Hey, everyone. I'm Kristine Liwag , Morgan Stanley Aerospace and Defense Analyst. Thank you for being here. For our next panel, we have Moog, Pat Roche, CEO, and Jennifer Walter, CFO. Pat, Jennifer, welcome. Thank you for being here.
Great! Before we start, the disclosure again. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative, so with that, out of the way, Pat, maybe we could start off. As you assess the Moog portfolio today, where do you see the deepest pockets of earnings growth opportunities? Where do you see risk? Because when you first started, as CEO, before that you were COO, so you've already looked at Moog as an enterprise, and you've really accomplished some really good, healthy margin expansion, so where do we go from here?
So I think the positive thing from our perspective is we've driven pricing and simplification now over the course of the last year since we announced it at the Investor Day conference, and we're seeing opportunity across the entire organization, Kristine. I think that's the positive. It is turning up as we go through these initiatives that there has been potential there that was maybe unrealized or untapped, certainly before, and that we've now identified that. So I would rather say that it's across the board in the company and it's across all the end markets that we serve.
With this pricing dynamic, I mean, look, you've been executing in a new margin expansion campaign since your Investor Day last year. You've been guiding to a hundred basis points of annual margin expansion through fiscal year 2026, and you know, part of that is pricing and some for business simplification efforts. So I guess on the pricing aspect, can you give us an idea of where you are in this journey? I mean, how much have you done, and are there specific years or milestones that roll off, where you're able to open up contracts, or do they end, and how are you gonna get that,
Yeah
-margin expansion?
So, when we rolled out the Investor Day, we said we had about the potential to deliver 100 basis points on average improvement over the course of the time period, the horizon of the Investor Day. And we said it was coming from the two mechanisms, and pricing was the one that was going to deliver the greater impact in the early years and simplification in the later years of it. So one tapers down, one tapers up. On the pricing initiatives that we have driven, we started with a sort of top-down, large account management approach to it.
We took our largest customers in each of the end market areas that we were dealing with, and we started into the conversations about how to reset the pricing with them as a customer to reflect the value that we believed that we were bringing to their end market applications. Actually, we secured some of those tier one negotiations and concluded them before we had the Investor Day because we wanted to be certain that we had them and could roll them forward into the plan. So, the biggest customers we had done our greatest work with prior to Investor Day. But, subsequent to that, we started working down through the next tier of customers within our organization across those businesses as well. So, that top-down focus continues.
We continue to work through pricing negotiations with customers, but an additional element to it, we've been driving 80/20 through our organization, and as we drive 80/20 down to the site level, it's looking at profitability by customer and product line at the site level, so at a much more granular basis. And now, when we find that we have a product, a B, a B customer and a B product, and have potentially in the past been leaking or draining margin in that portion of the business at those sites, we're addressing that in a much more timely manner now. We're giving visibility to the issue, and we're asking the general manager, site managers to make decisions about it and change the context. So that could be changing terms and conditions of business. It could be changing pricing.
It could be decide to end of life some of those products or to manage those customers in a different way, maybe move them into a distribution channel. So we've been making a lot of decisions like that. So I would characterize the pricing journey now as both top-down, the large account management approach, working down through those tier twos, and bottom up, as the general managers, site managers are actively making decisions now as they're contributing to it. So I would say pricing is part of how we work now, and it will be an ongoing activity. But as I said earlier, the biggest contribution came from those largest customers at the beginning of the journey, but we continue that journey. So that's where we are with pricing. So there's still more ground to cover, more potential there.
And then you asked a question as well in that about frequency at which you can do this, or... That dynamic varies between the end markets. So industrial end market is more transactional, much more frequent opportunities to reprice. Our defense businesses typically are in production lots that are of one- to three-year duration, and so as those come up, we reprice those. Some of the commercial ones were longer-term contracts. They were the ones we dealt with earlier in the whole process, so they're secured.
So I mean, Pat, you know, for a very long time, it seemed like Moog didn't really exercise the pricing power, you know? And now that you are doing it, can you give us an idea how customers are receiving these increases? And then are there pockets where you're seeing the most resistance-
Yeah
-to the pricing increases?
So if you look at our company, you look at precision components the whole way through to really complex engineered systems, systems of systems like the entire primary flight control system on the Embraer E2 Jet. We got a real breadth of technology and a depth of capability in the organization. Most of the applications we go into are highly sticky as well. Primary flight control system on a 787 or A350, we are the sole source for that system, and it's to be taken out or displaced, it's a requal. Now, that's not just on the commercial side. That also is on military applications. We're in even industrial applications. You need to go through a requalification of the machine before you could change out a part. So we own the IP, we're high tech, we're sticky in the application.
