AAR Corp (AIR) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the AAR CORP. first quarter fiscal 2010 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 turn the conference over to Mr. Tom Udovich. Mr. Udovich, you may begin.

Thank you. Good morning, ladies and gentlemen and thank you for joining our first quarter fiscal year 2010 earnings 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 yesterday as well as those factors discussed under item 1A entitled risk factors including the Company's May 31, 2009 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, Tom, and good morning, everyone. Joining me today in the Board room in Chicago is Tim Romenesko, our President and Chief Operating Officer; and Rick Poulton, our Chief Financial Officer.

We reported our fiscal year 2010 first quarter results last evening and hope that you have all had a chance to review our press release. For the first quarter, the Company reported sales of $341.5 million, and net income of $10.2 million or $0.27 per diluted share. Sales to defense customers increased 4% while sales to commercial customers declined 12%. In the Aviation Supply Chain and MRO segments we experienced lower results reflecting tough conditions in the commercial airline market. In our parts trading businesses we have seen a modest pick up in business through the first three weeks of September and on Monday, we announced an important win in our MRO segment as we signed a contract with Continental to install winglets on all 16 of their 757-300s and that work - has commenced in our Indianapolis facility.

As discussed in previous earnings releases, we combined the financial results of the aircraft sales and leasing segment with the results of the Aviation Supply chain segment effective this first quarter. During the quarter, we sold our remaining aircraft leverage lease from our wholly owned portfolio for $5.3 million in cash reducing our wholly owned aircraft fleet to five aircraft and also, please note that the $5.3 million in cash is not included in cash flow from operations for Q1, rather the $5.3 million is classified as cash from investing activities on the cash flow statement.

Aircraft owned in joint ventures remained unchanged at 26 and we have seven aircraft scheduled for lease expiration this fiscal year, and expect to release all seven of the aircraft with the current lessees. In the Structures and Systems segment, sales increased 4% driven by an increase in sales in specialized mobility systems products to defense customers. During the quarter we received a $40 million add-on contract from BAE Systems to make mobile shelters for army vehicles. Deliveries are expected to begin in April of this fiscal year.

Early in the first quarter, we announced the formation of AAR Global Solutions, a joint venture company that will provide value-added solutions in support of the U.S. and friendly foreign governments' defense and nation building initiatives. Through this joint venture, we are able to complement AAR's MRO, logistics and mobility capabilities with a team that has extensive experience winning and managing large-scale government programs as a prime contractor. We are bullish about the potential for this business as the bid pipeline is robust and we expect to announce business wins toward the end of fiscal year 2010.

I am very pleased with the cash generated from operations during the first quarter, combining first quarter cash from operations with cash generated during the fourth quarter of last fiscal year we have generated over $106 million in cash flow from operations the past six months. This has allowed us to continue to opportunistically reduce our debt obligations as well as retain ample liquidity and seize on opportunities in support of our government, defense and commercial businesses.

In closing, we expect modest sequential improvement in our second quarter results. We will remain focused on maintaining a lean cost structure, generating positive cash flow, and taking market share. We are also looking to step up the level of investment in certain targeted areas where we do see growth opportunities. Thank you all for joining the conference call today, we would now like to open up the line for questions.

(Operator Instructions) One moment, please. Our first question comes from Tyler Hojo with Sidoti and Company, your line is open.

Good morning, everybody.

Hi.

I guess firstly I would just like to talk about the gross margin in the Structures segment that is as high as we have seen in a pretty long time. So is that mix or is there something maybe a little bit more, more structural happening there?

It's mix. We are also getting decent operating leverage out of the mobility business. We have talked to you before at pretty good length about some of the lean initiatives that we have going on across the Company, and the Structure and Systems group was really at the forefront of that. So I think we are benefiting from some of that. We took on additional capacity down in Goldsboro which is fully engaged now, and at full production. So, that is giving us a little bit of help there, as a lower-cost manufacturing center. So I think it is a combination of product mix, in addition to some of the things that we have done internally to become as efficient as we can.

Okay. And I mean if you look at the backlog, as it sits now for structures, is there anything in there that would suggest that you would see some softening from this level or more normalized level?

I think you can see some variability, Tyler, but all in all we expect our margins in this segment to continue to be respectable.

Okay. That's helpful.

Tyler, this is Rick, I would just add, we have seen spikes in the past as you know, quarter to quarter and really our product mix. I think you are seeing that a little bit mow. Our long-term trend rate has really gone up for the reasons we just talked about. But you shouldn't fixate on this quarter as your go-forward number, I don't think.

