Earnings Call Transcript
TransDigm Group INC (TDG)
Earnings Call Transcript - TDG Q1 2024
Operator, Operator
Good day and thank you for standing by. Welcome to the TransDigm Group Incorporated First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised, that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jaimie Stemen, Director of Investor Relations. Please go ahead.
Jaimie Stemen, Director of Investor Relations
Thank you and welcome to TransDigm's fiscal 2024 first quarter earnings conference call. Presenting on the call this morning are TransDigm's President and Chief Executive Officer, Kevin Stein; Co-Chief Operating Officer, Joel Reiss; and Chief Financial Officer, Sarah Wynne. Also present for the call today is our Co-Chief Operating 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 release for a presentation of the most directly comparable GAAP measures and applicable reconciliations. I will now turn the call over to Kevin.
Kevin Stein, CEO
Good morning. Thanks for joining us on the call today. First, I'll start off with the usual quick overview of our strategy, a few comments about the quarter, and discuss our fiscal 2024 outlook. Then Joel and Sarah will give additional color on the quarter. To reiterate, we believe we are unique in the industry in both the consistency of our strategy in good times and bad, as well as our steady focus on intrinsic shareholder value creation through all phases of the aerospace cycle. To summarize, here are some of the reasons why we believe this. About 90% of our net sales are generated by unique proprietary products. Most of our EBITDA comes from aftermarket revenues, which generally have significantly higher margins, and over any extended period, have typically provided relative stability in the downturns. We follow a consistent long-term strategy, specifically; first, we own and operate proprietary aerospace businesses with significant aftermarket content. Second, we utilize a simple, well-proven, value-based operating methodology. Third, we have a decentralized organizational structure and unique compensation system closely aligned with our shareholders. Fourth, we acquire businesses that fit this strategy and where we see a clear path to private equity-like returns. And lastly, our capital structure and allocation 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 strong quarter. Our Q1 results ran ahead of our expectations. And we have raised our sales and EBITDA as defined guidance for the year. Commercial aerospace market trends remain favorable as the industry continues to recover and progress towards normalization. Global air traffic is closing in on pre-pandemic levels and demand for travel remains high. Airline demand for new aircraft also remains high, and the OEMs are working to increase aircraft production. However, total air travel demand remains slightly below pre-COVID levels and OEM aircraft production rates remain well below pre-pandemic levels. There is still progress to be made for the industry, and our results continue to be adversely affected in comparison to pre-pandemic levels. In our business, during the quarter, we saw a healthy growth in our revenues and bookings for all three of our major market channels; commercial OEM, commercial aftermarket, and defense. Our EBITDA as defined margin was 51% in the quarter, contributing to the strong Q1 margin and the continued recovery in our commercial aftermarket revenues, along with diligent focus on our operating strategy. Additionally, we had strong operating cash flow generation in Q1 of over $630 million and ended the quarter with over $4.1 billion of cash. We expect to steadily generate significant additional cash throughout the remainder of 2024. Next, an update on our capital allocation activities and priorities. As we discussed on our last earnings call, we agreed on November 9th to acquire the Electron Device Business of Communications & Power Industries, also known as CPI, for approximately $1.385 billion in cash. CPI's Electron Device Business is a leading global manufacturer of electronic components and subsystems, primarily serving the aerospace and defense market. The products manufactured by this business are highly engineered proprietary components with significant aftermarket content and a strong presence across major aerospace and defense platforms. Our team is working diligently through the approval process in the US and UK, and the acquisition is expected to close this fiscal year. We remain very excited about adding this proprietary business as one of our TransDigm operating units. Regarding the current M&A pipeline, we continue to actively look for M&A opportunities that fit our model. As we look out over the next 12 months to 18 months, we continue to see a target-rich environment for our focused acquisition strategy. As usual, the potential targets are mostly in the small and midsize range. I cannot predict or comment on possible closings, but we remain confident there is a long runway for acquisitions that fit our portfolio. The capital allocation priorities at TransDigm are unchanged. Our first priority is to reinvest in our business; second, do accretive disciplined M&A; and third, return capital to our shareholders via share buybacks or dividends. A fourth option, paying down debt, seems unlikely at this time, though we do still take this into consideration. We are continually evaluating all of our capital allocation options, but both M&A and capital markets are difficult to predict. As always, we continue to closely monitor the capital markets and remain opportunistic. As mentioned earlier, we ended the quarter with a sizable cash balance of over $4.1 billion, which includes the $2 billion of cash from the new debt issued during our first quarter. Sarah will comment on this in more detail later. We have significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future. Moving to our outlook for fiscal 2024. As noted in our earnings release, we are increasing our full fiscal year 2024 sales and EBITDA as defined guidance to reflect our strong first quarter results and our current expectations for the remainder of the year. At the midpoint, sales guidance was raised $85 million and EBITDA as defined guidance was raised $45 million. The guidance assumes no additional acquisitions or divestitures and is based on current expectations for a continued recovery in our primary commercial end markets throughout fiscal year 2024. Our current guidance for fiscal 2024 is as follows and can also be found on slide 6 in the presentation. Note that the pending acquisition of CPI's Electron Device Business is excluded from this guidance until acquisition closed. The midpoint of our fiscal 2024 revenue guidance is now $7.665 billion, or up approximately 16%. In regards to the market channel growth rate assumptions that this revenue guidance is based on, for the defense market, we are updating the full year growth rate assumptions as a result of our strong first quarter results and current expectations for the remainder of the year. For Defense, we now expect revenue growth in the high single-digit to low double-digit percentage range. This is an increase from our previous guidance of mid to high single-digit percentage range. We are not updating the full year market channel growth rate assumptions for commercial OEM and commercial aftermarket, as underlying market fundamentals have not meaningfully changed. Commercial OEM and commercial aftermarket revenue guidance is still based on our previously issued market channel growth rate assumptions. We expect commercial OEM revenue growth around 20% and commercial aftermarket revenue growth in the mid-teens percentage range. The midpoint of our EBITDA as defined guidance is now $3.985 billion, or up approximately 17% with an expected margin of around 52%. This guidance includes about 100 basis points of margin dilution from our recent Calspan acquisition. We anticipate EBITDA margins will move up throughout the remainder of the year. The midpoint of our adjusted EPS is decreasing versus our prior guide, primarily due to the higher interest expense associated with the incremental debt we took on to fund CPI. The midpoint of adjusted EPS is now expected to be $30.85 or up approximately 19% over the prior year. Sarah will discuss in more detail shortly the factors impacting EPS, along with some other fiscal 2024 financial assumptions and updates. We believe we are well-positioned for the remainder of fiscal 2024. We'll likely continue to closely watch how the aerospace and capital markets continue to develop and react accordingly. Let me conclude by stating that I am very pleased with the company's performance this quarter and throughout the recovery of the commercial aerospace industry. We remain focused on our value drivers, cost structure, and operational excellence. Now, let me hand it over to Joel Reiss, our Co-COO, to review our recent performance and a few other items.
