AAR's (AIR) CEO David Storch On Q4 2014 Results - Earnings Call Transcript

Jul.16.14 | About: AAR Corporation (AIR)

AAR Corporation (NYSE:AIR)

Q4 2014 Earnings Conference Call

July 16, 2014, 08:30 AM ET

Executives

David Storch - Chairman and Chief Executive Officer

Timothy Romenesko - President and Chief Operating Officer

John Fortson - Vice President, Chief Financial Officer and Treasurer

Michael Sharp - Vice President, Controller and Chief Accounting Officer

Analysts

Larry Solow - CJS Securities

Kevin Ciabattoni - KeyBanc Capital Markets

Alex Heinen - D.A. Davidson

Stan Manne - Manne Family Investments

Operator

Good morning, ladies and gentlemen, and welcome to AAR's fiscal 2014 fourth quarter and yearned earnings call.

Before we begin, I'd like to remind you that the comments made during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as noted in our news release and our Risk Factor section of the company's Form 10-K for the fiscal year ended May 31, 2013. 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 and Chief Executive Officer, David Storch.

David Storch

Hi, thank you very much, and good morning, ladies and gentlemen. Thank you for joining us today to discuss our fourth quarter and fiscal 2014 yearend results. We will also provide some guidance and expectations for our fiscal year 2015 with a little color. And I'm here in suburbs of Chicago, joined by Tim Romenesko, our Chief Operating Officer; John Fortson, our Chief Financial Officer; Mike Sharp, our Chief Accounting Officer and Controller.

Just to reiterate some of the highlights from the quarter. Sales were $505 million, although down from prior year, up from prior quarter. Sales in the Aviation Service segment were lower, primarily due to the softness in MRO and airlift, so we had fewer positions in the airlift operation, and MRO just went through some seasonality issues with certain customers. We haven't lost that business, just less demand during the period.

Our supply chain business had a lot of momentum, had a good quarter, and goes into the new year with a strong backlog and a lot of exciting things going on. Technology Products, we had softer commercial sales largely due to fewer 747-8 systems, but we did experience defense growth with A400M system sales.

Our operating income in the quarter was $33 million. Net earnings for the quarter were $0.43, which was higher than the latest consensus and higher than what we reported for fiscal year 2013 or the prior year's quarter.

For the full year, sales were $2.04 billion, which would be a decrease of just under 5% for the year. Operating income was $146 million with slightly better margin, [7.2%] than prior-year performance. We reported diluted earnings per share of $1.83, ahead of the $1.81 consensus expectation, and this compares to the $1.38 reported for fiscal year 2013.

As we look back at the year, it is important to point out that we also generated significant cash flow, so we had cash flow from operations of $140 million and free cash flow of $113 million, which equates to the $2.90 per share.

With that cash, we paid some dividends and we further reduced our net debt position. I should add that we made significant investments. Net of that, we made significant investments supporting the growth in our supply chain businesses.

As I move over to Aviation Services, in our fourth quarter, sales were down 10% versus prior year. Supply chain had strong performance, starting to see the benefits of investments we made throughout the year and the positive impact on new programs.

Today, we are fully operational on our supply chain hub in Brussels, and we continue to expand our reach across the series of new clients. We expect meaningful growth from these programs with supply chain having won an aggregate value of $1.9 billion of new contracts during the fiscal year that will be realized over the life of the program.

Some of the programs are five years in duration, some are 10, some are 12, but clearly this is a newer trend for the company. Historically, our supply chain businesses had a shorter window. Today, we're signing not just shorter deals, but also more longer deals in our effort to become more integral to our customers’ operations.

In MRO, sales for the quarter were down, driven primarily by cyclical downturn in our landing gear business, and wind down of meaningful engineering service contracts. You might recall that engineering service business, where we have a crackerjack team and capability in place is very deal-sensitive.

So, if we get a deal, it's great business. When you don't get a deal, it's not as good. But when we do comparatives on a year-over-year basis, last year we had a very appealing deal with North American carrier, and this year we didn't have that business. So those guys are knocking on doors, and I'm sure they'll have successes to report during this current fiscal year.

