Fourth 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 November 1, 2019 our most recent Form 8K filed on November 1, 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 fourth quarter of fiscal ’19 and reflect on our performance for the full year. We’ll also provide our initial guidance for fiscal ’20.
As usual, I’ll start with the headlines for the quarter.
• First, we had several noteworthy events for our flight control systems at our key customers, including the 1st deliveries of both the Embraer E195-E2 and Gulfstream G600 as well as the first flight of the Boeing MQ-25.
• Second, it was another good quarter for our operations with sales up 9% and earnings per share of $1.31 at the higher end of our guidance.
• And third, cash flow was soft as we continue to grow, invest in capex and acquire buffer inventory to safeguard our customer deliveries.
Looking back over all of fiscal ’19, the following headlines stand out.
1) First, it was a record year for our business in terms of sales and earnings per share. Over the last 2 years, our business has grown 16% organically after several years of flat sales.
2) Second, our defense portfolio was very strong this year with growth across all our major programs and continued investment in the platforms of tomorrow.
3) Third, it was a busy year for the acquisitions that didn’t happen. We continued to look actively, while remaining disciplined in terms of pricing and fit. Our focus is on good growth rather than growth at any cost.
4) Fourth, we suffered a supplier quality issue early in the year in our aircraft business. This taught us that some of our operational processes were not as robust as they need to be. As a result, we began a multi-year investment program to upgrade our processes to what we are now calling Operations 2.0.
5) Finally, we’re providing a first look at fiscal ’20 today. We’re projecting sales of $3.0 billion up 4%, and 40 basis points of operating margin expansion, including a significant recovery in our aircraft margins. Despite the headwind of a higher tax rate, our earnings per share will be up 9% to $5.55, plus or minus 20 cents.
Overall, fiscal ’19 was a good year for our company. As always, it played out a little different from what we anticipated going into the year, but our diversity across end markets helped us meet our goals. As I do at this time each year, I would like to express my thanks for the dedication and commitment of our 13,000 employees around the world who made this all happen.
Now, let me provide some more details on the quarter.
Sales in the quarter of $765 million were 9% higher than last year. Sales were up double digits in both Aircraft and Space & Defense, while sales in Industrial Systems were slightly lower. Taking a look at the P&L, our gross margin was down on an adverse mix in our aircraft business and some one-time charges we took this quarter. R&D was also lower as our spending in Aircraft continued to moderate. SG&A expense was slightly higher as a % of sales on increased investments in new business development and some consulting expenses. Interest expense was about flat with a year ago. Our effective tax rate in the quarter of 21.3% resulted in net earnings of $46 million and earnings per share of $1.31, up 15% from last year.
For the full year, sales of $2.90 billion were 7% higher than last year. The story for the year is similar to the story for the quarter with sales up nicely in Aircraft, very strong in Space & Defense and moderately lower in Industrial Systems. Foreign exchange headwinds reduced the sales growth by almost 100 basis points. Operating margins were up slightly from fiscal ’18 after adjusting for our exit from the wind business. Adjusted net earnings were up 9% and adjusted earnings per share were up 12% on a lower share count. Free cash flow for the year was$63 million.
For fiscal ‘20 we’re projecting continued organic growth with sales of $3 billion, up 4% from fiscal ’19. The sales growth is primarily driven by our Space andDefense group with sales in Aircraft up marginally and Industrial sales flat. We’re anticipating full year operating margins of 11.5%, up 40 basis points, and earnings per share of $5.55, plus or minus 20 cents. Free cash flow will recover from FY’19 to a conversion ratio of 80% for the full year.
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 $342 million were up 12% from a year ago, driven by strong commercial OEM results. Sales were up nicely on the 787 and A350 programs as well on the E-2 and on various Gulfstream jets. Sales into the commercial aftermarket were down on lower A350 IP and slowing activity on some legacy programs.
On the military side, OEM sales were up on increased V-22 and Blackhawk work as well as higher funded development activity. Military aftermarket sales were slightly lower than last year, a result of lower sales on various legacy platforms, partially compensated by higher F-35 sales.
Aircraft fiscal ‘19
Full year sales were up 9% from fiscal ’18 to $1.3 billion. On the commercial OEM side, strong sales on the 787, A350, E2 and Gulfstream business jets drove a 15% year over year increase. OEM sales on the 737 program were down $5 million for the year. Aftermarket sales were off 7%, mostly the result of lower A350 IP.
