TransDigm Group Incorporated (NYSE:TDG) Q4 2023 Earnings Call Transcript
TransDigm Group Incorporated (NYSE:TDG) Q4 2023 Earnings Call Transcript November 9, 2023
TransDigm Group Incorporated beats earnings expectations. Reported EPS is $8.03, expectations were $7.51.
Operator: Good day, and thank you for standing by. Welcome to the TransDigm Group Incorporated Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jaimie Stemen, Director of Investor Relations. Please go ahead.
Jaimie Stemen: Thank you, and welcome to TransDigm's fiscal 2023 fourth 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.
Kevin Stein: Good morning. Thanks for calling in today. First, I'll start off with the usual quick overview of our strategy. A few comments about the quarter and discuss our fiscal 2024 outlook. Then Mike and Sarah will give additional color on the quarter. As we previously announced on October 27, we had two Directors retired from the TransDigm Board, Merv Dunn and John Staer. Merv has served on our Board since 2009 and John since 2012. We sincerely appreciate both Merv and John's dedication to TransDigm over the years. They each have done an outstanding job as Directors and truly contributed to the long-term value creation of TransDigm. Considering these two Director retirements, our Board is now comprised of 10 Directors.
For the near-term, we feel our Board size of 10 is appropriate and composed of highly qualified leaders with the appropriate skill sets to oversee and guide TransDigm. However, as we always do, we will continue to regularly assess the Board composition into the future. Now moving on to the business of today. To reiterate, we believe we are unique in the industry in both the consistency of our strategy in good times and bad as well as our steady focus on intrinsic shareholder value creation through all phases of the aerospace cycle. To summarize here are some of the reasons why we believe this. Our 90% of our net sales are generated by unique proprietary products. Most of our EBITDA comes from aftermarket revenues, which generally have significantly higher margins, and over any extended period, have typically provided relative stability in the downturns.
We follow a consistent long-term strategy, 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 allocation 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 closed out the year with another good quarter. We had solid operating performance in Q4 with both total revenue and EBITDA as defined margin coming in strong. For the full-year fiscal 2023 revenue came in at the high end of our most recently published guidance and our fiscal 2023 EBITDA as defined margin surpassed that guidance. Commercial aerospace market trends remain favorable as the industry continues to recover and progress towards normalization. Global air traffic is still moving forward and demand for travel remains high. OEMs are making steady headway on aircraft production. However, total air travel remains slightly below pre-COVID levels and OEM aircraft production rates remain well below pre-pandemic levels.
There is still progress to be made for the industry and our results continue to be adversely affected in comparison to pre-pandemic 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 also sequentially improved in all three of these market channels. Our EBITDA as defined margin was 52% in the quarter. Contributing to the strong margin is the continued recovery in our commercial aftermarket revenues along with our strict operational focus and disciplined approach to cost structure management. Additionally, we had good operating cash flow generation in Q4 of over $460 million and ended the quarter with close to $3.5 billion of cash.
We expect to steadily generate significant additional cash through 2024. Next, an update on our capital allocation activities and priorities. As was mentioned in our press release, we've decided to pay a special dividend of $35 per share. The dividend will be paid on November 27. Sarah will address this more later. In aggregate, including Calspan acquisition completed this past May, and this dividend to be paid in late November, we have allocated over $2.7 billion of capital in the interest of our shareholders in under seven months. Also, we disclosed in our press release earlier today, we agreed to acquire the Electron Device Business of communications and power industries, also known as CPI, for approximately $1.385 billion in cash. CPI's Electron Device Business is a leading global manufacturer of electronic components and subsystems primarily serving the aerospace and defense market.
The products manufactured by this business are highly engineered proprietary components with significant aftermarket content and a strong presence across major aerospace and defense platforms. CPI's Electron Device Business generated approximately $300 million in revenue for its fiscal year ended September 30, 2023. The acquisition is currently expected to close by the end of the third quarter of our fiscal 2024. As mentioned earlier, we are exiting fiscal 2023 with a sizable cash balance of close to $3.5 billion. Pro forma for the dividend, our fiscal year end cash balance is over $1.4 billion and growing. As always, we continue to closely monitor the credit markets and we will be assessing opportunities to utilize leverage for the acquisition of CPI's Electron Device Business and general corporate purposes, which may include potential future acquisitions, share repurchases under our stock repurchase program and dividends.
