AAR Corp. (AIR) Q2 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the AAR CORP. 2014 Fiscal Second Quarter Earnings Call. [Operator Instructions] And 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 statements 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 to AAR CORP. Chairman and Chief Executive Officer, David Storch.

Hey, thanks, Chris. And 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'd do today is kick this session off by providing a half year or a 6-month overview of our company 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 starting with Aviation Services, we have the 3 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 2 kind of regards, one of which would be airline programs. And you can see we recently announced a new win of a program supporting airline with their expandable 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're very hopeful as we perform for EATON, this will expand the opportunities between our 2 companies. So looking at the supply chain businesses, a 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's the -- it's a core competency to the company, and it's 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 that 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'd like to do is build out, and we've talked about this before, geographic expansion. And 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're 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. You may recall a couple of years ago, we've made the acquisition of Airinmar. It gave us a little specialty -- or specialization around sourcing repair capability. We're looking at other things that, in a similar fashion, make the supply chain solution a more compelling and integrated solution. And hopefully, we'll have something to talk about here in the near future. Moving over to our MRO businesses. We've had solid performance. As you know, we're principally a North American service provider. We have recently added 2 facilities to our mix, Duluth a year ago, and I'm proud to say that we're now up to 3 lines in that facility. And as you know, back in September, we took over some space in Lake Charles, Louisiana. We have returned our first aircraft to service for a customer there, and we're very proud of the speed in which we're able to do that, and we should be returning a second aircraft in January. And we are out in the market looking for additional wide-body maintenance customers, and my sense is that we'll have some success along this regard. And as a result, we'll 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've kind of struck out in this regard, but we continue to see opportunities and we continue to be apt 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're looking for ways to continue to build that piece of our MRO. It's 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 had 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. And 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. Now obvious -- or I should say, a very large percent of that business, as we discussed in the past, is around business in Afghanistan. And we've seen a certain amount of uncertainty in the Afghanistan kind of transition, if you will, with the services agreement being delayed by Karzai, 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 received task orders, so we've not been able to translate the contracts into business. And we're a little bit -- we're anticipating that it's going to take a little longer than we had hoped. So if you look at the entire Airbus -- airlift business, just to give you a sense of proportionality. We have 40 positions that we operate in around the world. And 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, and then 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. The 3 -- there are 3 aircraft types that we will be exiting. And in those instances, the profit contribution of those 1 -- 2 fixed-wing and 1 rotary wing have been relatively negligible. So by definition, so the fixed-wing assets have been CASA 235 in the metros and the rotary wing has been the Bell 214. So those will be -- we'll be looking to do something different with those assets. But again, as they come out of the fleet, they'll simplify our fleet, but they'll also -- the profit contribution from these assets has been relatively negligible. Longer term for this business, strategically, we're bidding on a few very large contracts, one of which is larger in size than the businesses in terms of annual revenues. We -- it's 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, and it's coming home to -- it's coming into the near-term possibility range. We also are looking at other opportunities within Africa market, and 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 have 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. And 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'll 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 systems business is, we believe, in a very good position. They did have a little softness in Q2, but we believe that's more situational than directional. And as you've seen, we've recently acquired the A320 product line from PFW, which is now 51% owned by EADS. 25% of all of A320s delivered from Airbus have cargo systems. The balance is to have lower holds that basically cargo is put in, in a minor way. So the -- 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 3 systems in Q2, and we anticipate delivering systems now for the next 10 to 15 years. And hopefully, what we're planning on there is that we'll 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 got -- we knew that that business would be declining. We indicated that we, by Q2, it would be, on a comparative basis, relatively equal, and that's where it's at. It's performing at a steady state. It's performing well, still has leadership position in its market. And we will be looking for ways to deepen and broaden the product lines around mobility since we have a leadership position there. Clearly, we'd 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 underperform. 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 of 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're expecting to be able to produce positive results by Q1 of next fiscal year, but still a drag on earnings and underperforming our own internal expectations. So now, it's kind of 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'd 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 kind of 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 be organic. Our airframe 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 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 built over 5.1 million man-hours. During our first quarter, we experienced seasonal softness, as you may recall, in our commercial supply chain. And 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 and on December 11, we announced the signing of a 5-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 U.S. airline. The airline has to be unnamed, so you'll 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 distribution products to the -- or fluid products to the Defense Logistics Agency. And 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. And we're hopeful that as we show them our performance that they'll be inclined to move us into some of their commercial lines as well. As I indicated, airlift continued to deliver strong results as we maintained high-operational readiness levels. As we enter the second half of our fiscal year, also as I indicated, there are some moving parts. First, on October, we were awarded a 1- 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 4 helicopters, bearing critical supply to U.S. Navy ships. Also, subsequent to the end of the quarter, we announced additional contracts. On December 2, we entered into a contract for 2 aircraft valued at $23 million and up to 22 months in duration with U.S. AfriCom throughout 4 Central African states. The incumbent operator has filed a protest for this contract. We do, however, believe that the agency made a 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 $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're kind of trying to figure out how to proceed. They will be proceeding, and we expect some 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 led here in the near future. We've been notified by our customer that the 10 out of 12 rotary-wing positions for the contract that expired on November 30 have been extended. 6 contract positions were extended through January 31; 1 position was extended through February 28 and March 31, respectively; and 2 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 led, and that the Afghan National Security Force RFP is for 18 positions. We don't know if we can fill all 18. But clearly, we'll 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 descoped and will be available for future mission deployment. And we expect to have 9 aircraft positions added for a total of 29 aircraft positions by the end of 2014, assuming there's no changes in requirements. We are hopeful that there will be additional requirements. And then 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 a 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 the bolt-on acquisition of the cargo assets of PFW, which will fit very nicely into our Telair operations. And again, as I indicated earlier, this acquisition rounds out our capability in support of the A320 family of aircraft. And 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. And we anticipate revenues of $200 million to $250 million in total over the 5-year term, and with a 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 Mike 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 the prior year level of $512.8 million. Aviation Services revenue at $424.7 million was up 8.7% in comparison to the year -- the prior year. As David mentioned, all of the businesses in this segment performed well. Technology Products revenue were -- 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 included the sale or include the delivery of 2 aircraft to the U.S. 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 declined 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 with the prior year. Similarly, the first quarter in 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're 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 delever 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 and Nordisk. Depreciation and amortization, including amortization of 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're now ready to take questions.

