AAR Corp (AIR) 2016 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to AAR's FY16 first quarter earnings call. We are joined today by David Storch, Chairman, President and Chief Executive Officer; John Fortson, Chief Financial Officer; Tim Romenesko, Vice Chairman and Chief Operating Officer of Expeditionary Services; John Holmes, Chief Operating Officer of Aviation Services; and Mike Sharp, Chief Accounting Officer and Controller.

Before we begin, I would like to remind you that comments made during the call may include forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, as noted in our news release and the risk factor section of the Company's Form 10-K for the fiscal year ended May 31, 2015. In providing forward-looking statements, the Company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events. At this time, I would like to turn the call over to AAR's Chairman, President and Chief Executive Officer, David Storch.

Thank you, sir, and good afternoon to those attending today. And thank you for joining us to discuss the first-quarter results. I am traveling today, so I am not in our corporate offices, but John, Tim, John Holmes and Mike Sharp are. So I will direct the questions as questions are fired. If you have any direct questions for any of the guys, please feel free to ask them directly.

Generally speaking, our first quarter was in line with internal expectations. If I may, just commenting on the businesses, Aviation Services sales saw an increase of $4.2 million compared to the prior-year quarter. Our distribution program businesses were strong; they delivered solid results. Distribution business grew its customer base, and is actually achieving slightly above plan. Our program activity is strong, as well. Unfortunately, our trading business did experience some softness, and performed below our internal expectations, but we do expect a rebound in the second quarter. And you may recall the trading businesses are really the ad hoc parts, supply businesses, some of the engine shop activity that we normally support, or that we do support, was a little softer this summer than we had expected.

We also began, during the period -- although revenue will start in Q2 -- we started the ramp for our C-130 program in Afghanistan. We have our first wave of people in country now, and those revenues, in the past, I think we've indicated about $30 million contract. We are now expecting that contract to be roughly in the range of $50 million, or $10 million a year. It's a five year contract. And we should start seeing revenue in Q2.

In our MRO network, we experienced a higher utilization. You recall summer months are usually a little tougher, as the airlines like to keep the aircraft flying during the summer. So we were -- we did take on some work that, in the past, we had not taken on, which is doing completion work and mod work for a customer aircraft entering service. And so we had a -- generally speaking, a pretty decent summer period.

We completed the consolidations of our Hot Springs business into our Oklahoma City business. We did incur a $1.9 million one-time cost, most of which was absorbed during the quarter. And going forward, we expect annual savings of about $1.5 million from this consolidation. Also, our Lake Charles business was pretty busy during the summer, and did contribute to our earnings, where in the past they had been a drag on earnings. Now as we look ahead, our order book is filling nicely, and we are experiencing, and seeing, a fairly robust pipeline for our MRO services.

Moving over to our expeditionary service business, sales were $21.5 million below the prior year, mostly due to the mix of flying positions in airlift, and lower mobility product volumes. While airlift was down year-over-year, performance was up on a sequential basis. And during the quarter, we commenced operations on two new contracts, including our United Nations contract in Africa. And I might be able to report here that the customer is very pleased with the service that we've offered to date.

As we move on, on that business we are looking to expand the contracted fleet. And we have again, in this business, a pretty robust pipeline of activity. And as we have communicated before, we will be commencing our Falkland Island search and rescue contract, as a contractor to the UK MOD. And that contract will begin work in the fourth quarter of our fiscal year, and it is a fairly meaningful contract for the Company. Our first contract of this type outside the United States -- or I should say with a customer outside of the United States, other than the United Nations contract. And we are very encouraged by what we see.

Now, we will be incurring training costs and positioning costs in our Q2 and Q3, but we will be seeing good revenue stream and healthy margins coming out starting in Q4, and you may recall that is a 10 year contract. So we feel good about where we stand there. Mobility continues to be impacted by low defense spending. And then during the quarter, we did take some actions to right-size our overhead. Bookings appear to be on a slightly positive trend now, but growth in that business does remain a challenge for the near term.

