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Esterline Technologies (NYSE:ESL)

Q2 2013 Earnings Call

May 30, 2013 5:00 pm ET

Executives

Brian Keogh

Richard Bradley Lawrence - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Robert D. George - Chief Financial Officer, Vice President of Corporate Development and Secretary

Analysts

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Tyler Hojo - Sidoti & Company, LLC

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

Julie Yates - Crédit Suisse AG, Research Division

Noah Poponak - Goldman Sachs Group Inc., Research Division

J. B. Groh - D.A. Davidson & Co., Research Division

Thomas Lewis

Operator

Good afternoon, and welcome, ladies and gentlemen, to Esterline Technologies' Second Quarter 2013 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded. [Operator Instructions] Also, a replay of today's call will be available for 1 week by calling this toll-free number: 1 (888) 286-8010. You'll need the following PIN: 74473859. At the request of the company, we will open the conference for questions and answers after their presentation. [Operator Instructions] I will now turn the conference over to Mr. Brian Keogh. Please proceed, sir.

Brian Keogh

Thank you, and good afternoon, everyone. Brad Lawrence, Esterline's Chairman, President and CEO; and Bob George, our Chief Financial Officer, are here today to discuss Esterline's fiscal year-to-date and second quarter 2013 performance. In addition to the number Jason just gave you, you can also visit esterline.com in the Investor Relations section to access a webcast replay of this call. As always, I need to remind you that our call today contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are not guarantees of future performance. As you know, forward-looking statements always involve risk and uncertainty, which we detail in our public filings with the SEC.

I'll now turn the call over to Brad.

Richard Bradley Lawrence

Good afternoon, and thank you all for joining us. Looking in our results at the midpoint of our year, I believe we're making good progress. We're seeing solid margins, controlled costs and performance in a variety of businesses and programs despite some difficult market conditions. Sales were approximately $500 million and earnings of $1.12 per share were in line with last year's second quarter operating results.

At the outset of this year, I said, much like our fiscal '12, we will build to a strong finish. This still holds. And there are a number of favorable trends that we expect to continue to a strong back half of the year, including continuing strength in our commercial aerospace OEM business, particularly for single-aisle platforms, steady margin performance, a solid $1.3 billion backlog, continued strong cash flow and, throughout the business, an effective focus on cost controls.

Of course, we have to balance this optimism with a dose of caution. Although there remains a good source of strength in defense markets, we have seen a number of important programs slide to the right not only impacting the quarter but colors our full year outlook.

For example, JPATS, or the U.S. military's Joint Primary Aircraft Training System, is the Beechcraft T-6B. Esterline provides the integrated glass cockpits for this aircraft. A few months ago, in conjunction with its emergence from bankruptcy, Beechcraft implemented a program of rolling furloughs. As a result, full year build rate for the T-6B has been lowered from the earlier scheduled 49-per-year rate to 42 aircraft this year, essentially a 15% reduction.

Also there's ongoing uncertainty surrounding the fate of the Global Hawk UAV program and its future role in the U.S. Air Force's intelligence gathering mission. This is delaying orders for our signal intelligence receivers. That said, we're confident that whether it's Global Hawk or some other platform, there'll be a continuing need for signals intelligence technologies that our receivers provide. So we view this only as a delay.

More broadly speaking, there are some balances to these issues. Programs such as the European A400M military transport aircraft, the F-35 Joint Strike Fighter and the P-8 maritime surveillance aircraft are performing to expectations, have improving visibility and are now becoming meaningful to results. In general, however, defense customers, both in the U.S. and abroad, are responding to market uncertainty by slowing funded programs and keeping their options open.

Meanwhile, global economic conditions, particularly in Europe, have industrial markets stuck in neutral. Though our rail business continues to grow, other markets are under some pressure, slowing the pace of growth we anticipated at the beginning of the year.

With these market factors as a background, we decided it's prudent at this point to moderate our expectations. We continue to believe our business will strengthen as we move to the second half but not to the extent we previously thought.

For that reason, we have recalibrated our full year earnings guidance to a range of $5.30 to $5.50 per share, a range that we believe absorbs the potential impact of the market uncertainties I just described.

Now with that said, there are certainly numerous aspects of our business that give us cause for confidence. In Avionics & Controls, for example, our cockpit solutions are well positioned in the market. Esterline's modern avionics provide exceptional value and competitive pricing with very strong opportunities in the sales funnel for retrofitting the aging fleet of both military and civilian aircraft.

In Sensors & Systems, we believe there's a pent-up spares demand, especially due to our sole source position for exhaust gas temperature sensors on the predominant CFM56 engine.

Finally, the defense spending situation remains fluid. And as you can appreciate, we expect to be able to update our view as we see some movement on decisions related to our important programs.

