AAR Corp (AIR) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the AAR Corporation 2014 fiscal second-quarter earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded. Now I'll turn the conference over to your host, Mr. Chris Mason. Please begin.

Good afternoon, ladies and gentlemen. Before we begin, I'd like to remind you that comments made during the call may include forward-looking statement as defined in the Private Securities Litigation Reform Act of 1995, as noted in our earnings release and the risk factors section of the Company's form 10-K for the fiscal year ending May 31, 2013.

In providing forward-looking statements, the Company assumes no obligation to provide updates to reflect future circumstances, or anticipated or unanticipated events. At this time, I'd like to turn the call over it to AAR Corp Chairman and Chief Executive Officer, David Storch.

Thanks, Chris. With me here in our Chicago offices would be John Fortson, our Chief Financial Officer; Tim Romenesko, our Chief Operating Officer; and Mike Sharp, our Chief Accounting Officer. I thought what I would do today is kick the session off by providing a half-year or six-month overview of our Companies and our Businesses, our performance and our strategies; and then drill down a little further into the quarter's results and then pass it over to John to provide some color around the financials.

Let me start by going through a performance review, drilling down into our Aviation Services businesses, and then I'll talk about our Technology Products businesses. So start with Aviation Services, we have the three different interrelated activities, supply chain, MRO, and airlift. In supply chain, our parts business has been very steady, and we are seeing steady growth in our program activity.

We think of our program activity in two regards, one of which would be airline programs. And you can see we recently announced a new win of a program to support an airline with their expendable parts to the tune of about $40 million to $45 million per year.

And then we have our distribution program activity and you can see we recently won a contract from EATON to support them in the sale of their products to the DLA. We are very hopeful as we perform for EATON, this will expand the opportunities between our two Companies.

So, looking at the supply chain businesses, steady performance in our parts businesses, and steady growth in our program activity. As we think about the strategy around that business, and keeping in mind that supply chain is an activity that goes through all of the AAR businesses, so it is a core competency to the Company and it is something that supports directly our MRO activities. But even as you think of some of our manufacturing and production and Technology Products, one of the strengths we believe we have is our superior logistics and distribution capability.

So, as we think about the supply chain piece itself, one of the things we would like to do is build out, and we've talked but this before, geographic expansion. We are looking at a fairly sizable deal that would expand our presence, because as you know, we have a large reliance on the North American market. We, of course, do business in Europe, Asia, and the Middle East, but we are looking at a particular situation that would have a meaningful difference on our program activity outside of the United States.

We also think that there are ways for us to build more capability, so that our supply chain solution is a more robust solution. As you may recall, a couple of years ago we made the acquisition of Airinmar that gave us a little specialty or specialization around sourcing repair capability. We are looking at other things that would, in similar fashion make the supply chain solution a more compelling and integrated solution. Hopefully we will have something to talk about here in the near future.

Moving over to our MRO businesses, we have had solid performance. As you know, we are principally a North American service provider. We have recently added two facilities to our mix, Duluth a year ago. I'm proud to say that we are now up to three lines in that facility. As you know, back in September, we took over some space in Lake Charles, Louisiana.

We have returned our first aircraft to service for our customer there, and we are very proud of the speed in which we were able to do that. We should be returning a second aircraft in January. We are out in the market looking for additional wide-body maintenance customers and my sense is that we will have some success along this regard. As a result, we will have a good growth pattern for that group of -- for the MRO activity.

We are continuing to explore possibilities in other regions. To date, we have struck out in this regard, but we continue to see opportunities. And we continue to be asked to look at taking our technology and capability and applying it in different markets.

We are also, as you know we've had success intermittently over the years with our engineering service activity, and we are looking for ways to continue to build that piece of our MRO. It is a higher-margin activity, more value-added, and something that I think would add nicely to our mix of businesses and solutions.

Lastly, in the Aviation Service businesses, we have our airlift business. This business has been performing exceptionally well, very solid operating performance. Again, you may recall when we bought this business, it was underperforming in virtually every regard.

We saw an opportunity by being able to improve their supply chain and maintenance capabilities that would allow for the fleet to be more functional. We have had good growth in that business without having to make additional capital investments here in the last year. Most of that is coming through execution and supply chain and maintenance turn times and things of that nature. So, that business has performed well.

