TransDigm Group Incorporated
Q2 2016 Earnings Call Transcript

Published: 10 May 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the TransDigm Group Incorporated Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this call is being recorded. I would now like to turn the call over to Liza Sabol. You may begin.

[Liza Sabol:]

Thank you. Welcome to TransDigm's fiscal 2016 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 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 in 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 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.

[Nick Howley:]

Good morning and thanks to everybody for calling in. Today as usual, I'll start with some comments on the consistency of our strategy, an overview then of fiscal year 2016, both the second quarter and year-to-date performance. We'll update the guidance for the year. Kevin is then going to update you on some operating items and Terry will run through the financials for the quarter. 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 aerospace cycle. About 90% of our sales are generated by proprietary products, that is, products for which we own the intellectual property. Over half our revenues and a much higher percent of our EBITDA comes from aftermarket sales. Aftermarket revenues have historically produced a higher gross margin and have provided relative stability through the cycles. Because of our uniquely high EBITDA margin, TransDigm has, year-in and year-out, generated very strong free cash flow, this gives us lots of operating and financial flexibility. We follow a consistent long-term strategy. We own and operate proprietary aerospace businesses with significant aftermarket content. We have a well-proven value-based operating strategy, based on our three value driver concept. We maintain a decentralized organization structure, and a unique compensation system that closely aligns the management with the shareholders. We acquire proprietary aerospace businesses with significant aftermarket content, where we see a clear path to PE or private equity-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. We basically have four. First, invest in our existing businesses; second, make accretive acquisitions consistent with our strategy, and these two are almost always our first choices. Third is to give extra money back to the shareholders, either through a special dividend or stock buyback; and lastly is to pay off debt. But given the current low after-tax cost of debt, this is still likely our last choice. Depending on the specific business and capital market conditions, we'll allocate our capital and structure our balance sheet in a manner we think has the best chance to maximize the equity returns. Now, to update you on a few items from this quarter. The credit markets, at least as of today, have firmed up nicely in the last quarter. Our bonds and secured debt are trading roughly at par. We have adequate access to debt markets at rates roughly consistent with those we pay now. In the first six months of the year, we bought back about 1 million shares of TransDigm stock at an average price of $205 a share. Almost all of this occurred in the December through February timeframe. We currently have an additional $340 million of repurchase authorized. This authorization does not imply anything about our buyback plans. At 4/2/2016, which is the end of the quarter, based on current capital market conditions, we believe we have adequate capacity to make over $1.5 billion of acquisitions without issuing any additional equity and maintaining significant liquidity after we do that. This capacity grows as the year proceeds. On a very positive note, the commercial aftermarket revenues and bookings picked up substantially this quarter. Quarterly bookings ran ahead of the strong shipments. Recoveries are often not straight upward lines and we could still see bumps, but it's good to see a strong quarter like this. As I've said before, we see a number of factors that should contribute to continuing commercial transport aftermarket growth this year. Passenger traffic remains strong, slowdown in retirements, and potential ends to the deferral or inventory cycle. On the other hand, though much smaller in our revenues, the business jet and freighter aftermarkets could be weakening. Turning to Q2 fiscal year 2016 and year-to-date performance, and I remind you this is the second quarter for 2016, our year started October 1. As I've said in the past, quarterly comparisons can be impacted by differences in mix, inventory fluctuations, seasonality and things like that. Total company GAAP revenues and EBITDA As Defined were strong, both for the Q2 and year-to-date. For Q2, the revenues were up 29% versus the prior Q2, and 24% versus the prior year-to-date. EBITDA As Defined was up about the same percent as the revenues. Overall, organic revenues were up in the 4% to 5% range versus the prior year. Commercial revenues were up a bit more, while defense was modestly down. Defense bookings on the other hand ran well ahead of the shipments. EBITDA As Defined dollars and margin percent were both strong. To review the revenues by market