I want to be clear, the pressures we are now seeing do nothing to alter our view of the bigger pressure. We have more growth opportunity, both in terms of magnitude and diversification, than ever before. Our ability to both develop key technologies within our existing businesses and to supplement those technologies with complementary acquisitions has put us in a solid position across a range of markets and has deepened our relationships with our key customers across the globe.

We remain committed as ever to efficiency. There's a solid underlying strength to Esterline that is built upon a laser focus on operational excellence and thousands of quality components that we produce worldwide day in and day out.

Our business unit leaders are right on top of capitalizing on these efficiencies, managing expenses and incrementally reducing headcount. I believe our infrastructure is well aligned with the opportunities we see over the next several years.

I want to reserve some comments about the overall business environment for closing remarks. So at this point, I'd like to ask Bob George to walk you through the results in some detail.

Robert D. George

Thanks, Brad. Good afternoon, everyone. As Brad has indicated in his opening remarks, our second quarter results this year were very similar to last year's second quarter. This is in keeping with our expectations that this year would follow a pattern similar to 2012: start slow and build to a strong finish.

If we look at Esterline's results from a macro perspective, our Avionics & Controls segment results are being affected by the uncertainties in the defense environment that Brad just mentioned. Sensors & Systems segment results are somewhat affected by engine aftermarket softness and the tepid European industrial markets. And Advanced Materials segment results were stronger than last year, bolstered by defense programs.

Now a couple of other points to keep in mind while analyzing the quarter. The litigation settlement of $12 million recorded as a gain in last year's second quarter was worth $0.30 per share. And the financing activity we completed this quarter resulted in a charge of $1.8 million, or about $0.06 per share, after-tax, and this related to the redemption of our 2017 senior notes. With this information as a backdrop, let's review some of the details.

Sales in the quarter of $500 million were down slightly from last year's $505 million. In Avionics & Controls, the defense headwinds from T-6 and Global Hawk were partially offset with strength in medical and gaming markets. Sensors & Systems segment sales were affected by our Advanced Sensors products due to lower aftermarket sales. And our connectors were impacted by the sluggish European industrial climate.

The positive results in Advanced Materials were primarily due to surprising strength in combustible ordnance activity and orders received and shipped in the quarter for F-35 material.

These same things flow through in our 6-month sales picture as well. Sales of $958 million year-to-date are down 2% from last year's $976 million. However, gross margin performance is remaining strong, reflecting our platform leadership focus on operational excellence and cost control.

Gross margin in the second quarter this year was 36.3% compared to 36.6% last year. On a year-to-date basis, gross margin this year of 35.7% compares with 35.1% last year. Avionics & Controls segment gross margins were generally steady with year-to-date results up slightly and the quarter off somewhat from last year, and this primarily reflects some of the sales mix effects mentioned earlier. Sensors & Systems segment results are consistent year-to-year as Advanced Sensors margins, affected by weaker aftermarket sales, were bolstered by strong Power Systems results. Last year's strength in Advanced Materials was due to a very strong product mix across the entire segment. This year, the segment is not benefiting from the same strength as consistently as last year. Through the second quarter of this year, Advanced Materials segment sales and margins increased from last year, but collectively, in the first half, the learning curve for international countermeasure shipments compressed margins.

Selling, general and administrative expenses of $98 million this year were comparable with $99 million for the second quarter last year. And year-to-date, SG&A expense was $197 million this year compared with $194 million last year. A year-to-date increase in compliance and regulatory expenses was partially offset by reductions in our Avionics & Controls segment.

Research and development expense was down relative to last year for the quarter and year-to-date. For the quarter, R&D was $26 million this year, 5.1% of sales, compared with $30 million, 5.9% of sales last year. Through 6 months, R&D expense was at $49 million this year compared with $56 million last year, and this reduction in spending is primarily in the Avionics & Controls segment.

Segment earnings are consistent with what you would expect from the pattern I described, similar sales to last year, similar gross margins and reduced expenses, leading to improvements in return on sales. As a percentage of sales, segment earnings were 14.7% for the second quarter of this year, a full point higher than last year's 13.7% of sales. Year-to-date, segment earnings were 13.4% this year, 12.2% last year.

Income taxes were as expected for the quarter, 21% this year, 19.7% last year.

It's worth noting in the third quarter, it is likely we will reflect $5 million of tax benefits as a result of the settlement of tax examinations and/or the expiration of the statute of limitations. Additionally, also in the third quarter, there's a reasonable expectation of a corporate tax rate reduction in the U.K. This will benefit the company in the third quarter.

Bottom line, for the second quarter of 2013, net income was $35.5 million or $1.12 per share. Including the $12 million from a favorable litigation settlement of $0.30 per share last year, net earnings were $45.2 million or $1.44 per share in the second quarter of last year.

