TransDigm Group Inc (TDG) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2013 TransDigm Group Incorporated earnings conference call. My name is Allison, 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 this conference.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes.

I'd now like to turn the call over to Ms. Liza Sabol, Investor Relations. Please proceed, ma'am.

Thank you, Allison, and welcome to TransDigm's fiscal 2013 second-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 be also noted that our form 10-Q will be filed tomorrow, and also 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 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.

I will now turn the call over to Nick.

Good morning, and thanks, again, to everyone for calling in to hear about our Company. Today I will start off with some comments, as usual, about our consistent strategy, and then I'd like to talk a little about the status of the commercial aftermarket, our operating margins, and then go into a review of the second quarter and an update on the 2013 outlook.

To restate, 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 cycle. To summarize some of the reasons why we believe this -- and this is on page 4 of the slides -- about 90% of our net sales are generated by proprietary products. Around 75% of our net sales come from products from which we believe we are the sole source provider. Excluding the small ground transportation business, about 50% of our revenues, and a much higher percent of our EBITDA as defined, comes from aftermarket sales. Aftermarket sales have historically produced a higher gross margin, and have provided relative stability in the cycles.

Because of our uniquely high underlying EBITDA margins, somewhere around 50% of revenues, and relatively low capital expenditures, typically less than 2% of revenues, TransDigm has year-in and year-out generated strong free-cash flow. We pay close attention to our capital structure and capital allocation, and view this as another means to create shareholder value. In keeping with that philosophy, due to a combination of sub-optimum capital structure, a hot credit market, and significant liquidity, we declared and paid a $12.85 per share special dividend in Q1, and still maintained significant borrowing capacity post-dividend.

In Q2, we refinanced about $2.2 billion of senior secured debt. The goal and the net result was to reduce interest expense, and to increase our flexibility under the credit agreements. As of 3/30/13, we have about $680 million of cash, $300 million in unrestricted and undrawn revolver, and additional capacity under our new credit agreement. With no additional acquisitions or capital market activity, cash should be over $900 million at the end of our fiscal year, and net leverage a little under 4 times pro-forma EBITDA as defined. As usual, we will address our use of cash, borrowing capacity, and capital allocation issues as the year proceeds to make a determination as to how best to proceed based on the factors that exist at that time.

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. This consistent approach has allowed us to continuously increase the intrinsic value of our businesses, while steadily investing in new business and platform positions. We have also been successful in regularly acquiring and integrating businesses. We acquire proprietary aerospace products with significant aftermarket content. We have been able to acquire and improve such 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 have been able to create intrinsic value for our shareholders for many years through up-and-down markets. In uncertain times like this, we focus on these fundamental elements of value creation as the things we can control.

In April, we announced an agreement to acquire Aerosonics for about $39 million. This is a small public company, so we have to go through the various steps that entails. The revenue is roughly $30 million. Hopefully, this closes in the next 45 to 90 days. Aerosonics serves the commercial and military aerospace markets. The products are highly proprietary, with about 55% of the revenues from commercial markets, and 60% of the revenue from the aftermarket. This is similar to the Aero-Instruments business we bought in September. Since we don't own the business, and it's a small public company, we can't say much more at this time.

I'd like to address two other issues. One, our thoughts on the commercial aftermarket, and two, some clarification of the EBITDA as defined margins. With respect to the commercial aftermarket, through Q2, we still have not seen clear signs of a sustained pick-up. We, as many in the industry, are a bit surprised by how long this soft market has continued, especially in light of the decent underlying market trends. We are still hopeful of a pickup in the second half of the year, but suspect it may be more like the second half of the calendar year than the second half of our fiscal year.

As the commercial aftermarket softness beginning -- began last summer, we hired SH&E, a well-known aerospace consulting company to go through a rigorous analysis on a product-line-by-product-line basis of our commercial aftermarket revenues and outlook by platform, and give us a second opinion on our market position. They completed this work during our first quarter of fiscal-year 2013. There are a few significant findings, mostly good, over the mid to long term, but a few not-so-good in the short term.

Specifically, I think the following is worth sharing. On the positive side, SH&E concluded that our mix of products and platforms were strong. As a result, over a longer period, say, three to five years, TransDigm's aftermarket revenue growth should outpace annual RPM or market growth by 1 to 2 percentage points per year, if you include the new 787 C-series and Airbus platforms. And also should grow modestly above RPM growth or market growth, even if you just look at the base fleet. That is excluding the new platforms. For the near future, TransDigm will likely continue to use RPM as a base planning tool until we see more actual market results, but this generally confirms our view. We feel positive about this conclusion and its longer-term implications.

SH&E also noted that industry-wide, second-hand parts usage appears to be growing. However, due to the relatively low price points and lower percentage of rotable pool-type full assemblies sold by TransDigm, SH&E concluded that TransDigm's exposure to, and risk from, used parts and PMA is not a significant factor. This has generally been our view, but we're glad to have it confirmed. Of course, this bears continual watching.

On a less positive note, SH&E concluded that the near-term softer market and aftermarket revenues at TransDigm, and possibly many other component suppliers, is due primarily to -- one, softer European carrier demand as a result of attempts to draw down inventory and defer maintenance in response to the poor economic situation. And two, softer Asian-Pacific market carrier demand. Asian-Pacific carriers hold inventories, according to SH&E, that are quite high by North American standards, and many Asian carriers are making a concerted effort to both draw stocks down and to more carefully schedule maintenance cycles.

