AAR Corp (AIR) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the AAR Corporation fourth quarter fiscal 2010 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 follow at that time. (Operator Instructions). As a reminder, today's conference is being recorded.

I'd now like to turn the conference to your host, Mr. Tom Udovich.

Thank you, Amy. Good morning, ladies and gentlemen, and thank you for joining our fourth quarter fiscal year 2010 earnings conference call. Before we begin, we must remind you that comments made this morning may include forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. We ask that you refer to the disclaimer contained in our news release, as well as risk factors section of the Company's May 31, 2009, Form 10-K. In providing forward-looking statements, the Company has no obligation to provide updates to reflect future circumstances or the occurrence of anticipated or unanticipated events. At this time, I'd like to turn the call over to our Chairman and CEO, David Storch.

Thank you Tom, and good morning, everyone. Joining me today in Chicago is Tim Romenesko, our President and Chief Operating Officer, and Rick Poulton, our Chief Financial Officer. We reported our fourth quarter fiscal year 2010 results yesterday afternoon, and I hope that you've had a chance to review our press release. For the fourth quarter, the Company reported sales of $372.3 million, and net income of $11.2 million, or $0.29 per diluted share. During the fourth quarter, sales to government defense customers increased 17% year over year, principally reflecting the impact of the Company's acquisition of Aviation Worldwide Services, which closed in April, 2010.

Sales to government and defense customers in the fourth quarter represented slightly more than half of our consolidated revenues. In fiscal 2010, sales to government and defense customers were approximately 50% of total sales, so we have seen a meaningful increase in business in this market, as we have become a broader and more diversified company, serving a much wider customer base, and if you look at the growth in that timeframe, you would have seen customers move along from Air Force to Navy, Army, and now US Transcomm. Also, please appreciate that the majority our revenue is coming from the O&M portion of the Department of Defense budget, which is less susceptible to budget cuts.

Throughout fiscal 2010, we experienced lower demand from our commercial airline customers, as they adjusted their maintenance spend, in light of lower capacity, and looked for ways to reduce costs and conserve cash. Recently, the airline industry is experiencing a recovery, as capacity is beginning to be added back into the system, as passenger traffic has been increasing. During the fourth quarter, we did see an increase in sales to our airline customers versus the third quarter; however, margins were under pressure, in what continues to be a very competitive pricing environment. Going forward, I remain optimistic on our longer-term prospects in the commercial market. We have built a solid position as a leading independent provider of after-market support and MRO services to the airline industry, and I believe we are in an excellent position to benefit as the commercial markets recover.

We've been very focused on cash flow. During the fourth quarter, we generated $59 million in cash from operations, and for fiscal 2010, we generated $153 million of cash flow from operations, which far exceeds any prior year in the Company's history. This allowed us to pay a substantial portion of the AWS acquisition with available cash and maintain our strong balance sheet. As we approach fiscal 2011, we are exploring opportunities to invest in our businesses, supporting the commercial markets. Now, what I'd like to do is turn the call over to Tim to provide some additional details regarding our operating performance during the quarter. Tim?

Thank you, David, and good morning, everyone. I'd like to spend a few moments discussing the recent acquisition of Aviation Worldwide Services. Overall, we're very pleased with the progress of the integration efforts of AWS into the AAR family of businesses, and they are meeting our expectations in regard to their financial performance. The acquisition opens the Company up to a very dynamic niche market, as we have identified cost effective supplemental tactical airlift support as a growing worldwide need. We further see a benefit in the engineering expertise, which has been developed at AWS over the years as they have significant experience operating tactical aircraft in challenging environments.

Over the next twelve months, we will bring our supply chain expertise to AWS' operations. We will use many of the same proven methodologies we have used to support other defense programs, all with the goal of optimizing inventory and aircraft maintenance, leading to improved aircraft availability, which will allow us to be more earnings-efficient. In addition to improving the operations of the business, we are actively responding to RFPs, and have been successful in winning new business. We recently began providing additional airlift support under two separate awards transporting cargo and US and coalition personnel.

By the end of the fourth quarter we essentially were fully ramped on our new KC10 program, which contributed approximately $13 million of revenue in the quarter. This was the first full quarter of a nine year program, and by continuing to work with our customer and other business partners, we expect to see operating efficiencies as the program matures. Including the $135 million backlog from AWS, as of May 31, 2010, our total backlog at the Company is approximately $600 million. I'll now hand the call over to Rick Poulton, who will provide further details on our financial performance for the quarter.

Okay, thanks, Tim. Good morning, everyone. As we previewed when we announced the deal, in connection with the acquisition of AWS we are now reporting a new business segment called government and defense services. This change aligns our four business segments with the way we are evaluating performance of the Company, and it also provides better transparency to both commercial and government defense after market businesses. The new segment includes the results of AWS, and also includes defense systems and logistics which was previously reported in our Aviation Supply Chain segment, as well as Integrated Technologies, which was formerly known as Brown International, which was previously reported in the structures and system segment. In our release yesterday, we included the new segment presentation by quarter for fiscal 2010 and 2009 with fully restated results. Within the supply chain segment, although sales decreased 9% on a year-over-year basis, on a sequential basis from the third quarter, sales increased 15% as volumes improved in our airframe aftermarket support.

