TransDigm Group Inc (TDG) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2010 Transdigm Group Incorporated earnings conference call. (Operator Instructions).

I would now like to turn the conference over to your host for today, Jonathan Crandall of 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 2010 first quarter earnings conference call. With me on the call this morning are Transdigm's Chairman and Chief Executive Officer, Nick Howley; President and Chief Executive 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 this call which are not historical in fact are forward-looking statements. For further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, please refer to the Company's latest filings with the Securities and Exchange Commission. These filings are available through the Investor section of our website or through the Securities and Exchange Commission's website, at sec.gov. The Company would also like to advice you that during the course of the call, we will be referring to EBITDA -- specifically EBITDA as defined -- adjusted net income and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and a reconciliation of EBITDA and EBITDA as defined, adjusted net income and adjusted net earnings per share to those measures. With that, let me now turn the call over to Nick.

Good morning. Thanks again to everyone for calling in to hear about our Company. We had a lot going on this quarter. But before I talk about the business performance, I'd like to just take a minute to summarize in layman's terms as best I can the restatement of the financial statements that we announced today. I'll address this in two parts. First the impact on 2009 and prior years, and second, the impact on the 2010 guidance.

For 2009 and prior years, there's no change to our historical revenues, EBITDA, net income and the like. This restatement of GAAP EPS only results from the number of vested option shares that are included in the GAAP EPS calculation. Specifically, we determined this quarter -- and our auditors agree -- we should use the two-class method of EPS calculation versus the historical and much more commonly used treasury method. The reason is that our vested options are considered participating securities due to our long standing dividend equivalency feature. We have used the treasury method since our original IPO in 2006. In the more commonly used treasury method, the cash proceeds from the exercise of vested options are assumed to be used to repurchase shares at the then market price, and the quantity of vested options used in the EPS calculation is reduced accordingly.

In the new two class method, the exercised cash and the repurchase of stock from option exercise proceeds is not considered in the calculation. The calculation then yields a higher share count, and the GAAP EPS calculation is proportionately lower. This is effectively the only change. For 2010, the share count will be higher due to the reasons described above. Also in Q1, the actual dividend equivalency payment is deducted on a pre-tax basis from the GAAP net income, and the EPS calculated on that adjusted number. This is the GAAP required two class methodology. There is no impact on business fundamentals of revenue, EBITDA, EBITDA as defined, net income, cash generation or other financial statement items. Greg's going to give some more detail in his section, but that's my simple summary of the change.

Getting to the business now, I'd like to give some comments, as I always do, about our consistent strategy as well as our current sense of the status of the aerospace market as it applies to our business. To reiterate, we believe our model is unique in the industry, both in its consistency and its ability to sustain and create intrinsic shareholder value through all phases of the aerospace cycle. To summarize some of the reasons why we believe this, about 95% of our net sales are generated by proprietary products, and about 80% of our net sales come from products from 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 much higher gross margin and provided relative stability in the downturns. Because of our uniquely high EBITDA margins -- about 49% of revenues plus or minus -- and relatively low capital expenditures -- generally less than 2% of revenues -- Transdigm has year in and year out generated very strong free cash flows.

With about $160 million of cash as of December 31, 2009, an undrawn revolver of approximately 200 million, and expected cash generation in the range of 40 to 50 million per quarter for the balance of 2010, we feel we have adequate liquidity to meet our likely acquisition needs. Additionally, given current capital market conditions, we believe we have access to significant additional capital if attractive larger opportunities became available. As you know, we pay close attention to our capital structure and view it as another means to create shareholder value. In support of that goal, we sold 425 million of high yield bonds in Q1 and paid almost the entire amount out to our shareholders in the form of a $7.65 a share dividend and a dividend equivalency payment on our vested options. We have a well-,proven value-based operating strategy focused around what we refer to as our three value drivers; 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 while steadily investing in new business and platform positions. We have also been successful in regularly acquiring and integrating businesses. We acquire proprietary aerospace products with significant aftermarket content. We have been able to acquire and improve aerospace component businesses through all phases of the cycle. We've acquired five businesses in the last 16 months, including one this last quarter. Through our consistent focus on our operating value drivers, our clear acquisition strategy and close attention to our capital structure, we've been able to create intrinsic value for our shareholders for many years through up and down markets. As in prior downturns, in late 2008 and through 2009, we moved quickly to reduce our costs and stay ahead of this softening market. We continued this cost reduction effort through 2009 and continue to watch our costs and market conditions closely.

Additionally, as in past down cycles, we continued our new business generation activity as well as our value-based pricing initiatives. All these activities are reflected in the strong EBITDA margins. Now with respect to our underlying markets, although the market outlook is still not fully clarified, we're starting to see signs of stabilization in certain segments. In the commercial OEM area, many industry forecasters are becoming less pessimistic regarding the commercial transport OEM cycle. We don't know the future, of course, but we continue to plan conservatively. That is, we continue to plan for some rate reductions by both Airbus and Boeing in late 2010 or early 2011. Depending when and if these reductions occur, given our lead times, we could see negative volume impact in the latter part of fiscal year 2010.

