Hello, thank you for standing by and welcome to the Second Quarter 2022 TransDigm Group Incorporated 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. 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.

Thank you. And welcome to TransDigm's fiscal 2022 second quarter earnings conference call. Presenting on the call this morning are TransDigm's 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 the 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 from Cleveland, and 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 discussion of our fiscal 2022 outlook. Then Jorge and Mike will give additional color on the quarter. To reiterate, 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: 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 the downturn. 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 organizational structure and unique compensation system, closely aligned with shareholders. We acquire businesses that fit this strategy and where we see a clear path to PE like returns. Our capital structure and allocations are a key part of our value creation methodology. Our longstanding 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 another 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 Q2 results show positive growth in comparison to the same period in 2021,…

Thanks, Kevin. I'll start with our typical review of results by key market category. For the remainder of the call, I will provide color/commentary on a pro forma basis compared to the prior year period in 2021. That is assuming we own the same mix of businesses in both periods. Any acquisitions are included in both periods and the impact of any divestitures is removed in both periods. 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 28% in Q2, compared with the prior year period. Bookings in the quarter were strong, compared to the same prior year period and again significantly out pays sales. Sequentially, bookings improved almost 10%, compared to Q1 with sales improving almost 15%. While 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. Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 46% in Q2 when compared with the prior year period. Growth in commercial aftermarket revenue was primarily driven by increased demand in our passenger sub market, which is our largest sub market, although all of our commercial aftermarket sub markets were up significantly compared to prior year Q2. Sequentially, total commercial aftermarket revenues and bookings both grew by approximately 10%. Commercial aftermarket bookings were up this quarter, compared to the same prior year period and Q2 bookings strongly outpaced sales. To touch on a few key points of consideration, global revenue passenger miles remain depressed. There was a modest sequential decline in revenue passenger miles in January due to the Omicron variant and a tough comparison…

Good morning, everyone. I'm going to quickly hit on some additional financial matters for the quarter and also our expectations for the full fiscal year. First, in regard to profitability for our second quarter, EBITDA As Defined of about 633 million for Q2 was up 22% versus prior Q2. EBITDA As Defined margin in the quarter was approximately 47.7%. This represents year-over-year improvement in our EBITDA As Defined margin of about 420 basis points versus Q2 of last year. Sequentially, the margin increased by 40 basis points versus last quarter and we expect this improvement to continue for the balance of the fiscal year. Next, a few additional comments on select financial metrics for the quarter and again also the full-year. Organic growth was 15% for the quarter, driven by the rebound in our commercial OEM and aftermarket end markets. On taxes, we're revising our expected adjusted tax rate for this fiscal year downward slightly to a range of 24% to 26%. Our GAAP and cash tax rates guidance is unchanged and still expected to be in the 21% to 23% range. Moving over to cash and liquidity, we had another quarter of positive free cash flow. Free cash flow, which we traditionally define at TransDigm as EBITDA As Defined less cash interest payments, CapEx and cash taxes was roughly $222 million. As noted in the press release, this amount was slightly lower this quarter, but this is just timing. Specifically, due to the quarter-end date of April 2, we picked up an extra cash interest payment that was made on April 1. In addition, we had higher cash tax payments in the quarter. As we mentioned before, cash tax payments, and cash interest payments can be lumpy across the quarters. For the full fiscal year, our free cash flow…

Thank you. Our first question comes from Robert Stallard with Vertical Research. You may proceed with your question.

Yes, thanks so much and good morning.

Good morning.

Kevin, I just wanted to follow-up on your comments on China and what sort of percentage revenue exposure you're having there or have there already at the moment? And also if there is any sort a short-term impact you've already experienced in terms of bookings from this impact of the COVID locked?

So, China and bookings commentary, China, well China is in our numbers now. Obviously, we've seen depressed flight activity in China. Although Asia is starting to show some green shoots, of activity in the rest of Asia. So, remain encouraged there. This should be some, sort of upside for us, hard to gauge how much as the future unfolds as China starts flying domestically and internationally. On bookings, I think we remain encouraged on – aftermarket bookings continue to increase and so do OEMs, so does the defense, defense had very strong bookings as you heard Jorge comment on. It's why we remain confident and optimistic on the year for defense spending.

That's great. Thank you.

