Transdigm Group Incorporated (TDG) — Q2 2024 Earnings Call Transcript

Thank you, and welcome to TransDigm's Fiscal 2024 Second Quarter Earnings Conference Call. Presenting on the call this morning are TransDigm's President and Chief Executive Officer, Kevin Stein; Co-Chief Operating Officer, Mike Lisman; and Chief Financial Officer, Sarah Wynne. Also present for the call today is our Co-Chief Operating Officer, Joel Reiss. 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, everyone. Thanks for calling in today. First, I'll start off with the usual quick overview of our strategy, a few comments about the quarter and discuss our fiscal '24 outlook. Then Mike and Sarah will give additional color on the quarter. To reiterate, we believe we are unique in the industry in both the consistency of our strategy in both good times and bad as well as our steady focus on intrinsic shareholder value creation through all phases of the aerospace cycle. To summarize here are some of the reasons why we believe this. About 90% of our net sales are generated by unique proprietary products. Most of our EBITDA comes from aftermarket revenues, which generally have significantly higher margins and over any extended period have typically provided relative stability in downturns. We follow a consistent long-term strategy, specifically. First, 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 closely aligned with shareholders. Fourth, we acquire businesses that fit this strategy and where we see a clear path to PE-like returns. And lastly, our capital structure and allocations are a key part of our value-creation methodology. Our long-standing goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we stay focused on both the details of value creation as well as careful allocation of our capital. As you saw from our earnings release, we had a strong quarter. Our Q2 results ran ahead of our expectations, and we once again raised our guidance for the year. Commercial aerospace market trends remain favorable as the industry continues to recover and progress towards normalization. Global air traffic has surpassed pre-pandemic levels and demand for travel remains robust. Airline demand for new aircraft also remains high, and the OEMs are working to increase aircraft production. However, OEM aircraft production rates remain well below pre-pandemic levels. There is still much progress to be made for OEM rates and our results to continue to be adversely affected in comparison to pre-pandemic production levels. In our business, during the quarter, we saw a healthy growth in our revenues and bookings for all three of our major market channels, commercial OEM, commercial aftermarket and defense. Revenues and bookings also sequentially improved in all three of these market channels. Our EBITDA As Defined margin of 53.2% in the quarter, contributing to the strong Q2 margin is the continued strength in our commercial aftermarket along with diligent focus on our operating strategy, which is allowing margin performance to expand across all segments. Additionally, we had strong operating cash flow generation in Q2 of close to $230 million and ended the quarter with almost $4.3 billion of cash. We expect to steadily generate significant additional cash throughout the remainder of 2024. Next, an update on our capital allocation activities and priorities. Regarding the current M&A activities and pipeline, we continue to expect to close the Electron Device Business of Communications and Power Industries, which was announced on a prior earnings call, in fiscal year '24. We continue to actively look for M&A opportunities that fit our model. As we look out over the next 12 to 18 months, we continue to see an expanding pipeline of potential M&A targets. This remains a busy time, and we are actively expanding our M&A team to address these opportunities. As usual, the potential targets are mostly in the small and midsize range; I cannot predict or comment on possible closings, but we remain confident that there is a long runway for acquisitions that fit our portfolio. Please see our 10-Q for more detail on some smaller, but nicely accretive acquisitions that we recently closed. The capital allocation priorities at TransDigm are unchanged. Our first priority is to reinvest in our businesses; second, do accretive discipline to M&A; and third, return capital to our shareholders via share buybacks or dividends. Before the option of paying down debt seems unlikely at this time, though we do still take this into consideration. We are continually evaluating all of our capital allocation options, but both M&A and capital markets are difficult to predict. As always, we continue to closely monitor the capital markets and remain opportunistic. As mentioned earlier, we ended the quarter with a sizable cash balance of almost $4.3 billion, which includes the $2 billion of cash from new debt issued during our first quarter of fiscal '24. That debt was proactively raised for the acquisition of CPI's Electron Device Business and general corporate purposes. We have significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future. Moving to our outlook for fiscal '24. As noted in our earnings release, we are increasing our full fiscal year '24 sales and EBITDA As Defined guidance to reflect our strong second quarter results and our current expectations for the remainder of the year. At the midpoint, sales guidance was raised by $75 million and EBITDA As Defined guidance was raised by $60 million. The guidance assumes no additional acquisitions or divestitures and is based on current expectations for continued performance in our primary commercial end markets throughout fiscal '24. Our current guidance for fiscal 2024 is as follows and can also be found on Slide 6 in the presentation. Note that the pending acquisition of CPI's Electronic Device Business is excluded from this guidance until acquisition close. The midpoint of our fiscal '24 revenue guidance is now $7.74 billion or up approximately 18%. Regarding the market channel growth rate assumptions that this revenue guidance is based on, for the defense market, we are updating the full year growth rate assumptions as a result of our strong second quarter results and current expectations for the remainder of the year. For Defense, we now expect revenue growth in the mid-teens percentage range. This is an increase from our previous guidance of high single-digit to low double-digit percentage range. We are not updating the full year market channel growth rate assumptions for commercial OEM and commercial aftermarket as underlying market fundamentals have not meaningfully changed. Commercial OEM revenue growth is expected to be around 20%, and commercial aftermarket revenue growth is anticipated in the mid-teens percentage range. The midpoint of our EBITDA As Defined guidance is now $4.045 billion or up approximately 19% with an expected margin of around 52.3%. This guidance includes about 100 basis points of margin dilution from our recent Calspan acquisition. The midpoint of our adjusted EPS is increasing primarily due to the higher EBITDA defined guidance and is now anticipated to be $32.42 or up approximately 25% over prior year. Sarah will discuss in more detail shortly, the factors impacting EPS, along with some other fiscal '24 financial assumptions and updates. We believe we are well positioned for the second half of fiscal '24. We will continue to closely watch how the aerospace and capital markets continue to develop and react accordingly. Let me conclude by stating that I'm very pleased with the company's performance this quarter and throughout the recovery for the commercial aerospace industry. We remain focused on our value drivers, cost structure and operational excellence. Let me hand it over to Mike Lisman, our TransDigm Group Co-COO, to review our recent performance and a few other items.

