Q4 2022 TransDigm Group Inc Earnings Call

November 10, 2022

Welcome to the Q4 2022, Trans dying group incorporated earnings Conference call. At this time, all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need to press star one one on your telephone.

You will then hear an automated message advising your habits ways. Please be advised that today's conference call is being recorded.

I'd now like to.

I'll turn the call over to Jamie steam and director of Investor Relations. Please go ahead.

Thank you and welcome to <unk> fiscal 2020 to your fourth quarter earnings conference call presenting on the call. This morning are transient President and Chief Executive Officer, Kevin Stein, Chief Operating Officer, George valid Erez, and Chief Financial Officer, Mike Lisman.

Please visit our website at <unk> dot com to obtain a supplemental slide deck and call replay information.

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 Dot 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 <unk>.

Tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and applicable reconciliations I will now turn the call over to Kevin.

Good morning, Thanks for calling in today.

First I'll start off with the usual quick overview of our strategy a few comments about the quarter and discuss our fiscal 2023 outlook, then George and Mike will give additional color on the quarter to reiterate we are unique in the industry in both the consistency of our strategy in good times and bad as well as our steady.

Focus on intrinsic shareholder value creation through all phases of the aerospace cycle.

To summarize here are some of the reasons why we believed us.

About 90% of our net sales are generated by unique proprietary products. Most of our EBITDA comes from aftermarket revenues, which generally have significantly higher margins and over any extended period have typically provided relative stability in the downturns, we follow a consistent long term strategy specifically.

We own and operate proprietary aerospace businesses with significant aftermarket content.

We utilize a simple well proven value based operating methodology, we are a decentralized organizational structure and a unique compensation system closely aligned with shareholders. We acquire businesses that fit this strategy and where we see a clear path to PE like returns.

Our capital structure and allocations are a key part of our value creation methodology.

Our long standing goal is to give our shareholders private equity like returns with the liquidity of a public market to do this we stay focused on both the details of value creation as well as careful allocation of our capital as you saw from our earnings release, we closed out the year with another good quarter considering the market.

It environment, we continued to see recovery in the commercial aerospace market and remain encouraged by the favorable trends in air traffic. Our Q4 results show positive growth in comparison to the same period prior year period, as we are lapping the fourth fiscal quarter of 'twenty one.

Which was more heavily impacted by the pandemic, although our results have improved over the prior year quarter. They continued to be adversely affected in the comparison to pre pandemic levels as the demand for air travel remains depressed.

We are happy to see the continuation of the favorable trends in global air traffic recovery with domestic air travel is still leading in international air traffic catching up the majority of countries have fully reopened to international travelers. However, China air traffic lags the recovery seen in other countries domestic air travel and <unk>.

<unk> continues to experience, Steve Paul District Zero, Covid policies that limit travel China's international Air traffic remains very depressed and is only made modest improvement from COVID-19 lows.

And our bookings we saw another quarter of robust growth in our commercial revenues and bookings.

I am very pleased that despite this challenging environment, our EBITDA as defined margin was 49, 8% in the quarter.

Contributing to this strong margin is the continued recovery in our commercial aftermarket revenues along with our strict operational focus and disciplined approach to cost structure management and.

Additionally, we had good operating cash flow generation in Q4 of almost $275 million and closed the quarter with approximately $3 billion of cash we expect to steadily generate significant additional cash through 2023.

Next an update on our capital allocation activities and priorities during fiscal 'twenty. Two we are pleased to have allocated about $2 4 billion of capital in the aggregate across M&A and return of capital to our shareholders. Specifically. These activities included the acquisition of <unk> Aerospace a special dividend of $18 50.

<unk> per share and share buybacks as mentioned earlier, we are exiting fiscal 2022 with a sizable cash balance of approximately $3 billion.

Which leaves us with significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future.

Regarding the current M&A pipeline, we are actively looking for M&A opportunities that fit our model.

Acquisition opportunity activity continues and we have a decent pipeline of possibilities as usual, mostly in the small to mid size range I cannot predict or comment on possible closings, but we remain confident that there is a long runway for acquisitions that fit our portfolio, both the M&A and capital markets are all.

Louis is difficult to predict but specifically so in these times.

Now moving to our outlook for fiscal 2023 as you saw in the earnings release, we initiated full fiscal year 2023 guidance. The guidance assumes no additional acquisitions or divestitures and is based on current expectations for a continued recovery in our primary commercial end markets through fiscal 'twenty.

23 <unk>.

Guidance was previously suspended as a result of the significant disruption in our primary commercial end markets related to the COVID-19 pandemic.

Throughout fiscal 'twenty, two we were encouraged by the recovery seen in our commercial revenues and strong booking trends total commercial bookings in fiscal 'twenty two exceeded sales by a healthy double digit percentage that supports the fiscal 'twenty three commercial end market revenue guidance, which I will comment on shortly.

We are cautiously optimistic that the prevailing continued conditions will continue to evolve favorably.

However, as our fiscal 'twenty three progress we will continue to monitor the ongoing uncertainty and risks and market conditions closely and will react as necessary.

<unk> and market conditions, and the impact to our primary end markets could lead to revisions in our guidance for 2023.

Our initial guidance for fiscal 2023, continuing operations is as follows and can also be found on sites.

Slide seven in the presentation.

The midpoint of our fiscal year 2023 revenue guidance is $6, <unk> 9 billion or up approximately 12%.

As a reminder, and consistent with past years with roughly 10% less working days than subsequent quarters fiscal 'twenty three Q1 revenues EBITDA and EBITDA margins are anticipated to be lower than the other three quarters of 'twenty three.

This revenue guidance is based on the following market channel growth rate assumptions, we expect commercial aftermarket revenue growth in the mid teens percentage range commercial OEM revenue growth also in the mid teens percentage range and finally defense revenue growth in the low to mid single digit percentage range.

The midpoint of fiscal 2023, EBITDA as defined guidance is $3 45 billion.

Or up approximately 15% with an expected margin of around 50%.

This guidance includes about 50 basis points of margin dilution from our recent dart our aerospace acquisition.

We anticipate EBITDA margin will move up throughout the year with Q1 being the lowest and sequentially lower than Q4 of our fiscal 2022.

The midpoint of adjusted EPS is anticipated to be $21 38 or up approximately 25%.

We will discuss in more detail shortly the factors impacting EPS along with some other fiscal 2023 financial assumptions and updates.

We believe we are well positioned as we enter fiscal 'twenty three as usual, we will closely watch how the aerospace in capital markets continue to develop and react accordingly, let.

Let me conclude by stating that I am very pleased with the Companys performance in this period of recovery for the commercial aerospace industry. We remain sharply focused on our value drivers cost structure and operational excellence, we look forward to fiscal 2023, and the opportunity to continue to create value for our stakeholders through our <unk>.

<unk> strategy.

Now, let me hand, it over to George to review, our recent performance and a few other items. Thanks.

Thanks, Kevin and good morning, everyone.

I'll start with our typical review of results by key market category for the remainder of the call I'll provide color commentary on a pro forma basis compared to the prior year period in 2021.

That is assuming we owned the same mix of businesses in both periods. The market discussion includes the recent acquisition of Dart aerospace in both periods and the impact of any divestitures completed in fiscal 2021 are removed in both periods. We also included Dart in this market.

Analysis discussion in the third quarter of fiscal 2022.

In the commercial market, which typically makes up close to 65% of our revenue we will split our discussion into OEM and aftermarket.

Our total commercial OEM revenue increased approximately 29% in Q4 and approximately 24% for full year fiscal 2022, compared with prior year periods bookings in the quarter was strong compared to the same prior year period and again outpaced sales.

Sequentially total commercial OEM sales improved roughly 8% compared to Q3, we're encouraged by build rates steadily progressing at the commercial Oems, but risks remain with regard to the achievement of certain OEM production rate targets due to ongoing labor shortages and supply.

Train issues across the broader aerospace sector.

Now moving onto our commercial aftermarket business discussion.

Total commercial aftermarket revenue increased by approximately 36% in Q4 and 43% for full year fiscal 2022, when compared with prior year periods growth in commercial aftermarket revenue was primarily driven by the continued robust demand in our passenger sub market.

<unk>, which is our largest sub market, although all of our commercial aftermarket submarkets were up significantly compared to prior year Q3.

Sequentially total commercial aftermarket revenues grew by approximately 6%.

Commercial aftermarket bookings were strong this quarter compared to the same prior year period, and Q4 bookings once again outpaced sales a few key points to consider global revenue passenger miles remained lower than pre pandemic levels revenue passenger miles have generally continued to trend upwards over the past.

A few months, although there was a slight pullback in August Rpms and September has remained relatively flat compared to August. This is primarily a result of softer domestic China traffic due to ongoing zero COVID-19 policies.

Commentary from Airlines in recent months regarding passenger demand continues to be positive.

Spicy increase an airline ticket prices passenger demand has remained strong as the summer travel season came to a close and we entered the fall season. The recovery in domestic travel continues to be stronger than international travel in the most recently reported IATA traffic data for September domestic air traffic was.

