Fourth Quarter Conference Call, Fiscal Year 2013
November 1, 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 November 1, 2013, our most recent Form 8K filed on November 1, 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 www.moog.com.
Good morning. Thanks for joining us. This morning we’ll report on the fourth quarter of fiscal ‘13 and reflect on our performance for the full year. We will also reaffirm our guidance for fiscal ’14. Let me start with the headlines for the quarter and the year before diving into the detail.
First, the big news. In the fourth quarter we took a 52 cent per share goodwill impairment charge in our Medical Devices segment. As part of our strategic review process, we’ve taken a fresh look at the future projections for the business, and we now believe that the fair value of the net assets is less than the carrying value. The result was a non-cash charge of $24 million after-tax.
Exclusive of the impairment charge, Q4 earnings of 86 cents per share were 9 cents below our target for the quarter. About half of the shortfall was an operational miss in our Space and Defense Group and the other half was due to increased restructuring. In the quarter, Space and Defense sales came up short, some recent acquisitions struggled and profitability suffered. We reacted very quickly to this shortfall, incurring over $3 million of additional restructuring in September to adjust our cost basis for next year.
On a positive note, all of our other segments performed well in the quarter. In particular, our Industrial Segment is seeing the benefits of their restructuring activities and our Medical Segment is gaining traction with their sales efforts.
Total restructuring in the quarter was 10 cents per share. Exclusive of restructuring, the underlying operations delivered 96 cents per share in the fourth quarter of fiscal ’13. This compares to 91 cents per share for the same quarter in fiscal ’12.
Cash was very strong in the quarter – with free cash flow coming in well over adjusted net earnings.
Now let me provide some thoughts on fiscal ’13 in total. The year turned out to be quite different from what we had expected 12 months ago. In October 2012, we were projecting sales and earnings growth in fiscal 13. Our main concern at that time was the threat of softness in our industrial markets. Looking back on the year, the headlines are a collection of some good and some not so good news. Here are the highlights.
First, three of our operations came in ahead of plan. Margins in our Aircraft and Components segments were up from last year. Within our Medical segment our underlying operating margins, exclusive of specials, were also up from our forecast last year. Commercial Aircraft had a very strong year, Components enjoyed a nice mix of products and our Medical Segment saw a year of sales growth without any regulatory setbacks.
Second, we had some nice program wins in the year. We won the primary flight control package on the next generation E-Jets at Embraer. We believe this win, a first for us at Embraer, demonstrates our leading position in the flight controls business worldwide. We also won the HelpMeSee program – a 3-year development project of a training simulator for cataract surgery. HelpMeSee is an organization dedicated to curing cataract blindness worldwide by using advanced simulation systems from Moog to train thousands of eye surgeons.
Third, our industrial markets turned out softer than we had anticipated. The first half of the year was marked by disappointing sales and continuous restructuring. In the second half, our industrial sales stabilized and our profitability improved as the restructuring benefits started to accrue. In addition to slimming down our operations, we took a hard look at the product portfolio and decided to exit some underperforming product lines.
Fourth, our Space and Defense business came up short of what we were anticipating. This was a combination of two of our recent space acquisitions underperforming as well as some softness in our defense businesses. We had anticipated this segment would have a very strong second half, and instead the second half was marked by two disappointing quarters.
Fifth, our cash flow was a really positive story in fiscal 13. We finished the year with free cash flow of $158 million on net earnings of $120 million, a 131% conversion ratio.
Sixth, we completed 2 acquisitions in the year, spending approximately $80 million. We acquired Broad Reach Engineering in the Space market and Aspen Motion Technologies in the Components Group. Both of these acquisitions are working out well so far.
Seventh, we announced a Strategic Review of our Medical Devices segment. After 7 years in this business, we decided to take a fundamental relook at whether or not this business is a long-term strategic fit for us. We are still in the midst of that process, but already we have divested one of our facilities in Q3 and taken a goodwill impairment charge in Q4. We would hope to report the conclusion of this review process in the next quarter or so.