I should say a very large percentage of that business, as we've discussed in the past, is around business in Afghanistan. We have seen a certain amount of uncertainty in the Afghanistan transition, if you will, with the services agreement being delayed by [carisides] causing our customer to delay some of the orders.

Although as you know, we received a contract to supply additional lift into that market. We've yet to receive task orders, so we have not been able to translate the contract into business. We are a little bit -- we are anticipating that's going to take a little longer than we had hoped.

So, if you look at the entire airlift business, just to give you a sense of proportionality, we have 40 positions that we operate in around the world. We are expecting that of those 40 positions at the start of the year, that we will be down to 20 positions by the end of the year. We are anticipating that we will win an additional 9 positions that would make the differential between going from 40 at the start of the year, to 29 at the end of the year.

There are three aircraft types that we will be exiting. In those instances, the profit contribution of those, two fixed-wing and one rotary-wing have been relatively negligible. So, by definition, the fixed-wing assets have been a CASA 235 and a Metros, and the rotary-wing has been the Bell 214.

So, those will be -- we will be looking to do something different with those assets. But again, as they come out of the fleet, it will simplify our fleet, but it will also -- the profit contribution from these assets has been relatively negligible.

Longer-term for this business, strategically we are bidding on a few very large contracts. One of which is larger in size than the business is in terms of annual revenues. It is very hard to handicap what the likelihood of success may be, but this is an opportunity that we've been looking at for a few years. It is coming home to -- its coming into the near-term possibility range.

We also are looking at other opportunities within the Africa market. We feel very confident that we have a leadership position in this business and we believe that the requirements, although not as heavy in Afghanistan as we had once maybe thought, we do believe that there will still be requirements there, but that we are planning to grow the business outside of that market.

We have a lot of confidence in our management team, their track record, and believe that this business will continue to be an important contributor to the Company. Notwithstanding some of the changes that we will be going through here, as a result of some of the short-term changes in Afghanistan.

Moving along into our Technology Products business. Our cargo systems business -- commercial cargo system business is, we believe, in a very good position. They did have a little softness in Q2, but we believe that is more situational than directional.

And as you have seen, we recently acquired the A320 product line from PFW, which is now 51% owned by EADS. 25% of all A320s delivered from Airbus has cargo systems, the balance just have lower holds that basically cargo is put in in a minor way. So, we believe that we will have a very good product line there for many, many years to come, and that it complements what we currently do in Germany very well.

Our defense piece of the cargo systems business should start benefiting from deliveries of A400Ms. We did deliver three systems in Q2. And we anticipate delivering systems now for the next 10 to 15 years. Hopefully what we are planning on there, is that we will have a prolific spare parts business, too, that as I indicated, plays into our distribution capability very nicely.

Our mobility business continues to be very steady. As we said before, we knew that that business would be declining. We indicated that by Q2 it would be on a comparative basis, relatively equal and that is where it is at. It is performing at a steady-state.

It is performing well, it still has leadership position in its market. We will be looking for ways to deepen and broaden the product lines around mobility, since we have a leadership position there. Clearly we would be looking at lower multiples than you might pay for commercial products, but we will be looking for ways to opportunistically expand that business, both from a more of what we currently do as well as broaden our product offering.

And lastly, in our Technology Products, we have our precision business. Our precision business continues to under-perform. As I've said before, we stubbed our toe a few times. In certain instances, we've made some bonehead decisions. But we have a new leadership team in place today that is a proven leadership team with the Company.

The business is reporting into our mobility business. This particular piece of our business enjoys excellent market conditions. So if we can get our act together, we are expecting to be able to produce positive results by Q1 of next fiscal year. But still a drag on earnings and under-performing our own internal expectations.

So now that's an overview as to how our drilling down into our segments in terms of how our businesses are performing and how we view them strategically. If I may, what I would like to do now is get into second-quarter results. And rather than regurgitate what was in the release, what I'll do is share with you a little bit more detail into our different segments and their performance.

So the aviation service segment, sales were up 9% on a year-over-year basis, that would all we be organic. Our airplane maintenance operations continue to perform at a high level of capacity utilization.

Demand for our maintenance services from our customers remains strong. And in this quarter we delivered 176 aircraft and performed the work of approximately 1.3 million man-hours. So over the last 12 months we've returned 855 aircraft to service, in service to our customers, and we billed over 5.1 million man-hours.

