Q4 2023 Moog Inc Earnings Call
Participants
Aaron Astrachan; Director of IR; Moog Inc.
Jennifer Walter; VP & CFO; Moog Inc.
Patrick J. Roche; CEO & Director; Moog Inc.
Cai von Rumohr; MD & Senior Research Analyst; TD Cowen, Research Division
Michael Frank Ciarmoli; Research Analyst; Truist Securities, Inc., Research Division
Unidentified Analyst
Presentation
Operator
Good morning, and welcome to the Moog Fourth Quarter Fiscal Year 2023 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Aaron Astrachan. Please go ahead, sir.
Aaron Astrachan
Good morning, and thank you for joining Moog's Fourth Quarter 2023 Earnings Release Conference Call. I'm Aaron Astrachan, Director of Investor Relations. With me today is Pat Roche, our Chief Executive Officer; and Jennifer Walter, our Chief Financial Officer.
Earlier this morning, we released our results and our supplemental financial schedules both of which are available on our website. Our earnings press release, our supplemental financial schedules and remarks made during our call today contain adjusted non-GAAP results. Reconciliations for these adjusted results to GAAP results are contained within the provided materials.
Lastly, our comments today may include statements related to expected future results and other forward-looking statements. These are not guarantees as our actual results may differ materially from those described in our forward-looking statements and are subject to a variety of risks and uncertainties that are described in our earnings press release and in our other SEC filings.
Now I'm pleased to turn the call over to Pat.
Patrick J. Roche
Good morning, and welcome to the call. Today, we will share an update on a superb quarter, notable for record sales, record 12-month backlog, strong operating margins and strong cash flow. It is a tremendous performance from our teams to deliver 3 consecutive quarters of record sales and to continue to drive our margin enhancement initiatives. And for that, I wish to thank our Moog employees globally who contributed to our financial performance in the quarter and the operational improvements over the last 12 months.
Before we get into the detail on the quarter, let me first reflect on what has been an exceptional year for our company. We delivered record sales, we increased operating margin and we built an all-time high 12-month backlog. We have grown revenue over 11% organically to $3.3 billion. Each of our 3 segments contributed double-digit organic growth. The growth was led by recovery in commercial aircraft by broad-based demand for our defense and space applications and by strength in our industrial automation and flight simulators.
In addition, we have been successful in winning new business with exceptional -- exceptionally strong order intake on the defense side of the business, increasing our total backlog to just over $5 billion. We have expanded adjusted operating margin by 70 basis points from 10.2% to 10.9%. This is notable progress and a great start to our margin enhancement journey. The effort invested in both pricing and simplification are already delivering improved financial outcomes.
Adjusted earnings per share improved by a solid 11% to $6.15 and would have been even stronger if not for increased interest costs. We certainly have had challenges through the year with supply chain and specific labor availability issues, especially in the first 2 quarters. Those challenges have eased in the back half of the year, and we saw further improvement in Q4, finishing the year with strong cash generation.
Now let me turn my attention to the operational actions that we are taking to drive our performance improvement. Firstly, customer focus. We have completed the separation of aircraft into military aircraft and commercial aircraft segments. The business leaders have direct responsibility for the focused factories, the dedicated staff and the production resources for their respective businesses. They are fully accountable for operational and financial performance of the business, and each leader can now better align the business model with the distinct end market needs. Our forward guidance provides you financial visibility of these new segments.
We have also completed delivery of our first 4 meteorite satellites to our customer. Payload integration and testing of hardware and software have been completed successfully. This is significant progress for us in our space vehicles programs. On a further positive note, we are making progress slowing the growth of physical inventory. This is a sign of improving supply chain and labor market conditions resulting in better production flow and labor utilization. This is enabling us to better meet our customer commitments.
Next, people, community and planet. As I stated in my first earnings call, I believe that we have a moral responsibility to be good stewards of our planet for the next generation. I want to let you know that we're making good progress in characterizing and measuring emissions, and we've already published a sustainability and disclosure report last year. We've now baselined within our own facilities worldwide our CO2 emissions, water usage and hazardous waste production. We are strongly committed to drive improvement. And I can announce today that we are targeting a 40% reduction in Scope 1 and Scope 2 greenhouse gas emissions by 2030.
