Thank you for standing by. And welcome to the First Quarter 2022 TransDigm Group Inc. 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. As a reminder, today's program may be recorded. And now I'd like to introduce your host for today's program, Jaimie Stemen, Director of Investor Relations. Please go ahead.

Thank you. And welcome to TransDigm's fiscal 2022 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 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 Investors section of our website or at sec.gov. The company would also like to advise you that during the course of the call, we will be referring to EBITDA, specifically EBITDA as defined, adjusted net income and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and applicable reconciliations. I will now turn the call over to Kevin.

Good morning. 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. 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 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 a unique compensation system, closely aligned with shareholders. Next, we acquire businesses that fit this strategy where we see a clear path to private equity-like returns. And finally, our capital structure and allocation are a key part of our value creation methodology. Our longstanding goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we stay focused on both the details of value creation as well as careful allocation of our capital. As you saw from our earnings release, we had 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 the 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 the 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-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 closed 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 give that back to the shareholders in one form or another. At this time, we're still in the process of evaluating our capital allocation options regarding 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 in acquisition opportunity activity, but it's still slower than pre-COVID. We have a decent pipeline of possibilities as usual, mostly in the small to 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. 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 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 the prior year despite the slow start to the year. Jorge will provide more color on our defense end market. 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 will 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 TransDigm 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 report inaccurate and misleading. Additionally, at the request of the House Oversight and Reform Committee, we participated in a hearing on January 19 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. war fighter remain top priorities for TransDigm. 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 TransDigm 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 TransDigm, including as President of several operating units, Executive Vice President, COO of TransDigm's Airframe Business Group and most recently, Vice Chairman, where he oversaw the integration of the operating units acquired as part of the Esterline transaction. We wish Bob well in his retirement. Let me conclude by stating that I'm 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 Jorge to review our performance and a few other items.

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 discussion. Total commercial aftermarket revenue increased by approximately 49% in Q1 when compared with the 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 the 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 remained 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 reimposed 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 airfreight demand will remain robust throughout 2022. Business jet utilization remained strong. Commentary from business jet OEMs and operators have 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 TransDigm's ownership. This was the single largest contributor to the year-over-year decline. There are also some supply chain induced delays in fulfilling 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 with 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.

Good 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, EBITDA as defined of about $565 million for Q1 was up 19% versus our prior Q1. EBITDA as defined margin in the quarter was approximately 47.3%. This represents year-over-year improvement in our EBITDA as defined margin of about 450 basis points versus Q1 of last year. Sequentially, EBITDA as 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 GAAP 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 defined at TransDigm 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 paydown 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 a 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.

Certainly. Our first question comes from the line of Myles Walton from UBS. Your question please?

Thanks. Good morning. I was wondering if you could comment on the target for aftermarket growth for fiscal '22.

We can't hear you. Myles, sorry, we can't hear you.

Apologies. Can you hear me now?

There you go.

Yes, exactly. The batteries are 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?

I don't think we'd 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. And I know, Mike, you said that the TransDigm 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 TransDigm business ex Cobham look like on a year-on-year basis?

I think you'll see that some of the details in the footnotes, it was down about 5%, 6% ballpark.

Okay. All right. I’ll leave it there. Thanks.

Thank you. Our next question comes from the line of Ron Epstein from Bank of America. Your question please?

Hi. Good morning. It's Elizabeth on for Ron. I have two questions. First, can you discuss the trends you're observing in stocking and destocking? Secondly, as a follow-up to Myles, can you confirm that the 5% to 6% decline you experienced excluding Cobham is entirely due to supply chain issues? Are you seeing any improvements in that area, and how do you view it for the remainder of the year?

Jorge, do 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.

And on the second part of your question, the specifics of what drove the remaining 6% decline in the base TransDigm defense business. It's a mixed bag of both supply chain issues, but then also our planning too has been down this first quarter. We knew some of this was coming for us in the 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 combination of the two.

Do you expect any improvements for the rest of the year? Are you seeing any signs of improvement?

