Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

What does the recent ADPma ownership change mean for the organization?

YM: David and Rick Wedgeworth can provide an insight relative to the change in ownership from the private partners to MG.

David Blythe: When the three of us started the company, we grew it in a bubble with a very limited view of the market. We knew that our strengths were in engineering and manufacturing quality, but we didn't realize where our weaknesses were. Since MG bought us and Yusuf came on board it's become apparent that we had a very narrow view of the things that we were doing. The things we were engineering were simply interesting opportunities for us. We did them without seeing the value of them. What's been exposed is that you have to know your market, which we didn't, and you have to be able to go out and capture it, which we didn't do either. Where we thought we were doing a good job of selling to the world, it has become evident to me that we were missing a lot of things. The ability to go out and capture market share out in the world was right in front of us, but we were singularly focused on manufacturing and engineering quality.

We didn't have smart business people here to focus us in the aftermarket and actually selling our products we were doing. We were able to feed our families, we were able to have self-fulfillment in accomplishment and achieving engineering things that I look back on and realize they were probably fairly difficult, but that's where we lived. We made enough money to grow the company slow, make payroll and do some things, but what kept us going was that we did interesting things. That's what kept the three of us together. We were doing what we deemed were cool and interesting things and it was an enjoyable way of life. We've found out since that also has great value out in the world. That's my biggest hindsight looking where we've come in two years since the purchase.

Rick Wedgeworth: Customers brought us programs and we got excited about $5,000 or $10,000 and only focused on that. David said we had limited resources which we could only do so much with, but that is no longer an issue. The new owners are always asking us what they can do for us to help us achieve our goals. I agree with David in that we lived in a box with limited resources.

YM: Now we can take bigger risks so the growth trajectory has changed, but it's important that the foundational elements were all there. We were not getting bank loans or doing high risk financial stuff. If you marry those two, you get finance and business management people with strong quality, technical and operations teams, which allows us to create something which can further utilize our existing portfolio and keep adding new solutions for customers others are not reaching.

RW: In addition to increasing global sales and bandwidth, it allows for larger future sales. We had big hits but they are now getting bigger.

DB: Those big hits we had before were only to limited partners, whereas today that fleet is global.

RW: What we thought was stagnated, no longer is.

DB: We have to have homes for some of this stuff.

RW: Globally.

YM: We have a different reach. Having the right owners and philosophy on the business with the right support is an exciting time for ADPma.

YM: Engineered products with testing computation makes PMA sales much harder than license identicality. People trust Boeing and Airbus because they think everybody else checked all the boxes, whereas with ours there can be questions. Having the technical and sales team align to answer those questions quickly and fully is important.

Can you run through the different channels you're exploring now that you have new ownership and how you can commercialize the PMA parts?

YM: Many of the same channels remain, but there is a nuance to who is putting the part on the plane, the MRO shops or the airlines. Ultimately, everything has to be approved by the airline and there are a limited amount of channels available in aerospace because of the high regulation. We changed our behavior to make it simpler for whoever needs to make the approval in the chain.

What do they say when you bring a PMA part?

YM: We provide more savings than our competitors so they will move it up in their approval cycle. It is easier for them if they have all the documentation or know we have answers to the questions that may come up from service difficulty reports or airworthiness directives in a system, because our technical team have already discussed and included that in our development cycle, which makes it easier for them to quickly approve the part. There aren't many channels so it's about how the company enables those channel partners to get to yes.

RW: Every week we're reaching new customers we would never have attempted to go after.

Who is the end user?

YM: The end user is always the airline who need that asset to move people around the world. Everybody else in the middle is a service supplier.

Is the guy in the MRO shop at Lufthansa or Delta the end user?

YM: Yes, in terms of when we're doing transactionally, but holistically, the end users are only aircraft operators like Delta, Air France or Turkish.

What is the biggest challenge to get airlines to choose PMA over OEM?

YM: The biggest challenge is the amount of work it takes to get it done. The OEM is the easy one because it's in the manual with the instructions. The cage code of the OEM is on the part they remove, so every piece of information makes it simple for them to go back to the OEM and get that part. Changing the coding within that system to procure from us involves a huge level of inertia, which is why you need to be mindful about which parts you choose to consider for PMA.