Finally, turning to financial strength. We are making excellent progress in driving margin enhancement through pricing and simplification. On pricing, we have had good success working with our customers across all end markets to adjust pricing so that it better reflects the value that we deliver. Those negotiations have taken place over months, and in some cases, years, the impact is now feeding through to our financial results, notably within Industrial in the second half of the year and within aircraft in the current quarter. Those agreements already concluded, deliver a substantial portion of our planned operating margin expansion out to fiscal '26.
On simplification, we've increased the pace of simplification throughout the organization. This is evident in various initiatives. Firstly, portfolio shaping. We are well advanced in the sale of our industrial hydraulics business in Luxembourg, which we hope to complete before the end of the second quarter fiscal '24. We will also dispose of another industrial business before the end of fiscal '24 and have consequently taken a substantial charge in this quarter.
Footprint, we have closed 6 sites in fiscal '23, a mix of sales offices and remote engineering sites. We also sold 3 factory buildings that we had previously vacated through prior footprint closures. We announced a further 2 manufacturing site closures, the first of which we'll complete in fiscal '24.
On focused factory, we continue to segregate product by end market in order to simplify our manufacturing plants. We have several changes underway, including moving aerospace products out of our industrial facility in Murphy, North Carolina, and using the growth of our space business as an opportunity to tease apart the physical operations of our space and defense businesses since each are driven by different end market requirements. We continue to build 80/20 momentum in this quarter. Our pilots are demonstrating significant progress in both pricing and simplification. We're also seeing improvement in customer satisfaction and employee engagement. We trained a further 250 leaders in the approach. In addition, we agreed to transfer several more product lines on mature end-of-life aircraft platform to specialized third-party organizations from which we expect to see a gain in efficiency.
Finally, we added 2 more sites to full implementation under 80/20, bringing the total to 10.
Now before I turn attention to macroeconomic environment, I'd like to share 2 further updates. First, we report a positive impact in Q4 from the settlement of litigation. We are not able to provide specifics since the terms of the settlement are confidential. We are pleased to have this concluded. Secondly, I'm also happy to report that we are making good progress on revalidating our security clearance with the Defense Counterintelligence and Security Agency. And in the meantime, we continue to work without interruption on awarded defense contracts.
We have submitted a mitigation plan that we believe meets the DCSA requirements as we noted previously, we expect the plan to involve standing of a subsidiary with an organizational structure and procedures to ensure the protection of classified information. We're hopeful to have the situation resolved during the next 2 quarters and we'll provide an update when we have additional information to share. As a reminder, this matter relates solely to classified U.S. military programs.
Now turning to macroeconomic and end market conditions. It is shocking that we now have war in Ukraine and the Middle East. Simmering geopolitical tensions are leading most nations to reassess their national security and to increase commitment to defense spending. Defense constitutes half of our book of business. The commercial aircraft market continues to strengthen. We have a clearly defined wide-body production ramp over the next few years towards 10 and 9 shipsets per month in fiscal '26 for 787 and A350, respectively. We see no change in those plans.
Industrial markets continue to soften, there has been a gradual reduction in book-to-bill ratio over the last 6 months. Market data such as the Manufacturing Purchasing Managers' Index and the survey data from the German Engineering Federation, our VDMA all indicate contraction. We expect this to continue and we are managing our business accordingly.
Now looking forward to guidance for fiscal '24. We continue to execute on our Investor Day initiatives of growth and margin enhancement. Our fiscal '23 performance was in line with our expectations, and we are building momentum going into fiscal '24. For that reason, I'm confident in laying out our guidance for '24, which includes solid revenue growth, 4% year-over-year yielding a 7% CAGR growth from fiscal '22 to fiscal '24.
Secondly, strong margin enhancement with adjusted operating margin up 110 basis points to 12%; and thirdly, modest free cash flow. Our guidance is in line with our stated Investor Day targets, solid revenue growth, strong margin enhancement and modest cash flow. Our growth in '24 is driven by the continued commercial recovery, a full year of V-280 development, broad-based growth in Defense and Space, offset by a decline in industrial automation. We continue to execute on our pricing and simplification initiatives and we will update you on progress throughout the year on portfolio shaping, footprint rationalization and building our 80/20 maturity.
