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Moog Inc.  (NYSE:MOG.A) (NYSE:MOG.B)
Q2 2020 Earnings Call
April 24, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Moog Second Quarter FY 2020 Earnings Conference Call. [Operator Instructions]

At this time, I would like to turn the conference over to Ann Luhr. Please go ahead ma'am.

Ann Marie Luhr -- Head of Investor Relations

Good morning. Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance and are subject to the risks, uncertainties and other factors that could cause actual performance to differ materially from such statements. A description of these risks, uncertainties and other factors is contained in our news release of April 24th, 2020. Our most recent Form 8-K filed on April 24th 2020, and in certain of our other public filings with the SEC.

We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our Investor Relations' webcast page at www.moog.com. Thank you, John?

John R. Scannell -- Chairman and Chief Executive Officer

Thanks, Ann. Good morning. Thanks for joining us. This morning we'll report on the second quarter of fiscal '20 and discuss the future outlook for the company in light of the COVID-19 crisis. Given the uncertainty in global markets, we're suspending our normal practice of providing detailed guidance for the remainder of the fiscal year.

In reviewing my comments from 90 days ago, COVID-19 was not a topic on our agenda -- indeed, it wasn't even a word in our vocabulary. In late January, we talked about Brexit, the US trade dispute with China and unrest in the Middle East. Some eight weeks later, all our attention shifted to responding to the rapidly changing situation as a result of the spread of the virus. I hope our comments today will leave our investors with two clear messages about our business. First, short-term strength from our diversity and second, long-term value from our fundamentals.

As usual, I'll start with the headlines. First, the second quarter was strong. The pandemic only started to affect our operations late in the quarter and had relatively little impact on our results. Sales in the quarter were, up 6%, net earnings were, up 21% and earnings per share were, up 26% from a year ago. Free cash flow was $12 million and during the quarter we purchased 1.6 million shares under our share buyback program. The first half of fiscal '20 is a record for the company in terms of sales, net earnings and earnings per share and provides a solid foundation as we enter this crisis.

Second, early in March we started to understand the scope of the emerging pandemic. We set two clear priorities. First, and foremost was the health and safety of our employees and their families. And second, to continue to meet the needs of our customers and thereby secure the financial well-being of the company.

Third, we took action. We transitioned to working from home wherever possible and implemented changes in our work practices for production employees, who continued to come into the plants. We focused our financial attention on modeling liquidity and leverage. We implemented expense and cash conservation actions including hiring and salary freezes, elimination of consulting and other discretionary expenses and focused on minimizing capital expenditures. We paused our share repurchase program and also decided to temporarily suspend our quarterly dividend payment.

Fourth, we assessed our markets and developed future business scenarios. We believe we are relatively well positioned to weather this storm. Our diversity across markets is our strength. Our Defense and Space businesses combined make up almost half our sales and are mostly US government funded. Both businesses are strong and should continue to be well supported. Our medical business is close to 10% of our sales and we're seeing increasing demand for our pumps. Our industrial business is just over a fifth of our sales. We anticipate we'll see a drop off in demand in these markets as the crisis unfolds. And finally, our commercial aircraft business is likely to be the hardest hit. However, to put this into context, commercial OEM customers, represented 17% of our total sales in the first half of fiscal '20 and sales into the commercial aftermarket were about 5% of our business in the same period.

Fifth, our financial position is healthy and our relationship with our bank group is strong. We refinanced our entire balance sheet over the last six months and are conservatively leveraged.

And finally, we're investing where we can to support the fight against the virus. We're adding staff in our medical facilities as demand for pumps surges. In addition, our industrial group supplies small motors that are used in ventilators. The demand for these motors has increased from 800 units per month to 30,000 units per month. Our staff is working tirelessly to increase our capacity and expand the supply chain to meet this need.

In summary, I would describe our situation today as stable. The vast majority of our staff around the world are working productively. Most of our facilities continue to produce products and both our supply chain and our customers continue to operate. Under the new practice of social distancing, we estimate we are operating at perhaps 80% to 90% of our normal capacity. It may be early days yet in the crisis, but so far we're meeting our two primary objectives of keeping our employees safe and maintaining the financial health of our company. This is a testimony to the commitment of our employees around the globe and I would like to thank each of them for their dedication.

Now let me return to my normal reporting format. I'll describe the results of the second quarter in a little more detail and then walk through each of the operating groups.

For fiscal '20 second quarter. Sales in the quarter of $765 million were 6% higher than last year, driven by organic growth across our A&D portfolio. Sales were up 17% in our Space & Defense group, up 6% in our Aircraft Group and down just 1% in our industrial group. Taking a look at the P&L, our gross margin was more or less in line with last year. R&D spending was down on lower Aircraft activity, while spending on selling and admin was up on the higher sales. Interest expense was marginally higher than last year on higher debt levels. The effective tax rate this quarter was low at 19.2% as a result of some special items. The overall result was net income of $50 million, up 21% from last year, and earnings per share of $1.48, up 26% from last year.

Fiscal '20 outlook. Given the uncertainty of the present economic situation, we're not providing specific guidance for the second half of our fiscal year. However, I will offer some qualitative comments about each of our markets. I would stress that the situation in each of our markets is very fluid and there are many unknowns, so our commentary today could change materially in the future.

