AAR Corp (AIR) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen. And thank you for standing by. Welcome to the AAR Corporation second quarter fiscal 2010 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 presentation, Mr. Tom Udovich. Mr. Udovich, you may begin, sir.

Thank you for joining our second quarter fiscal year 2010 earnings 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 1-A entitled risk factors included in 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. Joining me today in Chicago is Tim Romenesko, our President and Chief Operating Officer and Rick Poulton, our Chief Financial Officer.

We reported our fiscal year 2010 second quarter results last evening and hope that you all have had a chance to review our press release. Overall I am very pleased with our second quarter results, as we reported strong sequential earnings growth, generated $24 million in cash flow from operations and won significant new business in both the defense and commercial markets. For the second quarter, the Company reported sales of $329 million, and net income of $13.3 million, or $0.34 per diluted share. Sales to defense and government customers increased 4%, while sales to commercial customers declined 15%. Sales growth in defense and government services market mainly reflects strength in our specialized mobility products unit. The sales declines to our commercial customers reflects lower year-over-year capacity and soft conditions in the airline industry as carriers have been reducing their spends.

Margins in the Structures and Systems segment expanded to 21% during the second quarter, which was several basis points higher compared to both a year ago and the first quarter of this fiscal year. Gross profit margins in the Structures and Systems segment benefited from strong volume, favorable product mix, cost reduction activities, and process improvement initiatives. Additionally, our North Carolina facility is fully operational and we are seeing the benefits from this more highly efficient, low cost facility. We expect margins will remain strong in the segment the balance of the fiscal year but decline from Q2 levels as we lose some of the benefits of favorable mix. We also saw margins improve sequentially in our supply chain businesses, principally reflecting favorable mix of products sold.

We continue to generate strong cash flow. For the first six months of fiscal 2010, we generated $58 million of cash flow from operations. Combining fiscal year 2010 cash from operations with cash generated during the fourth quarter of last fiscal year, we have generated $130 million in cash flow from operations the past nine months. This has allowed us to further strengthen our already strong balance sheet by reducing debt obligations and retain sufficient liquidity to seize on opportunities in the government, defense and commercial markets. I am very pleased with new business awards during the second quarter. During the period, we won a very significant and meaningful contract to provide supply chain logistics support as a member of the Northrup Grumman team for the United States Air Force KC10 fleet. Our role in this program is to provide strategic planning, parts procurement and distribution repair to ensure aircraft availability while shortening maintenance lead times. This is the largest program in the Company's history and our portion of the contract is valued at approximately $600 million over the next nine years. We will begin booking revenue from this program in February 2010, and will be fully operational by the fourth quarter.

During the quarter we also signed an agreement with Sikorsky Aircraft naming AAR as the exclusive provider of interiors for the F92 helicopter program. This is also an important win for the Company and as we look to expand our presence in the helicopter market. In addition to wins in the defense market we were successful in securing new business with several airline customers. As discussed in our press release, our MRO segment was successful in securing several awards with both existing and new customers. This new business will kick-in in the third quarter. We also landed a large follow-on engineering services contract with an airline that will contribute to sales beginning in fiscal year 2011. Supply chain also secured a new engine parts support agreement with an existing customer with the work beginning immediately.

During the period we acquired an A320 aircraft with a partner bringing the number of aircraft in our joint venture portfolio to 27. Our equity investment in this aircraft was $2.9 million and there is no debt on the aircraft and our plan is to disassemble the aircraft for parts when it comes off fleet in calendar year 2014. We will continue down the path of reducing our investment in aircraft. However, we purchased this aircraft on what we believe to be a very attractive basis and will provide high demand parts to our supply chain business in the future and we are looking at approximately a 30% return on our capital for this investment.

As we indicated in the earnings release, we remain diligent in managing our SG&A. During the second quarter, SG&A included $2.2 million of costs incurred at AAR Global Solutions, a joint venture Company that we established in early fiscal year 2009, as a player -- I'm sorry, in early fiscal year 2010 as a player in the defense and government services market. During the period, Global Solutions was awarded its first contract and this work is for work that will be performed, and has already begun to be performed in Afghanistan. Over the past several months Global Solutions have been very active on the proposal front and we expect the level of expenses incurred by Global Solutions to decline by approximately $600,000 to $700,000 in Q3, as many of the proposals have been submitted. We feel very good about the commercial deal flow and have booked a meaningful amount of business across our segments the past 30 days. We expect to see the benefits of these wins in fiscal year -- the balance of fiscal year 2010 and beyond. Thank you all for joining the conference call today and now we would like to open up the lines for any questions you may have.