During our first quarter we experienced seasonal softness, you may recall, in our commercial supply chain. As expected, we are pleased to report sales in our second quarter started to improve.

As far as our programs are concerned, we have steady performance, as I indicated in my opening comments. On December 11, we announced the signing of a five-year contract, valued at approximately $40 million annual revenue, to become the sole-source supplier of consumable and expendable line item parts for a major US airline. The airline has asked to be unnamed, so you will have to guess who it is.

Further on the distribution side of our business, on December 18, we announced the supply chain contract with EATON, to supply fluid products to the Defense Logistics Agency. As I indicated, EATON is a significant OEM, component OEM, serving the industry.

We are excited that they selected us to handle the interface of these defense-related products. We are hopeful as we show them our performance, that they will be inclined to move us into some of their commercial lines as well.

As I indicated, airlift continues to deliver strong results as we maintained high operational readiness levels. As we ended the second half of our fiscal year, also as I indicated, there are some moving parts.

First, in October we were awarded a one-year extension through October 2014 for 10 rotary-wing aircraft with a contract value of approximately $150 million. We also renewed the $50 million contract with Military Sealift Command for four helicopters ferrying critical supplies to the US Navy ships.

Also subsequent to the end of the quarter, we announced additional contracts. On December 2 we entered into a contract for two aircraft, valued at $23 million and up to 22 months in duration with USAFRICOM throughout four Central African states.

The incumbent operator has filed a protest for this contract. We do, however, believe that the agency made the correct decision in selecting us based on the requirements of the RFP, and the quality of our technical solution and historical performance.

On December 3, we also announced a $134 million IDIQ contract to provide fixed- and rotary-wing support for the Afghan National Security Forces, and under the NATO training mission. We have not received any task orders against these contracts yet.

And this contract, they are trying to figure out how to proceed. They will be proceeding, and we expect something to break in this regard in the January time period. A little further out than we had originally anticipated, but nevertheless we do expect task orders to be let here in the near future.

We've been notified by our customer that 10 out of 12 rotary-wing positions for the contract that expired on November 30 have been extended. Six contract positions were extended through January 31, one position was extended through February 28, and March 31, respectively. And two contract positions were extended through April 30 of the year.

And these, as you recall, we were, some of these we will be using for the Afghan National Security Forces, once those task orders start getting let. And the Afghan National Security force RFP is for 18 positions. We don't know if we can fill all 18, but clearly we will be able to fill some of those with our existing aircraft that come off of the contract I just indicated.

So, again to put all this in perspective, at the beginning of the year as I mentioned in my opening comments, we had 40 aircraft in revenue service. By the end of the fiscal year, 20 of these aircraft will be de-scoped and will be available for future mission deployment.

We expect to have nine aircraft positions added for a total of 29 aircraft positions by the end of 2014, assuming there is no changes in requirements. We are hopeful that there will be additional requirements.

In the near term, we are waiting for more clarity on the Status of Forces discussions. In the long-term, we expect airlift to be leading business in its market and a solid contributor to our results.

In the Technology Products segment, sales were down modestly in the period as we experienced some softer sales in the cargo systems and containers on a year-over-year basis. We did announce a bolt-on acquisition of cargo assets of PFW, which will fit very nicely into our carrier operations.

Again, as I indicated earlier, this acquisition rounds out our capability in support of the A320 family of aircraft. Just as a point of reference, 25% of all A320s are outfitted with cargo loading systems, and exclusively with this cargo loading system.

In addition, our mobility operations entered into a new contract to provide the DoD with specialized shipping storage containers, shelters and accessories. We anticipate revenues of $250 million in total over the five-year term, and with the possibility that that contract will grow to $400 million. So, I think what I'd like to do at this point is turn -- I'm kind of running out of voice, so I'm going to turn the call over to John Fortson, who will provide some color.

Thanks, David. I will provide a little more color around the financial performance of the Company during the second quarter, including comments around interest, cash flow, capital expenditures, and capital structure. And Mark Sharp and I both will be available after the call to answer any questions that you may have.

Revenues in the first quarter were $540.7 million versus a prior-year level of $512.8 million. Aviation Services revenue at $424.7 million was up 8.7% in comparison to prior-year. As David mentioned, all of the businesses in this segment performed well.

