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AAR CORP. (NYSE:AIR)

F3Q09 (Qtr End 02/28/09) Earnings Call Transcript

March 18, 2009 8:30 am ET

Executives

Tom Udovich – Director of Financial Planning and Analysis and IR

David Storch – Chairman and CEO

Tim Romenesko – President and COO

Rick Poulton – VP and CFO

Analysts

Larry Solow – CJS Securities

Tyler Hojo – Sidoti & Company

Eric Hugel – Stephens Inc.

Jim Okshow [ph] – ABH [ph]

Tom Louis [ph]

Jon Braatz – Kansas City Capital

JB Groh – DA Davidson & Co.

Henry Kennedy [ph] – Overhaul and Maintenance [ph]

Rick [ph] – Columbia Management

Stan Mann [ph] – Mann Family Investment [ph]

Operator

Good day, ladies and gentlemen, and thank you for joining the AAR CORP. Third Quarter Fiscal 2009 Earnings Call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions following at that time. (Operator instructions) As a reminder, this conference is being recorded.

And now your host for today's presentation, Tom Udovich. Sir, please begin.

Tom Udovich

Thank you, Tyron. Good morning, ladies and gentlemen, and thank you for joining this morning's conference call.

Before we begin, we would like to remind you that certain of the comments made today relate to future events, which are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Please refer to the forward-looking statement disclaimer contained in the press release issued yesterday as well as those factors discussed under Item 1A entitled "Risk Factors," included in the Company's May 31st, 2008 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.

David Storch

Thank you, Tom, and good morning everyone. Joining me today in our Chicago headquarters is Tim Romenesko, our President and Chief Operating Officer and Rick Poulton, our Chief Financial Officer.

We reported our third quarter results last night and trust that you’ve had a chance to review our press release. As you all know, the economic environment in the United States has continued to deteriorate with calendar year fourth quarter GDP a negative 6.2% and U.S. unemployment at the highest rate since 1983. As a result of weak economic conditions, both business and leisure travelers have reduced air travel, causing airlines to reduce capacity and seek ways to reduce cost, and conserve cash.

Capacity in North America is down approximately 8% during the first quarter of calendar year 2009 compared to last year and passenger traffic in North America is down approximately 10%. International traffic for certain of the carriers is worse with some carriers reporting declines in international traffic well in excess of 10%. While carriers are benefiting from the impact of lower jet fuel prices, additional capacity reductions may occur as a result of continued weakness and consumer confidence and declining business travel.

As airlines reduce capacity, it causes significant changes to their maintenance schedules, which in turn drives disruption to the demand pull for parts and services. Now, we have not been immune to the capacity reductions impacting the industry as we reported a 6.8% decline in sales to commercial customers, which excludes our Aircraft Sales and Leasing business.

We were impacted at our Indianapolis MRO where we experienced lower sales as a result of the United Airlines decision last spring to ground their 737-300 fleet as well as FedEx’s decision to retire a portion of their 727 aircraft. We are in discussions with other potential customers who have expressed interest in this world-class facility and we continue to perform work for Southwest.

As a result of the weak economic conditions and tight credit markets, we are focused on reducing our investment in our aircraft portfolio. Our equity investment in our joint venture and wholly-owned aircraft portfolio is approximately $80 million at February 28, 2009. Of the 33 aircrafts in our portfolio, 32 aircraft are on lease and we have only – and we have one wholly-owned aircraft coming off lease in the fourth quarter, which will be disassembled for parts.

There are two leased aircrafts on our wholly-owned portfolio in which the lessee is behind in their payments. We’ve obtained the judgment against the parent of the operator of the aircrafts and expect to recover amounts owed to us. Other than those two aircrafts, all the other aircrafts continue to operate according to our agreements.

Further, as we deemphasize this business, we are considering combining the activities of our Aircraft Sales and Leasing segment with the Aviation Supply Chain segment for our next fiscal year.

While the environment remains challenging, we believe the business strategy we adopted several years ago has positioned us well to respond to these challenges. Specifically, through target investments and business acquisitions as well as organic growth, we’ve been executing a strategy of building balance, balance across our two major customer segments, commercial and defense, as well as balance in our product and services offerings between front-end manufactured content and back-end aftermarket support.

