Q4 2020 TransDigm Group Inc Earnings Call
[music].
Good morning, ladies and gentlemen, and welcome to the fourth quarter two thousands rainy Transdigm Group incorporated earnings Conference call. At this time all participants are in a listen only mode. Later, we will conduct a question and answers.
Session and instructions will follow at that time, if anyone should require assistance. During the conference. Please press Star then zero on your Touchtone telephone as a reminder, this conference call is being recorded I would like to turn the conference over to your host Jamie's team and manager Investor.
[music] relations you may begin.
Thank you and welcome to Transdigm fiscal 2024th quarter earnings Conference call presenting on the call. This morning are trends Dimes Executive Chairman, Nick Holly President and Chief Executive Officer, Kevin Stein, and Chief Financial Officer, Mike listening.
Please visit our website at Transdigm dot com to obtain a supplemental slide deck and call replay information before we begin the company would like to remind you that statements made during this call which are not historical in fact 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 investors section of our web site or at <unk> Dot Gov.
The company would also like to advise you that during the course of the call.
Spring to EBITDA specific.
Typically EBITDA as defined adjusted net income and adjusted earnings per share all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and applicable reconciliation I will now turn the call over to Nick Good morning.
Thanks to everyone for calling in.
Usual I'll start off with a quick overview of our strategy.
Summary of a few significant items in the quarter and next year.
And Kevin and Mike will expand and give a little more color.
First I'd like to start here with the short tribute to my original.
Long term business partner Retrans find long term friend, Doug Peacock, Doug passed away. This quarter at 83 years old we worked together for 30 years with various business rolls between us as boss mentor partner adviser long term friends Wi.
We formed the plan for Transdigm and Doug.
Basement outside of Princeton, New Jersey and 1992.
Doug was involved and so almost the end and a participant in almost every major decision along the way.
It's been one how overrides and continues to be done.
Lived good full life will Miss his advice and guidance. He is really key part.
Far more consistent strategy. So it's only right we jump into that next note the remarkable consistency over the last 20 years, Doug has been a key part of that to reiterate we are unique in the industry in both the consistency of our strategy in good and bad times as well as our steady focus.
Just want intrinsic shareholder value creation through all phases of the aerospace cycle.
Our long standing goal is to give our shareholders private equity like returns with the liquidity of a public market to do this we must stay focused on both the details of value creation as wells careful.
Our allocation of our capital.
To summarize here some of the reasons why we believe this about 90% of our net sales are generated by proprietary products and over three quarters of our net sales come from products for which we believe we are the sole source provider most.
Most of our EBITDA comes from.
Aftermarket revenues, which typically have significantly higher margins and over any extended period of time provide relative stability in the downturn.
The commercial aftermarket revenue typically the largest and most profitable portion of our business dropped sharply in Q3.
As we expected due to the steep decline in air travel and though the commercial aftermarket picked up some in Q4 is still off substantially so.
Sharp drops have occurred in the past during severe shocks, though not to this magnitude and likely duration simply stated our commercial aftermarket will.
Recover as people worldwide start to fly more though not necessarily in lock step. This is starting to happen slowly but the rate of recovery has been slowed down by the recent resurgence in coated infections and the timing of the recovery is far from clear.
We follow.
Long term strategy, specifically, we own and operate proprietary aerospace businesses with significant aftermarket content second we utilize a simple well proven value based operating methodology.
Third we have a decentralized organization structure and a unique compensation system.
We are closely aligned with shareholders.
Fourth we acquire businesses that fit the strategy and where we see a clear path to PE like returns and five our capital structure and allocation are a key part of our value creation methodology.
As you saw from our earnings release.
We had a decent performance in Q4, but are still in a very tough commercial aerospace market environment.
On the Mark on the positive side, our revenue and EBITDA as defined were up sequentially that is versus Q3 about.
About 15% and 17% respectively with.
Puts and takes roughly in line with the planning scenario, we used for sizing.
Obviously due to the Cove and impact on flying both are down substantially versus the prior year Q4 turns.
Roughly frame the Q3 and Q4 Q4 revenues combined versus our planning is.
Options the commercial aftermarket wasn't quite as bad the commercial OEM was a little worse in our defense business was not quite as strong due to some Q3 timing issues defense businesses. However were up substantially sequentially that is versus Q3 and up about 7% versus the prior year Q4.
Defense bookings were ahead of shipments for the year.
In addition to safety the two most important items we've focused on.
Continued to be reducing and managing our costs as.
As I've said before Kevin and his team did an outstanding job of reducing the costs quickly are.
Revenues were down in the second half about 30% versus the prior year second half with some additional.
Cost reductions in Q4, our run rate costs are now also down by about the same amount.
The mix impact of low commercial aftermarket revenues continues to impact.
Our margin, but we have been able to mitigate part of this impact.
Second assuring liquidity, we raised an additional $1.5 billion at the beginning of the third quarter. The money was an insurance policy for uncertain times, it's unlikely we will need it but heading into a storm we filled our.
Fuel tanks as follows we could at a reasonable price.
We continued to generate cash in Q4, we generated over two.
$200 million of positive cash flow and closed the quarter with over 4.7 billion cash Mike will give more detail here.
Absent some large additional dislocations or.
Downs, we should come out of this with very substantial firepower.
We continue to look at possible M&A opportunities are always attentive to our allocation.
Both the M&A and capital markets are always difficult to predict but especially so in uncertain times like these acquisition opportunities.
In the last quarter, we're still slow, but we did start to see some modest pickup in activity. We are still actively looking for opportunities that fit our model in general with respect to our capital allocation, we still tend to lean towards caution, but we feel a little more optimistic than we did in Q.
Correct.
We.
Can you to review the esterline portfolio of businesses. We are investigating the sale of a few less proprietary defense businesses that don't fit as well with our consistent long term strategy. If they are are all sold the go forward revenue might decrease by.
By roughly 250 to 300 million.
EBITDA margins on these businesses are significantly lower than our average so the EBITDA impact would not be proportional.
This point I can't speculate if we will sell all these businesses are not but we are actively considering the possibility.
Heading into our new fiscal year.