Finally, we intensified our focus on bringing lean thinking to all our activities. As part of this process, we made a major decision in the fourth quarter to move the whole corporation to a single ERP solution over the next 5-6 years. Historically we have run multiple systems in our different operations, with all the inherent inefficiencies associated with that structure. After much internal review, we concluded that a single system would bring significant benefits in the long term. This will also be a significant investment and, in the short term, a slight headwind to earnings. However, as the implementation unfolds, we should see significant benefits in the out years.
Now let me move to the details starting with the fourth quarter results.
Sales in the quarter of $671 million were up 10% from last year. We saw higher sales in every segment except Industrial. Acquisitions contributed the majority of the $60 million sales increase. Excluding the effect of the write-downs I mentioned earlier, adjusted net earnings of $41 million were up 7% from last year and adjusted earnings per share of 90 cents were 6% higher.
Taking a look at the P&L, our gross margin is down slightly, primarily as a result of the program charge taken in the Space and Defense segment in the quarter. R&D remains elevated as the A350 program continues to move to certification, but other G&A expenses came in lower as a percentage of sales. We incurred $5 million in restructuring expense in the quarter, mostly in our Industrial segment. Our effective tax rate was up slightly from last year. The overall result, after restructuring and the write-offs I mentioned earlier, was net earnings of $34 million and earnings per share of 75 cents. The Medical write-down was equivalent to 11 cents per share and the Industrial write-down was another 4 cents per share. Adding these back, gives us an adjusted earnings per share of 90 cents, in line with our April forecast.
For the full year, sales were up 6%. 70% of the growth came from acquisitions. Aircraft sales were up on strong commercial demand, Space and Defense sales were up on acquisition growth, industrial sales were down as our wind business struggled, Components sales were up on acquisition growth and finally Medical sales were up on nice organic growth. Net earnings and earnings per share were down 21% from last year, driven by restructuring, asset write offs and the goodwill impairment charge. To compare the performance of our underlying operations, we need to add back 20 cents per share of restructuring, 15 cents per share of asset write downs and 52 cents per share of goodwill impairment to the fiscal ’13 numbers. With these adjustments, our operations delivered $3.50 per share and free cash flow of $158 million in fiscal ‘13. This compares with $3.33 per share and free cash flow of $107 million in fiscal ‘12. So, in fiscal ’13, earnings from operations were up 5% and free cash flow was up 48% – a respectable performance despite the challenges in both our Industrial and Space and Defense segments.
Fiscal '14 Outlook
Last quarter we forecast that the year would finish out with earnings per share in the range of $3.40 to $3.50 on sales of $2.6 billion. Sales for the year should be pretty much on plan, and the underlying operating performance of the businesses should end the year at the low end of this range. We also need to include the 15 cents per share of write downs in the third quarter in our projection for the full year. Taken all together, EPS for the year will be $3.25.
For next year, we are projecting a 3% increase in sales and a significant improvement in profitability, with earnings per share up 23% from fiscal ’13. This year, our Industrial business has struggled with a significant slowdown in demand and our Space business has suffered from some technical challenges at a couple of our recent acquisitions. We have spent the year repositioning our businesses and we will see the benefits in our margins in fiscal ’14. Sales next year should be up in Aircraft, Space and Defense and Components. We are assuming flat sales in Industrial, while sales in our Medical segment will be down slightly as a result of our recent sale of the Ethox Buffalo operations. Organic sales in Medical will actually be up in fiscal ’14.
Operating margins for the company in fiscal ’14 will be up to 12.4%, from 10.6% in fiscal ’13. We are projecting earnings per share in a range between $3.90 and $4.10.
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.
Q4 was another quarter of strong organic growth and healthy margins. Total Aircraft sales were up 9% in the quarter. The commercial side of the house continues to be the engine of growth with sales up 23% over the same quarter last year. We saw strong growth at our major OEM’s, a combination of higher rates, the timing of orders and the ramp up on new programs. The commercial aftermarket was down from last year, but within the normal quarterly variability we see in that business.
