TransDigm Group Inc (TDG) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2013 TransDigm Group earnings conference call. My name is Celia and I'll be your operator for today.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Liza Sabol, Investor Relations. Please proceed.

Thank you, Celia. And welcome, everyone, to TransDigm's fiscal 2013 fourth-quarter earnings conference call. With me on the call this morning are TransDigm's Chairman and Chief Executive Officer, Nick Howley; President and Chief Operating Officer, Ray Laubenthal; and our Executive Vice President and Chief Financial Officer, Greg Rufus.

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

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 SEC. 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 earning 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 for those measures.

I will now turn the call over to Nick.

Good morning, and thanks again for calling in here about our Company.

As I usually do, I'll start off with some comments about our consistent strategy; then an overview of a busy fiscal year 2013, the financial performance and some market summary for 2013; and our initial guidance for fiscal year 2014. A fair amount to cover.

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 aerospace cycle. To summarize why we believe this, about 90% of our sales are generated by proprietary products; around three-quarters of our net sales come from products for which we believe we are the sole source provider. Excluding the small non-aviation business, about 54% of our revenues and a much higher percent of our EBITDA comes from aftermarket sales. Aftermarket revenues have historically produced higher gross margins and have provided relative stability in the down cycles. Because of our uniquely high EBITDA margins and relatively low capital expenditure requirements, we have year in and year out generated very strong free cash flow.

We pay close attention to our capital structure and view it as another means to create shareholder value. As you know, we have in the past and continue to be willing to lever up when we either see good opportunities or view our leverage as sub-optimal for value creation. We typically begin the delever pretty quickly. In keeping with that philosophy, we paid out $2 billion of special dividends and related payments in fiscal year 2013, or about 25% of our beginning of the year market equity value. During the year, we also raised about $4.3 billion of both senior debt and high-yield bonds at an average interest rate of around 4.4%. About $2.2 billion of this was used to reduce our interest expense, extend maturities, and increase flexibility.

After paying the special dividends and making three significant acquisitions for about $475 million, we closed fiscal year 2013 with about $565 million in cash, $300 million in unrestricted undrawn revolver, and additional capacity under our credit agreement. We ended the year with a net leverage of about 5.5 times EBITDA.

Just to run through again, in deciding to pay out the special dividends this year, we looked closely at our choices for capital allocation. To remind you, again, we basically have four. Our priorities are typically as follows -- first invest in our existing business; and second, make accretive acquisitions consistent with our strategies. These two are always our first choice. Third, we can pay off debt, but given the low cost of debt, especially after tax, this is likely our last choice in the current capital market conditions. And lastly, we can give the extra back to the shareholders either through a special dividend or stock buyback, as you saw us do this year.

As we look at our likely needs for acquisitions and internal investment requirements, we believe, based on what we knew then and what we know today, that we had adequate cash and/or debt capacity for our near- or mid-term needs. Combining that with historically low interest rates and extensive capital availability, we had an opportunity to accelerate returns to our shareholders while maintaining adequate liquidity and borrowing capacity to meet our near- and mid-term operating and acquisition needs. Thus, the roughly $2 billion of payouts.

At 9/30/2013, based on current capital market conditions, we believe we have adequate capacity to make over $1.5 billion of acquisition without issuing additional equity. This capacity grows as the year proceeds. This does not imply anything about acquisition opportunities or anticipated levels of acquisition in 2014.

We have a well-proven value-based operating strategy focused around what we refer to as our three value drivers -- new business development, continual cost improvement, and value-based pricing. We stick to these as the core of our operating management methodology. This consistent approach has worked for us through up and down markets while allowing us to steadily invest in new business and platform positions.

We have also been successful in regularly acquiring and integrating businesses. We acquire businesses with proprietary aerospace products and significant aftermarket content. We have been able to acquire and improve aerospace businesses through all phases of the cycle. As you probably know, in fiscal year 2013 we acquired 3 such aerospace businesses, with over $200 million of combined revenues and about $45 million of EBITDA for a total price of approximately $475 million. All 3 of these businesses are proprietary aerospace businesses with significant aftermarket content, and we expect all to generate returns above our private equity-like targets.

Through our consistent focus on our operating value drivers, a clear acquisition strategy, and very close attention to our capital structure and capital allocation, we've been able to create intrinsic value for our shareholders for many years through up and down markets.

I'd like to address now the status of our commercial aftermarket. In our Q3 of this fiscal year, we believe we began to see signs of a market recovery. We, as many in the industry, have been a bit surprised by how long this soft market has continued, especially in light of the decent underlying market trends. The reported Q4 commercial aftermarket revenues were flat, and the annual revenues were roughly flat. However, the quarterly comps are messy, with a lot of noise, particularly around some of the acquisitions. As we dig deeper, we see this early stage and spotty recovery appears to have continued into our fiscal year Q4.

To expand on this a little bit and share with you how we look at this internally, our pro forma revenues on a same-store basis for Q4, normalized primarily for changes in business practices at recently acquired acquisitions, distributor changes, and some related inventory movements, appear to have trended up in the range of 4% versus the prior Q4, and about the same percent sequentially.