category, again, this is on a pro forma or same-store kind of a basis versus the prior year. And this is assuming we own 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 about flat for Q2 versus both the prior year, year-to-date, and versus the prior year Q2. Commercial transport OEM revenues, which make up the vast majority of our commercial OEM revenues, are up 2% versus the prior year-to-date, Q2 was flat versus a difficult comp in the prior year. We saw some modest inventory adjustments in certain commercial transport OEM Tier 1 accounts. Year-to-date, commercial transport bookings are running slightly ahead of revenues. The biz jet and helicopter OEM revenues are a much smaller percent of our business and are heavily biz jet weighted. In total, revenues in these markets were about flat versus the prior year Q2, and due to the weak Q1, down about 6% year-to-date. Business jet bookings for Q2 were slightly ahead of shipments. The biz jet market in total seems a little weaker than we originally anticipated. Total commercial aftermarket revenues were up about 13% for this quarter versus the prior year and are now up 7% on a year-to-date basis. On a year-to-date basis, the commercial transport aftermarket is now up a little more than the overall average and the business jet, helicopter and freighter markets are flat to slightly down. For the quarter, total commercial aftermarket bookings were modestly above shipments. Commercial transport bookings were up 16% in Q2 versus the prior Q2; biz jet, helicopter and other bookings were modestly down in Q2 versus the prior year Q2. But I'd remind you again, these other categories are far smaller than the commercial transport. The defense aftermarket makes up about 30% of our revenue. Defense revenues for fiscal year 2016 Q2 were down 3% versus the prior Q2, and down about 1% on a year-to-date basis. The revenues by product lines were spotty with no clear patterns. However, as I said before, year-to-date bookings are running ahead of shipments, they're running about 11% ahead of shipments with a very strong quarter of bookings in Q2. Moving on to profitability and on a reported basis, I'm going to talk primarily about our operating performance or EBITDA As Defined. The As Defined adjustments in Q2 were non-cash compensation expense and acquisition-related costs or amortizations. EBITDA As Defined of about $396 million for Q2 was up 28% versus the prior quarter – prior Q2, and $688 million, or up 23%, on a year-to-date basis. The EBITDA As Defined margin was 46.5% of the revenue for Q2, and 46% year-to-date. This is about the same margin percents as last year in spite of approximately 2% of margin dilution from the 2015 and 2016 acquisitions. As we mentioned last quarter, we've reduced our employment level in the range of 4% to 5% in Q1, this, combined with our other value drivers, contributes to the strong margins. With respect to acquisitions, we continue looking at opportunities, the pipeline of near-term possibilities strengthened from the last quarter and we are seeing more activity recently. Closings are difficult to predict, but we remain disciplined and focused on value creation opportunities that meet our tight criteria. Turning now to the 2016 guidance. We continue to have some concern about the duration of the commercial transport OEM cycle. As I've said before, we're cautious with our spending and are ready to react quickly if necessary. We see increasing variability in various industry forecasts and by platform, the news is somewhat mixed. In the commercial aftermarket, air travel is holding up well and as I mentioned, there are other factors that should positively impact demand. As I also said, that biz jet and freighter markets could be a little softer than we originally anticipated, recoveries don't always run in a straight line, so we tend to be a little cautious. All in all, this is our best estimate for the full year. Based on the above and assuming no additional acquisitions, beyond Breeze, in fiscal year 2016, the guidance is as follows. The midpoint of the 2016 revenue guidance is $3.17 billion, this is the same as our prior guidance. We've tightened the range up a little, it's up 17% on a GAAP basis year-over-year. The midpoint of the fiscal year 2016 EBITDA As Defined guidance is $1.46 billion, an increase of about $25 million. This is up 18% year-over-year. The increase in guidance is driven by improvements in our EBITDA margin. The base business, that is excluding the 2015 and 2016 acquisitions, is still anticipated to achieve an EBITDA margin of about 49%, or up around 2 points versus 2015 for the same mix of businesses. The recent acquisition margins are running a bit ahead of our prior estimates. The midpoint of the EPS as adjusted is now anticipated to be $11.16 per share, or up $0.39 a share from our last guidance. This is up 24% versus prior year. The increase in guidance is due to two factors, improved margins and modestly lower share count as a result of our buybacks. Terry will run through some of the details. On a pro forma or same-store basis, this guidance is based on the following growth rate assumptions

[Kevin M. Stein:]

