TransDigm Group Inc (TDG) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the TransDigm Group third-quarter 2007 earnings conference call. My name is Elmika and I will be the operator for today. (Operator Instructions). As a reminder, this conference call is being recorded for replay purposes.

At this time, I will like now 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 would like to thank all of you that have called in today and welcome you to TransDigm's fiscal 2007 third-quarter earnings conference call. We will be discussing the results of operations for the fiscal third quarter ended June 30, 2007.

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.

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. Following Nick, Ray Laubenthal, our President and Chief Operating Officer, will speak. And then Greg Rufus, our Executive Vice President and Chief Financial Officer, will discuss the financial results for the period.

With that, I will now turn it over to Nick.

Good morning. Thanks for calling in to hear about our Company again. As I've done in the past, because we are still relatively new in the public equity market, I'll start off with a short overview of TransDigm so that everyone is up to speed somewhat.

We completed our initial public offering and our shares began trading on the New York Stock Exchange in March 15, 2006 under the symbol TDG. At that time, we sold about 12.5 million shares at a price of $21 a share, representing about 28% of our outstanding shares.

More recently, or just in the last quarter in Q3, we completed the sale of about 11.5 million shares of stock or 21% of our outstanding shares in a secondary offering. The selling shareholders were primarily Warburg Pincus and also some management shares were sold. The transaction closed on May 25, 2007 at a price of $35.25 a share. Our shares closed last Friday just past at $41.10 a share.

To give you just a quick overview of the Company, we are a supplier of highly-engineered aerospace components. These components are used in nearly all commercial and military aircraft in use today. We estimate that about 90% of our sales are generated by proprietary products. By that, we mean we own the design and the intellectual property. Similarly, we estimate that about 75% of our sales come from products for which we are the sole source provider.

The commercial business currently accounts for about three-quarters of our total revenue with the balance being defense-related. We will generate a little over 60% of our revenue from aftermarket sales. That's typically to end-users of aircraft. About 40% of our revenues will come from sales to the OEMs. That is typically builders of the aircraft or system suppliers to the builders of the aircraft. Historically, aftermarket revenues have had significantly higher gross margins and have been more stable than sales to the OEMs.

Because of this large installed base of product and aftermarket revenue, high margins and relatively low capital expenditure requirements, TransDigm has historically generated very strong free cash flow. This has given us the flexibility to either pursue acquisitions or retire debt.

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 methods. This consistent approach has allowed us to improve and increase the intrinsic value with each of the businesses we have acquired.

As a key fourth element of our value proposition, we have been an active acquirer of aerospace component businesses. We acquire proprietary aerospace products with significant aftermarket content. We have in total acquired 19 such businesses and we have acquired three in the last 12 months.

Now, with that behind me, let me turn to the latest financial performance. I will remind you this is our third-quarter review for fiscal year 2007. Our fiscal year began October 1. Also, in Q1, Q2, and Q3 of 2006, we had a lot of financial structuring activity. So, profit-related comps to Q3 and year-to-date prior year require some adjustment to be meaningful. As I've 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 other factors.

But, by almost any measure, we had a good third quarter. And we're having a pretty good first nine months for fiscal year 2007. If you take out the impact of acquisitions, revenues were up about 13% on both a year-to-date basis and quarter-versus-quarter basis. Our commercial aerospace market continues to pick up strongly and our defense market was up modestly, both in the third quarter and now on a year-to-date basis.

If I review the revenues by each segment on a pro forma basis versus the prior year, that is something like a same-store basis assuming we own the same mix of businesses in both periods. In the commercial segment, which makes up about three-quarters of our volume, commercial OEM revenues were up about 7% on a comparable quarter basis and up about 12% on a year-to-date basis. We saw growth of around 20%, both this quarter and year-to-date in the business jet OEM shipments. Our commercial transport shipments were roughly flat, due in significant part to delays in the A380 shipments in fiscal year 2007 versus the 2006 period when we were shipping A380 product.

We continue to be very active in finalizing our Boeing 787 designs and manufacturing processes. The spending in activity is particularly heavy in our new composite fuel line products at Adel Wiggins and the audio systems at Avtech. This activity should start to decrease in the latter part of fiscal year 2008.

Moving to the commercial aftermarket revenues, commercial aftermarket revenues were up about 20% on both a comparable quarter and a year-to-date basis. The margins were again particularly strong in Q3. We don't believe this 20% rate of growth in commercial aftermarket is a sustainable growth rate.