We do continue to see incoming order rates below the shipping levels from commercial transport higher tier manufacturers. All of the business jet OEMs implemented significant rate reductions and related inventory decreases in 2009. We believe this sector is starting to stabilize. Though we do not believe it's bottomed out just yet, we think it's approaching the bottom. In the commercial aftermarket we see more glimmers of light in worldwide passenger traffic, freight traffic, our incoming order rates and other data. Exactly when this will result in higher quarter-over-quarter shipments by Transdigm remains unclear. Though we have not yet seen a recovery in revenues, many forecasters anticipate commercial aftermarket revenues will pick up in mid-calendar year 2010. We hope this is so, and we're beginning to feel better about these forecasts.

On a positive note, the incoming orders or booking levels are now running above the shipment levels. We also believe we are close to the bottom of the inventory reduction cycle for this segment, but as always this data is never quite clear. Though the business jet market impacts us to a much lesser degree, and in spite of utilization data starting to show signs of a pickup, we suspect demand may well stay down through most of 2010. For fiscal year 2010, we are still planning on a pickup in commercial aftermarket revenues in the second half of the year and a modest full fiscal year revenue improvement in this segment versus the prior year. Though quarterly numbers can bounce around, over longer periods of time our real or unit aftermarket volume has generally been able to track or slightly exceed overall worldwide passenger traffic. In our defense business, given the uncertainties around the defense budget, we are still not planning on growth in this segment in fiscal year 2010. We see nothing in the first quarter that changes our sense.

This segment, however, can be notoriously tough to predict, especially given the current US political winds and the worldwide geopolitical situation. We remain cautious regarding the market outlook, but confident in the strength of our unique business model to continue to create value, and our management team's ability to respond to changing market conditions. Now let me change -- turn to the latest financial performance. I'll remind you this is the first quarter of fiscal year 2010. Our fiscal year started October 1st. As I have said in the past, quarterly comparisons can be significantly impacted by differences in OEM and aftermarket mix, large orders, inventory fluctuations in the system, modest seasonality and other factors. But in spite of a continued weak economy and aerospace market, our first quarter fiscal '10 was better than we anticipated. The revenues were up about 2% versus the prior year Q1. Pro forma revenues -- that is, assuming we own the same mix of businesses -- is down about 7% on a quarter versus quarter basis, with the difference being our acquisitions.

Reviewing the revenues by market segment -- and again, this is on a pro forma basis versus the prior Q1, that is assuming we own the same mix of businesses in both periods. In the commercial segment, which makes up about 70% of our revenue, commercial transport OEM revenues were up about 15% versus the prior Q1, which was significantly impacted by the Boeing strike. Business jet OEM revenues are down almost 60% versus the prior Q1. Commercial aftermarket revenues were down about 13% on a Q1 versus Q1 basis. If you remove the severely depressed business jet revenues with very -- which had very difficult Q1 comps, the commercial transport aftermarket, which makes up the bulk of our commercial aftermarket, is down in the 8% range. On a positive note, on a sequential basis in the commercial transport aftermarket segment, revenues have now been almost flat for three quarters. Bookings were again up this quarter and running above the shipping level for the second quarter in a row. Two quarters don't necessarily make a trend, but it's another indication that the market may have bottomed. Though tough to quantify, we believe we still saw some modest systemwide inventory reductions in Q1.

In the defense segment, which makes up about 30% of our revenues, revenues are up 9% on a quarter versus quarter basis. However, this is compared to a low prior year Q1. Defense revenues were down both sequentially and versus the prior year average quarterly run rate. A quarter is not necessarily indicative, especially in defense spending, but we remain cautious about this segment. In total for the quarter, our revenues were a bit better than we anticipated going into the year. Moving to profitability -- and on a reported basis now -- I'm going to talk primarily about our operating performance, or EBITDA as defined. The adjustments to EBITDA have to do with acquisition-related accounting activities, and Greg will explain them some later. Our EBITDA as defined of about 90 million for Q1 is just about flat versus the prior Q1. That's better than we indicated in our full year guidance. The EBITDA as defined margin is 49% for the quarter. This is down from the 50.5% in the prior Q1 in 2009.

The dilutive impact pulls the margins down -- the dilutive impact of the acquisitions pulls the margins down by about 1.5%. I'd also remind you that the first quarter of 2009, I think, was our all time high EBITDA margin. With respect to acquisitions, as I mentioned, we made one acquisition this quarter for about 95 million. We acquired Dukes Aerospace, a manufacturer of proprietary aerospace valving. Due to its heavy dependence on business jets, we don't plan on any revenue growth in 2010 for this business. The Dukes integration is moving along well, and so far it looks like we got what we expected. We're continually looking at opportunities. The pipeline of possibilities remains. There's more small than large opportunities. Closings, as always, are tough to predict, so I'm not going to try, but we remain disciplined and focused on value creation opportunities in our very defined market segment.

