TransDigm Group Inc (TDG) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 TransDigm Group, Incorporated Earnings Conference Call. My name is Makita, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today's call, Mr. Sean Maroney, Director of Corporate Accounting and Investor Relations. Please proceed, sir.

Thank you. I'd like to thank all of you that have called in today and welcome you to TransDigm's fiscal 2008 Second Quarter Earnings Conference Call. With me on the line this morning are TransDigm's Chairman and Chief Executive Officer, Nick Howley; our President and Chief Operating Officer, Ray Laubenthal; and, our Executive Vice President and Chief Financial Officer, Greg Rufus. A replay of today's broadcast will be available for the next two weeks. Replay information is contained in this morning's press release and on our website at transdigm.com.

Before we begin, the Company would like to remind you that statements made during this call which are not historical in fact are forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied in the forward-looking statement.

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 information regarding forward-looking statements and risk factors included in the company's latest filings with the SEC. These filings are available in the investor section of our website or through the SEC's website at sec.gov.

The Company would also like to advise you that during the course of the call, we will be referring to EBITDA, specifically, EBITDA, as defined, and adjusted net income, both 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 measure and a reconciliation of EBITDA, as defined, and adjusted net income to that measure.

Now, having taken care of the necessary disclosures, let me introduce Nick Howley, our Chairman and Chief Executive Officer, who will provide an overview of the business for the second quarter and fiscal 2008 year.

Good morning, and thanks for calling in to hear about our company again this quarter. I'd like to start off this call with some comments about our stock price, our steady strategy in performance, the Company's consistent ability to create equity value through the cycle, and our current sense of where the aerospace market stands as it applies to our business.

As you probably know, our stock price as of Friday had dropped about 15% since the start of the fiscal year, that is, on October 1, though there's been some upward movement today. We, of course, don't like this drop. We understand that it's directionally consistent with the decreases in valuation among the other aerospace companies. However, we believe our business model is unique in this industry.

To summarize some of the reasons why we believe this, about 95% of our sales are generated by proprietary products, about 80% of our sales come from products for which we are the sole source provider. About 60% of our revenue and a much higher percent of our EBITDA comes from aftermarket sales. Aftermarket revenues have historically produced a higher gross margin and provided significant stability in the down cycles.

Because of our uniquely high EBITDA margins, which run 46% or more, and relatively low capital requirements, which typically run 2%, plus or minus a little, TransDigm has, year in and year out, generated very strong free cash flow. This has given us the flexibility to either pursue acquisitions, optimize our capital structure, or take whatever other actions we think are appropriate to maximize our value.

We have a well proven value-based operating strategy focused around what we refer to as our three value drivers of new business development, continual cost improvement, and value-based pricing. We stick to these concepts as the core of our operating management methodology. This consistent approach has allowed us to continually improve and increase the value of our business.

We have been successful in regularly acquiring and integrating businesses. We acquire proprietary aerospace component businesses with significant aftermarket content. We have, in total, acquired 22 such businesses, and we've been able to buy and improve these businesses right through the cycles.

For many years, the Company has performed in both up and down markets. Through our consistent focus on these operating value drivers, a clear, precise acquisition strategy, close attention to our capital structure, we've been able to create real equity value for our shareholders through all phases.

The performance after 9/11, when the EBITDA, as defined, grew right through the downturn, was the most recent example. This consistency does not seem to us to be fully recognized and valued at this time. I suspect this may well be due to our newness in the public equity market.

As you can see from our press release, in spite of a concerning economic outlook and excluding any acquisitions, we feel comfortable increasing our guidance from the previous EPS midpoint by about $0.24 a share, that's on an adjusted basis or about 10%. This improvement comes primarily from two areas -- an increase in the base operating performance in revenues and EBITDA, as our three consistent value drivers of productivity, price and new business continue to be effective both in our base and our recently acquired businesses, and, secondly, lower interest rates.

