First Quarter Conference Call, Fiscal Year 2016
January 29, 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 January 29, 2016, our most recent Form 8K filed on January 29, 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 first quarter of fiscal ‘16 and update our guidance for the full year. We had expected a slow start to the year, and we came in at the low end of our guidance for the quarter. We had also expected a pickup in many of our markets as we moved through the year. Over the last 90 days, the outlook for our A&D markets has held fairly firm, but unexpected macroeconomic developments have caused our view on our non-A&D markets to change significantly. I’ll discuss the details as I walk through each of our segments.
Starting with the headlines.
• First, earnings per share in the quarter of 71 cents were at the low end of our guidance.
• Second, we had a net use of cash in the quarter. This was not a surprise, as the favorable timing of receipts in our fourth quarter reversed this quarter. We still expect free cash flow conversion for the full year to be over 100%.
• Third, we’ve reduced our 2016 EPS forecast to $3.35, down from our last forecast of $4.00. Our outlook for our non-A&D businesses has weakened markedly over the last 90 days. In our energy markets, the outlook for the price of oil is directly impacting our fiscal 16 sales forecast. We’re also seeing impacts from the strong US dollar, slowdown in China and economic woes in Brazil.
• Finally, last month we announced the acquisition of 70% of Linear Mold
and Engineering, a small company outside Detroit with annual sales of
about $20 million. This company specializes in additive manufacturing, a technology we view as potentially transformative for many of our markets in the future.
Now let me move to the details starting with the first quarter results.
Sales in the quarter of $568 million were down 10% from last year. The stronger dollar accounted for one quarter of the decline. Excluding foreign currency effects, real sales were down in our Aircraft, Space and Defense, and Components segments. Sales in the Industrial segment were up marginally and organic sales in our Medical segment were up 22% over last year. Taking a look at the P&L, our gross margin is down slightly as a result of the lower sales, our R&D expense is up on increased aircraft activity and our SG&A expense is down as a percentage of sales as we continue to reduce our overhead costs. Our effective tax rate was 26.6% as we benefited from the reinstatement of the R&D tax credit in the US. The overall result was net earnings of $26 million and earnings per share of 71 cents.
We’re moderating our full year sales forecast by $100 million to reflect the weakening outlook across many of our markets. This number includes $20 million of additional sales from the acquisition of Linear Mold, so the outlook for our organic business is down $120 million versus 90 days ago. This reduction in sales will result in $35 million of lower operating profit, and corresponds to a reduction in earnings per share for the year of 65 cents to $3.35. Given the significant uncertainty we’re seeing in our industrial markets, we’re putting a range around this $3.35 of plus or minus 15 cents.
We’re taking an aggressive approach to revising our forecast downwards today based on what we’ve seen in the first quarter. It’s frustrating to announce this reduction to the market. Over the coming quarters, our team will be working very hard to deliver the best possible results in the face of the changing economic environment.
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.
Sales in the quarter of $255 million were down 4% from last year. Sales were lower on both the military and commercial side of the house. On the military OEM side, lower sales on the V-22 and the F-18 were partially offset by higher F-35 sales. The V-22 benefited last year from a catch up in deliveries while the lower F-18 sales reflect the slowing production rates. Sales were also lower in the military aftermarket as the C-5 refurbishment closes out.
On the commercial side, OEM sales were down across the legacy book at both Boeing and Airbus and also in our business jet product line. Higher A350 sales remained a bright spot as production continues to ramp up. Sales in the commercial aftermarket were off 6% as 787 initial provisioning slowed.
Aircraft Fiscal ‘16
We’re making some small adjustments to our sales forecast for the year. We’re moderating our military forecast by $10 million across a range of programs. We’re also moderating our commercial forecast by $10 million, reflecting the slow start to the year. On the other hand, we’re adding $20 million to our commercial OEM forecast as we incorporate the sales from our Additive Manufacturing acquisition under this segment. Net-net, no change to the total sales number for our Aircraft segment.
Margins in the quarter were 7.1%, down from 9.2% last year. The lower margin in the quarter is a combination of higher R&D expense and the anticipated unfavorable mix, including lower aftermarket sales in both military and commercial. R&D in the first quarter ran a couple of million dollars ahead of our plan and we anticipate that this spend rate will continue through the year. We’re therefore increasing our full year forecast for R&D by $5 million. The net impact is a reduction in our full year margin forecast to 9%. From the slow start in Q1, margins will improve as we move through the year due to stronger foreign military sales.
