MOG.A Q2 2017 Earnings Call
Operator: Good day and welcome to the Second Quarter Fiscal Year 2017 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to today’s speaker, Ms. Ann Luhr. Please go ahead ma’am.
Ann Luhr: Good morning. 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 April 28, 2017, our most recent Form 8-K filed on April 28, 2017 and in certain of our other public filings with the SEC. We have 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 homepage and webcast page at www.moog.com. John?
John Scannell: Thanks, Ann. Good morning. Thanks for joining us. This morning, we report on the second quarter of fiscal ‘17 and affirm our guidance for the year. It was another good quarter for both earnings and cash flow and in line with our full year guidance. Let me start with the headlines. First it was another milestone quarter for success first flight using mock flight controls. On March 29, the Embraer Air [ph] E195-E2 took for the sky for the first time and on 31st March; the 787-10 completed its maiden voyage. Second earnings per share in the quarter of $0.88 was above our guidance from 90 days ago and up 4% from last year. Sales were up 3% and operating profit for the quarter was up 15% from last year. Halfway through the year we remain on target to meet our full year guidance. Third, free cash flow in the quarter of $56 million was particularly strong. Fourth, we announced the acquisition of the Rotary Transfer Systems Slip Ring business in Europe. This transaction closed on April 2, the first day of our third quarter. This business adds to our global leadership in Slip Ring technology and opens new industrial markets for our products in the heart of Europe. We anticipate sales of $10 million in the second half of fiscal 2017 from the acquisition and no impact on earnings per share. In the quarter, we also acquired the remaining 30% stake in Linear Mold which allowed us to integrate this Additive Manufacturing technology into the rest of Moog. Fifth, we continued our portfolio clean up in the Space and Defense group, we adjusted the accounting reserve on European Space businesses held for sale and decided to divest a non-strategic product line which we acquired as part of our additive manufacturing acquisitions 15 months ago. This product line is now classified as held for sale. We took $4 million charge in the quarter associated with these future divestitures. And finally, we’re affirming our full year guidance for fiscal 2017 and tightening the range slightly. We anticipate earnings per share in the range of $3.50 plus or minus $0.15. Now let me move to the details starting with the second quarter results. Sales in the quarter of $632 million were 3% higher than last year. Sales were up in Aircrafts, Space and Defense and Components. Taking a look at the P&L, our gross margin is in line with last year. R&D expenses down 70 basis points while our SG&A is up 30 basis points on acquisition and divestiture related fees. Last year, we incurred $8 million of restructuring expenses which were absent this year, but this year we incurred $4 million of charges associated with products line in our Space and Defense segments which are held for sale. Earnings before taxes were up 19%, where we had an unusually high effective tax rate of 34.3% which Don will describe later in the call. The overall results of net earnings of $32 million and earnings per share of $0.88. Fiscal ‘17 outlook, we’re adjusting our sales forecast to account for the addition of $10 million in sales from the Rotary Transfer systems acquisitions. This shows up in our components segments. We’re also increasing our sales forecast in our Space and Defense segment by $20 million to reflect a strengthening Defense book of business. We’re keeping our sales forecast for the other operating segments unchanged from 90 days ago. We’re adjusting the sales mix slightly in some of the Groups to reflect the experience of the first six months of the year. And we’re maintaining our full year mid-point EPS guidance of $3.50 per share. Now to the segments, I’d remind our listeners that we provide two-page supplemental data package posted in our website which provides all the detailed numbers for your models. We suggest you follow this in parallel with the text. Starting with Aircrafts, Q2. Sales in the quarter of $290 million was 6% higher than last year. Similar to last quarter sales were up in both our Military and Commercial markets. On the military side, sales of the F-35 program were sharply higher as production volumes continue to ramp up. We also saw continued strong sales on funded development programs. The Military aftermarket was down on lower B-1B and C-5 repair activity. On the Commercial side, OEM sales on the A350 program continue to increase, while sales to Boeing and to our Business Jet and Components customers remained relatively flat. Sales in the aftermarket were down $1 million from last year on reduced activity on some legacy programs. Aircraft fiscal ‘17, we’re keeping our sales forecast unchanged from 90 days ago at $1.11 billion. We’re adjusting the mix slightly based on the experience of the first half. We’re increasing our F-35 sales by $10 million and increasing our commercial aftermarket sales by $5 million. At the same time, we’re reducing our commercial OEM sales by $15 million spread across each of our major customers. Aircraft margins; margins in quarter of 10.8% were up sharply from 7.3% last