TransDigm Group Inc (TDG) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the quarter one 2015 TransDigm Group Incorporated earnings conference call. My name is Ally and I will be your operator for today.

(Operator Instructions).

As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Liza Sabol from Investor Relations. Please proceed.

Thank you. I'd like to thank you all that have called in today and welcome you to TransDigm's FY15 first quarter earnings conference call. With me on the call this morning are TransDigm's Chairman and Chief Executive Officer, Nick Howley; Chief Operating Officers, Bob Henderson and Kevin Stein and our Executive Vice President and Chief Financial Officer, Greg Rufus. A replay of today's broadcast will be available for the next two weeks.

Replay information is contained in this morning's press release and on our website at transdigm.com. Before we begin, the Company would like to remind you that the statements made during this call, which are not historical in fact, are 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 Company's latest filings with the SEC. These filings are available through the investor section of our website or at 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 adjusted net income and adjusted earnings per share, all of which are non-GAAP financial measures. Please see the tables and related footnotes in the earnings release for the presentation of the most directly comparable GAAP measures and a reconciliation of EBITDA and EBITDA as defined adjusted net income and adjusted earnings per share to those measures. With that, let me now turn the call over to Nick.

Good morning and thanks again to everyone for calling in. As usual, today I will first review our consistent business strategy and then I'll go through our financial performance and some market summary for Q1 2015 and then just a few comments on our guidance for the full year. To restate, we believe our business model is unique in the industry, both in its consistency and its ability to sustain and create intrinsic shareholder value through all phases of the cycle.

To summarize a few of the reasons why we believe this, about 90% of our net sales are generated by proprietary engineered product and around three quarters of our net sales come from products for which we believe we are the sole source provider. Over half of our revenues and a much higher percent of our EBITDA come from aftermarket sales. Aftermarket revenues have historically produced a higher gross margin and have provided relative stability through the downturns. Because of our uniquely high EBITDA margins and relatively low capital expenditures, TransDigm has year in, year out generated very strong free cash flow.

This gives us a lot of operating and capital structure flexibility. We follow a very consistent long-term strategy. First, we own and operate proprietary aerospace businesses with significant aftermarket content. Second, we have a simple, well proven, value-based operating strategy focused around our three value-driver concept. Third, we maintain a decentralized organization structure and a unique compensation system with executives and senior management who think, act and are paid like owners.

Fourth, we acquire proprietary aerospace businesses with significant aftermarket content where we see a clear path to PE-like returns. Lastly, we view our capital structure and capital allocation as another means to create shareholder value. To reiterate, we basically have four alternatives for capital allocations. Our priorities are typically as follows: first invest in our existing businesses; second, make accretive acquisitions consistent with our strategy. These two are almost always our first choices.

Third, give the extra back to shareholders, either through a special dividends or stock buyback and fourth, pay off debt. But given the low cost of the debt, especially after tax, this is likely our last choice, particularly in current capital market conditions. With respect to financial capacity, we have a little over $1 billion of cash, roughly $400 million in unrestricted undrawn revolver and additional capacity under our credit agreement. We ended the quarter with a net leverage of 5.9 times EBITDA, well below our credit agreement limit.

At December 27, 2014, or the end of the quarter, based on current capital market conditions, we believe we have adequate capacity to make over $2 billion of acquisitions without issuing additional equity. This capacity grows as the year proceeds. This does not imply anything about acquisition opportunities or anticipated acquisition levels for 2015. We did not purchase any additional shares in Q1. Now, turning to our Q1 2015 performance. Remind you, this is the first quarter of our FY15. Our year started October 1. Q1 was relatively quiet.

As I have said in the past, quarterly comparisons can be significantly impacted by difference in the OEM aftermarket, mix, large orders, transient inventory fluctuations, modest seasonality and other factors. But in any event, total GAAP revenues were up about 11% versus the prior Q1. Organic revenues were up about 3% on a first quarter versus prior year first quarter basis. FY15 Q1 revenues were right in line with our expectations of roughly similar percent relationship as 2014. That is about 23% of actual full-year revenues.