So to your point, you do have a pricing power associated with that. I think we've learned over the years that when we start looking at sole source, dual source, multi-source, where do we stand in that? We have different levels of elasticity in the pricing that we can exert, and we have found that across our businesses. It's not just in one segment that we have done it. I think what we've developed is some muscle around the pricing and some backbone around taking that to the customer. It's not an enjoyable experience for key account managers to be doing that, but we've learned to do it, and we weren't doing it in the past.
Great. Moving to the simplification efforts, I mean, what's been your general approach? How much progress have you made with your site and project product divestitures? Should we expect to see more exits in the near term?
Yeah. So our simplification, if I take that as the overall heading for it, includes many different elements: portfolio shaping, footprint rationalization, focused factories, 80/20, lean activities. So we've had a collection of different techniques we've been using. The portfolio shaping one, taking that one first, we have sold off a number of businesses from our organization.
If we don't feel that they have the strategic alignment or synergies with the rest of the business to the degree we expected, if we don't have an opportunity to grow and develop that business the way it was, that was originally anticipated, or the margins are really poor and we don't see a way, a way out of that, we've then said, "We'll take those businesses, and we'll find a better home for them." They've typically been companies that have been in the range $15 million-$40 million. So that pruning is an ongoing activity. We've done several of them in the Industrial business. We've done them in the Space and Defense and in the aircraft part of our organization. That's an ongoing process, Kristine. At the moment, we have two of them that are being sold at the moment. Both are based in Europe.
Both are from the industrial systems side of the business, a motors manufacturing plant in the Czech Republic. Actually, there was a press release about closing out on that soon with Wittenstein, a German motor manufacturer. And then we have a plant in Luxembourg that makes hydraulic manifolds, which we're also in the process of closing out a sale as well. But that won't be the end of it. We will continue to review the portfolio, and we will continue to take out small piece - I would say small, relative to the overall scale of the organization, small pieces of business that are no longer the right fit for us. So that's on the portfolio shaping side of it. We've done work on consolidation of manufacturing plants as well.
So if I give one example, in terms of motor manufacturing, we had two manufacturing plants in the States, two in Europe, one in Asia Pacific. If I look at the needs of our customers, I just need one in each of the regions. So we're moving and shutting down one of our sites in the U.S., transferring product into another site. In Europe, the divestiture that I just mentioned to Wittenstein was such a rationalization move as well. We didn't need two plants there. So we're making good progress with those. We had a roadmap for those when we went into the Investor Day, and we are progressively executing against that. So we're on path in, in doing the things we wanted to do there. Yeah, so those, those are going really well. How far are we?
It's an ongoing journey, I would say, and we continue to evaluate the portfolio.
And then you called out 80/20-
Yeah
- as a piece of your strategy. Can you talk more about the benefits you've seen from 80/20 and?
Absolutely
... also maybe some dollars and cents around it?
So if I think over the course of the last year, what I learned is 80/20 is potentially more impactful for us as an organization than we'd at first realized, and I would have described it as one of those elements that I just laid out, this, this, this, and this, but actually, 80/20 is becoming more central to what we're doing. So when we look at 80/20, we started out doing a number of pilots in a couple of our industrial sites. We saw significant potential that could be unlocked in the business by adopting 80/20, and it's a really simple conceptual technique to adopt in the organization, and so we found great traction in the deployment of it. People get it pretty quickly and can start using it.
With the 80/20 journey, we're really prioritizing where we put our time and effort to best effect. And if I start out, the first thing we do when we go into a site is just look at who are the customers that are really helping us in terms of profitability and which are a drag to the profitability? And we do the same with products, and we do a simple quad analysis. So you end up with quad four, B customers, B products, and basically, you'd make a set of business decisions. What do I want to do with them? They're those B customers, B products are a drag to our margins at those sites. If we can address that, we can uplift the margin at that site overall, and we've been very successful at doing that at each site we've gone into with 80/20.
And then we start looking at a segmented P&L, which is saying by either end market or end customer, we're looking at how much indirect costs are truly associated with supporting that business line or that value stream within the plant, and we're learning things as we go there. We're learning that we actually have, in some cases, more profitability associated with a product line that's regular, with a consistent flow of product going through, and we're managing that business really well with very little indirect support costs associated with it. And then we're finding some businesses where it's not as positive for us, where we're actually, in some cases, at lower margin than our target or actually at break even on some products we've looked at, at some sites.
