Ladies and gentlemen, thank you for standing by, and welcome to the TransDigm Second Quarter Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today’s comments are being recorded. I would now like to turn the conference to your speaker today, Liza Sabol. Please go ahead.

Good morning. Thank you and welcome to TransDigm's fiscal 2020 earnings conference call. Presenting this morning are TransDigm's Executive Chairman, Nick Howley; President and Chief Executive Officer, Kevin Stein; and Chief Financial Officer, Mike Lisman. Please visit our website at transdigm.com to obtain a supplemental slide deck and call replay information. Before we begin, we'd like to remind you that statements made during this call which are not historical in fact are forward-looking statements. For further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, please refer to the Company's latest filings with the SEC available through the Investors section of our website or at sec.gov. We'd also like to advise you that during the course of the call we will be referring to EBITDA, specifically EBITDA as defined, adjusted net income, and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and applicable reconciliation. With that, I'll now turn the call over to Nick.

Good morning and thanks to everyone for calling in. Today, I'll start off with some comments as usual about our consistent strategy, then quickly hit a little on the last quarter, an overview of our efforts with respect to COVID-19 and the related market deterioration, and some short comments on capital allocation. Kevin and Mike will expand on most of these. To reiterate, we believe we are unique in the industry in both the consistency of our strategy in good and bad times, as well as our ability to create and protect intrinsic shareholder value through all phases of the aerospace cycle. To summarize some of the reasons why we believe this, about 90% of our net sales are generated by proprietary products, and over three quarters of our net sales come from products from what we believe we are the sole source provider. Most of our EBITDA comes from aftermarket revenues, which typically have significantly higher margins and over any extended period of time provide relative stability in the downturn. In the commercial aftermarket, the largest and most profitable portion of our aftermarket, the demand appears likely to drop very sharply. This has happened during other severe downturns. However, in this unique circumstance, it could likely take longer to recover. Simply stated, our commercial aftermarket won't start to recover much until people start to fly again. Our longstanding goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we have to stay focused on both the details of value creation as well as careful allocation of our capital. We follow a consistent long-term strategy. Specifically, we own and operate proprietary aerospace businesses with significant aftermarket concepts. We utilize a simple, well-proven, value-based operating methodology. In the current situation, we had to move past to adjust our costs while maintaining the other aspects of our value creation methodology. We have a decentralized organizational structure and unique compensation system closely aligned with shareholders. We acquire businesses that fit with our strategy and where we see a clear path to PE-like returns. Lastly, our capital structure and allocation are key parts of our value creation methodology. As you saw from our press release, we have a solid performance in both the second quarter and the first half of fiscal year 2020. Revenues and EBITDA as defined were up substantially. We continue to generate real intrinsic value for our investors. Unfortunately, this all happened in a different environment than that which has been thrust upon us in the last 60 days. Last quarter, we expressed concerns about both the durability of the commercial aerospace production cycle and the early signs of Pacific Rim air travel slowing. As a result, we began to adjust our cost structure down in January and February of this year. In March, it became clear that the COVID-19 situation and the related government actions around the world will substantially and negatively impact the worldwide commercial aerospace business. Exactly how badly, we just can't yet know for sure. However, we also can't wait for perfect information. We're moving fast and we will adjust as the situation clarifies. In addition to safety, the two most important items we focused on immediately were one, reducing our costs as quickly as possible and two, assuring substantial liquidity should things get worse than might be expected. To address these first, the cost reduction, we have significant experience in dealing with severe downturns. Our process is pretty consistent. We make the best estimate we can for a six-month run rate. We then try our best to get our costs down enough to hold the EBITDA as defined margin at that estimated run rate. This is perhaps more difficult than usual now in this situation. In order to size the new organization and our cost structure, we made certain assumptions regarding our major market segments. These are not meant as revenue guidance. We just don't know enough to provide that. The only thing I know for sure is that we won't be exactly right and we'll have to adjust upward or downward. In aggregate, I’m hopeful that we are appropriately conservative. Kevin will explain this in some more detail. We quickly reduced our cost structure in line with these assumptions. Most of these actions are already in place. To remind everyone, these costs are in addition to the cost cuts we made earlier in the second quarter. We believe we can get costs out ratably with our reduced revenue sizing estimates. We define costs as revenue minus EBITDA as defined. However, there will likely be a significant mix headwind if the drop in the highly profitable commercial aftermarket continues for the full six months. This will make holding the run-rate EBITDA as defined margin in the mid-40s range tough. We think we can come reasonably close to this. It will be hard to get all the way there. Regarding liquidity, liquidity appears to be fine based on any of the market forecasts we've seen. We expect to run cash positive over any extended period, including covering all required principal and interest payments. However, given the substantial market uncertainty, we decided to raise additional money and borrowed $1.5 billion in April. This new debt has no maintenance covenants and no maturities until 2025. This new money is an insurance policy for these uncertain times. It's quite unlikely we will need it. This is a great company with outstanding products and market positions. The only way you get in trouble here is if the situation becomes much worse than anyone expects and you run out of fuel or cash. We're filling our tanks as full as we can at a reasonable price. Pro forma for the new debt, our cash balance is $4.2 billion as of 03/20/2020. Again, I doubt we will need this money, but it's better to be safe than sorry in this environment. We hope to come out of this with a lot of firepower. We continue to look at possible M&A opportunities and are always attentive to our capital allocation. Both the M&A world and the capital market world are always difficult, especially today. As a general rule, we will tend to be fairly cautious until the smoke clears a little bit. We have withdrawn our 2020 guidance. There's just too much uncertainty. We will reinstate our guidance when we feel we have a clearer picture. Our fiscal year 2020 started off strong. The first half was good, but the second half will be pretty rocky. We believe we are about as well-positioned as we can be for right now. We'll watch how the situation develops and react accordingly. Now I'll hand this over to Kevin to review our recent performance and expand on our assumptions and COVID-related activities.