Joel Reiss, Co-COO
Good morning. I'll start with our typical review of results, by key market category. For the remainder of the call, I'll provide commentary on a pro forma basis compared to the prior year period in 2023 that is assuming we own the same mix of businesses in both periods. In the commercial market, which typically makes up close to 65% of our revenue, we will split our discussion into OEM and aftermarket. Our total commercial OEM revenue increased approximately 25% in Q1, compared with the prior year period. Bookings in the quarter were strong compared to the same prior year period. Our strong bookings continue to support the commercial OEM guidance of revenue growth around 20% for fiscal 2024. OEM supply chain and labor challenges persist, but appear to be progressing. We continue to be encouraged by the steadily increasing commercial OEM production rates and strong airline demand for new aircraft. Supply chains remain the primary bottleneck in this OEM production ramp-up. The FAA's recently announced production rate freeze at 38 per month for the Boeing 737 MAX will likely slow the expected MAX ramp, and time will tell how this plays out. The commercial OEM guidance given today takes into account an appropriate level of continued risk around Boeing's production build rate. While risks such as this and others remain towards achieving the ramp-up across the broader aerospace sector, we are optimistic that our operating units are well-positioned to support the higher production targets as they occur. Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 22% compared with the prior year period. Growth in commercial aftermarket revenue was primarily driven by the continued strength in our passenger submarket, which is by far our largest submarket. We also saw good growth in our interior submarket compared to prior year Q1 and biz jet was up slightly year-over-year as well. These increases were very minimally offset by a very slight decline in our freight submarket driven by the return of belly capacity and consistent with what we discussed on last quarter's earnings call. Commercial aftermarket bookings for this quarter were strong compared to the same prior year period. The strong booking levels in commercial aftermarket continue to support our commercial aftermarket guide for revenue growth in the mid-teens percent range for fiscal 2024. As a reminder, when forecasting our commercial aftermarket, we always look at a rolling historical 12-month average booking trend, never just the most recent quarter, due to lumpiness that we often see in this end market. Turning to broader market dynamics and referencing the most recent IATA traffic data for December. Global revenue passenger miles still remain lower than pre-pandemic levels, but only slightly. December 2023 air traffic was about 2.5% below pre-pandemic and full 2023 traffic was about 6% below. Globally, a return to 2019 air traffic levels is expected in 2024, and IATA currently expects traffic to reach 104% of 2019 levels in 2024. Domestic travel continues to surpass pre-pandemic levels. In the most recently reported traffic data for December, global domestic air traffic was up 2% compared to pre-pandemic. Domestic air travel in China also continues to improve and was up 8% in December compared to pre-pandemic levels. This is a significant improvement from China being down 55% a year ago in December 2022. Shifting over to the US, domestic air travel for December came in about flat with pre-pandemic traffic. International traffic has continued to make steady improvement over the past few months. A quarter ago, at the end of September, international travel globally was depressed about 7% compared to pre-pandemic levels, but in the most recently reported data for December, international travel was only down about 5%. This is a significant improvement over being down 25% a year ago in December 2022. In summary, for the commercial aftermarket, we continue to see strong growth in our passenger and interior submarkets, indicative of the continuing positive trends in the post-COVID passenger traffic recovery. Our biz jet and freight submarkets are performing in line with their underlying markets and also in line with our expectations at this point in the year. Shifting to our defense market, which traditionally is at or below 35% of our total revenue. The defense market revenue, which includes both OEM and aftermarket revenues, grew by approximately 28% compared with the prior year period. Q1 defense revenue growth was well distributed across our businesses. However, bear in mind that the comparable prior year period was an easy comp. We would not expect to see defense revenue growth rates at this level continuing throughout the balance of the year. We expect some moderation here as you can tell from the guidance. Defense bookings are also up significantly this quarter compared to the same prior year period. While the defense revenue growth this quarter was pretty broadly distributed across our customer base, we continue to see improvements in the US government defense spending outlays during Q1. We are hopeful we will continue to see steady improvement. But as we have said many times before, defense sales and bookings can be lumpy. We know the bookings and sales will come, but forecasting them with accuracy and precision is difficult. As Kevin mentioned earlier, we now expect our defense market revenue growth for this year to be in the high single-digit to low double-digit percentage range. This updated guidance for defense primarily reflects the stronger-than-expected Q1 defense sales as well as the good Q1 bookings. In closing, Q1 was a good start to the fiscal 2024 fiscal year, and I was pleased with our operational performance. We will remain focused on our consistent operating strategy and servicing the strong demand for our products as we continue throughout the balance of the year.
