AAR Corp (AIR) 2002 Q3 法說會逐字稿

This is Premiere Conferencing, please stand by, we're about to begin.

Good day everyone and welcome to the third quarter earnings release conference call.

Just as a reminder, today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to Dawn Kaiser with investor relations. Please go ahead.

Thank you . Good morning ladies and gentlemen, and thank you for taking the time to participate in this morning's conference call. Before we begin, we would like to remind you that certain of the comments made today relate to future events, which are forward-looking statements as defined in the private securities litigation reform act of 1995. Please also refer to the forward-looking statement disclaimer contained in the press release issued this morning, as well as factors which may affect future results discussed in our filings with the Securities and Exchange Commission. By providing forward-looking statements the company assumes no obligation to update the forward-looking statements to reflect events or circumstances after the date of such statements, or to reflect the occurrence of anticipated or unanticipated events. At this time I would like to turn the call over to our President and CEO, David Storch.

Thank you Dawn, and good morning. With me today is Tim Romenesko, our Chief Financial Officer. AAR reported results this morning which reflect a difficult commercial airline environment which continues to be affected by the aftermath of September 11th, and the relatively weak economy. For the third quarter, the company reported a net loss of 2.3 million, or a diluted loss per share of eight cents. Sales for the third quarter were 143.5 million. This compares to a year-ago quarter when the company reported sales of 200 million, net income of 5.4 million, and diluted earnings per share of 20 cents. The company believes it is beginning to see the aviation, and specifically the airline industry, slowly emerge from the lows experienced immediately after September 11th. Consolidated sales decline from the prior year principally due to the reduction in airline capacity, and the resultant reduction in buying activity for many of the company's airline customers. Consolidated sales were relatively flat, when compared to the second quarter of this fiscal year.

Although the third quarter proved challenging, we did experience improved results as the quarter unfolded. December was an extremely soft month, when many airlines scaled back purchasing activity. January's results were substantially bad than December, and in February we were profitable. Compared to the second quarter of this year, sales in the inventory and logistics services segment increased approximately six percent. Which mainly reflects an increase in spares and logistics support for the U.S. military and its contractors. Through the quarter we saw continued improvement in this segment, as our airline customers worked through their inventory positions and looked to replenish their stocks. We also were selected by GE Aircraft Engines to provide logistics support for the their F-414 military engine, which goes on the F-18 aircraft.

In the maintenance, repair and overhaul segments, sales declined from the second quarter as a result of reduced maintenance requirements from airline customers, as a result of the industry-wide reductions in flight hours. As the airlines add back capacity, and increase flight hours, we expect their maintenance requirements to increase, which should benefit this segment. And like in the inventory and logistics segment, we did see improvement in this, in these businesses throughout the quarter.

In the manufacturing segment, sales increased over the second quarter as we experienced increased shipments of the products we provide to the U.S. military in support of their tactical deployment requirements. We anticipate strong sales of these products as the U.S. armed forces expand its presence worldwide.

In the aircraft and engine sales and leasing segments, sales were slightly lower than the second quarter. We continue to experience minimal activity in this segment, due to the lack of capital investment activity throughout our industry.

Our total sales to U.S. military and subcontractors has increased from 16 percent of total revenues last year to 27 percent in this quarter, and they have increased sequentially as well. Just give you a sense as to the impact of the growth in this market. A year ago the defense business accounted for approximately 16 percent of our total revenues -- as I've indicated this year 27 -- but they grew in this period themselves by 29 percent.

Our consolidated gross margin of 13.6 percent remained low by historical standards, which is primarily attributable to the current level of sales. As volume increases through our facilities, we expect our gross margin percentage will improve. At the same time we continue to reduce the number of our facilities, including the consolidation of our landing gear facilities, which took place the first of March. We remain extremely focused on cash and expenses. For the third quarter, our consolidated SG&A was 19.5 million, down from 20.7 million during the second quarter this year. Based upon actions we have taken the month of February, our SG&A expenses will continue to decline in the fourth quarter. Since August we've reduced our annual expenses by nearly 25 million, and continue to aggressively pursue opportunities in our business to lower costs and improve the efficiency of the company. Since September we've generated more than ten million of cash from operations, and have lowered our annual interest expense by approximately $3.5 million.

