Transdigm Group Incorporated (TDG) — Q4 2019 Earnings Call Transcript

Thank you and welcome to TransDigm's fiscal 2019 fourth quarter earnings conference call. Presenting this morning are TransDigm's Executive Chairman, Nick Howley; President and Chief Executive Officer, Kevin Stein; 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, we'd 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. We'd 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'll now turn the call over to Nick.

Good morning and thanks for calling in. Today, as usual, I'll start with some summary comments on our consistent business strategy, a few comments on the operating performance and outlook, and capital allocation. To reiterate, we're unique in the industry due to both our consistency and our ability to create intrinsic shareholder value through all phases of the aerospace cycle. To summarize some of the reasons why we believe this, about 90% of our net sales are generated by proprietary products and over three-quarters of our net sales come from products for which we believe we are the sole source provider. Most of our EBITDA comes from aftermarket revenues, which typically have significantly higher margins and provide relative stability in downturns. Our long-standing goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we have to stay focused on both the details of value creation as well as the careful allocation of our capital. We follow a consistent long-term strategy. Specifically, we own and operate proprietary aerospace businesses with significant aftermarket content. Second, we utilize a simple, well-proven, value-based operating methodology. Third, we have a decentralized organizational structure and a unique compensation system that closely aligns our management team with the shareholders' interests. Fourth, we acquire businesses that fit our strategy and we see a clear, simple path to private equity-like returns. Lastly, our capital structure and our allocations are a key part of our value creation methodology. As you saw from our press release, we had a solid operating performance in fiscal year 2019, where the revenue is up 37% and EBITDA As Defined is up about 29% on a reported basis. Organically, our revenue was up almost 11% and EBITDA As Defined was up 14%. Including the dividends paid in August, our shareholders made about a 48% return in the last fiscal year, a pretty good year. Far and away, the largest portion of our business, our worldwide commercial aerospace markets, were strong in fiscal year 2019. The smaller worldwide defense segment also did well. The TransDigm legacy businesses performed well. The Esterline acquired businesses continue to exceed our acquisition model with a Q4 EBITDA As Defined margin of over 30%. In 2020, we will include Esterline in the core businesses and no longer break it out separately. Fiscal year 2020 looks like another good year for TransDigm. Revenue and EBITDA As Defined are both estimated to be up nicely. All our market segments appear to be in pretty good shape. There are some potential clouds on the horizon in the commercial aerospace market, but we're watching this closely and we're prepared to react quickly if required. Kevin will discuss 2019 and 2020 in significant more detail. With respect to M&A and capital allocation, as previously announced, we executed agreements to sell both the Souriau business for about $920 million and the EIT group of businesses for about $190 million. We closed the EIT deal and received the cash in September. We still hope to close the Souriau divestiture by the end of our fiscal first quarter 2020. We may still sell some smaller businesses with less proprietary aerospace and aftermarket content, but if we do so, at least as of today, I don't think they will be significant in size. We also completed a roughly $2.6 billion financing recently. About $1.5 billion is for general corporate purposes and the balance is used to refinance and extend the payments on some other debt. We wanted to take advantage of an accommodating credit market and attractive rates. With respect to capital allocation, we paid a $30 billion dividend in Q4 of 2019. We will review our capital allocation situation over the quarter and see where we stand towards the end of the calendar year. Absent any new capital market activity and assuming our recent divestiture closes in a timely fashion, we'd expect to have almost $4 billion of cash at the end of Q1 2020. That's on or about December 31, 2019. We also have a significant additional borrowing capacity under our credit line and our credit agreement. We have substantial liquidity and the financial flexibility to deal with any currently anticipated capital deployment, allocation, or other opportunities that may arise in the readily foreseeable future. We continue to actively evaluate and seek M&A opportunities. We have a decent pipeline of possibilities, as usual mostly in the small and mid-sized. I cannot predict or comment on possible closings, but as I said before, we are working steadily at M&A and we're still open for business. Now, let me hand it over to Kevin to review our 2019 performance, 2020 outlook, and some other items.

