TransDigm Group Inc (TDG) 2016 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the first-quarter FY16 TransDigm Group Incorporated earnings conference call. My name is Dave, I'll be your operator for today.

(Operator Instructions)

As a reminder, the call is being recorded.

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

Thank you.

I would like to thank you all for calling in today and welcome to TransDigm's FY16 first-quarter earnings conference call. With me on the call this morning are TransDigm's Chairman, President, and Chief Executive Officer, Nick Howley, Chief Operating Officer of our Power Group, Kevin Stein, and Chief Financial Officer, Terry Paradie.

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

Before we begin, we 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, 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 EBIDTA, specifically EBIDTA as defined, adjusted net income, and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and a reconciliation of EBIDTA, EBIDTA as defined, adjusted net income, and adjusted earnings per share, to those measures.

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

Good morning and thanks to everyone for calling in.

Today, as usual, I will start with some comments on our consistent strategy. Then, an overview of Q1 FY16 and I'll update on our guidance and then Terry will run through the financials for Q1.

To restate, we believe our model is unique in the industry, both in its consistency and its ability to sustain and create intrinsic shareholder value through all phases of the cycle. To summarize some of the reasons why we believe this, about 90% of our sales are generated by proprietary products and around three quarters of our net sales come from products for which we believe we are the sole source provider.

Over half our revenues, and a much higher percent of our EBIDTA, comes from aftermarket sales. Aftermarket revenues have historically produced the higher gross margin and provided relative stability through the cycles. Because of our uniquely high EBIDTA margins and relatively low capital expenditures, TransDigm has, year in and year out, generated strong free cash flow. This gives us a lots of operating and capital structure flexibility.

We follow a consistent long-term strategy. We own and operate proprietary aerospace businesses with significant aftermarket content. We have a simple, well-proven, value-based operating strategy based on our three value-driver concept. That is, steady cost reduction, profitable new business, and value-based pricing.

We maintain a decentralized organization structure and a unique compensation system, with executive and senior management who think, act, and are paid like owners. We acquire proprietary aerospace businesses with significant aftermarket content, where we can see a clear path to PE-like returns. And lastly, we view our capital structure and capital allocation as a key part of our efforts to create shareholder value.

As you know, we regularly look closely at our choices for capital allocation. To remind you, we basically have four, and our priorities are typically as follows. First is to invest in our existing businesses. Second is to make accretive acquisitions consistent with our strategy. These are almost always our first two choices. Our third is to give the extra back to the shareholders, through either special dividends or stock buybacks.

And fourth is to pay off debt. And as I've said before, given the low cost of debt, especially after tax, this is still likely our last choice in the current capital market conditions. As we've done consistently in the past, based on the specific business and capital market conditions, we'll allocate our capital and structure our balance sheet in the manner we think has the best chance to maximize our returns.

To update you on a few items, the credit market has been erratic over the last few months; however, our bonds have not traded down significantly, and we believe that we still have adequate access to the debt market at reasonable cost. Terry will give a little more detail on the rates.

As we mentioned in previous calls, the rates we pay on our current debt are significantly hedged, or collared, for about the next four years. Through January, we have bought back about $100 million of TransDigm stock at roughly $218 a share. About $70 million of this occurred in Q1, and the balance during January. We currently have an additional $450 million of repurchase authorized. This authorization does not imply anything about our current plans for capital allocation.

We closed the Breeze acquisition in early January, that is the start of our second quarter, for about $178 million, net of $27 million of acquired cash. The September 30, 2015, LPM EBIDTA was publicly disclosed by the seller at about $23 million and revenue of about $98 million. The seller's 2016 forecast was also a public number, at about $19 million of EBIDTA and $98 million of revenue. There were certain one-time items in 2015 that positively impacted the EBIDTA.

Breeze is a good, proprietary, mostly sole-source business, with about 70% aftermarket. It's a good fit with TransDigm. Though the margins may not get all the way to our overall average, we see significant opportunities for margin expansion. As usual, we see solid PE-type returns on our equity in this deal.

At January 2, 2016, based on the current capital market conditions, we believe we have adequate capacity to make about $1.5 billion of acquisitions, without issuing any additional equity. This capacity grows as the year proceeds. This does not imply anything about acquisition opportunities or anticipated levels for FY16. The commercial transport aftermarket continues weaker than the traffic growth would suggest. Though not clear, this still seems, at least for our Company's products, to be driven primarily by some mix of inventory management, by airlines, and deferrals of spending. If you look over the last five to six years, this does not appear dissimilar to prior market variations.

We also looked carefully at the impact of the surplus market on our sales. We are advised that parts above the $5,000 to $10,000 unit price are the most likely candidates. We looked through our last three years of sales. Commercial, aftermarket parts sales with the unit price over $5,000 only make up about 4% to 5% of our total revenues, and about 10% of our commercial aftermarket. In total, this group of parts, with a unit price over $5,000, has grown nicely over the last few years.