At the gross profit level, pricing pressure and unfavorable product mix in our trading businesses continued to product mix in our trading business continued to lower margins slightly during the fourth quarter. Margins will remain under pressure in these trading businesses in the short run, but are expected to improve as commercial demand recovers. The new government defense services segment grew on a year-over-year both organically and with the acquisition of AWS. Organic growth for the segment was primarily attributable to the KC10 support program, and AWS contributed approximately $30 million in revenue during the fourth quarter. This performance is consistent with our expectations we announced, as Tim referred to earlier.

In our MRO segment, sales and margins declined from the prior year, but improved over Q3. New long-term maintenance contracts that we had announced during the second and third quarters drove the improvement relative to third quarter performance. As we look ahead into the first quarter of fiscal 2011, we expect that first quarter revenues in the MRO segment will be lower than Q4, that's due to the summer flying season and the efforts of the carriers to keep their aircraft in the skies. But we do expect this to improve as the year progresses. Currently we forecast that we will report year-over-year sales improvement in the segment beginning in the second quarter of fiscal 2011.

Finally, in our structures and systems segment, sales were lower versus last year and on a sequential basis, as volumes on one of our large programs in our mobility business declined as we completed shipments under some supplemental funding. Gross margins in that segment improved to 20%, 20.3%, from 16.4% in last year's fourth quarter. As the margins continued to be favorably impacted by an advantageous product mix as well as some cost reduction and process improvement initiatives. We expect that margins will remain strong in this segment but decline from the current levels as we lose some of the benefit of favorable product mix.

Moving down the P&L, SG&A expenses increased $7.2 million over the prior year, to $42.8 million. This increase was driven by SG&A costs at AWS, including $1.1 million of acquisition-related expenses, and also included $1.4 million in expenses incurred at AAR Global Solutions. Due to both the nature of its business and the impact of purchase accounting amortization, as we expected, AWS currently has a higher than average SG&A as a percent of sales rate, when we compare it with the rest of the Company. We recently acted upon a series of cost reduction initiatives both at AWS and across the Company, and are evaluating additional items to get our SG&A rate down.

In June, 2010, the Company and our partners at AAR Global Solutions agreed to wind down the operations of Global Solutions. We'll continue to compete as a prime contractor in the domestic and international government and defense markets through the use of our own resources and personnel.

Interest expense for the quarter was $7.3 million, essentially flat with last year. I'd like to remind everyone that interest expense reflects both cash interest expense as well as non-cash interest expense related to the new accounting standard for convertible debt. During the fourth quarter, cash interest expense was $4.3 million, also essentially flat with last year. During the fourth quarter, total debt increased over the third quarter by approximately $110 million. That reflects the financing in conjunction with the AWS acquisition. We ended the year with $45 million outstanding on our bank lines and also had outstanding a $65 million term loan that was secured against the aircraft in the business. Finally, depreciation and amortization for the quarter was $12.3 million, and our CapEx for the quarter was $8.1 million. I'd like to now turn the call back over to David to close us out.

Thanks, Rick. As we look out to fiscal 2011, which we're about 45 days into at this point, we continue to expect sales in the region of $1.5 billion to $1.6 billion. I think we signaled that a couple of months ago and we feel pretty good about that range. That's up from $1.352 million in the fiscal year 2010 and diluted earnings per share we're looking at between $1.25 and $1.40, which is up from $1.16 the year that just ended. This outlook reflects improving conditions in the commercial market, increased sales and gross profit in the government and defense services segment, reflecting the full year impact of the AWS transaction and the KC10 program, and lower sales and gross profit at structures and systems, reflecting the change that Rick talked about in sales mix at our mobility products unit. I'd like to thank you all for joining the conference call today. I would now like to open up the lines to any questions you might have.

(Operator Instructions). Our first question comes from Larry Solow of CJS Securities.

Hi, good morning. Dave, can you maybe give a little more color just on some of the recent trends, on the commercial side. Obviously air traffic and load factors are improving, and I guess there's some hint of capacity coming up. Are customers spending a little more now? Maybe also a little more color on pricing pressure you're seeing and is that more mix related or is it just -- is the industry just becoming more and more competitive?

We are seeing signs of our business picking up in the commercial markets. So we are seeing increased inquiry level and we are seeing more input levels. So we are -- it's too early to say that a turnaround or a trend necessarily is taking place, however, we have seen an improving level of inquiries coming into the Company. And as a result, we have seen our sales tick up a bit as well. In terms of the competitive market, competitive environment, the customers are looking for extremely good pricing and we're taking the position as we have here now, really since January 2009 of really looking at capturing market share, growing market share, not just maintaining our customers but seeking new customers. So therefore, we are seeing a little bit of pricing pressure. I would expect that as this recovery, if we are in the early stages of the recovery, I would expect the pricing to firm up here as we move along.

Okay. And then do you have -- in your expectations, do you assume that in terms of MESA, things are not going so well there, maybe a little worse than they were a few months back, do you guys assume that -- I know you had put out a number, I think it was around $40 million, $45 million annual revenue number, do you see that shrinking as we go forward.

We've moved that number down slightly. We've moved that number down, so our number's in the $30 million, $35 million range.