SH&E also tended to be a bit more pessimistic on industry-wide longer-term RPM growth, more in the 4% range than the generally used 5% range. The net result of all of this is it's hard to predict the inflection point with any specificity, but is more likely later in the calendar year then earlier, and the European recovery [at least] could stretch into the next year. To remind you, TransDigm's fiscal year ends on 9/30. So, on upturns, our fiscal-year trend tends to lag the calendar-year trends by a bit. Time will tell how accurate all this proves to be.

Now, with respect to our operating margins, we use EBITDA as defined, as our best measure of operating performance. You will notice the reported EBITDA as defined margin for the first half of 2012 compared to the first half of 2013 is down from 49% to 47%. There is a fair amount of noise in the comparable-period numbers, and I'd like to try and sort this out a little. I'm going to review the first half of 2013 versus the first half of 2012. The longer the period you compare for this, at least in my judgment, the less distorted things get by cut-off issues, one-time events and the like.

The comparable numbers are muddied by three significant items. One is one-time scope-change settlements in the 2012 period, mostly on the 787. Two, differences in the mix of businesses owned in 2013, due primarily to the acquisition of the AmSafe businesses in February 2012. And three, product-mix dilution, with the slower commercial aftermarket revenues in 2013, as I believe you know, this is a high-margin portion of our Business.

In our view, a more consistent comparison between the two periods of the fundamental operating performance is generally as follows. If you look at the first half of 2012, the reported first-half EBITDA as defined margin is about 49%. If you remove the benefit of the one-time scope-change settlement, you reduce the margin by about 1%, to 48%. If you look at the first half of 2013, the reported first-half 2013 EBITDA as defined margin is about 47%. If you add back the dilutive impact of the acquisitions, primarily AmSafe, you increase the margin by about 2.5%. If you add back the unfavorable OEM-to-aftermarket mix to make it consistent, you add about another 1 point. So you adjust the first-half 2013 EBITDA margins on a comparable or normalized basis, we view at about 50.5%. That is a normalized increase from operations of about 2.5%, or 50.5% minus 48%.

This is how we look at the business operations, and track the results internally. Interesting, on the same normalized basis, over the same 12-month period, the older-based businesses, that is pre-McKechnie margins, are up a little -- on the business we owned before we bought McKechnie, are up a little over 1%, and the recently acquired, that is McKechnie and forward-business margins, are up between 4% and 5% over the same 12-month period. Hopefully this is helpful, but in any event, it's the pieces we use internally to track performance, and you can shuffle them around however it makes sense to you.

Moving on to our most recent quarter. I will remind you, this is the second quarter of fiscal-year 2013. Our fiscal year began October 1. In total, the quarter, with market channel puts and takes, was roughly in line with our expectations. As I've said in the past, quarterly comparisons can be impacted by a whole range of one-time events. But as you know, we began to see commercial aftermarket softness in the back half of fiscal-year 2012. As I just reviewed, the softness has continued into Q2 of fiscal-year 2013, and the market status is still not clear.

The total Company GAAP revenues were up about 10% versus prior Q2, and 16% on a six-month comparable basis. On a same-store or pro-forma basis, revenues, that is if we owned the same mix of businesses, was up about 3% on a Q2 versus Q2 basis, and about the same on a year-to-date basis. Again, on a same-store or pro-forma basis, year-to-date bookings continue to run ahead of revenues. Commercial aerospace OEM and defense are -- and total defense are booking significantly ahead of revenues. Commercial aftermarket is just booking slightly ahead, and our small non-aero business is about flat.

Reviewing the revenues by market category, and again, on a pro-forma or same-store basis versus the prior-year Q2, and this is slide 5, that is assuming we owned the same mix of businesses in both periods. In the commercial aftermarket, which makes up about 75% of our revenue, total commercial OEM revenues were up 6% versus the prior Q2, and 5% on a year-to-date basis. This is modestly ahead of our original expectations. As a reminder, commercial OEM revenues were up 36% in the prior Q2, and 28% for the first half of 2012. So the comps are tough. Total commercial aftermarket revenues were about flat versus prior Q2, and up 1% on the year-to-date basis. Revenues per day in both periods are up a bit.

To clarify this a little, on a Q2-versus-Q2 basis, the actual reported revenues are down less than 1%. However, on a revenue-per-day basis, they are up about 2.5%. On a year-to-date basis, the actual revenues are up about 1%, and the revenues-per-day basis are also up roughly 2.5%. This, to me at least, is a somewhat unclear picture, so I'm calling that roughly flat.

The booking and shipment trends continue to vary considerably across product lines. Ray is going to give you a little more color on this, but our more discretionary products continue to be particularly soft, while the other less discretionary, which make up the bulk of our revenue, appear to show more signs of stability. As I mentioned earlier, the market situation isn't clear, though given the underlying economics, we'd expect to see some pickup soon.

In the defense market, which makes up about 25% of our revenues, defense revenues continue significantly better than anticipated at the beginning of the year. Revenues are up about 8% on a quarter-versus-quarter basis, and 5% on a year-to-date basis. Again, Ray is going to add a little color here. The military and defense bookings and results are mixed by product line, but more are up than down. Military revenues are holding up better than we anticipated, especially in the aftermarket, but we remain very cautious about trends in this market.

Our non-aero business, though small, was down about 7.5% in Q2 and year to date. About 70% of the non-aero business is the ground-based seatbelt business.

