TransDigm Group Inc (TDG) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's Q3 2013 TransDigm Group Incorporated earnings conference call, hosted by Liza Sabol, Investor Relations. My name is Chris and I will be your conference coordinator today.

(Operator Instructions)

Thank you. At this time, I would like to turn the call over to Liza Sabol to begin. Please go ahead.

Thank you, Chris. I would like to thank all of you that have called in today, and welcome you to TransDigm's fiscal 2013 third-quarter earnings conference call. With me on the call this morning are TransDigm's Chairman and Chief Executive Officer, Nick Howley; President and Chief Operating Officer, Ray Laubenthal; and our Executive Vice President and Chief Financial Officer, Greg Rufus.

A replay of today's broadcast will be available for the next two weeks. Replay information is contained in this morning's press release and on our website at TransDigm.com.

Before we begin, the Company would like to remind you that statements made during this call which are not historical in fact are forward-looking statements. For further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, please refer to the Company's latest filings with the Securities and Exchange Commission. These filings are available through the Investor section of our website or 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 our 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 [for those] measures.

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

Good morning, and thanks again to everyone for calling in to hear about our Company.

Today, as usual, I will start off with some comments about our consistent strategy, then a short discussion of our capital market activities, some information on our recent acquisitions, and then I'll move on to an overview of the third quarter of fiscal year '13 and an update on our outlook.

To reiterate, we believe our business model is unique in the industry, both in its consistency and its ability to sustain and create intrinsic shareholder value through all phases of the cycle. To quickly summarize why we believe this -- about 90% of our net sales are generated by proprietary aerospace products, and around 75% of our net sales come from products for which we believe we are the sole-source provider. Excluding the small non-aviation segment, about 57% 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 provided relative stability in the downturns.

Because of our uniquely high underlying EBITDA margins and relatively low capital expenditure requirements, TransDigm has year in and year out generated very strong free cash flow. We have a well-proven, value-based operating strategy focused around what we refer to as our three value drivers. That is -- new business development, continual cost improvement, and value-based pricing. This consistent approach has allowed us to continuously increase the intrinsic value of our business, while steadily investing in new businesses and platform positions. We pay close attention to our capital structure and capital allocation, and view it as another means to create value. This has been a very active area this year. I will talk more about this later.

We have also been successful in regularly acquiring and integrating businesses. We acquire proprietary aerospace businesses with significant aftermarket top ends. We have acquired many such businesses and improve them through all phases of the market cycle. Through our consistent focus on our operating value drivers, our clear acquisition strategy, and close attention to our capital structure, we have been able to create intrinsic value for our investors for many years through up and down markets. We focus on these fundamental elements of value creation as the things over which we have some control.

Let me expand a little bit on the capital structure and capital allocation. In keeping with our strategy, 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 maintain significant liquidity and borrowing capacity post-dividend. In Q2 we refinanced about $2.2 billion of senior secured debt. The goal and the result was to reduce interest expense and to increase our flexibility under the existing credit agreement. In Q3, we began the offering process, and in early July borrowed another $1.4 billion, and announced our intention to pay most of this out to our shareholders in the form of a $22 a share dividend. We also further improved the terms of our credit agreement.

In deciding to pay out another special dividend this year, we looked very closely at our choices for capital allocation. We basically have four -- one, invest in our existing business; two, make a creative acquisition, consistent with our strategy. And let me be clear -- these two are always our first choice. Our third option is to pay off debt; but given the low cost of debt, especially after tax now, this is likely our last choice, at least in the current market conditions. And fourth, give the extra money back to the shareholders, either through a special dividend or a stock buyback.

As we looked at our likely need for acquisitions and internal investment requirements, we believed, based on what we knew then what we know today, that we had cash and/or debt capacity beyond our near- to mid-term needs. Combining that with historically low interest rates and extensive capital availability, we believed we had the opportunity to accelerate returns to our shareholders while maintaining adequate liquidity and borrowing capacity to meet our near-term and mid-term operating and acquisition needs. Since we were paying out about 15% of the equity value, we again decided to pay a special dividend versus a stock buyback in order to complete the action quickly and to reduce the execution risk. There should also be some additional tax advantage to recipients, as Greg will explain.

We'll evaluate the dividend versus buyback on a case-by-case basis as the situations arise. As a practical matter, we do not anticipate that this will restrict our ability to make the range of accretive acquisitions we will likely see over the next 12 to 18 months. We believe we could do $1 billion-plus of acquisitions immediately from our cash revolver and debt capacity, while maintaining a reasonable liquidity buffer. This number moves up fairly quickly. We historically have generated an average of $100 million to $125 million per quarter of free cash, and our borrowing capacity increases as our EBITDA grows.

