AAR Corp (AIR) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the AAR CORP. third quarter fiscal 2011 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 be given at that time. (Operator Instructions) As a reminder, today's Conference Call is being recorded. I'd now like to turn the conference over to your host, Mr. Greg Dellinger. Please go ahead.

Thank you, Allie. Good morning, ladies and gentlemen, and thank you for joining our third quarter fiscal year 2011 earnings Conference Call. Before we begin, I would like to remind you that comments made this morning may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. We ask that you refer to the disclaimer contained in our news release as well as the risk factors section of the Company's May 31, 2010 Form 10-K. In providing forward-looking statements, the Company assumes no obligation to provide updates to reflect future circumstances or the occurrence of anticipated or unanticipated events. And now at this time I would like to turn the call over to our Chairman and Chief Executive Officer, David Storch.

Thank you, Greg, and thanks for waking us up this morning. Good morning, everyone. Joining me today in Chicago is Tim Romenesko, our President and Chief Operating Officer, and Rick Poulton, our Chief Financial Officer. Yesterday afternoon we announced our third quarter fiscal 2011 results. Sales were a record $451 million which represents a 50% increase compared to the prior year period. Income from continuing operations was $18.3 million or $0.45 per diluted share. Overall, I am very pleased with our third quarter results which include a 44% organic sales growth in our commercial business. During the period we saw robust activity in the commercial market as airlines restocked their shelves, the level of maintenance spend accelerated, and we captured market share.

Over the last several weeks, there have been a series of global events which has caused us to look closely at our near term business prospects in the commercial market. Our direct sales activity to customers in Japan is nominal, less than 0.5 of 1% consolidated sales, although we are monitoring the indirect effects on our customers who do fly into that market. We also are monitoring oil price volatility for any impact that may have on our airline customers. While we are paying close attention to these global trends, our order book remains very strong, as does our committed work load. Therefore, we remain upbeat with our commercial prospects.

Turning to our government and defense businesses, sales to this customer segment increased 56% compared to last year and represented 51% of total sales for the quarter. So, we are achieving the balance that we've been attempting to achieve. The year-over-year sales increase was largely driven by the results of AAR Airlift and growth in our defense supply chain business. We continue to see robust activity at our mobility products business, although at lower levels than the prior year. During the period we began the relocation of AAR Airlift which we expect to complete during the fourth quarter. The relocation is a major step in the rebranding of this business. To date we have attracted a world class leadership team, improved the operational readiness of the fleet, and most recently we have renamed the Company, as well.

In addition to the relocation, we added six rotary wing assets in the quarter, all of which have been positioned in theatre and will be contributing to fourth quarter revenues. I am pleased with our operating performance in this business and expect operational enhancements to continue, leading to even more appealing financial results. Operating margins in the third quarter improved to 7.8% of sales, still below where our goals are, but nevertheless they are showing some signs of improvement. The third quarter operating margin was unfavorably impacted by approximately 50 basis points as a result of $2.2 million of unusual SG&A expenses in the quarter, mostly related to the relocation of the Airlift business. We do remain keenly focused on margin improvements. Let me now turn the call over to Rick who will provide further details on the financial performance during the quarter.

Okay, thanks, David, and good morning, everyone. As is customary, I'd like to provide a little more detail on the performance in each of our operating segments and then I'll conclude with some comments around our interest cost, depreciation and CapEx. So, beginning with our segments, within the supply chain segment, sales increased 39% compared to the year ago period, reflecting a stronger airline environment, market share gains at certain large customers and sales from our consignment programs.

The gross profit margin in the segment was 17.5%. This was down 80 basis points from last year. And the reduction in this gross profit margin compared to last year was due to product mix and increased focus on inventory turns and also increased sales from these lower margin consignment programs. I would note, though, that despite gross margin in this segment being down from last year, they have improved from the 16.8% we reported to you last quarter.

