, because of the limited availability of related tax savings in addition to mitigating our exposure to the volatile equity markets. Importantly, our future U.S. DB plan expense will be a noncash cost. Part of the U.S. DB plan's derisking strategy involved the plan trustees' desire to further diversify the plan's assets that total about $900 million. Accordingly, in August, we were able to buy back the pension plan's holdings in Moog stock, which totaled about 1 million shares, for just under $76 a share. This resulted in 1 million fewer shares outstanding for EPS purposes. The plan now has about 80% of its assets invested in fixed income securities and about 20% in a diversified portfolio of equities. This portfolio mix reduces future volatility on the P&L. Our Q4 effective tax rate of 26.7% compares with last year's Q4 tax rate of 20.8%. Last year's low rate was affected by a benefit related to the utilization of a net operating loss for a business restructuring that took place earlier in the year. For all of 2018, our effective tax rate was 47.4%. And when we remove the onetime effects of tax reform and wind restructuring in 2018, our adjusted 2018 effective tax rate related to our core operations was 25.1%. The unadjusted GAAP effective tax rates for 2017, '18 and '19 are 22.7%, 47.4% and 26.0%, respectively. For both 2018 and '17, these rates are affected by special events that won't repeat. These events included the 2018 impact of onetime effects from tax reform as well as business restructurings and divestitures in both years. Removing all this confusion, the comparable tax rates for 2017, '18 and '19 are 30%, 25% and 26%, respectively. The decrease from 2017 to 2018 is largely the result of the reduction in the U.S. corporate tax rate from 35% to 21%. The increase from 2018 to 2019 results primarily from the timing of when certain elements of the tax reform legislation take effect, which are offsetting the full year benefit from the lower 21% corporate tax rate. Specifically, beginning in 2019, the new GILTI tax on offshore earnings as well as reduced federal domestic manufacturing credits will negatively affect us. To reiterate, we're forecasting 2019's tax rate at 26%. Our leverage ratio, and that's net debt divided by EBITDA, was 2.2x compared to 1.8x a year ago as we allocated capital to accelerate our pension funding, buy companies and pay dividends. The net debt as a percentage of total capitalization was 38%, up from 33% last year. At year-end, we had $437 million of available unused borrowing capacity on our $1.1 billion revolver and that terms out in 2021, and our $300 million of 5 1/4% high-yield debt matures in 2022. Three quarters ago, at the end of December 2017, we had just under $400 million of cash in our balance sheet, and most of that was offshore. At the end of September of 2018, our cash balance is down to $126 million. We used $64 million of this cash for our second quarter acquisition of VUES Brno, headquartered in Czech Republic. In addition, over $200 million of this decrease results from our treasury team doing a great job in orchestrating the repatriation of offshore cash to the U.S., which has been used to pay down our outstanding revolver. We're targeting to get to a cash balance of around $85 million in the coming few quarters. This cash repatriation has no impact on our leverage as our net debt position is unchanged. As far as the associated interest savings from paying down our debt, it will not be apparent on our P&L in 2019. Interest expense for 2019 is forecasted to be $37 million compared to $36 million in 2018, the result of higher rates on a lower outstanding balance. There are 2 accounting changes that we've incorporated into our 2019 forecast that don't have a material impact on the numbers. First, we will adopt ASC 606 for revenue recognition in 2019. Our 2019 forecast reflects our best estimates of what the results will be under the new accounting rules. We wanted you to know that we believe that our comparability is not materially affected. The second change is the new presentation of pension expense as required by the new standard. Beginning in 2019, we'll now be showing nonservice-related pension costs below the operating profit line. We estimate this below-the-line element of pension costs to be $13 million in 2019 compared with $7 million in 2018. 2018 was a noisy year with tax reform and wind-related restructuring activities, and we did our best to help the investor focus on core earnings from operations, which reflect what we believe was a respectable year. We're anxious to begin 2019. Sales will be up 6% organically, with an EPS midpoint of $5.25, up 15% when compared to adjusted 2018 EPS of $4.57 a share. Operating margins will be 11.7% compared with adjusted margins in 2018 of 10.9%. Free cash flow will return to a more normal 100% conversion, and we'll continue to responsibly deploy capital, including our disciplined search for strategic acquisitions. The business is doing well, and we're looking forward to the future. And with that, I'd like to turn you back to John for any questions you might have. Matt?

