Transdigm Group Q3 2022 Earnings Results & Report

Transdigm Group EPS Results

• Actual EPS: $4.36
• Consensus EPS: $3.98
• Beat/Miss: Beat by +$0.38
• One Year Ago EPS: $2.89
• EPS Beat Rate: 7 of last 8 quarters

Transdigm Group Revenue Results

• Actual Revenue: $1.40 billion
• Expected Revenue: $1.41 billion
• Beat/Miss: Missed by -$11.84 million
• YoY Revenue Growth: +14.80%

Transdigm Group (NYSE:TDG) (NYSE: TDG) is a global aerospace manufacturing company that designs, produces and supplies aircraft components, systems and related products. Its portfolio includes mechanical and electrical systems, cockpit and cabin products, airframe components, power and control systems, engine components, and other specialized equipment used in commercial, business and general aviation, and military aircraft.

The company serves aircraft manufacturers, airlines, aircraft operators, maintenance providers and defense customers. In addition to selling products for new aircraft, TransDigm generates significant business through the aftermarket, supplying replacement parts, repair services and related support throughout the operating lives of aircraft.

TransDigm was founded in 1993 and is headquartered in Cleveland, Ohio. The company operates through a portfolio of aerospace businesses and serves customers in North America and international markets. Its operations include proprietary products as well as specialized components used across a range of aircraft platforms.

Transdigm Group Q3 2022 Earnings Call Transcript

Key Takeaways

• TransDigm reported 17% organic net sales growth and a Q3 EBITDA margin of 49.8%, generating over $300 million in operating cash flow and expecting full-year free cash flow above $1 billion.
• Commercial aftermarket revenues rose 44% year-over-year, driven by strong passenger demand domestically and recovering international air travel, with bookings significantly outpacing sales.
• The company deployed $245 million in share repurchases at an average cost of $5.54 per share and announced a special dividend of $18.50 per share, leaving a pro forma cash balance of nearly $3 billion and net debt/EBITDA around 6×.
• TransDigm closed the Dart Aerospace acquisition for $360 million in Q3, expected to add about $30 million to FY22 revenue, and continues to pursue small-to-mid-sized proprietary, aftermarket-focused M&A opportunities.
• Defense revenue growth was revised to flat for fiscal 2022 due to semiconductor supply-chain constraints and delays in U.S. government defense outlays, with overall demand below pre-pandemic levels.

Presentation

[Operator]

Good day, and thank you for standing by. Welcome to the TransDigm Q3 Fiscal 2022 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 hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jaimie Stemen, Director of Investor Relations. Please go ahead.

[Jaimie Stemen, Director of Investor Relations at TransDigm]

Thank you, and welcome to TransDigm's Fiscal 2022 Third Quarter Earnings Conference Call. Presenting on the call this morning are TransDigm's President and Chief Executive Officer, Kevin Stein, Chief Operating Officer, Jorge Valladares, and Chief Financial Officer, Mike Lisman. Please visit our website at transdigm.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 investor section of our website or at sec.gov.

[Jaimie Stemen, Director of Investor Relations at TransDigm]

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

[Kevin Stein, President and CEO at TransDigm]

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 discussion of our outlook for the remainder of fiscal 2022. Then Jorge 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 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.

[Kevin Stein, President and CEO at TransDigm]

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. 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 had another good quarter considering the market environment. We remain encouraged by the positive trends in air traffic and the recovery we continue to see in the commercial aerospace market.

[Kevin Stein, President and CEO at TransDigm]

Our Q3 results show positive growth in comparison to the same period in 2021, as we are lapping the third fiscal quarter of 2021, which was heavily impacted by the pandemic. Although our results have improved over the prior year quarter, they continue to be unfavorably affected in comparison to pre-pandemic levels as the demand for air travel remains depressed. However, we are happy to see the continued steady improvement in global air traffic. Domestic air traffic remains the leader in the air traffic recovery, and international air traffic improved these past few months as more passengers return to long-haul travel. With softened or fully lifted travel restrictions in majority of countries and the summer travel season upon us, passenger travel demand has been strong. China domestic air traffic remains low but is making progress from its most recent sharp drop-off due to strict zero COVID policies limiting travel.

[Kevin Stein, President and CEO at TransDigm]

International traffic in China is finally starting to improve off of COVID lows. In our business, we saw another quarter of robust growth in our commercial aftermarket revenues and bookings. I am very pleased that despite the challenging commercial 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, as well as the careful management of our cost structure and focus on our operating strategy. Additionally, we had good operating cash flow generation in Q3 of over $300 million and closed the quarter with a little over $3.8 billion of cash. We expect to continue generating additional cash in our final quarter of fiscal 2022. Next, an update on our busy quarter for capital allocation activities.

[Kevin Stein, President and CEO at TransDigm]

I am happy to report that during Q3, we opportunistically deployed $245 million of capital via open market repurchases of our common stock. This equates to approximately 444,000 of our shares at an average price of $554 per share. Although the price remained attractive, we were limited this quarter on the quantum we could purchase after the completion of the Dart acquisition. These repurchases are in addition to the approximately 1,000,000 shares we repurchased in our Q2, for a total of over $900 million deployed this year on share repurchases. We view these repurchases like any other capital investment and expect this will meet or exceed our long-term objectives. Also with respect to capital allocation, and as we mentioned in our press release, we've decided to pay a special dividend of $18.50 per share.

