Moog Inc (MOG.A) 2017 Q3 法說會逐字稿

Good day, and welcome to the Moog Third Quarter Fiscal Year 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ann Luhr. Please go ahead.

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 July 28, 2017, and our most recent Form 8-K filed on July 28, 2017, and in certain of our other public filings with the SEC. We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our Investor Relations webcast page at www.moog.com.

Thanks, Ann. Good morning. Thanks for joining us. This morning, we report on the third quarter of fiscal '17 and update our guidance for the full year. As usual, I'll start with the headlines before diving into the details.

First, it was another milestone quarter for our commercial aircraft business, with the Chinese C919 completing its first flight on May 5. Moog supplies the high lift system for this airplane.

We also had some positive news in our marine energy business as we received our first significant FPSO order in several years. While we don't think our offshore business will rebound anytime soon, we believe this order signals that we have turned the corner on declining demand and can plan for more stable business going forward.

Second, it was another good quarter financially. Our operations delivered $0.91 per share, above our guidance from last quarter of $0.80 to $0.90. In addition, we had an unusually low tax rate, which added $0.20 per share. The result was earnings per share of $1.11, up 11% over last year.

Third, free cash flow in the quarter of $32 million was also strong.

Fourth, we completed the divestiture of our remaining small European space operations in early June. In addition, in July, we completed the divestiture of a nonstrategic product line, which we acquired as part of our Additive Manufacturing acquisition 18 months ago. There was no operating profit impact in the quarter from these disposals.

Finally, with 90 days left to go, we're updating our full year guidance to sales of $2.46 billion, up $10 million; and earnings per share of $3.75, up from $3.50 per share last quarter.

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

Sales in the quarter of $626 million were up 2% from last year. Sales were up in Aircraft, Space and Defense and Components, but lower in Industrial Systems on weaker Wind Energy demand.

Walking down through the P&L. Our gross margin was slightly lower than last year, while our R&D expense was in line. Our SG&A expenses were down as a percentage of sales from the same quarter a year ago. Earnings before tax were down 6%, but our tax rate was an unusually low 17% compared with just over 30% last year. The overall result was net earnings of $40 million and earnings per share, as I said, of $1.11.

Let's go to '17 outlook. We're fine-tuning our sales forecast this quarter to reflect the experience of the first 9 months. Full year sales are now forecasted to be $2.46 billion, up $10 million from 90 days ago. The increase is in our Aircraft and Components groups.

We're increasing our earnings per share forecast by $0.25, a combination of $0.05 per share additional contribution from our Aircraft group and a $0.20 per share benefit we saw in this quarter from the unusually low tax rate. In total, we're forecasting EPS of $3.75, plus or minus $0.10. This suggests a fourth quarter of $0.92, operationally in line with our third quarter.

Now to the segments. I'd remind our listeners that we provided a 2-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.

Beginning with Aircraft, Q3. Sales in the quarter of $283 million were up 4% over last year. On the commercial side, OEM sales to Airbus on the A350 program continued to ramp nicely. We also saw sales increases in our Gulfstream business jet programs and are seeing very early-stage sales to Embraer on the E2 program. OEM sales to Boeing were down on lower 777 activity. Sales in the aftermarkets were up as a result of higher sales on some legacy programs. Total additional provisioning across the 787 and A350 was in line with last year.

On the military side, the F-35 OEM program continues to ramp up, but we saw lower aftermarket activity. Last year, we had significant aftermarket sales on the F-35 as we worked to stand up our repair depot at one of our customers. In addition, this quarter, we experienced a technical issue on the V-22 line, which slowed production. This issue is now resolved, and we are working to catch up on our backlog.

Aircraft, fiscal '17. We're refining various elements of our sales forecast as we head into our last quarter. We're increasing our military OEM sales by $15 million and reducing our military aftermarket sales by the same amount. We're also increasing our commercial aftermarket forecast by $5 million. The net result is an overall increase of $5 million to yield full year sales of $1.12 billion.