The weighted average cost of our new debt is about 5.1%, a bit below our current average. We have also entered into a forward interest rate hedge in order to fix about 70% of the total debt. Greg will provide a little more detail on that. As of 6/30/13, after closing the 3 recent acquisitions, we had about $270 million in cash, $300 million in unrestricted and undrawn revolver, and additional capacity under our amended credit agreement. With no additional acquisitions or capital market activity other than payment of the $22 per share dividend and associated equivalency payments, cash should be about $500 million by the end of fiscal year '13 at September 30, and our net leverage, about 5.7 times pro forma EBITDA As Defined at that point.

Q3 was also a busy time for acquisitions. So far we have acquired in excess of $200 million of annualized revenue and about $45 million of annualized EBITDA As Defined so far in fiscal year '13. We acquired Aerosonics in June for about $39 million. This was a small public company. The revenue was roughly $30 million. We also closed two additional larger acquisitions -- Arkwin, a proprietary manufacturer of aerospace actuators and valves, for $286 million. Arkwin's revenues were about $95 million. We also acquired GE's Whippany Actuation System business, another proprietary manufacturer of primary actuation products, for about $148 million. The Whippany business had revenues of about $80 million.

On a particularly positive note, these last two June acquisitions received early termination of the HSR waiting period from the US government. All three of these businesses are proprietary aerospace businesses with significant aftermarket content, and we expect all to generate returns above our private equity-like targets. The GE Whippany business has some excess distribution inventory that we will be working off for the next three to five months. This will impact our Q4, and maybe a bit into the next quarter. There are also some customer contractual issues that could make the improvement slower than usual, but these are all reflected in the price. Arkwin should progress towards a TD-type margin on a normal, typical progression.

I would also like to address the status of our commercial aftermarket. In Q3 we believe we began to see signs of a pick-up. We, as many in the industry, have been a bit surprised by how long this soft market continued, especially in light of the decent underlying market trends. Though we are beginning to see signs of a recovery, as a practical matter, the bookings have not risen quite fast enough to fully meet the prior full-year guidance for our core business. Our shipments on a same-store basis for Q3, excluding a one-time legal settlement in the prior Q3, were up about 4% versus the prior year. Revenues are also up about 4% sequentially.

On an additional positive note, our bookings, or incoming orders, were the highest in five quarters, up about 4% sequentially, and 7% versus the prior year on a same-store basis. Again, we will adjust it for this one-time settlement. It's probably too soon to declare victory, but many forecasters seem to believe we have reached a commercial aftermarket inflection point. Time will tell, of course, but our Q3 results would tend to support that view, though I will point out the pick-up is not yet consistent across product lines. To remind you, TransDigm's fiscal year ends September 30, so our fiscal year trends typically lag calendar year trends by a quarter, at least on the upturns.

Moving on now to the most recent quarter. As you may have noticed, we have begun to report on three segments. The vast majority of our business falls into the two Aero segments. Over the years, we've had discussions with the SEC about segment reporting, and recently agreed with the SEC to implement these segments going forward. Greg will describe them a little more detail during his part. I will still primarily discuss the overall business and overall market trends, since the market trends particularly apply to both major Aero segments.

I will remind you, this is the third quarter for fiscal year 2013. Our year began October 1 and ends on September 30. In total, the quarter with market channel puts and takes was roughly in line with our expectations. As I have said in the past, quarterly comparisons can be significantly impacted by difference in OEM aftermarket mix, large orders, one-time events, [trans] and inventory fluctuations, seasonality, and other factors. As you know, we began to see commercial aftermarket softness in the back half of fiscal year 2012. As also I just reviewed, we began to see some year-over-year revenue pick-up in Q3. The market does seem to be firming up.

Total Company GAAP revenues were up 6% versus prior Q3, and 12% on a nine-month, year-to-date basis. On a same-store pro forma basis -- that is, if we owned the same mix of businesses -- revenues were up about 3% on a Q3 versus Q3 basis, and about the same on a year-to-date basis. Again, on a same-store or pro forma basis, year-to-date total bookings are running about 4% ahead of revenues. All the market channels are booking at levels above the shipping dollars, except for our small non-aviation business, which is about flat. Reviewing the revenues by market category, again on a pro forma basis or same-store, versus the prior Q3 -- that is assuming again we own the same mix of businesses of both periods -- in the commercial aftermarket, which makes up about 75% of our revenue, total commercial OEM revenues were up about 10% versus the prior quarter Q3, and 7% on a year-to-date basis. This is a bit ahead of our original expectations.

