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spk08: Thank you for standing by and welcome to the first quarter 2022 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 the session, you'll need to press star 1 on your telephone. As a reminder, today's program may be recorded. And now I'd like to introduce your host for today's program, Jimmy Steeman, Director of Investor Relations. Please go ahead.
spk11: Thank you and welcome to Transdime's fiscal 2022 first quarter earnings conference call. Presenting on the call this morning are Transdime's president and chief executive officer, Kevin Stein, chief operating officer, George Valadares, and chief financial officer, Mike Listman. Please visit our website at transdime.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 would 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. 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.
spk03: Good morning, and thanks for calling in today. First, I'll start off with the usual quick overview of our strategy and then a few comments about the quarter and a discussion of our fiscal 2022 outlook. Then George 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 and bad times, 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 proprietary products, and over three-quarters of our net sales come from products which we believe we are the sole source provider. 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 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 organization structure and unique compensation system closely aligned with shareholders. Next, we acquire businesses that fit this strategy where we see a clear path to PE-like returns. And finally, our capital structure and allocations are a key part of our value creation methodology. our long-standing goals to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we stay focused on both the details of value creation as well as careful allocation of our capital. As you saw from our earnings release, we had a 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 Q1 fiscal results show positive growth in comparison to the same period in fiscal 2021, as we are lapping the first quarter of 2021, which was heavily impacted by the pandemic and prior to the widespread availability of vaccines. Although our results have improved, they continue to be unfavorably affected in comparison to pre-pandemic levels as the demand for air travel remains depressed. However, the continued improvement in global air traffic despite emergence of a new COVID 19 variant in late 2021 is encouraging. It further illustrates the pent-up demand for air travel and bodes well for the momentum of the commercial aerospace recovery in 2022. To date, the recovery has remained primarily driven by domestic leisure travel, although we are optimistic for recovery of international travel, as many governments across the world have softened travel restrictions. Even the travel restrictions reimposed by certain governments during the months of December due to the Omicron variant are now starting to ease, which is again an encouraging sign. In our business, we saw another quarter of sequential improvement in our commercial markets, with total commercial aftermarket revenues up 10% over Q4 of fiscal 2021, and bookings up more than 15% compared to Q4. Commercial OEM bookings came in even stronger, with almost 20% sequential improvement over Q4. I am also very pleased that despite the challenging commercial environment, our EBITDA's defined margin was 47.3% in the quarter. Contributing to this better than expected margin is the continued recovery in our commercial aftermarket revenues, as well as the careful management of our cost structure and focus on our operating strategy. This was achieved despite the emergence of the Omicron variant during the quarter. Additionally, we continued to generate significant cash in Q1. We had strong operating cash flow generation of almost 280 million and close the quarter with a little over $4.8 billion of cash. We expect to steadily generate significant additional cash throughout the remainder of 2022. Next, an update on our capital allocation activities and priorities. We are now at a decision point with regard to our sizable cash balance, which is now approaching $5 billion. Consistent with our history, when we have a significant amount of cash available, we aim to get that back to the shareholders in one form or another. At this time, we are still in the process of evaluating our capital allocation options with regard to any significant acquisitions, share buybacks, and dividends. All three options are on the table, each individually, but then also potentially in some combination over the next 12 months. Any significant M&A, share buyback, and or dividend activity will still leave the company with substantial liquidity and the financial flexibility to deal with any currently anticipated capital requirements or other opportunities in the readily foreseeable future. We continue to look at possible M&A opportunities and are always attentive to our capital allocation. Both the M&A and capital markets are always difficult to predict, but especially so in these times. Regarding the current M&A pipeline, we are still actively looking for M&A opportunities that fit our model. We continue to see a pickup and acquisition opportunity activity, but it's still slower than pre-COVID. We have a decent pipeline of possibilities as usual, mostly in the small midsize range. I cannot predict or comment on possible closings. We remain confident that there is a long runway for acquisitions that fit our portfolio. Now moving to our outlook for 2022. We are still not in a position to provide full financial guidance as a result of the continued disruption in our primary commercial end markets. We continue to be encouraged by the recovery we have seen in our commercial aftermarket revenues and the strong bookings received for both commercial OEM and aftermarket in Q1. We will look to reinstate guidance, reinstitute guidance when we have a clearer picture of the future. We continue to expect COVID-19 to have an adverse impact on our financial results compared to pre-pandemic levels throughout the remainder of fiscal 2022. under the assumption that both our commercial OEM and aftermarket customer demand will remain depressed due to lower worldwide air travel, although recent positive trends in commercial air traffic could impact us favorably. To reiterate what we said on the Q4 earnings call, our teams are still planning for our commercial aftermarket revenue to grow in the 20% to 30% range. We expect our commercial OEM revenue to grow significantly as well, but at a rate slightly less than the commercial aftermarket. As you know, we aim to be conservative and would be happy to have both of these end markets rebound more strongly. To reiterate, these are planning assumptions for organizational purposes and not guidance. As for the defense market, we still expect defense revenue growth in the low single-digit percent range from fiscal 2022 versus prior year, despite the slow start to the year. George will provide more color on our defense end markets. We now expect full-year fiscal 2022 EBITDA margin to be slightly north of 47% due to the rate of commercial aftermarket recovery. Please note that our Q1 EBITDA margin was stronger than anticipated, and we may see less year-over-year margin