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Esterline Technologies (NYSE:ESL)

Q4 2013 Earnings Call

December 05, 2013 5:00 pm ET

Executives

Brian Keogh

Richard Bradley Lawrence - Executive Chairman and Chairman of Executive Committee

Curtis C. Reusser - Chief Executive Officer, President and Director

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

Analysts

Howard A. Rubel - Jefferies LLC, Research Division

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

Tyler Hojo - Sidoti & Company, LLC

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

Julie Yates - Crédit Suisse AG, Research Division

Noah Poponak - Goldman Sachs Group Inc., Research Division

Kenneth Herbert - Canaccord Genuity, Research Division

Operator

Good afternoon, ladies and gentlemen, and welcome to the Esterline Technologies Fourth Quarter 2013 Financial Results Conference Call. At this time, I'd like to inform you that this conference is being recorded. [Operator Instructions] I will now turn the call over to Mr. Brian Keogh. Please go ahead, sir.

Brian Keogh

Thank you, operator, and good afternoon, everyone. Brad Lawrence, Esterline's Executive Chairman; Curtis Reusser, President and CEO; and Bob George, Chief Financial Officer, are here today to discuss Esterline's full fiscal year and fourth quarter 2013 performance and our strategy and initial guidance for 2014. In addition to our website, where you can get a replay of this call on the Investor Relations section, there is a toll-free number that you can call. It's 1 (888) 286-8010. You'll need the following PIN. It's 30504569. Either place, you can get a replay of the call.

As always, I should 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 risks and uncertainty, which we detail in our public filings with the SEC.

Thank you again for joining us. I'll turn the call over to Brad now.

Richard Bradley Lawrence

Thank you, Brian, and thank you, everyone, for joining us today. Before I introduce Curtis, I'd like to take you through some highlights from Esterline's fourth quarter and full year. As expected, our earnings accelerated throughout fiscal '13 and we finished strong, much like last year. We set another record for sales this quarter and grew even when compared to last year's exceptionally strong fourth quarter, even in a continued challenging defense environment. Growth in our commercial aerospace markets and certain new program ramps drove the business.

Operating profit was up over 12% and our fourth quarter operating margin rose 180 basis points versus last year to just above 17%. This was a result of some benefits of scale, effective cost controls and a number of positive contract resolutions, the latter reflecting our customers' recognition of our performance and contributions on key programs during the year.

Earnings per share from continuing operations was $2.07 in the fourth quarter, a record for Esterline compared with $1.97 last year. Full year revenues were down slightly, mainly due to timing of some large expected orders, but also due to the challenging defense environment. Full year operating margins improved significantly, though as Curtis will detail, we're working towards additional improvement. This drove our earnings per share for the full year up over 7% on an apples-to-apples basis.

I've been with Esterline for the past 11 years and I've been part of and initiated growth and change throughout the organization. We put together a strong group of businesses and created a culture of success. Curtis and the team will now build on that foundation to enhance Esterline's leadership position in each of our markets. Curtis brings to Esterline more than 30 years of broad experience in the aerospace and defense industry. He joins us from United Technologies, where he served as President of Aircraft Systems and was responsible for the financial and operational leadership of 7 strategic business units, employing more than 14,000 people generating revenues in excess of $7 billion. Prior to UTC's acquisition of Goodrich, Curtis was President of the Goodrich Electronics Systems strategic business unit, which consisted of 3 segments, including sensors and integrated systems; engine controls and electric power systems; and intelligence, surveillance and reconnaissance systems. Performance of this business was remarkable under his leadership. Not only did the size of that division nearly double during his tenure; it's posted significant margin improvement.

I've known Curtis for several years through our industry association activities. We were delighted to find such an experienced leader and just as importantly, one whose values are consistent with the Esterline culture.

With that, I'd like to turn the call over to Curtis.

Curtis C. Reusser

Good afternoon, everyone. Thank you, Brad, for the introduction and for the work that's been done to put Esterline on the path it's on today. I'm very excited to have this opportunity to lead Esterline forward. I've seen our kind of growth position here before and I'm confident that over the next few years we'll take Esterline to the next level.

I see a number of key fundamental reasons to be encouraged about our future. First is Esterline's can-do culture, which is very similar to what we built at Goodrich. The engineering roots go deep here. That creates value for our customers through innovative product offerings and makes operational excellence a natural focus throughout the organization.

Second is our balance. We have a complementary mix of category-leading businesses with great brands in the industry. We work in demanding markets, where customers consistently expect new levels of high-performance in extreme environments, ever-improving fuel efficiency and economies, more intelligent electronics and systems and lighter-weight materials and applications. Our customers and partners know that we consistently deliver those features across our entire portfolio of businesses.

Third is our strong balance sheet and the excellent cash generation ability that we have here. This past year, the business generated cash flow in excess of $250 million. That cash will support investments for organic growth, enable significant growth through M&A, facilitate value-added investments in R&D and maintain our balance sheet metrics through judicious capital allocation policies.

I've been on the job for a few weeks and so our strategy and tactics are still evolving. But I do know that 2014 is going to be an important year for us. We're in good shape in the commercial aerospace markets and adjacent markets. We continue to see acceleration in the build rates and some improvement in the aftermarket. These markets are essentially healthy and we have a positive long-term outlook for our commercial growth opportunities.