Okay. In terms of AWS, can you just -- obviously there was a contribution this quarter. I guess it was closed early April. Is that a ballpark, like a $25 million revenue contribution this quarter?

I think at this point we looked at $30 million of revenue contribution. And that was for, as you said, we closed on April 7th, so that's revenues from April 8th through the balance of the quarter.

I know there's these 20 helicopters that had been in Iraq and I guess now they're idling now. Any thoughts on selling those or maybe that's too early to say or -- ?

Well, there are approximately 20 aircraft as you suggested and helicopters, and we are engaged in discussions with folks who are interested in acquiring those aircraft from us. So we will continue to advance those discussions. We don't see those aircraft long range in our plans. One of the goals of this business is to simplify the operating structure. One of the challenges is the number of different fleet types that they operate, we're trying to simplify that a little bit. There's two model helicopters which are grounded, and if we're successful in selling those, then that will reduce our complexity fairly significantly.

Okay. Then just last question, obviously the free cash flow this year was close to $3 a share, which is pretty remarkable. Maybe it doesn't continue at that magnitude, but do you expect to be significantly positive going forward?

Our plan is to be positive. I agree with you. We are seeing, and we try to signal that we are seeing opportunities to invest more in the commercial markets, and as we get a little bit more bullish on the prospects, we probably will be inclined to do so. But we are planning on generating free cash flow for the year.

Okay. Great.

We also, Larry, just to add, we will be making some investments. We have won some new contracts at AWS. So we will be investing in helicopters to support some of those, the contracts that we've won.

I guess that's a high class problem. Okay, great. Thank you very much.

Our next question comes from Ken Herbert of Wedbush.

Hi, Ken.

Hi. Hey, it's [Andrew Dupay] actually on for Ken. I just had a question on your aviation supply chain business, specifically it says year-over-year it was down 9% and that was primarily because of lower engine part sales. Sequentially it was up 15% and that was because of airframe. I just was wondering what you guys -- like what exactly happened there.

My understanding is that airframe tends to lag and so I just was wondering if you could provide some color around that? Yes, I don't know that we have a whole loss more color to add to that Andrew, other than when we say airframe, that's also inclusive of some of our program related businesses as well. And I think we saw some -- the nice part about the program business is it's less volatile and we've seen some nice -- we've seen some nice pick-up on that side but I don't think we have a lot more color to add than that was the way the numbers came in for us.

Okay, is that by any chance planes being pulled out of the desert that needed overhaul work as they were parked and they're being pulled out potentially or -- ?

We're seeing some of that. We're seeing some aircraft coming out of the desert which I think is part of the reason for David's comments on early signs of a recovery. That is impacting some of our results. We're seeing some -- the engine shops becoming a little bit busier, so I think there's still some volatility in the demand but it feels like directionally that demand is returning for both engine and airframe.

Okay.

Andrew, just so you're clear, when you say a plane coming out of the desert that needs some overhaul work, that type of exercise would be an MRO activity if the airframe needs to be worked on. I think capacity being reintroduced such as that, though, that certainly could trigger some of the airframe demand requirements we're seeing as well.

Okay. Great. That helps. My other question too is just sort of generally speaking on your MRO segment, what your sort of strategy was there. Was wondering if you guys were going to look to buy any assets potentially or were you just looking to kind of hold firm, kind of wait for things to pick up and grow organically in that sense.

Absolutely. We still have capacity available within our facilities, so we don't see a need to go ahead and expand that business. It's our lowest margin contributor around the Company. It's been a wonderful portal for bringing business into the Company and I think we have sufficient portal space right now in our portfolio.

Okay. Awesome. Thanks, guys.

Thanks, Andrew.

Our next question comes from Troy Lahr of Stifel Nicholas.

It's actually Joe DeNardi for Troy. Could you talk about government defense services business, what a good run rate going forward there is, $80 million in the quarter, does that come down a little bit or is that a good one going forward?

Joe, so recognize in the quarter, we only had two months really of AWS, not three. So you should adjust for that and I think, again, we did $30 million roughly in two months, so you can think of it as -- you can think of it as about $15 million a month, roughly.

Okay.

So you can adjust for that. The KC10 program was just about fully up-to-speed in Q4 but there's a little more head room there we think as well. So I think you're looking more at a number closer to probably $100 million a quarter.

Okay. And then with the work with the new customers you guys have mentioned in previous quarters, like Hawaiian, Allegiant, has that work ramped up to kind of a full rate or does that pick up maybe after the summer traffic season? How should we think about that going forward?

The Hawaiian aircraft, it's not a steady line, so we've done some aircraft. We're on hiatus now and we pick up again in the fall. And one of the things that we've seen in MRO, as Rick mentioned in his comments is the summer flying season is particularly tough in the MRO, particularly in Miami, where many of their customers are -- have all of their aircraft operating during the summer. In terms of Allegiant, we're still ramping those lines. We've done some work for Allegiant but it hasn't kicked in completely yet.

Okay. Do you guys see any opportunities for an increase I guess in spares activity as airlines kind of look to increase capacity, maybe in the back half of the year? How are you guys thinking about that trending throughout the year?

We do. We're looking carefully at opportunities now to take inventory positions to support increases in demand, both on the engine parts side, driven by demand at the engine shops but also on the airframe side. So we're hopeful here that we will continue to see this uptick in demand.