[Operator Instructions] And our first question will come from Robert Spingarn with Crédit Suisse.

Good numbers, and particularly on the outlook, so congratulations there. I didn't want -- you both provided, as usual, a wealth of information, and I guess, I just can't keep up with it sometimes. And so at the risk of asking, Don, to restate some of the just -- what was just said, Don, can you just give us a bridge from the $93 million in free cash flow in '18 to the $185 million in '19? I know you just did this, but I was going to ask you to do it in big pieces, just the larger pieces, pluses and minuses, that get us from one to the other. And then the second part of this question, while you have said you should be at 100% conversion going forward, are -- is there anything about '19, that $185 million, that we should view as nonrecurring, good or bad?

Maybe you should view or consider nonrecurring? I think the -- well, let me try. So the 100% conversion, I think, is our target, and it's reflective of what we think is really going on. '18 was the messy year. So the bridge from 2018 to 2019, it's the pension issue that we talked about as well as working capital, is going to be much improved. We've got the noise in 2018 of some of the wind restructuring activities as well. And so once we get out to 2019, we haven't got any of that confusion. So I think we're looking at 2019 being more reflective of reality. We do have -- there might be some folks wondering, why isn't it even better than the $185 million or 100%? And we do have growth happening in the working capital side of things. That would -- it's an investment that has to be made as we grow the business. And we're also -- as I mentioned in my remarks, we've got some pressure as we're forecasting a decline in our customer advances which is not in a -- it's about $150 million or so on the balance sheet. And that's been through a lot of work over the years, and our guys pay attention to cash and we've done a good job of getting cash up front, in many cases. And just right now, it's hard for us to continue to forecast that growing. So we're actually forecasting that to decline. So that puts a little bit of pressure on that outlook. But basically, it's a working capital shift from what happened in 2018 to 2019.

And to the extent that the advances -- I'm sorry.

I can give you maybe an even simpler version. If you assume, next year, 100%, so you got net earnings, you got D&A, minus CapEx, assume that that's -- there's a little bit higher CapEx but assume that, that's 0. We've 6% organic growth, that will drive working capital up. So that's a negative. On the flip side, we'll have a positive from lower pension contributions and they almost cancel out. So that gives you -- that drops you to about 100%.

And because of the full funding -- and this was the part that was a little confusing, and I think Don knew that one, when he was describing it, because of the full pension funding, we should not be seeing the contributions, I think you said, in the foreseeable future. Because I'm just trying to think about how to build out beyond '19. We've -- obviously, we're focused on '19, but we want to make sure that '19 isn't just this big timing windfall and then it settles. Now you have said 100%, so it's easy enough to use that. But I just wanted to make sure there is nothing else we should consider.

No, no, it's not built with a flurry of onetimer activity in '19. Maybe another thing that might help bridge a little bit -- a better piece as I think about your question. So we had, for the year, $8 million of free cash flow. You referenced the $85 million. The $85 million is the accelerated portion of the contribution that we put into the pension plan. The total contribution into the U.S. DB plan was $145 million. That drops to 0 in 2019. So that's a big chunk of that reconciliation that perhaps wasn't clear.

Okay, no, that's very helpful. And then the only other 2 things -- well, the other thing that I wanted to ask was really about normalized margins. You talked about R&D declining here as we go from '18 to '19. I just want to get a sense, when we looked at all your margins, they go up in every segment on an operating basis to this 11.7% from 10.9%. Is 11.7% a pretty good rate or are we going to continue to see R&D coming down, efficiencies, et cetera and we should expect those to rise, over time, beyond that?