Thanks, Nick. Today, I will review our results by key markets and discuss the profitability of the business for the quarter, provide fiscal 2020 guidance, and then cover some other operational items. As you've seen, we had a strong fourth quarter, concluding another very successful year. Mike will provide more financial details. As Nick mentioned, our full year revenue and EBITDA were significantly higher than last year, partly due to above-average organic growth and continued acquisition integration and performance. Now, let's look at our revenues by market category. For the rest of the call, I will provide commentary on a pro forma basis compared to the same period in 2018, assuming we owned the same mix of businesses in both years. Please note that this market analysis section excludes Esterline for fiscal 2019. However, we will start including the former Esterline businesses in our market analysis for fiscal 2020. In the commercial market, which accounts for nearly 70% of our revenue, we will discuss both OEM and aftermarket. Our commercial OEM market revenue saw an increase of approximately 11% in both Q4 and for the full year fiscal 2019 compared to the prior year. This OEM revenue growth exceeded our last guidance expectation of mid- to high single-digit growth. This growth occurred despite a minor headwind from the impact of the 737 MAX grounding, a situation we are closely monitoring. Now, turning to our commercial aftermarket business. Total commercial aftermarket revenues grew by 9% over the previous year's quarter, with total fiscal 2019 revenue increasing by about 8%, aligning with our guidance expectations of high single-digit growth. During the quarter, growth in the commercial transport passenger and freight markets was slightly offset by a decline in the interior submarket. Notable successes in the commercial aftermarket include repairs and retrofits for Telair International on Boeing 747 freighters and retrofit igniters for G650 business jets from Champion. Overall, commercial transport fundamentals remain relatively strong, though we are watching a few trends. Global revenue passenger growth has slowed slightly in the last few months, yet remains near the long-term average. Additionally, cargo demand has weakened as FTKs have declined since reaching an all-time high in 2017. Next, regarding our defense market, which comprises just over 30% of our total revenue. The defense market, which includes both OEM and aftermarket revenues, increased by approximately 7% compared to the prior year Q4. It’s important to note that this quarter, we are starting to face tougher comparisons from the previous year as our defense revenue accelerated in Q4 last year. Full year defense revenue grew by 14%, with strong defense bookings from last year translating into sales this year. This robust growth was broadly distributed and appears to be fueled by most of our businesses supporting defense-related platforms. Now, regarding profitability, I will focus mainly on our operating performance or EBITDA. EBITDA for Q4 was around $707 million, reflecting a 35% increase compared to the prior Q4, and rose to $2.42 billion for the full year, up 29%. The EBITDA margin in the quarter of 45.9% was negatively impacted by acquisition dilution from Esterline. Excluding Esterline, margins in our legacy business were over 50%, showing improvements both sequentially and compared to the previous year’s quarter. Progress in margin improvement is important for us, indicating that our base business continues to identify opportunities to enhance efficiency through our value drivers. I would like to update you on the Esterline integration and our expectations. More than eight months after closing, the Esterline integration is progressing well. We have largely wound down the former corporate office activities in Bellevue, Washington, with those functions now transitioned to the business units or moved to our corporate office in Cleveland. We've equipped the Esterline integration team with senior executives from TransDigm’s legacy who are instilling our culture and operational model focused on value generation in all new business units. We are exceeding our expectations for growth from this largest of TransDigm acquisitions, although, as you know, culture change can be gradual and requires ongoing reinforcement. Now, turning to our guidance for 2020. Continued global revenue passenger mile growth, a favorable environment for defense spending both domestically and internationally, and generally positive economic conditions create a promising backdrop for sustained success and growth in the marketplace. However, global trade dynamics, the ongoing 737 MAX grounding, shipping delays, political risks, or other external events could negatively impact market conditions for TransDigm. We will monitor these factors closely and take any necessary preemptive actions. Based on this, and assuming no acquisitions in fiscal year 2020, our initial guidance for continuing operations is as follows: the midpoint for our fiscal year 2020 revenue guidance is $6.25 billion, which is approximately a 20% increase. As in previous years, with around 10% fewer working days in the first quarter of fiscal year 2020, revenues, EBITDA, and EBITDA margin are expected to be lower than in the other three quarters of the fiscal year, proportionate to the fewer working days. This revenue guidance is based on the following growth expectations for market channels. Note that these pro forma market assumptions now include Esterline. We anticipate commercial aftermarket revenue growth in the mid-single-digit to high single-digit range compared to the prior year, commercial OEM revenue growth in the low single-digit to mid-single-digit range, and defense military revenue growth in the mid-single-digit range versus the previous year. The midpoint of our fiscal year 2020 EBITDA guidance is $2.83 billion, with an expected margin of approximately 45.2%, a nearly 17% increase that includes almost 6 points of margin dilution from Esterline. We expect the EBITDA margin to rise throughout the year, as observed in previous years, with the first quarter being the lowest and sequentially lower than Q4. Our anticipated midpoint for adjusted EPS is $20.50. Mike will elaborate further shortly on the factors affecting EPS. Lastly, I would like to briefly touch on some executive management changes. We are constantly working to strengthen our talent pool and focus on succession planning. As part of this effort, we have recently promoted Marko Enderlein and Patrick Murphy to Executive Vice President roles. Marko has been with TransDigm for over three years as President of the Telair International team. Before joining us, he spent over 15 years at Airbus in various financial and leadership roles. He will be our first EVP in Europe, overseeing much of our European operations. Patrick has been with TransDigm for over four years as President of HarcoSemco and previously held various senior leadership roles at Danaher Corporation over an eight-year career. These promotions will help us manage the expanded group of business units following the Esterline acquisition and fill the position of Jim Skulina, who is retiring at the end of the calendar year. In conclusion, fiscal 2019 was another successful year for TransDigm. We are very pleased with the integration of Esterline and the strong operational performance of our legacy businesses. We are optimistic about 2020 and believe that our consistent strategy will continue to deliver the value you expect from us. I would now like to hand it over to our CFO, Mike Lisman.

