AAR Corp (AIR) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the AAR Corp. first-quarter earnings call. (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this program is being recorded.

I would now like to introduce your host for today's program, Mr. John Bowman, Director of Investor Relations. Please go ahead, sir.

Thank you, Jonathan. 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 7 entitled "Factors Which May Affect Future Results" included in the Company's May 31, 2005 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, everyone. With me today is Tim Romenesko, our Chief Financial Officer and others here in our corporate headquarters.

The quarterly results released this morning reflect the Company's continued momentum and a great start to the new fiscal year. Sales for the quarter increased 22% year-over-year to just short of 200 million, and our income from continuing operations more than doubled to 5.3 million, or $0.15 per share, from 2.5 million, or $0.08 last year, which included a $1 million pre-tax gain on the early extinguishment of debt.

During the first quarter, we delivered double-digit growth in sales to commercial and government customers and continued to achieve strong growth in our international markets. In addition, AAR secured a number of significant commercial military contracts, which substantially increased our backlog and will benefit our results in future quarters.

We are pleased that we are performing well against our stated objective of increasing sales 12 to 15%, as both commercial and military customers are sending more business to AAR as they seek high-quality cost-effective solutions. Sales to commercial and government customers increased 25% and 16% respectively during the first quarter versus the prior year. We continue to increase sales geographically, as evidenced by the 45% increase in sales to Asian customers and a 9% increase in sales to European customers, both off of already strong bases.

Sales in our Aviation Supply Chain segment were 107 million, up 25% from the same quarter last year. The sales increase in this segment resulted from increased demand from engine program customers, greater penetration in coverage in the regional market, increased outsource and component repair management by major carriers and the trend toward greater utilization of performance-based logistics programs by the Department of Defense. The gross profit margin in this segment for the first quarter was 18.4% versus 16% a year ago and was driven primarily by increased sales and the favorable mix of inventories sold.

In the Maintenance, Repair and Overhaul segment, sales were 38 million, up 16.7 million or 78% versus the prior year. More than half of the increase in sales with driven by our Indianapolis maintenance facility, which commenced maintenance operations in January 2005, with the remainder of the increase due to stronger sales at our Oklahoma facility. It is important to note that the Indianapolis Maintenance Center achieved its first profitable quarter, which comes in only its second quarter of complete operations. The gross profit margin at MRO for the quarter was 15.1% compared to 11% last year and was driven primarily by operational efficiencies and higher volumes.

Sales in the Structures and Systems segment were 51.4 million, up 14% compared to the same quarter last year. All units in this segment posted higher sales as revenues for our mobility systems, cargo systems and composite structure products increased, reflecting new product development and successful sales and marketing efforts.

Sales of our specialized mobility products remained strong. However, product mix (indiscernible) led to a reduction of gross profit margins for the segment from 18.2 to 16.2%.

As discussed in previous calls, sales in the Aircraft Sales and Leasing segment have become less meaningful because the majority of activity is now conducted through joint ventures. It is worthy to note here that consolidated sales growth, excluding Aircraft Sales and Leasing segment, would have been 29% for the Corporation. During the period, we added one aircraft to our joint ventures and expect to add more in the near future.

Our selling, general and administrative spend is increasing, as we have programs that position the Company for future growth. SG&A costs increased year-over-year but decreased as a percentage of sales from 12.2 to 12.6 -- to 12%. We are managing these costs diligently to leverage our cost base and maximize the contribution on incremental sales to the bottom line. We are very focused in this particular item.

Net interest expense of 3.6 million for the quarter, down 0.5 million versus the same quarter a year ago as we decreased debt over the last 12 months. During the quarter, we made investments in the inventory support supply chain programs, including the recently announced MESA program. These strategic investments resulted in operating cash outflow of 22 million for the quarter. While we invest in the Company's future, we improved our Asset Management performance, increasing working capital turnover from 3 times the 3.6. Again, this is another area of great concentration and focus at the Company.

Subsequent to quarter end, two of our valued customers, Delta Air Lines and Northwest Airlines, filed for bankruptcy protection. AAR was proactive in minimizing its exposure to these events and the financial impact was minimal and was provided for in the first quarter. The Company continues to support both airlines by providing cost-effective solutions for their maintenance and supply requirements.

With the cost of oil in the high 60s per barrel, airlines around the world are being forced to search for new ways to lower their cost of operations, including a thorough review of their maintenance and supply alternatives. We believe, at AAR, we provide an attractive alternative for our customers and we're seeing the benefits of our results.