Our goals in embarking on this strategy have always been two-fold, first, to mitigate short term earnings volatility by insulating our exposure to any one segment of industry, and, second, to generate opportunity over the longer term by creating larger addressable market opportunities.

Looking back on our third quarter, we see the value in executing this strategy as our results held up nicely despite a very difficult commercial environment and certainly held up much better than we’ve seen in prior downturns. We remain optimistic on longer term fundamentals for both the commercial and defense markets we serve and continue to position ourselves for long term success. For example, we recently opened an office in Abu Dhabi, which is staffed by one of our senior marketing executives to address growing opportunities in this region and we expect to see results shortly. And I should say meaningful results.

In yesterday’s release, we discussed that we were a net investor of cash during the third quarter. We used $16 million of cash from operations as we made significant investments in inventory and rotable assets to support our commercial customers. We expect cash – solid cash from operations in the fourth quarter as we do not have any large planned asset purchases.

Thank you all for joining the conference call today. And we would like to now open up the line for any questions you may have.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is from Larry Solow of CJS Securities. Your line is open.

Larry Solow – CJS Securities

Hi good morning. Can you maybe discuss your Aviation Supply, it looks like your margins actually were, it surprised me, held up pretty well, obviously I know they have the last couple of quarters, but are the – first of all, the bigger ticket items, are those lower margin? Were you – kind of your sales were kind of down a little bit and was it due to better mix or what was the color on that?

Tim Romenesko

Well, I think the – I think, Larry, the – but just the volumes were lower in big ticket items and at the components shop.

Larry Solow – CJS Securities

Right.

Tim Romenesko

And the margin on big ticket items can – it’s volatile. They are – sometimes they are modest, but other times they can be significant. So, I think you have just a – recently experienced in the quarter just a general softness in demand for parts and then it was exacerbated by the lack of any engines or large structural components.

Rick Poulton

Larry, it’s Rick. I’d just add to what Tim said (inaudible) by pointing out that as part of what we described is some of the revenue weakness, which was really out of our component repair shops. Those tend to be a little lower margin than the other aspects inside Supply Chain. So you are getting a little bit of margin left as those things show some softness.

Larry Solow – CJS Securities

Got it. And I know you’ve had some weakness in the European component shop and you talked about some potential actions taken and I guess I see you’ve had some headcount reductions there and severance costs. Any other actions you could take or –?

Tim Romenesko

We are working it. We are working both the cost side and the business development side. We’ve – we’ve moved a team in there now and working on improving the performance there. We’ve got some things that we are working on that are going to help. So, it’s a priority.

Larry Solow – CJS Securities

Got you. And then just last question. Can you, Tim, maybe just discuss – I see recent – looks like recent trends are at least stabilizing. You mentioned last couple of weeks in you press release kind of during the quarter did things get progressively worse in the Aviation Supply as capacity started to come off or how that play itself out?

Tim Romenesko

No, the – it got better actually. February was a strong month and we are seeing the volumes in March continue to track.

Larry Solow – CJS Securities

Okay. And then in MRO, in the Indianapolis facility, could you just give us the update, I guess it’s only Southwestern now and how many hangers are we occupying?

Tim Romenesko

It’s fluctuating between seven and eight.

Larry Solow – CJS Securities

Okay. That’s all Southwest?

Tim Romenesko

Correct.

Larry Solow – CJS Securities

Okay.

Tim Romenesko

But that includes some wing at work and things like that that are – produce less revenue than solid – the maintenance line.

Larry Solow – CJS Securities

Okay.

Tim Romenesko

So, the hanger count is not necessarily indicative of the activity level.

Larry Solow – CJS Securities

Got you. Okay good. Thank you.

Operator

Thank you, sir. Our next question or comment is from Tyler Hojo of Sidoti and Company. Your line is open.

Tyler Hojo – Sidoti & Company

Good morning. Just quickly on the 33 aircraft that you guys owned, how does that break between JV and wholly-owned.

David Storch

26 JV, Tyler, and seven wholly-owned.

Tyler Hojo – Sidoti & Company

Okay great. And I was hoping that maybe you could comment a little bit just in regards to the work stoppage in the Miami Landing Gear facility. Maybe if you can quantify what the impact in the quarter was and how maybe that is going to impact any potential sequential uptick in business in the fourth quarter.