year. In the second quarter last year, we incurred $6 million of restructuring charges which were absent this year. In addition, this year we have lower R&D expense. At the half mark at the year, aircraft margins are 9.7% and we’re maintaining our full year margin forecast at 9.5%. Overall our aircraft business is performing nicely to plan this year with R&D in line with budget and our commercial OEM programs coming down to production cost curves in line with our projections. Our Military book of business is strong and our level of funded developments on new military platforms is double what it was last year. Turning now to Space and Defense. Sales in the second quarter of $106 million were up 14% from last year. The strength was on the Defense side of the business. Strong sales of both US and European vehicle program in combination with higher naval and security sales contributed to a 26% overall Defense increase from last year. On the Space side, higher sales in satellites components compensated for lower sales to NASA [ph]. Space and Defense fiscal ‘17. Given the strong first half of the Defense markets we’re increasing our full year forecast for Defense by $20 million by keeping our Space forecast unchanged. Resulted full year sales of $387 million. Margins; margin in the quarter of 9.9% included two unusual items; first we increased our product reserves by $3 million on the investigation of an engineering issue on some our satellite components and second; we incurred $4 million of charges associated with business lines held for sale. For the full year, we’re increasing our operating profit by $2 million to reflect the increase sales forecast by keeping our margin forecast unchanged at 10.7%. Our underlying Space and Defense operations are performing extremely well this year. Over the last two to three years, we’ve restructured our operations and reshaped our portfolio of this business and the operating results are now showing the fruits of this hard work. Turning now to Industrial Systems, it was another challenging quarter in our Industrial Systems segments with sales in the quarter of $115 million down 10% from last year. We saw declines in each of our major markets although we believe that business is stabilizing. Sales into the Energy market were down 15% from last year with lower sales in both renewable and non-renewable markets. On the positive side however, our new pitch control system is slowly getting traction with our wind customers. In the Industrial Automation market sales were down 8%. Well we believe we hit bottom and are starting to see signs of improving orders in some of our core markets in Europe. Finally, Simulation and test sales were 9% lower in the quarter, but we recently secured new multi-year agreements with our major flight simulations customers and anticipate sales in flight simulation to be higher in the second half of year. Industrial Systems fiscal ‘17, we’re keeping our full year sales forecast unchanged at $470 million. Based on the performance in the first half, we’re adjusting the mix slightly by increasing our simulation test sales by $10 million while reducing our industrial automation sales by the same amount. Margins; Industrial Systems margins in the quarter were 10.7% up from 9.5% in the first quarter. Six months into the year margins are 10.1%. We anticipate margins will continue to strengthen through the second half, to yield full year margins of 10.4% in line with our forecast from 90 days ago. Components, sales in the second quarter of $121 million were up 3% from last year with the growth coming in on medical markets. Sales in medical pumps and sensors increased double-digit over last year. Sales into the AMD sector were about flat, last year with stronger sales on missiles and military vehicles compensating for lower sales of components on military aircrafts. Finally sales in the industrial market were slightly lower than last year driven by further weakness in our energy markets. Components fiscal ‘17, we’re adding $10 million of sales for the full year to reflect the additional revenue from our acquisition of the Rotary Transfer Systems business in Europe. The additional sales are all in our industrial markets. Moog is the largest producer of Slip Rings in the world and the addition of Rotary Transfer Systems further strengthens our market leading position. While also giving us new application opportunities to the heart of Europe. We’re keeping sales goal forecast and the other markets unchanged from last quarter, so we’re now forecasting full year sales of $487 million. Margins; margin in the quarter were 8.9% and for the first half were 9.4%. We’re now forecasting full year margin of 10.2% down slightly from last quarter’s forecast as a result of the $10 million of additional acquisition sales. Summary guidance, at the halfway mark in fiscal ‘17, we’re pleased to report that we remained on tract for our full year guidance. The first two quarters came in a little stronger than planned despite some one-time expenses associated with operations which are held for sale in Space and Defense segment. Our aircraft segments is performing nicely to plan with the military side of the business strengthening on the F-35 production and new funded classified development programs. On the commercial side, we’re coming down the production cost curves on our major OEM programs and we’re starting to see R&D decline in line with our forecast for