Liza Sabol - TransDigm Group, Inc. Nick Howley - TransDigm Group, Inc. Gregory Rufus - TransDigm Group, Inc. Terrance M. Paradie - TransDigm Group, Inc..

Carter Copeland - Barclays Capital, Inc. Noah Poponak - Goldman Sachs & Co. Myles Alexander Walton - Deutsche Bank Securities, Inc. Robert Stallard - RBC Capital Markets LLC Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) Ken G. Herbert - Canaccord Genuity, Inc. Gautam J. Khanna - Cowen & Co. LLC Michael F.

Ciarmoli - KeyBanc Capital Markets, Inc..

Good day, ladies and gentlemen, and welcome to the Second Quarter 2015 TransDigm Group, Incorporated, Earnings Conference Call. My name is Crystal and I will be the operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

I would now like to turn the call over to your host for today, Ms. Liza Sabol, Investor Relations. Please proceed..

Good morning and welcome to TransDigm's fiscal 2015 second quarter earnings conference call. With me on the call this morning are TransDigm's Chairman and Chief Executive Officer, Nick Howley; Chief Operating Officer, Kevin Stein; our Senior Executive Vice President, Greg Rufus; and Terry Paradie, our new Chief Financial Officer.

A replay of today's broadcast will be available for the next two weeks. Replay information is contained in this morning's press release and on our website at transdigm.com. Before we begin, the company would like to remind you that statements made during this call which are not historical in fact are forward-looking statements.

For further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, please refer to the company's latest filings with the SEC. These are available through the Investors section of our website or at sec.gov.

The company would also like to advise you that during the course of the call, we will be referring to EBITDA, specifically EBITDA As Defined, adjusted net income, and adjusted earnings per share, all of which are non-GAAP financial measures.

Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and a reconciliation of EBITDA and EBITDA As Defined, adjusted net income and adjusted earnings per share to those measures. With that, now let me turn the call over to Nick..

revenue – and this is to the midpoint – is $2.68 billion, up about $140 million versus the prior midpoint; EBITDA as adjusted guidance is now $1.21 billion to the midpoint, up about $32 million versus the prior; EPS as adjusted guidance is $8.62 a share to the midpoint – that's up $0.46 to the midpoint from the previous guidance.

Of the increase in adjusted EPS of $0.46 at the midpoint, the majority of the increase is from the recent acquisitions with much of the balance due to a more favorable tax rate. By market segment, excluding the most recent acquisitions, we are using the following assumptions. Commercial OEM, mid-single-digit growth. This is unchanged.

Commercial aftermarket, mid-single-digit growth. This is modestly down from our prior guidance. Defense, low to mid-single-digit growth. This is modestly up from our prior guidance. As usual, we'll look at this again next quarter and update you if we see things changing. All in all, a good quarter.

Our operating results were strong, we closed on two solid acquisitions and we expect Pexco to close soon. When Pexco closes, we will have invested about $1.3 billion in good solid aero businesses with strong value generation prospects over a 90-day period. And with that, let me hand this over to Greg..

$0.06 from the dividend equivalent payments, $0.41 from non-cash stock option expense and $0.46 from acquisition-related expenses. The large increase is due to the recent acquisitions of Telair and Franke.

Just of note, both acquisitions just closed will require transition service agreements which will include certain accounting activities we will require from the sellers for a period after ownership. Because of this, we will be on a one-month reporting lag for both Telair and Franke.

Our current plan is to have two months of activity in our third quarter results and catch up and have the four months of activity in our fourth quarter. Now, I'll it hand it back over to Liza to kick off the Q&A..

Thanks, guys. In order to give everyone the opportunity to ask questions, I'd ask that you'd limit your questions to two per caller. If you have further questions, please re-insert yourself into the queue and we'll answer those as time permits. Operator, we are now ready to open the line..

Our first question will come from the line of Carter Copeland from Barclays. Please proceed..

Hey. Good morning, Nick, and welcome, Terry and Greg. Thanks for helping us all this time and congrats on not having to put up with us anymore..

Not quite. He's got to hang around 15 months..

Yeah. I know. He just doesn't have to listen to us on this every quarter..

Still got to listen to Nick..

Couple of questions. One from a high level, Nick. When you look at the three recent transactions and compare them to some of the others you've seen, whether it's Airborne, EME, I wonder if you might compare and contrast those and how you feel about these.

They certainly look like some of the transactions we've seen in the past, obviously, Franke and Adams Rite or Pexco and Schneller. I wonder if you might just give us some color about how you think about how you think about these acquisitions versus some of the others you've done in the past couple years..