Year-to-date earnings this year are $61 million compared with $68 million last year, $1.92 and $2.18 per share, respectively.

Wrapping up before turning back to Brad. Cash flow remained strong. Cash flow from operations through 6 months this year, $123 million compares with $85 million last year. As we pointed out in the release, we're heading for another record year for cash flow, most likely in excess of $200 million for the year.

Capital expenditures are consistent year-to-year, $25 million this year, $26 million last year.

Through the first half of the year, depreciation and amortization was $56 million this year and $55 million last year.

Finally, our backlog is holding steady at $1.3 billion and is supportive of our expectations for a strong second half of the year.

Brad, back to you.

Richard Bradley Lawrence

Thanks, Bob. I agree we're in a good position to deliver a strong second half even with a tough defense market and a sluggish European economy, which, incidentally, we see improving.

As we finish this fiscal year, we're expecting good revenue growth, sustained strong cash flow, increasing earnings per share and a continued build in our backlog. Our people are effectively managing the short-term pressures while, in a very fundamental way, continuing to position Esterline for long-term growth.

Our business is built on the balance between commercial aerospace and defense. Being able to redeploy assets during the inherent business cycles of these markets gives Esterline an advantage in retaining critical resources as we manage through the inevitable near-term fluctuations. The fact is over the longer term, both markets show positive underlying growth trends. Fortunately, the near-term strength in the global commercial aerospace cycle remains very positive with respect to the outlook for high levels of passenger load, which bodes well for spares and aftermarket business, and a strong appetite for new, fuel-efficient aircraft, which bodes well for our OEM business.

Defense has always been a long-cycle market. And over the years, we've managed through those cycles successfully. In the current environment, we are taking the tough actions required. As I've said before, our people know the drill. Also as the European economy picks up, we see industrial markets as a major growth opportunity where our technology can make a difference.

In all of our markets, we work tirelessly to stay close to our partners and our customers. Keeping our pencils sharp and planning well, reducing our expenses where appropriate and, at the same time, executing at a high level is essential to long-term success.

We believe we have the right plan to grow our business while diversifying into a range of new markets. In particular, we see compelling applications for our technologies in high-speed rail, energy development, medical equipment and even gaming. We remain confident that in addition to our strong commercial aerospace position and our long-term view of growth in defense, these adjacent markets will become an important growth vehicle.

Taken together, we believe that the full range of our initiatives puts us in an excellent position to grow both top and bottom lines and drive value to our shareholders.

As I spend a great deal of my time visiting our operations, I am continually reminded of the breadth and depth of our company's product offerings in a wide variety of truly complex technologies and the critical role our products play in the markets we serve. These visits reinforce my confidence in our success. At the heart of everything, Esterline employees and managers are working hard every day to do the right things, to explore the most promising opportunities, to maintain and build our important partnerships and to make critical decisions for the future of our company.

Thank you. And operator, we're ready to take some questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Howard Rubel with Jefferies.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Brad, I kind of want to go back to, well, to 2 things. One is, gross margins sort of were flattish relative to what's you've been doing, and yet the commentary sort of points to some fairly significant improvement, and I'm struggling to reconcile one with the other.

Richard Bradley Lawrence

Well, Howard, I think Bob mentioned in his comments that we had some very favorable product mix last year, in the first half of the year, that we are not experiencing in our Engineered Materials business this year. So the impact on the gross margin, keeping it flat with the current product mix, represents some very strong performance within the company.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

And then I'm sorry, can I ...

Richard Bradley Lawrence

The other thing -- excuse me, Howard.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Okay.

Richard Bradley Lawrence

Another thing I want to mention in that product mix is -- and we'll get into this, but our spares business has been surprisingly weak in the first half of this year, and we had the opposite situation last year at this time.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Oh, that's for darn sure. And, I mean -- and really just to focus on that for a moment, I mean, you're not alone across the aerospace complex in seeing what I'll call sloppy spares as opposed to ones that would either track the fleet or traffic or whatever you want to call it. Have you really -- have you talked to your customers and -- or looked into what in fact has been some of the factors that seem to be causing -- I mean, frankly, all of us are forecast to be wide of the mark?

Richard Bradley Lawrence

We've looked into this to the best of our ability, Howard. And I've heard lots of reasons. A gray market activity from scavenging retired aircraft. I've heard that some of the products in our -- particularly in our sensors area are experiencing longer life -- kind of a positive in a way, but the longer life between intervals, more sophisticated health monitoring systems that postpone the retirement of spares based on performance rather than on periodic intervals. So I've heard all of those things, but it just doesn't hardly square with me with the volume of CFM56 engines that are being pumped out into the marketplace will tell me that the spares activity should be more robust than they currently are. So all I can assume from that, just logical deduction, is that people are working off inventories.

