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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, ladies and gentlemen, and welcome to AAR’s Fiscal 2019 Fourth Quarter Earnings Call. We are joined today by John Holmes, President and Chief Executive Officer; Sean Gillen, 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, 2018. In providing a forward-looking statement, 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 President and CEO, John Holmes.
Hey, thank you very much and good afternoon, everybody. Thank you for joining us. We are pleased to be here to discuss our Q4 and full-year 2019 results. Our sales for the full-year were up 17% from $1.75 billion to $2.05 billion. Adjusted diluted earnings per share from continuing operations increased 36% from $1.73 per share to $2.36 per share.
In Q4, consolidated sales grew significantly, up 19% to a record of $563 million. Our growth in adjusted diluted earnings per share from continuing operations was even stronger, up 33% from $0.48 a share to $0.64 per share. Additionally, we had solid cash generation again this quarter as we delivered $44 million of operating cash flow from continuing operations.
We continue to see outstanding performance from our parts supply and government programs activities. In MRO, we saw another quarter of sequential improvement. This improvement was driven by actions we have taken throughout FY 2019 to address the tight labor supply, such as enhancing our recruiting efforts, partnering with various schools and repositioning elements of our workforce across our network. Our customers have also continued to work with us to increase pricing, which has partially offset higher labor cost.
During FY 2019, we focused on implementing a number of new programs, as well as executing on certain strategic initiatives. Our government programs team successfully implemented both our U.S. Air Force landing gear PBL contract, as well as the WASS INL program. Both programs were extremely large and complex implementations, involving almost 1000 new employees and contractors. We are very pleased with the results of these implementations, and more importantly, so are our customers.
As part of our previously communicated strategy to shift to an asset-light GOCO business model, we entered into a definitive agreement to sell certain assets in our COCO business. In addition to executing on these and other prior awards, we announced several new business wins throughout the year.
Most recently, in the fourth quarter, we announced the extension of our engine support contract with MTU. We also received certification from the Japan Civil Aviation Bureau, the JCAB, that will expand our Japanese customer base and further strengthen the company’s position in Asia.
Subsequent to the quarter-end, we announced an exclusive distribution arrangement with Woodward to support the U.S. military and a joint repair management contract with Global Aerospace Logistics, or GAL, focused on UAE military fleets. We feel very good about what we have accomplished in FY 2019 and are particularly pleased with our record fourth quarter results.
With that, I’ll turn the call over to our CFO, Sean Gillen.
Thanks, John. Before I comment on the financial results, I would like to mention the 8-K we filed this afternoon.
As noted, the company retained outside counsel to investigate possible violations of the company’s Code of Conduct, the U.S. Foreign Corrupt Practices Act, and other applicable laws, relating to the company’s activities in Nepal and South Africa.
Based on these investigations, we self-reported these matters to the U.S. Department of Justice, the U.S. Securities and Exchange Commission and the UK Serious Fraud Office. We will fully cooperate in any review by these agencies, although we are unable at this time to predict what action, if any, they may take. Given that this is now an open matter with the government, we will not be able to offer further detail at this time.
With that, I will discuss the company’s Q4 and full-year 2019 financial performance in more detail.
Our sales in the quarter of $562.7 million were up 19%, or $89.2 million year-over-year. We experienced growth in both segments, including a $78.2 million, or 18% increase in Aviation Services revenues and $11 million, or 37% increase in Expeditionary Services revenues. This significant increase in top line growth was primarily driven by sales in our parts supply activities along with the WASS program.
Gross profit increased 11.8%, or $10 million to $94.7 million. Gross margin was 16.8% versus 17.9% in the prior year period, primarily due to the labor challenges in MRO and mix in Expeditionary Services.
SG&A expenses were 11.2% of sales versus 13.1% in the prior period, which reflects the utilization of our existing infrastructure to support WASS as well as other growth. However, increased legal cost in the quarter did drive SG&A higher than initially expected.
Fourth quarter reported results include tax benefits related to reversals of state valuation allowances, which reduced income tax expense by $5.1 million, or $0.15 per diluted share. Adjusted income from continuing operations was $22.3 million, or $0.64 per diluted share. This compares to $16.7 million, or $0.48 per diluted share in the prior year.
