AAR Corp (AIR) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the AAR Corp. first quarter fiscal 2011 earnings call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session. (Operator Instructions) As a reminder this conference call is being recorded. I would now like to turn the conference over to Tom Udovich, Director of Investor Relations.

Thank you, Latoya. Good morning, ladies and gentlemen and thank you for joining our first quarter fiscal year 2011 earnings conference call. Before we begin, I would like to 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 the risk factors section of the companies May 31, 2010 Form 10-K and providing forward-looking statements the Company assumes no obligation to provide updates to reflect future circumstances or the occurrence of anticipated or unanticipated events. On the call this morning is David Storch, Chairman and Chief Executive Officer of AAR and Rick Poulton, AAR's Chief Financial Officer. David and Rick are taking the call from Boston. Joining me here at AAR's corporate office just outside of Chicago is Tim Romenesko, AAR's President and Chief Operating Officer. At this time, we would like to begin the call with opening comments from David Storch.

Thank you, Tom, and good morning, everyone. Rick and I are sitting here in Boston overlooking Boston Harbor. It's a much more pleasant view than we typically experience in Wood Dale, Illinois. Yesterday afternoon we announced our first quarter fiscal 2011 results and I trust that you've all had a chance to review our press release. Overall, I am very pleased with our first quarter performance. Sales for the period reached a record $412 million, an increase of 21% on a year-over-year basis and up 11% sequentially from our fourth quarter. Net income was $13.7 million and diluted earnings per share was $0.35, an increase of 30% from the prior year and up 21% sequentially.

For the first quarter sales to commercial customers met our overall expectations. In that market we are beginning to see a modest recovery in demand from our commercial customers as the airline environment is showing signs of improvement. Passenger traffic has increased and airlines have added capacity, albeit at a slower pace, and we are guardedly optimistic that this trend will continue for the near term. We have an industry leading position in our supply chain businesses and are one of the three largest providers of outsourced MRO services in North America with a strong and diverse customer base. I believe we are in an excellent position for our business in supporting airlines to flourish as the environment improves.

For the first quarter sales to government and defense customers increased 45% compared to prior year and represent 55% of our total sales. The increase principally reflects the impact of AWS, and increased activity within the KC-10 program at our defense systems business. Our government and defense business is broad and while we anticipate the US defense budget may see reductions in the upcoming years due to budgetary pressure most of our business to this customer segment comes from the operations and maintenance portion of the budget which has historically been less susceptible to cuts. We've owned aviation worldwide services a little over five months and the performance has exceeded our financial expectations since closing on the acquisition in early April. This operation has quickly become a meaningful contributor to the Company's consolidated results.

During the period, our net investment in AWS increased approximately $33 million as we invested in aircraft to support recently awarded contracts as well as rotable spares for our existing fleet to improve operational readiness. Over the next six months our integration efforts at AWS will focus on improving the supply chain and as many of you know our defense logistics business currently provides supply chain logistics support to 16 defense programs supporting a number of different aircraft types. Our defense logistics business will integrate the AWS operation with the goal of optimizing the investment in assets used to support AWS's fleet and improve the aircraft maintenance process. This will lead to improved aircraft availability and expand margins in this operation.

Demand for our services is very strong as we continue to see opportunities to provide airlift support to numerous customers around the globe. During the first quarter we resumed buying shares of the Company's stock on the open market. We acquired 150,000 shares and have a little more than one million shares remaining under the Board authorized share repurchase program. While we made good progress in the first quarter, we are not satisfied and will continue to drive the Company for further sales growth and margin expansion. We are recommitting to our 10% operating profit margin goal and in the process of developing plans to achieve that important metric.

I will now hand the call over to Rick who will provide further details on our financial performance during the quarter.

Okay, thanks, David, and good morning everyone. As is customary on this call I'd like to provide a little more detail on the performance in each of our operating segments and then I'll wrap up with some broader comments around interest, depreciation and capital expenditure information.