Good morning everyone. Nick and Kevin covered the highlights, so I'm just going to really quickly hit on a few additional financial details. First, for full year FY 2019 and then second, for the FY 2020 guidance that Kevin just covered. As mentioned on our last earnings call, the Esterline organization as it used to exist, including the corporate office, is largely now gone, and the business units which used to comprise Esterline report independently into TransDigm within our power, airframe and non-aviation segments. We therefore don't plan to give any specific color around Esterline's performance, separate from that of legacy TransDigm. During the quarter, both EIT and Souriau were moved into discontinued operations. When you make this accounting change, the results from these business units get completely removed from the individual line items of the P&L and collapsed onto the discontinued operations line. So, the net result was that it's almost like we never owned them, except for the discontinued operations line. Now, for the consolidated TransDigm business, a few quick notes on how we ended FY 2019. Adjusted EPS for the year was $18.27, up 2.5% from FY 2018. And as a reminder, our FY 2018 EPS saw a significant one-time benefit from the implementation of U.S. tax reform that muddies any year-over-year EPS comparisons. On taxes, we came in slightly better than expected with an FY 2019 GAAP and cash tax rates of 21% and an adjusted rate of 25%. On cash and liquidity, we ended the year with approximately $1.5 billion of cash on the balance sheet and a net debt-to-EBITDA ratio of 6.2 times. Pro forma for the recent debt raise, which we closed last week on the 13th, our cash balance increased to just under $3 billion. Should Souriau close as expected during our second quarter of FY 2020, we'll receive almost $900 million of cash proceeds and subsequently have the cash balance of just under $4 billion. We also currently have access to about $720 million of our revolver. Next, on the FY 2020 guidance, I'm going to quickly give some more details on the financial assumptions around the interest expense, taxes, and then the share count. Interest expense is expected to be about $1.02 billion in FY 2020. This estimate assumes an average LIBOR rate of 1.7% for the full year, which is just an average of the forward consensus curve currently. This yields a weighted average cash interest rate of about 5.5%. On taxes, our fiscal 2020 GAAP cash and adjusted rates are all expected to be in the 24% to 26% range. We expect our weighted average shares outstanding to increase to $57.4 million from $56.3 million in FY 2019 and that assumes no buybacks occur during the fiscal year. Similar to prior years, the increase in shares outstanding is due to employee stock options that vested at the end of our FY 2019. With regard to liquidity and leverage at the end of FY 2020 and assuming no additional acquisitions or capital market transactions, we expect to have roughly $5 billion of cash on hand at the end of the year. This assumes the Souriau divestiture closes as expected. And we estimate our net leverage will be below five times EBITDA as defined at September 30th, 2020. In closing, we expect fiscal 2020 to be a good year for TransDigm. With that, I'll turn it back over to the operator to kick off the Q&A.

