Transdigm Group Incorporated

Ladies and gentlemen, thank you for standing by, and welcome to the first quarter 2020 TransDime Group Incorporated Earnings Conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you'll need to press star 1 on your telephone. As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Liza Thabel. Treasurer and Director of Investor Relations. Please go ahead.

Thank you and welcome to Transim's Fiscal 2020 First Quarter Earnings Conference Call. Presenting this morning are Transim's Executive Chairman, Nick Howley, President and Chief Executive Officer, Kevin Stein, and Chief Financial Officer, Mike Lisman. Please visit our website at transim.com to obtain a supplemental slide deck and call replay information. Before we begin, we'd 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 investor section of our website or at sec.gov. We'd 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'll now turn the call over to Nick.

Good morning, and thanks again for calling in. Today, as usual, I'll start off with some summary comments on our consistent strategy, a few comments on the operating performance and outlook in capital allocation, and then Kevin and Mike will expand and give more color. To reiterate, we're unique in the industry due to both our consistency and our ability to create intrinsic shareholder value through all phases of the cycle. To summarize the reasons why we believe this, About 90% of our sales are generated by proprietary products, and about three-quarters of our sales come from products for which we believe we are the sole source provider. Most of our EBITDA comes from aftermarket revenues, which typically have significantly higher margins and provide relative stability in the downturns. Our longstanding goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we have to stay focused on both the details of value creation as well as the careful allocation of our capital. We follow a consistent long-term strategy. Specifically, one, 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 very decentralized organization structure and a unique compensation system closely aligned with our 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 significant portion of our value creation methodology. As you saw from our press release, we were off to a good start in fiscal year 2020 with solid operating performance in the quarter. Revenues in EBITDA as defined are up substantially. Of course, much of this is due to the Esterline acquisition, but organic revenue growth was also up nicely. EBITDA margins were up versus the prior year as both the Trans9-based legacy and the acquired businesses all performed well. we continue to generate real intrinsic value for our investors. Far and away, the largest portion of our revenue, our worldwide commercial aerospace revenue, was up about 9% in Q1 versus the prior year, driven primarily by a very strong commercial aftermarket growth. Our smaller worldwide defense revenue was also up. Defense bookings were down a little, but defense bookings can be lumpy. At this time, fiscal year 2020 continues to look like a good year for TransLine, though we see possible clouds on the horizon. The commercial aftermarket was quite strong in Q1. However, given the uncertainty around the 737 program production rates, possible attendant inventory ripples, and uncertainty in China-related travel, we are leaving our full-year guidance unchanged. We have begun to trim our costs, However, this is a little more difficult than usual given the uncertainty in the 737 timing. We're watching this closely and are prepared to react more quickly if required. To put the 737 MAX OE production program into perspective for Transdyn, at full production rate, it makes up somewhere between 3% and 4% of our revenue and a smaller percent of our EBITDA. Kevin will discuss the quarter and the year in more detail. With respect to M&A and capital allocation, in the last six months, we closed and received payment on the sale of both the SORIO business for about $920 million and our EIT group of businesses for about $190 million. As I said last quarter, we may still sell some smaller businesses with less proprietary aerospace and aftermarket content. If we do so, As of today, I don't expect that they would be significant in size. With respect to capital allocation, in the last six months, we paid both a $30 per share special dividend and a $32.50 per share special dividend. The combined special dividends of $62.50 per share, or about $3.5 billion, is roughly 12.5% of the equity value at the start of fiscal year 2020. This is a pretty substantial payout. Due to the divestitures combined with the solid cash generation from our operating businesses, we're able to make these payments to our shareholders and still maintain substantial liquidity and firepower. As usual, we will review our go-forward capital allocation over the balance of the year and see where we stand towards the end of the year. We now expect to have over $3 billion of cash at the end of fiscal year 20. We also have significant additional borrowing capacity under our credit line and our credit agreement. We have the financial flexibility