Aerojet Rocketdyne Holdings Inc (AJRD) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the GenCorp 2007 third quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS).

I would now like to turn the conference over to Linda Cutler. Please go ahead.

Thank you, Chris, and good morning, everyone and welcome to GenCorp's third quarter 2007 conference call. Before we start, I would like to remind you that during this conference call, GenCorp's management team may make forward-looking statements as defined by the Private Litigation Reform Act of 1995. All statements in this conference call and in subsequent discussions, other than historical information are forward-looking statements. These statements represent management's current judgment on expectations for future operations. We encourage you to review the cautionary language regarding forward-looking statements, and the factors contained in the third quarter earnings release issued today, as well as management's discussion and analysis and elsewhere in our most recent form 10-K and other filings with the SEC. These statements and factors could cause business conditions and actual results to differ materially from those expected by the company or expressed in our forward-looking statements. With that I would like to turn the call over to Terry.

Thank you, Linda, and good morning, everyone. Today, GenCorp reported its third quarter earnings. We reported that our revenue was up 25% year over year at $198.5 million, and we reported net earnings of $15.6 million, which compares to a loss in the third quarter of 2006 of $13.1 million. Our EBIT margins, excluding unusual non-cash pension expense was up to 11.2%. The increases that we're seeing are being driven by missile defense programs, the Orion space program, and the Titan closeout. And we continue to expect good results through the fourth quarter of this year, again driven by those four items. I'm going to turn it over to Yasmin right now to go through the numbers with you and then I will be back and we'll talk about a little more detail about the quarter and what we see going forward in the future. Yasmin?

Thank you, Terry, and good morning to everyone. I'm pleased to report that the company had another good quarter in terms of financial performance, with sales, segment performance, net income, and earnings per share improved year over year. We were fairly neutral from a cash perspective, with a nominal increase in our debt position. My remarks, which follow, will touch on each of the areas in this order.

Looking at the topline first, sales were $199 million, approximately. That's up $40 million and 25% compared to the third quarter of last year. The increase reflects performance of our Aerospace and Defense business, with higher activity in a variety of space and defense programs, but most notably on Titan, Orion, and standard missiles. Segment performance for the quarter also improved year over year, with solid performance at Aerojet. Aerojet's segment performance for the third quarter excluding environmental remediation provision adjustments, retirement benefit plan expense, and unusual items, was income of $22 million, representing an 11.2% return on its sales. This compared to $13.8 million, and an 8.8% return on sales for the same period in 2006. The year over year increases reflect higher sales volume and net favorable contract performance on the Aerojet contracts.

Margins were helped again in this quarter by our Titan closeout activities. As I noted on the last call, the last Titan launch was in 2005. In 2007, we have been in the phase of decommissioning and decontaminating the test facilities here, and we've torn down a number of these facilities that supported the Titan program for the last 50-plus years. At our customer's recent question, we accelerated this closedown activity on this contract and most of the work, in fact, all of the work really has been completed in this quarter now. We've certainly been very, very pleased with our performance on this Titan closeout activity and the customer has also been happy with our performance.

From a full-year margin perspective for Aerojet, we've had good margins in the first three quarters and it is certainly our objective to deliver double-digit or better margins on a full-year basis. Looking at our real estate segment a little now, sales reflect our normal ongoing lease activities and don't include any transactions or any real estate sales for either period. Third quarter income included -- was $1.4 million in 2007 compared to $0.5 million in 2006. As we noted in the release issued this morning, we have started recognizing some royalty in income on our agreement with Granite Construction Company, where they will be mining the rocks off parts of our Sacramento property. However, we do expect this royalty income in the near-term to be fairly nominal until Granite actually gears up its efforts.

Lastly, commenting on the income statement side, net income for the quarter was $15.6 million, or $0.24 per diluted share, compared to a net loss of $13.1 million or $0.24 of a loss per share in the third quarter of 2006. Both 2006 and 2007 third quarter periods included income tax benefits, $1 million in 2006 and $12.4 million in 2007. With respect to the current quarter, the $12.4 million benefit reflects federal and state tax settlements for research and development credit claims, manufacturer's investment credit claims, and certain statute expirations.

