Transdigm Group Incorporated (TDG) — Q4 2021 Earnings Call Transcript

Thank you. And welcome to TransDigm's fiscal 2021 fourth quarter earnings conference call. Presenting on the call this morning are TransDigm 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 Investors section of our website or at sec.gov. The Company would also like to advise you that during the course of the call, we will be referring to EBITDA, specifically, EBITDA as defined, adjusted net income, and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and applicable reconciliations. I will now turn the call over to Kevin.

Good morning. Thanks for calling in today. First, I'll start off with a quick overview of our strategy, summarize a few significant items in the quarter, and discuss our fiscal 2022 outlook. Then, Jorge and Mike will provide additional details on the quarter. Jorge Valladares is joining our earnings call today and will do so going forward. George is currently our Chief Operating Officer and has been in the role since 2019. Over the last 20 plus years with TransDigm, George has had an unusually broad operating background and has been a key culture carrier. He most recently served as our COO of power and control, where all of the power group businesses reported to George. Prior to this role, he served four years as an Executive Vice President and was President at two of our larger operating units, AvtechTyee and AdelWiggins. George initially started at AdelWiggins Group and held various positions of increasing responsibility in engineering, manufacturing, and sales as he worked his way up. We're excited to have him join the earnings call and offer his expertise. Now, moving on to the business of today, to reiterate, we are unique in the industry in both the consistency of our strategy in good and bad times, as well as our steady focus on intrinsic shareholder value creation through all phases of the aerospace cycle. This should sound similar to what you have always heard from TransDigm. To summarize, here are 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 generally have significantly higher margins and over any extended period, have typically provided relative stability in downturns. We follow a consistent long-term strategy. Specifically, we own and operate proprietary aerospace businesses with significant aftermarket content. We utilize a simple, well-proven, value-based operating methodology. We have a decentralized organization structure and a unique compensation system, closely aligned with shareholders. We acquire businesses that fit the strategy and where we see a clear path to private equity-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 a good quarter considering the market environment. We continue to see recovery in the commercial aerospace market and are encouraged by the trends in air traffic, among other factors. Our current Q4 results continued to show positive growth in comparison, as we are lapping another fiscal 2020 quarter fully impacted by the pandemic. However, our results continued to be unfavorably affected in comparison to pre-pandemic levels due to the reduced demand for air travel. On a more encouraging note, the commercial aerospace industry has continued to show signs of recovery with increasing air traffic and expanding vaccination rates. The recovery has primarily been driven by domestic leisure travel, though we are optimistic for the recovery of international travel as more governments across the world soften travel restrictions. In our business, we saw another quarter of sequential improvement in commercial aftermarket revenues, with total commercial aftermarket revenues up 14% over Q3. I'm also very pleased that, even in this challenging commercial environment, we continue to sequentially expand our EBITDA margin. Contributing to this increase 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 continued to generate significant cash in Q4. We had strong operating cash flow generation of almost $300 million and closed the quarter with approximately $4.8 billion of cash. We expect to steadily generate significant additional cash through 2022. We continue to look at possible M&A opportunities and are always attentive to our capital allocation. Both the M&A and capital markets are always difficult to predict, but especially so in these times. First, I'd like to address the Meggitt situation that occurred this quarter. We have long admired and studied the Meggitt business and believe that a combination between us and Meggitt could provide value to investors of both companies. However, based on the quite limited due diligence information that was made available, and the resulting uncertainties, we could not conclude that moving forward with an offer of 900 pence per Meggitt share would meet our longstanding goals for value creation and investor returns. We put substantial time and effort into evaluating this potential transaction as we had communicated previously. However, as we have said many times before, we are very disciplined with our capital allocation. When we make acquisitions, we need a reasonable degree of certainty for achieving our investment return goals, especially for a deal of this magnitude. The diligence made available to us was too limited to provide the assurance needed to move forward, and our additional diligence requests were not met. These additional diligence requests were very similar to what was typically received in the almost 90 acquisitions we have done over the life of the Company. It was a disappointment that we could not move forward. But it was the most prudent decision for the Company and all of our stakeholders. In regard to the current M&A pipeline, we're still actively looking for M&A opportunities that fit our model. Acquisition opportunities in the last quarter were still slower than pre-COVID, but we are starting to see some pickup in activity. We remain confident that there is a long runway for acquisitions that fit our portfolio, primarily in the small to mid-sized opportunities, and look forward to continued M&A activity far into the future. At this time, we don't anticipate that we will make any significant dividends or share buybacks for at least the next quarter, but we will keep watching and see if our views change. Now, moving to our outlook for 2022. While we are not providing full financial guidance at this time as a result of the continued disruption in our primary commercial end markets, we are providing guidance on select financial metrics for fiscal 2022, including EBITDA margins, expected defense market revenue growth, tax rates, and other key financial assumptions. We continue to be encouraged by the recovery we have seen in both our commercial OEM and aftermarket revenues and bookings in fiscal 2021, but many unknowns remain for the pace and shape of the recovery. We will look to reinstitute guidance when we have a clearer picture of the future. Currently, we expect COVID-19 to continue to have an adverse impact on our financial results compared to pre-pandemic levels into 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. Given what we know today, our teams are planning for our commercial aftermarket revenue to grow in the 20% to 30% range. We expect our commercial OEM revenue to grow significantly as well, but at a rate slightly less than the commercial aftermarket. As you know, we aim to be conservative and would be happy to have both of these end markets rebound more strongly. George will provide further detail on a few key points of consideration that will drive our ultimate commercial growth. As for the defense market, we expect defense revenue growth in the low single-digits percent range versus fiscal 2022. Now, a bit more color on EBITDA as defined expectations for fiscal 2022. We expect full-year fiscal 2022, EBITDA margins to be roughly in the area of 47%, which could be higher or lower based on the rate of commercial aftermarket recovery. This guidance assumes a steady increase in commercial aftermarket revenue throughout fiscal 2022, with Q1 being the lowest. In a similar fashion, we anticipate EBITDA margins will move up throughout fiscal 2022 with Q1 being the lowest and sequentially lower than Q4. As a final note, this margin guidance includes the unfavorable headwind of our recent Cobham acquisition of about 0.5%. As a reminder, and consistent with past years, with roughly 10% fewer working days than the subsequent quarters, fiscal year 2022 Q1 revenues, EBITDA, and EBITDA margins are anticipated to be lower than the other three quarters of fiscal year 2022. We believe we are well-positioned as we enter fiscal 2022. As usual, we'll closely watch the aerospace and capital markets development and react accordingly. Let me conclude by stating that I'm pleased with the Company's performance in this challenging time for the commercial aerospace industry, and with our commitment to driving value for our stakeholders. The commercial aerospace market recovery continues to progress, and current trends are encouraging. There is still uncertainty about the pace of the recovery, but the team remains focused on controlling what we can control. We remain confident that in the fullness of time, the commercial aerospace market will return to pre-pandemic levels. We look forward to fiscal 2022 and the opportunity to create value for our stakeholders through our consistent strategy. Now, let me hand it over to Jorge to review our recent performance and a few other items.

