AAR Corp (AIR) 2015 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the AAR's FY15 fourth quarter and year-end earnings call. Before we begin, I'd like to remind you that comments made during the call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. As noted in our news release and the risk factors section of the Company's Form 10-K for the fiscal year Ended May 31, 2014. And provided forward-looking statements, the Company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events.

At this time, I'd like to turn the call over to AAR's Chairman and Chief Executive Officer, David Storch.

Good morning and thank you for participating today. As you know, yesterday, last evening we put out our fourth quarter and year-end release. What I'd like to do is just spend some time going through where we're at and where we're heading and I'll then turn it over to John who will fill in some of the financial data.

So as we indicated at last year's annual planning session, we felt that we'd be better served, our shareholder would be better served if we narrowed our focus and zeroed in on our industry leading services business as an area for growth and opportunity. So we set out during the year and determined that we would sell our large manufacturing businesses and like I said focus on our industry leading service activity.

And we really think about the activity in four phases. Phase 1 which we indicated was the sale of the Telair Cargo Group, which was completed at the end of March. And then the classification of our precision machining businesses as discontinued operations.

Upon completing this, we do so maintain our mobility business, which as you know is an industry leading business. Currently in a soft point at the cycle but a business nevertheless that has served the Company well over a long period of time and a very strong Management team, very strong position and unique business. And we feel at this point in time that we'd like to figure out still how to maximize that business and our investment in that business.

Phase 2, we paid down our High-Yield bonds and we returned a significant amount of money, capital I should say to shareholders. So we paid down our $325 million of roughly 7% interest rated bonds. By paying that down we'll save about $23 million, $24 million a year in interest expense.

And then we also as you know approved the tender offer purchased back 4.2 million shares. We had purchased another 0.5 million shares in the open market, so we returned about $162 million in cash to shareholders this year through share repurchase and dividends.

Phase 3, we really have been looking through the balance of our portfolio to identify and exit underperforming activities. So again, we could zero in and focus on those areas where we feel we have the most potential and biggest opportunity. So you see that we sold off the remaining of our owned aircraft from our aircraft leasing portfolio which we really started just investing back in 2007. This is more or less the tail and we saw an opportunity here to generate some cash and get our aircraft sales leasing folks focused on other activity and more profitable ventures.

And then lastly, phase 4 which we're currently in, we expect to grow our businesses by taking advantage of our very strong balance sheet.

In the fourth quarter you'll see that the Aviation Service segment sales grew 17%. That's organic growth, largely driven by the growth in our supply chain businesses, as well as improvements in our MRO.

We also as you know announced in Q1 of this fiscal year that we have closed down our Hot Springs operation. We're moving that work over to Oklahoma City. Goal there is to just figure out how to maximize our footprint and drive more margin through our service businesses.

The Expeditionary Service segment saw a sale decline of 51% on a year-over-year basis largely driven by lower fewer flying positions in airlift, but also lower revenues at mobility just reflecting reduced demand from the DoD for those types of products. But we do anticipate that this is at a bottom point for that business and we are hopeful that things will turn in our favor -- more in our favor in that business as this year progresses.

The airlift business did incur losses during the period as we continue to transition assets from Afghanistan into other theatres. We have incurred program start up costs and costs associated with repositioning some of the assets.

But we also on the positive we've been awarded over $500 million in new contract awards and as you know, we have a very robust deal pipeline. Some of the business has not happened as timely as we'd like to see but it still is out there and we still believe we're in pretty good shape to capture more business in the airlift operation.

The balance sheet and capital structure, so we've reduced our net debt from $446 million, I'm sorry we reduced it by $446 million on a year-on-year basis. So our net debt to capital ratio at the end of May is 10.5% and that's down from about 35% at that point in time prior year. So we are sitting today with close to $450 million of cash in availability and we feel pretty good about our powder and our ability to go ahead and grow our remaining businesses based on having this strong of balance sheet.

We also as I indicated bought in some shares. Our share count is down from 39.2 million at the end of last year to 34.9 million at the end of the latest fiscal year. So we think we have good leverage and really good possibilities and a really good opportunity pool out there that we're looking for.

So when I think about where we're heading, which I think is a critical question for you all would be, I want to take our industry leading supply chain business and MRO businesses where we have performed exceptionally well and grow these businesses. I'd like to grow them geographically, so I'd like to have more content outside the United States, and this is a drive we've been on for the last few years.

