FY18 Q4 Conference Call, Fiscal Year 2018 



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 2, 2018 our most recent Form 8K filed on November 2, 2018 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 webcast page at www.moog.com.

Good morning.  Thanks for joining us.  This morning we’ll report on the fourth quarter of fiscal ’18 and reflect on our performance for the full year. We’ll also provide our initial guidance for fiscal ’19. 

As usual, I’ll start with the headlines for the quarter.

·      First, it was a good quarter for our operations, with sales up 8% relative to a year ago and adjusted earnings per share of $1.28 up 20% from last year, and above the high end of our guidance from 90 days ago. Free cash flow conversion was approximately 80% in the quarter.    

·      Second, our portfolio refinement continued this quarter. We completed the exit from the wind pitch control business and took a net charge of $4 million. We also took a $2 million charge associated with the sale of a small European operation in our Space and Defense Group. 

·      Third, we’re providing a first look at fiscal ’19 today. We anticipate sales growth of 6% to $2.88 billion and earnings per share of $5.25 plus or minus 20 cents, a 15% increase over our adjusted numbers for fiscal ’18. 

As we reflect back on fiscal ’18, the following headlines stand out.

1)    First, it was another year of technical achievements in a variety of end markets. Examples include

a.    the successful first flight of the Bell V-280 Valor helicopter; 

b.    the entry into service of the Embraer E-2 airplane; and

c.     the success of our new reconfigurable turret system on several military vehicle programs.

2)    Second, it was a good year for our operations.  Sales were up 8% and earnings per share, adjusted for tax reform and the wind restructuring, came in at $4.57, ahead of our adjusted guidance of $4.40/share coming into the year.

3)    Third, we completed a strategic review of our wind pitch control business and, after several years of investment, decided to exit the business in Q2.

4)    Fourth, we made two bolt on acquisitions during the year, adding a large motor company in the Czech Republic to our Industrial Group and a UAV-tracking software company to our Space & Defense Group. Combined annual sales of these acquisitions in fiscal ’19 will be about $50 million.

5)    Fifth, we initiated a quarterly dividend in the second quarter, the next step in our strategy of ensuring prudent management of our shareholder’s capital. This decision reflects our confidence in the long-term future of the business.

6)    Finally, we fully funded, and de-risked our U.S. DB pension plan. We should not have to make any further cash payments into this plan for the foreseeable future.  

Fiscal ’18 was a good year for our company. Each of our operating groups grew in sales and the adjusted operating margin for the company was up nicely.  As I do at this time each year, I would like to express my thanks for the dedication and commitment of our 12,000 employees around the world that made this all happen. 

Now, let me provide some more details on the quarter. 

Q4 Fiscal ‘18

Sales in the quarter of $701 million were 8% higher than last year. Sales were up in each of our operating groups. Taking a look at the P&L, our gross margin was down on an adverse mix in our aircraft business, R&D was down on lower spending on commercial aircraft programs and our SG&A expense was also down as a % of sales. We incurred $9 million of restructuring expense in the quarter mostly due to the close out of our wind exit strategy. Interest expense was up slightly on higher rates. Our effective tax rate in the quarter of 26.7% included some residual adjustments for U.S. tax reform. Including the restructuring charges and the tax adjustments, the overall result was net earnings of $41 million, up 5%, and earnings per share of $1.14, up 7%.  Excluding restructuring and the one-time tax adjustments related to tax reform, net earnings were $46 million and earnings per share were $1.28. 



Fiscal ’18

For the full year, sales of $2.71 billion were up 8% over last year. The story for the year is similar to the story for the quarter with sales up in each operating group.  Underlying organic growth was $160 million. Acquisitions, net of divestitures, contributed about $20 million and stronger foreign currencies added another $30 million or so. As we’ve discussed in the past, the results for fiscal ’18 are complicated by the change in U.S. tax law and the restructuring expense associated with our exit from the wind business.  Exclusive of these one-time effects, operating margin was up 90 basis points, and net earnings and earnings per share were each up 17%.  Free cash flow for the year of $8 million included $85 million of accelerated contributions to our U.S. DB pension plan. 