Now let me hand over to Jennifer for a more detailed breakdown on the quarter and on our guidance.
Jennifer Walter
Thank you, Pat. I'll begin with the headlines for FY '23, followed by a more detailed review of our fourth quarter financial performance. I'll then describe our initial guidance for fiscal year '24.
Sales for FY '23 were at a record level coming in at $3.3 billion. This represents a 9% increase over FY '22 and adjusting for divestitures, 11%. Each of our segments contributed to our strong sales growth. The growth in Aircraft Controls was driven by the commercial aircraft recovery, offset somewhat by declining funded development work in the military business.
In Space and Defense control, sales grew as a result of the production ramp on the reconfigurable turret program and strong demand for satellite components. The growth in industrial systems related to increased demand for capital equipment driving industrial automation sales as well as air traffic recovery boosting flight simulation activity.
Our adjusted operating margin of 10.9% increased 70 basis points over FY '22. In Industrial Systems, our margin expanded 200 basis points largely due to pricing initiatives. In Aircraft Controls, our margin expanded 70 basis points. Again, pricing was a key driver of margin expansion, but reduced somewhat by negative impact on military aircraft funded development work. In Space and Defense Controls, our margin contracted 40 basis points as charges in our Space Vehicles business [MAST] and otherwise stronger core business.
As Pat described, we've made progress in both our pricing and simplification efforts. Pricing has already begun to contribute to our margin expansion in fiscal year '23. Margin loss from our early learnings in space vehicles was behind us, and we'll see that benefit come through in fiscal year '24. And simplification efforts will show up more meaningfully in the out years.
Our adjusted earnings per share of $6.15 were up 11%. This increase is driven by our adjusted operating profit, which grew 17%, offset by a significant increase in interest expense. For the year, we had negative free cash flow of $37 million. This resulted from an increase in working capital, specifically physical inventories and a high level of capital expenditures as we invest in our facilities.
Let's shift over to our fourth quarter results. The performance of our underlying business in the fourth quarter was exceptional. For the third quarter in a row, we hit a record level of sales for the company. Our key initiatives drove our operating margin expansion and cash flow performance was robust. We made progress on simplifying our business and took some charges in the fourth quarter as a result. We incurred $17 million of impairment and restructuring charges associated with planned portfolio and footprint rationalization activities, mostly in industrial systems.
We also continued our journey to get out of the pension business, settling over $40 million of our projected benefit obligation through a lump sum buyout which resulted in a $13 million nonoperating settlement charge. We also recorded $4 million for unrelated asset impairments.
I'll now talk through our fourth quarter, excluding these charges. Sales in the fourth quarter were $872 million, increasing 14% over the same quarter a year ago. The largest increase was in aircraft controls, sales of $377 million increased 16% over the same quarter a year ago. Commercial OE sales in the quarter were strong, driven by the continued market recovery and wide-body platforms as well as the growth on business jets.
Commercial aftermarket sales were at a record high. We had strong sales on the A350 program, which has been steadily ramping over the past several quarters. We also sold inventory associated with mature programs that we decided to exit as part of our simplification efforts. Sales in Space and Defense Controls of $241 million increased 11% over the fourth quarter last year. Adjusting for the divestiture of a security business last year, sales increased 13%, the sales growth was driven by increased activity on avionics and components for satellites and new defense work that's ramping up.
Industrial System sales increased 12% to $254 million. We experienced sales growth related to high demand on flight simulation systems associated with the recovery in commercial aircraft flight hours. In addition, our industrial automation sales grew driven by demand for capital equipment. This business has recovered nicely since the pandemic, though we've been seeing orders slow down in recent quarters.
We'll now shift to operating margins. Operating margin adjusted of 12.5% in the fourth quarter, increased 210 basis points from the fourth quarter last year. The increase is due to pricing initiatives and to a lesser extent, transactions resulting from our focus on simplification. Operating margin in Aircraft Controls was 12.8% in the fourth quarter, up nicely from 10.7% in the same quarter a year ago.