Understood. Okay. And one more for me, just looking at the JV line, I guess the Global Solutions expenses are running through there. Is that correct?

No, Global Solutions is up in our SG&A numbers, Tyler. And what you see is the JV earnings line is still purely aircraft.

Okay.

The other impact from Global Solutions is way down at the bottom of the P&L. You see that line, the portion that we do not own.

Yes.

The line is called the Loss Attributable to Noncontrolling Interest. So that's where you back out the piece of Global Solutions that we don't own.

I see.

But otherwise, the line item called JVs is still purely aircraft.

Okay, and great. Maybe you could just talk about, you know, what's going on there, just in terms of the profitability trend, and what your expectation is for the JV given that's where the majority of the aircraft you own are?

Our expectation is for profits from the JVs.

Yes, I mean it is off quite a bit. Just if you could maybe speak to that.

Let's reflect, it was a little bit of new lease rates, but we have also ratcheted up our depreciation rates on that, Tyler, given the environment we're in. We are depreciating that quicker, and that's what you are seeing.

Fair enough. Great. Thanks.

Our next question comes from Eric Hugel with Stephens Inc. Your line is open.

Good morning, guys.

Hey, Eric.

Just a follow up on Tyler's question, I mean is this 100,000 type of run rate in the JV line? Is that sort of what we should be expecting? Were there any one-time aircraft valuation write downs or something like that that we would expect maybe to see some stabilization there? I mean that is a big drop.

There were no one-time write downs, and there were also obviously no aircraft sold out of the JV either. So, this is a pure, "just manage the portfolio" outcome. And as I said, Eric, we are depreciating the aircraft a little quicker than we originally had. So, the rate you see here in the first quarter is probably a pretty good predictor of what to expect going forward.

Okay. Fair enough. You talked about modest improvement as we go into the second quarter. Can you sort of walk us through where you're expecting modest improvement to come from?

I think we see it in supply chain and we see it in MRO.

And should we be thinking about both the top line and that driving margin also, or are we going to see continued margin pressure?

I think you will see in top line, you will see some improvement in top line and hopefully we will get some improvement in margins as well as we get additional top line.

Eric, particularly in supply chain, what we did in response to a very weak demand environment in Q1, because of our focus on cash, was we participated in a weak market by being a little more aggressive on the pricing side. As we see the market firming up, we think that should help bolster margins as well.

Great. Lastly I will get back in the queue, the Structures and Systems business there's a lot of different things going through there. You have the mobility, SUMMA, composites, cargo, can you give us a break down or a sense as to how each of those businesses are performing?

We are gaining clear strength in mobility, we have good performance coming out of SUMMA, Composites is a little softer than we like to see and Cargo Systems has been holding its own. Cargo Systems is still very focused around the A400M. I would say that would be the characterization I would have for those businesses.

Great. Thanks a lot, guys.

Thanks.

Our next question comes from Stan Mann with Mann Family Investments. Your line is open.

Some simple questions. Debt repayment fairly slow, are you moving slowly because of opportunistic expectations trying to buy it in at a lower levels and market or value? Can you talk to us about rapidity of pay down?

As we have been doing over the last say 12 or 14 months I think we are very focused on buying it advantageously. So we are not aggressively out in that market. We are responding to opportunities, so we get phone calls and if the pricing looks good we then take advantage of it. We are focused on the yield and we've been shooting for, we have been consistent in the 9 to higher percent yield on our buy backs. So, that's what we are looking at.

Well, with the market, the overall liquidity easing, is that going to slow us down, or do you have plans to lower that?

It might slow us down. It might slow us down.

So you will build cash rather than pay down.

Yes.

Okay. Can you also give me a current number on depreciation, you said you made some changes in airplane write offs, looking forward for the quarter and the year?

Yes. So to be clear, just on that point, Stan, the aircraft and the JVs all of that depreciation flows through the JV line, so you don't see that in depreciation and amortization number. But to answer your question on the current rate for Q1 we had $8.7 million of depreciation and amortization. In addition, Stan, you may also be interested in, because of the new accounting standard related to our convertible debt, we now have to book interest that's noncash interest expense. So, it is effectively interest expense that's above and beyond the bond we actually pay. And that was $2.9 million during the quarter as well.

Okay. And expect similar rates through the year?

Yes, right now that's our expectation.

Okay. Thank you. Good job.

Thanks.

Thank you. Our next question comes from J.B. Groh with DA Davidson. Your line is open.

Morning guys.

Morning.

I think you mentioned you are experiencing kind of an up tick in business in the first three weeks of September. Can you throw a little more color on that? I think you answered when Eric asked this question that it was Supply Chain and MRO. Is that where you're seeing the strength?

