Fourth Quarter Conference Call, Fiscal Year 2023

Good morning and thank you for joining Moog’s fourth quarter 2023 earnings release conference call. I’m Aaron Astrachan, Director of Investor Relations. With me today is Pat Roche, our Chief Executive Officer, and Jennifer Walter, our Chief Financial Officer.

Earlier this morning, we released our results and our supplemental financial schedules, both of which are available on our website. 

Our earnings press release, our supplemental financial schedules and remarks made during our call today contain adjusted, non-GAAP results. Reconciliations for these adjusted results to GAAP results are contained within the provided materials. 

Lastly, our comments today may include statements related to expected future results and other forward-looking statements. These are not guarantees, as our actual results may differ materially from those described in our forward-looking statements, and are subject to a variety of risks and uncertainties that are described in our earnings press release and in our other SEC filings. 

Now, I am pleased to turn the call over to Pat…

Good morning and welcome to the call.

Today, we will share an update on a superb quarter, notable for record sales, record twelve-month backlog, strong operating margins and strong cash flow. It is a tremendous performance from our teams to deliver three consecutive record sales quarters and to continue to drive our margin enhancement initiatives.

And for that, I wish to thank our Moog employees globally who contributed to our financial performance in the quarter and the operational improvement over the last twelve months.

FY23 Financial Performance

Before we get into the detail of the quarter, let me first reflect on what has been an exceptional year for our company.  We delivered record sales, we increased operating margin and we built an all-time-high, twelve-month backlog.

We have grown revenue over 11% organically to 3.3 billion dollars.  Each of our three segments contributed double-digit organic growth.  The growth was led by recovery in Commercial Aircraft, by broad-based demand for our Defense and Space applications, and by strength in Industrial Automation and Flight Simulators. In addition, we have been successful in winning new business with exceptionally strong order intake on the defense side of the business increasing our total backlog to over $5B.

We have expanded adjusted operating margin by 70 basis points from 10.2% to 10.9%.  This is notable progress and a great start to our margin enhancement journey.  The effort invested in both pricing and simplification are already delivering improved financial outcomes.  Adjusted earnings per share improved by a solid 11% to $6.15 and would have been even stronger if not for increased interest cost.

We certainly have had challenges through the year with supply chain and specific labor availability issues, especially in the first two quarters.  Those challenges have eased in the back half of the year and we saw further improvement in Q4 finishing the year with strong cash generation.

FY23 Operational Performance

Now let me turn your attention to the operational actions that we are taking to drive our performance improvement.

Firstly, Customer Focus …

We have completed the separation of Aircraft into Military Aircraft and Commercial Aircraft segments.  The business leaders have direct responsibility for the focused factories, the dedicated staff, and production resources for their respective businesses.  They are fully accountable for operational and financial performance of the business. Each leader can now better align the business model with the distinct end-market needs.  Our forward guidance provides you financial visibility of these new segments. 

We have also completed delivery of our first four Meteorite satellites to our customer.  Payload integration and testing of hardware and software have been completed successfully.  This is significant progress for us in our Space Vehicle programs.

On a further positive note, we are making progress, slowing the growth of physical inventory.  This is a sign of improving supply chain and labor market conditions, resulting in better production flow and labor utilization.  This is enabling us to better meet our customer commitments. 

Next, People, Community and Planet …

As I stated in my first earnings call, I believe that we have a moral responsibility to be good stewards of our planet for the next generation.  I want to let you know that we are making good progress in characterizing and measuring emissions and have already published a sustainability and disclosure report last year.  We have now baselined, within our own facilities world-wide, our CO2 emissions, water usage and hazardous waste production. 

We are strongly committed to drive improvement and I can announce today that we are targeting a 40% reduction in Scope 1 and Scope 2 Greenhouse Gas (GHG) emissions by 2030. 

Finally, turning to Financial Strength …

We are making excellent progress on driving margin enhancement through Pricing and Simplification.

On Pricing…

We have had good success working with customers across all end-markets to adjust pricing so that it better reflects the value that we deliver.  Those negotiations have taken place over months and in some cases years.  The impact is now feeding through to our financial results – notably within Industrial in the second half and within Aircraft in the current quarter.  Those agreements, already concluded, deliver a substantial portion of our planned operating margin expansion out to FY26.

