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Moog Inc.  (NYSE:MOG-A) (NYSE:MOG-B)
Q4 2019 Earnings Call
Nov. 01, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Moog's Fourth Quarter and Year-end Earnings Conference Call. Today's conference is being recorded.

At this time I'd like to turn the conference over to, Ms. Ann Luhr. Please go ahead.

Ann Marie Luhr -- Head of Investor Relations

Good morning. Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. Forward-looking statements are not guarantees of our future performance and are subject to risks uncertainties and other factors, that could cause actual performance to differ materially from such statements. A description of these risks uncertainties and other factors is contained in our news release of November 1, 2019 our most recent Form 8-K filed on November 1, 2019 and in certain of our other public filings with the SEC.

We have provided some financial schedules to help our listener's better follow along with the prepared comments. For those of you who do not already have the document a copy of today's financial presentation is available on our webcast page at www.moog.com. John?

John R. Scannell -- Chairman and Chief Executive Officer

Thanks Ann. Good morning. Thanks for joining us. This morning we will report on the fourth quarter of fiscal '19 and reflect on our performance for the full year. We'll also provide our initial guidance for fiscal '20. As usual I'll start with the headlines for the quarter. First we had several noteworthy events for our flight control systems at our key customers including the first deliveries on both, the Embraer E195-E2 and the Gulfstream G600 as well as the first flight of the Boeing MQ-25. Second it was another good quarter for our operations with sales up 9% and earnings per share of $1.31 at the higher end of our guidance. And third cash flow was soft as we continue to grow, invest in capex and acquire buffer inventory to safeguard our customer deliveries. Looking back over all of fiscal '19 the following headlines stand out: first it was a record year for our business in terms of sales and earnings per share. Over the last two years our business has growing 16% organically after several years of flat sales. Second our defense portfolio was very strong this year with growth across all major programs and continued investment in the platforms of tomorrow. Third it was a busy year for the acquisitions that didn't happen. We continue to look actively while remaining disciplined in terms of pricing and shift.

Our focus on good growth rather than growth at any cost. For we suffered a supplier quality issue early in the year in our aircraft business. This taught us that some of our operational processes We're not as robust as they need to be. And as a result, we began a multi year investment program to upgrade our practices to what we're now calling operations two point O. And finally, we're providing a first look at fiscal 20. Today, we're projecting sales to three billion of 4% and 40 basis points of operating margin expansion, including a significant recovery in our aircraft margins. Despite the headwinds of a higher tax rate, or earnings per share will be up 9% to $5 and 55 cents, plus or minus 20 cents. Overall, it's because it was a good year for our company has always played I was a little different from what we anticipated going into the year. But our diversity across and markets helps us meet our goals. As I do at this time each year. I'd like to express my thanks for the dedication and commitment of our 13,000 employees around the world who made all this happen. Let me provide some details on the quarter. Sales in the fourth quarter of 765 million were 9% higher than last year. disrupt double digits in both aircraft and space defense, but sales and industrial systems were slightly lower.

Taking a look at the P&L our gross margin was down on an adverse mix in our Aircraft business and some onetime charges we took this quarter. R&D was also lower as our spending in Aircraft continue to moderate. SG&A expense was slightly higher as a percentage of sales on increased investments in new business developments and some consulting expenses. Interest expense was about flat with a year ago. Our effective tax rate in the quarter of 21.3% resulted in net earnings of $46 million and earnings per share of $1.31 up 15% from last year. Fiscal '19 in total. For the full year sales of $2.9 billion we are 7% higher than last year. The story for the year is similar to the story for the quarter with sales up nicely in Aircraft very strong in Space and Defense and moderately lower in Industrial Systems. Foreign exchange headwinds reduced the sales growth by almost 100 basis points. Operating margins were up slightly from fiscal '18 after adjusting for our exit from the wind business. Adjusted net earnings were up 9% and adjusted earnings per share were up 12% on a lower share count. Free cash flow for the year was $63 million.

Looking out now to fiscal '20. For fiscal '20 we are projecting continued organic growth with sales of $3 billion up 4% from fiscal '19. The sales growth is primarily driven by our Space and Defense group with sales in Aircraft up marginally and Industrial sales flat. We're anticipating full year operating margins of 11.5% up 40 basis points and earnings per share of $5.55 plus or minus $0.20. Free cash flow will recover from fiscal '19 to a conversion ratio of 80% for the full year. Now to the segments. I'd remind our listeners that we provided a three-page supplemental data package posted on our website which provides all the detailed numbers for your models. We suggest you follow this in parallel with the text. Beginning with Aircraft. Sales in the fourth quarter of $342 million were up 12% from a year ago driven by strong Commercial OEM results. Sales were up nicely on the 787 and A350 programs as well as on the E2 and various Gulfstream jets. Sales into the Commercial aftermarket were down on lower A350 IP and slowing activity on some legacy programs. On the Military side OEM sales were up and increased V-22 and BlackHawk work as well as higher funded development activity.

Military aftermarket sales were slightly lower than last year a result of lower sales on various legacy programs partially compensated by higher F-35 sales. Aircraft fiscal '19. Full year sales were up 9% from fiscal '18 to $1.3 billion. On the Commercial OEM side strong sales on the 787 A350 E2 and Gulfstream business jets drove a 15% year-over-year increase. OEM sales on the 737 program were down $5 million from the -- for the year. Aftermarket sales were up 7% mostly the result of lower A350 IP. Military Aircraft was up 9% for the year with growth on both our OEM platforms and in the aftermarkets. The F-35 continued to ramp up production and sales were also higher on the V-22 and some foreign programs. Funded development of over $70 million in the year was in line with the prior year. In the Military aftermarket sales of the F-35 and the V-22 were up strongly compensating for lower sales on some legacy programs. Aircraft fiscal '20. We're projecting next year sales of $1.33 billion up 2% from '19. We should see continued growth in our Military markets with the F-35 driving both OEM and aftermarket growth. Across the broader Military OEM portfolio we anticipate that helicopter programs will be down from a very strong fiscal '19 but further development programs should be up and continued investment in next-generation platforms.