The current quarter also included three unusual charges, which I would like to briefly comment on. One, for the unrecoverable portion of certain legal settlements we reached in the quarter and that was $1.8 million. The second was for $2.3 million associated with the tax benefits that are due back to the customer, the benefit of which was recorded in the tax provision line. Lastly, we had a charge for $600,000 for costs associated with the replacement of our senior credit facility, which many of you know we did on favorable terms back in June, extending maturities on our senior credit facility as well. Commenting briefly on the corporate expense line, which was higher this quarter, this was driven by a charge of approximately $2 million associated with some legacy environmental charges. Lastly, I would like to comment one more time that both quarters do include retirement benefit plan expense, which is mostly non-cash. The amount in the third quarter was $5.6 million, compared to $10.8 million for the same period in 2006.

Turning my comments next to our debt and cash flow positions, net debt, which is total debt less cash as of August 31, was $364 million, compared to $362 million as of May 31, 2007, increasing nominally. The $2 million increase represents the small amount of cash usage by Aerojet, with the balance of the corporate expenditures, like interest expense, corporate expense, retiree medical expenses being offset by cash tax refunds that were received in the quarter. As of August 31, 2007, we had cash balances of $82.2 million, and an undrawn revolver of $80 million. So from a liquidity standpoint, the company is certainly in a strong position. To sum it up, we had a good quarter. As we go forward, we continue to focus on margin improvement and cash generation.

With that, I'll turn the call back to Terry.

Thank you, Yasmin. I'm going to talk first about what we told you earlier in the year, and how we're doing against the objectives that we set for ourselves. When we talk about Aerojet, what we said our objective is this year was to get a 10% or better margin. It was to see growth greater than the D.O.D. NASA budget growth, and it was to be cash flow positive with the longer-term goal for Aerojet over the next year or two to be for Aerojet to produce cash flow equal or greater than 80% of EBIT.

It looks like, and we're highly confident based on what we see for the rest of the year, that we're going to achieve all of those objectives, so this has been a successful year for us. And the reason that it's done so well is one, obviously, our strategy of focusing on the in-space propulsion, the missile defense programs, and the other programs that we focus the company on has driven the success, along with all the good work of the management of Aerojet and the group of people here at GenCorp.

Now, what does it mean for us and with a do we see looking forward into 2008, at least as far as Aerojet is concerned? Right now, we have some uncertainties. Those uncertainties are that the defense appropriation bill has not been passed yet. The NASA constellation program, which includes the Orion, that -- or the Orion capsule that we're building, is currently being restructured and the COTS program that we've talked about in the past with Rocketplane Kistler is unlikely to receive the funding that they need in order to proceed.

Now, what do we know? One, the government's going to continue to support missile defense. The United States is going to stay in manned space and it appears likely that our scope on the NASA program, the Orion program will increase, what quite frankly is uncertain for us right now is that in order to fund the increases in the program, it's likely that NASA will have to go back to Congress and ask for an increase in budget for that program, or delay the schedule and not meet the schedule of returning to manned space in 2013. In terms of what we do know for next year for Aerojet, Titan will be done, which means we're going to need to replace about something close to $40 million in revenue in order to stay at least equal with where we're going to finish this year in terms of revenue. So we have some challenges, we have some positives, and we still have a lot of unknowns on what we're going to be able to do or tell you what Aerojet will be able to do in 2008.

Let's turn a little bit to the real estate. In terms of the real estate, we announced a little earlier at the Gabelli conference that there would be a delay in the entitlement of the Rio Del Oro project. This delay is the result of two lawsuits on other projects that the city of Rancho Cordova lost. One was dealing with wetland mitigations. There the court basically said that you had to -- if you were going to mitigate by buying off-site land for wetlands mitigation, you needed to identify where that land was in your EIS/EIR document. The second was a case where the court said there was an inadequate description of where the water supply was coming for that particular project. The third issue that's come up is the Attorney General of the State of California, Jerry Brown, has interpreted SEQA to require applicants in their EIR to address global warming.

So the decision of the city, and we certainly concur with it, was to go back, redraft or add to the provisions addressing those three issues, republish those three sections only, and basically that results in a delay in the city council being able to consider the approval of the EIR/EIS on Rio Del Oro until March or April of 2008. We think it's prudent that we comply with full disclosure and we've certainly intended to all along and therefore we are certainly in agreement with the city on that.