In defense, we still feel good about the low-single digit growth target for the year.

Okay. So expectations around supply chain, has that changed then?

That's right at this time. We continue to watch it.

Yes, we've observed some inflationary pressures and supply chain issues, particularly in electronic components and castings. However, this situation is not affecting the entire industry at the moment, but we are monitoring it closely.

Okay. Thank you so much.

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.

Thank you.

Thank you. Our next question comes from the line of David Strauss from Barclays. Your question please?

Thanks. Good morning.

Good morning.

I think you noted, Jorge 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 engine, interiors passenger?

Yeah. I don't think I have the specifics in front of me. But as a reminder, passenger is our largest submarket. 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 submarkets within the commercial aftermarket.

Okay. A 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.

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 2 or 3 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. 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.

Thanks.

Thank you. Our next question comes from the line of Ken Herbert from RBC Capital Markets. Your question please?

Yeah. 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.

I don't think we expect any material deviation from the close to 50% conversion of our EBITDA into 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 close to that kind of 45% to 50% ballpark of EBITDA we have 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.

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 shipped 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?

Correct. 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, 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.

Excellent. Thank you very much.

Thank you. Our next question comes from the line of Robert Spingarn from Melius Research. Your question please?

Hey, good morning. Kevin, I wanted to ask you a question about looking at the business from the different end markets, narrowbody, widebody, 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 widebody so idle that it's going to be problematic to get it back up and running?

Widebody is not so inactive that it would pose a problem to resume production. Narrow-body has performed better than wide-body, and the business jet sector has been very strong. That's the general assessment. However, there isn't anything specific about wide-body that would hinder our ability to ramp up manufacturing. Jorge, is there anything you would like to add?

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 widebodies 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.

And Jorge, would it be fair to say that biz jet is the most recovered or narrowbody?

I would say that biz jet is the most recovered. Absolutely.

Biz jet.

Thank you. Our next question comes from the line of Robert Stallard from Vertical Research. Your question please?

Thanks so much. Good morning.

Good morning.

Kevin, I think you noted this very strong Q1 aftermarket, but is 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?

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.

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?

Yeah. With the defense surging over the last couple of years, we saw a lot more defense opportunities in the M&A space. With the commercial market being so depressed right now, I think there haven'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.

That’s great. Thanks so much.

Thank you. Our next question comes from the line of Peter Arment from Baird. Your question please?

Thanks. Good morning, everyone. Kevin or Jorge, regarding the defense, what is your confidence in achieving low single-digit growth despite the slower start to the year? Also, how have you factored in the continuing resolution? If it were to last a full year, how would that influence your outlook? Thank you.

Yeah. I don't know that we can pinpoint any direct or quantifiable impact from the continuing resolution. 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.

Okay. That's helpful. Kevin, I wanted to follow up on your comments from the fourth quarter call regarding the supply chain disruptions. Did the situation worsen with electronic components this quarter, or is it still relatively stable?

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 casting. The casting industry has definitely been hurt coming back up after the slowdown.

Appreciate the details. Thanks.

Sure.

Thank you. Our next question comes from the line of Matt Akers from Wells Fargo. Your question please?

Hey, good morning, everybody. Thanks for the question. Can you talk about what's the kind of the biggest area of uncertainty that gives you pause in terms of giving guidance for this year? Is it OE build rates? Or what would you have to see to get the confidence to give that?

Well, I think it's OE build rates. Our largest customer still haven't given guidance, still haven't given us a forecast. This matters to us because, as Jorge 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 takeoffs 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. It's 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 it's difficult for us to forecast the future when there are so many unknowns. So that's where we come down.

Got it. Thanks. And then I guess on the defense business, with the hearing and the proposed new legislation, can you just talk about how that does that impact your business at all in the quarter? Does it have any effect on sort of how you about ship construction?

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 2 years. So we have not seen any material impact as a result of those two activities.

Thanks.

Thank you. Our next question comes from the line of Michael Ciarmoli from Truist Securities. Your question please?

Hey, good morning, guys. Thanks for taking my questions.