Now to the segments. I'd remind our listeners that we've provided a two page supplemental data package, posted on our webcast site. We suggest you follow this in parallel with the text. Starting with Aircraft Q2. Sales in the quarter of $341 million were 6% higher than last year, with all the growth coming on the military side of the house. Sales were up over 20% on the F-35. And sales were also higher on the Blackhawk helicopter and on the KC-46 tanker. In the military aftermarket, it was a similar story with higher F-35 and Blackhawk activity. We also enjoyed higher F-15 aftermarket sales. This quarter, the army down-selected to two competitors for the next phase of both the FLRAA and FARA future vertical lift programs. We are well positioned on the Textron V-280 for the FLRAA contest and are happy to report that we are on both the Bell/Textron and Sikorsky teams for the FARA competition.

On the commercial side, total sales were flat, with higher aftermarket sales compensating for slightly lower sales to our OEM customers. OEM sales to Boeing were in line with last year. We saw nice growth on the 787 program, which compensated for 737 sales down 50% from a year ago and 777 sales down 20%. Airbus sales were off over 10% from last year, driven by lower A350 activity and A380 sales essentially going to zero. The commercial aftermarket was up mostly on 787 activity as the size of the fleet out of warranty continues to grow.

Aircraft margins. Margins in the quarter of 10.2% were, up from 8.5% a year ago. In the second quarter last year, we booked a $10 million charge associated with a quality issue on a vendor supplied part. The higher margins this year are a combination of the higher sales and a better mix, as well as the absence of last year's charge. However, the margin performance in the quarter was tempered by about 100 basis points as a result of a charge on a development program.

Our Operations 2.0 improvement activities continued through the first two months of the quarter, but have since slowed as we focused on restructuring our working environment. Progress will continue over the coming quarters, but not at the pace we were planning.

Aircraft fiscal '20. In offering some thoughts on the coming six months, I will try to address both supply side and demand side issues. Let me start with the military half of the business. On the supply side, our facilities are located in the US and the UK, have been deemed essential by the authorities and continue to operate. To-date our supply base has continued to function well although we have a couple of suppliers who have shut their facilities for multiple weeks. We're optimistic that they will return to work before our inventory of parts is depleted, but the supply chain will remain our biggest unknown in meeting our customer needs. On the demand side, the vast majority of our business is funded by the US DOD and we're confident that this market will remain strong. In summary, we're optimistic that the military side of the aircraft business will remain solid for the coming quarter, with the risks skewed to the supply side of the equation.

Turning now to our commercial business, our major factories are in the Philippines, the UK and the US. All facilities continue to operate. Similar to defense we have risks in the supply chain but, for the moment, we are well positioned to meet the needs of our customers. On the demand side, it is a much more concerning picture. Our airline customers are dramatically reducing flights, and we believe that our OEM customers will cut production rates significantly. We're working with all our customers to get a clearer picture of their demand over the coming quarters, but the situation continues to evolve daily. In summary, we believe the commercial side of our business will be significantly lower over the coming quarters with the risk skewed to the demand side of the equation.

Turning now to Space and Defense. Sales in the quarter of $193 million were 17% higher than last year. This quarter it is the Space market that is providing the majority of the growth, with sales up 38% over a year ago. We had significant growth in hypersonic launch vehicle activity and NASA development programs, as well as strength in our satellite engine and avionics product lines. Note that we record our hypersonic development activity partially under our Space market and partially under our Defense market. Launch vehicles used to raise hypersonic weapons into space are included under Space, while fin steering controls on hypersonic vehicles used during descent are included under Defense.

Defense sales were up 7% from last year with strength across most of the product lines including missiles, vehicles and naval systems. Our security business was down as planned shipments to customers moved out to future quarters.

Space & Defense Margins. Margins in the quarter of 12.8% were, up from last year. We're pleased with this margin performance given the high level of funded development within the group. This funded development is very positive for the long-term, as it sets the foundation for future production programs, but tends to dilute margins in the short-term.

Space & Defense fiscal '20. In Space & Defense, it is a similar story to our military aircraft business. On the supply side, most of our facilities are in the US, with a couple of operations in Europe. All sites are operational and our risks are mostly in the supply chain. On the demand side, most of our business is supported by US government funding. We believe that funding should continue, more or less as planned, for the remainder of our fiscal year. Staffing challenges and production inefficiencies as a result of social distancing measures will result in lower productivity and lower output than normal, but overall, the business should weather the next couple of quarters reasonably well.

Turning now to Industrial Systems. Sales in the quarter of $231 million were down marginally from last year. The stability on the top line belies the sales shifts in our major markets. Sales into Energy applications were 23% higher, due to the fact that half of the acquired sales from our recent GAT acquisition in Germany are coded to this market. GAT specializes in Fluid Rotary Units, which complement our slip ring technologies. Sales were also up double digits in our Medical applications as demand for our infusion pumps continues strong. We have been gaining share in this market over several quarters as a major competitor has struggled with production challenges. As we look to the future, we anticipate continued strength in this market to support the COVID-19 crisis.