In total our Military Aircraft business will be up 7% in fiscal '20. On the Commercial side we are forecasting moderating sales at both Boeing and Airbus next year. 787 sales should be in line with fiscal '19 but we see a significant drop in 777 sales as that program continues to wind down. We're forecasting 737 sales more or less in line with this year. And Airbus A350 sales should be lower as a result of some accelerated shipments in fiscal '19. We're also anticipating A380 sales will essentially drop to 0. E2 sales are forecast to double almost $16 million while business jet sales should be close to the level of this year. We anticipate that the Commercial aftermarket will be up slightly as the A350 fleet slowly emerges from the warranty period. Combining OEM and aftermarkets. Our Commercial Aircraft business in total will be down 3% next year. Aircraft margins. Margins in the quarter of 8.2% included three unusual items. We made additional investments in operations consulting incurred some severance expense associated with continued reorganizations and took a charge associated with the termination of the A380 program. Taken together these items depressed margin by about 200 basis points over the quarter. Margins for the year were 9.4% down 150 basis points from fiscal '18.

And as we have discussed in the past the contraction was in the gross margin line as a result of operational challenges. During the year we responded to these challenges by launching our operations 2.0 program which includes a new organizational structure support from outside consulting and additional investments in capital investments. As we look to fiscal '20 margins will increase to 10.5% as the impact of our operational improvement take groups and our gross margin starts to recover. Turning now to Space and Defense. Sales in the fourth quarter of $190 million were up 23% from last year. We enjoyed growth in both the Space and Defense markets. Space sales were up 13% on strong launch vehicle activity increased funding for hypersonic applications and worked on the GBSD program. Defense sales were very strong up almost 30% from last year. The growth was across the entire portfolio of defense markets with particular strength in missiles vehicles and electrical components used in a wide variety of applications. Space and Defense fiscal '19. Full year sales of $683 million were up 18% from last year. The strength was on the military side of the house with sales up almost $100 million from fiscal '18. The biggest contributors to the growth were missiles ground vehicles naval applications and our general Components business. Sales of our reconfigurable target product were up $20 million over last year.

On the Space side sales growth of 2% masked some significant shifts in the mix. Sales of our avionics products were lower this year after a very strong fiscal '18. Our NASA work was mixed with SLS work down but Orion work up. Finally we had strongly funded development sales for various hypersonic applications. Space and Defense fiscal '20. Our forecast for next year projects another year of strong growth. Total sales of $770 million will be up 13% from fiscal '19. After a fairly flat year in '19 Space should be up 16% next year on strong growth in avionics additional NASA work as we seek to return to the moon by 2024 and continued growth in hypersonic systems. On the Defense side we should also see nice growth across our portfolio led by vehicles missiles and naval applications. Space and Defense margins. Margins in the quarter of 13.7% were particularly strong on higher sales and the favorable mix. For all of fiscal '19 margins of 13% were also strong. For fiscal '20 we are expecting margins in line with fiscal '19 at 13%. Before leaving our Space and Defense group I'd like to reflect on the recent performance of this business. In fiscal '17 our Space and Defense group had $530 million in sales. In fiscal '20 we are forecasting $770 million a 46% increase over three years.

Space is up over 35% while Defense is up over 50% over this period and essentially all organic. Over the same time period the group operating profit was doubled from $50 million to $100 million and operating margins will expand over 350 basis points. Growing defense budget in the U.S. has helped of course but our success has been grounded in a combinations of years of investment and the dedication to serving our customers with outstanding quality and delivery. As a result we have been a preferred supplier across the markets we serve winning market share and benefiting disproportionately as our customers' businesses have ramped up. Turning now to Industrial Systems. Sales in the fourth quarter of $234 million were 4% lower than last year. Adjusting from the last sales associated with our exit from the wind pitch control business sales were about even with last year. Strengthen in our medical markets across both pumps and components was offset by slightly lower sales in both industrial automation and simulation and tests. Sales in the energy markets were down slightly from last year a combination of slightly higher exploration sales with lower sales of components in the power-generating equipment.

Full year fiscal '19 sales for Industrial Systems of $918 million were 2% lower than last year a result of weaker foreign currencies relative to the dollar. Underlying wheel sales were flat year-over-year for with some notable shifts in the mix. Energy was way down on the absence of wind energy sales following our decision to exit that business in fiscal '18. Sales into industrial automation were stable as global capital investments continued through the year. Sales of medical products were up on strong growth in our enteral pumps product line. Finally sales into simulation and test applications were slightly lower. Included in this test of simulation markets are sales of motion bases for entertainment systems. These tend to be very lumpy and unpredictable. Fiscal '18 was a strong year for entertainment sales while fiscal '19 was a soft year. Industrial Systems fiscal '20. We're projecting flat sales for next year. We anticipate continued growth in our medical applications and slightly stronger sales of flight simulation systems. We're forecasting energy sales would more or less be in line with fiscal '19. And finally we are projecting industrial automation sales will be down 5% as global economy is slow and capital investment spending contracts. Industrial System's margins. Margins in the quarter were 11.1%.