Okay. All right. Thanks, guys.

Next question comes from Tyler Hojo of Sidoti.

Good morning. First question, more of a clarification. Did you say that the charge associated with shutting down global solutions was $1.4 million or $1.1 million? Or neither?

No, I did -- I used both of those numbers, Tyler. $1.1 million was related to acquisition costs, related to AWS. $1.4 million was what we incurred during the quarter related to Global Solutions. That wasn't a charge, per se, to shutting it down. It was just the normal burn rate that we had for that activity during the quarter. It was subsequent to the end of the year that we had the decision to just shut it down. Having said that, I don't expect a significant charge with that decision, Tyler.

Okay.

A little color around the closedown. We have retained some of the key contract people that we were interested in retaining. We've put them into some of our business units. And we also picked up some of this capability in the AWS acquisition.

Okay. Because it seemed like there was a lot of overlap in terms of the air lift with the contract or contracts that you won within that business. Okay. And then just maybe if you could talk a little bit about the SG&A line item and, I mean, do you think you can get that back down to kind of a 10% or below percent of sales, say within the next 18 to 24 months? I mean, what's kind of the internal goal there?

So Tyler, as you know, historically our goal has been to have SG&A as a percentage of sales at or below 10%. We've had a little bit of a tick-up here and our goal continues to be to work that down to 10%. So I think in about the time frame you've laid out, our goal would be to get it back down to the 10% of sales.

Okay. Great. And then --

Tyler, just to add to that. Again, one of the things we faced this first year with AWS is purchase accounting amortization, that's much greater in the first year than it will be subsequent. I mean, that's a reality we've talked about since we announced the deal. That's driving up the rate and as that burns off, that will certainly help us get that rate back down.

Understood. All right. Great. Just on KC10, you mentioned kind of profitability there and I was just wondering relative to kind of your expectations when you took on that work, how is it tracking from a profit standpoint? It certainly seems from a top line standpoint that it's kind of meeting the expectations.

I think the program is performing about how we expected it to perform. We are working through what I would consider to be kind of normal front end implementation issues. It's a new program. It's a large program. It's a complicated program. But on balance, I think it's on track and we're looking to continue to improve our overall performance.

All right. Great. And just lastly from me, I was hoping you guys could maybe touch on the aircraft portfolio, how many planes wholly owned, and joint venture and then perhaps if you could follow up, just speaking to the JV line item and kind of expectations there going forward.

Yes, so the portfolio as it sits today, Tyler, really hasn't changed. We have five wholly owned aircraft and 27 that are owned with joint venture partners. All the -- lots of detail on each of those aircraft types, who they're leased to, and what our expected disposition is, will all be outlined in our 10-K, which we will file at the end of this week, the same way we disclosed it in the past. In terms of the P&L impact, I think the guidance I would give you would be similar to what we saw in 2010. I would expect basically a breakeven outcome from the JV portfolio as we go through the year.

Okay. And in terms of -- how many leases are coming up, say within the next 12 months or so?

We have seven aircraft that are scheduled to come off the lease, seven or eight. I'll have to double check that for you. But all of them are being in discussion with the current operators about either extensions or in one case, taking it back for disassembly.

Okay. And in terms of the discussions, I know it's probably a little bit early but I mean, is the pricing relatively flat, down or up?

Current market conditions?

Yes.

Relatively flat. I mean, we don't expect major changes.

Okay. Appreciate it. Thanks.

Our next question comes from Eric Hugel with Stephens.

Good morning, guys.

Hi, Eric.

Maybe on the MRO and on the aviation supply chain, can you maybe just sort of give us a ballpark sense as to the weakness in the sales, how much of that is maybe volume versus how much is pricing?

Well, they get pretty interrelated, right, Eric? As we have talked about in the past, in what is a relatively soft demand environment, we can choose to either stay on the sidelines and hold out just for a price, or we can participate in that soft demand which usually means you get some weaker margin performance. So it's hard to bifurcate it as much as you'd say. I think fundamentally, demand has been softer than -- certainly than we'd like it to be and certainly than we'd seen a year ago and that's resulted in shortness in the top line as well as some of the margin degradation that you've seen.

With regard to the new AWS business that you won, I guess those contracts, just maybe you can clarify, my understanding was that when we spoke to you when the deal closed that all the planes that were -- except for those planes that were parked that you're trying to sell, were pretty much sold out. I guess maybe I'm confused now that you won this new business, where are you getting the planes to fly this business?

I think I mentioned, Eric, that as we look at -- to answer the question around cash, free cash flow for the year, that we would be investing in some helicopters to support some of these contract wins and actually we also won some fixed wing contract as well. In the case of the fixed wing contract, we're going to lease in the aircraft. There will be a lease in, lease out, at pretty acceptable margins. And then on the rotary wing contract we acquired this fiscal year-to-date, we've acquired four helicopters to deploy against these contracts. So that's where we're getting the assets from. The fleet is fully utilized, except for the aircraft as we communicated that came out of the Iraq theater that were put up for sale.

Are those major sort of -- buying those helicopters, are those sort of major investments.

We spent -- on four helicopters we spent $30 million, give or take.