Within our supply chain segment sales increased 5% on a sequential basis as volume increased in both our airframe and our engine after market parts businesses. This sequential growth includes the negative impact of the expected reduction in our sales to Mesa Airlines so we exclude the impact of the change in our Mesa program, the segment growth was 7.5% sequentially. Historically the fourth quarter has been our strongest quarter in this area as airlines ready their fleet for the busy flying Summer season so we feel pretty good about this percentage growth given the seasonal trend. At the gross profit level, margins improved 200 basis points over the fourth quarter reflecting the higher sales volume as well as a more favorable product mix. As you'll recall our aircraft sales and leasing product line is reported in this aviation supply chain segment. During the period one aircraft was returned off lease bringing our total from 32 down to 31 now, and that aircraft was disassembled. A second aircraft will be returned in the second quarter and also be disassembled for parts that will ultimately be sold to our customers.

Within our government defense services segment, AWS contributed approximately $65 million in revenue during the first quarter. This was higher than the original expectations we set when we bought the Company and it was driven by the new aircraft replacement service in the first quarter as well as a peak in volume for aircraft modification services of approximately $7 million. This peak in volume was related to an aircraft mod project that we are doing for a Middle Eastern customer and that is winding down and therefore not expected to repeat in the second quarter. Taking into consideration the business we've won since we have owned the Company, we expect that annual sales run rate for AWS will now be approximately $230 million to $240 million. You should note that this is $50 million to $60 million higher than previously communicated in March when we first announced the deal.

The gross profit margin in government defense services was 17.8% in Q1 compared to 21% in the fourth quarter. The reduction in this margin percentage was due to three primary reasons. The first being the KC-10 program continues to experience transition costs and that is being a drag on margins. We expect this will improve as the year progresses. The second item which unfavorably impacted the gross profit margin was a contract adjustment in the pricing structure at one of the Company's supply chain programs. This was a scheduled price reset and the impact of this item will stay with us. The third item reflects a change in the classification of certain expenses at AWS. In the fourth quarter we had treated approximately $2 million of costs as SG&A and now in the first quarter these are classified as cost of sales and therefore reflect in the gross margin calculation. This item is simply a reclass and while it lowers the gross margin percentage in this segment when we compare it to last quarter, it does have an offsetting positive improvement in our SG&A as a percent of sales ratio and ultimately has no impact on operating margin.

In our MRO segment, sales and margins declined slightly from the prior year as part of a typical seasonal trend. As we head into the second quarter, based on current customer commitments, we expect that year-over-year and sequential improvement in this segment. Our facilities are very busy and we are on track to deliver work on an engineering services contract for a major US carrier and that will increase nicely in the second half of the fiscal year. In our structures and systems segment, sales and gross margin are lower due to an expected reduction in activity at our mobility products unit. As we look ahead to the second quarter we would expect sales in this segment to be approximately flat with first quarter levels.

Moving to the cost side, we made progress on our stated goal of SG&A as a percent of sales to get ultimately down to less than 10%. For the first quarter, SG&A as a percent of sales was 10.4% and this compares to 10.8% in the first quarter of last year as well as 11.5% in the fourth quarter. The improvement reflects leveraging the existing SG&A base across the organization as well as the change in the classification of certain expenses at AWS as we previously mentioned. Net interest expense for the quarter was $7.3 million an increase of $1 million over last year and it reflects the higher average outstanding borrowings compared to the same point in time last year. As well as the non-cash interest expense accretion on our convertible notes. Breaking down that total interest, our cash interest expense was $4.3 million compared to $3.7 million last year and our non-cash portion was $3.1 million in the first quarter of this year compared to $2.8 million last year.

During the quarter we did opportunistically acquire $6 million face of our 2.25% convertible notes in the open market and we acquired these for $4.7 million in cash. This created an accounting gain of approximately $100,000. Our depreciation and amortization for the quarter was $14.4 million and this includes approximately $1.9 million of amortization expense of purchase accounting and tangibles at AWS. This impact from purchase accounting intangibles will stay constant this year and will decline by about a third on a quarterly basis in both fiscal 2012 and 2013 and then after 2013 should drop to close to zero.

