Transdigm Group Incorporated

Good afternoon, ladies and gentlemen, and welcome to the Q3 2019 TransDynGroup Incorporated 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 follow at that time. If anyone should require assistance during the conference, please press star, then zero on your touchtone phone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Liza Siebel, Director of Investor Relations.

Thank you, and welcome to TransTime's fiscal 2019 third quarter earnings conference call. Presenting on the call this morning are TransTime's Executive Chairman, Nick Howley, President and Chief Executive Officer, Kevin Stein, and Chief Financial Officer, Mike Lisman. Please visit our website at transtime.com to obtain a supplemental slide deck and call replay information. Before we begin, we'd 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. We'd also like to advise you that during the course of the call, We will be referring to EBITDA, specifically EBITDAs 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 to those non-GAAP metrics. I will now turn the call over to Nick.

Good morning, and thanks to everybody for calling in. As usual today, I'll start with some summary comments on our consistent strategy, a few comments on our fiscal year 19 performance, outlook, and then our capital allocation. To reiterate, we are unique in the industry due to both our consistency and our ability to create intrinsic shareholder value through all phases of the aerospace cycle. To summarize some of the reasons why we believe this, About 90 percent of our net sales are generated by proprietary products, and over three-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 downturns. Our longstanding goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we have to stay focused on both the details of value creation as well as the 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 decentralized organization structure and a unique compensation system very closely aligned with our shareholders. Fourth, we acquire businesses that fit with our strategy and where we see a clear path to PE-like returns. And lastly, our capital allocation and capital structure are a key part of our value creation methodologies. As you saw from our press release, we had a strong third quarter with both revenue, EBITDA as defined, and earnings per share well ahead of consensus. This is in spite of the payment of a $16 million voluntary refund to the Department of Defense. Our businesses are seeing strong demand in all major markets. Far and away the largest portion of our business, our worldwide commercial aerospace market is quite strong. The smaller worldwide defense segment is also doing well. Transdime's legacy businesses performed well, and the Esterline acquired businesses exceeded our acquisition model and our prior guidance. We have increased the full-year guidance substantially to reflect both of these factors. We now expect the Esterline businesses to run at an EBITDA margin in the mid-20% range for our six-and-a-half months of ownership, The long-term opportunity at Esterline is quite likely better than we modeled in our evaluation, and at this point, Esterline is improving faster than we originally modeled. We do not intend to comment on the 2020 outlook at this time. We will do so during our November call. With respect to M&A and capital allocation, As I'm sure you saw, we executed an agreement to sell the SORIO business to Eaton for $920 million. We expect this to close during the first quarter of our fiscal year 2020. We currently anticipate that this will be the largest disposition of the Esterline businesses. We do, however, expect to sell some other businesses. SORIO and any other Esterline businesses we may sell have less proprietary aerospace less proprietary aerospace, and aftermarket content than we target. As such, they don't fit well with our consistent long-term strategy. With respect to capital allocation, as we have done a number of times in the past, we've decided to pay a special dividend of about $30 a share, or roughly 6% of the recent 30-day average share price. This will be paid on or about August 23rd. Given the recently announced sale of Suryo for $920 million, the significant amount of cash currently available, our solid operating performance, and our ongoing expectations, we think this is appropriate at this time. This still leaves the company with substantial liquidity and the financial flexibility to deal with any currently anticipated capital requirements or other opportunities that may come up in the readily foreseeable future. After the special dividend payout in late August, we still anticipate having about $1.3 billion of cash and about $725 million of unused and unrestricted revolver as of the end of our fiscal year. That is 9-30-19. We also have additional capacity under our credit agreement. After closing the SORIO sale, and assuming no further acquisitions or capital market activity, we expect our cash balance to be over $2 billion at the end of Q1 fiscal 2020. We still expect to have borrowing capacity under our agreement and the revolver balance still available. As always, we will regularly evaluate our capital requirements and allocation decisions as we go forward. We continue Continue to actively evaluate and seek M&A opportunities. We have a decent pipeline of mostly small and mid-sized possibilities. I can't predict or comment on possible closings, but as I said before, we're still working steadily at M&A and we're open for business. And now let me hand it over to Kevin to more fully review our performance, outlook, and a few other items.