So with that, pretty much on balance, I am pleased with Q1 results. And as previously indicated, we see a strong ramp in the second half of our fiscal year. We do expect sequential growth in sales and earnings, Q2 over Q1, but getting to levels that we feel good about by our Q3 and Q4 time periods. We feel very good about our balance sheet, and our unused capacity, and our abilities to move swiftly. I think we indicated during -- in the earnings call that our debt to total capitalization is in the 15% range. And it gives us a lot of flexibility to take advantage of any opportunities that emerge as a result of some financial uncertainty around the universe. So yes, I think we are entering Q2 in a good position. Should see, as I indicated, better results Q2 over Q1, and then getting to pretty improved, more consistent results by Q3, and then into Q4.

So we communicated this. You may recall, back in the March time period, we have gone through some significant change at the Company. We feel really good about what we have done, and we feel really good about where we are positioned for the future. So with that, what I would like to do is turn the call over to John, to fill you in on some of the -- more of the financials, and then open it up to the Q&A.

Thanks, David. Good afternoon, everyone. I trust that each of you have had a chance to read our earnings release. I will talk about our financial performance in a little more detail. Let me start by saying that our sales for the quarter of $377.8 million were 4.4% less than our prior-year sales. As David mentioned, we grew aviation services by $4.2 million, or 1.3%, year over year. Our expeditionary services segment, however, declined by 25.7% year over year. As expected, however, this segment grew 11.5% on a sequential basis, due to the new fleet positions that David discussed at airlift.

On the profitability side, our results were impacted by the softness in trading, and by the contract mix at airlift. Our gross profit margin was 14.4% consisting of 15.8% margin in aviation services, and 7.4% margin in expeditionary services. SG&A as a percentage of sales in the first quarter was 10.4%. This is higher than it has been in recent quarters, due to increased legal expenses, some of which will recur in the second quarter. Partially offsetting these increases was the realization of our corporate savings from actions we took in FY15.

Depreciation and amortization, including the amortization of stock-based compensation, was $14.7 million for the quarter. For the first quarter, our effective tax rate was 34.9%. During the quarter, the Company used $63.7 million in cash flow from operations, due to investments in our supply chain business, a large tax payment, and the timing of receipts in MRO and at airlift.

Capital expenditures for the quarter were $15 million. Net debt grew $51.5 million from last quarter, to end at $150.8 million. During the quarter, we paid $2.6 million in dividends, and repurchased approximately 300,000 shares for $7.1 million. We also bought back 14.4 million of our convertible notes that are due in March of 2016. We started FY16 with 35.1 million shares in the diluted share count, and we ended the quarter with 35.1 million shares.

Finally, we have 22 aircraft under contract today, versus 19 on August 31, 2014. Note that we plan to add two leased aircraft to the fleet by the end of the calendar year, to serve under the Falkland Islands contract that David was referring to. Thanks for your attention, and I will turn the call back over to David, or we can go straight to Q&A.

Thanks, John. So why don't we move on to the Q&A, please.

(Operator Instructions)

Robert Spingarn, Credit Suisse.

Hi, everybody. Hopefully you can hear me. (multiple speakers) That's what I was looking for. I wanted to make sure we are connected. So that was a nice rebound there -- modest rebound, I should say, in Expeditionary.

I was going to ask you, David and/or John, if you could talk about what we should expect, in terms of flying positions, as we go through the year? You mentioned the leased aircraft. So we are 22 now, which I think is 1 above where we were in July, the last time we talked to you on one of these calls. How do we -- how does the year play out here? And how should we think about getting from a 7.5% gross margin? Do we go back to the mid to high teens? How do we think about that? Can you frame that?

John Fortson, would you answer that, please?

Sure. Robert, we are not giving guidance for the rest of the fiscal year. Obviously, we have a business plan out there, and we expect to see continued growth in our flying positions. You can extrapolate from the numbers that we have given you. It is not too hard to envision that we could be in the mid to high 20 aircraft positions, if some things go according to plan. But obviously, there's execution risk in Afghanistan, as well. So we feel good about where the fleet sits today. I do think, from a mix perspective, some of the contracts that we have today, we lost a couple of the very profitable S-92's. And so that is impacting the mix unfavorably, from the margin perspective. But I think that as the fleet gets back to a more normalized level in the back part of the year, you are going to see that -- those margins improve.

Right. Because when I look at the revenues, on a year-on-year basis, they are almost flat, [$316 million] versus [$318 million]. But the profit is about one-third of what it was back then, 7% versus 18%. So what you are saying is, we will see some mix improve. We don't have to get triple the sales to get the same amount of profit.

