AAR Corp (AIR) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your AAR Corp. third-quarter fiscal 2007 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. John Bowman, Director of Investor Relations. Sir, you may begin.

Thank you. Good morning, ladies and gentlemen, and thank you for joining us on this morning's conference call. Before we begin, I would like to reminder 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 this morning, as well as those factors discussed under item 1A entitled "Risk Factors" in the Company's May 31, 2006 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 will turn the call over to AAR's Chairman, President and Chief Executive Officer, David Storch.

Thank you, John, and good morning to all today. Joining me on today's call are Tim Romenesko, our Chief Financial Officer. Also here in our boardroom is Mike Sharp, our Vice President and Controller; and Rick Poulton, our Vice President of Strategy and Acquisitions.

Results for the quarter were strong with sales of $271 million and income from continuing operations of $15.5 million, or $0.37 per diluted shares. Both are record numbers and both of which we are fairly proud. Sales increased 21% year-over-year and income from continuing operations grew 69% compared with $9.2 million last year.

Included in the revenue for the quarter is $16.5 million from the sale of two aircraft which we sold at book value. As you recall, we indicated this transaction was coming back in the second quarter. Excluding the sale of these aircraft, consolidated sales for the quarter grew 14% year-over-year, keeping with the double-digit sales growth we have been projecting.

Through the first nine months of fiscal 2007, net sales were $755.5 million, a 19% increase year-over-year, and income from continuing operations grew 86% to $41.7 million, or $1.00 per diluted share. We expect our fourth-quarter sales growth to be similar to the growth rate experienced during the second and third quarters, once you adjust for the aircraft sales.

For the third quarter, sales increased 34% to commercial customers, largely driven by improving conditions in the commercial airline industry and our ability to capitalize on increased outsourcing opportunities. We also benefited from investments made in assets and capabilities, and our focus on innovation and execution. Sales to defense customers grew at a more modest 5% during the period.

In our Aviation Supply Chain segment, sales increased 16% to $135.7 million, and gross profit increased 7.5% to $29.9 million. Gross profit margin was 22%. Within that segment, sales to commercial customers grew 22%, with particular strength in Asia.

In January, we announced an agreement to provide logistics for tactical military trucks. Although the dollar value of this program is modest, it does represent an expansion of the supply chain services we provide to the DOD.

In the Maintenance, Repair and Overhaul segment, sales increased 20% to $52.3 million, and gross profit increased 21% to $7.3 million. Gross profit margin was 13.9%, with all businesses reporting increased profitability.

Results at our Indianapolis maintenance affiliate also improved, both sequentially and year over year, as we brought on new customers, including Southwest Airlines. We are currently operating seven hangars, providing eight lines of maintenance, and our current view is that we will be providing seven to nine lines of maintenance through the end of this summer.

In January, we acquired the assets of Reebaire Aircraft Inc., a regional aircraft MRO located in Hot Springs, Arkansas. This acquisition is consistent with our strategy to increase our market penetration into the regional aircraft market.

In the Structures and Systems segment, sales grew 6% to $63 million, and gross profit increased 8% to $8.9 million. Gross profit margin was 14.2%. Growth in this segment is mainly attributable to the development and delivery of increasingly complex and specialized shelter products, as well as higher volume in our pallet product line. Sales were lower at our cargo systems business, as we continue to relocate this business to North Carolina. We do, however, expect improvement in our cargo systems business during the fourth quarter, as we near completion of the move.

Performance in the Aircraft Sales and Leasing segment remains stronger. Operating income for this segment grew $2.6 million year-over-year, primarily as the result of the sale of the Company's interest in two aircraft held in a joint venture. We continue to see opportunities in this segment and expect our fleet to increase during the fourth quarter.

Consolidated gross profit increased 10% to $47.3 million. Gross profit margin declined 120 basis points from the prior year, due largely to the impact of the aircraft sold at breakeven. During the fourth quarter, in addition to the aircraft transaction, we expect our gross profit margins to further improve, reflecting efficiencies in our MR&O operations.

