Triumph Group (TGI) Q3 2017 Results - Earnings Call Transcript

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Triumph Group, Inc. (NYSE:TGI) Q3 2017 Earnings Call February 2, 2017 8:30 AM ET

Executives

Daniel J. Crowley - Triumph Group, Inc.

James F. McCabe - Triumph Group, Inc.

Analysts

Cai von Rumohr - Cowen and Company LLC

Robert M. Spingarn - Credit Suisse

Sheila Kahyaoglu - Jefferies LLC

David E. Strauss - UBS Securities LLC

Samuel J. Pearlstein - Wells Fargo Securities LLC

Peter J. Arment - Robert W. Baird & Co., Inc.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Kristine Tan Liwag - Bank of America Merrill Lynch

Michael F. Ciarmoli - SunTrust Robinson Humphrey, Inc.

Benjamin E. Arnstein - JPMorgan Securities LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Triumph Group Conference Call to Discuss our Third Quarter Fiscal Year 2017 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 are having trouble viewing the slide presentation. You are currently in a listen-only mode. There will also be a question-and-answer session following the introductory comments by management.

On behalf of the company, I would now 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 GAAP measures is included in the press release, which can be found on their website at www.triumphgroup.com. In addition, please note that 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 and Chief Financial Officer of Triumph Group, Inc. Go ahead, Mr. Crowley.

Daniel J. Crowley - Triumph Group, Inc.

Hey. Thank you, Stephanie, and good morning. Welcome to our third quarter conference call. Triumph's performance continued to stabilize in Q3 building on a solid second quarter as part of our commitment to predictable financial performance.

Since announcing Triumph's One Company integration efforts nine months ago, we are ahead of our cost reduction goals for the year, and winning new business at higher rates quarter-over-quarter. We delivered another quarter of improving cash usage as a result of working capital management. However, we are updating our full year cash guidance to reflect delays in customer payments. As we approach the end of our fiscal year in March, we reaffirm our full-year guidance for revenue and earnings. While Integrated Systems and Product Support remain our biggest drivers of shareholder value, we are seeing early benefits of our turnaround efforts in Aerospace Structures and Precision Components.

Now starting on slide 3, our results for the quarter were in line with our expectations. Triumph generated $55 million in operating income on net sales of $845 million. Net income was $29 million while earnings per share were $0.59. When charges for previously announced divestitures and restructuring are excluded, adjusted earnings per share were $1.01. We continued to tightly manage cash and used $37 million of free cash flow in the third quarter, down from prior-quarter levels. Our operational highlights include continued strong margins in Integrated Systems and Product Support, recovery of all corporate-level red programs in Integrated Systems, Precision Components, and Product Support business areas, and we continued to make progress in Aerospace Structures with only two remaining red programs, G650 and Global 7000.

We've seen improving execution on programs resulting in a net positive change in our program EAC positions in this quarter. This is an important financial inflection point. We've only had one forward loss in the quarter, limited to a $5 million overrun on an engine component production option that was bid aggressively in 2013. Our backlog remains about $4 billion in spite of customer rate reductions on several platforms as we succeed in dual-sourcing and take-aways. Triumph will exceed our FY 2017 cost reduction goals, and is now focused on FY 2018 and FY 2019 initiatives.

Turning to page 4, we are doing what we said we would to restructure and transform the company, and are seeing the benefits in the numbers towards our goal of long-term profitability and growth. Q3 was an intensive quarter for the transformation with plant consolidations, divestitures, head count reductions and lean deployments, all happening in parallel. The bottom line is that we forecast to exceed our FY 2017 cost reduction goal of $44 million by $12 million or about 25% towards our three-year goal of $300 million and we're now developing plans to step up these savings in the out years.

A few highlights. Our five facility consolidations are proceeding, which will eliminate over 450,000 square feet and save $25 million annually with five more planned for FY 2018. And while our current year earnings reflect the impact of restructuring, the payback on our consolidations is less than 13 months on average. We continued head count reductions to match our business pace and enhance competitiveness. And we've staffed the senior leadership team, upgraded 8 of our 22 operating company leaders, and staffed the four business unit functional teams to drive accountability for performance across Triumph.

Year-to-date, Triumph has improved its overall cash conversion cycle from 71 days to an average of 50 days. The supply chain initiatives we've implemented across all spend categories are now benefiting new bids. During the quarter, we announced sale of the Triumph Air Repair, our APU business in Asia and Tempe, and this sale reflects our objective to divest non-core businesses and shape our portfolio around businesses that align with our long-term strategies. We've also conducted over 204 lean events and trained over 100 change agents in the third quarter, who are streamlining the way we do everything, from closing our financial books to repairing thrust reversers. And these events have been key to improving cost, quality, and on-time delivery.

On slide 5, we provide highlights from our business units. Though our large structures programs get the headlines, two business units generate a majority of our company's shareholder value: Integrated Systems and Product Support. And while our efforts to drive more value out of Precision Components and Aerospace Structures are bearing fruit, Integrated Systems and Product Support are the biggest flywheels of revenue, cash and earnings for the company. In fact, some 40% of Triumph's revenue, and 74% of our operating income comes from these two business units.

Let's look at Integrated Systems first. Excluding corporate cost, Integrated Systems generated 29% of our revenue and 57% of our operating income year-to-date. Their Q3 operating margin was 20%, up year-over-year. They participate in a broad array of military and commercial platforms, from aircrafts like the A320 and A321, to Boeing 737 and 787, to helicopters, including the CH-47, Apache AH-64 and the UH-60, to engines, including the CFM-56 and Leap series. From hydraulics, to gearboxes, to landing gear actuators, to engine and thermal controls, Integrated Systems designs, builds and supports the parts that make takeoff, flight and landing possible.

They have roles on programs that are accelerating in rate, including the A320, 737, A350 and F-35. And they've got significant content on the CH-53 program, and are bidding new work on the B-21 Bomber, T-X Trainer and MQ-25 refueling drone. And although spares has always been a key revenue component, Integrated Systems is teaming with Product Support to capture more of the aftermarket for their own systems. And as customers refresh systems, such as the FADECs, or Full Authority Digital Engine Controls, for obsolescence and capability upgrades, we benefit.