David Storch

Tyler, we think that the impact on revenue was between $3 million and $3.5 million. We expect to have that flow through relatively quickly. The rework that’s being done is in process. So I think we’ll be through the bulk of that in Q4 and in Q1. We think that the margin and the operating income impact is about $1 million from – that came out of the third quarter that will go into Q4 and Q1.

Tyler Hojo – Sidoti & Company

Okay. And I guess just based on some of your prepared comments there I mean is it safe to say that you really don’t have a whole lot of visibility and I guess just using Indy as an example with the seven to eight days just in regards to that capacity going up or staying stable or going down, I mean is still visibility just not very good in order to maybe comment further there?

Tim Romenesko

No, I think we have fairly decent visibility. I mean we feel very good about our relationship with the customer we have today. And obviously we’ve been working diligently of late to replace the business that disappears as a result of grounding. And we have some stuff that we are working on that we – we feel our capture rate – we have confidence in our ability to capture some of the stuff that we are looking at.

Tyler Hojo – Sidoti & Company

Okay.

Tim Romenesko

We would anticipate that Indianapolis a year from now will be in stronger position than it is today.

Tyler Hojo – Sidoti & Company

Alight. And the work with Southwest, the expectation was that going to go up in the fourth quarter. Is that correct?

Tim Romenesko

I don’t know that for sure. I think there is changes in Southwest re-planning as well. So I wouldn’t count on that.

Tyler Hojo – Sidoti & Company

Okay. Alright great. Thanks very much.

Operator

Thank you. Our next question or comment comes from Eric Hugel of Stephens Inc. Your line is open.

Eric Hugel – Stephens Inc.

Hey, good morning guys.

David Storch

Eric, good morning.

Eric Hugel – Stephens Inc.

Can you comment – I mean, I guess one of the key buzzwords that we’ve been hearing from a lot of your I guess fellow aftermarket peers has been even over and above sort of the weak traffic numbers we’ve been seeing, sort of trends of airline de-stocking. But those trends don’t seem to – they only last a couple of quarters. Can you talk to us about where you think we are in that cycle and sort of – it is maybe February and March improving, maybe a sign that we are close to the end of sort of these de-stocking?

David Storch

I think it’s hard to predict, Eric, only as it relates to – try and understand what’s happening to the fleets. I think if the fleet stabilize you are probably correct, but if the fleets continue to come down a little bit then you could have more of that effect going forward. But our sense is that if you track the business on a weekly basis, obviously, which we are doing, the business is showing some strength. So, there demand seems to be stabilizing if you will, possibly increasing slightly.

Eric Hugel – Stephens Inc.

Okay.

Tim Romenesko

We clearly had a low back in December and we’ve seen some pickup since then.

Eric Hugel – Stephens Inc.

Okay great. With regards to – I guess you recently, I guess maybe a couple of months back, there was a big award that you guys won, I guess it was make tactical shelters for the FMTV, but I guess was supposed to start up this in the third quarter and I guess ramp to maybe full by the fourth quarter. Is that sort of on track, is that how we should be thinking about it?

David Storch

It is on track. It is on track, Eric, and it is.

Eric Hugel – Stephens Inc.

Okay. Are there any other big sort of programs? You referred to a couple of them because I mean your defense numbers looked really strong.

David Storch

You know, the numbers are strong. The performance, particularly at the mobility systems business is strong. We’re continuing to add to the – win new business at least and we are doing a good job delivering against our backlog.

Eric Hugel – Stephens Inc.

Can you talk about the sustainability of that kind of growth of maybe high-single digit growth? Is that sustainable or is like maybe the revenue level is sustainable?

David Storch

No, I think there is going to be at least a modest uptick in revenue and the outlook continues to be good through our early fiscal 2011. So, we are encouraged.

Eric Hugel – Stephens Inc.

Can you comment on defense side also on the performance based logistics opportunities you are seeing out there?

David Storch

There is opportunities that we are working. Clearly, we are continuing to execute well on the programs that we have and we are looking to add to them.

Eric Hugel – Stephens Inc.

But nothing that we would – nothing material that you would prefer to think is in relative near term, just sort of just general environment?

David Storch

Right.

Eric Hugel – Stephens Inc.

Okay. Thanks a lot guys. I get back into the queue.

Operator

Thank you, sir. Our next question is from Jim Okshow [ph] of ABH [ph]. Sir, your line is open.

