Third 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 July 26, 2019 our most recent Form 8K filed on July 26, 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 third quarter of fiscal ‘19 and update our guidance for the full year. Our business continues to perform well and we remain on track to meet our full-year EPS target.
1) First, this month we celebrated the 50-year anniversary of the Apollo 11 Moon landing. Moog provided the thrust vector control actuation on all 3 stages of the Saturn rocket on that historic flight back in 1969. This was one occasion when “performance REALLY mattered”, and thanks to the ingenuity and dedication of the Moog staff at the time, everything worked perfectly. As I’ve said before, at Moog we play for the very long term and today, 50 years after the Apollo landing, we continue to work with NASA to develop the next generation of technology which will take humans back to the Moon in 2024.
2) Second – coming back to today – our Q3 was a record quarter for both sales and earnings per share. Sales were up 7% from a year ago and earnings per share of $1.35 were up 19% over last year.
3) Third, relative to our forecast, we had a shift in the mix of earnings in the quarter with the Space & Defense segment very strong, while the Aircraft segment was behind plan.
4) Fourth, free cash flow in the quarter was soft as investments in working capital and fixed assets accelerated in support of our growth.
5) Finally, despite the on-going uncertainty around global trade and Brexit, the outlook for our major markets remains healthy giving us confidence to affirm our guidance for this year and an optimistic outlook for next year.
Now let me move to the details starting with the third quarter results.
Sales in the quarter of $741 million were 7% higher than last year. Sales were up double digits in both Aircraft and Space & Defense while Industrial sales were off 5% as a result of our exit from the wind pitch control business. Taking a look at the P&L, our gross margin was about in line with last year while our operating expenses were about 70 basis points lower. Our R&D spend was the same as last year at $31 million resulting in operating margins of 11.4%, up 50 basis from Q3 ‘18. Earnings before taxes were up 12%. We had a lower tax rate this quarter, resulting in net earnings of $47 million, up 17%, and earnings per share of $1.35 up 19% over a year ago. Overall, a nice quarter for the company.
With one quarter to go, we’re keeping our sales and EPS forecast unchanged from 90 days ago, while adjusting the mix slightly between the groups. We think sales in Aircraft will be slightly ahead of our forecast from last quarter, while sales in both Space and Defense and Industrial will be slightly lower. We’re also narrowing our EPS range to plus or minus $0.10. In summary, we’re forecasting full year sales of $2.9 billion and full year EPS of $5.05, plus or minus $0.10.
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 $337 million were 12% higher than last year. We saw double digit sales growth in both our military and commercial books. On the military side, higher sales across the OEM book of business compensated for lower sales on the F-35 program. In particular, we had stronger shipments on some foreign platforms and various helicopter programs. The military aftermarket was up nicely in the quarter, led by our 2 biggest programs, the F-35 and the V-22.
On the commercial side, OEM sales were up across most of the portfolio. Sales to Boeing were up 11%, led by the 787. Sales to Airbus were way up, all driven by the A350 program. Business Jet sales were also higher on strength across the Gulfstream portfolio. The commercial aftermarket was down from a very strong Q3 last year on slowing initial provisioning (IP) sales, particularly on the A350.
Aircraft fiscal ‘19
We’re increasing our full year sales forecast by $24 million to reflect the strength we’re seeing in the back half of the year. On the military side, we’re keeping our full year sales unchanged but adjusting the mix by lowering the OEM sales by $10 million while increasing the aftermarket sales by the same amount. The net increase is all on the commercial side. We’re increasing our commercial OEM sales by $16 million, balanced across the portfolio. In addition, although the commercial aftermarket was down this quarter relative to a year ago, it’s running ahead of our forecast for this year so we’re adding $8 million to our projected aftermarket sales in FY19. Overall, we now anticipate full year sales of $1.29 billion, split 48% military and 52% commercial.
Margins in the quarter of 10.2% were below expectations. From 2017 to 2019, we’ve seen Aircraft R&D drop by about 300 basis points while other operating expenses remained more or less flat as a percentage of sales. We had anticipated we would see much of this gain drop to the bottom line – but we haven’t. The challenge has been in the gross margin line, where our expected productivity gains have not materialized. Over the last 2 years, as we’ve experienced various challenges at certain vendors and with our in-house manufacturing processes, we’ve addressed each one on an individual basis. We believed each challenge was an isolated incident and, as we addressed each one in turn, the margins would improve. Given the margin and cash flow results this quarter, we’ve concluded that our operational challenges require a new approach. We’ve decided to engage in a more structural program of work and make additional investments in our factories and supply chain processes to deliver long-term operational excellence. As such, we’ve reorganized the management of our aircraft operations and engaged outside consultants to work with our internal team to lay out a plan that will deliver sustainable improvements.