Only down 19% compared to pre pandemic.

The U S and Europe continued to lead showing strong demand for domestic travel.

Domestic travel in September was back to pre pandemic levels. However, China domestic travel had another steep drop off in September due to strict COVID-19 policies and was down about 60% comparative pre pandemic.

The international Air traffic recovery has continued to make progress throughout 2020 too. Many countries have fully reopened to international travels travelers and there is pent up demand for long haul travel approximately six months ago International travel was still down about 50%.

<unk> recently reported IATA traffic data for September International travel was only down about 30% compared to pre pandemic levels.

International traffic in North America is within about 10% of pre pandemic and Europe International traffic is within 20% or so of pre pandemic.

Asia Pacific International travel has made good progress over the past months, but rpms are still down about 60%.

Global Air cargo demand has pulled back over the past months as of the autos. Most recent data September was another month, and which air cargo volume showed year over year decline and we're below pre pandemic levels further easing of pandemic related restrictions and factory reopening in China.

Could support near term improvement in air cargo, though uncertainty remains regarding China's timeline for full reopening.

This jet utilization has come down from pandemic highs, but it's still well above pre pandemic levels.

<unk> jet Oems and operators continue to forecast strong demand in the near term.

As growing optimism that the pandemic brought a favorable structural change to the business jet industry time will tell.

Moving on to our defense market, which traditionally is at or below 35% of our total revenue.

The defense market revenue, which includes both OEM and aftermarket revenues grew by approximately 2% in Q4 and declined by approximately 3% for full year fiscal 2022, when compared with prior year periods. This year, followed a typical pattern of irregular and lumpy defense.

Sales and bookings the lag in defense outlays in supply chain shortages were the main contributors to our softer than expected defense performance for 2022.

Negatively impacting our defense market revenues were the delays in the U S government defense spend outlays theres, often a lag between U S government defense sped authorizations and outlays and the lag is hard to predict.

While these delays have been longer than typical we did see some improvement in bookings this quarter, which bodes well for future defense order activity.

On the supply chain, our teams continued to experience delays due to part shortages surrounding electronic components. Our operating units are proactively engaged with the supply chain and continue to implement mitigating actions to overcome these challenging issues. We do expect our defense business to expand in fiscal 2023.

Due to the strength of our current order book as Kevin mentioned earlier, we expect low to mid single digit percent range growth in fiscal 2023 for our defense market revenues.

Like to finish by recognizing the strong efforts and accomplishments of our teams. During this challenging fiscal year I'm very pleased by our operational performance and our team's ability to overcome the negative impacts of the pandemic and supply chain disruptions, we experienced throughout the year as we enter our new fiscal year, our management and their teams.

<unk> focused on our consistent operating strategy and meeting the demand for our products with that I'd like to turn it over to our Chief Financial Officer, Mike Lisman.

Good morning, everyone I'm going to quickly hit on a few additional financial matters for fiscal 'twenty. Two and then also our expectations for fiscal 'twenty three.

First a few fiscal 'twenty two data point points on organic growth taxes in liquidity in the fourth quarter, our organic growth rate was 16% driven by the continued rebound in our commercial OEM and aftermarket end markets on.

On taxes, our GAAP and adjusted tax rates finished the year within their expected ranges our FY 'twenty two GAAP tax rate was 23% and the adjusted rate was just under 25%.

On cash and liquidity.

Free cash flow, which we traditionally defined as EBITDA less cash interest payments Capex and cash taxes was just over $1 2 billion for the year a bit higher than the one point or $1 billion. We had originally expected driven primarily by the good operating performance that Kevin and George mentioned.

We ended the year with approximately $3 billion of cash on the balance sheet and at quarter end, our net debt to EBITDA ratio was six four times down from six seven times level, where we finished last quarter. When you pro forma in the $18 50 per share dividend that we paid in August .

We continue to watch the rising interest rate environment closely we will.

Remain 85% hedged on our totaled 20 billion gross debt balance through a combination of interest rate caps and swaps through 2025. This provides us adequate cushion against any rise in rates at least in the immediate term.

With regard to any potential changes to our long term approach to using that to boost our equity returns we will see how the interest rate environment develops over the next three years, but do not anticipate any big changes in our approach at this time.

But one could envision a scenario, where really slightly dialed back the leverage on a net debt to EBITDA basis to achieve the type of cash interest coverage ratios, where we've historically operated and been comfortable operating the business.

Next on the FY 'twenty three expectations I'm going to really quickly give some more details on the financial assumptions around interest expense taxes and share count net.

Net interest expense is expected to be about $1 4 billion in fiscal 'twenty three and this equates to a weighted average cash interest rate of approximately 575%. This estimate assumes an average LIBOR rate of four 9% for the full fiscal year, which is simply the average based on the current forward consensus LIBOR.

Curve.

On taxes, our fiscal 'twenty, three GAAP cash and adjusted rates are all anticipated to be in the range of 24% to 26%.

The slight increase in our tax rates versus the prior year is due mainly to the manner in which the net interest deduction limitation as calculated under existing tax legislation for fiscal 'twenty three versus how it was computed in prior years.

On the share count, we expect our weighted average shares to be $57 1 million during fiscal 'twenty three and this figure takes into account the $1 5 billion shares we repurchased during the 'twenty two fiscal year, but assumes no additional buybacks occurred during the 23 fiscal year.

With regard with regard to liquidity and leverage for fiscal 'twenty. Three we expect to continue running free cash flow positive throughout the year as we traditionally define our free cash flow, which again is EBITDA as defined less cash interest capex and cash taxes, we estimate this metric to be in the one.

4 billion area, maybe a little better in fiscal 'twenty three.

Assuming no additional acquisitions or capital markets transactions, we will end the year with well north of $4 billion of cash on the balance sheet and estimate that our net leverage will be in the area of five times EBITDA as defined at September 32023.

From an overall cash liquidity and balance sheet standpoint, we think we remain in good position with adequate flexibility to pursue M&A or return cash to our shareholders via share buybacks or dividends during fiscal 'twenty three.

With that I'll turn it back to the operator to start the Q&A.

As a reminder, if you have a question. Please press star one on your telephone.

To compile the Q&A roster.

First question that we have.

Will be coming from.

Matt Walton.

Research. Please go ahead.

Sure. Thanks.

Good morning, guys.

Mike maybe to pick up on free cash flow or are you just where obviously you had a pretty healthy consumption of working capital as yet.

Into the growth ahead is it a similar amount of builds anticipated in fiscal 'twenty three and then just a clarification you talked about maybe bringing down the net.

Net leverage or net debt to EBITDA leverage.

Would you consider bringing down the gross leverage as well or is that something that is not what you are thinking about thanks.

Sure. So first on the net working capital point from peak to trough during Covid about $410 million came out of networking capital. That's if you define it as just a R plus inventory less payables, which is primarily how we look at it.

261, Bakken during fiscal 'twenty two so we've got about 140 $150 million more to go we expect the bulk of that to happen during the coming fiscal year. So fiscal 'twenty three that's generally how we think about it and getting back to where we were pre COVID-19 and then on the leverage.

We will see at this time, we don't anticipate going and paying down any of the gross debt balance because we have the benefit of the hedges and also the benefit of having taken out the bulk of that 20 billion of debt and a far better interest rate environment. When rates were a lot lower we have the next three years, where we have the benefit of the hedges.

We're really just not subject to the current market interest rates.

Given that Theyre now four percentage points higher than they were about 12 months ago, but we do look at it we think about it often and as you know historically, we've been comfortable operating the business with a higher leverage level on a net debt to EBITDA basis.

We tend to think we will have the similar approach going forward and the methodology there hasnt changed but no in response to your questions. We don't at this time envision paying down any gross debt alright.

Alright, thank you.

Thank you for your question Amit while the next questions.

The next question is coming from Robert Spingarn of Melas Research. Your line is open.

Hey, good morning.

Good morning, Martin and Kevin on the commercial aftermarket growth rate in the guidance.

If China opens up how how might that number adjust.

Well I think you know there is not much flight activity happening and as a percentage of the fleet.

It is a significant percentage of flight activity prior to Covid.

It could be a real tailwind to us as that opens back up.

Given the uncertainty in the market with.

Global conflicts, China and their zero Covid.

Inflation potential recession.

It was hard to forecast more growth than what we put in in the mid teens right now there's just enough uncertainty out there.

Is it as simple as just saying, maybe it's 20% of the market in <unk>.

Have recovered and so it is a 10% number is that math make any sense.

Hi, it could make sense, we don't like to get baked around those numbers, we don't look at things regionally like that however, it's probably directionally accurate.

Okay, and then just on M&A again, we've seen valuations come down in the public markets.

Today, notwithstanding but but they have also come down in the private markets for quality assets with significant amounts of commercial aftermarket content have you seen that.

I wouldn't say that.

We've seen that there's a lot of activity.

Unfortunately, we haven't.

Had anything cross the finish line since darts, a couple quarters ago.

We're very busy generally speaking and small to middle sized businesses.

We just haven't been able to.

Any of them across the finish line due to.

Unfavorable market.