With respect to our defense businesses, we're on good high priority programs, including the A400M in Europe, which is ramping up, the T-6 trainer aircraft, the P-8 Poseidon and the F-35. But overall visibility on the budget is limited and so it's prudent to assume that the budget will stand to pressure for the foreseeable future.

Our domestic defense is about 25% of our total revenue mix. Our focus is to protect our profitability and do a better job of capturing international demand. Maintaining revenues is one path to success, another is to ensure that we have a strong integrated approach to our business without duplication that's been streamlined for efficiency, that embraces lean practices and is supported by deep shared services, all this while leveraging customer relationships to maximize our opportunities.

I've been down this path before and see how successful it could be in driving growth and profitability. In the year ahead, we're going to accelerate efforts to organize our business and drive towards goals of higher operating margins and a stronger growth rate. I'm confident that not only can we deliver cutting-edge products, but we can be innovators of process and efficiency for ourselves, our customers and our shareholders.

We've identified an initial set of specific projects that we'll execute in 2014 and beyond. We have some internal processes to complete before we get into the specifics, but these actions will include driving accelerated Lean and operational excellence, consolidating certain facilities and product lines, centralizing some shared services and better utilizing certain support functions. This will drive efficiency, eliminate waste even as we make investments in some areas, including sales, compliance and customer service. Each of our segment group presidents has already begun to identify specific opportunities to accelerate and deepen our integration efforts. We are aiming for high return projects that will drive value in the short-term and enhance our competitiveness going forward.

At the corporate level, we're focused on risk management, maximizing the effectiveness of our shared services and capitalizing on economies of scale. In total, we're anticipating taking charges of approximately $40 million in total. $25 million to $30 million of that will happen in fiscal '14, with the balance incurred in 2015. Expense savings on these short cycle activities will commence in '14, with substantially more savings expected in fiscal '15. We expect these projects to build an annual savings in excess of $15 million per year beginning in fiscal 2016.

I'd stress that these are the first actions of what will be a core discipline for us as we maximize the return from our present businesses, growing them organically and continuing to grow through acquisitions.

In addition to these accelerated integration activities, we're taking a fresh look at our capital allocation model to continue to drive value to our shareholders. I'm sure you know given the highly regulated nature of this industry, most of our planned improvements won't come at the flip of a switch. Our guidance in FY '14 is limited to modest growth and steady margins. As we move forward, I'm confident we can do things better, we can do things faster and we're looking forward to showing you.

With that, I'd like to turn the call over to Bob George to run through our FY '13 results.

Robert D. George

Thanks, Curtis. Good afternoon, everyone. As Brad indicated and Curtis indicated, similar to last year, we finished the year with a remarkable fourth quarter. Unlike last year's fourth quarter though, this year, it did not feel as if everything was breaking our way. We had the government shutdown in October and this made it difficult to get a reasonable number of orders processed. Compound that with the fact that several of our international customers didn't complete final inspections and that meant we couldn't ship some product. And to top it all, several of our large completed contract orders were shipped but did not get finalized and this meant we couldn't recognize revenue from them in the quarter.

Fortunately, as it is now apparent, more than enough did go our way. Sales of $534 million in the quarter are a record; gross margin of 38.5% in Q4, a near record level; solid expense control in research and development and selling, general and administrative costs; excellent negotiating results closing out various NRE items and contracts previously impacting SG&A and R&D expense; and reduced debt levels and interest expenses. These items, combined to generate earnings performance for the quarter of $2.07 per share from continuing operations and for the year, adjusting for the items we discussed in the third quarter, $5.65 per share. This is right in the middle of the full year EPS guidance we gave at this time last year. And bottom line, from an operations and a cash flow standpoint, 2013 was a strong year.

Let's drill down into the details with a quick look at some of the consolidated metrics. Sales were down slightly in 2013 from 2012, $1.97 billion compared to $1.99 billion. This was a direct result of the challenging defense environment, specifically in our communications businesses. Gross margin performance continued our trend of year-over-year improvements, finishing the year at 36.9% compared to last year's 36.1%. Earnings per share, adjusting for non-operating factors in both years, were $5.65 this year compared to $5.27 last year. And cash flow from operations set yet another record in 2013, finishing over $251 million.

So let's take it down another layer and add some more color. First, sales. As we've discussed in previous quarters, our sales line this year has been a tug-of-war between solid commercial growth and a challenging defense environment as well as flat aftermarket activity. Fourth quarter sales were up over last year's powerful finish, however; $534 million this year, $531 million last year. Avionics & Controls and Sensors & Systems segments were both up nicely, offsetting a slight decline in Advanced Materials. As you know, last year, Advanced Materials carried the day to 2012's exceptionally strong finishing kick.

Gross margin performance in 2013 continued our trend of year-over-year improvement. For the year, we recorded gross margin dollars of $726 million, 36.9% of sales, compared with $719 million or 36.1% of sales last year. From a segment perspective, Avionics & Controls gross margin was influenced by the reductions in activity of high-margin products in our Communications businesses -- signals intelligence receivers and sophisticated headset devices -- leading to a decline in both the fourth quarter, as well as full year. However, this effect was offset as both the Sensors & Systems and Advanced Materials segments were positive for the quarter and the year.

