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Executives

Ronald S. Saks – President, Chief Executive Officer

Lawrence E. Dickinson – Chief Financial Officer

Analysts

Gary Liebowitz – Wachovia Securities

Ed for Myles Walton – Oppenheimer

Sherwin Prior – NorthPointe Capital

Barry Goggins – OFI

LMI Aerospace, Inc. (LMIA) Q4 2008 Earnings Call March 12, 2009 10:00 AM ET

Operator

Welcome everyone to the LMI Aerospace Incorporated fourth quarter 2008 year end conference call. This call is being recorded. With us today from the company is Ronald S. Saks, President and Chief Executive Officer and Lawrence E. Dickinson, Chief Financial Officer.

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 the management assumptions and analysis that are subject to numerous risks and uncertainties including risk and uncertainties related to acquisitions. There can be no assurance that our assumptions will prove to be accurate in the future. Actual results may differ from those forward-looking statements.

As a result, among other things are the factors detailed from time to time in our filings with the Securities and Exchange Commission. Please refer to the risk factors contained in the company's filings with the Securities and Exchange Commission. At this time, I'd like to turn the call over to Ronald S. Saks.

Ronald S. Saks

Thanks everyone for joining our call today. I'm Ron Saks, CEO and President of LMI. With me today are Ed Dickinson, our Chief Financial Officer and Ryan Bogan who's CEO and President of D3 Technologies.

The current market environment in aerospace and defense is one marked by volatile changes affecting the airline industry. The military budget proposals from the new administration, economic statistics on retail sales, jobs, credit markets, currency relationships, all of which are affecting ultimate demand for our end customers.

As passenger and freight traffic on large commercial transports have experienced double digit declines, and employment of corporate jets have declined even more, the prospect for added cuts and production rates from our customers seems ever more likely.

In order to counter these events, we are marketing aggressively and expect to win added work in market segments where there is some stability; in our case, helicopters and new model aircraft and to also add market share in declining market segments as suppliers to our customers exit our markets. I will elaborate on these themes later in this presentation.

2008 was a very good year for LMI. We executed our planned strategy, developed close working relationships within our Aerostructures and Engineering segments and for the first time, executed large projects to design and build complex assemblies for our key customers. We are pleased with the steady stream of positive feedback from those customers, acknowledging the exemplary performance of both D3 and Aero structures.

And despite the downturn we experienced in the fourth quarter, caused by the Boeing strike and customer order deferrals, our annual financial performance was the best in our history.

In 2009 we face different challenges. At Aerostructures and D3, we must execute our plan to increase cash flow and eliminate debt by mid 2010, and that requires a considerable change in operating philosophy at our plants and offices.

At Aerostructures we have developed our plans and put in place an infrastructure headed by our program management office designed to evaluate the effectiveness of our actions with assistance from our demand management group which assists our plants in prioritizing the releasing of work to meet our customer needs.

At both segments, our entire leadership team is playing an active role in assuring we meet our cash flow goals and our business development team has embraced the responsibility for assuring job security for our employees. Aggressive and creative marketing techniques are being used to provide numerous opportunities for new work statements from our customers.

Before I go on to describe our tactics, I would like to have Ed Dickinson review our financial results with information about inventory reduction goals and the reasons our guidance for 2009 has now been adjusted twice. In addition, Ed has prepared cash flow information he will share with you during the question and answer period.

As I said, I'll return to discuss the current state of our business, tactical plans and our expectations for the balance of 2009.

Lawrence R. Dickinson

Good morning everyone. It's a pleasure to speak with you today. I'll walk through some of the financial highlights, and then I'll walk through a little bit of the rational behind the changes in guidance.

On the consolidate level, revenue in the fourth quarter was $52.2 million compared to $54.6 million the prior year. Net income was $585,000 or $0.05 a share compared to $3.8 million or $0.34 a share in the fourth quarter of '07.

As noted in the press release, we did record a good will impairment and experienced other unusual charges in the quarter of approximately $2.9 million on a pre tax basis, resulting in an after tax impact of about $0.16 per share. Adding that back, we'd get to a relative base of about $0.21 a share.

Sales for the full year 2008 were $239.5 million, up from $168.5 million the prior year. Net income for the nine months was $15.3 million or $1.35 a share compared to $13.2 million or $1.17 a share the prior year.

Consistent with what we disclosed in the January 27th release, the Structures group generated $32.6 million of revenue in the current quarter, down about 10% from the prior year. The most significant declines were noted in our release yesterday and in January, the Boeing Strike, the Blackhawk inventory adjustment and delays in engineering pushing out tooling opportunities. These combined to impact revenues by approximately $15.5 million.