Because they're attracting a whole host of quality engineering, planning and scheduling activity, much more customer engagement required than we would have anticipated. So it wasn't built into the price for those at the beginning, and so that's causing us to say: Can we change the situation through price? Do we have to change our internal operating model associated with it, or do we stop doing it? And so we are getting really good insights into the operation of our business through the 80/20 deployment. And so where we are as an organization at this point is, we've deployed it to 20 sites within the company. Think of us as being, by 2026, having roughly 40-43 sites. So you could say we're sort of halfway through a journey of deploying 80/20 into the organization.
We have more distance to go on putting that in, but by the end of calendar 2026, we will have it in all of our manufacturing locations globally. And then we're building maturity with it as well. So the journey doesn't stop in 2026 because we can further drive enhancements and improvements at site level and up through the business as well. So it's an ongoing, continuous improvement journey. It's revealing a lot of potential to us as we go through it. We're confident in it as a technique to drive change in the organization. There's good commitment to it. We are institutionalizing it in the organization.
We've actually documented a playbook for implementing 80/20 in our company, and general managers who are not yet deployed are asking for that and starting to do the data analytics and starting to make decisions in their site about profitability. So I feel heartened by the approach, and we're learning as we do it, and we're gaining ground.
I mean, Pat, sounds like you've had a really busy year.
There's a lot of change, yes. I mean, we've had changes in leadership. We've had a lot of initiatives flowing in the organization, but we're building momentum with that, and there's a positivity around it as well, Kristine, because people inside the company look at our stock price as well, and they say: "Okay, something's changing in the organization. I'm on a winning team. Things are going in the right direction.
Great. So, you know, you've been very clear. Continuous improvement is the path. It, you know, it doesn't seem like things are over. But, when we look at low-hanging fruit, like how much of that have you picked? What's kind of left? And, you know, when you look at this continuous improvement over time, I mean, I'm not asking for upsides to your 100 basis points annual margin expansion, but maybe I am. Could you get beyond 100 basis points in this timeframe? Because it sounds like there's a lot of low-hanging fruit.
I mean, well, you can look at pricing as something that delivered early returns for us and results, which was great to have. The simplification activity itself does actually take time to execute. So from the point at which we make a decision to consolidate two plants, there's a lot of work in doing product line transfers. You're engaging customers, you're bringing it into the new plant, you're qualifying with the customer that it meets the requirements and matches what we had before. Anticipate 12 months work in doing something like that, or even in the divestiture of the small businesses, they've taken 12 months each as well. By the time we get the team together, get them out onto the market, get some interested buyers, and then negotiate with them. So that's why the simplification part takes a little bit longer.
It's not that we don't know what we want to do, and it's not that we are not able to make decisions timely. It's just you take time to execute upon them, and so we see the results of that coming later in the journey. But it's there, the potential is there, and we're on track, and we have now the support in the organization and momentum behind it.
I was going to say, for labor, I mean, whenever there's a lot of change, sometimes it's not always well-received. What's been the buy-in from the rank and file and then the decision-makers within the company to execute on this strategy?
Yeah, I mentioned the thing about being on a winning team. That's actually a quote from one of the members of the leadership team. You know, the next line of leadership below the top-level team in the company. That was: "I now feel like I'm on a winning team. Previously, I didn't." So the leadership get it. They're aligned with what we're trying to do, and they're on board. And I think the rank and file in the organization also see the impact. Because if you think about our employees, we have employee share purchase plans in place in the U.S. for all our domestic employees. We have that scheme in the U.K. and in Germany as well. Lots of people hold stock in the company through that scheme, but also through the 401(k) plans as well.
So when they see the value of the company going up, they're actually personally seeing their wealth increase as well. It's a good thing. It gives great alignment across the organization, and we have, as a consequence, good buy-in to the changes that are being made.
I guess the ESOP's pretty happy.
Yep, absolutely.
Great. So, on the supply chain, I mean, supply chain has been, you know, kind of a whack-a-mole- issue for you guys, and, like, you know, you're not alone. It's also something we're seeing in the different parts of the industry. Can you give us an idea of the state of the supply chain today? What are you focused on? What's been improving? What needs work?