Thanks, Nick. Today I will review our results by key market, then discuss the profitability of the business for the quarter, provide revised fiscal year guidance, and review some other operational items. As you have seen, we had a very strong third quarter, including another quarter of above-average organic growth. Mike will provide more details on the financials, but our third quarter operations, specifically revenue and EBITDAs defined, were up substantially over last year. Q3 gap revenues were up 69% versus prior year Q3, and EBITDA as defined was up 42% over the prior year with margins at approximately 42% of revenue. Now we will review our revenues by market category for the remainder of the call. I will provide color commentary on a pro forma basis compared to the prior year period in 2018. That is assuming we own the same mix of businesses in both periods. Please note this market analysis excludes Esterline. We will begin to include the Esterline acquisition in our market analysis once we have validated the data as legacy Transdime had a different market segmentation process. In the commercial market, which makes up close to 70% of our revenue, we will split our discussion into OEM and aftermarket. In our commercial OEM market, Q3 revenues increased approximately 10%. when compared with Q3 of fiscal year 2018. Due to our year-to-date revenue growth of 10% and continued booking strength, we are increasing our commercial OEM full-year revenue guidance to mid- to high-single-digit growth from our previous guidance of mid-single-digit growth. Please note this increased OEM guidance includes our expected impact from 737 MAX groundings and shipping delays and assumes we expect to be shipping at 42 aircraft units per month. We believe any impact from the MAX issues should not have a material impact on our financials this fiscal year. Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenues grew by 8% over the prior year quarter and grew sequentially. In the quarter, commercial transport passenger growth of 9% was offset by a slower growth in the commercial transport freight, sub-market, and business jet. Overall, commercial transport fundamentals continue to remain relatively strong, although a few items bear watching. Global revenue passenger growth has decelerated slightly in the past few months, albeit growth is still near the long-term average. Additionally, Cargo demand is weaker as FTKs have declined from reaching an all-time high in 2017. Business jet aftermarket growth has stagnated somewhat following a period of higher growth in 2018. Although we feel good about the overall commercial aftermarket, due to some of the items mentioned above, we maintain our commercial aftermarket guidance for high single-digit growth. 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 19% over the prior year Q3. Revenue growth was distributed across most of our business units. Last year, we reported strong defense bookings that we are continuing to see materialize into sales in both defense, OEM, and defense aftermarket. However, we anticipate defense sales growth to temper in the fourth quarter from the robust growth experience year to date, and tougher comps in the prior year Q4 period. Due to higher-than-expected defense sales growth year-to-date, we are increasing our defense full-year revenue guidance to grow in the low teens from our previous guidance of high single-digit growth. Now let's move on to profitability. I'm going to talk primarily about our operating performance, or EBITDA as defined. EBITDA is defined of about $691 million for Q3 was up 42% versus prior Q3. This includes $134 million of Estherline contribution in the quarter. EBITDA's defined margin in the quarter was approximately 42% of revenues. EBITDA in the quarter negatively impacted by acquisition dilution primarily from Estherline and the acquisitions purchased in fiscal year 2018. as well as the payment of the $16 million voluntary refund. Excluding these items, our core margin was robust at 52.4% and improved both sequentially and over the prior year. Margin improvement progress is always important to us and indicates that our base businesses continue to find opportunities to drive improvement within our value drivers. We continue our relentless pursuit of value generation. Now let's turn to 2019 guidance. We are increasing our sales and EBITDA guidance to reflect the strong results of our legacy Transdyn business and better than originally modeled Esterline integration performance. The midpoint of our fiscal year 2019 revenue guidance is now 5.53 billion, an increase of 85 million. This revenue guidance is based on the revised market channel growth rate assumptions we just discussed for Trans9 legacy business, plus higher expectations for Estherline revenue. The midpoint of fiscal year 2019 EBITDA's defined guidance is now $2.44 billion, an increase of $90 million, with an expected margin of around 44%. If you add back the voluntary refund, about 40% of this increase is related to performance of our legacy business, with a remainder attributable to Esterline. Excluding Esterline, the full year margin is expected to be around 50%. We are increasing the midpoint of our adjusted EPS $1.28 to $18.09 per share, primarily from the increased EBITDA guidance. As Nick said earlier, we won't comment on 2020 guidance just yet. The revised guidance for this full year assumes that we own all of the Estherline business units for the remainder of fiscal year 19, so it includes a full fourth quarter contribution from SORIO. As mentioned in the press release announcing the sale of SORIO to Eaton, we do not expect these transactions to close until the first quarter of fiscal year 2020. Now let me give you an update on the Estherline integration and expectations. After six and a half months of ownership, the Astraline integration is progressing well. We continue to wind down the former corporate office activities in Bellevue, Washington. The phased workforce reductions there appear to be working well as we migrate corporate job functions by the end of the calendar year. As noted before, we have equipped the Astraline integration team with senior Transdime legacy EVPs, who are teaching our culture and operating model around value generation to all new business units. We are making progress here, but as you know, culture change can be slow and requires constant reinforcement. Although we do not share many specific details on a business unit, I believe we can use the considerable operations performance improvement at Kirkhill to illustrate how we are addressing the opportunity provided. During our time of Kirk Hill ownership, we have followed our integration model, focused the team on the value drivers, invested capital well above historical levels, drove accountability and bias for action within our team, and organized the business along business unit structures. Kirk Hill provides a series of mission-critical seals for the Joint Strike Fighter program, and prior to Transdime ownership, the Kirk Hill contribution to the F-35 program was failing, our OEM and DOD partners, and Kirkhill as a whole was losing significant money. Today we have turned the company around, now making a solid profit. We have increased the F-35 output by almost 400% and have decreased our overdues by greater than 75% for this critical program, all within a short period of time. This is the true value we provide to our shareholders and customers today. our operations deliver highly engineered quality products on time as expected. Finally, during the second quarter, as Nick mentioned in the last earnings call, the Inspector General report on the sample of our aftermarket parts was completed with no allegation of any wrongdoing. Though the high level of profitability was questioned, the report requested a $16 million voluntary refund. As you may be aware, the company decided to make a $16 million voluntary payment spread around various Department of Defense agencies, and this was included in our results this quarter. This was not an obligation of the company. It was not characterized as such and was clearly specified as not any admission of wrongdoing. However, in the interest of dealing with a good and important customer, we thought this was in the best interest of the company. We have also been informed that there will be an additional Inspector General audit. At this time, we are unable to assess the timing or the exact scope of the audit. As in the past, we will not publicly comment on this audit along the way unless there is some substantial reason to do so. As a reminder, direct sales to the U.S. government make up in the range of 6% to 8% of our annual revenues, depending on the year and whether you include distributors or not. Of this 6% to 8%, typically about a quarter we estimate to be competitive product, and roughly another 10% is in contracts over $2 million covered by TINA, truth in negotiations, regulations that require certified cost data. Many, if not most, of our remaining direct military sales, we believe, fall under commercial designation, as expected given our commercial product development pedigree. So in summary, we are pleased with the Estherline acquisition thus far and with our strong operational performance both in the quarter and year-to-date. With that, I would now like to turn it over to our Chief Financial Officer, Mike Lisman.

