AAR Corp (AIR) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the AAR Corp third quarter fiscal 2006 earnings conference 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 call, the director of investor relations, Mr. John Bowman. Sir you may begin.

Good morning ladies and gentlemen and thank you for taking the time to participate in this morning's conference call. Before we begin, we'd like to remind you that certain 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, President and CEO, David Storch.

Thank you, John, and good morning to everyone out there. Joining me on today's call will be Timothy Romenesko, our Chief Financial Officer.

We are pleased with out with our third quarter results announced this morning as we successfully execute our growth strategy and see increases in both sales and earnings. Sales for the third quarter were 226 million, that is a 14% increase compared to the prior year and were driven by sales growth in our MRO, aviation supply chain and structures and systems segments.

Combined sales growth in these three segments was approximately 24%. Sales were lower in the aircraft sales and leasing segment as prior year results included the sale of the Company's interest in certain aircraft for $15 million, and that sale included practically no income. Income from continuing operations for the third quarter were 9.1 million, or $0.24 per share compared with 5.2 million, or $0.15 per share a year ago. The results for the third quarter of this year include two special items. First, a $3.9 million pretax expense or $0.07 per diluted share related to the exchange of a portion of our 2.875 convertible notes to common stock; and second, a $1.6 million tax benefit or $0.04 per share related to export activities.

Pretax income from continuing operations for the third quarter before the 3.9 million expense related to the exchange of convertible notes was 14 million, an increase of 132% over the prior year. Sales increased our defense customers by 22% and increased our to commercial customers 11%, which includes the effects of the $15 million aircraft sales in the prior year. In the aviation supply chain segment, sales were 117.2 million, up 21% from the same quarter last year. The increase was driven by sales from the new Mesa and UK MOD supply chain management programs, as well as increased demand for parts support from other commercial and defense customers. The gross profit margin in this segment for the third quarter was 23.7% compared to 17.6% in the prior year. Increased volume and a favorable mix drove the margin improvement.

Sales in the maintenance, repair and overall segment were 43.6 million, an increase of 14.6 million, or 51% versus the prior year. The sales increase is primarily attributable to sales in our Indianapolis-based maintenance facility as well as increased sales at our landing gear business. The gross profit margin in the MRO segment for the quarter declined slightly to 13.8% from 14.3% principally due to start-up activities at the Indianapolis facility. We expect gross margins for this segment to improve in the fourth quarter.

Also during the third quarter, our landing gear joint venture in Malaysia received its certification from the Malaysian Department of Civil Aviation and passed its FAA certification audit and is expected to receive its certificate shortly at which time it will commence operations. In the structures and systems segment, sales were 61.9 million, an increase of 16% over last year. Increased demand for specialized mobility products and cargo systems drove the increase in this segment. A change in product mix has pressured margins which are down year-over-year from 17.9 to 13.9%, but the results and backlog in this segment remain strong.

Sales in the aircraft sales and leasing segment were 3.4 million, down 15.6 million, or 82% from a year ago. The decrease in sales were almost entirely due to a $15 million sale of the Company's interest in certain aircraft at approximately book value included in last year's sales. During the current third quarter through its participation in joint ventures, the Company added five aircraft to its portfolio, bringing the total number of aircraft held in joint ventures to 15. The number of aircraft owned by the company outside of joint ventures remain at 7. Operating income for this segment improved both year-over-year and sequentially.

For the third quarter, the Company made meaningful progress in its margin goals, achieving a 19.2% gross profit margin compared with 15.5% last year, and an operating margin of 7.9% compared with 4.9% last year. SG&A expense is up 4.6 million compared to last year related to an increase in personnel-related expenses to support our growth.

During the third quarter, the Company filed its fiscal 2005 federal income tax return and determined that it was entitled to 1.6 million of additional tax benefits related to higher than estimated margins on export sales. This benefit was recorded in our just completed third quarter. We expect that our tax rate will be approximately 27% during our fourth quarter.

We consumed 39 million of cash flow from operations during the third quarter caused by an increase in accounts receivable principally due to the increase in sales and the repurchase of accounts receivable previously sold under the securitization program, as well as the purchase of an aircraft previously subject to an operating lease.

There were two important events with regards to our capital structure that occurred during the third quarter. First, in early February, we issued 150 million principal amount of 1.75% convertible bonds which mature in 2026. These senior unsecured notes are convertible under certain circumstances into approximately 5.1 million shares of our common stock at a conversion price of $29.43 per share. We used a portion of the proceeds to repurchase accounts receivable that previously had been sold under our accounts receivable program, to repay short-term debt and to purchase an aircraft which was subject to an operating lease. This financing increases our financial flexibility and provides the Company with the funds necessary to support our strategy and drive future growth. We ended the third quarter with 105 million of cash on hand and also have approximately $80 million available under our credit facilities and securitization programs.