Greg will give you a little more detail on this guidance in his portion of the talk. Also, in spite of a slower acquisition environment, as we've been able to do in the past, we were able to reach an agreement to acquire another solid proprietary component business, that is, CEF Industries. We expect this transaction to close within the next few days. Ray Laubenthal will give you some more details on this.

We continue to beat the bushes for more such businesses. We maintain our consistent focus on proprietary aerospace components with significant aftermarket. I'm confident we'll find more, but the timing is always tough to predict. With respect to our underlying markets for the balance of the year, in the commercial OEM world, the build-out look appears stable, and with the exception of the 787 delays, about as we anticipated going into the year.

The commercial aftermarket, however, is mixed with revenue passenger miles, with available seat mile statistics not sending clear messages in either direction. Our underlying sales growth is, so far, in line with the long-term trends, but with some spottiness across product lines. On the other hand, the domestic airline financial picture is surely weakening and the macroeconomic news doesn't seem encouraging.

To remind everyone, we are, however, well distributed across the installed base. We have very modest exposure to the possible what I'll call at risk platforms, platforms such as the DC-9, 737 Classics, MD-80, and 727, make up only about 3% of our annual revenues. Our revenue per plane is significantly lower on these older platforms than it is on the newer platforms.

Though the quarterly numbers can bounce around, over any extended period of time, our real aftermarket volume has generally been able to track or run a little ahead of the overall worldwide traffic trends. Lastly, our defense business, on the other hand, now looks better than we anticipated. We are cautious regarding the market outlook, but confident in the strength of our unique business model to continue increasing intrinsic shareholder value out in the future.

Now, let me turn to the latest financial performance. I'll remind you this is the second quarter review for fiscal year 2008. Our fiscal year started October 1, 2007. So we're halfway through the year. As I've also said in the past, quarterly comparisons can be significantly impacted by small differences in OEM aftermarket mix, large orders, transient inventory fluctuations, modest seasonality, and other factors.

But in spite of some timing issues, we had a good first half and a good second quarter. Revenues were up about 27% on a year-to-date basis, and about 21% on a quarter versus prior year quarter basis. Pro forma growth -- and when I say pro forma, I mean assuming we own the same mix of businesses in both periods -- is up over 8% on a year-to-date basis and over 11% on a Q2-versus-Q2 basis, in spite of some down drag from certain one-time items impacting the comparisons.

If I review the revenues by market segment, again, on a pro forma basis versus the prior year, which assumes, again, that we own the same mix of businesses, in the commercial segment, which makes up about three-quarters of our revenue, commercial OEM revenues were up 12% on a quarter-over-quarter basis, and 5% on a year-to-date basis. Both commercial transport segment revenues and regional business jet revenues picked up nicely after a soft Q1.

As we mentioned in the last call, the Q1 was a timing of shipment issues versus the prior year and this result bears this out. We still expect our pro forma commercial OEM revenues to be up a little over 10% for the year. Commercial aftermarket revenue was up about 7% on a year-to-date basis or first half, and about 5% on a Q2-versus-Q2 basis. The first half is significantly impacted by two significant one-time items.

The one-time activity in the prior year, which we mentioned last quarter, and an additional extension by the FAA of the maintenance cycle for certain cockpit security components to better reflect the recent airline maintenance history and certain product improvements we put forward. We anticipated one such extension. This additional extension by the FAA in fiscal year 2008 had the effect of reducing the near-term demand for these certain select components by more than we originally anticipated.

If you remove the impact of these two items, our core aftermarket was up in the low double digit percent on a year-to-date basis and about the same on a quarter-versus-quarter basis. Given the economic outlook and the airline financial situation, we remain cautious regarding this segment for the balance of the year.

However, with no adjustments for these one-time items in the first half, we now anticipate the pro forma commercial aftermarket revenue to be up about 10% for the year versus the prior year. This is slightly below our previous FY estimate -- our previous fiscal year estimate of low double digit percent growth.