Aircraft margins. Margins in the quarter of 10.3% were down from last year but in line with last quarter. R&D spend of $22 million was comparable with last year, but a less favorable sales mix, particularly the lower military aftermarkets and foreign military sales, resulted in lower margins than a year ago. In combination with the higher -- slightly higher sales forecast, we're increasing our full year margin forecast by 20 basis points to 9.7%. Overall, our Aircraft R&D this year is on track to finish the year at about $90 million, down approximately $10 million from last year. The A350-1000 and E2 programs continue to be the major consumers of our investment dollars. But we're also investing in several business jet programs and in the Chinese C919. The spend rate quarter-to-quarter tends to fluctuate based on how much hardware is being produced to support qualification and certification testing. But the longer-term trend is now declining, and we should continue to see that trend in the years to come.

Turning now to Space and Defense. Sales in the third quarter of $95 million were up 2% from last year. Space was lower as a result of the lost sales associated with the disposal of one of our European space businesses in Q1 of fiscal '17. Excluding this effect, Space sales were in line with last year, with higher sales of satellite avionics compensating for lower sales to NASA. Defense sales were up over last year with strong vehicle and naval sales, with slightly lower missile activity.

Space and Defense, fiscal '17. We're leaving our full year sales forecast unchanged from 90 days ago at $387 million, a combination of $183 million in Space and $204 million in Defense.

Space and Defense margins. Margins in the quarter of 10.6% were down from last year. We're investing about $1 million a quarter more this year on various R&D activities. For the full year, we're maintaining our margin forecast at 10.7%.

Industrial Systems. Sales in the third quarter of $122 million was down 6% from last year but up 6% from Q2. 1/3 of the reduction from last year is due to weaker foreign currencies relative to the U.S. dollar. [Wheel] sales were down in energy, primarily as a result of continued softness in our legacy wind business. Wheel sales were also lower in our industrial automation markets. However, wheel sales were up nicely in both test and simulation after a relatively soft first half of the year. Despite the sales decline this year relative to the same quarter last year, we're optimistic for the future of our Industrial business.

In Wind, our new pitch control system continues to gain traction at customers in Asia, and we should see the impact on the sales line as we move into fiscal '18. In industrial automation, we're slowly seeing signs of improving orders, which we believe bodes well for the future.

Industrial Systems, fiscal '17. We're leaving our sales forecast, again, unchanged from 90 days ago. Full year sales of $470 million are broken down approximately 50% in industrial automation and about 25% in each of energy and simulation and test.

Margins in the quarter of 10.2% were up nicely from the year ago despite the lower sales. The restructuring activities in fiscal '16 are playing through in the P&L, and a continued focus on cost control is paying dividends. For the year, we're keeping our margin forecast unchanged at 10.4%.

Turning now to the Components group. Sales in the third quarter of $127 million were 7% higher than last year. In early April, we closed on the acquisition of Rotary Transfer Systems in Germany, and this added $6 million in sales in the quarter. Organic sales, ex this acquisition, were up 2% over last year.

Sales in our A&D markets were flat, with stronger missile sales compensating for lower vehicle sales. In the industrial and energy markets, we're pleased to report that sales for offshore exploration were up marginally this quarter, only the second time since the precipitous drop in the price of oil that we've not reported a sales decline from the prior year. Organic sales to our other industrial customers were also stronger.

Finally, sales of medical components and pumps were up slightly from last year, a combination of stronger pump sales but weaker CAT scan slip ring sales.

Components, fiscal '17. We're increasing our sales forecast by $5 million to reflect higher sales into our A&D markets. In these markets, our third quarter was stronger than we had been anticipating, and we think this strength will carry over into the fourth quarter. We're keeping our forecast in industrial and medical unchanged. We now anticipate full year sales of [$492 million].

Margins. Components margins in the quarter were 9.5%. Higher R&D investment in next-generation products, combined with the slightly adverse sales mix, drove a lower margin than last year. For the full year, however, we're keeping our operating profit forecast unchanged, but inching down the margin to 10% on the slightly higher sales.

