AAR Corp (AIR) 2005 Q2 法說會逐字稿

Good afternoon. My name is Lynn, and I will be your conference facilitator. At this time I would like to welcome everyone to the AAR Corporation Q2 earnings release. (OPERATOR INSTRUCTIONS) Thank you. Mr. Moore, you may begin your conference.

Thank you, Lynn. Good morning, ladies and gentlemen. Thanks 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 refer to the forward-looking statement disclaimer contained in the press release issued this morning, as well as those factors discussed under Item 7, entitled "Factors Which May Affect Future Results", included in the Company's May 31, 2004 Form 10-K. 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, Greg, and good morning. With me today is Tim Romenesko, our Chief Financial Officer.

Before we begin I would like to wish those of you participating today a happy and healthy holiday season and a prosperous new year.

The earnings release issued this morning shows AAR continued to make solid progress in the second quarter. The Company reported double-digit sales growth and significantly higher net income compared to the same period last year. Sales and earnings were up on a sequential basis as well.

For the second quarter we reported consolidated sales 178.7 million, an increase of 12 percent over the prior year, and net income of 4.8 million or $0.15 per share. These results include a 1.6 million or $0.05 per share federal income tax benefit. I would like to add a few brief comments on the favorable tax adjustment.

In fiscal 2003 and 2004, the Company established a valuation allowance against foreign tax credit carryforwards that were scheduled to expire in fiscal 2006. In October new tax legislation that extends the carryforward period for these types of credits from 5 years to 10 years was enacted. As a result of this change in the tax law we now expect to fully utilize these tax credits and recorded a $1.6 million credit to the income tax provision.

Turning our attention back to the operating results for the quarter, net sales for our inventory with Inventory and Logistic Services business were 66.2 million, up 5.8 percent from the first quarter of this fiscal year, but down 4.4 percent from a year ago, due in part to lower sales of 2.5 million to general aviation customers as we continue to exit low-margin product lines in our distribution unit. Also, sales of spares and logistic support to our defense customers were lower by 3.5 million compared with record sales from a year ago. We do expect sales in this area to increase as revenues from the recently announced UK MoD program kick in latter part of this fiscal year. Part sales to airline-related customers increased 9 percent year over year. Favorable product mix, largely due to general aviation down-sizing, and operational improvements drove a 200 basis point improvement in gross profit margins compared with last year.

Sales in our Manufacturing segment were 47.5 million, representing a 49 percent increase over the prior year, driven by continued strong sales of mobility products and composite structures. We continue to experience a strong demand for our products supporting US defense efforts and expect this trend to continue. During the quarter were delivered the first mobile shelters for the US Army as part of the Stewart & Stevenson Light Mobile Tactical Vehicle Systems program. We expect additional revenues from this program to continue in our fiscal fourth quarter.

In the Maintenance, Repair and Overhaul segment net sales were 53.7 million, up slightly from a year ago and up 15 percent compared with the first quarter of this fiscal year. We continue to see improvement both in our heavy airframe maintenance and component repair businesses.

We are particularly excited about our prospects for the Indianapolis maintenance facility. During the quarter we received FAA repair station certification, and customer proposal activity has been very active. As stated in our release this morning, we expect to commence revenue-generating activities at this state-of-the-art airframe maintenance facility during our fiscal third quarter.

Sales were 11.2 million in the Aircraft and Engine Sales and Leasing segment, a significant increase over last year. The sales increase was the result of the sale of 4 aircraft during the quarter. We view the aircraft market very optimistically, and since the beginning of the fiscal year we have acquired 4 aircraft with a joint venture partner. 1 aircraft is currently on lease, 1 is scheduled to go on lease by the end of the calendar year, and the remaining 2 are scheduled to undergo maintenance in January.

We continue to focus on expanding our footprint in Europe and Asia. We made notable progress during the second quarter, growing sales to European customers by 40 percent and sales to Asian customers by 14 percent. We view these markets as key future growth engines for the Company and are committed to further strengthening our presence in these regions. On a combined basis, for the first 6 months sales are up 35 percent in these 2 regions compared with last year.

During the first half of the fiscal year the Company generated 8.6 million of cash flow from operations. Interest expense decreased 500,000 during the second quarter compared to the same period last year, reflecting the reduction in overall debt levels. SG&A expenses continue to decline as a percentage of sales from 12.3 to 11.5 percent, but increased 1.1 million year over year due to added resources to support Company-wide growth. Operating margins increased from 3.5 to 4.5 percent, and we are continuing to identify opportunities for improving this important metric.

