Moog's (MOG.A) CEO John Scannell on Q3 2016 Results - Earnings Call Transcript

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Moog Inc. (NYSE:MOG.A)

Q3 2016 Earnings Conference Call

July 29, 2016, 10:00 AM ET


Ann Luhr - Investor Relations

John Scannell - Chairman and Chief Executive Officer

Donald Fishback - Vice President and Chief Financial Officer


Robert Spingarn - Credit Suisse

Cai von Rumohr - Cowen and Company

Mike Ciarmoli - KeyBanc

Kristine Liwag - Bank of America Merrill Lynch


Good day and welcome to the Moog Third Quarter Fiscal Year 2016 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Ann Luhr. Please go ahead, ma'am.

Ann Luhr

Good morning. Before we begin, we call your attention to the fact 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 29, 2016, and our most recent form 8-K filed on July 29, 2016, 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 John.

John Scannell

Good morning. Thanks for joining us. This morning we will report on the third quarter of fiscal 2016 and update our guidance for the full-year. As usual, I will start with the headlines before diving into the business.

First, it was an exciting quarter from a technical perspective with major milestones from Moog hardware. On May 23, the new E2 jet from Embraer Air completed a 3 hour and 20 minutes first flight ahead of schedule with the complete fly-by-wire flight control system for Moog performance.

And in July 4, the Juno space probe entered orbit around Jupiter after a five year space flight. There is a multitude of Moog hardware on this massive vehicle including valves, engines and various avionic components. We congratulate the team at Embraer Air and NASA on these great successes and the Moog teams, which helped make them happen.

Second, it was a good quarter financially with earnings per share $1 coming in above the high end of our guidance. Third, it was another good strong quarter of free cash flow. Forth, we purchased over 300,000 shares of our stock in the quarter for $17 million. And finally, we are maintaining our full-year earnings per share forecast of $3.35 but now are in the range to plus or minus $0.10.

Now let me move to the details starting with the third quarter results. Sales in the quarter of $613 million were down 3% from last year. The lower sales were primarily the result of softness in our components group. Unlike previous quarters, change in foreign exchange rates from last year had a minimal impact on the top-line this quarter.

Taking a look at the P&L, our gross margin in line with last year, R&D was up a couple of million dollars, but SG&A was down by comparable amount. Last year we incurred 7 million of restructuring expenses in the third quarter, which did not recur this year. Our effective tax rate was 30.9% and the overall result was net earnings of $36 million and earnings per share of $1, up 6% from last year.

Fiscal 2016 outlook. We are fine-tuning our sales forecast this quarter to reflect our experience three quarters of the way through the year. We now believe full-year sales will be $2.42 billion, $45 million below our projection from 90 days ago. Most of the sales reduction is refined with our gross projection for our commercial aircraft business based on nine months of sales and three months left to go.

We are also planning for $0.12 of additional restructuring charges in our fourth quarter as we continue to adjust our businesses to market conditions. Coming off a strong third quarter, while maintaining our full-year earnings per share forecast, despite the lower sales and additional restructuring headwind. We are forecasting 335 per share by narrowing the range to plus or minus to time. This suggest a fourth quarter EPS of $0.79, down from Q2 and Q3 so let me explain the drop.

Last quarter, we said the third and fourth quarters would be in the range of $0.85 to $0.95. The third quarter was strong and came in ahead of guidance at a $1. We believe the operations in the fourth quarter will be in line with our previous guidance, hence adjusting for additional restructuring this resulted in the fourth quarter of $0.79 at the midpoint of our range.

Now to the segment, I would remind our listeners that we provided a two page supplemental data package posted on our webcast site, which provides all the detailed numbers for your model. We suggest you follow this in parallel with the text.

Starting with our aircraft group Q3. Sales in the quarter of $274 million were up marginally from last year. It was a familiar story with commercial sales up 8% while military sales were down 5%. On the commercial side, sales to Boeing was across the product portfolio but sales to AirBus surged on than doubling of our product on the A350 program.

Business jet OEM sales were up on softer demands while the commercial aftermarket was also down on lower 787 initial provisioning and weaker business jet activity. In the military markets, F-35 production was increased while we had lower sales on the V-22 and Black Hawk programs. On a positive note, we had entire sales on some foreign airplane programs, which boosted margins in the quarter.