Full year margins of 11.9% were up from last year as a result of our decisions to exit the wind business. For fiscal '20 we are forecasting margins of 11.5%. Summary guidance. Fiscal '19 was a good year for our company. Our plan for fiscal '20 builds on that base with full year sales of $3 billion up 4% organically. The growth is led by our Space and Defense group with strength in both markets. Aircraft sales in total will be up marginally with good growth on the Military side but slightly lower sales in our Commercial book of business. Industrial sales will be flat in fiscal '19 as growth in niche markets compensates for the slowing investment in industrial automation across the global economies. Free cash flow conversion in fiscal '20 should recover to 80% of sales as our growth in networking capital slows and our operational improvement starts to bear fruit. We're forecasting earnings per share of $5.55 plus or minus $0.20 a 9% increase over fiscal '19. As always our forecast does not include any projection for future acquisitions or potential share buyback activity. As with any forecast there are both opportunities and risks in our plan. In fiscal '20 the major opportunity to do better lies in the pace of operational improvements in our Aircraft business while the major operational risk is the potential slowdown in our Industrial markets.

As we wrap up fiscal '19 and look to a new year we believe it's helpful for our investors to look at our business through an ends market lens. We're organized in three operating groups but our business serves five major markets: Defense; Industrial including energy; Commercial; Space and Medical. Defense is our largest market with almost 40% of our sales. two years ago at the end of fiscal '17 I commented that we are coming out of the multiyear downturn in Defense spending and we are optimistic that fiscal '18 might see increased budgets. Closing out fiscal '19 the defense market has performed better than we could have imagined and we are set to see that strong performance continue this coming year. We have seen growth in almost every defense market we serve from Aircraft to missiles to ground vehicles. Through the multiyear downturn earlier in the decade we continued to invest in our defense portfolio combination of R&D spending on new product such as our reconfigurable targets and investments in operational improvements. As we enter fiscal '20 we have a full book of new development programs for next-generation Aircraft -- from next-generation Aircraft to hypersonic missiles. Our present production programs combined with our strong development pipeline gives us confidence that despite the ups and downs in defense budgets we continue to prosper in the long term.

Industrial including energy is our second largest market where we serve a wide range of applications across many niche markets. This is a global business and at a macro level our fortunes tend to move with the capital investment cycle of the major world economies. Coming into fiscal '19 we anticipated a good year but worried about the impacts of trade wars. The year played out pretty much as we expected although the outlook for major economies has weakened from a year ago. Uncertainty around tariffs and Brexit have added to the challenges of continued expansion late in the economic cycle. We're cautious about the outlook for the coming year but remain optimistic that lower interest rates a resolution of Brexit and the potential of a trade return with China as we approach an election here in the U.S. could mitigate the potential slowdown in our business. Commercial Aircraft is just over 20% of our business. Fiscal '19 saw strong growth in our major OEM programs and a modest slowdown in the aftermarkets. Our flagship programs 787 and the A350 will continue to be strong in fiscal 20 while our legacy programs particularly the 777 will slow.

We're anticipating the 737 Max situation will resolve itself early in 2020 and production rates will be in line with Boeing's forecast. Our R&D expense in '20 will be down to sustaining levels and we are not anticipating any major new development programs for the next couple of years. Overall the focus in this business remains on operational excellence and as execution improves we will see our margins expand over time. Space business is strong driven by increased defense spending and NASA's plan to return to the moon. After a modest increase in '19 we are anticipating strong growth as we move into fiscal '20. Over the course of this coming year our major investments will continue to be hypersonics and the GBSD program. Finally our medical market had an another good year of growth in fiscal '19 and we believe that growth will continue this coming year. In particular our pump products had a strong year as we captured share in the entry market. In summary we continue to leverage our core controlled technology successfully across diverse end markets where we solve our customers' most challenging problems.

Our strategy remains unchanged. We work to create value for our customers by tailoring our products to meet their specific needs. Customer intimacy is at our core and we enjoy multigenerational relationships with most of our customers. When there's a problem we always seek to do the right things by our customer sometimes at the expense of short-term financial results. We believe this is key to building a great company over time. We have a laser focus on our core technologies at motion and fluid control but a wide lens on end markets which can benefit from our capabilities. It seems to be prudent stewards of our shareholders' capital by maintaining a strong balance sheet and a disciplined approach to capital allocation. We believe growth is a core element of long-term value creation and continue to pursue aggressively adjacent acquisitions. However we remain disciplined in terms of pricing and strategic shift. As a result we have walked away from many opportunities in the last year instead of overpaying.

With three, corporate wide internal initiatives around talent lean and innovation our innovation spending is focused around three key themes which cut across all our major markets and they are: electrification autonomy and connectivity. In the year where we celebrated Moog's contribution to the 50th anniversary of the Apollo 11 moon landing in 1969 we are reminded of the very long-term nature of our business and the importance of continuing to invest for the future. Finally our culture of trust and collaboration remains the cornerstone of our business. As we look to fiscal '20 we are optimistic about our business. Next year we anticipate sales of $3 billion and earnings per share of $5.55 plus or minus $0.20. As usual we expect a somewhat slow start to the year with the first quarter earnings per share of $1.30 plus or minus $0.10.

Now let me pass it to Don who will provide more color on our cash flow and balance sheet.