Selling, general and administrative expenses were less than 10% of sales, as we continue to leverage our cost structure and benefited from a $700,000 bad debt recovery.

Operating income for the quarter grew 41% to $25.5 million, or 9.4% of sales. We expect our fourth-quarter operating income margin will be at or very close to our short-term goal of 10%, and we remain steadfastly committed to our previously stated mid-term goal of 12.5%.

Net interest expense for the quarter decreased $1.7 million year-over-year, to $2.3 million. Higher interest income, lower debt levels and the impact from capitalized interest were the main drivers for the reduction in interest expense.

The effective tax rate increased to 33.1% for the third quarter due to the elimination of the export tax credit. We expect our fourth quarter effective tax rate will be in the 33% to 34% range, and are currently forecasting a 35% tax rate for next fiscal year.

In closing, we are pleased with the quarter's results and the Company's position in our various markets. We continue to look for ways to leverage our existing product and service offerings across our customer base and to evaluate acquisitions that will broaden our capabilities. I would like to thank you for your participation on the call today, and we are ready to open the line for any questions you may have.

(OPERATOR INSTRUCTIONS) Arnie Ursaner, CJS Securities.

Good morning. Two quick questions, if I can. One on Indianapolis. The last conference call you had indicated you thought you would be at 10 lines by April. And I think in the call in your prepared remarks, you said seven to nine lines through the end of the summer. I know it is a rounding error, but what would have been causing this change?

Well I think what we're finding, Arnie, is that the ramp-up of employees is taking a little longer than we expected. And we are committed, obviously, to the customer base that we have in delivering quality product, and we are putting our top mechanics on the Southwest airplanes and some of the other customers we had. And we will get the growth that we were expecting -- previously communicated, I should say, for April, but it will take a little bit longer.

And following up as to the impact on margin, you mentioned clearly, and I think it is completely understandable, that you're having training costs and some initial inefficiencies because different airlines have different maintenance specifications. Is there any way you can attempt to quantify that and give us a feel for how that may evolve over the next quarter or two?

I can tell you the next quarter or two, our operating efficiency is going to improve, our training expense is going to be lower. So you should expect improving results coming out of our MRO segment as we look at the, say, the next couple of quarters, at least.

One more very specific question on United. You had mentioned last quarter you had some deferrals of reasonably scheduled maintenance. Did you pick any of that up this quarter, or is that moving further out?

It is out there in the schedule, and there is -- we expect the inputs from United to stay steady, and we will -- that business will be managed through AAR, and it is just part of the schedule at this point.

I'll jump back in queue. I had a few others, but I will jump back in queue. Thank you.

Peter Arment, JSA Research.

Good morning, David, Tim. Just a couple quick questions, following up on the previous questioner on the MRO segment. You had some nice results here year-over-year and up sequentially, and I assume Southwest was only a modest contributor at Indy. So David, maybe could you just provide us a little more color on the performance of the other units within that segment?

Very solid performance coming out of our Oklahoma City operation. They had record sales for the period. They continue to operate very efficiently; very pleased with the results from that operation. They have injected the acquisition that we announced and completed back in January, and that is going according to plan.

Our landing gear business is also very strong -- not quite at record levels, but approaching record levels. Very healthy margins, and I think the company is in a very good position. We continue to invest in our Malaysian operation and expect sales growth coming out of that region here very shortly, as well.

So all in all, MRO is strong. We were down at Indianapolis last week. Very pleased with the reports we are getting from the customers in terms of the service levels that they are receiving from the Company, and we are very -- I remain very bullish on the prospects for that business.

That's great. And just a couple of housekeeping questions. On the JV line, in terms of you have 15 aircraft now at the end of Q3, and you said, I guess in your comments, Q4, it should be growing. So should we expect some of the equity contributions from the sale of aircraft to decline and match more what the year-over-year -- the year-ago period looked like?

