AAR Corp. (AIR) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the AAR Corp. Fourth Quarter and Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference call Mr. Chris Mason, Director of Corporate Communications. You may begin, sir.

Thank you, Kevin. Good afternoon, ladies and gentlemen, and welcome to AAR's fiscal 2013 fourth quarter and year end earnings call. Before we begin, I'd like to remind you that 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 fiscal year ended May 31, 2012. 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'd like to turn the call over to AAR's Chairman and Chief Executive Officer, David Storch.

Thank you, Chris, and good afternoon. Thank you for joining us today to discuss what has been an excellent year for AAR. I'm joined in our boardroom by Tim Romenesko, our Chief Operating Officer; and Mike Sharp, our acting Chief Financial Officer. I am also very pleased to have our incoming Chief Financial Officer, John Fortson in the room with us here today. As you know, John joins us from Merrill Lynch, where he was the head of the bank's Global Capital Goods sector. Over the years, John interacted with the company over the last nine years and has a good familiarization with the business and the company and the challenges and the opportunities. And we're very excited to have John join our team. I'd also like to note that in terms of leadership experience, prior to his finance career, John was a company commander in the 82nd Airborne and is a West Point graduate. We're excited to the strength and experience he brings to our team. And John will assume the CFO responsibilities effective tomorrow. I'd also like to thank Mike Sharp for the job he did, acting as CFO over the past 10 years. Mike has been with the company for quite some time and will continue on with the company as our Vice President, Chief Accounting Officer and Controller. So moving along, here are some of the highlights from the quarter. Sales were $554 million. This solid performance was driven by continued strength in our commercial aviation businesses, including our MRO operations and Telair. Further, although we saw defense-related softness in certain areas, we continue to see strong results from our Airlift business, even with no additional aircraft or contracts being added during the year. Operating income in the quarter adjusted for a charge on the KC-10 program that Mike will give you more details about in a few minutes, grew to $39 million. And adjusted net earnings for the quarter was $0.50 per share, up nicely compared to $0.45 per share last year. And for the full year, sales were $2.14 billion, an increase of 3.5%. We grew adjusted operating income by 5.9% to $152.4 million and we reported adjusted diluted earnings per share of $1.85. As we look back at the year, it's important to point out that we also generated $125 million of free cash flow, allowing us to reduce our net debt position by $91 million. We retired the 1.75% convertible notes, which also reduced the number of shares used in our diluted share count by 3.4 million shares. We bought back nearly 1 million shares of common stock in average price of $14.90. We paid out $0.30 per share in dividend. And we also refinanced the portion of our revolver debt, locking in at a low interest rate. As you can see, we are working to pull all of the appropriate levers that create value for our shareholders. We're pleased with what we accomplished, both in the quarter and in the year. So if I may, Aviation Services, our segments performed well in the fourth quarter with sales up 7% versus prior year. I want to recognize -- I want to take a moment if I could and recognize the incredible work that our employees at our Airlift business are doing on the ground and in the air in Afghanistan and other locations. This is not easy work and these teammates are performing brilliantly. They have demonstrated exceptional levels of reliability and performance. Airlift revenues grew by 28% this year, strictly due to outstanding operational performance and high levels of readiness. We were pleased that the U.S. transportation command awarded as an option year, expense of $98 million for our fixed wing aircraft. This covers a meaningful portion of our revenue expectation for the year ahead, and in general, demand remains strong. We remain confident that our operational readiness will continue at high levels in the coming year. When we bought this business in 2010, we saw a long-term demand for this type of capability. Early on, we faced certain challenges transitioning the business. And over the past year, we made great progress exceeding our operational plan and positioning the company for the future. In MRO, I'd like to share with you that we had very strong fourth quarter, an excellent year, and this continues to be a growth business for the company. To update you on our operations, we have facilities in Indianapolis, Miami, Oklahoma City and Hot Springs. And in this fiscal year, we added Duluth. We delivered close to five million man-hours of work this year, which in essence is showing steady growth over our prior year. We continue driving efficiencies on our operations. And as a result, we are seeing improvements in margins. We have a strong position in the U.S. domestic narrow-body market, and now we are looking for opportunities to serve the wide-body market as well as to see if we can grow our footprint internationally. Very pleased with the progress we've made operationally. We've caught the notice of people, not just here in the States, but also around the globe, and this is creating opportunities for the company that in the past we didn't necessarily see. Our commercial supply chain management park support business had a solid quarter. We see steady demand for our products on the commercial side, and our view is that spares market remains fundamentally healthy and is expected to pick up over the next several months. And as many of you know, who have been following the company for quite some time, we have a really good leadership position in this market. And our view is that there's tremendous opportunities for us to go ahead and pivot off of our current position and see steady growth and some really exciting stuff happening in that business over the next year in front of us. We did see some weakness on our Defense Logistics business, largely due to the falloff in activity in the KC-10 program. Mike will give you the details, but as a result of adjusting our forecast to reflect lower flying activity, we incurred a $19.5 million after-tax charge in the quarter. Flight hours on the KC-10 program have been at historically low levels. We are, however, continuing to seek ways to improve the economics of this program. In the fourth quarter we delivered one of two specially-modified aircraft to the Colombian Air Force, that we discussed during our last call. The second aircraft has been delivered in the first quarter of fiscal 2014. This project is a great example of a complex undertaking that brought us together over eight different teams within AAR and is representative of our unique and integrated capabilities. As an additional piece of good news, we announced yesterday an award to deliver two customized 737 aircrafts to the U.S. Marshals Service. In both these instances, these were aircraft that we went on to the market procured, we managed the aircraft through overhauls and conversions, and we manage the engine overhauls, landing gear overhauls, et cetera. So I think it's a good example of the capability that AAR has, and in both regards these are defense and government related customers looking for lower-cost solutions. In Technology Products, we've had good results. We continue to see good results from the acquisition of Telair and Nordisk. And of course those gives us a lot more exposure in this sector towards the commercial markets. But overall, this past year has been a challenging one, given the pressure on defense budgets, and its impact, specifically on our mobility business. We had a significant decline in revenues as we had forecasted during this period in mobility, and yet we were able to go ahead and still have a -- I might add that even though they've had a significant reduction in revenues, they still are running a profitable business with decent margins. Telair showed improvement and finished the year with a particularly strong quarter if we look at it on year-over-year basis. And at Nordisk, we're in the process of introducing some new products, one of which is around fire contamination and elimination with a venture that we have with our partner, DuPont. In closing, as we move along our new fiscal year, we will continue to focus on execution. We'll look for ways to grow our business, to improve our margins, and we'll remain focused on cash generation, something that we're very proud of as you review this year's results. And the goal is to provide superior products and services to our clients and to deliver overall value to our shareholders. So with that, I'd like to turn the call over to Mike and fill you in on some of the financial details.