For the year, by segment, gross margin was 38.5% in Avionics & Controls, 37.4% in Sensors & Systems, 33.5% in Advanced Materials.

I mentioned in my opening comments that expense control was a positive contributing factor to our results this year. R&D investments for the year were $95.7 million or 4.9% of sales. This performance is right in line with the 5% of sales we target on an ongoing basis. Last year's comparable numbers were $107.7 million or 5.4%.

In the fourth quarter, R&D expense was 4.3% of sales this year, $22.8 million, compared to last year's 4.6% or $24.6 million.

Selling, general and administrative expenses were $391.1 million this year. In the third quarter, we recorded a $10 million expense contingency related to trade compliance. Adjusting for this reserve, SG&A was $381.1 million or 19.3% of sales this year compared with last year's $382.9 million or 19.2% of sales.

Segment earnings were up strong in both the full year and the quarter in 2013. For the year, segment earnings were $303.6 million this year compared to $271.6 million last year, an increase of 11.8%. Note that both of these figures were adjusted for Racal impairment expense of $3.5 million and $52.2 million, respectively. For the fourth quarter, segment earnings were up 12.1% to $101.2 million from $90.3 million last year.

Esterline's tax rate in the fourth quarter was 20.4%. This compares with 13% a year ago. Last year benefited from various tax credits and foreign interest expense deductions. For the year, however, these ratios were reversed. Esterline's tax rate for fiscal 2013 was 15.2% compared to last year's 20.9%. Both years benefited from a number of credits and foreign interest expense deductions. This year, however, the company also benefited from a $4.9 million release of reserves due to the expiration of the statute of limitations that we discussed in the third quarter.

Looking forward, our projections for 2014 are based on a tax rate of just over 21%. This increase makes for a tougher comparison on the EPS line 2013 to 2014. Bottom line, net earnings from continuing operations in 2013 was $166 million, $5.23 per share. Excluding the $3.5 million impairment and $10 million compliance charge, adjusted net earnings for the year were $179.5 million or $5.65 per share.

In 2012, Esterline's net earnings were $112.5 million, $3.60 per share. If we exclude last year's $52.2 million impairment charge, adjusted net earnings were $164.7 million or $5.27 per share.

The company's operating unit leaders continue to manage their businesses exceptionally well. A great measure for this is record cash flows. Cash from operations in 2013 was $251 million, smashing through the record levels set last year of $194 million. Capital expenditures were $55 million in 2013 compared with $49 million in 2012. Free cash flow, therefore, also set a new record, $196 million compared with last year's $145 million.

As we indicated in the release, we are looking at next year's revenues to be about $2 billion to $2.1 billion. So we are anticipating growth even in a tough environment. If we use the midpoint of the range, we expect operating earnings to increase by approximately 5%. So again, the tax rate increase we expect will keep a lid on the strength of the EPS comparison. Therefore, we expect earnings per share to be in the range of $5.40 to $5.70.

Curtis also identified in his remarks that we're commencing a series of moves designed to reduce expenses, improve efficiency and increase profitability. In 2014, we are projecting that we will take charges and expenses of approximately $25 million to $30 million related to execution on a number of different initiatives across the Corporation.

We expect to see some modest benefit from certain of these efforts late this fiscal year. We expect savings will continue to build in 2015 and we'll achieve run rate savings of $15 million a year in 2016.

In our third quarter 10-Q and in today's press release, we identified costs in 2014 associated with bolstering our trade compliance programs across our business units. As I mentioned earlier, these costs are incremental to 2013 and are not included in our operations guidance for 2014. As you know, we are fully committed to transparency with all of our stakeholders. Therefore, commencing with the first quarter 2014 results, we will be tracking our efforts in detail and providing you with a review of the expenses and, when appropriate, the benefits we are seeing.

Curtis, back to you.

Curtis C. Reusser

Thank you, Bob, and everyone for your time today. I hope you can sense and share the enthusiasm I have for Esterline in the years in front of us. Esterline is extremely well positioned. I see potential across the entire business. Taken together, I think there's a tremendous opportunity to enhance and improve our operations, drive up productivity and efficiency and layer on some powerful incremental growth over the next few years.

While I'm still just finding my stride after only 6 weeks on the job, what I see is a well-balanced business, a technology leader driven by powerful results-oriented culture that has been a fundamental part of Esterline for a long time. We are strong financially, both in terms of the balance sheet and our ability to generate cash and we have a lot of opportunity to do more with what we have. We're already taking important decisions and we will accelerate our progress along our strategic path. I'm excited to work with our team and with all of you on the line today to turn our aspirations and goals into accomplishments and building blocks for continuous improvement and consistent value creation.

Thank you again for your interest in Esterline. And with that, operator, we'll open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Howard Rubel, Jefferies.

Howard A. Rubel - Jefferies LLC, Research Division

First, I want to comment and, I mean, nice numbers in the quarter. And I know, Bob, usually I give you a little bit of a hard time on SG&A, but it's very nice to see the direction change. And so when I see something that's that way, I want to call it out because I know [indiscernible] otherwise. And then the second -- well and maybe just the only question I really have is one directed to Curtis. Maybe you could talk a little bit about how you thought about the outlook for the company and how you worked with Brad and the rest of the organization to sort of set some of the incentives for your senior operating executives.

