First Quarter Conference Call, Fiscal Year 2013

January 25, 2013

Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors that could cause actual performance to differ materially from such statements.  A description of these risks, uncertainties and other factors is contained in our news release of January 25, 2013, our most recent Form 8K filed on January 25, 2013, and in certain of our other public filings with the SEC.

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

Introduction - John Scannell

Good morning. Thanks for joining us. This morning we’ll report on the first quarter of fiscal ‘13 and update our guidance for the full year.  Our first quarter was a slower start to the year than we were planning. Our Aircraft and Components groups delivered excellent results, but sales in our Industrial Systems business were below plan and margins in this segment were weak.  

Six months ago, we provided our initial guidance for 2013.  At that time, we projected a sales range of $2.58 billion plus or minus $25 million. We intended the range to reflect uncertainty, principally in our industrial business. We also projected a range in earnings per share of $3.50 to $3.70. Ninety days ago, we reaffirmed that guidance. We updated our sales to account for some acquisitions we had made.  We maintained the earnings guidance. We were also forecasting earnings per share for this quarter of 80¢ at the midpoint of our range.  

The news of the day is that the first quarter of 2013 was not a strong industrial sales quarter. Sales of $148 million came in about $10 million below our expectations. As a result, our earnings per share for the quarter came in at 75¢. Some of the shortfall was the result of customers delaying the placement of orders. We think these orders will ultimately be placed, but given our experience in the first quarter, we are revising downward our forecast of industrial sales for the year. The leadership of our industrial group is taking the appropriate actions to adjust our cost structure, but the lower sales for the year will have an impact on the industrial operating profit. I’ll describe that in more detail in a few minutes, but first let me provide the highlights in the quarter and more detail on our revised outlook for the year.

Q1 Fiscal ‘13

Sales in the quarter of $621 million were up 3% over last year. The growth is all attributable to acquired sales from recent acquisitions. Absent acquisitions, sales were about flat with fiscal ’12. We had good organic sales growth in our Aircraft and Components Segments, relatively flat sales in Space and Defense and Medical and lower sales in Industrial. Net earnings of $34 million and earnings per share of 75¢ were both 6% lower than last year. Taking a look at the P&L, our gross margin is unchanged from fiscal ’12. R&D is up, driven by acquisitions and the continued spend on the A350. SG&A is also up in the quarter as a percentage of sales, due to a combination of acquisitions, higher pension costs and the timing of some expenses. For the full year fiscal ‘13, we are anticipating SG&A will be about level as a percentage of sales with fiscal ’12. Interest expense is unchanged from last year.  Our income tax rate came in at 30.5%, 80 bps below last year on a different mix of international earnings.  The overall result was a 5.5% net margin and, as I mentioned, earnings per share of 75¢.  

Fiscal '13

We are moderating our sales forecast for the year by $29 million. There is no change in Aircraft, Components or Medical. Sales in our Space and Defense group will be $20 million higher as a result of our recent Broad Reach acquisition. Our Industrial Systems sales will be $49 million lower than our last forecast, reflecting three more quarters about equal to the first quarter. As before, our forecast does not take account of any potential impact from sequestration, should it occur. Given the lower sales outlook, we are narrowing our EPS range to between $3.50 and $3.60 on total sales of $2.62 billion.  

Before I jump into the segments, let me provide some more color on the weakness in our Industrial Systems segment and expand on our thinking for the remainder of the year.  

We are disappointed with our results in our Industrial Segment this quarter.  Ninety days ago, our forecast for fiscal ’13 included a sales range for our Industrial Segment between $624 million and $674 million. We are now forecasting sales of $600 million, $24 million below the low end of that range. For several quarters, we have been reporting that the industrial markets in the US were strong, stable in Europe and weak in Asia, particularly China. Last quarter, we reported some slowing of incoming orders in Europe, but we believed our forecast for fiscal ’13 already captured this effect. This quarter, we saw further weakness in Europe, and a continued slowdown in China. Our new forecast of $600 million for the full year reflects a second quarter similar to the first and then a very modest improvement in the second half.  