Additionally, we take weekly samples of direct sales of our spare parts to airlines, both from certain operating units and our larger distributors. This is a sample of a significant percent of our spare parts revenues, and showed increases a bit above the mid-single digit percent, both in Q4 of fiscal year 2013 versus the prior, as well as Q4 fiscal year 2013 versus Q3, or sequentially -- so roughly in the same range as the normalization adjustment I talked about above.

I would say it is too soon here to declare victory. We are very comfortable with our market positions. I doubt this recovery will be linear. I suspect there will be quarterly ups and down. Many forecasters, however, believe, and our data seems to indicate, that we are at or past the commercial aftermarket inflection point. Time will, of course, tell here. As a point of interest, as we look at Q1 of fiscal year 2014, it has about 10% less working or shipping days than Q4 of fiscal year 2013. So it may be tough to see an absolute sequential improvement.

Now to summarize fiscal year 2013. It was a busy year. As I said before, we raised about $4.3 billion of debt. We acquired Arkwin for $286 million. We acquired the GE Whippany Actuation business for $149 million. We acquired Aerosonics for $40 million. We paid out $2 billion, or about 25% of our initial market value, in two special dividends. We continued integration of our various acquisitions, and we dealt with a softer commercial aftermarket than we anticipated. All the while, we think we continued to generate real intrinsic value in our new and existing businesses.

Turning to the performance, I remind you again this is the first quarter and full-year report for our fiscal year 2013. Our year ends September 30. As I've said in the past, quarterly comparisons can be significantly impacted by OEM aftermarket mix, large orders, inventory fluctuations in the system, modest seasonality, and the like. Although the commercial aftermarket was soft, fiscal year 2013 was generally a good year for TransDigm. GAAP revenues were up 17% versus the prior Q4, and 13% on a full-year basis. Pro forma revenues -- that is, if we owned the same mix of businesses -- was up about 5% over quarter versus quarter, and about 3% on a full-year basis.

Reviewing the revenue by market category, again on a pro forma basis versus the prior Q4 -- that is, assuming we owned the same mix of businesses in both periods -- in the commercial markets, which make up roughly three-quarters of our revenue, total commercial OEM revenues were up 10% versus prior Q4, and 7% on a full-year basis. This is primarily driven by commercial transport OEM revenues. The commercial transport growth rate primarily reflects increase in airframe production rates. The smaller, full-year business jet segment growth was lower, more like in the 3% range. I remind you the total commercial aerospace OEM was up 23% the prior year.

Total commercial aftermarket revenue comps are a bit messy, as I said before. As I described, normalized on a Q4 versus Q4 basis, they appear to be trending up roughly in the mid-single digit range, and about the same sequentially. Our individual operating units continue to be a little spotty, but about three-quarters, or 75% of our units, on the same basis were up in Q4 2013 versus the prior year Q4.

The defense markets, which roughly make up a quarter of our revenue -- our defense revenue continues better than we anticipated. Revenues were up about 11% versus the prior-year fourth quarter, and 7% on a full-year versus full-year basis. The UK Ministry of Defence new Clarion product shipments made up about 2% of the full-year 7% growth. Adjusted for the UK order, full-year incoming orders are still running slightly ahead of shipments. We remain cautious about trends in the military.

In total for the year, our revenues for commercial aftermarket were lower, while commercial OEM and military revenues were better than we expected going into the year.

Now, moving on to profitability. I'm going to talk primarily about our operating performance, or EBITDA as defined. The as defined adjustments in Q4 were primarily due to acquisition-related costs. Our EBITDA of about $248 million for Q4 was up 15% versus the prior Q4. On a full-year basis, our EBITDA as defined, again, was just about $900 million, or up about 11% from the prior year. The EBITDA as defined margin was about 46% of revenues for Q4. On a full-year basis our EBITDA margins were just about 47%. The full-year margins was diluted about 2% from the impact of acquisitions, and to a lesser extent, the commercial aftermarket mix. The Q4 margin was also diluted about 2.5%, primarily for the same reasons.

With respect to acquisitions, we continue actively looking at opportunities. The pipeline of possibilities is pretty active. It is about the same mix of sizes as we usually see. We are seeing a bit more defense-related businesses than we probably have in the past. Closings are tough to predict, but we remain disciplined and focused on the value creation opportunities that meet our tight criteria.

Now, moving on to 2014 guidance, which I think is slide 6. Once again, the military businesses budget is unclear. The rate of recovery in the commercial aftermarket seems to be turning up, but is still somewhat uncertain heading into 2014. This is our best current estimate. As the year proceeds, we will let you know if our views change. But based on the above and assuming no additional acquisitions in 2014, our guidance is as follows. The midpoint of our 2014 revenue guidance is about $2.19 billion or $2.2 billion, or up 14% on a GAAP basis. At the midpoint of the guidance, the growth is roughly half organic, with the balance coming from a full year of acquisitions.

Q1 of fiscal year 2014 is currently anticipated to be lower than the other quarters, roughly in the same relationship as you've seen in past years. The midpoint of 2014 EBITDA as defined guidance is $1.02 billion, or about 47% of revenue. This includes about 1.5% of margin dilution from prior acquisitions. The businesses, excluding the three acquisitions, are anticipated to have margins of approximately [49]%. In total, this EBITDA is up about 13% year over year.