Curtis C. Reusser

Again, I joined just a couple of weeks ago and we jumped right into looking really extending some of the -- a lot of these plans that we just announced today were in place. I think they've done a nice job of reacting to what you all have directed them to do. And we're starting to see some results but thought we needed to do some things further. We are looking at a couple of projects here as well as kind of an overall direction and we are tying in -- to get people's attention, we just came out of a board meeting and had lots of discussion about these projects and how we tie results to drive improvements on margin, return on invested capital. And we're going to be tracking a number of these projects to get pretty specific. So it's, so far, really good cooperation with the team. Brad and I think a lot a like. Coming in here has been a real pleasure because the team is real experienced and they've got a great momentum going forward. It's nice to be here and work with the team, specifically, in driving some of the compensation and how we're going to reward people. It's interesting, I think we've got a good practice in place. The team really came up with a lot of these ideas. They understand that they're going to have to drive costs out and become more efficient and drive more efficiencies. It's interesting, I just -- my first look was that this looks a lot like Goodrich did a number of years ago. And I think there's just a lot of opportunity to drive improvement across the enterprise.

Operator

The next question comes from the line of Michael Ciarmoli, KeyBanc.

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

Maybe just one question first on the quarter on the margins. Clearly, tremendous performance within the Advanced Materials segment, 24.9%. Can you give us a sense -- I know there was a gain on an asset sale and then I think Bob, you mentioned there were some contract adjustments. Was that a clean number there? Or can you give us a sense of what the normalized number was in Advanced Materials? And think on the last call, you kind of hinted that, that 22%, 23% range was sustainable. So maybe just a little bit of color on that at Advanced Materials profitability.

Robert D. George

Yes, Mike, thanks for the call, thanks for the question. First of all, I need to -- we need to complement the leaders of the platforms in Advanced Materials because they did an outstanding job this year generating that income. Fundamentally in the quarter, for the most part, I would say those margin levels were reasonably clean. And when I say reasonably clean, we did have a funding from our Defense Department customer. I can't speak about it too much for security reasons, but we've been working on a number of R&D projects. And the Defense Technologies group in particular are really stretching the boundaries. They did an outstanding job, delivered a new product and were rewarded for that to the tune of about $1.5 million in the quarter. It was just outstanding performance by the entire group. We also had also in the Defense Technologies group, we had about $0.5 million of reversal of a legal contingency that we had established last year in the fourth quarter. And that was settled very well. And so we were able to reverse about $0.5 million. The Engineered Materials team just performed outstandingly well and the Surface Finishing did as well. So with the exception of those 2 items, that was pretty much a clean quarter.

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

Okay, fair enough. And then maybe just one more bigger picture for Curtis and keeping in mind that you've just been here a short time. But looking at this integration, you guys mentioned there were some strong brands, which we all know. I mean, are there any opportunities to maybe prune the portfolio? Are there some assets that might not fit? I mean, how should we be thinking about the current composition of Esterline as you guys sort of execute on this plan?

Curtis C. Reusser

Yes, good question. I think there's always -- I think that's part of our -- my job is to diligently work to create value. We're going to be going through over the next probably 5 to 6 months developing a more thorough strategic plan, but part of that is going to be me getting out and really looking at what's driving value, timing-wise what makes sense, mix-wise what makes sense. So that's definitely on the table. We're taking a look at that. So that's definitely part of what we're going to be doing absolutely.

Operator

The next question comes from the line of Tyler Hojo, Sidoti & Company.

Tyler Hojo - Sidoti & Company, LLC

Just to follow on to Mike's question, Curtis, I'm just wondering now that you've taken the CEO reins, what you kind of view as your biggest challenges and potentially biggest opportunities. And specifically what I'd like you to potentially address is Esterline has had this I think long-term operating margin target of, I think it was 15%. Do you still think that's achievable or do you think there's perhaps some upside to it when you talk about portfolio shaping and some of the restructuring initiatives?

Curtis C. Reusser

Well, I've been guided to be very cautious about making commitments. But I think there's long-term -- we're going to be looking at that. I've jumped in -- my expectation is I come from a background of continuous improvement. And we're going to drive out ways throughout the organization and both really embracing Lean, looking at ways we can drive out duplication and efforts. So I think there's a lot of opportunity. So I think they did have a target out there internally. I'm sure we're going to drive higher than that. But I've got to work with the team to see what the biggest levers are. I'm very optimistic, I'm very optimistic. It's probably a little too early to commit on a time and a number, but I would hope that there's upside to that.

Tyler Hojo - Sidoti & Company, LLC

Okay, wonderful. And I guess for my follow-up question, I'm just curious what the current business mix is for -- was in fiscal '13 between commercial, defense and industrial and what the expectations are embedded in the guidance for fiscal 2014 within those markets.