and capital market access to deal with any currently anticipated capital requirements, allocations, or other opportunities in the readily foreseeable future. We continue to actively evaluate and seek M&A opportunities We have a decent pipeline, as usual, mostly in the small to mid-range. I can't predict or comment on any possible closings, but as I said before, we're still working steadily at M&A and are open for business. And now let me hand this over to Kevin to review our 2020 performance outlook and some other items. Thanks, Nick. Today I'll review our results by key market, then discuss the profitability of the business for the quarter. I'll also comment on the fiscal year guidance and review some other operational items. As you have seen, we had a strong first quarter and a good start to the year. Mike will provide more details on the financials, but our first quarter operations, specifically revenue and EBITDAs defined, were up substantially over last year, due in part to good organic growth as well as continued acquisition, integration, and performance. Q1 gap revenues were up approximately 48% versus prior year Q1, and EBITDA as defined was up 40% versus the prior year, with margins approaching 47% of revenue. Now we will review our revenue by 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 2019. That is assuming we own the same mix of businesses in both periods. Please note that beginning this quarter, This market analysis discussion now includes the results of the former Esterline businesses. In the commercial market, which makes up close to 70% of our revenue, we will split our discussion into OEM and aftermarket. Our total commercial OEM market revenue increased approximately 1% in Q1 when compared with Q1 of fiscal year 2019. Commercial transport OEM revenues, which make up the majority of our commercial OEM business, were flat versus prior year Q1. However, booking solidly outpaced Q1 sales in the current period by more than 15%. We did see minimal headwind from the impact of 737 max production halt this quarter. However, we believe any currently anticipated impact from the max issues should not have a material impact on our EBITDA for the full fiscal year. We are very diversified across all platforms worldwide. so the impact of the 737 MAX or any single program should not be material to Transdyn in the aggregate. Aside from isolated issues with a few aerospace platforms, general industry consensus remains mostly favorable long-term as significant OEM backlog remains across the industry. We are currently assessing the near-term impact of the 737 MAX rate reduction as well as smaller cuts in production for other Boeing, Airbus, and business jet platforms. As a result of the recent production rate changes and other evolving global concerns, we are implementing a necessary 3% to 10% reduction in direct and indirect headcounts, the impact of which will be felt in the second half of the year and will certainly vary by business unit. Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenues grew by 17% over the prior year quarter, with the commercial transport passenger market outperforming our expectations. In the quarter, growth in the commercial transport passenger and business jet markets were significantly offset by very modest declines in the commercial transport freight and commercial transport interior markets. Overall commercial transport fundamentals continue to remain relatively strong, although a few items still bear watching. Global revenue passenger growth continues to decelerate, albeit growth is still near the long-term average. This might be impacted by weaker economic activity and multiple geopolitical disruptions worldwide. Cargo demand is weaker as FTKs have declined from reaching an all-time high in 2017 to and business jet utilization data is pointing to stagnant growth that could create a headwind for the business jet aftermarket. Finally, it is unclear how the 737 MAX situation has or will impact our commercial aftermarket, but it may prove to be a net positive for Transdyn as older aircraft are utilized more. Now let me speak about our defense market, which is just over 30% of our total revenue. The defense market, which includes both OEM and aftermarket revenues, was up approximately 9% over the prior year Q1. As a reminder, we are lapping tougher prior year comparisons as our defense revenue accelerated in most of fiscal 2019. Defense bookings declined slightly in the quarter, driven by robust defense OEM bookings growth and a not unexpected decline in defense aftermarket bookings given the recent restocking pace. Now moving to profitability, I'm going to talk primarily about our operating performance or EBITDAs defined. EBITDAs defined of about $681 million for Q1 was up 40% versus prior Q1. EBITDAs defined margin in the quarter of 46.5% was negatively impacted by acquisition dilution from Esterline. Excluding Esterline, margins in our legacy business were over 51%. and improved both sequentially as well as over the prior year quarter. Margin improvement progress is always important to us and indicates that our base business continues to drive and find opportunities for improvement by