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Hello, and welcome to the Meggitt Trading Update Call. [Operator Instructions]. Just to remind you, this conference call is being recorded.Today, I'm pleased to present Louisa Burdett, CFO; and Mat Wootton, VP, Strategy and Investor Relations. Please go ahead with your meeting.
Good morning, everyone, and thank you for joining us this morning for our trading update for the third quarter of financial year 2019.As you would have seen this morning, we've announced a strong set of numbers for Q3 and an upgrade to our full year revenue guidance from 4% to 6% to 6% to 7%.With me is Mat Wootton, who, as some of you know, recently joined Meggitt to lead the IR function.So the format of today is that I'm going to take you through our 4 market segments, moving on to a brief update on our strategic initiatives, and then finishing with our outlook for 2019 before opening up for questions.Overall, organic revenue growth of 11% in the quarter was stronger than we had anticipated and reflects further big momentum across all end market segments with a particularly strong performance in Defence, which was up 20% in the quarter.And similarly, we delivered 4% growth after a strong first half, where growth was up 11%.Growth in the third quarter was largely driven by business and regional jets with large jets revenue slightly ahead of the comparative period.Year-to-date, we're up 9% in Civil OE. While we expect deliveries to OEMs to continue in the fourth quarter given the strong growth year-to-date and a strong comparison in Q4, we are maintaining our overall guidance in this segment for the full year at 5% to 7%.In Civil Aftermarket, against the backdrop of the ongoing grounding of the 737MAX and a slight softening in civil air traffic growth, market conditions remain supportive, with passenger load factors remaining high and continued low levels of retirement.In the first quarter, we achieved 4% growth, with 7% growth in large jets and 9% in business jets.Against this, our regional jet aftermarket revenues were lower than the same period last year.On a year-to-date basis, we are up 6% overall in Civil AM, and again, we are maintaining our guidance in this segment for the full year at 3% to 5%.In Defence, as already mentioned, we had a very strong quarter in both OE and Aftermarket, with 20% revenue growth, reflecting our significant position on the fastest-growing and hardest worked platform as well as continuing refresh and retrofit activity in the U.S., where our outlays remain strong.We are currently up 16% for the first 9 months of the year, and we are increasing our guidance for the full year in this segment from 6% to 8% to 9% to 11%, again, reflecting the very strong comp in Q4.Moving to Energy. Revenue was up 26% in the quarter, driven by our Heatric business, where we continue to see good demand for our printed circuit heat exchanges to serve the LNG and FPSO markets.Year-to-date, we are 7% ahead of the comparative period. And in light of this, and particularly given the quarter-on-quarter variability in this part of the business, we are maintaining our full year guidance at 0% to 5%.Turning our attention towards our strategic initiatives. Composites are worth a specific mention, where we have delivered further operational improvement, notably increased yields and delivery to our customers. We have also progressed the transfer of production of certain parts to our Mexico facilities.We continued to make good progress during the quarter in our categories of competitiveness and customer. We continued to achieve savings in purchasing and are on track to deliver our full year target of 2%. The progressive transfer of 4 of our U.K. sites into our new campus Ansty Park is also going well, and we are on track for this to start next year.During the period, we have also continued to strengthen our relationships with customers in our Service and Support division, signing a number of SMART Support deals and taking our total number of deals to 22.So finally, moving to the outlook for the full year, where we expect to deliver good top line growth reflected in the revenue upgrade to 6% to 7%.However, as set out in the statement, our ability to deliver margin progression for the full year from this stronger top line is expected to be constrained by 3 key factors. And I'd just like to spend a couple of minutes addressing each of these in a little bit more detail.Firstly, and I've mentioned at the half year, the unprecedented ramp-up in production of new aircraft has placed significant pressure on our external supply chain, notably with supply of forgings and castings into our higher-margin wheels and brakes business. This has constrained our ability to deliver at the required rate. And from an internal perspective, supply pressure has also resulted in inefficient manufacturing, driving higher unit costs.The second factor is the continued grounding of the 737MAX where we have previously quantified $1 million per month impact from delays in the delivery of initial provisioning spares to the airlines and the associated impact on our Civil Aftermarket.And the third and last factor is that strong revenue growth from the attractive but lower-margin defense business does have a mix impact.It's worth noting that we've had a low single-digit FX benefit in Q3 at profit level from a weaker pound, which has been taken into account in our margin guidance.So taking these factors together, we now anticipate margins being towards the lower end of our guidance range of 17.7% to 18.2% for the full year.So in conclusion, the business has had another good quarter with continued progress on a clear set of strategic objectives, including composites. We remain resilient in the face of externalities, which are creating short-term margin headwinds like the supply chain and the 737MAX, and we look forward to delivering another year of profitable growth in 2019.So that wraps up the main messages that we'd like to highlight from today's release, and we would now be very happy to take questions from the call.
