Third Quarter Conference Call, Fiscal Year 2017
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 28, 2017 our most recent Form 8K filed on July 28, 2017 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 third quarter of fiscal ‘17 and affirm our guidance for the year. As usual, I’ll start with the headlines before diving into the details.
- First, it was another milestone for our commercial aircraft business with the Chinese C919 completing its first flight on May 5th. Moog supplies the high-lift system for this airplane. We also had some positive news in our marine energy business as we received our first significant FPSO order in several years. While we don’t think our off-shore business will rebound any time soon, we believe this order signals that we have turned the corner on declining demand and can plan for a more stable business going forward.
- Second, it was another good quarter financially. Our operations delivered $0.91/share, above our guidance from last quarter of $0.80 – $0.90. In addition, we had an unusually low tax rate which added $0.20/share. The result was earnings per share of $1.11, up 11% over last year.
- Third, free cash flow in the quarter of $32 million was also strong.
- Fourth, we completed the divestiture of our remaining small European space operations in early June. In addition, in July we completed the divestiture of a non-strategic product line which we acquired as part of our additive manufacturing acquisition 18 months ago. There was no operating profit impact in the quarter from these disposals.
- Finally, with 90 days left to go, we’re updating our full year guidance to sales of $2.46 billion, up $10 million and earnings per share of $3.75/share, up from $3.50/share last quarter.
Now let me move to the details starting with the third quarter results.
Q2 Fiscal '17
Sales in the quarter of $626 million were up 2% from last year. Sales were up in Aircraft, Space and Defense and Components, but lower in Industrial Systems on weaker wind energy demand.
Walking down through the P&L, our gross margin was slightly lower than last year while our R&D expense was in line. Other SG&A expenses were down as a % of sales from the same quarter a year ago. Earnings before tax were down 6% but our tax rate was an unusually low 17% compared with just over 30% last year. The overall result was net earnings of $40 million and earnings per share of $1.11.
Fiscal '17 Outlook
We’re fine tuning our sales forecast this quarter to reflect the experience of the first 9 months. Full year sales are now forecasted to be $2.46 billion, up $10 million from 90 days ago. The increase is in our aircraft and components groups. We’re increasing our earnings per share forecast by $0.25, a combination of $0.05/share additional contribution from our aircraft group and the $0.20/share benefit we saw this quarter from the unusually low tax rate. In total, we’re forecasting EPS of $3.75, plus or minus $0.10. This suggests a fourth quarter of $0.92, operationally in line with our third quarter.
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.
Sales in the quarter of $283 million were up 4% over last year. On the commercial side, OEM sales to Airbus on the A350 program continued to ramp nicely. We also saw sales increases in our Gulfstream business jet programs and are seeing very early stage sales to Embraer on the E-2 program. OEM sales to Boeing were down on lower 777 activity. Sales in the aftermarket were up as a result of higher sales on some legacy programs. Total initial provisioning across the 787 and A350 was in line with last year.
On the military side, the F-35 OEM program continues to ramp up, but we saw lower aftermarket activity. Last year we had significant aftermarket sales on the F-35 as we worked to stand up a repair depot at one of our customer’s locations. This quarter we experienced a technical issue on the V-22 line which slowed production. The issue is now resolved, and we’re working to catch up on our backlog.
Aircraft Fiscal '17
We’re refining various elements of our sales forecast as we head into our last quarter. We’re increasing our Military OEM sales by $15 million and reducing our Military aftermarket sales by the same amount. We’re also increasing our commercial aftermarket forecast by $5 million. The net result is an overall increase of $5 million to yield full-year sales of $1.12 billion.
Margins in the quarter of 10.3% were down from last year, but in line with last quarter. R&D spend of $22 million was comparable with last year, but a less favorable sales mix, particularly the lower military aftermarket and foreign military sales, resulted in lower margins than a year ago. In combination with the slightly higher sales forecast, we’re increasing our full-year margin forecast by 20 basis points to 9.7%.