I'm not certain at this point in time, Peter, so I can say that we -- I am very pleased, again, with the progress we're making in that area, and we do expect to see our fleet size increase in size this quarter. I am not certain in terms of what kind of movement there will be in this period.

Okay, that's fair enough. And Tim, could you give us a little highlights on the interest expense? Is this the run rate going forward?

I think the run rate going forward, Peter, will be maybe just a couple hundred thousand dollars per quarter higher -- between -- say between $200,000 and $400,000 higher.

Okay, great. Thanks. I'll jump back in queue.

Christine Min, Calyon Securities.

Good morning. In the Supply Chain segment, you mentioned that you had significant sales growth that occurred in Asia. And I was wondering what kind of opportunities are you seeing in that region?

The Company continues to improve its presence in that region. You may recall, Christine, we've talked about offices that we've opened up in Shanghai and Zhuhai in China, as well as an office that we recently opened up in Melbourne. So the Company continues to expand its presence in that region.

We continue to make inroads into customers that we previously weren't necessarily connecting with, and we're very pleased with the organization we have in place in Asia. It is led by a long-standing veteran of AAR, who continues to perform and continues to look for ways to grow our presence in that region.

I am very hopeful that as we continue to invest in Malaysia, that we will see some benefits coming from that -- accruing from that, as well.

Great. And on a more macro level, what level of growth do you expect will continue in the supply chain segment? You mentioned that you had very strong, 20% range, growth in the commercial side, and that the overall growth was kind of brought down by the defense segment. On an overall level, do you think that we should expect more of a mid-teen year-over-year growth range in that segment versus the high teens to low 20% that we were seeing?

Well, we feel comfortable in mid-teens, but it wouldn't be out of the question for us to achieve better than that. But for now, at least, we are forecasting mid-teens.

Okay, great. Thank you.

Eric Hugel, Stephens Inc.

Can you talk about -- I guess the gross margins in the Aviation Supply Chain business were, I guess, down year-over-year and sequentially a bit lower than we were looking for. Was there anything sort of in there, or is it just sort of mix?

If you recall, what we said is that the margins were going to be in the 20 to 24 range, let's say. And if you look at the differential, it is fairly minor -- year-over-year I think it was 23.7 down to 22 and sequentially -- or vice versa, I guess -- it was 22.3 last year to 22 this year, so slightly down. And sequentially, it was down I guess 1.7%.

But basically, I think you should expect the margins to be in that range. It is very hard to pinpoint more precisely what the margins might be. But I think if you look at them in the low 20s, I think you should be comfortable.

Okay.

Nothing extraordinary during the period one way or the other, and nothing really extraordinary in the prior period. It is just a function of mix and timing and things of that nature.

Okay. In order to get the margins back up to 23, 24, are there certain things that need to happen or is it just sort of, well, we can do that, but it is just a matter of getting the right mix in there?

I think it is a function of mix. I think as the mix improves -- and the mix should be improving -- you should see some improvement. But it's a very tough business to go ahead and say that you are going to be in any one given quarter versus another quarter, that we can be that precise in forecasting the gross profit margins.

But we are very comfortable in stating that the gross profit margins will be in that low 20 -- between 20 and 24, let's say, and you will have some fluctuations from period to period.

Can you talk about -- I guess as part of the Aviation Supply Chain business, you guys do component repair work. I guess you have a lot of facilities that are doing it. Can you talk about sort of the throughput there, sort of what kinds of volumes you have, what kind of maybe capacity level you're at and sort of how comfortable you are that you need -- maybe there is potential for consolidation there?

The volumes are stronger for us today in North America than they are for us in Europe. We have capacity in both facilities to increase throughput, and we are working at increasing sales in both those operations.

I guess you have ability to increase volumes, but I guess is there too much capacity right now, and is that sort of a drag on margin?

I'm not aware of there being too much capacity. Clearly, there is competition, but I wouldn't state necessarily that there is too much capacity, no.

