LMI Aerospace, Inc. Q3 2008 Earnings Call Transcript

LMI Aerospace, Inc. (LCUT)

Q3 2008 Earnings Call Transcript

November 06, 2008, 09:00 am ET

Executives

Ron Saks - CEO and President

Ed Dickinson - CFO

Analysts

Alex Hamilton - Jesup & Lamont

Gary Liebowitz - Wachovia Securities

Tyler Hojo - Sidoti & Company

Ed Keller - Oppenheimer

Stan Manny - Manny Family Investments

Chris McDonald - Kennedy Capital Management

Myles Walton - Oppenheimer

Presentation

Operator

Good day and welcome to the LMI Aerospace third-quarter 2008 earnings conference call. Today's conference is being recorded. In addition to our past performance and other historical facts, we will be discussing certain forward-looking information such as our current expectations as to future performance. Such forward-looking information is based on management's assumptions and analysis that are subject to numerous business risks and uncertainties, including risk and uncertainties that relate to acquisition. There can be no assurance that our assumptions will prove to be accurate in the future.

Actual results may differ from these forward-looking statements as a result, among other things, of the factors detailed from time to time in our filings with the Securities and Exchange Commission, including those described in our annual report Form 10-K for the year ended December 31, 2007.

At this time, I would like to turn the conference over to the Chief Executive Officer, Mr. Ron Saks. Please go ahead, sir.

Ron Saks

Thank you, Laurie. Good morning, everyone. Thanks for joining our call. I'm Ron Saks, CEO of LMI Aerospace, and with me today in St. Louis is Ed Dickinson, our CFO. Ryan Bogan, CEO and President of D3 Technologies, will not be joining us today.

Here, normally, I start out with a description of what went on in the press release; but as I was driving in this morning, something occurred to me, because we're going to be talking a good bit in today's environment about risk mitigation and one evidence of that with respect to LMI is we have this call about an hour earlier than expected, because I was going to be attending the opening of a composite facility with a potential customer called [Dare Corp] in Nogales, Mexico.

However, when I was in California recently, I heard they were shooting one another in the streets of Nogales. So, if you’re wondering about whether LMI is going to mitigate its risk, I am sitting here in St. Louis, safely awaiting some thunder stocks.

In our press release issued yesterday, we announced record net income for the third quarter of 2008. Our revenues declined a bit from the second quarter, which was stronger than expected, at both our Aerostructures and Engineering Services segments, with Aerostructures impacted by the Boeing strike which began in September, and D3 experiencing mix changes and reduced overtime. Net income, however, was higher at both divisions, but gross margin improvement at both as well.

As we progressed through the third quarter and to the present, credit markets tightened and global economic performance began to deteriorate. Accordingly, we met with our largest customers, both OEMs and Tier 1s, in order to assess the validity of our current purchase orders and requested their view of the potential production changes which could occur in the next one to two years.

In addition, we tightened our review of capital expenditure requests and adjusted our current throughput goals in order to level production and provide productive work for our Aerostructures employees.

Our operating results for the third quarter were outstanding and we are taking steps to assure that we improve liquidity and optimize earnings while retaining our current workforce, despite the impact of the Boeing strike.

I would like Ed Dickinson to review the financial results and our press release with you, and then I will have more comments about our prospects for 2009, plans to improve free cash flow, and our acquisition strategy. Ed?

Ed Dickinson

Morning everybody, again as Ron said, obviously, there is a lot going on in our industry and the overall economy. I would just say that we were still pleased with the results we saw, even given some of the events in our environment.

Before we address the financials, as usual I will give the cautionary note that the acquisition of D3 in July of last year makes comparing the numbers year-to-year a little difficult. The third quarter and the year-to-date '07 only have two months of the contribution of D3 and also, as a reminder, the legacy LMI businesses make up the Aerostructures segment; and D3 comprises the entire portion of the Engineering Services segment.

As Ron said, on a consolidated level revenue in the quarter was $61.9 million compared to $47.8 million to prior year and our net income was $5.2 million or $1.30 per share compared to $9.3 million or $0.83 per share.

The Aerostructures group generated $39.4 million in revenue in the current quarter, up 10% from $35.8 million in the prior year. However, the sales were down from $41.6 million generated in the second quarter of '08. The third quarter was negatively impacted by approximately $1.5 million due to the recently settled IAM strike at Boeing.

Last quarter, we spoke of certain offload work that we were expecting to generate revenue in the third and fourth quarters, but it has not materialized at the levels that we expected due to the strike. This shortfall is not included in the $1.5 million we referenced.

As both Boeing and their Tier 1s get production schedules aligned, we expect to see continued impacts through the fourth quarter of 2008. This uncertainty has led us to withdraw our guidance for 2008.

In comparing the third quarter to the prior year, at Aerostructures, sales of military product were again the largest growth market for us this quarter, generating $10.8 million, up 18% from the prior year, even though the prior year included $1.1 million of revenue from a customer settlement.

Blackhawk volume reached $8.4 million in the quarter, more than doubling from $4 million in the prior year. Our Apache work was unchanged at $1.5 million in the quarter.

On the corporate and regional revenue, we reached $13.9 million, up 12% from the prior year and our revenues for Gulfstream aircraft were $12 million, up from $11 million in the prior year, primarily due to production rate changes and sales of Bombardier product were $1.5 million in the quarter, up from $1.1 million in the prior year.

