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Edited Transcript of TDG earnings conference call or presentation 5-Feb-19 4:00pm GMT

Q1 2019 TransDigm Group Inc Earnings Call

CLEVELAND Feb 6, 2019 (Thomson StreetEvents) -- Edited Transcript of TransDigm Group Inc earnings conference call or presentation Tuesday, February 5, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kevin M. Stein

TransDigm Group Incorporated - President, CEO & Director

* Liza Sabol

TransDigm Group Incorporated - Director of IR

* Michael Lisman

TransDigm Group Incorporated - CFO

* Walter Nicholas Howley

TransDigm Group Incorporated - Executive Chairman

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Conference Call Participants

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* Carter Copeland

Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Hunter Kent Keay

Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense

* Jason Andrew Rodgers

Great Lakes Review - VP

* Kenneth George Herbert

Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst

* Michael Frank Ciarmoli

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Myles Alexander Walton

UBS Investment Bank, Research Division - Research Analyst

* Peter J. Arment

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Rajeev Lalwani

Morgan Stanley, Research Division - Executive Director

* Robert Alan Stallard

RBC Capital Markets, LLC, Research Division - Analyst

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

* Seth Michael Seifman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Sheila Karin Kahyaoglu

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to your Q1 2019 TransDigm Group Inc. Earnings Call. (Operator Instructions)

As a reminder, today's conference will be recorded. I would now like to turn the call over to Liza Sabol with Investor Relations. Ma'am, you may begin.

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Liza Sabol, TransDigm Group Incorporated - Director of IR [2]

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Thank you, and welcome to TransDigm's Fiscal 2019 First Quarter Earnings Conference Call. Presenting this morning are TransDigm's Executive Chairman, Nick Howley; President and Chief Executive Officer, Kevin Stein; and Chief Financial Officer, Mike Lisman. A replay of today's broadcast will be available for the next week, and dial-in information can be found 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 available on our website or at sec.gov.

We'd 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 earnings per share to those measures.

I will now turn the call over to Nick.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [3]

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Good morning, and thanks for calling in. Today, I'll start off with summary contents -- or comments, as usual, on our consistent strategy, a few comments on the fiscal year -- first quarter and fiscal year, a quick update on the Esterline deal and related issues and a few comments on the status of the Inspector General audit. Kevin and Mike will do business performance for the quarter and the outlook for the year. To reiterate, we believe our business model is unique in the industry, both in its consistency and its ability to create intrinsic shareholder value through all phases of the cycle.

To summarize, some of the reasons why we believe this, about 90% of our sales are generated by proprietary products and over 3 quarters of our net sales come from products, for which we believe we are the sole-source provider. Most of our EBITDA comes from aftermarket revenues, which typically have higher margins and provide relative stability in the downturn.

Our long-standing 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 allocation of our capital. We follow a consistent long-term strategy, specifically we own and operate proprietary aerospace businesses with significant aftermarket content.

Second, we utilize a simple, well-proven, value-based operating methodology. Third, we have a very decentralized organization structure and a unique compensation system closely aligned with our shareholders. Fourth, we acquire businesses that fit with our strategy and where we see a clear path to a PE-like returns. And lastly, our capital structure and our capital allocation are a key part of our value-creation methodology.

Fiscal year '19 is off to a good start. Q1 revenues, EBITDA as adjusted and EBITDA margins were up nicely over the prior year. The incoming orders were strong and well ahead of shipments across all major market segments, boding well for the balance of the year. As you can see, we have increased our guidance for the year. The revised guidance excludes any contribution from the expected Esterline acquisition. Though we had a very nice booking quarter, one quarter does not make a trend, but if this continues, we could well increase the guidance again next quarter. Kevin will expand on both the quarter and the full year outlook.

Our liquidity is strong. We had $2.3 billion of cash at the end of fiscal year Q1. Based on our recently announced financing and assuming no additional acquisitions or capital market activity, other than the Esterline transaction, we still expect to be somewhere in the range of $3 billion of cash at the end of the fiscal year. We also expect to have over $600 million of unused revolver and some additional room under our credit agreement.

We continue to actively evaluate and seek M&A opportunities. We have a decent pipeline of mostly small and midsized possibilities. I can't predict or comment on possible closings, but we are still working steadily at M&A, as I said before, we're open for business.

A few comments about the Esterline transaction status and some related issues. As I think you know, we're paying about $4 billion for roughly $2 billion in revenue. Based on the public consensus information of about $330 million of fiscal year '19 EBITDA, we estimate this is about a 12x EBITDA multiple, again times the consensus '19 EBITDA.

With respect to regulatory clearance, that is antitrust and foreign investment approval, things are moving along well so far. In the United States, the HSR waiting period expired back in November, so we are clear to close with the FTC and the Department of Justice. All other required regulatory views are now complete, with the exception of the European Commission antitrust review and the French foreign investment review. These are proceeding through smoothly, and we expect to obtain approvals in a timely manner. As a reminder, we did not need to file for regulatory approval in China.

In addition, Esterline has received shareholder approval for the transaction. Overall, the process is moving along well. And at this time, we now hope to close in the March-April time frame. That is sooner than the Q4 time frame we originally estimated. However, it's not finished yet, so there's always some uncertainty until it's concluded.