The military aftermarket was down 4% in the quarter. There were various puts and takes in the military aftermarkets with two noteworthy changes from the year ago. A continued wind down of our work on the C-5 program compensated by a gain in the F-35 aftermarkets.

Aircraft fiscal 2016, we are moderating our full-year sales forecast as by $40 million to $1.09 billion. We are reducing our military forecast by $10 million primarily the results of lower F-35 and V-22 sales. We are reducing our commercial forecast by $30 million driven by lower 787, A350 and business jet sales.

There is no fundamental change in our commercial OEM outlook. This adjustments is nearly a refinements of our forecast based on nine months experience. Aircraft margins, margins in the quarter of 11.1% were stronger then we have seen in the recent past. A particularly favorable mix of business with relatively strong foreign military sales drove this performance.

R&D in the third quarter was down significantly from the second quarter, but still slightly ahead of what we have planned. We believe this run rate will continue in the fourth quarter, so we are increasing our full-year estimates for R&D by $5 million. Despite this higher R&D investments, we are maintaining our full-year margin forecast at 8.5% unchanged from 90 days ago.

Our R&D investments in new problems over the last decade had been a topic we discussed on many occasions. We typically focused on the numbers and less on the technical models. Our engineering teams have produced as a result of these investments. I would like to highlight two such models this quarter.

First as I mentioned in my headlines, this quarter our team celebrated a flawless performance of our fully integrated flight support system on the first flight of the Embraer Air E2 jet. Second the F-35 STOVL that's the Short Take-Off and Vertical Landing models stole the show at the Farnborough Air Show with an amazing demonstration of flying agility.

Starting back in the early 2000s Moog engineers developed both the flight controls for this airplane as well as the control unit for switching from horizontal flights to vertical hovering mode. Both of these R&D investments will pay dividends for decades to come.

Switching now to space and defense. Sales in the third quarter, up $91 million were down 5% from last year. The weakness was predominantly on the safe side of the business with lower sales across the range of avionics and component markets. In the past, we have described how our sales cycle in the space business is the result of the shift in programs between developments and production.

We also explained that we are experiencing a slowdown in sales this year as existing contracts close out and we awaited follow on production orders. The fact that this cycle has been the sales slowed each quarter from Q1 of fiscal 2015 to Q1 of fiscal 2016. But have sequentially increased in Q2 and Q3 this year and we believe we will continue that pattern in Q4.

Space and defense fiscal 2016. We are moderating our full-year forecast by $50 million split 40/60 between space and defense. The drop relative to our forecast from 90 days ago, it's across multiple across multiple product lines and is largely due to delays in anticipated bookings.

Space and defense margins, margins in the quarter of 15.1% continued the pattern of strong performance this year. These margins are up from 6.5% last year. Third quarter last quarter margins last year concluded $6 million of restructuring charges and absence of these costs, margins in Q3 last year would have been 12.9%. Given the very strong performance of the first nine months of this year, we are increasing our full-year margin forecast to 14%.

Turning now to industrial systems. Sales in the third quarter of $130 million or flat with last year, the quarter was broadly similar to Q3 fiscal 2015 with wind energy a little higher on some additional sales our European and Chinese customers and industrial automation and simulation tests are little lower. All-in-all, our industrial markets are fair stable.

Fiscal 2016 industrial systems, the third quarter given a little stronger than we had forecasted and as results we are increasing our full-year sales force by $10 million to $505 million. The increase is split evenly between our wind business and our test business.

Industrial systems margin, margins in the quarter of 8.9% were in line with our forecast, but a little softer than last year and softer than our first quarters this year. Increased R&D on our next generation wind products was primary driver for this lower margin. This quarter we made significant progress in quantifying some new technology and as a result incurred some higher external services expenses than our normal run rate.

Overall, our development remains on-tract and our first prototypes are working with customers. We remain optimistic that wind will be a great business for us in a few years time. With a solid performance through the first three quarters, we are increasing our full-year margin forecast to 9.8%.

Component, our components group continues recover from the sales made in Q1 although of course with comparisons with last year continue to remain unfavorable. Sales in third quarter of 92 million were down 18% from last year. The picture is similar to what we described in both Q1 and Q2 with reductions across every market we serve.

