TransDigm Group Inc (TDG) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Quarter Two 2007 TransDigm Group Incorporated Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the call over to 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 Second Quarter Earnings Conference Call. We will be discussing the results of operations for the fiscal second quarter ended March 31, 2007.

You should have already received our earnings news release that was issued this morning. If you have not yet received this 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.

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 first -- second quarter. Following Nick, Greg Rufus, our Executive Vice President and Chief Financial Officer, will discuss the financial results for the period.

With that, I'll now turn it over to Nick.

Good morning. Thanks for calling in to hear about our company again this quarter. As you may know, no April 20th, we filed a registration statement to sell approximately 11.5 million shares of stock or about 26% of the outstanding share of the company in a secondary offering.

The selling shareholders are primarily Warburg Pincus, and also some management shares will be sold. As a result of this registration, we are limited in what we can say. Accordingly today, we will not be taking any questions after our prepared remarks. As I've done in the past, I'll start with a short overview of TransDigm.

We completed our IPO, and began trading on the New York Stock Exchange on March 15, 2006, under the symbol TDG. At the time, we sold approximately 12.5 million shares at a price of $21 a share, representing 21% -- or 28% of the outstanding shares of the company. The shares closed last Friday at $38.70 a share. TransDigm supplies highly engineered aerospace components.

These 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 customers' requirement. We estimate that about 90% of our net sales are generated by proprietary products. That means we own the design and the intellectual property. Similarly, we estimate that over 75% of our sales come from products for which we are the sole source provider.

Our commercial business currently accounts for a little over three-quarters of our total revenues with the balance being defense-related. We will generate, this year, over 60% of our revenues from aftermarket sales. That is typically to end users of aircraft. Aftermarket is down slightly as a percent of the total due to the OEM production ramp-ups.

About 40% of our revenues come from sales to OEMs, typically the builders of airplanes or system suppliers to airplane builders. Aftermarket revenues have historically produced higher gross margins and been more stable than sales to the OEMs. Because of this large installed base of products, high margin and relatively low capital expenditure requirements TransDigm has typically generated very strong free cash flows. This gives us the flexibility to either pursue acquisitions or retire debt.

We have a very consistent, value-focused operating strategy around what we refer to as our three value drivers. These are new business development, continual cost improvement and value-based pricing. We stick to these concepts as the core of our operating management method. This consistent approach has allowed us to improve and to increase the intrinsic value of each of the businesses we've acquired.

As a key fourth element of our valued proposition, we've been active in making acquisitions. We acquire proprietary aerospace products with significant aftermarket content. We have acquired 19 such businesses over our history including ATI, our largest acquisition in the just completed quarter. We have made [four] acquisitions in the 13 months since our IPO.

Now, with that background behind me, let me turn to the latest financial performance. I'll remind you this is the second quarter review for our fiscal year 2007. Our year began on October 1st. In Q1, Q2 and Q3 of '06, we had a lot of financial structuring activity going on. So, profit-related comps to both Q2 and year-to-date require some adjustment to be meaningful.

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, modest seasonality and some other factors. But, by almost any measure, we had both a good second quarter and a good first half for 2007.

Removing the impact of acquisitions, revenues were up about 14% on a year-to-date basis versus the prior year, and about 11% on a quarter-over-quarter basis. Our commercial aerospace markets continue to pick up strongly, and our defense business was about flat for the second quarter, but up slightly on the year-to-date basis.

If I review the revenues by market segment, again on a pro forma basis, that is versus the prior year, that is assuming we owned the same mix of businesses in both periods. In the commercial sector, which again makes up about three-quarters of our volume, commercial OEM revenues were up between 15% and 20% on both a comparable quarter and year-to-date basis. We saw particularly strong growth this last quarter in business jet OEM shipments.

As I believe I told you in the last conference call, we continue very active in finalizing our Boeing 787 design and manufacturing processes. The activity is particularly heavy in our new composite fuel and hydraulic lines at Adel Wiggins, and also for the audio systems at Avtech in Seattle. This activity should begin to decrease in 2008, or in fiscal year 2008.

The commercial aftermarket revenue was also up between 15% and 20% on both a comparable quarter and a year-to-date basis. This was up due to a combination of both strong underlying demand, very good pricing, general success with certain retrofits and upgrades and some timing of shipments versus the previous periods. The aftermarket margins were also particularly strong again in Q2.

Coming into the fiscal '07, we were somewhat concerned about slower worldwide RPMs in the late summer. But, I'm -- as I mentioned in the last call, our shipments were not impacted, and RPMs seemed to be holding up nicely.

In the defense area, which makes up less than one-quarter of our business, the volume was about -- or, the revenue was about flat on a quarter-versus-quarter basis, but continues to be up slightly on a year-to-date basis. Interestingly, the incoming defense orders, that's the bookings for both year-to-date and Q2 continue to be up significantly over the prior year.