Well, if I compare that to say Airborne, these are more right down the middle of the plate kind of acquisitions, proprietary, aerospace, commercial aerospace, kind of things. I would describe them as I think that's the best way to do it, right down the middle of the plate.

I would say – which by the way is what Arkwin was like and what the GE business was like, which were the previous ones we bought. As I mentioned to you, I think there's the – let me stay off Pexco. I think that's just because we don't own it yet and we're restricted in what we can say..

That's fair..

But I think it's a significant value generator. The Telair one, I think there's good upside, though as I said, Carter, I don't know that it gets up to the average at least for the next three years or so. There's just some contractual issues there..

Are those basically agreed to long-term prices?.

I don't want – I can't really talk – confidentiality agreements with your customers. But that'd be a pretty good guess. I don't know what else would do it..

Yeah, exactly. Just a quick follow-on. Last quarter, you talked about being some distributor destocking. I didn't know if you saw any more of that or if you were past that or....

I don't think we saw any meaningful change there this quarter..

Great. Thanks, guys, and congrats on the deals..

Yeah..

Our next question will come from Noah Poponak from Goldman Sachs. Please proceed..

Hi. Good morning, everyone..

Morning..

Morning Noah..

Morning Noah..

Greg, congrats on the retirement and the run you had here..

Thanks. I feel old..

Can you guys walk us through why cash from ops was negative in the quarter and how you see it playing out the rest of the year?.

Terry, you want to handle this one?.

Yeah, Noah, I think the biggest driver for cash from ops being negative is kind of three areas.

There was a big income tax payment made during the quarter of over $80 million, as well as you're also seeing interest payments of over $140 million during the quarter and then just plainly the working capital changes during the quarter, which drove the negative cash from operations for the quarter. But it's just timing.

I think we're comfortable and confident that we'll generate the planned free cash flow for the full year..

And can you remind us what that plan is?.

Well, in my numbers, that by the end of the year, we'll now have $900 million in cash on the balance sheet..

Assuming we'll put $400 million from that financing.....

That's right..

That's right..

Okay..

So $500 million without the financing, $400 million because we'll probably throw in there from the financing..

Got it.

Can you tell us how much of the commercial OE and aftermarket revenues that you report are helicopter?.

It's a small – I don't know the exact percent. It's a small percent. It's surely in the single digits, well in the single digits. And the only reason that they register on the meter is because they drop off so much..

Yeah.

And that's all oil and gas I assume?.

I think so. I think so. Nobody gives us a reason when they don't order, but that's surely what we surmise..

And then in the full year commercial aftermarket growth target revision, is there any change to the large commercial aerospace piece of that?.

I don't know that I can call it exactly that close. I mean, clearly, the trends in the commercial transport look good. However, the comps get pretty tough. If you remember, the second half of last year was up 17%, 18%..

Right..

So the comps get tough. It's clearly going in the right direction. And absent anything else, it might well get there, but we're getting some down drags on the other pieces of it. And just when I'd put them all in a stew, it makes me feel like that high-single-digit number's a little risky.

Now we get a spike like we did last year at the end of the year, we'll be fine, but that seems to me more of a sort of a hope than a plan..

Okay. Thanks very much..

Our next question will come from the line of Myles Walton from Deutsche Bank. Please proceed..

Thanks. Good morning. I wanted to pick up on that cash flow question for just a second. So I think that the guidance had been $475 million. Cash taxes are now about $5 million lower and then you have another $32 million of EBITDA.

So is free cash flow going to be closer to $500 million? Because if that's the case, it seems like your year-end cash balance should be closer to $1 billion than $900 million..

I don't reconcile all of the pieces, but I could tell you that our cash flow is what it is and our operating capital is pretty good. Our DSOs are in good shape, our inventory is in good shape.

It's in the noise range, but we may spend like $10 million in transition service agreements, which wouldn't be part of the EBITDA, but that's only like $10 million with the two acquisitions.

So I don't know to your starting point, or we have so many moving pieces with everything we just threw at you, but we think it's more like $900 million and everything's clicking in the right direction..

I just think we don't foresee any other acquisitions, we don't see any difference in our operations than we have....

No. No..

...on the cash generation..

On the free cash flow side?.

Yeah..

Yeah..

Okay. And then, Greg, you also mentioned the tax structure improvements that you were making and it sounded like some of those may actually be more permanent and sticky. So is that 32% – I guess I couldn't quite discern what was discrete from prior years and what was more permanent in terms of tax structure going forward. So....