Moving to profitability, and on a reported basis, I already reviewed our operating performance on EBITDA as defined. The as-defined adjustments in Q2 were made up primarily of refinancing expenses and non-cash stock option expenses. Our EBITDA as defined of about $219 million for Q2 was up 8% versus the prior year, and 11% on the year-to-date basis. The EBITDA as defined margin was about [47%] (corrected by company after the call) for Q2, and slightly lower on a year-to-date. As I discussed earlier, adjusted for acquisitions, unfavorable mix, and contract settlements based on the way we look at operations that I described previously, we think the underlying margin is up around 2.5% versus the first half of last year.

With respect to acquisitions, we continue active looking at opportunities. The pipeline is still pretty active. Closings are difficult to predict, but we remain focused and disciplined on our criteria and our value creation method of analysis.

Moving now onto 2013. The current economic and political environment is still unclear. Hopefully it clarifies, but in the meantime, we remain cautious with our spending levels. Based on the above, and assuming no additional acquisitions, the 2013 guidance is slightly revised as follows. I will note that the midpoint for revenue and EBITDA is materially unchanged -- or EBITDA as defined. The range, again, is just tightened a bit. The midpoint of the 2013 revenue guidance is very slightly up at $1.86 billion, or about 9% on a GAAP basis, up about 9%. The midpoint of the 2013 EBITDA as defined guidance is unchanged at $888 million, or about 48% of revenues. This implies an EBITDA as defined margin approaching 49% in the second half of the year.

EBITDA dollars are up about 10% on a GAAP basis. The midpoint of the EPS as defined is now anticipated to be $6.94 a share. That's up $0.08 from the prior guidance. This primarily reflects the lower interest expense as a result of our refinancing.

On a pro-forma or, again, same-store basis, the guidance is based on the following growth rate assumptions. We will continue to assess the impact of the market uncertainty as the year proceeds. We are reducing our fiscal-year '13 full-year commercial aftermarket revenue growth estimates. Due to the continued industry-wide softening in the back half of 2012 fiscal year, and the continuation in the first half of our 2013, we are cautious here.

At this time, it appears unlikely that we would get to the low end of our 5% to 10% growth range. The second half of the fiscal year is usually a bit stronger, but we'd have to see a pickup in the back half of our fiscal year -- that's April through September -- of close to 10% year over year to get to the lower end of the range. This is possible, but seems like a stretch at this time. We will continue to watch it closely.

Based on the strong year-to-date revenues and bookings, we now estimate the defense or military revenues to be up in the low- to mid-single digits. This is an improvement versus our prior guidance. This assumes no cancellations or significant additional delays from sequestration in the balance of our fiscal year. Commercial OEM revenue growth we now estimate to be in the mid- to high-single-digit percentage growth range. This is also an improvement.

So in summary, for fiscal-year 2013, we now see commercial OEM and defense growth a little better than we originally anticipated, and commercial aftermarket a bit worse than we originally anticipated. As I said before, without any additional acquisitions or capital structure activity, we expect to have over $900 million of cash, $300 million undrawn revolver, and assuming no acquisitions -- no additional acquisitions, our net leverage is anticipated to be a bit under 4 times EBITDA at the end of the year. We also have additional capacity under our agreement.

It's still not clear to me that the market's settled out. Hopefully, the economy will start to pick up, and the political situation stabilize, but in any event, I'm confident in our consistent value-focused strategy, and the strong mix of our businesses. In times like this, again, we focus on the things we can control. We think that way, we can continue to create long-term intrinsic value.

And with that, let me hand this over to Ray, our Chief Operating Officer.

Thanks, Nick. As Nick mentioned, in total, our second quarter was roughly in line with our expectations. However, the lingering economic softness still has us tightly managing our cost structure. We have not implemented an across-the-board headcount reduction, but we have, adjusted for acquisitions, steadily reduced our headcount each quarter during the last six quarters. Our overall headcount is about 4% lower than it was at this time last year. This tight control of cost is particularly challenging with a stronger OEM revenues and softer aftermarket revenue mix that we are currently experiencing.

Generally, our OEM sales are at a lower margin than our aftermarket sales. Therefore, this mix of sales requires more labor wages and effort per dollar shipped, and makes improving headcount with regard to revenue particularly challenging. Despite this, we believe our operations are doing a good job of managing their cost structure during the current market conditions. As Nick said, we have been looking closely at the prolonged softness in the commercial aftermarket and the unexpected strength in the defense revenues. We have over 50 different product lines, and bookings and shipments do vary quite a bit from one product line to the other, but we have seen some trends.

In the commercial transport aftermarket, we continue to see particular softness in the sales of discretionary spares items. We estimate these products' sales make up in the range of 5% to 15% of our annual commercial transport spares revenue, depending on the different customers' definition of discretionary, and their unique maintenance practices and procedures. These discretionary products are typically things like cabin interior cosmetic items or discretionary product upgrades. The discretionary cabin interior spares products would include items such as the refurbishment portion of our engineered laminates business and non-textile flooring, some laboratory faucet components, luggage bin latches, and a portion of our lighting components. As I said, sales of these discretionary products continue to be weak. As Nick said, we still expect to see our second-half commercial aftermarket improve, but operationally, we will continue to proceed cautiously until the market recovers.

In our defense business, we continue to see stronger-than-expected sales. I remind you that defense sales make up almost 25% of our revenue. Here also, we see bookings and shipments vary quite a bit from one product line to the other, but we have seen some trends. For instance, military spares sales, especially foreign military spares, continue to be stronger than expected. We estimate the foreign military sales to be roughly 25% of our total defense revenue. Of particular note, our foreign spares sales of our Patriot Missile products, Fighter Jet products, and C-130 spares are strong. Additionally, both domestic and foreign military helicopter spares continue to be strong.

