Moog Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 28, 2023

There are 8 speakers on the call.

Operator

Good morning, and welcome to the Moog Third Quarter Fiscal Year 2023 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Aaron Astrakhan. Please go ahead, sir.

Speaker 1

Good morning, and thank you for joining Moog's turn the call over to the operator

Speaker 2

for the Q3 of 2023 earnings release

Speaker 1

conference call. I'm Aaron Astrakhan, Director of Investor Relations. With me today is Pat Roche, Chief Executive Officer to thank you for joining us

Speaker 2

today and Jennifer Walter,

Speaker 3

our Chief Financial Officer.

Speaker 1

Earlier this morning, we released our results and our supplemental financial schedules, both of which are available on our website. To our earnings press release, our supplemental financial schedules and remarks made during our call today contain adjusted non GAAP results. Reconciliations for these adjusted results to GAAP results are contained within the provided materials. Lastly, our to take a

Speaker 2

look at our comments today may include statements

Speaker 1

related to expected future results and other forward looking statements. These are not guarantees as our actual results to discuss the financial results may differ materially from those described in our forward looking statements and are subject to a variety of risks and uncertainties that are described in our earnings press release to turn the call over to Pat.

Speaker 4

To. Good morning and welcome. Today, we will share our update on a quarter notable for record sales, to Strong underlying operating performance improvement masked by a space vehicle charge and cash demands above expectation. To We are also increasing our full year earnings per share guidance, while reflecting this stronger demand on cash. To It's almost 2 months since our Investor Day Conference in New York City.

Speaker 4

Our team was delighted to have the opportunity to make public our business plans. To For the first time, we were explicit on our goals for the business, namely revenue CAGR of 5% to 7% from to discuss our financial results from fiscal 'twenty six from our 'twenty two baseline. Average annual adjusted operating margin expansion of 100 basis points to fiscal 'twenty six, to adjusted earnings per share CAGR of 15% to 20% to 26% and free cash flow returning to the 75% to 100% conversion by 2025, 20 20 to we took the time in New York City to explain how we were going to deliver on these significant improvements in performance to and talked in detail about our simplification and pricing activities that deliver margin enhancement. During today's call, I will give several specific examples of such activity to take a look at the Q1. 2 months ago 2 months on, I remain confident that we have a great business that is growing and becoming more to take a look at the next few years.

Speaker 4

Let me start right away with an update on our operational performance covering each of my three themes. To start with the customer focus. We delivered record sales, while managing the ongoing challenges of supply chain and labor availability. To These challenges have an impact on inventory holding, product flow and overall efficiency. Our enhanced to Maintenance, repair and overhaul service was recognized by both Boeing and Airbus, achieving a top 2 ranking with Boeing.

Speaker 4

To

Speaker 2

turn the call

Speaker 4

over to Mr. President. We continue to simplify how we're organized. We have made internal reporting structure changes within our $330,000,000 Space business to empower business leaders to better meet operational needs of our customers and to achieve financial performance. To Secondly, People Community and Planet, our Baguio site, which is core to our commercial aircraft operations, to recognize that the Employers' Confederation of the Philippines for our commitment to operational excellence, sustainability, employee relations and ethical behavior.

Speaker 4

We are thankful that our people are safe following this week's super typhoon. And finally, let me return to financial strength. To We are relentlessly driving simplification and pricing across our business. Let me share some examples. Within Industrial Systems, We continue to refine our portfolio with the launch of a sales process for our business in Luxembourg.

Speaker 4

To For context, this is a $15,000,000 revenue operation with 70 staff manufacturing cartridge valves and manifolds. To we are refining our footprint with several moves. For example, we've changed from a direct channel to market in South Africa to a distributor model, to Exiting our leased facility. In Aircraft Controls, we have announced the closure of the Cincinnati based operation of SureFly to take a look at the progress we made in the quarter. And it's transferred to our Genesis Aerosystems facility in Texas.

Speaker 4

While each change yields relatively small impact today, it is the to make a contribution of these changes over the next couple of years that delivers footprint benefit. We are seeing Eightytwenty gain further traction within our business. We have the data analytics on profitability complete for over 2 thirds of our revenue base to take a look at the progress we have made in the past. We have trained well over 100 leaders on the eightytwenty approach, and we have growing to take the capability as pilot sites mature the process and expand scope from profitability analysis to include reduction of cash conversion cycle. To Ultimately, Eightytwenty is accelerating decisions that increase our profitability.

Speaker 4

For example, we have identified several product lines that we feel are at end of life, and we are either working with customers to close our production or finalizing agreements with other companies who will continue to support to turn the call back to the call to the call to the

Speaker 2

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Speaker 4

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Speaker 2

to the call to the

Speaker 4

call to the call to the call to the call. We have a systematic approach, pursuing high impact opportunities early and using Eightytwenty to focus further margin enhancement. To Our philosophy is to ensure that pricing reflects the value that we deliver. Aircraft Controls has made very significant margin improvements through pricing to that are now reflected in our full year forecast. In addition, Industrial Systems has delivered substantial operating margin enhancement in this quarter, to With prices being the most important contributor.