Good morning.

Good morning. Maybe just to go back to Rob's kind of question on aftermarket with widebody. And can you parse that growth? I mean, presumably utilization is still running pretty light. Does the planning range that you've given assume any widebody recovery? Have you seen any, I guess, uptick in the bookings to support wide-body aftermarket activity?

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 will have to up-gauge our manufacturing there, but I don't think we see it as a concern for us right now.

Got it. And then just back to the $5 billion of cash. You talked dividends, you talked buyback, M&A, obviously. Has debt paydown entered the equation at all? I mean you guys have basically been operating as a public company in a free money environment. 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 the 84%, but I mean we really don't know how this is going to shake out. I mean is that or is that in the thinking or the thought process for use of cash or not?

We always evaluate all potential uses of cash. Our primary focus remains investing in our businesses. Next, we consider mergers and acquisitions, followed by returning capital to our shareholders. Paying down debt comes last in our priorities. I don't believe the current debt environment has changed enough for us to adjust our strategy, but that may change in the future.

When considering the cost of equity compared to the cost of debt, financing your business with debt, even at projected interest rates, remains a more advantageous option.

Absolutely.

Yeah. Fair enough. Thanks, guys.

Thank you. Our next question comes from the line of Seth Seifman from JPMorgan. Your question please?

Thanks very much. And good morning. Sorry for kind of a small board question here. But just noticed 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?

Sure. Regarding the stock compensation adjustment, this follows GAAP accounting standards for calculating our stock compensation expense and the GAAP profit and loss statement. It is a non-cash expense. We're not issuing more stock options to our management team this year than we did in previous years. The reason for the increase, which is approximately from last year’s $129 million in stock compensation expense to a projected midpoint of $145 million this year, is due to a change in our performance criteria. We reverted back from the temporary criteria established during COVID, which was based on EBITDA margin and dollar targets, to our original metric that has been in place since TransDigm's inception, which is a 17.5% growth target on intrinsic equity value per share. This change impacted the calculation of GAAP stock compensation expense. Moving forward, we will continue to use the same methodology as before, with no increase in the number of options granted to executives as part of our incentive plans. Concerning the proxy filing, we submitted the 10-Ka last week that contained much of the typical proxy information. We do not anticipate the proxy to be filed for a couple of months, likely around May or June, which is later than usual. However, much of that information was already included in the 10-Ka released last week.

Got it. Great. Thanks. And then just a couple of quick clarifications on 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, 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, what is it about the second quarter? It seems like you're expecting a little bit less margin expansion in the second quarter and then acceleration later in the year. What is it about the second quarter where there's a particular headwind?

Well, on the margin side, 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.

Right. Okay. And then on defense and kind of the implication is kind of mid-single growth the remainder of the year.

I believe that's the direction we need to take. Considering the slow start, achieving our goals will be more challenging this year, but we still maintain a level of confidence in our projections. As the overall business improves and Cobham begins to expand, I expect these issues will resolve themselves.

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.

Cool. Thanks very much.

Thank you. Our next question comes from the line of Hunter Keay from Wolfe Research. Your question please?

Good morning. Thank you.

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 a menu of options, none of which might be 100% appealing?

It involves a lot of art and less of a scientific approach. As we consider moving forward, we think about how paying a dividend today might affect our ability to finance future opportunities or unexpected acquisitions. We're keeping in mind the recovery in commercial markets and the increasing opportunities that are emerging. This makes us more cautious about issuing a large dividend at this time while we evaluate upcoming prospects. We're currently assessing how to utilize excess cash over the next year, which may involve a mix of mergers and acquisitions, share buybacks, and dividends, as we have done in the past. Our history shows that we've engaged in buybacks and have been committed to dividends while actively participating in M&A transactions. The situation remains fluid due to market volatility, and there's a lot going on.

Okay. 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?

