FY18 Q3 Conference Call, Fiscal Year 2018
(INTRODUCTION FOR CONFERENCE CALL)
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 July 27, 2018 our most recent Form 8K filed on July 27, 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 home page and webcast page at www.moog.com
Good morning. Thanks for joining us. This morning we’ll report on the third quarter of fiscal ‘18 and update our guidance for the full year. Our business continues to perform well and we remain on track to meet our original full-year EPS target. Last quarter we recalibrated our listeners to our target of $4.40/share – a number which excludes the wind restructuring and the one-time impact of tax reform, but includes the effect of the on-going lower tax rate. This quarter, we have a relatively simple story – a relief after a couple of quarters of major tax and restructuring adjustments.
As usual, I’ll start with the headlines.
1) On the technical front, The Embraer E-2 jet entered service in April 2018, equipped with the Moog primary flight control system. This event represents another milestone achievement in our commercial aircraft growth strategy.
2) It was another good quarter with double digit sales growth and earnings per share of $1.13, slightly ahead of our guidance of $1.10 from 90 days ago. Free cash flow was light in the quarter, the result of strong sales growth and higher pension contributions.
3) We paid our first quarterly dividend since the 1980’s on June 1st, and today we announced our second quarterly dividend of $0.25 per share.
4) We fully funded of our US DB pension plan this quarter. This plan was closed to new entrants, but not frozen, back in 2008. Now a decade later, we’ve achieved a funding level which should eliminate the need to further fund the plan in the foreseeable future.
5) Finally, across the portfolio, our markets continue to perform well. Talk of trade wars and a hard Brexit are concerns, but for the moment, business conditions remain positive.
Now let me move to the details starting with the third quarter results.
Q3 Fiscal ‘18
Sales in the quarter of $692 million were 11% higher than last year. Stronger foreign currencies combined with sales from acquired businesses made up about a third of the increase, with underlying organic growth running over 7%. Sales were up in each of our operating groups, with particularly strong organic growth in the Space and Defense group. Taking a look at the P&L, our gross margin was lower than last year on a negative sales mix and increasing pricing pressure across our military book of business. R&D was lower as our major aircraft programs continue to ramp down. Similar to last quarter, SG&A expense is running higher this year on additional selling activity, acquisition-related expenses and higher employee healthcare costs. Earnings before taxes are up 14% from last year, but our tax rate was almost 900 basis points higher than an unusually low quarter last year. The overall result was net earnings of $41 million and earnings per share of $1.13, up from $1.11 last year and slightly above the midpoint of our guidance for the quarter of $1.10.
Fiscal ’18 Outlook
With one quarter left to go, we’re adding $20 million to our sales forecast to
bring our full-year projection to $2.7 billion. Excluding the impacts of the wind restructuring and tax reform, we’re increasing our adjusted EPS forecast slightly
to $4.42, plus or minus 10 cents. Unadjusted, our full year GAAP EPS will be $2.67, plus or minus $0.10.
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.
Sales in the quarter of $300 million were 6% higher than last year. On the military side, sales on the F-35 were almost 40% higher on accelerating production activity associated with LRIP 11. Sales on other OEM programs were off slightly from the same quarter last year while the military aftermarket was up on higher F-18 and
On the commercial side, sales to both Boeing and Airbus were down from last year. Sales for the 787 program were in line with last year, but 777 deliveries are down 30% as legacy aircraft deliveries wind down. Airbus sales were down slightly on the A350 associated with the timing of deliveries. Overall, sales to business jet customers were in line with last year. The commercial aftermarket continues to show strength with sales up over 20%, driven primarily by continued strength in initial provisioning for the A350.
Aircraft Fiscal ‘18
We’re keeping our full year sales forecast unchanged from 90 days ago at $1.2 billion but we’re refining the mix in the commercial sector slightly. We anticipate sales on OEM programs will be about $10 million lower than our forecast from 90 days ago while sales into the commercial aftermarket will be about $10 million higher.
Margins in the quarter were 11.1%, up 80 basis points from the same quarter last year. Increased margins were the result of lower R&D, partially offset by a lower gross margin and higher SG&A expenses. Our gross margin was down from last year on a less favorable sales mix in commercial OEM and pricing pressures across the military book. SG&A expenses are up as we invest additional resources to find new avenues of growth, both organic and acquired. For the full year, we’re lowering our forecast for R&D by $7 million and increasing our operating margin forecast to 10.8%.
Space and Defense
Space and Defense Q3
Sales in the quarter of $150 million were up 17% from last year. This quarter we recorded nice increases in both our space and defense portfolios. On the space side, it’s a similar story to last quarter. Sales of avionics products were almost double the level of Q3’ fiscal 17. Over the last 2 years, we’ve won significant avionics content on new military platforms as the DoD places increased emphasis on space capabilities. We also continued to see strength in our launch products, in particular, activity at NASA for the SLS and Orion programs.
