TransDigm Group Inc (TDG) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2010 TransDigm Group Incorporated earnings conference call. My name is Michelle, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host, Mr. Jonathan Crandall of Investor Relations. Please go ahead, sir.

Thank you, Michelle. I'd like to thank all of you that have called in today, and welcome you to TransDigm's fiscal 2010 fourth 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. It should also be noted that our Form 10-K was filed yesterday, and it too can be found on our website.

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 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 earnings per share to those measures.

With that, let me now turn the call over to Nick.

Good morning. Thanks again for calling in to hear about our Company. I'd like to start with some comments again, about our consistent strategy, the pending the McKechnie acquisition, as well as our current sense of the status of the market -- of the aerospace market, as it applies to our business. To reiterate, we believe our business 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.

I'll summarize again why we believe this. Over 90% of our sales are generated by proprietary products, and around 0.75 of 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 after-market sales. After-market revenues have historically produced a higher gross margin, and have provided relative stability in the downturns.

Because of our uniquely high EBITDA margins, and relatively low capital expenditure requirements, TransDigm has year in, year out, generated strong free cash flow. We pay close attention to our capital structure, and view it as another means to create shareholder value. 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 relatively quickly.

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 methods. 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 after-market content. We have been able to acquire and improve aerospace component businesses through all phases of the cycle. We acquired two businesses in the 2010 fiscal year, including Dukes for about $96 million in Q1, and Semco for about $71 million in September of 2010. Through our consistent focus on our operating value drivers, our clear acquisition strategy, and close attention to our capital structure, we have been able to create intrinsic value for many years through all phases of the market.

As I believe you know, we recently announced execution of a contract to acquire McKechnie Aerospace, subject to HSR regulatory approval, for about $1.27 billion. We don't yet own the business, and we are presently working through the HSR regulatory and financing process. We still anticipate closing this quarter. We have full financing commitments for the $1.27 billion. However, since the debt market is strong, we're evaluating a range of other financing options for both the McKechnie deal funding, and possibly all or part of our existing debt.

Based on our current plans, we anticipate having over $200 million of cash, and about $300 million in an increased undrawn revolver immediately after close. Additionally, we typically generate $40 million to $50 million per quarter in cash. We also expect to have more capacity under our credit agreement, our debt-to-EBITDA will be about six times at close, and as in the past, we anticipate beginning to delever relatively quickly. Since we don't yet own the McKechnie business, and because we may also sell public bonds, we can't say much more at this time.

Now, with respect to our underlying markets, though the outlook is still not fully clarified, we are seeing clear signs of stabilization in many of the markets. In the commercial OEM, industry forecasters and airframe manufacturers continue to be optimistic regarding the commercial transport OEM production cycle. Both Airbus and Boeing announced rate increases on certain platforms, and while we don't know the future, of course, and continue to be somewhat wary of what by historical measures would be an unusually moderate downturn, it does now appear that the rate increases will occur at both Airbus and Boeing. As one indication, we saw full-year and Q4 order rates running about 10% greater than shipments from our commercial transport and regional higher-tier manufacturers.

All of the business jet OEMs implemented significant rate reductions and related inventory decreases in 2009. Though the outlook is mixed by airframe manufacturer, it appears this sector is starting to stabilize. Our full-year 2010 bookings or order rate is running a bit above our shipments.

In the commercial after market, we continue to see positive signs in both worldwide passenger traffic, our incoming orders, and other data. This quarter, we again saw both sequential and year-over-year increases in after-market revenues. We are beginning to feel better about forecasts of a pick up. Incoming orders or bookings for the full fiscal year 2010 ran in the 5% to 10% range above the shipment levels, and the bookings were about 20% above prior-year booking levels.

Indications are that we have hit the bottom of the inventory reduction cycle and capacity squeeze for this segment. For 2010, we saw steady, quarterly, sequential revenue improvements in the commercial after-market. The full year ended about 3% above the prior year on an organic, or sort of same-store, basis.

In the defense market, given the uncertainties around defense budgets, we were not planning on growth in this segment in fiscal year 2010. In fact, we saw slight growth in full-year revenues versus the prior year, although the second half revenues were lower than prior year. The segment can be tough to predict, especially given the current US political winds, and the worldwide geopolitical situations.

Now let me turn to the latest financial performance. I'll remind you this is the fourth quarter and full-year report for fiscal year 2010. Our fiscal year ended September 30. As I have said in the past, quarterly comparisons can be significantly impacted by differences in OEM after-market mix, large orders, transient inventory fluctuations, modest seasonality, and other factors.