Thanks so much. Good morning.

Good morning.

Good morning.

I wonder if you can, maybe, Nick, just tee us off. I know you didn't want to touch on the precision of the deals that may or may not be in the pipeline. But just as you look at how open the debt markets have been to you, is it fair to think that you'll have excess liquidity relative to your pipeline that would point you more towards additional special dividends? Or do you think the pipeline is rich enough to satisfy as open as the debt markets are to you right now?

I understand your question, but I prefer not to comment directly on that. If we end up with $4 billion at the end of the year, we won't just hold onto it. We will either have something significant lined up or pursue other options. As you know, we plan to return some value to our shareholders, but we’ll take a little more time to make that decision.

Fair enough. Mike or Kevin, can you provide insights on the free cash flow for fiscal 2019, which came in lower than fiscal 2018? I believe you were hoping it would be at least as strong, if not stronger. I'm curious if the divested properties play a role in this. Additionally, could you share your expectations for free cash flow in 2020?

Yes. It was somewhat lower in fiscal year 2019 primarily due to around $100 million in cash charges related to the Esterline integration. Looking ahead to fiscal year 2020, we generally anticipate that EBITDA minus capital expenditures, cash interest, and cash taxes will be approximately 50% of EBITDA. We believe we've communicated this 50% figure before. Historically, if you review fiscal year 2019 excluding the Esterline factors, we reached around 50%, and we expect fiscal year 2020 to reflect a similar outcome.

Okay, all right. Thanks. I'll leave at two. Thank you.

Hey good morning.

Good morning Ron.

When you think about potentially deploying some of that capital, are there areas in the portfolio that you think you need more coverage of? I mean is there any clue you can give us? And if you were to do some more M&A, what area would you be covering?

Yes, our focus remains on acquiring proprietary aerospace businesses with substantial aftermarket content. We don't have a preference for any specific part or product related to an airplane. If a potential acquisition meets these criteria and offers a clear path to our desired returns, we are very interested in pursuing it. We don't limit our options beyond that.

Got it. Got you. And then maybe just kind of peeling back the onion a little bit. When you think about the return of the 737 MAX into service, is it going to be a headwind or a tailwind? Meaning, there will be fewer older airplanes flying around, which would suggest a headwind. But if it's a new airplane going into service, you'll have provisioning, which would be a possible tailwind, right? So, on balance, how would you expect the return to service there to kind of impact you guys?

We consider it to be somewhat neutral. The aftermarket is performing well, and we are doing well with the OEM for the 737 overall. However, in the grand scheme, it is minimal to the business. The 737 MAX is small enough that any issues with its ramp rates or other challenges will not significantly affect the business. Therefore, we believe it's minimal, and that’s how we approach our modeling. Certainly, having more older planes in service is beneficial for us, but we also have OEM content, so it balances out.

Got you. Got you. And then one follow-on to that, if I may. As you mentioned in the prepared remarks, air traffic has slowed a bit this year, right? So, we're maybe a smidge below kind of the long-term mean, but maybe reverting to a mean. But we really haven't seen much impact on aftermarket demand because of that. Are you expecting that to change as we go into next year? I mean is there some conservatism in your outlook for next year because of what air traffic has been doing? I mean how can we think about it? I mean be it that air traffic has slowed pretty much across the industry, everybody has had a booming aftermarket performance.