Thank you. Our next question comes from Noah Poponak with Goldman Sachs. You may proceed.

Hi, good morning everyone.

Good morning.

Your aerospace aftermarket growth has now exceeded the industry average for a few quarters in a row coming off the bottom and that was after declining very in-line with the industry average on the way down. Can you also, I guess compared to flight activity that's true as well. So, can you spend a little bit more time on why your aerospace aftermarket business is growing faster than the end market right now and how sustainable that is?

I think that orders and shipments can be lumpy. The supply chain is not efficient. I don't have any exact commentary on why we might be outperforming today. I know at times we can appear to outperform and at times underperform, it's just the inefficiencies of the market.

Okay. Fair enough. And Kevin, could you spend a little bit more time on how you're thinking about capital deployment at the minute? I mean, I know you touched on in prepared remarks, but with the share repurchase, how do you think about the size of that that's appropriate and how do you balance the decision of that versus the special dividends that you've done in the past?

Well, we've historically done share repurchases. It has happened in the past sizable repurchases. We're looking at this, as I said in my comments, opportunistically, as a way to get capital back out to the shareholders. We're not thinking about it any differently. We're evaluating all options on the table. There are M&A opportunities and when we determine that the time is right, we will move forward with other capital deployment in terms of M&A deals or share repurchase dividends. There's no magic formula to decide which will do, it's kind of as we decide as we go, but everything's on the table right now.

Are there prospects for sizing that up given you've brought the leverage down and in the scenario where there is not deal activity, say through the end of the year, would you look at even larger repurchases?

Well, we have pre-authorization from the Board to go to. I believe 2.2 billion in share repurchases. We've used 667 million of that, I think it depends on the opportunities that come along. Again, we model this just like an acquisition and we see similar returns. We're evaluating all options. I can't comment much more than that. We want to ensure we have enough dry powder to do any deals that we see coming along of any sizable extent.

Okay. Thank you. Appreciate it.

Thank you. Our next question comes from Robert Spingarn with Melius. You may proceed with your question.

Hey, good morning. Kevin, what's the latest on the labor side, both recruiting and attrition, and to what extent is this a constraint?

Yes, I'll take that, Rob. From our perspective, we're seeing some pressures at the lower levels of direct labor in general. As most of you know, most of the labor requirements really are driven by the commercial OEM, so we think we're properly resource to support the improvement in the commercial aftermarket. I wouldn't say that we've seen any significant uptick in turnover on the engineering staff, it's a little bit more of a competitive marketplace. But as always, we're going to be cautious in adding back resources as it's still a little bit of a dynamic situation.

Okay. And then just Kevin, at a high level on defense, has your long-term outlook for defense sales growth and the low single digits changed given the latest defense budgets and obviously, the evolving National Security Environment in Europe and elsewhere?

Well, I think we're optimistic about defense budgets in the future. It obviously takes a while for that to trickle down to us as a component supplier, but we do see a favorable environment shaping up for us in the future on defense.

Okay. Thank you.

Thank you. Our next question comes from Myles Walton with UBS. You may proceed.

Hey, good morning. I was wondering, Kevin, you said that your commercial aftermarket would track ahead of the targeted 20% or 30% range, it looks like if you just maintained flat for the rest of the year, you're closer to 40%, do you want to put a new bogey out there or is it just greater than what you previously said?

Yes, I think I said to that we want to say on that, we're not giving guidance. I did say in my prepared remarks that we would – we see outperforming that 20% to 30% resource planning target. We are not – the market isn't so stable right now that we're going to go out on a and communicate higher where we tend to be conservative in our guidance and there is still book and shift that has to happen. So, we're sticking with, you know we're going to outperform the 20% to 30% that we initially gave at the year, but not put a finer point on it right now.

Okay. Any reason to think sequentially you can't grow? And then the other question is just on pricing, what's the base level inflation you're currently passing through? I’m not asking about your net price, just sort of your base level inflation benchmark? Thanks.

Well, pricing we don't comment on specifics. Our goal is that we need to overcome inflation. Inflation as you've seen from CPI values is running very high historically over many decades. It is a focus and what part of our job is to evaluate and to pass along the inflationary pressures that we see. So far, we have been successful in doing that.

Okay. Alright. Thanks.