Okay, thanks, David. I will now provide a bit more color around the financial performance of the company during the fourth quarter, including comments around interest, cash flow, capital expenditures and capital structure. John and I will both be available the rest of the day to answer any questions that you may have. As David mentioned, revenues in the fourth quarter were $554 million versus the prior-year level of $563 million. Aviation Services revenue grew 7% to $417 million, driven by strong performance at Airlift and in our airframe maintenance facilities, offset slightly by lower revenues and aftermarket support for our defense customers. Our airframe maintenance facilities continue to perform well and at high-capacity utilization. Our Duluth facility is up and running with two lines, and expected to go to a third line in September. Technology Products revenue declined 21% year-over-year to $137 million, driven largely by the expected decline in demand for mobility products, which saw a $47 million sales decline in the fourth quarter compared to the fourth quarter of last year. This was positively offset by strength, as David mentioned, in Commercial Cargo systems, which rebounded in the quarter. Consolidated gross profit margin in the fourth quarter was 10.9% and includes the KC-10 related charge. As you know, we are currently in the middle of a multi-year support program, teaming with Northrop Grumman to support the Air Force's fleet of KC-10 aircraft. Our primary responsibilities include inventory management and repairs of critical components. The contract has two primary revenue streams: First, a flight hour stream for which we are paid based on hours flown; and the second revenue stream is the over and above, which is for services not covered in the flight-hour portion. Under generally accepted accounting principles, we are required to project the future profitability of the flight hour portion over the life of the program. In order to make those projections, we have to estimate future flight hours, as well as costs to support the fleet. In fiscal 2012, we reduced the profit margin on the flight hour portion of the contract from 8% to 2% due to higher-than-expected costs. As we entered fiscal 2013, in order to support the 2% margin, we established cost-saving targets to reduce spend over the life of the program. I'm pleased to report that we exceeded our first-year savings targets. However, beginning in the second half of fiscal 2013, we experienced a decrease in flight hour revenue due to lower operations tempo in what we believe were the effects of sequestration. To put this in perspective, the annualized level of flight hours in the second half of fiscal 2013 was 28% lower compared with the annualized level of flight hours in the first half of the year. As a result of this unexpected and significant decline in flight hour revenue, together with our revised forecast for future usage of the fleet, which is below our previous forecast and below historical usage, we further lowered the revenue and profitability forecast for the flight hour portion of the contract, resulting in the $19.5 million after-tax charge during the fourth quarter. In fiscal 2014, we will record 0% margin on the flight hour portion of the contract, which is estimated to be approximately $45 million of revenue. And for the over and above portion, we will record normal margins on approximately $35 million to $40 million in revenue. Adjusting for this charge, the gross profit margin in the Aviation Services segment was 16.1%. As for the Technology Products segment, the gross profit margin came in at 15.1%, which was below our expectations due to our machining unit missing its targets. Midway to the fourth quarter, we began to implement a series of initiatives to improve the performance of our machining centers, including further integration with other manufacturing centers in the Technology Products segment. Moving on, SG&A as a percentage of sales in the fourth quarter was 9.5%, which is in line with our overall expectations. Net interest expense for the fourth quarter was $9.6 million, a reduction of $1.8 million from the prior year due to lower overall debt levels. As David mentioned, we're very focused on cash generation. During the quarter, we generated $75.1 million of cash from operations, and our CapEx was $13.7 million. Full-year cash from operations was a record $162.9 million and free cash flow was $125.3 million. During the fourth quarter, depreciation and amortization, including amortization of stock-based compensation, was $22.5 million. As it relates to our capital structure, in late April we completed an add-on offering of $150 million principal amount of our 7.25% notes. The notes were sold at a price equal to $107.5 million of the principal amount for a yield-to-maturity of 6.1% to 8%. The net proceeds, after expenses, were approximately $158 million and were used to reduce the outstanding borrowings on our revolving credit agreement. At May 31, there's $120 million outstanding under our revolver, compared to $280 million last year. Our net debt to capital ratio is 40.8% at May 31, 2013, compared to 45.6% last year. We enter fiscal 2014 with 38.6 million shares in the diluted share count, which is a full 4 million shares below last year at this time. Thanks for your attention. And I will now turn the call back over to David for some closing comments.