A few parts are down, but it is a very small dollar value, and other parts are up significantly. On balance at this time, we can see little, if any, quantifiable impact from surplus parts over the last few years on our parts. We see a number of factors that could contribute to stronger aftermarket growth in 2016. Plus, such as the continuing strong passenger traffic, a slowdown in retirements, potential end of deferral inventory cycle. But obviously, these have not yet resulted in much of a bump.

Turning now to our Q1 of our FY16 performance. I'll remind you, this is the first quarter for FY16. Our fiscal year started October 1, 2015. Also as a reminder, Q1 has about 10% less shipping days than the other three quarters. As I have said in the past, quarterly comparisons can be significantly impacted by differences in the OEM aftermarket mix, order timing, inventory fluctuations, modest seasonality, and the like.

Total GAAP revenues and EBIDTA were strong, both were up in the range of 20% versus the prior Q1. The organic revenue was slightly down on a quarter versus prior-year quarter. Q1 revenues in total were on our expectations. That is, excluding Breeze, there are about 10% less than the average, anticipated FY16 quarterly shipments. That is roughly in line with the reduced shipping days. The EBIDTA as defined was also on our expectation.

Reviewing the revenues by market category, again, this is on a pro forma basis versus the prior year Q1, that is assuming we owned the same mix of businesses in both periods. In the commercial market, which makes up about 70% of our revenue, total commercial OEM revenues were up about 1% versus the prior Q1. Commercial transport OEM revenues, which make up about 85% of our commercial OEM revenues, were up 5% versus the prior Q1. The commercial transport growth primarily reflects the market conditions and is in line with our expectations.

On the other hand, BizJet and Helicopter OEM revenues, which make up around 15% of our commercial OEM revenues, most of which is Business Jet, in total, revenues in these markets were down versus the prior Q1 about 11%. This significant drop pulled the total commercial average down. It appears this is mostly timing, as one, the Business Jet bookings ran well ahead of shipments, and two, our largest BizJet customers, Gulfstream and Textron, seemed to still be expecting decent years in 2016. For the quarter, total commercial OEM bookings were modestly above shipments.

The total commercial aftermarket revenues were about flat for this quarter versus the prior year Q1. Commercial transport aftermarket revenues, which also make up about 85% of our commercial aftermarket revenues, were up around 2%. This was offset by BizJet, Helicopter, and the GA market aftermarket revenues, which were down almost 15%. For the quarter, commercial aftermarket bookings in total were modestly above shipments, but the commercial transport segment bookings up, and the BizJet and Helicopter markets down.

In the defense markets, which make up about 30% of our revenue, defense revenues for FY16 Q1 were down 1% versus the prior year Q1. One large international shipment was delayed by a customer about a week at year end. Without that delay, revenues would have been up 2% versus the prior Q1. The revenues in other products were spotty with no clear pattern. Q1 defense bookings also ran modestly ahead of shipments.

Now, moving on to profitability, again, I'm going to talk primarily about our operating performance, or EBIDTA as defined. The as-defined adjustments in Q1 were non-cash compensation expenses and acquisition-related costs and amortizations. Our EBIDTA as defined of about $319 million for Q1, was up 18% versus the prior Q1. The EBITDA as defined margin was about 46% of revenues for Q1, about the same as last year's Q1, in spite of approximately 1.5% of margin dilution from the 2015 acquisitions.

As we mentioned in the last quarter, we reduced our employment level about 4% to 5% over the 120 days prior to this quarter-end. This, combined with our other value drivers, contributed to the strong margins. With respect to acquisitions, we continue looking at opportunities, the pipeline of near-term possibilities looks a little light. This can change quickly. Closings are difficult to predict. We remain disciplined and focused on value-creation opportunities that meet our tight criteria.

Moving on now to 2016, we continue to have some concerns about duration of the commercial transport OEM cycle. As I said before, we are being cautious with our spending and are ready to react quickly if necessary. In the commercial aftermarket, air travel is holding up well, and as I mentioned, there are other factors that should positively impact the demand. However, in general, publicly-reported commercial transport aftermarket revenue trends have been mixed and we still see reports of potential economic softening. On balance, these factors tend to keep us cautious. But all in all, this is our best current estimate for the year.

Based on the above, and assuming no additional acquisitions beyond Breeze, in FY16, our revised guidance is as follows: the midpoint of the FY16 revenue guidance is $3.2 billion, an increase of $70 million from our prior guidance. This is up 17% on a GAAP basis year-over-year. Organic growth is still anticipated to be in the range of 5% year-over-year. The revenue increase in our guidance is due primarily to the Breeze acquisition.

The midpoint of FY16 EBIDTA as defined guidance is $1.44 billion, an increase of $20 million. This is up 16% year-over-year. The increase in the EBIDTA guidance is mostly driven by the Breeze acquisition, with some modest upward adjustment in our base margin. The base business, excluding the 2015 acquisitions and Breeze, is still anticipated to achieve an EBIDTA margin of about 49%, or up roughly 2 points, versus 2015 for the same mix of businesses.