So far this year, Q1 was low point for sales, Q2 recovered nicely and Q3 was pretty much flat with Q2. The story remains the same as in the last two quarters. Lower sales across a range of AMB program including space is the aftermarket, comprised with general stock at our industrial customers and the continued depression in our energy market. On a positive note, we continue to restructure the business over the last three quarters and despite the disappointing top-line, we are seeing margin improvement as we move through the year.

Components fiscal 2016, we are keep up with full-year forecast unchanged from last quarter of $365 million. The forecast assumes an uptick in sales in the fourth quarter primarily in our AMB market. The sales uptick is supported by backlog scheduled for the fourth quarter on several aircraft, missile, and defense vehicle programs.

Margins, margins in the quarter of 11.7% were down from last year on the lower sale, but up sequentially from the second quarter. For the full-year, we are maintaining our margin forecast at 10%. Medical devices, sales in the third quarter of $26 million were in line with last year. Higher sales into the antrum on markets compensated for lowers into the IV market. Comparing sales year-to-date with last year shows a positive trend.

Last year, we divested our life sciences business half way through the year and adjusting for that sale, our medical devices segment has delivered organic growth of 8% so far this year. We have seen this growth in both the antrum and IV product lines. This performance validates the strategy we develop two years ago of focusing purely on the pump business.

Medical fiscal 2016, we are maintaining our full-year forecast at $102 million which corresponds to 7% organic growth over fiscal 2015. Medical margins, margins in the quarter of 8.4% were down from last year and from our results in the first and second quarters. The difference is primarily due to additional investments we are making in next generation pump products.

We have a pipeline of new products and developments and this quarter we incurred relatively high expenses for outside services in support of these new developments. This additional R&D equates over 400 basis points of margin headwinds or about a $1 million this quarter compared to last quarter. For the full-year, we are maintaining our margin forecast at 11.4%.

Before I leave our medical segments, I want to report on the results of our strategic review process. After detailed studies, we decided to keep this business as a it fits our strategic objectives for both groups in new markets and long-term margin potential. Let me provide some more color on this decision.

Our listeners may remember that we started this process back in early 2013. A time when this business had incurred several years of poor results. For the following 12 months, we have conducted an intensive campaign to sell the business. In March of 2014, we thought we had agreed a sale, but at the last minute, the deal fell through. At that point, we decided to restructure the business and when the business was in better shape, reconsidered our strategic options once again.

We cleaned up the portfolio by selling the life sciences business and transferring the piece and sensor product line to our components group. That will allow the management team to focus exclusively on pumps. We also refocused our development strategy on our ambulatory pump and developed a product roadmap to strengthen our positions in those markets.

We have increased our investments in R&D while reducing our other expenses to yield significantly improved margins. The results of all these work can be seen in our fiscal 2016 performance. A business with healthy margins and enviable organic growth.

Our original premise when we got into the medical devices business a decade ago was at a company like ours focus on the product niche could develop a very attractive business with strong margins and good organic growth. The medical market was growing and device manufacturers were nicely profitable. A decade later, after many challenges ,we believe we are now firmly on our way to achieving that goal.

Over the last two years, the management team has done an outstanding job of delivering short-term profitability, while investing for long-term growth. We have paid our fruition to learn this business and we have demonstrated that we can make money. It's a business we believe has a strong future and we look forward to reporting its continued growth and success to our shareholders in the years to come.

Finishing with some summary guidance. Overall, Q3 was a good quarter. sales were a little stock, but we came in above the high end of our EPS guidance and we had another quarter of strong free cash flow. With nine months in the bank, we are adjusting our full-year sales forecast down by $45 million and adding about $6 million of additional restructuring charges, which we anticipate taking in the fourth quarter.

Despite these combined headwinds, we are maintaining our full-year earnings per share forecast of $3.35 by narrowing the range to plus or minus two times. In total, assumes our fourth quarter in the range of $0.74 to $0.84. As usual, this forecast does not assumed any impact from forward-look share buyback activity. As we announced in our conference call last quarter, we will provide our first look at fiscal 2017 when we report on the results of our fourth quarter.

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

Donald Fishback

Thank you, John and good morning everyone. Free cash flow in our third quarter was $67 million, bringing our year-to-date free cash flow to $118 million or conversion ratio of 127%. Net debt increased $41 million and the $26 million difference between the free cash flow and change in our net debt is mostly related to share repurchases.

