First Quarter Conference Call, Fiscal Year 2017
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 27, 2017 our most recent Form 8K filed on January 27, 2017 and in certain of our other public filings with the SEC.
We've provided some financial schedules to help our listeners to 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 '17 and affirm our guidance for the full year. Overall it was a good quarter and a healthy start to fiscal '17.
Let me start with the headlines.
- First, on the technical front, the A350-1000 had a successful first flight on November 24th 2016, marking another important development milestone for our Aircraft group.
- Second, earnings per share in the quarter of 84 cents was above our guidance from 90 days ago, and up 18% from last year. It was a good start to the year which puts us on track for our full year guidance.
- Third, free cash flow in the quarter of $36 million is also on target for our full year guidance of $130 million.
- Fourth, we made progress on the sale of 4 small European space facilities. The sale of one facility is completed and the other 3 are held for sale, with the outlook that the sale will be completed within the next quarter or so. These actions are part of the portfolio review of our Space assets which we announced some 18 months ago. These sales essentially complete that process and we’re very comfortable with the remaining space business lines. The European facilities had annual sales in fiscal ’16 of $15 million. As a result of these sales, we incurred an operating loss of 25 cents in the quarter, partially offset by an 18 cents tax benefit.
- Finally, we’re affirming our full year guidance for fiscal '17. We anticipate earnings per share in the range of $3.50, plus or minus 20 cents on marginally lower sales as a result of the stronger dollar.
Now let me move to the details starting with the first quarter results.
Q1 Fiscal '17
Sales in the quarter of $590 million were up 4% from last year. Sales were up nicely in Aircraft, Space & Defense and Components, but down in Industrial where we saw softness in each of our major markets. Taking a look at the P&L, our gross margin is up on a favorable mix in each of the groups, except Aircraft. Our R&D expense is down as a percentage of sales while SG&A expense is also slightly lower on a percentage basis. The loss on the disposal of the European entities resulted in slightly lower operating profit than last year, but reduced the effective tax rate to only 17.6%. The overall result was net earnings of $31 million and earnings per share of 84 cents
Fiscal '17 Outlook
We’re moderating our sales forecast by $20 million to reflect the impact of the strengthening dollar over the last 90 days. The impact is all in our Industrial Group. Excluding this foreign exchange adjustment we’re keeping the sales forecast for each operating group unchanged. We’re also maintaining our EPS guidance from last quarter at $3.50 per share, plus or minus 20 cents.
Now to the segments. I’d 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 $268 million were 6% higher than last year. Sales were up on both the military and commercial sides of the house. On the military side, OEM sales were up led by a strong performance on the F-35 and an increase in funded development programs. The military aftermarket was down slightly on lower B-2 and C-5 sales.
On the commercial side, the sales increase was driven by a 72% increase on the A350 as production volume ramps up. Sales to Boeing were about flat with last year. Commercial aftermarket sales were down slightly on lower 787 and A350 initial provisioning.
Aircraft Fiscal '17
We’re leaving our sales forecast for the full year unchanged from 90 days ago at $1.11 billion.
Margins in the quarter of 8.6% were up from 7.3% last year. A combination of lower R&D and lower SG&A expenses contributed to the margin improvement, but these gains were tempered by the slightly more negative sales mix, due to lower foreign military sales and a lower aftermarket. For the full year, we’re maintaining our margin forecast at 9.5%.
Space and Defense
Space and Defense Q1
Sales in the quarter of $93 million were up 11% from last year. We saw double digit increases in both the space and defense markets. In the space business we saw nice increases in our satellite engines and space avionics businesses. These businesses have recovered from the low point of the business cycle a year ago. On the defense side, our vehicle business was particularly strong driven by the LAV turret upgrade program. We also had higher sales in missiles and naval systems.
Space and Defense Fiscal '17
There is no change to our sales forecast for the year. We anticipate full year sales of $367 million, split evenly between space and defense.