CapEx for the first quarter was $37 million and includes the previously mentioned aircraft purchase at AWS. Our net capital expenditure plan for the year remains at $60 million as we had indicated at our last conference call. That wraps up my prepared remarks on first quarter performance. I do want to mention though that we'll be hosting an investor conference in New York on October 6. I believe most of you have received an invitation but if you have not and would like to attend the event please contact our Investor Relations department. With that, I would like to thank you for joining us on the call this morning and we'll now open up the line for questions.

Thank you. (Operator Instructions) Our first question is from Troy Lahr from Stifel Nicolaus.

Yes, it's actually Joe DeNardi for Troy. Could you guys talk a little bit about the sequential decline in margins at your government defense services business? Is that kind of maybe lower margin on the KC-10 program or issues with some of the new programs at AWS and maybe how that trends through the year?

Yes, well Joe, let me go over it. We went into a fair amount of detail, I don't know if you heard all of my prepared comments but there were really three drivers to that decline sequentially in margin. Okay. The first was related to KC-10 program. We had some transition costs that we continue to incur to deliver the performance that the customer needs. We remain confident we'll work through those increased costs as the year progresses, so we see that as an impact but one that should be temporary.

The second area which I mentioned is we did have a pricing adjustment on one of our supply chain logistics programs so not related to AWS, but one of our other supply logistics programs besides the KC-10. It was a scheduled pricing adjustment. It's a very long term contract and it's not unusual to have some provisions in some of these longer term contracts where we readdress price that kind of protects both parties, so that was a scheduled event that occurred and that results in a little bit of an unfavorable margin impact to us; however we have extended the contract and it continues to be a profitable very desirable opportunity for us.

The third area was at AWS, but it was simply a reclassification of certain expenses from -- that previously had been in SG&A and now we are classifying them as part of cost of sales. As we looked at it a little closer and mapped it into the Company and saw how we were treating similar costs at other business units we concluded it made more sense to call it cost of sales, so that's simply a geography reclass on the income statement. So those are the three drivers and they all had -- that explains virtually the entire reduction in the margin and they all had impacts that were meaningful.

Okay, yes, and then the margins at structures and systems around 18%, is that a run rate we should look for going forward or does the mix begin to improve kind of as you start to maybe get some more work with mobility products?

So Joe, I think our guidance on that score is really not changing very much. I think what we would point out is if you looked historically back at the segment, this is a segment that traditionally generated gross margins of anywhere from 15.5% to roughly 16.5% and we saw that go up dramatically in fiscal '10. First quarter of last year was actually lower than we're creating this year but it was already on the rise and then if you looked at second quarter and third quarter last year we had very strong margins. We were pretty transparent during that whole time that we knew those margins were not here to stay and that they would come back down, but our expectation is when margins ultimately settle in in this segment they should settle in slightly higher than our historical norm because we've generated some of that margin improvement through factors that should stay with us such as our low cost manufacturing facility that we opened up, et cetera. So that's what we've been saying and I think we'll continue to say. That continues to be our guidance with respect to margins in that segment.

Okay, thanks.

Thank you. Our next question is from Tyler Hojo of Sidoti & Company. Your line is open.

Good morning, everyone.

Hi, Tyler.

So first question, just on the EPS guidance. I didn't hear you guys update that. You were at $1.25 to $1.40. It seems like you'd at least be at the high end of that but would you care to update that at all?

Tyler, you followed us long enough to know we have traditionally not provided a lot of guidance for a variety of reasons. We decided to deviate from that practice as we ended fiscal '10 and going into fiscal '11 in large part to try to set a common set of expectations with the investor base. We had a lot of wide range of expectations out there. I think we accomplished our mission with that and our current thinking is we're not really going to get in the business of providing quarterly guidance again. So we're not saying anything with respect to that prior. We do feel very good about the business though and we feel good about our environment.

Okay, that's fair. And maybe just going back to the KC-10. I guess what gives you the confidence that you're going to see kind of the margins improve? I'm sure there's things internally you're looking at but just for your investors if you could perhaps point to a couple of items that kind of are going better that give you guys the confidence that the margins are going to improve on that particular contract?