Jim Okshow – ABH

Good morning, gentlemen. I got a couple of questions relating to the aircraft leasing, both the planes you outright and the joint venture. First of all, do you have any leases that are expiring this year?

David Storch

We had a lease, as we indicated, that expires this quarter. The aircraft comes off lease in May. And the aircraft is attractively priced. It’s wholly owned by the Company and the aircraft will go into disassembly where we have demand for the parts for those – for that aircraft. We have – other than that, I don’t believe we have any other aircrafts that come due this fiscal year or this calendar–-

Tim Romenesko

Just the one. We do have some –later in the calendar year.

Jim Okshow – ABH

How many later in the year, in the calendar year?

Tim Romenesko

For the full fiscal year ’10, we have – it’s either six or seven repricing. They don’t start until Q2 and they are spread out to the balance of the year. So, I am just going to (inaudible) my head here, but it’s somewhere in the three to four range probably.

Jim Okshow – ABH

You just said repricing, what does that mean?

Tim Romenesko

Meaning leases coming to term.

Jim Okshow – ABH

Okay, okay. Could you give a breakdown of what kind of aircraft you have in the fleet, I mean how many – I don’t know if you want to go plane-by-plane, but how many are new generation and how many narrow bodies and how many wide bodies?

David Storch

We have three wide bodies. We have two 767-300s on lease long term with United. And we have one 747-400 on lease with Northwest-Delta. We then have two A320s on lease and we – I am sorry, we have three A320s on lease. And then we have – the balance of the fleet would be 737s 300s and 400s and one 737-500.

Jim Okshow – ABH

Okay. The – just final questions and put together. First of all, do you anticipate particularly with the 737s any need for any writedowns and in light of what you said about deemphasizing this business, are you planning to offer any of these planes – any of the planes in the fleet for sale?

David Storch

Well, we do have – a couple of the airplanes are offered for sale, but at this moment we think we have a good position in the aircraft. And we are deemphasizing because the capital markets are not extremely bullish in this kind of activity. So, we are not – we don’t see the same opportunities. There is a huge spread between what buyers want to pay and what sellers think the assets are worth and we see that continuing for a period of time.

Jim Okshow – ABH

Okay. So, when you say deemphasize, does that mean just that you are not going to be looking to add more planes or (inaudible) act at looking at get out of this business and sell what you have?

David Storch

Well, I think clearly on the front-end, where we haven’t added an aircraft into our portfolio since November’07, so I think that the facts speak for themselves in that regard in terms of adding. And in terms of selling we have sold – we have been a seller of these aircrafts since then. We continue to operate the leases and look for opportunities to sell the assets. So that would be the way I would characterize it.

Jim Okshow – ABH

Thank you very much.

David Storch

Yes.

Operator

Thank you. Our next question or comment comes from Tom Louis [ph] of (inaudible). Your line is open.

Tom Louis

Yes, good morning.

David Storch

Hi Tom.

Tom Louis

I was hoping for a little clarification on – you are clearly, you are enjoying a nice – some nice growth in your mobility business. Can you talk a little bit about the extent to which this might be due to capabilities you’ve added in the last few years as opposed to just the government’s need to protect its presence? Also, can you talk about the – what sort of visibility you might have against the day that this is not going to be a source of growth anymore and about your alternative uses for these capabilities or your ability to otherwise manage those assets at reduced volumes.

David Storch

Well, the first part of your question, Tom, is we’ve expanded our product line quite dramatically. We made the acquisition of Brown Engineering a couple of years back and – a year and a half back or so, and Brown Engineering gets us into the command and communications world and environment. We think that world continues to show opportunities going forward. We feel good about the breadth of the product line today versus where it was in the past. We have capability – we are now – have these mobile shelters that – going on the back of the trucks and things of that nature. We are getting a lot better at stuffing the shelters than we were in the past. So, yes, I think the product line is definitely broader than it was in the past.

And I think as it relates to moving forward, as I said in my opening comments, we feel very good about the balance to our portfolio that we have today and historically when the commercial airline business has been a little softer that business has been a little stronger and vice versa to some extent as well. So, I think that the story is around how we are fairing through this downturn versus how we faired through previous downturns, which you’ve been with us through. And I think that this – I think we are in a good position in that business. I don’t see world tensions diminishing in an appreciable fashion. They may move from theater to theater, but clearly the U.S.’ capability of moving into different theaters becomes more pressing and – one theater that’s developing, quite frankly, for the Company is the Southwest United States. And so there is I think broad range of applications for our product today as the product continues to broaden itself.

