Triumph Group, Inc.
Q4 2018 Earnings Call Transcript

Published: 10 May 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Triumph Group Conference Call to discuss our Fourth Quarter Fiscal Year 2018 Results. This call is being carried live on the Internet. There is also a slide presentation included with the audio portion of the webcast. Please ensure that your pop-up blocker is disabled if you're having trouble viewing the slide presentation. You are currently in a listen-only mode. There will be a question and answer session following the introductory comments by management. On behalf of the company, I would like to read the following statement. Certain statements on this call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause Triumph's actual results, performance or achievements to be materially different from any expected future results, performance or achievements expressed or implied in the forward-looking statements. Please note that the company's reconciliation of non-GAAP financial measures to comparable measures is included in the press release, which can be found on their website at www.triumphgroup.com. In addition, please note this call is the property of Triumph Group, Inc. and may not be recorded, transcribed or rebroadcast without explicit written approval. At this time, I would like to introduce Daniel J. Crowley, the company's President and Chief Executive Officer; and James F. McCabe, Jr., Senior Vice President Chief and Chief Financial Officer of Triumph Group. Go ahead, Mr. Crowley.

[Daniel J. Crowley:]

Thank you, Kevin, and good morning. Welcome to our earnings call for the fourth quarter and full-year results for 2018. We had a solid quarter in Q4 and met our full-year guidance on all measures

[James F. McCabe Jr:]

Thanks, Dan, and good morning everyone. Our full year FY 2018 results met or exceeded our original guidance reflecting our substantial progress in this transformation. FY 2018 was a year of significant accomplishments to Triumph. We negotiated several important customer settlements, improving our business cases on key programs and strengthening those relationships. We increased our liquidity with $500 million of new financing. We increased our backlog 13% and improved its quality. We reduced costs including consolidating locations and segments. And we continue to reshaping our portfolio with several divestitures. Looking forward, FY 2019 is the year Triumph returns to top line growth. But first, on slide 9, you'll find Triumph Group's consolidated results for the fourth quarter. Our net sales of $897 million, decreased by 3% from the prior due to divestitures, organic sales increased by $7 million. The net organic sales growth include increased deliveries on the Global Hawk/Triton program and the Global 7000 and G650 programs, partially offset by Boeing and Gulfstream program completions and rate reductions. Adjusted operating income improved sequentially from the third quarter to $71 million, representing an 8% adjusted operating margin. Our fourth quarter reported operating income included several items noted on the slide, which we've excluded in our calculation of adjusted operating income. The most notable of these is a previously disclosed $345 million charge for the impairment of goodwill in our Aerospace Structures segment. As we discussed when we reported our third quarter results in which we posted $190 million goodwill impairment, the $345 million impairment represents the remainder of the recorded (00

[Daniel J. Crowley:]

Thanks, Jim. So, in conclusion, we continue to improve last year, and we're benefiting from strong tailwinds in our core markets. Our top-line is growing with this next year of being the first year in four years where new awards more than offset sunsetting programs. Our profitability and cash flow are expected to follow the revenue trend as we derisk our program and company portfolio. The strategic choices we are making both on divestitures and programs will create a more focused and cost efficient company and we're excited about the opportunities in Integrated Systems and aftermarket segments. Our turnaround and transformation remains on track as we pursue our best path to value for our customers and shareholders. At this point, we'd be happy to take any questions, Kevin.

[Operator:]

At this time, the officers of the company would like to open the forum to any questions that you may have. Our first question comes from Seth Seifman with JPMorgan.

[Benjamin E. Arnstein:]

Hey. Good morning, guys. This is actually Ben Arnstein on for Seth.

[Daniel J. Crowley:]

Good morning.

[James F. McCabe Jr:]

Good morning.

[Benjamin E. Arnstein:]

I was hoping you could give a little bit more color on the cash flow for this year. I mean I think you had previously talked about getting to somewhere around breakeven cash flow in FY 2019 excluding advanced repayments. Is that still a good way to kind of think about how this year might shape out?

[James F. McCabe Jr:]

Yes. Hi, Ben. This is Jim. So as we said, we're not prepared to give a guidance range right now, but we are saying that we expect meaningful improvement over the usage we had this year, $331 million I mean the variables include elements working capital, which everything from production inventory to advance rates. And when we get better clarity, we'll be happy to give you an update on that. But our targets have not changed.