Thanks, Mike. Let me conclude with our guidance for fiscal year 2014. As stated in our press release today, we currently expect 2014 consolidated sales in the range of $2.175 billion to $2.225 billion. In Aviation Services we expect to see continued strength in our supply chain and MRO repair businesses. We also expect our Airlift business to continue to perform well as we work towards identifying and capturing additional market opportunities. In our Technology Products business, we expect to see revenue stability in the defense environment that remains under pressure. We believe our Mobility Products business, which was a major source of pressure in fiscal 2013, has leveled off. Our major initiatives in the segment are focused on operating efficiencies and innovation in lightweight solutions. Across the company, we intend to continue to drive improvement in our operating margin. As a result, we are currently guiding for a full year diluted earnings per share in the range of $2 to $2.05. Thank -- at this time, I would like to thank you for your participation and listening to our update. And we're now open for any questions you might have.

[Operator Instructions] Our first question comes from Larry Solow with CJS Securities.

David, I was wondering or Tim or whoever, just can give us sort of a read on the aviation market in general sort of where your customers stand, where you think -- sort of your pulse as we stand today?

Yes. We feel pretty good about commercial markets. We think we had a good year. We have a fair amount of initiatives underway. We have more visibility and opportunities than we've had in the past. So yes, I think that the commercial markets look okay.

Sort of, things -- sort of capacity wise, and load factors, it seems like things are sort of slowly ticking up, is that fair to say?

Yes. Our sense is that our customers are doing well. And that -- they're looking at a lot of different things. They're looking at a lot of -- it's a lot of moving pieces. You have the Delta taking on the Southwest aircraft, the 717. You have our building up of our people count, if you will, in Duluth, so we can handle more work up there. Yes, I -- our international business opportunity pool looks pretty strong. So I'd say, all in all, our distribution business has done well. We didn't really disclose much -- talk about Unison, but our Unison distribution business is very strong, very -- double-digit growth on a year-over-year basis. So, yes, I think we got a lot of good stuff going on. The MRO shops are full. It's pretty busy. Of course it's summer time, so they're a little less full than they've been in other parts of the year. But on a year-over-year basis, they're fairly strong. We continue to seek out engineering service opportunities, but the demand is there. There's few situations that we're competing for that we hope to win. So, yes, I'd say the feel is pretty good on the commercial side.

