Q2 2020 Earnings Call
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[noise]. Good morning, Thank you and welcome to try and find fiscal 2020 earnings conference call. Presenting this morning are Trans am executive Chairman, Nick How we President Chief Executive Officer, Kevin Stein Chief Financial Officer. My question. Please visit our website at Transdigm dotcom to obtain a supplemental.
That's right that and co replay information.
Before we begin we'd like to remind you that statements made during this call which are not historical impacts are forward looking statements for further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward looking statements. Please refer to the company's latest filings with the FCC available through the.
The Investor section of our website FCC Dot Gov.
We would also like to advise you that during the course of recall, we will be referring to EBITDA specifically if it does the fine adjusted net income and adjusted earnings per share all of which are non-GAAP financial measures. We see the table unrelated footnotes in the earnings release for presentation of the most directly comparable GAAP measures and applicable.
Reconciliation, but then I'll now turn the call over to Nick Good morning, and thanks, everyone for cooling.
Today I'll start off with some comments as usual about were consistent strategy.
[music] then quickly got little on the last quarter, an overview of our efforts with respect to the Kobin 19, and the related market.
Deterioration and some short comments on capital allocation not covered in my school in a standalone most of these to reiterate.
We believe we are unique in the industry and book the consistency of our strategy is good and bad times as well as our ability to create and protect intrinsic shareholder value through all phases of the aerospace cycle.
Summarize some of the reasons why we believe this about 90% of on net sales were generated by proprietary products and over three quarters of Ornette sales come from products for which we believe we all the sole source provider.
Most of our EBIT da comes from aftermarket revenues, which typically have significantly higher margins and over any extended periods of time provide relative stability in the downturn.
The commercial aftermarket in the commercial aftermarket the largest and most profitable portion of our aftermarket demand appears likely to drop very shortly.
It just happened during other severe shock. However in this unique circumstance it could likely take longer to recover simply stated our commercial aftermarket we'd start to recover much.
Until people start to fly again.
Our longstanding goal is to give our shareholders private equity like returns with the liquidity of a public market to do this we have to stay focused on both the details of value creation as well as careful allocation of our capital.
We follow a consistent long term strategy, specifically, we own and operate proprietary aerospace business is significant aftermarket.
We utilize a simple well proven value based off raising methodology in the current situation, we had to move fast to adjust our cost while maintaining the other aspects of our value creation methodology.
We have a decentralized organization structure any unique compensation system closely aligned with shareholders.
We acquire businesses that fit with our strategy and where you see a clear path the P.E. like returns and lastly, our capital structure and allocation or keep for.
Value creation methodology.
As you saw from our press release, we had a solid performance in both the second quarter and the first half from fiscal year 2020 revenues and EBITDA as defined substantially we continue to generate real intrinsic value for our investors.
Unfortunately, this all happens in a different environment, then that would use and thrust upon us and the last 60 days.
Last quarter, we expressed concerns about both the door ability of the commercial aerospace production cycle and the early signs of Pacific Rim Air travel slowing.
As a result, we began to adjust our cost structure down in January and February of this year.
In March it became clear the cobot 19 situation and the related government actions around the world substantially negatively impact the worldwide commercial aerospace business exactly how badly we just keep yet know for sure.
We also can't wait for perfect information, we got moving fast and we will just as the situation clarifies.
In addition to safety the two most important items, we focused on immediately were one reduce our cost as quickly as possible and true sure substantial liquidity, if things get worse they might be expected.
To address these first the cost reduction we have significant experience in dealing with severe downturns or process is pretty consistent we make the best estimate we can for a six month run rate.
We then try our best to get our cost down to know the whole the EBITDA as defined margin at that estimated run rate. This is perhaps more difficult than usual now in this situation.
In order to size the organization and our cost structure, we made certain assumptions.
Regarding our major market segments. These are not meant is revenue guidance, we just don't know.
Only a means to size our cost cutting efforts. The only thing I know for sure is that won't be exactly right and we'll have to adjust upward in aggregate I'm hopeful we are appropriately conservative Kevin will explain this in some more detail.
We quickly reduced our cost structure in line with these assumptions most of these actions are in place already.
To remind everyone. These costs are in addition to the cost cuts we made earlier in the second quarter.
We believe we can get cost not ratably with our reduced revenue sizing estimates, we define cost as revenue minus EBIT. The I asked the fun. However, there will likely be a significant mix headwind if the short drop in a hot in the sharp drop in the highway.
Profitable commercial aftermarket continues for the full six months this will make holding the run rate EBITDA has the fine margin in the mid Fortys range.
We think we can come reasonably close to this it'll be hard to get all the way there.
With respect to liquidity liquidity appears to be fine based on any of the market forecast. We've seen we expect run cash positive over any extended period, including covering all required principal interest payments. However, given the substantial market uncertainty we decided to.
Raise additional money and borrowed $1.5 billion in April this new debt has no maintenance covenants and no maturities until 2025.
This new money isn't insurance policy for these uncertain times, it's quite unlikely we needed.
This is a great company with outstanding products to market positions. The only way you get in trouble here is if the situation becomes much worse than anyone expected in your run out fuel or cash we're filling our taxes fools weekend at a reasonable price.
Pro forma for the new debt our cash balance is 4.2 billion has not 328 20 again I doubt, we will need this money, but better safe than sorry in this environment, we hope to come out of this with a lot of firepower.