Good morning, everyone, and thanks for the kind introduction, Kevin. I'm glad to be speaking with all of you today and look forward to being on these calls in the future. I will 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 2020. That is, assuming we own the same mix of businesses in both periods. This market discussion includes the acquisition of Cobham Aero Connectivity. We began to include Cobham in this market analysis discussion in the second quarter of fiscal 2021. This market discussion also removes the impact of any divestitures completed in fiscal 2021. In the commercial market, which typically makes up close to 65% of our revenue, we will split our discussion into OEM and aftermarket. Our total commercial OEM revenue increased approximately 1% in Q4 and declined approximately 25% for full-year fiscal 2021 compared with prior-year periods. Bookings in the quarter were very strong compared to the same prior year period and solidly outpaced sales. Sequentially, both Q4 revenue and bookings improved approximately 5% compared to Q3. Although we expect demand for our commercial OEM products to continue to be reduced in the short term, we are encouraged by build rates gradually progressing at the commercial OEMs. Recent commentary from Airbus and Boeing reiterated anticipated rate ramps for their narrow-body platforms in the near future. Hopefully, this will play out as forecasted. Now, moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 41% in Q4 and declined approximately 18% for full-year fiscal 2021 when compared with prior-year periods. Growth in commercial aftermarket revenue was primarily driven by increased demand in our passenger sub-market, although all of our commercial aftermarket sub-markets were up significantly compared to prior year Q4. Sequentially, total commercial aftermarket revenues grew approximately 14% and bookings grew more than 25%. Commercial aftermarket bookings are up significantly this quarter compared to the same prior year period, and Q4 bookings very solidly outpaced sales. To touch on a few points of consideration, global revenue passenger miles are still low, but have been modestly improving throughout fiscal 2021. IATA recently forecast a 39% decrease in revenue passenger miles in calendar year 2022 compared to pre-pandemic levels. Within IATA's estimate is the expectation that domestic travel will be back to 93% of pre-pandemic levels in calendar year 2022. Though the pace of the recovery remains uncertain, we continue to believe there is pent-up demand for travel as vaccine distribution expands and travel restrictions are rolled back; passenger demand across the globe will increase. The emergence and spread of COVID variants and other future evolutions may further complicate this picture, but for now, trends remain positive. We see evidence of pent-up demand through the recovery in domestic travel. Domestic air traffic trended upward throughout fiscal 2021. Airlines also continue to see strength in bookings and strong demand for domestic travel, especially in the U.S., with Europe catching up. China is currently a watch point with its recent drop-off in air traffic. The pace of the international air traffic recovery has been slow, and international revenue passenger miles have only slightly recovered. However, vaccinations continue to increase globally, and governments across the world are starting to reduce travel restrictions, which provides optimism on the international air traffic recovery. Cargo demand has recovered more quickly than commercial travel due to the loss of passenger belly cargo and the pickup in e-commerce. Global cargo volumes continue to surpass pre-COVID levels, and it is generally expected that airfreight demand will likely remain robust into 2022. Business jet utilization in certain regions rebounded to pre-pandemic or better levels earlier this year and remains strong. Commentary from business jet OEMs and operators has been encouraging that these higher levels of business jet activity may be here to stay, though time will tell. 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, grew by approximately 2% in Q4 and approximately 5% for full-year fiscal 2020 when compared with prior-year periods. This was in line with expected revenue growth expectations we provided for fiscal 2021 of mid-single-digit percent range growth. We continue to expect our defense business to expand due to the strength of our current order book. As Kevin mentioned earlier, we expect low single-digit percentage range growth in fiscal 2022 for defense market revenues. Lastly, I'd like to wrap up by stating how extremely pleased I am with our operational performance throughout this fiscal year that continues to be heavily impacted by the pandemic. Our management and their teams remained diligent and focused on our value drivers, and will continue to do so in this new fiscal year. We are ready to meet the demand as it returns. With that, I would like to turn it over to our Chief Financial Officer, Mike Lisman.