In addition to the new financing, we acquired 50.6 million aggregate principal amount of the 2.875 convertible notes in exchange for 2.72 million newly issued shares of our common stock during the quarter. As a result of the exchange, we recorded a 3.98 pretax expense which was comprised of interest that the noteholders would otherwise have been entitled to through the call date, plus an incentive. This debt for equity exchange allowed us to reduce our debt by 50.6 million and increase equity by 46.6 million, further strengthening our balance sheet.

Overall, I am pleased with our Q3 results as we have made progress in numerous areas. Thank you all again for joining us this morning and I would be happy to take any questions you may have at this time.

(Operator Instructions). Arnie Ursaner, CJS Securities.

I missed the number, and I think you gave it, on aviation supply chain, the gross margins please?

Arnie, it was 23.7%

Okay. And when you spoke about the gross margin on MRO, you indicated the 13.8, you did expect it to be higher in the upcoming quarter. Can you give us a little feel for, do you expect it to exceed the 14.3 you had last year in the quarter? Give us some feel for perhaps the magnitude of the startup expenses you are incurring?

Arnie, what I would say is that, as Indianapolis comes online, we expect the profitability to improve. As you know, we have had a significant increase in sales there, taking the base up to 6 bays now. And we expect to see our profit there to improve, which will drive the overall improvement in the gross margin for that segment.

And on the 6 bays you're having, obviously utilization would also help drive margin. I know -- can you give us any -- a little better feel for the utilization of the 6 bays you do have? I know you have 10 in total available, but --.

The 6 bays are being well utilized. Obviously, we can do better, show some improvement. Our biggest challenge, Arnie, as we have communicated before is getting our team and trained and up to speed on our processes, and that has been the -- I think in this past quarter, we added quite a few more people. And we continue to -- we expect the margins to improve as a result of the training that we have incurred and better utilization of the base.

One question I know I've been asked is sales in maintenance (indiscernible) and it's kind of hard to fault the 51% improvement. I think some people had built-in more, including ourselves. Was there any seasonality or any other factor that held back your sales a little bit that we might see recovered in Q4?

From the standpoint of the number of days, you have the fewest numbers of days in this particular quarter because this quarter is December, which by definition, has more days unavailable than most months, as does February because the calendar only gives us 28 days. So this quarter, which includes both December and February, is a short quarter than the other four quarters might be, the other three quarters might be. So -- and there is some seasonality to that business. We would expect pickup in activity here and we've seen the pickup of activity here in March, so we would expect that pickup to continue.

I will jump back in queue. Thank you.

Peter Arment, JSA Research.

Good morning. I want to follow up on Arnie's question regarding the gross margin aviation supply chain. You mentioned 23.7, that's certainly significantly higher than anything we've seen in that particular segment I guess from a historical standpoint. David, maybe you could just provide a little more I guess color, the overall trend you're going to see there. Is that a sustainable rate?

You know, it's a good question. I'd like a little bit more (indiscernible) before I comment on that. It was an exceptional quarter from a margin vantage point, it was a good mix. The programs, I was very pleased with the execution on the programs, we got to speed faster than we had anticipated. The expense of the programs was a little bit less than we had anticipated. So I would like to hold my comments on that in terms of waiting to see, get a little bit more time passed, make a determination of how sustainable those margins might be.

And this just Mesa and MOD, right, are all kicking in, right?

Yes. I would anticipate that the margins will be higher than they have been historically, but I cannot confirm that they would be at this level. I would like to allow a little bit more time pass by.

Just regarding that in general, your sales, talking on a consolidated basis overall, are up almost on a run rate, almost 50% from where they've been I guess a year after 9/11. Are you running into any sort of back to the utilization, any sort of capacity issues or anything across any of your operations?

I don't see that yet. We have not seen that. We still have in our component shops, which we're seeing a nice improvement, we still have third shift capacity available and we still have some facility space available for expansion, so I haven't seen that yet. So I think, Peter, we still have capacity to grow.

Okay. And then just switching over about regarding structures, have you seen any favorable impact from the recent supplemental and maybe anything you can quantify?

We haven't seen anything yet.

Was there anything that -- there wasn't any line items tied to your particular product areas, but have you gotten any sense that there will be additional monies coming?

I would be unsure at this point. We are asked exploring. We are looking closely at the supplementals, but at this point, we have not been notified of anything for us. We are working -- we have identified areas where we think there may be opportunity for us and we are exploring that.

But you did receive some money in the past from some past supplementals, correct, or no?

I believe we received some in last year's supplemental, but I cannot confirm. I can get back to you on that.

That's fine. Tim, just a couple of housekeeping items. D&A and CapEx in the quarter?

CapEx was $3 million, Peter, and D&A was 7.6 million.

