AAR Corp (AIR) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the AAR Corp. second-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, 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 Chairman and CEO, David Storch.

Thank you, John, and good morning, everyone. Joining me on the call this morning is Tim Romenesko, our Chief Financial Officer, and Jim Clark, our Group VP for our Aviation Supply Chain businesses.

As announced earlier this morning, the Company's results for the second quarter of fiscal 2006 were strong, improving significantly on both a year-over-year and sequential basis. Sales were 218 million, a 24% increase compared to the prior year, and income from continuing operations was 7.9 million or $0.22 per share, versus 5.0 millions or $0.15 per share a year ago.

The increase in earnings is even more significant considering the second quarter of last year included a 1.6 million or $0.05 per share federal income tax benefit related to a deferred tax adjustment.

The growth in pretax income from continuing operations was 149% -- quite a robust number. The overall sales increase of 24% for the quarter was well above our stated objective of 12 to 15% sales growth as sales increased to defense and commercial customers by 32% and 20%, respectively. Sales to our regional airline customers, which is a subset of our commercial market, grew 65%, due in part to the new Mesa supply chain management program.

On a geographic basis, sales to European and Asian customers were higher year over year as well, growing at 15% and 7%, respectively. You might recall last year, sales growth in both these geographic areas were in excess of 40%.

In the Aviation Supply Chain segment, sales were 108 million, up 17% from the same quarter last year. The major growth drivers in this segment included new program sales for our Mesa and our UK MoD programs, higher parts demand and increased component repair. The gross profit margin in this segment for the second quarter was 20.9%, compared to 16.8% in the prior year. Increased volume and favorable mix drove the margin improvement.

During the second quarter, we announced a partnership with BAE Systems whereby we will support their services division and largely in support of their regional jets in the European market. We also announced an additional supply chain management program with Mesa Air Group, supporting their fleet of CRJ 200 regional jet aircraft. This now brings the entire Mesa jet aircraft fleet under our management. We funded the investment for the new Mesa program in late November and will realize sales and earnings beginning in Q3.

Sales in the Maintenance, Repair and Overhaul segment were 43.3 million, an increase of 18.2 million or 73% versus the prior year. Activity at our Indianapolis Maintenance Center was the primary driver for the increase, but sales were also stronger at our Oklahoma City facility. The gross profit margin in the MRO segment for the quarter was 11.5% versus 11.1% last year.

As stated in today's earnings release, there were two items that impacted results in this segment during the second quarter. The first was the impact of Hurricane Wilma, which caused a three-week power outage at our Miami operation, and the second was a considerable increase in training costs as we added approximately 225 new employees during the period in this segment. We estimate the impact on second-quarter results of approximately 1 million from these items. Miami has been restored to full power, and we expect increased training costs for the balance of the fiscal year in our other MRO facilities.

In the Structures and Systems segment, sales were 63.8 million, up 30% from last year. We continued to experience strong demand for specialized mobility products and an increase in volume for cargo systems. Although gross profit dollars are up from a year ago, driven by higher volumes, a greater mix of shelter sales caused a decline in gross profit margin from 18.7 to 15.4%. We expect continued strong results from this segment as backlog has increased approximately 100 million since the beginning of our fiscal year. However, margins will remain under pressure due to the mix.

Sales in the Aircraft Sales and Leasing segment were 3.2 million, down 6.7 million from a year ago, due to, as we've discussed previously, sales comparisons in this segment are not as meaningful as a majority of activity in this segment is now conducted through unconsolidated joint ventures, which excludes revenue from our consolidated sales.

Our aircraft strategy post-September 11 has been to participate in the aircraft transactions principally through joint ventures. During the second quarter, one of the Company's joint ventures purchased five aircraft and sold one aircraft, bringing the total number of aircraft held in joint ventures to 10. The Company also owns seven aircraft out of the joint ventures. Operating income for this segment improved both year over year and sequentially.

