TransDigm Group Incorporated is hosting a Q3 2023 Earnings Conference Call. Jaimie Stemen welcomed participants and presented on the call, and other presenters included Kevin Stein, Joel Reiss, Sarah Wynne, and Mike Lisman. The company reminded participants that statements made during the call are forward-looking and referred to non-GAAP financial measures. Kevin Stein then began the call.

TransDigm announced three organizational changes this quarter, including the retirement of Jorge Valladares and his subsequent addition to the Board of Directors. Mike Lisman and Joel Reiss have assumed the roles of co-COO's, and Sarah Wynne has taken on the role of CFO. All three have been long-time employees of TransDigm and have had various roles within the company.

TransDigm promotes long-tenured employees internally, Mike, Joel and Sarah, to executive roles in order to perpetuate the company's unique culture. TransDigm is unique in the industry for its consistent strategy and focus on intrinsic shareholder value creation. This is achieved through 90% of net sales coming from proprietary products, aftermarket revenues providing stability in downturns, a value-based operating methodology, decentralized organizational structure, unique compensation system, and capital structure and allocations.

In Q3, total revenue and bookings for all three major market channels (Commercial OEM, Commercial Aftermarket, and Defense) were strong, and EBITDA margin improved to 52.5%. Operating cash flow was over $400 million and the company ended the quarter with $3.1 billion of cash. The company is actively looking for M&A opportunities in the small and mid-sized range over the next 12 to 18 months.

TransDigm is confident in their ability to acquire businesses that fit their portfolio, and have maintained their capital allocation priorities of reinvesting in their business, disciplined M&A, returning capital to shareholders, and possibly paying down debt. They have increased their guidance for sales and EBITDA for the fiscal year 2023, and are updating their growth rate assumptions for the commercial aftermarket and defense market based on their strong third quarter results.

The company has increased its revenue growth guidance for commercial aftermarket and defense to the low 30% and mid to high single digit percentage range, respectively. Additionally, it expects commercial OEM revenue growth in the 20-25% range. The midpoint of the EBITDA as defined guidance has increased to $3.365 billion, with an expected margin of 51.3%. The midpoint of the adjusted EPS is expected to be $25.15, an increase of 47%. The company is monitoring the aerospace and capital markets closely and will react accordingly.

Kevin concluded his remarks with a positive outlook on the company's performance this quarter and throughout the recovery of the commercial aerospace industry. Joel then discussed the company's results by key market category in comparison to the prior year period. Total commercial OEM revenue increased 25% in Q3 compared to the prior year, while total commercial aftermarket revenue increased 32%. All commercial aftermarket sub markets saw significant growth compared to the prior year period. The company is optimistic about the higher production targets and is cautiously optimistic about the broader aerospace sector.

Commercial aftermarket bookings for this quarter increased by 2% compared to the same period last year. Global revenue passenger miles remain lower than pre-pandemic levels, but there has been steady recovery momentum with IATA predicting that by 2024, air traffic will return to 2019 levels. Domestic air traffic in China has improved significantly, being up 15% in June compared to pre-pandemic levels. U.S. domestic air travel is slightly above pre-pandemic levels and international traffic has made strides, being down 12% in June compared to pre-pandemic levels. North American international travel is now 2% above pre-pandemic levels, while Europe is within 10%. Asia Pacific international travel is still down 29%, but should continue to improve.

Air cargo volumes are lower than pre-pandemic levels, but the contraction is moderating. Business jet utilization is below pre-pandemic highs, but still above pre-pandemic levels. Defense market revenue grew by 17% in Q3 compared to the prior year period and bookings are up significantly. The acquisition of CalSpan Corporation was completed in May for $725 million in cash.

CalSpan has established positions in the aerospace and defense development and testing services, with a state-of-the-art transonic wind tunnel. The acquisition integration is progressing well and Kevin McHenry was recently promoted to the Executive Vice President role. Joel concluded by expressing his satisfaction with the operational performance in the third quarter of fiscal 2023 and Sarah Wynne then took over to discuss organic growth and liquidity.

The company reported a 20.7% organic growth rate in the third quarter, and generated $540 million in free cash flow. Net debt to EBITDA was 5.3 times, and cash interest covered ratio was 3 times. The company also refinanced $8 billion of their nearest term maturities due in 2025 out to 2028, and their nearest term maturity is now 2026, with 75% of their total debt balance fixed or hedged through fiscal 2026.