Revenues due to the strike were down. They were $11.3 million, down 1.5% from $11.5 million in the prior year. They were down 9% from the second quarter at $12.4 million.

Continued deliveries on the newly developed 747-8 caused the [four seven] revenue actually to increase in the quarter compared to the prior year, reaching $3.2 million compared to $2.2 million the prior year and just as a note, we also finalized our first 767 wing mod kit during the quarter and we will be working diligently with our supply chain to maximize deliveries in the fourth quarter of that product.

Revenues for the 737 were $5.6 million, off $800,000 from the prior year and the 777 generated $900,000, down $0.5 million from the prior year, both resulting from the work stoppage at Boeing.

Technology products generated $1.9 million in the third quarter of '08, up slightly from $1.7 million in the prior year and all of this came from additional sales for laser equipment in the semiconductor industry.

In percentage terms, corporate and regional products still lead the way at 35% of sales. Commercial aircraft dropped slightly from last quarter to 29%; and military was 27%.

Gross margins in the Aerostructures segment were $11.8 million, just shy of 30% in the quarter, a bit above our guidance range of 28% to 29%. This compares to $11.1 million or 31% of prior year.

As stated previously, the prior year included a settlement that generated $1.1 million of revenue and approximately $800,000 of gross profit. Removing this item, gross margins were up a few basis points, but were basically unchanged year-over-year.

Aerostructures selling, general and admin expenses were $5.8 million, up from $5.1 million, primarily due to the higher salaries, wages, and fringe benefits costs as well as some additional professional fees. We also included in the press release the fact that we recorded the benefit on a recovery of a previously reserved receivable from a corporate aircraft manufacturer of approximately $260,000 in the quarter.

Moving on to D3, since we didn't own it for a full quarter of last year, I will compare the numbers to the second quarter. The Engineering Services segment provided $22.8 million of revenue in the quarter, down from $24 million in the second quarter, primarily due to lower overtime and, as mentioned last quarter, increased vacations and additional holiday.

Sales of services for commercial aircraft were $11 million, down slightly from $11.2 million. Some modest growth in sales for our winglet programs and the 777 offset modest declines in the 787 and the 747-8. Sales for corporate aircraft programs, generally the G650 and G250 were $7.6 million, down from $8.4 million.

Military programs provided $3.4 million, up from $3 million in the prior quarter, primarily on projects for the North Island Navy Group as well as JSF. Tooling design programs generated $800,000 in the quarter compared to $1.3 million in the second quarter.

Gross profit was very strong in the Engineering Services group this quarter at $5.1 million or 22.4% compared to $4.9 million or 20.4% in the second quarter. D3 continued to see very high utilization of its engineers, a better mix of business, and also negotiated several pricing adjustments to purchase orders that generated a benefit of approximately $250,000 in the quarter.

Offsetting these gains was approximately $100,000 of non-billable time on one particular contract. Since D3 sells labor hours, fourth quarter will face some sales and margin pressure due to the number of holidays that we expect, that we will see.

Selling, general, and admin expenses for the engineering segment were $2.5 million, up from $2.3 million in the second quarter, primarily due to additional professional fees and salary and wages.

As we move on to non-segment expenses, interest expense was $407,000 in the third quarter compared to $650,000 in the prior year. As you recall, we entered into a new loan agreement when we purchased D3 in July of last year and, as such, had only two months of interest expense in the prior year. But we did write-off $200,000 of deferred financing cost in connection with the acquisition in the prior-year period.

We continue to have a $25 million portion of our revolving line of credit and a one-year LIBOR-based arrangement that accrues interest at slightly below 4%.

Income taxes for the quarter were $3 million, an effective rate of 36.5%, compared to $2.1 million in the prior year with an effective rate of 33.1%. The increased rate is primarily due to a higher effective state tax rate due to the addition of D3.

Our borrowings on our revolving line of credit dropped to $25.1 million at the end of the quarter. CapEx was $2.8 million; and at this point we are on pace to be a bit below the guided range of $8 million to $9 million. Free cash flow was over $3.8 million for the quarter, resulting in a year-to-date free cash flow of $3.6 million.

With Boeing's strike, the beginning of our 767 wing mod program, and the expected Blackhawk growth, inventories continued to grow, rising $4.4 million in the quarter. Due to reduced demand from Boeing and the Tier 1s expected in the fourth quarter, we have taken actions to limit our exposures to the strike but we will continue to invest in inventories. We plan to work with our customers to support their ramp-ups and we’ll begin an inventory reduction plan as production schedules return to the expected levels, targeting our mid-2008 inventory levels.

With that, I will turn it back over to Ron.

Ron Saks

Thanks, Ed. As you know, our Engineering Services segment provides design and stress engineering to OEMs and Tier 1s in the commercial and military aerospace markets. During the third quarter and through the end of 2008, the D3 group will continue to provide service under existing contracts, with emphasis on Boeing and Gulfstream products as well as legacy military programs.

In early December, the Boeing contract with its Engineers Union will expire, and the results of those negotiations may impact D3's operations if a strike occurs. Our expectation in those circumstances is that D3 may be required to provide increased services in case of a strike and we are preparing for that possibility.

We are, however, assuming a new contract will be ratified without a work stoppage and expect D3's workload to continue at levels consistent with the first three quarters of 2008. D3's work statement in 2009 will likely remain steady to higher, based on recent new program developments and continuation of services for long-time customers.