After a relatively slow first half of the year, defense sales were up 15% this quarter. We enjoyed higher component sales across a broad range of applications. In addition, sales of security products were more than double the level of a year ago. The increase was a combination of higher sales on legacy pan & tilt systems, including aftermarket activity on the DVE program, as well as sales from the acquisition of Electro-Optical Imaging (EO Imaging), which we completed early in the quarter. EO Imaging is a small company, located in Florida, which has developed UAV tracking systems. Their technology adds to our growing capability in tracking and eliminating the threat of Unmanned Aerial Vehicle (UAV) systems in the field. The acquisition added $4 million of sales in the quarter.
Space and Defense Fiscal ‘18
With one quarter remaining, we’re increasing our forecast for defense sales by $20 million while keeping our space forecast unchanged from 90 days ago. Defense sales will be higher as a result of the Q3 acquisition and a recent win on a new military vehicle program.
Space and Defense Margins
Margins in the quarter of 11% were up 100 basis points from last year. For the full year, we’re increasing our margin forecast slightly to 11.8% on the higher sales forecast.
Industrial Systems Q3
Sales in the quarter of $243 million were up 13% from last year. The increase is roughly 40% acquired sales, 40% organic growth and 20% forex driven. At the end of the second quarter, we closed on the acquisition of VUES Brno, a company located in the Czech Republic that specializes in large motors. Large motors are a key component in helping our customers in certain markets transition from hydraulic to electric motion control solutions. The acquisition of Brno gives us a complementary capability to our in-house products and brings a cost effective manufacturing capability in Eastern Europe. For the fiscal year, the acquisition adds about $20 million in sales.
In total, we saw strong growth in 3 of our 4 major markets: energy, industrial automation and medical. In the energy market, sales into non-renewable applications were up as higher oil prices drove a modest recovery in exploration investment. We also saw a nice increase in products sold to makers of power generation equipment in the Pacific. Wind sales were up marginally from last year as we ship our backlog of customer orders before the end of this fiscal year. Industrial automation sales were also up as the global economies continue to invest in new capital. Sales into medical markets were up for both our pumps and component product lines. Finally, simulation and test sales were down from an unusually strong third quarter in fiscal ’17.
Industrial Systems Fiscal ‘18
We’re keeping our sales forecast for the full year unchanged from 90 days ago at $934 million. Some of our simulation & test customers have pushed out their demand into next fiscal year, but these sales will be compensated by slightly higher sales in each of our other 3 markets.
Industrial Systems Margins
Margins in the quarter of 10% were about in line with last year. In the quarter, we took a charge on a long-running program in our simulation & test business which depressed margins by 100 basis points, and, in addition, we added $1 million to the restructuring reserve for our wind exit plan. For the full year, we’re moderating our margin forecast to 6.7% to take account of slightly higher anticipated costs to exit the wind pitch control business. We’re on schedule to complete our facility wind down by the end of our fiscal year and we’ll true up the final numbers when we report out in Q4. Full year margins, exclusive of restructuring, will be 10.2%, more or less in line with fiscal ’17.
Q3 continues our pattern of good performance this year with earnings per share coming in above the midpoint of our guidance. In our Aircraft business, military programs are showing signs of strength and the commercial aftermarket is ahead of our expectations. Commercial OEM deliveries are level with last year, although the mix is moving against us as sales on new programs replace more profitable legacy production programs, particularly the 777. Company funded commercial R&D continues to moderate, replaced in large part by customer funded military R&D. Our Space & Defense business is enjoying the increased US investment in Space assets, identified as the next military battlefield, and we’re gaining traction on some new military vehicle programs which bode well for the future. Finally, our industrial markets continue strong on the back of good GDP growth in the major economies around the globe. Trade wars and a potential hard Brexit are concerns on the horizon but as yet we have not seen any significant impact. Our wind exit strategy is on schedule to be essentially completed by the end of next quarter. Finally, Q3 was the first quarter of sales for both our Brno acquisition and our EO Imaging acquisition. Both of these bolt on acquisitions bring us key technologies in select growth markets, large motors and UAV tracking, respectively.
Full year fiscal ’18 earnings per share are projected to be $2.67, plus or minus 10 cents. This now includes $0.74 of negative impact for the wind restructuring and $1.01 of negative impact from the one-time impacts of tax reform. Adjusting for these effects, our EPS forecast is up slightly from 90 days ago at $4.42, plus or minus 10 cents. For the fourth quarter, we anticipate earnings per share of $1.12, plus or minus 10 cents.