The midpoint of our EPS as adjusted is anticipated to be $7.16 a share, or up about 4% versus the prior year. This is negatively impacted by interest expense, tax rate, and a higher share count. Greg will review the details. On a pro forma or same-store basis, this guidance is based on the following growth rate assumptions. Commercial aftermarket revenue growth is assumed to be in the high-single digits, based on worldwide RPM growth of about 4% to 5%. We are still cautious here and expect growth to be lower in the first half than the second half of our fiscal year. We anticipate seeing our revenues begin to more closely reconnect to air travel as the year proceeds.

Defense military revenue is estimated to be about flat versus 2013; this assumes no significant additional sequestration impact. We will continue to evaluate this, of course, as the situation unfolds. The commercial OEM revenue growth is anticipated to be in the high-single digit percent range. Without any additional acquisitions or capital structure activity, we expect to have almost $1 billion in cash at the end of 2014; $300 million in undrawn revolver. Assuming no acquisitions or capital structure activity, our net leverage is anticipated to be about 4.6 times EBITDA at the end of 2014. We also have additional capacity under our credit agreement.

In summary, 2013 is a decent year in a tougher commercial aftermarket environment than we expected. Hopefully, this sector has turned and the political situation stabilizes. But in any event, I am confident that our consistent value-focused strategy and strong mix of businesses, we can continue to create long-term intrinsic value for our investors.

Now, let me hand it over to Ray, who will discuss some of the operating high points of the year.

Thanks, Nick.

As Nick mentioned, in total we had a good fourth quarter and a good finish to another very busy year. The consistent application of our operating value drivers and the successful integration of our most recent acquisitions continue to add solid value to TransDigm.

Let me explain in a little more detail our fiscal 2013 and fourth-quarter operational value creation. In spite of the slow economy, we are able to apply our value drivers and create real value. As Nick mentioned, our year-over-year pro forma growth was about 3%. A higher mix of commercial OEM work, coupled with the lower commercial aftermarket revenue, made managing our cost structure challenging. However, we continue to manage our resources tightly, and we are able to continue to reduce our pro forma and total headcount. Our continuing productivity efforts included consolidating certain acquired manufacturing operations, strategically sourcing material from efficient domestic and offshore sources, and moving various manufacturing operations to our Mexico, Malaysia, Sri Lanka, and China facilities.

Lastly, we continue to invest in our existing domestic facilities, keeping them up-to-date and productive. We also continue to provide innovative new business solutions to our broad customer base. We have successfully expanded our platform content with significant new business in both the commercial and military markets.

In the commercial transport market, we have developed many new applications and here's a few recent examples. Hartwells has been awarded the development contract for ending cowl latches on the A320 Neo. They are also developing the tail cone and belly fairing hinges and latches on the Airbus A350. Champion recently developed and was awarded the ignition systems for the A350 auxiliary power unit. Adams Rite Aerospace is developing the lavatory faucets, valves, water heaters, and various door latches on the 737 MAX. They are also actively providing upgraded water-conserving lavatory faucets and equipment for several airlines' existing 777 fleet.

Our Dukes unit is providing the de-icing systems bleed air valves for the Bombardier C-Series and also for the Mitsubishi regional jets. Likewise, on those two platforms, Adel Wiggins continues to expand their composite fuel and hydraulic isolator applications. Our engineered laminates continue be specified on upgrades to business class seats, cabin walls, and flooring. Schneller has been awarded the Singapore Airlines 777 fleet business-class seat laminate refurbishment. Delta has also selected them to provide the laminates for their Boeing 717 interior refurbishment program; and American is using Schneller laminates on their upgrade business-class seats for their A321 and 777 fleet. On the new Bell 525 Relentless helicopter, Adams Rite is providing the door bolting systems, Aero Fluid Products is providing seven fuel system valves, and AeroControlex is providing the in-tank fuel boost pumps, the AP lube pumps, and various pitot tube probes for sensing airspeed.

In the military markets, we continue to be selected to provide upgrades on the C-130 J. Our Avionic Instruments group is now supplying the upgraded 400-amp transformer rectifier units that supply low-static clean electrical power on the aircraft's upgraded avionic and electrical systems. Our AmSafe cargo unit has developed automatic quick drop cargo release actuation systems, which allow military helicopters to automatically and quickly release underslung cargo loads remotely from the cockpit, thus reducing ground crew risk and speeding the military operational tempo.

On the new Cessna Scorpion, which they just unveiled the new attack jet, AeroControlex Group has been awarded eight throttle control actuators in gearbox applications. Champion will be supplying the igniters, Dukes is supplying several engine and windshield anti-icing valves, and Electromech is providing pitch trim and roll trim motor actuators. On the Alenia Aermacchi M-346, Avionic Instruments has won an order to supply three-phase electrical power inverters that provide upgraded clean power and expand electrical capacity of the aircraft. And on the C-17, Avionic Instruments is also supplying frequency converters that provide hospital-grade 230-volt electrical power for its central airborne medical equipment. These new engineered solutions and many others not discussed continue to expand our profitable product offering and add to future growth.

