Q1 2023 TransDigm Group Inc Earnings Call
Speaker 4: Thank you and welcome to Transyme's fiscal 2023 first quarter earnings conference call. Presenting on the call this morning are Transyme's president and chief executive officer Kevin Stein, chief operating officer George Valideras and chief financial officer Mike Lithman.
Speaker 5: Please visit our website at transim.com to obtain a supplemental slide deck and call replay information.
Speaker 6: 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, we use referred to the company's latest filing with the SEC.
Speaker 7: all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings call for a presentation of the most directly comparable GAAP measures and applicable reconciliation. I will now turn the call over to Kevin.
Speaker 8: 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 23 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.
Speaker 9: 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 believe this. 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.
Speaker 10: and over any extended period have typically provided relative stability in the downturns.
Speaker 11: 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 have a decentralized organizational structure and unique compensation system closely aligned with shareholders.
Speaker 12: We acquire businesses that fit this strategy and where we see a clear path to PE-like returns. And lastly, our capital structure and allocations are a key part of our value creation methodology.
Speaker 13: 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 had a good start to fiscal 23 and increased our guidance for the year.
Speaker 14: We continue to see recovery in the commercial aerospace market. Our Q run results show positive growth in comparison to the same prior year period. We are encouraged by the progression of the commercial aerospace market recovery to date.
Speaker 15: and trends in the commercial aerospace market remain favorable as demand for travel remains robust.
Speaker 16: International air traffic is closing in on the domestic travel recovery, and China reopened its air travel in January with the lifting of its pandemic restrictions.
Speaker 17: However, there is still progress to be made for the industry as our results to continue to be adversely affected in comparison to pre-pandemic levels since the demand for air travel is still depressed.
Speaker 18: In our business, we saw another quarter of very healthy growth in our total commercial revenues and bookings.
Speaker 19: Bookings also outpaced revenues in all three of our major market channels. Commercial OEM, commercial aftermarket and defense.
Speaker 20: We also attained an EBITDA as defined margin of 50% in the quarter. Contributing to this strong margin is the continued recovery in our commercial aftermarket revenues, along with diligent focus on our operating strategy.
Speaker 21: Additionally, we had strong operating cash flow generation in Q1 of almost 380 million and ended the quarter with close to 3.3 billion of cash. We expect to steadily generate significant additional cash throughout the remainder of 2023.
Speaker 22: Next, an update on our capital allocation activities and priorities.
Speaker 23: The capital allocation priorities at TransDime are unchanged. Our first priority is to reinvest in our businesses, second to do accretive M&A, and third, return capital to our shareholders via share buybacks or dividends.
Speaker 24: A fourth option, paying down debt, seems unlikely at this time, though we do still take this into consideration.
Speaker 25: We are continually evaluating all of our capital allocation options. As mentioned earlier, we ended the quarter with a sizable cash balance of close to $3.3 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.
Speaker 26: 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 and mid-sized range.
Speaker 27: 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 especially so in these times.
Speaker 28: Now moving to our outlook for fiscal 2023. As noted in our earnings release, we are increasing our full fiscal year 23 sales in EBITDA as defined guidance, both by 65 million to reflect our strong first quarter results.
Speaker 29: and current expectations for the remainder of the year. The guidance assumes the continued recovery in our primary commercial end markets through fiscal 23 and no additional acquisitions or divestitures.
Speaker 30: Our current year guidance is as follows and can also be found on slide six in the presentation. The midpoint of our red revenue guidance is now $6.155 billion or up approximately 13%.
Speaker 31: In regards to the market channel growth rate assumptions that this revenue guidance is based on, for the commercial aftermarket we are updating the full year growth rate assumptions as a result of our strong first quarter results and current expectations for the remainder of the year. We now expect commercial aftermarket revenue growth in the high-
Speaker 32: changed. Commercial OEM and defense revenue guidance is still based on our previously issued market channel growth rate assumptions where we expect commercial OEM revenue growth in the mid teens percentage range and defense revenue growth in the low to mid single digit percentage range.
The midpoint of our EBITDA as defined guidance is now 3.11 billion or up approximately 18% with an expected margin of around 50.5%.
This guidance includes about 50 basis points of margin dilution from our recent DART aerospace acquisition. We anticipate EBITDA margins will continue to move up throughout the remainder of the year. The midpoint of our adjusted EPS is increasing primarily due to the higher EBITDA as defined guidance and is now anticipated to be 22.5 percent lower than 1 percent.
continue, including the expansion of flight activity in China, we could see further upward revisions to our guidance.