Space and Defense Margins
Margins in the quarter of 7.6% were negatively impacted by the loss associated with selling our European space operations. Exclusive of this loss, margins in the quarter were very strong at 17.3%. This quarter we benefited from a particularly favorable mix. We’re keeping our full year margin forecast, exclusive of the unusual loss, unchanged at 13.2%. Inclusive of the loss, margins for the full year will be 10.7%.
Industrial Systems Q1
Our industrial businesses are off to a slow start although we believe recently implemented restructuring and organizational changes, combined with our new products in the wind market, will turn our fortunes around by the end of this year. Sales in the quarter of $112 million were 10% lower than last year. The reduction is across our three major markets. In the energy market, sales of wind products into Brazil were way down as a result of the GE takeover of Alstom wind and their subsequent change in strategy in Brazil. The industrial automation market was also softer, particularly in the US. Our simulation and test market tends to be a little lumpy with big orders that can ship in one quarter or the next. We saw this trend last year where the first quarter was unusually strong – while this year’s first quarter was a little softer.
Industrial Systems Fiscal ‘17
WeWe’re moderating our full year forecast by $20 million to $470 million. This reduction captures the effect of the strengthening US dollar relative to our other trading currencies. The reduction is spread fairly evenly across each of the major markets and corresponds to a 4% sales reduction in each market.
Industrial Systems Margins
Industrial margins in the quarter were 9.5%, down from 10.9% last year as a result of the lower sales volume. We anticipate this business will improve from a slow start and are therefore keeping our full year operating profit forecast unchanged, yielding full year operating margins of 10.4%.
I would remind our listeners that we’ve integrated our former Medical Devices segment into our Components Group.
We’re off to a good start in fiscal ’17 and have a positive story to tell. Sales in the quarter of $116 million were 10% higher than last year. Sales were up nicely across each of our three major markets, A&D, Industrial and Medical. In A&D, the higher sales were driven by additional shipments on the Guardian program, a system mounted to the belly of an aircraft to protect it from shoulder-fired missiles. In the industrial market, sales were up to a broad range of specialty customers. Sales to off-shore oil customers were again lower than last year, but only by 4% so we’re optimistic that we may be finding a floor for this business. Finally, sales to our medical customers were up nicely on stronger sales of our medical pumps and related products.
Components Fiscal ‘17
Our full-year sales forecast is unchanged at $477 million.
Margins in the quarter were 9.9%, up nicely from the low point of 7.5% last year. We anticipate margins will pick up slightly as we move through the year to yield full-year margins of 10.4%, unchanged from 90 days ago.
We’re off to a good start in fiscal ‘17. Earnings per share were above our guidance and cash flow was very respectable. Our businesses have stabilized since this time last year, albeit it at lower levels of activity in several markets, in particular Energy and Industrial Automation. The one unusual item in the quarter was the loss associated with the sale of our European space operations, but we enjoyed a tax benefit from the transaction with the result that the net impact was only 7 cents. These divestitures complete the space portfolio cleanup we started a couple of years ago and the stronger margins we’re enjoying in our Space and Defense segment reflect the positive impact of that strategy. In total, it was a pretty quiet quarter and we’re pleased to keep our outlook for the year unchanged from 90 days ago. As we look out to the next 3 quarters, we think the risks and opportunities are about balanced. On the risk side, we think our industrial business could turn out slightly weaker than plan, but on the opportunities side, we believe our Space and Defense group could have a compensating upside. Our full year EPS forecast remains unchanged at $3.50, plus or minus 20 cents. We expect the second quarter to be in the range of 75 cents to 85 cents.
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
Thanks, John. Good morning.
We had a solid start to the new fiscal year with free cash flow in our first quarter of $36 million, or 119% conversion. We expect to achieve 100% free cash flow conversion for all of 2017, or $130 million, unchanged from our last forecast.
Net debt decreased $12 million as our positive $36 million of free cash flow was largely offset by foreign currency effects on the translation of our offshore cash into U.S. dollars.