(Operator Instructions) Our first question or comment comes from the line of Mr. Troy Lahr from Stifel Nicolaus. Your line is open.

You talked about two MRO programs rolling off but then you won some work in the second quarter. Is that an offset or do you still need to win some more work to offset the he decline?

We think that the work that we've won will offset the decline, Troy. There's been a fair amount of bid activity. We've been successful in landing several new awards and yet we did have a couple of fairly significant programs roll off but the short answer is, we expect that the new business to offset the business that's gone away.

Okay. And then in the past you talked about airlines kind of getting back to normal purchasing. I thought that that was kind of at the beginning of next year. Is that still on track and I mean do you think that that picks up in your fiscal third quarter?

That's what we're seeing. That's our expectation is come January that we expect pickup and Rick, you might want to add something to that.

Troy, I would just remind you. We've been saying for a while we think after the turn of the new year we would begin to see more of that behavior kicking in. When you line that up with our fiscal third quarter, recognize our third quarter is already a third done when you get to the beginning of the new year. So how much impact we'll see in the third quarter I think remains to be seen a little bit but we do continue to believe the trends will improve as we get into the new year.

Okay. So lastly, then, it looks like you would think that second quarter from a revenue standpoint probably is a trough period?

In what aspect?

Just for revenue, total revenue, do you think revenue starts to pick up for the Company in the third quarter? Or might we still see it down maybe one more quarter?

I think as you've heard here, we've secured some very important wins during the quarter, most of which contribute to the back half of the year. And when you look at that and you think about improving trends which we think will continue to happen in the commercial markets, I think you can draw your own conclusion from that.

Okay. Thanks. I'll jump back in queue.

Our next question or comment comes from the line of Mr. Eric Hugel from Stephens. Your line is open.

Good morning, guys.

Good morning, Eric.

In terms of those MRO awards, maybe it's hard to sort of think about it this way or get visibility but can we sort of think about this as airline -- is this sort of market share gain for you or is this sort of maybe airlines coming back and saying hey, we've got all this deferred maintenance that we need to catch up on and we need to start awarding this stuff?

For the most part, it's market share gains, Eric. There's still -- we're still seeing lower shop inputs from the core customer base, so I would say that this is more share gain than kind of fleet -- new fleet inputs.

Okay. Is the business centered around any one of your facilities or is it spread out?

No, it's spread around. It's spread around.

How should we think about, in terms of this new business, pricing? I mean, is this going to negatively impact margins? Are we talking about new aircraft types or are we talking about equipment that you're very good at fixing right now and there's very little ramp-up.

It's equipment that we have a lot of experience in, but as we talked in the past, the pricing environment is very tight.

So we should expect--?

You still have to characterize the industry as having over-capacity at this time on the maintenance side.

So we should expect that margins were down, were pretty low this quarter, we shouldn't really expect -- should we expect further deterioration there as you bring on this new work.

I don't think so, no. We're not expecting that. We're expecting actually as we get more volumes hopefully the margins improve.

Great. I'll get back in the queue. Thanks, guys.

Our next question or comment comes from the line of Mr. Larry Solow from CJS Securities. Your line is open.

Good morning, guys. Just looking at some of your -- your gross margin by segments, I know last quarter at least the spot market sort of fell out of bed towards the end of the quarter and clearly you've had some nice sequential improvement sort of somewhat back to normalized levels. Do you think sort of this number still has some depressed spot market impact in it?

Yes, so your question, Larry, I think just to be clear is really a commentary on the supply chain segment mostly?

Right. Exactly.

Yes. I mean, we are quite obviously pleased to see the improvement sequentially. I mean, was about 250 basis points of improvement if you normalize the first quarter for the aircraft transaction that we had. And so you still had 250 basis points. That's still not back to where we had gotten accustomed to seeing margins there and so I think that's indicative of you have not seen the market rebound entirely. We also are -- we also don't have the volume there that we would have, we would typically expect either and as volume improves that ought to be contributory towards margins as well. I think it's the same story, it's come back a bit but we would hope that there's more to come as both volumes and demand environment improves.

The KC10 deal I imagine most of that will be in the supply chain. Is that margin sort of comparable to where you -- historic averages or any way to look at that?

When it starts up, it will probably need a little bit of time to get to its full run rate margin. So we may see a little degradation in the beginning but as we ramp up to that over a couple of quarters, we would expect that to -- we wouldn't expect it to be dilutive to the overall segment.