Tyler, there's been a surge if you will in activity supporting the customer. The aircraft have been coming through maintenance and we've been trying to speed up the maintenance process, so together with our partners we're gaining more experience around the aircraft and the month of September is starting off better than the month of August let's say, and historically and traditionally in this kind of market early on in the program, you experience a more challenging environment than you do as the program matures and as we gain more experience around the program, so the KC-10 program is a large program and the maintenance is being performed at a couple of different sites. We're in the process of repositioning inventory to the different sites so that as we move forward, we'll need less people in the process. Right now we're throwing people and resources at the aircraft and less people and resources in October than we have in September, less in November than October, and hopefully by January, we'll be experiencing the kind of margins that we expect.

Thanks for that color, and just lastly for me, hoping you can touch a little bit more on the aircraft leasing business. I'm sure you guys saw there was pretty interesting pre-solicitation out in early August. Government is looking to purchase a couple 737-4s and it seems like kind of the market price they were indicating seemed reasonable and you guys were mentioned in the pre-solicitation. Just wondering how you feel you're positioned to kind of move a couple of those aircraft in this fiscal year?

Yes, well we're looking at that bid where we are aware of the bid obviously, the bid does have a certain weight requirement for the aircraft that many of our aircraft did not meet but we do have other solutions for that on that situation so we are -- we will be competing in that. As we see it today, we will be competing in that situation.

Okay, and you feel, I'm sorry, go ahead.

I would just add, Tyler too, recall all of our 737-400's are on lease today. Nothing is parked. So we have Operators for all of those aircraft today.

Okay, but you feel like the pricing is kind of firming here? I mean, is that fair?

My view is that the pricing is firmer today than it was say a year ago.

Fair enough.

So my anticipation is that it's pricing -- based on prior cycles the pricing will continue to firm.

Okay, great. Thanks.

Thank you. Our next question is from Larry Solow of CJS. Your line is open.

Hi, it's actually Arnie Ursaner backing up Larry. Good morning. On the AWS revenue change that you indicated, if I take out the $7 million that you referred to as kind of peak activity and look at the $58 million you gave us, it raises a couple of questions. One, is if I just take that level it would be in line with your guidance, so part one of my question is are you assuming no further growth in AWS for the balance of the year/ And then the second thing is if I were to look at the $50 million or $60 million delta versus your previous view, how much of that is from your previous conservative view when you inherited the business and how much from new contract wins that you've had?

Well, let's just start with the math. So Arnie, your math of 58 times four you're right gets in the range and that's all we were trying to do is point out to everybody that absent future growth, that's what our expectation should be and we wanted to make sure everybody understood that because we had put a $180 million target out there when we bought the Company. With respect to that we appreciate your labeling that conservative but that was our expectation. Most of the change does come from the new business we won. We are getting a little bit of increased volume under some of the contracts we inherited but most of it is coming from the new aircraft we won since we've owned it.

Okay.

So we're not attempting signal that there are no more growth prospects for AWS. In fact we remain encouraged by the pipeline of activity we have out there.

Perfect. My second question relates to a comment David had in his prepared remarks. David, you indicated you're encouraged and believe we're at the early stages of a recovery in demand. I know you don't want to give specific financial guidance but as you look at the balance of the year, maybe over the next 18 months since your view is we're in the early stages what sort of growth rate do you expect in aviation supply and what sort of growth rate are you expecting or building into your thinking for MRO for the balance of the year or 18 months let's say.

Yes, it wouldn't be uncommon that you'd see low single digits, low double digit growth. My sense is that it's hard to say whether that kicks in tomorrow or whether it takes a few more months but if you look at again from a historical perspective and you look at how we've done say in past cycles, it would be my sense that you'll see, you'll first see low single, I'm sorry, low double digit growth rates and then on the parts side and then the service side or the MRO side, it's somewhat predicated on deal flow that we might see but my sense is that you're going to see some strengthening in that business as well. I wouldn't want to put a growth rate on that at this moment but I do believe that you're going to see consistent steadier performance at higher levels coming out of that business starting with Q2.

And to clarify, if you were double digit, that's double digit in aviation supply excluding Mesa? Because that would be quite impressive performance.