[Kevin Stein, President and CEO at TransDigm]

The dividend will be paid on August 26th. Mike will address this and our buybacks more later. As for acquisitions during the quarter, we completed the DART Aerospace acquisition for approximately $360 million in cash. DART is a leading provider of highly engineered unique helicopter solutions that mainly service civilian aircraft and fits well with our proprietary and aftermarket-focused value generation strategy. Although we are not providing formal revenue guidance, we expect the DART acquisition to contribute approximately $30 million to our FY 2022 revenue. Regarding the current M&A pipeline, we are actively looking for M&A opportunities that fit our model. Acquisition opportunities continue, and we have a decent pipeline of possibilities as usual, mostly in the small and midsize range. Although I cannot predict or comment on possible closings, we remain confident that there is a long runway for acquisitions that fit our portfolio.

[Kevin Stein, President and CEO at TransDigm]

In aggregate, we have allocated about $2.4 billion of capital this year for value-generating activities. Pro forma for the special dividend payout in late August, we still expect to have a sizable cash balance of close to $3 billion. These capital allocation actions will still leave us with significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future. Now moving to our outlook for the remainder of 2022. Consistent with our commentary on the last earnings call, at this time we expect to reinitiate guidance on the November 2022 earnings call for our new fiscal year, assuming prevailing conditions continue to evolve. We remain encouraged by the recovery we have seen in our commercial OEM and aftermarket revenues and the strong bookings received for both thus far in fiscal 2022.

[Kevin Stein, President and CEO at TransDigm]

We continue to expect COVID-19 to have an adverse impact on our financial results compared to pre-pandemic levels in our final quarter of fiscal 2022, under the assumption that both our commercial OEM and aftermarket customer demand will remain depressed due to lower worldwide air travel. Although recent positive trends in commercial air traffic could impact us favorably. As for the defense market, we're revising our defense revenue growth to flat for fiscal 2022 versus prior year. We have lowered our defense revenue expectations for fiscal 2022, primarily due to shipment delays as a result of limited supply chain shortages and delays in U.S. government defense spending outlays. As you know, bookings and shipments in this end market can often be quite lumpy. Jorge will provide more color on this topic in his section.

[Kevin Stein, President and CEO at TransDigm]

We expect full-year fiscal 2022 EBITDA margin to now surpass 48% due to the rate of commercial aftermarket recovery. This margin guidance includes the unfavorable headwind of our Cobham acquisition and DART acquisition of about 0.5% this year. We believe we are well positioned for the last quarter of our fiscal 2022. We'll closely watch how the aerospace and capital markets develop and will react accordingly. Mike will provide details on other fiscal 2022 financial assumptions and updates. Let me conclude by stating that I'm pleased with the company's performance in this period of recovery for the commercial aerospace industry. We remain focused on executing our operating strategy and managing our cost structure. Now let me hand it over to Jorge to review our recent performance and a few other items.

[Jorge Valladares, COO at TransDigm]

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 own the same mix of businesses in both periods. The market discussion now 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. 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 23% in Q3 compared with the prior year period. Bookings in the quarter were up significantly compared to the same prior year period, and again, strongly outpaced sales.

[Jorge Valladares, COO at TransDigm]

Sequentially, total commercial OEM sales improved almost 5% compared to Q2. We're encouraged by build rates steadily progressing at the commercial OEMs. However, there have been overall downward revisions in expected future production rates by the commercial OEMs, primarily due to labor shortages and supply chain issues. Our expectation remains that in the short term, the demand for our commercial OEM products will continue to be reduced. Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 44% in Q3 when compared with the prior year period. Growth in commercial aftermarket revenue was primarily driven by robust demand 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 Q3. Sequentially, total commercial aftermarket revenues grew by approximately 7%.

[Jorge Valladares, COO at TransDigm]

Commercial aftermarket bookings were up significantly this quarter compared to the same prior year period, and Q3 bookings strongly outpaced sales. To touch on a few key points of consideration, global revenue passenger miles are still depressed compared to pre-pandemic levels. However, revenue passenger miles have continued to trend upwards over the past months after the slight pullback in January that was primarily due to the Omicron variant. The continued recovery in air travel, especially the progress we have recently seen in international travel, confirms the pent-up demand to travel. Commentary from airlines in recent months has also been positive regarding robust passenger demand. Even with airline ticket prices higher than historical levels, passenger demand has remained strong in the summer season. The recovery in domestic travel continues to be stronger than international travel.

[Jorge Valladares, COO at TransDigm]

In the most recently reported IATA traffic data for June, domestic air traffic was only down 19% compared to pre-pandemic. The US and Europe continue to lead, showing strong demand for domestic travel. The US domestic travel is only off about 8% from pre-pandemic levels. China domestic travel is still down about 50%, but is beginning to show signs of recovery from its most recent steep drop-off in air travel due to its zero COVID policies. The international air traffic recovery has made strides over these past few months. With many of the government-imposed travel restrictions lifted, passengers have been returning to long-haul travel. In March, international travel was still down about 50%, but in the most recently reported IATA traffic data for June, international travel was only down about 35% compared to pre-pandemic levels.

