TransDigm Group Inc (TDG) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quarter 3 TransDigm Group Incorporated earnings conference call. My name is Carolyn, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes. And now I'd like to turn the call over to Liza Sabol. Please go ahead, Liza.

Thank you. I would like to thank you all for calling in today, and welcome to TransDigm's fiscal 2012 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 web site, 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 web site, or through the SEC's web site. 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 related to 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, and thanks to everybody for calling in to hear about our company.

Before I get into the quarterly results, I would like to just talk about one tragic event that occurred in Q3. Al Rodriguez, our head of M&A, passed away suddenly at 51 years old. Al was a significant contributor to the Company since the formation of TransDigm. We lost a business partner and a good friend here.

But moving on, Bernie Iversen, another long-term member of our senior management team who has also been with us since the formation of the Company, has taken over the M&A position. Bernie's had a broad range of operating positions at TransDigm at a number of different locations. He was most recently a group Vice President -- a group Executive Vice President in charge of a number of our operating units. Bernie's been involved with many of our acquisitions, which will facilitate a smooth transition in his role. Bernie hits the ground pretty well running here.

Now with that behind me, I'd like to review our consistent strategy, our current sense of the status of the aerospace market as it applies to us, and a few miscellaneous items. To reiterate, we believe our business model is unique in the industry, both in its consistency and in its ability to sustain and create intrinsic shareholder value through all phases of the aerospace cycle. To summarize some of the reasons why we believe this, and these are highlighted on page 4 of the slides, about 90% of our net sales are generated by proprietary products and around 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 aftermarket sales. Aftermarket revenues have historically produced a higher gross margin and have provided relative stability in the cyclical downturns.

Because of our uniquely high EBITDA margins, typically in the range of 50% of revenue, and relatively low capital expenditure requirements, typically less than 2% of the revenue, TransDigm has year in, year out generated strong free cash flow. We pay close attention to our capital structure, and we 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 sub-optimum for value creation. We typically begin to deleverage pretty quickly. Based on the credit markets, our near term cash needs and potentially near-term acquisition candidates we address our liquidity and capital structure regularly.

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 methodologies. This consistent approach has worked for us through up and down markets and allowed us to continuously improve and increase the intrinsic value of our businesses while steadily investing in new business and platform positions.

We also have been successful in regularly acquiring and integrating businesses. We acquire proprietary aerospace businesses with significant aftermarket content. We have been able to acquire and improve proprietary aerospace businesses through all phases of the cycle. Through our consistent focus on our operating value drivers, a clear acquisition strategy and close attention to our capital structure, we've been able to create intrinsic value for our investors for many years, through up and down markets.

The just completed quarter was active, with some cleanup divestiture issues relating to the AmSafe acquisition. We now have agreements to sell two small non core businesses with 2011 EBITDA of about $3 million to $4 million in total. It appears at this time that the market price is not sufficient for us to sell, the AmSafe ground transportation business. To remind you, the 2011 EBITDA was about $5 million for this business. We believe we can improve the business and over the next year or so, possibly remarket it. After about six months of ownership, we continue to be comfortable with our ability to increase the value of the core AmSafe aerospace business through a mix of all three of our usual value drivers. Though again, I don't know that this business can achieve an EBITDA percent as high as the TransDigm average, we still see significant upside, at least as good as our acquisition assumptions.

At June 30, we had about $300 million in cash, about $300 million undrawn revolver. We expect to generate over $100 million in additional cash in the last quarter of fiscal year 2012. We also have additional capacity under our credit agreement. We estimate our gross debt to EBITDA ratio on a pro forma basis at June 30 is about 4.5 times and our net debt to EBITDA ratio is about 4.1 times. As in the past, absent acquisitions or other capital market actions, we will continue to delever. We currently anticipate the fiscal year-end leverage to be about 3.9 times on a net basis, assuming no additional actions are taken.

With respect to our underlying markets, the markets are a little bumpy, but in aggregate at this time still appear to support our full year guidance. The commercial markets are generally positive. The defense market, though less clear, is still holding up better than we originally expected, and roughly in line with our prior guidance. In the commercial OEM market, industry forecasters and airframe manufacturers continue to be optimistic regarding the commercial transport OEM production cycle and backlog. The rate increases are proceeding at Airbus and Boeing, and revenues continue to reflect that. The 787 schedule is still not quite clear, but it won't materially impact fiscal year 2012. On a positive note, there now appears to be more predictability in the 787 airframe shipments. We will likely see a period of inventory sorting out before our 787 shipments track airframe shipments. In total, our full year commercial transport OEM business jet revenues on a pro forma basis are expected to be up in the high teen percents versus last year.

In the commercial aftermarket, we continue to see growth in worldwide passenger traffic, though a bit spotty and somewhat muted. To remind you, last year our commercial aftermarket was up almost 25% on a year over year basis. This was not a sustainable level or growth rate. This quarter, on a pro forma basis, we saw an increase over both our prior year fiscal year Q3, as well as sequentially versus the current year Q2. I'll review the specifics later in this presentation. We are watching this carefully. The commercial aftermarket is a bit bumpy and not consistent across our businesses, and the revenue comps are tough in Q4.

In the defense market, though there are still major uncertainties around defense spending, we now anticipate the defense revenues to be up modestly in fiscal year 2012. Despite the first three quarters being better than we anticipated, we remain cautious. As I mentioned regarding commercial aftermarket, the revenue comps are tough in Q4. Military revenue can be tough to predict, especially given the current US political winds and the worldwide geopolitical situation.

Now let me turn to our latest financial performance. I'll remind you this is the third quarter of fiscal year 2012. Our fiscal year started October 1, 2011. And I have said in the past, quarterly comparisons can be significantly impacted by differences in OEM aftermarket mix, large orders, transient inventory fluctuations in the system, modest seasonality and other factors. Our third quarter fiscal year '12 is another good quarter. GAAP revenues were up about 42% versus the prior year. Organic revenue growth is up about 10% on a quarter versus quarter basis and 14% on a year-to-date basis.