Military aircraft was up 9% with growth on both our OEM platforms and in the aftermarket. The F-35 program continued to ramp up production and sales were also higher on the V-22 and some foreign programs. Funded development of over $70 million in the year was in line with the prior year. In the military aftermarket, sales on the F-35 and V-22 were up strongly, compensating for lower sales on some legacy programs.
Aircraft fiscal ‘20
We’re projecting fiscal ’20 sales of 1.33 billion, up 2% from ’19. We should see continued growth in our military markets with the F-35 driving both OEM and aftermarket growth. Across the broader military OEM portfolio, we anticipate that helicopter programs will be down from a very strong FY’19 but funded development programs should be up on continued investment in next generation platforms. In total, our military aircraft business will be up 7% in fiscal ’20.
On the commercial side, we’re forecasting moderating sales at both Boeing and Airbus. 787 sales should be in line with fiscal ’19 but we’ll see a significant drop in 777 sales as that program continues to wind down. We’re forecasting 737 sales more or less in line with this year. At Airbus, A350 sales should be lower as a result of some accelerated shipments in fiscal ’19. We’re also anticipating A380 sales to essentially drop to zero. E2 sales are forecast to almost double to $16 million, while business jet sales should be close to the level of this year. We anticipate the commercial aftermarket will be up slightly as the A350 fleet slowly emerges from the warranty period. Combining OEM and aftermarket, our commercial aircraft business in total will be down 3% next year.
Margins in the quarter of 8.2% included 3 unusual items. We made additional investments in operations consulting, incurred severance associated with continued reorganizations and took a charge associated with the termination of the A380 program. Taken together, these items depressed margins by about 200 basis pointsin the quarter. Margins for the year were 9.4%, down 150 basis points from fiscal ’18. As we’ve discussed in the past, the contraction was in the gross margin line as a result of operational challenges. During the year, we responded to these challenges by launching our Operations 2.0 program which includes a new organization structure, support from outside consulting and additional investments in capex. As we look out to fiscal ’20, margins will increase to 10.5% as the impact of our operational improvements take root and our gross margin starts to recover.
Space and Defense
Sales in the quarter of $190 million were up 23% from last year. We enjoyed growth in both the Space and Defense markets. Space sales were up 13% on strong launch vehicle activity, increased funding for hypersonic applications and work on the GBSD program. Defense sales were very strong – up almost 30% from last year. The growth was across the entire portfolio of defense markets with particular strength in missiles, vehicles and electrical components used in a wide variety of applications.
Space and Defense fiscal ‘19
Full year sales of $683 million were up 18% from last year. The strength was on the military side of the house with sales up almost $100 million from fiscal ’18.The biggest contributors to the growth were missiles, ground vehicles, naval applications and our general components business. Sales of our reconfigurable turret product were up $20 million over last year. On the Space side, sales growth of 2% masked some significant shifts in the mix. Sales of our avionics products were lower this year after a very strong fiscal ’18. Our NASA work was mixed with SLS work way down but Orion work way up. Finally, we had strong funded development sales for various hypersonics applications.
Space and Defense fiscal ‘20
Our forecast for fiscal ’20 projects another year of strong growth. Total sales of $770 million will be up 13% from fiscal ’19. After a fairly flat year in ’19, Space should be up 16% next year on strong growth in avionics, additional NASA work as we seek to return to the Moon by 2024, and continued work on hypersonic systems. On the defense side, we should also see nice growth across our portfolio led by vehicles, missiles and naval applications.
Space and Defense Margins
Margins in the quarter of 13.7% were particularly strong on higher sales and afavorable mix. For all of fiscal ‘19, margins of 13.0 % were also strong. For fiscal ’20, we’re expecting margins in line with fiscal ’19 at 13.0%.
Before leaving our Space and Defense group, I’d like to reflect on the recent performance of this business. In fiscal ’17, our Space and Defense group had $530 million in sales. In fiscal ’20, we’re forecasting $770 million - a 46% increase over 3 years. Space is up over 35% while defense is up over 50% - essentially all organic. Over the same time period, the group operating profit will double from $50 million to $100 million and operating margins will expand over 350 basis points. Growing defense budgets in the US have helped, but our success has been grounded in a combination of years of investment and a dedication to serving our customers with outstanding quality and delivery. As a result, we’ve been a preferred supplier across the markets we serve, winning market share and benefitting disproportionally as our customers’ businesses have ramped up.