Okay. David, maybe a little more -- the global solutions business, I mean, when you rolled that out a year or so ago, I mean, that was a pretty big sort of focused effort of the Company. I mean, you guys plowed a lot of bid and proposal money into that. I mean, can you maybe give us a little more color as to -- I mean, what kind of -- I understand maybe you acquired AWS and you've acquired some of the stuff, but what were some of the benefits that you learned and maybe why do you feel comfortable now or why don't you need it now?

First of all, there's tremendous benefit moving into that arena. We learned about a whole market niche if you will within the government services arena. Obviously, the direct impact was finding the AWS acquisition. But I think at the same time, it opened up our eyes to a series of government support contracts that are out there, that are kind of fit our model. So the contracting piece was -- and the reason behind global solutions was to be the front end, if you would, to helping us drive more of our fulfillment capability into the end user customer.

We've always had the fulfillment capability. Of course, we've added a bunch of it now with this AWS acquisition. But we didn't have the front end piece and now we've been able to take out, pull from that business, some of the front end piece assets, put them into our businesses and give us a little bit more ability around bidding and hopefully winning some contracts. At the same token, there may be other opportunities that emerge further downstream that cause us to get a little bit more aggressive in terms of a front end business of this nature showing up again. It will probably be a different form from what we previously did but there could very well be additional impetus on our side to get more aggressive in that regard. It is a marketplace that is fit -- the end user market for the type of service that global was designed to produce is a real fit for the skill sets that we have within AAR.

Lastly, and I'll get back in the queue, Rick, can you give us some expectations as to what your targets for D&A and CapEx are for fiscal 2011?

Yes, Eric, so let me start with the CapEx. It's going to be variable, quite variable, based on potentially new bid wins at AWS. As David indicated, we've had some nice momentum already since we bought the Company.

We have some current bids that are outstanding as well. And if in fact we're successful with those, we'll acquire assets to fulfill them. And while we may be able to lease them in, I think we would have to plan to potentially buy them. So I say all that, just to let you know. I think somebody earlier in the call called that a high class problem. We look at it that way as well. So we're quite excited about those bid opportunities.

Putting those aside, Eric, I think our CapEx -- and when I say this, inclusive of the money that David indicated we spent already on this business, our CapEx for the year should be between $55 million and $60 million. With new bid wins, we may increase that number. Again, the nice thing is, you don't have to buy the asset and hope you win the business. We can be assured of the business before we make that final commitment on the asset. Depreciation for the year, Eric, I'll have to get back to you with that. I think that number is going to be -- for this year we finished just under $40 million. We finished about $39 million. My expectation for this coming year is somewhere around $50 million to $55 million, but we'll have to -- I'll have to clarify that with you.

Great. Thanks a lot, guys.

Next question comes from Gregory Macosko of Lord Abbett.

Yes. Thank you. I wanted to thank Tyler for asking my questions on leasing. Could you talk about the backlog a little bit, give us some more color on that, please? You said $600 million?

Yes. We are going into the year, Greg, with a $600 million backlog. As you know, much of our supply chain business isn't really backlog business. The AWS backlog going into the year is $125 million, and the bulk of the remaining backlog is in our structures and systems segment.

And what's the life on that?

We'll go through the majority of the backlog, probably 70% of it this fiscal year, Greg.

Okay. Good. Good color there. And then with regard -- you talked about the KC10 program. I know that you had mentioned some transition issues from the previous manager there. Did you feel any of those in the quarter? Are those gone? And I would assume that would help the margins sequentially.

As I said, it's a new program. We've only been on the program for a few months here. It's large. It's complex. I think it's going to take a little while here to kind of be running kind of as smooth as we are on some of our other programs, and as I said, I mean, I think as the -- as our performance improves, I think there will be more efficiency.

And with regard to the proposals, the RFPs, et cetera, in AWS, et cetera, did you see -- what are you seeing there in terms of the activity on proposals? You had talked about it previously with regard to global solutions and I assume that is kind of merged together?

There is a fair amount of activity in AWS. We talked about the demand for this type of support and we're seeing it in many different areas.

Okay. Very good. Thank you.

Our next question comes from JB Groh of D.A. Davidson.

Good morning, guys.

Good morning, JB.

Rick, I had a quick clarification on this SG&A. You outlined kind of $2.5 million of costs that were sort of one-time and the acquisition related costs for AWS and the global solutions that you spent. In terms of the winddown of global solutions, how much longer are we going to see SG&A impact there and is there any remaining acquisition related costs from AWS that will be in SG&A in the future quarters?

So, on global, you won't -- we won't be talking about that. We'll have a de minimus amount of tail to that, but that won't be something you'll hear us talking about prospectively. With regard to acquisition related costs, no, I mean, everything acquisition-related on AWS in terms of deal related costs have been recognized. Okay? So now future impact at SG&A from AWS will just be really a function of purchase accounting impact as well as, again, the nature of their business, which as we've talked about is a little more capital intensive business.

So JB, there definitely will be a residual impact from AWS and as I had stated in my comments, as we sit here today, they have a higher than average for the rest of our Company SG&A rate to sales than the rest, so they are bringing up the collective number for the Company. But we see the opportunities to improve that and certainly as the purchase accounting impact of year one runs off, that will help out as well. So we remain optimistic that we're going to drive that rate down. And our goal continues to be to get back to 10%.