We continue to look at possible M&A opportunities and are always attentive to our capital allocation, both the M&A world and the capital market world or always difficult to predict, especially today as a general rule, we will tend to be fairly cautious until the smoke clears a little bit.
We have withdrawn or 2020 guidance, there's just too much uncertainty will reinstitute our guidance when we feel we have a clearer picture.
Our fiscal year 2020 started off strong first half was good but the second half will be pretty rocky.
We believe we are about is well positioned as we can be for right now we'll watch from situation develops and react accordingly, now hand this over to Kevin to review, our recent performance and expand on our assumptions and cobot related activities.
Thanks, Nick.
Today I will first provide my regular review of results by key market and profitability of the business for the quarter.
And then cover outlook in some Cupet 19 really the topics.
We're pleased with the solid Q2 results, particularly considering the increasingly difficult global economy and commercial aerospace industry.
In Q2, we saw modest unfavorable impact to our commercial aftermarket and OEM sales for the cold 19 pandemic as approximately the last three weeks of the quarter were negatively impacted the.
Despite these headwinds our second quarter operations, specifically revenue and EBITDA as defined expanded compared to Q2 last year due in part to positive organic growth as well as continued acquisition integration and our announced preemptive cost reduction actions Q2, GAAP revenues were up approximately 24% versus.
Prior year, Q2, and EBITDA as defined was up 19% versus prior year with margins approaching 47% of revenue Mike will provide more details on the financials later.
Now we will review our revenues by market category for the remainder of the call I will provide color commentary on a pro forma basis compared to the prior year period in 2019 that is assuming we own the same mix of businesses in both periods.
Please note that this market analysis discussion includes the results of the former Esterline businesses. We begin to include Esterline in this market analysis discussion in the first quarter fiscal 2020.
In the commercial market, which makes up close to 65% of our revenue we will split our discussion into OEM and aftermarket our total commercial OEM market revenue declined approximately 3% in Q2, when compared with Q2 fiscal year 2019, the decline in the core did reflect the minimal headwind from the impact.
After the ongoing 737, Max production halt and early OEM declines related to the pandemic.
It is already clear that the cold at 19 pandemic will have a significant negative impact on the commercial OEM market. We are under the assumption that the demand for commercial OEM products will be significantly reduce during the second half of fiscal 2020 due to reductions in OEM production rates.
And airlines deferring or canceling new aircraft orders longer term the impact of Cobot 19 is fluid and continues to evolve.
But we anticipate significant negative negative impacts on our commercial OEM market for some uncertain period of time.
Now moving onto our commercial aftermarket business discussion.
Total commercial aftermarket revenues grew by approximately 1% over the prior year quarter.
In the quarter flat commercial transport aftermarket.
Oh was driven by stronger growth in passenger and interior submarkets offset by a decline in the commercial transport freight market.
Our quarterly commercial aftermarket bookings were down over 10% versus prior year quarter. Most of the decline came in March of this year, but likely does not paint the correct picture for the remainder of the fiscal year as we expect a sharper decline in the second half.
There was a rapid Andrew dramatic decline in demand for air travel during our Q2 as global restrictions on business and shelter in place orders went into effect in response to cope with 19. This led to a significant reduction in global flight capacity and parked aircraft across the world.
He had a few of these points global revenue passenger miles or at unprecedented lows as a result of the cobot 19 pandemic.
Got a recently forecast the 48% decrease in revenue passenger miles in calendar year 2020 compared to 2019.
For cargo demand this was already weaker prior to the cool with 19 crisis as F. Teekays have declined from reaching an all time high in 2017.
However, a loss of passenger belly cargo due to covert 19 fleet restrictions could provide some unexpected opportunities.
Business jet utilization data was already pointing to stagnant growth before this economic downturn. So no. During this pandemic and in the aftermath the outlook for business Jets is more unpredictable and certainly weaker.
As the Cobot 19 situation is ongoing the duration and severity of the pandemic are still unclear and long term impacts for the commercial aftermarket are hard to predict.
Now, let me speak about our defense market, which is just over 35% of our total revenue.
The defense market, which includes both OEM and aftermarket revenues was about flat compared to the prior year Q2.
As a reminder, we're lapping tougher prior year comparisons as our defense revenue accelerated in most of fiscal 2019.
Year to date defense bookings have surpassed our expectations driven primarily by very robust defense OEM booking growth total defense bookings have solidly outpaced year to date sales, although bookings grew across most of the businesses it be kws and parachute related bookings were especially strong in the core.
Sure.
With continued good order flow in defense, we anticipate any favorable trends in immediate future will come from this segment.
Now moving to profitability I'm going to talk primarily about our operating performance for EBITDA as defined.
EBITDA as defined of about 675 million for Q2 was up 19% versus prior Q2.
EBITDA as defined margin in the quarter was just under 47% our EBITDA as defined margin expanded both sequentially and over the prior year period as a result, our cost mitigation efforts any consistent focus on our operating strategy, excluding esterline margins in our legacy business improves both sequentially.
As well as over the prior year quarter.
I'd Esterline, we're now over a year post close the integration continues to progress and to date. The acquisition is exceeding our expectations for growth in this largest of transdigm acquisitions.
As we've stated in the past, we will no longer refer to any esterline specific metrics as these businesses have now become part of the fabric of Transdigm.
Now moving to second half 2020.
In light of the uncertainty around the ultimate impact of Cobot 19 on global market and economic conditions and the highly fluid commercial aerospace industry. We still feel it is too early to provide forward looking guidance at the current time.