[Jorge Valladares, COO at TransDigm]

For both the US and Europe, international traffic is within 20% or better of pre-pandemic levels. Asia-Pacific international travel is improving, but continues to unfavorably impact the overall inter-international air traffic recovery, with RPKs still down about 70%. Global air cargo demand has tempered over the past few months. As of IATA's most recent data, June was another month of year-over-year decline in air cargo volumes, though they remain above pre-pandemic levels. There's optimism for improvement in air cargo as COVID lockdown measures ease in Asia, particularly in China. Business jet utilization still remains well above pre-pandemic levels. Commentary from business jet OEMs and operators reflects confidence in the demand outlook. It's possible that the pandemic brought a positive structural change to biz jet demand, but that will take some time to prove out.

[Jorge Valladares, COO at TransDigm]

Now let me speak about 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, was about flat in Q3 when compared with the prior year period. As we've said many times, defense sales and bookings can be lumpy. Similar to the first half of 2022, our teams continue to experience delays in fulfilling orders due to supply chain shortages. The supply chain issues mainly surround the lack of availability of electronic components. Our operating units continue to implement mitigating actions to overcome these challenging issues. Also impacting our defense market revenue are the delays in the U.S. government defense spending outlays. There's often a lag between U.S. government defense spending authorizations and outlays, and the lag is hard to predict, but these delays are longer than typical.

[Jorge Valladares, COO at TransDigm]

As Kevin mentioned earlier, and for the reasons I just discussed, we're revising down the expectation for our defense market revenue growth to about flat for fiscal 2022. We were previously expecting low single-digit percentage range growth. I'd like to wrap up by expressing how extremely pleased I am with our strong operational performance this quarter. Our teams have continued to put forth significant efforts in overcoming the negative impacts of the pandemic and supply chain disruptions. We remain focused on our value drivers and executing with operational excellence. With that, I'd like to turn it over to our Chief Financial Officer, Mike Lisman.

[Mike Lisman, CFO at TransDigm]

Morning, everyone. I'm going to quickly hit on some additional financial matters for the quarter and also our expectations for the full fiscal year. First, in regard to profitability for our third quarter, EBITDA as defined of about $696 million for Q3 was up 25% versus prior year Q3. EBITDA as defined margin in the quarter was 49.8%. This represents year-over-year improvement of about 390 basis points. Sequentially, EBITDA as defined margin increased by 210 basis points. Next, a few quick comments on select financial metrics for the quarter and also year.

[Mike Lisman, CFO at TransDigm]

Organic growth was 17% for the quarter, driven by the growth in our commercial OEM and aftermarket end market. On taxes, we still expect our GAAP and cash rates to be in the 21%-23% range and our adjusted tax rate to be in the 24%-26% range for the year. Moving to cash and liquidity. We had another quarter of positive free cash flow. Free cash flow, which we traditionally define at TransDigm as EBITDA as defined, less cash interest payments, CapEx, and cash taxes, was roughly $400 million. For the full fiscal year, we now expect to generate free cash flow in excess of the $1 billion target previously provided.

[Mike Lisman, CFO at TransDigm]

During the quarter, we used $245 million of cash to repurchase shares at a weighted average purchase price of about $554 per share and ended the quarter with $3.8 billion of cash on hand. We view these share repurchases just like any other capital investment, such as the acquisition of a new business, and expect a similar rate of return. With regard to the dividend, the $18.15 per share payment announced this morning represents a gross payout amount of about $1.07 billion. The record date for the dividend is August 19th, and the payout date is expected to be August 26th. Additionally, in the 10-Q that is filed later today, you'll see that our strong sales growth resulted in net working capital being a $119 million use of cash this quarter.

[Mike Lisman, CFO at TransDigm]

As mentioned previously, we have the cash to fund this investment and are glad to see our primary commercial end markets rebounding and therefore driving this need. As we continue to recover from COVID's impact on air travel and rebound to 2019 global activity levels, we'd expect an additional $100 million-$175 million of cash to go back into net working capital. The timeline over which this will happen remains uncertain, but should generally track the recovery. Moving on to leverage levels. Our net debt-to-EBITDA ratio is currently at 6.3x. Pro forma for the dividend, our leverage level will be just over 6.7x net debt to EBITDA.

[Mike Lisman, CFO at TransDigm]

We expect to continue running free cash flow positive during our fourth quarter, and this ratio will therefore come down from the 6.7x level by the end of the fiscal year, barring any additional capital market transactions or shareholder distributions. We are watching the rising interest rate environment closely, and we remain 85% hedged on our total $20 billion gross debt balance through a combination of interest rate caps and swaps through calendar year 2025. This provides us adequate cushion against any rise in rates for the time being. Finally, as Kevin mentioned, we are pleased to have allocated $2.4 billion of capital thus far this year across the range of options available to us, acquisitions, buybacks and dividends.

[Mike Lisman, CFO at TransDigm]

Consistent with our past practices, we'll continue to evaluate this full range of options with regard to all of our future capital deployment actions. The priorities are unchanged. First, reinvesting in our own businesses. Second, acquisitions. Third, returning capital to shareholders via dividends or share repurchases. Finally, paying down debt, which seems unlikely at this time, but remains an option. From an overall cash liquidity and balance sheet standpoint, we believe we'll remain in a strong and good position going forward. With that, I'll turn it back to the operator to kick off the Q&A.

[Operator]

As a reminder, to ask a question, you will need to press star one one on your telephone. Please stand by while we compile the Q&A roster. Our first question comes from David Strauss with Barclays. Your line is now open.