In the defense segment, which makes up a little less than a quarter of our business, the revenue are up about 25% on a quarter-over-quarter basis, and about 17% on a full year basis. We saw strength across almost every product line and across most platforms, primarily in the high margin aftermarket.

The defense business is always tough to predict in the near term and especially in the political season, always somewhat subject to political whims and budget uncertainties. However, absent any significant change, we now expect pro forma defense revenues to be up in the low to mid double digit percent range versus the prior year. This is an increase from our previous estimates.

In summary, for the full year, we expect our businesses to perform somewhat above our initial expectations in revenue, with a slight shift in aftermarket mix between commercial and defense revenues. Excluding any acquisitions, we expect our overall pro forma growth to be up a little over 10%, modestly above our previous guidance. If I move now to profitability and on a reported basis, I'm going to talk primarily about our operating performance or EBITDA, as defined.

The total adjustments to EBITDA are lower in the current year due to purchase accounting adjustments relating primarily to the acquisition of ATI. On a Q2 versus comparable quarter basis, our EBITDA, as defined, of 81 million is up 19% versus the prior Q2. The EBITDA, as defined, margin is 46.2% for Q2 and 46.3 on a year-to-date basis. This is almost the same margin as the year-to-date prior, in spite of the dilutive impact of acquisitions and higher 787 development expenses. These two factors had the impact of reducing the margins by about 1.5% to 2%.

We expect some modest margin improvement in the second half, primarily in Q4. Greg is going to give you some more details on that. With respect to the acquisition pipeline, we continue actively looking at opportunities. We have a pipeline of possibilities, as usual, more small than large. Things are still slow to close. We remain disciplined and focused on the type of businesses we want, with value creation opportunities. As I've said before, predicting the timing is difficult, and as a general rule, we're not going to discuss any specifics on acquisitions unless they're closed.

Regarding the most recent reschedule of the 787, we will likely see some additional higher development expenses as a result of this latest stretch-out. We have already removed most of the revenues from our outlook. In total, we don't believe the reschedule will have a material impact on our 2008 financial performance, but in any event, it's captured on our new guidance.

And with that, let me ask Ray Laubenthal, our Chief Operating Officer, to give you a short operating overview for the fiscal second quarter. Ray?

Thanks, Nick. As Nick mentioned, the second quarter results were better than expected. Our acquisition integration and productivity improvements continued to add solid value. Our new business order activity was strong and new product development activity made good progress. We continue to price our products to reflect the value we provide to our customers and, lastly, as Nick mentioned, we expect to close within the next few days on the acquisition of another operating unit, CEF Industries.

Let me explain each of these areas in a little more detail. The vast majority of the physical integration activity associated with the businesses we acquired in 2007 is nearing completion. The associated margins continue to expand as our productivity efforts and pricing actions take hold. Looking forward, our latest acquisition, CEF, will become our next integration project. Located in Chicago, CEF designs and manufacturers specialized highly engineered mechanical and electromechanical actuators, compressors, pumps and related components.

The majority of the company's revenues are military related, with the C-130 production program and the associated large worldwide installed base being their single biggest platform. Other CEF platforms include the A380, the A320, the A330 and 340, the Joint Strike Fighter, the F-15, C-17, V22, as well as certain regional jets and biz jets.

At CEF, we expect to integrate our three value drivers of productivity improvement, value pricing, and focused profitable new business growth to create future value. At our operating units, productivity projects continue to progress favorably. Of significance, we continue to improve operational efficiency. And in the last six months, our total headcount has reduced over 2.1%, while revenues have continued to increase.

We continue to be very active finalizing our Boeing 787 designs and manufacturing processes. The development activity and spending continue to be particularly high on our new composite fuel and hydraulic isolator products at AdelWiggins and on our digital quiet audio systems at AB Tech.