Reviewing the revenues by market category -- and this is on a pro forma basis versus the prior year, and much of this is on slide 5. And by pro forma, I mean assuming we own the same mix of businesses in both periods. Again, these pro forma comps do include the two most recent acquisitions, Harco and AmSafe.

In the commercial aftermarket, which -- or the commercial markets, which now make up about almost 80% of our current revenue, the commercial percent has been rising recently as a percent of our total business. In the OEM market, revenues were up about 16% versus the prior year Q3 and 24% on the year-to-date basis. Commercial transport OEM and business jet OEM revenue percentage growth both slowed a little in Q3. The picture was mixed by product lines, but the primary unfavorable factors included 787 overstock and finishing delays, minor 380 delay impact and some disruption from the Harper bankruptcy. Excluding the impact of the retroactive contract settlements, the increase in our commercial OEM business was approximately 20% on the year-to-date business.

Moving now to the commercial aftermarket. Commercial aftermarket revenues were up about 6% on Q3 versus Q3 basis, and up 10% on the year-to-date basis. The revenues were up modestly sequentially. Though the specifics are still unclear, anecdotally there still seems to be indications of inventory trimming and a generalized economic concern by many airlines. I can't at this time quantify this specifically.

A few additional bits of color on the commercial aftermarket. The total commercial aftermarket bookings ran slightly ahead of revenues on a year-to-date basis, and they were roughly even in the Q3. The business jet and GA aftermarket was down slightly in the third quarter versus the prior year third quarter. The commercial transport aftermarket revenue was up about 7% versus the prior Q3, but again was spotty across our operating units and product lines. To date, we have seen little, if any, 787 aftermarket orders or shipments. We are watching trends here very closely. The macroeconomic conditions are, of course, concerning.

In the defense market, which now makes up a little over 20% of our current revenue, the defense picture, again, continues better than we expected. The revenues are up 7% on a Q3 versus prior Q3 basis. On a year-to-date basis, they're up about 5%. Incoming orders are slightly ahead of the shipping rates on the year-to-date Q3. We'll see how this plays out. As I said, the military picture is not as clear; and for obvious reasons, we remain cautious. In total, for the revenue -- 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. The major as defined adjustments are made up of acquisitions and stock option expenses. Greg will review various other items on the income statement in his portion.

For Q3 our EBITDA as defined of $217 million was up 34% versus the prior Q3. The EBITDA as defined margin is 47% for the quarter versus the prior Q3 of 50%. The acquisition mix pulled the margin down by 4 margin points in the third quarter. The year-to-date EBITDA as defined margin is running at about 48% of revenue. There are a number of moving parts that complicate the EBITDA margin a bit, so as I did in the last quarter, just to help understand the year-to-date, if I break it out a little, the base business, including McKechnie, in spite of a modest OEM aftermarket mix down is running at about 50% of revenue. The Schneller, Harco, and AmSafe acquisition dilution pulls it down about 2.5%, and we pick up about 0.5% from the various contract settlements and special items through the year. That totals about 48% of the revenue, that comes to.

With respect to M&A activity, as I said, we've closed two acquisitions year-to-date, AmSafe and Harco, for about $840 million. We continue actively looking at opportunities. In the last two to three months, the pipeline seems to be picking up. We're seeing more activity than we did in the last three to six months. Closings are always difficult to predict. I, as always, can't speak about any specifics, but we remain disciplined and focused on a defined strategy and clear value creation acquisition opportunities.

I'll refer to the midpoint in the following, and these numbers going forward here do not include any future acquisitions. But based on all of the above, we have increased the midpoint of our EPS as adjusted guidance by $0.24 a share. That is, from $6.40 a share to $6.64. This increase is just about half attributable to an improved tax rate. We now expect TransDigm's revenues to be right around $1.7 billion or almost the same as the prior guidance. The 2012 EBITDA as defined is now anticipated to be in the range of $806 million. That's up $6 million from our previous guidance. This is generally fine tuning, as we get closer to year end. On a full-year basis, the EBITDA as defined margin of 58% is roughly made up --

48%.

48%. Back up. The full year EBITDA margin of 48% is made up of the following. The base business, including McKechnie, again in spite of a modest OEM aftermarket mix down, should end somewhere around 51%, and the Schneller, Harco and AmSafe full year dilution should be about 3%, getting us to the 48%.

Compared to 2011, and again on a pro forma basis, we're now planning on full year commercial aerospace OEM revenues to be up in the high teen percent. For commercial aftermarket on a pro forma basis, we're planning on a full year revenue growth in the 8% to 10% range, based on worldwide traffic up in the 4% to maybe 4.5% range, and also the recent softening in the business jet GA market. This implies about a 7% Q4 versus Q4 growth to the midpoint of our guidance here. Obviously, the aftermarket trends we've seen reported around the industry concern us. Our guidance assumes we don't see any significant additional economic softening in the next two to three months. For defense revenues, we are now planning year over year revenues to be up modestly.

In summary, our third quarter continued strong. The markets are a bit tenuous, but seem in total to be supportive of our guidance. In any event, I'm confident that by focusing on our consistent strategy, we can continue to create intrinsic value in good and bad times.

With that, let's me hand this over to Ray Laubenthal, our COO, who will talk a little about some operating items from Q3 and a little about some new business.

Thanks, Nick.

As you mentioned, in total we had a very busy third quarter with good operational results. We were quite busy with acquisition transitions and several divestitures. At our operating units, we also continued to diligently work our value drivers and we continued to create shareholder value.