[David Strauss, Managing Director and Senior Analyst at Barclays]

Thanks. Good morning.

[Mike Lisman, CFO at TransDigm]

Good morning.

[Kevin Stein, President and CEO at TransDigm]

Morning.

[David Strauss, Managing Director and Senior Analyst at Barclays]

Kevin, it looks like the air transport aftermarket is now back to around 10% of pre-pandemic levels. Is that about right? When would you expect this to, or your business to get back to pre-pandemic levels at this point?

[Kevin Stein, President and CEO at TransDigm]

Yeah, I think that's directionally accurate. You know, I don't really have a prediction. It depends on flight activity. We continue to follow that closely and think that takeoff and landings are the best indicator for aftermarket activity.

[David Strauss, Managing Director and Senior Analyst at Barclays]

Okay. From a headcount perspective, can you maybe baseline us where you are today, I guess, adjusting for acquisitions, divestitures, you know, what your headcount looks like today relative to pre-pandemic levels as much as you can on an apples-to-apples basis?

[Kevin Stein, President and CEO at TransDigm]

Yeah, I'll take that one. I don't have the exact numbers to pre-pandemic levels accounting for the acquisitions. I'd say we've held on to the bulk of the restructuring that we did as a result of the COVID crisis, and the teams have done a nice job managing the resources.

[David Strauss, Managing Director and Senior Analyst at Barclays]

Okay. Thanks very much.

[Operator]

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

[Ken Herbert, Managing Director at RBC Capital Markets]

Hi, good morning, Kevin and Jorge and Mike.

[Mike Lisman, CFO at TransDigm]

Good morning.

[Kevin Stein, President and CEO at TransDigm]

Morning.

[Ken Herbert, Managing Director at RBC Capital Markets]

Hey. Hey, Kevin, maybe on the commercial transport, commercial aftermarket up 56% in the quarter, can you provide any detail or any further segmentation on that by what you're seeing in the market? And was there any maybe one-time items in terms of shipments to distributors or inventory corrections or anything else in the quarter?

[Kevin Stein, President and CEO at TransDigm]

I'll let Jorge Valladares handle that. I don't think there were any one-time items, though.

[Jorge Valladares, COO at TransDigm]

Yeah. Working backwards, I concur with Kevin. There were no unique one-time items this last quarter that drove any of the performance. As I mentioned, we're seeing strong performance in our passenger sub-market, but I would say all of our aftermarket sub-markets are seeing pretty good strength. We're seeing continued recovery. It's as I mentioned, the domestic markets in the US and Europe, and then the international has been a little bit slower, but we are seeing some recoveries there.

[Ken Herbert, Managing Director at RBC Capital Markets]

Okay, helpful. If I could on that, I know obviously pricing has been a tailwind. With some of the commentary from airlines about maybe some slower capacity growth into next year, just on sort of broader concerns, are you seeing any of that slow down to any incremental pressure on pricing or your ability to get price in the aftermarket?

[Jorge Valladares, COO at TransDigm]

Yeah, I think our pricing philosophy remains unchanged. We look to get some level of real price increase above inflation, and the teams are doing a good job, trying to pass on some of the inflationary costs that we're seeing.

[Ken Herbert, Managing Director at RBC Capital Markets]

Great. All right. Thank you very much.

[Operator]

Thank you. Our next question comes from Noah Poponak with Goldman Sachs. Your line is now open.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Hi, good morning, everyone.

[Jorge Valladares, COO at TransDigm]

Good morning.

[Kevin Stein, President and CEO at TransDigm]

Morning.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

I wondered if you could spend a little more time just diving into the margin performance in the quarter. It stands out. You know, is there anything unusual in there? Can we use that as a starting point sequentially going forward, or is that aggressive? I know you've guided up, but I don't know if that changes soon. Then obviously the price-cost dynamic has been favorable, but also probably doesn't change. Any thoughts on how you progress moving forward from here?

[Kevin Stein, President and CEO at TransDigm]

I think you know we're benefiting tremendously from the mix right now. We have an aftermarket that you know that is expanding, and right now OEM is well behind where we would expect it to be or where it was. You know, there's gonna be a mix blend that has to come back. We'll have to see how the OEMs come up the curve in terms of their build rates. Right now, as Jorge alluded to, we're still seeing limitations in OEM build rate requests for product, even though the order book is building.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Do you have margin seasonality through the year organically if we strip out acquisitions?

[Jorge Valladares, COO at TransDigm]

I'm not sure exactly what you mean by margin seasonality, Noah.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Do you think?

[Jorge Valladares, COO at TransDigm]

I think you know from the past.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Yeah, go ahead.

[Jorge Valladares, COO at TransDigm]

There's a quarterly step-up as you go from Q1 through Q4.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Okay.

[Kevin Stein, President and CEO at TransDigm]

Yeah, Q1 is always.

[Jorge Valladares, COO at TransDigm]

We expect to continue seeing that going forward.

[Kevin Stein, President and CEO at TransDigm]

Yeah, Q1's always a poor quarter, generally speaking, for us. End of year, OEM's focused on inventory and the like. It's always one of our weakest quarters is Q1.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Okay.