We will not give 2021 guidance at this time when the smoke clears enough door for us to feel more confidence will reinstate. The guidance. Then we are hopeful that we have bottomed out there were still just too much uncertainty around commercial air travel the recent increases in Covance.
Infection rates timing of vaccine political situation and various related issues in general we are planning to keep very tight control on expenses and hold our organization roughly flat, but it's just too unclear to know exactly at this point.
A few clarifications on.
On some of the 2021 set points in EBITDA margin as defined for next year is dependent on the rate of recovery in the commercial aftermarket revenue among other factors for planning purposes, we are assuming a pickup in the second half of the year given the recent surge in Covance cases in.
The uncertainties I mentioned above we hope and intend to be cautious in our planning, but we just don't know.
Secondly, operating cash flow.
Add is EBITDA minus capex and interest and cash taxes as we traditionally define it is more in the.
A range of 40% plus a little of EBITDA as adjusted this was partially offset by some other conservative assumptions that Mike will review in more detail.
We believe we believe we are about as well positioned as we can be for right now we'll watch the market develop and react accordingly, and now let me hand.
Over to Kevin to review, our recent performance and to talk a little more about 2021.
Thanks, Nick today I will first provide my regular review of results by key markets and profitability of the business for the quarter and then cover fiscal 2021 outlook and some cove at 19 related topics.
Q4 was.
Deselection quarter that closed out our fiscal 2020 against the backdrop of a continued slowdown across the commercial aerospace industry and a difficult global economy. In Q4, we continued to see a significant unfavorable impact on our business from the pandemic as demand for travel has remained depressed just.
Despite these headwinds I am pleased that we were able to achieve a Q4 EBITDA as defined margin of 42.4%, which was a sequential improvement from our Q3 EBITDA as defined margin and in spite of the mix impact of low commercial aftermarket sales.
Achieving this Q4 margin was primarily a result.
Both of our quick preemptive cost reduction actions and continued focus on our operating strategy.
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.
In the commercial market, which typically 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 42% in Q4 and approximately 23% for full year fiscal 2020, when compared with prior.
Prior year periods, a pandemic has caused a significant negative impact on the commercial OEM market. We are under the assumption that demand for our commercial OEM products will continue to be significantly reduced during fiscal 2021 due to reductions at OEM production rates and airlines deferring or cancelling new aircraft.
The orders longer term the impact of COVID-19 is fluid and continues to evolve, but we anticipate significant negative impacts on our commercial OEM end market for some uncertain period of time.
On a positive note. It is encouraging that the Max is moving closer to recertification in several countries, although the near term impact to our business.
We'll likely be minimal given the low build rates.
Now moving to our commercial aftermarket business discussion.
Total commercial aftermarket revenues declined by approximately 50% in Q4 and approximately 22% for full year fiscal 2020, when compared with prior year periods.
In the quarter that.
The decline in the commercial transport aftermarket was primarily driven by decreased demand in the passenger and interior submarkets.
There was also a decline in the commercial transport freight market, but at a less impactful rates.
Our quarterly commercial aftermarket bookings were down in line with the.
Observed revenue passenger miles declines as a result of the decrease in air travel demand and uncertainty surrounding Cove at Q4 did demonstrate sequential bookings improvement although modest.
The decline in demand for air travel began to layer in our Q2 as global restrictions on business and shelter in place orders.
Went into effect in response to the pandemic lists led to a significant reduction in global flight capacity and parked aircraft across the world certain certain markets have reopened while others, particularly international markets remain closed or are enforcing strict quarantines area.
Airlines have added back some flight capacity.
And the and there have been relatively steady increases global passenger travel since its trough in April but has been a slow recovery thus far.
Recent research resurgence of global Cove at 19 cases, and renewed lockdowns in certain countries along with the end of.
Orders summer leisure travel season have also compounded the slow recovery.
Recent vaccine news is certainly encouraging and should drive recovery. However, the timing of vaccine approval in a rollout is still not clear considering these variables the shape and speed of the recovery remains uncertain to touch on a few key.
He points of consideration global revenue passenger miles are still at unprecedented lows, though off of the bottom.
As a result of the pandemic Hi, auto recently forecast the 66% decrease in revenue passenger miles in calendar year 2020, compared with 2019.
Cargo demand was weak.
Weaker prior to COVID-19 crisis as F. Teekays had declined from an all time high in 2017, however, a loss of passenger belly cargo due to flight restrictions and reduce passenger demand has helped cargo operations to be impacted to a lesser extent by COVID-19, then commercial travel.
Business jet utilization data was pointing to stagnant growth before this turn downturn now during the pandemic in the aftermath the outlook for business Jets remains.
Unpredictable as business jet flights are rebounding, but due to personal and leisure travel as opposed to business travel and now that we have exited.
The summer leisure travel season, a faced the winter season, the sustainability of this trend is especially difficult for c. although.
Although the long term impacts of the Pam demagogue hard to predict we do believe the commercial aftermarket will recover.
As long as air traffic continues to improve clearly a cobot vaccine would accelerate thus we've.
I believe the world will once again embrace travel in ever growing numbers, but for now the timing of the recovery is uncertain in the meantime, we will continue to make the necessary business decisions and remain focused on our value drivers now.
Now, let me speak about our defense market, which is typically about 35% of our total revenue.
The defense market, which includes both OEM and aftermarket revenues grew by approximately 7% in Q4 and approximately 1% for full year 2020, when compared with prior year periods. As a reminder, we are lapping tough prior year comparisons our defense revenue accelerated in most of fiscal year 2000.
In 19.
Year to date defense bookings were up high single digits and have solidly outpaced year to date sales.
Sequentially quarterly defense sales grew over 20% quarter to quarter, but as we have said many times defense sales and bookings can be lumpy, we continue to expect our defense.
Business to expand due to the strength of the current order book.
Now moving to profitability I'm going to talk primarily about our operating performance or EBITDA as defined ebay.
EBITDA as defined of about $498 million for Q4 was down 30% versus prior Q4 on a full year basis EBITDA.
As defined was about 2.28 billion down 6% from the prior year.
EBITDA as defined margin in the quarter was approximately 42.4% I'm pleased that admitted disrupted commercial aerospace industry, we were able to expand our EBITDA is defined margin.
By all.
