UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended December 28, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from _________ to _________
Commission file number 1-05129
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||
(Address of Principal Executive Offices) | (Zip Code) | |||
(716 ) 652-2000
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
☒ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | Smaller reporting company | |
Emerging growth company | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The number of shares outstanding of each class of common stock as of January 20, 2020 was:
Class A common stock, 31,332,013 shares
Class B common stock, 2,513,960 shares
Moog Inc.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PAGE | ||||||
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Statements of Earnings
(Unaudited)
Three Months Ended | ||||||||
(dollars in thousands, except share and per share data) | December 28, 2019 | December 29, 2018 (1) | ||||||
Net sales | $ | $ | ||||||
Cost of sales | ||||||||
Gross profit | ||||||||
Research and development | ||||||||
Selling, general and administrative | ||||||||
Interest | ||||||||
Other | ||||||||
Earnings before income taxes | ||||||||
Income taxes | ||||||||
Net earnings | $ | $ | ||||||
Net earnings per share | ||||||||
Basic | $ | $ | ||||||
Diluted | $ | $ | ||||||
Dividends declared per share | $ | $ | ||||||
Average common shares outstanding | ||||||||
Basic | ||||||||
Diluted | ||||||||
See accompanying Notes to Consolidated Condensed Financial Statements. (1) As adjusted, see Note 1 - Basis of Presentation. | ||||||||
4
Consolidated Condensed Statements of Comprehensive Income (Loss)
(Unaudited)
Three Months Ended | ||||||||
(dollars in thousands) | December 28, 2019 | December 29, 2018 (1) | ||||||
Net earnings | $ | $ | ||||||
Other comprehensive income (loss), net of tax: | ||||||||
Foreign currency translation adjustment | ( | ) | ||||||
Retirement liability adjustment | ||||||||
Change in accumulated income (loss) on derivatives | ||||||||
Other comprehensive income (loss), net of tax | ( | ) | ||||||
Comprehensive income (loss) | $ | $ | ||||||
See accompanying Notes to Consolidated Condensed Financial Statements. (1) As adjusted, see Note 1 - Basis of Presentation. | ||||||||
5
Consolidated Condensed Balance Sheets
(Unaudited)
(dollars in thousands) | December 28, 2019 | September 28, 2019 (1) | ||||||
ASSETS | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | $ | ||||||
Restricted cash | ||||||||
Receivables | ||||||||
Inventories, net | ||||||||
Prepaid expenses and other current assets | ||||||||
Total current assets | ||||||||
Property, plant and equipment, net | ||||||||
Operating lease right-of-use assets | ||||||||
Goodwill | ||||||||
Intangible assets, net | ||||||||
Deferred income taxes | ||||||||
Other assets | ||||||||
Total assets | $ | $ | ||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities | ||||||||
Current installments of long-term debt | $ | $ | ||||||
Accounts payable | ||||||||
Accrued compensation | ||||||||
Contract advances | ||||||||
Accrued liabilities and other | ||||||||
Total current liabilities | ||||||||
Long-term debt, excluding current installments | ||||||||
Long-term pension and retirement obligations | ||||||||
Deferred income taxes | ||||||||
Other long-term liabilities | ||||||||
Total liabilities | ||||||||
Shareholders’ equity | ||||||||
Common stock - Class A | ||||||||
Common stock - Class B | ||||||||
Additional paid-in capital | ||||||||
Retained earnings | ||||||||
Treasury shares | ( | ) | ( | ) | ||||
Stock Employee Compensation Trust | ( | ) | ( | ) | ||||
Supplemental Retirement Plan Trust | ( | ) | ( | ) | ||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
Total shareholders’ equity | ||||||||
Total liabilities and shareholders’ equity | $ | $ | ||||||
See accompanying Notes to Consolidated Condensed Financial Statements. (1) As adjusted, see Note 1 - Basis of Presentation. | ||||||||
6
Consolidated Condensed Statements of Shareholders' Equity
(Unaudited)
Three Months Ended | ||||||||
(dollars in thousands) | December 28, 2019 (1) | December 29, 2018 (1) | ||||||
COMMON STOCK | ||||||||
Beginning and end of period | $ | $ | ||||||
ADDITIONAL PAID-IN CAPITAL | ||||||||
Beginning of period | ||||||||
Issuance of treasury shares | ( | ) | ||||||
Equity-based compensation expense | ||||||||
Adjustment to market - SECT, SERP and other | ( | ) | ||||||
End of period | ||||||||
RETAINED EARNINGS | ||||||||
Beginning of period | ||||||||
Net earnings | ||||||||
Dividends | ( | ) | ( | ) | ||||
Adoption of ASC 606 | ||||||||
End of period | ||||||||
TREASURY SHARES AT COST | ||||||||
Beginning of period | ( | ) | ( | ) | ||||
Class A and B shares issued related to compensation | ||||||||
Class A and B shares purchased | ( | ) | ( | ) | ||||
End of period | ( | ) | ( | ) | ||||
STOCK EMPLOYEE COMPENSATION TRUST (SECT) | ||||||||
Beginning of period | ( | ) | ( | ) | ||||
Issuance of shares | ||||||||
Purchase of shares | ( | ) | ( | ) | ||||
Adjustment to market | ( | ) | ||||||
End of period | ( | ) | ( | ) | ||||
SUPPLEMENTAL RETIREMENT PLAN (SERP) TRUST | ||||||||
Beginning of period | ( | ) | ( | ) | ||||
Adjustment to market | ||||||||
End of period | ( | ) | ( | ) | ||||
ACCUMULATED OTHER COMPREHENSIVE LOSS | ||||||||
Beginning of period | ( | ) | ( | ) | ||||
Other comprehensive income (loss) | ( | ) | ||||||
End of period | ( | ) | ( | ) | ||||
TOTAL SHAREHOLDERS’ EQUITY | $ | $ | ||||||
See accompanying Notes to Consolidated Condensed Financial Statements. (1) As adjusted, see Note 1 - Basis of Presentation. | ||||||||
7
Consolidated Condensed Statements of Shareholders’ Equity, Shares
(Unaudited)
Three Months Ended | ||||||
(share data) | December 28, 2019 | December 29, 2018 | ||||
COMMON STOCK - CLASS A | ||||||
Beginning of period | ||||||
Conversion of Class B to Class A | ||||||
End of period | ||||||
COMMON STOCK - CLASS B | ||||||
Beginning of period | ||||||
Conversion of Class B to Class A | ( | ) | ( | ) | ||
End of period | ||||||
TREASURY SHARES - CLASS A COMMON STOCK | ||||||
Beginning of period | ( | ) | ( | ) | ||
Class A shares issued related to compensation | ||||||
Class A shares purchased | ( | ) | ( | ) | ||
End of period | ( | ) | ( | ) | ||
TREASURY SHARES - CLASS B COMMON STOCK | ||||||
Beginning of period | ( | ) | ( | ) | ||
Class B shares issued related to compensation | ||||||
Class B shares purchased | ( | ) | ( | ) | ||
End of period | ( | ) | ( | ) | ||
SECT - CLASS A COMMON STOCK | ||||||
Beginning and end of period | ( | ) | ( | ) | ||
SECT - CLASS B COMMON STOCK | ||||||
Beginning of period | ( | ) | ( | ) | ||
Issuance of shares | ||||||
Purchase of shares | ( | ) | ( | ) | ||
End of period | ( | ) | ( | ) | ||
SERP - CLASS B COMMON STOCK | ||||||
Beginning and end of period | ( | ) | ( | ) | ||
See accompanying Notes to Consolidated Condensed Financial Statements. | ||||||
8
Consolidated Condensed Statements of Cash Flows
(Unaudited)
Three Months Ended | ||||||||
(dollars in thousands) | December 28, 2019 | December 29, 2018 (1) | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net earnings | $ | $ | ||||||
Adjustments to reconcile net earnings to net cash provided (used) by operating activities: | ||||||||
Depreciation | ||||||||
Amortization | ||||||||
Deferred income taxes | ||||||||
Equity-based compensation expense | ||||||||
Other | ( | ) | ||||||
Changes in assets and liabilities providing (using) cash: | ||||||||
Receivables | ( | ) | ||||||
Inventories | ( | ) | ( | ) | ||||
Accounts payable | ( | ) | ( | ) | ||||
Contract advances | ||||||||
Accrued expenses | ( | ) | ( | ) | ||||
Accrued income taxes | ||||||||
Net pension and post retirement liabilities | ||||||||
Other assets and liabilities | ( | ) | ||||||
Net cash provided by operating activities | ||||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Acquisitions of businesses, net of cash acquired | ( | ) | ||||||
Purchase of property, plant and equipment | ( | ) | ( | ) | ||||
Other investing transactions | ( | ) | ||||||
Net cash used by investing activities | ( | ) | ( | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Net short-term repayments | ( | ) | ||||||
Proceeds from revolving lines of credit | ||||||||
Payments on revolving lines of credit | ( | ) | ( | ) | ||||
Payments on long-term debt | ( | ) | ||||||
Proceeds from senior notes, net of issuance costs | ||||||||
Payments on finance lease obligations | ( | ) | ||||||
Payment of dividends | ( | ) | ( | ) | ||||
Purchase of outstanding shares for treasury | ( | ) | ( | ) | ||||
Proceeds from sale of stock held by SECT | ||||||||
Purchase of stock held by SECT | ( | ) | ( | ) | ||||
Other financing transactions | ( | ) | ||||||
Net cash provided (used) by financing activities | ( | ) | ||||||
Effect of exchange rate changes on cash | ( | ) | ||||||
Increase (decrease) in cash, cash equivalents and restricted cash | ( | ) | ||||||
Cash, cash equivalents and restricted cash at beginning of period | ||||||||
Cash, cash equivalents and restricted cash at end of period | $ | $ | ||||||
SUPPLEMENTAL CASH FLOW INFORMATION | ||||||||
Treasury shares issued as compensation | $ | $ | ||||||
Equipment acquired through lease financing | ||||||||
See accompanying Notes to Consolidated Condensed Financial Statements. (1) As adjusted, see Note 1 - Basis of Presentation. | ||||||||
9
Notes to Consolidated Condensed Financial Statements
Three Months Ended December 28, 2019
(Unaudited)
(dollars in thousands, except per share data)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated condensed financial statements have been prepared by management in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments consisting of normal recurring adjustments considered necessary for the fair presentation of results for the interim period have been included. The results of operations for the three months ended December 28, 2019 are not necessarily indicative of the results expected for the full year. The accompanying unaudited consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in our Form 10-K for the fiscal year ended September 28, 2019. All references to years in these financial statements are to fiscal years.
Certain prior year amounts have been reclassified to conform to current year's presentation. Management does not consider the amounts reclassified to be material.
