TransDigm Group Inc (TDG) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter Transdigm Group Incorporated earnings conference call. My name is Sue, and I will be your coordinator for today. (OPERATOR INSTRUCTIONS). I would like now to turn the presentation over to your host for today's call, Mr. Sean Maroney, Director of Corporate Accounting and Investor Relations. Please proceed.

Thank you, Sue. I would like to thank all of you that have called in today and welcome you to Transdigm's fiscal 2008 third 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 www.transdigm.com. Before we begin, the Company would like to remind you that statements made during the 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 statements.

For further information about important factors that could cause actual results could 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 through the investor section of our website or through the SEC's website at www.sec.gov. The Company would also like to advise that you during the course of the call we will be referring to EBITDA, specifically EBITDA as defined in 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 in adjusted net income to that measure. Now having taken care of the necessary disclosures, I will turn the call over to Nick.

Good morning, everyone, and thanks again for calling in to hear about our Company this quarter. As I did last quarter, I would like to start off with some comments about both our stock price, our strategy and performance, the Company's consistent ability to create what I will call intrinsic equity value, and our current sense of the aerospace market as it applies at least to our business. Our stock prices dropped about 20% since the start of our fiscal year -- that's October 1st. We don't believe this to be reflective of the underlying value of our business; but we understand it's directionally consistent with the decrease in valuations of other aerospace companies, and I suspect driven significantly by fuel cost concerns and the related airline activities. However, I still believe our business model is unique in both the stability and diversity of our products and market segments.

To summarize some of the reasons that we believe this, to remind everyone, 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 the after market sales. After-market revenues have historically produced a higher gross margin and provided significant stability in the downturn. The equity market reaction and the discounted values seem inconsistent with the relative stability of after-market demand, to me. In fact, most analyses that I have seen tend to indicate some modest growth in worldwide traffic in the next year, in spite of the currently difficult fuel price and economic situation, though at a lower rate than in recent years. With our uniquely high EBITDA margins, which run 46% or higher, and our relatively low capital expenditure requirements that is in the 2 to 3% of revenue range, Transdigm has year in and year out generated very strong free cash flow. This has given us the flexibility to pursue acquisitions, optimize our capital structure, or take whatever actions we feel are necessary to maximize our value through all phases of the market..

We have a well-proven value-based operating strategy focused around what we refer to as our three value drivers. That's 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 worked for us through up and down markets and allowed us to continually improve and increase the intrinsic value of our businesses. We have been successful in regularly acquiring and integrating businesses. We acquire proprietary aerospace product component businesses with significant after-market content. We have in total acquired 22 such businesses, and we have been able to acquire and improve aerospace component businesses right through the cycles.

Through our consistent focus on one, our operating value drivers; two, our clear acquisition strategy; and three, close attention to capital structure, we have been able to create intrinsic equity value for our shareholders for many years, right through the cycles. The performance after 9/11, when the EBITDA grew and margins expanded 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. Our revenues continued strong in Q3, and we expect them to remain so in Q4. At this time, we expect 2009 revenues to be above the 2008 levels. However, as I said earlier, it becomes -- it appears increasingly possible that fiscal year 2009 could see low, if any, growth in worldwide air traffic. At this time, it appears the demand for commercial OEM production remains strong and should do so into next year. Our past practice, consistent with our value-focused management methodology, has been to reduce our cost structure ahead of any potentially softening market conditions. Over the past cycle, this has proven to be an effective means of protecting long term shareholder value.

We have begun this process and expect to have made significant cost reductions by the end of our fiscal year Q4. We will closely monitor our cost structure and the market conditions as we move into the next year. Our philosophy has always been to get out ahead of any potential market condition, and adjust our cost structure quickly. As I said, we will monitor this closely as we move into 2009, and we can adjust up or down as the market environment clarifies. As you can see from our press release, in spite of a softening in both economic outlook and the aerospace market, and excluding any additional acquisitions, we feel comfortable again increasing our guidance from the previous EPS midpoint of 272 a share to an adjusted guidance of 277 a share at the midpoint, all on an adjusted basis. This improvement comes primarily from two areas: One, a modest increase in the base operating performance; and two, the contribution from the recent CEF acquisition. Greg will give a little more detail in this guidance in his section. We continue to beat the bushes for more businesses to buy. We maintain our consistent focus on proprietary aerospace components with significant after-market content. I am confident we will 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 area, build-out looks appear stable for the balance of our year, and with the exception of the 787 delays, about as we anticipated. In the commercial after-market, we are beginning to see some signs of a slowdown in growth, especially in North America, as the fuel prices and economic conditions seem to be beginning to take a toll. Though quarterly numbers can bounce around, I remind you, over a longer period of time, our real after-market volume has generally been able to track at or a bit ahead of overall worldwide traffic trends. Also, just to remind everyone again, the DC-9/MD80s, Classic 737s and the 727 platforms most at risk of retirement make up only about 3% of our last year's revenues. The defense business continues better than we anticipated. We are cautious regarding the market outlook but confident in the strength of our unique business model to continue to create value.