In fiscal 2013, we also acquired three proprietary aerospace businesses -- Aerosonic, Arkwin, and Whippany Actuation. Integrating these businesses created a flurry of integration and value creation activity. We quickly went to work on transitioning these businesses into TransDigm value-creation mode. As we have done with each prior acquisition, we applied our proven value creation process. We restructured the businesses and their product line focus groups, and implemented our value creation metrics. We focused the engineering and new business efforts on winnable and profitable new business, and we tightened up the cost structures.

Again, I would like to switch gears and talk about our management team. These acquisitions drove a significant number of management structure changes. Our continual emphasis on succession planning and talent development again paid off well for us. We were able to populate almost all of the key management positions with internal candidates. These proven candidates are steeped in our value-focused culture and value-creation processes.

During 2013 we promoted Jorge Valladares to Executive Vice President. Prior to this promotion, Jorge had been an operating unit President at both Adel Wiggins, and more recently, AvtechTyee. Jorge has also had significant acquisition integration assignments. We also added six new division presidents; all six were internal promotions. These internal promotions bring the strong TransDigm value-creation culture to their operating units. Then, below the division president's level, we've added 17 senior operational function managers. 16 of the 17 were also internal promotions.

We believe our succession planning and talent development system is working. We have a good pipeline of talented people exposed to our value-creation methods and our defined training programs. We believe the availability of promotable internal talent and our consistent succession development process effectively complements our disciplined value-creation methods, and is key to our ability to regularly acquire and integrate new businesses.

Now, let me hand it over to Greg, who will review our financial results in more detail.

Thanks, Ray.

Before we review the financials, you may recall last quarter I described in depth some of the unique items that would impact our fiscal third and fourth quarters. We incorporated all these items in last quarter's full-year guidance, but to review them -- first, in early July, we raised $1.4 billion of additional debt to pay a $22 special dividend on July 25. Directly related to the special dividend, we paid $95 million in dividend-equivalent payments to holders of vested stock options. You will see the impact of the additional dividend equivalent payment in our GAAP earnings per share, and the additional financing increased interest expense in our fourth-quarter results. Second, we successfully close the three acquisitions for a total purchase price of about $475 million in our fiscal third quarter. As a result, higher acquisition costs and purchase price accounting items were recorded in the fourth quarter. Lastly, in the third quarter, we adopted segment reporting and are now reporting on three segments.

Just to remind you, 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. Year-to-date sales for this segment are $872 million, which represents 45% of our total sales. The EBITDA as defined is $456 million, or 52% of sales, and represents 49% of our total segments EBITDA as defined.

The airframe 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 technologies. Year-to-date sales for this segment are $951 million, which represents approximately 50% of our total sales. The EBITDA as defined is $440 million, or 47% of sales, and represents 48% of our total segment EBITDA as defined.

The non-aviation segment includes operations that primarily develop, produce, and market products for non-aviation markets. Year-to-date sales for this segment are $101 million, which represents 5% of our total sales. The EBITDA as defined is $24 million, or 23% of sales, and represents 3% of our total segment EBITDA as defined.

And with that, let me now review the consolidated financials on slide 7. Fourth-quarter net sales were $540 million, up $77 million, or 17% from the prior year. The collective impact of acquisitions -- primarily Arkwin, Whippany, and Aerosonic -- contributed approximately $57 million of the additional sales for the prior period. Our organic sales growth was about 6% over the prior year, primarily due to the commercial OEM and defense markets. Reported gross profit was $283 million, or 52.4% of sales. The reported gross profit margin was approximately 3 margin points less than the prior year margin of 55.5%.

The dilutive impact of acquisition mix from primarily Arkwin, Whippany, and Aerosonic, was approximately 2 margin points. In addition, an increase in non-operating acquisition=related costs -- that is primarily inventory step up and start up expenses resulting from the three acquisitions we acquired in June -- reduced gross profit margin by approximately 1.5 margin points. Excluding all acquisition activity, our gross profit margins in the base business versus the prior-year quarter were up modestly, despite unfavorable OEM aftermarket mix, which negatively impacted the current quarter.

Selling and administrative expenses were 11.3% of sales for the current quarter, compared to 11.7% for the prior year. The decrease is primarily due to a lower run rate of stock compensation expense as a result of the accelerated vesting of 2.4 million stock options that occurred last quarter, and that was partially offset by higher acquisition-related costs.

Net interest expense was $81 million, an increase of approximately $26 million versus the prior-year quarter. This is a result of an increase in our weighted average outstanding borrowings to $5.7 billion in the current quarter, versus $3.6 billion in the prior year. The additional debt was incurred to fund a $12.85 dividend paid in November and the $22 dividend paid in July. We used cash to fund the acquisitions. The weighted average cash interest rate on total debt at the end of the current quarter is approximately 5.4%, compared to 5.7% at the end of last year.

Our effective tax rate for the year was 32.5% for fiscal 2013, compared to 33.4% for fiscal 2012.

Net income for the quarter decreased $4 million, or 4%, to $84 million, which is 16% of sales. This compares to net income of $88 million in the prior year. The decrease in net income primarily reflects the higher interest expense in acquisition-related costs, partially offset by the growth in net sales and the lower effective tax rate.

