AAR Corp (AIR) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the AAR Corporation third-quarter fiscal 2012 earnings call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions following at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

Now I'll turn the conference over to your host, Greg Dellinger.

Thank you, Tyrone. Good morning, ladies and gentlemen. Thank you for joining our third-quarter fiscal year 2012 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 Company's Form 10-K for the fiscal year ended May 31, 2011. In providing forward-looking statements, the Company assumes no obligation to provide updates to reflect future circumstances or the occurrence of anticipated or unanticipated events.

Now at this time, I would like to turn the call over to our Chairman and Chief Executive Officer, David Storch.

Thank you, Greg, 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. As you know, we report our third-quarter fiscal year 2012 results yesterday afternoon. Sales for the quarter were $534.2 million which represents a 17% increase over the prior year and net income came in at $20.7 million or $0.50 per diluted share. As we discussed in the release, third-quarter diluted earnings per share were favorably impacted by $0.09 per share as a result of an income tax benefit. Rick will go into a little bit more detail on this later in his remarks. Overall the Company's third-quarter operating results did fall short of our expectations, but I would like to start my comments by making certain that we capture the positives that happened in the quarter.

First of all we had 12% sales growth in our supply chain segment. The recent acquisitions of Telair and Nordisk are performing exceptionally well and made a solid contribution to the quarter's results. MRO sales increased by 13% when you exclude the engineering service business that we had in the prior period and Rick will go into a little bit of that in his comments as well. We enjoyed a 28% sales increase year-over-year coming from our mobility products business. But at the same time, we did experience some disappointments around execution at two of our businesses. As we signaled and discussed in our Earnings Release, the airlift operation continued to be negatively impacted by aircraft shortages due to the delayed receipt of two aircraft that were expected into our fleet earlier in the quarter. The aircraft are currently in-theatre, however they have yet to go on our certificate and we're hoping that happens in the next day or so.

Then we also had some unscheduled maintenance inspections around the fleet as well, so things we should have nailed quite frankly and we let slip through the system and impacted -- negatively impacted the quarter's results. Then we had a miss at our precision machining business also around execution. So as we go forward, Randy Martin, as whom many of you met at our Investor Day is all over the airlift issues and Terry Stinson is deeply involved in the precision issues and we hope to see modest improvements in the fourth quarter and meaningful progress as we get into our next fiscal year. Sales to government defense customers were essentially flat. Our mobility products business did have a strong quarter as I indicated, compared to the prior year as we delivered against some large shelter programs. Sales were lower, however on certain programs in our defense logistics business due to reduced program activity.

But on the positive side in that business, after the quarter, we did announce that we signed a five-year agreement with Airbus Military to provide off-wing repair management and logistics services for certain of their aircraft. We are fixing the front end of our defense logistics business and hopefully we'll see a more robust deal flow coming from that group or businesses.

As we start thinking about where we are today, we are monitoring, I should say, the Defense Department budget issues very closely and specifically for its impact on our structures and systems segment and, in anticipation of budget cuts, we are evaluating existing capacity in this segment with a sharp focus on how we can be more efficient and reduce costs. Hopefully we expect to zero in a little bit more on this as the quarter progresses. Hopefully we can talk about that later in the quarter or early in the next fiscal year.

So with that, let me just turn call over to Rick and then, of course, after Rick's comments, we'll open up to questions.

Okay, thanks, David and good morning, everyone. As is customary, I'd like to provide some more detail on the performance in each of our operating segments and then I'll conclude with some comments around interest, depreciation and CapEx.

So as David mentioned, within our supply chain segment, sales increased 12% compared to the year ago period. We saw an increased demand from our airline customers, mainly due to strong inventory positions that we had built up earlier in the year. Sales also increased during the period due to increasing sales under our units and distribution agreement which we had launched earlier this year. As we look ahead, we feel pretty good about our current inventory positions. We exited the quarter with February being our strongest month yet from the Unison agreement, so we are encouraged by our momentum there. We also reported solid improvement in the gross profit margin in the supply chain segment which increased to 19.8% in the quarter, compared to 17.3% last year.

