Moog Inc (MOG.A) 2020 Q3 法說會逐字稿

Good day and welcome to the Moog Third Quarter FY 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ann Luhr. Please go ahead, ma'am.

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 July 24, 2020, our most recently filed Form 8-K 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 remarks. For those of you who do not already have a document, a copy of today's financial presentation is available on our Investor Relations webcast page at www.moog.com. John?

Thanks, Ann. 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 2 key messages: first, short-term strength from our diversity; and second, 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. First, this was a COVID quarter, perhaps the first of several. We came into the quarter believing our defense, space and medical businesses would be strong, industrial will be pressured and commercial aircraft would be hardest hit. Looking back, the quarter unfolded pretty much as expected.

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 $0.93 remain very respectable. In addition, free cash flow of $90 million was one of our best quarters ever.

Third, we incurred various charges associated with resizing our business and revaluing 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 noncash.

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

And finally, given our healthy financial position, we're reinstating our dividend this quarter at $0.25 per 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 mean 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. 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 in 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 $0.93 were down 29% from last year.

Fiscal '20 outlook. As we enter the fourth quarter, the macroeconomic environment seems more predictable than it was 90 days ago. We're 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 improvements 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, and we suggest you follow this in parallel with the deck.

Beginning with aircraft. Sales in the third 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 a 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 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 OEMs but also their actions to reduce their inventory levels.

In the aftermarket, sales were down almost 50%. This was slightly better than what we 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 in efficiency in our production facilities, a result of precautions taken to protect our employees' health.

During the quarter, we took action to (inaudible) our commercial operations across the globe and incurred costs of $55 million. This 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 2 major markets is more stable today than it was 90 days ago. We still find ourselves dealing with 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 products.

On the commercial side of the business, the situation remains volatile. The OEMs 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're hopeful that the commercial aftermarkets may tick up slightly.

Turning now to Space and Defense. 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 continue 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 the range of flight vehicles were also down from a year ago. And sales into vehicle applications were about in line with last year, but the naval and security sales were slightly higher.

Defense -- Space and 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 well practices.

Space and Defense fiscal '20. So far, the impact of COVID on our Space and Defense business has been somewhat 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 run of stability will continue and fourth quarter should be somewhat similar to the third within the normal quarterly fluctuations in this business.

Turning now to Industrial Systems. Sales in the third 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 and the acquired sales from GAT were down organically. The continued downward pressure on oil prices is undermining investment and 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 exacerbated its impact on our industrial automation business.

Sales into simulation and 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 more positive note, sales into our medical markets were way up in the quarter. Sales of components used in breathing aids were higher on serving demand and sales of our medical pumps continue to grow in support of COVID requirements.

Industrial Systems margins. Adjusted margins in the quarter were 9%. 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 macroeconomic trends will continue to pressure our business. Sales into the energy, industrial automation and simulation and test markets will continue to experience downward pressure while sales in the medical applications should remain healthy.

Shifting from the macro to the micro. Bookings through the third quarter were marginally below our billings, signifying a declining outlook. Taken all together, we anticipate that sales in Q4 will be slightly lower than Q3.

Summary comments. At the time of our last earnings call, we were heading into a storm. We had hoped that Q3 would be the eye of the storm, the COVID quarter, and Q4 will 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're 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 our business.

Now let me pass it to Jennifer, who'll provide more color on our cash flow and balance sheet.

Thank you, John. Good morning, everyone. We've 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 1 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 U.S. 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 buildup 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 fiscal year '19 tax return filing on a low earnings before income tax 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 also has remained stable for our international pension plan.

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. We funded 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 release measures, we've also managed expenses to mitigate the impacts to our operating margin.

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 noncash charges. The noncash 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 evaluating 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 (inaudible) 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 stabilize.

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

Thanks, Jennifer. Anita, we will be happy to take any questions now to comment, please.

(Operator Instructions) We'll take our first question from Robert Spingarn from Crédit Suisse.