Our aircraft business remains very strong and has excellent long-term prospects. However, the investment we’re making to build a world-class operating model will constrain the pace of margin expansion that we had planned to deliver. In the short term, we’re moderating our full year fiscal ’19 margin forecast to 10%, down 60 basis points from our forecast 90 days ago. We believe our fiscal ’19 margin is a reset and looking ahead, our additional investment in operations will deliver gradual and sustainable margin improvements over the following years
Space and Defense
Sales in the quarter of $173 million were up 16% from last year. Similar to recent quarters, the defense side of the business continues to be the powerhouse. Defense sales were up 23% over the same quarter last year, with strength across the portfolio, particularly in missiles, vehicles and slip ring components for a variety of end applications. Sales for our new turret product doubled from the same quarter last year to $9 million. On the Space side, sales were up marginally, a combination of slightly higher launch vehicle and NASA work, compensating for lower satellite avionics sales.
Space & Defense fiscal 19
With one quarter remaining, we’re moderating our sales forecast in both our Space market and our Defense market by $6 million each, resulting in full year sales of $669 million. On the space side, our avionics product line is coming in a little softer for the year than we had anticipated, while on the defense side, the ramp up on our new turret product, the RIwP, is lower than we had planned as a result of delays in locking down the final product design. For the year, we now anticipate RIwP sales of $31 million, up from $15 million in fiscal ’18 and only $3 million in fiscal ’17. Despite the slower ramp, we continue to be very excited about the prospects for this new product.
Space and Defense Margins
Our Space & Defense group is delivering excellent margin performance this year. In the third quarter, margins of 14% were up almost 300 basis points from the same quarter a year ago. This quarter we had a very favorable mix which helped with the strong results. For the full year, fiscal ‘19, we’re increasing our margin outlook by 90 basis points to 12.7%.
Sales in the quarter of $231 million were down 5% from last year. Loss of sales from our wind pitch controls business drove the decrease. Looking across our 4 major markets, Medical was up 5% on higher sales of enteral pumps. Industrial automation and simulation & test were more or less in line with last year, withsome minor changes in the mix. Energy was down almost 30% from a year ago. Sales into energy exploration applications were about flat with last year, but in addition to the loss of the wind pitch business, we also had lower sales in energy generation.
Industrial Systems fiscal 19
We’re moderating our full year forecast by $12 million to $919 million. We anticipate sales into energy generation applications will be down from our forecast and that sales of components into medical applications will also be lower.
Industrial Systems Margins
Margins in the quarter of 11% were up 70 basis points from last year. For the full year, we’re keeping margins unchanged at 12.0%. This is up 110 basis points from an adjusted operating margin last year, excluding the wind exit charges, of 10.9%.
Overall Q3 was a good quarter for the company but with some swings in margin from what we had anticipated. Growth in both sales and margins in our Space andDefense segment compensated for operational challenges in our Aircraft segment. Our Industrial segment is more or less on plan. Overall, our major markets remain strong and we continue to look optimistically to the next few years.
Defense makes up almost 40% of our business in total and continues to be very vibrant. The F-35 program continues to ramp, we’re seeing increasing orders in the military aftermarket, and our missile and vehicle businesses are growing nicely. We have over $70 million of funded R&D for next generation military aircraft this year and next, and we’re investing in new growth platforms for remote turrets and counter drone systems. We believe as we look out to fiscal ’20 this defense business will continue to grow and deliver strong returns.
Our commercial book of business is healthy, although the growth is slowing from a few years back. The 787 is at rate and the A350 ramp is leveling out. Our business jet applications with Gulfstream are doing well and the aftermarket is gradually increasing as the 787 and A350 platforms come out of warranty. Looking out to next year, we’ll see the legacy book of business decline on lower 777 rates in particular, but we’ll see the E-2 ramp up so that net, net we think our sales into the commercial aircraft market should be more or less in line with this year.
In the industrial markets, GDP growth is slowing in both Europe and Asia while the US remains strong. Given this picture, we believe the diversity of our end markets is a real plus. Year to date for fiscal ’19 our book to bill remains positive. We deliver products into energy exploration and power generation markets, industrial automation applications ranging from steel production to plastic molding machines, flight simulation systems and products that are driven by the global spending on medical technology. Each of these submarkets within our industrialgroup has a different economic cycle giving us optimism that fiscal ’20 will be another solid year for our industrial business.
Global events are hard to predict, and we cannot foresee the impact of a hard Brexit or escalating trade wars. Therefore, notwithstanding our optimism, we are very vigilant for any material changes in the outlook for our industrial markets. We plan for what we know and will remain flexible to adjust our business plans as events unfold.
For the full year fiscal ’19, we’re keeping our forecast unchanged from 90 days ago, while adjusting the sales and margin mix slightly between the groups. Full year sales should be $2.9 billion with earnings per share of $5.05, plus or minus $0.10. This results in earnings per share in the fourth quarter of $1.25, plus or minus $0.10. We’ll provide a detailed forecast for next year on our Q4 earnings call in early November. We anticipate that fiscal ’20 should be another year of good growth in both sales and earnings per share.