Just a 100 basis points sequentially, we were able to achieve such an EBITDA as defined margin primarily as a result of our stringent cost mitigation efforts and consistent focus on our operating strategy, our COO George valid Doris and really the entire operations and business unit team structure that we have provided.
Strong leadership during this very difficult time.
Now moving to our outlook for 2021 as Nick previously mentioned, we will not provide fiscal 2021 sales EBITDA as defined and net income guidance. At this time, we will look to reinstate guidance when there is less uncertainty and.
So have a clearer picture of the future.
Currently we expect COVID-19 to continue to have a significant adverse impact on our financial results during fiscal 2021 under the assumption that both our commercial OEM and aftermarket customer demand will remain depressed due to lower worldwide air travel although recent.
Recent news of an effective vaccine could impact these assumptions quite favorable.
As for the defense market customer demand here is more stable and we feel comfortable giving some color on expectations. We currently expect defense revenue growth in the low single digit to mid single digit percent range for fiscal two.
2021 versus prior year.
Given the uncertainty in the market channels, we are not providing an expected dollar range for EBITDA as defined for the new fiscal year.
We assume a steady increase in commercial aftermarket revenue going forward and expect full year fiscal 2021, EBITDA margin to be roughly in.
In the area of 44%, which could be higher or lower based on the rate of commercial aftermarket recovery.
Barring any other substantial disruption of the commercial aerospace industry recovery, we anticipate EBITDA margins will move up throughout the year with Q1 being the lowest and sequentially low.
Lower than Q4.
As in past years, with roughly 10% less working days than the subsequent quarters fiscal year 2021, Q1 revenues EBITDA EBITDA margins are anticipated to be lower than the other three quarters of fiscal year 2021, roughly in proportion to the lower working days.
Additionally, as discussed on the Q3 earnings call. Many of our businesses have taken the opportunity to explore new business opportunities by working on developing highly engineered solutions for emerging needs arising from co vid, including anti viral or anti microbial technologies air pure.
Occasion, and touchless technologies to name a few across Transdigm team has in place led by or Jewelries, one of our most experienced executive Vice presidents to help drive this effort and.
Is continuing to look for opportunities and we will update in the future.
Mike will provide detail.
Here's another fiscal 2021 financial assumptions, let me conclude by stating that although fiscal 2020 was a challenging year is a statement to our ability to expertly executed through difficult an unexpected circumstances I'm very pleased with the speed at which trends dime has responded to the unprecedented pandemic.
Taking immediate actions to protect employees from the spread of the virus, while also dealing with the disruption impacting the broader commercial aerospace industry.
There is still much uncertainty about the commercial aerospace market recovery. However, we have a strong tenured management team that continues to remain agile and ray.
Well to act as necessary, we're not taking our foot off the gas. The team is focused on controlling what we can control.
While also monitoring the ongoing developments in the commercial aerospace industry and ensuring that we are ready to respond to the demand as it comes back I have the utmost confidence that through our swift cost.
Ready integration efforts and focus on our operating strategy. The company will emerge more strongly from the ongoing weakness in our primary commercial end markets. We look forward to 2021 and the opportunity to create value for our stakeholders with that I'll hand, it over to our CFO Mike listener.
Good morning, everyone.
So I'm going to quickly hit on a few additional financial matters for the 22000 fiscal year that just completed and then also our expectations for the upcoming fiscal 21.
First for the full 2000 fiscal year, you can see the details on revenue EBITDA and EPS in the press release for today, So I am not going to rehash it on the taxes.
Our flight 20, GAAP and cash rates were about 12% and the adjusted rate was about 19%.
These were both aided by the carriers Act.
On cash and liquidity, we ended the year with approximately 4.7 billion of cash on the balance sheet and our net debt to EBITDA ratio.
The 6.8 times assumed.
Assuming air travel remains depressed this ratio will continue ticking up in the coming quarters as the stronger pre cobot quarters roll out of the LTM EBITDA computation.
Next on the fly 21 expectations, we aren't giving full guidance is Nick and Kevin mentioned.
We highlight quickly just a few additional financial assumptions into.
Interest expense is expected to be in the ballpark of $1.08 billion for the year and this equates to it to a weighted average interest rate of about 5.2%.
On taxes, our 21, GAAP cash and adjusted rates are all anticipated.
At all to be in the range of 18% to 22%.
And on the share count, we expect our weighted average shares outstanding to increase by about $1 million to 58.4 million shares assuming no buybacks occurred during the fiscal year similar to prior years. The increase in the shares outstanding is driven by employee stock options.
Invested at the end of fly 20.
With regard to liquidity and 21, we expect to continue running free cash flow positive throughout the year.
There has been some confusion on the fly 21 cast guide that we gave on the call slides for today. So just a few quick words to hopefully alleviate the confusion.
That we would traditionally define our free cash flow from operations at Transdigm, which is EBITDA as defined less debt interest payments capex and cash taxes. We expect this metric to be in the 800 to 900 million dollar area, maybe a little better during fiscal 2001.
However, the actual cash balances.
And over the course of the year should increase by $400 million to $600 million.
And the actual cash balance growth by less than the free cash flow from operations because it is reduced by term loan amortization paybacks, a potential uptick in net working capital investment assuming we do see a commercial aftermarket uptick late.
Later in the year.
Small product line acquisitions at some of our business units in delayed cash severance payouts related to the Cobi COVID-19 reductions in force and a few of our European op units.
As you know we aim to issue guidance that in time proves to be conservative.
From an overall cash liquidity.
Editing and balance sheet standpoint, we think we remain in good position here and well prepared to withstand the currently depressed commercial environment for quite some time.
With that I'll turn it back to the operator to kick off the queue today.
Ladies and gentlemen, if you have a question at this time. Please press the Star then the number one key on.
Yes, Thats tone telephone if your question has been answered or wish to remove yourself from the queue. Please press the pound key.
Your first question comes from Kristine Liwag of Morgan Stanley You May now ask your question.
Hi, good morning, everyone.
Good morning.
[noise] <unk> with the cost take out that you've done last quarter on SGN <unk> and the repositioning actions you've taken so far can you provide more color about how much of this cost do you think you could keep as volumes recover and ultimately how should we think about incremental margins of aerospace.
