Fourth Quarter and Year End Conference Call, Fiscal Year 2014

October 31, 2014

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 October 31, 2014, our most recent Form 8K filed on October 31, 2014 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

Introduction - John Scannell

Good morning. Thanks for joining us. This morning we’ll report on the fourth quarter of fiscal ’14 and reflect on our performance for the full year. We’ll also reaffirm our guidance for fiscal ’15. 

Fiscal ’14 was a very respectable year for the company, given the challenging market conditions we faced. Earnings were up and cash flow was very strong.  Folks around our company put in a tremendous effort to deliver on our commitments to both our customers and our investors, and, at the outset of this call, I thank them for their hard work and dedication.

Now to the headlines.


First, earnings per share in the quarter, excluding restructuring, came in very close to plan.

Second, during the quarter, the outlook for some of our markets weakened. We responded swiftly with restructuring actions to right-size the business to meet our fiscal ’15 projections. 

Third, it was another quarter of very strong cash flow, to close out a year of record cash flow. 

Fourth, we completed the first phase of our share buyback program in the quarter, ahead of our plan. 

Finally, we’re reaffirming our guidance for fiscal ’15 at $4.25 per share. 

Now let me move to the details starting with the fourth quarter results. 

Q4 Fiscal ‘14

Sales in the quarter of $671 million were down 1% from last year. Sales in our Aircraft and Components segments were up while sales in our other three segments were down from last year. Taking a look at the P&L, our gross margin is up on a slightly better mix and continued focus on cost reductions. R&D is up in the quarter on higher aircraft activity while total G&A expenses are also up marginally. We incurred $13 million of restructuring expense in the quarter, mostly in our Aircraft and Space & Defense segments. Our effective tax rate was relatively low at 25.2%, helped by the fact that the majority of the restructuring cost is in high-tax jurisdictions. The overall result was net earnings of $40 million and earnings per share of 93 cents. Excluding the effect of restructuring, earnings per share was $1.12.

Fiscal '14 and '15 Outlook

Fiscal ’14
For the full year, sales were up 1%, or about $40 million. Aircraft sales were up 5% while sales in Space & Defense, Industrial and Components were more or less flat. Sales in our Medical Device segment were down 18% from last year. Net earnings and earnings per share were up over 30% from last year. However, fiscal ’13 included a couple of unusual non-cash charges in our Medical segment.  Exclusive of these charges, earnings per share in fiscal ’13 were $3.26, which compares with earnings per share of $3.52 in fiscal ’14, an 8% increase. The performance of our underlying operations was very comparable between fiscal ’13 and ’14, but lower interest costs and our share buyback program in fiscal ’14 resulted in higher earnings per share. Free cash flow for the year of $208 million was up 32% from last year.   

Before moving to fiscal ’15, let me provide a little more color on the restructuring charges we took in our fourth quarter. On our July earnings call, we told the market we were anticipating restructuring charges of $5 million, or 7 cents per share in our Q4 numbers. At that time, our planned restructuring was confined to our Aircraft Segment. As the fourth quarter unfolded, the outlook for our space business started to weaken, and, in response, we broadened our restructuring actions to include the Space and Defense segment. In total, we incurred $13 million or 19 cents per share in restructuring charges in the quarter. $11 million of this cost relates to severance, while $2 million relates to decisions to exit a couple of product lines. I’ll provide a bit more detail on these decisions when I discuss the Industrial Systems and Medical Devices results.

Fiscal ’15 Outlook
We’re affirming our earnings forecast for fiscal ’15 at $4.25 per share. Sales will be up about 1% over fiscal ’14 with sales in each segment pretty much in line with this year. In fiscal ’15, we’re anticipating operating margins of 11.5%. Improvements in our Space and Defense and Industrial segments are driving the increase. Margins in Aircraft and Medical will be about flat with fiscal ’14, while margins in our Components segment will be slightly lower. We anticipate another year of healthy free cash flow.  

Now to the segments.

Aircraft Controls

Aircraft Q4

Sales in the quarter of $283 million were up 3% from last year. As in past quarters, commercial sales drove the increase, with military sales about flat with last year.  Sales to Airbus were up on the A350 ramp. Commercial sales to Boeing were flat with last year, a combination of higher 787 sales and lower legacy sales. Business Jet sales had an unusual spike this quarter as we closed out an old program.  Commercial aftermarket sales were up nicely on continued strong 787 initial provisioning.  