John, you said, and Jennifer echoed this, that you may have a little bit better visibility on commercial, not much. But can you talk to us about month-by-month trends, both OE and aftermarket? So going through the quarter just reported, and then maybe what you've seen into July here.

Let me do the OE side of the business. So the 2 big players, Boeing and Airbus obviously are our 2 major customers. They came out over the course of the quarter with new rates on a go-forward basis. I think the numbers was -- Airbus was going to go from 10 a month on the 350 down to 6 a month. And Boeing was going to go from 14 on the 87 to 10, and then that's kind of through the middle of next year. And then I think profits are about 7 a month. And so we size our business with that kind of long-term demand in perspective. That's what we sized for, that kind of adjustment that they were predicting.

I think the thing that happened, though, this quarter, as I mentioned on the call, was they also engaged in a significant amount of inventory rebalancing or destocking or however you'd like to call it. And so if I give you those numbers, 14 to 10 on the 87 and 10 to 6 on the A350, you might say, "Well, that's a 30% drop, 35% maybe drop in production rates." And yes, our OE business was down 60% in the quarter, and that reflects the destocking.

So we saw just a significant -- a much, much larger drop than we would have anticipated from the production rate adjustments that the OE -- that the major airline -- the airframers were making. And we think that's probably likely to continue as we go into the fourth quarter. It's very hard, Rob, to actually know exactly what that's going to look like because what happens is we have -- either we have orders from our OEM customers and then they just push the orders way out. Or we don't have orders and they order on a short time frame. They give us a long-term forecast but they order on a relatively short time period and the orders that you expect is literally still [don't turn up].

And so I'd say the quarter was -- on the OE side, reflected that. It reflected a kind of a volatility that was -- today, we look like we're pretty good. And then tomorrow, we get a push out that pushes things out by a year. Or we're expecting orders every 2 weeks for new ship sets, and then suddenly for a period or 2, you actually don't get them. So it was volatile, but the number was -- it was down 60%. And I'd say that was pretty, pretty fixed across the quarter. We'll report on what this quarter looks like as we end up the year. So I don't want to get ahead of that. We're just a couple of weeks into the quarter. But I think we're anticipating that, that kind of destocking would continue.

And so the downside of that is we're -- we've resized, but we've resized for their long-term production needs. And we're not resizing for the short term that might be a quarter or 2, where there's just much less demand. And so we still end up carrying a little bit of extra costs that we don't, in theory, need but we will need in September, October, November, whenever that comes back. (inaudible)

Before you go further, just quick to clarify. You said 14 to 10 on the 87 and that would be 30%. The destocking takes you down. I know you're not -- the 60% is not necessarily specifically the 87. How do we then factor in the continued decline later to 7 a month?

Yes. So we've adjusted our staffing to -- so that's not out at the presenting that's projected to be July of next year. And so we want to make sure that we've had the staffing to make sure that we can keep our -- maintain that 10 a month through that period of time. So that's 12 months away. And with attrition and some other natural things, I think we'll be able to adjust. It's always easy. If you know that in 12 months' time, there's going to be a 30% cut in the rate, that's something that you can adjust to. It's the precipitous fallout that was so difficult to -- that required such difficult actions.

So we're staffed to make sure that we can meet their needs. Their 10 a month, of course, Rob, doesn't necessarily all translate into exactly 10 a month from us. So there's a little bit of fluctuation there. There's also a little bit of timing advance on it. And again, they're holding a certain amount of inventory. But we're feeling comfortable that we're sized to meet their -- for the next 12 months, and then we'll make sure that we're properly sized after that.

Okay. And then on the aftermarket.

Yes. The aftermarket pretty much was down 50%. And I'd say it was fairly constant as we went through the quarter. And right now, I think it's pretty much in that same ZIP code. We monitor the amount of returns we get. There's a couple of bounce, the amount of returns we get, and then there's the spares that we felt.