Thanks, Nick. Today, I will first provide my regular review of results by key market and profitability of the business for the quarter, and then cover outlook and some COVID-19 related topics. We are pleased with the solid Q2 results, particularly considering the increasingly difficult global economy and commercial aerospace industry. In Q2, we saw a modest unfavorable impact to our commercial aftermarket and OEM sales for COVID-19 pandemic, as the approximately last three weeks of the quarter were negatively impacted. Despite these headwinds, our second quarter operations, specifically revenue and EBITDA as defined, expanded compared to Q2 last year, due in part to positive organic growth as well as continuing acquisition integration and our announced preemptive cost reduction actions. Q2 GAAP revenues were up approximately 24% versus prior year Q2, and EBITDA as defined was up 19% versus the prior year with margins approaching 47% of revenue. Michael will provide more details on the financials later. Now, we will review our revenues by market category. For the remainder of the call, I will provide color commentary on a pro forma basis compared to the prior year periods in 2019, that is assuming we own the same mix of businesses in both periods. Please note that this market analysis discussion includes the results of the former Esterline businesses. We began to include Esterline in this market analysis discussion in the first quarter of fiscal 2020. In the commercial market, which makes up close to 65% of our revenue, we will split our discussion into OEM and aftermarket. Our total commercial OEM market revenue declined approximately 3% in Q2 when compared with Q2 of fiscal year 2019. The decline in the quarter did reflect a minimal headwind from the impact of the ongoing 737 MAX production halt and early OEM declines related to the pandemic. It is already clear that the COVID-19 pandemic will have a significant negative impact on the commercial OEM market. We are under the assumption that the demand for commercial OEM products will be significantly reduced during the second half of fiscal 2020 due to reductions in OEM production rates and airlines deferring or canceling new aircraft orders. Longer-term, the impact of COVID-19 is fluid and continues to evolve, but we anticipate significant negative impacts on our commercial OEM market for some uncertain period of time. Now moving on to our commercial aftermarket business discussion, total commercial aftermarket revenues grew by approximately 1% over the prior year quarter. In the quarter, flat commercial transport aftermarket was driven by stronger growth in passenger and interior submarkets, offset by a decline in the commercial transport freight market. Our quarterly commercial aftermarket bookings were down over 10% versus the prior year quarter. Most of the decline came in March of this year, but likely does not paint the correct picture for the remainder of the fiscal year, as we expect a sharper decline in the second half. There was a rapid and dramatic decline in demand for air travel during our Q2, as global restrictions on business and shelter-in-place orders went into effect in response to COVID-19. This led to a significant reduction in global flight capacity and parked aircraft across the world. To hit a few of these points, global revenue passenger miles are at unprecedented lows as a result of the COVID-19 pandemic. IATA recently forecast a 48% decrease in revenue passenger miles in calendar year 2020 compared to 2019. For cargo demand, this was already weaker prior to the COVID-19 crisis, as STKs have declined from reaching an all-time high in 2017. However, a loss of passenger belly cargo due to COVID-19 flight restrictions could provide some unexpected opportunities. Business jet utilization data was already pointing to stagnant growth before this economic downturn, so now during this pandemic and in the aftermath, the outlook for business jets is more unpredictable and certainly weaker. As the COVID-19 situation is ongoing, the duration and severity of the pandemic are still unclear, and long-term impacts for the commercial aftermarket are hard to predict. Now let me speak about our defense market, which is just over 35% of our total revenue. The defense market, which includes both OEM and aftermarket revenues, was about flat compared to the prior year Q2. As a reminder, we are lapping tougher prior year comparisons as our defense revenue accelerated in most of the fiscal 2019. Year-to-date, defense bookings have surpassed our expectations driven primarily by very robust defense OEM booking growth. Total defense booking has solidly outpaced year-to-date sales, although bookings grew across most of the businesses, APKWS and parachute-related bookings were especially strong in the quarter. With continued good order flow in defense, we anticipate favorable trends in the immediate future will come from this segment. Now moving to profitability, I'm going to talk primarily about our operating performance for EBITDA as defined. EBITDA as defined of about $675 million for Q2 was up 19% versus prior Q2. EBITDA defined margin in the quarter was just under 47%. Our EBITDA as defined margin expanded both sequentially and over the prior year period, as a result of our cost mitigation efforts and consistent focus on our operating strategy. Excluding Esterline, margins in our legacy business improved both sequentially as well as over the prior year quarter. On Esterline, we are now over a year post-close. The integration continues to progress and to date the acquisition is exceeding our expectations for growth in this largest of TransDigm acquisitions. As we have stated in the past, we will now no longer refer to any specific metrics as these businesses have now become part of the fabric of TransDigm. Now moving to the second half of 2020. In light of the uncertainty around the ultimate impact of COVID-19 on global market and economic conditions and the highly fluid commercial aerospace industry, we still feel it is too early to provide forward-looking guidance at the current time. As Nick said, once we have a better picture, we will reinstitute guidance. However, I wanted to provide a bit more detail on the end market conditions we assumed for the second half of our fiscal 2020. This is not guidance. We always have a bias to act quickly and right-size the cost structure when required. When completing the organizational rightsizing analysis that drove the reduction in force levels implemented to date, we assumed the following with regard to the organization sizing needs for the second half of fiscal 2020: commercial aftermarket declines of approximately 70% to 80%, commercial OEM declines of 25% to 40%, and defense growth in the mid-single digit, which is in line with our prior guidance for the defense end market. Next, I would like to review our COVID-19 response and expectations in more detail. As mentioned, we currently expect COVID-19 to have a significant adverse impact on our sales, EBITDA as defined, and net income for the second half of fiscal 2020 under the assumption that the COVID-19 outbreak will negatively impact our non-defense customers and their demand for our products and services during the second half of fiscal 2020, particularly in the commercial aftermarket. As Nick said earlier, we remain confident in our business model over the long-term and are focused on mitigating the impact of COVID-19 to our business while supporting customers and employees. Since the early days of the outbreak, we have been following guidance from the World Health Organization and the U.S. Center for Disease Control to protect employees and prevent the spread of the virus within all of our facilities globally. Some of the actions implemented include flexible work-from-home scheduling, alternate shift schedules, pre-shift temperature screenings where allowed by law, social distancing, appropriate PPE, facilities deep cleaning, and paid quarantine time for impacted employees. Most of our facilities remain in operation, even if some are operating at reduced levels, as they are deemed essential businesses by government entities since we are the sole provider for many programs, including critical defense platforms. We are committed to preserving the health and safety of our employees while continuing to meet our customer commitments. In an effort to assist in the fight against COVID-19, certain of our businesses have begun producing medical equipment that is critically needed during the global pandemic. Our AmSafe Restraints business is producing respirators and surgical gowns, while Mason is producing face shields. We are grateful for this ability to contribute to the fight against COVID-19. Now before we move to specific cost-cutting measures that Nick mentioned, it is important to understand that we view a very high percent of our costs as variable. Cost meaning revenue less EBITDA. Roughly half of our spending is related to materials including production materials or subcontractor services that are production-related including plating, painting, and machining. Those costs should largely flex with volumes. The next big bucket is people and benefits or direct items related to employment and is more than one-third but less than 40% of our costs. The remaining 10% to 15% of costs include all others. We monitor these costs closely, and as such let me highlight some specific cost savings actions we have taken in response to the reduced demand and uncertainty resulting from the COVID-19 pandemic. These cost mitigation efforts were previously disclosed but worth reviewing: an additional reduction in force to align operations with customer demand. These actions are incremental to the cost mitigation efforts previously implemented in the second quarter of fiscal 2020, mainly in response to 737 MAX production rate changes and bring our total workforce reductions since our last earnings call to approximately 22% to 25% versus planned headcount levels. We are implementing 1 to 8 week furloughs at many businesses over the next six months in response to specific situations and substantially reducing cash compensation for the senior management team for the balance of fiscal 2020. The Board of Directors will forego their annual retainer fees. We will continue to vigilantly monitor our operations and external events and keep the market updated on developments as appropriate. So let me conclude by stating I am pleased with the speed at which TransDigm has responded to the COVID-19 pandemic, taking immediate actions to protect employees from the spread of the virus while also dealing with the harsh reality confronting the broader commercial aerospace industry in the near term. While the actions that the current circumstances require, ranging from broad cost reductions to furloughs and a rightsizing of the employee base are difficult to implement, I have no doubt that we will better position the Company to endure and emerge from the ongoing weakness in our primary commercial end markets more strongly. With that, I'll now turn it over to our Chief Financial Officer, Michael Lisman.