using our value drivers. On Esterline, we are now over 10 months post-close. The integration continues to progress. To date, the acquisition is exceeding our expectations for growth in this largest of Transdime acquisitions. As we have stated in the past, we will now no longer refer to any ESSER line specific metrics as these businesses have now become part of the fabric of Transdyn. Moving now to the 2020 guidance also found on slide seven in the presentation. We are not changing our full year revenue EBITDA or adjusted EPS guidance at this time, although we saw strong first quarter results. General market conditions have not meaningfully changed with the exception of the 737 MAX grounding and production hall. This is an evolving situation that could make it challenging for us to achieve the high end of our previously issued revenue guidance. However, as previously mentioned, we believe any impact from the MAX issues should not be material to our EBITDA this fiscal year. There's also a potential upside for us in the commercial aftermarket resulting from the 737 MAX issues as older aircraft may be utilized more. We will continue to closely monitor the 737 MAX situation and the expected impact on our business to be prepared to react as necessary, including any further preemptive steps that might be warranted. After consideration of these items at this time, we are not adjusting our full-year revenue and EBITDA guidance, as we still expect them to fall within the range previously issued. We will update again as this situation crystallizes. In addition, we are not changing our original market growth assumptions at this time. We do, however, realize there could be some shifting between commercial OEM and aftermarket growth rates, but it is just too close to call with only one quarter of data. I would also like to caution that although our EBITDA margin was strong in the first quarter, margins can be lumpy and margins may fluctuate over the next few quarters. So let me conclude by stating that Q1, of fiscal 2020 was another good quarter for Transdyn. We continue to be very pleased with the Estherline acquisition integration as well as the strong operational performance in the quarter from our legacy businesses. We look forward to the remainder of 2020 and expect that our consistent strategy will continue to provide the value you have come to expect from us. With that, I would now like to turn it over to our CFO, Mike Listman. Morning, everyone. I'm going to very quickly elaborate on some of the financial results that Kevin just discussed. As a reminder and as mentioned on our last earnings call, the Esterline organization as it used to exist, including the corporate office, is for the most part now gone, with the business units which used to comprise Esterline reporting independently into TransDOT. We're therefore not planning to give too much specific color or details around Esterline's performance. separate from that of legacy TransDyn. So for the consolidated TransDyn business, a few quick notes on how we ended the first quarter of FY20. And as a reminder, Esterline closed mid-March of last year, so it's not included in any of the fiscal 19 stats that I'm about to reference. As Nick and Kevin both mentioned, first quarter net sales were up approximately 48% versus the prior year. Organic sales growth was strong at 8.7%, and this figure still completely excludes Esterline, so it's for the legacy TransDyn business only. The Esterline acquisition drove the remaining 39% of the increase. On EBITDA as defined, $681 million for the quarter. That was up 40% versus last year, and adjusted EPS of $4.93 was up 28%. On cash and liquidity, this gets a little messy due to the timing of the dividend. We declared the $32.50 per share dividend in December, but then did not pay it until early January. So I'm just going to give you the pro forma financial stats, since that's what matters. So pro forma for that $32.50 dividend per share that was paid on January 7th, our cash balance is $2.3 billion, and net debt to EBITDA is now 6.1 times. We also currently have access to about $720 million of our revolts. Now a quick update on interest and taxes. Interest expense is expected to be about $1.02 billion in fiscal 20, and this estimate is unchanged from our prior guidance. As some of you may have seen, we're currently in the market with a repricing of our $7.5 billion of term loans. This reprice is still in the process of being finalized, and we'll update the interest expense guidance next quarter once the repricing completes. On taxes, our fiscal 2020 gap, cash, and adjusted rates are all still expected to be in the range of 24% to 26%, which is unchanged from prior guidance. With regard to liquidity and leverage at the end of fiscal 20, assuming no additional acquisitions or capital market transactions, we now expect to have over $3 billion of cash on hand at the end of the year. This is a slight reduction from previous guidance just to account for the $1.9 billion dividend we paid in the first week of January. In closing, the first quarter was a good start to the year for TransDime, and with that, I'll turn it back to the operator to start the Q&A.