TransDigm Group Incorporated — Fiscal 2018 Second-Quarter Form 10-Q
Business Context and Reporting Period
TransDigm designs, produces and supplies highly engineered aircraft components for commercial and military aircraft. Its reporting segments are Power & Control, Airframe and Non-aviation. The filing covers the thirteen-week quarter and twenty-six-week year-to-date periods ended March 31, 2018, compared with the corresponding periods ended April 1, 2017. The interim financial statements are unaudited.
Key Financial Metrics
| Metric | Q2 FY2018 | Q2 FY2017 | Change |
|---|---|---|---|
| Net sales | $933.1 million | $868.7 million | +7.4% |
| Gross profit / margin | $534.1 million / 57.2% | $489.4 million / 56.3% | Margin +0.9 pts |
| Income from operations / margin | $409.1 million / 43.8% | $366.5 million / 42.2% | Margin +1.6 pts |
| Income from continuing operations | $201.8 million | $155.7 million | +29.6% |
| Net income | $196.3 million | $155.5 million | +26.2% |
| Basic and diluted EPS | $3.53 | $2.78 | +$0.75 |
| EBITDA As Defined | $463.1 million / 49.6% of sales | $421.7 million / 48.5% of sales | +9.8% |
For the twenty-six-week period, sales increased 5.8% to $1.781 billion, net income increased 86.3% to $511.1 million, and EBITDA As Defined increased 7.7% to $864.7 million. The year-to-date effective tax rate was negative 17.3%, primarily because of a provisional $147.1 million discrete tax benefit related to the Tax Cuts and Jobs Act.
Cash Flow, Debt and Liquidity
- Year-to-date operating cash flow was $453.7 million, compared with $390.5 million in the prior-year period.
- Capital expenditures were $30.9 million; acquisition payments were $50.3 million; and proceeds from the sale of discontinued operations were $57.7 million.
- Cash and cash equivalents were $1.011 billion at March 31, 2018, compared with $650.6 million at September 30, 2017.
- Total debt, including the $299.8 million trade receivables securitization facility and current debt, was approximately $11.735 billion on a net carrying-value basis. Long-term debt was $11.366 billion.
- The company had $584.8 million of borrowing capacity available under its $600 million revolving credit facility, with $15.2 million of letters of credit outstanding.
- Interest expense was $161.3 million in the quarter and $322.2 million year to date. Management reported a 5.2% weighted-average cash interest rate on borrowings outstanding at March 31, 2018.
- Year-to-date financing cash outflow was $72.0 million, including $56.1 million of dividend-equivalent payments and $34.5 million of term-loan debt service, partly offset by $26.3 million from stock-option exercises.
Material Changes Versus the Prior Comparable Period
- Organic quarterly sales increased 6.6%, led by a 14.6% increase in commercial aftermarket sales and a 4.7% increase in defense sales. Commercial OEM sales declined 2.1%.
- Power & Control quarterly sales rose 11.5% to $528.5 million, while Airframe sales rose 2.6% to $369.8 million and Non-aviation sales rose 1.8% to $34.8 million.
- Year-to-date commercial aftermarket sales increased 12.2%, while commercial OEM sales declined 1.6%. Year-to-date defense sales increased 1.6%.
- Gross margin improved because of organic growth, operating leverage, value-driven operating strategies and the absence of prior-year inventory purchase-accounting adjustments. Year-to-date inventory purchase-accounting adjustments declined by $19.4 million.
- Amortization expense decreased by $4.5 million in the quarter and $13.0 million year to date as certain acquisition-related order backlog became fully amortized.
- Interest expense increased 9.1% in the quarter and 9.6% year to date because average borrowings were higher than in the prior year.
- The company acquired the Kirkhill elastomers business for approximately $50 million in cash during the quarter. Kirkhill was included in the Airframe segment.
- Schroth was sold on January 26, 2018, for approximately $61.4 million, subject to a working-capital adjustment. The transaction generated a $5.2 million after-tax loss on sale in the quarter and was reported as discontinued operations.
- The company refinanced portions of its term-loan facilities, including new tranche G term loans of approximately $1.809 billion and a reduction of the tranche G margin to LIBOR plus 2.50%.
Guidance, Outlook, Commentary and Risks
- No specific quantitative full-year revenue, earnings or cash-flow guidance is provided in the filing text.
- Management expects its three core strategies—obtaining profitable new business, improving cost structure and providing highly engineered value-added products—to support strong margins and sufficient operating cash flow for interest obligations and liquidity needs.
- Management expects to use available cash and borrowing capacity for capital spending, acquisitions, potential special dividends or repurchases, and debt-related actions, subject to market conditions, liquidity requirements and debt covenants.
- Sales backlog was estimated at $1.869 billion at March 31, 2018, compared with $1.648 billion at April 1, 2017. Most orders were scheduled for delivery within twelve months, but orders may be canceled or deferred.
- The company completed the $525 million acquisition of Extant Components Group on April 24, 2018, financed with cash on hand. It also launched a proposed $500 million senior subordinated notes offering and expected additional term loans and repricing activity.
- Accounting for the Tax Cuts and Jobs Act remained provisional. The recorded tax benefit and transition-tax liability may change as foreign earnings and other calculations are finalized.
- Principal risks include substantial indebtedness and interest-rate exposure, dependence on aircraft flight hours and customer profitability, defense-budget and government-contracting risks, customer concentration, acquisition integration, raw-material and labor costs, international operations, foreign exchange, cybersecurity, natural disasters, regulatory approvals and environmental liabilities.
- The company is defending securities class-action and shareholder derivative litigation concerning alleged disclosures and business practices involving U.S. government sales. Management expects no material adverse impact but states that potential loss cannot currently be estimated.
- Management reported compliance with debt covenants and effective disclosure controls. Acquisitions completed during the period were excluded from the internal-control evaluation under applicable SEC rules.
Investor Verification Checklist
- Verify the provisional Tax Cuts and Jobs Act accounting, including the $147.1 million discrete benefit and potential future adjustments.
- Assess leverage, refinancing needs, interest-rate sensitivity and the maturities of the 2020, 2022, 2024, 2025 and 2026 notes.
- Reconcile EBITDA As Defined to GAAP earnings and operating cash flow; it is a non-GAAP measure that excludes or adjusts for several cash and non-cash items.
- Evaluate whether commercial aftermarket growth can offset weakness in Airframe commercial OEM and defense sales.
- Review the integration and valuation assumptions for Kirkhill, Extant and prior acquisitions, including goodwill and intangible assets.
- Monitor the securities litigation, the former Schroth divestiture and any related indemnification or contingent liabilities.
- Confirm backlog conversion, customer cancellation or deferral risk, and the company’s planned use of cash for acquisitions, dividends, repurchases or debt reduction.