Our GAAP loss per share was $0.20 per share in the current quarter, compared to earnings of $1.63 per share a year ago. In addition to the increased interest expense and other items previously mentioned, the current quarter reported loss per share was significantly impacted by the $95 million of dividend equivalent payments, or $1.67 per share, in connection with the $22 dividend. As you recall, the accounting treatment requires this payment to be deducted from the actual net income before earnings per share is calculate. The details of this calculation are included on table 3 of this morning's press release.

The adjusted earnings per share was $1.75 per share, an increase of 2%, compared to $1.72 per share last year. In addition to higher interest expense just mentioned, the fourth-quarter earnings per share was negatively impacted by $0.10 due to higher share count of 56.9 million shares, compared to 53.9 million shares in the prior period.

Since this is our fiscal year end, let me take a minute to quickly summarize the full-year results. Net sales increased $224 million, or by 13%, to end our year at $1.9 billion. Acquisitions contributed approximate 75% of the increase in sales. Reported gross profit dollars increased 11% and was 54.5% of sales, compared to 55.6% in the prior year. The full-year margin would be closer to 58% after adjusting for the dilutive impact of acquisitions and unfavorable OEM to aftermarket mix, versus 57% on the same basis in the prior year.

Selling and administrative expenses of 13.2% of sales for fiscal 2013 is higher than the 11.9% of sales in fiscal 2012, due primarily to the higher non-cash stock compensation expense. This expense as a percent of sales increased to 2.2% this year from 1.1% in the prior year. Additionally, the current year includes incrementally higher acquisition-related costs of about 0.5 points. Net interest expense increased $59 million due to the additional debt incurred to fund the two special dividends as previously mentioned. In addition, fiscal 2013 included $30 million of refinancing costs associated with refinancing the senior secured credit facility this past February.

GAAP net income was $303 million, or 16% of sales. GAAP earnings per share was $2.39 per share, compared to $5.97 per share a year ago. However, on an adjusted basis, which excludes the dividend equivalent payments, the non-cash compensation costs, and the acquisition-related and refinancing costs, earnings per share was $6.90 per share this year, up 3% from $6.67 a year ago. When comparing GAAP EPS of $2.39 per share in the current year to the adjusted net income of $6.90 per share, the difference of $4.51 is comprised of the following items -- $3.11 related to the dividend equivalent payments, $0.60 for non-cash compensation expense; this includes an additional $25 million of expense in quarter 3 due to the accelerated vesting of options. $0.41 for acquisition-related expenses, including integration costs such as start up, inventory purchase accounting adjustments, and backlog amortization; and $0.39 for refinancing costs and other charges. It was a hectic year, but well worth it.

Switching gears to cash and liquidity, the Company generated $470 million of cash from operating activities. After consideration of the financing of the trust dividends paid and acquisitions made, we closed the year with $565 million of cash on the balance sheet. The Company's gross debt leverage at September 2013 was approximately 6.1 times pro forma EBITDA, and 5.5 times on a net basis. As we look forward to FY14, we estimate the midpoint of our GAAP earnings per share to be $6.32, and as Nick previously mentioned, we estimate the midpoint of our adjusted earnings per share to be $7.16. As we disclosed on slide 9, the $0.84 of adjustment to bridge GAAP EPS to the adjusted EPS includes the following assumptions -- $0.33 for dividend equivalent payments versus the $3.11 this year; $0.30 for non-cash stock comp expense versus $0.60 this year; and $0.21 of carry-forward activity related to the Arkwin, Whippany, and Aerosonic acquisitions.

Nick provided color on the FY14 sales and EBITDA as defined. I will walk through and explain why adjusted net income per share only increased 4%, despite sales and EBITDA as defined growth of approximately 13%. All growth percentages assume the midpoint of the guidance. Depreciation and amortization -- and that is excluding the backlog amortization -- is expected to total $72 million. This is a 9% increase over 2013. Interest expense is expected to increase approximately 20%, or almost $54 million, to $325 million in FY14. We used the weighted average interest rate of 5.5%.

Our effective tax rate in FY14 is expected to increase to be around 34%, compared to the 32.5% this year. And our adjusted net income will be up about 8% versus FY13. Finally, our weighted average shares outstanding will increase about 4% to be approximately 57.2 million, compared to 55.1 million this year. As a result of these items, the adjusted earnings per share of $7.16 is approximately 4% greater than fiscal 2013. Finally, with regards to our liquidity and leverage, we expect to generate $450 million of cash. Again, assuming no acquisition activity, we expect our gross debt leverage to be approximately 5.6 times EBITDA as defined, and our net leverage ratio will be near 4.6 times our EBITDA as defined at September 30, 2014, or almost a full turn of deleverage.

Now with that, let me hand it over to Liza to kick off the Q&A.

Thank you, Greg.

In order to give everyone the opportunity to ask questions, I would ask that you limit your questions to two per caller. If you have further questions, please reinsert yourself into the queue and we will answer those as time permits.

Operator, we are now ready to open the lines.

Thank you.

(Operator Instructions)

Carter Copeland, Barclays.

Hello, guys.

How are you doing?

Just a couple of quick ones, the first on the margin. The comment you made, Nick, around the core business at 49% --

Right.

