Zimmer Biomet Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 8, 2024

There are 20 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to TransDigm Group Incorporated First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

Operator

Would now like to hand the conference over to your speaker today, Jamie Seaman, Director of Investor Relations. Please go ahead.

Speaker 1

Thank you, and welcome to TransDigm's Fiscal 20 24 First Quarter Earnings Conference Call. Presenting on the call this morning are TransDigm's President and Chief Executive Officer, Kevin Stein Co Chief Operating Officer, Joel Rees and Chief Financial Officer, Sarah Wynne. Also present for the call today is our Co Chief Operating Officer, Mike Glissman. Please visit our website at transtyme.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.

Speaker 1

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 atsec.gov. The company would also like to advise you that during the course of the call, we will be referring to EBITDA, specifically EBITDA as defined, adjusted net income and adjusted earnings per share, all of which are non GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and applicable reconciliations. I will now turn the call over to Kevin.

Speaker 2

Good morning. Thanks for joining us on the call today. First, I'll start off with the usual quick overview of our strategy, a few comments about the quarter and discuss our fiscal 2024 outlook. Then Joel and Sarah will give additional color on the quarter. To reiterate, we believe we are unique in the industry in both 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.

Speaker 2

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 and over any extended period have typically provided relative stability in the downturns. We follow a consistent long term strategy. Specifically, First, we own and operate proprietary aerospace businesses with significant aftermarket content.

Speaker 2

2nd, we utilize a simple well proven value based operating methodology. 3rd, we have a decentralized organizational structure and unique compensation system closely aligned with our shareholders. 4th, 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. Our long standing goal is to give our shareholders private equity like returns with the liquidity of a public market.

Speaker 2

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 strong quarter. Our Q1 results ran ahead of our and we have raised our sales and EBITDA as defined guidance for the year. Commercial Aerospace market trends remain favorable as the industry continues to recover and progress towards normalization. Global air traffic is closing in on pre pandemic levels and demand for travel remains high.

Speaker 2

Airline demand for new aircraft also remains high and the OEMs are working to increase aircraft production. However, total air travel demand remains slightly below pre COVID levels and OEM aircraft production rates remain well below pre pandemic levels. There is still progress to be made for the industry and our results continue to be adversely affected in comparison to pre pandemic levels. In our business, during the quarter, we saw a healthy growth in our revenues and bookings for all three of our major market channels, commercial OEM, commercial aftermarket and defense. Our EBITDA as defined margin was 51% in the quarter.

Speaker 2

Contributing to the strong Q1 margin is the continued recovery in our commercial aftermarket revenues along with diligent focus on our operating strategy. Additionally, we had strong operating cash flow generation in Q1 of over $630,000,000 and ended the quarter with over $4,100,000,000 of cash. We expect to steadily generate significant additional cash throughout the remainder of 2024. Next, an update on our capital allocation activities and priorities. As we discussed on our last earnings call, we agreed on November 9 to acquire the Electron Device Business of Communications and Power Industries also known as CPI for approximately $1,385,000,000 in cash.

Speaker 2

CPI's electron device business is a leading global manufacturer of electronic components and subsystems primarily serving the aerospace and defense market. The products manufactured by this business are highly engineered proprietary components with significant aftermarket content and a strong presence across major aerospace and defense platforms. Our team is working diligently through the approval process in the U. S. And U.

Speaker 2

K. And the acquisition is expected to close this fiscal year. We remain very excited about adding this proprietary business as one of our Transyme operating units. Regarding the current M and A pipeline, We continue to actively look for M and A opportunities that fit our model. As we look out over the next 12 to 18 months, we continue to see a target rich environment for our focused acquisition strategy.

Speaker 2

As usual, the potential targets are mostly in the small and mid sized range. I cannot predict or comment on possible closings, but we remain confident there is a long runway for acquisitions that fit our portfolio. The capital allocation priorities at TransDigm are unchanged. Our first priority is to reinvest in our business. 2nd, do accretive disciplined M and A and third, return capital to our shareholders via share buybacks or dividends.

Speaker 2

A 4th option paying down debt seems unlikely at this time, though we do still take this into consideration. We are continually evaluating all of our capital allocation options, but both M and A and Capital Markets are difficult to predict. As always, we continue to closely monitor the capital markets and remain opportunistic. As mentioned earlier, We ended the quarter with a sizable cash balance of over $4,100,000,000 which includes the $2,000,000,000 of cash from the new debt issued during our Q1. Sarah will comment on this in more detail later.

Speaker 2

We have significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future. Moving to our outlook for fiscal 2024. As noted in our earnings release, we are increasing our full fiscal year 2024 sales and EBITDA as defined guidance to reflect our strong Q1 results and our current expectations for the remainder of the year. At the midpoint, sales guidance was raised $85,000,000 and EBITDA as defined guidance was raised 45,000,000 The guidance assumes no additional acquisitions or divestitures and is based on current expectations for a continued recovery in our primary commercial end markets throughout fiscal year 2024. Our current guidance for fiscal 2024 is as follows and can also be found on Slide 6 in the presentation.

Speaker 2

Note that the pending acquisition of CPI's Elektron Device business is excluded from this guidance until acquisition close. The midpoint of our fiscal 2024 revenue guidance is now $7,665,000,000 or up approximately 16%. In regards to the market channel growth rate assumptions that this revenue guidance is based on, For the defense market, we are updating the full year growth rate assumptions as a result of our strong Q1 results and current expectations for the remainder of the year. For defense, we now expect revenue growth in the high single digit to low double digit percentage range. This is an increase from our previous guidance of mid to high single digit percentage range.

