Moog Inc.

Welcome to the Mohs fiscal year 2022 second quarter earnings conference call. Today's conference is being recorded. At this time, I would like to hand the conference to Ann Lohr. Please go ahead.

Good morning. 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 April 29, 2022, our most recent form, 8K, filed on April 29, 2022, 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 a copy of the document, A copy of today's financial presentation is available on our investor relations webcast page at www.mo.com. John?

Thanks, Anne. Good morning. Thanks for joining us. This morning we'll report on the second quarter of fiscal 22 and affirm our guidance for the remainder of the year. Let me start with the key financials. It was a strong quarter with adjusted earnings per share of $1.49, 12% higher than the adjusted $1.33, we recorded in Q2 fiscal 21. Adjusted EPS this quarter was also slightly above the high end of our guidance from 90 days ago. The situation around COVID and supply chain disruption continued to present challenges during the quarter, but our teams managed these well. Adjusted free cash flow in the quarter, excluding the impact of our securitization facility, was negative 24 million. Finally, there's no change to our guidance for the full year. Full year sales will be $3 billion, with adjusted earnings per share of $5.50 plus or minus 20 cents. Now let me move to the headlines. First, the world has changed considerably since we reported our Q1 earnings at the end of January. The Russian invasion of Ukraine has reset expectations around long-term defense spending, particularly in Europe. At this stage, the impact on our overall defense business is difficult to estimate. We believe, however, that there will be no material change over the next six months, which potential tailwinds in future fiscal years. Second, COVID, supply chain, labor attrition, and inflation continue to weigh on economic activity and make short-term financial forecasting difficult. To date, we've managed well through these challenges, as evidenced by our results this quarter. However, they will continue to be major distractions to normal business operations throughout the remainder of this fiscal year. Third, we took charges this quarter across our segments tied to the delayed recovery in the commercial aircraft business, the Russian actions in Ukraine, and further refinements in our portfolio. The total charges had an adverse impact on earnings per share of 59 cents in the quarter. I'll provide more details on each of the charges as I move through the segment discussions. And finally, we're pleased with the results of our second quarter, which came in ahead of forecast. 90 days ago, our plan for the year included a considerable ramp up in earnings in the second half. The underlying outlook for the year has not changed. Rather, some of the forecasted Q3 and Q4 earnings increase actually accelerated into the second quarter. As a result of the stronger Q2, we're now forecasting Q3 and Q4 to be pretty much in line with Q2 both in terms of sales and earnings. Now let me move to the details, starting with the second quarter results. Sales in the quarter of $771 million were 5% higher than last year. We saw increases in each of our three operating groups. Taking a look at the P&L, we incurred a $2 million charge as we wrote down some inventory and receivables associated with exiting our activities with Russia. Despite this charge, our gross margin was up slightly on the higher sales and a better mix. R&D and SG&A expenses were more or less in line with last year as a percentage of sales. We incurred restructuring costs of $8 million in the quarter, as well as an impairment charge of $15 million. Both charges were associated with resizing the business and continuing our portfolio shaping activities. Interest expense was slightly lower than last year. The effective tax rate this quarter was 24.9%, resulting in GAAP net earnings of 29 million and GAAP earnings per share of 91 cents. In order to compare the underlying operating performance with Q2 last year, there are adjustments we need to make to each quarter. In Q2 fiscal 21, we recorded an 18-cent gain on a pension curtailment in Europe. Excluding this gain, the adjusted net earnings last year were $43 million, and the adjusted EPS was $1.33. This year, in Q2, we incurred the inventory write-down, restructuring, and impairment charge in the quarter. Excluding the impact of these one-time charges in Q2 fiscal 22, our net earnings this year were $48 million, and our earnings per share were $1.49. On an adjusted basis, net earnings and earnings per share were both up 12% over the same quarter last year. This is 22 outlook. Our full year outlook remains unchanged from 90 days ago. We're forecasting sales of $3 billion of 6% from last year and adjusted earnings per share of 550 of 13%. We anticipate a slight acceleration in earnings in the second half. We're keeping our full year EPS range unchanged at plus or minus 20 cents to reflect the continued uncertainty in the global economic climate particularly in relation to the supply chain. Now to the segments. I'd remind our listeners that we provided a four-page supplemental data package posted on our webcast site, which provides all the detailed numbers for your models. We suggest you follow this in parallel with the text. Beginning with aircraft. Our aircraft business provides flight control products to two very distinct markets, each with their own macroeconomic drivers. On the military side, the Russian invasion of Ukraine has changed the narrative around defense spending. In the U.S., both sides of the aisle are aligned on the importance of strong defense spending, while the European nations are redefining their level of commitment to defense budgets. The impact of these shifts on our business will play out over many years to come, although we don't believe there will be any material impact in the present fiscal year. On the commercial side, the overall atmosphere continues to improve, with U.S. airlines showing stronger