On the military side, sales to foreign militaries were up nicely in the quarter, compensating for lower F-35 development sales and lower sales on various helicopter programs. Despite the continued pressures on U.S. defense spending, our military aftermarket was relatively strong, down only slightly from last year. 

Aircraft Fiscal ’14

Fiscal ’14 was another record sales year for our Aircraft business. Sales topped $1.1 billion, almost evenly split between military and commercial. This compares with almost two thirds military and only one third commercial just 4 years ago.  Over that 4-year period, military sales have grown 18% while commercial sales have more than doubled.  Sales growth in fiscal ’14 was all on the commercial side, with sales to Boeing and Airbus up over 20% and commercial aftermarket sales up 16% on 787 initial provisioning.  Military sales were down 4% in fiscal ’14, mostly driven by lower F-35 development revenues and reduced work on the V-22. 

Aircraft Fiscal ’15

We’re keeping our sales forecast for fiscal ’15 unchanged from 90 days ago.  Total sales of $1.1 billion will be marginally lower than fiscal ’14. Continued growth in commercial OEM will compensate for slower military sales. We’re anticipating a weaker commercial aftermarket as the 787 initial provisioning slows from a banner year in fiscal ’14.  We believe ’14 was an outlier for IP and that fiscal ’15 could be much slower as our customers adjust their inventory holdings based on the fleet growth. 

Aircraft Margins

Margins in the quarter were 9.8%. These margins included $5 million in restructuring charges.  Margins, exclusive of restructuring were 11.7%. Margins for the full year were 10.8% excluding restructuring. These margins are down from 12% in fiscal ’13. Last quarter we explained the shift in outlook for our Aircraft margins. Let me remind you of the 3 elements which have impacted the margins in fiscal ’14 and which will continue next year. First, our R&D costs are running ahead of what we had planned 12 months ago, driven by the A350 certification process and the accelerated ramp up on the Embraer E-2 program.  Second, margins in our military business are coming under increased pressure domestically and we’re seeing a less favorable mix with lower sales on foreign military platforms. Finally, the production ramp up on new commercial programs is proving more expensive than we had expected. We’re in the early stages of building our commercial portfolio, with significant OEM sales on new platforms and the aftermarket less than a quarter of our sales. As this book of business matures, the margins will also improve. 

Looking to fiscal ’15, these margin headwinds will continue to weigh on our performance.  Therefore, we’re moderating our margin forecast for fiscal ’15 to 10.5%, more or less in line with our fiscal ’14 performance.

Space and Defense

Space and Defense Q4

Sales in the quarter were down 6% from last year. The weakness was all in the satellite market where we saw a slowdown in activity across our components, engines and avionics businesses. Our satellite business is going through a cyclical down turn at the moment which we believe will extend into 2015. Sales in our space business are subject to 2 cyclical effects. First, the sales mix between development and production contracts, and second, the success of our customers in winning new programs. We have seen these cycles in the past and we’re now adjusting our cost structure going forward in light of the lower sales outlook.  On a positive note, sales in the defense market were up nicely in the quarter driven by higher volumes on our missile programs. 

Space and Defense Fiscal ’14

Total sales in fiscal ’14 of $395 million were flat with last year. Sales were flat in both the space and defense markets. In the space market, higher sales to NASA compensated for lower satellite sales. In the defense market, higher missile and security sales compensated for lower sales on military vehicles.  

Space and Defense Fiscal ’15

Given the sales weakness we have seen in the space market over the last few quarters, we’re moderating our forecast for fiscal ’15 by $15 million. The reduction is about half in the satellites market and the other half in the launch vehicle and NASA market. We’re keeping our defense forecast unchanged from 90 days ago. The result is total sales for fiscal ’15 of $403 million, up very slightly from this year. Space sales will be lower but we’re anticipating higher defense sales on strength in the missiles market as well as improving sales on foreign military vehicle programs. 

Space and Defense Margins

Margins in the quarter were a very disappointing 60 basis points. Exclusive of restructuring, margins were 6.2%. We had been anticipating higher sales in the quarter, and significantly better margins. The sales shortfall relative to our forecast from 90 days ago was across all markets. Anticipated bookings on various programs did not materialize. The lower sales drove the lower margins.  We had been forecasting an improving sales picture for several quarters, but we have now concluded that we need to adjust our cost structure downward to reflect the actual sales level we’re seeing each quarter. As a result, we took a restructuring charge of $5 million in the quarter. We believe this lower cost structure will enable us to meet the operating profit target we set 90 days ago for fiscal ’15 of $43 million, to yield an operating margin of 10.7%. 90 days ago for fiscal ’15 of $43 million, to yield an operating margin of 10.7%. 