We recognize that a global recession may result in a reduction of engineering investment by our customers and if that occurs, D3 has considerable flexibility, if necessary, to adjust to reduction in demand. At this time, however, we are estimating that 2009 revenue will approximate 2008, with some upside possible early in 2009.

Free cash flow at D3 should continue at high levels, barring possible required investments in new programs, none of which are currently identified.

Our Aerostructures group presently has roughly equivalent sales volume derived from Boeing, Gulfstream, and Black Hawk helicopter components and subassemblies. We have currently executed long-term contracts on most of this work that last until 2011 through 2016, depending on the customer and model type.

In the case of Boeing products, we expect production rates on 737 and 777 models to hold at current levels at least through 2009 and do not expect much contribution from the 787 model until 2010. Our ship set value on the 787 model remains at about $160,000.

Expected production rates for the 767 winglet modification kits and wing edges are 120 to 140 ship sets for both 2009 and 2010, supported in part by relatively high fuel prices and continuing delays in Boeing 787 production. Boeing model 747-8 orders, including some of the offload orders anticipated previously, continue at a relatively high level and, as Ed said, did partially offset the impact of the Boeing strike in the third quarter. Shipments on that model have continued to date.

Production rates on the Gulfstream G450 and G550 are expected to improve slightly in 2009. We have also built our ship set value on the G650 model to $205,000, with some likely upside from a portion of $40,000 of offload work. We also have about $135,000 of ship set value on the G250.

Volume from the G650 and G250 both in development is not expected to be significant in 2009, with the exception of front-end costs, including tooling. We do expect production rate reductions on the mid-cabin G150; but we have only about $15,000 of ship set value on that aircraft.

The Boeing and Gulfstream products are subject to buyer financing risk, given the current lack of availability in world credit markets, and could influence production rates earlier than expected. At this point, given recent positive action in credit markets and the possibility that manufacturers may supplement financings of some of this product, we are planning our production to meet current build rates.

Black Hawk helicopter production rates are steady on the L and S models in 2009, and production of the M model is growing. We believe that build rates on this program in 2009 should be consistent with the demand currently planned from our two major customers.

We recognize that the current economic climate suggests a possible global recession and do believe that our revenues will be negatively impacted if that occurs. Our analysis of our current markets reflects some risk but we currently assess that risk affecting LMI in 2010 or later.

In order to buffer the impact of a possible downturn in our markets, which we don't currently foresee in 2009, our management attention is directed to maximizing free cash flow. We intend to reduce inventories, as Ed stated earlier, by the end of 2009 to mid-2008 levels despite the expected increases in purchased items needed to support both the Black Hawk and 767 winglet programs. We're also deferring certain capital expenditures.

On the other hand, we are winning new programs and have strengthened our project management, supply chain, and estimating groups in order to take advantage of new opportunities including possible market share increases which may result from the potential failures of some members of the aerospace supply chain.

We have targeted Airbus products as desirable market segment additions and continue to expand our dialog with Airbus direct as well as Tier 1s producing Airbus work.

In order to provide products and Engineering Services on Airbus models as well as those produced by our key customers, we are continuing to aggressively seek composite production capability through acquisition and greenfield operations. A review of several acquisition opportunities continues. Our plan is to be offering composite products and services in the first quarter of 2009.

Although, we continue to believe, we should add meaningful machining capability to support current programs and provide more complex products to our customers, we are not actively seeking that capability at this time. We believe that when the current uncertainties in the market are resolved, we will resume our search and expect the valuations may be lower.

We will continue to manage our business conservatively with continued emphasis on diversification of the markets we serve. Our business strategy for each segment is the anchor that continues to give us direction.

We remain optimistic that we will gain market share as we further develop our organizational infrastructure and win new design-build contracts even in a potentially flat- to-declining aerospace market. Thank you for your interest. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). And we’ll go first to Alex Hamilton with Jesup & Lamont.

Alex Hamilton - Jesup & Lamont

Hi! Good morning. I don't know if you went through it, so I apologize if I am making you go through something that you already did.

You suspended '08 guidance, yet you reiterated '09. Can you kind of explain that? Because I would think that if there is an impact to '08 there would certainly be an impact to '09.

Ron Saks

Well, I'm not sure I agree, in this sense. Our markets for the Gulfstream and Black Hawk products continue in the Aerostructures division as they have been. And D3 revenues appear to be unaffected by the Boeing strike.

However, the Boeing strike has had an impact on us. It started in September and in a recent investor conference, we mentioned also that there was a potentially considerable shortfall in revenue where the strike to continue through the end of the year, in both components assemblies and tooling.

Now that the strike has been resolved, and this lasted for two months, during September we were still shipping some product and what we don't know is the extent of the ramp-up period for Boeing to resume production on commercial models. If they are going to delay the ramp-up of that production until the first of the year and utilize whatever inventory they have, selectively. We believe that some of the impact sectors at rates that we previously predicted.

So 2008, we don't know exactly the impact yet and that’s why we withdrew. But we believe it will be a one-quarter occurrence.

Alex Hamilton - Jesup & Lamont

Great, thank you for the explanation.

Operator

We’ll go next to Gary Liebowitz with Wachovia.

Gary Liebowitz - Wachovia Securities

Good morning, gentlemen. Ron, can you remind us what your lead time typically is on the 737 for your leading edge and the fuselage work that you do? In other words, you have recognized revenue how many months in advance of eventual customer delivery?