improvement for Q2 and expect margins to move up throughout the second half of the fiscal year. As a final note, this margin guidance includes the unfavorable headwind of our Cobham acquisition of about 0.5%. We believe we are well positioned for the remainder of fiscal 2022. As usual, we'll closely watch the aerospace and capital markets as they develop and we'll react accordingly. Mike will provide details on other fiscal 2022 financial assumptions and updates. Now shifting gears for a moment to non-financial matters. I'd like to touch on our DOD IG audit report, which was released in mid-December. As we expected and communicated, the audit scope and results were similar to prior audits. The report found no legal wrongdoing on behalf of Transdyn or any of our employees. The report asked for a purely voluntary refund of approximately $21 million. We disagree with many of the implications contained in the report as well as the methodology used to arrive at many of the report's conclusions. We also disagree with the use of arbitrary standards and analysis which render many areas of the port inaccurate and misleading. Additionally, at the request of the House Oversight and Reform Committee, we participated in a hearing on January 19th to discuss the results of the audit. Going forward, we will continue to work with the IG, the DLA, and any other relevant parties to evaluate the results of this audit. The U.S. government and the U.S. warfighter remain top priorities for Transdyn. At this time, we are engaged directly with the DLA and do not have any further update on whether or not we expect to pay all or a portion of the $21 million voluntary refund request. Finally, I wanted to announce the retirement of our Vice Chairman, Bob Henderson. He retired at the end of first fiscal quarter. Bob has been a key member of the Trans9 management team for over 25 years and a significant partner in the company's growth during the entire period. He served in a range of roles over his years with Transdime, including as president of several operating units, executive vice president, COO of Transdime's Airframe business group, and most recently vice chairman, where he oversaw the integration of the operating units acquired as part of the Estherline transaction. We wish Bob well in his retirement. Let me conclude by stating that I am pleased with the company's performance in this challenging time for the commercial aerospace industry, and with our commitment to driving value for our stakeholders. As always, we remain focused on executing our operating strategy and managing our cost structure as we continue on this journey to a full recovery of the commercial aerospace industry. We look forward to the remainder of our fiscal 2022 and expect that our consistent strategy will continue to provide the value you have come to expect from us. Now let me hand it over to George to review our performance and a few other items.
spk05: Thanks. Thanks, Kevin. I'll start with our typical review of results by key market category. For the remainder of the call, I'll 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. This market discussion includes the acquisition of Cobham Aero Connectivity. We began to include Cobham in this market analysis discussion in the second quarter of fiscal 2021. This market discussion also removes the impact of any divestitures completed in fiscal 2021. 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 13% in Q1 compared with the prior year period. Bookings in the quarter were robust compared to the same prior year period, and strongly outpaced sales. Sequentially, the bookings improved almost 20% compared to Q4. Although 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. We are hopeful that the narrow body rate ramps disclosed by Airbus and Boeing will play out as forecasted. Now moving on to our commercial aftermarket business discussions. Total commercial aftermarket revenue increased by approximately 49% in Q1 when compared with prior year period. Growth in commercial aftermarket revenue was primarily driven by increased demand in our passenger submarket, although all of our commercial aftermarket submarkets were up significantly compared to prior year Q1. Sequentially, total commercial aftermarket revenues grew approximately 10%, and bookings grew more than 15%. Commercial aftermarket bookings are up significantly this quarter compared to the same prior year period, and Q1 bookings strongly outpaced sales. To touch on a few key points of consideration, global revenue passenger miles remain low but continued to modestly improve throughout our Q1. IATA currently forecasts a 39% decrease in revenue passenger miles in calendar year 2022 compared to pre-pandemic levels. Within IATA's estimate is the expectation that domestic travel will be back to 93% of pre-pandemic levels in calendar year 2022. Despite the impact of the Omicron variant, December global revenue passenger miles still improved month on month, which demonstrates the strong underlying demand and the willingness of passengers to travel. Countries that reimpose travel restrictions due to this variant are already announcing significant easing of those restrictions. The limited impact from the Omicron variant on air travel provides optimism for the pace of the recovery of air traffic in 2022. The recovery in domestic travel has been more resilient than international. Domestic air traffic for calendar 2021 was only down 28% compared to pre-pandemic versus international, which was still down 75%. As the commercial aerospace recovery has progressed, the U.S. and Europe have shown strong demand for domestic travel. China has been more volatile due to its zero COVID policies, which lead to localized lockdowns and rapid drop-offs in air travel. Though the pace of the international air traffic recovery has been slow, we are hopeful for improvement in international travel in 2022 as vaccination rates continue to improve globally, and many of the government travel restrictions are softening. Global cargo volumes continue to surpass pre-COVID levels, and it is generally expected that air freight demand will remain robust throughout 2022. Business jet utilization remains strong. Commentary from business jet OEMs and operators has been encouraging, and these higher levels of business jet activity may be here to stay, though time will tell. Now let me speak about 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, decreased by approximately 12% in Q1 when compared with the prior year period. As we have said many times, defense sales and bookings can be lumpy. This quarter, Cobham was lapping a very tough prior year comparison as Cobham's defense sales accelerated in fiscal Q1 2021, which was the last quarter prior to Transdime's ownership. This was the single largest contributor to the year-over-year decline. There were also some supply chain-induced delays in filling orders at certain operating units. As Kevin mentioned earlier, we continue to expect low single-digit percent range growth in fiscal 2022 for our defense market revenues. Lastly, I'd like to wrap up by stating how pleased I am by our operational performance in this first quarter of fiscal 2022, despite the continued impact of the pandemic. We remain focused on our value drivers and executing with operational excellence. With that, I'd like to turn it over to our Chief Financial Officer, Mike Lisman.