As Nick said once we have a better picture will reinstitute guidance. However, I wanted to provide a bit more detail on the end market conditions, we assumed for the second half of our fiscal 2020. This is not guidance. We always have a bias to act quickly and right size the cost structure when required when completing the organization.
National Rightsizing analysis that drove the reduction in force levels implemented to date, we assumed the following with regard to the organization sizing needs for the second half of fiscal 2020, again organization sizing commercial aftermarket declines of approximately 70% to 80% commercial OE declines.
25% to 40%.
And defense growth in the mid single digit which is in line with our prior guidance for the defense end market.
Next I would like to review, our Cobot 19 response and expectations in more detail.
As mentioned, we currently expect cobot 19 to have a significant adverse impact on our sales EBITDA as defined as net income for the second half of fiscal 2020 under the assumption that the cobot 19 outbreak will negatively impact our nondefense come customers and their demand for our products and services during the second half fiscal 2020.
Particularly in the commercial aftermarket.
As Nick said earlier, we remain confident in our business model over the long term and are focused on mitigating the impact of cobot 19 to our business, while supporting customers and employees.
Since the early days of the outbreak we have been following guidance from the World Health organization and the U.S. Center for disease control to protect employees and prevent the spread of the virus when within all of our facilities globally.
Some of the actions implemented include flux flexible work from home scheduling alternate ship schedules pre shift temperature screenings were allowed by law, social distancing appropriate pp facility deep cleaning and paid quarantine time for impacted employees.
Most of our facilities remain in operation, even if some are operating at reduced levels as they are deemed essential businesses by government entities. Since we are the sole provider for many programs, including critical defense platforms. We are committed to preserving the health and safety our employees, while continuing to meet our customer commitments.
In an effort to assist in the fight against Cobot 19, certain of our businesses have begun producing medical equipment that is critically needed during the global pandemic, our MCV restraints business is producing respirators and surgical gowns, well Mason is producing face shields, we're grateful for this.
Ability to contribute to the fight against called at 19.
Now before we move to specific cost cutting measures met measures that Nick mentioned it is important to understand that we view it very high percent of our costs as variable.
[noise] costs, meaning revenue less EBIT da.
Roughly half of our spending is related to materials, including production materials or subcontractor services that our production related including plating painting machining.
Those costs should largely flux with volumes.
The next big bucket is people and benefits or direct items related to employment and is more than one third but less than 40% of our costs and the remaining 10% to 15% of costs include all other.
We monitor these cost closely and as such let me highlight some specific cost savings actions. We've taken in response to the reduced demand and uncertainty, resulting from the cobot 19 pandemic.
[noise] these cost mitigate mitigation efforts were previously the scope disclose but worth reviewing.
An additional reduction enforced to align operations with customer demand.
These actions are incremental to the cost mitigation efforts previously implemented in the second quarter fiscal 2020, mainly in response to 737 Max production rate changes.
And brings our total workforce reduction since our last earnings call to approximately 22%, 25% versus planned headcount levels.
Furloughs, we're implementing one to eight week furloughs that many businesses over the next six months in response to specific situations.
Subs in the substantially reducing cash compensation for the senior management team for the balance of fiscal 2020, and the board of directors will forego their annual retainer fees, we will continue to Vigilantly monitor our operations and external events and keep the market updated on developments as appropriate.
Excuse me so let me conclude by stating I am pleased with the speed at which translated as responded to the cubit 19 pandemic.
Taking immediate actions to protect employees from the spread to the virus will also dealing with the harsh reality confronting the broader commercial aerospace industry in the near term.
While the actions that the current circumstances require ranging from broad cost reductions to furloughs and a rightsizing of the employee base are difficult to implement I have no doubt that we will better position the company to endure and emerge more strongly from the ongoing weakness in our primary commercial end markets with that.
Now I'll turn it over to our Chief Financial Officer, Michael This morning, everyone I'm not going to elaborate on the results for the quarter any further as you can see the details in the press release on sales EBITDA as defined and adjusted EPS growth.
Just quickly one a highlight the updates on interest expense and then tax rates included in the call slides for today.
Interest expense will pick up slightly due to the new debt issuance, but it's partially mitigated by the decline in expected average LIBOR or for the balance of our fiscal year on taxes, our fiscal 2020 gap cash and adjusted tax rate will be three to eight percentage points lower than the pre.
This guidance due to benefits included in the cares Act primarily the expansion in the interest deduction limitation from 30% of EBITDA to 50% of EBITDA.
Moving over to the balance sheet and liquidity as of second quarter end, our net debt to EBITDA ratio stood at 5.9 times.
On the recent debt issuances, Nick mentioned, our thinking here. The 1.5 billion of debt is basically an insurance policy and while the interest rates were slightly higher than we would like to quick points worth mentioning the after tax rates look better due to the interest deduction limit expansion included in the carriers Act and then.
Second the terms on the debt are such that we can repay it or refinance it in two to three years without too much penalty should we decide that that's the best use of capital at that point in time.
While there is of substantial uncertainty in our commercial end markets right now we do expect to run free cash flow positive for the back half of the fiscal year under the sizing assumptions the Kevin described in detail.
From an overall cash liquidity in balance sheet standpoint, we think we're in good position here, we have a sizable 4.2 billion dollar cash reserve and we don't face any big debt maturities until July of 2024, So 50 months from now.
We expect that the commercial aerospace industry will find its footing before then.
