TransDigm Group Inc (TDG) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the TransDigm Group Incorporated's fourth-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, today's conference call is being recorded. I would now like to introduce your first speaker for today, Liza Sabol, Investor Relations. You have the floor, ma'am.

Thank you, Andrew. Welcome to TransDigm's FY16 fourth 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 and replay information is contained in this morning's press release and on our website, at transdigm.com. It should also be noted that our Form 10-K will be filed tomorrow and also will be found on our website.

Before we begin, the Company would like to remind you that statements made during this call which are not historical in fact are forward-looking statements. For further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, please refer to the Company's latest filings with the 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 EBITDA, specifically EBITDA as defined, adjusted net income and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and a reconciliation of EBITDA, EBITDA as defined, adjusted net income, and adjusted earnings per share to those measures. I will now turn the call over to Nick.

Good morning, and thanks again to everybody for calling in. Today I'll start off, as always, with some comments about our consistent strategy. I'll then overview a busy FY16.

I'll review the initial guidance for FY17. Kevin will then review some key operating items for FY16 and FY17, and Terry will run through the financials. A fair amount to cover here today.

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 some of the reasons why we believe this, about 90% of our sales are generated by proprietary products, about 75% of our sales come from products for which we believe we are the sole source provider, over 50% our revenues, and a much higher percent of our EBITDA, come from aftermarket sales, aftermarket revenues have historically produced a higher gross margin and have provided relative stability through the cycles.

Our longstanding goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we have to stay focused on both the details of value creation, as well as careful management of our balance sheet.

We follow a consistent long-term strategy. We own and operate proprietary aerospace businesses with significant aftermarket content. Second, we have a simple, well-proven, value-based operating methodology based on our three value driver concepts.

-Third, we maintain a decentralized organization structure and a unique compensation system that is closely aligned with shareholders. Fourth, we acquire proprietary aerospace businesses with significant aftermarket content where we see a clear path to private equity-like returns. And lastly, we view our capital structure and capital allocation as a key part of our effort to create shareholder value.

As you know, we regularly look closely at our choices for capital allocation. To remind, you we basically have four. Our priorities are typically in the following order; one, invest in our existing businesses; second, make accretive acquisitions consistent with our strategy.

To state again, these two are almost always our first choices. Third, give the extra money back to the shareholders, either through a special dividend or stock buyback; and lastly, pay off debt. But given the low cost of debt, especially after tax, this is still likely our last choice in the current capital market conditions.

In the last three years, you've seen three distinct business environments and corresponding real-life examples of how we manage our capital structure to best take advantage of the current business and capital market environment. In FY14, with the acquisition opportunities not particularly compelling, we gave back about $1.6 billion to our shareholders in the form of a large special dividend and some modest stock buyback.

In FY15, we saw a number of attractive acquisition candidates. We acquired about $1.6 billion worth of proprietary aerospace businesses that met our strategic and shareholder return requirements.

In FY16, we again saw a number of attractive acquisition candidates that met our criteria. As a result, we acquired another $1.4 billion of aerospace businesses.

In addition, the combination of our usual high cash flow and continuing attractive credit markets allowed us to return about $1.6 billion more to our shareholders in the form of roughly $200 million of share buyback, plus a $1.4 billion special dividend paid out in early FY17. To summarize, over the last three years, that is, since the beginning of FY14, we have returned about $3.2 billion to our shareholders.

In that same period, we made nine acquisitions for about $3.3 billion. We fully invested our existing business, we kept a healthy cash balance and maintained significant dry powder for additional acquisitions. As we have done consistently in the past, depending on the specific business and capital market conditions, we allocate our capital and structure our balance sheet in a manner we think has the best chance to maximize the return to our shareholders.

At 9-30-16, based on the current capital market conditions and adjusting for the $1.4 billion special dividend and recent financing, we still have adequate capacity to make over $1 billion of additional acquisitions without issuing any equity. This capacity grows steadily to over $2 billion as the year proceeds. This does not imply anything about acquisition opportunities or anticipated acquisition levels for FY17.

Now to summarize FY16 year. FY16 was a busy year, in FY16 and early FY17, we raised about $3.8 billion. The proceeds were used primarily to fund acquisitions and to pay a special dividend.

We were also able to modestly decrease our average interest rate, as well as to refinance and extend maturities on certain existing debt. We acquired three businesses, as I mentioned, for about $1.4 billion, Breeze-Eastern, [DEC], and Tactair, Young and Franklin. Kevin will talk a little more about each of these acquisitions.

We continued the integration efforts of our various FY15 and FY16 acquisitions; and most importantly, we continued to generate real value in our new and existing business and we created substantial intrinsic value for our shareholders.

Now turning to the performance. To remind you, this is the fourth quarter and full year summary for FY16. Our fiscal year ended September 30, 2016.

Total GAAP revenues were up 8% versus the prior Q4 and 17% on a full year basis. Organic revenue was up about 2% on a full year basis. The Q4 organic growth was up slightly after normalizing for the one month reporting delay in Telair 2015 reporting timing, as we've discussed in the previous calls.

Reviewing the revenues by market category, again on a pro forma basis versus the prior year Q4 and the prior year full year, that is, assuming we owned the same mix of businesses in both periods, in the commercial market, which makes up roughly 70% of our revenue, total commercial OEM revenues were down 4% versus the prior Q4 and roughly flat on a full year basis. Commercial transport OEMs were up 2% on a full year basis and down slightly in Q4.