Donald R. Fishback -- Vice President and Chief Financial Officer

Thank you John, and good morning. Free cash flow in the fourth quarter, was $25 million and for all of 2019 it was $63 million representing a conversion ratio of 35%. Growth in our businesses explain most of the soft free cash flow performance in 2019. We have had to support our top-line growth with a corresponding increase in net working capital where every sales dollar has a corresponding investment of about $0.25 in inventories and receivables and the increased demand for capex spending is noticeable. As we have transitioned from a relatively stagnant period of top-line growth from 2012 to 2017 for the most recent upward trend driven largely by the exposure to defense markets the increased demand for capital in our businesses has been significant. Isolating these effects we would have expected our free cash flow conversion for all of 2019 to be in the 75% range. The rest of the story is, the incremental growth in our physical inventories some of which appears in unbilled receivables. Inventories have increased with a faster pace than our normal net working capital investments. This has been necessary to ensure we are supporting our customers' delivery demands while we are working through our operational process investments as John referenced.

With our current focus, on upgrading our operations we expect inventory turns to get slightly worse before they get better with improvement starting in the latter part of 2020. Despite the relatively soft 2019 our free cash flow conversion is averaged better than 100% from the period 2013 through to 2019 while our top-line revenues have grown 18% over the same period. And most of that coming in the last couple of years. Our free cash flow conversion target remains 100% over time. For fiscal 2020 our free cash flow forecast is $155 million or a conversion ratio of 80%. We expect a soft start to free cash flow in the first half of 2020 but as our processes around inventory management strengthen we expect a good finish to the year. Our year-end networking capital excluding cash in debt as a percentage of sales was 27.9% compared with 24.9% a year ago up 300 basis points. This largely reflects the growth in inventories that I've referenced. The $63 million of free cash flow, for the year compares with an increase in our net debt of $4 million. The difference is mostly explained by our quarterly dividend payments and share buyback activity. During the fiscal year we repurchased 302000 shares for $23 million and there were 241000 shares of which we acquired during our fourth quarter.

Capital expenditures in the fourth quarter were $27 million and depreciation and amortization totaled $21 million. For all of 2019 capex was $118 million while G&A was $85 million. Capital expenditures in 2020 will continue to be at the high end of our historical spending range or around $120 million which is 4% of sales. We're engaged in various facility expansion projects and we are investing in machinery and test equipment to improve our operational efficiencies. Our normal sustaining level of capex is between 3% and 4% of sales. Depreciation and amortization in 2020 is forecasted to be $86 million. Cash contributions to our global retirement plans totaled $10 million in the fourth quarter resulting in $37 million of contributions for all of 2019. This compares with contributions of $181 million in 2018 when we fully funded our U.S. DB pension plan. For 2020, we are planning to make contributions into our global retirement plans totaling $37 million. Global retirement plan expense in 2019 was $65 million compared with $57 million in 2018. And in 2020 our expense for retirement plan is projected to be around $70 million up from 2019 largely related to lower discount rates. Our Q4 effective tax rate of 21.3% is down from last year's Q4 rate of 26.7% reflecting the absence of last year's restructuring impacts in addition to lower state tax accruals in the U.S. this year.

For all 2019 our effective tax rate was 23.1% compared with last year's 47.4%. When we remove the onetime effects of tax reform and wind restructuring that took place in 2018 our adjusted 2018 effective tax rate related to our core operations was 25.1%. For 2020 we are forecasting our tax rate at 25.3% up from 2019's rate of 23.1%. 2020's tax rate assumes lower U.S. foreign tax credit, and benefits as the time-free phasing of a provision in the 2017 tax law begins to negatively affect us. In addition to a less favorable mix of global earnings. On October 15 2019 so just a couple of weeks ago our treasury team closed on the refinancing of our $1.1 billion revolving credit facility extending the term through October 2024. We have got 13 committed partners in our facility with competitive terms and conditions and we have a $400 million accordion feature providing us with the option to expand the facility. The other major piece of our debt financing is our $300 million of 5.25% high-yield debt that matures in December of 2022. Our leverage ratio which is net debt divided by EBITDA was 2.1x compared with 2.2x a year ago. With the recent modifications made during the October revolver financing the revised leverage ratio would have been 2% at the end of the fiscal year as the definition has been modified to exclude letters of credit. Net debt as a percentage of total capitalization was 35.9% down from 37.6% last year.

And at year-end we had $670 million of available unused borrowing capacity under the terms of our updated revolver that includes an increase in permitted leverage. Regarding capital deployment today we announced our quarterly cash dividend of $0.25 per share payable to our shareholders. We continue to look at strategic M&A targets and we repurchase our shares opportunistically. As we reflect back on 2019 we have been engaged in a lot of M&A activity with not much to show for it. But, we continue to exercise patience and discipline throughout our processes looking for targets that fit well strategically culturally and of course financially. We're excited to shift our focus for 2020 and beyond continuing the trajectory of record sales and earnings per share. Sales will eclipse the $3 billion mark for the first time up 4%. Our consolidated operating margins are forecasted to improve 40 basis points to 11.5% with importantly our Aircraft margins improving 110 basis points to 10.5%. Free cash flow will be respectable for our growing business with 80% conversion. And finally our EPS will be up 9% to $5.55 a share. It's worth pointing out that our 2020 EPS forecast reflects higher pension costs of about $5 million or roughly $0.10 a share and our 2020 effective tax rate is forecasted to increase 220 basis points or about $0.15 per share relative to 2019.

So with that I'd like to turn it back to John, and we will take any questions that you may have.

John R. Scannell -- Chairman and Chief Executive Officer

Thank you. Thanks Don. And Stephanie any questions we would be happy to take them in queue.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Cai von Rumohr with Cowen.

Cai von Rumohr -- Cowen -- Analyst

Morning guys.

John R. Scannell -- Chairman and Chief Executive Officer

Hi.