In our government and defense services segment, we had a meaningful sales increase compared to the third quarter of last year. And this reflects the acquisition of AAR Airlift as well as growth at our defense logistics unit. In this segment, the gross profit margin was 17.4%. While this was marginally down from levels we have seen earlier this year, we remain confident that with our relocation of the Airlift business, as well as deployment of the new aircraft, we will experience improvement in these segment margins as we look into the future.

In our MRO segment, sales increased 53% over the prior year as we captured new business, increased deliveries under an engineering services contract, and saw growth at our landing gear center. Gross profit margin in our MRO segment was 15.9% in the third quarter compared to 12% in the year ago period. This improvement was due to increased volumes at our MRO centers, improved efficiencies on all of our new programs, and some favorable mix. Having said that, we do expect that fourth quarter sales in the MRO segment will decline slightly from third quarter levels as our engineering services business completes one of its larger contracts.

Finally, in our structures and systems segment, sales were down year-over-year due to lower volumes at our mobility products unit. Our gross profit margin in this segment was 18.4%. While this was lower than the prior year due to some lower volumes and the mix of products sold, it is still very strong when we look back from a historical perspective. As we look ahead in this segment to the fourth quarter, we do expect top line improvement and see some growth from third quarter levels.

Moving on to costs, SG&A as a percent of sales for the third quarter was 9.4% compared to 11.3% in the same period last year. As David previously mentioned, SG&A expenses in this quarter did include approximately $2.2 million of unusual costs. And this was mainly related to the Airlift relocation. And I would note that this cost was net of assistance that we had received from the state of Florida. In addition to the net relocation expenses incurred during the quarter, we are forecasting that we will incur an additional approximately $2 million of move-related costs for this business next quarter.

Net interest expense for the quarter was $7.5 million, an increase of $1.2 million over last year, and it reflects higher average outstanding borrowings, as well as the non-cash interest expense accretion on our convertible notes. Cash interest expense in the period was $4.3 million compared to $3.3 million last year, and our non-cash portion was $3.2 million compared to $3 million last year. Depreciation and amortization for the quarter was $14.4 million, and CapEx for the third quarter was approximately $22 million, $17 million of which related to the investment in new aircraft at our airlift business and items to support this new business. Our capital expenditure forecast for the year remains at $110 million.

Finally, in an effort to further enhance our liquidity and position ourselves even stronger for future growth opportunities, during the third quarter we launched an early effort to up size and renew our bank credit facility. We've already received commitments from our three lead banks and we expect to finalize this new facility during the fourth quarter. That wraps up our remarks -- our prepared remarks for the third quarter. I would now like to open up the call for any questions.

(Operator Instructions) Our first question comes from Troy Lahr of Stifel Nicolaus. Please go ahead.

Thanks, I'm wondering if you can maybe talk about the pipeline of airline outsourcing opportunities that you're seeing out there. Are airlines getting back to cash conservation mode, and so you're not seeing that much activity there? Or are you?

Actually, we're seeing a fair amount of activity. So, the ad hoc business has been strong but also looking at different program activity as well. So yes, we anticipate that as the fleets grow and as the airlines look to get more efficient, I think they pretty much buy into the fact that we can add value there. So yes, I would anticipate that in the next 12 months you'll see some additional programs coming from the Company.

Okay. And how should we think about the revenue impact in the fourth quarter from the six new helicopters coming online at government services? Is that a big jump up or is there a dollar amount that we should think that would improve sequentially?

I think it's a steady improvement. There is some business that comes out from some service contracts that we had but you will see an improvement in Q4.

Yes, Troy, part of what drives the answer to your question is actual flight hours. So you'll recall, the basic business model is we get paid -- a good portion we get paid is related to positioning the aircraft in theatre for the customer, but another significant portion comes from how much they use the aircraft during the quarter. These aircraft just were placed over there. So, we're still getting -- I think, it's still early to say how much use we'll see in this next quarter, but it is something you'll notice as we go through the fourth quarter.

