Fourth Quarter Conference Call, Fiscal Year 2016

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 November 4, 2016 our most recent Form 8K filed on November 4, 2016 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

Good morning. Thanks for joining us. This morning we’ll report on the fourth quarter of fiscal ’16 and reflect on our performance for the full year. We’ll also provide our initial guidance for fiscal ’17.

As usual, I’ll start with the headlines for the quarter.

  • First, our operations came in strong this quarter with earnings per share of $92c.  This brings full year fiscal ’16 earnings to $3.47c, 12c ahead of our projection from 90 days ago.
  • Second, we incurred a total of 24c of restructuring and impairment charges during the quarter, versus our plan from 90 days ago of 12c.
  • Third, we had another good quarter for free cash flow to close out the year at a conversion ratio of 120%.
  • Fourth, we’re integrating our Medical Devices segment into our Components segment and simplifying our reporting structure accordingly.
  • Finally, we’re providing a first look at fiscal ’17 today. Our segments are stable relative to fiscal ’16 but we have some adverse mix shifts, and a 15c higher tax burden. Therefore, we’re initiating guidance for fiscal ’17 at $3.50c, plus or minus 20c.

As we reflect back on fiscal ’16, the following headlines stand out.

  1. First, it was another year of technical achievements for Moog products in many different applications.  Examples include:
    • the successful first flight of the Embraer E-2 jet
    • the performance of the F-35 STOVL at the Farnborough airshow
    • the entry of the Juno spacecraft into orbit around Jupiter and
    • the successful beta test of our new wind products with lead customers.
  2. Second, it was a tough year in several of our markets, particularly energy, industrial and defense. As in previous years, we responded with restructuring and portfolio pruning.
  3. Third, it was a year of heavy R&D spend, as we continued to invest for the long-term future of the company.
  4. Fourth, we won several new military aircraft development contracts which will position us well for long-term growth.
  5. Fifth, we acquired a controlling interest in an additive manufacturing company – a technology we view as key to our future.
  6. Sixth, it was another year of good cash flow.  We used about a quarter of our free cash flow to repurchase shares.
  7. Finally, we completed the strategic review of our Medical Devices segment and, based on the excellent performance over the last couple of years, decided to keep the business and integrate it into our Components Group.

Fiscal ’16 will go down as another challenging year for many of our markets, but also a year in which our operations responded to the challenges and delivered solid results. As always, it was the dedication and commitment of our 11,000 plus employees around the world that made this all happen, and I’d like to thank them for their hard work. 

Now, let me provide some more details on the quarter. 

Q4 Fiscal ‘16

Sales in the quarter of $619 million were down 1% from last year.  Sales were down marginally in Aircraft and Components, and up in Space & Defense and Industrial. Taking a look at the P&L, our gross margin was about flat, R&D was up a million dollars but SG&A expenses were down $5 million. We incurred $12 million of restructuring and impairment expense in the quarter, spread across various segments.  Interest expense was up slightly year over year. Our effective tax rate was 31.3%, down from last’s year unusually high rate of 33.3%. The overall result was net earnings of $33 million and earnings per share of 92 cents.

Fiscal ’16

For the full year, sales were down 4% from fiscal ’15.  Weaker foreign currencies accounted for almost a quarter of the sales decline. Sales were down in Aircraft, Space and Defense and Components, and about flat in Industrial.  Our Components Group was hardest hit, with sales down 13% from the prior year.  Full year operating margins were 9.9%. Operating margins, exclusive of restructuring, were up in Aircraft, Space and Defense and Industrial. Operating margins were down in Components as they struggled with challenges across all their markets. Net earnings were down 4%, while earnings per share were up 4% on a lower share count.  Free cash flow for the year of $149 million was 120% of net earnings, the 4th year in a row where free cash flow conversion exceeded 100%. 

Fiscal ’17 Outlook

For fiscal ’17 we’re projecting sales of $2.44 billion, up 1%. The growth is all in commercial OEM sales as the A350 continues to ramp up.  Sales in Space and Defense and Components should be about flat with fiscal ’16, while Industrial sales will be down about 5%. We’re anticipating full year operating margins of 10.3%, and earnings per share of $3.50, plus or minus 20c.  Cash flow next year is projected to be $130 million, or about 100% of net income.