Good morning, everyone. I'm going to first quickly hit on profitability trends for the business. Then, address a few additional financial matters for fiscal 21 and finally, I'll provide some more detail on our expectations for fiscal 22. First, in regards to profitability for fiscal 21, EBITDA as defined of about $636 million for Q4 was up 28% versus prior year Q4. On a full-year basis, EBITDA as defined was about $2.19 billion, down 4% from the prior year. EBITDA as defined margin in the quarter was approximately 49.7%. This represents sequential improvement in our EBITDA defined margin of almost 400 basis points versus Q3 of '21. Moving on, a few quick notes on the full '21 fiscal year. I want to provide one quick M&A related data point that you might find helpful for your financial models as we head into FY22. As you know, we divested several businesses during 2021, all of which were sold out of continuing operations. As a result of the accounting treatment applied, roughly $130 million of revenue and $25 to $30 million of EBITDA as defined from the divested operating units remain in our FY21 results. This revenue and EBITDA will obviously not carry over into FY22. On cash and liquidity, we ended the year with approximately $4.8 billion of cash on the balance sheet, and our net debt to EBITDA ratio was 7 times. In the early days of October, we repaid the $200 million revolver drawdown that we made at the onset of COVID back in April of 2020. This was done out of an abundance of caution at the time, and we don't need the cash, so we've repaid it. Pro forma for the revolver paydown, our cash balance is $4.6 billion. Next on the FY22 expectations, we are not giving full guidance as Kevin mentioned, but we are providing guidance on select financial metrics, including the following: Interest expense is expected to be about $1.08 billion in FY22; on taxes, our fiscal '22 GAAP and cash rates are anticipated to be in the range of 21% to 24%, and the adjusted tax rate will be a few points higher, in the range of 26% to 28%. On the share count, we expect our weighted average shares outstanding will increase by about 800 thousand shares to $59.2 million in FY22, and that assumes no buybacks occurred 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 FY21. With regard to liquidity, we expect to continue running free cash flow positive throughout FY22. As we traditionally define our free cash flow from operations at TransDigm, which as a reminder is our EBITDA as defined, less debt interest payments, less CapEx, less cash taxes. We expect this metric to be in the $1 billion area, maybe a little better in fiscal 22. Assuming no M&A, no dividends or share repurchases, and no additional debt capital markets activities, this free cash flow generation together with a higher EBITDA figure, should the COVID rebound continue, will likely reduce our net debt to EBITDA ratio to something more like 6 times at the end of fiscal 22 versus the current 7 times level. Finally, one last note on the DOD Inspector General audit. As we mentioned previously, we've been actively engaged with the IG office, with some ebbs and flows, and this engagement is now complete. In our best assessment, and based upon what we saw, this audit appeared to be similar in scope to prior audits. While it's difficult to know exactly when a final report will be issued publicly, we expect that this could happen any day now, very likely during the first quarter of our fiscal 22. With that, I will turn it back to the operator to kick off the Q&A.