This sector's always tough to predict in the near term, and we remain cautious. Defense buys are still at historically high levels, and are always somewhat subject to political wins. But, we continue to be a bit more bullish on defense revenues for the full year now than we were at the start of the year.

I move on to profitability, let me remind you again, there were a lot of financing activities in the last year, which Greg will quickly touch on. I'm going to talk primarily about our operating performance, which we refer to as EBITDA as defined, and excluding the various one-time charges. On a Q2 versus comparable quarter basis, our EBITDA as defined of $68.3 million is up 37% versus the prior Q2. On a year-to-date basis, the EBITDA as defined is up 34%.

The EBITDA margin is 47.3% for -- that's as a percent of sales, for Q2 '07. This is higher than a very strong Q2 prior year of 46% in spite of the slightly dilutive impact of the ATI acquisition. Aftermarket revenues in the quarter were particularly profitable. This was due to both the specific mix of products as well as some contractual pricing adjustments that began to show up in the Q2 shipments and could continue.

As I've said in the past, small changes in mix can move the margins up or down a few points in a quarter. We anticipate the EBITDA as defined margin to be slightly lower for the second half of the year. As you know, in February, we closed on the acquisition of Aviation Technologies, or ATI, for approximately $430 million. We still expect to recover roughly $10 million of tax benefit for a net cost of $420 million.

Just to give you a short update on ATI, we still see significant opportunities to improve the profitability. 90 days into the acquisition, our improvement plans seem to be proceeding on track. If I look at a few of the big areas, in the area of cost, some of the specific activities we've undertaken are the corporate cost reductions are significant and are generally now complete and behind us. The plant consolidation in Seattle is proceeding and should complete now before the fiscal year ends.

In addition to reducing the corporate overhead, we reduced the headcount in the US operations by about 10% and expect further reductions before the fiscal year ends. This is in the face of a generally rising shipment level. The Boeing 787 development expenses continue high but, as we expected before, should start to ramp down over the next 12 to 18 months.

In the area of value selling, we've identified opportunities at ATI where the pricing doesn't adequately reflect either the cost, the effort or the value that's being provided. We have begun making these planned adjustments. Due to the size of the backlog, this won't show much in the operating results until fiscal year 2008. Overall, ATI looks to be on track to meet our 2007 expectations.

Now, moving again back to the overall company and looking to the full year fiscal 2007. As you know, on February 12th, we increased our full-year guidance. This was due at the time to both a strong Q1, and also the ATI acquisition. We are now revising our guidance again. We still expect revenues to be in the range of $575 million to $585 million, or up 33% versus the prior year.

About half of this growth was due to the ATI acquisition. This forecast remains unchanged from our last guidance. With the continuing strong aftermarket and our other value generation efforts, we now expect a somewhat higher full-year margin. The 2000 EBITDA as defined, we now anticipate to be in the range of $263 million to $268 million, up about 37% versus the prior year.

Our adjusted diluted EPS on the same basis as above, that's excluding primarily the deferred comp stock option acquisition-related expenses and rapidly amortizing step-up purchase accounting, is now anticipated to be in the $1.96 to $2.02 per share, or up about 52% versus the prior year. If I summarize that, Q2 in the first half looked pretty good. Our operations performed well. We're pleased with our acquisitions, and 2007 looks to be like another good year for TransDigm.

And with that, let me ask Greg to review the financial performance in a little more detail.

Thank you, Nick. Last quarter, we announced record results for Quarter One. As announced in this morning's press release, we're proud to report that we had record results for our second consecutive quarter. The core businesses we have owned for several years are operating extremely well.

Our recent acquisitions before ATI are delivering expected results. Our value drivers are engrained in the operations, and we have seen expanding margins since we have incorporated these acquisitions into our company. As Nick reported, our most recent acquisition, ATI, has been on board since February 7th, and the transition and integration is on track.

And the prior-year financial restructuring of our debt structure has lowered our year-over-year interest rate, yielding favorable results. This morning's call will focus on second quarter results and our new guidance. Nick's comments centered around pro forma comparable results. I'd like to switch to GAAP for this P&L review.

Our Quarter Two sales were up -- were $144.4 million, up $36.1 million or 33.4% from prior year. Excluding acquisitions, sales were up $12.2 million or an 11.3% increase over prior year. The acquisitions, that is CDA, Sweeney Engineering, Electra-Motion and Aviation Technologies contributed $23.9 million or 22.1% of the growth to the quarter.

Reported gross profit was $75.1 million or 52% of sales. This is an $18.6 million increase, and is 32.9% greater than the prior year. The reported gross profit margin of 52% is marginally below the prior-year margin of 52.2%. This slight decrease is a direct result of the impact of our recent acquisitions.

