TransDigm Group Incorporated: Fiscal 2019 Second-Quarter Form 10-Q Summary
Business context and reporting period
TransDigm designs, produces and supplies highly engineered proprietary aircraft components for commercial and military aerospace markets. The filing covers the thirteen and twenty-six week periods ended March 30, 2019, compared with the corresponding periods ended March 31, 2018. The financial statements are unaudited.
TransDigm completed its acquisition of Esterline Technologies on March 14, 2019. Esterline contributed $122.0 million of second-quarter sales and $7.5 million of pre-tax income; its preliminary results were reported as a separate segment pending integration.
Key financial metrics
| Metric | 13 weeks ended March 30, 2019 | 13 weeks ended March 31, 2018 | 26 weeks ended March 30, 2019 | 26 weeks ended March 31, 2018 |
|---|---|---|---|---|
| Net sales | $1,195.9 million | $933.1 million | $2,189.2 million | $1,781.0 million |
| Gross profit | $659.3 million | $534.1 million | $1,223.4 million | $1,010.7 million |
| Gross margin | 55.1% | 57.2% | 55.9% | 56.7% |
| Income from operations | $471.9 million | $409.1 million | $893.8 million | $762.1 million |
| Net income attributable to TD Group | $202.4 million | $196.3 million | $398.5 million | $511.1 million |
| Net earnings per share | $3.60 | $3.53 | $6.65 | $8.18 |
| EBITDA As Defined | $571.8 million | $463.1 million | $1,058.4 million | $864.7 million |
Second-quarter sales increased 28.2%, including 11.0% organic growth and 17.2% acquisition-related sales. Second-quarter EBITDA As Defined was 47.8% of sales. The filing identifies EBITDA As Defined as a non-GAAP measure that excludes, among other items, interest, taxes, depreciation and amortization, acquisition-related costs and stock compensation.
- Net cash provided by operating activities was $453.0 million for the first twenty-six weeks, versus $453.7 million in the prior-year period.
- Capital expenditures were $43.4 million.
- Acquisition cash payments were $3.57 billion, primarily for Esterline.
- Cash, cash equivalents and restricted cash totaled $2.83 billion at March 30, 2019, including $387.6 million restricted for the subsequent redemption of Esterline’s 2023 Notes. Unrestricted cash and cash equivalents were $2.44 billion.
- Net debt, based on reported debt less cash and restricted cash, was approximately $14.13 billion; reported debt was approximately $16.96 billion net of issuance costs, discounts and premiums.
- The company had $726.3 million of borrowing capacity available under its $760.0 million revolving credit facility, subject to covenant restrictions, and $33.7 million of outstanding letters of credit.
- Stockholders’ deficit was $1.48 billion at March 30, 2019, compared with $1.81 billion at September 30, 2018.
Material changes versus the prior comparable period
- Organic sales growth was driven primarily by defense sales, commercial OEM sales and commercial aftermarket sales. Second-quarter organic sales increased 11.0%; first-half organic sales increased 11.3%.
- Power & Control second-quarter sales increased 13.7% to $600.7 million, and Airframe sales increased 18.0% to $436.5 million. Esterline added $122.0 million of sales.
- Gross margin declined 210 basis points in the quarter and 80 basis points year to date, primarily because of Esterline inventory purchase-accounting adjustments and higher stock compensation, partly offset by operating leverage and foreign-currency gains.
- Second-quarter selling and administrative expense increased 52.9% to $164.4 million, including higher acquisition-related costs and stock compensation. Acquisition-related costs were $22.0 million year to date.
- Net interest expense increased 24.9% in the quarter and 15.9% year to date as weighted-average borrowings increased to approximately $15.3 billion and $14.1 billion, respectively.
- Year-to-date net income declined 22.0% and EPS declined from $8.18 to $6.65. The prior-year period benefited from a $166.6 million deferred-tax benefit related primarily to the Tax Cuts and Jobs Act; the current-year period recorded a $118.3 million tax provision.
- TransDigm issued $4.0 billion of 6.25% senior secured notes due 2026 and $550 million of 7.50% senior subordinated notes due 2027, redeemed its $550 million of 2020 Notes, and increased revolving credit capacity from $600 million to $760 million.
- Sales order backlog excluding Esterline increased to approximately $2.19 billion from $1.87 billion. Esterline backlog was excluded while management evaluated consistency with company reporting policies.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a clear quantitative full-year revenue or earnings guidance figure. Management expects operating strategies and strong margins to generate sufficient operating cash flow to meet interest obligations and liquidity needs, while retaining flexibility for acquisitions, capital spending, dividends or share repurchases. Management also stated that higher debt financing will increase future interest payments.
- Management was integrating Esterline and reassessing its reporting-unit and segment structure; Esterline was expected to be integrated into the existing segments during the third quarter of fiscal 2019.
- The Esterline purchase-price allocation was preliminary. Approximately $2.4 billion of goodwill and $1.0 billion of intangible assets were recorded, and valuation adjustments could be material during the one-year measurement period.
- Acquisition accounting produced $14.9 million of Esterline inventory step-up amortization in the quarter and $20.4 million year to date. Estimated identifiable-intangible amortization for fiscal 2019 was $122.2 million.
- TransDigm remained in compliance with its debt covenants. Covenant breaches could accelerate debt obligations, terminate revolving commitments and permit creditors to proceed against collateral.
- Key operating risks include exposure to aircraft flight hours and customer profitability, the U.S. defense budget and government contracting, customer concentration, acquisition integration, substantial indebtedness, interest-rate and currency movements, cybersecurity, natural disasters, international operations, and raw-material, tax and labor costs.
- The company and certain current or former officers and directors faced consolidated securities class-action litigation and a related shareholder derivative action concerning alleged disclosures about sales to the U.S. government. Management believes the claims are without merit and expects insurance coverage, but stated that the potential outcome and loss range cannot presently be estimated.
- On April 15, 2019, subsequent to quarter-end, the company redeemed approximately $373.8 million of Esterline’s 2023 Notes for approximately $387.6 million, including interest, premium and fees.
- The company adopted ASC 606 using the modified retrospective method. The adoption increased retained earnings by $3.3 million and did not materially affect reported results, financial position or cash flows.
Most important facts for investors to verify
- Whether Esterline integration delivers the expected sales, margin and cost-synergy benefits without materially increasing restructuring or integration costs.
- The company’s post-acquisition leverage, interest burden, debt maturities, refinancing requirements and compliance with leverage-related covenants.
- Whether operating cash flow remains sufficient after interest, taxes, capital expenditures, working-capital investment and acquisition spending.
- The sustainability of organic sales growth across defense, commercial OEM and commercial aftermarket channels.
- The effect of purchase-accounting amortization, acquisition costs, stock compensation and other adjustments on GAAP earnings versus EBITDA As Defined.
- The final valuation and tax treatment of Esterline goodwill and intangible assets, including potential measurement-period adjustments or impairment risk.
- The resolution and potential financial impact of the securities litigation and derivative action.
- The completeness and comparability of backlog, particularly because Esterline backlog was excluded from the reported $2.19 billion total and purchase orders may be canceled or deferred.