Integrated Systems is active in dual-source opportunities including the F-35, A320 and A350, all driven by affordability pressures. And we're developing products that will plug and play in the new electric aircraft, just as cars are adopting electric steering racks in lieu of hydraulic ones. We view Integrated Systems as an area to invest, including product R&D, product line acquisitions and niche technology from M&A. So in closing, Integrated Systems is well positioned in multiple markets and platforms, is driving shareholder value and is a candidate for growth on dual-sourcing and new starts.

Now shifting to Product Support, the demand for aftermarket services is well documented in the press as thousands of new aircraft enter service each year, and this is drawing OEM attention to the $67 billion market. Triumph is already well positioned in MRO. It is now expanding into longer-term partnerships with OEMs and carriers to ensure aircraft ability and provide top and bottom line growth. Product Support generated only 10% of our revenue year-to-date, but delivered 17% of our operating income. In Q3, operating margins were 17%, up from prior year.

Product Support is also a strong contributor to our top line growth with a 6% revenue CAGR over the last three years, which is projected to grow to 9% in the coming years. Their strong customer support is enabling them to win new MRO work and expand their customer base. Some recent wins include the KC-10 and C-17 on the military side, and overhauling of the CF56-3 (sic) [CFM56-3] fan reverser, which has over 3,500 units in the field. And we're partnering with FedEx and UPS, and our sales with them are up over 20% in the last two years. In fact, I recently visited FedEx's Memphis hub to see the [ph] sort (10:05) and received accolades on Product Support's work there.

Over time, we expect to partner with the OEMs on long-term agreements for sustainment. For example, we're doing thrust reversers and flight controls for Boeing and Airbus out of our Thailand facility. And we're supporting discontinued fleets as well. And last, we're partnering with world-class distribution companies like Aviall and Satair on distribution. We'll be making investments in Product Support in the following areas: acquiring rotable inventories to support out-of-production aircraft, and pursuing acquisitions to take advantage of the fragmented aftermarket supply chain.

Now moving to slide 6, and looking at our Precision Components portfolio, as you recall, as part of our April 2016 reorganization, we consolidated ten separate machine shops and five separate fabrication facilities into centers of excellence. For the Composites business, we've combined our Milledgeville, Farnborough and Thailand businesses to further develop our low-cost source supplies and offer a blended rate to our customers. And while operating results have been weighed down this year by restructuring, the strike in Spokane and forward losses, without which they would have earned 6% this quarter, they've now recovered on schedule on the demanding A350 cabin bracket program and are delivering on schedule for the Boeing 767 landing gear contract.

We're closing three of our machine shops and relocating equipment and work to larger, more cost-efficient sites. This will save over 380,000 square feet and 35% of our machining footprint will go down. These consolidation savings are already being bid into our new proposals, and have enabled Precision Components to have the highest win rate across our four business units. Precision Components reduced their head count by over 480 people in Q3, while improving our leadership team and reducing management layers. We're outsourcing less profitable work and we're starting up new awards that have been recently added. And we're targeting business development where they can be competitive, achieving a trailing 12-month book-to-bill of 1.2 and expanding the revenue base. We're also pleased to have received the 2016 Partner of the Year Award at the Mitsubishi Heavy Industries' supplier conference for the work performed by our Interiors business.

Now, a few comments about Aerospace Structures. No doubt this business has been the source of our financial challenges over the last two years as a result of rate reductions, high development costs, overruns and impairments. While they generate 36% of our revenue year to date, they contributed 23% of our operating income and earned about 8% operating margin in Q3. However, customer relationships are improving as we stabilize performance across all seven sites.

In addition to getting the Boeing programs on track, our recovery efforts on the Global Hawk/Triton programs were key to winning the DoD support for Milestone C, or LRIP authority to proceed for the U.S. Navy's Triton variant, and this is expected to lead to over 60 wing orders over the next 15 years. Our E2 and Global 7000 programs are close to completing their development efforts and transitioning to production.

In Q3, Triumph continued to execute on the Global 7000 wing development contract and transition to production. Triumph continued to deliver wings for flight-test vehicles to Bombardier's final assembly line in Toronto, and we're close to delivering all development test articles. Bombardier's flown the first test jet FTV1 numerous times, helping to validate structural and aerodynamic models used to design the wing. And our supply chain and Red Oak factories have begun work on the first several production wings.

On G650, we're now fully into production, having transitioned from Spirit in 2015. Aerospace Structures has now delivered 95 wing boxes and completed wings to Gulfstream, and with good performance, we expect Gulfstream to award other wing work to Triumph over time. We've also delivered the early G600 composite horizontal tail skins in support of their latest platforms. And in the quarter, we delivered the 500th G550 wing last month. Note that Aerospace Structures is actively bidding new military programs, including the T-X Trainer, V-22 Multi-year 3 and the H-60 Blackhawk.

A short update on the Bombardier Global 7000 dispute. In prior calls, I discussed the need to resolve long-standing disputes with Bombardier over development cost growth. After meeting with their leadership extensively for several months, we were unable to reach an acceptable resolution of our non-recurring and recurring claims. In January, we disclosed that Triumph Aerostructures, LLC, a wholly-owned subsidiary of Triumph Group, initiated legal action against Bombardier in late December in Quebec. Specifically, the lawsuit relates to Bombardier's failure to pay Triumph Aerostructures for completed work and customer-directed changes to the proposed wing configuration, as well as Bombardier's delay, disruptions, acceleration and interference in connection with its contract with our subsidiary.

Triumph Aerostructures is asking Bombardier to recognize its share in the significantly higher than expected development cost and to honor its obligations under the contract to compensate Triumph on a timely basis. As been reported, Bombardier has responded with potential claims against Triumph Aerostructures, which we believe to be without merit. In the meantime, we continue to support the Global 7000 program and we'll provide an update on these matters in future earnings calls, if not sooner.