Good morning everyone, I'm not going to elaborate on the results for the quarter any further, as you can see the details in the press release on sales, EBITDA as defined, and adjusted EPS growth. I just quickly want to highlight the updates on interest expense and tax rates included in the call slides for today. Interest expense will pick up slightly due to the new debt issuance, but it's partially mitigated by the decline in expected average LIBOR for the balance of our fiscal year. On taxes, our fiscal 2020 GAAP cash and adjusted tax rates will be 3 to 8 percentage points lower than the previous guidance due to benefits included in the CARES Act, primarily the expansion in the interest deduction limitation from 30% of EBITDA to 50% of EBITDA. Moving over to the balance sheet and liquidity, as of the second quarter end, our net debt to the EBITDA ratio stood at 5.9 times. On the recent debt issuances, Nick mentioned our thinking here is that the $1.5 billion of debt is basically an insurance policy and while the interest rates were slightly higher than we would like, two quick points worth mentioning. The after-tax rates look better due to the interest deduction limit expansion included in the CARES Act; and then second, the terms on the debt are such that we can repay or refinance it in two to three years without too much penalty, should we decide that that's the best use of capital at that point in time. While there's substantial uncertainty in our commercial end markets right now, we do expect to run free cash flow positive for the back half of the fiscal year, under the sizing assumptions that Kevin describes in detail. From an overall cash, liquidity, and balance sheet standpoint, we think we're in a good position here. We have a sizeable cash reserve of $4.2 billion and we don't face any big debt maturities until July of 2024, which is 50 months from now. We expect that the commercial aerospace industry will find its footing before then. With that, I'll turn it back to the operator to kick off the Q&A.