Thanks, Nick. Good morning, everyone. As Nick mentioned, in total, we had a good second quarter. As we've stated previously, we believe our planning 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. For an update on our acquisition-related value driver, let me give you an update on the last acquisitions we accomplished. To this point, let me once again provide some color to our acquisition strategy. As we do with each acquisition, we follow a detailed and scripted integration plan. This includes an implementation of our value creation process and metrics, restructuring the company into our business unit focus groups, focusing the engineering and business development efforts on winnable and profitable new business and finally, we tighten up the cost structure. For Telair, this was a significant acquisition in early 2015 for TransDigm and focuses on the defense and commercial cargo markets. Today, the acquisition is on track, on its integration path and has delivered sales and EBITDA in excess of our model. In general, the defense market has performed well for us in this business, but the freight market may be beginning to soften. We remain confident that this is a fine business for TransDigm. Additionally, we closed on Pexco in May of 2015, a custom plastics extrusion company located in Yakima, Washington, which specializes in proprietary commercial aerospace interior products used in the galleys, lavatories, floors, ceilings, and stowage bins of aircraft. Today Pexco Aerospace is performing at our expectations across all key financial and growth metrics, with a strong focus on our value generation strategy. The team successfully closed and completed the consolidation of the manufacturing facility in Huntington Beach with minimal customer disruption. While implementing a largely new management team at Pexco, we have realized better than expected productivity results with all of our manufacturing activities now under one roof. With performance on our value drivers ahead of plan, we currently are finding sales and EBITDA are additionally running ahead of plan. We are pleased with the overall performance of the team and have confidence that the acquisition will continue to run at expectations. In August of 2015, we finalized the acquisition PneuDraulics into the TransDigm family. PneuDraulics is located in Rancho Cucamonga, California, about 60 miles east of Los Angeles. PneuDraulics' highly engineered and proprietary products primarily are valves, actuators and subsystem components used in hydraulic and pneumatic applications. PneuDraulics serves all of the major markets in aerospace, including commercial, regional, business jet and defense markets. We were confident when we acquired PneuDraulics that it was a solid business with an excellent management team. This has proven to be the case, as the management team has proven to be fast adopters of the TransDigm value drivers culture. The integration of PneuDraulics is going according to the plan. The company's performance has met or beat expectations for the three value drivers of new business, productivity and value-based pricing. Although we have experienced some softness in the business jet market, the commercial aerospace market is currently holding up well and our EBITDA, driven by our value driver concept, has exceeded our expectations. In general, we are pleased with the results and expect this business to be a solid acquisition and a good company for TransDigm in the future. Lastly, Breeze-Eastern was acquired by TransDigm on January 4, 2016. Breeze, which is located in Whippany, New Jersey, designs and manufactures mission critical electromechanical systems. The main products consist of rescue hoists, cargo hooks and winches, primarily for rescue helicopters and cargo aircraft. Approximately 75% of Breeze revenue comes from the defense sector and approximately 70% of it comes from the aftermarket. In the first 90 days since the acquisition, we have established a new leadership team, comprised of both existing Breeze-Eastern employees as well as experienced TransDigm personnel. We have also taken productivity actions to better align the size of the organization with the level of business activity, which will increase overall value, including the announcement of the consolidation of the Virginia facility into the main campus by late calendar year 2016. We are also realigning the business into our usual customer-focused business unit teams to enhance operational performance and responsiveness. These changes will be completed during the second half of our fiscal year as we align the financial reports with these two business units and we physically colocate the team personnel within the facility. These changes will support and accelerate new product development activities as the teams are beginning to focus on rapidly bringing advanced hoist and winch technologies to market. To date, the Breeze-Eastern acquisition has delivered value as expected for TransDigm shareholders, with revenue and EBITDA as expected. To update on the recent progress of our new business value driver, let me bring your attention to three recent wins we have received in the aerospace market. AvtechTyee recently was awarded significant bookings across multiple configurations of a recently upgraded sealed audio control panel used on the Boeing 737 Next Generation. The bulk of these orders were primarily to satisfy initial provisioning of spares by airlines with upcoming deliveries from Boeing. The bookings also included upgraded sealed audio control panels with satellite communication functionality. This functionality enables the flight crew to directly dial and connect to any phone number around the world through existing satellite communication networks in areas where HF and VHF radio function can be unreliable. Next at PneuDraulics, we were awarded components in four major hydraulic system areas by Textron Aviation for the Cessna Longitude program. PneuDraulics was awarded hydraulic components for spoiler actuation, brake systems, landing gear and central hydraulic systems. Additionally, this represents the largest total shipset award for PneuDraulics to date. 24 discrete components were awarded per aircraft, with a forecasted build rate of 36 aircraft per year at peak and a production launch in the next couple of years. Lastly, Aero Fluid Products has won an exciting new program for the A320neo. The Painesville, Ohio-based team was awarded the oil control manifold for this new program. The OCM is an aluminum block mounted on the main engine gearbox that contains multiple valves, openings and sensors that control the temperatures and pressures of the engine oil. This is a growth award as the team did not enjoy this business on the A320 legacy platform. Finally, I wanted to bring your attention to one of our key business planning processes. Last time, I updated all of you on our succession planning process. Given the time in the fiscal year, I now wanted to update on our fiscal year 2017 planning process, which we have just kicked off. This process gives us an excellent glimpse of the aerospace market for commercial and defense applications. This process is a bottoms-up forecast done by each of our individual product lines, rolling up to business units then the entire company, with a focused emphasis on our TransDigm value drivers of productivity, value-based pricing and new business. This process, which is the foundation of our fiscal year guidance that we provide to the market each year, begins with a lot of hard work by each individual business unit and culminates with focused reviews of each of our 31-plus operating companies and about 80 business unit teams throughout the back end of our fourth quarter. We believe this granular bottoms-up data-based review is the best way we know of to compile market intelligence and provide guidance to our shareholders. It has served us well and allowed us to generally be quite accurate in our annual guidance and internal planning. With that, now let me hand it over to our CFO, Terry Paradie, who will review our financial results in more detail. Terry?