Summary guidance. Q3 was another good quarter. Sales were up slightly, and our operations performed at the high end of our expectations. We enjoyed an unusually low tax rate, which contributed $0.20 per share, and we had another good quarter of free cash flow. With 9 months in the bank, we're adjusting our full year sales forecast up by $10 million and increasing our EPS forecast $0.25 to $3.75 a share, plus or minus $0.10. This assumes a fourth quarter of $0.92, in line with our operational performance in the third quarter.

Overall, we are pleased with the way fiscal '17 is unfolding. Our operations have exceeded their original plan for the year, and we've been able to absorb additional charges associated with our continued portfolio clean-up while increasing our full year guidance. We'll provide our first look at fiscal '18 when we report on the results of our fourth quarter.

Now let me pass it to Don, who will provide some color on our cash flow and balance sheet.

Thank you, John, and good morning, everyone. Solid free cash flow of $32 million in our third quarter resulted in year-to-date free cash flow of $124 million, reflecting a year-to-date conversion ratio of 122%. We're forecasting a solid finish to FY '17 as we expect to achieve a conversion ratio for all of '17 of better than 100%, which was our target. Specifically, we're increasing our FY '17 free cash flow forecast by $10 million to $140 million.

Looking out over the coming quarters, we expect to see higher capital expenditures for growth-related investments in facilities, for engine propulsion testing and for the production ramp and the F-35 program.

We're also forecasting that customer advances will begin declining in the coming quarters after reaching their current high levels, partly due to payment terms associated with their commercial aircraft programs. We'll discuss FY '18 in greater detail next quarter.

Net debt decreased $2 million in the quarter compared to free cash flow of $32 million. The difference is primarily related to the April 2 acquisition of the Rotary Transfer Systems business from Morgan Advanced Materials with operations in Germany and France. Rotary Transfer Systems designs and manufactures industrial slip rings and opens up the opportunity for us to effectively expand our business throughout Europe. The business is being managed as part of our Components segment. Q3 sales from this acquisition were $6 million and in line with our projections.

Net working capital, excluding cash and debt, as a percentage of sales was 24.7% at the end of the third quarter compared with 24.9% a year ago, continuing the downward trend that we've been reporting over the past few years.

Collections of receivables and the timing of payments on our accruals contributed to this quarter's favorable comparison.

Capital expenditures in the quarter were $15 million, while depreciation and amortization totaled $22 million. For all of 2017, we decreased our CapEx forecast by $10 million to $70 million based on our year-to-date run rate, while D&A will be about $90 million. Over the last decade or so, our CapEx as a percentage of sales has averaged just under 4%. More recently, since 2013, our run rate has averaged about 3% of sales. We'll finish '17 just under 3%. As we look out over the next year or 2, we expect to see our CapEx pick up a bit. And over the longer term, we believe our sustainable CapEx rate -- run rate as a percentage of sales is in the 3% to 4% range.

Cash contributions to our global retirement plans totaled $33 million in the quarter, while year-to-date, we've made $74 million of contributions. For all of 2017, we're planning to make contributions into our global retirement plans totaling $92 million, and that's unchanged from our forecast from 3 months ago.

Global retirement plan expense in the third quarter of 2017 was $16 million, again, similar to last year. Our global expense for retirement plans is projected to be $64 million this year compared with $65 million in '16.

So this is certainly a year for quarterly volatility in our effective tax rate. In the first quarter, our tax rate was 17.6%. In the second quarter, the rate was 34.3%. And now in our third quarter of '17, we again had a very low tax rate of 17.0%, which compares with last year's third quarter rate of 30.9%. The fluctuations quarter-to-quarter are mostly the result of tax benefits that are associated with the divestitures. The timing and ultimate outcome of working through each of these individual tax matters with the applicable taxing authority in order to arrive at the final conclusion is difficult for us to forecast. Comparing our rate in Q3 of '17 with last year's rate, the decrease is mostly related to tax benefits associated with our dispositions. Additionally, the filing of our 2016 tax return just last month surfaced some conservatism in our accruals for manufacturing and R&D tax credits. Year-to-date, our 2000 (sic) [2017] tax rate is 23.4% compared to last year's 25 -- or 27.5%. Removing the effects related to divestitures, the year-to-date FY '17 tax rate is 28.1%, similar to last year's year-to-date rate.