[Benjamin E. Arnstein:]

Okay. And then maybe on the working capital, you've talked about I mean like $100 million to $200 million of improvement this year. How much of that is Global 7000?

[Daniel J. Crowley:]

So, we tracked working capital last year. Month-over-month, we saw the balance of physical inventory. I'm not counting the engineering development that's carried on the balance sheet. And it was trending up throughout fiscal year 2018. In about November, we're able to arrest that growth and by the end of the fiscal year, we pulled it down about $145 million, and that's all a result of our Inventory Attack Team. And as we look at what we accomplished in the first four or five months of that effort and planning for FY 2019, it comes from all three business units and all functions. Certainly, Global 7000 is part of that because we're priming the pump in production and production deliveries are going to be coming off. But it's also going to come from past due backlog and our Integrated Systems business. It will come from better material planning across all of our Structures programs, making sure we align our customers' schedules with our MRP, ERP schedules in the factory. And it'll come from smarter buying. So what I'm excited about on this inventory project is not only will it provide improvements in cash flow, but it's going to make us a tighter better run company because we'll plan and execute programs better.

[Benjamin E. Arnstein:]

Okay. Thank you.

[Operator:]

Our next question comes from Noah Poponak with Goldman Sachs.

[Gavin Parsons:]

Hey. Good morning, everyone. This is Gavin on for Noah.

[Daniel J. Crowley:]

Good morning.

[Gavin Parsons:]

On the $300 million cost reduction initiative, I think you're in year three now on track to hit the $300 million. But it looks like margins are coming down again this year in the guidance. So if you strip out kind of the headwind from declining pension income and amortization, can you help us understand what's offsetting the reductions? If there's more you can do beyond this plan? Yeah. Thanks.

[Daniel J. Crowley:]

Yeah. Okay. Great, Gavin. So, I'll start and, Jim, you can join in.

[James F. McCabe Jr:]

Sure.

[Daniel J. Crowley:]

So, Triumph's margins reflect the mix of programs that we have today and some of our larger programs like Boeing 747 and Global 7000 and in past G650, we're not generating margin. And so, overall, company margins have been temporarily depressed. Now, as we fulfill our contract obligations on Boeing 747 and as we convert Global 7000 from development spending and early production losses to crossover, breakeven and profitability and now with our new contract settlement on G650 all of those headwinds either abate or reverse. So it's really a phasing issue as it relates to margins. And Triumph is looking forward to the upside of having invested so much in development programs and also continuing to see strong margins out of systems and aftermarket. Jim?

[James F. McCabe Jr:]

Hey, Gavin. The two things you pointed out are very significant to this, so I'll just remind you this, the amortization of contract liabilities which rose about $125 million of non-cash income this year and – this year of being FY 2018 is going down to $65 million to $75 million next year, so that's part of it. And the other part is pension, and not only – on slide 16, I have the pension listed, it's going from $72 million down to $61 million. But the margins are reduced because pension is now being reported below operating income. So it's coming out completely. So it's not just that decline. The whole $72 million is coming out. So those are two big key non-cash drivers to keep an eye on.

[Gavin Parsons:]

Got it. And then on the divestiture strategy, when you took on the Tulsa Gulfstream ops, you were actually giving cash to takeover that business. So now I appreciate that kind of divesting in the underperforming businesses will have a meaningful impact on your margin and cash, but I'm just curious if it's now harder to divest those businesses that are either cash losing or have pension liabilities attached. Thanks.

[Daniel J. Crowley:]

So we've seen a strong response to all of the properties that we put up sale, and they often come from strategic buyers that know how to run those operations, that are prepared to make larger capital investments in those businesses than Triumph has been able to do in the last four or five years. And there's not that many properties out there, so we have not seen an issue in that regard. And we expect that the new owners of these businesses to build on the backlog that exists here and the strong relationships we have with the OEMs. And there's also international interest in getting a U.S. footprint in markets, so that really hasn't been a challenge. And the capabilities of these operations are quite good in terms of machine assets and talent, so I'm not concerned about that.

[Gavin Parsons:]

Great. Thank you.

[Operator:]

Our next question comes from Cai von Rumohr with Cowen and Company.