As you saw in our press release, we have increased our guidance for revenues, EBITDA as defined, net income and EPS as adjusted. This primarily reflects the Dukes acquisition, but also some modest operation improvements. Our GAAP EPS is negatively impacted by the accounting treatment of the dividend equivalency payout and the two class methodology I mentioned previously. To summarize, Q1 was a decent start to the year. I don't feel like we're quite out of the woods yet, but at least in the commercial aftermarket segment I believe we're getting close. The market signals are clearly improving. We'll watch closely and adjust our guidance appropriately as the situation clarifies. And with that, let me pass it on to Greg Rufus.

Okay. Thanks, Nick. Okay. Thank you. Good morning, everybody. I hope everyone has the press release available and had the opportunity to read it in its entirety. I will be referencing it today and most likely during our Q&A. In typical Transdigm fashion, quarter one was very active.

Before I jump into the details, let me first give you an overview of what took place during the quarter. The operations had a good quarter, as Nick just mentioned, and it exceeded our expectations. In October, we successfully issued $425 million of high yield bonds. Later in the month, we paid out a $7.65 per share dividend to shareholders and made a dividend equivalent payment to vested option owners. In December, we announced the acquisition of Dukes Aerospace. This did require new accounting, specifically the business combinations or FAS 141, which was adopted in the beginning of this fiscal year; and while preparing our quarter one financial statements, we determined we were using the wrong method to calculate our earnings per share. This morning, we filed an amended fiscal year 2009 10-K and amended 10-Qs for the entire '09 year. We also filed an 8-K and a press release this morning which is very detailed.

Let me first touch on our operations. Nick gave a good analysis of what went on operationally in the quarter, but let me point out a few more specific details. Our net sales for the quarter increased $3 million or 1.7% to 184.3 million. Sales of $16.4 million resulted from the 2009 acquisitions of APC, Acme, the Woodward HRT product line, along with Dukes Aerospace which we acquired this quarter. Organic sales declined $13.4 million, primarily due to a drop of 7.1 million in commercial OEM sales. This drop was primarily from the impact of the significant decline in production rates in the business jet market. Along with this, we also had a $9.7 million decrease in the commercial aftermarket sales. This is reflecting ongoing worldwide airline traffic softness, destocking of inventory and very weak business jet activity. Partially offsetting the decline in organic sales was an increase of 4.3 million in defense sales, as Nick just mentioned. Cost of sales was 1.6 points greater -- 1.6 percentage points greater -- this quarter versus the prior year.

75% of this increase in cost was directly related to increased amortization from purchase price accounting for step up acquired inventory and some startup costs. We also had some negative mix from acquisitions. Selling and administrative expenses were also 2.2 margin points greater this quarter versus the prior year. The single biggest contributor to this increase was 1.5 million of transaction-related costs associated with the adoption of new accounting rules for business combinations. The Duke's acquisition made during the quarter is the first to be affected by the new rule. These costs are now charged directly to the income statement. Previously, they were recorded on the balance sheet. Also during the quarter, R&D and other professional expenses were up versus the prior year. Amortization of intangibles increased versus the prior year, reflecting all the recent acquisition activity.

The increase in interest expense is associated with the new debt I mentioned earlier. Our blended average interest rate for the quarter was 6.2% compared to 6.4% a year ago. Our effective tax rate is 35.8% for the quarter compared to 35% in the prior year. The prior year period benefited from a retroactive reinstatement of the R&E credit. As you can see, this was an active quarter operationally. I believe the new debt we issued in the quarter and the $7.65 per share dividend were adequately disclosed during the quarter, so let me talk about the restatement we issued this morning. First and foremost, the historical restatement today only impacted the share count information and the resultant earnings per share calculation. The other items on the income statement; that is, sales through net income, did not change. There were also no changes to the historical balance sheets, changes to stockholders' equity or statements of cash flows. EBITDA as defined did not change, and there were no impacts regarding covenants or on our credit agreements.

So what happened? During our first quarter review, the dividend equivalent payment received much scrutiny, and three things came from the comprehensive reviews. First, the dividend equivalency plan, which has been in place since 2003 and modified several times thereafter, allows vested option holders the right to receive nonforfeitable dividends paid to common shareholders. This right triggers certain GAAP rules which deemed the vested option as a participating security. This designation requires the use of the two class method to compute basic and diluted earnings per share instead of the more common practice known as treasury method. We should have been using this two class method since the first day we went public in March of '06. The second ramification impacts our original guidance which we gave November 19th. For our original guidance, we anticipated and included the dividend equivalent payment to option holders as compensation. This payment was $22.4 million after tax or $0.44 per share.