The midpoint of EPS as adjusted is anticipated to be $10.77 a share, or up about $0.32 a share from our last guidance. This is a 20% increase from the prior year. The increase in guidance is due about half to the Breeze acquisition and the balance through a combination of improved margins, lower tax rate, and slightly lower share count. Terry will review these details a little more.

On a pro forma, or same-store basis, this guidance is based on the following growth rate assumptions: commercial aftermarket revenue growth in the mid to high single-digit percent based on worldwide RPM growth of around five. We're still cautious due to the factors I discussed earlier, and frankly, due to a somewhat softer Q1.

Defense and military revenue growth is still forecast in the low single digits. Given world events, there could well be variations here. Commercial OEM revenue growth, we are guiding in the mid-single-digit percentage range, primarily due to the 2016 and 2017 commercial transport production rates. We're still assuming commercial transport unit airframe shipments are up in the low single-digit percent for 2016. We are cautious about 2017 production rates and how this could reflect in our 2016 shipments.

At this time, we are assuming that the sharp drop in Q1 business jet shipments is mostly timing. Without any additional acquisitions or capital structure activity, we expect to have around $1.2 billion in cash and over $500 million in undrawn revolver at year end 2016. We also had additional capacity under our credit agreement. Again, assuming no additional acquisitions or other capital market activities, our net leverage is anticipated to be about 4.9 times the EBIDTA at the end of 2016, or down roughly one turn.

In summary, Q1 was a decent start to the year. We met our expectations. As I look to the balance of the year, the market conditions are somewhat unclear and that makes us cautious. However, we may have some margin upside to help offset some market variations. In any event, I'm confident with our consistent value-focused strategy and strong mix of business, we can continue to create long-term intrinsic value for our investors.

And with that, let me hand this over to Terry.

Thank you, Nick.

I will now review our Q1 financial results. First-quarter net sales were $702 million, up $115 million, or approximately 20% greater than the prior year. The collective impact of the acquisitions, Telair, Pexco, PneuDraulics, and Franke, was an increase of $121 million, offset by a slight decline in organic sales. Our first-quarter gross profit was $375 million, an increase of 17%. Our reported gross profit margin of 53.4% was 1.3 margin points lower than the prior year.

This quarter's decline in margin was due to the dilutive impact from acquisition mix and higher acquisition-related costs, which accounted for a decrease of over two margin points. Excluding all acquisition activity, our gross profit margins in the remaining business versus the prior-year quarter improved over one margin point, due to the strength of our proprietary products and continually improving our cost structure, despite slight decline in organic sales.

Our selling and administrative expenses were 11.7% of sales for the current quarter compared to 11.5% in the prior year. Excluding acquisition-related expenses and non-cash stock compensation, SG&A was about 9.9% of sales compared to 10.6% of sales a year ago.

We had an increase in interest expense of approximately $13 million versus the prior-year quarter. This was a result of an increase to the outstanding borrowings of $900 million in the current quarter versus the prior year. The increase in outstanding borrowings was partially to fund the acquisitions in the FY15.

Our effective tax rate was 30% in the current quarter compared to 32.6% in the prior year. The lower effective rate in the quarter was primarily due to foreign earnings taxed at lower rates in the US statutory rates and the reinstatement of the R&D tax credit. Our expected full-year estimated tax rate has decreased slightly to below 31%, due to the R&D tax credit.

We believe we have an opportunity to increase the benefit of the R&D credit in the future and we have just began a study to explore this opportunity. We will update the progress with you next quarter. We still expect our cash taxes to be about $200 million for FY16.

Our net income for the quarter increased $19 million, or 20%, to $115 million, which is 16.4% of sales. This compares to net income of $96 million, or 16% of net sales in the prior year. The increases in net income primarily reflect the increase in net sales, the lower tax rate partially offset by higher interest expense, non-cash compensation, and acquisition-related costs versus the prior period.

GAAP EPS was $1.97 per share in the current quarter compared to $1.63 per share last year. Our adjusted EPS was $2.27 per share, an increase of 26% compared to the $1.80 per share last year. Please refer to table 3 in this morning's press release, which compares and reconciles GAAP EPS to adjusted EPS.

Now switching gears to cash and liquidity, we ended the quarter with $805 million of cash on the balance sheet after spending $71 million to purchase 324,000 shares in the quarter. As Nick mentioned, we continued to repurchase shares in January. We spent another $28 million to purchase 128,000 shares. So in total, we purchased 452,000 shares at a total cost of $99 million. We now expect the full year, weighted average shares to be 56.5 million shares.