As a reminder, commercial OEM revenues were up 16% in the prior year Q3 and 24% for the first nine months of 2012, so the comps are high here, or tough. As I already mentioned, excluding a one-time settlement in the prior Q3, total commercial aftermarket revenues are up 4% versus the prior. On a reported basis, they're roughly flat. The booking and shipment trends still continue to vary considerably across product lines. As I mentioned earlier, the bookings also seem to show some signs of improvement.

Moving on to Defense. Again, Defense makes up about a quarter of our revenue. Defense revenues continued significantly better than anticipated at the beginning of the year. Revenues are up about 8% on a quarter versus the prior quarter; and about 5% on a year-to-date basis. The military and Defense booking results are somewhat mixed by product line, but more are up than down. Military revenues continue to hold up better than we expected. Though we remain cautious about trends here, we're starting to feel that we may not see as tough a down market as we have been planning. Though I want to be clear, our visibility in this sector is very limited. The revenues in our non-aviation business, though small, were down about 8% in Q3 versus the prior year, and about the same on a year-to-date basis.

Moving on to profitability, and now on a reported basis, the as-defined adjustments in Q3 were made up primarily of non-cash stock option expense. Greg will go into this a bit more. Our EBITDA As Defined of about $232 million for Q3 was up around 7% versus the prior Q3, and EBITDA As Defined is up about 10% on a year-to-date basis. The reported EBITDA As Defined margin was 47.5% of revenues for the quarter, and the EBITDA margin is about 47% on a year-to-date basis versus 48% in the prior year.

As I discussed last quarter, in our view, a more consistent comparison between the two periods of the fundamental operating performance is as follows. If you look at the first nine months of 2012, the reported EBITDA As Defined margin is about 48%. If you remove the benefits of one-time settlements, you reduce the margin by about 0.5%, the 47.5%. If you look at the first nine months of 2013, the reported 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 1.5 points on a comparable basis; and if you add back the unfavorable OEM aftermarket mix to make it consistent, you add back another one point. So after you adjust the nine months of 2013 EBITDA margins on a comparable or normalized basis, or operating basis, we view it at about 49.5%. This is a normalized increase from operations of about two points.

With respect to acquisitions, we continue actively looking at opportunities. The pipeline of possibilities is reasonably active -- more small to mid than large. Closings are always very difficult to predict, and I surely can't predict them now. We remain disciplined and focused on our tight strategic specification and in value-creation opportunities.

Moving on now to guidance for the balance of the year. The current economic and political environment are still somewhat unclear; however, hopefully, the situation clarifies. But in the meantime, we continue to remain somewhat cautious on our spending levels. You will note the midpoint for revenues and EBITDA is up modestly, though perhaps not as much as some of you might calculate, given the recent three acquisitions. Excluding the three acquisitions, the Q4 core revenue and EBITDA are not quite as high as we forecast last quarter. This is due to the timing and rate of recovery in commercial aftermarket. Additionally, the Whippany acquisition will be reducing distribution inventories in Q4, and possibly a little into the following quarter; and also making certain TransDigm-related changes that will negatively impact the EBITDA in the quarter.

Based on the above, and assuming no additional acquisitions, 2013 guidance is as follows. The midpoint of our 2013 revenue guidance is now $1.92 billion, or up 13% on a GAAP basis versus the prior year. The midpoint of the 2013 EBITDA As Defined guidance is now at $895 million, or 47% of revenue. This implies an EBITDA As Defined margin of almost 46% in Q4, a bit lower than our prior guidance. This is depressed a bit by a less rich aftermarket and OEM mix continuing and three new acquisitions. Based on our current forecast, these items will reduce margins in Q4 by a little over 3%, the lion's share of which comes from the acquisition dilution.

EBITDA As Defined dollars were up 11% on a GAAP basis year over year. The midpoint of the adjusted EPS As Defined is now anticipated to be $6.80. This is down $0.14 from the prior guidance. This reflects higher interest rate expense as a result of our recent refinancing, and higher share count through the accelerated vesting of certain stock options under the market sweep provisions. These are offset, in part, by the earnings of the three new acquisitions.

On a pro forma or same-store basis, this guidance is based on the following growth rate assumptions for the year. We are now estimating fiscal year '13 full year commercial aftermarket revenue growth to be up in the low single digits. This anticipates a 4% to 5% year-over-year pick-up in Q4, as well as a sequential pick-up of about the same percent. Based on strong year-to-date revenues and bookings, we now estimate the or military revenues to be up in the mid single digits. This is an improvement versus the prior guidance. This again assumes no cancellation or significant delays from sequestration in the balance of our year. Commercial OEM revenue growth we continue to estimate in the mid to high single digits percent growth versus the prior year.