Operator

Your next question comes from the line of Tyler Hojo with Sidoti & Company.

Tyler Hojo - Sidoti & Company, LLC

Just a follow-up to Howard's aftermarket question. I was hoping that you could tell us, what's baked into the guidance in terms of growth? I think previously, you were looking for something like low double-digit growth within that guidance. So what is it now? And where are we kind of year-to-date?

Robert D. George

Tyler, this is Bob George. Can I just ask a clarifying question? When you say low double-digit growth in our guidance...

Richard Bradley Lawrence

Spares.

Robert D. George

Were you referring specifically to spares activity?

Tyler Hojo - Sidoti & Company, LLC

Yes. I mean, at least in my notes, I had as of the fourth quarter you guys were indicating aftermarket growth growing somewhere in the low single-digit range year-on-year. And then I think as of the first quarter, you were indicating something like 4%-type growth.

Robert D. George

Okay, okay. I thought you said -- my apologies. I thought you said double-digit growth, and I was kind of -- really, I was surprised at that.

Tyler Hojo - Sidoti & Company, LLC

If I said that, I didn't mean it.

Robert D. George

Okay, good. Well, we're clarified now. That's good. That's all that's important. Right now, we are -- on an aftermarket basis through 6 months, all in, we're flat with last year. We see no growth year-to-year. We are expecting nominal growth in the second half of the year. We are not at the 4% level. We're looking at nominal growth.

Tyler Hojo - Sidoti & Company, LLC

Got it, okay. Very helpful. And I guess my follow-up, Brad, you -- I think in your prepared remarks you were indicating that you were starting to see some signs of improvement in Europe. I was hoping that you could expand upon that. Is it really orders? Or is it just kind of conversations with customers?

Richard Bradley Lawrence

No. No, it is a -- it's a recent uptick in orders. Not enough for me to call it a trend but certainly encouraging after seeing -- operating at what I would call extremely low rates for the first half of the year. So these are mainly in the connectors area that are used in heavy equipment and mainly in Europe. So we're seeing some increasing demand in that area, which is encouraging. But I would -- I'd probably look to the true economist for a trend of what's happening in Europe.

Operator

Your next question comes from the line of Michael Ciarmoli with KeyBanc Capital Markets.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Brad or Bob, I guess just digging into the guidance reduction, first on the top line, the $100 million, you quantified the T-6B. You just quantified the aftermarket spares revision. Can we assume the balance is just cutting that general industrial forecast? And I guess I'm wondering, sequestration, it hasn't really hit too much yet, but it seems like it's out there. Could it slide into '14? I'm wondering how your guidance sort of incorporates any kind of unforeseen sequester pressures. Or are you just still banking on or baking in timing delays into the outlook?

Robert D. George

Mike, this is Bob. I'll start and Brad may have some follow-up comments. I think the last portion of your question really strikes at the heart of where we're at right now. I mean, we are seeing -- we're not seeing program cancellations. The buildup of our forecast has been program by program based on what we know. We have baked in -- part of the reduction that we've got here in our revenue guidance is continued delays. Slowness is maybe a way to describe it. Our guys who are closest to the program officers were just indicating that it's very difficult to get orders released. Orders that can be released are being delayed. So we factor that in as we've looked at our forecast going forward. We identified, as you said, the primary impact that we've been impacted with, Global Hawks, T-6. Where -- what's really interesting is, we do see some cross-currents going on as well. I mean, we had -- as a mentioned in my comments, we had some surprising strength in our combustible ordnance activity, F-35 orders are holding firm, but then we've got those other programs that are sliding out. And as Brad made a -- in his comments, I mean, we're seeing that internationally as well, the slowness. I mean, they're just order delays is what we're experiencing.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Okay.

Richard Bradley Lawrence

A thing I might add to that, Michael, is we've talked in the past that -- and I even mentioned it in my comments here, that there's a strong sales funnel for cockpit retrofits. And this is trainers, this is transport. We have just a large number of those programs that we're working on and have been working on and have bid and had expectations in our plan this year that a certain percentage of those would be secured now and have received activity, and there's just a general inclination to push those programs out. Inevitably, they need to be -- these cockpits need to be upgraded with the new FAA system coming our way here. But in the meantime, people are reluctant to spend in this environment.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Sure. Now -- and when you talk about those retrofits, the C-130s had already been removed entirely from the forecast, correct? So are there additional...

Robert D. George

That's correct.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Okay. And I guess just the last one for me and I'll jump back in the queue. You had a debt redemption in the quarter. What can we expect for interest expense on a go-forward basis?