Your first question comes from the line of Carter Copeland of Melius Research.

Just a couple of questions for you guys. One, the mix of products and platforms, on the back end of this crisis, what do you foresee in terms of the impact on the business? I realize we're kind of unprecedented. We're going to take several platforms effectively out of service at this point. And so, is there some offset there from shutting particular product lines or whatnot? Anything you can do to help us understand that would be appreciated?

This is related to a market waiting. We believe we're market leaders across our business in the platforms that we support. So, we're not overexposed to any platform or other. Obviously, as planes get older and platforms get older, they do become slightly more profitable over time as we've been able to work our value drivers on them. But since we think of ourselves as market-weighted, we're not as concerned right now. We'll have to see how this plays out. Right now, it's all speculation. Our plan in this, Carter, is to follow the revenue stream closely, look at the order book, and react accordingly as aggressively and quickly as possible. The speculation side of this is always hard for us to rationalize. But again, we believe we are market-weighted or distributed across the platforms that are sold in use today, and not overexposed to anyone. Certainly, there's going to be some impact in the future, but we're just going to have to weigh that as it develops.

And then just as a quick follow-up, the comment on M&A and Nick, you alluded towards waiting till the dust settles, but I just find myself wondering in this scenario, if there are small opportunities that pop up before the dust settles. How you'd be thinking about those? And if you compare this to the prior downturns we've gone through, what's the thought process? How does this normally go?

Yes, I'll address that in a few ways. Firstly, we're still in the business, but I would say we are more cautious now than we were six months ago. We have a bit more skepticism regarding any valuations proposed. We're not entirely shut down, but we definitely approach things with caution for the time being. Over the past quarter, we focus on acquiring strong businesses and enhancing their performance. We generally avoid buying fixer-uppers or underperforming companies; instead, we seek proprietary assets with a significant aftermarket potential. Typically, such opportunities arise when the market is depressed. While it’s not impossible to find a rare opportunity here and there, it's uncommon given the types of assets we prefer.

Your next question comes from the line of Noah Poponak with Goldman Sachs.

Do you have the number on how much your commercial aerospace aftermarket revenues declined in April versus April of last year?

