TransDigm Group INC Q4 2025 earnings call

Thank you, and welcome to TransDigm's Fiscal 2025 Fourth Quarter Earnings Conference Call. Presenting on the call this morning are TransDigm's President and Chief Executive Officer Mike Lisman, Co-Chief Operating Officer Joel Reiss, and Chief Financial Officer Sarah Wynne. Also present for the call today is our Co-Chief Operating Officer, Patrick Murphy. 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, and 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. Third, discuss our fiscal 2026 outlook. 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 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 allocations are a key part of our value creation methodology. Our long-standing goal is to give our shareholders private equity-like returns with the liquidity of a public market. To do this, we stay focused on both the details of value creation as well as careful allocation of our capital. As you saw from our earnings release, we closed out the year with a good quarter.

During the fourth quarter, we saw healthy growth in the revenue for our commercial aftermarket channel, robust growth in our defense market channel, and finally, as expected, our commercial OEM revenues returned to a growth position following the brief destocking trends we saw last quarter. For the full year, our fiscal 2025 revenue and EBITDA as defined margins surpassed our most recently published guidance. Commercial aerospace market trends remain favorable. Air traffic continues to steadily progress, and airline schedules remain fairly stable, with takeoffs and landings growing in the 3% to 4% ballpark year over year. In the commercial OEM market, there is still much progress to be made for OEM rates, and our results continue to be adversely affected by OEM performance. Airline demand for new aircraft remains high, and the OEMs have long backlogs.

OEMs are working to increase aircraft production to meet this demand, but the recovery to date has been bumpy and will likely remain so. Our EBITDA as defined margin was 54.2% in the quarter. Contributing to this solid Q4 margin is the continued growth in our commercial aftermarket, along with diligent focus on our operating strategy, which is allowing margin performance to expand across all segments. Additionally, we had strong operating cash flow generation in Q4 of over $500 million, and we ended the quarter with a cash balance of over $2.8 billion and over $2 billion pro forma for the Simmons acquisition. We expect to steadily generate significant additional cash throughout fiscal 2026. Next, an update on our capital allocation activities and priorities.

During our full fiscal 2025 and continuing into October, we are pleased to have allocated approximately $7 billion of capital in the aggregate across M&A and return of capital to our shareholders. Specifically, these activities included the acquisitions of Servotronics, Simmonds Precision Products, and approaching $300 million of other small tuck-in acquisitions, as well as a special dividend of $90 per share and $600 million of share repurchases. The dividend of $90 per share was our largest to date. As you know, we are continuously assessing our capital allocation options, and we were very pleased to return this capital to our shareholders. The recent share repurchases, including $100 million in October, are rooted in the same targeted returns math we have consistently applied over the years. 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 will remain disciplined around our approach to M&A. Additionally, acquisitions are by their nature hard to predict, so consistently with past practice, I will not be saying too much on what is currently active in our funnel. The capital allocation priorities at TransDigm are unchanged. Our first priority is to reinvest in our businesses, second, do accretive disciplined M&A, and 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, but both M&A and the capital markets are difficult to predict.

We exited fiscal 2025 with a sizable cash balance, and our recent capital allocation actions still leave us with significant liquidity and financial flexibility to meet any likely range of capital requirements or other opportunities in the readily foreseeable future. Now moving on to our outlook for fiscal 2026. This guidance incorporates the recently acquired Simmons Precision Products business, which we are very excited to now own, but which comes into the TransDigm fold at a profitability level below that of our typical acquisition. The guidance assumes no additional acquisitions or divestitures during the year. Our initial guidance for fiscal 2026 is as follows and can be found on slide seven in today's presentation. The midpoint of our fiscal 2026 revenue guidance is $9.85 billion, or up approximately 12% over the prior year.