Speaker 2

We are not updating the full year market channel growth rate assumptions for commercial OEM and commercial aftermarket as underlying market fundamentals have not meaningfully changed. Commercial OEM and commercial aftermarket revenue guidance is still based on our previously issued market channel growth rate assumptions. We expect commercial OEM revenue growth around 20% and commercial aftermarket revenue growth in the mid teens percentage range. The midpoint of our EBITDA as defined guidance is now $3,985,000,000 or up approximately 17% with an expected margin of around 52%. This guidance includes about 100 basis points of margin dilution from our recent CalSpan acquisition.

Speaker 2

We anticipate EBITDA margins will move up throughout the remainder of the year. The midpoint of our adjusted EPS is decreasing versus our prior guide, primarily due to the higher interest expense associated with the incremental debt we took on to fund CPI. The midpoint of adjusted EPS is now expected to be 30 $0.85 are up approximately 19% over prior year. Sarah will discuss in more detail shortly the factors impacting EPS along with some other fiscal 2024 financial assumptions and updates. We believe we are well positioned for the remainder of fiscal 2024.

Speaker 2

We'll likely continue to closely watch how the Aerospace and Capital Markets continue to develop and react accordingly. 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 value drivers, cost structure and operational excellence. Now let me hand it over to Joel Rees, our

Speaker 3

Good morning. I'll start with our typical review of results by key market category. For the remainder of the call, I'll provide commentary on a pro form a basis compared to the prior year period in 2023. That is assuming we own the same mix of businesses in both periods. In the commercial market, which typically makes up close to 65% of our revenue, we will split our discussion into OEM and aftermarket.

Speaker 3

Our total commercial OEM revenue increased approximately 25% in Q1 compared with the prior year period. Bookings in the quarter were strong compared to the same prior year period. Our strong bookings continue to support the commercial OEM guidance of revenue growth around 20% for fiscal 2024. OEM supply chain and labor challenges persist, but appear to be progressing. We continue to be encouraged by the steadily increasing commercial OEM production rates and strong airline demand for new aircraft.

Speaker 3

Supply chains remain the primary bottleneck in this OEM production ramp up. The FAA's recently announced production rate freeze at 38 per month for the Boeing 737 MAX will likely slow the expected MAX ramp and time will tell how this plays out. The commercial OEM guidance given today takes into account an appropriate level of continued risk around Boeing's production build rate. While risks such as this and others remain towards achieving the ramp up across the broader aerospace sector, we are optimistic that our operating units are well positioned to support the higher production targets as they occur. Now moving on to our commercial aftermarket business discussion.

Speaker 3

Total commercial aftermarket revenue increased by approximately 22% compared with the prior year period. Growth in commercial aftermarket revenue was primarily driven by the continued strength in our passenger submarket, which is by far our largest submarket. We also saw good growth in our interior submarket compared to prior year Q1 and bizjet was up slightly year over year as well. These increases were very minimally offset by a very slight decline in our freight submarket driven by the return of belly capacity and consistent with what we discussed on last quarter's earnings call. Commercial aftermarket bookings for this quarter were strong compared to the same prior year period.

Speaker 3

The strong booking levels in commercial aftermarket continue to support our commercial aftermarket guide for revenue growth in the mid teens percent range for fiscal 2024. As a reminder, when forecasting our commercial aftermarket, we always look at a rolling historical 12 month average booking trend, never just the most recent quarter due to lumpiness that we often see in this end market. Turning to broader market dynamics and referencing The most recent IATA traffic data for December. Global revenue passenger miles still remain lower than pre pandemic levels, but only slightly. December 2023 air traffic was about 2.5% below pre pandemic and full 2023 traffic was about 6% below.

Speaker 3

Globally, a return to 2019 air traffic levels is expected in 2024 and IATA currently expects traffic to reach 104% of 2019 levels in 2024. Domestic travel continues to surpass pre pandemic levels. In the most recently reported traffic data for December, global domestic air traffic was up 2% compared to pre pandemic. Domestic air travel in China also continues to improve and was up 8% in December compared to pre pandemic levels. This is a significant improvement from China being down 55% a year ago in December 2022.

Speaker 3

Shifting over to the U. S, domestic air travel for December came in about flat with pre pandemic traffic. International traffic has continued to make steady improvement over the past few months. A quarter ago at the end of September, International travel globally was depressed about 7% compared to pre pandemic levels, but in the most recently reported data for December, International travel was only down about 5%. This is a significant improvement over being down 25% a year ago in December 2022.

Speaker 3

In summary, for the commercial aftermarket, we continue to see strong growth in our passenger and interior submarkets Indicative of the continuing positive trends in the post COVID passenger traffic recovery, our biz jet and freight submarkets are performing in line with underlying markets and also in line with our expectations at this point in the year. 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 28% compared with the prior year period. Q1 defense revenue growth was well distributed across our businesses. However, Bear in mind that the comparable prior year period was an easy comp.

Speaker 3

We would not expect to see defense revenue growth rates at this level Continuing throughout the balance of the year, we expect some moderation here as you can tell from the guidance. Defense bookings are also up significantly this quarter compared to the same prior year period. While the defense revenue growth this quarter was pretty broadly distributed across our customer base, We continue to see improvements in the U. S. Government defense spending outlays during Q1.

Speaker 3

We are hopeful we will continue to see steady improvement, But as we have said many times before, defense sales and bookings can be lumpy. We know the bookings and sales will come, But forecasting them with accuracy and precision is difficult. As Kevin mentioned earlier, we now expect our defense market revenue growth for this year to be in high single digit to low double digit percentage range. This updated guidance for defense primarily reflects the stronger than expected Q1 defense sales as well as the good Q1 bookings. In closing, Q1 was a good start to the fiscal 2024 fiscal year and I was pleased with our operational performance.

Speaker 3

We will remain focused on our consistent operating strategy and servicing the strong demand for our products as we continue throughout the balance of the year. With that, I would like to turn it over to our Chief Financial Officer, Sarah Wynne.