Speaker 4

Across all businesses, pricing is driving margin enhancement. To now let me turn to the macro economy. The Department of Defense budget for fiscal 2024 is still on its way through the House and Senate. To The requested increase of 3.2% is looking to protect new platforms. Significantly, this includes maintaining the future vertical lift to move the next generation air dominance aircraft and collaborative combat aircraft to programs of record in 2024 to And increasing to $30,000,000,000 the funding for the Space Force.

Speaker 4

Unfortunately, the war in Ukraine has now stretched beyond 500 days. Politically, the obstacles to Sweden's accession to NATO has been overcome and ratification by Turkish and Hungarian parliaments is anticipated. The significant demands of arming Ukraine is driving missile replenishment orders and increased equipment MRO activity. To According to Lockheed Martin, the fleet of F-thirty five fighters operating in Europe is expected to increase fourfold by 2,030. To U.

Speaker 4

S.-China tensions continue with the trade dispute over semiconductors now extending the cloud computing and precious minerals. To It appears that important diplomatic efforts continue with Anthony Blinken, Janet Yellen, Henry Kissinger and John Kerry all visiting China in recent weeks. To Whilst the slowdown in Chinese economic activity is a minor concern, escalating trade embargoes would be a greater concern and potentially more disruptive. To Our philosophy remains to be in China for China. The recovery of commercial aircraft continues.

Speaker 4

To conclude with the Q1 of 2019. Consequently, we are seeing real strength in aftermarket and consistent with Investor Day, Boeing and Airbus continue to project to discuss the doubling of rates in wide body production by fiscal 'twenty six. Industrial Automation remains a watch item. To turn the call over to John. The June Purchaser Managers' Index for Manufacturing shows contraction in the U.

Speaker 4

S. And for 12 straight months in the Eurozone. To Our order intake for industrial automation is down about 4% in the last 6 months relative to the prior 6 months. To note that, however, we have a healthy backlog carrying us into fiscal 2024. Now turning to what was notable in the quarter, to We returned to the Paris Air Show after 4 years' absence.

Speaker 4

It was a remarkable show in which the sentiment was extremely positive. Both commercial aerospace and defense markets are anticipating continued strong growth. In fact, record breaking gross orders to to deploy hardware so far on 2 of these aircrafts. In May, the C919 entered revenue service with China Eastern. To This is a significant step for Cormac.

Speaker 4

We are planning a handful of shipments in calendar year 2023 and a gradual increase through calendar year 2024. To as noted at Investor Day, the engineering and manufacturing development phase of V-two eighty started in June. To We are making good progress in ramping our engineering team. It was notable that Collins Aerospace was sold by RTX to Safran. To Given no new commercial platform development over the next decade, the sale does not, in our opinion, change the competitive landscape for flight control systems.

Speaker 4

To now turn your attention to our financial performance. Our 2nd consecutive quarter to note that the record sales was a great achievement for our entire staff. We are starting to see the benefits of simplification and pricing feeding through in our operational performance. To We delivered sales of $850,000,000 up over 10% on prior year with every segment posting double digit organic growth. To We are seeing the recovery of commercial aircraft, reconfigurable integrated weapons platform at full rate and to discuss the high levels of activity in Space Components, Industrial Automation and Simulation.

Speaker 4

Our bookings remain strong overall to With 12 month backlog at $2,300,000,000 up 2% over prior year. We do see some softening within Industrial Automation as noted earlier. Our adjusted operating margin was down 30 basis points on prior year. Excluding space vehicle charges, to Our margin performance would have been up 120 basis points. This margin enhancement is due to pricing and business growth.

Speaker 4

Our cash flow is clearly pressured in this quarter with a $19,000,000 use of cash arising from growth of physical inventory. To Before I hand over to Jennifer, I'd like to expand on my view of the 2 key issues impacting performance in this quarter and for the full year, to namely space vehicle charges and cash flow. Firstly, we incurred a $14,000,000 charge on our space vehicle fixed price contracts. To ask, since we were 90% complete on our last call, how a further charge could arise. The charge is driven by 2 factors, to namely additional software development effort required to resolve all remaining open issues necessary to achieve flight ready software to provide additional integration and test effort required to rework issues arising at integration of the last couple of flight units.

Speaker 4

To These are complex systems in which the final stages of integration can flush out unanticipated challenges. To provide a brief update

Speaker 2

on our financial results.

Speaker 4

Despite incurring year to date charges of $25,000,000 in Space Vehicles, I remain very confident in that business. To These charges represent additional investment in gaining a much deeper understanding of satellite bus system integration to and building our capability to deliver. Our achievements to date include the development of 2 spacecraft bus platforms, to Namely meteorite and meteor, which weigh 120 kilograms and 650 kilograms respectively. These buses share many common components, in particular, the avionics unit and the software base. We have now fully built and tested 6 payload ready meteorite class satellites, to And we've shipped all flight hardware required under 2 contracts as of last week.