Let me explain our third quarter acquisition integration and operational activities in a little more detail. Almost six months ago, we acquired the AmSafe businesses. Our acquisition transition work is progressing well and starting to generate real value. To date, we have closed and absorbed the AmSafe corporate office into our own, we have consolidated four AmSafe satellite locations into several of the existing AmSafe locations, and we have also restructured the AmSafe aftermarket process. These consolidation moves and pricing actions have started to expand the EBITDA margins, and we believe we're running ahead of our value creation expectations for this acquisition.

We are now implementing our proven product line structure at AmSafe. Each business now has several product lines. Our product line structure consists of a product line manager who's responsible for the product line P& L and creating real value. Implementing this product line structure at acquisition takes a lot of work. In addition to the product line manager, we form a product line team that's focused on our three value drivers, those being value pricing, productivity improvement, and managing profitable new business generation. We are also applying our proven set of product line metrics that are focused on tracking value creation process. Additionally, we are conducting specific product line training, ranging from negotiating customer contracts, implementing value pricing, driving productivity improvement, and managing and financially modeling new business programs.

At our other recent acquisitions, Schneller and Harco, those are also transitioning well. At Schneller, their Kent, Ohio building expansion is nearly complete. They're on track to consolidate their entire Florida facility into the Kent operations next month. This consolidation will eliminate many redundant operations, streamline production, and improve their cost structure. At both Schneller and Harco, the aftermarket process has been restructured. Other cost reductions have been implemented, and we've also organized these two businesses into our product line structure.

Now let me turn our discussion to our base operating units and their recent value generation activities. Overall, the base TransDigm operating units are performing well. They have diligently controlled their cost structures and have managed resources tightly. They also continue to execute our consistent value focused operating strategy.

Our new business development has continued to be quite active during the past several years. We continue to invest in a broad range of engineered solutions for our customers. And for this call, I'd like to give a summation of our new business content on the three newest commercial platforms, the Boeing 787, the A-380 and the A-350. On each of these programs, we have increased our pro forma ship set dollar content substantially over the predecessor platforms. That is, on a same-store basis, we have significantly more proprietary product dollars on each of these new platforms than we had on the platforms they are replacing. These new business awards not only secure new OEM production revenues, but they also secure our future aftermarket revenues.

To give this a little color, I'd like to give some examples of our content on these new platforms. On the 787 program, we have increased our ship set dollar content by over 60% versus the predecessor platforms. In addition to winning a larger footprint of production applications, we have increased our dollar content as the aircraft's advanced design has increased many of the product's scope and complexity. For example, we're now supplying a broad range of composite products which make the 787 lighter and safer. These products include composite fuel system isolators and hydraulic system isolators, which arrest the propagation of electrical energy during a lightning strike, the complex composite structural elements, which reduce weight and improve aircraft fuel efficiency. And in addition to composites, we are supplying a broad range of latching mechanisms for both internal cabin and external engine applications, the cockpit communication system, which is integrated into the aircraft computer system, the ignition systems for those aircraft, about 50% delivered with the Rolls-Royce Trent 1,000 engine, the seat belts, a variety of which the new air bag technology incorporated in them for added safety, and the luggage and cargo area restraint systems.

On the A-380 program, we have increased our ship set dollar content by over 90% versus the predecessor platforms. Similar to the Boeing 787, we've also increased our footprint and our dollar content, as the aircraft's advanced design has increased the product application scope and complexity. For example, we are supplying the entire cockpit door module, which includes the entire cockpit bulkhead, separation wall, the ballistic door, and cockpit security system, the complex horizontal trim stabilizer valves and control systems, along with the main engine lubrication system and components, a broad range of latching mechanisms and structural elements employed throughout the airframe, and on the complex engine itself. On the engine, we're supplying the ignition system for those aircraft, again about 50% outfitted with the Rolls-Royce Trent 900 engine. And on the interior, we are supplying decorative wall and bulkhead engineered laminates, and the seat belts and the seat belt air bag systems.

On the A-350 program, not all the application contracts have been awarded yet, but so far we've already increased our ship set dollar content versus the predecessor platforms, and we expect this content expansion to well exceed the predecessor platforms once all these open contract bids are finalized. Similar to the 787 and the A-380, we've increased our footprint and our dollar content, as the aircraft's advanced design has increased the products application scope and complexity. For example, like the A-380, we're supplying the entire cockpit door module, which includes the cockpit bulkhead, separation wall, the ballistic door and the cockpit security system. We're also supplying a variety of engine valves, hydraulic system valves, landing gear valves, water system and waste system valves, and a broad range of latching mechanisms and structural elements for both internal and external applications, with many employed on the complex engine. We're supplying the ignition systems for those aircraft, about 50% a again outfitted with the Rolls-Royce Trent XWB engine. And lastly, we are bidding on a significant number of other product applications that we expect to be awarded as the A-350 design work is completed.

These new engineered solutions have increased our content on the next generation of aircraft entering into service, and these three major programs exemplify our advanced technical ability to develop value driven solutions for our customers. It also demonstrates our continued commitment to invest in our product lines and to organically grow our OEM business, and more importantly, secure our future aftermarket revenues.

Now let me hand it over to Greg Rufus, our CFO, who will review our third quarter and year-to-date financial results in more detail.

Thanks, Ray.

I hope everyone had an opportunity to read our press release, which was issued this morning. Before we jump into the details, let me remind you again that we acquired Schneller in the fourth quarter of fiscal '11, Harco in our first quarter of this year, and am AmSafe in our second quarter of this year. The current quarter and comparisons to the prior year are significantly impacted by these recent acquisitions.