[Operator Instructions] Our first question is from Julie Yates Stewart of Credit Suisse. Julie Yates - Crédit Suisse AG, Research Division: On the supply chain, last quarter, you talked about the customer deferrals of having maintenance on engines. It sounded like, from your comments, that this has improved some. Can you just give us an update on what you're seeing in the business?

We had strength in the quarter, and we have made some investments in inventory for anticipated strength continuing into Q3 and Q4. So the business clearly had a dip in Q1, but it is not exactly where we wanted 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'll have some strength in Qs 3 and 4. Julie Yates - Crédit Suisse AG, Research Division: 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're starting to compete with the likes of Wesco and B/E here?

Julie, 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. So it's an extension of what we've been doing, but -- and it's similar to what some of the others are doing. But it's an area that -- where we're leveraging our systems, we're leveraging our relationships and we're leveraging our core capabilities. Julie Yates - Crédit Suisse AG, Research Division: Okay. And then just lastly on the guidance. If you guys can help us understand the positives and the negatives, with the positives being the new acquisition, the distribution contracts and the negative being airlift and perhaps a little bit of weakness in the cargo side, just maybe helping us size those different pieces.

Yes. So Julie, it's John. Yes, I mean, look, as we've thought about it, this has obviously been -- there's been a lot of planning and analysis going on and particularly as we've gotten sort of more visibility around what airlift is going to do, right? It has been a particularly strong first half of the year. I think from our perspective, you can kind of look at the aircraft positions and make a rough guesstimate as to how we think the business will impact in the back half of the year. It will get offset by positive contributions, particularly, I think, in the fourth quarter in the supply chain parts of our business, and also offset by some improvement in our Technology Products, specifically our commercial Cargo Loading Systems business. So positive supply chain, positive cargo loading services offsetting and mitigating some of the downward pressure that you're seeing from airlift.

Next question is from Larry Solow of CJS Securities.

David, can you just clarify that the 40 positions, if that was a fiscal year-end '12 or calendar year-end '12? I know you're saying 30 at calendar year end now, basically, and then back to -- or 20 now and then back to 29 at the end of calendar '14, is that what you're saying, or are these fiscal years?

Yes, so fiscal -- starting the fiscal year, we had 40 positions. We lost a few positions between end of the fiscal year and now. And then we're -- and so expecting for -- from fiscal year start to end where we had start with 40, of those 40, 20 are going to go away is our best estimate...

Right, by fiscal year end of the...