[Terrance M. Paradie:]

Thank you, Kevin. I will now review our (25

[Liza Sabol:]

Thanks, Terry. Operator, we are now ready to open the lines for questions.

[Operator:]

Our first question comes from Carter Copeland of Barclays. Your line is open.

[Carter Copeland:]

Hey, good morning, guys.

[Nick Howley:]

Hey, Carter.

[Terrance M. Paradie:]

Good morning, Carter.

[Carter Copeland:]

Just a quick clarification, Nick, on the OEM revision, should we just assume that it's just a inventory destock associated with the rate cuts on 777, 747 the publicly announced ones and maybe some of the business jets, is that really what you're really seeing there, it's the sort of transitory effect of inventory?

[Nick Howley:]

Yeah. There's a little bit inventory movement, and I would say we're a little – and the other is the freighter rate cut but everyone knows about that, but the – and we're probably – we're less bullish – maybe more bearish is the better way to put it on the business biz jet market.

[Carter Copeland:]

So when you say you're less – or bearish, does that mean you're looking to the end of the year and keeping some cushion for potential summer lower production activity?

[Nick Howley:]

Yeah, you're talking about the biz jet now, Carter?

[Carter Copeland:]

Yeah, on biz jet. Yeah.

[Nick Howley:]

I think what you're probably seeing – what you're seeing is the numbers have been less exciting than we hoped. We had sort of anticipated the year that was flat to slightly up in business jet. As we see our numbers part-way through the year in our bookings, that's starting to look a little less likely to us. Could there be a little upside to that? Possibly there could.

[Carter Copeland:]

Okay. Great. Thanks. I'll let somebody else ask.

[Nick Howley:]

Yeah.

[Operator:]

Our next question comes from Ken Herbert from Canaccord. Your line is open.

[Ken Herbert:]

Hi, good morning.

[Nick Howley:]

Morning.

[Ken Herbert:]

Hey, Nick. (32

[Nick Howley:]

Hey, Ken, I can barely hear you. You're breaking up.

[Ken Herbert:]

Okay, sorry about that. Is that any better?

[Nick Howley:]

Yes.

[Ken Herbert:]

Sorry. So, I just wanted to follow up on the commercial aftermarket, great numbers in the quarter. Was there anything – I know obviously you were flat last quarter, do you get a sense that there was anything that may be pushed from the first quarter to the second quarter or anything unusual or one-time in nature in the up 13%, or really just sort of a culmination of what we started to hear about in terms of increased spending by the airlines on some of the older aircraft?

