TransDigm Group Inc (TDG) 2007 Q1 法說會逐字稿

Good day ladies and gentlemen, and welcome to the TransDigm Group's First Quarter 2007 Earnings Conference Call. My name is Jeremy, and I'll be your coordinator for today. [OPERATOR INSTRUCTIONS].

I would now like to turn the call over to your host, Mr. Sean Maroney, Director of Corporate Accounting and Investor Relations. Please proceed sir.

Thank you. Good morning ladies and gentlemen. I'd like to thank all of you that have called in today and welcome you to TransDigm's Fiscal 2007 First Quarter Earnings Conference Call. We will be discussing the results of operations for the fiscal first quarter ended December 30, 2006.

You should have already received our earnings news release that was issued this morning. If you have not received the release, you may retrieve it by visiting www.transdigm.com. A replay of today's broadcast will be available for the next two weeks. Replay information is contained in our news release.

Before we begin, the company would like to remind you that statements made during this call, which are not historical in fact, are forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied in the forward-looking statements.

For further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, please refer to the information regarding forward-looking statements and risk factors included in the company's latest filings with the SEC. These filings are available through the "Investor" section of our website or through the SEC's website at www.sec.gov.

The company would also like to advise you that during the course of the call, we will be referring to EBITDA, specifically EBITDA as defined and adjusted net income, both of which are non-GAAP financial measures. Please see the tables and related footnotes in today's press release for a presentation of the most directly comparable GAAP measure and a reconciliation of EBITDA as defined and adjusted net income to that measure.

Okay. Now having taken care of the necessary disclosures, let me introduce Nick Howley, our Chairman and Chief Executive Officer, who will provide an overview of the business for the quarter and afterwards, Mr. Rufus, our Executive Vice President and Chief Financial Officer, who will discuss the financial results for the period. With that, I'll turn it over to Nick.

Well, good morning. Thanks everybody for calling in to hear again about our business. Since we're just coming up on our first anniversary as a public equity and I see we have a number of new people on the call, I'll again start with a short overview of TransDigm.

Just to review, we completed our initial public offering, and our shares began trading on the New York Stock Exchange on March 15, 2006, under the symbol TDG. We sold about 12.6 million shares at a price of $21 a share, representing about 28% of the outstanding shares. The shares closed Friday at $31.95 a share.

TransDigm supplies highly engineered aerospace components. The components are used on nearly all commercial and military aircraft in service today. The products are typically engineered to meet the needs of a particular aircraft, platform, or customer. We estimate that about 90% of our sales are generated by proprietary products. That is where we own the design. Similarly, we estimate that over 75% of our sales come from products for which we are the sole-source provider.

Commercial business accounts for a little over three-quarters of our revenue with the balance being defense-related. We expect to generate this year about 60% of our revenue from aftermarket sales. That is to the end-users of aircraft or organizations that service the end-users. Aftermarket is down a bit as a percent of the total. This is due primarily to the OEM production ramp-up.

About 40% of our revenue are from sales to OEMs. That is typically the builders of airplanes or the system suppliers to these builders. Historically, the aftermarket revenues have produced a higher gross margin. They've been more stable than the sales to the OEM.

Because of the large installed base, the products, the high margins, and the relatively low capital expenditures, TransDigm has historically generated a strong free cash flow. This has given us the option to either repay debt or pursue other acquisitions. We also, just to remind people, we have a very consistent value-based operating strategy, focused around what we refer to as our three value drivers. That is new business development, continual cost improvement, and value-based pricing. We stick to these concepts as the core of our operating management methodologies. This consistent approach has allowed us to increase the intrinsic value of each of the businesses we have acquired.

As a key fourth element of our value proposition, we've been very acquisitive through the years. We've acquired proprietary aerospace products with significant aftermarket. We have acquired 19 such businesses over our history including ATI, the largest one, in the last week. We have made four acquisitions in the last 12 months.

Now, let me turn to the latest financial performance. First, let me remind you, this is the first quarter review for fiscal year 2007. Our 2007 began on October 1st. In both Q1, Q2, and Q3 of '06, we had a lot of financial structuring activity. So, profit-related comps to the previous Q1 in 2006 require some adjustment to be meaningful on an operating level.