Thanks, Kevin. It was a good third quarter. I'll quickly review the financial results and revise full year guidance in more detail. First for the legacy trans-time business and then second for Estherline. So for the legacy trans-time business, third quarter net sales were were just over 1.1 billion, which is up approximately 13 percent versus the prior year. Organic sales growth was above average at 11.8 percent and drove the majority of the increase. EBITDA as defined increased 14 percent from the prior year to 557 million. Excluding the non-operating 16 million voluntary refund paid to the U.S. government, EBITDA as defined would have been 573 million, implying a margin of 51.4% versus the 49.7% from last year's third quarter. Now switching gears over to Esterline, Esterline generated $545 million of revenue and $134 million of EBITDA in our Q3, which implies an EBITDA margin of 24.6%. As Nick and Kevin mentioned, This margin is ahead of our expectations and beats the rough EBITDA margin guidance we provided on last quarter's call. Now for the consolidated entities, so including both legacy Trans Thyme and Esterline. Adjusted EPS for the quarter was 495, which is up 23% from the same quarter last year. If you were to exclude the $16 million non-operating charge for the voluntary refund and then also a $10 million one-time tax charge that we took during the quarter, adjusted EPS would have been $5.35 per share, which is an increase of 33% from last year's third quarter. Quick update on taxes. We're still expecting our GAAP and cash tax rate to be about 24% to 25% for the year, and we're expecting an adjusted tax rate of roughly 26.5 percent. On cash and liquidity, we ended the quarter with just over $2.7 billion of cash on the balance sheet and a net debt to EBITDA ratio of 5.8 times. Pro forma for the dividend that was just announced, our net debt to EBITDA ratio will increase to approximately 6.3 times as of the date of the dividend payment, which is about August 23rd. One final note on financial disclosure going forward. In our comments on today's call, as well as on the call slides, we've given some additional info on Esterline's financial performance for the first full quarter under TransTime ownership. Going forward, so on the November earnings call and after, we do not intend to disclose this information. As Kevin mentioned, the Esterline organization as it used to exist is largely now gone, and the 20 business units that used to comprise Esterline report independently into TransTime within our power, airframe, and non-aviation segments. I would also quickly caution everyone not to expect the $130 million plus of EBITDA from the former Esterline business units going forward, as this figure for our Q3 includes certain units that are likely to be divested as next dated. With that, I'll hand it back over to the operator to kick off the Q&A.

Ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touchtone telephone. If your question has been answered and you wish to remove yourself from the queue, please press the pound key. And your first question comes from Ronald Epstein with Bank of America Merrill Lynch.

Hey, good morning, Chris. Good morning. Now that you've owned Astraline for a while, What surprised you the most, positively and negatively?

Positively, I think the amount of opportunity we're finding. I think the way that the teams are identifying that with us and aggressively going after it. I think that has been just... a breath of fresh air how much opportunity there is both on, you know, improving the operations themselves and in, you know, productivity and other items. But really in improving the operations, there's a tremendous amount of opportunity. But that's also the negative is that finding businesses that I think are in times need some more capital injection, need to – redo their operations, drive accountability. I think it all fits well with the Transdime model. I also think some of the morale was maybe a little lower than it could have been. So I think the teams are responding very well to our leadership and assistance we're providing.

The only thing I might add is on the downside, Kevin, I don't know that we've seen any significant downsides that we didn't know of when we went into it. Now, hopefully that continues to be the case.

One of the questions that's in the back of everybody's mind, so see if I can articulate this well. Is there any way you can maybe give rough quantification of that opportunity? Because as people build their models and they think about this, how can we think about it in a more quantified fashion?

Yeah, that's difficult. We will give guidance for 2020 next year. It's difficult for us as we're still unpacking this to give you a lot of guidance on that. So can we give 2020 guidance next earnings call? I know that it's difficult to model right now, but we're still trying to unpack and learn this as we go as well.

Right, and then just one last follow-on on that. I think the guidance you gave for this year implies that the margins at Esterline might slow down a bit in the second half. But historically, that was usually the better margin period for Esterline. I mean, would there be any reason why we would expect that historical precedent to change?

I think it's, in general, conservatism on our part. That's what we're stressing right now is, again, we're learning and unpacking the Esterline businesses. We haven't seen anything, as Nick said, that – you know, alarms us, but we just don't want to get anyone ahead of our performance just yet. All right. Thank you very much.

Your next question comes from David Strauss with Barclays.

Thanks. Thanks for taking my question. Maureen, I wanted to ask about free cash flow. It looks like based on your year-end target for the balance sheet, you're forecasting about a billion, maybe a billion one in free cash flow this year. Is that correct? And so it looks like that's implying like a 40% conversion, a low 40% conversion of EBITDA. And I think you've targeted closer to 50, if you could just talk about that a little bit. Thanks.

I think that... The stats you gave are directionally accurate. We had some one-time cash charges on the Esterline acquisition. If you were to take a stab at backing those out, I think you would get closer to the 45% to 50% range on EBITDA conversion that we've had historically.

And that's true for the quarter and the full year. And, Mike, so that's a good way to think about the modeling free cash flow conversion looking ahead from here, 45% to 50% on EBITDA? It is.

It is. And obviously, you know, as you get to higher leverage points in the cycle, with the interest payment, it'll be slightly towards the lower end, but it'll be in that kind of range as we've been historically.

Okay. And then on the Surya sale, how should we think about the adjusted EPS dilution associated with that as we think about modeling 2020? Okay.

We haven't. It's basically in the guidance, as we said. We haven't given specific, you know, or quantified in the past exactly what business units are contributing to our guidance, and we don't want to start doing that now, but we expect that basically it's in the guidance for the year. There's a chance it could move into discontinued operations during the next quarter, and I think you've probably seen from some of the press releases that are out there roughly what it could be contributing on revenue and EBITDA.

Okay, thanks very much.

Your next question comes from Carter Copeland with Milius Research.

Hey, good morning, guys. Just a couple quick ones. One, the commentary that you made around cargo, freight, and business jet, just that sort of stagnation and the comment around FTKs, are you seeing anything in the bookings, in the four bookings that is really driving any sort of material cause for concern there, or it's just something you wanted to note?

I think it's something we wanted to note. We have seen a little softness or slowing down in maybe some of the business jet side, but just wanted to comment on that, that that was dragging down the total number. And certainly on the FTK side, the cargo metrics have become more important to us because of acquisitions we've made over the years and just wanted to draw that to everyone's attention, that that's an important piece for us and has performed not unexpectedly as a little bit of a drag on our aftermarket number.

So it's down, but are bookings running below shipments, even beyond that?

In the freight, I don't have that split out in front of me. So I can't comment on that. I think In general, it's better. Liza's giving me the thumbs up. So it's generally getting better in our cargo space. Okay.