And then -- and so we're monitoring those on a weekly basis. And right now, there's -- it drops about half. That's kind of probably better than if you look at flights up, that you might say are down 75% or 80%. But as I mentioned, we had a reasonably good backlog coming into the quarter, and the freight folks held up. And I think even if you're parking airplanes, there's some amount of maintenance that you need to make sure you're doing if you're bringing them back on, on the flight controls. And so we're anticipating that.

I would have said a quarter ago, we were hoping that the fourth quarter will be better and the first would be better again. Right now, I'm not sure that I have any grounds to say that. So we're thinking maybe the fourth will be similar to the third. Maybe there's a little bit of an uptick, but hard to predict at this stage.

Okay. And then just on the defense margins, the decline that we saw, does this reflect COVID disruption? Is it development? Is it mix? And do these come back as COVID improves? I know it's a modest decline.

Yes. So I think when you say defense, I think -- because the only margin that I think we provide is the Space and Defense margin. So as you know, defense, over half of our...

Space and Defense.

Space and Defense, yes. If you look at the margins year-to-date, actually, they're exactly flat with last year. They're in the kind of high 12s, 12.7, 12.8. And so I think it's just -- it's a reflection of slight shift in mix. We get margins move up and down. A very strong book of business on funded development. And there's no doubt there are some inefficiencies associated with the COVID activities that are going on that's probably pushed them down a little bit.

But it's within the normal, what I'd call, noise in that business. And as I say, year-to-date margins are holding pretty strong, pretty stable with last year.

Okay. And then just lastly for Jennifer on cash flow. You mentioned the strength in the quarter. Receivables sounded like they played a big role there. How do we think about -- is there any reversal from a working capital standpoint? Because I imagine some of your receivables benefit was not just collections but lower new business. And so how do we think about that going forward? And what is your CapEx for Q4?

So our -- so yes, we definitely had a very strong quarter from a working capital standpoint. Strong collections certainly led the pack. We also had customer advances that were really strong as well. In both of those areas, we will see that strength reverse as we go into the next quarter. However, we're still projecting to be cash flow positive into our fourth quarter. It will be moderating off the high level in the strength that we saw in Q3.

We're going to continue to monitor the situation as we go on a very regular basis. And that will be our guide for the spending patterns that we wind up choosing, and that goes for our capital expenditures as well. As I mentioned earlier, we held back on our capital expenditures to some very critical and necessary activities in the third quarter. We will selectively look to start reinvesting in some areas, so that may increase a little bit. And again, it's going to be the guide of how our business is performing as to how quickly we're able to do that.

And now we take our next question from Ken Herbert from Canaccord.

John, I just wanted to first start off. The restructuring charges you took in the quarter, I know, obviously, visibility is a challenge. But do you feel like you've effectively captured most of what you're going to have to do? And I know most of these are obviously in Aircraft Controls. But -- or should we expect further adjustments here maybe in the fourth quarter and into '21?

So we are hopeful that we've captured everything. As Jennifer did mention in her text that we had the word provisional on our filings today. And that's because one of the pieces -- evaluation of the business, and we're still going through the final elements of that before we file the Q. So there's -- there may be a marginal adjustment on that over the next week or so.

And then as we look into the next quarter, we're -- we believe that we passed the commercial resized. Now having said that, some of our customers are still looking at potentially adjusting their rates. So if the customers wanted to say on some of the big programs, the A350 and the 87, "That rate that we gave you a quarter ago, we're now adjusting it again." Perhaps that might precipitate something. But by and large, we think we've done everything we need to do on the commercial side.

The industrial side, there's still a lot of volatility there. We described the energy business. Oil is not looking particularly strong. So that may continue to weaken. Our industrial automation business may weaken. And so we may continue to have, what I'd call, small adjustments in some of our facilities around the world. There was a little bit of restructuring in our industrial business this quarter. Some of that may continue into next quarter. But we're not anticipating a big number, again, in the fourth quarter or into next year, like we saw in the third quarter. So I think it will be at the margin. There'll be adjustments here and there to try and reflect more local conditions.

Okay. And as I think about the actions you've taken from a cost standpoint, how do we think about those in terms of just sort of running still to stay in place versus how much can actually contribute to sort of margin improvement as we start to think about coming off the trough in '21 and beyond?