Yes, I think the RPM growth has been impacted by the lack of availability of the 737. So, I don't want to overblow that to the industry and how it may impact us. So, I look at RPM, it's close to the 50-year average. I don't see a looming problem in the industry. So, I'm still optimistic about the future for this market as a whole, whether it's aftermarket or OEM. I think aftermarket orders can be lumpy at times and we certainly see that. Last year, the POS, which is a nice forward-looking indicator, that was up high single-digits. So, that kind of reinforces how we feel about this year and why we guided to mid to high single-digit growth in the aftermarket. But certainly, we've put necessary conservatism into our forecast, and hence the mid to high comes into play.

Great. Thank you so much.

Hey good morning guys, it's actually Matt on for David.

Good morning.

I wanted to know if you have any updates on the Inspector General audit you mentioned last quarter, to the extent that you can share. Also, I believe there was a pricing memo over the summer where the DoD was requesting additional pricing data. Are you still receiving requests for that data, and is it having any significant impact on you?

Yes. There are two parts to your question. Regarding the Inspector General update, that audit involves the Defense Logistics Agency and its purchasing practices related to TransDigm products. We are in close collaboration with the Inspector General. I don't have a timeline for when this will be completed, but we are actively engaged and making progress. The audit seems to cover similar areas as previous ones. That's all I can provide at the moment, but we are working together closely. On the pricing memo, we have had direct discussions with the Department of Defense about this issue. The memo was released to clarify the situation. We are noticing some increased scrutiny on pricing or costs and various requests for information. Overall, our collaboration with the DoD and the DLA on their purchases continues. There has been a slight slowdown in some orders, but it hasn't had a noticeable effect on the business. These orders are generally small, and we are actively cooperating with the DLA in the fair and reasonable acquisition process as mandated by regulations, and we fully adhere to those guidelines. We are continuing to work closely and meet with them directly.

I might just add that the last couple of times we've had these, they took about 18 to 24 months to complete. I don't know how long this one will take, but at least there are a couple of benchmarks.

Got it. Yes, that's really helpful. Thanks. And then, I guess, on Esterline. So last quarter, you commented there was some loss-making contract write-up. Can you say what that level was for the quarter and kind of what the level is you'd expect going forward on that?

Yes, it was $15 million in Q4. We expect it to continue with that kind of level going out quarterly. The average over the next, say, three, four years should be about, roughly, $40 million per year, more in the earlier years than in the out years.

It's gradually tapering off, right.

Got it. Thanks.

Hi good morning.

Good morning Ken.

I just wanted to ask, Nick or Kevin, in prior periods when you've started to maybe see some cautionary signs in your commercial market or other, maybe reasons for a bit of pessimism on the broader outlook, you've been fairly quick to take action and adjust your cost structure ahead of that. Are you at the point where you might start to think about that? Or is it way too early to think about that? And if so, what would you want to see specifically? Or how is your outlook near term as you think about some of the clouds you mentioned on the horizon and some of the lower growth we've seen in passenger traffic?

Yes. I believe your question revolves around how cautious we are regarding the market and our observations. We have provided guidance that, along with our order book, doesn’t suggest we are starting the year on a weak note, so I feel confident. Jorge Valladares and I discuss this often; we've met frequently in recent weeks, and while we consider it, neither of us believes immediate action is necessary because the forward-looking indicators, particularly bookings, appear solid. Therefore, I don't think an adjustment is needed at this moment, but we are actively discussing it to ensure we stay ahead. We understand that falling behind can hinder productivity, which we definitely want to avoid. However, we also do not want to compromise the business and deliveries by making premature decisions. Ongoing discussions are part of our process.

Okay, that's helpful, Kevin. And I just wanted to follow-up on your comments around sort of the wind-down of the legacy Esterline corporate office in Bellevue and a lot of the transition to your operating businesses over there to Cleveland. Is it fair to say that you'd have the capacity now and the bandwidth for a larger acquisition? Or do you still feel like there's significant integration around Esterline and sort of realization of the upside that you'd maybe not be as excited near term about a larger deal?

