TransDigm Group Inc (TDG) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2010 TransDigm Group, Incorporated, earnings conference call. My name is Yusinia and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session at the end of today's presentation. (Operator Instructions) I would like to now turn the presentation over to Mr. Jonathan Crandall of Investor Relations. Please proceed.

Thank you. I would like to thank all of you that have called in today and welcome you to TransDigm's fiscal 2010 third quarter earnings conference call. With me on the call this morning are TransDigm's Chairman and Chief Executive Officer, Nick Howley, President and Chief Operating Officer, Ray Laubenthal, and our Executive Vice President and Chief Financial Officer, Greg Rufus. A replay of today's broadcast will be available for the next two weeks. Replay information is contained in this morning's press release and on our website at TransDigm.com.

Before we begin, the Company would like to remind you that statements made during this call which are not historical in fact, are forward-looking statements. 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 advise you that during the course of the call we will be referring to EBITDA, specifically EBITDA as defined, adjusted net income and adjusting 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 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. As usual, I'll start off with some comments about our consistent strategy as well as the current sense of the status of the aerospace markets as it applies to our business. To reiterate for everyone, we believe our business model is unique in this industry, both in its consistency and its ability to sustain and create intrinsic shareholder value, through all phases of the aerospace cycle.

To summarize why we believe this, over 90% of our sales are generated by proprietary products and around three-quarters our net sales come from products for which we are the sole source provider. About 60% of our revenue and a much higher percent of our EBITDA comes from aftermarket sales. Aftermarket revenues have historically produced a higher gross margin and have provided relative stability through the down cycles. Based on our uniquely high EBITDA margins, about 49% of revenue, and relatively low capital expenditures, TransDigm has year-in, year-out generated strong free cash flow. With about $260 million of cash as of July 3, an undrawn revolver of about $200 million, and typical cash generation in the $40 million to $50 million per quarter, we feel we have adequate liquidity to meet our typical acquisition needs. Additionally, given the current capital market conditions, we believe we have access to significant additional capital if attractive larger opportunities become available.

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 per share dividend and dividend equivalency payments. As you know, we have in the past and continue to be willing to lever up when we either see good opportunities or view our leverage as suboptimum for value creation. We typically begin to delever pretty quickly after such an event.

We have a well-proven, value-based operating strategy focused around what we refer to as our three value drivers. That is new business development, continual cost improvement, and value-based pricing. We stick to these concepts as the core of our operating management method. This consistent approach has worked for us through up and down markets and allows us to continually improve and increase the intrinsic value of the business while steadily investing in new businesses and platforms.

We have also been successful in regularly acquiring integrating businesses. We acquire proprietary aerospace products with significant aftermarket content. We've been able to acquire and improve aerospace component businesses through all phases of the cycle. We have acquired five businesses in the last 22 months, including one so far this fiscal year. Additionally, as you may have seen, we expect to close another acquisition for about $73 million prior to the fiscal year-end.

Through our consistent focus on our operating value drivers, a clear acquisition strategy and close attention to our capital structure, we have been able to create intrinsic value for shareholders for many years. As in prior downturns, in 2009 and through 2010, we moved quickly to reduce our costs and stay ahead of the softening market. We continued this cost reduction through 2009 and continue to watch our cost and market conditions closely. Our employment levels have stabilized for the last few quarters. Additionally, as in past down cycles, we continue our active new business generation efforts as well as our value-based pricing initiatives. All of these activities are reflected in the strong EBITDA margins.

With respect to our underlying markets, though the market outlook is not fully clarified, we are starting to see clear signs of stabilization in many of the segments. In the commercial OEM world, industry forecasters and air frame manufacturers continue to be optimistic regarding the commercial transport OEM production cycle. Both Airbus and Boeing announced rate increases on certain platforms and are threatening more increases. We don't know the future, of course, and we continue to be somewhat weary of what, by historical measures, will be an unusually moderate downturn, but it now appears that rate reductions by Boeing and Airbus in 2011 are highly unlikely and a pickup is likely. We are starting to see year-to-date and Q3 incoming orders greater than shipments from the commercial transport and regional 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're not sure it has bottomed out just yet, we think it's getting close and the year-to-date order rate may be recovering slightly; however, frankly, the quarters have been mixed.

In the commercial aftermarket, we continue to see positive signs in worldwide passenger traffic, freight traffic, incoming orders and other data. This quarter, for the first time in a number of quarters, we saw both sequential and year-over-year increases in our revenues. We hope this continues and are beginning to feel better about forecasts of pick up. Incoming orders or bookings year-to-date continue to run in the 5% to 10% range above shipment levels and a much greater percent above the prior year bookings. We also believe we may be at or close to the bottom of the inventory reduction cycle and what I call the capacity squeeze for this segment, though the data still is a little unclear.