In addition to the excellent financial performance in the first quarter, we won numerous contracts, which should favorably impact future results. The Airbus A400M Cargo Systems contract is the largest manufacturing contract in the Company's history. Two supply chain programs, the one supporting MESA's regional fleet and the other partnering with Northrop Grumman to support the UK Ministry of Defense AWACS fleet, are significant long-term wins that strengthen the Company's position as the leading supply chain solution provider in the airline industry. We also received a larger award to supply specialized valves to the U.S. Air Force after the close of the quarter. We're in a great position to capitalize on the changing aviation Aerospace industry and look forward to the quarters ahead.

Thank you for your time this morning. Let's go ahead an open the line for any questions you may have at this time.

(OPERATOR INSTRUCTIONS). Jay Khetani from SG Cowen.

I was wondering, David, if you could talk about how much of the Pallet contract -- did we see any of that 30 million Pallet business come into this quarter or is that just in subsequent quarters?

From the order we just announced, you are going to see most of the -- you are going to see the impact begin in the second quarter.

Okay. Is that also the case with -- let me just finish on that. That is about -- does that run at a fairly smooth rate for the next 12 months?

It should run at a smooth rate for the balance of the fiscal year.

What kind of costs do you have to add into that segment in order to support that production? I mean, is it essentially just ramping production in the factory? Is there any SG&A? Is essentially just a pretty clean pass-through on the gross margin?

Yes, fairly minimal. There'll probably be -- there should be no SG&A impact. There may be some additional indirect expense but for the most part, you know, there should not be much in the way of incremental expenses.

Okay. The MESA and AWACS, is this also something that comes in starting in Q2?

Yes, you had probably a small impact in Q1 but you have -- both programs ramp up in Q2 and out into the future.

Okay. MESA is a 200 million over 10 years. Is this a ramp up over that period or I mean, I presume it is a base level for their aircraft and then with growth based on the ASMs activity. Is that fair?

Yes, I think you will see, in the first couple of years, you know, it starts really kicking up and gearing up in the third year, but you still have pretty decent revenues in years one and two.

Okay. The inventory investment for MESA, what does that profile look like for MESA in particular as we roll forward? In other words, are we through with the inventory build to support that program?

Then the follow-on is, as you continue presumably to win these new contracts, should we think about equivalent type of inventory builds?

So the first part of the question is that we would anticipate that there will be some additional build, and once we get a year or so under our belt, we will have a much better handle in terms of what the inventory requirements to support these fleets might be. So I would anticipate that early on you get some build and then a little later on you get a reduction.

I think, in terms of additional deals, obviously if we can tap into the CRJ markets and the ERJ markets in a broader sense, we should be able to use this inventory to leverage additional opportunities. If -- as we look to support fleets different than say the CRJ and ERJ, then we may be in a similar mode of having to invest in inventory.

Okay great. Got it. The last question on, again, on working capital. So turns are up on working capital, but there is some increase in inventory. We don't have that number. Does this mean that we had a nice improvement in either payables or receivables to support those turns?

Well, yes, but we also have an increase in inventory turns as well. So for us to get from 3.0 to 3.6, we need do not just be turning receivables, we also need to be turning inventory. So inventory turn increases up about 20% from roughly 2 to 2.5, give or take, in the quarter.

Peter Arment from JSA Research.

A question on -- I wonder if you could maybe just give us a little bit of a handle on the Northwest level of business you're during I guess before and maybe after the strike and maybe on an annual sales basis. Is there an order of magnitude of what you can give us?

Well, we have not necessarily seen the ramp up necessarily as a result of the strike. We have been seeing a ramp-up inactivity with Northwest that has been dating back for, say, the last six months, maybe in preparation of a strike, I'm not sure, but I believe that Northwest has been looking, searching for ways to lower their cost of operation. We have been recipients as a result of a couple of successful competitions in component repair. We are doing some maintenance for Northwest project-oriented in Indianapolis. Then we would expect that, as time marches on here, that we will see more opportunities develop from Northwest. Northwest is very pleased with the service they are receiving from AAR and as they look to outsource more of the things they do, we should be a beneficiary.

Okay, and that is particularly on the heavy maintenance side?

Yes.

Okay. Also, just on the same talking about maybe maintenance, could you give us an update on the ATA reconfiguration, maybe how that is progressing?

Yes. I mean, it is okay. I mean we're doing some work for ATA, but we have done -- I think we have performed mod work on one aircraft, maybe two, and we continue to watch the ATA account very closely.

How about other opportunities or at least give us an update maybe on performance with United?

United is very pleased. Myself and a couple of other senior leaders have met with the senior folks from United very recently. They are very pleased with the service and support they are getting from the Company. They are looking to put additional aircraft types on their ticket for AAR to support. So I would expect that the United relationship, which is solid today, will continue to grow.

Okay, great. Tim, just did you guys just disclose what the total backlog is for the Company now?

We did not put it in a press release. It is 180 million.

What was that versus a year ago?

I believe it was 160 million, Peter.