Sarah Wynne, CFO
Thanks, Joel, and good morning, everyone. I'll recap the financial highlights for the first quarter and then provide some more information on the guidance update. First, on organic growth and liquidity. In the first quarter, our organic growth rate was 23.5%, and all market channels contributed to this growth as Kevin and Joel have just discussed. On cash and liquidity, free cash flow, which we traditionally define as EBITDA less cash interest payments, CapEx and cash taxes, was roughly $660 million for the quarter. This is a higher than average free cash flow conversion for the quarter, primarily due to the timing of our interest and tax payments. Cash interest and tax payments will pick up again in the next quarter and for the full fiscal year, our free cash flow guidance is unchanged. We expect to continue to generate free cash flow of close to $2 billion in fiscal 2024. Below that free cash flow line, net working capital consumed a smaller amount of cash than in prior years coming in close to flat. For the past few years, we saw a large influx of cash into our working capital as our primary commercial end markets experienced strong rebound post COVID. We were obviously very happy to support this increase. Going forward, we expect our annual dollars invested in net working capital to moderate from the elevated levels seen over the prior two years, but pinpointing the exact amount of investments for fiscal 2024 is difficult. As you know, the rebound of the OEM market channel does impact our accounts receivable as customers in that bucket typically have slightly longer payment terms. We ended the quarter with approximately $4.1 billion of cash on the balance sheet, and our net debt-to-EBITDA ratio was five times, down from 5.4 at the end of last quarter when pro forma was $35 dividend. As a reminder, we are comfortable operating in the 5 to 7 net debt-EBITDA ratio range. And while we are currently sitting on the low end of this range, a go-forward strategy of capital deployment has not changed. Our EBITDA to interest expense coverage ratio ended the quarter at 3.3 times on a pro forma basis, which provides us with comfortable cushion versus our target range of two to three times. During the first quarter, we went to the market and proactively raised $2 billion of debt, the acquisition of CPI's Electron Device Business, which is still subject to regulatory approval with the rest going towards general corporate purposes. As a result of the additional debt, our interest expense estimate for fiscal 2024 increased by $130 million, as you can see in today's updated interest expense guidance. Regarding our debt, we expect to continue both proactively and prudently managing our maturity deck stack, which for us means pushing out any near-term maturities well in advance of the final maturity date. Our near-term debt maturity is now 2026, and we remain approximately 75% hedged on a total $22 billion gross debt balance through our fiscal 2026. This is achieved through a combination of fixed rate notes, interest rate caps, swaps, and collars. This provides us adequate cushion against any rise in rates at least in the immediate term. With regard to guidance, as Kevin mentioned, we increased our midpoint sales and EBITDA by $85 million or $45 million, respectively, given the strong quarter and current expectations for the year. Our EPS guidance is now $30.85 compared to prior guidance of $31.97. The reduction is due to additional interest expense. Without that, it would be $32.57. 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 dividends or share repurchases. With that, I'll turn it back to the operator to kick off the Q&A.
David Strauss, Analyst
Great. Thanks. Good morning, everyone.
Kevin Stein, CEO
Good morning.
David Strauss, Analyst
Kevin, could you talk about maybe what you saw in terms of the aftermarket growth on a sequential basis Q4 versus Q1? And then, it looks like you have a very tough aftermarket comp in Q2. Any range on kind of how we should calibrate aftermarket growth in Q2?
Kevin Stein, CEO
I think we're forecasting mid-teens percentage. It might revise up. We'll have to see how the year unfolds. It was a strong quarter in Q1. The bookings are there. We saw a sequential increase in shipments in Q1, and we anticipate that, that will continue.
David Strauss, Analyst
Okay. A quick follow-up. Has there been any change in the timing around closing on the CPI deal? I think previously you said by the end of Q3; I think now you're seeing before the year-end, I don't know if there was a meaningful change there at all? Thanks.
Kevin Stein, CEO
Yes. We're still incredibly positive on the CPI acquisition. There's zero overlap with anything we do. Right now, it's going through the approval process, and yeah, we're very positive about it happening. It's just difficult to predict timing. As you know, things are taking a little bit longer, but we anticipate this fiscal year.
Operator, Operator
Our next question comes from the line of Noah Poponak with Goldman Sachs. Your line is open.
Noah Poponak, Analyst
Hi. Good morning, everyone.
Kevin Stein, CEO
Good morning.
Noah Poponak, Analyst
Maybe you could elaborate on how the M&A pipeline looks and ability or opportunities to deploy capital after CPI? Because you mentioned being at the low end of the target balance sheet leverage range and you're basically going to generate the CPI cost over the remaining quarters of the year in free cash. So that's not actually going to raise your leverage. So how are you looking at managing that? And how much more opportunity is there to deploy capital in the near term?