The business jet aftermarket impacts us to a much lesser degree. Utilization data is mixed but generally showing sign of recovery, and we did see some modest pickup in incoming orders here. For fiscal year 2010 we are still planning on a modest fiscal year revenue improvement in the commercial aftermarket versus the prior year. Although quarterly numbers can bounce around, over a longer period of time, our real or unit commercial aftermarket volume has generally been able to roughly track worldwide passenger traffic growth.

In the defense business, given the uncertainties around the defense budgets, we are not planning on growth in this segment in fiscal year 2010. Q3 was a bit better than we originally expected, but this segment can be tough to predict, especially given the current US political wins in the worldwide geopolitical situation. We remain cautious regarding the market outlook, but confident in the strength of our unique business model continuing to create value and our management team's ability to respond to changing market conditions.

Now let me to turn to the latest financial performance. I'll remind you, this is the third quarter of fiscal year 2010. Our fiscal year started October 1, 2009, and as I have said in the past, quarterly comparisons can be significantly impacted by difference in the OEM aftermarket mix, large orders, [transient] inventory fluctuations, modest seasonality and other factors. But in spite of a mixed economy in aerospace market, our third quarter of fiscal year 2010 was a pretty good quarter. GAAP revenues were up about 13% versus the prior Q3. Pro forma revenues, that is, if we owned the same mix of businesses in both periods, is up about 3% on a quarter-versus-quarter basis. This is the first year over year organic growth we've seen in a while. Revenues were up 4% on a sequential basis.

Reviewing the revenues by market segment and again on a pro forma basis versus the prior Q3, that is assuming we owned the same mix of businesses in both periods. In the commercial area, which makes up about 70% of our revenue, specifically commercial OEM revenues, commercial transport revenues were down about 8% versus the prior year Q3, and down slightly on a full-year basis, though about flat sequentially. This should start to pick up to reflect the revised production rates. Bookings are running modestly ahead of the shipments. Business jet OEM revenues were about flat versus the prior Q3 and still down a bit on a year-to-date basis. Again, year-to-date bookings here are also running modestly ahead of the shipments.

In the commercial aftermarket, revenues were up about 12% on a Q3 versus prior Q3 basis, the best quarter versus quarter comp we've seen in a while. On a sequential basis, our commercial aftermarket was up again this quarter, up about 5% versus the prior quarter, or the previous quarter. This is the second sequential quarter up in a row. Bookings are up at a significantly higher percent than the shipments, both compared to the prior Q3 as well as year-to-date.

Defense segment, which makes up about 30% of our revenues, revenues are down slightly on a quarter versus quarter versus prior quarter basis compared to a very strong prior year Q3. This is actually better than we anticipated earlier in the year. Defense revenues were up sequentially, incoming orders are running about even with the shipping rate. A few quarters are not necessarily indicative of future trend, especially in the defense area. We remain cautious in this area. In total for the quarter, our revenues were a bit better than we expected.

Moving to profitability, and now on a reported basis, I'm going to talk primarily about our operating performance, or EBITDA as defined. Adjustments to EBITDA were modest to get that as defined. Our EBITDA has defined of about $105 million for Q3 was up about 12% versus the prior Q3. On year-to-date basis, EBITDA as defined is up about 6%. EBITDA as defined margin is 49.4% for the quarter. This is roughly equal to the previous year's Q3. On a year-to-date basis, our EBITDA margin is just about 49% also. The year-to-date margin was diluted about 1% by the impact of acquisitions.

With respect to acquisitions, we have completed one acquisition, Duke Aerospace, this year for $95 million. Additionally, we announced the execution of a contract to buy Semco for about $73 million. This is subject to Semco shareholder approvals and we expect this to close prior to our fiscal year end. Semco is a producer of highly engineered proprietary engine transducers, sensors, and related hardware. The company is about half commercial and half defense and about 40% aftermarket. It looks like a good fit with strong value creation potential.

We continue actively looking at opportunities. We have a pretty full pipeline of possibilities. Lots of smoke. As I said before, we'll see how much fire there is there. Closings are always difficult to predict. We remain disciplined and focused on what we buy, and being sure that there's a clear path to value creation.

As you saw in our press release, we have modestly adjusted our guidance for revenues, EBITDA as defined, net income, and EBITDA as adjusted. The revenue band has just tightened a little while the measures of profitability reflect a mix of modest operating improvement along with a decrease in interest and tax expense. I will note that this guidance includes no contribution from Semco because we are not certain this will close prior to the end of the year. If so, it will be very close. Our GAAP EPS is negatively impacted, as you know, by the accounting treatment of the dividend equivalency payback and the two class EPS methodology.

