AAR Corp (AIR) 2005 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the AAR Corp. fourth quarter fiscal 2005 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (OPERATOR INSTRUCTIONS) As a reminder this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. John Bowman, Director of Investor Relations. Mr. Bowman, you may begin.

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 refer to the forward-looking statement disclaimer contained in the press release issued this morning as well as those factors discussed under item seven, 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 John and good morning. With me today in Chicago is Tim Romenesko, our Chief Financial Officer, and Jim Clark, our group Vice President of our newly named Aviation Supply Chain segment. For the fourth quarter of fiscal 2005, the Company recorded consolidated sales of 209.9, just slightly under 210 million, an increase of 19% over the prior year, and net income from continuing operations of 5.8 million an increase of 119%.

Diluted earnings per share for the fourth quarter were $0.17, fourth quarter results were driven largely by a 33% increase in sales to our commercial airline customers. For the full fiscal year consolidated sales were 747.8 million, an increase of 16% over the prior year, and net income from continuing operations was 18.6 million or $0.55 per diluted share.

During the fourth quarter, sales in the Inventory and Logistic Services segment surged 44% over last year to 88.9 million with all business units reporting solid increases. Strong demand for parts support from commercial and military customers as well as the impact from new supply chain programs drove the increase in this segment.

In our Maintenance, Repair and Overhaul segment sales were 65.2 million for the fourth quarter, up 13% year-over-year. Higher sales resulted from the startup of our operations at our new Indianapolis MRO facility, and increase sales at our component repair and landing gear business units. Sales in the Company's manufacturing segment were 52.2 million in the fourth quarter, up slightly from a year ago. Sales increased year-over-year of both our Cargo Systems and composite structures businesses.

Sales of specialized mobility products to defense customers continued to be strong but declined compared to last year, when sales were record levels. Over the past year our strategy in the Aircraft Engine Sales & Leasing segment has been to pursue aircraft acquisitions with strategic financial partners. Sales from these investments are recorded on the joint venture books and not included in our reported revenues. As a result, sales comparisons between periods are not meaningful. The income from our aircraft joint ventures is reflected in equity and earnings of joint ventures on our statement of operations.

We continue to see progress from our efforts to increase market share in Asia and Europe as the Company experienced 52% sales growth in Asia and a 37% sales increase in Europe. In Asia, our performance reflects our more aggressive move into this growing region while in Europe we are gaining market share. We view these markets opportunistically and will continue to aggressively market our products and services to airline and defense customers operating in these regions.

The Company's gross profit margins improved 110 (ph) basis points in the quarter to 16.7%, and this includes the negative impact from the ramp up of our stock (ph) operations in Indianapolis. Higher margins were driven by the sales increase, operational efficiencies across several of the Company's operating units and a favorable mix of products and services sold. Many of the Company's other key balance sheet and operating performance indicators improved substantially on a year-over-year basis and are trending in the right direction.

The Company generated 23 million of cash from operations in the fourth quarter and a record 51 million for the year. The record cash flow allowed us to reduce recourse debt by 18 million, and to continue to make strategic investments. Additionally, even while short-term interest rates were rising, we were able to lower our net interest expense for the year by 1.5 million. We also experienced an improvement in inventory turns and working capital turnover for the year. Indicators are very important for the Company.

During the quarter our operating expenses increased as we expanded our global reach and incurred costs related to the startup of the Indianapolis facility. Even with the effects of these higher expenses SG&A expense as a percentage of sales declined from 12.5% to 11.8% on a year-over-year basis getting us closer to our stated target of less than 10%. As the Company positions itself for the future we are aligning our businesses to maximize revenues and increase market share. As a result the names and composition of our business segments are changing and will be incorporated on our Form 10-K for fiscal 2005.

The Aviation Supply Chain segment includes parts supply, component repair and logistics. In this segment we are combining our supply, repair, redistribution, information technology, and logistics skills to support our customers through industry-leading supply chain management programs. We have been in this business in essence for over 50 years, where we have gained a fair amount of experience. This group of businesses is clearly includes many of our core competencies and I believe we have a recognized brand -- a worldwide recognized brand name in this arena.

The Structures and Systems segment includes our specialized mobility products, Cargo Systems, and composite structure businesses. This group designs, engineers and produces a variety of systems and components for aircraft and non aircraft applications. The goal of the Structures and Systems segment is to deliver more original equipment and to increase our service offerings as we increase the installed base of our products. Our recently announced Airbus A400M Cargo Systems win is a great example of the type of program we are pursuing. It represents our first large-scale program to provide OE products for the Airbus platform, and will provide increased aftermarket support opportunities including spare parts and service revenues.