[Cai von Rumohr:]

Yes. Thank you very much. So you mentioned you're working on contract settlements, obviously Global 7000, G650 are high among them. Could you give us a little color of the key ones and you said it's going to be a contract plus, but is this because they gave you a little bit money and then you sign up for an onerous – potentially onerous future obligation or is this because you spent all this money and therefore it's clearly going to be a plus? Give us a little color on that if you could.

[Daniel J. Crowley:]

Sure. Probably the best example, Cai, is the one that I covered related to Boeing 767, and I went a little deeper on that on this call because after the last call, people made the assumption that when we do these negotiations with customers that it's an exchange of cash advances for margin give up, but in the case of Boeing 767, we had two plants that were generally underutilized that used to produce at higher rates and the cash advance funded the transition and then time – closure of the one of the two plants are shutting down those lines. That gives more base to the receiving plant. Marginal rates go down, fixed costs go down, and the business case improves and a portion of that we pledge back to the customer, as I said partnering for success. But our business case also went up. So it's those creative deals that we do with each customer and our negotiation with Gulfstream was different but also mutually beneficial. And with Global 7000, we've come a long way with Bombardier and we've put a lot of investment into the program, on development, and facilities, now production ramp up, and we're looking forward to getting to a rate of production where the cash flows is now reversed and we're in discussions with them and other customers about the fastest way to get there and what are the cash needs of the program between here and there, can't go into any further detail on it. But I think our track record of settlements with Spirit, Northrop Grumman, Boeing Commercial, and now Gulfstream give us some credibility when we say we're going to work through these issues in FY 2019.

[Cai von Rumohr:]

Thank you. And are there any of these that would require, I mean, are all of them settlements in which you get some cash up front and maybe you spend some money later and you get a net benefit later, or are any of these contractual settlements where you have to pay something back so that they would be – so they're all positive near-term as well as positive longer term?

[Daniel J. Crowley:]

That has been our track record and that will be our goal for FY 2019 as well. Just some color, all of the OEMs are trying to derisk their production ramps, so they are using – deploying their cash to their supply chain to make sure that deliveries remain on track. We're seeing that across the board. You cover the OEMs; you know their cash positions and you know their ramp rates. So it's about risk management, and while each deal is different, what we try to seek is what are the needs of the customer in the program versus what are the needs to Triumph and see if there's an overlap, and so far, we've been able to find those.

[Cai von Rumohr:]

Thank you. And just the last one, on divestitures, maybe give us a little color on what you sold in the fourth quarter. And more importantly, you've increased the target from 10% to 20% of sales, so that's, what, $340 million, something like that in terms of revenues. Can you give us some color on what you're selling? Are these profitable businesses where you get money, but you're giving some seed corn away, or are these businesses that are struggling, not making money, so to get anything for them is a net positive to the cash flow?

[Daniel J. Crowley:]

So rewinding the clock, our first divestiture was Newport News, which is an engineering services company, non-core, the buyer was an engineering services firm, so it was a perfect fit for them. And because it was non-core, we had a pickup. Then we sold our engine APU overhaul business. That used to be a struggling business. The team turned it around. We got a good price for it from Gores, and now they're looking at ways to expand the business. We sold in the fourth quarter a small machine shop that used to be family-owned and we sold it back to the family-owned. We viewed it as something that is a lower cost structure business that is highly price sensitive and really non-core and more build-to-print. We have other transactions that are similar to that that are very close to being completed. And then we're going to continue to look at core, non-core. Yes, some of the businesses will be cash users, others are cash generators, but we'll use a very strict criteria in terms of its strategic fit and its contribution to the company's economic value. And our goal is to clean up the portfolio. As you know, Triumph started with 47 companies two years ago. Through consolidation, we got it down to 20. Now, we've sold three. And I think when we're all done, that number will be closer to 10 to 12 operating companies, a better span of control for management, and a clear strategic focus.

[Cai von Rumohr:]

Thank you.

[Daniel J. Crowley:]

Thank you.

[Operator:]

Our next question comes from Sam Pearlstein with Wells Fargo.

[Samuel J. Pearlstein:]

Good morning.

[Daniel J. Crowley:]

Good morning.

[Samuel J. Pearlstein:]

Jim, can you talk a little bit about the revenue recognition change and how that's going to impact things for contract accounting and capitalized costs? I mean, what does it mean for the E2 and the Global 7000 revenues and margins? Are they at zero, or can they be negative now in the new rules? And any non-recurring kind of one-time impacts we should be expecting?