The proper GAAP treatment of this payment requires us to book 34.8 million, which is pre-tax, as a charge to retained earnings and not the income statement. So everyone is clear, in all other areas -- that is, W-2 reporting, officer compensation in our proxy and for tax book treatment -- this payment is classified as compensation. The third item that results from the two class method is the difference in the numerator and the denominator when using the two class method of earnings per share calculation compared to the treasury method. In quarter one, this is the reason we only show $0.01 earning per share, even though our net income is $30.8 million. I would ask you to reference table four, and unfortunately we didn't number them as tables. We did them as pages, but it was pointed out to me, depending where you get the press release your page numbers could change. But what it does on table four, it compares the two methods arriving at EPS. For those of you who do not have ready access to the press release, let me try to explain. The two class method assumes dividends paid in a period are funded by current earnings of the same period.

Also, the dollar value of dividends paid to securities with participating rights are deducted from net income on a pretax basis before the earnings per share share calculation. Quite frankly, this method never contemplated the special dividend paid for accumulated historical earnings which Transdigm did this quarter. Thus, the numerator -- that is, net income adjusted for dividends paid to participating securities -- is severely reduced in this quarterly earnings per share calculation. So although our net income is $30.8 million, for earnings per share purposes, the net income available to common shareholders is only $445,000. This is the rule. Now the two class method also impacts the denominator -- that is, the number of outstanding shares used to compute EPS. As Nick explained, this method ignores the concepts of the treasury method to compute the effect of dilution. This two class method increases our diluted share base by 2,125,000 shares versus the treasury method this quarter.

Now let me switch to the actual earnings per share. As you can see from our press release, net income was down 22% from 39.6 million to 30.8 million. However, earnings per share was down 99% from $0.75 in '09 to $0.01 in fiscal '10. If you can again refer to table four of the press release, you will see the impact of the dividends which reduces earnings per share by $0.57. Also the higher share count under the two class method reduces earnings per share by another $0.03. Adjusting for these two items, reported earnings per share would be down approximately 19%, which is more in line with the decrease of net income of 22%. I'd like you to flip the page to table three, which is the reported and adjusted earnings per share of the press release.

If you go about three quarters down the page, you can see that adjusted net income decreased in the current quarter to 35.5 million from 41.3 million or 14%. Again, the primary decrease in adjusted net income is the result of additional interest expense from the debt offering as well as acquisition related. Adjusted earnings per share using the two class method or the treasury stock method is down approximately 15%, which is consistent with the decrease for adjusted net income of 14% during the quarter. Finally, for this quarter we have issued several additional supplemental pages in our press release to help clarify a complicated issue. I apologize for the length of time and detailed explanation, but we did not feel we could clearly summarize what all has gone on this quarter. Again, I can't emphasize enough that our sales, EBITDA as defined, cash flow and balance sheet has no other changes. With that, we'll now open it up for questions.

(Operator Instructions). Your first question comes from the line of Robert Spingarn with Credit Suisse. Please proceed.

Morning, guys.

Morning, Rob.

Nick, you talked about the book to bill being above one in aftermarket for a quarter or two now. If I interpreted what you said correctly, why should we see such a waiting time to see that improve the sales? What's the cycle on that?

It is -- it can vary. I mean, obviously, Rob, sometimes it's immediate, but obviously these orders aren't immediate. Some of them are distributors starting to anticipate a market pickup and book out in front of it. That's some of it. I would say it can vary, Rob, from probably one month on the fast side, which it obviously hasn't been, to maybe four to six months on the other side -- on the outside.

Can you give us a sense in your product range of fast to slow, what kinds of things are on the fast side versus the sow side?

I don't know that I can, as I sit here, make a ready distinction on that. I mean, I don't think I can give you a meaningful distinction there, Rob. It's -- in most any product line, there's parts that are longer and parts that are shorter.

Have you heard any commentary from the airlines? We saw a good RASM numbers yesterday, so the indications are somewhat more positive. In your discussion with airline people, what do they tell you with regard to their CapEx for spares?

I mean, what we understand -- and now you obviously are going to be somewhat skeptical of this, as I am -- that the inventory draw down is approaching bottom.

Who would think?

Or hit the bottom. On the other hand, I would have thought that would have happened last quarter. But if I look at our numbers and everyone else's numbers they're putting out, it surely appears not to happen.

Would you say, then -- last quarter you said you hadn't quite bottomed yet. We saw another 13% decline in aftermarket here. Is this December quarter the bottom?

I hope so. Rob, I hope so. I see the -- one thing I would say, it's 13, but if you pull out the business jet -- which drags it down, which (expletive) near stops, and it's against a very high quarter the previous -- the commercial transport, which is the more indicative number, was down about eight.

Right. And that's a little bit worse than the six to seven in the September quarter, right?

Yes, yes. I think.

Which isn't --

I don't remember -- I just don't remember that quarter very well, Rob.

