Second Quarter Conference Call, Fiscal Year 2013

April 26, 2013

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 26, 2013, our most recent Form 8K filed on April 26, 2013, 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

Introduction - John Scannell

Good morning.  Thanks for joining us.  This morning we’ll report on the second quarter of fiscal ‘13 and update our guidance for the full year.  Sales, earnings and earnings per share are all up this quarter, so the news is generally good.  However, fiscal ’13 looks like it will continue to be a challenging year and we are taking further action to ensure we meet our operating goals for  this year and position ourselves for a stronger 2014.  Let me start this morning’s call with the major items of interest and then move to the numbers. 


The headline story this quarter is strong Aircraft sales & margins compensating for lower Industrial sales & margins.  The Aircraft segment had a strong quarter.  The military business is holding steady and the commercial business is growing.  Margins continue to improve as our sales grow and our operational initiatives bear fruit.  We are anticipating continued strength for the remainder of this year.  On the other hand, our industrial business continues to struggle with weak demand in many of our major markets.  We are in the middle of a restructuring effort to align our costs with our projected sales level and are focused on positioning ourselves for double digit margins in this segment in 2014. 


Since our last call, sequestration has gone from a threat to a reality.  So far, we have not seen a direct impact on our business that we can clearly attribute to sequestration.  We are paying particular attention to our military aftermarket which has shorter lead times than our OEM business.  This aftermarket business has enjoyed significant growth over the last few years as we have expanded our scope of supply and built cooperative arrangements with many of the US military depots.  We think that sequestration could have a disproportionate effect on fleet maintenance and upgrades which could affect this portion of our business.  We are optimistic that our military aftermarket should be OK in 2013, given our backlog and short term visibility.  Any measurable impact would likely be felt in 2014.  We are working hard in this market to expand our footprint, evidence the growth over the last 2-3 years.  We are hopeful that these initiatives will mitigate the longer-term effects of slowing defense spending.  For our production programs we believe 2013 will also hold up and are waiting to understand more about the impact in the following years.  We are already taking action to trim our overhead costs in anticipation of tougher times ahead.  In our next quarterly conference call we will provide initial guidance for 2014 and at that stage we will give you an update on how we are factoring sequestration into next year’s numbers. 

Looking to the second half of 2013, we think our sales will be somewhat lighter than our forecast from 90 days ago.  Excluding the effect of acquisitions, our organic sales in fiscal ’13 will be down about 2% from our January forecast.  Our industrial markets continue to be soft and we are moderating our defense outlook slightly.  In light of these trends, we are intensifying our restructuring efforts to position ourselves for 2014. 

Now to the numbers.

Q2 Fiscal ‘13

Sales in the quarter of $643 million were up 3% from last year.  Sales growth in commercial aircraft balanced the sales decline in our Industrial segment.  Acquisitions contributed $29 million of additional sales.  So, as I said in my opening, it is a story of strong commercial aircraft compensating for weaker industrial markets, with growth coming from acquisitions.  Net earnings of $37 million were up 3% and earnings per share of 80 cents were up 4% from last year.  Taking a look at the P&L, our gross margin is up nicely.  R&D is significantly higher, driven by the continued spend on major aircraft programs.  We incurred $2 million of restructuring in the quarter, the equivalent of 3 cents per share, but interest expense is down a similar amount.  SG&A as a percentage of sales is in line with last year.  Taxes came in slightly lower than last year.  The result was a net margin of 5.7% and, as I mentioned, earnings per share of 80 cents.  

Fiscal '13

We are moderating our sales forecast for the year by $26 million compared to our guidance 90 days ago.  The major drivers are lower industrial sales and a slightly softer defense outlook.  Aircraft sales will be $11 million lower, mostly the result of slower sales in our navigation aids business.  Space & Defense will be down $13 million, spread across their 3 markets – space, defense and security.  We estimate that Industrial will be about $10 million lower on weaker wind and industrial automation sales.  Components will be $12 million higher because of the addition of acquisition sales.  Finally, Medical will be about $5 million lower, reflecting the run rate of the first half.  