Supply Chain is seeing some nice improvement over the comparable period, in Q1 and MRO we are optimistic that this will be a better quarter than prior quarters. So, that business is a little hard to look at a three week period. The supply chain business, we can look at specific data, three weeks over three weeks and it is very favorable at this stage.

Maybe you could give color on the pricing environment specifically from competitors, OEMs, that kind of thing?

There has been some pricing pressure, and I think you saw some of that in the margins. We maintain our top priority at this stage continues to be to manage the business around cash and generate cash. We are less focused on margin but we would expect the margins to strengthen as the environment improves and as time marches on. So yes, I would hope that we hit a low point in Supply Chain margins in Q1 and that margins will, you will see an up tick to margins as we get into Q2, 3 and 4.

Got you. Okay. What's the utilization right now and how you see that playing out over the balance of the year?

It's filled up for the most part, as we have discussed before, with Southwest. We took on a recent win with Continental and we do have some space availability, but for the most part we are in pretty good shape there.

But is the reason that the MRO number is down say from last quarter, is it just lower, just lower cost work, or how do we think of that or was there something specifically in first quarter that made that number come down?

You mean from last year you are talking?

Just from either looking it up Q1 last year to Q4 of last year.

Q1 last year we still had the benefits of having United and Fed Ex in our shop. So we were a little bit more loaded there. So, that work came out, I think Q2 last year if I am not mistaken. So the comp gets a little bit more favorable in that regard. But we also had some fall off in our Miami operation. And Oklahoma City. So we've had Indy maintain those, let's say United and Fed Ex aircraft, but OKC and Miami have been a little bit down on a year-over-year basis.

Okay. And then just one housekeeping, this $2.9 million noncash interest expense, that's probably going to be the same number quarterly, right? Roughly around that going forward?

It is one of these things where you have to accrete the debt back up to its par value over time, on a constant yield basis. So the absolute dollar amount may change, but we will try to give you a little better guidance on that, but right now 2.9 is what you should think about for the near term on a quarterly basis.

But so roughly $6.5 million a quarter would be a good number to use for interest expense for GAAP purposes?

For interest expense for GAAP purposes, yes.

Okay. Thank you very much.

Okay.

Thank you. Our next question comes from Jim Altschul with Aviation Advisory Service. Your line is open.

Good morning, gentlemen. With regard to the lease portfolio I believe you said you have seven aircraft left in your lease portfolio, and you are planning to renew the leases on all of them. Is that correct?

No, what we were saying is we have seven aircraft where the lease expires this fiscal year and we expect to release all seven of those aircraft to the current lessees.

Okay. Sorry. So, how many airplanes in total do you have left in lease portfolio?

31, five that are owned and on our balance sheet and 26 through joint ventures.

Could you give us a run down of the different aircraft types you have.

What we are going do is we're going to put that in the 10-Q that we will be filing on Friday. We will have a complete description of each aircraft that we have and the lease term, and what we expect to happen at lease expiration, but basically we have a fleet of largely 737-400s, they make up about 18 or 19 of the aircraft, and we have one 747-400. We have two 767-300s, we have one MD-83 and we have two A320s. That's roughly it. We have one CRJ- 200.

Okay.

I think I have just covered all 31.

Excellent. Do you think you will be able to release those planes at lease rates comparable to what you are getting now or are you going to have to take a hair cut to get them released?

We may have to release them at slightly lower rates but for the six that we're talking about, those lease rates should be, some of them should be fairly constant.

Okay.

With what we have been experiencing.

Good. You were alluding to the cargo system, the A400, are you seeing any impact from the delays in that program?

Absolutely. That program was supposed to be live by now. We would have been expecting shipments but it has been delayed and we have received some encouragement at least that there is a date for a flight test, and hopefully that goes well and hopefully we can get back on a firm schedule from Airbus, sooner rather than later.

Jim, just to be clear, that's obviously not in any numbers currently or any historic numbers.

It doesn't effect our backlog. It is not in, we haven't had any shipments and we don't have anything forecast in our backlog.

Thank you very much.

Thank you. Our next question comes from Jon Braatz with Kansas City Capital.

Just a follow up on the lease portfolio, David occasionally you have mentioned in the past, your expectation that you may have some, may sell some, planes during the year. You didn't really mention that. Do you think that you will have some additional plane sales this year?

I would, I would anticipate we have one. We have presold one of our aircraft. We have one aircraft that is on lease with US Air that we have presold. I believe we sell that in fiscal year '11.

Okay.