In spite of a mixed economy and aerospace market, our fourth-quarter of fiscal year 2010 and full-year 2010 were good. GAAP revenues were up about 13% versus the prior year Q4, and 9% on a full-year basis. Pro forma revenues, that is, assuming we own the same mix of businesses in both periods, is up about 7% on a quarter-versus-quarter basis. This is the second quarter in a row of year-over-year organic growth. On a full-year organic growth basis, the revenues were about flat.

Reviewing the revenues by market category, again on a pro forma or same-store type basis versus the prior Q4, that is assuming we own the same mix of businesses, in the commercial markets, which make up around 70% of our revenue, commercial OEM revenues, the commercial transport OEMs, were roughly flat versus both the prior Q4 and on a full-year basis. This should start to pick up to reflect the increasing airframe production rates, and as I mentioned, the bookings are running ahead of the shipments.

Q4 business jet OEM revenues were up about 30%, versus a very depressed prior year Q4, and down about 30% on a full-year basis. Full-year bookings in this market are modestly ahead of shipments, and well ahead of the bookings the prior year. Commercial after-market revenue was up about 18% on a Q4 versus Q4 basis. This is the best quarter-versus-quarter comp we've seen in a while, but I'll remind you it is versus a weak prior Q4. On a sequential basis, our commercial after-market was up again this quarter, up about 3% versus the prior. And as I mentioned, bookings are running 5% to 10% above on a quarterly and year-to-date basis -- a full-year.

Our defense revenues, the revenues were down about 5% on a quarter-versus-quarter basis, compared to a strong prior year Q4, and up about 4% on a full-year basis. This is better than we anticipated early in the year. Second half defense revenues were about flat versus the prior year, and the incoming orders are running about even with the shipping rates. A few quarters are not necessarily indicative of future trends, especially in defense spending, we remain quite cautious about trends in this area. In total, for the quarter our revenues were a bit better than expected.

Moving to profitability, and on a reported basis, I'm going to talk primarily about our operating performance or EBITDA as defined. The as-defined adjustments were modest. Greg will give a bit more detail. Our EBITDA as defined of about $116 million for Q4 was up 23% versus the prior Q4. On a full-year basis, the EBITDA as defined is up about 10%. EBITDA as defined margin is about 52% for the quarter. On a year-to-date basis, our margin is about 50%. The full-year margin was diluted about 1% by the impact of acquisitions. Mix was positive in Q4, and margins are likely not sustainable at the Q4 levels.

With respect to the acquisitions, we completed two acquisitions in fiscal year 2010, I've already described them, for a total of about $170 million purchase price. Additionally, as I talked before, we executed the contract to buy McKechnie Aerospace, subject to HSR approval. McKechnie produces highly engineered proprietary aerospace components. The company is about 85% commercial, a little under 15% defense, and about 40% after-market. It's a good fit, with clear value-creation potential. We continue looking at opportunities, we have a reasonable pipeline, lots of smoke still, we'll see how much fire. Closings are always difficult to predict. We remain disciplined, and focused on value-creation opportunities.

Now, putting 2010 behind us, and moving on to a little bit of information on 2011. Given the likely closing of the McKechnie transaction in the near future, we are going to delay much of our guidance. We will, however, give some directional indications for the TransDigm business alone, that is without McKechnie. We expect revenues for TransDigm, again without McKechnie, to be up a little over 10% from fiscal year 2010, organic growth makes up a bit over half of this, with the balance due to the full year of acquisitions. This assumes no additional acquisitions in 2011.

We expect our fiscal year 2011 results to be stronger in the second half of the year. Our fiscal first quarter is typically the slowest, and this year will likely be the same, with steady growth anticipated throughout the year. The 2011 EBITDA as defined, as a percent of revenue, is anticipated to be roughly flat year over year. In 2011, we anticipate favorable pricing and productivity, offset by modest acquisition dilution.

Compared to 2010, we are planning on full-year commercial aerospace OEM revenues to be up around 10%. This assumes the rate increases in commercial transport production generally occur as announced, and very modest 787 shipments in 2011. We are assuming no further reduction in the OEM business jet rates.

For commercial aerospace after-market, we are planning on revenue growth in the mid to high single digits, based on worldwide traffic up in the 4% to 6% year over year. We could see some upside here if the inventory levels begin to recover, or traffic returns more quickly.

For defense revenues, we are planning year-over-year revenues to be flat to modestly down. We will update this guidance, and provide a bit more detail around the time of the McKechnie closing. Again, though there is no certainty, we still anticipate closing McKechnie this quarter.