We suspect we are seeing some system-wide inventory adjustments, as wide body rate decreases ripple through the system. Biz jet revenues continue to drop, with revenues down 15% versus the prior year Q4 and about 10% down on a full year basis. This segment is small compared to commercial transport, but has been tougher than we expected all year.

For the fiscal year, total commercial OEM bookings were about even with shipments. Total commercial aftermarket revenues versus the prior year were up 6.5% for both FY16 and for Q4. For the full year, commercial transport aftermarket revenues were up about 9.5%; however, this was partially offset by the softness in the business jet, helicopter and freighter aftermarkets.

Sequentially, revenues were up modestly in the commercial aftermarket. For the full fiscal year, total commercial aftermarket bookings ran slightly ahead of shipments.

The defense markets, which make up about 30% of our revenue, defense revenues for the year were modestly better than we anticipated. Fiscal year Q4 revenues are up 3% versus the prior year. Full year revenues were up 2% versus the prior fiscal year.

Full year defense bookings ran about $50 million behind shipments. This is almost entirely attributable to a few multi-year orders placed in 2015, specifically for the A400 cargo system, a few large international parachute orders, and a large order for the APKWS smart bomb system. In total, the rest of the defense bookings were roughly even with shipments.

In total for FY16, excluding acquisitions, our revenues for commercial aftermarket were just about as we originally expected. The commercial OEM business was a little lower, and the military revenues were pretty close to our expectation at the start of the year. All in all, total revenues were close to our original expectations.

Moving now to profitability and on a reported basis, again I'm going to talk primarily about our operating performance, or EBITDA as-defined. The as-defined adjustments in Q4 were non-cash compensation expenses and acquisition-related costs and amortization. Our EBITDA as-defined of about $423 million for Q4 was up 17% versus the prior Q4.

On a full year basis, our EBITDA as-defined was roughly $1.5 billion, or up 21% from the prior year. The EBITDA as-defined margin was 47% of revenue for the full year and 48.5% for Q4. The full year EBITDA margins without dilution of the acquisitions purchased in FY15 and FY16 was approximately 49%, or up 2.5 margin points versus FY15 for the same mix of businesses we owned going into FY15.

With respect to acquisitions, we continue to actively look at opportunities. The pipeline of near-term possibilities is reasonably active. Once again, closings are always difficult to predict, but we remain disciplined and focused on opportunities that meet our tight criteria.

Now, moving on to 2017 guidance. As we head into FY17, we again have concerns about the duration of the commercial transport OEM cycle. As you may recall, at the start of FY16, we reduced headcount to get ahead of any potential softening.

In retrospect, given the wide body softening and the weaker biz jet revenues, I'm glad we did this. Though we have not yet cut again for FY17, we're cautious and we're ready to move quickly, if necessary. All in all, this is our best estimate for FY17, as you know, we'll update this as the year proceeds.

But based on the above and assuming no additional acquisitions, our guidance is as follows. The mid point of the FY17 revenue guidance is $3.54 billion, or up 12% on a GAAP basis year-over-year. Organic growth is roughly 4% year-over-year.

As in the past years, with roughly 10% less working days in FY17 Q1, revenues are anticipated to be lower than the other three quarters of FY17, roughly in proportion to the lower working days. I'm not sure I made this point clear last year, so I'd ask you to keep it in mind as you work through your outlooks.

The mid point of FY17 EBITDA as-defined is $1.68 billion, or 47.5% of revenues. That's up 13% year-over-year. We anticipate the EBITDA margins will move up throughout the year, as we've seen in previous years.

The base business, that is excluding two 2016 acquisitions, is anticipated to achieve an EBITDA margin of about 48.5%, or up 1 point versus 2016 for the same mix of businesses that we owned at the start of 2016. The mid point of the EPS as adjusted is anticipated to be $11.98 per share. That's up 4% versus the prior year.

This is driven by a significant increase in core operating performance and recent acquisitions, offset in part by higher interest expense and a somewhat higher tax rate. Terry will review this in more detail.

On a pro forma or the same same-store basis that I talked about before, this guidance is based on the following growth rate assumptions. Commercial aftermarket revenue growth in the mid to high single-digits, based on worldwide RPM growth in the 5% range. We're hopeful there could be some catch up upside here; but given the recent history, we remain cautious until we see it.

Defense military revenue is estimated to be flat to slightly up as a percent of prior year. Given world events and the political uncertainty, there could well be variations here. Commercial OEM growth we anticipate in the low to mid single-digit percentage range, primarily due to the 2017 and 2018 commercial transport production rates. We are cautious about 2018 production rates and how this could reflect itself in the 2017 shipments.

We are assuming a modest pick up of business jet revenues off a depressed FY16. Without any additional acquisitions or capital structure activity, we expect to have around $1.6 billion to $1.7 billion in cash and almost $600 million in undrawn revolver at year-end FY17.

We also have additional capacity under our credit agreement. Our net leverage is anticipated to be about 5.5 times EBITDA at the end of FY17, or down a little over one turn.

In summary, 2016 was a good and busy year. 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. Now let me hand this over to Kevin, who will discuss some of the operating highlights of FY16 and a little about FY17.

Thanks, Nick. Good morning, everyone. As Nick mentioned, in total we had a good fiscal year in 2016. I will now take you through some of the most important operational highlights of the last few quarters.