Kevin Stein, CEO
We plan to consider deploying capital during the fiscal year, likely closer to the end as we assess the M&A pipeline. There is a lot happening with various targets, including many unexpected ones. We are continuously evaluating these opportunities. It's important to highlight that we maintain a disciplined approach to M&A at TransDigm. We will not pursue acquisitions that do not meet our criteria for highly engineered aerospace products with aftermarket access. We aim to stay disciplined in this regard, and it's promising that there are many targets available. Most of these are small and medium-sized targets, which are the easiest for us to pursue.
Noah Poponak, Analyst
Okay. In the aerospace aftermarket, has there been any deceleration in the rate of increase in price as broader inflation has decelerated? Or has that rate of change held in despite that deceleration?
Mike Lisman, Co-COO
There's really been no change to our overall philosophy and approach. We continue to look to market-based value the product and offset the inflationary pressures that I see. Obviously, not all operating units see the same level of inflationary pressures. And that's generally what they're trying to do is to offset that.
Noah Poponak, Analyst
Okay. Is there a window of time here though, where the cost side is decelerating with the pricing is not? Or are they pretty much marked to each other pretty quickly?
Mike Lisman, Co-COO
Yeah. I think they're generally going to be pretty close to one another. Obviously, our teams are focused on driving productivity. The same team, our teams are trying to make sure that we've priced the product appropriately.
Operator, Operator
Our next question comes from the line of Robert Spingarn with Melius Research. Your line is open.
Robert Spingarn, Analyst
Hi. Good morning.
Kevin Stein, CEO
Good morning.
Robert Spingarn, Analyst
As a follow-up on that last answer on Noah's question on inflation, we think about commercial OE and defense, which I would think would be different than commercial aftermarket where you can price in real time. How much of that revenue base is tied to long-term agreements that may have some stale pricing still to work through and can be renegotiated, let's say, over the next year or two? So what I'm asking is if there's upside in those two groups because of LTAs?
Kevin Stein, CEO
Most of our OEM business is tied to long-term agreements, which are regularly expiring and being renegotiated. This is a consistent aspect of the industry. There is potential to recover from inflation impacts that have been absorbed over the past couple of years, so that remains a possibility.
Robert Spingarn, Analyst
Okay. And Kevin, just a high-level question on your workforce, you guys are just consistently executing the margins where we would expect or better. But for everyone else in the industry there are workforce issues. And recovering workforce or labor from COVID, getting people trained and so on. Is it fair to characterize those folks as different than TransDigm? Or are there things that we can't see?
Kevin Stein, CEO
I believe there are various business models, and our ability to manage inflation means we should be able to adapt to the labor market and ensure we have the best talent and sufficient resources to drive our business forward. It's also important to recognize that TransDigm excels in operational efficiency, and we continually enhance productivity across our operations while making ongoing investments in that area. Joel, do you have anything to add?
Joel Reiss, Co-COO
Yeah. And the other thing I'd add to what Kevin said, I mean, fortunately, I think the labor markets continue to improve, which is certainly helpful. And we had some locations where we saw higher turnover a couple of years ago. I think that's really gone back to more normal levels, but we've put a lot of time and effort into training our folks. And as Kevin said, we've worked over the last few years to put more and more automation in place, which certainly mitigates what the impact of that is. And so I think we're well-positioned going forward.
Robert Spingarn, Analyst
Thank you both for the color.
Operator, Operator
Our next question comes from the line of Louis Raffetto with Wolfe Research. Your line is open.
Louis Raffetto, Analyst
Hi, good morning. Thank you.
Kevin Stein, CEO
Good morning.
Louis Raffetto, Analyst
So I know within defense, you said aftermarket growth outpaced OE. Just curious what like magnitude is different there or just pretty similar?
Joel Reiss, Co-COO
Defense aftermarket was up more, it was not significant, but defense aftermarket did outpace defense OEM.
Louis Raffetto, Analyst
Was there anything in particular that drove that growth? I understand you mentioned the easier comparisons to some extent, but was there anything else contributing to it?
Kevin Stein, CEO
There is a normal variability within the defense sector, similar to what we see in the commercial aftermarket. As we noted, the comparison is easier this time. Overall, our businesses performed well, with most experiencing a significant year-over-year increase in Q1. I want to highlight the performance of Armtec, our flare countermeasures business, which had strong shipments in Q1 compared to the same period last year.
Louis Raffetto, Analyst
All right. That’s great. Thank you.
Operator, Operator
Our next question comes from the line of Robert Stallard with Vertical Research. Your line is open.
Robert Stallard, Analyst
Thanks so much. Good morning.
Kevin Stein, CEO
Good morning.
Robert Stallard, Analyst
It's probably a question for Sarah. On the debt issuance, I was wondering if you could comment on why you did it now, given it could be still some time until the Electron Devices acquisition closes?
Sarah Wynne, CFO
Yeah. I mean we're always going to be proactive at having cash ready for pending acquisitions. We want to be opportunistic on that front. And we don't want to be obviously up against any time line except the markets weren't open.
Robert Stallard, Analyst
Okay. And then as a follow-up, we're probably in a changing interest rate environment, and rates could be coming down over the next 12 months. How do you think you're going to be adjusting the balance sheet and the interest rate derivatives you have in place to try and make the most of that?
