AAR Corp (AIR) 2018 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to AAR's Fiscal 2018 Fourth Quarter Earnings Call.

We are joined today by David Storch, Nonexecutive Chairman; John Holmes, President and Chief Executive Officer; Mike Milligan, Chief Financial Officer.

Before we begin, I would like to remind you that the 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, 2017. 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 of the Board, David Storch.

Thank you, sir, and thank you very much everyone today for participating. Good afternoon, and also thank you for joining us to discuss our most recent fourth quarter and full year 2018 results.

I'm very happy to open up the call by introducing John Holmes as my successor, AAR's new Chief Executive Officer, and only the third CEO in the company's history. In John's role as President and leading our Aviation Services businesses, he has shown keen strong leadership skill, a great understanding and sense of our markets and the entrepreneurial skills to take over our great company and to drive its even greater heights. I'm very excited to watch John perform in his new role as CEO.

Before handing the call over to John, I'm pleased to share that AAR had a solid fourth quarter to finish a very strong fiscal year overall, and we will walk you through the highlights momentarily. I'm also pleased to share the company has successfully completed the full transition of the INL/A Worldwide Aviation Support Services contract at the end of June. I'm incredibly proud of our team and want to thank the entire team for their dedication and commitment, especially in the period since contract award.

Together with John, we are also very proud that AAR was named to the Forbes list of America's Best Mid-size Employers for 2018. This is a reflection of the company's entrepreneurial spirit, validating our culture, enabling us to continue to attract world-class talent.

So with that, what I'd like to do is turn the call over to John to discuss the company's recent results.

Thank you, David. Good afternoon, everybody.

I'd really like to begin by thanking David for the opportunity to lead this outstanding organization. David has been a tremendous mentor and friend for 17 years and it is truly an honor to succeed him. I also want to recognize David for his 4 decades of exceptional service and leadership to AAR and we will continue to look to David for strategic guidance as we grow the company.

We are pleased to report our very strong Q4 and full year FY '18 results. For the full year, we drove double-digit sales growth with strong performance across all of our businesses. Our sales were up $157 million or 10% to $1.75 billion and, excluding the impact of the wind-down of the KC-10 Program, which lowered sales by $81.5 million from the prior year, sales increased 16%. This is primarily driven by our industry-leading commercial and government programs, parts supply activities and MRO offerings.

As David mentioned earlier, we have completed the WASS program transition, including the sites in Afghanistan, Iraq, Panama, Peru and Patrick Air Force Base. This program is now fully operational and July will be our first month at a full run rate. In the fourth quarter, the program contributed $14.1 million of sales with minimal operating income contribution. And in the first quarter, we will have one partial month and 2 full months of operations.

During the quarter, we had several significant wins. Most notably, we we're awarded our first indefinite-delivery/indefinite-quantity or IDIQ contract for the U.S. Army for aircraft and support equipment maintenance as well as supply chain management in the program. The work will be primarily performed outside the continental U.S. in support of U.S. Army operations. We are pleased to be one of 3 primary defense contractors on this $25 billion IDIQ and anticipating our initial task quarters in mid-FY '19.

In addition, our distribution team was awarded a new contract with Sumitomo Precision Products to support a critical engine component for the A320 family. This long-term exclusive agreement will be supported by our global customer support team as well as our global warehousing network.

FY 2018 was a year of significant new business capture for AAR and we are all extremely focused on the successful execution of this new business. We are also focused on our cost structure and have taken several actions to reduce our SG&A expenses, including personnel reductions, which resulted in the severance you saw in Q3 and also in Q4.

Based on these moves and other initiatives, we see a path to bring SG&A expenses back to our historical level of 10% of sales during the year FY '19. We have also taken actions to address the labor challenges we mentioned last quarter that we experienced in certain of our MRO facilities, which included modifying our recruiting efforts to attract more experienced technicians, forming partnerships with local governments and tech schools and enhancing our internal training programs.

Overall, we continue to see robust demand across all of our businesses, in particular for parts -- our parts supply and commercial and government programs offerings. We have strong momentum and are feeling very good about our prospects going forward.

With that, I'll turn the call over to Mike Milligan.

Thanks, John. Good afternoon. I'll take a few minutes to discuss the company's Q4 and full year 2018 fiscal financial performance in more detail.

Our sales in the quarter of $473.5 million were up 5.1% or $23 million year-over-year. We experienced growth in both segments, including a $14.7 million, 50% increase in Expeditionary Services revenues combined with an $8.3 million increase in Aviation Services revenues. The INL/A WASS contract ramp drove the Expeditionary Services sales increase while Aviation Services experienced strong sales from parts trading distribution, airframe maintenance and landing gear services, more than offsetting the KC-10 sales decline of $13.8 million to $4.5 million from $18.3 million in the prior year.