Sentiment around how do I get financing for a business not us, but it's certainly restricting deals that are available in the marketplace. So I think all together, it's been a little bit disappointing there are some headwinds in M&A.

For the general market and we stay aggressive.

Okay, great. Thank you Kevin.

Yes.

Thank you for your question and one moment.

While we get ready for the next question.

The next question I have is from Robert Stallard vertical research your line is open.

So much good morning.

Morning.

Kevin just following up on the other question about the capital deployment situation.

Seeing any change in sentiment or maybe direction or activity from financial buyers and these guys getting squeezed by the higher interest rate today, not bidding for things aggressively as they were in the past or perhaps even having to sell assets.

Yeah.

I don't think we've seen anybody selling assets, but we believe there is squeezing happening. It's certainly limiting the number of people that can bid on businesses today and I think that is slowing the number of businesses that can come to market.

Okay, and then maybe a follow up on this area as well and given the strength in the U S dollar and I would argue more interested in perhaps buying more European aerospace and defense assets going forward.

We don't factor that into really the way we look at returns on our business, we evaluate them all.

Based on really what they can do.

So we're not looking for businesses in Europe any more than usual, we look at all geographies regions. So.

We're encouraged and looking everywhere we have.

A team of M&A folks that.

We're looking for opportunities in Europe , certainly as we speak.

Okay, that's great, but there is no additional focus on it yes, that's great. Thanks, Kevin.

Thank you for your question one moment, while we get ready for the next question.

And the next question that I have.

Will be coming from Noah <unk> of Goldman Sachs. Your line is open.

Hi, good morning, everyone.

Good morning, Noah and good morning.

Just a few more to make sure I have it on capital structure and capital deployment, Mike you alluded to the potential to hold.

Slightly lower leverage if the rate environment stays here can you define what.

Quantify what that would mean in terms of net debt to EBITDA and you mentioned the interest coverage ratio can you quantify what you are looking to maintain there and then.

To the extent that you keep this bid ask spread challenge in the M&A environment.

Will you look to maybe repurchase shares to start off the year here.

Sure. So a couple of things on.

The interest coverage ratios and leverage point and I'll come around to the repurchase shares point I can tell you how we think about it.

So two things first the first part is just the cost of capital question right with regard to the approach with leverage in that piece is pretty easy to the extent that remains cheaper than equity, which is true today with our debt cost trading in the 8% to 9% area based on implied yields we still have a preference to use debt.

As much as we can simply because it's cheaper.

The debt cost is 575% this coming year with the benefit of the hedges and that's well below the targeted equity equity return of 17, 5% that we've had for a long time now here at <unk>. So that piece is pretty easy, but then second and this gets the cash interest coverage point and thats of equal or more importance in this kind of rising rate.

<unk>.

And that's practically how much debt and prudently and we take on without being stupid and jeopardizing the value of the equity right now.

The cash interest coverage question, we look at EBITDA to interest coverage ratios. So we frequently in the past have talked about net debt to EBITDA that you guys have heard on this call many times and that ratio is sort of been in the six times ballpark.

Trans time, that's if you take the last five years and average it when you strip out the Covid period.

And if you look at that same time period, but instead focused on our cash interest coverage ratio like EBITDA to interest expense you would see that one bounce around two to three times and that two to three times ballpark with an average of just about two five so we look at that ratio a lot now more than we have in the past.

Along with the net debt to EBITDA ratio and we feel comfortable running trans dime and that kind of two to three ballpark for EBITDA to interest coverage ratio going forward.

And if you think about fiscal 'twenty, three specifically because of the hedges were nicely in the middle of those brackets right and we've got that benefit in fiscal 'twenty, four and 2025 as well, but again, that's only because of the hedges and because we took out that debt in those lower interest rate environment and thats not lost on us as a management team. So.

Think about it quite often and we know that we have those benefits for the next three or four years and you could envision a time, where if we didn't have today. We didn't have those benefits we might have to dial back the leverage a bit to sort of hit the EBITDA to interest coverage ratios that I mentioned of sort of the two to three times ballpark, that's not the case and won't.

For three years, because we got the benefit of the hedges and haven't taken out the debt in the prior.

Lower interest rate environment.

So that's a long winded way of hopefully, giving you some insight at least into how we think about it and put some bands around the coverage ratios that we're comfortable running the business at and then coming around to your second question no on the share repurchase point I think as Kevin has said many times before we will continue to evaluate all three options the priority to trans dime.

<unk> unchanged first reinvest in our own businesses second go and do M&A and then third return capital to our shareholders via buybacks or dividends will look at both.

Could do both maybe not as we did this prior year than last.

Down gross debt balance.

Okay.

Super helpful. I appreciate all that detail Mike. Thank you.

Sure.

Thank you for your question and now for the next question.

Our next question will come from Sheila <unk>.

Jefferies. Your line is open.

Great. Thank you so much good morning, guys.

Good morning.

I think when we think about fiscal 'twenty three.

Adjusted EBITDA margins the guidance implies about 130 basis points above your target of 100, despite 50 basis points of dilution from acquisitions.

Yes.

Commercial OE and aftermarket.

15%.

How do we think about the puts and takes to margin expansion.

I think generally we.

Went through a fair amount of restructuring due to the Cove advanced pandemic.

Historically, we've been able to restructure the business during these types of processes and get some gains as the business returns I think we're seeing that we saw that throughout this year.

We would expect that to flow through next year as well.

With some of the reduction in the real heavy focus on productivity that we've got going on at the operating units.

I think we've given the general guidance that were comfortable with in terms of the particular market segments in the OEM assumptions in the aftermarket assumptions.

And.

That's where we feel comfortable guiding to in this environment.

Yes.

And this and this.

A world.

As we've said many times, we're a bottoms up not a top down are forecasting company. So this is the work of all of our many businesses that roll up their forecast to us and I think over time.

<unk>.

Can be more accurate than a top down approach of.

<unk>, what RPM growth is going to be I think this is the most accurate way to forecast the business and we've been very successful with it.

And just to follow up on that you mentioned supply chain a few times in your script.

How are you preparing for that and do you expect any impact to your profitability from that.

Yes, I think the teams have been active really going back 12 months to 18 months. When we started to see early signs of trouble with the supply chain.

So we've been engaged with our suppliers, we're putting inventory in back into the system to support the recovery as Mike noted in his remarks and.

And we continue to sustain on top of the details and Thats really what we have found.

To help us through the situations. So I don't think we're anticipating any unusual unusual pressures, obviously, we're seeing inflation.

The rest of the world is seeing and where.

We're trying to do our best to battle that inflationary pressure.

The teams continue to stay engaged at the detailed level.

Great. Thank you.

Thank you for your question one moment wanted to prepare for the next question.

And the next question is coming from Watson, Canada.

Your line is open.

Hey, good morning, guys.

Good morning, good morning.

Just a couple of questions first I was wondering just can you quantify.

The impact of supply chain shortfalls on defense sales or whatever all land sales.

What.

Yeah.

If theres any carryover you expect to recover next year.

Yes, I'll handle that I think it's been minimal in nature, you run into a supply chain issue that might impact a handful of orders and you work with the existing backlog to offset that with other orders where you've got the supply so.

So we're not we're not seeing a material impact in any shape or form in terms of the FY 'twenty two results and were not anticipating.

Significant carryover.

That would influence the FY 'twenty three guidance.

Okay. That's helpful.

On the aerospace aftermarket commercial Aero.

Any trends that youre seeing that you can discern between kind of discretionary aftermarket versus non.

Non discretionary and maybe anything.

In 'twenty, two that was amplified by reactivation of parked aircraft or anything anything that sort of.

You can parse out within.

The results have already reported.

Yes, I mean, I think at a high level. The overall industry enjoyed the benefit of the recovery.

Certainly the last three quarters.

As travel returned in some of the restrictions opened up I think.

As we noted we've seen the strength in our largest submarket, which is the passenger submarket and that includes interiors spare parts.

Structural type parts component avionics across our full portfolio of products. So I don't think theres been any unique trend in terms of one product type versus the other we've just.

Enjoyed participating in the return to air travel.

Thank you guys.

Thanks.

Thank you for your question and one moment, while we get ready for the next question.

And the next question will be coming from Matt Akers of Wells Fargo. Your line is open.

Yes, thanks, good morning I.

I'm wondering if you could talk about the OEM forecast and what sort of build rates youre assuming in there just given.

Some of the delays you've seen that Boeing did they need to get back to kind of their target rate call.

Call. It early next year something like that for you to hit that mid teens and also is there is there any risk that you may have delivered ahead, just given some of the delays.

From the edge and stuff that we've seen.

Yes.

Again as Kevin noted, we've got a well established bottoms up forecasting and planning process at each individual operating unit. So they are closest to the customers or close to <unk>.

Boeing and Airbus and the other air Framers.

And we utilize the information that they provide they being the oes and Boeing and Airbus in each unit looks at what.

It thinks it's at in terms of the deliveries to date and what that means in terms of the future deliveries. So we use their information is best guidance, but again, we do a bottoms up process and each operating unit looks at its specific scenario.