So we're focused on continuing to see margin expansion over the coming years. Actually, R&D as a total for the company will go up next year. So '18, we spent $130 million. We're going to spend about $140 million next year. I think on a percentage basis, that doesn't change much. Aircraft R&D this year came in at about $67 million, $68 million. We're anticipating that will drop just a little bit to about $65 million. But as a percentage of sales, we're going to get very close to that 5% run rate that we believe is a healthy kind of rate that you want to keep engaging folks and make sure that you're investing for the future. So as we look out, Aircraft R&D will probably continue to moderate a little bit over the coming years. And Aircraft margins, as we continue down the learning curve on the commercial side, hopefully, the aftermarket grows as the fleet grows, and then military business, assuming that the military defense budgets don't fall apart in '20 or '21, we're anticipating that we can continue to see some steady margin improvement in Aircraft over the coming years. And then, our Industrial business and our Space and Defense business, we also think that there is opportunity. We're seeing a nascent pickup in our Industrial business next year, and we think there's more runway to go there. So our focus is to continue to try and get our margins up towards the mid-teens over a multi-year period and that next year is a nice step. This year was a step in that direction, but we don't anticipate that this is the end. Now, of course, Rob, all of these preface on that the defense budgets don't fall apart and that the world doesn't fall into a depression. So you've always got that. But assuming that the world keeps turning at its axis, we should continue to see opportunities to expand margin.

Next, we will hear from Kristine Liwag with Bank of America Merrill Lynch.

I want to dig a little bit deeper in the Aircraft segment margins. I mean, I would have thought that a decline in commercial aerospace aftermarket in fiscal year '19 would have adversely affected margins. And since you articulated so well that R&D is only coming down $2 million year-over-year, I was wondering what's driving that margin expansion and if you could do a more specific bridge. Are you getting better pricing? How much of that 60 basis points is from learning curve, production efficiency? Or anything else we should factor in?

So it's difficult, Kristine, to do one year to the next because I can -- and I'll offer you the flip question, which is, so could margins have been better in '18 because you had a better mix and then '19 is a negative mix? So you're right. When you look at '18 to '19 on the surface, if you just do the big numbers, you'd say, "Oh, the commercial aftermarket's down a little bit." So that doesn't feel like a positive. Some of the 777 stuff is going to come down. That doesn't feel like a positive. But the military aftermarket is up. The military business in total is up. And despite the fact that we're cautious about the long-term margin outlook there, it's up -- the business is up, so that's a positive. And R&D is down a little bit. So it really gets back to the mix, Kristine. And the mix in the Aircraft business has kind of moved around quite a lot from '17 to '18 to '19, and when you put it all together, the mix, the balance between military, commercial, the 2 aftermarkets and the R&D, next year, we see that margin expanding. Equally, this year, we saw margin expansion, but if you were to dig into it you'd say, "Well, R&D came down a significant amount this year, but your margin didn't expand by the same amount." And the reason was, as I described, we spent more money on bid and proposals, looking for new opportunities. Plus, we saw pressure on our gross margin and we've been focusing some of that engineering resource, some of that R&D line back into the operational side of the business to try and extract additional opportunities to reduce costs there. And that's why some of that margin didn't drop to the bottom line. It essentially went up into the gross margin line. And I suppose, as we look out to '19 and beyond, we're anticipating that we will continue to see benefits from that as we see the gross margin pick up a little bit.

That's helpful. And maybe a question for Don. Don, how should we think about normalized tax rate for your business past fiscal year '19? What are the moving pieces? And how should we compare that expected tax rate to the 21% U.S. corporate tax?

Yes. Right now, my best forecast for that, Kristine, would be about where we are in '19. So we've got a 26% rate in '19. That's -- I was trying to do my best in explaining some of the confusion in '18 and the comparisons and stuff. But I think '19 turns out to be somewhat of a clean year right now where we've got everything built in. We are still, as a team, trying to make sure we understand all the nuances of the new tax reform. The GILTI tax is something that, as our folks tell us, is extremely complicated, and we've got our best estimates included in these numbers. And I would expect that, that would continue to persist some time -- or out into the near future anyway. So 26% would be my answer.