Net Working Capital (excluding cash and debt) as a percentage of sales was down to 25.4% at the end of Q1 compared with 27.0% a year ago on sales that were 4% higher. We’ve restated the comparable historical numbers to conform to the Q1 adoption of a new accounting standard that now requires us to show all deferred tax accounts as long-term whereas before they were split between current and noncurrent. We had 370 basis points worth of net current deferred tax assets as a percentage of trailing twelve month (TTM) sales in the “old” version of net working capital. As we’ve shared before, we’ve seen a rather steady decline in this working capital metric since we peaked at almost 34% of sales in 2009. We continue to focus on improvements to managing our balance sheet in order to bring our investment in working capital down.
During the first quarter we had no share repurchase activity. Our capital deployment focus is on smart top-line growth, including acquisitive growth. We’ve not had much to report in the last few years with respect to M&A, but we’re increasing our efforts to target strategic growth in all of the broader markets that we serve.
Capital expenditures in the quarter were $15 million and depreciation and amortization totaled $22 million. For all of 2017, our CapEx forecast remains unchanged at $80 million. D&A in 2017 will be about $94 million.
Cash contributions to our global retirement plans totaled $17 million in the quarter compared to last year’s first quarter of $22 million. For all of 2017, we’re planning to make contributions into our global retirement plans totaling $92 million, unchanged from our forecast three months ago. Global retirement plan expense in the first fiscal quarter of 2017 was $16 million, similar to last year. Our global expense for retirement plans is projected to be $64 million, nearly the same as in 2016.
Before I tackle the topic of our effective tax rate, I’d like to dive a little deeper into the divestitures of the European Space businesses that had an impact on our operating profit and tax rate in the quarter. The European Space entities that I’m referencing include Bradford Engineering in the Netherlands that makes satellite attitude and orbit control subsystems, propulsion and thermal subsystems and components. This business was sold in November. Also included are three other space businesses that make liquid propulsion systems and components for satellites and missile defense systems located in the U.K. and Ireland that are currently “held for sale”. Net/net, as John said, there is an EPS loss of $.07 in the first quarter of 2017 as a result of these disposals. This net loss of $.07 is comprised of a pretax loss on the disposition of the assets of $9 million reflected in the operating results of our Space and Defense segment. We also generated an offsetting tax benefit of $6.5 million. Stripping out the $9 million loss included in operating profit, our adjusted consolidated operating margin in the first quarter of 2017 is 10.4% compared to the 8.9% we reported and compared with last year’s Q1 consolidated margin of 9.1%. As John mentioned earlier, these combined European space businesses had annual sales in 2016 of $15 million and were not material to our bottom line. Our updated 2017 sales and EPS forecasts reflect the effects of these disposals.
Now, on to our effective tax rate. In the first quarter of 2017 we had an unusually low tax rate of 17.6%. Stripping out the effect of the divestitures just described, our “clean” effective tax rate in Q1 was 28.7% compared with last year’s rate of 26.6%. Last year’s first quarter tax rate was comparatively low as Congress had enacted tax legislation that included the permanent reinstatement of the R&D tax credit during the first quarter of 2016. For all of 2017, we’re now forecasting an effective tax rate of 28.5%. Excluding the effects of the divestitures, the 2017 tax rate will be 31.0%. This compares with our tax rate in 2016 of 28.5% and with our 2017 forecast of 90 days ago of 31.5%. The 2017 tax rate is higher compared with 2016 due to lower R&D credits associated with of the timing of the U.S. law change in late 2015 (our first quarter of fiscal 2016), and due to the 2016 favorable impact of lower corporate rates in the U.K. on our deferred tax liability that doesn’t repeat in 2017.
Our leverage ratio (Net Debt divided by EBITDA) decreased to 2.1x at the end of the quarter compared with 2.6x a year ago. Net debt as a percentage of total capitalization was 40.8%, down from 44.6% a year ago. At quarter-end, we had $458 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2021.
With that, I’d like to turn you back to John to take any questions you may have.