Robert D. George

Mike, again this is Bob. We're looking -- in the third and fourth quarter, we're looking somewhere around $8.8 million. It was down a couple of million dollars per quarter from what we've been running at.

Operator

Your next question comes from the line of Sam Pearlstein with Wells Fargo.

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

If you could just go back to the guidance a little bit. If I just look at your roughly $2 billion in revenues this year, it would mean that the second half of the year has got to have low to mid-single-digit growth, and we've just had 2 quarters where your total sales were down year-over-year. So I'm trying to just think about what actually reverses and starts to get better in the second half of this year in terms of the top line.

Richard Bradley Lawrence

Let me take a shot at that first, Sam, is that this is a forecast for the second half. We're 6 months into the year. We have good visibility into the remainder of the year. The forecasts we have are a buildup program by program. And we knew this going into the year, that it was going to be stronger in the second half. We didn't get as much -- as you pointed out, much strength in the first half, so we moderated our second half strength also. But I don't know that -- and Bob can add some color here, I don't know that I can point to specific programs that are ramping strongly in the second half, but the forecast we have does reflect the scheduling of our backlog.

Robert D. George

Yes, Sam, I'll just add a few more words. Through the first 6 months, we're actually not that far off of our anticipated sales picture for the year. As we said last December, we anticipated a very significant ramp towards the year end, very similar to what we did last year and with particular emphasis on the fourth quarter. That pattern is still holding true. As you know from following Esterline as long as you do, or as long as you have, our makeup is not in single, significant, major programs that ramp but rather the continual sales of a whole lot of products across the whole series of programs. And as Brad said, we do have that visibility into the second half of the year.

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

I mean, I was just thinking that it seemed like some of this unusual strength in Advanced Materials would moderate, so that would actually put some headwind. And so I'm trying to just think about if there were specific contracts that were driving that, but that's fine.

Robert D. George

Well, in the Advanced Materials arena, a -- we had -- as you know from last year, we booked a number of very large international orders that are -- that we are working on and will be delivering in the second half of the year. So in the Advanced Materials arena, that is part of the growth that we see going forward. As I mentioned in my comments, we're in the learning curve phase of those international orders in the first 6 months. We haven't delivered many of those, and that's beginning now as we go into the second half.

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

Okay. And then you mentioned the one tax benefit that you would have in the third quarter. What -- can you size the other one in terms of the U.K. tax change, what that might -- how that might impact things?

Robert D. George

Not as precisely as I can the discretes that we have, but we're looking at it somewhere between let's just call it $2.5 million and $4 million.

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

So that, call it $5 million to $10 million between the 2, was that anticipated originally when you had your guidance or were these plus-ups of things that are coming in?

Robert D. George

We did discuss this in the first quarter. We were aware of the timing of this. But as you know, from a GAAP basis, we can't include them in our estimates for our tax rate as we go forward. But we did -- as we discussed in the first quarter, we have seen these all along.

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

Okay. And then one last question and I'll turn it over. The corporate expense line now a couple of quarters you've been running in the $15 million, $16 million range. Would you say that, that's a new range as to what you'll be operating at those levels?

Robert D. George

There been some unusual expenses in the corporate line this year in each of the first couple of quarters, including some of the financing activities we did, the acquisition-related costs that we had from gains and as well as some regulatory items that we had in the first quarter. So I think that there would be -- we're modeling it to be a little bit lower than that on an ongoing basis.

Operator

Your next question comes from the line of Julie Yates Stewart with Crédit Suisse.

Julie Yates - Crédit Suisse AG, Research Division

Brad, can you give us an update on the Saudi Arabia retrofit program and if you have any idea on timing? And then maybe talk about the various scenarios in terms of when you would need to receive the order to include any of those incremental revenues in FY '13?

Richard Bradley Lawrence

Yes, Julie, the unnamed Middle Eastern government that's interested in retrofits of C-130s, we've been in close contact with our joint venture in that country who has a close association with the Air Force and the government budgeting agencies. And they remain bullish on the program, believe the program is -- remains viable. There are different variations on the program they're looking at. They're perhaps breaking it into smaller pieces. If you remember, it covered not only C-130s but some 707s, tankers and some AWACS. So there are some various possibilities of combinations on how this might turn out. We've done a lot of work on that generation of aircraft, and so if we were to receive that -- an order like that anytime in the remaining of '13, we would be able to book additional revenue.

Julie Yates - Crédit Suisse AG, Research Division

Okay. And then I know last quarter I think you talked about weakness in the defense aftermarket. Can you just update us on what you saw in the second quarter specifically in the defense aftermarket?

Richard Bradley Lawrence

Yes, that remains the same. We've -- can have continued weakness, particularly in our cockpit business for the defense aftermarket.

