Esterline's (ESL) CEO Curtis Reusser on Q2 2014 Results - Earnings Call Transcript

May.29.14 | About: Esterline Technologies (ESL)

Esterline Corporation (NYSE:ESL)

Q2 2014 Results Earnings Conference Call

May 29, 2014; 05:00 p.m. ET

Executives

Curtis Reusser - President & Chief Executive Officer

Bob George - Chief Financial Officer

Brian Keogh - Director, Corporate Communications

Analysts

Sam Pearlstein - Wells Fargo

Howard Rubel - Jefferies& Company Inc.

Julie Yates - Credit Suisse

Tyler Hojo - Sidoti & Co.

Michael Ciarmoli - KeyBanc Capital Markets

Noah Poponak - Goldman Sachs

Ken Herbert - Canaccord

Operator

Good afternoon and welcome ladies and gentlemen to the Esterline Technologies, second quarter 2014 earnings call.

At this time I’d like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company we will open up the conference for questions-and-answers after the presentation. (Operator Instructions).

I will now turn the conference over to Mr. Brian Keogh. Please go ahead, sir.

Brian Keogh

Thank you Sara and good afternoon everyone. Curtis Reusser, Esterline's President and CEO; and Bob George, Chief Financial Officer are here today to discuss Esterline's 2014, second quarter and year-to-date performance.

Before I go further I wanted to remind everyone that our Investor Day is coming up on Thursday, June 19 in Boston and we’d love to see you there. It is an invitation-only event, so if you are able to attend, please send us an email at the following address. Its investor@esterline.com and request an invite and we’ll get that out to you.

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.

We also will discuss certain financial information on this call that is considered non-GAAP under the SEC's Regulation G. For a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure, please refer to the section in today's press release titled non-GAAP financial information. If you don't have the release, it can be found at esterline.com under the News and Press Center tab.

I’ll now turn the call over to Curtis. Curtis.

Curtis Reusser

Thank you Brian and good afternoon to everybody on the call today. We’re pleased to report a solid second quarter. The performance reflects good trends throughout the business and goes a long way to de-risk our ability to achieve our full year financial objectives. More importantly, the steady performance is helping us focus on the bigger picture, which I’ll come back to at the end of my remarks today.

To start, I’ll provide a few highlights and then turn the call over to Bob for a detailed review of the numbers. After that I’ll wrap-up before we take your questions.

So on the revenue side, we had an increase for the quarter that was a healthy 6% as we grew the top line to $530 million. Importantly, a significant portion of that growth was organic.

On the earnings side, of course we used GAAP standards to convey our performance, but as in prior quarters, we are also providing adjustments for our integration and incremental compliance costs.

On a GAAP basis net income was up 3.9% to $37.2 million or $1.15 per diluted share. After adjustments, our net income was $41.8 million or a $1.28 per diluted share, an increase of over 15% year-over-year. This kind of performance clearly indicates that we’re benefiting from our investments on a number of key programs.

As you know the commercial aerospace market remains strong. The Boeing 787 ramp-up continues on track and narrow body production at both Airbus and Boeing continues at all time highs. Our adjacent markets are also contributing well and there are even a few bright sports for us in the defense arena, specifically the JSF and the A400M at Airbus.

If there is a key takeaway for this quarter, I’d say it’s steady progress. We’re executing well, progressing on all our initiatives and seeing good trends in our order book, all of which gives us confidence in the future.

So lets talk briefly about each of our three segments. I’ll start with the Sensors & Systems segments, which had sales of $211 million for the quarter, which is up 19% versus last year. The top line growth in this segment was driven primarily by Power Systems and Connection Technologies, which includes the Sunbank acquisition.

Regarding Sunbank, although acquisition accounted for the quarter impacted overall gross margin, we are already beginning to see the benefits of synergies with our Souriau connector product like. We believe that longer term Sunbank will enable increased efficiency across our connector business, expanding the range and scope of our growth opportunities.

Also the recovery of Europe’s industrial sector continues, which is positive for this segment, especially in our connector business. Sensors and systems is also where we have the lion’s share of our A400M content, this military transport program illustrates several points about our overall business that are worth noting.

First, it’s a significant platform that is now ramping up to be a steady source of new long-term business for Esterline with a very important customer. It also highlights that there are defense related opportunities within our portfolio, despite the current state of macro budgeting issues, and I’d point to the A400M as a good example of how our defense exposure is diversified pretty evenly between the U.S. and other international markets.

Turing to the Avionics & Controls segment, they generated sales of $196 million in the quarter, slightly up, compared to $192 million last year. The segment revenue performance was driven by our Avionics Systems platform where sales of enhanced division and flight management systems were very strong in the quarter.

We also saw good bookings and backlog growth, which should accelerate as the year progresses. Bookings were particularly strong from adjacent markets in this segment, specifically gaming and medical. Importantly, previously delay orders in our advance signal receivers have now been realized. We are recognizing some sales revenue late in the quarter on those programs and we expect to ship the balance over the course of the year.

Finally in the Advanced Materials segment sales declined about 5% versus last year. This however is not a surprise as we’ve been talking for some time about the soft market conditions for our combustible and countermeasure products. This softness was somewhat offset by very strong performance in engineered materials, as a result of our work on the JSF and from a strengthening 787 program.