Note that Q4 adjusted income from continuing operations and diluted EPS exclude the aforementioned state tax benefits. Additionally, full-year adjusted results exclude these Q4 state tax benefits, as well as the Q3 federal tax benefits discussed on the previous call. This change in presentation is to more clearly reflect the underlying performance of the business.
As John mentioned, in the quarter, we took action to reposition certain elements of the workforce across our network. We incurred after-tax costs of $0.7 million associated with these actions, which we have excluded from our adjusted results.
Capital expenditures for the quarter were $5.1 million and depreciation and amortization was $11.5 million. Net interest expense was $2.1 million, compared to $2.2 million last year.
During the quarter, our cash flow from operating activities from continuing operations was $44.1 million, which is net of a $13.3 million reduction in our AAR program. Also, we repurchased 291,000 shares for $9.5 million.
Switching to full-year results. Our sales for the full-year were $2.05 billion, up 17.4%, or $304 million year-over-year. Aviation Services sales grew 17.4%, or $285 million. Our sales increases were driven by our parts supply activities, as well as government programs. Expeditionary Services sales grew 16.6%, or $19 million due to volume growth for our mobility products.
Gross profit for the year increased 11.8%, or $35 million to $330 million. Gross profit in Aviation Services increased 13.8%, or $38 million, primarily due to parts supply and government programs sales flow-through. Gross profit in Expeditionary Services declined 16.1%, or $3.1 million due to changes in product mix.
SG&A expenses were 10.5% of sales versus 11.9% in the prior period. Adjusted income from continuing operations was $83.1 million, or $2.36 per diluted share, compared to $60.6 million, or $1.73 per diluted share in the prior year.
Capital expenditures for the full-year were $17.4 million, depreciation and amortization were $42.8 million. Net interest expense for the year was $8.5 million, compared to $7.9 million last year due to an average increase in the underlying interest rate. We feel very good about the strength of the balance sheet and the strong cash flow generation.
Net debt decreased $26.2 million to $121.6 million, resulting in net leverage of 0.7 times. Additionally, we returned $20.8 million to our shareholders through dividends of $10.5 million and share repurchases of $10.3 million.
I will now turn the call back over to John.
Thank you, Sean. As we enter FY 2020, we are really excited about the opportunities ahead of us and the outlook for all of our businesses. As indicated in our release, we are providing FY 2020 guidance for sales to be between $2.1 million and $2.2 billion, which represents a growth rate of 5% at the midpoint.
We expect diluted earnings per share from continuing operations to be in the range of $2.45 a share to $2.65 a share, which represents a growth rate of 8% at the midpoint of the range. As part of this guidance, we expect SG&A to be approximately 10.5% of sales and having an effective tax rate of 24%. This guidance reflects continued growth in our parts supply business, which is coming off of a very strong year, a partial recovery in MRO and growth in programs that reflects the full ramp of contracts that had already occurred in FY 2019.
Regarding WASS, while we have added a new site and anticipate adding more sites, we expect the financial performance and operational tempo of the WASS program to be consistent with last year.
Our estimate for SG&A as a percentage of sales reflects anticipated investments to support the growth of our business, including sales, quality, compliance and IT resources.
Regarding the effective tax rate, we want to note that last year’s effective tax rate adjusted for one-time items in Q3 and Q4 was 18.5%, which compares to an anticipated tax rate of 24% for FY 2020.
Overall, we are very excited as we enter FY 2020. Our markets are strong. We have robust pipeline of opportunities and we have significant liquidity to fund our growth. We look forward to discussing all of this in more detail at our Investor Day next week in New York on July 17.
At this point, I’ll turn it back over to the operator for questions.
Thank you, sir. [Operator Instructions] Our first question comes from the line of Rob Spingarn of Credit Suisse. Your line is open.
Good afternoon, everybody.
Hey, Rob, how are you?
I’m good. Thanks. And nice numbers from you guys. I wanted to ask you, John, to talk a little bit more about some of the strength in the quarter, particularly Expeditionary, it sounds like program is coming online. And is that sort of a one or two quarter event then it moderates?
