First Quarter Conference Call, Fiscal Year 2019
((INTRODUCTION FOR CONFERENCE CALL)
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 25, 2019 our most recent Form 8K filed on January 25, 2019 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 ‘19 and affirm our guidance for the full year. Overall it was a strong start to our new fiscal year.
Let me start with the headlines.
First, it was a good quarter for our operations. Sales were up 8%, and earnings per share were up 25% relative to an adjusted first quarter last year. The Q1 FY18 adjustment is to factor out the one-time negative impacts of US tax reform. EPS this quarter of $1.25 was at the high end of our guidance from 90 days ago. Company operating margins were up 100 basis points relative to the same quarter last year. Free cash flow conversion was 90% in the quarter.
Second, on the technical front, Moog hardware performed flawlessly on two key NASA missions in the quarter, the successful landing of the InSight mission near the Martian equator and the OSIRIS robotic explorer’s journey to within 12 miles of the Bennu asteroid, some 76 million miles from earth. The products we delivered to our customers on these programs were made several years ago – long before our products had to perform in space. But, as our tag line goes “When Performance Really Matters”, that’s when our customers choose Moog.
Finally, our major markets continue to perform well. Defense is particularly strong across all our applications and we continue to see opportunities for growth. Commercial is also very healthy as Boeing and Airbus deliver planes at record rates. Our industrial markets remain solid and our book to bill is over one.
Now let me move to the details starting with the first quarter results.
Q1 Fiscal ‘19
Sales in the quarter of $680 million were 8% higher than last year, driven by strong underlying organic growth. Sales were up in each of our operating groups, ranging from 2% growth in Industrial to 17% growth in Space and Defense. Taking a look at the P&L, our gross margin was flat with last year reflecting higher margins in Industrial, as a result of our exit from the wind business, offset by a slightly less favorable mix across our A&D portfolio. Both R&D and SG&A were lower as a percentage of sales, while interest expense was $1 million up on higher rates. Last year, there was a lot of movement in the tax line in the first quarter as a result of US tax reform. Excluding the one-time impacts of tax reform from the Q1 fiscal ‘18 results, adjusted net earnings last year were $36 million and adjusted earnings per share were $1.00. The effective tax rate this quarter was 24.3% resulting in net income of $44 million, up 22% from last year’s adjusted number, and earnings per share of $1.25, up 25% from last year’s adjusted number.
Fiscal ’19 Outlook
We’re keeping our guidance for fiscal ’19 unchanged from 90 days ago. We anticipate full-year sales to be 6% higher at $2.88 billion, operating margins of 11.7% and earnings per share of $5.25 plus or minus 20c, an increase of 15% over last year’s adjusted EPS.
Now to the segments. I’d remind our listeners that we’ve provided a 3-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 $304 million were 9% higher than last year. On the military side, sales were up over 70% on the F-35 program relative to a year ago. Sales on this program tend to vary quarter to quarter based on the timing of orders and deliveries. Last year, the first quarter was unusually soft while this year the first quarter was particularly strong. For the full year, we anticipate the F-35 will be up 16% relative to last year. Excluding the F-35, the remaining OEM book of business was about flat with last year while the military aftermarket was up on increased V-22 activity.
On the commercial side, sales were up marginally from last year. OEM sales to Boeing were flat, while slightly lower Airbus sales were compensated by higher Embraer sales. Sales into the commercial aftermarket were in line with last year.
Aircraft fiscal ‘19
We’re keeping our full year sales forecast unchanged from 90 days ago at $1.3 billion, up 6% from fiscal ‘18. We anticipate military aircraft sales of $625 million and commercial aircraft sales of $640 million, also unchanged from last quarter.
Margins in the quarter of 10.9% were down marginally from last year, but are in line with our plan for the full year. The sales mix this quarter resulted in over 100 basis points of lower gross margin, but lower R&D and in-line SG&A brought operating margins close to last year. First quarter R&D of $15 million is more or less in line with the run rate of $65 million we expect for the year. We’re maintaining our full year margin projection of 11.4%.
Space and Defense
Space and Defense Q1
Sales in the quarter of $156 million were 17% higher than last year, driven by huge growth in our defense sector. Sales into the defense market were up across all our major business lines including missiles, vehicles, components and security. Sales into missile applications were up over 40% as production programs continue strong and activity on funded R&D programs for the next generation of missiles increased. Sales on our new turret system, the Reconfigurable Integrated weapons Platform or RIwP, of $9 million were up from $2 million a year ago. Finally, security sales were higher, driven by our acquisition of Electro-Optical Imaging last year and the emerging demand for more effective drone detection systems.