For all of 2017, we lowered our forecasted tax rate by 390 basis points compared to last quarter's forecast and are now projecting an effective tax rate for all of '17 of 25.7%. This compares with our tax rate in '16 of 28.5%.

Last point. Our leverage ratio, net debt divided by EBITDA, decreased to 1.92x at the end of the quarter compared with 2.33x a year ago. Net debt as a percentage of total cap was 36%, down from 41% a year ago. And at quarter-end, we had $530 million of available unused borrowing capacity on our $1.1 billion revolver that terms out in 2021. In addition, our $300 million of 5.25% high-yield bonds terms out in December of 2022.

And with that, I'd like to turn you back to John for any questions you may have.

Evan, we would be happy to entertain questions at this stage from our listeners.

(Operator Instructions) Our first question comes from Cai Von Rumohr from Cowen and Company.

So if I look at your full year guide, where is the R&D now for the year?

Our R&D for the year, Cai, is at $144 million. We've actually -- because we've -- Aircraft is online, we've seen a little bit of R&D spends go up in Space and Defense, Industrial and the Components group. And so we've added about $3 million or $4 million to the total for the year. So it's really just $1 million here and $1 million there in the other 3 groups that's adding to that.

But so I assume it's kind of coming off in the third -- in the fourth quarter for Aircraft. And your mix wasn't great with military aftermarket. I assume you get some of that in the fourth quarter. So why is your fourth quarter Aircraft margin down from the second and third quarter?

So if you look at the total year, our Aircraft business is online with what we said. Actually, we bumped it up a little bit. We've added a couple of million dollars to it. We probably see -- we may see the R&D come down. That fluctuates up and down, but at the $90 million run rate, it may come down a little bit. We're not anticipating, Cai, that the military aircraft aftermarket will be much stronger in the fourth. As I said, we've taken -- this quarter relative to last year was down about $7 million or $8 million, and we've taken it down $15 million in total. So we anticipate a relatively soft fourth quarter military aftermarket as well. And that's the big contributor to the margin when it's strong. So it's the mix of the business. We've increased the OEM on the military side. But keep in mind that some of the OEM build on the military side is cost plus development work. We've talked about that in the past, that, that doesn't tend to be a big contributor. So we try to balance the various pieces out. We've increased overall Aircraft performance for the fourth quarter despite the fact that R&D was still relatively strong this quarter. So we think what we've got is a reasonable -- a reasonably solid position for what they'll deliver.

And then if we look at Space and Defense, Components and Industrial, each of those businesses, your full year estimate assumes a pretty nice step-up sequentially in margins from the third quarter to the fourth. Maybe you could give us some color on what's going on there.

It's really just a mix issue, Cai. We've been looking at that. And Space and Defense had a relatively soft third. If you kind of back out some of the effects, they've had a couple of very nice quarters. The first and second were pretty strong. The third was more of the anomaly. Typically, in our Space and Defense business, you see some contracts finish up, you see starts. And you get that type of fluctuation in margin of 700 basis points quarter-to-quarter. So I'd say the fourth is closer to what we think for the year if you, again, back out the effect of the divestitures. So the third, I would say, was the softer one. Industrial, we've seen the business improve a little bit. We think their sales will pick up a little bit, particularly in the wind stuff in the fourth quarter, so that may contribute a little bit to the margin. And Components, if you look back last year, we had something similar. We had a kind of a progression of margin through the year. They actually had a very strong fourth quarter last year. Typically, we see some of that with some of the A&D stuff shipping out in the fourth. So we're seeing a little bit of an uptick in the fourth. Again, if you look back at last year, you'd see the same phenomenon. Actually, last year, it was even stronger than we're predicting in the fourth this year. So we think we've got a little bit of history that suggests there's a little bit of seasonality on the Components business that should contribute to a slightly stronger fourth.

Got it. And then I think at one point, you talked about longer-term normal for the Aircraft group would be 5% R&D to sales. You're running about 8% now. Maybe give us some color as we move into '18 and '19 and how we should think about what's happening to R&D in the Aircraft group.

