Third Quarter Conference Call, Fiscal Year 2020



Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors that could cause actual performance to differ materially from such statements. A description of these risks, uncertainties and other factors is contained in our news release of July 24, 2020 our most recent Form 8K filed on July 24, 2020 and in certain of our other public filings with the SEC.


We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our investor relations webcast page at

Good morning.  Thanks for joining us.  This morning we’ll report on the third quarter of fiscal ‘20 and provide some insights on the remainder of the year.  Overall, it was a good quarter against the backdrop of a very challenging environment. This result is a tremendous credit to the dedication of our employees around the globe. We believe our results today should reassure our investors around our two key messages:

1)                 Short term strength from our diversity.


2)                 Long-term value from our fundamentals

As we look forward, our priorities remain unchanged.  First and foremost is the health and safety of our employees and their families.  And second, to continue to meet the needs of our customers and thereby secure the financial well-being of the company. 

As usual, I’ll start with the headlines.



1)     First, this was the COVID quarter – perhaps the first of several.  We came into the quarter believing our Defense, Space and Medical businesses would be strong, Industrial would be pressured and Commercial Aircraft would be hardest hit.  Looking back, the quarter unfolded pretty much as expected. 

2)     Second, our underlying operations performed extremely well under very difficult circumstances.  Despite the precipitous drop in sales, adjusted net earnings of $30 million and adjusted earnings per share of 93c remained very respectable.  In addition, free cash flow of $90 million was one of our best quarters ever. 

3)     Third, we incurred various charges associated with resizing our business and re-valuing assets as a result of COVID.  We booked a total of almost $60 million in charges including severance, write downs and asset impairments.  Over 90% of this charge is non-cash.  

4)     Fourth, on a very positive note, our activities to curtail spending and improve cash flow resulted in lower leverage and improved liquidity at the end of Q3 relative to Q2.

5)     Finally, given our healthy financial position, we are reinstating our dividend this quarter at 25c/share. 

In summary, Q3 was a very tough quarter but we managed through it well and delivered strong results.  All our facilities continued to operate and the majority of our staff transitioned to working from home.  Our diversity across markets, our actions to reduce expenses and improve cash flow and the commitment of our employees, means that today we are more financially secure than we were 3 months ago.

Now let me move to the details starting with the third quarter results.


Q3 Fiscal ‘20

Sales in the quarter of $658 million were 11% lower than last year, the result of the decline in our commercial aircraft business and weaker industrial markets.  Taking a look at the P&L, our gross margin was down on the lower sales and inefficiencies resulting from our new work practices.  Our dollar spend on R&D and SG&A were lower as cost containment initiatives were swiftly adopted.  Interest expense was marginally lower and we had a very low adjusted tax rate.  We incurred $58 million in charges associated with the sudden change in business conditions.  Excluding these charges, adjusted net income was $30 million, down 34% from last year, and adjusted earnings per share of 93c were down 29% from last year.

 Fiscal ’20 Outlook

As we enter the fourth quarter, the macro economic environment seems more predictable than it was 90 days ago.  We are coming to accept our changed reality, but that new normal still includes significant uncertainty.  Therefore, we believe it would be inappropriate to provide detailed guidance for our fourth quarter.  However, we can offer the following color on our sales outlook.  We believe our fourth quarter will look somewhat similar to our third with continuing strength in our Defense, Space and Medical markets, further weakness in Industrial and little or no improvement in our commercial book of business. 

Now to the segments.  I’d remind our listeners that we’ve provided a 3-page supplemental data package, posted on our webcast site.  We suggest you follow this in parallel with the text.



Aircraft Q3

Sales in the quarter of $249 million were 26% lower than last year as a result of the pandemic.  On the positive side, military sales were up in the quarter.  We saw nice growth on the F-35 program as well as in our portfolio of funded development work.  Partially offsetting these increases, was a decrease in foreign military sales which were particularly strong last year.  In the military aftermarket, we had a blowout quarter.  We had a strong backlog across the portfolio coming into the quarter and benefited from transferring some of our production staff from commercial programs over to military jobs.

On the commercial side of the house, we felt the full brunt that COVID had on the airline industry.  Sales to our OEM customers were down over 60%.  We saw dramatic decreases across the portfolio.  The overall decrease was larger than we had expected, a combination of declining production rates at the OEM’s, but also their actions to reduce their inventory levels.  In the aftermarket, sales were down almost 50%.  This was slightly better than would be expected based on flight data.  We benefited from a healthy backlog coming into the quarter and also from the relative strength of our freight customers.  

Aircraft Margins

Adjusted operating margins in the quarter of 4.5% were primarily the result of the significant change in commercial volumes.  In addition, we suffered some loss of efficiency in our production facilities, the result of precautions taken to protect our employees’ health.  During the quarter, we took action to resize our commercial operations across the globe, and incurred costs of $55 million.  This total includes severance costs, asset impairments and various other write offs, all attributable to the structural decline in our commercial business.   