In summary, for fiscal 2013 we now see commercial OEM and defense growth a bit better, and the commercial aftermarket not quite as good as we originally anticipated. As I said before, without any additional acquisitions or capital structure activity beyond the payment of the dividend, we expect to approach $500 million in cash and $300 million in undrawn revolver at year-end 2013. Again, based on the same assumptions, our net leverage is anticipated to be 5.7 times EBITDA at the end of 2013. And without any additional acquisition or capital market activity, typically drops about a turn a year. We also have additional capacity under our credit agreement. We will see how the commercial and defense markets sort out, but in any event, I'm confident that with our consistent value-focused strategy, strong mix of businesses, and focus on the things we can control, we can continue to create long-term intrinsic value for all of our investors.

Ray is here with us for Q&A, but in the interest of time, he won't give prepared comments this quarter. And let me hand it over to Greg, our CFO.

Before we review the financials, I want to remind you again that this was a very active quarter on a number of fronts. Nick mentioned some of these items already, but I want to take a few minutes to review some unique items to the quarter and next quarter. They were -- we adopted segment reporting; we had an acceleration of option vesting; we raised $1.4 billion of debt to pay a $22 special dividend; and we closed on three acquisitions, all in June.

We will file Form 10-Q tomorrow. This will be the first quarter we will report segment information. Usually, there is a material precipitating event which causes changes in segment reporting. We did not have such an event, but we have grown into a large company, and it was time to make a change in our reporting structure. On a prospective basis, starting with this quarter, we will report a Power and Control segment, an Airframe segment, and a small Non-Aviation segment.

The Power and Control segment includes operations that primarily develop, produce, and market systems and components that predominantly provide power to or control power of the aircraft, utilizing electronic fluid power and mechanical motion control technology. The primary customers of this segment are engine and power system and subsystem suppliers, along with the airlines' third party maintenance suppliers, military buying agencies, and repair depots. Products are sold in the original equipment and aftermarket market channels. Year-to-date sales for this segment are $616 million, which represents 45% of our total sales. The EBITDA As Defined is $328 million, or 53% of sales, and represents 49% of our total segment EBITDA As Defined.

The Airframes segment includes operations that primarily develop, produce, and market systems and components that are used in non-power airframe applications utilizing airframe and cabin structure technology. The primary customers for this segment are airframe manufacturers and cabin systems suppliers and subsystem suppliers, along with the airlines' third-party maintenance suppliers, military buying agencies, and repair depots. These products are also sold in original equipment and aftermarket channels. Year-to-date sales for this segment are $695 million, which represents 50% of our total sales. The EBITDA As Defined is $326 million, or 47% of sales, and represents 49% our total segment EBITDA As Defined.

The Non-Aviation segment includes operations that primarily develop, produce, and market products for non-aviation markets. Primary customers in this segment are off-road vehicle suppliers and subsystem suppliers, child restraint system suppliers, satellite and space system suppliers, and fueling system components primarily for the mining industry. Year-to-date sales of this segment are $73 million, which represents 5% of our total sales. The EBITDA As Defined is $16 million, or 22% of sales, and this segment represents 2% of our total segment EBITDA As Defined.

I would like to now take some time and talk about the acceleration of vesting of performance-based incentive stock options that were granted prior to October 1, 2011. This is somewhat complicated, and has three distinct impacts in our reported financial results. To remind you, we have a somewhat unique incentive stock option program for a public company. All of our grants and options are 100% performance-based, which aligns our Management very closely to you, our shareholders. Historically, our options could vest in two ways. One is the achievement of an internal rate of return, or IRR target, established at the award date; and the other is when the market price of the stock exceeds a predetermined market price for 60 trading days.

For options that just accelerated, that market price was around two times the market price on the date when the market sweep was put into place. In other words, the stock price had to at least double during the period between when the sweep was put in place and the acceleration occurs. The details of the program are disclosed in our proxy statement. On June 26, a total of 2.4 million stock options vested on an accelerated basis due to this market sweep provision. 1 million of these stock options were scheduled to vest in just four months from now at the end of this fiscal year, and the remainder were scheduled to vest in FY '14 and FY '15. Because of the market sweep trigger, we had to accelerate the non-cash compensation expense of $24.5 million into this quarter. This expense will now step down in quarter four and the next two years. Full fiscal 2013 expense will now be approximately $49 million for this line item.

The second item associated with the accelerated vesting and related expense is the acceleration of dividend equivalent payments for the past dividends of $7.65 paid to shareholders in the first quarter of FY '10 and the $12.85 dividend paid to shareholders this past November 2012. For financial statement reporting, the dividend equivalent payment is classified as a participating security, which is the reason we report our EPS under the two-class method for basic and fully diluted EPS, versus the more commonly used treasury method for basic and diluted shares. The cash payment associated with the prior two dividends paid is $38 million. Again, a little more than half of this amount was scheduled to be paid this coming November. Although this payment does not get expensed, for accounting purposes the payment must be deducted from reported net income before the calculation of quarterly EPS. You can see this on Table 4 in this morning's press release.

