Well, here we go again: AAR Corp. reported earnings after the market closed on March 18th, 2008, and needless to say, my investment thesis is playing out just as expected with AAR reporting another quarter of record revenue and earnings, while beating analysts estimates on both the top and bottom line.

I’ll give a more detailed breakdown of AAR Corp.’s earnings, margins, etc., but I wanted to provide some quick numbers, and conference call and earnings highlights, as well as talk about their latest acquisition.

First The Numbers

Across the Board Improvement in All Areas

(Growth from previous year’s 3Q/analysts estimates where applicable):

• Record quarterly sales of $376.6 million (up 39% from prior year (25% organic)/vs. $337.50 million projected by analysts)
• Record quarterly income from continuing operations of $20.1 million (up 32% from prior year)
• Gross margin improves to 18.7% (up from 17.4% from prior year)
• Operating margin improves to 10.1% (up from 9.4% prior year)
• $0.47 earnings per share (up 27% from prior year/ vs. $.46 projected by analysts)
• Generated $22 million of cash flow from operations
• Double-digit sales growth in all four segments
• In February, 2008, the Company raised $250 million in capital through a private placement of convertible notes.

AAR Increases Their MRO Reach

New Acquisition Increases AAR’s Capabilities

After the close of the 3rd quarter, AAR completed their acquisition of Avborne Heavy Maintenance, Inc for $40 million including the assumption of $25 million in debt.

This marks another in a long line of intelligent and accretive acquisitions for AAR which allows them to further expand their Maintenance Repair and Overhaul (MRO) capabilities at a time when more and more airlines are outsourcing this part of their business to save costs in the face of rising fuel prices.

According to ChicagoBusiness.com, CEO David Storch said AAR has been keeping an eye on Avborne, waiting for the right opportunity.

“We looked at it a few years back, and at that time we passed,” he told Crain’s. “The time was right.” Mr. Storch said Avborne’s performance improved, and the price “got better.”

This deal will give AAR a fourth major airframe overhaul facility, add new customers to its roster and expand the breadth of its capabilities.

The acquisition adds 226,000 square feet of modern hangar space at Miami International Airport and 467 aviation maintenance technicians (AMTs), increasing AAR’s hangar space by 22% and bringing the total number of AMTs at AAR to more than 2,000 worldwide.

If you’ve been following the company recently, you know that finding good AMT’s is hard to do, and they are having trouble keeping up with the demand in their industry because of the lack of qualified workers.

Avborne’s facility opened in 2000 and is large enough to accommodate three widebody or nine narrowbody aircraft at one time.

“It’s our first facility with real widebody capability, and it’s our first facility with real Airbus capability,” said Tim Romenesko, president and chief operating officer of AAR. “Those are two important strategic differences from our other airframe MRO centers,” he said.

AAR currently operates a 300,000-square-foot facility in Oklahoma City, where it overhauls 727s, 737s, DC-9s, MD-80/90s and regional aircraft; the former Reebaire Aircraft, Inc., in Hot Springs, Ark., which specializes in regional aircraft; and a huge, 1.6 million-square-foot, 12-bay facility in Indianapolis that was built and then abandoned by United Airlines. AAR now overhauls United 737s at the facility.

Moving up the ladder: Last year, Aviation Week’s Overhaul & Maintenance ranked AAR as the world’s ninth largest third-party airframe MRO provider with 1.98 million man-hours of work performed in 2006.

Romenesko, the COO, said Avborne does 70,000 to 90,000 man-hours of work a month, which could add nearly 1.1 million man-hours to AAR’s total, making it the seventh largest in the world, based on O&M’s 2007 survey. He also said AAR sees an opportunity to get more utilization out of the Avborne facility through the implementation of lean initiatives that it has been rolling out at its other facilities. Avborne’s customers include US Airways, Airtran, Continental and ABX Air, according to Romenesko.

“One of the things that we see is that having an [airframe] MRO relationship with a customer opens the door to other areas within AAR, such as landing gear repair, component repair and logistics,” he said.

AAR plans to retain Avborne’s current management, Romenesko said.

AAR’s 4 Business Segments Continue To Shine

Double Digit Growth For All Segments

• Aviation Supply Chain — Sales grew 11.5% to $151.2 million for the quarter. Gross profit increased 22% to $36.3 million, resulting in a gross profit margin of 24.0%. Growth in this segment was fueled by steady demand and throughput from investments made in recent quarters.
• Maintenance, Repair and Overhaul (MRO) — Sales increased 43% to $74.8 million in the third quarter. Gross profit increased 53% to $11.1 million, resulting in a gross profit margin of 14.9%.

According to AAR, strong performance and operational gains have contributed to increased market share in this segment, which bodes well going forward as more and more airlines are consolidating operations, and outsourcing their MRO activity to save costs.

• Structures and Systems — Sales grew 75% to $110.5 million for the quarter, and gross profit increased by 84% to $16.4 million, resulting in a gross profit margin of 14.8%.

While the acquisitions of SUMMA Technology, Inc. and Brown International contributed the majority of the growth, organic growth still contributed an impressive 17% for the quarter as the AAR continued to experience strength in its mobility systems business.

Finally, on December 3, 2007, AAR completed the acquisition of SUMMA Technology, Inc., a leading provider of high-end sub-systems, precision machining and engineering services that serves defense, general aviation and commercial markets.

• Aircraft Sales and Leasing — Operating income, which includes earnings from aircraft joint ventures, increased $3.1 million in the third quarter due principally to the sale of two aircraft from AAR’s wholly- owned portfolio.

