Third Quarter Conference Call, Fiscal Year 2015

July 31, 2015

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 July 31, 2015, our most recent Form 8K filed on July 31, 2015 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  webcast page at www.moog.com.

Press Release and Financial Statements

Introduction - John Scannell

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 July 31, 2015 our most recent Form 8K filed on July 31, 2015 and in certain of our other public filings with the SEC.

We've provided some financial schedules to help our listen ers 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 webcast page at www.moog.com.

Good morning.  Thanks for joining us. This morning we’ll report on the third quarter of fiscal ‘15 and update our guidance for the full year.  We’ll also provide our first look at fiscal ’16.  Let’s start with the headlines.

Headlines
• First, earnings per share of $0.94 cents in the quarter were slightly ahead of what we were projecting 90 days ago. Included in this total is 11 cents of restructuring charges.  It was also another good quarter for cash flow.  
• Second, we continue to see sales and margin headwinds in many of our businesses. We’re responding with additional restructuring activities and on-going reviews of our product and business portfolio.  
• Third, we’ve decided to look for strategic alternatives for our European space operations. These 3 operations have total sales of about $15 million in fiscal ‘15.
• Fourth, we’re re-engaging in our sales process for our Medical Pump business.  
• Fifth, we continued our buyback activity in the quarter and are on track to complete our current 9 million share authorization around the end of the fiscal year.  
• Finally, we’re providing a first look at fiscal ’16 today. For next year we’re projecting 1% sales growth and earnings per share of $4.00 up 14% over our fiscal ’15 forecast.

Now let me provide you with some numbers, starting with the third quarter results. 

Q2 Fiscal ‘15

Sales in the quarter of $635 million were 7% lower than last year. Two thirds of the decline was due to the effect of the stronger US dollar.  Setting the currency effects aside, sales were down in our Aircraft and Space & Defense segments, flat in Industrial and Components and up in our Medical Devices business.  

Taking a look at the P&L, our gross margin is in line with last year. R&D is up on higher Aircraft spend on the Embraer E-2 development program while SG&A expenses are lower as we continue to manage our costs. Interest costs were up due to last November’s sale of high yield debt and increased borrowing as a result of our share buyback activity. We incurred almost $7 million of restructuring expense in the quarter. Our effective tax rate was 28.4%. The overall result was net earnings of $36 million and earnings per share of 94 cents. 

Fiscal '15 and Fiscal '16 Outlook

Fiscal '15 Outlook

With 3 quarters behind us, we’re refining our sales forecast for the year very slightly. There are some puts and takes in each of the groups but nothing of significance. Full year sales should be $2.53 billion. We’re updating our earnings per share forecast to reflect higher restructuring charges than forecasted 90 days ago, as well as the impact of our on-going share buyback program. 90 days ago, we provided a full-year forecast of $3.55 per share. We’re on track to complete our authorized share buyback around the end of the fiscal year, adding 5 cents to that total to bring us to $3.60. Our forecast of $3.55 assumed $5 million of restructuring in Q3 and Q4. We’re now increasing that restructuring total to $11 million – or about an additional 10 cents per share.  The net result is a full year earnings forecast of $3.50 per share.  

Fiscal '16 Outlook

For next year, we’re projecting sales of $2.57 billion, up 1% from this year. We anticipate commercial OEM sales will continue to grow as the A350 ramps up. Sales in Space and Defense, Industrial and Medical will be in line with fiscal ’15 while sales in our Components segment will be slightly lower as a result of continuing low oil prices. Operating margins in fiscal ’16 are forecast to be 10.7%, up from our forecast of 10% this year. We’re projecting earnings per share of $4.00, up 14%. We’re not including the effect of any further share repurchase plans in this total. Cash flow next year is projected to be $150 million or just over 100% of net income.  