In summary, Q3 was a good quarter. The commercial aftermarket is feeling better, though still a bit spotty. The defense market is less clear. We'll watch this closely as we prepare our 2011 plan and guidance. Now let me hand this over to Greg Rufus, our CFO, who will review the third quarter and the year-to-date financial results.

Thank you. And, again, good morning to everyone who has called in to hear about our Company this quarter. I hope everyone had an opportunity to read our press release, which was issued this morning. Nick just gave a very thorough description of TransDigm's revenue stream and our market conditions, and as we have discussed in the past, we are active with controlling costs, acquisition integration and new product development. Unless specifically discussed, the following comments in our guidance exclude any impact of the Semco acquisition as Nick just announced. Let me first touch on our operations on a GAAP basis. Nick gave a good analysis of what went on in operations this quarter, but mostly on a pro forma basis which includes all acquisitions as if we owned them on a comparable basis. I will provide a little more color on a few more specific items in our reported GAAP numbers.

Third quarter net sales were $214.2 million, up $24.3 million or 12.8% from the prior year. The increased sales growth includes $20.9 million that was a result of the acquisitions of Acme and the [Woodward] product line made in fiscal 2009, and Duke's Aerospace which was acquired in the first quarter of fiscal 2010. On a positive note, organic sales also increased by $3.4 million. The is the first positive growth in organic sales after five consecutive negative quarters. The organic growth was led by an increase of $7.2 million in commercial aftermarket sales due to improved demand in the commercial aerospace market across most of our product lines. Partially offsetting the increase in organic aftermarket sales was a modest decrease of $3.6 million of commercial OEM sales and a slight decrease of $1.1 million in our organic defense sales.

Reported gross profit was $122.4 million or 57.2% of sales. The reported gross profit margin increased by 0.4 percentage points versus the prior year. Strong organic aftermarket product mix plus a modest nonrecurring contract pricing adjustment more than offset the dilutive impact of 1.7 margin points from the previously mentioned acquisitions this quarter.

Selling and administrative expenses were 10.9% of sales for the quarter, an increase of $4 million or 0.7 margin points greater versus the prior year. This increase, which is consistent for the entire year, is primarily due to the following items -- higher research and development expense primarily related to the Airbus A350 and A380 platforms, some higher professional and new business development expense, and incremental selling and administrative expenses related to recent acquisitions and some other minor items. We expect our fourth quarter run rate to be a little less and should finish the year a little bit above 11% of sales, which includes $1.4 million of acquisition transaction expenses now required to be expense under the FAS 141R rule. Amortization of intangibles was about $0.5 million higher versus the prior year. This line item reflects all recent acquisition activity.

Net interest expense was $28.2 million, an increase of $7 million versus the prior year quarter. This increase was primarily due to interest expense of approximately $9.4 million attributable to the successful first quarter senior subordinated note offering. Partially offsetting the increase was lower interest rates on our term loan on our senior secured credit facility. The average interest rate on our total long-term debt was approximately 6% for both the current and the prior quarters. Our effective tax rate was 34.4% in the current quarter and 35.3% for the prior year quarter. The slight decrease this quarter was primarily to due to favorable adjustments to income taxes applicable to the year ended September 30, 2009. Our full year effective tax rate will be in the range of about 35.5% to just under 36%. This does not include any reinstatement of the R&D tax credit for fiscal 2010.

Net income for the quarter was $44 million, which is 20.5% of net sales and up $2.6 million or 6.3% versus the prior year quarter. These results reflect a combination of all the items just discussed. As a reminder, in the first quarter, TransDigm determined that the two class method of calculating EPS was the proper GAAP accounting treatment instead of the more commonly used treasury method. This morning's press release includes several tables. Please reference tables three and four, which shows the calculation of the two-class method of EPS.

For the quarter, our adjusted diluted EPS was $0.88 on 52.9 million diluted weighted average shares outstanding. This represents a 6% improvement over the prior comparable quarter. Remember that the application of the two-class method as compared to the treasury stock method requires the inclusion of approximately 2 million additional shares outstanding for the quarter. This results in dilution of earnings per share by approximately 3% to 4% on a fully diluted basis.

Cash flow from operations was solid at $155.3 million for the first nine months of fiscal 2010. We ended the quarter with $258 million of cash on the balance sheet and, as a reminder, this cash balance reflects the Duke's acquisition for which we paid $96 million in cash. Our net debt leverage ratio was 3.8 times our pro forma EBITDA as defined. Given the current credit market, we believe our current cash position, together with our undrawn revolver of almost $200 million, is more than adequate for our operating needs.