As I've also said in the past, quarterly comparisons can be significantly impacted by differences in the OEM aftermarket mix, large orders, transient inventory fluctuations in the system, modest seasonality, and some other factors. But, by almost any measure, we had a good first quarter for 2007.

If you remove the impact of acquisitions, our Q1 sales were up about 16% versus the prior year. Our commercial aerospace market continues to pick up nicely, and our defense business was up modestly for the first quarter.

I'll just take a minute to review the market segments, and I'll do this on a pro forma basis. That is assuming we owned the same mix of businesses in both periods. In the commercial segment, which to remind you, makes up over three-quarters of our volume, in commercial OEM area, our revenues were up 14% on a comparable quarter basis. They were down a little from the fourth quarter of last year or on a sequential basis. This is primarily the timing of shipments and the fact there's less working days in the first quarter.

We continue to be very active in finalizing our Boeing 787, both the designs and the manufacture processes. This activity should peak in 2007. We still expect our OEM business to be up in the range of 15% on a year-over-year basis.

If I look at the commercial aftermarket revenues in the quarter, they were up between 20 and 25% on a comparable quarter basis. On a sequential quarter basis, that is against the fourth quarter of last year, the aftermarket revenues were still up about 15%.

Coming into '07 from the end of the summer, we were somewhat concerned about the slower world-wide RPMs in the late part of the summer and early fall, but our shipments weren't impacted, and it appears to us that the RPMs seem to be picking back up.

In the defense segment, which makes up a little under a quarter of our business, our revenues were up modestly versus a low prior-year Q1. They were just about even with the average quarterly run rate through 2006. We saw a significant pick-up on Q1 in incoming defense orders. It's tough to predict in the near term.

We remain cautious about defense buys, and they're still at historically high levels. And they're always subject to, at least to some degree, to the political winds. But, we are now, a little more bullish on our defense revenues for the full year than we were at the start of the year.

Let me turn now to our recent acquisition. As you know, in January, we announced an agreement to acquire Aviation Technologies, which we call ATI, for approximately $430 million. We expect to recover roughly $10 million of tax benefits for a net cost to us of about 420.

This transaction closes -- closed on February 7th, substantially on the previously announced terms. I'm going to reiterate a little bit, some of the information from our previous call and also expand on it a little.

ATI has very similar characteristics to the TransDigm base business. That is the products are proprietary, highly engineered aerospace products. They have significant aftermarket content and broad platform positions.

The annual revenue is about $105 million. 95% comes from aerospace. About 90% is proprietary, and most of it's sole-source. 80% of the revenue is from the commercial aerospace market. About half of that and about half of the overall revenue comes from the aftermarket.

The primary product lines, just to remind everybody, in decreasing order of volume, are flight deck and passenger audio systems. This is the equipment and the sub-systems that perform the selection, the switching and the controls that enable the pilots to communicate with the crew, the ground and the passengers. This is a new area for us.

The next product line is power conditioning and power control equipment. This is very similar to the products made by our Avionics Instrument business. The third product line is specialty cockpit displays. This is a new product area for us also.

And the fourth is motion control products. This is primarily motors, transducers, and actuators. They're very similar to the products made by our Skurka and our CDA businesses. The first three product lines I mentioned are relatively comparable in revenues.

Turning a minute to the operations of ATI, the business employs about 600 people. It operates -- it runs as two operating units with four manufacturing facilities. There's two facilities in Seattle, and this is where they make the audio systems and the power conditioning equipment. There's one facility in Malaysia and one in Philadelphia. And at these two facilities, they make the motion control products and the specialized displays.

ATI's products are positioned on a broad and attractive base of platforms. The top eight platforms in descending order are the Boeing 737 family, and these are all families by the way, the A320, the Boeing 747, the CRJ family of regional jets, the Boeing 777, the Embraer family of regional jets, the C-130, and the Cessna Citation family. For those of you familiar with TransDigm, you'll see this is quite similar to the top platform list in the TransDigm business.

As we go forward with ATI, we see opportunities to improve the profitability of the business. The mix of market segments and platforms is quite similar to TransDigm. As a result, we would anticipate a long-term organic growth rate in the high single digits. We also see some solid new product rollout opportunities here.