I'd remind everyone there are less shipping days in Q1 than any other quarter. Now, reviewing the revenues by market category on a pro forma basis versus the prior year Q1. By pro forma, I mean if we owned the same mix of businesses in both periods. In the commercial markets, which make up about 70% of our revenue, total commercial OEM revenues were up 6% versus the prior Q1.

This is primarily driven by commercial transport OEM revenues. Though a modest part of our business, our biz-jet OEM revenues were up about 11% year-over-year, a bit higher than we've seen. I think this is mostly timing. After a red-hot last six months of FY14, total commercial aftermarket revenue growth slowed down some in Q1 of 2015. On a Q1 versus prior year Q1 basis, revenues were up 5% after year-over-year increases of around 16% in the second half of 2014. The revenue growth in Q1 versus the prior year was reduced about 1.5% to 2% by some distribution inventory movements. We could see a little more of this.

Bookings for the quarter were modestly ahead of shipments in the commercial aftermarket. The defense markets, which make up about 30% of our revenues, defense revenues were up 2% versus the prior year first quarter. The revenues were spotty by operating unit with no clear trends. First quarter defense bookings were up 23% versus the prior year Q1 and ran well ahead of revenues. The primary contributors were two large Airborne specialty parachute orders. As always, we remain somewhat cautious about trends in the military market.

All in all, we had no substantive variation from our revenue expectations for Q1. Now moving on to profitability and on a reported basis, again I'm going to talk primarily about our operating performance or EBITDA as defined. The as defined adjustments in Q1 were quite modest, made up non-cash compensation expense and some acquisition costs. Our EBITDA as defined of about $270 million for Q1 was up 11% versus the prior Q1. EBITDA as defined margins were about 46%.

The Q1 margins without dilution from the impact of the two acquisitions purchased in 2014, that is Airborne and EME only, was approximately 48%, were up 2% versus Q1 of 2014 for the same mix of business. With respect to acquisitions, we continue actively looking at opportunities. The pipeline of possibilities is active with a fairly broad range of deal sizes, but closings have been slow. We've seen a reasonable amount of activity recently, but closings are always difficult to predict. We remain disciplined and focused on value creation opportunities that meet our tight criteria.

Now moving on to the 2015 guidance, based on our current view of the markets, we are not changing our full-year guidance. We believe there could be some organic upside in the EBITDA, but we prefer to see a little more market strength before we make an adjustment. As usual, our guidance does not include any new acquisitions. To confirm the original market growth assumptions for year-over-year growth: commercial aftermarket, high single-digit percents; commercial OEM, mid-single digits; defense, about flat.

In total, with some puts and takes, our markets look about as we anticipated three months ago. As usual, we'll look at this again next quarter and update it if we see any changes. With that, I'll hand it over to Greg.

Okay. Thanks, Nick. Good morning. As we have said in the past and just to remind you again, all of my comments are on a GAAP reported basis, where Nick's comments are mostly on a pro forma basis. Sometimes we do have minor differences in our explanations. As disclosed in this morning's press release, our first quarter sales were $587 million and 11% greater than the prior year. Our organic sales were 3% higher than last year, driven by growth in commercial aftermarket and commercial OEM, offset with a modest decline in GAAP defense sales.

Our first-quarter gross profit was $321 million, an increase of 13% over the prior year. The reported gross profit margin of 54.7% was 1 margin point higher than the prior year. A decrease in non-operating acquisition related costs versus the prior year contributed to the higher reported gross margin. Margins in the current quarter were also negatively impacted by approximately 2 margin points due to acquisition mix from Airborne and EME.

In other words, excluding all acquisition activity, our gross profit margin in the remaining business versus the prior-year quarter improved approximately 2 margin points. The base businesses continue to expand margins as a result of the strength of our proprietary products and continually improving our cost structure. Selling and administrative expenses were 11.5% of sales for the current quarter compared to 10.8% in the prior year.