Space and Defense Q1
Sales in the quarter of $83 million are 17% lower than last year. Sales were down in both the Space and the Defense markets. Our Space business is going through a down cycle. We’ve closed out several programs over the last year and the follow on business has not yet begun. That will improve as we go through this year and we anticipate sales recovering to the run rate of last year by the second half. On the defense side, the sales reduction was all in our security business. Last year we went through some significant restructuring of this security business, as we rationalized the product portfolio to concentrate on our key customers.
Space and Defense Fiscal ‘16
We believe the last 3 quarters will be in line with our sales forecast from 90 days ago, but we won’t recover the slight sales shortfall in the first quarter. As a result, we’re moderating our full year forecast by $10 million to $375 million.
Space and Defense Margins
Margins in the quarter were 14.3% - up from 8.7% last year. This is a particularly impressive result given the lower level of sales in the quarter. Last year we had a drag of 200 basis points as we wrote down some inventory in our security product line. This year we had some one-time benefits as we closed out some programs. More importantly, however, this quarter the benefits of last year’s restructuring came through in the margin.
Given the strong first quarter, we’re increasing our full year margin forecast to 12% on slightly lower sales.
Industrial Systems Q1
Sales in the quarter of $125 million were 6% lower than last year. The reduction is all due to the strengthening of the US dollar over the course of the last 12 months. Excluding foreign currency effects, sales were actually up marginally from last year. The real increase was all in the Simulation and Test business across a range of programs. Real sales were slightly lower in our industrial automation market and were down 70% in our oil & gas market.
Industrial Systems Fiscal ‘16
Although first quarter sales were more or less flat with last year on a constant currency basis, we saw a slowdown in our incoming orders which suggests that sales could weaken as we go through the year. The continued decline in the price of oil has had a direct impact on our sales into the on-shore exploration market. We’ve also seen a direct impact from the economic woes in Brazil as $12 million of planned wind energy sales have evaporated. In addition, we believe we’re now seeing second order effects from the strong dollar and the slowdown in China. Industrial automation sales in Europe are slowing and our industrial aftermarket activity is below plan. At the moment, there doesn’t seem to be any macroeconomic indicator which would suggest a global recovery anytime soon. We’re therefore moderating our full year sales forecast by $30 million in an attempt to capture the effects of this new reality on our business. The reductions are all in our energy and industrial automation markets.
Industrial Systems Margins
Margins in the quarter were 10.9%. As in our Space and Defense segment, we’re seeing the benefits of last year’s restructuring coming through. We’ll continue to adjust capacity to demand over the coming year as the sales picture unfolds. However, given the challenging outlook we’ve reflected in the sales forecast, we’re moderating full-year margins to 9.2%.
Normally, my report on the Components segment is fairly boring – and boring is good. It’s always been “another quarter of strong sales and great margins”. Well, to say our Components segment experienced a perfect storm this quarter would not be an exaggeration. Sales in the quarter of $80 million were down 26% from last year. Sales were down in every market we serve – ranging from an 11% reduction in Space and Defense to a 56% reduction in Energy. In our A&D markets we saw some slowing in our aftermarket parts business as well as unfortunate timing on a range of customer programs. In our energy market, the continuing decline in the price of oil is reflected in our sales. In our industrial automation market, we’re seeing the same effects as in our Industrial Systems segment - the strong dollar, slowdown in investment in the energy sector and slowing economy in China are filtering down to the lower tiers of industrial suppliers like us. Finally, in our medical market, our customer for sleep apnea equipment is introducing a new product to the market. We continue to be their primary supplier for motors, but the price point for our new motor is lower than in the previous product generation.
Components Fiscal ‘16
Despite the slow start to the year, our A&D backlog is healthy and we anticipate these markets will recover significantly as we move through the year to yield full year sales close to our fiscal ‘15 total. In our non-A&D markets the story is very different. We anticipate continued weakness in our energy, automation and medical markets and we’re adjusting our forecast for the full year in each of these markets to align them with the run rates of the first quarter. The result is full year sales for the Components segment of $365 million, down $60 million from our forecast 90 days ago.