The EBITDA margins run in the 35 to 36% range. Currently over time, we see no reasons that these businesses can't get up or even a little above the TransDigm average of the mid 40s, EBITDA margins. We see cost reduction opportunities. There is significant corporate cost that will come out. We see at least one plant consolidation opportunity in Seattle.

We may also see some cash generated from a real estate transaction and some additional productivity by combining both Seattle facilities in a larger new facility. We're still in the process of evaluating this option. We also see just general, what I'll call blocking and tackling productivity opportunities in both the internal costs and the external or outside purchase cost.

We anticipate that we can utilize the Malaysian facility to assist some of our other units and their cost reduction efforts. And also, the Boeing 787 development expenses should start to ramp down over the next 12 to 18 months.

In the area of what we call value selling, we see select opportunities here where the pricing doesn't adequately reflect the cost, the effort or the -- and/or the value we provide. We'd anticipate some adjustments in these areas.

What does this mean to TransDigm? Well, Greg's going to go through the financials in a little more detail. But on an adjusted EPS basis, that is adjusted primarily for the ATI transaction expenses, and the rapidly amortizing purchase price inventory, and backlog step-up accounting at ATI, we expect the earnings per share for fiscal year 2000 to increase about $0.03 a share as the result of ATI.

We expect the EPS for the first 12 months of ownership to be up about $0.07 a share. We expect the impact on EPS to expand significantly beyond that. On a GAAP basis, the acquisition will be slightly dilutive in fiscal year 2007 because of the purchase accounting.

Looking at the full fiscal year 2007, as you know on January 23rd, we increased our full-year guidance. This was due to the strong Q1 and our sense that both the commercial aftermarket and the defense segments appeared to be a little stronger than we anticipated.

With the acquisition of ATI, we are revising our guidance again. We now expect revenues to be in the range of 575 to $585 million. That's up about a third versus fiscal year 2006. About half of this growth is due to the ATI acquisition.

As in prior years, we anticipate the organic revenues will be modestly weighted towards the second half of the year. We now expect 2007 EBITDA as defined to be in the range of 256 to $264 million or up a little over a third versus the prior year.

The adjusted diluted EPS on the same basis above, that is excluding primarily the deferred comp, stock options, acquisition-related expenses, and the rapidly amortizing step-up purchase accounting is anticipated to be in the range of $1.82 to $1.94 a share. Today's increase from our prior guidance on January 23rd in revenues, adjusted EPS, and adjusted EBITDA as defined is due to the ATI acquisition.

In summary, Q1 2007 is a good start. Our operations perform well. We're pleased with our new acquisition, and 2007 looks to be another good year for TransDigm. With that, Greg, if you could take them through some of the financial details.

Okay. Thanks Nick, and I will. As our press release stated, we had a record Quarter one result. We hit on every cylinder. Our core business is operating extremely well. Our recent acquisitions are delivering expected results without any surprises. We completed due diligence on our largest acquisition in our history. And the prior-year financial restructuring of debt and other items is delivering the expected results.

Nick's comments centered around pro forma comparable results. I'd like to switch to GAAP for the P&L review. Quarter one sales were $122.7 million, up $22.6 million or 22.5% from the prior year. Excluding acquisitions, the sales were up $16.3 million or a 16.2% increase over the prior year. The acquisitions, that is CDA, Sweeney Engineering, and Electra-Motion contributed $6.3 million or 6.3% for the quarter.

Gross profit was $63.6 million or 51.9% of sales. This $14.4 million increase is 29.2% greater than the prior year. The improved margin is primarily due to the favorable aftermarket mix and to a smaller extent, favorable leverage on greater volumes and continued productivity improvements. With the increased volume however, our operating expenses decreased $1.1 million or 7.7% for the quarter versus the prior year, and this was on increased sales of 22.5%.

This decrease is explained in more detail in our Q and in previous filings, but the short answer is, the prior-year first quarter included approximately a net of about $3 million of non-operating, non-recurring, unusual activity that did not repeat this year. This reduction in expenses was partially offset by current-year volume increases and some increases in stock-option expense.

Overall, selling and administrative expenses were 9.9% of sales, which is closer to a more normal run rate versus the prior year. The above activity resulted in first quarter income from operations to be $49.9 million or 40.6% of net sales. This $49.9 million is 45.2% greater than the prior year.