Good morning, everyone. I'll begin with our usual overview of results by key market category. For the remainder of the call, I'll discuss the pro forma results compared to the previous year in 2023, assuming we have the same business mix in both periods. In the commercial market, which generally accounts for around 65% of our revenue, we will break down the discussion into OEM and aftermarket segments. Our total commercial OEM revenue rose about 21% in Q2 compared to the same period last year. Sequentially, total commercial OEM revenues increased by approximately 12% compared to Q1. Bookings for the quarter were strong relative to the same prior year period and continue to support the commercial OEM revenue growth guidance of around 20% for fiscal '24. Although OEM supply chain and labor challenges remain, they seem to be improving. Overall, we are encouraged by the strong demand for new aircraft from airlines. Supply chains are still the main bottleneck in ramping up OEM production. Concerns have recently emerged regarding the anticipated ramp-up in 737 MAX production rates, and we are cautiously monitoring this situation for any necessary adjustments to our current MAX order backlog in light of the reduced production rates. The commercial OEM guidance we are providing today includes an appropriate level of risk regarding the MAX production build rate for the remainder of our '24 fiscal year. While risks related to the 737 MAX and other factors exist for ramping up across the broader aerospace sector, we remain optimistic that our operating units are well-prepared to support higher production rates as they arise. Moving on to our commercial aftermarket business, total revenue increased approximately 8% compared to the previous year period. I want to elaborate more than usual on our commercial aftermarket submarkets because the differences in growth rates among them this quarter were notably larger than typical. The 8% growth rate was largely driven by continued strength in our passenger submarket, which is by far our largest segment, with growth of roughly 20% compared to the prior year. This submarket continues to perform exceptionally well, and we also observed good growth in our interior submarket, which grew at a similar rate compared to last year’s Q2. However, these increases were countered by declines in our freight and biz jet submarkets, with freight down about 15% and biz jet down around 5%. The decline in freight is primarily due to the ongoing return of belly capacity, as we've discussed in recent earnings calls. The decrease in biz jet is attributed to a reduction in biz jet flight activity, which has been declining since the pandemic peak. For the full year, our guidance for commercial aftermarket growth in the mid-teens remains unchanged. We are confident due to several factors, including strong Q2 bookings in commercial aftermarket, which exceeded our expectations and significantly outpaced sales, reinforcing our full-year growth outlook. Moreover, Q2 point of sales data from our distribution partners, a reliable leading indicator, rose significantly, well into double digits percentage-wise. It's important to remember that commercial aftermarket can experience fluctuations on a quarterly basis, both in revenue and bookings, though less erratically than the defense aftermarket. Our mid-teens percentage growth guidance for total commercial aftermarket still takes into account ongoing impacts from the cargo and biz jet submarkets for the remainder of this fiscal year. Turning to broader market trends and referencing the most recent IATA traffic data for March, global revenue passenger miles exceeded pre-pandemic levels for the first time in February 2024 and continued to rise in March. Air traffic in March 2024 was approximately 1% above pre-pandemic levels, and IATA anticipates that traffic will reach 104% of 2019 levels in 2024. Domestic travel consistently exceeds pre-pandemic levels, with global domestic air traffic up 6% compared to that same period. This growth has been significantly driven by strong performance in China, which reported a 14% increase in March compared to pre-pandemic. This marks a substantial improvement from last year when China was down 3% in March 2023. In the U.S. domestic market, air travel in March was around 4% above pre-pandemic traffic. International traffic has shown steady improvement over the last few months, and slightly surpassed pre-pandemic levels for the first time in February. The data for March indicates that international travel was down just 2% compared to pre-pandemic levels, a marked improvement from being down about 18% a year ago. In conclusion, for the commercial aftermarket, we continue to witness growth in our passenger and interior submarkets, reflecting the positive trends in the post-COVID recovery of passenger traffic. Our biz jet and freight submarkets are performing as we anticipated based on current market conditions. Now, regarding our defense market, which traditionally constitutes about 35% of our total revenue, defense market revenue, inclusive of both OEM and aftermarket, grew by approximately 21% compared to the prior year period. Q2 defense revenue growth was well-distributed across our various businesses and customer segments, with the aftermarket component growing slightly faster than the OEM component. We do not expect to maintain defense revenue growth rates at this level for the remainder of the year, and anticipate some moderation based on our guidance today. Defense bookings significantly increased this quarter relative to the previous year and support our revised defense revenue growth guidance for the full year. Additionally, we experienced growth in U.S. government defense spending, and we are optimistic about continued growth in this area. However, as we’ve noted before, defense sales and bookings can be variable. We understand that bookings and sales will materialize, but accurately forecasting them, especially quarterly, is challenging. As previously mentioned, we now project our defense market revenue growth for this year to be in the mid-teens percentage range. This updated forecast mainly reflects stronger-than-expected Q2 defense sales and positive bookings in the same period. In closing, I want to express my satisfaction with our operational performance in the second quarter of fiscal '24. While we experienced some variability in our most profitable segment, the commercial aftermarkets, our teams executed exceptionally well on our value drivers, delivering strong results this quarter. Our management remains dedicated to our consistent operational strategy and meeting the robust demand for our products as we proceed through the remainder of the year. I will now hand it over to our CFO, Sarah Wynne.