In summary, 2010 was a good year, in spite of a tough commercial market in the first half of the year. For 2011, the commercial market seems in better shape, but in any event, I'm confident that by focusing on our consistent strategy, we will continue to create intrinsic value in good and bad times.

And with that, let me hand this over to Ray Laubenthal, our Chief Operating Officer, to discuss some operating issues in 2010. Ray?

Thanks, Nick. As Nick mentioned, in total we had a good fourth quarter, and a good finish to fiscal 2010. Our operating value drivers and acquisition integration continued to add solid value. Let me explain our 2010 and fourth quarter operational value creation in a little more detail.

In addition to managing operations through a bumpy market, we completed a valve product line acquisition consolidation, and acquired two stand-alone businesses during 2010. The valve product line that we purchased from Woodward Governor was successfully moved from California, and combined with our aerofluid products facility in Painesville, Ohio. This consolidation netted substantial operational savings. The consolidation savings, combined with our product line value creation efforts, have significantly improved the associated margins.

Late in our fiscal Q1, we acquired Dukes Aerospace. During the last three quarters, we have implemented significant value pricing and cost restructuring. We also replaced key managers with talent from our other TransDigm operating units. This new team will continue to expand the product margins, and create real shareholder value.

And as Nick mentioned, just over two months ago, on September 3, 2010, we acquired Semco Instruments, Incorporated. Semco designs and manufactures a variety of engine sensors, engine thermocouples, and related engine wiring harnesses. Semco has operations in Valencia, California, and Nogales, Mexico. Since we acquired Semco, we have launched our value-creation initiatives, including restructuring, and moving high labor content work to their Mexico facility.

Now let me turn the discussion to our other operating units, and their recent value-generation activities. As we have reported in the past, we reduced resources significantly in 2008 and 2009. During the first half of fiscal 2010, we continued to modestly reduce headcount. Then, during the second half of the year, we began to add resources sparingly to our base businesses, as the market started to recover.

However, restructuring associated with our recent acquisitions and related consolidations, have more than offset the market-related increases in our employment levels. Overall, our total employment has decreased roughly 2.5% during 2010 on a pro forma or same-store basis. Going forward, we will continue to diligently control our cost structure, and add resources sparingly as the market continues to recover.

All throughout 2010, our new business development continued to be quite active. We continued to invest in a broad range of engineered solutions for our customers. To give this a little color, I'd like to give a few examples of our larger new business programs. In the commercial segment, we continued to develop new applications, and win new business awards. We are nearing completion on the development work on the Airbus A380 and A350 cockpit door structure, and the associated cockpit security systems. During 2010, we developed a series of complex working prototypes. These units successfully passed a battery of tests, ranging from ballistics, intrusion impact loading, vibration and endurance.

Our expanding expertise in this product category has served us well. We were awarded the cockpit security door module system on the Mitsubishi Regional Jet, and we are negotiating additional applications on other OEM airframers. On the Boeing 787, this year we completed the major development program on the digital flight audio system, and we are wrapping up work on a variety of fuel and hydraulic composite tubing connectors and electrical isolators.

We have also developed several engineered solutions to optimize water capacity and water quality on the Boeing aircraft. On the Boeing 777, we have developed a water-capacity sensor that allows airlines to optimize the water weight carried, and thus provide fuel savings. Boeing is also using this solution on their 747-400ER, and we are exploring opportunities with Boeing on the 737 platform.

We have also developed an ozone-based water purification system that replaces costly and cumbersome chemical water-treatment methods. We are now selling these systems to major airlines for use on their fleets. Additionally, we have developed an energy-efficient LED cabin lighting system that Boeing operators can use to replace their heavier, less efficient fluorescent lighting systems.

In the military segment, as with the commercial segment, we continued to develop new equipment to enhance the capabilities or extend the life of the military fleet. Rotary-wing aircraft projects have been particularly active. On the CH-47 and the CH-53 helicopters, we have been awarded several programs to expand and upgrade the electrical power systems. Some of these power upgrades allow the fleet to add direct infrared countermeasures to the helicopters, while other power applications supply clean frequency power that eliminates radio communication static.

On the Apache helicopter, we are supplying an expanded-capacity fibrous nickel main battery, the battery charger, and the emergency back-up battery pack. We also have been awarded the transformer rectifier units and uninterrupted power supplies on the Global Hawk unmanned aerial surveillance vehicle. And additionally, on the Navy's P-3 Orion, the P-8A, and the EP-3 ARIES reconnaissance aircraft, we won the awards to develop upgraded electrical power units for improved avionics, and increased power availability.

