Moog : Q1 FY2020

(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 January 24, 2020 our most recent Form 8K filed on January 24, 2020 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 first quarter of fiscal '20 and fine tune our guidance for the full year. Overall it was a strong start to our new fiscal year in terms of both sales and operating performance.

This quarter I'm adopting a new approach to the headlines, first offering some macro-economic comments, followed by some micro-economic thoughts and then focusing on what's going on inside our company.

Headlines

First, from a macro-economic perspective, there is more clarity around both Brexit and the U.S. trade dispute with China than there was a quarter ago. While neither situation has significant direct impact on our business, the additional clarity should help stabilize the global economy and be positive for both our industrial and commercial aircraft businesses longer term. On the defense side, the continued unrest in the Middle East suggests a reduction in U.S. overseas activities is not imminent, which supports our thesis for continued strong defense spending.

Second, within our industry sectors, there have been developments in both our commercial aircraft and industrial markets. The uncertainty around the Boeing 737 Max Return to Service has increased while the potential addition of simulator training requirements for Max pilots has also emerged. On the industrial side, the economic climate in Europe has continued to weaken, particularly in Germany, and our team believes we've not yet seen the bottom. In the defense market, excluding developments in the Middle East, the underlying narrative concerning near-peer rivals in China and Russia has not changed and spending priorities remain stable.

Third, it was a good quarter for our business. Sales were up 11%, operating profit was up 14% and earnings per share were up 18%. During the quarter we witnessed the first flight of the Embraer E2-175 using all Moog flight controls, and our medical manufacturing facility in Costa Rica received a prestigious national award
for operational excellence. We completed the acquisition of an industrial manufacturing company in Germany which further strengthens our market leadership position in rotating devices. We refinanced our debt structure, reducing our interest rate and providing additional capital deployment flexibility. Our balance sheet is now nicely set up for the next several years and provides
us with tremendous flexibility in how we allocate capital to create value for
our shareholders. In the quarter, we repurchased 670,000 shares under our outstanding authorization.

Finally, our colleague and friend, Don Fishback, decided to retire at the end of our first quarter. Don spent 38 years with our company in various finance functions, spending the last 9 years of his career as CFO. He was a wonderful CFO, great business advisor and personal friend. I will miss him as will many of our listeners who have known Don. He'll continue as a director of Moog. Our new CFO is Jennifer Walter, who has been with Moog almost 20 years as controller and more recently as Vice President of Finance. She will do an excellent job taking over from Don.

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

Q1 Fiscal '20

Sales in the quarter of $755 million were 11% higher than last year, driven by strong organic growth particularly in our A&D portfolio. Sales were up in each of our operating groups, with Space and Defense up 19%, Aircraft up 12% and Industrial up 4% over last year. Taking a look at the P&L, our gross margin was down from last year on a less favorable mix. R&D was down on lower Aircraft spend while SG&A was lower as a percentage of sales. Interest expense was up slightly on higher debt levels. In 'other income', we had a benefit of $2 million last year as a result of the sale of a small product line. Excluding this unusual item, the 'other income' line is flat with last year. The effective tax rate this quarter was 25.2% resulting in net income of $50 million, up 17% from last year, and earnings per share of $1.44, up 18% on a slightly lower share count.

Fiscal '20 Outlook

Our forecast for operating performance is unchanged from 90 days ago. However, we're making two minor adjustments to our full-year outlook to reflect events in the first quarter which we had not forecasted. First, we're increasing our sales forecast by $35 million to account for the sales of the GAT acquisition in our Industrial Group. Given first year acquisition accounting impacts, we're modeling this business to be break even in fiscal '20. Second, we're adjusting our EPS forecast to include the combined impact of calling our High Yield bonds and the Q1 share buyback activity. The net impact is a 5c reduction in our EPS forecast. The overall result is full year sales of $3.05 billion and earnings per share of $5.50 plus or minus 20 cents.

Now to the segments. I'd remind our listeners that we've provided a 2-page supplemental data package, posted on our webcast site, which provides all the detailed numbers for your models. We suggest you follow this in parallel with the text.