To counter some of the headwinds that we have experienced, we've refocused our MRO leadership to exploit the advantages of our one MRO strategy, and to aggressively pursue business opportunities with new customers and for wide-body airframes. We're proud to complete our first 777 work, which we performed on behalf of Aeromexico, who we also did 767 work for as well.

So, although sales were down in the period, we have taken steps to improve that performance, and I think as this year unfolds, when you look at the back half of the year, we're fully sold-out in our MRO shop, and we do expect the turnarounds in our landing gear operation as the gear repair cycle kicks in.

Airlift continues to transition new opportunities as we discussed at the beginning of fiscal year 2014 with 40 flying aircraft positions. We ended the year with 20, which was three lower than we guided last quarter. Airlift did a good job reducing costs and finding efficiencies throughout the year to reflect this new environment and came in with excellent operating margins.

For fiscal year 2015, we anticipate the positions will trough in Q1, and that's where we got down to 17 in June, but will increase its previously awarded positions to come on line. We expect to finish the year with 28 positions operating.

Let me now turn to Technology Products. Sales in this segment were down 4%, driven primarily by softer demand for the commercial cargo products. Mobility products actually had a strong quarter and performed better than last year, with higher sales for the quarter than prior-year period. However, commercial cargo had lower sales than expected due to reduced 747-8 cargo systems demand from Boeing and lower spare sales.

Going into fiscal year 2015, we expect commercial cargo to transition, to increase production as the A320 and the A350s ramp. So, we are exclusive on both of those models. We will also be a beneficiary of the A330, where we sell systems between $350,000 and $450,000 per shipset. And as many of you saw on Monday, Airbus announced their intentions to create an A330neo, which will keep that aircraft operating or on the production line for at least another 10 years.

In closing, as we move into our new fiscal year, we will continue to focus on execution, finding growth opportunities, improving our performance and margins, while delivering higher levels of cash generation.

So let me do this at this moment. Let me turn the call over to John, who will fill you in on some of the financials, and then will circle back to me for closing comments.

John Fortson

Thanks David. I trust that each of you had a chance to read our earnings release, which was posted yesterday afternoon. On this call, I'd like to review a few key points with regards to our performance.

We improved our consolidated gross profit margin in the fourth quarter to 17% from the adjusted 16.3% in the prior-year period. This performance translated into a 16.8% margin for Aviation Services and a 17.6% margin for Technology Products.

SG&A as a percentage of sales in the fourth quarter was 10.5%. This is higher than last few quarters due to higher compensation expenses this quarter. I would like to note that we expect in FY '15 for these margins to improve on a year-on-year basis going forward, as our cost control initiatives continue. Our operating margin for the year was 7.2%.

During the fourth quarter, we generated $63.1 million in cash from operations and our capital expenditures were $5.3 million. We are very focused on receivables management and cash collection. We continue to delever and reduce our net indebtedness by further $89 million from the prior year, ending the year with total debt of $634 million and net debt of $545 million.

Our net debt-to-EBITDA is currently at 2.3x, down from 2.6x a year ago and 3.2x at the end of fiscal year '12. This is within the range we have set ourselves as a target of 2x to 2.5x.

Net interest expense for the fourth quarter declined to $9.1 million. Our net interest expense numbers continue to decline, as we focus on paying down debt. Depreciation and amortization, including amortization stock-based compensation, was $23.6 million during the fourth quarter.

For fiscal year 2014, our effective tax rate was 30.5%. For fiscal year 2015, we are anticipating this rate to be 32.7%. This is a change from the 34.5% we historically guided people to for planning purposes and reflect increased utilization of tax credits.

We are analyzing our tax position carefully, and after reviewing our tax obligations over the last five years, we feel comfortable in guiding to this rate of 32.7%. We enter fiscal 2015 with 39.1 million shares in the diluted share count.

David discussed our anticipated schedule of aircraft positions over the next year in airlift, but I would also note that we now have 12 aircraft available for sale, which is up from nine at the end of last quarter with a combined book value of over $33 million. We continue to analyze the portfolio and may consider adding more aircraft to this list, if the situation warrants.