Yes. I think the way I would describe it is the adjustments that we've made, all other things being equal, our commercial business is down -- well, let me do the commercial OE side. So the commercial OE side of it is down this quarter by 60%. On a run rate basis, at the March volumes that the OEs are predicting, a year out, it should be down 50% on a volume basis from what it was 2019 -- back in 2019. And so our adjustments are designed to when you get to that stability, that you recover the margins that we would have had prior to '20, to what's happened with COVID. So you get to margins that were equivalent to when you had production rates that were much higher back in 2019.

The underlying margin improvement across the aircraft business is tied to the overall operational improvement program that we've described, and that's continuing. But of course, in the course of the last quarter, that has taken somewhat of a backseat to liquidity issues and leverage issues. So that's where we will see fundamental margin improvement. What I'd say is the actions that we've taken when the production rates stabilize to get it back to margins pre-COVID and then the underlying set of activities that we've had to improve margins will continue in parallel.

Okay. That's helpful. And if I could, just finally, within Space and Defense, the defense sales were, if I remember well, just down slightly, maybe mid-single digits there. Was there anything in particular driving that? Or anything that maybe just slipped to the right? I know you called out maybe timing around some of the 4 military sales, but anything else you'd call out within defense that's non-aero related.

No. Some of the midsized programs were a little bit lower but nothing of significance. I think it was -- over the last year, we've seen significant growth in that business. Some of it is you've got some pretty high comps. So no, nothing unusual. Nothing that we're concerned about at this stage. We still have good, strong hypersonic activity both on the space side and then the defense side. And there was just some lower rates than some of the component shipments.

So I don't think at this stage there's any trend. If it were to continue for a few quarters, I think we might want to discuss it a little bit more. But for the moment, I'd call it, normal noise. And that business has been very strong, and so it's perhaps just coming off a little bit of a peak.

(Operator Instructions) And now we take our next question from Michael Ciarmoli from SunTrust.

John, just on maybe -- just quickly for some more clarification. The charges that you took in the Aircraft Controls segment, I think it was almost $19 million of inventory write-down. Could you maybe elaborate what specific -- just more details there? Any specific programs? And then even the write-down of the asset impairment, what that was tied to?

So I'll offer some thoughts and I'll invite Jennifer to perhaps add additional color. So both the inventory and the asset impairments are looking at the future size of the business, the future volumes in the business and taking a look at the inventory and the assets that you have and then reevaluating -- revaluing them on that basis.

And so part of our -- part of the inventory processes that we have, of course, is as inventory ages, you start to take some obsolescence charges on the inventory. And given the reduction in demand, inventory is going to age. If 87 is half of what it was and 350 is half of what it was, inventory is just going to age into that obsolescence process. And so you get some inventory write-down through that.

And the assets, we have machines. We have lots of test equipment and stuff, where we had assumptions around the utilization of that over the coming years. And again, if the business has dropped to half, the value of those assets is reduced accordingly.

Let me ask Jennifer, is there anything else you'd add to that?

Maybe just a little color on those. On the inventory side, as we take our review for charges there, we look at various things that can include design changes that can happen in a certain amount of time before we can no longer use that inventory. And customers have different requirements as far as some of the ages of the inventory that we're using on their products. So those are some of the things that get into our calculation when there is a delay in -- or a shift out in requirements from a customer demand standpoint.

And on the long-lived assets, we certainly are looking at the recoverability. There's -- it really follows the accounting rules that we need to take into consideration from a recoverability standpoint. So we do that. We look at the future cash flows of these businesses over a certain amount of time that's prescribed by the literature to make those determinations on those charges.

Got it. And then maybe just segueing in with keeping the inventory in mind and sort of the aftermarket trends. Obviously, you guys were a little bit more wide-body exposed. We're seeing certainly some of the older legacy wide-bodies just totally get scrapped. But we're also seeing dramatically reduced flying hours, again, with the international travel restrictions still in place. How are you guys thinking about sort of inventory obsolescence tied to some of those older planes? Even if there's parting out used in serviceable, does that keep your aftermarket maybe tamped down even more until we really see a big recovery in international travel and more utilization on those larger platforms?

