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.

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.

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,…

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…

Thank you, Kevin. I will now review our (25:28). Second quarter net sales were $797 million or approximately 29% greater than the prior year. The collective impact of the acquisitions, Telair, Pexco, PneuDraulics, Breeze and Franke, was an increase of $150 million. Organic sales were up approximately 4.5%, driven by strong growth in the commercial aftermarket, partially offset by weaker commercial OEM and defense sales. Our first quarter gross profit was $426 million, an increase of 25% over the prior year. Our reported gross profit margin of 53.4% was almost 2 margin points lower than the prior year. This quarter's decline in margin was due to the dilutive impact from acquisition mix and higher acquisition-related costs, which accounted for a decrease of over 3 margin points. Excluding all acquisition activity, our gross profit margins in the remaining business versus the prior year quarter improved about 1.5 margin points due to the strength of our proprietary products, continually improving our cost structure, as well as favorable mix from strong commercial aftermarket sales. Additionally, gross profit margins improved over 0.5 point sequentially, excluding all acquisition activity. Our selling and administrative expenses were 11.9% of sales for the current quarter compared to 12% in the prior year. Excluding the acquisition-related expenses and non-cash stock compensation, SG&A was about 9.7% of sales compared to 10.2% of sales a year ago. We had an increase in interest expense of approximately $11 million versus the prior year quarter. This was the result of an increase to our outstanding borrowings of $900 million in the current quarter versus the prior year. The increase in outstanding borrowings was to fund acquisitions we did in fiscal 2015. Our effective tax rate was 31% in the current quarter compared to 29.2% in the prior year. The higher effective rate in…

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

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

Hey, good morning, guys.

Hey, Carter.

Good morning, Carter.

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?

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.

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?

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

Yeah, on biz jet. Yeah.

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.

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

Yeah.

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

Hi, good morning.

Morning.

Hey, Nick. (32:43) the commercial aftermarket.

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

Okay, sorry about that. Is that any better?

Yes.

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?

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.

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

Right.

...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?

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

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

Thanks.

Our next question comes from Gautam Khanna of Cowen. Your line is open. Bill Ledley - Cowen & Co. LLC: 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?

Well, I presume you mean recently, not in the history of our whole life? Bill Ledley - Cowen & Co. LLC: Yeah. Recently.

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 - Cowen & Co. LLC: 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?

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 - Cowen & Co. LLC: Okay. Thanks very much.

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

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

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

(36:01)

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?

Yeah.

I think on the back half (36:19)

I thought we moved the margins up (36:20).

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

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

Okay.

(36:28) high second quarter aftermarket mix.

Let me just look into the numbers.

Yeah. Right there.

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

If you back into it.

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

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?

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.

Okay. Thanks.

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

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

Is this Myles?

It is, Myles on for Myles.

It is Myles? Myles for Myles.

Myles on for Myles.

I'm already in Seattle.

Okay.

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

This actually is Harry speaking for Nick.

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?

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.

Sure.

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.

Price and cost.

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

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?

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

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

Yeah.

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?

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.

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.

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.

Yeah.

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

Yeah.

...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.

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

Yeah. Right.

All right. Thanks. Good quarter.

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.

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

Yeah.

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?

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?

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...

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.

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.

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 (43:23)

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.

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?

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.

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

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

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?

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.

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

Yeah.

Okay. Okay. And then...

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.

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?

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.

Great. Okay. Thank you very much.

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

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

How are you doing?

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?

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.

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?

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.

Got it.

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

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 (48:38)

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.

Okay.

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.

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

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

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

Yeah.

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?

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.

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?

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.

Thank you very much.

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

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

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.