The good news is that our underlying businesses continue to perform well, despite the lower sales forecast.  Excluding restructuring, our EPS forecast for the year is in the range of $3.55 - $3.65.  Last quarter we estimated a total of $4 million in restructuring this year, but given the softening sales outlook, we are increasing that total to $11 million, or 15 cents per share.  So, including restructuring, our EPS for the year should be in the range of $3.40 - $3.50/share. 

We are often asked what we see as the risks and opportunities associated with our forecast.  On the risk side, I would say that we may not yet have found the bottom in the present industrial cycle, and that sequestration could bite sooner than fiscal ’14.  On the opportunities side, our aircraft business could continue to strengthen and we could see a bounce back in industrial demand.  As always we try to provide a forecast which balances these pluses and minuses. 

Now to the segments.  I would remind our listeners that we have 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. 

Aircraft Controls

Aircraft Q2

Q2 was another good quarter for this segment.  Total aircraft sales were up 10% to $259 million.  90% of the growth was in our commercial OEM sales, with sales to Boeing up over 40% from last year.  787 sales were up almost 70% as we continued to ship product to Boeing’s original production plan, unchanged by the 787 grounding.  We also saw a nice pick up in our business jet sales.  The commercial aftermarket was about flat with a year ago. 

In the military market sales were up marginally from last year.  Our OEM business was off about 5%, mostly the result of the timing on F-35 production sales.  This should correct in the coming quarters.  We had some other puts and takes with some domestic programs a little weaker balanced by slightly stronger foreign sales.  The military aftermarket was up nicely in the quarter, also driven by better foreign military sales.

Aircraft Fiscal 13

We are reducing our sales forecast for the year slightly.  The primary driver is weaker sales in our navigation aids business.  We had anticipated some additional contract awards in this business unit in fiscal ’13 which we are no longer planning.  Overall, we are reducing our military sales forecast by $11 million or about 2%.  We are keeping our commercial forecast unchanged from 90 days ago.  We are tweaking the mix a little.  We think sales to Boeing will be slightly higher, while sales to Airbus will be slightly lower. 

Aircraft Margins

Margins in the quarter were 12.2%, in line with the first quarter.  Higher sales and a nice mix drove the improvement over last year.  The margin performance was particularly impressive given the relatively high R&D load this quarter.  R&D was up nearly $5 million from our first quarter.  We had higher R&D on the A350 as well as significantly higher costs on the 787-9 program.  We will be reimbursed for the 787-9 development work but, because of the way the contract is structured, the reimbursement shows up on the gross margin line.  We had previously expected it would be classified as an R&D credit.  Development work on the 787-9 will continue for the next 3-4 quarters and, combined with the higher run rate on the A350, our R&D line is likely to stay elevated for the remainder of this fiscal year before trailing off in 2014.  Despite the higher R&D load, our aircraft business continues to perform well.  Given our strong showing in the first half we are increasing our margin forecast for the year to 12.2% after restructuring, or 12.4% before restructuring.

Space and Defense

Space & Defense Q2

Sales in the quarter were up 18% from last year to $106 million.  The growth is all a result of our 2 recent acquisitions, In Space Propulsion and Broad Reach Engineering.  Each of these acquisitions contributed $11 million in sales in our second quarter.  Factoring out the effect of these acquisitions we see that our legacy space business is down 12% from last year, our defense business is marginally lower and our security business is about flat.  The space market is coming off a strong 2012.  In addition to a general slowdown, we saw some mix changes across the program portfolio.  Of note is the reduction in sales on the common TVC program as the development phase winds down and the production phase has not yet ramped up.  In the defense market our tactical missile business remains strong, while our armored vehicle and submarine businesses were slightly lower.  In the security market sales are in line with last year.  Previous comparisons of this sector were dominated by the effect of slowing DVE sales, an effect which is now essentially behind us. 

Space & Defense Fiscal 13

For the year, we are moderating our sales forecast by $13 million to $420 million to reflect some of the softness we saw in the first half.  We are reducing our space forecast by $3 million, our defense forecast by $6 million and our security forecast by $4 million.  Despite the reduction in our full year forecast, we are still anticipating a pickup in sales in the second half as a result of acquisition sales, additional launch vehicle work for NASA and common TVC and increased tactical missile sales. 