Robert D. George

Tyler, this is Bob. As you would expect and it's fairly normal with our relatively balanced mix and a strong commercial upmarket, commercial is moving a little bit beyond the 40% and defense is down somewhat this year. I don't have the exact numbers yet. We're working on that for the Q, but I would guess that commercial was probably in the neighborhood of 45%; defense maybe a little lower than 35%; and industrial the balance.

Curtis C. Reusser

There's probably just a couple of other things that would be -- might have some impact there. We saw kind of a flat industrial in Europe last year. There might be some upside there. And also we'll have a full year of the Gamesman acquisition so that might impact a little bit to -- to the upside in that segment.

Operator

The next question comes from the line of Sam Pearlstein, Wells Fargo.

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

Bob, I guess my first question is -- I just wanted to make sure I understood. In the release, you talked about these positive resolutions to contract assertions and other matters. I mean, we know that -- you identified the gain, can you just say which segment that ended up flowing through? You identified a couple of things in Advanced Materials, but what about the other 2 segments? Are there any other items we should be thinking about?

Robert D. George

Well, Sam, most of the items that we talked about there, that we identified, they essentially were settlements of negotiations that have been going on for a period of time, in both R&D and SG&A, related to costs that we had carried within the year. So essentially, they weren't -- we called out the product line sale as you saw, but the others are ongoing business matters and they were spread across the segments.

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

Okay. And I guess for Curtis, can you just talk -- you mentioned one of the things you're going to look at is capital allocation plans. Can you just talk a little bit about what you're thinking in terms of either uses of cash, capital structure? How are you thinking about that?

Curtis C. Reusser

All of the above. We're still as -- as we develop the strategic plan -- we just met with the board today, yesterday and today, and a lot of focus on that just because we have, obviously, very, very strong cash generation. So we're going to be looking at, obviously, growing organically, looking at strategic bolt-on acquisitions and looking at other levers to return value to shareholders potentially. So there are a lot of discussion on that right now. Probably just a little too early to get specific on it, but it's a nice -- as we talked about, it's a nice problem to have. Again, the outlook is extremely strong and over the next couple of years, it's an issue that we're going to have to get a plan together and we expect to do that over the next couple of months.

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

So do you think the resolution or when you're going to be able to talk about that is similar to when you might talk about some of the other long-term plans in terms of margins in terms of it's a few months away?

Curtis C. Reusser

Yes, we're -- I've committed to review that with the board, probably Q2. And along with that will be a capital allocation strategy.

Operator

Next question comes from the line of Julie Yates, Crédit Suisse.

Julie Yates - Crédit Suisse AG, Research Division

You guys, you cited some improvement in aftermarket. Can you elaborate on what you're seeing and then what your expectation for that end market embedded in your FY '14 guidance?

Robert D. George

Julie, this is Bob. I'll jump in here. As we discussed, most of the year, we were surprised and a little disappointed with our aftermarket performance this year being roughly flat. We're expecting that to turn around next year and we're looking at nominal growth. We're certainly not -- I mean, I've seen some very, very large numbers out there. We're not expecting that. But we are expecting normalized growth pattern to retain -- or to resume, if you will, in 2014. Particularly in our Sensors & Systems segment.

Julie Yates - Crédit Suisse AG, Research Division

Okay. So perhaps maybe in line with capacity?

Robert D. George

Yes.

Julie Yates - Crédit Suisse AG, Research Division

Okay. And then, Bob, what level of SG&A should we be thinking about for '14 and then also for interest expense?

Robert D. George

Well, interest expense, again, as Curtis just finished in his discussion with Sam, we'll be identifying our capital allocation plans more specifically as we get to the middle of the year. In the meantime, we still have prepayable debt. So we'll continue to be down our debt. But if you just take a look at the trend we've been going, that's what we modeled for in 2014. We're certainly not looking at increasing the debt numbers, so we're using that cash flow there. As far as SG&A, I'm going to take a pass right now on that one, Julie, simply because we'll be beginning work on these projects and I'd rather see how that's influencing us as we go through next year. Right now, what we've done is we've modeled the year -- basically when we took a look at modeling, fiscal 2014, we started with our business mix and revenue mix as we see it today. And from there, we looked at each one of the individual projects with a detailed project plan, roll that up and then got to the levels that we've identified in our guidance. What we're expecting to do as I mentioned in my comment, with each quarter, we're going to be specifically identifying the cost, the impacts, whether it be in cost of sales or SG&A or otherwise and what the benefits we're seeing. So we'll be providing that transparency as we go forward.

Julie Yates - Crédit Suisse AG, Research Division

Okay. Okay, great. And then last year you offered some color on the cadence or more specifics around F Q1. Is there anything you can offer? Are you going to try to do it as you go through the year?

Robert D. George

I will say that what we are looking at next year is a more normalized Esterline pattern. We're still going to have a relatively light first quarter, as we always do, primarily based on the holidays and the like. Second and third quarters are going to be stronger in about -- at about the same level. Fourth quarter will continue to be our strongest, but not to the extent, on a relative sense, that 2012 and '13 were.

Operator

The next question comes from the line of Noah Poponak, Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

You've talked about this a little bit, Curtis, but I wondered if you could just maybe speak a little bit more about just how different the core everyday lean continuous improvement processes and controls are here versus the companies you're coming from. Just because -- the things where you're giving us specific numbers, today, are facility integration and sort of specific things we can look at. Is there more upside in the lien and efficiency improvement stuff for margin improvement or are you able to get less out of that than the numbers you're giving us on the facility side because things are already pretty good?