Speaker 4

We will deliver the final software release within the next 2 weeks. To From my perspective, we have a great offering with 2 satellite bus platforms that can carry a variety of customer payloads. We are operating in a rapidly expanding market and see plenty of new opportunities ahead. Our execution risk is reduced to due to our improved capability and the commonality of hardware and software across both the meteorite and meteor platforms. To now turn my attention to our cash situation.

Speaker 4

We adjusted our free cash flow guidance from 0 to minus $60,000,000 for FY 2023. Let me describe what has changed. First, our sales have come in much stronger than anticipated. To We also believed 90 days ago that there would be less growth in physical inventory during the second half of the year. To We now recognize that it will take longer for our actions to slow the growth of inventory as we work to strike the right balance between slowing material inflow to Our efforts have begun to reduce the underlying rate of increase of physical inventory, to And we expect this improvement to continue.

Speaker 4

Given our leverage, the demand on cash is manageable with free cash flow turning strongly positive in Q4, to Reversing a 3 quarter use of cash. We are actively managing the situation. 1st, we are working to reduce material inflow to While dealing with material constraints and ensuring a healthy supply chain. We are unlocking production challenges to improve throughput and material flow, to take a look at the financial results and the financial results. We reflected during Investor Day that cash flow would take until to take a look at fiscal 2025, 'twenty six before it would normalize.

Speaker 4

We are confident that this is getting the necessary attention and oversight throughout the organization. To We have executed and will continue to drive many tactical changes that are slowing inventory. We are now focused on longer to We've significantly reduced risk on our space vehicle contracts and we have made initial progress on physical inventory and will drive progressive improvement over the coming quarters. To Overall, I remain very optimistic for our business. We have a strong growth, which I see as a sign that we are creating value for our customers.

Speaker 4

In addition, we've made excellent progress on our journey to improve margins through simplification and pricing. Now I'll hand over to Jennifer to review our financials to discuss in more detail.

Speaker 5

Thanks, Pat. I'll begin with a review of our Q3 financial performance. To I'll then provide an update on our guidance for all of fiscal year 2023. It was another exceptional quarter from a sales perspective. To For the Q2 in a row, we hit a record level of sales for the company.

Speaker 5

Our adjusted operating margin was 10.2 to extend the call to the call to questions. Thank you, Jim. Our underlying operational performance was strong this quarter. To We achieved $1.37 of adjusted earnings per share, which was negatively impacted by $0.33 from the space vehicle charges to discuss the financial results and results of the financial results. Thank you, Steve.

Speaker 5

Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve.

Speaker 5

Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve.

Speaker 5

Thank you, Steve. Thank you, Steve.

Operator

Thank you, Steve. Thank you, Steve.

Speaker 5

To discuss performance near the high end of our guidance when carving out these two factors. Sales in the 3rd quarter were 850,000,000 to turn the call over to our operator. Thanks, Chris. Total company sales increased 10% over the same quarter a year ago. Excluding the impact of divestitures, to Sales were up 11%.

Speaker 5

The largest increase in segment sales was in Aircraft Control. Sales of $355,000,000 increased 12% over the same quarter a year ago. Commercial OE sales in the quarter were to be extremely strong, driven by the continued market recovery in wide body platforms as well as growth on business jet. To Commercial aftermarket sales were at a record high with strong sales on the A350 program, which has been steadily ramping over the past several quarters. Military aircraft sales declined in the Q3 compared to the same quarter a year ago.

Speaker 5

The military sales decrease reflects to lower funded development activity, including the delayed start on the flower program. In addition, military to note that aftermarket sales were down slightly from the same quarter a year ago. Sales in Space and Defense Control to note that $242,000,000 increased 8% over the Q3 of last year. Adjusting for the divestiture of a security business to

Operator

turn the call over to Steve. Last year, sales increased 11%.

Speaker 5

The ramp up in production on the reconfigurable turret program, which hit full rate production levels in the first to turn the call over to Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve. Good morning, everyone.

Speaker 5

To turn the

Speaker 2

call over to the operator

Speaker 5

for Satellites. Industrial Systems sales increased 9% to $253,000,000 to excluding the divestiture of our sonar business last year, sales were up 11%. Within Industrial Systems, Our Industrial Automation sales growth was driven by demand for capital equipment. This business has recovered nicely since the pandemic, though we're now seeing orders slow down Simulation and Test sales were also strong, driven by high demand on flight simulation systems. Sales and Energy adjusting for the divestiture last year were up nicely compared to a year ago.

Speaker 5

These sales increases were partially to turn the call back over to the operator for questions. We'll now shift to operating margins. To Adjusted operating margin of 10.2 percent in the 3rd quarter decreased 30 basis points from the Q3 last year. The space vehicle charges pressured our total operating margin by 150 basis points. These pressures were mostly to discuss a strong operational performance on our underlying business and a marginal return on the sales increase.