We believe we are well positioned for the remainder of fiscal 2023. We'll continue to closely watch how the aerospace and capital markets continue to develop and react accordingly.
On the organization side, I wanted to announce the retirement of Hallie Martin, our general counsel, chief compliance officer and secretary. Hallie has been an integral part of our team since 2012 and long before as outside counsel.
Jess Warren has been promoted from her position as Associate General Counsel to fill this critical role as part of our robust succession planning process.
Thank you, Hallie, for all of your great counsel and dedication to TransDime.
Let me conclude by stating that I am very pleased with the company's performance this quarter and throughout the recovery of the commercial aerospace industry.
We remain focused on our valley drivers, cost structure, and operational excellence. Let me hand it over to George to review our current, our recent performance and a few other items.
Thanks Kevin and good morning everyone.
I'll start with our typical review of results by key market category.
For the balance of the call, I'll provide commentary on a pro forma basis compared to the prior year period in 2022. That is, assuming we own the same mix of businesses in both periods.
The market discussion includes the May 2022 acquisition of Dart Aerospace in both periods.
DART has been included in this market analysis discussion since the third quarter of fiscal 22.
In the commercial market, which typically makes up close to 65% of our revenue, we'll split our discussion into OEM and aftermarket.
Our total commercial OEM revenue increased approximately 20% in Q1 compared with the prior year period. Bookings in the quarter were strong compared to the same prior year period and solidly outpaced sales. Sequentially, the bookings improved almost 15% compared to Q4.
present risks to achieving OEM production rates.
Now moving on to our commercial aftermarket business discussion.
Total commercial aftermarket revenue increased by approximately 31 percent in Q1 when compared with the prior year period.
Growth and commercial aftermarket revenue was primarily driven by continued strength in our passenger sub-market, which is our largest sub-market, although all of our commercial aftermarket sub-markets were up significantly compared to prior year Q1. Sequentially total commercial aftermarket revenues grew by approximately
broader market dynamics, global revenue passenger miles remain lower than pre-pandemic levels, but have continued to steadily trend towards upwards over the past few months.
airline passenger demand remains strong throughout the fall and holiday season.
I audit currently forecast calendar year 23 air traffic will be within about 15% of pre-pandemic.
The recovery and domestic travel continues to be stronger than international travel, although international traffic is catching up. In the most recently reported IOTA traffic data for December , global domestic air traffic was only down 20 percent compared to pre-pandemic.
For the U.S., domestic travel in December was within 10% of pre-pandemic levels.
The domestic travel in China continued to lag other major air traffic regions.
and was down about 55% compared to pre-pandemic.
However, the lifting of COVID restrictions and the reopening of China to international travelers oeds well for air traffic growth.
Roughly a year ago, international travel globally was depressed about 60 percent. But in the most recently reported IOT traffic data for December , international travel was only down about 25 percent compared to pre-pandemic levels.
International traffic in North America and Europe were within 5% and 15% of pre-pandemic, respectively.
Asia Pacific international travel was still down about 50%, but should improve subsequent to the January reopening of China.
Global air cargo demand has continued to pull back over the past few months.
As of IATA's most recent data, December was another month in which air cargo volumes showed year-over-year decline and were below pre-pandemic levels.
The recent easing of pandemic-related restrictions in China could be favorable for air cargo in 1923, but it's too early to determine.
Business jet utilization has come down from pandemic highs and has continued to temper over the past handful of months.
However, activity is still above pre-pandemic levels and business jet OEMs and operators forecast strong demand in the near term.
Time will tell how this plays out as there is softening optimism for the business jet market due to the uncertainty within the current macro and financial environment.
Shifting 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 3% in Q1 when compared with the prior year period.
Defense bookings are up significantly this quarter compared to the same prior year period, and Q1 bookings strongly outpace sales, which bodes well for future defense order activity.
Impacting our defense market revenues are the ongoing delays in the US government defense spend outlays.
While these delays appear to be slowly improving, they do remain longer than historical average levels.
Our teams are steadily making progress with the supply chain but continue to face challenges.
The lack of electronic component availability continues to be the primary focus for our teams.
As Kevin mentioned earlier, we continue to expect low to mid-single digit percent range growth this year for our defense market revenues.
Lastly, I'd like to wrap up by stating how pleased I am by our operational performance in this first quarter of Fiscal 23. We remain focused on our value drivers in meeting increased customer demand for our products.
With that, I'd like to turn it over to our Chief Financial Officer, Mike Lisman. Morning everyone. I'm going to quickly hit on a few additional financial matters for the quarter and then expectations for the full fiscal year. First, on organic growth and liquidity.