During the second quarter, SG&A costs increased as we added resources to support new programs and positioned the Company for continued growth. Although SG&A costs were up 3.4 million compared to the second quarter of last year, we are leveraging our cost base as SG&A cost as a percentage of sales declined from 11.5% to 10.8% year over year. This also represents a significant improvement from the first quarter, when the percentage was 12%.

Our asset management performance remains strong. Inventory turns increased from 2.2 to 2.5 year over year, and we met are working capital turnover objective of four times in the second quarter. Operating cash outflow during the period was 2 million as we funded the new Mesa program and made other attractive investments as well.

Overall, our operating environment continues to show signs of improvement. Increasingly, airline customers are seeking partners that can help them lower their costs without sacrificing quality, safety or service. On the defense side of the house, the drive to increase mobility and cost-effectively manage supply chains creates more demand for the types of services we provide.

We are very pleased with the results of the second quarter. Our focus remains on growth and solid execution. We will continue to respond to customer needs, getting new programs and capabilities, expanding to new platforms and investing in our people and our businesses.

Looking ahead, I anticipate the Company's growth will be achieved both organically and through strategic acquisitions. This is certainly an exciting time for AAR, and we are very optimistic about the future. Thank you for joining the call this morning. And I'd like to open up the call for any questions you may have.

(OPERATOR INSTRUCTIONS). Peter Arment, JSA Research.

Question, David, regarding -- you mentioned in the press release regarding the Mesa investment that you made in the quarter. Given these large programs that you've won in terms of the UK AWACS deal and the A400M and the expansion of the Mesa, how much more of the upfront investment is required, or are you essentially complete with some of these programs?

The only program, Peter, that requires ongoing investment would be the A400M at this point. There is some additional investment in Mesa, but it is really spreads out over a 10-year period. But we would anticipate the cash flows from Mesa going out from here to be very positive. And the cash flows in the UK MoD should be positive. And the only -- the A400M, keep in mind now, we are in the development stage today, and that program will not start contributing sales and earnings until the end of '07.

Right, okay. But characterizing --

The majority of the investments required for the other programs are pretty much behind us.

That is what I was getting at. And then regarding -- back to the Mesa deal, it seems like there are numerous other opportunities out there in the marketplace. Maybe you could just give us some details of what you're seeing in terms of outsourcing in the market. I assume maybe you're not going to name names, maybe that just a little color on that.

I think, Peter, we are seeing good deal flow. Keep in mind, now, the latest contract was just signed on November 22. So it is becoming operational as we speak. I believe the organization, that we have strength in the organization -- enough strength to go ahead and attract some additional programs. And we are in discussions with numerous parties, not just regional carriers, but also other larger carriers as well.

We also anticipate and we are looking at some opportunities on the defense side as well in this area. So the deal flow is strong. And I believe as we execute here on the existing deals that we should be able to capture additional programs of this nature.

And just sort of a housekeeping -- on the $30 million pallet contract, when is that expected to be completed? I know some of these are follow-ons, but --

Yes, that should be completed this fiscal year. It might bleed over a little bit into next fiscal year.

And you mentioned some of the gross margin numbers. Was that 20.9 you mentioned for Aviation Supply Chain?

Yes.

I don't remember ever seeing a number that high. Is that just a function of mix? Or is that sort of a level that we should expect going forward?

I think that level is a strong level. I think the trend is for improving margins in that area. There was some favorable mix, but also as we get our component shops -- get filled with more work, the margins in that group improve. So I would be hopeful that the margins, if they're not quite at the same level, will be very close. But more importantly, they will be trending historically higher than they have been.

And then I guess just talking about the margins, if you excludes the costs from Wilma, it looks like your consolidated operating margin was over 7%. Now I guess could you highlight maybe some more where you see additional opportunities within -- you mentioned the component area, where there's been excess capacity -- where there are opportunities you're seeing from a margin standpoint?