Moving down the P&L, our net interest expense was $17.8 million, a decrease of $2 million versus the prior first quarter. Even though our average level of borrowing increased to $925 million versus 889.5 a year ago, the average interest rate decreased to approximately 7.6% compared to 8.7% in the prior year. This was primarily due to the refinancing of the debt structure during FY '06.

Regarding our tax provision, our effective tax rate was 36.6% for the first quarter. The primary reason for the lower effective tax rate was a retroactive reinstatement of the research and development tax credit. We have now lowered our estimate of the full-year effective tax rate to 38%.

As a result of the first quarter activity, net income was $20.3 million or 16.5% of net sales. The $11.3 million increase over prior year is a 126% improvement. With the net income improvement, on a GAAP basis, our Quarter one diluted EPS was $0.43 per share compared to $0.19 per share a year ago, again an increase of 126%.

Let me now switch to some other metrics that we use, specifically, EBITDA as defined and adjusted net income. Since we were so active in financing and acquisition activities, there are certain times where GAAP accounting treatment overshadows the operating performance. We believe the adjusted numbers are a better reflection of the real underlying operating performance.

This quarter and today's guidance is a perfect example of why we make these adjustments, and I'll go through in some detail later. But, these adjustments are typically some combination of non-recurring or non-cash items. This is why we include a reconciliation and lay out all the details in our earning release so investors and analysts can see the nature of each adjustment.

In the first quarter, EBITDA as defined was $56.3 million or 45.9% of net sales compared to 43.1 or 43.1% of sales a year ago, an increase of 30% versus the prior year. Again, it was a very strong quarter regarding margin, primarily driven by the particularly rich aftermarket mix, as mentioned earlier. The combination of higher volume, better margins, lower interest expense, and a lower tax rate all contributed to an adjusted net income that was up about 82% versus the prior period.

Accordingly, the adjusted diluted EPS was $0.46 per share compared to $0.26 a year ago, an increase of 77%. The above difference in GAAP versus adjusted EPS in the first quarter is only $0.03, but as we report the results of the acquisition of ATI and the related purchase priced accounting adjustments, this spread will be greater for the remainder of the year.

We ended the quarter with $54.6 million of cash on the balance sheet, again, a very strong quarter. Cash flow from operations was approximately $38 million and it was aided by obviously the high net income. We also had unusually strong accounts receivable collections, which didn't follow our historical holiday patterns. Usually with the timing and Christmas and other company's December year-ends, our cash collection has been historically slow.

But this year it doesn't appear that the seasonality affected us. Also, we only paid interest on our bank debt during the quarter and we had no tax payments during the quarter. And finally, I'd like to remind that this cash balance also reflects the use of $45.2 million that we did early October to acquire CDA.

Overall, strong cash performance for the quarter and there's really nothing else that stood out on the balance sheet that I think needs a discussion this morning.

I'd now like to switch topics again and talk about the ATI acquisition and the revised guidance. First, the only change from our January 23rd guidance is the impact of the ATI acquisition. This revised guidance only reflects 7.5 months of ownership since TransDigm is a September 30 year-end close.

For the remainder of our fiscal year, because of this acquisition, we have taken up sales of $75 million. EBITDA as defined was taken up $29 million, our adjusted diluted earnings per share is taken up $0.03, but the GAAP diluted earnings per share was down $0.06, due to the purchase priced accounting.

Let me explain this $0.09 difference. Our adjusted EPS of $0.03 is reduced by two items, both non-cash and both resulting from purchase accounting. First, we are taking a $0.06 charge for inventory step up. As you know, after an acquisition we are required to write up finished goods inventory to market value and then charge it off to cost of sales.

This write off will occur through the fourth quarter and will be completely written off in behind us this fiscal year. The second charge is a $0.03 charge for order backlog step up. It's the same principal as inventory.

However this has a 12-month life and will be amortized through the second quarter of '08, so we'll take a $0.03 charge this year and about a $0.02 charge in '08 for this. Again, I can't emphasize enough, both of these charges are non-cash charges resulting from the rapid write-off of specific purchase accounting items.

