TransDigm Group INC Q3 2026 earnings call

Thank you. Welcome to TransDigm's Fiscal 2026 Third Quarter Earnings Conference Call. Presenting on the call this morning are TransDigm's President and Chief Executive Officer, Mike Lisman, Co-Chief Operating Officer, Patrick Murphy, and Chief Financial Officer, Sarah Wynne. Also present for the call today is our Co-Chief Operating Officer, Joel Reiss. 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 investor section of our website or at sec.gov.

The company would also like to advise you that during the course of the call, we will be referring to EBITDA, specifically EBITDA As Defined, adjusted net income, and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for a presentation of the most directly comparable GAAP measures and applicable reconciliations. I will now turn the call over to Mike.

Good morning. Thanks for calling in today. First, I'll start off with the usual quick overview of our strategy. Second, make a few comments about the quarter, and third, discuss our fiscal 2026 outlook. Then Patrick and Sarah will give some additional color on the quarter. To reiterate, we believe we are unique in the industry in both the consistency of our strategy, in both 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.

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. 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 delivered another solid quarter with Q3 results exceeding expectations. As a result, we are raising guidance for the year.

During the quarter, we saw healthy growth in revenue, both sequentially and compared to the prior year in all three of our market channels, commercial OEM, commercial aftermarket, and defense. In commercial aftermarket, we delivered a strong performance in Q3 with the commercial transport component of our commercial aftermarket growing 18% versus the prior year period. Further, given the strong performance seen to date as well as our current expectations for Q4, we raised our commercial aftermarket guidance for the year. Note that we are seeing this healthy growth despite the overall decline in RPMs arising from the conflict in the Middle East, from which we have yet to see any material impact. In the commercial OEM market, sales have increased well into the double digits as production rates at Boeing and Airbus have continued to steadily rise over the past few quarters.

Lastly, our defense end market saw a double-digit revenue increase this quarter and continues to build backlog that will drive growth as we finish fiscal 2026 and head into our fiscal 2027. Our EBITDA As Defined margin was 52.8% in the quarter, which includes more than full two percentage points of dilution from recent acquisitions. This is an improvement sequentially from Q2, with higher volumes and strong performance across all market channels. The sequential margin improvement is in spite of margin headwind of about half a percentage point in the quarter related to the newly acquired Jet Parts Engineering and Victor Sierra Aviation Holdings operating units. Our acquisitions continue to contribute meaningfully as well and over time should see an expansion in their respective operating margins. Additionally, we had strong operating cash flow generation in Q3 of over $700 million and ended the quarter with nearly $2.8 billion in cash.

Before I get into our usual capital allocation update, I would like to quickly provide some additional color on our withdrawal from the acquisition of Stellant Systems in mid-July. This was a difficult decision that came after the Department of Justice notified us that they intended to challenge the transaction. While we respectfully disagreed with the DOJ's decision on the matter, ultimately, the complications and hurdles that would have arisen from continuing with the acquisition through a litigation, coupled with the timeline constraints in the stock purchase agreement, contributed to our decision to withdraw and pursue other targets. At the end of the day, we will always be practical and prioritize the best long-term use of our shareholders' capital and our management resources. We felt we did that here, and the outcome, though disappointing, won't impact our future M&A approach. We are always actively working away on new targets.

Next, an update on our capital allocation activities and priorities. Regarding the current M&A activities in the pipeline, we continue to actively look for opportunities that fit our model. As usual, the potential targets are mostly in the small and mid-size range. As always, we'll remain disciplined around our approach to M&A. Additionally, acquisitions are, by their nature, hard to predict. Consistent with past practice, I will not be saying too much on what is currently active in our funnel. Last week, we announced that we agreed to acquire Prince & Izant from Industrial Growth Partners for approximately $1.1 billion in cash. Prince & Izant is a leading global designer and manufacturer of highly engineered brazing alloys and specialty metal components used across a range of advanced performance and high cost of failure applications. The company primarily supports the aerospace and defense, aeroderivative turbine, and transportation end markets.

It is expected to generate approximately $360 million of revenue for the 2026 calendar year. We've tracked this Cleveland-based company for some time now, and Prince & Izant's highly engineered solutions and excellent customer service align well with TransDigm's acquisition strategy. We look forward to getting the transaction closed and welcoming the company into the fold. The capital allocation priorities at TransDigm are unchanged. Our first priority is to reinvest in our businesses. Second, do accretive, disciplined M&A. Third, return capital to our shareholders via 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. As we sit here today, we have significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future.

Specifically, we have substantial M&A firepower and capacity remaining, in excess of $10 billion. Moving to our outlook for fiscal 2026. As noted in our earnings release, our business outlook has continued to strengthen. We're increasing our full fiscal year 2026 sales and EBITDA As Defined guidance to reflect another solid quarter of results and our current expectations for the remainder of the year. At the midpoint, sales guidance was raised $150 million, and EBITDA As Defined guidance was raised $100 million. Current guidance for fiscal 2026 is as follows, and can be also found on slide six in the presentation. The midpoint of our fiscal 2026 revenue guidance is now $10.51 billion or up approximately 19% over the prior year.