Thank you. Our next question comes from Gautam Khanna with Cowen. You may proceed.

Hey, thanks. Good morning, guys.

Good morning.

I was wondering on the defense side, you saw the big pickup in bookings was it sort of broad based, was it isolated to a couple of product areas. I know you've talked about it as being lumpy in the past, but how representative of ongoing demand do you think the quarter’s bookings were?

Yes. We think it was in general broad based in nature. There wasn't one or two specific programs driving that. In general, we saw the pickup with the passage of the DoD budget throughout the quarter. So, we expect that there may be a little bit of catch up that the DoD and DLA are playing there with that delay.

Interesting. And then, do you then expect that because some of these funds have to be put on contract by the fiscal year end of the government will see sustained bookings in the next, are you still seeing that if you will that trend has continued into the third fiscal quarter and would you expect it to?

In general, these can be lumpy. So, we're not in a position to comment on whether we're seeing any increases right now and what we hope we're being cautious here, but time will tell.

I think we're seeing an uptick in aftermarket defense out

weighted towards the market. That's fair.

Okay. I’ll leave it there. Thank you.

Thank you. Our next question comes from David Strauss with Barclays. You may proceed.

Thanks. Good morning. Kevin, just to level set, there’s is been some acquisitions, some divestitures, is your commercial transport aftermarket still down about 15%, 20% from kind of pre-pandemic levels? Is that the right level?

We aren't splitting out the pieces. All of the key market segments have gone up and are doing better. We're not splitting out the segments. That activity though has, I think increased the most in any of the sub markets so far.

Okay. And what about, you talked about passenger being the strongest, what are you seeing on the interior side?

Interiors has also improved quite surprisingly. The only, I think as Jorge touched on, the only sector that is still growing, but starting to slow its growth a little bit was the freight as we've already heard there would be some slowdowns, but interiors, all of the sub markets are up until the right. It's the first time I think we've seen something that pronounced across all of the sub markets.

Okay. And Mike, the lost amortization, how does that play out over the next year? Does it kind of hold at these levels or does that start to start to bleed off?

Sorry, the lost contract amortization from the acquisition? It starts to bleed down. I think you probably remember when we came out with it. We expect something in the area of $30 million to $40 million a year or so and it trails off. So, as we get further out, you're right, that amount will continue coming down. And then it ends about five years post deal, completely.

Okay. Great.

Well, you'll see that continue to trend down a bit.

Okay. Got it. Thank you.

Thank you. Our next question comes from Ken Herbert with RBC Capital Markets. You may proceed.

Hey, Kevin, good morning. I just wanted to follow-up on the aftermarket bookings comment. Is it fair to assume from your comments that you probably saw some of the softness in cargo related bookings in the quarter relative to transport or Business jets and helicopters or can you parse-out the bookings for the aftermarket in the quarter any further?

Hey, Ken. This is Jorge. I'll take this one. Yes, in general, as we've noted, we saw decent recovery across all the sub markets. There wasn't any specific concentration in any particular market and we’re cautiously optimistic that that will continue. As you know, we don't get any visibility to the inventory levels at the airlines.

And how are you viewing inventory levels maybe across the industry either with your own operations at distributors? And then of course, it's sounds like your , you don't how much visibility, but how do you view inventory levels of the distribution and your own shop floors?

Yes, we have limited views on inventory at distribution. I think, in general, we believe that the destocking cycle is kind of running out of gas and everyone is hopeful with the commentary from the airlines on a busy summer travel season and trying to prepare accordingly.

Great. Thanks, Jorge.

Thank you. Our next question comes from Matt Akers of Wells Fargo. You may proceed.

Hey, good morning. Thanks for the question. Could you talk about the defense so the full year guidance implies, kind of a big acceleration in the back half on year-over-year basis, can you talk about what that looks like sequentially like Q2 versus second half? Just wondering if there's like a year-over-year comparison that makes that look bigger than it kind of really is?

Yes, I think we don't want to get into given quarterly guidance on defense revenue outlooks, but generally as Jorge mentioned, there were such strengths in the booking and as we look out over the next two quarters that we feel pretty confident that we're going to be able to hold a low single digit range for the year. So, Q3 and Q4 will be quite a big ramp up to your point, but in terms of forecasting how big each quarter? I don't think we want to get on the quarterly the expectations…

But with defense bookings up 30%, clearly that's why we're still sticking with what we communicated at the beginning of the year. As Jorge alluded to, the budget just being signed, things are opening up a bit, we'll see.