[Nick Howley:]

I think you're starting to see – you have a situation where it ran low too long. I don't think you can count on 13% growth quarter-over-quarter in perpetuity by any means. I'd probably look at it more like the first half of the year, it's up 7% to 8%, maybe it was a little too light in the first quarter and a little heated in the second quarter. But I think the best way to look at it sort of on a year-to-date basis.

[Ken Herbert:]

Okay. Now, that's reasonable. And obviously, you've maintained the full year guidance...

[Nick Howley:]

Right.

[Ken Herbert:]

...even though your comparisons now start to anniversary with certainly the weaker back half of fiscal 2015. Is that really, like you talked about, just reflecting, obviously this recovery could be lumpy and visibility is probably a little more challenged now, or is there anything else that is maybe holding you back a little bit on this – on the outlook?

[Nick Howley:]

No. I think we had a judgment in the beginning of the year and we're about the same place still.

[Ken Herbert:]

Okay. Perfect. Well, thank you very much and nice quarter.

[Nick Howley:]

Thanks.

[Operator:]

Our next question comes from Gautam Khanna of Cowen. Your line is open.

[Bill Ledley:]

Hi. Thanks. This is Bill Ledley on for Gautam as he's traveling to Boeing. I have a question for you on if any of your proprietary products have been sole source -the sole source products, have they been awarded to any competitors or second source from the OEMs?

[Nick Howley:]

Well, I presume you mean recently, not in the history of our whole life?

[Bill Ledley:]

Yeah. Recently.

[Nick Howley:]

Not that we know of. Not that we know of. And I don't mean to be evasive there, but I think we'd know of them but we don't know of any.

[Bill Ledley:]

Okay. Thanks. And then on the M&A pipeline, you mentioned some better strength at least relative to what you saw at the end of Q1, can you talk about if there's any strength in any one particular area?

[Nick Howley:]

I don't – we clearly see more activity. I don't know that I can say it's one more than another and as you know, we don't – as we've said, it's very difficult to predict closings. It was last quarter, I said it didn't look very good, and this quarter things are getting active again. For some reason, we see more. I'd like to – I wish I knew a good reason for it, but I'm not sure I do.

[Bill Ledley:]

Okay. Thanks very much.

[Operator:]

Our next question comes from David Strauss of UBS. Your line is open.

[Matthew C. Akers:]

Hey, good morning. It's actually Matt on for David.

[Nick Howley:]

Yeah. We're feeling bad about everybody heading out to the Boeing.

[Kevin M. Stein:]

(36

[Matthew C. Akers:]

Quick one on your guidance, it looks like you're expecting margins about the same in the back half as the first half, is there any reason why that shouldn't sort of grow a little bit just on higher volumes?

[Nick Howley:]

Yeah.

[Terrance M. Paradie:]

I think on the back half (36

[Nick Howley:]

I thought we moved the margins up (36

[Terrance M. Paradie:]

It will be up probably in the second half than they were year-to-date.

[Nick Howley:]

Yeah. I'm sort of disconnecting on that. I thought the second half was up a little, not a lot, but a little.

[Matthew C. Akers:]

Okay.

[Terrance M. Paradie:]

(36

[Nick Howley:]

Let me just look into the numbers.

[Liza Sabol:]

Yeah. Right there.

[Nick Howley:]

Yeah. It's not up a lot, but it's up maybe 0.5 point in the second half.

[Terrance M. Paradie:]

If you back into it.

[Nick Howley:]

And as I said, we could have a little room there.

[Matthew C. Akers:]

Yeah. Okay. And then I guess one other one going back to your acquisition pipeline, it sounds like things are accelerating a little bit there. I guess, as you get bigger, is it getting more difficult to find deals that are big enough to move the needle there or is that not an issue?

[Nick Howley:]

Well, we think there's still plenty of stuff. I mean, obviously, just mathematically, the bigger you get, the average size acquisition doesn't move the needle as much, you got to buy more of them to move the needle as much. But I think at least so far, we still see adequate number of businesses, the question is getting them to sell or not, not are there enough. And then – and we feel better about the, as I've said, the rate of activity right now.