The bottom line on our four businesses is we are maximizing value out of our higher-performing businesses while we restructure and drive operating excellence in the others. And we look forward to being on the other side of our development production balance point and seeing our new wins translate into revenue growth in the core businesses we retain.

Last, I'd like to touch on our organic growth plans. Turning to page 7, as Triumph's performances improved and as we bring our cost down to enhance competitiveness, we are seeing the benefit in the area of new bid opportunities. In a challenging market environment, Triumph is finding ways to win and grow, especially in our shorter-cycle Product Support and Precision Component business units, while we position to win new contracts in the longer-cycle Integrated Systems and Aerospace Structures.

As shown on slide seven, across our four business units, our pipeline of addressable opportunities continues to expand. We're tracking over 800 active opportunities worth over $16 billion, a majority of which are in the later customer evaluation phase. In Q3, Triumph had 55 competitive new business wins worth over $350 million and this excludes normal follow-on business which is higher in value. This equals our wins in Q1 and Q2 combined. In our efforts to upgrade the business development team and still discipline the capture process have led to month-over-month increases in our win rate with December being the highest month year-to-date in terms of competitive wins and follow-on awards.

Given our backlog has remained around $4 billion for four quarters and new wins are offsetting the effects of sun-setting programs, we are demonstrating the effectiveness of our drive to grow organically. Key wins in Q3 included Cessna's Longitude machining contract with revenue estimated to be over $100 million during the next ten years. We also finalized an eight-year agreement worth $52 million with Rolls Royce to supply their thrust links for the Trent XWB engine program. We were selected by Raytheon to provide 31 Servo Control Systems in support of the U.S. Navy's Next-Gen Jammer program and this helps to demonstrate how our ability to provide highly engineered yet costly-effective solutions is valued.

We won the KC-10 refueling boom and thrust reverser repair work in support of L3 and we won over $70 million of work in Q3 on F-35 dual-sourcing machining work. And we continued to have a strong backlog of work with Sikorsky Aircraft on the Blackhawk, the combat reconnaissance helicopter and the Presidential Helicopter. I'm excited about our support to a number of new start and ramp-up programs, including B-21, T-X and the MQ-25, great engine programs with Pratt, Rolls, GE, and Safran, the joint multi-role helicopter, DARPA's Tern demonstrator and the AETP, Advanced Engine Transfer Program (sic) [Adaptive Engine Transition Program].

My team and I recently met with Northrop Grumman executives to discuss opportunities related to the MOU we signed last year for UAS opportunities, and we hosted the Lockheed Martin's Concourse team in Red Oak and visited their Palmdale facility to discuss new opportunities.

So in conclusion, in the Q3, we made solid progress on our top three priorities of delivering on commitments, becoming more predictably profitable, and driving organic growth. Jim will now take us through the financials for the quarter. Jim?

James F. McCabe - Triumph Group, Inc.

Thanks, Dan, and good morning, everyone.

On slide 8, our consolidated results for the third quarter, net sales of $845 million were down approximately 8% from last year. This was driven by rate reductions on the 747, the G450/550 and C-17 programs, unfavorable model mix, lower demand in commercial aircraft and foreign exchange rates, which were partially offset by increased production on the 767/Tanker program and stronger sales from our Product Support segment. Operating income was $55 million or 7% for the quarter. Last year included a $229 million non-cash impairment charge. Operating income includes $14 million in restructuring costs and a $14 million loss on the assets held for sale related to the APU engine repair business being sold. Adjusting for these items, operating income was $84 million and operating margin was 10%.

Turn to slide 9, is earnings per share. We start with GAAP EPS which was $0.59 for the quarter, and we adjust for the loss on assets held for sale which was $0.21 per share. And we adjust for $0.21 of restructuring costs of which $0.16 is cash. Result is adjusted EPS of $1.01 for the quarter.

Now on to our segment results on slide 10. Third quarter sales in our Integrated Systems segment were $256 million, down 6% compared to the third quarter of last year, but operating margin was up 90 basis points to 20%. And our adjusted EBITDA margin was 22%. Sales decreased due to softness in the commercial rotorcraft market, $6 million was from currency, primarily the British pound, and $5 million was from our Q2's divestiture of Newport News. And those were partially offset by $1 million from Fairchild Controls acquisition a year ago, October. Integrated Systems has strong margins and is working on profitable growth.

On slide 11 is our Aerospace Structures segment. Sales were $304 million, down 12% from last year. Sales were down due to production rate reductions on the 747, G450/550 and C-17 programs, partially offset by increased volume on the 767/Tanker program. Operating income was $24 million and operating margin was 8%, and last year included that $229 million non-cash impairment charge. Adjusted operating income excludes last year's impairment charge, and shows adjusted operating margin this quarter's comparable to last year at 8%. In the quarter, we had net favorable EAC adjustments of $2 million, reflecting net favorable performance against our program costs estimates for which we continued to enhance accountability. Aerospace Structures is stabilizing and improving its operating performance.

On slide 12, third quarter sales on our Precision Components segment were down 10% compared to last year. The sales decline was primarily due to lower Boeing commercial production rates and unfavorable model mix, partially offset by increased production rates on the A350 program. This segment is in the process of closing three facilities, Washington and New York and Texas, and starting up a new facility in Kansas. Restructuring expense of $5 million in the quarter and related inefficiencies impacted its operating income and margins. We also recorded a forward loss of $5 million in the quarter in one of our engine programs, which is included in operating income. Looking forward, our trailing 12-month book-to-bill ratio is a favorable 1.2 to 1, including new wins with Rolls Royce and Textron that Dan mentioned earlier. Overall, Precision Components continues to win work and meet customers' expectations during its restructuring.

On slide 13, third quarter sales of $87 million in our Product Support group was a 12% increase over last year. The increase in sales was primarily due to key contract wins with regional jet and commercial operators for components and accessory repairs. Our operating margin of 17% is an increase over last year, driven by strong sales and cost reduction initiatives including a facility consolidation. We announced the pending sale of the APU engine repair businesses last month, and the transaction is expected to close before our year-end. Product Support is healthy, growing and taking market share.

