Second 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 April 28, 2017 our most recent Form 8K filed on April 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 second quarter of fiscal ‘17 and affirm our guidance for the year. It was another good quarter for both earnings and cash flow and in line with our full year guidance.
Let me start with the headlines.
- First, it was another milestone quarter for successful first flights using Moog flight controls. On March 29 the Embraer E195-E2 took to the skies for the first time and on March 31 the 787-10 completed its maiden voyage.
- Second, earnings per share in the quarter of 88 cents was above our guidance from 90 days ago, and up 4% from last year. Sales were up 3% and operating profit for the quarter was up 15% from last year. Halfway through the year we remain on target to meet our full-year guidance.
- Third, free cash flow in the quarter of $56 million was particularly strong.
- Fourth, we announced the acquisition of the Rotary Transfer Systems slip ring business in Europe. This transaction closed on April 2, the first day of our third quarter. This business adds to our global leadership in slip ring technology and opens new industrial markets for our products in the heart of Europe. We anticipate sales of $10 million in the second half of Fiscal ’17 from the acquisition and no impact on earnings per share. In the quarter, we also acquired the remaining 30% stake in Linear Mold which allows us to integrate this additive manufacturing technology into the rest of Moog.
- Fifth, we continued our portfolio clean up in the Space and Defense group. We adjusted the accounting reserve on the European space businesses held for sale and decided to divest a non-strategic product line which we acquired as part of our additive manufacturing acquisition 15 months ago. This product line is now also classified as held for sale. We took a $4 million charge in the quarter associated with these future divestitures.
- Finally, we’re affirming our full year guidance for fiscal ’17 and tightening the range slightly. We anticipate earnings per share in the range of $3.50, plus or minus 15 cents.
Now let me move to the details starting with the second quarter results.
Q2 Fiscal '17
Sales in the quarter of $632 million were 3% higher than last year. Sales were up in Aircraft, Space and Defense and Components. Taking a look at the P&L, our gross margin is in line with last year, our R&D expense is down 70 basis points while our SG&A is up 30 basis points on acquisition and divestiture related fees. Last year we incurred $8 million of restructuring expenses which were absent this year, but this year we incurred $4 million of charges associated with product lines in our Space and Defense Segment which are held for sale. Earnings before taxes were up 19% but we had an unusually high effective tax rate of 34.3% which Don will describe later in the call. The overall result was net earnings of $32 million and earnings per share of 88 cents.
Fiscal '17 Outlook
We’re adjusting our sales forecast to account for the additional $10 million in sales from the Rotary Transfer Systems acquisition. This shows up in our Components Segment. We’re also increasing our sales forecast in our Space and Defense Segment by $20 million to reflect a strengthening defense book of business. We’re keeping our sales forecast for the other operating groups unchanged from 90 days ago. We’re adjusting the sales mix slightly in some of the groups to reflect the experience of the first 6 months of the year. We’re maintaining our full-year midpoint EPS guidance at $3.50 per share.
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 $290 million were 6% higher than last year. Similar to last quarter, sales were up in both our military and commercial markets. On the military side, sales on the F-35 program were sharply higher as production volumes continue to ramp up. We also saw continued strong sales on funded development programs. The military aftermarket was down on lower B-1B and C-5 repair activity.
On the commercial side, OEM sales on the A350 program continue to increase, while sales to Boeing and to our business jet and component customers remain relatively flat. Sales in the aftermarket were down $1 million from last year on reduced activity on some legacy programs.
Aircraft Fiscal '17
We’re keeping our sales forecast unchanged from 90 days ago at $1.11 billion. We’re adjusting the mix slightly based on the experience of the first half. We’re increasing our F-35 sales by $10 million and increasing our commercial aftermarket sales by $5 million. At the same time, we’re reducing our commercial OEM sales by $15 million spread across each of our major customers.
Margins in the quarter of 10.8% were up sharply from 7.3% last year. In the second quarter last year, we incurred $6 million of restructuring charges which were absent this year. In addition, this year we had lower R&D expense. At the halfway mark of the year, aircraft margins are 9.7%. We’re maintaining our full-year margin forecast at 9.5%.