Our defense OEM programs are also, on balance, more up than down. Our A400M component sales are starting to ramp up, as Airbus increases their production rates. On the A400M, we provide a range of products, including composite fuel isolators, the main and auxiliary propeller feathering pumps, the engine ignition system, the landing gear kneeling manifold and flow regulator, a range of cargo area actuators, and a variety of cargo-related products.

Additionally, our Joint Strike Fighter and military helicopter OEM products are also seeing sustained solid sales. However, somewhat dampening the above OEM sales, for example, is the ramp down of the C-130 production rates, and the related inventory draw down associated with it. As we look forward, we're concerned that the military's reduction in aircraft utilization due to sequestration, and the reduced operating tempo, could reduce future demand for military spares.

Overall, the TransDigm operating units are performing well, given the uncertain economic environment. We continue to diligently control our entire cost structure. Our value-generation activities have continued to be effective across our businesses, and they also contributed to our first-half results.

Now let me hand it over to Greg, our CFO, who will review the second-quarter financial results in more detail.

Thanks, Ray, and good morning, again. I hope everyone had an opportunity to read our press release, which was issued this morning. I'd also like to remind you that Nick's narrative of the business, including some of the financial results, is mostly on a pro-forma basis. That is, assuming we own the same mix of businesses in both periods, while my focus is on GAAP [results]. So there may be slight differences in our year-over-year comparisons.

Before we begin, I want to remind you that we refinanced our $2.2 billion senior secured credit facility during the second quarter. We are happy that we were able to take advantage of a good credit market, and make the following improvements. We reduced our total interest expense. We extended the maturity on $1.7 billion of the term loan an additional three years, out to 2020, and we modified certain covenants to increase our overall flexibility, which aligns with our philosophy to also use our debt structure to help increase shareholder value.

Now, let me review the quarterly financial results. Our second-quarter net sales were $466 million, up $42 million or 10% from the prior year. The collective impact of acquisitions, primarily AmSafe and Aero-Instruments, contributed the vast majority of the increase. Our organic sales growth was up about 2% over the prior year, primarily due to the commercial OEM and defense markets, which was already discussed in detail. Reported gross profit was $259 million, up $23 million or 10%, which is in line with our sales growth versus the prior year. Gross profit margin was 55.7% of sales, which was flat when compared with the prior year. As Nick reconciled the three significant items impacting the EBITDA as defined margin compared to the prior year, these same items impacted gross margins between the two periods also.

The current-quarter margin is closer to 58% after adjusting to the dilutive impact of the acquisition mix and unfavorable OEM-to-aftermarket mix. This 58% compares to a margin of about 56.5% in the prior-year quarter when adjusted for the impact of inventory purchase accounting adjustments in the prior year, and the one-time settlement for scope changes that Nick discussed. This comparison illustrates that the base business continue to expand margins as a result of the strength of our proprietary products and continually improving our cost structure.

Our selling and administrative expenses were 11.9% of sales for the current quarter, compared to 11.7% the prior year. This was a sequential improvement compared to the first-quarter SG&A rate of 12.8%. We expect to run at a rate closer to 12% in the second half of fiscal '13, as we continue to pay close attention to our cost structure.

Interest expense of $64 million, an increase of approximately $12 million versus the prior-year quarter. This is a result of an increase in our weighted-average total debt to 4.3 billion versus $3.4 billion in the prior year. The higher average debt was due to the additional term loan of $500 million related to the AmSafe acquisition made in February of last year, and the addition of term loan and subordinating notes added to funded dividend just paid in November, totaling approximately $700 million. Our weighted average cash interest rate has decreased to 5.5% from 5.7% in the prior year. Refinancing costs of $30 million that were previously capitalized from our 2010 credit agreement when we acquired McKechnie, were written off during the quarter in conjunction with the refinancing of our senior secured credit facilities in February this year.

Our effective tax rate was 31.9% in the current quarter, compared to 34.7% in the prior year. The quarter rate was primarily reduced by the retroactive reinstatement of the R&D tax credit. We continue to expect our effective tax rate for the full year to be between 33% and 34%.

Net income for the quarter decreased $14 million, or 17%, to $68 million. This compares to net income of $82 million in the prior year. The decrease in net income primarily reflects the one-time refinancing cost and the higher interest expense, partially offset by higher sales volume and a lower effective tax rate.

Our GAAP earnings per share was $1.25 per share in the current quarter compared to $1.51 per share. The current quarter was significantly impacted by the one-time refinancing cost just mentioned, which is an impact of $0.38 per share. Adjusted earnings per share was $1.74 per share, an increase of 6% compared to $1.65 per share last year. The increase in adjusted earnings per share was lower than the increase in sales, due primarily to the higher interest expense, partially offset by the lower effective tax rate.

The quarter adjustments to bridge GAAP and adjusted EPS are as follows. The refinancing costs were $0.38 per share. The non-cash compensation cost was $0.09 per share. And acquisition-related expenses were $0.02 per share.

Switching gears to cash and liquidity, we generated $240 million of cash during the first half of this year, and ended with $[680] million of cash on the balance sheet. The Company's debt leverage ratio was 5.1 times at pro forma EBITDA on a gross basis, and 4.3 times on a net basis. As we expect to continue to generate over $100 million of cash each quarter, and assuming no acquisition activity, we expect our debt leverage ratio to be 4.9 times EBITDA on a gross basis, and 3.9 times on a net basis at the end of the year.