Ron Saks

You know, as far as I know on the leading edge, which is a segment which has affected one of our plants pretty significantly and I will just digress for a moment and mention in the case of that plant, we did build inventories up to two months levels. We aren't quite there yet, but we are getting there, so that we have adequate inventory when they ramp up.

The ramp up on the leading edge generally is three to four months. However, during this period, Spirit has said that they had sufficient product to be able to build a number of fuselage sections and, we presume, wing sections as well. We don't know how much of that they built and as you know, what we may be encountering just in this quarter, we have seen in the case of United Technologies, Boeing, and others a desire to reduce freight windows and bring their inventory levels down, as a conservative tactic, not knowing exactly what is going to happen. I think, we are all in the same game, and so we’re starting to do the same thing with our suppliers as well.

That having been said, three to four months is typical and so as they burn off their inventories and we expect them to be burned off by the end of the year, they will be drawing some additional product from us as the quarter goes forward.

In the case of Gulfstream, we have a kitting program that generally runs about three to four months ahead as well. A lot of our components are longer lead times that can stretch as much as six months, ahead of time and we’ve seen regular draws of those components from our customers that are not on strike or have not been on strike.

Gary Liebowitz - Wachovia Securities

So, if you were anticipating in your 2009 guidance, pretty well, I think you said steady levels through the year that implies that it wouldn't be until early to mid 2010 that we would see a potential rate cut at Boeing.

Ron Saks

That's correct.

Gary Liebowitz - Wachovia Securities

Okay and also, maybe just a little more color on the D3 margins. I thought Ryan would be on the phone to take some credit. But they look like they were as strong as at any time in history.

Were there any unusual items that can't repeat? Are you still expecting sort of a 20% gross margin going forward?

Ed Dickinson

Yeah, it was a very good quarter for them and yeah again, we don't want to get into particular customer margins. But they did have some growth in certain customers that have had better rates.

So, is that going to continue? Again, Ron gave a little color on what we expected going forward for D3. I think they can continue to generate margins as we’ve guided. I think you have seen a bit of a high-water mark right here, this means very good results for D3 and we talked about a couple of isolated items in there, but if utilization continues to be very high they manage it very tightly. If you saw their monthly reports that they generate and go through with their site directors, they chart their hours, they look at what their utilization is and then they work very hard to keep it quite high and then they have been very successful.

They also are targeting to shift some work in-house. They get generally, what they call work transfer, where work comes back in-house versus doing it on-site at the customer and that generally also boosts margins a little bit.

So, it's a mix of several different things that added up to a very good quarter for them and again, we talked about the one item where they got some additional benefit on renegotiating some pricing; and that was about 100 basis point benefit to them.

Ron Saks

I would also add, however, one of the strategic bullets that D3 has adopted jointly with us as they have joined our group is to increase the amount of work transfer relative to their so-called industry assist, where they work on projects back at their office where they have more project control, as compared to working on-site at customers.

They still have considerable amounts of both but they have been successful at moving more work transfers, as Ed mentioned. And margins should improve as a result of that because rates are somewhat higher and cover their overhead better.

They also are working on a couple of programs with which you all are very familiar, the 747-8 and the G650, which have continued to be under real pressure in order to get those aircraft completed. So there have been although overtime reduced during the period and we mentioned revenues reduced nonetheless, there has been in those particular segments considerable demand for their people and not that those are necessarily the highest margin, but the ability to cover overhead is the bigger issue.

Gary Liebowitz - Wachovia Securities

Thank you.

Operator

And we’ll go next to Tyler Hojo with Sidoti & Company.

Tyler Hojo - Sidoti & Company

Hi! Good morning, guys. First, just on Black Hawk, Ed, did you give the Black Hawk revenue in the quarter?

Ed Dickinson

Yes, I think it was $8.4 million, up from $4 million in the prior year.

Tyler Hojo - Sidoti & Company

Yeah okay, but the Black Hawk revenue in the second quarter was $9 million, if I remember it correctly.

Ed Dickinson

That's correct. It was down about $0.5 million second quarter to third quarter.

Tyler Hojo - Sidoti & Company

And I guess, I'm just looking for some sort of explanation just in regards to what happened there.

Ed Dickinson

I think we could -- Ron alluded a little bit, to some actions taken by several customers and UTC certainly some putting some pressure on Sikorsky to manage their inventories a bit.

We are not seeing any change in the ultimate demand for Black Hawks but as Sikorsky makes decisions to rebalance their inventories or adjust freight windows, it has a direct correlation to what our inventories do and what our revenues do. So that pressure, I think, will still be prevalent in the fourth quarter as well.

Ron Saks

To give you a little color, and we have mentioned in previous conference calls that trying to anticipate the MRP system demands at those customers has proven to be difficult at times. The schedules for production aren't as linear as one would think and as a result, we do find real mixtures.

In the fourth quarter, we likely will see some reduced demand as a result of the inventory reduction. But the ramp-ups that are scheduled to come, together with the fact that on the M model, which is the largest contributor to us, both Sikorsky through its Bridgeport facility and Vought in Texas are building those assemblies.

And, as Vought ramps up and Sikorsky tries to maintain volumes, at sometime during the year and we are not sure which quarter it is going to occur but what we are likely to see is some build-up of demand from Vought as they ramp up their production, with Sikorsky continuing fairly steady and then, as Vought ramps up over the time, Sikorsky will likely reduce their demand unless the overall demand for that aircraft were to go up.