Sales into Industrial Automation were down almost 10%. There were two factors at play. First, the continued slowdown of global capital spending, independent of the pandemic, and second, a loss of sales in the quarter, particularly in China, due to the virus. Finally, sales into our simulation and test market were also lower as demand for both auto and aero test systems, particularly in China, slowed.

Industrial Margins. Margins in the quarter were 10.7%. These margins are down from a year ago on a less favorable mix. Our traditional hydraulics products sold into industrial automation applications are off significantly from a year ago. And in addition the sales from our GAT acquisition are at relatively low margin due to first year acquisition accounting effects.

Industrial Systems fiscal '20. The outlook for our industrial business over the next couple of quarters is perhaps the most difficult to project. Here we have a combination of both supply and demand uncertainties. On the supply side, some of our facilities produce products essential in the fight against the virus, such as medical pumps and certain small motors used in ventilators. These facilities will continue to produce as fast as possible. However, most of our industrial plants, and their supporting supply chains, are spread across the globe. Each location is at a different phase in their fight to contain the virus and each plant is subject to local government regulations on work practices.

The good news is that, so far, almost all our facilities continue to operate and our supply chain is working. On the demand side, our book to bill remained just above one in the second quarter, but bookings may slow as we move through the rest of the year and our customers adjust their orders in line with the end market demand. What that demand will look like is difficult to determine.

Let me provide some summary comment, before handing you over to Jennifer. We all find ourselves in unprecedented times. Today, as we face the immediate COVID-19 lockdown and the ensuing economic fallout, we believe we are relatively well positioned. Our diversity across markets and our strong balance sheet are key to navigating the short-term challenges, while the strength of our franchise and our fundamental approach to business are the basis for our continued long-term success.

Over the years, we've described the fundamentals of our business as follows. One, We solve our customer's most difficult technical challenges. Two, we develop a leading position in niche technologies across a diverse range of markets. Three, we develop unique IP both in product design and manufacturing and four we believe in a conservative financial approach to business.

Our highly technical products, specifically designed to meet our customer's applications, make it very difficult to be replaced by alternative sources of supply. Therefore, our fortunes will rise again as our customers recover. Our investment in R&D and our staff of highly skilled engineering talent will continue to create new opportunities to provide value to our customers. And our prudent approach to capital allocation and focus on maintaining a strong balance sheet will allow us to rebuild for the longer term.

Finally, we believe our employees are our most important asset. Our culture of trust, integrity and cooperation means that our leadership and staff around the world are committed to the long-term success of the company. As we look out over the coming six months, we believe our defense, space and medical businesses will remain strong. Our industrial business is likely to face some challenges and our commercial aircraft business will be hardest hit. As the picture becomes clearer we will take all necessary steps to restructure our business to this new reality.

Beyond that horizon, it is difficult to say, but our diversity across end markets should serve us well as some markets recover ahead of others. Throughout this time, we will continue to invest in R&D, process improvements and long-term initiatives that will provide benefits for years to come. So let me finish with this thought. I believe in years to come, we will tell future generations about the time the world stood still. And then, one day, it started turning again.

Now let me pass you to Jennifer, who will provide more color on our cash flow, balance sheet and COVID-19 financial modeling.

Jennifer Walter -- Vice President, Finance

Thank you, John. Good morning, everyone. We come into the current situation from a position of relative financial strength. Earlier in our fiscal year, we refinanced the debt on our balance sheet, which provides us with liquidity and financial flexibility. As business challenges emerge related to the pandemic, we'll maintain our financial health from two key factors. First, as John described, we will benefit from the diversity in the markets we serve. Second, we're taking action to assess and address the financial implications in the current environment.

I'll cover these topics in more detail, but first I'll walk through our cash flow for the second quarter and other topics we typically describe. Free cash flow in the second quarter was $12 million, and was $27 million for the first half of the year; that's a conversion ratio of 27%. We had expected this slow start for free cash flow generation in the first half of 2020. The $12 million of free cash flow for Q2 compares with an increase in our net debt of $124 million. The difference includes share repurchases.

During the second quarter, we repurchased 1.6 million shares at an average price of $75 for a total of $120 million. We also paid $8 million for the quarterly dividend and $4 million for the early redemption of our $300 million senior notes. Net working capital excluding cash and debt as a percentage of sales at the end of Q2 was 29.6%, compared with 28.8% a quarter ago. The increase largely reflects growth in physical inventories. We are continuing our Operations 2.0 activities in our Aircraft Group, but these activities slowed late in our second quarter and will be moving forward at a rate lower than previously planned. These activities will reduce net working capital levels over time.

Capital expenditures in the second quarter were $26 million, while depreciation and amortization totaled $22 [Phonetic] million. Both capital expenditures and depreciation and amortization continued at levels from our first quarter. Our leverage ratio, which is net debt divided by EBITDA, increased to 2.6 times from 2.3 times a quarter ago. The increase in our leverage ratio was driven by our share buyback activity in the quarter. Net debt as a percentage of total capitalization was 44%, up from 39% last quarter.