Turn to slide 14. Free cash use was $37 million during the quarter. This was an improvement from $49 million last quarter, and $96 million in the first quarter. Free cash flow is net of capital expenditures of $9 million, and includes $13 million cash proceeds for the sale of some real estate in Q3. In order to provide more insight into our cash use, here are some key drivers this quarter. They include $48 million cash used for development programs, $11 million for restructuring, $22 million for the G650/G280 programs and $12 million was provided by customer advances in the quarter.

On slide 15 is a summary of our capitalization, leverage and liquidity. Our net debt is just over $1.6 billion and 63% of our total book capitalization. Our total leverage based on our trailing 12 month adjusted bank EBITDA is approximately 4.3 times our net debt, and our senior secured leverage is 2.6 times. We're compliant with all our financial covenants, and we have $284 million of cash and availability.

And finally, moving to our fiscal year 2017 guidance on slide 16. As Dan mentioned earlier, we are reaffirming our fiscal year 2017 revenue guidance range of $3.5 billion to $3.6 billion, and our GAAP EPS range of $3.15 to $3.45. We are updating our free cash use guidance range from $100 million to $120 million to a use of $190 million to $210 million. The change in cash guidance is substantially all due to the anticipated delay in expected payments and higher inventory in our major development program.

We are reaffirming our capital expenditures range of $40 million to $60 million. We are also reaffirming our full year effective tax rate guidance of 18%, but with a caveat in the footnote that it could still change significantly based on year-end circumstance, but this is noncash. As for cash, we have updated our cash tax rate from 5% to 7% to reflect expected tax payments in the year.

So to wrap up from a financial perspective, our $37 million cash use is another step in an improving cash trend. Our cost reduction initiatives are expected to exceed our $44 million target this year. Operating margins are strong and increasing in our Integrated Systems and Product Support segments, and we are reaffirming our revenue and EPS guidance.

With that, I'll now turn the call back to Dan.

Daniel J. Crowley - Triumph Group, Inc.

Yeah. Thanks, Jim. So FY 2017 continues to be a transition year, but as the year has gone on, we're demonstrating stability in our operational and financial performance. And our cost reduction efforts are exceeding plan as we right size the business. We've improved program execution and cost cutting, they're both leading to new opportunities and new wins, and my team and I will continue to find ways to drive shareholder value.

With that, let's turn it over for Q&A.

Question-and-Answer Session

Operator

At this time, the officers of the company would like to open the forum to any questions that you may have. We ask that you please limit yourself to one question and one follow-up to give everyone the opportunity to participate. Our first question comes from Cai von Rumohr. Please state your affiliation followed by your question.

Cai von Rumohr - Cowen and Company LLC

Yes, Cai von Rumohr from Cowen and Company. So can you give us a little bit more help? That's a pretty big change in your cash flow guide. What were the circumstances? Why it went opposite, basically that you're not hitting the milestones? That they're not paying? Any color there would be very helpful. Thank you very much.

Daniel J. Crowley - Triumph Group, Inc.

Sure, Cai. We're sort of at the peak period of concurrency of development, building test articles, supporting safety of flight, and then transitioning productions. So the expenditure rates are high on the program and we certainly expected a certain amount of cash to be coming in during the quarter, and that's part of our – the basis for our claim with Bombardier. I'd refer interested parties to our legal complaint that was filed in Quebec in December for more information, but that's really all I can say on the call.

Cai von Rumohr - Cowen and Company LLC

Okay. Well, is it in terms of (28:33) giving you having money coming in? Is it that you are not hitting contractual milestones or just a disagreement that you guys have? If you could explain that.

Daniel J. Crowley - Triumph Group, Inc.

Yeah. I really can't go any further subject to the litigation that's ongoing. But what I will say is that we continue to support the program, although we continue to assert our belief that we're due payments for work that's been completed over the last five years.

Cai von Rumohr - Cowen and Company LLC

Thank you very much.

Operator

Our next question comes from Robert Spingarn. Please state your affiliation followed by your question.

Robert M. Spingarn - Credit Suisse

Good morning. I'm with Credit Suisse. I want to first – I want to thank you for slides five and six. I thought those were particularly helpful, both Dan and Jim. And high-level question for you both. Where do you expect those percentages of revenue and profit for the four businesses to be at the end of your planning period, let's say five years from now? How should those line up?

Daniel J. Crowley - Triumph Group, Inc.

I'd say there's an imbalance right now that's a reflection of the cyclicality of, especially, Aerospace Structures. Their margins are declining as a result of profitable mature legacy programs running out and programs that really bear no fee at this point, such as the E-2D and the Global 7000. Those should come back in the balance, and over time their contributions of margins should go up as well as Precision Components. Precision Components has really had a tough year this year. Some things that we didn't expect, as mentioned, the strike and some cleaning up of older programs, and also the impact of restructuring. So, they shouldn't continue to operate at that low of a contribution. But what we're excited about is the growth that is coming out of both Systems and Product Support.

I've been traveling around to customers and there's a reason why Boeing has stood up a third product line for global support. It's – with all these aircraft going into service, they've got to be supported. And I expect a question related to whether the OEMs are taking away our after-market business, so I'd like to touch on that. It's my view that you either get in line and work with them, and become a service provider within the OEM's overall sustainment model, or you're on the sidelines.

And fortunately, because we've got a good reputation in support with Boeing, Airbus, and also with the carriers such as Delta, FedEx, UPS, they're pulling us in as they come up with strategies on how to support things under programs like Boeing's GoldCare. So, we expect that to be a source of growth on top line.

Robert M. Spingarn - Credit Suisse

So just to tie the loop on that, Dan, do we look at the manufacturing businesses as being roughly equal in size in five years, and then what would the support business be relative to that? And then for Jim, on cash flow, what is normalized cash flow going forward, let's say, once we get through the heavy lifting in 2017 here and maybe 2018? What does a normalized cash flow look like? And as an addendum to that, Dan, how do you do any M&A? You mentioned M&A at some point in the monologue. How do you do that given the leverage right now and the negative cash flow we have today? Thanks.