Overall, our aircraft R&D this year is on track to finish the year at about $90 million, down approximately $10 million from last year. The A350-1000 and E-2 programs continue to be the major consumers of our investment dollars, but we’re also investing in several business jet programs and in the Chinese C919. The spend rate quarter to quarter tends to fluctuate based on how much hardware is being produced to support qualification and certification testing, but the longer-term trend is now declining and we should continue to see that trend in the years to come.
Space and Defense
Space and Defense Q3
Sales in the quarter of $95 million were up 2% from last year. Space was lower as a result of the lost sales associated with the disposal of one of our European space businesses in Q1 fiscal ‘17. Excluding this effect, space sales were in line with last year, with higher sales of satellite avionics compensating for lower sales to NASA. Defense sales were up over last year with strong vehicle and naval sales, but slightly lower missile activity.
Space and Defense Fiscal '17
We’re leaving our full year sales forecast unchanged from 90 days ago at $387 million – a combination of $183 million in Space and $204 million in Defense.
Space and Defense Margins
Margins in the quarter of 10.6% were down from last year. We’re investing about $1 million a quarter more this year on various R&D activities. For the full year, we’re maintaining our margin forecast at 10.7%.
Industrial Systems Q3
Sales in the quarter of $122 million were down 6% from last year, but up 6% from Q2. One third of the reduction is due to weaker foreign currencies relative to the US dollar. Real sales were down in energy, primarily as a result of continued softness in our legacy wind business. Real sales were also lower in our industrial automation market. Real sales were up nicely in both test and simulation after a relatively soft first half of the year. Despite the sales decline this year relative to the same quarter last year, we’re optimistic for the future of our industrial business. In wind, our new pitch control system continues to gain traction at customers in Asia, and we should see the impact on the sales line as we move into fiscal ‘18. In industrial automation we’re slowly seeing signs of improving orders which we believe bodes well for the future.
Industrial Systems Fiscal ‘17
We’re leaving our sales forecast unchanged from 90 days ago. Full year sales of $470 million are broken down approximately 50% in industrial automation and about 25% in each of energy and simulation & test.
Industrial Systems Margins
Margins in the quarter of 10.2% were up nicely from a year ago despite the lower sales. The restructuring activities in fiscal ’16 are playing through in the P&L and a continued focus on cost control is paying dividends. For the year, we’re keeping our margin forecast unchanged at 10.4%.
Sales in the quarter of $127 million were 7% higher than last year. In early April, we closed on the acquisition of Rotary Transfer Systems in Germany and this added $6 million in sales in the quarter. Organic sales were up 2% over last year. Sales into our A&D markets were flat, with stronger missile sales compensating for lower vehicle sales. In the industrial and energy market, we’re pleased to report that sales for off-shore exploration were up marginally this quarter – only the second time, since the precipitous drop in the price of oil, that we’ve not reported a sales decline from the prior year. Organic sales to our other industrial customers were also stronger. Finally, sales of medical components and pumps were up slightly from last year, a combination of stronger pump sales and weaker CAT scan slip ring sales.
Components Fiscal ‘17
We’re increasing our sales forecast by $5 million to reflect higher sales into our A&D markets. In these markets, our third quarter was stronger than we had been anticipating and we think this strength will carry over into the fourth quarter. We’re keeping our forecast in Industrial and Medical unchanged. We now anticipate full year sales of $492 million
Margins in the quarter were 9.5%. Higher R&D investment on next generation products combined with a slightly adverse sales mix drove a lower margin than last year. For the full year, we’re keeping our operating profit forecast unchanged, but inching the margin down to 10.0% on the slightly higher sales.
Q3 was another good quarter. Sales were up slightly and our operations performed at the high end of our expectations. We enjoyed an unusually low tax rate which contributed $0.20/share and we had another good quarter of free cash flow.
With 9 months in the bank, we’re adjusting our full-year sales forecast up by $10 million and increasing our EPS forecast $0.25 to $3.75/share, plus or minus a dime. This assumes a fourth quarter of $0.92 – in line with our operational performance this quarter. Overall, we’re pleased with the way fiscal ‘17 is unfolding. Our operations have exceeded their original plan for the year and we’ve been able to absorb additional charges associated with our continued portfolio clean up while increasing our full-year guidance. We’ll provide our first look at fiscal ‘18 when we report on the results of our fourth quarter.