Our effective tax rate was 19.2% in the second quarter, compared to 23.8% in the same period a year ago. The lower rate in this year's second quarter primarily reflects the reduction in tax rate related to taxes accrued on accumulated earnings in one of our foreign jurisdictions. In addition, legal entity restructuring resulted in reduced withholding taxes previously accrued in another foreign jurisdiction.

Cash contributions to our global retirement plans totaled $12 million in the quarter, compared to $10 million in the second quarter of 2019. Global retirement plan expense in the second quarter was $20 million, up from $18 million in the second quarter of 2019. Our largest defined benefit plan is in the US and has been closed to new entrants for more than a decade. We fully funded this plan in 2018, at which time we shifted our investment strategy to derisk our portfolio. We're invested 80% in liability hedging assets and 20% in return seeking assets. As a result, our portfolio is largely insulated from the recent market turbulence, and we continue to be fully funded. The funded status has also remained stable for our international pension plans.

The impacts on our business from the COVID-19 crisis started to become evident late in our second quarter. John referenced that our strong second quarter results provide a solid foundation as we enter this crisis. The same is true from a balance sheet perspective. We entered this situation having recently refinanced the debt within our capital structure. This past October, we amended our $1.1 billion US revolving credit facility, obtaining more favorable terms, both with respect to interest rate and financial flexibility. We also extended the maturity, such that it now runs through October 2024.

In addition, we issued $500 million of 4.25% senior notes that mature in December 2027, and we redeemed and retired $300 million of 5.25% senior notes that were set to mature in December 2022. We also extended our securitization program through October 2021. This program effectively increases our borrowing capacity and lowers our interest rate on up to $130 million of borrowings. These refinancing activities position us nicely coming into the situation we now face.

Our net debt was $975 million at quarter end. We had $119 million of cash and $1.1 billion of debt. The major components of our debt were $500 million of senior notes, $473 million of borrowings on our US revolving credit facilities and $130 million outstanding on our securitization facility.

We have available borrowing capacity on our US revolving credit facility. At the end of our second quarter, the unused balance on this facility was $600 million. Our ability to draw on the unused balance is limited by our leverage covenant, which is a maximum of 4.0 times on a net debt basis. Based on our leverage, we could have incurred an additional $536 million of debt as of the end of our second quarter. We have assessed the financial impacts on our business from the pandemic and will continue to do so as the situation evolves. We are estimating the pressures on our sales, profits and cash flow, all the while considering the risks and uncertainties involved that widen the range of potential outcomes.

Our businesses are facing varying levels of pressure depending on the markets they serve. Looking to the second half of the year, our defense and space businesses may face only modest pressures associated with supply chain risks and productivity levels. Our medical business is strong and likely unaffected. These businesses represent over half of our sales. Our industrial businesses may see supply chain, productivity and demand challenges, so we're assuming sales to be pressured by up to 25% in the remainder of the year.

Finally, commercial aircraft faces the greatest pressures with demand declining associated with steep reductions in flights. In the short-term, the aftermarket is likely to be impacted more than OEM, and we're modeling second half sales declines for all of commercial aircraft between a third and a half. Due to the uncertainties with respect to severity and duration of this situation, we are not providing specific financial guidance as we have in the past. However, we can share some insights. The scenario I described suggests that sales could decline from the first half of the year to the second half by 10 to 20%. Right sizing our business will take a little time, so it's possible that we could experience a marginal loss on sales in the 30% to 40% range over the second half of this fiscal year.

We have been proactive in implementing measures to counteract these impacts. Our immediate financial focus revolves around cash preservation and cost management. We are making significant adjustments to our major capital deployment activities in the current environment. We have paused our M&A pursuits for the time being. We have been active in our share repurchase activity, but suspended purchases in mid-March when financial uncertainties became evident. We are also temporarily suspending our dividend program.

In addition, we are delaying most capital expenditures that are not business-critical or compliance-related. Each of these actions helps to preserve our liquidity. We're also preserving our liquidity in other ways such as reducing incoming inventories from our supply chain to be in line with expected demand, taking advantage of payment deferrals and implementing financing programs. We are implementing measures to mitigate the earnings impact of this situation, in addition to providing cash relief. These measures include workforce and expense management and are important as they not only preserve our cash, but also protect our earnings. This in turn protects our leverage, allowing us to more fully access the credit on our revolving credit facility.

We believe that our existing financial arrangements, along with the actions we're taking to mitigate the business pressures we're facing, will be sufficient to weather this storm over the coming quarters. In addition, we have long-standing, strong relationships with our bank group and access to capital markets that can provide further funding sources should the situation become more stressed.

In the current environment, we have shifted our capital deployment strategies from a long-term perspective that balances growth and capital returns with one that focuses on liquidity and leverage in the near-term. We are committed to ensuring that we have adequate liquidity during this crisis, protecting the long-term health of the company and emerging financially strong and ready to capitalize on opportunities once this situation passes.

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

John R. Scannell -- Chairman and Chief Executive Officer

Thanks, Jennifer. And Valerie, we will open it for questions, please at this time.

Questions and Answers:

Jennifer Walter -- Vice President, Finance

Thank you. [Operator Instructions] We will now move to our first question from Robert Spingarn of Credit Suisse. Please go ahead.