With that I'll turn it back to the operator to kick off in Q on that.
Thank you and at this time to your question. Please press star one on your telephone keypad.
Star one to ask a question. Your first question comes line of Carter Cofield, Okay.
Research.
I go by Cofield too that's fine Hey, guys, how did everybody hope you'll know.
There could be anything you want I answered a lots of things just.
Couple of questions for you guys one.
The mix of products and platforms I got on the back end of this crisis you know what what do you foresee in terms of the impact.
On the business I realize we're kind of unprecedented we're going to take several platforms.
Effectively out of service at this point and so.
Is there some offset there from shutting particular product lines or what not anything you can can do to help us understand that would be appreciated.
So this is related to.
A market leading a we believe were market weighted across our business in the the platforms that we support so we're not over exposed to any one platform or other obviously as a planes get older as platforms get older. They do become slightly more profitable.
Overtime as we've been able to work our.
Value drivers on them, but since we think of ourselves as market weighted we're not a you know as concerned right now we'll have to see how this plays out.
Right now it's all speculation our plan in this Carter is to follow the revenue stream closely look at the order book and react accordingly, as aggressively as quickly as possible. The speculation side of this is always hard for us to to rationalize but again, we believe we are market.
Weighted were distributed across the platforms that are sold in use today and not over exposed to any one certainly there's going to be some impact in the future, but we're just going to have the way that as it comes about.
Okay. That's great and then just as a quick follow up.
The comment on.
M&A and Nick you alluded towards waiting till the dust settles, but I just find myself wondering I Miss in this scenario if there are.
Small opportunities that pop up before the dust settles how.
You'd be thinking about those then and if you compare this to the prior downturns, we've gone through what's the.
And what's the thought process how does this normally go thanks, Yeah, I'll I'll address that a couple of ways. One I, we're not out of the business, but I think we'd have to say that we're going to be were more cautious now than we would have been six months or no.
No, we're probably a little more skeptical any valuation someone would come up with.
[music].
But we're not but we're not shutdown word we aren't absolutely cautious here for awhile.
I would say in the past.
Corner, you know, we buy as you know, we buy good businesses and try and make our we good we typically don't buy fixer uppers aura were in our bad businesses were looking for proprietary stop with a fair amount aftermarket generally people don't sell that kind of stop and depressed times because it's not.
Hi, if you if you stay alert every now and then you might be able to pick one off but it's it's.
It's unusual because of the things we buy.
Okay. Thanks, guys.
Your next question comes line of Noah Poponak of Goldman Sachs.
Hey, Hey, everybody good morning.
Morning morning.
Do you have the number on how much youre commercial aerospace aftermarket revenues declined in April versus April of last year.
We did look at that and what I'll tell you is that I think it it aligns with our sizing assumptions for that one month period now one one month does not six months make so we'll have to keep a close eye on it but it aligns more or less with our sizing assumptions.
And the only thing I'd add to that is I think it was clear, but in Kevin sizing of 70, 870, 80% down and the commercial aftermarket, we're assuming that stays that way for six months, which we hope is a.
Hey.
Very conservative assumption right that but that's what we're using for sort of our sizing in cost planning for right now.
That's helpful. Just I'm just kind of staying on Carter's question on.
The question, we're hearing most frequently from from investors is.
If the makeup of the fleet when the dust has settled here is going to decline in age significantly as older aircraft are retired.
What's the impact to transact and Kevin understanding that your answer there is your your market weighted I'm, assuming you're you're kind of market weighted on units, but I don't know if you if you'd be willing to quantify even if a rough order of magnitude what percentage of your aftermarket revenues come from.
2020 year or older airplanes, and then also if you'd even give us some direction on how much higher the margins are in that order bracket versus your average aerospace aftermarket.
The only thing I would say about older products is they're slightly more profitable it's not like it's a while difference.
I do believe were market weighted on this I don't believe were over exposed to any platform products certainly.
MD Eightys, we might expect will go away.
That is going to have a small impact to us of course.
But we think that it's weighted by the markets theres not that many of them out there.
That's our answer today on this we just need to keep watching.
The the best thing you can use to analyze the market is the order stream coming in and that's what we need to follow closely and to ensure we are getting ahead of the cost side as well as where theres opportunity.
For additional sales where theres opportunity.
Both on the defense and in the commercial space there are still opportunities that you need to capitalize on.
That's helpful. I'm, just going to sneak in one last one Nick on on the effort to hold the EBITDA as defined margin.
Somewhere in the zone of are you had it in the first half.
Understanding that.
It's a difficult house with how quickly things are moving but you have tried to match the cost of the revenue.
Im hearing you talked about that proving harder than than prior downturns.
[music].
Do you steer foresee a scenario where your EBITDA margin gets a three handle on it in any of the next four quarters are we talking more you know a couple of hundred basis points of potential deterioration I don't want to speculate on that I would hope not.
But I don't want to spicy you know the problem is the math is obvious if you're if you're a revenue drops.
You know X percent and you take X out of the costs everything works as long as your mix stays the same typically in a downturn. What has happened is you had a much sharper drop in the OEM than you did in the aftermarket so that was up.
And that tough job.
Because you've got you've got a little tailwind from the mix here you got a headwind.
Which makes it harder.
We look at the EBITDA margins is kind of run in the mid Fortys.
I would.
I say I would hope we could come reasonably close to that which I'm I'm hopeful that means we could stay in the 49 hope a little more than just over the edge.
But that's going to be very dependent.