Julie Yates - Crédit Suisse AG, Research Division

Okay. And then just one last one. Cash continues to be a very strong point for you, and now you've hit your delivering targets from Souriau. Can you update us on your cash deployment priorities?

Richard Bradley Lawrence

So as we have historically done and as you know, Julie, our priorities is to grow the business. We're starting to see, particularly in the defense arenas, some admittedly smaller opportunities, but we're starting to see more activity in companies that would likely be accretive to Esterline and fit well with our -- within our strategy. So it's -- our first preference is to find good-fit acquisitions. We are still paying down debt. Although we've hit our ratios, we're still paying down debt. And so that's where we'll continue to deploy our cash until we find a better use.

Julie Yates - Crédit Suisse AG, Research Division

Okay. And are buybacks something that you're considering?

Richard Bradley Lawrence

I think when and if we have excess cash, and we'll have to look at our alternatives for use of that cash. And we have a responsibility to our shareholders to look for the best use of the cash. And if share buybacks pencils out, then we'll include that in the possibilities.

Operator

Your next question comes from the line of Noah Poponak with Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

I wanted to go back to the conversation around margins and SG&. Specifically, margins -- operating margins through the first half of the year looked fairly similar to last year, and it doesn't look like the guidance implies any year-over-year margin expansion in the back half of the year. I know you started to talk about mix there earlier in the Q&A, but I'm just sort of wondering what some of the other inputs are in the operating margin and in the SG&A line specifically, which also looks similar to the year ago period. Because I'm hearing you in your qualitative remarks talk a lot about a focus on cost control, efficiency improvement. I guess I'm sort of wondering when we'll see that a little bit more impactful in the numbers.

Robert D. George

Noah, this is Bob. I'll start with those. It's a very broad question with a lot of very good points, and I'll see if I can do some justice to it. First of all, I would like to say that you're right. I mean, as we look at the second half of the year, we are not projecting an expansion in our gross margin from where we were in -- of 3, 6 months. So we're still looking at in and around that 36% level that we've been exploring. One of the reasons for that is, as Brad indicated earlier and as we mentioned in our remarks, is our product mix this year is not as robust as it was last year. So we've actually made substantial changes, reductions in our cost structure. Included in our expenses this year, particularly in SG&A, are a number of severance and incremental restructuring costs that we've absorbed. So as we look at the second half of the year, revenues are roughly going to be in the $2 billion range; margins in and around 36%; R&D drop -- continuing to be compressed at the level we're at now, so roughly 5%; SG&A running around where we're at right now; and then resulting in essentially the guidance that we've provided is how we've looked at it. What we decided to do as we are looking at the guidance this year is reflecting some of the delays that we've talked about, as well as that product mix is take a little bit more conservative view of that late third quarter, fourth quarter activity.

Richard Bradley Lawrence

Noah, let -- this is Brad. Let me add to that, that for competitive reasons, we're pretty reluctant to be real specific. I know mix is a pretty unsatisfying answer on your end, and I understand that completely. But we're pretty reluctant to point out the margins on specific programs, as I said, for competitive reasons. But there -- the one thing we can talk about clearly is that as everyone knows in this industry, the spares and aftermarket activity have a disproportionate impact on our margins and that, that activity, as we've mentioned earlier, has been weak and the product mix that we experienced for the first part of the year, not as strong as last year. And additionally, as Bob mentioned, we've had some restructuring severance costs to absorb in the first half of the year. So I believe that the expense control and the rightsizing of our business has been well managed by our operating group.

Noah Poponak - Goldman Sachs Group Inc., Research Division

What is your latest thinking on where you want to take SG&A as a percentage of revenue long term, 3 to 4 years down the road?

Richard Bradley Lawrence

I'm not prepared at this time to give you a forecast on that particular metric. We have a relatively expensive structure because of -- half of our business is being outside the United States and there's lot of statutory costs in maintaining those operations internationally. But we're certainly not happy with our level of SG&A. We see some opportunity. Clearly, I would much rather perform and demonstrate that our strong performance through reductions in SG&A demonstrated by results rather than predicting a number that I'm not sure will happen in a certain time frame.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Fair enough. And if I can just ask one more. Could you quantify, similar to how you did on the commercial aftermarket but for defense, what defense revenues have done year-to-date from a growth rate perspective and then what's embedded in the outlook for the back half of the year?

Robert D. George

The answer to that, Noah, is virtually the same as what we did for commercial. And that is, we are seeing nominal growth from where we were last year, and we're not see -- we did not see growth in the first half.

Noah Poponak - Goldman Sachs Group Inc., Research Division

And in terms of the back half expectation?

Robert D. George

Nominal growth.

Operator

Your next question comes from the line of J. B. Groh with D.A. Davidson.