Well, Mike, I mean we hope that -- so we did -- our aftermarket is down 50% this quarter. I think most of us are hoping that the beginning of this quarter was the nadir in terms of flight operations, and if anything, flights happening. There are some more flights happening now, not a lot more but a little bit more. The freight business has continued. And so we're feeling like the 50% that we did in Q3, we think that's sustainable into Q4. But -- and part of that is we've already assumed -- I mean all of those old 777, 47, 380s, I mean they're already pretty much parts. And so we -- that's already baked into how we're thinking.

So we believe we've captured it, but it's so much of an unpredictable time right now. But we're watching it week-to-week, and the third quarter played out like we thought. I'd have to say 90 days ago, I would have said -- and that we had this conversation internally multiple times with our aftermarket folks on the commercial side, I have been doing that, why wouldn't we be down 80% -- 75%, 80%? That seems like nobody is flying airplanes. But they went through it detail by detail with each of their customers and line by line. And they were pretty confident we'd be down maybe 50% to 60%. And in the end, we were down just about 50%. So that same process that we are looking at as we go into the fourth quarter. And right now, we're feeling pretty comfortable that it should be somewhat similar to the third, but hopefully, not significantly worse. I think size up in the fourth quarter, at least at the moment. Okay, they're a little bit better than the third quarter. So that's what we're thinking.

Got it. And then just the last one. Can you just give us an update on where you are with the MAX? I know you don't have a significant amount of content. But I think last call, you were talking about kind of keeping that production line a little bit warmer. And you had some safety stock there. You expect it to drop off. But where do you think that -- does that really drop off significantly now in the coming months?

Well, it's been down significantly over the last several quarters. And I think as we look into the fourth quarter, it's immaterial, let me put it that way. The sales on the MAX are immaterial in the fourth quarter at this stage.

And I will take our next question from Cai von Rumohr from Cowen.

So start with the green eye shape question. The individual comments you made on commercial -- excuse me, on aircraft add up to $281 million, and basically you reported $249 million, so a difference of 32, but the other ones were pretty much spot on. How come the difference?

Okay. You're going to have to do those numbers for me again because I didn't catch all of those.

Well, if we do the bottoms up, what you gave us about where commercial OE was, where military was, it looks like it adds up to $280 million. And yet you reported $249 million. Is that is -- is this part of this, the inventory? Is the revenue...

Oh, sorry. You're saying -- the $280 million number, Cai, where are you getting the $280 million number?

From adding it up individually. What -- the individual comments you made about commercial and military?

So I apologize, Cai. Are you talking about the comments that we made last quarter or the comments that I made just now?

The comments you made just now, yes. Well, listen, if this doesn't ring a bell, let's deal with it offline. So you mentioned -- you talked about sales being better in the fourth quarter. I mean when you made those comments about the individual items, were you talking relative to the third?

Yes.

Okay. And then specifically on industrial, I was kind of surprised that the industrial -- that the automation didn't look a little worse. And basically, given that there are no -- I mean, I know Textron, for example, in simulation, closed a plant. In energy, even with gap, I mean the numbers look good. The last downturn, you got totally smashed. What kind of risk is there in those 3 businesses? Because you said -- I mean I think the guide -- the comment was you expected industrial to be a little bit weaker. It's down a bit 10% because -- any color you could give would be great.

Okay. Cai, just -- your voice is very faint. So I think I heard it all, but let me try to answer it. And if I miss something, maybe you could repeat it. I think your question is, so you might have expected a more precipitous drop in our industrial markets on the automation side, on the energy side and on the simulation test. And I think you mentioned the Textron folks getting out of some of the simulation business.