As we've said before, we think Esterline has been a misunderstood company. It's core aero and defense business make up 3 quarters or more of the revenues. Its core business has proprietary content and sole-source positions, quite similar as a percent of revenue to TransDigm. The core aftermarket also appears significant. We estimate this at over 30% of revenue. Though we have not made any final decisions on asset disposition at this time, I do expect that we will be selling certain assets that don't fit well with our focus. We are still working on specifics and timing, so I don't have any more to share on this topic at this time.

We have now arranged the financing for the Esterline transaction. Last week, we priced about $4 billion of secured notes, with a fixed interest rate of 6.25% and a term of 7 years. This is scheduled to fund on February 13. This new financing will result in an average weighted cash interest rate on our total debt of about 5.7%. This is very close to the rate that we gave for the year with our original 2019 guidance. Additionally, we decided to refinance the $550 million of our high-yield bonds that come due in 2020 in order to push the maturities out until 2027. Including the new debt and the hedges and collars, we will have approximately 80% of our debt fixed or hedged, and will remain close to that level for the next 5 years.

I don't expect that our net leverage at close will be out of line with our recent levels, and if market conditions hold, we should still have the adequate flexibility to consider the full range of capital allocation alternatives. We will likely defer any other 2019 decisions on capital allocation until after we close the Esterline transaction and assess the overall business and capital market environment at that time. Absent any other acquisition or capital market activity, we would still delever about one turn a year.

With respect to the Inspector General or IG audit, we and several Department of Defense contracting agencies, primarily the Defense Logistics Agency, known as DLA, have now received the draft report. The DLA is the largest of the buying agencies that were audited in this report. There has been no allegation of any wrongdoing or illegality. As in the past, the Department of Defense buying agencies are requesting a voluntary refund of some profits. The sum of the various individual requests appears to total about $16 million. Again, this is a voluntary request, and there is no assertion that this is a financial obligation of the company. The government is a good customer, and like any good customer, we want to be responsive where practical. We're glad to have the IG report concluded. We understand that the report will be available to the public within a few months.

Now let me hand this over to Kevin, who will discuss both Q1 '19 performance as well as the full year outlook.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [4]

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Thanks, Nick. Today, I will review our results by key market then discuss the profitability of the business for the quarter, and finally, provide revised guidance for the fiscal year.

As you have seen, we had a strong first quarter and a good start to the year. Mike will provide more details on the financials, but our first quarter operations, revenue and EBITDA As Defined were up nicely over last year. Q1 GAAP revenues were up 17% versus prior year Q1, and EBITDA As Defined was up 21% over the prior year, with strong margins at 49% of revenue.

Bookings or incoming orders are the real story here, however, with pro forma Q1 bookings up 20% compared with a year-ago period, a robust increase observed across all aerospace market segments.

Now we will review our revenues by market category. For the remainder of the call, I will provide color commentary on the pro forma basis compared to the prior year period in 2018. That is assuming we own the same mix of businesses in both periods. In the commercial market, which makes up close to 70% of our revenue, we will split our discussion to OEM and aftermarket.

In our commercial OEM market, Q1 revenues increased approximately 13% when compared with Q1 of fiscal year 2018. Commercial transport OEM revenues, which make up the majority of our commercial OEM business, were up 10% in Q1 when compared to the prior year period. Bookings in the quarter were strong and outpaced sales by a wide margin. For most of 2018, we commented that the softness we were experiencing in the OEM market was a transient as our shipset content had experienced no negative revisions.

Now in Q1 of fiscal year '19, we are seeing growth across narrow-body and wide-body form factors once again. As we said at the time, revenues can be lumpy due to a number of factors.

Business jet and helicopter OEM revenues make up around 20% of our commercial OEM revenues. Revenues in this combined market were up over 20% compared to the same period in 2018. Bookings in this submarket outpaced sales in total with strong business jet bookings slightly offset by some weakness in helicopter bookings. Although business jet delivery forecasts continue to look positive for 2019, driven largely by larger cabin jets, the robust sales growth experienced this quarter is not likely sustainable. In addition, the smaller revenue helicopter market may be a slight headwind going forward.

Now moving on to our commercial aftermarket business. Total commercial aftermarket revenues grew by just over 6% in the quarter. Both the commercial transport and business jet/helicopter aftermarket revenues were up close to the average of 6% over the prior year quarter. Bookings well outpaced sales in the quarter, and year-over-year bookings growth came in at over 20% in this important market segment. The aftermarket freight segment continues to outperform our expectations within this composite. Time will tell if this continues as the freight market fundamentals have slowed.

Now let me speak about our defense market, which is just over 30% of our total revenue. The defense market, which includes both OEM and aftermarket revenues, was up approximately 15% over the prior year Q1. Revenue growth was well distributed across our business. For Q1 of fiscal year '19, defense aftermarket revenue growth also outpaced defense OEM growth. Total defense bookings continued the recent trend and were up significantly over prior year and have similarly outpaced sales by a nice margin. This is a similar narrative to fiscal year '18, but we are now seeing those bookings materialize in the sales.