Well, the discrete items were – we finished up an audit and did that. That was only $0.06, the discrete item..

Okay. Yeah..

And then as we go forward, we think the rate will be below 32%.

Of this tax structure stuff, we won't give you an effective tax rate that we're going to forecast in 2016, but we think on an annualized basis, it's between $10 million and $12 million of tax savings from this restructuring – from this new structure we've set up with the former operations (37:36)..

Okay. Good deal. I'll take the two. Thanks..

Our next question will come from the line of Robert Stallard from Royal Bank of Canada. Please proceed..

Thanks so much. Good morning..

Good morning..

And congratulations on your retirement, Greg..

Thank you..

Nick, I thought we'd kick it off on the acquisition front.

With Telair having a lower margin and Pexco having a higher percentage of OEM sales, does this indicate that you're not seeing as many of your classic targets out there as you maybe would have seen in the past?.

I don't know that I can say that. As I've always said, we're die everyday and the ones that look like they work, we take a swing at. I would say on aftermarket, Telair is a pretty hefty aftermarket. Franke's pretty hefty aftermarket.

I think as we told you, the Pexco one is about 35% now, but just by natural occurrence, it's going to drift up to 60% just because the planes going in have much more content than the planes coming out. So I don't know that I would say that they're proprietary aerospace businesses with a fair amount of aftermarket.

They don't – now, they see a clear path to that..

Okay. And then second, you mentioned that bizjet aftermarket was a bit weak in the quarter. What's the driver of that? Is it lower flight activity or some destocking....

I don't know enough – I really am not sure. I think it's a transient because the bookings look pretty good..

Okay.

So we should expect that to accelerate maybe in the second half?.

We give a guidance in total. We don't give it by each one of those segments. But with the bookings good, you would hope to see some pickup..

Great. Okay. That's all from me. Thank you..

Yeah..

Our next question will come from the line of Robert Spingarn from Credit Suisse. Please proceed..

Good morning. Welcome, Terry. Congrats, Greg..

Thanks, Rob..

Thank you..

Nick, on helicopter, since it's so weak, is there a way to frame where it is relative to its peak and its trough? I mean, how much more downside could there be both OE and/or aftermarket?.

I don't have the number in front of me, Rob. I don't think it's big enough to have a material impact on the business through the year, but it drops off enough it can sort of make some quarterly comparisons look funny. But I don't know the – as I sit here, I just don't know the exact numbers.

It is far and away – it's way smaller than commercial transport as I'm sure you know and it is significantly smaller than business jet..

But it could continue to impact? In other words, we could see similar commentary next time?.

Yes..

Okay. And then going over to Telair and the three years till the margins – well, I want to make sure I understand you correctly.

Are you saying you can get there eventually, it's three years away or you're not going to get there?.

No. I'm saying right now, as I sit here today, we are not figuring we can get there. Now as contracts run out over time, our view on that may change, and hopefully – we tend to be somewhat conservative in our acquisition models, so hopefully we can do better.

But we don't – we want to be sure we have a model that we can meet and get our PE-like returns without making too many wild assumptions. So, I'd figure it doesn't get there right now..

Okay. And then just the last thing, on the air transport aftermarket, or large aircraft aftermarket, and your comments earlier, understanding part of it's helicopter, part of it's bizjet.

But just what the airlines are doing, do you think that just flight activity is so robust that we've maybe seen a slower sales demand or spares sales demand than we might see at some point? You mentioned a spike last year.

Is there a bow wave that might be out there?.

I mean, you know that's always a possibility. Right? Because if you take the, probably the last couple quarters, add them up and adjust for price, it probably isn't quite keeping up with RPMs. Now you also have the confounding variable of the six months before that, it was up 18% or something like that..

(42:29)..

Yeah. So I don't exactly know how to parse that out. But, Rob, clearly there's some chance. But as I said, if we get a fourth quarter spike like we did last year, all will be well, but we're just not figuring on that. Now whether that comes or it doesn't come along, will have no effect or impact on that. It either will or it won't..

Okay. Thanks very much, Nick..

Our next question will come from the line of Ken Herbert from Canaccord. Please proceed..

Hi. Good morning and congratulations, Greg, and welcome Terry again. Just wanted to first follow up on the defense market, if we could. Now, do you get a sense, Nick – I mean this is the second quarter in a row where you've talked about better bookings. Obviously, you raised the guidance a little bit.