Speaker 4

Thanks, Joel, and good morning, everyone. I'll recap the financial highlights for the Q1 and then provide some more information on the guidance update. 1st on organic growth and liquidity. In the Q1, our organic growth rate was 23.5% and all market channels contributed to this growth as Kevin and Joel have just discussed. On cash and liquidity, free cash flow, which we traditionally define as EBITDA less cash interest payments, CapEx and cash taxes, was roughly $660,000,000 for the quarter.

Speaker 4

This is a higher than average free cash flow conversion for the quarter, primarily due to the timing about interest and tax payments. Cash interest and tax payments will pick up again in the next quarter and for the full fiscal year. Our free cash flow guidance is unchanged. We expect to continue to generate free cash flow of close to $2,000,000,000 in fiscal 'twenty four. Below that free cash flow line, net working capital consumed a smaller amount of cash than in prior years, coming in close to flat.

Speaker 4

For the past 2 years, we saw a large influx of cash into our working capital as our primary commercial end markets experienced strong rebound post COVID. We were obviously very happy to support this increase. Going forward, we expect our annual dollars invested in net working capital to moderate from the elevated levels seen over the prior 2 years, but pinpointing in fact dollar amount of investment for fiscal 2024 is difficult. As you know, the rebound of the OEM market channel does impact our accounts receivable as customers in that bucket typically have slightly longer payment terms. We ended the quarter with approximately $4,100,000,000 of cash on the balance sheet and our net debt to EBITDA ratio was 5 times, down from 5.4 at the end of last quarter when pro form a ed for the $35 dividend.

Speaker 4

As a reminder, we operating in the 5% to 7% net debt EBITDA ratio range. And while we are currently sitting on the low end of this range, our go forward strategy of capital deployment not changed. Our EBITDA to interest expense coverage ratio ended the quarter at 3.3 times on a pro form a basis, which provides us with comfortable cushion versus our target range of 2x to 3x. During the Q1, we went to the market and proactively raised £2,000,000,000 of debt for the acquisition of CPI's Electron Device business, which is still subject to regulatory approval with the rest going towards general corporate purposes. As a result of the additional debt, our interest expense estimate for fiscal 2024 increased by £130,000,000 as you can see in today's updated interest expense guidance.

Speaker 4

Regarding our debt, we expect to continue both proactively and prudently managing our maturity deck stack, which for us means pushing out any near term maturities well in advance of the final maturity date. Our nearest time maturity is now 2026, And we remain approximately 75% hedged on our total $22,000,000,000 gross debt balance through our fiscal 2026. This is achieved through a combination of fixed rate notes, interest rate caps, swaps and collars. This provides us adequate cushion against any rise in rates at least in the immediate term. With regard to guidance, as Kevin mentioned, we increased our midpoint sales and EBITDA by $85,000,000 $45,000,000 respectively, given the strong quarter and current expectations for the year.

Speaker 4

Our EPS guidance is now $30.85 compared to prior guidance of the $31.97 The reduction is due to the additional interest without that it would be $32.57 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 and A or return cash to our shareholders via dividends or share repurchases. With that, I'll turn it back to the operator to kick off the Q and A.

Operator

And our first question comes from David Strauss with Barclays. Your line is open.

Speaker 5

Great. Thanks. Good morning, everyone. Good morning. Kevin, Could you talk about maybe what you saw in terms of the aftermarket growth on a sequential basis Q4 versus Q1?

Speaker 5

And then It looks you have a very tough aftermarket comp in Q2. Any range on kind of how we should calibrate aftermarket growth in Q2?

Speaker 2

I think we're forecasting Mid teens percentage? It might revise up. We'll have to see how the year unfolds. It was a strong quarter in Q1. The bookings are there.

Speaker 2

We saw sequential increase in shipments in Q1 and we anticipate that that will continue.

Speaker 5

Okay. Quick follow-up, is there any has there been any change in the timing around closing on the CPI deal, I think previously you said by the end of Q3, I think now you're saying before the year end, I don't know if there was meaningful change there at all. Thanks.

Speaker 2

Yes. We're still incredibly positive on the CPI acquisition. There's 0 overlap with anything we do. Right now, it's going through the approval process and we're very positive about it happening. It's just difficult to predict timing.

Speaker 2

As you know, things are taking a little bit longer, but, we anticipate this fiscal year.

Speaker 5

Great. Thanks very much.

Operator

Our next question comes from the line of Noah Poponak with Goldman Sachs. Your line is open.

Speaker 6

Hey, good morning, everyone.

Speaker 7

Good morning.

Speaker 6

Maybe you could elaborate on how the M and A pipeline looks and ability or opportunities to pull your capital after CPI because You mentioned being at the low end of the target balance sheet leverage range and You're basically going to generate the CPI cost over the remaining quarters of the year in free cash. So that's not actually going to raise your leverage. So, how are you looking at managing that and how much more opportunity is there to deploy capital in the near term?

Speaker 2

I think we'll look at deploying capital during the fiscal year, probably closer to the end of the fiscal year as we sort out the M and A pipeline. The M and A pipeline is there's a lot going on. There's a lot of targets Much like usual, a ton of names that we didn't see coming and we continue to evaluate. I think The point about TransDigm is we're incredibly disciplined in our M and A. We're not going to acquire something that doesn't match our criteria of highly engineered products in aerospace and with access to the aftermarket.

Speaker 2

I mean, that's we're going to continue to stay disciplined on and it's extremely encouraging that there's so many targets on the list. Now they There's a lot of small and medium sized targets. Those are the easiest ones for us to exercise.

Speaker 6

Okay. In the aerospace aftermarket, has there been any deceleration in the rate of increase in price as broader inflation has decelerated or has that rate of change held in despite that decel?