The development and expense on these projects should begin to reduce during our fiscal fourth quarter, assuming there's no more schedule push-outs or significant design revisions by Boeing. And in addition to these new programs across our businesses, pricing at our operating units is improving steadily, and in fact, it's running slightly better than we originally anticipated.

Now, let me hand it over to Greg Rufus, our CFO, who will review our second quarter financial results in more detail.

Thanks, Ray. Good morning, everyone, and again, thanks for calling in. As you have just heard, Nick's comments centered on pro forma revenue and EBITDA, as defined, comparable results, and Ray gave a brief summary of our value drivers and the integration of acquisitions we made in 2007 and the CEF planned acquisition.

For those of you who have listened to prior calls, you are aware of the various accounting charges associated with our past acquisition activity. Halfway through fiscal '08, we still have purchase price amortization for both backlog and inventory step up, along with some startup expenses that are still with us in '08. As these expenses wind down, we will then shift to include new acquisition expenses associated with CEF.

Consistent with our past practice, these adjustments will be fully disclosed in detail in our press releases and our SEC filings. As you know, for an inquisitive company like TransDigm, all of these items come into play when looking at GAAP financial results, compared to prior year comps for any given quarter and throughout the year. Today, my comments will focus around our second quarter GAAP reported results.

It is a pleasure to continue to report to you that we had a very successful second quarter. In a nutshell, the second quarter sales were what we expected. The base margins are very strong. The acquisition margins, although dilutive, continue to improve, and the cash flow was very strong. Let me explain in some more detail. Quarter two sales were $175.3 million, up $30.8 million or 21% from the prior year. Organic sales were $13.9 million or about a 10% increase over the prior year.

This quarter, organic sales came from strong defense sales, primarily the defense aftermarket across all product lines, an increase in commercial OEM, and an increase in commercial aftermarket sales. In other words, organic sales growth came from all markets. Our recent acquisitions, ATI and Bruce, contributed to the balance of the growth. Reported gross profit was $93.9 million or 53.6% of sales. This $18.8 million increase is 25% greater than the prior year, and it is also greater than our sales growth of 21%.

The reported gross profit margin increased approximately 160 basis points versus the prior year. The primary driver for the improved margin was due to the decrease in purchase price accounting charges between the two periods. Excluding purchase price accounting, gross profit margins were flat. This included the dilutive impact of the ATI and Bruce acquisitions, which are included in all three months of the current year.

Selling and admin expense was 10.5% of sales for the quarter, compared to a prior year expense of 10.1%. Research and development expense, which Ray just spoke to, is the primary driver of the increase in expense as a percent of sales. As Ray mentioned, we expect these costs to reduce in our fourth quarter as the 787 development finalizes. Amortization of intangibles decreased by $600,000 to $2.8 million for the quarter. This is primarily due to a decrease in order backlog amortization resulting from the prior year acquisitions.

Net interest expense was $24 million, a net increase of $1.4 million or 6.2% versus the prior year's quarter two. For the quarter, our weighted average level of borrowing is approximately $1.4 billion, versus approximately $1.2 billion a year ago. The increase in average debt was due to the ATI acquisition made during the second quarter of 2007. The average interest rate decreased to approximately 7.3% this quarter, compared to 7.6% last year. We anticipate a further reduction in the average interest rate to approximately 6.5% for the remainder of the year.

Regarding our tax provision, our effective tax rate was 34% for the quarter, compared to a prior year effective tax rate of 37.7%. This current quarter tax rate reflects the favorable impact of our legal entity restructuring which took place in the fourth quarter of last year, and a favorable resolution of a prior year state tax refund claim of about $900,000.

We are forecasting our '08 effective tax rate at 36% now. We anticipate our '08 cash tax payments to be approximately $40 million, of which we have paid $13.6 million midway through the year. Quarter two net income was $32.2 million or 18.4% of net sales, compared to $21.5 million or 14.9% in the prior year. This is a 49.5% improvement versus the prior quarter.