The current quarter was running a little higher than the past prior period, primarily due to higher run rate as a percent of sales from our recent acquisitions. Interest expense was $99 million, an increase of approximately $18 million or 22% versus the prior-year quarter. This was the result of an increase in the weighted average total debt to $7.5 billion in the current quarter versus $5.7 billion in the prior year. The higher average debt year over year was primarily due to the amount borrowed to fund the $25 per-share special dividend paid in Q3 of last year.

Also, in conjunction with the dividend, we refinanced $1.6 billion of existing notes at a lower interest rate. This refinancing help lower our weighted average cash interest rate to 5.1% compared to 5.4% to the prior year. Our effective tax rate was 32.6% in the current quarter compared to 33.6% in the prior year. The lower effective tax rate in the quarter was primarily due to the retroactive reinstatement of the R&D tax credit. We still expect our effective tax rate for the full fiscal year to be around 33% and our cash taxes to be approximately $180 million.

Our net income for the quarter increased $9.4 million or 11% to $95.5 million, which is 16% of sales. This compares to net income of $86.1 million in the prior year. The increase in net income primarily reflects the increase in net sales, the decrease in acquisition related costs and amortization expense and a lower effective tax rate. These items were offset with the higher interest expense just discussed. GAAP earnings per share was $1.63 per share in the current quarter compared to $1.44 per share last year.

The current earnings per share growth of 13% is higher than net income growth due to lower weighted average shares outstanding, resulting from repurchasing over 900,000 shares last year and slightly lower dividend equivalent payments made in the current year versus last year. Our adjusted earnings per share was $1.80 per share, an increase of 8% compared to $1.66 per share last year. Again, please reference table 3 in this morning's press release, which compares and reconciles GAAP to adjusted EPS.

Switching gears to cash and liquidity, we ended the quarter with over $1 billion of cash on the balance sheet. The company's net debt leverage ratio was 5.9 times our pro forma EBITDA as defined and gross leverage was 6.8 times pro forma EBITDA. We still expect to generate $475 million of cash in the current year and expect our September 30, 2015 year-end net leverage to be near 5.2 times EBITDA as defined or delevering approximately one full turn on a net basis. Before I hand it over to Liza to kick off the Q&A session, I'd like to inform you that we will be filing our Q this upcoming Friday.

Thank you, Greg. Operator, we are now ready to open the lines.

(Operator Instructions).

Robert Stallard, Royal Bank of Canada

Thanks very much. Good morning.

Good morning, Robert

Nick, I was wondering if we could kick off with your thoughts on the debt market here, whether you are seeing any opportunities to raise debt at more attractive rates than what you have seen in recent history and then also, your follow-on from that, your thoughts on deploying that as a special [blend].

The debt market, first, as I think you know, the recent history, the last round of financing we raised -- what was that, nine months ago or something --

It was back in June.

That was pretty darned attractive rates. I think those, particularly the bonds, are selling at just a hair under par, which would tell me that the rates are very, very, very close to what they are now.

That market got a little bumpy, but I think it's reasonably stable now. So I think if we went out today, we could raise money today. I don't know what [tomorrow] would be, but I think if we went out today, we could probably raise money at very comparable rates to what we did six or nine months ago, presuming we went the route with the same leverage levels.

As far as capital deployment, we will address that as the year proceeds. We have a fair amount of acquisition, I would say activity, we're working on. And we probably will let them play out a little bit before we make a decision on capital allocation.

Great and then a follow-up; you mentioned some issues in the distribution channel in the aerospace aftermarket. I was wondering if you could elaborate on what you think might be going on there?

I think they probably got a little bit ahead of themselves in the ordering at the end of the last year and then we ran 15% and 18%. We also moved a few distributors around which might have influenced it a little bit. I don't take a whole lot from that, but I just thought it was a worthwhile data point to let people know.