Yes, I just checked it; but again, a worse number suggests maybe we're at bottom.

You'd think so. When I look at the things you would look at which is the traffic, the freight traffic, our booking rates; all those things are starting to send signals that you'd think you were bottoming out.

Okay. A couple other quick things. In defense you still had some growth in the quarter. You've guided flat. Does that mean we should anticipate a negative comp at some point here in the year?

I guess that's true. Mathematically, it would have to be. (Overlapping Speakers) You know what? I think what I also said is I don't take much comfort in the defense pickup. It's against a very low comp the prior quarter.

Okay.

I find it more indicative that it's -- if you take the average run rate -- the average quarterly run rate last quarter -- it's a little down from that.

Okay, so sequentially. Just very briefly, Greg, on the tax rate I think it was 36% guidance?

It was that, or I think I was close to 35.8 or 36.2.

Talking about for 2010 guidance?

Right.

Okay. And there's no R&D tax credit in there?

A minimal amount.

Okay. So if they enact the credit, there's no adjustment to the guidance?

If they enact it, it will impact it favorably.

Can you quantify?

First quarter was about a $200,000 credit, Rob. So it could be a $400,000 to $600,000 additional credit during the year.

Okay. Okay. And just a final question, 787 rate, are you seeing any pickup here?

No. The 787 inventory -- this is Ray Laubenthal. The 787 inventory that we shipped last year and so forth is still kind of sitting at Airbus -- excuse me, at Boeing. We expect throughout the year they'll start to order and pick up, but that program is now just starting to take off.

Okay. Thanks, guys.

Your next question comes from the line of Carter Copeland with Barclays Capital. Please proceed.

Morning, guys.

Morning, Carter.

Nick, I wonder if we can revisit this that we talked about last quarter on the OE order trends that you're seeing and how they seem to not jive with, obviously, what the OEs are saying. Do you have any sense of anything abnormal that could be driving this, whether it's related to inventory in the system, if it's related to strange strike comps based on different approaches that people took during the strike in terms of production slowdown, and then subsequent ramp-up?

I don't know that I can say any of that, Carter. It's been fairly consistent. I mean, it's been -- the bookings have been below the shipments for a while now, and for probably all last year, and the -- though maybe they're drawing closer together, they're still not lined up. I don't know that I can honestly say I can point out any one issue -- like, I understand what you mean -- did somebody load up at the strike time because they were concerned or something like that?

Right.

Possibly, but I don't hear that.

And is it any different magnitude than what you talked about in the prior quarter in terms of what sort of differential you're seeing between bookings and shipments?

Yes. Maybe the bookings are a little closer to the shipments this quarter, but the numbers aren't great. They're still concerning.

Still off in the double digits?

Yes. Close.

Okay. And a couple --

Which leads us to believe -- Carter, you know where that leads us. What we tend to do is watch the hands, don't listen to the lips. So that still concerns us.

Of course. A couple quick ones for Greg. You've mentioned briefly the accounting changes related to the inventory and how they're flowing to the income statement from here forward, and Dukes being the first deal where that's affected. Can you provide some more color on exactly what's happening with that change?

No, I think you're co-mingling. Two points, Carter. We always have amortization on purchase price inventory. That's always been there, because you have to write up finished good and some whip up to the market value and then you amortize it off.

Right.

That's always been there. What has changed is that certain transaction expenses associated with a acquisition, in the old days you'd take that to the balance sheet. Now you have to expense them. So we had a finder's fee and some professional fees tied into the Dukes acquisition. That now has to be expensed, and that was about 1.5 million for the quarter.

But for the purposes of your as defined calculations, will you be including those in the --

That's -- we exclude that, also. The as defined excludes those, and so it's still an apples to apples comparison on our EBITDA as defined and the adjusted net income as defined.

Okay, great. And the last one, for historical purposes, I recall you having a certain number of -- I think you referred to them as performance vested options -- that weren't included in the share count because they were related to performance targets that needed to be met before they could vest. Under the two class method, do those now move into the diluted share count? Are they still out there waiting for performance targets to be met before they --

All of our options are performance weighted. The difference now is that all vested options have to be included as if they're a common stock. Unvested options are excluded.

But I think his question, Greg, each year some will vest presuming we meet the target.

That is correct.

And then the number will go up a little bit.

That is correct.

Okay, great. Thank you, gentlemen.

Your next question comes from the line of Myles Walton with Oppenheimer & Co. Please proceed.

Thanks. Good morning.

Good morning.

Thanks for the detail on the accounting change. The commercial OEM overall rate of change in the quarter, what was that on a blended basis? I think you gave us 15% up on transport and 60% down in biz jets.

Yes. I don't think we gave it to you on employment basis.

I don't think we --

I don't have that in front of me right now. Yeah. I don't have it in front of me right now.

What is it --

The commercial transport is significantly larger than the business jet.