We did look at that and what I can tell you is that I think it aligns with our sizing assumptions for that one month period. Now one month does not mean six months, so we'll have to keep a close eye on it. But it aligns more or less with our sizing assumptions.

The only thing I'd add to that is, I think it was clear, but in Kevin's sizing of 70% to 80% down in the commercial aftermarket, we're assuming that stays that way for six months, which we hope is a very conservative assumption. Right. But that's what we're using for sort of our sizing and cost planning for right now.

Just kind of staying on Carter's question on the question we're hearing most frequently from investors is: If the makeup of the fleet, when the dust has settled here, is going to decline and age significantly as older aircraft are retired. What's the impact on TransDigm? Kevin, understanding that your answer there is your market-weighted, I'm assuming you're kind of market-weighted on units, but I don't know if you'd be willing to quantify it even if a rough order of magnitude. What percentage of your aftermarket revenues come from 20 year or older airplanes? And then also, if you'd even give us some direction on how much higher the margins are in that older bracket versus your average aerospace aftermarket?

The only thing I would say about older products is they're slightly more profitable. It's not like it's a big difference. I do believe we're market-weighted on this. I don't believe we're overexposed to any platform products. Certainly, MD 80s, we might expect will go away. That is going to have a small impact on us of course. But we think that it's weighted by the markets. There's not that many of them out there. That's our answer today on this. We just need to keep watching. The best thing you can use to analyze the market is the order stream coming in. And that's what we need to follow closely and ensure we're getting ahead of the cost side as well as where there's opportunity for additional sales where there are opportunities both on the defense and in the commercial space. There are still opportunities that you need to capitalize on.

That's helpful. I'm just going to sneak in one last one, Nick, on the effort to hold the EBITDA as defined margin, somewhere in the zone where you had in the first half. Understanding that it's a difficult task with how quickly things are moving, but you have tried to match the cost of the revenue. In hearing you talk about that, proving harder than prior downturns. Do you foresee a scenario where your EBITDA margin gets a free handle on it in any of the next four quarters? Or are we talking more, a couple of hundred basis points of potential deterioration?

I don't want to speculate on that. I would hope not. But I don't want to speculate. You know, the problem is, the math is obvious. You know, if your revenue drops X percent and you take an X out of the cost, everything works as long as your mix stays the same. Typically in the downturn, what has happened is you had a much sharper drop in the OEM than you did in the aftermarket. So that wasn't that tough a job. I appreciate. Got you got a little tailwind from the mix here, you got a headwind, which makes it harder. We look at the EBITDA margins kind of running in the mid-forties. As I say, I would hope we could come reasonably close to that, which I'm hopeful that means we could stay in the forties and I hope a little more than just over the edge. But that's going to be very dependent on the duration and the depth of the aftermarket drop. People need to start flying again. This will be tough.

Sounds like you have a process to stay there, but just with a high degree of uncertainty relative to everything?

That's right. And the problem is the math of a very sharp aftermarket drop.

Your next question comes from the line of Robert Spingarn of Credit Suisse.

I wanted to ask you, Nick or Kevin, about the exposure you have to used serviceable material. I know you deal with some consumables or expendables. When considering your commercial aftermarket portfolio, what percentage is not exposed to used serviceable material compared to what is?

So, we analyzed this a couple of years ago. And we found it's hard to see any areas where USM was a real concern or a drag on revenue or growth. Certainly, there may be some spots or part number here or there, but broadly speaking, we did not see USM as a real competitor to our aftermarket business. We've looked at USM since then regularly and we've looked at buying parts out of the user serviceable market. And we've not seen that there's much available out there or much we can do to impact that market. So, we've heard the same concern that as planes are retired, more of them will be put into the USM market and parted out. That's possible. We haven't seen that as a large drag on our revenue. Historically, it's something we've talked to all of our teams about to make sure that they're looking for these opportunities or looking for inventory of their parts out there. And we'll have to carefully watch that. Again, historically, USM was not a big concern, I don't know if it will transform into that today. Generally speaking, the way we have analyzed this and what we've heard from the market, $5,000 to $10,000 needs to be the average sale price, most of our parts, the line share of our parts fall well below that. I believe we've communicated prior that about $1,000 average sale price at least a couple of years ago. It just puts our parts not in the USM available market, generally speaking. So, it's something we will watch closely, but right now, I'm not as concerned about the parting out of planes impacting us. That may happen, and we will have to react to it.

Just staying on this for a second, is there a way to think about your exposure or your parts with regard to ABCD checks? Have you ever looked at that? Are you more heavy tracks, or are you there's the more routine frequent checks?