With regards to our fiscal '13 guidance, we have made some modest changes, which include slightly raising the midpoint of sales by tightening our guidance on each and maintaining the midpoint of EBITDA. Our full-year GAAP EPS guidance decreased to reflect the one-time refinancing cost, but adjusted EPS increased as a result of interest expense savings from the refinancing. The midpoint of our GAAP EPS is now $5.40, down $0.32 from the prior guidance, and adjusted EPS guidance is now $6.94, up $0.08 from the prior guidance. The $1.54 adjustment to bridge GAAP EPS to adjusted EPS includes the following items. $0.70 dividend equivalent payments, $0.38 from refinancing costs, $0.35 from non-cash stock option expense, and $0.11 from acquisition-related expenses.

With that, let me turn it back over to Liza to kick off the Q&A.

Yes, let me -- this is Nick Howley. If I confused anybody, apparently once or twice I used the wrong EBITDA margin for the second quarter. 47% was the reported EBITDA as adjusted margin, if that was any confusion there.

Thank you, Nick. In order to give everyone the opportunity to ask questions, please limit your question to two per caller. If you have further questions, I'd ask that you re-insert yourself into the queue, and we will answer those questions as time permits.

Allison, we are now ready to open the lines.

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

(Operator Instructions) Please stand by for your first question. And your first question comes from the line of Myles Walton of Deutsche Bank. Please proceed.

Nick, could you comment on what the aftermarket growth second half over first half in fiscal '13 is now implied to be, and also, what's your -- it kind of sounded like you are counting more on the not this quarter recovery, but a fourth quarter year, fiscal year recovery, and then first quarter next fiscal year recovery. So, our expectations are in line, how much of a hockey stick is it for this year still within that aftermarket guidance?

Yes. Let me start off, Myles, by saying in case it is not transparently obvious, I don't know when the pickup is coming. (laughter) I would say for the first half -- first and second halves, I think I've said -- I mean it's essentially just math. We're up 1% the first half. 5% for the year. Over 5, we've got to be 9 or 10 for the second half.

Sorry, I meant sequentially second half over first half, not year-on-year.

I don't what that number is. I looked at it year-on-year, is what I do know. But it's definitely up. It's got to be up to get there. We -- I guess we could largely figure that out. I just don't know the numbers as I sit here.

What was your other question? Are you are figuring the pickup more in our fourth-quarter than our third quarter? Yes, I surely -- it feels to me like it's slipping out further. You know, I hear everybody else talking about the second half of their year, and the second half of their year starts in our fourth quarter. You know, the further out I go, the better I feel about it. I think that's probably about the best I can tell you. I don't want to get into speculating about the next quarter yet.

And then in the M&A pipeline, Nick, maybe a quick comment on -- what kind of size of deals are you looking at?

A range. Not real big, but not real little ones, either. We have some decent stuff in the pipe line.

Okay. All right. Thanks.

Thank you, and your next question comes from the line of Noah Poponak from Goldman Sachs. Please proceed.

Good morning, everybody.

Good morning.

As a follow-up to the last question there, you know, last quarter I think you pretty definitively said the M&A pipeline had picked up pretty noticeably, but there has been -- I think there has been less activity than many of us would have expected. Can you talk about where the breakpoints have been in conversation, and what it is that's holding things up? Or is it just that the pipeline didn't pick up until three or four months ago, and it takes longer than that to make something happen?

I think it's more like that. I would say that some of the things we've been working on, frankly, have been moving along slower than I might have hoped. You can't always control the speed of movement on them. I guess you can. You can give up. (laughter) You know, generally, we have seen some things moving a little slower than we hoped. I'm very wary, and I'm very cautious about speculating on the rate of close on anything. But I would tell you, we are still pretty busy.

Okay. And then just a follow-up on the margin detail you gave which was very helpful, so thanks for that. You have had AmSafe for over a year. I guess maybe the way to ask questions is, you talked about how you would be a little over 50 -- call it 50.5% EBITDA as defined if you adjusted -- if you made all those adjustments. Maybe talk about when you think the timing is that you could cross over that on a reported basis.

Well, I think what we did tell you is to meet our EBITDA goal for the year, we have to get close to 49% for the second half of the year.

Okay.

So, that I would say starting to get close to 50 again.

Okay.

I don't want to get into speculating what next year's quarters might look like, but I think we try to give you a little bit of guidance and that our base businesses, the pre-McKechnie EBITDA margins, if you normalize the noise, in our view are still moving up in the 1% -- a little over 1% per year. So, you can almost take, if you got any -- wherever we stand, you'd expect even if it stops sort of a significant improvement, you'd expect you could move the things a point a year. So, 49% in the second half of the year starts to make you feel pretty good, all things being equal. And in the next year, you ought to be able to get there.

To put that timing in perspective, we closed on AmSafe in about the middle of February of last year. So, when you look at the first half, we only hold them for about 40 days last year.

Right.

By the way, let me just back up on whoever asked me -- I think it was Myles. The second half would have to be up to get to the five. Second half would have to be up 8% versus the first half.

Thank you.

Which I would say is not -- I wouldn't say that's impossible, but it's starting to feel like a pretty good stretch to me.

Thank you, and your next question comes from the line of Robert Spingarn of Credit Suisse.

Good morning, guys.

Good morning.

Nick, could you just clarify something you said earlier, which was about the pre-McKechnie margin expansion (multiple speakers) about 1%. Did I catch that right, and what was the time period?

The same 12-month period. First half '12 to first half '13 That's always what I'm talking about. (multiple speakers) Margin analysis.