And Don, what's the big bucket that's driving the difference between that 26% to 21%? And then as you kind of get your head around the change in tax code, does that mean that going forward, you might actually see that 26% be a little bit lower over time?

The answer to your second question is no. I tried to answer that by saying I think the best estimate would be 26%. And then the bridge between the 26% and the 21%, can I just to make sure I understand your question, is the 21% the marginal tax rate in U.S?

That's fair, yes.

I'll assume that, that's what you're asking, sorry. And so if that's the case, we're a global company. We've got taxes around the world. And the tax rate in the U.S. of 21% is the starting point in determining what your tax bill is. And then we've got other add-ers to that, and it's this GILTI tax that I'm talking about, which is a tax that's been imposed on companies who are generating offshore earnings. And it's a complicated calculation, but it's those kinds of issues that take the tax rate on a normalized basis from what one might expect to be a 21% rate in the U.S. We also have state taxes on top of that as well, that take the 21% up to, what is it, 23% or 24%? And then the mix of earnings around the world and other adjustments to the tax return. I'd be happy to walk you through that if you want to get into more details.

And our next question will come from Cai Von Rumohr with Cowen.

So the turret, basically -- so the big surprise, this huge gain, how big was it this year? And so we obviously have a great big gain next year. And what are the platforms that are purchasing this turret, and what's the longer-term potential?

The turrets, sorry, I was -- so yes, I mean, it's -- well, it's, as I said, it was $3 million in sales in '17. And we're anticipating $50 million in sales in '19. So it's a very nice...

And '18?

No, in -- well, '18 was about $15 million, roughly. So kind of between $15 million and then to $50 million, 5-0. It's been something -- it's one of those things, Cai, that looks like an overnight success but it was 10 years in the making. About a decade ago, we bought a small outlet, a bunch of engineers out of General Dynamics that were -- had been doing turret design work there. And they're out in the West Coast. They did some work with us. We did some retrofit activities. We did some other work. And in parallel, we were starting to try and address a specific issue in the field, where there's a challenge around reconfiguring turrets. We're not trying to compete in any way with the guys who make tanks or vehicles and stuff, but these are specific needs that various services have that we thought we could do something for. So the big win on that was the IM-SHORAD, that's the mobile short-range and defense -- or Mobile Short-Range Air Defense system, which is a turret on top of a variety of vehicles. And then we've also won a couple of smaller pieces, and when I say smaller, this is a couple of pieces. But again, when you have a turret, it's more than a couple of motors. So it's a bigger sales dollar. But they're mostly around counter-UAS systems, it's the ability to move quickly and to reconfigure it. So the key is, Cai, that is kind of a flexible platform that, in the fields, now not literally when you're driving, but if you go back to the base, you can take off a gun and put out a missile launcher or you take off a missile launcher and put a [ size armor ]. And it's really built around that flexibility. So it's not a fixed turret that would take significant amount of work to reconfigure. It's designed to allow the guys on base, in theater to say, "For this next mission, I don't need a 30-millimeter gun. I need some kind of a missile or I need some kind of a [ sizer ] or I need some other form of a weapon." And I can do that in the base and so I've got this ultra flexibility. And the other thing is it allows them to reload under armor, which is a big deal. So nobody has to stick his head out and get his head shot at. So it's a new product area for us. If you were at the AUSA show a couple of weeks back in Washington, we actually had it on display. And typically, our displays have kind of relatively small stuff, stuff you can pick up, motors and hydraulic systems and then slip rings. And this time, we had a full-up turrets and there was a lot of interest in it. So we're excited about this. We've got some nice backlog. We think we've got an interesting product. Like all these things, it will take time, and $50 million in '19 is, of course, a very nice piece of business. But again, in the scheme of everything we do, it goes with the overall diversified play that we have. So nice opportunity, and the team there has done a really nice job. But it's been 10 years in the making, like so many of the things we do.

And so do we have any other kind of pleasant surprises that could come out of the -- kind of some of the back shop?