Yes. Well, I mean -- so the industrial automation is down 17% from a year ago. That business, as we kind of described in the past, typically, it lags the consumer. And then it takes more time, but it's a kind of a slow lag into a reduction. We were already anticipating a reduction coming into the quarter, but most of our customers continued to take products. So a 17% reduction is pretty large. Is it likely to continue to weaken? I think that's what we are feeling. Our book-to-bill was slightly below 1, as I mentioned. But it's not a precipitous drop in terms of the book-to-bill.

So coming into the quarter, we had a reasonable backlog. We had a reasonable book-to-bill in the quarter, north of 90%. And so that's really where we start to do -- that's the best predictor of what the next quarter looks like. Beyond that, how long it will continue to soften versus when we might see a recovery is always hard to predict. I think it will continue to soften for 2, 3, 4, maybe 4 quarters yet to come before we start to see a recovery. So that's the industrial automation.

The simulation and test, clearly, that's down. We had anticipated a couple of quarters ago, simulation might be an upper this quarter with additional training for the MAX, but that's down. The big guys at CAE and flight safety, though, continue to be reasonably predictable. And the true business at Textron got out of, that was not a big player, plus the assumption is that the other guys pick up whatever they might have done. So the fact that one of the smaller players' exits hasn't affected the market, and given the fact that we have pretty much the vast majority of the market, it doesn't affect our volumes to a large extent. It just reallocates them across some of the other customers. So that's down. And we -- again, we don't think that, that's going to get better in the next quarter or 2.

And then the energy business, we had a little bit of acquired sales. And I'd say the energy business just isn't going to get any better. I mean it's been down for quite a while. And you're right. We got slammed. Well, it's a long time ago, now it's 2014, '15. But at that time, we had an energy business that if I rolled it all together in terms of exploration stuff was in the $80 million to $100 million range, and it dropped to $30 million. As we're here today, we're in the $30 million to $40 million range. We were in the mid-30s, and so it never recovered. Even though oil has kind of crept back up into the $60, $70 a barrel range, we started to see a little bit of the recovery but nothing significant. And so we're still very close to what I'd call the low points of the clash that we had back in '15 and '16. And that's why I don't think it will get better. But we're feeling like it's got some level of stability associated with it.

Very helpful. And then going to the balance sheet, is there any opportunity -- the inventories were up particularly with the write-off. Is there any opportunity to destock your own inventories in the fourth quarter? And what about payables?

Yes. So as we're looking at inventories, that actually does present an opportunity. So I mentioned before, kind of the receivables and customer advances that were strong, that will have some pressure into next quarter. We will see some opportunities in inventory. So as we've worked through this past quarter, we have had success in slowing our incoming inventories down. And that happened over the quarter.

So earlier on, as you might imagine, there's a lag as we're waiting from clarity from our customers as far as demand goes. And then there's a further lag when we push it through our supply chain. So throughout the quarter, we did see some improvements in slowing the build of the inventory. That should start to turn as we look into the next couple of quarters. And that will push some of the pressure into the receivables as we're able to move some of that inventory.

Yes. There was a big refocus of, and most of the purchasing supply chain folks onto trying to push inventory out. But what's happened, Cai, is that as fast as we're trying to push it out with our customers, demand from our suppliers, demand from our customers was dropping even faster. And so our folks were chasing it. They were running down a hill and they just couldn't run fast enough. And so we're going to continue with that. But we think it may take another quarter or 2 before we actually turn that tide.

Our incoming receipts were down fairly significantly in the third relative to the run rate of the first half, but not sufficiently down just to get ahead of the lower demand on the customer side. And we have to be a little bit careful because we've got a lot of suppliers. Some of them are smaller suppliers. And we want to make sure that we're honoring contracts. And we're working with our suppliers so that over the long term, they'll continue to be partners for us. And so we want to -- it's not just a matter of tell them, please don't deliver or we won't pay you. It's something that you have to work with them. So we're working very hard. There's a lot of effort going into it. But it's trying to get -- we're not going to -- we're not ahead of the drop in demand yet. That will probably take another quarter or 2.

Terrific. And the last one, Operations 2.0 in the aircraft sector, where are you in that?