Daniel J. Crowley - Triumph Group, Inc.

Okay. I'll pick out a couple of those questions to hit. On Product Support, we do expect their revenue contribution to be higher over time as the shift towards sustainment of the fleet increases and as we sign up long-term agreements for partnership for repair of control surfaces and thrust reversers and accessory drives, you name it. So, we do look to them as a growth area. In terms of M&A, and I'll throw it back to you, Jim, on the normalized cash question, right now we can only really do small sort of bolt-on and product line acquisitions. That's part of our focus for organic growth, is to grow from the assets that we already have. But we are looking ahead as we complete divestitures and we create more firepower to go back to the market, something that Triumph demonstrated over 20 years of doing successfully. We're looking at those candidates now. We're not ready to pull the trigger on anything big, of course, but over time it's part of our growth strategy. Jim?

James F. McCabe - Triumph Group, Inc.

In terms of cash flow, I know it's a confusing cash story. There's a lot going on. I look to adjusted EBITDA. That's why I put that on the slides. I think, if you look – start with adjusted EBITDA, estimate our CapEx, then that's the best estimate going forward because we're looking for one-to-one cash conversion over time. But cash is a challenging story when you have a lot of investments in big development programs. We have been successful in managing our balance sheet very tightly with really a focus on working capital and taking advantage of all the opportunities we have to generate cash without impacting our ability to generate profit.

Robert M. Spingarn - Credit Suisse

And what kind of growth rate do you see on the adjusted EBITDA?

James F. McCabe - Triumph Group, Inc.

I think that depends on the underlying businesses. And we are in the middle of our planning process now, so we'll see what our portfolio is going to look like when we come out of the planning process and what guidance we can put out for years to come.

Robert M. Spingarn - Credit Suisse

Okay. Thank you, both.

Daniel J. Crowley - Triumph Group, Inc.

Thank you.

Operator

Our next question comes from Sheila Kahyaoglu. Please state your affiliation followed by a question.

Sheila Kahyaoglu - Jefferies LLC

Hi. Good morning. It's Jefferies.

Daniel J. Crowley - Triumph Group, Inc.

Good morning.

Sheila Kahyaoglu - Jefferies LLC

I guess, as a follow-up on free cash flow, shorter term, how do we think about free cash flow and maybe a framework for 2018? I guess, just thinking about development expense, because that's really been the biggest change for 2017, how do we think about development expense in 2018 as it relates to the Global program and maybe inventory buildup on production aircraft? And if you could comment on pension as it relates to cash outflow.

Daniel J. Crowley - Triumph Group, Inc.

Sure. Touching on Global 7000, we expect to complete the development work in fiscal year 2018, and we're declining month-over-month on the work that's required for engineering release, as an example. And then, as far as buildup of inventory for production, that's already – we're seeing that in the numbers now as we order the first lot of production article components from the supply chain. And then, as the rate ticks up year-over-year, we'll continue to expend in support of the long lead parts and ramp-up. So, that is in our calculus for when we build our FY 2018 and FY 2019 cash forecast. Jim, on the pension?

James F. McCabe - Triumph Group, Inc.

Yeah, so on the pension, there's no required – no material required pension payments in the next couple years. And you'll see in our year-end the full amounts of the pension plans, but there's no cash requirements to worry about.

Sheila Kahyaoglu - Jefferies LLC

Okay. Thanks, Jim. And so, Dan, just to follow-up on the development expense, so it would still be an outflow and maybe like half the magnitude? Or is there any sort of range you could give us?

Daniel J. Crowley - Triumph Group, Inc.

So, I won't try to quantify the magnitude. What I will say is that there is still an outflow in development and early production spending. The uncertainty is around flight tests and any items that might have to be corrected coming out of that. That's true of all development programs. So far, Bombardier has been encouraged by the flight test results of the first articles, so I won't speculate into those costs. But it's something that we are looking forward to retiring in FY 2018.

Sheila Kahyaoglu - Jefferies LLC

Okay. Understood. And then if you could just comment a bit more on the 650 program, it still being one of the two red programs, I guess, within Aerospace Structures. How do you think about the improvement and the progress there?

Daniel J. Crowley - Triumph Group, Inc.

Yes. It's a high-oc tempo program right now. Every four days we're pushing out a set of wings – wing boxes from our Tulsa operation, and we fully re-hosted the program within the Triumph systems. And our quality levels continue to improve. We've got a lot of focus on building these wings with zero foreign object damage and no scratches and perfect wing alignment. And because Gulfstream is still co-producing wing boxes and finished wings in Savannah, we're working with them to transfer best practices, things they've learned. And it's really not their intention to stay in that business.

Once we've got ahead of our learning curves, we've already achieved the buffer stocks that they've asked us to maintain to sustain the line, then we see them transitioning that work back to Triumph. So we're doing well. We had some stability issues at our Nashville plant as we rolled folks from the G450 program onto G650, that's now behind us, and we're coming down our learning curve as well. So we'll provide more color on G650, performance schedule is there, now we're focused on driving down cost.

Sheila Kahyaoglu - Jefferies LLC

Great. Thank you very much.

Operator

Our next question comes from David Strauss. Please state your affiliation, followed by your question.

David E. Strauss - UBS Securities LLC

Thanks. UBS. Dan, following up on that question on the 650, I think at the beginning of the year you were talking about a $40 million to $50 million burn there. It's well above that already through Q3. And then you used to show a chart that I think had us getting – had you getting pretty close to breakeven in 2018. Can you just talk about what changed that profile that we were supposed to be on, on the 650?

Daniel J. Crowley - Triumph Group, Inc.

I'd say that the early data before we built very many wings, we didn't have a tight confidence interval on the hours per wing that were required to deliver it. Now we do. Now that we've delivered approaching 100 wing boxes and wings, we're coming down the steep part of the learning curve. The first 100 always have learning curves that approach 70%, 80%, and then you flatten out into the 80%'s and 90%'s as you get beyond that point. So it's really a focus of our lean deployment efforts. We've been running value stream maps and kaizen events repetitively in that area to take cost out, and they're showing a lot of benefits. So yes, the burn rates are higher here on the first buildout, but we're coming down the curve nicely. And we believe we can recover to our overall program profitability goals. Jim?