So Arnie, let's just be clear. We said our performance in the first quarter was consistent with our expectations for the commercial markets that were implied and behind the guidance we had provided for the year. The one exception to that is the seasonal pattern in MRO, so you should certainly see MRO pick up but everything else is consistent with our expectations.

And I tell you what. It's not going to take too long here with a Mesa comparison is going to be a non-item for the Company.

Okay I'll jump back in queue, thank you.

Thank you. Our next question is from Ken Herbert of Wedbush. Your line is open.

Yes, hi, good morning. Thank you. I just wanted to see on the MRO side, can you talk about -- you mentioned that obviously the facilities are running at what seems like good volumes. Can you talk about the pricing pressure you're seeing in the marketplace now and any sort of near term opportunities we should be thinking about specifically on the MRO side within that business?

We would expect at this moment at least, we're still operating under some pricing pressure. We've entered agreements with our customers that restrict or limit our pricing flexibility. We would anticipate as we add incremental business that the pricing will be firmer and we would anticipate that as we move on using Arnie's time frame of 18 months, let's say, that he asked in the prior question, we would expect the pricing would be improving in that period.

Okay and you've got then I would imagine flexibility on capacity within the MRO segment as volumes ideally start to pick up?

Yes.

Just then on structures and systems, can you talk about the impact or what the potential impact could be of the FMTV shift over to Oshkosh from BAE for the production there, specifically as that transaction happens and implications for structures and systems on the margin side?

Well, that transition is in the process right now, Ken, and there is an impact on margins as you're seeing in the structures and systems results today and so we're not expecting any kind of further negative impact on margins of significance as we complete the transition over to Oshkosh.

Okay, good. And just finally to bounce around, again within aviation supply chain, it looks like obviously some pretty encouraging comments on -- are you seeing anything relative or any difference that you can comment on from the engine parts as compared to airframe and any distinction there? I know David you mentioned initially that both seem to be if I remember well what you said, both up and you're encouraged by both but are you seeing out the rest of this year any variability between those two lines of business?

Tim, do you want to take a shot at that?

Sure. Our engine shop customers are busy so we're seeing I think what I would characterize as good demand for engine parts on the supply side we've been able to find I think good supply to go ahead and meet the requirements of our customers, so on the engine parts side I think I would characterize the market as pretty favorable. On the aircraft side, we're seeing our customers invest in inventory after a long period of taking inventory levels down, so I think that the dynamics are similar and the behavior is similar between the airframe side and the engine parts side.

Great. Thank you very much and congratulations on the quarter. Thank you.

Thanks, Ken.

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

Good morning guys.

Hi, JB

I just had a question on the inventory. You mentioned in the release there's some investment in inventory for some programs. Is there any way to -- you gave a little abbreviated balance sheet but is there any way to quantify that and the impact on the quarter?

On the investment of inventory?

Yes.

Yes. I mean, when we file our Q, you'll see the details obviously in there but I mean we're happy to share that a little bit with you. Our inventory across the Company went up about $8 million relative to where we ended the last fiscal year and when we look at where we were investing we invested really in I think a couple of primary places. We had a little bit of inventory support to support some of the fleet growth at AWS. We're also investing in some inventory in support of the engineering services project that I mentioned in my comments that is part of our MRO group and will contribute to stronger results in the back half of the year.

Is there some inventory growth there associated with new contract wins or are those just all expected and planned?

Both of those, you could argue both of those are new contract wins.

And then a small portion of it, well, I guess you'd classify the fleet support inventory as a growth too.

Correct.

Thanks a lot.

Sure.

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

Good morning guys.

Hi, Eric.

Congratulations on a good quarter. Can you talk about -- in the MRO business, I know you guys have won a number of new contracts that are going to begin to start ramping up and you're going to see the benefits of that but maybe can you just comment on what you're seeing in sort of the underlying trends in the industry sort of are the underlying trends improving on top of your gaining I guess these additional awards.