results and projecting further growth over the coming months. Aftermarket activity is on the rise, and we're seeing this filter through in our numbers. On the other hand, the recent crash of a 737 in China, the continued delay in resuming 787 deliveries, and the decision by Airbus to temper the future ramp on the A350 are weighing on the longer-term outlook for our business. China's new front in their battle with COVID and the risk of recession in Europe arising from the Ukrainian conflict are also items we're watching. On balance, we remain bullish about the commercial business, but believe the recovery to pre-pandemic activities continues to move to the right. This shift in our longer term view of the commercial OEM recovery drove us to take further actions in the second quarter to resize the business. Back in 2020, we made a significant adjustment to our commercial workforce and incurred impairment charges as a result of the pandemic. At that time, The level of adjustment was based on our internal model of when we would see a recovery in the commercial business. Our intention was to ensure we had sufficient labor and capital to respond to the increase in production rates the OEMs were forecasting. The delays in expected volume recovery at our major customers made it clear that we needed to make further adjustments to our staffing and asset base this quarter. As a result, we incurred $15 million of impairment charges and $4 million of restructuring charges in the quarter. Aircraft Q2. Sales in the quarter of $311 million were 2% higher than last year. This quarter, our growth came from the aftermarket, both on the military and commercial side. Military aftermarket sales were up nicely, with growth across a broad range of programs. We saw particular strength on the V-22 and F-15 platforms. In contrast, our military OEM sales were down from a year ago. The largest component of this drop was lower F-35 sales, driven mostly by the timing of material receipts. We also saw lower foreign military sales compensated by higher B-22 activity. In last year's second quarter, we had $5 million of sales from our navigation aids business. You may remember we divested this business in Q1 this year, further driving the negative sales comparison with a year ago. On the commercial side, OEM sales were about flash with last year, Lower 787 sales were compensated primarily by higher business jet sales, as well as slightly higher activity on the 737 and A350 programs. We are keeping the OEM production rates on our major programs fairly steady internally in order to maintain the health of our supply chain and the efficiency of our plants. Therefore, the fluctuation in sales numbers from quarter to quarter is less a reflection of internal production volatility and more the impact of the timing of material receipts. Commercial aftermarket sales were way up this quarter. This is a combination of two items, underlying strength in the book of business and some one-time activities that booked this quarter. Each of these items contributed about half of the growth in the quarter. The underlying business continues to surprise to the upside with increases across all major platforms. The 787 continued to lead the way as international travel recovers. We also benefited from seven one-time items in the quarter, including some test equipment sales. These items will not repeat in future quarters. Aircraft margins. Gap operating margins in the quarter of 4% included 600 basis points of headwind from the resizing activities I've described. Adjusted operating margins of 10.0% were up nicely from the same quarter a year ago and also from our first quarter. The strength in the aftermarket on both the military and commercial sides of the house drove the margin gain. Aircraft fiscal 22. We're keeping our full-year sales forecast unchanged from 90 days ago at $1.25 billion, up 7% from fiscal 21. However, we're adjusting the mix between military and commercial based on the experience of the first half. In total, military sales would be marginally lower than our previous forecast, while commercial sales would be marginally higher. We're keeping our full year adjusted margin forecast unchanged at 10.1%. This implies a strengthening from the run rate of the first half. We've already seen a nice margin pick up from the second quarter. I believe we will see some further improvements as we move through the next two quarters. Turning now to space and defense. Similar to last quarter, underlying demand in both our space and defense markets remain strong. The shift in the global defense posture over the last 90 days should ensure our business in both markets remains strong for years to come. While our space portfolio has growth opportunities in both commercial and defense-related markets, our present book of business is dominated by U.S. government contracts. Therefore, increases in future defense spending and the emphasis on space as the next frontier in any future conflict bode well for our business. In other news, we concluded some portfolio refinement this quarter and incurred a $2 million charge. Space and defense Q2. Sales in the quarter of $223 million were 8% higher than last year. Both the space and defense portfolios are driving growth in this business, with the lead passing from one market to the other from one quarter to the next. This quarter, it was the defense side of the house that drove the growth. Defense sales were up 15%, driven by strong growth on our RIP shore ad program. Sales of missile applications were down marginally, compensated by slightly higher component sales. On the space side, growth in our space vehicles business compensated for lower hypersonic activity and slightly softer sales across a range of our heritage components businesses. As I mentioned last quarter, our hypersonic development activity is winding down, and we will have a period of lower activity as the government decides which programs to move forward to the next phase of development and production. Space and defense margins. Gap margins of 10.8% included 80 basis