Well, the way I would describe it, Cai, is it's taken a pause over the last quarter because the focus was on liquidity. So for instance, a big part of that effort is to work more with our supply chain, improve our supply chain processes. We talked all about that a year ago when we had some quality issues with suppliers. And the last quarter has been focused on reschedule to try and conserve cash. And so the underlying process improvements that we've been working on, they essentially took a back seat to get everybody trying to reschedule delivery so that we can conserve cash and make sure that we're not building excessive amounts of inventory.

As we stabilize, which is I think what we described on the call, our focus will gradually shift back to those underlying structural improvements that we had been engaged in. So I would say we've taken a pause for a quarter. We've stalled in terms of our ability to move it forward, also with a lot of people working from home. And as we get into the fourth and the first, we're starting to fire that up again, but it's going to be at a slower pace than we thought. So all in all, we'll probably miss 1 to 2 quarters in terms of the improvement that we would have anticipated had we not had this COVID issue.

We'll take the next question at this time. Mr. Herbert, your line is open.

John, just one quick follow-up. You've obviously talked about and we've got the build rates from Boeing and Airbus. As you look at your wide-body portfolio, where do you see still the most incremental, maybe further downside risk? And are there any -- beyond what Boeing and Airbus have talked about, and are there any particular programs that you're notably worried about?

I think, at the moment, everybody is worried about the whole commercial side of the business. Let me do -- let me just walk through the program. So the 87, I think Boeing has said, will drop from 14 to 10 to 7. I'd hope that we could do 10 for the next 12 months. I'm not sure whether that's all going to play out. I could imagine that, that might come under some pressure just given the additional COVID cases around the world and perhaps the lack of a resurgence in international flying that could take another 6 to 12 months before we ought to get back on international airplane. So I can see that, that -- perhaps that would pressure 87 volumes. 350, they're already dropping to 6. Maybe that's -- I don't know. Again, maybe they'd see an incremental drop down. 37, we're not planning for a lot. It's not a big program. We hope that, that would come back, but that's probably into next year based on everything I read. And I'm sure, Ken, you have even more insight than we do.

So -- and then beyond that, those are, by far, the biggest programs for us. They're the ones that really drive our book of business. We got some 777 stuff. Maybe there's a little bit of extra 777. I think the 777X looks like it may be delayed a little bit. But those are the big programs for us. We don't have much of any -- we've got nothing after the 380s. So that was already done.

So I think it's more kind of a macro worry that I think we would all share, which is are the wide-body production rates going to sustain even at the lower levels that the OEMs are now predicting? How long will it take for international flights to come back and really start to see the utilization pick up on those?

And we'll take our next question from Ron Epstein from Bank of America.

How -- in the crisis that we're in now or the pandemic situation, how has it gone with the OEs, right? I mean there was Partnering for Success 1 and then Partnering for Success 2. Has there been any back off of that in terms of helping the suppliers out through the major disruptions that we've gone through? And how has the messaging been from the OEs down to you in terms of rates? And like you just highlighted the probable and reasonable risk to 787 numbers probably being a bit lower than what we thought or maybe what Boeing communicated. Has there been any communication on those fronts?

So let me be really clear. I said possible, I think. I didn't say probable, Ron. And that's just -- that's based on what I read in the headline newspapers and the folks in your business you publish in terms of international flights. So there is no insight behind that. It's a purely one man's opinion and as such has a very dubious value, I would suggest.

But I think there is always the risk of how the airplanes are going to come back. So that's not a reflection of anything that we have got from our customers. It's just when I asked the question, "Do you see downside risk?" I'd say the answer is yes.