Okay. Thank you.

Okay.

Thank you for your question one moment, while we get ready for the next question.

Okay.

Our next question will be coming from Scott Jay.

<unk> Suisse. Your line is open.

Hey, good morning. Thank you for taking my question, Kevin can you address the timing and scope of aftermarket price increases contemplated in guidance or to ask in another way.

Can you help me disaggregate, the mid teens ash market guide between volume and price.

Yes.

Well, we don't see.

Split out these things so carefully our our goal is always to.

Pass along inflation.

Right now the forecast from our teams that we have bottoms up is mid teens of our forecast for growth year over year.

There is so much uncertainty in that with what's going to happen in in Asia.

It's hard to forecast larger numbers than that.

Obviously there is.

As always some price in these numbers year over year as we've all seen inflation, but.

But we don't split it out too.

Put such a specific number on it because it differs by product business I think the way to look at it is what has inflation then we're trying to pass that along.

We see <unk>.

<unk> inflationary pressures across our business.

Okay, and then Mike the Capex guide for next year, I think implies around 3% of sales at the high end.

Obviously the returns on capital in this business are amazing so I think thats great to see but just curious if you can talk a bit about what the spend is for thank you.

Yes.

Slightly elevated I think youre right 272, 8% of sales versus two 5% in some prior years, we're investing that money because we see good paybacks and good projects from our op unit teams.

Two years or less and Thats whats driving the productivity one of our three value drivers in the EBITDA margin expansion that you guys see in here, we're seeing good capex investments and where we're putting money.

Behind it and then we've got a couple of one time projects on some solar projects that make good sense and have good paybacks because of tax incentives, particularly in the state of California, where its elevated a bit because of that but generally we're investing behind good projects here that are driving the productivity and the margin improvement.

Okay, great. Thank you guys.

Thank you for your question one moment, while we prepare for the next question.

Okay.

And the next question will be coming from Christine the Wang of Morgan Stanley . Your line is open.

Hello, Youre on mute.

Okay.

I think we lost Christine.

Can you hear me Hello.

Okay, sorry about that.

No problem.

Margins.

The last question is earlier.

50% adjusted EBITDA margins will be record high for you I mean at some point OE comes back a headwind to margins.

You talk about other level levers you can pull to keep growing margins beyond 'twenty three outside of pricing and also on that pricing portion is there a level there.

Pricing is too good and the portfolio becomes more attractive for PMA to revisit your part.

Yeah, I'll handle that.

In terms of productivity and margin expansion, it's something that we have always focused on.

That has historically been one of our three value drivers as most of you know.

May be one that we don't promote or talk about as much as we need to but the teams have really done a great job of absorbing the restructuring.

As they go through their process and the planning process. They understand what the OE impact is going to be in the mix of the products and as Mike mentioned, we continue to look for good opportunities to invest in capex in the form of automation of processes automation of testing trying to take some of that labor generally.

Out of the process.

So I think the teams have really done a fantastic job and you're seeing that benefit the margins as you go through.

In terms of pricing.

Ultimately our goal has always been to get incremental price slightly above inflation inflation is running hot we're seeing the inflationary pressures at our op units in terms of our cost structures.

It's a market priced stu.

Strategy that we've always employed and obviously, we're continually aware of what's going on the market and trying to understand what the competitive threats are in the marketplace and I don't think that has changed today, that's always been enacted focus for us.

Great and the PMA questions.

Yes can you repeat the specific DMA question for me.

They're a point when youre pricing is so good that the PMA providers could revisit your portfolio and find it attractive.

Some of your part.

Yes, I think in general as I mentioned this is part of the competitive analysis that our teams go through and understanding what the market prices are for a particular product.

Generally we have low value component type products.

So.

There is some limit in terms of the overall PMA targets to our portfolio, but it's something that the teams actively are aware of and trying to protect against.

Great. Thank you.

Sure.

Thank you for your question.

While we prepare for the next question.

And the next question will be coming from Seth Schiffman of Morgan Stanley . Your line is open.

Yes.

Okay.

Hello.

Sorry.

Yes that sorry from JP Morgan, yes, okay.

Good morning.

No.

I was just curious I don't want to nitpick. It was a very solid quarter, but the EBITA margin flat year on year ish.

Flat sequentially despite higher.

Higher revenue.

I'm sure you guys will be comfortably in line or above.

What you forecast for 2023, but were there some some elevated costs that led to the incrementals being only kind of just about in line with the current margin of 50%.

I think we had about a half a point of.

Drag from the Dart acquisition and the other element is commercial OEM was up about 29% year over year quarter over quarter right. So there is some mix impact there as well.

Okay, Okay, Okay, and then I.

I guess stepping back and looking longer term.

I thought one of the interesting slides at the Boeing Investor meeting last week was they had a slide with their backlog, where they showed it being 70% for replacement.

And 30% for growth, which I think is much.

Much lower growth component than than in the past when you think about all of that replacement that at least they are anticipating.

Do you guys think about a coming wave of retirements over the next.

Several years, and maybe what that might mean for your business.

I think there's always the risk of <unk>.

But I.

I think there is.

A lot of need right now and a difficulty to supply OEM.

Aircraft I think it's going to be a while before build rates catch up to actual demand. So.

Im less worried in the next five year horizon after that.

We'll have to evaluate.

What's what the market conditions look like are there new technologies.

Generally speaking the aerospace industry changes very slowly.

Theres not a lot of new platforms coming out in the future a lot of these planes are going to go into.

Aftermarket demand arena as they come as they get older I don't really think that we're setting ourselves up for a lot more retirements or something different than in the past.

But we'll have to see I think as we look forward again over the next several years, we're pretty comfortable that this is going to set up favorably for the company both on the commercial side and it should be also true on the defense side.

That's very helpful. I appreciate it if I could sneak in one more really quick you guys. When we were on this call a year ago, you guys talked about 20% to 30% aftermarket growth you did.

43, and I would imagine that the situation in China was much worse than anybody would have anticipated in November of 2022.

Not looking forward and thinking about the impact to 2023, but looking backward to this year do you have any sense of how much the situation in China hurt the business if at all or is that just not the way that you guys look at it at all.

I don't think Thats the way we look at it we look at what is the opportunity out in front of us, but certainly China is 20%.

<unk> aerospace travel may be a little more plus or minus it's a significant market that didn't participate almost whatsoever. So yes that was in our numbers and was a headwind to better even better results in a recovery to pre COVID-19 levels.

Really down to just the Asia Asia region, most of the other regions have come back pretty close already.

Great. Thank you very much.

Thank you for your question one moment, while we prepare for the next question.

And the next question will be coming from Michael.

CMO Lee from <unk>.

Please go ahead your line is open.

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

Kevin maybe just on the guidance I mean, you kind of said the way you do the bottoms up approach, but it also sounds like in addition to China contemplated in that guidance or the range of economic risks inflation potential recessionary like condition.

And I mean, it would seem like this mid teens incorporates a lot of risks and I'm just wondering is <unk>.

Sort of.

Hate to say it worst case scenario, but it sounds like you've really baked in a lot of potential headwinds there.

And I guess, just thinking about as we go through the year I know you've got some dark contribution but on an apples to apples do we get pretty close because we exit the year to two back to pre.

Colgate aftermarket revenue peak.

Okay.

I think we're approaching that yes, I think thats a comfortable way to look at it that sometime in 'twenty three.

Across the board, we will achieve aftermarket parity with prior to Covid levels, we'll have to see how that all impact theres still a lot that has to happen in Asia for that to happen but.

Again, I think it sets up favorably for us.

<unk> commercial and on the defense side.

Got it got it and any color on that guidance I mean, just think.

Thinking about it I mean, if you guys came up with a range. It would seem like this would be more on the low end of the range from about a risk factor could be already.

Volumes up approach from our teams and they go out and look at what they think is going to happen. The problem with aftermarket is that a lot of it is not booked it's book and ship within the quarter.

So you are forecasting things that are unknown, but theyre closer to their customers. Then we are up here at corporate. So this is why we tend to trust their numbers we.

Hope that it is conservative we hope that.

All of these things don't come out as any significant impact to the aerospace market will have to see.

And I would add as a practical matter, we don't have any visibility to the inventory levels.

Our airline customers.

The teams are using all the communication that they can directly with the customer to try and build up their plans and forecasts.

Got it perfect. That's helpful. Thanks, guys I appreciate it sure.

Thank you for that question one moment, while we will take our next question.

And we have our next question will be coming from David Strauss of Barclays. Please go ahead.

Thanks, Good morning, so far.

Following up on that last comment about new visibility into airline inventories, but what about on the distribution side. What do you see in terms of that channel and at this point how much of how much of your aftermarket is maybe update us how much is running through distribution. These days.

Yes, I think roughly <unk>.

20% to 25% runs through.

Distribution exclusive distribution type agreements.

Point of sales.

Our improving in each future quarter in.

In each of the teams work with their distribution partners to at a forecast what the right inventory levels are to support that growth.

We think we're in the reasonable range based on the assumptions that all the teams have been making.

Okay.