The MRO segment comprise the aircraft maintenance and landing gear services businesses, adding the Indianapolis MRO capability to our existing Oklahoma City operation allows AAR to provide a more complete and competitive MRO service offering. Since operations commenced with United Airlines earlier this year, four out of the five "C" checks were completed in three days and the fifth check missed by only one shift. Far better than performance elsewhere in the industry.

We also expect to gain market share in the landing gear services segment as our joint venture in Malaysia becomes operational during the second quarter of fiscal year 2006.

The Aircraft Sales & Leasing segment leases and manages aircraft for its own accounts and in partnership with others. We view this market opportunistically, and during fiscal year 2005 we added six aircraft to the portfolio and expect to add more aircraft to this portfolio during fiscal 2006.

As we enter the new fiscal year we have good momentum, however, in the near-term we remain cautious in light of the impact of high fuel costs on our airline customers and their already precarious financial condition. Thank you all for joining us this morning. And what I would like to do at this point is open up the call for any questions you may have.

(OPERATOR INSTRUCTIONS) Arnold Ursaner from CJS Securities.

Good morning gentlemen. This is actually Joe Giamichael sitting in for Arnie Ursaner. Congratulations on a very good quarter. SG&A, I may have missed this earlier, if SG&A was up 30% year-over-year could you just give us some color as to what drove that and what a more normalized level should be?

We had approximately $950,000 in the quarter related to Indianapolis which we did not have in the third quarter. The special items that we referred to in our press release related to the pension curtailment and the stock options also impacted SG&A in the quarter.

That was about --?

1.8 million, I believe.

Okay. And the 950 related to Indy, that should be built in going forward, correct?

Correct, that is correct.

Great. As you are setting up to do this sort of reclassification of the segment reporting, could you just give us a little better idea as to sort of what the rationale is there and what you're hoping to give more clarity on?

If you look at the -- from the past, we included our component repair businesses as part of MRO. In the future, and in practice, we have been teaming our component businesses with our parts supply businesses to offer more supply chain solutions. So that we are managing the business in that fashion. We believe we have a powerful combination combining the parts with the component repair, a unique offering for the industry. And we just felt it would give a better picture, clearer picture to the industry of our progress in this area or lack thereof if that happens to be. But we believe it is fairly reflective of how we intend to run the business going forward.

On the Structures and Systems which used to be largely MRO, I mean manufacturing, basically we are looking at more service and spare parts support opportunities in that segment so that the main manufacturing didn't really define what we were doing in that area any longer. Structures and Systems are more akin I guess to the actual activity and it includes designing, engineering, manufacturing, as well as after sales support so that we -- the adjustment that is principally an adjustment in name. We used to combine aircraft and Engine Sales & Leasing; we've taken the engine piece of the business, we have moved that over into the aviation supply segment. And we have really identified aircraft from a sales and leasing perspective on a stand-alone basis. We have attracted outside partnership financial partners, to share in the on a going forward basis investments we are making in the aircraft arena. So again, more accurately reflective of how we view the business going forward.

MRO with the addition of Indianapolis we want to put more of a focus and a spotlight on the MRO businesses. So if you look at the heavy maintenance businesses that we have with the Company you're looking at the Oklahoma City operation, the recently added Indianapolis operation and our landing gear business. So that would be the rationale behind the alignment.

Got it. Great. Just one more question and then I will jump back in the queue. Cash from operations for the year was 53 million I believe. What was CapEx total for the year?

Cash flow from operations for the year was 51 million and CapEx was 13 million.

Got it. Great, thank you very much. I look forward to seeing you at our conference.

Jay Khetani from SG Cowen.

Congratulations. The growth in commercial aviation so up 26% for the year, can you break that all out at all between just growth with the end market and versus market share gains and new program wins? My guess is that end market growth absent these wins is in the mid-single-digit range, is that fair?

I believe that is how we are viewing it, Jay. I think we try to signal that as much in the release by talking about gaining market share. I don't believe that this market is growing at 26%. Obviously. So I believe market share, I think it is shifting in terms of the airlines focus more along the lines of outsourcing and I think it is some of our -- due to some of our alignment in terms of the service offerings that we're bringing to the market.

As we sink forward, as you look at what you have got in the pipe for additional wins and growth of your recent wins, how should we be thinking about a, commercial with regards to growth rate and second, military? I presume that military while it is not maybe moving as rapidly it still is advancing in terms of share gains. How should we think about that for '06 and just out the next couple of years?