J. B. Groh - D.A. Davidson & Co., Research Division

I had a question on Boeing. You spent a fair amount of time at the Analyst Day talking about the partnering for success initiative, and I was curious as to your thoughts as how the environment has kind of changed and how you plan on working under those new initiatives going forward.

Richard Bradley Lawrence

Well, J. B., you're absolutely right that there has been pressure from Boeing. They're not alone. We're seeing this as a general trend across the industry. And the good news is that our Lean initiatives, efficiency, the cost-saving initiatives allow us to share some savings with our customers. We have a long list of opportunities that require the cooperation of the OEMs in the way they order things to do some level loading, to simplify the processes that we have in place we believe will result in legitimate cost savings for them and for us. So our attitude about these things is that the products we currently have are under contract, were competed fairly, and that we would be willing to work with them to find value-engineering opportunities to reduce those costs. And certainly on new products, we're very willing to be very aggressive in using the leverage that we have with our advantages in Lean and efficiencies to be very competitive with other companies out there in the marketplace.

J. B. Groh - D.A. Davidson & Co., Research Division

Good. Okay. And then I just had a point of clarification. I saw on the income statement there's the extinguishment of debt -- 9 46. So the remainder of that charge is in the interest?

Robert D. George

Yes, J. B. You're talking about the total amount, J. B.?

J. B. Groh - D.A. Davidson & Co., Research Division

Yes, the total amount you said was $0.06. What number did you -- it looks like $2.4 million?

Robert D. George

That is -- yes, it's in the interest expense, you're correct.

J. B. Groh - D.A. Davidson & Co., Research Division

But the total is 2 points.

Robert D. George

Pretax would be about $2.2 million.

J. B. Groh - D.A. Davidson & Co., Research Division

$2.2 million. Okay.

Operator

Your next question comes from the line of Tom Lewis with High Road Value Research.

Thomas Lewis

I was hoping -- I was wondering if you could help me reconcile what you were saying about R&D spending being down as much as it is at Avionics & Controls. With the impression that I got a few years back that based on what the -- you've accomplished at the Korry in the cockpit of the 787 and being able to deliver what you did the way you did it, there was a lot of opportunity to do similar things for other aircraft managers -- or manufacturers. I would think there would be -- so can you flesh that out? Or, I mean, is that a correct way of thinking about the opportunity?

Richard Bradley Lawrence

Well, so, Tom, this is Brad. We -- it's -- first off, let me give you the big answer and then we can talk about some of the intricacies. It's basically a timing issue on the R&D expense. We had some programs coming to an end, and we're not at the point to charge against some other programs. So we think that 5% range, a little over 5%, is likely where we're going to be operating in. We got the whole bunch. And you're actually right, pointing at Avionics & Controls. We've got a whole bunch of opportunities on the KC-390, which are moving into the mature stage. We had 6, I believe, the number 6 additional overhead panels, we're very far along on R&D expense on those projects. So look, it's just the timing where some of these programs are coming to the end of the R&D phase and moving into the development phase.

Thomas Lewis

Got you, great. Okay. And also, if I could, are we far enough along with the engine on the A350 that you're doing the sensor suite to talk about what that -- I mean, is that a -- going to be a -- on a net, per ship set basis, as meaningful with the CMF56 or more so or less so? What can you -- is there anything you can tell us about that at this point?

Robert D. George

Tom, I'll start and then Brad can add some comments. Yes, as you may be aware, possibly not, that is a -- power by the hour contract. So it's different than traditional ship set content. Our projections of the size of that market and the importance of it is that it's in that same category, absolutely. It's a fantastic program, and the A350 seems to be moving along reasonably well. Airbus is being a little bit cautious right now about the timing of it. But based on our most recent conversations with our customer, things are moving fine. Yes, that is very important program moving forward.

Richard Bradley Lawrence

I just happened to see some of the details on the performance of that particular program. And what I can tell you is that the -- where that program stands today is within 1% of the return that we anticipated when we initially bid on the program. So we're very pleased about how that's moving along for us.

Operator

[Operator Instructions] We have a follow-up question from the line of Howard Rubel with Jefferies.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Bob, this is probably a fair question for you because you keep track of all the numbers in great detail. And what I tried to do is back into sort of the change in the guidance. And if we assume, as you -- we look quarter-to-quarter, you're down about $100 million versus where you thought, that would translate into about a $0.90 reduction in the outlook, yet the outlook's only down about $0.20 to $0.25. Now some of the benefit comes back to us in terms of lower interest expense and then maybe you're allowing for some of the taxes. So it seemed to me either we have some -- you either had some severance in the first half of the year that you kind of talked about but didn't want to break out, or there is some mix or something else that sort of allows for improved gross margin in the half. Can you help me a little bit along there?