The military business was down 2% in the quarter with slightly lower sales on the OEM side. Slowing F-35 development work and lower V-22 sales contributed to the drop. Despite our continued sequestration worries, the military aftermarket was actually up from last year.
Aircraft Fiscal 13
Fiscal ’13 was a record year for our Aircraft business, with sales topping $1 billion for the first time. Commercial sales were up 20% with the growth coming on the OEM side. Sales to Boeing and Airbus were both up nicely as order rates increased and new platforms ramped up. The commercial aftermarket was down slightly in the year as some of our work on legacy platforms slowed.
On the military side sales were up 4% for the year with the growth coming in the military aftermarket. A nice contributor to the aftermarket this year was strong foreign military sales on the F15 platform. The OEM segment was about flat with fiscal ’12 with strength on the KC‑46 tanker program compensating for weakness in our navigation aids business.
Aircraft Fiscal 14
We are projecting sales in fiscal ’14 in line with fiscal ’13. Military sales will be down 6% on much reduced F-35 development work, lower V-22 production rates and a softer aftermarket. We think our military aftermarket will be down about 5% from fiscal ‘13. This projection includes our best guess on the effect of sequestration.
On the commercial side, we should see an 8% increase in sales as the 787 continues to ramp up and the A350 production starts in earnest. We think the commercial aftermarket will be off slightly next year as 787 initial provisioning slows.
Margins in the quarter were 12%, and margins for the full year were also 12%. Margins expanded 110 basis points over fiscal 12 on higher sales and a continued focus on cost reductions. We are projecting margins in fiscal ’14 of 13%. Next year we will have a less favorable product mix as the sales shift from military applications to commercial OEM sales. However, R&D should start to moderate slightly and our continued Lean activities should help drive a nice uptick in margins over fiscal ’13.
Space & Defense Q3
Space and Defense Q4
Sales in the quarter were up 11% from last year to $104 million. Similar to the last couple of quarters, sales from our recent acquisitions contributed most of the growth. Organic sales, ex acquisitions, were up 4% from last year. We saw a little growth in our legacy space markets, and had a nice pick up in our NASA business due to work on the Soft Capture System. This is a system designed to help decommission the Hubble Space telescope in years to come when it has reached its end of life. Defense and security sales were down almost 10% in the quarter as program orders slipped to the right. Over the last year, we’ve noticed a repeated slowdown in the receipt of military orders relative to what we were expecting.
Space and Defense Fiscal 13
Total sales in fiscal ’13 of $396 million were 10% higher than last year. Acquisitions added nearly $60 million of sales to our space total, while the legacy space business dropped 6% on a softer commercial satellite market. We had no acquisitions in the defense or security markets in fiscal ‘13. Defense was off 5% for the year as activity on various programs slowed. Security was down 9% for the year, all because in fiscal ’12 we had about $4 million of Driver’s Vision Enhancer work, and that program was down to $1 million in fiscal ’13.
Space and Defense Fiscal 14
Despite the challenges in fiscal ’13, sales in fiscal ’14 should be up in total. We are projecting a 9% increase to $433 million. In the space market, the growth is primarily the result of a full year of the Broad Reach Engineering acquisition. In the defense market, we should see a nice pick up in missile defense as well as stronger foreign military sales for ground vehicle systems. Security sales should be up slightly with additional sales coming from some recent new product introductions.
Over the last 2 years we have strengthened our position in foreign markets in both the Space and Defense markets. The combined acquisitions of Bradford and In Space Propulsion have given us 3 space facilities in Europe – previously we had none. In the defense business, we strengthened our European operations and we are now focused on bringing our full range of U.S. Defense capabilities to potential foreign opportunities. We believe these actions position us strongly to benefit from increased foreign sales in the years to come.
Space & Defense Margins
Margins in the quarter were a disappointing 2.6%. Exclusive of restructuring, margins were 6.9%. There are 2 elements to this shortfall.