For the full-year 2016 we are moving our previous free cash forecast up slightly to $135 million or 112% conversion ratio. Due to strong third quarter and the timing of certain receipt, we are expecting a relatively softer fourth quarter for free cash flow. Working capital as a percentage of sales continues to improve coming off of the strong third quarter, that working capital ended up at just under 29% of sales and improvement of over 450 basis points since the end of fiscal 2013.

We continue to better manage our balance sheet including paying more attention to cash related contract agencies at the beginning of business cycle, all the way to the end of cycle where we are collecting that cash. We have many lean projects that are having a positive impact on our cash including increased attention to inventories, improved quality, lead times and timely deliveries are the ultimate result and we are seeing those benefits across all of our businesses.

We are still in the early phases of our lean journey, but we believe our focus on everyone improving everyday is having a real positive impact. During the third quarter, we repurchased 324,000 shares under our share buyback program for $17 million. We have 3.4 million shares remaining under the outstanding board authorization and we continue to report our repurchasing activity at the end of each quarter.

Capital expenditures in the quarter were $15 million and deprecations and amortization totaled $25 million. CapEx spend for the first nine months of 2016 was $43 million and paid D&A of $75 million. For all of 2016, we are reducing our CapEx forecast to $70 million. Our fourth quarter will be at a higher run rate as compared to the first few quarter relatively due to the purchase of one of our offshore facilities that is currently being leased. D&A in 2016 will be about $100 million.

Cash contributions to our global retirement plans totaled $42 million in the quarter compared to the last year's $32 million for the nine months to-date we have contributed cash totaling $88 million. For all of 2016, we are planning to make contributions into our global return of plans totaling $95 million unchanged from our forecast three months ago. Global retirement plan expense in the quarter was $17 million, up just slightly from a year ago.

In 2016, our expense for retirement plans is projected to be $66 million compared with $61 million in 2015 of largely because of effects of updated mortality assumptions. Our effective tax rate in the third quarter was 30.9% compared with last year's 28.4%, up due to the higher taxable earnings in the U.S. for 2016 with forecasting our effective tax rate of 28.0% up 40 basis points from our forecast 90 days ago.

Cash rate for all last year 2015 was about the same at 28.3%. Our leverage ratio decreased to 2.33 times at the end of the quarter compared with 2.45 times a year ago. Net debt as a percentage of total caps was 41% compared with 42% last year.

During the quarter, our treasury team successfully extended the term of our $1.1 billion revolving credit facility by two years. We will nicely oversubscribe reflecting the strong relationships that we have with our bank group comprised with 13 banks. At quarter end, we had $368 million of available unused borrowing capacity on our $1.1 billion revolver that now terms out in 2021.

With that, I would like to turn you back to John for any questions you might have. Stephanie.

John Scannell

[indiscernible] take questions.

Question-and-Answer Session


[Operator Instructions] We will take our first question from Robert Spingarn of Credit Suisse.

Robert Spingarn

So, John you had very good margins this quarter, they haven't been as strong in the past. So, a bit of volatility there. What's the right run rate on a forward basis and I'm not just looking to Q4, but beyond that?

John Scannell

So, Rob are you talking about any particular segments or in total. I'm not sure of - I guess maybe can you be a little more specific.

Robert Spingarn

I was speaking overall, but maybe is it worth talking about it on a segment basis?

John Scannell

Sure, I can do that. So, our aircrafts group had better margins this quarter then we have had in quite a while, it was 11%. We actually had very strong margins in the second quarter as well if you backed in the restructuring charge, we took in the second quarter and the difference in R&D. So we had actually from the mix perspective the second and the third quarter were both very positive and they both had some very strong part in military stuff that really contributed to that.

And as we look to the fourth quarter, that mix normalizes the fact to what we have seen before. So, we are forecasting margins for the year of about 8.5%. We had anticipated and I think we said earlier in the year that margins would improve through the year particularly in the third quarter and then we will see it normalize.

As we look out in aircrafts, the story Bob is the same as the story we have been telling for quite a few years, which is really the R&D starting to come down and the commercial aircraft, the OEM starting to mature and then the commercial aftermarket kicking in.