On the latter point, you may recall back in 2008 we made a play on the unique requirements of the 787s composite structure, by acquiring a specialty aerospace fastner business. This operation suffered through the early program delays, but it’s now really talking off. In addition to the Boeing ramp up, we just received our first order for similar products on the new Airbus A350. On a consolidated basis, I’d say the quarter’s overall performance was consistent with our expectations, both by market segment and in market.

Bob, now I’ll turn it over to you so you can get into the detailed numbers.

Bob George

Thanks Curtis. Good afternoon everyone. 2014 is continuing to unfold as we projected. As we indicated in the release and Curtis has reiterated, the second quarter was solid and our integration activities are on track. Before jumping into the operating results, lets lay out the integration and compliance cost impacts on the quarter.

For the quarter, from a macro perspective we incurred $3.5 million in integration costs and $2.8 million in compliance expenses at the EBIT line. The tax effect was $2.1 million, resulting in a $4.3 million effect at the bottom line or $0.13 per share.

Of the total $6.3 million of expenses in the quarter, you will see $2.1 million reported as restructuring charges on the income statement. $2.4 million are included in SG&A and $1.8 million is in the cost of sales. On a year-to-date basis integration cost are $8.9 million and compliance expenses are $4.6 million at the EBIT line.

Similar to the quarter, $6.9 million is reported as restructuring charges on the income statement. $3.9 million is included in SG&A and gross margin impact is $2.7 million. In earnings per share, this impact is $0.28 for the first half of the year.

Reviewing these initiatives by segment for the quarter and year-to-date the totals are as follows. In the Avionics & Controls segment $1.6 million in the quarter, $4.3 million year-to-date; Sensors & Systems, $2.7 million for the quarter, $3.8 million year-to-date; Advanced Materials $0.8 million in the quarter, $3.6 million year-to-date and in corporate expenses $1.2 million in the quarter, $1.8 through six months. All these costs have been cash expenses to-date and we are beginning to see some of the early cycle savings from the programs and we expect to report on them next quarter.

Okay, housekeeping is out of the way. Lets return to our operating results. Beginning with the top line, sales of $530 million were 6% ahead of last year’s $500 million. We received nice contributions from our two most recent acquisitions, Sunbank and Gamesman, as well as solid support from Connection Technologies, Power Systems and Engineered Materials. Organic growth in the quarter was slightly over 3%.

As Curtis mentioned in his opening remarks, we are seeing broad base strength in commercial aerospace and certain specific defense programs. These positives are partially offset by softness and uncertainty in defense generally and defense communications specifically.

These same themes flow through our six-month sales picture; sales of $1.03 billion or 8% ahead of last years $958 million, slightly over 4% organic growth. Gross margin performance for the quarter and year-to-date is being affected by the Sensors & Systems segment. I’ll return to this in a minute.

On a GAAP basis consolidated gross margins for the quarter was 34.4% compared with 36.3% last year. Year-to-date gross margins was 34.4% this year compared with $35.7 million last year.

A couple on non-operating effects impacted this year’s numbers. First on the integration expenses and second is the accounting for the Sunbank acquisition. We adjust for these effects. Second quarter gross margin was 34.9% and year-to-date 34.7%.

By segment, Avionics & Controls gross margin performance was generally consistent with last year. Improvement in Avionics Systems is being offset by weakness in control and communications. In the advanced material segment, performance improved from last year’s levels on the strength of outstanding results and Engineered Materials.

Defense Technologies is continuing to feel the adverse effect from declining combustible ordinance sales, but Engineered Materials is benefiting from record setting performance in a number of their business units in both defense, as well as commercial applications.

Returning to the Sensors & Systems segment. Segment gross margin in the quarter was 32.6% compared with 38.2% last year. Here we have a combination of factors influencing our results. Advanced sensors margins continue to feel the effect of a soft aftermarket activity. Power Systems is off from last year’s mark, due largely to a very difficult comparable set, which was due to outstanding product mix last year.

Connection Technologies margin dollars are up nicely. Margin percent is down a bit for a few reasons, including Souriau product mix, Sunbank’s acquisition entries and some expense re-class entries for consistency sake.

Selling, general and administrative expenses and research and development expenses are in line with our expectations. SG&A was $98 million this year at the quarter, virtually identical to last year.

Integration cost as I mentioned of $2.1 million are reported separately on the income statement, but $2.4 million of incremental compliance costs are included in SG&A. If we adjust for these compliance costs, SG&A of $96 million was 18.1% of sales compared with 19.7% of sales last year.

Year-to-date adjusted SG&A expenses of $190.7 million or 18.4% of sales compare with a $196.9 million or 20.6% of sales through six months last year. This is a movement in the right direction and reflects the hard work of our business leaders across the company.

Research and development expense is tracking consistent with expectations right around 5.1% of sales. Segment earnings are as you would expect from the pattern I described. Sales are up nicely, gross margin percentages down slightly and reduced operating expenses are resulting in improving return on sales metric.

For the quarter, this year’s return on sales adjusting for integration and compliance was 14.6% and the year-to-date metric is 14%, compared with 14.6% and 13.4% respectively last year.