Sarah Wynne, CFO
Obviously, we're always looking at the market and trying to be opportunistic with that debt structure. We do have the benefit of hedges. So from that perspective, we've fortunate enough to have 75% hedged. We've got some stuff coming up, and we'll continue to look and be opportunistic as long we can with our debt comes forward.
Operator, Operator
Our next question comes from the line of Gautam Khanna with TD Cowen. Your line is open.
Gautam Khanna, Analyst
Hey, good morning, guys.
Kevin Stein, CEO
Good morning.
Gautam Khanna, Analyst
Could you please discuss the M&A pipeline, particularly regarding small to midsize opportunities? Is the focus still primarily on hardware, or are you also considering service assets? Additionally, could you provide an update on Calspan’s performance compared to your initial expectations?
Kevin Stein, CEO
Yeah. In the pipeline of small, medium-sized businesses mostly in hardware, although we're looking also at some services businesses, if they would meet our criteria. It's not always clear that some of those do. But we're open as long as it's within aerospace and defense. I don't think we see the need of going outside of aerospace and defense, not for a while. There's still so many great targets to go after in this business. On Calspan, I'll let Joel comment.
Joel Reiss, Co-COO
Yeah. So I think we're encouraged by where we're at, at this point in the integration. We've got our leadership team in place. We've put our business unit teams, structure in place. We're going through the value generation strategy that we employ. And as of right now, I think we're running a bit ahead of the model, and we're encouraged by what we're seeing.
Gautam Khanna, Analyst
As a follow-up on the M&A hardware pipeline, is it primarily focused on defense-related items? Are there any notable trends or variations?
Kevin Stein, CEO
No, it's actually a blend of commercial and defense assets. It's not only just defense. It's hard to control. You can't really dictate what the pitches will be throttled at you. So you just have to react to them when they come along. Right now, we see a nice balance. That isn't always the case, let's say it is.
Gautam Khanna, Analyst
Okay. And just my last one. In the commercial aero aftermarket, any discernible differences between growth rates into the distribution channel versus direct to customer? Thank you.
Kevin Stein, CEO
Distribution accounts for about 20% to 25% of our commercial aftermarket shipments. When we examine the point-of-sale data from our distribution partners in comparable markets, we find that they are quite similar, with no significant differences.
Operator, Operator
Our next question comes from the line of Kristine Liwag with Morgan Stanley. Your line is open.
Kristine Liwag, Analyst
Hey, good morning everyone.
Kevin Stein, CEO
Good morning.
Mike Lisman, Co-COO
Good morning.
Kristine Liwag, Analyst
Kevin, another question on the pipeline, you've mentioned the target-rich environment and assets are coming up that weren't available before. In the past, you've mentioned that you're open to doing deals that have some industrial exposure. Can you update us on your current thinking? And what proportion maximum industrial would you be willing to entertain at this point based on what's available?
Kevin Stein, CEO
Yes. It's an interesting question and gets me into speculation. I don't know if there's a certain percentage that would kick a deal out. We want to be in aerospace and defense. If there are non-aerospace and defense products or business, that's okay. We don't thumb our nose at it, but we look at a business in its totality, can it achieve our 20% plus internal rate of return for that acquisition. Yes, we don't look scantily at those businesses, but we don't want to go after anything industrial only. So I would guess it has to be, predominantly aerospace.
Kristine Liwag, Analyst
Great. Thanks for the color. And maybe in aftermarket, if I could have a follow-up question, with customer behavior, I mean, there's clear scarcity of aircraft assets out there. How much of the volume that you're seeing are coming from an Ad Hoc, break-and-fix type thing versus airlines potentially proactively purchasing product?
Joel Reiss, Co-COO
I don't think we have any real meaningful way to understand that. The vast majority of our commercial aftermarket orders are booked to ship. They come in over the trends of they're typically not advanced bookings. And we don't get a color in terms of why they're buying. We try to watch and make sure there's no inventory significant moves, but it's hard to get that kind of level of granularity.
Operator, Operator
Our next question comes from the line of Matt Akers with Wells Fargo. Your line is open.
Matt Akers, Analyst
Yeah. Hey, guys. Good morning. Thanks for the question.
Kevin Stein, CEO
Good morning.
Matt Akers, Analyst
I guess the M&A deals that you've looked at that haven't closed. What's the main thing preventing the valuation? Is it strategic ticket, because it seems like you're looking at the deals and you get the balance sheet to do more.
Kevin Stein, CEO
We evaluate whether potential deals meet our strict criteria. We want to see aftermarket content primarily in aerospace and defense. While we prefer commercial opportunities over defense, the crucial factor is whether they possess genuine intellectual property, specifically highly engineered IP. This is what we prioritize and use as our screening benchmark. When deals do not go through, it's typically because the proprietary nature isn't sufficient for our standards. Therefore, we choose not to pursue those opportunities. We aren’t interested in products that simply replicate what others offer. Our focus is on acquiring high IP, high engineering content in aerospace and defense that also has access to the aftermarket.
Matt Akers, Analyst
Got it. Thanks. And then, I guess back to your comments on some of the aerospace OE supply chain issues. Is that more around your supply chain and your suppliers are more just sort of Boeing and Airbus in general slowing down? And is it possible to comment kind of what you're assuming for 737 MAX for this year?