Curtis C. Reusser

No, I just -- I think it's a little early. I've been to a couple of the facilities so far. I've got plans to get out to see all of them. Very similar at Goodrich and at UTC is there's a mix of nuggets that are really -- it's really ingrained and others that they've had other priorities. That's going to be a focus area for me, is to make that more consistent, get us up to a consistent level and get personally involved in looking at that and getting people up to speed. Because it's just a -- I think, no matter what business I'm in, I don't think you're ever as lean as you can be. So I think there's a lot -- no matter where -- I think there's a lot of opportunity here, I think. On the plus side, they understand it, there's been work here, they know the lingo. It's not like it's -- you get a blank stare on your face. However, I think there's good opportunity and I think it's probably peaks and valleys throughout the organization and part of our drive as a management team is going to be to make that consistent. And the good news is the senior managers here and the folks that I've met so far are all saying, yes, let's get going.

Unknown Analyst

Okay, that's helpful. And then, separately, in the Defense business or in the defense end market, can you maybe just talk a little bit about the buying patterns you're seeing from the customer right now? Are there any signs of stabilization, at all, in the shorter cycle businesses? And then I'm also curious what you're feeling from the prime contractors in the long cycle businesses.

Curtis C. Reusser

Well, there's -- we've seen kind of some ups and downs. We tried to bake -- we think there should be some consistency. We've already tried to break some -- build some of that into our guidance, as far as what we've seen. We had some weakness in a number of our businesses last year. So we're down pretty far. I would sure hope that we're going to see some improvements going forward. On the platforms, on the new programs, we've got the A400M. That's moving forward. We've got the P-8, which is real stable. We've got the F-35. So, I mean, those are all pretty -- we think pretty good stable programs and should see pretty consistent. Some of the smaller parts that we either supply direct or through distributors at certain cases, we're going to have to wait and see on those. We're optimistic, though, for the year.

Operator

[Operator Instructions] The next question comes from the line of Ken Herbert, Canaccord.

Kenneth Herbert - Canaccord Genuity, Research Division

I just wanted to follow up on the defense discussion with just a two-part question here, if I could. First, it sounds like you haven't gone through each of the end markets. But it sounds like the guidance would imply defense sales maybe up low single-digits, flat at low single-digits in '14. And I just wanted to see if that was consistent with your thinking. And then second, Bob, you talked about some things that fell out of the fourth quarter due to the government shutdown and other issues. Are those things you expect to sort of make up here in the first quarter or first half of the year, or are those potential sales that are at risk and you -- can you quantify that at all?

Curtis C. Reusser

Yes, Ken, I'll jump in here with the last one. Let me just give you an example. I won't give you the customer or the product, but -- of what we're dealing with here. And the issue really -- and I'm sure that all of our peers are in the same boat, so I don't think we're unique here. So one of the orders that we were anticipating getting in the fourth quarter, that we did not get, okay, it was not lost. It was just not able to get through there. Shortly -- actually near the end of our fiscal year, we were told that it was going to be released the middle of this month -- the middle -- well, actually, the middle of last month. The middle of November. As we were approaching that date, that date was then moved out to March. The other day, our segment group VP was talking to the Platform President there, was told now that it's December 13. So all of that is to say that, yes, we anticipate that those orders and shipments that we were not able to get processed in the fourth quarter are going to roll into next year. The answer that you asked, however, is no, I'm not anticipating that they will all roll into the first quarter. The environment is just too unstable right now. We are expecting them to come into '14, but not in the first quarter.

Kenneth Herbert - Canaccord Genuity, Research Division

Okay, great. And then -- yes, I was just gonna say, broadly, for your outlook for that market for fiscal '14.

Robert D. George

Yes, what we're looking at in the defense side for our activity next year is we're looking at generally flat defense level activity year-over-year.

Curtis C. Reusser

And we've probably got some up -- we've got some opportunities there. But that's what we're thinking. There's some discrete programs that we're out pursuing that could be some nice upside. But we're planning, roughly, flat.

Kenneth Herbert - Canaccord Genuity, Research Division

Okay. Okay, now, that's helpful. And then just finally, if I could, it's -- I know it's early on and you're not prepared to talk about priority or specific strategies for cash deployment. But, Curtis, you mentioned a few times, bolt-on acquisitions, is there anything you can say, based on your time there, where you might identify particular gaps or opportunities that you would look for from a bolt-on strategy, to the extent that you would pursue that?

Curtis C. Reusser

[indiscernible] now and the approach I think that the team here has evolved to is we've got enough...

[Audio Gap]

...we are looking at things that we can bolt-on and drive better synergies than just bringing them in and operate on their own. To be fair, though, I'm going to need a little more time to go through the detail. We've already got -- I've been through a couple of them, but detailed strategic plans of each of our operating units. And that's one of the questions we're going to be asking.

Operator

The next question comes from the line of Howard Rubel, Jefferies.

Howard A. Rubel - Jefferies LLC, Research Division

Just to go back to something and maybe -- I don't know whether Bob or Curtis or Brad would like to answer this. But you've been very cautious in how you thought about cockpit upgrades and the outlook for that. Might you address how you're thinking about that business for next year?