Income taxes were as expected for the quarter, 19.6% this year, 21% last year. Bottom line, for the second quarter of 2014 net income was $37.2 million or $1.15 per share from continuing operations.

Adjusting for incremental integration and compliance costs of $4.3 million with increased earnings per share to $1.28 is compared to $35.5 million last year or $1.12 per share. Year-to-date earnings this year are $67.3 million compared with last year’s $60.6 million and earnings per share of $2.08 and $1.92 respectively. Again adjusting for incremental integration and compliance cost of $9.1 million with the increased earnings per share to $2.36 from last years $1.92.

Cash flow remains strong. Cash flow from operations was $84 million, somewhat lower than last year, but still a very health number despite working capital metrics that are working against us. Inventories are increasingly particularly at some of the units involved in integration activities. We are building safety stocks and also stocks for recertification purposes.

Further acquired inventory is a factor as well. We are actively engaged in monitoring this and improvement in working capital is one of our key strategic plan metrics. Capital expenditures were in line with expectations at $21 million and depreciation and amortization was $59 million through six months.

Wrapping up before turning the call back to Curtis. At the halfway mark sales performance is positive. New acquisitions are performing well, integration activities are proceeding as we like, on schedule and within budget. Bookings and backlogs are remaining steady. We remain confident in our full year outlook and look forward to seeing you in Boston.

Curtis, back to you.

Curtis Reusser

Thank you, Bob. Its good to be on-track for the year and running at a pace consistent with our expectations. This is particularly true as our senior management team is focused on a much bigger picture.

As we’ve discussed, the integration and consolidation work we announced when I first joined the company is a healthy evolutionary process that will provide a more consistent and comprehensive set of improvements across the business.

We are looking forward to sharing the details of our strategy to improve our efficiency and financial performance at our Investor Day in Boston, until then so I don’t steal our own thunder, I’ll make just a few brief comments.

First, our market position is solid. We continue to have an opportunity to grow organically and to bolster that growth through strategic bolt-on acquisitions should we choose so. Just as with efficiency, every segment has an opportunity and ability to contribute to our overall growth.

Secondly, we see the potential for improvement, efficiency and best practice implementation across the entire company. At our Investor Day we’ll be talking about some of the very concrete initiatives that we are getting our entire organization aligned and moving towards the same goals.

Third, we have a powerful ability to generate cash. This creates the opportunity for incremental returns to our shareholders and we are going to be very thoughtful about how we use our strategic capital to insure that we are maximizing our long-term value creation opportunities.

So as I said, we are pleased to be on track in achieving our short-term goals while remaining focused on a solid strategic process that will take us forward into the years ahead.

So thanks and operator, with that I think we’ll open up the questions.

Question-and-Answer Session

Operator

All right, great. (Operator Instructions) And we do have our first question coming from Sam Pearlstein from Wells Fargo. Please proceed.

Sam Pearlstein - Wells Fargo

Good afternoon.

Curtis Reusser

Hi Sam.

Bob George

Hi Sam.

Sam Pearlstein - Wells Fargo

Hi. I was wondering if you could talk a little bit more about just the margin profile and specifically I guess the Avionics & Controls. Because even if I added back in the restructuring, you’re still well below that kind of mid-teens numbers that you used to do a few quarters ago and I’m just wondering if you can talk about, I guess what’s in there? Is there anything that is preventing you from getting those margins back to those kind of levels.

Curtis Reusser

Yes Sam, I’ll start it off, because that’s a very good question and its spot on. The primary difference between the margins we are looking at in Avionics & Controls today and where we were with the numbers you referenced are really the activity level in the Avionics Systems platform itself. As you know, back 18 month or so ago when we were running at those levels, we had a significant volume of retrofit activity on C-130 in particular. We have run that backlog off. In fact I think we referenced that in our earnings release and that is the primary difference there.

Other platforms in that segment are performing reasonably well. Interface Technologies is performing very strong. Control and Communications however also contributes to some degree, largely because that’s the combination of our former control platform, as well as our communications and as we’ve been discussing for some time, that communications platform is virtually entirely defense and we’ve suffered on the downturn in that platform.

So the two primary contributing factors there are Avionics Systems and retrofit activity and Control and Communications with defense activity.

Sam Pearlstein - Wells Fargo

Okay, thanks. And then on the Sunbank piece, the purchase accounting impact, how long does it take for I guess that inventory to move through the P&L, so that we’re now looking at an apples-to-apples numbers.

Curtis Reusser

We’ll be looking at apples-and-apples beginning next quarter; we’ve watched that through.

Sam Pearlstein - Wells Fargo

Okay, and then last question is the order strength in the quarter. Is there anything in there that you can say that you would see that after market, especially in the sensory side starting to turn positive based on the order intake.

Curtis Reusser

Well, as you know on that question Sam, we don’t really have a backlog in our aftermarket. We don’t have that luxury. We really never had that luxury. Its kind of what comes in over the trends and its what we have to deliver. So we can’t really project based on backlog. What we use is, we use an adjusted 90 days factor and its holding stable at the moment.

Sam Pearlstein - Wells Fargo

Okay, thank you.