Moving to profitability. I'm going to talk primarily about our operating performance or EBITDA As Defined. EBITDA As Defined of about $487 million for Q1 was up 21% versus prior Q1. EBITDA As Defined margin in the quarter was 49% of revenues. This includes 1 margin point of dilution from the fiscal year '18 acquisitions of Kirkhill, Extant and Skandia. Excluding the acquisitions, margins improved approximately 2.5 points year-over-year for the same period. Margin improvement progress is always important to us. It indicates that our base business continues to find opportunities to drive improvement within our value drivers. We are relentless in our approach to value generation.

Turning now to 2019 guidance. We are modestly increasing our fiscal year 2019 full year sales and EBITDA guidance, both by $20 million to reflect our strong first quarter results. However, until we see more data, we are not updating the full year market assumption at this time as the underlying fundamentals do not seem to have meaningfully changed. The midpoint of our fiscal year 2019 revenue guidance is now $4.19 billion. The revenue guidance is still based on the following market channel growth rate assumptions. We expect the commercial aftermarket revenue growth of mid- to high single-digit percent versus prior year, commercial OEM revenue growth in the low to mid-single-digit percent range and defense military revenue growth of mid- to high single-digit percent versus prior year.

The midpoint of fiscal year 2019 EBITDA As Defined guidance is now $2.09 billion, with an expected margin of around 50%. This includes approximately 1 margin point of dilution for the recent acquisitions purchased in fiscal year '18, implying our pre-fiscal year '18 core is now at about 51% margin.

We are increasing the midpoint of our adjusted EPS to $0.50 to $16.76 per share, primarily resulting from higher EBITDA guidance and slightly lower interest expense. Mike will discuss in more detail shortly.

Finally, let me briefly speak to our organization structure with the impending completion of the Esterline acquisition, the need for experienced leadership increases. To account for this, we have moved Jim Skulina, a long-term TransDigm operations executive, and most recently, our interim CFO, to lead the financial integration of Esterline. And additionally, added 2 seasoned executive vice presidents, Joel Reiss and Pete Palmer, to also be part of the Esterline acquisition integration team reporting to Bob Henderson. To backfill this need, we have promoted Paula Wheeler to Executive Vice President. Paula has been with TransDigm since 1995 and has served in a number of leadership roles. She was most recently President of Aero Fluid Products for the past 7 years. As a reminder, we promoted Rodrigo Rubiano and Alex Feil in early 2018 to build capacity in the EVP ranks for expected acquisitions. As always, we continue to focus on developing a deep bench of diverse culture carriers for future succession needs.

With that, I would now like to turn it over to our new Chief Financial Officer, Mike Lisman.

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Michael Lisman, TransDigm Group Incorporated - CFO [5]

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Thanks, Kevin. I'll recap the financial highlights for the first quarter and then provide some more info on the guidance update. First quarter net sales were $993 million, up 17% from the prior year. Organic sales growth for the quarter was 11.6% and the balance of the sales increase was from our 3 fiscal '18 acquisitions: Kirkhill, Extant and Skandia.

Our first quarter gross profit increased 18% to $564 million, and was 56.8% of sales compared to 56.2% in the first quarter of the prior year. As called out on our slide comments, we had 1.5 points of margin headwind from the new acquisitions, but still netted to over 0.5 point of gross margin improvement from the execution of our value drivers on the base business.

Moving on to taxes. The year-over-year comparisons get slightly confusing here due to a onetime impact of tax reform last year. This also muddied the year-over-year EPS comparisons. For the first quarter, our effective GAAP income tax rate was a provision of 21.5% compared to a benefit of 63.4% in last year's first quarter.

To remind you, last year, our tax rates were significantly reduced due to the enactment of tax reform in the U.S., and we reported a onetime net benefit of $147 million. There is no update to our full year effective tax rate assumptions at this time. So excluding Esterline, we're still anticipating the GAAP, cash and adjusted rates to all be in the range of 21% to 23%.

Moving on to EPS. I want to first point out that the decrease in both the current quarter GAAP and adjusted EPS was due to the previously mentioned enactment of tax reform. If you remove the onetime benefit of $147 million, which equates to $2.65 per share so that you can do an apples-to-apples comparison of the '18 to '19 growth rates, you'd get Q1 FY '18 GAAP EPS of $1.95. The current quarter GAAP EPS of $3.05 per share then represents an increase of 56% over this prior year figure.

Similarly, excluding the onetime impact of tax reform, Q1 FY '18 adjusted EPS would be $2.93 per share. Our current quarter adjusted EPS of $3.85 is then up 31% over this prior year figure.

Table 3 in this morning's press release reconciles GAAP EPS to adjusted EPS, so you can look for more detail there.

Switching gears to cash and liquidity. We generated almost $330 million of cash from operating activities and ended the quarter with over $2.3 billion cash on the balance sheet. Our net debt leverage ratio at quarter end was 5.4x pro forma EBITDA As Defined and gross leverage was 6.6x.

Excluding Esterline, we still estimate that our cash will grow steadily throughout the year to around $3 billion and our net leverage at September 30, 2019 will be around 4.8x our EBITDA As Defined.