Thumbs up is official, so we'll take that. And then just one quick follow-up on the thought process around the sizing of the dividend, the leverage ratio that you'll be left with there. I think you said it was 6.3. You've obviously had some comfort having that be a bit higher than either on deals or dividends in the past. And so I wondered if that implied anything about the M&A pipeline or flexibility you're leaving yourself. Any comments you can make there would be helpful. Thank you.

Yeah, I wouldn't take a lot from that, Carter. This is Nick. You know, it seemed, put the whole thing in the picture, it seemed like a reasonable number to go with right now. You know, as you can see, we continue to build up both the cash and financial flexibility, so we'll make that call sort of quarter by quarter. Okay. All right, thanks, guys.

Your next question comes from Gautam Khanna with Cohen & Company.

Yes, thank you. Sorry for the noise in the background. I was wondering, after you've looked at Esterline now, are you still comfortable that about 30% of the aerospace and defense-oriented revenue is aftermarket, as you guys would define it, or has that changed at all?

Yeah, I think it's too early to tell on this. We certainly feel good about the acquisition. It's exceeding our expectations so far. but it's too early as we haven't completed our market segmentation work on Estraline. We both did things a little differently, and we need to go through this accurately, and it's on a part number by part number basis, so it takes some time. So we're still going through this. But I wouldn't think we feel any reason to think it's any worse than we thought. Yeah, I think in general the acquisition looked better, but beyond that I don't know.

Okay, so in terms of kind of reassessing the pricing strategy, that's still early innings, I presume. Is that a fair assumption? Absolutely. Thank you very much, guys. Sure.

Your next question comes from Michael Ciamarli with SunTrust.

Hey, good morning, guys. Thanks for taking the questions. You're a nice resource. Kevin, can you give a little bit more, get more granular on – where Esterline is exactly outperforming your expectations? I mean, is it on the cost side? Are you seeing, you know, better revenue growth in certain product lines? Are you getting better pricing? I mean, can you just give us some tangible examples of maybe where and how it's exceeding your expectations?

Yeah, I think it's really across the board, not to cop out on you. But, you know, operationally, we're getting more volume through the facilities and We've done some selective hiring in a few places. So operationally, productivity, we're getting more out of the same milestones and we're able to do it at lower cost. We're finding some pricing opportunities. Certainly there's some lost contract reserves that Mike has discussed that are put into there that we'll have to resolve later. out into the future, but it's really on all legs of our value generation stool. It's productivity, it's price, it's value generation, it's driving more volume across the milestones, and it's also winning new business as we go forward. So I can't point to any one area. I tried to give some evidence of our operational progress that is significant on the you know, the problem or the opportunity that we're facing and what we're doing about it. Got it.

And then just as it relates to, you know, the DOD and the Inspector General, I mean, you know, it sounds like on a go-forward basis, you know, they put out a government-wide request requesting pricing details from all your subsidiaries. What, if anything, do you guys have to change internally regarding your processes going forward, maybe how you show cost data? I mean, can you just give us a sense as to what might have to take place on your end?

Well, it's still very early in the process. We still have – I mean, there are two issues that you've raised. One is there's a secondary IG audit, and then there's this DOD pricing memo issue. As far as the IG audit goes, it's unclear to us how long this audit will take. We assume that given the results of the last audit that took a while, the IG is looking at a slightly larger pool of contracts, but we don't believe that there will be anything different in this process than in the last. We also believe the results will be the same as the last IG audit. but we are cooperating with that and will provide information as requested. We assume that any exposure here is voluntary and also de minimis to the corporation, given the size of the military business that we have direct to the government, to the DOD. As far as the DOD pricing memo goes... As best we understand, that memo reflects the wording of the applicable FARs or those federal acquisition regulations. The contracting officers could always request cost or pricing data, and of course, we always comply with the FARs. We all know we're highly decentralized, so our operating units are handling any cost or pricing data requests locally as they always have when they come up on a case-by-case basis. We're trying to be cooperative here. Some awards could be delayed, but it's hard to estimate how much of this we still see our defense business moving forward. And we're supplying costs on a necessary basis as requested. So we are attempting to work together we recognize that, you know, the DOD is a valuable customer to us and we want to work together to, you know, come to a workable solution on this. Does that answer your question?

That does. That does. Helpful. I'll jump back in the queue. Thanks, guys.

Your next question comes from Miles Walton with UBS.

Thanks. Good morning. I did want to follow up maybe on – where Mike was just on defense. I think last quarter you said you were expecting kind of flattening sales as the bookings were flattening, but obviously you put up a really good number here in the quarter. So I'm just curious, can you make a comment on where bookings are trending year-to-date in defense, similar to what you did in the commercial businesses?