Yes, I would say we're making very good progress on Esterline. Frankly, it's moved faster than we expected. If we saw the right opportunity, I don't believe we would hesitate to act due to bandwidth concerns, as our restrictions are now more related to the value and potential of the opportunities available.

Okay, great. Thank you very much. I'll pass it back.

Hey good morning guys. Thanks for taking my questions.

Good morning.

Maybe, Nick or Kevin, just on Esterline, I think you said EBITDA margins were running above 30%, and I mean that's come a pretty long way. I think the initial guide was maybe low-20% level. Can you just maybe give us some color on what's really helping to drive the improvement there? I mean maybe even compartmentalize it? I mean is it price, is it getting rid of excess overhead? Is it just implementing better productivity and better execution initiatives?

Yes, I think, Michael, the answer is yes to that. We've seen opportunities on productivity, on price. Certainly, better leveraging the overhead structure that we have in place already is important to that. We've continued to see new business wins in this business at Esterline. That's important. I think one of the most important points is that we reported that we modeled that the aftermarket at Esterline was somewhere around 30%, and that's up from the 12% that was most recently reported when Esterline was a public company. We found that 30% to maybe be a little conservative. It's better than even what we had modeled, similar, directionally, to TransDigm. And so that has been a great reason why we're seeing improvement faster than what we had originally planned. But it's a balance of productivity and price. It's not one thing or the other. We emphasize all areas including new business growth in our improvement.

The only thing I want to add is that, as we've consistently stated since acquiring the company, our strategy is to approach acquisitions with caution in our projections. We strive to ensure that if we invest our resources, we have a strong likelihood of seeing a return.

That better than expected aftermarket exposure, what do you guys attribute that to? I mean, was that just Esterline taking its eye off the ball, not having the systems in place to sort of track the lifecycle of their products, not having good turnaround times? I mean anything you can attribute the better than expected 30% exposure?

I think we define the market very carefully on aftermarket because we understand how valuable that segment is. So, I think it's largely definitional, and we spent the time combing through the data for those opportunities so that we understood our product mix very well and our market mix.

And I'd just like to repeat the same. Going into something like this, when the data is unclear and we're unsure, we tend to be conservative. Yes.

Got it. Just the last one, maybe housekeeping on capital deployment. But I guess, with the interest expense, where you guys are for fiscal 2020 as a percent of EBITDA, I think the tax law still restricts deductibility at 30%. I mean do you guys have any plans to get that interest expense below that 30% threshold, whether it's paying down?

No.

Okay. Got it.

No, we think of it the same way. The cost of the debt is currently 5.5%. Depending on how much is or isn't deductible, the after-tax cost ranges from 3.5% to 4.25%. We always compare that to the after-tax cost of our equity, aiming for a return similar to private equity. That still looks quite favorable compared to the typical private equity return of 15% to 20%.

Got it, perfect. Thanks guys.

Good morning.

Good morning.

Overall, in defense, you didn't call out bookings like the other two end markets. I mean what type of activity are you seeing from an order perspective and how do you think about that backlog as we head into 2020?

We had a strong bookings year in defense, not as strong as the year before, but our total defense bookings were up in that mid-single-digit range, much like we guided to. That's produced by stronger bookings on the defense OE side and a slowdown in bookings in the aftermarket, which may indicate that maybe some of the sequestration, refilling of spares and maintenance-related activities in the defense sector has been caught up. Time will tell.

Thanks. And then just one more. You called out business jet and helicopter aftermarket being up 20% in the quarter. I mean what is driving that, whether it's activity or mandate driven? And what type of visibility are you seeing in that market?

Yes, I think we're surprised, a little bit cautious surprise there about the performance. We certainly don't see the support on the business jet side on the takeoff and landing cycles, which is how we follow and monitor the business, much like all of you. So, we continue to be pleasantly surprised by the strength of the OE and the aftermarket on the business jet defense. On the helicopter side of the business, I really don't have that much comment. It's a pretty small sector and nothing jumps to mind as worthy of commentary.