Sales into the Space market were up 2%. We saw increased activity on launch vehicle systems and strong avionics sales, but work on NASA advanced missions was down from last year.
Space and Defense fiscal ‘19
We’re leaving our forecast for the year unchanged. We anticipate full year
sales of $680 million, up 17% over last year. This sales total is a combination of approximately $220 million in the Space market and $460 million in the Defense market.
Space and Defense Margins
Margins in the quarter of 11.8% are in line with our forecast for the year. However, they are down slightly from last year as the work load shifts from mature production programs to funded development and growth in newer production programs. For the full year, we’re keeping our margin forecast unchanged at 11.8%.
Industrial Systems Q1
Sales in the quarter of $220 million are up 2% from last year. Sales were relatively flat across most markets, with some shift in the mix between end applications. The 2 biggest movers in the quarter were increased sales of about $10 million from our motors acquisition in the Czech Republic last year offset by about $10 million of lost sales as a result of our exit from the wind pitch control business. Sales into simulation & test applications were slightly lower than a year ago but sales into medical applications were slightly higher. In general, our industrial businesses continue to show strong performance and our book to bill remains healthy, supporting our forecast for increasing sales as we move through the year.
Industrial Systems fiscal ‘19
As with the other operating groups, we’re keeping our full year sales forecast unchanged from last quarter, at $930 million. Close to half of the sales are to industrial automation customers, with medical about a quarter and the balance divided equally between energy and simulation & test.
Industrial Systems Margins
Industrial margins in the quarter of 12.6% were up nicely from 9.2% last year. Our exit from the wind business combined with a better mix and the absence of some one-time charges in last year’s first quarter account for the improvement. In addition, we sold a small product line in the quarter which contributed just over 100 basis points of operating margin. For the full year, our margin forecast is unchanged at 12.0%.
We’re pleased to get off to a good start in Q1. Sales were up 8%, supporting our target of 6% sales growth for the full year. EPS was up 25% at the high end of our guidance, operating margins expanded 100 basis points, and free cash flow was in line with our expectations. Our defense businesses are very strong across the board. The F-35 is our largest military production program, and our missiles, vehicles and security businesses are all growing. Defense spending in the US looks poised to continue strong for the next couple of years and we believe we’re well positioned to capitalize on the future needs of the armed forces. Across all our product markets, we’re engaged in funded development work for the next generation of planes, vehicles and missiles. Indeed, our major challenge today is not winning new development programs, but rather finding the talent required to realize all the opportunities.
Our commercial book continues to mature, with R&D coming down, production programs continuing strong and the aftermarket growing. This year we’ll see the Embraer E-2 sales start to ramp up, and both the 787 and A350 will have higher sales than last year. Our focus across the portfolio continues to be on operational excellence.
Finally, our industrial business is much stronger this year as a result of our decision to exit the wind pitch control business a year ago. Each of our sub-markets is healthy and our book to bill remains positive. However, political uncertainty in the US, the government shutdown, Brexit and tariffs continue to weigh on sentiment. There seems to be a general consensus that we’re in the late stages of the present expansion with differing views about when we will see a slowdown. Recent news suggests growth in Europe, and Germany in particular, as well as growth in China is slowing while the US continues to show signs of strength. Our industrial business is a global business and is affected by growth in all the major markets around the world. Typically, a slowdown at our industrial customers lags a GDP slowdown by about 12 months, so we’re comfortable that fiscal ’19 will remain solid but are more cautious about what fiscal ’20 might bring.
Taken all together, we believe the diversified nature of our portfolio across defense, commercial and industrial should give our investors great confidence in the overall performance of our business looking into the future.
There are always upside opportunities and downside risks associated with our forecast. As we close out our first quarter, I believe there are opportunities for further gains in our defense business, although the availability of talent is a potential constraint on further growth. I think we’re not alone in this challenge with record low unemployment in most of our major markets. It’s a good problem to have. On the risks side, the longer-term industrial outlook is a little cloudy, mostly the result of political turmoil driving economic uncertainty. The optimist in me would hope that when we report on Q2 in 90 days, the government shut down will be long over, there will be a sensible Brexit strategy, and the trade dispute with China will have been resolved. As always we try to provide the market with a forecast which balances these pluses and minuses.
Our forecast for the year is holding firm, with sales growth of 6% and earnings per share of $5.25. For the second quarter, we expect earnings per share of $1.25, plus or minus 10 cents.
Now let me pass you to Don who will provide more details on our cash flow and balance sheet.
Thanks, John. And good morning, everyone.