Thanks, Mike, and good morning, everyone. I'll recap the financial highlights for the second quarter and then provide some more information on the guidance update. First, on organic growth and liquidity. In the second quarter, our organic growth rate was 16.1%, and all market channels contributed to this growth as Mike and Kevin have just discussed. On cash and liquidity, free cash flow, which we traditionally define as EBITDA less cash interest payments, CapEx and cash taxes, was roughly $290 million for the quarter, coming in around $950 million on a year-to-date basis. As a reminder, our fiscal Q1 free cash flow was higher than average due to the timing of our interest and tax payments. For the full fiscal year, our free cash flow guidance is unchanged. We continue to expect to generate free cash flow of approximately $2 billion in fiscal 2024. Below that free cash flow line, net working capital consumed $82 million, driven by accounts receivable with the higher sales in the quarter and inventory as we support the second half of our year. We continue to expect our annual dollars invested in net working capital to moderate from the elevated levels we've seen over the prior 2 years, but pinpointing an exact dollar amount of investment for fiscal '24 is difficult. We ended the quarter with approximately $4.3 billion of cash on the balance sheet, and our net debt-to-EBITDA ratio was 4.6x, down from 5x at the end of last quarter. As a reminder, approximately $1.4 billion of this cash is reserved for the anticipated closing of the CPI acquisition. We continue to be comfortable operating in the 5 to 7 net debt-EBITDA ratio range, and while we are currently sitting slightly below the low end of this range, our go-forward strategy of capital deployment has not changed, and we continue to see the best opportunities for providing value to our shareholders through our leverage strategy. Our EBITDA to interest expense coverage ratio ended the quarter at 3.4x on a pro forma basis, which provides us with a comfortable cushion versus our target range of 2x to 3x. During the quarter, we completed a few financing objectives, including pushing out our nearer-term debt stack along with repricing approximately $6 billion of our term loan debt from SOFR plus 3.25% to SOFR plus 2.75%. This financing activity effectively pushes out our nearest term maturity date by 2 fiscal years for fiscal 2028. Our capital allocation strategy is always to both proactively and prudently manage our debt maturity stack, and these actions accomplish that. The financing activities slightly reduced our interest expense for fiscal '24, reducing expense by $12 million or $25 million on an annualized basis. However, as you'll note, our guidance for the interest expense has decreased by $60 million, primarily driven by the interest income we received year-to-date and project for 2024. We remain approximately 75% hedged on our total $22 billion gross debt balance throughout fiscal '26. This is achieved through a combination of fixed rate notes, interest rate caps, swaps and collars. This continues to provide us adequate cushion against any rise in rates at least in the immediate term. With regard to guidance, as Kevin mentioned, we increased our midpoint sales and EBITDA by $75 million and $60 million, respectively, given the strong quarter and current expectations for the year, along with increasing our EBITDA margin guidance from 52% to 52.3%. Our adjusted EPS guidance is now $32.42 compared to the prior guidance of $30.85. As we sit here today from an overall cash, liquidity and balance sheet standpoint, we think we remain in good position with adequate flexibility through M&A or return cash to shareholders via dividends or share repurchases. With that, I'll turn it back to the operator to kick off the Q&A.