spk04: Morning, everyone. I'm going to quickly hit on some additional financial matters for the quarter and then our expectations for the full fiscal year. First, in regard to profitability for the quarter, EBITDAs defined of about $565 million for Q1 was up 19% versus our prior Q1. EBITDAs defined margin in the quarter was approximately 47.3%. This represents year-over-year improvement in our EBITDAs defined margin of about 450 basis points versus Q1 of last year. Sequentially, EBITDAs defined margin declined slightly by about 200 basis points during Q1 versus Q4 of last fiscal year. As you know, this is typically the case for us, given the higher volume levels in Q4 and lower number of working days in our fiscal Q1. Now, a few quick additional financial data points for the quarter. Organic growth was 9%, driven by the rebound in our commercial OEM and aftermarket end markets. On taxes, the slightly lower than expected gap rate for the quarter was driven by significant tax benefits arising from equity compensation deductions. This is just timing. Barring some deviations in the rates for this first quarter, our tax rate guidance for the full year is unchanged from what we provided on our last earnings call. Moving to cash and liquidity, we had another nice quarter on free cash flow. Free cash flow, which we traditionally define at TransTime as EBITDA, Less cash interest payments, CapEx, and cash taxes was roughly $250 million. We ended the quarter with about $4.8 billion of cash. During Q1, we also paid down our $200 million revolver balance, which was drawn at the onset of COVID in March of 2020 out of an abundance of caution. The $200 million revolver pay down is the primary reason that our cash balance ticked up much less than the $250 million of free cash flow we generated in Q1. Our net debt to EBITDA ratio is now at 6.7 times. This ratio is down from 8.2 times at its peak. We expect to continue running free cash flow positive, and barring any additional capital markets activities, this ratio would keep coming down as we proceed through our fiscal 22. From an overall cash liquidity and balance sheet standpoint, we remain in good position. and well prepared to withstand the currently depressed but now rebounding commercial environment for quite some time. With that, I'll turn it back to the operator to kick off the Q&A.
spk08: Certainly. Ladies and gentlemen, once again, if you have a question, please press star then 1. Our first question comes from the line of Miles Walden from UBS. Your question, please.
spk07: Thanks. Good morning. I wonder if you could comment on the 23% target for aftermarket growth for fiscal 2022.
spk02: We can't hear you, Miles. Sorry, we can't hear you.
spk07: Apologies. Can you hear me now?
spk02: There you go. Perfect.
spk07: Yeah, exactly. The battery's dead. Can I ask about the range of aftermarket growth that you're looking for for fiscal 22, given the strong number in 1Q? Are you comfortably at the top, very top of that sales range at this point? And or was there anything in particular that was driving aftermarket that wouldn't keep this pace for the rest of the year?
spk03: I don't think we see anything that's keeping the pace that we know about. That's really the issue with sticking our neck out and giving guidance is that there's still a lot of unknowns. Omicron variants pop up. I think we're just communicating our planning purposes that we're using to staff accordingly. We hope that it's conservative. Okay.
spk07: And I know, Mike, you said that the TransLime defense business was including Cobham on your organic calculation down year on year. Given you didn't own Cobham in the first quarter of last year, what did the TransLime business ex-Cobham look like on a year-on-year basis?
spk04: I think you'll see that some of the details in the queue, it was down about 5%, 6% ballpark. Okay.
spk07: All right. I'll leave you there. Thanks.