Aircraft fiscal 20

The situation in our two major markets is more stable today than it was 90 days ago, but we still find ourselves dealing with significant uncertainty.  The military side of our business has remained strong and we anticipate this will continue into the fourth quarter.  Our factories continue to operate and our customers continue to need product. 

On the commercial side of the business the situation remains volatile.  The OEM’s have announced new production schedules for their major programs and we have adjusted our staffing to align with their future long-term demand.  However, in the short term, we continue to struggle with significant demand volatility as our customers reduce their inventory and preserve cash.  This destocking was a significant factor in our third quarter and is likely to continue to some extent through this coming quarter.  In the commercial aftermarket, increasing COVID cases around the world over the last month is delaying the recovery in flight operations we might have expected.  Our business is predominantly on wide body airplanes, and the dearth of international flights does not bode well for a meaningful recovery anytime soon. 

Overall, this continued volatility makes it difficult to predict what will happen in this coming quarter.  At the moment, our assumption is that our military business will remain strong but will come down a little from Q3 on marginally lower aftermarket sales.  We anticipate that our commercial OEM sales will be slightly higher as destocking actions abate and we are hopeful that the commercial aftermarket may tick up slightly.


Space and Defense

Space and Defense Q3

Sales in the quarter of $184 million were 6% higher than last year.  Similar to last quarter, the growth is all coming in the space market, with sales up 33% over last year.  We continued to see nice growth in our hypersonic development activity, as well as strength across our portfolio of products including avionics and mechanisms.  We also had higher sales on various NASA programs, with activity on both the Orion crew vehicle and the Space Launch System up from last year. 

Defense sales were 7% lower than last year, primarily the result of lower activity across various missile programs.  Sales of slip ring products on a range of flight vehicles were also down from a year ago.  Sales into vehicle applications were about in line with last year while naval and security sales were slightly higher.  

Space & Defense Margins

Adjusted margins in the quarter were 12.3%, down from a very strong 13.9% a year ago.  Last year we had a particularly favorable mix, while this year we experienced some inefficiencies as a result of our changed work practices.  

Space & Defense fiscal ‘20

So far, the impact of COVID on our Space & Defense business has been muted.  Changes to our production facilities have kept our employees safe and healthy and our engineering crews have been able to advance our development jobs while working from home.  As we look to the fourth quarter, we believe this relative stability will continue and the fourth quarter should be somewhat similar to the third, within the normal quarterly fluctuations in this business.    


Industrial Systems

Industrial Systems Q3

Sales in the quarter of $224 million were down 3% from last year.  However, adjusting for forex and the sales of our GAT acquisition, organic sales were down about 6%.  Similar to last quarter, below the top line number, there were significant shifts in the mix between our major markets.  Sales into energy markets were up slightly on the acquired sales from GAT, but down organically.  The continued downward pressure on oil prices is undermining investment in exploration, suggesting a recovery in our energy market is unlikely in the near term.  Sales into industrial automation applications were down 17%.  Capital investment was already slowing pre-COVID as the global economy started to cool.  The impact of the pandemic has served to both accelerate this drop in capital spending and exacerbate its impact on our industrial automation business.  Sales into simulation & test applications were also down in the quarter.  In particular, our flight simulation business has softened as demand for pilot training has dropped.  To finish on a positive note, sales into our Medical markets were way up in the quarter.  Sales of components used in breathing aids were higher on surging demand, and sales of our medical pumps continued to grow in support of COVID requirements.    

Industrial Systems Margins

Adjusted margins in the quarter were 9.0%.  The continued shift of our mix away from our industrial automation business is having a negative impact on our margins.  In addition, the sales from our GAT acquisition are at relatively low margin due to first year acquisition accounting effects.  

Industrial Systems fiscal 20

Accurately forecasting our industrial business continues to be difficult.  As we look to next quarter, we believe the underlying macro-economic trends will continue to pressure our business.  Sales into the energy, industrial automation and simulation & test markets will continue to experience downward pressure while sales into medical applications should remain healthy.  Shifting from the macro to the micro, bookings through the third quarter were below our billings, signifying a declining outlook.  Taken all together, we anticipate that sales in Q4 will be slightly lower than Q3.   


Summary Guidance

At the time of our last earnings call, we were heading into a storm.  We had hoped that Q3 would be eye of the storm - THE COVID quarter, and Q4 would be the transition back to a more normal business environment.  That is clearly not the case, and today we find ourselves planning for several more COVID quarters to come.  During Q3 we took dramatic action to reduce our spending and resize our business.  These actions paid off.  Today, our balance sheet is stronger than last quarter, both in terms of leverage and liquidity.  As a result, we are reinstating our dividend and selectively starting to reinvest in our business.  In the present environment, we believe our shareholders are best served by activities which preserve value today and create value tomorrow.  We are committed to maintaining the right balance between our short term financial strength and the long-term investments required to grow the business. 