Speaker 5

To adjustments to operating profit this quarter and the same quarter a year ago were $2,000,000 $1,000,000 respectively. To these adjustments reflect restructuring and other charges. I'll now describe the key drivers of our adjusted operating margins for each of our segments. Operating margin in Aircraft Controls was 10.9% in the 3rd quarter compared to 11.0% in the same quarter a year ago. Operating margin in Space and Defense Controls was 7.8%, down 360 basis points from 11.4% a year ago.

Speaker 5

To discuss the benefit associated with higher sales and improvements in the core business. Operating margin in Industrial Systems was 11.5%, to be up nicely over the 8.7% of last year's Q3. Benefits associated with our pricing initiatives to account for 3 quarters of this improvement. In addition, last year's margin was pressured by supply chain disruptions to discuss the financial results. Interest expense is another area that's impacting our financial results.

Speaker 5

To In the Q3, interest expense was $17,000,000 up $8,000,000 over the Q3 last year. To discuss the increase in interest expense relates to higher interest rates and to a lesser extent, higher levels of debt. To Our adjusted effective tax rate in the 3rd quarter was 16.0%, about the same as in the Q3 last year. To We're benefiting from higher levels of R and D tax credits and have captured these benefits in our return to provision 3rd quarter adjustments in both years. To Putting it all together, adjusted earnings per share came in at $1.37 within the range we provided a quarter ago.

Speaker 5

EPS is down 15% from the same quarter a year ago due to higher interest expense and corporate expense, to take a look at the Q3, partially offset by increased operating profit. Let's shift over to cash flow. In the 3rd quarter, we had negative free cash flow of to turn the call over to Steve. Net earnings were solid and capital expenditures were unplanned. However, net working capital, in particular physical inventories, to Grew substantially.

Speaker 5

Growth in physical inventories, both unbilled receivables for long term contracts to note that the inventory is shown on the balance sheet resulted from continuing to receive in materials at a faster rate than shipping product to customers. To We've maintained material flow to ensure we're positioned well for customer deliveries. However, a combination of staffing shortages, Supply chain challenges and production inefficiencies have limited our ability to convert inventories to cash. In addition, this quarter, we took ownership of some inventory from a vendor to prevent a supply chain disruption. To Capital expenditures were $35,000,000 That's pretty much in line with our average spending last year and just over the average to extend this year excluding the facility we purchased last quarter.

Speaker 5

We're investing in facilities to accommodate our growth, to focus our factories and enhance our capabilities through automation. Our leverage ratio calculated on a net to reiterate that the Q3 was 2.7 times within our target range of 2.25 times to 2.75 times. To take our capital deployment priorities, both long term and near term, are unchanged. Our current priority continues to be investing for organic growth. To now shift over to guidance for the full year.

Speaker 5

Compared to a quarter ago, we're increasing sales, to discuss our financial results. Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve.

Speaker 5

Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve.

Speaker 5

Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve. Thank you, Steve.

Speaker 5

Thank you, Steve. To Based on continuing pressures on cash, we are decreasing our free cash flow guidance for the year. Let's take a more detailed look at our guidance. To We're projecting sales of $3,300,000,000 in fiscal year 'twenty three, which is up $60,000,000 over our previous guidance. To reflect a foreign currency movement.

Speaker 5

We expect high single digit organic sales growth in each of our segments. To aircraft control sales are projected to increase 8% to $1,400,000,000 The increase is all on the commercial side of the business. To Commercial OE will be up across the board with growth on Airbus and Boeing Platforms, Business Jets to and the Genesis business we acquired a couple of years ago. We'll also see growth in an already strong commercial aftermarket business. To account for the strong sales this quarter, we're increasing our commercial OE forecast by $35,000,000 to end our aftermarket sales forecast by $20,000,000 We expect a decline in military to note that we are seeing strong sales driven by lower funded development and aftermarket sales.

Speaker 5

We're decreasing our military aircraft sales guidance by $30,000,000 to reflect the results we're seeing, especially related to funding development activities. To Space and Defense Control sales are projected to increase 7% to $930,000,000 Adjusting for the divestiture of a security business late last to turn the call over to our financial results. When looking at our numbers within the segment, you may recall that we shifted a product line from to extend into space at the beginning of our Q1. We've now adjusted last year's numbers for that shift in our supplemental materials. To Space sales will increase for satellite components and space vehicles and defense sales will increase on production ramps for the reconfigurable turret and tactical to review our financial results.

Speaker 5

Our sales forecast is up $10,000,000 over our previous forecast, reflecting the strong sales levels we're achieving in both to discuss the financial results. Industrial Systems sales are projected to increase 6% to $965,000,000 to adjust for the sale of the sonar business and foreign currency movements, the increase is 10%. Most of the growth will come from industrial automation and to take a look at simulation tests, both of which were particularly strong this quarter. Our sales forecast is up $25,000,000 from our previous forecast to turn the call over to operating margins. To We've updated our segment operating profit and margin guidance to reflect retroactive pricing benefits to discuss the Q4 on aircraft programs, the higher level of sales we're now projecting and the charges we incurred this quarter to turn the call over to our operator for questions.