Regarding the financing and the acquisition, as you know we successfully funded and closed on ATI last week. Our new debt structure will have an average interest rate of approximately 7.5%. With our new debt structure and using the December 31 LTM EBITDA, that's the last 12 months, for both ATI and TransDigm, our debt to EBITDA leverage ratio is 5.4 times.

This leverage is lower than we started out at the IPO. By the end of our fiscal year, assuming no additional transactions, our gross leverage, that is excluding cash on the balance sheet, will be about 5 times. Net of cash, this leverage by year-end will be about a half a turn lower than that or about 4.5 times. Again, we are very pleased with the results of the first quarter and we're very excited about the prospects of this ATI acquisition.

With that we'll open it up for questions.

[OPERATOR INSTRUCTIONS] And your first question is from the line of Joe Campbell with Lehman Brothers.

Hi, good morning, it's actually Carter Copeland, good quarter guys.

Thank you.

Great.

Just a couple of quick ones for you, Nick, I wonder if you could talk a little bit about just sort of M&A. The ATI deal was a big deal and has both some integration work to be done but also it sounds like a lot of opportunities.

Does that in any way impact the way you're thinking about the pace of M&A as we head through the rest of this year? Does it limit you in any way? Or should continue to think of TransDigm the way we have in the past, which is capable to do any deal at any time if it comes along?

I appreciate that Carter, any deal at any time. That's pretty good --.

Well, given the appropriate size.

No, we are continuing the same way we continued before. This is a business we know pretty well, we feel pretty comfortable with it, this is ATI now. Interestingly at least, you know we feel pretty good about the management. That's not to say it's not going to take some integration time, but, Carter, we're not changing our acquisition pace at all.

I mean what will change it, is the arrival rate of good deals or places where we think we can generate value, not the fact that we feel either over stretched either operationally or financially. Does that answer your question, Carter?

Yes that's fine. It's just the largest deal you've done to date. And it seems like there's both some work to be done, but also in terms of the new product lines, if we were to think about it as we had in the past, you guys would add on to those new areas in ways that we would expect to see [some] further M&A.

Well Carter, one of the things we like about this is we've expanded what I'll call our footprint a little bit.

Of course.

You know in the audio systems and a little bit in the specialized cockpit displays too. You know we'd hope as we go down the road we could find some other things to tuck in there.

Of course. Just a couple of other ones, the defense orders which you said you saw an uptick in the quarter, did you see any particular areas of strength on specific programs?

No, I really can't say we did. You know most of our volume, and surely the vast majority of the profit, comes out of the aftermarket orders. And my general sense, and this is a general sense, is that things sort of slowed down at the end of the fiscal year, at least in order placement, and then sort of a pile of them spit out in the new year. Now we'll see, you know we'll watch that by quarter. But I really can't, Carter, focus or identify one particular thing. We just saw more activity.

Just across-the-board, it wasn't necessarily in helicopters or --?

No.

Okay. And this one for Greg, you said the cash tax payments in the quarter were zero, what sort of cash taxes are you expecting for the year?

You know, Carter, I don't have that info in front of me, I was so focused on doing the quarter that I don't want to give you bad information. I have it in my cash flow, but I don't have it at my fingertips right now.

Okay that's fine. We can take it off line. And the 38% tax rate that you said for the year, now that we have the R&D tax credit in here, should we be thinking that 38% is a regular run rate for TransDigm?

In the short run, that's what we're using and that's what we have in our models, Carter.

Okay. Well great. Thanks again and good quarter.

Thanks.

[OPERATOR INSTRUCTIONS] And your next question is from the line of Errol Rudman with Rudman Capital Management.

Good morning.

Okay.

Hello?

Mr. Rudman has disconnected.

Hello?

Yes.

Can you hear me?

I can hear you.

Okay yes I can hear you, I didn't disconnect. I had some questions about your guidance. As I understand what you said, you indicated that you expect a growth rate for ATI going forward of about 6% and you expect mid teens for the remaining three quarters for the old TransDigm.

I was hoping for two things, your first quarter you were up in the low 20s and for the next nine months you're looking for the old TransDigm to be up roughly 15%. Could you outline why you expect the slowdown in the remaining three quarters? And also, what is the difference in the mix of the businesses between TransDigm old and ATI, such that the growth rate is significantly faster than ATI?