Speaker 3

There's really been no change to our overall Our philosophy and approach, we continue to look to market base value the product and to offset The inflationary pressures that the sites see, obviously not all operating units see the same level of inflationary pressures. And But that's generally what they're trying to do is to offset that.

Speaker 6

Okay. Is there a window of time here though where the cost side of it is decelerating, but the pricing is not? Or are they pretty marked to each other pretty quickly?

Speaker 3

Yes. I think we they're generally going to be pretty close to one another. Our teams are focused on driving productivity. At the same team, our teams are trying to make sure that we've priced the product appropriately.

Speaker 6

Okay. Appreciate it. Thank you.

Operator

Our next question comes from the line of Robert Spingarn with Melius Research. Your line is open.

Speaker 8

Hi, good morning. Good morning. As a follow-up on that last answer on Noah's question on inflation, we think about commercial OE and defense, which I would think would be different than commercial aftermarket where you can price in real time. How much of that revenue base is tied to long term agreements that may have some stale pricing still to work through and can be renegotiated, let's say, over the next year or 2. So I'm asking is if there's upside in those two groups because of LTAs?

Speaker 2

Yes. I would say the bulk of our OEM business is on LTAs and those continue to roll off and be renegotiated. So that's really a constant thing throughout the space. So yes, there's opportunity to improve clawback inflation that you haven't been able to over and you had to eat for a couple of years. So yes, that is always a possibility.

Speaker 8

Okay. And Kevin, just high level question On your workforce, you guys are just consistently executing the margins Where we would expect or better. But for everyone else in the industry, there are workforce issues and recovering workforce or labor from COVID getting people trained and so on. Is it fair to characterize Those folks is different than TransDigm or are there things that we can't see?

Speaker 2

Yes. I think people There's different business models. I think our ability to pass along inflation means that We ought to be able to respond to labor in the marketplace and make sure that we always have the best people and adequate resources to drive our business. But let's not forget that TransDigm is also an incredible operations excellence machine and we drive productivity every day in our businesses and we're constantly investing in that. Anything else to add to that, Joel?

Speaker 3

Yes. The only thing I'd add to what Kevin said, I mean, fortunately, I think the labor markets continue to improve, which is certainly helpful. And we had some locations where we saw higher turnover a couple of years ago. I think that's really kind of gone back to more normal levels, but we put a lot of time and effort into training our folks. And as Kevin said, we've worked over the last few years to put more and more automation in place, which certainly mitigates what the impact of that is.

Speaker 3

And so I think we're well positioned going forward.

Speaker 8

Thank you both for the color.

Operator

Our next question comes from the line of Louis Raffeta with Wolfe Research. Your line is open.

Speaker 9

Hey, good morning. Thank you. Good morning. So I know within Defense, you said aftermarket growth outpaced OE. Just curious was Like magnitude is different there or just pretty similar?

Speaker 3

Defense aftermarket was up more. It was not significant, but defense aftermarket did outpace defense OEM.

Speaker 9

And was there anything sort of, I want to say one time, but that stood out that that growth? I know you said easy comp to some extent, but anything else in there?

Speaker 3

Yes. So first, there's we just have the normal kind of lumpiness within the Defense sector similar to commercial aftermarket, obviously, as we mentioned, the kind of easier comp, It was pretty broad across our businesses. I mean, the vast majority of our businesses actually saw a pretty good increase year over year for Q1 versus Q1. If I was kind of calling out one business and it wasn't a one time set of work was ArmTec. Our flare countermeasures business had a really solid Q1 shipments, coming certainly in comparison to where they were a year ago at the same time.

Speaker 9

All right. That's great. Thank you.

Operator

Our next question comes from the line of Robert Stallard with Vertical Research. Your line is open.

Speaker 10

Thanks so much. Good morning.

Speaker 9

Good morning.

Speaker 10

It's probably a question for Sarah. On the debt issuance, I was wondering if you could comment on why you did it now, given it could be still some time until the Elektron Devices acquisition closes?

Speaker 4

Yes. I mean, we're always going to be proactive for having ready for pending acquisitions. We want to be opportunistic on that front. And we don't want to be obviously up against any time line if ever the markets weren't open. Okay.

Speaker 10

And then as a follow-up, we're probably in a changing interest rate environment. Rates could be coming down Over the next 12 months, how do you think you're going to be adjusting the balance sheet and the interest rate derivatives you have in place to try and make the most of that?

Speaker 4

Yes. Obviously, we're always looking at the markets and trying to be opportunistic with our debt structure. We do have the benefit of hedges. So from that perspective, we're fortunate they're over 75% hedged. We've got some stuff coming up, and we'll continue to look and be opportunistic as and when we can with our debt going forward.

Speaker 4

Okay.

Speaker 10

Thanks so much.

Operator

Our next question comes from the line of Gautam Khanna with TD Cowen. Your line is open.

Speaker 11

Hey, good morning, guys.

Speaker 2

Good morning.

Speaker 11

I was wondering if you could talk a little bit about the things in the M and A pipeline you mentioned small to midsize. Is there Is it still kind of skewed to hardware oriented stuff or are you also entertaining some of these service assets? And maybe if you could just give us An update on how Calspan has done relative to what you guys were thinking originally, Given

Speaker 12

it's Yes.

Speaker 2

Okay. I'll on the M and A pipeline, small, medium sized businesses, Mostly in hardware, although we're looking also at Some services businesses, if they would meet our criteria, it's not always clear that some of those do. But we're Open as long as it's within aerospace and defense. I don't think we see the need of going outside of aerospace and defense, Not for a while, there's still so many great targets to go after in this business. On CalSpan, I'll let Joel comment.

Speaker 3

Yes. I think we're encouraged by where we're at this point in the integration. We've got our leadership team in place. We've put our business unit team structure in place. We're going through the value generation strategy that we employ.