Look, I think that's right. I think you will see some mix improve. I think we have got some operational opportunities to improve the efficiency of our fleet in different geographies. And then obviously, as the other contracts come on board that we expect to see, that will help it, as well.

Okay. And then just the reluctance to go out with specific guidance. I don't know, David, maybe this is for you. But where does the hesitation come from?

We've been through a fairly significant transformation at the Company, so my preference is to let the dust settle. I think as we progress throughout the year, I think we will be in a better position to offer up guidance. So I think we indicated, back in March, that we were going to take a pause from guidance between now and through the second quarter of this fiscal year, and I would like to stick with that at this point. So I think we will have a lot more visibility come the second half of the year. We have to get all of our cost to flow through. We have had a lot of one-time exceptional costs, and we want to get our handle on those. And then we do have, as I indicate, a fairly -- a robust pipeline inside of the Airlift business, and we want to see how that fleshes out, as well.

Okay, fair enough. I will pass it to the next person. Thank you.

Great.

Larry Solow, CJS Securities.

Good afternoon, guys. On Aviation Services, David, I was wondering maybe if you could just parcel out your thoughts for the remainder of the year? So I guess Q1 was a little weaker on your trading end of business, and I guess that translates to some of the weakness some of your -- some of the other after-market providers have seen. Is that correct? And what gives you confidence that it is a temporary thing? Is it just the air miles and capacity still remain strong? So --

Yes. So I have a little bit of an advantage over others, in that I've seen this movie for the last 37 years.

Absolutely.

So my sense is that we have had a little bit of a lull. I've seen these before. My -- in talking with some customers, and talking with our people, I get a sense that things -- and I already see, in the month of September, that we are seeing some improvement. Now I am not excited yet, but I do believe that the -- that we will see strengthening throughout the balance of the year, and that the first quarter was a little rough. But my sense is, air miles have not really diminished much. And what you would say the fleet age really hasn't changed a lot. And I think similar to what you see with Southwest, with taking 737-700's, and putting them to work. I think my sense is that, that's more the norm than the not -- then something out of the norm. So my view is that, yes, we will see strengthening as the year progresses.

Okay, and not to hold you to this, and I know it wasn't a guidance number. But on the last call, you threw out a double-digit sales expectation. You don't have to necessarily confirm that. But it sounds like you are still pretty confident that whether it's 10, 8, 9 or whatever, that you are pretty confident in the overall outlook. Is that?

Yes, I am.

Okay. And then on the MRO side, nice to see Lake Charles actually turn positive. Is that just the tip of the iceberg? How does the backlog look there? And what are your expectations as we go out?

I believe that Lake Charles itself, if I were to isolate Lake Charles, it would still have certain risks associated with it, because we are still trying to get a normalized pattern going there. We came through the quarter, I think, in good shape, and we have some optimism. But I would like to hold back -- reserve my comment on that, until I see another quarter of two under our -- have another quarter or two under our belt. So in general, though, if I can comment on MRO in general, I feel very good about our prospects. And we are having a good interaction with our customers. We're getting a sense that there is a fair amount of demand that is pent up, and we expect good, solid results through the balance of the fiscal year from our MRO activities.

And on prior calls, I think if we go back to even several quarters back, landing gear had some slowness. And it was -- you had discussed it being a cyclical downturn. Have we seen the inflection point? Or do you still expect that to -- is that part of your positive outlook?

Not as much as it is on the heavy maintenance side. However, we do see a better, let's say, Q2 over Q1. But still not satisfied with the level of inputs, and still not achieving the same levels we've had in the past. So I would like to reserve my comments there, as well.

Okay. Just on the SG&A line, I think you -- there was the -- was the severance for the consolidation in the MRO space, was -- did that, that $1.9 million, was that actually -- you did not pull that out as nonrecurring, right? (multiple speakers)

Yes, some of that occurred in SG&A, and some of that occurred in direct expense.

Got you.

And the biggest single item that would be unusual in SG&A would be the legal costs that we've -- some of the legal costs that we have incurred.