Well, as I kind of -- I mentioned in the remarks, I think this year, we'll see it come down, and this is the first time, I think, that we've really seen that inflection point. And we continue to see that trend over the coming years. But I don't want to get ahead of myself yet on '18 and, particularly, not on '19 in terms of actual numbers. We'll share those with you next quarter. But as I say, the trends downwards has -- have firmly been established, and we should continue to see that. But I would -- I'd caution 2 things. One is it typically takes a little bit longer to drop and -- E2 flies and then suddenly that goes away. It's typically not that. There's always some work that continues on for a couple of years after that as the airplane gets into production. So it's not a precipitous drop that we're anticipating. And the other thing is that long-term 5% is a number that I think we have said is that's a kind of a solid run rate for the business. We want to be cautious as well. We built a tremendous capability over the last decade in terms of talent, ability to do programs, and we want to make sure that as we see that wind down, that we maintain the type of capability and that we don't find ourselves in a few years' time trying to rebuild that capability. So we will proceed down that path cautiously, trying to find -- I mean, one of the nice things right now is we have a lot of military work, so a lot of the talent is moving over to the military work. But there will remain commercial work and other new types of activities, R&D activities within the Aircraft business, which will keep the team engaged and make sure that we don't lose what we've built. But the 5% is clearly, Cai -- we do think that that's a solid number for the longer term.

Our next question comes from Michael Ciarmoli from SunTrust.

Maybe just -- John, you may have just hit on this, but I want to make sure I've got it. On the Industrial margins, higher revenues in the current quarter, but yet we saw that sequential downtick of about 50 basis points in margins. Was that specifically just a mix issue quarter-to-quarter?

Michael, I think your numbers are reversed from mine. We saw a downtick in sales. Sales were off 6%, and we saw an uptick in both margins and profit contribution in the Industrial Systems.

I think Michael is asking about sequential...

Sequentially.

Oh, sorry. Okay. Apologies, Michael. I was trying to -- okay. Sequentially -- so yes. So sequentially, we saw a little bit of an uptick in sales. It went from about -- went up about $7 million, and we saw a little bit of an uptick in operating profits, up marginally. And margins came down slightly. I would put that, Michael, in the category of mix and noise. I don't think it's significant that I would draw any conclusions from it. We're anticipating that we'd see margins pick up in the fourth. So $7 million increase in sales on the base of $115 million, $120 million, operating profit up slightly, while margins down marginally. Typically, you'll have expenses run through at different times of the year. So I wouldn't read anything into that. The only thing I'd read into it, I think, is that the business is solid. The sales, we think, we saw for the first time in our industrial automation, we started to see the book-to-bill turn slightly positive. So we're feeling like the outlook is better for that business, as part of what I said in my prepared remarks. So we're feeling more optimistic about it. So I -- mix of business, one particular contract that might finish off a particular issue with a program, and you might find that your margin would shift by that much 1 quarter to another. And I wouldn't read anything particular into it.

Okay. And on that, you mentioned that book-to-bill ticking higher on the automation. Is that something -- do those products typically carry, from a mix perspective, better margins? I mean, does that give you better clarity and visibility into the profitability picture going forward? Or -- I'm just trying to get a sense of go-forward mix. Is that automation going to help drag up that margin?

Yes. So it's a better mix. If I -- the only distinction I would make in our Industrial business is in our winds -- is in the wind piece of it. So the rest of it is a -- there's puts and takes, but whether it's industrial automation, the non-wind energy or it's in our simulation and test business, it's a good solid margin business. And the piece that we've been investing in for quite a few years is the wind business. Now we're seeing traction. We're starting to see our new products come to market. We're still suffering a little bit because a year ago, we had -- we still had some nice sales into South America. That was business that we had with Alstom. You may remember GE bought Alstom, and unfortunately, that business almost overnight went away. It was also a nicely profitable business in Brazil. So we're still suffering from that in terms of the comparability on the sales, but also even on margin and contribution within wind. But as wind starts to pick up, we see the sales improving. And hopefully, our new product really taking hold, we'd start to see better gross margin contribution from that better contribution. And then the other pieces of the business are all good, solid contributors. So yes, industrial automation is a -- would be a positive in terms of contribution.

