Good morning and thank you for joining Moog’s first quarter 2023 earnings release conference call. I’m Aaron Astrachan, Director of Investor Relations. With me today is Pat Roche, our new Chief Executive Officer, Jennifer Walter, Chief Financial Officer and Ann Luhr, Manager of Investor Relations. I’m excited to join Ann as we serve the information needs of the investor community.
We’ve taken Pat’s first investor call as an opportunity to update the format of our prepared remarks. Pat will share his perspective on our strategic direction, priorities and the business’s performance, while Jennifer will provide further commentary on the quarter’s results and guidance for the year. You may notice our prepared remarks are shorter than they have been in the past, as we are now focusing on the key drivers of our results.
We released our results earlier this morning. Our results and our supplemental financial schedules are available on our website.
Our earnings press release, our supplemental financial schedules and remarks made during our call today contain adjusted, non-GAAP results. Reconciliations for these adjusted results to GAAP results are contained within the provided materials.
Lastly, our comments today may include statements related to expected future results and other forward-looking statements. These are not guarantees, as our actual results may differ materially from those described in our forward-looking statements, and are subject to a variety of risks and uncertainties that are described in our earnings press release and in our other SEC filings.
Now, I am pleased to turn the call over to Pat…
Hello and good morning to you all.
It is an honor and privilege for me to lead our amazing company. I look forward during this call to share my thoughts on the future and together with Jennifer reflect on a great quarter and a year that is holding together nicely.
Before I proceed, I would like to acknowledge John’s leadership. Over the last 11 years, John has led with passion, conviction, and integrity. Under his guidance, we have become financially stronger, with sales growth from $2.3B to $3.0B and more innovative, which has led to new start-up opportunities. John’s compassion for our people shone through in his leadership through the global pandemic – with a focus on protecting the wellbeing of our employees and the financial health of our company. On behalf of all Moog employees, thank you, John for your wonderful contributions.
Now, turning to the future. I want to highlight my thoughts on our vision for the company and my key priorities.
Over my last 23 years with the company, I have been inspired by the energy, passion, and creativity that our talented staff apply in solving real world problems for our customers.
It all started with a spark of inspiration - Bill Moog’s innovative servo valves and an application to defend naval ships and crew members. Over the last 70 years, our positive impact on people and our planet has grown significantly.
At heart, we are a technology company with deep capability in motion control systems and critical components. Our highly collaborative culture delivers innovative solutions for our customers most difficult technical challenges. We target specific applications “when performance really matters”® across a range of end-markets.
Today, our people, products, and technologies affect the lives of millions across the globe. Moog solutions are critical to our national security; to safe transportation; to reducing factory emissions; and to enhancing patients’ lives – just to name a few.
To continue on our path of growth and success, I see our talented people making a difference together by building a sustainable Moog for current and future generations.
We will do that by concentrating on three areas:
· Customer Focus
· People, Community & Planet, and
· Financial Strength
I’ll share some brief details on each.
First, CUSTOMER FOCUS
Customer focus is about meeting our commitments: delivering programs on schedule, shipping product on time. It is about creating value now and, in the future by being responsive to changing needs. It is about having a clear advantage over our competitors and being able to sustain that advantage.
Second, PEOPLE, COMMUNITY & PLANET
Our culture defines us as a company. It enables great collaboration with customers and across the company. Our culture is a competitive advantage for Moog and a key attraction for employees.
I want to ensure that we remain true to our values; that we have a clear sense of purpose across the company; and that we create the opportunities to challenge and develop our people; Furthermore, I believe that our work force should be more diverse and reflective of the communities that host us. I am convinced that it will strengthen our company.
Turning attention to our planet, I believe that we all share a moral responsibility to be good stewards of our planet for the next generations. The solutions we develop for our customers are part of our contribution to a better planet. And in addition, we will do more to reduce emissions from our own manufacturing operations.
Third, FINANCIAL STRENGTH
I believe that we must do better financially and that we have a clear view of how to do it!
Our focus is on enhancing our operating margins. We will simplify our business. We will focus on businesses, customers, and products where the value we create is reflected in the profits we make. We will focus our manufacturing capability by end market, located as necessary to serve our customers and of sufficient scale to be economically sound. We will drive further profitability through continuous improvement activities and convergence of systems and processes.
We will grow revenue, both through established businesses and new areas of activity. We have a solid core with positive growth drivers: higher defense spending, recovery of commercial travel, more investment in energy efficiency and ever-increasing health spending. In addition, we have really exciting growth opportunities beyond the core. We are entering new markets and redefining our position within existing markets.