Right, okay. And that -- last -- and I don't want you -- I know you put out a comment yesterday, in terms of the -- some of the legal stuff going on near Expeditionary services. So I realize you probably can't comment on that, or where we stand with the State Department contract. One thing that caught me by surprise -- and I don't know if you can -- care to comment on it at all. But on your website, I see you are solicitating for a potential employment -- and you still say that decision has not been made, so that disclaimer is clear. But can I read anything into that? Other than you just -- or are you just being prepared, in case you get that contract? Any thoughts?

Yes. We are getting -- we're -- that's in preparation, in the event that we are -- that we win that contract. That's correct.

Okay. Great. Thanks, David.

Yes.

Kevin Ciabattoni, KeyBanc Capital Markets.

To follow up on the -- Rob's first question on Airlift. I know last quarter, you talked a lot about the startup costs associated with some of these new contracts. Just curious if you saw any of that flow through here in 1Q? And maybe what we can expect -- should we expect margins to maybe dip in Q2, as some more of those startup costs creep up?

Tim Romenesko, you want to take that question?

Sure. So we are expecting to have startup costs on the Falklands program in Q2 and Q3, and it will be $3 million to $4 million. It's people cost, it's training cost, it's positioning cost. And so we think that, that will have an impact between Q2 and Q3 and then Q4. When the program starts, obviously, those costs go away, and then we flip around into profitability. So those are the -- that's the biggest startup costs that we are seeing in front of us, for the balance of the fiscal year

Yes, but is that $3 million to $4 million cumulatively, or per quarter?

Yes. Yes, no, cumulative. Spread over the two quarters.

Okay, thanks. Any particular -- you touched a little bit on the weakness in trading that I assume impacted supply chain, and the flat quarter, year over year. Was there anything else in supply chain in the quarter that was -- that came in below expectations? And then anything specific in that trading business that caused that?

John Holmes, do you want to answer that question?

Sure. Outside of trading, the rest of Aviation Services actually came in at or above expectations. Trading was the single area that was below. And there really was not one single product or category that was soft. We felt it in multiple ways, across the business, both in the engine parts and airframe parts side. The only thing I would say is that, in certain areas, we saw weak demand, and we had supply. And in other areas, we saw strong demand, but were unable to get our hands on the material to fill that demand. So we had a couple of different dynamics going there.

Okay. That's helpful. Thanks. You mentioned in the press release, and on the call -- I think, John, this is probably directed at you -- some investment -- inventory investment for supply chain. Was that related to contract wins that you've already announced? Or business that you are going after that we have not see flow through yet?

That is contract wins that are already announced. So building off of programs that have already been won, and those investments are in line with the plan.

Okay. And then last one for me, and I will jump back in queue. Any color you can give on your thoughts around maybe additional stock repurchase activity, going forward here? Just based on where the stock is, relative to where it was when we last talked?

I will take that one, and we will watch that closely. We have about [$]95 million left on our authorization, and we will look at that closely

Okay. Thanks

(Operator Instructions)

J.B. Groh, D.A. Davidson.

John, I just wanted to clarify on the SG&A. You had some of that legal -- the legal is all in SG&A? And the severance is split into the segments?

Yes, that's right. That's right.

Okay. So what is the appropriate level SG&A, on a go forward basis, based on -- you had a pretty nice decline here, quarter to quarter?

We would like to get it down. We have historically operated, call it, in the 9.5% range, and anything north of that we are not happy with. But I think we want to be clear. Some of these legal expenses we expect to continue for a while.

Okay, so those will persist for --

A couple of quarters, I would think.

Right. Okay. Thanks. That's all I had.

(Operator Instructions)

Robert Spingarn, Credit Suisse.

So David or John, I am back with just some cadence questions. David, you said earlier Q2 is going to be a little better sequentially than Q1, and then you are going to have more consistent results for Q3 and Q4, the kind of results that you would feel good about. Can you give us a little better sense what that actually means, in terms -- just relative to Q1?

I would expect that, through the balance of the year, we will continue to see improving results. And --

That part I got. So I'm looking at $0.23 in Q1. I've got a 7% margin in Expeditionary. I think John was saying that will go up, though it sounds like it may go down before it goes up?

In the back part of the year, Robert, right.

Okay. So let's just start there. Does that mean that Expeditionary is a negative gross margin in Q2?

Not to our expectations, no.