Now to the segments. I’d remind our listeners that we’ve provided a 2-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

Aircraft Q4

Sales in the quarter of $265 million were down 4% from last year. On the military side, sales were down 13% from last year with lower volumes across most of the OEM portfolio, including F18, F15, V-22, Blackhawk and several foreign programs.  Sales were also down in the military aftermarket as the C-5 refurbishment program essentially ended.  On the commercial side, higher sales to Boeing and Airbus more than compensated for lower business jet sales. The commercial aftermarket was off marginally from last year. 

Aircraft Fiscal ‘16

Fiscal ’16 was another challenging year for our aircraft business with full year sales down 2% from fiscal ’15. As anticipated, we saw growth in our major new programs, the F-35 and A350, but these were more than offset by softness across the broader military OEM portfolio, the military aftermarket and in our business jet programs. In addition to the lower sales, a negative mix shift weighed on margins as we saw declines in our legacy military OEM programs as well as in the military aftermarket. We also had lower commercial aftermarket sales on weakness in the business jet market.

Aircraft Fiscal ‘17

We’re projecting fiscal ’17 sales of $1.11 billion, an increase of $46 million over fiscal ’16. The growth is all on the commercial side, driven by the A350 ramp up.  We’re forecasting the commercial aftermarket will be down next year on lower 787 initial provisioning. On the military side, we’ll see growth on the F-35 program and a shift in sales from mature OEM programs to work on some new, cost reimbursed, development jobs.

Aircraft Margins

Margins in the quarter of 10.3% were up 130 basis points from last year, despite
an adverse mix shift. Last year’s fourth quarter included about $3 million in restructuring charges as against just over a million dollars of restructuring this quarter. R&D this quarter was up about $2 million from last year, but lower overhead expenses more than offset this increase.

For the full year, aircraft margins of 9.3% were up marginally from fiscal ’15. We incurred a total of $7 million of restructuring expense in fiscal ’16, $4 million higher than fiscal ’15. We also absorbed $16 million of higher R&D expense, and experienced an adverse shift in our sales mix.  Despite these margin headwinds, a combination of cost containment activities, lean improvements and the continued movement down the cost curve on the major commercial OEM programs resulted in comparable margins with fiscal ’15.

Looking to fiscal ’17, we’re projecting Aircraft margins up slightly from fiscal ’16.  On the positive side, R&D will come down about $10 million relative to fiscal ’16, and we’ll continue to see improvements on our new commercial OEM programs as we move down the learning curve on the 787 and the A350.  These positive effects are being negated by the shift in the mix of military programs with cost plus development jobs replacing some nicely profitable foreign military programs.  We’re also seeing lower sales on our mature commercial programs, in particular the 777, as well as lower initial provisioning in the aftermarket. 

Looking beyond fiscal ’17, R&D will continue to abate as a % of sales and the new commercial programs will continue to improve. We’re also optimistic that our military book of business will strengthen as foreign programs recover and US defense spending moves beyond the era of sequestration. Taken all together, we should see margins expand over a multi-year period.

Space and Defense

Space and Defense Q4

Sales in the quarter of $97 million were up 5% from last year.  Sales on the Space side of the business were up on stronger sales of our satellite propulsion products.  Defense sales were down slightly in the quarter due to lower sales on various military vehicle programs.

Space and Defense Fiscal ‘16

Full year sales were 4% down from last year. Space sales were lower across most satellite and launch programs. This reflects the cycle in our space market which we’ve described before. Defense sales were also slightly lower this year as sales for missiles and to European vehicle customers weakened, compensated somewhat by higher US military vehicle sales.

Space and Defense Fiscal ‘17

We’re forecasting fiscal ’17 sales in line with fiscal ’16.  Sales will be about the same in both the space and the defense markets. Slightly higher satellite component sales will compensate for slightly lower NASA sales, while on the defense side, higher military vehicle sales will compensate for marginally lower missile sales.