Our other projects still are maintaining the schedule that we've laid out with the next entitlement being the Glenborough entitlement by the County of Sacramento, which we basically view to occur sometime in mid-2008. In terms of the marketplace and what we're seeing right now -- in the Sacramento residential market, it's still searching for the bottom of the market. The issue as we see it in this marketplace. It's been a rapid increase in price that occurred from 2002 to 2005, has priced a large segment of people out of the market. In 2000 the affordability factor, or the number of families that could afford homes in Sacramento exceeded 50%. Today it's somewhere in the neighborhood of 27%. So the issue we see here is price and the market's going to have to work its way through that before CA recovery or a large demand for new homes.

Having said that, we're still fairly bullish on with a we have here in terms of an asset, simply because the long-term drivers of residential real estate value is job creation and population growth. Both of those are forecasted to be quite strong for the Sacramento region out as far as anybody can see 20 to 30 years. So where we are today, is we continue to expect and to see improvement from our Aerojet business, we continue to make progress on the real estate, and we have a good chance of, as we have product available over the next two to three years, that the market will have recovered and that the demands of population growth and job growth will drive demand for the product that we have. So with that I would like to open it up for questions, operator.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Joe Nadol with JPMorgan. Please go ahead.

Good morning, Terry and Yasmin. It's actually Seth here for Joe this morning. Wanted to ask a couple of questions. Starting off first with the revenue picture for Aerojet, and I know that you talked at the Gabelli conference about 2008 being a challenging year for Aerojet without the Titan revenue. Now that the Titan program is essentially done, is that challenging environment something that starts in Q4 of this year, or do we still expect to see this sort of double digit growth that we've seen thus far throughout 2007 in the fourth quarter?

We'd expect it to have no affect on the fourth quarter, Joe.

And as we look out into next year, and we see a little bit more of a challenging environment, what are the potential drivers of revenue growth next year? Standard missile is something that for the last few quarters has driven revenue growth and you cited in the press release contracts there. Are those contracts that continue into next year and could provide some growth?

I think so -- yes. Standard missile should grow some next year. Missile defense overall as a segment should show growth. Orion may or may not, depending upon what NASA is able to do budget-wise. As I said, the good news is we're getting additional scope.

What would that additional scope be?

It would be more engineering content, more testing, primarily, and the testing will result in more prototypes having to be built and designed a little earlier. The issues, as you know, is going to be how is NASA going to afford an increase, I think -- an increase in the cost of the program.

Right. And if that -- even if that was to come through and you were to get this increase in engineering and testing work, is that something that we'd start to see -- if the program was to proceed on schedule, would we start to see that soon, or would we start to see that later in the program as we get closer to a launch?

We would see it soon, if they have the funding. That's going to be the driver.

Then as we look at the budget, are there any line items that you're concerned about as we look at the FY08 budget and we see it move through the Congress?

No. Where our issues are ism there's a number of programs where there's been a request for plus ups, increases in what was initially submitted, and we're waiting to see how those turn out. Historically, we've done quite well, but this is a slightly different Congress, so who knows.

Right. So you would say that the budget risk is sort of on the upside?

The budget risk is -- yes.

And then about cost, with it seeming like the Rocketplane venture is in trouble, maybe not in the near-term, but looking out further, is there a chance for you to use the engines that you have on another object for cost?

Yes, there is. There's a program that we're currently conducting some preliminary design work or orbital science called the Taurus II launch vehicle. It's a Delta II class vehicle that would use two of our AJ26s to power it's first stage.

Okay. Looking at this quarter, can you tell us what the EBIT margin at Aerojet would have been ex Titan?

It would have been lower.

I think it's normal for us to expect 10% margins.

Okay.

So when you see something above that, it's being driven in a great part by Titan.

But it would have been close to 10%, even without Titan?

Yes.

And then you mentioned the temporary increase in corporate costs this quarter. As we look out to next year, what should we expect to see on that line? Something similar to what we've seen this year, or something in sort of the 4 to $5 million range per quarter?

Yes. I think that's certainly what we're targeting, Joe, on a full-year run rate basis. The $2 million here is certainly unusual.

And then for free cash flow, I know you spoke about Aerojet, are you still targeting next year being free cash flow positive for the company as a whole?

Yes. And we are basically saying we're going to be cash flow positive this year.

Yes.

As a whole. But the target for next year is to be cash flow positive. Obviously, that cash mainly comes from Aerojet.

Yes. Then just a couple of brief ones about the real estate. I know this is difficult to predict, but have you gotten any more indications recently about the potential for someone to file a lawsuit on Rio, specifically, maybe the groups that have filed lawsuits against other developments in the area?