Speaker 5

We're now projecting an adjusted operating margin of 10.9% in fiscal year 'twenty three, to turn the call over to 10.8%, also reflecting the benefit we'll see from pricing initiatives. Factory utilization will improve as sales in the to provide

Speaker 2

an update on our commercial OE business increase.

Speaker 5

However, this benefit will be largely offset by an unfavorable mix with the relative increase in commercial OE. To Operating margins in Space and Defense Controls will decrease 40 basis points to 10.5%, to reflecting $25,000,000 of charges incurred on space vehicle programs this year, offset by incremental return on higher sales. To discuss higher interest expense will depress adjusted earnings per share by $0.62 relative to fiscal year 2022. To 1st fiscal year 'twenty three, we're now projecting adjusted earnings per share of $5.75 to take a look at the financial results, plus or minus $0.10 which is up 3% over fiscal year 2022. To Adjusting for interest, EPS would be $6.37 an increase of 15%, reflecting strong operational performance.

Speaker 5

Next quarter, we're forecasting earnings per share to be $1.71 plus or minus 0 point 1 $0 to Finally, turning to cash. We're projecting free cash flow for fiscal year 'twenty three to be negative $60,000,000 to down from 0 that we were projecting 90 days ago. The change largely reflects our 3rd quarter growth in physical inventories. To take your questions. As we move into the Q4, we expect working capital to be a source of cash the first time in several quarters.

Speaker 5

Receivables will be the largest generator of cash within working capital. Accruals for compensation will normalize from a timing perspective in the 4th to take a look at the Q4 also contributing to free cash flow generation. Those sources of cash will be partially offset by continued growth in physical inventories. So we're beginning to see the growth in physical inventories trend downward. Outside of working capital, we're projecting a strong earnings quarter to and we're maintaining our forecast of $165,000,000 in capital expenditures for the year.

Speaker 5

To Overall, we had a solid Q3 and our outlook for the Q4 looks strong. We're positioned well from a liquidity and leverage standpoint, enabling us to invest for future growth in our business. And now, I'll turn it over to Pat.

Speaker 4

Thank you, Jennifer. As you've heard, we closed out to take a solid quarter delivering record sales, and we're on a path to deliver a fiscal year with 9% organic sales growth to And 70 basis points margin improvement. We are now happy to take your questions.

Operator

Your mute function is turned off to allow your signal to reach our equipment. And our first question is going to come from Christine LeWigg from Morgan Stanley. Please go ahead.

Speaker 6

Great. Hey, guys. Thanks for putting me in to first on pricing. You guys mentioned aircraft controls, you're getting the pricing increases rolling through. Can you quantify that?

Speaker 6

And are you seeing that in specific aircraft programs or all programs? And how much of a pricing increase is this?

Speaker 4

Hi, Christine. Good morning. How are you?

Speaker 6

Great, great. Happy Friday.

Speaker 4

To Thank you. So I think we've made really strong progress during the course of this year in pricing conversations with our customers. It's across all of our customers on the commercial aircraft side of the business and in the other businesses as I've emphasized in the Investor Day. In those conversations, we also said in Investor Day that some of them have been going on for an extended period of time. And We reached agreement with our customer that the negotiation would be retrospective to the 1st January.

Speaker 4

And so to Now that we've concluded those conversations with our customer, we're able to, in the Q4, reflect an increased operating margin in our aircraft group to take a look at the numbers as

Speaker 2

those prices flow through.

Speaker 4

The gain or step up in performance of the aircraft group in Q4 is including to That retrospective pricing element. And so it will be in our business going forward, but not at the same high level of operating margin as Q4 will show for to So I would say in answer to your question, Christine, we don't want to be specific about which customer it is and it is across multiple customers within our Aircraft Group business. And I don't think we want to share the increment of the increase at this point. Although in Q4, to we will do a retrospective that shows how much gain has come through pricing in our business and how much has come through simplification. Jennifer, do you have anything you'd like to add?

Speaker 5

No, I think that's fair, Pat. I think we've made a lot of progress. As Pat said, we've got a retro coming up In the Q4, so when we look at it for the full year, pricing is a substantial contributor to the margin enhancement to comment for all of fiscal year 2020 3 compared to all of fiscal year 2022 across our aircraft business. To

Speaker 6

It's great to see you guys make progress there. And so when we think about this pricing reset, is this a one time to reset on all the programs that you have or is this something that we should expect to occur on an annual basis?