We're really all over the place. Some of our parts get replaced by time on wing. Others it's number of cycles. Others, it's like seatbelts or passenger-related, passenger volume related not takeoffs or landings. So we've looked at this across the board and not really seen any trends that we need to exploit or there's an opportunity to.

Your next question comes from the line of Myles Walton of UBS.

Maybe a clarification and then a bigger level question. The clarification is that the organic growth of 5% in the pro forma and markets. Can I derive to something closer to flat? And so is that more just the Esterline mix or sales dynamic maybe a little bit lower than the legacy TransDigm activity? And then the bigger question is, as you're entering the downturn of the end market. How is your line performing, adapting? How are those businesses performing adapting relative to your legacy TransDigm businesses? And are they kind of fitting into the same mold, Nick or Kevin, as you kind of look to adapt to these new volume levels?

Thanks Myles. On the organic growth, it's obviously a little confusing how you could do the computation this quarter just because Esterline closed mid-quarter last year. So, there are different approaches you could take. You could put Esterline completely in, you could take it completely out, or you could allocate it based on the number of weeks owned. The punchline is depending on however you do it, the organic growth comes out somewhere between 1% and 5%. We did it based on the number of weeks owned, and what we'll do in the 10-Q filing, you'll see the detail. We provided enough detail so that you guys can hopefully read through it and then do the computation however you want. But at the end of the day, you get something between 1% and 5% depending on the approach you take. And it's just a little muddy because of how the acquisition dates are on Esterline.

And that's, I think, safe to say, it isn’t materially different; it's not materially different from other businesses. As far as Esterline performance goes, much like the first quarter, Esterline performed very well across the board really, but certainly on the aftermarket side, they performed well. So I think they're fitting into the general performance window of our legacy businesses as they should. They're sort of products that fit the same mold as the rest of TransDigm. So, they're performing very well in the market.

Your next question comes from the line of David Strauss of Barclays.

Want to ask about working capital. I mean you talked about remaining free cash flow positive in the back half of the year but how do you might get this for you, how do you think working capital moves just thinking, receivables, payables and inventory levels?

Well, over a longer period of time we do expect some cash to come out of it, but we don't count on it. So when we do the downside financial modeling assumptions, we don't count on any immediate inflow, positive inflow from a downturn in working capital, whether it's accounts receivable or inventory or for stretching out your payables. As this goes on for a longer period of time, maybe 6 months to 9 months, we would expect it to be more of a source of cash, but that's not what is driving the assumption of positive free cash flow in the back half of our fiscal year.

I would just add, like our other assumptions, we think that a conservative assumption, but we don't want to kid ourselves here. But I would say Mike got out really early in this whole process and talking to the controllers and our businesses about watching AR and AP closely on these to ensure we didn't get overextended in debts, or in basically extending credit to folks. Operationally, we're managing our inventory. We're looking at this very closely. As Mike was alluding to, it's going to take a little while for us to impact these and start bringing them down. You need production levels to bring inventory down. And it will happen we're working on shutting off all the incoming taps and ensuring we're not extending too much credit to airline customers or distribution partners.

I have a follow-up question regarding the 70% and 80% assumptions you're using for planning purposes, which I understand is not guidance. How do these figures relate to your underlying assumption for the global capacity decline? Are you suggesting that the 70% and 80% are above the underlying global capacity decline? Additionally, how are you approaching pricing for your aftermarket business in this environment?

Let me try that. I would say the 70% to 80% decline, just because I'm sure, I'll keep forgetting 70% or forget about 75%, because I can remember that's one of them. It's not 75. I'm not sure I followed your question, but it's not 75% less than the cash flow decline. I mean, we're just if you took the run rate was 100. We think the run rate is going to drop down to 25. That's yielding for our sizing assumption. And we're assuming that's going to stay there for six months, which I think is a hopeful conservative assumption. It wouldn't surprise me that it could be a little sharper for the first month or so. But hopefully it wouldn't last six months. But we'll see. The market dynamics for the sort of supply and demand and switching costs to the like, I don't think they change a lot. And the way I'd address your second part of your question.

Price side, we will still manage our value drivers and what we need to look at are: Where are the green shoots in the business? Is Asia coming back? Are they flying? They're starting to recover a little bit; it's still slow. As Nick said, the next few months sharp decrease and maybe it comes back a little bit in the following months, that's the way our profile might look like, but a 70% to 80% downturn in the aftermarket side.

I was just asking if you were thinking that your aftermarket business was going to be down in excess of the decline in global capacity.

I would have to say, I don't, we're using the numbers we gave you. I don't know quite how to calibrate that against other. There's assumptions all over the place on capacity that people are making and we set our numbers sized to and that's what we use.