Please reference slide 7 for our quarterly financial results. Third quarter net sales were $462 million, up $137 million, or 42% from the prior year. The collective impact of the acquisitions of Schneller, Harco and AmSafe contributed approximately $106 million of additional sales versus the prior period, or just over about 75% of the increase in sales. In addition, our organic growth was almost 10% greater from the prior year. All market channels contributed to this growth. $20 million came from commercial OEM and aftermarket, and $10 million from defense, which was equally split between OEM and aftermarket.

Our reported gross profit was $253 million, or 55% of sales. The reported gross profit margin decreased by almost 1.5 percentage points versus the prior year. The dilutive impact of acquisition mix from Schneller, Harco and AmSafe was approximately 2 margin points versus the prior year quarter. Partially offsetting this was improved margins in our core business, despite unfavorable OEM to aftermarket product mix experienced this quarter.

Our selling and administrative expenses were 12.2% of sales for the current quarter, compared to 9.7% in the prior year. The increase is primarily due to the following. We had a $3 million accrual reduction in Q3 of the prior year relating to an acquisition earn out adjustment. Also, we have a higher run rates of selling and admin expenses as a percent of sales from our recent acquisition, and we had an increase in stock compensation expense versus the prior year quarter.

Net interest expense was $55 million, an increase of approximately $5 million versus the prior year quarter. This is a result of an increase in weighted average total debt to $3.6 billion in the current quarter versus $3.1 billion in the prior year. The higher average debt is due to the additional turmoil related to the AmSafe acquisition made in February of this year. The weighted average cash interest rate on total borrowings at the end of the current quarter is approximately 5.7%.

Our effective tax rate was approximately 31% in the current quarter. The lower rate is due to the following. We had a settlement of an IRS audit for fiscal years '09 and fiscal year '10, and we also made adjustment to the current year, resulting from filing our FY '11 federal income tax return. We now expect our effective tax rate to be between 33% and 34% for the full year.

Net income from continuing operations for the quarter increased $32 million, or 55%, to $90 million, which is approximately 20% of our sales. This compares to net income from continuing ops of $58 million in the prior year. The net income increase of 55% is greater than the increase in sales of 42% due to the following three items. We have leverage on lower interest expense as a percent to sales, we have a lower effective income tax rate, and these two items were partially offset with higher acquisition-related and non-cash compensation costs.

GAAP earnings per share from continuing operations was $1.68 per share in the current quarter, compared to $1.10 per share a year ago, due to the increase in net income from continuing operations we just discussed. Adjusted earnings per share was $1.88 per share, an increase of 55% compared to $1.21 per share last year. The quarter adjustments to GAAP earnings per share were $0.20 per share, the adjustments net of tax, acquisition related expenses of $0.12 per share and non-cash compensation costs of $0.08 per share.

Cash flow from operations was strong, at $258 million through the third quarter of fiscal 2012. Despite using a little over $330 million of cash on the balance sheet to help partially fund the acquisitions of Harco and AmSafe, we ended this quarter with over $300 million of cash on the balance sheet. Our net debt leverage ratio was 4.1 times our pro forma EBITDA as defined. We expect to continue to delever, and the amount projected our net leverage ratio will be approximately 3.9 times our pro forma EBITDA defined at the end of our year, September 30.

Moving to guidance, we estimate the midpoint of our GAAP EPS to be $5.93. And as Nick previously mentioned, we estimate the midpoint of our adjusted EPS to be $6.64. The $0.71 of adjustments to bridge GAAP EPs to adjusted EPS includes the following items. $0.40 for acquisition related expenses, $0.25 from non-cash stock option expense, and $0.06 from dividend equivalent payments.

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

Thank you, Greg. Operator, we are now ready to open the lines.

Thank you, Liza.

(Operator Instructions)

Carter Copeland, Barclays.

Good morning.

Morning.

Two questions. One, Nick, I wondered if you might talk about the environment as we think about the setup here for your fiscal '13. It doesn't look like we've had a year like this during an up cycle where we've seen aftermarket slows since '05, '06. And you guys saw, at that time, a pretty good snap back in organic growth in the commercial aftermarket following that period. Are we setting up for something like this, or do you think we're going to be at this weak level next year, especially given the traffic numbers coming in a little bit better than people have forecast all year long. I wondered if you might help us think about what you're thinking about 2013?

One, Carter, as you know, I can't back into 2013 guidance yet, and it's -- our view on aftermarket gets pretty close to the guidance for the year, probably. The -- but the reality is, we're uncertain. I think this is primarily a function of worldwide economic activity. If you believe we're just in a little bit of a dip or a slowing down, and it moves along sharply again, either as we proceed into the next quarter or after the election, I think you'll likely see some kind of a snap back, like you talked about. But that looks very uncertain to me right now, Carter. I don't know how to call it. As I sit here today, I describe myself as quite cautious.

Can you see anything within the product lines? You said it was bumpy and different throughout the business, but if you look at products that are discretionary versus non-discretionary, are you seeing weakness in discretionary items that would support that conclusion, or is there any data on a more granular basis that helps you get comfortable with that kind of viewpoint?

No. The true answer is, Carter, no. By the way, hopefully all the answers are true, but -- (Laughter). I can say -- and frankly, this somewhat surprised me. As I looked at our more discretionary things, parts, in the last month. And we're in the middle of our business planning review process, so we're looking at detail in all the product lines. Surprisingly they don't look down any more than average, or -- I can't say they're systematically off more, which surprised me, which I don't know what that tells me, other than I don't see a systematic pulling back on discretionary items, particularly at this point.

Okay. Thanks. And one question quickly on the margin. Nick, you mentioned a 2.5 point impact from acquisition dilution and then the -- Greg mentioned 2. Is that just the difference between the quarter and the year, in how you were talking about?

There's two things. Let me answer -- there's two things. For the quarter, I'm always talking EBITDA margins. And Greg was talking gross profit. So for the quarter, the dilution was 4 points on EBITDA margin for the acquisitions. For the year-to-date, it was 2.5 points for the acquisition dilution. Greg's 2 points was gross profit. Greg, am I correct?