And you did not give us any accounts receivable inventory numbers. You said they were up?

Yes. Accounts receivable was up due in part to the $15 million repurchase of the securitized receivables, and also an increase in trade receivables. The net receivable balance at the end of the quarter is 153 million. Inventory was up 8 million.

Great, I will get jump back in queue.

Arnie Ursaner, CJS Securities.

Going back to structures and systems, you mentioned the change in products mix has pressured margins. Could you expand a little bit on that and give us your feel over the next several quarters of how that may change?

Arnie, we have had -- over the past several quarters, we have been producing a high volume of containers under various contracts. The containers have higher margins than our habits pallets and our shelters that we produce. What's happening now is that the demand for pallets and shelters has increased and the demand for containers has decreased. And so that is impacting our margin in the quarter and we expect that to continue for the next few quarters.

Okay. And a mechanical question. I'm sure this is a remarkably simple answer, but you bought back 76% of the outstanding bonds. Just remind us, the balance of the 24%, I assume you tried to buy those, and what is the call date on that?

There's $17 million of notes outstanding. They are convertible today at option of the note holder.

So you again I assume tried to offer incentives to the remaining 17 million, and those investors chose not take them?

Actually, all of these were done by people contacting us.

Okay, thank you.

Gregory Macosko, Lord Abbott.

Thank you. With regard to the Indianapolis, you are at six bays now. What is the decision process or what is needed to go to 7, 8, 9, 10. I assume that you have your eye on the remaining for?

Absolutely, so it's an opportunity and volume-paced decision. We don't pay rent until we utilize the facility. So, A, Greg, what we're trying to do is go ahead and solidify the current base that we have and get the operating margin to the level that we expect. And then B is once we are at the level where we want to be, go ahead and expand the -- move into the other base. We are ahead of schedule now. We were not expecting to be in six bays at this point in time. We were not expecting to have 700 employees at this time. Our plan had called for us to have 250 employees at this time, 250 to 300 employees, and we have in excess of 2.5 times as many. We were thinking at this point in time we would be in four bays and we've in six. So we want to ingest the current workload and then, as we solidify the position, go ahead and aggressively merchandise/market the remaining capacity.

Put it another way, for you to take on the seventh bay, would that come from existing customers that have increased their numbers, or would you need a new customer?

It might come from existing customers, not necessarily increasing their numbers as much as giving us an additional fleet type to what we currently may enjoy. So it may come from existing customers. I would think that it would come more from new customers.

Okay. And then talk a little that more about the Malaysian approval with landing gear, just remind me of that?

So we had that joint venture with a local Malaysian company that built the landing gear repair shop in Kuala Lumpur. We have received certification from the Malaysian equivalent to the FAA and we have passed the FAA audit and we're waiting for the actual certificate, which should come within the next 30 days, at which point in time we will commence operations.

Will that take any volume from any of your other operations?

What it might do is it might provide lower cost back shop support for our landing gear operation in Miami, which might allow the Miami-based operation to grow at a faster rate, so that could be a potential. Our goal is to increase our visibility in the Asian market and use that operation to some degree as a storefront to funnel work back to Miami and then do some -- as time passes on, build more capability in Malaysia that we can handle at the lower cost rate in Malaysia. And it will also serve -- and that's for aircraft for the gear types that we can't currently handle in Malaysia. Gear types that we can currently handle in Malaysia, we'll probably do subcontract work for the Miami operation.

And then with regard to the cash flow just again to make sure I understood it all, you are saying that you were cash flow negative because of the accounts receivable repurchase and the repurchase of the lease?

We had two big buckets, each one worth 15 million. One is the bulk of what you just said, 15 million each approximately. We had an aircraft on lease in an off-balance sheet, if you will, synthetic lease arrangement. And we acquired that. Interest rate was at a higher rate than we felt, plus we're sitting with pretty good cash position. So we paid off that loan, and then we bought back the receivables that we had sold to LaSalle Bank during the period. We bought them back during the period, also as a result of the cash position of the Company. Also on an interest rate arbitrage, if you look at the rates that we are paying for our capital today versus the interest rate that we're paying on the securitization. We also increased our inventory in our supply chain group to support not just some of these programs, but also to support our arbitrage business, and I think basically that is where (MULTIPLE SPEAKERS). Plus, we had an accounts receivable increase due to sales value increase.

Well, that's good. So that aircraft becomes one of the seven that is fully owned then?

Yes.

And you added five from joint ventures?

Yes.

Okay. And kind of what is your outlook there? How does that all look, and we're going to see 20 by the end of this quarter?