And lastly, on the laser-guided APKWS missile, we're developing the [fin] actuator motors and the positioning encoders. These engineered solutions, and many others I have not discussed, continue to expand our profitable product offering, and add to our future growth.

Now let me hand it over to Greg, our CFO, who will review our second quarter and first-half financial -- I'm sorry, our fourth quarter and second-half financial results in more detail.

Okay. Thanks, Ray, and good morning. I hope everyone had an opportunity to read our press release, which was issued after the market closed yesterday. Nick and Ray did a very good update of our business, the market, and what lies ahead of us. I'll focus on our GAAP results for the fourth quarter, compared to the prior-year fourth quarter, commenting on the major lines with a little more detail.

Quarter four net sales were $223.1 million, up $25.8 million or 13.1% from the prior year. The increased sales growth includes $16.8 million that was driven by the acquisitions of Acme and the Woodward product line in fiscal 2009, and the Dukes and Semco businesses in fiscal 2010.

On a positive note, organic sales also increased by $9 million. The organic growth was led by an increase of $11.3 million in commercial after-market sales, and a modest increase of $2 million in commercial OEM, due to improved demand in the commercial aerospace market across most of the product line. Partially offsetting the increase in organic after-market sales was a decrease of $5.4 million in our organic defense sales.

Reported gross profit was $132.4 million, or 59.3% of sales. The reported gross profit margin increased by 4.4 margin points versus the prior year. Strong organic after-market and OE product mix more than offset the dilutive impact of 1.7 margin points from the previously mentioned acquisitions.

Selling and administrative expenses were 11.4% of sales for the quarter, an increase of $3.4 million or 0.2 of a margin point greater than the prior year. One-third of this increase was caused by a $1.2 million charge for acquisition transaction expenses now required under FAS 141R accounting rule relating to Semco acquisition. The remainder is due to incremental selling and administrative expenses related to recent acquisitions, and some other new business initiatives.

Amortization of intangibles was about flat to the prior year. This line item reflects all the recent acquisition activity.

Net interest expense was $27.1 million, an increase of $7.5 million versus the prior-year quarter. This increase was primarily due to interest expense of approximately $9.2 million, attributable to the successful first quarter senior subordinated note offering. Partially offsetting the increase was a lower interest rate on our term loan, and our senior secured credit facility. The average interest rate on our total debt was approximately 6% for the current and prior quarters.

Our effective tax rate was 33.5% in the current quarter, and 34.8% for the full year. The domestic manufacturing deduction, or the 199 deduction, and tax deductions related to acquisitions costs more than offset our state tax obligations, giving us an effective tax rate closer to the statutory rate of 35% for the year. We are forecasting our fiscal year 2011 effective tax rate to be 35%. This does not include any restatement for the R&E tax credit in FY 2011.

Net income for the quarter was $50.6 million, which was 22.7% of net sales, and up $9 million, or 21.7%, versus the prior-year quarter. These results reflect the combination of all the items I just discussed.

As a reminder, in quarter one, TransDigm determined that the two-class method of calculating EPS was the proper GAAP accounting treatment, instead of the more commonly used treasury method. Our press release includes several tables. Please reference tables three and four, which show the calculation of the two-class method of EPS.

For the quarter, our adjusted diluted earnings per share was $1.02 on 52.9 million diluted weighted average shares outstanding. This represents an 18.6% 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 two million additional shares outstanding for the quarter, which results in dilutions of earnings per share by approximately 3% or 4% on a fully diluted basis.

Now, let me summarize the fiscal year on a GAAP basis. Net sales increased by 8.7%, to $827.7 million. Reported gross profit increased by 10.2% to $473.1 million, or 57.2% of net sales. Selling and administrative expense increased by $14.9 million, to 11.5% of sales. This increase, which is consistent for the entire year, is primarily due to the following items, higher research and development expense, primarily relating to the Airbus A350 and A380 platforms, some higher professional and new business development expense, and incremental selling and admin expense related to recent acquisitions and some other minor changes, which includes $2.7 million of acquisition transaction expense now required under FAS 141 rule.

Net interest expense increased $27.8 million, primarily due to the interest expense of approximately $37.3 million, attributable to the first quarter senior subordinated note offering I mentioned earlier. Partially offsetting the increase was lower interest rates on our term loan, or our senior secured credit facility. Net income was $163.4 million, which is 19.7% of net sales.