Corporate and regional revenues were $13.5 million in the quarter, basically unchanged from the prior year, and down slightly from the third quarter. Revenues from Gulf Stream aircraft were $11.8 million, down approximately $200,000 from the prior year. Sales of Bombardier products were approximately $1.7 million in the quarter up from $1.3 million the prior year.

The Boeing strike negatively impacted the commercial revenues which dropped to $9.4 million, down from $10.5 million the prior year. Included in the current quarter was approximately $1.3 million of revenue related to the wing modification kits and winglets for the 767 retrofit program.

Within the models, the 737 sold $2.8 million or 58% below the prior year level of $6.8 million. Sales for the 777 declined to $608,000 from $1.1 million the prior year. The bright spot for us in the commercial transport shipments was the impact of the new 747-A. The shipments more than doubled on the 747 reaching $3.4 million, up from $1.6 million the prior year.

Military programs generated $7.8 million, down from the prior year level of $8.9 million. Inventory management techniques at Sikorsky and Gulf combined to reduce shipments on the Blackhawk program to $5.8 million, only down $200,000 from the prior year, but down $2.5 million from the third quarter. Apache sales were $1.4 million compared to $1.6 million in 2007.

Technology products were hit hard as well, generating $900,000 in revenue in the fourth quarter compared to $2.3 million in the prior year due to a rapid downturn in demand for semiconductor equipment.

The Aerostructure segment generated gross profits of $8.3 million or 26% of sales in the quarter, down from $11 million or 30% the prior year. The decline in demand during the quarter led to less efficient production as we moved people between the various programs to keep them working and we had a lower level of coverage in fixed costs.

SG&A expenses were $6.2 million, up from $5.3 million primarily due to $0.5 million of unusual expenses related to severance pay and the write off of intangibles related to the discontinuation of technical change associates. We experienced increases in salaries and professional fees as well in the group.

In reviewing this quarter and in conjunction with previous quarters this year, I think it best to start with Aerostructures operating loss and recognize that approximately $2.9 million of unusual charges impacted it. Using the respective margins of the work, the loss of revenue from the Boeing strike, Blackhawk and tooling deferrals, resulted in a loss of operating margins of approximately $3.5 million in the quarter. Adding back these results in a hypothetical operating profit of approximately $6 million, roughly consistent with prior quarters.

Additionally, we experienced operational inefficiencies from the disruption in customer demand as noted above. It can't be as easily quantified.

Net sales for D3 were $19.6 million. Revenues of $9.9 million in large commercial transports were primarily for services on the new freighter and passenger version of the 747 as well as the 87. Sales of $5.1 million on corporate aircraft were primarily G-650 related with some contribution from Bombardier as well.

Military programs generated $3.8 million, largely from JSF, the CH53 and various maintenance programs.

Gross profit for the Engineering Services segment was $3.6 million or 18% of sales, up from $3.1 million or 17% the prior year. D3 has been enjoying gross profits of over 20% for most of the first nine months of 2008; however we did experience dilution from holidays in the fourth quarter as mentioned in the third quarter call.

The way the calendar worked this year; six holidays were included in the fourth quarter. Not only did we experience additional costs from the holidays, but we lose significant billable time.

Selling, general and administrative expenses for the Engineering segment were $2.2 million, up from $1.8 million the prior year, primarily due to professional fees and salaries.

Moving on to non segment expenses, interest expense was $449,000 in the quarter and we had an unusual tax rate of 26% as we recorded certain reconciling items from the filing of our tax return since taxable income for the quarter was so low, the adjustments had a disproportionate impact on the effective tax rate which we realistically believe was 36%.

Our borrowings on our revolving line of credit were $25 million at the end of the year. We spent $5.6 million on CapEx in 2008 after giving affect to the sale of approximately $2.5 million of recently acquired assets that we converted to operating leases. Excluding the sale, we spent $8 million in line with our expectations of $8 million to $9 million.

Free cash flow for the year was $3.4 million and included the use of approximately $200,000 in the fourth quarter.

The impact of the Boeing strike, the start up of our 757 wing mod program, delays in the Blackhawk program, investments of the new G650 aircraft and tooling tied up in work in process caused inventories to grow by $9 million in the quarter. We're working closely with our operations team to take action to reduce inventories during 2009.

We do expect much of the investment in tooling to turn to revenue in the first quarter and cash in the second quarter. We don't expect to see significant benefits from our operational efforts until the middle of 2009.