Your next question comes from the line of Robert Stallard of Vertical Research.

I'm going to try and ask David's question, try differently. Nick or Kevin, what's the sort of risk of inventory in the chain, be it in MRO shops or distribution channels or wherever it might be? Does that could end up dragging down the aftermarket more than whatever airline traffic and capacity is doing?

I'll take a shot at it, Nick and follow up. I think there's clearly inventory in the supply chain. We do not know how much. We know a distribution, but we do not know MRO shops, airlines, and the like or for that matter really what OEMs have. Clearly, the inventory overhang concerns us and it's something we'll have to watch. This is the problem with a downturn like this as you get a little bit of a double hit, I think given the aftermarket, I think people manage our inventory pretty closely. But I'm sure there's inventory out in the field that will need to be accounted for and will be a bit of a double hit as we managed through that initially.

The only thing I'd add is just, I think this is the right, Kevin, distribution where we know the inventory pretty well is about 25% of our aftermarket right now. The other 75 is not distribution, it's a little harder to get you off now.

Your next question comes from the line of Sheila Kahyaoglu of Jefferies.

Hi, good morning and thank you everyone for the time. Nick, I want to maybe talk about EBITDA margins is that holding that mid-forties level's pretty tough, but you're aligning 80% of your cost structure. So it's variable whether it's materials and labor. Understanding as a very high incremental, how do we think about that mix impact of in commercial as generating 70% of your EBITDA? And I know you just commented on price, but it's you're hoping to get a positive and you've had a positive impact on pass down terms. So I guess is it all a mixed impact that you're seeing to see from commercial aftermarket?

Yes, it’s very simply that segment, that piece of our business is the highest margin business. All things being equal, if that one drops off more sharply than in the rest of the business, which is likely the situation here at least for a little while. That's a headwind on your margin. I think on the cost reduction, all things being equal. In other words, if you kept constant mix and you took the revenue minus the EBITDA or EBITDA as defined, you took that slog costs. I think we can get that down pretty well ratably with the volume assumptions, at least within the kind of ranges we're talking about now. So, all things being equal that would hold your margin, but I think you got some headwind from this aftermarket being a sharper downturn and that just make it tougher. I think we can get close, but I don't know that we can get all the way there. We think the steady state with this mix of business is somewhere in the mid forties.

Okay that makes sense. So that's why you're not getting 35% margins because of the mix headwind or that cost cutting is getting you somewhere in the low forties during the downturn, in terms of the EBITDA margin.

I don't know what the 35 means, but I think I'm not quite sure I follow that. But anyway, I think you've got the side.

Your next question comes from Hunter Keay of Wolfe Research.

As I think about the commercial aftermarket business, is there a way you can help us understand sort of a breakdown of what you do as more discretionary versus directly tied to flight hours or RPM?

I would say most of our business is tied to flight hours or RPM; takeoff and landing cycles. I think very, very little of our business is truly discretionary. You can argue that seatbelt might be slightly, because they can maybe live with them a little longer than they'd want to. Worn floor tiles and marked walls, those are aesthetics and those are part of our Schneller and Pexco businesses lighting at some of our businesses, bathroom fixtures. Some of those may be slightly more discretionary. That's what we've always said about our aftermarket. But we believe the lion's share of it is dependent on cycles or time or hours in the air. That's what we believe the bulk of our products are. So, that's why, if not much of your aftermarket is discretionary. With even small amounts of flight travel, you're still going to get some aftermarket. That's what we count on.

And then Nick, obviously every quarter come on you talk about the beauty of the model sole source proprietary, the two biggest moats and realize the deities how they complement each other. But is one of those two, maybe a little bit of a deeper moat through down cycles over the long term if you were to sort of lean towards one of the others having a little bit more sort of durability or moat that which one was or lean towards?

I don't think you mean proprietary and sole source. I don't think you separate them. I think there are complementary.

Your next question comes from the line of Seth Seifman of JP Morgan.

I just wanted to ask about the, so the mix shift here, the defense part of the business still holding off and probably in line with what you expected. You talked about over 75% of EBITDA coming from the aftermarket, but that includes their defense aftermarket, which is decentralized. I've always thought of the defense aftermarket margins being not quite at the level of commercial, but still solidly healthy and all above the Company average, and maybe the defense OEM margins being, I don't know, in line or slightly below the Company average, but better than commercial OEM. Is that a fair way to think about it?

I think that's a fair way to think about it. In total, we make less money on our defense business than we make on our commercial business. And the mix between OEM and aftermarket is a little different in defense, but directionally what you're saying is correct.