Recent Accounting Pronouncements Adopted
Standard | Description | Financial Statement Effect or Other Significant Matters | ||
ASU no. 2016-02 Leases (and all related ASUs) | The standard requires most lease arrangements to be recognized in the balance sheet as lease assets and lease liabilities. The standard also requires additional disclosures about the leasing arrangements. The provisions of the standard are effective for fiscal years beginning after December 15, 2018 and interim periods within those years. Early adoption is permitted. | We adopted this standard using the modified retrospective method, without adjusting prior comparative periods. We recorded an initial right-of-use (ROU) assets of $68,126 and lease liabilities of $71,776, which included reclassifying deferred rent as a component of the ROU asset on the Consolidated Condensed Balance Sheets. There were no material changes to our Consolidated Condensed Statements of Earnings or Consolidated Condensed Statements of Cash Flows. We have completed the necessary changes to our financial statements and related disclosures, internal controls, financial policies and information systems. See Note 7 - Leases, for additional disclosure. | ||
Date adopted: Q1 2020 | ||||
10
Recent Accounting Pronouncements Not Yet Adopted
Standard | Description | Financial Statement Effect or Other Significant Matters | ||
ASU no. 2018-15 Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract | The standard amends ASC 350 to include in its scope implementation costs of a Cloud Computing Arrangement (CCA) that is a service contract and clarifies that a customer should apply ASC 350-40 to determine which implementation costs should be capitalized in a CCA that is considered a service contract. The ASU is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The amendments should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. | We are currently evaluating the effect on our financial statements and related disclosures. | ||
Planned date of adoption: Q1 2021 | ||||
ASU no. 2016-13 Measurement of Credit Losses on Financial Instruments | The standard replaces the incurred loss model with the current expected credit loss (CECL) model to estimate credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures. The CECL model requires a Company to estimate credit losses expected over the life of the financial assets based on historical experience, current conditions and reasonable and supportable forecasts. The provisions of the standard are effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The amendment requires a modified retrospective approach by recording a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. | We are currently evaluating the effect on our financial statements and related disclosures. | ||
Planned date of adoption: Q1 2021 | ||||
We consider the applicability and impact of all ASUs. ASUs not listed above were assessed and determined to be either not applicable, or had or are expected to have an immaterial impact on our financial statements and related disclosures.
11
Impact of Change in Accounting Principle
Beginning in the first quarter of 2020, we changed our method of accounting for the determination of the market-related value of assets for a class of assets within the qualified U.S. defined benefit plan (the plan). This class of assets is currently comprised solely of the fixed income funds asset class held in the portfolio for the plan and provides a natural hedge (liability-hedging assets) against the changes in the recorded amount of net periodic pension cost. Refer to Note 13 - Employee Benefit Plans, in our Form 10-K for the fiscal year ended September 28, 2019, for our fair value disclosure by asset classification. Our previous method of accounting was to calculate the market-related value of assets for all the plan’s assets recognizing investment gains and losses ratably over a five-year period. We have elected to use the fair value of our liability-hedging assets, which represent approximately 80% of the plan’s assets, to determine the market-related value of the assets beginning in the first quarter of 2020. This change in accounting principle is preferable as the recognition of the gains and losses on this class of assets will affect net periodic pension cost in the period in which they occur. No change is being made to the accounting principle for the other classes of pension assets, which represent the remaining 20% of the pension asset portfolio for the plan. The gains and losses for these other plan assets will continue to be amortized into earnings over a five-year period.
The change in accounting principle requires retrospective application and prospective disclosure. The tables below represent the impact of this change on the Consolidated Condensed Statements of Earnings and the Consolidated Condensed Statements of Comprehensive Income (Loss) for the three months ended December 28, 2019, the Consolidated Condensed Balance Sheets for the period ended December 28, 2019, the Consolidated Condensed Statements of Earnings and the Consolidated Statements of Comprehensive Income (Loss) for the three months ended December 29, 2018 and the Consolidated Condensed Balance Sheets for the periods ended December 29, 2018, September 28, 2019 and September 29, 2018, respectively. The change in accounting principle had no impact on the Consolidated Condensed Statements of Cash Flows for these periods.
The tables below represent the impact of the change in accounting principle on the Consolidated Condensed Statement of Earnings and the Consolidated Statements of Comprehensive Income (Loss) for the three months ended December 28, 2019.
Three Months Ended | ||||||||||||
As Reported (With Change), December 28, 2019 | Impact of Change | Without Change, December 28, 2019 | ||||||||||
Other | $ | $ | $ | |||||||||
Earnings before income taxes | ( | ) | ||||||||||
Income taxes | ( | ) | ||||||||||
Net earnings | $ | $ | ( | ) | $ | |||||||
Net earnings per share | ||||||||||||
Basic | $ | $ | ( | ) | $ | |||||||
Diluted | $ | $ | ( | ) | $ | |||||||
Retirement liability adjustment | $ | $ | $ | |||||||||
Other comprehensive income (loss), net of tax | $ | $ | $ | |||||||||
Comprehensive income (loss) | $ | $ | $ | |||||||||
The table below represents the impact of the change in accounting principle on the Consolidated Condensed Balance Sheet as of December 28, 2019.
As Reported (With Change), December 28, 2019 | Impact of Change | Without Change, December 28, 2019 | ||||||||||
Shareholders’ equity | ||||||||||||
Retained earnings | $ | $ | $ | |||||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ( | ) | ||||||
Total shareholders’ equity | $ | $ | $ | |||||||||
12
The tables below represent the impact of the change in accounting principle on the Consolidated Condensed Statement of Earnings and the Consolidated Condensed Statements of Comprehensive Income (Loss) for the three months ended December 29, 2018.
Three Months Ended | ||||||||||||
As Previously Reported, December 29, 2018 | Impact of Change | As Reported, December 29, 2018 | ||||||||||
Other | $ | $ | $ | |||||||||
Earnings before income taxes | ( | ) | ||||||||||
Income taxes | ( | ) | ||||||||||
Net earnings | $ | $ | ( | ) | $ | |||||||
Net earnings per share | ||||||||||||
Basic | $ | $ | ( | ) | $ | |||||||
Diluted | $ | $ | ( | ) | $ | |||||||
Retirement liability adjustment | $ | $ | $ | |||||||||
Other comprehensive income (loss), net of tax | $ | ( | ) | $ | $ | ( | ) | |||||
Comprehensive income (loss) | $ | $ | $ | |||||||||
The table below represents the impact of the change in accounting principle on the Consolidated Condensed Balance Sheet as of December 29, 2018.
As Previously Reported, December 29, 2018 | Impact of Change | As Reported, December 29, 2018 | ||||||||||
Shareholders’ equity | ||||||||||||
Retained earnings | $ | $ | ( | ) | $ | |||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||||||||
Total shareholders’ equity | $ | $ | $ | |||||||||
The table below represents the impact of the change in accounting principle on the Consolidated Condensed Balance Sheet as of September 28, 2019.
As Previously Reported, September 28, 2019 | Impact of Change | As Reported, September 28, 2019 | ||||||||||
Shareholders’ equity | ||||||||||||
Retained earnings | $ | $ | ( | ) | $ | |||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||||||||
Total shareholders’ equity | $ | $ | $ | |||||||||
The table below represents the impact of the change in accounting principle on the Consolidated Condensed Balance Sheet as of September 29, 2018.
As Previously Reported, September 29, 2018 | Impact of Change | As Reported, September 29, 2018 | ||||||||||
Shareholders’ equity | ||||||||||||
Retained earnings | $ | $ | $ | |||||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ( | ) | ||||||
Total shareholders’ equity | $ | $ | $ | |||||||||
See Note 13 - Employee Benefit Plans and Note 16 - Accumulated Other Comprehensive Income (Loss) for adjusted reporting for prior periods.
13
Note 2 - Revenue from Contracts with Customers
We recognize revenue from contracts with customers using the five-step model prescribed in ASC 606. The first step is identifying the contract. The identification of a contract with a customer requires an assessment of each party’s rights and obligations regarding the products or services to be transferred, including an evaluation of termination clauses and presently enforceable rights and obligations. Each party’s rights and obligations and the associated terms and conditions are typically determined in purchase orders. For sales that are governed by master supply agreements under which provisions define specific program requirements, purchase orders are issued under these agreements to reflect presently enforceable rights and obligations for the units of products and services being purchased.
Contracts are sometimes modified to account for changes in contract specifications and requirements. When this occurs, we assess the modification as prescribed in ASC 606 and determine whether the existing contract needs to be modified (and revenue cumulatively caught up), whether the existing contract needs to be terminated and a new contract needs to be created, or whether the existing contract remains and a new contract needs to be created. This is determined based on the rights and obligations within the modification as well as the associated transaction price.
The next step is identifying the performance obligations. A performance obligation is a promise to transfer goods or services to a customer that is distinct in the context of the contract, as defined by ASC 606. We identify a performance obligation for each promise in a contract to transfer a distinct good or service to the customer. As part of our assessment, we consider all goods and/or services promised in the contract, regardless of whether they are explicitly stated or implied by customary business practices. The products and services in our contracts are typically not distinct from one another due to their complexity and reliance on each other or, in many cases, we provide a significant integration service. Accordingly, many of our contracts are accounted for as one performance obligation. In limited cases, our contracts have more than one distinct performance obligation, which occurs when we perform activities that are not highly complex or interrelated or involve different product life cycles. Warranties are provided on certain contracts, but do not typically provide for services beyond standard assurances and are therefore not distinct performance obligations under ASC 606.
The third step is determining the transaction price, which represents the amount of consideration we expect to be entitled to receive from a customer in exchange for providing the goods or services. There are times when this consideration is variable, for example a volume discount, and must be estimated. Sales, use, value-added, and excise taxes are excluded from the transaction price, where applicable.
The fourth step is allocating the transaction price. The transaction price must be allocated to the performance obligations identified in the contract based on relative stand-alone selling prices when available, or an estimate for each distinct good or service in the contract when standalone prices are not available. Our contracts with customers generally require payment under normal commercial terms after delivery. Payment terms are typically within 30 to 60 days of delivery. The timing of satisfaction of our performance obligations does not significantly vary from the typical timing of payment.
The final step is the recognition of revenue. We recognize revenue as the performance obligations are satisfied. ASC 606 provides guidance to help determine if we are satisfying the performance obligation at a point in time or over time. In determining when performance obligations are satisfied, we consider factors such as contract terms, payment terms and whether there is an alternative use of the product or service. In essence, we recognize revenue when or as control of the promised goods or services transfer to the customer.
Under ASC 606, revenue recognized over time using an input method that uses costs incurred to date to measure progress toward completion ("cost-to-cost") was 64 % for the three months ended December 28, 2019. The over time method of revenue recognition is predominantly used in Aircraft Controls and Space and Defense Controls. We use this method for U.S. Government contracts and repair and overhaul arrangements as we are creating or enhancing assets that the customer controls as the assets are being created or enhanced. In addition, many of our large commercial contracts qualify for over-time accounting as our performance does not create an asset with an alternative use and we have an enforceable right to payment for performance completed to date. Our over-time contracts are primarily firm fixed price.
14
Revenue is recognized on contracts using the cost-to-cost method of accounting as work progresses toward completion as determined by the ratio of cumulative costs incurred to date to estimated total contract costs at completion, multiplied by the total estimated contract revenue, less cumulative revenue recognized in prior periods. We believe that cumulative costs incurred to date as a percentage of estimated total contract costs at completion is an appropriate measure of progress toward satisfaction of performance obligations as this measure most accurately depicts the progress of our work and transfer of control to our customers. Changes in estimates affecting sales, costs and profits are recognized in the period in which the change becomes known using the cumulative catch-up method of accounting, resulting in the cumulative effect of changes reflected in the period. Estimates are reviewed and updated quarterly for substantially all contracts. For the three months ended December 28, 2019 and December 29, 2018 we recognized revenues of $14,619 and $11,759 , respectively for adjustments made to performance obligations satisfied (or partially satisfied) in previous periods.