The increase was driven by retroactive pricing in the fourth quarter. In addition, as part of our 80/20 work, we've exited some mature commercial platforms and sold associated inventory. The resulting benefit to margins from that activity was offset by charges on funded development work that's winding down.
Operating margin in Space and Defense Controls was 12.8%, up from 9.4% a year ago. This quarter, we had the benefit of lower charges associated with our space vehicle start-up business, stronger core business performance and pricing initiatives. Operating margin in Industrial Systems was 11.9%, up 110 basis points over 10.8% in last year's fourth quarter. Benefits associated with our pricing initiatives drove this margin expansion. Interest expense is another area that's impacting our financial results. In the fourth quarter, interest expense was $18 million, up $7 million over the fourth quarter last year. Our adjusted effective tax rate in the fourth quarter was 18.5%, down from 23.4% in the fourth quarter last year as we benefited from higher levels of R&D tax credits.
Putting it all together, adjusted earnings per share came in at $2.10, well above the range we provided a quarter ago. EPS was up 54% from the same quarter a year ago, driven by the increase in operating profit and the benefits of the legal settlement and lower tax rate. Relative to the midpoint of our previous guidance, our EPS was up $0.03 after adjusting for the lower tax rate and legal settlement.
Let's shift over to cash flow, which was another highlight for the quarter. In the fourth quarter, we generated $105 million of free cash flow. This represents free cash flow conversion on adjusted net earnings of over 150%. The key driver to the strong cash generation this quarter was working capital, in particular, collections from customers and timing of compensation and vendor payments.
Capital expenditures were relatively high at nearly $50 million this quarter as work progressed on facilities, most notably our advanced integrated manufacturing facility for military aircraft. We're continuing to invest in facilities to accommodate our growth, focus our factories and enhance our capabilities through automation.
Our leverage ratio, calculated on a net debt basis as of the end of the fourth quarter was 2.2x, around the lower end of our target range of 2.25x to 2.75x. Our capital deployment priorities, both long term and near term, are unchanged. Our current priority continues to be investing for organic growth.
We'll now shift over to our initial guidance for next year. Fiscal year 2024 will be another positive step in our journey towards our long-term financial targets. Our operating margin will expand by over 100 basis points and earnings per share will increase over 10%. Over the past several months, we have worked on creating our aircraft business into 2 segments: military aircraft and commercial aircraft. As of the beginning of FY '24, they're officially split, and we will now begin to report on them as separate segments.
The sales breakdown that we've historically shared will largely be the same as in the new organization. I'll also share estimated operating margins for these segments looking back at FY '23. We're projecting sales of $3.5 billion in FY '24, that's a 4% increase compared to FY '23 and a 7% CAGR from FY '22. We're projecting sales growth in military aircraft, commercial aircraft and Space and Defense and expecting a decrease in sales in Industrial.
The largest increase in sales will again be in commercial aircraft. We're projecting sales to grow 14% to $785 million. The production ramps on our wide-body programs, most notably the 787 account for most of the increase in OE sales. Aftermarket sales will decrease from the record high in FY '23, reflecting the absence of some onetime sales activity that occurred in FY '23.
Space and Defense sales are projected to increase 7% to $1.0 billion. We're seeing strong defense demand across our entire book of business. Areas in which we experienced strong demand, in particular, our satellite components, missile control and new defense programs. Military aircraft sales are projected to increase 5% to $735 million. A full year's worth of V-280 sales will drive OE sales up in FY '24. While aftermarket sales continue to soften as defense priorities shift to modernization.
Industrial sales will decrease in FY '24. We're projecting sales of $915 million, down 7% from last year or 6% when we adjust for divestitures. This decrease relates to the softening of orders that we're seeing in industrial automation and is consistent with macro indicators for capital spend. We'll see increases in our other submarkets, partially offset the lower industrial automation business.
Let's shift over to operating margins. We're projecting our operating margin in FY '24 to be 12.0%, a 110 basis point increase over FY '23. Operating margins will expand in each of our segments with the exception of commercial aircraft. Our operating margin in Space and Defense will increase 300 basis points to 13.5% due to the absence of charges on our space vehicle program and reflecting our otherwise strong operational performance.