Recovers.
I'll take the first I think incremental margins as we guided would we believe they will continue to improve during.
The year.
I think thats important to know puts dependent on aerospace recovery.
And people continue.
Renewing to fly so is there a second wave is that a concern that slows us down I think all of these factors will will weigh in but right now we anticipate things will continue to improve we will make the most I've said this before on our earnings calls and I'll say it again, we will make the most of the opportunity of whatever revenue.
Q.
Comes our way in this.
Lumpy recovery that we're seeing.
And we will make the most of it we just don't see enough visibility yet to give more clarity on the go forward.
Thanks, and maybe one clarifying question.
When you had the 400.
Hundred million plus in cash generation on your slide and then right with the commentary on the 800 to 900 million in fiscal year 21 can you bridge that to what's the difference in the definition of what's on the slide versus your define.
Defined free cash flow.
Yes.
The the disconnect between the.
I.
Actual cash build to the balance sheet of 400 to 600 million versus the cash from ops to have 800 to 900 is just some some assumptions around a couple of different things first just net working capital build we've had a benefit here as cash has come out of working capital has just come out of accounts receivable, but as we go into the recovery.
That's going to go back in and become a source of cash we've baked in some product line acquisitions do at a couple of our op units.
And there is some severance payments that European op units related to the.
The co good reductions in force, where we simply have taken the accrual, but we havent made the cash pay out yet.
Hopefully.
Really all those assumptions in those bridging items.
Prove to be conservative in time.
We think the amount we put into the estimates we provided today is a little conservative, but we'll see.
I think there was also an earlier part of your question, which was about how many heads will we bring back and costs will return.
And I'll I'll say the same points on that so that we've made many times and I think similar to what Nick has said in the past is we will.
Bring heads back as the volume dictates, but in a very reduced manner, we will be.
Stringent on that and.
Sure that we.
Bring cost back in a very slow and timely manner.
So that we don't think let things run away.
And I would think when the dust settles and everything normalizes will likely come out the end of this with an improved cost structure absolutely.
Thank you for the color guys.
Your next question comes from Myles Walton, whether you'd be asking me to ask your questions.
Good morning, this is actually lower federal on for Myles.
Good morning Arnie.
Can you just give us a little bit more of the assumptions you have built into the the 44% EBITDA.
The margin I know you sort of assumes the aftermarket I guess recovery starts in the second half and you've got the low to mid single digit growth in defense.
We are you sort of expecting this minus 40 plus percent to continue through 21 or just any additional color on those assumptions.
Got.
Yes.
I think the key assumptions driving the 44% for the first half of the year, we roughly assume the current environment. So sort of what we've been seeing for the past six months and then we put in a an uptick as Nick mentioned in the back half of of the year. The defense forecast should be as we as we mentioned on the commercial.
Hello, we side, we do expect it to be down for the first two quarters sequentially versus versus last year and the aftermarket as well and then a modest.
A modest uptick in the back half of the year on commercial aftermarket.
I think the best way to follow this is to look at the flight takeoffs and landings and as we've seen them.
Our increase we're at about 50% of where we were globally.
I think thats the way to follow we need people flying we need planes, taking off and landing that's what generates aftermarket content and thats, what we need to follow and right now thats largely plateau in with this.
So second wave, we'll see how this comes.
How this changes over the next couple of months with this.
This the advent of a vaccine.
Okay, Great and then just one quick model is there any backlog amortization expected. This year I think you had 50 million or so.
This year I guess Rick.
Yes.
No I think it's de Minimis. This year that was mainly just from the acquisition of estimated thrown out mountain.
Okay. Thank you.
Your next question comes from Carter Copeland with.
[music].
Neely Melius right research you may ask your.
Understood.
Don't worry that when every day May go yes partner I know, where you work though.
I like it Nick I'm, sorry to hear about sorry to hear about Doug you guys really built something.
Amazing and that said that sadness, so apologies about that but thanks. Thanks a lot.
Kevin I wondered if you.
Like about a couple of things one of them just stocking dynamics, if theres anything unique that.
You're seeing across the product lines or in particular geographies or customer sets just anything to be aware of in terms of.
Inventory in the channel or buying behaviors any anything like that we should be aware of.
Clearly inventory in the channel is something to consider we don't get a lot of visibility on inventory in the channel with OEM partners or airlines. It is a largely unknown. What we do know is our distribution partners and I will tell you that their Pos is running in.
Line with.
Our.
Performance, so they're very much in lockstep and very much in lock step with.
Take off and landing.
So we're seeing that come together.
What was the rest of the question repeat.
Murder.
Just just in terms of both products and geographies if theres anything.
So you have again, we yeah geographies Carter, we don't comment on its hard for us to see geographies.
Anyway, because of the way our products are sold either through Oems are airlines.
Section partners, we don't see much on the geography side I know in talking to our partners in Asia.
The distribution partners there that we have that they're seeing an uptick there seeing more.
Consumption because of the domestic business that has now returned to largely the same.
<unk> internal China flights metrics as before so that continues to be.
Good performance geographically Thats, probably the only color I can give you is that things appear to be improving although.
At a.
A conservative rate there.
I think the lack.
International flight activity is certainly.
Following that business down, but I think the piece we've touched on USM in the past and how that's not a big driver for us.
I think the the only piece you have to keep in mind is the amount of inventory that may be present is dependent on our.
Sales process and philosophy, we do not give volume discounts to the field. So there's going to be less available inventory as some people may give volume discounts. If you buy 100 pieces you might save something we don't do that at.
At all it's one of the things that we.
Yeah look to remove on acquisition, so that's something to keep in mind okay.
Okay, and then just a quick follow up I I think.
You'll be below.
The hurdle for some of the interest deductibility, just given the income I think that implied for next year does that.
Does that put any any emphasis on getting a deal done capital deployment or is it just de minimis any impact.
I think it's de Minimis, we you're right on the math there we are slightly above it.
We got a lot of a benefit just from the cares Act and spent expansion in a deduction to 50%.
The U.S. EBITDA, but I don't think that factors into any of the capital allocation or M&A thinking yes. Okay.
Do you know how we go through a.
