AAR Corp (AIR) 2016 Q2 法說會逐字稿

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

Before we begin, I would like to remind you that comments made during the call may include forward-looking statements as defined by Private Securities Litigation Reform Act of 1995, as noted in our news release and risk factors 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. Thank you for joining us today to discuss our second-quarter FY16 results. Overall, as you can see, it was a strong quarter in top-line growth and cash flow generation, and performance was consistent with our expectations. I plan to share some of our highlights on business performance and then I'll turn it over to Mike Sharp who will provide more detail on the financials, and then we'll come back to Q&A.

First off, Aviation Services saw a growth in sales of $33.7 million on a comparative to prior-year basis, which was up 10.3%. And just reiterating, that's organic growth, no acquisitions in the period. Distribution programs delivered strong results again, supported both our commercial and government end markets, as our innovative solutions and services are resonating with key customers. During the period our C130 support program for the US Air Force in Afghanistan began generating revenue. And we launched a repair management program for the Royal Saudi Air Force as a subcontractor to Northrop Grumman. We're experiencing improved operational performance on our largest airline consumable and expendable program.

Trading improved on a sequential basis but was down year over year. And across our one MRO network we experienced double-digit growth, driven largely by higher utilization in our hangars. We continued air work in Lake Charles which reported a record top line this quarter. And Duluth celebrated the completion of its 200th aircraft for Air Canada, marking a new milestone in what has been a great customer relationship. Landing gear repair was up 16% in the period on higher volumes. And looking ahead to the second half of the year, we expect continued strength in supply chain as we ramp some of our distribution program contracts and continue to strengthen MRO based on robust order book and increasing bid activity.

Expeditionary Services, on the other hand, saw a sales decline of $13.2 million from the prior year, largely due to lower demand and delayed decisions for program awards by our government customers. Airlift was down year over year but performance was up slightly on a sequential basis. And during the quarter we were awarded extensions on our VERTREP program. And we also started incurring costs associated with our MOD, British Ministry of Defense, program support of the Falkland search and rescue contract. Mobility also was negatively impacted by lower demand. However, our integrated technologies sub-business inside mobility did announce some contract wins during the period with US Air Force and the US Army.

As we look ahead to the second half of the fiscal year for this segment, our customers, although they foresee needs for airlift services, solicitations continue to be delayed, largely due to insufficient funding and political uncertainty. And due to the market headwinds, we do expect continued softness in the third quarter for this segment and then some improvement come Q4 as the revenue for the MOD search and rescue contract kicks in. We continue to be market leaders in airlift mobility and we remain confident in our ability to win new awards when decisions are made and new RFPs hit the market.

So, with that, if I may, let me turn it over to Mike and he can provide a little bit more financial color.

Thanks, David. I trust that each of you have had an opportunity to review our earnings announcement. I will discuss our second-quarter performance in a bit more detail, and start by saying that sales for the quarter were $423.8 million, which is up on a consolidated basis 5.1% over the prior year.

As David mentioned, Aviation Services sales increased $33.7 million, up 10.3% year over year, while expeditionary services segment reported a 17% decline in sales. The gross profit margin in Aviation Services was 16.2% this quarter compared with 16.5% last year. The slight decline in the margin year over year at Aviation Services was principally caused by mix within our supply chain activities, reflecting increased program and distribution sales and less trading revenue. In the Expeditionary Services segment the gross profit margin declined to 2.6% of sales, caused by the decline in revenues, mix of business within the segment, and, as David mentioned, startup costs associated with the Falkland Islands contract.

SG&A expenses in the period were 10% of sales compared to 10.4% in our first quarter. As many of you know, this ratio has historically run between 9% and 10% for the Company. We feel good about our cost structure, and the real opportunity for additional improvement in this ratio is by increasing sales.

Net interest expense was $1.5 million in the period compared to $6.5 million last year and reflects the significant decline in outstanding borrowings. Our effective tax rate for the period was 33.8% and includes a small favorable adjustment for a completed state tax audit. We expect our tax rate to approximate 35% in the back half of the year.

We had strong cash generation in the quarter, generating a little under $48 million in cash from operations. Capital expenditures for the period were $15.7 million, inclusive of two payments on two AW189 rotary wing aircraft that were since sold and leased back. These are the two aircraft we will be using on the British MOD contract in the Falklands. Depreciation and amortization, including amortization of stock-based compensation, was $14.3 million. Net debt declined $43.3 million from August 31 to end at $107.5 million.

During the period we bought back $9.7 million of our convertible notes. The remaining amount of the convertible notes is $25.7 million and will be retired March 1, 2016. The book expense interest rate on these converts is 7.4%, and we expect additional annual interest savings of approximately $1.4 million once these notes are retired in March. During the period we paid $2.6 million of dividends and repurchased 142,000 shares in the open market for $2.8 million. As of November 30, there's a little over $91 million available under the Board authorized share repurchase plan.

Thanks for your attention, and I'll turn the call now back over to David.

Thanks, Mike. So, as you can see, pretty good quarter, good double-digit organic growth in Aviation Services, good cash flow. Balance sheet is in a wonderful position. We're looking for ways to invest the capital wisely. We do have some deal flow but we are staying very disciplined in our deployment of capital.

With that, let me open to any questions you might have.

(Operator Instructions)

First question is from Larry Solow of CJS Securities. Your line is open.

Hi, this is actually Lee Jagoda for Larry. Good afternoon. Can you quantify the startup expenses from the Falkland contract in the quarter and what, if any, additional expenses you might expect prior to the contract generating revenue?