In the month of February we strengthened the company's capital structure with a common stock offering, which raised 34.5 million. The cash raised from this offering provides the company with the additional financial flexibility to seize opportunities in the market as they arise, and to execute our business strategy. Although we expect the next six to 12 months to be difficult for our airline customers, we believe we will continue to see outsourcing opportunities in the commercial airline market, including the fast-growing regional jet market. More than ever, the airlines need cost-effective solutions to their maintenance and spares requirements. Furthermore, our military business should continue to expand as we support the U.S. armed forces mobilization efforts world-wide with our shelter, container and pallet products, and as we capture more military logistics opportunities.

This concludes the formal section -- remarks section of the call. I'd like to thank you for your time, and open the lines for any questions you may have.

Thank you.

At this time, today's question and answer session will be conducted electronically. If you would like to ask a question, please press star, followed by the digit one.

Again, that's star one, if you have a question. We'll take as many questions as time permits, and we'll go in the order that you signal us. We'll pause for just a moment to assemble the roster. And we'll take our first question from from CL King.

Yeah, good morning David. What exactly happened to your landing gear operation on the first of March -- you consolidated it you say? Could you ...

what we -- if you recall Tom, a couple of years back we bought a regional landing gear facility in Miami.

Yeah.

And in the last three or four months we've been working on cons -- putting those staff facility into our long-standing established facility in Miami. And we concluded that consolidation on March first.

OK. So it's ...

This gives us about -- it should -- we have the capacity to handle both the regional and the larger commercial gear in the one facility, and we save about 700 grand a year by consolidating under one roof.

OK. And this was not disruptive of your capability to ...

Absolutely not. It was transitioned in, I think in a smooth fashion. The employees have all relocated -- the ones that we wanted to have relocate. And the business is up and running, and should start seeing some improvement. That business has suffered from the events of September 11th. We have seen improvements in that business, actually beginning in February. Hopefully all continue through our fourth quarter.

And your comment about February being profitable -- was that directed specifically at the inventory and logistics service line, or the whole, the whole ...

For the whole corporation. The corporation in its whole, was profitable on operating expense in January, profitable pre-tax in February, and was fairly unprofitable in December.

OK. What portion of your manufacturing operation was going south to offset the gains you're getting on the military side, and what are the prospects for that hitting bottom and turning around?

Well our whole cargo systems business is been soft. The cargo spare parts business, which has been increasing over the last five years, was soft as well. So I think we had a little bit of an offset there, but I think still if you look at the consolidated results in manufacturing on its own, you'll see we have significant increase. On a year over year and quarter over quarter basis.

OK. I'll let somebody else jump in, thanks.

Thanks Tom.

And as a reminder, press star one if you would like to ask a question. We'll next hear from with Farallon Capital.

Hi. A few questions. First one, could you sort of help me understand a bit better the cost structure in terms of fixed costs and variable costs. If we were to look at your costs of sales, could you give some guidance on what you recon -- or sort of the magnitude of fixed versus variable costs? And a similar analysis for a SG&A.

The -- approximately ...

I'll go through this for you. I'll tell you what our indirect costs are on a quarterly basis. They're approximately $21 million of the total cost of sales. The other direct costs are materials and labor. The indirect expenses are basically related to our people and our facilities that support the operation. In the SG&A area, there's really a small percentage of those total costs that you would consider to be, to be fixed. It's mostly people costs, and costs associated with having people -- travel, entertainment, telecommunications -- things like that that support the marketing efforts of the business. So the SG&A are largely variable, however in terms of the expenses that we have taken out of the SG&A, we don't believe that those expenses will come back in the same proportion as the sales. We think that the sales will return faster than the costs. pawn: you mentioned -- I mean -- just before I move on -- on the cost of goods sold, you said the direct costs have both labor and material costs. In a wide -- from an accounting perspective you could look at that as variable. Just trying to understand, given your production process, aren't the labor costs really variable? Are they driven by number of activities, or by the volume of product?