This aircraft sale we just had this past quarter, we had been working on for some time, this has been a leverage lease, we have with Continental Airlines. They were looking to get out of the fleet type and they were able to actually sell the aircraft on our behalf into Russia. And it is hard for me to say at this point, Jon, what the deal flow looks like from a sales vantage point between now and the end of the fiscal year. We don't expect any real changes, let's say, but there could be opportunistic situations, particularly on the A-320, to sell maybe one of those aircraft.

All right. Thank you. And Rick, are all of the aircraft being depreciated more rapidly or just some?

All of the 737s, Jon, and any older generation aircraft.

Okay. And then Rick, will we have two questions, will we have the restated numbers for the second on through the fourth quarters provided short, in the 10-Q?

With respect to the--?

The new accounting rule.

For the convertible debt?

Yes.

Yes, John, we are going to put that into the 10-Q.

Okay. When everything is said and done, I think you had earlier indicated in your prior filings that you thought the new accounting rules would cut earnings by about $0.10 to $0.12 or something like that, for this year, okay. Does it look like that's going to indeed be the case?

Yes, the only caveat on that where it gets a little complicated is when you buy back some of the debt.

Okay.

The impact changes because we don't recognize any longer the same kind of economic gain on the P&L the way we used to. So, if I can just say to you that we, if you assume for a moment we did not buy back anymore debt, then the answer is, it will be at the lower end of that range. You saw us talk about it being $0.02 this quarter and probably expect that to be the quarterly impact for the rest of the year.

How much debt did you buy back in the quarter?

12.5 of par value of our convert back.

All right. Thank you, Rick.

You're welcome.

Our next question comes from [Tom Lewis] with [High Value Research].

Thank you. Good morning.

Hi, Tom.

Yes, hey, I was hoping you could shed a little light on this winglet contract that you got. Is this the capability that AAR has had for very long?

Yes. We've had that capability for... This is not the first work of this type. We have performed winglet work for Continental before on 737s and we performed winglet work for Southwest on 737s, both in Miami and in Indianapolis.

Okay. So this is something that you can do for aircraft other than the 757? Does it tend to be, is it something that you just do because an operator puts out an RFP and you show up? Based on what I recollect about what these can do for performance it sounds like something you could proactively market. How should I think about this as a business opportunity for you?

I think correct in both. But the impetus on the merchandising side is really with volume. An OEM partner, obviously they control the technology, and it is a function I think of how many of these winglets they can produce in a period of time. So, so far, they've had pretty good success. The numbers look fairly compelling from an investor vantage point so I think Continental took advantage of a good opportunity with a good pay back and I am sure other carriers are looking at the same. I think it is a function to some extent as to how quickly aviation partners can deliver kits.

I see. Okay. Thanks.

Yes.

Thank you. Our next question comes from Troy Lahr with Stifel Nicolaus. Your line is open.

Thanks. Can you just talk about what level of confidence you have that customers are going return to this normalized buying pattern in early 2010 and maybe how much is dependent on passenger travel picking back up and yields starting to improve for the airlines?

There's two factors that we have considered here. One is the overall fleet size itself, and the impact on the possibility that there will be continual reduction in fleet size, but the other side of the coin which I think we are, in terms of dialogue we've been having with customers, is the amount of deferral if you will, in terms of work being performed, in particular on engines. So I think the carriers are looking at they have been depleting, the serviceable stockpile if you will, and we have a fairly high level of confidence that that can only go on for so long, we expect. That is why we are pointing toward the January time frame as a period for a more robust environment. But keep in mind ,I think the first part of that equation, weighs on us a little bit in terms of what the overall economic picture look like and therefore what does the fleet size look like. And obviously our business is pegged, to some extent, on aircraft in the service.

Okay. Thanks. And the defense business was up I guess about 4%. How should that business trend if we start seeing troops pulled out of Iraq, is it largely dependent on if we put more troops into Afghanistan. There's a little question on adding 40,000 troops there.

I believe that would be a positive. I think at this point in time, we are selling more into the pipeline than we are into going right into theaters. So I believe most of the mobility equipment has already been procured and is performing its task and then, clearly, if you sit in the Pentagon today you are not just focused on Afghanistan and Iraq but you are also looking around the world in Somali and some other interesting places and may be worried about Iran to some extent, maybe even worried about North Korea. I think the supply chain needs to be filled out, if you will, to allow for the possibility of quick movements into other theaters. So the visibility we have leads us to believe that there will continue to be demand for the things we are doing.

Do you see work picking up if you pull out of Iraq in the shelters business packing up and moving everything back, do you guys benefit from that?