We are not providing 2017 guidance today, but I think what I have said already in the past is 2017 is probably another year where we have continued to see pretty high R&D but still be into C919 start to pick up and the A350 will wind down a little bit, but then as you get beyond 2017 we should start to see those effects really start to kick in. Plus in terms of the commercial OE side is the 350 will still be ramping in the E2 you will start to see the initial cost build on that.

So you still have that mix issue that the OE business is still relatively immature, the A7 is obviously maturing, we obviously now. And then the aftermarket just takes time to kick in, you got the initial IT provision which we have seen in A7 and now the 350, but the real aftermarket for that takes a few more years because of the four to five warrant period.

So, aircraft there is a long-term path to get to the mid-teens, part of it of course is how the military business behaves and that's been down for the last few years, but that seems like it's flattening out and the F-35 is obviously a big goal for us.

Space and defense is having a banner year, if you put back in the restructuring stuff that they had last year, last year was also a nice double-digit year, this year was particularly strong and I think next year as we look out I wouldn't forecast that stronger year, but I think it's a good solid margins in the teens.

Industrial, it's a tough industrial environment right out there right now. Our industrial business is if I go across both our industrial systems and our components business, we have seen challenges in terms of general industrial automation. We have obviously seen tremendous challenges on the energy side of it.

Our simulation and testing has done okay. And our wind business as we have described in the past, that's an investment business that we are in. We are starting to see some positive in terms of first prototype of customers, but it will be a year or two before the new products we lay through and we start to see a pick up there. But we continue to restructure those businesses to try and make sure that we are delivering the acceptable margins.

And then medical is actually doing very nicely and we anticipate as I said in my comments, we actually think that has a bright future. So that's fairly broad. I think the key on -the industrial, the [indiscernible] side is what we and of course everybody else would like to see it some hint of an industrial recovery or picket in China, industrial recovery in Europe, or strong GDP growth in the U.S. and there just isn't any macroeconomics signals out there right now that suggests the market recovery and therefore our focus in all of these businesses of course is about taking share with new technologies.

Robert Spingarn

But you are seeing some improvement in that industrial margin here, right, in terms of your forecast for EBIT for the year?

John Scannell

An improvement relative to -

Donald Fishback

Yes, three months yes.

John Scannell

Yes, relative to three months that's correct.

Robert Spingarn

Okay and then just that was very helpful and a lot of details. So I just have a couple of more quick things, the F-35 guidance, I think that's revenues just down slightly, what is going on there? Would you not have had greater visibility at this point coming into the quarter?

John Scannell

What we try to do as we go through the year Rob is we try to adjust our forecast with the major things that we are seeing. But on the other hand, we are also conscious of not adjusting every single program every quarter outside and of course internally everything is just every quarter modestly.

So with nine months behind us, we decided let's just correct for what we think over the three months and if we probably look back a quarter that was probably our internal forecast was a little bit down from what we went from the outside. But again it's a matter of not providing too much noise in the forecast we provided outside.

There is nothing fundamentally changing and of course, we used long-term contract accounting, so much of that is about cost input, it's not about shipments to [indiscernible]. And that's vary depending upon what goes through, how much product comes in, how much purchases come into door et cetera.

Robert Spingarn

So it’s just minor timing really.

John Scannell

That's all it is. Yes, these are all adjustments. They are not fundamentally shift in any of the program.

Robert Spingarn

Okay and then the last thing I wanted to ask you is the commercial OE other that you have guidance reduction on there, what is in there?

John Scannell

That would be a range of component type stuff we do, some of our stuff where we are supplying second tier type of stuff. A very-very broad range of programs would be in that.

Robert Spingarn

Okay. Thank you very much.

John Scannell

Welcome. Thank you.


And we will move next Cai von Rumohr of Cowen and Company.

Cai von Rumohr

Thank you very much and the good performance John. How big was aircraft R&D in the quarter and where you expect it in the full-year number, which I assume now is a $145 million?

John Scannell

Yes, so the full-year for the cooperation is a $145 million and third aircraft R&D was about $22 million and for the year we are forecasting to be in the mid 90s.

Cai von Rumohr

In the mid 90s, okay. So basically not down much. So basically it's the main reason the R&D is up for the year and maybe give us some color on kind of which programs are driving the number up relative to your prior expectation?