DB: It's a lot of work for salespeople to get a part to them and once they agree to look at it, we have to submit a package for their engineering group to approve before it goes further. There are several steps but it's a lot of work by several people trying to get that part to the end.

RW: In order to sell something to somebody, it has to be valuable to them. Historically, the only value ADPma concentrated on was saving sales dollars, but now we say we add value to the product by having product available due to current global supply chain issues. The fact that we have parts on the shelf is a value add for our customer. If we can also keep our part on-wing longer, the part is more valuable to them. We have recently been selling parts because our parts are designed to stay on-wing longer and we have them on the shelf. We don't say we'll have it 180 days, which many other people do.

YM: They need to turn that asset out of the shop to keep that plane flying, so not having to wait 180 days is more valuable than anything else, especially on larger air-frames like 777, 787, A350 used for international global travel, where having an unavailable asset is very costly to the airline.

There is a misconception from investors that PMAs are half the price of OEM and that they are cheaper and aim to save dollars, but you guys are saying the parts are better and the availability is higher, allowing you to sell at closer to OEM prices?

YM: Yes, that's a valid point.

DB: We're currently doing that which has changed since ownership, and that has been a drastic change in perception of how you create value.

HEICO used to release their alternative parts program which is relationships they had with BA, Delta and Air Canada; do you guys do something similar to that? Once you sign up an airline, do you have exclusivity on that part?

YM: It's a mix. I would call it a prime relationship rather than exclusive. As long as we meet our side of the bargain of parts availability without any quality issues, they will buy from us but are not tied in for five years. Some airline partners agree to multiple years, but we push for a prime relationship with all partners. As Rick described, after their engineers have done reviews and they have spent all this money to approve us, it makes sense we are prime because that's the only way they will capture the value we created. They overhaul once a year instead of twice by using our components. We don't tie them up in an LTA relationship for five years because if we're delivering and providing that value, they're incentivized to keep us there forever.

How are you structuring or trying to prevent any onslaught from the OEMs?

YM: It's about that value proposition and prime piece. They know if the OEM changes the individual component acquisition price by any percentage, if the reliability is half of ours and they have to go into a shop twice a year versus once with ours, the OEM can no longer respond with a price war. We haven't seen any OEMs respond technically to us because most aircraft you fly on were designed 30 to 50 years ago and the manufacturing technology is no longer the same. A realistic example would be a housing used in a landing gear actuator module. In the past, that housing had to come from a casting house and sometimes go through multiple processes and vendors, and there is a legacy cost to keeping that supply chain around. Rick gets parts machined from a billet plate with a 5 axis machining company, and those machines didn't exist back then. The OEM cannot overcome that differential unless they are willing to redesign.

Why can't the percentage of PMA parts on a platform be 10x the current amount?

YM: MARPA is a PMA lobbying group in Washington DC and Europe, and at the last MARPA event in San Diego in November we were literally having that discussion. The real issue is the marketing OEMs are doing. There's a perception from years ago about bad PMA going horribly wrong; someone didn't fully understand the system requirements and it caused a failure, loss of an aircraft or an accident. OEMs continue to push that narrative to the airlines and MRO shops. MARPA exists so that you can reach engineers who manage fleets to debunk the myth of PMAs being inferior because they are half the price of OEMs. That narrative is why we aren't there. The future opportunity is the more success companies like ADPma, HEICO, Jet Parts and that ecosystem has, the more we are debunking the myth as a whole.

YM: People see our parts and sit the OEM next to ours, and are shocked by the quality difference from an engineering perspective. They ask how we made something like this and the OEM didn't.

RW: I went to one of the first MARPA meetings 20 years ago and sat next to two engineers and purchasing people, and I overheard them talking down the PMA process. They were sitting there to understand who was there but I would hear them say that a PMA house doesn't go through the testing. That is all a myth because the FAA has to be satisfied. There are myths out there that we simply reverse engineer without doing any of the testing, which many people used to believe.