In the first quarter, our organic growth rate was 15% driven by the continued rebound in our commercial OEM and aftermarket end markets.
On cash and liquidity, free cash flow, which we traditionally define as EBITDA, less cash interest payments, CapEx, and cash taxes, was roughly $400 million for the quarter.
We ended the quarter with approximately 3.3 billion of cash on the balance sheet, and our net debt T-bidai ratio was exactly six times, down from 6.4 times at the end of last quarter.
On a net debt to you but on a basis, this puts us right at the five-year pre-COVID average level.
Additionally, our cash interest coverage ratios such as EBITDA interest expense are currently in line with where we've historically operated the business.
We feel comfortable here, given the benefit of our interest rate hedges and fixed rate debt instruments that were entered into in a lower interest rate environment.
As always, we continue to watch the rising interest rate environment and the current state of the debt markets very closely.
During the first quarter, we completed an extension of our nearest maturity term loan, pushing the maturity date from mid-2024 out into 2027. Proforma for this refinancing, our nearest term maturity is now 2025.
As a result of this REFI, our interest expense estimate for FY23 ticked up very slightly, as you can see in today's updated interest expense guidance.
Over 75% of our total 20 billion gross debt balance is at a fixed rate through a combination of fixed rate notes and interest rate caps and swaps through 2025. This provides us adequate cushion against any rise in rates, at least in the immediate term. Going forward, we expect to continue both proactively and proactively.
As we sit here today 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 23. With that, I'll turn it back to the operator to kick off the Q&A.
As a reminder to ask a question, please press star 11 in your telephone. Again, that's star 11 on your telephone to ask a question.
A first question comes from the line of no pop-a-neck of Goldman Sachs.
Your line is open. Noah.
Noah. Okay, good morning everyone.
Morning. Good morning.
How are you anticipating the commercial aerospace aftermarket revenue to progress sequentially through the year compared to the first quarter?
I would expect much like flight activity that it should keep trending upwards. That's our expectation. We'll see if that plays out.
Okay.
And you mentioned bookings ahead of shipments across the board. Do you have any quantification of that?
We've historically not given book to bills across the end markets, no, but I think it's pretty healthy growth that supports the revised guidance on revenue for today, so we feel good about it in that. Healthy growth and healthy out performance and really positive book to bill ratios across the end markets.
Okay, and just last one, the EBITDA guidance revision is the same as revenue at the midpoint, so June 30th, 2012.
you know, it implies a 100% incremental on the additional revenue. I know it's not that simple, but.
Can you just walk me through how the the evidaz is able to be the same as the revenue on the guidance revision?
Yeah, I think Noah, what you're seeing there is just the upside mainly in the commercial aftermarket space, which is our most profitable end market of the three and then separately some better cost performance. Right, you're not typically getting 100% drop through to your point, but we are doing slightly better on the cost than we expected. So that's what you're seeing there.
Okay, appreciate the time.
Thank you.
Our next question comes from the line of Robert Stollard of Vertical Partners. Your line is open, Robert.
Thanks so much. Good morning. Good morning. Kevin, you mentioned that the M&A pipeline is still looking pretty active. I was wondering if you were seeing any sign of these higher interest rates starting to impact the appetite of financial buyers.
Yeah, I think we've seen some impact over the last six months or so. I think you see that in a general lack of activity, although we've been busy evaluating different targets.
I think we see that changing though, as there seems to be some important properties coming to market in the next six months or so. I think this should change. So we remain relatively optimistic as always. But as you said, do the exact same process until they do repeat itself and then we head out of the story. Positive, ie, positive.
I think that gives you some indication of what we're looking at in the future. And one for Mike in related topic actually. You mentioned there's some debt due in 2025. If you were to refinance that today, what sort of interest rate would you expect to pay on that?
It's hard to say. Something like what we got on the December refi we just did a month or two ago. You know the interest rate ticked up by about 1.0% from LIBOR plus 225 to SOFR plus 325. And debt markets are a little bit better.
given what's come out on inflation and the fed rate moves since that December raised. So maybe you do a little bit better than that, but it's you know it's hard to say that's just a guess.
Yep, that's great. Thanks so much.
Thanks so much. Thank you. Our next question.
Consonal line of Scott Dushal of Credit Suits. Your line is open Scott.
Hey, good morning. Kevin, I wanted to get your thoughts on M&A outside of A&D. Is that something you'd ever do? And if you were to do something outside of A&D…
Should we expect you to start small or could we see you start with something bigger?