Now to the segments. I would 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 Controls

Aircraft Q3

Sales in the quarter of $270 million were 8% lower than last year. The familiar pattern of lower defense sales continued this quarter, but unusually, commercial sales were also lower this quarter. On the military side, sales were lower in both the OEM and Aftermarket areas.  Sales on the F-35 development program declined to below $1 million this quarter while sales on various foreign platforms were also down from a year ago. On the commercial side, sales were lower in every sub-market except Airbus. Sales to Boeing were down from a record quarter last year as a result of the timing of orders and deliveries. Sales to Airbus were up on the continued ramp in the A350 program.  Sales into the commercial aftermarket were lower on general market softness as well as lower 787 initial provisioning. 

Aircraft Fiscal ‘15

With 3 quarters behind us, we’re refining our sales mix for the year to include slightly higher military sales and slightly lower commercial sales. More specifically, we believe the F-35 and V-22 production sales will be higher while A350 production sales will be lower on a slower ramp than anticipated. The total remains essentially unchanged at $1.09 billion. 

Aircraft Fiscal ‘16

We’re projecting fiscal ’16 sales of $1.13 billion, an increase of $43 million over this year. The increase is all on the A350 program which will be up $47 million from ’15 to ’16. Other commercial OEM sales should be more or less in line despite lower business jet sales.  We’re forecasting the commercial aftermarket to be down 5% in fiscal ’16 as 787 initial provisioning continues to moderate.  On the military OEM side, higher F-35 sales will make up for lower V-22 and Blackhawk sales. The military aftermarket will be down 3% as our refurbishment program on the C-5 winds down. 

Aircraft Margins

Margins in the quarter of 10.5% were up from 10.3% last year despite the adverse mix. We also had $2 million higher R&D costs this quarter driven by our Embraer program. We continue to make progress on our commercial book of business with declines in unit costs this quarter on both the 787 and A350 programs as planned.  Despite the margin improvement this quarter from 12 months ago, we’re behind our plan for the year and are therefore moderating our full-year margin forecast to 9.5%. For fiscal ’16 we’re forecasting an adverse shift in the sales mix with lower aftermarket in both the military and commercial markets. R&D next year should be in line with fiscal ’15 as spending on the A350 and E-2 programs continue at an elevated level. In total, we anticipate that the continued improvement in the commercial book of business will compensate for the negative mix shift to yield full year margins of 9.5%, in line with fiscal ’15.    

Twelve months ago, we reset expectations for the trajectory of our aircraft margins over the following few years. At that time, I described the following challenges

  • margin pressure on our domestic military book of business and lower sales on a variety of foreign military platforms, and
  • on-going cost challenges as we ramp up production on our new commercial programs combined with continuing high R&D spend for a few more years. 

I said that we would continue to see margin headwinds for a couple of years and that when we got to fiscal ’17 we should start to see margins expand again as our commercial book of business matures and R&D spending comes closer to 5% of sales. 12 months later, the story has not changed, although the magnitude of the headwinds has proven to be bigger than we had projected. We anticipate that fiscal ’16 will be a low-point for aircraft margins and that in fiscal ’17 we’ll turn the corner on a path to higher margins over the following years to get to the mid-teens by the end of the decade.

Before I leave our Aircraft segment, let me put our short-term margin headwinds into a longer-term perspective. Over the last decade we’ve become the leading supplier of flight control systems globally. We’ve moved from a tier two component supplier into a tier one systems supplier. This has been a patient and deliberate strategy – a multi-program strategy - not a single airplane project. It’s a 20-year strategy and, perhaps inevitably, is not without its challenges along the way.  Since the early 2000’s, we’ve invested heavily in R&D which has compressed our margins.  The 787 and A350 programs have taken longer and cost more than originally planned. We’ve learned a lot from these programs and our more recent development programs are performing very close to plan. 

We’re now in the relatively early stages of the production phase of our strategy.  Similar to the development phase, it is turning out to be more expensive than we had anticipated. We’re introducing new products and technologies to production and learning about building a global supply chain while meeting unprecedented ramp up rates. The margin headwinds associated with our heavy R&D phase are now shifting to the early production phase. As with our development programs we’re learning along the way and we’re seeing favorable results as the production startup on our newer programs are performing much better than the earlier programs.