Got you. On the Structures and Systems, just it seems like some of it is structural improvements and so you had been running at 16ish and then you did 17 last quarter and then you bounced to 21 and I know David said it should come back towards the -- the next few quarters, I guess, next couple quarters. Does it come back to a higher level? Is some of the structural change obviously I assume some of it is sustainable?

I think the structural changes David commented on regarding our North Carolina facility and some of the machining in-sourcing we've done are -- again, are structural changes that should be sustainable. Some of the product mix comments and some of the volume comments will change. So you had all of that contributing to what was a very stellar second quarter margin performance in the segment, some of that we think's permanent, some of it's probably not.

Okay. Good. Great. Fair enough. Thanks a lot.

Our next question or comment comes from the line of Mr. Tyler Hojo from AAR. Your line is open.

Hey, good morning, everyone.

Good morning.

First question, good to hear Global Solutions making some progress but I was kind of wondering how many proposals you had out there for that venture and kind of how we should think about additional awards kind of ramping up through the back half of the year?

Yes, we have a few major awards out there and we have a series of smaller programs that we're bidding on, so there's a good mix. I would still hold to our original premise that it would take 9 to 12 months to see revenue coming from this business and we started back middle of June, first of July. So I still think we're expecting the flow of business to hit later as this -- as we move into the middle of next calendar year.

Okay. All right. I guess that makes sense.

And we can get a pleasant surprise. I mean, there's one bid in particular that's due. This one at least, is due before the end of this calendar year but we are seeing an influx of activity particularly around Afghanistan that's kicked in since the President's announcement.

Okay. Interesting. And maybe just to follow on to that, the mobility business or the containers and the pallets and all that stuff, that seems like it's historically done pretty well with troop movement and I guess how does one look at kind of maybe the demand trends for those products in relation to kind of the 30,000 additional troops going to Afghanistan?

Well, that's a hard -- it's a hard one to answer only because we're trying to get a sense right now as to what the current supply chain looks like inside the DoD and we're in the process of accumulating that data. But what we have seen is as we've moved into different theaters over time, the needs inside the theater have changed and evolved and one of the reasons we've been able to do so well is we've been able to continue to upgrade our product offering, increase our product offering to meet the surging demand and the changing demands so we would anticipate there will be some of that as they get more entrenched into Afghanistan.

Very good. And just lastly from me, a couple quarters back, David, you were talking about the composite business and I think you had a multi-year target of growing that to $100 million per annum and I was just wondering if that was still on track? It seems like you've made some progress there, just in terms of--?

The Sikorsky win is a composite win and we will -- we have another business win that we should be announcing here shortly that's also for our composite business. So we are seeing some traction and obviously when we set out with the growth plan that we had, of course we hadn't seen necessarily the falloff in the economy that we've experienced, so although we still have that growth target, it's probably pushed out a couple of years. But nevertheless, we have had a two meaningful wins here in the real short term.

And where do you think that business is currently, rough numbers on an annual run rate including the Sikorsky win?

35 million to $40 million -- 30 million to $40 million, in that range.

Okay. Great. All right. I'll hop back in the queue. Thank you very much.

Our next question or comment comes from the line of Mr. Jon Braatz from the Kansas City Capital. Your line is open.

Good morning, guys. Couple questions. Going back to Afghanistan, you made some comments about some opportunities as relates to Global Solutions. I assume it goes beyond Global Solutions and goes into some of your other areas too. Am I correct there?

Yes, we expect to see some action coming out of Afghanistan, yes, that's correct.

All right. Secondly, not only did the Dreamliner fly recently or yesterday but the A400M flew I think last week.

It flew on Friday at 1015 AM Paris time.

Good. I think from what I had read, even though it flew there is still some question about whether it's going to actually--?

Get funded.

Get funded. Is there a timetable or any sense as to when some of those decisions will be made? And can you also tell us maybe what kind of costs you've capitalized on the balance sheet related to that program?

What we understand in terms of a decision point and this is what we have actually read in the press, we don't know this in any private discussions of any sort but in terms of public message is that the decision will be made by January 31, 2010. So we're looking out approximately 45 days from now.

And John, in terms of the second part of your question, what's capitalized on our balance sheet has been in our SEC filings for a while but just to remind everybody it was $45 million.

Thank you.

Our next question or comment comes from the line of Mr. Stan Mann from Mann Family Investments. Your line is open.

Just a couple questions on use of cash. Can you kind of expound on that?