Industrial Systems

Industrial Systems Q4

Sales in the quarter of $148 million were down 3% from last year. Wind energy sales were up nicely in the quarter with stronger sales in both China and Brazil.  Sales to our flight simulation customers were 22% lower in the quarter as these customers continued to adjust their inventory levels. We believe we’re nearing the end of this inventory adjustment phase and have new orders in house to support our forecast of higher sales to these customers in fiscal ’15. Industrial automation sales were flat with last year. 

Industrial Systems Fiscal ’14

Full year sales of $591 million were flat with fiscal ’13 although there was a slight change in the mix. The story for the year is similar to the story of the quarter.  Wind energy sales were up with stronger sales in China and Brazil. Industrial automation sales were up as our European business improved. On the downside, sales in the flight simulation market were down as our customers worked down the inventory they built up in fiscal ’13. 

Industrial Systems Fiscal ’15

We’re adjusting our fiscal ’15 sales outlook as a result of the recent strengthening of the U.S. dollar. Much of our industrial sales are in Europe and the recent run up in the dollar relative to the Euro has a negative translation effect of approximately $15 million on our sales outlook for next year. On a positive note, over the last 90 days we believe the demand for our products has firmed somewhat. Combining these effects, results in an $8 million reduction in our sales outlook for next year. The reduction is all in our Industrial automation market. The result is total Industrial System sales in fiscal ’15 of $600 million, up about 2% over this year. 

Industrial Systems Margins

Margins in the quarter were 9.5%. There were 2 unusual items which negatively affected margins. First, as part of our on-going portfolio review, we decided to stop our sales activities in the semiconductor market. As a result, we took a non-cash charge in the quarter, equivalent to 75 basis points of margin. We entered the semiconductor market back in fiscal ’09. Over the last 5 years the market has not developed as we had anticipated and, with minimal sales, we have decided to focus our attention on more promising areas going forward. Second, in the quarter we took a reserve for a quality issue. The issue is associated with one particular application and is limited to a specific customer. The reserve equates to 175 basis points of operating margin. Exclusive of these unusual items, margins in the quarter were 12%. 

Margins for the year were 9.8%. These margins include several one-time charges we made over the course of the year as we continued to clean up the portfolio of product lines. These charges equated to about 150 basis points of margin headwind. 

In fiscal ’15 we’re projecting margins of 12.1%. The improvement over fiscal ’14 will be driven by the absence of special charges and our continuing cost containment activities.   

Components Group

Components Q4

Sales in the quarter were up 6% from last year. Non A&D sales were up 8% in the quarter as shipments into the energy market continued strong.  Sales on the A&D side of the house were also up this quarter. In the aircraft market, we had some nice international aftermarket orders. On the other hand, component sales for military vehicles were lower in the quarter – a trend we have seen for several years now. 

Components Fiscal ’14

For the full year, sales were up 2%. The increase was driven by higher sales in the Industrial market as a result of our acquisition of Aspen Motion Technologies half way through fiscal ’13. Higher industrial sales compensated for lower sales across our A&D markets, with particular weakness in the military vehicle markets. 

Over the last 4 years, our Components Group has managed through a significant shift in their sales mix. In fiscal ’14, total sales were $425 million, of which only 42% were into the A&D markets. In fiscal ’10, total sales were $360 million, 63% of which were into the A&D markets. Over this 4 year period, our A&D sales have declined 21% while our sales into non-A&D markets have increased 87%.    

Components Fiscal ’15

Our forecast for fiscal ’15 is unchanged from 90 days ago.  We’re projecting total sales of $440 million next year – a 3% increase over fiscal ’14. In the A&D markets, we believe we’ll see slightly stronger defense sales as some of our missile programs ramp up and international sales on military vehicles increase. In the non-A&D markets we anticipate further growth in our general industrial category as the U.S. economy continues to improve. 

Components Margins

Margins in the quarter were 16.7%, resulting in full year margins of 15.3%. For fiscal ’15 we’re projecting margins of 14.8%, unchanged from 90 days ago.

Medical Devices

Medical Q4

Our Medical segment continues to perform well, despite some significant sales headwinds. Sales in the quarter of $32 million were down $7 million from last year. Sales of pumps and in our “other” category were flat with last year but set sales were off $7 million in the quarter. Last year’s fourth quarter included a significant stocking order for enteral sets from one of our major distribution partners. This did not repeat this year. 