Regarding the current M&A pipeline, 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 have a slightly stronger than typical pipeline of potential targets and remain encouraged concerning deal flow. 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. As we move into our new fiscal year, the capital allocation priorities at TransDigm are unchanged. Our first priority is to reinvest in our businesses; second, do accretive disciplined M&A; and third, return capital to our shareholders via share buyback or dividends.
A fourth option paying down debt seems unlikely at this time, though we still do take this into consideration. Moving to our outlook for fiscal 2024. The guidance assumes no additional acquisitions or divestitures and is based on current expectations for a continued recovery in our primary commercial end markets through fiscal 2024. Throughout fiscal 2023, we were encouraged by the recovery seen in our commercial revenues and strong booking trends. Our strong bookings support the fiscal 2024 commercial end market revenue guidance, which I will comment on shortly. Trends are positive across all three of our major market channels, commercial OEM, commercial aftermarket and defense. We are cautiously optimistic that the prevailing conditions will continue to evolve favorably.
We will watch this closely as we always do. And will react as necessary, including taking any preemptive steps that might be warranted. Changes in market condition and the impact to our primary end markets could lead to revisions in our guidance for 2024. Our initial guidance for the fiscal 2024 continuing operations is as follows and can also be found on Slide 7 in the presentation. The pending acquisition of CPI's Electron Device Business is excluded from this guidance. The midpoint of our fiscal 2024 revenue guidance of $7.58 billion or up approximately 15%. As a reminder and consistent with past years, with roughly 10% less working days than the subsequent quarters, fiscal 2024 Q1 revenues, EBITDA and EBITDA margins are anticipated to be lower than the other three quarters of 2024.
This revenue guidance is based on the following market channel growth rate assumptions. We expect commercial OEM revenue growth around 20%. Commercial aftermarket revenue growth in the mid-teens percentage range and defense revenue growth in the mid to high single-digit percentage range. The midpoint of fiscal 2024 EBITDA as defined guidance is $3.94 billion or up approximately 16% with an expected margin of around 52%. This guidance includes about 100 basis points of margin dilution from our recent Calspan acquisition. We anticipate EBITDA margin will move up throughout the year, with Q1 being the lowest and sequentially lower than Q4 of fiscal 2023. The midpoint of adjusted EPS is anticipated to be $31.97 or up approximately 24%. Sarah will discuss in more detail shortly the factors impacting EPS along with some other fiscal 2024 final assumptions and updates.
We believe we are well positioned as we enter fiscal 2024. As usual, 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 am very pleased with the company's performance this year and throughout the recovery for the commercial aerospace industry. We remain focused on our value drivers, cost structure and operational excellence. We look forward to fiscal 2024 and expect that our consistent strategy will continue to provide the value you have come to expect from us. Now let me hand it over to Mike Lisman, our TransDigm Group Co-COO, to review our recent performance and a few other items.
Mike Lisman: Good morning. I'll start with our typical review of results by key market category. For the remainder of the call, I'll provide commentary on a pro forma basis compared to the prior year period in 2022, that is assuming we own the same mix of businesses in both periods. In the commercial market, which typically makes up close to 65% of our revenue, we will split our discussion into the OEM and aftermarket. Our total commercial OEM revenue increased approximately 22% in Q4 and 24% for full fiscal year 2023 compared with the prior year periods. Sequentially, total commercial OEM revenues grew by about 4% compared to Q3. Bookings in the quarter were strong compared to the same prior year period. This strong bookings throughout fiscal 2023 supports the commercial OEM guidance for revenue growth of around 20% for fiscal 2024.
OEM supply chain and labor challenges persist, but appear to be slowly progressing. We continue to be encouraged by the steadily increasing commercial OEM production rates at Boeing and Airbus and the strong airline demand for new aircraft. Supply chains remain in the bottleneck in its OEM production ramp-up. While risks remain towards achieving this ramp-up across the broader aerospace sector, we are optimistic that our operating units are well positioned to support the higher production targets. Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 27% in Q4 and 31% for the full fiscal year 2023 compared with the prior year periods. Growth in commercial aftermarket revenue was primarily driven by the continued strength in our passenger submarket, which is by far our largest submarket.
We also saw growth in our interior and biz jet submarkets compared to prior year Q4. These increases were minimally offset by a slight decline in our freight submarket. The post-COVID return to flying globally continues and is buoyed our primary commercial aftermarket submarkets, passenger, biz jet and interior, while the now sustained global softness in declines in global freight volumes, seen over the past year plus likely contributed to the minor decline in the freight submarket that we saw this quarter. Sequentially, total commercial aftermarket revenues increased by approximately 2%. Commercial aftermarket bookings for this quarter were strong compared to the same prior year period. And in the full 2023 fiscal year, these commercial aftermarket bookings exceeded sales nicely.