The combination of strong EBITDA, as defined, growth of 19%, a decrease in non-operating and acquisition costs, an increase in interest expense of only 6%, and a lower effective tax rate, just discussed, all contributed to this significant increase in net income over the prior period. With the net income improvement on a GAAP basis, quarter two diluted EPS was $0.64 per share, compared to $0.45 a year ago, a 42% improvement in this quarterly comparison.

Our adjusted diluted EPS was $0.68 in the second quarter, which was 28% improvement versus the prior year. These improvements were dampened somewhat by higher common shares outstanding versus the prior year. Cash generation continues to remain strong. We ended the quarter with $194 million of cash on the balance sheet. For the year, we have had a positive net increase in cash and cash equivalents of $88 million halfway through our fiscal year.

Excluding acquisitions, we expect our year end cash on the balance sheet to be in the range of $280 million to $285 million. As you know, however, we will use approximately $83 million of cash upon closing of the CEF acquisition, which would reduce the forecasted year end balance to approximately $200 million.

At the end of the second quarter, our net debt leverage ratio to EBITDA, as defined, was 3.8 times, compared to 4.3 times this past September. I am now going to shift from quarter two financial results to a new subject. As announced in our press release this morning, along with Nick mentioning it earlier, we are increasing our guidance halfway through our year.

We give full year guidance on five items -- revenues, GAAP net income, EBITDA, as defined, GAAP EPS, and adjusted EPS. All five line items have been increased. Our press release spells out the detail of each of these line items. To keep things simple, I will focus on the adjusted earnings per share. Our prior guidance of adjusted EPS was a range of $2.43 to $2.53, or a midpoint of $2.48 per share. Our current guidance for adjusted EPS is a range of $2.69 to $2.75, or a midpoint of $2.72 per share.

Let me walk you through a reconciliation of the two midpoints. The increase in the adjusted earnings per share midpoint is $0.24 per share. That is $2.72 less the $2.48, almost a 10% increase. The $0.24 per share increase is approximately divided as follows. $0.12 is a result of stronger operating results, which we have discussed this morning. $0.10 is a result of the lower interest expense for the year since we originally gave guidance.

With the lower interest rates in effect currently, our second half interest expense will be about $3 million per quarter lower than originally forecasted. And, finally, $0.02 is a result of the favorable effective tax rate, just discussed, this quarter and a lowering of our full year effective tax rate. These three items total a 24% increase between the prior midpoint of $2.48 for adjusted EPS, to $2.72 for the current adjusted earnings per share midpoint.

All of the data just discussed excludes the acquisition of CEF. We anticipate closing on CEF in the very near future. Assuming a relatively fast close, we would add an additional $10 million to $13 million in revenue. Our GAAP EPS, however, would decrease approximately $0.02 because of purchase price accounting amortization, and our adjusted EPS would increase approximately $0.02 favorable.

Because these amounts reflect a partial year's result, that is, less than five months of ownership, and the EPS changes are minor to our current guidance, just disclosed, we do not anticipate formally changing our guidance once CEF formally closes. Again, it is our pleasure to have you listen to this call. As I said earlier, we had a very successful second quarter.

This concludes our prepared remarks, and we will now open the phone lines to questions.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of David Strauss of UBS. Please proceed.

Good morning. Thanks. Nick, you talked about some softness in the aftermarket in certain product lines. Can you give us a little bit of detail what product lines specifically?

I can't say it's specific. What I'd say is if you look across all the product line we have, if you looked at them -- if you looked at it 18 months ago or 15 months ago, when everything was booming, it's sort of a rising tide. All the ships were coming up with the tide.

If you looked at it now, you don't necessarily see everyone rising. There's kind of puts and takes from month to month and quarter to quarter. The net is still a good number, but it's somewhat indicative, in my view, of a market that's getting a little shaky.