Okay. Because I think you also said the commercial OEM was down, though, about seven million. So that decline --

The decline is all business jet, yes. The commercial transport was up.

Yes.

From the prior quarter.

I mean it sounds like business jets are anemic, as expected, but even more anemic than I could imagine. Is this sequentially flat on the biz jet revs, and what do the compares look like from here?

It's not -- in the OEM it's close to flat but not quite. It's still continuing to drop a hair. It's way down -- way down from the first quarter of the previous year.

Okay. And so from a compares basis, are we looking at 4Q when the furloughs kind of took hold, or did you have some 3Q easing as well that --

You mean in the business jet?

Yes.

In the OEM part of the business, it dropped every quarter from the first quarter.

Okay, okay.

And consistently.

And then with respect to the Dukes acquisition and the earnout that's associated with, that how are you treating that under the assumptions for your purchase-based accounting and kind of balance sheet treatments as your reserve against that?

We're still using -- our valuation experts still haven't finished that. We will have to accrue something, but our current expectations are it's going to be on the smaller side rather than the larger side. But until I get the final amount from our valuation experts, Myles, I'd have to wait. We'll report that in the next quarter.

Okay. And then with respect to the incentive program for performance-based options, are the -- number one, what are the adjustments you'll have to make to the vesting criteria on the dividend payout? And number two, are the IR calculations going to be using the diluted share count from the treasury method or from the two stock method?

You mean for the vesting of options?

Correct.

I'm not sure the answer to that yet. The plan is written around the treasury method, so we're going to have to look at that. This has relatively recently come up. Your question is whether you keep it consistent or not. We will have to come up with some way that's consistent. The way the dividends are handled is the dividends are -- a dividend is counted as part of the IRR return. So essentially you get the money a little earlier.

But when you take a step back, though, the two -- the diluted shares under the treasury method and the diluted shares under the two class method are consistently within the range of 3 or 4%. So it's not miles off, Myles, and we have to adjust this. The first flurry was to get through all the amendments in reporting that, but at the end of the day on the diluted method, you could get pretty close, but it's immaterial.

You follow?

Yes, I do.

If you're consistent from the beginning to the measurement points, it doesn't make a heck of a lot of difference.

Yes. I was just assuming, though, that there's probably going to be a little more creep under this method than the prior method as well, though?

I think.

I got to run it up again. Our first priority was to get in compliance with all filed returns and I took a quick look at it and I got pretty close, but because of those two methods were fairly close and immaterial, and in theory it shouldn't impact an operating performance.

Okay, great. And the last one for me on cash, could you give some color on working capital and deferred tax accounts in the quarter, and also what that looks like for the full year?

Well, I won't address the deferred tax because I don't look at it that closely on a quarterly basis, but our working capital is well behaved. It's consistent with our metrics. What we look at is what an operating working capital, which is receivables and inventory less accounts payable. We target that to be about 30% of our sales, and it's hovering right around there. We manage our day outstanding sales, looks pretty good. Our past dues are very good, and we monitor the inventory, but it's not as good as our peers. But we do manage the inventory with that. So we're in good shape on our operating items in the balance sheet.

Okay, great. Thanks again.

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

Yes, good morning, gentlemen.

Good morning, Fred.

Just wanted to check in on a couple items. You'd mentioned regarding the guidance that in addition to increasing your expectations based on the increment from the Dukes acquisition, you see some modest operational improvements. Can you elaborate on that a little bit, and is this something that could potentially generate upside throughout the year?

Yes. I want to emphasize the moderate here, or modest. Our first quarter was a little better than we expected, so that made us feel a little better better about the year. I would say we probably feel a little more positive today about the commercial aftermarket turning than we did three months ago. I don't know that we're ready to crank that number into our guidance, but the sum of those two things made us feel like there was a little up bump rather than down bump.

Got it.

I don't want to overplay that.

Okay. No, that makes sense. And then I thought also when going through the SG&A, Greg, that you'd also seen some increase in spend on R&D, and can you give us some color on what that was tied to?

Well, it ties to when you're doing it. But we still have a very active new business product generation going on, and we are now doing some work on the A-350 and it's cranked up a little bit right now. Greg, you want to comment any more on it?

No. That's about it. A-350 work is starting to crank in, and sometimes R&D spending can be lumpy if you have a particular test you're paying for or big generation of some work in one quarter versus the next.

Yes, and it is lumpy, right.

Deliverable kind of prototypes and so forth.

Okay. Got it. Well, thank you very much for that.

Your next question comes from the line of Robert Stallard with MacQuarie. Please proceed.

Morning.

Morning.

Nick, I was wondering if you could comment first of all on the pricing situation for your aftermarket spares, if you've been able to achieve your normal historical increases at the start of the year?

Yes, yes, we have. Yes, we have.

Yes, okay. Secondly, on the special dividend, you mentioned obviously these options keep vesting as the years go by. Can we expect any more of these in one-off charges or is everything done in this first quarter?