As we have stated previously, we believe our business processes, unique application of the TransDigm value drivers, and our organizational focus on accretive acquisitions that meet our strategic vision are the keys to delivering shareholder value. And as you will see, we have made appreciable progress on each of these this past year.

First, let me provide an update on our acquisition-related value driver. For review, as we do with each acquisition, we follow a detailed and scripted integration plan. This includes, but is not limited to, an implementation of our value creation process and metrics, restructuring the Company into our product line focus groups, including co-location of the team members to facilitate communication, focusing the engineering and business development efforts on winnable and profitable new business, and finally, we tighten up the cost control.

Since the beginning of FY15, TransDigm has deployed over $3 billion of capital to acquire several value creation engines for the Company. These include the businesses, or product lines acquired in FY15 of Franke Aquarotter, Telair Cargo Group, Pexco Aerospace and PneuDraulics, and in FY16, the acquisition of Breeze-Eastern Corporation, Data Device Corporation, and most recently, Young and Franklin and its subsidiary, Tactair Fluid Controls.

Now to quickly update on our FY15 activity. Franke Aquarotter, a product line acquisition, has now been relocated to our Adams Rite Aerospace facility in Fullerton, California. After some initial start-up issues, the product line and the manufacturing equipment have been successfully transferred.

This business is similar to current Adams Rite faucet businesses and allows them to provide fluid control and accessories across all major large commercial aerospace OEM manufactures and all major commercial transport platforms. Finally, this business should approach TransDigm margins.

The Tel Air cargo group was split into three businesses, along the similar lines as they had been divided under previous ownership. The cargo container company Nordisk Aviation Products is led by an internal promotion of Neal McKeever as the President and is located in Norway. Telair US Cargo Systems, led by the incumbent President at acquisition, Tim Dumbauld, is based in Goldsboro, North Carolina and is largely responsible for the design and manufacturing of military cargo handling equipment for the Airbus A400M.

Finally, the largest segment, Telair International, headquartered in Miesbach, Germany, is led by Marko Enderlein, a recent hire from the Satair Group, a division of Airbus, and is responsible for the design and manufacturing of large commercial cargo handling systems. All of these businesses have been fully integrated into our culture and value generation strategy. Headcount reductions have been performed, where warranted by business demand and opportunity.

Value pricing opportunities have been slightly muted, due to long-term agreements and our new product portfolio as limited aftermarket demand at this stage in the product life cycle. As stated previously, we believe this combination of businesses will deliver on the expectations of our acquisition model for TransDigm, a solid business, but one that will be short of Company average margins.

Pexco, a custom plastics extrusion company located in Yakima, Washington, which specializes in proprietary commercial aerospace interior products used around the aircraft. This business is led by Joe Glover, who was recently placed after the integration with TransDigm was completed. To date, we have been able to close the Huntington Beach manufacturing facility and combine all operations into Yakima.

We reduced headcount in Yakima to align with our productivity targets, evaluated value-based pricing opportunities, and exited non-core production. We believe that this team will continue to perform at expectations and that significant value generation opportunities exist for the future. This business should run at or above the average EBITDA margins of TransDigm.

PneuDraulics, a manufacturer of precision hydraulic components for the aerospace industry, is located in Rancho Cucamonga, California. At acquisition, PneuDraulics had a strong management team and this allowed us to place Dain Miller, a long-time PneuDraulics employee, into the role as President. The integration of PneuDraulics has gone to plan and the group has been an active participant in our culture, management, and business process training.

The Company's performance has delivered on expectations for the three value drivers of new business, productivity and value-based pricing. We expect this business to deliver at the margin average of TransDigm.

Next, acquired on January 4, 2016, Breeze-Eastern, which is a leading global designer and manufacturer of high performance lifting and pulling devices for military and civilian aircraft, has been integrated into the TransDigm culture, successfully implementing our value drivers and product line organization strategy. We have established an appropriate pricing structure by streamlining price lists and providing more value-added services to our aftermarket offerings.

To help our productivity initiatives, we closed the standalone Virginia facility in September and centralized all engineering and product development at the main New Jersey location. This rationalization across the business has allowed a 23% headcount reduction at Breeze-Eastern since acquisition. The business has been reorganized around two main product lines, hoists and wenches, and our usual customer support team structure has been put in place, with leaders established and team members physically relocated into dedicated work areas.

This has allowed for an increased focus on new product development, with a number of innovative new products under accelerated development which we expect to begin contributing to the growth of the business in 2017. The overall results have met our expectations, with revenue and EBITDA at or above our acquisition plan. With some existing LTAs and a few government TINA covered contracts, this business probably doesn't quite get up to our average EBITDA margins.

Next we have Data Device Corporation, DDC, located in Bohemia, New York, on Long Island, which was acquired by TransDigm on June 23 of this year. DDC is the world leader in the design, manufacture of high reliability databus motion control and solid state power controller products for aerospace and defense vehicles. This capability allows them to deliver the smallest, lightest and highest performing products in the most cost effective packaging for these applications in the aerospace market.

DDC consists of five global manufacturing locations and approximately 650 employees. To date, we have aligned the DDC structure with TransDigm's operating strategy around a product line focused organization. Our product line structure has allowed us to quickly implement two product lines of databus and power, a 10% headcount reduction to better align organization size and cost structure, review of pricing and contractual opportunities and new product initiatives.

Although only four months under TransDigm, the DDC team and business has delivered value as expected for TransDigm shareholders, with revenue and EBITDA slightly ahead of expectation. We anticipate this business will be able to deliver EBITDA margins at or in excess of TransDigm averages.