spk08: Thank you. Our next question comes from the line of Ron Epstein from Bank of America. Your question, please.
spk12: Hi, good morning. It's actually, it's Elizabeth on for Ron. Two questions. One, can you talk to the trends you're seeing in stocking and destocking? And then secondly, as a follow-up to Miles, just to confirm that the 5% to 6% decline that you saw ex-Cobham, is that all attributable to supply chain? And are you seeing any improvements there? Or how are you thinking about that for the rest of the year?
spk05: George, you want to take the destocking question first? Sure. I think as most of you know, we don't have insight into the specific inventory levels at our airline customers. That being said, we're hopeful, we're cautiously optimistic we're at the end of any significant destocking activities at the airlines.
spk04: And then on the second part of your question, the specifics of what drove the remaining 6% decline in the base trans-time defense business, it's a mixed bag of both supply chain issues but then also our planning to have been down this first quarter. We knew some of this was coming for us and that Q1 would be a little bit weaker this year, but I don't think we want to get into specifics of exactly what drove it, but it was a combo of the two.
spk12: I mean, what are you thinking for the rest of the year in terms of improvement? Are you seeing any signs of improvement?
spk04: In defense, we still feel good about the low single-digit growth target for the year.
spk12: Okay. So expectations around supply chain have not changed then?
spk04: That's right, at this time.
spk03: Yeah, I don't think – We'll continue to watch it. We've seen – this is Kevin – we've seen some inflationary pressures. We've seen some supply chain issues, I think, in – electronic components and castings, but it's not across the whole industry yet, but it's something we're watching closely.
spk12: Okay. Thank you so much.
spk05: Yeah, our teams have been very active in engaging with the supply chain. We would suspect that we'll probably still have a couple of quarters of activities related to supply chain issues, but they're engaged in mitigating as best as they can.
spk12: Thank you.
spk08: Thank you. Our next question comes from the line of David Strauss from Barclays. Your question, please.
spk13: Thanks. Good morning. Good morning. Good morning. I think you noted, George, noted the strongest part of the aftermarket was passenger. Can you just give a little bit of color, I guess, the 10% sequential improvement you saw in the quarter, how that broke out? you know, engine, interiors, passenger?
spk05: Yeah, I don't think I have the specifics in front of me, but as a reminder, passenger is our largest sub-market. It constitutes anywhere between 60% and 65% of our overall commercial aftermarket sales. But as I noted, we saw strength across the board in all the sub-markets within the commercial aftermarket.
spk13: Okay, quick follow up. Mike, you obviously have a decent amount of floating rate debt. Can you talk about how the higher interest rate environment might impact your overall rate? I know you've got caps and swaps, but what kind of sensitivity are you looking at in terms of the impact of higher rates? Thanks.
spk04: We don't expect too much of an impact. When you factor in the current caps and swaps, we're about 84% fixed going out for the next two or three years. So not a sizable impact as things pick up here. We do factor in the latest LIBOR curve when we give you guys the interest rate guidance, the consensus market curve, so it's all taken into account. But given the fact that we're close to 85% fixed rate anyway, you know, even if interest rates were to surge by quite a bit, there's not too much pain to be felt, at least during the period of those hedges before they run out.
spk08: Thanks. Thank you. Our next question comes online of Ken Herbert from RBC Capital Markets. Your question, please.
spk16: Hey, thanks. Good morning. Mike, I wanted to first ask on cash flow. I mean, good cash generation in the quarter. How do you think about cash conversion, say, relative to your EBITDA as defined moving forward? And with all the cost actions, could that framework be perhaps a little higher than you've talked about it in the past?
spk04: I don't think we expect any material deviation from the close to 50% conversion of our EBITDA to free cash flow that we've always relayed in the past. And that's, again, based on the definition of free cash flow that I mentioned in my script. Over time, as we rebound out of COVID, we expect to get back and close to that kind of 45% to 50% ballpark of EBITDA that we've operated at historically. Right now, we're a little bit lower just given the fixed nature of the interest charge and the fact that the EBITDA is still depressed. But once we rebound and come out of this, we expect to go back to that same ballpark.
spk16: Okay. Very helpful. And if I could, just on the aftermarket, I know in the past you've talked about a fairly significant percent of your business that's book and ship there. Has that mix changed as you think about sequentially what we should expect through the next few quarters? I guess it sounds like you're still A 10% sequential improvement through the rest of the fiscal year is a fair starting point, correct?
spk05: Correct. You know, I think as we look across the balance of the fiscal year, we would expect a gradual ramp-up in the commercial aftermarket. As Kevin noted, you know, we're a little bit conservative here just with the different variants of COVID-19 potentially providing a temporary disruption. So we hope we're on the conservative side, but we thought 10% sequential growth was a good start, and we'd anticipate that to carry throughout the balance of the year.