- First, our space acquisitions of Bradford and ISP continued to fall short of what we had planned. Last quarter we had a big write-off on one program at Bradford but this quarter there was not any one particular program that came up short, rather a range of shortfalls across the entire portfolio. The lesson learned is that when buying small Space companies, they often don’t have the systems and controls in place that we have come to expect and it is sometimes a lot more expensive than we expect, both in terms of dollars and time, to get them squared away.
- Second, our defense business fell short this quarter. Compared to our forecast of 90 days ago defense sales came in well below plan, as anticipated orders pushed out to the right. Typically, defense sales are nicely profitable, but they also tend to carry a relatively high percentage of fixed costs so that when sales come up short, profitability is disproportionally affected.
In response to these challenges, we took swift action in the quarter. We incurred over $4 million in restructuring costs to resize the workforce to address the current sales levels and to meet our profitability goals for next year. As a result, we are keeping our margin forecast for fiscal ’14 unchanged from 90 days ago at 10%.
Some of our recent space acquisitions have turned out to be more challenging than we had planned. However, in time we will get them squared away and despite the short term challenges, we believe our strategy in the space market of expanding our components footprint and moving into the systems business will pay off nicely over the long term.
Industrial Systems Q4
Sales in the quarter of $153 million were up 2% from last year. The sales mix, however was quite different from a year ago. Wind energy sales were down 31% compared to the fourth quarter of fiscal ‘12, but more or less in line with our forecast from 90 days ago. Industrial automation sales were up nicely in the quarter. While we view this positively, it’s too early to tell if this signals a return to growth in that market just yet. Simulation and test was up strongly in the quarter. Our customers in the flight simulation business continue to see strong demand for their products. The macro picture shifted slightly this quarter, with our wind business stabilizing and our industrial automation markets perhaps starting to recover.
Industrial Systems Fiscal 13
Full year sales of $592 million were 7% down on fiscal ’12. The drop in wind energy sales of over $40 million made all the difference. Apart from wind, there was a slight shift in the mix with industrial automation down about $10 million, but simulation and test up a similar amount. We restructured our wind business during the year, consolidating our Asian operations in Shanghai. On a more positive note, we introduced a new AC pitch control system this year which offers performance benefits to our customers and better margins internally. With this new system we won our first major order in South America with Alstom for 300 systems over the next 3 years.
Industrial Systems Fiscal 14
Last quarter, we said that sales in fiscal ’14 would be flat with our projection for fiscal ’13. We projected sales of $585 million next year. The fourth quarter came in a little stronger than we had expected, but we are not yet adjusting our forecast for next year. Sales in the second half of fiscal ’13 were up about 3% from the first half. While we view the stronger second half as a positive sign, there is a natural range of sales fluctuation from any one quarter to the next. Therefore, we think it is too early to tell if the second half improvement is simply a reflection of a market that has stabilized or a market that has started to grow again. For the moment, we are taking the more conservative approach and assuming that next year will be more or less the same as this year.
Industrial Systems Margins
Margins in the quarter of 10.5% were very encouraging. Exclusive of about $3 million in restructuring, margins in the quarter were a healthy 12.3%. This is up over 400 basis points from the fourth quarter of fiscal ’12 on similar sales. Continuing the comparison of margins ex- restructuring, we have seen a quarter over quarter improvement in margins throughout fiscal ’13 from the low point of 6.1% in the first quarter.
Margins for the year were 7.1% compared with 10% in fiscal ’12. Exclusive of restructuring and the effect of an asset write down in the third quarter, underlying operating margins in fiscal ’13 were 8.7%.
In fiscal ’14 we are projecting margins of 12.2%. Fiscal ’13 has been a year of considerable adjustment, but we believe we have taken the necessary steps to make fiscal ’14 a more successful year.
Sales in the quarter were up marginally from last year. Component sales into the industrial markets were up almost 50%, driven by the recent acquisition of Aspen Motion Technologies. The energy and medical markets were about flat with last year. Sales on the A&D side of the house were down 6% in the quarter as we encountered some technical issues on a couple of defense programs which delayed shipments into next quarter.