points of portfolio refinement charges. Adjusted margins of 11.6% were up from our first quarter results and are in line with our forecast for the full year. Space and defense fiscal 22. There's no change to our sales forecast for the full year. Full year space sales of $350 million assume a second half in line with the first. Full year defense sales of $530 million assume a slight acceleration in the run rate as both our missile and components portfolios grow. For the full year, we're keeping our adjusted margin forecast unchanged at 11.5%, slightly better than the performance of the first half. Turning now to our industrial systems business. Underlying demand for industrial products was strong over the last quarter. Higher energy prices, increased pilot training, and the general demand for automation equipment to expand production capacity bode well for continued strength in our business over the next few quarters. Growth across the industrial world remains healthy, although COVID spikes, particularly in China, and geopolitical events in Europe have increased the risk of an economic slowdown next year. The direct impact of the Russian actions in Ukraine show up in our industrial segments. Very soon after the invasion, we made the decision to cease all business with Russia. Our ongoing sales into Russia were small, so there's no material impact to our outlook for the year. However, this decision, combined with some minor portfolio refinements across the footprint, resulted in a $4 million hit to earnings in the quarter, just over half associated with Russian charges and the remainder portfolio shaping. Industrial systems Q2, sales in the quarter of $236 million were 5% higher than last year. Excluding the impact of foreign exchange movements and lost sales from portfolio shaping activities, underlying sales were up over 10% organically. Simulation test sales were way up on increased flight simulation activity. Sales into the sub-market almost doubled from a year ago. It would appear that flight training activity is finally recovering from the pandemic slowdown. Energy sales were up on higher generation and exploration activity. Industrial automation sales were about flat, but adjusting for portfolio shaping and our organic sales into this market were up mid single digits over last year. Finally, sales into medical markets were down slightly on lower component sales for ventilator applications. On a positive note, across the portfolio, our bookings continue to be strong and our backlog is growing. Our challenge, is meeting the demand from our customers given the supply chain constraints. Industrial margins. Gap margins in the quarter of 8.8% include 170 basis points of restructuring and impairment charges. Adjusted margins of 10.5% were in line with last year and up nicely from the first quarter. In Q1, we incurred some production disruption and moving expenses as we consolidated facilities in Europe and the U.S. Industrial fiscal 22. There's no change to our sales forecast from last quarter. For the full year, we anticipate sales of $910 million. This total assumes a modest pickup in the second half as we work to accelerate shipments to meet customer demand. Our full year forecast for adjusted margins is also unchanged at 9.5%. This margin is slightly ahead of the run rate of the first half. So, in summary... It was a good quarter overall, with adjusted earnings per share above our forecast from 90 days ago. We saw an acceleration of some planned earnings upside later in the year into the second quarter, so that our overall forecast for the year remains unchanged at $5.50 plus or minus $0.20. This full year forecast assumes a second half performance slightly ahead of the first half, but in line with the second quarter, both in terms of sales and margins. Cash flow in the quarter was soft, but this should recover in the second half. As we look to the next six months, there are both risks to our plan as well as opportunities to do better. On the risk side, an escalation of hostilities in Ukraine or a spread to other parts of Europe could materially change the outlook. Also, further aggressive lockdowns in China as they fight the Omicron variant could exacerbate the supply chain challenges and slow overall economic growth. On the opportunity side, the rebound in global travel could drive further commercial aircraft aftermarket upside, and an easing of supply chain constraints could provide the opportunity to accelerate sales in each of our operating groups to meet customer demand. As always, we try to weigh the possibilities of both upside opportunities and downside risks, and provide the market with our best estimate of the outcome. Overall, our business remains very healthy, and we believe there are many opportunities to see continued growth in both sales and margins over the years to come. For the third quarter, we anticipate earnings per share of $1.45 minus 15 cents. Our range continues to be relatively wide due to the uncertainties in global economic conditions. Despite these uncertainties, our backlog is strong and our outlook remains bullish. 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. As a reminder, we amended our securitization facility in the first quarter. Under the facility, a receivable financing subsidiary may sell receivables to a financial institution up to $100 million. We reached that level at the end of our second quarter, and we were at $90 million at the end of our first quarter. Due to the structure of this facility, the associated receivables are not recognized on our balance sheet. The new structure reduces our working capital levels. To provide a comparable look at our cash generation and financial position, I'll first share free cash flow and net working capital metrics without the benefit of the new facility. I'll also include the metrics as calculated off of our financial statements near the end of my comments for your reference. We're keeping our forecast for free cash flow unchanged for the year. Free cash flow in the quarter was negative $24 million. We saw pressures