Okay, and why might the pricing not have a bigger impact than that -- on those businesses?

I have to think about that. The answer is a little over 1%.

Well, you clearly still have some of the OEM aftermarket.

Well, but I normalized that out. I'm not sure we normalized all of the pricing out of it.

I figure this is as -- mature business lines for you. You're very efficient. You get more efficient every year, and the pricing -- so I just thought the 1% would be higher on the most mature stuff.

Well, it's a little over 1%. It's a little over 1% is what I said, but that's about what it is, Rob. I think in old business that we've had for a while, you know, they are not going to hit infinity. (laughter) They are not going to hit 100%. You know, these things are running at pretty high margins. It takes a fair amount to move them.

Okay, and is it fair to -- you've already talked a lot about the aftermarket trends, and how this is pushing to the right. So you are not seeing any improvement in the bookings or the behavior very recently.

I don't want to talk about this quarter, Rob. I can't talk about this quarter and things that we haven't come out with yet. But, I mean, you here -- I guess you hear what I'm saying is I hear everyone off talking about the second half of the calendar year, which is -- starts in our fourth-quarter, and that sort of seems like it makes more sense to me.

All right. And then you mentioned what SH&E told you. They talked about Europe and Asia --

Yes.

Trends there. What is your relative exposure -- I guess it tracks the fleet.

It tracks the fleet, Rob. Take the installed base or the hours flown or something like that. You know, I would guess the two of them are -- I'm just going to say this from memory, 55% or something like that.

And have they given you some sense in doing this study? You talked about how you think Europe's recovery goes. What about Asia? What's the view on when you start to see that?

Their view on that, again, for what it's worth -- I think, Rob, you probably know those guys. They are fairly knowledgeable.

I do know them.

They do a lot of work. They keep a lot of track of it. Their general view for us was by next year, the Asian ones are pretty well sorted out and cranking along. They are a little more nervous about Europe.

Okay. Well, thanks very much for that. A last question for you on defense. With regard to the fact that you don't have sequestration in there, you've talked about the risk profile. With the focus from DOD on maintenance and on pulling back flying hours and so on, don't you think you might be a little more conservative in the guidance there than what you are looking for here? It seems to me that could change sharply even in the quarter.

It could. Rob, I would say we are probably booked out now -- not booked out to the end of the year, but on defense, I'm going to say this. We are probably booked out more than three and less than six months, which doesn't get us all away to the end of the year but gets us close. As I said, there is always risk. Defense Department can cancel things. I'm assuming they don't cancel things. So that's what gives me a little more comfort. Usually, not never, but it's fairly unusual for them to start canceling orders they already placed.

Okay. Excellent. Thank you.

Thank you, and your next question comes from the line of JB Groh of D.A. Davidson.

Thanks, guys. Hey, just playing off that last question. Do you get a sense there's any sort of pull forward of aftermarket purchases particularly in defense?

That's awful hard to know. You know, it's obviously better than we expected. I would say that we are getting a pretty good pop from the 25% of our military business that is non-US. That's going along pretty well, but the orders are higher than we expected. I don't exactly know why.

Does the profitability vary on the International business versus the domestic?

Yes, I don't know that it is material.

And then I just had a point of clarification. I think I heard you say -- I was writing down 2% organic growth. Then I saw in the press release that said it was flat. What was the acquisition contribution --?

You are talking about the aftermarket now. Okay. That was just aftermarket. What I said about the aftermarket is it was on a reported basis for the quarter. The aftermarket revenues were down less than 1%, but there were less days in the previous quarter. If you adjusted per days, it was up about 2.5%, and it was the same sort of relationship for the first half of the year. It's the way holidays fall in our quarterly cut-offs.

Got you, but overall, organic was flat if you don't adjust for the days.

Yes, that's right. So what I said, you got one a little up, the other a little down. I call that about flat.

Got it. Thank you.

You are just talking aftermarket.

Aftermarket I'm talking about now. Commercial aftermarket.

Thank you, and your next question comes from the line of Robert Stallard of Royal Bank of Canada. Please proceed.

Morning.

Good morning.

Nick, to follow-up on the acquisition front. I was wondering if you could comment on what sort of prices you are seeing potential sellers trying to get [at demand]. But also if you are seeing any more competition for these assets than you would normally see?

I really can't say I see a substantive change in the market dynamics, either people in or pricing levels. I mean, good stuff typically sells at a pretty good price. But I can't say I have seen significant difference in market participants. Probably the only way that realistically happens would be to get a bunch of PE guys jumping in on the deals, and we haven't seen a lot of that.

Okay. Now on the aftermarket, I was wondering if you could comment on your pricing environment, if there have been any changes there, and if you strip out pricing that if -- whether your aftermarket volumes are actually down year-on-year?

There's no change in the pricing environment. If you strip out pricing, they are down.

Okay, that's great. Thank you very much.

Thank you, and your next question comes from William Raynor of Oppenheimer.

Thank you. Just a follow-up call on the work you've done to try to understand the weakness in the commercial aftermarket. You mentioned that you see a long-term positive in some of the new platforms you are on. Any findings in terms of weakness in some of the more important platforms for you today? In other words, is your platform mix an incremental headwind here?