We delivered a solid performance for the second quarter, and I am encouraged by the Company's progress during the first half of the year. We feel good about recent investments we have made, particularly in the Indianapolis maintenance center, inventory purchases and the joint-venture aircraft, all steps that we believe strengthen our future prospects.

I like to thank you for your time this morning and wish you all a safe and happy holiday season. I would like to now open up the call to any questions you may have.

(OPERATOR INSTRUCTIONS) Tom Lewis, Rockhouse Research.

Good morning and another fine quarter. Just a couple of things. Is there anything you can tell us about how much you spent during the quarter getting Indianapolis up and going? Can you refresh our understanding of your commitment with respect to -- as I recall, you're going to start out with just a couple of bays with the potential to grow it to a larger number.

One second, Tom. We are trying to figure out the answer to the first part of your question. So I think from a P&L standpoint there was no impact. There was money spent, but that money was covered through our agreement with the Indianapolis authorities. As you recall, we indicated early on that the up-front investment would be minimal. Obviously, there's a lot of time and management effort put into this operation, so there has been a fair investment that would be hard to figure out what it is momentarily.

Okay. But it's not meaningful, then? Fair enough.

But there's no P&L impact on the investments that have been made to date. Second part of your question?

And you will be starting out with a couple of bays, and then has the potential -- I'm trying to recollect --

Okay. We expect -- by the end of our third quarter, we expect to have anywhere from 2 to 3 bays running by the end of the quarter. So the first aircraft will be arriving next week, I believe; and work will commence on that aircraft beginning, I think it's January 5th or 7th. I think it's either that Wednesday or that Friday of that week. And then we will commence another line in latter January, and then there will be a line toward the end of February. That is at least the forecast at this point.

And I guess my other question would be that if we look at general aviation now on a sequential basis, are the sales there flat or did they have a trend to them 1 way or the other?

I think flat to slightly down.

Peter Arment, JSA Research.

A quick question on the Light Mobile Tactical Vehicle System and the combination with the AWACS UK support deal. You indicated that Q4 is when you would see a more meaningful impact. Is there any sort of dollar level that you can give us? How much are we talking; an additional 10 million or 5 million in terms of deliveries?

I think we would prefer not to comment. I don't think we have commented before. In both cases you have meaningful programs. The UK MoD program should be not fully kicked in, but mostly kicked in by the fourth quarter. And the Stewart & Stevenson program should experience good shipments during the fourth quarter period.

You have had a seasonality in terms of much higher deliveries in Q4, so it seems to me that just your overall timing and the combination of some of these other deals, that Q4 would be materially higher in terms of sales compared to Q1. Is that fair?

That would be our expectation.

Tim, do you have any of the segment gross margin numbers at all?

I do, Peter. In the Inventory and Logistics gross profit margin was 12 million 569 in the quarter or 19 percent. MRO was 5 million 765. Manufacturing was 9 million 279. And Aircraft Sales and Leasing was 965.

Great. And then, regarding the Indianapolis, David, just your comments about expanding into the third bay? So I take it the activity in terms of the interest level must be pretty high?

Very strong. The challenge for us at this point in time is staffing and making sure we do a great job for the customers that come in. I spent the last couple of days in Indianapolis, visiting with the facility and the management team and going through kind of an analysis of where we stand today versus the demand and things we need to do between now and, say, the end of January to have this facility prepared to accept the work.

And, Tim, just 1 final -- more of a housekeeping issue. Your interest expense jumped sequentially from the first quarter. What was the actual mechanics behind that?

In the first quarter, Peter, we had a discount on some notes that we had repurchased that flowed through the interest expense line impacting about $0.5 million in the first quarter.

Derek Wenger (ph) of Jefferies & Company.

2 quick financial questions. What was the depreciation and amortization for the quarter and also the capital expenditures for the quarter and the outlook for the year?

Depreciation and amortization was 6.9 million. CapEx in the quarter was 3.1 million. Year to date we are at 6.7 in CapEx, and our forecast for the full fiscal year is approximately $14.5 million.

Jay Khetani, S.G. Cowen.

Can you talk about on the 2 or 3 bays that your talking about going into on Indy, how should we think about how loaded those schedules are for the next, say, 12 months? In other words, do you have 250 days of work kind of booked in the schedule there? You have got aircraft starting there soon, but are there gaps? Is the capacity for those 2 or 3 bays meaningfully sold out for the next, say, 12 months?

The plan at this point in time would be that we would have of those 3, 2 would be nose-to-tail, and then the third nose-to-tail line would come up in, say, late March/early April. So we would anticipate at this point in time -- we are in dialogue with a customer on to 3 nose-to-tail lines for the balance of the year. And then we would have another line that would be more, let's call it intermittent.