Mike you talked a bit about working capital one specifically about asking about your inventory levels are now back to basically where they were pre pandemic are you are you carrying any sort of extra inventory yourselves just.

In and around concerns around the supply chain are these inventory levels about right for ray from where your projected sales levels are.

We're carrying a little bit of extra just the op units are just frankly, given the supply chain risks and Thats done op unit by Op unit based on the specifics of what they're purchasing.

And we do that obviously to mitigate shipments risk in supply chain risks, there's a little bit of extra in there can't put an exact dollar amount to it but we're also just ramping up and taken product in for the growth that we see ahead going into 'twenty, three and the elevated revenue level.

Okay and last one.

Mike One would you expect to deal with this 2024 term loan how far out would you would you look at that.

We look at it off and it goes current obviously in August of 'twenty. Three later this year, so we'd have to take it out by.

August 24, we have enough cash to do that at the present moment, if worse came the worst <unk>.

Plenty of cash come that point in time, given what will generate from operations, but we look at it the market seems to be open up a bit opening up a bit in the last two weeks or so with different types of debt transactions to push maturities out when we look at all that stuff and memorial want to manage the stacks maximize the white space upfront as you guys see in the slides.

Pushed things out into the right.

We focus on that every day.

Now, yes, that's important point to stress. This is looking at the debt refinancing capital allocation. It's something this team spend a lot of time on daily.

Thanks very much.

Thank you.

One moment for our next question we have.

Follow up question from Noah pop on that.

Of Goldman Sachs.

Kevin You just were asked about building your aerospace original equipment forecast.

You spoke to the business units.

Up to you but.

You've been speaking.

You sort of I guess, it's been a little bit ahead of the curve and saying this stuff is not coming through to the production rates that the large commercial oes have been talking about.

And obviously theres a lot of supply chain.

Disruption out there.

I was just wondering if you could update us on how you're seeing that or is it getting better is the demand pull you're feeling now from Boeing and Airbus linking up closer to the production rates that are talking about or has it not changed.

Yeah, I'll take that one Noah I think generally.

Airbus demand pool has been tracking.

Within a reasonable tolerance bands.

Stated production rates.

Boeing obviously has noted they're working through a variety of supply chain issues as well as labor shortages. So from from operating unit to operating unit is varies a little bit.

I think we've seen it's probably fair to say a little bit of improvement over the last quarter.

And we're all hopeful that Boeing continues to resolve some of its issues and hits the rates.

Okay.

Then.

Similarly in your defense business.

That entire end market has had.

Supply chain labor headwinds and we've seen this the outlay pace.

Strangely behind the authorization pace.

But that is the last few months, that's caught up and we see a little bit of an inflection in your defense topline is.

That getting better or is your order rate getting better there how do you see that dynamic playing out moving forward.

Yes, I think generally across the defense market.

Both at the OEM level and aftermarket we did see improvement in terms of the order rate.

This last quarter in Q4 of FY 'twenty two.

As was supporting the growth forecast that we've provided in 2023 FY 'twenty three.

Okay.

Low to mid single.

If we strip out what we estimate price to be does it doesn't imply much for units.

Is it safe to interpret that forecast is made.

Splitting the difference of.

What's going on in this end market, starting 18 months ago.

With what <unk>.

<unk> seen in the last quarter, but it only being a quarter. So you don't want to assume that it's fully recovered quite yet, but if it if that outlay trend keeps.

Recovering back to authorization there may be some upside there.

Well I think knows Kevin I think we were surprised in 'twenty two.

The defense business not being stronger in the defense industry was hit harder it seems like by supply chain issues in and outlays.

And I think we're just being a little conservative as we look forward to what the defense industry could become in 'twenty. Three we had a good bookings quarter in Q4, but it's been lumpy and difficult to predict through 'twenty two so.

We're taking a little bit more conservative approach here I think.

Makes sense.

Okay. Thanks again.

Sure.

Thank you for your question.

And our last question is coming as a follow up from Scott.

Okay excuse me of quite a switch.

Your line is open.

Hey, Thank you for taking a quick follow up Mike is the stock and deferred compensation expense for next year is that a good run rate to use beyond 2023.

Sorry is that a good way.

Run rate to use beyond 2023.

I think so with some moderate uptick obviously per.

Per head count, but I think it's a fair gauge yes.

Okay. Thanks.

That concludes the Q&A session I would like to turn the call back over to Jamie <unk> director of Investor Relations for closing remarks go ahead. Please.

Thank you all for joining US today. This concludes the call. We appreciate your time and have a good rest of your day.

Okay.

The conference will begin shortly to raise your hand during Q&A you can dial one one.

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And thank you for standing by.

Welcome to the Q4 2022 Transcon Group incorporated earnings Conference call. At this time, all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session.

Ask a question during this session you will need to press star one on your telephone.

You will then hear an automated message advising your hands wait please be advised today's conference call is being recorded I would now like to.

I'll turn the call over to Jamie Steve <unk> Director of Investor Relations. Please go ahead.

Thank you and welcome to <unk> fiscal 2022 fourth quarter earnings conference call presenting on the call. This morning are <unk>, President and Chief Executive Officer, Kevin Stein, Chief Operating Officer, George valid, Eric and Chief Financial Officer, Mike listening.

Please visit our website at <unk> dot com to obtain a supplemental slide deck and call replay information.

Before we begin the company would like to remind you that statements made during this call which are not historical in back or 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 <unk>.

SEC available through the investors section of our website or SEC Dot 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 <unk>.

Tables and related footnotes in the earnings release for a presentation on the most directly comparable GAAP measures and applicable reconciliations I will now turn the call over to Kevin.

Good morning, Thanks for calling in today.

Focus on intrinsic shareholder value creation through all phases of the aerospace cycle.

To summarize here are some of the reasons why we believed us.

We own and operate proprietary aerospace businesses with significant aftermarket content.

We utilize a simple well proven value based operating methodology, we are a decentralized organizational structure and unique compensation system closely aligned with shareholders. We acquire businesses that fit this strategy and where we see a clear path to PE like returns.

Our capital structure and allocations are a key part of our value creation methodology.

It environment, we continue to see recovery in the commercial aerospace market and remain encouraged by the favorable trends in air traffic. Our Q4 results show positive growth in comparison to the same period prior year period, as we are lapping the fourth fiscal quarter of 'twenty one.

We are happy to see the continuation of the favorable trends in global air traffic recovery with domestic air travel is still leading in international air traffic catching up the majority of countries have fully reopened to international travelers. However, China air traffic lagged the recovery seen in other countries domestic air travel and <unk>.

<unk> continues to experience, Steve Paul pumps District zero Covid policies that limit travel China's international Air traffic remains very depressed and is only made modest improvement from COVID-19 lows.

In our bookings we saw another quarter of robust growth in our commercial revenues and bookings.

I am very pleased that despite this challenging environment, our EBITDA as defined margin was 49, 8% in the quarter.

Contributing to this strong margin is the continued recovery in our commercial aftermarket revenues along with our strict operational focus and disciplined approach to cost structure management <unk>.

<unk> per share and share buybacks as mentioned earlier, we are exiting fiscal 2022 with a sizable cash balance of approximately $3 billion.

Which leaves us with significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future.

Regarding the current M&A pipeline, we are actively looking for M&A opportunities that fit our model acquisition opportunity activity continues and we have a decent pipeline of possibilities as usual, mostly in the small to midsize range I cannot predict or comment on possible closings, but we remain confident that.

There is a long runway for acquisitions that fit our portfolio, both the M&A and capital markets are always difficult to predict but specifically so in these times.

'twenty three guidance was previously suspended as a result of the significant disruption in our primary commercial end markets related to the COVID-19 pandemic.

We are cautiously optimistic that the prevailing continued conditions will continue to evolve favorably.

However, as our fiscal 'twenty three progress we will continue to monitor the ongoing uncertainty and risks and market conditions closely and will react as necessary.

<unk> in market conditions, and the impact to our primary end markets could lead to revisions in our guidance for 2023.

Our initial guidance for fiscal 2023, continuing operations is as follows and can also be found on sites.

Slide seven in the presentation.

The midpoint of our fiscal year 2023 revenue guidance is $6, <unk> 9 billion or up approximately 12%.

Midpoint of fiscal 2023, EBITDA as defined guidance is $3 <unk> 5 billion.

Or up approximately 15% with an expected margin of around 50%.

This guidance includes about 50 basis points of margin dilution from our recent Dart our aerospace acquisition, we anticipate EBITDA margin will move up throughout the year with Q1 being the lowest and sequentially lower than Q4 of our fiscal 2022.

The midpoint of adjusted EPS is anticipated to be $21 38 or up approximately 25%.

Mike will discuss in more detail shortly the factors impacting EPS along with some other fiscal 2023 financial assumptions and updates.

We believe we are well positioned as we enter fiscal 'twenty three as usual, we will closely watch how the aerospace in capital markets continue to develop and react accordingly, let.