Okay. And then just last question then. Can you talk about government service margins a little bit more and why it declined a little bit? I thought with some of the KC10 work improving that you would have seen some margins ramping up there?

Yes, I'd start by let's have the right context. Since we brought Airlift into the fold and aligned all of the reporting on Airlift, and also launched KC10, we've bounced around within a pretty small range, I think. Within 50 basis points on a margin basis. So, we're not talking about big swings here. And if you did the actual dollars that equate to those small 30 to 40 basis point swings, it's pretty small in absolute terms. So, you have to start with the right context. But having said that, yes, we do believe there's upside opportunity from KC10. It's coming a little slower than we expected but there are definitely signs of improvement there. And we will see lift as we deploy these new aircraft for Airlift and get some operating efficiencies out of these new aircraft there. So, that's why we do remain very confident that these segment margins will head north.

Starting next quarter or does it take time?

I think you'll begin to see it next quarter, Troy, but it will certainly be -- there's not a silver bullet. So, it will be something you'll see throughout fiscal '12, as well.

Okay, thanks guys.

There's a fair amount of energy, Troy, this quarter on the relocation. So, I think getting the team all under the same roof, which will be completed here before the month of April is out, will be real positive for the operating efficiency of the business.

Sounds great. Thanks guys.

Our next question comes from Larry Solow of CJS Securities. Please go ahead.

Hi, good morning. Have you guys sequentially during the quarter seen any impact in terms of just spending or maybe a tightening of spending from airlines as the price of oil has risen so dramatically?

We have not, to date we have not seen any tightening in spending. We're keeping a close eye on that, obviously, but we have not seen a tightening in spending.

I would just add, Larry, February was the strongest month of our quarter, by far, and March to date has not shown any fall-offs.

And remind me, seasonally, generally this current quarter is usually your strongest? I know in the MRO segment you'll have a little bit of a shift because of the engineering.

Which quarter are you referring to?

Your fiscal Q4.

Yes, that's correct.

And then in terms of you mentioned that you're trying to increase your credit facility. Is that indicative of more opportunities out there or do you care to shed any light on that?

As I said, the facility that we've been living under we put in place four years ago, Larry. We're a much bigger Company now than we were when we launched that. So, part of that, I think, is natural evolution. But part of it is yes, we want to be well positioned for the growth, we think we have access to ahead.

Okay. And then just a quick follow-up on the AWS, or Airlift, I guess you call it now. The $450 million task order that you guys had received, I guess that's still ramping up? I noticed the Sikorsky S-92s, was just purchased about a month ago. So, did that contribute at all to the product order and perhaps there was some inefficiencies in that, too, as it first started?

I'll let Tim comment on efficiencies, but I would just say yes, we deployed those aircraft at the very end of the quarter and, as a result of that, we're eligible for what's called a deployment fee. So, there's a little bit of revenue in there. It's a modest amount but there is a little bit in there. That, as I mentioned during Troy's question, as we ramp that up now into operating service we'll get a bigger impact off that business.

Okay. And then just lastly, you mentioned another component shop is on the block. Is there any potential, are you seeing some interest in it and you think you may resolve it one way or the other in the shorter term versus the longer term?

I believe that the disposition will be determined in the next -- no later than six months from there now, as to whether we will be looking to sell or retain and reposition assets elsewhere within the Company.

Okay, great. Thanks a lot guys.

Our next question comes from Tyler Hojo of Sidoti & Company. Please go ahead.

Hi, good morning. Just wanted to ask you about the sustainability of the margins within the MRO. I think the 15.9% you put up this quarter is the strongest level since back in 2006 and just trying to understand how sustainable that is, is there further improvement from here. And maybe if you could talk a little bit about, what the utilization rates are in terms of the Indianapolis base.

Tyler, it's Tim. Utilization at Indianapolis is high. All of the hangers are under lease, so they all have aircraft in them. They're not fully utilized and we're taking some actions to modify some of the hangers, so that we can get actually more utility out of them. So, we do see opportunities for more revenue and efficiency coming out of Indianapolis.