Look, well, if they were pleasant surprises and I told you now, it would no longer be a surprise. No, we -- I mean, as always, Cai, we're trying to give guidance on the basis of everything we know. Every now and again, we have an unpleasant surprise, as well as you know. You've followed us for long enough. So we try to find that right balance. We do -- I mean, I've described that we are trying to, as some of the big commercial jobs wind down, is we have a very talented engineering force and we are trying to redeploy them into, what I would call, the next generation of opportunities. So I mentioned 3 on the call. I mentioned additive. As you know, we've got a small company on that. We continue to work on that, develop our capability. But it's a small business at the moment, but we think it has significant long-term potential. I mentioned next-generation robotic systems. We're working with a variety of customers that are typically not our normal customers, looking for opportunities there. But again, it's searching around for that right opportunity. And then autonomous systems, and in autonomous systems, our interest is not to be in competition with the Teslas or the Googles or any of those types of folks. It's really looking at opportunities where you've got very specialized equipment in unusual applications, where the guys that make the equipment in one of the areas, for instance is defense, another area is agriculture, are typically making 15, 20, 50 vehicles a year for some very specialized application. And the big boys, the Caterpillars and the Deeres, are -- they've got all of the capabilities they could ever want to make autonomous systems. But the smaller guys typically don't. And we think, maybe we have a suite of capabilities and technologies we could bring to bear in some of those opportunity areas and try to find new growth opportunities. But I would say that, like the turret thing, 10 years in the making, an overnight success, 10 years in the making. These are much earlier, but we are trying to make sure that we're investing for that next range of opportunities. And so when and if they turn out to be surprises, it probably will be a few years out. I'd love to report that we have something really exciting there, yet. At the moment, I can report that we're spending some money and folks have gone out looking for opportunities.

And so Don, is your guidance of margins by each of the sectors for '19, is that on current accounting? Or is that on new accounting with the $13 million nonservice pension number moving below the line?

Yes, it's the new accounting. So it's -- that's about, what, 30 basis points or so, I guess. Well, 30 basis points in '19, and then the adjusted number in '18 is about 20 basis points. It's about 10 or 15 basis points between the 2 years. So it's not that big of a difference. So the 11.7% that we're reporting, we've got in our documentation the presented 2018's 10.9%. If we were to adjust, apples-to-apples, 2018 would be 10 point -- sorry, 11.0%. So it's about -- still, about 70 basis points improvement.

Okay. But -- so the $13 million is basically going to be a charge, correct, below the line?

Yes, exactly.

Yes, that's correct.

Okay, okay. And then the tax refund, how large is that? And talk to us a little bit more about deployment. Do you have a full M&A pipeline? What's the chance of buying some more stock? Did you buy any kind of -- after August, et cetera?

So let me take a step -- start. And John, then you can go -- pipe in. So the tax rate refund issue that I'm referring to is around $10 million. So it's part of the explanation. It's not the whole explanation, but it -- well, it's a big number that we were expecting in the fourth quarter and we couldn't control it. So it's likely to come in, in the first quarter, maybe the second quarter of 2019. M&A, the pipeline, we continue to try build the pipeline. It's interesting that it kind of ebbs and flows. We have periods where we're incredibly busy and periods where it's not as busy. And so if I moderate it and say, over time, I would say it's a healthy process. We'll continue to look for growth through acquisition. We have looked at an awful lot of opportunities and we've reported a couple that we closed on, but there are many that, for a variety reasons, we didn't continue the process. So it's -- I would describe it as disciplined. And I would say the pipeline is active. I don't know that there's anything imminent that, that I'd hinting at, but there's certainly a constant level of activity going on. So -- and then with respect to the stock buybacks, we did -- shared that we bought back 1 million shares from the DB pension plan. We continue to look at opportunities to return capital to shareholders, and so the share buyback is more opportunistic. And we don't report anything other than what happened so I'm not going to put anything in the table as far as what we are doing right now or what we might do in the future, but it's always a path to return capital to shareholders, in addition to the dividend that we are paying now on a quarterly basis.

And your next question will come from Michael Ciarmoli with SunTrust.