[Matthew C. Akers:]

Okay. Thanks.

[Operator:]

Our next question comes from Myles Walton of Deutsche Bank. Your line is open.

[Myles Alexander Walton:]

Thanks. Good morning. It's actually Myles on for Myles.

[Nick Howley:]

Is this Myles?

[Myles Alexander Walton:]

It is, Myles on for Myles.

[Nick Howley:]

It is Myles? Myles for Myles.

[Terrance M. Paradie:]

Myles on for Myles.

[Myles Alexander Walton:]

I'm already in Seattle.

[Nick Howley:]

Okay.

[Myles Alexander Walton:]

I came in early just to be in your call, Nick.

[Nick Howley:]

This actually is Harry speaking for Nick.

[Myles Alexander Walton:]

So, the first one is on the EBITDA margin increase. So I think, Kevin, you said it was from the acquisitions, or maybe it was Nick who said it was from the acquisitions and the core was still running at 49%. That's a pretty high increase for the acquired margins in terms of versus what you were otherwise planning. I think if you back into it, it's maybe a 500 basis point plus increase to your underlying acquired margins in the kind of planning period. So was that cost, is it price, is it volume, can you just elaborate a little bit?

[Nick Howley:]

Yeah. The answer is in total, I don't know the answer. I know it business by business but I don't know the answer in total. But they are – I'm going to give you a guesstimate here to some degree.

[Myles Alexander Walton:]

Sure.

[Nick Howley:]

I don't think – the volumes are not – in net-net, the volumes are not way up, which means it's primarily the other pieces of margin, which is cost and price.

[Myles Alexander Walton:]

Price and cost.

[Nick Howley:]

Yeah. I know in total, their revenues aren't way up.

[Myles Alexander Walton:]

Okay, okay. And the only clarification on the 13%, so when you give the organic, which would exclude the acquisitions for both periods, would the aftermarket growth be materially different than that 13% we saw reported on a pro forma basis?

[Nick Howley:]

It's not materially different. It's not materially different.

[Myles Alexander Walton:]

Okay. Great. And the last one, Nick, so you talked about the normalization in the debt markets

[Nick Howley:]

Yeah.

[Myles Alexander Walton:]

Is there any inclination to tap when the well is running healthy and maybe take advantage of open markets and healthy markets, if they're giving you the same rates you currently have, and just be more proactive than not?

[Nick Howley:]

As you know, we're always looking at that. We're always looking at that in conjunction with the acquisition pipeline. And that's one we'll sort of decide as things clarify for us.

[Myles Alexander Walton:]

Okay. But you don't feel like the trends are kind of a cloud break before more clouds return, you think it's kind of just become more of what it was and it was anomalous earlier in the year.

[Nick Howley:]

Myles, I think it's, as I've said before, I kind of feel like it's a loser's game to speculate on the capital markets.

[Myles Alexander Walton:]

Yeah.

[Nick Howley:]

To some degree we have our sort of view of what we like and what we don't like, and...

[Myles Alexander Walton:]

Yeah.

[Nick Howley:]

...we kind of make a decision when the time comes. As I've said for the last five years, we've consistently lost money on interest rate hedges. That hasn't changed our view, we'll just keep pouring the money down a rat hole.

[Myles Alexander Walton:]

Yeah. You make more than enough money in other places, Nick.

[Nick Howley:]

Yeah. Right.

[Myles Alexander Walton:]

All right. Thanks. Good quarter.

[Operator:]

Our next question comes from Robert Spingarn of Credit Suisse. Your line is open. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) Hey, guys.

[Nick Howley:]

Hey, Rob. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) Good morning. Can you hear me all right?

[Nick Howley:]

Yeah.

[Terrance M. Paradie:]

Yeah. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) Here in Seattle as well, they do have phones here. So given that, I just want to go back to where Myles was going. The 13% aftermarket in fiscal second quarter versus this flat performance in fiscal first quarter. I want to make sure I understood, were you alluding to that being more pricing-driven rather than volume, or is it equal?