Yes, that's correct.

Not EBITDA.

That's correct.

Because also, the SG&A is higher because of the acquisitions, also.

Exactly. With respect to that, if you look specifically at the acquisitions, it would look sequentially, the margins were similar. Did they increase or was there something going on there in terms of your cost efforts in terms of the relocation and whatnot that would cause that to be the case? Can you comment on how the acquisitions margins trended quarter to quarter?

I'm not following the question. You're drawing some conclusion that it changed, somehow, from before?

It looks, per our math, that the sequential -- the margins would have been roughly flat sequentially for the acquired businesses, and I was wondering if that was actually the case per your numbers?

The truth is I don't remember exactly what specifically the acquisitions were quarter to quarter, but I would be surprised if they were flat. Generally, they're moving up.

Okay.

But I can't remember, Carter, what they were the last quarter, but in general they're moving up.

But the G&A weight on them, is that the right G&A going forward?

I suspect somehow we're losing this in a quarter in rounding, or something like that, I suspect.

They are smaller numbers versus the total, but the trend is that they are expanding.

Yes.

Okay. Great. I'll let somebody else ask.

Myles Walton, Deutsche Bank.

Thanks. Good morning, guys.

Good morning.

It looks like the fourth quarter commercial OEM sales, if I've done the math right, implies slowing up to mid-single digit growth. And I know, Nick, you mentioned some of the 787 inventorying. But I'm curious if that amount is right and are there other things driving it, compares and/or 787?

What are you getting when you solve for the fourth quarter?

Mid-single digit growth. If it's 24% year-to-date and up high teens for the full year.

Yes, I would have thought you'd get closer to 10, but yes, it's a little bit slower. I wouldn't -- that is just reflective of what the timing is on different product lines. Generally, we are primarily, in the commercial OEM, if you look at the commercial transport production rates, we're pretty evenly distributed across the miles. We probably run, I don't know, depending on the product line, somewhere between three and 12 months ahead. So maybe six months. So any -- whatever you're seeing is just a quarterly impact. It's just a timing question on shipments. Now, I would say sometime, if things start to flatten out in '14 in the commercial transport growth rate, we'll start to see that sometime in '13.

Okay. That was the first part of the question, because it looks like your implied aftermarket growth is about the same as your implied OEM growth. Maybe it's slightly smaller in the fourth quarter. But it looks like that mix won't be hurting you as much in the fourth quarter. And presumably, your acquisitions will be a little bit better in the fourth quarter. And I think the guidance doesn't imply much of an up tick in EBITDA margins as defined in the fourth quarter. So I'm just wondering if I'm missing anything, or if it's just conservatism?

I think probably the difference in those growth rates is probably too close to call, and it's in the noise level in the quarter, you know, when you look at it over a full year. I think we're trying to get pretty close to what we think now.

Okay. But that implied flat EBITDA margin as defined, about 47% in the fourth quarter versus 47% you did here in the third quarter, any reason that shouldn't be higher, given higher volumes and another quarter of integration?

I think you're in the -- whether it could be a half a point one way or the other, I think you're in -- I think it's in the noise level.

Okay. And one other cleanup one, just a clarification, I guess. You mentioned you had agreement on some divestitures, $3 million to $4 million in sales -- or $3 million to $ 4 million in EBITDA. What's the sales corresponding to that?

Let me not -- I think we probably -- we have confidentiality agreements on that, and I think I've probably said about as much as I can say. Okay?

All right.

But I think, use -- the figure is around $3.5 million of EBITDA. And you can probably figure, they aren't the most profitable businesses in the world or we wouldn't be selling them.

Right, right. Okay. Okay. Well, that's good enough. And then one last one. Sorry. The stock option comp expense is trending higher here. And I know that obviously the EBITDA is growing, but what's the underlying rate we should expect for that stock comp expense on a go-forward basis?

You know, I haven't gone through the '13 guidance yet. But the reason it's going up is a combination of these acquisitions initialing options, and we value them under the black shoal. So just to kind of put it in perspective, in 2010 they were going for about $20 -- or it was valued at about $20 a share. In '11, it was $35 a share. And this year, because of the price of the stock, it's between $40 and $44. But let me remind you, as you know, it's a non-cash charge, just based on expense and stock options.

Okay. All right. Thanks again.

David Strauss, UBS.

Morning.

Morning, David.

Last quarter, you guys gave guidance for, I think, AmSafe EBITDA contribution this year around $50 million. If I take what you said this time in terms of 51% EBITDA margins for the base business, and then dilution by about 3% from the acquisitions, it would imply that AmSafe's running better than that $50 million. Can you give an update to that number?

I don't remember what --

That would be on a GAAP basis right, David?

Yes.

Yes, as I said, the AmSafe businesses look -- and let me put the ground transportation aside for a minute. They look like they're -- we're doing as well, if not, as I said, a little better than we expected when we bought it. I mean, these are -- we're happy with these.

And Nick, where is that upside specifically coming from? Is it pricing, or which of the value drivers, where are you seeing the upside?

All. Obviously, new business isn't kicking in yet. But we're doing reasonably well in pricing, and we're also getting the cost down, pretty aggressively. Greg, how many plants have we closed?

Four, plus the corporate office.

We closed the corporate office plus four facilities, which is a lot of movement in six months.

Have you been able to reprice the entire business, or what percent was -- what percent of AmSafe was under LPAs that you haven't been able to address at this point?

I don't remember, but we haven't -- we're not done there.

Okay. And then my last question. Nick, you talked act that the aftermarket is not consistent across your businesses, you're seeing different things in different businesses. Can you give me some additional color there? Which businesses are outperforming expectations and which are underperforming, specifically on the aftermarket side?