Speaker 3

And as of right now, I think we're running a bit ahead of the model and we're encouraged by what we're seeing.

Speaker 4

Just as a follow-up in

Speaker 11

the M and A hardware pipeline, is it mostly defense oriented stuff? Is it I mean just is there anything you

Speaker 2

want to add? No, it's actually it has a nice blend of commercial and defense assets. It's not only just defense. It's hard to control. You can't really dictate what pitches will be thrown at you.

Speaker 2

So you just have to react to them when they come along. Right now, we see a nice balance. That isn't always the case, but today it is.

Speaker 11

Okay. And just my last one, in the commercial aero aftermarket, any discernible differences between Growth rates in the to the distribution channel versus direct to customer? Thank you.

Speaker 3

So distribution represents about 20% to 25% of our commercial aftermarket shipments. As we look at it, the point of sale that our distribution partners are seeing in comparable markets is pretty close to one another. There's no significant difference.

Speaker 11

Thank you, guys.

Operator

Our next question comes from the line of Christine Liwag with Morgan Stanley. Your line is open.

Speaker 1

Hey, good morning, everyone.

Speaker 2

Good morning.

Speaker 13

Kevin, another question on the pipeline. You've mentioned the target rich environment and assets are coming up that weren't available before. In the past, you've mentioned that you're open to doing deals that have some industrial exposure. Can you update us in your current thinking? And What proportion maximum industrial would you be willing to entertain at this point based on what's available?

Speaker 2

Yes, interesting question and gets me into speculation. I don't know if there is a certain percentage that would kick a deal out. We want to be in aerospace and defense. If there are non aerospace and defense products or business, That's okay. We don't thumb our nose at it.

Speaker 2

But we look at a business in its totality, can it achieve our 20% plus internal rate of return for that acquisition. Yes, we don't look Scantly at those businesses, but we don't want to go after anything that's industrial only. So I would guess it has to be predominantly aerospace.

Speaker 13

Great. Thanks for the color. And maybe on the aftermarket, if I could have a follow-up question. With customer behavior, I mean, there's clear scarcity of aircraft assets out there. How much of the volume that you're seeing are coming from An ad hoc break and fix type thing versus airlines potentially proactively purchasing product?

Speaker 3

I don't think we have any real meaningful way to understand that. The vast majority of our Commercial aftermarket orders are booked to ship. They come in over the transom. They're typically not advanced bookings and We don't get the color in terms of why they're buying. We try to watch to make sure there's no inventory significant moves, but Hard to get that kind of level of granularity.

Speaker 13

Great. Thank you, guys.

Operator

Our next question comes from the line of Matt Akers with Wells Fargo. Your line is open.

Speaker 7

Hey guys, good morning. Thanks for the question.

Speaker 8

Good morning.

Speaker 9

I guess the M and

Speaker 7

A deals that you've looked at that haven't Close, what's the main thing preventing? Is it the valuation? Is it strategic? Has it been there? Because it seems like you're looking at the deals and you get the balance sheet to do more?

Speaker 2

Yes. It's do they meet our disciplined criteria? We want to see aftermarket content. We want it to be aerospace and defense. We prefer commercial over defense.

Speaker 2

But the biggest reason is whether they really have IP, whether they're highly engineered intellectual property, That's the key. So that's what we look for and that's what we screen against. And when deals fall apart, it's because things aren't as proprietary as we would like them to be and so we walk away from. We're not interested in being in the me too product space like everyone else. I mean, we're not trying to do build the print business.

Speaker 2

We want high IP, high engineering content in aerospace and defense that has access to the aftermarket.

Speaker 7

Got it. Thanks. And then I guess back to your comments on some of the Aerospace OE supply chain issues. Is that More around your supply chain, your suppliers are more just sort of Boeing and Airbus in general slowing down. And is it possible to comment what you're assuming for 737 MAX for this year?

Speaker 3

Yes. So it's not specific for us the comments around the supply chain. I think that's just what we're generally hearing from others. I think our supply chain teams have done a really solid job of working through the challenges that have persisted for the last couple of years. Last year, we were talking about castings and then electronic components.

Speaker 3

Think largely those have gone away. I do think we're in some level of a new normal where there's more kind of issues that pop up randomly In comparison to where we were from a pre pandemic level, I think that too is getting better, but likely that's going to persist for the next couple of years, I don't think any of that's material. I think right now, our assumption is based not so far off of what Boeing's current stated rate is in terms of what the FA's numbers are. We always put a little bit level of conservatism around the number. And I think We think our guidance is pretty well set around what we're hearing Airbus and Boeing are doing.

Speaker 7

Great. Thank you.

Operator

Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is open. Good morning, everyone. Thank you.

Speaker 3

Good morning.

Speaker 1

Good morning. I wanted to ask about margins. First with TALSpan. It looks like for the Q1 you guys had owned it, it was about 20% margins and now you're at 28% for this quarter. You're still guiding to it to be 100 basis points dilutive, which obviously is conservative because it would imply you're going to end the year at 16% margins for that business.

Speaker 1

So I guess What did you guys do to raise margins 700 bps in the last quarter? And where can this business be organically?

Speaker 3

Well, I'm not sure I know where it's going to go long term. Our goal is to implement our value generation strategy. We think it's A good business. We'll continue to work to maximize the value. In terms of any other guidance beyond that, I mean, we we've highlighted, we think it's dilutive obviously at the level that it's at in comparison to overall TransDigm and we'll continue to work to improve the value over a long ownership.

Speaker 1

Okay. And then I wanted to ask about defense aftermarket again or defense just given it's not often you see it outperform commercial aftermarket. You mentioned What percentage of your business is maybe more short cycle weapons oriented? And where do we think about defense relative to commercial OE margins perhaps?