Joel Reiss, Co-COO
Yes. So, it's not specific for us the comments around the supply chain. I think that's just what we're generally hearing from others. I think our supply chain team has done a really solid job of working through the challenges that have persisted for the last couple of years. Last year, we were talking about castings and then electronic components. I think largely, those have gone away. I do think we're in some level of a new normal where there's more kind of issues that pop up randomly in comparison to where we were from a pre-pandemic level. I think that too is getting better, but likely that's going to persist for the next couple of years. I don't think any of that's material. I think right now, our assumption is based not so far off of what Boeing's current stated rate is in terms of what the FAA numbers are. We always put a little bit level of conservatism around the number. And I think we think our guidance is pretty well set around what we're hearing Airbus and Boeing are doing.
Matt Akers, Analyst
Great. Thank you.
Operator, Operator
Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is open.
Sheila Kahyaoglu, Analyst
Good morning everyone. Thank you.
Kevin Stein, CEO
Good morning.
Sheila Kahyaoglu, Analyst
I wanted to ask about margins. First with Calspan, it looks like for the first quarter, you guys had owned it, it was about 20% margins, and now you're at 28% for this quarter. So, you're still guiding to it to be 100 basis points dilutive, which obviously is conservative, because it would imply you're going to end the year at 16% margins for that business. So, I guess, what did you guys do to raise margins 700 bps in the last quarter? And where can this business be organically?
Joel Reiss, Co-COO
I'm unsure about the long-term direction. Our aim is to execute our value generation strategy, as we believe it is a solid business. We will keep striving to enhance its value. We recognize that it is currently dilutive compared to the overall TransDigm, and we will focus on enhancing its value over the long term.
Sheila Kahyaoglu, Analyst
Okay. And then I wanted to ask about defense aftermarket. Again, our defense, just given than often you see it outperform commercial aftermarket. You mentioned Armtec. What percentage of your business is maybe more short cycle weapons oriented? And where do we think about defense relative to commercial OE margins perhaps?
Joel Reiss, Co-COO
Defense margins are lower than those in comparable commercial markets. We usually provide a discount in the defense sector. Regarding weapon systems, I don't have detailed specifics on that. The order variability in defense is somewhat similar to the commercial aftermarket, as we often lack visibility on incoming orders. We receive solicitations and we respond to them, and when budget allocations are favorable, it typically benefits us. However, I don't have additional insights on this matter.
Sheila Kahyaoglu, Analyst
Okay. Thank you.
Operator, Operator
Our next question comes from the line of Ken Herbert with RBC Capital Markets. Your line is open.
Ken Herbert, Analyst
Yes. hi, good morning. Thank you. Kevin, in the past, you've talked about the business organically supporting about 100 basis points of margin expansion each year across the cycle. As we think about maybe aftermarket mixing down over the next couple of years relative to defense or commercial OE and just with where margins are today. Is that still the right framework as we think about organically for the business?
Kevin Stein, CEO
I think it still is. I don't think it's going to change. I know that there's math involved here, and you got to work your way through it. But what I always say is 100 to 150 basis points of improvement, and we've been running 150. Yes, it may be back down at 100, but it's still, I believe, going to sequentially expand.
Ken Herbert, Analyst
Okay, that's great. And as you look at the business today, just to that point, obviously, you've always run a pretty lean ship and kept costs pretty tight. Operationally, as you look across the business, are there still significant areas where you see opportunities for improvement? Or can execution be maybe a bigger piece of the mix moving forward relative to maybe relative to volume or price?
Joel Reiss, Co-COO
Well, for productivity, this is again one of our three value-generating strategies. Our teams are challenged themselves to work to offset inflation over the entire cost of the business. And so automation continues to come down in price in that we would have looked at two or three years ago, but didn't make sense. The capability wasn't there. Those come across. We continue to look at opportunities to how we resource materials where possible. So, I think we continue to believe there's a lot of opportunity for us in productivity. I'm always encouraged when I can see a long-term TransDigm business 10, 15, 20 years since we acquired it, and they are still achieving as good or better at times level of productivity. That's partly because things that they looked at before weren't there. We also won a sizable amount of new business. And one of the great things about new business, it continues to give you an opportunity to find new ways to reduce the cost of those new products as well. So, I think we think all three value drivers are where we want to focus.
Ken Herbert, Analyst
Great. Thanks, Joel.
Operator, Operator
Our next question comes from the line of Jason Gursky with Citi. Your line is open.
Jason Gursky, Analyst
Hey, good morning, everybody.
Kevin Stein, CEO
Good morning.
Jason Gursky, Analyst
Just a quick question on working capital moving forward. I'm just kind of curious what kind of contractual terms do you have with some of your commercial OEM customers on the need to hold inventory? One of the things you've got potentially going on with Boeing is them asking the supply chain to continue producing it, but they're going to be producing something to the master schedule, actually above their production rates, and that inventory has got to go somewhere. So, I'm just kind of curious, where that inventory might land from a contractual perspective, might some of the land on your balance sheet? Just kind of curious how it all works?
Sarah Wynne, CFO
Yes, I don't think we have any of that. For Boeing, it would be small, very noise level. And especially if you're asking from a bigger picture perspective, with working capital as a whole, we project future net working capital needs, and we use model fairly flat for that as a percent of sales as we go forward through the year with that being noise level, if anything.
Jason Gursky, Analyst
Right. Okay. That's helpful. And then just a quick follow-up on the aftermarket side and the strong bookings that you saw. In the quarter, you suggest it's hard to know exactly where all of that demand is coming from, whether it's rate fix or planned stocking by the airlines. But I'm curious if you've gotten any feedback from your airline customers on how they're grappling with what's going on with the GTF and the plans, OEGs that we're likely to see here this calendar year going into 2024. Is that, from your perspective, helping your aftermarket bookings here in the near term, that's what we're seeing in the strike that you've seen here recently and Kevin, as you mentioned the potential for upward pressure on the guidance? Just curious, if that's what's driving that statement that you made there? Thanks.