In the defense segment, which makes up a little less than a quarter of our business, our revenues were up modestly on both a quarter versus quarter as well as a year-to-date basis. Interestingly, the defense orders for both year-to-date and Q3 continue to be up significantly over the prior year.

As I've told you before, this is always tough to predict in the near term. We always remain cautious. Defense buys are still at a historically high level and always somewhat subject to political winds. But we clearly are more bullish now than we were at the beginning of the year on the defense spending.

If I move to the profitability, let me remind you again a lot of financing activity in the prior year which Greg will quickly review for you in his portion. I'm going to talk primarily about our operating performance or what we call EBITDA as defined. That's excluding these various onetime charges.

On a Q3 versus comparable quarter basis, our EBITDA as defined of 73.6 million is up 49% versus the prior quarter and on a year-to-date basis is up 39%. The EBITDA defined margin of almost 47% for Q3 2007 is as higher than the very strong Q3 in the prior year of 44.5. And this is in spite of the slightly dilutive impact of the ATI acquisition.

Aftermarket revenues in the quarter were again particularly profitable. This was due to both the specific mix of products as well as certain pricing adjustments that continue to roll through well in our Q3 shipments. As I've said in the past, small changes in mix can move the margins up or down a few points in a quarter quite easily.

As you also know, or I believe you know, in February, we closed on the acquisition of Aviation Technologies, or ATI, for approximately $430 million. We still expect to recover about $10 million of tax benefit for a net cost of about 420.

Ray Laubenthal is here with me today, who is our Chief Operating Officer and President, has been very intimately involved in that. He is going to give you a short update on our ATI acquisition. Ray?

We still see significant opportunity to improve the profitability of ATI. We're now 180 days into the acquisition and our improvement plan seems to be proceeding on track. In the cost reduction area, here are some specific actions we have taken.

We have closed the corporate office and the reductions are complete there. The plant relocation in Seattle area will be completed in August this month with modest costs running into next year. In addition to reducing corporate overhead, we have reduced the headcount in the US operations by about 10% and expect further reductions by fiscal year end. And this is in the face of generally rising shipment levels.

We've seen some softness in certain ATI defense program bookings, but this has generally been offset by stronger commercial revenues. The Boeing 787 development expenses continue to be high which should start to ramp down over the next 12 to 18 months. The scope of certain products has expanded and this is stretching out the development program modestly.

In the value selling area, we've identified opportunities where pricing does not adequately reflect the cost, effort, and/or the value that is provided. Since the acquisitions, we've made a number of adjustments in our pricing policies. Due to the backlog, this will not show much in our results until mid fiscal year 2008.

We have moved TransDigm marketing executives into the two senior positions at both of the ATI operating locations to ensure the success of our pricing and new business initiatives. Overall, ATI still looks to be on track to meet our 2007 expectations.

Greg will review the financial information in more detail.

I would like to thank all of you who called in this morning. And I would like to welcome all of the new investors who are on this call for the first time. As mentioned earlier, on May 25, we completed a secondary offering of 11.5 million shares of common stock at $35.25 per share. This was a secondary offering. The Company did not receive any proceeds from the offering and Warburg Pincus who had controlling interest has now fallen below a 50% shareholder threshold.

Of the 11.5 million shares sold, approximately 80% were acquired by new investors. We were very pleased with the outcome of this offering. Because we have so many new shareholders in TransDigm, I'm going to repeat some items I discussed on earlier calls to give more color.

Last quarter, we announced record results for quarter two. As announced in this morning's press release, we are proud to report that we have record results for our third consecutive quarter. The core businesses which we have owned for several years are continuing to operate extremely well.

Our recent acquisitions before ATI are delivering expected results. Our three operating value drivers, which are developing profitable new business, continual focus on cost improvement, and value-based pricing are ingrained in the operations. And we have seen expanding margins since we've incorporated these acquisitions in our Company.

As Ray reported, our most recent acquisition, ATI, has been on board since February 7 and the transition and integration is on track. And as Nick mentioned, 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 third-quarter results and our new guidance. Nick's comments centered around pro forma comparable results. I would like to switch to GAAP for the P&L review.