Okay. Can you talk about maybe the MRO front, sort of opportunities that you are seeing out there? What is the pipeline looking like and sort of how is pricing?

Pricing has been firming. I believe that as it relates to our current position, I think we are in the mode right now where we are absorbing the workload that we have. And clearly Southwest came online in January. We have about 1.5 months' of revenue from January in the third-quarter results. In the fourth quarter we will have three months of revenue from Southwest. We want to do, obviously, a great job for that customer, and so far, by all accounts, we are meeting their objectives, and that is where our focus is right now.

We feel good about the growth opportunities in the regional markets. That's why we invested in the Reebaire operation. We are currently, I would say, at 75% capacity, so some growth opportunities for that business. We continue to expand our engineering service capability, and we think next year we are going to be much stronger in that arena than we are today in line service work. Where we are performing line service work for customers in Indianapolis, we're looking to expand that into other cities, as well.

So all in all, we feel very confident about the opportunity pool that we are facing in the MRO. Keep in mind, once we get our performance to a level that we are comfortable, we do have additional hanger space in Indianapolis to grow, and we would anticipate in time that will be the case. So MRO is -- we feel good about -- we feel good about the quarter we just ended, and we think there is a lot of runway ahead of us for improvement.

I guess one final question and I'll get back into the queue. Can you give us some perspective about maybe potential benefits, looking at the supplemental budget, that you might have in the mobility equipment business, sort of in the lines of pallets or shelters?

The business continues to be strong. If you take a look at our Structures and Systems, we had modest sales growth of 6%, but we had decline in cargo systems, due largely to the move. So we look at the kinds of product that we produce for the DOD. They are in demand, and we don't see that demand declining here in the foreseeable future.

But you don't see anything in particular that sort of stands out in the new budget submissions, either on the budget or in the supplemental, that might sort of be a nice opportunity for you guys?

Nothing that is extraordinary.

Okay. Thanks a lot, guys. I'll get back in the queue.

Jon Braatz, Kansas City Capital.

David, just sort of a big picture standpoint. Obviously, on a relative basis, the airlines might be getting a little bit healthier. Is there any reason to believe that the outsourcing activity that the airlines have been engaged in, whether it be MRO or logistics, any reason why that would let's say deaccelerate. Or would we continue to see at a similar pace?

I can only give you my view in that regard, John. My view is that there is no turning back, that, if anything, that there will be continued momentum. We are building our value proposition around how we've benefited our customers, and I think as we share that with more customers, my view is that it is a compelling case and that where the trend is heading, I don't see that diminishing.

Tim, just going back to the interest costs again, I think last quarter interest costs were $4.7 million. I know it looks like you've paid off a little bit of debt. But help me understand why we go from 4.7 down to 3.6, and it looks like you paid down debt by about $12 million or something like that in the quarter. Where is it all coming from?

I was talking about net interest, first of all, John.

Okay.

Okay? So we've had an increase in interest income as a result of the investments that we are making with our cash. And interest expense is coming down due to lower borrowings, as well as some capitalized interest on our A400M contract.

Okay, all right. Well, you said you expect that to continue -- or move back up a little bit in the quarter.

Right.

Okay. Can you tell us a little bit about your inventory position at year-end -- at quarter-end?

Sure. Inventory came down in the quarter by about $16 million, mostly due to the sale of those two aircraft. Our equipment on short-term lease increased. We made an investment in some assets to support our supply chain business. These are assets that were purchased for a short-term lease, but will shortly be disassembled and sold.

Okay. One last question. The cargo business, mentioned you had declined a little bit in the quarter. As the move is completed, how quickly does that ramp up and what kind of expectations would we have in that area, in that regard?

That business gets very healthy as we start producing A400M systems. That should be towards the latter part of next fiscal year. But you should start seeing improvements here beginning in the fourth quarter.

Okay. Thank you much.

Scott Blumenthal, Emerald Advisors.