Bob George

One last thing just on the margin side. In the Avionics side, one of our consolidation projects is in that platform. So that’s one of our attempts to kind of adjust for some of the volume there, which we’ll start to see the benefit. That’s actually one of the projects that’s gone very smoothly; it’s ahead of schedule. So we should probably start to see some benefits of that in the next couple of quarters.

Sam Pearlstein - Wells Fargo

Okay. Thank you.

Operator

Great. Our next question comes from Howard Rubel from Jefferies.

Howard Rubel - Jefferies& Company Inc.

Thank you very much. I actually want to follow up first of Sam’s question on orders. I mean Curtis, I’m not sure exactly how best to characterize them, but sometimes orders can be for long term and sometimes they can be for near term. Would you say that these are sort of filling in nicely and adding to the business base or are they outer wise?

Curtis Reusser

No, I think its both Howard. That’s a real good question. As a matter of fact, with our strategic plan, we just went through with the board, we really characterized our business in kind of two flavors, what I term long cycle and short cycle and some of our connector business specifically, some of our input technologies, those are shorter orders and tend to drive nearer term sales potential.

So what we’re seeing, kind of a mix of both, some longer-term things with the bigger aerospace programs that are nice, that are filling in, but also some of the things on the medical side, connector side, on the gaming side, those typically turn around pretty quickly. So those are within the year, sometimes its even three to six months out. So overall we feel pretty good about it.

Howard Rubel - Jefferies& Company Inc.

And related to that, do you see – I mean on the good news side, the receivers finally came through. Are there other indications that your at a base or a bottom in defense or is it still one where there’s gap.

Curtis Reusser

I think we’re getting to a base. It maybe another quarter or two of slight drop off, but its nothing like we’ve seen. If you look at our overall sales profile, its been organically pretty flat and so we’re pleased that we’re starting to see some organic growth, because what that’s been is really a tail of some pretty solid commercial growth with some nicer defense longer term programs starting to kick in, offsetting some pretty dramatic downturns like on the receiver side, on the retail side. So I feel pretty comfortable that we are getting to a flat spot.

I don’t know. Bob, would you…

Bob George

I definitely agree with that, yes. I think that particularly on the defense technology note, I think as you pointed out Howard, the receivers orders that come in, we look like we’ll be able to deliver those for the balance of the year. Defense technologies, combustible ordinance is kind of getting down to that trough point. It might be as Curtis said, a quarter or two, but I think that the down curve is clearly flattening.

Curtis Reusser

Just a nice defense opportunity to CMC that again our a little bit longer cycle and again, there’s just more opportunities out there that we’re seeing that should start to sell through pretty quickly I think.

Howard Rubel - Jefferies& Company Inc.

Thank you. And then last, as you’ve initiated these restructuring projects, sometimes you find either new or different opportunities or a buy-in from your team and your workforce. Could you for a moment Curtis elaborate a little bit on sort of the attitude or the Esprit de Corps that’s developing?

Curtis Reusser

Sure. The good thing Howard was as I think we talked before, when I came through the door, luckily I didn’t have to say, guess what, I’m here and we’re going to start restructuring things. The team had already come up with the mindset of hey, this is something that’s probably overdue. We’ve done a number of acquisitions and we’ve really not tried to drive synergy when we’ve done those acquisitions. So the team had – I think the mindset was there at the senior staff and at the businesses.

It is different for them, but I feel very positive about the progress we’ve made so far. People understand it. Again, our philosophy here at the company is to be very upfront with people, talk about what the situation is, communicate it to them upfront and its I think gone as well as it can be. It’s obviously a difficult process to go through, but so far its gone pretty well.

We’ve announced them all, we’ve talked to all the people, they know what’s coming and they are off executing on them. So far there’s always ups and downs, some of them are a little bit ahead, some of them new things come up, but we put plans in place and go address those. But so far it’s going pretty well.

Howard Rubel - Jefferies& Company Inc.

Thank you gentlemen very much.

Curtis Reusser

You’re welcome. Thanks Howard.

Operator

All right, great. Our next question comes from Julie Yates from Credit Suisse.

Julie Yates - Credit Suisse

Good evening.

Curtis Reusser

Hi Julie.

Julie Yates - Credit Suisse

Just back to the order strength, up nicely year-on-year and quarter-on-quarter, any color in terms of which end markets this has been driven by?

Curtis Reusser

Well, gaming continues to be a real strong plus for us. That’s not a huge part of our business, but the games inside, they continue to drive nice strength.

We mentioned on the connector side, the connect, Souriau had nice growth overall and again its encouraging when we’ve seen. We had a little bit of a downturn in the industrial side and we’re seeing some strength there and again, that typically has higher margins, because they are typically more custom engineered, so it drives a higher margin, so that’s pretty nice.

On aerospace overall, the volume there is picking up pretty well, consistently across the board. We’ve got a couple – we talked about nuclear opportunities. Those are probably a little bit further out. Our power business has done well and that’s primarily in aerospace, but some on the rail and the transportation side.

So it’s pretty fairly broad. It’s a mixed bag, but fairly broad. I mean it looks fairly positive. You know we’re not going to count all our chicks yet, but it seems like its pretty broad.