So, I say that only because as we go through future quarters, don't be surprised if we see some anomalies in the quarterly revenues. But on balance, our estimates of revenue through the third quarter and even through the fourth are pretty consistent with our internal projections that we anticipated for the full year.

Tyler Hojo - Sidoti & Company

Okay, okay. That's good. You mentioned Vought, and I guess just in regards to the strike that is going on there, I don't think it would impact Black Hawk. But just in regards your 450 exposure, have you seen any pushback area? Or do you plan to?

Ron Saks

What we have seen is communication from our end customer regarding the impact of the strike and we’re not sure exactly what the implications are but we do know that there are tactics being used to potentially increase 550 production in the short-term, while 450 is stalled until Vought is able to resume production and Vought is producing despite the strike, Vought is producing some 450 wing sections. We don't know the total impact, but in terms of number of units being shipped, we are not being advised that there will be a meaningful change in the total number of large-cabin aircraft to be produced in 2008.

Tyler Hojo - Sidoti & Company

Very good and just lastly, you mentioned the investor conference that you were at. I believe you mentioned basically saying that if you ship no product to Boeing in the fourth quarter it would be about a $13 million hit in sales.

Is that still how you see it? Or has it maybe gotten a little bit worse and that’s the reason why you are withdrawing the guidance? Or how should we think about that?

Ron Saks

The $13 million couldn't get worse because that was everything. That was assuming. We shipped nothing. At the time of the conference, we expected about 60% of that would ship. We are in the process now of trying to evaluate what that is and that we do know that for example, of that $13 million, there is about $1 million to $1.5 million worth of tooling that would have been stalled because we couldn't ship components on 747-8 program. But we know now that we will be able to ship that.

So that $13 million was a very conservative estimate. What we are going to try to do for you as we go through this process and figure out what the draws are going to be and as we get into the MRP systems in particular at Spirit and Vought and other Tier 1s, as well as directly at Boeing, how close we are with regard to that estimate of about 60% of the $13 million.

Tyler Hojo - Sidoti & Company

Okay, but I guess at that time, you still held your 2008 guidance. So, I guess, what I am wondering is, is the read that the guidance is going to be lower? Or is it just that it's going to be somewhere in that range and you're just going to tighten it when you have a little bit more visibility?

Ron Saks

The overall guidance will likely be lower because the strike lasted an additional month beyond the timing of that conference. We just didn't know how long it was going to last.

But the more important issue is how quickly now Boeing and the Tier 1s are going to ramp up back up and that’s what we are trying to access.

We also have, as Ed mentioned, the 767 coming in and we have -- you may recall that our estimate for the fourth quarter of 2008 was going to be benefited both by the 767 winglet increase as well as tooling.

We also have some engineering delays on some of the programs for which we have tooling and we’re trying to assess whether our original estimate of that tooling is going to be accurate, if it's going to be higher or lower.

So, we are not -- I'm not trying to be evasive but just to say that yes, the quarter is going to end up a bit lower than we anticipated and it will be impacted by the speed with which Boeing and the Tier 1s ramp back up.

Tyler Hojo - Sidoti & Company

Fair enough, okay. I’ll let somebody else ask a question. Thanks.

Operator

We’ll go next to Ed Keller with Oppenheimer.

Ed Keller - Oppenheimer

Hi, Ron and Ed. Nice quarter. A couple of questions. One is it sounds like growth on 787 has kind of shifted to 2010 from previous 2009, which isn't unexpected of course, but I'm wondering, did something offset that relative to '09 guidance? Or is there a little bit of pressure on '09 now?

Ron Saks

We really didn't have any volume of consequence on the 87 in '09. In part because as you may know, Boeing had already built up a number of aircraft internally and we aren't sure when that demand for components and subassemblies is going to pick back up, regardless of when they actually ship.

The only purpose for that comment was in trying to give you a sense that right now during the quarter there hasn't been any real quoting activity on the 787 and so our ship set value has remained at levels that existed prior to that.

We would expect to see some improvement in that ship set value as production increases. But our 2009 right now is not impacted by the delays on the 787.

Ed Keller - Oppenheimer

Okay, thanks and on the G250, I think, you mentioned that the ship set value there is 135k. I was wondering if you could contrast that with your ship set value on the G200.

Ron Saks

Yeah on G200.

Ed Dickinson

Ed, did you say that the G650 was on?

Ed Keller - Oppenheimer

No, no, I thought you said that the G250 ship set.

Ed Dickinson

Yes, okay.

Ed Keller - Oppenheimer

Right.

Ron Saks

Would you repeat the question? [Multiple Speakers].

Ed Keller - Oppenheimer

So, I was wondering if you could contrast what your ship set value on the 250 is relative to the 200. Are you picking up some share there?

Ron Saks

No, we don't have any 200 there. It was all share gain.

Ed Dickinson

That was all share gains.

Ron Saks

The 250 is all new to us. There are – initially, we’ve been working with Israeli Aircraft Industries on the 150 and the 200. And earlier this year, it was anticipated that we would get tendered product on both of those models and at the same time, we’ve been working with them on G250 work as well as Spirit in particular and as the year progressed, and delays in engineering continued to occur, it was decided jointly that we would take the 150 [Bismizsam] would not take the 250 because by the time they got it to us, -- I'm sorry, the 200. By the time they got it to us there wouldn't be enough volume to offset our front-end costs since the 250 will likely replace it once it goes into service.

So, as a result although we anticipated some 200 work earlier, we agreed not to take that.