This is our strongest margin performance in several years and it reflects the favorable mix of inventories sold particularly around our engine parts business. In part, because of the recent Airbus Military win that David just mentioned, we made the decision to retain the Amsterdam component repair business, which had previously been reported as a discontinued operation. As a result, the operating results for Amsterdam are reported in continuing operations for all periods presented and will continue as such going forward. This change of classification had an insignificant impact on the year-over-year comparisons. In the government and defense service segment, sales and gross profit margin declined due to the reasons David mentioned related to our airlift business and our defense logistics business. It's important to reiterate that the weakness we experienced in the quarter at our airlift business is not indicative of a reduction in demand for our services. Rather this is a result of executional challenges that we are aggressively addressing.

In our MRO segment, sales increased 4% compared to the prior year, but again, as David indicated, this was due to a difficult year-over-year comparison stemming from our engineering services business. If we exclude the effect of engineering services the year-over-year growth was a strong 13%, very similar to what we experienced in our supply chain segment. While the gross profit margin was a disappointing 11.8% compared even to our last quarter, this is really the result of some one-time charges we took related to our Miami aircraft services business. The pricing environment remains very constructive and demand remains strong for our MRO services and we expect meaningful improvement in gross margins in Q4. In our structures and systems segment, sales increased 86% year-over-year. Excluding the impact of the acquisition of Telair and Nordisk, sales increased 20% primarily due to higher shipments at our mobility products unit, which had a very soft third quarter last year.

As we indicated in our release, Telair and Nordisk contributed $55 million in sales during the period, which exceeded our expectations for these new businesses. The gross profit margin in the structures and systems segment of 18.2% was up over 375 basis points from where we were for the first half of this year. This reflects the strength of the new businesses which more than offsets the continuing weakness we experienced with our precision business. On an absolute dollar basis this segment was our largest profit contributor during the quarter. SG&A as a percent of sales was 9.6% in the third quarter, which was essentially unchanged from a year ago. In total, our earnings before interest, taxes, depreciation and amortization, including the amortization of stock based compensation, was $61 million for the quarter. This was up 17% from the year ago period.

In January, we had completed the offering of $175 million aggregate principal amount of notes which have a stated coupon of 7.25. Proceeds from the offering were used to repay a portion of the borrowings under our revolving credit agreement, which we incurred to fund the Telair and Nordisk acquisitions. With the result of this capital raise, we now feel very good about our liquidity position. Net interest expense for the quarter was $10.1 million, which was up from $7.5 million last year. The cash interest expense was $6.7 million of this total and the non-cash portion of the interest expense was $3.4 million. We generated $13.4 million in cash flow from operations during the third quarter, while CapEx, excluding the acquisitions, was approximately $7.5 million. Our depreciation and amortization for the quarter was $21.6 million.

As David mentioned, during the quarter we recorded a $4 million income tax benefit which primarily related to a reduction in the Company's state income tax rate on our net deferred tax position. The benefit was driven by recently implemented tax planning strategies around our corporate structure and the relocation of one of our significant businesses. There will be an ongoing benefit to State taxes as a result of these actions, but as we mentioned in our release, our effective tax rate should be approximately 34.5%.

I'll wrap up my comments by reiterating David's message. Our quarter had a mix of some very positive results as well as some disappointments. Our largest disappointments were around airlift and precision where their results fell approximately $0.10 per share short of what we would consider to be their expected contribution. We believe our action plans will be effective at addressing this under performance as we continue to execute them throughout the fourth quarter.

So with that, thanks for joining our call this morning and we'll now open up the line for some questions.

(Operator Instructions) Tyler Hojo, Sidoti & Company.

I was hoping you could maybe go into a little bit more detail on some of the issues in the precision machining business. Is that tied to the work that you won with Spirit on 7 Series?

Tyler, it's Tim. The Spirit is one area where we're not delivering as much as we had anticipated. We have a couple other programs that we're working through both on the costs and pricing side as well as delivery performance, so there's a few programs in addition to Spirit that we're working to improve. We have made some progress. We're working hard on the C-Series and we see some light there but it's not just Spirit but Spirit is one of the programs that we're working to improve.

Okay, and is there anything specific that you could point to that would help give us a little bit more confidence in seeing that this is more or less a one-time issue and that things will improve next year?

Well, I think we see progress here. We do expect that it's going to take a little bit of time to fully implement the actions that we're taking but we have confidence that we'll see improvement as we go into the new fiscal year.