Military aircraft operating margin will increase 280 basis points to 11.6%. We'll benefit from having a full year of activity on the V-280 program in FY '24. In FY '23, our activity was interrupted by the delay in the contract award followed by a ramp up to the current activity level. In addition, charges incurred on certain funded development programs will not repeat as those programs are winding down.
Pricing will continue to drive operating margin expansion in industrial controls, where our operating margin will increase 80 basis points to 12.3%. In commercial aircraft, our operating margin will decrease 260 basis points to 10.2% as aftermarket specialists don't repeat. In FY '23, we had a number of onetime aftermarket initiatives that contribute nicely to our operating margin as well as the sale of inventory upon exiting mature platforms. In FY '24, we're projecting adjusted earnings per share of $6.80, plus or minus $0.20, which is up 11% over FY '23, reflecting strong operational performance. For the first quarter, we're forecasting earnings per share to be $1.45 plus or minus $0.10.
Finally, turning to cash. We're projecting free cash flow for FY '24 to be modest. Relative to FY '23, we'll see stronger cash from net earnings and working capital while capital expenditures remain around the same level. We use less cash for working capital needs next year. Physical inventories will grow at a slower rate, reflecting the improvement we saw this past quarter. However, we'll see pressure from customers as we work down advances that came in during FY '23. Overall, we had a great quarter and our outlook for next year looks strong.
With that, we'll turn it back to Pat.
Patrick J. Roche
Thank you, Jennifer. I'm really pleased with our outstanding performance this quarter, and I look forward to another year of even stronger performance in fiscal year '24. Now let's open the floor up to questions.
Question and Answer Session
Operator
(Operator Instructions). Our first question is coming from here from Cai von Rumohr with TD Cowen.
Cai von Rumohr
Yes. Thank you very much, and good performance. Did I miss it? I didn't hear a guide for free cash flow in '24 and much color in terms of what you expect?
Jennifer Walter
Hi, Cai. We've -- we shared that it's going to be modest. So we're going to have positive cash flow generation next year, but it's not going to be at a robust level. That's similar to what we had projected and shared back in the Investor Day in June. Looking at some of the pieces that make up our cash flow, we're going to have adjusted net earnings that are up. That's up about $20 million, $25 million. So that's a big part of it as well. Capital expenditures will stay around the same level. We have a little bit of an increase in depreciation and amortization. But the 2 things that are going to be moving the most are both happening within working capital.
The pressure that we'll see is actually going to be in receivables and advances, and it's really related to the advanced side of it for the most part. We've got great customer advances in '23, especially earlier in the year. We had it on military commercial programs. We had a nice advance on the RIP as well. We started working them down later this past year, and we're going to continue to work them down such that the combination of receivables and advances is going to be pressure for us next year.
But the real change that we're going to see the improvement is going to be driven by our physical inventories. We had a significant use of cash for physical inventories this year, especially in the middle part of the year. But we've made improvements. In the fourth quarter, we still grew our physical inventories, but it's done obviously a nice growing business. And we've been able to slow that down for 2 reasons. We're seeing benefits on the external standpoint. We've seen some components come and shake out that we can actually get product out of the door to a greater extent than we have in the past. In addition, we've got higher utilization within the company that's helping that flow as well. So we're projecting that the use of cash for physical inventories is going to continue around the improved level that we saw in the fourth quarter for all of next year. So that really makes it a much more better situation for cash than it was in '23. Obviously, in '23, we use cash. We'll generate cash next year, but there's still pressures associated with a growing business of -- [cautious] from that standpoint.
Patrick J. Roche
And Cai, that's on a path towards improvements again in fiscal '25 and '26. And as we said in Investor Day, we'd expect free cash flow at that time to be up around 75% to 100%.
Cai von Rumohr
Got it. And then basically, if you could give us where are we in terms of meteor and meteorite charges? I guess meteor has been delivered through those charges? Or do we still have exposure?
Patrick J. Roche
We've made a lot of success, I think, Cai, in reducing the risk on those programs. As we said -- as I mentioned in my notes on the call, 3 of the units, the first -- sorry, 4 of the units, the first 4 meteorite units have shipped to the customer. They've been integrated with the customer's hardware, they've been tested, they're subject to environmental testing, and they're ready for launch. So that's a really positive step forward. So the risk is burned down significantly in those programs.