In terms of your first question, part of the concept behind the MRO business is to drive ancillary revenue, including engineering services, including the back shops, the third party repairs, field service work. And there is margin opportunity in these kinds of ancillary services and that's some of the things we benefited from in Q3. We expect to continue to benefit from the ancillary services. We expect to continue to drive margin improvement in the core MRO business. But you're going to see volatility because some of these larger ancillary services or programs are a little bit lumpy. So, we're continuing to focus on margin improvement. I wouldn't commit, though, to the levels that we experienced in Q3 on a going forward basis. We'll see them again but not necessarily every quarter.

Okay. And you said that one of your engineering related pieces of work was rolling off in the fourth quarter, is that correct?

That's correct. We're wrapping it up, right.

Okay, great. And just another question for me. Just looking for an update. Back at your Investor Day, it was a while ago, talking about business opportunities with Spirit. Just looking for an update there.

Tyler, we have received work from Spirit. We are in the process of developing the manufacturing protocols. We're programming the machines. We're buying the metal. And we expect that in fiscal 2012, we'll start to see the benefits of the work from Spirit.

Would you be able to talk about what aircraft you're on or if there's additional opportunities there?

There's a variety of different programs and different parts that we're manufacturing, and we continue to, yes, see opportunities for more.

Okay, great. And just lastly for me. Just curious if there were any changes in the aircraft portfolio this quarter.

None. No, same as we left you with last year, last quarter.

That was easy. Thanks a lot.

Our next question comes from Ken Herbert of Wedbush Securities. Please go ahead.

Yes, hi, good morning everyone. Just wanted to first dig into structures and systems a bit. You mentioned sequentially that the fourth quarter should see some improvement in the sales line. Is the third quarter essentially the bottom for this business here? And can you just talk a little bit about some of the moving parts within mobility and obviously, what's going on in the business?

Yes, it's fair to say, Ken, if you go back to this call last quarter, I think we had thought at that time that we expected the back half of the year, meaning third and fourth quarter to be essentially around the sales levels we had experienced in Q1, Q2. So, the third quarter wound up being lower than we expected and it was a variety of things that contributed to that. One was a large customer, did a product switch on us early in the quarter, which led to some delays. It was a choice for them and it led to some delays in putting out any product. And then the product that they did take from us was lower value than what we thought we would be making. So, that was one reason. There was a couple of other things that impacted it but I think the punch line is third quarter was a little lower than we anticipated. So, as we look to Q4 we expect to get back to where we thought we were going to be.

Okay, that's encouraging. And then it was nice to see, though, that you, at least with what you just implied, maybe some of the negative mix implications, you were able to maintain margins sequentially in that business at least. Do you see then holding that as you get back to some of the levels you saw earlier in the year within structures and systems?

The structures and systems chronology, Ken, just to be clear, if you went back in time two years ago or so, this was regularly a segment that had gross margins in the 15% to 16.5% range. And so, in our last fiscal year, fiscal 2010, we really saw some explosive margin growth in the segment. And that was due, in large part, some things that were related to efficiencies that we thought would be recurring and would be sustainable for us, but some of it was just some very favorable one-time events. We had gotten some very good input cost breaks. You may remember us talking about it last year. So, we had some very favorable mix of, I think, product mix, costs, and some efficiencies that contributed to significant improvement in gross margins last year. We've been saying for a while now we expected them to come back down and it was a question of how far down they would come. And we think they will settle in above the old historical norms, and I think that's what you're seeing. For the last couple quarters now we've been in this 18%, a little over 18%. We don't see that changing any time real soon but we obviously, it's a manufacturing business that has to deal with rising commodity costs and things like that, as well. So, we'll continue to keep you abreast of that as we see it evolving.

Okay, yes, it's good to see that thinking of this business now as a high teen margin business instead of a mid teen margin business. Finally then, to one of the earlier questions, as you look at new business, whether it be with Spirit or anybody else potentially in this segment, does that have incrementally significant margin impact one way or the other?