Kevin, I was wondering if you could touch on the aftermarket growth rate in the quarter and the reacceleration implied in the back half of the year? And in particular, if you can parse out the freighter complement to that. I think GE on their call actually raised their freighter outlook for the year on aftermarket. So I'm not trying to align two different data points. But just what you're seeing overall? And I know you said that the guidance incorporates drag for the rest of the year, but is it fair to think that, that drag becomes less and less.

Sure, Myles, it's Mike. I'll take that one. Overall, with regard to commercial aftermarket, we had a very solid bookings quarter. We significantly outpaced sales in the segment, commercial aftermarket overall, which sets us up well nicely for the back half and the mid-teens percentage growth for the year that we mentioned. Passenger and interior were both ahead of our expectations. A bit more color on the freight point and to address some of your questions there, we were down about 15%. That was about what we expected, maybe a little bit worse than we had foreshadowed, I think, on the last two calls. I think, as you guys know, we have about three operating units that fall into that freight bucket and facilitate the movement of freight on aircraft, both past and full freighters as well as the belly cargo systems. And that submarket, it's about plus or minus depending on the quarter, 15% or so of our commercial aftermarket bucket. We weight a bit more towards freighter in that bucket. And I think as you guys know, within the freight market, there's been a trend away from freight being carried within full freighters and more towards the belly of the passenger capacity that's coming back into the market on passenger aircraft, the belly systems. And specifically, we've got a couple of operating units that, as I said, they're a bit more freighter weighted. And as that market has trended off and we've seen a shift more towards belly, they've seen a bit of a decline in some of their product sales. It tends to be stuff that's slightly lower margin for us across our commercial aftermarket than the rest of that bucket. So there's not too much of a margin drag or impact as a result of it. But you see the sales decline, and that's part of what drove the 15% drop. For the balance of the year, we do see that continuing in the back half. We factored that into our guidance, and we feel good about the mid-teens percentage rate growth, given the strength we've had in the bookings. But on the freight side, we do expect to see some continued headwinds here in the back half of the fiscal '24 year.

This is Scott Mikus on for Rob Spingarn. Kevin, to follow up on Myles' question, airlines have been flagging elevated turnaround times in MRO shops, particularly for engines. So I'm just wondering, are any of your operating units getting the sense that volume growth on components for engines isn't as high as they would expect, just because throughput at the MRO shops isn't as fast as it was pre-COVID.