We continue to see improvement in our business unit profitability as gross profit increased $6.8 million or 8.7% to $84.7 million. Gross profit in Expeditionary Services improved $3.8 million or 84% from increased sales and higher profitability. Gross profit in Aviation Services increased $3 million from parts supply, airframe maintenance and landing gear sales flow-through.

SG&A expenses were 13.1% of sales impacted by increased personnel-related costs, including higher stock-based compensation costs as well as severance and restructuring expenses of $2.5 million or $0.05 per share. Adjusted SG&A expenses, excluding stock-based compensation, severance and restructuring charges, were 11.2% of sales for the quarter compared to 11.3% in the prior year.

Income from continuing operations was $18.1 million or $0.52 per diluted share impacted by a $1.1 million $0.03 per diluted share, tax benefit related to the deferred tax re-measurement from the U.S. tax law changes. Overall, adjusted income from continuing operations was $18.8 million or $0.54 per diluted share compared to $16.4 million or $0.49 per diluted share in the prior year.

Capital expenditures for the quarter were $3.6 million and depreciation and amortization was $9.1 million. Net interest expense was $2.2 million compared to $1.5 million last year due to higher average borrowings during the quarter and the increased underlying interest rate.

Our sales for the full year were $1,748,300,000, up 10% or $157.5 million year-over-year. Aviation Services sales grew 16% or $239 million, excluding the impact of the KC-10 Program wind-down. Our sales increases were driven by our parts, trading and distribution activities as well as commercial and government programs as well as airframe maintenance and landing gear services. KC-10 sales were [$29.1 million] (corrected by company after the call) for the year, down $81.5 million from $110.6 million in the prior year, and will have minimal sales going forward. Expeditionary Services sales grew $24 million or 23% to $129.4 million from sales increases from the INL/A WASS contract ramp-up and growth in our Mobility business unit.

Gross profit for the year increased $31.2 million or [11.8%] (corrected by company after the call) to $294.6 million. Gross profit in Aviation Services increased $25.9 million or 10.5% from parts supply, airframe maintenance and landing gear sales flow-through. Gross profit in Expeditionary Services improved $5.3 million or 30.5% from increased sales and higher profitability. As we move forward into fiscal 2019, we expect our margins to improve as we grow the business and leverage our fixed cost structure.

SG&A expenses were 11.9% of sales for the year impacted by elevated legal costs, increased personnel-related costs, including a higher stock-based compensation as well as severance and restructuring charges of $4.4 million or $0.09 per share. Adjusted SG&A expenses, excluding stock-based compensation and severance and restructuring charges, were 10.8% of sales for the year compared to 10.6% in the prior year.

Income from continuing operations was [$73.7 million] (corrected by company after the call) or $2.11 per diluted share, which were impacted by a $14.1 million, $0.41 per diluted share, tax benefit related to the deferred tax re-measurement from the U.S. tax law changes as well as severance and restructuring charges of $3.1 million or $0.09 per share. Overall, our adjusted income from continuing operations was $62.7 million or $1.79 per diluted share compared to $52.5 million or $1.53 per diluted share in the prior year.

Capital expenditures for the full year were $22 million. Depreciation and amortization was $40.5 million. Net interest expense for the year was $7.9 million compared to $5.2 million last year due to the higher average borrowings during the year and increased underlying interest rate.

Our cash flows from operations were positively impacted by our accounts receivable off-balance sheet financing, which generated $61 million. While we experienced higher average borrowings during the year, we maintained low leverage and significant liquidity.

Overall, we are confident in the investments that we've made in our business units. And during the year, we returned $23.4 million to our shareholders through dividends of $10.3 million or $0.30 per share and share repurchases of $13.1 million or approximately 350,000 shares.

Thanks for your interest. And with that, I'll turn the call back over to John.

All right. Thank you, Mike.

As we enter FY '19, we expect to continue to be a net investor in our businesses to support our customers and our continued growth. We do expect to turn our cash positive in the second half of the year.

At this point, we'd like to reaffirm our guidance for FY '19, which includes sales in the range of $2.1 billion to $2.2 billion, diluted earnings per share from continuing operations in the range of $2.50 a share to $2.80 a share and adjusted EBITDA in the range of $180 million to $190 million. I'm very proud of our team and I'm confident that we will deliver another year of strong performance.

Thank you for your time and interest in AAR. And at this point, I will turn it back over to the operator for questions.

(Operator Instructions) Our first question comes from the line of Ken Herbert of Canaccord.

I just wanted to first ask, if I could, a question on the guidance. Can you just remind us again for fiscal '19 what's implied for the INL contract? I know the ramp has been a little slower than expected, but it sounds like it's fully up and running now. But from a revenue or an EPS standpoint, what does that particular contract contribute in fiscal '19?

From a revenue standpoint, consistent with what we talked about in January, it's about a $200 million contract in FY '19. And it's close to that range with the slightly delayed start.

Okay. And your margin assumptions haven't changed on that program either?

Correct.

