Moog Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended March 30, 2019. Unless noted otherwise, financial amounts are in U.S. dollars; financial statement amounts below are in millions.
Business context and results
Moog designs and manufactures precision motion and fluid controls for aerospace and defense and industrial markets. Its three segments are Aircraft Controls, Space and Defense Controls, and Industrial Systems.
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $718.8 | $689.0 | $1,398.5 | $1,316.6 |
| Gross margin | 27.5% | 28.0% | 28.4% | 28.7% |
| Net earnings | $42.4 | $14.0 | $86.4 | $15.3 |
| Diluted EPS | $1.20 | $0.39 | $2.46 | $0.42 |
| Operating cash flow | Not provided by quarter | $108.8 | $45.2 |
Q2 sales rose 4% and first-half sales rose 6%, primarily on organic growth in Space and Defense Controls and Aircraft Controls. Q2 earnings also benefited from the absence of prior-year restructuring charges and a lower effective tax rate. The 2018 comparison was affected by Tax Act charges; Moog reported a 79.2% effective tax rate for first-half 2018 versus 24.1% in 2019. First-half 2018’s rate excluding one-time Tax Act effects was 29.2%.
Segments and material changes
- Aircraft Controls: Q2 sales increased 3% to $320.6 million, while operating profit fell 20% to $27.1 million. Profit included a $10 million supplier-quality charge. First-half sales rose 6% to $624.7 million; operating profit declined 7% to $60.3 million.
- Space and Defense Controls: Q2 sales increased 15% to $164.8 million and operating profit rose 20% to $20.5 million. First-half sales grew 16% to $320.9 million, driven mainly by defense programs.
- Industrial Systems: Q2 sales were broadly flat at $233.4 million, while operating profit was $30.2 million versus a $5.4 million loss a year earlier. The prior period included wind pitch controls exit-related restructuring charges. First-half sales rose 1% to $452.9 million and operating profit was $57.9 million versus $14.5 million.
Gross margin was lower year over year, including the $10 million supplier-quality charge in Q2 2019; Q2 2018 included a $7 million inventory write-down tied to the wind pitch controls exit. Management said margins were relatively unchanged after excluding these charges. Moog sold a small non-core Industrial Systems business in Q1 2019 for $4.2 million and recorded a $2.6 million gain.
Moog adopted ASC 606 using the modified retrospective method, without restating prior periods. The standard increased reported Q2 sales by $14.2 million and net earnings by $3.5 million; first-half sales and net earnings increased by $16.6 million and $3.5 million, respectively.
Cash, debt and liquidity
- First-half operating cash flow was $108.8 million, up from $45.2 million. Management attributed the improvement mainly to $83 million lower pension contributions, partly offset by increased inventory use of cash.
- Cash and equivalents were $112.1 million at March 30, 2019, down from $125.6 million at September 29, 2018; the filing says cash was primarily held outside the U.S.
- Long-term debt, including current installments, was approximately $826.0 million; short-term borrowings were negligible. Debt included $392 million drawn on the U.S. revolver, $300 million of 5.25% senior notes due 2022, and $130 million under the receivables securitization program. Net debt to capitalization was 35%, down from 38% at fiscal year-end.
- Moog reported $716 million of unused borrowing capacity before covenant limitations and said the leverage covenant limited total borrowing capacity to $520 million. It was in compliance with its debt covenants.
- First-half investing cash outflow was $57.5 million, including $60.0 million of capital expenditures. Financing cash outflow was $66.9 million, including $17.4 million of dividends and $16.3 million of share repurchases.
Outlook, risks and contingencies
Management’s 2019 outlook was sales of approximately $2.877 billion, operating profit of $327 million, net earnings of $178 million and diluted EPS of $4.85–$5.25. The forecast anticipated defense growth, commercial aircraft program ramp-ups, and Industrial Systems acquisitions offsetting wind pitch controls exit-related lost sales. Management expected full-year capital expenditures of approximately $110 million. It also projected 2019 U.S. defense sales of about $850 million.
Backlog was approximately $2.23 billion, with about 73% expected to be recognized as sales over the next twelve months. The twelve-month backlog was $1.636 billion, up 26% year over year. Management cautioned that backlog may not convert fully to revenue. Other key risks include government funding and contract termination, cost overruns on fixed-price contracts, estimation changes on over-time contracts, supplier performance, market cyclicality, foreign exchange, and debt covenants.
Contract and contract-related loss reserves were $49.4 million. Moog noted that further project cost growth, delays, or unsuccessful contract resolutions could require additional loss provisions. It reported no pending legal proceedings expected by management to have a material adverse effect and stated that environmental reserves were adequate. Standby letters of credit totaled $35.3 million.
Important facts for investors to verify
- Whether the $10 million Aircraft Controls supplier-quality issue causes further costs or affects the full-year margin outlook.
- Progress against the $4.85–$5.25 EPS guidance and the assumptions behind expected defense and commercial program growth.
- Backlog conversion, contract estimates, and the adequacy of the $49.4 million contract-loss reserve.
- Liquidity available after leverage-covenant limits, and the effects of debt costs, foreign currency movements, and cash held outside the U.S.
- Comparability of reported growth given ASC 606’s contribution and the unusually high 2018 tax rate and restructuring charges.