We’re clearly disappointed that our margins have not started to improve as quickly as we had predicted a few years ago.  However, our strategy remains solid and the long-term pay off will be worth the wait. The path to higher margins remains the same. On the commercial side, R&D will abate as we look out to fiscal 17 and beyond, production costs will come down and the aftermarket will grow. On the military side, the F-35 program will continue to grow and as the hardware matures and the aftermarket develops the margins will expand. We should also see some of our foreign programs pick up again and we’re positioning ourselves for the future with our content on the tanker program and our teaming arrangements on the next generation helicopter and Long Range Strike programs. 

Day to day, the team remains focused on delivering on our customer commitments and working all the cost elements to meet our long-term financial goals.  

Space and Defense

Space and Defense Q3

Sales in the quarter of $95 million were down 7% from last year. Following the pattern of last quarter, the weakness was all on the Space side of the business.  The wind down of various satellite programs continued this quarter and, combined with lower activity at NASA on the soft capture program, resulted in a 21% overall sales reduction in the Space market. This type of sales fluctuation in the Space market is familiar to us, and is the natural cycle of programs shifting from development into production and then back to the next development phase over time.  In the defense market sales are up 13% as strong sales on vehicle programs and into the naval market more than compensated for lower security sales. 

Space and Defense Fiscal ‘15

We’re reducing our full year forecast by $5 million to $384 million. The reduction is all in the Space market as we anticipate continued weakness in both our satellite and NASA businesses. 

Space and Defense Fiscal ‘16

We’re projecting fiscal ’16 sales flat with fiscal ’15, although we anticipate a continued shift in the mix from Space to Defense. We’re forecasting a further 7% decline in our Space sales next year, on top of the anticipated 11% decline this year.  On the defense side, we’re projecting an 8% increase in sales in fiscal ‘16, on top of an anticipated 8% increase in fiscal ’15.  The underlying drivers in each market are the same in both fiscal ’15 and fiscal ’16. 

On the Space side, two effects are driving the declining sales. First, the natural program cycle of shifting between production and development, and second, the results of our internal review of the product portfolio to focus on our most profitable products.  

On the Defense side, we also have two major effects over the ’15, ’16 period.  First, missile sales have continued to improve and, second, military vehicle sales have recovered from their lows of a few years back with nice gains in both domestic and foreign markets. 

Space and Defense Margins

Margins in the quarter were 6.5%. This margin includes $6 million of restructuring charges taken in the quarter. Exclusive of this restructuring charge, margins in the quarter were a healthy 12.9%. For the full year, we’re now projecting margins of 8.1%. Excluding the restructuring charge, this full year margin projection is up 70 basis points from our projection 90 days ago as the underlying business continues to perform well.  For fiscal ’16 we’re forecasting margins of 11.5%. 

As I mentioned in my opening remarks, over the last few months, we’ve done a deep dive review of our Space business. Back in fiscal ’11 our sales into the Space market were $136 million, and were based on mature products and technologies.  Over a 12-month period from December 2011 to December 2012 we completed 3 small acquisitions which brought our sales in fiscal ’13 to just over $220 million.  Our strategy was to expand our footprint in components and to broaden our market opportunities by acquiring sites in Europe. During fiscal ’13 and ’14 we struggled to integrate these acquisitions and learned that small, independent Space businesses often do not have sufficient capabilities and controls in place to meet their program commitments. Over this time, we made the necessary investments to complete the commitments to customers which we had acquired, while re-evaluating the portfolio to focus on the most profitable products going forward.  Coming out of our recent review we’ve decided to focus our future investments on opportunities in the US market, and in particular, the Minute Man refurbishment program. As a result, we’re reviewing the strategic alternatives for our European Space sites. These European operations will have combined sales of about $15 million in fiscal ‘15.  We anticipate it could take up to 12 months to complete this process and will keep you informed as events unfold. 

Industrial Systems

Industrial Systems Q3

Sales in the quarter of $131 million were 12% lower than last year. Excluding the impact of the stronger dollar, real sales were essentially flat with last year.  Setting the forex effect to one side, we saw a sales decline in our non-renewable energy markets, compensated by slightly higher sales in our Industrial Automation and Simulation businesses. 