Aircraft

Aircraft Q1

Sales in the quarter of $340 million were 12% higher than last year. On the military side, we enjoyed good growth in both the OEM and aftermarket portfolios. OEM sales on foreign platforms were up nicely in the quarter while F-35 sales to Lockheed were down slightly after a very strong first quarter last year. For the full year, we anticipate OEM sales on the F-35 will be up 17% over last year. In the military aftermarket, sales were up across much of the portfolio, led by strong F-35 growth. As the fleet of F-35 airplanes in service continues to grow, our aftermarket activity will grow accordingly. In FY20, we're forecasting the F-35 aftermarket to be more than twice the level it was two years ago.

On the commercial side, sales were also up nicely from last year, albeit less than on the military side. OEM sales to both Boeing and Airbus were up double digits. Our Boeing book of business was up on higher 787 sales, the result of timing of orders. Sales on the 737 platform were down marginally from last year. Sales to Airbus were up on the A350 program with the remainder of the Airbus programs down slightly. Sales into the commercial aftermarket were more or less in line with last year, with slightly higher 787 activity compensating for slightly lower A350 sales.

Aircraft fiscal 20

We're keeping our full year sales forecast unchanged from 90 days ago at $1.33 billion, up 2% from fiscal '19. We're planning for 7% growth in the military portfolio, led by strong F-35 activity, but slightly lower commercial activity on reduced 787 and A350 OEM sales. Given the present uncertainty around the 737 Max production rates, we're not adjusting our sales outlook for that program as yetuntil we know more.

Aircraft Margins

Margins in the quarter of 11.4% were a good start to the year. This quarter we benefited from the unusually high level of sales on foreign programs as well as relatively low expenses. These effects will normalize as we move through subsequent quarters so we're maintaining our full year margin forecast at 10.5%. Our Operations 2.0 initiative continues to make steady progress and, as we've said in the past, we should start to see the impact on both cashflow and margins towards the end of fiscal '20.

Space and Defense

Space and Defense Q1

Sales in the quarter of $186 million were 19% higher than last year, driven by strong growth across both our space and defense markets. Sales into space applications were up 25% in the quarter as that market returns to healthy growth in fiscal '20. Sales were up in our each of our core markets of launch, satellites and special missions. The growth was led by our development programs for thrust vector control on launch vehicles as well as work on various NASA programs.

In the defense market, sales continue to be strong across most of the portfolio. Missile sales are up on continued high levels of production on our legacy platforms and increased development work on hypersonics. Vehicle sales were up on stronger domestic and European activity, while sales of our general components into a wide variety of end applications were up over 20%.

Space and Defense fiscal '20

We're leaving our forecast for the year unchanged from 90 days ago. Full year sales of $770 million will be up 13% from last year, a combination of 16% growth in Space sales and 11% growth in Defense sales.

Space and Defense Margins

Margins in the quarter of 13.6% were strong and a good start to the year. Compared to last year, higher sales, a slightly improved gross margin and some favorable timing on certain expense lines resulted in almost 200 basis points of margin expansion. Over the next 3 quarters, spending on R&D and selling will gradually increase, so, for the full year, we're keeping our margin forecast unchanged at 13%.

Industrial Systems

Industrial Systems Q1

Sales in the quarter of $229 million were up 4% from last year. We had strong sales growth into medical applications on higher enteral pump and set activity. Sales into our other 3 markets of Energy, Industrial Automation and Simulation & Test were more or less in line with last year. Energy sales were marginally up on offshore production activity while sales into industrial automation applications were slightly lower. As anticipated, we're seeing weakness in this business in central Europe as the German economy continues to struggle. Finally, sales into flight simulation applications were up but sales into the test market were down in both auto and aero applications.