The third item associated with the sweep is an increase in shares outstanding for computing EPS on a fully diluted basis. Under the two-class method, vested options are included in the weighted average of shares we use to calculate EPS. This is the major difference versus the treasury method computation for basic and fully diluted shares. Thus, our full fiscal 2013 weighted average share count will now be approximately 55.1 million, and fourth quarter will be 56.9 million

I'm now going to switch to the third topic, which is our new debt and the $22 dividend announced in July. On July 1, we raised $1.4 billion of additional debt to pay a $22 special dividend on July 25. We were able to take advantage of what we believe to be relatively low interest rates. On the new $900 million term loan, we obtained a rate of LIBOR plus 300, with a 75 basis point floor, maturing in 2020. We also issued $500 million senior subordinated notes with a fixed interest rate of 7.5%, with a maturity in 2021. Immediately after the financing, our fixed-to-variable debt ratio was split approximately 50% fixed and 50% variable. So we recently entered into a forward-starting interest rate hedge for $1 billion and a fixed rate of about 5.4%. The fixed rate starts October 1, 2014, and ends in fiscal 2019. This hedge will increase our fixed rate debt from around 50% to approximately 70%.

One additional note regarding the $22 dividend. We estimate the tax treatment of this most recent dividend will be at least 90% or more a return of capital. That is, your taxes will be deferred, and then the remaindering difference will be dividend income. We plan to post a preliminary Form 8937 on our website in early September, and the final determination will be available after we file our tax return for fiscal 2013, which is around June 15, 2014.

And finally, the last item occurred in June was the successful closing of three acquisitions for a total purchase price of about $475 million. We paid cash for all three acquisitions.

With that, let me now review the consolidated quarterly financial results, which are on slide 7. Q3 net sales were $489 million, up $27 million, or 6% from the prior year. Our organic growth was up 4.5% over the prior year, primarily due to the commercial OEM and defense markets, which Nick has already discussed in detail. Reported gross profit was $269 million, up $16 million, or 6% versus the prior year, and is in line with our sales growth. Gross profit margin was 55% of sales, which was flat when compared to the prior year. The current quarter margin would be closer to 57% after adjusting for the dilutive impact of acquisition mix, unfavorable OEM to aftermarket mix, and higher stock compensation expense. This 57% compares to a margin of approximately 56% in the prior year, when excluding the impact of the acquisition-related costs.

Selling and administrative expenses were 16.9% of sales for the current quarter compared to 12.2% in the prior year. A majority of the increase in SG&A was related to the non-cash stock compensation expense I previously discussed. Stock compensation expense as a percent of sales increased to 5.5% this quarter from 1.1% in the prior quarter. Transaction-related expenses from our recent acquisitions also increased our current SG&A percentage by about 1 percentage point. If you normalize SG&A by excluding these 2 items, the rate as a percent of sales would have been about 11%, which is similar to the prior year. Full year fiscal 2013 SG&A rate will now be closer to 13% with all of the above expenses.

Interest expense was $62 million, an increase of approximately $7 million versus the prior year quarter. This is the result of an increase in the weighted average total debt to $4.3 billion in the current quarter versus $3.6 billion in the prior year. The higher average debt was due to the additional term loan and subordinated notes added to fund the dividend paid in November, which totalled approximately $700 million. Our weighted average cash interest rate decreased to 5.5% compared to 5.7% versus the prior year. Please note that since we closed on the dividend financing in July, the third quarter did not include any impact for the newly incurred $1.4 billion of debt. We now expect our full fiscal year 2013 net interest expense to be approximately $272 million.

Our effective tax rate was 32.9% in the current quarter, compared to 30.7% in the prior year. The prior quarter rate was favorably impacted by discrete items related to an IRS settlement and adjustments resulting from the filing of the previous year's federal tax return. We now expect our effective tax rate for the full year to be closer to 33%. Net income for the quarter decreased $14 million, or 15%, to $77 million. This compares to net income of $90 million in the prior year. The decrease in net income primarily reflects higher stock compensation and interest expense, partially offset by higher sales volume and lower acquisition-related expenses.

GAAP EPS was $0.71 per share in the current quarter, compared to $1.68 per share in the prior year. In addition to increased stock compensation and interest expense previously mentioned, the current quarter was also significantly impacted by dividend equivalent payments paid on the accelerated options vesting to amounts of -- to $0.70 a share. Please reference page 12 of the slide deck. Adjusted earnings per share was $1.89 per share, an increase of 1% compared to $1.88 per share last year. The increase in adjusted EPS was lower than the increase in sales, primarily due to the higher interest expense in the current quarter and the lower effective tax rate in the prior year quarter.