Yep
... and, how much of an opener is this for acceleration of burning down your backlog?
Yeah. Our supply chain constraints and pressures that we've seen over the past couple of years have really eased. If we're comparing it to a year ago or even six months ago, it's really eased. That's good news for us. It doesn't mean that the supply chain issues are gone. Like you said, from time to time, we may experience different pressures in different areas. Some of the areas that seem to pop up more than others are gonna be in bearings or specialty electronics. So those are the things that we watch a little bit more closely, but we've been able to take action, and it's part of our ongoing way that we manage our supply chain now, and with this easing, we're actually, in this past quarter, able to keep our inventories, our physical inventories flat.
Great. So, bearings. We had a bearing company present earlier today. I guess they're winning share.
We talked to all the main suppliers on the bearing site, so we're well connected.
Are they all good or one good, one bad? I guess we could take that offline. So, how about defense? I mean, your defense business spans Military Aircraft and your Space and Defense control segments. What's been the driver of revenue strength in defense? And by the way, with the defense primes, we saw 2Q 2024 was a significant positive inflection point. So how much visibility do you have there, and how should we think about the rest of the year?
Yeah. So, yeah, I'll take that. So our defense business is half of our exposure of the company, so it's a big part of our business. We are seeing broad-based demand in defense. We're seeing it in all aspects of the defense. Military Aircraft is where we've got the most exposure to it, and we're seeing increases there. Some of the things that we're seeing in the Military Aircraft, we are seeing some legacy programs go down, but at the same time, we are seeing some development jobs turning into production, and those productions are starting to ramp up, and they're going to continue to ramp up over the next couple of years. So we are seeing some growth as well as a reduced risk profile, which we like to see as well. So that's what we're seeing in the Military Aircraft business.
There's also the once in a generational type of opportunities that are out there for us. We're seeing that in the Space and Defense as well. It's definitely opportunity-rich for us. So we're seeing the defense with just the geopolitical atmosphere that's out there right now, and the replenishment activities that need to happen, as well as the once in a generation types of opportunities that we're happy to start looking at investing on so that we can be positioned for some great platforms in the future.
So if I add on to that, I mean, if I look at that market at the moment, I would say it's an opportunity-rich environment for us as a company. We can afford to be selective about those programs we want to pursue. We are using a sort of filter, which is: How close is it to our core activity? Maybe we're adding in a scope of supply by combining some of our products together to deliver a new solution for the customer. We're looking at our win probability against our competitors, so have we got something that can help really differentiate us in that application?
And then finally, we're looking at the, what's the program likelihood of winning, and if that program wins and succeeds, has it got sufficient substance to it that it's going to be important to us as a company going forward? So we're focusing our BD effort into that area. On the last quarterly call, we mentioned our Space and Defense group margins were down slightly because we had decided to invest in one of those, what we were calling once in a generation type applications that was coming up. So we're being selective. We're targeting the ones we want to go after. There's plenty of opportunity out there, and we talk about, maybe that once in a generation type opportunities landscape that's there.
For our company, being a leading provider of primary flight control systems, any talk of a next generation, sixth generation aircraft is something that we obviously have a interest in and a set of capabilities to contribute towards. That applies to collaborative combat aircraft as well. When I look at other defense areas, you know, things like artillery vehicle or armored vehicles and artillery, you know, in Germany, they placed a big order on us for our RCH 155, which is a howitzer gun, but there's a high level of automation going into these products now, more so than in the past. So taking the shell and loading it into the breech of the gun, there's 20 to 26 different axes of controls in that system, and we supply that to that company.
We see opportunities in the States where you're looking at the next generation of mechanized armored fighting vehicles, XM30. Obviously, that's another big platform that's coming to the fore. We are interested in having positions on that, and so we're competing with others to get onto the competing teams. And so I think we're making good progress there as well. But these are the types of things that are coming up again and again for us. So when I look at our organization today and I see, you know, four major platforms, we talk about wide-body 787 , A350, our RIwP turret that we have in the market and Joint Strike Fighter.
I look forward positively to maybe in the late 2020s, early 2030s, where we would have another handful of such significant programs for us, 'cause we have that type of activity going on today within the organization.
Great. And Pat, Jennifer, when you guys say selective, I just want to be clear, are you also being selective regarding returns?
Yes.
and,
Yeah, yeah.
contract terms?
