First Quarter Conference Call, Fiscal Year 2015
January 30, 2015
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 30, 2015, our most recent Form 8K filed on January 30, 2015 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 ‘15 and update our guidance for the full year. Overall it was a mixed quarter for the company. On a positive note, although sales were about flat, earnings came in slightly over plan and cash was very strong. However, looking to the balance of the year we’re introducing some caution in our forecast today as several macroeconomic forces are starting to weigh on our business.
Starting with the headlines.
First, earnings per share in the quarter came in slightly over plan. We delivered this performance despite the challenge of 7 feet of snow in November in Buffalo which resulted in a one-week shut down of our facilities.
Second, it was another quarter of very strong cash flow. We continued to put this free cash to work through our share buyback program.
Third, our medical segment continues to improve with great margins in the quarter.
Fourth, 3 macroeconomic forces are starting to have an impact on our projection for the year. These are the strengthening US dollar, the general industrial malaise outside the US and the fall off in the price of oil.
The stronger US dollar has an adverse impact on our sales in several segments, but total operating profit should be relatively unchanged. The major impacts are in our Industrial Segment and our Aircraft Segment. Sales and operating margins in our Industrial Segment will weaken as the dollar strengthens. Conversely, sales in our Aircraft Segment will be essentially unchanged but operating margins will strengthen.
Next, the industrial stagnation in Europe and the continued slowdown in growth rates in Asia are having a negative impact on our Industrial Segment.
Finally, the sharp and sustained drop in the price of oil is unwelcome news for our energy businesses, particularly in our Components Segment and to a lesser extent in our Industrial Segment.
The impact of these macroeconomic headwinds, combined with some minor shifts in our underlying markets, is a reduction in our sales forecast for the year of $95 million and a reduction in our earnings per share forecast of 30 cents to $3.85.
Now let me move to the details starting with the first quarter results.
Sales in the quarter of $631 million were down marginally from last year. Adjusting for currency effects, sales were essentially flat with 2014. Sales in our Aircraft and Space and Defense segments were unchanged, while sales in our Industrial Systems, Components and Medical Devices segments were slightly lower. Taking a look at the P&L, our gross margin is down almost 200 basis points driven by an unusual quarter in our Aircraft business. R&D is down 60 basis points on lower activity on our major aircraft programs, particularly the A350. There is no change in SG&A expenses. Our effective tax rate was relatively low at 28.7% as we benefited from the reinstatement of the 2014 R&D tax credit in the U.S. The overall result was net earnings of $35 million and earnings per share of 86 cents, an increase of 23% over last year on a lower share count.
We’re moderating our sales forecast for the year by $95 million principally due to the impact of the 3 macroeconomic headwinds I mentioned earlier.
First, the stronger US dollar will result in a negative translation impact on our foreign sales of approximately $40 million concentrated in our Industrial Systems business. Second, the industrial malaise outside the US will have a negative impact of $30 million on our Industrial Systems sales. Finally, we estimate that the drop in the price of oil will adversely impact sales in our Components Segment by about $20 million. In our other markets, we’re adjusting our military aircraft forecast down slightly, while, on a positive note, we’re seeing strength in our Medical Devices segment and are increasing our sales forecast in that segment modestly. In terms of earnings, we estimate that the stronger dollar will be essentially neutral to earnings with the negative translation effect cancelled by the positive transaction effect. The $55 million lower real sales, however, results in a negative impact of 30 cents per share. The overall result is total sales for fiscal ’15 of $2.57 billion and earnings per share of $3.85. As in previous quarters, our guidance does not include the positive impact of further share repurchases over the coming 3 quarters. Should we continue our buyback program on a pace to conclude our 9 million share authorization by the end of this year, then earnings per share would be $3.95.
Now to the segments. I would remind our listeners that we’ve 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.
Sales in the quarter of $266 million were flat with last year. It was another quarter of strong organic growth on the commercial side compensating for slowing defense sales. Commercial OEM sales were up 12% with growth at Boeing, Airbus and in our business jet product line. The major increases were on the 787, A350 and on our Gulfstream programs. The commercial aftermarket was flat with last year.