Technology Products revenue was $116 million and declined 4.9% from last year's levels as a result of softer sales in our cargo systems and container operations. In our Mobility Systems, this is the first quarter since the second quarter of 2012 in which sales were on a comparable basis from a demand level, and we expect them to remain steady going forward.

During the quarter, sales to commercial customers were 57% of total sales, compared to 60% of consolidated sales in the second quarter of last year, with the balance of sales attributable to government and defense. The second-quarter defense sales include the sale, or include the delivery of two aircraft in the US Marshals service.

Consolidated gross profit margin in the first quarter was 16.8%, compared to 17% margin in the prior-year first quarter. As mentioned in our release, margins in Aviation Services segments decline to 16.8% from 17.2% in the prior-year period, as a result of unfavorable margin mix. On the Technology Products side, margins increased to 17% in comparison to the prior year.

Similarly, in the first quarter and fiscal year 2014 we did a great job of cost management this quarter bringing SG&A as a percentage of sales to 9.5% from 9.9% in the prior-year quarter as a result of a combination of higher sales and effective cost management. We remain focused on cost control across the Company and expect further progress.

Operating profit at 7.5% for the quarter was 10 bps better than prior-year quarter. As we've said before, improving our operating profitability is a focus across the Company and we are pleased to see this margin improvement.

We also remain very focused on cash generation. During the second quarter we generated $38.8 million of cash from operations. We had $7.1 million in capital expenditures, and $31.7 million of free cash flow. Further, we paid $3 million in dividends.

Net interest expense for the first quarter was $10.2 million, a decrease from $10.5 million in the prior year. We continue to de-lever the Company and as of November 30, net debt was reduced by $29 million sequentially and by $127 million from November 30, 2012. As David mentioned, our net debt levels are down by almost $180 million from its peak in Q3 of fiscal year 2012, right after we closed the acquisition of Telair Nordisk.

Depreciation and amortization, including amortization stock-based compensation was $22.3 million during the second quarter. Our second-quarter diluted earnings per share is based on 39.2 million shares in our diluted share count, which is down 2.3 million shares from last year's level.

As communicated in our press release, given our expectations for fewer aircraft positions at our airlift operations during the second half of the year, we are adjusting both our revenue and diluted earnings per share guidance for fiscal year 2014. For the full year, we expect to generate revenues in the range of $2.1 billion to $2.15 billion, and diluted earnings per share in the range of $1.95 to $2 per share. Thanks for your attention, and operator we are now ready to take questions.

(Operator Instructions)

Julie Yates Stewart, Credit Suisse.

David, thanks for the business update, that was really helpful. On the supply chain, last quarter you talked about the customer deferrals of heavy maintenance on engines. It sounded like, from your comments, that this has improved some. Can you give us an update on what you're seeing in that business?

We had strength in the quarter and we have made some investments in inventory for anticipated strength continuing into Q3 and Q4. The business clearly had a dip in Q1, but it is not exactly where we want it to be, but significantly higher than Q1. So Q2 was a good quarter, and we anticipate, with some investments we've recently made in Q2, that we would anticipate that we will have some strength in Qs three and four.

Okay. And then on the -- with your comments on the distribution business and the win with the major airline, can you help us understand exactly what you guys are doing on the distribution side? And whether you are starting to compete with the likes of WESCO and BE here?

Julie, it is Tim. In this particular situation, we are really taking over the supply of consumable and expendable products for the airline. So, everything from the sourcing of the parts to delivering it to the bins at the airline.

It's an extension of what we've been doing, and it is similar to what some of the others are doing. But it is an area that we are leveraging our systems, we are leveraging our relationships, and we are leveraging our core capabilities.

Okay. And then lastly on the guidance, if you can help us understand the positives and the negatives. The positives being the new acquisition, the distribution contracts, and the negatives being airlift and perhaps a little bit of weakness in the cargo side, helping us size those different pieces?

Yes, Julie, it is John. As we've thought about it, this is obviously been -- there has been a lot of planning and analysis going in, particularly as we've got more visibility around what airlift is going to do. It has been a particularly strong half of the year.

I think from our perspective, you can look at the aircraft positions and make a rough guesstimate as to how we think the business will impact on the back half of the year. It will get offset by positive contributions, particularly I think in the fourth quarter and the supply chain parts of our business.

