TransDigm Group Incorporated: Fiscal 2014 Third-Quarter Form 10-Q
Business context and reporting period
TransDigm designs, manufactures and supplies highly engineered proprietary aircraft components for commercial and military aircraft. The filing covers the unaudited 13-week and 39-week periods ended June 28, 2014, compared with periods ended June 29, 2013.
- Reporting segments: Power & Control, Airframe and Non-aviation.
- Fiscal third-quarter net sales were $610.6 million; year-to-date net sales were $1.731 billion.
- Estimated backlog was $1.289 billion at June 28, 2014, versus $1.107 billion a year earlier; approximately $138 million of the increase related to acquisitions.
Financial performance and liquidity
| Metric | Q3 FY2014 | Q3 FY2013 | 39 weeks FY2014 | 39 weeks FY2013 |
|---|---|---|---|---|
| Net sales | $610.6 million | $488.6 million | $1,730.7 million | $1,384.7 million |
| Gross profit | $327.5 million | $269.0 million | $919.2 million | $766.8 million |
| Gross margin | 53.6% | 55.0% | 53.1% | 55.4% |
| Income from operations | $240.0 million | $176.7 million | $669.1 million | $543.7 million |
| Operating margin | 39.3% | 36.2% | 38.7% | 39.3% |
| Net income | $16.2 million | $76.7 million | $192.7 million | $218.8 million |
| Net margin | 2.6% | 15.7% | 11.1% | 15.8% |
| Net income applicable to common stock | $(94.7) million | $38.7 million | $72.1 million | $142.7 million |
| Basic and diluted EPS | $(1.66) | $0.71 | $1.26 | $2.62 |
| EBITDA As Defined | $275.6 million | $231.9 million | $782.1 million | $652.1 million |
Q3 EBITDA As Defined margin was 45.1%; the year-to-date margin was approximately 45.2%. EBITDA As Defined is a non-GAAP measure and includes adjustments such as refinancing costs, acquisition-related costs and stock compensation.
- Operating cash flow was $349.5 million for the 39 weeks, up from $267.0 million. Capital expenditures were $25.5 million.
- Investing cash outflow was $320.9 million, including $311.9 million for acquisitions, partially offset by $16.4 million of real-estate sale proceeds.
- Ending cash and cash equivalents were $729.1 million, compared with $564.7 million at September 30, 2013.
- Total debt, including the $200.0 million trade-receivable securitization borrowing, was approximately $7.491 billion at June 28, 2014. Long-term debt was $7.251 billion.
- Available borrowing capacity under the 2014 Credit Facility was $413.1 million, with $6.9 million of letters of credit outstanding. The securitization facility provided borrowing capacity of up to $225 million and matured October 20, 2014, subject to extension rights.
- Stockholders’ deficit was $1.592 billion, primarily reflecting the special dividend and related dividend-equivalent payments.
Material changes versus the prior comparable period
- Q3 sales increased 25.0% to $610.6 million, consisting of 6.9% organic growth and $88.1 million of acquisition sales. Year-to-date sales also increased 25.0%, with 7.3% organic growth and $244.8 million of acquisition sales.
- Commercial aftermarket demand was strong. Excluding a favorable prior-year commercial OEM pricing adjustment, Q3 commercial aftermarket sales increased 14.9%; defense sales decreased 1.9%.
- Gross margin declined 1.4 percentage points in Q3 and 2.3 points year to date, primarily because acquired businesses carried lower margins. Acquisition sales generated approximately 36% gross margin in Q3 and approximately 37% year to date.
- Q3 selling and administrative expense declined to 11.7% of sales from 16.9%, mainly because of lower stock compensation and acquisition-related expense. Year-to-date expense declined to 11.5% of sales from 14.0%.
- Interest expense increased 40.3% in Q3 and 32.4% year to date because average borrowings increased. The average borrowing level was approximately $6.26 billion in Q3 and $5.95 billion year to date.
- Q3 net income fell 78.9%, and year-to-date net income fell 11.9%, largely because of higher interest expense and a $131.5 million refinancing charge.
- Dividends and dividend equivalents paid year to date totaled $1.445 billion, including a $25.00-per-share special dividend of approximately $1.325 billion and approximately $106.1 million of related option-plan dividend equivalents.
- Acquisitions included Airborne Global for approximately $263.8 million and Elektro-Metall Export GmbH for approximately $49.5 million. Purchase price allocations remained preliminary for certain acquired assets.
Guidance, outlook, commentary and risks
The filing does not provide a clear quantitative fiscal-year revenue, earnings or cash-flow guidance target. Management reported continued organic growth, strong commercial aftermarket activity and benefits from its strategies of obtaining profitable new business, improving cost structure and supplying highly engineered value-added products.
- The company refinanced its capital structure by issuing $1.15 billion of 6.0% notes due 2022, $1.20 billion of 6.5% notes due 2024 and drawing $825 million of Tranche D term loans. The proceeds funded the special dividend and redemption of the 2018 notes.
- The 2018 notes were fully retired in June 2014. The refinancing generated a $131.5 million charge, comprising a $121.0 million redemption premium and a $10.5 million write-off of debt issue costs.
- Variable-rate debt creates interest-rate exposure. A hypothetical one-percentage-point increase in rates would increase annual interest expense by approximately $38.9 million based on June 28, 2014 borrowings.
- Key risks include substantial indebtedness and restrictive covenants, dependence on aircraft utilization and customer profitability, commercial and defense-market conditions, U.S. defense spending, customer concentration, acquisition integration, required government and industry approvals, foreign operations, environmental liabilities and potential terrorism or geopolitical events.
- ASC 606 revenue-recognition guidance was issued in May 2014 and becomes effective for the company in fiscal 2018. The company was evaluating the adoption method and potential impact.
- Federal, state and foreign tax examinations were ongoing. Unrecognized tax benefits totaled approximately $6.1 million; the filing does not indicate a material expected change within the next 12 months.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Reconcile reported share repurchases: the financial statements indicate 421,200 treasury shares purchased year to date, while an Item 2 disclosure states 241,200 shares.
- Assess leverage, maturity dates, covenant compliance and mandatory prepayment requirements under the 2014 Credit Facility and note indentures.
- Separate recurring operating performance from the $131.5 million refinancing charge, acquisition-related costs, stock compensation and other nonrecurring adjustments.
- Evaluate whether lower-margin acquired sales continue to dilute gross margins and whether organic aftermarket growth remains sustainable.
- Review the preliminary purchase price allocations for Airborne and EME and any resulting changes to goodwill, intangible assets and amortization.
- Confirm the treatment and renewal status of the trade-receivable securitization facility, which had $200 million outstanding and an October 20, 2014 maturity.
- Monitor exposure to floating interest rates, defense-budget changes, aircraft utilization, customer cancellations or deferrals and acquisition integration execution.