Now let me turn to our specific financial performance for this quarter. I will remind you, this is the third quarter review for fiscal year 2008. Our fiscal year started October 1st. We are three quarters of the way through the year. Also, as I have said in the past, quarterly comparisons can be significantly impacted by differences in OEM after-market mix, large orders, transient inventory fluctuations in the system, modest seasonality and some other factors. In spite of some timing issues, we had a good year to date in third quarter. Revenues are up about 24% on year-to-date basis and 18% on a quarter versus prior quarter basis. Pro forma growth -- that is, assuming we own the same mix of businesses in both periods -- is up about 10% on a year-to-date basis and about 12% on a quarter 3 versus quarter 3 basis. That is in spite of a down drag from certain one time items impacting comparisons.

Revenues by market segment -- again, on a Pro forma basis versus the prior year -- that is, assuming again we own the same mix of businesses -- in the commercial segment, which makes up about three quarters of our volume -- first in the commercial OEM area, it is up about 12% on a quarter over quarter basis and about 8% on a year-to-date basis. Though both sectors grew on both the quarterly and year-to-date basis, our commercial transport sector grew OEM grew faster than the regional biz jet sector. We still expect our Pro forma commercial OEM revenues to be up about 10% for the year. The commercial after-market revenue was up about 6% on the year-to-date basis, and about 3% on a quarter over quarter basis.

This year-to-date-growth is impacted by two significant one-time items, which we mentioned earlier. First, some one-time activities and shipment timings in comparison to the prior year. The other was the extended maintenance cycle for certain cockpit security components. Additionally, we have now seen some modest inventory adjustment at some of our distributors. If you remove the impact of these three items, our core after-market was up almost 10% on a year-to-date basis. Q3 was also impacted, but to a lesser degree, by some of these items. Given the fuel price situation, the economic outlook and the airlines' financial position, we're now less optimistic regarding the balance of the year in the commercial after-market. With no adjustments for one time items, we now anticipate Pro forma commercial after-market revenues to be up in the 6 to 8% range, for this year versus the prior year. That's below our previous fiscal year estimate of about 10% growth.

In the defense segment, which makes up about a quarter of our revenue, revenues were up over 25% on a quarter versus quarter basis, and 20% on a full-year basis. Though we saw strength across almost all of our product lines, the activity in the after-market was particularly strong in the area of helicopter upgrades, both for increased tower requirements and to add countermeasures. We also saw a lot of activity across a broad range of air-based and ground-based gun positioning products. The defense business is always tough to predict, especially in the political season -- always subject to political whims and budget uncertainties. Absent any significant changes, however, we now expect Pro forma defense revenues to be up in the mid-teen percentage range versus prior year. This is up from our previous fiscal year estimate.

In summary, for the full year we expect our businesses to perform a bit above our initial expectations, with a modest shift in after-market mix between commercial and defense revenues. Excluding any acquisitions, we expect our overall Pro forma revenue growth to be up about 10% -- very close to our previous guidance. Moving on now to profitability -- and I am on a reported basis now -- I am 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 both less acquisition-related expenses, and we didn't have any secondary offering costs as we did in '07. On a Q3 versus comparable quarter basis, our EBITDA is up -- of about $87 million -- is up about 18% versus the prior year -- or prior Q3.

The EBITDA margin is 46.6% for Q3, and 46.4 on a year-to-date basis. This is almost the same as the year -- as the prior year, in spite of the dilutive impact of the acquisitions and the ongoing 787 development expenses. These two factors still have a margin impact of about 1.5 to 2% -- to 2 points on a year-to-date basis. We still expect to see some margin expansion in Q4. Greg also will give you a little color on that. With respect to the acquisition pipeline, we continue actively looking at opportunities. There is a pipeline of possibilities through our more small than larger opportunities, as is typical. They are still slow to close. We remain disciplined and focused on value creation opportunities. Predicting the timing is always difficult; and as I have said in the past, as a general rule, we're not going to discuss any specifics on acquisitions until they are closed or unless they are closed. And with that, let me ask Ray Laubenthal just to give you just a short bit of color on the Q3 operations.

Thanks, Nick. As Nick mentioned, in total, third quarter results were as we expected. Our acquisition integration and productivity improvements continued to add solid value. Our new business order activity was strong, and the new product development activity made good progress. We continue to price our products to reflect the value we provide to our customers, and we also acquired another operating unit, CEF Industries. Let me explain each of these areas in a little more detail. We acquired CEF on May 7th. Located in Chicago, CEF designs and manufactures specialized and 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 large after-market supporting the worldwide C-130 installed base being the single biggest platform.

Other platforms include the V22, Joint Strike Fighter, the A380, A320, A330 and 340; the F-15, the C-17, as well as certain regional jets and business jets. At CEF, we quickly went to work on transitioning this business to be focused on our three value drivers. We are revising their pricing, we reduced the cost structure by 16% through a workforce reduction, and we have focused their new business efforts to target profitable programs. We are in the midst of modifying their go-to-market process. And lastly, to insure these transition efforts continue, we promoted Pete Palmer, one of our veteran managers, to be the President of this operating unit. At our other operating units, productivity projects continue to progress favorably. In addition to the normal blocking and tackling productivity projects, we've started to reduce our cost structure in preparation for a possible near term softness in demand. As Nick mentioned, this initial reduction will be completed by the end of Q4, and then we will closely watch the activity level. We continue to be very active finalizing our Boeing 787 designs and manufacturing processes. The development activity and spending continues to be particularly high in our new digital flight audio systems at Aztec.