So far, Stan, what we've been doing is paying down debt, continuing to pay down debt. Our net debt today is somewhere in the vicinity of about 200 million to $220 million.

Face value is just under $300 million. Just under 300 of net debt.

Net debt.

So your plan is to continue using the majority of cash for debt reduction?

Well, depends on how much cash we continue to generate and I don't want to necessarily make a decision on that at this moment. Or make a -- or communicate what our plan will be at this moment. Depends how much more cash we continue to generate.

Okay. But what about CapEx? You're looking forward. Is CapEx due to any of these programs going to increase dramatically?

We don't see that, no.

You don't see that?

No.

So cash generation should stay in this area, theoretically?

I think we feel good about our cash, our ability to generate cash. You've seen we've done a pretty good job in that regard and our plan is to continue at that pace.

All right. You said that gross profits would decrease because of mix. What about net operating profit as you look forward?

Gross profit in the one segment I'm referring to and that's in the Structures and Systems segment where we had extraordinarily high margins this quarter. It's not accidental. We've taken steps to grow those margins and we would anticipate that the margins will continue to be strong but there might be some mix implications that would cause those margins to come off that peak but still be running at a pretty good, healthy rate and I think as we get volumes in the commercial parts of our business, we would expect margins to strengthen.

Okay. Just last question on Indianapolis, any commentary at all?

Continues to perform, principal customer there is Southwest. We are getting work from Continental there as well. We are competing for work from other carriers for the plant and we're holding our own.

Okay.

Still have a relatively small investment so our return on investment continues to be acceptable.

Okay. Good job. Thank you, gentlemen.

Thank you.

Our next question or comment comes from the line of Mr. John Healey from Forrest Investments. Your line is open.

Good morning, gentlemen.

Good morning.

Most of my questions have been answered but you paid down your revolver by approximately $30 million so that left a balance of, what, $20 million at the end of the quarter?

Correct.

Okay. Thanks. Terrific job.

Thanks.

Our next question or comment is a follow-up from Mr. Troy Lahr. Your line is open, sir.

Yes, just want to be clear on Aviation supply chain. Sounds like you're saying that there's some mix issues but this level is sustainable, the margins that we saw in the second quarter?

Yes, the margins we saw in the second quarter, Troy, are still -- in supply chain are still below what you would see as kind of historical average if you look back over the last eight to ten quarters. So what I think our comment was was we had hit a real what we hope was a low watermark in first quarter. We had nice sequential improvement in second quarter but where we find ourselves is still below the norm we had gotten accustomed to so we believe with a return of demand, which will translate to obviously volume and will also translate to a better spot market pricing environment, we think there's more room to go there.

Okay. And the KC10 program, the margins, is that kind of in line with segment average?

When it's fully operational, Troy, we're fully operational and we've gotten all aspects of it, we would hope that to be pretty consistent with the segment margins.

And we expect to be fully operational by Q4.

Okay. And then I think at your Investor Day that you guys were pursuing some composite work on the F35. Is there any update there on that?

We continue to work it. No real updates at this point. We did win some F35 business in the quarter but relatively small and it was metal work that we won.

Okay. And then lastly, I think you said you bought one aircraft in the quarter. Is this an indication that you're back to buying leased aircraft or is this kind of a one-off, being very opportunistic?

One-off, being very opportunistic.

Okay. And can you update us on the portfolio then? Is it still five?

Five owned outright, 27 with the inclusion of this aircraft owned through -- with partners.

Okay. Thanks, guys.

Our next question or comment comes from the line of Mr. J.B. Groh from D.A. Davidson. Your line is open.

Hi, guys. I had a question on Global Solutions. I hopped on a little late. You mentioned you won your first contract in Afghanistan. Can you give us some details, what you're going to be doing there?

The contract we won is to provide lift for a group of geologists. They're going into the territories to look for mineral composition in the soil and we have contracted with a local Afghan partner to provide the lift so we have the contract to assure that that lift is handled properly and we have executed against some of the contract and we expect more of that work to continue.

So this is truly something a little different than you've done before, so it's a successful win on I guess that Global Solutions initiative, is that how you would--?

I believe -- yes, that's clearly the way to look at it and it's a small start but it is at least a start.

And so where is that revenue eventually recognized? Is it going to be aviation supply revenue? And do the expenses associated, that $2.2 million, which I guess is going to go down to more of a $600,000 level in the next couple quarters?

It's not going to go to 600 it's going to go down.

Down 600. I'm sorry, my mistake. Does that all eventually roll up into Aviation supply chain so that the normal run rate of G&A is a little lower? How should we kind of model that?