Now let me pass you to Don who will provide more details on our cash flow and balance sheet.
Thanks, John. Good morning.
Q3 Free Cash Flow (FCF) was a use of funds totaling $11 million, coming in below what we had been expecting. Year-to-date, FCF stood at $38 million or a 28% conversion ratio, behind the pace of our previous 90% conversion forecast for all of FY19 and short of our recent average historical FCF success that has been in excess of 100% conversion.
Growth-related challenges are putting more pressure on our FCF than we had anticipated, driven by CapEx and Working Capital demands. At the end of Q3, Working Capital as a percent of sales was 28.4%, up from 24.9% at the end of FY18. This Working Capital increase is mostly related to growth in physical inventories where we’ve procured and built safety stock partly in response to the strains on the global Aerospace and Defense supply chain. As we focus on improving our operational processes, we expect that we’ll see our physical inventories, and more generally our Working Capital, drop back down to the levels that we had been realizing until recently.
For all of FY19, we’re reducing our FCF forecast to $90 million, or a conversion ratio of 50%. Most of the decrease in our forecast from three months ago is the result of Working Capital demands. In addition, we’ve increased our CapEx forecast for FY19 by $10 million from three months ago. Increased demand for Machinery and Test Equipment is significant in support of our growing business. Our updated FCF forecast for all of FY19 suggests that our Q4 FCF will be in excess of 100%. Looking ahead to future years, we remain focused on FCF as an important metric and believe that 100% conversion, while challenging during a strong organic growth cycle, is an appropriate and realistic target to average over a number of years.
Net debt increased $23 million compared to a use of Free Cash Flow of $11 million. The difference relates primarily to the payment of our quarterly dividend.
Capital expenditures in the quarter were $31 million while depreciation and amortization was $21 million. YTD, CapEx was $91 million while D&A was $64 million. For all of 2019, our updated CapEx forecast of $120 million compares with projected D&A for all of 2019 of $86 million. Our normal, sustaining level of CapEx is between 3% and 4% of sales. In 2019, our spend rate will be at the higher end of that range.
Cash contributions to our global pension plans totaled $9 million in the quarter compared to last year’s third quarter of $75 million. Last year included incremental accelerated contributions to our U.S. DB pension plan to take advantage of some tax benefits related to the Tax Act passed by Congress in December 2017. For all of 2019, we’re planning to make contributions into our global retirement plans totaling $37 million, essentially unchanged from our forecast three months ago. Global retirement plan expense in Q3 was $17 million compared with $15 million in 2018. Our expense for retirement plans for all of 2019 is projected to be $64 million, an increase over last year’s $57 million and unchanged from our forecast three months ago.
Our Q3 effective tax rate of 23.1% compares with last year’s Q3 rate of 25.8% and with our previous forecast for all of 2019 of 26.0%. The lower rate this quarter is due to a refinement of estimates associated with the filing of our fiscal 2018 tax return and to changes in our projected mix of global earnings. YTD, our tax rate is 23.7% compared with last year’s 56.4% which was complicated by the significant effect of the Tax Cuts and Jobs Act and the restructuring of the Wind pitch controls business. We’re now projecting our tax rate for all of 2019 to be down to 24.2% compared with our forecast 90 days ago of 26.0%, driven by the same factors as in our Q3.
Our leverage ratio (Net Debt divided by EBITDA) was 2.1x at the end of Q3, unchanged from last quarter and down from 2.2x a year ago. Net debt as a percentage of total capitalization at the end of Q3 was 35% compared with 36% a year ago. At quarter-end, we had $507 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in mid-2021. And our $300 million of 5.25% high-yield debt matures in late 2022.
Interest expense in Q3 was $10 million compared with last year’s $9 million, up due to higher borrowing rates. Our forecasted interest expense for all of 2019 is $39 million, nearly unchanged from our forecast last quarter.
With respect to leverage, 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 Q3, and we expect to be slightly below our target range by the end of the fiscal year.
Regarding capital deployment, today we announced our quarterly cash dividend of $.25 per share payable to our shareholders. And we continue to look at M&A targets strategically and share buybacks opportunistically. M&A tends to ebb and flow and it feels like we’ve got a lot going on just now. We’ll continue to exercise patience and discipline throughout our processes, looking for targets that fit well strategically, culturally and, of course, financially.
FY19 will show respectable sales and EPS growth and operating margin improvement. Business, particularly in Defense, is good, giving us reason to be optimistic as we look beyond FY19. Our backlog is strong. Since the end of FY17 seven quarters ago, our twelve-month backlog is up over 30%. That’s a nice tailwind to have as we look ahead to continued growth. Lastly with respect to Free Cash Flow, our increased focus on strengthening our operational performance should serve us well.
With that, I’d like to turn you back to John and open it up for any questions you may have.
Please note that the Q&A is not available.