Okay. And in terms of -- Greg, you talked about increasing the guidance by about $0.12 for improved operating results. Obviously, you talked about the aftermarket maybe being a little bit softer. That's your highest area of profitability. What's the offset? Is that the defense aftermarket being stronger than expected?

Yes. As Nick mentioned, the defense aftermarket is coming in really strong, plus we're clicking on all the cylinders with our value drivers at the core locations and with the acquisitions, David.

Okay. Thanks, guys.

Your next question comes from the line of Carter Copeland of Lehman Brothers. Please proceed.

Good morning, guys. Good quarter. I wanted to shift to the order book a little bit, Nick. I wonder if you could sort of provide some color on what the book-to-bill looked like both in aftermarket and in the military business. Presumably, military was pretty good. But I'm wondering what you saw in terms of book-to-bill in aftermarket relative to the past couple of quarters.

I don't think we generally disclose that. Do we, Sean?

No.

And I don't have that at my fingers. But I would say -- Carter, I don't know what the number is exactly. But I would say, generally, the bookings give the same type of a picture as you might see in the revenues. It's still okay, but it gives you some concern about the go forward outlook for the market.

And you mentioned this cockpit security sort of drag against the aftermarket growth. Is there a reversal of this at some point that benefits the numbers in '09 or how should we think about future impacts?

Yes, maybe a little bit. Maybe a little bit. This is Carter still?

Yes.

What this is is we have, as you know, we have all these cockpit security systems out and we put a bunch of them out after 9/11 and we've had a bunch of upgrades and improvements to them and things like that.

The FAA decided to extend the hard life on them. In other words, some of the components -- and I'm giving you approximate, I'm not sure exactly the years. Where they used to say replace every three years, they changed it to every five years, which has the impact -- what happens then is people don't buy for a couple of quarters. They all sort of adjust down.

What happened here is they did it once at the end of last year, which we expected, and then they extended the life again at the end of calendar '07 or the beginning of calendar '08. So it happened twice to it. We expected it to happen once. I would say, Carter, yes, you'd adjust down and I'd expect sometime out in May '09, you see a little bit come back. That's what you would expect to normally happen in something like this.

Of course. But right now, I mean, is there a risk that it gets extended again? Presumably, this is -- I mean, it's quite a drag if we go from 5% to -- it would have been double digits. It's 500 basis points.

We think not, Carter. We think we've captured -- we've given you a guidance for the year. We think we've captured the risk in that guidance, but there's always clearly some risk to that, but we don't know of anything that's going on now.

Okay, great. Thanks, guys, and good quarter.

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

Hey, guys. When you went public, we talked about your three real sources of revenue growth. We've all been kind of hyper-focused on the end market trends and, of course, you have the external growth from acquisitions.

But the other one that we don't talk about as often is market share. Could you talk, Nick or Ray, about any upcoming market share opportunities that may actually be noticeable? I think at the time of the IPO, you had just come off a 767 retrofit that added to the growth rate. Anything like that out there?

You mean that would change the sort of historical growth pattern?

Not necessarily change it, but contribute to the growth rates you're looking for or perhaps offer some upside.

Well, I would say, as I think you know, Rob, our content on the 787 and the A380s is significantly higher than it was on the predecessors. So as they come up, I would expect to see a little pickup. On the other hand, as you also know, that's not a lot of volume for a while and it's also not a lot of profitability.

Ray, I'm trying to -- as I sit here, I don't think of anything that disrupts the usual pattern here.

Nothing that's additive. I'm thinking in terms of things like the cockpit work you've talked about. So in other words, not tracking the ASM or RPM growth, but something that might be mandate-driven that comes forward here on one of your platforms.

Rob, I don't -- we're always out chopping away at new business and we're always working on some retrofits, but I honestly, as I sit here today, I don't know of any that would make a step change in your sort of calculation or tracking.