Now let me pass you to Don who will provide some color on our cash flow and balance sheet.
Thanks, John. Good morning.
Solid free cash flow of $32 million in our third quarter resulted in YTD free cash flow of $124 million, reflecting a YTD conversion ratio of 122%. We’re forecasting a solid finish to FY17 as we expect to achieve a conversion ratio for all of FY 2017 of better than 100%. Specifically, we’re increasing our FY ’17 free cash flow forecast by $10 million to $140 million. Looking out over the coming quarters, we expect to see higher capital expenditures for growth-related investments in facilities for engine propulsion testing and for the production ramp of the F-35 program. We’re also forecasting that customer advances will begin declining in the coming quarters after reaching their current high levels, partly due to payment terms associated with the newer commercial aircraft programs. We’ll discuss FY ‘18 in greater detail next quarter.
Net debt decreased $2 million in the quarter compared to free cash flow of $32 million. The difference is primarily related to the April 2nd acquisition of
the Rotary Transfer Systems business from Morgan Advanced Materials with operations in Germany and France. Rotary Transfer Systems designs and manufactures industrial slip rings and opens up the opportunity for us to effectively expand our business throughout Europe. The business is being managed as part of our Components segment. Q3 sales from this acquisition were $6 million and in line with our projections.
Net Working Capital (excluding cash and debt) as a percentage of sales was 24.7% at the end of Q3 compared with 24.9% a year ago, continuing the downward trend that we’ve been reporting over the past few years. Collections of receivables and the timing of payments on our accruals contributed to this quarter’s favorable comparison.
Capital expenditures in the quarter were $15 million while depreciation and amortization totaled $22 million. For all of 2017, we’ve decreased our CapEx forecast by $10 million to $70 million while D&A will be about $90 million. Over the last decade or so, our CapEx as a percentage of sales has averaged just under 4.0%. More recently, since FY ‘13, our run-rate has averaged about 3.0% of sales. We’ll finish FY ‘17 just under 3.0%. As we look out over the next year or two, we expect to see our CapEx pick up a bit. Over the longer-term, we believe our sustainable CapEx run-rate as a percentage of sales is in the 3% to 4% range.
Cash contributions to our global retirement plans totaled $33 million in the quarter while YTD we’ve made $74 million of contributions. For all of 2017, we’re planning to make contributions into our global retirement plans totaling $92 million, unchanged from our forecast three months ago. Global retirement plan expense in the third quarter of FY 2017 was $16 million, similar to last year. Our global expense for retirement plans is projected to be $64 million this year compared with $65 million in FY 2016.
This is certainly the year for quarterly volatility in our effective tax rate. In the first quarter our tax rate was 17.6%. In the second quarter the rate was 34.3%. And now in our third quarter of 2017, we again had a very low tax rate of 17.0% which compares with last year’s third quarter rate of 30.9%. The fluctuations – quarter to quarter – are mostly the result of tax benefits that are associated with the divestitures. The timing and ultimate outcome of working through each of these individual tax matters with the applicable taxing authority in order to arrive at a final conclusion is difficult to forecast. Comparing our rate in Q3 of FY ‘17 with last year’s rate, the decrease is mostly related to tax benefits associated with our dispositions. Additionally, the filing of our 2016 tax return just last month surfaced some conservatism in our accruals for manufacturing and R&D credits. YTD, our 2017 tax rate is 23.4% compared to last year’s 27.5%. Removing the effects related to divestitures, the YTD FY ‘17 tax rate is 28.1%, similar to last year’s rate. For all of 2017, we’ve lowered our forecasted tax rate by 390 bps compared to last quarter’s forecast and are now projecting an effective tax rate of 25.7%. This compares with our tax rate in 2016 of 28.5%.
Our leverage ratio (Net Debt divided by EBITDA) decreased to 1.92x at the end of the quarter compared with 2.33x a year ago. Net debt as a percentage of total capitalization was 36%, down from 41% a year ago. At quarter-end, we had $530 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2021. In addition, our $300 million of 5.25% high-yield bonds terms out in December 2022.
With that, I’d like to turn you back to John to take any questions you may have.
Please note that the Q&A is not available.