this quarter on working capital, most notably as we worked down significant customer advances that we received in the first quarter. Receivables also grew in the second quarter. We continued investing in capital expenditures at a similar rate to the past few quarters. We're able to make these investments from the strong financial position we're in. Over the past eight quarters, our free cash flow conversion on an adjusted net earnings has been over 100%. The negative $24 million of free cash flow in Q2 compares with an increase in our net debt, adding in debt related to the securitization of $52 million. During the second quarter, we acquired Team Accessories for $12 million. Team Accessories is based in Ireland and specializes in the maintenance, repair, and overhaul of engine and airframe components. This business will be part of our commercial aftermarket service offering. We also had cash outlays of $8 million for the quarterly dividend and $4 million for share repurchases. Networking capital, excluding cash and debt, as a percentage of sales at the end of Q2 was 29.0%, up from 27.6% a quarter ago, but in line with the levels we saw in 2021. The increase during the quarter largely resulted from an expected workdown of significant customer advances on military programs that we received in the first quarter. We also saw growth in receivables. We experienced growth in receivables on commercial aircraft programs where our production level is higher than the rate at which customers are taking deliveries. We're maintaining steady production levels to ensure a healthy supply chain and efficiencies in our facilities. The timing of invoicing from strong sales late in the quarter also drove higher levels of receivables. In addition, an advance that builds up from pandemic relief on the defense business unwound this quarter. This growth in receivables as a percentage of sales was offset by a growth in payables. On the inventory front, this quarter marks our fifth straight quarter of decreasing inventories as a percentage of sales. We continue to make progress on our initiatives to reduce inventory levels while being very mindful of ensuring sufficient inventory levels on hand in a supply chain constrained environment. Capital expenditures in the second quarter were $37 million, in line with our spend over the last few quarters. This level of capital expenditures reflects our investment in facilities to support growth and provide next-generation manufacturing capabilities. At quarter end, our net debt was $711 million, including $122 million of cash. The major components of our debt were $500 million of senior notes and $320 million of borrowings on our U.S. revolving credit facilities. In addition, we had $100 million associated with the securitization facility that does not show up on our balance sheet. We have $756 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 4.0 times on a net debt basis. based on our leverage, we could have incurred an additional $581 million of net debt as of the end of our second quarter. We are confident that our existing facilities provide us with the flexibility to invest in our future. Our leverage ratio was 2.3 times on a net debt basis as of the end of our second quarter, compared to 2.7 times a year ago. Strong cash generation and earnings drove this improvement. Our leverage ratio is at the low end of our target range of two and a quarter times to two and three quarter times. Cash contributions to our global retirement plan totaled $17 million in the quarter compared to $14 million in the second quarter of 2021. Contributions have increased for our defined contribution plans as participation grows in our U.S. plan. Global retirement plan expense in the second quarter was $21 million, up from $13 million in the same quarter a year ago. In the second quarter of 2021, we recorded a $6 million curtailment gain associated with terminating our defined benefit pension plan in the Netherlands, which reduced our pension expense last year. The remaining increase in global retirement plan expense relates to the growth in our defined contribution plan. Our effective tax rate was 24.9% in the second quarter, compared to 21.6% in the same period a year ago. Adjusting for impairment charges and restructuring activities in the second quarter this year, our effective tax rate was 24.4%. In the second quarter of 2021, there was no tax expense associated with a curtailment gain on the termination of the Netherlands defined benefit pension plan. Excluding this benefit, the effective tax rate in the second quarter of 2021 was 23.9%. The increase in our adjusted effective tax rate is due to the relative mix of earnings. In the second quarter, we incurred 59 cents of impairment and restructuring charges, of which two-thirds were non-cash charges. We're keeping our forecast for free cash flow the same as our forecast from 90 days ago. We expect free cash flow generation, excluding the benefit from our securitization facility, to be $78 million in 2022. or about 45% on an adjusted net earnings. Working capital, more specifically receivables, will consume cash this year. Customer advances, inventories, and payables will all be sources of cash and will partially offset the consumption of cash by receivables. We expect capital expenditures in 2022 to be $150 million. Depreciation and amortization are expected to be $94 million. I'd also like to share some of the metrics and amounts you'll be able to calculate from our financial statements. These reflect GAAP accounting for the securitization facility. Pre-cash flow in the quarter was negative $14 million, and pre-cash flow generation for the year is projected to be $178 million, which is about 100% conversion on adjusted net earnings. Networking capital was 25.6% of sales at the end of the quarter. Our financial situation continues to be strong. We're positioned nicely to fund organic growth and make investments in our operations that will serve us well for years to come. With that, we'll turn it back to John for any questions you may have. John?