GAAP full-year earnings per share under the two-class method was $2.52 per share, compared to $3.10 per share a year ago. The current year includes a $0.57 per share charge for the dividend equivalent payment previously discussed. Please refer to table four in the press release, which has a full reconciliation. On an adjusted basis, earnings per share under the two-class method for fiscal 2010, was $3.35 per share compared to $3.29 per share a year ago. The increase in interest expense mentioned earlier diluted year over year performance. For fiscal 2011, we anticipate approximately $3 million of dividend equivalent of payments will be made in the first quarter.

Switching gears to cash and liquidity, the Company generated $197.3 million of cash from operating activities during fiscal year 2010. This represents 121% of our net income. We closed the year with $234 million of cash on the balance sheet, a net cash increase year-over-year of $44 million. This increase includes the use of $167 million of cash for the two acquisitions made during the year. The Company's debt leverage ratio for fiscal year 2010 was approximately 4.3 times our EBITDA as defined.

Now, let me hand it over to Jonathan to kick off the Q&A session.

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

(Operator Instructions). Your first question comes from the line of Myles Walton from Deutsche Bank. Please go ahead.

Thanks, good morning, and good quarter. I was wondering if you could touch a little bit more on the margin performance -- the gross margin performance in the quarter, and also your comment that fiscal 2011 margin performance for the full year would be roughly flat year on year. Just given the performance improvements we've seen throughout this year, it's surprising that the dilution from the acquisitions would offset what you've achieved. And why we wouldn't see some margin improvement into fiscal 2011. If you could just talk a little bit about if there's anything specific in the quarter, or anything more than acquisitions in 2011.

Well, in the fourth quarter, everything just fell into place perfectly. We had very good after-market mix, and then within OEM, we had very good OEM mix also. Our biz jet for the year was down, I think in the high 20%s. But for the quarter, it was up in the single digits, which gave us a good OEM mix. And again, we just clicked on all cylinders in after-market product mix, and we had good operating performance for the year.

That was your first -- the first part of your question, Myles. What was the second part again?

The second part is translating that into your fiscal 2011 comment that year on year, it would be roughly flat. I just would imagine the gains you made in the last half of the year would fall through for the full course of next year . Is there a mix issue, or anything --

I mean, this is a -- ultimately, what happens -- this is Nick answering. What happens in 2011 -- .

I could tell.

Yes, we'll get our price. We'll get our productivity. We'll get a little down drag, some from acquisitions, and it ultimately becomes a judgment on what the mix is. If the defense drops -- defense is pretty good margin stuff, if it drops, that drags you down. If the OEM picks up faster than the after-market, that pulls you down. If the after-market picks us up more, that pulls you up. So it's ultimately a call on the mix. I think we're hopefully somewhat conservative.

Okay. My other question was on McKechnie. It has a 40% after-market mix today, but I'm curious what you think the model will look like a couple years from now, as you sort through the channels that it should serve -- just kind of proportionally, does that mix change significantly?

We don't own the business yet, so I'm reticent to talk a lot about it. But I would say we think we can probably move the after-market mix up over time. And I think that's about the most I'm willing to say on that.

Okay, fair enough. Thanks, guys.

Your next question comes from the line of Carter Copeland of Barclays Capital. Please go ahead.

Morning, gentlemen. Nice quarter.

Thanks.

Quick question. I know you can't talk a lot about McKechnie, but as you look back over the number of deals you've done over the past decade or more, it would seem that ATI is a similar sort of acquisition to look to as a kind of reasonable example, a bit larger size, some different product lines to grow into, margins that were more mature. Is that the type of acquisition we should be looking to as a kind of example to think about how McKechnie might go?

I think that's a reasonable way to look at it. We thought that was a good deal with good returns, and we think this one is the same. Carter, I suspect if you just took absolute percent returns, you probably don't make as much percent upgrade on a good one that's performing well as a small one that's not performing well. But in absolute dollars, this should be very significant.

And remind me -- .

Absolute dollars of accretion, if you know what I mean. Of share value accretion.

Understand completely. I'm just wondering, where -- and where did ATI get in terms of margin relative to the TransDigm average?

I don't think we disclose that, do we, Greg? But it moved up. I think when we announced it, we said it should be a TransDigm kind of business, and I think we're still comfortable with that.

Great. And then one quick one for Greg, on the tax rate guidance of 35%, will that change materially with McKechnie?

I don't think so.

All right.

From what I (inaudible) right now, but when we get into the details, we'll give you better guidance with that.