And then we believe between now and fiscal year end, we will come -- we will win 9 new positions.

Got it. So basically, from now, you already -- you basically, had you lost a few positions already or are you really...

Yes.

Right, okay.

Yes, we had lost some positions in Q2.

Okay. And the position, the 9 you expect to add, is that mostly -- is that assuming that some deal gets some of these task orders? Is that...

Yes, yes. And we're expect -- yes, so we're hoping that -- we're expecting the protest -- we believe the protest is frivolous. And we believe that will be over -- that will be ruled in our favor. So those would be 2 that would go back -- going to Africa. We believe that we're probably going to win -- we're in the vicinity of 4 to 5 task orders in Afghanistan. And then we believe there's another 2 rotary wings that we'll win in Africa.

Okay. Okay, so that will the increment -- additional 2 incremental that you haven't announced yet for Africa?

You're correct.

And the 4 to 5 task orders, you say you think you'd get, that's of the potential 18 that you could get, not today, but in theory?

Yes, that's correct.

Okay, okay. Just a couple of other questions, the 5-year contract you just announced, the $40 million to $45 million, is that a potential number, is that a number you have to ramp towards? How should we look at that?

That's our expectation of the first year performance. We do think that there's opportunities to build on that. Larry, just to maybe follow up a little bit on Julie's question too, I mean, we provide this kind of support for our own internal shops. It's just that we haven't had large programs like this with external customers. So it's something that we know very well, and 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, is that -- can you put any numbers to that? I mean, is that somewhat small -- I imagine in like the Unison deal, but how does that compare? Is it much smaller? Is it -- can you put any quantification on that?

It's, in the zip code, slightly smaller. But we prefer -- I think at their request, we prefer not to put the numbers to that.

So that would be -- it's actually a decent size. And does that one take longer to ramp? Because I know Unison took a while, and I don't know...

Yes, you'll see that will take a little longer. Unison, of course, had a much broader range of customers; this has a narrower range. So I think it probably shouldn't take quite as long, but there will be a ramp period there.

And is Unison now up to like this $60 million that it was, I think -- when it was signed, that it's supposed to be. Is that ballpark to where it is now?

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

Okay. And then just a couple of other quickies. Duluth, I guess, you're up to your third line. Is there -- is that -- do you see that going to 4 anytime soon? Or is that -- is 3 sort of a number you expect for the near term?

The goal is to get to 4, and I think let's get through 3. It's a manning challenge. And at this time of year, people aren't dying to fly up to Duluth to work.

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

Yes, right. Right.

And how about the other facility, in the Miami -- they're all running -- it sounds like they're 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, but typical, nothing unusual.

And mobility, was that actually -- was that flat year-over-year or was it -- I thought it was supposed to be down a little more this quarter and then sort of flatten out -- it's pretty flat.

I think relatively flat, slightly, slightly down, but not in a meaningful way.

And you see it sort of being flat at least in the near term, is that fair to say?

Yes, right.

[Operator Instructions] The next question is from Tyler Hojo of Sidoti & Company. Tyler Hojo - Sidoti & Company, LLC: Just 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. And just when I go through kind of the prepared commentary, obviously, MRO is up, supply chain is up. Just kind of wondering what the offset is. Is that -- is the offset on the precision business? Just a little help there.

Yes, I think, that's fair, all right? It's softness around precision and also in our cargo loading systems businesses, right? So it's Technology Products that kind of drove it. But your correct, it's kind of flat to down like 1%. Tyler Hojo - Sidoti & Company, LLC: Okay. And could you maybe talk a little bit about what -- what's going to be the catalyst to turn precision around? I think, David, you said Q1, you were expecting kind of a shift in that business.

Yes, and we have had improvement. So the Q2 is better than Q1. It's still low, operating in the red, I guess, was my point. And we've got -- so the team operating the business now, we shifted the management in early summer. And the business now reports to our mobility GM and who reports to Dany Kleiman who you may have met, Tyler. And Dany, before he left Israel Aircraft (sic) [Aerospace] Industries, was running their MRO business, the deck 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 he has -- they put some discipline in place, which will -- which has already yielded improvements. We now have to win customer confidence back. And we've -- we did some -- I made a comment about bonehead decision, what -- one of the prior manager have made some pricing decisions that, quite frankly, pissed off some of the customers. So we're now trying to recover some of those customer relations, and I think the key to recovering customer relations is doing a fabulous job on operational stuff. And 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 good -- make them feel better about what we're doing and then probably give some price concessions so that we regain their trust. Tyler Hojo - Sidoti & Company, LLC: Okay. But longer term, David, are we still thinking that precision could be additive to kind of the long-term margin goals that you [indiscernible] ?