Thanks, Jennifer. Ali, we would be happy to take any questions we have now from our listeners.

Of course, thank you. And if you would like to ask a question, please press star 1 on your telephone keypad. If you're on a speakerphone, please pick up your handset and make sure your mute function is turned off so that your signal reaches our equipment. Again, it is star one if you would like to ask a question. And we'll go ahead and take our first question from Christine Laiweg with Morgan Stanley. Please go ahead.

Hey, John, Jennifer, good morning. Morning, Christine. On inflation, John, Can you provide more details in terms of how much you're able to pass through to customers? And then on the supply side, how much of your raw materials do you have long-term agreements with? And are those suppliers honoring your contract?

So let me break it down between A&D and industrial, Christine. Typically, on the industrial side, we have a lot more ability to pass through inflationary cost pressures or price adjustments. So I would say on the industrial side, we've been very active to try and make sure that we don't get caught in the squeeze. The timing is never perfect, of course, but I would say in general, on the industrial side, we're pretty well covered. We typically don't have long-term pricing agreements with any of our customers. On the aerospace and defense side, on the commercial side, as you're aware, with the OEMs, typically we have long contracts, long pricing duration contracts But typically there also, we have worked very hard over the years to try and lock our suppliers into a similar timeframe. It doesn't always work, but we're probably covered for a reasonable percentage of the prices on the commercial OE side. And then on the military side, typically we'll also try to do the same. If our input costs increase, most of the time we've got one-year, maybe two- to three-year multi-year contracts on some of the major military OEM programs. So the opportunity to reprice comes up. It just doesn't come up quite as quickly, I'd say, on the industrial side. So inflation is definitely a concern. It's something we're watching, Christine, but it's not the case that every, you know, we've got a lot of fixed price from some of our suppliers, and on the industrial side, we have the opportunity to adjust prices relatively quickly. On the defense side, the price adjustment takes maybe a little bit longer before you can work through some of the major programs.

Thanks, John. That's really helpful. And then on the restructuring charges that you took in the quarter, how should we think about incremental margins going forward as volume recovers? Presumably now you've got a better cost footprint. So how much higher should we expect that incremental margins to come?