Free cash flow in the first quarter was $40 million, or a conversion ratio of 90%. So, we’re off to a good start in what is traditionally a softer quarter. We’re forecasting $185 million of free cash flow for all of 2019, or a conversion ratio of 100%, unchanged from last quarter’s forecast.
Net Working Capital (excluding cash and debt) as a percentage of sales at the end of Q1 was 25.6% compared with 24.9% last quarter and with 26.7% a year ago. The adoption of the new accounting standard for revenue recognition inflated this ratio in Q1 of 2019 by about 70 bps. Excluding the impact of the new standard, these comparisons would have been a bit more favorable. Over the better part of the last decade, we’ve reported a rather steady decline in this working capital metric since we peaked at almost 34% of sales in 2009. Throughout the balance of 2019, we believe we’ll see a modest continuation of this trend despite the upward pressure on this metric from our growing businesses.
The $40 million of Free Cash Flow for Q1 compares with a decrease in our net debt of $30 million. The $10 million difference relates primarily to the payment of our quarterly dividend.
Capital expenditures in the first quarter were $24 million and depreciation and amortization totaled $22 million. For all of 2019 we’re forecasting $95 million of CapEx with D&A of $89 million, unchanged from three months ago. We believe that our normal, sustaining level of CapEx is between 3% and 4% of sales. In 2019, our spend rate will be within that range.
Cash contributions to our global retirement plans totaled $8 million in the quarter, comparatively low due to last year’s strategy of accelerating contributions to fully fund our U.S. DB Pension Plan. For all of 2019, we’re planning to make contributions into our global retirement plans totaling $34 million, unchanged from our forecast three months ago. Global retirement plan expense in Q1 was $15 million compared with $14 million in 2018. Our expense for retirement plans for all of 2019 is projected to be $62 million, an increase over the prior year’s $57 million.
Our Q1 effective tax rate of 24.3% compares with our forecast for all of 2019 of 26.0%. The lower rate this quarter is due to the utilization of tax loss carryforwards associated with a gain on a divested business. Last year’s Q1 tax rate of 97.3% reflected the significant effect of the Tax Cuts and Jobs Act that was enacted during that quarter. Excluding the one-time effects of the Tax Act, last year’s adjusted Q1 tax rate was 24.8%.
Our leverage ratio (Net Debt divided by EBITDA) was 2.1x compared with 2.2x
three months ago and with 1.9x a year ago. Net debt as a percentage of total capitalization was 36%, down from last quarter’s 38%, but up from 32% a year ago. The increase from twelve months ago largely reflects last year’s funding strategy for our U.S. DB Pension Plan. At quarter-end, we had $499 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2021. And our $300 million of 5.25% high-yield debt matures in 2022.
Twelve months ago, at the end of December 2017, we had just under $400 million of cash on our balance sheet. Most of that cash was offshore. At the end of December 2018, our cash balance was down to $111 million. Changes related to the December 2017 Tax Act allowed us to repatriate much of our offshore cash, resulting in the precipitous drop. Most of the decrease was used to pay down our outstanding Revolver debt, while some was used for an offshore acquisition. As far as the associated interest savings from paying down our debt, it won’t be apparent on our P&L in 2019. Interest expense for 2019 is forecasted to increase to $37 million compared with $36 million in 2018 because of higher interest rates on lower borrowings. Interest expense in Q1 was $10 million.
There are two accounting changes that we adopted beginning in 2019 that don’t have a material impact on the comparative numbers. First, as I mentioned earlier, we adopted ASC 606 for Revenue Recognition. There are plenty of footnote disclosures in our 10-Q that will be filed later today providing you with more details. But the effect on our comparative numbers is not material. This rather uneventful end-result masks the massive effort that occurred behind the scenes over the last two years. Our dedicated Moog team who has made this transition appear seamless deserves a huge shout-out.
The second accounting change affects the presentation of pension expense. We’re now showing “non-service related pension costs” below the operating profit line. This “below the line” element of pension expense was $3 million in Q1 of 2019 compared with $2 million in last year’s first quarter.
Lastly, Capital deployment. We’ve previously shared that our target leverage is between 2.0x and 2.5x (Net debt divided by EBITDA). We’re within our target range at 2.1x levered at the end of Q1, and with strong free cash flow forecasted for 2019, we’ll be below our target range by the end of the year, everything else unchanged. Over the last couple of years, we’ve acquired a couple of smaller acquisitions which are doing well. We continue to see a lot of M&A pipeline activity. However, we remain disciplined and patient.
As John described, we’re off to a solid start to 2019 and we’re looking forward to a successful year with our continuing focus on strategic growth, margin improvement and strong free cash flow.
With that, I’d like to turn you back to John for any questions that you may have.