Can we quantify that purchase accounting impact in the year or just trying to get to sort of a normalized run rate on G&A excluding these kind of items that are abnormally high currently but should come down naturally, even without your cost saving initiatives.

Well, I think there's a lot of numbers. There's a lot moving around as you anniversary this contract. And let me -- just maybe before we keep talking further, let me clarify a question that Eric Hugel had asked earlier because I think it relates to this conversation. So depreciation and amortization for the Company, and that's not all that's in SG&A, but it's part of it, was $12.3 million for the quarter, and for the year was about $39 million. Our expectation for 2011 is that depreciation and amortization will be a little over $60 million in fiscal 2011. So you can see the big jump and that's, again, reflective of the CapEx as well as the purchase accounting effect as well as the capital nature of AWS. I think in terms of -- if you're looking for a pure run rate on that going forward, JB, I'll have to give a little more thought to that and provide that, provide some information on that supplementally.

Safe to say a good portion of the increase in the D&A from 2010 to 2011 is that purchase accounting adjustments?

Well --

Going from, say, 40 to 60, that $20 million is a number half that or something in.

Okay. But that is depreciation and amortization.

Right.

So purchase accounting would just be the amortization part.

Right, right, right.

And you have a large asset base that you're depreciating that we've added to the Company. I think maybe said differently, the jump from $40 million annually to $60 million is that mostly driven by AWS, the answer is yes.

Got you. Okay. And then maybe a little guidance on your expected interest charge and the tax rate was a little volatile. What's the expectation there?

Interest of -- net interest of around $7.5 million a quarter I think is the right way to model it right now. Tax rate should be somewhere between 34% and 35%. So 34.5% I think is an appropriate effective tax rate. The volatility you saw really in 2010 was related back to our first quarter where we had kind of a peculiar accounting related to a leverage lease transaction that was unwound. I think it's been reasonably consistent since then.

Okay. Thanks a lot, Rick.

You're welcome.

Our next question comes from Stan Mann of Mann Family Investments.

Gentlemen. A couple of questions. One on cash, cash utilization in the new year. Would you say you're leaning toward paying debt down or utilizing it for acquisition? Is there a sense at this point in the year?

As we enter the year, Stan, I think what I signaled is that we expect once again to be positive cash, generate free cash flow from the business. At the same time, we are seeing opportunities for some pretty solid investments. We've kind of raised the bar in terms of what we want to see in a return on our capital and we do see opportunities as we've been discussing to support this AWS acquisition, and we also see opportunities to support the commercial markets. So my sense is that there will be a -- kind of a combination, if you will, of investing in the growth of the business, as well as continuing to address the debt repayment.

And the cash flow in the new year really compared to this year should not go down, I would think, especially with that D&A going way up.

The free cash flow might not be as -- won't be as appealing because we will be applying some of that cash to some deals.

Okay. Last question is at this point your projection for the new year on earnings from me is kind of conservative. At this point in the cycle and what you're seeing, are you encouraged? I mean, do you feel good about the new year? I mean, you've seen -- I know you've seen just a little bit of it, but you're seeing the things come together and can you comment on your optimism, pessimism, whatever, and strength of -- ?

I feel really good about our businesses. I think as we sit here today on July, what, 14th, 15th, we feel -- we've gotten off to a good start for the year. We've had some contract awards. And we feel good about our business.

You do feel strongly that you put out some good -- you feel strongly about what you've forecast relative to what you're seeing?

We feel good about the business.

Okay. Well, that's not the general trend. A lot of people are extremely nervous and there's butterflies in their stomach. So you're feeling good. That's good.

We always have butterflies in the stomach. I've never gotten away from butterflies in the stomach. That's still there. They're good, butterflies, not they're caterpillars.

Good. Thank you.

We have a follow-up question from Larry Solow of CJS Securities.

On the CapEx I guess nearly doubling from sort of your -- it's been around $30 million a year for the last several years, is that pretty much all related to AWS?

Yes. Larry, it is all related and don't conclude that that's an annual run rate for AWS. Again, we have won some new business and that new business is what's triggered the asset investment. But yes, our expectation of what I said earlier, close to 60 for the year, which is, as you point out, almost double what we've seen the last couple years is entirely related to the AWS entity.

Does that assume additional contract wins or it would actually go higher if you got more contract wins, I assume, right?

That includes all the contract wins announced to date.

Right.

There are -- there is bid activity and proposal activity that could trigger more contract wins.

I know when you acquired it you put out sort of a year two, $0.20 to $0.30 EPS impact. Are you still comfortable with that number?

The business has met or exceeded our financial expectations.

Fair enough. You had obviously some multiple bids out there with global solutions. Does the fact that you're winding down that JV, does that impact these outstanding bids at all or -- ?

No, the bids that we had, we have -- we've elected -- the bids that were outstanding, we've elected not to pursue at this stage and the things that we're focused on, we will be picking up just within AAR.

Got it. Okay. Thanks.

We moved the capability into our defense systems and logistics business as well as what's embedded within the AWS business.

Got it. Great. Thank you.

And we have a follow-up question from Eric Hugel of Stephens.