Hi. Good morning, everybody.

Good morning, Noah.

Good morning.

Could you spend a little bit more time on the 47% EBITDA as defined margin target for next year? How do we bridge from the 49.7% exit rate of this year? And I know there's a little bit of seasonality, but if I look at all the data historically, it's not that seasonal. And it looks like you'll be mixing up based on your end market growth rate comments.

It's possible, Noah, that we could mix up. It’s possible that we are being conservative. I think there were some good news that happened in Q4 in terms of market mix and our performance. We're trying to be reasonable and transparent in what we see; there are a lot of unknowns that have to come to pass in terms of the commercial aftermarket bookings for this to all play out. So that’s the approach we took and what we rolled up from our teams. If it's conservative, that will be great. We would love to beat that.

Okay. Sensible. And then Mike, on the cash flow inputs for next year, you had the working capital headwind this year, maybe just help us out with how that changes next year? And then CapEx, that number as a percentage of revenue is fairly high relative to where you've been historically, what's behind that?

Sure. So first on the working capital, you'll see when we publish the 10-K later today, I don't think you have the full cash flow detail yet, but accounts receivable did tick up a bit this quarter, about $100 million went back into accounts receivable. We knew that was going to happen as a reminder from peak to trough, about $400 million came out of accounts receivable during COVID. So that's going to have to go in as we go back in, as we go through the rebound here. It did tick up this year over the past couple of quarters, as you know, this last quarter was $100 million that's going to continue into FY2022. Ultimately, how much goes back into AR and the pace at which that happens depends on the pace of the recovery. But we do expect it to be a use of cash on the order of at least $100 million during our FY2022, potentially more. That'd be a good problem to have, by the way. I mean, if the commercial markets rebound and we have to invest more in AR, we're happy to do that. We certainly have the cash. And then sorry, Noah, your second question was on CapEx, I think.

CapEx, yes.

We put out a range of $135 million to $155 million today. It is slightly higher on a percentage basis. It's tied to some one-time projects at some of our operating units. As you know, our first use of cash is to go and deploy it into our own businesses to help them grow and we're just doing some of that with some large one-time projects on select operating units.

Thank you.

Thanks so much and good morning.

Good morning.

Morning.

Kevin, first question. Have you seen any supply chain issues or labor issues this quarter?

Jorge, do you want to take that one?

Sure. We've started to see some of the pushing out of lead times from the supply chain, primarily focused on electronic components. It's been spotty, nothing too significant at this point. But in all likelihood, this will get worse before it gets better.

And just a quick follow-up on that maybe. As you look at how this could pan out in 2022, you built some sort of contingency for these issues into that EBITDA margin guidance?

I don't think we have specifically allocated anything to supply chain disruption, but we take a conservative approach in our forecasts. We believe this could be an issue as we move forward, particularly concerning electronic components, where we are experiencing some supply difficulties. Regarding inflationary pressures, we plan to pass those costs along, as we always have, rather than absorbing them.

That's great. Thank you very much.

Thanks. I have another question about margins. Mike, you mentioned the divestiture in the '21 guidance that will be compared against in '22, and it seems that this alone contributes around 70 basis points to the EBITDA margin. So, I don't want to dwell on this too much, but it appears there's a significant amount of conservatism in the 47% unless you want to.

On the margin guide, remember we also bought Cobham too, which kind of counteracts the divestitures the other way and cancels it out. So I think that kind of negates some of the impact that you mentioned.

I think I said it was what a 0.5% drag to us.