Okay. Turning for a moment to margins. Your gross margin continues to be quite strong. It's a little bit off the first quarter, but better than last year. What are the pricing trends and to what extent does this very, let's say, limited or just appearing softness in the commercial aftermarket affect pricing, if at all?

Not at all. So far, we have not seen any impact and we would not expect to see any impact. As I think Ray said in his part of the presentation, actually, our pricing is running a little ahead of our expectation.

Did airlines, at any point historically, come to a point of pressure where they come to you and ask for some help?

We've had requests on and off through the years, but, generally, we're pretty comfortable with our positions and absent some real mitigating circumstances, we're not terribly receptive to that.

Okay. And then just going back to the aftermarket growth, you talked about, if I've got this right, kind of a 10% number for the full year. Now, is that commercial aftermarket or is that overall?

That happens to be both, about. Commercial aftermarket, we said 10%. Overall, I think we said slightly above 10%.

And maybe this gets a little bit to Carter's question, but looking at what we've seen in the first half, and it does imply a higher growth rate in the back end of the year, because, again, that 10% doesn't factor in any of the adjustments we might make to exclude the one-time factors.

That's right.

Are you looking for a 12%, 13% type rate?

As you know, Rob, it has to be or those numbers won't work.

Okay. I just wanted to make sure my logic was right.

Yes, your logic is right. Now, I would say that is an area there could be some risk in the forecast, but we think we've pretty well captured all the risk in the numbers we've given you.

And you seen to be fairly confident on the military side. It sounds like that's provided a very good offset so far.

Yes. Yes, it has.

Okay. Then just a final one for Greg. Any receivables on the books from impaired carriers or Chapter 11 filers?

No. We're in good shape with that and especially, don't forget, Rob, with the end users, because it's aftermarket sales, your exposure is really only about one month's worth of sales and we keep a pretty tight credit limit on them and make sure we've got the cash.

So at any given time, you have a month's worth of sales with your larger carriers. And with the margins we have, having a month of sales out there isn't too bad.

And then is the mechanics --

Also, Rob, about half of our volume is through distribution, remember.

Right.

So that cuts down your risk by half.

But plus, if I understand it correctly, those carriers that have filed, for example, a Frontier, there can then be some kind of an arrangement post-filing where you do get paid on new business.

Absolutely, yes.

So in other words, if some kind of a new contract gets structured and really all that's at risk is what was on the books at the time of the filing.

That's right.

Correct.

That's right. That's all that catches you. So if you start watching it closer and closer, historically, we've been able to keep that pretty low. Even after 9/11, we didn't get hit too hard with it.

Okay. That's helpful. Last thing. You talked about your exposure on the oldest platforms, which is very helpful, I think, just to understand the dynamics at work here. Can you talk about your highest content platforms? You mentioned 787 and A380, but I'm thinking more from an aftermarket perspective, maybe it's A320 or 737 next gen.

Can you give us some sense of your percentage of sales -- I think you've done this in the past -- in those areas?

I think as we've disclosed in the past, our biggest platforms are the 737, the A320 -- what's number three? I can't remember what's number three -- 777. Again, it goes 737, A320, 777. I can't remember what the fourth -- I'll see if I can find the list up here. But it's pretty well distributed, Rob, on the high use platforms. The content on those you can see by the percent that I gave you, the 3% on those older platforms.

Our content on the newer ones is higher. Otherwise, you couldn't only have 3% on the ones that I mentioned, because they make up a much higher percent of the installed base than 3%.

Clearly. And I would suspect you're doing probably double digit growth in aftermarket on those higher content platforms.

Surely, significantly higher.

Excellent. Thank you, guys.

Your next question comes from the line of Fred Buonocore of CJS Securities. Please proceed.

Good morning, guys. Great quarter. Nick, on the last call, you had pointed out that there was downside risk to your guidance in the event of continued general economic slowdown. I notice you didn't make that statement at all with this guidance. Should we take that as implicit in your guidance or are you just feeling confident enough about the year based on what you're seeing now that that kind of goes away?