Margins in the quarter of 5.9% reflect the significant shortfall in the sales. Let me put this performance in context. We acquired the Components segment in 2003, and in the last 12 years, margins have averaged mid-teens and have never dropped below double digits in any one quarter. So this quarter was truly an outlier. We have the same team serving the same markets for over a decade and they really know their business. That team is very focused on getting their business back on track, and they’re taking all the necessary steps to align their cost structure with the sales outlook. However, given the reduction in the sales forecast for the year, combined with the soft margins in the first quarter, we’re moderating our full-year margins to 10%.
It was another good quarter for our Medical Devices segment. Sales in the quarter of $26 million were up 13% from last year. In the first quarter last year we had almost $2 million in sales from our Life Sciences operations which we divested in the second quarter. Excluding these Life Sciences sales, shipments of pumps and sets were up 22% in the first quarter. The gains were fairly evenly spread across both our Enteral and IV product lines.
Medical Fiscal ‘16
We’re keeping our sales forecast for the full year unchanged at $102 million, which corresponds to 7% organic growth for the year.
Margins in the quarter were 12.5%, a good start to the year. We’re keeping our full year margins unchanged at 11.4%.
Last quarter I reported that we had a couple of open items left to complete in our Medical Devices segment before restarting our strategic review process. These items included some further process improvements as well as a review of our channel partners. In the next 90 days, we believe we’ll get these items behind us and will be able to conduct a review of the strategic options for this segment. The objective of our review will be to identify the best option for this business to maximize long-term shareholder value. We hope to report out next quarter on our progress.
We’ve gotten off to a slow start in the first quarter – but we had expected as much. What we had not expected was the significant deterioration in the outlook for our non-A&D businesses in the space of 90 days. The stock market turmoil over the last few weeks may be a reflection of what we’re seeing in the real world. As I’ve described in the text, the macroeconomic climate for our industrial and energy businesses has weakened significantly. We’re experiencing first order effects from the low oil prices and the economic meltdown in Brazil with lost business in each market. We’re also experiencing second order effects from the strong dollar and the slowdown in China as our industrial automation businesses in both Europe and the U.S. slow. We’re moderating our sales forecast for the year by $100 million to $2.47 billion, and we’re moderating our EPS forecast by 65 cents.
We’re now forecasting full year EPS of $3.35, with a range of plus or minus 15 cents. Comparing this total with our forecast of $4.00 from 90 days ago, there are 3 major items which explain the 65 cent change:
- 35 cent reduction in our outlook for the Components segment;
- 20 cent reduction in our outlook for the Industrial Systems segment;
- 10 cent reduction from higher R&D in our Aircraft segment.
As usual, our forecast does not include any projection for future acquisitions or further share buyback activity. Earnings in the second quarter should be in the range of 75 cents to 85 cents with the last 2 quarters averaging just over 90 cents.
On the surface it might appear as if fiscal ’16 is similar to the past few years and one might conclude that our internal actions to improve our performance have not been very effective. However, it’s helpful to look at the influence of market forces over the recent past to see how much headwind they’ve generated, and then to look at how our internal actions have shaped our results.
Looking at our fiscal ‘16 forecast, our military aircraft business is down 11% from 2013 as a result of slowing defense spending in the U.S. Our industrial systems business is down 16% in just 2 years while our oil & gas businesses are off 60% over the same period. Our sales into the space market are down almost 20% since 2014 as are our sales into the medical devices markets. While our commercial OEM
sales are up 25% since 2013, our commercial aftermarket has remained flat. Unfortunately, every one of these sales changes has had a negative impact on our margins over the last few years.
As the sales picture has evolved, we’ve gone through multiple rounds of restructuring to adjust our cost structure proactively. We’ve continually reviewed our portfolio of businesses to ensure we’re focusing on the most promising areas for the future. We’re promoting Lean processes in all our operations and investing in the long-term future across all our markets. And, as a result, we’ve seen positive developments in several segments. Both our Medical Devices segment and our Space and Defense segment are showing significant improvements in profitability over the last few years, even in the face of declining sales. Our Industrial and Energy businesses continue to wrestle with slowing demand across many markets, but in time the markets will stabilize and eventually start to grow again, and the impact of our internal actions will come through. Finally, the aircraft business is a long-term play. Over the coming years, the military business will improve as the JSF ramps up and the associated aftermarket kicks in. The commercial R&D will come down gradually as the A350 and E-jets move into full production. The commercial OEM profitability will continue to improve as we come down the cost curves on the new platforms and finally, the commercial aftermarket will start to benefit as the size of the 787, A350 and later E2 fleets expands.