Just two thoughts. The Unison deal, I think when you signed that it was supposed to ramp and inevitably reach sort of, I think, $600 million plus or minus over 10 years. Is it sort of reaching its $60 plus million potential sales?

Not quite there this year. I think that we should start hitting that target this year, we're coming up to in the following year. But we do have nice progress from year one to year two. And we would expect that -- there's no reason to believe that progress won't continue into year three and on to year four.

Could you just remind be on the Colombian Air Force, I think you probably discussed the last quarter. What's the general -- what was the impact on the P&L, and with the sale -- the deal you announced yesterday be similar?

Yes. The -- so the Colombian deal was -- we took two commercial aircraft and converted one into a freighter -- full-freighter and we converted 1 into a combi, which is part freighter, part passenger. We delivered the first aircraft in Q4. It had a -- not a significant impact on earnings. It had good impact on cash because we utilized some assets that we had in stock to go on the air -- to fit on to the aircraft. And so we converted some inventory into cash, but we fell out of margins. So it was still a profitable transaction. It contributed to the quarter's results. And then, the second aircraft delivered this month -- earlier this month to the customer and had a little bit better margin than the first aircraft. And, yes, I think it was a good transaction for the company -- we've also received some follow-on business and we have a reason to believe that there may be more business opportunities to the company with the customer. They're very pleased with the product. They showcased both aircraft at their airshow on July 11 this month. And the aircraft will be on show at a Chilean airshow in March next year.

Okay just last question, just on free cash flow, which was ridiculously good this year. I mean is that over $3 a share versus $1.80 or whatever and EPs, is that sort of -- I imagine not quite sustainable, but how should we look at that as we go out?

This is a very critical component for us, so we're working very hard. Compensation plans are tied to cash flow generation, so the business is very focused on turning lazy assets into cash, as well as generating better margins and better throughput. So hard for me to quantify precisely if we get to the same level, but I think directionally we'll be in the same ZIP code. We will not have the same kind of yo-yo effect that we've had in prior years when we've had successful cash generation. We believe this cash flow will be steady. Will it be exactly these levels, Larry? Maybe not, but they'll -- they will be solid -- you should see solid cash flow numbers coming from the company this year.

Our next question comes from J. B. Groh with DA Davidson. J. B. Groh - D.A. Davidson & Co., Research Division: I had a question on your realignment of the KC-10 business. I know you've baked in $45 million at 0% margin. Is there any potential upside to that, if you can work on some costs?

Yes. The upside will be in the flight hours. So we've taken our conservative look at the flight hours as a result of what we've experienced the last six months. And -- so we've forecast -- we're forecasting fairly low aircraft utilization. And our revenue from the flight hours comes through the utilization, or the number of flight hours that they operate. So we have mild in very low hours. If we get a pickup as a result of the movement of assets away from Afghanistan, or if there's a buildup in Syria or place like -- or something like that, then we would expect the business to be more profitable than the 0% that we now have baked in. J. B. Groh - D.A. Davidson & Co., Research Division: But has the customer told you any reason why the flight hour numbers are down so significantly?

No. The customer has not divulged because, first of all, our customer is Northrop Grumman. Northrop Grumman's customer is the Air Force. We have had indirect contact with the Air Force, but most of contact is directly through Northrop, and they do not have visibility precisely as to why or visibility as to what we should be expecting. Now what we've done is we've looked at the flight hours going back since 1998, and that's as far back as we can get records. And we have been forecasting average usage in the fleet. And we've been a little bit disappointed or surprised that the actual usage, which is at this historical low level. So we think we took a prudent action at this point in time. And if the flight hours resume to historical levels, then this will be -- this segment of the contract will be -- once again, will be profitable. J. B. Groh - D.A. Davidson & Co., Research Division: Okay. And then on -- you mentioned a pretty decent results in Airlift, and it sounds like you perhaps picked up some share there. Is that correct?