Got it. Thanks. And then I guess the supply chain disruptions there within you kind of touched on this earlier, but are those – are there signs that those are easing and does that need to, kind of get fixed to hit that guidance or is there upside there if those get better?

Yes. I mean as I noted, primarily what we're seeing are difficulties on the electronic components. We would anticipate there's probably still some headwinds, excuse me and challenges in the second half, but we do expect with six months to go that we’ll be able to clear fair amount of those. The teams are working the details daily and communicating with the customer base. So, we think we can get there by the end of the year.

Okay. Thank you.

Thank you. Our next question comes from Seth Seifman with JPMorgan. You may proceed.

Hey. Thanks very much and good morning.

Good morning.

Kevin, when you think – how should we think about the role of being opportunistic in terms of the amount of share repurchase you're going to do from here to gather that, call it that outlook for the company probably hasn't changed very much from what it was in the March quarter. And the stock market is just doing all kinds of weird stuff right now. So, I'd imagine that return proposition in your guys probably looks better today. So, should we expect you to continue to be very opportunistic in that regard or is there just a lot more to think about in terms of balancing that with other potential uses of the cash?

I think we – I'll let Mike chip in on this as well. We will be opportunistic. We will keep all the options on the table. As we said, clearly the return would be better at this share price. We remain very bullish on the business. So, as we see the market recovery. Mike, do you want to add anything to that?

We're always looking at all options, every week, everything's on the table.

Right. Okay, okay, great. And then I guess just as far as M&A opportunities, you guys have made at times acquisitions in Europe and with the increase in defense spending there, does that become a place where you might spend a little bit more time looking for opportunities or not so much?

We actively look for opportunities around the world. Certainly in Europe, we're always evaluating opportunities. I don't think we want to be, grow defense exposure. We're a commercial aerospace company and we will continue to look for those opportunities and value them generally higher than defense opportunities, but all options are open on the table including in Europe where we've had excellent luck doing acquisitions.

Great. Thank you very much.

Thank you. Our next question comes from Kristine Liwag with Morgan Stanley. You may proceed.

Hey, good guys.

Good morning.

When we started looking at air traffic, it seems like it's starting to pick up. International travel starting to open up to, and in this quarter, we saw the engine guys post after-market growth of above 20%, 30%, how are you guys thinking about the opportunity in other parts of the aftermarket where you're not as present? For example, the opportunities in engine PMAs, how are you thinking about those things? Do those become more attractive in environments like today?

We are not a big PMA player. We are heavily a engineered product developer. So, I'm not sure we're looking at getting out of our comfort zone or the products that we make to get into other areas of aerospace unless acquisitions lead us there.

I see. That's really helpful context. And maybe if I could do a follow on, I mean, Kevin, in a rising interest rate environment, if we're going to be here for longer, how do you think about the sustainable leverage for the business? Do you have a target in mind?

I would just say, and I'll let Mike jump in that even in this rising interest rate environment, it's still historically very low interest rates. So, there's a long way for us to go. It's not changing my mentality around capital allocation or debt? Mike, do you have…?

No, I think that's right. And we're hedged as you guys know too. So, the near term impact of any rise in rates is somewhat muted just by the impact, the offsetting impact of the hedges.

Great. Thanks Kevin. Thanks Mike.

Sure.

Your next question comes from Peter Arment with Baird. You may proceed.

Yes. Good morning everyone. Mike, I want, maybe just a clarification on the working capital comment you made, the 200 million to 275 million kind of going back in the networking capital, you're saying kind of attracts to commercial markets, so we've seen a big recovery for you. How – what's the right way to be thinking about that? Is it spread over multiple quarters or we see that come in stronger in the second half of this year?

I think it'll be spread over multiple quarters and it's hard to say, right? It sort of attracts the revenue and where we go with the end markets and things have been so lumpy there that it's hard to pinpoint exactly where working capital is going to go, but there's still 200 some that will have to go back into working capital when you look at the receivables, inventory, and payables balances. That's how we look at it. From peak-to-trough, we were down about 400 million during COVID, so somewhere on the order of like 130 million or so or 150 million or so has gone back in to date, but we've still got 200 to 275 more to go and the pace over which it happens, we'll see, right. It depends on how commercial recovers.