Curtis C. Reusser

Yes, just -- this is Curtis. We feel pretty optimistic about it. We have not planned any of the bigger cockpit upgrades that we've had in the past. But we're pretty optimistic about it. Brad was just over at the Dubai Airshow and just gave an update to the board today and it was -- the outlook was pretty good. I don't know, Brad, if you want to make any specific comments.

Richard Bradley Lawrence

I just think that -- Howard, we just -- as you know, we've been unable to time these. However, I believe the market fundamentals are very strong in this area. The FAA continues to march on towards next gen and the requirements to upgrade the avionics and these fleets around the world is very real. CMC is in a terrific position with their FMS and their navigation capabilities to upgrade these fleets of primarily military aircraft. So I see a very strong opportunity, but we just -- we don't see enough visibility to include any of those in our '14 forecast.

Curtis C. Reusser

There might be some upside on the defense side.

Howard A. Rubel - Jefferies LLC, Research Division

All right, got it. I mean, you want to -- you don't want to plan for something that can't happen and that -- I get it. Your inventories were up on a year-over-year basis. Maybe you could elaborate a little bit on why that's the case. I mean, considering we were flat in sales.

Robert D. George

Yes, Howard, I'll -- this is Bob, I'll take that. We had a couple of operating units we were -- first of all, I guess I want to point that some of those inventories were acquired with the Gamesman acquisition. So that was part of the differential. But fundamentally, the other growth is looking at the organic growth that we've got plugged in for next year and some inventory allocation on that. Most of it's raw materials.

Richard Bradley Lawrence

Also, Bob, if I might, there's -- just to remind everyone that we had some shipments in Q4 that we expected to go but we didn't get the releases for. So that didn't help the inventory number any.

Robert D. George

That's a great point, that's a great point.

Howard A. Rubel - Jefferies LLC, Research Division

And then just one last item on Souriau. I heard Curtis sort of indicate that you feel there's -- stability might be a fair way to describe it. And maybe for a moment, could you both describe the condition and the profitability as you saw the end of the year and what you're seeing as possible improvements?

Richard Bradley Lawrence

Yes, Howard, let me take that one. The Souriau has been performing very well. And operationally, they've been performing outstanding. There's just -- I won't bore you with all the details, but primarily from European customers, Souriau continues to get supplier award after award and their on-time delivery and quality is really terrific. They have been suffering, as we said in the past, from a mix switch. So the top line revenue number is doing pretty much exactly as we anticipated and -- when we acquired the company. But the shipments are going more strongly to commercial aero where the margins aren't as robust as they are in the industrial markets. So as we see the industrial markets returning in Europe, we see upside opportunity for Souriau's performance.

Operator

The next question comes from the line of Michael Ciarmoli, KeyBanc.

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

Maybe, Bob, just on the cadence of some of these integration costs, how should we be thinking about the $25 million to $30 million? I mean, is that going to be spread fairly evenly quarter-to-quarter or are you guys anticipating some heavy lifting right out of the gate here? Just maybe help us out there.

Robert D. George

Yes, that is a great question, Mike, and thanks for asking it. As you know, with some of our strong positions and being flight-certified, we just can't make changes without our customers' involvement. And we have made a number of moves in the past and we understand that these things, particularly in an area or timeframe where commercial aerospace growth is very robust, getting those resources and approvals is sometimes more time-consuming we anticipate. What we have looked at, in terms of that cadence, to use your phrase, as we look at it, is we'll probably start relatively slowly. And then we will begin to build as we go forward. We have programs that are launched that we're moving forward with right now. Some of those do not require those customer involvements and those will be much quicker. What I would expect is that as we get a couple of months under our belt and we begin executing on these, that we -- when we are back on the phone in March or late February -- I can't remember exactly when our earnings call is for the first quarter next year -- we will be -- we will have more information and we'll be more directive in terms of how we're seeing that play out during the year. But I do not think that it's going to be front-loaded. And it will not be even, it will tend to grow as we go through the year.

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

Okay, perfect. That's helpful. And then just lastly, the compliance cost. I just want to make sure I understood you, in your prepared comments. Are there potentially going to be more cost there, that aren't baked into your outlook?

Robert D. George

What we have done and the way that we've talked to the board about it -- we've looked at the year -- and the answer to that is, yes. We obviously have a base of compliance costs that are in our numbers and that have been growing. But as we are nearing the -- probably the conclusion, with our discussions with DTCC, we are anticipating an incremental $10 million in 2014 of which some of that will be in our base on a going-forward basis and some of that will, generally, begin to phase out in 2 to 2.5 years.

Operator

The next question comes from line of Tyler Hojo, Sidoti & Company.

Tyler Hojo - Sidoti & Company, LLC

Just, first, what was D&A in the quarter?

Robert D. George

For the year, we were $112 million. That compares to $108 million last year.

Tyler Hojo - Sidoti & Company, LLC

Got it, okay. And then just lastly, I was just hoping that you could maybe comment on expectations for free cash flow generation in fiscal '14. Obviously, surpassed expectations this year. Do you expect that to continue?