We are. You know, I would say in the past, if I looked at our portfolio of businesses over the last number of years, we would have had a higher portion of firm fixed price contracts on the development side. They carry technical risk associated with them, of course, and I mean, with our space vehicles business, you saw some of the drag that that created on us in prior years. If I look at that business going forward, that is a diminishing portion of our overall development activities for two reasons. One is some of those programs are actually converting into production, as Jennifer already mentioned, so they're coming out of the development phase, and we're not putting as many of them into the funnel.
So when we're looking at these projects now, we have a perspective that if I'm in the early stage up to a preliminary design review or critical design review, I want that to be a cost plus project rather than a firm fixed price project, while the risk is highest, and then as I progress to production, for sure we'll have firm fixed price contracts on the production side, but it's better understood from a risk perspective as we move into production, so we're changing our approach, and we're also unwinding some of the work that we already had in flow.
Great. Thank you for the color. Maybe switching gears to commercial aerospace, I mean, both Boeing and Airbus are looking to ramp up wide bodies. Both manufacturers are at different stages of their own production versus supply chain. You have more wide-body exposure than narrow-body anyway. I guess Boeing has been procuring, I think, 787 from you guys at around five per month, but their actual production rates below that. How much visibility do you have in the skyline? How do you think about this progressing through, where their production, they're procuring at a higher rate than production? Do you think that's sustainable?
So, these are ongoing conversations we have with both of our major customers on the wide-body side of the business. We're running at deliveries to them at five a month. I think their production rates in both organizations are roughly at five a month now for the last couple of months, at least. We have the visibility to the skyline you're talking about as well. Both have an aspiration to be at 10 by 2026, even Airbus saying 12 by 2028. So we're on a progressive path to get towards supporting their needs. Our cycle time as an organization, manufacturing lead time, is around 12-18 months.
So if you want to be at 10 and 26, you can back off from that and say, "I need to be making sure my supply chain is able to keep up with them." So that's why it's such an active conversation for us with both players. We will not be the long pole in the tent when it comes to them being able to deliver at those rates. We have the facilities to do it. We are able to hire the staff we need to continue to add capacity in that area. So that's the path we're on.
We recognize that there's challenges for certainly for some of the players in the market, and that there are other problems that may disturb their ability to deliver, but we're working to minimize the whipsaw effect that goes on as you start making changes in the demand patterns, in order to ensure that our supply base is secure and stable, and that is a mutually shared interest that we have with our customers as well. They also want the same thing. In the past, we've had to smooth it out ourselves as a company, with support from our customers as we've worked through that. We would anticipate that we'll have a similar agreement between both sides on how to manage our way through the next number of months as we get up to the volumes that are projected.
Great. You know, in the interest of time, one last question.
Sure.
No surprise, it's a cash question.
Okay. Yep.
So cash, I mean, you know, you've shown, you know, the margin expansion. You've executed on that, but free cash flow expectations continue to be not exciting.
Yeah.
Can you talk about, you know, the working capital that's pressured free cash flow this year? How do you expect this to unwind? And, you know, does the long-term target of net income to free cash flow conversion, is that still intact, and how do you get there?
So let me start, and then you can add in the detail. We are still working to the goals that we laid out in Investor Day. That's to get our free cash flow conversion up between 75% and 100% in 2025, 2026. We still think that that's the path we're on. We're working towards delivering on that for the business. I think we had a period of maybe elevated levels of use of cash in the course of last year or so. Part of that was funding physical inventory growth that was occurring. Part of that came from the supply chain challenges. We think we're getting that behind us now.
Certainly, our growth of physical inventory came to a peak, and we think is now going to begin to release cash into our business for next year, contributing to our ability to deliver on the goals that we have in front of us. So. And we're driving internal initiatives that we think will further help it in the future. So basic things like vendor-managed inventory and Kanban will give a contribution to releasing cash. Longer term and more structurally, I think that we have an opportunity to shorten up some of our supply chains in significant parts of the business, like the commercial side, and that that will actually release a lot of future potential off of our balance sheet as we shorten those up and reduce net working capital requirements. So I think we're in good shape. I think we're moving in the right direction.
There's some short-term effects, some longer-term strategies that need to play out, and the benefit from changing around the supply chain and the manufacturing cycle length, that probably comes beyond the Investor Day numbers that we have. Do you want to add anything to that? Sorry.
I think that was kind of a full answer there, Pat.
Okay.
Great. Looking forward to seeing that. Pat, Jennifer, thank you for joining us today. This concludes our presentation on Moog.
Thanks very much. Thank you.