Fiscal ’19 Outlook

For fiscal ’19 we’re projecting continued organic growth with sales of $2.88 billion, up 6% over fiscal ’18.  Sales will be up in Aircraft and growth will be particularly strong in Space & Defense.  Industrial sales will be flat with last year, but adjusting for the loss of wind sales, will be up 4% organically. We’re anticipating full year operating margins of 11.7% and earnings per share of $5.25, plus or minus 20 cents. Free cash flow next year should come in at 100% conversion.

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. 




Aircraft Q4

Sales in the quarter of $304 million were 7% higher than last year with all of the increase on the military side of the house. Sales on the F-35 program were almost 50% higher than last year, a combination of increased volumes on LRIP 11 and the timing of some deliveries.  Sales in the military aftermarket were also higher across a range of programs, in particular the B1-B, F18 and V-22.  On the commercial side, OEM sales on the 787 and A350 were in line with last year, while lower OEM sales to Boeing on the 777 were partially compensated by higher aftermarket sales on the A350 program. 

Aircraft fiscal ‘18

Full year sales were up 6% from fiscal ’17 to $1.19 billion. Military aircraft was up 10% year over year. We saw strong growth on the F-35 program as Lockheed Martin continues to ramp up production. Sales were also higher on the KC46 tanker and in our Navigation Aids business as well as on some foreign platforms. We enjoyed increased work on funded development programs. The military aftermarket was marginally higher as additional F-18 repairs and spares activity compensated for lower B-2 sales. On the commercial side, OEM sales were 3% lower.  777 deliveries were off almost 50% from fiscal ’17 and we also saw lower volumes on legacy 737 platforms. On the positive side, 787 sales were up as we prepare to increase the rate to 14 shipsets per month while A350 sales were in line with last year.  The commercial aftermarket had a great year driven by strong A350 initial provisioning, retrofit activity on aging platforms and an increased focus on capturing market share. 

Aircraft fiscal ‘19

We’re projecting fiscal ’19 sales of $1.27 billion, a 6% organic increase over fiscal ’18. Similar to this year, most of the growth is on the military side with continued ramp up on the F-35 program and higher sales on some foreign platforms compensating for a softer helicopter book of business. The military aftermarket should also be up on increased F-35 and V-22 activity.

We’re forecasting higher commercial OEM sales driven by our flagship programs, the 787 and A350. We’ll also see the initial ramp on the Embraer E-2 program.  Sales on the legacy Boeing book will continue to decline as the older models are gradually phased out.  We anticipate that the commercial aftermarket will be lower as initial provisioning declines from a boom year in fiscal ’18.


Aircraft Margins

Margins in the quarter were 10.2% and for the full year were 10.8%.  These margins are up 70 basis points from fiscal ’17.  We anticipate a further increase in margins by 60 basis points in FY19 to 11.4%.  This continues the trend of expanding margins of the last few years. The margin improvement in fiscal ’18 was driven by lower R&D spending on commercial jobs, but this benefit was eroded somewhat by higher investment in new business capture as well as a lower gross margin on a negative mix.  As we look out to fiscal ’19, R&D will be down slightly from FY18 as it continues to converge on our 5% long-term target.  



Space and Defense

Space and Defense Q4

Sales in the quarter of $154 million were up 10% from last year. We had nice increases in both the Space and Defense markets. Space sales were up on increased work on NASA programs, both the Space Launch System and the Orion Crew Vehicle. Defense sales were up on strong tactical missile work, strong growth in navy programs and acquired sales from our acquisition of EOI, a small UAV tracking company.

Space and Defense fiscal ‘18

The story for the year is similar to the story for the quarter with overall growth of 10%.  Our space avionics had another great year, with sales up over 60%. Sales in this product line have more than doubled in the last 2 years as we gain positions on new defense satellites.  Sales across the full range of launch vehicles were also very strong.  On the defense side, the bright spots were missiles, including funded development work on new hypersonic opportunities, security systems, including acquired sales from EOI, and various components for a range of end uses. Our military ground vehicles was a tale of two cities. Lower sales on legacy platforms were mostly compensated by increased sales of our new Reconfigurable Turret system. 