I guess the point I would like to make on that, what I expected to see -- and this is to Carter's question at the beginning. I expected, when we looked at the details, we'd see our more discretionary stuff, which is the minority of our products, would be dropping off much more than the rest of them. I don't see any consistency across it. The discretionary stuff is not reacting substantially different than the non-discretionary, which just says to me, Myles, we're in a bumpy, uncertain market. That's the only conclusion I draw from that now.

Okay. All right. Thanks a lot.

Robert Spingarn, Credit Suisse.

Hello, guys.

Good morning, Rob.

So on the same topic that you addressed, both to David's question and Carter's question, maybe this is a question for Ray, actually. But are you seeing in any categories anything that would explain, any categories or parts, the different growth rates we've seen so far in the results season from the engine guys versus the airframe guys, on the aftermarket? Is it -- is there something going on in the distribution channel for certain types of parts that you're not seeing elsewhere? Is there a cannibalization effect from parked aircraft? Anything you can help us with here?

Robert, I'll echo what Nick said before. We're not seeing any kind of pattern.

I think geographically, though we -- though it's hard to get the data exactly every quarter, but we have a decent idea, obviously the European market is worse than the others. So presumptively, items that were used more heavily in that area are probably down more, but I can't -- I can't put a number around that. But it's hard, as you know, across the world the economic situation is slowing down a little bit.

Do you see much evidence of cannibalization from -- ?

No.

No.

And then, Nick, on M&A you mentioned activity is up. Are you seeing more targets in the pipeline, or is it more about the bid/ask spread narrowing? What's driving it?

As of right now, Rob, we're seeing more in the pipeline.

And how is pricing?

I can't say, because they haven't closed. The real answer is, I'm not sure. But my guess is, things that close won't close at prices substantially different than they did over the last year. Surely, from the outside looking in, watching other deals that have closed, they've still closed at pretty healthy prices.

Okay. And then just a couple quick things. You mentioned a fair amount of activity moving product lines around, reducing the number of plants. Is that driving the higher CapEx we saw in the quarter?

In the quarter, especially -- Ray mentioned the Kent facility, Schneller. We moved it, and they are finishing -- they're putting on a couple thousand square feet, about 10,000 square feet, or more.

More.

Fairly significant building construction job.

Okay. So how should the fourth quarter look on CapEx?

We give guidance for CapEx.

It's so regular --

I mean it's going to be -- we're not going to be way off from where we typically are.

So go back to where you were. Okay.

Think of 1.5 to 2 for the year, and at the high end of that, you'll probably be pretty safe.

Okay. Thanks, guys.

Joe Nadol, JPMorgan.

Thanks. Good morning. On the defense side, another good quarter. And I think perhaps a few quarters ago, if someone had told you that your defense growth would be higher than your commercial aftermarket this quarter, you probably would have been a little surprised. So as you're looking through all that data in your process here, and you look business by business within defense, have you learned anything about why that continues to remain stronger than you expected?

To be kind of (expletive) about it, the government spent more money than we expected. Our product lines are weighted towards helicopters and transports, and not so heavily towards fighters and ground vehicles, where you're really seeing the slower stuff. And they're just holding up better. They're continuing to buy parts and repair services at a rate more than we expected. But mostly focused around, I would say, probably helicopters first and the transport planes second.

And do you have a clear read through in most of your businesses as to whether it's aftermarket or OEM that's driving it? I would imagine, it's probably --

Yes, pretty clear. It sometimes gets a little more confusing in the defense world than commercial, but generally pretty clear. I mean, the OEM rates don't change very quickly or very much, and we know the ship set content, so we can pretty well back in to what's production.

This is really the aftermarket just remaining a lot stronger.

Yes, into the aftermarket, absolutely.

Okay. And then, on the some of the data you gave, Ray, I thought was interesting on the platform by platform basis for the newer commercial platforms. Just a couple questions on that. Those are pro forma numbers I imagine, including the AmSafe and Schneller content on the legacy platforms?

Yes, they are. I think I said in the script on the same-store basis.

Okay. And I mean, clearly -- well, just in listening to the list, obviously, it ran across all your businesses platform by platform. But definitely it seems like a little heavy on some of the newer acquisitions, AmSafe on all of them, Schneller it sounded like. If you had taken this measurement a year or two ago, would those increases have been as high, or have you really targeted that via your acquisitions? Is that a coincidence, or not?

In our prior year's investor days and so forth, we had given an indication of how we were expanding our footprint. And really, I didn't want to have the call go on for another half hour with me mentioning every product line, so we tried to pick a cross section that wasn't heavy in either the new acquisitions or in the existing platforms. We just took a cross section. There's many, many other product line applications I just didn't mention. I was just trying to add color there. But prior to these most recent acquisitions, we had very good success expanding our footprint. And these acquisitions are no different.

Yes, I would say to answer the -- is it systematically or is it just serendipitous that we picked up good stuff on the acquisitions, I'd like to say the commercials -- I believe it to be true, also -- the commercial stuff we have bought in the last year and a half has been a good fresh product lines. And they've kept up and they've been companies that kept up with their products, which means they've kept up with decent positions on the new plat forms.

Okay. All right. Thank you.

Rama Bondada, Royal Bank of Canada.

Thank you. Starting on the margin side, it looks like on the legacy business you've been able to mostly offset the margin dilution from the mix shift over the last couple of quarters here. If aftermarket remains at the current growth levels and you have these Boeing and Airbus production rates go up, do you think you can hold that EBITDA margin of about 50% for your legacy businesses?

Say that again. If the OEM continues to grow faster than the aftermarket?

Yes. Can you hold to these margins?

We will give out the guidance for next year when we give it out. But I would say, it would -- I would be surprised if the difference in growth rates next year between the two was enough to materially impact our margins.