We're not necessarily disclosing that at this moment but it's not insignificant. It will be higher in Q3 than it was in Q2 but then we'll start -- obviously as we start getting revenues in Q4 it turns from being a drag to being a contributor.

Sure. And then looking at Aviation Services, given that it sounds like the trading and parts business was actually a negative to the growth, what, in your opinion, is driving the strong growth? And how do you look at the sustainability of that going into the back half of the year?

We've had a series of contract wins. I believe our business model is appealing to a broad range of customers, commercial markets and defense customers. And, yes, I think our team is doing a nice job, good leadership coming out of John Holmes' office, and his team surrounding him is executing and doing a good job.

Okay. And one more from me and I'll hop back in queue. Are you guys seeing any of the benefit from lower oil prices and extending the useful lives of aircraft in the fleet?

I wouldn't have an answer for that that would be quantitative in nature. My sense is that the airlines are adding capacity, and more capacity is good for our business.

Fair enough. Thanks very much. I'll hop back in the queue.

Thank you. Our next question is from Kevin Ciabattoni with KeyBanc Capital. Your line is open.

Hi, good afternoon, guys. Thanks for taking my questions. Nice quarter. You mentioned the parts trading business down year over year but up sequentially. Are you better positioned now, you think, in terms of your inventory? I think last quarter it sounded like maybe there was some mismatch there. Maybe, David, if you could just give us an update.

I think our inventory's in good position. We were a little bit surprised Q1 in terms of the softness. I believe our inventory's probably ballooned a little bit Q1, and I think they're probably more in line with results coming out of Q2.

We have a great position in this market, not just here in the United States but worldwide. And we had nice improvement Q2 over Q1, notwithstanding the fact that on a year-over-year basis we were down. A great team in place. And, again, I believe that that market, our performance will be fine.

Okay. Can you give us an update on where you are in term of airlift positions to finish the quarter, and maybe also what the bid pipeline's looking like there currently? I know it sounds like there's some delays in terms of awards but just in terms of what you're seeing on RFPs, et cetera.

Let me turn it over to Tim Romenesko.

We ended the quarter with 22 positions, but then on December 1, three contract positions were completed. Those we expect to be put out for rebid here in the next few months and we've got a chance, at least, to get those back.

There are a few other larger RFPs that we think are going to be coming, we've heard are going to be coming, but we haven't seen them yet. And these are the RFPs that we've been talking about for a few quarters here. As David mentioned in his comments, they've been slow to hit the market and it's impacted our results and our outlook.

So, with those three positions rolling off ahead of the Falklands coming on in 4Q, is it likely that we'll see negative gross margins out of Expeditionary in the third quarter?

The third quarter we're expecting to be lighter than the second quarter due to the three positions coming out, as well as the increase in cost that David referred to related to the startup of the Falklands program. So, yes.

Okay. And last one and I'll jump back in queue -- any update you can give on where things stand with the DynCorp legal matter. And then also related to that, where the recompete stands for that program. We've also heard that they're considering splitting that contract up into multiple silos. Does that impact your revenue opportunity there on the recompete?

They already split a year ago from the traditional INL contract. That's generally well-known. In terms of our expectation for the current bid, let's say, there's been no indication of a desire to split that. We think we have a good competitive solution set and we have submitted our proposal and we're waiting to hear.

Have you got any update on timing there as to when they expect to award that?

I think we're led to believe somewhere in the January-February time frame.

Okay. And nothing on the legal matter that you can update?

No. I think so far all decisions are public in nature and have been favorable towards us.

Okay. Thanks, guys.

(Operator Instructions)

Next question is from Stan Manne of Manne Family Investment. Your line is open.

Good afternoon. I have three questions, one on cash utilization, David. You mentioned acquisitions, you mentioned buybacks. Is there any color that you can give us on your sense, are acquisitions near? Far? Are you looking at accretive? A little color on cash utilization.

The only confidence I have is accretive. So, anything that happens will be accretive. In terms of near or far, it would be relatively out of our control. We are actively engaged on a few situations but hard to say whether decisions are imminent or not.

So, we will continue to look at all the different possibilities. Obviously balance sheet is in very strong position, and with some of the uncertainty in the world we view that as a pretty good position to be in.

Okay. And the buybacks, of course, you have $91 million, which could be a significant reduction in shares outstanding. There seem to be wars that are occurring or battles, including the Saudis in Yemen, with air force and troop. And now I guess Great Britain and US are sending operations teams to Helmand Province in Afghanistan. Will any of those events have a near-term effect on our business?

I'm not sure. I can't say I have an answer to that. I think if pace picks up, so if there's more action, then it will have a favorable impact on our business. But I can't comment because I just don't know if moving people into Helmand Province or other things you referenced will have a meaningful impact on our business.

Okay. The reason I ask about the Saudis is you said you had a Saudi air repair contract that you jointly administer.

Right. I'm not aware of any direct impact. Our relationship with the UAE, they're also actively engaged in the Yemen market. Should be favorable, too. But I can't think of anything short term.

Are you seeing additional solicitations or interest?

We're seeing lots of interest and we are seeing solicitations. I don't believe they're necessarily related to those items, Stan. I think they're related to the needs in a general sense.

Okay. It's positive, though, potentially.

I don't see how it can get any more negative.

Okay. Thanks. Good job, gentlemen.

Thank you. I'm showing no further questions at this time.

Okay. Thank you, ladies and gentlemen, for participating, and thank you for your confidence in our Company. Appreciate it. Take care. Bye-bye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.