The company's net debt leverage ratio at quarter end was 5.7 times our pro forma EBIDTA as defined. And gross leverage was 6.3 times pro forma EBIDTA. We estimate our net leverage at September 30, 2016, will be 4.9 times, assuming no acquisitions or capital market transactions. As for access to the capital markets, we believe the high-yield market would be very receptive to our high-quality paper, despite the current high-yield market conditions.

We believe the coupon rate on a new offering could be 50 basis points higher from where our bonds are trading today, depending on the tenor of the issuance. With regards to our guidance, we now estimate the midpoint of our GAAP earnings per share to be $9.60. And as Nick previously mentioned, we estimate the midpoint of our adjusted EPS to be $10.77. The $1.17 of adjustments to bridge the gap to adjusted EPS includes the following assumptions: $0.05 from dividend equivalent payments, $0.56 from non-cash stock option expense and $0.56 of acquisition-related expenses, up $0.13 primarily related to Breeze.

Now, I'll hand it back to Liza for kick-off of Q&A.

Operator, we are now ready to open the line for questions.

Thank you very much.

(Operator Instructions)

Please stand by for your first question, which comes from the line of Noah Poponak at Goldman Sachs.

Good morning, everyone.

Good morning.

Terry, do you happen to have that same EPS bridge from the old guidance to the new guidance?

Yes. I believe it's in the conference materials, the presentation materials on --

Excuse me, for that then.

On page 7 there's a comparison that should help you do the reconciliation.

Okay. In terms of the acquired revenue in the quarter, the $121 million that you disclosed, does that have the same --

I'm sorry, Noah, the page was page 9 of the reconciliation.

Yes, got it. Perfect.

The acquired revenue in the quarter, does it have the same seasonality as the legacy business as soon as it's brought in? And was it what you expected it to be the quarter?

Are you talking about the Breeze business?

No, I'm talking about the combination of the four prior to Breeze that you disclosed as being $121 million in the quarter.

Oh, you mean do they have the same sort of seasonality pattern of less shipping days? Is that the question?

Yes.

Noah, the answer is I believe, yes. Though I frankly haven't looked at the exact number. I mean they have the same issue. There's less shipping days essentially, you don't ship anything around Christmas week and all that sort of thing.

Okay. I just ask, it looked a little light of what we had and revenue in the quarter was light of consensus and I just wonder if, myself, and potentially others, were just modeling the seasonality of that incorrectly.

The way we look at this as I think I tried to say, if you strip out an acquisition, which is only Breeze in this case, you know, the first quarter runs about 10% less shipping days than the average quarter through the year. And we see that most years.

Okay. And then, where you mentioned having better margins in the legacy business, which I guess changed in the outlook, can you talk about where that's coming from?

You mean which business or which segment?

The primary driver I would say is the normal -- our pricing works as usual but I don't think it was anything extraordinary. But we're squeezing cost out. I think we simply took about 4% to 5% out of the headcount, which is one of the biggest controllable costs and the volume was knocked down 4% to 5%.

Okay. Thank you.

Thank you. The next question comes from the line of Carter Copeland at Barclays. Please go ahead.

Good morning.

Good morning.

Just to dig into the headcount again. The comment you made on the SG&A leverage on an adjusted basis, the 9.9% versus 10.6%, was that presumably all related to the headcount? Or how should we think about the headcount reduction in terms of cost of sales versus G&A?

The costs that Nick was referring to, the 4% to 5%, are really primarily driven from the sites as probably cost of sales. There will be some overhead costs in SG&A, but the bulk of that piece would be in the cost side in the gross margin line item.

Okay. So it was actually a decent amount of better SG&A performance on an apples-to-apples basis as well.

I would say yes. Absolutely. We had better SG&A performance on an apples-to-apples basis.

And on the shipping days comment, I can appreciate the fact that there's fewer shipping days in every single Q1, but when you look at the year-over-year comparison, was there a difference in shipping days this Q1 versus the prior year's Q1 because of the timing of holidays and did that have an impact?

The real answer to that, Carter, is I don't know the answer. (laughter) The pattern is roughly the same every year.

But I frankly didn't go back and see when the last -- it's when the last holiday around New Year's falls. I just don't remember.

It just seemed like flat or organic down 1% was a little bit less than probably what you would've expected.

Yes. As I said, Carter, our revenues for the quarter were just about what we expected them to be.

Okay. All right. I'll let someone else ask. Thanks, guys.

Okay.

Thanks. The next question is from the line of Gautam Khanna at Cowen and Company.

I was wondering if you could talk a little bit about the decision to re-up the buyback authorization in the context of your other comments around the M&A pipeline being a little softer? Should we expect to see buybacks take a higher priority over M&A in the short-term?

On any capital and capital allocation, we'll do what makes sense at the time we address it. As I said, I would not take the increase of $450 million to mean anything regarding our intention, other than I think $450 million is roughly what's still available in our credit agreement. Is that correct? Isn't that close?

It's in the ballpark, it's a little higher though.