Third-quarter sales were 157.6 million, up 46.7 million or 42.2% of sales from prior year. Excluding acquisitions, our organic sales growth was up 13.9 million or 12.5% increase over prior year. Our recent acquisition, that is CDA, Sweeney Engineering, Electra-Motion and Aviation Technologies contributed 32.9 million or 29.7% for the quarter.

Reported gross profit was 82.3 million or 52.2% of sales. This $25.1 million increase is 44% greater than the prior year. The reported gross margin of 52.2% exceeds the prior year margin of 51.5% despite the dilutive impact of our recent acquisition of ATI.

As I mentioned last quarter, our GAAP results are negatively impacted by non-cash purchase price accounting charges for inventory step-up and other acquisition-related expenses. This quarter, we expensed 2.5 million of acquisition-related expenses in cost of sales. 2.4 million was for the inventory step-up for the ATI acquisition completed in February and the remainder was start-up expense.

Excluding charges for acquisition-related expenses, the current quarter gross margin would've been 53.8%, up about 230 basis points versus the prior year third quarter. The significant expansion in margin was attributable to the strength of our proprietary products, favorable product mix on the increase in commercial aftermarket sales and continued productivity efforts along with operating leverage on higher sales.

Selling and administrative expense was 11% of sales for the quarter, which included 1.7 million or roughly 1% of non-recurring charges related to the secondary offering which was completed May 25. The prior year expense was 10.4% of sales but included about $300,000 or 0.2% of sales of non-repeat IPO expense we incurred last year in the third quarter. As we've said in the past, historically, 10% of sales have been the normal run rate for our SG&A expenses.

Amortization expense increased $2.2 million versus the prior year quarter. This increase is primarily a result of the acquisition of CDA and ATI made this fiscal year. Over half of the increase or $1.3 million is accelerated amortization for order backlog which is typically expensed over a 12-month period and will be fully amortized by the second quarter of fiscal 2008.

The above activity resulted in third-quarter income from operations to be $61.3 million or 38.9% of sales. This compares to a loss from operations of $4.3 million in the prior year. If you recall, we financed our entire debt structure last year during the third quarter. This resulted in a $48.5 million charge for the period. The action significantly lowered our interest rate and gave us greater flexibility for acquisitions, which we have subsequently taken advantage of with the acquisition of ATI.

Net interest expense was $25.9 million, a net increase of 6.4 million versus the prior year. This increase in interest expense reflects the additional 430 million of debt associated with the ATI acquisition, which is partially offset by a lower interest rate resulting from the June 2006 refinancing. For the quarter, our weighted average level of borrowings is at 1.4 billion versus 0.9 billion a year ago, while our average interest rate decreased to approximately 7.6% compared to 8.5% in the prior year. The reduction in interest rate is primarily due to the refinancing of the debt structure during the third quarter of 2006 which I just mentioned.

Regarding our tax provision, our effective tax rate was 37.5% this quarter, compared to 43.9% in the prior year. The primary factor for the decrease was the adoption in FY '06 of a Texas law change that increased the effective tax rate by 6.5% of loss before taxes.

Our current estimate for the full effective tax rate is approximately 37.5%. Due to the secondary offering creating a significant tax deduction, our third-quarter estimated tax payments were minimal. And our fourth-quarter estimate has been reduced to approximately $10 million. As a result of the third-quarter activity, net income was 22.1 million, or 14% of net sales compared to a net loss of 13.4 million in the prior year quarter due to the previously-mentioned refinancing charge, which was approximately 29 million after tax.

With the net income improvement on a GAAP basis, third-quarter diluted EPS was $0.45 per share compared to a loss per share of $0.30 a year ago. Cash flow from operations totaled approximately $90 million for the current year-to-date period through June 30. We ended the quarter with $120.2 million of cash on the balance sheet. The strong cash flows from operations during the quarter were assisted with a favorable tax deduction from the exercise of stock options from the secondary offering and the timing of the interest payment on our senior subordinated notes which are payable in January and July.

This cash balance also reflects the use of approximately $54 million to acquire CDA and ATI. Adjusted for the acquisitions, our accounts receivable and inventory metrics are within our normal operating parameters. As you know, we financed the ATI acquisition with the debt. At the end of the quarter, our net debt leverage ratio was approximately 4.6 times and should be closer to 4.3 times EBITDA by the year end, assuming no acquisitions for the remainder of the year.