spk08: Excellent. Thank you very much. Thank you. Our next question comes from the line of Robert Spingarn from Melios Research. Your question, please. Hey, good morning.
spk06: Kevin, I wanted to ask you a question about looking at the business from the different end markets, narrow body, wide body, biz jet, so forth, and where you are relative on sales to pre-pandemic in those areas, and to what extent that affects your factory and plant. In other words, is wide body so idle that it's going to be problematic to get it back up and running?
spk03: No, wide body is not so idle that it would be problematic to get it up. You know, narrow body's done better than wide body, and business jet has been very good. I think that's generally how we would describe it, but there's nothing more specific about wide body that would make it difficult to bring the manufacturing up. George, you want to, anything you want to add to that?
spk05: Yeah, I would agree. I mean, typically, and as you know, we're market weighted in terms of the fleet. From an aftermarket perspective, Supporting the wide bodies is not an issue. The majority of the labor and the higher volume production comes on the OEM side, so we don't anticipate any issues with the depressed OEM environment impacting the commercial aftermarket support.
spk06: And, George, would it be fair to say that BizJet is the most recovered or Narabadi?
spk05: I would say BizJet is the most recovered, absolutely.
spk06: Okay.
spk05: Thank you.
spk08: Thank you. Our next question comes to the line of Robert Fallard from Vertical Research. Your question, please.
spk00: Thank you so much. Good morning.
spk08: Good morning. Good morning.
spk00: I think it's maybe for Kevin. You notice this very strong Q1 aftermarket, but are there any indications that airlines are pulling forward work that they would otherwise have done later in the year, and therefore the sequential growth might ease as the year progresses?
spk03: I would tell you that Q1 was... strong and the order book was strong. Was it stronger than we anticipated? Yeah, maybe a little bit, but I don't think there's any indication that things will slow down necessarily. I don't have any indication that people are front-loading maintenance work or buying spares ahead. That's usually not the way the industry operates. I think this will continue as long as flight activity continues.
spk00: Right. And then, Kevin, on the M&A front, you said things are a bit slow at the moment. I was wondering if you might want to comment on what the cause for that might be, whether you're seeing any differences in the commercial versus defense end markets.
spk03: Yeah. You know, with the defense surging over the last couple of years, we saw a lot more defense opportunities in M&A space. With the commercial market being so depressed right now. I think there hasn't been as many commercial opportunities that have come along on the M&A front, but that's starting to change. We're starting to see more of the commercial properties that we covet, so we will look for more of those as we go forward. It's always difficult to predict when things will close. We frequently are looking at businesses and don't get to the point of closing for some reason, but we're optimistic right now.
spk08: That's great. Thanks so much. Thank you. Our next question comes from the line of Peter Arment from Baird. Your question, please.
spk19: Hi, thanks. Good morning, everyone. Kevin, George, Mike. Good morning. This is Kevin with George. Just on the defense, your confidence around the low single-digit growth, just given the slower start to the year, but just also how you factored in. Are you seeing any impact from the continuing resolution, and if it did go a full year, How does that impact your thinking? Thanks.
spk05: Yeah, I don't know that we can pinpoint any direct or quantifiable impact from the continuing resolution. You know, I think, as I mentioned, the largest single driver in the defense market for this quarter was some of the lumpiness related to the Cobham acquisition. Quote volumes in general continue to remain strong at the teams, so we're cautiously optimistic that those will convert over to orders as we would expect for the balance of the year.
spk19: Okay, that's helpful. Kevin, I just wanted to circle back to your comments about, and you made some comments in the fourth quarter call about you thought the supply chain disruptions might get a little worse on the electronic component side. Did that get any worse in the quarter, or is it still kind of neutral?
spk03: I think they did in some places get worse. We are definitely struggling on some of the electronic components. We're seeing inflation, supply chain issues on those. But right now, I think limited to electronics and castings. The castings industry has definitely been hurt coming back up after the slowdown.
spk08: Appreciate the details. Thanks. Sure. Thank you. Our next question comes from the line of Matt Akers from Wells Fargo. Your question, please.
spk02: Hey, good morning, everybody. Thanks for the question. Can you talk about what's kind of the biggest area of uncertainty that gives you pause in terms of giving guidance for the CRI? Is it OE build rates, or what would you have to see to get the confidence to give that?
spk03: Well, I think it's OE build rates. Our largest customers still haven't given guidance, still haven't given us a forecast. This matters to us because As George alluded to, all of our hiring and staffing is really related to OEM build rates. So it's really difficult to forecast that if you're not getting any guidance. Aftermarket, we also feel very optimistic that it's moving in the right direction. We're seeing more takeoff and landings, revenue passenger miles. By any metric, it continues to improve, but it is lumpy around the world. I think that's what gives us pause in issuing guidance is really a lack of clarity on the market. We saw Omicron come out of nowhere in Q1 in our first quarter, largely out of nowhere, and saw it really impact. So, you know, it's difficult for us to forecast the future when there are so many unknowns. So that's where we come down.