Well, as the unvested options vest -- and that will be a small amount in comparison to what was paid in the first quarter, we will pay that out, but I believe -- Mike, correct me if I'm wrong -- that is going to be a charge to retained earning.

That's correct.

So we can see more of these style bottom line adjustments as time goes by, but a lot smaller --

It's immaterial, but they'll be very small.

Immaterial.

If 100% of the 2010 options vest, it could be about $4 million. Over a three or four years.

Over three or four years.

Okay, so 4 million over the next three to four years is a realistic forecast for that?

Yes.

Okay, and then just finally, Nick, on the acquisition front, I was wondering if you could give us some more color on the type of assets you're seeing in the moment, and whether there's been any changes on the prices in terms of what people are trying to get these days.

Not -- I can't say there's a significant change. The things that close still close at pretty good prices.

Yes.

And I would say sizewise, we still see the same kind of things, more small than large. I can't say that I can -- I have any feel that there's a change in that market.

Okay. That's great. Thank you.

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

Good morning.

Morning, David. I understand you're snowed in.

A little bit. Yes, little bit. Getting close to Cleveland. The only question I have left is your -- what is the total -- Greg, what is the total adjustment amount this year we're looking at to go from EBITDA to the EBITDA as defined at 390 to 405?

As you know, on the press release you can see in the first quarter that adjustment to net income of 30,000,313.

Right.

That is what we'll also use for the full year. So you'll have to take the full year reported income and reduce it by 30,000,313 to get to the net income available for the calculation.

Okay. Then I guess the 390 to 405 that you have in EBITDA as defined, what are the total adjustment amounts in that number for stock options, deferred comp, acquisition-related costs? What are you projecting that will be this year?

If you see the $0.70 on table four, for the year I think it's $0.85 -- or $0.83. So we're going to have another couple -- where you have the non-cash compensation, that's $0.02 a quarter, I think it rounds out to about that. It could be $0.08 or $0.09 for the year, David.

Okay. So it's $0.83 less the $0.57 for the dividend -- the difference is kind of the usual amount that we've seen in the past?

Right. And then like $0.02 is for the new accounting for 141-R. But it's the usual stuff for acquisitions, that's correct.

Okay. Thanks, guys.

Yes.

Your next question comes from the line of Ken Herbert with Wedbush. Please proceed.

Yes, hi. Good morning.

Good morning.

Just wondered if you could provide or dig a little deeper into the defense side. I mean, it seems like there's been a lot of mixed signals around, from the budget and what we're hearing out there heading into 2010 -- calendar 2010. What are you specifically looking for, or do you think there's any opportunity here for any sort of incremental upside like we've seen in some of the prior quarters heading into the year? And any color you can provide on that would be great.

Well, is there opportunity? Yes, there's opportunity in both directions. I think what we -- I think there's possibility it could move in either direction. I think what we said going into the year -- and we still are at about the same place -- that we move into the year uncertain and unsettled about defense spending. It's been running red hot for the last couple years. I think we were up -- I want to say about 15% in '08 and 20% in '09. It seems to us to be running pretty hot. We look at the political situation in the US and sort of the geopolitical situation, and it's -- you get very mixed signals. It's hard to predict, particularly over a short period of time. I don't take much comfort, as I said, from the numbers in the first quarter.

They're up, but they're up versus a low quarter, and they're really down versus our prior year run rate, and I think we still stand where we did at the beginning of the year. We are planning on a slight decline. Now if you told me it was not a slight decline but it was up 5 or 6%, I'd say I couldn't argue with you. If you told me it was down 10%, I'd tell you I couldn't argue with you. But we are uncertain and tend to be conservative when uncertain.

Okay. And I guess, though, just considering the exposure to the aftermarket and what you do there relative to the OE side within defense specifically, just continued activity and equipment usage, so to speak, at similar levels as what we've seen has got to obviously be -- potentially an incremental positive?

That's right. Now, of course, the question is at what level versus the levels they were using at the past. Just continual level won't necessarily -- just continual use won't necessarily hold up because, it has been running hot, as I've said.

Yes. Okay, good. And just one final quick question on the aftermarket, just to follow-up on the comment earlier. I mean, the book to bill seems to be moving in the right direction now. You said, I think, it was up in each of the last two quarters over one. Did you see any sort of -- any strengthening in that in your fiscal first quarter relative to the fourth quarter of 2009, or sort of up similar amounts, or is there anything you could say? I know it's getting fine tuning here, but anything you can comment on that?

Yes. I would say that the first quarter if you -- let me just look. Let me just think a minute here. Yes. The first quarter was up from the fourth quarter. It was up. It was a little better.

Okay. Excellent. Thank you very much.

Your next question comes from the line of Carter Leake with Davenport & Company. Please proceed.

Good morning. Let's see, I want to just clarify on the rate reductions in 2010. You're talking about your fiscal year and not calendar? Is that correct?