Conversely, the work on our composite fuel and hydraulic isolater products out at Adel Wiggins is nearing completion. We expect the development and expense on these projects to come down in Q4; but we anticipate some modest spending to push into our fiscal 2009 year due to the Boeing-driven scheduled pushouts and design revision. In addition to these new programs, pricing at our operating programs is improving consistent with our past actions and is progressing well. Now let me hand it over to Greg Rufus, who will review our third quarter financial results in more detail.

Thanks, Ray. Good morning, everyone. Again, thanks for calling in. As you have just heard Nick's commented centered on current market conditions, pro forma revenues and EBITDA as the fine comparable results, and Ray gave a brief summary of our value drivers and integration at CEF this quarter, for those of you who have listened to prior calls, your aware of the various accounting charges associated with our acquisition activity. As you know, for an acquisitive company like Transdigm, these charges come into play when looking at GAAP financial results compared to prior year comps throughout the year. Consistent with our past practice, all adjustments used to arrive at EBITDA as defined and adjusted EPS are reconciled in this morning's press release. With the CEF acquisition, we will continue to be impacted by purchase priced accounting activity through FY '09, and this activity will continue to be a factor in quarterly comparisons.

Today, my comments will focus around third quarter GAAP reported results. I am pleased to report to you that we had another very successful quarter. In a nutshell, the third quarter sales were what we expected, the base margins were strong, the acquisition margins, although dilutive, continued to improve, and the cash flow was very strong. Let me explain this in detail. Quarter through -- quarter 3 sales were 186 million, up 28 million or 18% from the prior year. Organic sales were up 18 million, or about 12% increase over the prior year. Similar to last quarter, organic sales growth came from strong defense sales, primarily the defense after-market, and to a lesser extent defense OEM sales across all product lines, an increase in commercial OEM and an increase in commercial after-market sales. In other words, organic sales growth came from all markets.

Our recent acquisitions, CEF and Bruce, contributed to the balance of the growth. Reported gross profit was $100 million, or 54% of sales. This is an $18 million increase and is 22% greater than the prior year, and it is also greater than our sales growth of 18%. The reported gross profit margin increased approximately 180 basis points versus the prior year. The biggest factor for the improved margin was due to the decrease in purchase price accounting charges between periods. Excluding purchase price accounting charges, gross profit margins improved 60 basis points, including the dilutive impact of the CEF and Bruce acquisitions. The strength of our propriety product and productivity improvement at our base businesses continue to enable us to expand our margins. Selling and administrative expense was 10.4% of sales for the quarter compared to prior year expense of 11% of sales. Included in the prior year was $1.7 million or about 1% of sales of nonrecurring expense, associated with the May '07 secondary offering.

R&D spending increased from the prior year and was high by historical standards, but consistent with the prior year as a percent of sales for the quarter. Net interest expense was $22 million, a decrease of $4 million -- almost 16% versus the prior year third quarter. The decrease in interest expense was due to a lower interest rate. Average interest rate decreased to approximately 6.4% this quarter compared to 7.6% last year. The weighted average net balance was $1.4 billion for both periods. Regarding our tax provision, our effective tax rate was 36.4% for the quarter compared to a prior year effective tax rate of 37.5%. 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 an increase in the domestic manufacturing deduction, which was both partially offset by the lower research and development tax credit. We expect our fiscal year '08 effective tax rate to be 36% and our FY '08 cash tax payments to be approximately $40 million.

Quarter 3 net income was 36 million or 19.3% of net sales compared to $22 million or 14% of net sales in the prior year. This is a 63% improvement versus the prior quarter. The combination of strong EBITDA as defined growth of 18%, a decrease in non-recurring and acquisition costs, a decrease in interest expense of almost 16%, and a lower effective tax rate all contributed to the significant increase in net income over the comparable prior quarter. With the net income improving on a GAAP basis, quarter 3 diluted earnings per share was $0.72 per share compared to $0.45 per share a year ago, a 60% improvement in the quarterly comparison. Our adjusted diluted earnings per share was $0.75 in the third quarter, which was a 39% improvement versus a year ago. Cash generation continues to remain strong. We ended the quarter with $189 million of cash on the balance sheet. We expect our year-end cash on the balance sheet to be around $215 million.

As a reminder, we will make our semi-annual payment on our subordinate notes of approximately $22 million, and tax payments of approximately 20 million in the fourth quarter. Excluding the purchase of CEF, the Company will generate approximately $185 million of cash for the fiscal year 2008, which is over 55% of EBITDA as defined for the full year, or 140% of our net income. At the end of the third quarter, our net debt leverage ratio to EBITDA as defined was 3.6 times, a significant improvement from 4.3 times this past September. I would now like to switch subjects. As announced in our press release this morning, along with Nick mentioning it earlier, we're increasing our guidance for the remainder of the 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 gives all five comparisons.