I'm not sure. I don't want to pinpoint exactly what the number might be. Let me say that the aircraft that we have been buying are we think very opportunistic. We think we'll get very meaningful returns on our equity, which is how we are measuring that business. And we are in the market looking for -- we have an active deal flow. I'm not sure, Greg, that we're at a point where that we have things that might close between now and May 31. But I would say safely in the next, let's call it six months period, that you would be in the range of what you indicated.

All right, so we will see that increase. And again, that will be primarily joint ventures?

Primarily. There may be certain situations that develop where one-off opportunities for us to use our own capital for trading purposes. We are starting to see signs that that market may in fact be reemerging, so you might see us do a trade or two on our own account.

I'm going to watch that, David.

Okay.

Thank you very much.

(Operator Instructions). [Stan Manny], a private investor.

Good job, gentlemen. A couple of questions, simple. What is the depreciation in the quarter, and what do you anticipate depreciation for next year, what run rate?

That depreciation, it was 7.6 million in the quarter, and I would expect the going forward run rate to be in that same range.

Similar. Do you measure [EBTA]?

We do measure it.

What was it in the quarter?

I will tell you. I don't (MULTIPLE SPEAKERS). [EBITDA] in the quarter was 65 million. (MULTIPLE SPEAKERS) 21.6 million.

Versus -- do you have last year's?

I do. 17.1 million.

That is a nice ramp-up. Can you speak a little bit to the diluted shares outstanding, what it is now, where it's going to be moving?

yes. Diluted shares outstanding were 39.1 million.

That's in the quarter.

And they will go to 42.5 million.

In?

In the fourth quarter, and then stay in that range.

Any feel for expectations on growth rate going forward, expectations or outlook?

We have not really put a growth rate out there. We have not put earnings estimates out there.

Okay. Would you say then -- I will simplify it -- would you say that the incoming business is strong, getting stronger? Kind of good us a little feel for directional.

I think that we're with the pace of the activity around us. It's acceptable.

And it's strong then?

I think I'd stick with acceptable.

Acceptable. Okay, thank you, good job.

[James Altschul], Aviation Advisory Service.

It's Aviation Advisory Service. A couple of questions please. What did you have a CapEx forecast for the rest of the year?

Your CapEx in the fourth quarter will be between 3.5 and 4 million, I would expect.

Second, there's been a lot written at about how there's significant growth potential for third-party maintenance because many of the legacy carriers are looking to cut costs by outsourcing and you offer a lower-cost alternative. Do you still believe that there's significant upside, or have most of the most likely prospects been nailed down, either by you or somebody else?

If you look at the North American marketplace, the North American marketplace is still, I would classify it as opportunistic in this respect, I think. Although certain of the legacy carriers have placed their aircraft let's say, I think they're still kind of working through their longer term decisions on outsourcing. So my view is that, there is still -- I cannot tell you percentage wise how many more aircraft are now available for third-party maintenance providers today versus how many might be available next year at this time. Clearly in the last 12 months, you've had more of an adjustment than you might have in the next 12 months, but there still continues to be an adjustment in this area.

Thank you, one more if I may. To what extent -- you have a number of different maintenance businesses. I believe you have both heavy maintenance and more specialized things, such as avionics and component repair. How much of your maintenance business is subject to lower-cost competition from other third-party providers in Asia and Latin America?

Well, if you look at the airframe maintenance that we're focused on, that business is mostly narrow-body aircraft. And typically, the carriers wouldn't send a narrow-body aircraft across the ocean because there's not enough labor hours to go ahead and justify that kind of transportation cost. Typically, the wide bodies, you might be competing more in Asia for wide-body maintenance here in North America, but we really have not dabbled at this point in time in wide bodies.

On the components side, again, the parts tend to travel in a closer vicinity than going all the way across the either pond might suggest. Our component shops incidentally are -- we don't classify them as part of our MRO operation, we classify them as part of our supply chain business. But yet at the same time, we have facilities in Europe and -- a facility, I should in Europe, and we have a facility here in North America, principally dealing with the local markets. But we do some business in North America for European and Asian carriers and we do some business in Europe for Asian carriers, let's say. But our goal eventually would be to have facilities in Asia to deal -- to handle that market as well. So I cannot say that we've -- I am unaware of any business that we've lost to a lower cost environment, let's say.

Thank you very much.

Matt [Vittorioso], Goldman, Sachs & Co.

I was just curious as to whether you guys had any plans to take out or refinance some of the senior notes that are coming due shortly?

The only notes that we have coming -- the next note that we have coming due is December '07.

Right, the '07s, yes.

So I mean, we don't have -- if people were to call us and tender the notes at par or so, we might be interested.

Thank you.

(Operator Instructions). I show no further questions in queue, sir.

Okay, thank you very much for your participation today, and hopefully we helped you in your assessments of the Company's prospects. Thank you.

Thank you ladies and gentlemen for attending today's conference. This concludes the program. You may now disconnect. Good day.