I'd say the communication with the OEMs has been -- it differs by OEM. Again, there's only 2 major players right now, and there's nuances to the way they communicate. But I think both have been going through, of course, an incredibly difficult time themselves over the last quarters. And from our perspective, because the commercial business, I mean as we looked at the third quarter, it's under 20% of our business. We have a very strong Defense, Space, Medical business. It's -- this is not a life-or-death business for us. Clearly, the drop in rates has a negative impact on us from the margins. And -- but even at that, our aircraft business was still, on an adjusted basis, had a positive operating margin. We're generating cash. And so we're not in the type of a critical situation that I think some of the other suppliers to the major OEMs may be in because they're so dominated by commercial. And I'm guessing that that's where the Boeings and the Airbuses have spent more of their time. When they assess the risks to the supply chain, they are probably looking at which companies are really at risk. And they're probably spending more time working with them and changing the way they do business with them.

For us, it's a big part of our business, but it's not a life-or-death part of our business. And so I would say the relationship with the OEMs has been a lot of communication, a lot of working together, but not fundamentally different in terms of providing additional funding or anything like that.

And then maybe just as a follow-on to that. When -- given the resilience that you've seen because of the diversity of the portfolio or the businesses that you have, longer term, do you see any tweak to your strategy to diversify even more, right? Because I guess, clearly, having that diversity today really has been a blessing. So when you start to selectively invest in stuff that you guys have said that you'll start doing at some point, are there new areas you want to go into? Space looks like it's doing just fantastic for you. Is there more to do in space, particularly with the emerging and quickly growing commercial space markets? I mean how are you thinking about that?

Yes. I think, Ron, interestingly enough, we've always been diversified. And actually, I think if you go back through decades and you look at how much of our business was aerospace, how much was kind of space, defense and industrial, it actually has always been somewhat similar.

The one area, of course, that we did get into, which was a significant diversification just over a decade ago, was the medical business and now it's doing great. But of course, as you know, we had our challenges. And for many, many years, we were -- the question was, why are we in that business? Both from the analyst community but also ourselves. We were asking ourselves.

So I think we've always been diversified, but this, I think, is really important. We are diversified across markets. We are incredibly focused in our technologies. And so we take our technologies, which is high-end, high-performance motion, fluid control systems, and we will take them to any customer that actually needs that type of capability. And what happens is as we find new customers, eventually those customers kind of turn into a market because they've got similar needs. But what we provide to downhole exploration is actuators that are not the same but somewhat similar to the actuators that go on military vehicles, on industrial equipment. And to some extent, it's the same technology that goes on flight controls with airplanes. So we are incredibly focused on our technology.

And so if you said, will you diversify out of the technology that you're in? I'd say, no. That's what we do. There's add-on pieces and you broaden your product portfolio over time. But we are focused there. Does that -- if there's new opportunities emerge in markets that are -- that need that, then we will find our way into those markets through working with customers. And then maybe at some stage, we'd call it a market. Another -- it looks like we've diversified further but it's not a strategy to say, well, let's look at a new market and let's jump into that.

So I think we're nicely diversified as it is. I like diversification. I've always liked it. And I think right now, of course, it's nice for the market. Sometimes the market wants you not to diversify. The market is like, "We can do diversify it for you, just you be a pure play." But if you're running a business, diversification is really helpful, and we'll continue to remain diversified. And if the right opportunities come up because they fit with what we do and the capabilities we have, we jump into them. But it has to fit with who we are and what we do. We are -- just jumping to a new market, I don't think would be very successful for us.

And now we'll take our next question from Michael Ciarmoli from SunTrust.

Can you happen -- Jennifer, John, do you have the bookings by segment at the quarter end?

No. We don't provide that, Michael, sorry. We provide the total backlog, but we don't provide detailed bookings by segment. Total backlog as consolidated 12-month backlog at the end of the quarter was $1.7 billion, which was unchanged from a year ago.

We have no further questions at this time.

Anita, thank you very much, indeed, for your help. Thank you to all of you for listening. We hope that you all remain healthy and safe and that your families do as well. It's been a tumultuous quarter, I think, for everybody, all of us. And so hopefully, in 90 days' time, I think the next quarter is probably going to be challenging for everybody as well. But perhaps in 90 days' time, we'll all feel like there's more light at the end of the tunnel. And we wish you all well in the meantime. Thank you very much.

This concludes today's call. Thank you for your participation. You may now disconnect.