At the end of November, we completed the acquisition of GAT, a privately-owned German company which specializes in Fluid Rotary Unions, or FRU's. These are devices which are used to carry fluids across rotating interfaces and are used in a wide range of industrial applications from machine tools to off-shore oil exploration. We're already the world's leader in slip ring technology, which are devices used to carry electrical power and signals across rotating interfaces. Slip rings and fluid rotary unions are complementary technologies and are often used in the same applications. The acquisition of GAT opens new markets to Moog and enhances our competitive position at some of our existing slip ring customers. GAT sales for fiscal '20 should be $35 million.

Industrial Systems fiscal 20

We're adjusting our full year sales forecast to account for the acquired sales of GAT. These additional sales are within the industrial automation market. We're also refining our outlook for both Simulation & Test and Medical. Given the slowing global economy, we believe our test sales will be $10 million lower while the strength in our medical end markets, particularly for our enteral products will deliver $10 million of additional sales. The net result is full year sales of $950 million.

Industrial Systems Margins

Margins in the quarter of 11.7% were down from last year but in line with our plans for the year. In the first quarter of fiscal '19, we completed the sale of a small product line which contributed just over 100 basis points of operating margin. The acquisition of GAT will contribute $35 million of additional sales, but given the impact of first year accounting adjustments, we're modeling no additional operating profit. Therefore, for the full year, we're keeping our forecast for operating profit unchanged at $106 million, but moderating the margin forecast slightly for the higher sales to 11.1%.

Summary Guidance

Q1 was a strong start to fiscal '20. Sales were up 11% against a plan of 5% growth for the full year. Operating margin is ahead of our full-year forecast and earnings per share were above the high end of our guidance.

Our defense business continues to show real strength across the complete portfolio and our Space business is back to strong growth after a flat year in 2019. Space is benefiting from the additional US defense spending as well as the ramp up of activities at NASA to get back to the moon in the next 4 years.

Commercial aircraft had nice growth in the quarter at our major OEM customers, although the aftermarket was off slightly from last year. Uncertainty around the Max return to service increased during the quarter, but it's too early for us to model the impact yet on our full year results. Overall, commercial is on track for a year in which we're modeling a slight decrease in total sales from fiscal '19 due to the slowdown in some of our legacy programs.

Finally, industrial sales in the quarter of almost $230 million are in line with the run rate for the year, excluding the impact of the acquired sales from GAT. We've been modeling a flat year for industrial compared to fiscal '19, but should now see about 3% growth from the acquisition. We believe the pattern of the first quarter will repeat over the coming quarters, with strong medical sales compensating for continuing softness in our industrial automation business.

Taken all together, we're pleased with our first quarter start to the year. We're keeping our outlook for the full year unchanged, with minor adjustments for the acquired sales of GAT and the impact of our financing activities. Our first quarter benefited from some positive timing on various defense contracts as well as a slower ramp up of expense spending than we had anticipated. As our hiring catches up with our growth plans, expenses should come back into line with our forecast. In addition, the favorable timing of orders and shipments we enjoyed in the first quarter will unwind over the balance of the year.

Opportunities to do better include further growth in our defense business, although the availability of talent to meet the needs remains a constraint. In addition, our operational initiatives in aircraft could show positive results ahead of plan. Risks include the uncertainty around the Max return to service as well as a further deterioration in the industrial climate. As always, we try to provide a balancedview which weighs both the upside opportunities and the downside risks.

For the second quarter, we expect earnings per share of $1.30, plus or minus 10 cents.

Now let me pass you to Jennifer who will provide more color on our cash flow and balance sheet.

Thank you, John. Good morning, everyone.

It was an excellent quarter for our balance sheet. We refinanced the debt portion of our capital structure in the first quarter, and we are now very nicely positioned to deploy capital that will create value for our shareholders in the coming years. During October, we extended the term of our $1.1 billion U.S. revolving credit facility through October 2024 and obtained more favorable terms. This facility also has an accordian feature to facilitate up to $400 million of expansion should we be looking for that capacity in the future. We also extended our securitization program through October 2021. This program effectively increases our borrowing capacity and lowers our interest rate on up to $130 million of borrowings. Then in December, we issued $500 million of 4.25% senior notes with an eight-year maturity. In conjunction with the issuance, we called our outstanding $300 million of 5.25% senior notes and incurred a call premium of $4 million. We completed this redemption in January. We're pleased to have this solid debt structure fully in place.

