Thank you for standing by, and welcome to the TransDigm Group's 2023 First Quarter Results Call. [Operator Instructions]. I would now like to hand the call over to Jaimie Stemen, Director of Investor Relations. Please go ahead.

Thank you, and welcome to TransDigm's Fiscal 2023 First Quarter Earnings Conference Call. Presenting on the call this morning are TransDigm's President and Chief Executive Officer, Kevin Stein; Chief Operating Officer, Jorge Valladares; and Chief Financial Officer, Mike Lisman. Please visit our website at transdigm.com to obtain a supplemental slide deck and call replay information. Before we begin, the company would like to remind you that 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 call for a presentation of the most directly comparable GAAP measures and applicable reconciliations. I will now turn the call over to Kevin.

Good morning. Thanks for calling in today. First, I'll start off with the usual quick overview of our strategy, a few comments about the quarter and discuss our fiscal '23 outlook. Then Jorge and Mike will give additional color on the quarter. To reiterate, we are unique in the industry in both the consistency of our strategy in good times and bad as well as our steady focus on intrinsic shareholder value creation through all phases of the aerospace cycle. To summarize, here are some of the reasons why we believe this. About 90% of our net sales are generated by unique proprietary products. Most of our EBITDA comes from aftermarket revenues, which generally have significantly higher margins and over any extended period have typically provided relative stability in the 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 organizational structure and a unique compensation system closely aligned with shareholders. We acquire businesses that fit this strategy and where we see a clear path to PE-like returns. And lastly, our capital structure and allocations are a key part of our value creation methodology. Our long-standing goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we stay focused on both the details of value creation as well as careful allocation of our capital. As you saw from our earnings release, we had a good start to fiscal '23 and increased our guidance for the year. We continue to see recovery in the commercial aerospace market. Our Q1 results show positive growth in comparison to the same prior year period. We are encouraged by the progression of the commercial aerospace…

Thanks, Kevin, and good morning, everyone. I'll start with our typical review of results by key market category. For the balance of the call, I'll provide commentary on a pro forma basis compared to the prior year period in 2022. That is, assuming we own the same mix of businesses in both periods. The market discussion includes the May 2022 acquisition of DART Aerospace in both periods. DART has been included in this market analysis discussion since the third quarter of fiscal '22. In the commercial market, which typically makes up close to 65% of our revenue, we'll split our discussion into OEM and aftermarket. Our total commercial OEM revenue increased approximately 20% in Q1 compared with the prior year period. Bookings in the quarter were strong compared to the same prior year period and solidly outpaced sales. Sequentially, the bookings improved almost 15% compared to Q4. We continue to be encouraged by build rates steadily progressing at the commercial OEMs and the strong demand for new aircraft. However, ongoing labor instability and supply chain challenges across the broader aerospace sector present risks to achieving OEM production rates. Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 31% in Q1 when compared with the prior year period. Growth in commercial aftermarket revenue was primarily driven by continued strength in our passenger submarket, which is our largest submarket, although all of our commercial aftermarket submarkets were up significantly compared to prior year Q1. Sequentially, total commercial aftermarket revenues grew by approximately 7% and bookings grew more than 25%. Commercial aftermarket bookings were robust this quarter compared to the same prior year period and Q1 bookings significantly outpaced sales. Turning to broader market dynamics. Global revenue passenger miles remained lower than pre-pandemic levels, but have…