Speaker 4

I would describe it as a progressive program, Christine. We have still more work to do on pricing with other customers, So it's ongoing. And in addition, the pricing that we have negotiated with our customers to date has included a provision in the contracts to for escalation year over year. And so we have a framework and a mechanism for further increases over time depending on certain indices that we're tracking. To

Speaker 6

Great. Thanks. And if I could just squeeze one last one on free cash flow. I mean, we've seen fairly dramatic cuts to take a look at the free cash flow outlook now for 2 consecutive quarters. I mean, what would is this what makes you confidence that negative $60,000,000 is for the year.

Speaker 6

And is that a conservative enough number if to revenue maybe picks up even more than you thought. And then also at some point, we'll see an inventory unwind.

Operator

To At what pace do

Speaker 6

you think that unwinds that will be for 2024? Could we see all of that come back and you get to your normal course of positive free cash flow plus the inventory unwind.

Speaker 4

Yes. I'll start and then I'll hand over to Jennifer as well for some comments on this. I think the difference where we sit today is that we know it's taking longer to slow the rate of growth. We took a lot of actions in the last 90 days, which have had an impact and have slowed down the growth of inventory. But it's striking that right balance between the inflow of materials and sufficient material on hand to meet our customers' requirements.

Speaker 4

So That's a little bit longer going and taking a little bit more time than we anticipated. It will to your point, it will unwind, Christine. The inventory that we have is non perishable and it will get used in our programs. That unwind will begin to come through to In future quarters, what you got to bear in mind that our especially our commercial aircraft programs are ramping. We are currently running at rate 5 to on our Boeing production.

Speaker 4

So that's up from the rate 4 we were previously running and we are getting we are ahead because of our lead times to of Boeing's own rates. So the unwind is balanced in some way by a pickup in inventory required for those higher rates in the future. So that will play out during the course of fiscal 2024. Our cash used in 2024 Is it demand for next year? Our free cash conversion will be I don't know if we get the figure in Investor Day, it will be lower than it will be in 2025, 2026.

Speaker 4

To We get back to the normalized levels in 2025, 2020 6. So there are demands through the course of next year. So you see it as multiple quarters as we go through this to transition now. Jennifer, do you have anything to add to that?

Speaker 5

Yes. Maybe just to complement that. So for our forecast this year for a $60,000,000 to Use of cash. To your point, I would say it's balanced. To your point, if we have higher sales, We may be pressured from the receivable standpoint associated with that.

Speaker 5

But I would say overall it's balanced. The area we give confidence to it when we're looking at how the Q4 is going to shape up is we do have to discuss some customer advances that were billed late in Q3. And just on the normal terms associated with that, we will get the collections to make sure that we have the right questions of that advance in Q4. With our high level of sales in Q3, we'll also collect on those sales as well. So there's definitely some things especially on the receivable side that will help us as we move into the Q4.

Speaker 5

We're also seeing a slowdown in the need for growth in physical inventory. So it's still growing. To But over the past few quarters, it's been decreasing. So in the Q1, it was about $71,000,000 in the second quarter, to It was $67,000,000 although in the Q3 it was $65,000,000 that included about $10,000,000 of a payment we made to prevent a supply chain disruption by taking some inventory from a vendor, and we're projecting that to improve to $40,000,000 in Q4. So we are seeing a slowdown in the growth of physical inventories, but we're not yet projecting that to turn.

Speaker 5

As we look into next year, we're expecting a modest level of free cash flow generation, which is consistent with what we said A month or 2 ago as well. So definitely physical inventories is an area that will take us a while to work through. To Great. Thank you for the color, guys. Yes.

Speaker 4

You're welcome.

Operator

To and our next question is going to come from Michael Ciarmoli from Truist Securities. Please go ahead.

Speaker 7

To Hey, good morning, guys. Thanks for taking the questions. Just, Jennifer, I guess to stay on to The inventory and cash side of things. Can you kind of specify what end markets From a material standpoint, I guess that you're trying to reduce, is it more aerospace related to And then any color on where you are with 787 inventories? I know you guys have been building ahead there and it Sounds like Boeing is certainly pushing for 5 a month by year end and kind of how that fits into kind of the equation?

Speaker 5

To Yes. From a market perspective, we're seeing the supply chain pressures in many of our markets. Each of our markets is reacting a little bit different, but we're still seeing supply chain constraints in many areas for electronics. To some areas have eased up a little bit, but there's also some forgings and other areas that continue to pop up as well on that. I would say, in our industrial businesses, it's easing up from a standpoint of to to be opening in the Aerospace business and they still seem like there's a changing associated with it.

Speaker 5

So for instance, We're still keeping our incoming receipts for the most part fairly level from our supply chain. We want to make sure first to that we've got everything that we need so that we can meet customer requirements and also to make sure that we've got a healthy supply chain. To Obviously, we want to balance that so that we're not carrying excess amounts of safety stock. So we're being very careful, but it's a very tedious to go through and make these decisions and then input them into our system and then wait for it to actually manifest to take a look at our numbers. But in some of the A and D size of the business, and it's in different parts of it, some places we've got we're short on staff a little bit.