During the quarter, the company’s aircraft position declined by two to 37, with 29 aircraft held in joint ventures and eight in the company’s wholly-owned portfolio.

• Sales Mix: Sales to commercial customers increased 30%, and sales to defense customers grew 57%, year-over-year. For the third quarter, defense sales represented 39% of consolidated sales, up from 34% a year earlier.

Brief Conference Call Highlights

Management Continues To Execute

• Margins: AAR achieved 10.1% operating margins and if you were to back out the effects of acquisitions and aircraft sales, margins in AAR’s organic business would have been 10.4%.

AAR reiterated their longer term target of 12.5% operating margins, but also stated that some of their recent acquisitions have a lower operating margin than this, so they have some challenges going forward in getting all their acquisitions to this level.

• MRO Segment Growth: Management talked about how their sales growth in their MRO segment was due to steady performance at their Indianapolis maintenance center and Landing Gear businesses, which resulted in market share gains which drove the exceptional sales and earnings growth in the overall segment.
• Miami Facility Already Yielding Results: The CEO recounted how their brand new acquisition, Avborne, has already yielded them positive traction in their MRO segment.

The CEO Stated:

“We look forward to the opportunities this business brings and along these lines just last week, there was an aircraft at MIA (Miami) that required a return-to-service maintenance and the aircraft was brought over to our facility.

This maintenance required landing gear repair, and folks from our landing gear operation, about 10 miles away from MIA airport, came over to the airport and provided the repair on the landing gear, while our aircraft maintenance folks worked on the repair to the aircraft.

We were successful putting that aircraft back up into the sky same day.

The customer, who is not a current customer of our heavy maintenance operations, was very pleased with the service we performed, and next week our folks will be meeting with this customer to talk about how we can capture more of their maintenance.”

• Composite Structures: During the quarter, AAR signed a lease to occupy 90,000 square feet in McClellan Business Park, formerly McClellan Air Force Base, in Sacramento, California for the manufacture of composite structures and parts, where they are seeing increasing demand.

McClellan Air Force Base was closed as a result of the BRAC Base Realignment Act of 1994, and AAR already had another operation at that airfield, so they were able to grab this facility rather quickly.

The CEO further commented that as a result of the financial market turmoil, they expect more opportunities to emerge in this market.

When an analyst asked about the aforementioned composite business that AAR acquired, the CEO replied that it was not a business that they acquired, but rather a facility that was fully equipped by the US Air Force back in the ’90s for composite manufacturing.

It’s a long-term lease, and as the lease progresses, the equipment inside the facility becomes the property of AAR.

The CEO stated that he thought this is an opportunistic move by the company in an area that appears to be “chock-full” of demand.

• Consumer Demand: The CEO stated that demand for air travel does not appear to be easing at this point in time
• Credit Crunch/Liquidity Crisis: When an analyst asked if they were seeing any problems from the credit crunch and other liquidity issues, the CEO stated that they believe that the liquidity pressures on some of the other Sales and Leasing players will create a certain amount of opportunity, and that they are paying very close attention and talking with those who have been publicized to have liquidity problems on owned aircraft and those who might not be publicized but may in fact have liquidity concerns.

Ultimately, they are fairly optimistic in this regard that as a result of some of the liquidity pressure that there will be aircraft opportunities in the aircraft Sales and Leasing business going forward.

Bottom Line - Time to Buy!

Don’t Let The Current Stock Price Pass You By

I’ve been pounding the table for AAR for over 6 months now.

In that time we’ve ridden quite a roller coaster of price swings as the overall market turmoil and fears about a recession spilled over into the Aerospace and Defense industry, of which AAR is a part.

As long as AAR continues to execute marvelously, it will only be a matter of time before Wall Street seeks out companies like AAR with steady growth, profitability, and that are more protected in a downward spiraling market.

With increasing margins, sales, profit, and now even cash flow, AAR is starting to reach a critical mass in their lifecycle whereby they are leveraging their large size to make more and more accretive acquisitions, improve margins through operating efficiency, and drop more and more money to the bottom line.

I’ve said it throughout my recommendation cycle of AAR, if they keep this up, it won’t take long for their shares to reflect their fair value.

The time to take advantage of this price discrepancy is not when the market turns, but now.

• Click here to read the complete AAR Corp. research report and buy recommendation | PDF (516 KB)

*Variables You Should Know About AAR Corp. (NYSE: AIR)
Current Recommendation:	BUY
The Company:	AAR Corp. provides products and services to the aviation, aerospace, and defense industries worldwide. It operates in four segments: Aviation Supply Chain; Maintenance, Repair, and Overhaul (MRO); Structures and Systems; and Aircraft Sales and Leasing.
Why Buy Now:	Excellent risk/reward profile at current price Margins are improving US military and defense spending will continue and could possibly increase in the foreseeable future Diversified company, operating in 4 primary segments with no segment representing more than 50% of total revenue and each one showing double digit growth The beauty of their operations lies in the synergies that exist between all their business segments There are no direct competitors that do exactly what AAR does Seasoned management
Market Cap:	$999.5
Revenue (TTM):	$1,299.6
Cash/Debt:	$40.1/ $368.6
Current Price:	$26.00
Risk Rating (?):	5 (Average)
Position Size (?):	1/2 (10-22-07), 1/4 (1-8-08), 1/4 (1-9-08), 1/4 (3-3-08)
Buy Around Price (?):	$30.00 (10-22-07), $34.00 (1-8-08), $31.25 (1-9-08), $26.00 (3-3-08)

*As of 3-19-08. Except share price, all values in millions.