With regard to the market channel growth rate assumptions in this revenue guidance, the full-year market channel assumptions for our three primary end markets are also being increased to account for our results to date and expectations for the final quarter. The updated revenue guidance provided today is based on the following market channel growth rate assumptions. We expect commercial OEM growth in the mid-teens percentage range. We expect commercial aftermarket revenue growth to be in the low double-digit percentage range, and we expect defense revenue growth in the high single digit to low double-digit percentage range. The midpoint of fiscal 2026 EBITDA As Defined guidance is now $5.52 billion or up approximately 16% versus the prior year, with an expected margin of around 52.5%. We're very pleased with our margin performance in the year-to-date period and continue to perform ahead of our expectations.

As discussed in prior quarters, the guidance includes more than two full percentage points of margin dilution related to recent acquisitions compared to the prior fiscal year quarter. The midpoint of adjusted EPS is now expected to be $41.04. We believe we're well-positioned for the last quarter of fiscal 2026. We'll continue to closely watch how the aerospace and capital markets develop and react accordingly. Lastly, I'd like to reiterate how pleased we are with the company's performance this quarter. Our teams remain focused on our value drivers, cost structure, and operational excellence. We will continue to control what we can control and expect that our disciplined, consistent strategy will deliver the value you have come to expect from us. With that, I will now hand it over to Patrick Murphy, TransDigm's Co-COO, to review our recent performance and a few other items.

Good morning, everyone. 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 2025. That is, assuming we own the same mix of businesses in both periods. For reference, the market discussion includes the acquisition of Simmonds Precision Products, but excludes Jet Parts Engineering and Victor Sierra Aviation acquisitions. Purpose of excluding these newly acquired businesses is for two reasons. First, we are still working through the integration and aligning their data into our reporting structure. Second, we want to highlight the strong aftermarket performance of our base business. Beginning with the fiscal 2027 guidance, Jet Parts Engineering and Victor Sierra Aviation Holdings will be included in the pro forma reporting. In the commercial market, we will split our discussion into OEM and after.

Our total commercial OEM revenue increased approximately 17% in Q3 compared with the prior year period. As we anticipated, commercial OEM added another quarter of strong revenue growth. Commercial transport OEM revenues, which excludes the biz jet sub-market, were up 25% over the comparable prior period. This is primarily driven by the production improvements at Boeing and Airbus. Our teams are well-positioned to support the increasing build rates. As Boeing and Airbus production rates continue to climb, we anticipate continued strength in the commercial OEM market. Commercial OEM bookings posted another quarter of solid growth compared to the same prior year period, significantly outpacing sales. Commercial transport bookings had double-digit growth for the third quarter, which represents another quarter of consistent growth for the commercial OEM market.

As you know, commercial OEM bookings is an important leading indicator for our commercial OEM business. We are pleased that our book-to-bill rate remains solidly positive in Q3. Today's commercial OEM guidance assumes that the OEMs maintain their rates for the remainder of our 2026 fiscal year. The commercial OEM guidance we are giving today contains what we believe is an appropriate level of risk around the production build rates for the 2026 fiscal year. Our fiscal 2026 commercial OEM revenue guidance range, as Mike mentioned, is increasing to the mid-teens percentage growth range based on the performance to date, current outlook for the remainder of our fiscal year. Moving on into our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 17% compared with the prior year period. As a reminder, this excludes our newly acquired Jet Parts Engineering and Victor Sierra Aviation businesses.

This quarter, nearly all sub-markets delivered strong performances in the quarter. Our commercial transport aftermarket revenue growth, which excludes our bizjet sub-market, was up 18%, driven by solid growth in the transport sub-markets of engine, passenger, and interiors, while freight was roughly flat for the quarter. Q3 bookings and commercial aftermarket delivered ahead of our expectations for the third quarter in a row. Bookings continue to support the full year growth outlook, and we are well-positioned to execute our fourth quarter. Additionally, POS at our distributors also grew double digits on a percentage basis this quarter. As Mike already mentioned, we are raising our commercial aftermarket revenue growth guidance from high single-digit to low double-digit range up to the low double-digit range based on our strong performance through Q3, as well as our current backlog and outlook for the remainder of the year.

I also wanted to comment briefly on the conflict in the Middle East. While jet fuel prices have risen from pre-conflict levels and select airlines have adjusted capacity in the short term, we have not yet seen any meaningful slowdowns in our commercial aftermarket. We continue to monitor the situation in close partnership with our customers, and we will take all appropriate actions if something changes. Now shifting to our defense market. Defense market revenue, which includes both OEM and aftermarket revenues, grew by approximately 11% compared with the prior year period. Over the past year, we have seen strong growth in the defense market, driven by a combination of new business wins and excellent operational execution from our teams. This positions us well for continued growth in the defense market. Q3 defense revenue growth was well distributed across our businesses and customer base.