Speaker 3

Defense margins are comparable defense margins are lower than their kind of equivalent commercial markets. We typically offer a discount to the defense world. In terms of weapon systems versus not, I don't have any good detail split for what that looks like. In some ways, as I said, the lumpiness of the orders in the defense world is not So different than the commercial aftermarket and the standpoint that we don't get a lot of visibility of an order coming in. We'll get a solicitation, we work to bond and when outlays are good, that generally helps us out.

Speaker 3

But beyond that, I'm not sure there's any more kind of color I have on that.

Operator

Okay. Thank you. Our next question comes from the line of Ken Herbert with RBC Capital Markets. Your line is open.

Speaker 14

Yes. Hi, good morning. Thank you. Hey, Kevin, in the past, you've talked about the business organically supporting about 100 basis points of margin expansion each year Across the cycle, as we think about maybe aftermarket mixing down over the next couple of years relative to defense or commercial OE And just with where margins are today, is that still the right framework as we think about organically for the business?

Speaker 2

I think it still is. I don't think it's going to change. I know that there's math involved here and you got to work your way through it. But What I always say is 100 to 150 basis points of improvement. And We've been running 150, yes, it may be back down at 100, but it's still, I believe, going to sequentially expand.

Speaker 14

Okay. That's great. And as you look at the business today, just to that point, obviously, you've always run A pretty lean ship and kept costs pretty tight. Operationally, as you look across The business, are there still significant areas where you see opportunities for improvement? Or can execution be maybe a bigger piece of the Q should be maybe a bigger piece of the mix moving forward relative to maybe relative to volume or price?

Speaker 3

Well, for productivity, this is again one of our 3 value generating strategies. Our teams are challenged themselves to work to offset inflation over the entire cost structure of the business. And so automation continues to come down in price, things that we would have looked at 2 3 years ago that didn't make The capability wasn't there. Those come across. We continue to look at opportunities to how we resource materials, if we were possible.

Speaker 3

So I think we continue to believe there's a lot of opportunity for us in productivity. I'm always encouraged when I can see a long term TransDigm business 10, 15, 20 years since we acquired it and they are still achieving as good or better at times level of productivity. Is that partially because things that they looked at before weren't there. We also went a sizable amount of new business. And one of the great things about new business, it continues to give you an opportunity to find new ways to reduce the cost of those new products as well.

Speaker 3

So I think we think all three value drivers are where we want to focus.

Speaker 14

Great. Thanks, Joel.

Operator

Our next question comes from the line of Jason Gursky with Citi. Your line is open.

Speaker 7

Hey, good morning everybody.

Speaker 9

Good morning. Just a

Speaker 15

quick question on working capital Moving forward, I'm just kind of curious, what kind of contractual terms do you have with some of your commercial OEM Customers on the need to hold inventory. One of the things we've got potentially going on here with Boeing is them asking the supply chain to continue producing at rate, but they're going to be producing at something to the master schedule that might be actually above their production rates, and that inventory has got to go somewhere.

Speaker 2

So just kind of curious

Speaker 15

where that inventory might land and from contractual perspective, might some of it land on your balance sheet? Just kind of curious how it all works.

Speaker 4

Yes. I don't think we have any of that for Boeing. It would be small, very noise level from and especially if you're asking from a bigger picture perspective With working capital as a whole, we project future net working capital needs, and I would just model fairly flat for that as a percent of sales as we go forward through the year with that being noise level if anything.

Speaker 15

Right. Okay, that's helpful. And then just a quick follow-up on the aftermarket side and the strong bookings that you saw In the quarter, you suggest it's hard to know exactly where all of that demand is coming from, whether it's break fix or kind of planned stocking by the airlines. But I am kind of curious if you've gotten kind of any feedback from your airline customers on how they're kind of grappling with what's going on with the GTFs and the planned OAGs that we're likely to see here, this calendar year going into 20 24. Is that from your perspective, helping your aftermarket bookings here in the near term, is what we're seeing in the strength that you've seen here recently.

Speaker 15

And Kevin, you mentioned the potential for upward pressure on the guidance for the year. Just kind of curious if that's what's driving that statement that you made there? Thanks.

Speaker 3

Yes. We've tried to take a look at it. We think it probably has a slight tailwind for the business. For a few of our business, it's helping out. Obviously, those platforms that were older planes are flying more.

Speaker 3

This is helpful, but We're also getting fewer hours on the GTF engine. So some other sites that would start to see some benefit of longer flight hours and those are kind of missing out. I think net for net as we've looked We think it's a slight tailwind for the business.

Speaker 7

Okay, great. I'll leave it there.

Operator

Our next question comes from the line of Mariana Perez Mora with Bank of America. Your line is open.

Speaker 16

Thank you very much. Good morning, everyone.

Speaker 2

Good morning.

Speaker 16

My question is, I'd like to tilt the onion a little bit on the commercial aftermarket. On this mid teens guidance that you have, how much of that is driven by volumes? How much is pricing? And in that pricing, how much is like passing through inflation and labor costs and this like supply chain disruption things and how much is actually being able to price this excess demand environment in the aftermarket?

Speaker 2

We don't comment on price and volume and that and split that out. It's kind of difficult for us to assess that anyway. So yes, we don't give that kind of color. For volume, what we can offer is looking at takeoff and landings, RPMs, clearly, Volume is going to continue to grow and expand. And I believe we all gave you in our prepared comments that we think volumes are going to return in 2024 here and we may actually then see growth ahead of where we were pre COVID.

Speaker 2

But we don't get into parsing out how much is price and how much is volume.

Speaker 4

And are

Speaker 16

you able to discuss How open are customers to have price increase conversations at least?

Speaker 2

I think that Our focus on operational excellence and performance means that the pricing part of the conversation is often quite simpler because you can provide products on time to their needs.