At least M&A allocation, you know I I can't imagine that calculation would materially change our return into a true and wouldn't trains judgments on individual businesses.
Okay.
Thanks for the color guys and keep up the good work.
Thanks Carter.
Your next question comes from David Strauss.
Trey seeming to ask a question.
Thanks, Good morning, everyone.
Morning.
So Mike just going back to this cash generation.
Block just to put a finer point on it.
So it looks like working capital was maybe a 200 million or positive. This year are you assuming that that reverses or in a similar fashion next year and then looks.
We're assuming a chunk of it reverses yeah.
If you.
Peel that onion back a little bit you would see.
Accounts receivable was basically a source of cash for us of about 350 million was down 36% or so on the year that was just driven by the commercial end market declines in the fact that we've been driving collections from the customer says is the sales drop provided you keep.
Collecting in 57 days, which is about our average your accounts receivable sort of resets to your current sales level level.
That amount of cash is obviously, when we get back up to.
In the commercial commercial markets fully recover the 350 million is going to have to go back in but.
The pace at which that happens is really uncertain depends how quickly recovery happens.
The quicker it is the sooner we will see that being a source of capital source of cash usage, but we baked in some conservatism here into the forecast because we frankly don't want to give you guys a target doesn't take that.
Taking into consideration and ends up being too high.
And I think.
So assuming it's appropriate we'd love to see the receivables run up because that means the market is picking up right now.
Yeah, I got it and then cash taxes, or maybe 50 100 million iron what does that assume for the payroll tax deferral.
It's going to take care of that next year or is that a beginning yeah. The 22 item.
We'll take care of it this year the cash taxes should be somewhere in the home.
We've modeled that we expect something north of 100 million, but not above $200 million and again it depends on the pace of the recovery. It's just really uncertain, obviously in our deferral.
Forecast.
Okay, and then last one on on leverage.
Yes, Mike you talked about is going to your net leverage will go up here. It looks like it will peak out may be around E con somewhere in that range.
I guess, how are you guys thinking about where where you're where you want your net leverage to be kind of when things start.
We are recovering and get back to normal given we've got an even lower interest rate environment today than when we came into this thanks, yes.
If you look back over the past say three years pretty.
Pre covert our average net debt to EBITDA was about almost exactly 6.0 times I don't think we have any inclination.
And to change that one things reset, it's obviously going to pick up a bit here and your math is correct. What the current we're run rating at slightly over eight times net debt to EBITDA. We're currently at 6.8, because we have to prevent pre covert corridors and the LTM EBITDA computation, but I think coming out of this thing the views.
Use on where we're comfortable operating the business from a leverage standpoint wont change from what you saw three years ago.
That average period pre covance.
Yeah, well aligned that is that you know specific calls on the on capital allocation and leverage levels.
They maybe came around acquisitions.
In opportunities.
As you know if we saw the right opportunity and felt comfortable with the market situation, we'd be willing to give up above that six on a steady state, but generally it then drops back down.
All right thanks very much.
Your next question comes from Raul.
Robert Robert Spingarn with credit Suisse seeming to ask your question Hi.
Hi, good morning.
Morning.
Kevin on the M&A pipeline is it still the way you've described it previously a lot of defense properties against.
No commercial properties, maybe being a bit overpriced.
In this environment and do you think the prospect of maybe better recovery visibility with this vaccine news changes that dynamic at all.
I'll I'll take a crack at that the answer is yes, more defense and we're not seeing quality commercial businesses hardly at all so.
What we tend to be seeing his defense.
And I, just don't know how to speculate but I I would suspect if you start to get a robust recovery people that we've become more willing to sell its just tough to get evaluation around something now right.
Okay and then just.
Anybody's going to like yeah.
Right.
Right and just a it just as a follow up on the defense, what the big sequential growth in it being 43% of of the current.
Sales profile, we know that will change with the recovery, but what are the may and are we I guess.
Growing a bit stronger than aftermarket what are the main platforms that are driving this.
On the on defense side, yes.
Yes.
I think its F 35, I am PK W.U.S. is a major program for us hit several platforms, but beyond that were nicely market weighted to the key opportunities I can hit on a couple.
Have some parachute business here or there a that's important to us, but we're market weighted on platforms, but you know it ticked off to that.
A P kws an F 35 that immediately come to mind.
Okay and Rob as you know we're on we're on most of the fighters most of the operators most of the helmet.
Helicopters, you know across the across sort of the U.S. defense fleet and and many of the European ones.
Yeah, I thought it was interesting, though your comment on OE versus aftermarket so that prompted the question.
Thank you.
Your next question comes from no.
So poponak Goldman Sachs ask your question.
Hi, good morning, everybody good.
Good morning, everyone.
I just wanted to stay on defense actually for a second.
The 2021, it will have a pretty easy comparison, given the below growth rate in 2020.
And you know given an approximation of where your pricing power is in that business.
Maybe low single I think you know units would would have to be negative and just given outlays will still be growing given the easy comp you have there given the pricing power.
How would you get to low single.
Is there any programmatic headwind.
Following up to that last question.
Yes, I would say hopefully we're conservative in our approach we don't know of any headwind necessarily it's interesting that you low you know low growth rate in 2020, but thats.
Historically thats been.
Go right, where we historically, our zero to one or 2% so low.
Low given where we were over the last couple of years, but historically in line. So we don't really see it so low but there is more opportunity as we go into 21, we have a strong order book you saw the way we closed the year with a very strong.
Bookings in the fourth quarter I think we're in a good position. It's just can we get it out and do they want to receive it per the original order schedule.
Okay, I think the OEM business.
Other than inventories switches inventory movements and defense isn't going to change.
Oh, no I assume now on the other hand, the you know the aftermarket business in defense is not booked out.
Yeah, you know you could you could easily see some swings down I wouldn't think it would be dramatic or up.
Up in that I mean, that's where the that's where the movement could be okay.
Okay.
Yeah.
In the arrows in the aerospace business, both both OE and aftermarket.
The first half of 21 of the first two quarters of 21 will still be comping to two to normal times.
Should we think about the sequential revenues in each of those just being reasonably.
Similar to the fourth quarter and therefore, the you know the year over year rates of decline there, maybe a little better, but just kind of similar or is there an inventory component or some other component that would change that significantly.