Contract costs include only allocable, allowable and reasonable costs which are included in cost of sales when incurred. For applicable U.S. Government contracts, contract costs are determined in accordance with the Federal Acquisition Regulations and the related Cost Accounting Standards. The nature of these costs includes development engineering costs and product manufacturing costs such as direct material, direct labor, other direct costs and indirect overhead costs. Contract profit is recorded as a result of the revenue recognized less costs incurred in any reporting period. Variable consideration and contract modifications, such as performance incentives, penalties, contract claims or change orders are considered in estimating revenues, costs and profits when they can be reliably estimated and realization is considered probable. Revenue recognized on contracts for unresolved claims or unapproved contract change orders was not material for the three months ended December 28, 2019.
As of December 28, 2019, we had contract reserves of $62,221 . For contracts with anticipated losses at completion, a provision for the entire amount of the estimated remaining loss is charged against income in the period in which the loss becomes known. Contract losses are determined considering all direct and indirect contract costs, exclusive of any selling, general or administrative cost allocations that are treated as period expenses. Loss reserves are more common on firm fixed-price contracts that involve, to varying degrees, the design and development of new and unique controls or control systems to meet the customers’ specifications. In accordance with ASC 606, we calculate contract losses at the contract level, versus the performance obligation level. Recall reserves are recorded when additional work is needed on completed products for them to meet contract specifications. Contract-related loss reserves are recorded for the additional work needed on completed and delivered products in order for them to meet contract specifications.
Revenue recognized at the point in time control was transferred to the customer was 36 % for the three months ended December 28, 2019. This method of revenue recognition is used most frequently in Industrial Systems. We use this method for commercial contracts in which the asset being created has an alternative use. We determine the point in time control transfers to the customer by weighing the five indicators provided by ASC 606 - the entity has a present right to payment; the customer has legal title; the customer has physical possession; the customer has the significant risks and rewards of ownership; and the customer has accepted the asset. When control has transferred to the customer, profit is generated as cost of sales is recorded and as revenue is recognized. Inventory costs include all product manufacturing costs such as direct material, direct labor, other direct costs and indirect overhead cost allocations. Shipping and handling costs are considered costs to fulfill a contract and not considered performance obligations. They are included in cost of sales as incurred.
Contract Assets and Liabilities
Unbilled receivables (contract assets) primarily represent revenues recognized for performance obligations that have been satisfied but for which amounts have not been billed. These are included as Receivables on the Consolidated Condensed Balance Sheets. Contract advances (contract liabilities) relate to payments received from customers in advance of the satisfaction of performance obligations for a contract. We do not consider contract advances to be significant financing components as the intent of these payments in advance are for reasons other than providing a significant financing benefit and are customary in our industry.
15
Total contract assets and contract liabilities are as follows:
December 28, 2019 | September 28, 2019 | |||||||
Unbilled receivables | $ | $ | ||||||
Contract advances | ||||||||
Net contract assets | $ | $ | ||||||
The increase in contract assets reflects the net impact of additional unbilled revenues recorded in excess of revenue recognized during the period. The increase in contract liabilities reflects the net impact of additional deferred revenues recorded in excess of revenue recognized during the period. For the three months ended December 28, 2019, we recognized $35,759 of revenue that was included in the contract liability balance at the beginning of the period.
Remaining Performance Obligations
As of December 28, 2019, the aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied), also known as backlog, was approximately $2,430,000 . We expect to recognize approximately 69 % of that amount as sales over the next twelve months and the balance thereafter.
Disaggregation of Revenue
See Note 19, Segments, for disclosures related to disaggregation of revenue.
Note 3 - Acquisitions, Divestitures and Equity Method Investments
On November 28, 2019, we acquired Gesellschaft für Antriebstechnik mbH and GAT Inc. (GAT), headquartered in Geisenheim, Germany for a purchase price of $53,906 , net of acquired cash. GAT designs and manufactures high-end fluid rotating unions and slip rings. This operation is included in our Industrial Systems segment. The purchase price allocation is subject to adjustments as we obtain additional information for our estimates during the measurement period.
In the first quarter of 2020, we sold a non-core business of our Industrial Systems segment for $1,775 in net consideration and recorded a gain in other income of $169 .
In the first quarter of 2019, we sold a non-core business of our Industrial Systems segment for $4,191 in cash and recorded a gain in other income of $2,641 .
Note 4 - Receivables
Receivables consist of:
December 28, 2019 | September 28, 2019 | |||||||
Accounts receivable | $ | $ | ||||||
Over-time contract receivables: | ||||||||
Billed receivables | ||||||||
Unbilled receivables | ||||||||
Total over-time contract receivables | ||||||||
Other | ||||||||
Less allowance for doubtful accounts | ( | ) | ( | ) | ||||
Receivables | $ | $ | ||||||
We securitize certain trade receivables in transactions that are accounted for as secured borrowings (Securitization Program). We maintain a subordinated interest in a portion of the pool of trade receivables that are securitized. The retained interest, which is included in Receivables in the consolidated condensed balance sheets, is recorded at fair value, which approximates the total amount of the designated pool of accounts receivable. Refer to Note 9, Indebtedness, for additional disclosures related to the Securitization Program.
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Note 5 - Inventories
Inventories, net of reserves, consist of:
December 28, 2019 | September 28, 2019 | |||||||
Raw materials and purchased parts | $ | $ | ||||||
Work in progress | ||||||||
Finished goods | ||||||||
Inventories | $ | $ | ||||||
There are no material inventoried costs relating to over-time contracts where revenue is accounted for using the cost-to-cost method of accounting as of December 28, 2019 and September 28, 2019.
Note 6 - Property, Plant and Equipment
Property, plant and equipment consists of:
December 28, 2019 | September 28, 2019 | |||||||
Land | $ | $ | ||||||
Buildings and improvements | ||||||||
Machinery and equipment | ||||||||
Computer equipment and software | ||||||||
Property, plant and equipment, at cost | ||||||||
Less accumulated depreciation and amortization | ( | ) | ( | ) | ||||
Property, plant and equipment, net | $ | $ | ||||||
Note 7 - Leases
On September 29, 2019, we adopted ASC 842: Leases, and the related amendments (ASC 842), using the modified retrospective method, as described in Note 1, Basis of Presentation, without adjusting prior comparative periods.
We lease certain manufacturing facilities, office space and machinery and equipment globally. At inception we evaluate whether a contractual arrangement contains a lease. Specifically, we consider whether we control the underlying asset and have the right to obtain substantially all the economic benefits or outputs from the asset. If the contractual arrangement contains a lease, we then determine the classification of the lease, operating or finance, using the classification criteria described in ASC 842. We then determine the term of the lease based on terms and conditions of the contractual arrangement, including whether the options to extend or terminate the lease are reasonably certain to be exercised. We have elected to not separate lease components from non-lease components, such as common area maintenance charges and instead, account for the lease and non-lease components as a single component.
Our lease ROU assets represent our right to use an underlying asset for the lease term and our lease liabilities represent our obligation to make lease payments. Operating lease ROU assets are included in Operating lease right-of-use assets and operating lease liabilities are included in Accrued liabilities and other and Other long-term liabilities on the Consolidated Condensed Balance Sheets. Finance lease ROU assets are included in Property, plant and equipment and finance lease liabilities are included in Accrued liabilities and other and Other long-term liabilities on the Consolidated Condensed Balance Sheets. Operating lease cost is included in Cost of sales and Selling, general and administrative on the Consolidated Condensed Statements of Earnings. Finance lease cost is included in Cost of sales, Selling, general and administrative and Interest on the Consolidated Condensed Statements of Earnings.
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The ROU assets and lease liabilities for both operating and finance leases are recognized as of the commencement date at the net present value of the fixed minimum lease payments over the term of the lease, using the discount rate described below. Variable lease payments are recorded in the period in which the obligation for the payment is incurred. Variable lease payments based on an index or rate are initially measured using the index or rate as of the commencement date of the lease and included in the fixed minimum lease payments. For short-term leases that have a term of 12 months or less as of the commencement date, we do not recognize a ROU asset or lease liability on our balance sheet; we recognize expense as the lease payments are made over the lease term.
The discount rate used to calculate the present value of our leases is the rate implicit in lease. If the information necessary to determine the rate implicit in the lease is not available, we use our incremental borrowing rate for collateralized debt, which is determined using our credit rating and other information available as of the lease commencement date.
The components of lease expense were as follows:
Three Months Ended December 28, 2019 | ||||
Operating lease cost | $ | |||
Finance lease cost: | ||||
Amortization of right-of-use assets | $ | |||
Interest on lease liabilities | ||||
Total finance lease cost | $ | |||
Supplemental cash flow information related to leases was as follows:
Three Months Ended December 28, 2019 | ||||
Cash paid for amounts included in the measurement of lease liabilities: | ||||
Operating cash flow for operating leases | $ | |||
Operating cash flow for finance leases | ||||
Financing cash flow for finance leases | ||||
Assets obtained in exchange for lease obligations: | ||||
Operating leases | ||||
Finance leases | ||||
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Supplemental balance sheet information related to leases was as follows:
December 28, 2019 | |||
Operating Leases | |||
Operating lease right-of-use assets | $ | ||
Accrued liabilities and other | $ | ||
Other long-term liabilities | |||
Total operating lease liabilities | $ | ||
Finance Leases | |||
Property, plant, and equipment, at cost | $ | ||
Accumulated depreciation | ( | ) | |
Property, plant, and equipment, net | $ | ||
Accrued liabilities and other | $ | ||
Other long-term liabilities | |||
Total finance lease liabilities | $ | ||
Weighted average remaining lease term in years | |||
Operating leases | |||
Finance leases | |||
Weighted average discount rate | |||
Operating leases | % | ||
Finance leases | % | ||
Maturities of lease liabilities were as follows:
December 28, 2019 | ||||||||
Operating Leases | Finance Leases | |||||||
2020 | $ | $ | ||||||
2021 | ||||||||
2022 | ||||||||
2023 | ||||||||
2024 | ||||||||
Thereafter | ||||||||
Total lease payments | ||||||||
Less: imputed interest | ( | ) | ( | ) | ||||
Total | $ | $ | ||||||
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Note 8 - Goodwill and Intangible Assets
The changes in the carrying amount of goodwill are as follows:
Aircraft Controls | Space and Defense Controls | Industrial Systems | Total | |||||||||
Balance at September 28, 2019 | $ | $ | $ | $ | ||||||||
Acquisitions | ||||||||||||
Divestitures | ( | ) | ( | ) | ||||||||
Foreign currency translation | ||||||||||||
Balance at December 28, 2019 | $ | $ | $ | $ | ||||||||
Goodwill in our Space and Defense Controls segment is net of a $4,800 accumulated impairment loss at December 28, 2019.
Goodwill in our Medical Devices reporting unit, included in our Industrial Systems segment, is net of a $38,200 accumulated impairment loss at December 28, 2019.
The components of intangible assets are as follows:
December 28, 2019 | September 28, 2019 | |||||||||||||||||
Weighted- Average Life (years) | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||||||||
Customer-related | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||
Technology-related | ( | ) | ( | ) | ||||||||||||||
Program-related | ( | ) | ( | ) | ||||||||||||||
Marketing-related | ( | ) | ( | ) | ||||||||||||||
Other | ( | ) | ( | ) | ||||||||||||||
Intangible assets | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||
Substantially all acquired intangible assets other than goodwill are being amortized. Customer-related intangible assets primarily consist of customer relationships. Technology-related intangible assets primarily consist of technology, patents, intellectual property and software. Program-related intangible assets consist of long-term programs represented by current contracts and probable follow on work. Marketing-related intangible assets primarily consist of trademarks, trade names and non-compete agreements.