No. That's what I tried to say. Just to be clear, if you strip out the new platforms, which I will define as C-series, 787, and new Airbus A380, not too much A350, because it's not all defined yet. If you strip that out, at least the conclusions that we got on the base aftermarket business, was still that the positions were such that you could expect to grow slightly above the RPM growth rate, which says you have a pretty good distribution of parts. If you add the new ones on, the estimate was you would grow a bit of the RPM rate. What that says to me, you've got a decent portfolio mix, and that was one of the main goals we gave, or a scope definition in the job, by the way

Got it. And then just to follow-up question also on the pricing dynamic, I know you are limited to what you can say about Aerosonics, but it does seem at least on the EBITDA basis, it looks pretty pricey. Maybe you can help us understand how maybe it's not as pricey as it looks.

I just simply can't talk about that. It's a public company and they are going through the tender process, and I just can't say anything about it.

Okay. Thank you.

Thank you and your next question comes from the line of Joe Nadol of J.P. Morgan. Please proceed.

Hi, good morning. It's Seth for Joe this morning. Just had one question, maybe about commercial OE and the strength in the quarter on a very strong quarter last year, and the increase in the guidance. Last quarter you seemed quite concerned about the 787 inventory overhang and the flattening OE production profile. How has your thinking about the commercial OE market changed since last quarter?

I don't know that our view has changed a lot since the last quarter. You know, I don't know that I can make any judgment from one quarter on the -- you know, on the OE production rates and inventory draw down. That's more like a multiple-year issue than a three or six month issue.

So you still have that similar outlook for flattening production in a lot of 787 inventory out there?

Yes, I think we go through that once a year, what our view is of the subsequent year production rates. I think I will address that when we do our next year's guidance.

Okay. Thank you.

Thank you, and your next question comes from Gautam Khanna of Cowen and Company.

Hey, it's Lucy in for Gautum, who sends his regards. I just have a follow-up on your Defense business. What was the revenue trend sequentially, and was there any change in orders trends in April?

We can't talk about anything beyond the published information at the end of March. We'll talk about the next quarter when we talk about it. Sequentially -- sequential revenues in defense I think she's asking. Generally, it's going better than we anticipated, and I don't remember the exact number.

And then can you just refresh my memory on --

I think we did tell you that the bookings continue to run ahead of the shipments. (Multiple speakers) We will figure out the sequential number here in a minute.

And can you just refresh my memory on the contingency for sequestration -- your outlook, your defense outlook?

We are assuming -- the biggest assumption is that we will not get any cancellations. In other words, we are probably booked out for a goodly part of the year. It's more than three and less than six months we are booked out. We've only got six months left in the year. So I think we are pretty comfortable if we don't start to get cancellations or if things don't just stop. I don't know that I can give your number on that.

Okay. Is there any cancellations out of the ordinary so far?

Yes. I would say I don't think -- surely, I can't tell you if it's zero across the Company, but I can tell you there has been no substantive or material cancellations from the government. We have not seen them do that. Generally, they do not, but they have the right to. Defense contracts can almost always be canceled for convenience, which means that they have to pay you whatever money you have in it, and a negotiated markup. They typically don't do that, because they'd rather have the product and pay half the money and not get the product.

Right.

But they can do it. They have the right to do it.

Right. Finally, just in broad terms, can you talk about any discussions you may have with Boeing, regarding their Partnering for Success initiative, and are the discussions on the business-by-business basis or a company-wide basis?

Both, and I really don't -- yes, we are a supplier like all other suppliers are to them. Yes, they are discussing with us also. I really am not willing to get into -- I don't want to get into the details of our discussion with individual customers.

All right. That's all for me. Thanks.

By the way -- what is it? Sequentially the shipments. Defense is high-single digits increase sequentially. That's a percentage.

Thank you.

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

Good morning.

Good morning, David.

Nick, going back to the margin discussion, thanks for the color on bridging the adjusted EBITDA margins. I guess my question is around AmSafe and how AmSafe is doing. I would've thought even with the dilution from AmSafe and the aftermarket mix hurting -- going against you, I would've thought given some underlying improvement in AmSafe that the margins would be a little bit better than what we are seeing today. So, can you just talk about how AmSafe is progressing, maybe relative to what you saw with McKechnie.

AmSafe is -- you're not going to get as rapid an increase in McKechnie because you do have, at least, the net business. It's not going to change as much. You know, it's not as good a business.

The Net and Cargo.

The Net and Cargo business, which was the smaller portion. I would say the big chunk, which is the seatbelts, is moving along very nicely. It's starting to look a lot like a TransDigm business. I think that's probably about the best I can tell you on it. That's the big chunk is the aerospace seatbelts, and that's looking very good to us. The Net business is looking fairly good, too; it's just the margins. So you are moving -- you know, you are trying to move a 10% margin to a 20% or something. It doesn't look as dramatic when you add it all up.

And Nick --

And the Ground business is about flat.

And at this point, you're still -- your thinking is you are still going to hold onto that business?

Yes, it will be -- we're surely going to hold onto it for another year. It's really not a big enough business to make much impact on anything when you take the revenue times the EBITDA. So, it sort of a value call after a while. You know, does is make any sense to sell something if you have to substantially discount what the EBITDA is valued at?

Right.

You know what I mean? Plus, you get the tax leakage. Usually it's easiest to do them all bang, bang, bang, right around the time of the acquisition. (laughter)

Right. And then cash. It sounds like the cash balance is going to be a little bit higher than what you are seeing earlier by the end of the year. Given what you highlighted, slow progress, and on the acquisition side, I mean, how long do you sit around with this much cash on the balance sheet?

David, I think you've seen before, we don't sit around too long. (laughter)

Right. I guess typically when you've paid special dividends, they've been end of the calendar year. Did something happen earlier than that?