Eric, it's Tim. I think the underlying trends are positive. We're seeing several of our customers are adding aircraft to their fleet and we've been supporting them as they do this. The Indianapolis facility has four customers in it today, not all nose to tail lines which is our goal but nonetheless, it's busy and what we see is over time, some of the bays that are being handled with lower hour mod work and things like that will migrate to more nose to tail so increasing the utilization of the facility, but all of our MROs as Rick mentioned are busy following the peak flying summer seasons. I think the underlying trends are favorable.

Okay, fair enough. Can you guys maybe comment, on the defense side, your big area is on the mobility products but a fair amount of on the services side. Maybe can you comment with regards to the potential impact? I guess maybe AWS is the biggest sort of risk here and the DOD is really sort of drive there to increase scrutiny over services and sort of maybe restructuring contract margins and maybe putting more risk on contractors. Can you sort of comment as to sort of how you might be hurt or benefit under this new environment?

I don't think the new environment is going to impact this particular business. I think if I'm correct, if I'm hearing correctly you're asking about the AWS?

Well, in general, just the entire, your government services types of businesses.

Yes, my feeling is that the entire government service, the entire government market is going to be under some pressure here as they look to reign in the budget. I do believe that within the government and defense budget that the areas that we are heavily weighted towards are going to be less impacted by that budget pressure, but I do believe there will be budget pressure. I do believe that many of the things that we do are at a lower cost than the government -- than any alternatives that the government has and I do believe services that we are providing are critical to the ongoing performance of, in particular the DOD.

And one thing to think about as you think about the Company's position, and if I zero in on the AWS opportunity for a second, today 100% of that business other than the one contract that we have on the service side with the Middle East customer, 100% of the business is with DOD. We do believe there are opportunities with other branches of the US government as well as other governments, so we are fairly optimistic and even as you look at some of the other service offerings that we have that we do see opportunities beyond just supporting DOD.

Are most of those contract structures sort of fixed price incentive fees sort of anyway?

The contracts that we have -- the existing contracts that we have are the pricing is already in place, so that pricing other than Rick alluded to a 22 year contract we have the with a British MOD which had certain pricing breaks inside the contract, most of our other contracts are fixed price in structure. But what I'm more referring to is future business opportunities for the Company as a result of the new environment that you've identified.

Right. I'm trying to sort of cover the margin side also, if you're already at fixed price and that's where the government wants to go that really shouldn't have much impact on you.

Right, correct.

My last point is on the cash generation. You didn't really address it in your commentary but I thought it was $7 million cash flow from operations in the quarter. A pretty weak number relative to where you've been over the last year or so. Can you sort of comment as to sort of what's going on there? I assume there have been some inventory investments or whatever. We were expecting to see the CapEx spike up but cash flow from ops was particularly weak and disappointing. Can you sort of talk about that and sort of maybe what your expectations are for the year?

So Eric, the cash flow -- as you noted cash flow from operations was about 60% of our net income for the quarter. It does reflect, I mean, we had got into this a little bit with JB's question earlier but yes, we did invest in some of the kind of traditional working capital areas of the business so we invested in some inventory, we invested in some rotable spares to support the growth at AWS. We also have made some investments in the A-400-M program as we bring that development process to closure, so all of that impacted us in the quarter and contributes to the impact you see. I don't think, as you know, from studying our business in the past Eric, if we're seeing growth on the commercial side, we typically invest to support some of that growth and I'd say we'll probably take the question about what our expectations are for the rest of the quarter offline and think about that a little more and we'll get back to you.

I mean, I guess the broader point of my question is, if you look at your business over the last up cycle you never generated cash because you were always sort of investing and investing and investing and sort of the strong cash generation that you've had over the last year or so has just really been a liquidation of that. Are we getting back into a cycle where we shouldn't expect cash generation because you guys are just going to continue to invest?

We believe in creating free cash flow and it's our objective to create free cash flow. You're not going to see it at the level you saw in late 2009, 2010, when we were generating free cash flow three to four times our net income but I think you will, you should expect to see free cash flow generation from us on a recurring basis.

Is there a portion of management sort of comp that's tied to free cash flow generation?

Not directly that metric, Eric. We are certainly tied heavily to keeping a strong balance sheet though. So any efforts to lever up the balance sheet considerably and go on a spending spree of assets would certainly negatively impact us.