[Jorge Valladares, COO at TransDigm]

To go back to one of your original questions, Noah, there were no unusual accounting items or anything else during the quarter. With regard to where we go from here, I think we'll, you know, we'll give the FY 2023 guidance on the November call. At this point, we don't wanna comment on where we could go from here from a margin standpoint until we do that.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Okay. Kevin, could you just spend another minute on the acquisition pipeline and, you know, what's maybe holding things back from closing right now, but what's unusual, when can it change? Just any other color you could give there.

[Kevin Stein, President and CEO at TransDigm]

Yeah, I suspect this is the biggest question. As we, you know, pay a dividend, sometimes people will then reflect that the pipeline may not be full. We believe we have enough cash and access to cash as we look forward that, you know, we can handle the acquisition pipeline that we see coming at us. I always comment on this that it's difficult to predict when things will close. I know the team is very busy. We're looking at a lot of businesses. The unfortunate piece is sometimes in our very disciplined acquisition approach, things fall out and we're not interested in taking flyers on, you know, not great companies. We take our time. We're very disciplined and structured in our approach.

[Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs]

Okay. Thank you.

[Operator]

Thank you. Our next question comes from Robert Spingarn with Melius Research. Your line is now open.

[Robert Spingarn, Managing Director of Aerospace, Defense, and Space Equity Research at Melius Research]

Hey, good morning.

[Jorge Valladares, COO at TransDigm]

Good morning.

[Kevin Stein, President and CEO at TransDigm]

Good morning.

[Robert Spingarn, Managing Director of Aerospace, Defense, and Space Equity Research at Melius Research]

Kevin, in the past, you've talked about commercial OE being a bit more labor-intensive than the aftermarket, and I believe you've been investing in automation. With that activity, if OE build rates get back to pre-COVID levels, could you accommodate that with less labor than you needed pre-COVID, and would OE margins be higher as a result?

[Kevin Stein, President and CEO at TransDigm]

You know, I think we always focus on productivity in this business. We have historically focused on it. It's reasonable to expect that, with years of productivity under our belt since the OEMs were shipping at high volume, that we'd be able to do some things better than we could before. This is always part of our ongoing, you know, productivity ramp as we try to overcome, as you realize, dramatic inflationary pressures that we're seeing really across the board, whether it's labor or materials. There's a lot of inflation pressure on the business. We have a model that allows us and, you know, helps us pass along those inflationary pressures, but productivity is something that we're always laser focused on.

[Kevin Stein, President and CEO at TransDigm]

I believe we will be in a slightly better position, but it is hard to quantify that, and you have to offset that against the inflationary pressures that we're seeing.

[Robert Spingarn, Managing Director of Aerospace, Defense, and Space Equity Research at Melius Research]

Just on that, while you're clearly pricing above inflation, what are you seeing in terms of wage inflation?

[Kevin Stein, President and CEO at TransDigm]

Well, it's different by region. You can't really pick on any. I think, Jorge, what are you seeing in California and some of the regions for direct labor?

[Jorge Valladares, COO at TransDigm]

Yeah. I mean, we've seen it more towards the entry-level labor pool where we've seen regional increases. We've seen anywhere probably between 5%-7%. That might be a little bit of a lagging indicator, right? The inflationary pressures continue in the current job market. A little bit on the technical side as well, probably higher than the entry-level labor side. Again, the teams, as Kevin mentioned, productivity is near and dear to our hearts. They continue to find opportunities to do their best to offset those increases.

[Robert Spingarn, Managing Director of Aerospace, Defense, and Space Equity Research at Melius Research]

Jorge, are you getting the people you need or are you behind?

[Jorge Valladares, COO at TransDigm]

No. So far the teams have been able to support the resource needs. You know, there's some timing, hiring takes a little bit longer. We're not seeing any significant or material impacts due to labor issues.

[Robert Spingarn, Managing Director of Aerospace, Defense, and Space Equity Research at Melius Research]

Okay, great. Thanks so much.

[Jorge Valladares, COO at TransDigm]

Sure.

[Operator]

Thank you. Our next question comes from Robert Stallard with Vertical Research Partners. Your line is now open.

[Robert Stallard, Vertical Research Partners at Vertical Research Partners]

Thanks so much. Good morning.

[Kevin Stein, President and CEO at TransDigm]

Morning.

[Jorge Valladares, COO at TransDigm]

Morning.

[Robert Stallard, Vertical Research Partners at Vertical Research Partners]

Kevin, on the M&A topic again, what's your latest sort of feeling on what the prices are out there? 'Cause we've clearly seen some pretty high multiples being paid, particularly on the aerospace side recently. I was wondering if it can still make things work under your calculations.

[Kevin Stein, President and CEO at TransDigm]

Yeah, we can still make things work. I think some of the prices have come under pressure recently as there's been some corrections. I think we can still make it work in our LBO model that we run through. You know, our goal is, you know, we're not focused on certain products. As long as it sits in the aerospace world, is proprietary, and has aftermarket, you know, we will find a way to drive the returns we look for, and those are the types of businesses we continue to stay very disciplined in our approach to find.

[Robert Stallard, Vertical Research Partners at Vertical Research Partners]

Right. On the supply chain issue, particularly in defense, are you seeing any sign of this getting any better, or in the sort of medium term, should we expect the same remain pretty much the same?