Operator

Thank you. And my second question, if

Speaker 16

I may, on M and A. Why are so many M and A deals available right now. Has something changed?

Speaker 2

I don't know if anything's changed. I think it just comes in waves, sort of a sine wave. You have periods of time where it's up and periods of time where it's lower, it's been an encouraging time over the last, I think a year or so we've seen some good deals. Unfortunately, we've seen some things not work out and we have to pass on. But I'm not aware of any outside forces moving more deals to the table.

Speaker 2

It's just the way it is.

Speaker 16

Great. Thanks so much.

Operator

Our next question comes from the line of Peter Arment with Baird. Your line is open.

Speaker 17

Hey, good morning everyone. Nice results. Hey, Kevin, maybe just a quick one on defense. I know it's about 38% of your mix. Do you have much exposure from international defense?

Speaker 17

And if you do just kind of what you're seeing there?

Speaker 2

Yes, we do have international defense exposure. We provides products to our allies and we also have manufacturing facilities in Europe that provide products directly to European defense contractors.

Speaker 17

Any rate of change differences there or just kind of still at normalized rates?

Speaker 2

Have you seen any, Joel?

Speaker 3

I'm not sure there's anything significant versus The U. S. I mean, the U. S. In many cases is buying foreign military and they're supporting the same.

Speaker 3

So it ends up to some level of kind of co mingled and hard to separate One versus the other.

Speaker 2

Clearly, I think international defense is improving. Than the U. S. Rate, I'm skeptical.

Speaker 17

Okay. That's helpful. Joel, and just a quick follow-up when you gave the color on the kind of the MAX rates. And in general, I was wondering if you could provide a little more color like what you're seeing on your suppliers. Is everyone seem to be synced up and just broadly on the OEM kind of Published rates, are you seeing any kind of suppliers that are still behind and this is an opportunity to catch up?

Speaker 3

When You're saying suppliers as in like because we obviously sell to the air framers as

Speaker 2

well as Frontier suppliers? Yes.

Speaker 3

Our suppliers to us. I don't think that there's anything significant. I mean, we're still well as Kevin put in his opening remarks, We're still well below the peak we were at pre COVID. 787, I think, was running at 14 aircraft per month. And so I don't think from that standpoint, our suppliers have that issue.

Speaker 3

I think it's just been very sporadic. They can't get a certain component in. They've got to ramp it up. I don't know that anything specific material, but I think we believe right now we're well positioned for the where we are and can support a higher ramp up rate.

Speaker 17

Appreciate the details. Thanks guys.

Operator

Our next question comes from the line of Michael Syarmoli with Truist Securities. Your line is open.

Speaker 18

Hey, good morning guys. Nice results and thanks for taking the question. Kevin, maybe just back to the Arrow, the commercial aftermarket, anything you could parse out From demand trends or actual booking sales, wide body, narrow body, airframe engine, I know you flagged interiors. Is that maybe a function of just more retrofit activity or any noticeable trends?

Speaker 3

I think on the interior side, we're really just in the early innings of refurbishment. We're starting to see a few of those programs Again, I think we're anticipating seeing more of that likely as we get to the end of this year and into early next a few of them we originally thought might have happened earlier have slid to the right. In terms of passenger, I don't know if we have any specific Data to tell you the single aisle versus widebody, certainly we're encouraged by the continuing improving trends in the international market. So that still lags the single aisle market, but continues to be on a good rate of growth. I don't know that we have any specific data.

Speaker 3

I mean, with the number of part numbers we sell, it's too difficult to try to come back to some specific around single aisle wide body, unfortunately at that level of granularity.

Speaker 18

Got it. And then maybe Kevin, Just one last one on M and A. You keep talking about the small and kind of medium sized pipeline. What is sort of your definition? I mean CPI, I guess, dollars 300,000,000 How big is the sort of the upper range of a medium sized transaction?

Speaker 2

Yes, probably somewhere around $1,000,000,000 plus, but Not $4,000,000,000 that becomes big

Speaker 19

for us.

Speaker 2

So hopefully that gives you some there's no science here.

Speaker 18

Yes. Got it. All right. Perfect. Thanks guys.

Speaker 3

Sure.

Operator

Our next question comes from the line of Gavin Parsons with UBS. Your line is open.

Speaker 12

Thanks guys.

Speaker 9

Yes.

Speaker 12

Maybe on CapEx, what's driving the big step up this year?

Speaker 4

Yes. On the CapEx, obviously, we're always looking to add infrastructure to our OP units and provide cash for productivity improvements, much like what Joel just mentioned with machinery and other efficiencies in the op units to help drive the value drivers. There's nothing specific. There's no big one thing in there. It's just the usual CapEx that we provide to the op units based on their needs and driving the value?

Speaker 2

Yes. Our process, it comes these requests come from the site. So our goal is to keep them fully funded. And if they see great productivity projects, that's where the bulk of our CapEx goes to. But I would also say one thing that's different from years past is we're now doing more solar types of programs that we wouldn't have done in the past.

Speaker 2

They have great payback, but that has been an added need for us on the CapEx side.

Speaker 12

Interesting. Appreciate that detail. And I know a lot of aerospace work needs to be manual, but how much automation do you think you can get in the business over time? I

Speaker 3

don't know that we have any specific number as I kind of highlighted. If you were asking me the same question 5 years ago, I I have a very different answer. I continue to be impressed by the ways that we've been able to incorporate. I was one of our businesses in the UK last month and they've automated painting operations, polishing operations, brazing operations. So I think we continue to be optimistic that As automation costs come down, as the cobots, prices comes down is that it becomes easier and easier for us to incorporate it.