Was that a 0.5% for the quarter or for the year?

That's '22 versus what it would have been had we not bought the Cobham Aero Connectivity business.

Got it. And what was it in the quarter?

On the quarter, I think it was about close to a percent. Just below 1%. A couple of tens below.

Perfect. And then, within the aftermarket growth rate range to 20% to 30%, Kevin, is there a figure of merit that you're using to ballpark that? Is that a sequential growth that's underlying? Is that a traffic growth, any formula?

Well, I think it's traffic-growth related. And I think we're counting on that largely being U.S.-Europe related. We'll have to see how it unpacks around the globe. As you guys all know, we don't have geographical information along those lines. But we will continue to monitor this closely; if the traffic patterns come along like we believe they might, then the other 20% to 30% planning, and I emphasize planning. It's difficult to issue that as guidance, because as you know, aftermarket bookings tend to be booked and shipped; you don't have as much visibility. So this is for planning purposes and every business will have a slightly different plan along those lines. But we tried to give you a rollup of the range that will be based largely on takeoff and landing activity.

Okay. Alright. Thank you.

Hi. Good morning. I wanted to follow up Kevin on the discussion on the commercial aftermarket. I know your sequential growth has been a little lumpy over the last three quarters. But considering your comment on bookings and shipments pace, how should we think about the sequential growth here into the fiscal first quarter of '22?

We are somewhat cautious about the first quarter, although "concerned" might be too strong a term. It's typical for us to see a normal decline from Q4 to Q1 due to the fewer number of days. We have always thought that the market might not accurately reflect that. To support our optimism, we had strong bookings in Q4, and we booked in advance of shipments. This is clearly encouraging and positions us well as we move into 2022, even though Q1 tends to be a bit weaker because of seasonal factors.

That's helpful. Again, as we think about the 25% for your planning purposes for the aftermarket for the year, what are your assumptions on travel say, and take-offs and landings in Asia or in international markets? I know you don't have great visibility internationally, but are you anticipating a significant recovery in these numbers in international? I am just trying to get us some of the puts and takes in that 20% to 30% planning range.

Well, you've highlighted the challenges we face in providing guidance on these numbers because I lack visibility into where they'll originate. This information is gathered from all our teams who share their observations about market trends based on customer feedback. It’s difficult for me to make predictions by region or platform. That's why I’m offering some planning guidance. We have an expectation of what should occur, but the path to achieving that is unclear. We are unsure about order locations and shipment details, which affects our understanding of traffic requirements. We are relying on a steady recovery, similar to what we've experienced, which we believe will lead to improved aftermarket numbers.

Great. Well, thank you very much.

Sure.

Hey, good morning, guys.

Good morning.

Good morning.

Alright, Kevin, Mike, the business was free cash flow positive even at the depths of COVID. And considering the defensibility of the business model, how are you thinking about the maximum leverage that the balance sheet can support, versus what you would have thought pre-COVID? And can you discuss your appetite for large versus small deals?

Sure. On leverage, we don't anticipate any kind of change. If you went back to the pre-COVID two-year period and averaged the quarterly net debt to EBITDA levels, you get about 6.0 times almost exactly. We're comfortable operating at that level. Some of the debt incurrence tests and other things in our credit agreement are based off operating at that level and we're comfortable with it. If anything, this pandemic, as you said, has proven that the business is very durable from a free cash flow standpoint and probably can sustain more leverage than historical level we've run at that. But we do want to keep some firepower for M&A at all times, including large deals. Moving on to the second part of your question, large deals, as Kevin mentioned, we're more active now on the M&A side at the small to mid-size range. But there are also obviously some large potential transactions that we track from time to time, both on the strategic side, but then also big divestitures that could maybe come out of some of our peers in the aerospace industry. So we're always looking and always on the hunt as you know, whether it's large or small, we're targeting M&A of all sizes from kind of the really low range below $100 million up to a couple of billion.

I see. As a follow-up regarding the Esterline deal, you've identified some valuable assets and also sold off certain businesses that didn't align with the TransDigm model. What are your thoughts on the potential for large deals? What criteria are you considering when deciding what to retain versus what to sell, especially in relation to your interest in pursuing these larger transactions that might not fully conform to the TransDigm standards?