Amortization of acquired intangible assets is as follows:
Three Months Ended | |||||||
December 28, 2019 | December 29, 2018 | ||||||
Acquired intangible asset amortization | $ | $ | |||||
Based on acquired intangible assets recorded at December 28, 2019, amortization is estimated to be approximately:
2020 | 2021 | 2022 | 2023 | 2024 | |||||||||||
Estimated future amortization of acquired intangible assets | $ | $ | $ | $ | $ | ||||||||||
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Note 9 - Indebtedness
We maintain short-term line of credit facilities with banks throughout the world that are principally demand lines subject to revision by the banks.
Long-term debt consists of:
December 28, 2019 | September 28, 2019 | |||||||
U.S. revolving credit facility | $ | $ | ||||||
SECT revolving credit facility | ||||||||
Senior notes 4.25% | ||||||||
Senior notes 5.25% | ||||||||
Securitization program | ||||||||
Obligations under capital leases | ||||||||
Senior debt | ||||||||
Less deferred debt issuance cost | ( | ) | ( | ) | ||||
Less current installments | ( | ) | ||||||
Long-term debt | $ | $ | ||||||
On October 15, 2019, we amended and restated our U.S. revolving credit facility, which matures on October 15, 2024. Our U.S. revolving credit facility has a capacity of $1,100,000 and provides an expansion option, which permits us to request an increase of up to $400,000 to the credit facility upon satisfaction of certain conditions. The credit facility is secured by substantially all of our U.S. assets. The loan agreement contains various covenants which, among others, specify interest coverage and maximum leverage. We are in compliance with all covenants.
The SECT has a revolving credit facility with a borrowing capacity of $35,000 , maturing on July 26, 2022. Interest is based on LIBOR plus an applicable margin. A commitment fee is also charged based on a percentage of the unused amounts available and is not material.
On December 13, 2019, we completed the sale of $500,000 aggregate principal amount of 4.25 % senior notes due December 15, 2027 with interest paid semiannually on June 15 and December 15 of each year, which will commence on June 15, 2020. The senior notes are unsecured obligations, guaranteed on a senior unsecured basis by certain subsidiaries and contain normal incurrence-based covenants and limitations such as the ability to incur additional indebtedness, pay dividends, make other restricted payments and investments, create liens and certain corporate acts such as mergers and consolidations. The aggregate net proceeds of $492,750 were used to repay indebtedness under our U.S. revolving credit facility, thereby increasing the unused portion of our U.S. revolving credit facility.
On December 13, 2019, we issued a notice of redemption to the holders of our 5.25 % senior notes due on December 1, 2022, to redeem and retire all of the outstanding notes. The notes were redeemed on January 13, 2020 at 101.313 % pursuant to an early redemption right. We redeemed the aggregate principal amount of $300,000 using proceeds drawn from our U.S. revolving credit facility. The associated loss on the redemption includes $3,939 of call premium paid to external bondholders.
The Securitization Program was extended on October 16, 2019 and matures on October 29, 2021 and effectively increases our borrowing capacity by up to $130,000 . Under the Securitization Program, we sell certain trade receivables and related rights to an affiliate, which in turn sells an undivided variable percentage ownership interest in the trade receivables to a financial institution, while maintaining a subordinated interest in a portion of the pool of trade receivables. Interest for the Securitization Program is based on 30-day LIBOR plus an applicable margin. A commitment fee is also charged based on a percentage of the unused amounts available and is not material. The agreement governing the Securitization Program contains restrictions and covenants which include limitations on the making of certain restricted payments, creation of certain liens, and certain corporate acts such as mergers, consolidations and sale of substantially all assets. The Securitization Program has a minimum borrowing requirement equal to the lesser of either 80 % of our borrowing capacity or 100 % of our borrowing base, which is a subset of the trade receivables sold under this agreement. As of December 28, 2019, our minimum borrowing requirement was $104,000 .
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Note 10 - Other Accrued Liabilities
Other accrued liabilities consists of:
December 28, 2019 | September 28, 2019 | |||||||
Contract reserves | $ | $ | ||||||
Employee benefits | ||||||||
Warranty accrual | ||||||||
Accrued income taxes | ||||||||
Other | ||||||||
Other accrued liabilities | $ | $ | ||||||
In the ordinary course of business, we warrant our products against defects in design, materials and workmanship typically over periods ranging from twelve to sixty months. We determine warranty reserves needed by product line based on historical experience and current facts and circumstances. Activity in the warranty accrual is summarized as follows:
Three Months Ended | ||||||||
December 28, 2019 | December 29, 2018 | |||||||
Warranty accrual at beginning of period | $ | $ | ||||||
Additions from acquisitions | ||||||||
Warranties issued during current period | ||||||||
Adjustments to pre-existing warranties | ( | ) | ( | ) | ||||
Reductions for settling warranties | ( | ) | ( | ) | ||||
Foreign currency translation | ( | ) | ||||||
Warranty accrual at end of period | $ | $ | ||||||
Note 11 - Derivative Financial Instruments
We principally use derivative financial instruments to manage interest rate risk associated with long-term debt and foreign exchange risk related to foreign operations and foreign currency transactions. We enter into derivative financial instruments with a number of major financial institutions to minimize counterparty credit risk.
Derivatives designated as hedging instruments
Interest rate swaps are used to adjust the proportion of total debt that is subject to variable and fixed interest rates. The interest rate swaps are designated as hedges of the amount of future cash flows related to interest payments on variable-rate debt that, in combination with the interest payments on the debt, convert a portion of the variable-rate debt to fixed-rate debt. At December 28, 2019, we had interest rate swaps with notional amounts totaling $45,000 . The interest rate swaps effectively convert this amount of variable-rate debt to fixed-rate debt at 3.18 %, including the applicable margin of 1.50 % as of December 28, 2019. The interest will revert back to variable rates based on LIBOR plus the applicable margin upon the maturity of the interest rate swaps. These interest rate swaps mature at various times through June 23, 2020.
We use foreign currency contracts as cash flow hedges to effectively fix the exchange rates on future payments and revenue. To mitigate exposure in movements between various currencies, including the Philippine peso, the British pound and the Czech koruna, we had outstanding foreign currency forwards with notional amounts of $44,475 at December 28, 2019. These contracts mature at various times through May 28, 2021.
We use forward currency contracts to hedge our net investment in certain foreign subsidiaries. As of December 28, 2019, we had no outstanding net investment hedges.
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These interest rate swaps, foreign currency contracts and net investment hedges are recorded in the Consolidated Condensed Balance Sheets at fair value and the related gains or losses are deferred in Shareholders’ Equity as a component of Accumulated Other Comprehensive Income (Loss) (AOCIL). These deferred gains and losses are reclassified into the Consolidated Condensed Statements of Earnings, as necessary, during the periods in which the related payments or receipts affect earnings. However, to the extent the interest rate swaps and foreign currency contracts are not perfectly effective in offsetting the change in the value of the payments and revenue being hedged, the ineffective portion of these contracts is recognized in earnings immediately. Ineffectiveness was not material in the first three months of 2020 or 2019.
Derivatives not designated as hedging instruments
We also have foreign currency exposure on balances, primarily intercompany, that are denominated in foreign currencies and are adjusted to current values using period-end exchange rates. The resulting gains or losses are recorded in the Consolidated Condensed Statements of Earnings. To minimize foreign currency exposure, we had foreign currency contracts with notional amounts of $85,957 at December 28, 2019. The foreign currency contracts are recorded in the Consolidated Condensed Balance Sheets at fair value and resulting gains or losses are recorded in the Consolidated Condensed Statements of Earnings. We recorded the following gains or losses on foreign currency contracts which are included in other income or expense and generally offset the gains or losses from the foreign currency adjustments on the intercompany balances that are also included in other income or expense:
Three Months Ended | |||||||||
Statements of Earnings location | December 28, 2019 | December 29, 2018 | |||||||
Net gain (loss) | |||||||||
Foreign currency contracts | Other | $ | $ | ( | ) | ||||
Summary of derivatives
The fair value and classification of derivatives is summarized as follows:
Balance Sheets location | December 28, 2019 | September 28, 2019 | |||||||
Derivatives designated as hedging instruments: | |||||||||
Foreign currency contracts | Other current assets | $ | $ | ||||||
Foreign currency contracts | Other assets | ||||||||
Interest rate swaps | Other current assets | ||||||||
Total asset derivatives | $ | $ | |||||||
Foreign currency contracts | Accrued liabilities and other | $ | $ | ||||||
Foreign currency contracts | Other long-term liabilities | ||||||||
Total liability derivatives | $ | $ | |||||||
Derivatives not designated as hedging instruments: | |||||||||
Foreign currency contracts | Other current assets | $ | $ | ||||||
Foreign currency contracts | Accrued liabilities and other | $ | $ | ||||||
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Note 12 - Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, various techniques and assumptions can be used to estimate fair value. The definition of the fair value hierarchy is as follows:
Level 1 – Quoted prices in active markets for identical assets and liabilities.
Level 2 – Observable inputs other than quoted prices in active markets for similar assets and liabilities.
Level 3 – Inputs for which significant valuation assumptions are unobservable in a market and therefore value is based on the best available data, some of which is internally developed and considers risk premiums that a market participant would require.
Our derivatives are valued using various pricing models or discounted cash flow analyses that incorporate observable market data, such as interest rate yield curves and currency rates, and are classified as Level 2 within the valuation hierarchy.
The following table presents the fair values and classification of our financial assets and liabilities measured on a recurring basis, all of which are classified as Level 2.
Balance Sheets location | December 28, 2019 | September 28, 2019 | ||||||||
Foreign currency contracts | Other current assets | $ | $ | |||||||
Foreign currency contracts | Other assets | |||||||||
Interest rate swaps | Other current assets | |||||||||
Total assets | $ | $ | ||||||||
Foreign currency contracts | Accrued liabilities and other | $ | $ | |||||||
Foreign currency contracts | Other long-term liabilities | |||||||||
Total liabilities | $ | $ | ||||||||
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Note 13 - Employee Benefit Plans
Net periodic benefit costs for our defined benefit pension plans are as follows:
Three Months Ended | ||||||||
December 28, 2019 | December 29, 2018 | |||||||
U.S. Plans | ||||||||
Service cost | $ | $ | ||||||
Interest cost | ||||||||
Expected return on plan assets | ( | ) | ( | ) | ||||
Amortization of prior service cost (credit) | ||||||||
Amortization of actuarial loss | ||||||||
Pension expense for U.S. defined benefit plans | $ | $ | ||||||
Non-U.S. Plans | ||||||||
Service cost | $ | $ | ||||||
Interest cost | ||||||||
Expected return on plan assets | ( | ) | ( | ) | ||||
Amortization of prior service cost (credit) | ( | ) | ||||||
Amortization of actuarial loss | ||||||||
Pension expense for non-U.S. defined benefit plans | $ | $ | ||||||
Pension expense for our defined contribution plans consists of:
Three Months Ended | ||||||||
December 28, 2019 | December 29, 2018 | |||||||
U.S. defined contribution plans | $ | $ | ||||||
Non-U.S. defined contribution plans | ||||||||
Total pension expense for defined contribution plans | $ | $ | ||||||
Note 14 - Restructuring
Restructuring activity for severance and other costs is as follows:
Space and Defense Controls | Industrial Systems | Total | |||||||
Balance at September 28, 2019 | $ | $ | $ | ||||||
Adjustments to provision | ( | ) | ( | ) | ( | ) | |||
Cash payments - 2018 plan | ( | ) | ( | ) | ( | ) | |||
Foreign currency translation | |||||||||
Balance at December 28, 2019 | $ | $ | $ | ||||||
Note 15 - Income Taxes
The effective tax rate for the three months ended December 28, 2019 and December 29, 2018 was 25.2 % and 24.3 % respectively. The effective tax rate for this period is higher than would be expected by applying the U.S. federal statutory tax rate of 21 % to earnings before income taxes primarily due to tax on earnings generated outside of the U.S. The effective tax rate for the three months ended December 28, 2019 includes the impact of the Global Intangible Low-Taxed Income ("GILTI"), which imposes U.S. tax on certain foreign subsidiary income in the year it is earned, and Foreign-Derived Intangible Income ("FDII") deduction. Our accounting policy is to treat tax on GILTI as a current period cost included in tax expense in the year incurred.