Sales in the quarter of $234 million were 4% lower than last year. Adjusting for the lost sales associated with our exit from the wind pitch control business, sales were about even with last year. Strength in our medical market, across both pumps and components, was offset by slightly lower sales in both industrial automation and simulation and test. Sales into the energy markets were down slightly from last year, a combination of slightly higher exploration sales but lower sales of components into power generating equipment.
Industrial Systems fiscal ‘19
Full year sales of $918 million were 2% lower than last year, a result of weaker foreign currencies relative to the dollar. Underlying real sales were flat year over year, but with some notable shifts in the mix. Energy was way down on the absence of wind energy sales following our decision to exit that business in fiscal ’18. Sales into industrial automation were stable as global capital investment continued through the year. Sales of medical products were up on strong growth in our enteral pumps product line. Finally, sales into simulation and test applications were slightly lower. Included in this market are sales of motion bases for entertainment systems. These tend to be very lumpy and unpredictable. Fiscal ’18 was a strong year for entertainment sales while fiscal ’19 was a soft year.
Industrial Systems fiscal ‘20
We’re projecting flat sales for next year. We anticipate continued growth in our medical applications and slightly stronger sales of flight simulation systems. We’re forecasting energy sales will be more or less in line with fiscal ’19. Finally, we’re projecting industrial automation sales will be down 5% as global economies slow and capital investment spending contracts.
Industrial Systems Margins
Margins in the quarter were 11.1%. Full-year margins of 11.9% were up from last year as a result of our decision to exit the wind business. For fiscal ’20, we’re forecasting margins of 11.5%.
Fiscal ’19 was a good year for our company. Our plan for fiscal ’20 builds on that base with full year sales of $3.0 billion, up 4% organically. The growth is led by our Space and Defense group with strength in both markets. Aircraft sales in total will be up marginally, with good growth on the military side but slightly lowersales in our commercial book of business. Industrial sales will be flat with fiscal ’19 as growth in niche markets compensates for the slowing investment in industrial automation across the global economies. Free cash flow conversion in fiscal ’20 should recover to 80% of sales as our growth in net working capital slows and our operational improvements start to bear fruit. We’re forecasting earnings per share of $5.55 plus or minus 20c – a 9% increase over fiscal ’19. As always, our forecast does not include any projection for future acquisitions or share buyback activity.
As with any forecast, there are both opportunities and risks in our plan. In fiscal ’20, the major opportunity to do better lies in the pace of operational improvement in our aircraft business while the major risk is the potential slowdown in our industrial markets.
As we wrap up fiscal ’19 and look to a new year, we believe it’s helpful for our investors to look at our business through an end market lens. We’re organized in 3 operating groups but our business serves 5 major markets – defense, industrialincluding energy, commercial, space and medical.
Defense is our largest market with almost 40% of our sales. Two years ago, at the end of fiscal ’17, I commented that we’re coming out of a multi-year downturn in defense spending and were optimistic that fiscal ’18 might see increased budgets. Closing out fiscal ’19, the defense market has performed better than we could have imagined and we are set to see that strong performance continue this coming year. We’ve seen growth in almost every defense market we serve from aircraft to missiles to ground vehicles. Through the multi-year downturn earlier in the decade we continued to invest in our defense portfolio, a combination of R&D spending on new products, such as our reconfigurable turret, and investments in operational improvements. As we enter fiscal ’20 we have a full book of new development programs from next generation aircraft to hypersonic missiles. Our present production programs, combined with our strong development pipeline, gives us confidence that, despite the ups and downs in defense budgets, we’ll continue to prosper in the long-term.
Industrial is our second largest market where we serve a wide range of applications across many niche markets. This is a global business and, at a macro level, our fortunes move with the capital investment cycle of the major world economies. Coming into fiscal ’19 we anticipated a good year but worried about the impact of trade wars. The year played out pretty much as we expected although the outlook for the major economies has weakened from a year ago. Uncertainty around tariffs and Brexit have added to the challenges of continued expansion late in the economic cycle. We’re cautious about the outlook for the coming year but remain optimistic that lower interest rates, a resolution of Brexit and the potential of a trade detente with China as we approach an election year in the US could mitigate the potential slowdown in our business.