All right, great. Thanks a lot guys and again good quarter.

Thank you.

Thank you. Our next question is from Jon Braatz of Kansas City Capital.

Good morning, gentlemen. David could you talk a little bit more about the new business at AWS? You invested in five new planes. What might be the level of investment there. Number two, what is the duration of that contract and is this something that we could maybe expect further investments in? How much more might we be able to see out of that type of opportunity at AWS?

Yes, Jon, I think it's a really good question. We're kind of working with the leadership team and as you'll note, we recently brought on a retired two star general from the Army who is the Head of-- Director of Army Aviation and we're strategizing on this very question as we speak and we do have a strategy session with the new President of the business coming up here early October to address this very issue. We are seeing a fair amount of demand today for additional investments and we're kind of weighing the investment right now, certain of these investments as we speak basically.

So my preference here would be to defer answering until we have a clearer picture. Suffice to say though that the environment is very favorable and we are looking for ways to capture business in some cases without making investments. We had some aircraft in the last quarter where we're leasing the aircraft in, so I think this is an area that's important to us and some that we are exploring at this time.

David, but specifically, the new business that you won this quarter and the five new planes you invested, what is the duration of that contract?

The contracts are typically five years in duration. They're one year firm with four option years and I believe that's the case. Tim, do you know specifically on these if that's the case?

That is the case.

Okay. Now, I was just trying to gauge what might be the risk of owning that aircraft and the contract expiring.

Well, we have, in the case of five aircraft that we've brought in, we own four, one replacement aircraft that was actually damaged and so we added from an acquisition standpoint we added three aircraft and then we're leasing in a couple of aircraft and the aircraft that we own we have a high level of confidence that if the contract that we're performing against were to end that we would be able to redeploy these assets elsewhere. So we are obviously looking at what the back door is to each one of these investments and we feel pretty confident based on a dialogue we've had with the State department, dialogue we've had with Transcom, and dialogue we've had with some other potential foreign customers that we feel pretty good about the investments that we've made.

What kind of aircraft were they, David?

S61s were the aircraft we acquired and the aircraft we were leasing in are the Havelin-8s.

One last question. Rick, you talked a little bit about the reclassification from SG&A to COGS. How much was that? Do you have a dollar amount?

It was approximately $2 million John.

Thank you very much, Rick.

Thanks.

Thank you. Our next question is from Stan Mann of Mann Family Investment.

Good job, gentlemen. Three questions. One, on the use of cash, that you generate, you bought back stock which was a unique process near term. What would be your plans for the generating of cash in 2011? Do you have a favorable or a --?

Well, I think, Stan let's start by reiterating we said we expect that a net CapEx plan of $60 million. Certainly we spent a good chunk of that in the first quarter but there remains a bit to go there, so that's kind of earmark number one. Number two is again I think as we continue to monitor the tempo of growth around growth and growth opportunities around the business and particularly around some of the commercial areas of the business we may invest in assets for that as well. We think we get sufficient returns on those and we create pretty high hurdle rates as we contemplate those investments that it makes sense to use the cash in that manner. I think after that, I think you've seen some of what we've done, just buying direct stock this quarter was unique but certainly remains in consideration for us and also taking in some of our bonds if they're at the right prices, we've done quite a bit of that so all of that remains I think addressable from our perspective.

Yes, but a question on the debt. The set interest on the major party of debt via recourse is what about over 6%.

I'm sorry, Stan you cut out for a second. Could you say that question again?

Your cost of debt on your major debt that you're holding, I calculate it's a little over 6% based on your interest payments. Is that close or not close? Or not?

Yes, we have basically the non-cash and the cash part of our interest cost, Stan, and so our interest expense real roughly is about all in on a GAAP basis will be about $30 million for the year and you're doing that, that's off of face value of debt of approximately $450 million roughly. It's a little bit higher than that but just to keep the math simple so at a gross basis, it's about 6.5% to 6.7% but I would point out to you that quite a bit of that interest is actually non-cash interest expense, so if you were thinking about it from a cash perspective, it would be quite a bit lower. It would be half of that.