[James F. McCabe Jr:]

Well, without getting into the program detail, the overall impact of revenue recognition on us this coming year is not material, on revenue or an operating income basis. It's an acceleration of revenues which is – but also acceleration from the future years, so the net impact is not negative or positive. The real impact is going to be on the balance sheet, and that's where we take inventory, primarily NRE (00

[Samuel J. Pearlstein:]

Okay. And is there any change in terms of the reporting for your accounts receivable sales in terms of the cash flow, because I know there are other companies with the new rules that it moves out of operations into I think an investing activity.

[James F. McCabe Jr:]

I'm not aware of that. I will look into that, but there shouldn't be any change in the cash flow as a result of this. Firstly, the overall cash does not change. The presentation does not change to my knowledge. But we haven't reported yet in that format.

[Samuel J. Pearlstein:]

Okay. And then just going back to just the overall cash outlook for this year, I mean, I'm trying to just understand what you don't know at this point. It sounds like it would be the advances and then the timing on divestitures. What else really would be the driver, and is there any way you can put, other than an improvement on next year, any sort of bounds or a range or a magnitude of improvement?

[James F. McCabe Jr:]

I think we have put a bound on it to say that we expect meaningful improvement over what's happened in FY 2018. And if you look back at FY 2018, the cash used for the year was in the low end of our use range that we gave you last quarter, and it's much lower than the guidance we gave you at the beginning of the year. So we've over-performed, and yes, it's working capital which includes advances. But it's all the elements of working capital that are variable. We do work – we work on settlements. It can have big impacts on terms, on advances, on inventory, who owns the inventory, and development programs and the ramp rates. Those are all the variables. We are still in a transition, and I think we're more cautious about wanting to provide – only provide guidance when we have better information.

[Operator:]

Thank you. Our next question comes from Peter Arment with Baird.

[Peter J. Arment:]

Yes. Good morning, Dan and Jim.

[Daniel J. Crowley:]

Good morning.

[Peter J. Arment:]

Jim, a question on kind of expectations for debt levels this year. I mean your interest expense you kind of commented that it's mainly tied to higher – just higher interest costs. Are you expecting the debt levels to be relatively stable this year? Could you help us out there?

[James F. McCabe Jr:]

Yeah. So the debt level has a couple of components that change it. Divestitures are one of the ones that's variable. So as you know, we've done some divestures. We said we have a higher divesture target. And so I can't speak to exactly what the debt level would be because that would imply how much cash we're going to use as well as how many divestitures we're going to do, and that's still up in the air at the moment. But our interest is based on a forecast, which has debt not increasing dramatically.

[Peter J. Arment:]

Okay. And then just as a follow-up. Dan, you mentioned you've had a big effort on reducing the number of Triumph sites from 75 down to 52. How much does that dramatically change after what this increase amount of divestitures you're doing?

[Daniel J. Crowley:]

So the 52 number includes a transaction that we expect to close in the first quarter. And it's all part of the goal of getting Triumph focused on more value-added companies that have greater intellectual property and more design content and less built to print. As a leader, I try to get out to all the sites as often as I can, but with that many it's not always possible and you learn so much from walking the floor. Recently at our Macomb, Michigan gearbox business which is a critical supplier to GE and Rolls-Royce and others and having been there, it just really informed my views of things we need to do on information technology systems and shop floor process controls and automation investments. Now I have P&L leaders for the three businesses, but Triumph, we're a mid-cap company, but we operate and think as a smaller company, and the number of layers between me and frontline supervision is really low. And so I want to have a number of companies that we can really keep our hands on and some of these companies as I mentioned are better positioned with firms where that's their core business and they've got a very low cost structure. And that's the business they're in. Maybe Triumph has been tried to be too many things to too many people. And I think that works to a limit. And today's specialized world with global competitors, today you're not competing just with other companies and let's say the Southern California area, it's Korea, it's Taiwan. And it's the ability to focus and invest in the right areas. Triumph can afford to invest in what was 47 companies equally. So it's really rationalizing the portfolio, both the program portfolio and the operating companies and I think that's ultimately going to generate value for the shareholders.

[Operator:]

Thank you. Our next question comes from Ken Herbert with Canaccord.

[Kenneth George Herbert:]

Hi. Good morning.