It will be accretive to our margins for the business, certainly, and probably in line to slightly accretive to the margins for the segment.

Okay, great. And just finally, one question on aviation supply chain, Rick. You alluded to some mix there which again led to some of the issues in that business, in terms of the margin. Can you just go a little deeper on that business. And what you're seeing in terms of the consignment versus the -- and obviously, the program work versus the trading work you're doing. And looking out into the fourth quarter and into next year some of how you see that evolving?

Yes, why don't I let Tim start on some of that.

Ken, in the supply chain business, you've always had fairly significant volatility in the margins, just based on the opportunities in any particular quarter. We view the consignment programs as a wonderful opportunity to satisfy our customers' requirements. And there's a modest impact on margins because you don't have the carrying cost and the obsolescence risk and things like that associated with it. But I think the larger driver is more of the nature of the supply chain business where supply and demand fluctuate between quarters, and margins go along with that fluctuation. So, I think it's really not structural as much as it is transactional.

Okay, great. Thank you very much.

Our next question comes from J.B. Groh of DA Davidson. Please go ahead.

Good morning, guys. Thanks for taking my call. Rick, I don't know, did you give an organic number on Government and Defense?

I didn't but we had -- it's roughly in the 6.5% range.

Okay, that's good. And then obviously with Boeing winning this tanker deal, do you guys have any inventory or costs hung up on the balance sheet related to development of your cargo system for that Airbus tanker that we should see come out?

No.

That's all been expensed?

Right.

Okay. And then the strength in the Airlift business, is there any sort of Egyptian or Libyan impact there?

We haven't seen any. Our assets that are deployable, are deployed. We have some assets, as you'll recall, that came out of Iraq that some need to be serviced. But at present, we haven't seen any surge requirements for coming out of those theatres.

Okay, thanks. Everything else I've had here was covered. Thanks a lot.

Our next question comes from Omear Khalid of Stephens.

Good morning, guys. Great quarter. Rick, just a quick question for you. UT Hex has recently been awarded a large upgrade contract for the F61 fleet for the State Department for State Department's use in Iraq and Afghanistan. Just a question there. Is that something that the State Department might potentially outsource to a player like AAR for bid? And if so, is that the kind of opportunity you guys look to pursue or have already looked at pursuing?

Yes, we've had discussions with Sikorsky, we've had discussions with the State Department. We're very familiar with that piece of business that you're referring to. So, it would be ideal at some point for the State Department to outsource that kind of work. At this point, they felt the necessity to control the assets and to perform the service on their own. So, that's something that we're chipping away at.

Okay. That's all I had guys, thank you.

Our next question comes from Alex Hamilton of EarlyBird Capital. Please go ahead.

Hi, good morning. CapEx, I know you don't provide guidance but if we were to look out the next year or two, should we expect CapEx to run at the rate that it did this year?

No, Alex. This years CapEx is significantly increased because of the growth aircraft we've been buying for the Airlift business. So, let me maybe pars your question. Maintenance CapEx for us, will be significantly south of where it is this year. Probably -- historically we had about $30 million annually in CapEx and the Airlift business probably increases that maintenance CapEx number by $10 million to $15 million or so a year. But it's in that zip code of $40 million to $50 million would be the maintenance number. If there are more growth prospects we decide to pursue next year, then that number could change but that would again all be in the name of growth.

Fantastic, thank you.

(Operator Instructions) Our next question comes from Stan Mann of Mann Family Investments.Please go ahead.

Good job, gentlemen. I have one question, probably for David. Your goal of operating margin that you've been stating the last couple years, 10%, when I do the number for this year and add back the $4 million moving costs for Airlift, I move us up about a point which moves us closer to 9%. Can you frame in your words work? It seems like we're getting towards 10% sooner. And can you reframe that and give us some feedback on your feelings and vision on the operating margin?