Got it. Okay. And then just last one. You mentioned the Aircraft, I think Cai was getting at it, the margins dipping down. It sounded like it was all military aftermarket. Is that military aftermarket disproportionately higher? I mean, because I would have thought the offset would have been the corresponding increase in the commercial aftermarket. But it sounds like that weakening military aftermarket is having more of a negative impact and maybe offsetting some of the positive impact of the commercial aftermarket.

Well, it's also the numbers, so we're taking the military aftermarket down $15 million, and we're taking the commercial aftermarket up $5 million. So I wouldn't make the big distinction in margins between them, but I would say it's just the order of magnitude in the sales change.

(Operator Instructions) Our next question comes from Kristine Liwag from Bank of America.

John, we're hearing more discussion on the Boeing middle-of-the-market aircraft. And from what we're hearing, it sounds like the aircraft could be a small wide-body. So you've now done a larger integrated system in the size of a 787 and A350, and you've also done smaller jets like the Embraer E-Jets. So if the middle-of-the-market aircraft is launched and you decide to bid, how much in total R&D do you think you'd have to spend?

Well, Kristine, that's a million dollar -- hundred million dollar question. I have no idea. And the reason I say that is for a couple of reasons. One is we've not seen any description of the airplane. As you say, the speculation is that maybe it's a small wide-body. There's been talk about it being a 57 replacement, a narrow-body. So we don't know that. We don't know the configuration. So the 787 was a 5,000-psi integrated hydraulic system. The A350 was a 3,000, but it had electro-hydro static backup systems. The E2 is a standard 3,000 psi, although we don't do some of the work on that. We don't do the high lift. But -- so that it's -- there's -- it depends on the technology. It depends on the type of airplane. And then, of course, it depends very much on how Boeing approaches this procurement. And as we know, in the 787 days, Boeing gave large packages out and had systems integrators like Moog, but more recently, on the 777X, they've decided to keep some of that systems design in-house and do more packages or more actuators. And that has an enormous bearing on what the R&D might be in a program like that. If Boeing said, "I want to procure these 4 actuators," that's very different from, "I want to procure a flight control system." And then lastly, of course, is the question about the economic stuff and whether we would win it or not. And therefore -- so there's so many unknowns in that, Kristine. I'd love to give you an answer, but until it's much firmer in terms of understanding what the airplane looks like, what the architecture is and what Boeing's procurement strategy is, I think I'd be just speculating wildly, and I don't think it would help you any.

No, that's helpful. And maybe if I can have a second question. Boeing is actively trying to expand its aftermarket reach, and I think next quarter, they'll start breaking out an aftermarket segment. So for your aerospace programs, how defensible is your aftermarket business? And how much of your portfolio ultimately is build-to-print versus where you own the IP?

So let me do the second question first. Only a tiny amount of what we do is build to print. I'm going to say it's less than 5%. I'm picking a number now, but it's almost -- everything we have, all the 87, the A350, the E2, the 919, that's all our own. That's all Moog IP. We had some 777 build-to-print work from way, way back. But as you know, the 777 is kind of slowly winding down. So the vast majority of our stuff is Moog IP. And then in terms of our aftermarket, Boeing's aftermarket, again, difficult to say, Kristine. Boeing, obviously, has the GoldCare package on the 787. We are part of that offering. We also have independent offerings that we've made to the airlines because some airlines want to work with Boeing in the aftermarket. Others have chosen not to because they've got their own repair houses. I think in the end, if -- we will work with Boeing to try and make sure that we're supporting them. But I think, our stuff, we will end up supporting our own stuff. So I guess, again, it's an unfolding picture, but it's Moog IP on the vast majority of what we supply.

(Operator Instructions) There appears to be no other questions at this time.

Thank you, Evan. Thank you to our listeners. We feel it was another nice quarter. 9 months in the bank, we're feeling pretty good about fiscal '17. We'll come back to you in 90 days' time. We hope to report a nice end to the year, and we will provide you our initial guidance on fiscal '18. Thank you very much.

And this does conclude today's presentation. Thank you for your participation. You may disconnect.