As a reminder, and consistent with past years, with about 10% or so fewer working days than the subsequent quarters, fiscal 2026 Q1 revenues, EBITDA, and EBITDA margins are anticipated to be lower than the other three quarters of 2026. This revenue guidance is based on the following market channel growth rate assumptions. We expect commercial OEM revenue growth in the high single-digit to mid-teens percentage range, which is highly dependent on the evolution of the production rates in the commercial OEM environment. Commercial aftermarket revenue growth is expected to be in the high single-digit percentage range, and defense revenue growth in the mid-single-digit to high single-digit percentage range. The midpoint of our fiscal 2026 EBITDA as defined guidance is $5.15 billion, or up approximately 8%, with an expected margin of around 52.3%. This guidance includes an additional 200 basis points of margin dilution from recent acquisitions compared to fiscal 2025.

Additionally, some commercial OE and defense mix headwind in the range of a half percentage point to a full percentage point is further reducing our margins versus fiscal 2025. Adjusting for these two dilutive factors, the margins would have increased more versus fiscal 2025 and in line with the margin improvement we would typically expect on our base business. We anticipate EBITDA margins will move up throughout the year, with Q1 being the lowest and sequentially lower than Q4 of fiscal 2025. The midpoint of adjusted EPS is expected to be $37.51. We believe we are well positioned as we enter our fiscal 2026. We'll continue to closely watch how the aerospace and capital markets develop and react accordingly. We are pleased with the company's performance this year and 2025.

Our team successfully navigated the challenges of uneven demand in our commercial OEM market throughout the year to deliver a healthy EBITDA as defined margin. Looking to our new fiscal year, we remain focused on our value drivers, cost structure, and operational excellence. We look forward to fiscal 2026 and expect that our consistent strategy will continue to provide the value you've come to expect from us. Now let me hand it over to Joel Reiss, our TransDigm Group Co-COO, to review our recent performance and a few other items.

Morning, everyone. I'll start with our typical review of our 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 2024. That is, assuming we own the same mix of businesses in both periods. The market discussion excludes the recent acquisition of Simmons Precision Products.

In the commercial market, we will split our discussion into OEM and aftermarket. Our total commercial OEM revenue increased 7% in Q4 and was down 1% for the full year fiscal 2025 compared with the prior year periods. As we anticipated, commercial OEM revenue in the fourth quarter returned a positive growth as we supported higher bill rates. However, overall, the commercial OEM revenue performance for the full year was softer than we originally expected for fiscal 2025. The year-over-year declining commercial OEM revenue was primarily driven by the negative impact to OEM build rates that resulted from the Boeing strike and production ramp-up challenges at Airbus. Bookings in the quarter were up compared to the same prior year period. Commercial transport bookings growth was up over 20% for the fourth quarter.

The bookings levels for OEM commercial transport show that the market is recovering from the various disruptions seen over the past year or so, but as we have said before, this recovery could be a bit bumpy and uneven on a quarterly basis as the OEMs and our tier one and tier two customers right-size inventory levels. We are encouraged by the progress of the 737 MAX production line, as well as the FAA's approval for Boeing to increase its production rate. Our operating units are well positioned to support the higher production rates as they occur. The commercial OEM guidance we are giving today contains what we believe is an appropriate level of risk around the production bill rates for the 2026 fiscal year. Our fiscal 2026 commercial OEM revenue guidance range of high single-digit to mid-teens % growth contemplates reasonable risks around the Boeing and Airbus rates.

Now moving on to our commercial aftermarket business discussion. Total commercial aftermarket revenue increased by approximately 11% in Q4 and 10% for the full year compared with the prior year periods. Sequentially, total commercial aftermarket revenues were up 5% in Q4. This quarter, all submarkets within the commercial aftermarket experienced positive growth. Our commercial aftermarket, excluding our VizJet submarket, was up 13%, driven by solid growth in freight, interiors, and engines. Bookings across all submarkets were up compared to the prior year period, and POS at our distributors grew in double digits on a percentage basis this quarter. For the full year, the 10% revenue growth for commercial aftermarket was in line with our original expectations. Each of the submarkets performed about as expected, with strong performance from our interior submarket and from the operating units with higher engine content within the passenger submarket.