As Nick discussed and is spelled out in this morning's press release, we have made some modest changes which includes tightening our revenue band a bit, tightening the bottom range of our guidance, plus improvements in interest expense, taxes and depreciation versus our previous forecast. Our full year adjusted diluted EPS guidance now has the impact of increasing the mid-point of our guidance to $3.22, up $0.12 from the prior guidance. Now, let me hand it back over to Jonathan.

Thank you, Greg. In order to give everyone the opportunity to ask questions, I would ask that you limit your questions to two per caller. If you have any further questions, I would ask that you re-insert yourself into the queue and we will answer those questions as time permits. Operator, we are now ready to open the line.

(Operator Instructions) First question comes from the line of Fred Buonocore with CJS Securities. Please proceed.

Good morning, gentlemen. Nice quarter. First question relates to the defense market. Nick, are you actually seeing any signs of a softening or anything that would lead you to believe that we should see more and more of a slowdown as we go forward, or is this just your continued cautiousness?

Primarily continued cautiousness. Actually, the third quarter is better than we expected, but I don't know that you can draw a lot of conclusions. It's continuing -- I don't see a whole lot of good things on defense spending and it's been running hot, same way I've talked about this before. So I view it more as my ongoing caution than the fact that I have any other specific data.

Sure. And on the aftermarket you guys seem to have a more favorable view on that piece of your business than several of your peers have which have been saying that things are kind of still sluggish, not really picking up. You're certainly seeing more improvement there. Can you give us a sense for maybe why? Is it just your breadth of platforms that you're on or--?

It's hard for me to comment on somebody else's comment.

Sure.

Without knowing what the background or the data is there. I will tell you I'm not ready to pull the alarm and say its time to start the party yet. If you look month to month it's still spotty, but on balance our quarter has, as you see, have been moving up and the incoming orders seem to be hanging in reasonably well, but it's not just a continually increasing line. I mean, it's still a little spotty.

Okay. Fair enough. Thank you.

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

Good morning, guys. On the commercial aftermarket, is there -- a nice number there, up 12%. Is there a big difference between sort of what the biz jet side of the market grew versus large commercial transport?

Yes, the -- I don't have the number here in front of me, or maybe I do. I believe -- I'm pretty sure there is. Just a second, let me look real quick here. Yes, the commercial transport is up much stronger as a percent. Now, remember, the commercial transport makes a far, far higher value than the biz jet.

Right. No, no, I understand. I just wanted to make sure there was a--?

The biz jet is just up very modestly.

Okay. Great. And, Nick, on the defense side you said sort of the strength in the biz jet side of the business exceeded your expectations. Could you give us some idea where is it coming from, helicopters, ground vehicles, fixed wing aircraft?

Well, not ground vehicles. Ground vehicles are doing poorly. Helicopters are doing well. I would say helicopters are at the high end, ground vehicles are at the low end, and the fixed wing stuff is kind of in the middle. The quarter was better than we expected, and there's no -- both the bookings and the shipments were better than we expected, but we still remain wary of it. We're right now running just about even year-to-date booking to shipment which is not what we were doing prior to this quarter, as you know.

Greg, can you just give us the cash flow from ops number real quick again and is there a CapEx number?

From cash flow from ops, I believe that was $155 million nine months into it, and the CapEx year-to-date -- give me one second. Does somebody have the cash flow in front of them? It's within the range. I don't have it. $9.9 million year-to-date.

Thanks a lot, guys, and good quarter.

Thanks.

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

Good morning. Thanks for taking my call. Defense, I want to drill down a bit there. Can you help us understand the correlation between your comments on defense budgets and your outlook for defense? And while there is certainly risk on new gold-plated platforms, I haven't heard anything to suggest that say, for example, the 130, the Blackhawk and the F18, three of your top 15 platforms are seeing any cut back in spending. In fact, there was news yesterday that -- somewhat dated, but it said that JSF delays could certainly increase F18 service lines. So given the intense utilization in Iraq and Afghanistan and your concentration on these platforms, I would think that you guys would have very bright prospects in defense. Can you help me out on that?

I hope that's true. I don't know how else to say. We are -- yes, we have a good C130 position, we have decent F18 positions. I will tell you the ground vehicle stuff is pretty miserable, it is in a lot of our work. You are mostly seeing a reflection of our concern about where the defense spending is going. Our experience has been when it starts to slow down, it kind of dampens down most things. Now, admittedly the C130 is in good shape and we feel good about that, but you're mostly seeing a reflection of our concern. Now, we'll recast these numbers soon -- or not soon, whenever -- we're doing it now, but when we do the 2011 guidance, but I suspect we'll still be somewhat concerned about that and, Carter, I hope you're right. I don't want to be right in this area, I want to be wrong.