Let me conclude by stating that I am very pleased with the Companys performance in this period of recovery for their commercial aerospace industry. We remain sharply focused on our value drivers cost structure and operational excellence, we look forward to fiscal 2023, and the opportunity to continue to create value for our stakeholders through our <unk>.

<unk> strategy.

Now, let me hand, it over to George to review, our recent performance and a few other items. Thanks.

Thanks, Kevin and good morning, everyone.

I'll start with our typical review of results by key market category for the remainder of the call I'll provide color commentary on a pro forma basis compared to the prior year period in 2021.

Analysis discussion in the third quarter of fiscal 2022 and.

In the commercial market, which typically makes up close to 65% of our revenue we will split our discussion into OEM and aftermarket are.

Train issues across the broader aerospace sector.

Now moving on to our commercial aftermarket business discussion.

<unk>, which is our largest sub market, although all of our commercial aftermarket submarkets were up significantly compared to prior year Q3.

Sequentially total commercial aftermarket revenues grew by approximately 6%.

Few months, although there was a slight pullback in August Rpms and September has remained relatively flat compared to August. This was primarily a result of softer domestic China traffic due to ongoing zero COVID-19 policies.

Commentary from Airlines in recent months regarding passenger demand continues to be positive.

Only down 19% compared to pre pandemic.

The U S and Europe continued to lead showing strong demand for domestic travel use.

According to IATA traffic data for September International travel was only down about 30% compared to pre pandemic levels.

International traffic in North America is within about 10% of pre pandemic and Europe International traffic is within 20% or so of pre pandemic.

Pacific International travel has made good progress over the past months, but rpms are still down about 60%.

Could support near term improvement in air cargo, though uncertainty remains regarding China's timeline for full reopening.

This jet utilization has come down from pandemic highs, but it's still well above pre pandemic levels business jet Oems and operators continue to forecast strong demand in the near term there is growing optimism that the pandemic brought a favorable structural change to the business jet industry time will tell.

Moving on to our defense market, which traditionally is at or below 35% of our total revenue.

Sales in bookings and the lag in defense outlays in supply chain shortages were the main contributors to our softer than expected defense performance for 2022.

Negatively impacting our defense market revenues were the delays in the U S government defense spend outlays theres, often a lag between U S government defense sped authorizations.

And outlays and the lag is hard to predict while these delays have been longer than typical we did see some improvement in bookings this quarter, which bodes well for future defense order activity.

Due to the strength of our current order book as Kevin mentioned earlier, we expect low to mid single digit percent range growth in fiscal 2023 for our defense market revenues.

I'd like to finish by recognizing the strong efforts and accomplishments of our teams. During this challenging fiscal year I'm very pleased by our operational performance and our team's ability to overcome the negative impacts of the pandemic and supply chain disruptions, we experienced throughout the year as we enter our new fiscal year, our management and their teams.

We remain focused on our consistent operating strategy and meeting the demand for our products with that I'd like to turn it over to our Chief Financial Officer, Mike Lisman.

Everyone I'm going to quickly hit on a few additional financial matters for fiscal 'twenty, two and then also our expectations for fiscal 'twenty three.

On taxes, our GAAP and adjusted tax rates finished the year within their expected ranges our FY 'twenty two GAAP tax rate was 23% and the adjusted rate was just under 25%.

On cash and liquidity.

We ended the year with approximately $3 billion of cash on the balance sheet and at quarter end, our net debt to EBITDA ratio was six four times down from the six seven times level, where we finished last quarter. When you pro forma in the $18 50 per share dividend that we paid in August .

We continue to watch the rising interest rate environment closely we remain 85% hedged on our totaled 20 billion gross debt balance through a combination of interest rate caps and swaps through 2025. This provides us adequate cushion against any rise in rates at least in the immediate term.

Next on the FY 'twenty three expectations I'm going to really quickly give some more details on the financial assumptions around interest expense taxes and share count net.

Curve.

On taxes, our fiscal 'twenty, three GAAP cash and adjusted rates are all anticipated to be in the range of 24% to 26%.

4 billion area, maybe a little better in fiscal 'twenty three.

With that I'll turn it back to the operator to start the Q&A.

Okay.

As a reminder, if you have a question. Please press star one on your telephone one moment, while we compile the Q&A roster.

First question that we have.

Will be coming from.

Matt Walton.

Research. Please go ahead.

Sure. Thanks.

Good morning, guys.

Mike maybe to pick up on free cash flow or are you just where obviously you had a pretty healthy consumption of working capital as yet bill.

Into the growth ahead is it a similar amount of builds anticipated in fiscal 'twenty three and this is just a clarification you talked about maybe bringing down the net.

Net leverage or net debt to EBITDA leverage.

Would you consider bringing down the gross leverage as well or is that something that is not what you are thinking about thanks.

260 went back in during fiscal 'twenty. Two so we've got about 140 $150 million more to go we expect the bulk of that to happen during the coming fiscal year. So fiscal 'twenty three that's generally how we think about it and getting back to where we were pre COVID-19 and then on the leverage.

We'll see at this time, we don't anticipate going and paying down any of the gross debt balance because we have the benefit of the hedges and also the benefit of having taken out the bulk of that $20 billion of debt and a far better interest rate environment. When rates were a lot lower we have the next three years, where we have the benefit of the hedges.

We're really just not subject to the current market interest rates.

We tend to think we will have the similar approach going forward and the methodology there hasnt changed but no in response to your question. We don't at this time envision paying down any gross debt alright.

Alright, thank you.

Thank you for your question one moment, while the next questions.

The next question is coming from Robert Spingarn of Melissa Research. Your line is open.

Hey, good morning.

Good morning, Kevin on the commercial aftermarket growth rate in the guidance.

If China opens up how how might that number adjust.

Well I think you know there is not much flight activity happening and as a percentage of the fleet.

<unk> is a significant percentage of flight activity prior to Covid.

It could be a real tailwind to us as that opens back up.

Given the uncertainty in the market with.

Global conflicts, China and their zero Covid.

Inflation potential recession.

It was hard to forecast more growth than what we put in in the mid teens right now there's just enough uncertainty out there.

Is it as simple as just saying, maybe it's 20% of the market.

Have recovered and so it's a 10% number is that math make any sense.

Hi, it could make sense, we don't like to get baked around those numbers, we don't look at things regionally like that however, it's probably directionally accurate.

Okay, and then just on M&A again, we've seen valuations come down in the public markets.

Today, notwithstanding but but they have also come down in the private markets for quality assets with significant amounts of commercial aftermarket content have you seen that.

I wouldn't say that.

We've seen that there's a lot of activity.

Unfortunately, we haven't.

Had anything cross the finish line since darts, a couple of quarters ago.

We're very busy generally speaking and small to middle sized businesses.

We just haven't been able to.

Any of them across the finish line due to.

Unfavorable market.

Sentiment around how do I get financing for our business not us, but it's certainly restricting deals that are available in the marketplace. So I think all together, it's been a little bit disappointing there are some headwinds in M&A.

For the general market and we stay aggressive.

Okay, great. Thank you Kevin.

Yes.

Thank you for your question and one moment.

While we get ready for the next question.

The next question I have is from Robert Stallard vertical research your line is open.

Thanks, so much good morning.

Morning.

Kevin just following up on the other question about the capital deployment situation are you seeing any change in sentiment or maybe direction or activity from financial buyers. These guys getting squeezed by the higher interest rate today not bidding for thing as aggressive as they were in the past or perhaps even having to sell assets.

I don't think we've seen anybody selling assets, but we believe there is squeezing happening certainly limiting the number of people that can bid on businesses today and I think that is slowing the number of businesses that can come to market.

We don't factor that into really the way we look at returns on our business, we evaluate them all.

Based on really what they can do.

So we're not.

Looking for businesses in Europe , any more than usual, we look at all geographies regions. So.

We're encouraged and looking everywhere we have.

A team of M&A folks that.

We're looking for opportunities in Europe , certainly as we speak.

Okay, that's great, but there is no additional focus on it yeah, that's great. Thanks, Kevin.

Thank you for your question one moment, while we get ready for the next question.

And the next question that I have.

Will be coming from Noah <unk> of Goldman Sachs. Your line is open.

Hi, good morning, everyone.

Good morning, Noah and good morning.

Just a few more to make sure I have it on capital structure and capital deployment, Mike you alluded to the potential to hold slightly lower leverage if the rate environment stays here can you define what or quantify what that would mean in terms of net debt to EBITDA and you mentioned the <unk>.

This coverage ratio can you quantify what you are looking to maintain there and then.

To the extent that you keep this bid ask spread challenge in the M&A environment.

Will you look to maybe repurchase shares to start off the year here.

Sure. So a couple of things on.

The interest coverage ratios and leverage point and I'll come around to the repurchase shares point I can tell you how we think about it.

As much as we can simply because it's cheaper.

The debt cost is 575% this coming year with the benefit of the hedges and thats well below the targeted equity equity return of 17, 5% that we've had for a long time now here at <unk>. So that piece is pretty easy, but then second and this gets the cash interest coverage point and thats of equal or more importance in this kind of a rising rate.

<unk>.

And that's practically how much debt and prudently when we take on without being stupid and jeopardizing the value of the the equity right.