Tyler, I would add too, part of our challenge is I think we expanded capacity pretty aggressively. We have some inefficient capacity utilization right now and I think we see an opportunity to correct some of that as well.

Okay, got it. And then I just wanted to -- secondly just ask about aircraft sales in the quarter. I know last conference call you mentioned expecting to pare down the portfolio a little bit. Where do we stand today?

Yes, so let's start by saying there were no transactions during the quarter, so none of the results are impacted by that. We continue to work the portfolio. You should expect to hear more from us as those deals come to fruition. We have some LOIs right now that we're continuing to work towards finding agreements, but there's really no story during the quarter on aircraft right now.

Larry Solow, CJS Securities.

Wondering just on the issues in the airlift business, it sounds like there's two different buckets I guess so the delayed receipt of -- those are the two S-92s and then the unscheduled maintenance. It sounds like at least the airplanes are now going into service eminently so, that piece is resolved. Then in terms of the maintenance, where do you stand there and give a little more color on that, that would be great.

Larry, it's Tim again. The aircraft while they are in-theater they're not on the certificate yet. We are optimistic that we're going to get them on the certificate in the next week to 10 days but we're managing it closely but they're not on the certificate now, so I don't want you to think that they're on.

In terms of the maintenance issues, we have an unacceptable number of aircraft that are out of service. Our teams both in Melbourne and in-theater are working diligently to get those returned to service. As you know, it's a very difficult environment but nonetheless, the number of aircraft that we have on the ground is a problem. We're moving parts into the theater to help us get those aircraft back up and running but I guess what I would say there is, it's got all of our resources working to get those aircraft up and flying.

Because it almost sounds like it's gotten even a little worse because I know you certainly discussed this issue last quarter and how you were working at least on a maintenance part or availability of aircraft.

It has. Some of it is maintenance related specific failures of the aircraft and others of it is extra inspections that we've taken on as a result of the situation that we had in January, so -- but you're right. It has.

Larry, business is still very profitable and it's still exceeding what we started out with, but it's just not hitting the targets that we know are achievable nor that we've hit in the past as well.

Right. Well I guess the positive is at least it's maybe more in your control so hopefully --

Yes. That's correct.

Larry, one point of clarity too is I think you mentioned S-92s. The S-92s are in service and performing extremely well.

So it's not those two.

The aircraft that have been slow to get in are actually S-61s which is a smaller helicopter.

Ah, okay, and was there any particular reason why it's being so slow or is it just a --

The aircraft came in, in lousy condition and our people for the acceptance inspection rejected the aircraft. The aircraft then needed a change out of some major components. We then were a little slow in going through the certification process with the FAA. We ultimately made the delivery date and shipped the aircraft into theater but without having the aircraft on the certificate with the goal of having the aircraft on the certificate shortly after arrival in Afghanistan. The aircraft are there now, ready to be operate, however they're not on our certificate yet. We've heard anywhere from one day to 10 days but hopefully we can get them on the certificate here very quickly. The aircraft will be in good serviceable condition and will be ready to operate the day we get the certification cleared.

Got you. Maybe to switch gears real fast. Just on the decision to retain the Amsterdam component repair shop and then obviously the agreement with Airbus, could you maybe just talk about that agreement and could it be a gateway to other deals with the Airbus or similar companies and does retaining the Amsterdam business make you believe that should that imply that maybe you think there's more to this deal or other potential deals?

Yes, this deal is around the Airbus Military fleet of CASA aircraft which is their backbone to the military fleet and our Amsterdam shop is configured to go ahead and handle parts similar to the parts that would be coming off of these type of aircraft. We believe and we've been lead to believe that if successful in supporting Airbus on this program that there will be further programs with Airbus. The jewel in the Airbus Military fleet would be the A400M, once that aircraft gets into production.

Ken Herbert, Wedbush.

First, you mentioned David about or Rick about a $0.10 impact to the quarter from both precision and the airlift business. How do you parse that out? How much down in the quarter was the airlift business relative to a year ago?

Well, Ken, bear appreciate we don't usually talk about specific contributions at a business level. I think suffice it to say though you can look at the segment results year over year and you'd see that a pretty good chunk of the fall off year over year is attributable to airlift. That's the GDS segment, Government Defense Services segment. So that will give you some sense to the second part of your question. I think the $0.10 is meant to give you a sense of, we believe the rehabilitation of both of these deficiencies is within our control and it gives you a sense for what the magnitude is and in terms of the relative split, you could think of them as pretty close to equal opportunities. So slightly more on the airlift side.