The strong bookings levels in commercial aftermarket over the past 12 months support our commercial aftermarket guide for revenue growth in the mid-teen percent range for fiscal 2024. As a reminder, when forecasting our commercial aftermarket, we always look at rolling historical 12-month average booking trends, never just the most recent quarter, due to some lumpiness that we can often see and have historically seen in this end market. This lumpiness is not quite as big as what we can see in the defense end market, but it is there nonetheless. Turning to broader market dynamics and referencing the most recent IATA traffic data for September. Global revenue passenger miles still remain lower than pre-pandemic levels, but growth in air traffic over the past few months has continued to signal steady recovery momentum.
Globally, a return to 2019 air traffic levels is still expected in 2024. Domestic travel continues to surpass pre-pandemic levels. And the most recently reported traffic data for September, global domestic air traffic was up 5% compared to pre-pandemic. Domestic air travel in China continues to improve and was up 8% in September compared to pre-pandemic. This is a significant improvement from China being down 55% only 9 months ago in December. We did not expect such a steep ramp-up in China activity this past year, and it was a nice surprise. Shifting over to the U.S. Domestic air travel for September came in 6% above pre-pandemic traffic. International traffic has continued to make strides over the past few months. A quarter ago, at the end of June, international travel globally was depressed about 12% compared to pre-pandemic levels, but in the most recent data for September, this travel was only down about 7%.
Now some quick color on our commercial aftermarket submarkets, starting with the biz jet submarket. Business jet utilization is below the pandemic highs reached in 2021 and continues to temper. Overall, global business jet activity does remain above pre-pandemic levels by about 10% to 15% and time will tell how this normalizes over the upcoming months. Within our biz jet submarket, our revenue was well above pre-COVID levels. Next, on the cargo submarket. As a reminder, this is one of our smaller submarkets within the commercial aftermarket bucket. Global air cargo volumes have continued to struggle and after 19 straight months of year-over-year declines, just returned to flattish to slightly positive growth these last two months. Cargo Ton-Kilometers, CTKs have been below pre-pandemic levels.
Additionally, full freighter aircraft are being used less now and have seen an increase in part rates due to the return of belly-cargo capacity on the passenger side. As mentioned on our last earnings call, we've started to see some booking softness in the freight submarket of our commercial aftermarket, likely as a result of the sustained declines in CTKs and the full freighter market challenges that I referenced. One quick aside to summarize what is currently going on in our commercial aftermarket submarkets and how we, as a management team, think about it. If you take a step back and look at how things have trended from pre-COVID to the present over the past four years. At COVID's onset, we saw a precipitous drop at first in the passenger submarket, followed shortly thereafter by a big run-up in freight to levels well in excess of pre-COVID activity.
After a few years of seeing these trends, these markets are now in various stages of returning back to their original trend lines. Passenger traffic continues to surge back and with it, belly-cargo, while full freighter cargo aircraft traffic is dropping back to trend. We are happy to see this dynamic. Passenger is by far our largest submarket within the commercial aftermarket and we win on this trade-off between full freighters and passenger. Shifting to 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 15% in Q4 and 11% for the full fiscal year 2023 compared with the prior year periods. This full-year defense revenue growth exceeded our last guidance expectation of growth in the mid to high single-digit range that we gave on the last call.
Sequentially, total defense revenues grew by approximately 9%. Defense bookings are also up significantly this quarter compared to the same prior year period. We continue to see improvements in the U.S. government defense spend outlays, which is reflected in our defense revenue and bookings performance this quarter. We are hopeful we will continue to see steady improvement. But as we have said many times before, defense sales and bookings can be lumpy. We know the bookings and sales will come, but forecasting them with accuracy and precision is difficult. Lastly, I'd like to finish by recognizing the strong efforts and accomplishments of our 49 op unit teams during fiscal 2023. It was a good year, and we are pleased with the operating performance they delivered for our shareholders.
As we enter our new fiscal year, our management teams remain committed to our consistent operating strategy and servicing the now very strong demand for our products. With that, I'd like to turn it over to our CFO, Sarah Wynne.