We believe we have a robust forecasting process – a combination of a detailed roll up by customer from our field sales people, coupled with a top down analysis of major trends. We have also been watching our order rate for signs of structural weakness – and, given our experience in the recession of 2009, we have been particularly vigilant.  Despite our best efforts however, we missed the turn in the business this quarter.  I am reminded of a quote I heard one time which was attributed to a famous economist (whose name I don’t recall). He said, “when you have seen one recession, you have seen one recession.” For our industrial segment, this means forecasting will remain challenging so we need to plan our business assuming volatility in the market, both on the downside and on the upside, and build as much flexibility into our cost structure as possible. This is the path we have been on for the last three years and continue to pursue.  

Margins in our Industrial Segment were 6.1% this quarter. Based on a range of actions we are taking, we believe margins for the year will be 8.4%. These margins include about $4 million, or 80 basis points, of restructuring. Over the last few years, we have increased the number of temporary workers in our production areas and we have used this flexibility to align our direct staff with the needs of the business as our sales have dropped. Given the nature of our business, however, it is not possible to maintain a large temporary workforce of skilled development, application and sales engineers.  Therefore, we are now engaged in a range of restructuring activities including reducing overhead, consolidating facilities and exiting some product lines. Some of these actions have already occurred but others have not yet been communicated within the company so we are not going to discuss these in detail at this stage. These activities will take several quarters to complete, but we plan to exit fiscal ’13 with a more profitable and focused industrial business.    

We are often asked about the upside potential and the downside risk associated with our forecasts. On the upside, I would say that our A&D businesses could be a stronger than we have forecast and our off-shore energy market could be better.  On the downside, we still have the risk of sequestration and, of course, our industrial business could continue to weaken beyond what we are now forecasting.  
Now to the segments. I would remind our listeners that we have provided a two-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.  

Aircraft Controls

Aircraft Q1
Q1 was a very strong quarter. Total aircraft sales were up 9% to $252 million. There were gains in both the commercial and military markets. In the commercial OEM market, sales on the 787 were more than double the level of a year ago, rising to $19 million this quarter. The growth in sales to Boeing accounts for 100% of the OEM sales increase year over year with 787 sales contributing 80% of the growth. In our other OEM categories, we saw some ups and downs but little of note. The commercial aftermarket was up 5% on strong 787 initial provisioning.  

In the military market, our OEM business was about level with last year, but we saw a nice pick up in the military aftermarket driven by strong sales on the C-5, F-15 and F-18 platforms.  

Aircraft Fiscal 13
We are keeping our forecast for both commercial and military aircraft unchanged from 90 days ago. On the military side, we are expecting fiscal ’13 sales of $590 million.  Comparing to our forecast last quarter, we think the military OEM will be about $7 million lower, balanced by $7 million higher military aftermarket sales.  

On the commercial side, we are forecasting fiscal ’13 sales of $437 million. The production ramp up on the A350 program is going to be slower than we were anticipating, so that will reduce our Airbus forecast for the year by about $7 million but we should see higher sales in our other OEM accounts and a slightly stronger commercial aftermarket.  

Aircraft Margins
Margins in the quarter of 12.3% were strong on a nice mix of sales. We are not forecasting the same margins for the full year but, given the strong first quarter, we are we raising our margin forecast for all of fiscal ’13 to 11.9% from 11.5%. We have been telling the story for several years that our aircraft margins would expand as various programs shifted out of development and into production.  We are now seeing this effect come through strongly with margins in 2013 up 100 basis points over 2012.  And, as I mentioned last quarter, were it not for the higher pension costs associated with the low discount rate, aircraft margins in 2013 would have been 50 basis points higher, or 12.4%.