Overall our aircraft business is performing nicely to plan this year, with R&D in line with budget and our commercial OEM programs coming down the production cost curves in line with our projections. Our military book of business is strong and our level of funded development on new military platforms is double what it was last year.
Space and Defense
Space and Defense Q2
Sales in the quarter of $106 million were up 14% from last year. The strength was on the defense side of the business. Strong sales on both U.S. and European vehicle programs, in combination with higher naval and security sales contributed to a 26% overall defense increase from last year. On the space side, higher sales on satellite components compensated for lower sales to NASA.
Space and Defense Fiscal '17
Given the strong first half in the defense market, we’re increasing our full-year forecast for defense by $20 million while keeping our space forecast unchanged. The result is full-year sales of $387 million.
Space and Defense Margins
Margins in the quarter of 9.9% included 2 unusual items. First, we increased our product reserves by $3 million for the investigation of an engineering issue on some of our satellite components. Second, we incurred $4 million of charges associated with business lines held for sale. For the full year we’re increasing our operating profit by $2 million to reflect the increased sales forecast, while keeping our margin forecast unchanged at 10.7%.
Our underlying Space and Defense operations are performing extremely well this year. Over the last 2-3 years, we’ve restructured our operations and reshaped our portfolio in this business and the operating results are now showing the fruits of this hard work.
Industrial Systems Q2
It was another challenging quarter in our Industrial Systems Segment with sales in the quarter of $115 million down 10% from last year. We saw declines in each of our major markets, although we believe that business is stabilizing. Sales into the energy market were down 15% from last year with lower sales in both our renewable and non-renewable markets. On the positive side, our new pitch control system is slowly getting traction with our wind customers. In the industrial automation market sales were down 8% but we believe we’ve hit bottom and are starting to see signs of improving orders in some of our core markets in Europe. Finally, simulation & test sales were 9% lower in the quarter, but we recently secured new multi-year agreements with our major flight simulation customers and anticipate sales in flight simulation to be higher in the second half of the year.
Industrial Systems Fiscal ‘17
We’re keeping our full year sales forecast unchanged at $470 million. Based on the performance in the first half, we’re adjusting the mix slightly by increasing our simulation & test sales by $10 million while reducing our industrial automation sales by the same amount.
Industrial Systems Margins
Margins in the quarter were 10.7%, up from 9.5% in the first quarter. Six months into the year, margins are 10.1%. We anticipate margins will continue to strengthen through the second half to yield full-year margins of 10.4%, in line with our forecast from 90 days ago.
Sales in the quarter of $121 million were up 3% from last year with the growth coming in our medical markets. Sales of medical pumps and sensors increased double digits over last year. Sales into the A&D sector were about flat with last year with stronger sales on missiles and military vehicles compensating for lower sales of components on military aircraft. Finally, sales in the industrial market were slightly lower than last year driven by further weakness in our energy markets.
Components Fiscal ‘17
We’re adding $10 million of sales for the full year to reflect the additional revenue from our acquisition of the Rotary Transfer Systems business in Europe. The additional sales are all in our industrial market. Moog is the largest producer of slip rings in the world, and the addition of Rotary Transfer Systems further strengthens our market leading position, while also giving us new application opportunities in the heart of Europe. We’re keeping our sales forecast in the other markets unchanged from last quarter. We’re now forecasting full year sales of $487 million.
Margins in the quarter were 8.9% and for the first half were 9.4%. We’re now forecasting full year margins of 10.2%, down slightly from last quarter’s forecast as a result of the $10 million of additional acquisition sales.