Good morning, everyone. I'm going to quickly hit on a few additional financial matters for the quarter and then expectations for the full fiscal year. First, on organic growth and liquidity. In the first quarter, our organic growth rate was 15%, driven by the continued rebound in our commercial OEM and aftermarket end markets. On cash and liquidity, free cash flow which we traditionally define as EBITDA, less cash interest payments, CapEx and cash taxes was roughly $400 million for the quarter. We ended the quarter with approximately $3.3 billion of cash on the balance sheet, and our net debt-to-EBITDA ratio was exactly 6x, down from 6.4x at the end of last quarter. On a net debt-to-EBITDA basis, this puts us right at the 5-year pre-COVID average level. Additionally, our cash interest coverage ratios, such as EBITDA to interest expense are currently in line with where we've historically operated the business. We feel comfortable here given the benefit of our interest rate hedges and fixed rate debt instruments that were entered into in a lower interest rate environment. As always, we continue to watch the rising interest rate environment in the current state of the debt markets very closely. During the first quarter, we completed an extension of our nearest maturity term loan pushing the maturity date from mid-2024 out into 2027. Pro forma for this refinancing, our nearest term maturity is now 2025. As a result of this refi, our interest expense estimate for FY '23 ticked up very slightly, as you can see in today's updated interest expense guidance. Over 75% of our total $20 billion gross debt balance is at a fixed rate through a combination of fixed rate notes and interest rate caps and swaps through 2025. This provides us adequate cushion against any rise in rates at least in the immediate term. Going forward, we expect to continue both proactively and prudently managing our debt maturity stacks. Practically for us, this means pushing out any near-term maturities well in advance of the final maturity date and then also utilizing hedging instruments where we can in order to lock in the cash interest costs. 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 via share buybacks or dividends during fiscal '23. With that, I'll turn it back to the operator to kick off the Q&A.

[Operator Instructions]. Our first question comes from the line of Noah Poponak of Goldman Sachs.

How are you anticipating the commercial aerospace aftermarket revenue to progress sequentially through the year compared to the first quarter?

I would expect much like flight activity that it should keep trending upwards. That's our expectation. We'll see if that plays out.

Okay. And you mentioned bookings ahead of shipments across the board. Do you have any quantification of that?

We've historically not given book-to-bills across the end markets, Noah, but I think it's pretty healthy growth that supports the revised guidance on revenue for today. So we feel good about hitting that healthy growth and healthy outperformance and really positive book-to-bill ratios across the end markets.

Okay. And just last one. The EBITDA guidance revision is the same as revenue at the midpoint. So it implies a 100% incremental on the additional revenue. I know it's not that simple. But can you just walk me through how the EBITDA is able to be the same as the revenue in the guidance revision?

Yes. I think, Noah, what you're seeing there is just the upsides mainly in the commercial aftermarket space, which is our most profitable end market of the 3. And then separately, some better cost performance, right? You're not typically getting 100% drop to your point, but we are doing slightly better on the cost than we expected, but that's what you're seeing there.

Thank you. Our next question comes from the line of Robert Stallard of Vertical Partners.

Kevin, you mentioned that the M&A pipeline is still looking pretty active. I was wondering if you're seeing any sign of these higher interest rates starting to impact the appetite of financial buyers?

Yes. I think we've seen some impact over the last 6 months or so. I think you see that in a general lack of activity, although we've been busy evaluating different targets. I think we see that changing, though, as there seems to be some important properties coming to market in the next 6 months or so, I think this should change. So we remain relatively optimistic as always. But I think that gives you some indication of what we're looking at in the future.

And one for Mike in related topic actually. You mentioned there's some debt due in 2025. If you were to refinance that today, what sort of interest rate would you expect to pay on that?

It's hard to say, something like what we got on the December refi, we just did a month or 2 ago. The interest rate ticked up by about 1.0% from LIBOR plus 225 to SOFR plus 325, and debt markets are a little bit better given what's come out on inflation and the Fed rate move since that December rate. So maybe you do a little bit better than that, but it's hard to say that's just a guess.

Our next question comes from the line of Scott Deuschle of Credit Suisse.

Kevin, I wanted to get your thoughts on M&A outside of A&D. Is that something you'd ever do? And if you were to do something outside of A&D, should we expect you to start small? Or could we see you start with something bigger?

Well, we don't like to speculate on that. We have studied what it would look like to acquire something outside of M&A -- of A&D, but we think it's best to stay focused on aerospace. There are still so many great opportunities and a number of them coming up. Like I said, in the next 6 months that keep us very focused on the pure-play aerospace and defense. For intellectual reasons and also because we may have to do one day in the distant future, we do look at other areas, but none of them have appeared interesting enough to overshadow our desire to keep growing in aerospace and defense.