Space and Defense

Space and Defense Q1
Sales in the quarter were down marginally from last year at $87 million. We had growth from acquisitions, balanced by softer sales on some of our legacy platforms. The satellite market was way up with the growth coming from our recent ISP acquisition.  Our NASA business was lower as work on the Orion Multi Purpose Crew Vehicle slowed significantly. In the defense market, sales were slightly lower as work on armored vehicles declined. The missile replenishment work was in line with last year.  The security sector was also lower, but the majority of this drop is due to the lack of DVE sales in this quarter.   

Space & Defense Fiscal 13
For the year, we are increasing our sales forecast by $20 million to $433 million. We acquired Broad Reach Engineering, a manufacturer of spacecraft avionics, at the beginning of Q2.  This will add $32 million in sales to the year.  

Our legacy space and defense markets softened in the first quarter from what we were anticipating, so we are moderating our forecasts for these markets slightly to reflect that slowdown. We are keeping our forecast for security unchanged from 90 days ago.  Overall, Q1 was a relatively slow start to the year but we believe activity will accelerate as we move through the year. Our activity on the common TVC system for Delta IV and Atlas V will pick up in the second half and we are anticipating orders for some foreign military programs in our missiles product line.    

Space & Defense Margins
Margins in the quarter were 9.5%, below our average of the last four quarters. Acquired sales from recent acquisitions balanced lower sales on our legacy business. This resulted in an unfavorable mix which depressed margins. We think we may continue to see a slightly adverse mix over the next couple of quarters so we are moderating our margin outlook for the year to 10.2%.   

Before I leave the Space & Defense segment, let me add a couple of comments about our recent acquisitions in the space market. Over the last year, we have acquired Bradford in The Netherlands, with capability in space components, ISP in Niagara Falls and the UK with satellite engine capability and Broad Reach in the US with avionics capability. When we combine these capabilities with the Moog heritage space business,  we believe we have the broadest range of satellite components on offer in the market.  Our strategy has been to increase our scope of supply on every satellite, and add value by integrating components into more reliable and compact subsystems. With the addition of these three recent acquisitions, we believe we have carved out a unique market niche as a full range supplier of components and subsystems to the global spacecraft market.  

Industrial Systems

Industrial Systems Q1
Sales in the quarter of $148 million were 6% lower than last year. Sales were down in energy and industrial automation, while simulation and test sales were marginally higher.  Within energy, the story continues to be the wind challenges in China. Sales this quarter were only $6 million compared to $17 million a year ago. The non-renewable energy sector was actually up nicely in the quarter. Turning to industrial automation, we have seen a slowdown in most of the major industrial markets we serve, including plastics, metal forming and steel mills. Last quarter, we reported that Europe was starting to slow, although we weren’t sure if it was more a summer month seasonal effect or a structural shift. This quarter, the slowdown continued and we believe we are now facing a structural slowdown which we do not see improving in the next few quarters. Our test and simulation business was up slightly in the quarter, the combination of strong simulation growth and a slowing in auto test systems.   

Industrial Systems Fiscal 13
Given the slow start to the year, and our outlook that sales are unlikely to improve much over the next three quarters, we have moderated our forecast for the year down to $600 million. This total is in line with the run rate of the first quarter. Last quarter, we forecasted a sales midpoint of $649 million. Comparing our thinking now with that midpoint, we are reducing our wind forecast by $14 million, our industrial automation forecast by $25 million and our test and simulation forecast by $10 million. The reduction in the test and simulation market is all on the test side, where we anticipate the delayed receipt of orders for some large automotive test projects.  

Industrial Systems Margins
Margins in the quarter were a disappointing 6.1%. Coming into the quarter, we were sizing our organization for higher sales through fiscal ’13. Lower sales, a poor mix and higher operating expenses all contributed to the weak margin performance. Last quarter, we reported that we had taken action in our wind business in response to slowing sales in China. This quarter, we have developed a more comprehensive restructuring plan to align our cost structure with our revised sales forecast. Based on the plans in place, we anticipate a recovery of margins in the second half to yield full year fiscal ’13 margins of 8.4%. These margins are inclusive of restructuring costs of about 80 basis points, or $4 million.   