It very nicely gets in defense orders too. We’re waiting for the receiver order, which again was on some programs that were hung up with just all the defense delays. That as you I’m sure hear from everyone, there’s just this real stagnation that no one wants to make decisions. So it will actually free up due to budget process and some of that we’re not the prime on. So we’ve got to work through the negotiations that the primes are doing with the government and then to have that flow down to us, but it was nice to see that free up.

Julie Yates - Credit Suisse

Okay, and then just on advanced materials margins. Those continue to come in at a very nice rate despite the decline in defense technologies. Any additional color to add there on the trends in the quarter or what we should look for in the second half of the year?

Curtis Reusser

We get a lot of questions about that. We still got opportunity to go drive cost improvement there. We definitely get pressure from our customers across the board, from the big guys, that’s not new, but I don’t see any big changes there. That’s a business that we’ve done a nice job of realigning some of the management team, giving a focus on process. There’s a lot of opportunity for both supply chain and lien in the factories there and they are really starting to show some good improvement, but there is still room to improve there.

So I don’t think it’s going to reverse course and we’re going to keep driving all of our businesses. I will say this in general. My philosophy is that everybody can improve and whether your at the top of the rank or at the bottom of the rank, my expectation is that everybody can take waste out of their business and drive improvement and I think we’ve got everybody aligned on that now.

Julie Yates - Credit Suisse

Okay, great. Thank you very much.

Curtis Reusser

Thanks Julie.

Operator

Okay, our next question comes from Tyler Hojo, Sidoti & Co.

Tyler Hojo - Sidoti & Co.

Yes hi, good evening. I actually wanted to ask you a little bit about after market. I know in the prepared remarks sheet you indicated that was a bit of a headwind this quarter. I was wondering if you could actually provide us with a little bit more granularity in terms of the growth rate and I’m specifically talking about commercial aftermarket.

Curtis Reusser

Well, I’ll give you some granularity on – it’s not a huge piece of our business. We have some spare part sales; primarily in our sensors is the one that we can talk about, because that’s a big piece of theirs. And as Bob mentioned specifically, we did implement a performance improvement on the CFM product line, because of interest from our customer and from the airlines to increase reliability. Both we implemented that as a new production program introduction, as well as when engine sensors were coming back for overhaul, the increased reliability.

So I think we’re seeing – it isn’t like it’s been a huge step function, but it is actually – there’s a lot of those units out in the field. If we looked at reliability the same, we would have seen a very nice sizable increase and I guess its just not increasing to the level that we wanted and we’re starting to see more of that higher reliability out in the field.

So I don’t think it’s a replacement or a P&A issue or a surplus issue. I’m sure some of those issues are out there, but that has had a big enough effect that it provides some downward dampening on us.

A number of our other programs are clipping along. Its just that sensors piece has a sizable effect for us. That’s probably the one – I wouldn’t say that it’s a concern overall with commercial aftermarket, but again from a spare part sales, Bob I’d say that’s probably like 10% of our business is actually spare part sales. We have another nice chunk that’s retrofit market where we go out and win it, especially on the upgrade and on the cockpit side and that continues to cope along with a nice pace, but on the spare part side, that’s kind of sizably impacted by our sensors business.

Tyler Hojo - Sidoti & Co.

When did – I’m sorry, did I cut you off?

Curtis Reusser

No, go ahead.

Tyler Hojo - Sidoti & Co.

Okay, when do you think your going to anniversary kind of that headwind on the CFM side? I mean is it a quarter or two away or is it like a year or two, how do you think about that?

Curtis Reusser

I don’t think it’s a year or two. We’ve had our team do some analysis and we would have expected it to start to upturn by now and so I’m going to punch on that one and say sooner rather than later I hope, but I don’t really have the visibility to see that. As Bob mentioned, we kind of see the orders when they come in and so its what’s out in the field and what the utilization rates are and how many engine overhauls and some of that is dependant on when they are overhauling their engines also.

Tyler Hojo - Sidoti & Co.

Got it. Okay, thanks for that color and just I guess last week from the – as a follow on to the commentary on defense kind of bottoming out here, I’m just curious what goes into that? I know we’ve kind of been all on pins and needles kind of waiting for additional C-130 retrofit orders to come in. Are seeing additional orders on that front necessary to see a bottom in the defense business or is that just incremental?

Curtis Reusser

That’s a really good way to look at it and that’s exactly how we’d characterize that. I think those big retrofits are lumpy and I would not include those kind of in our base business and so those should be incremental to our baseline business.

Just from our counter measures business, the flair side and the combustible business, looking at those orders and the volumes, looking at our Racal business and the communications business and JSF and A40M, looking at all those in total is where I see kind of that bottoming out and some of the larger programs starting to kick in while we’ll start to see some up tick.

Another thing I’ll point out is just our exposure to international, with opportunities on the international trainers. You’ve seen we’ve announced – we were awarded a cockpit on the C-27J. So there’s some nice opportunities out there, but I would say those are incremental to our kind of baseline business.

Tyler Hojo - Sidoti & Co.

Great, thanks a lot.

Curtis Reusser

Thanks Tyler.

Operator

Right. Our next question comes from Michael Ciarmoli from KeyBanc Capital Markets.