And then if you could then extrapolate into next year and maybe a little bit further color on the relative business lines, it sounds like MRO’s low single-digit growth and other things are above that 5% rate?
Yes, sure. Just on the quarter – thanks. We’re really happy with the way the year ended, very strong results from the businesses across the company. As it relates to Expeditionary Services, we’ve announced a few wins in the mobility business throughout the year and we’re starting to perform on those wins and produce and ship our products.
So, we saw the benefit of that in Q4. And [when it’s due in] [ph] quarters, we expect to see additional benefit as we ship off against those wins. Thinking about the year ahead, MRO, as I mentioned, we expect a partial recovery. We’re encouraged by the results that we’re seeing both in terms of the labor attraction and retention, as a result of the initiatives that we implemented throughout the year. And we also feel good about the loading in the hangars heading into this year, as well.
And you’re right. I mean, as you think about the growth rate at the midpoint of 5%, certain businesses are above that, certain businesses are below that, but that represents our best view of the blended rate from where we sit today.
John, before you go further, how do we factor India into this MRO outlook?
Yes. Our India JV, I think, we indicated last quarter that, we expected construction to be complete this calendar year. Based on what we know right now, we still look for that. We’re working to finalize the agreement with the customer. And once all that’s done, we’ll be able to give more color on how that will play into the results.
Is there any revenue from that joint venture in the guide?
No, we’re not anticipating any.
Okay. Okay. Just with regard to the EPS guidance that the 10 – is the 10.5% SG&A maybe a little higher than you originally expected. Is there anything there maybe tied to this legal situation? We thought it might have been closer to 10%?
Yes. It is a little higher than we anticipated. As it relates to the matter that Sean mentioned in the 8-K, we haven’t factored in costs there. Although we did see some cost that came through in the fourth quarter. The 10.5% is really based on investments that we’re making around sales resources to promote the continued growth, particularly in the parts businesses, and then we are adding some IT resources.
We’re making a number of investments around the digital space and we saw some nice returns from those investments in FY 2019. So we want to continue to fund that growth, and then additional quality and compliance resources as well.
Okay. And then just to finish up, Sean, on the cash flow for this coming year, how should we think about either operating cash or free cash, especially off of what looked like a bit of an inventory build in this past year?
Yes. We do expect for this upcoming year to have a nice cash flow year to be cash flow positive. But we’re not giving any specific guidance as it relates to either free cash flow or operating cash flow for this upcoming year.
What are the moving pieces that prevent you from doing that?
I’d say just – the part of our business if we’re going to – if we see opportunity, which we think will continue to do so to invest either support parts supply in inventory or new business wins in distribution or other programs, we’re going to do that. And so we don’t want to limit our ability to grow the business by boxing ourself in our cash flow.
So you can’t even provide a range, a conversion range?
We’re not providing any guidance on cash flow.
Okay. All right. Thank you, guys.
Other than to say, we expect to be cash flow positive this year.
Yes.
Yes.
Right.
Right.
Thank you. Our next question comes from the line of Larry Solow of CJS Securities. Your line is open.
Great. Thanks. Good afternoon, guys. Could you – I’m not sure, if you can maybe give us a little more granularity just on the Aviation Services, the 18% growth, maybe just help parse this out? Is the WASS contract sort of similar sequentially that’s been running out like $50 million plus or minus top line? Is that fair to say?
Yes, that’s a fair range. Yes.
Right. So excluding that, you had essentially low double-digit, it looks like growth. And MRO itself in the quarter, was that actually – it sounds like you recovered sequentially. Was it still down year-over-year?
It was down year-over-year, but we did see sequential improvement.
Got it. And for next year, you’re looking to continue sequential improvement and a little bit, I guess, of growth for the full-year basis on MRO you said, right?
That’s correct. That’s correct.