On Simplification…

We have increased the pace of simplification throughout the organization.  This is evident in various initiatives:

a)     Portfolio Shaping – we are well advanced in the sale of our industrial hydraulics business in Luxembourg which we hope to complete before the end of Q2 FY24. We will also dispose of another industrial business before the end of FY24 and have consequently taken a substantial charge this quarter.

b)     Foot Print – we closed six sites in FY23 – a mix of sales offices and remote engineering sites.  We also sold three factory buildings that we had previously vacated through prior foot print closures.  We announced a further two manufacturing site closures – the first of which will complete in FY24.

c)     Focused Factory – we continue to segregate product by end-market in order to simplify our manufacturing plants.  We have several changes underway:  moving aerospace product out of our industrial facility in Murphy, NC; and using the growth of our space business as an opportunity to tease apart the physical operations of our space and defense businesses, since each are driven by different end-market requirements.

d)     80/20 - We continued to build 80/20 momentum in the quarter.  Our pilots are demonstrating significant progress in both pricing and simplification.  We are also seeing improvement in customer satisfaction and employee engagement. We trained a further 250 leaders in the approach. In addition, we agreed to transfer several Moog products on mature, end-of-life aircraft platforms to specialized third-party organizations from which we expect to gain efficiency.  Finally, we added two more sites to full implementation bringing 80/20 to 10 manufacturing sites. 

Now before I turn attention to the macroeconomic environment, I’d like to share two further updates.

Firstly, we report a positive impact in Q4 from the settlement of litigation.  We are not able to provide specifics since the terms of the settlement are confidential.  We are pleased to have this concluded.

Secondly, I’m also happy to report that we are making good progress on revalidating our security clearance with the Defense Counterintelligence and Security Agency and, in the meantime, we continue to work without interruption on awarded defense contracts.

We have submitted a mitigation plan that we believe meets DCSA requirements. As we noted previously, we expect the plan will involve standing up a subsidiary with an organizational structure and procedures to ensure the protection of classified information. We are hopeful to have the situation resolved within the next two quarters and will provide an update when we have additional information to share.  As a reminder, this matter relates solely to classified U.S. military programs.

Macroeconomic & End-Market Conditions

It is shocking that we now have war in Ukraine and the Middle East.  Simmering geopolitical tensions are leading most nations to reassess their national security and to increase commitment to defense spending. Defense constitutes half of our book of business.

The Commercial aircraft market continues to strengthen.  We have a clearly defined wide-body production ramp over the next few years toward 10 and 9 ship sets /month in FY26 for 787 and A350 respectively.  We see no change in that plan. 

Industrial markets continue to soften.  There has been a gradual reduction in the book to bill ratio over the last 6 months.  Market data such as manufacturing Purchasing Managers Index (PMI) and survey data from the German Engineering Federation (VDMA) all indicate contraction. We expect this to continue, and we are managing our business accordingly. 

Guidance for FY24

Looking forward to FY24, we continue to execute on our Investor Day initiatives of growth and margin enhancement.  Our FY23 performance was in line with our expectations, and we are building momentum going into FY24. 

For that reason, I’m confident in laying our guidance for FY24 which includes:

• Solid revenue growth of 4% YoY, yielding 7% CAGR from FY22 to FY24
• Strong margin enhancement, with Adjusted operating margin up 110 bps to 12.0%, and
• Modest free cash flow.

Our guidance is in line with our stated investor-day targets – solid revenue growth, strong margin enhancement and modest cash flow.  Our growth in FY24 is driven by the continued Commercial recovery, a full-year of V-280 development, broad-based growth in Defense and in Space, offset by a decline in Industrial Automation.  We continue to execute on our pricing and simplification initiatives. We will update you on progress throughout the year on portfolio shaping, foot print rationalization and building our 80/20 maturity. 

Now, let me hand over to Jennifer for a more detail breakdown on the quarter and our guidance.

Thanks Pat.

I’ll begin with the headlines for FY 23, followed by a more detailed review of our fourth quarter financial performance. I’ll then describe our initial guidance for FY 24.

Sales for FY 23 were at a record level, coming in at $3.3 billion. This represents a 9% increase over FY 22 and, adjusting for divestitures 11%. Each of our segments contributed to our strong sales growth. The growth in Aircraft Controls was driven by the commercial aircraft recovery, offset somewhat by declining funded development work in the military business. In Space and Defense Controls, sales grew as a result of the production ramp on the reconfigurable turret program and strong demand for satellite components. The growth in Industrial Systems related to increased demand for capital equipment driving industrial automation sales as well as air traffic recovery boosting flight simulation activity.