Lastly, I'll add some color on the changes to our guidance. As you recall in January, we reduced revenue guidance for Structures by approximately $7 million on a net basis. We reduced approximately $14 million due to expected weakness in our machining business, a revision on delivery rates on the wing mod program and the discontinuance of TCA. These were offset by the additional benefit of approximately $8 million with the addition of In Tech in January. At the same time we reduced the Engineering Services group by approximately $1.5 million.

Yesterday we announced that Structures is reducing guidance by approximately $13 million, attributable to our estimate of the impact of Gulf Stream's announcement last week about reducing production rates this year.

We also have continued to see limited demand for overtime at D3 and are managing the transition of engineers on certain programs. These factors suggest to us that we moderate our expectations in '09 and we therefore reduced our revenue guidance for D3 by approximately $8 million.

We almost moderated margins in both segments due primarily to the lower volume expectations. We have been and will continue to work with each of our facilities to match labor needs and costs with demand to preserve margins of the coming months. I would like to reiterate a statement we made in January in our release.

There is a lack of comparability in D3's margins, at least in how we're forecasting. We shifted about 100 basis points of costs that in 2008 were impacting SG&A and we shifted them down to overhead, so there is about 100 basis point flip between the two that are included in the guidance outlook.

With that, I'll turn it over to Ron for his comments.

Ron S. Saks.

With regard to our business, we entered 2009 with customer production rates being confirmed as firm and our four primary customers and that includes the large commercial transport area dominated by Boeing, the corporate and regional jet area dominated by Gulf Stream, the military markets dominated by Sikorsky and then aviation partners Boeing's winglet programs.

And in January, we mentioned where those production rates were and what our customers were telling us. In January we had a marketing meeting and we primarily targeted to fill 2010 requirements because we expected that most of 2009 would hold. We were surprised by the speed and depth of the Gulf Stream cuts although we kept reading about lower deployments of Gulf Stream corporate aircraft and declines in the value of Gulf Stream corporate aircraft as well.

In the past, we have seen production rate cuts that were staged, however as Gulf Stream and General Dynamics said in their comments, the structure of the business seemed to change in February to the point where they needed to take action more quickly.

We also anticipate that the potential of some impact on the second half of 2009 if Boeing were to cut production rates at the beginning of 2010 and we've spoken often on these conference calls about the fact that production rates for us, production rate cuts for us will normally precede the effective date of delivery cuts to our end customers.

Interestingly at the [Speedness] Conference this week, there was a lot of discussion about the 777 and the fact that the cargo carriers were experiencing larger declines than even the passenger rates. However on the 777 were it to decline, we have relatively low content on that aircraft.

Sikorsky's remain strong. At a meeting in February of this year, we learned that they expect their volumes to grow on helicopters by 20% a year for the next two years. LMI Aerostructures was singled out in terms of its creativity in setting up its Mexicali plant providing lower cost opportunities to our customer as well as being noted as the first of the structures suppliers to be considered for their supplier gold program which if we are able to pass, and we expect to be assessed in the second quarter of this year, will open up not only more opportunities for Sikorsky business but with its sister companies.

As far as new work opportunities, for Sikorsky there are continuing opportunities on the M and R models dealing with assembly of large sections of the aircraft as well as detailed components and we're seeing additional awards of the 747-8 passenger model which are just starting. Some additional 777 opportunities interestingly, and some being transferred potentially from other suppliers, and of course the 787, no new opportunities but rates, assuming that Boeing meets their objectives, it should start to kick in late this year or in 2010.

We are looking to transfer work to Mexicali and we have an audit scheduled in the middle of March, middle of this month by Sikorsky to consider approval of our heat treat facility and our quality programs, and we will then see the timing for transfer of more work down to Mexicali which also should create some opportunities for us to provide lower cost product to the Sikorsky and others from our Mexicali plant.

Tactically, we met with our GM's on February 23. We did not at the time anticipate the Gulf Stream cuts and the theme of those meetings was inventory reduction, preservation of margins, investment in lean projects and training of our employees, elimination of overtime, reduction of economic field quantities, adjustment of the work force to accommodate potential production rate cuts and we asked that they get these in place before production rate cuts were to occur.

Obviously we didn't see Gulf Stream coming when it did and so we're now in the process of implementing all of those actions and at the same time adjusting to the Gulf Stream announcement on March 5.

On March 10, just earlier this week, we had meetings with all of our Aerostructures employees and explained to them that these cuts are made, require us to take actions including employee layoffs, work reductions and shift changes, and we are working through those issues currently.