Great. Thanks again, guys.

Your next question comes from the line of Eric Hugel of Stephens. Please go ahead.

Hi, good morning, guys. Good quarter.

Thanks.

Good morning.

Can you give us some of the breakdown by sales, sales by market in fiscal 2010, for the defense, OE after-market, commercial OE, and after-market? Do you have those numbers?

Jonathan, do we have that? I forget what we published on that.

Yes, it's in the K.

The answer is, we have them but we don't memorize them.

I tell you what, while he's looking it up, I'll start to babble.

Well, I have another question here in terms of the nice growth in terms of the after-market up 18% year over year, biz jet is in there, though. Was that sort of a headwind? So if you think about large commercial, it was up higher?

In the after-market -- .

Yes, biz jet isn't a -- .

It's not a big number in after-market.

It's a small number.

They don't do the flight hours like the commercial transport.

Okay. And I guess, maybe lastly, while waiting for the answer, did you see in the after-market any sort of difference in sales through distribution versus direct to airlines?

Not that I can recall. I don't think it's significantly different. Another way of asking that, is there a significant inventory change, right, in distribution? I don't think there was a material change.

Okay.

While he's looking for it, I know -- I'll give you about the mix. It's roughly 60% after-market, 40% OEM. That's one way of cutting it. The other way of cutting it is, if you look at the commercial business, it's about 70% commercial, 30% defense. If you take the defense, it's probably -- the defense is probably 20% after-market, 10% OEM. That takes care of that 30% On the 70% side, in the commercial world, it's probably a little over 40% commercial after-market, and the difference is commercial OEM.

Great. Thanks a lot, guys.

That gives you rough numbers. And if we come up with more exact -- and that's pretty consistent. It changes a couple points here and there, but not a lot.

Okay, great. Thanks, guys.

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

Yes, good morning.

Good morning, Fred.

You gave a rough breakout of McKechnie's business in terms of after-market, OEM, defense and such. When you look within those buckets if you will, at the mix of aircraft in there, do you think it's at least reasonable to assume that we can overlay the outlook that you gave for the TransDigm core business market sector growth for 2011 onto the McKechnie business, and come up with a reasonable facsimile of what their growth should look like as well?

Well, I don't want to -- I guess I don't want to back into a guidance number, Fred. I know what you're trying to do.

Darn, I thought I was being more subtle.

I would say, remember, the defense is significantly lower than ours. I would say their commercial OEM business is primarily commercial transport. It's very well distributed across the fleet in the active platforms at Boeing and Airbus, and the after-market is. There's no disproportionate waiting in one direction or another. Maybe a little heavier Boeing than Airbus, but not a lot. I would say they have a particularly good [content] on the 787. How much that comes into play next year, I don't know, but over time that will be a significant factor.

Okay, that's helpful. Thank you for that. And then, just turning to the defense market, can you, number one, remind us how much lead time do you have in your defense bookings to when you ship? And then, the second part on the defense question, is does your flat to down outlook for 2011 reflect some contribution from some of the initiatives that Ray was talking about earlier, or are those longer-term things?

Yes, some of it does. But I will say, Fred, what it mostly reflects is we are very uncertain about the defense as we go forward. And I'd almost say our degree of uncertainty, one of our relevant band around a number we give you, our degree of uncertainty is probably larger than any new program might be.

Yes.

So I think I'd sort of use the guidance we gave you as -- for your thinking of that number. As I've said before, I think we said for next year flat to modestly down. If you change -- drop the flat and said modestly down, I wouldn't argue with you. If you drop the flat and said modestly up, I wouldn't argue with you. If you said it was up -- way up, I'd argue with you.

Okay.

And then, the lead times for the defense stuff you asked, they vary around with all of our other product lines, between three and nine months. But six months would be a good average number to use.

Got it. Okay, thanks, guys. I appreciate it.

Your next question comes from the line of JB Groh of DA Davidson. Please go ahead.

Good morning, guys.

Good morning.

Nice quarter. I was just wondering if you could maybe parse out the growth between volume and pricing. When I look at the incrementals, which are unbelievable, it makes me think that there is some good pricing in the quarter. Can you maybe discuss that?

First, we don't disclose the pricing. So you have to sort of make your own estimate there. I would say, I don't believe that the pricing in the fourth quarter was materially different than it generally is. The mix was quite good. The pricing may have been a hair better, but not materially better.

Okay, so maybe I rephrase it. Which one of your value driver strategies -- I'm kidding. So the good incremental is explained by mix, as well as maybe some -- ?