Great. That's really helpful. And then for Mike, you showed some really good leverage on SG&A this quarter. I think your sales were up 17%, but SG&A was actually down. So curious if you could outline a bit what the cost mitigation efforts are that you're running there and then how SG&A might trend as we move throughout the year?

Yes. We really look at the EBITDA line historically. We've not gone back and looked and commented specifically on gross profit versus SG&A trends just because of the accounting puts and takes there. And as we think about forecasting for the year, we really look at EBITDA as defined ratio and feel good about hitting the 50.5% or maybe slightly better than we gave the guidance for today. And it's hard to comment specifically where SG&A could go for the balance of the year on a quarterly basis.

Yes. I would just add, I think, in general, as we've had and we've performed in past downturns in the uptick. We did a lot of heavy lifting with restructuring as a result of the COVID pandemic and the teams have done a nice job managing to the lower cost structure and supporting the additional demand. And I think we'll continue to do so throughout the year.

Our next question comes from the line of David Strauss of Barclays.

This is Josh Corn on for David. Working capital was fairly neutral in Q1. Do you still see the $150 million drag for the year?

We do. I mean, as we come back to pre-COVID levels, that's going to go in over the course of the year. It's kind of lumpy in how it happens and the progression and forecasting is tough, but we do expect that amount to go back in.

And it looks like overall aftermarket revenues were back pretty much to pre-pandemic levels. Can you give us a sense of where volumes are?

I think we're still 20% to maybe 30% off in volumes. There is still a lot of regions, as Jorge reviewed, that have not fully come back.

Our next question comes from the line of Peter Arment of Baird.

Nice results, and I'm sorry if you missed your opening remarks, but just on China, just kind of assumptions around what you expect there just as we get the reopening traffic picking up pretty materially, hopefully, wide-body activity comes back. Just remind us kind of the mix that we should be thinking about with China and just how you kind of incorporated that in your forecast?

Sure. I'll take that one. From our perspective, we're still in the early innings of China opening up, obviously, this past month. Our teams, as they always do, do a bottoms-up analysis and planning process as we enter any fiscal year. And there was some recovery expected baked into our forecast and our plan. We'll see how it plays out. Generally, we don't have and we don't track specific regions. We think we're fleet weighted. And obviously, it's a big market. So hopefully, that will be helpful as we progress throughout the year.

I guess just a follow-up quickly. On just the wide-body activity, could you make a comment, Jorge, just on what you're seeing regarding some of the airlines behavior on the wide-body?

Yes. I don't think we've seen much shift. Again, the opening for China international travel is pretty new. You would logically expect the wide-body usage to improve given those types of routes. But we're still, again, in the early innings of this.

Our next question comes from the line of Gautam Khanna of Cowen.

In the past, you've sometimes given color on discretionary versus nondiscretionary aftermarket demand. Any color there or by channel distribution versus direct?

Yes. I think most of our revenues are on direct sales. In general, we're seeing good strength and good recovery across all of the individual submarkets.

And on the discretionary versus nondiscretionary point, we think consistent with what we've said in the past, we're mostly nondiscretionary when it comes to the commercial aftermarket bucket.

And that's where you're seeing kind of the incremental strength is in the nondiscretionary. I'm just curious like...

It's like hard to break it out...

I think we're seeing strength across the board in all of the submarkets.

Okay. And just curious what you're seeing in terms of inflation this year from your suppliers? What if -- do you have a dollar value you could give to us and how -- what you're doing to offset it with pricing?

Yes. I don't have a specific dollar value to give you. In general, we really focus on productivity. We are seeing inflationary pressures from the supply chains. We've got all of our teams have individual decentralized procurement organizations that are doing a nice job working with the supply chain, trying to minimize the level of inflation, and we continue to work the productivity to offset that, and you're seeing that flow through in terms of the lower cost structures.

Our next question comes from the line of Matt Akers of Wells Fargo.