Speaker 5

So to So when we've got the materials in, it still takes a while for us to push those products through based on our staffing. Some of the supply chain challenges are happening as well and it's the throughput through our factories of making that all happen. So if we get a huge slug of inventories in even from our supply chain, the time that it still takes to process it through Doesn't necessarily mean that we'll catch up right away. So there's 2nd level challenges that we're facing even though that we are getting to share some details in the door. As it relates to 787 inventories, to Currently, it's not having a significant amount of impact on our free cash flow.

Speaker 5

To However, we are carrying inventory that we had built up in previous periods, especially in fiscal year 2022. That's going to help us as we start going into this ramp and we're at that 5 a month rate right now on that. So to right now it's stable, not causing any further pressure, but and we do have stock in hand so that we can manage as we move forward.

Speaker 7

Got it. And then what about you called out the, I think earlier, the unbilled receivables. What sort of the line of sight in terms of to driving that down. Do you is it more milestone based? Are they presumably to More on the space and defense side and should we expect that to be more of a tailwind out in 2025 or 2026 or do you think you can start unwinding

Speaker 5

to Yes. So the unbilled receivables, There's a number of things that are happening. 1st of all, with our level of activity, we've got continuing growth with our sales growth. A lot of our business to reiterate that

Speaker 2

on the A and D

Speaker 5

side is on long term contracting. So it does happen to go through the unbilled receivables as we have progress on that. To Certain things have gotten delayed in the unbilled and converting that over into cash. For instance, the space vehicle charges that we described, The delays associated with that, the higher expenses has delayed our activity on that such that the cash that we would have expected to get in this year, we're now projecting getting into next year instead. So there's different things on different programs.

Speaker 7

Okay. And then Pat, can I just try the pricing in aircraft one more time? I mean, Can you maybe even I know you don't want to maybe give a lot of specifics, but are you having more success immediately in the aftermarket or are you getting some to On the OE side, I figured that the conversations with Boeing and Airbus might be a bit more challenging there. And then are you getting some across the military as well? And then I guess with that price, you talked about some of the escalators, but are you trying to manage, I guess, Future price step downs with volumes, are those components in the conversations as well?

Speaker 4

Well, thanks, Michael. The pricing activity is across all of the OEMs and all of the aftermarket. So it's not limited to OEM activity. And as you know, in some of our OEM contracts, aftermarket is an element of the contract and that's So all those factors are rolling into the conversations that we're having. But my position is that we've made great progress with those conversations with the customers.

Speaker 4

There's a recognition on both sides to have a sustainable business. There has to be an adjustment and that has come through now.

Speaker 7

Okay.

Speaker 4

Got it. I'm really pleased, Michael, where we got to with those conversations and the impact then, as we say, will show through in Q4 and throughout next year.

Speaker 7

Perfect, perfect. Okay, great. I'll jump back in the queue here. Thanks, guys.

Speaker 2

To open the call for questions.

Operator

Thank you. And our next question is going to come from Cai von Rumohr from TD Cowen.

Speaker 2

To

Speaker 3

Yes. Thanks so much for taking the call. So maybe switching back for a second to to space, another large charge. How close are we to the end of this? I mean, what should we be looking for as a milestone to to say from here on out, we shouldn't expect more space vehicle charges.

Speaker 4

To Hi, Kai. Welcome, and thank you for the question. I think we have really done a good job over the last to take 2 months in burning down the risk associated with that space vehicle program. There are 2 programs on which we have shipped units, the first to take a look at our Meteorite class units. Those shipments completed 2 weeks ago or last week was the last to take a look at our facility to our customers' facility.

Speaker 4

So in terms of the integration and test activities, All of those have been completed for all 6 units. So that's one element that reduces the risk down. We know that the hardware is functional and it is with our customers at this point. The software, we have a revision of software to be delivered to the customer on August 11. So that's within the next 2 weeks.

Speaker 4

So we're in the final stages of working through that update code. And so again, because we're so close to the finish line now with the software, to We have really high confidence that we have the issues addressed in terms of delivery there, and we don't expect to see a change in the cost of development of the software as a consequence of being so close to the finish line at this point. We also sent in a expert team about 2 months to go to do an assessment on work left to be completed, and that was part of revising the estimate to complete. So 90 days ago, I would have said we were 90% complete. If I look at the estimates to complete as of last week, we were 97% to 98% complete.

Speaker 4

So we are most of the way almost entirely through those two programs, Cai.

Speaker 3

So is that both METEOR and METEORite, the both the 2 vehicles basically you've to add shipments on other 6 all meteorites.

Speaker 4

So it is on the meteorite class that we have shipped 6 to satellites. On meteor, we will ship the first of those in the latter part of this calendar year. To What's my point around Meteor and Meteorite is that they have a common platform of avionics, which is the electronics that controls the system to And a common base of software. And so a lot of the complexity and the integration risk is actually associated with those parts of the system. To Many of the hardware components are also similar.