Let me switch gears now. Although I've covered the following topic in some detail on prior calls, I think it is worth repeating again, specifically our use of EBITDA as defined in adjusted net income. Since we are 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. Again, this quarter and today's guidance is a good example of why we make these adjustments.

You've just heard me explain the quarterly comparison and some of the large 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 the details in our earning release so investors and analysts can see the nature of each adjustment.

For the third quarter, EBITDA as defined was 73.6 million or 46.7% of net sales compared to 49.3 million or 44.5% of net sales a year ago, an increase of 49.4% versus the prior year, another very strong quarter regarding margin which Nick did cover earlier. The combination of higher volume, better margins, lower interest expense as a percent of sales and a lower tax rate all contributed to an adjusted net income that was up about 60% versus the prior period. We were very pleased with this performance, especially on a sales volume that increased 42%.

Accordingly, adjusted diluted EPS was $0.54 per share compared to $0.35 per share a year ago, an increase of about 54%. The above difference in GAAP versus adjusted diluted EPS in quarter three is $0.09 per share. The impact of the acquisitions made during the period and the related purchase price accounting adjustments, non-cash compensation charges and non-recurring charges will cause this spread to grow to $0.26 for the full year. Again, this $0.26 expected spread is why we feel it is necessary to continue to report on EBITDA as defined and adjusted gross income.

Reminding that we are three-quarters of the way through the year, looking at our fiscal year 2007, as you know on our last call on April 30, we increased our full year guidance. This was due at that time to a strong second quarter. With our strong third quarter and outlook for the fourth quarter, we are now revising our guidance again. We expect revenues to be in the range of approximately 584 to 589 million, up about 35% versus FY 2006. About 60% of this growth is due to the acquisitions we made while organic growth will be up about 14% versus the prior year.

With the continuing strong aftermarket and our other value generation efforts, we now expect a somewhat higher full year margin. The 2007 EBITDA as defined we now anticipate to be in the range of 270 million to 273 million, up about 40% versus the prior year. Adjusted diluted EPS based on adjusted net income that is adjusted primarily for acquisition and financing activities as just mentioned is now anticipated to be in the range of $2.04 to $2.07 per share, up about 57% versus the prior year.

In summary, quarter three, year-to-date and full year financial performance look very good. Generally, our operations have performed well and we're pleased with our acquisitions. 2007 looks to be another good year for TransDigm.

With that, we will now open the call to any questions.

Greg, let me just correct one thing I think I said. The 11.5 million shares we sold in the secondary offering, I think I may have said it was 21% of the equity. It's closer to 26% of the equity.

That's right. That's right.

Just so we can make clear how the change of control or the non-controlling situation happened.

So with that, we'll open it for questions.

(Operator Instructions). Carter Copeland, Lehman Brothers.

I have got a couple of questions for you. First off, the guidance seems to imply that the margins might be a little weak in the fourth quarter. Is this -- you've been running on an EBIT as defined basis are up 42.5 throughout the whole year. But it would seem that maybe you are implying a little bit weaker in the fourth quarter. Is that just being a little conservative or is there something that I'm not catching here?

A little bit of product mix, Carter. As Nick said, within a given quarter, things can move around quite a bit. No spending problems or anything of that nature. It's more tied to the product mix.

Nick, I wondered if--?

I might add the 20% aftermarket growth is -- that's a pretty spicy growth rate.

Yes, well, it just seems like you've got several things. You've got ATI corporate expense coming down. At some point out here on the horizon, we will have amortization coming down. It seems like the margin outlook when we start considering all of these things is pretty good going forward especially as we look out into 2008.

Specifically on those two, the ATI corporate expense we received the majority of that benefit already in our third quarter because we moved quickly in the second quarter for that. And the amortization of some of it will go as I said until about the second quarter of 2008. So you're not going to get a pickup in this quarter versus third quarter.

Is there any impact there on SG&A? I noticed you had a decent step-up here in the third quarter and how should we think about that as we go forward? It's about 3 million higher than where we were running in the past.

Yes, I don't have a specific comment on that, Carter. But we break out the purchase price accounting. We have higher sales volume and a couple of more entities now. So the absolute dollars will go up.

Nick, I wondered just if you could provide some general comments on the order book in terms of a book-to-bill if you have that ratio available just to give us a sense of you've talked about strong defense orders but sales not coming along?