Our operating units continue to monitor market share and competitive losses, and we see no material change in this space from either USMs or PMAs. As Mike already mentioned, we expect 2026 commercial aftermarket revenue growth in the high single-digit % range. Regarding how commercial aftermarket revenue is likely to progress throughout the fiscal 2026, Q1 is expected to be the lowest quarter of the year on a sales dollar basis, as there are roughly 10% fewer working days than in other quarters. Now shifting to our defense market. Defense market revenue, which includes both OEM and aftermarket revenues, grew by approximately 16% in Q4 and 13% for full year fiscal 2025 compared with the prior year periods. We have seen strong growth in defense driven by new business wins and strong performance by our teams in both domestic and international markets.

Q4 defense revenue growth was well distributed across our businesses and customer base, although we saw similar rates of growth in both the OEM and aftermarket components of our total market, with aftermarket running slightly ahead of OEM. Defense bookings for the quarter and full year significantly surpassed the comparable prior year periods and support our 2026 guidance for mid-single to high single-digit revenue growth. Additionally, this quarter, we saw continued growth in the US government defense spend outlays. 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, especially on a quarterly basis, is difficult. We anticipate capital expenditures of about $300 million in fiscal 2026. About two-thirds of our capital expenditure spending is on new business and productivity-driven projects.

Typical payback for cost reduction projects is just a couple of years. We have over 150 new automation projects planned for the year. We continue to see the cost of automation technology decrease year over year. We are a high-mix, low-volume manufacturer, and our continued success taking on new automation tasks in assembly, machining, polishing, and painting is exciting. As a result of our continued focus on productivity in both the factory and offices, we anticipate our headcount will remain roughly flat despite the increase in commercial and defense OEM work content during the year. We also had good continued success winning new business this year. I can't get into specifics, but several operating units have been awarded content on the F-47, and we believe this will be an excellent platform for us. Hopefully, in upcoming quarters, I'll be able to provide more specifics.

To highlight a few new business programs, I can talk about. In September, the U.S. Army placed its first large production order for Airborne Systems Glide Modulation Canopy, marking a major milestone following nearly two years of successful test and evaluation. This product represents a significant technological advancement over the current generation system used by the U.S. Army and Air Force. This new product allows jumpers to more precisely target landings in confined areas. The initial order value at $5 million begins the full transition to the new canopy in all future procurements. Airborne will deliver the first canopies in February 2026 to the U.S. Army Military Free Fall School, where all new jumpers will be trained on this new upgraded system. In August, the UK Ministry of Defence awarded a $30 million contract to IrvinGQ for an advanced aerial delivery system.

This new system, termed PRIBAD, enables the RAF's Atlas A400 aircraft to airdrop a rigid pole boat up to 40 m long and weighing up to 12 tons. In addition, IrvinGQ has reached an agreement with Rolls-Royce to supply its complete sensor suite on the Trent XWB-84 enhanced performance engine for the A350-900. This agreement encompasses OEM supply and power-by-hour support to operators, ensuring that the proven reliability of our sensors continues to contribute to the success of all XWB engine variants. We are making good progress integrating our two most recent acquisitions, Servotronics and Simmons Precision Products. Both integrations are being led by experienced EVPs. We have augmented the existing team with seasoned individuals from other TransDigm operating units to accelerate their progress. It's still early, but our experience to date indicates that these are going to be two very good additions to TransDigm.

Lastly, I'd like to finish by recognizing the strong efforts and accomplishments of our operating unit teams during fiscal 2025. It was a good year, and we are pleased with the operating performance they delivered for our shareholders. As we enter our new fiscal year, our management teams remain committed to our consistent operating strategy and servicing the strong demand for our products. With that, I'd like to turn it over to our Chief Financial Officer, Sarah Wynne.