In the military market, sales were down 8% as a result of lower OEM activity. F-35 sales slowed on lower development revenues and a relatively light production quarter. Sales to foreign customers were also down this quarter and sales on the KC46 tanker program were lower as the development work starts to wind down. On a positive note, we had a very strong quarter for V-22 shipments as we caught up on some over dues from last quarter.
Aircraft Fiscal ‘15
We’re reducing our full year forecast by $10 million. The reduction is all in the military market. Based on the first quarter results, we believe the KC46 tanker program will be about $5 million lower this year than our original forecast. We also believe that some foreign military programs will be weaker, so we have adjusted that forecast down by $5 million.
On the commercial side, we’re not changing the forecast in total, but we’re adjusting the mix slightly. We’re increasing our forecast in the aftermarket by $5 million, driven by continued strong 787 initial provisioning and we’re reducing our A350 OEM forecast by the same amount on a slightly slower production ramp rate.
Margins in the quarter were 9.2%. This was a relatively unusual quarter for our Aircraft Group, so let me provide a little more color. Although R&D was down this quarter from an elevated level a year ago, the gross margin was also down from last year. In Q1, our gross margin was about 200 basis points below the average gross margin for this business. The lower gross margin was the result of an adverse mix of military programs this quarter, in particular, lower sales on foreign platforms. This will correct as we go through the year so that our full-year gross margins will be close to last year.
For the year, there is no change in our operating profit forecast, but given the slightly lower sales, our margin performance will tick up to 10.6%. There are two factors influencing our operating profit - one positive, the other negative. On the one hand, the stronger U.S. dollar results in a positive transaction impact to operating profit of about $3 million for the year. On the other hand, the $10 million reduction in our military sales forecast will have an adverse impact on operating profit of the same amount. Net net, no change in operating profit.
Space and Defense Q1
Sales in the quarter of $100 million were flat with last year, with stronger defense sales compensating for lower space sales. In the defense market, the production rates on our missile programs continue to strengthen while in the Space market we saw lower demand for our avionics products.
Space and Defense Fiscal ‘15
We’re keeping our full year forecast unchanged from 90 days ago, at $403 million.
Space and Defense Margins
Margins in the quarter were 8.7%. These margins are still not where we want them to be and we continue to take actions to improve the underlying performance. One of those actions has been the combination of 2 facilities involved in our security market into one. As a result of this consolidation, and an associated review of the product portfolio, we determined that we should write down the value of our inventory by $2 million, depressing margins by 200 basis points. For the full year, we’re keeping our margin forecast unchanged at 10.7%.
Industrial Systems Q1
Sales in the quarter of $133 million were down 7% from last year. There are two major effects impacting our industrial business - the stronger US dollar and the general industrial malaise outside the US. For the quarter, two thirds of the sales drop was due to foreign currency movements, and one third was lower activity. The lower sales were primarily in our non-wind energy business and in our simulation and test markets. In the energy sector, we had lower sales on steam and gas turbines, particularly in Asia, as the economies there continue to slow. In simulation and test, some orders we had anticipated booking in Q1 have moved out into next quarter.
Industrial Systems Fiscal ‘15
We’re moderating our forecast to reflect the twin headwinds we’re facing. We’re reducing our full year forecast by $70 million, $40 million due to currency effects and $30 million due to slowing activity at our customers. The reductions are spread across each of our major markets - energy, industrial automation and simulation & test. Our new forecast assumes business continues at about the run rate of the first quarter, with some slight improvement in the simulation business as we move through the year.
Industrial Systems Margins
Margins in the quarter were 9.9%. We had been anticipating higher margins in the quarter, but lower sales and the adverse impact of the stronger dollar did not help. Looking to the remainder of the year, we believe margins will improve as we move through the year and we adjust our cost base to align with the lower forecasted sales. We’re now projecting full year margins of 11.5%, down from 12.1% 90 days ago.
Sales in the quarter of $100 million were down 3% from last year. Within our non-A&D markets, our industrial components continue to perform well as we benefit from the on-going improvement in the US market. Sales into the energy market were lower in the quarter as we shipped fewer FSPO products than last year. FPSO’s are Floating Production and Storage Offloading ships used in off-shore oil production. We sell very large slip rings used on these ships with average selling prices of over $1 million. Given the high sales value and low quantities, sales from quarter to quarter can vary significantly. Sales into our medical markets were also lower as one of our major customers adjusts their inventory levels as they work through some regulatory issues. Sales in the aerospace and defense markets were down slightly. We had some positive gains in the military aircraft aftermarket, which partially offset weaker demand for commercial helicopter de-ice slip rings.