Yes. And we wanted to have maximum flexibility. So we moved the authorization up to roughly about where the limit was.

You saw we bought $100 million back. But I can't say that we're making a specific decision to change our capital allocation. Obviously, if the stock bounces all around and continually drops, we will view it as a better opportunity.

Okay. And could you maybe elaborate on what you are seeing in the M&A pipeline? What do you think explains the pause?

The answer is -- what explains the pause, I don't know. But I can say we just don't seem to see as much activity.

You know, now this moves around. If you remember in 2014, we bought a very modest amount of businesses. In 2015, over a 12 month period, we put out close to $2 billion.

It seems a little light right now, but I could tell you just on my past experience and our past experience with TransDigm is, you've seen in the public market, we saw it before in the private market, we could end up in 30 days or 90 days with a whole rush of stuff. But, if I had to look at a list today, it's a little lighter than I would've hoped.

And Nick, could you maybe remind us, including Breeze Eastern, what the lag is in terms of the value-based pricing initiatives on acquired businesses? I know it differs by each one of them, but how much of a lag is there?

Yes. That's hard to say. It really does depend on the businesses.

We model businesses when we buy them and we hope to model them conservatively. We model the improvements over a four year to five year period. And I think as I've said before, we assume we're going to buy them, hold them for four years or five years, and sell them and we have to see a return on our equity up above 20% usually, well above. And we generally do better than that, and also, frankly, we never sell them.

So I would say, the mix in pricing is very dependent on where the company stands in its LPA cycles, what, if any, commitments they have in the aftermarket. It's hard to give a general number.

I guess, because the aftermarket came in a little bit light relative to the full-year guide anyway, is the value-based pricing on the recently acquired deals a big part of why you think you'll still be able to achieve the mid to high single-digit in the aftermarket? Or are you anticipating something else, just as an improvement in the underlying there?

Well we're hoping for an improvement in the underlying market.

Okay. All right. Thank you very much.

I see nothing in the pricing dynamics that concerns me.

Okay. Thank you. I'll turn it over.

Thank you. The next question is from the line of Myles Walton at Deutsche Bank.

Good morning. This is actually Lou Rifederal for Myles.

That's your alias. (laughter)

So last quarter you guys were back on the aftermarket. You were more optimistic on aftermarket and a little bit of risk on the OE. Is that sort of the same as you're feeling now? I know you're cautious overall, but are you still more cautious on the OE side after the first quarter?

I'd say we're at the same place on the OE side. The BizJet revenue, that was a little softer than we expected, but from what our bookings look like and what our customers tell us, we think that's a timing issue. It's also a relatively small part of the business. I think on the commercial transport, we went in cautious and we remain somewhat cautious and that's probably best reflected in the fact that we started to take the cost down.

All right. And based on what you said just to round out the revenue questions I guess. You said they are roughly in line.

Obviously you talked about the slippage of the one contract in military and then obviously the BizJet being light. That obviously would make up for some of the lightness, maybe not the full amount versus what the Street was expecting, but I think those two together, they help provide some of that?

Yes. They do. Yes, they closed the gap some. The military one was just a couple-of-days issue, but that's not a big deal, but it moves it. It moves the military.

I think probably the most significant difference is, we typically look at the first quarter as having less shipping days and you're going to ship 10% less than the run rate or something like that. I'm not sure that was reflected in the numbers all floating around.

Thank you.

Thank you. The next question comes from the line of Robert Spingarn at Credit Suisse.

Good morning.

Morning.

So, Nick, going back, I guess Gautam was getting at this, but you made the comment that aftermarket's really not a whole lot different than it has been over the last five to six years. Having said that, though, your organic growth was quite a bit higher going back a couple years ago than it is now. So either it's not tied to aftermarket or maybe it's tied to either the timing or the magnitude of the price increases on the acquired businesses.

I'm not sure that's what I said, so let me try to mean what I meant to be saying. Maybe I didn't make it clear.

If you go back and trace, take something like RPM, and track that over, say, five or six years and then take our aftermarket sales and whatever index you want to use for the other people in the business and track them, you'll see a lot of variation around that. You'll see some way higher, way lower, run right along.

If I look at a graph, it doesn't look that unusual to me. That's what I'm saying.

I noticed, Rob, you had a chart that tracked it, what you put out this morning, for a couple years. We look at this over the last five years and track ourselves against the rest of the industry and there's a fair amount, it doesn't look that different than other cyclical variations have looked.

Look, our numbers could be wrong, but it's lower than it used to be and I'm wondering if this is, one, different aftermarket behavior, which would contradict a little bit that five to six year comment? Or is it simply that your acquisitions as a percentage of the total business are smaller today than they used to be? And therefore, that pricing dynamic has a smaller effect on the organic.

I don't think that's the answer, Rob, but I honestly can't give you a direct answer to that. I would tell you, just to be clear, I see no change in the pricing dynamics. I see no change in the pricing dynamics of the businesses we buy.