No, they're driven by the, by the hours performed on jobs that go through the shop. So they're -- the direct labor is probably our most variable cost.

OK, so they're not driven by a set of activities that need to be done. So even if, even when the volumes comes down, you just can't -- you still need to do the same set of activities ...

When volume comes, when volumes come down, direct labor comes down.

OK. Just on the expenses you talked about, you know since August you've reduced expenses by $25 million. Can you -- what is the fair sort of annual run-rate on these expenses? Should we annualize that, or is 25 million a guidance sort of for the annual?

I think that the -- I think you can take the third quarter costs. We expected to see continued reductions in the fourth quarter. So I think what you can do, is you can take the third quarter cost structure, apply a reduction to that, and that should be our run-rate going forward. We would expect to see total costs come down approximately a $1 million in the fourth quarter.

OK, so the number of 25 million that you've taken out, that is 25 million for the year?

That's an annualized number, yes.

Annualized number, OK. So for '02 that is the number we should be taking out. Sort of from the overall cost structure.

Right. The 25 million is basically the third quarter IFG&A expenses compared to the first quarter.

Annualized.

In terms of, can you talk a bit about the margins on the defense and military contracts versus commercial?

The margins on our overall military business have been running slightly higher than our commercial business right now. And also, our military business, particularly the logistics business, requires significantly less working capital than the commercial business. So not only do we generate higher margins, but we are also generating higher returns on capital.

Can you give a sense of what the account receivable days for military business would be versus those for commercial?

The military is paying us extremely well. In the probably 35 days, and our overall is in the high 40's -- I think it's 47.

So we should have some mixed changes, perhaps working capital could be a provider of cash?

Yes, I think though as revenues return we're going to be ...

Sure.

... we're going to be increasing receivables somewhat.

Sure, sure. Just a last question, you mentioned that $1 million for the saving in fourth quarter which we could add based on your existing cost structure. Any sort of other improvements that you expect in terms of operating cost structure that you guys are of focusing on right now?

Well we're very focused on our cost structure. We do think that there are additional opportunities that we're focusing on. But I think, you know, right now we'd like to just leave it at that.

Except, I might add if I may, that we're also consolidate -- we have plans to consolidate two more facilities. I had indicated that we consolidated our landing gear facilities in March. We have two other facilities that are on the board to be consolidated between now and the end of our current calendar year.

Last question. What's happening to pricing -- per unit pricing right now for your products.

I think in certain markets we're seeing strengthening. In other markets it continues to kind of bounce around what would be historically bottom. But I think on balance, I would say that it's relatively stable And the operative word here is right now. That wasn't necessarily the case 90 days ago.

Thank you very much.

And as a final reminder, press star one if you would like to ask a question. And we'll pause for just one moment to assemble the roster. And we'll take our next question from with Highland Advisors.

Good morning. Can you talk a little bit about the competitive environment in the sense of, you know, what's happening with other folks that are trying to play in the logistics area and the spare parts area. How extended they might be financially, and what kind of acquisition opportunities might be out there for you?

Hey David, I think that's a good question. You know if you look at it from a competitive standpoint, historical competitors are not as much a factor as they once were in the spares business. We are seeing more competition from the OEMs than we've seen in the past. As it relates to the buying opportunities, today we're seeing some very attractive buy opportunities which we believe will translate into positive results for the company as the fourth and next year's quarter unfold. As it relates to the service businesses, there's not as much competition as there is over capacity at this moment. Specifically due to the reduction in flight hours. We are seeing a improvement in this, in this regard. We're seeing aircraft come back into the sky, and therefore we think that from a competitive standpoint there we're in pretty good shape, as the -- we think what's happened to us there is strictly a result of reduced activity. Was there more to your question?

Well -- no, I think you pretty much covered it. Let me, let me follow it up on a, on a service and logistics sides. I mean I guess you're playing against two diametrically opposed forces. One is the desire for, I guess for airlines to outsource some of their logistics and parts support, versus the overcapacity and because some of their people maybe are not working as hard now because they have less flights, that they bring that back in. Can you just kind of talk about that dynamic and what you see happening, both in the short term and maybe in the long term. Is the trend to outsourcing even more pronounced now than is was, it once was.