Cai von Rumohr -- Cowen -- Analyst

Yes. Good morning, John. So maybe you could give us an update in terms of the work that consultants have been doing in your Aircraft area basically where are you? How long is it going to take to get this done? What recommendations have they made? And when can we expect to see the financial results of all of that?

John R. Scannell -- Chairman and Chief Executive Officer

So, we engaged with our consultant friends in the second quarter. If you remember at the end of the second quarter we reported that we have that quality issue that was essentially what triggered us to say we got to take a step back here because granted it was a quality issue with a particular supplier. But what it demonstrated to us was the operational processes that we have said that we had in place which were working fine with the both but we are not robust enough to take into account a hiccup on the outside. And so, you had the proverbial straw to fold the camels back. So that was the process then that said we got to start upgrading those processes to the next level of sophistication. We engaged with them in March April. It's the usual type of process there's a several months of review there's a several months of review then there's several months of laying out new processes. And then you get into pilot testing and from there you get into systematic implementation across the company.

And so where we are right now Cai is that we have kind of gone through that diagnostic phase we have gone through that testing phase. And now we are starting to work of -- actually pushing that out across the whole organization within the Aircraft business. And that will take as Don reported It will take probably -- before we start to see the impact on the financials and we start to see the inventory turning down probably the second half of 2020 and then into 2021 we should really see the benefits coming through. So once you get into a situation where you got these types of challenges it just takes quite a bit of time to dig your way out of it. And it's a lot of hard work a lot of focus but that's where we are right now. And so we are starting to see the internal benefits we are definitely seeing the benefits to our customers in terms of making sure that we are getting everything done on time. But we won't see the impact on the financials until we get our way through 2020 probably toward the back half of the year.

Cai von Rumohr -- Cowen -- Analyst

Got it. And so clearly the inventory and receivables have been impacted in the fourth quarter. I think clearly for the full year they're going to be impacted this year. Why only 100% for future cash flow conversion? Don't you have your way out of the wack on those two ratios and just to get them back to normal should take you comfortably over a 100% conversion in fiscal '21?

Donald R. Fishback -- Vice President and Chief Financial Officer

So I'll try, take that one Cai. I think we are focused on improving our cash flow conversion as I reported. Over the span of the last 70 years we have actually been around 100% last year and a half have been tough. But in all fairness last year we spent 100 -- almost $150 million to fully fund our pension plan. But if I include all that, we are close to 100% just a little over 100% over the past seven to eight years. As I look into 2020 we have got to remember -- which I know we all do but we have got to remember that our growth trajectory also consumes some working capital. And as I said, about $0.25 on the dollar is a natural increase in working capital largely because of inventory and receivables. So if you look at 2020 I acknowledge that we have got some growth in working capital just naturally because of our investments in -- or I should say because of our growth investments in working capital. I've also got capital expenditures that we are forecasting right now that will be in excess of our depreciation and amortization of about $30 million as well.

And when I capture all of that it does say that we are still consuming in 2020 a disproportionate amount in inventories which is kind of reflecting what John just said that we are not going to see the benefits of all this process focused -- process improvement focus that is ongoing right now. It's not going to start to show for us until the latter part of 2020. So when you add all that up it does suggest that we should be coming in at about the 80% conversion range in 2020. Could it better in 2021? Let's wait, for a little bit and we will report out as this year unfolds. But we are focused on bringing the working capital back into alignment with where we were happy with the trajectory a year ago because it was declining we reversed that trend most recently but we are focused trying to bring that working capital back down over the next couple of years.

John R. Scannell -- Chairman and Chief Executive Officer

Maybe another way of thinking about it Cai is that we -- '19 was a growth in working capital '20 we see as a stabilization but not an improvement in the working capital percentage and so if you do that then you're at the 80% with the growth of the top line. And then as you get into 2021 we start to see that working capital as a percentage of sales come down. And so we would hope to see that improvement as we get out into 2021. But right now we don't want to get ahead of ourselves and we need to start seeing those new processes really taking roots and having an impact. And so we are cautious about the '20 outlook at this stage.

Cai von Rumohr -- Cowen -- Analyst

And just a last one and I'll get back into the queue. So maybe give us a little bit more color in the trends in receivables in payables in customer advances? Just in terms of the ratios relative to sales. And what are you doing to kind of pull some of those labors to improve the results?

John R. Scannell -- Chairman and Chief Executive Officer

I'll try this Don, and maybe you can pipe in. But receivables actually on -- the trends in receivables is not bad that. Our days outstanding has been holding pretty good and our folks are doing a really good job as we invoice and collect in accordance with the terms of sales. So that's not our challenge. I think you referenced customer advances customer advances are certainly a focus of ours and we are focused on trying to get as much cash up front as possible but we -- not surprisingly have customers that aren't interested in giving us a lot of cash up front. So that's a negotiation, but I can assure you that our teams that are out there seeking business are out there, using cash as a negotiating tool to drag as much cash up front as possible. And then the last thing is inventories and it really is reflective of our operations. We actually have been doing a pretty good job with bringing inventories down increasing the terms of inventories up until I'd say 1.5 year or so ago. And that trend has started to show it in a negative way where it's increasing. So right now we are expecting as I said the -- that negative trend to continue into the first half of 2020. And I think that will start to reverse as we get things settled our processes improve I would expect that we would see that to start to come down. So cash flow for '20 anyway might be a slow start but I think it'll be a good second half. And overall I think we will get to the 80%.

Cai von Rumohr -- Cowen -- Analyst

Thanks so much.

Operator

Thank you. Our next question comes from Kristine Liwag with BAML.