So if you look -- defense has been great. Do you think that we've been doing maintenance already? In other words, do you think that we can see a snap back in maintenance, maintenance that was maybe not deferred or not done in the field, or do you think it has already been done? Any idea on that?

I don't think I can answer that. I think it's so platform specific. I think it's very platform specific and I don't think I can give you any generic answer on that. The one thing I can tell you is ground vehicles, particularly things like Bradley fighting vehicles, the demand for repair and overhaul and spares for those are way off.

Great. Just one more question. On the Dukes $60 million earn out. As you sit today, do you think that that provision could still be triggered?

That's over several years and if you look at our Q or our K, our net present value estimate of that is on the very low end of that, under $10 million.

Yes.

Okay. Great.

And we just can't speculate any more than that.

And your next question comes from the line of J.B. Groh with D.A. Davidson. Pleased proceed.

Afternoon, guys. I have a question on this OEM rampup that we're all expecting. When does that really start to pull through on some of these bigger programs? I'm assuming there will be a little bit of margin dilution from that. When does that really start to hit on programs like 777. I know it's hard to given a general answer because you got so many different products.

Yes, the general rule -- we're all over the map. We have some products we deliver just in time to the Boeing factories, literally they pick up every day at the business we have in Seattle. We have other products that go through a couple of layers to get there. We sort of use for our own planning something like six to eight months ahead. Six months is a rough rule of thumb. So if you think the rates will go up at the end of 2011, maybe you start to see a pick up in the middle of 2011.

And then on the margin?

OEM work is lower than aftermarket work, so that's just a question of which grows faster. The OEM is supposed to pick up next year, but most things would indicate the aftermarket may pick up, too.

So they offset each other.

Relative calculation, and it's hard for me to give you an answer other than we'll do a plan for the year, which we're doing now, and we'll look at them both. They're bother going to go up, and we hope they would both go up a little, and the question then becomes what's the relative change in them.

Got you. And on the acquisition, looking at it it looked like the multiple was a little bit on the higher end of what you've been paying. Is that just a trend in pricing, or is it that there's maybe just a little more imbedded opportunity in that particular acquisition in terms of cost savings and the pricing readjustment?

I don't know that I would agree to -- first, we don't disclose the multiples that we pay on them, but I think we have said generally we're paying in the 8 to 10 times EBITDA range for component businesses, and this is in that range.

Okay. Okay. All right. Thanks. Good quarter.

Thanks.

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

Hi. Good morning. Excellent quarter. If I could, I would just like to drill down a little bit into the aftermarkets. I think you mentioned, Nick, in the quarter up 5% sequentially and 12% year-over-year?

Yes.

Are you -- is there any particular--?

Is that -- that was quarter over quarter wasn't it, the 12%?

It was Q3 to Q3.

Yes, Q3 to Q3.

Yes, for the quarter over quarter for the 12%.

Yes.

Can you comment, is there any particular region that you're seeing that is stronger than others or underneath that obviously on the transporter side, anything you can comment to to further break that down a little bit?

Well, this is a general statement based on the revenue passenger miles and the plane utilization. I mean, in general the US North American business is picking up, the Pacific Rrim business is picking up, and the European business is kind of soft.

Okay. And I guess within that, similar to what we see at the demand on the freight traffic side must be particularly strong then?

Yes. Though that isn't a big slug in the volume.

Okay. And I just was curious, you mentioned -- I think you referred to the inventory reduction cycle, and I think you referred to what we're into right now as a capacity squeeze, if I remember well.

Yes.

How do you -- from your experience or in prior cycles, how do you see that playing out over the next, say, few quarters? At what point do the airlines have to start to bring capacity back on assuming we continue to see the kind of travel strength and increase that we're seeing and how does that then start to flow through to your business?

Well, in general what we use is RPM to track our business which is to some degree capacity independent, but in reality the number of planes impacts you some also. I mean typically what they do in the front of an upswing is they try and squeeze more people into the airplanes, and then when the capacity numbers get up to a certain percent, it gets tough to do that, and they have to start to put airplanes on. Exactly when that happen, I don't know, but I suspect the utilization numbers or capacity numbers or the capacity numbers are getting pretty high by historical standards.

Yes, okay. And just--?

Whether it's one quarter, two quarters, three quarters I don't know, but I think it's -- if we see anywhere near the kind of RPM growth that people are talking about, I wouldn't think it would be too long.

Okay. Just one other question on this then. You mentioned as well sequentially, I think you said book to bill running about -- or bookings running about 5% to 10% over shipments. When you -- just from prior cycles, I guess, and prior history, as that capacity starts to come back on-line for your business, sort of what can that ramp up to? I mean, could you see this at 40% to 50% bookings over shipments or is there any way you can help with thinking about sort of the upside opportunity from that standpoint as we start to model the potential implications of the capacity coming back on here?