Space and Defense Margins

Margins in the quarter of 6.2% included 2 unusual items. First, we increased our product reserves by $3 million for an engineering issue on some of our satellite engines. Second, we took a $5 million non-cash impairment charge on our additive manufacturing acquisition.  Over the last year, we’ve learned an enormous amount about how to make additive parts in production and are more convinced than ever of the long-term potential for the technology.  However, we also learned that the anticipated sales ramp up in this business will not materialize as quickly as we originally thought and are therefore taking a write down on the goodwill.

Full year fiscal ’16 margins of 11.3% are up nicely from last year on improved operating performance, lower restructuring costs and the absence of the accounting correction in fiscal ’15. For fiscal ’17 we’re forecasting margins of 13.2%.

Industrial Systems

Industrial Systems Q4

Sales in the quarter of $131 million were 2% higher than last year. The increase was mostly due to slightly stronger foreign currencies relative to the US dollar. Sales were up in energy, about flat in simulation & test, but down in our industrial automation markets.

Industrial Systems Fiscal ‘16

Full year sales of $515 million were down marginally from last year. Sales were up in energy on stronger wind sales into China, and were also up in simulation & test reflecting increased activity at our key customers. Sales to Industrial automation customers were down in metal forming, steel production and in the aftermarket.  Our general industrial automation markets continue to move sideways awaiting a structural recovery in the global capital investment cycle.

Industrial Systems Fiscal ‘17

We’re projecting a 5% sales decline in fiscal ’17 to $490 million. Sales into the energy market will be lower, the result of lower wind sales in Brazil as a consequence of the GE takeover of Alstom. Sales to non-renewable energy customers will also be lower on the assumption that oil prices remain depressed. Sales to industrial automation customers will be marginally lower based on the softness we’ve seen in bookings over the last few quarters. Finally, sales of simulation systems will be slightly lower after a strong year in fiscal ’16. Unfortunately, there continues to be little positive news on the macro-economic front which might suggest a structural improvement in our industrial business any time soon. Therefore, fiscal ’17 will be another year of cost containment, focus on lean and continued investment in longer-term organic growth opportunities.

Industrial Systems Margins

Margins in the quarter of 7.7% included $4 million of restructuring expenses. As in prior years, we’ve continued to respond to the challenges across our industrial markets with cost reduction activities. Margins for the full year of 9.4%, were up from last year, despite a negative shift in the mix. For fiscal ’17, we’re forecasting margins of 10%. 

Components

As I mentioned in my opening remarks, we’re integrating our Medical Devices segment into our Components Group going forward. My comments in this section on Components relate to this combined segment.

Components Q4

The steady recovery in sales from the low point in Q1 fiscal ’16 continued again this quarter. However, as in previous quarters this year, the comparison with last year continued unfavorable. Sales in the quarter of $125 million were down 1% from last year.  Sales into our Aerospace & Defense and Medical markets were about flat with last year, but we continued to see softness in the general Industrial markets, which include our sales for oil & gas exploration products.

Components Fiscal ‘16

For the full year, sales of $467 million were 13% lower than last year. It has been a very tough year for our Components Group, unlike any other we’ve seen since we acquired this business back in 2003. Sales were down across every major market we serve. Sales into the aerospace and defense markets were down in almost every category with the Guardian program being one of the few bright spots. Sales to our energy customers were down 50% in fiscal ‘16, following on from a 26% decline the year before. Finally, sales of motors to our customer for sleep apnea equipment were also down 50% from fiscal ’15 as they changed consumer models and added a second source of supply.

Components Fiscal ‘17

We’re projecting sales next year of $477 million, up from combined sales of $467 million in fiscal ’16. We’re creating a new medical category for reporting purposes, where we’re combining our Medical Devices sales with sales of other components into various medical applications.  All of the sales increase next year in our Components Group is in this new medical category, driven by increased pump sales.  Sales will be about flat in our A&D portfolio but we anticipate some further deterioration in our energy sales, compensated by slightly higher sales into our industrial markets.

Components Margins

Margins in the quarter were strong at 14.3%, continuing their sequential improvement throughout fiscal ’16. Higher sales and a favorable mix helped the margins in this quarter.  Full year fiscal ’16 margins of 10.7% were very respectable, given the very weak first half.  For fiscal ’17, we’re forecasting margins of 10.4%.