Speaker 4

What might vary from one to the next is the propulsion system and the size of the solar array panels. To But there's a high level of commonality. So I would look at them as modular platforms, Kai, which is another reason why we have confidence.

Speaker 3

To Very good answer. Thank you very much. So getting back to the cash flow. So what about as we think about next year, so I guess we can expect the inventory to continue to go up. But to even with some improvement, it looks like your DSOs have really been going up a fair amount.

Speaker 3

To where do you see those going next year? Where do you see kind of your payables relative to sales? To And also with the inventory uptick, it looks like you're close to 23% of sales, whereas to If we go back to 2022, you'd gotten down to below 20%. So it looks like there's really quite a lot of Excess inventory relative to your sales level, when do you see that sort of starting to crest?

Speaker 5

So I'll take that, Cai. We'll give further detailed guidance on fiscal year 2024 when we do this in 90 days. But just on a general type of basis, what we can expect to see is on physical inventories. As you mentioned, we're going to continue to see Growth, we expect that to moderate at least in this Q4 and we'll comment more in next year in next quarter's call. We will have a little bit of lumpiness associated with our customer advances.

Speaker 5

Our customer advances level right now is strong, But it comes in lumps and we do expect to see some next year, probably in the later part of next year And it's just due to program timing that we've got. We are still expecting to generate modest levels of free to take a look at the cash flow generation, which is what we shared in the Investor Day for fiscal year 2024. So some of the that we're talking about now the physical inventories, we would not see a significant turn in that until we're getting out in some out years when we'll return to more normal levels of free cash flow.

Speaker 3

Right. But so what about the receivables? I mean, the DSOs look like they also are higher. I mean,

Speaker 5

to reach you.

Speaker 3

Do you expect your collection rate to improve?

Speaker 5

There's a couple of forces. There's They're offsetting forces, so let me describe that. Right now, our sales are high. There's a couple of receivables are high. So they're high to the level of to take a look at our balance sheet right now, there is a gross up between some receivables and advances for advances that we have to build but not collected until the Q4.

Speaker 5

So that comes through, but that just shows up as a bad guy in our receivables in the 3rd quarter, but that converts fully to cash in the 4th quarter. As our sales continue to grow, there is pressure on our receivables That continues to happen, especially on the ramp up associated with our aircraft business, where our terms are less favorable than the average of the company and that's the area of the business that we're growing. So there are some pressures associated with that. But again, we do have the strong collections that we're expecting from the Q3 sales that we had as well as the advances that we are collecting and at the timing from Q3 to Q4.

Speaker 3

Got it. So, to Pat, you described lots of improvements, which all sound really very good and better pricing going forward on aircraft on a normalized to take a look at the space and space defense like we're out of hopefully, we have less problems from the satellite vehicles. And industrial, you've got some price hikes. You're looking for, I think, 100 basis points on average for the next to take a look at the next couple of years. I mean, it would look like you would get sort of a proportional percent of that next year.

Speaker 3

I mean, you could be close to Up 100 basis points on the op margin. Am I reading that incorrectly?

Speaker 4

We are Feeling really confident, Cai, that we are going to deliver on the 100 basis points a year on average, as we said in the Investor Day. Everything that we're doing is on track to report that at this point.

Speaker 3

Okay. Thank you very much.

Speaker 4

You're welcome.

Speaker 2

To

Operator

ask Michael to see a Mali from Truist Securities. Please go ahead. To give him just a moment here.

Speaker 2

To turn the call over to Michael.

Operator

Please go ahead.

Speaker 7

Hey, can you guys hear me now?

Speaker 4

Perfect. Hey, Michael. Thank you.

Speaker 7

Okay. Sorry about that. Pat, just to Can you give us maybe a little bit more insight into maybe within Space and Defense, do you have a lot of other to Development contracts or new start contracts. I mean, we are seeing this mix shift across to The defense sector of legacy programs winding down, new programs ramping up. And I mean just to try and get an assessment to Maybe how much risk you see with some of the other contracts in there.

Speaker 7

For example, I don't know if you have any firm fixed development contracts, Just trying to maybe get a framework on what else could crop up in that sector.

Speaker 4

To Thanks, Michael. I think we have, in general, reducing our exposure to firm fixed to contracts in our military side of the business. We have some for sure. We have some legacy programs that are still to close out. To And there are a couple of pieces of business in Space and Defense that are still under fixed price contracts.

Speaker 4

So I think we feel comfortable with the profile that we have there, Michael. I wouldn't say it's degrading in answer to your question. To Okay.

Speaker 7

Okay. Perfect. Yes, that was the last one I had. Thanks, guys.

Speaker 4

You're welcome. Thank you.

Operator

To turn the call back over to to ask Aaron Astartan. Please go ahead.

Speaker 4

So it's back to Pat, and to I appreciate you taking the time to join the call, and I look forward to meeting you all again in 90 days' time. Thank you very much.

Speaker 2

To and

Operator

this concludes today's call. We appreciate your participation. You may now disconnect.

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Moog Q3 2023
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