Bookings are still – we're still booking. We're still booking ahead of sales, but at a slower rate. I think our total bookings for the year versus 18 are only up modestly year over year. We still see strength in OEM. I think our defense aftermarket has slowed a bit on the booking side. So that's our commentary on bookings. That's why we anticipate this will be flattening out. It just hasn't happened yet. It's difficult to predict when some of the bookings are due to ship. Just trying to flag what we see as some weakness in our business looking forward. But, you know, it's a smaller piece for us, but just looking to be fully transparent. Yes, I appreciate it.

Yes.

And then on Estraline specifically, if you can comment on their booking strength. I mean, it looks like they did about 9% organic sales growth this quarter, which is an acceleration from last quarter. And I'm just kind of curious if you can make any comment around customer receptivity and how that's flowing through to bookings trends.

I don't have any bookings trends in front of me on Estraline, and there's nothing to comment on right now on that. And I don't want to get into the specifics of this business or that business, but I think in general we are happy with and the acquisition appears to be exceeding our expectations. So that includes, you know, there is good demand out there.

Okay. And, Mike, just a clarification, the $100 million transaction cost, how much of that is cash for the year?

The exact cash for the year – I don't have the year in front of me. 60 is cash for the quarter, and the bulk of it fell into this quarter.

Okay. Thanks again.

Your next question comes from Robert Springer with Credit Suisse.

Hey, good morning. Wondering if you could at least speak to – Kirkhill as a proxy for the rest of Estraline. You mentioned it's a pretty good example. You've owned that now for, I guess, about five quarters. And so while you're not ready to predict where the rest of Estraline can go, how does Kirkhill inform you in terms of the timing and the magnitude of the margin improvement?

Interesting question. That was certainly what I wanted to illustrate in including them. In terms of the amount of time or where it can get to, I think what it tells us is there's a lot of operational improvement that we have to go through in our facilities. It's not just, you know, there's a lot of work to be done here as we look at the facilities. I think there's costs to remove. There's improvements to make. I think Kirkill sits as an example because it was undercapitalized on some key areas and was sort of in a difficult, maybe even losing morale. That has been the part to turn around and drive with our culture. I think that it's going to take time. Operations improvements, you don't come in and just wave a magic wand and they happen. But clearly, across the board, there's a lot of work to be done here to get these businesses to delivering on time with the quality necessary, appropriate quality. So there's a lot of work to be done. So it will take time on the order of several years to get this where we need it to be and where our customers need it to be. I think that's all I can comment on. Again, we're still unpacking the Estherline business's and each one is a bit of a snowflake. Each one needs different structural improvements. Some need hiring. Some need engineering injection. Each one requires a different business plan to get it turned around, but what we provide is that intimate, transparent contact with our EVPs and the business units in a forum that is all about, not about blame, but about finding the solution and driving it quickly.

Okay, so based on that, it sounds like you're not through Kirkhill yet either. That's probably got several more quarters.

We have a couple years to get through all of Kirkhill, I think, even. We've made great strides. You heard 400% output improvement on key seals that we were struggling on before, overdues down, but that's just on one. That's on the F-35 cell itself. There's still a lot more work to be done throughout the rest of the plant.

So just last question on this. In general at Esterline, you talked about getting more volume through, and you just mentioned the productivity side of that. So were they simply underproducing or not producing quickly enough, or are there examples across Esterline where they were also underselling, and is that an opportunity?

Difficult to comment on underselling. I think, again, it's going to take us time to unpack this. So difficult for me to know. I think there's been a strong response from customers. I think the aerospace environment knows what Transdyn does when it takes over a company about fixing them, making them better, investing, driving operations improvements, and I think that positive attitude has certainly come forward from our customer base. But beyond that, difficult to comment. Okay, thanks, Kevin.

Your next question comes from Noah Poppenack with Goldman Sachs.

Hey, good morning, everyone. Good morning. Can you just specify what the esterline margin in the remaining quarter of the year guidance is that rolls into the full year guidance?

We aren't guiding individually on Esterline versus Legacy Transline. We're just basically doing it, Noah, for the consolidated company going forward. And that's how we're going to do it in future quarters as well.

Okay. I only ask that because, I mean, we know a lot of the inputs into the algebra, but not all of them. But it looks like the guidance implies kind of like almost like a mid-teens margin for Esterline in the fourth quarter versus the over 20 you're running at and the over 20.

No, it's... higher than that and closer to something more like what we did this quarter.

What we said is that we expected to run in the mid-20s for the six and a half months ownership.