Maybe, John, just on the '19 outlook, maybe what are the swing factors? You've given us an isolated bogey for revenue. What drives the upper end versus the lower end of the EPS range? I mean, are -- the different things you're looking at from mix, volume? Is it the pricing? Or are there sort of other nonoperational items that might move that EPS range up or down -- or move it up from the high end to the low end, I mean?

Well, the range is driven by a thing called experience, Michael, which means that, our experience is that it's never quite exactly what you think, and so it's called a hedge factor. Now when we get numbers from the group, it's called sandbagging, but we wouldn't do that at this level. So that's so that -- the lower end or the upper end, Michael, is really based on the usual types of things. So we're forecasting -- as you know, we have a very diverse range of products and portfolios, and typically, you get some ups and you get some downs. You go back through the last 5, 6, 7 years, there's always been some positive or negative surprises, and it's really trying to capture that. On the downside, tariffs, Brexit, we've looked at both of these in great detail. The tariff thing, when we look at just our own direct purchases, they're not big numbers. On the other hand, the feed-through from our suppliers, our availability of components could cause an issue. The whole commercial supply chain, I think, is going to get strained, just given the ramps that are happening. So you get a hiccup there, and suddenly, that could change some of that. I'm going to give you the negative, first. Defense spending looked very strong, but the latest is that, '20, we're going to start to cut back. So just -- how does that start to affect some of the programs, some of the investments, the development stuff that we're doing? Saudi, some of those types of things continued to be kind of in the news. So I think there's some concerns there. Industrial, if we start to see a little bit of a recession, start to see interest rates pick up, how could that affect? So there's downside there. On the flip side, right now, military spending, everything -- I listen to when I talk -- when I go to military conferences, is we got to get ready. We got to have -- we got to invest more and cleaning up some of the underspend, particularly in R&O, over the last few years. So that could be a positive. We had a great and unbelievably good year in commercial aftermarket. We're forecasting that to come down. But in the past, we forecasted IP, as always coming down, it seems to do a little bit better. So maybe that could be a little bit stronger. Industrial is doing really well. Oil, if -- oil continues to go up and we started to see additional investment there, some of the big oil guys are making a lot of money again. So that could be a positive. So it's trying to find that balance, Michael. And I wish I could give you a better answer than that, but there's just a lot of potential moving parts and so what we're trying to do is capture the upside and the downside as best we can.

No, that's helpful. And then just one more on my end. You've talked about the working capital investment a couple of times now to support the growth. Can you give us any color on specific lines of business or programs where you're putting more of that capital to work?

No, I think that's getting into a level of detail that I think is more than -- actually makes any sense at this level, Michael, because what -- if you just look at -- let's assume that you got 33% net working capital. That's the net working capital number, so I'm just taking that as the number. So you increase sales by $100 million, and assuming that everything kind of stays the same, you add $33 million of additional working capital or whatever that percentage is. And it's -- typically, that's a very broad brush thing. There are, again, so many moving pieces, but when you take a big step back, typically, that's what kind of seems to happen. And you work continuously, as Don described, over the last 10 years, we've worked at net working capital number down year after year. And that's the benefit of operational improvements, lean, et cetera. But you're not going to make dramatic moves in that one year to the next. And so if you grow by $100 million, a round number is to assume net working capital stays at about the same percentage, and that's how much you're going to suck out of work -- out of free cash flow.

Michael, one of our -- so one of the things we said is that net working capital as a percentage of sales is just under 25%, and we'd expect to see that trend continue to decline. It's not going to be by 100 or 200 basis points. It's going to be by 10, 20, 30 basis points. But there's a lot of increased focus these days on cash generation and managing our working capital. So we do expect that -- the trend that we've been experiencing the past decade to continue.

And with no further questions, I'd like to turn the call back over to management for any additional or closing remarks.

Thank you, Matt. Thank you to all our listeners. And we -- as we said, we think '18 was a pretty good year. We look forward to '19, and we look forward to reporting the first quarter in 90 days. And we wish everybody a very happy Thanksgiving and a great Christmas. Thank you for your time.

Once again, that does conclude our call for today. Thank you for your participation. You may now disconnect.