the year. In Space and Defense underlying operations are performing very nicely and we’re seeing an uptick in our military programs. The industrial segments continuous to be challenged, but there are signs that the declines of the last several years are bottom [indiscernible]. Finally, our Components segments continues to wrestle the soft market demand but has some bright spots, particularly in the medical market. Cash flow continues to be very strong and we added Rotary Transfer Systems to our Slip Ring business. We’re keeping our forecast for the full year unchanged from last quarter at $3.50 a share, but tightening the range to plus or minus $0.15. As always, there are both opportunities and risks to the forecast, on the opportunity side the Aircraft and, Space and Defense segments are performing ahead of plan. But on the risk side our industrial businesses in both the Industrial Systems and Components segment continue to operate in challenging markets. We expect the third quarter to be in the range to $0.80 to $0.90. Now let me pass it to Don who’ll provide some color on our cash flow and balance sheet.
Don Fishback: Thank you, John and good morning, everyone. As John highlighted at the start of the call, we had a strong quarter for free cash flow $56 million and that brings our year-to-date free cash flow to $91 million or conversion ratio of 148%. We expected our cash flow in the second half of 2017 and will be softer in the first half due to the timing of various cash receipts and disbursements as well as somewhat higher spending levels for capital expenditures. Our projection suggest that this cash flow softness will be most pronounced in our Q3, due to our planned timing and contributions to our domestic defined benefit pension plan. In addition, the customer advances are projected to begin declining in the second half of 2017 after reaching the current high levels partly due to payment terms associated with our commercial aircraft growth programs. In the end, we expect to achieve over 100% free cash flow conversion for all 2017 or $130 million unchanged from our last forecast. Net debt decreased $57 million in line with our free cash flow of $56 million. John also mentioned that we announced during the second quarter, the acquisition of the Rotary Transfer Systems business with - I should say, from more than advanced materials with operations in Germany and France. Rotary Transfer Systems designed to manufacturers products that are similar to our Industrial Slip Rings and opens up the opportunity for us to expand our business throughout Europe. The business will be managed as part of our components segment. We closed this transaction on April 2, which was the first day of our third quarter so our financial statements will reflect this acquisition in the third quarter. Net working capital, excluding cash and debt as a percentage of sales was down to 24.4% at the end of the second quarter compared to the 26.5% a year ago continuing the downward trend that we’ve been reporting over the past few years. Our capital deployment focus is on smart, top line, inquisitive [ph] growth. It was nice to report on the acquisition of Rotary Transfer Systems this quarter as our M&A activity has been admittedly quiet over the past few years. And although it’s a relatively small transaction, we’re pleased to have closed [indiscernible] strategic partner. Capital expenditures in the quarter were $15 million and depreciation and amortization totaled $22 million. For all of ‘17, our CapEx forecast remains unchanged at $80 million, while depreciation and amortization will be about $94 million. Cash contributions to our global retirement plans totaled $24 million in the quarter the same as a year ago, while year-to-date we made $41 million of contributions. For all of 2017, we are planning to make contributions into our global retirement plans totaling $92 million unchanged from our forecast three months ago. Global retirement plan expense in the second quarter of ‘17 was $16 million, similar to last year. Our global expense for retirement plans is projected to be $63 million in ‘17 compared with $65 million in 2016. In the second quarter of 2017, we had a higher effective tax rate as John mentioned. It was 34.3% compared with the last year’s 23.9%. This high Q2 tax rate was influenced by the effect of charges associated with the divestitures in our Space and Defense segment unfortunately there is no tax cover as well as a less favorable mix of global taxable earnings due to relatively more profits being generated in the US. Also last year’s low rate reflected the reversal of accruals for certain tax exposures outside of the US for what the statute of limitations had expired. Year-to-date our 2017 tax rate was 27.1% compared to last year’s 25.2% for all of 2017, we’ve slightly adjusted our outlook and are now forecasting an effective tax rate of 29.6% up 110 basis points from our forecast last quarter. This compares with our tax rate in 2016 of 28.5%. Our leverage ratio, net debt divided by EBITDA decreased to 1.91 times at the end of the quarter compared with 2.47 a year ago. Net debt as a percentage of total cap was 37.4% down from 42.3% a year ago. And at quarter end, we had $532 million of available unused borrowing capacity on our $1.1 billion revolver that terms out in 2021. So with that, let me turn you back to John and will take any questions you might have. Cari [ph], can you help us please.
