Business Context and Reporting Period
TransDigm Group Incorporated filed its Form 10-K for the fiscal year ended September 30, 2016. The company designs, manufactures and supplies highly engineered aerospace components through three reporting segments: Power & Control, Airframe and Non-aviation. Approximately 90% of fiscal 2016 net sales were from proprietary products, 80% from sole-source products and 54% from aftermarket sales.
Fiscal 2016 included contributions from the Breeze-Eastern, Data Device Corporation and Young & Franklin/Tactair acquisitions. The company reported approximately 9,300 employees, 57 principal manufacturing facilities and estimated backlog of $1.554 billion, compared with $1.428 billion at September 30, 2015.
Key Financial Metrics
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Net sales | $3.171 billion | $2.707 billion | +17.1% |
| Gross profit | $1.728 billion | $1.450 billion | +19.2% |
| Gross margin | 54.5% | 53.6% | +0.9 percentage points |
| Income from operations | $1.268 billion | $1.074 billion | +18.0% |
| Operating margin | 40.0% | 39.7% | +0.3 percentage points |
| Net income | $586.4 million | $447.2 million | +31.1% |
| Basic and diluted EPS | $10.39 | $7.84 | +$2.55 |
| Cash flow from operations | $668.9 million | $520.9 million | +28.4% |
| Capital expenditures | $44.0 million | $54.9 million | −19.8% |
| EBITDA | $1.374 billion | $1.149 billion | +19.5% |
| EBITDA As Defined | $1.495 billion | $1.234 billion | +21.2% |
Net sales growth consisted of $409.2 million of acquisition sales and $55.1 million of organic growth. Commercial aftermarket organic sales increased 6.1%, commercial OEM organic sales declined 1.1% and defense organic sales were flat.
- Power & Control: $1.622 billion of sales, up 21.9%; EBITDA As Defined was $787.4 million, or 48.6% of segment sales.
- Airframe: $1.448 billion of sales, up 13.1%; EBITDA As Defined was $709.9 million, or 49.0% of segment sales.
- Non-aviation: $101.8 million of sales, up 5.7%; EBITDA As Defined was $28.2 million, or 27.7% of segment sales.
Liquidity, Debt and Capital Structure
- Cash and cash equivalents were $1.587 billion at September 30, 2016, compared with $714.0 million a year earlier.
- Total debt, excluding approximately $17 million of letters of credit, was approximately $10.2 billion, up from $8.35 billion. Debt represented 106.8% of total book capitalization, and stockholders’ deficit was $651.5 million.
- The company had $5.289 billion of fully drawn term loans, a $600 million revolving credit facility with $583 million of availability, and $200 million outstanding under a $250 million trade receivable securitization facility.
- The debt leverage ratio was approximately 6.8 times EBITDA As Defined. The weighted-average cash interest rate on total borrowings at year-end was 5.2%.
- Fiscal 2016 financing included approximately $1.726 billion of net term-loan proceeds and $939.6 million of net proceeds from the 6.375% 2026 Notes. The company repurchased $207.8 million of common stock.
- The company was in compliance with its debt covenants at September 30, 2016. A one-percentage-point increase in interest rates would have increased annual term-loan interest expense by approximately $52 million based on year-end borrowings.
Material Changes Versus the Prior Comparable Period
- Organic growth improved modestly, while acquisitions accounted for most of the reported sales increase.
- Gross margin expanded despite acquired businesses carrying lower margins; management attributed improvement to organic growth, pricing, cost control and fixed-cost absorption.
- Interest expense increased 15.5% to $483.9 million because of higher average borrowings and a slightly higher cash interest rate.
- The effective tax rate declined to approximately 23.7% from 29.8%, primarily due to excess tax benefits on equity compensation and lower-tax foreign earnings. Adoption of ASU 2016-09 increased fiscal 2016 net income by approximately $43.6 million, or $0.78 per share.
- Goodwill increased to $5.679 billion from $4.686 billion, and other intangible assets increased to $1.764 billion from $1.540 billion, primarily reflecting acquisitions.
- Operating cash flow increased, but trade receivables used $80.1 million of cash and days sales outstanding increased to 54 days from 50 days.
Guidance, Outlook, Commentary and Unusual Items
- Management expected continued commercial aftermarket growth in fiscal 2017, supported by rising revenue passenger miles, aircraft fleet activity and the installed base.
- Industry consensus cited by management indicated continued, though moderating, increases in large commercial aircraft production during 2017 and 2018. Management assumed military-related sales would remain flat at recent high levels.
- Fiscal 2017 capital expenditures were expected to be between $85 million and $90 million. Management believed internally generated funds and revolving-credit availability would support operations, capital expenditures, research and development and debt obligations through at least fiscal 2017, absent disruptive events.
- On October 14 and October 27, 2016, the company drew an additional $1.15 billion of Tranche F term loans, principally to repurchase the 2021 Notes. It also declared a $24.00 per-share special dividend, with total cash payments for the dividend and related option equivalents expected to be approximately $1.4 billion in the first quarter of fiscal 2017.
- Unusual fiscal 2016 items included $15.8 million of refinancing costs, $23.4 million of inventory purchase-accounting adjustments, $18.5 million of acquisition integration costs, $15.7 million of acquisition transaction expenses and $48.3 million of non-cash stock compensation.
- Environmental remediation liabilities were $46.1 million, up from $21.9 million, primarily due to liabilities assumed in the Breeze-Eastern acquisition. The company stated that pending legal proceedings were not expected to have a material effect, but environmental estimates remain subject to change.
Principal Risks and Contingencies
- High leverage, floating-rate debt, refinancing requirements and restrictive covenants could limit financial flexibility and increase cash interest expense.
- Demand is sensitive to flight hours, airline profitability, aircraft production, commercial aerospace cycles, defense budgets and geopolitical conditions.
- Airbus and Boeing accounted for approximately 13% and 12% of fiscal 2016 net sales, respectively; the top ten customers represented approximately 45%.
- Acquisition execution and integration risks are significant, including potential margin dilution, goodwill or intangible-asset impairment, additional debt and integration costs.
- The company faces regulatory, certification, export-control, government-contracting, product-liability, environmental, cybersecurity, supply-chain and skilled-labor risks.
- Goodwill and identifiable intangible assets represented approximately 53% and 16% of total assets, respectively, increasing sensitivity to impairment assumptions.
Facts Investors Should Verify
- Reconcile reported growth with organic growth and acquisition contributions, particularly the sustainability of commercial aftermarket trends.
- Assess leverage after the post-year-end $1.15 billion term-loan financing and approximately $1.4 billion special dividend payment.
- Review debt maturities, covenant capacity, refinancing needs and sensitivity to higher LIBOR or other interest rates.
- Evaluate receivables collection trends, inventory reserves and working-capital requirements following the increase in days sales outstanding.
- Review the purchase-price allocations, environmental reserves and integration progress for Breeze-Eastern, DDC and Tactair.
- Separate GAAP earnings and operating cash flow from EBITDA As Defined and other adjustments, which management acknowledges are not substitutes for GAAP measures.
- Confirm the fiscal 2017 capital-expenditure outlook, commercial OEM production assumptions and defense-sales expectations against subsequent filings.