Thanks, Joel, and good morning, everyone. I'm going to review a few additional financial matters for fiscal 2025 and then also our expectations for fiscal 2026. First, a few additional fiscal 2025 data points on organic growth, taxes, and liquidity. In the fourth quarter, our organic growth rate was approximately 11%, and all market channels contributed to this growth, as previously discussed by Mike and Joel.

On taxes, our GAAP and adjusted tax rates finished the year within and slightly better than their expected ranges. On cash and liquidity, free cash flow, which we traditionally define as EBITDA, less cash interest payments, CapEx, and cash taxes, was roughly $2.4 billion for the year, slightly above our expected estimate of $2.3 billion. Below that free cash flow line, investment of net working capital consumed approximately $330 million on a full year basis, and the final net working capital ended the year roughly in line with historical levels as a percentage of sales. We ended the year with approximately $2.8 billion of cash on the balance sheet, or approximately $2 billion when pro forma for the completion of the Simmons Precision Products acquisition.

At year-end, our net debt-to-EBITDA ratio was 5.8 times, up from the 5.9 times at the end of last quarter after returning capital to our shareholders via a $90 per share dividend. While we do not target a specific amount of cash that we like to have on hand, we have sufficient capital available through both cash on hand and as well as incremental debt capacity to support all potential M&A in the pipeline. Over the course of fiscal 2025, we did a fair bit of proactive financing. We pushed out our nearest term maturity from 2027 to 2028. Additionally, we reduced the interest rate on two of our loans. We also raised $5 billion to fund the aforementioned $90 dividend paid out in September.

Our EBITDA to interest expense coverage ratio ended the quarter at 3.2 times, which provides us with comfortable cushion versus our target range of 2 to 3 times. We continue to be comfortable operating in the 5 to 7 net debt EBITDA ratio range. Our go-forward strategy of capital deployment has not changed, and we continue to seek the best opportunities for providing value to our shareholders through our leverage strategy. Our capital allocation strategy is to both proactively and prudently manage our debt maturity stacks by keeping the nearest term maturity far out. In addition, approximately 75% of our $30 billion gross debt balance is fixed through fiscal 2029. This is achieved through a combination of fixed-rate notes, swaps, and collars. Next, on the fiscal 2026 expectations, I'm going to give some more details on the financial assumptions around interest expense, taxes, and share count.

A special note that all of my comments and data here include the acquisition of Simmons. Their interest expense is expected to be about $1.9 billion in fiscal 2026, and this equates to a weighted average interest rate of approximately 6.3%. This estimate assumes an average SOFR rate of 3.8% for the full year. On taxes, our fiscal 2026 GAAP, cash, and adjusted tax rates are all anticipated to be in the range of 22% to 24%. On the share count, we expect our weighted average shares outstanding to be 58.5 million shares in fiscal 2026. With regards to liquidity and leverage for fiscal 2026, as we would traditionally define our free cash flow from operations at TransDigm, which again is EBITDA as defined, less cash interest payments, CapEx, and cash taxes, we estimate this metric to be close to $2.4 billion.

After paying for the Simmons acquisition and assuming no additional acquisitions or capital market transactions, we would end the year with around $4 billion of cash on the balance sheet, which would imply a net debt-to-EBITDA ratio of approximately five times at the end of fiscal 2026. We will continue to watch this ratio along with the cash interest coverage ratio as we actively pursue options for maximizing value to our shareholders through our capital allocation strategy. In summary, we think we're remaining in good position with adequate flexibility to pursue M&A or return cash to our shareholders via share buybacks and/or additional dividends during the course of fiscal 2026. With that, I'll hand it back to Jamie, our Director of Investor Relations.

Before we open the line for Q and 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, given that it is our Q4 call and there is a lot of material to cover today. Operator, can you please open the line?