In addition, we've had some unique problems at our machining company, Tempco Engineering in California. Their customer in the semiconductor business basically shut off sales at the end of November and that customer represented about 40% of their business and continuing contact with that customer suggests that the anticipated volume from them in 2009 will be quite low.

We also had a performance problem at that facility with one of our other customers and so that facility has been hit harder than any of our facilities and we are working through those problems at this time.

We have been working on contingency plans since November at Aerostructures and on some cost cutting at D3 since January. Ryan can talk with you about that if you're interested, and our contingency plans include, although there are no current plans for this, consolidation of plants that could be required if additional rate cuts were to occur.

The purpose for our mentioning all of this is just to let you know how we're planning to address the changes in the industry as they occur. We believe 2009 will be difficult because the visibility of demand from the customers, both D3 and Aerostructures has been clouded by larger macro economic events buffeting most industries.

We believe the only effective way to overcome this uncertainty is to manage our business in a financially conservative way while aggressively seeking new ways to provide lower cost services and products to our customers. We have in D3 and Aerostructures, two well respected companies which have not just survived previous down cycles, but have come out of them stronger financially with added market share.

We believe we have the people and the organizations to continue to prosper despite the down turn in our industry cycle and we intend to work very hard to show that we have the capability to remake ourselves once again.

The equity markets today are placing low valuations on many companies and we have not escaped that treatment. We regret our shareholders and employees are not enjoying the returns our recent performance should have provided. We will continue to run our business creatively and conservatively and are confident that over time, our dogged persistence and dedication to our business goals will reward all of us once again.

With that having been said, we'll now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Gary Liebowitz – Wachovia Securities.

Gary Liebowitz – Wachovia Securities

Can you lay out for us how you expect the Gulf Stream reduction to play out on a quarter by quarter basis, because it sounds like for the first two months of the year things were running normally. Is there going to be a period maybe March/April where there is minimal shipment to Gulf Stream to catch up, or is this going to play out over the course of the year?

Ronald S. Saks

One issue and you raised an issue I failed to mention, as we've gone through the first quarter, for some reason we have not seen the pulls from Gulf Stream that we expected and we know that there were some dislocations resulting from work stoppage at a plant in Nashville supplying links on the 450.

And so we have already seen some reduction which we don't believe is related at all to the recent announcement, but it has impacted us in the first quarter.

What we see going forward and we have implemented a 30% reduction in Gulf Stream volume for the balance of the year. We do have good visibility in Gulf Stream because most of their product is on this so-called min-max replenishment system that we've talked with you all about before.

So we know where their inventories are. We expect consumption rates to decline. We expect them to continue to pull, but they likely will pull at rates of one each of the two major models at rates of roughly three per month each as opposed to four per month each. So we think we can anticipate the decline reasonably well.

The other impact on us, and the reason we've used 30% instead of the 20%, a little over 20% reflected in the decline for 94 ships to 73 ships, is that they're going to be closed for five weeks in July. And so we had some inventory reduction we'd like to do anyway, and so we're going to try to balance our inventory reduction with producing at the lower rates, 30% lower rather than 20% lower.

We'll continue to produce in July, except that our Savannah plant which delivers direct to them will see some downturn in activity during those five weeks. But we expect our production to be balanced. Our shipments may be reduced, likely will be in the third quarter because of the shut down in July.

But over the balance of the year, our even production should have us meeting their demand over the full remaining roughly nine months of the year.

Gary Liebowitz – Wachovia Securities

Clearly with the 787 and the 747 ramping up for you in 2010, how much of decline in the 737 line would we have to see before your Boeing business turns negative in 2010? I mean it sounds like you can perhaps withstand a 10% decline but maybe something bigger, you'd be looking at negative Boeing comps.

Ronald S. Saks

With our turning negative, the 747-8, I just saw on a purchase order entry this morning that we had some orders for two pieces of each of about 100 part numbers without pricing on them because we have, we're just getting engineering and so we expect that the passenger model volume will grow as we go through 2009.

The freighter model, our customers generally and not just Boeing direct, but others are ordering relatively large numbers of aircraft in 2009 and the purchase orders we're receiving even going into 2010 in order to have their lines going evidently in anticipation of the production rates they expect to publish.

And so 2009 is going to be we think pretty representative of what 2010 volume will be also on the 747-8 with the possible exception if the passenger model were to improve in sales and production rates go up, we could see some improvement in 2010 over '09. But assuming that those would stay the same, the real offset for us to the 737 and any 777 and other legacy products would be the 787, and all of us are waiting to see how quickly the 787 ramps up.