Okay, that's helpful and the earlier comment seemed to allude to either some restructuring or something other perhaps in terms of a change of the business to expect within structures. Is that, is there any more detail you could provide on that and I'm alluding specifically to David's comments in his opening remarks.

Yes. I'd reiterate what we've said to one of the questions too as well, Ken, fundamentally the business has had a little bit of executional challenges with some start up programs but we also I think are suffering from some inefficient capacity utilization right now. I'm not sure if restructuring is the right word but you should look for us to continue to execute profit improvement initiatives that could include some footprint rationalization as well.

Okay, so I guess that's based on the comments something we may hear about this quarter or certainly as you look to position it heading into fiscal 2013?

Yes.

Okay, great. Then just finally, on the MRO segment, good sales, you talked about pricing I guess rationalization or holding up there. Obviously in the last few months or last few weeks there's been a lot of competitive change with one of your competitors filing for Chapter 11 and then most recently Avios. It seems like there could be some capacity coming out of at least the heavy maintenance side. Can you talk about what your expectations are for the fourth quarter and heading into next year for MRO specifically and then opportunities to maybe get better pricing and how some of the recent competitive situations may ultimately impact the business?

So when we look at the capacity issue that you've clearly articulated, we view that as a real positive for the Company. We believe that there will be ample capacity taken out of the industry. There is a little bit of a flip side to that and that is that you may have some airlines paring some capacity if fuel prices continue to be as high as they've been. But I think net-net, when you look at the pros and you look at the positives and the negatives I believe net-net, it should improve the pricing environment for us. We are seeing some of that, so if you look at our engineering, I'm sorry if you look at our MRO segment and if you were to take the engineering piece out, if you look at purely our heavy maintenance piece of the business, you will see margin improvement and as we come into this quarter, we're expecting not only a contribution from the engineering segment piece of that business but we're also expecting the margins and MRO to strengthen as well.

Great. Then just one final question on MRO. I know you're facing some difficult comparison on the engineering side within that segment from the Delta contract. How has the -- is the outlook getting better for the engineering work heading into fiscal 2013 or is there any commentary you can provide on that part of the business specifically?

The outlook is good actually. We'll start delivering on an existing contract in the fourth quarter here and it will continue through next fiscal year and then we'll be looking to add some business behind that, so the outlook is good here.

JB Groh, DA Davidson.

I think you might have addressed this, Rick but just within like supply chain and the demand on the commercial after market side, can you address the trend throughout the quarter? It seems like the guys that reported the December quarter had very, very strong after market and then one that had a January close had a little bit lower after market sales and so I'm just trying to figure out what the trajectory was for demand for after market going through the quarter.

Yes, JB, here would be my response to that. So what I said was I made a comment with regard to our Unison distribution agreement which as you know is scaling up and so in the grand scheme of the full results for the segment is a small contributor but the trend there is nevertheless very positive for us. We exited the quarter with the strongest month yet under that agreement, so we're very encouraged by that. Our trading businesses, engine and air frame trading businesses, which would be more larger contributors to the overall segment results tend to skew later in the quarter anyway so it's not, it may not be as pure of a read as you would like but we had extremely strong February in both of those businesses.

Okay. That's helpful and then on the SG&A, that was up a little bit sequentially. Is that just a reflection of the acquisitions or is that a run rate we should look at, look toward going forward? Is there any deal related costs in there?

There's no one-time deal related costs, JB, but you do pick up some amortization from purchase accounting so that's with us to stay for a little while. I think we've for a long time targeted getting our number below 10%. We had a couple of pretty good quarters there where it was closer to 9% but I think mid-9%s is where we're targeting right now.

Eric Hugel, Stephens.

Rick you talked about some one-time issues in Miami. Can you elaborate and maybe give us some numbers around that so we can look at what the underlying profitability in the group was?

Yes, we had some write-offs that we had to take during the quarter and it's just a couple of again what I'd call one-time charges, Eric. Nothing -- there's not really a bigger story to it than that. What the real point I wanted to leave you with is I don't expect to experience them in the fourth quarter and if you corrected for those in the quarter you'd see, you'd definitely see a couple hundred basis point lift. So between that and we had a tough comp with engineering services and that will change as well, so we're feeling pretty good, even absent any improvement to the pricing environment, we're feeling pretty good about a lift in margins there and if we get some lift on pricing as well that could even look better.