It's Mike again. We have not really seen much of that action. I think we've seen pretty good strength across all of our different products, both on engine and off engine across the commercial aftermarket at this point of the fiscal year. But I would say we probably have lower exposure to engine aftermarket as a percentage of our business.

Okay. Got it. And then on the defense end market, historically, you've characterized it as a low single-digit organic grower. Armtec has seen some large awards and contracts related to munitions and artillery. Army wants to increase 155-millimeter artillery production to 100,000 shells per month by late 2025. So how should we be thinking about the long-term growth trajectory for your defense sales going forward?

I think you guys know we have an Analyst Day coming up in June, and we don't want to go ahead and give long-term guidance by submarket outside of this year. We do feel good about the mid-teens percentage growth range this year for defense. We're seeing that strength across the OEM and aftermarket. It's pretty broadly distributed across all of our operating units. But Armtec, in particular, has had some good flare shipments this year as well as some new product out of their California facility, which is the 155-millimeter program that you mentioned. That growth should continue for a couple of years. You might have seen in the Department of Defense budget documents for the next 2 years or so. So we remain optimistic about the growth outlook there, but it's not really driven by just one or two operating units. It's been pretty evenly distributed across our full group. As we said, we don't expect defense growth of 20% or so that we've seen in the first half of this year to continue; there's just got to be some moderation there. This is always lumpy. Fortunately, for us, in the first half of this year, it's been lumpy to our benefit, probably a bit better than we expected, but we do expect some moderation in the long-term. It's not going to grow anywhere close to 20%.

I wanted to see either Mike or Kevin, if you could drill down maybe somewhat on the defense commentary. I can appreciate the lumpiness, but is there anything in particular you saw in the first half, either things pulled to the left or sort of an acceleration in shipments that specifically gives you reason to be more cautious on the second half? I can appreciate the step-down in guide probably reflects some conservatism to get to the full year growth. But just wondering if there's anything you'd call out relative to just a track record of lumpiness and conservatism as you think about the second half of the year.

I think we always strive to be conservative in our guidance. We did bring, obviously, our guidance up for the year. But I take your point that on a quarter basis, that would imply we're going back down. It's difficult to predict. I think what we're seeing is finally the backlog, the demand that is clearly in the defense market space coming out. They're finally placing the orders for this product. We would anticipate that this will be a good tailwind for us, but it's hard given the lack of visibility at times in the defense industry to predict it so accurately. So we don't want to get out over our skis on really any of our submarkets; we choose to be a little bit more conservative as we break things up.

Appreciate that. And if I could then, Kevin, maybe one other way to think about it is how much of your defense aftermarket, in particular, would you classify as short cycle versus sort of backlog-driven?

I think defense aftermarket tends to be different than commercial aftermarket. It can be longer cycle, but there are still drop-ins that happen everywhere.

This is Josh Corn on for David. I wanted to ask in the guidance. Why would EBITDA margins in the second half drop from Q2 on what appears like it would be a similar mix to the second quarter?

I think we're comfortable not providing quarterly guidance on these matters. We're confident in our position for the year. Yes, business can fluctuate. We were pleasantly surprised by the EBITDA this quarter. We're uncertain about how future quarters will progress. However, our intention is to remain conservative. So that's our current forecast that we are maintaining.

Okay. And then I just wanted to follow up on the first question about sequential aftermarket in the second half. Are you baking in any sequential improvement? Or is it just easier comps in Q3 and Q4?

I think we don't tend to give quarterly guidance by end market. But I think, as you guys know, if you look at how we did in the first half in commercial aftermarket, what's implied for the second half, you'd expect probably Q4 to be the highest and some ramp up as we proceed through the balance of the year on the commercial aftermarket.

Kevin, just on M&A. Is there optimism on the pipeline more about the next 12 to 18 months? Or are you still optimistic about the pipeline for the second half of this year specifically?

I'm optimistic about the future. It's difficult for me to unpack it into quarterly buckets. I remain optimistic about what the future holds for M&A. And our M&A tracker that I follow constantly, it has the most names. It's the busiest we've probably ever been in M&A. Again, it doesn't tell you what's going to close. We remain very picky in the businesses that we choose, and we will continue to do that. We have a lot of activity in the small and medium size. We announced two in our 10-Q today that are smaller sized businesses, but nicely accretive, as I said in my opening comments, yes, there's a lot going on out there. We're very busy.