Thank you.

Yes, thanks. Good morning guys.

Good morning.

Maybe inside the air transport aftermarket numbers, could you give us some granularity on discretionary versus nondiscretionary? Maybe if you saw any differences by region or by channel distribution or direct, any color there?

Yes, I can provide some detail by submarkets. We observed some strength in the freight area, primarily due to the 737 freighter. Any weakness on the interior side stemmed from large stocking packages that were arranged last year, which did not occur again this year. This impact will diminish over time. The business jet segment remains robust. Our passenger segments in the commercial aftermarket are performing at the multiyear average, aligning with our expectations. Generally, the segments are performing as anticipated. The freight side has exceeded our expectations, while the interiors are currently undergoing a cycle. They have recently secured several international OEM projects, which will lead to growth and future aftermarket opportunities. These represent some of the variations we observe in the aftermarket across different submarkets.

Thanks, Kevin, that's helpful. I have a separate question regarding the progress of the value-based pricing implementation for Esterline's aftermarket. Have you had any updates?

Yes, we don't really talk about it that way. Our value drivers are a constant focus for us. We don't look at it as the journey is complete and we've reached Nirvana. We continue to work on these; it's part of our discipline, it's part of our process. So, we see opportunities ongoing in our legacy TransDigm businesses, just like we see them on the old Esterline side, and we'll actually stop referring to it as the Esterline businesses. It'll just be part of our power, airframe and non-aerospace sectors as we go forward. But that's kind of how we see it.

That's a fair answer, I appreciate it. Maybe asked a better way, of the 30%-plus of Esterline's revenue that is aftermarket, do you have a sense for how much is sort of spot aftermarket or, if you will, off contract?

No, I do not. I do not have that knowledge as I sit here, sorry.

That's okay. Thank you very much. appreciate it.

Sure.

Thanks very much and good morning.

Good morning.

Nick, I remember back in 2011 when your group reduced the target return from 20% to 17.5% at the top and 12.5% to 10% at the bottom. One of the reasons for this change was the business growth, which was around $1.2 billion at the time. Clearly, the company has grown significantly since then and likely surpassed your own expectations as well as those of others. Now that we’re over $6 billion, does that return framework still apply?

We do not have any plans to change it now. Let me clarify your question. Are you asking about our expectations for future growth in shares or what we intend to do with our compensation plan?

I think the compensation plan is intended to reflect the shares, right? And so, let's say the shares then.

I'll address both questions. Our aim for the shares is to provide a return similar to private equity, which we define as being in the range of 15% to 20% over the long term. Annual returns may vary, as public market growth has averaged around 35% over the past 12 or 13 years, but we don't expect that trend to continue. We still believe a private equity-like return is a reasonable expectation. Regarding our compensation targets, the 17.5% we have set aligns with the returns of top quartile private equity funds. This approach is consistent with how we've targeted returns over the years, and as we grow, it made sense to align ourselves with top quartile private equity funds, which led us to set that target. Whether this figure might decrease to 15% in the future is uncertain, but it is not something we are currently focusing on.

Got it. Got it. Okay. And then as a follow-up, just to make sure I understand, last quarter without Esterline, it looked like the pro forma of commercial aftermarket contribution to the company was 36% of revenue, and this quarter it's 31%. And so it would seem that the Esterline piece is coming in with below 30% commercial aftermarket. Or is that like an incorrect reading on my part?

We're not following your math. I'm not sure that's correct. I guess if the Esterline contribution is well below 30%, we know that's not correct.

Right. Okay, okay. Okay. I was just looking at the slides from last quarter and this quarter. But maybe two more quick cleanup ones. On the defense piece that's 37% now, what's the rough split there with Esterline and the total TransDigm defense pie between aftermarket and OE?

I think it's similar to our commercial business, but that's as much as we guide on that.

You mentioned having $4 billion in cash at the end of the year. I'll leave it at that.

Thank you. That concludes our call today. We just would like to thank you again for calling in.