<unk>, that's if you take the last five years and average it when you strip out the Covid period.

And if you look at that same time period, but instead focused on our cash interest coverage ratio like EBITDA to interest expense you'd see that one bounce around two to three times and that two to three times ballpark with an average of just about two five so we look at that ratio a lot now more than we have in the past.

Along with the net debt to EBITDA ratio and we feel comfortable running trans dime and that kind of two to three ballpark for EBITDA to interest coverage ratio going forward.

We think about it quite often and we know that we have those benefits for the next three or four years and you could envision a time, where if we didn't have today. We didn't have those benefits we might have to dial back the leverage a bit to sort of hit the EBITDA to interest coverage ratios that I mentioned of sort of the two to three times ballpark, that's not the case and won't.

B for three years, because we got the benefit of the hedges and haven't taken out the debt in the prior.

Lower interest rate environment.

<unk> unchanged first reinvest in our own businesses second go and do M&A and then third return capital to our shareholders via buybacks or dividends will look at both.

Could do both maybe not as we did this prior year than last.

Hey down gross debt balance.

Okay.

Super helpful. I appreciate all that detail Mike. Thank you.

Sure.

Thank you for your question and now for the next question one moment.

Our next question will come from Sheila <unk>.

Jefferies. Your line is open.

Great. Thank you so much good morning, guys.

Good morning.

When we think about fiscal 'twenty three.

Adjusted EBITDA margins the guidance implies about 130 basis points above your target of $100. Despite 50 basis points of dilution from acquisitions.

Yes.

Commercial OE and aftermarket.

15%.

How do we think about the puts and takes to margin expansion.

Yes.

I think generally.

We went through a fair amount of restructuring.

The Covid pandemic and.

Historically, we've been able to restructure the business. During these types of prices season, and get some gains as the business returns I think we're seeing that we saw that throughout this year and we would expect that to flow through next year as well.

With some of the reduction in the real heavy focus on productivity that we've got going on at the operating units.

I think we've given the general guidance that we're comfortable with in terms of the particular market segments in the OEM assumptions in the aftermarket assumptions.

And.

Thats, where we feel comfortable.

<unk> two in this environment.

Yes.

In this world.

As we've said many times, we're a bottoms up not a top down are forecasting company. So this is the work of all of our many businesses that roll up their forecast to us and I think over time.

<unk>.

Can be more accurate than a top down approach of.

Guessing what RPM growth is going to be I think this is the most accurate way to forecast the business and we've been very successful with it.

Just to follow up on that you mentioned supply chain a few times in your script.

How are you preparing for that and do you expect any impact to your profitability.

Yes, I think the teams have been active really going back 12 months to 18 months. When we started to see early signs of trouble with the supply chain.

So we've been engaged with our suppliers, we're putting inventory in back into the system to support the recovery as Mike noted in his remarks and.

And we continue to sustain on top of the details and Thats really what we have found.

To help us through the situations. So I don't think we're anticipating any unusual unusual pressures, obviously, we're seeing inflation.

The rest of the world is seeing.

We're trying to do our best to battle that inflationary pressure.

The teams continue to stay engaged at the detailed level.

Great. Thank you.

Thank you for your question one moment, while we prepare for the next question.

And the next question is coming from Watson, Canada.

Your line is open.

Hey, good morning, guys.

Good morning, good morning.

Just a couple of questions first I was wondering just can you quantify.

The impact of supply chain shortfalls on defense sales or whatever all land sales.

What.

Yeah.

If theres any carryover you expect to recover next year.

Yes, I'll handle that I think it's been minimal in nature, you run into supply chain issue that might impact a handful of orders and you work with the existing backlog to offset that with other orders where you've got the supply so.

So we're not we're not seeing a material impact in any shape or form in terms of the FY 'twenty two results and were not anticipating.

Significant carryover.

That would influence the FY 'twenty three guidance.

Okay. That's helpful.

On the aerospace aftermarket commercial Aero.

Any trends that youre seeing that you can discern between kind of discretionary aftermarket versus non.

Non discretionary and maybe anything.

In 'twenty, two that was amplified by reactivation of parked aircraft or anything anything that sort of.

You can parse out within.

The results you've already reported.

Yes, I mean, I think at a high level. The overall industry enjoyed the benefit of the recovery.

Certainly the last three quarters.

As travel returned in some of the restrictions opened up I think as we noted we've seen the strength in our largest submarket, which is the passenger sub market and that includes interiors spare parts.

Uh huh.

Structural type parts component avionics across the full portfolio of products. So I don't think theres been any <unk>.

Unique trend in terms of one product type versus the other we've just enjoyed participating in the return to air travel.

Thank you guys.

Thanks.

Thank you for your question and one moment, while we get ready for the next question.

And the next question will be coming from Matt Akers of Wells Fargo. Your line is open.

Yes, thanks, good morning.

If you could talk about the OEM forecast and what sort of build rates you're assuming in there just given.

Some of the delays you've seen that Boeing did they need to get back to kind of their target rate.

Call. It early next year something like that for you to hit that mid teens and also is there is there any risk that you may have delivered ahead, just given some of the delays.

From the edge and stuff that we plan.

Yes.

As Kevin noted, we've got a well established bottoms up.

Forecasting and planning process at each individual operating unit. So they are closest to the customers or close to <unk>.

Boeing and Airbus and the other air Framers.

And we utilize the information that they provide they being the oes and Boeing and Airbus in each unit looks at where it thinks it's at in terms of the deliveries to date and what that means in terms of the future deliveries. So we use their information is best guidance, but again, we do it.

Bottoms up process and each operating unit looks at its specific scenario.

Okay. Thank you.

Okay.

Thank you for your question one moment, while we get ready for the next question.

Okay.

Our next question will be coming from Scott <unk>.

Suisse. Your line is open.

Hey, good morning. Thank you for taking my question, Kevin can you address the timing and scope of aftermarket price increases contemplated in guidance or to ask it another way.

Can you help me disaggregate, the mid teens aftermarket guide between volume and price.

Yes.

Well, we don't split.

Split out these things so carefully our our goal is always to.

Pass along inflation.

Right now the forecast from our teams that we have bottoms up is mid teens of our forecast for growth year over year.

There's so much uncertainty in that with what's going to happen in in Asia.

It's hard to forecast larger numbers than that.

Obviously there is.

As always some price in these numbers year over year as we've all seen inflation, but.

But we don't split it out too.

Put such a specific number on it because it differs by product business I think the way to look at it is what has inflation then we're trying to pass that along.

We see that.

<unk> inflationary pressures across our business.

Okay, and then Mike the Capex guide for next year, I think implies around 3% of sales at the high end.

Obviously the returns on capital in this business are amazing. So I think that's great to see but just curious if you can talk a bit about what the spend is for thank you.

Yes.

It's slightly elevated I think youre right 272, 8% of sales versus two 5% in some prior years.

And that money, because we see good paybacks and good projects from our op unit teams.

Two years or less and Thats whats driving the productivity one of our three value drivers in the EBITDA margin expansion that you guys see and here, we're seeing good capex investments and where we're putting money.

Behind it and then we've got a couple of onetime projects on some solar projects that make good sense and have good paybacks because of tax incentives, particularly in the state of California, where its elevated a bit because of that but generally we're investing behind good projects here that are driving the productivity and the margin improvement.

Okay, great. Thank you guys.

Thank you for your question one moment, while we prepare for the next question.

Okay.

And the next question will be coming from Christine.

<unk> of Morgan Stanley Your line is open.

Hello, Youre on mute.

Okay.

Well I think we lost Christine.

Okay.

Hello there.

Okay, sorry about that.

No problem, maybe following up on some margins.

<unk> questions earlier.

Yes, 50% adjusted EBITDA margin will be record high for you.

One point OE comes back that headwind to margin.

Can you talk about other levels levers you can pull to keep growing margins beyond 'twenty three outside of pricing and also on that pricing portion is there a level there.

Pricing is too good and the portfolio becomes more attractive for PMA to revisit your part.

Yeah, I'll handle that.

So in terms of productivity and margin expansion, it's something that we have always focused on.

That has historically been one of our three value drivers as most of you know.

It's maybe one that we don't promote or talk about as much as we need to but the teams have really done just a great job of absorbing the restructuring.

Processes automation of testing trying to take some of that labor generally out of the process.

So I think the teams have really done a fantastic job and you're seeing that benefit the margins as you go through.

In terms of pricing.

Ultimately our goal has always been to get incremental price slightly above inflation inflation is running hot we're seeing the inflationary pressures at our op units in terms of our cost structures.

It's a market priced.

Great and then on the PMA question.

Yes can you repeat the specific DMA question for me.

Is there a point when youre pricing is so good that the PMA providers could revisit your portfolio and find it attractive to PMA some of your part.

Yes, I think in general as I mentioned this is part of the competitive analysis that our teams go through and understanding what the market prices are for a particular product.

Generally we have low value component type products.

So.

There is some limit in terms of the overall PMA targets to our portfolio, but it's something that the teams actively are aware of and trying to protect against.