As we fold our Medical Devices segment into Components, I’d like to recognize the tremendous improvement the leadership of the Medical Devices segment has achieved over the last 3 years, with operating margins increasing from 3.1% in fiscal ’14 to 8.7% in fiscal ’15, up to 11.5% in fiscal ’16. It’s a great turnaround story, and we look forward to further success in the coming years as part of the Components Group.

Summary Guidance

As we look to fiscal ’17, we’re optimistic that our Aircraft, Industrial and Components businesses are starting to turn the corner to multi-year performance improvement. Our new commercial aircraft programs are coming down the cost curves, R&D is starting to wane and new military development programs bode well for the future.  Our industrial businesses are introducing new products in the wind and general automation markets. After a year of restructuring, our Components Group should start the slow recovery from the oil shock of the past couple of years.

Despite our optimism for the coming years, we’re starting out fiscal ’17 with a cautious view of our markets. We’re assuming most of our markets will be fairly stable with the only real growth coming from our A350 program. We’re also assuming a negative shift in the mix of programs in both our military and commercial aircraft businesses as production rates on legacy programs, such as the F-18, 777 and business jets slow and new programs, such as the F-35 and A350, ramp up. Our Aircraft R&D will abate somewhat, but will remain relatively high on our A350 and E-2 programs. We’ll also have a higher tax rate than fiscal ’16.

We continue to look for topline growth by remaining close to our key customers. Our internal focus continues to be on cost containment and portfolio refinement on the one hand, and investments in lean and innovation on the other.

Let me finish my comments as I did last year, by looking at our business through the lens of the end markets we serve. Those markets are defense, industrial, commercial, energy, space and medical.

Defense remains the cornerstone of our company, led by the strength in our military aircraft business. Defense spending is in a cyclical trough but, we believe, as global conflicts continue, we’re ideally positioned to benefit from a recovery.  Over the last year, the F-35 program has gained momentum and we’ve won several development jobs on new platforms which bodes well for the longer term. We’ve seen some of our legacy U.S. programs slow and have been subject to sales volatility on foreign military programs.  On the other hand, our missile business remains very strong and we’re seeing our ground vehicle business improve. Defense is a long-term play, and we remain focused on building a portfolio of platforms which will provide returns for decades to come.

Our industrial markets broadly follow the pace of global investment in capital goods. As that cycle has stagnated over the last few years, we’ve restructured our business while investing in new products and technologies. Our areas of focus are next generation miniature hydraulics, and very large brushless motors for use in a variety of specialized industrial applications.

Our commercial aircraft sales grew modestly in fiscal ’16 but are poised to accelerate again in fiscal ’17. Our primary focus is operational as we look to close our several large development jobs and continue our progress down the cost curve on the new production programs. Fiscal ’16 was a year of steady progress, despite the elevated R&D spend. In fiscal ’17 we’ll see further progress and, as the following years unfold, we’ll have the compounding benefits of reducing costs, lower R&D expenses and a growing aftermarket.

The energy market remains very challenging, but our strategy is unchanged from a year ago. In the oil & gas business, our focus remains on cost reduction while looking for selective growth opportunities. In the wind business, we’re investing in new products to rebuild our market position. We believe we’ll start to see the impact of these new products by the end of fiscal ’17.

In our space business, fiscal ’16 was a very good year, despite slowing sales. We benefited from restructuring activities in the prior year and a focus on our most profitable product lines.  We continued to invest in new technologies, such as green propellant, and to position ourselves for the Ground Based Strategic Deterrent program.  This program, to replace the Minuteman missiles, has the potential to be a $100 million plus annual business for Moog, although full production is probably 10 years in the future.

Finally, our Medical Devices segment performed particularly well in fiscal ’16 and we believe will improve further in fiscal ’17 as part of the Components Segment.

In summary, we continue to enjoy strong positions in a diversified portfolio of businesses.  Like many companies, we’re faced with a slow-growth environment. We’ve responded to this environment with restructuring activities, on-going portfolio adjustments and continued investment for the long term. Despite the market challenges, our fundamental strategy has not changed – we solve our customers’ toughest problems in applications where performance really matters.  We focus on niche markets where we seek to be the dominant supplier. Our growth comes from expanding our range of high-performance components while also increasing our scope to become a systems supplier to our major customers. Long-term growth will continue to be a combination of organic and acquired. Our internal initiatives to deliver on our goals are Talent Development, Lean and Innovation. Finally, we’re focused on deploying our capital to maximize shareholder returns over the long-term.