Have – you get a sense that we've hit an inflection point and this is sort of now what to expect moving forward? Or do you get a sense there's still some one-time issues perhaps that you're seeing in this market?.

some up, some down, some sideways. I think I'd just have to stick with sort of the guidance we gave you. I feel pretty good looking six months out because our book – we've been shipping pretty well and our bookings are hanging in pretty well. I just – it's very difficult for me to speculate beyond that..

Okay..

I think the chances – let me back – I think if you asked me four years ago, me and many people would have said, you could be looking at a 25% dislocation. I don't – I think the risk of that is likely behind us..

Okay. So it sounds like, at least moving forward here, with the bookings you've seen, there's a little more confidence perhaps in the outlook than certainly – I mean, I know you outperformed relative to your pessimistic expectations. But it sounds like there's just more confidence or visibility in the business..

Surely for the next six months..

Yeah. Okay. That's great.

And if I could, just on the commercial aftermarket, did you see – throughout the quarter, did you see any trends where maybe the year started a little softer and picked up through March that's maybe continued into April? Or was there any noticeable difference coming out of, calendar-wise, coming out of the fourth quarter December into January within commercial, specifically on the transport side with commercial aftermarket purchasing?.

Yeah, I don't think I can sort of slice the onion that thin. March always looks better to us because it's a five-week month for us in our accounting system..

Plus, we have all the holidays in the first quarter..

Yeah. In the first quarter, as you know, we're about eight to 10 days short on shipping days. So it always – the first quarter always looks a little worse. And the last quarter – the last month of each quarter looks good to us. Always looks good, because we're on a 4-4-5 schedule.

So I don't know that I can parse that out and give you anything definitive..

All right. That's helpful. Thank you very much..

Our next question will come from the line of Gautam Khanna from Cowen and Company. Please proceed..

I'd just like to ask if you can comment on the M&A pipeline now.

After all these deals, do you still have a number of such opportunities?.

Well, one thing I can say for sure is the pipeline today has three less businesses in it than it had 90 days ago. I think that's about the only thing I can say with certainty. We're still active. We're still looking at things. I have no ability to predict whether we are done buying or not done buying here for the year.

Obviously, we think there is – we don't think we're dead or we wouldn't be looking to borrow more than we need to pay out, but time will tell..

Okay. And could you comment – the comment on defense bookings up significantly.

Was this pretty broad based? Before it was mostly Airborne Systems, right?.

Yeah. I would say it is across businesses, though the Parachute business is the biggest pickup. That one's up very substantially. Others are up, but not to that degree. And it's still – I don't want to say it's a tide rising and all the ships are coming up still. I mean, it's still a mixed picture..

Okay. Thank you very much..

Our next question will come from the line of Michael Ciarmoli from KeyBanc Capital Markets. Please proceed..

Hey. Good morning, guys. Thanks for taking my question..

Morning Mike..

Morning Mike..

Congrats, Greg. Maybe, Greg, just for clarity, the $900 million in financing, I'm assuming that's not embedded in the outlook and I think maybe even perhaps more so I'm asking on maybe the right interest expense for the year. I don't think you gave an interest level for the year..

No, that's not embedded in the forecast right now. I mean, as a general rule until we actually own it, we don't put it in. We were just giving you a little color on leverage..

Got it..

So neither Pexco nor the additional debt. Neither one are in there..

Are in there. Right..

Got it. Just maybe on Pexco and Telair, is there any – you mentioned obviously the margins.

Have both of those entities worked out their sort of Partnering for Success agreements with Boeing?.

Pexco, yes. Telair is primarily an Airbus business..

Right..

And they don't have the same situation at Boeing..

Okay. Okay. That's fair. And then just the last one maybe on Telair.

Structurally, is it going to be harder to implement your value creation just given a lot of their European operations and labor laws there? And I guess maybe just an add-on to that, how much of a FX tailwind do you guys are going to pick up from Telair this year?.

I don't know what the tailwind is on FX, but it's a tailwind, not a headwind obviously..

I don't know exactly....

Yeah, yeah..

We're only putting on for half the year from when we bought it..

Yeah. And it's the change from when we bought it till the end of the year. A lot of the tailwind you saw already. So it isn't a big number. On the European productivity or cost situation, that's one that we understand we're in a different environment and I think we've – we hope we've reflected that appropriately.

We're a little more conservative than we might be in a different situation..

Got it. All right. That's all I had. Thanks, guys..

Okay..

And with no further questions, I would like to turn the call back over to Liza for closing remarks..

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

Ladies and gentlemen, that concludes today's presentation. You may now disconnect. Have a great day..