Over the last few years, our internal initiatives have yielded strong cash flow and, in the absence of strategic acquisitions, we’ve returned significant value to shareholders through our share buyback program. Most importantly for the long term, we’ve continued to invest in innovation across all our businesses. Our acquisition of a majority stake in Linear Mold this quarter is a further demonstration of this commitment to the future. We believe additive manufacturing has the potential to disrupt many of our markets over the next 5-10 years, and we intend to lead that disruption.
Let me finish by reiterating our commitment to our investors to deliver the best possible results against the backdrop of the challenging macroeconomic climate we’re in.
Now let me pass you to Don who will provide some color on our cash flow and balance sheet.
Thanks, John. Good morning.
Three months ago we enjoyed a record quarter for free cash flow that approached 400% conversion. I referenced the fortunate timing of certain cash receipts and disbursements that contributed to this unsustainable accomplishment and I noted, accordingly, that we expected to get off to a slow start in FY16. Well, we’ve gotten off to a slow start in ’16. Our free cash flow in our first quarter was a net use of funds totaling $13 million. We’ve enjoyed really strong free cash flow performance over the past three fiscal years averaging over 150% conversion. And we expect to continue to report respectable results as we look ahead. We expect to achieve better than 100% free cash flow conversion for all of 2016.
Net debt increased $44 million, primarily the result of the acquisition of Linear Mold. For the full year 2016, we’re modifying our previous free cash flow forecast to $130 million, down from our last forecast of $150 million, reflecting the decline in our earnings outlook that John has discussed.
During the first quarter we did not repurchase any Moog shares under our share repurchase program. Coming into the first quarter, we were expecting a soft quarter for free cash flow. In addition, our leverage was 2.4x to start the quarter which was at the higher end of our optimal range of 2.0x to 2.5x. And this ratio was forecasted to increase during Q1 before considering any M&A activity such as the Linear deal. At the end of the quarter, our leverage did, indeed, increase to 2.6x. Accordingly, we decided it would be best to refrain from using our capital to buy back any more Moog shares for the time being. We have about 4.2 million shares remaining under the outstanding Board authorization. Our projections for 2016 do not factor in the impact of any share buyback activity. We’ll report on any further activity next quarter.
With respect to M&A, we were excited to announce the December acquisition of Linear Mold, an additive manufacturing company located outside of Detroit. If you were fortunate enough to have attended or listened to our Annual Meeting, we spent a fair amount of time describing additive manufacturing in general, the acquisition of Linear, and what we think it will mean to Moog. The Linear transaction results in Moog owning 70% of the business and included an initial cash payment of $11 million plus the assumption of about $12 million of debt. Beyond Linear, we continue to look for strategic opportunities as we consider M&A an important complement to our organic growth objectives.
Capital expenditures in the quarter were $12 million and depreciation and amortization totaled $25 million. For all of 2016, we’re lowering our CapEx forecast to $80 million. D&A in 2016 will be about $103 million.
Cash contributions to our global retirement plans totaled $22 million in the quarter compared to last year’s first quarter of only $14 million. For all of 2016, we’re planning to make contributions into our global retirement plans totaling $95 million, unchanged from our forecast three months ago. Global retirement plan expense in the first fiscal quarter of 2016 was $16 million, up just slightly from a year ago. In 2016, our expense for retirement plans is projected to be $66 million compared with $61 million in 2015, up largely because of the effects of updated mortality assumptions.
Our effective tax rate in the first quarter was 26.6%, compared with last year’s 28.7%. During the first quarter of this year, congress enacted tax legislation that included the permanent reinstatement of the R&D tax credit. This had a beneficial impact on our quarter’s results of $1.5 million due to the “catch-up” of last year’s credit. For all of 2016, we’re forecasting an effective tax rate of 28.3%, essentially unchanged from our forecast 90 days ago.
As I just mentioned, our leverage ratio (Net Debt divided by EBITDA) increased to 2.6x at the end of the quarter compared with 2.1x a year ago. Net debt as a percentage of total capitalization was 44.6%, up from 36.5% last year. At quarter-end, we had $268 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2019.
With that, I’d like to turn you back to John for any questions that you may have.