We will also focus on our cash generation. We will work to reduce the amount of cash it takes to run the business. For example, we see opportunities to increase our inventory turns.
Now, let me briefly summarize:
We are building a sustainable business that has a positive impact on people and planet for generations to come.
We have 3 areas of focus, with our immediate priorities in each being:
· Customer Focus – enhancing operational performance
· People, Community and Planet – driving employee engagement and workforce diversity
· Financial Strength – driving business simplification
I look forward to sharing more specific information on our key initiatives and our long-term goals during an Investor Day to be held later this year.
Now let me turn to our attention to the quarter …
First, from a Macro-economic perspective
The war in Ukraine – close to one year on – has strengthened the resolve of Western governments to support Ukraine and to increase domestic spending on Defense. The deployment of increasingly sophisticated defense systems to Ukraine could boost sales of our existing defense components and systems. The planned increase in defense spending long term will lead to increased sales of existing platforms and increased development activity.
The recovery of global air travel continues. Wide body aircraft flight hours are already above pre-pandemic levels – demonstrating the value of these efficient aircraft to the airline industry. The opening of travel to and from China should further accelerate that recovery. We were pleased to see the resumption of 737 MAX flights in China. On another note, Comac C919 achieved flight certification in China in Q1.
The potential impact of recession in our major industrial markets appears to have lessened – being either less severe, or less imminent than first anticipated. Several risks factors have diminished. European economic activity appears more resilient to the pressures of inflation, high interest rates, energy constraints and war. China could rebound now that it has abandoned its zero-Covid policy. Inflation appears to have peaked in the US, UK and Europe. On the other hand, Industrial markets have begun to soften following a post pandemic surge with the manufacturing PMI for our main industrial markets indicating contraction. On balance, given our increased backlog quarter-over-quarter, we are confident in our FY23 forecast.
Next, from an Operational perspective
Severe winter storms in Western New York led to the closure of our manufacturing operations for a few days in the quarter. We estimate this as a $0.07 EPS drag on our performance. We managed to overcome that impact through other operational gains.
Supply Chain challenges are a continuing cause of uncertainty that is no better or worse than 90 days ago. While some component constraints have eased, sporadic de-commits interfere with production shipments and productivity. We continue to diligently work these issues in order to meet customer commitments but recognize the impact on both past due and inventory. We anticipate that supply chain constraints will begin to ease later in FY23.
Labor attrition has slowed over the last number of months, but we do see some specific hiring challenges. As supply chain challenges are resolved the ability to quickly clear past due is somewhat constrained by labor.
Turning our attention to notable events in the quarter
Bell Textron won the Future Long Range Assault Aircraft (FLRAA) award from the US Army on Dec 5. We have been part of the Bell Textron team for nine years and we are excited by this success. The award was protested by Lockheed. We look forward to a favorable ruling by the Government Accountability Office in April. FLRAA will drive development activity over the next few years and substantial production orders throughout the 2030s and beyond. Hopefully, we can start to ramp our activities in April, albeit 3 months later than originally anticipated.
Our customer, NASA successfully launched the un-crewed Artemis I on Nov 15. This re-starts lunar exploration with many more launches anticipated over the next decade. Moog components play a crucial role in thrust vector control of the Artemis rocket and environmental control within the Orion crew capsule. Space market expansion is driven by exploration, commercialization and defense, and we are seeing this growth in our core component business and Space Vehicle business.
Our partner Komatsu exhibited a Fully Electric Wheel Loader in October at Bauma – the world’s largest construction trade show held every 3 years in Germany. This demonstrates another Original Equipment Manufacturer in the construction industry turning to Moog for solutions as electrification and autonomy continue to disrupt that market. We see construction as a significant growth opportunity for Moog.
I’d now like to turn the focus to our strong financial performance.
It was a great first quarter: Organic sales grew 9% and adjusted EPS grew 14%. We delivered in line with our forecast due to strong operational performance.
Our sales growth was driven by robust Commercial aftermarket, higher Reconfigurable Integrated Weapons Platform (RIwP™) production, and stronger Industrial Automation activity.
Adjusted margins improved by 130bps year-over-year. This was supported by increased industrial systems volumes, sales mix in aircraft and operational improvement.
Adjusted EPS was in line with forecast at $1.25, an increase of $0.15 or 14% versus prior year $1.10.
Our cash flow was pressured due to continuing supply chain challenges already mentioned – leading to increased past due and higher inventory as we purchased additional stock in certain circumstances to partly mitigate material lead time and availability issues.
Now, I’ll hand over to Jennifer for a more detailed analysis of our performance in the quarter and the outlook for the year.