Now I guess your point is, if you buy a $300 million business, it's nowhere near the percent of our total as it was in the past. That's just true.

Yes. And I'm wondering if that's ultimately the factor, and people should calibrate around that.

I happen to be looking at a chart that anybody could make up. My own guess is, we'll see a cycle back.

Okay.

I have to admit, Rob, I'm a little surprised that it hasn't moved faster.

Okay. Fair enough.

I had another question just on the BizJet. You mentioned the OE was a little bit soft and it might be timing related. Is there anything seasonal about that period of time, historically, with the BizJet OE?

This seems disproportionate, Rob. It's down substantively versus the prior Q1.

The reason I ask is we're getting a lot of mixed commentary from the manufacturers in BizJet and what's going on, some stronger than others.

Yes. We take some comfort there in that the bookings were pretty strong. And the two big customers, the two biggest -- we sell to all of them, but the biggest are Gulfstream and Textron, and they seem to still be expecting a decent year. Though we do seem to have a lot of moving around of deliveries and that sort of thing.

Last question on FX, or those who are domiciled in weak currencies, have you seen any change in behavior on the aftermarket side from airlines that might be struggling with currency more than others that aren't?

That, I don't know that I can pin it to that specifically, Rob, but that could make sense to me. There's an awful lot -- though we sell everything in dollars, the majority of our aftermarket customers are living in some other currency. Things look more expensive to them.

Now, I can't give any specifics on that, but that sort of makes sense to me. Now, that can't go on very long, right? The consumption is the same. At some point, you have to buy.

Right. Or fly less.

Or fly less. That's right. But anecdotally, that could make sense. But I have to tell you, I can't put any numbers around that.

Now, one of the things we did put some effort into, as I mentioned, with putting numbers around, was to surplus parts. And we have a very hard time seeing -- we don't see anything in there when we track the high dollar value parts.

Right. Okay. Thanks, Nick.

Thanks. The next question comes from the line of Seth Seifman at JPMorgan.

Thanks very much and good morning. On the headcount reduction, were there costs associated with that in the quarter? And if so, were they in the acquisition-related adjustments?

No, the cost would be pretty tiny to be honest with you, and that would be included in whatever line item would be in cost of sales and/or SG&A.

Okay. So they were very small but they're in the adjusted -- they're in the EBITDA as defined.

They're in the numbers.

Okay. Great.

And I'm curious a little bit about the share repurchases, your decision to buy back stock, it sounds like you've become a little bit more cautious on the OE side. I feel like you sound a little bit more cautious about aftermarket than you did last quarter and the decision to ramp up the repurchases in the context of those end market sentiments.

I'm not exactly sure how to answer that. We obviously bought shares because we felt the price looked good, is why we bought them. Maybe the reason for that is because the market assumptions that the market is making, but we just look at this as a capital allocation. When the buy looks good and we don't immediately see any near-term uses that are better, we buy.

Okay. Thanks very much.

Thanks. The next question is from the line of Hunter Keay at Wolfe Research.

Thank you very much. Good morning.

So, it kind of touches on a couple other questions, one that maybe Rob was asking with the FX question. But Nick, I'm curious if you're seeing any changes in behavior with how some of your US customers and customers in markets whose currencies have really gotten hit, and particularly emerging market customers, as it relates specifically to some of the really, really discretionary stuff? Have you seen any major disparate changes?

I don't think we have. I don't think we have. I don?t think; I know we haven't.

We have a few businesses that are tied to more discretionary things, like interior upgrades and things like that and frankly, they are doing okay. I'd like to be able to put my finger on something like that and say, there it is. But I can't.

Can you maybe help us think about Nick, I don't know if you've put this out there and I'm sorry if I missed it, but how much of your aftermarket exposure is actually US-based and how much is not?

It's roughly the same as the installed base of airplanes. We're pretty well market-weighted, so take RPMs, take installed base of airplanes, I'm saying this from memory, but I'm guessing that's something around 30%.

Okay. That's helpful.

And if that's not exactly the right number, it doesn't mean that our business is disproportionally weighted, it means I forgot the right number.

Sure. Of course. Absolutely. Thanks for taking a stab.

And then we saw, Nick, the change in your composition structure, I'm assuming this is unrelated to the next part of this question. But can you talk about any updated thoughts around succession planning at the company? Thanks for the time.

I think no different than we've said before. I have a contract and you know what my contract says.

With a change in the compensation, frankly, probably 95% of my compensation from the last 10 years has been equity-driven anyway and I'm willing to make it all equity-driven, which I think generally is a vote of confidence. Now after I do that, by the way, the stock is supposed to go up, not down, by the way. That's a joke, guys. (laughter)

I was on mute. I enjoyed it. Thank you.

Thank you. The next question comes from the line of David Strauss at UBS.

Good morning.

Morning.