And you may recall last year, we were successful in buying out the Sabena supply chain business, Sabena technics supply chain business. And we're looking at other opportunities along those lines and having this strong a balance sheet, we feel really good about our ability to go ahead and grow that business.

We're also looking at other MRO opportunities. We did announce an MOU with South Africa technical operations to explore doing work in that market. The -- once upon a time that was one of the industries leading MRO facilities.

More or less, deteriorate over the last few couple of decades and they have a motivation to improve their position and they sought out AAR as a partner to help them achieve that. So we think we can potentially look at that, it's a low cost environment for us to grow more of our -- grow our MRO business outside the United States.

The airlift business as I indicated, we have as a result of the drawdown in Afghanistan, we have taken our fleet count from nine different fleet types, we will be down to five fleet types here once we start operating the AW189s over in the Falklands. So we're looking to grow that business through the -- doing more what we currently do in Africa. We have placed a couple of aircraft into Iraq. We still do have positions in Afghanistan. We expect those to continue.

And then we're looking to see if there's some opportunities in the GOCO market which the government provided equipment that we'll operate on behalf of the government. As well as more niche markets that we think are out there for us. And again, we have I think an excellent leadership team at the helm of that business and they will win their fair share of business going forward.

So in summary from my vantage point, we've done -- this has been a very momentous year. I think its been a great year for the Company. If you look at, if I may just for a second, if you look at how we built this Company, we looked at the market terrain coming post 9/11 let's say and we viewed the need to go ahead and diversify our product mix largely.

Coming into 9/11 we were very heavily dependent on the US domestic commercial airline industry. We now believe that industry is in pretty good healthy position and that the need for us to be as diversified and have as many activities going on was not as prevalent as it had been say 15 years ago.

So when I look at the portfolio today, I feel very positive about the mix of businesses. I feel exceptionally positive about our balance sheet and our financial flexibility. And when I look out into the future, I get very excited about what's in front of us as a Company.

When I think about the year that we're about to go into, clearly the fourth quarter was a lot of moving parts and as I indicated strength in our supply chain and MRO businesses, weaknesses in our Expeditionary Services. I believe as we enter the new fiscal year, we should continue to see the strength in the Aviation Service side and we should start seeing improvements in our Expeditionary Service activity. And as the year progresses, as particularly as we start operations in the Falklands, that business returns to profitability, decent profits I should say before the year is out.

So I'm going to turn the call over to John and let John describe some of the financial items. Thanks, John.

Thanks, David. I trust that each of you guys have had a chance to read our earnings release. It was a very busy year for AAR and I'll try and put some color around the events that occurred in the fourth quarter and the effects they had both on the quarter and on the full year.

Let me start by saying sales for the quarter of $415.8 million were 1.1% less than prior-year sales. As David mentioned we had strong results in Aviation Services but they were not sufficient to offset the decline in our Expeditionary Services segment, which as you guys are aware is heavily leveraged to the defense markets.

On the profitability side, our results were impacted by the unusual charges as a result of us refocusing our platform to product lines that we consider core to our services offering going forward.

During the fourth quarter we recorded the following operational charges from our continuing operations. $69.5 million in impairment charges and other losses related to certain product lines identified as underperforming and are not a part of the Company's strategy going forward. The majority, $61.4 million of these actions relate to our Aviation Services segment and include $17.9 million for sold aircraft in the aircraft lease portfolio, $43.6 million in inventory and supply chain and MRO businesses that are in excess to AAR's need or where we're exiting certain lines, and $8.2 million for certain aircraft and inventory that are in the Expeditionary Services segment.

Besides those, we also took charges related to our recapitalization and our corporate restructuring and they also were in the continuing operations for the fourth quarter. $44.9 million loss recognized in the extinguishment of our High-Yield debt, $4.5 million in charges related to the corporate office restructuring including writing down certain corporate assets and severance which are recorded in the SG&A line, and then $2 million in charges for early termination of a swap and cap arrangement that's recorded in our interest expense line. As a result of the above actions and in combination with the reduced share count, which we anticipate to be 34.9 million for the start of this coming fiscal year, we expect to achieve significantly better operating income to net income conversion.

Also during the fourth quarter, we recorded the following charges from discontinued operations. We had a pretax gain net of transaction expenses and fees of $198.6 million from the sale of the Telair Cargo Group. The gain excludes $35 million of contingent consideration which could be realized prior to December 31, 2015.

We also had an additional $11.1 million impairment charge to reduce the carrying value of precision systems businesses. The total impact for that over the course of the year is $57.5 million.