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Note 16 - Accumulated Other Comprehensive Income (Loss)
The changes in AOCIL, net of tax, by component for the three months ended December 28, 2019 are as follows:
Accumulated foreign currency translation (1) | Accumulated retirement liability | Accumulated gain (loss) on derivatives | Total | |||||||||||||
AOCIL at September 28, 2019 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
Other comprehensive income (loss) before reclassifications | ( | ) | ||||||||||||||
Amounts reclassified from AOCIL | ( | ) | ||||||||||||||
Other comprehensive income (loss) | ||||||||||||||||
AOCIL at December 28, 2019 | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | ||||||
(1) | Net gains and losses on net investment hedges are recorded as cumulative translation adjustments in AOCIL to the extent that the instruments are effective in hedging the designated risk. |
The amounts reclassified from AOCIL into earnings are as follows:
Three Months Ended | ||||||||||
Statements of Earnings location | December 28, 2019 | December 29, 2018 | ||||||||
Retirement liability: | ||||||||||
Prior service cost (credit) | $ | ( | ) | $ | ( | ) | ||||
Actuarial losses | ||||||||||
Reclassification from AOCIL into earnings (2) | ||||||||||
Tax effect | ( | ) | ( | ) | ||||||
Net reclassification from AOCIL into earnings | $ | $ | ||||||||
Derivatives: | ||||||||||
Foreign currency contracts | Sales | $ | $ | ( | ) | |||||
Foreign currency contracts | Cost of sales | |||||||||
Interest rate swaps | Interest | ( | ) | ( | ) | |||||
Reclassification from AOCIL into earnings | ||||||||||
Tax effect | ( | ) | ||||||||
Net reclassification from AOCIL into earnings | $ | $ | ||||||||
(2) | The reclassifications are included in the computation of non-service pension expense, which is included in Other on the Consolidated Condensed Statement of Earnings. |
The amounts deferred in AOCIL are as follows:
Net deferral in AOCIL - effective portion | ||||||||
Three Months Ended | ||||||||
December 28, 2019 | December 29, 2018 | |||||||
Foreign currency contracts | $ | $ | ||||||
Interest rate swaps | ( | ) | ( | ) | ||||
Net gain (loss) | ||||||||
Tax effect | ( | ) | ( | ) | ||||
Net deferral in AOCIL of derivatives | $ | $ | ||||||
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Note 17 - Stock Employee Compensation Trust and Supplemental Retirement Plan Trust
Note 18 - Earnings per Share and Dividends
Basic and diluted weighted-average shares outstanding are as follows:
Three Months Ended | ||||||
December 28, 2019 | December 29, 2018 | |||||
Basic weighted-average shares outstanding | ||||||
Dilutive effect of equity-based awards | ||||||
Diluted weighted-average shares outstanding | ||||||
For the three months ended December 28, 2019 and December 29, 2018, there were 34,635 and 44,465 common shares from equity-based awards, respectively, excluded from the calculation of diluted earnings per share as they would be anti-dilutive.
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Note 19 - Segment Information
Disaggregation of net sales by segment for the three months ended December 28, 2019 and December 29, 2018 are as follows:
Three Months Ended | ||||||||
Market Type | December 28, 2019 | December 29, 2018 | ||||||
Net sales: | ||||||||
Military | $ | $ | ||||||
Commercial | ||||||||
Aircraft Controls | ||||||||
Space | ||||||||
Defense | ||||||||
Space and Defense Controls | ||||||||
Energy | ||||||||
Industrial Automation | ||||||||
Simulation and Test | ||||||||
Medical | ||||||||
Industrial Systems | ||||||||
Net sales | $ | $ | ||||||
Three Months Ended | ||||||||
Customer Type | December 28, 2019 | December 29, 2018 | ||||||
Net sales: | ||||||||
Commercial | $ | $ | ||||||
U.S. Government (including OEM) | ||||||||
Other | ||||||||
Aircraft Controls | ||||||||
Commercial | ||||||||
U.S. Government (including OEM) | ||||||||
Other | ||||||||
Space and Defense Controls | ||||||||
Commercial | ||||||||
U.S. Government (including OEM) | ||||||||
Other | ||||||||
Industrial Systems | ||||||||
Commercial | ||||||||
U.S. Government (including OEM) | ||||||||
Other | ||||||||
Net sales | $ | $ | ||||||
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Operating profit is net sales less cost of sales and other operating expenses, excluding interest expense, equity-based compensation expense and other corporate expenses. Cost of sales and other operating expenses are directly identifiable to the respective segment or allocated on the basis of sales, number of employees or profit. Operating profit by segment for the three months ended December 28, 2019 and December 29, 2018 and a reconciliation of segment operating profit to earnings before income taxes are as follows:
Three Months Ended | ||||||||
December 28, 2019 | December 29, 2018 | |||||||
Operating profit: | ||||||||
Aircraft Controls | $ | $ | ||||||
Space and Defense Controls | ||||||||
Industrial Systems | ||||||||
Total operating profit | ||||||||
Deductions from operating profit: | ||||||||
Interest expense | ||||||||
Equity-based compensation expense | ||||||||
Non-service pension expense | ||||||||
Corporate and other expenses, net | ||||||||
Earnings before income taxes | $ | $ | ||||||
Note 20 - Related Party Transactions
John Scannell, Moog's Chairman of the Board and Director and Chief Executive Officer, is a member of the Board of Directors of M&T Bank Corporation and M&T Bank. We currently engage with M&T Bank in the ordinary course of business for various financing activities, all of which were initiated prior to the election of Mr. Scannell to the Board. M&T Bank provides credit extension for routine purchases, which for the three months ended December 28, 2019 and December 29, 2018 totaled $4,574 and $5,289 , respectively. At December 28, 2019, we held a $15,000 interest rate swap with M&T Bank and outstanding leases with a total original cost of $25,526 . M&T Bank also maintains an interest of approximately 12 % in our U.S. revolving credit facility. Further details of the U.S. revolving credit facility can be found in Note 9, Indebtedness.
Note 21 - Commitments and Contingencies
From time to time, we are involved in legal proceedings. We are not a party to any pending legal proceedings which management believes will result in a material adverse effect on our financial condition, results of operations or cash flows.
We are engaged in administrative proceedings with governmental agencies and legal proceedings with governmental agencies and other third parties in the normal course of our business, including litigation under Superfund laws, regarding environmental matters. We believe that adequate reserves have been established for our share of the estimated cost for all currently pending environmental administrative or legal proceedings and do not expect that these environmental matters will have a material adverse effect on our financial condition, results of operations or cash flows.
In the ordinary course of business we could be subject to ongoing claims or disputes from our customers, the ultimate settlement of which could have a material adverse impact on our consolidated results of operations. While the receivables and any loss provisions recorded to date reflect management's best estimate of the projected costs to complete a given project, there may still be significant effort required to complete the ultimate deliverable. Future variability in internal cost as well as future profitability is dependent upon a number of factors including deliveries, performance and government budgetary pressures. The inability to achieve a satisfactory contractual solution, further unplanned delays, additional developmental cost growth or variations in any of the estimates used in the existing contract analysis could lead to further loss provisions. Additional losses could have a material adverse impact on our financial condition, results of operations or cash flows in the period in which the loss may be recognized.
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We lease certain facilities and equipment under operating lease arrangements. These arrangements may include fair market renewal or purchase options. Rent expense under operating leases amounted to $25,510 at September 28, 2019 and $26,594 at September 29, 2018. As of September 28, 2019, future minimum rental payments required under non-cancellable operating leases are $20,993 in 2020, $19,118 in 2021, $15,636 in 2022, $11,344 in 2023, $7,151 in 2024 and $41,670 thereafter.
We are contingently liable for $35,728 of standby letters of credit issued to third parties on our behalf at December 28, 2019.
Note 22 - Subsequent Event
On January 23, 2020, the Board of Directors declared a $0.25 per share quarterly dividend payable on issued and outstanding shares of our Class A and Class B common stock on March 2, 2020 to shareholders of record at the close of business on February 14, 2020.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report filed on Form 10-K for the fiscal year ended September 28, 2019. All references to years in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are to fiscal years and amounts may differ from reported values due to rounding.
OVERVIEW
We are a worldwide designer, manufacturer and systems integrator of high performance precision motion and fluid controls and control systems for a broad range of applications in aerospace and defense and industrial markets.
Within the aerospace and defense market, our products and systems include:
• | Defense market - primary and secondary flight controls for military aircraft, stabilization and automatic ammunition loading controls for armored combat vehicles, tactical and strategic missile steering controls and gun aiming controls. |
• | Commercial aircraft market - primary and secondary flight controls for commercial aircraft. |
• | Commercial space market - satellite positioning controls and thrust vector controls for space launch vehicles. |
In the industrial market, our products are used in a wide range of applications including:
• | Industrial automation market - injection molding, metal forming, heavy industry, material and automotive testing and pilot training simulators. |
• | Medical market - enteral clinical nutrition and infusion therapy pumps, ultrasonic sensors and surgical handpieces and CT scanners. |
• | Energy market - power generation and oil and gas exploration. |
We operate under three segments, Aircraft Controls, Space and Defense Controls and Industrial Systems. Our principal manufacturing facilities are located in the United States, Philippines, United Kingdom, Germany, Czech Republic, Italy, Costa Rica, China, Netherlands, Luxembourg, Japan, Canada, India and Lithuania.
Under ASC 606, 64% of revenue was recognized over-time for the quarter ended December 28, 2019, using the cost-to-cost method of accounting. The over-time method of revenue recognition is predominantly used in Aircraft Controls and Space and Defense Controls. We use this method for U.S. Government contracts and repair and overhaul arrangements as we are creating or enhancing assets that the customer controls. In addition, many of our large commercial contracts qualify for over-time accounting as our performance does not create an asset with an alternative use and we have an enforceable right to payment for performance completed to date.
For the quarter ended December 28, 2019, 36% of revenue was recognized at the point in time control transferred to the customer. This method of revenue recognition is used most frequently in Industrial Systems. We use this method for commercial contracts in which the asset being created has an alternative use. We determine the point in time control transfers to the customer by weighing the five indicators provided by ASC 606. When control has transferred to the customer, profit is generated as cost of sales is recorded and as revenue is recognized.
We concentrate on providing our customers with products designed and manufactured to the highest quality standards. Our technical experts work collaboratively around the world, delivering capabilities for mission-critical solutions. These core operational principles are necessary as our products are applied in demanding applications, "When Performance Really Matters®." By capitalizing on these core foundational strengths, we believe we have achieved a leadership position in the high performance, precision controls market. Additionally, these strengths yield a broad control product portfolio, across a diverse base of customers and end markets.