Our after-tax ROIC for the year was 6.1%. In fiscal year 2015, we are adjusting management's compensation plan to include ROIC as a performance metric in the company's long-term incentive plan. ROIC is being used by our business units to mange their businesses for a long time.

We believe it is an important return metric that we can use a corporate to drive performance and we'll be monitoring it closely going forward and seeking to improvement. There are a few businesses that have been a drag on this corporate rate and we are now dedicating effort to improve these, as we have finished our deleveraging.

Thank you for your attention. And I will now turn the call back over to David for some closing comments.

David Storch

Let me just add a little bit to that. As John has alluded, our net debt-to-EBITDA ratio has come down from a peak of 3.2x down to 2.3x. Another way of looking at it, we had actually peaked net debt at about $805 million after we closed on Telair and Nordisk acquisitions, and today we're at net debt of $545 million. So we've had meaningful reductions.

In the two fiscal years, we've gone from $750 million-ish to $545 million. So we've taken $200 million of debt or capital off the business. So we're very pleased with that. And we think we put ourselves into an appealing leverage ratio, which now causes us to look at things and focus on those businesses that are performing and those businesses that are underperforming.

We've had a couple of underperforming businesses, which have been a drag on our return calculations. And I just want to state that before this year is out, we will take actions with these businesses that will lead to a positive impact on how we give returns on the capital that you've entrusted us with to manage on your behalf.

So let me move on and conclude with our guidance for fiscal year 2015. As stated in our press release, we currently expect sales in the range of $2.100 billion to $2.150 billion. Aviation Services, we expect to see strong growth in our supply chain business and improve our opportunities in MRO.

We also except the airlift to have some puts and takes, as it evolves, both losing some existing positions, but gaining others. And you please have comfort in knowing that we've had very appealing, very attractive returns from this business, and this business has been a very positive cash generator for the company.

In our Technology Product business, we do expect the ramp of shipments on the A400M, cargo loading system and improvement in commercial cargo, as a result of A320 and A350 deliveries. And our mobility business will continue to experience some softness, as military budgets remain under pressure. And taking a look around the world and looking at so many unsettling situations, we won't be surprised that at some point the mobility business gets a call to action and sees an up tick in its activity.

I should also just comment on the fact that this business is still a leader, has a leadership position in its market niche, and we've seen operating income in that business that has been the $75 million range. Today we're operating in the $20 million range. So you can see we've had a significant fall-off in demand, but we still maintain a leadership position in that market in exclusive on many of the products that we do deliver for the DoD.

We anticipate full year diluted earnings per share in the $1.80 to $1.90 range. And our customer schedule for heavy maintenance business is light during the first quarter, but increases significantly in the second half of the fiscal year to the point where most of our facilities are sold-out for the second half of the year.

Because of this and the positioning schedule, our aircraft portfolio, we do anticipate the first quarter will be a little softer than other quarters of this year. And we always like to stay away from hockey stick approaches, but the reality is we do have some seasonality to our businesses and this is how we look to the businesses unfolding for the year.

In closing, I would want to reiterate the strengths and the performance of the company during the year in terms of the cash flow generation, and I would encourage investors to look at this indicator as a sign of strength coming from the company.

So with that, I'll close my comments and open up the phones for any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Larry Solow with CJS Securities.

Larry Solow - CJS Securities

Just a few questions. We've spoken a lot about the ramping of several contracts in the supply chain. Perhaps you could just sort of review where we stand, some of the major ones, I guess, Unison, is that fully ramped? And how is the Eaton deal going? And then also probably, just new consumable parts contract that you announced last quarter?

Timothy Romenesko

So yes, the consumable program is still ramping. We're working aggressively to setup a new distribution center in Indianapolis to support that program. So, it will probably take us a few more months, I would say, to get the full ramp. The Unison transaction is going as we had anticipated in accordance with our schedule. And then on Eaton, we're continuing to ramp that program, and we see additional opportunities to grow that product line. We've had a tremendous amount of success in this piece of our business. We're digesting some of the volumes, but we see significant new opportunities here.