Space & Defense Margins

Margins in the quarter were soft at 7.3%.  There are several reasons.  First, our acquisitions drove all the sales growth, and more, but did not contribute any margin this quarter.  Our legacy sales were actually down 6% from last year.  Second, we encountered a technical challenge on a space program this quarter and took a reserve of $2 million, or 200 bps, to cover the future costs to fix this issue.  Finally, our space margins tend to fluctuate quarter to quarter as the mix of development and production programs shifts.  In this quarter we had fewer higher-margin production jobs than last year.  We believe the second half will be much stronger and, despite the lower sales forecast, we are keeping our margin forecast for the full year unchanged at 10.3%.  

Before I leave this segment, let me offer a longer term perspective on our strategy in the space market.  Over the last 18 months we have made 3 acquisitions in this market, almost doubling our sales run rate.  Unfortunately, over the same period the market for our space components has softened a little, tempering our profitability.  Historically, space has been a great contributor for our company.  However, our space business tends to be cyclical, a combination of market dynamics and the mix of development and production programs we are involved in at any particular time.  Looking past the short term cycles, it is a great business for us, with high barriers to entry and limited competition for specialized components.  We believe our recent moves to expand our scope of supply and broaden our geographical footprint, put us in an excellent position to continue our growth trajectory in this market and deliver double digit profitability over the long term. 

Industrial Systems

Industrial Systems Q2

Sales in the quarter of $144 million were 14% lower than last year.  Sales were also down slightly from our first quarter total of $148 million.  The good news, however, is that our incoming order rate picked up in the quarter and we hope to see moderately improving sales in the second half. 

Sales in Energy were 27% lower than last year.  The decline is in our wind energy business which remains a challenge.  In this quarter we saw continued weakness in China as well as a slowdown in Europe and the US.  We continue to consolidate our activities around the globe and reduce our cost basis.  The wind OEM’s are struggling with over capacity and slowing demand, and we are riding that roller coaster with our customers.  Turning to industrial automation we continue to see a slowdown in most of the major industrial markets we serve, including plastics, metal forming and steel mills.  The slowing in Europe has persisted this quarter, although our incoming order rate has improved over the first quarter.  Our test & simulation business was down slightly in the quarter, the combination of higher simulation sales and lower test sales.  

Industrial Systems Fiscal 13

We continue to look for the bottom in our industrial forecast for the year.  Last quarter we projected the year at $600 million, more or less in line with the run rate of the first quarter.  Given the weaker second quarter, we are now reducing our forecast for the year slightly from $600 million to $590 million.  The adjustments downward are in our wind forecast and our industrial automation forecast. 

Industrial Systems Margins

Margins in the quarter were 5.4%.  Exclusive of restructuring, margins were 6.6%, 50bps higher than the first quarter, despite the lower sales.  Last quarter we reported that we had developed a restructuring plan to align our cost structure with our sales projection.  We were planning for a restructuring charge of $4 million in 2013.  Given the global nature of our industrial business, restructuring actions typically take longer to execute than is normal in our other businesses.  We booked about $2 million in restructuring in the second quarter.  Given the continued weakness in the business, we now believe we will need to take additional action to position ourselves for a stronger 2014.  Therefore, we are increasing our anticipated restructuring costs in our Industrial segment for the year from $4 million to $9 million.  We should start to see the benefit of these activities in the second half.  For the full year, we are anticipating margins of 8.8% before restructuring and 7.2% after restructuring. 

Let me finish our Industrial segment with some further thoughts on our wind business.  You may remember that we entered this business in fiscal ’08 with the acquisition of Lti – a German company which provided electric pitch control systems for wind turbines.  The first couple of years were great, but in the last 3 years our business has declined as the industry has consolidated and demand has waned.  With the benefit of hindsight, our timing for getting into this market was not great – however hindsight is always 20/20 and the more relevant question, I think, is whether we believe the wind business is a good business for us to be in long term.  We believe it is. 

Many of you have heard me describe our company as the supplier of choice “When Performance Really Matters”.  We believe that we deliver superior value in applications where performance, reliability and durability are key.  In these applications, the cost of a component failure is usually far higher than the cost of acquiring that component so a premium is put on performing first time, every time.  This is where we excel.  When we look at the wind business, we believe the opportunity fits our profile. 