[Daniel J. Crowley:]

Good morning.

[James F. McCabe Jr:]

Good morning.

[Kenneth George Herbert:]

Dan, I wanted to follow up on the comments you made regarding the sort of what you classified as a much more higher quality backlog, and I don't know if this is appropriate or not. But following on that prior comment, can you maybe just give some examples of that or maybe specifically how much of the backlog today would you consider build-to-print versus what it might have been in the past as compared to more design engineering work or if that's not the right way to look at it, how else would you sort of really characterize the quality of the backlog and what's driving the better push there?

[Daniel J. Crowley:]

Sure. So our backlog is about $4.5 billion. It's up 13% this year. If you look at Integrated Systems, which had the highest book-to-bill at 1.26, they're about 80% designed and 20% build-to-print, and they have an aftermarket component as well. Our aftermarket business is largely build-to-print. We don't do design, but this build degree (00

[Kenneth George Herbert:]

Thanks. Just as a follow on that, specifically within the Structures business, as you obviously taken a lot of cost out and you become more competitive in the marketplace, where would you say you are relative to sort of the peers or the industry from a cost standpoint within Structures or maybe how much further do you have to go to feel like you're – where you want to be whether at best-in-class or however you view sort of the goal or the benchmark there?

[Daniel J. Crowley:]

Sure. When I talk to our customers, the Vice President of the Supply Chain and we asked them, should Triumph be in the Structures business, and they said, we want you in the business. You're better than a number of other providers. And I can't tell you, which ones they named, but we're targeting takeaways from those customers or we're getting RFPs because of non-performance. Recently, I went over and met with the GKN leadership before the Melrose transaction closed, and they were very interested in Triumph's journey because we are two years ahead of where they were about to go and maybe where Melrose will go, and their question was how did you fix your relationship with Boeing, how did you get those settlements? And it was very clear. It started with fixing performance and then it went to finding mutually acceptable contract terms because they ultimately do need their Structures. But there'll be a shakeout in this market over time. I would say the Triumph right now is sort of mid-pack in terms of Structures. Some areas were better. Obviously, Northrop Grumman, they're happy with our performance in Global Hawk. We did a good job on G450 and G550. Ultimately on G650, we concluded it's cheaper for Gulfstream to do that. So it's a case-by-case basis. But in the end, Triumph's going to get down to Structures where we can add the most value and customers who want to buy from us whether it's design, build or just supply chain. And I'm not married to any one program. We'll continue to perform for our customers during any transitions. But I want to get to potentially a smaller footprint, but more profitable one out of Structures.

[Operator:]

Thank you. Our next question comes from Mike Ciarmoli with SunTrust.

[Michael Ciarmoli:]

Good morning, guys. Thanks for taking the questions. Jim, maybe just a little bit more to follow on on the Global 7000. You kind of mentioned minimal impact from the accounting changes. But I mean, presumably that's still going to be running at an operating loss this year considering everything has got to be expensed through the P&L. And I mean, is that the right way to think about it and calibrate our expectations and so you at least get to – I don't know where the learning curve really kicks in and you get to above cash breakeven, maybe unit 50 or so, but what should we expect that to be a drag on overall operating income in that sector – or in that segment this year?

[James F. McCabe Jr:]

Mike, you're right. When you're moving into production, there isn't much income to book and that's not going to change for us this year on that program. So it is a bit of a drag until we get into full production. And when we do with the revenue recognition in out years not in FY 2019, but in the out years could have a positive impact on margins because that NRE that we otherwise would have amortized in as expense will be written off the retained earnings on the initial adoption. So yeah, there will be a bit of a drag, but it's less of a drag than it was in the past as we continue to improve the program. And we'll talk about improving our mix – improving backlog, we talk about improving mix and improving price.

[Michael Ciarmoli:]

Okay. But presumably if we were on the old accounting method, you'd still be building up a deferred pre-production inventory and that's all flowing through the P&L right now under the new. So is it fair to say it's going to be running at a negative operating income level?

[James F. McCabe Jr:]

So, you're right that we now to expense some of those pre-production costs otherwise we would have capitalized, but they're not as significant as they were in the past and that's why I said it's not a material impact.

[Operator:]

Since there are no further questions, this concludes Triumph Group's fourth quarter fiscal year 2018 earnings conference call. There is a replay of the conference that starts today at 11