My general view is that we are making great progress in the commercial airline markets. That is somewhat mitigated by the state of the U.S. commercial airline market. We are anticipating come the end of the summer that there may be some disruptions in the U.S. airline commercial market in light of the consistent pressure on fuel costs. But I think notwithstanding, short-term issues that might evolve come fall winter months as a result of this continued pressure, I believe that you should be expecting consistent double-digit growth coming out of the commercial markets from the Company.

On top of the end markets? So in other words double-digit plus end market or -- I'm sorry I'm just trying to be clear?

I would say I would feel comfortable just referring to it in double digits. I think in terms of on top of end markets I cannot necessarily say, but definitely I feel confident that we can continue to grow this piece of our business in a very healthy fashion going forward.

And the win in mobility the re-compete, should we be thinking that that business at least is staying flat for the next, at least 12, 18 months? Activity is still fairly high in the battlefields, is this a business -- the military mobility that can be maintained the sales level for the next period of time?

I think it can maintain its sales level. I think it may have some fluctuation up or down. I think clearly we benefited from some surge activity in that market but at the same token, we have continued to build new products in that area. Our shelter business is very strong; as you can tell the palette business obviously should be strong for the period of time you indicated. Low pressure on containers because that was more clearly a benefit of surge activity. But nevertheless on an across-the-board basis that business should continue to perform well. I think the key ingredient in that business gives us a very healthy return on our investment and should continue to do so out into the foreseeable future.

Two last questions. Any help with revenue pattern in '06 as we look to '05, there was a step down sequentially from the fourth quarter to the first but with an MRO in manufacture. Is there any reason to think that this sales level that you established in the fourth quarter should not be a base for the growth as we think about quarters in '06?

If you look back in time historically there has been a decline in the first quarter versus the fourth quarter, largely due to the summer flying activity of the commercial customers. I am not sure that that pattern -- I am not sure if that pattern continues or not. Clearly we should have a nice increase over the prior year quarter-over-quarter, but I am not sure how it will translate fourth quarter to first quarter. I don't have enough visibility at this point.

Okay, great. Last question for Tim. Do you have segment gross margin for gross operating profit?

I have segment gross profit. Inventory and logistics for the fourth quarter, 15,970,000 or 18%; Maintenance, Repair and Overhaul 10,080,000 15.5; manufacturing 8,084,000, 16.1 and Aircraft and Engine Sales & Leasing 960,000, 17.2.

Great. Thank you.

Peter Arment from JSA Research.

Good morning David, good morning Tim. Just following up on Jay's comments he talked about the growth opportunities in double-digit growth. How about margin gains? You have made some nice progress -- granted Indy was expected to be a drag, how do you look at '06? Do you still see 100 basis plus improvements on an operating basis or maybe give us a little color there?

I think that, Peter, as we continue to grow the top line, we continue to see opportunities for leveraging our cost structure. So we think it is reasonable that our margins continue to improve as our volumes improve.

Okay. That is fair enough. How about your tax rate. What are you assuming for '06?

25 to 30, Peter.

Okay. Is there tax credits that you still are expecting to possibly come through and that would be the difference between that range or?

Yes, and also the impact of the changes in the tax law depending on the manufacturing content of our revenues, those types of things.

Just another follow-up on the overall growth. You're generating a lot of cash and you still have roughly 50 million on the balance sheet. Is there any notes due that are in '06? Any principle payments?

No.

Could you just run down in terms of your priorities the use of cash? Are you looking at external growth opportunities or is it more of these joint ventures? Or how do you view it versus in terms of acquisitions or joint ventures?

Peter, we are out there on the joint venture front from a couple of different perspectives, one is on the service side, obviously we have the startup of our joint venture in Malaysia. We are also looking at a component, form a component joint venture in the Asian market. We are also looking to continue to invest in aircraft through the joint ventures. So we feel it is wise to keep our powder dry and keep generating cash and keep building up a stockpile. At the same time, one of our stated goals is to increase the OE contents of the products that we offer into the industry. We think because of our knowledge of the after markets, that we can combine the OE with the aftermarket activity and build a very powerful Structures and Systems business. It is possible that we may look to make acquisitions that make sense as well.

Right, okay. And that is more on the -- you mentioned on the OE side?

Yes.

Okay, great. Fair enough. Thanks guys.

Tom Lewis from Century Management.