Commercial aircraft is just over 20% of our business. Fiscal ’19 saw strong growth in our major OEM programs and a modest slowdown in the aftermarket. Our flagship programs, the 787 and A350, will continue to be strong in fiscal ’20 while our legacy programs, particularly the 777 will slow. We’re anticipating the 737 Max situation will resolve itself early in 2020 and production rates will be in line with Boeing’s forecast. Our R&D spend in ’20 will be down to sustaining levels and we are not anticipating any major new development programs for the next couple of years. Overall, the focus in this business remains on operational excellence and, as execution improves, we’ll see our margins expand over time.
The Space business is strong, driven by increased defense spending and NASA’s plan to return to the Moon. After a modest increase in fiscal ’19 we’re anticipating strong growth as we move into fiscal ’20. Over the course of this coming year, our major investments will continue to be hypersonics and the GBSD program.
Finally, our medical market had another good year of growth in fiscal ’19 and we believe that growth will continue this coming year. In particular, our pump products had a strong year as we captured market share in the enteral market.
In summary, we continue to leverage our core controls technology successfully across diverse end markets where we solve our customers’ most challenging problems.
Our strategy remains unchanged. We work to create value for our customers by tailoring our product to meet their specific needs. Customer intimacy is at our core and we enjoy multi-generational relationships with most of our customers. When there’s a problem, we always seek to do the right thing by our customer, sometimes at the expense of short term financial results. We believe this is key to building a great company over time. We have a laser focus on our core technologies of motion and fluid control, but a wide lens on end markets which can benefit from our capabilities. We seek to be prudent stewards of our shareholders’ capital by maintaining a strong balance sheet and a disciplined approach to capital allocation. We believe growth is a core element of long-term value creation and continue aggressively to pursue adjacent acquisitions. However, we remain disciplined in terms of pricing and strategic fit. As a result we’ve walked away from many opportunities in the last year instead of overpaying. We have 3 corporate-wide internal initiatives around talent, lean and innovation. Our innovation spending is focused around 3 key themes which cut across all our major markets – electrification, autonomy and connectivity. In a year when we celebrated Moog’s contribution to the Apollo 11 Moon landing in 1969, we’re reminded of the very long-term nature of our business and the importance of continuing to invest for the future. Finally, our culture of trust and collaboration remains the corner stone of our business.
As we look to fiscal ’20, we’re optimistic about our business. Next year we anticipate sales of $3.0 billion and earnings per share of $5.55 plus or minus 20 cents. As usual, we expect a somewhat slow start to the year with Q1 earnings per share of $1.30 plus or minus 10 cents.
Now let me pass you to Don who will provide more color on our cash flow and balance sheet.
Thanks, John. Good morning.
Free cash flow in the fourth quarter was $25 million and for all of 2019, free cash flow was $63 million representing a conversion ratio of 35%. Growth in our businesses explains most of the soft free cash flow performance in 2019. We’ve had to support our topline growth with a corresponding increase in net working capital (where every sales dollar has a corresponding investment of about 25 cents in inventories and receivables) and the increased demand for CapEx spending is noticeable. As we’ve transitioned from a relatively stagnant period of topline growth from 2012 to 2017 to the more recent upward trend driven largely by our exposure to defense markets, the increased demand for capital in our businesses has been significant. Isolating these effects, we would have expected our free cash flow conversion for all of 2019 to be in the 75% range.
The rest of the story is the incremental growth in our physical inventories, some of which appears in “Unbilled Receivables”. Inventories have increased at a faster pace than our “normal” net working capital investment. This has been necessary to ensure we’re supporting our customers’ delivery demands while we’re working through our operational process investments that John referenced. With our current focus on upgrading our operations, we expect inventory turns to get slightly worse before they get better, with improvement starting in the latter part of 2020.
Despite the relatively soft 2019, our free cash flow conversion has averaged better than 100% from 2013 through 2019 while our topline revenues have grown 18% over the same period, most of that coming in the last two years. Our free cash flow conversion target remains 100% over time. For all of 2020, our free cash flow forecast is $155 million, or a conversion ratio of 80%. We expect a soft start to free cash flow in the first half of 2020. But as our processes around inventory management strengthen, we expect a good finish to the year.