On the duration and the depth of the aftermarket drop.
People need to start trying again people got to start again until they start again this will be top.
Sounds like you have a process to stay there, but just with a high degree of uncertainty relative to everything that's right subject. That's right in the problem is the map of the very sharp aftermarket drop.
Yes.
Okay I appreciate it thanks, so much.
Your next question Robert Spingarn of Credit Suisse.
Hey, good morning, good morning.
Just wanted to ask you Nick or Kevin.
On the just sticking with this topic, but in terms of.
The kind of exposure that you have to used serviceable material. So I know you do some consumables are expandable when you think of your commercial.
Aftermarket portfolio.
What portion of that is not exposed to USM versus what is.
So we analyze this a couple of years ago.
And we found its hard to see any areas, where USM was a.
A real concern a drag on revenue or growth.
Certainly there may be some spots of part number here or there, but broadly speaking we did not see USM as a a real competitor to our aftermarket business. We've looked at USM. Since then regularly we've looked at buying parts a out of the.
Used and serviceable market and we've not seen that theres much available out there or much we can do to impact that market. So.
We've heard the same concern that as planes are retired more of them will be put into the USM market will be parted out.
It's possible, we haven't seen that as a large drag on our revenue historically, it's something we've talked to all of our teams about to make sure that they're looking for these opportunities or looking for inventory of their parts out there.
And we'll have to carefully watch that again, historically USM not a big concern.
I don't know if it will morph into that today generally speaking what we have analyzed this and what we've heard from the market five to $10000 and needs to be the average sale price most of our parts the lions share of our parts of fall well below that I.
I believe we've communicated prior that above thousand dollar average sale price at least a couple of years ago. It.
It just puts our parts not in the USM available market generally speaking so it's something we will watch closely but right now.
I'm not as concerned about the parting out of planes impacting us that may happen and we will have to react to it.
Just staying on this for second is there a way to think about your exposure or your parts with regard to ABCD checks do you have you ever looked at that.
Are you more heavy checks are you there.
The the more routine frequent checks that.
Yes, we're we're really all over the place some of our parts.
You know get replaced by time on wing others. Its number of cycles others. It's like seat belts are passenger related passenger volume related not takeoff and landing. So we've looked at this across the board and not really seen a or not.
Really seen any any trends.
But we need to exploits or there's an opportunity to.
Okay. Thanks, Kevin.
Your next question.
Yes.
Thanks, Good morning.
Maybe a clarification and then a kind of bigger level question. The clarification is that the organic growth of 5% in the pro forma end markets connect derived to something closer to flat and so is that some mortgage at the esterline.
[noise] mic or sales.
Dynamic, maybe a little bit lower than the legacy.
Transdigm activity and then the bigger question is as you're entering the downturn at the end markets. How is esterline performing adapting how are those businesses performing adapting relative to your legacy transdigm businesses and are they kind of fitting into the same old.
Nick or Kevin as you kind of look to adapt to these new volume levels. Thanks.
So Michael handle the pro forma organic growth question, and then I can handle the second part.
A mild on the organic growth it is.
It's obviously a little confusing how you could do the computation this quarter, just because esterline closed mid quarter last year. So there are different approaches you could take you could put esterline completely in you could take it completely out or you could allocate it based on the number of weeks owned the punch line is depending on however, you do it the organic growth comes out.
Somewhere between 1%, 5%, we did it based on number of weeks owned and what will but we'll do in the 10-Q filing you will see the detail we provided enough detail. So that you guys can hopefully read through it and then do the computation. However, you want but at the end of the day, you get something between one and 5% dependent on the approach you take.
And it's just it's a little muddy because of the.
How the acquisition date fell on esterline.
Thanks safe to say it isn't materially different it's not materially different from for other business.
Okay as far as as Esterline performance goes.
Much like first quarter Esterline performed very well in the across the board really but certainly on the aftermarket side. They performed well. So I think they are fitting into the general performance a window of our legacy businesses as they should there sort of products that fit the same way.
All those the rest of Transdigm so.
They are performing very well in the market.
And there are adapting from your cost structure, yes, yes.
Okay. Thank you say that push it again can you say that I just want to make sure there they're able to adapt to the same kind of quickly moving cost structure that the legacy translates they are.
And we Oh, we have.
Gone too.
Gone to them and asked for head count reductions and furloughs and cost containment and they've been able to respond just like the rest of our businesses. So they yes, they're very much in tune to what needs to be done they're seeing the same.
Market.
Dynamics as our legacy business.
Great. Thanks.
Next question.
Okay.
Mr. Cano are you there.
I think he is not.
Alan is okay.
Your next question comes line of David Strauss of Barclays.
Thanks, Good morning, everyone one corner.
Wanted to ask about work working capital I mean, you talked about remaining free cash flow positive in the back half of the year, but how do you. Mike I guess is for you. How do you think working capital movements, just thinking receivables payables and inventory levels.
Yep, well over a longer period of time, we do expect.
Some cash to come out of it.
But we don't count on it so when we do the downside financial.
Modeling assumptions.
We don't count on any immediate inflow positive inflow from a downturn in working capital whether its accounts receivable or inventory are stretching out your payables.
As this goes on for a longer period of time, maybe six months nine months with expected to be more of a source of cash, but thats not what is driving.
The assumption of positive free cash flow in the back half of our fiscal year.
I would just add like our other assumptions, we think thats, a conservative assumption, but we don't want to yeah, we own acute ourselves here, but I would say Mike got out really early in this whole process and.