To keep things simple, I will focus on the adjusted earns per share. Our prior guidance for adjusted EPS was a range of 2.69 to 2.75, or a mid-point of $2.72 per share. Our current guidance for adjusted EPS is in a range of $2.75 to $2.79 or a mid-point of $2.77 per share. The increase in the adjusted EPS midpoint is $0.05 per share -- $2.77 less the $2.72. With one quarter remaining this fiscal year, the $0.05 per share increase comes from two areas: $0.02 results from stronger operating performance, including expenses associated with our cost reduction programs that Nick mentioned earlier. $0.03 results from our ownership of CEF, which we acquired in mid-May. This current year estimate of adjusted EPS of $2.77 is 32% greater than our FY '07 EPS of $2.10. On an unadjusted GAAP basis, the 2008 EPS midpoint of $2.61 is 43% greater than the FY '07 earnings per share of a $1.83. As I said earlier. we had a very successful third quarter and nine months for fiscal 2008. And with one quarter remaining, it is turning out to be one heck of a year. This concludes our prepared remarks, and we will now open the phone lines for questions.

(OPERATOR INSTRUCTIONS). And your first question comes from the line of Carter Copeland from Lehman Brothers. Please proceed.

Good morning, guys.

Good morning, Carter.

Quick question just to clarify something here on the after-market. You said the after-market revenues year-to-date were up 6 and you're expecting 6 to 8 for the year. But they were 3 on a quarter over quarter basis. So that -- that would seem to imply an acceleration sequentially for next quarter. Do some of these headwinds go away in terms of these extensions in cockpit security retro fits or the inventory adjustment? Just trying to square what is going on in the pattern -- the quarterly pattern, if it is lumpiness or what is really going on there. Carter, I wouldn't draw a whole (EXPLITIVE) of a lot out of the quarterly pattern.

I mean, there is enough kind of moving around, and little bits of shipments can adjust it from quarter to quarter. I -- you know, we feel pretty good with that 6 to 8%. You know, which obviously means we think -- we surely don't expect to see any decline, and maybe a little move up in the fourth quarter. But I -- I wouldn't -- I don't mean to suggest that that is any fundamental change in the market. Just more kind of a timing.

You said that you're beginning to see the weakness -- presumably in the order rates in North America. Can you provide any more color about other regions around the world? Is there is any differentiation in U.S. versus Europe versus Asia? Any color there would be much appreciated.

I -- I don't know that I can give you a lot of specifics on that, Carter, and I say that -- and the reason I say that is because we sell a fair amount through distribution, and sometimes the numbers lag a little on that. You know, you're not right up to date on where everything went. But generally -- my general sense is it is, it's the same as most people are talking about. You know, North America is the toughest hit. As best I can tell, Pacific RIM is doing okay, and Europe is kind of in the middle.

And with respect to margins and profitability as you look beyond '08. It sounds like there's several pieces here -- whether it is the 1.5 to 2 points from 787 development expenses and those items and given the drag on the mix, meaning OE growing faster than after-market. As you think about into '09, how does that change? What are your expectations? Do some of those 787 development expenses and those items, do they roll off? And do we get a reversal of some of these -- some of these drags in terms of inventory adjustments of distributors and the cockpit security retro fits? Just what are your expectations, at least broadly or directionally, in terms margins for next year?

I don't think in the -- in the Company -- for the Company, Carter, we will give that when we give out our guidance for the year. And I don't want to start to kind of peck at it a piece at a time. One thing I will say on the 787 is, as Ray mentioned ,we do expect -- or we hope a goodly part of that will be run off by the end of this year. And -- as --

The spending --

The spending, as Ray talked to you about that. You know, on the cost reductions, Carter, in the past, what we have done -- and that's what we're doing again here. When we're in a time of uncertainty, our view has been get out ahead of it quickly, adjust the cost structure as quickly and as -- as down as you prudently think you can, and then watch what happens. And that's sort of where we are. We frankly feel a little uncertain about next year.

Fair enough, thanks a lot, guys.

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

Hey, guys.

Good morning, Rob.

Good morning. Just to talk, I think, about the same issues that Carter brought up. The after-market -- can you talk a little bit about the inventory adjustments you have seen at the distributors, and perhaps help us to understand how this connects to the capacity cuts that we're all anticipating, I guess, starting after Labor Day? Are we already seeing those? How -- what is the flow that we should be thinking about that you consider from these capacity cuts?

Let me answer that kind of generically first, and then maybe a little -- a little specifically, Rob. I -- I would say -- I -- it is tough to tie them directly. My general experience is, when the market starts to soften a little bit people start to get nervous and you start to see a little bit of inventory adjustment all through the system. It is always tough to tell what the airlines have -- the distributors we can get a better look at. And I don't want to overplay that. That is not a big number, but it is a slight down-drag. Most of the distributors -- or most of our largest distributors -- have agreements that require them to hold "X" months in inventory. And the month is different depending on the product line. So to the extent they start to see or perceive any softening, they start to pull their inventories in a little bit. Now again, we haven't seen a lot of it. We have just seen a little bit of the start of it here recently, and we will see how it goes forward. I mean, it ultimately it is a function of what happens to the end demand.

So we should be thinking -- from that answer, Nick, it sounds like some distributors have been above -- I don't know how significantly above -- that minimum inventory level. Simply allowing themselves less cushion?

Yes, not much. Most of them are pretty darn close to their contracted levels; but if their outflow moves off a little or they start to think it is a little, they will start to stretch the deliveries a little bit.