Medical Fiscal ’14

For the year, sales were down 18%. One third of the decline is due to the divestiture of the Buffalo Ethox operation which we completed in the third quarter of fiscal ’13. The other two thirds is primarily due to lower set sales. As mentioned already, fiscal ’13 set sales benefited from an unusual stocking order in the fourth quarter, while fiscal ’14 sales were lower as our partner worked down this inventory. 

Medical Fiscal ’15

Full year sales in fiscal ’15 are projected to be $120 million, in line with our fiscal ’14 sales. We anticipate higher set sales will compensate for lower sales in our “other” category. 

Medical Margins

Margins in the quarter were 10.1% to yield full year margins of 8.8%. In the quarter we incurred a $1 million charge related to exiting an old product line.  Absent this charge, margins in the quarter were 14.1%.  Given the challenges this business faced during the year, this is an impressive result. For the first half of fiscal ’14, the management team was focused on supporting the divestiture process which distracted from the day to day operations. When the divestiture did not complete in March ’14 as planned, the second half of the year involved significant reorganizing. On top of these challenges, sales in the year were down 18% from fiscal ’13. Despite these headwinds, operational performance was over $2 million better in fiscal ’14 than fiscal ’13.  

For fiscal ’15, we’re projecting full year margins of 8.8%, in line with the fiscal ’14 results.

We anticipate that it will take us another couple of quarters to stabilize this business in preparation for a return to the market in the second half of fiscal ’15. 

Summary Guidance

With fiscal ’14 behind us, we’re looking forward to a stronger fiscal ’15. We’re forecasting full year sales next year of $2.66 billion, up 1% from fiscal ’14.  Commercial aircraft OEM sales will continue to grow nicely next year - up 9% over fiscal ’14. However, aircraft sales in total will be 2% lower on weaker military and commercial aftermarket sales. We’re forecasting 2-3% increases in sales in our Space & Defense, Industrial and Components segments. We think Medical sales will be flat with fiscal ’14. We’re projecting net earnings of $180 million and net margins of 6.8%. Earnings per share of $4.25 will be up 21% over fiscal ’14. We’re also forecasting another strong year of free cash flow with a conversion ratio over 100%. As usual, we think the year will start out slowly with earnings in the first quarter of $.85.

As always our forecast does not include any projection for future acquisitions.  Fiscal ’14 was a quiet year for acquisitions, but we continue to look for adjacent opportunities which meet our strategic and financial goals. With patience, we believe the right opportunities will come along and our strong financial position will allow us to move quickly. In the meantime, as we continue to generate excess cash, we’ll continue our share repurchase program. Note that our $4.25 outlook for fiscal ’15 does not include any impact from additional share repurchases that we might undertake during the coming fiscal year, nor does it include any impact from financing decisions we might make in support of additional repurchases. We’ll report on these items again at the end of our first quarter.

As we look to fiscal ’15, our focus remains unchanged. Our goals are growth, margin improvement and strong cash generation. We’ll continue to invest in R&D to drive long-term organic growth and will continue to seek adjacent acquisitions. We’ll continuously review our portfolio of product lines to ensure we’re following a strategy which maximizes long-term value creation and enhances margin performance. We’ll promote lean techniques to increase our cash flow and improve our returns on capital. Finally, we’ll consider all capital allocation decisions in the light of long-term shareholder returns.   

As always there are both opportunities and risks associated with our fiscal ’15 outlook. On the opportunities side, we could see a pickup in our global industrial markets and the commercial aftermarket may be stronger than we’re forecasting. On the risks side, defense spending remains a concern and meeting our production cost targets on our new commercial aircraft programs will continue to be a major area of focus. The recent drop in the price of oil could also negatively impact our off-shore energy business.  The forecast we have provided balances these pluses and minuses.  

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.

As John’s already described, we had an impressive year for cash flow. Our strong fourth quarter resulted in Free Cash Flow for the year of $208 million, or a conversion ratio (free cash flow divided by net earnings) of 132%. Coming into fiscal 2014, we had projected free cash flow of $165 million assuming $51 million of pension contributions. We actually contributed $80 million to our global defined benefit pension plans as we made discretionary incremental contributions.  And despite the higher pension contributions, we ended with free cash flow that was significantly stronger than our original projection. The $208 million of 2014 free cash flow compares with an increase in our net debt in fiscal 2014 of $91 million. The difference relates primarily to $266 million of cash used to repurchase Company stock during the year.