Hey, guys. Just a follow-up to the prior question. You talked about the $0.20 to $0.30 accretion in the outyear. Could you give us a ballpark estimate as to how dilutive AWS is for this year, given the step-up in the purchase accounting.

It's not dilutive, Eric. It's not dilutive. It's just not at its what I would call normal earnings rate potential. So we have to get past a year one hit. But we definitely don't see AWS as being dilutive this year.

Okay. Is there any -- if you sort of looked at -- I lot of your commercial aftermarket operations, the MRO, is very US-centric and obviously that's where the least amount of capacity growth is coming back into the market. Are you seeing any difference in trends in the US market versus maybe some of your component repair and overhaul shops over in Europe or demand coming from outside the US?

Well, the demand increases that we're seeing now are largely coming from our North American customer base, Eric.

In the trading business, our program business, Eric, has some pretty good proposal activity from customers outside of the US.

Okay. Fair enough. Can you talk about specifically with regard to your MRO business, I know like first quarter is weak because of the summer flying season but as you look out and you look at sort of how booked you are in terms of your bays to sort of perform maintenance, can you give us sort of a sense as to sort of as we look out in the second and third quarter, you're talking about growth, are you pretty much full? Are you maybe at 70% capacity? 80% capacity? Can you give us sort of an understanding sort of based on the business you're seeing now sort of where things stand?

We're not full across all of the facilities, but we're starting to see this increase that I've been referring to. We're ready to -- getting ready to announce a new customer at Indianapolis which will take on another hangar or two, at least eventually. Miami, which has less long-term visibility is the one as I said earlier gets hurt the hardest during the summer months but does get pretty busy during the rest of the year. And then Oklahoma City is pretty solidly booked. So we still have room but it is definitely getting busier.

And can you just maybe give us an update as to on the logistics support side of the business, sort of like KC10, those contracts don't come across all that often, but sort of is there anything sort of in the pipeline, either on the military side or on the commercial side of meaning that we should be sort of looking out for?

I think Rick signaled that there's a couple larger international air carrier opportunities on the supply side, supply chain logistics side, commercial aviation, I should say, and we are stepping up our BD effort in the defense logistics area. There's a lot of focus right now on the KC10 integration program that we've been talking about because it has interesting dynamics about it in terms of potential earnings leverage, as we get over the initial phase. But there is a good pipeline of transactions but not of the size of the KC10.

On the commercial side on logistics support, those are typically the types where you have to go and buy a lot of equipment, effectively they want to use your balance sheet. Can you sort of give us sort of where you stand with regards to sort of effectively taking on other people's inventories, given sort of the experience you had with MESA?

If you look at the blend of contracts that we've had over the years, the MESA one obviously is a real exception and I think if you look at the recent transaction we had last year with Jazz, we used very minimal amount of inventory to succeed in that transaction. In a couple of these different transaction that's we're looking at today, one we are looking at with a partner, where the partner will be providing the financing and we'll be providing the logistics, the repairs, the replacement, et cetera, and then one of the other international transactions that Rick alluded to we will be using some of our balance sheet and it will be -- the balance sheet will be utilized for -- this will be very new generation equipment, 737 NG type of equipment and so we have a high level of confidence in the quality of the assets and the portability in the event that the customer itself should go through what a MESA went through.

And I guess lastly, maybe with regards to the leasing business, can you sort of give us an update as to sort of where things stand on maybe what you're seeing in terms of the market in terms of pricing, in terms of your availability to sell some of these aircraft, credit, just sort of where do things stand in this cycle right now?

The credit markets are still very tight. The aircraft changing hands is not as brisk as you'd like to see. So we've taken a position, we continue to work down the investment so the investment today is about $5 million or $6 million less than it was last year at this stage. So we're looking at this as kind of a holding period, if you will. It's not -- haven't been a tremendous amount of opportunities to flip assets. We do have one of the assets has been presold for delivery in later in 2011, I believe fiscal year 2012. So we're constantly looking for opportunities to keep working that asset base down.

And you're still confident that in the event that you can't sell an airplane that comes off a lease, you can just sort of tear it apart and sell the parts for profit?

We've had some success in that regard. We could use in cases -- some of these assets, we do require that they continue to stay on lease longer before we can be in the position you just indicated.

Thanks a lot, guys.

(Operator Instructions). Our next question comes from Tom Lewis of High Value Research.

Hey, good morning.

Good morning, Tom.

Just a quick question about this new line of business of being an owner operator of supplemental air lift. Seem to me it would entail a risk that you haven't really encountered before in terms of suddenly and catastrophically losing an aircraft. I guess there's folks out there that don't want you doing that. I was curious how you would manage that risk. Is that something you could insure for or is there something in the operating contract that would cover all or most of that loss.

Both. So it's insured and then we're operating under certain regulations, if you will, that protect us from our investment.

Okay. So if you were to suddenly lose a $6 million aircraft, I imagine there would be some kind of like the deductible on your car but it wouldn't be a $6 million hit to the owners of AAR?

That's correct. That's correct, Tom. We carry property insurance. I mean, just, again, to be clear, a good chunk of the fleet in this business is collateral for secured loans so you can imagine that lender has gone through all the same questions that you've just asked. So it's a pretty tight structure in terms of the property coverage on these assets.