YM: Here is a good one on the reverse for that mythology. When I came here, ADPma's philosophy was you have to pass the test; you get it done. You guys had no idea that 85% of the time OEM's ask for a waiver of the requirement from the regulators, so the OEM is the one who didn't meet the real requirement. PMA houses have no insight to that so were surprised when I asked why they couldn't say they were done.

DB: We didn't realize you could ask for a waiver for a requirement because, in our engineering brains, it's a checklist of requirements which we have to complete, but the OEMs don't operate that way. If they come across a problem during testing, they would simply ask for a waiver. They know they needed 4,000 psi but could only get 3,500 psi, and the OEM will do their analysis and say that's good.

YM: The manuals all say you have to go to 4,000, which means that someone else designing that who didn't know this waiver existed, are trying to complete Mission Impossible, but most of the times you guys completed it.

RW: This is why our parts can last longer because we use modern technology and thinking and figured out a way to make the thing pass the test.

It makes no sense.

YM: The real challenge is debunking that myth.

Another thing which often appears in my research is that leasing companies and OEMs believe that having PMAs on a plane reduces the residual value of an aircraft, therefore they advise airlines not to use them, what are your thoughts around that?

YM: That's changing too.

DB: Most of the parts we do are replaceable, so you could put our part on a leased engine and when it's done with its cycle, replace the OEM part and you're back where you started. You're not decreasing the value of the leased asset because it's an expendable item which is being replaced on some regular schedule.

YM: You can sell that asset and show you have all OEM this time, but while you were operating the aircraft, using our component saved you money on labor and acquisition and the fact that it was more reliable, removals. The pandemic caused global travel to tank, so everybody in the aerospace industry had to think differently about how to conserve cash and spend more reasonably to maintain their profits. This made them take a second look at, not just ADPma, but the whole PMA ecosystem. PMA wouldn't exist without the big fight HEICO had on GE engines getting Congress and the FAA to pass regulations that say no, PMA and OEM parts are equal. It will take all of us making progress to debunk the myth, which is why there isn't a bad PMA company.

How do you define a great PMA business?

YM: It goes back to the engineering excellence and quality of manufacturing and following FAA regulations to the letter without falling outside the AS9100 certifications. If you're not a good PMA company, the market will get rid of you. Those businesses don't stay in business because if you have an escape or other issue, it will cost you enough that it shuts you down. MIDO, the manufacturing side of the FAA, will shut people down if they're not right, which is why we work with MARPA and other PMA companies to debunk the myth and have a clear record of proven performance. As you have more PMAs in more systems on aircraft having a proven record of performance, it helps us all go up against a giant OEM monopoly.

DB: All PMA companies start with what they know best. What made the larger PMA companies successful is their ability to grow the size of the product lines they could delve into.

YM: If you're not adding value, the market will push you out and if you're doing things outside of the regulations, the FAA will ensure it doesn't get out into the field. PMA companies wouldn't exist if they were not as capable as OEMs.

It seems difficult to grow and scale a PMA company because you start in one specific area of engineering that you are competent in. ADPma have a broad portfolio which seems to have been developed mainly in-house, which is unique, whereas HEICO seem to buy all their PMA, how do you think about continuing to broaden your portfolio or develop internally, is that even possible or do you have to acquire the new PMA IP?

YM: It's a mix.

RW: I think it's both, you could pick up PMAs but we're always trying to expand our bandwidth and develop parts.

DB: It's a philosophical question because somebody made it 30 years ago and it functions and works, but can you make it better today? We believed from the very beginning that the answer to that philosophical question was yes.

DB: That's still a potential but also what allowed us to grow. It was a core belief among the three of us that if somebody made it, we can make it.

YM: The exit sign on the plane is made by a little lady who captured that market, but Boeing and Airbus rarely talk about those small independent businesses who are part of their ecosystem. They spend most of their time on Collins, Safran and Honeywell. We've been able to grow because we partner with people and spend the time to find out who is the person truly making the value, versus assuming it based on a bunch of prints and specifications. We get behind all that detail and find the real human beings doing the work that is necessary to make these products available.