Space and Defense fiscal ‘19

Our initial forecast for next year projects strong growth. Defense sales will be up 25%.  Sales on missile programs will be up over 30%, a combination of higher rates on existing programs and initial production on new platforms. We’ll also see increased naval sales on the Virginia class submarine. Sales on military vehicles will be significantly higher driven by our reconfigurable turret offering. This is a new product for us and is part of our strategy to meet the needs of the forces directly with tailored products for specific requirements. It’s part of our “agile prime” strategy – to invest selectively internally to develop capability and then respond quickly to urgent needs in the field. This product has been in development for about 5 years, and had initial sales of about $3 million in fiscal 17.  In fiscal ’19, we’re projecting sales of over $50 million. On the Space side, sales will be up 3% in ’19, with slight increases in our work on a range of launch vehicle systems. 


Space and Defense Margins

Margins in the quarter were 11.2% and for the full year 11.5%.  For fiscal ‘19 we’re projecting an increase in margins to 11.8% on higher sales. 


Industrial Systems


Industrial Systems Q4

Sales in the quarter of $243 million were 8% up over last year.  The increase is split approximately 50/50 between organic and acquired growth. Our energy market was about flat with last year. We’ve essentially completed the wind down of our wind pitch control business and shipments of those products will be negligible next year.  Industrial automation was up nicely in the quarter as our major markets around the globe continue to invest in new capital equipment. Sales into simulation & test applications and for medical applications were up modestly from last year. 

Industrial Systems fiscal ‘18

Full year sales of $935 million were up 11% over last year.  About half the gain is organic growth, and the remainder split evenly between acquired growth from our two acquisitions over the last 18 months and stronger foreign currencies relative to the dollar. Our energy markets were strong this year, with increases in both exploration and generation. Industrial automation was also strong on the foundation of strong global GDP.  Sales of simulation & test systems were about flat with last year while sales into medical applications, both components and pumps, were up nicely. 

Industrial Systems fiscal ‘19

We’re projecting flat top line sales as we move into FY’19. This is a result of 4% organic growth compensating for the loss of $40 million in wind energy sales.  Sales into industrial automation markets and for medical applications should be up about 5% while we anticipate a flat year for simulation and test sales. 


Industrial Systems Margins

Adjusted margins in the quarter were 12.1%, excluding the restructuring expense associated with our exit from wind of about 200 basis points. Margins for the full year, excluding the wind exit charges were 10.6%.  For fiscal 19, we’re forecasting margins to increase to 12.0%.  About 100 bps of this improvement is a result of the decision to exit the wind business in ‘18. 



Summary Guidance

Fiscal ’18 was a good year operationally and we’re looking to build on that performance as we move into fiscal ’19. We’re forecasting full year sales of $2.88 billion, up 6%.  Our aircraft group should see nice growth on the military side as the F-35 continues to ramp up and the aftermarket recovers. The commercial OEM business will also grow, fueled by the A350 ramp, but we anticipate the commercial aftermarket will be down from a bumper year in fiscal ’18.  In Space and Defense we’re seeing strong growth in our military sales.  Finally, the headline sales number in Industrial is flat with last year as 4% organic growth compensates for the loss of wind pitch control sales.  We’re forecasting earnings per share of $5.25 plus of minus 20 cents – a 15% increase over our adjusted ’18 results.

As always, our forecast does not include any projection for future acquisitions or share buyback activity.  We anticipate strong free cash flow generation in fiscal ’19 and will continue to manage this shareholder capital prudently.  We’ll continue to look for bolt-on acquisitions which support our organic growth strategies, but we’ll remain disciplined in our evaluation and will not acquire top line growth at a price level that prohibits earning an acceptable return on our capital.  Our dividend and buyback policies provide ample opportunities to return capital to shareholders should we not find the right acquisition opportunities.  We’re patient, and believe that growth is an essential ingredient to long-term value creation.  As our R&D spend winds down on large commercial programs, we’re redirecting some of our resources to exploring new, innovative solutions to the technical challenges our customers will face tomorrow. From additive manufacturing to next generation robotics to autonomous systems, we’re exploring the next generation of opportunities for our capabilities. As always, our focus will remain on driving long-term value for our shareholders. 