But are you talking about a lift versus this 11.8% number which really isn't much?

I would orient you back to 11.8% is clearly disappointing to us, I would orient you towards what you saw more in the first two quarters and then hopefully --

Well Rick, first quarter was 11%.

Okay, so last quarter, Eric.

Okay, so a lift versus let's say that 14.7%.

Let's say look, we've always, this is a segment that has always bounced and by our target between 14% to mid-15%, as high as 16% and what I'm saying to you is we should be comfortable within that range with hopefully upside potential.

Okay, fair enough. Can you talk about in terms of the airlift business, maybe some metrics with regards to how many aircraft these maintenance issues are impacting, maybe some metrics about how many aircraft are deployed versus how many aircraft are available to do missions?

Yes, I don't think I'd really have any figures for you there. We'll have to probably think about that a little, Eric and get back to you guys. The fleet, the operating fleet as you know approximates roughly 50 fixed and rotary wing aircraft. We've tried to build up a spare compliment around that operating fleet to try to bolster aircraft availability. The unplanned maintenance events tend to occupy those spares and then some and that's what we're suffering so far, so that leaves us in a position where we're not able to deliver the ready aircraft that our customer's looking for. In terms of giving you more numbers or guidance on that, I think we'll have to think about that and get back to you.

Can you talk about I guess as you look in the industry and you look at some of your customers, it was referred to maybe in another question a little bit but I guess there's some issues with some of your customers many Pinnacle being one of them potential -- that there's talk about them maybe potentially opening the file for bankruptcy. Can you talk about how you're conducting operations. What you do when you start to see some of your clients that you have sizeable exposure to maybe getting on the ropes and on the flip side, opportunities like American and Avios, how you react to those?

So Eric, on the specific situation you're asking about, we're doing a fair amount of work for them. We don't have a significant exposure so we've taken care of that part of the risk. We do expect that requirement, that utilization of that fleet to continue no matter what actually happens with Pinnacle. But I think as David mentioned, we are seeing other opportunities out there including American as you mentioned but we see robust demand for MRO services across -- really across the market, so we're watching it very closely. We keep very close tabs on the customer performance. We do have though a blue chip list of customers in our MRO business, so we feel good about our position there and we feel good about the opportunity for additional work.

Lastly, just in terms of the supply chain, I believe you guys acquired Airinmar in what, was it the second quarter or something like that?

October.

So is that number that you have there, can you talk about how much sales Airinmar contributed and what the underlying organic growth in that business was?

Yes. We bought Airinmar in October, just to clarify. Airinmar's sales contribution, remember Airinmar is primarily about obtaining a capability that we think we can both leverage across our existing businesses that we own and then market it on a third party basis to airlines, et cetera. The answer to your question is they had low single-digit million dollar sale contribution.

Low single-digits, million.

John Braatz, Kansas City Capital.

David, you mentioned in your prepared remarks about monitoring the Defense budget and the impact on the structures and system division. Can you talk a little bit about maybe what you think maybe the size of any impact would be or is it just too premature? When do you think we might begin to see and feel a little bit of the impact of cutbacks in the Defense budget on that segment?

So first of all if we look at the entire across the spectrum of AAR activities, I believe that there are positives and negatives, so I do believe that there will be a series of positives related to ways that we can help the Defense Department reduce its expenses. They have been in contact with the Company to ask us to share best practices around commercial, our experience in the commercial world, recognizing that we've been faced with customers who have been financially challenged for decades as they see some of our skill sets as being able to assist them in achieving their missions while doing it within a compressed budget environment. At the same time, we of course are a manufacturer of certain products for the DOD which we have some concern around how those get impacted by budget actions and so we would be probably looking at the structure and systems group a little differently than we would be looking at the, say MRO and supply chain and government services segments of our business. So the comments are around going ahead and making certain that we get ahead of the trend and not get behind it and so therefore, do the best we can and Rick alluded to looking at -- taking a look at our capacity and ways to go ahead and streamline capacity, so hopefully that's helpful.