Yeah, it's hard to put an exact percentage on something like that. Ultimately, it depends on the on-sale risk. If there was something where it was maybe 50-50 and you had someone who wanted to buy the other 50%. That's a different situation than Esterline where we sold roughly a quarter of it. It's hard to answer that question. But obviously, the Esterline transaction proved to us that we can go and buy something that's not 100% fit the day we own it, but then execute on M&A in the year or two post-deal close, to shape it down to the portfolio that we want to own forever in the long term. So we do look at M&A situations like that going forward.

Thanks for the color.

Hello. David, phone on mute.

Yes.

Okay. Great. Thanks. So Kevin, appreciate the color there on Meggitt. Just wanted to ask you about the fact that you were willing to entertain the idea of potentially getting involved in Meggitt given what appears to be pretty high valuations, what does that say about kind of the pipeline, the ability to find large aero deals for you guys from here?

At the end of the day, the market determines the value of a property, and we need to adhere to what the market indicates we should pay. We are focused on highly-engineered, proprietary aerospace products that offer aftermarket access. The size of these businesses is less important to us; we want to identify them and integrate them into our operations. We believe we can invest in these businesses and enhance their strength. Our goal is not to chase larger deals; rather, we aim to acquire between $50 million and $100 million annually, which aligns with our model and enables us to continue delivering valuable returns. We're not overly focused on landing large transactions, but we do evaluate them when they arise, and we've had success with those we've pursued. The market is certainly experiencing increased activity, and while predicting closings is always challenging, we are currently witnessing some encouraging developments.

Thank you for that. As a follow-up, can you discuss your current headcount situation, how much you believe you have reduced structural costs, and what your target headcount would be if we return to pre-pandemic levels for your business in 2023?

I don't have the numbers in front of me, Jorge can comment on that, but I think we are very disciplined in our approach to adding back, and that is one of the hallmarks of our operation's discipline. Jorge, do you want to expand on that?

I would add the teams have done a lot of heavy lifting in terms of restructuring and productivity focus. The last 12 months, we're pretty comfortable with the resource level that we currently have. I think as most of you know, as the commercial aftermarket rebounds, that’s not as heavy in terms of labor requirements or resource requirements. So I think I'm pretty comfortable with where the teams are at. They've done a great job. And now we just need the market to recover.

Alright, thanks very much.

Operator?

Thanks very much. And good morning.

Good morning.

I'm curious about the OE end market. I heard comments about the expectations for this coming year, and I definitely anticipate growth picking up there. However, I'm wondering about how growth at TransDigm will phase in relation to our position in the build cycle. We've already seen some OE growth starting at other companies, as Boeing and Airbus have increased their narrow body production rates in advance of that growth. On the business side, it appears that you experienced low single-digit growth or flat results in both areas. How do you view the growth trajectory there, and how will it connect to the increases in build rates?

Yes. In general, we found that the OEMs in the Tier 1s were a little bit slow to respond in mid-year 2020, as the pandemic was ramping up. So we believe there is some natural inventory de-stocking continuing to go on. The orders are starting to come in. As I mentioned, the bookings were up in the commercial OE in Q4. So that's a positive indicator. I don't have the details in terms of how it lays in across fiscal year 2022, but we don't think there's any significant issue there. It's just the timing and the lag of the OEM shutting off the valve, if you will, on the supply in 2020. And now, as they continue to ramp up in production.

Great, thanks. Then just as a quick follow-up in the defense end market. I think last year you guys ended up towards the higher-end of the initial range that you gave. Is there anything to be aware of for this year that might determine either on the plus side or the minus side where things end up in defense?

No. I think the guidance that we provided is reasonable as you guys might know. Remember that defense markets, in general, have been very strong over the past two to three years. They can be lumpy in nature in terms of the bookings, so I think the guidance that we're providing is within a reasonable range.

Great. Thanks very much.

Hey, good morning. This is Pete on for Michael Ciarmoli. Thanks for taking our questions. First, kind of question on the aftermarket, has there been any product categories that have been particularly strong or weak? Just wondering what you've been seeing on airlines spending priorities. And then also what you're seeing in the pricing environment in aftermarket.

Yeah, I think in general, our passenger sub-market, which is our largest sub-market has been strong as well as the cargo, as I noted in Q4 and sequentially ramped up across 2021. I don't think we have any data that would point it to a specific type of product or application. Generally, the airlines are starting to increase their flight schedules, which are positive, and they're ordering spares based on these.

Thank you. Then just to follow up on financial guidance. Just wondering what are the key improvements or catalysts that you might be looking for in the coming periods in the overall market for you to have the confidence and visibility to provide full financial guidance?