James F. McCabe - Triumph Group, Inc.

Yeah. And the – I understand that there was a question earlier about cash on this program. That's why I highlighted the amount we used was $22 million in the quarter. Our expected turn, so that we're no longer using cash in this program, is in 2019 at the moment. But we're making a lot of efforts that may improve that, but that's our current view.

David E. Strauss - UBS Securities LLC

Okay. Thanks. That's helpful. I want to turn to the 747, you've talked about the progress you've made there. I think, you're reversing some of the forward losses that you've taken. You previously talked about I think it being a pretty significant cash drag as we get out to 2018 and 2019. Can you just update us on that?

Daniel J. Crowley - Triumph Group, Inc.

Sure. I think, both 747 and 767 are harbingers of what we're going to do on G650. When I got here a year ago, Boeing was very unhappy with our delivery performance and quality on 747 and 767. We weren't meeting the on-dock need dates. We threw a new team at it. We used lean processes to drive out waste. We got focused. We got more employees involved in improvement, and that program has turned now. At one point Boeing thought we were going to have to add 200 people more to hold schedule. We've actually been able to reduce about that many folks and improve schedule adherence. So, that's the challenge is to do it now on G650.

We're in discussions with Boeing about the end of the 747 program, when will it come. They had planned to offer some of our work to make in Georgia. They've stepped back from that plan. And now, based on the market demand for that platform, they're going to decide does the program go beyond our current contract obligation or end early? And so, we'll support them in doing some what-ifs and as they test the market for follow on opportunities. Should we be required to build out everything under our contract, then we've got that covered in forward losses, including any tail-up costs.

Yes, there'll be cash to outlay in support of those end builds. Now should they truncate the program sooner, we would benefit from both the reversal of the forward loss and avoidance of that cash outlay.

David E. Strauss - UBS Securities LLC

Okay. And the last one I had was, I think before you had been talking about $65 million in milestone payments from Bombardier this year, can you just update us what your guidance assumes in terms of milestone payments?

Daniel J. Crowley - Triumph Group, Inc.

So I can't discuss the details of the contract itself. What I can say is that we're not assuming any further payments in the fiscal year, and we're focused now on getting our claim resolved through our path and litigation, and we're still hopeful that we can resolve it through other means.

David E. Strauss - UBS Securities LLC

Thanks very much.

Operator

Our next question comes from Sam Pearlstein. Please state your affiliation followed by your question.

Samuel J. Pearlstein - Wells Fargo Securities LLC

Good morning. Wells Fargo.

Daniel J. Crowley - Triumph Group, Inc.

Good morning.

Samuel J. Pearlstein - Wells Fargo Securities LLC

If I can just follow-up on that last point. Now that you include the, I guess, the $13 million for the sales, it looks like the total free cash flow change for the guidance was now a little over $100 million. And knowing roughly where the milestone payments were, I guess, what accounts for the remainder of the increase? Is it the development spending on the Global 7000 running ahead of schedule? Like what else is in there that's driving cash flow a little bit worse?

James F. McCabe - Triumph Group, Inc.

Hey, Sam. It's Jim. Yeah, it is. It's inventory related to that program as well, which is primarily development cost at this point. There is some production inventory in there too.

Samuel J. Pearlstein - Wells Fargo Securities LLC

Okay. And given that you are negative $183 million for the first nine months, it implies, I guess, the fourth quarter is roughly break even on free cash. But there's still a $20 million swing. What would account for you to be either at the low-end or the high-end?

James F. McCabe - Triumph Group, Inc.

As you see, we define free cash flow to include some of these discrete events like real-estate sales, and we're continuing to do that. So our guidance does include those kind of things. And for the fourth quarter we're looking at all options to how we achieve our cash goals. So we're going to do as much as we can through operations, through working capital management, but we still have some one-off opportunities for assets that we don't need going forward to turn this into cash.

Samuel J. Pearlstein - Wells Fargo Securities LLC

Okay. And then one other thing as you talked about foreign exchange, you mentioned the UK. How are you thinking about, one, foreign exchange going forward? And then two, any of the discussion around border adjustments given your Thai facilities? And how to think about that?

James F. McCabe - Triumph Group, Inc.

Yeah, it's a good question. We do have some natural hedges in obligations in pounds, but we're not selling completely in pounds. So we reviewed – we don't anticipate big movements right now in the currencies, but we are reviewing our hedging options to make sure we can mitigate any potential future impact.

Samuel J. Pearlstein - Wells Fargo Securities LLC

Thanks.

Daniel J. Crowley - Triumph Group, Inc.

Thanks, Sam.

Operator

Our next question comes from Peter Arment. Please state your affiliation followed by your question.

Peter J. Arment - Robert W. Baird & Co., Inc.

Yeah. From Baird. Dan, maybe not a lot of discussion on how the E-2 program is going, but obviously it's going to be a major program for you. So could you give us a little color on how you're looking at that outlook? And bracketing the risks there? Thank you.

Daniel J. Crowley - Triumph Group, Inc.

Sure. Thanks, Peter. So we're in good shape on the E-2 program. Our development is complete now, and we built some nice factories that build the fuselage components and empennage. And there is a slowdown in the program at Embraer's level as they work through some of their entry-into-service certification challenges. They're unrelated to the structures. And so we've cut back spending on that in terms of while we're ahead of the game, so to speak, but we expect them to return to the ramp up that was planned.

It's about 12-month delay, that's several months of which are already behind us, so we're looking forward to that ramping back up in the fiscal year. We'll use the time to focus our energies elsewhere in Aerospace Structures. And I'm not concerned about the program. The feedback from Embraer on their first flights has been very positive, and they're happy with the work we're doing. So, although it's delayed on its ramp up, we do have revenue bearing units in queue ready to go when ready.