And also, offset by some improvement in our Technology Products, specifically our commercial cargo loading and systems business. So positive supply chain, positive cargo loading services, offsetting and mitigating some of the downward pressure that you are seeing from airlift.

Okay. Thank you very much and have a happy holiday.

Thanks, you too.

Larry Solow, CJS Securities.

Dave, can you qualify the 40 positions that was a fiscal year-end 2012, or calendar year-end 2012? And are you saying 30 at calendar year-end now, basically? Or 20 now and then back to 29 at the end of calendar 2014? Is that what you're saying? Or are these fiscal years?

Yes, so starting the fiscal year we had 40 positions.

Right okay.

We lost a few positions between end of fiscal year and now.

Okay.

And then, so we are expecting from fiscal year start to end, where we would start with 40. Of those 40, 20 are going to go away, is our best estimate.

Right, by fiscal year-end (multiple speakers)

And then we believe between now and fiscal year-end, we will win nine new positions.

Got it. So basically, from now, or you've already -- you basically have you lost a few positions already or -- ?

Yes, we had lost some positions in Q2.

Okay, and the position, the nine you expect to add, is that mostly, is that assuming that you get some of these task orders?

Yes, and we are expecting the protest to -- we believe the protest is frivolous.

Right.

And we believe that will be ruled in our favor.

Okay.

So those would be two that would go into Africa.

Right.

We believe that we are probably going to win somewhere in the vicinity of four to five task orders in Afghanistan.

Right, right.

And then we believe there is another two rotary-wing that we will win in Africa.

Okay, that will be the additional two incremental that you haven't announced yet in Africa? And the four to five task orders that you say you think you'll get, that's of the potential 18 that you could get, not today, but in theory?

Yes, that's correct.

Okay. Just a couple of other questions. Did the five-year contract you just announced, the $40 million, $45 million. Is that a potential number or is that a number you have to ramp towards? How should we look at that?

That is our expectation of the first year performance. We do think that there is opportunities to build on that.

Larry, just to maybe follow-up a little bit on Julie's question, too. We provide this kind of support for our own internal shops.

It is just that we haven't had large programs like this with external customers, so it is something that we know very well. We expect that we can build off of this program with this customer and with other new customers.

Okay. And the distribution agreement with EATON that you announced, can you put any numbers to that? Is that somewhat small? I imagine like the Unison deal, but how does that compare? Is it much smaller? Can you put any quantification on that?

It is in the zip code, slightly smaller. But we prefer, I think at their request we've (multiple speakers)

That's actually a decent size then. And does that one take longer to ramp? Because I know Unison took a while, and I don't even know if it's right.

Yes, that will take a little longer. Look, Unison, of course, had a much broader range of customers. This has a narrower range.

Right.

So I think it probably shouldn't take quite as long, but there will be a ramp period.

And as you to analogous to the $60 million that was, I think, when it was signed that is supposed to be? Is that ballpark to where it is now?

Yes, I think it's a little bit less than that. But it is clearly meaningful.

Okay. Then just a couple of other quickies. Duluth, your LP is third line. Do you see that going to four any time soon? Or is three a number you expect the near-term?

The goal is to get to four. And I think let's get through three. It's a manning challenge.

Right.

At this time of year, people aren't dying to fly up to Duluth. (laughter)

Yes, you're right. So maybe in the summer.

Right.

How about the other facility, Indy, Miami, are they all running? Sounds like they are all running pretty high.

I think Q2 they ran strong. I think Q3, we get into the holiday season, you should expect some softness there.

Okay.

But typical, nothing unusual.

Mobility, was that actually, was that flat year over year? I thought it was supposed to eke out more this quarter and then flatten out? Pretty flat?

Yes, I think relatively flat. Slightly down, but not an a meaningful fashion.

Didn't you see it being flat at least in the near-term? Is that fair to say?

Yes.

Okay, great. Thanks, guys.

(Operator Instructions)

Tyler Hojo, Sidoti & Company.

The first question is just, if you look at commercial aviation sales in aggregate, it looks like those volumes are roughly flat year on year in 2Q. When I go through the prepared commentary, obviously MRO is up, supply chain is up, just wondering what the offset is? Is the offset on the precision business? Just a little help there.