Components Fiscal ‘15
We’re moderating our forecast for the year by $20 million to $420 million. The reduction is all in our energy market as we try to anticipate the impact that lower oil prices will have on demand for our products in the second half of the year.
Margins in the quarter were 14.7% on a slightly adverse sales mix. For the year, we’re moderating our margin forecast to 14% from 14.8% based on our lower sales forecast in the energy market.
This was an excellent margin quarter for our Medical Devices Segment, despite slightly lower sales. Strong demand in our “other” category mostly compensated for lower sales in our enteral pumps and sets. This “other” category is made up of a range of medical sensors and components sold to medical device OEM’s.
Medical Fiscal ‘14
Given the strong first-quarter sales, we’re increasing the full year forecast by $5 million to $125 million. The increase is all in our “other” category.
Margins in the quarter were very strong at 14.9%. A favorable mix, combined with continued operational improvements drove this performance. Based on the strong first quarter, we’re increasing our margin forecast for the full year to 10.9%.
Q1 was a slow start to fiscal ’15, in line with our guidance. During the quarter, we saw our industrial markets soften and the outlook for our energy businesses weaken significantly. Commercial aircraft is very strong and our medical devices segment continues to improve, but they don’t make up for the macroeconomic headwinds we’re facing. Therefore, we’ve moderated our sales forecast for the year by $95 million, to $2.57 billion. We’re also lowering our earnings forecast for the year as we see the impact of the global industrial weakness and the sharp drop in oil prices filter through to the bottom line. We’ll be continuously adjusting our cost structure as we go through the year in response to the changing sales outlook.
Taken all together, we’re now forecasting full year EPS of $3.85. Comparing this total with our $4.25 from 90 days ago, there are four impacts of note. First, the net impact of our first quarter High Yield bond issuance combined with our share repurchases will decrease our EPS by about 7 cents per share. Second, the slowdown in our industrial markets will have a negative impact of about 13 cents per share. Third, the lower price of oil and associated reduction in exploration activity will have a negative impact of about 13 cents per share. Finally, we’re forecasting a higher tax rate on a less favorable mix of taxable earnings which will reduce our EPS by about 7 cents per share. The second quarter should be slightly better than the first with earnings per share of about 90 cents, while the second half should improve to just over $1 per share in Q3 and Q4 as sales pick up slightly. As I mentioned earlier, this total of $3.85 does not include any impact from further share buyback activity through the next three quarters.
Before I pass you to Don, I would like to provide our listeners with some general thoughts on our business. Last year at this time, we revised our forecast for fiscal ‘14 downwards based on the experiences of our first quarter. It is very disappointing to have to do go through a similar revision this year. When we put a forecast together, we work very hard to provide the market with a plan which we believe is both realistic and achievable. This quarter, our plan has been impacted by three global forces - exchange rates, oil prices and the continued weakness in our industrial markets. We’ve always prided ourselves that the diversity in our businesses has allowed us to show sales and earnings gains, even in periods of weak demand in one or other market. Unfortunately, we find ourselves in a situation today where growth is challenging in most of our markets - defense, industrial, space and medical. Our growth engine is commercial aircraft OEM, but we’re in the early production phases of this business and therefore the margin contribution is muted.
In challenging times, we find it helpful to remember our primary goal and remain focused on the long term. Our over-arching objective is to generate shareholder value. On an operating level, we focus on sales growth, margin expansion and cash flow. Over the last few years, sales growth and margin expansion have been challenging, but cash flow has been very strong. We’ve continued our search for acquisitions while remaining disciplined in our capital allocation process. We’ve decided to return cash to shareholders through our buyback program rather than over pay for top line growth in the present frothy acquisition environment. We continue to restructure our operations and focus our portfolio on the best performing sectors. We’re investing in R&D to fuel future organic growth and focusing on Lean initiatives to improve operations. In time, our markets will improve, and our internal initiatives will bear fruit. In the meantime, we’ll continue to respond to the changing market conditions and provide the financial community with the best possible information to help you understand our Company.