Yes, I guess -- let me give you directional rather than actual numbers. I mean, historic -- if you take a long-term -- again, I'm going to talk RPM trend because that's what we tend to look at the most. The long-term trends in revenue passenger miles tend to be 5% to 6% a year growth worldwide. Now, what happens there is it overgrows on the upside and it undergrows on the downside of the cycle. Clearly 2009 was the downside of the cycle and some of 2010. If you look at years like six and seven whereas revenue -- let me say -- excuse me, that's the cycle on the RPMs, and aftermarket buys get multiplied on that, too. People tend to stock inventory at the front end when they start to get money back and draw it down in the downturn. In the 2009, 2010 period they were clearly drawing down the inventory. They were ordering across the industry at less than the RPM demand would have indicated and everybody said they were drawing down inventory. I would expect at some point that starts to pick back up and you'll get growth above the RPM level. Now, whether that's 2 points above, 5 points above, 8 points, I just don't know.

Okay. So I guess it sounds like we're very close to entering, if we haven't already, potentially sort of the period of restocking, so to speak?

I don't -- I think I'm comfortable saying we seem to have hit the bottom of the destocking cycle, though I also have to add to that, me and everyone else in the industry have said this about three times in the last year. I don't even think we've hit the bottom of the destocking. We think we have.

Okay. Well, that's very helpful. Thank you very much and good quarter again.

Okay. Thanks.

(Operator Instructions) And your next question comes from the line of Ron Epstein with Bank of America. Please proceed.

Yes. Good morning, guys.

Good morning, Ron.

When you look at the aftermarket, how much of the growth was organic versus acquired?

I think I gave it. I think I gave you same-store sales.

You did?

Yes. But I gave them in that segment. Same-store sales. The numbers I gave you were apples to apples.

Okay. Great. Cool. And then the second question. When you look at the aftermarket, what subsegment of the airplane is doing better? Is the igniter business doing better than the interior bits and pieces? Is it just doing well across the board? I'm just trying to figure out if there's any trend--?

I don't think I can -- honestly, I can't slice the onion that thin. As best we can see, the aftermarket is starting to pick up across the product lines.

Okay. Great. All right. Super. Thank you.

And your next question comes from the line of Michael Callahan with Capstone Investments, please proceed.

Hi, good morning guys. Thanks for taking my questions. I just wanted to ask, again on the commercial aftermarket side, I guess, at the beginning of the quarter, we had a lot of issues with Iceland's volcano. Did you see any impact from that at the end of the day, and did you maybe see the volumes ramp towards the end of the quarter, or was there just no visibility within -- any impact within that?

I can't say we saw much there. We saw a lot of talk in the news, but I can't say that we saw any measurable impact.

So it was pretty steady across the quarter as far as order flow?

Yes, I surely don't know any way to attribute any dollar value or impact to that tornado impact -- or volcano.

I mean, week to week, those sales bounce all around.

Yes, there's more noise -- if you look at our weekly or monthly sales, there's more noise in the raw data than that would interject.

Okay. Fair enough. And then I guess second question on the Semco acquisition. Do you plan to run that through its existing facilities or are you planning to maybe consolidate into some of your other business units?

No, we're planning to run that where it stands. They operate both in Valencia, California, and Mexico, and we plan to run it the way they're running it right now.

Okay. Thank you. That's all for me.

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

Good morning, guys. This is actually Julie for Rob.

I would have never guessed.

Nick, you talked about commercial aftermarket bookings up significantly year on year and then also sequentially. Can you guys quantify that at all?

We haven't quantified it, but the numbers I gave you on comparison to bookings where I said it was to up 12% and sequentially up -- the bookings are up significantly more than that.

Okay. And then was that evenly distributed through the quarter or did the improvement in orders accelerate in June?

I would say the real answer is I'm not sure. My impression is it picked up a little as the quarter went through, but the real answer is I'm not sure of that.

And are you seeing that improvement continue in August?

I believe that to be go-forward information.

Okay. Thanks, guys.

And your next question comes from the line of Greg Halter with Great Lakes Review. Please proceed.

Yes, hello, guys. I think, Nick, you had mentioned that the employment has stabilized the last two quarters but are you seeing any hiring or your employee count up on a year-over-year basis at all?

No, it's pretty much flat. Pretty much flat. It's not dropping anymore, pretty much flat.

Do you envision the need to hire any going down the road?

We'll try and be careful about that. Yes, obviously as the market recovers, we'll start hiring at some point, but we try and be very careful. Our hope is we can come out of a cycle with a better cost structure than we went in which means we have to hire less than ratably as we start to pick up.