As presented on page 9, the quarter adjustment to bridge GAAP to adjusted EPS were the following. The dividend equivalent payment of $0.70 per share, the non-cash compensation cost of $0.39 per share, and acquisition-related costs of $0.09 per share. Switching gears to cash and liquidity, which is shown on slide 8, we ended the quarter was $270 million in cash on the balance sheet. The Company's actual debt leverage ratio was 4.8 times our pro forma EBITDA on a gross basis, and 4.5 times on a net basis. Adjusted for the new debt, dividend, and DEP payments made in July, our pro forma net debt leverage ratio would have been 5.9 times our pro forma EBITDA. We now estimate year-end cash balance will be approaching $500 million, and our net debt leverage ratio to be approximately 5.7 times our pro forma EBITDA.

With regards to our FY '13 guidance, we have updated it to reflect all the activity from quarter three and quarter four. Our full-year GAAP earnings-per-share guidance decreased to reflect the additional dividend-equivalent payments, increase in our non-cash stock compensation, interest expense, and higher share count, partially offset by the favorable impact of recent acquisitions. The midpoint of our GAAP EPS is now $2.34, down $3.06 from prior guidance, and adjusted EPS is now $6.80 or $0.14 lower from prior guidance. So $4.46 of adjustments to bridge GAAP EPS to adjusted EPS includes the following. $3.11 from dividend equivalent payments. This includes an additional $1.71 in the fourth quarter related to the $22 dividend paid on July 25, $0.59 from non-cash stock option expense, $0.37 from refinancing costs, and $0.39 for acquisition-related expenses.

Hopefully, this explanation and the handouts given out today will help you understand all the significant fluctuations. With that, I'd like to now turn it back over to Liza.

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

(Operator Instructions)

Joe Nadol, JPMorgan.

Good morning, everyone. Actually, it's Seth on for Joe this morning. If I can ask about the aftermarket. In terms of what is changing, you highlighted that were areas of strength and weakness.

But if you can talk a little bit about the two, what we will see tomorrow when the queue comes out, how the aftermarket fared in each of the two aerospace segments? How it fared geographically relative to what you told us last quarter about areas of strength and weakness, any additional color would be helpful.

Yes. Well, you won't see how it fared geographically. We don't -- that's not part of what we disclose. I don't think the trends changed significantly from last quarter.

Where the softness is, is there's softness in Europe, and you're not seeing as much growth as we would have anticipated in China. Now that being said, obviously, it looks like we they all may be getting a little better.

With respect to the two segments, I don't think you'll see anything significantly different in them, and if it is, it's just a quirk in the timing. The airframe segment, just by the nature of the products, has a little less aftermarket, so its margins will always be a little lower. It just has some of the products in there -- go on and airplane and stay on longer, so you don't have quite as much aftermarket in that segment.

Thanks. If I could follow up with just one more, you talked about having a little bit more confidence incrementally the outlook for defense. What's giving you that confidence, and what's changed relative to the past?

Maybe a little more confidence, I think you might be overstated there. I think I said I feel a little less negative about it. Kind of the degree of the downturn.

Yes.

Very simply, everything I read from other aerospace companies, and I look at our underlying numbers, and they're hanging in better than I expected. That happens three or four quarters and it starts to influence a little bit of your view of it.

Yes. Okay, great. Thanks very much.

Michael Ciarmoli, KeyBanc.

Thanks for taking my questions. Nick, maybe on -- can you comment a little about the pricing environment in the aftermarket, or on the OE side? Boeing's partnering for success? A lot of the larger tier 1 suppliers looking to get cost of the business, is that having any sort of impact on your ability to get price and execute on the value creation process?

I would say there is no -- I can't say there's any substantive change in the pricing environment. Surely that is true in the aftermarket.

Many of the large OEMs are around seeking to get their costs down. I don't -- I'm not going to comment on any customer relationships specifically, but I would be surprised if it materially impacts the Company at the end of the day, whatever sorts out of those issues.

Okay. Just one other follow-up on the aftermarket. You've got this mix here with OEM aftermarket as a little bit of a reason for the margin pressure. What kind of improvement do you need to see in aftermarket to maybe help offset that OE strength? Is it just getting back to a more normalized sort of --?

I would say, you can almost look at the differences in growth this year between the two. The OEM grew faster than the aftermarket, or we have an aftermarket almost flat, and the OEM up whatever we said, to -- I'm saying this from memory now, about 10%. That generated about a one-point margin movement. You can work backwards on that.

Okay, fair enough. Perfect. Thanks guys. I will jump back in the queue.