Let me finis
h with this thought. Despite the challenges we’re facing, fiscal ‘15 is forecast to be another year of strong cash flow and a record year for our Company in terms of earnings per share.
Now let me pass you to Don who will provide some color on our cash flow and balance sheet.
Thanks, John. Good morning.
Free cash flow in the quarter of $58 million is a great start to fiscal ’15. We had very strong receivables collections in the quarter. This equates to a 165% cash conversion ratio. Although we don’t expect this conversion ratio to persist throughout the balance of 2015, we are affirming last quarter’s forecasted free cash flow for all of 2015 of $190 million. This is despite our moderated earnings projections that John has just described and will result in a conversion ratio for 2015 of 121%.
Our net debt increased by $69 million during the quarter to $711 million. The $127 million difference between our positive free cash flow and the increase in net debt outstanding is principally the result of our share buyback program.
Our 9 million share repurchase program that we initiated in January of 2014 continued during Q1. During the three months ended December 2014, we acquired an additional 1.46 million shares for $103 million or an average price of just over $70 per share. At the end of December, we’ve still got another 3.5 million shares remaining under the existing authorization. Our present plan is to continue buying back these shares programmatically on the open market throughout the duration of 2015. Our EPS projection for 2015 does not include approximately $.10 per share of positive impact associated with our plan to continue repurchasing shares during the next three quarters.
On November 21, we closed on the sale of $300 million of 8-year High Yield debt with a coupon interest rate of 5.25%. Our strategy was to term-out some of our variable-rate debt under our revolver and to increase our borrowing capacity. This will allow us to comfortably continue our share buyback program as well as consider any moderately sized acquisitions that may opportunistically come along. At the end of the quarter, we had $952 million of total debt outstanding with more than half either priced or hedged at fixed interest rates. Also, as of the end of December, we had $535 million of unused capacity on our $1.1 billion revolver before considering the $200 million unexercised accordion option.
Capital expenditures were $20 million and depreciation and amortization totaled $27 million in the quarter. We’re leaving our forecasts for CapEx and depreciation and amortization for all of fiscal 2015 unchanged at $100 million and $114 million, respectively.
Cash contributions to our global defined benefit pension plans totaled $9 million in our first quarter. These Q1 contributions were low relative to our forecast for all of 2015 due to us pulling $10 million of domestic plan contributions into last year’s Q4. We’re currently forecasting $61 million of global DB plan cash contributions for all of fiscal 2015. The discount rate used to determine our domestic DB pension expense for 2015 was 4.40%, down from 5.0% used last year. Lower discount rates cause global DB pension costs to be higher in 2015 vs. 2014 by $6 million and is already captured in our EPS projections.
Our effective tax rate in the first quarter was 28.7%, down from last year’s 31.5%. Included in the Q1 2015 rate is the retroactive R&D tax credit benefit due to the credit’s extension passed by Congress in December. This benefit does not repeat in future quarters resulting in a projected effective tax rate for all of fiscal 2015 of 31.4%. This 2015 rate is higher than our last forecast of 30.0% as we’re now projectingsofterresults fromournon-U.S.operations. This results in proportionately more U.S. taxable income which is taxed at relatively higher corporate tax rates.
Our financial ratios at the end of the quarter are solid. Net debt as a percentage of total capitalization was 36.5%, up from 24.8% in last year’s first quarter because of our share buyback program. Our leverage ratio (Net Debt divided by EBITDA) was 2.07x.
In summary, our balance sheet is strong. We’re generating strong free cash flow which is feeding our current share buyback program. M&A activity has been quiet in recent quarters; however, we continue to remain active in looking at opportunities. A couple of prospective deals have gotten close, but have simply not crossed the finish line. Our due diligence includes making sure we’ve got a solid strategic and financial fit. Eventually, we’ll have something to report. Despite challenging market conditions, we’re still projecting improved bottom-line financial performance this year. EPS in 2015 of $3.85 will be a record year, reflecting an increase of 9% over last year. After consideration for the continuation of the share buyback program that is estimated to add another $.10 per share in 2015, the increase in EPS over 2014 will be 12%. And this is happening in a year when our top-line revenues are forecasted to decline by 3%.
With that, I’d like to turn you back to John for any questions that you may have.
Note: The Q&A is not available.