Both OEM and aftermarket components in our defense market were up versus the prior year, with aftermarket running slightly ahead of OEM. Defense bookings for the quarter increased nicely, up both year-over-year and sequentially, outpacing sales for the period. Our strong bookings this year support our guidance of high single-digits to low double-digits. As we have said many times before, defense sales and bookings can be lumpy, especially quarter-to-quarter. The current environment remains positive for defense spending, and the global defense outlook continues to indicate this end market will remain solid heading into next year. Moving on to our value drivers. I wanted to touch on a few new business wins that the teams have secured in the last quarter, specifically driven by highly engineered, innovative technical solutions.

Adams Rite Aerospace was recently awarded a major line-fit position with a leading airframer for its complete touch-free lavatory product suite. The award covers the full portfolio, including a touchless faucet, touchless flush switch, and touchless waste bin door. These products incorporate next-generation sensors and robust aircraft-specific designs engineered to withstand the demanding high-use environment of modern aircraft lavatories. The avionics instruments team was engaged by a major supplier of fighter aircraft to develop a new battery for a critical aircraft system when the previous supplier was unable to sustain the program. The battery powers main aircraft operations during ignition and flight, enabling the platform to carry out diverse and complex missions. Our team took the program from design through qualification and into production in under two years, giving the customer a qualified, production-ready replacement that kept the warfighter mission-ready.

Our Electromech business developed a precision electromechanical actuator engineered to control landing gear deployment and retraction on a new unmanned combat aircraft. Compact, mission-critical design combines high load capability, precise motion control, reliable performance in demanding flight environments. Canyon AeroConnect developed a new audio indicator capability for its AMU-50 digital audio control system, DACS, to meet the new U.S. Forest Service aircraft requirement, enhancing pilot situational awareness by providing a visual indication of incoming radio transmissions regardless of audio volume or mute status. These innovation-driven new product wins will deliver substantial new business revenue over the next three years from prototype and LRIP orders as the teams work toward full production. A quick update on our acquisition integration activities. Simmonds Precision Products, which was acquired at the beginning of our fiscal year, continues to progress nicely and run ahead of our expectations.

Jet Parts Engineering and Victor Sierra Aviation Holdings acquisitions closed early in the third quarter and are also progressing well. We have experienced EVPs assigned to each of the operating units and are very pleased with the team's progress to date. Still early in our ownership, but these businesses are a good complement to our existing portfolio, and we are excited that they are a part of TransDigm. I would like to wrap up by recognizing the strong contributions of our operating units during this third quarter of fiscal 2026. Our management team stayed focused on our consistent operating strategy, executing our value drivers, working hard to satisfy our customers' growing demand. We are truly pleased with the impressive results our teams delivered for our shareholders this quarter. I'd like to turn it over to our Chief Financial Officer, Sarah Wynne.

Thanks, Patrick. Good morning, everyone. I'll recap the financial highlights for the third quarter and then provide some more information on the guidance. First, on organic growth and liquidity. In the third quarter, our organic growth rate was approximately 13%. All market channels contributed to this growth, as previously discussed by Mike Patrick. On cash and liquidity, free cash flow, which we traditionally define as EBITDA less cash interest payments, CapEx, cash taxes, was approximately $870 million for the quarter, coming in at $2.1 billion on a year-to-date basis. For the full fiscal year now, we expect our free cash flow guidance to be closer to $2.6 billion, an increase from the prior guide of $2.5 billion. Below that free cash flow line, net working capital consumed approximately $160 million of cash in the quarter.

For the full year, we expect working capital to end roughly in line with historical levels as a percentage of sales. We ended the quarter with a cash balance of $2.8 billion. Our net debt-to-EBITDA ratio ended the quarter just slightly up from the prior quarter of 5.8x. This cash balance, together with our available debt capacity, gives us ample liquidity to fund the pending Prince & Izant acquisition. More broadly, our strategy is to operate in the five to seven net debt-to-EBITDA ratio range, which preserves capacity for additional acquisitions and other capital deployment as opportunities arise. Regarding our debt, our capital allocation strategy is to both proactively and prudently manage our debt maturity stacks by keeping near-term maturities well extended. In addition, approximately 75% of our $33.7 billion gross debt balance is fixed through fiscal 2029.

This is achieved through a combination of fixed rate notes, interest rate swaps, caps, and collars. This provides meaningful cushion against any near-term rate boosts. Our EBITDA-to-interest expense coverage ratio ended the quarter at 3x, which provides us with comfortable cushion versus our target range of 2x-3x. During the quarter, we continued to apply the same targeted return criteria we have consistently applied over the years, and that led us to opportunistically deploy about $980 million of capital via open market repurchases of our common stock. This equates to approximately 800,000 shares at an average purchase price of approximately $1,208 per share. Including our first and second quarter repurchase activity, year-to-date repurchases now total $1.8 billion. We expect these repurchases to meet or exceed our long-term return objectives. We continue to seek the best opportunities for providing value to our shareholders through our capital allocation strategy.

We think we remain in a strong position to do that With adequate flexibility to continue to pursue M&A opportunities or return cash to our shareholders via share buybacks and/or additional dividends. With that, I'll hand it back to Mary Hartman, our Director of Investor Relations.

Before we open the line for Q&A, I'd ask everyone in the queue to consider your fellow analysts and ask one question only so we can get to as many people as possible. Operator, can you please open the line?