As I mentioned last quarter, GAAP results would be negatively impacted by non-cash, purchase-price accounting charges for inventory step-up and other acquisition-related expenses. During the second quarter, we expensed $3.2 million of acquisition-related expenses and cost of sales. $2.5 million was for the inventory step-up for both the CDA and ATI acquisitions just completed. The remainder was primarily start-up expenses.

Excluding charges for acquisition-related expenses, the current quarter gross margin would have been 54.2%, up 220 basis points. Selling and administrative expenses were 10.1% of sales for the quarter, which is a normal run rate. The prior-year expense was 11.5% of sales, but included $1.7 million or 1.5% of sales of non-repeat IPO expenses we incurred last year in the second quarter.

Amortization expense increased $1.9 million, versus the prior year quarter. This increase is a result of the several acquisitions made during March of '06 through now, including $1.3 million of accelerated amortization for backlog, which is typically expensed over a 12-month period. The above activity resulted in second quarter income from operations to be $57.1 million, or 39.5% of net sales. This is 34.1% greater than the prior year.

Net interest expense was $22.6 million, a net increase of $3.2 million, versus the prior year's second quarter. This increase in interest expense reflects the additional $430 million of debt associated with the ATI acquisition, which is partially offset by favorable impacts from the June 2006 refinancing.

For the quarter, our weighted average level of borrowings increased to $1.2 billion versus $900 million a year ago, while the average interest rate decreased to approximately 7.6% compared to 8.2% in the prior year. The reduction in interest rate is primarily due to the refinancing of the debt structure during the third quarter of FY '06.

Regarding our tax provision, our effective tax rate was 37.7% this quarter, compared to 38.5% in the prior year. The primary factor for the decrease is a lower effective state tax rate for the quarter. Our current estimate for the full effective tax rate is slightly below 38%. We are planning on paying about $25 million in cash taxes in the second half of the year.

As a result of the second quarter activity, net income was $21.5 million, or 14.9% of net sales. The $14.3 million increase over the prior year, represents a 50.7% improvement for the period. With the net income improvement, on a GAAP basis, quarter two diluted EPS was $0.45 per share, compared to $0.30 per share a year ago, an impressive increase of 50%.

Let me now switch gears. Although I covered the following topic in some detail on last quarter's call, I think it is worth repeating again, specifically, our use of EBITDA as defined and adjusted net income. Since we are so active in financing and acquisition activity, 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. Again, this quarter and today's guidance is a perfect example of why we make these adjustments. You've just heard me explain the quarterly comparison, and some of the largest items were acquisition and financing-related.

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. For quarter two, EBITDA as defined was $68.3 million, or 47.3% of net sales, compared to $49.8 million, or 46% of net sales a year ago, an increase of 37.1% versus the prior year.

It's a very strong quarter regarding margin, which Nick covered earlier. The combination of higher volume, better margins, lower interest expense as a percent to sales and a lower tax rate, all contributed to an adjusted net income that was up about 56% versus the prior period. We were very pleased with the performance, especially on a sales volume increase of 33%.

Accordingly, adjusted diluted EPS was $0.53 per share for the quarter. compared to $0.35 per share a year ago, an increase of about 51%. The difference in GAAP versus adjusted EPS in quarter two is $0.08 per share. As we continue to report the results throughout the year, the impact of the acquisitions made during the relevant period, the related purchase-price accounting adjustments and the financing activity done in the prior year will cause this spread to grow to $0.24 per share by the end of the year.

Again, this $0.24 expected spread is why we feel it is necessary to continue to report on EBITDA as defined and adjusted net income. Cash flow from operations was approximately $55 million midway through the year. We ended the quarter with $64.8 million of cash on the balance sheet. This cash balance reflects the $45 million used in quarter one to acquire CDA.

Adjusted for the acquisitions, our accounts receivable and inventory metrics are within our operating parameters. As you know, we financed the ATI acquisition with debt. At the end of the quarter, our net debt leverage ratio was approximately 5.0 and should be about a half a turn lower or closer to 4.5 by year-end, assuming no other acquisitions for the remainder of the year.

Unfortunately, because of the registration statement we recently filed, we are in a quiet period, and therefore we cannot make -- we cannot take any other questions today. But, Nick would also like to make a closing comment.

The only comment I want to make is I'd just like to correct one miss-statement I made in the beginning. We've made four acquisitions in the 13 months since our IPO, not 14. We've made 19 acquisitions over our history.

And we look forward to next quarter having another call, and we'll be able to take questions then. Thanks for calling in.

Thank you for attending today's conference. This concludes the presentation, and you may now disconnect. Have a great day.