Well, the way I would put it, I'd put it slightly differently, Christine, because the vast majority of it, of the $25 million we took, about $3 million is associated with Russia. And then there's $3 million of what I call portfolio shaping. But the vast majority of it, $19 million of it, was in the aircraft business. And that really was us taking a step back and saying, look, we had projected OEM recovery rates by now of 2020, you know, in 2022, 2023, higher than what they're now seeing. And, of course, our projections were based on what both Boeing and Airbus thought back in 2020. And so we've made an adjustment to the size of the business, both the capital base and the – the employees to reflect on an ongoing basis maintaining profitability rather than it's going to be more profitable next year or the year after. In the year we're in, we're saying there's no adjustment one way or another, Christine, but it's more about we were over-facilitized and over-staffed given what we're now seeing in the recovery on the OEM rates. So there's no real incremental margin in that sense. What I would do is I'd say is the actions that we have taken are to secure the margin profile that we were going to anticipate over the coming few years.

Great, John. And if I could squeeze one more, and I'll pass it on to the next analyst. When you mentioned about the labor adjustment, what does that mean in terms of your preparation for when OE production rates actually do come up? And how do you balance between that lower cost structure and that flexibility to ramp up? It seems like the 737 MAX is actually at 31 per month now. And if Boeing is able to get the FAA approval for the 787 come second half of this year, it seems like then you'll have upward pressure there. In the rest of the industry, we're seeing labor shortage really be an issue. Like, how do you balance the two to make sure that when you do need the labor, you can get it back and meet those production rate increases?

Yeah, that's a good question to ask, Christine. So here's how I think of it. Let me just Let me use the 8-7 as an example. We've described that we have maintained our production level on the 8-7 over the last year or so, and we are maintaining a production level in the kind of the three to four shipsets a month level. And the reason we're doing that is because we want efficiency in the factory, and we want to make sure that our suppliers are not, you know, we don't cut them off and then try to restart them. You're aware of, you know, Boeing is not shipping any at the moment. So what's happening is we're building inventory of our finished products, Of course, that's part of the receivable story that Jennifer was telling as well. And so when Boeing – now, of course, Boeing is aware of this. We've agreed with them about this whole process. But when they start shipping again, they have a lot of them in inventory. Then they're going to wrap up to – I'm not sure what the number is – three a month, four a month, five a month. But it would be quite a while before their rate and the reduction in their inventory means that we would have to actually increase our production level. And that would give us sufficient lead time, I believe, more than sufficient lead time, probably a year or two, to put the necessary labor in place to do it. So we have, they've got lots of inventory sitting on the tarmac. We're building inventory to keep the supply chain running efficiently. And therefore, I'm not concerned about our ability to respond. That will not be a problem. We will be able to respond quickly enough to meet any demand increase they see.

Great. Thank you for the color.

You're welcome. Thank you.

And next, we'll go ahead and take our questions from Michael Termoli with Truist.

securities please go ahead hey good morning guys thanks for taking the question I guess John just to maybe stay on Christine's line of thinking I mean you guys implemented you know a significant restructuring plan in aircraft controls in 2019 and you know, and I think you've said, you know, the rates, you know, at this point now weren't really where you're thinking they would be. I mean, it seems like the 787s, you know, the only one that would be a big, you know, difference. I mean, how aggressive was your planning in terms of OE production rates at this point in 22? I mean, it certainly seemed like you know, we all knew the widebodies weren't going to recover for some time. So I'm just trying to further understand, you know, what was driving that impairment and restructuring when you guys seemingly started this process and probably had a good opportunity to even do more when rates and volumes were pretty low in the COVID downturn.

Yeah, so the previous restructuring, Mike, was in 2020. I think it was a quarter after the whole downturn. And keep in mind, at that time, nobody knew what was going to happen. And so we erred on the side of, in response to Christine's question, of making sure that if the OEMs were going to come back sooner, that we had both the necessary capital and the people in place to do that. So we tried to cut as deep as possible, but recognizing that the OEMs were going to do that. If you look at what happened this quarter, well, the E2, the 195 got pushed out by several years. That was a big production problem that we were planning for. And Airbus tempered their ramp from six a month to five a month. And that's been kind of an ongoing process. I think if you go back into the early 2020s of our fiscal year, I think they were all projecting six, seven a month on their rates, and it's just not happening. So this was, it was what I call a refinement Majority of it was a non-cash charge, but it was a refinement based on what we are now seeing and how long it's going to take for that OEM recovery to happen.