No inventory components or anything that would change it significantly I think you should.
That we.
We expect in Q1 and Q2 of this fiscal year, some pretty sizable downturn downticks in the revenue.
You know in the upper teens doesn't make a whole narrow because its not because of anything thats changed versus the run rate because the comp is basically the same run rate sequentially. So you just start I think.
The right way to look at it we would hope that it would be up a little bit in the key areas and that's the way we're looking at it but we don't know what up a little bit means.
It's we're just seeing a little bit of increased flight activity and until that crystallizes with vaccine.
It's not going.
To lead to greater aftermarket growth numbers and I think we're very reticent to get out over our skis on forecast as you know historically weve, yes, whether it would be better to plan conservative size Conservative and you can always deal will be upside.
Yeah I mean.
Hopefully in the back half of their there is theres a lot of upside.
Just wanted to make sure there wasn't something that took.
The first half actually down while you know even if the market is just kind of moving sideways. It sounds like there is not.
There are there is there anything that's taking us down, but we're counting on as being the same a little bit better with an uptick in the second half.
And then lastly on the on your margins.
If I look at 2019 if.
If I if I attempt to strip out esterline it looks like the margin ex Esterline was yes.
EBITDA as defined was kind of 50% on the nose.
If I assumed that 2023 revenues matched.
19, I think theres theres reasons, it could be better, but if I just gave you that hypothetical could.
Could the EBITDA margin of the business is it reasonable to assume it's back to that close to 50% on the nose type of EBITDA margin.
I don't know, if we know enough to say that.
If I can take off all of the reasons why.
Might fall short with uncertainty unknowns, but.
I think it's maybe an okay way to look at it that we're still thinking that 2023.
We would see things returning back to normal.
A significant of the weights and normal I'm not sure we're still back all the way to where we were in 19.
I think they'll still be some overhang, but I think there will be a significant uptick between now and then.
And it will be it will be gradual at first then with viral.
Chris or.
Or vaccine I should say I would expect a short change when because there's pent up demand for fly I don't know how else to think about it than that and to keep yourself lean and nimble. So that you can respond to the orders that come in and.
Be prepared.
Paired to bring people back if needed that's the way we're viewing this.
I might take just a little expansion on that no.
I will say again I think fullness of time, we're at steady state again, I think we come out of this with a better cost structure than we went into it we typically don't put back.
Like everything Ratably in the pickup.
So I guess you saw.
Well in general things get better.
And the margin now I guess the crux of your question is do you think you can get all the esterline businesses upper over 50% right. Because that's what you have to do to have that happen then I just.
I'm not sure we're ready to say.
Say that yet.
Yes, I guess, if that's your line is a little short of that depending on mix.
Those are kind of the crush and marks but then the cost structures better. So you're if it's not quite 50, maybe it's probably pretty close to where you get you get you get the point I mean, okay. Okay.
Okay.
Thanks, so much.
Your next question comes from Sheila Kahyaoglu with Jefferies. Please ask your question.
Hey, good morning, guys. Thanks for the time.
So maybe we could just dig on margins if that's okay per second on 21 I think.
Thank you guided to 44% margins and that implies.
H one is at around 42 is the same as age to 2020.
So if that actually assumes you're down flat to down in the second half of next year and just wondering why that would be the case.
I don't I don't I guess flat to down versus each 120, or so because in each 120 year Mark.
Ins were almost 47 full year volume difference in each 120 versus 821 will be dramatically different we have adjusted.
Costs, but I.
I don't expect to see the margin run up quite that fast.
That makes sense. Thanks, and then I understand you guys have limited visibility in the aftermarket, but your story is the best proxy for it. So I just wanted to ask more on this Kevin you talked about it earlier.
What are you seeing in terms of pricing either from competition in the market with other smaller suppliers or maybe even airline mros are they.
Being more price conscious are actually less price conscious because they're doing their own cost initiatives within their maintenance departments and furloughing people and so on.
You know I really I don't have that much visibility to that.
Hi.
Yeah, I don't have that much visibility to it so I don't know if I have a.
A nice answer for you I think I'm sure in this market people are price sensitive.
Im sure Theyre concerned about prices, we have historically been able to maintain pricing in downturns. That's historically, what we've been able to do and we would assume we would be able to do that through this downturn.
Sure.
No I don't think we've seen any change in the fundamental dynamics no change okay.
Okay. Thanks, guys.
Sure.
Your next question comes from.
Advisement with JP Morgan you May ask your question.
Great. Thanks, very much on out good.
Good luck.
Just a question.
I think kind of bounce around a little bit quarter to quarter, but you talked about the 57% down revenue for the commercial part of.
Commercial aftermarket.
Look at takeoffs and landings, probably down 49 50.
And you guys get the the topline portion of your value drivers. So there's probably kind of a at least low double digit gap there between the decline in the.
Revenues and.
The takeoffs and landings didn't sound like inventories really an issue. So I guess what are your country, what do you attribute that to.
Turning up and even if we kind of run rate is that that's down 50 for a while when would you expect to kind of converge with the market.
[noise].
I'm not sure that we're not already with the market. It's I'm sure. There's a there's some sort of a discount to the take off.
Soften landings that we see I simply pointed out but I think it's a it's a good way to look at our business I'm not sure that.
I see things so coalescing so much as as people fly more as there is more activity, we will see more aftermarket activity necessarily I think we're.
Pretty good place as I look at.
Yes down about the same as a flight activity is I think that were in line with where I would expect to be and as people fly more that we will see the aftermarket improve does that.
And I'm sorry your question.
I, just yeah that pension, though the flights maybe are on that.
40% to 50% down the rpms are probably down 77 by something like that yes. It does have the effect of that was something I thought. So the answer that you know sort of a market answer is probably somewhere in the middle.
Yes, I don't know a fine fine.
Find looking with other people seem to be saying they seem to be saying down the same kind of range. We are you know I. Just don't think you can call. It much closer than that we used to use I think RPM is as yet we always talked about and so I'm I'm rpms don't seem.
Like there.
So well a link to indicators. So I'm just trying to point out that take off and landing is probably are a better way to look at aftermarket recovery.