Industrial Systems Fiscal ‘15

We’re adjusting our full year forecast down $6 million to $524 million. We’re tweaking the forecast in each category. Sales into our Energy and Simulation markets will be slightly lower with sales in our general industrial automation markets higher. 

Industrial Systems Fiscal ‘16

We’re projecting flat sales for fiscal ’16 at $525 million. Over the last several quarters, sales in this segment have been very consistent at about $130 million.  The macro-economic outlook for fiscal ’16 does not suggest any improvement in the general industrial arena and while we have several internal initiatives underway to drive sales growth, we’re not comfortable at this stage forecasting how successful they may be. 

Industrial Systems Margins

Margins in the quarter were 10%, consistent with prior quarters and with last year.  The absence of organic growth, combined with our on-going investment in the wind energy business are making margin expansion difficult. However, we believe we will see improvement in fiscal ’16 to 10.7% as a result of our continuing focus on managing our costs.

Before I leave the industrial segment, let me offer some comments on a couple of the key growth opportunities we’re pursuing. The first is in wind energy, and the second is in the aftermarket. As our listeners are aware, we’ve had a roller-coaster ride with our wind business over the last 5 years. Similar to our Space business, we recently completed a thorough review of our wind business and considered the various alternatives to maximize shareholder value – including the potential sale of the unit. Our analysis of the future opportunity made it clear that the best option to maximize shareholder value was to continue to invest to grow the business. The wind market is projected to grow between 5-10% over the next 5 years and the profitability of the market participants is improving after several years of losses.  The competition in our space of pitch control systems has suffered over the last few years, as have we, and we may be the only company prepared to make the investment in new products. We have a product roadmap laid out and have already fielded the first iteration – what we call our AC system.  We’re well underway with our second product iteration which will further enhance functionality and improve profitability. We anticipate having first units in the field during 2016. We believe we have an addressable market of several hundred million dollars.  It will be late 2017 or into 2018 before we will know if our strategy has been a real success, but we believe the upside opportunity justifies the investment we’re making today and staying the course. 

The other area of opportunity is in the aftermarket. Over the years we’ve placed hundreds of thousands of hydraulic and electric components in the field.  Over that time, we’ve enjoyed some aftermarket in this business, but we’ve never built an aftermarket organization focused on capitalizing on this installed base opportunity.  We’ve done this very successfully in our Aircraft Segment and are now bringing that same learning to our industrial markets. The organization change has been relatively recent and it is too early yet to gauge the potential gains, but we believe there is a lot of opportunity that we’ve not exploited in the past.   

Components Group

Components Q3

Sales in the quarter of $107 million were down 3% from last year.  The weakness was all in our non-A&D markets. Sales into the Energy sector were way down as weak oil prices impact the pace of off-shore exploration. We also saw lower sales into our medical markets as demand from our major customer for sleep apnea equipment fell. On a positive note, sales into our general industrial markets were up on strength from our Aspen acquisition. In the A&D markets sales were up 4%.  We continue to see a trend of firming missile and vehicle sales as well as some improving demand for slip ring assemblies used on military aircraft. 

Components Fiscal ‘15

Third quarter sales came in ahead of expectations so we’re adjusting our full-year forecast up by $5 million to $415 million. We believe military aircraft sales will be higher and, despite the continued low price of oil, we think our full-year sales into the energy market will be slightly higher than our conservative estimate from 90 days ago. 

Components Fiscal ‘16

We’re projecting a modest sales decline of 2% in fiscal ’16 to $405 million.  However, we anticipate some significant swings in the mix. Within our space and defense markets we will see some nice gains on foreign vehicle programs as well as continuing strength in our missile programs. On the downside, we anticipate our sales into the Energy sector will be off by over 20% as the full impact of lower oil prices filters through to lower demand for our components. 

Components Margins

Margins in the quarter were 12.7%, similar to last quarter. Our Components segment is going through a period where their mix of business is less favorable than in the past and the top line is coming under pressure. We’re taking action to respond to this situation, but we’re likely to see relatively soft margins for this segment until the top line recovers and oil rebounds. For fiscal ’15 we’re forecasting full year margins of 13.5%. Next year we’ll see the impact of a full year of lower oil prices and therefore are forecasting full-year fiscal ’16 margins of 12.6%.  