Ed Keller - Oppenheimer

Okay, so the 250 is a pickup for you in terms of the market.

Ed Dickinson

Yes, it is.

Ed Keller - Oppenheimer

Okay, the last question is, on the fourth quarter cash flow. I know that you're expecting inventories to pick up a little bit. I'm just wondering if you can provide any detail and color on what you're expecting as far as cash flow in the fourth quarter. Thanks.

Ed Dickinson

We certainly are going to continue to grow some inventories. I think it is somewhat part and parcel with this whole issue of giving guidance for '08, to know what our output relative to our sales will be, and what we actually turn into revenue, versus what we turn into inventory. So, it's a little difficult for us to forecast.

I think suffice it to say we will certainly see several million dollars invested in inventory. We saw that in the third quarter. So again, I don't know that I can give you much color on exactly how that’s going to pan out until we really get a better view from our customers about what will turn into sales versus inventory.

Ron Saks

I think our point is that we are focused on the inventory reduction; but we are also trying to keep the workforce productive and as we do that it will likely require some inventory build in the fourth quarter.

But as soon as production resumes at normal levels, we are not going to produce at as higher rate in the opening months of 2009 and ship out of inventory and start bringing the inventory down. So, we would expect free cash flow to increase significantly as we progress through 2009.

Ed Keller - Oppenheimer

Okay, thanks.

Operator

(Operator Instructions). We’ll go to Stan Manny with Manny Family Investments.

Stan Manny - Manny Family Investments

Good job, gentlemen. I have several questions of interest. Number one, can you repeat your 2009 outlook please?

Ed Dickinson

I've got it right here but we have to fill in some data.

Ron Saks

It is a little lengthy, so bear with us, because we give guidance on the --

Stan Manny - Manny Family Investments

Well, why don't you just shorten it into top line, bottom line, and cents per share, etc. range?

Ed Dickinson

We generally don't provide guidance on the cents per share. But I think we said that Aerostructures segment sales will be -- I'm trying to see if it's consolidated here. Here we go.

On a consolidated basis 289 to 304 on the top line. Gross margins at 24% to 25%. SG&A between 33.8 and 34.3. Interest expense at $1.5 million to $1.7 million. And an effective tax rate of 36.5%. [Technical Difficulty] but that is something that will be --

Stan Manny - Manny Family Investments

Okay and then you've got the D3 and other but you did the same thing on, I assume.

Ed Dickinson

No, I'm sorry, that was consolidated.

Stan Manny - Manny Family Investments

Alright it is consolidated? That's great. That is superb. Second question. What is your anticipated debt pay down in 2009? Certainly you have kind of looked at that. Similar to '08, accelerated?

Ed Dickinson

I would say somewhere in that range again. Obviously the success we would have -- we are going to be borrowing a bit to get up and we will likely to see a little bit of debt increase this quarter with inventories going up. But we do plan to turn those around.

So, certainly we would expect a pretty strong cash flow year next year and debt reduction absent any acquisition or some major new project we invest some capital into.

Stan Manny - Manny Family Investments

Okay, looking forward, the composite business that you are entering seems to be fairly significant in commercial -- in your market areas. Do you have any feel at all for the market potential to you as you enter that business?

Boeing, Airbus, they are all going to composites. Is it a $100 million potential market for you to go after $200 million? Or do you have any feel at all? It seems like it is fairly substantial and growing rapidly.

Ron Saks

It is substantial, it is growing. However, the Boeing 787, we don't have a good sense of how much work may be available there because the type of composite structures we are going to be building will not be those that are currently being used by the major Tier 1s, where they use the filament winding approach. The entry cost for that segment of the market is quite high and so we are looking at starting with more typical hand lay-up and resin transfer molding type products, but positioning ourselves to handle larger structures and those structures would be a combination of metallic and composite assemblies. We are looking at not only growing the composite, but growing our metallic content on aircraft as we market the design-build products.

So, as we look at that overall market, it is far larger than we could possibly service on our own. But we think, we will be relatively early in, at least among domestic manufacturers, in seeking that kind of product.

I can't put a number on it, but we do expect it to be substantial. One of the acquisitions we are looking at is already in the market and generating in between $15 million and $20 million worth of that type of composite volume today which is just the fairly rudimentary composite product sales that they have in place.

Stan Manny - Manny Family Investments

Now does that fit into your current customer? Is it complementary to some of your current customers like Gulfstream, or et cetera? Where are the structures -- the products that you are going to enter in composites fit?

I know that metallic composites go in, that’s the Boeing -- that is their structural concept now. Can you talk to that a little bit?

Ron Saks

In terms of -- it is a concept now and there is more composite present on Boeing aircraft and corporate aircraft, Airbus as well in increasing amounts but nothing like the sea change that occurred with the development of the 787 and presumably the 350.

Those markets, since the 787, so much of it has been put out to Tier 1s, major Tier 1s, so a lot of that market has already been absorbed by existing suppliers. However, some of those suppliers -- there is one in Switzerland recently that filed for bankruptcy and their work has become available. We would expect because of the difficulties that some of the composite suppliers have been experiencing, given the delays in the 787, that there will be other work that’s going to move.

But we are getting into composites at this stage largely looking at building that to be a sizable segment of our business in 2010 and beyond. But the real increased opportunities will occur as newly designed aircraft requiring more and more composites will be going into service and that’s going to put us out into the 2013, 2015 range.