And then on the Expeditionary side and obviously a nice bump up sequentially and year-over-year. And on the margin basis, a little bit of an improvement, I guess, sequentially. How come – I guess, the pressure year-over-year, is that also labor-related? And considering, expeditionary is predominantly mobility, which I know historically had been a very high-margin business, but I realize some high fixed costs in there. So I would think that with a pretty good bump up in revenue, your gross margin would improve there. Any thoughts on that?
Yes. I think you hit on it. A couple of moving parts there. One is labor, and we highlighted that in the third quarter and that continues to be an element impacting the results there going forward. And then also, there is a mix of – there is a mix issue there as it relates to margin on different product lines. And certain of those where we’ve wanted on producing are lower-margin product that you might – we might have otherwise seen.
Okay. And the [indiscernible] agreement to sell the COCO assets, I know, I think you had announced that last quarter. So is that still sort of set to close sometime in calendar 2019? Is there – any update on that, or…?
Yes, that’s correct.
Okay. And then on the WASS, as we look out, you said sort of similar to this year, or do we get incremental growth from Costa Rica and potentially additional sites, so are you…?
Yes. We – yes, good question. We are expecting similar performance in FY 2020 to what we saw in FY 2019. And as we’ve been on the program now, we – we’ve learned more about how it operates. And we added a new site. We anticipate adding more sites. But new sites does not necessarily correlate with growth of the program, as you do have some up and downs between sites throughout the year.
Okay. I mean, in the long run, would you expect to add more sites that you would get some growth, or I mean, does that necessarily – I would think that would equate with growth over the long run?
Again, if you look historically, still the program is in a [historical] [ph] low from where it was a few years ago. And so we believe that there’s potential for the program to grow from where it is. But as we look out over the next 12 months just based on what we see, we expect it to be consistent with the prior 12 months.
Okay. And then just lastly, just a follow-up to Rob’s question on the SG&A, because I know long-term, you had sort of this, like 10% goal. It looked like we were sort of getting close to that, maybe looks like, obviously, perhaps a little bit of a reset expectation there for some required investments. Would you view some of this stuff as one-time in nature? Is that a recurring type thing? How should we kind of anyway to sort of parcel that out?
Yes. I mean, based on some investments that we’re making, that’s what’s driving the 10.5% that we’re forecasting for this year.
Right.
But it is still a long-term goal to get to the 10% or below level and we did make meaningful progress. So if you look at where we were last year to this year, we made some really nice progress towards that long-term 10% goal. But given some of these resources that we want to bring on during the year, that puts us at the 10.5% estimate now.
And that doesn’t really – you’re not taking into account or will you sort of call that out on – in legal expenses, or…?
Yes. To the extent, we see legal expenses related to the item in the 8-K. We would – we’ll call that out.
And was there any that you mentioned I know in the prepared remarks, there was some of that already in Q4 and not significantly elevated to where you need to call it out, or…?
There was – there were expenses related to that in Q4.
But that’s in your operating numbers, right, you left that in there?
It’s left in there. We did not call it out.
Okay. But potentially next year maybe you don’t pull it out, but at least you might be able to call it out. Is that fair to say?
Yes. We want to see how it goes, but…
Right.
…likely we’ll highlight that.
Fair enough. Great. Okay. Thanks, guys. I appreciate it.
Thank you. Our next question comes from the line of Ken Herbert of Canaccord. Your line is open.
Hey, Ken.
[Operator Instructions]
Yes. Hi, good afternoon, John and Sean.
Hi, Ken.
Hey, I just wanted to follow-up on the guidance for fiscal 2020 on the top line. Are you seeing specifically within the parts supply side, it looks like maybe growth slows there a little bit. And I’m just wondering, within distribution and purchase trading, are you seeing any sort of sequential shift in those markets, or is it really just up against some very difficult comps from fiscal 2019?
I think it’s the latter. Yes, we had, as we’ve highlighted throughout the year, we had really substantial growth throughout FY 2019 in both the trading business as well as the new parts distribution business and we’re very pleased with that. We anticipate more growth in both of those business and we’re really happy with our market position in each one of those. But you’re absolutely right. You get up against some pretty significant comps as you go throughout the year.