Robert Spingarn -- Credit Suisse -- Analyst

Hi, good morning.

John R. Scannell -- Chairman and Chief Executive Officer

Good morning, Rob.

Robert Spingarn -- Credit Suisse -- Analyst

Thank you both for as much color as you're able to give here. It's very, very helpful. I was wondering if I might attempt to reach out a little bit though and see what your latest experience has been in aerospace. John, can you give us any color on what you're seeing in April, so far here in the beginning of this current quarter and how markedly it's changed from March?

John R. Scannell -- Chairman and Chief Executive Officer

Well, I'd say Rob, our comments really are based on what we've been seeing literally in the last weeks and days. And so our -- if I think of -- the military side has -- I mean, it's almost like, no news that business continues. We've benefited a little bit from accelerated funding from some of our major customers, because of progress payments. So that's all in April. So the military side of the business looks like it's doing just fine. Space business, same thing, so I'd say, there's kind of no news there. The medical side of the business as well as we mentioned is strong.

The commercial side is a changing picture. We've -- Airbus has come out and said they're changing rates. So that's no Boeing has not provided any detail yet. I think their plan is to do that on their call next week. But we have not received any updates on our Boeing book of business. And then the commercial airlines, I mean we're talking with our customers daily, we're looking at our backlog of actuators, carcasses as they call them. That we have in our shop. We're looking at the incoming rates on that we're looking at the blend between freighters and passenger traffic. And then of course, we're reading all of the materials that you guys are putting out. And so that's what, but it's changing every day. And it's very hard to put numbers around it.

I would say, the materials that the investment community has put out are as good as anything that we have internally. I think you have exactly the same insights at this stage that we have. And so we're kind of modeling off of what we're hearing from our customers and what we see you folks putting together from the macro perspective.

Robert Spingarn -- Credit Suisse -- Analyst

Well, just then on a couple of specific programs, just to get some clarity. On MAX, had you -- I assume you've been stopped since the stoppage and earlier in the year, are you starting to ramp in preparation for Boeing going to some level of production? And then on 787 has the opposite happened and maybe on all of the programs, because of the COVID-19 driven stoppages that you've seen at Boeing?

John R. Scannell -- Chairman and Chief Executive Officer

So on the MAX -- so as we've described it in the past and when MAX was running at race, it was a kind of $35 million to $40 million piece of business for us. Through the first half, we're kind of at the $13 million or $14 million. So we need -- we were kind of trying to do a combination of build some safety stock, keep our line warm, while also working with Boeing in terms of their demand. We anticipate that, that would really drop off for us over the next several months. Not necessarily because we're reflecting exactly what Boeing is doing. It's more reflection of inventories that we already have, parts that we built ahead. And so it's a little bit disconnected. So we will be working very closely with Boeing to understand their demand, but we think we're probably covered.

So we think the MAX -- our MAX business, again, relatively small or less than $15 million in the first half. That'll probably drop off fairly significantly in the second half and then pick up again. But that's not a reflection of Boeing's plans or what they may be in terms of how they will reramp their business. We will be ready whatever they do and it will be easy enough to restart if we think that there is a need for more product than we already have in the supply chain.

And then on the 787, as I mentioned, we do not have updated production rates from Boeing. So we still have open POs at the race that was prevalence two, three, four months ago. We anticipate that there will be some significant changes, but we have not yet received that information.

Robert Spingarn -- Credit Suisse -- Analyst

But in your quarter just reported, did you stop at all? I guess it was before perhaps Boeing actually shut things down in Seattle, but you were producing at mature 787 rates in the quarter?

John R. Scannell -- Chairman and Chief Executive Officer

Yes, yes. I mean, we produce to the POs that we have for Boeing and we deliver to the POs that they give us. And so on, unless they change the POs and typically, you wouldn't change PO of a week or two before it's due to be shipped. We have been producing at the race that was prevalent. And so in the quarter, it was -- the second quarter sales in the 787 were in line with the first quarter, in line with the fourth quarter. So we've not seen or we have not adjusted yet. And as I say, we adjust -- we try to anticipate, but what we are -- primarily PO driven to meet the customer needs.

Robert Spingarn -- Credit Suisse -- Analyst

Okay. And then just last thing and maybe this is for Jennifer, but can you speak at all to your variable versus your fixed costs? You did give us some sense of decrementals Jennifer, when you talked about sales translating to losses, but is there any kind of color or guidance you can give us on the cost structure either for aerospace specifically or for the company as a whole?

Jennifer Walter -- Vice President, Finance

Yes, Rob. So as we've looked at that, there is -- depending on how short-term and near-term you look at the horizon for your fixed and variable costs. It has a huge dependency there. And so as we looked at that, what we thought was more appropriate to describe it, is really in terms of what in the short-term we might see pressures on. And so that's why we described it from a short-term marginal loss on sales. As we go through this process, there's a number of things that we are going to be taking action on. Some are short-term temporary types of measures and others depending on the size, the sizing of the business and what the demand looks like afterwards will help us determine what the changes structurally we need to make to the business.

Robert Spingarn -- Credit Suisse -- Analyst

Okay.