Talking to the controllers and our businesses about watching Aer and ATP closely on these to ensure we didnt get over extended and debts or in the basically extending credit to folks.
And operationally, we're managing our inventory.
We're looking at this very closely as Mike was alluding to its going to take a little while.
For us to impact these and start bringing them down you need production levels to bring inventory down and it will happen. We're working on shutting off all the incoming taps and ensuring we're not extending too much credit to airline customers or distribution partners.
Okay.
A follow up question this.
70% assumption that use for for planning purposes, I know, it's not guidance, what how does that compare to what your underlying assumption is for the global capacity decline are you assuming that this 70, 80% is in excess of the underlying global.
Passing declined and then also how you're thinking about pricing for a figure aftermarket business in this environment.
I I, let me try that I would say 70, 80% decline.
And just because I'm sure I'll keep forgetting 17 also talking about 75, because I can remember that it's one them.
I just it's not 75 I'm not sure I, followed your question, but it's not 75% less than.
The capacity decline I mean, we're just if you took the run rate was 100, we think the run rate's going to drop down to 25 right. Yes, that's what we're using firsts for our sizing assumption and we're assuming that's going to stay there for six months.
Which I think is I'm hopeful as conservative.
Surprise me that it could be a little sharper from the first month or so but hopefully it wouldn't last wouldn't last the last six months.
But we'll see I think the market dynamics.
For the shorter supply and demand and switching cost and the like I don't think they change a lot.
The way I address your second part of your question.
I would say on price side, we will still.
Manage our.
Value drivers and what we need to look at or where are the green shoots in the business.
As Asia coming back or they flying in other starting to recover a little bit it's still slow.
As Nick said the the next few months sharp.
Decrease and maybe it comes back a little bit in the following months, that's the way our profile might look like yes, 70, 570% to 80% downturn in the aftermarket side.
Is it.
I was just that you were thinking that your aftermarket business was going to be down in access of the decline in global capacity I would have to say I don't.
We're using the numbers we gave you.
Quite and how to calibrate that against.
Other theres assumptions all over the place on capacity with people make you know we had a set or number of size thats. That's what we used.
Okay fair enough. Thanks.
Your next question comes line of Robert Stallard vertical research.
Thanks, so much good morning, good morning.
I'm going to try and off David's question slightly differently.
Nicole Kevin what's the sort of risk of inventory in the chain beat and raise shops or distribution channels or wherever it might be that that could end up dragging down the aftermarket more than what an airline traffic in capacity is doing.
I'll take a shot at Nick can follow up I think there's clearly inventory in the supply chain, we do not know how much we know a distribution, but we do not know MRO shops airlines and the like or for that matter really what Oems have clearly the inventory overhang concerns us.
And it's something we'll have to watch this is the problem with a downturn like this as you get a little bit of a double hit.
I think given the aftermarket I think people manage our inventory pretty closely but I'm sure. There's inventory out in the field that will need to be accounted for and will be a bit of a double hit as.
We manage through that initially.
The only thing I'd add is just.
I think this right Kevin to strip distribution, where we know the inventory pretty wells about 25% of around yeah. That's right now.
The other 75 is not distribution right. She was a little harder to get you want.
Yes, and then as a follow up and I'm as he said the declines were talking about here pretty much unprecedented abbvie you have been through some previous allied damn sense.
Can you give us some sort of color on the pricing situation LCM I'd say facing bankruptcy and other things here how is your pricing held up in previous experience.
Reasonably well reasonably well no no no.
No significant change.
Right that's great. Thank you very much.
Your next question comes the line of Sheila Kahyaoglu of Jefferies.
Hi, good morning, and thank you everyone for the time, Nick I want to maybe talk about EBITDA margin. You said, you know holding that mid fortys levels pretty tough, but you are aligning 80% of your cost structure. So its variable whether its materials and labor I understand you guys have very high Incrementals, how do we think about that mix impact given commercial is generating 70% of your EBIT.
And I know you just commented on price that it's yeah, you're hoping to get a positive and you've had a positive in past downturns. So I guess, it's all a mix impacts that you're seeing the fee from commercial aftermarket.
Yes, yes, it's very very simply.
You know that set that segment that piece of our business is the highest margin business.
All things being equal if that one drops off more sharply than the and the rest of the business, which is likely the situation here at least for little while.
You know that's a headwind on your margin I think on the cost reduction all things being equal in other words to be kept constant mix.
When you took the revenue minus the EBITDA as defined.
He took that slugger cost I think we can get that down pretty well ratably with the volume assumptions.
Least within the kind of ranges, we're talking about now.
Right.
So all things being equal that would hold your margin, but I think you've got some headwind from this aftermarket being being a sharper downturn.
And now I'm, just make a tougher I think we can get close but I don't know that we can get all the way there right.
Thank God, we think a steady state with this mix of business is somewhere in the mid fortys. Okay that makes sense. So that's why you're not getting 35% margins because of the mix headwind all that cost cutting is getting you somewhere in the low low fortys during the downturn in terms of EBITDA margin I don't know what the 35 means but I think the I'm not quite sure I follow that.
But but anyway I think you've got the got the so yes that makes sense and then just a follow up on my other question a little bit with asked your line is the cost structure. There any different or are you guys have aligned at so it's in line with the trends on average I think it's in line with the average.
I'm sure there's.