Operator: Thank you. [Operator Instructions] And we will take our first question from Cai von Rumohr with Cowen and Company.
Cai von Rumohr: Yes, thank you very much. First, your Boeing and Airbus sales forecast went down what programs were those, were those the 777 and the A-330?
John Scannell: It was across the portfolio Cai. It was little bit on the 87, a little bit on the 350. Keep in mind, the way that flows is not exactly in line with the way their production flows and there was a lot of inventory movement itself [ph]. So we moderate both of them slightly.
Cai von Rumohr: Okay and then your R&D was a little bit higher than we were looking for. How much of that was in the aircraft area and kind of what programs?
John Scannell: So I’m thinking when you say, your R&D, you’re talking about total R&D for the company?
Cai von Rumohr: Yes, the $37 million was down year-over-year, but up sequentially. How much of that was aircraft?
John Scannell: Aircraft was down 6 over from quarter last year and that was as you might expect that was 350 and the two stop, but we did see a little bit of an increase in some of the other segments. Little bit of $2 million in the Space business and a $2 million in the Industrial business. So that was, why it was going up.
Cai von Rumohr: So for the year, what is the R&D target? And how much is Aircraft?
John Scannell: Yes, so that hasn’t changed. None of that is changed. The target for the year is still about $140 million and our forecast for Aircraft is just under $90 million. So that’s not changed, we’re on track for the year, we think.
Cai von Rumohr: Okay and then so walk us through the space because those margins look sensational if we take out the divestiture and the product loss. Walk us through that and give us a little more background on that, if you could?
John Scannell: Well as I said on the call. We’ve spent the last two or three years Cai, if you go back three years or so, we were struggling [ph] in that business. So there is a combination of things, one is I would say, a focus restructuring, we’ve taken restructuring over the last year from that. We’ve been cleaning up the portfolio, I mean held for sale stuff, we got rid of Bradford in the first quarter, we’ve been cleaning that up over the last couple of years as well. So that’s kind of an underlying improvement in the business. And then on top of that, I think the first half of the year we had some favorable contract stuff that happens, very nice mix. So we’re not forecasting that strength, we’ll continue in the second half. Although, it will continue to be nice double-digit business but it’s just as I say, it’s a series of activities in over multi-year period that we’re starting to see some very nice performance round. Now we did have, as we say we had a product reserve issue and it’s always easy to back those out, we’re always a little bit cautious though because there’s always something or other tends to pop up in these types of business whether in the Aerospace and Defense side of the business. So that was unusual in the quarter, but typically we had some unusual items as you go through the year. But it is, the business is performing nicely, the Defense side is doing nicely, we’ve got very missile programs, we’ve got vehicle programs and the Space business I think if you go back a year or so I was kind of saying, when Space continues to come up that seems to have levelled out and seems to be start improving. We want some nice position. Our new classified satellite program. So we’re feeling that the Space business is also starting to tick up. The business is doing well. now I would say there’s been a lot of focus on because of the contract a lot of production stuff and over the next few quarters and even in this quarter we’re seeing a little bit more tick up in R&D, there’s some long-term programs, programs we’ve talked in the past of those GBSD that we’re going to start spend a little bit more money on. So those kind of high teen margins, exclusive of those discussions, we don’t anticipate that, that’s sustainable over long period of time. But we do think that the business is nicely position. It’s got some nice programs and it’s performing well.
Cai von Rumohr: And last one, so you bought in the minority interest in the Additive Manufacturing business. Is that basically now at breakeven? Is that contained so that, that won’t be a problem going forward?