But not miles less; it's not a big difference.

And our next question comes from the line of Michael Ciarmoli of SunTrust.

I don't know, Nick or Kevin, maybe just back on the OE, the down 25 to 40. Does that contemplate, obviously, for the next six months? I mean, presumably it contemplates the reduction, some of the facilities shut down. Does it also contemplate inventory destocking and a realignment of the supply chain that you guys kind of put your best assumptions in there?

There's, I don't have a lot of, I know that there's going to be an inventory overhang. And we tried to give you a range to hit that. So, we do have some in there the amounts, it's hard to speculate on, because we don't know how much inventory is held at Boeing or Airbus for instance. We're not on min-max buck been schedule. So I don't know what amount they have generally speaking in their different products of buckets that they buy from us. So again, looking at this 25% to 40% OEM reduction in the next six months, we will include some of the inventory overhang, but we don't know how much is really there.

I think just to recap, just to restate what I think is the obvious. We can't wait for perfect information here in these situations. What we have to do is read everything we can read, look at what we got and our incoming data at some point, just stick a stake in the ground and current costs and then watch it. As I said at the beginning, the only thing I know for sure is we'll be wrong and we'll have to adjust one way or the other over the next six months, hopefully up a little, I don't know, maybe up a little, maybe down a little. We'll just have to see.

And maybe just one follow-up on that, Nick. Considering the costs and the aftermarket, do you think that a year from now when we have more flying, the cost actions you've taken will result in permanent reductions? It seems it might take a couple of years for aftermarket revenues to return to 2020 levels.

I mean, I don’t think our costs are going to stay down by this magnitude as the cost. I know it's a little bit incremental fall through the profits or something. But as has happened in the last, in the previous downturns, we tend to come out of these things with a better cost structure than we went in because we tend to not put the cost back in at the same rate that revenue covers.

Your next question is from the line of Ken Herbert of Canaccord.

Hi Kevin, Nick, and Mike, thanks for the time. I just wanted to ask, when traffic starts to stabilize for your commercial aftermarket, if I think of that business broadly in sort of three buckets, repair, spare parts sales, and provisioning, where do you expect to see the recovery first and how would you expect that to potentially play out?

My guess is it would be in the repair area is where we would see the first reloading as they are bringing planes that need to be serviced now to the service line. That's what my assumption is, but we'll have to see. Provisioning as we've said in the past isn't a huge driver for us for volume. There's certainly some here and there, on some programs, but I think it's repair of spare parts that we would see and I think it's probably going to be the repair. Nick, do you have a thought on that?

I mean repair and spare parts are hard to separate.

Your next question comes from the line of Gautam Khanna of Cowen.

Thank you for the information. Many of my questions have already been addressed. I’d like to follow up on the OEM discussion regarding aerospace. Do you have an idea of the level of destocking or inventory in the channel? Can you provide an estimate of how many subcontract manufacturers you supply to within the Boeing and Airbus supply chain? Is this market relatively concentrated or spread out among numerous manufacturers?

It depends on business. Some businesses, it's very concentrated; in others, it's very diffuse and we sell to Tier 2s and the like. So, it is very diffuse and I can't give you any more clarity around that.

And then the other thing I want to make sure we understand. Is the commercial aero business profitable? It contributes to the 25% of company EBITDA or is it widely skewed towards the defense side that 25%?

Yes, I don't think following up on percentages on profitability by end markets, but we can say the commercial OE businesses, as we look at it, to the best of our abilities, it's a profitable business for the rest profitable in the aftermarket.

And then last one, you've mentioned the defense business. Can you talk a little bit about the parachutes and what have you? Are there any other kind of lumpy orders or drivers this year that we should be thinking about as we model out next fiscal year just perhaps non-recurring?

No, I don't know of anything that's non-recurring that. The issue with defense is that it often can be non-recurring. But right now, I don't know of any pieces. Our parachute business looks like it's well aligned international military sales continues strong. We haven't really seen any downturn from any countries around that yet. So we think of the military is reasonably robust for the next six months to a year.

And then we'll see. The problem with defense is lumpy. And this quarter, we commented on APKWS, the system turning dumb bombs into smart bombs. We sell a lot of product to APKWS, the Advanced Precision Kill Weapon System from BAE. That comes in very lumpy orders.

Something lumpy comes all the time.

Something lumpy comes all the time and we had lumpy orders last year just in different quarters than we're getting on this year. So, it makes the year-over-year comparisons bounce all over the place.

But it's much more applicable to bookings and shipments.

The shipments are not lumpy, generally speaking.

Your next question comes from Michael Ciarmoli of SunTrust.