John Scannell

Given the size through the number of sites, the R&D were up at about $5 million, color about 5% or 6%, now for the second half of the year relatively to what we said before. It's across a range of programs, it's not typically one program that we sell. The A350 is an additional $5 million, it will be the 350, the E-2, the C-919, there is a variety of military programs that we do some investments of our own on. There are still some 787, more of that is kind of couple of million dollars of ongoing type of refinement type there. So it's typically across a whole range programs. It's not one program that there was some issue on that particular program and the R&D is up on that.

Cai von Rumohr

And then you are very helpful, had the mix come at about the foreign military sales but maybe update us on how you are doing in terms of profitability and supply chain on the 787 and A350?

John Scannell

On both of those we have forward projections of costs and we came into the year with a set of forward projections and you will remember of course that last year we ended up - we base line in some of that. And I think on the basis of that we are pretty much in line with what we anticipated for this year. So it continues to be - the cost continues to come quarter-after-quarter and I think given the experience that we have had over the last few years, we have got much better at calibrating the results.

The challenge with forecasting costs or forecasting any of these that you have the series of thousand individual inputs and each of the inputs on their own makes sense. It's when you pull them all together and you integrate it in your final number. The question is does that number makes sense? Because everybody assumes 50% or 60% profitability but they think it will happen.

And that's where I would say in the past that we [indiscernible] that's what we've tried to improve. So we are on-track with what we anticipated for the year, we anticipate further improvements on A7 and 350 as we look into next year and of course then E2 will start to pick in towards the back end of next year and into 2018.

Cai von Rumohr

Okay and maybe update us in terms of your whole cash deployment and cash use. I mean you are keeping cash as pretty close to $400 million why do have so much cash around them? How do you think about under what circumstances would buy more stock? How active are you in terms of looking for M&A?

Donald Fishback

Cai this is Don. So thanks for the question. So you would know as well as anybody up until three or four years ago we had a strategy of heavy focus on growth through acquisitions, last few years we all know that we haven't had much activity and acquisitions. We have continued to look during that period or most recent period, but we haven't closed that many deals and actually one smaller one within the last year. But we continue to look.

And if you believe that M&A is still an important part of our growth strategy that complement our organic growth interest. From a financing strategy or capital deployment strategy perspective, today as I said in my comments were levered at about 2.33 times today. We shared with you guys before that our comfort zone is somewhere between two to 2.5 times.

So in that range we do look at capital deployment somewhat opportunistically between our share buyback program and continuing down that path and looking at M&A opportunities. There are a handful of things we continue to look, and I don’t this there is anything laid across the finish line but you can think definitely that there is opportunities for us to grow and so we are trying to keep that balance.

With respect to cash and the balance sheet, I think that’s great question. Like you said it's close to $400 million most of that is offshore so there is not an easy way from the tax perspective to bring that back, most beneficial way for us to deploy that capital is to find acquisitions and we are focused on looking for growth and a way to put that to use. So did that help?

Cai von Rumohr

That’s very helpful.

John Scannell

I would just add to that Cai, that $400 million as Don said its wrapped oversea, so you have got the tax implication and the earning. We decided to bring it back, but even if we did, it doesn’t affect our ability to buy back stock, because our leverage the 2.33 John mentioned that's a net debt EBITDA and we have a covenant issue at 2.5 like in terms of buyback, which we have explained in the past. So bringing back the cash doesn't affect our ability to buy back stock one way or another.

Cai von Rumohr

Thank you and last one pension. The discount rates down considerably from year-over-year, and maybe just give us a sensitivity of how much - all other things being equal, your pension expense would swing with a 25 bps decline in the discount rate?

Donald Fishback

I don't know that we are prepared to give a solid answer on that, but it is fair to say that a decline in the discount rate is going to put upward pressure on the cost. But I don’t have the quick answer. I’m looking at Jennifer, as he can do that real quick now. Let's not do that on the fly and maybe we can do that offline. Your observation is correct that discount rates declining and that what we are steering at as well is vertically put a little bit of upward pressure on our pressure cost, but I honestly I don’t think it's going to be material.

Cai von Rumohr

Thank you very much.


And next we will move to Mike Ciarmoli of KeyBanc.

Michael Ciarmoli

Hey good morning guys, thanks for taking my questions. Maybe John just a fact that space and defense, I know Rob was getting at the margin. but it sounds like at these levels you are definitely not sustainable given a lot of the closeout contracts and maybe fewer new start. So looking back on a trailing basis you know of get into that low-double-digit. I’m just trying frame it for next year. I mean do you expect, I guess from a pipeline perspective from new orders, do you kind of see new program kicking in over the next three to six months, which would probably allow you to keep this margin or how should we really think about that margin right now?