Components Fiscal 13
For the full year, sales were up 11% with all the growth coming in our non-A&D markets. Sales in energy were way up, a combination of organic growth in our off-shore markets and the Tritech acquisition which we completed at the end of fiscal ’12. Industrial sales were also up, the result of the recent Aspen acquisition. Absent this acquisition, industrial sales would actually have been down in fiscal ’13, reflecting the softness in this market. Medical sales were up slightly for the year.
In our A&D markets, sales were pretty much flat with last year. Fiscal ’10 was the high point for sales into these markets and over the following couple of years we have seen a significant decline as various platform upgrades wound down. The sales leveled off in fiscal ’13 and we are optimistic that they may actually tick up slightly next year.
Components Fiscal 14
Our forecast for fiscal ’14 is unchanged from 90 days ago. We are projecting a sales increase of 11% next year to $460 million. Component sales into the aerospace and defense markets will be marginally higher than fiscal ’13, but sales in industrial automation will be up nicely as we enjoy the benefit of a full year of the Aspen acquisition.
Margins in the quarter were 15.4%. Full year fiscal ’13 margins were 16.5%, above the average of the last few years. This year we had a particularly nice mix of business and also had the benefit of an earn-out reversal in our first quarter on our Protokraft acquisition. This reversal contributed $2 million in operating profit and boosted full year margins by 50 basis points. For fiscal ’14 we are projecting margins of 15.0% on a slightly less favorable mix of sales.
Q4 was another eventful quarter for our medical business. As I mentioned at the start of my remarks, we took a $24 million after tax goodwill impairment charge this quarter. Setting this non-cash charge aside, our medical segment had strong sales and good profitability. The underlying performance of this business continues to improve nicely.
Sales in the quarter of $39 million were up 9% from last year. Last year’s sales included about $3 million for the Ethox Buffalo operations that we sold so, on a same store basis, sales were up 17%. We had nice growth in both our pump and set sales.
Medical Fiscal 13
For the year, sales were up 5% with growth across our 3 product categories. In the past, we have described the focus of this group on developing a “culture of compliance.” In other words, we wanted to become the model at the FDA for how a medical device company should operate. That strategy bore fruit in fiscal ’13. We enjoyed a clean bill of health from a regulatory perspective and could focus our attention on sales growth.
Medical Fiscal 14
Full year sales in fiscal ’14 are projected to be $137 million, down $10 million from fiscal ’13. The drop is the result of the sale of the Ethox Buffalo operations. We should see a mix shift with higher pump sales and lower set sales. Growth in pump sales will come as our sales efforts continue to gain traction. Set sales will be slightly lower due to a change in our contract with a large customer who is shifting from the sale of our components to a royalty structure.
Margins in the quarter, exclusive of the goodwill charge, were 6.6% up from 2.8% last year. Strong sales and the continued focus on cost containment contributed to the improved performance. Fiscal ’13 full year margins, adjusting for both the Ethox Buffalo sale and the goodwill charge, were 6.4%, a 250 basis point improvement over fiscal ’12.
For fiscal ’14, we are projecting full year margins of 7.1%.
With fiscal ’13 behind us, we are looking forward to a much better fiscal ’14. We are reiterating our guidance from 90 days ago for full year sales next year of $2.67 billion, a 2% increase over fiscal ’13. Aircraft sales will be even with fiscal ’13 as commercial growth compensates for military softness. Component and Space sales will be higher on full year acquisition sales. Industrial sales will be about even with fiscal ’13 and Medical sales will be down as a result of the divestiture of the Ethox Buffalo facility. We are projecting earnings per share in a range of $3.90 to $4.10. At the mid-point of the range, net earnings will be $185 million, net margins will improve to a record 6.9% and adjusted earnings per share will be up 14% from fiscal ’13. As usual, we think the year will start out slowly with earnings in the first 2 quarters in the 85 cent ‑ 95 cent range. The second half should be better with 2 quarters over $1/share.