Our mix strategy.

Okay, good enough. All right. And then, can you talk about, I've heard from a couple smaller suppliers that there's some concern that airline customers and such have entered this new era of ultraprofessional management, where they are going to -- everything is going to be JIT, and there may never be a restocking of anything, which I find it kind of hard to believe. But I was wondering if maybe you could address what you're hearing from customers on the match between after-market and capacity changes, and that sort of thing?

Yes, let me answer this more generically than specifically. I would say, you saw the guidance we have for 2011, I think we gave you, for the base business. That assumes no significant inventory recovery. I think some year, whether it's 2011 or 2012, I don't know, I think there will be some year that runs ahead of revenue growth, which is another way of saying there will be some inventory recovery. I'm just uncertain exactly when it happens. I'd be surprised if we come out of the down cycle, go through this up cycle, without some couple of quarters or a year where it runs ahead.

Good. Okay, thanks a lot for your time.

Your next question comes from the line of Rama Bondada of Royal Bank of Canada. Please go ahead.

Good morning.

Good morning.

I just wanted to get some more color around what you guys are seeing in the commercial after-market in terms of areas of improvement. Is there any particular product type, like ignition, that's doing better or trending faster than the others?

Ignition was one of the first that picked up sooner than the others, but overall we're just seeing generally a pick up around all of our different after-market products. One or two laggards here or there, but nothing that's material that makes a trend that makes a discussion on today's call.

Okay.

The only thing I'll add to that is -- it sort of smells to us like a rising tide that picks up all the ships.

Okay. And the recovery, is it continuing to be strongest in Asia? Or is -- you're starting to see a little bit of a pick up in North America and western Europe?

I don't know that I can draw -- Asia is always a little better, but the -- we're picking up around the world.

Wherever the planes are, they're being flown.

Okay. And a couple of your peers have pointed to 4% capacity growth as kind of like the over/under on whether airlines need to start bringing back some of these older, less fuel-efficient airplanes. Do you guys kind of see that also, like kind of being the break point? Why would they bring back these less fuel-efficient planes?

I don't know that I can call that. I just don't know that I can call that. I just don't know. Clearly, fuel prices are a driver, as the fuel price drops down, you're more likely to pull those old ones back in. If you take the oil down to $60 a barrel or something, you probably pull a bunch of them back in. I just don't know the answer to that.

Okay. And just to clarify, you said it was 3% organic commercial after-market growth in the quarter?

Against what? That was year over year.

Yes.

Or sequentially?

It was year over year and sequentially.

Sequentially, we're 3%.

Okay.

Both organically -- quarter over quarter was much higher than that.

Okay, thanks a lot.

Those were all organic or same-store kind of numbers.

Got it, great. Thanks a lot.

Your next question comes from the line of Carter Leake of Davenport and Company. Please go ahead.

Good morning. Commercial after-market bookings for the year were up approximately 20%. Could we get the bookings -- this bookings figure for the quarter, year-over-year, and sequentially? Just bookings.

We don't always give them out. We haven't always given them out every quarter, but I'll say the bookings have been running, have been running nicely ahead. Now, by the way, this is comped to a pretty bad year the year before. The flip side of that is that they looked pretty bad through the year, the year before.

All right. Nick, when you speak about go-forward OEM production rates, you still seem to have doubt, or an element of uncertainty on these rates. What drives this caution?

No, I will tell you, everything I see tells me these are real. The orders are picking up. People are turning their lines up. The only thing that makes me a little concerned is that by historical standards, this is a very surprisingly shallow trough. Now, there's all kinds of reasons why that is true. Many of which make sense to me now, but I just, when you see something so far off of the historical pattern, it makes you a little wary. But I don't -- I'd say as I look at it now, we think they are all holding.

And I'm going to go with one more, and I'm not trying to circumvent forward guidance, but in the past you have spoken about a good rule of thumb for free cash flow as 50% of that EBITDA's adjusted number. Is that how we should still think about 2011 free cash flow, as well?

Can I answer that with McKechnie?

Sure.

I don't want to give you that. It will be north of 40%. It will be in the mid-40%.

But that's with the McKechnie.

That's with the McKechnie.

The base business, Greg, I think it's safe to say -- .

The base business is in the low 50%.

We don't see anything different than we ever saw.

No, no.

Okay, great. All right, thank you.

Your next question comes from the line of Jason Rogers of Great Lakes Review. Please go ahead.

Hello. I wonder if you could provide an estimate for CapEx and D&A for fiscal 2011.