Kristine Liwag -- BAML -- Analyst

Hi. Good morning, guys.

John R. Scannell -- Chairman and Chief Executive Officer

Hello Kristine.

Kristine Liwag -- BAML -- Analyst

So following up on some of Cai's earlier questions in Aircraft controls you ended the quarter at an operating margin of 8.2% and you're expecting 10.5% for fiscal year '20. Can you provide more color on the specific initiatives you're putting in place in the supply chain? And also what are the milestones that will drive margins higher for next year? And when do you expect margins to start inflecting positively?

John R. Scannell -- Chairman and Chief Executive Officer

So Kristine, we did finish the quarter on -- with the quarter at 8.2%. For the year it was 9.4%. And as I described in the quarter we took some additional charges. We spent more on consulting we took some restructuring charges and we took a charge on the A380. So that's depressed the margin in the quarter by about 200 basis points. So let me jump off the year at 9.4% rather than the quarter and the 9.4% to the 10.5% next year. If you go back, we have had the -- we had that supplier quality issue. So that was a real hit in the year but if we don't have that next year and we are assuming that we don't have that. Then we just had start to see some gradual improvements in the margin you can get to the 10.5% pretty quickly. And so it's a bit of an improvement next year. It's definitely an avoidance of some of the challenges that we had this year but that's how you get there. It's starting to see those operational improvements come through. But it's not a huge jump from where we have just been here in the board in '19. And certainly it's only -- it's still down a little bit from what we were looking at in '18. In terms of the timing of it that really depends -- there's a couple of things that will effect that.

The operational improvements, will start to happen as we go through the year. So you'll get to see an improvement as we go through the year. However we also have mixed issues that happen typically quarter-to-quarter which could have a -- an influence over and above that. So I prefer not to say it's going to be 8 on one, two, three, 4% because I think that will all depend on -- some of it is a mix that our business that comes in and then ships out and some of it will be the operation improvement. Underlying structurally the operational stuff will get better as we go through the year. Not a lot of -- I don't think you'll see a lot from it in Q1 Q2 and then three and four it's where we will see it. Mostly on the cash will be the first thing before you see it on the earnings I think. But then as I say there's an overlay of the product mix and particularly some point foreign programs and stuff that will be on top of that. And so that may affect the margins beyond just simply the operational improvement. So I don't want to give you right now a forecast that says how each of the quarters lay out because I think that will be a bigger -- that could be a big effect as well.

Kristine Liwag -- BAML -- Analyst

And then on the specific initiatives that you're putting in can you provide color there?

John R. Scannell -- Chairman and Chief Executive Officer

So these are process-related initiatives, which are based around -- I mean the entire suite of processes that you've got from your planning processes; your sales and operations systems; your processes with suppliers in terms of improvement process; your quality systems it's a whole suite of processes. And essentially what we are trying to do is upgrade each of these processes. We have had processes around all of these things for many many years and they served us very well as long as I -- what I call a Tier two supplier, it served us OK, as a Tier one supplier until, we discovered that strains in the supply chain something happening on the outside created an effect that we couldn't absorb. We did not have sufficient robust processes in additional excess capacity to absorb this preservations. And so know what you do is you take all of those processes and you look at them and you say "we want to upgrade each of these processes". So it's not a singular we are just going to install a sales and operations planning process or we are just to going to modify our inventory management systems or we are just going to put in a more advanced supplier quality program. It is a range of processes across all of those. And that's why we are calling it operations 2.0 because it's broad-based it's not a singular thing it's not a singular issue or a singular problem it's a broad-based upgrade from a series of processes that serve us well but now we need to move to the next step as we become a really strong Tier one supplier.

Kristine Liwag -- BAML -- Analyst

That's helpful. And switching gears to Defense you highlighted growth in hypersonics. Can you describe to the extent that you can your capabilities in hypersonics and the long-term opportunity that you're seeing in that end market?

John R. Scannell -- Chairman and Chief Executive Officer

So many of the hypersonic stuff, we can't talk about Kristine. But our capability is similar to our capability in the missile businesses. We're really in the motion- steering- control-type of area. That's our technology it's motion-controlled. And if we look at say the traditional missile programs it's the steering of the fins on the back of the missiles. And so you can imagine that our capability as we look at hypersonics is an extension of that core technology. And in terms of the long term I actually can't because I don't know that anybody can. I don't know that we know. I think at this stage like happens in many of these government problems is there's a range of applications that are being developed. And it's not quite clear which ones will be more successful which ones will have production problems behind them. What we do feel like is that we are on a portfolio with multiple customers and multiple programs.

And so, by betting on lots of them hopefully you end up being on the winners when the time comes. If you go back a long time the JDAM there were dozens and dozens of Military missile programs and it turned out that the JDAM was the golden goose and somebody -- it was Woodward I think who won the JDAM at the time. Nobody knew us and of course that was a huge one. And I think with the hypersonics it will be similar. There'll be some real winners and probably some losers. As I say our focus is on to get on as many of them as we possibly can to make sure that we end up with some of the winning programs. But at this stage it's way too early a thing I think. I think partially because many of them we don't -- they're still in the test phase as well and I don't think the Military folks know yet which one they think will be more successful.

Kristine Liwag -- BAML -- Analyst

Thanks for the color.

John R. Scannell -- Chairman and Chief Executive Officer

You are welcome.

Operator

Thank you. Our next question comes from Robert Spingarn with Credit Suisse.

John R. Scannell -- Chairman and Chief Executive Officer

Hi Rob.