Okay, so there is not that much downside from a inventory perspective since they are close to those --

I would say not -- you know, it is almost you make your judgment on what you think the end result is going to drop off, which it hasn't a lot yet. And -- you know, you will get a little bit of a ripple, just like you will in the airlines. The airline numbers are tougher to see, but to some degree you see the same thing. They overreact a little at the beginning of the downturn.

And going back to -- Carter touched on this, with the -- 6% rising perhaps to a 6 to 8% level by the end of the year, and considering your answer to that in terms of the specifics are tough to nail down, let me try it at a different way. Sequentially, quarter-to-quarter -- so I am talking about June to September, September to December -- on an absolute basis, absolute dollars in after-market, okay? Organic after-market. Are we going to see an increase, you know, off this June quarter as we get into September and December, or is this the area that you really do think we're going to start to flatten out on?

Well, we gave you -- Let me answer that first by saying it is -- this is the area that we're most uncertain about, Rob.

Right.

I mean, it is pretty easy -- as you know, it is pretty easy to take a pretty good shot at the commercial OEM rates. If you miss that 90 days, out you're in trouble.

Uh-huh.

The after-market is where we feel the most uncertainty going into next year. I would say -- you know, you see our guidance. For the fourth quarter -- you see our annual guidance for the after-market, which just by the math tells you we don't expect next quarter to be down. Either we couldn't be 6% on the year, and 6% year-to-date and 6 to 8% on the year if the next quarter drops.

But that also has to do with the comps and what is in last year's quarter and so on. So that's why I asked about it on an absolute basis.

You mean on the fourth quarter against the prior year fourth quarter?

Yes.

You know I don't -- let me just look -- the truth of the matter is, I am not sure I know that number. Let me see if I can quickly see it.

And I don't recall what was in last year's fourth quarter, but if it was a weakish quarter you could have a great growth rate, but it is misleading on an absolute basis.

Well, last quarter -- last year's last quarter was a pretty good quarter.

Yes. No, we expect it to be up over the fourth quarter of last year. I just looked at -- on a Pro forma basis again.

(inaudible) only the same mix of businesses.

Okay. And the whole point to this -- and you guys knew you were going to be asked about the after-market.

Yes, sure.

Very clear that it is a focus area for you, for the obvious reasons we're all interested in it. I just go back to -- you have talked about 3% revenue exposure to the aircraft at issue. The older airplanes that are -- that are, you know, up for consideration for grounding. And I try to think about if it is only 3% exposure and you have got the kind of commercial after-market growth rate you have got, I am trying to see if I -- you know, what would justify a flatish after-market number next year, or if that is conservative, or are we starting to see pressure trickle into some of the in-production platforms?

Rob, I can't -- I don't know that I have that much specificity on our view yet for next year. You know, we're primarily looking at our internal information and sort of taking data on what other people seem to be forecasting for world traffic miles. And you have probably seen them; most of what I see bantered around are numbers like North America down, you know, zero to 5%, Pacific RIM up, maybe, you know, 5, 6, 7%, and Europe flatish. You know, when you weight those out, you get a relatively modest growth next year. We're picking up on that and saying I don't -- I don't know that I have any reason at this point to disagree with that. And I would add to that, my other experience has been when the market starts to slow, people tend to overreact for a quarter or two throughout the industry.

What I am hearing from you, Nick, not to belabor the point --

Yes.

-- but is that maybe you think the overreaction will be on the A320s or the Triple 7s, because there I think the growth rates will be higher and that is what I think you have attempted to tell us is where your greater exposure is -- 737, NG, et cetera.

You're drawing -- Carter, you're drawing more out of this than I am saying.

Okay.

Okay? What I am saying is, we -- we look at the data we have, we look at the economic situation, we look at the forecast that you different analysts are making for revenue passenger miles, and we look at that and say '09 is something we have some concern about.

All right.

As I told you before, generally we're able to, over any extended period, track the worldwide traffic miles. I also say in the beginning of a softening, people tend to overreact some, and it is not always logical and it is not always by platform. It is just nervousness.

I think that's a fair point.

So that is why we are, I would say, cautious; that is why we -- as we have in the past -- why we tend to -- as soon as we get any sniff around us of market softening, we tend to tweak in our cost structure as fast as we can, and then see what happens. And that is sort of where we stand. We feel uncertain.

Okay. Okay, thanks very much, Nick.

Okay, Rob.

Sorry, did I call you Carter, Rob? I apologize.

And your next call comes from the line of Fred Buonocore from CJS Securities. Please proceed.

Yes, good morning. Very nice quarter, gentlemen.

Thank you.

So, I guess after all that we have established that you have got some concern and uncertainty over the after-market for FY '09 and, you know, there is a scenario where commercial air travel could be flat for 2009, and I think that's -- you know, that is not a surprise to anybody. Can you help us then -- understanding that you're not planning on giving any FY '09 guidance until your Q4 announcement -- Nick, can you help us kind of build up maybe a way to think about potential revenue growth in a zero RPM growth scenario for next year?

Well, you know, I'm not going to back into giving guidance yet for 2009.

Oh, no, of course.

God forbid, you would hate me to do that.

Oh, definitely not.