John Godyn, Morgan Stanley.

Thanks a lot for taking my question here. I wanted to follow up on the M&A pipeline.

Nick, I think you said that you had the ability to do $1 billion in deals. When we look out 12 months to 18 months, of course, we do not know what deals are going to pop. Like you mentioned, it's difficult to predict, but should we be surprised to see $1 billion of deals? If you could just help add some clarity (multiple speakers) pipeline.

Yes. That is purely -- all that is is a math calculation to say how much we could do. That is not speaking at all to what may or may not be available. We wanted to be sure, and wanted to be sure our shareholders knew, that after we paid this dividend out, it didn't materially impact our ability to buy. That was the point of that.

Got it. And could you add some color on the pace or nature or activity levels around M&A conversations going on -- in the background? Of course, it's difficult for us to quantify, but any kind of qualitative commentary would be helpful.

I can't say this significantly, if I say the chatter -- I can't say it's particularly higher or lower than it was over the last three or four months. Obviously, there's three less companies on the list than there were a month ago, because we bought them. But other things fill in.

Great, thanks a lot.

Gautam Khanna, Cowen and Company.

Yes, thanks. Gautam Khanna here. Nick, can you comment on your comfort going above your six times -- that number you throw out sometimes -- of six times as we hear comfort zone on leverage. Given the aftermarket seems to be strengthening, are you comfortable going to seven, or perhaps above that?

I would say that we don't have a hard rule here. Our general range is in the four to six times.

We've said, and we continue to say, that we're willing to be outside of that range for short periods of time if the circumstances dictate. I could envision a situation that you got -- that you were willing to go below it if there was either something pending or you had some particular concern.

And we surely, as you see here -- we went up, what did we jump up to, 6.2 or 6.3? Something like that? But we expect we will be down in relatively short order into the range we typically run.

I don't -- I think we gave you the rough range. When we move outside of it, there's usually some transient reason that it makes sense to do for a short period of time.

Got it. But you are not structurably comfortable running well above six?

It depends on the facts and circumstances. We haven't changed our fundamental idea of where we target.

Okay. And just to switch subjects, so I understand the share count better, have both of the tranches, the $170 million originally before dividend adjustments, and the $160 millions clearly come into the share count, but is the $170 million the other stretch target? Has that also --

No. That is still open.

How many shares (multiple speakers)

Boy, how many shares is the $170 million? About 5 million -- no, about 500,000 shares would be impacted by the $170 million.

So conceptually, we could have the 56.9 going forward could rise by 500,000?

That would take place during -- it could take place in FY 2014.

Okay. And given -- obviously, you guys have done a great job and have well earned -- so no criticism there. My question is -- what are you guys going to do to realign longer-term interests with the shareholders?

Are you guys going to issue a similar plan, five-year options, what have you? What is going to be new in this year's proxy relative to what we've seen recently?

I don't know that I'm following your question. Let me see where at least I'm coming from on that. I don't see anything disconnecting. We are still primarily compensated on our equity, and the Company will continue to do that. So I guess I'm seeking what is you're after here on this.

I guess I'm asking, if I recall, you had a two-year extension to the existing plan, right, to 2015 on the option grants? Is there a new plan in the works that runs out for a longer period of time that we could expect to see?

Okay, I get it. Typically what we do, and I will speak now to the Senior Management, and we typically do this also for the Operating Management, we renew -- we give a new award -- Let me put aside -- assuming someone is not promoted into a new job, because that is handled differently.

But in the existing job, what we typically are do -- and at least anticipate continuing to do, is every two years, a person gets a new, two-year award that they vest fourth or fifth year out in front of them. So the idea is to always have four or five years of performance-based vested options in front of you. If you follow that.

We used to, some number several years ago, let them -- up until about three or four years ago, probably -- we'd give out five years at a time. The we'd let them run down to almost zero, then reload everybody. We decided to smooth that a little more.

Got it. So that would be the -- Okay, that's great. I appreciate it.

I think you get to the same place, but we didn't want this cliff thing going on.

Understood, thanks.

Amit Mehrotra, Deutsche Bank.

Thanks, good morning. It is Amit here for Miles. Nick, just another question on the commercial aftermarket inflection point comment on the press release. Maybe you can provide the book-to-bill for commercial aftermarket in the quarter, and also how defense order trends are looking into the end of the fiscal year?

I would say the book-to-bill in the commercial aftermarket was a little better in the quarter. It's up about, what did I say, 4% for the year? It is up a little less than that for the quarter, though I wouldn't -- I draw more conclusion from the full year book-to-bill.

The book-to-bill for the year is running in defense ahead -- I want to say, did we publish that number? It's running -- I don't remember the exact number.