[Jorge Valladares, COO at TransDigm]

I think I'll take that one. I think the situation is somewhat stable but still challenged. That's probably gonna continue for the foreseeable future, you know, primarily on those electronic components, the issues with semiconductors, etc. The teams are doing good jobs trying to mitigate those issues.

[Robert Stallard, Vertical Research Partners at Vertical Research Partners]

That's great. Thank you.

[Operator]

Thank you. Our next question comes from Gautam Khanna with Cowen. Your line is now open.

[Gautam Khanna, Aerospace and Defense Equity Analyst at Cowen]

Yeah. Thank you. Good morning, guys.

[Kevin Stein, President and CEO at TransDigm]

Good morning.

[Jorge Valladares, COO at TransDigm]

Good morning.

[Gautam Khanna, Aerospace and Defense Equity Analyst at Cowen]

Hey, just wanted to ask on defense, following up on Rob's question. Is this, the guidance reduction there, is that a function of bookings or is it supply chain? Is it both? If so, could you parse out how much it was to each? Then just,

[Kevin Stein, President and CEO at TransDigm]

I think there's a little bit of impact. Let me, before you move on, there's a little bit of impact to both. You know, in our minds, we're not a bellwether of the defense industry. We follow what everyone else sees, and we're seeing, you know, a larger slowdown in defense outlays and a slowdown in the defense industry. That's. We just react to what we see. It's not necessarily a bookings problem, it's when are things due and when do they want product.

[Gautam Khanna, Aerospace and Defense Equity Analyst at Cowen]

Okay. Any chance you can quantify, you know, how much the supply chain has dragged your ability to deliver? You know, if there's any line of sight to improvement there?

[Kevin Stein, President and CEO at TransDigm]

I don't think it's a major driver, because we find ways to work around it. I'm not necessarily seeing it as a drag on our business. I see it as a drag on the defense industry as a whole, and that's slowing down. It's hard for me to put a quantum on that.

[Gautam Khanna, Aerospace and Defense Equity Analyst at Cowen]

Fair enough. Last question, just by region in the aftermarket, any discernible differences from where you sit? I don't know if China's getting better. Was it particularly soft in the quarter? Anything you could speak regionally on aftermarket?

[Jorge Valladares, COO at TransDigm]

Yeah. I think as you know, we don't track the aftermarket specific by region. I think generally we're seeing what some of the larger macro level trends with the U.S. and Europe domestic travel.

[Jorge Valladares, COO at TransDigm]

Being stronger, and international travel showing a little bit of recovery. Obviously, Asia seems to be the laggard right now in terms of international travel. We don't track specific regional activity.

[Gautam Khanna, Aerospace and Defense Equity Analyst at Cowen]

Thank you.

[Kevin Stein, President and CEO at TransDigm]

Sure.

[Operator]

Thank you. Our next question comes from Peter Arment with Baird. Your line is now open.

[Peter Arment, Senior Research Analyst at Baird]

Yeah, thanks, Kevin, Mike, and Jorge. Thanks so much for that.

[Kevin Stein, President and CEO at TransDigm]

Morning. Good morning.

[Peter Arment, Senior Research Analyst at Baird]

Morning. Hey, Kevin, or there was some commentary around, you know, biz jets being back to kind of, you know, their post. They're well above pre-pandemic levels, and there's a structural shift. Maybe you could just talk about, you know, what are you seeing there in the ability to take rates up even further on the biz jet side. Thanks.

[Kevin Stein, President and CEO at TransDigm]

I think there's room for them to take rates up as their order book seems to support it. This is a special time for the business jet world market. It is, you know, very busy. We're seeing it both on OEM and aftermarket that this is a much busier time for business jet market. Jorge, anything else to add on that?

[Jorge Valladares, COO at TransDigm]

Yeah, I think and the only thing I'd add is, you know, we're seeing some good performance on the larger cabins. You know, there's obviously increased demand for the larger cabin aircraft.

[Peter Arment, Senior Research Analyst at Baird]

Okay. Related to aftermarkets. I know you don't break it out versus narrow body versus wide body, but as wide body starts to reengage, you know, is it still a smaller portion just compared to how levered you are in narrow body? How should we think about the wide body recovery there? Thanks.

[Jorge Valladares, COO at TransDigm]

I think generally we're market-weighted based on the fleet between narrow body and wide body. You know, you might have some noise on any particular operating unit, but generally, we seem to be market-weighted between the two.

[Kevin Stein, President and CEO at TransDigm]

We don't care if it's narrow body or wide body. We are profitable with both segments.

[Peter Arment, Senior Research Analyst at Baird]

Appreciate the color. Thanks, guys.

[Operator]

Thank you. Our next question comes from Seth Seifman with JPMorgan. Your line is now open.

[Seth Seifman, Executive Director at JPMorgan]

Hey, thanks very much. Good morning, everyone.

[Kevin Stein, President and CEO at TransDigm]

Morning. Morning.

[Seth Seifman, Executive Director at JPMorgan]

Morning. I think I asked you this probably about a year ago, or so, but I was wondering, you know, how you know you're thinking about M&A in the current antitrust landscape. You know, now we see reports that you know the FTC is poking around a deal that Northrop Grumman closed four years ago, that you know the Department of Justice is trying to prevent, you know, Booz Allen Hamilton from doing a relatively small $400 million deal. You know, as a company that's kind of traditionally been focused on M&A, you know, how do you think about what may be changing in the landscape?