Now, acquired on September 16, the Liverpool, New York-based Young and Franklin and the subsidiary Tactair Fluid Controls are the latest additions to the TransDigm team. They manufacture highly engineered valves and actuators and are almost all of their products are proprietary. With about 70% of revenues coming from the aerospace industry, the remaining 30% comes from the industrial gas turbine markets.

Given the recent nature of the acquisition, it is too early to comment on the outcome of all of our value-driven initiatives. Productivity and enhanced new business initiatives are all being actively investigated and we will update on these as they come into focus. Additionally, a thorough top-to-bottom review of all contracts, purchase orders and forecasts has been done to evaluate any value-based pricing reset opportunities.

However, product line teams have been formed around the IGT and aerospace market segments, and these teams have now been trained in our culture, methods and expectations. We are pleased with the overall performance of the team and have confidence that the acquisition will live up to model expectations. Although numerous margin expansion opportunities have been identified, we expect this business to achieve margins just under the average for TransDigm.

To update the recent progress on our new business value driver, let me bring your attention to several recent developments in our aerospace market. Our Telair US Cargo Group business was able to overcome a difficult engineering challenge on the Airbus A400M cargo loading system. Telair recently upgraded the design of their highly engineered cargo lockdown mechanism which holds containers in place during flight.

The retrofit program is a one-time upgrade to this restraint system that will allow the containers to be held in place in flight and is also certified to release during an air drop. Going forward this new design will become part of the OEM package sold to Airbus, and we anticipate normal defense aftermarket demand for maintenance of this critical cargo handling system.

The Adel Wiggins Group, which has pioneered technology and lightning protection for over 20 years in design, testing and manufacturing of dialectric fuel and hydraulic lightening isolators for the aerospace market, was awarded the fuel and hydraulic system lightening isolators for the Boeing 777X and the Bombardier Global 7,000, 8,000 program. The safety oriented product is put in place to protect a fuel tank in case of a lightning strike.

For Airbus and their A320 platform, a few key design wins have recently occurred. Hartwell Corporation recently designed and upgraded engine [Nacelle] latch for the A320 CEO, or current engine option. This retrofit program is covered by an EASA airworthiness directive requiring airlines to make this upgrade.

This new patent pending locking mechanism is designed to prevent a Nacelle from being in an unlocked condition after maintenance. And for the A320 NEO, or the latest new engine option, Marathon Norco was just awarded a newly designed fan cowl hold open device for this platform. These awards add to the considerable number of design wins that we have already received for the latest new platforms of A350, A320 NEO, 737 Max, and 777X across all of our business segments.

Innovation is clearly a focus of our shareholder value generation culture and value driver strategy. We continue to invest fully in our businesses, from legacy through recent acquisitions of the TransDigm family to allow the development of new products and technologies for both the OEM and aftermarket segment. This has allowed TransDigm to once again be named to the Forbes Most Innovative Companies list in the world.

This award identifies TransDigm as one of the Top 100 global companies in innovation, and the only European or American aerospace company so recognized. Now let me hand it over to our CFO, Terry Paradie, who will review our financial results in more detail.

Thank you, Kevin. Nick already summarized the key elements that occurred in FY16, so I will now review the consolidated financial results for our fourth quarter, give a brief fiscal year end summary and review certain assumptions for FY17.

Fourth quarter net sales were $875 million, up $65 million, or approximately 8% greater than the prior year. The collective impact of acquisitions PneuDraulics, Breeze-Eastern and DDC contributed $89 million of additional sales for the period, offset by a slight decrease in organic sales.

The decrease in organic sales was primarily driven by declines in commercial OEM and defense markets, offset by slight growth in commercial aftermarket sales. The organic growth was also negatively impacted due to the prior period including four months of Telair, due to a reporting lag, as we've previously discussed.

Our fourth quarter gross profit was $484 million, or 55.3% of sales. Our reported gross profit margin of 55.3% was 2.5 margin points higher than the prior year. Excluding all acquisition-related accounting adjustments and operating activity, our gross profit margins in the remaining businesses versus the prior year quarter improved about 3 margin points, due to the strength of our proprietary products, continually improving our cost structure, and favorable product mix.

Our selling and administrative expenses were 12.7% of sales for the current quarter, compared to 12.1% in the prior year. Excluding all acquisition-related expenses and non-cash stock compensation, SG&A was 10.3% of sales, compared to 10.2% of sales a year ago.

We had an increase in interest expense of approximately $27 million versus the prior year quarter, due to the increase to outstanding borrowings. The higher average debt year-over-year was primarily due to the financing completed during our fiscal third quarter. As part of the financing, we borrowed an incremental $1.9 billion, of which the proceeds were used to primarily fund the acquisition of DDC and for general corporate purposes, including to partially fund the $24 per share special dividend paid on November 1.

Our GAAP effective tax rate was 26% in the quarter, compared to 29.1% in the prior year. During the quarter, we adopted a new accounting standard related to the accounting for excess tax benefits for stock option exercises that were previously recorded as a direct credit to equity and are now recognized in the income tax provision on the income statement. As a result, our effective tax rate generally approximates our cash tax rate.

Our full-year GAAP effective tax rate is 23.7%, compared to 29.8% in the prior year. The lower effective rate in the current year was primarily due to the accounting standard change. Excluding the accounting standard change, our 2016 effective tax rate is 29%, the same rate that we use for our full-year adjusted EPS.