I don't think we give out -- we don't disclose the bookings do we Sean? But I can tell you -- though I can't give you the number -- I can tell you the bookings are still coming in faster than the shipments are going out. It's above 1. I think we give a backlog but we don't give that.

Last but not least, the cash balance at the end of the quarter was obviously impressive. This is the highest it's been. I know you guys have a little bit of difference in the quarters as it relates to interest payment timings. But, that's quite a bit of balance -- cash to have on the balance sheet at the end and I'm wondering how you're thinking about either M&A or paying down some debt in the fourth quarter because you're sitting on quite a bit of cash here.

No, as we've said in the past, Carter, our first choice is to look at acquisitions. In the short time horizon, we don't have any specific targets or earmarks for that cash balance as we speak today. But we do visit it every quarter.

Greg, let me just say, there's a little bit of a timing issue there on that cash.

Yes but it's still a good balance.

But it's higher than it might be if you normalized it a couple of weeks later.

I guess what I'm getting to if it's going to stay this high and there's not necessarily something in the pipeline, would you consider doing a little bit of debt paydown in the fourth quarter? How do we think about that?

Carter, ultimately and specifically we don't comment on this. But ultimately, we will do the thing that makes the most sense for the capital structure. If we don't see good acquisition opportunities, we will try and find some way to give some stakeholders some of the money back.

(Operator Instructions). Karl Oehlschlaeger, Banc of America.

Just a couple of questions. One of the -- you have the $0.26 I guess for the full year is what you are expecting in terms of your adjustments and if it compares to $0.20 so far. Can you talk about how that breaks out maybe in dollar values? I would imagine that the non-based -- non-cash based comp and stock option expense I guess or deferred comp costs are going to be about the same. But the acquisition-related costs, should we expect that to kind of half and then you wouldn't have any other items?

Can you repeat that one more time?

Yes. I guess really just kind of can you break out the fourth-quarter expectations built into your guidance for your adjusted items for EBITDA?

Yes, we can. In the third quarter, with the secondary offering, okay that we completed in the third quarter, that was almost $0.04 in the third quarter that obviously carries forward. And we also had some inventory purchase -- the inventory write-down was almost a nickel too. But when you look at it in total for the fourth quarter, the deferred comp hasn't changed much. Startup costs remain about $0.015. The inventory purchase adjustments will be about $0.02. And the backlog amortization is about just under $0.03 and that should get you pretty close to the fourth quarter. And then when you add it, you will be at about $0.26. And there is a bit of rounding in there too.

As we look into next year, how should we be thinking about these adjustments assuming no transactions?

Well, you know, the purchase price-related items will diminish. Specifically like with inventory, on the inventory purchase adjustments, that will be $0.12 of the $0.26 this year. And the IPO is just under $0.04. The non-recurring IPO cost is just under $0.04. And we will still have some backlog amortization but that will go from $0.08 this year to maybe about $0.04 next year. Then, we will have some small amounts. But we will come out with more detail in that when we do announce our 2008 guidance in a couple of months.

Also kind of looking at it year to the -- next year to the extent you can talk about it, what do you -- how should we be thinking about your -- the ATI pricing?

We have not given out the 2008 guidance yet. It would be a little premature. We are currently right in the middle of going through our planning process and we will disclose that like I said in the next month or two.

But you've already sort of made adjustments to the pricing structure which should -- as the backlog tails off and start to ship going into next year, what sort of step-up should we be thinking about?

I think we just say, we will be giving out some guidance for 2008. Greg, when do we do that -- or sometime in the first quarter here?

Yes, sometime in the first quarter.

First quarter coming up. But we don't want to start commenting on that piecemeal.

Than just finally, you gave some detail on the growth in the quarter by the different segments and with transport OEM flat and basically it's because the A380 was down. If you sort of stripped that out, how should we be thinking about organic growth in that OEM business?

Roughly like the production rates. If you look at the Boeing Airbus production rates, we pretty well track that if you strip out oddball things like that A380 not repeating.

We're probably offset. We've got a little lead-time. We're probably offset six, nine months or something.

(Operator Instructions). At this time, there are no additional questions in queue. I would now like to turn the call back over to Mr. Greg Rufus for closing remarks.

We would just like to thank everybody for calling in. And we will be sending out a press release announcing when we will give guidance out hopefully around in the October/November timeframe. Thanks for calling.

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Thank you and have a good day.