Well, we don't like to speculate on that. We have studied what it would look like to acquire something outside of A&D, but we think it's best to stay focused on aerospace. There are still...
So many great opportunities and a number of them coming up. Like I said in the next six months that, you know, keep us very focused on the pure play aerospace and defense for intellectual reasons and also because we may have to one day and
a distant future. We do look at other areas, but none of them have appeared interesting enough to overshadow our desire to keep growing in aerospace and defense.
Great, that's really helpful. And for Mike, you know, you showed some really good leverage on SG&A this quarter. I think your sales were up 17%, but SG&A was actually down.
So curious if you could outline a bit what the cost mitigation efforts are that you're running there as in how SG&A might trend as we move throughout the year. Thanks.
Yeah, we really look at the EBITDA line. Historically, we've not gone back and looked and commented specifically on gross profit versus SG&A trends just because the accounting puts and takes there. And as we think about forecasted for the year, we really look at EBITDA's defined ratio and feel good about hitting the market.
you know, 50.5 percent or maybe slightly better that we gave the guidance for today. And it's hard to comment specifically where SG&A could go for the balance of the year.
on a quarterly basis. Yeah, I would just add, you know, I think in general, as we've had, and we've performed in pass-down turns in the uptick, you know, we did a lot of heavy lifting with restructuring as a result of the COVID pandemic. And the teams have done a nice job managing to the lower cost structure and supporting the additional demand.
and I think we'll continue to do so throughout the year. Great, thanks guys.
Thank you. Our next question comes from the line of David Strauss of Barclays. Your question, please, David.
Hi, good morning. This is Josh Corn on for David. Working capital was fairly neutral in Q1. Do you still see the $150 million drag for the year? Thanks.
We do. I mean, as we come back to pre-COVID levels, that's going to go in over the course of the year. It's kind of lumpy in how it happens and the progression and forecasting. It's tough, but we do expect that amount to go back in.
Thanks, and it looks like overall aftermarket revenues were back pretty much to pre-pandemic levels. I think that's a sense of where volumes are.
I think we're
still 20 to maybe 30 percent off in volumes. There are still a lot of regions as George reviewed that have not fully come back.
Thank you. Our next question. Yeah.
comes from the line of Peter Arment of Baird.
Please go ahead. Okay, thanks.
Thanks. Good morning, everyone. Nice result. Good morning. Hey, good morning. And I'm sorry if you missed your opening remarks, but just on China, just kind of assumptions around what you expect there, just as we get the reopening traffic picking up pretty materially, hopefully wide body activity comes back. Just remind us kind of the mix.
that we should be thinking about with China and just how you kind of incorporated that in your forecast. Thanks Kevin.
Sure, I'll take that one. From our perspective, we're still in the early innings of China opening up, obviously, this past month. Our teams, as they always do, do a bottoms-up analysis and planning process as we enter any fiscal year.
And, you know, there was some recovery expected baked into our forecasts and our plan. We'll see how it plays out. Generally, you know, we don't have and we don't track specific regions. We think we're fleet weighted. And obviously it's a big market, so hopefully.
that will be helpful as we progress throughout the year. I guess it's just to follow up quickly on just the widebody activity. Could you make a comment, George, just on what you're seeing regarding some of the airlines behavior on the widebody?
Yeah I don't think we've seen much shift again the opening for China International travel is pretty new. You would logically expect the wide-body usage to improve given those types of routes but we're still again in the early innings of this.
Appreciate the call. Thanks so much.
Sure.
Thank you.
Our next question comes from the line.
of Kotham Kenna of Cohen. Your line is open Kotham.
No.
Hey, guys.
Hey guys, good morning.
Good morning.
In the past, you've sometimes given color on.
discretionary versus non-discussionary aftermarket. Demand any color there or by channel distribution versus direct.
Yeah, I think most of our revenues are on direct sales. In general, we're seeing good strength and good recovery across all of the individual submarkets.
And on the discretionary versus non-discretionary point, we think consistent with what we've said in the past were mostly non-discretionary when it comes to the commercial aftermarket bucket.
And that's where you're seeing kind of the incremental strength.
is in the non-disquestionary. I'm just curious like- It's hard to break it out. I think it's across all. I would reiterate, I think we're seeing strength across the board in all of the submarkets.
Okay.
And just curious what you're seeing in terms of inflation this year from your
suppliers, you know, what?