Our adjusted operating margin of 10.9% increased 70 basis points over FY 22. In Industrial Systems, our margin expanded 200 basis points, largely due to pricing initiatives. In Aircraft Controls, our margin expanded 70 basis points. Again, pricing was the key driver of margin expansion, though reduced somewhat by negative impacts on military aircraft funded development work. In Space and Defense Controls, our margin contracted 40 basis points as charges in our space vehicles business masked an otherwise stronger core business.

As Pat described, we’ve made progress in both our pricing and simplification efforts. Pricing has already begun to contribute to our margin expansion in FY 23, margin loss from our early learnings in space vehicles is behind us and we’ll see that benefit come through in FY 24, and simplification efforts will show up more meaningfully in the out years.

Our adjusted earnings per share of $6.15 were up 11%. This increase is driven by our adjusted operating profit, which grew 17%, offset by a significant increase in interest expense.

For the year, we had negative free cash flow of $37 million. This resulted from an increase in working capital, specifically physical inventories, and a high level of capital expenditures as we invest in our facilities.

Let’s shift over to our fourth quarter results.

The performance of our underlying business in the fourth quarter was exceptional. For the third quarter in a row, we hit a record level of sales for the company. Our key initiatives drove our operating margin expansion, and cash flow performance was robust.

We made progress on simplifying our business and took some charges in the fourth quarter as a result. We incurred $17 million of impairment and restructuring charges associated with planned portfolio and footprint rationalization activities, mostly in Industrial Systems. We also continued our journey to get out of the pension business, settling over $40 million of our projected benefit obligation through a lump sum buyout, which resulted in a $13 million non-operating settlement charge. We also recorded $4 million for unrelated asset impairments.

I’ll now talk through our fourth quarter results excluding these charges.

Sales in the fourth quarter were $872 million, increasing 14% over the same quarter a year ago.

The largest sales increase was in Aircraft Controls. Sales of $377 million increased 16% over the same quarter a year ago. Commercial OE sales in the quarter were strong, driven by the continued market recovery in widebody platforms as well as growth on business jets. Commercial aftermarket sales were at a record high. We had strong sales on the A350 program, which has been steadily ramping over the past several quarters. We also sold inventory associated with mature programs that we decided to exit as part of our simplification efforts.

Sales in Space and Defense Controls of $241 million increased 11% over the fourth quarter last year. Adjusting for the divestiture of a security business last year, sales increased 13%. The sales growth was driven by increased activity on avionics and components for satellites and new defense work that’s ramping up.

Industrial Systems sales increased 12% to $254 million. We experienced sales growth related to high demand on flight simulation systems associated with recovery in commercial aircraft flight hours. In addition, our industrial automation sales grew, driven by demand for capital equipment. This business has recovered nicely since the pandemic, though we’ve been seeing orders slow down in recent quarters.

We’ll now shift to operating margins.

Adjusted operating margin of 12.5% in the fourth quarter increased 210 basis points from the fourth quarter last year. This increase is due to pricing initiatives and, to a lesser extent, transactions resulting from our focus on simplification.

Operating margin in Aircraft Controls was 12.8% in the fourth quarter, up nicely from 10.7% in the same quarter a year ago. The increase was driven by retroactive pricing in the fourth quarter. In addition, as part of our 80/20 work, we’ve exited some mature commercial platforms and sold associated inventory. The resulting benefit to margins from that activity was offset by charges on funded development work that is winding down.

Operating margin in Space and Defense Controls was 12.8%, up from 9.4% a year ago. This quarter, we had the benefit of lower charges associated with our space vehicle start up business, stronger core business performance and pricing initiatives.

Operating margin in Industrial Systems was 11.9%, up 110 basis points over 10.8% in last year’s fourth quarter. Benefits associated with our pricing initiatives drove this margin expansion.

Interest expense is another area that’s impacting our financial results. In the fourth quarter, interest expense was $18 million, up $7 million over the fourth quarter last year.

Our adjusted effective tax rate in the fourth quarter was 18.5%, down from 23.4% in the fourth quarter last year, as we’ve benefitted from higher levels of R&D tax credits.

Putting it all together, adjusted earnings per share came in at $2.10, well above the range we provided a quarter ago. EPS was up 54% from the same quarter a year ago, driven by the increase in operating profit and the benefits of a legal settlement and lower tax rate. Relative to the mid-point of our previous guidance, our EPS was up $0.03 after adjusting for the lower tax rate and legal settlement.

Let’s shift over to cash flow, which was another highlight for the quarter. In the fourth quarter, we generated $105 million of free cash flow. This represents free cash flow conversion on adjusted net earnings of over 150%. The key driver to the strong cash generation this quarter was working capital, in particular collections from customers and timing of compensation and vendor payments.