Tom Louis

So, maybe moving to Texas wasn’t such good idea. Okay. Now, with respect to the Aircraft Sales and Leasing, is there anything in this year your willingness to – or your decision to talking to deemphasizing, I mean you’ve got – clearly, where we are cyclically speaking and the state of the – present state of the capital markets, but if we think of this business compared to maybe the way we would have perceived it five of ten years ago, is there more to it than that or is it those two factors?

David Storch

I think it’s also resource allocation for AAR. We see greater opportunities else where. And we feel really good about our positions in the other three markets. And this market – we’ve always been just a dabbler in that market and I think it’s time for us at least to dabble a little bit less.

Tom Louis

Okay. And just one last question kind of under the vein of resource allocation. You had the opportunity during the quarter to buy back some of your converts. It was real obviously early in the quarter prior to the end of the last calendar year that there were a lot of motivated sellers among the holders of various convertible bonds out there. My sense is it’s a lot less so, but do you still see an opportunity to meet with a motivated potential – with motivated sellers on this part of managing your capital structure.

David Storch

Yes, Tom, from time to time we are getting phone calls from capital market folks who were representing people who have bonds that they would like to liquefy. So that has not – that has not diminished. And I can't really tell you what that’s going to look like 90 days from now, but as we sit here today they are still – those opportunities still do exist for the Company.

Tom Louis

Okay great. Thanks a lot guys.

David Storch

Yes.

Operator

Yes, thank you, sir. Our next question or comment is from Jon Braatz of Kansas City Capital. Your line is open.

Jon Braatz – Kansas City Capital

Good morning gentlemen.

David Storch

Good morning.

Jon Braatz – Kansas City Capital

When we look at the MRO facility in Indianapolis, did we see the full brunt of the slowdown in the loss of FedEx and United Airlines in the quarter or did that get progressively worse as the quarter progressed?

David Storch

No, you saw the full brunt within the quarter.

Jon Braatz – Kansas City Capital

Okay alright. And then secondly, during the year we saw there were a couple of FAA issues, Landing Gear and on the Boeing plant I think it was, is there anything you can do to I guess I don’t want to – and I don’t want to assign blame or anything like that – to be somewhat more proactive or work with the FAA more quickly so that these things don’t get out into the public view because that will cause a little bit of a investor anxiety? But is there anything that can be done in a private manner so that these things are resolved, let’s say, more quickly?

David Storch

Absolutely. We could have done a better job here. And we have a lesson learned, if you will, a tough lesson, a hard lesson. And shame on us to some extent. But, yes, definitely we are much more cognizant. It was an unfortunate wake up call in this context. But keep in mind now, safety of flight was never an issue, quality was never an issue, more about relationship management more than anything else. And, yes, we can do a better job in the relationship management. And I have – since this even, I have held meetings with the senior people from the flight safety and flight standards group within the FAA in Washington, D.C., and I will be meeting on a one-on-one basis with the head of the Miami (inaudible) on April 6. So, yes, clearly, we could have been – done a better job at the front end here.

Jon Braatz – Kansas City Capital

Okay, David, is it true, is my understanding correct that let’s say an FAA inspector in Oklahoma could have a different interpretation of the rules of an FAA inspector in Miami? Is it –?

David Storch

I don’t know. I won't necessarily characterize it that way, but I would say that the local SIFDOs [ph] are powerful in and of themselves and need to be reckoned with in their – in the – on the locale in which they are operating. But, yes, I mean in this case here we’ve been in the Miami operation now since late 80s. We’ve had relationship where we let the relationships – my interpretation is that we let the relationship get away from us. And we have to do a better job on the front-end in that relationship aspect.

Jon Braatz – Kansas City Capital

Okay. Alright. Thank you.

David Storch

Yes. But you should know also that the FAA holds the Company in very high regard, and that was conveyed to me when I was in D.C., and like I said – I just want to reiterate it, this was never a safety of flight issue, never a quality issue. And as you can tell, the parts have not been recalled or anything of that nature. So – okay.

Jon Braatz – Kansas City Capital

I understand. Thank you.

David Storch

Okay. Alright.