No. I think what we've seen is we've operated the aircraft much more efficiently than we have in the past. So you may recall, JB, when we bought this business, we felt there was about $25 million of income on the table that could be assumed once we were able to put certain disciplines in place and the keep the aircraft operationally ready. And the team, led by Randy Martin, has done a remarkable job this past year in having those aircraft in a ready position. So the growth that we've had is really -- actually with fewer aircraft in theater, we've had a significant growth in sales and in income coming from that business. J. B. Groh - D.A. Davidson & Co., Research Division: So just better utilization and asset management is what you're saying?

Absolutely. We've actually freed up some assets that we can possibly apply elsewhere, or if not sell. J. B. Groh - D.A. Davidson & Co., Research Division: But with all the talk of the drawdown, that sort of thing, is that market still -- I mean is it growing in terms of more outsourcing and more potential bid activity?

There's additional demand. Actually, as we sit here today, there's a demand that's been identified in Afghanistan. So there is an RFP that's on the street to support the Afghan nationals. So we are -- we're in there with a bid and hopefully we'll have news in the next few weeks. Other than that, we are looking for other places where we can get utilization and take some market share there -- as we've talked about before, there is a pretty broad and varied application for this kind of capability across different government entities. And it would be our intention to go ahead and compete and capture some of that business. J. B. Groh - D.A. Davidson & Co., Research Division: Maybe guys, you can give us a portfolio update in terms of the owned aircraft and the ones that are in the JV.

Are we talking about the aircraft leasing portfolio now? J. B. Groh - D.A. Davidson & Co., Research Division: Yes, yes.

Mike?

JV, there's six aircraft in total. Two of the aircraft are wholly-owned and there are four aircraft that are owned under joint venture.

JB, also keep in mind now, these aircraft that we've been talking about that we traded here with U.S. Marshal service and with the Colombians, were aircraft that we did not own before we made these transactions. So these are not -- these aircraft did not come from our inventory. They were aircraft that we sourced, purchased, fixed, and then in some cases modified, and then sold. J. B. Groh - D.A. Davidson & Co., Research Division: Great. And then lastly, Mike, could you maybe give us what's embedded in your 2014 outlook in terms of a tax rate and interest expense?

So for the tax rate, we're thinking in the 34% to 35% range, which is where we historically have been, notwithstanding some of the benefits that we've had from some of the state tax planning strategies we've incorporated over the last couple of years. In terms of interest, it's fairly steady with the fourth quarter interest levels. J. B. Groh - D.A. Davidson & Co., Research Division: Okay, so about 9%, 6% net?

Maybe slightly higher.

Our next question comes from Jon Braatz with Kansas City Capital.

David, can you talk a little bit about the A400 program? I think the plane started flying. Do you expect any revenue from that program this year?

Yes. We should have revenue. We could have revenue as early as Q1, but we will have that revenue in Q2. The program, as you said, is very -- they're very close. They have not delivered the first aircraft, which is MSN 7 to the French Air Force yet, but they are planning to do that pretty much any day now. And it should happen before this month is out actually. So, yes, we've made a lot of progress on that program.

I think the program has shrunk from the original size. And you've capitalized a lot of costs associated with that program. Is there any risk that those, that you might have to write-off some of those costs? Or how are you going to -- how is that going to be reflected in the revenues coming upstream?

Yes. So as we see it now, based on the price that we have per system, we did have a renegotiation with Airbus that we completed here recently. In that renegotiation, we have identified kind of scope of work that we will now be doing, which is slightly less than the original slope -- scope. And then we have a pricing, which is very similar to the pricing we have for the full scope. We anticipate that over the life of the program, we will recover our investment through the selling price that we have. We also will have spare sales. We've had some already. We had some that went into Q4. And we anticipate additional spare sales throughout the fiscal year. J. B. Groh - D.A. Davidson & Co., Research Division: Well since you capitalize a lot of these costs, I guess the cash flow from any revenue would be rather significant.

Yes, that's correct. Yes, you should expect solid cash flow as we sell A400M systems correct.

Okay. On the Airlift business, how many -- how much of the portfolio is sort of booked for this year? And how many may come off contract?

The fixed wing are booked all the way through. A very large percentage of fixed wing are booked all the way through May of next year, so May of '14. There are the -- the rotary wing contract, one contract expires in November and one contract is up for an option year in October. We have a high level of confidence that a large percentage of those assets, even the ones that come off contract, will be transferred over to the contract that still has option years remaining, at least that's our intel as we sit here today.

How many rotary aircraft do you have?