Robert Spingarn -- Credit Suisse -- Analyst

Hi, good morning. Hey, there. I wanted to ask you about the defense margin guidance just flat but still double-digit growth. If we could just talk about that a little bit.

John R. Scannell -- Chairman and Chief Executive Officer

I think Rob you're asking about the margins in Space and Defense group. Is that correct?

Robert Spingarn -- Credit Suisse -- Analyst

Yes. In the Space and Defense group you're calling for a 13% sort of flat -- year-on-year 13% margin. Now your growth is coming down a little bit but it's still pretty good so I thought maybe you have some leverage there?

John R. Scannell -- Chairman and Chief Executive Officer

Yes. So -- that is a good question. So the sales grew by about $90 million. But about 1/3 of it is actually funded development activity. And typically that's very low margin business. 1/3 of the growth is about funded development.

Robert Spingarn -- Credit Suisse -- Analyst

So 30 billion?

John R. Scannell -- Chairman and Chief Executive Officer

And it's a very low-margin business and so that's what tempers your volume leverage that you might otherwise hope for or expect.

Robert Spingarn -- Credit Suisse -- Analyst

Okay. Very high-level question then changing gears. But with all of this strength that we see in Space and Defense and I suppose eventually Industrial will get working. But just the dynamics that you've seen in Commercial aviation. Do you think that Commercial aviation over time will shrink as a percentage of the business? I'm talking like on a five to 10-year basis.

John R. Scannell -- Chairman and Chief Executive Officer

Well, so let's take a step back and look at the programs we have got. So, we have got a range of legacy programs. We mentioned the A380 it was never really a big program but that's gone away. The 777 is reducing. We're -- we have got a stable position on the 37 so that looks like it's got long-term legs. And of course we are on the 87 and the 350 the E2 the 919 I mean eventually that will probably become a program. So I think we have got some very nice programs that will keep us going for the next 10 15 years. However right now there is no major new development program. Maybe the NMA is coming. It's seem hard to imagine that they're going to do anything with the 320 or the 37 in the next five to 10 years. And so, I can't tell you what that next program might be. And there's also of course the dynamics that Boeing has said that they would like to do more actuation internally. And so we can't put a figure around that. But I think we have a nice -- a very nice book of business our focus is on continuing to improve the operational performance and watching the aftermarket growth. And we have lots of other opportunities for growth with our technologies given the diverse range of things that we do we can refocus on some other areas and new innovations.

And, we are looking within the Aircraft business beyond, just the flight controls business at other possible areas of future growth. So I don't know that if I -- if we are sitting here in a decade's time with our Commercial OE business the -- as much as it is now I'm not sure I think the aftermarket will be a lot stronger. But it all depends on when those new programs come up and if we win some of them. We have very strong relationships I think with our customers. On the Military side where there have been new programs, we are -- we believe we are the tri factor company to do almost all of the Military programs. And so we think we are in a very strong position and the more we can get better on the operational side to better position we will be for the future potential programs problems that are coming along. I do think that whole industry has changed of course Rob as you know. We have gone from what I might call four OEMs and the Chinese is a fifth down to 2. I mean it's an Airbus Boeing duopoly at this stage so that's an interesting shift. And then the consolidation in that industry. And then it's hard to see how that all plays out. Our focus is simple we want to be very deep in flight controls and that's what we are really good at and then look at how we gradually expand beyond that core. And I think we have got the time to do that now while there's a lot in the major Aircraft programs.

Robert Spingarn -- Credit Suisse -- Analyst

And, just on that you may have touched on this earlier I might've missed it. But when I look at the decline in Boeing OE sales in your forecast I imagine that's 787-driven but to what -- how -- given the advanced the lead times you have is that a fully baked in 12 in that number? Or do we have a more headwind in the subsequent year? And then how the MAX factor into that effort? So what's happening with those two programs between '19 and '20.

John R. Scannell -- Chairman and Chief Executive Officer

Yes, so in '19 and '20 the 87 is about flat after enticing them both it's pretty much flat. And given the way inventory moves the way ours is submitted. We probably see that reduction in 787 top-line for Boeing that will be more in the 2021 time period. So the drop is essentially all the 777. I mean that's essentially what it is. We modeled the 37 in '20 at pretty much the same rates as in '19. So you can do 87 about flat 37 about flat and the drop that we are showing on the top line is essentially all the drop in the 777 rates.

Robert Spingarn -- Credit Suisse -- Analyst

Is the 777 -- given the delays the push out at the 777 X I mean is it possible you will outperform that number if they keep selling freighters and essentially extending the classic?

John R. Scannell -- Chairman and Chief Executive Officer

If they ship more of them, and does more of them then yes I think there may be some upside. But I -- again it drops from mid-30s to mid-teens next year. They make a couple of more aeroplanes maybe that gets up a couple of million dollars. But I don't think it will move the needle.

Robert Spingarn -- Credit Suisse -- Analyst

Okay. All right. Appreciate the color. Thank you.

John R. Scannell -- Chairman and Chief Executive Officer

You're welcome.

Operator

Thank you. Our next question comes from Mike Ciarmoli with SunTrust.

John R. Scannell -- Chairman and Chief Executive Officer

Good morning Mike.

Mike Ciarmoli -- SunTrust -- Analyst

Good morning, guys. Thanks for taking the questions here. John or Don maybe just one housekeeping maybe I missed it. Did you talk about how the year would start first quarter from an earnings perspective? Or sort of give the earnings cadence for the year?

John R. Scannell -- Chairman and Chief Executive Officer

Yes. We said the year would be $5.55 and the first quarter would be $1.30 plus or minus $0.10.