John Scannell

Well, I think you are right Mike, the margin is at relatively speak and I know it's an all time high, but it's pretty closer and it does have to do with finishing up our - closing up production contracts which typically are more profitable and having slightly less development contract. So there is that element to it and the margins are particularly strong when you look at the fact that organic sales are down significantly from a year ago and despite that margins are better.

So it is a particularly favorable mix at the moment on the space side and that's not sustainable only from the perspective that as you bring on new programs there you tend to get more into development side. Most of the development is typically paid development, but it's not at the same type of margin. So I think it's a good solid business. We have done some restructuring over the last year or two that have helped significantly.

The missile side is a nice business, nice production orders on the missile business, they continue, that’s nice contributor overall to the performance and nice ground vehicle. So I don't want to ahead of fiscal 2017 guidance, which, Mike, that you are asking to focus, we do that at the end of next quarter and we give you much more visibility on this.

But the margins this year are unusually high I would say and it's been a very nice year for the space and defense. So maintain growth I think part of what will happen next year there will be a little bit more - we probably wanted to invest a little bit more of R&D as well in that group. So I don't think these are sustainable margins in the short-term, but we are enjoying them this year.

Michael Ciarmoli

Okay perfect that helps. And then just on the industrial. I think you hinted that China maybe, but can you give us a sense of what you are seeing from a booking strength perspective? Maybe even on a sequential basis, current quarter what you are seeing in July right now or any product lines or geographies improving, is Brexit having an impact in sort of your European based industrial end markets or just some additional color there?

John Scannell

Yes. I would say we look at the book-to-bill on the quarterly basis, obviously the guys running the business are looking at it lot more frequently than that. Brexit hasn't had any impacts yet that we can measure on. I mean our businesses are typically long-term type of business. So there is nothing to add from an industrial perspective that we can - have seen yet.

And I would say that the bookings have tended to be typically what is common in book-to-bill, slightly under one over the last several quarters. Sometimes you get some big orders, some of the businesses are bigger, but there is nothing in the bookings that indicates an improving picture as we look out over the next three to six to nine months.

And so much of our industrial business is predicate is on a pickup in GDP, the consumer getting better and then you start to see the capital investment cycle. And a lot of what we do is the automation type of equipments, and that's typically used in factories.

So you want utilization rates to be going up and we are just not seeing that, we are not seeing any recovery in Europe, we are not seeing any pickup in China much and the U.S. is it's going to move in sideways and upwards a little. So I would describe it as stable but there is no signs really yes that we could feel like it’s going to start getting stronger any time soon. Much as I would like to report something different to you.

Michael Ciarmoli

Got it. that’s definitely helpful. and then just the last one…

John Scannell

One other thing I would put into that and this is the broader impact of the price of oil and the drop in energy prices, not just on our energy business. But I think I have talked to other CEO's of industry and companies and their sense is that if the impact across the broader economy and the lot of the industrial capital growth would be much deeper than we all understood or expected. And again, there is no sign of anything oil seems to return slight back into the 40s again rather than into 50s. So, none of that seems to bode well for the industrial capital goods market I think.

Michael Ciarmoli

Got it. now that’s extremely helpful. And then just a last one, you decide to keep medical - not really asking for guidance, but can you give us a little bit of insights in terms of what you are long term view is there. I mean you conducted the strategic review, do you think these margins are low double-digits, what sort of were some of the drivers in leading you to keep this business? I mean is this an upper teens margin business, how fast can it grow, do you envision a lot of capital requirements in terms of R&D, are you going to make more investments there, maybe just some more insights into what drove the overall decision process from a longer-term target perspective?

John Scannell

So the business has grown nicely. This year, the organic is 7% or 8%, which we don't have any other businesses, maybe commercial OE has been growing nicely like that but it's growing nicely and we started - we have seen the margins - at the same time that we are trying to refresh a product line where we intentionally lost several years because of strategy changes and strategy direction.