Okay. And then on the M&A side, now that the UTX and Goodrich deal is closed, it looks like there are some parts of Goodrich that UTX is looking to dispose of. Can you comment on the potential there for TransDigm, whether it fits your criterias of acquisition?

They're one of our -- they're one of the companies that we call on all the time to see what they have to sell. We've been following that for six or seven months, and we're hopeful we can see some things come out of there. But it's too soon to tell.

Okay. All right. Great. Thanks a lot.

Noah Poponak, Goldman Sachs.

Good morning, everybody.

Morning.

A few part question on balance sheet utilization and capital deployment. So with the comments on the M&A pipeline picking up, I'm curious, is there anything that's fairly late stage there and it's just a matter of time to close, or is it just early in things popping their head up for the first time? Secondly, at the investor day we started to get the sense that you were looking at a special dividend again, maybe. Is that something that's still relatively on the table or not? And then third part is, you talked about the net debt to EBITDA metric getting to 3.9 by the end of the year. I'm curious just what the current thinking is on how comfortable you are with that, whether or not that's flirting with the sub-optimal balance sheet that you referred to or not.

Yes, let me start. By the time I answer the first question I probably will have forgotten the third, but I'll give it a try. On the acquisitions, I would say we don't -- we can't comment on that, where they stand in the process. We're active. We'll see what falls out. Sometimes things move fast. Sometimes they all die and you end up with nothing. So I just -- I don't know how to handicap that now. The -- what was the next question? Was the next question on the special dividend? I would say, as I've said in the past, you see our leverage drop down into the 3s, you know it's getting into the kill zone for us. I would think, absent any acquisitions of significance, or if we look ahead and we think we don't see any pending, if it gets down into that area, we'd probably very seriously consider doing something with our capital structure. You know, last winter, whenever, November or December, we remember almost in the throes of that, and then this AmSafe came along.

And Harco.

And Harco, together. So we had a need for $850 million, which is always our preference, is to use it that way. I mean, we still believe that this is a company that should be leveraged, and letting the leverage drop down too low is not the way to optimize equity value. But it's a very fact and circumstance-specific call.

Yes. Okay, that's helpful. Thank you. One follow up on the aftermarket. Is the value based pricing model, not in any part of the business specifically, just broadly, is it even a little bit more difficult in a slower growth, generally tougher aftermarket environment, or is it just still humming along normally?

I don't think it's substantially different. I mean, obviously, you get more hand wringing and wailing and gnashing of teeth when the market's tough. But I mean, the fundamental economics don't change.

Okay, and then just one last one for me. You've told us business jet and general aviation aftermarket growth was negative. Just curious what you think of that, or what you're seeing there? Do you think that's strictly the comparison, or do you think the business jet user and buyer is much more stooped now than they were three, six months ago? Maybe just broadly what you're thinking about the business jet market.

First, it's not a big number. It's down, but it's down modestly. But it had been growing steadily, so that was noteworthy to us. I suspect it's just part of the general economic concern and little bit of a feeling of malaise right now. That's what I suspect. I don't know whether it's a one quarter phenomenon. If we see it for two or three quarters in a row, then we'll be getting a pretty good idea. In the general aviation, which isn't a huge part of our business, but impacts it a little, that tends to be impacted by av gas prices, and av gas prices are pretty high for those propeller operators. But that's not a new phenomena, but that's been a phenomena for a little while. But my overall guess is this is just part of the general economic concern we're seeing across things, and I'm sure everyone else is seeing across a lot of industrial businesses.

Okay. Thanks a lot.

Gautam Khanna, Cowen and Company.

Yes. Thank you. Just two --

Can you speak up? We can't hear you.

Yes. Two quick questions, please. Just following up on Noah's question about leverage, given where we are in the cycle and some of the choppiness in the aftermarket, do you have a different level of comfort with the amount of leverage you might put on? So would you be reluctant to go to as high as 5.5 or six times debt to EBITDA, and want to keep it five times or under, or do you have any criteria that you can share with us, given the changing landscape?

Yes, I don't think we'd share a number. I would say, all things being equal, if we feel uncertain about the economy, the number would probably be a little lower than it would when we felt very good about the economy. But I don't know -- in the numbers range, as you've been talking about, I don't think any of those would concern us.

Okay. And could you also talk about in the incoming order rates in the aftermarket in the fourth quarter, have you seen any discernible change in pattern in the month and a week we've had since the close of the quarter? Have things deteriorated sequentially? Have they got stabilized sequentially? Is there any trend you can draw?

I can't really speak to that. I can't really speak to that, at this time.

Okay. Could you talk -- when you think about the fourth quarter, is there -- are you looking for sequential aftermarket stability, or are you expecting that to rise a bit year-on-year?

I think we gave you -- I think we gave you the number. We expect the -- we gave you guidance for the year of aftermarket at 8% to 10%. So if you put the middle point at 9%, say, that would imply a 7% quarter-over-quarter growth from fourth quarter to fourth quarter.

Okay. Yes, I see that here. Okay. Thank you very much.

Carter Leake.

Nick, let me follow up on that. If I put in this commercial aftermarket growth -- if I put in the 8% to 10% number, for sequential growth I get either down minus 4% or up 3%. Does that make sense to you?

I didn't do the sequential. I did the quarter over quarter.

Okay.

I just don't -- it's math. You figure it out. It is what it is.

I just -- so could fourth quarter, could we see a decline as much as 4%? That would be -- that would hit an 8% full year number, based on what we've gotten. Is that something that you could see in the fourth quarter? It could be down that much.

I think we gave you the range as 8% to 10%. So whatever that works out to. That's what we think the band is.

All right. You won't be selling AmSafe. Was that in -- I assume that was not in any guidance, was it?

AmSafe what?

You had said you won't be selling the AmSafe ground piece.