Good morning and nice quarter. First question, David, could you talk a little bit about what your volume expectations are for Indianapolis over the next few quarters relative to the 5 that you did in the last quarter?

We should -- revenues should continue to increase in Indianapolis. At this moment, I wouldn't want to necessarily put out my expectation versus what we're actually experiencing, but I think that we should see steady revenue increases coming out of Indianapolis.

You mentioned the big win to do some work for the A400. Should we look for a meaningful development expense in the quarters or years ahead from that or is that meaningful?

Yes, we will have some NRE expense over the next couple of years, revenues won't kick in until '07. So we are expecting NRE in the 20 million range spread out I believe over a three-year period or two-year period.

That would go to the balance sheet until the program -- until we start to deliver against the program.

Yes, okay. The six aircraft during '05, was that you purchased six, or you grew your inventory by six? You said you added six?

We grew our inventory by six. We did sell one during the period.

Last question, as far as the additional pension expenses, were those of a onetime nature or should we be looking at something of a bump up in your SG&A because you changed the nature of your plan?

No. It is a onetime item related to the change in the plants.

Will it cost essentially the same, or more or less? Or it does not matter.

It will not cost more.

Okay. All right, great. Keep up the good work.

John Rolf (ph) from Argon (ph) Capital.

Most of the questions have been answered. I just had one additional. You highlighted the Airbus A400M contract which you said would be about 300 million in revenue over the life of that contract. Can you give me some sense for sort of order of magnitude how long that contract you would expect to last?

We are expecting the numbers that you are referring to are from our fiscal '07 through fiscal '15.

Okay, great. Thanks very much.

Edmund Griffin (ph) from Flat Rock.

Just follow-up on the pension expense and stock options. What is the breakout between the two? Why is it that stock option expense is considered somewhat of a onetime item?

We don't expect to have to account for stock options -- we are not issuing any new stock options. And we don't expect to have to have this accounting convention for stock options in the future. And the split is approximately 40% of the total related to the pension and 60% related to the stock option expense.

So going forward, would you use restricted stock or you are just not--?

Yes, that's correct. Performance-based restricted stock.

We will be issuing -- last year we issued a historical level similar to what we have done historically. Last year issue was a two-year program so we will not be issuing significant numbers of shares this year. We will be identifying throughout our Company what we call high potential employees who in the past maybe have not received stock grants, but if you take a look at the names -- five executives for instance -- most highly paid executives will not be receiving any stock this year as part of at least as part of the annual plan.

Okay. But next year there will probably be some restricted stock that might offset some of this?

There will be very minimal -- this year at least, other than if there any special events from an annual vantage point there will be significantly less this year than we have in the past. Less than -- approximately 100,000 shares.

Right. Okay. Great, thank you.

There will be no stock options -- there is no plan for stock options at this point.

Greg Macosko from Lord Abbett.

Thank you. Talk about -- you mentioned steady increases in revenue in Indianapolis. Do you expect to take on another hangar or whatever it is that you have options -- I know is there any timeframe on that?

Greg, the ideal situation for us is where we can get to the point where we are operating approximately 7 hangers, 7 bays. Right now we are operating 3 bays. The business starts really working for the Company when we get up to 7. Obviously we need to win more business to get to that point. Keep in mind now we received FAA certification in the latter part of '04. We began hiring mechanics in January. We were successful in winning one contract. We have had other work that has dropped in, but really we are I believe from an operational standpoint we have made some great headway. And now we have to get our story out into the marketplace and capture more business so we can get to the point where we get the number of bays that really start making financial sense for the Company.

But to add a bay, I assume you have to get another customer or significantly expand you relationship with United?

That would be correct. We need more business to expand the number of bays we are operating out of.

But the point is you feel comfortable with the 3 you have for the business that you have?

Right now, we have the right level, the right amount of hangars, we need to win more business so we can get more hangars. So we can utilize more hangars.

Did you break out the amount of military? Military in the quarter and the year?

Military is approximately 37% of sales for the quarter and for the year.

So they are about the same for the quarter and the year?

Yes.

Your expectations on that score I guess you have signed some contracts and things, what are we looking at that kind of growing at the same rate as the rest of the business?

I think we commented earlier that on the sales growth in the commercial business being in the double digits, and military probably slightly less than that.

Okay. That's fine.