If you look at our facilities today, I do not believe we have any facilities operating at full capacity. Oklahoma City probably comes the closest to being at full capacity. But Indianapolis clearly has room for more growth. Our landing gear shop can handle more work. And our component shops can handle more work. Manufacturing plants, one or two might be a little stretched, but for the most part, we do have additional capacity to handle the sales growth. As we start experiencing the sales growth, that should drive improved margins.

Jay Khetani, SG Cowen.

The operating margin ramp this -- I mean, you essentially did 140 basis points sequentially. And you're talking, David, about continued what looks like good performance in supply chain, maybe kind of perhaps somewhat flattish from here, maybe some opportunity in structures -- and I'm talking gross margin basis. But is there any region to think that your operating margins could not continue to expand at a similar type of rate as we look through the balance of '06?

Yes, we are expecting the margins to continue to improve. So we feel fairly confident that that will be the case.

And in terms of the topline, again, this is essentially the fourth quarter of close to or at above a 20% year-over-year growth rate. Again, that is something that you would expect to continue as a function of both strong core business, but also roll-in of the new contracts. Is that fair? So again, over 20% for each of those subsequent quarters?

That is what we're looking at, yes.

Okay. Great. Can you just give us a status of where you are on loading at Indy today, where you think you will be also at the end of fiscal '06?

Well, we continue to add people. We continue to hire people in Indy. Our biggest constraint right now would be getting people up to speed. And as we attract qualified mechanic and putting them through our training regimen, I think there is a kind of a balance, if you will, that should allow us to see steady growth coming out of that facility.

The pacing factor -- obviously we have floorspace. The pacing factor is attracting and retaining qualified mechanics. And we are working hard and diligently in that respect. We have had some success. We've had a nice increase in business flow through that facility this past 90-day period. We are expecting continued growth the balance of the fiscal year -- should be steady and consistent.

The one thing that's very important for everybody to keep in mind is this operation is not up and running a full year yet. So the success that we've experienced in this facility I think is quite remarkable. We don't want to get ahead of ourselves here. We want to continue to build a quality product and stay focused on the things that the customers are looking for. And I believe as we continue to build in this fashion, we will end up with a very successful enterprise.

So are you actually having to moderate the pace at which you bring in new business or slow discussions because of the challenge of finding the labor?

I'd say there's a balance. We are able to find the labor that we need. If all of a sudden, somebody dumps another 500 employees on us, we could ramp up that much quicker in that operation. But at the same token, it's very important that these folks be trained properly and learn our system. And I don't see any reason why we can't continue to grow at the rate that you've seen us grow the last 90 and 120 days in this business.

Okay. Could you break out the 1 million kind of lost operating profit between Wilma and the higher training at Indianapolis between those two?

Yes, it's about approximately 50/50.

50/50. So that 50 -- that 500,000 type of level should continue at Indy, right?

Slightly less as we go into the third quarter and slightly less in the fourth quarter. But still fairly meaningful.

Okay. Maybe you could just talk about for a second M&A. So what are the types of things that you might consider to do here in terms of expanding? Is it needing -- I mean, you make this case that you are in pretty decent position with regards to capacity, with some exceptions. So is it expanding the breadth of your capability so that you can be more of a complete offer to your customers? Or how would you describe that?

As we look at different markets and we look at different capabilities, there are clearly voids in our portfolio. So like, for instance, there are more things we'd like to offer the regional markets. I believe we've made some very good progress in supporting regional carriers. And of course, as we've talked about over the past, regional carriers would be defined as not necessarily having heavy investments in maintenance and supply. So they play into our strength. And as we see the regional carriers growing in market share, that's a segment that we want to continue to play in. So I could see adding additional service capability and supply capability in support of that market.

We also, as I look at our Structures and Systems area, I think there's room for growth in the mobility world, both in terms of providing more value to our customers and by being a little further up the food chain, but also being a little further down the food chain as well in terms of some of the things that are stuffed into the shelters and having the capability to build some of that equipment.

