TransDigm Group Incorporated — Fiscal 2017 Second-Quarter Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended April 1, 2017, compared with April 2, 2016. The interim financial statements are unaudited. TransDigm designs, produces and supplies highly engineered aircraft components across Power & Control, Airframe and Non-aviation segments.
Key financial metrics
| Metric | Q2 FY2017 | Q2 FY2016 | 26 weeks FY2017 | 26 weeks FY2016 |
|---|---|---|---|---|
| Net sales | $873.2 million | $796.8 million | $1,687.3 million | $1,498.5 million |
| Gross profit / margin | $491.1 million / 56.2% | $425.7 million / 53.4% | $935.3 million / 55.4% | $800.2 million / 53.4% |
| Operating income / margin | $366.4 million / 42.0% | $312.1 million / 39.2% | $683.4 million / 40.5% | $588.1 million / 39.2% |
| Net income | $155.5 million | $141.7 million | $274.4 million | $271.1 million |
| Basic and diluted EPS | $2.78 | $2.52 | $3.17 | $4.75 |
| EBITDA As Defined | $421.2 million | $368.6 million | $806.2 million | $688.0 million |
| Cash flow from operations | Not separately provided | Not separately provided | $390.5 million | $286.9 million |
Q2 EBITDA As Defined was 48.2% of sales. Net income margin was 17.8% in both quarters. The year-to-date effective tax rate was 22.5%, compared with 25.7% in the prior-year period; the quarter rates were 27.7% and 29.4%, respectively.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $985.4 million at April 1, 2017, down from $1,587.0 million at September 30, 2016.
- Net long-term debt was $10.84 billion, compared with $9.94 billion at September 30, 2016. Including the $199.9 million receivables securitization facility, gross debt obligations were approximately $11.0 billion, before applicable issuance costs and discounts.
- The company had $6.406 billion of term loans and $586 million of available revolving capacity, with $14 million of letters of credit outstanding. The facility requires quarterly term-loan principal payments of $16.2 million.
- During the period, TransDigm generated $390.5 million of operating cash flow, spent $38.4 million on capital expenditures and $108.9 million on acquisitions, and used $841.6 million in financing activities.
- Cash financing uses included a $1.376 billion special dividend and related dividend equivalents, $339.8 million of share repurchases, and $528.8 million for the tender and redemption of the 2021 Notes. These uses were partly funded by $1.133 billion of term-loan proceeds and $301.0 million of net proceeds from additional 2025 Notes.
- The company issued $300 million of additional 6.5% 2025 Notes at a 101.5% issue price and redeemed all $500 million of 2021 Notes during the first half of fiscal 2017.
- Management stated that internally generated funds and anticipated refinancing should meet debt obligations, and that operating cash flow and available borrowing capacity should support potential acquisitions, share repurchases and dividends. The filing does not provide formal full-year earnings guidance.
Material changes versus the prior comparable period
- Q2 sales increased 9.6%, including $69.7 million of acquisition sales and 0.8% organic growth. Year-to-date sales increased 12.6%, including $157.2 million of acquisition sales and 2.1% organic growth.
- Q2 gross margin expanded 2.8 percentage points, primarily from acquisition contributions, organic growth, cost actions and lower acquisition integration, inventory purchase-accounting and stock-compensation costs.
- Q2 operating income rose 17.4% and net income rose 9.8%. Year-to-date net income rose only 1.2%, as higher interest expense and $35.6 million of refinancing costs substantially offset operating growth.
- Net interest expense increased 32.8% in Q2 and 31.6% year to date, reflecting higher average borrowings. Management reported a 5.1% weighted-average cash interest rate at April 1, 2017.
- Power & Control led growth: Q2 sales increased 18.3% and EBITDA As Defined increased 22.0%. Airframe sales were essentially flat, while Non-aviation sales increased 10.9%.
- The company acquired Schroth Safety Products and certain aviation and defense assets from Takata for approximately $88.9 million, including $78.9 million paid in cash. Purchase accounting remains subject to measurement-period adjustments.
- Backlog was estimated at $1.648 billion at April 1, 2017, up from $1.570 billion a year earlier; most orders were scheduled for delivery within twelve months, but orders may be canceled or deferred.
Outlook, risks and unusual items
- Management expects the company’s value-driven operating strategies to support strong margins and sufficient cash generation for interest and liquidity needs, but expressly notes that future results are not assured.
- Key risks include sensitivity to aircraft flight hours and customer profitability, commercial and defense-market conditions, U.S. defense spending, customer concentration, acquisition integration, substantial indebtedness, interest-rate exposure, cybersecurity threats, terrorism, natural disasters, international operations, raw-material and labor costs, regulatory approvals and environmental liabilities.
- Breeze-Eastern-related environmental reserves totaled approximately $24.9 million for contamination at former facilities. The filing also discusses a $6.2 million settlement with dissenting shareholders, with portions recorded in selling and administrative expense and interest expense.
- Interest-rate swaps and caps hedge portions of floating-rate debt; the company remains exposed to interest-rate, counterparty and refinancing risks.
- The Schroth business remained on separate systems and internal controls after acquisition; integration into TransDigm’s systems and control environment was expected to be completed in fiscal 2018.
- Management reported compliance with all debt covenants as of April 1, 2017. Amendment No. 2 to the credit agreement permitted up to $1.5 billion of dividends and share repurchases through March 6, 2018; approximately $1.31 billion remained permissible as of April 1, 2017, subject to conditions.
- New revenue-recognition, lease, credit-loss and cash-flow standards were under evaluation. The company planned to adopt ASC 606 beginning October 1, 2018; the filing does not provide a quantified expected impact.
Important facts for investors to verify
- Reconcile reported operating performance with the company’s substantial leverage, rising interest expense and refinancing requirements.
- Assess the sustainability of organic growth, particularly the decline in commercial aftermarket sales in Q2 and the dependence on acquisition-driven growth.
- Review debt maturities, floating-rate exposure, hedge coverage, covenant calculations and the August 1, 2017 maturity extension of the receivables securitization facility.
- Evaluate the effect of the $24.00 special dividend and continuing share repurchases on liquidity, leverage and per-share results.
- Monitor integration and final purchase accounting for Schroth and other recent acquisitions, including potential adjustments to goodwill and intangible assets.
- Consider the non-GAAP nature and limitations of EBITDA As Defined, which excludes or adjusts for refinancing, acquisition, stock-compensation and other costs.
- Review environmental reserves, tax examinations and approximately $7.4 million of unrecognized tax benefits, as well as the company’s ability to refinance future maturities.