Do you have a dollar value you could give to us and what you're doing to offset it?
pricing? Yeah, I don't have a specific dollar value to give you. You know, in general we really focus on productivity. We are seeing inflationary pressures from the supply chains. We've got all of our teams have individual decentralized procurement organizations that are doing a nice job.
working with the supply chain trying to minimize the level of inflation. And we continue to work the productivity to offset that and you're seeing that flow through in terms of the lower cost structures.
Thanks guys.
Sure.
Thank you.
Our next question.
comes from the line of Matt Acres of Wells Fargo. Your question, please, Matt.
Yeah, hi, thanks. Good morning. I wonder if you could elaborate. There's the comment we could see further upward revision in the guidance as we go through the year. How much of that uncertainty is this China versus kind of OE build rates or sort of if you can kind of quantify what the biggest.
buckets of that uncertainty could be. I think it's probably a big piece from China, but clearly OEM is not performing at where it was prior to the COVID outbreak. So there's room really in all of the market segments for improvement.
to leave that just so you have the optionality in case a deal comes through or something like that.
Yeah, we're you know, obviously we're sitting on more than we've had historically to your point. We feel good about, you know, the M and a pipeline as Kevin said, and what's what's coming. We do have, you know, far more than we need to operationally run the business, but it's something we think about.
quite a bit just in terms of you know the capital allocation priorities that Kevin provided and want to make sure we have enough firepower for potential M&A in the in the current environment.
Thank you.
Thank you. Our next question.
comes from the line of Seth Safeman of J.P. Morgan. Please go ahead, Seth.
Good morning. This is Rocco Barbera on for Seth. Now that leverage six times range that has been stated in the past to be the general ballpark range for the company. How do you think about new acquisitions and or capital deployment moving forward? Also, where would you consider returning cash again?
Yeah, it's hard to say exactly. Like I just mentioned, we're always looking at the capital deployment options. We're doing that today. We do it quite a bit obviously monthly and we want to be strategic with our capital and make sure we have enough at all times for
M&A if it comes and then also it's the shareholders capital so we want to be efficient with it And if we don't find a use for it give it back With regard to the leverage ratio. We are at about six times Which is historically where we were in a lower interest rate environment I think you know, we're as I mentioned we feel comfortable
where we are today at the six times level and given the benefit of the hedges. It's hard to say if we pick up from here, if we went and found a good acquisition candidate, you know, and use a little bit of debt, you could always do that. Though you'd then be adding EBITDA. So I think it's safe to say going forward, given that we have the hedges and also that our interest rate.
But no real material change with the approach to leverage expected.
Great, thank you. Then as a quick follow up, you mentioned earlier that you expect Ibera as defined margin to kind of expand as we go through this year. Should we be expecting that expansion to continue in the out years or are we approaching a range where the margin will begin to plateau? You know, we are still navigating 2023.
Our next question comes from the line of Andre Madrid.
A Bank of America. Your line is open, Andre.
Hi everyone, thanks for the time, good morning. I kind of wanted to take a look back at the supply chain. Obviously there's a lot of financial stress in the lower tiers. Do you guys see that as a room for opportunity when it comes to M&A? Just kind of wanted to get your outlook on that.
Not really. We don't look to vertically integrate. We look to acquire phenomenal aerospace and defense businesses that we can further improve. You know, buying up parts of the supply chain vertically integrating.
usually doesn't meet our criteria for highly engineered, unique aerospace components with aftermarket content. And we like to stay very disciplined in that approach. That's been the secret to our success, I think, in our M&A culture.
All right, that's helpful. I'll keep it at once. All right, that's helpful.
Thank you. Once again to ask a question, please press star 11 on your telephone. Again, that's star 11 on your telephone to ask a question.
Our next question comes from the line of Pete Osterlin of Truist. Your line is open, Pete. I'm Mike Trimoller this morning. Thanks for taking the question. I just wanted to ask, how are you managing through the current labor market environment? Has Bridget been managed?
we've been able to invest in the business and find different automation opportunities to take labor out of the process here and there. I think in general, the labor market conditions have been improving over the last couple of months. Most teams have plans in place to...
to support potential OE production rate increases as we're all hoping will occur. So I don't see any significant issues and I'd say in general terms, it's probably improved a little bit over the last couple of months.
All right, I'll leave it at one. Thank you.
All right, I'll leave it at one, thank you. Thanks.
Thank you. At this time, I'd like to turn the call back over to Jamie Steeman for closing remarks. Thank you all for joining us today. This concludes today's call. We appreciate your time and have a good rest of your day.
And this concludes today's conference call. Thank you for participating. You may now disconnect.
The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 11.