Okay, that's great. Thanks so much.

Gautam Khanna, Cowen and Company.

Yes, thank you. Good morning.

Good morning.

I wanted to ask if you could elaborate on the defense bookings comment. You mentioned the two parachute orders and what was the trend, if you x that out? Was it a book to bill of around 1 or any comment there?

I don't remember the book. There's a couple things. If you want to normalize it, if you go into the previous first quarter we had some of those big Tarian shipments, if you remember them. So you almost have to normalize them both out and I don't think, if you normalize both of those, I don't think the organic growth is that much different whether you put it in or take it out on sales, on revenues.

On the bookings, the big difference is, if you may or may not recall, the first quarter last year things looked pretty ugly in the parachute business. But that has really started to book up. We've got some quite big orders dropped in and we have some more just cooking away.

So that business, where as we were a bit concerned six months into it, we're starting to feel significantly better now about it. When you normalize the revenues, the answer doesn't change a whole lot if you normalize it for things in both quarters.

Okay. And could you give us, you mentioned this pipeline of opportunities being active in the M&A pipeline, can you give us some sense for what kinds of things you were seeing international versus domestic, whether you are seeing more in defense or commercial and relative sizes, any way to kind of --

I would say the sizes are roughly comparable to what we've seen before, although I have to say we've seen a few of a little more sizable. I don't mean in the $3 billion to $4 billion range, but a little more sizable. If you pull those couple out, the rest are more in the normal kind of things we see.

We clearly continue to see more European activity than we have in the past. And I would say most of what we are looking at, not all but most, is commercial rather than military.

Okay and are most of these privates or are they -- do you also have public --

A range. The usual range of suspects: private, strategic and PE

Okay. Thanks a lot. I will get back in the queue.

Robert Spingarn, Credit Suisse.

Hi, good morning. This is Joe on for Rob. Thanks for taking the question. Nick, I wanted to ask on biz jet OE and recognizing that it is a small part of commercial OE, but what's driving that big uptick in biz-jet OE? Are there any particular platforms where you are seeing that strength?

We're pretty broadly distributed across the platform. I wouldn't draw much from that other than it's just timing.

As everybody knows, the bigger, more expensive ones go a little better than the lower-priced ones. And we're reasonably represented on that, but I don't mean to imply anything as far as the production rate forecast for business jet OEM. I think it's just timing, when the shipments happen to fall.

Okay. Got it. That's very helpful. Thank you. I'll jump back in the queue.

Noah Poponak, Goldman Sachs

Hi. Good morning, everyone

Good morning.

I wondered if you could help us out with how aftermarket averages something greater than 10% the rest of the year to get to your full-year guidance. Just because the quarter at 5% and it seemed like end market conditions were reasonably strong in the quarter. I know you pointed out the distributor item, but even if I adjust for that --

It's not a lot.

Not a lot? So help us out with what changes in that growth rate through the rest of the year

I believe, Noah, that's a leading question. I believe to make it for the year we'll have to see a pickup in the back half of the year, to state the obvious.

What changes in the actual end market, because the comps get more difficult, doesn't seem like traffic would accelerate, seems like you'd almost have to be counting on airline inventory restocking or some deferred maintenance opening up or something else idiosyncratic to the company --

I would say, Noah, as I said, if you look at the balance of the year, if I had to handicap our guidance, and I'm going to take our guidance on EBITDA, which ultimately is our bps guidance too, I would say there's probably some uncertainty around that commercial aftermarket. It clearly has to pick up in the second half of the year. We sort of were halfway through the year last year with the same concern and then in the last six months it got pretty strong.

I'm not prepared at this point to say that the numbers we've been using are not good. I think there is some reasonable chance. But it clearly is a little bit of a stretch each quarter that goes by.