With regards to our guidance, we now estimate the midpoint of our GAAP earnings per share to be $15.10, and we estimate the midpoint of our adjusted earnings per share to be $16.76. The primary reasons for the increase in both GAAP and adjusted EPS were the increase in our EBITDA guidance and also lower expected interest expense. However, the increase to the GAAP EPS was partially offset by higher expected acquisition-related costs related to Esterline.

Excluding any new debt from the Esterline acquisition, we are now expecting net interest expense to be $725 million for the full year, a decrease from our previous expectation of $745 million. The lower expected interest expense is primarily due to a slight decline in the projected LIBOR rate for the year and higher interest income booked in Q1 compared to a conservative forecast. This $725 million completely excludes any interest expense from the $4 billion of new debt we'll be incurring to complete the Esterline acquisition.

Slide 9 shows a bridge detailing the $1.66 of adjustments between GAAP to adjusted earnings per share.

In summary, Q1 was a solid start to fiscal 2019. Finally, a quick organizational update. During the quarter, Sarah Wynne became our Chief Accounting Officer. Sarah has worked at TransDigm in various accounting functions for the past 15 years, both as a group controller, and prior to that, as the controller at Aero Fluid Products. Sarah has a solid financial background, is a strong promoter of the TransDigm culture and is already settled into her new role.

With that, I'll turn it back over to Liza.

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Liza Sabol, TransDigm Group Incorporated - Director of IR [6]

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Thanks, Mike. (Operator Instructions)

Operator, please open the lines.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Carter Copeland with Melius Research.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [2]

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Just 2 quick ones. One, Kevin or Nick, I wonder if you could comment on what looked like a pretty strong quarter of performance out of Esterline. I mean, I know you obviously haven't closed and whatnot, but just looking at that set of results, it's sort of stood out. And I wondered if you might give us some color on what you, from the outside-in, what you thought may have driven that and how do you feel about it? And secondly, just with respect to the recent kind of news flow around the A380 and the potential closure of that line and end of that product, what do you think the risks may be? I mean, obviously when we close a product line, there's destocking and stuff that happens that can be somewhat abrupt, and I just wondered if you could maybe walk us through your thoughts on that.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [3]

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Yes, let me address the first, and Kevin will take the second question. Carter, we just don't want to comment on the first quarter public filings by Esterline. We don't know it yet, and I just -- I don't think it's our place to elaborate on the -- it's not on our place yet to elaborate on their public filings. So I'm just going to have to pass on that.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [4]

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And Carter, on the A380, I read the same announcements and news. We're starting to study what, if any, real impact that would be, the A380 rates have come down quite a bit over the last little while, so effective and real. So the contribution on our numbers is not huge. So we need to study that more and have a better answer on the future.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [5]

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Do you sense, Kevin, if there's a decent amount of inventory in the system?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [6]

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I do not have a sense for that, to be honest. I think that it's been held pretty closely, so I don't have better insight there.

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Operator [7]

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Our next question comes from Robert Spingarn with Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [8]

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I wanted to talk about the margin a little bit. It was quite strong, notwithstanding, I guess, some of that dilution from acquisitions. The gross margin, I think, both in the fourth quarter, the fourth fiscal quarter and in this quarter, are as good as I've seen in a while. Kevin, could you delve into that a little bit? And to what extent is that operating leverage, productivity, pricing? What are we looking at here?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [9]

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I think we're looking at all of our value drivers coming into play. It's all of contributions, whether it's we're driving value, pricing or productivity or winning new business. So it's really everything. I can't comment that one is more successful than the other in the current quarter.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [10]

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Okay. And then for -- just a quick one. You mentioned the higher acquisition expenses for Esterline, I guess, Mike did. Is there anything specific to that?

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Michael Lisman, TransDigm Group Incorporated - CFO [11]

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It's banker fees and legal fees for the most part that you see rippling through what's in there today.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [12]

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And just higher-than-expected? I mean is that typical in what you've seen in the past or is there anything notable?

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Michael Lisman, TransDigm Group Incorporated - CFO [13]

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Given the size of this acquisition, those dollar amounts are higher than would typically be.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [14]

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Given the size of the acquisition, Rob, I don't think the fees are any different than what we thought would be.

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Michael Lisman, TransDigm Group Incorporated - CFO [15]

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No, the fees are what we thought they'd be.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [16]

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We are patient.

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Operator [17]

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Our following question comes from Myles Walton with UBS.

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [18]

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Nick, I was wondering if you could -- or Kevin, can comment on the integration that's going to require, obviously, it sounds like you hired and/or promoted a few people to add to Bob's integration team for Esterline. And I'm curious, you have $3 billion pro forma cash on the balance sheet at year-end, would you enter enough acquisitions to satisfy that amount? Or do you almost feel a little overwhelmed with Esterline integration? How do you balance the availability of your cash versus the availability of your talent to integrate?