John R. Scannell -- Chairman and Chief Executive Officer

Yes. I'll add, Rob that the --it depends. Your part of it is what's fixed and what's variable, part of it also is what's the margin on the self that's going down of course, and that -- so that plays into that overall equation. And then I think the problem with the present scenario that we all face is that demand is potentially dropping precipitously. And we as a -- when we look at what the demand might in certain markets, and when we look at that demand, we have to do a couple of things. One is we have to -- first of all, wait to see what does that demand look like. And since it's changing on a daily basis, you'd like to settle it a little bit before you make some structural adjustments.

And then the second part is -- the question is, our flights going to come back in September, January, March, because we have a very skilled workforce. And so if you think it's going to bounce back reasonably quickly or even if you think it's good for the pick up at some relatively, within some couple of months, quarter or two, you don't want to get ahead of losing the staff to do that and so all of that plays into the equation. And therefore, our ability to adjust the underlying cost base is a function of what we think that future will look like. And our -- I'd say, our management approach over the last, let's call it six weeks thinking about since this crisis has really become a big issue, has been, let's make sure we are managing our way to a new kind of way of working as we go through the immediate crisis. And then at that sentence, which I say we're now starting to get to that point and demand for our products becomes clear. So let's see and we put some model in place as to what we think the recovery might look like and what it might happen. Then you start to put plans around, what the size of the business needs to be and readjusting that cost structure.

But that's all going to play out. I think in 90 days time when we report out, of course, will have much more clarity around that like everybody else will. But at the moment, there's just a lot of uncertainties and that's why I'd say, the insights as we call them, it's a wide-range, but that's as wide-range as we think it could end up being as well.

Robert Spingarn -- Credit Suisse -- Analyst

Okay. Thank you both.

John R. Scannell -- Chairman and Chief Executive Officer

Thank you.

Jennifer Walter -- Vice President, Finance

Thank you.

Operator

Thank you. [Operator Instructions] We'll take our next question from Michael Ciarmoli of SunTrust. Please go ahead.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Hey, good morning guys. Thanks for taking the questions. Hope you guys are all safe and healthy and your families as well.Thanks, Michael, yes.

John R. Scannell -- Chairman and Chief Executive Officer

Thanks, Michael, yes.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Just maybe John, a little bit more color, I think you said Aero down 30% to 50% second half versus first half. Can you maybe parse that out between OE and aftermarket? I mean, I would imagine you could see the aftermarket dry up very, very rapidly and I think you kind of just said, you're evaluating sort of what's in the shop right now, but could you give any more detail on how you're expecting the aftermarket to trend here in the short-term?

John R. Scannell -- Chairman and Chief Executive Officer

Well, it's -- Mike, it's -- my guess is as good as yours almost to some extent, there are some factors that I will offer you though that you want to keep in mind that we are looking at; one is, so you have a backlog of just parts to be repaired in your shop as you come into this. And so coming into April we had a backlog of parts already available. So that's some that covers you a little bit as you go through our third quarter. We have a freighter business that we anticipate should hold up much better than the customer of the flying public business. We have fly by -- we've got fly by hour contracts on some of our newer programs. Again, these are not, each of them is a small piece of the pie, but some of those will continue to have some amount of revenue even in the events that there's a reduction in flight hours. And then of course there's the underlying demand.

So we've modeled all kinds of things from down in the next quarter or two by 30%, 40%, 50%, 60%, 70% and we don't know Michael. We really don't know at this stage. We are watching daily how much stuff is coming in. We're also being very careful about credit terms, right now we're feeling OK, but some of our smaller customers we got to be careful that they will be able to actually pay us. So that may also be something that could affect that demand. I'd say we're probably anticipating that the aftermarket, this is a safe bet would probably be down more than the OEM demand over the coming couple of quarters. But it's a wide range, Michael.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it. No, I can appreciate that. What about, I mean, even for both aftermarket and OEM, do you guys think there will be some level of destocking? Do you think there is a lot of buffer stock in the supply chain? Do you think broader supply chain realignment to -- we know Airbus rates are going down, I'm sure Boeing will tell us their rates are going down. Do you think that creates added pressure onto the already weak demand environment? I mean, do you guys have good line of sight into what level of product you guys have in various channels right now?

John R. Scannell -- Chairman and Chief Executive Officer

I think of course, I mean inventory -- inventory adjustments all of this happened and in the aftermarket, I think that's inevitable. There's a lot of talk or stuff that you read about the used serviceable materials is the number of potential retirement of the older platforms, the shift from perhaps the larger twin aisles to the smaller twin aisles, which might favor an 87. But there's a lot of talk, of course, about the shift from twin aisles to single aisles in terms of demand. I think all of that will play through.

I think that -- if I think of the 87 and the 350 Boeing and Airbus have been working very hard over the years not to be building excess inventory in their supply chains. Everybody is interested in just in time in reducing those inventory, so I don't know how much they hold on hands. I described that we had a fairly strong second quarter on 87 purely Boeing will not producing it at the same level given that they closed their factories and that may have been more toward more of an effective April. So I think there's an inevitable adjustment associated with that. But I think, when you think of those big airplane problems, I think those are not precipitous that, that inventory management and stuff it slows down, but it's not precipitous drop. It dropped from 14 a month to some other to 87 -- I don't think a seven days a month, overnight that will be the bigger impact that we will have to try and adjust to.