No, I think that is fair. It is softness around precision and also in our cargo loading systems businesses. So it is Technology Products that drove it. But you are correct, it is flat to down like 1%.

Okay, and could you talk a little bit about what is going to be the catalyst to turn precision around? I think, David, you said Q1 you are expecting a shift in that business.

Yes, and we have had improvement, so the Q2 is better than Q1. It is still operating in the red, I guess was my point. We've gotten it -- so the team operating the business now, we shifted the management in early summer. The business now reports to our Mobility GM who reports to Dany Kleiman, who you may have met, Tyler.

Dany, before he left Israel Aircraft Industries was running their MRO business, Bedek Aviation. But before that he was in charge of their manufacturing plant, building the airplane, the G250, as well as building parts for Boeing under contract.

So they have put some disciplines in place which has already yielded improvements. We now have to win customer confidence back. We did some, I made a comment about bonehead decision. The prior manager had made some pricing decisions that, quite frankly, pissed off some of the customers.

So, we are now trying to recover some of those customer relations. I think the key to recovering customer relations is doing a fabulous job on operational stuff. So the guys are fixing the operation, which I think is getting close to where we want to be. And now we have to regain the customer confidence and make them feel better about what we're doing, and then probably give some price concessions so that we regain their trust.

Okay, but longer term, David, are we still thinking that precision could be additive to the long-term margin goals that you've talked about?

Absolutely, and it should be. It is really -- I got to watch my language because I'm not happy about it, but we really have, to put it mildly, stubbed our tow.

This is, of all our different subset markets, this is probably the healthiest of all the markets. So we should be enjoying some of what is going on in the build cycle in this business, and we are not. So, we've got to fix it.

We know we have to do. I have confidence in the team that we have in place today, to fix it. And I would hope that next year at this time, while we are talking, it will be contributed to the profitability and hopefully the additive to margins.

Okay, wonderful. Thanks for that color. On another topic, when you talk about the 11 airlift assets that are going to be unutilized at the end of this fiscal year, curious what the current thinking is surrounding them? Would you prefer to sell them or place them somewhere else?

It's probably seven assets that we would probably look to sell. One of the things that we would like to do is simplify the fleet. So at one point in time we were operating nine aircraft type.

If we sell these three aircraft type, we've already gotten rid of one aircraft type, we would be down to two fixed-wing type, de Havilland -8 and CASA 212s. And then we would be down to three rotary-wings which would be the F-92s, the F-61s and Pumas.

So that would be ideal state for us. But let's see what we have. One of the aircraft that we have out, the CASA 235, we actually have some requirements for, so we are arm wrestling as to whether we want to -- what we want to do exactly with those requirements.

Okay, that is interesting. One follow-on to that, one of the discussions at least I've been having is what some of the underlying value is with some of the airlift assets that is on your books. Do you have any idea what the market value is of the seven birds that you are looking to sell?

The book value is $30 million. And we think the market value is pretty close to that level.

Great, thanks a lot. Appreciate it.

Tyler, if you are still there, the value I gave you includes all the spares that support those fleet types as well. So it's the aircraft themselves plus the spares, engines and spares.

Great, thanks.

Kevin Ciabattoni, KeyBanc Capital Markets.

To echo Julie's sentiment, I went to thank you for the strategic update at the beginning of the call, that was very helpful. Looking at the recent distribution and supply chain wins, EATON and then the unnamed airline customer, can you give us an idea of what -- are there meaningful start-up costs involved in those in terms of infrastructure, inventory, what have you, that may be dilutive to margins early on?

There aren't really any significant start up costs. We will be putting a team in place where we are going to be warehousing this out of one of our existing facilities. We are going to take on some additional space in that facility.

We will invest a little bit of capital to mezzanine the shipping area. In terms of the provisioning of the inventory, we will be and have started, issuing purchase orders. So there will be a working capital investment, but no costs or start up costs that are significant that would have a negative impact on margins.

Okay, perfect. And then on the airlift, you mentioned you hadn't received any task orders for the NATO contract in Afghanistan, but I assume that that it is still, that contract is still included in the outlook for the year, despite the fact that you haven't received orders yet, correct?