Yes. By the way, let me start off by saying Rob, I'm sorry I called you Carter at the end there. Yes. The -- I think in a flat RPM environment, I would expect we would still get our pricing. With that -- and if I take history, after 9/11, that was -- was not an issue and I don't expect this to be anywhere near that kind of a disruption.

Right.

So you would still see that. I would expect the -- I think, in 2009, as we said, we still expect the OEM business to be bullish in 2009.

Uh-huh.

The defense business, I think, is kind of a judgment call.

Uh-huh. So aside from kind of the vagaries of the government budget process, is there anything transpiring on the defense side of things that would give you any reason to believe that anything should change dramatically in the next six months on -- ?

Other than what I will tell you is the defense business is historically difficult to predict in the short term, particularly in the political season.

Got it. And then just on the acquisition environment, you talked about, you know, deals still continuing to be slow to close but have you've seen, you know, continued trend in, you know, maybe multiples potential sellers are expecting or you know, prices -- potential prices coming down here?

I would say we're still seeing a reasonable amount of activity. In other words, we're seeing transactions and we're seeing -- excuse me potential transactions.

Right.

Things are closing slower. They are moving slower. Some of that I think is just uncertainty, you know, in an uncertain market -- in an uncertain aerospace market and economy. Some of it I think is sort of a bid ask spread. Everyone remembers that their -- you know, their buddy got 12 times EBITDA two years ago, and why can't I?

Right.

And in that market -- those -- those are sort of the -- the things we see. What we know is things are moving a little slower.

Uh-huh. And then it sound like, really, your priorities for cash have -- haven't changed one bit in the face of what could be a tough 2009. Is that a fair assessment?

Our priorities are the same as they always are. Our first priority with our cash is to make acretive acquisitions of proprietary aerospace component businesses with significant after-market content. That's our first priority. As long as we think there is a reasonable possibility that we can utilize the money that way and maintain our flexibility, that's what we will do.

Got it. And then finally, in addition to cost-cutting that you have talked about and your ongoing productivity initiatives, are there any other actions that you can talk about that you can take to continue the strong performance we've come to expect from the Company in the face of what could be a tough year?

Well, I think what I told you before on the cost side, we're making a pretty decent adjustment here in the fourth quarter, and what we will do there is we will just -- we'll watch and see what happens. I will tell you historically, and I would -- I expect we could do it in the past, if the market gets tougher than we might have thought, you will see us adjust some more. If we overshot a little, we're fine with tweaking that back in.

Great, and anything you can do to make up on what might be a slowdown on the top line?

Yes, yes. We'll do what we can. Historically what we do is our three value drivers: Our price productivity, our cost, and new business. We will work them all as hard as we can. Usually we have been able to -- or not usually, almost always -- we have been able to find a way to see ourselves through softening markets.

And your next question comes from the line of David Strauss from UBS. Please proceed.

Thanks. Have you -- Nick, have you spoken specifically on the call? I didn't hear what you're doing on the cost side at this point. Is this headcount or is this SG&A? What exactly are you doing at this point?

Well, first it is -- primarily what we have done so far is headcount. The largest chunk of our costs, if you take out materials, is people cost, by a very significant amount. And that's basically what you have to work with. And that's what -- we're in the process now of adjusting our headcount, at least for this present effort, most of which will be concluded by the end of September.

Can -- how much are you looking to take out with this move as a percent of total?

Close to 10%.

Okay. How does that compare to --

And other related -- you know, other -- close to 10% of the headcount, and then there's other related expenses that go with that.

And that 10% will be out by the beginning of next fiscal year?

Yes.

Okay and that -- is that -- that's about in line with what you did post 9/11?

No, we took a little more post 9/11. We don't feel quite that nervous.

Right. Okay. And I guess, in relation to that, in terms of your cost structure, it looks like, you know, last cycle you were able to hold your gross margins and your SG&A as a percent of sales went down pretty nicely ;and I know you've got R&D baked into that. Your SG&A got down to looks like got down to about 8.5% of sales. Is that a level you think that you could get to again this time? Is that kind of the objective to kind of hold gross margins and bring down the SG&A?

Well, we don't look at it that way. We look at it on EBITDA margin. And our hope -- I don't want to get into forecasting next year's margins.

And David, I would just like to point out that going back to 9/11 versus now, our composition of the Company has changed with our acquisition, too. S we don't want to reference a prior target like that.

It's just -- every cost between sales and EBITDA is what we look forward, David.

Right. I mean, we just don't think of it that way. We think of a whole cost basis what has to adjust; but I would say we would surely hope that we could keep our margin -- our EBITDA margins consistent. We hope we might be able to do a little bit better.

Okay, and then looking back kind of 2001 through 2003, what do you think that your organic revenue growth was during that period if you -- obviously you adjust for acquisitions -- I think you bought Champion during that period -- and if you also exclude the -- you had the Airbus cockpit door mandate. It looks like your -- you know, your revenues were relatively -- on that kind of basis were relatively flat over that period. Does that look about right?

You know, going back, history, what we -- and what we have looked at was our commercial after-management in -- for the first six or nine months did drop, but it was offset nicely by a big pick up in defense. So when you total totaled them all up, it was pretty close to flat.

On pricing. Yes, but he asked -- I think he asked for a two-year stretch.