So if you pay down, you would pay the highest cost debt first on pay down?

The highest yield. Part of that is rate and part of it is duration.

Where it's available, Stan. Clearly some of our bonds you don't have to pay a premium to take that in early. Some of the other financing we have would -- that may be higher cost but would require premium to take it out so we have to weigh all of that when we think about taking it out.

Okay, question two. It looks like you're moving toward your goal that you've repeated of 10% operating margin. Do you see it speeding up a little? I mean, I think you're six point something this quarter?

Yes, 6.8% is where we were at and we would hope to cross 7% here in the near future and get that back down in this current planning cycle, we're in the first year of a three year planning cycle.

But you do see it, because you've got AWS, as you said you've got a lot of room to start trying to make it more efficient and rationalize it?

That's correct.

Last question is you put out a note on hiring maintenance engineers from the AMR, American Airlines shut down. Can you talk to us about if you've hired additional people and secondly the opportunity that you see in the major airline space for growing business in the MRO area.

Tim?

Stan, we have been successful in hiring some people. We're looking for a broad range of people from engineers to technicians but we did have a job fair in Kansas City and we did see some good people there and we've been able to bring some over to our businesses. And in terms of the overall look of the business as I said earlier, I think we're encouraged by what we're seeing. We're seeing -- we're talking to a lot of customers about their maintenance requirements, as we said our shops are busy, so we're feeling okay about our prospects here.

So the outsourcing for a major airline is economically positive, that view?

It is.

Okay, so we could expect to see some of the larger airlines like Delta, et cetera, converting and buying your service?

Well, Delta already outsources airframe maintenance. They have internal capabilities through Delta Tech Ops but they also use the third party repair centers as well.

Thank you. Good job, gentlemen.

Thank you.

Thanks, Stan.

Thank you. Our next question is from Tom Lewis of High Road Value. Your line is open.

Hi, good morning.

Hi, Tom.

First question. With respect to your recommitting to a 10% operating margin, is there anything and why it's happening -- why you're saying this now as opposed to 90 days ago or waiting for a while, is there anything you can tell us about your thought process there other than I think you said something about a three year planning cycle that you are doing this at this particular time?

Well, we feel in a general sense, we just feel better about the commercial market today than we felt 90 days ago.

Okay, yes, yes, agreed and also, with respect to AWS, I was hoping you could clarify a bit. I see a business here that on the one hand, there seems to be no shortage of operators offering supplemental lift in the world. On the other hand, it looks like you're meeting a relatively complex requirement there. Can you give us a sketch or can you characterize for us what the competitive landscape for this business is like and give us a sense of what the factors are that determine just how competitive it is or the prospects of it becoming more competitive if it continues to be what appears to be an attractive business?

For this activity Tom we're one of the very few qualified providers, particularly for the DOD, so DOD has a requirement called a Carb certification and there are very few, there are only two other Operators who comply with Carb certification, and we believe that AAR is better positioned than both the other two competitors to compete in this sector and we feel good about our competitive position and we feel very good about the opportunities in front of us, so yes, I think it's good market for the Company.

Now does this standard apply when the customer is another entity of the US government or perhaps even another government someplace else?

Say it one more time, please?

Does that standard play apply if the customer was another entity of the US government or perhaps even another -- an entity of somebody else's government?

No, no. That standard is specifically a DOD standard. Now it's part of our marketing ploy, and the reason that standard exists is because the DOD takes more caution around safety of flight than other agencies might and we're trying to bring that requirement over to the other agencies and we're at least meeting with people who are interested in what we have to say, so I think if we can -- obviously if we can figure out a smart way to expand our capability, then we should be able to differentiate ourselves in these other markets. Today it's not uncommon for other users to utilize Eastern equipment for instance and we're trying to convince folks to use Western equipment as a more safer and reliable source of equipment.

Yes, well that makes sense to me. Keep up the good work.

Thanks, Tom.

Yes.

Thank you. I'm not showing any further questions at this time.

Okay, well thank you very much for participating today and I wish everybody a very nice day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Good day.