John Scannell: So what we’re doing Cai, is we bought the minority in it and as you heard on the call as well. It was a product line within that that we’re divesting, so when we bought there was two pieces. There was the additive piece and there was the, a piece with essentially an mold, a tool and die [ph] molding type business that came with it, which was the original business that the founder started, but then he got into additives and we were never planning to keep that. So we’ve also arranged for that to be held for sale. So now as we move forward, we see this more as the technology that we feel is critical for the company in the long-term as against standalone business that we think, got its own P&L. so it’s integrated with the other segments. It’s within our Space and Defense segment but it’s a technology and a capability that we will be sharing across the whole corporation. So rather than talk about as a P&L, we see this as a critical technology that will be used by all of our businesses in the coming years and that’s the way we’re starting to see it. So it’s probably more of and the R&D type of line sales and profitability line.
Cai von Rumohr: Great, thank you very much.
John Scannell: You’re welcome. Thank you.
Operator: And we’ll take our next question from Kristine Liwag with Bank of America/Merrill Lynch.
Kristine Liwag: Good morning, guys. John in your prepared remarks, you mentioned growth in classified programs in Defense. And I understand you’re limited in what you can, but are these programs in general dilutive or accretive to margins or they in line with segment margins?
John Scannell: So typically Kristine, when you have Military Defense programs like that, they are cost plus type programs but they will be low margin programs. So they would be dilutive to margins, however one of the nicest things is happening is, as the commercial R&D starts to come down, we have the opportunity to redeploy those engineers into these types of programs and so essentially you gain all of the expense because it becomes sales in the cost of cover. So as we shift from R&D from commercial but it’s all in your R&D line into Military, you have an improving situation in margins, but it’s because your R&D line has essentially come down. Does that help?
Kristine Liwag: That helps and would you be able to quantify the size of classified for you?
John Scannell: No. But what I would say, is we funded R&D I said in the last and I think in the previous call. last year our funded R&D in Aircraft was about $25 million and this year it’s about $50 million of sales.
Kristine Liwag: Great and then maybe switching gears. The Boeing Middle of the Market aircraft seems to becoming more topical. If the aircraft becomes reality, how should we think about R&D for you, if this is a program that you end up pursuing?
John Scannell: I’d prefer not to speculate on that because I think the aircraft hasn’t yet been approved there’s been absolutely no conversations yet in terms of what it might look like, I think Boeing’s procurement strategy is kind of changing as they move from the 87 to the next generation of airplanes. Our position, our potential opportunity on it, we would have to see as a combination of what Boeing might be interested in, what we might have to offer to competition. So I think it’s too early to speculate and that’s the same. I just couldn’t really give you a picture of it. And I think, in any event, I think you know matter what, it’s probably a couple years out in terms of when you’d actually see any kind of significant R&D spend, we’re going to be part of that program. so I think it’s a little bit too early to speculate on what that might look like.
Kristine Liwag: Great, thank you for the color.
John Scannell: You’re very welcome. Thank you.
Operator: [Operator Instructions] and we’ll take our next question from Michael Ciarmoli with SunTrust.
Michael Ciarmoli: Good morning, guys. Thanks for taking the question, nice quarter. Just back to Space and Defense, ex-the charges. You had 17% also in the first quarter, 16.5% I get it. It sounds like there was some one-time items in there. What sort of, I mean do you have very good visibility. I mean because that would be quite a falloff in second half margins. Clearly it sounds like you’re getting some uptick in the Defense side, which maybe offsetting some of the weakness. But I mean, do you have very good line of sight into I guess the profit potential of the - what’s going to come through the backlog or what’s going to come through from the order book?