Now let me pass you to Don who will provide more details on our cash flow and balance sheet as well as additional color on our pension funding and tax rate.
Thanks, John. Good morning.
Free Cash Flow for Q3 was a use of funds totaling $26 million. YTD, our Free Cash Flow is a use of funds of $24 million. Included in these numbers are YTD contributions of $175 million to our global pension plans compared with last year’s $74 million. You’ll recall our strategy to accelerate U.S. DB pension funding because of the December 2017 changes in the U.S. tax law which fit nicely with our pension de-risking strategy. We’re forecasting a much stronger Q4 which will result in Free Cash Flow for all of 2018 of $55 million. This is a reduction of $20 million from our forecast last quarter due primarily to tax-related estimates. As we look ahead into 2019, we expect Free Cash Flow conversion to be closer to our longer-term target of 100% of net earnings.
Net debt increased $51 million compared to Free Cash Flow usage of $26 million. The $25 million difference relates to:
· the payment in June of our first quarterly dividend consuming $9 million of cash;
· $5 million used to acquire the small counter-UAS business mentioned previously by John that complements our security business strategy, and
· the effects of currency translation on our cash balances.
Net Working Capital (ex cash and debt) was 25.2% of sales at the end of Q3, comparable with last year’s 24.7%.
Our Q3 effective tax rate was 25.8%, close to the 27.4% tax rate that we forecasted last quarter for the second half of the 2018, and compares with last year’s Q3 tax rate of 17.0%. Last year’s unusually low rate was affected by tax benefits associated with a disposition. YTD, our 2018 effective tax rate is 56.4%. When we remove the one-time Tax Reform and wind restructuring effects, our YTD Q3 effective tax rate related to our core operations was 26.5%. We’re now forecasting our GAAP tax rate to be 47.7% for all of 2018 with everything included, essentially unchanged from last quarter’s forecast. Our 2018 adjusted effective tax rate related to core operations, again, after removing the one-time effects of tax reform and wind, will be 26.8%. Similar to our comments last quarter, our updated preliminary look at 2019 suggests that our effective tax rate will be in the 25.5% realm as we benefit from a full twelve months of the lower U.S. corporate tax rate.
Capital expenditures in the quarter were $27 million while depreciation and amortization totaled $23 million. YTD, CapEx was $71 million while D&A was $68 million. For all of 2018, our CapEx forecast remains unchanged at $95 million. We’ve got a couple of facility expansion projects this year that are driving a slight increase in CapEx relative to recent years. D&A in 2018 will be about $90 million.
Cash contributions to our global pension plans totaled $75 million in the quarter compared to last year’s third quarter of $33 million. For all of 2018, we’re planning to make global retirement plan contributions totaling $183 million, nearly unchanged from our forecast 90 days ago. We’ve described how we’ve accelerated a total of $85 million of contributions into our U.S. DB Pension Plan from future years into this year, $35 million of which happened in Q3. This results in total 2018 contributions for our U.S. DB Plan of $145 million, all of which has happened as of the end of Q3. 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 U.S. DB Plan for the foreseeable future.
Global retirement plan expense in the quarter was $15 million, compared to last year’s $16 million. Our global expense for retirement plans is projected to be $59 million for 2018, down from last year’s $64 million.
Our leverage ratio (Net Debt divided by EBITDA) increased to 2.18x at the end
of Q3 compared with 1.92x a year ago. Net debt as a percentage of total
capitalization was 35.8%, almost unchanged from a year ago. At quarter-end, we had approximately $450 million of available, unused borrowing capacity on our $1.1 billion revolver that terms out in 2021.
At the end of the first quarter, we had just under $400 million of cash on our balance sheet and most of that was offshore. At the end of Q3, our cash balance is down to $157 million. $144 million of this decrease results from the repatriation of offshore cash to the U.S. which has been used to pay down our outstanding revolver. We also used $64 million of cash for our second quarter acquisition of VUES Brno headquartered in the Czech Republic. Our plan is to repatriate an additional ~$100 million by the end of calendar 2018. This cash repatriation has no impact on our leverage as our net debt position is unchanged.
With respect to capital deployment, we announced on March 15th that we would be initiating a quarterly dividend of $.25 per share starting on June 1st with a yield of about 1.2%. Today, we announced that we’re paying our second quarterly dividend of $.25 per share on September 4th to shareholders of record on August 15th. The quarterly cash cost is about $9 million. Top-line growth and margin expansion continue to be a priority, including acquisitive growth. We remain active and disciplined as we evaluate acquisition opportunities that will complement our business strategies.
In summary, despite all of the noise in our 2018 YTD numbers from Tax Reform and restructuring activities, our core business is performing well and consistent with our earnings forecast at the start of the year.
With that, I’d like to turn you back to John and open it up for any questions you may have.