Yes, it is part of the reason for our taking a softer look at the second half earnings. Because we had originally been anticipating that those task orders would have been issued by now, and that we would have the benefit of those assets operating in Q3. We are now little bit -- we are taking a more cautious view and thinking it is going to take a little longer, because we still don't have the task orders to go ahead and deploy those assets.

Okay. And then in airlift, you mentioned at the beginning of the call, a large opportunity you were looking at outside the existing business. I was just wondering, can you give us any color what kind of end market? Are we looking at military, government, commercial? Can you give us any color on where that would be?

Let's call it government.

Okay, fair enough. And then last one for me, it's a longer-term question, but we saw a Air Canada order a number of Boeing narrow bodies recently. Just wondering, long-term, what the impact of that shift would be at Duluth?

Well, longer-term depends on what you're talking about, in terms of longer term. At some point in time, obviously today in Duluth we are doing their A320 fleet. I would expect that the order from Boeing was to replace some of those assets, I'm not sure, I don't recall. Although I believe I did see it, but I don't recall when those aircraft come into the Air Canada fleet.

2017 would be the earliest they're looking at this point in time.

Yes, so I think as they phase in, I don't know how many a year. What did they order, 69?

In the ballpark of that (multiple speakers).

I think there are 80 A320s currently in the fleet if I remember correctly. So I would imagine that over time they will be transitioning A320s out and probably transitioning 737s in.

And you would be able to -- at this point obviously that's a ways off, but you think you would be able to handle the Boeing aircraft in Duluth?

Absolutely, I would have to check the stats to know if we can handle three or four, but we would definitely be able to handle at least three.

Okay, perfect. That's all I had. Thanks.

J.B. Groh, D.A. Davidson & Co.

You mentioned the working capital investment. Is there any way, on some of these new contracts, is there a way to quantify that or how should we think about it in terms of days of inventory versus that $40 million or $45 million?

Yes, I think we wish the inventory turns in that program of free to four times. Maybe not right at the start, but I think it should have decent turns.

Okay, so a little bit -- okay not a huge cash flow then. And then what is the pace on the A400M now? You said three for the quarter. Is that what the expectation is over the next several quarters?

It moves around, some are a little more than that. But yes, it is starting to get into a pretty good ramp here. So, yes, it goes up from here.

And that all shows up in Technology?

Correct.

Okay. That's all I had left. Thank you.

Let me if I may, you made a comment about the returns on the investment for those programs. Let me also add one more thing and that we mentioned in the question that Julie asked about the, some of our businesses in the spare parts arena.

Weaved in in this quarter generate meaningful cash, positive cash flow, cash flow in excess of our net after-tax earnings. And keep in mind that that includes a significant investment in inventory to support our supply chain business.

So, we increased our supply chain inventory by approximately $20 million, that should go ahead and auger well for Q3 and Q4 in that business. So, the cash flows take into consideration investment in inventory to support growth of the business.

But Dave, that is almost, I always look at those as an acquisition almost, right?

Absolutely.

So maybe you could -- I'm hopping back in here -- prioritize cash flow deployment? It sounds like you are working on some other potential transactions, but what else?

Yes, clearly, as you know, we're supporting and growing our supply chain -- looking to support and grow our supply chain businesses. So there will be capital applied to those businesses.

I signaled in my strategic overview, some additional things that we are looking to do to build out our capabilities. We are feeling pretty good about where we stand right now in terms of opportunities for capital deployment.

Great, thank you.

And it helps that we generate the kind of cash that we have over the last year or 1.5 years.

Jon Braatz, Kansas City Capital Associates.

Most of my questions were answered. I was going to ask about the A400, but in your text you talk about sales of two aircraft to the US Marshals Service. How much was that? And was there any profit associated with it?

It was a fairly thin margin transaction. I think we may have announced, or I don't recall precisely if we announced the sales and we may be prohibited from doing that. It was a relatively thin margin transaction.

One of the things that we are trying to secure there. Keep in mind that they are headquartered there. Their air operation is at the Oklahoma City airport where we have our maintenance operation. It would be goal/ambition to do the maintenance support for that fleet of aircraft.

Great. So how many aircraft do you have now remaining in your portfolio?

Six.

Six, okay. Any timetable that you would like to reduce that by? Do you have a timetable?

Yes, I would like to get them done by the end of the quarter, if we could. (laughter) I don't think that's going to happen.