Okay, great. Thanks very much, guys.

Oh, Peter, it was 189 million.

Okay.

At August. It was 160 million at May 31.

James Aultre (ph) from Aviation Advisory Securities.

It is Aviation Advisory Service. A couple of questions please. First of all, you said prior to be -- it was prior right after the Northwest and Delta filings you took some steps to protect yourself. Can you elaborate on what you mean by that?

What we did was we managed our exposure. I would not say that we did anything special in terms of protection, but we matched our cash coming in with our goods going out.

Okay. Now this is obviously not the first time you have had a major airline customer go into bankruptcy. With any of these other bankruptcy situations, have you ever had any trouble getting paid in a timely fashion?

We assume on pre-petition receivable that we are only going to get paid a fraction of the pre-petition amount. On postpetition, our history has been that we have been paid dollar-for-dollar.

Have you written, in the last, say, 12 months, have you written off any amounts relating to some of these pre-petition receivables?

Well, in the quarter that just ended, we put up a small relatively small reserve for our prepetition exposure to Delta and Northwest.

When do you typically recognize the loss on these -- because I guess you don't really know what the loss is going to be until the company comes out of bankruptcy and they make a settlement with you.

We feel pretty confident that, in this case, we recognize the full loss.

I assume you have established a reserve for United?

When they filed, yes.

How does that match up with what the plan says you're likely to get?

I think we will be right. We are not going to get much.

Okay. Have you expanded your leasing activities in the past six months? Have you established any new joint ventures or have any of your joint ventures taken any more planes or engines?

Yes. Well, as we have announced, we have entered into one formalized joint venture, which is over the last year or so we have added seven or eight airplanes to that venture. We are in discussions with another party on another venture today, which will probably add another six or seven aircraft to our portfolio.

Jay Khetani from SG Cowen.

Just another follow-up. David, can you just comment or what you're seeing in terms of the type of new business opportunities, say versus six, nine months ago?

Then second can you give us an update on any developments with AIROD in terms of kind of getting that business really off the ground and having I guess presumably Air Asia and Malaysia Air come through that facility?

Jay, first of all, the pipeline is very strong. You know, obviously, we have announced some major wins here recently. We will be in the process here in the current period of ingesting the programs we have recently announced while, at the same time, we believe that the model is very compelling for other carriers and we are seeing increased interest. If I were to compare the flow today to say a year ago, I would say it is considerably stronger. In relationship to Malaysia, the AIROD venture is progressing pretty much on schedule. We have received gear in already. We have received two gears that have come into our Malaysia operation. We expect full certification sometime in October. Hopefully our VP of Engineering, Micky Cohen, will be visiting with the FAA during that time period to hopefully secure that -- secure the certifications. We would expect business to be fairly brisk coming out of that region.

Arnold Ursaner from CJS Securities.

Can you give us a little better feel? You obviously mention you took some modest charge, if you will, related to the bankruptcies. Was that a key factor in the margin decline that we saw a little bit in the quarter?

Why, you had a margin increase in the quarter?

Or how did it impact the margin? Let's word it that way.

Minimally as we have said.

(OPERATOR INSTRUCTIONS). Arthur Caltharanas (ph) from JH (ph) Advisors.

Just a question on the write-off of pre-petition -- I mean, would you do is -- like, for the United example, if you just historically assume recoveries were $0.07 on the dollar, that type of ratio to 100 to par is what you would probably -- that is what you would probably flow through the income statement? Would that these sort of analogous to that?

Yes, I think that is about right. You know, you assume you might get $0.10 on the dollar.

Okay and you guys -- okay, you had your exposure. You said, okay, this is where we get postpetition on the (indiscernible) this would get on our prepetition amount upon confirmation.

Right.

Okay. Then the second question I have, when I look at your maintenance business, I mean, there is more talk about -- not talk but I mean regional, larger regional jets coming into the fleet to replace some of the smaller mainline equipment. I mean do you guys -- I mean, is that an opportunity? Is it longer-term? Are you like equipped to do something like that? Does it really slow down maintenance for you guys or MR&O business?

We're very bullish on the regional jets. We support the regional jets in our MRO facilities, both front a heavy maintenance vantage point as well as landing gear. We also have inventory positions to support regional jet growth and we have component repair capability for that market as well. And I believe that is one of the reasons why MESA selected us for this very important program.

So is that a better -- is it a more profitable business than if like let's say you had a DC-9 versus like an Embraer or like, you know, 90 or 95?

I think each situation is different, so I cannot say a blanket standpoint, but I think, you know, the margins are appealing.

Okay. Got you. That is it. Thank you very much.

Thank you. I'm not showing any further questions in the queue at this time.

Okay, well, thank you very much for your attention today and I look forward to producing very good results in the future. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.