22? There is -- I should know it, 19, 2 and 2. So 24.

24. And so only one...

24 in Afghanistan, approximately, okay? We can get you the exact number.

No, that's fine. So -- but only one comes off-contract in November and there's one with an option. So basically, 22 solid?

No one contract. The contracts are for multiple aircraft. We have it laid out in our 10-K, and we can get you that data here very easily, I just don't have it right at this minute.

Our next question comes from Doug Carlson with Bank of America.

If you could just give us some kind of broad color on the Middle East and kind of what the demand picture looks like there. I think you've done a great job navigating that area. A little color on that would be my first question.

Well, let's see. I mean, Middle East is -- in terms of the -- we've opened up an office in Abu Dhabi to capture more commercial business in the Middle East. So where my head is kind of going in the Middle East right now is to try to figure out how we take advantage of their order book and be in a position to support their growing fleets. So that's the first thing that comes to mind when I think Middle East. Secondly, of course, is Middle East as it relates to U.S. activity. Today we do virtually no business in support of the State Department in Iraq, although there are certain opportunities to do business in support of that customer, we are not currently participating. If we think of Afghanistan as the Middle East, we have a significant presence there with our Airlift operation. Our mobility business, which in the past has supported U.S. operations in moving supplies into that, the other has been softened by the reduction in activity. And then we have recently won a contract supporting the Saudi Arabia -- an effort in Saudi Arabia, where we've -- our C4I business is providing some integration work, as is our container -- our mobility business providing some shelter. So I believe that the Middle East continues to be an area of opportunity for the company. We've invested by opening up an office, as I indicated, in Abu Dhabi. We're staffing that office with one of our senior marketing types and we've had some good success. I might add also that, that office is also handling our activities in Africa. And we have had some success, most notably in Kenya. But we're also touching other potential customers in the Africa region. So for this company, that territory from a commercial vantage point has been relatively negligible in terms of results. And we have some optimism that that will be a productive region for the company.

Excellent. And I guess moving to technology kind of segment, it looks like you expect it to stabilize next year. I mean what's driving that improvement?

Well, I don't think it's improvement as much as we don't think there's going to be a lot more decay. So we think we've -- the major piece -- you got two major pieces in that sector. You have the Mobility business, which historically has been AAR's strongest piece of its technology business. And that business has suffered from reductions in activity in support of the U.S. government movement of troops and supplies. I think Mike indicated on a year-over-year basis, we have a revenue decline of $47 million. But I did also indicate that that's been a profit -- continues to be a profitable business. But our carrier and our commercial Cargo Systems businesses is relatively strong -- it's strong. We're on some very good platforms. We continue to support virtually all Airbus-manufactured aircraft. And we have a position on the 747-8 aircraft. So we think the commercial cargo business is decent. Is it gangbusters? No, but its decent. And then we have, as we alluded to from the last questioner, we will start making deliveries of A400M cargoes this year. And those are approximately $1.5 million per unit.

[Operator Instructions] Our next question comes from Stan Manny with Manny's Family Investment.

Two basic questions. One, where do you envision is the growth opportunities for 2014 and beyond?

Stan, I think you'll see continued growth in our commercial activities, so I think you'll see some -- you'll see growth in our spares business and our logistics -- spares and logistics. You'll see growth in our MRO activities. And you'll see growth in our -- you should see growth in our commercial cargo systems arena. So I think you'll see some new programs. You'll see some new wins, I believe. And so you'll see, I think, continued progress in the commercial space. I think on the defense side, we've had some success here recently creating some of these unique aircraft solutions for customers. And we continue to kind of canvas the world to see who else might be interested in that kind of lower cost solution. And whether we can close something and deliver within the next fiscal -- this next fiscal year or not, might be a question. But I do believe that we will have continued success doing that kind of activity. So, yes I think you'll see good growth out of commercial markets. Our defense markets business should hold its own, notwithstanding any other dramatic cuts to budgets. And yes, I think that's where you'll see the action.

Two -- one question that's an add on to this. The American merger or takeover, do you see that as a near-term opportunity in your maintenance business?