Components Group

Components Q1
A great quarter for our Components Group with sales up 13% to $99 million. Our A&D businesses were slightly lower this quarter but our sales of components for off-shore exploration were very strong. Historically, we have classified our oil & gas exploration sales in this segment as “Marine.” Going forward, we are including all marine sales as well as sales of slip rings on wind turbines in a new “Energy” category.  In this quarter, our sales of slip rings on wind turbines in the components group were $1 million, while our sales into the marine market were $23 million. Sales in the marine market were driven by very strong deliveries of large slip rings used on off-shore oil storage vessels as well sales from our Tritech acquisition.   

Components Fiscal 13
We are keeping our forecast unchanged from 90 days ago.  Our new “Energy” category includes $75 million of marine sales and $5 million of wind sales. These wind sales were previously in our Industrial category so that category is now $5 million lower than 90 days ago.    

Components Margins
Margins in the quarter were very strong at 19%. In addition to a very strong underlying business, margins this quarter benefited 200 basis points from the partial unwinding of an earn out provision on our Protokraft acquisition.  Protokraft is forecasted to grow very nicely in fiscal ’13, but will not meet the sales level required to secure the full earn out for the sellers. Based on the strong underlying margins in the first quarter, we are increasing our margin forecast for the year to 16.2%.   

Medical Devices

Medical Q1
Sales in the quarter of $35 million were in line with the last eight quarters. Pump sales were down a little from a year ago, balanced by slightly higher set sales.   

Medical Fiscal 13
There is no change in our sales forecast of $146 million for the year. We think pump sales may be a little lower and set sales a little higher, reflecting the trend we saw in the first quarter. One development of note over the last quarter has been the decision by Abbott nutrition to exit the enteral pump market in the US. This creates an opportunity to gain some market share which we are actively pursuing. Any impact on fiscal ’13 is likely to be small, but longer term, we could see some gains from the departure of a major player in the market.  

Medical Margins
Operating profit in the quarter was $1.6 million, or 4.6% of sales. This was up from the average margin in fiscal ’12 of 3.9%. For the year, we are maintaining our margin forecast at 6%.    

Summary Guidance

We are off to a slow start this year. The weakness is in our Industrial markets, while our A&D businesses are strong. For the year, we are projecting sales of $2.62 billion, down $29 million from our last forecast but up 6% over last year. We are projecting EPS within a range of $3.50 to $3.60, a 7% increase on fiscal ’12 at the midpoint. We believe the second quarter will be similar to the first and that we will see an acceleration in sales and earnings in the second half. On the sales side, we anticipate a modest increase in each of the segments as we move through the year. On the earnings side, we should see a stronger second half in both our Space and Defense segment and our Industrial Segment. In Space and Defense, higher sales on the common TVC program and in our missiles product line will drive the improvement. In our Industrial Segment, we will see higher sales in the second half in our simulation business and will also have the benefit of our restructuring activities. The midpoint of our new earnings range is $3.55 and we are projecting EPS of 73¢ in Q2, 99¢ in Q3 and $1.08 in Q4.  

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

Cash Flow and Balance Sheet - Don Fishback

Thanks, John.  Good morning.

Our net debt decreased by $9 million during our first quarter to $607 million and free cash flow was $6 million. Our first quarter was a slow cash flow quarter due to the payment of annual profit share to all employees in December. Were it not for this special item, our first quarter free cash flow would have been in-line with the run rate we’re forecasting for the full year. So, although it appears that we’re off to a slow start, we understand why and we’ve left our free cash flow outlook for the year unchanged at $135 million. Similar to last year, we do expect a strong second half compared to the first half largely due to timing issues on receivables and customer advances. In summary, our cash flow conversion of net earnings will be in excess of 80% for the year.