Okay. And then if I could, just as a follow-up, your comment, John, at the very end on free cash flow, do you expect to be free cash flow positive in fiscal '19? It sounds like first half of the year is more investments than second half, you generate -- you start to see positive free cash flow, but how do we think about the full year? And maybe as part of that, what's the expected benefit from the off-balance sheet program or how should we think about that contributing in fiscal '19?

Sure. You're right. We're looking, as I said, at being a net investor in the first half of the year and going to positive cash flow generation in the second half of the year. We're still viewing our cash flow for the full year in the range that we have communicated at the January Investor Day, which would be 50% EBITDA conversion for the year. And in terms of the accounts receivable -- that's a -- go ahead, Mike.

Yes, Ken, that assumes that the use of the facility -- AAR facility will be consistent.

Okay, so sort of neutral from '18 to '19?

Yes.

Yes, constant. Right.

Our next question comes from line of Michael Ciarmoli of SunTrust.

Maybe, John, just to touch on Aviation Services, I guess, in the prepared comments there you talked pretty optimistically about continuation of the trends across most of the business, but we saw, even normalizing for the KC-10, the growth decelerated pretty sharply this quarter versus prior quarters. Any additional color you could provide there? Any start of a new trend or kind of what you're seeing under the surface?

We don't -- if we take our KC-10, growth would have been roughly 8.5%, which is in the range that we've been communicating, 5% to 10%. So we don't see it as any start of a trend. We continue to see, as I mentioned, demand across all of the businesses in the Aviation Services unit. So the short answer is I wouldn't view that as part of a trend and 8.5% backing out KC-10 is right in line with what we've been expecting.

Okay. And then, what about -- you touched on labor pressure and kind of some measures you're taking there. How should we think about that labor pressure if you're going to have to potentially increase wages? Can that be passed across or passed on to the airlines? Does that have any margin implications or any implications for hitting that 10% SG&A target for fiscal '19?

Yes. I would view those 2 things differently on the hourly labor and that's where we see the pressure. Our -- as I mentioned on the last call, we certainly are in communication. All of the customers are aware of the tightness and the way we're supplying and the potential downstream implications for cost. The last thing that the customers want to see is our -- us raising our price to them so we're doing what we can, with the number of other options that I mentioned, to broaden the labor pool.

The real constraint there was felt after the summer flying season when we got back to -- when the air -- when the hangar's filled back up and the aircraft came back in and we're out there looking for a mechanic. We're well ahead of that exercise this year versus last year. And so far, we've been able to do that on a relatively consistent cost base. We had to make some targeted increases at certain levels within the organization based on experience, trying to get certain people into the organization, but nothing at this point that would materially impact the margin. Having said that, that is a trend in terms of the tightness of the labor supply and it's something that we're monitoring closely, which is why I wanted to bring it up.

Got it. Got it. And then, that shouldn't have any impact on the SG&A dropping to 10% for fiscal '19?

No. It's not in SG&A. You've got -- those are direct costs. Right, right.

(Operator Instructions) The next question comes from the line of Josh Sullivan of Seaport Global.

Can you just expand on the INL/A WASS contract. How do you see that vehicle ramping over the next couple of years? It seems like a nice win.

So we're on the IDIQ, the -- and we're one of 3 large contractors on the IDIQ. There's also a small business component, so there were 3 smaller contractors. And the value of the IDIQ was up to $25 billion over its 10-year period. And what will happen next is task orders will come out that will be bid separately. And as each one of those task orders come out, we'll compete against the other contractors that are on the IDIQ for that task order.

So the first step is getting on the IDIQ to have the ability to bid on the task order. The next step is winning the task order themselves. And at this point, we don't have visibility into the size or duration or the scope of the individual task orders. Obviously, with a $25 billion ceiling, it's a pretty significant opportunity, but we do have to compete to win further -- to win actual work on that contract.

Okay. And then, just can you provide us any color on the pace of parting on or scrapping of aircraft at this point? Any trends or themes emerging globally?

We -- in general, I think there are certain asset classes that are in higher demand than others. We see pockets of demand for certain asset classes based on fleet movement and we're getting ahead of that demand by going out and securing certain assets. I don't want to get in the specifics obviously for competitive reasons, but suffice to say that both in the engine and airframe market, the trading of business continues to look good, but the key is going out there and being able to get your hands on the right material.

And at this time, I'd like to turn the call back over to David Storch for any closing remarks.

Thank you. Thanks for your participation.

One comment back, Mike, on your comment on the deceleration of revenue growth. Just keep in mind, as we enter fiscal year '19, we are forecasting 20% organic growth in the -- in this year. So there may have been a slight deceleration ex-KC-10 from prior quarters. However, we are expecting ramps into the new fiscal year that get us into the exceptional growth rate for the year.

And with that, I think that's a good way to wrap. And thanks for your participation today and I wish you all well. Thank you.

Thank you.

Thank you, sir, and thank you, ladies and gentlemen. This concludes today's conference. Have a wonderful day.