Nick, your cautiousness on commercial OE, is it anything specific beyond just emerging markets look weak, airlines are scrapping fewer airplanes? Is there anything else that you're looking at and seeing and saying that this doesn't feel right relative to the OE rates that are out there?

David, I don't have any unique insight any more than any of you guys do. As I said before, it feels long in the tooth to me. I noticed some rates are starting to move down due to wider bodies.

I know this airline monitor, I'm sure you follow them. I noticed they softened their outlook here in the last time they published it. It concerns us.

Again, I have no unique knowledge, nor do I have any certainty about it. But our view is, you're better off if you get the cost out quick and you can always adjust the other direction if you have to.

Right. And talk about how much more you can do from a cost-cutting side if you end up being right and OE rates end up moving lower rather than higher over the next couple of years.

Yes. I think, to say somewhat procedurally, I think we do whatever we have to do to try and hold the margins. But, I think in drops in the 10%, 15%, 20% kind of range, particularly with the fact that the aftermarket typically doesn't drop like that at all, and you get a little mix, I think we can pretty comfortably, between cost reductions and the balance of our business, hold the margins -- hold the margin percent.

Right. Got it. Okay.

Last one for me. Terry, on the cash balance that you're implying for year end at 1.2%, that implies something around $700 million to $750 million in free cash flow. Now, obviously adjusted earnings are going up, cash taxes are offsetting a fair amount. Can you help us see what the big working capital moving pieces are to get you to that kind of level on free cash flow?

Yes. I think our working capital is going to stay fairly consistent. What we try to do is we look at receivables, inventory, net of payables, and we try to keep that in the, call it, 26% to 30% of pro forma sales on a regular basis. And that's where we're at today and that's the plan to continue going forward.

I think what you're going to see to get us to the 1.2% is very consistent with what we said last quarter. We said we were just under 1.5% for the year. You think about the buybacks that we've done in the acquisition of Breeze, I think you can reconcile down to the 1.2%, so we really haven't changed anything from where we were last quarter coming out with cash at the end of the year.

Right. Okay. Thank you.

Thanks. The next question is from the line of Robert Stallard at Royal Bank of Canada.

Thanks so much, good morning.

Morning.

Nick, I want to follow up on David's question. You've got this hunch about OEM, the aerospace up cycle there maybe not lasting forever. But you sound pretty confident about the aftermarket.

I'm just wondering if you could give us some more character on why you think this suspected deferral there in past purchasing is going to improve pretty radically over the next nine months. And also what your assumptions might be for the smaller BizJet and Helicopter aftermarket?

Yes, on the commercial transport aftermarket, if I look at previous cycles around flight hours, this seems to me to be down a lot. It seems to me, typically these have started to come back and have caught up. I don't know of any change in the underlying use or consumption of the parts, so at some point it's got to pick up.

Now, do I call the turn exactly right? I don't know. That's our best judgment as we sit here today.

As I said, if we're off a little, we think we may have some margin room if you look at it down in EBITDA or EPS. I don't have any crystal ball to call the turn exactly. And what was your other question about the BizJet?

Your assumptions are for the aftermarket in the BizJet and Helicopter because I think they were a bit of drag in Q1.

Yes, they were down pretty significantly. You know, our assumptions are roughly they don't stay like that, they pick up a little bit through the year. It seems to us to be an overreaction.

Now, the commercial Helicopter business is pretty bumpy, as I'm sure you know, and aftermarket OEM, but that's not a lot of our business. So I don't see that driving it much, but I would expect the aftermarket from the Business Jets to be a little better, though I have to say, the aftermarket Business Jet bookings weren't great in the quarter. That's in the aftermarket. The OEM bookings were quite good.

Right. Thanks a lot.

Thank you. The next question is from the line of Michael Ciarmoli at KeyBanc Capital Markets.

Good morning, thanks for taking the question.

Just on the whole aftermarket trend here. Last quarter, I think you characterized it, we're guiding to mid to high single-digits, maybe hopeful for some upside. Now you kind of maintain that forecast. It seemed like there's maybe more of a bias toward some downside there.

Can you give us a sense of what you are seeing quarter-to-date? How do we get comfortable without having that visibility into what you were just talking about, deferral, unwinding there? How do we see this acceleration in the remaining quarters here?

You have to see a pickup in demand, Michael. As you know, if you take the numbers this quarter and take the numbers for the year and divide by three, you've got to see a pickup in demand. Historically, that's happened after a period like this. You've ended up with some pretty high quarters.

If pickup doesn't happen, we won't meet the number. Now that doesn't mean we won't meet our revenue or EPS numbers some other way, but that segment, we would not meet it.

Got it. And then, you're appropriately conservative and cautious on commercial transport OE, but you don't sound that cautious on Business Jet OE.

And I'm wondering, it seems like there's more reasons for concern there, given what we're seeing in emerging economies. And I know what we've heard from Gulfstream and Textron, but it seems like there's more risk to that production definitively. Are you guys hedging BizJet OE in a similar manner to commercial transport?