By focusing on customer intimacy and commitment to solving their most demanding technical problems, we have been able to expand our control product franchise to multiple markets; organically growing from a high-performance components manufacturer to a high-performance systems designer, manufacturer and systems integrator. In addition, we continue expanding our content positions on our current platforms, seeking to be the dominant supplier in the niche markets we serve. We also look for innovation in all aspects of our business, employing new technologies to improve productivity and operational performance.
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Our fundamental strategies to achieve our goals center around talent, lean and innovation and include:
• | a strong leadership team that has positioned the company for growth, |
• | utilizing our global capabilities and strong engineering heritage to innovate, |
• | maintaining our technological excellence by solving our customers’ most demanding technical problems in applications "When Performance Really Matters®," |
• | continuing to invest in talent development to strengthen employee performance, and |
• | maximizing customer value by implementing lean enterprise principles. |
These activities will help us achieve our financial objective of increasing shareholder value with sustainable competitive advantages across our segments. In doing so, we expect to maintain a balanced, diversified portfolio in terms of markets served, product applications, customer base and geographic presence.
We focus on improving shareholder value through strategic revenue growth, both acquired and organic, through improving operating efficiencies and manufacturing initiatives and through utilizing low cost manufacturing facilities without compromising quality. Additionally, we take a balanced approach to capital deployment in order to maximize shareholder returns over the long-term. Our activities may include strategic acquisitions, further share buybacks and dividend payments.
Acquisitions, Divestitures and Equity Method Investments
All of our acquisitions are accounted for under the purchase method and, accordingly, the operating results for the acquired companies are included in the consolidated statements of earnings from the respective dates of acquisition. Under purchase accounting, we record assets and liabilities at fair value and such amounts are reflected in the respective captions on the consolidated balance sheets. The purchase price described for each acquisition below is net of any cash acquired, includes debt issued or assumed and the fair value of contingent consideration.
On November 28, 2019, we acquired Gesellschaft für Antriebstechnik mbH and GAT Inc. (GAT), headquartered in Geisenheim, Germany for a purchase price of $54 million, net of acquired cash. GAT designs and manufactures high-end fluid rotating unions and slip rings. This operation is included in our Industrial Systems segment. The purchase price allocation is subject to adjustments as we obtain additional information for our estimates during the measurement period.
In the first quarter of 2020, we sold a non-core business in our Industrial Systems segment for $2 million in net consideration and recorded a minimal gain in other income.
In the first quarter of 2019, we sold a non-core business in our Industrial Systems segment for $4 million in cash and recorded a gain in other income of $3 million.
CRITICAL ACCOUNTING POLICIES
On a regular basis, we evaluate the critical accounting policies used to prepare our consolidated financial statements, including revenue recognition on long-term contracts, contract reserves, reserves for inventory valuation, reviews for impairment of goodwill, reviews for impairment of long-lived assets, pension assumptions and income taxes.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 of the Consolidated Condensed Financial Statements included in Item 1, Financial Statements of this report for further information regarding Financial Accounting Standards Board issued Accounting Standards Updates ("ASU").
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CONSOLIDATED RESULTS OF OPERATIONS | |||||||||||
Three Months Ended | |||||||||||
(dollars and shares in millions, except per share data) | December 28, 2019 | December 29, 2018 | $ Variance | % Variance | |||||||
Net sales | $ | 755 | $ | 680 | $ | 75 | 11 | % | |||
Gross margin | 28.0 | % | 29.4 | % | |||||||
Research and development expenses | $ | 28 | $ | 32 | $ | (4 | ) | (12 | %) | ||
Selling, general and administrative expenses as a percentage of sales | 13.0 | % | 14.2 | % | |||||||
Interest expense | $ | 10 | $ | 10 | $ | 1 | 6 | % | |||
Other | $ | 8 | $ | 5 | $ | 2 | 47 | % | |||
Effective tax rate | 25.2 | % | 24.3 | % | |||||||
Net earnings | $ | 50 | $ | 43 | $ | 7 | 17 | % | |||
Diluted earnings per share | $ | 1.44 | $ | 1.22 | $ | 0.22 | 18 | % | |||
Total backlog | $ | 2,430 | $ | 2,100 | $ | 330 | 16 | % | |||
Twelve-month backlog | $ | 1,670 | $ | 1,400 | $ | 270 | 19 | % | |||
Net sales increased in all three of our segments in the first quarter of 2020 compared to the first quarter of 2019. The sales growth was driven by higher military sales in our Aircraft Controls and Space and Defense Controls segments, increased commercial aircraft sales and improved medical application sales in our Industrial Systems segment.
Gross margin decreased in the first quarter of 2020 compared to the first quarter of 2019. Gross margin declined in Industrial Systems, driven by less favorable sales mix. Partially offsetting the decline was improved sales volume in Space and Defense Controls.
Research and development expenses declined in the first quarter of 2020 compared to the same period of 2019. Lower activity across our major commercial OEM programs in Aircraft Controls reduced expenses $2 million, while lower activity in Industrial Systems reduced expenses $1 million.
Selling, general and administrative expenses as a percentage of sales decreased in all of our segments in the first quarter of 2020 compared to the first quarter of 2019. Within Industrial Systems, we had lower selling expense due to our decision to exit the wind pitch controls business, and within Space and Defense Controls, the incremental sales growth offset minimal growth in expenses.
Other expense in the first quarter of 2020 includes a $4 million call premium as we redeemed our $300 million aggregate principal 5.25% senior notes. Other expense in the first quarter of 2019 includes a $3 million gain on the sale of a non-core business in Industrial Systems.
Our effective tax rate in the first quarter of 2020 is higher than our effective tax rate in the first quarter of 2019. In the first quarter of 2019, we benefited from utilizing tax loss carryforwards associated with the non-core business sale in Industrial Systems.
Other comprehensive gain in 2020 includes $22 million of foreign currency translation gain, whereas other comprehensive income loss in 2019 includes $9 million of negative foreign currency translation adjustments. The change in foreign currency translation in 2020 compared to 2019 was primarily attributable to the appreciation of the the British Pound and the Euro relative to the U.S. Dollar.
The change in twelve-month backlog at December 28, 2019 compared to December 29, 2018 was driven by our aerospace and defense business. Within Aircraft Controls, backlog increased due to the timing of F-35 and Boeing 787 orders, as well as higher military aftermarket orders. Within Space and Defense Controls, backlog increased supporting the expected incremental sales for launch vehicles and for defense components. However, twelve-month backlog declined slightly within Industrial Systems, as lower industrial automation orders, driven by the slowdown in global capital investments, were mostly offset by higher orders for our medical products.
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SEGMENT RESULTS OF OPERATIONS
Operating profit, as presented below, is net sales less cost of sales and other operating expenses, excluding interest expense, equity-based compensation expense and other corporate expenses. Cost of sales and other operating expenses are directly identifiable to the respective segment or allocated on the basis of sales, manpower or profit. Operating profit is reconciled to earnings before income taxes in Note 19 of the Notes to Consolidated Condensed Financial Statements included in this report.
Aircraft Controls
Three Months Ended | |||||||||||
(dollars in millions) | December 28, 2019 | December 29, 2018 | $ Variance | % Variance | |||||||
Net sales - military aircraft | $ | 174 | $ | 147 | $ | 27 | 18 | % | |||
Net sales - commercial aircraft | 166 | 157 | 9 | 6 | % | ||||||
$ | 340 | $ | 304 | $ | 36 | 12 | % | ||||
Operating profit | $ | 39 | $ | 33 | $ | 5 | 16 | % | |||
Operating margin | 11.4 | % | 10.9 | % | |||||||
The increase in Aircraft Controls' net sales in 2020 was driven by increases in our military OEM and aftermarket programs, as well as our commercial OEM programs.
In 2020 compared to 2019, military OEM sales increased $19 million and military aftermarket sales increased $8 million. Within military OEM programs, sales for foreign military programs increased $13 million due to the timing of orders. Also, higher activity on funded development military programs increased sales $3 million. The increase in military aftermarket sales was driven by $5 million of higher F-35 spares orders. Also in 2020 compared to 2019, commercial OEM sales increased $10 million. Sales for Boeing programs increased $8 million, as favorable order timing increased sales for both the 787 and legacy programs. Sales for Airbus programs increased $5 million, driven primarily by higher sales for the A350. Partially offsetting these increases was a $2 million decline for business jets, as the prior year's high order volumes for Gulfstream did not repeat.
Operating margin increased in 2020 compared to 2019. Incremental margin from higher foreign military sales and $2 million of lower research and development expenses across our major OEM programs helped to increase operating margin.
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Space and Defense Controls
Three Months Ended | |||||||||||
(dollars in millions) | December 28, 2019 | December 29, 2018 | $ Variance | % Variance | |||||||
Net sales | $ | 186 | $ | 156 | $ | 30 | 19 | % | |||
Operating profit | $ | 25 | $ | 18 | $ | 7 | 37 | % | |||
Operating margin | 13.6 | % | 11.8 | % | |||||||
Space and Defense Controls' net sales growth was driven by both of our defense and our space markets in 2020.
In the first quarter of 2020 compared to the first quarter of 2019, sales in our defense market increased $18 million across all of our major programs. Defense sales for missile applications increased $5 million due to higher volumes on both legacy and funded development programs. Additionally, sales increased $5 million across a variety of our defense components programs driven by higher levels of defense spending. Sales increased $5 million for defense vehicle controls as we had higher activity for European defense vehicles. Also in the first quarter of 2020 compared to the first quarter 2019, sales increased $13 million in our space market. Sales for launch vehicles increased $8 million driven mostly by higher amounts of development work and higher NASA activity. Sales also increased $3 million for satellite controls, due mostly to higher space avionics activity.
Operating margin increased in the first quarter of 2020 compared to first quarter of 2019 due primarily to higher sales volumes for our defense and our components products. Also, the sales growth contributed to incremental margins beyond our selling and administrative expenses.
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Industrial Systems
Three Months Ended | |||||||||||
(dollars in millions) | December 28, 2019 | December 29, 2018 | $ Variance | % Variance | |||||||
Net sales | $ | 229 | $ | 220 | $ | 9 | 4 | % | |||
Operating profit | $ | 27 | $ | 28 | $ | (1 | ) | (3 | %) | ||
Operating margin | 11.7 | % | 12.6 | % | |||||||
Industrial Systems' net sales growth in 2020 was driven by higher sales for our medical application products.
In the first quarter of 2020 compared to the first quarter of 2019, sales in our medical market increased $11 million. Sales for medical devices increased $9 million as we had higher demand for our enteral and IV products. Also, sales for our medical components products, including medical imaging, increased $2 million. Partially offsetting these sales increases was a $2 million decline in our industrial automation market. The continued slowdown of capital investments in the European economy reduced orders for our general automation components.
Operating margin decreased in the first quarter of 2020 due to the absence of a $3 million gain on the sale of a non-core business we recorded in the first quarter of 2019. Lower expenses, including lower selling, general and administrative expenses and lower research and development expenses helped to improve operating profit in the first quarter of 2020 compared to the first quarter of 2019.