I’ll begin with a review of our first quarter financial performance. I’ll then provide an update on our guidance for all of FY 23.
It was a great start to the year from an operational performance perspective. We achieved our adjusted earnings per share guidance of $1.25 overcoming the negative impact from the storms in Western New York. Operating margins were up nicely over last year.
Sales in the first quarter of $760 million were 5% higher than last year. Excluding the impact of foreign currency movements and divestitures, sales were up 9%. Sales increased in each of our segments.
The largest increase in segment sales was in Industrial Systems. Sales of $232 million increased 9% over the same quarter a year ago. Excluding foreign currency movements and the divestiture of an offshore energy business last year, sales were up an impressive 17%. Sales increased in each of our markets, most notably in industrial automation and simulation and test. The growth in sales reflects a recovery from the effects of the pandemic on our business. Demand for our industrial products remains solid, while we continue to face supply chain challenges.
Sales in Space and Defense Controls of $218 million increased 5% over the first quarter last year. Adjusting for the divestiture of a security business last year, sales increased 8%. The sales growth was driven by the ramp up in production on the reconfigurable turret program, which is now running at full-rate production levels.
Aircraft Controls sales were also up this quarter, increasing 2% to $310 million. Adjusting for the sale of the navigation aids business and foreign currency movements, sales were up 5%. Commercial aftermarket sales in the quarter were particularly strong, driven by market recovery in widebody platforms. Airlines are bringing their most efficient airplanes back into service first, and we’re seeing higher utilization of the 787 and A350 aircraft fleets. We expect this trend to continue throughout 2023. We also benefitted from retrofit activity for the 787 program, boosting aftermarket sales this quarter.
Military aircraft sales declined in the first quarter compared to the same quarter a year ago. The military sales decrease largely reflects supply chain pressures as incoming materials were delayed. In addition, V-280 development activity on the FLRAA program decreased due to the timing of starting the next phase of the program post-award.
We’ll now shift to operating margins.
Adjusted operating margin of 10.4% in the first quarter increased 130 basis points from the first quarter last year. Adjustments this quarter consisted of a $10 million gain on the sale of two buildings and $2 million of restructuring and other charges. Adjustments for last year’s first quarter consisted of a $16 million gain on the sale of an offshore energy business and $2 million of an inventory write-down.
Adjusted operating margins increased in Industrial Systems and Aircraft Controls and decreased in Space and Defense Controls. Industrial Systems generated a significant improvement in margins, increasing over 400 basis points to 12.3%. Incremental margin from strong sales drove the increase along with a favorable sales mix. Operating margin in Aircraft Controls increased to 9.6% in the first quarter from 8.5% in the same quarter a year ago. The 110 basis-point increase resulted from a favorable sales mix driven by strong commercial aftermarket sales, along with lower R&D expenses. Operating margin in Space and Defense Controls was 9.4%, down from 11.0% a year ago. We incurred charges on space vehicle programs for the second quarter in a row and continued to feel supply chain pressures.
Interest expense is another area that’s impacting our financial results. In the first quarter, interest expense was $13 million, up $5 million over the first quarter last year. The increase in interest expense relates to higher interest rates and is consistent with our forecast from a quarter ago.
Putting it all together, adjusted earnings per share came in at $1.25, in line with our guidance from a quarter ago. The $1.25 adjusted earnings per share this quarter is up 14% over the same quarter a year ago.
Let’s shift over to cash flow. For the quarter, we had a use of free cash flow of $22 million. The negative free cash flow this quarter was driven by working capital growth.
Working capital grew this quarter related to supply chain pressures, our production decision on the 787 and delayed milestones for billings. Supply chain constraints continue to impact our inventory levels. We purchased certain components in advance of requirements to reduce the risk of shipment delays. Despite that, we’ve experienced situations in which we couldn’t ship product because a necessary component wasn’t available. We continue to prioritize meeting customer commitments. Also, we’re maintaining a steady level of production on the 787 program to ensure our supply chain remains healthy and to keep our facilities operating efficiently. This level of production exceeds the rate at which Boeing is taking deliveries, which puts pressure on our working capital. In addition, reaching milestones in our space vehicles business was delayed associated with our challenges in that business and caused a growth in our receivables.
Capital expenditures came in at a relatively light $30 million, which is about 4% of sales. Over the past several quarters, and as we look to the rest of this year, we’re spending closer to 4.5% of sales. Our focus continues to be on investment in facilities and infrastructure to support our growth, and investment in next generation manufacturing capabilities to drive efficiencies. The lighter quarter simply reflects timing of these major activities.