Right. Yeah, Nick, that's what I was asking because it didn't square with that comment.

Yeah, so maybe we're being a little conservative. Yeah, maybe somehow we got some piece we said we're conservative on.

Okay. I can also follow up on my math with you guys after the call there. Okay. Kevin, the example you gave on the F-35 at Kirk Hill, is that variance in on-time and to specification, is that something you find, maybe not quite to that degree, but is that something you find in pretty much everything you acquire?

We frequently find operations that aren't performing at the level that they need to for what their customers expect. So If that is specifically what you're asking, yes.

I guess I'm asking less on operations broadly, which I think I'll think of as just sort of price cost and margin performance. I'm asking more specifically on the delivery specification to the customer, because I sense that that's something that's sort of underrated in your business relative to all the things we think about that go into the business. I'm curious if that was very specific.

Yeah, I think you're right. We do find in general that businesses that we acquire need to have some part of their operation fixed. They make great products. They're great engineers. But operationally, they run a little laxer than they need to on delivery performance and other key attributes. So, yeah, that means that many of them, if not most, are improvement projects when we get them. And I think, yeah, you're hitting on the point that I've been trying to drive on, that, you know, there's more to us. We're excellent operators, and we fundamentally improve businesses by investment, by structure, by empowering the teams to make a difference, and it absolutely works.

Tax rate, is there any change to the recurring beyond 19 medium term tax rate?

No, no change.

Okay. Thank you.

Your next question comes from Robert Stallard with Vertical Research. Thanks so much. Good morning.

Good morning. First question is a bit boring, I'm afraid. On SG&A, obviously some one-off items here in the third quarter. But if you look at the underlying number, do you think there's an opportunity to bring that down over time?

We basically run the business as Rob and look more at EBITDA margin over time. If you were to look historically as well as at this quarter, it has trended down a little bit by a couple of tenths of a percentage point, and we expect to see continued improvement like that going forward.

But if you're looking at absolute numbers, you know, you strip out that DOD refund and stuff, it's probably tough to actually bring that absolute number down, right, going forward?

The absolute dollars, you're saying, rather than on a percentage basis? Yes. I don't know. Yeah, I'm not sure.

Well, it depends, too, because what's bulked into SG&A versus gross profit and as we work that out.

Yeah, I'd suggest, as Mike says, that you focus on the EBITDA margin. And I would, in total, with Esterline included, I would expect we should see that continue to move up. Hard to say. I don't know exactly which piece it comes out of.

Right. And then, secondly, on the guidance, this may be conservative, but your forecast for Aerospace OEM seems to suggest quite a big slowdown in the fourth quarter, and I was wondering if there's anything specific business-wise that drives that.

No, there's nothing that stands out as a slowdown. It's conservatism. There's some unknowns that we talked about with Max and other pieces that we've tried to include, but I think it's just conservatism given the market.

Okay. Maybe just one final one. A couple of other suppliers have noted that there has been slower than expected initial provisioning on the 737 MAX. Is that something you've seen in the last two quarters?

We don't do a lot of initial provisioning, but I think given that they're slowing down shipments, that would, if 737 provisioning wasn't a significant piece for you, that would make sense. It's not a significant piece for us, so we don't, we're We've been building at anywhere from 42 to full rate, depending on what our customers want from us. So, you know, it's kind of different business by business. But our forecasts going forward assume a 42 build rate.

Okay, that's great. Thank you very much.

Your next question comes from Ken Hubert with Canaccord.

Hi, good morning. Good morning. Interesting. I first wanted to ask on your defense business, a similar question. I'm assuming it's conservatism just with sort of the full year up 17, but the guide will lower in teens. Is there anything specific you'd point to besides just caution in the outlook?

Just caution in the outlook. There's nothing that we're pointing to.

Okay, that's helpful. And then can you provide any more color either around the third quarter results for aftermarket or OEM on the defense side, any relatively doing better or any specific programs or opportunities you'd specifically point to where you saw notable strength in the quarter?

You know, I think F-35 is a leading program for us. I comment on that, that that continues to do well. well and continue to grow and expand for us. Many of our businesses are on that platform. But I think we looked for that. I anticipated that question. We all did. And we went looking for, are there any one-timers? It's nicely spread across the business. You know, if you look for platforms, that takes us a little bit longer to diagnose. But, you know, F-35 is important. A-400 is important. You know, there's a lot of important platforms, the same ones that you would expect, but the OEM strength is really nicely across many businesses for us.