Now let me pass you to Jennifer who will provide more color on our cash flow and balance sheet.

Thank you, John. Good morning, everyone.

We had an incredibly strong cash flow quarter, and we achieved these results during a time filled with uncertainty and pressures in some of our end markets.  To ensure that we maintained our financial health during the crisis, we implemented company-wide initiatives that focused on cash conservation and liquidity.  These actions directly contributed to our strong cash performance.

Free cash flow in the third quarter was $90 million, up from $15 million in the first quarter and $12 million in the second quarter.   Free cash flow conversion, adjusted for charges associated with the pandemic, was nearly 300%.

The $90 million of free cash flow for Q3 compares with a decrease in our net debt of $92 million.  During the third quarter, we did not repurchase any shares or pay a quarterly dividend.  However, based on our strong cash performance and after just one quarter of suspending it, we have reinstated the dividend at $0.25 per share.

Net working capital (excluding cash and debt) as a percentage of sales at the end of Q3 was 28.5% compared with 29.6% a quarter ago. The decrease largely reflects robust collections as well as increased receipts as the US government raised the progress payment rates on its defense contracts. Customer advances also contributed to the improvement.  Offsetting these sources of cash generation were a continued and expected build-up in inventories and a reduction in payables associated with lower spend.

Capital expenditures in the third quarter were $17 million, down from a $27 million quarterly run rate in the first half of the year.  We actively managed and prioritized our spend, focusing on compliance and business critical projects.  Depreciation and amortization totaled $22 million, continuing at levels from our first and second quarters.

Our leverage ratio, which is net debt divided by EBITDA, decreased to 2.4x from 2.6x a quarter ago.  The decrease in our leverage ratio was driven by our strong cash performance.

Our effective tax rate, excluding charges associated with the pandemic, was 6.8% in the third quarter compared to 23.1% in the same period a year ago. The lower rate in this year’s third quarter primarily reflects an increase in foreign tax credit utilization associated with our FY19 tax return filing on a low earnings before income taxes base.

Cash contributions to our global retirement plans totaled $12 million in the quarter, compared to $9 million in the third quarter of 2019.  Global retirement plan expense in the third quarter was $21 million, up from $18 million in the third quarter of 2019.  Our largest defined benefit plan is in the U.S. and has been closed to new entrants for more than a decade.  We fully funded this plan in 2018, at which time we shifted our investment strategy to derisk the portfolio.  Accordingly, it’s largely insulated from the recent market turbulence, and we continue to be fully funded. The funded status has also remained stable for our international pension plans.

At quarter end, our net debt was $883 million, inclusive of $106 million of cash. The major components of our debt were $500 million of senior notes, $404 million of borrowings on our U.S. revolving credit facilities and $82 million outstanding on our securitization facility.

We have $654 million of unused borrowing capacity on our U.S. revolving credit facility. Our ability to draw on the unused balance is limited by our leverage covenant, which is a maximum of 4.0x on a net debt basis. Based on our leverage, we could have incurred an additional $620 million of debt as of the end of our third quarter.  We are confident that our existing facilities provide us with adequate liquidity to successfully navigate through these uncertain times.

We made significant adjustments to our major capital deployment activities in the third quarter.  We have paused our M&A pursuits, had no share repurchases, suspended our dividend and delayed certain capital expenditures.  We also took measures to slow our incoming inventories to be in line with expected demand, and took advantage of payment deferrals.  In addition to these cash relief measures, we also actively managed expenses to mitigate the impacts to our operating margins.

Over the past quarter, we’ve gotten more clarity around customer demand.  We’ve resized the business in end markets in which we’re facing significant and sustained reductions in demand, most notably in commercial aircraft.  As a result, we recorded $58 million of charges associated with the COVID-19 pandemic.  We incurred $5 million of severance charges and $54 million of non-cash charges.  The non-cash charges include a $34 million impairment of long-lived assets, of which $9 million is a provisional charge on property that we’re still in process of valuing, and a $19 million write-down of inventory. 

Despite the increased level of clarity, we are still facing risks and considerable uncertainties remain.  Our immediate financial focus will continue to revolve around cash preservation and cost management, while opportunistically resuming investments in a measured and balanced way.  We will adjust our spending to suit the evolving landscape as we move into the fourth quarter and beyond.

We are committed to ensuring that we have adequate liquidity during this crisis, protecting the long-term health of the company and emerging financially strong and ready to capitalize on opportunities once the situation stabilizes.

With that, we’ll turn it back to John for any questions you may have.

The Q&A is not available.