In addition to our capital expenditures being lower this year than in recent years, we’ve also had success managing down our working capital. Working Capital (excluding cash and debt) declined as a percentage of sales by 260 basis points in the last 12 months. This equates to more than $60 million of capital that we’ve freed up from our balance sheet. The improvement is shared between receivables and inventories. For 2015, we’re reaffirming our free cash flow forecast of $190 million, which reflects a cash conversion ratio of 106%.

Our 4 million share repurchase program that we announced in January of
this year was completed as of the end of September. During fiscal 2014, we repurchased 4.0 million shares, representing about 9% of our shares outstanding, at an average per-share price of about $68. In addition, you’ll remember our Board authorized an additional 5 million share buyback in August of this year. We’ll report on the progress of that buyback at the end of our first quarter of fiscal 2015. Also, to reiterate John’s previous comment, our projections for 2015 do not include the impact of any further share buyback activity or related financing strategies.We’ll report them as they occur.

Capital expenditures in the quarter were $21 million and depreciation and amortization totaled $28 million. For all of 2014, CapEx was $79 million, our lowest level since 2010, while D&A was $109 million. For 2015, we’re leaving our CapEx forecast at $100 million, up from 2014 due to increased spending on the Airbus A350 and Embraer E-jet programs to support their production ramp-ups. D&A in 2015 will be about $114 million.

Cash contributions to our global defined benefit pension plans totaled $35 million in the quarter resulting in $80 million of contributions for the full year. This compares with $43 million for all of fiscal 2013. In the latter part of 2014, we decided to make discretionary incremental contributions to the U.S. plan because of our strong cash position. In addition, we made some initial contributions to a trust associated with our German pension obligations in order to utilize some of our idle off-shore cash. For 2015, we’re planning to make contributions into our global defined benefit plans totaling $62 million. Despite these increased contributions to our DB plans over the last couple of years, we’ve been able to report strong free cash flow results. Global pension expense for our DB plans in 2014 was $36 million compared to $51 million in 2013, and our 2015 global DB plan expense is projected to be $42 million. 

Our effective tax rate in the fourth quarter was 25.2%, compared with last year’s 14.8%. Before the tax effects of last year’s goodwill impairment charge, the
Q4 fiscal 2013 effective tax rate was a more normal 30.2%.  The comparatively low rate in 2014’s fourth quarter resulted from the mix of taxable earnings, particularly affected by the larger-than-previously-estimated Q4 restructuring  charge associated with higher tax jurisdictions. For all of 2014, the effective tax rate was 27.7% vs. 27.0% for all of 2013.  For 2015, we’re forecasting an effective tax rate of 30.0%, down slightly from our forecast of 90 days ago. The increase in our rate from 2014 to 2015 results primarily from a less favorable mix of taxable earnings around the globe. More precisely, we’re forecasting our U.S. based taxable income to be substantially higher in 2015 compared to 2014.

Our financial ratios at the end of the fourth quarter are solid. Even after spending $266 million in 2014 to buy back 4.0 million shares, our leverage ratio (EBITDA to Net Debt) was 1.85X compared with 1.56X a year ago. Net debt as a percentage of total capitalization was 32.3%, up from 26.4% last year. 

With respect to M&A, we’ve not had anything to report on in the last 6 quarters.  However, as John noted, we continue to look for strategic opportunities. We consider M&A an important complement to our organic growth objectives and we remain actively looking. Prices are high in some of our markets and deal flow is, on balance, moderate. In the meantime, our shareholders are benefiting from our strategy to return value by buying back some of our shares.

At quarter-end, we had $321 million of unused borrowing capacity on our $1.1 billion revolver that terms out in 2019. We also have an additional $200 million untapped accordion feature with our bank group that is available
for us to exercise at any time.

In summary, we’ve got 2014 in the history books. Sales were $2.65 billion, net earnings were $158 million, net margins were 6.0%, EPS was $3.52 after $.19 per share of restructuring costs, and our free cash flow conversion ratio was 132%. As we look ahead to 2015, we’re projecting an increase in revenues of 1%. Despite this top-line challenge, we believe that with the benefits of the restructuring actions we’ve just taken, we’ll see 2015 operating margins increase by 110 bps (or an improvement of 60 bps ignoring restructuring costs) and earnings per share will be $4.25.  This will reflect an EPS increase over 2014 of 21%.  Although many of the markets we’re in are showing tepid growth or are even declining in some cases such as in defense, we believe the diversity of our portfolio of products, markets, geography, customers and technical capabilities positions us well for any recovery that we’ll see in the markets that we serve. 

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

(Note: The Q and A is not available.)