There is a noticeable reluctance to sell and a shortage of properties that meet your interests. The current commercial market is quite depressed, and sellers are unable to achieve the prices they could have prior to COVID. They are hoping conditions will return to that previous state. As for committing to transactions, I prefer not to speculate. If a business aligns with our criteria, we would seriously consider it. Therefore, it’s important for us to maintain discipline in our M&A approach. Our M&A models remain unchanged, and we are evaluating businesses in the same manner as before.

Great. Thank you.

Our next question comes from the line of Kristine Liwag from Morgan Stanley. Your question please?

Hey, guys. Good morning.

Good morning.

With the tightening credit environment, how do you view your maximum leverage going forward? You were at 8.2% net debt to EBITDA last year and were quite comfortable at that level. Given that there isn’t a significant downturn, do you think the new calculations would affect your decision to pursue a special dividend or an acquisition?

Yeah. Practically, Kristine, I don't think it will change very much from where we've operated historically. If you looked at the three years pre-COVID for TransDigm, the net debt to EBITDA was averaged about 6 times almost exactly, and it kind of oscillates between like 5.5% 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. 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 6 times we run at, the markets are only willing to give you so much. So I think we'll likely stay around the 6 times, and we feel really comfortable operating 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 to the right, I don't see any big obstacle or issue that could come from the leverage level.

Thanks. 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 at $20 million.

Yeah. I think it's probably an artifact of doing business with the U.S. government, the DoD. 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 Jorge 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.

Thank you, guys.

Our next question comes from the line of Noah Poponak from Goldman Sachs. Your question please?

Hi, good morning, everyone.

Good morning.

How wide is the bell curve of possibilities that you plan the business for around that 20% to 30% aftermarket growth? Just with still limited visibility. Just curious how you manage and plan the business? And what could you handle to the downside and what's even possible to deliver on to the upside?

I think we're not overly concerned. If we see an upside, it's important to remember that the aftermarket is less dependent on labor compared to the OEM side. The range of expectations is quite broad. We're simply trying to indicate some potential scenarios so that everyone can plan accordingly. To succeed in this environment, we need to be agile and respond quickly, which is one of our strengths. Therefore, planning for a 20% to 30% growth seems reasonable. At the time, it was hard for us to consider planning for a growth larger than that, as it felt like a significant increase from our previous understanding. Generally, we're less concerned about the ramp-up in the aftermarket compared to the OEM side. This is why it's challenging for us to provide guidance without knowing more about the OEM plans.

Okay. That makes sense. Did the margin in the quarter have sort of stranded costs related to the decline in defense revenues because at least the supply chain part of that is maybe a surprise you can't react to compared 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 truly going through the business.

No, I don't think so.

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.

So it's a mixed picture. I understand that you prefer not to provide quarterly guidance, but for clarification purposes, as we approach the second quarter of fiscal year 2, should we anticipate the defense business to decline again year-over-year in the second quarter? It would require a significant sequential improvement.

Yeah. 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 we'll see how it plays out.

Fair enough. Okay. Thank you.

Thank you. Our next question comes from the line of Pete Skibitski from Alembic Global. Your question please?

Good morning, everyone. I have a follow-up question. Kevin, you mentioned in your opening remarks that some of the restrictions on global air travel are starting to ease. It seems like this trend has accelerated over the past month. I’m curious if, in the early days of the second quarter, you are experiencing a significant increase in orders as a result of this, or if it's still too early to tell. Thank you.

Yeah, I can't comment on this quarter. We're just into it. I think you can look at last quarter and see the improvement in OEM bookings and 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 of momentum building.

Thank you. Our next question comes from the line of Sheila Kahyaoglu from Jefferies. Your question please?

Good morning, guys. How are you?

Good morning.

Maybe if you could talk about inflation, how you're seeing right 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 your cost inflation as well and how you're handling that?

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 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.

Great. Understood. And then maybe on the aftermarket, if you could comment some more, 49% was really strong. And you noted, obviously, the variant came in December 1. So can you talk about how you saw trends in October, November and maybe in December?

Yeah. I don't have the specific monthly data. 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.

Okay, great. Thanks, guys.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Jaimie Stemen for any further remarks.

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

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.