We feel pretty confident with the guidance numbers we've given you now. Now, that being said, what we won't have in the backlog in any six-month period is we won't have all the aftermarket booked and that's where the highest margin is.

Right.

A significant economic downturn could affect that. Now, we think we've captured the risk in our guidance, but that assumes a certain level -- an economic downturn that doesn't get worse than a certain level.

We feel pretty good about the guidance, but, again, with that codicil I give you. The commercial aftermarket is the thing that we typically have the shortest turnaround cycle, so the least booked.

Got it. And kind of relative to commercial aftermarket and what Carter was asking about before, are there other components that you have at risk of being extended or having the life extended by the FAA that may be lurking out there?

Not that we know of. Not that we know of. I'd remind you that this cockpit security is a relatively new program of which we put tons of them out in the field in the '03-'04 timeframe, and people are just starting to accumulate enough maintenance history to make a judgment on them.

Got it. And then on the defense side, pretty impressive growth there and impressive expectations. Are there particular programs that you could talk about that are driving that, that drove that this quarter and for last year?

No. I have to say we looked at that in considerable detail here. It's almost across all our products and across most of the platforms. It's just a significant step up in buying activity. And as I said, we somewhat get nervous as to will that continue, but it looks to us like we have enough booked and enough in the backlog that we should have a better year than we thought.

Excellent. And then, finally, just on the 787 and the associated R&D expense, as we look to the next quarter -- I know you mentioned that it should kind of fall off a bit in Q4. Just directionally in Q3, is there any reason that that R&D expense would increase in Q3 or is it kind of running flat line and then just falls off as we get into Q4 and beyond?

Ray?

I think your last statement captured it, kind of flat line and then fall off in Q4.

Great. Okay.

That all assumes Boeing doesn't stretch again.

Right.

If they stretch again, all the development activity likely stretches, too.

I don't know what the under-over is on that, but --

I don't either.

-- I'm not stepping near that. Anyhow, thanks a lot, guys, and again, great quarter.

Your next question comes from the line of [Brian Goodsight] of [Helm Partners]. Please proceed.

Hey, guys, nice job this quarter. Pro forma for the CEF acquisition, it looks like you'll have about $200 million of cash at the end of the year, about four bucks a share. Your leverage ratios are, obviously, coming down. You had previously said you feel like four times or greater is the right leverage ratio for this business. In the absence of more acquisitions, do you expect to return any of that to shareholders and if so, in what timeframe?

As I said before -- and I'm shocked that you would come up with this question. One of the issues you have now is the credit market isn't very good. So you can't get a whole lot of comfort in how much you can borrow. I'd also say I don't know that I said our target leverage ratio was four. I said it's sure not below four. We're comfortable. We're not uncomfortable at levels up above four.

I would say with our cash -- I said before, the management is significant owners, Warburg is still a significant owner. We'll try and do what we think is the right thing to maximize the equity value. Our first choice is to find creative acquisitions and to the extent that we can find them, we'll do nothing other than buy them and improve them.

To the extent that we can't, we're going to have to do something. Now, I would say I'd feel better if the credit market was better, which it isn't right now, but we won't just pile up cash just to pile up cash for fun. If it continues long enough, we'll do something in the capital structure.

Thanks, Nick. And just one quick follow-up. I'm not sure if I heard you correctly, but did you say that there were two one-time items impacting the commercial aftermarket this quarter or was it just the cockpit security stuff?

It was two in the first half. The one I talked about last quarter was cockpit security, and primarily this quarter.

Thank you.

(OPERATOR INSTRUCTIONS)

It appears there are no further questions at this time. I will now turn the presentation back over to Mr. Sean Maroney for closing remarks.

Thank you for joining us on today's conference call. We will be filing our 10-Q in the next few days, and I'll be available for phone calls this afternoon. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.