TransDigm Group Incorporated (NYSE:TDG) Q2 2024 Earnings Call Transcript

TransDigm Group Incorporated (NYSE:TDG) Q2 2024 Earnings Call Transcript May 7, 2024

TransDigm Group Incorporated beats earnings expectations. Reported EPS is $7.99, expectations were $7.42. TDG isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by. Welcome to TransDigm Group Incorporated Second Quarter 2024 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 like now to turn the conference over to Jaimie Stemen, Director of Investor Relations. Please go ahead.

Jaimie Stemen: 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.

Kevin Stein: 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 2024 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 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 unique compensation system closely aligns 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 longstanding goal is to give our shareholders private equity-like returns with 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 has 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 a fiscal year 2024 closure of the Electron Device Business of Communications & Power Industries, also known as CPI, which was announced on a prior earnings call.

We continue to actively look for M&A opportunities that fit our model. As we look out over the next 12 months 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.

A fourth option, 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 2024. 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 2024. As noted in our earnings release, we are increasing our full fiscal year 2024 sales and EBITDA defined guidance to reflect our strong second quarter results and our current expectations for the remainder of the year. At the mid-point, sales guidance was raised $75 million and EBITDA as defined guidance was raised $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 2024. 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 Electron Device Business is excluded from this guidance until acquisition close.

The mid-point of our fiscal 2024 revenue guidance is now $7.74 billion, or up approximately 18%. In regards to 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 and commercial aftermarket revenue guidance is still based on our previously issued market channel growth rate assumptions.

We expect commercial OEM revenue growth around 20% and commercial aftermarket revenue growth in the mid-teens percentage range. The mid-point of our EBITDA 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 mid-point 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 2024 financial assumptions and updates. We believe we are well-positioned for the second half of fiscal 2024. We’ll 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.

Mike Lisman: Good morning, everyone. 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 2023. 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 OEM and aftermarket. Our total commercial OEM revenue increased approximately 21% in Q2 compared with the prior year period. Sequentially, total commercial OEM revenues grew by about 12% compared to Q1. Bookings in the quarter were strong compared to the same prior year period. These booking levels continue to support the commercial OEM guidance for revenue growth of around 20% for fiscal 2024.

OEM supply chain and labor challenges persist, but appear to be progressing. Broadly speaking, we continue to be encouraged by the elevated and healthy airline demand for new aircraft. Supply chains remain the primary bottleneck in this OEM production ramp up. As many of you know, concerns have recently arisen around the expected 737 MAX production rate ramp. Time will tell how this plays out. At this time, we remain cautious and are watching for a potential realignment of our current MAX order backlog to reflect the lower production rates. The commercial OEM guidance we are giving today contains an appropriate level of risk around the MAX production build rate for the balance of our 2024 fiscal year. While both the 737 MAX risk as well as other risks remain towards achieving the ramp up across the broader aerospace sector, we’re optimistic that our operating units are well-positioned to support the higher production rates as they occur.

Now, moving on to our commercial aftermarket business discussions. Total commercial aftermarket revenue increased by approximately 8% compared with the prior year period. I would like to provide a bit more color than is typical on our commercial aftermarket submarkets, as the variation in growth rates seen this quarter across those submarkets was much larger than usual. The 8% growth rate mentioned was primarily driven by the continued strength in our passenger submarket, which is by far our largest submarket. Growth in our passenger submarket was roughly 20% versus the prior year period, and this submarket continues to perform exceptionally well. We also saw good growth in our interior submarket of about the same rate when compared to prior year Q2.

These increases were offset by declines in our freight and biz jet submarkets. Freight was down roughly 15% and biz jet was down in the 5% area. The freight decline was primarily a result of the continued return of belly capacity, consistent with what we discussed on our past few earnings calls. The biz jet decline is a result of tempering biz jet flight activity, which has continued to come down from the pandemic hubs. For the full year and as you saw in today’s guidance, our outlook for commercial aftermarket growth in the mid-teens is unchanged. We saw a number of elements in our Q2 results that make us confident. Mainly Q2 bookings in commercial aftermarket were strong, running ahead of our expectations, significantly outpacing sales and supporting the full year growth outlook.