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CONSOLIDATED AND SEGMENT OUTLOOK | ||||||||||||||
2020 vs. 2019 | ||||||||||||||
(dollars in millions, except per share data ) | 2020 Outlook | 2019 | $ Variance | % Variance | ||||||||||
Net sales: | ||||||||||||||
Aircraft Controls | $ | 1,325 | $ | 1,303 | $ | 22 | 2 | % | ||||||
Space and Defense Controls | 770 | 683 | 87 | 13 | % | |||||||||
Industrial Systems | 950 | 918 | 32 | 3 | % | |||||||||
$ | 3,045 | $ | 2,905 | $ | 140 | 5 | % | |||||||
Operating profit: | ||||||||||||||
Aircraft Controls | $ | 140 | $ | 123 | $ | 17 | 14 | % | ||||||
Space and Defense Controls | 100 | 89 | 11 | 12 | % | |||||||||
Industrial Systems | 105 | 109 | (4 | ) | (4 | %) | ||||||||
$ | 345 | $ | 321 | $ | 24 | 7 | % | |||||||
Operating margin: | ||||||||||||||
Aircraft Controls | 10.5 | % | 9.4 | % | ||||||||||
Space and Defense Controls | 13.0 | % | 13.0 | % | ||||||||||
Industrial Systems | 11.1 | % | 11.9 | % | ||||||||||
11.3 | % | 11.1 | % | |||||||||||
Net earnings | $ | 190 | $ | 175 | $ | 16 | 9 | % | ||||||
Diluted earnings per share | $ 5.30 - $5.70 | $ | 4.96 | $ | 0.54 | 11 | % | |||||||
2020 Outlook – We expect higher defense sales in both Space and Defense Controls and in Aircraft Controls to drive the increased sales compared to 2019. We also expect increased space sales due to higher amounts of launch vehicle program activity. In Industrial Systems, we expect acquired sales and higher medical application orders to also increase sales compared to 2019. However, within commercial aircraft programs, we expect slightly lower sales. We expect operating margin will increase due to operational improvements within Aircraft Controls. Net earnings in 2020 will benefit from the incremental operating margin and from lower non-operating expenses, but both will be somewhat offset by a higher effective tax rate. We expect diluted earnings per share will range between $5.30 and $5.70, with a midpoint of $5.50.
2020 Outlook for Aircraft Controls – We expect 2020 sales in Aircraft Controls will increase due to higher amounts of military aircraft sales for both OEM and aftermarket programs, primarily related to the F-35 program. However, moderating the military growth is an expected wind down of the legacy Boeing 777 program, as well as lower activity for the Airbus A350 within commercial OEM. We expect operating margin will increase in 2020 due to operational improvements and due to the absence of the 2019 supplier quality charge.
2020 Outlook for Space and Defense Controls – We expect 2020 sales in Space and Defense Controls will increase in both of our markets. Within our defense market, we expect higher sales across all of our programs, driven by higher volumes for our existing and new product offerings. We expect sales in our space market to increase as well, driven by higher amounts of NASA and funded development work, as well as increased bookings for avionics products. We expect operating margin will remain level with 2019 as the incremental margin from the higher sales volume is offset by higher amounts of lower-margin development work.
2020 Outlook for Industrial Systems – We expect 2020 sales in Industrial Systems will increase due to the acquisition of GAT and due to higher orders for our medical devices products. Partially offsetting the increases is an expected decline of our industrial automation product sales, excluding the GAT acquisition, due to slowing global capital investments. We expect operating margin will decline acquired sales from GAT with no incremental margin contribution and due to the absence of last year's gain on the sale of a non-core business.
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FINANCIAL CONDITION AND LIQUIDITY
Three Months Ended | |||||||||||
(dollars in millions) | December 28, 2019 | December 29, 2018 | $ Variance | % Variance | |||||||
Net cash provided (used) by: | |||||||||||
Operating activities | $ | 42 | $ | 64 | $ | (22 | ) | (34 | %) | ||
Investing activities | (85 | ) | (22 | ) | (63 | ) | 293 | % | |||
Financing activities | 76 | (59 | ) | 136 | (229 | %) | |||||
Our available borrowing capacity and our cash flow from operations provide us with the financial resources needed to run our operations, reinvest in our business and make strategic acquisitions.
At December 28, 2019, our cash balances were $127 million, which was primarily held outside of the U.S. Cash flow from our U.S. operations, together with borrowings on our credit facility, fund on-going activities, debt service requirements and future growth investments.
Operating activities
Net cash provided by operating activities decreased in the first quarter of 2020 compared to the first quarter of 2019. In the first quarter of 2020, accounts receivable activity used $27 million more cash, driven primarily by customer activity within our Space and Defense Controls segment. Also, we had $16 million more use of cash in accounts payable, due to the timing of vendor receipts. Partially offsetting these increases was $11 million of lower inventory levels, primarily in Industrial Systems and Space and Defense Controls. Additionally, we had $9 million of higher customer advances across both Aircraft Controls and Space and Defense Controls.
Investing activities
Net cash used by investing activities in the first quarter of 2020 included $54 million for our acquisition of GAT and $27 million for capital expenditures.
Net cash used by investing activities in the first quarter 2019 included $24 million for capital expenditures.
We expect our 2020 capital expenditures to be $120 million, due to facilities and information system investments supporting the increased production, as well as machinery and test equipment to improve our operational efficiencies.
Financing activities
Net cash provided by financing activities in the first quarter of 2020 included the net proceeds of issuing our $500 million aggregate principal 4.25% senior notes, which were used to repay a portion of our outstanding borrowings. Additionally, financing activities in the first quarter of 2020 included $57 million to fund our stock repurchase program, and $9 million of cash dividends.
Net cash used by financing activities in first quarter of 2019 included $46 million of net payments on our credit facilities and $9 million of cash dividends.
Off Balance Sheet Arrangements
We do not have any material off balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.
Contractual Obligations and Commercial Commitments
Our contractual obligations and commercial commitments have not changed materially from the disclosures in our 2019 Annual Report on Form 10-K.
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CAPITAL STRUCTURE AND RESOURCES
We maintain bank credit facilities to fund our short and long-term capital requirements, including for acquisitions. From time to time, we also sell debt and equity securities to fund acquisitions or take advantage of favorable market conditions.
On October 15, 2019, we amended and restated our U.S. revolving credit facility, which matures on October 15, 2024. Our U.S. revolving credit facility has a capacity of $1.1 billion and also provides an expansion option, which permits us to request an increase of up to $400 million to the credit facility upon satisfaction of certain conditions. The U.S. revolving credit facility had an outstanding balance of $50 million at December 28, 2019. The weighted-average interest rate on primarily all of the outstanding credit facility borrowings was 3.25% and is principally based on LIBOR plus the applicable margin, which was 1.50% at December 28, 2019. The credit facility is secured by substantially all of our U.S. assets.
The U.S. revolving credit facility contains various covenants. The covenant for minimum interest coverage ratio, defined as the ratio of EBITDA to interest expense for the most recent four quarters, is 3.0. The covenant for the maximum leverage ratio, defined as the ratio of net debt to EBITDA for the most recent four quarters, is 4.0. We are in compliance with all covenants. EBITDA is defined in the loan agreement as (i) the sum of net income, interest expense, income taxes, depreciation expense, amortization expense, other non-cash items reducing consolidated net income and non-cash equity-based compensation expenses minus (ii) other non-cash items increasing consolidated net income.
We are generally not required to obtain the consent of lenders of the U.S. revolving credit facility before raising significant additional debt financing; however, certain limitations and conditions may apply that would require consent to be obtained. In recent years, we have demonstrated our ability to secure consents to access debt markets. We have also been successful in accessing equity markets from time to time. We believe that we will be able to obtain additional debt or equity financing as needed.
The SECT has a revolving credit facility with a borrowing capacity of $35 million, maturing on July 26, 2022. Interest was 3.87% as of December 28, 2019 and is based on LIBOR plus a margin of 2.13%. As of December 28, 2019, there was $7 million of outstanding borrowings.
On December 13, 2019, we completed the sale of $500 million aggregate principal amount of 4.25% senior notes due December 15, 2027 with interest paid semiannually on June 15 and December 15 of each year, which will commence on June 15, 2020. The senior notes are unsecured obligations, guaranteed on a senior unsecured basis by certain subsidiaries and contain normal incurrence-based covenants and limitations such as the ability to incur additional indebtedness, pay dividends, make other restricted payments and investments, create liens and certain corporate acts such as mergers and consolidations. The aggregate net proceeds of $493 million were used to repay indebtedness under our U.S. bank facility, thereby increasing the unused portion of our U.S. revolving credit facility.
On December 13, 2019, we issued a notice of redemption to the holders of our 5.25% senior notes due on December 1, 2022, to redeem and retire all of the outstanding notes. The notes were redeemed on January 13, 2020 at 101.313%, pursuant to an early redemption right. We redeemed the aggregate principal amount of $300 million using proceeds drawn from our U.S. revolving credit facility. The associated loss on the redemption includes $4 million of call premium paid to external bondholders. We had a total outstanding balance on our senior notes of $800 million at December 28, 2019.
We have a trade receivables securitization facility (the "Securitization Program"), which was extended on October 16, 2019 and matures on October 29, 2021. The Securitization Program provides up to $130 million of borrowing capacity and lowers our cost to borrow funds as compared to the U.S. revolving credit facility. Under the Securitization Program, we sell certain trade receivables and related rights to an affiliate, which in turn sells an undivided variable percentage ownership interest in the trade receivables to a financial institution, while maintaining a subordinated interest in a portion of the pool of trade receivables. We had an outstanding balance of $130 million at December 28, 2019. The Securitization Program has a minimum borrowing requirement, which was $104 million at December 28, 2019. Interest on the secured borrowings under the Securitization Program was 2.62% at December 28, 2019 and is based on 30-day LIBOR plus an applicable margin.
At December 28, 2019, our leverage ratio covenant limits our unused borrowing capacity to $631 million as of December 28, 2019.
Net debt to capitalization was 39% at December 28, 2019 and 36% at September 28, 2019. The increase in net debt to capitalization is primarily due to our share repurchases and our net earnings.
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We believe that our cash on hand, cash flows from operations and available borrowings under short and long-term arrangements will continue to be sufficient to meet our operating needs.
We declared and paid cash dividends of $0.25 per share on our Class A and Class B common stock in the first quarter of 2020.
The Board of Directors has authorized a share repurchase program. This program has been amended from time to time to authorize additional repurchases that includes both Class A and Class B common stock, and allows us to buy up to an aggregate 13 million common shares. Under this program, we have purchased approximately 10.6 million shares for $732 million as of December 28, 2019.
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ECONOMIC CONDITIONS AND MARKET TRENDS
We operate within the aerospace and defense and industrial markets. Our aerospace and defense markets are affected by market conditions and program funding levels, while our industrial markets are influenced by general capital investment trends and economic conditions. A common factor throughout our markets is the continuing demand for technologically advanced products.
Aerospace and Defense
Approximately two-thirds of our 2019 sales were generated in aerospace and defense markets. Within aerospace and defense, we serve three end markets: defense, commercial aircraft and space.
The defense market is dependent on military spending for development and production programs. We have a growing development program order book for future generation aircraft and hypersonic missiles, which we hope to embed our technologies within these high-performance military programs of the future. Aircraft production programs are typically long-term in nature, offering predictability as to capacity needs and future revenues. We maintain positions on numerous high priority programs, including the Lockheed Martin F-35 Joint Strike Fighter, FA-18E/F Super Hornet and V-22 Osprey. The large installed base of our products leads to attractive aftermarket sales and service opportunities. The tactical and strategic missile, missile defense and defense controls markets are dependent on many of the same market conditions as military aircraft, including overall military spending and program funding levels. At times when there are perceived threats to national security, U.S. Defense spending can increase; at other times, defense spending can decrease. Future levels of defense spending beyond 2019 are uncertain and subject to congressional debate. Our security and surveillance product line is dependent on government funding at federal and local levels, as well as private sector demand.