On the other hand, I think the defense, we're probably -- could be conservative and I think we could be a little conservative on the margins so when I put them all in the stew, it looks to me like there's probably a little more up than down at this point in the guidance. I can't tell you I'm absolutely sure about one segment versus the other, but hopefully you go the sense.

Okay. And then following on that, Nick, I wondered if you might provide your view on what you think lower oil means for the industry. It would seem like that could potentially help the aftermarket, but sounds like others are saying at least, that it's not quite yet and it seems like it could potentially stretch out the replacement decision for an airline. Anything you are already hearing and seeing or anything you think could happen as a result?

I think, Noah, probably the same things you hear and see and would surmise. First, I would say I think the oil prices have to stay down for a longer period of time to change anyone's behavior substantively.

As you know, they have got to work out through the hedges or buy them out or something. And I don't think this is enough time to change people's thought patterns or behavior patterns.

Now if it does, there are two schools of thought, as you know. On the one hand, if you fly older planes longer, that's better for the aftermarket. If you pull them out of the desert or if you keep flying them more hours, which you would tend to do if you have lower fuel prices, that's good.

On the other hand, I'll say historically, if the fuel prices go down and airlines get profitable, right or wrong, historically when they make money they start buying new airplanes. So that's sort of the counterbalance.

At this point, I don't know how to call that other than to say it's something we've got to watch closely. But I suspect it takes a longer period of time for anyone to change their thought pattern.

So you haven't actually yet seen any real behavioral change?

No. No, we have not.

Okay. All right. Thank you.

Myles Walton, Deutsche Bank.

Yes, hi. This is actually Lou on for Myles. How are you guys doing?

Okay.

Just a quick question, the cash flow was very strong in the quarter, anything in particular to drive that? It's not usually the strongest quarter.

You're right. First, our quarter effectively ended December 25 and we didn't have any principal and paid almost no income taxes, so it was timing. That's why in my comments I said we still expect to get the same amount by the end of the year, because we have a little bit of outflow for those payments in the second quarter.

And it looked like working capital was a boost as well?

I don't know what you mean when you say a boost. Can you expand on that?

It was $65 million, prior years it was more of a use of cash.

When I look at the working capital, when I look at operating, I look more at my DSOs and my inventory turns and they were well behaved versus our expectations. Sometimes when you look at the GAAP numbers you can get distorted with some acquisition accounting.

The big number's Greg, the timing, so you didn't have an interest payment.

That's right.

Perfect. Thank you.

Ken Herbert, Canaccord

Hi, good morning.

Good morning.

I wanted to first ask about Airborne and EME. It's been over a year for Airborne and almost a year for EME.

Are these following sort of a trajectory in terms of margin improvement as you expected or is it a little slower than expected considering still sort of a two point of gross margin impact we saw from acquisition? I get it, it's all the related expenses, but how are these tracking relative to your expectations?

Let me deal with them in two pieces. Airborne first, as you probably know, for the first year of ownership Airborne was frankly, the revenues and bookings were lower than we expected. And concurrently the EBITDA was a little lower.

However, in 2015 it's starting off well. Our present expectation is that for this year it will be at or above our expectations at the time we bought it.

I'd remind you that both Airborne and EME, as we said when we bought them, we sort of had to buy these right. These are not businesses that are going to get the typical TransDigm margins. They will move up and they are moving up, but they won't get to those kind of margins. We bought them at substantially below the margins we typically buy things. But we saw plenty of value there.

EME is again moving up. We bought that at a sub 20% or significantly cut EBITDA margin. That is moving up reasonably nicely. Again, it will never get up to 40% or 50%, but it's moving up significantly.

It's a small business so it's never going to move the average much. Dollar-wise, it's also been impacted by the exchange rate situation. It's a euro business, so the absolute dollars have been not knocked down in the conversion, so the margin is moving up reasonably well.

Okay, that's helpful

That was never going to move anything. That's never going to move anything.