No, they don't exactly tell us what they're planning on doing. We don't know. After the city improves entitlement, there's a 60-day window in which they can appeal to the court the adequacy of the disclosures, primarily, or that the process wasn't followed. That's why we're being extremely careful about the process and extremely disclosing about the content to try to either minimize the risk of a lawsuit or to minimize the risk of losing a lawsuit. We can't stop anybody from filing. All we can do is try to do the best we can and make sure that anything they file will be found to be without merit.

That makes sense. Do you get a sense that the way that you approach this might affect whether or not a group would file a lawsuit, or that there are groups out there who are just going to file a lawsuit no matter what?

I think it's the former rather than the latter. We can't control whether somebody's going to file a lawsuit, but we can control in part what the issues really are that are contested. That's why we want to disclose as much as we can possibly do on this project.

Sure, sure. And then I was wondering if there was anymore you can tell us about this global warming declaration? I understand that it's something new. Are there a set criteria out there? Do you just have to say what the impact is, or does the California Attorney General have to approve it and do they know what standards they would use to approve it?

That's a very good question. I think the answer is nobody knows what the standard is at the moment. We are aware of a project where the attorney general reached a settlement with the entitlement authority, and we're looking at what that settlement entailed to try to make sure that we comply with it, but is there any -- is there any definitive standard, the answer is no. There's not.

Then just the last question is sort of about Glenborough. These issues that are coming up, I guess there will be a global warming issue for --

Yes, you're going to see the same thing come out and what we will try to do is use -- utilize with a we've learned and utilize the approach that we and the city ultimately decides on global warming in the Rio matter to address it also in the Glenborough.

But the rest of the issues in Glenborough might not come up in more experienced titling authority?

Yeah. The cases -- both these two cases that I mentioned were losses by the city of Rancho Cordova, as opposed to the county which obviously has been doing entitlement for a lot longer period of time, simply because the counties existed a lot longer than the cities of Rancho Cordova.

Great. Well, thanks very much for answering my questions.

Sure.

Thank you. Our next question comes from Andrew Sidoti with Markston International. Please go ahead.

Good morning. Just a couple of questions here. First, on the Atlas V, I know you are in negotiations with Lockheed. I was wondering where you are at that, where the status of that is currently?

We have recent agreement with Lockheed.

Okay. And are we able to get margin on that business? If memory serves --

Double digit. Double digit margin.

Okay. Versus what was it previously?

Zero.

Zero? Okay. The restructuring, you mentioned that the NASA constellation program, that Orion's being restructured. What's your current best guess as far as what a restructuring program might -- Orion program might look like and the possible impact that could have on Aerojet, both positive or negative?

Well, what we've been seeing is we see some kind of expectation of 30 to $50 million a year. Now, the scope is increasing. How much, we won't know until we finally get an answer from NASA. I think their constraint is until the shuttle's retired, they have a hard time getting additional funding to accelerate that. The increased scope, obviously, is for our propulsion content and we are waiting for them to tell us how they want to proceed. In fact, Lockheed -- we all are. I think their issue is going to be -- right now the schedule is have men fly in this vehicle, 2013. If the costs are going up, they're going to -- they either have to get more money sooner, or they have to push out the schedule. Either one helps us over the long-term, but we won't know until they decide what they can do.

Okay. Any idea ballparkish of when we expect this to be resolved?

Well, we're dealing with Congress and NASA, so no.

Okay.

NASA's in the point of where they would like to do more things than what they've got funding to do. So how they're going to deal with it, your guess is as good as mine.

Okay. Any idea where the money that was earmarked for or any guesstimates the money that was earmarked for the Rocketplane, what NASA will be doing with that?

It's still not clear. The program, basically, they had two suppliers they selected. One was Rocketplane Kistler, the other was Space X. So Rocketplane Kistler, if in fact they get terminated, they haven't been yet, but they've been given notice of missing the milestone, which usually results in termination, that means either it's going to be the other winner or else the program, assuming neighbor can meet the technical requirements, could shift to an orbital program or could shift to something else. We just don't know.

Okay. You mentioned the engines that were going to go with the rock plane program, if they were successful, you may be doing something with orbital sciences. Could you kind of go into that a little bit more and also when you would expect to see something like that kick in in terms of revenue?