Yes, just kind of looking --

Specifically not the two years but in that timeframe, that's what happened.

In the year after --

In the year after. I just don't remember with the two years -- (inaudible).

So your after-market was down a little bit including -- including price?

Oh, no, no.

No, no, no. We're just talking the organic -- the market itself.

Okay. Okay. And then, Greg, I -- interest expenses quarter was down a couple of million bucks, and you had -- you know, your debt level didn't change. What's going on there? I know you had --

Well, we entered into a couple of hedging contracts during the course of this year that have proven out to be paying off right now.

Okay. All right, guys thanks.

The LIBOR is down, too, David.

Yes, I know some of it is variable. Okay. Thanks, guys.

(OPERATOR INSTRUCTIONS). And your next question comes from the line of Carter Copeland from Lehman Brothers. Please proceed.

Yes, just one sort of house-keeping thing. Greg, could you tell us what the sales contribution from CEF was in the quarter?

We -- we haven't disclosed the top line. You know, I gave the EPS impact of over about -- we bought it in the middle of May.

Yes.

And we typically, Carter, don't break out the location top lines and disclose it publicly.

Okay.

And your next question comes from the line of Matt [Vitros] from Barclays. Please proceed.

Good morning, guys. Not to harp on it, but I just want to be a little bit more clear. I mean, we always talk about the proprietary products and the after-market and how that gives you, you know, absolute pricing power. And not to get into too much of a what-if, but say RPMs here domestically were a little bit lower than you had expected, can you just talk about your absolute level of pricing power? Do you get a lot of push back, or is the fact your sole source in selling proprietary products is that powerful and give you the ability to really push price?

Well, we don't disclose our absolute level of pricing so I can answer that one easily. I can tell you that we generally get our pricing through all phases of the market cycle. The best measurement is after 9/11, during that period of time, we were able to get our pricing; and our pricing stuck and I would expect it to stick next year and this year.

Okay. And then just a quick clarification. You know, in your presentation for your Analysts Day, there was a small pie chart that showed, you know, I think 24 or 25% of your sales come from, you know, overseas or foreign sources, and 75, I guess, is here domestically. So, you know, if we expect air traffic to be slower here domestically, would -- wouldn't you be more weighted to that zero to 5% decline, or there is a different way we should be thinking about that?

Greg, I don't know where those numbers come from.

I know -- it -- (inaudible).

Am I looking at the wrong thing?

No, there were two pie charts. The one on the left was how we report sales for GAAP basis, if you're looking at that specific schedule.

Yes, that's what I'm looking at, yes.

And when we report our sales, it appears that more of our sales are U.S. related, and then -- but they are really not, and how you have to think of that is there is a pie chart right next to it.

The installed base?

The installed base.

Yes.

And you have to think of our sales being consumed where the installed base was. So that was a point clarification. When you read the 10-K, for example, you sell to Avial -- that is all a domestic sale, but they sell all over the world. You sell to Boeing, that is a domestic sale, but they export all over the world. So that was a clarification point of what is in the 10-K versus our business is really impacted by what goes on in the world and where the installed base is.

Understood. So it really is a global traffic number that would impact your --

Absolutely.

Perfect, thank you very much, guys.

And your next question comes from the line of Jason [Horowitz] from News, Inc. Please proceed.

Hey, guys. Just a couple of clarifications from earlier questions. The question that was asked earlier about your revenues -- organic revenues -- after 9/11, did I hear you right? You said the after-market overall for the industry was down a little bit. You guys were down -- I think you said a little bit. But then that was offset by pricing? Can you just go back to that and just explain, you know, what happened to -- to the industry itself and to you guys for after-market revenues, you know, say like for the next 6 to 12 months after 9/11?

Well, I don't -- I don't remember the exact numbers.

Okay.

But I will say the best indication our after-market is revenue passenger miles. And if you take the year after 9/11, I want to say the worldwide traffic over that 12 month period came down -- I want to say something in the mid-single digits kinds of range, as a percent.

Okay.

And generally, our pricing was able to offset that. In addition, the defense after-market grew quite rapidly over that period.

Sure.

Now this is just core sort of over the transom stuff. Additionally, we were able to get a very large cockpit security retrofit order that significantly pushed up the after-market volumes. So those are sort of the pieces on it after 9/11.

Okay, so would you say that -- I know you don't have the numbers handy, but is it fair to say that excluding the cockpit door mandate, that you think that your after-market revenues after 9/11 were essentially flat because volume was down but pricing was up?

I think -- I do not remember the actual numbers and -- but I -- your -- you have got the general concept.

And we're starting to blend a couple fiscal years here because the shipments for cockpit security took place in '03.

Yes, right.

So you can't -- I mean, you can only look at a portion of that --

But I think conceptually, yes. I mean, those are the pieces and you're in the right direction.

Okay, so that mandate actually wouldn't have really helped revenues in 2002 anyway -- fiscal '02 -- because you were really shipping --

Which subject?

Which subject? You lost me.

Well, the cockpit shipment --

Oh, yes, we only started shipping that in the fourth quarter of '02 and it was like maybe 7 or 8 million.

Yes, and those are disclosed numbers, by the way. If you look at the 10-K, I don't remember them but I think we supplied the numbers for cockpit security because it was so large.