RPM surely surely aren't giving you a tailwind the earn or yeah.
Yeah sure certified absolutely.
Like that maybe as a follow up you spoke a little bit about leverage earlier, when we think about.
That leverage heading up towards that the inc. level, and I know, where you want to be kind of long term, but in the interim.
Capital deployment initiatives that temporarily increased leverage from.
The seven and a half the level is that is that something feasible is there should we think about there being any kind of near term cap on leverage or is it just really does matter.
I think you ought to think of our capital allocation rule priority. The same way I always think of that funding existing businesses first accretive acquisitions third give money.
The shareholders fourth.
And at this kind of.
I would say a debt markets.
And the cost that sport and distant fourth.
Okay, great. Thanks, Thanks very much.
Your next question Kevin <unk> from.
Back on Connor that Colin you didn't ask the question.
Yes, Thank you guys.
Congratulations on the good margins in the quarter.
Thanks, I wanted to just ask a little bit.
In those numbers here, you know bizjet and helicopter aftermarket goes down less.
This quarter than it was in the June quarter, any sort of comment on sequential trends there.
Did it get better or is that just to compare issue.
I think we've seen a general that Bizjet heli markets get a little bit better.
I tried to comment a little bit on it in my prepared.
Nodes are that that has.
It's been a source of steady improvement as we have seen the takeoff and landing cycles for business jet get closer to where they were pre cove. Its still way off of 2008, but back closer to where they were pre cove and faster than.
A large aerospace has recovered.
But it appears to be due largely to leisure.
So cove it avoidance activities, if you will not necessarily business travel as the weather cools, we're not sure that that will continue but it has been a source of modest.
Strength now this is a small market segment for us about 15% so.
So it's not a major place for us to see a driver.
Okay.
And then secondly on the commercial Aero, we business do you think that Destocking has now kind of abated.
I'm just curious like how much.
Much of the results do you think in the in the September quarter were impacted by Destocking.
Destocking relative to underlying demand and how long you might that persist as you look it's hard for me to know I.
I commented earlier that we don't get inventory information or much of it.
But from the large Oems, we guess that theres not as much there, but beyond that there's not much of a much to know so we watch it closely from an order book point of view.
Things are down a little bit more.
More than what we might or basically in line with their building you know there are adjustments to build rates, but I think it just bears close watching I don't see.
That are changing down much more faster or or up until we see more.
Billy in the build rates I know there is some indication that Airbus may raise rates, we'll have to see I don't doubt them, we'll do whatever they.
Book to the markets, we will deliver parts for.
But with the Max coming back on Board I think OEM is.
You know a concern.
It's a little bit as we go forward on how much inventories out there.
We are seeing consistent results quarter over quarter, so that may indicate that.
The inventory is being dealt with and being dealt with reasonably quickly, but we'll have to see how this how this rolls forward I don't have much better visibility than that for you.
Okay. Thank you very much.
Okay.
Your next question can trend, but proper calorie with vertical research you may ask your question.
Thanks, so much and good.
Good afternoon.
Good morning, good afternoon, how are you.
Thanks.
So Mike I've got a couple of.
Cash questions for you.
First of all on the European cash restructuring can you give us an idea of how much of a cash expense that is.
Go to be 2021, and also what your expectation might be for Capex and 2021.
Yeah on the on the Capex, we don't want to give any.
An exact stat I think if you want to assume something that was in line with 2020, which was on the order of 120 million Bucks, maybe a little more is there on the severance cost in Europe.
It's several tens of millions of dollars not quite 100 million.
But as you know we've got.
Blop units over there and when you let folks go is more expensive than doing it in the U.S.
Yes.
And then just for nickel, Kevin some of the other aerospace supply has been talking about airlines deferring maintenance and one of them talking about the potential risk of a more surplus activity out there in 2021 have you factored any of this into.
Couple conservative thoughtful way aerospace could be going this year.
I would.
I guess Holistically say sure we factored all of that into our our general concerns about the market as we go forward to avail.
Available green time or what.
Lanes. They have available I think all of this adds to the general uncertainty of the market as we go forward.
And we just continue to focus on just takeoffs and landings as a predictor for what the market's going to do.
You know Rob we're hopefully conservative we that's what we want to be.
Please.
Hopefully were right, but we just don't know.
Fair enough. Thanks.
Yeah.
Your next question comes from Ken Herbert with Canaccord, you May ask a question.
[noise] hi, Thanks, I wanted to first ask.
Kevin the potential divestitures you called out.
Defense businesses it sounds like if I remember legacy Esterline did anything fundamentally change in these businesses either in your ability to sort of get cost, where you wanted or or maybe the top line outlook wasn't what you'd expected I'm just curious on timing of that and if anything fundamentally.
The change with those businesses.
Well other than that I mean, I guess the thing that fundamentally changes the whole commercial it all commercial market. Thanks.
But I mean other than that the businesses are we thought the structure is what it is the cost savings.
No our donor quite achieve.
Okay, and I don't see any difference in their proprietary content sole source content aftermarket content et cetera, other than the huge dislocation in the market. Yes, I would just I agree completely I don't think there is anything.
That has come up there on the defense side, we have can.
Continue to implement.
The cost reductions and the like to improve the businesses and I think they are better than.
The way we found them, we just don't see the same level of.
Shareholder value generation in those businesses as we might see in some other ones. So we want to focus where we can make it.
Prince and those businesses that align with our strategy.
Thats the only thing that's different here and we did comment from the beginning I think much like you saw was soriano and that some businesses, we would evaluate and look to off load. If we didn't see the value generation possibilities there.
Okay. So so I guess the way to think about it is these businesses now that youve hydro that you've been into it for two years don't quite provide sort of the upside maybe that fits with what you'd like to see across the portfolio. I don't know I don't think I'd say that I don't think I'd say that what I'd say is that they don't our strategy is proprietary aerospace.
Businesses with significant aftermarket content I would say things that we are looking at typically are not as proprietary as we like we don't have as much aftermarket as we like.
I mean, that's that's the you.
That's the issue okay.
Okay, Okay, perfect and if I could just on the.