Despite the challenges in the business, the market is growing and it is here to stay.  It is slowly settling down as the over capacity which was built up over the last decade is reduced.  We are starting to introduce new products which we believe will put is in a better competitive position and allow us to capture market share.  I have no doubt that the coming couple of years will continue to be challenging, but longer term, I believe this will be a great business for us. 

Components Group

Components Q2

Another solid performance from our Components Group with sales up 3% to $99 million.  The growth was in our non-A&D markets, which were 5% higher than last year.  The strength was all in the energy category where our off-shore exploration business continues to flourish.  Our recent Tritech acquisition has helped bolster our position in this market and we continue to win new applications for our technology.  Our medical sales were about flat with last year and our industrial component sales were down reflecting the weakness we have seen in our broader industrial segment.  Our A&D businesses were flat with last year in both the aircraft and space & defense categories. 

Components Fiscal 13

We are increasing our forecast from 90 days ago by $12 million to reflect the recent acquisition of Aspen Motion Technologies.  This sales increase all shows up in our industrial category. 

Components Margins

Margins in the quarter of 15.5% were healthy and in line with the long-term average for this business.  For the year, we are moderating our margin forecast slightly to 16% to reflect the effect of the higher sales due to the Aspen acquisition. 

Let me finish this segment with a word on our acquisition strategy in Components.  Over the last 12 months, we completed 3 acquisitions in this segment.  In March of 2012, we acquired Protokraft, a niche supplier of ruggedized connectors to the aerospace industry.  In August we acquired Tritech, a supplier of sonar components used in off-shore energy exploration.  Last month we acquired Aspen Motion Technologies, a supplier of small motors and controls for industrial applications.  Each of these acquisitions are extensions of existing product ranges, and expand our footprint in established markets.  Our other segments are organized around end markets, and our acquisitions have been market focused.  In contrast, our Components acquisitions have been more product focused – expanding our product portfolio across multiple markets.  We believe we have developed a capability to integrate bolt on Component acquisitions very profitably and will continue to find opportunities to grow this business. 

Medical Devices

Medical Q2

Sales in the quarter of $35 million were in line with last year.  It seems our business has settled down into a pattern of fairly consistent sales quarter over quarter.  We are seeing shifts in the mix from one quarter to the next.  In this quarter we had higher pump sales compensating for lower set sales. 

Medical Fiscal 13

We are moderating our forecast for the year to reflect the run rate of the first half.  Sales for the year should be $141 million. 

Medical Margins

Operating profit in the quarter was $1.3 million, in line with the average margin of 4% of the last 5 quarters.  We anticipate slightly higher margins in the second half as a result of some cost reduction activities, to give full year margins of 5%.   

Summary Guidance

Q2 was a solid quarter despite the industrial headwinds.  We are engaged in cost controls and restructuring activities across the company to mitigate the impact of lower industrial sales and the moderating defense outlook.  We are anticipating a benefit from these activities as we move through the second half of the year and into fiscal ’14.  For 2013, we are projecting sales of $2.59 billion, up 5% from last year.  All of the sales growth is coming from acquisitions completed in the last 12 months.  Our operations should deliver earnings per share in the range of $3.55 to $3.65, but we will incur a total of 15 cents per share in restructuring which will reduce that range to $3.40 - $3.50/share for the year.  Sales in the second half will be $60 million higher than the first half, and we should see a pickup in earnings in both our Industrial and Space & Defense segments.  Industrial operating profit will be up as the cost base comes down while Space & Defense operating profit will be up on higher sales and a better mix.  Post restructuring, we are anticipating EPS of 90c in Q3 and $1.00 in Q4. 

Now let me pass you to Don who will provide some color on our cash flow and balance sheet.   

Cash Flow and Balance Sheet - Don Fishback

Our free cash flow during our second quarter was a positive $39 million while our net debt increased by $60 million to $667 million primarily related to M&A activity.  We spent $77 million on the acquisitions of Broad Reach Engineering and Aspen Motion Technologies during the quarter.  For the first six months, our free cash flow is $45 million, about where we expected to be after a slow first quarter.  We’re leaving our free cash flow forecast for all of fiscal 2013 unchanged at $135 million, resulting in a cash flow conversion ratio of 85%.