Scott Blumenthal. Thank you for taking my question. The Armor Holdings supply chain agreement appears to be one of the first ones that is kind of a non-aero defense customer. I was wondering if you look at the pipeline of opportunities that you have now across the supply chain segment, are we going to see some more of these, I guess, non-airline customers? And I guess associated with that, a little bit of pressure on margins from here on?

I don't believe pressure on margins. We are viewing the DOD differently today than say we viewed the DOD five years ago. We are looking at all the branches of the DOD and trying to figure out how we can apply our capabilities to a broader base. And I believe the Armor Holdings transaction is kind of the first leg, if you will, in terms of making the move along those lines.

I believe if you look at the budgets and you look at the amount of capital expended by DOD in support of their ground equipment, as well as their air equipment, it is fairly sizable. And as there is a drive to more efficiency, I believe there's more opportunities for us to play a role in that market. So I don't view it as necessarily being a drag on margins. As a matter-of-fact, I think it should be a pretty good margin.

So it is a great -- an open field for us, if you will, and we are viewing it very opportunistically.

Do you have opportunities there with the government itself, in some of the government's DOD operations, or are we just talking about suppliers to the department?

Most of the opportunities as we see them today is working with suppliers. You should know that the DOD points some of the suppliers in our direction because they are pleased with the service we are providing in support of other OEs. So I believe it is more around total system support, and we can play a role supporting the owner of the technology.

And just one follow-up on the MRO segment. If you had to take a guess, how much of the current quarter's activity is United, and how much is, I guess, kind of other customers in the Indianapolis facility?

If we are strictly talking about Indianapolis, I would guess that United is in the 20% range, give or take. If we're looking at the entire MRO, it is obviously a much smaller number.

Okay, great. Thank you so much.

Kevin Klarnet, Palisade Capital Management.

I was wondering if you could give a little more detail on the contract with Armor Holdings in terms of the types of vehicles involved and what kind of volumes you might be looking at.

The vehicle is the Stewart & Stevenson truck -- I think it's called FMTV. And the volumes are modest to start. And we think we might be able to leverage this into other areas of Armor Holdings and take our capability here into other platforms, as well.

This is for supply chain management?

Yes.

I was wondering if you could talk about your aircraft fleet sales, if you could give any kind of guidance as to what kind of sales you might be expecting going forward, or if that is just too lumpy an item to really be predictable.

We're not out there with guidance in that regard, and rather than single any -- if our folks are in a any negotiations, I don't want to put any pressure on them -- undue pressure, I should say, beyond what they currently have. So we prefer not to comment at this point.

Okay. Thank you.

Tyler Hojo, Sidoti.

I was wondering if we could go back to supply chain for a second. Spent some time talking about Armor, and that seems like a nice little contract win for you guys. And also, you had the Chautauqua Airlines win recently. Obviously, these aren't too big in scope of revenue, but do you feel pretty comfortable growing upon your base on supply chain, or are you still going through a little bit of a digestion period here? How would you characterize that?

We're comfortable with growth.

Comfortable with growth?

I would say that the major ingestion is behind us.

Okay, good. And would you think that --.

And by the way, let me just add that I am very pleased with the execution -- our team's execution in this regard. Because really, if you speak with -- if you had an opportunity to speak to any of our customers in this regard, they are very pleased with our performance. That is on the government side, if we talk to Northrop Grumman or GE, and if you talk on the commercial side, Mesa, Chautauqua, very pleased with the support they are getting from AAR.

Okay. Thanks for that color. I guess would you characterize -- I guess you said before that you thought mid-teen growth was reasonable here, and I think you have said that before -- and with 20% growth feasible. I would imagine that what is driving that is additional contract wins. And with that kind of framed, do you think there are other opportunities out there at the same scope of a Mesa or a UK MoD?

If you look at the size of the customer base, the customers that we are currently providing services to, and you look at the overall scope of the market that we are servicing, clearly there are opportunities of this size, if not larger, out there. And I believe our organization's challenge, obviously, is getting our story in front of the right customers and convincing them of the merits of this approach. And I have confidence that over time you are going to see, I think, more wins in this regard.