There aren’t any notable changes on the balance sheet. Receivables were flat and inventories were up slightly as our production activity on commercial aircraft programs continue to ramp up. Accrued liabilities were down because of the profit share payments. Customer advances increased during the quarter by $6 million to $118 million. Loss reserves declined from the prior quarter by $6 million to $42 million.  Capital expenditures were $22 million and depreciation and amortization totaled $26 million in the quarter. We’re leaving forecasts for CapEx and depreciation and amortization for all of fiscal 2013 unchanged at $105 million and $114 million, respectively.

As we’ve begun fiscal 2013, it’s worth remembering that we have two rather substantial hurdles that are a drag on what would otherwise be a very respectable outlook.  Between higher pension costs and a higher tax rate compared with last year, our earnings per share are negatively affected to the tune of about $.34 per share. That’s a hole of 10% on last year’s EPS before we even start the year. Our operations, for the most part, are filling that hole and then some, but it’s a significant headwind to deal with.  

John referenced our pension costs pressures in our Aircraft Segment, but I’d like to offer a broader perspective. In Fiscal 2013, we’re forecasting our DB pension expense to increase $15 million over last year, or about $.19 per share, to over $50 million. This is principally driven by a very low 3.75% discount rate that we used to measure the liabilities at the end of our last fiscal year. With respect to cash contributions to the plans, we contributed $10 million in our first quarter, in line with our projected contributions for all of fiscal 2013 of $39 million.  

Our effective tax rate in the first quarter was 30.5%, down from last year’s 31.3%. We are now forecasting our effective tax rate for all of fiscal 2013 to be 30.0%, down slightly from our forecast of 30.6% three months ago. In early January, President Obama signed into law the American Taxpayer Relief Act that included the retroactive extension of research and development credits. Moog does benefit from these credits, and we’ve captured an estimate of these benefits in our projected effective tax rate.  Our tax rate in 2013 is up noticeably from our full-year tax rate last year of 27.0%. The increase is mainly due to lower tax accruals last year at a couple of our foreign operations that won’t repeat this year, and to a less favorable mix of global taxable earnings. This higher tax rate is another $.15 per share headwind on our 2013 EPS growth.

Without the effect of the pension and tax headwinds in the first quarter, our EPS would have compared more favorably to last year’s $.80 per share despite the negative effects associated with the softness in our industrial markets.

Our financial ratios at the end of the quarter were very respectable. Net debt as a percentage of total capitalization was 30.9%, down from 33.7% in last year’s first quarter. Our leverage ratio (Net Debt divided by EBITDA) is 1.73x, and at quarter-end we had $583 million of unused capacity on our $900 million revolver that terms-out in 2016.

We closed on the acquisition of Broad Reach Engineering on December 31st. This is a second quarter event based on our first quarter cutoff of December 29th and it will be shown as part of the Space and Defense segment.  The accounting and financial effects of the acquisition are in our projections. The purchase price for Broad Reach was $48 million, including $37 million in cash, a $6 million note payable and a $5 million earn-out payment depending on the achievement of certain financial targets. Broad Reach is forecasted to add sales for the last nine months of the year totaling $32 million.

On January 15th, we completed calling in $200 million of outstanding 6.25% high-yield debt that was otherwise due in 2015. There is an interest arbitrage savings that we’ve built into our financial projections associated with this transaction. Our plan at this time is to take advantage of the low cost of our revolver debt on which we’re paying interest at Libor plus 150 basis points in margin. Cash flow is strong, our balance sheet is solid and we have plenty of unused capacity remaining under our revolving credit facility with our bank group. Accordingly, in our projections for all of 2013, we have assumed that our interest costs will be $29.0 million or $6.4 million less than our forecast three months ago.

We’re off to a slow start, yet we see some strength as we look out into the second half of the year. Our Aircraft and Components businesses were very strong in the first quarter, and we expect that to continue. We’re expecting Space and Defense to build as the year evolves, partly related to the Broad Reach acquisition, but also due to some targeted opportunities that should enhance the second half of the year. Our Industrial controls business is going through a restructuring that will continue throughout the next quarter or two, and we expect improved operating margin performance in the second half of the year.

Now, I’ll turn you back to John for any Q&A.

(The Q and A is not available.)