Operator

Thank you. Our next question or comment comes from JB Groh of DA Davidson. Your line is open.

JB Groh – DA Davidson & Co.

Good morning guys. Just a couple clarification questions on the margins. On the Structures the margin came down a little bit sequentially, is that just a mix issue or – what – remind me why it was so strong last quarter and dropped a little bit this quarter.

Tim Romenesko

I think if you looked historically, JB, you’d see that this quarter’s performance is sort of more in line with what you would you have – what would you’ve seen as trend line – we’ve been fractioning [ph] up the margin in this area, but somewhere in the 15% [ph] or just under is more in line with what you’ve seen historically. So, last quarter’s was a little bit of an aberration. And it was product mix or anything.

JB Groh – DA Davidson & Co.

Okay. And then on the Aircraft Sales and Leasing (inaudible) that looks kind of strange, is that due to the parting out of the aircraft or what makes that number look a little odd?

Tim Romenesko

Sorry, which number –?

JB Groh – DA Davidson & Co.

In the Aircraft Sales and Leasing –?

Tim Romenesko

Gross profit or –?

JB Groh – DA Davidson & Co.

Yes, gross – I mean it shows up, it’s like a 50% gross profit margin. I am just guessing that has something to do with parting out the aircraft or –?

Tim Romenesko

Yes, it’s really just – it’s just least revenue. That tends to be a very high margin area when you have very little revenue. So, in the past, if you look back, when we sell an aircraft from our own portfolio, you have more sales and then you sort to actually have a slightly lower margin. But the lease revenue on – which doesn’t show up as a – it tends to be a very high margin area, J. B., so I think it’s just a kind of a (inaudible) small number so–

JB Groh – DA Davidson & Co.

Okay. Okay. Okay. And then I don’t know, I am not sure if you gave a depreciation and amortization number for the quarter.

Rick Poulton

We gave some (inaudible) it’s $9.7 million for the quarter.

JB Groh – DA Davidson & Co.

Okay. Thanks a lot. That’s all I have.

Operator

Thank you, sir. Our next question or comment is from Henry Kennedy [ph] of Overhaul and Maintenance [ph]. Your line is open.

Henry Kennedy – Overhaul and Maintenance

Hi good morning. You mentioned before that your long term strategy includes growth, internal growth and acquisitions. Could you speak a little bit about what kind of acquisitions you might at least be interested in over the next year, where they might be or are you looking at anything in commercial overhaul or you are trying to sort of balance your portfolio away from commercial overhaul?

Henry Kennedy – Overhaul and Maintenance:

Tim Romenesko

Henry, the comment, you know – just to be clear – the comment upfront was that we had made acquisitions and investments and targeted some of our organic growth in a (inaudible) enterprise. So, going backwards, there was an effort to get more defense exposure, little more front-end content exposure and that’s where we had been emphasizing. As we look ahead, we continue to see organic investment opportunities as well as acquisition opportunities, are all ways of – for us of using some of the cash we generate. I don’t know that we have a specific priority right now, but we are interested in serving both major customer segments and we are interested in continuing to serve them both with front-end content as well as aftermarket services. So, I think all of the above are in solutions for us.

Henry Kennedy – Overhaul and Maintenance

Okay. Thank you.

Operator

Thank you. Our next question or comment is from Rick [ph] of Columbia Management. Your line is open.

Rick – Columbia Management

Yes, just a follow-up on the Landing Gear shutdown. Has there – can you characterize the customer response once you were back up running, I guess, only five days later, has there been any kind of backlash or negative response.

Tim Romenesko

No. I would say there was concern obviously around the disruption as we were going through it, but we tried to keep the customers as current as we could in terms of what was happening. Since it’s been resolved, we’ve been visited by all of our customers, basically. And I would say that there is no backlash, if you will, in terms of gear coming into the facility for repair.

Rick – Columbia Management

So, you don’t expect to lose any material business from that event?

Tim Romenesko

That’s right. And we are working hard to make sure that that doesn’t happen.

Rick – Columbia Management

Okay. Thank you very much.

Operator

Thank you. And our next question or comment is from Larry Solow of CJS Securities. Your line is open.

Larry Solow – CJS Securities

Just a follow-up to Rick’s comments and I believe someone else asked about Southwest, if I am not mistaken, did Southwest recently actually expand their relationship on – with your Landing Gear Services?