Does it make sense to own a distributor? Obviously, I can imagine HEICO put their PMAs front and center at Seal Dynamics, but how do you think about that?

YM: It is a necessary part of the business, but we have to do the hard part of the sale upfront. Once we capture a certain volume, a distributor will make sense for most businesses as you're getting help with your working capital. Somebody is holding the inventory that today we may be holding, and that helps us reach more customers, have higher and faster turns, but the distributor isn't making that first sale. That's why they're called the distributor.

Do you have to go to the airline first?

YM: Correct. We had to make the sale to the end user to say yes, this is approved and can be utilized in my fleet. All these distributors are doing is helping us move that product nearer to the end customer. If I bake cookies at home, 3PL allows me to get my cookies to more people because their channel does it for me.

You have to go to the airline first to get the volume on the ships set. You can then increase that over time by selling via Seal or Aviall because more end users are then aware of your product and are pulling it through the distribution channel?

YM: Exactly. The biggest piece of aerospace distribution is their margin is linked to them keeping stock that aligns with the global domain, and being able to help execute. That goes back to what David spoke about earlier, if you go to the OEM and they tell you 180 days, having a distribution partner is important. You pay that distribution margin because they cut that 180 days to 60, 45 or 30 days because they have stock on hand.

Why would you PMA a PMA?

YM: No, the regulations don't allow you to PMA a PMA, it just happened that we both developed product against the OEM's product, and for whatever reason, our product may have a longer life than the one they developed, or they may have decided to shut that line down because it costs more money, so they'll buy from us and spend their money on other programs. We've seen it across the marketplace as big PMA companies, like Wencor bought Soundair and Fortner. HEICO bought several ADPma customers who continued to be customers regardless of the change in ownership.

HEICO has a decentralized management philosophy where they let each P&L be responsible for generating its profit individually versus a dictate to say you must use our own stuff inside. The way they run their business is wise but that's not uncommon and we are perfectly happy working with them. We've worked with them on other programs and are part of MARPA helping push this advantage. It is slightly less cutthroat than the OEM side where Raytheon goes up against Honeywell in a winner-takes-all on the Boeing 787 environmental control system. It is slightly different than that because nobody has unlimited capital or engineers. It goes back to what David said; you do what you're good at and we all go up against the monopolies.

Given your engineering talent, could you simply produce for the direct OEM business or how do you think about the attractiveness of OEM versus PMA?

YM: There's a lot of inertia but there's also a lot of bureaucracy which makes it hard for small companies to efficiently work with an OE. It comes down to the tier in which we participate in the overall OEM ecosystem. There is a space between tier three and four where we supply components into a system as an individual component where that makes sense. There are many program coordinators making meeting memos which is not part of the ADPma DNA in terms of being lean and understanding what value they're adding. The answer is, we are going to be careful about who we select, but we're not at all shy about participating in the OEM side of the market. Coming from the aftermarket, we're also keenly aware that we're not going to give up our aftermarket to participate with an OEM. When we show up to participate, we're not giving up the ability to sell our spares directly to airlines and MROs, but we will help you solve the OEM problem.

That's your TransDigm roots.

YM: Exactly, you don't get a free lunch.

How did TransDigm approach PMAs? I know they mentioned in their deck that is has not been much of a risk to them over the years in their opinion.

YM: Adams Rite is a PMA and an STC company when you get down to it, and most of the products they make are either replacing something or solving a new problem which never existed, so that was already part of their DNA. Most of the products they deal with, their customers don't like negotiating with them because they're slightly prickly or difficult or carve out what they want, but when you get down to the things that matter, such as is the part available, does it work, stay on-wing long enough and meet the requirement or beat the other competitor, that's the stuff we're not going to hear about wanting a PMA. If they're operating the way they should, we don't bump into them. That's what you hear in their standard deck, and it's true because if you get back to what David talked about as far as the principle of are you providing value or not, that's the real reason people want to buy a PMA. To save 35 cents, $20 or $300 per part is not that big a deal in most of what you're dealing with; it's about is it available, is it reliable and are you meeting those things?