Michael Ciarmoli - KeyBanc Capital Markets

Hey, good afternoon guys. Thanks for taking my questions.

Curtis Reusser

Hi, certainly.

Michael Ciarmoli - KeyBanc Capital Markets

Maybe Curtis or Bob, can you give us a sense on that kind of a gaming side of the business and even the connector side? Is Sunbank still expected to run at a $40 million or $50 million run rate this year and then maybe if you can give us a sense how Gamesman is tracking?

Curtis Reusser

Yes, you’re right on track with the Sunbank side. That acquisition is going really well. I will say that both Gamesman and Sunbank are very typical of the types of acquisitions that we’ll be looking for in the future. We’ve had teams in there that are working really closely together.

We’ve integrated the organizations and so on the Sunbank side there was some operational issues that were preventing us from getting additional deliveries out the door and to be honest, we put the brakes on accepting new orders. We had a lot of our Souriau customers saying, hey, can you look at a bunch of opportunities on day one and we said, give us a couple of months to get the operations, keeping stuff out of an acceptable on-time delivery rate.

But having said that, we are starting to take on new orders. It’s pretty exciting to see the teams work closely together and start looking at capabilities and customers together. But we should be in the $45 million to $50 million, that’s right on track.

On the specific numbers on Gamesman; Gamesman is I will say ahead of our internal projections for this year. They’ve just had some very nice, some big orders. They come in quick and you got to turn them around fast and so that is prototype something to get solutions set out to a customer. They put a demo out on a piece of equipment or machinery in a casino and if that is well accepted by the public, they call up and literally say, can you get me thousands of units within a very short period of time. So we’ve had a number of couple of big customers turn around a couple of big orders that have been really nice surprises.

So it’s tracking ahead of where we thought we would be, I’ll just say that. I think substantially ahead of where we thought they’d be for the year.

Michael Ciarmoli - KeyBanc Capital Markets

Okay, that’s helpful. And then what about if you can comment, how are you guys into your strategic planning or what the status is of Boeings partnering for success initiative, what you guys are seeing there on some of your key programs and product lines?

Curtis Reusser

Well, we’re working very closely. They are one of our biggest customers and so we’re working real closely with them. I luckily got some experience with partnering for success at Goodrich and at UTC and now here.

We’re trying to work with some basic philosophies of how can we jointly go take cost out. They have supported some of our integration moves and in consideration for that we’ve shared some of the savings where they’ve helped support us. We are looking at opportunities where we can drive volume improvements or engineering change improvements. So it’s something that we have to go work with them on.

I think today we’re not done with them yet. We have some businesses that I think are, I would say that they’ve wrapped up and they’ve done what they can do. We’ve got some others that are still making proposals and we have just in the last couple of months, we’ve had a number of meetings with them. I’ve gone up there and met with them personally to talk about the direction of the company and see what we can do to work closer together. So we’re engaged with them, but we don’t have a final solution set yet, but we’re sure working it.

And we’ve got that with other customers. It’s pretty typical with some of the big primes where we’re trying to work with them on how we can drive performance and help share it with them.

I will say this, that that’s nothing new from what I’ve seen and I’ve told my team, we’ve got to be competitive in the marketplace and continually take cost out of our business and there’s an expectation that we’re going to have to be competitive in the marketplace and probably share some of that with our customer. So that’s something that I think is just a given in this industry and we’re going to become really good at taking out cost and hopefully put more of that to our margin improvement than we give away.

Michael Ciarmoli - KeyBanc Capital Markets

Got it, okay, and then just a housekeeping, a last one Bob. Any change to the full year tax rate?

Bob George

No, we’re still looking at the same numbers we were looking at Michael. There were just slight adjustments to the UK, a favorable adjustment in the UK corporate tax rate in the quarter, but we’re still looking at that 21% level, 20%, 20.5% or something like that.

Michael Ciarmoli - KeyBanc Capital Markets

Okay, perfect. Thanks for that.

Bob George

We do not have any significant discreet items in the plan this year.

Michael Ciarmoli - KeyBanc Capital Markets

Perfect, thank you.

Bob George

Yep.

Operator

All right, great. Our next question comes from Noah Poponak from Goldman Sachs.

Noah Poponak - Goldman Sachs

Hi, good afternoon everyone.

Curtis Reusser

Hi Noah.

Noah Poponak - Goldman Sachs

Curtis, you’ve kind of outlined a fairly long list of projects to dig into or to attack in your operational improvement and margin improvement strategy and recognizing that its early and recognizing that you want to wait for the Investor Day to really dive into them, I just am curious if there’s any one or two items in that list that as you start to dig in are proving substantially more difficult to change than you might have thought at the onset?

Curtis Reusser

No, I don’t. I wouldn’t say that. They are all kind of tough, but the team is aligned there. Some of the restructuring was top, but again as I mentioned before, that’s something that we tried to put a box around it and say, here’s what we’re going to go do. I would say that one pleasant surprise was that a number of our businesses had as we called, a good beachhead in low cost country footprint, so that wasn’t started from a clean sheet of paper. So that’s you know optimizing our sights and looking at what our utilization is in our factories. That’s a longer-term project, but we kind of got on that one right out of the box.