Speaker 3

And our challenges were a low mix sorry, high mix, low volume manufacturer. And so the challenge is to be able to do automation, but be able to do it for many, many part numbers, not just one very small subset of parts. And I we believe there's still a lot of opportunity for that.

Speaker 12

Got it. And I think Noah asked about kind of the price cost Spread, have you guys seen your input costs starting to ease or not yet?

Speaker 3

I think we're still in the early innings for that. Labor costs, I think, are probably starting to as you see in the overall market, but I don't know that there's anything significant at this point. It's really too early in the fiscal year for us to have seen something dramatically different than planned.

Speaker 15

Makes sense. Thank you.

Operator

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

Speaker 19

Thanks very much and good morning everyone.

Speaker 11

Good morning. Good morning. I wanted to ask About,

Speaker 19

I may be misremembering here, but if we go back to sort of the pre COVID days, maybe even pre Esterline days, I think kind of the Cash balance to think about was something in the $750,000,000 range. A lot of stuff has changed since then. I think if we do pro form a for the pending acquisition probably at about $2,000,000,000 right now. How do we think about what's the appropriate cash balance now and going forward?

Speaker 4

Yes. We're not anchored into a specific amount, As you could obviously see, we're happy to keep cash on the balance sheet. And like you pointed out, we would have $2,000,000,000 after the pending CPI acquisition, which is obviously more than we need to run the business, but we're happy to have that cash on hand to support any other opportunities, M and A or any other investments that pop up for us.

Speaker 19

Okay, great. And then maybe just a quick follow-up. I thought that last answer to Gavin's question was interesting. We think about I think when we hit the pandemic and all the rates came down, most of the more labor intensive part of your business is in the commercial OE piece. And so there was probably an expectation that as rates came up, you'd be adding employees.

Speaker 19

And so we're Certainly far from fully back up, but we've kind of come off the bottom. Has the amount of labor that you've added off the bottom, Has it been kind of consistent with what you might have expected, less or more and why?

Speaker 3

I think our teams have worked hard over the last 3, 4 years to continue to find good productivity projects. And so if I I don't have any specific numbers in front of me, but I would think that we're probably trending better than what we would have If we were looking at the same thing 3, 4 years ago, we had some learning curves, I said, with turnover a couple of years ago. But I think the good news is with the lower rates we've had. We've had a good opportunity to get those folks up to speed. So I think we think we're positioned well going forward.

Speaker 19

Okay, very good. Thank you.

Operator

Our next question comes from the line of Scott Digital with Deutsche Bank. Your line is open.

Speaker 12

Hey, good afternoon.

Speaker 2

Good afternoon.

Speaker 12

Joel, is F-thirty five aftermarket a significant portion of defense aftermarket revenue at this point? And then can you comment at all on how quickly that's been growing recently?

Speaker 3

I don't have any specifics around any platform To give you, I think as we said, the defense aftermarket was a good solid quarter for us. I think Considering the number of business it was distributed, I think we saw many, many platforms benefiting from it in the quarter, not just a single one. Certainly, as F-thirty five continues to fly, that's beneficial for us. We're on effectively every platform. And so Certainly, the more things are used, the more that's just good for us in general.

Speaker 12

Okay. And then Sarah, sort of following up on Jason's Can you clarify what the outlook is on working capital this year? It's a pretty big headwind last year. You had a strong Q1 here. So just curious where things go from here on.

Speaker 12

Thanks.

Speaker 4

Yes, you're right. We had an influx of about, I think, it's €500,000,000 last year. So we think we're now in a good position so that going forward, would expect working capital to follow the revenue as a percent of sales, staying fairly flat as the Revenue goes up as a percentage.

Speaker 12

Okay. And then last question, Kevin, it's been a while since the last Investor Day. Any plans for another one sometime soon? Thanks.

Speaker 2

Yes, this summer.

Speaker 4

We expect it.

Speaker 2

Yes, we more than expect it. We're planning on it. So I think it's Not officially announced, but sometime soon, this summer, we will have another one. Stay tuned. It will be announced shortly.

Speaker 12

All right, great. We could finally meet in person. Sounds good.

Speaker 2

That would be nice. You can always come to Cleveland though.

Operator

And our next question comes from the line of Burt Soudin with Stifel. Your line is open.

Speaker 7

Hey, good morning and thank you for the question. I guess, good afternoon now, sorry.

Speaker 2

Yes, it's now afternoon, isn't it? I know.

Speaker 7

Tracking it. So I guess my first question, airlines have been calling out maintenance related expenses as headwinds are trying to get down this year, just Broader unit costs have been inflating there. Are you seeing any impact from competition be it USM or PMA as they seek to do that or is that not really showing up on your radar just given those markets are smaller?

Speaker 3

I don't think we've seen any material change this year. USM is typically not a big factor for us. USM is typically for systems that are going for $25,000 and more, which really is a very, very small percentage of what our products are. And I don't think we've I've heard of any specific kind of changes in the PMA world from what we have seen in the past.

Speaker 7

Got it. Okay. And just as a follow-up, I know cargo is a small part of what you guys do, but it sounded like the increase in belly space had been a little bit of a drag. What's your view toward cargo as you go through the balance of FY 2024? Are you expecting that to improve at all?

Speaker 3

So I'm not sure to give you specifics. I mean, the passenger for us, I mean, belly Cargo obviously was a big thing that popped up during the year. Overall, the last year the traffic within the Cargo market was down a little bit from 2023. I think most folks anticipate that moving back up a little bit in 2024 and we think we're going to follow the underlying market.

Speaker 7

Great. Well, thanks so much for the color.

Operator

I'm showing no further questions at this time. Would now like to turn the conference back to Jamie Seaman for closing remarks.

Speaker 1

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

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

Remove Ads
Powered by Quartr
Earnings Conference Call
Zimmer Biomet Q1 2024
00:00 / 00:00
Remove Ads