We haven't yet shipped a meteor satellite to the customer. They are in developments and finalization. I think it will be sometime during next year that we deliver a meteor satellite to a customer. There are some further deliveries of meteorite. I think there's another 3 units have been delivered to our customer site.
So my summary is that we're making good progress with it, Cai. We've more and more hardware shipping through. There is still some development work ongoing. So you can say, yes, there still remains some risk, but we're not anticipating any charges.
Cai von Rumohr
Good. And I guess the last 2. First, can you give us any color in terms of the quarterly rollout of earnings over the year. And maybe on the industrial, you're looking for a big dip in industrial automation. How much of that is the divestitures? And how much of that is just the business softening?
Patrick J. Roche
The Luxembourg entities that we're looking to divest is about $15 million of revenue in total. So that's and maybe helps you characterize the piece that's being taken out of the business. We are expecting a slowdown in the industrial automation business. We've sort of signposted it for a while now that the economies are slowing down. And Germany has seen 2 quarters of basically stagnant economic growth. And so we've built that into our plans for the year. I mean, we've already -- we took some restructuring charges in this quarter. That's sort of getting ahead of that contraction in business that we're showing here, and that's what helps us maintain our profitability through the year in the industrial side.
Jennifer Walter
The other thing is that we will -- we've had nice margin expansion from pricing in Industrial during FY '23. We're going to build on that going into '24 as well.
Cai von Rumohr
I mean you have the sales down. Usually, you don't account for divestiture until it's done. So have you -- is the 50 -- is your guide assume the $15 million or the $15 million from Luxembourg will take it down even further.
Jennifer Walter
It Is only in for a short period at the beginning of the year, Cai.
Patrick J. Roche
We have it in for a quarter out of the 4.
Cai von Rumohr
Okay. And the quarterly pattern, what are you looking for in the first quarter? What sort of a range?
Jennifer Walter
So in the first quarter, we're looking for $1.45 plus or minus 10%. So it's a little bit of a slower start. We've seen that in other first quarters as well. And so that's what our numbers are telling us, and we'll share more on the second quarter as we get into the first quarter.
Operator
And we have a question coming from Michael Ciarmoli with Truist Securities.
Michael Frank Ciarmoli
Real nice results. Pat or Jennifer, just -- can you give us any sense as to what the pricing true-up in commercial was in the quarter? I was thinking maybe $6 million ballpark or so? I'm just trying to get a sense of what the underlying margins are looking like in '24. Obviously, you've got that big bump here in the fourth quarter.
Jennifer Walter
Yes. So when you look at '24, you see that our commercial margin is down because we don't have that true-up. So that is actually making up for a large portion of that.
Patrick J. Roche
And there's less aftermarket in '24 as well, and the aftermarket has got good margins. So it's a mix shift as well, Michael.
Michael Frank Ciarmoli
Okay. What was it about -- was it in that $6 million range that you took retroactively in the quarter, just so we can kind of do some rough math on it into next year?
Patrick J. Roche
We've only a limited number of customers there, Michael. It's gotten too sensitive to be giving our actual numbers. Sorry.
Michael Frank Ciarmoli
Fair enough. Got it. And then, same thing for aftermarket, I guess, good year, tough comps, you're selling some lines there. Are you seeing any changes with the underlying trends on an apples-to-apples to business is that you're keeping?
Jennifer Walter
For the commercial aftermarket?
Michael Frank Ciarmoli
Commercial -- commercial aftermarket, yes.
Jennifer Walter
Yes. So that business, we definitely had so many specials that came in. You remember that we had specials in FY '22 and a bunch of those actually continued into '23 as well. The one part that we've seen growth in the underlying business is on the A350. And that's happened over the past few quarters. So we're still seeing that continue to grow. But most of the underlying business, I would characterize as stable with maybe that one exception.
And then you've got the noise, the very positive noise that we experienced in '23 associated with certain initiatives and activities that we've had on platforms that are not of a recurring kind of constant base, as well as exiting some work that we were able to sell some nice inventory outcome. So I consider it, it's stable, but there are certain elements that are growing on somewhat.