Great. Thank you.

Sure.

Thank you for your question.

While we prepare for the next question.

And the next question will be coming from Seth Schiffman of Morgan Stanley . Your line is open.

Yes.

Okay.

Hello.

Sorry.

Yes, sorry from JP Morgan, yes, okay.

Good morning.

No.

I'm just curious I don't want to nitpick, it was a very solid quarter, but the EBITDA margin flat year on year ish.

Flat sequentially despite higher.

Higher revenue.

I'm sure you guys will be comfortably in line or above.

<unk> forecast for 2023, but were there some some elevated costs that led to the incrementals being only kind of just about in line with the current margin of 50%.

I think we had about a half a point of.

Drag from the Dart acquisition and the other element is commercial OEM was up about 29% year over year quarter over quarter right. So there is some mix impact there as well.

Okay, Okay, Okay and then.

I guess stepping back and looking longer term.

I thought one of the interesting slides at the Boeing Investor meeting last week was they had a slide with their backlog, where they showed it being 70% for replacement.

And 30% for growth, which I think is much.

Much lower growth component than than in the past when you think about all of that replacement that at least they are anticipating.

Do you guys think about a coming wave of retirements over the next.

Several years, and maybe what that might mean for your business.

I think there's always the risk of Av, but I.

I think there is.

A lot of need right now and a difficulty to supply OEM.

Aircraft I think it's going to be a while before build rates catch up to actual demand. So.

Im less worried in the next five year horizon after that.

We'll have to evaluate.

What's what the market conditions look like are there new technologies.

Generally speaking the aerospace industry changes very slowly.

There's not a lot of new platforms coming out in the future a lot of these planes are going to go into aftermarket demand arena as they come as they get older I don't really think that we're setting ourselves up for a lot more retirements or something.

Different than in the past.

That's very helpful. I appreciate it if I could sneak in one more really quick you guys. When we were on this call a year ago, you guys talked about 20% to 30% aftermarket growth you did.

43, and I would imagine that the situation in China was much worse than anybody would have anticipated in November of 2022.

Not looking forward and thinking about the impact to 2023, but looking backwards. This year do you have any sense of how much the situation in China or hurt the business. If at all or is that just not the way that you guys look at it at all.

I don't think Thats the way we look at it we look at what is the opportunity out in front of us, but certainly China is 20%.

<unk> aerospace travel may be a little more plus or minus it's a significant market that didn't participate or almost whatsoever. So yes that was in our numbers and was a headwind to better even better results in a recovery to pre COVID-19 levels. It is.

Really down to just the Asia Asia region, most of the other regions have come back pretty close already.

Great. Thank you very much.

Thank you for your question one moment, while we prepare for the next question.

And the next question will be coming from Michael.

CMO Lee from <unk>.

Please go ahead your line is open.

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

It would seem like this mid teens incorporates a lot of risks and I'm. Just wondering is this sort of.

Hate to say worst case scenario, but it sounds like you've really baked in a lot of potential headwinds there.

And I guess, just thinking about as we go through the year I know you've got some dark contribution but on an apples to apples do we get pretty close as we exit the year to two back to pre.

Colgate aftermarket revenue peak.

Yes.

I think we're approaching that yes, I think thats a comfortable way to look at it that sometime in 'twenty three.

Across the board, we will achieve aftermarket parity with prior to Covid levels, we'll have to see how that all impact theres still a lot that has to happen in Asia for that to happen but.

Again, I think it sets up favorably for us.

On commercial and on the defense side.

Got it got it and any color on that guidance and then just thinking about it I mean, if you guys came up with a range. It would seem like this would be more on the low end of the range from about a risk factor would be already this bottoms up approach from our teams and they go out and look at what they think is going to happen.

The problem with aftermarket is that a lot of it is not booked it's book and ship within the quarter.

So you are forecasting things that are unknown, but they are closer to their customers. Then we are up here at corporate. So this is why we tend to trust their numbers we.

Hope that it is conservative we hope that.

All of these things don't come out as any significant impact to the aerospace market will have to see.

And I would add as a practical matter, we don't have any visibility to the inventory levels.

Our airline customers. So the teams are using all the communication that they can directly with the customer to try and build up their plans and forecasts.

Got it perfect. That's helpful. Thanks, guys I appreciate it sure.

Thank you for that question one moment, while we will take our next question.

And we have our next question will be coming from David Strauss of Barclays. Please go ahead.

Thanks, Good morning so.

Yes, I think roughly.

20% to 25% runs through.

Distribution exclusive distribution type agreements.

Point of sales.

Our improving in each future quarter in.

In each of the teams work with their distribution partners to at a forecast what the right inventory levels to support that growth.

We think we are in the reasonable range based on the assumptions that all the teams have been making.

Okay.

Mike you talked a bit about working capital ones, specifically about asking about your inventory levels are now back to basically where they were pre pandemic are you are you carrying any sort of extra inventory yourselves just.

In and around concerns around the supply chain are these inventory level is about right for now.

Ray from where your projected sales levels are.

We're carrying a little bit of extra just the op units are just frankly, given the supply chain risks and Thats done op unit by Op unit based on the specifics of what they are purchasing.

And we do that obviously to mitigate shipments risk in supply chain risks. So there is a little bit of extra in there can't put an exact dollar amount to it but we're also just ramping up and taken product in for the growth that we see ahead going into 'twenty, three and the elevated revenue level.

Okay and last one.

Mike What would you expect to deal with this 2024 term loan how far out would you would you look at that.

We look at it off and it goes current obviously in August of 'twenty. Three later this year, so we'd have to take it out by.

August 24, we have enough cash to do that.

<unk> moment.

First came the worst and boss.

Plenty of cash come at that point in time, given what will generate from operations, but we look at the market seems to be open up a bit opening up a bit in the last two weeks or so with different types of debt transactions to push maturities out when we look at all of that stuff and memorial to want to manage the stacks maximize the white space upfront as you guys see in the slides.

Pushed things out into the right and we focus on that every day.

Yes, that's important point to stress. This is looking at the debt refinancing capital allocation. It's something this team spends a lot of time on daily.

Thanks very much.

Thank you.

One moment for our next question, we have a <unk>.

Follow up question from Noah pop on that.

Goldman Sachs.

Kevin you just asked about building your aerospace original equipment forecast.

Spoke to the business units feeding up to you but.

You've been speaking.

You sort of I guess, it's been a little bit ahead of the curve and saying this stuff is not coming through to the production rates that the large commercial oes have been talking about.

And obviously theres a lot of supply chain.

Disruption out there.

I was just wondering if you could update us on how youre seeing that it is it getting better is the demand pool, you're feeling now from Boeing and Airbus linking up closer to the production rates that are talking about or has it not changed.

Yeah, I'll take that one I think generally the.

Airbus demand pool has been tracking.

Within a reasonable tolerance bands.

Stated production rates.

Boeing obviously has noted they're working through a variety of supply chain issues as well as labor shortages. So from from operating unit to operating unit it varies a little bit.

I think we've seen it's probably fair to say a little bit of improvement over the last quarter.

And we're all hopeful that Boeing continues to resolve some of the tissues and hits the rates.

Okay.

Then.

Similarly in your defense business.

That entire end market has had.

Supply chain labor headwinds and we've seen this the outlay pace.

Strangely behind the authorization pace.

That is the last few months, that's caught up and we see a little bit of an inflection in your defense topline.

Is that getting better as your order rate getting better there how do you see that dynamic playing out moving forward.

Yes, I think generally across the defense market.

Both at the OEM level and aftermarket we did see improvement in terms of the order rate.

This last quarter in Q4 of FY 'twenty two.

Which is what is supporting the growth forecast that we've provided in 2023 FY 'twenty three.

Okay I mean.

Low to mid single.

If we strip out what we estimate price to be does it doesn't imply much for units is it safe to interpret that forecast is maybe splitting the difference of.

What's going on in this end market, starting 18 months ago.

With what you've seen in the last quarter, but it only being a quarter. So you don't want to assume that it's fully recovered quite yet, but if it if that outlay trend keeps.

Recovering back to authorization there may be some upside there.

Well I think knows Kevin I think we were surprised in 'twenty two.

The defense business not being stronger in the defense industry was hit harder it seems like by supply chain issues and outlays.

We're thinking a little bit more conservative approach here I think.

Makes sense.

Okay. Thanks again.

Sure.

Thank you for your questions.

And our last question is coming as a follow up from Scott.

Excuse me of quite swiftly.

Your line is open.

Hey, Thank you for taking a quick follow up Mike.

Stock and deferred compensation expense for next year is that a good run rate to use beyond 2023.

Sorry is that a good way.

Run rate to use beyond 2023.

I think so with some moderate uptick obviously for.

For head count, but I think it's a fair gauge yes.

Okay. Thanks.

Okay.

That concludes the Q&A session I would like to turn the call back over to Jamie <unk> director of Investor Relations for closing remarks go ahead. Please.

Thank you all for joining US today. This concludes the call. We appreciate your time and have a good rest of your day.

Q4 2022 TransDigm Group Inc Earnings Call

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