Yes, so I think there's two parts to your question, J.B. The first is when revenue starts to get recognized or realized in Global Solutions. It will roll into the supply chain, at least as we've currently structured our segments. So you would expect to see it there. The commentary on the cost, that is in our SG&A numbers, so as that comes down you'll see SG&A come down.

Okay. And then one more thing. Did you give a D&A number for the quarter?

I didn't yet, J.B. It was $8.8 million.

Okay. Thanks a lot, guys. Good job.

Our next question or comment is a follow-up from Mr. Eric Hugel. Your line is open, sir.

Just in thinking about as we go into third quarter, some of the puts and the takes that you guys have been talking about, you're going to be ramping up some new awards but I guess a lot of those phase in in the quarter or in the fourth quarter and it looks like a good part of the reason why Q2 is better than Q1 was because you had those stellar margins in Structures and Systems. I guess as those margins come down and we're looking at everything, I'm sort of wondering if my mind should we be expecting -- I think prior you were expecting to see sequential ramp-ups in earnings. Is that potentially -- is that possible? Should we think of Q3 more in line with Q2 or could it be better?

Absolutely it can be. But more to your question, to the heart of your question, let's just be clear on your comments. Supply chain had -- excuse me, Structures and Systems segment was -- segment margin was extremely strong this quarter and you've heard us say we don't think it's going to stay at that level permanently and it will come down a bit but I would also -- you're not hearing us say it's going to come down, fall off a cliff so we think it will kind of come down a bit. You're also hearing us talk about new wins, Eric and you're also hearing us talk about as we get into the new year an expectation of demand improvement in the commercial markets. So, you can net all that out in your own mind but I mean, is it possible for sequential improvement? Certainly.

Well, I mean, possible is anything. I mean, would you think it's likely that we're going to see growth in the third quarter, given just sort of the dynamics of everything that you've sort of thrown out there?

Yes, Eric, this is Tim. What I'm looking for is modest sequential improvement in Q3. There's still some variables but that's what we're looking for. We're looking for a better quarter in MRO and we're looking for a better quarter in supply chain.

Great. Can you give us an update on where things stand with MESA. Is MESA sort of coming down? Is that one of the headwinds you guys are facing in the supply chain business?

It's coming down but it's not falling off a cliff, Eric. They are -- it's well-publicized that MESA is not renewing its business with United Airlines, at least with its 50 seat aircraft and, therefore, they will be moving 50 seat aircraft out of their fleet. Whether they redeploy those or not I think remains to be seen but as those come out we will see that come out of some of our supply chain performance. But it's not -- having said all that, we're not expecting in Q3 or Q4 to have dramatic changes to our -- from that.

Okay. I mean, what's sort of the time frame on when that might be hitting? I mean, is that just sort of next year or is it just the slow sort of ramp-down so we might not see it sort of balancing off general improvement in other places?

We do a lot of work for MESA. As you know from our public filings we do about $70 million of revenue for them. That is split across 50 seat aircraft as well as 70 and 90 seat aircraft. And as we also pointed out in our public filings, the 50 seat business is about half of that total, $35 million, and that in turn is split again between CRJ200 and ERJ145 work. The kind of business that MESA was doing for United is strictly CRJ200. ERJ145 work is still under contract for longer term with Delta Airlines. So you're talking about a relatively small subset of their overall scope of what we do with them which is being impacted by this and so when you whittle that down, yes, we will see that impact but when you put that in the context of all the other things we've talked about today, with some new business wins, et cetera, I don't think you're going to see -- you're not going to see that trickle -- you're not going to see that kind of filter through all that.

Great. In terms of sort of additional sort of large contract opportunities, I know KC10 type things don't come along every day, but can you talk about anything out there on the horizon that maybe over the next three to four quarters that could be interesting?

Well, as David mentioned, the deal flow has been strong and you'll see us coming out with some fairly significant announcements here and there's deals behind the ones that we're landing today. So Eric, we feel pretty good about the deal flow here in the near term.

And just one follow-up. CapEx, did you give a number for the quarter on what you expect for the year?

No, Eric. I think you're the first to ask. The CapEx for the quarter was pretty modest, it was $6 million, brings our six month total to $15 million and that's pretty consistent with what I think we've been expecting all year which is roughly $30 million of CapEx for the year.

Great. Thanks, guys.

(Operator Instructions) I'm showing no additional audio questions at this time.

Okay, well, thank you very much for your participation today and I would like to wish everybody a happy and healthy holiday season.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.