Okay, specifically on some of the products are we talking about mobility and shelters?

Yes, the mobility group would be the group that would be largely focused around -- 100% of their business is of a government orientation. So yes, they would be the most dramatically impacted by budget cuts.

And I don't know if you can tell me this, but what's the revenue size of that segment?

Yes, that piece of our segment?

Yes.

Yes, it's a meaningful piece of the business. We prefer not to disclose that for competitive purposes. But that being said, it's an important part of our structures and systems segment.

Okay, and that wouldn't -- when you look at the Defense budget that wouldn't go away entirely would it?

No. That business will remain very profitable and it will be a very healthy business. They will continue, their backlog is still pretty strong. The current inputs are strong. I'm just giving you my view in terms of what may happen with Defense budgets. I view it as a potential neutral for the Corporation but I think it could be negative for our structures and systems group.

I know you're trying to be proactive on this in this regard but when might we see the first impact of these cutbacks as it relates to this particular segment?

Well, I can't really, I don't think I really have a crystal ball in that regard. They have a lot of moving parts around the Defense budget. Keep in mind that the services that we offer are fairly critical to the operation of the Defense Department. So as I've indicated, this is not a falling off the cliff situation. I think that what -- all I'm alerting you to is the fact that the Defense budget cuts are real and I believe will impact our structures and systems group. I do believe though at the same time that we will see certain benefits as a result of dialogue we've had with the Defense Department that we will see benefits elsewhere in the Company as they look to go ahead and streamline their operations.

They've got a major hurdle in terms of -- they're faced with the following scenario. The world is about as unsettled as its ever been. The equipment that they operate is of an aging nature, and yet, their budget is coming under immense pressure, so they must be in a position to deliver against multiple fronts though and they have to have their equipment up and running and they have to do that all while they are operating under a reduced budget environment. So very similar to how the airlines have operated for the last 30 years. We have a lot of experience in helping the airline community in navigating through tough times and the DOD recognized that we have that skill set that can be helpful to them as well.

Michael Callaghan, Ariga Securities.

I was hoping we could talk about the MRO segment a little bit and just your maybe capacity constraints. We talked about the industry as a whole I guess already but for you guys when you're at the $112 million run rate, what is your facility utilization look like and does upside from here really come from price or is there more space available?

So the existing facilities are very busy. There is additional upside on yield we believe through processing improvement and other initiatives. In terms of capacity there are other facilities that we can move into fairly rapidly and we're positioned to do that. So we can grow this business beyond our existing footprint in relatively quick fashion. So as we see some of the opportunities that are emerging and we're talking to our customers about some of this incremental capacity that's available to us. So I guess to summarize, we're pretty well booked up at our existing facility but we have other alternatives to talk to customers about once they're ready to move.

Okay, so if you took out a new facility is that through a long-term arrangement or is that just to satisfy the peak?

It would be very flexible for us, so we could have it for a long time or if there was a peak, we would be able to size it to whatever the requirement is.

Okay. Then lastly on the MRO segment, on the $112 million, is there pretty much zero contribution from engineering services in that number?

It's modest, yes.

Okay, and then just to shift gears a little bit to the airlift business, since you guys owned the Company, there's not a lot of history there yet and then history that we do have was during a time when you were picking up several contracts. So the growth rates look strong but as we stabilize a little bit, specific to the maintenance issues, not the new aircraft issues. But on the maintenance side as we get more history behind us, should we expect to see this happen from time to time? It seems a little bit more just part of the ongoing business that maintenance issues like that would pop-up or is this really one-time issues?

Well I think to your point, it's hard to say precisely only because like to your point we've only owned the business for two years but I think if you look at the airline business in general, I think there are kinds of peaks and valleys in the maintenance cycles of the aircraft. We happened to hit a high peak here in terms of the maintenance requirement for the fleet. We also though have had a fair amount of unscheduled maintenance which I would venture to say is unusual; however, could it happen again? The answer would probably be yes.

Okay, and just lastly on that topic. What drives the unscheduled maintenance issue? Is it just something breaks on the aircraft?

Yes. You pull into a station and a radio is out or you do your line station inspection, you find a crack, so there's any variety of reasons. The one thing I would like to make sure though that is captured here is the business is still highly profitable and still ahead of our expectations when we made the acquisition so just keep things in perspective. We set a high target in terms of what our expectations were. We did achieve some of those targets in prior periods like last year this time of year, but we have had some things not go our way let's say and hopefully we can get back to where we had been in terms of performance on this business.