Our net income for the quarter increased $13 million, or 9%, to $155 million, which is 17.7% of sales. This compares to net income of $142 million, or 17.5% of net sales in the prior year. The increase in net income primarily reflects the increase in net sales versus prior period, improvements to our operating margin, and lower effective tax rate, partially offset by higher interest expense.

GAAP EPS was $2.70 per share in the current quarter, compared to $2.50 per share last year. Our adjusted EPS was $3.29 per share, an increase of 16% compared to the $2.83 per share last year. Please reference table 3 in this morning's press release, which compares and reconciles GAAP EPS to adjusted EPS.

Since this is our fiscal year end, let me take a minute to quickly summarize some significant items. Net sales increased $464 million, or by 17%, to end our year at almost $3.2 billion in revenues. Acquisitions contributed $409 million of the increase in sales.

Organic sales were 2% above the prior year. Reported gross profit increased 19%, to $1.73 billion, and was 54.5% of sales compared to 53.6% in the prior year. Excluding all acquisition activity and stock compensation expense, our full-year margin versus prior year improved over 2 margin points.

Selling and administrative expenses of 12.1% of sales in FY16 is slightly ahead of the 11.9% sales in FY15. Again, excluding all acquisition-related expenses, stock compensation and non-operating expenses, SG&A was about 9.9% of sales, compared to 10.2% of sales last year.

Net interest expense increased $65 million, due to the increase in weighted average outstanding borrowings to $8.8 billion from $7.8 billion last year. Our FY16 weighted average cash interest rate was 5.3%. Adjusted EPS was $11.49 per share this year, up 28% from the $9.01 per share a year ago.

Switching gears to cash and liquidity. The Company generated $668 million of cash from operating activities and we closed the year with $1.59 billion of cash on the balance sheet. The Company's gross debt leverage ratio at September 30, 2016 was approximately 6.5 times of pro forma EBITDA and 5.5 times pro forma EBITDA on a net basis.

Adjusting for the dividend and financing that occurred subsequent to our fiscal year end, our net debt to EBITDA leverage would have been 6.4 times on a pro forma basis. We believe FY16 was another great year for TransDigm and our shareholders. As we look forward to FY17, we estimate the mid point of our GAAP EPS to be $8.65 and, as Nick previously mentioned, we estimate the mid point of our adjusted EPS to be $11.98.

As we've disclosed on slide 9, there's $3.33 in adjustments to bridge to GAAP EPS to adjusted EPS. Nick provided color on FY17 sales and EBITDA as-defined. As a result of the recent acquisition activity, refinancing and dividend, I'm going to walk through the cost below.

EBITDA as-defined and explain why adjusted net income per share increases 4%, despite EBITDA as-defined growing 13%. Both percentages assume the mid point of the guidance. So appreciation and amortization, excluding backlog amortization of approximately $25 million, is expected to be $121 million, compared to $102 million in FY16, an increase of 19%.

Interest expense is also expected to increase about 20%, to around $580 million in FY17. This estimate reflects the latest financing just completed in October and includes both cash and interest and approximately $20 million amortization of debt issuance cost. Also in the forecast assumes an average LIBOR increase to 1% for the full year, we also expect $33 million in refinancing fees.

Our effective tax rate for both GAAP and adjusted EPS in FY17 is expected to be around 31%. The benefit from FY17 stock option exercises and dividend equivalent payments will be recorded as the Street adjustments throughout the quarters and we reduce our GAAP tax rate along with our cash taxes. We expect our weighted average shares outstanding will increase slightly and be approximately 56.5 million shares.

As a result of these items, our adjusted EPS of $11.98 is approximately 4% greater than FY16. Finally, with regards to our liquidity and leverage, after paying a special dividend and assuming no additional acquisitions or capital market transactions, we expect to have around $1.6 billion to $1.7 billion of cash on hand at the end of FY17. This includes an estimate of CapEx of $85 million, or approximately 2.4% of sales.

Again, as Nick mentioned, assuming no other acquisition activity, our net leverage will be around 5.5 times our EBITDA as defined at September 30, 2017. We're delevering almost one full turn. I will hand it over to Liza to kickoff the Q&A session at this time.

Thanks, Terry. Operator, we are now ready to open the lines. I do ask that you limit your questions to just two per person and then reinsert yourself into the queue. Thank you.

(Operator Instructions)

Our first question comes from the line of Robert Stallard from Vertical Research.

Thanks so much. Good morning.

Good morning.

Nick, first question --

And welcome back, by the way.

Oh, thanks so much. Appreciate it. My first question for you is on debt. Very simply, do you think we've seen the peak in the debt market here? You mentioned that you expect LIBOR rates to go up going forward. So do you seize the opportunity as much as you can?

You mean in the past or going forward, Rob? Just to be clear on your question.

Going forward.

I'm very reticent to forecast that. You know, the one thing I've learned, at least for me, is I'm not very good at is predicting the directions of the capital market. We would, I would expect that the rates might start to move up, but I have to say, we've been consistently wrong on that for the last three or four years. We used a little higher rate here, primarily to be conservative, not that we have any particular insight into that, Rob. I think realistically, what we'll do is we'll assess it quarter by quarter, as we go forward.

Yes. And then as a follow-up on the business, on the aerospace aftermarket, are you seeing any of these larger industry trends changing? We've talked about destocking and inventories being brought down and things like that. Do you see any improvement there?