For FY15, adjusted financials for the unusual items will result in $0.87 per share on a continuing basis, or $2.51 on a consolidated basis. SG&A as a percentage of sales in the fourth quarter was 12.3%, this is higher than the last few quarters and it's due to some extent to the lower sales volume but also to the effects of some of the charges that I've outlined. Same is true for the operating margins, also negative due to the charges that we took.

During the fourth quarter, the Company used $52 million in cash flow from operations, this was negatively impacted by the Telair Cargo Group sale tax requirements and was also reduced by some of the cash generation of our Expeditionary Services segment. And we had capital expenditures in Q4 of $22.6 million.

The Company paid dividends totaling $3 million for the year. We used $43 million of cash from operations. And our total capital expenditures were $46.3 million.

We deleveraged significantly and we reduced our net indebtedness as David mentioned by $446 million, ending the year with net debt of $99 million. Our net debt to EBITDA is less than 1 down from 2.3 times last year.

Net interest expense for the fourth quarter increased to $7.1 million but this included as I mentioned before the $2 million associated with the one-time settlement of the cap and swap. Our net interest expense numbers will be significantly lower next year as a result of our large debt pay down.

Depreciation and amortization, including amortization of stock-based compensation, was $76.9 million for the year. In the fourth quarter, we entered a sale and leaseback transaction for two aircraft supporting our new contract in the Falklands.

In addition, in June we sold one Bell 214 aircraft, bringing our total aircraft held for sale to eight. The current book value of assets held for sale is approximately $14 million. As we've alluded to in some of our previous conversations, our effective tax rate for 2015 was 34.4%.

Thanks for your attention and I'll turn the call back over to David for some closing comments.

Thanks, John. Let me just say, the operational charges that John referred to were taken and the primary motivation there is to get our team and organization focused around higher performing opportunities, higher margin opportunities. So we exited certain product lines in our landing gear repair business. We exited certain product lines in our trading activities, all geared again getting people to really focus on higher margin opportunities and that's a theme that you'll be hearing from us throughout the year.

In any event, let me now turn it back to the Moderator to open up for any questions.

(Operator Instructions)

Our first question comes from the line of Robert Spingarn with Credit Suisse.

David, at a high level, is there a reason you haven't given us a more specific guidance for 2016?

Yes, Rob, what we'd like to do is we'd like to let the year kick in, let's start the year. We have a fair amount of variability in our airlift business. And as I've indicated, we've won some contracts and we do have some contracts we believe we're going to win. So there's a little bit of -- far enough range at this stage that I think we prefer not to put out some numbers at this point.

Can I ask you then just a couple of more specific questions at least that may give us some help in that area? One would be the $500 million in new contracts for airlift, what period of time do those cover?

Well, the largest contract is the Falklands contract which is $339 million and that's over a 12-year period. And then the balance of the contracts are three years and one contract is a five year.

Okay, and then in terms of the fleet, are you down to -- how many aircraft are you down to now? I think you said 21 are in contract service.

Hi, Rob, it's John. Yes, so when we talk, we talk in terms of contracted revenue generating positions. We finish the year with 19 positions, sitting here today we're at 21.

Do you have a rough idea of where you expect to close out the year if or a range perhaps that maybe reflects--

Yes, and so we based on current deal flow, based on current contracts, we're looking at 32 at the end of the year.

Okay and then how do we think about margins going forward in the two businesses? Do you think as volumes improve in aviation we can get some margin lift there? You've done the consolidation. I assume that starts to help at some point or are you doing that in August. And then how do we think about the profitability or the incremental profitability of the new work in Expeditionary? Thanks.

Yes, so we have historically had very strong margins in the Expeditionary segment, so that's going to be volume paced. So as the volume picks up we'll start seeing margin throughput from that business. So right now in both businesses, in Expeditionary you're at the bottom point of the historical result cycle, if you will.

In terms of the MRO and supply chain, I would anticipate that we'll see better margins throughout the year. So the supply chain margins will improve as volumes grow as will the MROs. And the MRO, the move out of Hot Springs saves us about a $1.5 million a year in -- or adds $1.5 million a year to the margin, the gross margin for that section of our business.

Okay, thank you.

Our next question comes from the line of Kevin Ciabattoni with KeyBanc Capital Markets.

To follow up on Rob's last question, any disruption that we would see over the next quarter or two as Hot Springs shuts down, or I guess any other one-time charges that might be residual over the next quarter or two?

Well, the one-time charge from that is what $1 million?

$1 million.