Okay, and is it fair to say that unscheduled maintenance puts the aircraft out of service a little longer given where the location of the aircraft is and how long it takes to get the repair equipment?

Yes.

Doug Carson, Bank of America.

Just a broader question you've answered most of my questions already. Just Afghanistan outlook, while they publicly phasing out by the end of 2014 and there will be a transition in 2015 potentially to other government commercial opportunities, can you just see, is there any update in that? Do you have any change in view? How do things feel in that area from an outlook perspective?

Yes, so the demand remains very strong but we're also receiving demand from other sources outside of that market and we're trying to figure out how to go ahead and either reposition assets out of that market into new markets or go ahead and augment our position with newer assets. So this is ongoing opportunity/challenge for us that we continue to work. But the short-term needs inside of that market remain very robust and very strong. We see no signs of any fall off in demand for our products and services. As a matter of fact, we're anticipating as there is a little bit of draw down that the organic equipment will leave first and the demand for our product will be as strong as we had experienced here in the two years that we've owned the business.

Dan Goldberg, RBC Capital Markets.

Just some housekeeping. Could you tell me how recourse debt ran up to $820 million from the roughly $500 million of the quarter before? I expect that the 10 year bond deal you did plus perhaps borrowings off the credit line?

Yes, that's how we funded it, that's correct. So recognize the acquisitions that we closed in the first week of December had a price tag of $280 million. So we had prepared ourselves to fund that by up sizing our revolving credit facility and then we followed-on with the bond offering in January to reload some of that credit facility, but that's your big driver to the debt increase.

[Stan Mann], Mann Family Investors.

David, a couple of questions. One, how do you feel currently about your 10% operating margin target? Do you feel stronger than the past since you are hitting higher gross margin levels?

Yes, Stan, I think we have communicated here that we have a couple of operations that are not executing to our standards and executing to the standards that they've achieved before, so we've got to fix those two businesses to get back on task let's say to get that margin objective. But if you take a look at the businesses that we brought into the Company since we've established that objective, if you take a look at the airlift business even though it's not giving us the maximum contribution, it is helping us achieve that 10% target and then the recent acquisition of the -- particularly the Telair business has very healthy margins and adds to our margin mix. So we continue to drive the business in that fashion and hopefully we'll be able to overcome some of the internal challenges that we have in these two businesses and get back on that path.

Okay, so if you look at the negative $0.10 and add it to what you did in the quarter, you would have pretty well a record quarter of $0.61?

That's correct.

Do you see us coming to that near-term?

Well, I think what we're saying, Stan, is that we're going to see some improvement in these businesses in Q4 but that we expect a lot of these improvements to kick in and start seeing benefit as we get into the next fiscal year, so it depends on how people define near-term but I think you'll -- hopefully, you'll see some steady progress in this regard.

And what's your view on use of cash? Stock buys, more acquisitions, debt pay downs, could you speak to that?

Yes, I think the first use of cash will be to pay down debt.

Okay.

As we generate more cash, we'll take a look but I think right now, if you're asking me near-term, I would say that as we generate cash, we'll be paying down our debt.

All right, last question. You mentioned that you thought the Defense Department similar to US Airlines would start moving to outside or outsourcing their MRO. That leads me to the question, are we in the correct locations to process Defense Department MRO? Or do we need new locations?

Well there's two ways that we can assist the Defense Department, two or three ways we can assist the Defense Department. One is around MRO. One is around logistics -- spare parts and logistics and availing them of some of our IT capability and then we also have our airlift operation which has proven to the Defense Department that we can lower their operating expenses. If I had to zero in on the areas of most impact, I would start with supply chains, I would then go to MRO. I would then go to the third piece, so I think the greatest ability for us to impact DOD budgets or the quickest way would be through the supply chain where we have, where the location is not critical.

Okay, so it's not location critical.

Right.

Good job, thank you.

Andrew Berg, Post Advisory Group.

Just a couple questions going back to airlift for a second. How much of the issues that you're experiencing there are related to the environment and mechanical problems and how much is related to your own self-imposed inspections that you alluded to earlier in terms of doing more maintenance on the aircraft which is slowing down the process.