Yeah, I believe so, and I think what you've seen is you've seen the budgets cut by these airlines in numerous dimensions, one of which is the dollars they can spend. But secondly is also on their own headcounts. One particular airline here in North America, one of the major carriers, reduced its purchasing department by 18 percent. Their workload had reduced significantly more than the 18 percent reduction in workforce, but now what's happening to them is the work is coming back, but they're advised that the workforce cannot return. So in their situation, they're looking for AAR to provide additional services because they can no longer handle it. I think that's more the case than not. I think you're going to -- I think the airlines have kind of drawn a line in the sand as it relates to their own headcounts. On the behind-the-scenes, in the behind-the-scenes areas, not necessarily pilots and flight attendants, but I think for mechanics and logistics people. But, so I think that work is, as the work comes back, they're going to be hard-pressed to support the operations. And I think that creates opportunity for us.

Lastly David, again following that up, can you kind of characterize, you know whether you're in discussions to try and, or whether or not there's a deal flow here that's out there -- I don't know -- any color on the opportunities to get some additional customers for your logistics services?

Yeah, I think David that we have a few things in the works right now that could be very interesting. You know, I would say that there had been a period of time here -- particularly say October, November, December -- and even into January where things were relatively slow from a standpoint of new opportunities. I think what we're seeing here since say, middle of January is a pick-up in the deal flow. And we have our Chief Operating Officer, who's not participating today, is on the road on a couple of different opportunities that he's exploring. So yeah, I'm somewhat optimistic David, that the logic will prevail and that we'll see opportunities here. fundear: Thanks very much.

Thank you.

Next we'll hear from with Deprince, Race and and Zollo.

Hi, actually. I wanted to see if you would break down the working capital into its components. I guess really the receivables, balance, inventories and so forth.

The receivables' worth 71 million.

OK.

And the inventory and equipment on lease was 271 million. Those are the major -- and cash was 34 million.

OK. And what's the -- can you tell me the current cash balance?

We ended the quarter with 34 million in cash.

I guess I was looking for, as of today -- a ballpark.

I think ...

To date?

Yeah ...

20.

Around 20 million.

So the proceeds from the offering was used to pay down some debt, or ...

We really -- if you, if you kind of look at the, at the net cash position, taking cash and short-term debt comparing November 30th to February 28th. The net cash position increased by approximately the amount of the, of the offering.

OK.

So the, you know the funds are basically there on the balance sheet. We did pay down some short-term debt, yes.

OK. And I guess your inventories -- I guess if I'm looking at the same, the same number, at the end of November, I believe were 215 million. Is that right? Actually if -- well if I include the equipment ...

Right, the inventory -- the total inventory including the leases increased about $5 million in the quarter.

OK.

That was primarily a result of some opportunistic purchases that we made, that we expect to sell this quarter and next quarter.

OK, and how do you see inventories at your customers?

We see them as being depleted, reduced significantly, and we see them replenishing them.

OK. Very good, I appreciate your help -- thanks.

Next we'll take a follow-up question from with CL King.

Yeah, I would think that a lot of the opportunities that have started to pop up for you would probably best be pursued with a financial partner, like with a couple of planes that you've got there. I was wondering, can we assume that the interest is out there on a par with what we've seen in past, or did possibly last fall change that appetite.

Our interests are you referring to?

No, the interests of financial partners that might want to go into a plane purchase.

They're out there. I think that there is some caution, but we are talking to partners -- potential partners on the right assets and on the right transactions.

But I would say it's definitely different Tom, today than it was on pre-September 11th. Definitely -- there's a lot more caution than there was pre-September 11th.

OK. And kind of in the same vein -- I would imagine that in the opportunities that you have with the military to help them with their -- to help them with their inventory issues, that among the OEMs that you might be working with would be GE, and can be we assured that the -- what you went through with them a year ago wouldn't be a sticking point as far as being able to that?

Well, it's interesting because the -- I referred to earlier the contract that we signed during this period, or I guess at that the end of the second period, was actually with GE Aircraft Engines, to support their F-414 engine. So no, we believe that the issues that were around that circumstance on the support of the are behind us.