Additionally, our Q2 point of sales data through our distribution partners, which can be a decent leading indicator, was up significantly, well into the double-digits on a percentage basis. Finally, a reminder, commercial aftermarket can be lumped on a quarterly basis both revenue and the bookings not as lumpy as defense aftermarket, but lumpy nonetheless. Finally, note that our guide for mid-teens percentage growth across our total commercial aftermarket, given today still incorporates the continued drag from the cargo and biz jet submarkets for the balance of this fiscal year. Now, turning to broader market dynamics and referencing the most recent IATA traffic data for March. Mobile revenue, passenger miles surpassed pre-pandemic levels for the first time in February 2024 and continued to do so in March.

March 2024 air traffic was about 1% above pre-pandemic and IATA currently expects traffic to reach 104% of 2019 levels in 2024. Domestic travel continues to surpass pre-pandemic levels. In the most recently reported traffic data for March, global domestic air traffic was up 6% compared to pre-pandemic. Domestic air travel growth has been driven significantly by outsized growth in China, which was up 14% in March compared to pre-pandemic. This is a significant improvement from China being down 3% a year ago in March of 2023. Shifting over to the U.S. domestic market, domestic air travel for March was about 4% above pre-pandemic traffic. International traffic has continued to make steady improvements over the past few months. It slightly surpassed pre-pandemic levels for the first time in February.

In the most recently reported data for March, international travel was down just 2% compared to the pre-pandemic levels, and this marks a significant improvement from being down about 18% one year ago. In summary, for the commercial aftermarket, we continue to see growth at our passenger and interior submarkets indicative of the continually positive trends in the post-COVID passenger traffic recovery. Our biz jet and freight submarkets are as we’d expect in light of the current trends in their underlying markets. Now 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 21% compared with the prior year period.

Q2 defense revenue growth was well distributed across our businesses and customer base. Additionally, we saw similar rates of growth in both the OEM and aftermarket components of our total defense market, with aftermarket running slightly ahead of the OEM. We do not expect to see defense revenue growth rates at this 20% plus level continuing for the balance of the year, and we expect some moderation or tempering here as you can tell from the guidance given today. Defense bookings were up significantly this quarter compared to the same prior year period and support the revised defense revenue growth guidance for the full year. Additionally, this quarter we saw growth in U.S. government defense spend outlays. We’re hopeful we’ll continue to see steady growth here, 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, especially on a quarterly basis is difficult. As Kevin mentioned earlier, we now expect our defense market revenue growth for this year to be in the mid-teens percentage range. This updated guidance for defense primarily reflects stronger than expected Q2 defense sales, as well as the good Q2 bookings. Lastly, I’d like to wrap up by expressing how pleased I am by our operational performance in the second quarter of fiscal 2024. Even though we saw some lumpiness in our most profitable end market commercial aftermarket, our operating unit teams did an exceptional job of executing on our value drivers to generate the strong results delivered this quarter.

Our management teams remain committed to our consistent operating strategy and servicing the robust demand for our products as we continue through the balance of the year. With that, I’d like to turn it over to our CFO, Sarah Wynne.

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 that Mike, 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, a fiscal year 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, networks and capital consumed $82 million, driven by AR with the highest sales in the quarter and inventory as we support the second half of our year. We continue to expect our annual dollars invested in networking capital to moderate from the elevated levels we’ve seen over the prior two years, but pinpointing an exact dollar amount of investment for fiscal 2024 is difficult. We ended the quarter with approximately $4.3 billion of cash on the balance sheet and our net debt to EBITDA ratio is 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 five to seven 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 seek the best opportunities for providing value to our shareholders through our leverage strategy. Even if the interest expense coverage ratio ended the quarter at 3.4x on a pro forma basis, which provides us with 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 stacks, 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 dates by two fiscal years, so fiscal 2028, our capital allocation strategy is always to both proactively and prudently manage our debt maturity set, and these actions accomplish that.