I believe we are seeing a recovery in the market with international travel picking up as more people are flying again, alongside ongoing domestic travel. While business travel represents a smaller portion of total flights, it remains crucial for airlines in terms of fleet management and capacity planning. We are focused on the acceptance of resumed international flight activities and further domestic recovery in various regions to align more closely with the U.S. situation, which is nearing pre-COVID levels by about 10% to 20%. These are the factors we are monitoring, although there are still many uncertainties. For example, China's flight activity fluctuates significantly from month to month as they implement and ease restrictions. Such variability makes it challenging for us to provide clear guidance. Nonetheless, we recognize that the market is steadily improving and progressing. Does that address your question?

Yes it does. Thank you for taking the question.

Sure.

Good morning, guys. Thanks for the time. Maybe I'll start off on EBITDA profitability going forward. Just in the absence of any major M&A and pretty good performance in the quarter. How do we think about medium-term EBITDA profitability levels, is 50% the new level? Then if you could just comment on expectations for free cash flow conversion.

I don't think we want to provide any long-term guidance. Generally, based on our analyst day, if we focus on the value drivers, EBITDA margins at TransDigm should improve by about 1 percentage point per year. If we come out of COVID, there’s a possibility that this could change. You might see better results if we lean more towards the commercial aftermarket, but over a long period, absent M&A, the base business should continue to improve by about a percentage point per year.

Okay. Cool. And then, I wanted to follow-up on a defense question earlier. You mentioned the IG report came to a close, which is a big accomplishment. Was there any impact to defense during that time? And then, as your peers have had softer defense volumes, are there certain areas that you're watching, just as cautionary, in defense?

I think there's a potential for some disruption on the IG side as the report comes out just with the government purchasing, maybe slowing down a little bit. We did see some of that in the past. But remember of the defense bucket, the direct to government isn't all that significant, right? We also sell more product internationally into Tier 1, so it doesn't comprise all of that bucket, but we do potentially expect some slowdown as the report comes out here.

Yes, it's possible. But we anticipate a similar process or similar conclusions to last time. We'll see as we're still in the dark on the reports and some of its details. We've had a very cooperative, I think, work process going on with the IG and the DOD. And I think we're in a good place, but we're anxious to get the report issued and move on with business.

Okay. Thank you.

Good morning. Thank you for the question. Regarding the commercial aftermarket, do you believe there is still pent-up demand for maintenance, similar to what we saw with airlines deferring maintenance during COVID, or has that situation already been resolved?

I think there's been speculation out there in terms of the airlines trying to prioritize certain maintenance activities. It's hard for us to know, and we don't get visibility on the inventory levels at the airlines. I think just the general improvement in the marketplace and more planes flying have led to some of the improvements we've seen across the whole fiscal year of 2021. And as Kevin and Mike noted, we again expect some sequential improvement from quarter to quarter as we go through fiscal year 2022.

Got it. Okay. Are your customers discussing the impact of higher fuel prices on maintaining their large park fleet? Have they made any decisions about whether to continue flying those planes, and does the higher fuel price influence that decision, or has that not been mentioned?

I don't think we've heard anything specific to decisions the airlines might be making regarding the higher fuel costs. I haven't heard anything from our teams.

Got it. Okay. Thanks.

Kevin, your comment that we should not be looking for share repurchase or special dividend in the next quarter. Can we interpret that to mean you see a reasonable likelihood of acquisition activity in that period of time? And then, if that doesn't play out, how quickly do you start to consider share repurchase or special dividend?

We cannot predict when the acquisitions will occur. Our approach has always focused on funding our internal investments and ensuring a return on that. We also consider potential acquisitions, with the goal of recovering that cash. We will pursue this in our usual manner. While we cannot forecast the timing of any acquisitions or what may arise, we understand that currently, we are waiting a bit longer before moving forward with dividends or share buybacks, likely until next quarter.

Okay. That makes sense. Yeah, I just wasn't sure how specific that was versus taking it quarter-by-quarter.

Yeah. I think next quarter is a decision point for us.

Okay. Makes sense. And then the commentary on bookings ahead of shipments by end-market. Do you happen to have the numbers on exactly where the book-to-bill is by end market in the quarter and year?

No, I don't have the exact numbers.

Okay. No problem. Thank you.