Yes, I think you have both so I wouldn't be in a position right now to quantify that. We probably could be in a position to quantify that. I don't know if we are on this call but I would say you probably have a little bit of both. You clearly have environmental challenges which is why the margin is as strong as it is and at the same token, we have imposed certain maintenance requirements that would be self-directed, so probably a little bit of each and if you want to get more granular, we can get back to Rick and we can provide that in short order.

Okay, and can you quantify the benefit from the two additional aircraft? Are you guys willing to say what you think that can generate for you in the quarter once they come on line?

Yes. We prefer not. We don't get into that specifically, but suffice it to say that if the S-[61] category is a very profitable aircraft for the Company.

Andrew, recognize those two aircraft are part of a broader puzzle. We have a few other aircraft that we think will come back in to service that have been out in inspections and we have a longer list of pipeline of spare aircraft as well, so the ultimate resolution of airlifts portion of what I quantify as a $0.10 per share shortfall is addressed by all of those events, not just the two.

Okay, and on the precision side a similar thought process on the question. How much of the issues you're having is a result of not manufacturing product to the level that you'd like it to be coming out at and how much is related some of the inefficiencies you guys talked about in terms of layout that you can address a little bit more easily?

I think in this case you have a combination of issues. I'd prefer not to get too deep into some of these issues only because they do have competitive implications but we do have a series of initiatives going on to address all these -- efficiencies, it addresses the types of products that we're producing, so there's a series of types if you will that are being addressed and our team is pretty much all over this at this stage.

Okay. Two final questions. The Airbus contract, can you guys put any numbers around that for us in terms of what you think that can generate?

The Airbus Military contract that we have talked about in the call and announced last week will be worth -- it's approximately $5 million a year to start and as you've heard a couple of occasions we think that's a platform for potentially more from them.

Okay, well it was a nice start. And then lastly, just housekeeping. What was the availability on your revolver at the end of the period?

We had available liquidity of North of $300 million.

Ken Herbert, Wedbush.

Just a quick follow-up. On Telair and Nordisk, looks like they had a good quarter. Can you provide anymore granularity specifically on their performance in OE versus after market and was there anything in particular now that you've been into these businesses about three months that has surprised you either positively or negatively?

On the mix, we have strong after market coming out of Telair which is one of the motivations in acquiring the business, so we were pleased with the progress there. We are working on a fairly large program in that business that would be a pleasant surprise and something that we had not previously anticipated. The Nordisk business is pretty much as we had expected. It's a business -- kind of a grind them out kind of business and I don't think we're going to see much excitement or unexpected positives or negatives coming from that business. So the focus inside our Company is largely around the Telair opportunity and that's the one that we zeroed in on when we made these acquisitions and that one is far more positive than we had anticipated.

(Operator Instructions) Eric Hugel, Stephens.

Rick, can you talk about -- I gather in the quarter from Telair and Nordisk there was a headwind to margins from the normal purchase accounting step up of inventory that you then sell at the zero margin. Can you maybe give us some visibility as to what the impact there was and are we pretty much through that burn given that we've gone through pretty much a whole quarter now with the business?

Yes, so let me first start by Eric, it's not as harsh as 0%. We are able to book some margin but it's not what a full spares margin might look like. So you're correct in that there's a little bit of dilution relative to what a full run rate of spare would look like, but not zero. Then the answer to your question is, we think we'll have it still in Q4 but then once we get by Q4 it should probably have burned through most of the inventory.

And just lastly, any update to your EPS guidance for the year, $1.85 to $2.05. Are you keeping that intact, which is now including the $0.09 from the tax benefit. Is that how we should think about it?

Yes, I think we've -- trying to give you some color on how we feel about the fourth quarter, some of the good things and the bad and with that we'll let you guys do your own updates. We're not going to formally update the ranges we had out there.

Actually one more. In terms of the margins in the government and defense services, and it does look like we're going to have these S-61s come back into service, should we expect some incremental at least improvement in terms of the top line as well as the margins in the airlift business?

In Q4?

In Q4, yes.

That's our expectation, yes.

Thank you. I'm showing no further questions at this time. I'd like to turn the call over to management for any closing remarks.

Well, thank you very much for your participation today and look forward to having another call in a few months to discuss the fiscal year. Be well.

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