So relatively heavy &D investments in the business and at the same time increasing margins and growing share with our existing product portfolio that's a kind of the picture we got right now. When we look back two years ago Mike, we thought we had a deal and we looked at what we would have ended up having to sell the business for and we look at what the value of the business today is. I think we have created well over $50 million of shareholder value by keeping it.

Now that wasn't our plan, we had a deal and we thought we had a hand shake agreement, but it fell through at the last minute. So by restructuring the business, refocusing on profitability, targeting a specific niche in the market which is ambulatory pump. We have created over $50 million of value to that periods of time and we think that the management team that's in place really has a very strong visions of future and it's been very focused on the particular niche, become very good of that.

Focus on growing this has been this organically for two years. Perhaps in the few years' time we get very comfortable and we say “you know maybe there are some add ins that we could put on here,” but this is focused on, let's make sure we are doing what we are doing right. It's a 100 million business, hopefully that can grow nicely organic deal over the few years. But this isn’t a change of strategy that suddenly says we are going to start making very large acquisition in the medical devices business.

We have a nice $100 million piece of business, it's doing nicely we can get and create very nice value internally. Let's continue to keep doing that for a few years. Maybe there is little talking that comes along and I wouldn't preclude it, but it's not part of the strategy right now. So let's make sure we can make this and continue to make this successfully organically and then that's see where we want to go from there. We paid a lot of tuitions to learn about the FDA to learn about the technology, to learn this market and now we would like to spend a few years just taking advantage of this.

Michael Ciarmoli

Got it. that’s helpful. thanks a lot guys.

John Scannell

Thanks Mike.

Donald Fishback



[Operator Instructions] And we will move to Kristine Liwag of Bank of America Merrill Lynch.

Kristine Liwag

Hey guys good morning. John, 45% increase in AirBus sales and the quarter seems just a little bit rich. Can you provide a little bit more detail on your shipping rate is in the A350 today versus the OEM production rate? And was this jump due to buffer stock to prepare for the ramp, timing or is it something else?

John Scannell

So Kristine the sales that we had on the 350 versus the year ago are up significantly and that's a run. You got to keep in Kristine that we need to long-term contract accounting and therefore it's cost based inputs and it's based on the steady ramp in production, which was typically the six to 12 months ahead of what AirBus is shipping of the door. Plus it's somewhat designed around an AirBus stable production, not specifically how many airplanes they go out of front door.

So it's very hard to say, AirBus only ships this many airplanes, how come your sales have ramped up that much. You got to be looking out 12 months at a steady ramp and what AirBus is kind of forecasting over the next 12 months period. That's the way it works, so it’s a cost based and sales number based on receipts, walk in plus all of those times of things.

Donald Fishback

Kristine, this is Don. Just to help frame that the sales and the A350 and 2015 were in the mid 30s range and for this year we are forecasting the A350 sales to be in the mid 70s. So that ramps got to be coming through obviously.

John Scannell

So, doubling the sales over the 12 months period Kristine.

Kristine Liwag

Great that’s very helpful. And at what point would you expect to the A350 initial provisioning to start being material?

John Scannell

Well, we had initial provisioning this quarter, so we had initial provisioning for the last couple of quarter. And it's running at the kind of - this year it would be about around $10 million.

Kristine Liwag

Great. And maybe lastly for me from less than so far and partnering for success with Boeing, now we are hearing chatter in partnering for success 2.0, what do you think that could mean for you?

John Scannell

Typically, Kristine we prefer not to get into specifics around the negotiations that we have with our major OEM customers. I just don't think it's an appropriate thing to do. I would say that Boeing is our biggest customers and a very important customer for us. And typically the contracts with Boeing are very complex, there is so many moving parts, to pick out one individual piece may not make a lot of sense.

Plus contracts typically go over multiple years and typically what happens is when there is contract renewal process, new elements get baked in. So I wouldn’t like to speculate on the specific outcomes of any particular Boeing set of initiatives that may take several years of layout depending on contract negotiation timing and a variety of other things.

Kristine Liwag

Thank you. That’s very helpful.

John Scannell

Thank you.


[Operator Instructions] And there are no further questions in the queue at this time.

John Scannell

Stephanie, thank you very much indeed. Thank you to all our listeners. Thanks for tuning in. We look forward to reporting again in 90 days time. Hope you all have a nice summer.


And ladies and gentlemen this does conclude today's conference. Thank you everyone for your participation. You may now disconnect.

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