And you also mentioned some increases on the R&D side for the [35380]. Are there any specific areas that you can mention that you're working on for that platform or anything else that may be of interest on the new products or solutions side?

Greg, we -- this is Ray Laubenthal. We talked in detail about it on the last call and we thought we'd be repeating ourselves on this call so we didn't, but in general, we're working on the cockpit door security systems on the A350 and A380 and then we have a smattering of other applications across our product lines on those platforms, and also on the last call we mentioned that the spending on the cockpit door module development for the A350 and A380 would be higher in the second half of our year, and that's going as expected.

Okay. Thanks.

Your next question comes from the line of J.B. Groh with D.A. Davidson. Pleased proceed.

Yes, guys, I just had a follow-up on the tightening of the range on the guidance. What were kind of the scenarios that would have had to play out to hit that prior end, was it just maybe aftermarket not snapping back as fast as you gad hoped, even though it was pretty good in the quarter it sounded like?

Didn't change a whole heck of a lot. Didn't the midpoint stay the same?

Yes, the midpoint was up like $1 million but I was just curious.

I wouldn't draw much from it other--.

Okay.

--than we're closer to the end of the year, so we tightened up the band around the middle.

My initial guess was maybe just aftermarket but it sounds like your aftermarket bookings were up pretty strong and -- okay. Thanks a lot.

And your next question comes from the line of Ron Epstein with Bank of America. Please proceed.

Hi, guys, just another quick follow up. What -- how -- what's going on in the marketplace right now, the M&A marketplace. How are valuations doing? Is there much you see out there and how is it?

I would say the -- we're seeing more than we -- than we -- if you roll the clock back a year, there's no question our kind of pipeline and we're cranking out more spread sheets than we were this time a year ago. I would say there have not been a lot of closings, and we'll see whether there are, not just us but in other commercial aerospace businesses, but there's surely more activity, and we'll see whether it turns into more closings or not. I would say I don't see any indication that the prices are dropping. That's for sure.

Okay. Okay. Cool. Thank you.

Thanks.

And your next follow-up question comes from the line of David Strauss with UBS. Please proceed.

Good morning.

Good morning, David.

What are you guys seeing on 787? Talk about maybe what kind of shipping rate you're at and when you expect to see a benefit from a rampup there.

David, the answer is kind of mixed there. When the 787 got delayed and pushed out, our customers, both Boeing and the tiers that feed them, were asking us to deliver, deliver, deliver, don't stop. So we have a smattering across the board of different inventory levels for the 787 already out there. And so that's got to be kind of chewed up before we start seeing a big pick up or ramp up in 787 deliveries.

Okay.

I would also add -- I would also add, David, as far as the go-forward kind of view on that, in the early parts of the production program it doesn't contribute a whole lot of profit, so it -- whether you ship 25 airplanes or 35 airplanes or 52 airplanes, doesn't make all that much difference to us, I mean.

Great. Greg, tax rate, what kind of impact are you looking at if the R&D tax rate does get extended and what do you think as far as a go-forward tax rate as we think about next year? Your tax rate has been coming down fairly consistently over the years?

I think we're at about as low as we're going to get on a run rate between 35.5% and 36%. If the R&D credit comes through, I think we'll have another incremental maybe $800,000 to book.

Okay. Great. Thanks.

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

Yes, just wanted to see if you could maybe give us a little bit better look at Semco and the potential benefits of fiscal 2011, just given, it appears to have pretty significant exposure onto the business jets, and regional jets, and you disclosed like a $38 million revenue for 2009 being a really depressed level. So can you maybe give us a sense for what you might expect as an incremental contribution when you get that deal closed?

Well, first, did we say it was a depressed level?

No. I'm making that assumption.

Okay. I would say we can't -- we'll give 2011 guidance when we give 2011 guidance. So we're not going to do that now. Obviously we buy a business, we think there's a clear path to create value and to generate the kind of equity returns that we seek which generally are kind of 20% IRR on the equity on the deal. So if something isn't meeting that, we probably aren't interested over time. With that, Ray, you might just go through some of the specifics of it, though we're not going to give you a 2011 number.

Right. As with all of our acquisitions, we tend to create value with them by running the businesses a little bit tighter, paying more particular attention to how we price contracts going forward. Semco's products are on a broad range of small to mid-range turbine engines manufactured by Pratt and Honeywell and GE, and those engines are used primarily on helicopters, biz jets and some select regional aircraft, and as the market picks up, those will pick up along with it. So we have our productivity value play, our pricing value play, and we hope to get a little pick up as the volume picks up.

That's both military and commercial, with a fair slug of commercial helicopter work.