Absolutely, and it should be. And it's really -- I mean, I've got to watch my language because I'm not happy about it, but we really have, to put it mildly, stubbed our toe. I mean 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's going on in the build cycle in this business, and we're not. So we've got to fix it. We know we have to do 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're talking, it will be contributing to the profitability and hopefully additive to margins. Tyler Hojo - Sidoti & Company, LLC: Okay, wonderful. And just maybe on another topic. When you talk about the, I guess, it's 11 airlift assets that are going to be unutilized at the end of this fiscal year, just curious what kind of the current thinking is surrounding them. I mean, would you prefer to sell them or place them somewhere else?

Well, there's probably 7 assets that we would probably look to sell. And because one of the things that we'd like to do is simplify the fleet. So at one point in time, we're operating 9 aircraft type. And if we sell these 3 aircraft type, we've already gotten rid of 1 aircraft type, we'd be down to 5 -- 2 fixed-wing type, the Havlin-8s [ph] and CASA 212s, and then we'd be down to 3 rotary wings, which would be the S-92s, the S-61s and the Puma. So that would be ideal state for us. So -- but let's see with that -- we have one of the aircraft that we have out, the CASA 235s, we actually have some requirements for, so we're kind of arm wrestling as to whether we want to -- what we want to do exactly with those requirements. Tyler Hojo - Sidoti & Company, LLC: Okay, that's interesting. And maybe just one follow-on to that. Kind of one of the discussions, at least I've been having, is just what some of the underlying value is with some of the airlift assets that's on your books, do you have any idea what the market value is of the 7 birds that you're looking to sell?

Yes, the book value is $30 million. And we think the market value is pretty close to that level. And hey, Tyler, if you're 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.

The next question is from Kevin Ciabattoni of KeyBanc Capital Markets.

Looking at the recent distribution of supply chain wins, Eaton and the unnamed airline customer, can you give us an idea of what -- are there meaningful startup costs involved in those in terms of infrastructure, inventory, what have you, that may be kind of dilutive to margins early on?

There aren't really any significant startup costs. We will be putting a team in place. We're going to be warehousing this out of one of our existing facilities. We're going to take on some additional space in that facility. We'll 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'll be working capital investment. But no costs or startup 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 is still -- that contract is still included in the outlook for the year, despite the fact you understate orders, is that correct?

Yes, it's part of the reason for kind of 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 have had the benefit of those assets operating in Q3. We're now a little bit -- we're taking a more cautious view and thinking it's going to take a little longer. Of course, we still 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're looking at kind of outside of the existing business. I was just wondering, I mean, can you give us any color whether that -- what kind of end market, I mean, are we looking at military, government, commercial? Can you give us any color on where that would be?

Yes, let's call it government.

Okay, fair enough. And then last one from me. It's kind of a longer-term question, but we saw 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, it depends on what you're talking about, right, in terms of longer term. I mean, at some point in time, obviously, today, in Duluth, we're 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's fleet.

Yes, 2017 would be the earliest that they're looking at at this point.

Yes, yes. Yes, so I think as they phase in, I don't know how many a year of the -- whether they ordered 69 or...

In the ballpark, about [indiscernible] that number.

Yes. So I think there were 80 A320s currently in the fleet, if I remember correctly. So I would imagine that over time, they'll be transitioning A320s out and probably transitioning 737s in.

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

Absolutely. I have to check the stats to know if we can handle 3 or 4. But we would definitely be able to handle at least 3.

Next question is from J. B. Groh of D.A. Davidson. J. B. Groh - D.A. Davidson & Co., Research Division: You mentioned the working capital investment, is there any way to -- on some of these new contracts, is there a way to quantify that? Or how should we think about it in terms of kind of days of inventory versus that $40 million to $45 million?

Yes. I think we should see inventory turns in that program of 3x to 4x. Maybe not right at the start, but I think it should have decent turns. J. B. Groh - D.A. Davidson & Co., Research Division: Okay. And this is -- Okay, so a little bit of it. Okay, not a huge -- very slow event. And then what's the pace on the A400M now? You said 3 for the quarter. Is that kind of what the expectation is over the next several quarters?