I think realistically, I think that we have two 767s on lease with United. Those come down nicely, I'm not sure yet. I think those it expire in 2016 or 2017 -- 2015 or 2016 -- so I'm not sure if we've heard from United yet as to what their intentions might be at that stage.

Keep in mind they've invested fairly heavily in the interiors on that aircraft, so just not sure what they're plan is. And then we have a 747 on lease with Delta that they have plans to operate for a long time.

I guess we have that in the finance category, now. And so yes, I would say that I would anticipate that this fleet will move out of our portfolio in the next three or four years.

Okay. David, thank you very much.

Stan Manning, Manning Family Investments.

Good job, David, several questions. One, can you talk to the thoughts on the American-USAir merger and its possible effects on your business?

Well first of all, I think it is good for the industry. I think it has a potential of being positive for us. The USAir management team is integrating, I think, well with the American management team.

I would expect that as the time goes on, they will be looking at their maintenance spend and trying to figure out how to do that most efficiently. And I would hope that they would view AAR as somebody who can assist them in that regard.

We do business today in support of USAir. We do less business in support of American, but we would be optimistic that we would be able to convince them that we offer competitive solutions for them.

Are your current maintenance locations conducive to helping them?

One of their core markets would be the Miami market, and we have a maintenance facility at the Miami airport. So, that would be very conducive.

And I think that the -- why buy a facility we have in Louisiana, although not necessarily right on their network, I think, I'm certain they have lots of airplanes that fly over that location, so it is not totally inconvenient. It is not perfect, because it's probably not on their route network, but it is probably not totally inconvenient. So, yes, our facilities, I think, are in a good physical location for their business.

Okay. Last question is you have mentioned a large acquisition outside the US. Can you speak to how you would do that deal according to your current balance sheet and cash flow?

Yes, it would be meaningful for the supply chain businesses. It would not be -- it is not a deal changer kind of large. It is a very affordable opportunity. So, I would about do that we would actually pay for it out of our cash account and, yes, I think that's about it, Stan.

Okay, last question is your thoughts on increasing operating margin near-term or long-term?

It is a goal of ours. We continue to stay focused around it. This quarter, we struggled a little bit in terms of the gross margins. But you can see, we continue to manage our SG&A, and it gave us a slight improvement in operating margins.

We did not have a needle mover. But as we continue to go through the portfolio and assess our different businesses and where we want to put more emphasis, it would be our goal to improve operating margins.

Okay, so you can see gains in the future?

Yes.

Okay, thank you.

Donovan Chaney, Wells Fargo.

Most of my questions have been answered, but did you guys comment yet on your free cash flow goal? I think last quarter you were targeting free cash flow about equal to or a little bit greater than net income. How does your working capital investment for that new supply chain when, or maybe the lower airlift business, shrink that? Is that something to think about?

Yes, think of free cash flow for the balance of the year will be under a little bit of pressure, because we just made this acquisition of the cargo system product line over in Germany. And we have won these recent supply chain deals which will require capital investment.

So, our internal goal, up until some of these investments we made has been what you have indicated, the second half of the year might be a little bit harder to achieve that. Now the cash flow from operations, we are still expecting that number to be continue to do well and, but we might be challenged on free cash flow.

Okay, that's great. Thanks.

Julie Yates Stewart, Credit Suisse.

To follow-ups for me. David, on the precision business, would you consider selling this, if you can't realize the improvement you're targeting? I would imagine multiples for these types of businesses are pretty attractive, given that the positive cycle dynamics and the consolidation we've already seen.

Julie, the answer is yes. We would, but we have to get it into the black first. If you multiply by a loss, there's no real multiple. We've got to get our act together in the business and we've got the right team on it. We will get it fixed.

Okay. And then second, did you guys look at the Airborne Systems business that TransDigm acquired?

Yes.

Okay. Did you get outbid? Or is it something --

First of all, I wouldn't comment on it. But we did look at it.

Okay. That's it for me. Thanks.

Thanks, Julie.

Thank you. There are no further questions in the queue. I would like to turn the call over to management for any closing remarks.

Well thank you very much for your participation today. Hopefully, the call was of value. And I hope you appreciate the color that we provided today, and appreciate your support. I want to wish everybody a happy and healthy and safe holiday season. Thank you.

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