That's really helpful. And then just related to that, I guess, Kevin, do you see yourself just more strategically carrying a little more inventory just because of the supply chain comments you guys have talked about with the electronic side?

We've certainly encouraged our teams not to skimp on inventory in this environment that not having necessary inventory and not being able to complete a sale is not acceptable. So, if we need a little bit extra to help us bridge through this time, we've certainly told our teams to look at those options.

Appreciate all the color. Thanks.

Thank you. Our next question comes from Pete Skibitski with Alembic Global. You may proceed.

Good morning, everyone. Just one for me. Can you guys talk a little more, just about kind of the relative risks and opportunities with regard to your adjusted margins next year or so because it seems like now for this year, you're only, call it a point or so below prior peak? And certainly you've got volumes on your side going forward, maybe you talk about the magnitude of the mix shift necessary to keep margins flat or should we be pretty confident that you're going to break through prior peak?

You know, it's hard to say and I think we'll give guidance when we go back to giving guidance as far as next year goes, but generally you guys know the way we like to run the business. We should always see our margins given some stability in the end markets, March upward each year. By exactly how much is just hard to say, given where commercial aftermarket is, and how the mix shift there can impact your margins, but generally obviously should trend upward, but at this point, I don't think we want to say by how much, hard to do.

Okay. No, thanks for the color.

Operator? Did we lose our operator?

Thank you. Our next question comes from Michael Ciarmoli with Truist Securities. You may proceed.

Hey good morning guys. Nice results.

Good morning. Sorry about that.

No worries. Maybe Kevin, just to kind of go back a little bit to Noah’s line of questioning and even maybe dovetail kind of Myles’ questioning on pricing. I mean, do you guys think you're outperforming due to having better pricing practices than your peers and there's been some chatter out there I guess from some of your customers that you guys are considering a mid-year price hike, do you think if that's the case, do you think you're seeing some ordering ahead of that price hike, and I don't know if it's called restocking, but maybe airlines customers just trying to trying to get in under that. If that's, if you can comment?

Yes, Michael, this is Jorge. I'll take that one. In general, we don't provide specifics about our pricing. Our long-standing approach has been to get real prices above inflation. Obviously, we're generally in a higher inflationary environment and the goal is still the goal. So, we're trying to get some real prices increases above that inflationary level. And that's how we approach it.

Got it. Got it. And then any thoughts on, I know it kind of came up, but thoughts on airlines, restocking, I mean, it seems with supply chain tightness, everybody is looking to have some inventory on-hand, so not necessarily over ordering, but do you think there's a little bit of that going on in the marketplace to kind of have that buffer stock available?

I think in general terms as supply chain issues arise in any industry, right, and any good buyer would try and get some inventory on the shelf to what extent airlines, distributors are doing that, we just don't have enough visibility there.

Okay. Fair enough. Thanks guys. Appreciate it.

Thank you. Our next question comes from with Jefferies. You may proceed.

Hi guys, good morning. Just on , you were up pretty significantly quarter-over-quarter, but when we look at what the OE’s have been saying is pretty but the Max is expected pretty steady around 31 per month and ongoing headwinds for the 787, is there opportunity for sequential improvement from here or how do we think about that business?

Yes. I think in general, as Mike commented earlier, we don't provide any guidance on a quarter-to-quarter basis. Obviously Boeing recently announced their expectations in terms of increasing the 737 Max production rate, I think later this quarter, and they continue to work with the FAA in resolving the outstanding issues on the 787. But across our entire business space, everyone has different lead times and where they may enter and see those future rate increases depends by business.

Okay. And just on the supply chain in the commercial side of the business, is there any area where longer lead times may limit growth?

Right now, we don't see any issues supporting the growth on the commercial side. It's been a little bit more concentrated on our defense businesses, and again towards electronic components, the teams have been pretty active over the prior couple of quarters trying to adapt and adjust their MRP’s as they need to plan for additional supply and anything that might happen, but we do not see that limiting our growth prospects at all.

Thank you.

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Jaimie Stemen for any further remarks.

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

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.