We don't have a direct benefit to that at this point that we see, but I would, there are other pieces of our business that do benefit as equipment gets reset. We will be in a position to provide some service work and things of nature through our repair and supply chain businesses.

The Global Solutions, I think you were investing $2.4 million this quarter. Can you just talk about maybe what that gets down to, it sounds like that kind of, you stay about that investment level for the next quarter and then it starts to fall off. Is that how we should think of that?

We are currently not receiving any revenue from that business. So we started that business in the middle of June, and we have had a ramp up, if you will, in terms of bidding on different programs. The real expense comes in when we pull a team together to bid on these contracts, and we have. There's a lot of action going on in that business so, the bidding expense is not going to decline, is not going to decline too much. But at some point in time, we are going to win some business. So when we win some business, we would expect that the business will have some income than expense obviously, more gross margin than expense, and be profitable here, hopefully in the near term, being toward the end of our fiscal year. So we are managing our costs, watching closely, but at the same token, to get our name out, to get into this market, you have to bid on contracts and the bidding process has a cost associated with it.

Should this level of bid activity that we are seeing for Global Solutions, I mean is that steady the next four quarters?

Yes. I think the expense is a little steeper than we should expect in Q2, 3 and 4 but not way out from what we might expect.

But think of it as a development stage business for the next two quarters, probably, and then it transitions to more of an operating enterprise at that point.

Okay. Thanks. Just last one last question, sorry. No inventory write downs in the quarter, I assume you guys feel kind of like you're comfortable with your inventory levels or might there still be something left to come next quarter or two?

There were no write downs, Troy. You are never done looking at all of that stuff, so we will always be looking at our inventory to make sure we feel good about it. We didn't have any write downs this quarter, we felt good about monetizing some of the inventory head and reducing some of our balances. Our terms have held up. So yes, we feel pretty good about the inventory position right now.

Thanks, guys.

Thank you. Our next question comes from Larry Solow with CJS Securities.

Just to follow up on the Continental deal, it seems like it's relatively modest up front but I imagine it will absorb a little bit of the capacity left over in Indy and also, is there some potential for expansion in that agreement with Continental?

The agreement itself doesn't call for expansion, Larry, but we are optimistic that having Continental aircraft in there and performing well for them will get them familiar with the facility, familiar with our work and then bring them on as a long-term customer.

Okay. And then could you guys maybe just take a minute and give us without stealing your thunder from your coming analyst day but what kind of stuff we are going to be hearing about. There's going to be, I imagine a lot of longer-term type things?

Yes. What you are going to do is get color from our group operating leaders, how they see their businesses, and what kind of exciting things they have going on a little deeper inside of each one of the segments.

Okay. Fair enough. All right. Great. Thanks a lot.

Thank you. (Operator Instructions) We have a follow up question from Eric Hugel with Stephens Inc. Your line is open.

Hey guys. David, you mentioned making investments in areas that you saw growth opportunities. Can you maybe sort of give a little more color there on maybe size and sort of what areas you are specifically talking about?

Let me stay away from size, but in terms of the general areas, we see some opportunities in that defense arena, defense and government service arena, I should say, they look pretty interesting for us, and yes, that since we have been in the Global Solutions environment, we have seen opportunities that we had not seen before, they're coming through to the Company. And, some of which, look rather interesting for the Company. So, that's an area that looks very interesting and at the same token, in conversation with certain of our commercial airline customers, there are some targeted areas of opportunity that we are exploring.

So you are talking acquisitions as well as building up of inventory for logistics types of stuff?

Very targeted on the inventory and yes acquisitions on the defense and government service business.

Okay. CapEx for the quarter, and what you would expect for the year?

Eric, CapEx for the quarter was $8.9 million, and if you annualized that, that obviously gets you right around 35 to 40, and that's about consistent with what our expectations are.

All right. A follow up on the Continental deal. You haven't had Continental at Indy before. I know they were an Avborne customer. Was that really a cross sell? Or, was that sort of something where they came to you? Or how should we think about that?

We have been working on Continental and I think the relationship that Avborne had with them did help. But Continental has been a target for us. We would like to do more work with them not just on MRO but across the Company.

Remind me again. That's a pretty big deal to get a new customer into a facility because they have to, especially for a guy like a Continental, because they have to go around and may get very comfortable about what's going on there. Correct?

Absolutely. Absolutely.

Okay. All right. I guess that's all I've got. Thanks a lot, guys.

Thank you.

Thank you. (Operator Instructions) I am showing no further questions.

Okay. Well, thank you very much for participating today and let's look forward to talking with you in 90 days. Thank you. Bye bye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.