Okay. And if I could on the trading side, I mean, we all follow, retirements are down pretty significantly, which is maybe lowering your access to some material, but probably more than offset by better pricing. Just can you talk a little bit more, John, about some of the dynamics you’re seeing in that market? And how with retirements and access to material, how we should think about maybe some of the changes or dynamics of that market here into fiscal 2020?
I think, that’s a great question. And I think you highlighted the two most important elements there. Retirements are down in certain areas. The material availability is tight, but you’re able to make up for that in price. And we have a market-leading position in the aftermarket parts business. And our team has done an exceptional job over the last several quarters dealing with that tight market and really outmaneuvering our competition to get our hands on the best material when it becomes available and that’s come through in the results.
And we feel very good about our position there. We feel very good about the availability of materials that we believe will be able to get our hands on versus our competitors. And really, I think, for our ground game is a lot better there. And even in a tight market, we’re able to get the best stuff and sell it at a premium.
Okay. No, that’s helpful. And just finally, as I think about the balance sheet and leveraging, you’re obviously, you could argue underlevered and you’ve got plenty of capacity. How should we think about maybe capital allocation this year? And is there anything else you can say or anything in the guidance regarding potential step-up in the buyback and or the M&A pipeline? I know, you’ve continued to invest for organic growth and I know, that’s clearly a priority, which is great.
Yes.
But how do we think about maybe other changes in allocation moving here, as you’ve got very favorable balance sheet position?
Yes. I think as you highlight, we feel good about the balance sheet and where it is and it gives us flexibility to invest. I think, priority number one, we’re going to continue to invest in the business to grow the business that we have. But as it relates to the capital allocation, after that, you saw some increased repurchase activity in Q4.
I think given the balance sheet and cash flow, we’ll continue to look to deploy capital that way to return capital to shareholders. And on M&A, we will – we do see some opportunities out there and some ability for us to add to our portfolio, and we’re going to look to do that over the next year or so.
Okay. Can you just remind us, Sean, what you’ve got left or what’s outstanding on the buyback authorization?
Yes. We got about 230 left on the buyback as the current authorization.
Great All right. Well, thank you very much.
Thank you. Our next question comes from Joseph DeNardi of Stifel. Your line is open.
Hey, good evening, everybody.
How are you?
John, when you look back at your kind of tenure at AAR and the MRO business, what’s the range of margins that that businesses has produced over time over a cycle? Where are they now? And it feels like there maybe towards the lower end? And what’s the strategy for improvement there?
Yes. You’re absolutely right. I mean, there is a cycle, the MRO business and we’ve talked about this –historically is a single-digit margin business. And it ranges from very low-single digits to high-single digits. But you’ve – we’ve definitely seen that. I would characterize us right now at the low-end of that range.
We did a lot in FY 2019 to improve that situation, both in terms of getting more price from the customer, as well as launching a whole series of different recruiting efforts and partnerships to develop our own proprietary pipeline of talent. And we’re starting to see the benefits of those now. And we’ve got a market-leading position in MRO. We’ve got a blue chip customer base. We’ve got great facilities, and we’ve got very supportive customers, and everybody in the industry is aware of this tightness of mechanics.
And so we’re getting, as I said in the prepared remarks, we’re getting a lot of support, as it relates to pricing to help deal with the tightness and supply. So I’m encouraged by the progress that we made in FYI 2019. I’m encouraged by the sequential improvements that we saw in the fourth quarter. I’m encouraged by the loading in the hangars that we have going into this summer versus where we were a year ago. And so all of those are positive things.
So, again, getting back to your original question about the cycle, while we’re at the low-end, these are all favorable results from the initiatives that we started over the last 12 months to move us back to the higher-end of the range.
John, is that an area of the business where you’re looking at M&A to maybe get yourselves some better pricing tower?
We’re looking at a number of different things there more specifically about our own footprint and rationalizing the workforce across that footprint that we took. As we noted in the prepared remarks, we took some steps during the first quarter to do that and we’re seeing the benefit of those things now. But as it relates to M&A, we – we’re always open to ideas and we will continue to look at creative solutions to deal with the overall labor challenge.