Well, our assumption going into the year wasn't much growth there. Now it wasn't a drop like we saw in the first quarter, so we're kind of the same place as we were going into the year -- that's sort of a flattish market.

Okay.

And you know, it's not running at a real high level. Every year, everybody thinks it's going to pick up, but it hasn't. Now, the underlying take-off and landings aren't great, but they're not drastically down.

Yes. Okay. And just last one for me.

The revenue change, was that entirely Breeze, was there any other moving part there? 777 rates being cut?

Almost entirely Breeze. Almost entirely. Anything else was puts and takes.

If some unit went up, something else went down to offset it. It's almost dollar per dollar Breeze.

Okay. Thanks a lot guys.

Thank you. You now have another question from the line of Noah Poponak at Goldman Sachs.

Hello, again. Terry, on issuing debt, where you mentioned you think you would be 50 basis points higher tomorrow than where your active yields are. You have a number of products and they all have different coupons and different changes in yield and there's new issue discount and I don't know if you're including that or not. Could you maybe also frame that as one of the products you issued in the last year, you got a coupon of X, and if you issued the same or very similar product tomorrow, you would have a coupon of Y?

I can cover that. So the last thing we did was last April or May of 2015. I think the coupon on that was about 6.5%.

Kind of stepping back from the standpoint of the market, the high-yield market has a lot of volatility in there and is primarily in the oil and gas area. There is a lot of demand for quality paper that we have. We talk to our banks on several occasions and we stay close to them and there would be a lot of interest in us issuing more paper if we had to. We don't see the need at this point in time. But ultimately, if we were to go to market today in today's conditions, we're probably looking at something in the 7.25%, 7.5% range as a coupon rate.

That's for step up and leverage. Not to replace.

Right. Just a step up and leverage for new issuance bond -- unsecured bond.

Great. That's very helpful.

On this Business Jet discussion where, Nick, you're saying bookings were ahead of shipments. Can you maybe go a little more specific on where that was? Because, that's surprising, unless it's possibly just a function of the denominator there being --

I think it's just the shipments are so low, Noah. I don't think it's because, it's not that the bookings are so off, it's the shipments are disproportionately down. That's the point I was trying to make.

Okay. And then, Breeze has a pretty healthy mix of military. Are you actively looking to acquire more in military, just given where we are in the respective cycles?

No, we're not. We're not avoiding it. It's just, we have the same sort all the time, proprietary aerospace significant aftermarket content.

What we pay is dependent on what we think of the outlook of it. We're neither avoiding nor are we seeking military, disproportionately.

Okay.

We're just going to go through it, look at the platforms, look at our forecast, look at our view of it, and price it accordingly.

Okay. Makes sense.

Final one. Terry, the R&D tax credit potential further incremental step you mentioned, anything you can say on rough order of magnitude in timing related to that?

No. We're too early into the study period right now. I think there is some opportunity but we will have to do our due diligence.

You know we're decentralized. We have 31, 32 business units. We're going to have to go do our homework there and see what qualifies and once we have that data, we'll come up and change our effective tax rate for you guys.

Okay. Thank you.

Thank you. We now have another question from Gautam Khanna. Go ahead please.

Yes, thanks again. I wondered, could you give us any color on how the aftermarket has trended since December 31?

Did you say since the end of the quarter?

Yes.

Yes. I don't want to comment on short-term times like that. I think we'll wait until the quarter and talk about it when we have the data. I don't want to start anecdotally commenting.

I just wonder, do you think any part of the softness could have been just year end inventory management by many of your MRO and airline customers as opposed to --?

It surely could be. But I don't want to hang on anything specific unless I have the data pretty clearly.

But it's not unusual that we see inventory adjustments at the end of the year. People wanting to polish things up.

Okay. And in terms of how your catalog pricing changes, do you change price ratably throughout the year or is there a big price hike you put into effect?

It's all over the map. It's all over the map for the businesses.

Some have a catalog they put out once a year, but it's not necessarily on a calendar cycle. Some don't -- some don't have a catalog, they price a lot of it on demand. So, there's not a one point in time when you can say that they step up.

Okay. January 1st is not a significant date from that standpoint?

I don't think so. The real answer is I think it's pretty ratable through the year. Maybe a little weighted toward the prices going in in the first half of the year, but then you have to work through the backlog a little bit, so.

Okay. And just one last one. Are you seeing any differences between the products you sell through distribution that's out there versus the direct sales if there's an aftermarket trend?

No.

Okay. Thanks a lot, guys.

Thank you very much. There are no further questions for you now, gentlemen. So I'd now like to turn the call back to Liza Sabol for closing remarks.

Thank you all for participating on this morning's call and please look for our 10Q that we expect to file tomorrow. Thank you.

Thank you, Liza. Ladies and gentlemen, that concludes the presentation. You may now disconnect. Good day.