At the halfway mark in fiscal ’17 we’re pleased to report that we remain on track for our full-year guidance. The first 2 quarters came in a little stronger than plan, despite some one-time expenses associated with operations which are held for sale in our Space and Defense Segment. Our Aircraft Segment business is performing nicely to plan with the military side of the business strengthening on the F-35 production and new funded classified development programs. On the commercial side we’re coming down the production cost curves on our major OEM programs and we’re starting to see R&D decline in line with our forecast for the year. In Space and Defense, the underlying operations are performing very nicely and we’re seeing an uptick in our military programs. The Industrial Segment businesses continue to be challenged, but there are signs that the declines of the last several years are bottoming out. Finally, our Components Segment continues to wrestle with soft market demand but has some bright spots, particularly in the medical market. Cash flow continues to be very strong and we added Rotary Transfer Systems to our slip ring business. We’re keeping our forecast for the full year unchanged from last quarter at $3.50/share, but tightening the range to plus or minus 15 cents. As always there are both opportunities and risks to the forecast. On the opportunities side, the Aircraft and Space and Defense segments are performing ahead of plan, but on the risks side, our industrial business in both the Industrial Systems and Components Segment continue to operate in challenging markets. We expect the third quarter to be in the range of 80 cents to 90 cents.
Now let me pass you to Don who will provide some color on our cash flow and balance sheet.
Thanks, John. Good morning.
As John highlighted at the start of the call, we had a strong quarter for free cash flow…..$56 million. That brings our YTD free cash flow to $91 million, or a conversion ratio of 148%. We expect that our cash flow in the second half of 2017 will be softer than the first half due to the timing of various cash receipts and disbursements as well as somewhat higher spending levels for capital expenditures. Our projections suggest that this cash flow softness will be most pronounced in our Q3 due to our planned timing of contributions to our domestic defined benefit pension plan. In addition, customer advances are projected to begin declining in the second half of 2017 after reaching their current high levels partly due to payment terms associated with our commercial aircraft growth programs. In the end, we expect to achieve over 100% free cash flow conversion ratio for all of 2017, or $130 million, unchanged from our last forecast.
Net debt decreased $57 million, in line with our free cash flow of $56 million.
John also mentioned that we announced during Q2 the acquisition of the Rotary Transfer Systems business from Morgan Advanced Materials, with operations in Germany and France. Rotary Transfer Systems designs and manufactures products that are similar to our industrial slip rings and opens up the opportunity for us to expand our business throughout Europe. The business will be managed as part of our Components segment. We closed on this transaction on April 2 which was the first day of our third quarter. Our financial statements will reflect this acquisition in Q3.
Net Working Capital (excluding cash and debt) as a percentage of sales was down to 24.4% at the end of Q2 compared with 26.5% a year ago, continuing the downward trend that we’ve been reporting over the past few years.
Our capital deployment focus is on smart top-line acquisitive growth. It was nice to report on the acquisition of Rotary Transfer Systems this quarter as our M&A activity has been admittedly quiet over the last few years. And although it’s a relatively small transaction, we are pleased to have closed on this strategic target.
Capital expenditures in the quarter were $15 million and depreciation and amortization totaled $22 million. For all of 2017, our CapEx forecast remains unchanged at $80 million while D&A will be about $94 million.
Cash contributions to our global retirement plans totaled $24 million in the quarter, the same as a year ago, while YTD we’ve made $41 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 second quarter of 2017 was $16 million, similar to last year. Our global expense for retirement plans is projected to be $63 million compared with $65 million in 2016.
In the second quarter of 2017 we had a high effective tax rate of 34.3% compared with last year’s 23.9%. This high Q2 tax rate was influenced by the effects of charges associated with divestitures in our Space and Defense segment for which there is no tax cover as well as a less favorable mix of global taxable earnings due to relatively more profits being generated in the U.S. Also, last year’s low rate reflected the reversal of accruals for certain tax exposures outside of the U.S. for which the statutes of limitations had expired. YTD, our 2017 tax rate was 27.1% compared to last year’s 25.2%. For all of 2017, we’ve slightly adjusted our outlook and are now forecasting an effective tax rate of 29.6%, up 110 bps from our forecast last quarter. This compares with our tax rate in 2016 of 28.5%.
Our leverage ratio (Net Debt divided by EBITDA) decreased to 1.91x at the end of the quarter compared with 2.47x a year ago. Net debt as a percentage of total capitalization was 37.4%, down from 42.3% a year ago. At quarter-end, we had $532 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 to take any questions you may have.