Joel Reiss, Co-COO
Yeah. We've tried to take a look at it. We think it probably has a slight tailwind for the business. For a few of our businesses, it's helping out, obviously, those platforms that were older planes are flying more. This is helpful. But we're also getting fewer hours on the GTF engine. So some other sites that would start to see some benefits of longer flight hours and those that are kind of missing out. I think net for net, as we've looked at it, we think it's a slight tailwind for the business.
Jason Gursky, Analyst
Okay. Great. I will leave it there.
Operator, Operator
Our next question comes from the line of Mariana Perez Mora with Bank of America. Your line is open.
Mariana Perez Mora, Analyst
Thank you very much. Good morning, everyone.
Kevin Stein, CEO
Good morning.
Mariana Perez Mora, Analyst
My question is, I'd like to peel the onion a little bit on the commercial aftermarket. On this mid-teens guidance that you have, how much of that is driven by volumes, how much is pricing? And in that pricing, how much is like passing through inflation and labor costs and just like supply chain disruption things? And how much is actually being able to price this excess demand environment in the aftermarket?
Kevin Stein, CEO
We don't comment on price and volume and split that out. It's kind of difficult for us to assess that anyway. So, yeah, we don't give that kind of color. For volume, what we can offer is looking at take-off and landings, RPMs, clearly, volume is going to continue to grow and expand. And I believe we all gave you in our prepared comments that we think volumes are going to return in 2024 here, and we may actually then see growth ahead of where we were pre-COVID, but we don't get into parsing out how much is price and how much is volume.
Mariana Perez Mora, Analyst
And are you able to discuss how open are customers to have price increase conversations at least?
Kevin Stein, CEO
I think that our focus on operational excellence and performance means that the pricing part of the conversation is often quite simpler because you can provide products on time to their needs.
Mariana Perez Mora, Analyst
Thank you. And my second question, if I may, on M&A. Why are so many M&A deals available right now? Has something changed?
Kevin Stein, CEO
I don't know if anything's changed. I think it just comes in waves sort of a sign wave. You have periods of time where it's up and periods of time where it's lower. It's been an encouraging time over the last, I think, a year or so. We've seen some good deals. Unfortunately, we've seen some things not work out, and we had to pass on. But I'm not aware of any outside forces moving more deals to the table. It's just the way it is.
Operator, Operator
Our next question comes from the line of Peter Arment with Baird. Your line is open.
Peter Arment, Analyst
Hey, good morning, everyone. Nice results. Hey, Kevin, maybe just a quick one on defense, I know it's about 30% of your mix. Do you have much exposure from international defense and if you do, just kind of what you're seeing there?
Kevin Stein, CEO
Yeah, we do have international defense exposure. We provide products to our allies and we also have manufacturing facilities in Europe that provide products directly to European defense contractors.
Peter Arment, Analyst
Any rate of change differences there or just still at normalized rates?
Kevin Stein, CEO
Have you seen any, Joel?
Joel Reiss, Co-COO
I don't know if there's anything significant versus the US. I mean, the US in many cases, is buying foreign military and they're supporting the same. So it ends up to some level of co-mingled and hard to separate one versus the other.
Kevin Stein, CEO
Clearly, I think international defense is improving, whether it is improving faster than the US rate, I'm skeptical.
Operator, Operator
Our next question comes from the line of Michael Ciarmoli with Truist Securities. Your line is open.
Michael Ciarmoli, Analyst
Hey, good morning, guys. Nice result.
Kevin Stein, CEO
Good morning.
Michael Ciarmoli, Analyst
Thank you for the question. Kevin, could you provide insights on the commercial aftermarket, specifically regarding demand trends or actual booking sales for wide-body and narrow-body airframe engines? You've mentioned interiors; is this primarily due to increased retrofit activity or are there any noticeable trends?
Kevin Stein, CEO
I think on the interior side, we're really just in the early innings of refurbishment. We're starting to see a few of those programs. Again, I think we're anticipating seeing more of that likely as we get to the end of this year and into early next year. A few of them we originally thought might have happened earlier have slid to the right. In terms of passenger, I don't know if we have any specific data to tell you, single-aisle versus wide-body. Certainly, we're encouraged by the continuing improving trends in the international market. So that still lags the single-aisle market but continues to be on a good rate of growth. I don't know that we have any specific data, I mean with the number of part numbers we sell is it's too difficult to try to come back to some specific around single-aisle wide-body, unfortunately, at that level of granularity.
Michael Ciarmoli, Analyst
Got it. And then maybe, Kevin, just one last one on M&A. You keep talking about the small and kind of medium-sized pipeline. What is sort of your definition? I mean, CPI, I guess, $300 million. How big is sort of the upper range of a medium-sized transaction?
Kevin Stein, CEO
Yes, probably somewhere around $1 billion plus. But not $4 billion, which would be significant for us. Hopefully, that provides some clarity, although there isn't an exact science to it.
Michael Ciarmoli, Analyst
Yes. Got it. All right. Perfect. Thanks guys.
Operator, Operator
Our next question comes from the line of Gavin Parsons with UBS. Your line is open.
Gavin Parsons, Analyst
Thanks, guys.