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [19]

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Yes. I mean, let me say you're right. We have a lot of cash we're building up and we borrow a lot of money to -- and we're maintaining that. I don't know, Myles, what we'll do with that. I would say we would be reticent to take on right now an acquisition of the size of Esterline again. So we swallow that for a little bit. And it would have to be a hugely compelling value for us to look at that. But the normal range of acquisitions, I would think, we're fine for. And I think your follow-up question is what are you going to do with all the cash, and the answer to that is we'll decide after we buy. We'll take a look after we get this acquisition closed, we'll see what the range of opportunities look like and we'll make a decision.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [20]

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Don't have much to add there, but to say that the succession planning has been an important part of this company's process for quite a long time, and we've been focused on adding talent, developing talent for quite a while. So I do not think we're tapped out organizationally on what we can take on. As Nick said, we would probably wait a little while to bite off another Esterline-sized acquisition if that came along today. But the general course of business flow, we continue to stay in the acquisition market and believe we are not tapped out on bandwidth. It's really has a lot to do with the way we integrate businesses, and our decentralized control allows us to have more bandwidth to take on acquisitions.

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [21]

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Got it. And then just another clarification. The size of your aftermarket for defense versus OE defense at this point is what, relative basis?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [22]

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We don't comment on the individual pieces, do we? Yes, they're about the same, but we don't comment about the exact magnitude.

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Operator [23]

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Our next question comes from Robert Stallard with Vertical Research.

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Robert Alan Stallard, RBC Capital Markets, LLC, Research Division - Analyst [24]

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Nick or Kevin, the big debt issuance you did last week, one of the rating agencies downgraded your debt rating as a result of that. I was wondering if you could comment what their beef was with the situation, whether this might have an impact on the cost of debt going forward.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [25]

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Mike, you might add.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [26]

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I don't think they downgraded.

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Michael Lisman, TransDigm Group Incorporated - CFO [27]

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Sorry guys, I think the corporate rating remained B1, B-plus with negative outlook from each.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [28]

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Right. And we almost always get -- when you're going to do a big issue and they hold the rating, they almost always give a negative outlook, which says, "We're going to evaluate as we go forward. So I don't..."

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Robert Alan Stallard, RBC Capital Markets, LLC, Research Division - Analyst [29]

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So you don't think the outlook...

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [30]

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Yes, the outlook, I think, that's right, Mike? It must have just changed.

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Michael Lisman, TransDigm Group Incorporated - CFO [31]

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It's a B1, B-plus.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [32]

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Yes, that's same thing I saw last week.

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Robert Alan Stallard, RBC Capital Markets, LLC, Research Division - Analyst [33]

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Okay. And then on the defense side, we see good result in the first quarter and you commented that the bookings were also strong. I was wondering if you could maybe characterize what you think is driving that. Is it more shorter cycle demand that's coming through, which makes you a little bit reticent to raise your guidance for the year? Or is this something that's slightly longer term more visible that could have like?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [34]

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Yes, I think the defense aftermarket business would fall into your shorter-term horizon bucket. We are seeing stronger performance there in terms of bookings growth. Yes, I think we're looking at the guidance, as I said in the prepared comments, one quarter, it's hard to develop a trend from that, need to see some more data points to evaluate the market segments. Certainly, it's encouraging so far, and maybe we're just being conservative.

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Operator [35]

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And our next question comes from Ken Herbert with Canaccord.

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Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst [36]

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Either Kevin or Nick, I just wanted to see if you could provide a little more detail on the commercial aftermarket. I mean, you highlighted that, broadly, you had very strong bookings across the business, and I think you said commercial aftermarket bookings up over 20%. But you also commented, Kevin, that you really weren't -- you didn't see any meaningful change, I guess, across the businesses with the strength that continued here. On the commercial aftermarket, in particular, can you just remind us again how much of that business would you estimate to sort of book and ship? And then maybe what else would you like to see there to get a little bit more comfortable with perhaps upside to the full year guidance of that market?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [37]

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I think what I would say is we're just being cautious. We're 1 quarter in, and we'd like to see some more. The bookings were strong in the quarter, as we commented, up 20%. I did comment that maybe some of the freight fundamentals were not as strong. We've seen some -- going forward, maybe that will ease a bit in growth in the future, maybe, I was just trying to provide some color for the future that it may not be as rosy as the bookings might indicate. The interiors market, discretionary interiors, a little soft to start the year, but that's anticipated to come back strong in the second half. So I mean, I think we feel comfortable with our mid- to high single-digits guidance around the commercial aftermarket segment. If we continue to see strong bookings, the bulk of which are still book and ship in the quarter, then we'll look to evaluate that in the future. But one quarter does not a trend make yet.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [38]

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I think there's a couple of things. One, we don't mean to indicate any negative view on that.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [39]

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No.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [40]

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Just that we're always wary when the fundamental of the underlying demand hasn't -- still looks good, looks about the same as the beginning of the year. We'd like to see more than 1 data point before we change the trend.

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Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst [41]

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No, that makes sense. I can appreciate that. Specifically on the freighter markets, I know 2018 was a really big year for conversions and I know some of the freight traffic seems to have been slowing on the margin. I think it probably was a pretty good year for you last year. Can you just quantify may be how much you think that could be down this year? And I know it's not a big piece of the business overall, but is that a material headwind that we should really watch that could soften? Or how should we think about freighter markets in particular?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [42]

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Well, it isn't yet. I just -- I see the same fundamental that you see in FTKs cooling -- slowing down, maybe some concerns about the macroeconomic trade environment, I don't know. So I'm just cautious there, that I was -- we -- I think we're all surprised that freight was as strong as it was in the quarter. Just commenting that, that strength may not continue. But I don't have any indication to say that it's cooling, except the fundamentals of the market.