Well, the maintenance business -- as we sit here today on this call, we have a capacity problem, right? Because we don't have a lot more space. We have some space we can accommodate some additional demand, but we couldn't accommodate a dramatic requirement as we sit here today. Now we're thinking about how we deal with that and we're trying to create -- we're trying to open up some space, so to speak. But at this moment as we sit here today, it would be hard for us to digest meaningful slug of airframe business. Now, we will -- we do think that we have a better shot at improving some of the component activity. We have -- American has not been a significant customer for the company over the years. US Air, we've had decent relationships with US Air. We do landing gear repairs, we do component repairs. We sell them some parts. So as they -- as the two businesses merge, and as the U.S. Air leadership moves into a more prominent role and a merged entity, we think that there'll be some opportunities for the company. I can't comment on the duration -- when you're talking about short term -- we're not baking in any short-term pickups -- meaningful pickups. But I think longer term, I think it bodes well for the company.

Okay. My last question is, one I ask all the time. You have a gigantic amount of free cash flow. So can you give us your vision or priorities, whether it would be buyback, a new acquisition, pay down a debt -- could you kind of flesh that out for us please?

Yes. I think that there are a few different parameters that go into that decision. So when you look at last year, we generated a significant amount of cash. We used some of that to pay down our debt, so we feel very pleased with the improvement in our debt to equity position. We used some of that to pay down -- to buy in stock. And so if you see the average purchase price of our stock, 1 million shares at $14.19 a share. And then we took some of the cash and we invested it back in the business. And I think as we look forward, I think there'll be a combination -- we'll apply to capital. We still have -- we have about $35 million remaining on our authorization from the board to purchasing shares. I think that's probably -- that's an option. I believe continuing to pay down debt is important to us. I think we'll probably, at some point in time, take a look at the board level, take a look at the dividend and see how we feel about that. And I think, obviously, returning capital and giving our shareholders a good return on their capital is important to us. So we will continue to explore all these things. Acquisitions are also in the mix as well. So, there a few different things that we're looking at, that fit in strategically very well with what we're doing. And we may be in the position to pull the trigger there. As we sit here today in the month of July, we had a very good cash generation. A good month in June. Our net debt position has improved from year end at $91 million improvement in net debt. We knocked off another $40 million of debt improvement. So when you look at June of '12 versus June of '13 our net debt is down $130 million. So we will continue to focus on all the different places we can put -- we can use the capital.

Okay. As you're sitting here today, looking at the -- what's available on the acquisition front, because your free cash flow seems to be better than many of your comparable competitors. Do you see any near-term acquisitions as possible -- good possibilities?

Stan, I'd rather not comment on that, if you don't mind. I believe that we will continue to look for good deals as they present themselves. I think I indicated some of the objectives that we have for the year. So if opportunities present themselves that match up with things that we're trying to do, then we may pull the trigger.

Our next question comes from Larry Solow with CJS Securities.

Just a couple of follow-ups. The interest rate assumption, or the interest expense assumed to be basically flat from this quarter. But does that assume then that you don't pay down new debt? Or it's just sort of -- just sort curious how that works out.

Well we've got, Larry, we've got some converts that mature. Well there's -- converts that mature, I think in February -- late February, early March, so that comes out later on in the year.

Okay.

No. But Larry, I think you're looking at it correctly.

That's fine. David, just in terms of the Airlift business, the sort of the big concern is what happens after Afghanistan or -- and I believe you have a lot of options. But do you see Afghanistan really, not from your sake, but just on the macro level, do you see Afghanistan's needs or demand for Airlift dropping significantly in the next year? Or do you think this can go beyond 2014?

I'd be surprised if it doesn't go beyond 2014.

Right. Okay. So there's a good chance that you may -- not that you're not looking for opportunities, but you may still be significantly there in '15?

Yes.

Okay. Last -- just a housekeeping question. The charge -- the $29.8 million debt all go into gross margin -- was that all cost of goods, or was there some -- would there be piece of that go somewhere else?

You know it's interesting Larry. It does all impact gross profit. There was a portion of it that we were required to reduce revenues. And then the rest of it went to cost of sales. But the important part is that it all impacts gross profit.

So I guess just simple math, you can't add that back to gross margin, because I didn't get a little higher gross margin than what you guys said. Is that right? Am I doing -- I can't do that?

Right. Because there was a -- when you adjust for the impact that the sales would have been a little higher, so I think that's why you're probably off.

And I'm not showing any further questions at this time. I'd like to turn the conference back over to our host for closing comments.

Well, thank you, everybody, for participating today. Once again we're very proud of the year that we just ended and we're excited about the year that we're about to enter. Thank you so much.

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