[Nick Howley:]

No. All I meant to say is that I'd probably look at it as a year-to-date number, rather than get too hung up on what the first quarter and second quarter were. If I implied it was mostly price – if I implied it was 13% was price was the big driver, I didn't mean to say that. If I did, that was a mistake. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) No. No. Okay. I just wanted to make sure – I want to get a sense from a destocking or activity perspective, what's really creating this volatility and then how we can get comfortable – if we can get comfortable – with what the second half looks like. And which begs a follow-on question, which is what is the embedded organic growth in the full year guidance? So we've had minus – let's say, we've had 1.7% for six months organic growth, what is in the guidance?

[Nick Howley:]

I think we gave you the guidance, it's mid to high single-digits. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) I'm talking about...

[Nick Howley:]

That's the guidance for the year, which happens to be about where we are halfway through the year. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) Hold on, I'm talking about your organic growth, 4.4% in the quarter, minus 1.1% in the first quarter. So, 1.7% positive for the first half of the year, okay, organic growth.

[Nick Howley:]

Oh, total company, I thought you were talking about commercial. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) No, no, no. I'm sorry. I switched gears there.

[Nick Howley:]

Yeah. I lost you, I thought you were talking about the commercial aftermarket. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) So I know that you've divided it by segment in the slides, so I'm talking about the overall company (43

[Nick Howley:]

Got you, got you, got you. I want to – I'm not looking at the number here, but I want to say it's about 4%. It's about 4% is the organic growth year-over-year in our guidance. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) So the second half should be marginally better than the first half.

[Nick Howley:]

Yes. Yes. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) Okay. Okay. And then from an employment perspective, you obviously raised your margins, you've streamlined – Kevin talked about this but, again, I know you're looking at the volumes from a six-month perspective. If you're going to have a little bit better growth here in the backend of the year, how do you – do you have the capacity as is, do you have to add some people?

[Nick Howley:]

We have capacity. Whether we'd have to add a few here and there, I don't know the exact number Rob, but there's no problem with capacity. Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) Okay. Well, that's it for me. Thanks, Nick.

[Nick Howley:]

It'd be within a reasonable range, within the reasonable range of variation. You could see in six months.

[Operator:]

Our next question comes from Seth Seifman of JPMorgan. Your line is open.

[Seth M. Seifman:]

Thanks very much. Good morning and good quarter. In the aftermarket, there's been a disconnect recently in the level of organic growth for the power and control pieces versus the airframe. Wonder if you could talk about what that was in the quarter and maybe a little bit about why do you think that disconnect emerged?

[Nick Howley:]

I don't think there's any particular reason for that. It's primarily just a mix of the businesses. I would say that one probably has a little more defense business in it than the other and that may have it down a little lower. There's no systematic difference between them.

[Terrance M. Paradie:]

And you'll see the numbers in the 10-Q when we file that tomorrow.

[Nick Howley:]

Yeah.

[Seth M. Seifman:]

Okay. Okay. And then...

[Nick Howley:]

Any difference in the results are primarily just the difference between what the aftermarket content is from one versus the other, what the defense versus commercial content is and one versus the other, it'll make them move around.

[Seth M. Seifman:]

Okay. Okay. And then I guess of the, let's say, 7% to 8% year-to-date pro forma aftermarket growth that we've seen, of the 30 or so business units that you referenced, about how many of those would you say were above average, how many were below average?

[Nick Howley:]

I don't know the exact number, but it was a good quarter, and it was not – everyone's not up, but generally – as a general rule, it was a good quarter for most businesses.

[Seth M. Seifman:]

Great. Okay. Thank you very much.

[Operator:]

Our next question comes from Michael Ciarmoli of KeyBanc. Your line is open.

[Michael F. Ciarmoli:]

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

[Nick Howley:]

How are you doing?

[Michael F. Ciarmoli:]

Nick, can you talk – I mean there's certainly been a lot of structural change in the aftermarket, I mean you've got the battle tested business model with -pricing may be coming under pressure, more OEMs getting involved, pooling, used parts, do you guys have to do anything differently or can the model continue to sustain without any change?

[Nick Howley:]

We think the model is fine. We'll keep watching, I don't quite know that we're as bought in to these structural changes, but – how much of it's just the normal cycle, but we keep watching them. We don't see any reason that our fundamental model doesn't continue to work, at least in the foreseeable future. I can't tell what 20 years from now does, but in the foreseeable future, I don't see anything that structurally changes the fundamentals here.