Okay. Great. And my other question would be -- I don't know how you would quantify this, but maybe you could characterize if we look back over the last couple of years as sort of an ebb cycle, part of the cycle in commercial assets, how would you characterize your opportunity to purchase either engines or aircraft for teardown as compared with past similar moments in the cycle?

It's a little hard to -- actually zero in on where we are in the cycle at this stage. Our sense is we could spend as much money as the US government could print right now and so we're kind of picking our spots, if you will, Tom. We are making investments. We are making investments at attractive levels. But to Rick's point also, we are focused on playing in the game on the sales side. So the margin, the purchase price might be more attractive but the selling price might be a little less than ideal. So my sense is we're still in the early stage of the recovery and you could spend as much money as you wanted to.

Okay. And in terms of whoever else might be showing up to bid against you, and again, compared with the past, more so? Less so? About the same?

About the same.

Okay. Great. Thanks a lot, guys.

Our next question is a follow-up from Larry Solow of CJS Securities.

Just a quick follow-up on structural systems with some of these mobility contracts, it's winding down, do you expect -- I guess you had a run rate of around 110 the last couple quarters. Do you expect that to kind of come down a little bit on the revenue side?

Larry, it's Rick. Yes, I think we would expect to come down a little, not a ton, but I think it could come down a little bit on the top line but I think margins is where we would expect a little more impact as those come back a little bit towards more traditional levels.

Right. Okay. And then just on Indy, how many hangars are being utilized today? Like six or seven or -- ?

We have five heavy maintenance lines going. We have three mod visits in and the paint hangar going.

And you add this new customer, would obviously fill in there so actually it's looking like it's getting pretty filled there.

It's getting closer, yes.

Okay. Excellent. Thanks.

Our next question is a follow-up from Tyler Hojo of Sidoti.

Hi. Just on the capital expenditures that are kind of related to AWS in the upcoming year, I'm just kind of looking at the business and when you bought AWS I think there was something like 20 helicopters that were available for sale or whatever. So basically you're going to buy more helicopters here. I'm just trying to get a better sense of how -- what gives you guys confidence that the same thing's not going to happen with the new assets that you buy. Does the government give you some sort of guarantee in terms of time or how do you think about that when you're actually making these purchases?

The contracts that we're purchasing the assets again have a longevity. These are five-year contracts with basically one-year -- five year contracts with one year renewals. We have recently spent time with the US trans com command folks to get a sense as to how they saw this supplemental demand continuing. And they feel that this is extremely vital air lift capability for a few different reasons, one of which is it's cost effectiveness. For instance, we perform an air drop function that alternatively, with a relatively small what's called CASA aircraft and we perform that service where the government would have to use a C130 in its place an the C130 would cost a lot more to operate for that kind of mission. So the kinds of missions that they have slated for us are of a supplemental nature, but also of a taking into consideration the cost effectiveness of which we can deliver.

So as we go out and acquire these assets, one of the things I mentioned earlier in this conversation, Tyler, is the need for simplicity within this operation. Keep in mind now, we've only owned this business for 90 days. So we're kind of in the last phase if you will of what we call phase one. We've kind of broken this transition into three phases and phase one has kind of been to normalize the business. As we get into phase three, we'll be looking at commonality amongst our fleet. The two aircraft types, the aircraft that we've been acquiring are not new aircraft types to the fleet.

They're additive to the fleet which means that our -- if you think of the Southwest business model around 737s and the simplicity that's kind of where we're heading in terms of this operation. The two, of the 20 aircraft helicopters that are parked, there are two category aircraft and it is our goal to exit from those two categories of aircraft. In the process of doing that, we have less training expense, we have less spare parts expense, less maintenance expense, and more simplicity.

Tyler, just two follow-on comments to what David just said. I mean, first and foremost, I want to be clear, the CapEx guidance we provided so far is a gross number so it's not net of any expected proceeds of disposing of this idle fleet. You can recirculate cash and I want to be clear on that.

The second is, to be really clear, in your question you made it sound like it was perhaps a problem with these aircraft, I mean, when you look at the acquisition cost of these aircraft plus -- and then compare that to the earnings they generated while they were operating and the expected residual value as we sell them, it's a great ROIC. It's a great investment. And that's the same kind of approach we'll take, we've taken and will continue to take to these new investments in front of us. If the expected earnings power and considering a very conservative residual value make it look like a good return on investment, that's the way we'll analyze it. Just because this fleet's idle, it shouldn't be construed as a problem.

Just so I understand what David was saying before, basically is what you're saying is that you could find new business for the 20 helicopters that are basically parked but it's just not the best use of capital? I mean, is that kind of the take-away?

I think what I would say is our preference is to simplify the fleet structure. In the process of simplifying the fleet structure, the aircraft that are currently parked are better off exiting our fleet and we believe there's demand. We know there's demand. We've had people come in and look at acquiring the aircraft. So it would be our preference at this stage to cash out of that fleet and essentially use that cash to finance additional lift under with similar type aircraft to what we currently are operating.

Great. Okay. Thanks for the clarification. Really appreciate it.

I'm not showing any additional questions at this time.

Okay. Well, thank you very much for your participation this morning and I hope everyone has a nice day and a good summer. Take care.

Ladies and gentlemen, this does conclude today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.