The commercial aircraft market is dependent on a number of factors, including global demand for air travel, which generally follows underlying economic growth. As such, the commercial aircraft market has historically exhibited cyclical swings which tend to track the overall economy. In recent years, the development of new, more fuel-efficient commercial air transports has helped drive increased demand in the commercial aircraft market, as airlines replace older, less fuel-efficient aircraft with newer models in an effort to reduce operating costs. The aftermarket is driven by usage of the existing aircraft fleet and the age of the installed fleet, and is impacted by fleet re-sizing programs for passenger and cargo aircraft. Changes in aircraft utilization rates affect the need for maintenance and spare parts impacting aftermarket sales. Boeing and Airbus have historically adjusted production in line with air traffic volume. Demand for our commercial aircraft products is in large part dependent on new aircraft production, which is increasing as Boeing and Airbus work to fulfill large backlogs of unfilled orders.
The space market is comprised of four customer markets: the civil market, namely NASA, the department of defense market, the commercial space market and the new space market. The civil market is driven by investment for commercial and exploration activities, including NASA's return to the moon. The department of defense market is driven by governmental-authorized levels of funding for satellite communications, as well as funding for hypersonic defense technologies. The commercial space market is comprised of large satellite customers, which traditionally are communications companies. Trends for this market, as well as for commercial launch vehicles, follow demand for increased capacity. This, in turn tends to track with underlying demand for increased consumption of telecommunication services, satellite replacements and global navigation needs. The new space market is driven by investments to increase the speed and access to space through smaller satellites, at reduced cost.
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Industrial
Approximately one-third of our 2019 sales were generated in industrial markets. Within industrial, we serve two end markets: industrial automation and medical.
The industrial automation market we serve is influenced by several factors including capital investment, product innovation, economic growth, cost-reduction efforts and technology upgrades. We experience challenges from the need to react to the demands of our customers, who are in large part sensitive to international and domestic economic conditions. Our simulation and test products operate in a market that is largely affected by these same factors and challenges. Our energy generation and exploration products operates in an energy market that is affected by changing oil and natural gas prices, global urbanization and the resulting change in supply and demand for global energy. Historically, drivers for global growth includes investments in power generation infrastructure and exploration of new oil and gas resources.
The medical market we serve is influenced by economic conditions, regulatory environments, hospital and outpatient clinic spending on equipment, population demographics, medical advances, patient demands and the need for precision control components and systems. Advances in medical technology and medical treatments have had the effect of extending average life spans, in turn resulting in greater need for medical services. These same technology and treatment advances also drive increased demand from the general population as a means to improve quality of life. Access to medical insurance, whether through government funded health care plans or private insurance, also affects the demand for medical services.
Foreign Currencies
We are affected by the movement of foreign currencies compared to the U.S. dollar, particularly in Aircraft Controls and Industrial Systems. About one-fifth of our 2019 sales were denominated in foreign currencies. During the first three months of 2020, average foreign currency rates generally weakened against the U.S. dollar compared to 2019. The translation of the results of our foreign subsidiaries into U.S. dollars decreased sales by $2 million compared to the same period one year ago.
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Cautionary Statement
Information included or incorporated by reference in this report that does not consist of historical facts, including statements accompanied by or containing words such as “may,” “will,” “should,” “believes,” “expects,” “expected,” “intends,” “plans,” “projects,” “approximate,” “estimates,” “predicts,” “potential,” “outlook,” “forecast,” “anticipates,” “presume” and “assume,” are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to several factors, risks and uncertainties, the impact or occurrence of which could cause actual results to differ materially from the expected results described in the forward-looking statements. These important factors, risks and uncertainties include:
• | the markets we serve are cyclical and sensitive to domestic and foreign economic conditions and events, which may cause our operating results to fluctuate; |
• | we operate in highly competitive markets with competitors who may have greater resources than we possess; |
• | we depend heavily on government contracts that may not be fully funded or may be terminated, and the failure to receive funding or the termination of one or more of these contracts could reduce our sales and increase our costs; |
• | we make estimates in accounting for over time contracts, and changes in these estimates may have significant impacts on our earnings; |
• | we enter into fixed-price contracts, which could subject us to losses if we have cost overruns; |
• | we may not realize the full amounts reflected in our backlog as revenue, which could adversely affect our future revenue and growth prospects; |
• | if our subcontractors or suppliers fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted; |
• | contracting on government programs is subject to significant regulation, including rules related to bidding, billing and accounting kickbacks and false claims, and any non-compliance could subject us to fines and penalties or possible debarment; |
• | the loss of The Boeing Company as a customer or a significant reduction in sales to The Boeing Company could adversely impact our operating results; |
• | our new product research and development efforts may not be successful which could reduce our sales and earnings; |
• | our inability to adequately enforce and protect our intellectual property or defend against assertions of infringement could prevent or restrict our ability to compete; |
• | our business operations may be adversely affected by information systems interruptions, intrusions or new software implementations; |
• | our indebtedness and restrictive covenants under our credit facilities could limit our operational and financial flexibility; |
• | the potential phase out of LIBOR may negatively impact our debt agreements and financial position, results of operations and liquidity; |
• | significant changes in discount rates, rates of return on pension assets, mortality tables and other factors could adversely affect our earnings and equity; |
• | a write-off of all or part of our goodwill or other intangible assets could adversely affect our operating results and net worth; |
• | our sales and earnings may be affected if we cannot identify, acquire or integrate strategic acquisitions, or if we engage in divesting activities; |
• | our operations in foreign countries expose us to political and currency risks and adverse changes in local legal and regulatory environments; |
• | unforeseen exposure to additional income tax liabilities may affect our operating results; |
• | government regulations could limit our ability to sell our products outside the United States and otherwise adversely affect our business; |
• | governmental regulations and customer demands related to conflict minerals may adversely impact our operating results; |
• | the failure or misuse of our products may damage our reputation, necessitate a product recall or result in claims against us that exceed our insurance coverage, thereby requiring us to pay significant damages; |
• | future terror attacks, war, natural disasters or other catastrophic events beyond our control could negatively impact our business; |
• | our operations are subject to environmental laws, and complying with those laws may cause us to incur significant costs; and |
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• | we are involved in various legal proceedings, the outcome of which may be unfavorable to us. |
These factors are not exhaustive. New factors, risks and uncertainties may emerge from time to time that may affect the forward-looking statements made herein. Given these factors, risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictive of future results. We disclaim any obligation to update the forward-looking statements made in this report.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Refer to the Company’s Annual Report on Form 10-K for the year ended September 28, 2019 for a complete discussion of our market risk. There have been no material changes in the current year regarding this market risk information.
Item 4. Controls and Procedures.
(a) | Disclosure Controls and Procedures. We carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures are effective as of the end of the period covered by this report, to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. |
(b) | Changes in Internal Control over Financial Reporting. There have been no changes during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. |
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PART II OTHER INFORMATION
Item 1A. Risk Factors.
Refer to the Company’s Annual Report on Form 10-K for the year ended September 28, 2019 for a complete discussion of our risk factors. There have been no material changes in the current year regarding our risk factors, other than the addition of the following:
The potential phase out of LIBOR may negatively impact our debt agreements and financial position, results of operations and liquidity. On July 27, 2017, the United Kingdom’s Financial Conduct Authority announced that it intends to phase out LIBOR by the end of 2021. It is unclear whether new methods of calculating LIBOR will be established or whether different benchmark rates used to price indebtedness will develop. If LIBOR ceases to exist, we may need to renegotiate our debt agreements that extend beyond 2021 that utilize LIBOR as a factor in determining the interest rate, which may negatively impact the terms of such indebtedness. In addition, the overall financial markets may be disrupted as a result of the phase out or replacement of LIBOR. Disruption in the financial markets could have an adverse effect on our financial position, results of operations, and liquidity.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(c) | The following table summarizes our purchases of our common stock for the quarter ended December 28, 2019. |
Period | (a) Total Number of Shares Purchased (1)(2)(3) | (b) Average Price Paid Per Share | (c) Total number of Shares Purchased as Part of Publicly Announced Plans or Programs (3) | (d) Maximum Number (or Approx. Dollar Value) of Shares that May Yet Be Purchased Under Plans or Programs (3) | |||||||||
September 29, 2019 - November 2, 2019 | 42,471 | $ | 79.85 | 33,967 | 3,013,340 | ||||||||
November 3, 2019 - November 30, 2019 | 245,155 | 87.93 | 228,710 | 2,784,630 | |||||||||
December 1, 2019 - December 28, 2019 | 419,756 | 87.92 | 406,269 | 2,378,361 | |||||||||
Total | 707,382 | $ | 87.44 | 668,946 | 2,378,361 | ||||||||
(1) | Reflects purchases by the Moog Inc. Stock Employee Compensation Trust Agreement ("SECT") of shares of Class B common stock from the Moog Inc. Retirement Savings Plan ("RSP") and the Employee Stock Purchase Plan (ESPP) at average prices as follows: 8,504 shares at $81.09 per share during October; 6,852 shares at $88.03 per share during November and 13,240 shares at $86.65 per share during December. |
(2) | In connection with the exercise of equity-based compensation awards, we accept delivery of shares to pay for the exercise price and withhold shares for tax withholding obligations. In November, we accepted delivery of 9,593 Class B shares at $85.95 per share and in December we accepted delivery of 247 Class A shares at $89.70 per share, in connection with the exercise of equity-based awards. |
(3) | The Board of Directors has authorized a share repurchase program. This program has been amended from time to time to authorize additional repurchases up to an aggregate 13 million common shares. The program permits the purchase of shares of Class A or Class B common stock in open market or privately negotiated transactions at the discretion of management. In October, we purchased 33,880 Class A shares at an average price of $79.53 per share and 87 Class B shares at an average price of $83.74 per share. In November, we purchased 228,710 Class A shares at an average price of $88.01 per share, and in December, we purchased 406,269 Class A shares at an average price of $87.96 per share. |
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Item 6. Exhibits.
(a) | Exhibits | ||
Preferability Letter of Independent Registered Public Accounting Firm dated January 24, 2020. | |||
Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||
101 | Interactive Date files (submitted electronically herewith) | ||
(101.INS) | XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. |
(101.SCH) | XBRL Taxonomy Extension Schema Document |
(101.CAL) | XBRL Taxonomy Extension Calculation Linkbase Document |
(101.DEF) | XBRL Taxonomy Extension Definition Linkbase Document |
(101.LAB) | XBRL Taxonomy Extension Label Linkbase Document |
(101.PRE) | XBRL Taxonomy Extension Presentation Linkbase Document |
In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section and shall not be part of any registration or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Moog Inc. | |||||
(Registrant) | |||||
Date: | January 24, 2020 | By | /s/ John R. Scannell | ||
John R. Scannell | |||||
Chairman of the Board and Director Chief Executive Officer (Principal Executive Officer) | |||||
Date: | January 24, 2020 | By | /s/ Jennifer Walter | ||
Jennifer Walter | |||||
Vice President and Chief Financial Officer (Principal Financial Officer) | |||||
Date: | January 24, 2020 | By | /s/ Michael J. Swope | ||
Michael J. Swope | |||||
Controller (Principal Accounting Officer) | |||||
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