Tim Romenesko

We do Landing Gear for Southwest, yes?

Larry Solow – CJS Securities

Well, didn’t they – I think I read in one of the aviation magazines, they actually increased their exposure I mean or their – I guess their planned volume in you facility, is that incorrect or –?

Tim Romenesko

No, I am sure that that’s correct.

Larry Solow – CJS Securities

Okay. Just one question on SG&A. It seems like if you strip out the severance and (inaudible) that’s flat on a year-over-year basis, is that a kind of a good way to look at it going forward or –?

Rick Poulton

In absolute dollars, Larry, that’s – you are correct in your assessment and – yes, I mean we are very focused on managing SG&A, very focused given the environment.

Larry Solow – CJS Securities

Okay. And then just last question. Any color – how about the other – the MRO facilities at Oklahoma doing and (inaudible)?

David Storch

They are both busy.

Larry Solow – CJS Securities

Okay. That’s good. Okay good. Thanks.

Operator

Thank you. Our next question or comment is from Stan Mann [ph] of Mann Family Investment [ph]. Your line is open.

Stan Mann – Mann Family Investment

Good morning gentlemen. I have a question on, one, on use of cash. You did comment that you – possibly on acquisitions, et cetera. In this current market with financing not available, would you say the use of cash would be more for buying and converts and maybe paying down debt, et cetera? So, could you comment on your – the way you view use of cash in this environment?

David Storch

Stan, first of all, hello.

Stan Mann – Mann Family Investment

Hello.

David Storch

Been a while. Okay, good morning. You know, I think it’s around balance. It’s clearly looking for – our first use of cash is – it’s all around yield and return on capital, so wherever we feel we can get the best return for our capital. Right now, if you look at the (inaudible) we felt very good about putting some capital to work, taking advantage of some buying opportunities. And we put some capital to work on investment in longer lived assets. We, for instance, acquired a ship set, a 777 landing gear for approximately $8 million from Delta Airlines and secured a multi-year contract from them as a result of putting that capital to work.

We also acquired some bonds that we felt were attractively priced. As you can see, we have a 9% yield. Our cost of incremental capital is – or incremental dollars is – it’s a real positive arbitrage for us, let me put it that way. So, yes, I think it’s a balance. You know, we are constantly looking for ways to maximize the dollars that we put to work.

Stan Mann – Mann Family Investment

Well, what I was getting at it it’s less likely that we’ll see a large acquisition as we had seen in the past couple of years in the current environment that’s all I was asking.

David Storch

Yes, I would say that if we were to do an acquisition, it would be obviously accretive, first of all. Secondly, I think we’d be looking for a way to finance it that would be appropriate. But at this moment, we have a couple of minor situations that we are looking at in the overall scheme of things and, yes, so I think the opportunity would have to be a good opportunity that made sense for our portfolio.

Stan Mann – Mann Family Investment

Okay. Second question on operating margin, it slipped, obviously. So, if you put back some of the non-recurring severance, et cetera, do you still see your near term goals above 10% operating margin?

David Storch

Yes.

Stan Mann – Mann Family Investment

Seems like we reached pretty close in this quarter to back things then–

David Storch

Yes, yes correct.

Stan Mann – Mann Family Investment

So, you–

David Storch

And it’s hard, but yes that –

Stan Mann – Mann Family Investment

Yes.

David Storch

Keep in mind, also, a piece of the strategy to get the margins from 10% to 12.5% for instance is around the Aircraft Sales and Leasing portfolio. So, we are going to be diminishing that. And that will add a – create a little bit more pressure on bringing the margins up in the short term.

Stan Mann – Mann Family Investment

In the short term. Well you still have moved up operating profit dollars tremendously in the last three, four years. So –

David Storch

That’s –

Stan Mann – Mann Family Investment

It’s a really different ball game.

David Storch

Yes, that’s correct.

Stan Mann – Mann Family Investment

Anyway, I think it’s a good job in this environment. Thank you.

David Storch

Thank you very much.

Operator

Thank you. Our next question or comment is from Eric Hugel of Stephens Inc. Your line is open.

Eric Hugel – Stephens Inc.

Hey guys, just a couple of follow-ups. The MRO segment, I guess, 2.9% growth year-over-year, but you had the Avborne acquisition in there. What was the organic growth or what was Avborne round about?