Robert D. George

Well, that's a -- there's a lot of details there, Howard, in factoring it in. And I'll go back to my discussion that I had with Noah. As we look at the second half of the year, so we're sitting here with revenues today of about $950 million. We're looking at $2 billion for the year. Our margins -- as I mentioned, our gross margins, we're not anticipating expansion there, so we're looking at a very similar margin picture through the year. R&D is continuing to be compressed. And you're correct, we've got some benefit in the interest expense line, as I mentioned earlier in answer to one of the questions. And corporate expense, as Sam asked, I believe, is we're anticipating leaning a little bit lower. And we do have the tax benefits in there.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

So you might not have had those tax benefits in the earlier part of the outlook. Or they might have been a little fuzzy. Is that a fair statement? [Indiscernible]...

Robert D. George

So when you say, I just want to make sure we're on the same page, the earlier part of the outlook...

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Excuse me, the first quarter.

Robert D. George

Okay. When we -- in our first quarter call, I think we were quite clear in indicating that to get to the higher end of the -- of our guidance range, we would require the benefits of the tax reductions. I might be mistaken on that, but I believe we were...

Howard A. Rubel - Jefferies & Company, Inc., Research Division

No, you're not. You're not. That was articulated on the call at that time.

Robert D. George

Thank you.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

No, no, no, not at all. But just to -- so then is there -- can you articulate then is it -- is there -- there is some headcount reduction as well? And can you sort of point to some of the specifics? I mean, it just seems to me that there's a lot -- you have a lot of potential and you talk about a lot of moving parts to make the enterprise better, but it's kind of 1 step forward and maybe 1 step backwards.

Robert D. George

Well, the -- what -- as we've said, I mean, I think it's a -- we're doing tremendous amount of work in the business units to offset cost increases on flat revenues. I mean, essentially, what we're looking at right now is year-over-year, no organic growth and our earnings performance is substantially better than what we returned last year. If you take a midpoint of our current guidance compared to last year's performance, we've got substantial improvement there.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

You mean -- right, $5.40 versus $5.27.

Robert D. George

Well, actually, the $5.27 on an operating basis is really more like $4.97. We had the $0.30 per share from the litigation settlement last year.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

True. Okay. All right. I just still kind of feel like there's a little bit more that you're starting to articulate. But maybe just to finish this, if -- could you elaborate a little bit more then, on some of these initiatives that are, in fact, allowing you to stay ahead of the pressures you're feeling from the customer?

Robert D. George

Well, as you know, we have -- from our conversations over the years, I mean, we have been -- I mean, and platform concept is a strong move in that direction. Our platform presidents are working aggressively on taking advantage of the synergistic effects of a larger base of units together. We're continuing that initiative as we go forward. And at this point in time, providing more specifics is -- we're just not prepared to do that at this time.

Richard Bradley Lawrence

So Howard, I would add a couple of things that -- fairly small items but they're moving in the right direction. We had the -- we reduced the workforce by about 5% in the first half of the year, and that was done surgically at the units that were affected by the volumes. And we also have started a strategic sourcing initiative across Esterline. You're familiar with our decentralized model. And as we gain critical mass with Souriau, we see opportunities to combine some purchasing, use our purchasing power and reduce some cost in that area. So it's pretty much an additive thing of a lot of fairly smaller initiatives that add up to improved performance.

Operator

Your next question is a follow-up from Michael Ciarmoli with KeyBanc Capital Markets.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

You guys hit most, covering with Howard just now. But maybe one last one on that topic, Bob. What are the puts and takes to the high end and the low end of the EPS range? Do you still need that U.K. tax gain to be sort of $4 million versus $2.5 million to get to a $5.50 number? Or how should we be thinking about the range of like the EPS?

Robert D. George

As we've talked about it, Michael, in assess -- in assessing this guidance, a key part to reaching the upper end of that range in the second half is an improvement in our aftermarket activity.

Operator

At this time, there are no further questions. I would now like to turn the call back over to Mr. Brad Lawrence for closing remarks.

Richard Bradley Lawrence

Thanks, Jason. And before we sign off, I would like to reiterate a few key points. First off, I would like to remind everyone that the discrete programs that are currently impacting our performance are experiencing delays. They are not program cancellations. Also, as Bob just reminded us, we should bear in mind that even our revised -- with our revised guidance for the full year, the midpoint of our range is nearly a 9% improvement over 2012's adjusted earnings result of $4.95 per share. And finally, the overall health and strength of Esterline is apparent. We expect to see record cash flow and earning this year. And as Bob mentioned, we're on track to generate over $200 million in cash. And with that, thank you for joining us today. We look forward to speaking with you again next quarter or seeing you while we're out on the road. Good evening.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect, and have a great day.

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