Okay. And what was specifically the impairment charge related to?

Mostly, you know, equipment, machines that were building this type of stuff. Okay.

Okay.

So you've got a lot of utilized machines. Okay. And then just on this, you know, building ahead, you know, on specifically, I guess, the 787 and the receivables, what are the mechanics there in terms of inflation, raw materials? I mean, you know, it sounds like you've worked this out with Boeing, but I'm just trying to think about, you know, I guess the value of that inventory you're holding, are you able to effectively pass that on to Boeing as you're building ahead or just, I guess the mechanics there, I mean, you kind of mentioned, you know, OEM long-term pricing, but any, any, differences or color there? I mean, it seems like as you're holding inventory, you know, that inventory could maybe potentially keep going up in value here, just given the tightness on raw materials and inflation.

Well, our pricing to Boeing is not, I mean, we renegotiated pricing with Boeing a year or two ago, Mike, so that's fixed for the foreseeable future. So that's The value of that inventory is not going to change because it's part of 787 and we've agreed upon price with Boeing. So that doesn't change. We've obviously done this in collaboration with Boeing to say we need to keep our production facilities going and we need to keep our supply chain going because the costs to all of us and the potential disruption, if you get a line break, would be much more difficult to restart than going from four a month to five a month to six a month. And so we have discussions with that, but there is definitely a growth on our receivables associated with this because we are clearly building inventory. Now, one thing that's nice about airplane programs is that we don't change this hardware hardly ever, if ever, given the type of product it is. So it doesn't age out in any way, but also the value won't change because of inflation. The value on our books won't change because of inflation over the foreseeable future. So we don't worry about any of that.

Okay. I mean, has your margin, your negotiated margin with Boeing then on that specifically gotten squeezed? I mean, especially in this environment. I mean, it sounds like you're going to have some pretty sharp headwinds on the 787 from a margin standpoint then.

Yeah, we don't go into the margin details, Mike, at the program level, I'm afraid.

Okay. But safe to say you can't, the pricing's been locked in. over a year ago, you said. I mean, is the same old true for you talking about the aftermarket? I mean, we were just at the MRO show hearing, you know, broadly suppliers getting 5% to 10% pricing. I mean, are you still locked in on the aftermarket with 787 in terms of pricing with Boeing?

Typically, Mike, the way our contracts with all of the OEMs work is that there is a – factor between OEM pricing and aftermarket pricing. Typically on the aftermarket, there's also escalation clauses that are different from the OEM side. So they are linked, the OEM price and the aftermarket price are linked, but typically the contracts around adjustments, inflationary adjustments or escalation clauses are different in the aftermarket, but I can't get into any more details than that.

Okay. All right. Perfect. Thanks, guys. I'll jump back in the queue. Thanks, Mike.

Next, we'll take our next question from Kai Von Loomer with Kellen. Please go ahead.

Yes. Thanks so much. So I'm a little confused about the 787. How come if you're building the inventory, and I assume you're not shipping it, how come it doesn't appear in inventory going up as opposed to appearing in receivables going up?

Because we have a long-term contract with Boeing, a long-term supply contract with Boeing, Kai, and so therefore it becomes an unbilled.

Okay, so it's basically been booked as a sale. It goes through the sales, but then it's there as, okay.

So that's why the receivables... That's why, you know, when we look at our sales on the A7, they're fairly... Steady, despite the fact that Boeing isn't shipping anything.

Right, right. But so many other suppliers or most of them are going at two a month. And if you're going at three to four a month, you've basically, you know, like how many of these things do you have sitting around? I mean, I would think it's going to be like a pretty big number.

Well, Boeing is taking some of them because they're still building airplanes, as you know. They're not shipping airplanes, but they are still building airplanes. And then we are, obviously, there are conversations about who holds what where, Kai, as you might imagine. I would say we don't have as many of them as Boeing has sitting on the tarmac. That's nice. But there is a certain build of finished product, which is, as I say, we have done this, in agreement with Boeing. We visited the Boeing factory in Charleston about a couple of months ago, and their only question was, are you sure you can get to seven a month when we tell you, like, you know, soon? And so they were not, you know, you've got to be able to ramp up. You've got to be able to ramp up. So their focus, at least a couple of months ago, was you've got to be able to respond because once we get this going, we're going to be ramping up pretty quickly. So we, you know, the level we've chosen in consultation with them, we feel is the Ideal level for the type of product we make to keep the equipment and the facilities going, not to overbuild and to be able to respond then appropriately if and when they see their rates go up.