Great. And then Mike, you're seeing really good leverage on gross margins, but SG&A has been growing. It looks like a bit faster than sales, at least over the last few quarters. So I'm curious if you could talk a bit about what's driving that SG&A expense growth to outstrip sales? And then when we should expect to see better operating leverage on that line specifically?

Yes, I can speak to that one. A large portion of what you see is some of that increase on the noncash stock compensation that plays into it. When you look at that just the raw sales, which you'll see in the quarterly and it's published later today, you'll see actually the spend going down.

I was wondering if you could expand upon your comments in the prepared remarks about differences in the distribution channel versus what you're seeing direct. So maybe if you could just tell us a little more where you're seeing better sell-through and if that's applying to the freighter market or not yet, etc.?

The trends we observe through our point of sale with our distributors do not always align perfectly with our direct sales. Currently, about 20% to 25% of our CAM sales go through distribution. This can fluctuate, but it generally serves as a reliable indicator of future orders since distributors deplete their inventory held for us, allowing us to quickly serve customers and then necessitating replenishment. While quarterly sales may not always align perfectly, over time, point of sale data tends to provide a fairly accurate forecast of the overall commercial aftermarket direction. This gives us confidence in our outlook for the commercial aftermarket for the remainder of the year.

And can you comment on biz jet and freighter specifically? Do you think we're in the early innings of that business declining? Or what's your expectation for when that might actually turn positive again in the aftermarket?

I think it's hard to say. It depends on where the freighter market goes. But generally, with the belly capacity having come back, you'd expect 2024 to be the year where we take the most of the decline on the full freighter business. We had a great runoff during COVID on the freighters, and now the market is just sort of correcting back to the 2019 levels in terms of what goes via full freighter and what goes via belly. So 2024 is going to be probably the biggest year for that correction curve.

Nice results. I want to circle back on Joel, you gave some comments about just how some of the passenger travel markets were doing, you talked about China. Could you maybe talk about if you're seeing any aftermarket perspective on a regional basis? Or any color international versus domestic, if you're seeing any big differences?

We don't get great split-outs by region when it comes to our commercial aftermarket sales. A lot of the IATA data, we referenced, basically supports the highest growth rates being in China and Asia. A lot of that would go via our distributors. We don't get great visibility into it. We're, of course, benefiting from it. I think we've seen that in the booking strength we have, but we don't get great data by region.

Okay. That's helpful. Just was curious. And then just could you give us an update on what you're seeing in the supply chain? Obviously, it's been something that has slowly improved, but it's always an important factor, I assume? And just any color on what you're seeing in the latest in the supply chain.

I'd say it continues to get better, not back to where it was in 2019 yet, but better than where it was 12 months ago and 24 months ago. We continue to have issues with items like certain electronics, castings, certain chemicals or materials, but continued progress.

This might be for Kevin. Your comments on the Boeing situation on commercial OEM that you've pointed out on what you said 3 months ago. I was wondering if you did actually reduce your Boeing expectations this quarter? And if you did, only being offset or it must be offset by something else, right?

I'll respond to that, Rob. In the commercial OEM sector, our performance in the first half exceeded our full-year guidance, showing an increase of about 23%. We remain cautious about the outlook for commercial OEM overall, and our OEM forecast reflects a reasonable level of risk regarding a potential change in Boeing's production rates. Our forecast is evidence-based, originating from the insights of our operating units rather than a top-down directive regarding production rates for the MAX, which might be around 38. It's developed from the specific circumstances that each unit is experiencing. Additionally, much of our content for those aircraft does not go directly to Boeing but is often directed to sub-tier suppliers, who may independently make decisions based on their own observations. Overall, we are optimistic about our guidance for the year around 20%, and we have accounted for any potential reductions in the guidance provided today. It is also important to note that Airbus continues to perform well, which may help offset any shortfall from Boeing in the near term.

Yes. And then just as a follow-up, Kevin, on your comment about your M&A tracker and it being as busy as you can remember. What do you think is driving that? And is there any sort of change given the amount of target or any change to the pricing that you're seeing being discussed?