So, this is a long-term investment that will, we believe, pay for itself relatively early in our investment cycle. But what we are really looking to is as legacy metal products are replaced by products that have more composites, that we will be in a position to take on at least as much, if not more, product utilizing composites as we lose our metal products in the future.

Stan Manny - Manny Family Investments

Okay, so it opens up the market for you on parts that you are currently supplying and increasing where the dropping the weight of the part of the airplane for greater distance and efficiency.

Ron Saks

That's correct.

Stan Manny - Manny Family Investments

Last question. Can you give me your projected depreciation and amortization for 2009 approximately?

Ed Dickinson

Yeah hold on just one second and I can. It should be about between $6 million and $7 million.

Stan Manny - Manny Family Investments

Does that include the acquisition amortization?

Ed Dickinson

Yes, it does.

Stan Manny - Manny Family Investments

It does? Okay, thank you. Good job, gentlemen, really good progress.

Operator

We’ll go to Chris McDonald with Kennedy Capital.

Chris McDonald - Kennedy Capital Management

Hi! Good morning, thanks for taking my question. I was wondering -- forgive me if you mentioned this, Ed. But could you give a ballpark idea on the impact of the strike on earnings? I know it was $1.5 million on the top line, but I just didn't know if you had a bottom-line impact.

Ed Dickinson

Yeah, it was not overly dramatic, I would say, given debt level. We still built inventories, obviously, which cushioned it a bit. So, we really just didn't get the SG&A coverage. So, I would estimate it at between $0.01 and $0.02.

Chris McDonald - Kennedy Capital Management

Okay, very good and then looking at 2009, it sounds like the wing mod program is progressing according to your plans. Is that fair?

Ed Dickinson

I'm sorry.

Chris McDonald - Kennedy Capital Management

The 767 wing mod program, it sounds like as it relates to your guidance next year, you haven't seen any meaningful change in schedule or volume requirements. Everything appears to be right in line with your previous expectation.

Ed Dickinson

Ron I think led in with some of his comments. We have actually talked with most of our customers, and that is one of them, to really try to firm up what they really see their demand would be next year. At this point, there is still pressure and they are putting pressure on us to get a few more ship sets out this year.

We've got to work through the supply chain. So I think at this point, we still are comfortable with the estimate of 140 for next year.

Ron Saks

We have a meeting scheduled in two weeks with our customer where we are going to go through not only that issue on the 767 but other programs that may be under consideration. So, we believe we are getting reasonably good information based on where we are today.

Chris McDonald - Kennedy Capital Management

Ron, did I hear you correctly that you actually have delivered the first unit, or you have completed the first unit at this point?

Ron Saks

We did and we shipped and placed part of the second unit during the month of October. We are striving to be able to ship in the 10 to 14 ship set range by the end of this year.

Chris McDonald - Kennedy Capital Management

Okay, great. That's very encouraging and then lastly, you mention that due to the Boeing strike some of the offload opportunities had shifted to the right. Is that purely just a timing issue on some of the uncertainty that’s just the temporary uncertainty that has developed associated with the Boeing strike? And all those opportunities are still out there. It is just a couple quarter lag is the effective implication here?

Ron Saks

Certainly, on the 477-8 there seems to be a lot of interest in continuing to offload. One of our divisions of one of our customers, we have ended up with 80 or 90 part numbers. We got them on a temporary offload basis, and now we are putting them into our long-term agreement.

Because of the strike, at some of the Tier 1s that were going to do some offload, including those that have a strategy to offload their component work on a permanent basis in the future, nonetheless when the Boeing strike occurred they had excess people and so they used their own people to produce this product rather than put it outside at the time. But we believe that is only a deferral.

So, in answer to your question, we do expect the offload to pick back up again once normal production resumes on other models.

Chris McDonald - Kennedy Capital Management

Are there other offload opportunities that are out there that you haven’t included in guidance of any significance? For 2009, I am talking.

Ron Saks

There are continuing opportunities on offload. The G650 we continue to be tendered additional work almost on a daily basis, some of which is on a quick-term basis where they want the product, and then they may bring it back in-house. But a lot of it is work that requires tooling and that we will be doing over a lengthy period of time.

In the case of that program, which is a major one for us and where we keep setting the bar higher in terms of the amount of ship set value we want to extract, we believe, we will continue to succeed at getting more of that work.

However, 2009 guidance will be unaffected, because the production of that product will be deferred probably until 2011, 2012.

So, what we have is a mix of new programs that we are working on where we have front-end costs with non-recurring charges for tooling and engineering that bulk up our current year and then production is delayed until certification and flight. So, we are building some volume for the future and won't affect 2009.

What we haven't factored into 2009 is a continuation of that type of revenue on additional new projects that we believe, sure unless the industry investment in R&D declines dramatically. We believe we will experience more of that front-end benefit from tooling and other non-recurring charges in 2009. But we have not included any of that in our current guidance.

Chris McDonald - Kennedy Capital Management

Okay, excellent. So that's all upside. Great, well very nice results. Thank you.

Operator

I’ll take our next question from Tyler Hojo with Sidoti & Company.

Tyler Hojo - Sidoti & Company

Hi!, quick one on CapEx. If you had to guess, what do you think your maintenance CapEx level would be?

Ed Dickinson

You know, we used to always throw a number out of $1 million. But with the addition of D3 and the computer equipment and licenses they have needed to maintain current. I would say the number is probably closer to $2 million.