As we said in the past, at this stage our approximate ship set value on the 787 is $150,000 a ship and on the 737 it's about $90,000. So a 10% reduction would probably be neutralized, but anything more than that would likely turn us negative.

Gary Liebowitz – Wachovia Securities

We haven't been dealing with a downturn with D3, a public company; can you give us a sense how far down the business turned during the last Aerospace downturn?

Lawrence E. Dickinson

It was interesting. We had actually used the last downturn as an opportunity to show the value that we can add as an extension of our customers' engineering arms, and with Boeing in particular during their downturn, they looked at us and exercised us more than they had previously because they say the additional value and the cost reduction that they could see with the outsourcing of that engineering based on the good relationship that we have with them and the fact that we are a risk averse engineering solution because they know our system so well.

We do expect to see those same sorts of opportunities both from the organic engineering side but also the design build side as customers are looking for greater value. But you know, we are taking a conservative approach. We've worked hard to become an extension of our customers' engineering arms and development arms and we do recognize that as times get difficult, one of the areas where they can look for cost reductions is a reduction of their development programs.

So, we're trying to position ourselves on the programs that we believe have the most legs going forward. We are transitioning off some of our engineers on projects that are concluding onto programs that may be safer with more of a military slant.

We're working hard to do that, so if you look at the numbers that we have provided, we don't expect a significant decline, and we're hopeful that we can use this opportunity again to show that engineering outsourcing is a trend that makes sense, that saves our customers money and ultimately should be the model that they employ going forward.

Gary Liebowitz – Wachovia Securities

Did sales actually rise through the past downturn or did they not fall as much as the overall market?

Lawrence E. Dickinson

We actually saw a slight increase during the last downturn and we were able to really change the company at that point in time to more of a commoditized type of engineering to more of a niche based high end services type of support structure where we got involved in our customers development cycles earlier on and became more critical to their development.

And so it wasn't a significant uptick, but we definitely saw some organic growth during the last downturn.

Operator

Your next question comes from Ed for Myles Walton – Oppenheimer.

Ed for Myles Walton – Oppenheimer

Congratulations on the record year. When times get tough at the end of the year like this, it's easy to forget what's been accomplished. On the 4Q sales, the $15.5 revenue loss in the fourth quarter on the strike, could you break that down any further by market area, customer or program?

Ronald S. Saks

I think what we basically, there was $7 million related to machining that we pulled down, and that was in guidance in terms of what we did in the quarter. It was $5 million of Blackhawk. It was $5.5 million of Boeing and the tooling was primarily the balance.

Ed for Myles Walton – Oppenheimer

On Tempco, the two sides of that, the technology side and the military side relative to recent quarters, where do you see the technology business going between now and some potential recovery in 2010? You mentioned it would be quite low. I'm just wondering how low. And then on the military side, has it been affected or is it faring about as it was?

Lawrence E. Dickinson

Our people have been meeting with the tactical buying group and have a meeting next week I believe with the strategic buying group at Simor in November, and I think we mentioned this on our last conference call, we had a shipment that was made at the end of November, hit receipt in early December and our shipments together with other supplier shipments were turned around and sent back.

And we since have been talking with Simor in a very positive way discussing how we can help them through this period. Right now because they have such low visibility on their product mix, what they're telling us is that they expect some, they hope for, let me say that instead of expect, they hope for some improvement in their business late third quarter into the fourth quarter of 2009.

But even with that, as our business with them was running $7 million to $7.5 million rate in 2008 until we hit the fourth quarter, we're only projecting about $1.5 million to $2 million for the full year. With any volume coming in in the fourth quarter and then hopefully ramping up as we get into 2010. But it's had a significant impact on Tempco.

At the same time we had a performance issue with a military customer that has cut back rates and waiting for Tempco to correct its problems. We have our CO, Darrel Kiesling who has been spending a lot of time with the Tempco management people figuring out how to improve the situation It is improving. There will be a meeting with their buying group in about three weeks which I expect to attend as well to see what our prospects are for the balance of the year.

But we've taken a very conservative approach to sales for 2009 with them as well. So as the $7 million in reduction actually is partially somewhat more than that from those two customers, but there are some products that we're currently building for the 767 winglet that we're transferring to Tempco to offset some of the impact.

Ed for Myles Walton – Oppenheimer

On the winglet program for the fourth quarter, the $1.3 million in revenue would seem maybe a little lower than you were expecting. First is that a fair assessment and second, how do you now see that program evolving over the coming 12 months?