Resolved and behind us.

OK, great. Well, thanks a lot.

Next we'll hear from with Eden Capital.

Actually, my -- most of my questions have been answered. I'm going to pass it on to someone else.

Thank you. We'll now take a follow-up question from with Farallon Capitol.

Hi. Could you sort of help me understand a bit better as to when the airlines look at you as an sort of outsourcing partner or vendor. Where -- how are you adding value to the airlines? I mean, what are the sort of areas which you guys do better that help you create that value.

Well, you know we support multiple airlines. So if you look at us as a pooling source, we can go ahead and use economies of scale on the purchasing side because we can acquire inventory on behalf of numerous airlines. We can then store that airline -- that inventory on behalf of numerous airlines. We can provide the product to them on a just-in-time basis so that they can reduce their risk of ownership, and tying up their cost of -- you know, tying up their capital. We can, we can provide them the part on a couple of different levels. One is we can provide a refurbished part, which usually is at a lower price. So we can, we can use alternative sourcing. We can provide PMA parts. We might repair the part for them. And we can provide them logistical service which allows us to help them move the parts through their system, in a way that's a little faster than they can. Keep in mind now, we are non-unionized in this area, and our costs are substantially lower than theirs.

Alright. So, for large airlines who perhaps, where the economies of scale argument is less applicable I guess, the non-unionization and lower labor costs are a primary contributor you'd say?

No, I don't think so. I think you have the economies of scale on the materials side. Like for instance at Delta Airlines, before they purchase any parts from the OEM, they come to AAR for select parts. And if AAR can provide the parts, they are contractually obligated to purchase the parts from AAR. So they look at us as a resource to save them money. So we have a savings objective that's communicated, actually contractually, with Delta that, you know that we're obliged to meet, and they're obliged to give us the opportunity. We have similar programs with other airlines, not as specifically pointed out as in the Delta contract, but we have arrangements with -- where we have to supply them a certain amount of parts over a certain period of time. And they look to us to source in a way that's better than they have historically sourced. I also mentioned earlier some of the airlines have cut back their workforce to an extent that they need to rely on their partners to go ahead and help them execute the movement and the purchase -- the planning, the purchase and then the movement of the spare parts.

In terms of, you know most of these outsourcing contract in the industry, tend to protect the outsourcer through a change in rates if the sort of user of that service drops in demand substantially. Which obviously is happening this environment for you. Do you have in your contracts, say with Delta, or with other airlines, do you have such provisions whereby it allows you to at least base cost coverage?

To do what?

Do what sir?

If in terms of, if the, if the demand for parts sort of drops, or the demand for your outsourcing services drops. You know, do they have to still pay you a certain amount?

No.

To cover your fixed costs.

No, actually our obligation is to deliver the part and they pay when we deliver the part. So, if we have a cost to do that, and they do not -- and they can't take delivery because they no longer require it, then it's something we have to absorb.

I see.

I think that's probably what you see in terms of our results. I think as -- you know, you know to get back to your question before about fixed versus variable costs. I mean there's a certain amount of capability that we continue to maintain, that I guess even though it could be traditionally considered variable, in our case it may be fixed. Because we believe that we've gone through an unusual period in this industry as a result of events of September 11th. And we believe we're starting to see, at least if you look at our results, from a month over month basis on a sequential basis, you'll see the improvement that, you know we believe will continue as the airlines look to replenish their stores, and as they put aircraft back in the sky and have more historical maintenance requirements.

Of the 101 million in direct costs and cost of goods sold, how much would labor be roughly in terms of percent?

Material's about 65 percent -- labor's the balance.

OK.

Some outlay -- and there's about even split between direct labor and indirect labor.

Thank you very much.

OK.

And as a final reminder that is star one to ask a question. And that does conclude today's question and answer session. I would now like to turn the call over to Mr. Storch for any final or closing remarks.

Hey, I want to thank everybody for their participation today. Good session, and if you have any further questions feel, please feel free to call us. Thank you.

And that does conclude today's conference. Thank you for your participation.

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