David Storch

Larry, let me add also that the investments that we've made in the Brussels operation is leading to deals flow coming out of European customers and Middle East customers that we have not seen before. So, the team is aggressively pursuing that market in a way that we didn't really have the capability or visibility in the past.

Larry Solow - CJS Securities

And then on the airlift business, the projection for 28 aircraft being utilized at yearend, does that assume most are out of Afghanistan except for the -- I guess, there are some from this new contract you announced last year. And I realized there's some uncertainties, but are you assuming or is this 28 based on sort of ongoing discussions or what you sort of have believed to be in-hand today or do you assume that you'll get new contracts?

John Fortson

These assumptions are based on our contract positions in Afghanistan as well as previously announced contract positions both in Afghanistan for NATO, but also incremental positions in Africa that we've already been awarded, Larry. Of the 28, four are what I would call sort of new business, right. The rest are already awarded positions that we're expecting the contracts to get turned on.

Larry Solow - CJS Securities

And then just calling on David's comment about some of the underperforming businesses, can we expect a potential sale of some of these things to improve? Are you expecting – are there initiatives out there that you expect to sort of improve operations which will help returns?

David Storch

Larry, let me just say that by the end of the year that we will have these -- our intention is to have these problems solved.

Larry Solow - CJS Securities

On cash flow, another fabulous year in terms of cash flow. Is that a sustainable number? What's the outlook for that in '15?

David Storch

So, we're looking at directionally in a similar way as we experienced last couple of years, but we do anticipate some investments in the supply chain business, which might not allow us to hit quite the same level as we had this year, but we expect it to be strong.

Operator

Our next question comes from Julie Yates with Credit Suisse.

Unidentified Analyst

This is actually [ph] Krishna, her associate. Julie is on a flight right now. But just wanted to ask, if you could give a bit more color on your '15 guidance, I was just wondering where do you guys see some potential for upside to that and potentially even where do you guys see some risks?

David Storch

So yes, I think we see potential for upside in the supply chain. We've been putting pressure on the supply chain group to grow its earnings at a faster clip than they submitted, let's say, and the deal flow seems to be pretty robust. We are not calculating in any significant deals in that number. So, if we do have a deal or two which -- and they are out there that would have a positive impact on our results.

Operator

The next question comes from Kevin Ciabattoni with KeyBanc Capital Markets.

Kevin Ciabattoni - KeyBanc Capital Markets

Looking at the guidance for '15, just wondering if you could give us some color on maybe some of the margin headwind versus '14, is that just a matter of mix with airlift positions coming out? Any color you could give there would help?

John Fortson

Kevin, that's an accurate read. I mean I think really you've got -- we do have a sales and a margin mix shift going on a little bit, and so as airlift comes down, obviously that puts some downward pressure, and as the supply chain businesses sort of kick in, they have to kind of continue to produce volume to get the margins kind of back up. So that's kind of what's happening there.

Kevin Ciabattoni - KeyBanc Capital Markets

And then, just following up on Larry's airlift question, can you, John, maybe tell us how many positions do you have baked in for that NATO 18 contract? And then also what you guys have baked in in terms of the asset sales for next year?

John Fortson

So we have four NATO positions that we've been awarded. We're just waiting for the go-ahead, and I think part of that is waiting on the services agreement to be signed between the countries. In terms of baked into the plans for sales, I think we have a few, but not the full complement of aircrafts that are for sale.

Kevin Ciabattoni - KeyBanc Capital Markets

Last one from me. Last couple of quarters, you guys have given the billable hours in the quarter. I was just wondering if you could give us that for 4Q and maybe that comp for last year?

John Fortson

Yes, just hang on a sec here. I got so many pages in front of me. So, our billable hours over the last 12 months, we sold over 5 million, 5.035 million hours of work sold, right. That's a production efficiency of a 107%. We worked on 1,082 aircrafts.

Kevin Ciabattoni - KeyBanc Capital Markets

Do you have the fourth quarter number, if any John?