I'd like to see, Rob, it's hard to put an actual number on it. But I would say in the commercial transport for the year, our commercial transport, which is the biggest slug of it, was up a little over 9%. I think that is getting closer to reflecting the consumption rate, though maybe not quite there yet, but it hasn't, it doesn't reflect any snapback, which frequently happens after you have a couple of years that don't quite reflect the consumption. I think that's probably about the best I can add to it.

That's great. Thanks very much.

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

Thanks. Good morning.

Good morning.

Given that you have a fair amount of floating rate debt, I know you've assumed 100 basis point increase, Nick. But can you, maybe Terry, can you remind us of, I think you have some caps in place on your floating rate debt, if we do see higher rates?

Yes, David. I think we ended the year in compliance to, we're essentially above 75% fixed. We're currently looking, as a result of our most recent financing, looking at other options to hedge that with, either a cap or a swap to essentially get us back to that 75% fixed rate.

The question was on collars, how much room is there in the collars.

Exactly. Just where the portion that appears as floating but is actually capped, where that is and maybe some detail around that.

As we've disclosed, we have essentially a hedge that we have a cap in there at around 2.4%, and then we also have another swap up there that has caps at a rate of 2.8%. So you have around 150 to 175 basis points, if you will, of room within that collar of those swaps we have in place.

Got it. Okay. And then on cash flow, could you maybe, it looks like you came in pretty close this year, but maybe a little bit light to what you were guiding for, for year-end cash balance, normalizing for the acquisition you did at the end of the year. Can you maybe just touch on that, if anything moved around? And then it looks like you're anticipating a pretty good year for free cash flow next year. Maybe some of the moving pieces there, working capital and cash taxes, what you're assuming there? Thanks.

Let me talk about FY16, you can talk -- FY16, essentially the receivables, when you sort it all out, the receivables were a little higher at the end of the year, which is just the timing of how much stuff shipped in August versus September. That's the significant movement.

As moving into FY17, I think the key assumption there is around the cash taxes. As we've said on some of my prepared comments, we expect, before discretes, our effective tax rate to be around 31% this year. And with the new accounting change, most of the stock option exercises reduced your cash tax rate down to the lower amount. So now that's in your provision, we expect our cash tax rate to be slightly below or at that 31% going forward.

Thanks, guys.

Yes.

Thank you. Our next question comes from the line of Noah Poponak from Goldman Sachs.

Good morning.

Good morning.

Just as a follow-up to that, what do you guys expect to generate in free cash flow in FY17?

Well, I think we gave the number, right? The number, we told you between $1.6 billion and $1.7 billion is where we expect the cash to be at the end of the year.

Okay.

If you have our EBITDA as defined number, and we're still in that ratio of around 50% cash turn, you can figure out what the free cash flow would be in our CapEx number.

I'd use something again. Take the EBITDA in the range of 50% turns into cash. And hopefully, a little higher.

So that conversion has been a little light. It sounds like you're saying that's timing of working capital versus being something else?

Yes, I think that, as Nick talked about a little bit earlier, receivables are up a little bit this year, but purely on a timing standpoint. And I think we talk about EBITDA as defined, we turn 50% of that into cash and that's our metric for free cash flow, and we don't see anything unusual there.

Has there been any change in any terms of trade, if you will, with any customers that has impacted working capital?

I don't think materially. As you probably know, Boeing is pushing around the industry to extend the terms out to 90 days. I don't think that has materially impacted our number. Maybe that's moved around through the industry, maybe it's moved it one day or something. But I don't think it's a material impact.

Okay. And then Nick, you've expressed some caution on the large commercial original equipment supply demand picture for a few quarters now, but this is the first time I've heard you specifically say that you were cautious on 2018 production rates. Could you maybe just elaborate a little on why you're saying that?

Yes, I'd say, Noah, it's the same as usual. The cycle seems long in the tooth to me. You're starting to see, I would say probably more negative comments, some positive comments. And the FY18 cycle, the shipments in FY18 will start to reflect back on our FY17 shipments in the back half of the year. So if people start to tweak that, it will reflect into FY17. That's what I was trying to, the point I was trying to make. And so we're cautious.

Do you have a working view on rate of change in 2018 production rates versus 2017?

I don't recall. I think -- I don't remember. Let me not speculate. We are concerned that the back end of it could soften and reflect back into FY17, and that's why our percent OEM pickup isn't larger. I don't remember the exact rate, Noah, and I don't want to stab at it.

Okay. Thanks a lot.

Thank you. Our next question comes from the line of Seth Seifman from JPMorgan.

Thanks very much and good morning. You spoke a little bit about wins that you'd had on the 777X. I wonder if you could talk about your total level of content on that plane relative to the current generation of 777 and where you think it's going to end up?

Yes, we don't disclose the content by plane, but we think the 777X, as we sit here today, will very likely end up somewhere around the same content. We don't expect a lot of change.

Okay. And then just as a quick follow-up, within the pro forma guidance for defense, where does DDC fit in relative to that? I think it's flat to slightly up, right?

The total is flat to slightly up.

Slightly up. How does DDC fit in there?

We don't break it out by operating unit. We're happy with the DDC acquisition. It's doing well.

Great. Thank you very much.

Thank you. Our next question comes from the line of Sheila Kahyaoglu from Jefferies.

Hi. Good morning, guys.

Good morning.