Yes. I wish I knew that. It would help me when things slow down to better understand. It just seems to be a busy time right now, whether that's expectations around the market segment. I don't know, and it's difficult for me to speculate. It's just a busier time. We haven't changed our standards or our expectations at all. We still view business the same way we have since the beginning. So you can only swing at the pitches that get thrown as Nick used to say years ago, and that's still true today.

I was curious if you could help me better understand if you are assuming that freight is a drag inside of the aerospace aftermarket in the back half. How does the total aftermarket growth rate accelerate in the back half? Is biz jet and helicopter and the passenger side, faster growth in the back half? Or is it just the comps or something else?

I believe I can provide some insights, Noah, that hopefully address your question. We've observed strong growth in the passenger segment, and we expect that to continue based on bookings for the second half of the year. On the freight side, we've experienced some softness in bookings, which indicates a likely slight decline in that area for the second half. The business jet segment was slightly up in the first quarter but down in the second, resulting in overall flat growth for the year. We anticipate that it may improve a bit in the latter half. However, the primary driver of strength in the commercial aftermarket is the continued robust performance in passenger and interior sectors, which represent the majority of the commercial aftermarket. This strength is helping to offset some weaknesses we’re seeing in other areas as we look toward the next six months.

Okay. Yes, I guess it sounds like you're qualitatively directionally saying you expect passenger and freight to do something similar in Q3 and Q4 as they did in Q2, but for the aggregate segment or end market growth rate to accelerate somewhat significantly. But I guess if passenger is a little better, freight is a little better and the comp is easier, maybe that gets you there.

I think that's right. Yes.

Okay. Did the rate of change in price change very much in the aftermarket in the second quarter?

Not appreciably, no. I think we always, as you guys know, we seek the price slightly ahead of inflation. And that's unchanged. This quarter, same expectation as we always have for our operating units and what the teams look to execute on.

Well, I think we don't spend enough time talking about or emphasizing the gains we've made in productivity. We are down thousands of heads compared to where we were at very much comparable volumes approaching comparable volumes. That's real productivity as we have been reluctant to add back and driving engineering productivity projects in our facilities that is clearly having an impact on our EBITDA.

Yes, you can definitely see that in the margins. Okay. Kevin, you mentioned adding people to the M&A team. Can you quantify that? Like how many people relative to the base or what kind of percentage increase you're making? Just curious there.

Yes. We are looking to add one or two more people to our M&A team. We are encountering a lot of interesting smaller-sized deals, and these small deals require as much time to process as larger ones. Therefore, we need additional support to manage them. Hopefully, this will create more opportunities for us as we are seeing new deals come across our desks that we haven't encountered before.

First, I wanted to speed up another aftermarket question. It's been asked several ways. But up 8%. If we take out freight, which is 15% of your aftermarket, just an assumption there, that's 2 points of a headwind. How do we think about where peers were averaging about 15% on the quarter and you guys at 10% and you having more price power, how do we think about what held aftermarket back outside of freight and biz jet?

I think on a quarterly basis, you can always see a little bit of lumpiness as we said here before. I'm not sure how exactly to follow the math on the 2% drag. But as we said today, we saw really strong bookings across our whole business; that can be lumpy. We feel really good about the outlook for the full year with the mid-teens percentage growth there.

Yes. I mean, we sequentially booked more in the aftermarket. We're seeing robust bookings in aftermarket on the commercial side. I think we feel optimistic, right?

Okay. Great. And then Kevin, I had to buy myself some time to do that math on the headcount productivity you just gave us. So I think headcount is 15% below 2019 levels, while sales are up significantly above 2019. So with that productivity benefit in mind, how do we think about EBITDA margins decelerating 100 basis points half over half in the second half?

Yes, I understand your point. We aim to be cautious in our forecasts and are committed to maintaining our yearly EBITDA outlook. We experienced strong performance in the second quarter, and we will monitor how the remainder of the year progresses. Currently, we are not aware of any major negative factors, so our approach remains one of usual caution. We are not trying to overlook any concerning trends. Our bookings have been solid across all segments, with positive momentum in OEM, commercial OEM, commercial aftermarket, and defense. We maintain an optimistic outlook.