The other one that I think has more opportunity and people give credit is if you really adopt good operational excellence and lean towards a production system, which is tough to do in aerospace, because its low volume, high mix, but that to me is a machine that if you get it in place and get people trained and accepted to, it adds – it’s the gift that keeps on giving.

The good news there is we have some excellent sights and people that have really adopted it and so we’ve already had, we’ve had a three day summit that I was in with my entire corporate capital management team, with all our Presidents and their Heads of Operation and we had with some, went to one of our better facilities and said hey, look at the opportunity here and if these guys can do it, think of what you can do in your factories. So we’re starting that process, we’re starting to roll that out.

Some of the guys were saying, boy, this is different. As we walked out of that meeting though, I think everybody was like, okay, we see what you’re talking about. This isn’t something from a different plant. Its close to what we were doing before. Its standardizing things and it was more how can you help me and what resources can I pull on.

On the procurement side, that’s one where we’re going to get some outside help and I probably mentioned this publicly before, we’ve got our process where we’re looking at a couple of outside consultants. We just recently hired a supply chain person that I’ve dealt with in the past, who I think is really good and that person is coming onboard in the next couple of weeks. So that takes a little bit of time and again, we don’t have fully integrated systems. So that’s a big challenge, but I don’t think its something we didn’t know about.

So these are longer-term projects, but I think they will pay dividends for a long time and they’ll continue to gain momentum and part of my team’s charter is just to not make this a flash in the pan and put the real basics in place, so that it continues to improve year after year.

Noah Poponak - Goldman Sachs

Okay, that’s great, I appreciate the color there. On the cash flow statement, I noticed the fiscal second quarter is seasonally weak. I just wondered if you could discuss whether or not cash in the quarter was better or worse than you expected and then with the working capital changes you referred to going forward, which items have the most opportunity that we should be on the lookout for to change going forward.

Bob George

Yes, I know. This is Bob. Cash flow, when you look at cash flow from ops, where as I mentioned in the call we’re at $84 million. That compares unfavorably to last year at the same time, but last year of course was an all time record. If I compare it to the year before, which was still a very, very strong year, we’re right on track with where we were the prior year.

The drivers in the delta between last year if you will and this year are in working capital. Inventory is the more significant one, which is up. That is a trend that we absolutely have to get our arms around, and are committed to getting our arms around. In fact all these projects we’re talking about and continuous improvement will address that.

But right now, to some degree, to be a little bit more evenly balanced if I will, I mean there’s a fair amount of safety stocks that’s being built up there with respect to these consolidation projects we’ve got going on, but fundamentally when you look across the corporation, the inventory growth is pretty evenly balanced.

Our collection performance is still good, although relative to last year it’s not quite as strong as it was last year, so that’s a year-over-year contributor. But fundamentally when you look at it and to get to your punch line question, the biggest opportunity we have in working capital without any question and we will drive it down is in inventory and I mean just speaking as the long time person in seat, you know its not been a focus point in the corporation. We have great cash flow generation and maybe we are a little lazy there. We are not going to be lazy going forward. I’m used to focusing on that, yes.

I mean, as a corporation we do enjoy relatively a luxurious position of being consistently over 100% cash conversion ratio, but it can get better. I mean going back to the point that Curtis made earlier, no matter how good you are, no matter where you are in the performance chain, there’s always a way to improve and as I mentioned in my prepared remarks, improvement in working capital is one of our key strategic plan metrics and it will be improved going forward.

Noah Poponak - Goldman Sachs

Great. Just one last one for me, the defense communications that you specified as being soft, can you just elaborate on exactly what that was?

Curtis Reusser

Yes, I probably should have been less generic than that. I was really talking specifically about our signals receivers business there that we talked about for some period of time. We did give good news towards the end of the quarter, however we got some orders that were late, that we had been waiting for, that we talked about last quarter and we’re dragging it down. We got those released, we got them out and we got another order that came in early in this quarter, so it looks like we won’t be overly concerned with that business for the balance of this year, although its still soft.

Noah Poponak - Goldman Sachs

How did the size of the one early this quarter compare to the one at the end of the quarter?

Curtis Reusser

Well, what we’re looking at now is that the two orders that we got and looking going forward, that gets us back on track to where our expectations were for the year.

Noah Poponak - Goldman Sachs

I see. Okay, thanks very much.

Curtis Reusser

Okay, thank you.

Bob George

Thanks Noah.

Operator

All right. Our next question comes from Ken Herbert from Canaccord.

Ken Herbert - Canaccord

Hi, good afternoon.

Curtis Reusser

Hi Ken.

Bob George

Hi Ken.

Ken Herbert - Canaccord

Hi. I just wanted to follow-up on the guidance. I mean it seems like you’ve had a good quarter for orders. I know you don’t want to get caught up in tweaking the guidance every quarter, but is it fair to assume the guidance implies sort of flat top line and down earnings in the second half of the year slightly? Maybe that your not seeing as much of a fourth quarter bump as you’ve seen in prior years or is there anything else besides just general conservatism that you maybe want to highlight and reference to the guidance in the second half of the year.

Curtis Reusser

Well, I’ll take that one. I’m the new guy, I got to be conservative, come on.

Ken Herbert - Canaccord

Yes, I get it and that’s appreciated.