Still opportunities for productivity there across the board, but I think it's it's in line Directionally I think those numbers you gave or the overall company numbers yes.
Okay. Thanks, guys.
Your next question comes from Hunter or Keith Wolfe Research.
Thank you good morning.
So think about the commercial aftermarket business is there or what you could help us understand.
Sort of a breakdown of what you view as more discretionary versus directly tied to a flight hours or rpms.
I would say most of our business is tied to flight hours or RPM seek off and landing cycles, I think very very little of our business is truly discretionary I know you can argue that.
Seat belts, maybe slightly because they can maybe you live with them a little longer than they would want to.
Warren a floor tiles and.
Marked walls.
Those are statics and those are part of our schneller and pexco businesses lighting at some of our businesses a bathroom fixtures some of those may be slightly more.
Discretionary that's what we've always said about our aftermarket, but we believe the lions share of it is is dependent on cycles or time.
Or a hours in the air that's what we believe the bulk of our products are so that's why if not much of your aftermarket is discretionary.
We have even small amounts of a flight travel you're still going to get some aftermarket.
That's what we count on.
Got it.
And then Nick you. Obviously every every quarter you can you talk about the beauty the model sole source proprietary the two biggest moats and realize the beauty is how they complement each other but.
It is one of those two.
Maybe a little bit of a de promote through down cycles and over the long term. If you were sort of lean towards one or the other is having a little bit more sort of durability or remote depth.
Which one was a lean towards I don't think you mean proprietary and sole source I don't think suffering from I think there okay I think there interlock.
Okay. Thank you.
Your next question comes line of sight of JP Morgan.
Oh, thanks, very much of the money back.
Hi, good morning.
I just wanted to ask about the.
So the mix shift here.
The defense part of the business still holding off probably.
Hi, with what you expected.
You talked about over 75% of the EBITDA coming from the aftermarket but that includes the the defense aftermarket, which is decent size I've always thought of the defense aftermarket margins being not quite at the level of commercial but still solidly healthy.
You know solidly above the company average and maybe the defense OEM margins BA.
I don't know inline or slightly below the company average, but better that commercial OEM is that not a fair way to think about it.
Yeah, I think Thats, a fair way to think about its a engine and in total we make less money on our defense business than we make on our commercial business and the mix between OEM and aftermarket a little different in defense, but directionally, what you're saying is correct.
Not miles last mile is not yet it's not a lot of big difference.
Okay on a long well quick follow up in terms of just looking at the adjustment.
There in terms of the workforce actions you took in the quarter.
For their severance costs in the quarter and if so where are those in the EBITDA as defined or where they adjusted out it was.
De Minimis this quarter in Q2 in Q3, it will be a larger charge something on the order of.
$40 million to $70 million, a onetime costs, we think and what we'll do is we'll show in the add back table next quarter, but it will be an add back since its onetime nonrecurring costs and the EBIT da Mike.
Complies with our credit Thats right Thats, the EBITDA adjusted EBITDA as defined in our credit agreements that we use.
Gotcha I'll start off.
Your next question comes the line of Peter.
[music].
Yes, Thanks, Nick Kevin Mike.
Just a question or more maybe a clarification sizing that you mentioned.
On the OE, Kevin you said 25 to 40 for the for the second half, but we've got Boeing and Airbus, both kind of talking about rates being down through 2022. How are you thinking about just the OE piece of sizing for the longer term well, obviously when this crystallizes, we will be able to issue guidance.
Around what will happen in 2021, and 2022 right now we're trying to size the business for the next six month period. So that we can attack it and be ready when the volumes and capacity in the like return, which Nick said, we think 18 24 months I think thats, a fair way to low.
Look at it so.
We'll see but that's the way we're looking at it right now.
And just this is a quick follow up just is your.
Thanks for the details on the month of weighted the products is it also similar in terms of your narrow body there since wide body mix.
In terms of what.
In terms of your overall and installed base. When you think about the aftermarket is it similar to 70% more narrow body that wide body or just how should we think about that.
You know we.
Yeah, I don't think we've ever disclose that so I don't know how to think about that.
We.
Wide bodies are important to us they tend to have slightly higher.
Dollar Shipset content split the volume isn't there so again I come back to where market weighted in those.
In the aftermarket and then the OEM side.
So for us to follow the business look at the order book and react that's what we continue to try and do.
I'm not sure I'm answering your question I think that guys as you wrap it up and do the math I think your question you're trying to get it is there some kind of.
Overexposure to wide body production on the OE side and as we do the math, there's there's not that's right.
No I appreciate that thank you I think the best way, though the best way to look at how this.
Business starts to recover is frankly watch the number of flights you know until the flights around the world start to pick up its.
I want to be tough to predict anything you're just guessing anything until it starts app.
Thanks very much.
Your next question comes line of Garden.
[music].
Hey can you guys Jeremy Yeah, we can hear you know, okay, sorry about that technical products.
Hi, Thanks for all the color a lot of the questions I had already been house. The one I guess just a follow up on the OEM discussion Aero OEM.
Can you do you have much of a sense for the level of destocking or inventory in the channel I mean, maybe is there a way to size how many different subcontract manufacturers you guys sell too in the Boeing and Airbus supply chain is it it's a fairly concentrated or is it very diffuse.
In terms I think at the number of depends on business in some business is very concentrated in others, it's very diffuse and we sell to.
So tier twos and and the like.
So it's very diffuse.
And I can't give you any more clarity around that.
Okay and then.