Do you have a guarantee? Well, I guess my concern would be that they have 100 in inventory. You've got quite a few, not 100, but quite a few. that in fact if it takes longer that you will then have to you know do you have any guarantees that they will pay you and if you don't have to bring your rate down to two or pause for a while um we have a long term you know we have a long-term supply agreement with boeing we're obviously the only people that make this stuff if if you said like if the airplane program

went away, would you have an inventory problem? Then, of course, the answer would be yes.

No, no, no. I'm just saying if it takes them longer, that you would have to go down to a lower rate.

Yeah. And I think that would be something. So what we've tried to do, Kai, is rather than adjusting the race quarter to quarter based on the latest news, we've said, why don't we lock it in at the rate we're now at? And we review that each quarter. And we might decide in three months or six months or nine months, again, in consultation with what Boeing is seeing, to say, well, let's go down half a ship set a month or a ship set a month. And so we would try to throttle it in a way that's controlled and that also allows us to make sure the supply chain continues to function appropriately and ensures that we can wrap up again at the rate that we need. So, yes, we would adjust, but our objective is to adjust more slowly and deliberately, rather than saying, well, let's stop now for the next two quarters and not make anything, and then let's go back to making four a month after that or three a month after that. So the three is about trying to level load the facility at a level that we and Boeing think is a sensible level for the type of product we're doing.

So Boeing has said that nobody's going to be going at five a month. They're going to be at five a month or less through the end of 23. So The most favorable case for you is that they start actually taking these and paying them. But so until then, just so I understand it, until they really start taking the three to four so that your inventory doesn't continue to build or your receivables don't continue to build up, that number is going to go up. And once it comes down, if it ever gets to, I don't know, five or 10 in inventory, you're going to have a big cash flow gusher at some point, but you're going negative until then. Is that a fair way to think about it?

It will be a drag on cash until they start to take, build, ship more than we're actually making. That is true, Kakai. But as we start to look into the next fiscal year, I think we should start to see that equation change.

Right. And do you have any similar situations like on the A350 or any other important programs?

No, no. And I would also add, Kai, we have been in conversations that we are in continuing conversations with Boeing about the cash implications of building ahead, essentially, of what they're doing. And so there are conversations around that. So we're making sure that we're managing that effectively with Boeing to make sure that the overall situation is as best as it can be.

Great. I don't say we've spent a lot of time on this. Just one last one. The advances, they came down this quarter, but they have spiked up substantially. So where should we expect that the advances go as we move forward?

Yeah, so, Kai, the advances that we've had are activity largely on military customers. As you mentioned, in the first quarter we had it very significant. It went up about $100 million. We did work it down. I would say looking forward for the rest of the year, we're going to continue to work down, but I think it's probably going to be a net positive of maybe $10 million or so from where we are right now. We do anticipate getting some more advances, again, on the military side of the business.

So we'll see a little bit of a benefit. Net, they will go up from where they are or they will go down?

Oh, sorry. They will go probably up just a little bit from where they are right now.

Got it. And last one. So as we think ahead, they seem to be at an abnormally high level. I mean, going forward, is this kind of a normal level? So they might fluctuate, you know, 5, 10, 15 million, but they stay more or less at this level or is there a lot of room for them to either go up or risk that they go down?

I wouldn't say that there's, as you mentioned, we're at a very high level right now compared to our historical norm. Right now we're seeing strength in that business as it relates to the military and the willingness on the funding of that. So I would expect it to stay at these elevated levels for some time.

Excellent. Thank you very much, guys.

Thanks, guys. And as a final reminder, this is Star 1. If you would like to ask a question. And it appears we have no further questions at this time.

Ali, thank you very much indeed for helping us with the call. Thank you to all our listeners. We look forward to reporting out again in 90 days' time. Thank you.

And with that, that does conclude today's call. Thank you for your participation. You may now disconnect.