Orbital science as a program that's kind of -- they're trying to develop and get NASA interested in. It basically is again a low-cost cargo lift up to the shuttle called RS2. At the same time they're seeing a niche in the market. One of the older projects of the air force is the Delta 2 program, of which we supply the second stage engine and the attitude control systems. If the air force and the government continues with -- unless they change their decision, we'll be finished in the next two years. So Orbital is trying and is offering a product to take the place of that. If the government likes it and continues to fund it, and obviously we will support Orbital in trying to get it through, then we'll have a program. If the government doesn't, then we won't with Orbital.

Okay. Just another question I would like to make and I would like to finish up with a comment. The question is that the Granite Construction Company, when do you -- you said that you're getting some royalties -- first of all, what exactly is being mined and how much are royalties? And how -- when do they become meaningful to your top line, do you expect?

Our -- first thing, our property, a lot of it was strip mined for gold, so there's a lot of rock berms on the service. Some are as high as 100 feet tall, which was real nice when we were doing rocket testing here, because you had natural barriers that would contain any explosive-like activity. That is what Granite is mining. And they're going to use it for aggregate. Obviously, it helps us because it will reduce the cost of preparing the land for residential or development. In the near-term, we're talking less than $1 million annually. In the long-term, it could go up to two or three times that. But it's not going to -- it's not going to be a huge item. It's just another way, one, to reduce our cost of putting the land into beneficial use and two they're paying us instead of us paying them to do it.

Okay. And my last question or comment is that you mentioned that you're bullish in terms of what you have in terms of real estate assets and your outlook for Aerojet. The comment I would like to make is I think it would send a strong message to the market to see management kind of step up to the plate and do some open-market purchases. Is there anything that is precluding management from actually going out there and adding to your positions?

Only for the next day or so. After that I think there's an open period.

Okay.

Thank you. Our next question comes from James Foung with Gabelli and Company. Please go ahead.

Good morning, Terry, how are you?

Good, Jim. How are you?

Good. Just a bit on the Atlas program, do you think the revenues that you lose from Titan could be replaced by the Atlas program in '08?

No, it won't go up that much. I mean, the revenue line's going to stay somewhere between around $50 million and we already have $50 million or something close to that for this year. So it won't be an increase. The margins help.

Okay. So it's just the margin change from zero to double digits then. But do you expect your renegotiated contract to get additional revenues that should go out the next couple of years?

It will depend on the demand for the program. That will depend on a lot of things. Some I can speculate about, some are totally outside of anybody's control. It's the number of launches, obviously, heavy launches, that are going to drive it. It's the number of market share that Atlas five is going to get. There's an issue of something is probably -- needs to be a backup through the NASA constellation program, and whether either Delta IV or Atlas V get man-rated is another issue that may or may not occur.

So if RE stays the same in '08 and you lose the Titan, you can actually see -- and standard missile grows 3 to 5% in '08?

Yes. Something in that neighborhood. It ultimately depends on what the government is going -- it's their decision, not ours.

So we could actually see a revenue decline in Aerojet in '08, then, right?

We don't know yet. I think, given what we know right now, it will be hard for us to match this year, certainly.

Okay.

In fact, I can tell you we won't.

Right. And then could you just talk about pension expense? That came down this year and do you see another drop in '08 with your pension costs?

Yes, Jim. We obviously saw a big drop in '07 compared to '06. We do expect to see a big drop in '08 compared to '07. We will tell you what those numbers look like at the next call.

Okay. So we could kind of model some sort of decline. And how about the tax rate, Yasmin? What should we look for in the tax rate? You've gotten a couple benefits this year from what you've outlined.

I think as we go forward, Jim, we're not going to be in a tax-paying position, and given our NOLs and our release on the valuation allowances against our deferred taxes, we don't expect to be looking at a provision either at this point in time. We certainly won't be paying any cash taxes, other than very, very minimal AMT taxes.

Okay. So actually -- so it would be like from zero to even a tax benefit in '08 then?

Yes. We donate expect any more substantial tax benefits in '08.

Okay, so -- all right. Thank you.

(OPERATOR INSTRUCTIONS) Presenters, there appears to be no further questions at this time. Please continue with any closing remarks.

All right. Thank you all for being on the call. Again, we look for continued good things here at the company and we will talk to you again as soon as we close out the next quarter. Thank you and good day.

Thank you. Ladies and gentlemen, this conference will be available for replay after 11:30 a.m. Pacific time today through October 10, 2007, at midnight Pacific. You may access the AT&T executive replay system at any time by dialing 1-800-475-6701 and entering the access code 887847. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844; access code 887847. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.