spk02: Got it. Thanks. And then I guess on the defense business, you know, with the hearing and this proposed new legislation, can you just talk about how that, you know, did that impact your business at all in the quarter? Did it have any effect on sort of how you think about that relationship?
spk05: I'll be happy to talk to that one. We have not seen any material impact from the IG audit release or the hearing. Again, we're touching base with the teams. As we've mentioned in prior calls, we continue to be directly engaged with the DOD and the DLA, and we've formed this working group, we think, that has been beneficial to both parties over the last two years. So we have not seen any material impact as a result of either of those two activities.
spk13: Thank you.
spk08: Thank you. Our next question comes from the line. Michael Chamberly from TruSecurities. Your question, please.
spk01: Hey, good morning, guys. Thanks for taking my questions. Maybe just to go back to Rob's kind of question on aftermarket with wide body. Can you talk about that growth? I mean, the organization is still running pretty light. Does the planning range that you've given assume any wide body recovery? Have you seen any, I guess, uptick in the bookings to support wide body aftermarket activity?
spk03: We don't have that split out by... different segments in our bookings. It's too difficult to see that. We just look at ourselves as market weighted. And as wide bodies start to fly more and are utilized more, certainly we'll have to up gauge our manufacturing there. But I don't think we see it as a concern for us right now.
spk01: Got it. And then just back to, you know, the $5 billion of cash, you talked dividend, you talked buyback, M&A, obviously. Has debt pay down entered the equation at all? I mean, you guys have basically been operating as a public company in a free money environment. You know, you're seemingly inversely correlated with rising rates. You could probably add a lot to EPS accretion. I mean, is that even in the cards at all? And I know you're hedged and you just mentioned that the 84%, but I mean, we really don't know how this is going to shake out. I mean, is that in the thinking or the thought process for a use of cash or no?
spk03: Sure. We always, you know, look at all uses of cash. And I think we've always communicated that the first and primary use is to invest in our own businesses. Secondarily is M&A and next comes capital allocation back out to our shareholders, and then the last priority would be paying down debt. I don't think the debt environments have changed enough for us to modify our strategy. It may happen one day, but it's certainly not yet.
spk04: And if you look at just the cost of equity, from a cost of equity versus cost of debt standpoint, the debt, even at forecasted interest rates, is still a much better way to finance your business than equity. Absolutely. Yeah, fair enough.
spk01: Thanks, guys.
spk08: Thank you. Our next question comes from the line of Seth Seifman from J.P. Morgan. Your question, please.
spk18: Thanks very much, and good morning. Sorry for kind of a small bore question here, but just notice from the slides the significant increase in stock comp this year. A, what's that due to, and B, should we expect you guys to file the proxy soon?
spk04: Sure. So first on the stock comp ad back, this is GAAP accounting rules as they pertain to how we do the computation of our stock comp expense and the GAAP P&L. It's a non-cash expense. We're not handing out any more stock options to the management team or anything this year than we have in prior years. What drove the increase, and I think it was about last year we had $129 million of stock comp expense. This year we're stepping up to a midpoint of $145. Rough justice is the target we gave you. The driver of that increase is that we changed the best criteria back from the temporary criteria we had during COVID, which was an EBITDA margin and dollar target, and we flipped it back to the metric that we've always had since Transline was founded, which is the 17.5% growth target on the intrinsic equity value per share. That switch just drove a bit of a change in the way you do the gap stop comp expense computations. But going forward, we're going to adhere to the same methodology we've always had. And again, no increase in the number of options that are being handed out to executives or anything as part of our incentive plans. On the proxy filing, you probably saw that we filed the 10-K-A last week, which included a lot of the content of the usual proxy. You wouldn't expect the proxy to come for a couple months, probably May or June time frame. so a little bit later than would typically be the case, but much of the content that's in that was released last week in the 10-KA.
spk18: Got it. Great. Thanks. And then just a couple of quick clarifications on, you know, stuff that you guys have talked about for the remainder of the year. Just to get to that kind of low single-digit growth for the defense business, you know, that implies that we should be seeing a kind of return to sort of mid-single-digit growth for the remainder of the year? Or is it much more back half-weighted than that? And then secondly, you know, what is it about the second quarter? You know, it seems like you're expecting a little bit less margin expansion in the second quarter and then acceleration later in the year. You know, what is it about the second quarter where there's a particular headwind?
spk03: Well, on the margin side, you know, we don't want to give quarterly guidance. We're not there yet. So I don't want to give margin guidance on a per quarter basis. I don't see anything out there that concerns me about Q2. And as we go forward, we just aren't issuing guidance. And we had a very strong Q1. So it's just the normal conservatism in our commentary.