The financing activity slightly reduced our interest expense of fiscal 2024 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 2026. 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 mid-point sales and EBITDA by $75 million and $60 million respectively given 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 to pursue M&A or return cash to our shareholders by dividends or share repurchases. With that, I’ll turn it back to the operator to kick off the Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions]. The first question comes from Myles Walton with Wolfe Research. Your line is open.

Myles Walton: Thanks. Good morning.

Kevin Stein: Good morning.

Myles Walton: Hey, 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?

Mike Lisman: 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 as we mentioned. Passenger and interior were both not the 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, and we foreshadowed it, I think on the last two calls. I think, as you guys know, we have about three op units that fall into that freight bucket and facilitate the movement of freight on aircraft, both passing 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 wait 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 we specifically, we’ve got a couple of op units that, as I said, they’re a bit more freighter weighted. And at 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 2024 year.

Operator: One moment for the next question. The next question comes from Robert Spingarn with Melius Research. Your line is open.

Scott Mikus: Thank you. Hi, 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 a 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?

Mike Lisman: Hi, 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.

Kevin Stein: But I would say we probably have lower exposure to engine aftermarket as a percentage of our business.

Scott Mikus: 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?

Mike Lisman: 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 some market 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 op units. But Armtec in particular has had some good flare shipments this year, as well as some more than project 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 some of the Department of Defense budget documents for the next two 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 the defense growth of 20% or so that we’ve seen in the first half of this year to continue. There 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%.

Operator: One moment for the next question. Next question comes from Ken Herbert with RBC Capital Markets. Your line is open.

Ken Herbert: 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 pull 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 and guide probably reflects some conservatism to get to the full year growth, but just wondering if there’s anything you’d callout relative to just a track record of lumpiness and conservatism as you think about the second half of the year?

Kevin Stein: I think we always strive to be conservative in our guidance. We did bring, obviously, our guidance up so 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.

Ken Herbert: 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?

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

Operator: One moment for the next question. Next question comes from David Strauss with Barclays. Your line is open.

Josh Corn: Hi, good morning. 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? Thanks.

Kevin Stein: I think we’re comfortable. We don’t want to get into giving quarterly guidance on these things. We’re comfortable for the year at where we sit. Yes, business can be lumpy. We were pleasantly surprised by the EBITDA this quarter. We’re not positive how the future quarters will unfold, but again, our goal is to be conservative. So that is our forecast for now that we’re sticking with.

Josh Corn: Okay. Thanks. 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?

Mike Lisman: 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.

Operator: One moment for the next question. The next question comes from Scott Deuschle with Deutsche Bank. Your line is open.

Scott Deuschle: Kevin, just on M&A, is your optimism on the pipeline more about the next 12 months to 18 months, or are you still optimistic about the pipeline for the second half of this year specifically?

Kevin Stein: 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. 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.

Scott Deuschle: Great. Thank you. 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. Thanks.

Sarah Wynne: Yes, I can speak to that one. A large portion of what you see, some of that increase on the non-cash.com that plays into it when you look at actually just the raw sales, which you’ll see in the quarterly when it’s published later today, you’ll see that spend going down.

Operator: Please standby for the next question. The next question comes from Gautam Khanna with TD Cowen. Your line is open.

Gautam Khanna: 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 just tell us a little more where you’re seeing better sell-through and if that’s applying to the greater market or not yet, et cetera.

Kevin Stein: The two don’t always perfectly correlate in terms of what we see through our POS with our distributors and then what we do directly. What goes through distribution now it bounces around a little bit, but it’s about 20% to 25% or so of our TAM sales and it’s a decent leading indicator usually of future orders that will come obviously because the distributors sellout their inventory that they hold on our behalf so that we can get product quickly to customers then we got to replenish it. So the sales come eventually to replenish the sales they see, but they on a quarterly basis don’t always move exactly in the right direction. But over time, POS tends to be a pretty decent leading indicator of where the whole commercial aftermarkets heading. And that’s what gives us, as we said in the remarks, some confidence today as we look out where commercial aftermarkets likely to go for the balance of the year.

Gautam Khanna: And can you comment on biz jet, helo, 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?