[Kevin Stein, President and CEO at TransDigm]

Well, you know, we're still active in M&A. It's certainly something that we're cognizant of. You know, I tend not to speculate on things that haven't impacted us or provide that kind of color. It is something that we're cognizant of. We're watching it closely. You know, that's probably all I can say on it. It hasn't derailed our activity.

[Seth Seifman, Executive Director at JPMorgan]

Got it. No, that's helpful. Thanks. Just as a follow-up also on capital deployment, I think you mentioned that the DART deal limited the potential for share repurchases this quarter. I guess, can you give us an update with this dividend? You know, first of all, you know, were you limited on the size of the dividend that you could pay out? And second of all, you know, with this move to 6.7 pro forma, probably something more like 6.3 by the end of the fiscal year, you know, what are the options for capital deployment? Is it pretty much M&A at this point? Or, you know, in the first half of 2023, if you wanted to buy stock or, you know, pay another dividend, is that an option?

[Mike Lisman, CFO at TransDigm]

Well, the priorities are unchanged, as we mentioned in the comments, just in terms of what we'd like to spend our capital on with acquisitions coming ahead of dividends and share repurchases. That's the same as it has always been. On the dividend, we do have a restricted payments basket cap in our credit agreement that I think you guys are familiar with. That did play into our thinking on the side there, but we should nicely continue to tick down here over the course of the fourth quarter, and we'll end the year down closer to where we ended this quarter. We'll have more than enough firepower to go do M&A deals and, you know, if things don't materialize there, pay dividends or repurchase shares.

[Mike Lisman, CFO at TransDigm]

We continuously evaluate all those options every month, every quarter to decide what the best use of capital is for us.

[Seth Seifman, Executive Director at JPMorgan]

Great. Thanks very much.

[Operator]

Thank you. Our next question comes from Kristine Liwag with Morgan Stanley. Your line is now open.

[Kristine Liwag, Head of Aerospace and Defense Equity Research at Morgan Stanley]

Hey, good morning, guys.

[Kevin Stein, President and CEO at TransDigm]

Good morning.

[Jorge Valladares, COO at TransDigm]

Morning.

[Kristine Liwag, Head of Aerospace and Defense Equity Research at Morgan Stanley]

You know, Kevin, Jorge, with the tightness of the supply chain breadth of the TransDigm portfolio, are there opportunities for you to step in some struggling suppliers and gain additional market share?

[Jorge Valladares, COO at TransDigm]

Yeah. I mean, I think our teams are always looking, you know, for good new business opportunities to improve their portfolio in products. I think the teams are very engaged with our airline customers as well as the OEMs. You know, they've done a nice job navigating the current supply chain issues, and hopefully we'll get some opportunities. I think that's part of our standard focus on new business and profitable new business.

[Kristine Liwag, Head of Aerospace and Defense Equity Research at Morgan Stanley]

I see. Maybe following up on Noah's question earlier on margins. I mean, margins continue to trend up, and you're pretty much just shy of 50% in the quarter. With mix getting better or, you know, as OEM volumes shift to the right and aftermarket still got a ways to go to get to pre-COVID levels, I mean, what do you need to see to see margins step up and stay at 50% and above sustainably?

[Mike Lisman, CFO at TransDigm]

I think.

[Kevin Stein, President and CEO at TransDigm]

Yeah, go ahead, Mike.

[Mike Lisman, CFO at TransDigm]

I think it's hard to say where margins go from here, just given the uncertainty in the market and the way the mix plays out going forward on a quarter-by-quarter basis. We're hesitant to give any guidance on where we go going forward in this environment. I think we'll give just some more in terms of expectations are there for our next fiscal year on the November call when we give the formal guidance.

[Kevin Stein, President and CEO at TransDigm]

Yeah. Guidance comes on when we review next call, as Mike said. Let's keep in mind that there is a favorable mix environment that we're experiencing right now. Until OEM shipments come back, you know, you'll see some you know balancing higher margins that you know will come back the other way when OEMs ship more. We just have to know that that's going to happen.

[Kristine Liwag, Head of Aerospace and Defense Equity Research at Morgan Stanley]

Great. Thanks, guys.

[Operator]

Thank you. Our next question comes from Peter Skibitski with Alembic Global. Your line is now open.

[Peter Skibitski, Director of Aerospace and Defense Equity Research at Alembic Global]

Hey, good morning, everyone. Just one last for me on the defense side. Kevin, I'm wondering, you know, if all of this surge in European defense spending does come to pass, you know, maybe in the next couple of years, is that something you guys expect to kind of directly benefit from? Or on the defense side, are you a bit more, you know, or generally speaking, are you much more domestically exposed, you know, versus internationally?

[Kevin Stein, President and CEO at TransDigm]

Yeah. We're nicely exposed to international defense as well. I think some of this business you might expect would come our way at some point, but it's difficult to predict or understand. I think we all have to recognize that some of this production will happen locally in or within the European Union, possibly. We do have production there, so we will be part of it. We should all keep that in mind, that some of this may be domestic consumption as well as international orders. We would expect that this is a favorable environment for TransDigm as we look forward. The degree of favorability, well, we'll have to see.

[Peter Skibitski, Director of Aerospace and Defense Equity Research at Alembic Global]

Thank you.