If you look at the Company and you have been following the Company for a long time. If you go back to before 9/11, military revenues were approximately 17, 18% of total revenues. Since 9/11, military became a larger percentage of the total mix of business. This year, it will probably be the first year that we have since 9/11 this is probably the first twelve-month period that we have had stronger growth commercially than we have selling to the defense markets. I believe going forward, you'll probably see greater growth coming from the commercial markets, but that is just kind of a sense. And I think that we should be -- we should see the military -- the ideal defense mix for the Company in my view is somewhere between 35 and 45%.

Okay. So we're at the lower end of that right now?

I think we're at the lower end from a -- from where we would like to be going forward.

All right, but we're not going to get there next year, clearly.

I don't think so.

With regard just so I understand, you moved the engines into the Aviation Supply Chain. Those are -- do you have joint ventures on those engines or is that --?

No. The engines are wholly-owned by the Company. Whatever engines we have at this point.

So basically pretty much all of that Aircraft Sales & Leasing is now partnership revenue?

All the new investments are coming through partnerships. We still have some legacy aircraft from before, let's say there are some aircraft still remaining from before 9/11. And from time to time we may buy an aircraft on our own account, but most of the business that we intend to do at least would be through joint ventures.

You mentioned that $900,000 charge for the lease I guess you restructured a lease with a bankrupt or closed a bankruptcy airline. How is that -- are you seeing anything else, out there? Should we keep our ears open and be expecting possibly some additional situations like this?

Nothing that I can see at this point, but it is hard to tell exactly what happens in our industry. If fuel continues to stay at this level I cannot be totally certain what the financial viability of some of our customers may be. But at this point, we feel that we don't see -- we don't have any sense that there is other problems out there.

Good. And then finally, Tim, you gave those margin numbers for I think the previous structure, was that right?

That is correct.

What are they for the going forward structure?

For Aviation Supply Chain for the fourth quarter?

Yes.

21,501,400 (ph) or 18.6%. Maintenance, Repair and Overhaul, 5,164,000, 14.1%. Structures and Systems, 8,545,000, 16% and aircraft essentially breakeven.

Oh, breakeven? So basically it is engine that is the profitable piece of that business right now, I assume?

I think it is just related to one or two particular transactions.

But it has to be in engines?

Right.

But that is a unique situation now and we should look forward to seeing that business as more profitable going forward?

We are.

Very good. Thank you very much.

Daniel Moore from Aquamarine Fund.

Good morning gentlemen. Just drilling down a little bit on the Air Force and the A400 contract. Should we expect margins on those similar to what we have seen in manufacturing segment historically?

The A400 margins in the beginning will be less than we have experienced until we really the spare parts piece kicks in, at which point in time the margins should be similar to what we have experienced. So I believe in the early years you may have a little bit of margin compaction as the program starts moving along. You should start seeing traditional margins and hopefully at some point in time if the Airbus build is higher than we have estimated, and it looks like its a very strong aircraft then you will start seeing margins stronger than we have historically experienced.

Very helpful. And on the Air Force contract?

The Air Force contract will be historical margins.

In line?

Yes.

One last question perhaps, just a little bit of color -- in the press release and in your comments you mentioned some near-term caution. Are you signaling perhaps expectations might be a tweak higher for the next quarter or two or is that just a general conservatism (multiple speakers)?

Just I think the comments we're making are not related to what there may be in the way of expectations. We're just trying to give color to how we see the world. So we have had a lot of momentum here as a Company, and yet at the same time we remain a little bit concerned particularly here in the U.S. domestic market with the financial condition of many of the airline players. We just want to be balanced in our view of the world.

Fair enough. Thank you very much.

(OPERATOR INSTRUCTIONS) (indiscernible) Ginsberg (ph) from Columbia.

Just following up on your comment on potential weakness in commercial aerospace in conjunction with the answer to Greg's question on the leases, it sounded like you don't have any particular leases that you are worried about future charges at this point. So impact -- is it on a volume side on the parts or MRO? Where are you particularly concerned that would make you highlight the weakness at this point other than the broad fuel environment that we see?

I am not really highlighting a weakness. I think what we're trying to say is that we have had a lot of momentum here at the company. The business environment has been relatively -- has been improved let's say from how it was in the periods close, more preceding the 9/11 events. And all we are saying is that as we look out, we have some caution in light of the impact of high fuel prices on our airline customer results. And of course you already have some of our airline customers are in somewhat of a precarious financial condition. So we just want to -- we are not at this point in time, we're not seeing any weakness. We're just aware that the markets we are in are potentially choppy here coming off after the summer flying season.

Fair enough. Thank you. Nice quarter.

I am showing no further questions at this time.

Thank you. Thank you very much for your participation today.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now all disconnect. Have a great day.