Our year-end Net Working Capital (excluding cash and debt) as a percentage of sales was 27.9% compared with 24.9% a year ago. This largely reflects the growth in inventories that I’ve just referenced.
The $63 million of free cash flow for the year compares with an increase in our net debt of $4 million. The difference is mostly explained by our quarterly dividend payments and share buyback activity. During the fiscal year, we repurchased 302,000 shares for $23 million, 241,000 of which were acquired during our fourth quarter.
Capital expenditures in the fourth quarter were $27 million and depreciation and amortization totaled $21 million. For all of 2019, CapEx was $118 million while D&A was $85M. Capital expenditures in 2020 will continue to be at the high end of our historical spending range, or around $120 million which is 4% of sales. We are engaged in various facility expansion projects and we’re investing in machinery and test equipment to improve our operational efficiencies. Our normal, sustaining level of CapEx spend is between 3% and 4% of sales. Depreciation and amortization in 2020 is forecasted to be $86 million.
Cash contributions to our global retirement plans totaled $10 million in the fourth quarter resulting in $37 million of contributions for all of 2019. This compares with contributions of $181 million in 2018 when we fully funded our U.S. DB Pension Plan. For 2020, we’re planning to make contributions into our global retirement plans totaling $37 million. Global retirement plan expense in 2019 was $65 million compared with $57 million in 2018. In 2020, our expense for retirement plans is projected to be $70 million, up from 2019 largely related to lower discount rates.
Our Q4 effective tax rate of 21.3% is down from last year’s Q4 tax rate of 26.7% reflecting the absence of last year’s restructuring impacts in addition to lower state tax accruals in the U.S. For all of 2019, our effective tax rate was 23.1% compared with last year’s 47.4%. When we remove the one-time effects of Tax Reform and wind restructuring in 2018, our adjusted 2018 effective tax rate related to our core operations was 25.1%. For 2020, we’re forecasting our tax rate at 25.3%, up from 2019’s 23.1%. 2020’s tax rate assumes lower U.S. foreign tax credit benefits as the time-phasing of a provision in the 2017 tax law begins to negatively affect us, andreflects a less favorable mix of global earnings.
On October 15, 2019, our Treasury team closed on the refinancing of our $1.1 billion revolving credit facility, extending the term through October 2024. We’ve got 13 committed partners in our facility with competitive terms and conditions and we have a $400 million accordion feature providing us with the option to expand the facility. The other major piece of our debt financing is our $300 million of 5.25% high-yield debt that matures in December 2022.
Our leverage ratio (Net Debt divided by EBITDA) was 2.1x compared with 2.2x a year ago. With the recent modifications made during the October 2019 revolver refinancing, the revised leverage ratio would have been 2.0x at the end of fiscal 2019 as the definition of debt has been modified to exclude Letters of Credit. Net debt as a percentage of total capitalization was 35.9%, down from 37.6% last year. At year-end, we had $670 million of available, unused borrowing capacity under the terms of our updated revolver that includes an increase in permitted leverage of up to 4.0x (increased from 3.5x previously).
Regarding capital deployment, today we announced our quarterly cash dividend of $.25 per share payable to our shareholders. We continue to look at strategic M&A targets and we repurchase our shares opportunistically. As we reflect back on 2019, we’ve been engaged in a lot of M&A activity with not much to show for it. But we continue to exercise patience and discipline throughout our processes, looking for targets that fit well strategically, culturally and, of course, financially.
We’re excited to shift our focus to 2020 and beyond, continuing the trajectory of record sales and EPS. Sales will eclipse the $3 billion mark for the first time, up 4%. Our consolidated operating margins are forecasted to improve 40 bps to 11.5% with, importantly, our Aircraft margins improving 110 bps to 10.5%. Free cash flow will be respectable for a growing business with 80% conversion and finally, our EPS will be up 9% to $5.55 per share. It’s worth pointing out that our 2020 EPS forecast reflects higher pension costs of $5 million or about $.10 per share, and our 2020 effective tax rate is forecasted to increase 220 bps, or about $.15 per share, relative to 2019.
With that, I’d like to turn you back to John for any questions that you may have.
*Please note that the Q&A is not available.