-- next year, it looks like that is comparable to where you are exiting this year. And you don't -- you are not implying any adverse mix shift OE versus aftermarket or commercial versus military, but there should be some good volume leverage there. I wondered if you might just elaborate on why it doesn't seem to be any expansion there?

I don't know if I can answer that, Greg.

Greg, I didn't follow that either. (Multiple Speakers)

Greg, we've been going back and forth on so many different margins.

Yes, yes. The question I guess was at least when you do the adjustments and you adjust the other one, you'd look like the margins are about flat, is that sound like?

If you take the 47% and you add back the 200 basis points, you get to 49% on the core business which is what you are guiding to for next year. So, you got some incremental volume and you don't have the same mix headwinds for next year, so I was just wondering why it wasn't up?

We do have some special not repeat items this year, so when I look at it my way I was getting a margin improvement about 1.5 -- (Multiple Speakers)

Yes, I thought we were too, that's why --

Carter, you got to take FY 2013 because we still had one or two what we call one-time favorable adjustment or events that took place.

Okay. Okay. That is fair. And the second one --

We think the underlying organic number is about 1 point.

1 point of expansion?

Yes. I think that's what --

And on the revenue --

Greg says a hair more, by the way.

Okay. On the revenue side, the pro forma versus normalized aftermarket growth --

Yes.

-- it sounds like you pulled something out of distribution, did that happen this quarter?

Yes, maybe --

Can we estimate the next couple quarters?

Yes, that is worth a little clarification. There is a couple of things, Carter, when we -- the data points we were getting and the stuff we were picking up in the industry and the data points we were picking up right in our units didn't exactly seem to jive with what our segment numbers said. So we dug into that a little more, and there are probably eight to ten items that impacted that, and the big ones or the most significant ones are, I will say, primarily acquisition related. And some of them are make things a little higher in the previous quarter and some of them make things lower in this quarter, but let me give you a sense of it. At the Whippany business that we bought from GE, the distributor inventories were too high, I think we told you this last quarter. And we decided when we saw this in diligence and decided we had to draw them down. So we purposely drew down their inventories this quarter and that will continue a little into next year.

At the Arkwin business that we bought, they had a consignment inventory agreement with the distributor, we essentially that they had recognized the way they look at it wasn't a similar consignment, it was a sale. We did away with that and changed the contract, but I'd essentially meant we did not recognize there wasn't revenue to be recognized because we had to burn off the consignment inventory distributor. We divested a -- if you may or may not recall, we divested a distribution business in Q4 of last year, but we didn't sell the AmSafe net product line with it. We kept that ourselves, then we had to find and restock another distributor in the prior Q4, and we also replaced the Pacific Rim distributor for one of our recent acquisitions, and that sort of got the inventory bouncing around. So that will give you a sense of the stuff, those are some of the most significant ones that we tried to adjust for.

That's it --

I think the other way that I got some comfort here, and is that we did these direct sale channel checks in our businesses and in our large distributors. And saw somewhere a little above the mid-single digit pick up there, too.

Okay. So, the guidance for next year on the high-single digit on the commercial aftermarket corresponds to the pro forma growth? Or does that correspond to normalized?

I get -- that is the number, that is the number we expect to see.

(multiple speakers) It's pro forma.

Okay. That will be, that will be --

Carter, let me back up the minute. It is same-store sales basis.

Exactly.

In other words it is not GAAP because GAAP number will always be bigger, right? Because we are buying it.

Okay, thank you for the color, guys.

Robert Spingarn, Credit Suisse.

Hello, good morning, guys.

Good morning.

Just going back to the aftermarket sales you just talked about, and understanding that there is a little bit of growth there, if you look through some of the items that Nick just reviewed. But it does seem to suggest that even at the low growth rate that you've come up with their against the flat, that volumes were probably down for the year and for the quarter with offset to some extent by pricing. I wanted to ask you, how we could look at the difference between volume declined or just relative volume performance between out of production models and in production models? Spares for those two groups?

Rob, I don't know that I can -- I don't know that I can tell you that, the real answer is I don't know the answer, but I don't know of anything unusually disproportionate between them.

How would you characterize your relative exposure to the two?

Oh, our exposure to any out of production you're talking about --

Yes, the 737 class.

Old 737s, 727s, MD-80s, that kind of stuff is that what you mean?

75s, that kind of thing.

Yes, I mean, I haven't looked at them for about a year or so now, but I know the numbers that it was running were somewhere in the -- Greg, I want to say 3%, 4%, 5% of our aftermarket volume of the real old stuff? Yes, yes.

5% is high.

I may be high on that.

You're high on 5%.

Is not a big number.

Okay. And then I wanted to ask, and maybe we can go into more detail offline on that, but I wanted to also ask you about defense. So I think it has been better than expected the last couple of years?

Yes.

And wondering in your assumptions for flat next year, don't you think you might see some negative catch up from higher volumes this year?

Rob, that is clearly a risk. That is clearly a risk. And I wouldn't --

I've seen this and unders a little bit.

I wouldn't tell you that is not a possibility.

Well, and then maybe we can fine tune it a little bit. Have you worked through, if sequester were to happen as written, since it is not in your number, what kind of guidance sensitivity is there to that?

That is a very hard number, there are so many things bouncing all around. Rob, when we say a flat year over year, remember there is price in there. Right? So a flat year over year means an absolute decline.