Commercial aftermarket youve talked in the past, Kevin I believe about sort of the whipsaw effect as things do eventually come back at some point and I know who knows when that will be exactly but has anything changed this down cycle or is there anything structurally different now that would lead you to believe we don't see sort of similar pace of Rick.
Covering if and when we get to that when we get to that point.
I have not seen anything that.
Looks different to me yet.
At all a I have not seen any fundamental changes to the market or the way business is done.
You indicate that there would be a delay in the way we would see a recover.
Every as people started to fly more.
Okay, great. Thanks, a lot.
Your next question, Kevin from Michael Ciarmoli Lit service Securities You May ask your question.
Hey, good afternoon, thanks for sticking around taking my question guys.
Kevin just on.
On the aftermarket I guess I think you said it a couple of times with RPM is down 70% are are the incoming bookings tracking with that down 70% and if so how does how do we get comfortable.
Incoming order flow is is that that depressed level.
Yes, we remember aftermarket.
Look at bookings are booked and shipped within the quarter. There is backlog that carries over from quarter to quarter. So you can.
You know kit I.
I guess.
Draw.
The wrong conclusions by just looking at that we're still seeing strong.
The activity activity in general as we look at the Pos data.
Order book is in line with that.
The takeoff and landing activities.
So.
It's in line with what we're talking about I'm not I don't know the exact purpose.
Bid MTGE as I'm sitting as I'm thinking or talking to you right now but it's.
It's not a a yes, it's a concern as we go forward as were looking.
We have to continually follow the take off and landing cycles. There is some backlog in aftermarket, but not to the extent.
Of OEM or defense.
So it is book and ship within the quarter.
So that's part of the uncertainty as we go forward as we look forward on a in why it would be difficult to provide guidance right now if I, if I had better visibility on that we would be able to do that right.
Right now.
Now we can't so we'll have to see how this unfolds with people flying Okay. Right now we're we feel like we're in the right place for the way. The business is recovering we have not seen any fundamental changes we've not seen more use of USM more USM flooding more.
More delays.
It is in any.
You know maintenance activity in reality, the bulk of our products are not exposed to C and D checks there a and b checks as we reviewed in previous quarters with you guys. We don't see any reason why the aftermarket activity will not return.
Term.
To the same extent than it was before as people are flying like they were before it's just going to be a little hard to predict from now to then as we recover.
Got it the other day, they're good in Nevada that is you can't see out further than 60 or 90 days.
In your aftermarket.
And that's the most profitable chunk of it that's that's the good and the band of it you know you can move up quickly or you when it starts to move up but you can't see out much further than that right now.
Yeah understood got it and then just one on margins, obviously, a lot of focus on the EBITDA.
Again, some real good sequential increase what was going on with the gross margins ticking down sequentially. Despite the higher volumes and the continued cost takeout and how should we expect those gross margins to trajectory here.
Yeah, we had some noise in the gross margins over the quarter because of just an accounting classification in.
In the way it works on the French Leach French facility that we mentioned to you guys before where we had a fire the way the insurance recovery accounting works. That's what drove the majority of the impact the weird trend you're seeing if you were to normalize for that I think it would make a lot more sense, yes, okay got it.
Got it perfect. Thanks, guys.
Mark.
Your next question comes from front Epstein with Bank of America, immuno acts or ask your question.
Hey, guys just a quick.
Quick financial detail and maybe a broader question.
So when you look at and 22.
When.
Interest deductibility switches from an EBITDA standard to an EBIT standard.
How does that impact you guys.
And obviously its good right now based on the tax.
Plan in place nationally in the US It would result in a slight uptick in the tax rate by a couple percentage points.
Okay. Okay, great. Thanks for the clarity on that and then and then for Kevin.
Yes. These.
Disruptions can create opportunities right.
Do you think any differently about the business today than you did before the pandemic Herman has the pandemic brought.
The focus for you guys.
Aspects of the business changes to the business things that you did really well things you didn't do well that.
You know now that you might not have noted before I mean, just a sense of the question.
Ah, Yes, I do.
You know we have.
In terms of both the business Ah you know we've learned about what indicators might be better predictors. Ah. You know is that RPM is it do you know what we have learned some things about how to follow the business. We've learned that a more reinforcing of our business model.
Miller as Nick has always said at the beginning you know were consistent in our approach.
And that consistency, we continued and the model proved that it was resilient going through really a once in a lifetime once in a 100 year pandemic.
Yeah.
That has it impacted our business that we we were rights. We could continue to you know pay the debt and the like and keep the business moving forward. We were right I don't know beyond that what we've learned about the business. It just validated some things for me that this is the incredible business.
And as we thought the team is really strong and can lead and respond quickly and they know what to do it was more reinforcing than learning new things Ron.
And I would agree with that I would say.
What it did what it did for me now Tonight, how did it.
But it just reinforce.
Sort of the strength of the business and the strategy in the model. We have I mean, we quickly got the cost readjusted with the far and away. The most substantial dislocation I've seen in my career in this industry, but we ran the same playing up the cost down.
You know we've done these different downside.
Slide models, the deal with leverage issues, but frankly, we never did one this bad.
And we easily dealt with it all without a without a bump in the road in fact, we're able to raise money right through it so.
We felt that we felt pretty good about that.
Yeah, Yeah, Great Hi, guys. Thank you.
Sure.
Your next question comes from Hunter Keay itself Research you May ask your question.
Thanks for getting me on here Hi, everybody, Hey, can you guys just clarify on that given what you said on the on the Beach X versus the C and the D. Checks can you give me a sense for what your exposure is in the commercial aftermarket relative to those two buckets.
We have talked about this in the past, we're more exposed to and be than we are to see Andy.
So it's a there's significant more exposure on the a and b side to those checks than to the C and D checks. We don't have to go through major checks to see opportunities for.
For aftermarket for us.
Okay.
Hi, I'm kind of wondering about the order of magnitude is it three.
3% to 75% to third something in that nature in that area.
You know, it's a it's more but I don't know we've clarified exactly how much in the past okay.
That's great and then.
Dear commercial Oems ever get involved in your aftermarket pricing decisions have they ever in the past and then would you expect that to happen in the future.
No I wouldn't expect any difference from current status quo, yeah, Okay, we've not getting that involvement than I would've expected.
Got it thanks a lot.
Sure.
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