Sure. Stan, we have an elaborate internal road map that gets us from where we currently are to the 10%. And there are lots of moving factors, if you will. It is a major driver here at the Company. We believe that, obviously if you take a look at the revenue base that we're currently generating, if we can get a couple more margin points, obviously you can figure, you can do the math and figure out what it means to our earnings profile. So, some of it is along the lines of what you're talking about. SG&A normalization. Some of it is amortization from deal amortization that goes away. Some of it is loading within the maintenance operations. As we get an improvement to the commercial markets, we should see some lift in our parts operations. So when we survey the landscape, we have a series of measures that we are initiating as well as monitoring quite closely. So, it would be our anticipation to see constant improvement, steady improvement, and then as some of the structural things go away, we obviously get a natural pick up there as well. So, we feel -- we have a plan and we're on path and hopefully we get there sooner than later.

Yes, seems like sooner. Second question is use of cash, David. Can you kind of give us a little more? You're starting to generate a pretty good cash flow number. And I know you have some debt taking on the acquisition. You've also got some converts. Earliest due, I think, 2013 and 2014. So, can you give us a little feedback on cash flow as you see it?

Sure. We continue to focus on generating cash from the business and you'll see in the quarter that just ended we generated $30 million approximately of cash from the operations. You'll also note, if you look at the balance sheet closely, that receivables have gone up. Fortunately, most of those receivables are with the US government, so we anticipate collecting on those receivables here in Q4, giving us a strong cash flow from operations period here, as well. Now, we have been investing in the assets that we've acquired for Airlift. We've added six assets in the quarter that just ended. We paid for the smaller assets but we will be paying in Q4 for the two newer assets that we acquired from Sikorsky. So, when you look out, there will continue to be an emphasis on generating cash from the business. At this moment, we're not anticipating additional or any significant investments in our Airlift business, but that can change as a result of the opportunities that come in front of us. We do have the debt repayment this quarter. $42 million bond payment gets taken care of this quarter. And that interest rate is approximately 8%. So, that will go away so we'll use cash proceeds to take care of that. So, I think we continue to look at cash as a valuable asset to us and turning our assets into cash is something we're focused on. And generating cash position is important to us, so that we can go ahead and feed our businesses and grow the Company.

Do you feel any better now than you have a year ago?

I feel that market conditions are improved. I believe the Company's position is stronger. So, when I add those things up, yes, I feel better about where the Company stands today than I did a year ago, yes.

Okay. Last question is when will you give us some 2012 outlook?

We are in that process today. Stan, we have stayed away from outlook, for the most part. But, first of all, we're in the final throes -- not the final throes but the middle throes of that ourselves. We'll be in a position to discuss some of that with our April Board meeting. And we'll have much clearer visibility come the May time frame. I'm not sure how, at this stage, at least, we'll look to share that but first step is for us to get a handle on how we see things and then figure out how best to communicate that.

Good job, David. Thank you.

We do have a follow-up from Tyler Hojo of Sidoti & Company. Please go ahead.

Yes, hi. Just a quick follow-up on structures and systems. In your prepared remarks you guys indicated you expected that to be up in the fourth quarter. I'm just looking back at the guidance, the segment guidance you guys provided on October 6, and it looks like if you were to hit that range it would imply something like $114 million to $134 million in the fourth quarter. My guess is that's just out of date and no longer applies to the business, relative to the fact that all of the other segment guidance that you provided looks like you're going to surpass. But just looking for some commentary there.

Yes, what I'd say, Tyler, is reiterate something I said a little while ago which is I think third quarter was lower than we expected. So, we don't expect to necessarily make up that amount but we do expect fourth quarter to return to what we thought would happen. So, that's probably a long winded way of saying, yes, the October 6 guidance is not something you should stick too closely to. And I think we probably will come in a little lower than what was predicted at that point.

Great. Thanks for the clarification.

And I'm showing no further questions at this time.

Thank you. Have a nice day. Thanks for participating.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect and have a wonderful day.