Kevin Stein: It’s hard to say — I think it’s hard to say. It depends 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 it most of the decline on the full freighter business. We saw a great run up during COVID on the freighters and now the market’s 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 where that correction occurs.

Operator: One moment for the next question. The next question comes from Peter Arment with Baird. Your line is open.

Peter Arment: Yes. Good morning, everyone. Nice results. Hey, I wanted to circle back on Joel, you gave some comments about just some of the — how some of the passenger travel markets were doing. You talked about China. Could you maybe talk about maybe just if you could call out what you’re seeing from an aftermarket perspective on a regional basis or any color that international versus domestic if you’re seeing any big differences?

Joel Reiss: 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 see that the bookings strength we have, but we don’t get great data by region.

Peter Arment: Okay. That’s helpful. Just was curious and then just could you give us an update just on what you’re seeing in the supply chain, obviously, it’s been something that has slowly improved, but it’s always whack a mole, I assume. And just any color on what you’re seeing in the latest in the supply chain.

Joel Reiss: 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, 24 months ago. Continue to have issues with items like certain electronics, castings, certain chemicals or materials, but continued progress.

Peter Arment: Appreciate the color. Thanks, guys. I’ll stick to one. Thanks.

Operator: One moment for the next question. The next question comes from Robert Stallard with Vertical Research. Your line is open.

Robert Stallard: This might be for Kevin. Your comments on the Boeing situation on commercial OEM. Let’s say given to what you said three months ago, I was wondering if you did actually reduce your Boeing expectations this quarter. And if you did, aren’t they being offset? It must be offset by something else, right?

Mike Lisman: I’ll take that one, Rob. I think the commercial OEM; our first half ran a little bit better than the full year guidance at something like plus 23%. I think we’re cautious on the outlook here in commercial OEM overall. And the OEM forecast incorporates an appropriate level of risk around a potential Boeing rate change. Our forecast is a reminder, and I think, as you know, it’s a bottoms-up forecast from our op units based on what they’re seeing, what they’re hearing from their op units. It’s not a corporate top down mandate on, hey; the build rate you should assume for MAX is, say, 38 or so. It’s a bottoms-up bill based on what they’re seeing at their specific op unit. And as a reminder, we, a lot of our content on those aircraft, it doesn’t go direct to Boeing.

It often goes into sub tiers just given the nature of the components we’re selling, who could be taking actions independently based on what they’re seeing hearing as well. But in a nutshell, we feel good about the guide for the year of around 20% and any potential reductions we’ve baked into the guidance we’re given today for the year.

Robert Stallard: Okay. And then as a follow-up —

Kevin Stein: I think it’s also fair to say that Airbus is continuing to do better. So that’s going to continue to backfill some of the possible hole created by Boeing in the short-term.

Robert Stallard: Yes. And then just as a follow-up, Kevin, on your comment on 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, any change to the pricing that you’re seeing being discussed?

Kevin Stein: 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 businesses 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.

Operator: One moment for the next question. The next question comes from Noah Poponak with Goldman Sachs. Your line is open.

Noah Poponak: 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 in the passenger side faster growth in the back half, or is it just the compares or something else?

Kevin Stein: I think we’re — I’ll take a stab at it. No, and hopefully it addresses what you’re trying to get at. We’ve seen really strong growth in the passenger and we see that continuing based on bookings in the back half of the year. Freight we’ve continued to see a bit softness on the booking side there, which is how we know in the second half that we’re likely to see some continued slight decline there. Biz jet, thus far this year it was up a bit, I think, in Q1, Q2 was down a bit for the year, it’s about flattish. We expect to see something like that maybe a little bit better in the back half, but really what’s driving the commercial aftermarket overall is the continued strength in passenger and interior. That is the vast majority when you lump those two buckets together of that commercial aftermarket bucket. And we’re seeing really good strength there, that’s covering up some of the weakness elsewhere as we look out for the last six months.