Sarah Wynne: Thanks, Mike, and good morning, everyone. I'm going to review a few additional financial matters for fiscal 2023 and then also our expectations for fiscal 2024. First, a few additional fiscal 2023 data points on organic growth, taxes and liquidity. In the fourth quarter, our organic growth rate was 18.5%, driven by the continued rebound in our commercial OEM and aftermarket end markets. On taxes, our GAAP and adjusted tax rate finished the year within their expected ranges. Our fiscal 2023 GAAP rate was 24% and the adjusted rate was just under 25%. On cash and liquidity, free cash flow, which we traditionally defined as EBITDA less cash interest payments, CapEx and cash taxes was roughly $1.8 billion for the year, higher than the $1.4 billion we had originally expected, driven primarily by the good operating performance that Kevin and Mike mentioned, and the extra EBITDA we generated above our original guidance carries over to cash flow.
As Kevin mentioned, we ended the year with approximately $3.5 billion of cash on the balance sheet or over $1.4 billion when pro forma for the $35 dividend. At year-end, our net debt-to-EBITDA ratio was 4.8x, down from the 5.3x at the end of last quarter. Pro forma for the $35 per share dividend announced this morning, our net debt-to-EBITDA ratio is 5.4x. The dividend payment date is expected to be November 27. We continue to watch the rising interest rate environment closely. We remain 80% hedged on our total $20 billion gross debt balance through a combination of interest rate caps, swaps and collars through 2025. This provides us adequate cushion against any rising rates, at least in the immediate term. Our EBITDA to interest expense coverage ratio, which, as a reminder, becomes more important in a higher interest rate environment and is a metric we actively monitor and take into consideration in these times of elevated interest rates ended the year at 3.1x on a pro forma basis, which sits comfortably in line with our pre-COVID average range of 2x to 3x.
We continue to be comfortable operating the business within these brackets. With regard to any potential changes to our long-term approach to using debt to boost our equity returns, we are actively watching the interest rate environment closely, but do not anticipate any big changes in our approach at this time. Next, on the fiscal 2024 expectations, I'm going to give some more details on the financial assumptions around interest expense, taxes and share count. Special note that all of my comments and data here include the payment of the $35 dividend, but exclude the acquisition of CPI's Electron Device Business entirely, which is still subject to regulator approval, and we expect to close by the end of our third quarter in fiscal 2024. Net interest expense is expected to be about $1.25 billion in fiscal 2024.
And this equates to a weighted average cash interest rate of approximately 6.3%. This estimate assumes an average SOFR rate of 5.4% for the full-year. On taxes, our fiscal 2024 GAAP, cash and adjusted tax rates are all anticipated to be in the range of 22% to 24%. The slight decrease in our tax rate versus the prior year is due mainly to the additional interest expense we are able to deduct for tax purposes, given our higher expected EBIT for 2024. On the share count, we expect our weighted average shares outstanding to be 57.8 million shares in 2024. With regard to liquidity and leverage for fiscal 2024, as we would traditionally define our free cash flow from operations at TransDigm, which again, is EBITDA as defined less cash interest payments, CapEx and cash taxes, we estimate this metric to be close to $2 billion in fiscal 2024.
With regard to the dividend, the $35 per share payment announced this morning represents a gross payout of just over $2 billion. The record date for the special dividend is November 20, and the payout date is expected to be November 27. After paying out the $35 per share dividend in cash and assuming no additional acquisitions or capital market transactions, we would end the year with over $3 billion of cash on the balance sheet, which would imply a net debt-to-EBITDA ratio close to 4x at the end of fiscal 2024. However, this excludes the acquisition of CPI's Electron Device Business which is still subject to regulator approval, and we expect to close by the end of our third quarter in fiscal 2024. As Kevin mentioned at the outset, we are actively monitoring the capital markets and assessing opportunities to utilize leverage for this acquisition and general corporate purposes, which may include potential future acquisitions, share repurchases or dividends.
And as a reminder, there has been no change in our approach to how we think about capital allocation or leverage with our typical target in the 5% to 7% net debt ratio range. We will continue to watch this ratio along with the cash interest coverage ratio of EBITDA to interest expense as we actively pursue options of maximizing value to our shareholders through our capital allocation strategy. So a final note on that, we think we remain in good position with adequate flexibility to pursue M&A or return cash to our shareholders via share buybacks and/or additional dividends during the course of fiscal 2024. With that, I'll turn it back to the operator to kick off the Q&A.
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