Okay, fair enough.

So pick your number, but it's probably above inflation. So could you be down 10% rather than 4% units? If you told me that, I don't think I could argue with you. I wouldn't say that doesn't appear to our operating units to be what they expect, and at least so far from our bookings, we don't see it or we haven't seen the fourth quarter.

Okay. And then just, Greg, a clarification. If I look at your guidance and what you've said about the contribution of the acquisitions, is it fair to calculate you had about $80 million, $90 million in 2013 from these three businesses? And next year it will be about the $200 million or little higher? And so about half of your -- what Nick said, about half of your revenue growth is from that and then the other $100 million or something is?

Right, yes, it's roughly half of that. Yes.

Okay, thank you.

David Strauss, UBS.

Good morning.

Good morning.

Greg, you mentioned about I think it was $450 million in cash generation, and Nick, you said about $1 billion. I would've thought it would've been a little bit higher than that by the end of next year maybe around $1.1 billion. Is there any unusual movements in cash next year? It looks like you're forecasting about flat in line with this year?

We will pay quite a bit more in cash taxes next year. This year my cash taxes were about $82 million, which was extremely low versus my provision. Next year my cash taxes are going to be more like $160 million --

Okay.

-- so you've got to factor that if you are just looking at year over year. That may be one of the things that might help you, Dave.

Yes, that is probably it. Back on the defense side, Nick, how long is Carion over or how much longer does that run? Does that benefit your numbers at all of next year?

Yes, it benefits it some. If we're lucky or hopefully we could sell some more, but we booked about $18 million, I want to say $18 million of it, and roughly half of it shipped this year and half of it will ship next year.

Okay. So ex that, things on your forecast is even a little bit worse than might be taken at face value?

Yes, took that out, you'd be down a little more.

We are actively trying to roll that out to other governments, and we have active negotiations that I don't want to get into the details with with other governments on that product.

Okay. And then lastly, Nick, any additional color perspective on discussions with Boeing, partnering for success, or royalties, or any progress update with regard to that?

I think, David, we got to say the same thing we always said. We are not going to get into the details of the negotiation with our customer. It's an ongoing activity, I think we, along with many people around the industry, probably the activity level has sped up a bit in the last quarter. But I don't know that our position is a heck of a lot different than it has been in the past.

Okay. Thanks, guys.

Yair Reiner, Oppenheimer.

Thank you. Just some questions on the M&A environment. You mentioned that there are more prospects right now on the defense side. Can you give us a flavor for the difference in the purchase price and also maybe can discuss your tolerance for turning TransDigm into more of a defense company? What is the limit you are willing to go towards?

We don't have any rule on that. What I said is we see more -- I didn't necessarily say there were more defense businesses than there were commercial. I said there were probably more defense businesses in our prospects than there are typically are. Doesn't mean there are absolutely more than there are commercial. We evaluate defense businesses just like we evaluate commercial businesses. They, in all likelihood, the revenue is going -- the growth is going to be lower or declining which means the price, we can't pay as much of a price. But we still have to see a private equity like return, which we see say is a 20% IRR on our equity in the thing, but we look at them the same way. We don't have a rule for what percent of defense we go to, but we have no intention of turning this into a primarily defense business.

Got it, thank you. And then just one more, you mentioned that in the current interest rate environment, paying down debt is not very appealing and that makes sense. Where do interest rates need to go for you to think maybe it is good to take some leverage off and conservatize the balance sheet?

Well, I would, first, I don't know the answer to that. It would be very dependent on what the situation with acquisitions and the like was at the time. Our first choice is always going to be to fund our existing businesses to make accretive acquisitions, so that is a tough one to answer theoretically. But I would also say that our goal here is to give our shareholders over time private equity like returns. Which we define as 15% to 20% return on our equity over time. You are not going to get that without staying in a reasonable leverage level.

Thank you.

John Godyn, Morgan Stanley.

Hello, guys. Jeff John Godyn here. I wanted to follow up on the last question on M&A. We've seen other acquisitive companies out there respond to what might be a little bit of a tougher aerospace deal environment by looking at verticals outside of A&D, oil and gas has come up. Is there any appetite for TransDigm to look outside of A&D for M&A.

Not at this time. We think we've got enough runway in front of us. If that turned out to be the case, then we would have to decide. But we have other alternatives. One alternative is to open the aperture up a little on proprietary content, then you see many more things. That is not our desire nor our intention right now, just to be clear.

But that is all within aerospace.

Yes, but that's all within aerospace. The other alternative we frankly have, we always have, is to be more aggressive with our capital structure and more payout if we don't see enough to buy that meets our criteria. But our goal now hasn't changed. We want to buy proprietary aerospace businesses with significant aftermarket content.

That's very helpful, and if I could ask one on aftermarket in general. How much capacity is there to accelerate price growth to offset some of the volume weakness, or some of the volume weakness that we are seeing price sensitivity among customers and them responding one way or another?

No, it is just the demand is -- I don't want to speak much to price, what we might or might do with the prices, but there is not a lot of elasticity in demand here for the price. This stuff tends to be sole source.

Thanks, guys.

Robert Stallard, Royal Bank of Canada.