So you are basically 100-percent booked on 2 lines, and then for the calendar year, say, about 60 to 75 percent booked on that third?

That would be right. From the time we opened up the third line it would be 100-percent booked.

Got it. And on your component --

When I say 100 percent, in that business things happen. So the plan, the commitment, is for nose-to-tail for 3 lines.

The in other words, you don't -- as the schedule stands today, as you have got it laid out, there are not any big gaps that you know about or that you are planning on?

For those 3 lines, that is correct. And we are going to keep a fourth line that would be taking work, like I said, intermittently.

On your component business, component repair, can you just talk about how that business performed sequentially and then year over year?

Tim, you got the --? Sequential improvement -- year over year a slight improvement?

Slight improvement year over year.

Slight improvement year over year. Okay. And then sequentially?

And sequentially as well.

And sequentially. Okay. And then on Inventory and Logistics, you talked about high kind of legacy carrier inventories on JT8 and 9 and the CF6, which were impacting those, I guess, kind of pricing on the Inventory and Logistics piece, but also then component repair. What are the trends that you have seen in the last, say, 90 days on those engines?

Those engines have been, obviously, less important to us, really, since 9-11. So we still see some activity in the 8-D (ph) and the CS-650 (ph), very minimal activity in the JT-9 (ph), although there are from time to time a transaction. These are not where we are spending our time, nor focused. The engines that we are focused on are more of the later-generation equipment, the CFMand the PW4000, 2000 and the V2500 type engines.

And how did the business look on the Inventory and Logistics side for those newer engines, the 2 and 4 that IE (ph) and so on?

Yes, very strong.

Very strong?

Very strong.

(OPERATOR INSTRUCTIONS) Peter Arment.

David, in regard to the Indianapolis facility, the MRO gross margins have been historically running a lot lower than what you would expect, given the lower volumes. How should we think about the margins when you first open up? You have got a pretty favorable cost structure right out of the box. Should we be back to a more historical level out of that particular segment?

What we see in the early stages of an operation -- so, for instance, if you look back at Oklahoma, excepting when they first accepted a certain category of aircraft, what you will find is that the first couple of months are a little less efficient. In the first 6 months you gain about, roughly, on average 5 percent efficiency each month. It takes about 6 months to get really efficient. So I think if you use similar guideline here you are going to be a little less efficient in the first few months, and then you will continue to get efficiency.

As we gain the efficiencies, I would expect the operating margins, particularly in light of the cost structure of that business unit, to be favorable from the current standpoint and probably favorable from a historical vantage point as well.

The key, Peter, incidentally, if you look at our MRO margin numbers, the key there is loading. And we have a challenge out to our businesses, and we are trying to have our businesses work -- the supply businesses, we're seeing some strength. We are closer with the component businesses to try to drive more component work. And we met with some success here this quarter. And we expect to meet with some success here the balance of the year. The key to that business is loading and getting volumes up. If we get the volumes up, we can have a tremendous impact on Corporation's bottom-line. And I would expect that kind of the trend that we are seen, as well as some of the firepower that we are putting into the marketplace in this respect, that we will start seeing some traction here. I think I mentioned at the last conference call I was expecting some improvement in the component repair business. We did get some of that improvement, and we should start -- we should see more than coming forward here third quarter and fourth quarter out into the future.

Gregory Macosko, Lord Abbett.

Could you talk a little bit about the aircraft business? I perhaps missed it earlier. Did you talk about the revenue or profitability on that or your expectations there?

Greg, actually we mentioned that we had some sale of some aircraft during the period. We had acquired -- toward the latter part of fiscal 2004 we had acquired some aircraft, some older aircraft from TACA down in South America, and we acquired 10 aircraft. We sold some of those aircraft during the first quarter, and then we sold pretty much the balance -- I think there's 1 aircraft remaining -- during the second quarter. So that had a positive impact on those results. We also acquired some aircraft for lease with our joint venture, and we expect some revenue -- or income pickup, I should say, from that activity through the balance of the fiscal year. And as we continue to acquire more assets, we are thinking that that business will once again become a nice contributor to the overall product mix.

There's 2 ways to look at the aircraft business from AAR's -- 2 ways that we look at it. 1 is, obviously, the income that it generates on its own. But secondly, for instance, 1 of the aircraft that we recently acquired will go through the Indianapolis maintenance center for repair. So we should capture a fair amount of the maintenance in-house. So we are seeing the aircraft leasing business as a feeder for some of the other things that we do here inside the Company. So that's part of our strategy.

And so, then, the gross profit was 965,000 on the 11 million? Did I read that right?

That's correct.