It's a smaller deal. With EME in particular being obviously based in Europe and in Germany, in particular, currency risk aside, because who knows about that, but has your experience with that acquisition changed your appetite at all for European transactions? Maybe you opened it up a little bit or is there anything we can infer from your experience now, almost a year in with EME that might alter your thinking as you review European --

We feel okay about that. I think we feel okay about it. We see acquisitions with the right value proposition. We feel fine about it.

I'd remind you, we have a business in Belgium, we have a business in Germany now, we have a couple of businesses in UK that we're operating. So we have, I would say in general, not 100% but mostly our experience has been positive.

Okay. That's good. And finally, to follow up on the commercial aftermarket discussion, to your comment, Nick, that in an environment like this when the airlines have better visibility on profit, you're maybe not seeing utilization change in terms of the older aircraft or pulling them out of the desert or anything.

But does their willingness to spend on new aircraft translate to the aftermarket environment either in terms of maybe they might take a different approach, airlines, different approach to their own working capital, their own inventory levels, their safety stocks et cetera? Do you expect, perhaps, to see that as we go through the year, assuming ongoing lower crude prices?

Typically you have. Typically that's what happens, as you know. When they start to get profitable and they get money, they start buying more. They start buying more of everything; airplanes, parts, everything.

I can't say we have seen it yet, but that would be a not atypical pattern. As I said before, I don't think this situation and these low, significant drop in fuel prices has been in there long enough that it's changing people's behavior yet.

Okay. All right. I appreciate it. Thank you very much.

Michael Ciarmoli, Keybanc

Hey, good morning, guys. Thanks for taking my questions. Nick, back on defense, it clearly sounds like you've got some of the orders you were waiting for on the Airborne side and I'm curious, were you guys expecting those orders to come in when you laid out your initial guidance? I know you talked, maybe there was potential upside to defense this year, but I'm trying to get a sense of whether or not the Airborne order flow was baked into this year's outlook.

We definitely had an increase in -- this year's outlook for Airborne we expected a pickup.

Okay.

And at least one quarter in, it's looking quite strong and the pipeline look strong. I don't want to start to pull out our full year's guidance between operating units, but it surely makes us feel better rather than worse.

Sure. And what about broad commentary about your remaining traditional military aftermarket activity? Are you seeing any movement there?

I know there are some other companies expecting aftermarket to begin picking up here. Are you seeing any changes in purchasing pattern from the DoD or any discernible trends?

I honestly can't say we have. I also am getting (indiscernible). The only thing I can say with certainty is every time I've tried, I have been wrong, by the way, on the upside, thank God. I can't say, it's mixed.

If you look across our operating units, it's mixed. I don't know that I can give you a clear pattern of reason for that other than in the parachute business, we know we had some big international orders [hang in fire].

Okay. That's fair. And last one, I don't know if you have color on this, but now that the A350 has been delivered, any kind of change in the view there on initial provisioning? I know there probably aren't too many airlines getting that platform this year, but any color on that? Could that be additive to this year or is that more going to be a --

Michael, we are not figuring on any. Could it be? Yes, maybe, but we are not figuring in our guidance or our numbers, we are not figuring any.

Okay. Perfect. That's all I had. Thanks, guys.

Joe Nadol, JPMorgan

Hi, good morning

Good morning.

You mentioned you didn't buy back any stock in the quarter (technical difficulty). The last few quarters you have been buying back some stock. What caused you to hold back in the quarter?

I don't know anything in particular. We sort of bought up what we planned to buy up. We reauthorized some more, but we just decided not to do it.

I don't know that there is any -- I wouldn't take too much out of that. We bought about 900,000 or so shares, it was more unusual we bought than we didn't buy. So we bought up about what we had in mind to buy and we stopped.

Joe's line has disconnected.

Is that the end? Did we cut everybody off?

It's only Joe's line.

If there's no further questions, we thank you all for calling in today and look for our 10-Q to be filed on Friday, as Greg mentioned. Thank you.

Thank you. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.