Thank you for the follow-up on a couple of questions. Regarding the book-to-bill in the aftermarket, it appears that for three quarters, we have seen bookings exceed shipments. I have two questions about this. First, are all shipments eventually booked? Therefore, is the book-to-bill a meaningful metric? Second, can you explain what's happening? It seems like there is an increase in backlog. Are customers ordering products for later delivery, suggesting a duration extension to the backlog that you are observing in the aftermarket? That's my first question.

Aftermarket orders are for more immediate shipments. But that doesn't mean they're all due tomorrow. So there is still a little bit of a range over when these things are due. That's why it bleeds over quarter-to-quarter. In general, I think we're optimistic, because we see bookings continue to improve. And that means growth in aftermarket as we go forward. And why we're planning on 20% to 30% possible aftermarket growth.

Fair enough. And just to that point, so you're actually probably seeing some visibility beyond December quarter, in terms of shipments? At this point in the aftermarket, is that unusual?

That's a fair comment. I don't think it's unusual. In a steady-state, we have airlines and distribution partners that we'll book some near-term and they also give us and the team some visibility on mid and longer-term needs.

Okay. But every book or shipment ultimately had a bookings, correct?

Yes, that is correct.

Okay. It's fair enough. Just want to make sure on the nomenclature. And then the other thing just to follow up on the earlier questions. Supply chain, did it actually impede your ability to deliver some sales? Did you leave some sales on the table or their delinquencies? And if so, can you quantify how much of catch-up opportunity that might be in fiscal 22?

Yes. I would say there was nothing material in terms of what was left at the dock, if you will. There's some noise here and there at a couple of operating units. But I don't think it provides a big tailwind as we go into FY22.

Okay. And one last thing, I'm sorry. Jorge, you might have mentioned that for next year, with a target of 6 times adjusted EBITDA and a free cash flow of a billion, the calculation would indicate approximately 2.4 billion in adjusted EBITDA based on that. Is that what you were trying to communicate, or are we just reiterating what we discussed earlier?

No. We're not providing guidance on that specific number; we're just giving you a general idea of the deleveraging, which is about one turn per year. However, if you are trying to back into the EBITDA guidance or something similar, it's not advisable because you won't arrive at the correct figure.

We believe that if we can fulfill orders faster and more reliably than anyone else, we will achieve the returns and value creation that both you and we expect. No other company can deliver that level of reliability. We just want to make it clear that there will always be fluctuations and challenges in this business.

I appreciate it, guys. Thank you.

Hey, thanks. Just a couple of quick one’s for you, Mike. First one is how much are you budgeting internally for TransDigm business travel spend next year relative to pre-COVID?

We're stepping up a little bit, but not quite to pre-COVID levels. I don't have the exact stats in front of me, but it's not quite back to 2019 levels, but it's more than 2020. For the most part, all of our folks here are back to traveling, whether it's M&A people pounding the pavement looking for deals or internal audit folks going out to OP units to do their work, we're not holding back at all here. It's pretty much full-go where we'd typically be, but it's slightly reduced headcount levels.

Business as usual, but some of our customers maybe aren't yet receiving us, but certainly within the Company, we are back to normal, yeah.

Okay. Alright, thanks. And then you mentioned a couple of projects on the CapEx line driving a little bit of higher spend, what are they? What business lines or is this defense, is this interiors, is it around freight? I mean, just not going to give any too much away, but what are the natures of these projects? Thanks.

I mean, generally we don't give that kind of detail. I could say as we continue to adjust our resource levels that puts additional pressures on increasing production rates. We've got a few teams investing in new technologies for automation projects, and then a handful of other projects across the ranch.

But the lion's share of this is productivity in new business related. It is not infrastructure nice-to-have kind of stuff, we are investing for payback and return. And that at the end of the day is the most important part of what we evaluate is what returns we are expecting as we invest a little more or less, we have to make sure we're still capturing those returns.

Okay. Thank you very much.

Hi. Good morning.

Good morning.

Everything about your comments and your expectations for aftermarket next year. How are you thinking about retirements with regards to that expectation?

We're not projecting a significant impact from retirements in 2022 as the teams prepare their individual plans.

Yeah. As you know, retirements have been very slow, and I think that has something to do with the stability of OEM supply and a ramp up in demand that doesn't allow retirements. I think that answers the question.

Great. Thank you very much.

Thank you all for joining us today. This concludes today's call. We appreciate your time. Have a good day.