Thanks, guys. Good morning

Good morning, Rob.

Nick, I think on the last call you mentioned you had a survey done about what was going in the aftermarket. And one of the things you called out was the Asian airlines destocking and differing.

Right.

Have you seen our regional trend improve since then?

I honestly can't say whether that's changed much in the last 90 days, I don't think it has. Clearly, the European airlines have gotten no better. And I don't believe the situation has changed much in the Asian airlines on stocking, but I honestly can't say we took another set point in the last 90 days. I cannot say we have.

And maybe a follow-up on the defense side of things. Obviously, the DoD has got some spending challenges at the moment. Are you seeing them being any more strict on pricing or inventory levels or anything like that?

We haven't yet. As I say, our defense is holding up better than we anticipated and at least so far, the bookings are holding up, too. And we really haven't seen significant changes.

Great, thanks so much.

Ken Herbert, Canaccord.

Hello, good morning.

Hello.

I wanted to follow up on the question regarding the aftermarket. When you talked about some of the work you that you ICF SH&E do, a couple quarters ago, you talked about the inventory issues in Europe and Asia as ideally in the bucket of one-time our near-term issues. It sounds like you haven't seen much change on that front. To what extent do you think this is still a near-term issue that gets corrected as volumes start to pick up again versus structurally, are you getting a sense that maybe there is some changes with your airline customers that are going to have a bigger impact perhaps than we've seen in prior cycles?

What I don't -- in prior cycles what is happened is is eventually the inventories snapped back. So you've got a year or two of very high growth. The most recent instance I want to say was probably 2011.

Yes.

After a bad 2009 and 2010, it probably jumped up around the industry 20%. And then, obviously, that was a little bit of an overshoot which we probably gained some back in 2013. Different people, I hear speculation that the airlines are getting better at their inventory control, and you may not see as much snapback. Maybe it's more start to couple with some underlying air travel.

Obviously, you can see in our go-forward numbers, we are not planning on an inventory snapback. If there is one, that would be unusual by the way. If there wasn't a snapback, that would say their airlines are getting better at managing their inventory. If there is, that's an upside to our forecast for the year.

And is it safe to say that the guidance implies a strengthening commercial aftermarket as we go through the year? Your commentary on the first quarter seem to imply that things strength and as we go through the year. How do you see that cadence playing out?

I think I specifically said we expect that second half to be better than the first half. And our first quarter of our year is always lower than the rest of the year, and it has about 10% less days in it. In the quarter. In our Q1, our Q1 captures Christmas and Thanksgiving.

Okay. So most of the first-quarter impact is, obviously, just the reduction in working days?

Right, if you got, just the point I tried to make or maybe I wasn't too clear with it, if you got the same shipments in dollars from Q4 to Q1, effectively you would have had a 10% pick up in shipments per day. If that's clear?

Yes, perfect. Thank you very much.

Michael Ciarmoli, KeyBanc.

Hello, good morning, guys. Thanks for taking my questions. Nick, I know you don't want to get too much into price, but just to get a sense here, Ray had a number of comments about the value creation, mentioned cost consolidation, headcount. But didn't mention price on any of those recently acquired businesses. Can we assume that that price is still the same value creation lever it is say couple of years ago?

Nothing has changed in the recent businesses we've bought.

Okay.

When you look at them the same way, we evaluate them the same way, they've got to have the same attributes and we've got to see what I call private equity-like returns, which means we have to change the margin.

Okay. And then can you remind us, a couple years back in your, I think it was your Investor Day presentations, you used to call out some of the major platform exposure. Within the defense market, should we still be thinking at Black Hawk, C-130, C-17 as you're biggest programs or has that changed to some extent?

You mean in aftermarket or production?

I would say aftermarket or production, what do you think could have a bigger -- be the biggest variable? If we see Black Hawk OE units go down significantly, is that going to create a headwind? What is the most sensitive to revenues?

Let me answer that this way, C-130 is still our biggest by the way. In the aftermarket, it is pretty well spread. I would say, if I look at next year, in the OEM production rates, I don't think there's a whole lot of risk, there. Those are, we tend to be sole sourced, the things are pretty well locked for the next, what do we got now? 10.5 months or something is all you are looking out on.

Right.

In the variation will come in the aftermarket, that is where the risk is.

Okay. And we assume that that would be more helicopter exposure aftermarket if readiness levels go down, would that be swing back?

Yes, probably. As I think we've told you, you met roughly our defense business and our defense aftermarket is something like one-third transport, one-third helicopter, and one-third other which is mostly fighters, though it is other odds and ends of things, too.

Okay that is helpful. And then last one, just housekeeping. Greg, on the interest for next year, is that annual interest expense you are looking at pretty fixed? I know you have got a portion of the debt that floats, how much variability is there to that interest expense next year?

I think 2014, the bank that there's a little bit pick, but most of it will get picked up toward the end of the calendar year of 2014. So we are still riding the floating rate, where the bank is at.

Okay. Perfect, thanks a lot, guys.

At this time, I will now turn the call back over to Ms. Liza Sabol, Investor Relations. Please proceed.

Just wanted to thank everyone again for joining this morning's call, and just wanted to point out that we expect to file our 10-K sometime tomorrow.

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