Okay. That's helpful. I guess one more. Just maybe if you could quantify this 12.5% longer-term margin goal -- is that something ten quarters out, eight quarters out? Anything you could give.

My view, Tyler, we have a three-year planning cycle. So what we are looking at is in this three-year planning cycle, we aim to achieve that number.

Do you think that there is upside to that, or is that just kind of a far-reaching goal?

I would say it is far-reaching. I wouldn't comment as to whether there is upside. I would be very pleased if we get to that goal during this period. And as we continue to refine our business and the products that we are offering, it would be our goal, of course, to improve upon that. But I think for this cycle right now, I would be very pleased achieving that level.

As you recall, we were up against the 10% target. We have a very high level of confidence. We said we were shooting, if you recall, for the fourth quarter this year, and we have a fair degree of confidence that we will achieve that or get very close to it this quarter. So rather than go ahead and put another target beyond the 12.5 out there, I think it would be incumbent upon us to near that target before we go ahead and start talking something higher.

But yes, clearly, as we get better at what we do and as we refine our business model, it would be my hope, at least, that we would be able to run the business at a higher operating margin than 12.5.

Okay, good. And I guess one more while I have you. You said that you're shooting for seven to nine lines of maintenance in Indy. You've got ten bays. I guess you have access to another two if you need. But when you really start thinking about it, at some point, you're going to be capped out in the not-too-distant future. How do you continue to grow the airframe side of the business?

The MRO side of the business has multiple channels of opportunity, if you will. I alluded to a couple in this call, in terms of providing engineering services and providing line services. As we get better at what we do, we can cycle more aircraft through the hangar space that we have.

Our challenge today, though, just so we don't get ahead of ourselves, Tyler, is still to ingest the business that we have. We have some world-class customers in our facility today, and our goal is to continue to work with those customers to continue to prove our worth, if you will. And as we perform, I think we have some more growth.

There is considerable growth yet ahead of us in the Indianapolis facility. Let's leave it at that.

That's fine. Thanks so much.

Eric Hugel, Stephens.

Dave, can you talk about -- maybe just a follow-up on a previous question with regards to the Aviation Supply Chain business. Specifically, when -- your end-to-end supply chain business for the regional jet guys, it seems like a pretty compelling product. And you said, look, the key challenge is getting the pitch out in front of them.

I guess what is the key hangup when you do sit down in front of them, and what is sort of the key thing from them from a go/no-go perspective with you that you've got to overcome? What are the key pressure points there?

Change and giving up control.

And, I guess, what have you -- how have you been able to overcome that so far? It's just sort of an indoctrination process?

The math is compelling. They have to get comfortable -- obviously, each airline has a different emphasis on things like how they control their supply chain, how they control the maintenance, how they control the support of the aircraft. And it is convincing them that relinquishing the responsibility to us is not in any way, shape or form going to diminish service levels; if anything, it will improve service levels.

So you just have to get people comfortable turning over a very integral part of their operation to an independent provider like ourselves.

So it would seem that something like Chautauqua, that you've sort of now got your foot -- from still a relatively small portion of their overall fleet. But if you can convince them by actually doing work for them, that should be pretty positive in winning their whole fleet, which is quite large.

Right. You are correct.

Okay. The other question is with regards to the cargo loading business. Can you talk about, I guess now that you have moved that business down to Goldsboro -- I guess, one, can you talk about now -- because obviously Goldsboro is a lower-cost facility. I understand you moved it down there from the perspective of the A400M contract.

But can you talk about that business going forward now in terms of competitiveness, in terms of winning additional awards because it has a much lower cost basis. I guess previously was the business very competitive to begin with, and now that you have a much lower cost basis, it is going to be very, very competitive?

And I guess the other question would be what other opportunities does Goldsboro offer you? Are there -- from, again, leveraging a lower cost base, are there other opportunities -- more machining types of applications that you can do there?