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Operator [43]

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Our following question comes from David Strauss with Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [44]

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So I guess, Nick or Kevin, I thought with the announcement with -- when you announced Esterline that you're considering using some of the cash on the balance sheet, what made you decide to finance the entire deal? Was it the M&A pipeline that you see out there? Was it just solely the attractiveness of the capital markets and where you could do the deal?

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [45]

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Yes, I think, David, we were pretty vague about how we would finance when we announced it. I think what we said is we had a fair amount of cash. I don't think we went much further than that. I think the credit markets looked quite good to us, and we don't have anything specific on the horizon, just credit markets looked good to us. It looked like a very attractive source of capital, so we decided to go a little bigger.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [46]

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Okay, fair enough. Kirkhill, how is that progressing?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [47]

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Kirkhill continues to perform well. We've seen some improvements since ownership. We don't comment on the margins or the individual details, but we've seen gradual improvement there as we plan. So I think Nick or I, or we've all talked about Kirkhill was a nice lab experiment for Esterline, and it continues to perform well. So we're happy with what we've got there and the way it's performing.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [48]

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Okay. And last one, the Esterline intangible amortization that you would expect to run through your adjusted numbers. Do you have an estimate for that at this point?

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Michael Lisman, TransDigm Group Incorporated - CFO [49]

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I think you probably looked at the pro forma financial that were filed with the bond documents, and it's $20 million and that could change as we work through the final accounting.

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Operator [50]

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Our next question comes from Hunter Keay with Wolfe Research.

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [51]

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I just want to flesh out a comment, I think you guys have said OE business jet and helos, the top line growth of over 20%. But you said it was hard to sustain that, but you also said bookings were up over 20%. Did I hear that correctly? And can you just flesh that out a little bit more, please?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [52]

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Yes, let me read the exact quote here back, just so I'm not confusing myself. I said, business jet and helicopter OEM revenues make up 20%. The revenues in this combined market were up over 20% compared to the same period. Bookings in this submarket outpaced sales in total, with strong business jet bookings, but weaker helicopter bookings. So that's what I said. What was the question again about?

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [53]

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Yes. Well, I think you also noted some -- there's some questions around sustainability of that growth rate. I'm sure you highlighted that to the booking commentary you gave as well.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [54]

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Well, we see strong bookings. They're largely -- or they are in the business jet sector and it's large-format cabins mostly. That's what we're seeing. We're seeing some slowness in orders on the helicopters side. So that's -- the bookings are strong, sales are up, but we do see some weakness there. Again, I'm trying to comment, provide a little color on the fundamentals of the business jet. We do see growing OEM demand large form factor, of course, but just look for the stability in the market and the takeoff and landing cycles has not been robust. We're not seeing a tremendous amount of growth there, so we're cautious. And I'm just trying to highlight much like in the freight market, some caution around the future.

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [55]

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Okay, that makes sense. And then a question for Mike. Mike, I'm kind of curious to hear your personal views on leverage, how they've evolved, maybe through the course of your career before you got to TransDigm and how your time at TransDigm has maybe evolved your own views on balance sheet maintenance and leverage?

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Michael Lisman, TransDigm Group Incorporated - CFO [56]

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My background is in the private equity industry. So I think I'm more familiar with seeing companies that operate at TransDigm's high leverage ratios. And I think going forward, as we've shared with you guys previously, we kind of intend to continue to keep relatively high leverage ratios relative to the rest of our A&D peers. But I don't think my thinking or background has evolved a ton over time and hasn't changed a ton since coming to TransDigm either.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [57]

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Obviously, Mike's -- I would add there. Obviously, Mike's significant background of private equity was a very attractive attribute to us.

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Operator [58]

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Our next question comes from Michael Ciarmoli with SunTrust.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [59]

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Nick or Kevin, just -- I could understand and appreciate the conservatism especially on some of the shorter cycle markets, but you had the real strong commercial OE growth in the current quarter. I mean, I would think, just given the rate increases, the visibility there, you'd have a little bit more comfort in that market channel, maybe A380 aside. But anything that you're seeing in the OE side of the market that would give you reason for pause in the commercial side?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [60]

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No, nothing is giving us pause. We are just -- the same concerns about raising guidance, one data point does not alignment make. So if it continues this way and we see future quarters, we would look to revise. But right now, maybe it's just conservative, but we're leaving it as is for right now.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [61]

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Okay, that's fair. And then just on the overall kind of revenue front. Organic growth, I know it seems maybe 2 years ago, there were speculation you guys couldn't really grow organically anymore, and here you put up one of the best organic growth rates in quite some time. I mean, could you give any color, what really drove that volume versus price? I mean did you see volume, material volume increases in all markets? Or was there more price in certain markets? Any kind of color, if you could parse out that growth? Just it was such a good rate that we haven't really seen in quite some time.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [62]