spk18: All right. Okay. And then on defense and kind of, you know, The implication is kind of mid-single growth the remainder of the year?
spk03: Yeah, I think that's what we would have to get to. So, you know, the math will share what, you know, given the slow start, this will be, you know, more of a stretch for us for the year, but we still feel confident enough to leave it there. As, you know, the business generally recovers, as Cobham starts to grow, I think this will
spk04: rectify itself. And as you guys know, the defense is always lumpy too, so we're not going to go and give quarterly guidance there either because it's hard to forecast with precision.
spk18: Cool. Thanks very much.
spk08: Thank you. Our next question comes from the line of Hunter K. from Wolf Research. Your question, please. Good morning.
spk15: Thank you. Good morning. Good morning. So we know that M&A is your preferred means of capital deployment, but all is equal. It's a tough acquisition environment, as you said, but would you be more inclined to maybe overpay a little bit for a really quality business that fits well or maybe bend a little bit on the mix of the business that you're acquiring? And if the answer is neither, how do you know when it's time to cut a special dividend? I guess the nature of the question is it's really just an art versus science type question as you evaluate
spk03: menu of options none of which might be a hundred percent appealing yeah it is a lot of art and not science on that so we do look as we go forward of you know if we pay a dividend today how could we finance anything that we see coming along on the horizon or sometimes there are surprise acquisitions that come up how could you deal with them So there's always a bit of art and looking at what's happening as we go forward. Given that we're starting to recover in the commercial markets and we're starting to see more commercial opportunities, it may be that we want to be a little more thoughtful about paying out a huge dividend today and looking at the opportunities that are coming. This is all in our thought process right now as we're evaluating what we should do over the next 12 months to get this excess cash out. As I said, some combination of M&A share buybacks and dividends will be utilized as we always have. You can go back and look at our previous history. We did buybacks. We've always, you know, we've been very engaged in dividends. We do a lot of M&A transactions. So nothing has changed. The market is very volatile right now. There's a lot happening.
spk15: Okay. And to that, has your due diligence process changed at all? Has it lengthened? Have you raised your internal return thresholds for deals? Or is it really just about a lack of willingness to sell?
spk03: It's really a lack of willingness to sell. It's a lack of opportunities of properties that you are interested in. um there is uh yeah there's not a lot of them when the commercial market is so depressed people would not be able to sell at the same price they could have before covid so they're trying to see that things get back to that space as far as paying up on transactions i never like to speculate i think if things match our criteria if a business matches our criteria we would look very strongly at it and so For us, it is staying disciplined in our M&A process. Our M&A models are the same. We are looking at businesses the same way as always.
spk08: Great. Thank you. Thank you. Our next question comes to the line of Christine Luang from Morgan Stanley. Your question, please.
spk09: Hey, guys. Good morning. Good morning.
spk08: Good morning.
spk09: Well, with a tightening credit environment, how do you think about your maximum leverage going forward? I mean, you guys were at 8.2% net debt to EBITDA just, you know, as you said, last year. And you were quite comfortable there, and there's no special stress. So do you think that's the new max in terms of where you would go should you do a special dividend or do an acquisition?
spk04: Yeah, practically, Christine, I don't think it'll change very much from where we've operated historically. If you looked at the three years pre-COVID for TransTime, the net debt EBITDA was averaged about 6.0 times almost exactly, and it kind of oscillates between like 5.5 and a half or so up to 6.5, and then maybe you do an acquisition or dividend or something that drives it towards the top end of the range. But the average was about 6.0. I think we're comfortable staying in kind of that range going forward. To Kevin's earlier comments, we always want to leave some capacity there to do a big acquisition. If something comes along that you weren't expecting, you don't ever want to dial it up so much to the high end of the range that you're tapped out because M&A is the biggest value driver for us as a company. We don't want to not have the flexibility to do that. And practically for a company like us, even though we've proven through COVID that we can probably withstand more debt than the six times we run at. The markets are only willing to give you so much, so I think we'll likely stay around the 6.0 times, and we feel really comfortable operating it at that kind of level. I mean, you guys saw we went through the worst commercial aerospace downturn in history. We stayed free cash flow positive throughout, and as long as we keep the maturities out and to the right, I don't see any big obstacle or issue that could come from the leverage level.
spk09: think that's helpful color and maybe on the DOD IG audit I mean you've had a few of these now and they've all resulted in voluntary refunds I mean nothing more major than that so at what point do these audits stop or is this just kind of a continual thing we'll see every few years that you know 20 million dollars yeah I think it's probably an artifact of doing business with the US government the DOD and
spk03: There are many audits that happen constantly amongst defense contractors and suppliers to the government of all kinds. I think this is part of the nature of doing business, and we have to get used to it. I think that the work that George has done with the working groups with the DLA, DOD, will certainly help this. It's a communication gap, I think. and we will continue to work this issue and improve it, I think, as we go forward.