Medical Devices

Medical Q3

This was another very good quarter for our Medical Devices segment.  Sales were up 10% with continuing strength in both pumps and sets. We continue to see growth opportunities in our IV pumps as competitors remove some older products from the market. Our set business was also stronger across both our IV and enteral product lines. The growth in sets comes as we place more pumps in the market and the installed base grows.  

Medical Fiscal ‘15

Given the strong sales in the third quarter we’re inching our full year sales forecast up by $1 million to $122 million.

Medical Fiscal ‘16

Full year sales in fiscal ’16 are projected to be flat with fiscal ’15 at $122 million.  However, in fiscal ’15 we had approximately $3 million of sales from our Life Sciences operations which we sold in March. Adjusting for these lost sales, we’re projecting 3% organic growth in fiscal ’16. 

Medical Margins

This segment continues to outperform our expectations with excellent margins in the quarter of 15.4%. Given this strong performance we’re adjusting our full-year margin forecast up to 12.8%. For fiscal ’16 we’re forecasting further margin improvement to 13.6%. 

Before leaving our medical segment, let me remind you where we are in our strategic review process. In July 2013 we began this process. At the time our medical segment was facing significant challenges. Our planned sale of the segment fell through in March 2014 and over the last 15 months we’ve focused on refining our strategy and improving profitability. Today we have a very healthy business with the highest margins in the company. However, we continue to believe that medical pumps are not a long-term fit for Moog and therefore we’re restarting the review process in the coming quarter and testing the market’s appetite for our asset.  In contrast, however, to the process we started in 2013, we now have a business which is growing and nicely profitable. Therefore we’ll be seeking a price that reflects this new reality, and will not hesitate to keep this business for longer if we cannot realize full value for our shareholders in a sale.  

Summary Guidance

After all the various tweaks, our fiscal ’15 sales forecast is now $8 million lower than our forecast from 90 days ago.  Total sales for fiscal ’15 should be $2.53 billion.  Our updated operating margin is 10% and earnings per share will be $3.50. This EPS number includes a total of $11 million in restructuring charges in Q3 and Q4, and also assumes we complete the present buyback program around the end of September.  

In fiscal ’16 we’re projecting a 1% increase in sales and a 14% increase in earnings per share. The most significant change from fiscal ’15 will be higher sales in our commercial aircraft business as the A350 production ramps up. We’re projecting earnings per share of $4.00.  Net earnings will be $148 million and our free cash flow conversion should be just over 100%. 

Fiscal ’15 is turning out to be much tougher going than we anticipated 12 months ago. On our third quarter call in July of 2014, I offered some thoughts on the risks and opportunities associated with our forecast for fiscal ’15.  On the risk side, we thought that slowing defense spending combined with cost challenges in the early stages of our new commercial aircraft programs could cause us to miss our numbers. On the other hand, we thought there might be some upside in our Industrial and Space forecasts.  It is turning out that our risks have materialized, while our upside opportunities have not.  In fact both our Industrial and Space forecasts for fiscal ’15 are now well below what we thought 12 months ago. In addition, we had not anticipated the dramatic shift in exchange rates or the sharp drop in oil prices. So, all in all, fiscal ’15 is turning out to be a year of headwinds across the board. Our medical devices group has been the real bright spot in the portfolio.  Looking to fiscal ’16 we don’t anticipate a significant change in the macro-economic environment. Therefore we’re proactively adjusting our cost structure now to size our business to meet our goals for next year. 