Kevin Stein commented on their M&A pipeline, saying that they are looking for potential targets and have a slightly stronger than typical pipeline over the next 12-18 months. He also mentioned that they have a sizable cash balance of close to $3.1 billion, and all three capital allocation options, such as significant acquisitions, share buybacks and dividends, remain on the table.

Kevin Stein and Joel Reiss answer a question from Kristine Liwag about the aftermarket parts of the business. They explain that the book-to-bill rate for the company is still positive and that there is strength in OEM and defense. They also mention that the rate of expansion of the order book has slowed a bit, but it is still positive. They do not have the specific data around the MRO and what implications that may have for the aftermarket parts.

Kevin Stein commented on the margins in the quarter, which were strong despite the inclusion of CalSpan. He mentioned that the aftermarket is more profitable and that their goal in pricing is to pass along inflation. He also mentioned that they forecast conservatively for the future and that the margins may go down a 100 basis points sequentially into 4Q.

Kevin Stein and Sarah Wynne discussed the potential tax rate for the next year and the progress of the business, which was aided by aftermarket growth that has exceeded initial expectations. They plan to give guidance on the interest and tax rates for the upcoming year in the next quarter.

Kevin Stein and Joel Reiss from an unknown company discussed the company's fiscal year '23 and the unexpected upside from the Chinese market. They also discussed the potential headwinds in '24 due to the increased activity in '23 and the fact that global air traffic is still below pre-pandemic levels. They also mentioned that the M&A pipeline is looking interesting.

Robert Spingarn asked Kevin Stein and Joel Reiss about how they could mitigate the potential headwind to margins from OEMix increasing and OE growth overtaking aftermarket growth. Kevin Stein responded that they could do this through productivity and pricing on the aftermarket side.

Kevin Stein and Joel Reiss discussed the challenges of driving cost improvements and growth in the aftermarket. They noted that the OEM growth is slower, but the market conditions are favorable for the aftermarket. Joel Reiss mentioned that the interior side of the business is seeing a positive trend, with repair driving the increase. Kevin Stein also noted that aftermarket volumes are still 10-15% light.

Kevin Stein congratulated everyone on their promotions and retirements, to which Joel Reiss thanked him for the recognition. Jason Gursky then asked how the situation at Pratt with the GTF engines would impact TransDigm. Joel Reiss responded that they do not think it will have any significant change.

In this paragraph, Kevin Stein and Joel Reiss discuss the book to bill ratio, defense outlays, and the commercial aftermarket bookings. They note that bookings were up across the company for aftermarket, but slightly off year-to-date. They also mention that defense outlays are still a bit slow in terms of solicitations converting into orders, but that bookings were stronger than shipments, suggesting some runway ahead.

Kevin Stein of TransDigm states that they look for businesses that can generate a 20% return and they usually don't seek out "fixer-uppers". They stay disciplined in their approach and usually do one to two deals a year. Ron Epstein from Bank of America asked if they need to open up their aperture and Stein says that there is still plenty of activity in the aerospace world and they need to stay disciplined.

Kevin Stein and Sarah Wynne discussed their capital deployment plans, with a focus on small and midsize M&A opportunities. They plan to evaluate their options throughout the year, and remain disciplined in their approach. They also mentioned their goal of driving up gross margins.

Kevin Stein answered a question about aftermarket revenues, which have been up 20% the past couple of quarters despite business jet flight hours in the U.S. remaining flat. He attributed this to the timing of bookings and shipments. He also mentioned that EBITDA margins have not yet peaked and there is still room to grow.

Kevin Stein answers Gautam Khanna's question about whether there is a discernible difference in demand patterns through their distribution channels versus direct, and how shortening lead times may have impacted ordering patterns by customers. He states that there is no significant change in demand patterns, and the recovery in the aftermarket has been supported by investments in inventory. Additionally, lead times are set by each operating unit and may not be the same.

TransDigm recently closed on an acquisition and is looking to leverage a three-pronged approach of value-based pricing, cost structure management, and innovative solutions. They believe Calspan will deliver a return of 20% or more. Sheila Kahyaoglu asked if there were any negative signs in the aftermarket, such as inflation, cooling, cargo weakness, or yield softness from low cost carriers.

Kevin Stein and Joel Reiss discussed the cargo and business jets aftermarket, and how the increased belly capacity has impacted yields. Sheila Kahyaoglu asked about EBITDA margins, which had expanded despite Calspan being only owned for part of the quarter. Stein attributed the margin expansion to strong performance in the aftermarket and OEM side of the house. The conference was then concluded by Jaimie Stemen.

This summary was generated with AI and may contain some inaccuracies.