I wonder if you could elaborate the comment, you could see a further upward revision in the guidance as we go through the year. How much of that kind of uncertainty, is China versus kind of OE build rates or sort of -- I don't know if you can kind of quantify what the biggest buckets of that uncertainty could be?

I think it's probably a big piece from China. But clearly, OEM is not performing where it was prior to the COVID outbreak. So there is room really in all of the market segments for improvement.

Okay. Got it. And then I guess on your cash balance, it's kind of come down from where it was during COVID, but still higher than what we saw a few years ago. How much higher should we expect you to kind of leave that just so you have kind of the optionality in case a deal comes through or something like that?

Yes. We're -- obviously, we're sitting on more than we've had historically to your point. We feel good about the M&A pipeline, as Kevin said, and what's coming, we do have far more than we need to operationally run the business, but it's something we think about quite a bit just in terms of the capital allocation priorities that Kevin provided and want to make sure we have enough firepower for potential M&A in the current environment.

Our next question comes from the line of Seth Seifman of JPMorgan.

This is Rocco Barbara on for Seth. Now that leverage is in the 6x range that has been stated in the past to be the general ballpark range for the company, how do you think about new acquisitions and/or capital deployment moving forward? Also where would you consider returning cash again?

Yes. It's hard to say exactly. Like I just mentioned, we're always looking at the capital deployment options, right? We're doing that today. We do it quite a bit, obviously, monthly, and we want to be strategic with our capital and make sure we have enough at all times for M&A if it comes. And then also, it's the shareholders' capital. So we want to be efficient with it. And if we don't find a use for it, give it back. With regard to the leverage ratio, we are at about 6x which is historically where we were in a lower interest rate environment. I think we're -- as I mentioned, we feel comfortable where we are today at the 6x level and given the benefit of the hedges. It's hard to say if we tick up from here if we went and found a good acquisition candidate and use a little bit of debt, you could always do that, though you'd then be adding EBITDA. So I think it's safe to say going forward, given that we have the hedges and also that our interest rate hasn't moved much because of those, it's probably likely that we stay sort of at the 6x ballpark with some movement this way or that way, consistent with the last 5 years of history or so. But no real material change with the approach to leverage is expected.

Great. Then as a quick follow-up. You had mentioned earlier that you expect EBITDA as defined margin to kind of expand as we go through this year. Should we be expecting that expansion to continue in the out years? Or are we approaching a range where the margin will begin to plateau?

We are still navigating 2023. We'll give guidance on '24 and beyond when it's appropriate. But obviously, our model is to keep, keep expanding, keep improving our business.

Our next question comes from the line of Andre Madrid of Bank of America.

I kind of wanted to take a look back at the supply chain. Obviously, there's a lot of financial stress in the lower tiers. Do you guys see that as a room for opportunity when it comes to M&A? Just kind of wanted to gauge your outlook on that.

Not really. We don't look to vertically integrate. We look to acquire phenomenal aerospace and defense businesses that we can further improve. Buying parts of the supply chain vertically integrating usually doesn't meet our criteria for highly engineered, unique aerospace components with aftermarket content, and we like to stay very disciplined in that approach. That's been the secret to our success, I think, in our M&A culture.

[Operator Instructions]. Our next question comes from the line of Pete Osterland of Truist.

Just wanted to ask, how are you managing through the current labor market environment? Has attrition been manageable? Do you need additional hires to meet the growth you're anticipating this year? Or have there been any challenges related to productivity?

Yes, I'll take that. I think generally, the teams have done a really nice job. We continue to focus on CapEx and productivity. Over the last couple of years, we've been able to invest in the business, and find different automation opportunities to take labor out of the process here and there. I think in general, the labor market conditions have been improving over the last couple of months. Most teams have plans in place to support potential OE production rate increases as we're all hoping will occur. So I don't see any significant issues. And I'd say, in general terms, it's probably improved a little bit the last couple of months.

Thank you. At this time, I'd like to turn the call back over to Jaimie Stemen for closing remarks. Madam?

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

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