That's a quarter.

Oh, that's just a quarter. If I can find it here before we get done, I'll tell you. It looks like it's running -- that's against bookings and shipments?

Yes, bookings and shipments.

It's running ahead -- it looks like almost 10%, though actually in this last quarter, it was below. So I wouldn't draw much from that, just because it's running strongly ahead for the year.

Okay. Just one question, a follow-up on the M&A, one question on the pricing environment. Obviously, general economic conditions are getting better, so I'd just be curious if deals are getting tougher to do because of price expectations.

I can't say I've seen that. I can't say that it has changed materially.

Okay. One last question to follow-up on Gautam's question on the share count. If the stock stays where it currently is -- stock price stays where it currently is through September, is there any dilution that we should expect beyond what was reported in the third quarter? I was under the impression that maybe another slug of accelerated vesting, but --

Not in the fourth quarter. Others will take place, it will come probably more readily in FY 2014.

Okay, great. Thank you.

We don't anticipate any in the first quarter either.

Okay. Thanks a lot.

Thank you. A question --

Just let me -- this is Nick Howley. Let me back up a minute. I had the wrong number. The bookings to shipments for defense for the year are 7% about, not 10%. Right?

Yes.

It is always the danger of just pulling the number quickly off the chart.

J.B. Groh, DA Davidson.

-- dead horse -- what's that? On aftermarket, are you seeing -- is there any product line differentiation, or is there a -- are the pockets of strength associated with any, say, engine or anything like that? Or is there any discernible patterns there that give you some clarity?

Yes, I would say, and this is subjective. I don't have a good number for you. Though Ray and I have been doing next year's business plan reviews, so we've been getting a pretty good subjective feel here.

I would say the discretionary-type product lines, or the guys running them, are still not feeling so good. The ones that are less discretionary are feeling a little more upbeat.

So that would be maybe interior product, not as strong as something an engine would be, an example?

Yes. That would be an example. Now it depends on the interior product.

But that would be -- an example might be faucets, interior faucets. If the faucet gets ugly and just drips a little bit, you cannot replace it. Or bin latches. You can let them get sloppy.

Got you, okay. Then in defense, same sort of thing. Is it aftermarket or OE that is really driving the unexpected strength there?

I don't know that I can draw a clear distinction there. Probably both a little better than we thought.

Okay. And then a quick one for Greg, what should the run rate on SG&A be inflated this quarter for the reasons you mentioned?

The full year it will be at 13%, and that will have some of these unusual charges I just talked about.

So on a GAAP basis, 13% for the full year.

13% on a GAAP basis with those charges.

Okay. All right. Thank you very much.

Karl Oehlschaeger, RBC Capital Markets.

Nick, you talked about capital deployment to the shareholders and cash versus buybacks. Can you talk about how you evaluate between the two. And maybe related to that, is it fair to think about special dividends making up maybe a similar percentage of cash deployment going forward, as it has over the last couple years?

Let me ask -- to go forward first. I just can't make any prediction there. That's just a function of how much cash we think is available based on how much we're generating, what we see, and what our needs are. To some degree that's why we handle them as special dividends.

But we do generate a lot of cash, and to the extent that we have extra cash, we will continue to do things with it. Or we'll continue to give back to the shareholders. I would say as far as the special dividend versus buyback, I would say we will look at that on a case-by-case basis.

As a general rule, and again, many times the specifics in the situation overrule it, but as a general rule, a significant payout, like we just did -- 10%, 15%, 20% of the value that would make you buy back in 10% to 20% of the shares, probably would concern us about the -- that we could get that done quickly and we would not have a lot of execution risk on the price. As the number dropped down lower, we'd probably be more inclined to do a buyback. We view them as the same thing, just call them one way or the other.

Also, maybe can you talk about --

Also, by the way, I would add, there was -- at least now and there could be in the future, there is some tax advantage due to the return of capital calculation of the dividend.

Right. Now on -- defense has been stronger than expected, I guess, and maybe this is difficult to get a sense of, given the way the market has been going. But if you think about defense aftermarket over the next 12 months with the sequester, and maybe OCO spending coming down, how are you seeing that? Or do you have any good sense?

I think we'll wait and forecast 2014 when we give the guidance out for 2014.

Okay, fair enough.

Our next question is -- I do apologize. We have no further questions in the queue at this time.

I would like to turn the call back to Liza Sabol for closing remarks. Thank you.

Thank you again, Chris. Thank you everyone for calling in and participating on this morning's call, and I'd like to remind you to look for our 10-Q that will be filed tomorrow.

Thank you. Ladies and gentlemen, that does now conclude your conference call for today. You may now disconnect your lines. Have a great day. Thank you very much for joining.