Ron Saks

Or more, I would guess probably closer to $3 million, in that range. But when we are looking at $8 million to $10 million, we have got quite a bit of room to defer some of the new equipment purchases and software purchases that we have been contemplating.

Tyler Hojo - Sidoti & Company

Okay, and just given the fact that, I guess, let's see here. Year-to-date you're at $6 million in CapEx. Unless you expect a really big pickup it doesn't look like you will get to the high end of that range. Should we expect maybe a lower level in 2009?

Ed Dickinson

Again, I would say, we won't get near the top end of that range. I would say, we actually had in the quarter really two pieces of equipment that were almost half of the capital acquisition of $2.6 million. So, yeah, we won't see that kind of number again. So, I think -- at least in the fourth quarter.

So, I would expect us to be a little shy on the CapEx number that we’ve guided to for this year. Next year, we will be looking and we've been going through this. I have a general managers meeting on Monday to talk about several things and this may be a topic that we go through.

The only caveat I would put in there is we are also looking at an ERP system at some point. And that once we make a decision about that that could be a substantial amount of money. Not that it would necessarily hit '09, but it certainly could be something that we would start investing in late in '09.

Tyler Hojo - Sidoti & Company

But ex-ERP system, directionally we are talking down in 2009; is that fair?

Ed Dickinson

Again, I think, depending on how we go about the composites business that’s it. But yes, we would be down on core business and if we find something that we do greenfield wise and composites that could well be an investment number that could cause us to push that number up.

Tyler Hojo - Sidoti & Company

Fantastic, thanks a lot.

Operator

Our final question today comes from Myles Walton with Oppenheimer.

Myles Walton - Oppenheimer

Yeah, thanks, good morning. Sorry, I did jump on late. Ed got most of our questions. I did have one quick follow-up for you.

Ron, if I could, you brought up kind of de-stocking of inventories that you are seeing at some of the prime customers you are supplying to. Given, what you see in the industry in the past cycles, how far along do you think we are on kind of this de-stocking? Do you think we will actually get to the point where they kind of take it a little too far and there will be almost a rush to catch up?

Ron Saks

You know, this de-stocking effort is relatively recent and one of the things that has changed for us since prior cycles is an awful lot of the work that we received now is on this so-called min-max system. What that does is give us a look into at least the raw components that are kept in inventory at our customers.

We try to keep them somewhere just above the halfway mark between their minimum and maximum levels. Depending on the customer, that can represent two months to as many as four months worth of product.

For those that are in that two-month range and that includes corporate jet for example. It is unlikely there is going to be any push to de-stock there.

In the case of the Black Hawk helicopter because they are being produced by two customers and only one of which do we have the inventory numbers readily available to us, it is hard to tell how far they can go. But it's expected that we will likely see the bulk of that de-stocking occur in the fourth quarter.

I would not anticipate more of it unless production rates come down. As production rates come down, normally then the required inventory levels come down. We often have a double whammy when that kind of situation occurs.

In the Boeing case, we are also on -- we were on a min-max but a lot of that work has shifted to average monthly draws. That is one that is still a question mark for us. So, we would expect that there will be -- given their present intention to return to existing production rates in particular on the 37 and 777 that is really what we are expecting to see the impact on in the fourth quarter of this year as well.

Could it last longer? It could, maybe into January, but we don't think it will last much longer than that. So, we would expect that most of that destocking will have occurred by mid-January anyway.

Myles Walton - Oppenheimer

Okay, thanks. That's helpful color and good quarter.

Operator

At this time, I would like to turn the conference back to our presenters for any additional or closing comments.

Ron Saks

Well, thank you all for your interest. I don't really have any major closing comments. I thought, not knowing what might be asked, there were some questions last time about transfer of work to Mexicali. We are currently working with Sikorsky in particular to finalize the approvals to make those transfers. Our strategy is to continue to put commodity type work in Mexicali and retain the more complex work in our US facilities. So, all of this seems to take a little longer than we expect but there is a lot of effort on the part of both companies to get this going.

Another issue, although small, that I might mention is that we have had a joint venture with a Mexican company providing us heat-treat and processing services in Mexicali. One of the activities we will be going through in the fourth quarter and into the first quarter of next year is that we will be assuming control over that joint venture and providing those services directly to ourselves. So, there will be some people cost associated with taking that over but the benefit to us we expect in the future to be quite substantial.

We also, unlike some of the other of our competitors, have not been as effective at claiming research and development tax credits. Several of them have announced some relatively low tax rates as a result of the R&D tax credit extension that occurred recently when Congress passed a law that included it. We are going to mine that field a bit harder and expect to have some improvement in the future, once we learn a little better what is required to qualify for those credits.

So, those are just a few items I thought I would mention in addition to those that we have discussed earlier.

It's a difficult time, as you know. We appreciate your interest. We generally in previous cycles and if this is a typical cycle see aerospace and defense affected but generally later in the downturn, we don't know when it's going to come or if it's going to come. Maybe we will be fortunate and slide by this one in the main.

But we are not planning on that but we have customers that require product now and we think that our tactics designed to improve liquidity and hold our inventories down and defer some CapEx will serve us well in case we see a downturn.

But in 2009, we simply don't see that occurring based on the facts we have available to us today. So, we look forward to continued improvement in 2009 as we go forward.

Thanks for your attention. I'm sure we will be talking to you as the quarter goes on.

Operator

That does conclude today's conference call. Thank you for your participation. You may disconnect at this time.

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