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I think it's important in this business to recognize that revenues can, at times, be lumpy. They can be really strong and unexpectedly strong at times one quarter to the next. It's a lumpy business. It has to do with managing of inventories and the supply chain and other factors. So yes, we, again, want to be appropriately conservative in the way we look at this. Not seeing concerns in the future, but just wanted to appropriately conservative without getting ourselves ahead.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [63]

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Got it. Was there anything in the quarter, I mean, any big, chunky kind of deliveries or positives that won't repeat.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [64]

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No. Actually, there weren't any. On the OEM side, commercial OEM, we did see a return of wide-bodies that we had seen some related softness to last year. I think I was a little surprised that the amount of narrow-body orders that came in as well. So I think orders and sales are both pointing to better wide-body and narrow-body performance.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [65]

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I think, in the overall, the fundamental market conditions seemed like what we thought they were a year ago, and as Kevin says, we're always careful that one data point doesn't make a lot.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [66]

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Got it. Nick, just one last one in Esterline. You're probably going to punt on this, but I'll try and ask it. Can you give us a sense of what you guys might be targeting for cost synergies? I mean, just knowing the Esterline model, knowing that you had Kirkhill as the lab experiment, I mean, do you have a ballpark synergy target just on the cost side of what you realistically think you can kind of immediately take out of that business?

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [67]

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I'd like to comment on it, except they snapped the ball over my head, so I can't. I missed the punt. I think we've kind of given you as much guidance as we can on that. We told you, we expect the private equity-like return based on the certain capital structure that we've given you as an assumption, and I think that's about the most specificity I can give.

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Operator [68]

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Our following question comes from Gautam Khanna with Cowen.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [69]

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I wanted to ask you just if you could comment on the interiors kind of market within the commercial aerospace aftermarket. And if you're seeing any change in trend there, positive or negative?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [70]

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On the discretionary interiors, that's our Schneller and Pexco business. We have seen the year begin a little slower than we had liked or than we anticipated. But the order book for the second half of the year seems to indicate that, that will be a transient softness. So we're anticipating the interiors will recover and perform well for the year.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [71]

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Okay. And Nick, maybe just for you, if you could talk about what level of leverage would you actually be comfortable taking the balance sheet up to in this type of credit and economic environment for the right transaction recognizing?

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [72]

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Yes, I wouldn't want to -- I just wouldn't want to comment on that. I think you've seen the number year history of our leverage. If I was trying to figure out what we're going to do, it's probably not a bad idea to look at what the history has been, but -- and I think that's around where we feel comfortable. But I wouldn't want to comment on what we might do if the situation was right on some interim basis. We have no plans right now, but I am very reticent to comment on what we're doing in capital market condition before they exist.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [73]

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I guess what I'm asking is, generally, you feel pretty strong about the macro. It seems like -- I mean, even though you were late in the cycle.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [74]

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About what?

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [75]

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About macro and the health of the euro market and the like?

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [76]

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Yes, we feel -- we don't have any unique insight other than anybody else does. We see all the -- we saw all the market data and we know what our numbers look like and we still feel pretty good. I get it, we're getting late in the cycle. But we try to be pretty consistent with the way we run the businesses and the way we capitalize them.

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Operator [77]

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Our next question comes from Sheila Kahyaoglu with Jefferies.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [78]

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Kevin, Nick, you talked about a few organizational changes and promotion, just going back to Myles' question a bit more. Can you give us how you're going to tackle this deal versus other deals just given the relative size? Any qualitative color would be helpful.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [79]

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I actually don't think we're going to approach it really all that different. We are going to have a focused team to work on it. We're putting some dedicated resources on it, but we're going to use the same integration playbook that we always use. And we have some resources to apply to it, both in finance, as you've heard. There's obviously other folks that were able to dedicate to the Esterline integration team, senior group controllers and the like that will help round out the team. We've been, I think, planning for something significant for a while and putting resources in place, stretching folks, getting our EVPs ready. We have another wave of potential folks ready, depending on what's needed. So the succession planning and people development as a way of business is really what we've been working on for a very long time. So I don't feel -- I'm not as concerned on the resource side. And I think we will have the people to put on the Esterline integration team to make it successful.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [80]

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Great. And then just one follow-up on commercial aftermarket. I know it could be lumpy and you guys have tough comp last year. But just looking at the passenger side of the business, it seems to have grown at about a 6% rate. You look at air traffic, it's that rate. So it's growing slightly below that if you exclude price. Any color you could give, what you saw in the quarter on maybe repairs versus ad hoc or replacement business?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [81]

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I don't have a lot of additional color to offer on that. It tends to come out in time. I think the repair and overhaul market has been solid for us. You're directionally correct in your passenger segment of the commercial transport. It was a strong quarter for us, and we continue to see good opportunity, both on MRO, repairs, overhaul and spare parts. The outside, the look through sales for the distribution sales, the POS for them, remains very strong as well.

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Operator [82]

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Our next question comes from Peter Arment with Baird.

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Peter J. Arment, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [83]

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Nick, Kevin, very nice results. Kevin, maybe just a quick one for you. Given the -- all this growth that you're seeing, are you seeing any stretch out in lead times within the supply chain or anything that is a watch item for you just given the strength that you mentioned across all your end markets?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [84]

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We have seen some limited supply hiccups. Generally speaking, we try to cover that with inventory buffers and our own work in progress to ensure that we can survive that. But yes, we've seen some limited -- I don't want to say that we've seen none of that. I think it's isolated to a few areas mostly around chemical processing, outside processing, not fundamental across the business. So we've seen a little bit of that. But so far, we're handling it.