So yes, I think all of that could play out and that's part of what makes it so difficult to forecast, the future. I would say on our commercial aftermarket products. Our stuff is flight critical and so it's not a nice to have in terms of keeping the airplanes in the air. It's absolutely critical and so if there are flights and if our stuff needs repair and overhaul that has to happen.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it, got it. And then just one more, I mean I know you guys are cutting a lot of non-essential costs, but how is this going to impact the status of, sort of, the operational initiatives you had, you've been implementing in the aircraft control segment, did you still or were you still relying on a level of consultants? And I mean, obviously, the demand environment, I mean it just seems like this throws a wrench in that whole equation. So how do we think about what you had been implementing in aircraft controls as it relates to what's happening here with COVID?

John R. Scannell -- Chairman and Chief Executive Officer

Yes. As we said in the comments, the first couple of months we continued down that path and last month, the quarter and its April has been around social distancing and all of the things going with that, setting up separate shifts, moving people around. All of that, as of course slowed, I can say for the last call it six days weeks, the initiatives around fundamental improvements have completely been displaced by continuing to making sure that we're continuing to make products in the present environment that we've got. As you said, we've essentially cut-off all consulting again in the last month or two.

What I would say Michael is, the first of all as the business, as we stabilize and we normalize into a new way of working with social distancing and all of that, it starts to give a little bit of chaos for the first few weeks, because it's who is it, who's not, what machines are running, who needs to be there, how much support staff, all of that. And then you get to where that settled down. And I'd say that it's settled right now. And now we can start to think again about, OK, let's think about how we start to do reestablish some of those improvement activities.

Part of them though, I'll give you an example would be things relaying out the shop, relaying out the shop and doing value stream mapping is typically stuff that's done with big crews or folks all together in a room working on stuff, moving equipment around to become more efficient. That clearly would be hindered by some of these things.

But I leave you with one other thought, as we get a better sense of what the impact in the business will be. We will try to reengage and what I will call long-term specific investments that we think have benefits over the next year, two, three, four, five across the business, doing it very cautiously and selectively. But I would like to start spending some money on those critical consulting areas, investment areas that we think this is going to be a long console. Maybe that takes us again in the short-term and as long as we are from liquidity and leverage perspective, feeling pretty comfortable about where we are going. We will take the hit on the P&L to make sure that we're investing for the longer term. It's not big numbers, but we will try to make sure, we continue to invest for that long-term improvement.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it. Thanks guys. Stay safe and I will get out of the way here.

John R. Scannell -- Chairman and Chief Executive Officer

Thanks, Mike.

Operator

Thank you. [Operator Instructions] We'll take our next question from Cai von Rumohr of Cowen and Company. Please go ahead.

Cai von Rumohr -- Cowen and Company -- Analyst

Yes, thank you very much. Jennifer, maybe give us some color on the balance sheet, where do you see inventory going, because you had been basically building a buffer, because of the process changes in aircraft. What about receivables? What are you doing to make sure those stay under control? What can you do in payables and then also you had a very nice uptick in advances in this quarter, where should we look for those to go in the future?

Jennifer Walter -- Vice President, Finance

Sure. Thanks, Cai. Yes, as we look at our balance sheet certainly there's lots of uncertainty around all of this, so I'll just caveat it with that perspective. I'll start with inventories, because that's the one that has been the source of growth over the past couple of quarters for us and was previously anticipated to be providing some relief as we headed toward the end of this fiscal year. Some of that benefits was largely attributed to the Operations 2.0 activities that John just described a moment ago. So certainly with those activities, we are going to see some delays in reaping those benefits. So I'm not sure when that'll happen, it's all going to depend on how quickly folks can get back to work, how, when things starts to normalize and priorities start shifting back around to focus on these items.

The program is going well as John described, however it is taking longer than anticipated. So we probably will see some pressure on our inventories in the short-term. However, longer-term we will see the benefits associated with those, but we may not see them near the end of this fiscal year as we had originally anticipated. We are taking a number of actions to look at the demand side of the business. Some of our customers have not forecast and changes yet, but we anticipate those to come. So we're considering those things in mind, so that we can put controls in place and we are putting controls in place to limit the amount of receipts of inventory coming in. So I would consider those more of mitigation efforts, so that we can temper the rise that we would otherwise be feeling in the inventory side of things.

On receivables, we are still seeing good trends there as far as, invoicing. On collections, we've not seen anything as far as pressures on that just yet. I think we're still in the early days of some of the uncertainties though, so there may be pressures on folks wanting to delay payments. We've not seen that yet, but there's certainly that risk out there with respect to receivable. We are managing our payables and starting to put some vendor payment facility types of programs in place. So we're trying to work it from that perspective. And as you mentioned, we do have our advances that are up. When I look at our advances, I often look at those kind of coupled with our receivable. So we are seeing an increase in both receivables so far and an increase in the customer advances. And so there's really an offset in what we've experienced between the both of those items.