Noah Poponak: Okay. Yes, I guess it sounds like you’re qualitatively, directionally saying you expect passenger and freight to do something similar in 3Q and 4Q as they did in 2Q. But for the aggregate segment or end market growth rate to accelerate somewhat significantly. But I guess, if passengers a little better, freight’s a little better, and the compares are easier. Maybe that gets you there.

Kevin Stein: I think that’s right, yes.

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

Kevin Stein: Not appreciably, no. I think we always, as you guys know, we seek to 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.

Mike Lisman: But I think we should 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 or 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.

Kevin Stein: Yes, you can definitely see that in the margins.

Noah Poponak: 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.

Kevin Stein: Yes, I don’t. We’re looking to add one or two more folks to our M&A team. We are seeing a lot of really interesting smaller size deals, and small deals take as much time to go through as bigger ones, so we need some more help to go through that. So hopefully, this will produce some more opportunity for us as we’re seeing things come across our desks that we haven’t seen before.

Operator: One moment for the next question. The next question comes from Sheila Kahyaoglu with Jefferies. Your line is open.

Sheila Kahyaoglu: Good morning, guys, and thank you. First, I wanted to speed up another aftermarket question. It’s been asked several ways, but up eight. 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?

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

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

Kevin Stein: That’s right. Yes.

Sheila Kahyaoglu: 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 bps half over half in the second half?

Kevin Stein: Yes, I take your point. Again, we hopefully aim to be conservative in our forecasting. We’re trying to stick to our yearly forecast on EBITDA. We had a very strong Q2. We’ll see how the back half of the year unfolds. We certainly don’t have any large negatives that we’re aware of. So I think it’s just our standard conservatism. We don’t have any concerning trends that we’re trying to peanut butter over here or anything. This is strong bookings across all of our segments, and really a good tailwind both on the OEM, commercial OEM, commercial aftermarket. And clearly on the defense side, we remain optimistic.

Operator: One moment for the next question. Next question comes from Kristine Liwag with Morgan Stanley. Your line is open.

Kristine Liwag: Hey, good morning, everyone. Kevin, in previous Investor Days, you’ve talked about how TransDigm had about 400,000 — excuse me, 400,000 PMA SKUs. And I think there was a point in time you were averaging something like 20,000 new 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?

Kevin Stein: So 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 of 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 the — it’s much similar situation to what we’ve seen in the past. The opportunities exist for us to replace other struggling suppliers. We certainly see that. We — again, PMA and used and serviceable materials aren’t a significant impact to 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.

Kristine Liwag: 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 head count 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?

Sarah Wynne: 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.

Kevin Stein: I think we — to add to that, I think we just — we paid a dividend in Q1. I think we’ll be able to make a decision in Q4 probably this year about our plans.

Operator: One moment for the next question. The next question comes from Michael Leshock with KeyBanc. Your line is now open.

Michael Leshock: I think — 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 callout 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?

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

Michael Leshock: Yes, that’s right.

Kevin Stein: 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 forecast, 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.

Michael Leshock: 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? Thanks.

Mike Lisman: Yes, the biggest investment and use of our capital has been to the productivity comment Kevin made earlier, it’s automation projects. We have said — as we said before, when we were in the depths of COVID will not add costs back ratably as we come out of it, and we haven’t done that. That’s reflected in the head count we have today. And the operating unit teams have done an exceptional job of finding good automation projects, whether it’s cobots or material movers or new machining centers to basically increase the amount of automation in their facilities and reduce the headcount, reduce the cost footprint that’s why you’re seeing the better margins that we delivered this quarter.

Operator: Please standby for the next question. The next question comes from Pete Osterland with Truist Securities. Your line is now open.

Pete Osterland: Hey, good morning. I’m on for Michael Ciarmoli. Thanks for taking our questions. 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?

Mike Lisman: I think it varies a lot off unit by off unit based on the demand they’re seeing from their customers. Obviously, sometimes that sub-tiers, 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 hands.

Pete Osterland: 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?

Mike Lisman: No. Continued with strength that supports the guidance on both.

Operator: I show no further questions at this time. I would now like to turn the call back over to Jaimie for closing remarks.

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

Operator: This does conclude today’s conference call. Thank you for participating. You may now disconnect.