Okay. And then John, can you just walk us through maybe the pipeline of opportunities that you’re seeing and I hopped on to the call a little late, so apologize if you did this already. But just a pipeline of opportunities on the government business? And if there are any big ones pending? Thank you.
Yes. For competitive reasons, I wouldn’t disclose the specific bids that we have out there. But what I will say is that, there are some significant bids out there, both that have already been submitted and also those that are in the works.
I think it’s important to note that in the guidance, we – while we have a very strong pipeline of government opportunities, these deals take a long time to award and we are anticipating that even if we see some significant awards during the year, it’s likely that implementation wouldn’t occur to have a meaningful impact on the FY 2020 results. And we could talk a little bit more about the pipeline and the type of things that we’re looking at the Investor Day next week.
Got it. Thank you very much.
Thank you.
Thank you. Our next question comes from the line of Michael Ciarmoli of SunTrust. Your line is open.
Hey, good evening, guys. Thanks for taking the question. Nice quarter to close out the year here. Maybe just to stay on that topic, John, winning these government deals and having them taking time, I think, you just want a sizable C130 contract for the Afghan Air Force. Should we expect – is that going to be a contributor at all, modest contributor this year, or is that more of a 21 event?
It’s actually, it’s a recompete. So we’re on that contract today.
Right.
So we successfully competed to retain that contract. We have that – yes, so we have that – we had – we were confident in our ability to retain it and so that’s included in the guidance.
Got it. And then maybe Sean, just – your first time going through establishing a framework for guidance, maybe could you just give a little color on what maybe you did differently establishing the guidance this year, or did you guys make any philosophical changes to how you establish the guidance? And any color kind of given your prior experiences and what may be brought to the table?
Yes. I’d say, no major shift in kind of how we came about guidance in terms of the planning of the organization and budgeting process for the year. Obviously, we’re giving guidance at a different point in the fiscal year than the previous guidance. So I think that allows us to have a little bit more insight into what we’re seeing over the next 12 months rather than an 18-month period. But other than that, and I think largely consistent with other company has thought about creating its plan and budget and communicating to the Street.
Got it. Got it. And then John, just overall, airline customer behavior, I mean, we’re looking, there’s some – there’s definitely been some profit pressure for some of the carriers traffics decelerating. Just in general, what are you seeing from a behavioral standpoint from your customers? And even kind of weaving in, what’s happening with the MAX, presumably that’s creating some more opportunities for you guys? But maybe just if you can just a little bit of color on the overall market conditions and how you’re looking at them, as we wrap up the summer here and get into the fall?
Yes, I think, overall, and I think about our most transactional businesses where we’re in, day-to-day contact with the customer, notwithstanding those the macro factors that you mentioned, the pace of activity that we’re seeing on a day-to-day basis is as robust as we’ve ever seen. And that – but that’s enhanced by what I said earlier about our market position and the fact that we’re able to get material that others cannot.
And as it relates to the MAX, we talked about that in the third quarter. And we’ve seen some shifting in the MRO schedule as a result of the MAX. And we have seen a slight, I’d say increase in parts demand as a result of the MAX, but nothing that really influenced the results, at least, in the fourth quarter. But certainly, that’s something that we’re monitoring closely.
Got it. And then just the last one for me. The labor pressure and you guys talking about pricing and getting support from your customers. I mean, in short, are you guys able to increase your pricing on existing contracts to pass through some of those higher labor rates you might have to be offering out there?
Yes, we have.
Okay.
We have been able to renegotiate. Not – we have not been able to pass dollar for dollar, but we have been able to get some relief.
Okay. And all of your customers have been open to that renegotiation?. I mean, they obviously understand the dynamics in the marketplace. So it sounds like they’re being receptive to that?
Yes, the customers are being supportive.
Okay. Got it. Got it. All right. Great. Thanks, guys.
Right. Thank you.
Thank you. At this time, I’d like to turn the call back over to John Holmes for any closing remarks. Sir?
Again, thank you for your time and interest in the company. We’re really proud of what we accomplished in FY 2019 and very excited about the opportunities ahead of us in FY 2020 and look forward to seeing everybody at the Investor Day next week. Thank you.
Thank you, sir. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time.