Yes. If you look at the -- you had a very complex question, by the way. Let me try to respond to a few of the things -- a few of the queries that you've had here.

One is the cargo systems business is very highly paced by engineering content. So the challenge in competing in that market, clearly cost is always an element, but it is also designing a system that works for that operator. So the key here is maintaining weight levels or reducing weight levels while maintaining stability and strength and all those kinds of good things. So the challenge -- the principal challenge in that business is engineering.

Now, once you've engineered a solution and you've won a contract, now you want to produce this as profitably as possible, and that is where the cost element comes in. So the move to North Carolina is about being in a lower-cost environment, principally, as you said, driven by the A400M. Because the A400M is the first large-scale original equipment program that we've been on. So the move was necessitated by the size of that contract and our desire to be as profitable as possible, obviously.

So now that we are in Goldsboro, much to your point, there are opportunities to produce things other than cargo systems and create a manufacturing center of excellence, which we have been doing. And some of the work, actually, that came out of Goldsboro in the third quarter was work performed for our mobility systems business.

So yes, cargo systems will benefit from the relocation. And yes, AAR will further benefit by creating a manufacturing center of excellence that can do work not just on sister AAR companies' businesses, but also third-party work for other people looking for low-cost manufacturing solutions.

I guess from the perspective of, let's say, that FedEx or UPS is looking for some cargo systems for some new freighters that they are looking to buy. I would think that having a lower-cost production capability, sort of incremental to where you were up in Livonia, should make you that much more competitive.

Absolutely. But keep in mind that the key remains the engineering. Now, we haven't really -- our engineering organization is still pretty much intact -- is intact, and will continue to do its thing. But a major point of difference is how effective you are at design and engineering solutions. So the lower-cost element is -- yes, it makes us more competitive, clearly. But it is more for our benefit probably than for the customer's benefit.

Yes, but you can trade your benefit at a lower price, and you should win more share.

Absolutely, you're correct.

I guess my final question, more of a housekeeping, is do you have free cash flow numbers, Tim, for the quarter -- and D&A and CapEx also?

Sure. Depreciation and amortization was $7.9 million. CapEx was $6.5 million. Cash flow from operations, I mentioned earlier that we made some working capital investments; receivables were also higher in the quarter. So we actually had negative cash flow from operations of about $5.8 million, again due to the increase in the receivables driven by the sales, and also due to the investment in some inventory assets.

Thanks, guys.

(OPERATOR INSTRUCTIONS) Peter Arment, JSA Research.

Just a quick one regarding your use of cash. You've got quite a bit of availability on your bank lines and you have are carrying over $100 million of cash. What is your current -- in terms of the objectives there, and you've got a couple notes, a note that is coming due here in December and another one in May of '08. Are the make-whole payments still too sort of high or expensive to sort of call in any of these additional notes, or you just waiting until they come due?

We've been picking up some of the notes as they have become available, when the pricing is right for us, Peter. We still think that there are opportunities to deploy our cash into the business. So we are keeping a balanced view there. But we will continue to buy in the debt as it becomes available.

Okay, so no urgent need to retire these early?

No.

Okay. Thanks.

[Stan Mann.]

Thank you, gentlemen. Good quarter. Can you give me the EBITDA number for the quarter and year-to-date?

Sure. I will give you the components and you can do the math. Operating profit was $25.488 million, and depreciation and amortization was $7.929 million.

And year-to-date?

Year-to-date, depreciation and amortization was $24.089 million, and operating profit was $67.183 million.

Second question, the last call, you mentioned that you were moving toward a 12% operating ratio -- 12% on the net operating line. Do you have any timetable at all for moving toward that goal?

Stan, what we are looking at there is that is part of our three-year planning cycle. So sometime within this three-year planning cycle, we aim to achieve that target.

Okay, and do you see the markets you are in continuing strong?