John Fortson

Fourth quarter, we sold 1,218,000. The production efficiency just so you know is 111%, so it was good.

Operator

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

Alex Heinen - D.A. Davidson

This is Alex Heinen on for J.B. today. So just a follow-up question on the MRO business here, you know you said that you were seeing a bit of cyclical downturn in the landing gear business and maybe some seasonality kind of washed into this quarter. Do you expect that to kind of go away starting in Q1 or should we see maybe a slow ramp backup from the space going forward?

Timothy Romenesko

So we see the summer is actually the toughest month in the hangers. All of the operators want to have their fleet deployed as much as they possibly can. So we see that the aircraft starting to come back into the hangers' kind of mid-second quarter and then ramping up through the balance of the fiscal year.

Also in the September, October timeframe we have access to an additional hanger in Lake Charles. We have some good customer interest in that. So that also contributes to kind of our optimism for the second half of the fiscal year. And we are training our workforce now in anticipation of some of the work that we have scheduled for Lake Charles. And so we are optimistic that it's going to turn into a successful operation.

Operator

Our next question comes from Stan Manne with Manne Family Investments.

Stan Manne - Manne Family Investments

A prime question I have is on your expectations for use of cash in 2015. You did mentioned debt reduction, but what about M&A possibilities?

David Storch

Yes. So the M&A pipeline is fairly robust for us at this stage. We do feel pretty good about our ratios and financial position today. So we may be looking for ways to strengthen our supply chain business during the upcoming period.

Stan Manne - Manne Family Investments

But you do have opportunities or targets that exists?

David Storch

We do.

Stan Manne - Manne Family Investments

You mentioned, kind of obliquely, the possible sale of any of your businesses, is that something?

David Storch

Let's stand to be more precise, so I have indicated is that we had certain underperforming business that we will solve this fiscal year.

Stan Manne - Manne Family Investments

So that means you possibly could have operating margin improvement?

David Storch

Yes.

Operator

Our next question is a follow-up question from Larry Solow with CJS Securities.

Larry Solow - CJS Securities

Just a couple of quickies on the trading, the parts business, what's the recent trends, pricing been in that piece?

David Storch

I would say, fairly consistent with historical pricing. It's steady and it's been pretty decent for us. We are seeing our returns improved in that business and we anticipate our returns will continue to improve in that business. The market is fairly bullish. It's a fairly positive market environment for that business today.

Larry Solow - CJS Securities

Right.

David Storch

I think we have done some smart things in positioning the company in a more international way.

Larry Solow - CJS Securities

And then you touched on the Lake Charles. I think it's just starting to ramp, and I guess part of the increased focus is on the wide-body, is that supported by Lake Charles?

Timothy Romenesko

Yes, Larry, it's Tim. Yes, it is. That would be kind of our main wide-body operation. We have a couple of aircraft in there now. But we do expect the Lake Charles facility to be busy as we get into the second half of the fiscal year.

Larry Solow - CJS Securities

And you expect that to be profitable this year for the full year?

Timothy Romenesko

We do.

Larry Solow - CJS Securities

Great.

Timothy Romenesko

We do. But we also do wide-body in other places in our network, but Lake Charles will be well-suited for it.

Larry Solow - CJS Securities

And then just last one, on the tax rate. I like the position there with the 32.7%. Is that ballpark, is that lower number, maybe not exactly that, but is that a sustainable number going forward or do you have something?

Timothy Romenesko

We went back, Larry, and we actually went back more than five years, but if you look back over the last five years, we feel that that's a comfortable rate that we sort of have achieved year-on-year. I mean, when you look specifically at what we're looking at for next year, it kind of triangulates in.

Larry Solow - CJS Securities

And then, but going out in the out years, is it hard to say?

Timothy Romenesko

I think, if history is any indictor, we think that's a good number.

Operator

And I am not showing any further questions at this time.

David Storch

Well, thank you for your participation today. And hopefully everybody has a nice day and including our share price. And I just want to leave everybody with the impression that the company, we are working hard to increase value and very focused on executing and delivering value to everybody. So thank you for your participation.

Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect. And have a wonderful day.

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