$1 million from the shutdown of Hot Springs. I believe that for the most part, I can't think of any other charges that we see coming at us. We will be selling some Airlift aircraft. The net effect though of the sale of the aircraft is about say somewhere between $18 million and $22 million of sales will probably be neutral.

We wouldn't expect losses, if anything we might have slight gains from those sales. So we don't expect any other noise other than John referred to the tail to the Darwin -- I'm sorry, for the Telair transaction of up to $35 million and that would be a positive impact.

Okay, that's helpful.

That $18 million to $22 million, Kevin, includes inventory that's associated with some of those aircraft down there.

Right, okay, got it. And then just touching on Airlift, so you added 2 positions to go from 19 to 21 post the close of the quarter here. Can you just help us, should we expect to see a sequential growth in Airlift revenues as we go into Q1 because of that or are those not active yet so the revenue is not going to flow through? I know obviously we'll have some impact, negative impact on the gross margin line for start-up costs that you mentioned. Just trying to get a handle on what to expect in terms of the revenue from those two positions.

Yes, so Kevin this is Tim Romenesko. So we really see the revenue ramp later in the fiscal year when the larger programs kick in. In the early part of the fiscal year, we'll be incurring costs associated with the start up of the Falklands program and that includes taking on the new aircraft, it includes the pilot training, the building up the maintenance capability. So those costs are fairly significant and will mute some of the positive impact of the new aircraft that we're bringing on board.

But once we get into -- once we get the Falklands contract ramping and we get the cumulative effect of the other aircraft coming on, we'll be -- that business will be generating decent returns and will be back to not exactly where it was before but approaching its peak performance.

Okay, thanks, Tim. And then the last one for me and I'll jump back in queue here. If you could just give an update on what you're seeing at Lake Charles in terms of capacity and business development there. And then maybe a quick update on the progress at Rockford.

Sure. This is John Holmes responsible for the Aviation Services group. But at Lake Charles we're still in a hiring phase there. We went through quite a ramp up period in FY15. We expect to get to at least a breakeven operation there in FY16. We've got some significant programs starting with Delta Airlines that'll be ramping up in the Fall and so we're looking forward to the positive impact there out of Lake Charles.

And Hot Springs, the consolidation actually will be done by the end of this month and we'll have exited -- so the main customer that was in Rockford was Air Wisconsin, they're transitioning to Oklahoma City. And then by the end of August we'll have exited the operations in Hot Springs.

Great, thanks.

Our next question comes from the line of J.B. Groh with D.A. Davidson.

Could you talk about this organic growth in supply chain and MRO? Could you maybe break that out between the two businesses just generally?

Can you repeat that please, we weren't able to hear you?

Oh, I'm sorry. The organic growth in the Aviation Services business, can you break that out between what you saw at supply chain versus MRO, is one of those stronger than the other? And is there a new program to supply chain that's driving that growth or is it just pure organic growth?

So we don't comment on the individual necessarily, but suffice it to say the growth in supply chain was strong -- was very strong.

So was there new programs that were driving that or was it just -- ?

Yes, new programs and you may recall I would say about a year ago we entered an agreement with Eaton and we started taking delivery of the inventory for Eaton and we started making sales from -- in supporting the Eaton product during this period. And program activity was strong and across the board we had strength in the supply chain businesses, as we did in the MRO business.

Okay, and then--

At 17% organic growth in this period if you check around the horn there's very few companies growing at that rate in our industry.

Agreed, agreed. John can you maybe give us now that we've got some charges through, a run rate on SG&A, what's the expectation there?

Yes, look I think our SG&A is going to revert into the 9% to 10% range where it should do a little better than we have historically, but I think for modeling I would assume that.

Okay, that's all I had, thank you.

Our next question comes from the line of [Stan Main] with [Main Family Investments].

Thank you, good job, gentlemen.

Thanks.

I have a couple of questions, David. One, use of cash. Do you see the cash being used for acquisitions, more stock buy back? Have you got a feel or outlook for that?

Well, Stan, I like how you always get right to the key elements. You've been very consistent with that over the years, so listen we're going to keep our options open, Stan. Obviously in the period just ended we spent $150 million on share repurchases. I believe we are seeing a good deal flow and opportunity. So we'll probably have probably I would say a very balanced approach between returning capital and opportunistically investing.

I mean the leverage, I joined the Company, we had leverage ratio of 40% debt to total capitalization and we've really never been below 30% since I've been at the Company and here we are today at 11%. So we have a lot of flexibility and we're going to hopefully make some intelligent moves here.