[Kevin Stein, President and CEO at TransDigm]

I think there's also concern whether some of this additional spending maybe loses steam if social issues, you know, overcome the military desires right now. We'll have to see how this all unpacks in the future.

[Peter Skibitski, Director of Aerospace and Defense Equity Research at Alembic Global]

Yeah, makes sense. Thank you.

[Operator]

Thank you. Our next question comes from Michael Ciarmoli with Truist Securities. Your line is now open.

[Michael Ciarmoli, Senior Research Analyst for Aerospace and Defense at Truist Securities]

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

[Jorge Valladares, COO at TransDigm]

Sure.

[Michael Ciarmoli, Senior Research Analyst for Aerospace and Defense at Truist Securities]

Just to stay on defense, are you guys seeing any noticeable difference between aftermarket or OEM? I'm assuming it's probably your Data Device Corporation that's probably seeing the outsized impact of kind of the semiconductor shortages. Any color there?

[Jorge Valladares, COO at TransDigm]

Yeah. I think the defense aftermarket is hanging in there a little bit better than the defense OEMs. Some of that could just be timing of the outlays, as we noted. In terms of the electronic components, you know, I think it's fair to look across the portfolio, and those businesses that are more electronics-based, naturally are seeing more of that impact.

[Michael Ciarmoli, Senior Research Analyst for Aerospace and Defense at Truist Securities]

Okay. I know you're not gonna, you know, talk to 2023 yet, but assuming we get some level of supply chain improvement, I mean, you're gonna start the year with some pretty easy defense comps. Do you think supply chain, you know, kinda is a headwind in first half of 2023, or do you think we can get some nice growth there just based off the comps and maybe some alleviation of the tightness we're seeing?

[Jorge Valladares, COO at TransDigm]

Yeah. I don't think we're in a position to comment on the FY 2023 guidance or any specific comparisons, as Mike and Kevin have mentioned. I think the supply chain continues to be strained. We don't see this going away anytime soon or overnight.

[Michael Ciarmoli, Senior Research Analyst for Aerospace and Defense at Truist Securities]

Okay. Perfect. Thanks, guys.

[Jorge Valladares, COO at TransDigm]

Sure.

[Operator]

Thank you. Our next question comes from Nicholas Zhang with Credit Suisse. Your line is now open.

[Nicholas Zhang, Equity Research Analyst at Credit Suisse]

Hi, folks. Can you guys hear me all right?

[Jorge Valladares, COO at TransDigm]

Yes.

[Kevin Stein, President and CEO at TransDigm]

Yes.

[Nicholas Zhang, Equity Research Analyst at Credit Suisse]

Hi. You're seeing strong recovery in commercial aftermarket. You're seeing some supply chain issues in defense, and you're also seeing, like, order book buildup. What does expansion of existing operations look like? Will there be more CapEx going forward?

[Kevin Stein, President and CEO at TransDigm]

I'll comment on CapEx. I think, you know, there's always opportunity for internal investment in our businesses, and we're constantly looking for those. You know, we are looking at, you know, some selective additional investment in some of our businesses. But again, these things all pay back. We have the same payback standards as before. Maybe there'll be some selective, but I don't see any major trend of additional spending.

[Jorge Valladares, COO at TransDigm]

Yeah. I think in general, the operating units, you know, come to us with different ideas, and they've been very focused in automation over the last 2-3 years. We don't expect any significant shift in the overall CapEx that we've traditionally run at. In terms of capacity, we're looking to leverage some of the restructuring activities that we did over the past couple of years and the process improvements to support additional demand. That's something that each team looks at individually and something that we're constantly talking about in this environment.

[Kevin Stein, President and CEO at TransDigm]

I think one area that we are doing some selective investment is, you know, solar at some of our facilities help with our greenhouse gas footprint. We are looking for investments of that nature as well, and that's something that we are spending a little more money on as those opportunities now have reasonable payback across our businesses.

[Nicholas Zhang, Equity Research Analyst at Credit Suisse]

Thank you very much.

[Jorge Valladares, COO at TransDigm]

Take care.

[Operator]

Thank you. I would now like to turn the conference back to Jaimie Stemen for closing remarks.

[Jaimie Stemen, Director of Investor Relations at TransDigm]

Thank you all for joining us today. This concludes today's 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.

Participants

Executives

• Jorge Valladares, COO
• Kevin Stein, President and CEO

Analysts

• David Strauss, Managing Director and Senior Analyst at Barclays
• Gautam Khanna, Aerospace and Defense Equity Analyst at Cowen
• Jaimie Stemen, Director of Investor Relations at TransDigm
• Ken Herbert, Managing Director at RBC Capital Markets
• Kristine Liwag, Head of Aerospace and Defense Equity Research at Morgan Stanley
• Michael Ciarmoli, Senior Research Analyst for Aerospace and Defense at Truist Securities
• Mike Lisman, CFO at TransDigm
• Nicholas Zhang, Equity Research Analyst at Credit Suisse
• Noah Poponak, Managing Director of Aerospace ad Defense Equity Research at Goldman Sachs
• Peter Arment, Senior Research Analyst at Baird
• Peter Skibitski, Director of Aerospace and Defense Equity Research at Alembic Global
• Robert Spingarn, Managing Director of Aerospace, Defense, and Space Equity Research at Melius Research
• Robert Stallard, Vertical Research Partners at Vertical Research Partners
• Seth Seifman, Executive Director at JPMorgan