Patrick J. Roche
And I'd agree with Jennifer's comments. I mean flight hours and fleet utilization are high again. And that's the stable part of it that's driving more business into us on the aftermarket side and the absence of the specialists that really reflected in the reduction.
Michael Frank Ciarmoli
Got it. And then just back to Cai, if we take one more shot at modest cash flow. I mean the puts and takes as we can look at net income, D&A up a little bit. CapEx, it sounds like inventory still builds. I mean, it's modest $25 million. Is that kind of how we -- and I know it's consistent with what you guys called out at the Investor Day, but is that the general direction? Or is there a bigger sort of advanced repayment receivables headwind.
Jennifer Walter
Yes. The biggest thing that's going to happen is going to be the change in the physical inventories because we grew so much. As you saw during the year, we had such wide variation in our cash flows. And even this quarter, we came in higher than we were anticipating. So the timing of these things just have -- can have some decent size variability, and that's why we've limited to just saying modest. It will be cash flow -- it's not looking at $2 million of cash flow or something just close to 0, but we're not at the robust level that we'll ultimately get back to either.
The big driver is going to be really in the physical inventories. We're seeing that utilization internally come through. And that feels like we're in great shape. What's happening there is there's more of the training that's happening that's getting through in our throughput. And so that's actually helping. We don't have as much turnover where we need to have more folks go through training where they've got those hours that are not efficient in it.
So that's definitely turning. What happens in supply chain. We saw some good news this quarter. We'll have to see how that actually comes. That's the variable that we've got with us. But we're projecting right now to be at the level of growth that we had in the fourth quarter, which was quite low compared to where it was in the first 3 quarters of the year. So that's where we are on projecting that. We'll have free cash flow generation, but we're also mindful that we're growing the business as well.
Michael Frank Ciarmoli
Got it. Got it. And then last one for me. I think, Pat, you made and Jennifer made a lot of comments, a lot of different markets. I didn't really hear much on medical. It looks like it's only going to be up about 1%. Any kind of simplification, restructuring, pricing? Anything that you can say in sort of that market in terms of what's happening '23 to '24.
Patrick J. Roche
Yes. There was some realignment going on within the market with some of the distribution channels changing during the course of '23, Michael. That resulted in some flow-through of our flushing through of inventory that was in the system, and so that caused a reduction in demand on us. That's partial part of the picture that's still normalizing. That's the main thing that's going on, some changes in the market dynamics. Yes, let me stop there.
Operator
(Operator Instructions). Our next question coming from Kristine Liwag with Morgan Stanley.
Unidentified Analyst
This is Justin on for Kristine. You mentioned that defense is now half of the book of business. I was just hoping you could touch on maybe how you're thinking about the defense budget environment and sort of what are the baseline assumptions that underpin the outlook for next year? And what sort of maybe scenario planning you're doing given the sort of range of potential outcomes?
Patrick J. Roche
Audio broke up slightly when you started the question, but I think it's around the defense budgeting for next year and is there going to be any impact if there let us say, or delays in Congress or delays in continuing resolutions. And if that was the question, Justin. We're not expecting any impact on our business next year as a result of that. That will be a transient thing that will get resolved, but it won't affect the programs that are actually running in our facilities at this time.
Unidentified Analyst
Okay. Perfect. And just maybe back on the margin guide for '24. Is there a way to parse out sort of how much lift is coming from the pricing initiatives versus the simplification efforts?
Patrick J. Roche
We haven't split that out, Justin, in detail. What we did say during the Investor Day was that the pricing activity will be coming in stronger at the front half of our program over the 3 years and the simplification activities would flow through in the latter part of the 3-year period. They take a little bit more time to execute and therefore, you see the benefit of them further downstream. So what you're seeing today and in the last 6 months or so, feeding through an industrial and aircraft group is predominantly coming from pricing activity.
Operator
There are no additional questions in the queue. I'll turn it back to you, Pat, for any closing remarks.
Patrick J. Roche
So thanks, everyone, for attending the call. I think we had an outstanding quarter. We're really pleased with the progress we're making on our journey, and we look forward to reporting further progress in the Q1 call, which will be my fifth earnings call. Thank you very much. Bye now.
Operator
This concludes today's call. Thank you for your participation. You may now disconnect.