spk09: Thank you, guys.
spk08: Thank you. Our next question comes from the line of Noah Popanek from Goldman Sachs. Your question, please.
spk17: Good morning, everyone. Good morning. How wide is the bell curve of you know, possibilities that you plan the business for around that 20 to 30 aftermarket growth? You know, just with still limited visibility, just curious how you manage and plan the business and, you know, what could you handle to the downside and what's even possible to deliver on to the upside?
spk03: Yeah, I think we're not as worried if upside comes. Remember, aftermarket is more – less labor dependent than is the OEM side. I think the bell curve is pretty wide in expectations. We're just trying to guide to what are some of the possibilities so that people can plan accordingly. For us to be successful in this environment, we must be nimble. We must react quickly. And, you know, that's what we're good at. So I think the 20 to 30 percent planning is appropriate, it was difficult for us to think that we would have to plan for something larger than that. At the time, that seemed like huge growth from where we were with what we knew. I think in general, we're less worried about the aftermarket curve ramp up than we are about the OEM side. It's why it's difficult, again, for us to give guidance without that OEM knowledge plan.
spk17: Okay. That makes sense. Um, did the margin in the quarter have, you know, sort of stranded costs related to the decline in defense revenues? Because the, at least the supply chain part of that is maybe, you know, a surprise you can't react to, you know, compared to, to the aerospace revenues, maybe having a clean incremental margin to them. I'm sort of curious if that makes the margin in the quarter actually you know, sort of lower than what's really going through the business?
spk04: No, I don't think so.
spk17: No. Okay. Okay.
spk03: And I know you just said you don't want to die. Defense business is generally lower profitability. So it all goes with the mix. We make less money on defense. We make less money on the OEM side at the aftermarket where we make our dollars on commercial aftermarket. So all of these things lead to the stronger margin performance in the quarter.
spk17: Right, so it's a mixed positive. I know you say you don't want to guide the quarters and that's sensible, but just for sort of calibration purposes and a month into fiscal 2Q here, should we expect the defense business to be down again year over year in the second quarter? It just would be a big sequential lift, I think, to have it be.
spk03: I think we're not guiding on a quarter-by-quarter basis. We're looking at it for the year, and we're comfortable with low single digits in defense, and, you know, we'll see how it plays out.
spk17: Fair enough. Okay. Thank you.
spk08: Thank you. Our next question comes in line of Pete Skibitsky from Olympic Global. Your question, please.
spk14: Yeah, good morning, guys. Just one for me, a little bit of a follow-on. Kevin, in your opening remarks, you talked about some of the restrictions in global air travel starting to come in. It seems like over the last month or so that's kind of accelerated, and they're really starting to come down. So I'm just wondering, early days here in the second quarter, if it's a floodgates opening type of effect that you're seeing the orders come in as a result of that, or if maybe it's just too soon right now. Thanks.
spk03: Yeah, I can't comment on this quarter specifically. We're just into it. I think you can look at last quarter and see the improvement in OEM bookings, in aftermarket bookings. The fact that we're booking more than we're shipping and our shipments are up 49% in the aftermarket, these are all encouraging signs to momentum building.
spk14: Okay. Thank you.
spk08: Thank you. Our next question comes from the line of Shia Kailuku from Jefferies. Your question, please.
spk11: Good morning, guys. How are you?
spk08: Morning, Shia.
spk11: Morning. Maybe if you could talk about inflation, how you're seeing that across your business, both from a pricing perspective. Have you changed the way you price at all, just given inflation is prominent everywhere? And then if you could talk about, you know, your cost inflation as well and how you're handling that.
spk05: Yeah, in general, we saw a little bit of an increase in inflation in Q1, primarily on electronic components, not so much on labor, although we would anticipate, obviously, given the macro indications that labor will feel that inflationary pressure throughout the year. In general, our goal with pricing is is to institute price increases above inflation, so real price increases. That philosophy has not changed in this environment. Ultimately, with the higher inflation, we've got to pass on some of that to the customer base, and that's done at the operating unit level, and the teams are doing their best job to get in front of that, knowing that the inflationary pressures will likely continue to increase throughout the balance of the year.
spk11: Great, understood. And then maybe on the aftermarket, if you could comment some more, 49% was really strong. And you noted, you know, obviously the variant came in December 1st. So can you talk about how you saw trends in October, November, and maybe in December?
spk05: Yeah, I don't have the specific monthly data. You know, really we look at it across the quarter. The aftermarket recovery can be lumpy in nature as well. And we saw good sequential improvement quarter over quarter.
spk11: Okay, great. Thanks, guys.
spk08: Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Jimmy Steven for any further remarks.
spk10: Thank you all for joining us today. This concludes today's call. We appreciate your time and have a good rest of your day.
spk08: Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.
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