The other thing just I want to make sure. We understand is the commercial Aero OE business profitable it contributes to the 25% of company EBITDA or is it widely skew to the defense side that 25%. So are you asking.
You're talking about the headcount reduction.
No no sorry, the commercial OE business early business.
Im just curious if I can give us a rough sense for how much of the 25% of company EBITDA.
I would attribute.
Following up on specific percentages on profitability by end market, but we can say the commercial OE business as we look at it to the best of our ability to the profitable business.
Well then the aftermarket yes sure.
Yes.
Okay, and then last week.
[music].
Defense business, you talked a little bit about the parachutes and what have you are there any other kind of lumpy orders that are.
For drivers this year that we should be thinking about as we model out next fiscal year has perhaps nonrecurring.
No I don't know of anything Thats nonrecurring that.
The issue with defense is that it often can be nonrecurring, but right now I don't know of any any pieces are parachute business looks like it's well aligned international military sales continue strong.
We haven't really seen any downturn out of any countries around that yet.
So we think of the military is reasonably robust for the next.
Six months to a year.
And then Okay and then we'll see.
The problem with defense is it's lumpy.
And this this quarter, we commented on HCP kws, the a the system turning dumb bombs in the smart bombs.
We sell a lot product to 80 Kws the advanced precision kill weapon system from B.
And that comes in very lumpy orders.
What that something lumpy comes all the time something will become more but we had lumpy orders last year just in different quarters, then we're getting a miss year. So it makes the year over year comparisons bounce all over the but it's much more applicable to bookings and shipments yes, the orders teradyne's won't be the shipments from the ship.
Happens or not loans generally speaking.
That makes sense. Thank you very much guys I appreciate it.
Thank you. Your next question comes from Michael.
Suntrust.
Hey, good morning, guys. Thanks for us sticking around to take a question.
I don't know Knicker, Kevin maybe just back on the Oh, we the down 25 to 40 does that contemplate obviously for the next six months I mean, presumably a contemplates the rate reductions some of the facility shutdowns does it also contemplate.
Inventory de stocking and a realignment of the supply chain units that you guys kind of put your best assumptions in there.
There's a I don't have a lot of I know that theres going to be inventory overhang and we tried to give you a range to to hit that.
So we do have some in there the amounts it's hard to speculate on because we don't know how much inventory is held.
At Boeing or Airbus for instance were not on Min Max but you know been schedules. So I don't know what amount. They have generally speaking in their different products of buckets. So that they buy from us so we.
In looking at this 25% to 40% OEM a reduction in the next six months.
We'll include some of the inventory overhang, but we don't know how much is really there.
I got it I think just to recap just to restate because the obvious.
We can't we can't wait for perfect information here in these situations what we have to do is read everything we can read.
Look at what we got another incoming data.
Some 0.26 stake in the ground and current cost down to that and then watch it as I said in the beginning the only thing I know for sure is will be wrong, and we will have to adjust one way or the owner over the next six months hopefully uplift, but you know I don't know maybe up a little maybe down a little we'll we'll just have to see.
And maybe just one follow up on that Nick the cost out there and thinking about the aftermarket and presumably a year from now we'll have more flying do you envision that the cost actions you've taken I mean, you know or do you do you view. These guys as permanent reductions you know as you know the African I would think it's going to be a couple of years for after.
The market revenues to getting I would say level.
I mean, I don't think our costs are going to stay down by this magnitude as the Costco and always will be incremental flow through the profit.
But I might as has happened in less than previous downturns, we tend to come out of these things with a better cost structure than we went in.
Because we tend to not put cost tracking same rate the revenue coffers.
Okay, that's what I was getting that thanks guys.
Your next question.
Canaccord.
Hi, Kevin Nick and Mike Thanks for thanks for the time.
Morning.
Yeah, I just wanted to ask when traffic starts to stabilize for your commercial aftermarket if I think of that business broadly in sort of three buckets repair spare parts sales and provisioning.
Where do you expect to see the recovery first and how would you expect that to potentially play out.
Yeah I would my guess is it would be in the repair area is where we would see the first.
The first reloading as a there.
Bringing.
Claims that need to be service out to the service line.
That's what my assumption is but we'll have to see provisioning as we've said in the past isn't a huge driver for us for volume, there's certainly some here and there.
On some programs, but I think it's repair spare parts that we would see and I think it's probably going to be the repair Nic do you ever thought on Oh, I mean were apparent spare parts are hard to separate.
Okay and as you look at your aftermarket business, obviously with with crises like this as we start to come through it I'm sure you'll you'll find some opportunities are you are you starting to think differently about the business in terms of maybe the distribution versus direct mixed are you maybe finding opportunities with other partners.
I'd imagine you know an opportunity like this you will as things stabilize the there'll be some ways to maybe shifts summit areas to your advantage, but how are you thinking about that or is it too early to be thinking about those discussions I think it's too early to I think it's too early to draw any conclusions.
I agree completely.
Okay Fair enough and then just just finally for Mike any risk.
Moving forward at all in terms of of impairments on the intangibles, just with some of the dislocation and prices in the marketplace.
No no I think you guys probably saw the require some quarterly test for companies like us and we've done the analysis with our auditors that he why and we've got pretty good cushion across the across the board here.
Great. Thank you.
And there no further questions at this time.
I think that's it I think theres no one else in the queue. So we'd just like to thank you all for calling in this morning and that concludes our call. Thank you. Thank you. Thank you.
Oh, you may now disconnect.