Since we had a reasonable amount of M&A activity in the quarter, I’d like to dive a little deeper on acquisitions for a moment.  The Space and Defense group closed on the Broad Reach Engineering Company on the first day of our second quarter, December 31st.  They are located in Golden, CO and are a leading designer and manufacturer of spaceflight electronics and software for aerospace, scientific, commercial and military missions in addition to supporting ground testing, launch and on-orbit operations.  We’re forecasting $32 million of sales for Broad Reach for the nine months that we’ll own the business in fiscal 2013.  Aspen Motion Technologies was acquired by our Components group on March 21st.  Aspen is located in Radford, VA and John described them as a supplier of small motors and controls for industrial applications.  Aspen will contribute sales of $20 million for the six months that we’ll own them in fiscal 2013.  Strategically, we continue to look for acquisition targets that enhance our competitive technical, product or market positions.  We think both of these acquisitions will contribute nicely to this strategy.  Over the past four quarters, we’ve spent $150 million on acquisitions which will generate a comparable dollar amount of first year revenues.  We are confident that each of these will be strong top-line and bottom-line contributors in the coming years.  Our recent pace of acquisitions is relatively consistent with our average historical dollar volume of M&A deals and complements our organic growth.

Turning to our financing strategy, we had a couple of refinancing events that I think are worth mentioning.  First, on January 15th we closed on the redemption of the $200 million of our 2015 High Yield bonds that became callable without any market premium on that day.  We effectively exchanged 6¼% debt for 1¾% money through our revolving credit facility.  Second, on March 28th, we closed on a modification to our revolving credit facility by extending the term of the revolver by two years to 2018 and modifying the pricing grid in our favor by an eighth of a point.  It was a great effort led by our Treasury team in concert with our valued bank group.

Regarding the balance sheet, receivables are up $26 million from last quarter to $770 million largely due to the timing of receipts at quarter-end, and inventories increased $7 million over the last three months to $559 million principally related to the Aircraft group’s continued production ramp-up.  Customer advances increased during the quarter by $5 million to $123 million, and loss reserves were up $1 million from the prior quarter.

Capital expenditures in the quarter were $23 million and depreciation and amortization totaled $27 million.  Year to date, capital expenditures were $45 million while D&A was $53 million.  We’re sticking with our forecast from last quarter for CapEx for all of fiscal 2013 of $105 million and we’re moderating our D&A forecast to $111 million.

Cash contributions to our global defined benefit pension plans were consistent with our previous projections.  We contributed $11 million in the quarter and $20 million for the first six months of the year.  For all of fiscal 2013, we’re forecasting pension contributions of $39 million. 

Our effective tax rate in the quarter was 26.9%, down from last year’s 28.9% primarily related to the retroactive reinstatement of the R&D tax credit for three-quarters of our last fiscal year.  We are now forecasting our effective tax rate for all of fiscal 2013 to be 29.5%, down slightly from our forecast of 30.0% from three months ago.  This compares with last year’s full-year tax rate of 27.0%.  The increase, this year over last year, is mainly due to an adjustment made last year to a deferred tax asset valuation account at one of our foreign operations that won’t repeat this year, in addition to a less favorable mix of global taxable earnings. 

Our financial ratios at the end of the quarter were very respectable, even after considering the two acquisitions that we completed during the quarter.  Net debt as a percentage of total capitalization was 32.8%, about the same as last year’s 32.7%.  Our leverage ratio (Net Debt divided by EBITDA) is now 1.86x, and we currently have $372 million of unused capacity on our $900 million revolver that terms-out in 2018.  This is down from last quarter-end’s availability of $583 million primarily because we used the revolver to finance the redemption of the High Yield bonds.

Our forecast for interest expense for fiscal 2013 is now $28 million, down a bit from our last forecast because of the financial engineering that we completed during the quarter.

We continue to focus on improving our operating margin performance in a very challenging environment that includes uncertainty surrounding sequestration and a soft, global industrial business.  We’ve been managing our cost base down to correspond with the declining Industrial sales outlook and we’re trying to stay ahead of what is likely to be a softening defense outlook.  We’re working on a number of restructurings throughout our global company resulting in significant restructuring charges forecasted for this year.  As John stated, we’re planning to come out of 2013 in much better shape compared to our first half, which will result in a solid foundation for improved margin performance as we head into 2014.

Now, I’ll turn you back to John for any Q&A. 

(The Q and A is not available.)