Curtis Reusser

So a little bit. We talked about that and thought that that question might come up. There are just enough moving pieces. We feel good that we’re executing to our plan. The integration projects are going very well, so that’s nice. The defense orders as we talked about, getting something late in the quarter, that stuff is bouncing around.

I wouldn’t say there is any big concern, but there are enough moving pieces that to raise it at this point just didn’t seem – I’m not looking for the glory to be able to raise guidance. It seemed appropriate to keep it where it was and not bounce it around. And I’m doing something that’s just with enough – to be fair, I am still kind of learning the business and seeing how things go throughout the cycle of the year and getting familiar with the seasonality of the quarters that Esterline has and guidance was from my management team boys. Someone might ask that question, but it might be a little premature.

Ken Herbert - Canaccord

Yes. No, I can appreciate that and I think that’s certainly the better way to go. I guess though Bob we shouldn’t expect or we should continue to expect the season of up tick that we usually see in the fourth quarter, correct?

Bob George

Ken, you’re exactly right. But I want to caution, as we said back in December and we are tracking right to our expectations in December. Had our audit committee yesterday, telephonic review of financials and that’s exactly what I told them.

Remember, in December we said we are going to be a little bit more balanced this year. We weren’t going to have quite the spike in the fourth quarter, quite the high wire. The last two years have been kind of the high wire act as you know in the fourth quarter and so we expect slightly smoother performance, but without a doubt, yes, we will have that fourth quarter up-tick.

Ken Herbert - Canaccord

Okay, okay, that’s helpful. And then the risk of maybe getting ahead of the Investor Day a little bit, because I expect more about this there, but Curtis can you just talk if anything’s changed or if you have any thoughts now, sort of another quarter in in terms of capital deployment and as you think about the returns your getting from the restructuring, I know its early, but clearly you sound pretty positive and optimistic about those investments relative to maybe the M&A pipeline, relative to other things you maybe looking at.

Curtis Reusser

Well, again we’re definitely going to talk about that at Investor Day. We split our strategic plan up into two pieces. We had one in early May and we have another one coming up, the final part of it next week and it had a very robust discussion about capital deployment and what the thoughts are about our portfolio and acquisition opportunities.

So I will say we are still, we are still in the hunt for good acquisitions as we always have been. Its really a question of is there, as other people said, is there another leg to our capital allocation strategy and I think there needs to be one, but it hasn’t been finalized yet. We are going to be reviewing that with the Board this week. But again, I’m very encouraged with the stability of the company and with the cash position we have and on the opportunities that we have. And with that I’ll punt to next week or punt to Investor Day.

Ken Herbert - Canaccord

Perfect. Well, thank you very much for taking the time.

Curtis Reusser

Thanks Ken.

Operator

All right. (Operator Instructions) And we do have another question coming from Julie Yates from Credit Suisse.

Julie Yates - Credit Suisse

I just wanted to ask a quick housekeeping question on corporate and how we should think about that in the second half of the year. It looks you’ve been excluding the integration compliance expenses, it still was at a higher run rate from where its been. So what should we expect for the third and fourth quarter there.

Curtis Reusser

Julie, you’re right. Corporate expenses are going up largely, because the corporate is absorbing much of the incremental compliance cost and we are going to continue to see that pressure go up in the compliance arena in the second half of the year.

We won’t see a significant increase. I mean we’re driving at about the speed limit that I anticipate, but as we have got our consented agreement with the Department of State signed and we are moving forward with that plan, we will be adding additional resources into our corporate office on the compliance side. But that will only be rounding around the edges. I think where we’re at right now is what you will see for the balance of the year, with a slight up-tick.

Julie Yates - Credit Suisse

Okay, so that mid-teens level.

Curtis Reusser

Yes.

Julie Yates - Credit Suisse

Okay. All right and then any update on the full year expectations for interest expense?

Curtis Reusser

Actually I defer to Investor Day on that one.

Julie Yates - Credit Suisse

Okay.

Curtis Reusser

You almost got me saying something there Julie.

Julie Yates - Credit Suisse

I was trying to trick you.

Curtis Reusser

You almost got me there.

Julie Yates - Credit Suisse

One last one, this is easier. CapEx in the Q?

Curtis Reusser

Capital expenditures for the first six months were $21 million, that’s a little lighter than we anticipated. What we got going on is a lot of our business unit leaders are focused on those restructuring projects, but there are a number of CERs in the Q. Actually they were put in my desk yesterday and there was some fairly significant ones. So I would expect that we would be on track for give or take $55 million or $60 million for this year on the capital expenditure side.

Julie Yates - Credit Suisse

Okay, so that’s below where you thought you were maybe going to come in around $75 million.

Curtis Reusser

Yes, and that’s fundamentally a function of the other projects we’ve got going on, that we are working on.

Julie Yates - Credit Suisse

Okay, all right. Thank you very much. See you in a couple of weeks.

Curtis Reusser

Okay Julie.

Bob George

Julie thanks.

Operator

All right. And that looks like there are no further questions in queue.

Brian Keogh

Great. Thanks Sara and thanks for your continued interest in Esterline and we’ll hope to see you all in June. Have a great evening.

Operator

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may disconnect and have a wonderful day.

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