I’ll finish my comments as I have done in previous years by looking at our business through the lens of the end markets we serve. These are defense, industrial, commercial, energy, space and medical.

Defense is our largest market at over one third of our sales. Over the last year we’ve seen the benefit of the increasing U.S. defense budget as sequestration has been temporarily put on hold. We anticipate continued strength in fiscal ’19 in both existing programs like the F-35 and in new application areas such as reconfigurable turrets and counter UAV systems.  Our funded military development work in fiscal ’18 was over $150 million as we work on the next generation of weapons platforms across our portfolio. Despite the short-term worries about defense budgets dropping significantly beyond fiscal ’19, this funded development work demonstrates that we’re well positioned for the very long run. 

Sales into various industrial markets represent our second largest market at about a quarter of our sales. This market has recovered significantly over the last 18 months or so as global GDP has strengthened. We believe this strength will continue in fiscal ’19 despite the increasing interest rate environment in the U.S. and the threat of tariffs. Longer term, our industrial markets are cyclical and we remain vigilant in these good times to continue to structure the business and control costs to ensure maximum returns throughout the cycle. 

Commercial aircraft is also about a quarter of our sales and has been an engine for organic growth over the last 15 years as we invested in the 787, A350 and E-2.  Over the last 5 years, the primary focus of this business has shifted from R&D spending to certify new airplanes, to operational execution as deliveries have ramped up.  Fiscal ’19 will continue this trend as R&D again falls as a % of sales and volumes on new programs continue to build. This trend should continue for several years to come and the aftermarket for these new programs will continue to grow. We’re experiencing a margin headwind as volume on some of our older platforms, in particular the 777, wind down. This will continue until the program comes to an end in the next few years. We don’t anticipate any major new wins in the foreseeable future and are therefore confident that the R&D load will continue to abate, resulting in continued margin expansion. 

Our energy, space and medical markets each represent less than 10% of our sales.

Putting aside our wind challenges, fiscal ’18 was actually a positive year for our energy markets. In particular, our exploration sales improved from a low point in fiscal’17 and are forecast to see further modest improvement in fiscal ’19. The recovery in the price of oil over the last couple of years has helped put this business back on a solid footing.

Our Space business was up a healthy 15% in fiscal ’18 and we’re projecting modest growth into fiscal ’19, driven by increasing sales on a variety of launch platforms.  Sales of our avionics products have doubled over the last 2 years and are set to continue strong into next year.

Finally, our medical market grew 9% in fiscal ’18 and should grow an additional 6% in fiscal ’19. We anticipate stronger sales for both our pump products as well as components sold to medical OEM’s. 

In summary, as we close out fiscal ’18, the majority of our key markets are healthy and we’re looking forward to a strong fiscal ’19.  Our fundamental strategy remains unchanged. We work closely with our customers to solve their most difficult technical challenges.  We look for applications where performance really matters – where the cost of failure is high and where our technology offers real differentiation for our customers.  We continue to serve a diverse range of markets with a focused set of technologies built around precision motion and fluid control.  We look for adjacent acquisitions that complement our organic growth strategy.  We remain focused on 3 corporate-wide initiatives, Talent, Lean and Innovation.  Our key financial measures are sales growth, margin expansion and free cash flow.  We look to invest our shareholder’s capital wisely, always with a view to long-term value creation. Our preference is to invest in organic growth first, followed by strategic acquisitions, and lastly on returning capital to shareholders through dividends or buying back shares. We’ll continue to operate with a conservative balance sheet, using leverage prudently to balance returns with financial resilience and flexibility. 