Looking to fiscal ’17, we anticipate sales of $2.44 billion and earnings per share of $3.50, plus or minus 20c.  Similar to previous years, we anticipate a slow start to the year with earnings per share in the first quarter of between 70c and 80c.

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.

We finished the year with a solid $30 milliom of free cash flow in the fourth quarter resulting in $149 million of free cash flow for the full fiscal year. Our conversion ratio for the year was a respectable 120%.  This follows strong results averaging more than 150% conversion over the previous three years.  During the fourth quarter of this year we were not in the market repurchasing any of our stock. With respect to leverage, we’re within our comfort zone at 2.2x, particularly as we look for acquisitive growth.  We haven’t had much to report regarding M&A in recent quarters, but we continue to look for strategic targets.

The $149 million of free cash flow for the year compares with a decrease in our net debt of $79 million. The difference relates primarily to cash used to repurchase Company stock earlier in the year as well as the December 2015 acquisition of 70% of Linear Mold.

For the full year, we bought back 850,000 shares under our share repurchase program at an average per share price of $46.00.  We currently have 3.4 million shares remaining under our existing Board authorizations for share repurchases. Our projections for 2017 do not include the impact of any future share buyback activity.

Net Working Capital (excluding cash and debt) as a percentage of sales was up for the year to 29.3% compared with 28.2% a year ago on slightly lower sales. The fortunate timing of certain cash receipts and disbursements during last year’s fourth quarter contributed, in part, to the increase year over year.  Notwithstanding this year’s slight uptick, we’ve seen a rather steady decline in this working capital metric since we peaked at almost 38% of sales in 2009. We continue to focus on improvements to managing our balance sheet in order to bring our investment in working capital down.

We’re forecasting Free Cash Flow for 2017 to be $130 million, reflecting a cash conversion ratio of just over 100%.

Capital expenditures in the quarter were $25 million, including $9 million of expenditures for the purchase of two leased facilities. Depreciation and amortization totaled $24 million for Q4.  For all of 2016, CapEx was $67 million while D&A was $99 million. For 2017, we’re forecasting CapEx of $80 million, more consistent with our typical run rate.  D&A in 2017 will be about $96 million.

Cash contributions to our global retirement plans totaled only $7 million in the quarter resulting in $95 million of contributions for the full year. This compares with $76 million for all of fiscal 2015. For 2017, we’re planning to make contributions into our global retirement plans totaling $91 million. Global retirement plan expense in 2016 was $65 million compared with $61 million in 2015. In 2017, our expense for retirement plans is projected to be flat at $65 million.

Our effective tax rate in the fourth quarter was 31.3% compared with last year’s 33.3%. Last year’s rate included an unfavorable mix of taxable earnings relative to the full year’s previously forecasted results. For all of 2016, the effective tax rate was 28.5% vs. 28.3% for 2015.  For 2017, we’re forecasting an effective tax rate of 31.5%, higher compared with 2016 due to lower R&D credits associated with of the timing of the U.S. law change in late 2015 (our first quarter of fiscal 2016), and from the 2016 favorable impact of lower corporate rates in the U.K. on our deferred tax liability that won’t repeat in 2017.

Moving to cash and liquidity, we were able to bring back $91 million of offshore cash to the U.S. late in the fourth quarter with no net tax impact. We used this repatriation of cash to pay down the outstandings on our revolver. We remain hopeful, like other global U.S. companies, that after the Presidential election our political leaders will provide us with enough incentive to return the rest of our $300 million of offshore cash back to the States.

Our leverage ratio (Net Debt divided by EBITDA) decreased to 2.2x compared with 2.4x a year ago. Net debt as a percentage of total capitalization was 41.0%, down from 43.5% last year. At quarter-end, we had $418 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2021.

With that, I’d like to turn you back to John for any questions that you may have.

John.

Q&A is not available.