Lawrence E. Dickinson

I think it was a bit lower than we had expected. We ran into some supply problems trying to get our hands full of the first ship sets out and some of the ship sets were shipped out as partials but I think we are now on track. We are actually looking for a very significant month in the month of March on this program, and it will be ramping up through the year with the second and third quarter of very high volumes.

So I think we've, we are at least consistent with what our expectations have been on this program. I think as anyone would tell you at the beginning and the start up of the process and really get it rolling, you always get a couple of hiccups, and I think we've gotten through those and we've got a staff down in Savannah that's operating now that I think is looking ahead, making sure the supply is coming in.

As Ron alluded to, we may be shifting some of the supply into some of our internal shops to add some stability to that group, but it was down a bit in the fourth quarter from our original expectations, but I'd say it is on track for 2009.

I would add to that, earlier this week American Airlines flew their first revenue producing aircraft with those winglets installed and the demand here has fluctuated. At one point when we announced some guidance reduction I think in January, we estimated a $4 million reduction from the previous plan that for winglets.

We've said that 120 to 140 is the range of volume we expect to produce this year both for the winglet modification kit from one customer and for winglet leading edge assemblies for another customer. Right now that has been adjusted back up a bit to about the mid point of that level, I think 131 ships is the last forecast I saw, and I'm supposed to get another one tomorrow.

And so some of that volume has been restored and it appears that that program as of now will go forward at the rates, roughly the rates that have been anticipated all along.

Ed for Myles Walton – Oppenheimer

Gulf Stream implied in their press release announcing the production cuts that 2010 might be sort of level with 2009, and I'm just wondering at what point in the year would you expect too have better clarity on that given their past order practices understanding of course that could be sooner or later.

Lawrence E. Dickinson

The calls that were made by the Gulf Stream people to us suggested flat to slightly higher production in 2010 versus 2009. However, I don't know that that past is present the future in this case because I think there was a sincere expectation among the Gulf Stream people that rates were going to hold at 94 ships through 2010.

What ever happened in February to cause this change, we're not sure exactly what the ramifications of that are, so I really can't speculate exactly what they're going to do in 2010 at this stage. I can tell you that Gulf Stream is very good about communicating with its supply base and I think they were likely somewhat surprised at the speed with which they decided to do this, because they have long term agreements with their larger suppliers, the engine makers and others that generally call for penalties when rates decrease.

I don't know what happened in those discussions, and it's really not germane to us, but obviously Gulf Stream has been a valuable customer to them as well and whatever was worked out allowed them to reduce their rates more quickly than we anticipated.

Whether that same kind of thing would happen the next time or not, we really don't know. The hope I think all of us have is that we see some stability in employment and some firming of airplane values and then we'd be in a better position to know exactly what 2010 looks like. But I think we're still in an awfully volatile period.

Operator

Your next question comes from Sherwin Prior – NorthPointe Capital

Sherwin Prior – NorthPointe Capital

As you know, we've been holders of your stock for a long time, so I wanted to take a second to just reaffirm our support for the leadership you have provided. Airbus, can you give us an update on some of the discussions that may or may not be happening currently with Airbus?

Ronald S. Saks

Thanks very much for the comments. We appreciate it. With regard to Airbus, we talked a good bit about them a couple of conference calls ago when there was a lot of activity going on and a lot of interest from Airbus, Eurocopter and others in doing more work in the U.S. and in Mexico.

Given the currency exchange switch that became favorable to doing business in the U.S., we saw some proposals that were not as attractive as we would have liked because they required some significant capital expenditures I think we mentioned earlier and didn't feel it was in our interest or the company's interest to take on that degree of risk and put as much capital into those projects as were required because the pay out was very lengthy given the high outside cost associated with raw material and other processes associated with those products.

Once those discussions ended and we decided not to bid on those programs. We've not had much additional dialogue with the Airbus people or their tier one. There is one program still pending that we're waiting on an answer for or at least an opportunity to present, but frankly given the nature of the industry, we're really placing more emphasis right now on some of the newer Boeing models and on the military aircraft, and that's where we think our capital ought to go in the near term.

So we have not been as aggressive about looking for that work. The currency impact while favorable for awhile, we had some quotes out to companies in western Europe also that we know met their objectives, but we've seen consistent delays in decision making on whether to put the work outside or whether to transfer it from other suppliers.

And part of that may be currency shifts and part of it may just be the nature of the global economy today and relative unwillingness to make any moves until things stabilize.

And so we're cocooning so to speak and working with our key customers who know us well and we know well to look for market share in the near term.