Robert D. George

Well, first of all, the answer to that question is yes. I mean, as I mentioned, our business unit leaders are doing a great job and we see that continuing. We had another strong fourth quarter revenue activity, as we said, this year. That will translate into cash flow, strong cash flow, beginning early next year. I am not, however, promising that we will set another record in cash flow from operations. I have been accused of being a risk-taker at some times, but in this case, this was an exceptional year. And I'm not willing to go that far. But I will say that it will be strong. As you know, because you're a strong follower of the company for a long time, I mean, Esterline does generate a significant number amount of cash on an ongoing basis. The one aspect that you -- when you asked, because you asked about free cash flow and not cash flow from operations, one, I'm being a little hesitant here because we're still working through some of the details on the projects we have. And I'm not sure -- we don't have significant incremental capital expenditure plans, but as we get into this, that might evolve a little bit. So right now, that would influence free cash flow.

Curtis C. Reusser

Probably not significant though.

Robert D. George

Probably. It is definitely not our plan.

Operator

The next question comes from line of Sam Pearlstein, Wells Fargo.

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

I'm not sure that -- I have a lot, but I did want to just ask one specific question. You highlighted a few programs like A400M and F-35. Can you talk about how many ship sets you delivered in fiscal '13 and how many you expect to in '14 for those 2 programs?

Robert D. George

Okay. Sam, this is Bob, I'll jump in. On the A400M, I believe that we delivered 2, okay, in fiscal '13. And the -- I will speak to what the current plan is, as we've been given in our skyline chart. We're looking at 18 in fiscal '14. On the F-35, that is a little bit more problematic for us, because as you know, our -- the lion's share of our content on the F-35 is essentially -- are stealthy material, which we don't necessarily ship in ship sets in the same way that Lockheed or Northrup are rolling the aircraft out. What I can tell you is that we are anticipating and our budget is for approximately the same number of aircraft to be produced as were produced in 2013.

Operator

A question from the line of Julie Yates, Crédit Suisse.

Julie Yates - Crédit Suisse AG, Research Division

Curtis, one for you. Between the largest 2 segments, where do you see the most opportunity from the integration activities?

Curtis C. Reusser

Well, I think there's probably going to be -- let me look at my list here. Actually the activities we've -- they're pretty evenly split, we've -- numbers of activities, they're divided up. We made sure, from a bandwidth standpoint, that it was pretty equally split. There's different kind of types. I would say that they're pretty close, but -- they're pretty close in the 2 of them. We're still -- we've already done some changes in controls and communications, by pulling those together. So we've already launched some things there. On the sensors side, they've already been making some moves to move some things to low-cost countries. So there's some continuation of those projects. So it's pretty evenly split between the 3. I'm going to say they're pretty close to each other.

Julie Yates - Crédit Suisse AG, Research Division

Okay. And then on Advanced Materials, I think there has already been a little bit of facility consolidation there, there's some new leadership there and that segment is operating at its highest margins. Is there still room to go?

Curtis C. Reusser

Nobody gets a free pass on this. They're all included. Absolutely.

Julie Yates - Crédit Suisse AG, Research Division

Okay. All right. And then just on the '14 guidance, what are you assuming on the non-aerospace markets?

Curtis C. Reusser

For Gamesman, probably non-aerospace. So probably Gamesman -- they've got some good opportunities there. Again, we'll have a full year. So that looks better. I don't know if we have a specific...

Robert D. George

Yes, Julie, this is Bob. Just going to jump in here. Let me just talk generalities. So Curtis has mentioned Gamesman is a positive. We're looking at some opportunities on the nuclear side. We're pretty optimistic on the nuclear side. As Brad indicated earlier in his response, we're seeing a gradual return to the industrial side in Europe. So fundamentally, when we look at the industrial opportunities for next year, it's looking reasonably positive.

Julie Yates - Crédit Suisse AG, Research Division

Okay. And then is there any update on the T-6B program and kind of what -- how that program is trending and what you're thinking for the next year? Is that going to be flat?

Curtis C. Reusser

Yes, we think it'll be flat. There are some -- again, Brad was over at the airshow. I mean, there are some positive indications, but we're thinking it's flat in our plan right now. Encouraging, but we're not banking on that.

Richard Bradley Lawrence

Yes. Julie, this is Brad. I think the success at Beech will be more in the out-years and my expectation is they'll be holding their build rates relatively flat. And the successes that they'll be having in the marketplace will extend the production as opposed to an increase in build rate. But that's my understanding of how they're going to operate.

Julie Yates - Crédit Suisse AG, Research Division

And the positive indications, that would be for international orders or more from the Navy?

Richard Bradley Lawrence

We'll let Beech announce those.

Julie Yates - Crédit Suisse AG, Research Division

Okay. What is the current backlog? What period does that take you through?

Curtis C. Reusser

As we said, Julie, we're good with the current Navy order through 2015.

Operator

At this time, ladies and gentlemen, I'd like to turn the conference back over to Mr. Curtis Reusser for closing remarks.

Curtis C. Reusser

So, again, nice to talk to everybody. I want to thank you all again. I look forward to seeing many of you in the coming months. Excited to be here at Esterline. So thanks again.

Operator

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

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