Can I just clarify one item on the free cash flow? You estimate about $850 million. And I have cash taxes offsetting the increase in CapEx. Is the $200 million improvement year-over-year primarily working capital?

I'm not sure exactly how you're coming up with that number. What I would do is take the 50% of EBITDA. You saw our CapEx number around $84 million, $85 million, and use the 31% initially as your cash tax rate, and that should get you in that free cash flow range that we were talking about. And we guided $1.6 billion to $1.7 billion.

Right. Okay. And then maybe Nick or Kevin, is there, I appreciate the qualitative comments on the new wins. Is there any way you could guide us more quantitatively, percentage of new wins or percentage bids for full year FY16?

You broke up.

Is there any quantitative way you could talk about new program wins as a percentage of total bids or whatever metrics you guys look at it internally?

Yes, I don't have a good number for that. I would say, as I think we've told you before, the content picks up pretty well in the 787. The content picks up nicely on the A350. I would expect the 777, the A320 NEO, and the 737 Max to not have a lot of change in their content. Boeing and Airbus' goal was to not make substantive changes in them. So you wouldn't expect to see a lot of change.

Got it. Okay. Thank you.

Thank you. Our next question comes from the line of Ken Herbert from Canaccord.

Hi. Good morning. I just wanted to, Nick, dig into the commercial aftermarket, if I could. When do you, you obviously another quarter where you had a 3% headwind from business jets, helicopters and it sounds like cargo in the fourth quarter. When do those, when do you anniversary those more or the comps maybe get easier for that part of the business? And does the guidance, and what does the guidance imply for commercial transport growth versus these other markets in FY17, which seem to clearly have been about a significant headwind the last few quarters?

The commercial transport growth, if you look at mid to high single-digit next year, the commercial transport growth we would expect to be higher, or higher than the average, same thing. If you take the business jet, business jet, and I suspect the freighter, they will be a little bit of a down drag. So take whatever number you want to use from mid to high single digits. The commercial transport is probably on the upper end of that point and the others are down on the lower end.

Okay. So there's no specific inflection point maybe after the second quarter when you start to see the comps get easier for the non-transport side of the business?

I don't think so. I think it's going to change versus the intrinsic demand, not just some trick in the comp.

Okay. And then if I could, geographically have you seen any change in the last few quarters or in the outlook in FY17 on the aftermarket in terms of, I know it sounds like we've had really good demand in Asia in your FY16, do you assume maybe a little slower growth there and pick up in Europe or North America, or anything you could comment on geographically?

Yes, I would say you can almost generally go through, now we do it unit by unit, product line by product line. So it bounces around. But the way I would think about it is almost take the growth in RPMs by region of the world and that will give you some pretty good idea.

Okay. Thank you very much.

Thank you. Our next question comes from the line of Myles Walton from Deutsche Bank.

Thanks. Good morning. Nick, or maybe Terry, could you clarify the net cash flow impact of the dividend less the incremental leverage being taken on in FY17? I know you gave the cash year-end number, but just that moving part would be helpful.

I think it would be, I'm just doing here --

That's the dividend minus the incremental debt.

It's $650 million to 700 million.

Okay. With that, I think we can back into the free cash flow. But without it, I think it's a little tougher.

Yes.

And then the other question, Nick, you talked about bookings are tracking slightly ahead -- excuse me, orders tracking slightly ahead of bookings in aftermarket in the quarter. Any way to clarify if that's an acceleration or a continuation of a trend, just commentary in the aftermarket in general near term, is it similar to what you saw last quarter, just positioning into the next year?

Well, the aftermarket shipments were sequentially up. The bookings I don't, I just don't have a good, I'd say the same -- I can't say they're noticeably separated. We're awfully close on the year, and I think the fourth quarter isn't much different.

Okay. And the last one, the CapEx implied doubling year-on-year. Is that just conservatism on the CapEx budget?

I suspect that's a high number. We underspent against our budget the previous year, and I expect that's a little high.

Okay. All right. Thanks, guys.

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

Good morning. This is actually Joe on for Rob. Nick, given the $1 billion to $2 billion in potential dry powder by year-end and any updated covenants under your latest debt structure, what's your restricted payment capacity for the coming year, assuming no M&A?

Our restricted payment is, we can go up to 7.25 net and 4.25 on secured debt capacity, for new debt, plus the including the target of that.

Are you after how much dividend can we pay out? Is that what you're after?

Essentially, yes.

At this point in time, we only have about $130 million remaining on it through the end of the year. And we would have to get an amendment to do any more additional dividend.

Which, by the way, just so you know, almost every time we do this, you have to get an amendment.

Or the other point is if we get under six times net debt, we can pay a dividend up to that six times.

Okay. Understood. And then you already cut headcount to get ahead of that potential softening in commercial OE. You said you'd adjust again, if necessary. You've talked about how you're cautious on FY18 production rates. What has to happen for you to adjust further? What would you need to see to do that?

Oh, I think it would be, it's hard to say exactly what the point is when your concern gets to that. It's a little bit of an art, rather than a science. But clearly starting to see more announcement of turn down of rates in either predictions of turn downs in FY18 or even the beginning of FY19 would do it. Now sometimes, you don't see the announcements. No one announces it, but you all of a sudden see the orders are starting to slow down. That's another thing that would do it. And we'll just watch those as the year goes through. We're quite, we're prepared, and as we've done in the past, we'll move quick to stay out ahead of this.