Okay. So is it fair to say that -- you know, forget about fiscal '09 -- just in general, if RPMs -- worldwide RMMs are flat, which would be quite soft relative to historical levels -- if RPMs are flat, that you guys would think your business model, just the after-market itself, revenues would still up because volume would be flat because you generally track the after-market, but you will still get pricing of, you know, say 2 to 3%. And then that would flow down to even faster EBITDA growth, because you would always trade volume for pricing, right? Because that is just more profitable because that flows to the bottom line? Is that fair for the business model in general? And I am not asking for specific '09 guidance, I am just asking is that how you think about your after-market business?

Let me make a couple comments to be sure I understand you. Yes, directionally that's the way we think about it. Now, I would tell you for '09, all that would be true assuming everybody operated in a steady state. But what can happen in a downturn is, you can get a couple of quarters of people overreacting. You know, so you can get, you know," X" percent revenue passenger miles, and for a couple of quarters you can get "X "minus part sales, because people start to draw inventories down or they just get nervous and don't order. That can't last very long, but it can last for, you know, a quarter or so at the beginning of a downturn.

Fair enough.

So you have that working against you. But you have the model correct. The other thing I would add is, I don't know if you're believing there is some trade off between our price and our volume -- in other words, we put the price up and we lose volume -- (inaudible) but if you are, I don't agree with that.

No, no, no. I was just saying that all else being equal, EBITDA will grow faster on a 3% price increase versus a 3% volume increase.

And by the way, I am not confirming 3 and I'm not saying that 3 is in the right range, even.

No, no, I understand. What was your pricing after 9/11? Like in fiscal '02? I thought it was like 2 or 3%.

That -- when we talk -- that's low.

That is low. Okay. And then last question is, historically what has been the volatility in that overreaction? I mean, when you say "X" minus, again --

Very difficult to predict. Very difficult to predict. All I can say is that there is -- typically some overreaction. I don't have a good sense and don't know there has been any consistency to it.

Okay, but is it ever like as high as 10% or or anything like that?

I told you I don't feel comfortable with a number. 10% sounds high to me, though.

Okay. Just trying to get some order of magnitude of how -- obviously just hitting the downside.

There is not tons of inventory out in the system.

Okay. It is unlikely you would see that level. Okay, thanks very much.

And you have a follow-up question from Robert Spingarn from Credit Suisse. Please proceed.

Nick, Ray, Greg, I am thinking about -- you have all talked about the expenses that you can reduce next year, and I think you all have a very good track record on this sort of thing and on margins in general, and so I want to delve into that a little bit. If I just take my own model and look at the costs above the EBITDA as defined line, I think one of you mentioned that's the way to think about this --

Right.

-- everything above that number. So if we have roughly -- I don't know, let's call it 380 million in costs between revenue and EBITDA in '08 -- that's a rough number because we don't have the fourth quarter yet. How does -- how should we think about the labor component of that number?

You're just taking the revenues and subtracting the EBITDA, right, saying everything else is cost?

Correct.

Is that basically what you're doing?

Well, only because you phrased it that way and I just figured it was the easiest way to attack this here.

That's the way we look at it.

And so when we talk about a 10% reduction, what piece of that are we reducing?

We are reducing -- yes, yes --

The 10% by the way, just to be sure, that's headcount reduction. I said a little less than -- less than 10%.

Right, and you said there were associated costs. Maybe the right way to ask the question is what headcount -- or what percentage of that figure is headcount that is addressable here.

Yes, fair point. Rob I would say, it -- if you take our cost structure -- and I have said this many times in the past -- if you take that cost -- that lump of cost that you came up with, what I guess it was 380 -- this isn't exactly right, but it is something like half material, or outside buys, and half inside costs.

Okay. So you take the inside costs and divvy that up a little bit?

Yes, and if you take the inside costs you might have -- the big chunk of that is wages in some way, shape or form.

Benefits, yes.

And benefits. It is not -- I don't know this number exactly. It is not 90% of it, but it is surely well above 50.

Okay. So about -- some number above a quarter.

You go and you're going to try -- you're going to try to get a cutback number out of me, and I am not willing --

No, I understand. I am not trying to get you to give us '09 here, but I am trying to come up with a decent construct for figuring out how your cost initiatives can affect margin next year, and can they actually more than offset what we might see in terms of weakness on the top line if all this commercial aerospace stuff end up happening?

What we're reacting to is the fact that if the OEM continues to rise and the after-market growth slows down, you get a mix in the wrong direction.

Absolutely.

Right? So we're --

It is more acute for you than it is for almost anybody else.

Pardon?

In your particular business mix, it is more noticeable.

That's right.

Less for other guys who are less reliant on the after-market and less profitable on the after-market.

That's right. So one of the things we're trying to do is we are -- we don't know exactly what that that mix swing is going to look like. As I told you, we're uncertain going forward to next year. We -- we're trying to get enough costs out up ahead of the problem that we feel that we're close enough that we -- you know, we won't get ourselves in a margin squeeze here.

Uh-huh. Okay. Fair enough. I think we can back in. Thank you.

Sir, at this time you have no more questions.

Okay. I would like to thank everybody for calling in today. And I would like to let you know that we will be filing our 10-Q in the next couple days. Thank you.

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