It was included in our GAAP numbers. It it's always been in our GAAP numbers.

The ground transportation business has always been in our numbers.

(Multiple speakers). We're not assuming any cash from the sale.

Okay. Moving to the platforms that you gave us, I appreciate your color. I just want to clear up a couple things. When you speak about the aircraft and the engine content, you do single out Rolls. Perhaps I should know this, but do you only have ignitors on Rolls power?

No we have -- our ignitor, you may or may not know -- GE, there's basically two suppliers of ignitors and ignition systems, ourselves and Unison. GE owns Unison. So that we tend to get the Rolls work. We tend to get the Pratt work, and we tend -- GE on new platforms, they tend to get it. Now on historical platforms, like the CFM56, that's a situation where we're dual sourced, so we share the aftermarket when the CFM56. And each GE engine has a little bit of a different split between it.

And then when you were citing these platforms, you were citing large content increase, for example, the A-380 up 90% versus the -- I think you said sort of prior platforms. What would be the prior platforms we'd be using?

We make -- when we do this, we track this from a -- when we start a program, our program starts and we start investing in it, we make an estimate on what do we think it will replace. So maybe with that one we might say, if it takes a job, it will replace 75% of a 747 and 25% of an A-330, A-340, or something like that. We make some weighted index and then we hold it consistent, and that way, we calculate what our base ship set content is weighted that way, and then we keep measuring it as we go forward. On the A-380, there's a little bit of a disconnect there, because you've got more seats. But even if you -- if you have 90% more content, it doesn't mean you have 90% more content per seat or per body in the plane. But even if you adjust for that, you're still -- I want to say if you adjust for the number of seats, I want to say, Ray, you're still up 20%, or something like that.

Yes, yes.

Do you follow what I mean there?

Yes.

It's a bigger airplane. So if everything was perfect, you'd have more dollars on it.

And you can see in some of the literature where people will plot the number of seats versus the range of the aircraft. And it's a scatter diagram of all the Boeing and Airbus aircraft, and we look at that scatter diagram and we say, what predecessor airplanes are plotted around that aircraft it's replacing. You can get quite academic on how you're going to weight them, but we basically put a stake in the ground and we try to measure it consistently.

And these numbers, 787 up 60% versus -- whether it be a 767 or whatever, is this volume you're telling us, or are you telling us dollar base?

Dollars per aircraft.

Okay.

So they're selling one, whatever -- let's say it was 100% replacement on the 747,which it's not, by the way. It's an index. We're saying if we had $100 on that, we'll have $190 on the 380 as it goes out.

As I look at some of this content, is there -- because some of the composites is nice, but I wouldn't think if would have as much aftermarket as, say, ignitors. Are you telling us these figures today to speak to top line growth? Because I -- this is attractive to that end, but it also could have some dilutive impact in here as well.

I wouldn't draw any conclusion on that. We don't see any reason that the mix of parts that we -- the way we look at it is if we take the mix of parts that are going on a platform and we run it out until sort of a mature point where there's a reasonable aftermarket, we want to be sure that we still got 50% EBITDAs or more. And we don't see anything significantly different here. As Ray said, we didn't go through everything. We tried to highlight the stuff we thought was a little different or we hadn't talked about before. If we have 14 valves in the air system, he didn't go through all the 14 valves and that sort of thing.

Great. Thank you.

Michael Ciarmoli, KeyBanc Capital Markets.

Good afternoon, guys. Thanks for taking the question. Nick, I guess, with your defense exposure, you're clearly not as exposed as some of the other players in the space, but how are you guys going to handle the impact of sequestration when you give your '13 outlook?

You know, you're just going to have to wait until we give the '13 outlook. We're going to collect data, and we'll make our best guess when we get there. We know our ships, we know what ships we're on, we know what the aftermarket demand is by different platforms. We'll keep gathering information and we'll do the best we can when we get there. The truth is, I don't know.

Okay. Okay. Fair enough. And then, most of mine have been answered. If I look at your passenger traffic growth assumptions for the year, 4.5%. I think the recent data implies, ITA saying we're annualizing at 2% growth. Should we look at that correlation, your 4.5% this year, that aligns with your midpoint on aftermarket of essentially 9%. Is that a good multiplier to use, if we're assuming growth next year might be 3% to 4%, can we use that as a good proxy for your expected aftermarket?

I don't know, I think I said 4% to 4.5%, by the way, in the range of 4% to 4.5%. I don't have a good feel for that.

Okay. Perfect. Thanks a lot, guys.

J. B. Groh, D. A. Davidson.

Thanks for taking my call. I think you pretty much addressed how you're looking at channel inventory and that kind of thing, but is there different product lines we can sort of look through the list that's pretty diverse. Are there some products that are more heavily inventoried than other, and maybe more subject to some draw down if perhaps there was a lower capacity in ASM growth next year?

Yes, the answer is yes, there are. As I sit here, I don't think I can come up with a list for you. You know, the ones with that go through distribution probably are a little more risk because they have two levels of inventory. They have distribution level and an airline level. But I don't have a good sense of how much that is.

So when we think about that, what percentage of your products go through distribution and what -- how much is -- what percent's sold direct?

I want to say, if you take the commercial aftermarket, something a little under half, I think, goes through distribution.

Okay. That's helpful.

But even that's a -- depending on the product, they have different stocking requirements. Some have very low stocking requirements. Some have longer ones, depending on lead times and things like that. As a general rule, that's probably a little more susceptible to fluctuation than the ones that aren't.

Okay. And did I miss a backlog number or does that just show up in the Q?

We show it in the Q, yes.

Okay. Thank you.

Does it show up in the Q, or just the K?

The Q.

Okay. Thanks.

We have no more questions in the queue.

Thank you. I would like to thank you all for participating in this morning's call, and we expect to file our third quarter 10-Q tomorrow.

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