Capital expenditures were relatively high at nearly $50 million this quarter as work progressed on facilities, most notably our advanced integrated manufacturing facility for Military Aircraft. We’re continuing to invest in facilities to accommodate our growth, focus our factories and enhance our capabilities through automation.

Our leverage ratio, calculated on a net debt basis, as of the end of the fourth quarter was 2.2x, around the low end of our target range of 2.25x to 2.75x.

Our capital deployment priorities, both long-term and near-term, are unchanged. Our current priority continues to be investing for organic growth.

We’ll now shift over to our initial guidance for next year.

Fiscal year 2024 will be another positive step on our journey towards our long-term financial targets. Our operating margin will expand by over 100 basis points and earnings per share will increase over 10%.

Over the past several months, we’ve worked on separating our aircraft business into two segments – Military Aircraft and Commercial Aircraft. As of the beginning of FY 24, they’re officially split and we will now begin to report on them as separate segments. The sales breakdown that we’ve historically shared will largely be the same as in the new organizations. I’ll also share estimated operating margins for these segments looking back at FY 23.

We’re projecting sales of $3.5 billion in FY 24. That’s a 4% increase compared to FY 23 and a 7% CAGR from FY 22. We’re projecting sales growth in Military Aircraft, Commercial Aircraft and Space and Defense, and expecting a decrease in sales in Industrial.

The largest increase in sales will again be in Commercial Aircraft. We’re projecting sales to grow 14% to $785 million. The production ramps on our widebody programs, most notably the 787, account for most of the increase in OE sales. Aftermarket sales will decrease from the record high in FY 23, reflecting the absence of some one-time sales activity that occurred in FY 23.

Space and Defense sales are projected to increase 7% to $1.0 billion. We’re seeing strong defense demand across our entire book of business. Areas in which we’re experiencing strong demand in particular are satellite components, missile controls and new defense programs.

Military Aircraft sales are projected to increase 5% to $735 million. A full year’s worth of V-280 sales will drive OE sales up in FY24, while aftermarket sales continue to soften as defense priorities shift to modernization.

Industrial sales will decrease in FY 24. We’re projecting sales of $915 million, down 7% from last year, or 6% when we adjust for divestitures. This decrease relates to the softening of orders that we’re seeing in industrial automation and is consistent with macro indicators for capital spend. We’ll see increases in our other submarkets partially offset the lower industrial automation business.

Let’s shift over to operating margins.

We’re projecting our adjusted operating margin in FY 24 to be 12.0%, a 110 basis-point increase over FY 23. Operating margins will expand in each of our segments with the exception of Commercial Aircraft. Our operating margin in Space and Defense will increase 300 basis points to 13.5% due to the absence of charges on our space vehicle programs and reflecting our otherwise strong operational performance. Military Aircraft’s operating margin will increase 280 basis points to 11.6%. We’ll benefit from having a full year of activity on the V-280 program in FY 24. In FY 23, our activity was interrupted by the delay in the contract award, followed by a ramp-up to the current activity level. In addition, charges incurred on certain funded development programs will not repeat as those programs are winding down. Pricing will continue to drive operating margin expansion in Industrial Controls, where our operating margin will increase 80 basis points to 12.3%. In Commercial Aircraft, our operating margin will decrease 260 basis points to 10.2% as aftermarket specials don’t repeat. In FY 23, we had a number of one-time aftermarket initiatives that contributed nicely to our operating margin, as well as the sale of inventory upon exiting some mature platforms.

For FY 24, we’re projecting adjusted earnings per share of $6.80, plus or minus $0.20, which is up 11% over FY 23, reflecting strong operational performance. For the first quarter, we’re forecasting earnings per share to be $1.45, plus or minus $0.10.

Finally, turning to cash.

We’re projecting free cash flow for FY 24 to be modest.  Relative to FY 23, we’ll see stronger cash from net earnings and working capital, while capital expenditures remain around the same level. We’ll use less cash for working capital needs next year. Physical inventories will grow at a slower rate, reflecting the improvement we saw this past quarter. However, we’ll see pressure from customers as we work down advances that came in during FY 23.

Overall, we had a great quarter and our outlook for next year looks strong.

And now I’ll turn it over to Pat.

Thank you, Jennifer.

I’m really pleased with our performance this quarter and look forward to another year of even stronger performance in FY 24.

Now, let us take your questions.