Okay, my second question maybe looking out quite a distance, but do you have any goal or feel for what your operating margins will go to in future years? Have you got a targeting or -- ?

We have a three-year plan that gets us up to our 10% objective.

Oh, wow that's really optimistic.

Right. But it's real, and we have to win some business and yes, but we feel we can get there.

Okay, good job.

By the way we've lowered our corporate expense by $8.2 million in the quarter. So going forward, our corporate expense will be as I said lowered by $8.2 million.

That's a good number. It's hard to discern what the exact numbers are but that's really quite a move in the right direction. Thank you, good job.

Yes, thanks.

(Operator Instructions)

Our next question is a follow up from the line of Robert Spingarn with Credit Suisse.

So back to the comment on the healthy airline industry, we've all seen this. How is that translating in MRO? You mentioned a moment ago that supply chain is really the driver in this segment, but in MRO is there a way to think about same-store sales so to speak in terms of growth?

The way to think about the MRO is probably the hours of maintenance and the cumulative man hours. And that number has been a little bit down. And give or take it around the $5 million level. And so it's one of the reasons why we took the action we did with Hot Springs to reduce some of our footprint and get more productivity out of our remaining footprint.

So we're also trying to find the lowest cost solution. One of the reasons why we moved into Lake Charles was it gave us a lot of capacity at a low expense. Now we got to make sure we can, as John Holmes indicated, make sure we can get the workforce in place to make that business hum.

So David, maybe you can help me reconcile. We've got seat miles rising 5%, 6%, 7% depending upon where you're looking and why would maintenance hours be down?

Just where the aircraft are in the repair cycle as well as capacity in North America.

Is there any element of fleet age playing a role here? Is the fleet newer?

Not really. I think the average age, the fleet age I think has been -- my again using my historical knowledge, I don't think there's been more than a one year average age variation over the last 25 years.

Okay.

If the average age is and don't quote me exactly, if it's 12.9 years or 13.2 or 12.7, it really doesn't play a factor here.

Well, a lot of airlines have been addressing or avoiding maintenance by parking aircraft that are due for heavy checks. Has that been an element?

We haven't really seen much of that.

And then just the last question on this, David. So it sounds like your approach to guiding for this year reflects some of the variability in Expeditionary and you want to get a little further into the year before you look there or make specific targets. But on the Aviation side, is there some framework we can think about in terms of growth expectations, sales expectations?

Well, we're looking at double-digit sales growth and we're looking at double-digit earnings growth from those businesses.

And again this is driven by supply chain rather than MRO?

No, we're looking for improvement in MRO as well, so we're looking for improvement or growth I should say in both.

Okay, and then last question--

MRO is not earning at peak levels right now, so we have had higher earning levels at MRO than we are currently experiencing.

Okay I was going to ask you just one last question on this. John and I have talked in the past about capacity utilization, where would you say you would be once you close the facility you're closing in terms of MRO?

70%.

Okay, thank you.

We have a follow-up question from the line of Kevin Ciabattoni with KeyBanc Capital Markets.

You mentioned some restructuring in the landing gear business, wondering if you can maybe give us some color on what happened there and if you're seeing any pick up there in terms of the cyclicality of that business?

Yes, so we are -- we have exited certain product lines that we viewed non-productive and we are seeing an uptick in the cycle. We expect that to kick in more so as the fiscal year moves forward, so think of it as a 10-year cycle. So if you look at deliveries out of factories 10 years back, they were starting to pick up in the 2005 time period. And so we should start seeing 2005, 2006, we should start seeing improvement in that operation.

Okay, thanks, David. And then my last question I guess, looking at Airlift and the contracting environment, is there a specific reason you can point to that the contracts are taking longer to get through the finish line here than what you'd originally thought?

And then as a second part of that question, is there any impact on how that plays out that you see from the FY16 Federal budget process, or is that separate from that I guess?

No, I think it's all connected. My sense is that there are clearly operational needs that the customer has, customer being USTRANSCOM for the most part. So it's just there are delays in funding and appropriations I believe that have had some impact. So yes I don't think anything specific to AAR that you wouldn't be seeing in other government contracting environments.

Great, thanks.

Thank you. And that does conclude today's question-and-answer portion. I would like to turn the call back over to David Storch for any closing remarks.

Thank you very much for your participation today and I look forward to our next call in September. Have a nice afternoon. Bye-bye.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, you may all disconnect. Everyone have a great day.