In fiscal ’19 we anticipate sales of $2.88 billion and earnings per share of $5.25 plus or minus 20 cents.  As usual, we anticipate a somewhat slow start to the year with Q1 earnings per share of $1.15 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 $32 million.  For all of 2018, free cash flow was $8 million including $85 million of incremental funding to our U.S. defined benefit pension plan. This compares with net earnings for 2018 of $97 million. To keep this in perspective, I’d like to share two points. First, despite a relatively soft 2018, our free cash flow conversion has averaged 114% since 2012.  And second, we’ll see a noticeable rebound in 2019.

Coming into Q4, we were forecasting a better free cash flow finish to the year. The shortfall is explained by a combination of net working capital demands and tax refunds. While net working capital as a percentage of sales actually came down 30 bps from 90 days ago, in hindsight, we were simply too optimistic in forecasting a more significant reduction.  We were also expecting that certain tax refunds would be received before year-end, but they slipped into 2019. 

As we look ahead to 2019, we’re expecting free cash flow of $185 million, or a conversion ratio of 100%. Our forecast is helped by lower ongoing pension contributions because of our accelerated funding strategy, and by the tax refund that we thought we’d receive in 2018.  However, our outlook is tempered by an anticipated decline in customer advances in addition to more working capital needed to support our topline growth.

Our year-end Net Working Capital (excluding cash and debt) as a percentage of sales was 24.9% compared with 25.2% both last quarter and a year ago. Over the better part of the last decade, we’ve reported a rather steady decline in this working capital metric since we peaked at almost 34% of sales in 2009. In 2019, we believe we’ll see a continuation of this trend.

The $8 million of Free Cash Flow for the year compares with an increase in our net debt of $148 million. The $156 million difference relates primarily to the following:

·      We repurchased one million shares of Moog stock at $75.74 per share from our DB pension plan, completing our de-risking strategy,

·      $70 million for acquisitions that we completed earlier in the year, and

·      $18 million for two quarterly cash dividend payments that began in June.

Capital expenditures in the fourth quarter were $24 million and depreciation and amortization totaled $20 million. For all of 2018, CapEx was $95 million while D&A was $89M.  2019 will look nearly identical to 2018 as we’re forecasting $95 million of CapEx with D&A of $89 million.  We believe that our normal, sustaining level of CapEx is between 3% and 4% of sales.  In 2019, our spend rate will be within that range.

Cash contributions to our global retirement plans totaled $6 million in the quarter resulting in $181 million of contributions for all of 2018. This compares with $93 million for 2017. We’ve described how we accelerated a total of $85 million of contributions into our U.S. DB Pension Plan from future years into this year. This resulted in total 2018 contributions for our U.S. DB Plan of $145 million. Our U.S. DB Plan is now fully funded relative to our Projected Benefit Obligation. Accordingly, we won’t be making any further cash contributions to this Plan for the foreseeable future. For 2019, we’re planning to make contributions into our global retirement plans totaling $34 million. Global retirement plan expense in 2018 was $57 million compared with $64 million in 2017.  In 2019, our expense for retirement plans is projected to be $62 million.

I’d like to explain why we’re expecting our global pension expense for 2019 to increase compared to 2018 after having accelerated $85 million of funding to the U.S. DB Plan.  This may sound counter-intuitive since having more assets in the Plan should, in isolation, result in a greater return and, therefore, less expense. However, we contemporaneously pursued a de-risking investment strategy that resulted in more of our plan assets being invested in lower-risk instruments with lower returns. This Liability-Driven Investment strategy lowers the overall return on all Plan assets and offsets the benefit of having more assets in the Plan. The de-risking strategy was absolutely the right thing to do particularly because of the limited availability of related tax savings, in addition to mitigating our exposure to volatile equity and debt markets.  Importantly, our future U.S. DB plan expense will be a non-cash cost.