Sure. And speaking of volume pick up, just as you look across your different business units, what kind of capacity utilization are you at right now, and do you have the opportunity to take on a lot more volume without really making any additional investments in those facilities?

Clearly coming out of this down turn on prior calls we had mentioned how we'd cut the headcount down I think over the prior seven quarters by about 15%. So we clearly have capacity we created in this downturn, and even before the market turned down we had plenty of capacity for growth. Most of our facilities run single shifts with a scant second shift. So we don't really view capacity as an issue within our facility.

I wouldn't -- this is Nick. I wouldn't expect that our capital expenditures would be out of the range, in the ranges they've been in the past which we typically use numbers like 1.5% to 2% of revenue, and I don't know that we would use anything else as we think about our business now.

Yes. That's a fair point.

Okay. Thanks for answering my follow ups.

Your next question comes from the line of [Milas Wilson] with Deutsche Bank. Please proceed.

Thanks for taking the call. Two questions for you. The first one, on the free cash flow I think you had previously been looking for $190 million, and I'm just trying to interpret it from your comment about $40 million to $50 million run rate per quarter and operating cash flow, we're still looking at that $190 million free cash flow for the year?

Yes.

Okay. And is that a fair way to think about it on a go-forward basis as well? Is there any movement on cash taxes or working capital needs?

No, what we have said in the past, a good way to look at it is, when you look at our EBITDA as defined, about 50% of that should convert to cash over the course of the year.

Okay. Great. And then the other question, Nick, on the defense side, you had mentioned your expectations were flat in 2009. I think you've had some--?

Excuse me. Say that again? Expectation of flat what?

Flat growth in defense in 2010 over 2009. So what is the run rate year to date in growth and what does that imply for declines in 4Q?

I think I would tell you that we just stick with our about flat for the year. If you have the numbers, you could back into that.

Yes, just looks like a pretty steep decline.

As I sit here, I just don't know it without trying to do the math quickly.

Okay. But you -- you have done the math, so you are looking at that steep decline, it's more or less just on that land based segment than it is on the air base?

No, I didn't say that. I just said land based segment was a segment that wasn't doing well. We are -- we are now, the third and fourth quarter of last year were very strong quarters, too. So the comps get tough.

Yes, yes. Okay. Fair enough. And then did you give what the commercial OEM was year on year in the quarter in terms of growth rate?

Yes, we did. I want to say it was down 7% or 8%, but let me just look at my script or my notes here. Is that right, Jonathan, 7% or 8%?

8%.

8% quarter over quarter it was down. It's roughly flat, down very slightly on a full year basis and about flat sequentially. Commercial transport I'm talking about now. That isn't a lot different.

But just relative to last year's 3Q, I think 3Q last year would have been a relatively easy comp. I'm just curious the lingering weakness you're still seeing on the OEM side. Is there a piece of the portfolio that's seeing it the most?

No. I mean, we're seeing incoming orders. Our orders are in and our customers -- that is just the rate they're taking the shipments. Our positions are where they are. We're, in most cases, the sole source provider, it's so just a function of how the customers place the orders, which platforms are ramping up at which speed and how much inventory they have in the system.

Okay. Good enough. Thanks.

(Operator Instructions) And your next question comes from the line of Eric Hugel with Stephens. Please proceed.

Hey, guys, just a quick follow-up. There was an FAA directive issued I think it was effective early July on fixing defective cockpit doors on a number of Boeing aircraft, I think like MD80s, 37s, 47s, 67s and 777s. Is this anything sort of meaningful for you guys or just sort of noise out there?

This is Ray. I think it's generally noise. We supply for the Airbus platforms the entire cockpit door system that is in a kit, but for Boeing we supply pieces and Boeing is responsible for the whole door -- the whole cockpit door module.

And not all pieces.

And not all pieces, right. If there were an aircraft directive that required an upgrade, that would have flown directly to us and we would have been all over it. I haven't heard anything from our operating units that supply that hardware at all.

There was some upgrade on some of the Boeing strikes a year or two ago.

Yes, a couple of years ago, but if it's now -- and that was primarily in the 73s and aerobodies, if it's now hitting some of the MDs and so forth, the older aircraft so be it, but I don't know if it's of any meaningful volume.

We know we haven't seen any meaningful volume.

Okay. Great. Just thought I would ask. Thanks a lot guys.

And with no further questions in queue, I now would like to hand the call back to Jonathan Crandall for closing remarks.

Thank you. I would like to thank everyone for participating on this morning's call. We expect to file our 10-Q for the third quarter of our fiscal year 2010 no later than tomorrow morning. Thank you.

And ladies and gentlemen, that concludes today's presentation. You may now disconnect. Have a good day.