John Scannell: You’ve reasonably good line of sight on it Michael. So as we’re sitting at this point, typically as you go into quarter into Space and Defense business. You’re probably in the 90s booked in terms of what you’re going to ship that quarter, six months, maybe you’re in the 70s, 80s. So it’s not like an industrial business where you’re waiting to receive orders as you go through the quarter with, four to six week lead time. However in some of those businesses, particularly in the Space business depending on how a contract sources [ph] out, you can have fairly significant swings in the profitability and the reason I say that is because typically the Space stuff, if you put it all together. With all of the engineering capabilities and the processes and everything, but if that’s. I said, the final test, you discovered if there is some nuance that for whatever reason in the product of the functioning and you have to do some rework, typically that could be expensive. So what we find in that business is, if the product sales through very nicely, you make very nice margins, if you’ve got a hick up and these type of thing happen when you do very highly engineered products, you’ll end up going back and that will have a significant impact on the margin. So we will always try to be conservative in our margin forecast and hopefully, do a little bit better. I think our segment half margins are in the north of 12% to reach the full year numbers that we’ve thought it so, yet it’s down from 16%, 17% that we did in the first half. But that 12% is, if you compare that with you run rate over the last several years, it’s a pretty good performance. I said at the end of my call in terms of opportunities and risk that both Space and Defense and Aircraft are performing well, so maybe there’s some upside there. On the flipside, our Industrial business is continued to be challenged that maybe well we might have some challenges. So we’re trying to do a balanced out, but that is, we have looked at the first half, second half in the Space and Defense business. There will be additional R&D’s as I mentioned, we’re putting money into couple of particular Military programs that we think have a long-term opportunity. GBSD is the program that we think has long-term potential for it. So it’s - there’s mix across the various programs, but right now we’re pleased with the way it’s going through the first half and we hope that we continue to do that or do what we forecasted for the second half.
Michael Ciarmoli: No great, that’s helpful, I get that. And then what about Aircraft margins. With the revised forecast, aftermarket being increased a little bit. I’m assuming that carries higher margins. I think you guys tweaked obviously some of the OE [ph] work, but it still seems like and I get the R&D no change there. Why aren’t we seeing any better lift or more favorable mix maybe on the aftermarket controls into the second half of the year?
John Scannell: Yes, the aftermarket you’re right. I mean, we treat some of the [indiscernible] F-35 is production. And the commercial aftermarket, we tweaked up a little bit, so that has some contribution and we reduced some of the commercial OE side, which typically is not as higher margin. Halfway through the year, we’re at 9.7%, we got full year margins 9.5%. maybe we’re doing a little bit better. Mix changes as you go through the year. R&D is going to be up a little bit in the second half relative to the first half, $2 million that means meets the target of getting to the $89 million, $90 million that I talked about. So it’s again, I think there maybe some upside there. But we’ve seen also in the past R&D can spike I described that in the past, where we’re going through trial program something comes up and then there’s a rework or something and because of the amount of hardware that goes through when something like that happens, it’s never $200,000 it’s always a seven figure number. So again I think we’re trying to be a little bit cautious and conservative and not get ahead of ourselves. But we’re feeling halfway through the year, we’re nicely on track for the full year and that’s different from where we were sitting a year ago or couple of years ago. So we’re feeling more comfortable with the year, this year than I’d say that we felt last year or the previous year.
Michael Ciarmoli: Got it and then just last one from me. Maybe Don on the free cash flow. I think you mentioned the customer advances and payment terms. Is that stemming from Boeing’s change in how they’re paying suppliers?
Don Fishback: No it’s totally unrelated to that, that specific topic. This is contractual it goes back quite a few years and terms that we negotiated and with, I won’t [indiscernible] Boeing but terms we negotiated with couple of our commercial aircraft customers and we knew this was going to be happening, where we had built up a real nice customer advance and we’re going to have to repay that. So that’s going to happen over the next three years or so and it’s not a huge number but it’s going to have some impact and cash flow as we reported, as we look ahead. It was just kind of teeing up expectations that’s probably why, the second half is starting to come with up, we had a great first half of free cash flow and I was just trying to tip you guys, that it’s not going to continue.
Michael Ciarmoli: Got it. Great. Thanks a lot guys.
Operator: It appears there are no further questions at this time. I’d like to turn the conference back over to our speakers for any additional or closing remark.
John Scannell: Thank Cari [ph]. Thanks for your attention. Thank for your questions and we look forward to reporting out again in 90 days’ time and hopefully folks will have a nice summer. Weather here in Buffalo it’s just starting to improve, so things are looking good. Thank you.
Operator: This concludes today’s call. thank you for your participation. You may now disconnect.