Sherwin Prior – NorthPointe Capital

If you think about a lack of visibility throughout the aerospace period, but if your earnings were worst case scenario and my kind of calculations were $1.25 in '09, using a five multiple gives me $6.25. Clearly the stock is below that now, so I think there's a concern about survivability. Some investors seem to be looking at the previous downturn. A lot of your competitors went away. So the stock price is suggesting that investors are still thinking that you're going out of business. So let's talk about free cash flow. Did you give the free cash flow number for '08?

Lawrence E. Dickinson

Yes, for '08 it was about $3.4 million. Again, it was heavily taxed by the growth in inventories which were for the year over $20 million so I think the real issue for us is how to generate cash from our balance sheet. We've got a borrowing arrangement that has plenty of flexibility in it right now. We have no covenant pressure to speak of.

So I think we're in a different position than we were going into the last downturn, not the least of which is the addition of D3 where there really aren't inventory issues to worry about and it is a cash generator. So I think the business with its balance in sectors, the addition of D3, the fortunate position we have with our current lending arrangements, I think certainly give us comfort that we've got a lot of work to do, but I think from a capital standpoint, we're in pretty good shape.

Sherwin Prior – NorthPointe Capital

Did you pay down any debt in '08 or how much?

Lawrence E. Dickinson

Total debt pay down was, we went from, I think we were around $30 million to $32 million at the end of '07 and $25 million or $26 million at the end of '08. We did pay down but it was in the $3 million to $4 million range.

Sherwin Prior – NorthPointe Capital

It's been a tough go for all of us but I think as investors when you begin to do the work and stop trading headlines that they'll see the value. We still believe in you. So thanks a lot for your support.

Operator

Your next question comes from Barry Goggins – OFI

Barry Goggins – OFI

Following up on the cash flow question, at the beginning of the call it seemed like you were really making a push to eliminate your debt by the middle of 2010?

Lawrence E. Dickinson

That is an objective that we've set based on the numbers we've given you and without any outside acquisitions for example and we can talk about those at a later time, but the expectation is that that's an achievable objective given the inventory reduction goals that our plants have committed to and the profitability that we expect during 2009 and 2010.

Barry Goggins – OFI

I know you haven't given specific guidance on 2010, but can you kind of flush out the progression of the bulk of that pay down, say close to $20 million, another $25 million or $26 million, that going to be this year with the inventory benefit and if earnings stay in that current range or is it going to be kind of split evenly and you need similar earnings power next year?

Lawrence E. Dickinson

I think if we again, with what our efforts here to try to preserve margins as best we can, you would see in the second half of this year, a significant benefit from these inventory reductions. If you think of where we are, we did buy In Tech in January and we've currently borrowing at a level of slightly over $40 million. Some of the increase in inventories we saw in the fourth quarter, we've since paid payables to support that so our borrowing line is up a bit.

Our first quarter is always a little heavier in terms of cash outlays as 401-K matches and those things all start rolling in, but I think you'll see probably in the middle of the year to the third quarter, you're going to see inventories begin to decline and I think you would see a relatively rapid cash generation process and the debt begin to fall pretty rapidly in the second half.

Barry Goggins – OFI

So that would actually be falling from a $40 million level, currently?

Lawrence E. Dickinson

Correct. That would include repaying all the debt on the In Tech acquisition as well.

Barry Goggins – OFI

Looking at the reduction in gross margins from the initial production cut in January to the current, if 737 got hit by a similar amount and there was another $10 million to $15 million hit to revenue expectations, would there be a similar gross margin deterioration or would it be more rapid? I mean you've got to get a point where it really starts to eat up your profitability.

Lawrence E. Dickinson

I think first, just taking the reduction that we've put in this guidance, our belief is, and certainly we'll see how this works, but our belief is we've been conservative here. We put a fairly high incremental reduction on this $13 million decline and so I think we want to make sure that we can improve upon that.

Again, if we see additional rate reductions from Boeing or from where ever, I think the real question for us is going to be then, how do we look at what Ron alluded to in his comments, consolidations, other things that likely would have some one time charges related to them, but we had to get some of the fixed costs out of the process to be able to make a reasonable attempt at preserving the margins.

Barry Goggins – OFI

As far as getting any push on composites with your joint venture, has that kind of been pushed off with everything going on now or are there opportunities because of weak suppliers currently?

Ronald S. Saks

It hasn't been pushed off other than to this extent. Actually, In Tech and D3 are doing a lot of joint marketing, and we see a number of opportunities there. And we're very pleased. Everybody buys companies for different reasons, but we always look at the people and In Tech really has some top notch highly technical people who know their jobs and are very effective at doing them.