[Operator Instructions] And our first question is from Robert Stallard from Vertical Research.
Just a couple from me. First on the Defence side, obviously, a very good quarter there. A number of moving parts. How much of this do you think could be categorized as one-off? Basically, how sustained do you think this growth could be?
So Rob, obviously, we're really pleased with the performance in Defence. And we've had a look at the moving parts there, but it's actually pretty broad-based across all of our platforms, fixed wing, rotor and ground. We are strong on both OE and AM, and we see this particularly across refresh and retrofit activity. So pretty broad-based, and particularly also strengthening our software training systems business.In terms of whether that question is going to the outlook, I'd like to remind folks that we have got a particularly strong comp in the Q4 period in '18, where we grew at 14%. So obviously, we're anticipating that, that softens off on a year-to-year basis in Q4 and with the continuing revolution in the background. But just to answer your question, it was pretty broad-based growth in Q3.
Okay. And then secondly, in terms of this issuance of supplying parts due to your suppliers having issues getting things to you. Have you actually held up any customer delivery with aircraft? Or is that just generally carried on as planned?
No, we're not aware that it's held up any delivery of aircraft. It's really just made our -- it's drifted a little bit of our product shipments to the right, but we're seeing most of it in terms of our inability to plan smoothly in our factories. So we're getting lumpy flow and increased unit production costs. But unfortunately, we won't be able to claw back at a later date, but we're not aware that this is holding up any deliveries now.
Okay. And then just finally from me. Have you got any update on the cash flow situation? What we might expect for the full year?
Yes, our free cash flow consensus is Q1 2020.
'20, yes.
And we're pretty happy with that consensus on cash.
And our next question is from Harry Breach from MainFirst.
Can I just ask a couple? Firstly, I think you sort of gave an answer to Rob that you touched on Defence drivers being broad-based. It doesn't feel like there is any 1 program you'd particularly call out. And I guess sort of thinking further ahead as you look into 2020 and '21, clearly, we have the pace of growth in budget authority moderating.Are there any sort of indications that the business is seeing from program officers that the pace of contract letting might be slowing down as you look into 2021?Next question was just really about the pace of transfer of volume to the Mexico site. Can you sort of help us to think about whether you're sort of halfway through the anticipated volume that you're going to move there? How far there is to go? And then just finally on Erlanger. Can you give us any update on how things are progressing there?
Yes. No problem, Harry. To answer your first question, I don't think we have any leading KPIs in the business around the pace of that contract letting slowing. I guess I've already mentioned just the overhang of the continuing resolution, which, I think, broadly, the market is expecting to continue into December and potentially next year, but nothing more specific than that.If I move on to the Erlanger and Mexico dynamic, our transfer activities, we've got a basket of important parts that are planned -- are predicated on transferring to Mexico. And we are happy with where we are there. The important dynamic is that, that's allowing us to substitute lower-cost labor in Mexico, but also in the Erlanger U.S. plant. It's allowing us to decrease the amount of higher-cost temporary contractors that we have servicing volume in the U.S. So I think we are happy with where we are, and we're continuing to make good progress in the quarter and the half in that transfer activity.Just to finish off, we've got quite a lot of extra machines and buildings into that part of the world to help us furnish that volume in a progressive manner. And at the risk of extending the answer too much, no, we have been very clear in the market that we are undertaking a 2-year plan to get this business back to exit margins from 2021 in the mid-teens. And yes, there's still a bit of work to do, but as I said, we're happy with where we are.
And I think the next extension is that we'll expect to ship parts to Mexico by the end of the year.
Yes. Actually, yes.
Yes. And just one thing, I think you gave us a data point in your prepared remarks about the monthly impact due to 737MAX today. I didn't quite catch the number, Louisa. Could you remind me?