Peter J. Arment - Robert W. Baird & Co., Inc.

Appreciate the color. Thanks.

Daniel J. Crowley - Triumph Group, Inc.

You bet.

Operator

Our next question comes from Myles Walton. Please state your affiliation followed by your question.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Thanks. Deutsche Bank. I was wondering if you could help us with the fourth quarter walk that's implied? I guess about $120 million of EBIT inclusive of restructuring, so a couple different questions. One is kind of the confidence to get to that level of profitability, if you think that's a reasonable jumping off point for 2018? And then likewise on restructuring, I think the target for restructuring have been $65 million to $75 million of cash restructuring. And I think year-to-date it's only around $28 million. So is there a big lump coming in the fourth quarter? Or you're finding a way to spend less, and is that helping the cash flow?

James F. McCabe - Triumph Group, Inc.

Good question. It is a little lumpy because some of the plant closures, there's expenses that accrued in advance when we announced them, and there's another slug that we have to expense when they occur, when the actual closure happens. And a few of those are coming up. So we're on track with the program, but it is back ended with the restructuring costs.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

And then the fourth quarter implied EBIT?

James F. McCabe - Triumph Group, Inc.

So, I don't have the exact number for restructuring in the fourth quarter, but it's all in the mix for the guidance that we've put out there. So the full year mid-point of around $3.30 on EPS. I can go back and do some work so we can share more details of that next quarter, but is there a specific question about EBIT? A piece of it that you're worried about that I could...?

Myles Alexander Walton - Deutsche Bank Securities, Inc.

It just looks like a pretty significant margin expansion sequentially into fourth quarter, that's all; a couple hundred basis points inclusive of restructuring.

James F. McCabe - Triumph Group, Inc.

Yeah, the fourth quarter is usually our strongest quarter, and we are seeing the impact of a lot of the cost reductions we've done year-to-date. So, as we do them, they accumulate and I'm expecting a good pickup in the fourth from them as well.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Okay.

James F. McCabe - Triumph Group, Inc.

There are a lot of moving parts here. What we do have is a very rigorous forecasting process, and I'm feeling confident that each quarter we're getting better and better about the accountability for the delivery of the forecast that we put out there.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

And then, when you look to 2018, Dan, on the mature program, is the 747 (48:41) rate, the 777 rate, the 450/550 rate, is it a few hundred million dollars that you kind of have tabled for those programs that you kind of have to overcome? Is that the right ballpark of those mature declines that you're facing and then offsetting with the rest of your business?

Daniel J. Crowley - Triumph Group, Inc.

So, the rate reductions on those programs are not just future challenges. We've been dealing with them for the last two years. Believe it or not, we used to build the 747 at 7 a month, and it's stepped down over time. On my watch, I think we started at maybe 2, 2.5, and then it was 1.5. We're now building at 0.8, which is above their published rate of 0.5. So, we've been dealing with it. That's why I think it's important to emphasize the backlog stability, even in the presence of the V-22s and C-17s and 747s coming down; and, yes, 777.

So, that's impacted some of our sites that build, let's say, inboard flaps. But we've known these were coming. Some were surprises, but we planned for it and – therefore, the emphasis on growth. But we're on a lot of platforms that are going up in rate, both defense programs like Global Hawk and Triton, F-35, G650; they're in discussion about rate increases, and then our work on A350, A320, on NEO. These programs are increasing and that's helping to offset the ones you mentioned.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Okay. Is this relative size there? I mean, Precision in particular, the number one program there is 777 and that, I would imagine, is going to be challenged on the rate reduction, in particular.

Daniel J. Crowley - Triumph Group, Inc.

It is our number one program, but they have a very broad base of programs and we're really winning more work outside of commercial. You read about our nuclear machining work. We just announced the Cessna award. That's a large award for us. Engine work is ramping up, helicopter work. So, we get the need to balance out their portfolio, and the fact that they're leading our book-to-bill is our response to that.

And what Boeing has said to us about machining, in particular, is you really have to be competitive with low-cost countries and up your automation. So, we've been investing in some of the high-speed aluminum machining facilities. We just opened up our new Kansas City Plant. That's going to support the Airbus A350. And really, the challenge in Precision Components is to find those niches where we can compete. We have some of the longest gantry machine tools in the United States. We have probably the largest number of these high-speed aluminum machining cells in the U.S. And we have some of the best fabrication, chemical milling, titanium forming capabilities. So, we're not going to compete with every low-cost country, let's say, in small volume machining of parts, but where we can compete, we are winning.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Okay. Thanks.

Operator

Our next question comes from Ronald Epstein. Please state your affiliation, followed by your question.

Kristine Tan Liwag - Bank of America Merrill Lynch

Hi. Good morning. This is Kristine Liwag calling in for Ron.

Daniel J. Crowley - Triumph Group, Inc.

Good morning.

Kristine Tan Liwag - Bank of America Merrill Lynch

With the moving pieces in production rates and your restructuring actions, can you just provide us some clarity on your expected cadence of cash flow? And what year do you expect to be net cash positive?

James F. McCabe - Triumph Group, Inc.

Hey, Kristine. So, as you saw in the slides, we are improving our cash flow. Maybe not at the pace we would like, but it is quarter-over-quarter improved the last two quarters; and, we're forecasting with our full-year guidance to improve it again next quarter. But we haven't given cash guidance for next year or further, but we do intend to continue to improve that. What year, in particular, we're going to go cash positive? I couldn't tell you today. And hopefully, we'll have updates for that in the future.

Kristine Tan Liwag - Bank of America Merrill Lynch

But can you provide some sort of cadence? Should we think about the sequential improvement in cash this quarter? And do we forecast that in a similar pace?

James F. McCabe - Triumph Group, Inc.

Well, you can interpret what the fourth quarter cash is just by looking at our full year and subtracting our year-to-date. But that's as far as we're forecasting cash right now. I'd love to tell you exactly what it's going to be next year; we haven't finished our process. And I need everyone to make their commitments so that we know we can make it.