It moves around. Some are a little more than that. But yes, it's starting to get into a pretty, pretty good ramp here. So yes, it goes up from here. J. B. Groh - D.A. Davidson & Co., Research Division: And that all shows up in technology?

Correct.

Let me, if I may, you made a comment about the terms and investments in those -- for those programs. Let me also add one more thing and that we mentioned it in the question that Julie asked about the -- some of our businesses in the spare parts arena. We did, in this quarter, generate meaningful cash -- positive cash flow, and in 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 augur well for Q3 and Q4 in that business, so the cash flow taken into consideration investments in inventory to support the growth of the business. J. B. Groh - D.A. Davidson & Co., Research Division: That's almost -- I mean, I guess, I always kind of look at those as kind of like an acquisition almost, right? I mean...

Absolutely. J. B. Groh - D.A. Davidson & Co., Research Division: And then so maybe you could, hopping back in here, sort of prioritize cash flow deployment. It sounds like you're working on potential -- some other potential transactions, but what else?

Yes, clearly, as you know, I mean, we're -- our supply -- we are supporting and growing our supply chain, looking to support and grow our supply chain businesses. So there will be capital applied to those businesses. And I signaled in my strategic overview some additional things that we're looking to do to build out our capabilities. So we're feeling pretty good about where we stand right now in terms of opportunities for capital deployment. And it helps that we generate the kind of cash that we have over the last 1 to 1.5 years.

Next question is from Jon Braatz of Kansas City Capital.

Most of my questions were answered. I was going to ask about the A400. But in your text, you talked about the sales of 2 aircraft to the U.S. Marshals Service. How much was that, and was there any profit associated with it?

It was a fairly thin-margin transaction. I think we're -- we may have announced, or I don't recall precisely if we announced the sales, and we may be prohibited from doing that. But it was a relatively thin-margin transaction. One of the things that we're trying to secure there, keep in mind that their headquarter, their air operation is at the Oklahoma City Airport where we have our maintenance operation. We are goal/ambition to do the maintenance support for that fleet of aircraft.

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

6.

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

Yes, I'd like to get them done by the end of the quarter, if we could, but I don't think it's going to happen. I think, realistically, I think that we have 2 767s on lease with United. Those come down nicely, I'm not sure yet. I think those expire in '16 or '17 -- '15, '16, so I'm not sure if we've we 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 their plan is. And then we have 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 this fleet will move out of our portfolio in the next 3 to 4 years.

The next question is from Stan Manning [ph] of Manning Family Investors [ph].

Several questions. One, can you talk to the thoughts on the American-US Air merger and its possible effects on your business?

First of all, I think it's good for the industry. I think it has a potential of being positive for us. The US Air management team is integrating, I think, well with the American management team. And I would expect that as the time goes on, they'll 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 US Air. We do less business in support of American. But we would be optimistic that we'd be able to convince them that we offer competitive solutions for them.

Are your current maintenance locations conducive to helping them?

Well, they have a heavy -- 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 wide-body 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's not totally inconvenient. It's not perfect because it's probably not on their route network, but it's probably not totally inconvenient. So yes, our facilities, I think, are in a good physical location for their business.

Okay. Last question, as you've mentioned a large acquisition outside the U.S, can you speak to how you would do that deal relative to your current balance sheet and cash flow?

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

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

It's 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 didn't 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.

Our next question is from Donovan Chaney of 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 of about equal to or a little bit greater than net income. Does that -- how does your working capital investment for that new supply chain win or maybe the lower airlift business kind of shrink that? Is that something to think about?

Yes, I think 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've made, has been what you've indicated. We -- the second half of the year might be a little bit harder to achieve it. So that will be cash flow from operations. We're still expecting that number to be -- continue to do well, but we might be a little challenged on free cash flow.

Our next question is from Julie Yates Stewart of Credit Suisse. Julie Yates - Crédit Suisse AG, Research Division: Just 2 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 the positive cycle dynamics and the consolidation we've already seen.

So Julie, the answer is yes, we would, but we have to get into the black first. Because if you do it -- if you multiply by a loss, there's no real multiple. So we got to get our act together in the business and we've got the right team on it. And we will get it fixed. Julie Yates - Crédit Suisse AG, Research Division: Okay. And then second, did you guys look at the airborne systems business that Trans Am acquired?

Yes. Julie Yates - Crédit Suisse AG, Research Division: Okay. Did you get outbid or is it something that you just...

No, first of all, I won't comment on it, but we did look at it.

There are no further questions in the queue. I'd 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, and 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.