Okay. Because you can absorb a couple million dollars, or half of that cost you talked about, and still be slightly positive.

That's correct. (multiple speakers) We expect to be positive in Q2.

Positive. And then similarly positive in Q3, with then a real nice number in Q4? Is that how I think about Expeditionary profit?

Yes.

Okay. Fair enough. And then on the Aviation side, given the fact that some businesses were better than expected, others were worse, is that profitability level -- is $50 million in gross profit per quarter a steady run rate here? Or is it going up?

We expect to do better.

Okay. And just cadence-wise, how do we think about each of the [other] quarters? Do you expect to do better -- similar jumps per quarter? Or is it back-ended?

I think you are going to see an improvement, a steady improvement, in Q2. And then hopefully, you see more meaningful improvements in Q3 and Q4.

Okay.

And what I was really referring to, Rob, is more from a historical perspective. I think we get into historical return levels by Q3.

By Q -- that kind of a run rate, which would then mean -- and I don't want to get too far ahead of ourselves -- that next year, presuming things go the right way, you can actually get to a full-year type historical level.

Yes. Correct.

Okay, thank you

Yes. And -- yes, correct.

Okay.

Just we're seeing -- just so everyone is clear. We are seeing strength in our businesses in the commercial markets. We see opportunities in the Airlift market. We have softness in the Defense spending for our Mobility businesses. That would be, I would say, a general overview of our businesses And we would expect that the supply chain business will continue to improve, as well as the MRO businesses. And we see a little bit of choppiness, though, in the Airlift business. We feel better about that once we have the Falklands contract operating, versus spending money to get ready for it to operate.

Right. I don't know if I am still connected here. But does that -- it sounds to me, David, like what you are saying is, when you get all that together again, you're back to doing $0.50 a quarter, and maybe better. But the next quarter or two are going to be -- won't be quite there. They will be somewhere between the $0.23 you just did and that target of $0.50, $0.60 a quarter.

I think that's a good way to look at it.

Okay, thank you

Larry Solow, CJS.

David, just a quick follow-up, just on the Mobility business. Obviously, it continues -- it remains soft. Do you think we are close to a bottom? Or -- obviously, it's hard to predict a rebound, especially --

Yes, we've predicted close to bottom before. And --

And we've been wrong. No, I know. So have I. But --

And we've surprised ourselves. So what I would like to do is just wait and see how the government reacts to all the different skirmishes and activity around the world. Right now, they have been very passive, as you know, and that has impacted our business. If, in fact, troop levels stay steady or strengthen, and we actually put troops -- move troops around, then it should spell opportunity for our business. But we have been a little bit surprised at the softness, and don't know precisely if we are at bottom. But maybe Tim Romenesko, maybe you can give a little bit more color on that, if you don't mind?

I -- David is right. We've predicted the bottom before, and we have been wrong. We are seeing a little bit of year-end activity, around a couple of product lines, but other product lines are pretty quiet. So I think David's characterization is right on

And the legal expense, is that -- without giving an exact number, is there somewhere -- like $2 million or $3 million, something, per quarter? Is that --

Not that high.

Not that high. Okay. Thanks.

(Operator Instructions)

Kevin Ciabattoni, KeyBanc Capital Markets.

One quick follow-up. I just wanted to touch base on the ExpressJet agreement with Airinmar that you guys announced recently. It seems like a pretty nice win; they have got a fairly sizable fleet. Is that new work for you guys? Or something that you've been doing with them in the past?

John Holmes?

Yes, sure. No, that is new work. That's a new contract. The scope of that is, I would characterize it as a modest start. But there is an opportunity to add on the rest of the Airinmar services with SkyWest ExpressJet. So no, that is a new win for that business

Great. Thanks. That's all I have.

Thank you. And that concludes today's question-and-answer session. I would like to turn the call back over to Mr. Storch for any closing remarks.

Thank you very much. Thank you for your attendance today, and thanks for your very thoughtful questions. We remain very excited about our business. Feel really good about our position, feel really very positively about our balance sheet, and the opportunity pool that we are looking at. So look forward to our next call, and hope everyone has a great day. All the best.

Ladies and gentlemen, thank you for attending today's conference. This does conclude today's program. You may now disconnect. Everyone have a great day.