Kristine Tan Liwag - Bank of America Merrill Lynch

Great. And then, on your slides you said that you're compliant with all your financial covenants. Are there specific covenants that we should be aware of in the period where you may not be generating cash?

James F. McCabe - Triumph Group, Inc.

Well, our most restrictive covenant is our total leverage ratio, which is 5 times right now. And we're at 4.3. So, that's the one that I watch the most and that we're cognizant that's the limitation on our availability, which is $284 million at the end of the period.

Kristine Tan Liwag - Bank of America Merrill Lynch

Thank you.

Operator

Our next question comes from Michael Ciarmoli. Please state your affiliation followed by your question.

Michael F. Ciarmoli - SunTrust Robinson Humphrey, Inc.

Hey. Good morning, guys. Thanks for taking my questions.

Daniel J. Crowley - Triumph Group, Inc.

Good morning.

Michael F. Ciarmoli - SunTrust Robinson Humphrey, Inc.

Just to stay on the cash, I mean, how big of a headwind – and maybe even revenues, too – how big of a headwind will the 777 be? I mean, are you guys seeing the full impact of that, yet, on the top-line and bottom-line? Or does that maybe exacerbate into fiscal 2018, given the timing of your fiscal year and the timing of the step-downs there?

Daniel J. Crowley - Triumph Group, Inc.

Sure. The 777s monthly build rates are dropping from – and these are the numbers that we use because we have a setback from the Boeing's deliveries, but from about 7.7 a month in FY 2017 down to 4.75 in 2018, and then down to 3.5 for 2019, 2020. So, it does step down over time. And we've got time to offset that with new wins. We know it's coming. And you don't think of Triumph as being a big player on 737, which is increasing in rate, but that's the number two program for our Integrated Systems business. And we're also on the 787. So, yes, some programs are going down, others are going up. And we have enough visibility in time to work the offsets against the 777.

Michael F. Ciarmoli - SunTrust Robinson Humphrey, Inc.

Do you think this is the trough year for revenues? I mean or is it going to be sort of some headwind next year and then maybe we start to see organic growth in 2019?

Daniel J. Crowley - Triumph Group, Inc.

So, the early signs of that is the book-to-bill, and then how quickly we can convert that into revenue. And as I mentioned, the shorter-cycle businesses like Product Support and Precision Components, that's a fast turn. When we win work, let's say on Integrated Systems, if we take away the landing gear or we take away the nose wheel steering or some of the hydraulic systems from a competitor, it may take them a year or 18 months to cut in that change. Or if you get on the new start, there's the design development phase. So those take a little bit longer. But the fact that we've been around $4 billion now for four quarters and we are winning, gives us encouragement for the next two years in terms of revenue. Just one other point, Michael, we'll adjust revenue consistent with our divestitures, but from the businesses that we retain, we're looking forward to top-line growth.

Michael F. Ciarmoli - SunTrust Robinson Humphrey, Inc.

And just to get on that Product Support, I've always felt about that business as maybe obviously shorter cycle, limited visibility, but I think you called out getting to a 9% CAGR in the coming years here. I mean is that based on the new wins that you've recently had? I mean you seem pretty confident in that growth rate accelerating.

Daniel J. Crowley - Triumph Group, Inc.

Yeah. There's really three legs to that stool. The one is traditional MRO work where the truck backs up and it's got three thrust reverses in it, and they say fix these fast. The second is expanding our customer base, so we go from Delta and UPS and FedEx, and we add Express Jets as we have. And the third is going to more annuity long-term agreements with the OEMs that are taking ownership of their aftermarket. And so you sign an agreement that says, I'm going to repair all of the damage control services for your entire fleet. If it comes in, it's coming to us. And they see that as a better way to operate than parsing all of those control services to 30 or 40 different suppliers; they'd rather have fewer that have more critical mass and are better at it. And based on the feedback we've gotten and them pulling us into meetings, I'm encouraged about our prospects there.

Michael F. Ciarmoli - SunTrust Robinson Humphrey, Inc.

Got it. Thanks a lot, guys. That's helpful.

Daniel J. Crowley - Triumph Group, Inc.

Thanks, Michael.

Operator

Our next question comes from Seth Seifman. Please state your affiliation followed by your question.

Benjamin E. Arnstein - JPMorgan Securities LLC

Good morning. This is actually Ben Arnstein on for Seth and JPMorgan.

Daniel J. Crowley - Triumph Group, Inc.

Good morning.

Benjamin E. Arnstein - JPMorgan Securities LLC

I just wanted to ask about Integrated Systems quickly. It seems to be doing pretty well. Just wondering how much runway there is to expand margins there? And how do you feel about getting back to organic growth next year?

Daniel J. Crowley - Triumph Group, Inc.

Thanks, Ben. So we think we can do more on margins there. When we went from 17 companies to 5, we've begun the work of combining the product roadmaps for all of the different fuel system companies into one, the gear box companies, the thermal systems, the fluids, hydraulics, they're now under a common management. But we haven't fully driven all the cost out from consolidating those business, in part because they were all on separate financial reporting systems. So Jim's been working hard to integrate those, and then to look for areas that we can reduce support cost.

But what I'm excited about in that business is the conversations we're having with Airbus. They're not happy with a number of their current suppliers. We've been investing to upgrade our technology and solenoids, actuators, valves, FADECs, thermal systems, and so they're pulling us in and asking us for alternative proposals, sometimes to meet rate; sometimes to reduce cost. So that's the work, whether it's fixed-wing or helicopter or military that I think will drive their top line, and then we'll continue to work on the cost side as we – I think by the of FY 2018 we will have finished the full integration of TIS and be in full stride.

Benjamin E. Arnstein - JPMorgan Securities LLC

Thank you.

Operator

Since there are no further questions, this concludes Triumph Group's third quarter fiscal year 2017 earnings conference call. This conference will be available for replay after 11:30 a.m. today through February 9, 2017 at 11:59 p.m. You may access the replay system by dialing 855-859-2056 and entering access code 56908608. Thank you, all, for participating and have a nice day.

All parties may disconnect now.

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