Yes, yes. I don't see any substantive change in that regard. I believe the commercial markets are particularly strong. And with AAR, you've seen we have had meaningful sales growth. And I believe the defense markets are a little less predictable today, but nevertheless remain fairly strong for the kinds of products and services we provide.

Last question, how much dollar capacity is left in Indianapolis -- availability?

I don't know if I have an answer to that question. Give us -- let us kind of stew on that and figure out how to calculate that better. But there is still, I would say, capacity.

Is it 60% full, 70%? What kind of range of capacity is being utilized in Indianapolis?

70%.

70%, okay, great.

Let's say 60% to 70%.

Okay. That's great. Thank you for your good quarter.

Arnie Ursaner, CJS Securities.

A couple of follow-ups, if I can. Your defense sales were a little bit soft. Is there anything, in your opinion, other than timing that affected military sales this quarter?

Nothing unusual. We had an exceptionally strong period last year, if you recall, in defense sales. So we are -- nothing unusual in that regard. We could use -- we are out there knocking on doors trying to get some wins, and that would obviously help. So nothing unusual.

Focusing on Structures and Systems a little bit more, you had 6% growth there. And I know you were in the process of a pretty complex move. Can you give us a little better feel for maybe the backlog in the entire segment, your visibility and how far out it may go? And perhaps, again, was it more again timing and the move that affected your revenue growth this quarter?

Arnie, we have excellent visibility in this segment. Our backlog is strong there. On the mobility products area, we are basically sold out for the next at least 12 months. So great visibility and continued strong demand for our products.

And I don't think you've disclosed this, so I'm not sure you'd want to disclose it, but have you given us a dollar content per plane on the A400M?

No, I don't think we have, and I think it changes based on the options.

We actually provided size of the contract, and I think what we didn't provide you is how many units we are estimating that against. But if you look at the Airbus numbers, you can do a division and come up with that answer.

I want to focus a little bit on Southwest Airlines, if I can, and just maybe try to understand how this could impact you. I am assuming you're working on their 737 fleet, which is consistent with work you've done in Indianapolis, and I'm assuming they have kind of tested you.

Just remind us of a few things, if you would. How have they previously handled their maintenance would be one question. Two, what specific type of work are you doing for them? And how many planes could you eventually have if you were successful winning a greater share of their business?

Southwest has been outsourcing their maintenance pretty much from their formation 30 some odd years ago. So it is just that these aircraft moved from one maintenance organization to AAR.

The kind of work that we are doing is we have -- we are doing two different types of support for Southwest. We are doing a winglet mod on their 737 300, and we are also performing heavy maintenance on their aircraft -- different aircraft. So one aircraft comes in for a mod; a different aircraft comes in for heavy maintenance.

And as we perform, Southwest has indicated a desire to put more lines into our facility. I prefer not to disclose that or discuss that at this point.

Perhaps wording the question a slightly different way, assuming you're successful, which I assume your investors would assume you will be, will you eventually have to either buy another facility similar to Indianapolis, either build a facility similar to Indianapolis? At some point, if they're very successful with you and vice versa, won't you run out of capacity?

We also expect to be successful, and we expect to get more work from Southwest. And we believe we have the capacity to accommodate what they would be interested in outsourcing to AAR.

Okay. Thank you.

Christine Min, Calyon Securities.

I had two quick housekeeping questions. Could you just remind us again what was the lost revenue for the move to North Carolina and whether you expect to recover this in the fourth quarter?

I wouldn't have a specific number for lost revenue. I think it is more a disruption than it is anything that was permanently lost.

Okay. And then on the SG&A line, it came in better than your previous stated goal of around 10%. So I was wondering if you expect the 9% level to be a more appropriate level going forward.

I think the 10% level is our target. There are going to be some fluctuations. We might get better as we continue to leverage our cost structure. But I think the 10% is still our goal.

Great. Thank you.

If there are no more questions, I want to wish each of you a pleasant afternoon, and thank you for your participation.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may now disconnect, and have a wonderful day. Thank you.