I don't want to -- now I'm being evasive, of course. (laughter) I would say in the capital market something could happen whenever it seems right. You know, I would suspect it would be more toward the back end of the year. I think we'd probably keep looking and wringing our hands for a while before we do it.

Got it. Thanks, Nic.

Thank you, and your next question comes from the line of Ken Herbert of Imperial Capital. Please proceed.

Hi, good afternoon. I just wanted to follow-up specifically on the work that SH&E did. How is that, perhaps, changing two things, either your approach to acquisitions as you look at opportunities there, or perhaps, the existing product portfolio. I'd expect maybe there is some rationalization or other output of that that may ultimately happen. But just a little bit on sort of how you are going to use that moving forward from those two standpoints, would be helpful.

I wouldn't expect that to drive any kind of product rationalization or selling things off or anything like that. The main scope we are trying to understand is, is there anything, I'll say, discontinuous or unusual about our portfolio, that is making this aftermarket stay down longer than we might have hoped. The biggest part of the scope was -- but fill-in -- figure out all of our parts, which we thought we knew, but give us a second set of eyes, figure out all of our products on the different ship sets, then extend that by the hours of flight and things like that on each of the ship sets and tell us whether we have a portfolio that's better weighted, the same as, or a little worse than the market.

That is probably the biggest part of it. The second was, can you give us any sense as to why this market is staying down? Those are the two things that I tried to talk to you about. I think the summary we got is we feel pretty good about the portfolio products we have. So, I wouldn't see us doing anything significantly different with them. On acquisitions, we will buy what we always buy. We will buy proprietary aerospace businesses with significant aftermarket content. You know, we are not trying to fill a hole in or something like that. It's hard enough to find good ones without getting -- putting too many boundary conditions on it.

Okay. That's helpful. So it's safe to say then that you didn't find anything in the research that was TransDigm-specific in terms of the impact right now.

No.

From a negative standpoint.

No.

And then if I just could -- you've talked about, and I know you've mentioned the 4% headcount reduction and the puts and takes you are facing with better-than-expected strength on the OE side relative to aftermarket implications for the resources you need to put in play here. If that continues, is that a significant barrier to your ability to continue to look at the cost structure, or how should we think about the puts and takes of that as we go through the rest of the year?

What we give you -- headcount is sort of -- it's a proxy for cost structure. It's not perfect, but there's other things. Typically there is outside buys is the other thing. But if the OEM mix continues to get higher, this is just the same -- it's another way of saying that there is a mix impact. You need more people and more effort to produce a part for OEM then you do a part for the aftermarket per dollar revenue, just because they are priced differently.

If the difference kept going on for a period of time, it would get increasingly difficult to get the headcount balanced up with the revenue or the volume. We do not see that as a problem now. Historically, we have been able to -- it hasn't swung so drastically that we have not been able to get the cost structure adjusted. I don't see that in the foreseeable future right now.

Okay, great. Well, that's very helpful. Thank you very much.

Thank you, and your next question comes from the line of Michael Ciarmoli of KeyBanc and Capital Markets. Please proceed.

Hey, good morning. Thanks for staying on here guys to take my question. Nick, just on the SH&E. Did you guys learn anything regarding your pricing power or the pricing environment. Do you think that will be sustainable? And then the other part to that with SH&E, they are forecasting some pretty big military headwinds on parts purchasing. How do you guys think about dealing with that headwind on the portfolio over the next, you know, beyond sort of --?

Well, just to be clear, I only spoke about Commercial business. Anything having to do with SH&E as I talked about, was only to do with the Commercial business, not the Defense business.

Okay. So you didn't get an opinion on military.

What I spoke about was the Commercial business.

Got you.

So, what they may or may not be on the defense business is separate from that. We didn't ask them to opine, particularly, on a pricing capability, but we don't see, nor have we seen, any change in the dynamics there.

That's fair. Most of my other questions were asked. Thanks, guys.

Thank you, and your final question comes from the line of Noah Poponak of Goldman Sachs. Please proceed.

Yes, just a couple of follow-ups. On the parting out discussion within the aftermarket specifically, is that something where you are able to actually locate in the customer data that that's not happening, or where you have some hard concrete evidence that that's not happening? Or is it just that the consultant agreed with your logic and intuition as to why that wouldn't happen to you?

Well, what they know is they have a pretty good idea of what is getting parted out, because people are forever hiring them to study that and study what they can part out and sell. So they know the kind of things that are. I can't tell you they know every part number, and they know sort of the dollar price points and the type of things people are buying. Their conclusion is somewhat the same ours has been. For relatively low dollar value items, people tend to not do it.

They see the actual parts. It's not just -- they were just making it higher level.

They got -- they see the unit prices and things like that for us when they go through it. They don't meet the criteria for the kind of things they have been seeing parted out. Now, the answer is never 100% or 0, but it's not a significant factor. You know, the PMA stuff you can get a little bit better bead on because you can look up what's been or hasn't been approved by the FAA, so we have a pretty good idea that that's de minimus.

Got it. And did you give your expectation for interest expense for the full year?

The absolute dollar, or the rate?

Absolute dollar.

About $250 million for the year.

Got it.

You woke Greg up with that one. (laughter) He thought he was done for the day. He had the answer. (laughter)

I will let you guys go now. Thank a lot. (laughter)

Thank you. I'd knowledge to turn the call back over to Liza Sabol for closing remarks.

I think that concludes our call for today, and we'd like to thank everyone for your participation.

Thanks.

Thank you, ladies and gentlemen. This concludes your presentation. You may now disconnect, and good day.