Historically, our company has enjoyed the benefits of diversification across many different end markets. Typically, these end markets were counter-cyclical – where we had tailwinds, we pushed for earnings growth, and where we had headwinds we reduced our costs and prepared for the next upswing. Today, we find ourselves in the unusual situation where we face headwinds in almost all of our markets.  We’re addressing this situation proactively and as we see the challenges mount in a particular business, we’re taking all necessary steps to restructure the business for success.  Two years ago we had a struggling Medical Devices business. We took a step back, refocused the business and today it is performing much better. Over the last few years, our Space business has also faced significant challenges. Over the last 12 months, we’ve refocused the business and taken some significant steps to reduce the cost base. As a result, we’re forecasting improving margins for fiscal ’16, even in the face of declining Space sales. Our Aircraft business is now facing bigger challenges than we had predicted. As with our other businesses, we’re taking all the necessary steps to ensure we get back on a margin expansion trajectory as soon as possible.

The folks across the company remain focused on the long-term health of the business. We continue to pursue our Lean journey, and maintain our investment in new innovation that will drive the next wave of growth. We’re generating strong cash flow and following a capital allocation strategy which maximizes shareholder value. We’re forecasting $4 per share in fiscal ’16, on flat sales, and another year of good cash flow. This will be a 14% increase in EPS and a record year for the company. 

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.

Free cash flow in our third quarter was $56 million bringing the year-to-date total to $149 million.  This represents a cash conversion ratio (free cash flow divided by net earnings) of 153% for the third quarter and 144% for the nine months ended June 2015. While our free cash flow was strong, our net debt increased by $29 million over the last 90 days as we used $91 million to continue our share repurchase program.

With respect to free cash flow, we are seeing some benefits of focusing on our balance sheet. Since 2013, we’re averaging 200 bps of lower trading working capital annually, going from 34.4% of sales in 2013 to 30.6% presently. Our forecasted free cash flow for 2015 is unchanged at $190 million or a cash conversion ratio of 138%.  In 2016, our initial forecast for free cash flow is $150 million, or a conversion ratio of 102%.

Through the end of June, we’ve repurchased, under our existing Board authorization, approximately 7.9 million shares at an average per-share price of just under $70 resulting in a total return of capital to shareholders of $549 million since January 2014. Our plan is to complete the authorized buyback program by repurchasing the remaining 1.1 million shares by around the end of our fiscal year.

Capital expenditures in the quarter were $20 million and depreciation and amortization totaled $25 million. For the nine months ended June, CapEx was $58 million while D&A was $78 million. We’re reducing our 2015 forecast for CapEx to $80 million, which compares with projected D&A of $105 million. For 2016, we’re forecasting CapEx of $90 million and D&A of $107 million.

Cash contributions to our global defined benefit pension plans totaled $27 million in the quarter. Our forecast for all of 2015 is unchanged at $62 million. For 2016, we’re planning to contribute $71 million.

Our effective tax rate in the third quarter was 28.4% compared with last year’s 25.6%.  The low rate in last year’s third quarter resulted from a tax-deductible loss associated with the sale of the Ethox Medical operations in June 2013. We’ve lowered our projected effective tax rate for all of 2015 to 27.7% resulting from a favorable shift in taxable income. For 2016, we’re forecasting an effective tax rate of 28.5%.

Our financial ratios at the end of the quarter reflect the effects of our stock repurchase program. Net debt as a percentage of total capitalization was 42% compared to 27% a year ago.  Our leverage ratio (Net Debt divided by EBITDA) is currently 2.45x compared to 1.60x twelve months ago.

At the end of our third quarter, we had $350 million of available unused borrowing capacity on our $1.1 million revolving credit facility.

2015 has turned out to be a more difficult year than we had forecasted a year ago.  We’ve dealt with numerous unexpected challenges by critically reviewing our portfolio of products, restructuring where appropriate, and focusing on generating strong cash flow.  We have seen some solid success with cash flow, affording us the opportunity to return value to our shareholders in the form of our share repurchase program.

Lastly, M&A is still an integral part of our growth strategy.  We’ve not done an acquisition since the second quarter of 2013. But we’ve been busy assessing opportunities and we’ve seen a recent increase in deal flow.  We intend to remain disciplined in our capital allocation decisions, focusing on what will provide an optimal return for our shareholders.

With that, I’d like to turn you back to our moderator to facilitate any questions that you may have for us.  Thanks.

(Please note that the Q&A is not available.)

Press Release and Financial Statements