So we -- when we came out at the half year, we had planned alongside our customers that we would expect to see some of the initial provisioning spend coming back in the fourth quarter. And clearly, the news now is that that's going to be probably early Jan. So if you want to quantify that, we talked about $1 million a month shifting to the right. So there's probably around $3 million of incremental headwind that we didn't have insight at the half year.
[Operator Instructions] Our next question is from Andrew Humphrey from Morgan Stanley.
Just a couple on some of the supply constraints. The first is on, I guess -- is question around whether your perception is that this is a general industry issue affecting competitors as much as it's affecting your business in mills and brakes? And I guess, by extension, is this -- is it your sense that the suppliers in this part of the business are possibly prioritizing other areas of the aircraft like engines? And I guess, to what extent does this relate to some of the comments you made at the half year around consolidation of suppliers looking to drive cost out of this part of the business as you are in other parts of the business. And I guess the related and possibly sense of the question is how far into 2020 you're expecting it to last?
Thanks, Andrew. We believe this is affecting more than just us and is more of a general industry issue. We noted, in particular, that CFM came out and mentioned the impact of forgings and castings on the Leap engine. And essentially, I guess, we mentioned this back in June and August, didn't quite anticipate that this squeeze would have been quite as significant or projected -- protected. So we have added a little bit more impact into Q3 and Q4.In terms of how long we think this is going to go on. I guess I just answered part of that, but we're planning for this to impact Q4. We're not factoring anything into 2020. But obviously, we'll update you if that changes. But I think the important metric is that we have got some of our focus in -- at the 2 important suppliers, trying to fight for allocation so that we can continue to supply customers, and we are seeing some improvement on that. So hopefully, this will temper fairly quickly. I'll just point you back to my prepared comments about the short-term margin headwinds.
And I think to add on consolidation of suppliers, that's very much being a focus on areas of the business, Andrew, where we've had many, many suppliers and reducing those from, in some cases, hundreds to very few. In this part of the business, obviously, the supply chain is not much more limited to a very few number suppliers. So as Louisa mentioned, the opportunity to consolidate further revenues really isn't about the broader strategy of reducing purchasing costs and consolidating suppliers. It's a very different issue.
And our next question is from Malini Chauhan from Redburn.
Two questions from me. Just firstly, on the marks in terms of -- I know you've quantified the cost from the continued grounding, but in terms of the ramp-up that Boeing is planning from 42 to getting to 57 by year-end, are there kind of any margin headwind or expected cost associated with ramping back up to that rate?And then second question on free-of-charge shipsets. I guess you just have some more color now that you've got another quarter in the bag. How are they tracking in terms of a full year guidance towards the top end? Or where are they tracking generally?
So I'll take the FoC one first, Malini, no change to where we indicated at half year. I think it's about 30 bps we said we were tracking to and no significant change on that. So in our [ insuring ] segment, the guidance at the back of that deck is still valid. On the 737 ramp-up, nothing material in terms of getting back to rate. I think we've indicated in the past that we've continued at a higher rate at the 50s rate during the -- during that 42 ramp-up to allow us to get back to 50 and to pull down some of our rears. So I don't see any significant impact there.
Just one thing on the MAX as well, just to expand on what Louisa said, Malini, I think, other planes have been probably flying longer and harder because of the MAX being grounded. So it may have actually delayed for aftermarket and that part of the market may come back into the shelf next year. So that's something perhaps to look out for, for the positive. And then, of course, you've mentioned the fact that with the IP space, moving to the right again, it's, we believe, more favoring than anything else. So there are those 2 factors as well to consider when we think about when that's coming back, when it does come back.
And as there are no further questions, I will hand it over back to the speakers for any final comments.
Great. Thanks, everybody, for attending today. Just in summary, just like to remind everyone, we've had a good quarter. You've seen our revenue upgrade, which has largely been driven by the Defence segment. Hopefully, we've outlined to you that we have some short-term margin headwinds, which, although we are continuing within our margin consensus range, we are guiding slightly to the lower end, which is actually pretty much where the market is at 17.9%. We're making really good progress on our strategic initiatives, including composite. And as I said in the prepared statements, looking forward to delivering another year of profitable growth.As always, if you have further questions off-line, Mat and I are available for follow-up. So thank you very much for your time this morning.
Thank you.
This does conclude our conference call. Thank you all for attending. You may now disconnect your lines.