Looking at the risks and opportunities for next year, sequestration remains our major concern. Our leaders in Washington may reach a bargain which addresses this concern, but I don’t think we should hold our breath. On the opportunities side, we have seen a slight pickup in our industrial markets in the second half of ’13 so perhaps that bodes well for the future. In addition, our Space business could have a better year than we are planning.
As always, we try to provide a forecast which balances these pluses and minuses. In the past, it has been suggested that we hedge our forecast to come in better than plan. Fiscal ’13 was one of those years when we got it wrong and we came in under our forecast. We hope that in fiscal ’14 we’re back to getting it right.
Now let me pass you to Don Fishback who will provide some color on our cash flow and balance sheet.
Thank you, John. Good morning, everyone.
As John already mentioned, our Free Cash Flow in the fourth quarter was strong at $61 million. Our net debt declined by $71 million to $552 million. The difference is explained by the proceeds associated with the sale of our Ethox Buffalo medical operations that came in during the fourth quarter in addition to movements in foreign currencies.
For the year, our Free Cash Flow was $158 million compared to net earnings of $120 million resulting in a conversion ratio of 131%. After adjusting net earnings for the significant noncash charges that we’ve described, the conversion ratio is still in excess of 100%. Net working capital declined during the fourth quarter largely due to higher customer advances and accounts payable and lower inventories, offset by higher receivables. The increases in customer advances and receivables are the result of timing, mostly on a number of commercial aircraft programs. Our loss reserve balances declined by $1 million to $44 million.
Capital expenditures were $30 million in the quarter compared to $28 million of depreciation and amortization. Capital expenditures for the full fiscal year were $93 million while D&A was $108 million.
Our global Defined Benefit Pension plan expense for all of fiscal 2013 was $51 million while our cash contributions were $43 million.
Last quarter, we provided our first look at our forecasted Free Cash Flow for fiscal 2014. We’re leaving that forecast unchanged at $165 million, or a cash conversion ratio of about 90%. We’re forecasting $105 million of Capital Expenditures and Depreciation and Amortization of $113 million, also unchanged from last quarter’s forecast. We’re currently forecasting our global DB Pension Plan expense for fiscal 2014 at $36 million while our contributions will be $51 million. Compared to this past year, DB Pension Plan expense in 2014 will be down due to higher discount rates.
Our total debt outstanding at the end of the year was $709 million and our cash balances were $157 million. Our year-end ratio of Net Debt to Total Cap was 26.4%, down from 32.1% last year. Our leverage ratio (Net Debt divided by adjusted EBITDA) was 1.56x. Year-end unused available capacity on our $900 million revolving credit facility was $482 million.
Interest expense was $27 million in 2013 and we’re forecasting $24 million in 2014 as we called in our 6¼% debentures in January of this year.
Our effective tax rate in the fourth quarter of 2013 was an unusually low 14.8%. Before the tax effects of the goodwill impairment charge, the effective tax rate was a more normal 30.2%, up from last year’s 20.8%. The low tax rate in 2012 was due to a statutory tax rate decrease in the U.K. and the reduction in a valuation allowance for a European deferred tax asset. For all of fiscal 2013, the effective tax rate was 27.0% the same as last year. Looking ahead to fiscal 2014, we’re leaving our effective tax rate at 31.7%, unchanged from our last forecast. The 2014 rate is up from our 2013 rate for a number of reasons including the effect of the 2013 goodwill impairment charge, last year’s large R&D tax credit benefit, and because we’re forecasting a less favorable mix of global taxable earnings.
It’s been a tough finish to a challenging 2013. We’ve made the appropriate restructuring decisions to respond to soft market conditions in our Industrial and Space and Defense businesses. We’re working through the review process for Medical that will settle out in the coming quarter or two. And we’re committed to leaning out our core business processes including moving to a new company-wide ERP system using SAP. We are taking these initiatives with a focus on achieving our long-term strategic growth and return goals. We’ve now begun turning our full attention to 2014.
Thanks for listening. We’ll now turn the call over to our moderator and take any questions you may have.
(The Q and A is not available.)