And I know that they're going to blend very well with D3 and the Aerostructures group. We've got a lot of people who understand composites. We've were talking with another company about possibly taking a minority interest in their business and getting operating control and I referred to that I think in an earlier conference call.

In today's environment that doesn't look like it's going to be feasible because the value of the company isn't where the owner would like it to be, and so we continue to look at other composite opportunities, but I would tell you frankly that if nothing else, we believe that this downturn gives us some time to be selective and to find the right partner.

We know that there are other opportunities out there and we're, I have a meeting next week to discuss collaboration with a pretty successful composite supplier to the industry that I hope will bear some fruit. We are continuing to look actively at opportunities but we're going to be very careful.

Until we've got our inventory reduction and goals going and we see free cash flow and debt coming down, leveraging right now in this environment doesn't seem to us to be the most appropriate tactic to use until we feel a little more comfortable that the business is stabilized. So we will be set back a little bit in terms of the timing of some of those investments.

We're not seeing a lot of demand from customers right now for that kind of product from us, and we don't expect we will for a bit of time but the delay in the 787 and potential delay in the 350 and other new products is likely to cause there to be a delay, and we need to do that right away.

So we're not going to be emphasizing acquisitions until we get our existing operations straightened around.

Lawrence E. Dickinson.

If I could add to that from the B-3 perspective, we have worked hard over the last several years to position ourselves as true subject matter experts in composites and we think we solidified that with a lot of our customers with the formation of the composite technology center of excellence, and our participation on some of the programs that are using the most advanced materials from the composite side.

And now that we have aligned with In Tech and their full scale testing capabilities, we think we're really segmenting ourselves as development composite experts and though the decision on the production side may be deferred for some period of time, we think we're in a great point from an industry perspective to really leverage that upfront development and test reputation when the time is right to jump into the production composite side.

But certainly as Ron mentioned, we will take a conservative approach and during these sorts of times of economic uncertainty, we would much prefer to leverage the upfront composites expertise and make sure the time is right on the production side.

Operator

Your next question comes from Gary Liebowitz – Wachovia Securities.

Gary Liebowitz – Wachovia Securities

Can you just clarify on the backlog? You have an Aerostructures backlog of 184 but the guidance is 180 to 190. Is there an assumption that some of that backlog gets pushed out to 2010?

Ronald S. Saks

Some will be, especially the Gulf Stream. The Gulf Stream issues blanket orders and those are expectations for the full year. They're in the process right now of adjusting those orders down and we expect that by maybe the end of the month into early April, we'll see that backlog decline consistent with the reduced production rates. Other than that, we're not aware of any changes.

Gary Liebowitz – Wachovia Securities

I think you talked about in the past about locking in on your borrowings the current fully loaded interest low interest rate. Any movement on that?

Lawrence E. Dickinson

We've actually re-stratified or laddered throughout the course of this year between a one year, a nine month and six month and a three month array, so we have basically locked in tranches' of our debt. We will see segments of it maturing each quarter that we'll have to roll in and certainly as rates are a little less favorable than they have been over the last couple of months, we'll likely see a little bit of appreciation in the cost, and you saw a little bit of that reflected in our guidance on interest, a combination of expecting to have a little more debt as well as a little higher cost.

Gary Liebowitz – Wachovia Securities

What is that average rate? 3% to 4%?

Lawrence E. Dickinson

I think what we put in the guidance was 4%. That would be all in costs. We expect it to be likely that coupon rate or payment rate to be a bit below that, but there's some other fees related to the loan.

Ronald S. Saks

Considerably lower. I actually think we locked in most of the rates as well as about 150 to 95, plus LIBOR, 1.08 to 1.38, so we're probably closer to 3% to 4% for the bulk of the year on a coupon basis, but we've got other amortization of loan costs and things that go into that number.

Operator

We have no further questions. Mr. Saks, I'd like to turn the conference back over to you for any additional or closing remarks.

Ronald S. Saks

Thanks all of you for attending the call. Sorry to be quite as wordy as we were but we thought in the circumstances, we'd like to share as much information as we could, and we do appreciate the comments from one of our large shareholders.

As stated earlier, we work hard at our business. We continue to work hard to try to understand as best we can what the pressure points are in determining how to adjust to this changed environment. We're confident that we've got a lot of people that understand this business and are going to serve us well as we go through the next couple of years.

We appreciate your interest. We look forward to the next conference call. Hopefully things will be a little better and the world economy and we can talk about more positive things. Thank you.

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Source: LMI Aerospace, Inc. Q4 2008 Earnings Call Transcript
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