Kevin, in previous Investor Days, you've talked about how TransDigm had about 400,000 PMA SKUs. And I think there was a point in time you were averaging something like 20,000 SKUs per year. I guess this has been a few years ago since you've disclosed this. I was wondering if you could size PMA today as a percent of your portfolio and also in an environment where the supply chain is still struggling and you're clearly able to produce parts. Can you provide more color on where that is, that market and how attractive you think it is?

I think we can give more update and color on this topic at our Investor Day coming up at the end of June. But just from a top level, we don't consider PMAs to be a significant impact on our business. We have somewhere around 500,000 part numbers that we sell across commercial and defense. We do monitor it regularly. We are the largest creator of PMA parts in our space that we sell into on our products; that's how you sell into the aftermarket. So I think it's a similar situation to what we've seen in the past. The opportunities exist for us to replace other struggling suppliers. We certainly see that. Again, PMA and used and serviceable materials aren't a significant impact on our business on a regular day-to-day basis. It doesn't mean that there aren't some parts that are more impacted, but on a go-forward basis, it's a very, very small leak in our business, if you will.

Thanks, Kevin, and Sarah, if I could follow up on leverage. I mean, you guys are clearly investing in your M&A team with the headcount add. But if there are no incremental deals to fund in the near and medium term, how do you think about the split between paying a special dividend versus doing more share buybacks?

Yes. I mean, obviously, we look at both of those, obviously, the first and foremost is to invest the capital in our businesses and do M&A, and then we look at those two, and we look at them all the time. And obviously, we're sitting on plenty of cash, as you know. So at some point in the future, we look to make a decision on which one makes sense and what best to do with the cash.

I think we paid a dividend in Q1 and we will likely make a decision in Q4 this year about our plans.

I think you had previously alluded to volume growth within aftermarket in 2025. And if we look ahead a bit further, is that still your view? And is there anything you could call out that needs to happen to meet the strong demand within aftermarket that we're seeing and continue to grow volumes, just given some of the constraints that we're seeing out there right now?

Sorry, is the question about whether 2025 commercial aftermarket volume growth will continue?

Yes, that's right.

I think, generally, as you look at the forecast from IATA, the investment bank forecasts that are out there, generally folks are expecting RPMs and takeoffs and landings to continue to tick up next year. That said, it's at a moderating pace relative to what it's been in the past couple of years as we come out of COVID. So there's still growth but maybe not quite as high as it was in say, 2022. We've already seen some of that moderation. But yes, of course, if you look at IATA forecasts and other forecasts, the world is flying a lot. People continue to fly. That's reflected in takeoffs and landings and expected RPM growth. So we very much expect as a result of that continued volume growth in commercial aftermarket.

And then just on capital allocation on your priority of reinvesting in the business. Could you talk to what areas of the business you expect to invest the most or anything you're targeting, whether it be bottlenecks or just any way to frame the organic investments you're making?

Yes, our primary investment focus has been on automation projects aimed at enhancing productivity, as Kevin mentioned earlier. We previously stated that we would not gradually add back costs as we emerged from COVID, and we have adhered to that. This is evident in our current headcount. The teams in our operating units have excelled at identifying valuable automation initiatives, including collaborative robots, material handlers, and new machining centers, which have helped increase automation in their facilities while reducing headcount and overall costs. This is why we are seeing improved margins this quarter.

I'm on for Michael Ciarmoli. I just had a follow-up on the question on Boeing production expectations. I appreciate the color you gave on the bottoms-up approach to your forecast. But could you share any specifics on what monthly rate you would estimate you are currently producing to for the MAX on average? And just directionally, what assumptions are embedded in your guidance there for the balance of the year?

I think it varies a lot operation unit by operating unit based on the demand they're seeing from their customers. Obviously, sometimes that subtiers, as we said. So it's hard to go and back calculate into some kind of rate. I'd expect that something around 38, maybe a little bit less, but it's hard to say there's some kind of averaging exactly what it is across their ranch.

Okay. Understood. And then just as a follow-up, has the uncertainty around OEM production and some of the delayed deliveries we've heard about showed up in any meaningful way in your bookings? Have you seen any shift in the bookings environment between commercial OEM and aftermarket?

No. Continued good strength that supports the guidance on both.

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