[Michael F. Ciarmoli:]

Okay. Is there – can you walk me – I mean we keep hearing some suppliers talk about going after product lines that are maybe at a premium. And maybe just educate me on this, there is sole source proprietary product, can it actually be recompeted, can it be certified? It seems like there's some mix messaging out there. I mean do you guys still feel like those product lines that are our sole source proprietary that you own the IP, are those still bulletproof or can they be recertified, redesigned or dual sourced?

[Nick Howley:]

Well, anything – I mean, ultimately, as I like to say, if TransDigm went bankrupt and died and all the plants caught on fire, ultimately, the airline industry would find a way to survive. So, it's not that there's no other way to get around it. It is a – there's a significant entry barrier, there's significant cost, there's significant qualification. There's also the issue that we own the IP, so you've got to find a way around that. It's a substantive barrier that we frankly have not seen any material change in. Now, is it impossible? If you don't care about the costs, you can always find a way around most anything.

[Michael F. Ciarmoli:]

Got it.

[Nick Howley:]

But I don't see any fundamental change in the switching cost characteristics here.

[Michael F. Ciarmoli:]

Okay. Just the last one for me, defense. Looks like it got a little worse sequentially, still guiding for the up low single-digit for the year. How good do you feel about that, how good is your visibility? I know you talked about the bookings running ahead of (48

[Nick Howley:]

It's not good through the whole year, but it's good – it's getting good through more of the year, obviously, each month. And we have – the bookings have been strong.

[Michael F. Ciarmoli:]

Okay.

[Nick Howley:]

So, we feel reasonably good about our guidance. So, I would say we feel quite good about our guidance in total. I don't – we could be off a point here and there on a segment and we think we've given you our best judgment.

[Michael F. Ciarmoli:]

Okay. Fair. I'll jump back in the queue. Nice quarter, guys.

[Operator:]

Our next question comes from Hunter Keay of Wolfe Research. Your line is open.

[Hunter K. Keay:]

Hi, thank you. Sorry for the cell phone, can you hear me, okay?

[Nick Howley:]

Yeah.

[Hunter K. Keay:]

Great, thanks. So a little more on commercial aftermarket. So when everything was melting down earlier in the year and with the benefit of hindsight, Nick, can you – are your customers maybe a little more fragile than you thought they were? And if so, which areas of the business might be a little bit more soft or discretionary that maybe you didn't anticipate? And conversely, which areas might be a little bit less discretionary and maybe hung in a little bit better relevant to some of the other parts, as things were really, really hairy there earlier in the year?

[Nick Howley:]

Well, first let me pack up the word fragile. The vast majority of our aftermarket is sole source proprietary stuff. So it's not that it's going somewhere else, it's that the customer either has decided to defer something or draw down their inventory, so I mean ultimately over time. And that's a very customer by customer situation. So, it's hard to make any generic comment on that. As far as our outlook for the year, I guess the way I would answer that is we started off the year saying that our outlook was for mid to high single-digits growth and we're still the same place. So I would say if I look at this half way through the year, we're about where we thought we'd be.

[Hunter K. Keay:]

Great. Okay. Maybe let me ask the question in a different way as a follow up. Again, when things were really, really dicey there a few months ago, I know you guys were worried you thought you were going to be all-in, but does it change the way you maybe think about certain segments of the aftermarket in terms of how you'd pursue M&A? Or do you look at just those prior couple months there sort of a one-off anomaly, and not so much sort of like a thesis-altering type of approach in how you think about pursuing acquisitions going forward?

[Nick Howley:]

Certainly doesn't change the way we pursue acquisitions. We're looking for proprietary aerospace businesses with significant aftermarket content. And I would say we don't find a quarter or a couple of quarters' – that would be nothing that would change our fundamental strategy nor has it.

[Hunter K. Keay:]

Thank you very much.

[Operator:]

There are no further questions at this time. I'd turn the call back over to Liza Sabol for any closing remarks.

[Liza Sabol:]

Thank you all for participating on our call this morning and please look for our 10-Q, which we expect to file sometime tomorrow.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.