Okay, that's helpful. And just finally, I know you typically don't talk about operating segments much, but as I think about some of your businesses like Teler and DDC and others that have significant defense exposure, I guess is it fair to assume you're seeing similar trends either across businesses or geographically as I think about Do European defense exposure relative to the United States?

I have not diagnosed European defense versus U.S. defense, so I can't comment on that. Okay. I assume there's strength because I'm not seeing it as regionally weak. I assume that it's solid across, but I can't comment for sure.

Okay. I'll leave it there. Thank you very much. Sure.

Your next question comes from Arjeev Lawani from Morgan Stanley.

Hi, gentlemen. It's actually Jonathan on for Arjeev. Just a quick one on the MAX. Are you seeing any uplift because of the grounding on commercial aftermarket? I realize you guys have talked about how it's not a material impact for the year, but just wondering if there's any older aircraft coming online and helping on the aftermarket side.

Yeah, I can't point to, you know, that gave us X amount of uplift in the quarter. It's in the noise. The other, you know, other legacy planes were already flying. They're simply flying them a little bit harder than they were before. So we haven't seen anything noticeable. And I think that is similar to what others have commented on in the industry so far.

Got it. Thanks.

Your next question comes from Greg Conrad from Jefferies.

Good morning. Morning. I just wanted to follow up. I think on the last call you had talked about recovering maybe a billion dollars of the purchase price from Astraline from divestitures. I think you said Soria is the largest part of that at 920, but it seems like maybe there's upside. Is there any way to think about the percentage of the business that kind of fits your proprietary strategy versus maybe things that are non-core?

Yeah, I think we gave you, this is Nick, I think we gave you when we first talked about the acquisition some sense of what we thought was core kind of businesses and what didn't. Now, and I think that number was somewhere in the 20, 25% of the, now that's not, a lot of that's not all severable because some of it's sort of embedded into other business. I think the guidance we gave you on about a billion dollars or more of asset sales, as you see, we got 920 on the first one, and I don't think we're finished. So I think that's pretty safe conservative guidance, you know, as long as things go as we anticipate.

Thank you. That's helpful. And then just one follow-up. I mean... You talked about freight and business jet aftermarket maybe being a little bit concerning, but the commercial aftermarket has stayed strong as air traffic has decelerated. A lot of suppliers have talked about some pent-up demand. Is there a portion of that business that maybe concerns you in terms of tied to slower air traffic growth?

No.

I think it bears constant watching to see if it changes, but so far... It's not. We are 9% year-over-year growth in the large commercial transport aftermarket. That's a robust number, so I feel good about it. Yes, freight's a little weaker. We've been flagging that for a little while. Business jet, we've also been flagging as not really understanding the fundamentals behind that market and why it's predicted to go up so much. But beyond that, You know, we're seeing a little bit softer in freight, a little bit softer in business jet, but our large transport, again, robust at plus 9%. Thank you.

Your next question comes from Seth Seifman with J.P. Morgan.

Thanks very much. Good morning, and good morning. Mike, I think we spoke on the last call, but I wanted to see about following up. Were there write-ups of loss-making contracts at... at Esterline, and how much did those contribute to EBITDA?

There was a reserve during the quarter that impacted EBITDA was about $12 million for our Q3.

Okay, and is that sort of like a go-forward number?

We're finalizing our calculation. Our rough estimate is we expect an amount like that to run out over three to four years as the contract's completed.

Okay, great, thanks. And then as a follow-up, you know, Nick, you mentioned open for business, again, for acquisitions. You know, as you look out at the landscape, do you expect any more scrutiny on potential acquisitions with significant DoD content like a DDC or an extant?

I don't. The truth of the matter is I don't know. I'm not sure. I think we go through the normal antitrust check, and I'd expect that we would get the same kind of results, but it's just, frankly, I just don't know. We haven't seen any indication of that yet, or do we anticipate?

Thanks very much. Your next question comes from Hunter Kieh with Wolf Research.

Good morning. This is Will for Hunter. Going back to selling administrative costs, what was that as a percentage of sales exclude all acquisition-related costs and non-cash comp in third quarter?

Sorry, can you repeat that?

So if we think about the selling administrative costs, what was that as a percentage of sales if you exclude all acquisition-related costs and non-cash comp?

I think the detail for you to run that computation will be in the queue that we released this week, so I would just point you towards that when it comes out.

Okay, but excluding that $16 million refund, was it roughly flattish directionally? How should we think about it? I'd point you towards the queue. Okay, thanks.

And at this time, you have no further questions. I'll turn the call back over to Ms. Sable for closing remarks.

That concludes our call for today. We'd like to thank you again for calling in, and again, Look for the queue later this week. Thanks.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.