We expect our interest expense in 2020 to be $39 million, the same amount we had in 2019, as higher outstanding borrowings are offset by lower interest rates.

As of quarter end, we had both sets of senior notes outstanding, and just $50 million outstanding on the U.S. revolving credit facility. We also had $127 million of cash at quarter end, compared to $93 million a quarter ago. The increase resulted from the timing associated with our debt refinancing activities.

Free cash flow in the first quarter was $15 million; that's a conversion ratio of 30%. We had expected a slow start for free cash flow generation in the first half of 2020. We are still forecasting a full year conversation ratio of 80%, or $152 million of free cash flow. We'll pick up in the back half of the year as we start to see the benefits associated with our efforts to improve our operational processes.

Net working capital (excluding cash and debt) as a percentage of sales at the end of Q1 was 28.8% compared with 27.9% a quarter ago. The increase largely reflects the growth in physical inventories we've experienced.

Capital expenditures in the first quarter were $27 million, while depreciation and amortization totaled $22 million. We're forecasting slight ramp ups in both capital expenditures and depreciation and amortization as we progress through the year. For all of 2020, we're forecasting $120 million of capital expenditures and $91million of depreciation and amortization. Capital expenditures in 2020 will be about 4% of sales, which is at the high end of our historical spending range. We're working on various facility expansion projects and we're investing in machinery and test equipment as part of our operational improvement activities.

The $15 million of free cash flow for Q1 compares with an increase in our net debt of $110 million. The $125 million difference includes share repurchases. During the first quarter, we repurchased 670,000 shares at an average price of $88 for a total of $59 million. As is our typical practice, we'll report on any future share repurchase activity when we report out on our next earnings call. We also paid $54 million for the acquisition of GAT and $9 million for the quarterly dividend.

Our leverage ratio, which is net debt divided by EBITDA, increased to 2.3x from 2.1x a quarter ago. Net debt as a percentage of total capitalization was 39%, up from 36% last quarter.

Shifting over to taxes, our effective tax rate was 25.2% in the first quarter compared to 24.3% in the same period a year ago. The lower rate a year ago included the benefit associated with utilizing tax loss carryforwards associated with the gain on a divested business.

Cash contributions to our global retirement plans totaled $10 million in the quarter, compared to $9 million in the first quarter of 2019. We plan to make contributions of $42 million in 2020, up from $37 million in 2019. Global retirement plan expense in the first quarter was $18 million, up from $17 million in the first quarter of 2019. Total expense for 2020 is expected to be $74 million, compared to $72 million in 2019.

We made an accounting change in the first quarter that reduces our pension expense volatility. The change relates to how we value certain assets in our U.S.defined benefit plan. In 2018, we made significant contributions and fully funded that plan. Accordingly, we rebalanced the investment portfolio such that we had 80% liability hedging securities, providing an economic hedge. The changes in fair value of these assets will now flow through the income statement annually, rather than being smoothed over time, and this reduces the volatility we're exposed to in our income statement. Our previous guidance for 2020 already considered this new principle. This change does require retroactive application, so we've updated our 2019 numbers. It affects non-service pension cost, so operating profit is not affected. First quarter 2019 earnings per share are now $0.03 lower than previously reported. For all of 2019, our earnings per share will be $0.15 lower than previously reported in our 10-K.

We're in really good shape from a capital perspective, having completed the refinancing activities in the first quarter. Regarding capital deployment, we will continue to take a disciplined approach towards strategic acquisitions and returning capital to shareholders through opportunistic share repurchases and dividends. This morning, we announced our quarterly cash dividend of $0.25 per share payable to our shareholders.

As John described, we're off to a strong start for the year, and we're looking forward to the rest of 2020. We expect to top the $3 billion mark in sales this year and achieve double-digit growth in earnings per share.

With that, we'll turn it back to John for any questions you may have.

John……