Yes, but you see, the plane doesn't have to be reduced in that period for us to see dropped decreasing shipments. If you were going to drop a rate in early '11, we'd be impacted in the latter part of '10, if not now -- soon, because we're probably on average running -- I don't know -- four to eight months ahead of that.

On OEM.

On OEM, that's right.

And I'm sorry if you said this. Do you have narrow body cuts baked into your 2010 guidance?

We have some modest.

You have some modest?

And let me just say if you take out the 787 -- rather than slice the onion too thin here -- if you take out the 787 we're presuming the commercial transport production rates, which obviously has to be narrow body because they're the big numbers, come down somewhat at the end of '10 or in the early part of '11 or mid part, and that starts to reflect back on our shipments at the end of our year. Now whether that happens or not, I don't know. Surely people are less pessimistic or more optimistic about that than they were maybe four or five months ago. But time will tell.

Any chance of giving sensitivity if the cut does not occur on your forecast?

I'd rather not do that.

Okay. Real quick --

I will say the commercial transport OEM shipments are our least profitable segment.

Okay. Cash tax payments for 2010 last quarter was guided to 60 million. Is that still in line?

Yes, yes. This activity doesn't change the cash taxes. The cash taxes will be about 75% of my book provision, and that will be, I think, more in the high 60s, not the low 60s.

Okay. And I don't know if I heard this right. But would you be able to give the commercial OE year over year, excluding any Boeing strike impact?

No.

No?

I don't know how to do that. I don't know how to do that adjustment for a quarter. Clearly, the first quarter was adjusted -- or impacted. Clearly, the first quarter last year was disproportionately low, so I don't take great comfort from a 15% positive comp.

And finally what business jet platforms, if you could give color, do you -- are driving the sort of worse than expected activity? Any color there?

Well, I don't know that we said it was worse than expected. It was bad. I think we went into the year expecting -- even though it was down substantially from the prior year -- that it would continue to drop for a while. I mean, we've pretty well covered the waterfront on platforms. We're maybe a little underweighted at the so -- not zero -- but we're pretty much across the waterfront on the rest of them.

Okay. Thanks a lot.

Your next question comes from the line of Eric Hugel with Stephens. Please proceed.

Can you first -- about -- from what I recall, about half of your aftermarket sales go through distributors. Do you have any sense as to sort of what's going on there? Are your distributors seeing any pickup in business yet, or is that still sort of mixed?

That's half of the commercial aftermarket sales?

Right, right.

Specifically commercial transport. I would say the distributor picture is mixed. We think the inventories are still in good order there. It's mixed. They'll have a good month, a not so good month. It's sort of bouncing around. It's not clear yet.

Okay. Fair enough. And you're comfortable with the inventory levels that they have, that there won't be --

I think as long as the airline buys don't drop further, I think they're in pretty good shape.

Okay. So in other words what, they see the pickup in demand, it's going to be pretty quick that they're going to flow through the pickup in demand to you guys?

We think so, and that's some of the reason we're seeing booking orders picking up.

Okay, fair enough.

Even if not seeing, they're starting to anticipate or speculate.

Right. I got on a few minutes late, so I missed -- you might have addressed it, but did you guys give your free cash flow generation for the quarter as well as CapEx?

We didn't give it for the quarter, and we'll be reporting our Q1 either after -- later today or first thing in the morning.

Okay.

I don't have it with me right now.

I guess you get a rough idea. We started the year off at about 190.

Yeah.

And we paid 95 bucks -- 95 for an acquisition.

Yes. 95 million.

95 million for an acquisition, and got 160 left, so you can sort it back in there.

And lastly, Greg, I guess your guidance last quarter was for SG&A to be sort of in that 10% to 10.5% range. I understand you had the acquisition accounting impact that. Should we expect ex any additional acquisitions for that number going forward to be in that 10 to 10 1/2% range, or is there anything structural that we need to take into account?

No. Excluding the acquisition and the accounting for that there's no need to think our SG&A would be any higher than we originally said.

Great. Thanks a lot, guys.

Your final question comes from the line of Greg Halter with Great Lakes Review. Please proceed.

Yes. Yes, the waterfront or snow front has been the cover here basically. A couple accounting quickies, if you could, and you may not have them given your 10-Q coming out. But any estimate on where your equity balance stood at year-end, 12/31? And also wondering if there's any short term debt in the debt you show in your press release?

No short-term debt and the equity -- where are we at, Mike? Because of the dividend, the equity will be 441 million positive after the dividend.

All right. Thanks.

Thank you. Thanks, Mike.

There are no more questions in queue at this time.

With that, I'd like to thank everybody for dialing in and putting up with one heck of a quarter. I could tell from the calls that everybody did read the press release from beginning to end and I thank you for that, and with that hopefully we can get on with running the business in our usual Transdigm fashion. Thanks for calling in.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.