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Operator [85]

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Our next question comes from Jason Rodgers with Great Lakes Review.

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Jason Andrew Rodgers, Great Lakes Review - VP [86]

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What is the pro forma net leverage ratio including Esterline?

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Michael Lisman, TransDigm Group Incorporated - CFO [87]

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As of 3/31, it's going to tick up slightly to just over 6x. But obviously, that assumes no kind of cash payout or anything. Just to footnote that.

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Jason Andrew Rodgers, Great Lakes Review - VP [88]

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And are you planning on...

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Michael Lisman, TransDigm Group Incorporated - CFO [89]

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Sorry.

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Jason Andrew Rodgers, Great Lakes Review - VP [90]

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The next question was are you planning on providing updated guidance once the acquisition closes? Or are you planning on waiting this quarter?

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Michael Lisman, TransDigm Group Incorporated - CFO [91]

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Once acquisition closes, we'll update our guidance and assumptions.

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [92]

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Well, I think, I'd say, once acquisition closes and we feel comfortable with it. It may not be immediate. I wouldn't expect something today after we close.

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Jason Andrew Rodgers, Great Lakes Review - VP [93]

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And then finally, for your fiscal '19 forecast, not including Esterline, what is the organic growth rate and tariff impacts you have embedded in that guidance?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [94]

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We don't have any tariff impact in our guidance at all. And so far, we haven't seen anything significant. .

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [95]

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And I just don't think I know what the answer is.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [96]

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It's whatever we gave in the beginning of the year. 6% to 7% range, (inaudible) falls within in long-term guidance range.

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Michael Lisman, TransDigm Group Incorporated - CFO [97]

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6% to...

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [98]

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Whatever gave at the beginning of the year plus the bump.

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Michael Lisman, TransDigm Group Incorporated - CFO [99]

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Yes, 6% to 7%.

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Operator [100]

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Our next question comes from Seth Seifman with JPMorgan.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [101]

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I was wondering if you could talk, you guys have always managed cost pretty tightly. Margins were very impressive in the quarter. Were there any headcount actions or specific cost actions you took in either the September or December quarter that supported the profitability in the quarter?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [102]

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No, nothing other than our normal approach to driving productivity on a daily basis, daily, weekly, monthly. It's a constant process other than our normal approach, nothing specific that we could call out. So we're always looking to drive productivity and contain cost across our businesses.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [103]

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Right. And then just a follow-up on that real quick. To what extent did you view the strong growth in commercial OE and that becoming a bigger part of the mix as a headwind for profitability that needed to be overcome in the quarter to put up the kind of margins you did? Or was that not really an issue?

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [104]

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That was not an issue. I did not know that ahead of time that we would have such strong OE and you have to overcome that. There was no special one-timers in the quarter that helped our profitability. So yes, there was none of that. The commercial OE helped deliver what it did. We saw the increases on the defense side and on the defense aftermarket side. Those all contributed, including commercial OE to our profitability.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [105]

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Great. And it is still fair to think of the commercial OE is fairly well below average margin.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [106]

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That's right, yes. And it also takes more headcounts, there's a lot of volume there. The commercial OE side of the house, yes, we have to watch that closely.

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Operator [107]

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(Operator Instructions) Our next question comes from Rajeev Lalwani with Morgan Stanley.

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Rajeev Lalwani, Morgan Stanley, Research Division - Executive Director [108]

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Nick, just coming back to your comments on getting close to wrapping up the IG audit. Is there any ongoing impact associated with that? You talked about the $16 million voluntary refund. I'm assuming that's onetime in nature. So I'm just trying to get a sense of if there are any pricing concessions going forward. Any changes in business practice that you have to assume such that you may impact margins or revenues. I think you get what I'm getting at?

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Walter Nicholas Howley, TransDigm Group Incorporated - Executive Chairman [109]

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Yes, you're right. It would be a onetime. And we're not suggesting we concur with that, by the way, just to be clear. And we don't know of any impact going forward. I'll just repeat, there's no allegations of any illegality or wrongdoing or anything like that.

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Rajeev Lalwani, Morgan Stanley, Research Division - Executive Director [110]

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Okay. And then, Kevin, this maybe for you. In terms of just your dialogue with the OEMs over maybe the last couple of quarters, has there been maybe a change in tone in terms of how they're trying to work with you, specifically pushing more for royalties on some of your revenues? Any color you can provide will be great.

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Kevin M. Stein, TransDigm Group Incorporated - President, CEO & Director [111]

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Yes, we have not seen any change in approach from OEMs asking for anything different than the approach that we always see. Nothing new.

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Operator [112]

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And I am showing no further questions. At this time, I would now like to turn the call back to Liza Sabol for any closing remarks.

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Liza Sabol, TransDigm Group Incorporated - Director of IR [113]

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Thank you. That concludes our call for today. And we'd like to thank you all for calling in this morning.

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Operator [114]

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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.