I don't know where you got the 6%.

Well what I did, I'll tell you what I did. I just took the balance of the amount that you increased your estimate from before you made the ATI, I took that difference and I got $75 million. And then I made an adjustment for last year, you said that ATI was $106 million, so I took three-quarters of the year to get 75, and that then plugs into if I compare it. Maybe I'm doing too many adjustments, but if you could talk to the issue that would be helpful.

Well let me reiterate, Greg, what I said. What I said about ATI, and again I'm not sure of your arithmetic, you may well be fine. But what I said is that the market mix and the platform mix is very similar to TransDigm, so that what we typically say over a long term, we typically say people should expect high single-digits, maybe low double-digits out of TransDigm absent acquisitions in the revenue line.

We think ATI is very similar. If I didn't make that clear, that's what I was trying to make clear. We think it has a very similar sort of long-term organic growth pattern to what TransDigm has. Now, Greg, I wasn't following all those --.

I did. Errol, on some of the data points -- in our prior press releases I believe what we said the LTM revenues through December of '06 were about 105. If you back that up to a September number, they were more in the mid to high 90s. So, a couple, 5 or $6 million there could throw your ratio up a little bit.

I see, well that's helpful. And the other question --.

Now Errol, your other question was to do with the mix?

Yes, and then I'd also like to touch on the uses of cash.

Was mix your other question though? Do you want me to address that?

Yes please, thank you.

I would say if you look at the businesses, it's not exactly the same as TransDigm, but it's pretty close. TransDigm's aftermarket revenue now runs a little over 60% of our annualized revenue, ATI is about 50%. So it's slightly less but not materially off.

We also by the way expect that to move up a little as we work on the company. The commercial OEM revenues at TransDigm run I think 26, 27%, I'm saying that from memory. At ATI it's about 31%.

So I don't see those as materially different. Their defense work is roughly 20, 20% of volume, whereas TransDigm is maybe closer to 25. Again those are fairly comparable mixes in my view and I'd hope as time goes forward we may be able to move that aftermarket content up a little.

Okay thank you. And then my last question had to do with you're building cash at a rapid rate, will that be used primarily to continue making funding of acquisitions? Or would you use it for debt? How do you view its disposition?

Well it's hard to predict now. As I've said in the past, our first choice for cash is to make creative acquisitions. But we'll only do that if we see things that generate good solid value and pretty well fit our proprietary aerospace component with significant aftermarket content requirement. That's our first choice.

If that's what we can find, that's what we'll do. If we can't, we have no interest in hoarding up cash or anything like that, we'll do whatever makes sense to increase the equity value, given the capital markets at the time.

Okay could you give us a sense of your financial structure now, how much more you could borrow based on how you're constituted?

Well we have, Greg, I want to say $200 million left on our credit line, or is it --?

Well we have an unused revolver of 200.

Of 200, plus we have more flexibility.

And we have uncommitted bank debt too of flexibility. And as long as we maintain the proper ratios, you know depending on the targets, EBITDA that you acquire, gives you a calculation of what you could borrow, plus you have cash on the balance sheet.

But it's significantly over the $200 million revolver.

Okay, thank you.

And your next question is from the line of [Peter Brimm] with [First Q Capital.]

Hey there, fellows, congratulations on the quarter.

Thanks.

Thanks.

I had a question around the charges you're taking here for the accounting [offices] under pressure, your gross margins here going forward -- is that going to be depleting over time? Or is that going to be just spread equally?

The accounting charges I mentioned? The $0.06 is just you have to write up your inventory.

Right.

That'll be behind us in August. We'll be done with in August this fiscal year. And then backlog, as I said, it'll be about a nickel but $0.03 will be this year and then we'll be out of it in the second quarter of next year.

And those are the ones that we carve out as unusual. You know there's other obviously items of purchase price accounting, but those are normal courses of business. Those are the only two we pull out because of just how you have to write it up in the rapid amortization you have to take.

Right, thank you very much.

And at this time there are no further questions.

Okay, well we'd like to thank everybody for calling in. We will file our Q tomorrow morning and with that I'd just like to thank you for your interest in TransDigm.

Thank you for your participation in today's conference, ladies and gentlemen, this does conclude the presentation. You may now disconnect, have a great day.