Kevin Stein, CEO
Yes.
Gavin Parsons, Analyst
Maybe on CapEx, what's driving the big step up this year?
Sarah Wynne, CFO
Yes. On the CapEx, obviously, we're always looking to add infrastructure to our op units and provide cash productivity improvement, much like what Joel just mentioned with machinery and other efficiencies in the op units to help drive the value drivers. Nothing specific, there's no big one thing in there. It's just the usual CapEx that we provide to the op units based on their needs and driving the value.
Kevin Stein, CEO
Yes. Our process begins with requests from the sites. Our goal is to ensure they are fully funded. When they identify significant productivity projects, that is where most of our capital expenditures are allocated. Additionally, one notable change from previous years is our increased focus on solar programs that we had not pursued before. These programs offer excellent returns, but they have created an additional requirement for our capital expenditures.
Gavin Parsons, Analyst
Interesting. Appreciate that detail. And I know a lot of aerospace work needs to be manual, but how much automation do you think you can get in the business over time?
Joel Reiss, Co-COO
I don't have any specific numbers at this moment. If you had asked me the same question five years ago, my response would have been quite different. I continue to be amazed by how we've managed to integrate these changes. Last month, I visited one of our facilities in the U.K. where they have automated painting, polishing, and brazing operations. I remain optimistic that as automation costs decrease and the prices of collaborative robots fall, it will become increasingly feasible for us to implement these solutions. Our challenges stem from being a high-mix, low-volume manufacturer. The key challenge is to adopt automation that accommodates a wide variety of parts rather than just a small set. We believe there is still significant potential in this area.
Gavin Parsons, Analyst
Got it. And I think Noah asked about kind of the price cost spread. Have you guys seen your input costs starting to ease or not yet?
Kevin Stein, CEO
I think we're still in the early innings for that. Labor costs, I think, are probably starting to, as you see in the overall market, but I don't know that there's anything significant at this point. It's really too early in the fiscal year for us to have seen something dramatically different than planned.
Gavin Parsons, Analyst
Make sense. Thank you.
Operator, Operator
Our next question comes from the line of Seth Seifman with JPMorgan. Your line is open.
Seth Seifman, Analyst
Hey. Thanks very much, and good morning, everyone.
Kevin Stein, CEO
Good morning, Seth.
Seth Seifman, Analyst
Good morning. I wanted to ask about, if I remember correctly, in the pre-COVID days, possibly even before the Esterline acquisition, the cash balance was around $750 million. A lot has changed since then. If we adjust for the pending acquisition, we are probably looking at about $2 billion now. How should we consider the appropriate cash balance currently and in the future?
Sarah Wynne, CFO
Yeah. We're not anchored into a specific amount, as you could obviously say. We're happy to keep cash on the balance sheet. And like you pointed out, we have $2 billion of pending CPI acquisition, which is obviously more than we need to run the business, but we're happy to have that cash on hand to support any other opportunities, M&A or any other investments that popup for us.
Seth Seifman, Analyst
Okay, great. I found your response to Gavin's question interesting. Considering the pandemic and the decrease in rates, the more labor-intensive part of your business is in the commercial OE segment. There's an expectation that as rates rise, you would be adding more employees. While we're still not back to where we were, we've made some progress. Has the amount of labor you've added as you've recovered been in line with your expectations, or is it less or more? And why?
Joel Reiss, Co-COO
I believe our teams have worked diligently over the past three to four years to identify effective productivity projects. While I don't have specific numbers available, I would speculate that we are likely performing better than what we would have expected if we were comparing to three or four years ago. We encountered some challenges with turnover a couple of years back, but the positive aspect is that with the lower rates we've experienced, we've had a strong opportunity to train those new employees. Overall, I believe we are well-positioned for the future.
Seth Seifman, Analyst
Okay. Very good. Thank you.
Operator, Operator
Our next question comes from the line of Scott Deuschle with Deutsche Bank. Your line is open.
Scott Deuschle, Analyst
Hey, good afternoon.
Kevin Stein, CEO
Good afternoon.
Scott Deuschle, Analyst
Joel, is F-35 aftermarket a significant portion of defense aftermarket revenue at this point? And then can you comment at all on how quickly that's been growing recently?
Joel Reiss, Co-COO
I don't have any specifics around any platform to give you. I think as we said, the defense aftermarket was a good solid quarter for us. I think considering the number of businesses it was distributed. I think we saw many, many platforms benefiting from it in the quarter, not just a single one. Certainly, as F-35 continues to supply, that's beneficial for us. We're on effectively every platform. And so certainly, the more things are used, the more that's just good for us in general.
Scott Deuschle, Analyst
Okay. And then, Sarah, sort of following up on Jason's question, can you clarify what the outlook is on working capital this year? It was a pretty big headwind last year. You had a strong first quarter here. I was just curious where things go from here on? Thanks.
Sarah Wynne, CFO
Yes. You're right. We had an influx of about, I think, it's $500 million last year. So, we think we're now in a good position so that going forward, we'd expect working capital to follow the revenue. As a percent of sales, barely flat as the revenue goes up as a percentage.
Operator, Operator
And I'm showing no further questions at this time. I would now like to turn the conference back to Jaimie Stemen for closing remarks.
Jaimie Stemen, Director of Investor Relations
Thank you all for joining us today. This concludes the call. We appreciate your time and have a good rest of your day.
Operator, Operator
This concludes today's conference call. Thank you for participating. You may now disconnect.