Got it. Thank you. That's helpful, Nick.

Thank you. Our next question comes from the line of Hunter Keay from Wolfe Research.

Good morning. Thanks, Nick. How you doing? When you say 80% of your sales comes from sole source, as far as you believe, why do you add that caveat? I don't want to over wordsmith your word choice, but what percent of that 80% sole source do you know is sole source? What I'm really trying to do is get a sense for the barriers around that 80%, in the event that some of the aftermarkets --

Oh, I think that is materially very close. Why we hedge a little bit is there's no guarantee that if someone makes a change, they send us an e-mail and tell us they changed it. But we have a pretty good bead on it.

All right. So the vast majority of it?

Yes. Yes.

Got it. And you mentioned Boeing pushing people around a little bit. Are you getting pressure from them or any other OEs to roll up the contracts into maybe not one single contract but certainly fewer contracts, like we've seen from a couple other OE suppliers?

Like everyone in the industry, Boeing has been pressing on what they call this partnership for success, which is at least to roll into less contracts, I would say. And we ended up about two or three years ago with a modified version of that, where the terms and conditions we agreed to generically and the rest of it is more product by product focused.

So would you say that's largely behind you, at this point, or is that still ongoing?

I don't know. It was behind us two years ago, but the contract runs for five years, or maybe it was three years ago, or two years ago? I can't remember now. But the contract runs for five years, so you'll reengage again a couple years before the contract runs out.

Okay. Thanks, Nick.

Thank you. Our next question comes from the line of Gautam Khanna from Cowen.

Thanks and good morning, or good afternoon, I guess now. A couple questions. First, to follow up on the last one -- I ask this every quarter, sorry -- but has there been any more evidence of more second sourcing type incursion in your product lineup? Are you seeing any evidence of that?

No, we have not. We have not. As always, we hear talk about it periodically, but we haven't seen any significant activity, at least for any of the proprietary. A very small percent of our business is non-proprietary, and that part of it, you see it. It's not unusual to see it.

Okay. And I just wonder, what can you do to guard against that? I know you own some of the IP and what have you. But what other strategies do you have in place?

Primarily, we own the IP, and it is a very expensive switching process. It's long and expensive. The main way you protect yourself is deliver quality product, deliver it on time, and service the heck out of the account and fix it fast, if something comes up. Because the math rarely works, because of the switching cost.

That makes sense. Wanted to get your high level view if there's any upside or downside with the new administration to your business. How could you be benefited at all, if at all?

I doubt -- first, I have no idea, but that's not going to stop me from saying something, but I want to lead with that I have no idea -- I'd be surprised if it has much impact on worldwide revenue passenger miles. But I guess you might see more defense spending, perhaps. But I have no way to know how to handicap that at this point.

Okay. And then one last one. You mentioned a reasonably active M&A pipeline. In the pipeline today, are there any larger opportunities, needle moving opportunities, or are they more of the under $100 million of revenue size? Any characterization?

I would say they're more small to mid than large. But I would also say that's almost always the case. The bigger ones tend to, somebody decides to sell them and they come up and you've got to move pretty quick on them. I would say the backlog doesn't look a lot different than it often looks.

Okay. And the profile is similar, i.e., high aftermarket, high proprietary, et cetera? You're not seeing a quality deterioration?

Well, when I say the backlog of things we're looking at, if it's not proprietary and doesn't have a reasonable amount of aftermarket, it's not in our backlog.

Got it. All right. Thank you guys.

Okay.

Thank you. Our next question comes from the line of Noah Poponak from Goldman Sachs.

Hi, guys. Just had one follow-up. In the defense segment, you mentioned a few programs that I believe you said were order rate headwinds in FY16 versus FY15. I guess those are therefore revenue growth headwinds in FY17. Is that true, and can you quantify that? It would be great to just understand how much the segment is growing for you, excluding those program specific headwinds.

Well, yes, Noah, what I was trying to point out there is the bookings ran behind the revenues this year, FY16. So what I was trying to point out is that I don't think that's indicative of FY17, because there were a few big orders placed in FY15 that were multi-year orders. So they don't repeat each year, they repeat every other year or every third year, something like that. I don't know if that's clear or not. I was trying to point out what the rationale was for the bookings running behind.

Are any of those revenue headwinds in FY17 that then don't repeat beyond FY17, or is it more that they're long cycle programs with lumpy order patterns?

It's more like they're long cycle programs. I would say the only one that I would say that could is you pays your money and takes your choice on what the A400 shipping rate is going to be. That was one of them. And you know, there could well be up or down adjustments to that. As you know, it's been running in fits and starts.

I guess it begs question then a little bit more broadly on the end market. Is there anything holding that up from reaccelerating a little faster, just given what we're seeing with the budget and what we're seeing some other defense companies project for growth next year?

Noah, if the question is could it be higher? Yes, it surely could. And I would hope it would be. But we have to take our best estimate based on what we get out of the product teams, what we see in our incoming booking rates, and forecast it out. Now I would doubt we'd be very far off on the OEM programs, but what could easily move up or down -- I would hope up, not down -- is the aftermarket. If you get more active or you just decide to restock, those things can move pretty quickly.

Okay. Thanks again.

(Operator Instructions)

And I'm seeing no other questioners in the queue at this time, so I would like to turn the call back over to management for closing comments.

Thank you again for calling into our call this morning and please look for our 10-K that will be filed tomorrow.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you may all disconnect at this time. Everyone have a great day.