Our leverage ratio, calculated on a net debt basis, was 2.3x as of the end of the first quarter. Our leverage ratio continues to be around the low end of our target range of 2.25x to 2.75x.
Our capital deployment priorities, both long-term and near-term, are unchanged. We are committed to our dividend policy and, as just announced, we’re increasing our quarterly dividend by 4% to $0.27 per share. We look to have a balanced approach to capital deployment, growing our business both organically and through acquisition, while also returning capital to shareholders in the form of dividends as well as share repurchases. Our current priority, and where we see the greatest potential return, is investing for organic growth. We’re building up new businesses that we believe have huge potential, like the electrification of construction equipment. We’re also investing in our core businesses. Capital expenditures are a part of these investments. We’ll continue to look for strategic acquisitions to complement our portfolio, and we will continue to be disciplined from a financial perspective.
We’ll now shift over to guidance for the full year.
We are reiterating our fiscal year 2023 guidance for sales, adjusted operating margin and adjusted earnings per share. Our backlog is strong, and our performance is on track to achieve these results.
Let’s take a more detailed look at our guidance.
We’re projecting sales of $3.2 billion in FY 23. That’s a 5% increase over FY 22, and 6% when we adjust for divestitures over the past year. We expect sales growth in each of our segments, with the biggest drivers being commercial aircraft and space and defense.
Aircraft Controls sales are projected to increase 6% to $1.3 billion. The increase is all on the commercial side of the business. Commercial OE will be up across the board, with growth on Boeing aircraft, Airbus platforms, business jets and the Genesys business we acquired a couple years ago. We’ll also see growth in an already-strong commercial aftermarket business. To account for our very strong start to the year, we’re increasing our commercial aftermarket sales forecast by $15 million. We expect a modest decline in military aircraft sales, with not too much of a change in mix from last year. We’re projecting $25 million of sales for the FLRAA program, down from our previous forecast of $40 million due to the delay associated with the protest.
Space and Defense Controls sales are projected to increase 5% to $920 million. Adjusting for the divestiture of a security business late last fiscal year, sales will be up 8%. When looking at our numbers within this segment, it’s helpful to remember that we shifted a product line from Defense into Space at the beginning of our first quarter. Adjusting for that shift, we’re expecting nice increases in both space and defense. The increase in space sales relates to launch vehicles and our growing integrated space vehicles products. The increase in defense sales reflects a production ramp for the reconfigurable turret and growth across all major areas of the business. Our sales forecast reflects a $10 million decrease from our previous forecast.
Industrial Systems sales are projected to increase 2% to $925 million. Adjusting for the sale of the offshore energy business, the increase is 3%. Growth will come from each of our submarkets, reflecting our strong backlog. Our sales forecast is up $10 million from our previous forecast on our strong start to the year.
We’re forecasting an 11.0% adjusted operating margin in FY 23, up from 10.2% in FY 22. We’re expecting stronger performance in each of our segments. Industrial Systems will increase 140 basis points to 10.9%, largely due to capturing efficiencies on the higher level of sales and realizing benefits associated with our portfolio shaping activities. Space and Defense Controls will increase 110 basis points to 12.0% on higher sales. Aircraft Controls will increase 20 basis points to 10.3%. We’ll benefit from factory utilization as sales in the commercial OE business increase; however, this benefit will largely be offset by an unfavorable mix, with the relative increase in commercial OE.
Higher interest expense and a higher tax rate will depress earnings per share by $0.64 relative to FY 22. For FY 23, we’re projecting adjusted earnings per share of $5.70, plus or minus $0.20, which is up 3% over FY 22. Adjusting for interest and taxes, EPS would be $6.34, an increase of 14%, reflecting strong operational performance. We’re forecasting earnings per share for our second quarter to be $1.40, plus or minus $0.15.
We’re projecting free cash flow for FY 23 to be $100 million, representing a 55% conversion ratio. Our cash flow generation reflects working capital requirements associated with an increase in sales and a deliberate investment in capital expenditures. It also reflects a reduction in working capital associated with operational improvements. We’ve decreased our free cash flow forecast from a quarter ago by $30 million as we’ve changed our assumption related to the repeal of the R&D expense amortization law. While there still seems to be bipartisan support for innovation, the challenges of congress getting a bill passed are becoming more evident.
As always, our aim is to share a forecast that represents a balanced outlook for the year. We’re assuming that supply chain disruptions continue, but moderate in the back half of the year. Other external factors such as the geopolitical landscape could also impact our performance.
Overall, we had a good start to the year and our outlook for the rest of the year looks strong. We’re positioned nicely from a liquidity and leverage standpoint, enabling us to invest for future growth in our business.
With that, we’ll open it up to questions.