The CapEx won't be materially different than our historical run rate. I mean, it's going to be right around 2% of sales, or a little less. There's no major or material projects that have popped up in our planning session.

Okay. And do you have an equity balance for the quarter, shareholders' equity?

Well yes, we do, because we issued the K last night.

The K is out? Okay.

Yes, the K is out.

Okay. And then finally, looking at China, there was an article in the Wall Street Journal about their planes, that they are coming out with competing with Boeing and Airbus. And I was wondering if you can talk a little bit about the opportunity you see in China, either on an organic basis or potentially through acquisitions.

Those planes are active, starting to be developed. A lot of the major system manufacturers in the United States are participating in those aircraft, because China doesn't have the expertise. And our relationships with those system integrators are strong, so we are going along with them on some of those platforms. I would say there's not a whole lot more to say about it, other than that they are in the early stages.

I think the numbers they -- I saw that article, too. Didn't they say shipment sometime 2016 kind of timeframe?

Yes, it was -- .

Yes, I mean, I'm just unable to assess the viability of the program. I would expect the Chinese government would have all the Chinese airlines buy some. How big that gets, I just don't know. We'll have some representation on it if it goes.

Very good. Thank you.

(Operator Instructions). Your next question comes from the line of Cliff Greenberg of Baron Capital. Please go ahead.

Yes, hi, guys. It sounds like the biz jet business is coming back strongly. How much of the business now is Dukes, and how is that doing compared to your legacy business. Are you happy with that acquisition now, a year later?

I would say yes, we are happy with the acquisition. We fully anticipated the business jet cycle when we went into it and bought it. Cliff, I might take issue with you that it's coming back strongly. I guess I would -- the most I'd probably say at this time, and particularly for the OEMs, is it's not getting any worse.

Okay.

And maybe there's some slight glimmer.

Right.

But I don't know that I would feel very comfortable that it's coming back strongly yet.

Okay.

Our comp that we gave was off of the lowest number in 2009. The fourth quarter 2009 was where the shipments tanked.

Full year is down. We think it's about stabilized. But Cliff, if you look at the different manufacturers, it's not necessarily stabilized across every business jet manufacturer.

Right, okay.

You have a follow-up question from the line of Eric Hugel of Stephens. Please go ahead.

Sure. Can you guys give us any visibility -- what are your assumptions, as we look forward into next year, for your pro forma, net income, and EBITDA adjustments?

Given the acquisition with McKechnie, we haven't finalized all the purchase price accounting, so I'm hesitant to give that out -- .

But ex-McKechnie, just sort of the base business. Is there some level that we should be expecting?

Well, we assume no acquisitions in our forecast, so where we list the backlogs, those amortize over 12 months on backlog, and inventory purchase accounting, and the other pieces of the amortization where the assets are in the K will go their normal life. I don't have the number in front of me.

Okay, fair enough.

There's no big discontinuous event or anything like that.

You'll have big dropoffs tied to inventory and backlog. Once you're done with that, then it takes a longer life, to get those out.

And then the other issue we have here is we don't exactly know what our capital structure is going to be. As I think I told you, we're trying to evaluate how much we're going to refinance part of this deal.

Okay. I guess, the second question would be, I remember with regards to Dukes, there was a fairly sizable potential earnout to -- that the prior owners could earn, and it was primarily based on, you guys were arguing over growth expectations for the biz jets. Was there any impact there? What's sort of the timeframe of that potential earnout? Was there any material impact there?

It's a four-year earnout, and in the purchase agreement it was pretty sizable, it was a $60 million earnout there. In our valuation of it, last year and this year, we still have -- we have a liability booked for $8 million.

Okay.

So far, we've paid nothing.

We've paid nothing, and so, even though the agreement was there, it was pretty aggressive growth. And so, as I said, we have $8 million accrued for, as we speak.

What did you have accrued when you first set that -- .

$8 million. We haven't changed it. It's only been one year. So we started it out of the box at $8 million, and we still have it at $8 million today.

Okay, great. Thanks a lot, guys.

If there are no further questions, I would now like to turn the call back over to Jonathan Crandall for closing remarks.

As a point of clarification, sales by market for fiscal year 2010 is as follows, commercial OEM, 23%, defense OEM, 16%, other OEM, 1%, for total OEM of 40%. Commercial after-market, 40%, defense after-market, 18%, other after-market, 2%, for total after-market of 60%. These items can be found in our 10-K.

With that, I'd like to thank everyone for participating on this morning's call. Have a good day.

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