And you expect that the purchases, like the 10 you bought, we will see those periodically during the rest of this year and next year?

Yes. What you'll see is you'll see income from the lease stream, and from time to time we will sell -- when the conditions are right and somebody who wants to own the asset more than we do, from time to time you will see us selling those assets as well.

But sort of on a longer-term, overall basis, would we expect to see that as something less than 10 percent of revenue, generally speaking?

Yes. Most of the acquisitions will be with our joint venture partner. This is a very large, internationally renowned financial institution based in New York who prefers to be referred to confidentially. So this entity, together with ourselves, have been going into the marketplace and buying assets. And these assets are -- we are carrying them on a joint-venture basis. It's a 50-50 joint venture. AAR receives certain fees and step-ups based on performance, and we are carrying these in the fashion. So we bring the -- income is recorded on our P&L. There is no sales treatment for these assets. So we expect the contribution margin to be -- as time goes on, more meaningful. Today it's relatively insignificant. And from a sales standpoint it will not be a factor.

So, then -- and that partnership is with regard to both the sales and the leasing?

Yes, that's correct.

The 50-50?

The acquisition, the repair, the lease and the sale.

So you share the MRO revenue as well?

No. I'm sorry. The MRO revenue would flow through to AAR, I'm sorry, in that respect. What I meant is that the joint venture may acquire assets that require maintenance. AAR would then received the maintenance work for those assets as long as AAR maintains a competitive pricing structure.

And then, finally, you have only 1 partner and you don't expect to have other partners in the (multiple speakers)

No, we may have other partners. Depending on the size of the opportunities, it may require us to seek out other equity players. There are interested parties in joining up in this respect, so there may be other partners that we bring to the table. And it may be other ventures with different category or classes of aircraft.

So this partnership is limited to certain kinds of aircraft?

It's limited to certain types of aircraft. And we have explored -- with this partner we have explored assets outside of the framework. But we also -- as I indicated, Greg, we also have had interest from other investment companies as well.

Jay Khetani.

Was there any sense in the quarter that you are gaining share on the component MRO business? Or did the move essentially mirror what you saw happen in the end markets?

I don't think there was any meaningful change in that regard. I believe we continue to give a good accounting for ourselves in this market. I think we have won our fair share of business. We have been selected for a group of components from 1 of the legacy carriers that I guess is taking some market share, but that work won't commence until the third quarter. But I would say that on balance we are holding our own.

And you talked about very strong interest in the MRO business. What does the prospect kind of pipeline look like in terms of component MRO agreements, such as the 1 that you described with this legacy carrier?

My believe is that you have a few different things going on at the same time. 1 is you have -- you mentioned earlier about the older technology aircraft, on the engine side at least. And then on the aircraft side you have aircraft that have been cannibalized, replacing spare sales, as well as replacing component -- repair opportunities. I believe that most of that cannibalization has -- clearly it's slowed down. I won't say that it's not there any longer, but it has slowed down. I think will be beneficiary of the fewer of those situations.

Secondly, we have really sharpened our focus in this market. We have combined some of the activities with our supply companies. As a matter of fact, come next year, we will be showing our business is a little bit different because we are really going to market today more as a parts unit, which includes the supply, the PMA and the repair. And we expect some traction from that move.

And, thirdly, you have legacy carriers and other folks looking to outsource in a way that they may have not in the past, and we believe we will be a beneficiary at least with 2 major US legacy carriers here in yet this fiscal year.

So I think if you look at all 3 trends, if you will, I think they all bode very positively for the component repair business. Now, keep in mind our component repair businesses have really been at a historical low point. And we maintain basically the same infrastructure, the same skill set. We continue to make investments in that business to get newer technology repair activities flowing through those businesses. So I believe that you will see consistent, steady and maybe even acute growth from those businesses here moving forward.

(OPERATOR INSTRUCTIONS) There are no further questions at this time. Mr. Moore, are there any closing remarks?

Yes. If I might say, there seems to be a fair amount of interest on the component side. And 1 of the things that I've mentioned to Tim and that we may want to consider is for those folks who would maybe like to explore this issue further what we can do is host a little get-together at our Long Island Garden City facility. For those of you based in New York, it's either a Long Island Railroad ride out or a car ride out that's not too far from Central Manhattan. And we can probably organize something like that in the middle to latter part of January or early February at your convenience, and share with you what happens in that facility, how it works and go through the prospects on a live basis.

Okay. So with that, no further from this end. And thank you for your participation. And once again, which everybody a happy, healthy holiday season and prosperous new year.

This concludes the AAR Corporation Q2 earnings release conference call. Thank you for your participation. You may now disconnect.