Part of the U.S. DB Plan’s de-risking strategy involved the Plan Trustees’ desire to further diversify the Plan’s assets that total about $900 million. Accordingly, in August, we were able to buy back the Pension Plan’s holdings in Moog stock which totaled about one million shares for just under $76 per share. This results in one million fewer shares outstanding for EPS purposes. The plan now has about 80% of its assets invested in fixed income securities and about 20% in a diversified portfolio of equities. This portfolio mix reduces future volatility on the P&L.

Our Q4 effective tax rate of 26.7%, compares with last year’s Q4 tax rate of 20.8%. Last year’s low rate was affected by a benefit related to the utilization of a Net Operating Loss for a business restructuring that took place earlier in the year.  For all of 2018, our effective tax rate was 47.4%.  When we remove the one-time effects from Tax Reform and wind restructuring in 2018, our adjusted 2018 effective tax rate related to our core operations was 25.1%.

The unadjusted GAAP effective tax rates for 2017, 2018 and 2019 are 22.7%, 47.4% and 26.0%.  For both 2018 and 2017, these rates are affected by special events that won’t repeat. These events included the 2018 impact of one-time effects from Tax Reform, as well as business restructurings and divestitures in both years.  Removing all of this confusion, the comparable tax rates for 2017, 2018 and 2019 are 30%, 25% and 26%, respectively. The decrease from 2017 to 2018 is largely the result of the reduction in U.S. corporate tax rates from 35% to 21%.  The increase from 2018 to 2019 results primarily from the timing of when certain elements of the Tax Reform legislation take effect which are offsetting the full-year benefit from the lower 21% corporate rate.  Specifically, beginning in 2019, the new GILTI tax on offshore earnings as well as a reduced federal domestic manufacturing credit will negatively affect us.  To reiterate, we’re forecasting 2019’s tax rate at 26.0%.

Our leverage ratio (Net Debt divided by EBITDA) was 2.2x compared with 1.8x a year ago as we allocated capital to accelerate our pension funding, buy companies and pay dividends.  Net debt as a percentage of total capitalization was 38%, up from 33% last year.  At quarter-end, we had $437 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2021.  And our $300 million of 5.25% high-yield debt matures in 2022.

At the end of December 2017, we had just under $400 million of cash on our balance sheet and most of that was offshore. At the end of September 2018, our cash balance is down to $126 million. We used $64 million of this cash for our second quarter acquisition of VUES Brno headquartered in the Czech Republic.  In addition, over $200 million of this decrease results from our Treasury team doing a great job in orchestrating the repatriation of offshore cash to the U.S. which has been used to pay down our outstanding revolver.  We’re targeting to get to a cash balance of around $85 million in the coming few quarters.  This cash repatriation has no impact on our leverage as our net debt position is unchanged.  As far as the associated interest savings from paying down our debt, it will not be apparent on our P&L in 2019. Interest expense for 2019 is forecasted to be $37 million compared to $36 million in 2018, the result of higher rates on a lower outstanding balance.

There are two accounting changes that we’ve incorporated into our 2019 forecast that don’t have a material impact on the numbers.  First, we will adopt ASC 606 for Revenue Recognition in 2019.  Our 2019 forecast reflects our best estimates of what the results will be under the new accounting rules. We wanted you to know that we believe that our comparability is not materially affected.

The second change is the new presentation of pension expense as required by the new standard. Beginning in 2019, we will now be showing “non-service related pension costs” below the operating profit line. We estimate this “below the line” element of pension costs to be $13 million in 2019 compared with $7 million in 2018.

2018 was a noisy year with Tax Reform and wind-related restructuring activity.  We did our best to help the investor focus on core earnings from operations which reflect, what we believe was, a very respectable year.  We’re anxious to begin 2019.  Sales will be up 6% organically with an EPS midpoint of $5.25, up 15% when compared to adjusted 2018 EPS of $4.57. Operating margins will be 11.7% compared with adjusted margins in 2018 of 10.9%.  Free cash flow will return to a more normal 100% conversion and we’ll continue to responsibly deploy capital, including our disciplined search for strategic acquisitions. The business is doing well and we’re looking forward to the future.

With that, I’d like to turn you back to John for any questions that you may have.