Certainly, we're hoping to make some improvements and expecting to make some improvements in our working capital at the end of -- toward the end of the year, largely again attributed to the activities that we've got going on in the aircraft business. Again, lots of uncertainty around what we're able to do, but we are actively managing it, very actively managing our cash and our cash spend that's going out of the door as we're focusing on liquidity at this time.

Cai von Rumohr -- Cowen and Company -- Analyst

That's very helpful. And then the tax rate was lower this quarter. I mean, obviously you were at 25% before. I mean, should we assume that the tax rate more likely is going to be somewhat lower than that?

Jennifer Walter -- Vice President, Finance

I would say our ongoing tax rate at 25% is pretty fair still. However, we had a couple of specials that were one timers that brought it down to the lower 19.2%. Both of them related to withholding, but there is two independent ones, there was a change in India related to a repeal and the replacement of taxes on the withholdings. And then we had some legal entity restructurings in Germany that reduced our withholding taxes when we simplify that organization. Those are both one-time specials in the quarter that would not repeat, but the ongoing rate would continue as is depending again on the mix of earnings. But there's not much variation between, jurisdiction these days as there had been prior to tax reform.

Cai von Rumohr -- Cowen and Company -- Analyst

Terrific. John, you cited ventilators, small motors. How big roughly is that business and how big can it be and how big can it grow?

John R. Scannell -- Chairman and Chief Executive Officer

Yes. So I think like almost everything on our book of business, each one is a relatively small speaks at peace in the scheme of things. But let me put that into aside. So, this is -- actually we're supplying motors to Phillips, we'll make these ventilators and as you can imagine the ventilator business right now is exploding for all of the companies that do us. It was a product that, as I understand, it was approved kind of toward the end of last calendar year. And we were just starting last production. And we have got to this 800 motors per month and now the demand has gone north of 30,000 motors per month. That overall demands, we had got for the next couple of years originally was about 30,000 motors and that's now 10 times, so it's now 300,000 motors over the next year, 18 months. And so one motor per ventilator.

The motors built are double digit $50, $60 pieces of kit, Cai. So it's -- if you take 300,000 of them, it's maybe a $15 million to $20 million business over the next 18 months. I think we'd see a lot of other pressures in our industrial businesses. As you know, we have a business that's related to the oil, -- to oil, offshore oil production. I think that will probably drop by a similar amount or more. And so it's great to be able to help with the effort. Folks are working flat out to increase production, as you can imagine gone from 800 to 30,000 in a month, it's not easy. So that would take us a few months. And it'll be a little bit of a shot in the arm in our industrial business, but it's -- there'll be lots of other things I think in the industrial world that will overwhelm us. So it's good, it's nice to be able to help, we do everything we possibly can, but it's not a material impact in the financials I'd say.

Cai von Rumohr -- Cowen and Company -- Analyst

Very helpful. So turning to the defense side, you had the 100 basis point development loss. Can you tell us, is that a classified program? And secondly, you highlighted hypersonics as being strong, roughly how big is your hypersonics business and what's the profile going forward?

John R. Scannell -- Chairman and Chief Executive Officer

So we have dozens and dozens of development programs, Cai, in the aircraft business. And as you say some of them are classified. So I won't go into which particular program it was. But it was -- I would say it's a military program and it's in the, what I'd call the normal course when you have the type of portfolio, the size of book of business that we have. Some military programs are cost plus, some of them are fixed price, some of them there's technical assumptions when you go into them that don't quite turn out the way you thought, some of the things ships. So I won't go into specifics of which program it was, but I would describe it as, it's somewhat a normal course of business in the overall book of business.

The hypersonics business, it's divided between our space sector and our industrial sector. Sorry, our space and our defense sector, we typically don't try to break it out Cai, in terms of separate from our missile business in total. So if I give you our missile business, missile systems businesses is a $30 million, $40 million business a quarter, and that includes the hypersonic development activities. So we don't break that out specifically as a subcategory. It's like everything, if I take our space business that's running at $50 million, $60 million a quarter, it would be 10%, 20% of that, it's not half that are more.

Cai von Rumohr -- Cowen and Company -- Analyst

Terrific. Thank you very much.

John R. Scannell -- Chairman and Chief Executive Officer

You're welcome.

Operator

Thank you. [Operator Instructions] It appears there are no further questions at this time. Mr. Scannell, I'd like to turn the conference back to you for any additional or closing remarks.

John R. Scannell -- Chairman and Chief Executive Officer

Thank you, Valerie. Thank you to all our listeners. We do hope that everybody is staying safe and healthy. It is an amazing time for every one of us. We hope to come back in 90 days time and have a much clearer picture of what our future looks like. We hope your future looks better at that stage as well. And in the meantime, we wish everybody the very best that we'd be working real hard to make sure the company continues on a very solid footing. Thank you.

Operator

[Operator Closing Remarks]

Duration: 56 minutes

Call participants:

Ann Marie Luhr -- Head of Investor Relations

John R. Scannell -- Chairman and Chief Executive Officer

Jennifer Walter -- Vice President, Finance

Robert Spingarn -- Credit Suisse -- Analyst

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Cai von Rumohr -- Cowen and Company -- Analyst

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