Mike Ciarmoli -- SunTrust -- Analyst

$1.30. Okay I missed that. And then just back to the margins. I mean I'm trying to get -- I guess more of an apples to apples on this Aircraft. You closed the year at 9.4%. You're guiding to 10.5%. There was $7 million roughly in the quarter and then you had the supplier charge of $10 million in 2Q. That would -- just losing those charges would kind of put you at a 10.7% margin. So is there any -- I would imagine these implementation costs are lingering throughout next year. But am I thinking about the math correctly? Is there any other headwind next year from maybe the implementation of these processes? It just seems like the core margins are really expanding much.

John R. Scannell -- Chairman and Chief Executive Officer

Your math is right, Mike. And so what we are seeing is we are starting out with what we think is maybe a conservative view of what we think Aircraft will do next year. So there's always mix shift there's always movement in the mix that move one way or the other. But our anticipation is if we avoid some of the challenges that we have had this year there is ongoing -- you're right there's ongoing investments that will continue. So we will continue to be spending more in terms of consultants in terms of process upgrades in terms of those types of investment than what we might do it when we get to a steady stage. But that's why I said that the margin expansion when I answers Kristine's thing from the 9.4% to the 10.5% is not an unreasonable step to go with next year.

Mike Ciarmoli -- SunTrust -- Analyst

Okay. OK. Got it. And then just on -- I guess on the capital deployment side you guys were saying you're really busy looking at the M&A nothing came across the finish line. What's been the biggest obstacle? Has it really just been valuation preventing you from closing these deals? Or could you give a little bit more color as to maybe why you have not done anything across the finish line?

John R. Scannell -- Chairman and Chief Executive Officer

Yes. I would say it's primarily valuation Mike. So if people -- I mean if folks are paying 12, 14, 15, 16x EBITDA. And we -- and the assumption is that cost of capital has fundamentally and structurally going down and it's never going to go back up. I think we are -- if it's something that we feel is absolutely core to what we do we will pay up. If it's something that's adjacent that's kind of in the growth factor we are cautious about being able to make the numbers work when you're paying well into the double digits in EBITDA. And we just have backed away from some things where when we run the numbers it just doesn't seem to make sense for us. My own belief for what it's worth is -- and the other thing I think that's happening is the PE guys have money to invest. And they're paid to invest money not to paid to sit on it. And we can be patient. We have got other uses for the capital. And my belief is that in a couple of years' time some of those deals that we have been incredibly high levered may come unglued. And there may be assets to pick up at a more reasonable price. And so we are patient. If it's something that we absolutely fear is core to what we do we will pay up because there is a strategic element to it that we believe is workers. But otherwise we are cautious and we will find -- we look we are patient and we have got lots of things we can do with the capital to make sure that our shareholders will get the type of returns they need.

Mike Ciarmoli -- SunTrust -- Analyst

That'll be it.I'll jump back in the queue guys. Thanks.

John R. Scannell -- Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. [Operator Instructions] Our next question comes from Tony Bancroft with Gabelli Funds.

John R. Scannell -- Chairman and Chief Executive Officer

Good morning Tony.

Tony Bancroft -- Gabelli Funds -- Analyst

Hi Good morning, thanks so much for taking my call on my question. On the GBSD program could you remind us again how you participate there? What the potential opportunity is? As well as your thoughts on the recent dynamics regarding with Boeing? And how that can play out? And what would it mean for you depending upon how does it play out.

Donald R. Fishback -- Vice President and Chief Financial Officer

So, I can tell you a little bit Tony. But the irony is, that the GBSD program is -- in theory not something we are supposed to talk a lot about. It seems to be all a surprise. So within that context I think what we have said in the past is that we are participating with both teams. We think we have got offerings for both teams always you favor one team over an another because of the content that you might have. But right now it seems like it's getting down to one team although what seems to be in the news is there may be a unified team. A kind of a national team. So at this stage we don't know how to answer. I mean we -- we are reading the same things that you guys are reading.

At I don't think, we have the better read on this. We do still think there is significant opportunity for us. It's a very long-term play. And so it would be the next call it decade of investments funded development work a couple of millions here a couple of millions dollars there. It's really as you get out toward the end of the decade that it would turn into production. So we are still optimistic that we have got the type of products capabilities and technologies we are talking to both potential OEMs. We don't know how it's going to play out the latest FTC investigation who knows. But we are -- we will continue to be part of it and to supply our customers with everything and anything that they think they would like to get from us. And, we do think it has long term potential. But as I say it's outer ways.

Tony Bancroft -- Gabelli Funds -- Analyst

Great job. appreciate it. Good luck.

John R. Scannell -- Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. [Operator Instructions]

John R. Scannell -- Chairman and Chief Executive Officer

Sounds like we have -- we are -- we are done Stephanie.

Operator

There are currently, no additional questions at this time. I'll go ahead, and turn it back over for closing remarks.

John R. Scannell -- Chairman and Chief Executive Officer

Thank you all for listening in this morning. Thank you for taking the time. We look forward, to reporting out again in 90 days' time. Thank you.

Operator

[Operator Closing Remarks]

Duration: 57 minutes

Call participants:

Ann Marie Luhr -- Head of Investor Relations

John R. Scannell -- Chairman and Chief Executive Officer

Donald R. Fishback -- Vice President and Chief Financial Officer

Cai von Rumohr -- Cowen -- Analyst

Kristine Liwag -- BAML -- Analyst

Robert Spingarn -- Credit Suisse -- Analyst

Mike Ciarmoli -- SunTrust -- Analyst

Tony Bancroft -- Gabelli Funds -- Analyst

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