Rick Poulton

Avborne – we’ve talked in the past about the size of Avborne, and so just to reiterate that, that’s somewhere between $10 million and $15 million per quarter, okay? So, I won't get anymore specific than that but you can kind of play around with the numbers based on that information.

Eric Hugel – Stephens Inc.

Alright. So the organic growth in that business was something like maybe 10% to 13%, 10% to 15% or something like that and that would have been impacted by the MRO (inaudible) by the landing gear [ph]. Okay.

Second, can you talk about the Aviation Supply Chain, one of the impacts – and I just trying to sort of work my brain through – I mean you talked about the FX impact. Is that FX impact more sort of just visual in terms of your having lower sales, but higher operating income or is there no net impact or are there real sort of EPS impacts there?

Rick Poulton

The EPS impact would be much more modest, so that’s why we are not really talking about it in EPS level. We have a pretty good natural hedge to the operation. But on the top line you see the impact.

Eric Hugel – Stephens Inc.

Can you talk about how much the top line impact was with regards to FX?

Rick Poulton

It was in the neighborhood of a couple of million dollars, Eric.

Eric Hugel – Stephens Inc.

Okay. What was CapEx in the quarter?

Rick Poulton

Just under $7 million – $6.8 million.

Eric Hugel – Stephens Inc.

Can you give us an update on how things are going with regards to the ramp up on the new composites expansion as well as how things are going with Summa, I know there are some headwinds there with regards to Gulfstream.

Tim Romenesko

On composites, the Sacramento facility is up and running. The – looking for – looking some more work, but nonetheless operating. In terms of Summa, the volumes continue to be strong there. We are looking – I am actually going to be visiting there this afternoon. We are encouraged by some of the prospects we have down there. We do have some work to do on some particular programs. But we’ll work on those, we’ll work through them.

So, I think on balance, I think we feel good about what’s going on down at Summa.

Eric Hugel – Stephens Inc.

Okay. Can you give us – maybe a round a ballpark figure as to sort of this new composites facility? I mean is it sort of delivering meaningful additional contribution or is this still just pretty small right now.

Tim Romenesko

No, it’s still small, but it’s – it positions us very nicely as the – as demand for composite materials increases. So, it’s a great facility with tremendous capability that puts us in a nice place in a market that we see as really taking off here in the next three to five years.

Eric Hugel – Stephens Inc.

And your goal is still over that time period what you said $80 million to $90 million of sales?

David Storch

Well, we are looking at for the –the composite business in total is $100 million for the two businesses.

Eric Hugel – Stephens Inc.

Okay.

David Storch

We are doing today roughly what $35 million – approximately $35 million today, we are looking to get to $100 million in five years. That’s in our plan. Now, we have two – if you look at the operation now in Sacramento, we have two very large defense oriented contracts that are being worked at this – at this time. And too hard to handicap whether we’ll be successful or not, but if we are, we’ll get to that target quicker, sooner rather than later.

Eric Hugel – Stephens Inc.

Great. That’s perfect. Thanks a lot guys.

Operator

Thank you, ladies and gentlemen. Our next question is from Tyler Hojo of Sidoti and Company. Your line is open.

Tyler Hojo – Sidoti & Company

You guys just answered my follow-up question. Thanks.

Operator

Thank you, sir. Our next follow-up is from JB Groh of DA Davidson. Your line is open.

JB Groh – DA Davidson & Co.

Yes, one more question. Just on inventory, is there a way to look at that in terms of ageing and quality in light of all these retirements that we are seeing, is there a way you can sort of give us a framework to think about that?

Rick Poulton

Yes, I mean J.B., we monitor that closely by looking at turns data and we also do look at ageing data for our inventory. And our – we haven’t seen any fall back in our major metrics there. And so in particular ageing more than about 85% of the inventory balance has been acquired within the – is less than 18 months. And so we feel pretty good about our carrying values in that product.

JB Groh – DA Davidson & Co.

Okay. So, that’s 85% less than – okay, that’s good. Thank you.

Operator

Thank you. And I show no further questions or comments at this time, sir.

David Storch

Well, thank you very much for your participation today. Have a nice day. Thanks.

Operator

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

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Source: AAR CORP. F3Q09 (Qtr End 02/28/09) Earnings Call Transcript
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