I also see the aircraft parts business expanding for the Company -- things that we could manufacture, like for instance, as we plan out the demand for the A400 systems, we recognize there's going to be a large appetite for machining and building many of those parts that go into the system. And we are exploring possibilities of having more of that capability under our umbrella. So I think there's a lot of different areas for us to go ahead and expand through smart acquisitions.

(OPERATOR INSTRUCTIONS). Arnie Ursaner, CJS Securities.

Two questions, if I can. One of your key areas of targeted growth has been Asia. We know the AROB (ph) landing gear program, the JV you have in Malaysia, is doing well. But you have also talked about trying to find a maintenance component JV partner for the Chinese market. Can you update us on kind of the thought process -- the kinds of target that are out there?

We're spending a fair amount of time developing that strategy as we speak today. We still continue to place a lot of emphasis. Our products are being received quite well in that market, and we're still fairly bullish on having more presence in that market.

We are looking very closely in China. As you know, last year or a year and a half ago, we opened up an office in Shanghai. It is now staffed with four folks who are not just covering the customer base from a selling standpoint, but also looking at the strategy for the Company in that market.

We also see the Malaysian market as a very friendly market for the Company and one in which we hopefully will be growing our presence. So Asia is a very broad geographic region, and we're developing different strategies for different pieces of that region.

The second question I have is on the pallet business -- the military business. A lot of people are questioning kind of what you will do when we move out of the Iraqi market. Can you give us your view of kind of how you plan to grow that when that conflict ends, and if there is any visibility beyond the current contracts you have in hand?

Of course, it is -- there's clearly a piece of our business today is what we would refer to as surge activity due to the activity that the U.S. defense forces are currently engaged in. But if you look at the long-term strategy for the U.S. defense forces, if you study the Rumsfeld plan, it's really to have a smaller, more mobile fighting force. And although the Iraqi issue may get solved at some point in time, there probably will be other places around the world that the U.S. will either be engaged in or will need to be prepared to be engaged in.

So the products that we build are really designed to assist in the effort to move products and supplies into various theaters of operation at any given point in time. So this world is very far from being a safe place. And we feel very confident that the product line that we currently enjoy is very well-positioned to deal with the overall geopolitical environment that we are currently faced with.

At the same time, we think that there's areas and ways for us to grow our position in this market that can transcend any, not just this difficulty but any other difficulties, by virtue of making ourselves more important -- a more important supplier and a more value-added supplier.

(OPERATOR INSTRUCTIONS). Jay Khetani, SG Cowen.

Just one follow-up. Do you care to offer any kind of commentary on 2007 growth rate? I know you have talked generally about being able to support a 20% topline growth for a couple of years here. I'm just curious on '07 -- how much of that is business that is in hand versus your expectation of your ability to continue to win? And then what does that also imply for operating margin in '07?

So Jay, if you taken look at the Company today versus the Company, say, two or three years ago, today much more of our business is contract-based and a little bit more forecastable. And our goal is to, as we sit here and plan out our future, is to win more of that type of business. I believe that the products we have, the services we provide will allow us to attract a very predictable stream of business for quite -- for a very sustainable period of time.

So I am encouraged with the prospects. I'm encouraged by the position that the Company has. I prefer at this point in time not really to delve into specific forecasts. Our management team, our leadership team will be meeting in January to talk about not just the six months that have passed, but the six months ahead of us, and then start the foundation for the next 12-month period in front of that. So I will be in a much better position to address the next -- the '07 period in the next 45 days than I might be today.

(OPERATOR INSTRUCTIONS). I am not showing any further questions at this time. I would like to turn the program back to you for any further remarks.

Well, thank you very much. I hope everybody enjoyed today's session. And I'd like to wish all participants a very happy and healthy and prosperous holiday season and New Year. Thank you for participating.

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