Executives
Ron Saks – President and CEO
Ed Dickinson – CFO
Analysts
Tyler Hojo – Sidoti & Company
Michael Conlon – Wells Fargo Securities
Edward Yang – Oppenheimer
Stan Manny – Manny Family Investment
Chris McDonald – Kennedy Capital
LMI Aerospace, Inc. (LMIA) Q3 2009 Earnings Call Transcript November 6, 2009 10:00 AM ET
Operator
Good day, and welcome to the LMI Aerospace’s third quarter 2009 earnings conference call. Today’s call is being recorded. This call includes forward-looking statements related to LMI Aerospace outlook for 2009 and 2010, which are based on current management expectations. Such forward-looking statements are subject to various risks and uncertainties many of which are beyond the control of LMI Aerospace. Actual results could differ materially from the forward-looking statements as a result of among other things the factors detailed from time-to-time in LMI Aerospace’s filings with the Securities and Exchange Commission.
Please refer to the risk factors contained in the company's annual report on Form 10-K for the year ended December 31, 2008, and any risk factors set forth in our other subsequent filings with the Securities and Exchange Commission.
I'd now like to turn the call over to Mr. Saks, Chief Executive Officer.
Ron Saks
Thank you, Katie, and good morning everyone. I'm Ron Saks, CEO of LMI. And with me today is Ed Dickinson, our Chief Financial Officer; and Ryan Bogan President and CEO of D3, who has also joined us from California.
2009 has been a year of uncertainty for LMI in most of the supplier base in the aerospace and defense industry. The difficulty LMI encountered in 2008 trying to predict customer demand, exacerbated by the Boeing strike and inventory destocking that followed made it difficult to plan our needed production throughput, and the worldwide financial crisis caused customers and suppliers alike to focus on generating cash to protect against a potentially dangerous drop in demand.
LMI chose to focus on inventory reduction in our Aerostructures segment as the primary means to reduce debt, and also worked on productivity improvements and retention of our skilled workforce. Because of new programs startups in the first half of 2009, the plan was to moderate inventory growth for new programs in the first six months of 2009 and then to reduce inventory ratably through the end of the year.
Changing demand from our customers, the significant production rate decline for Gulfstream aircraft, and a drop in demand for 767 wing mod kits challenged over plans to level load production in the face of such volatility.
Our engineering segment was working on new product development and gave our operations some stability through the first nine months of 2009, assisting considerably in generating cash as well. And as we entered the third quarter of 2009, our plans began to experience significant reductions in inventory. However, the inventory reductions were so rapid that we hit our year-end inventory goal by September 30, and have continued to reduce inventories in October.
We began to react to this sharp drop-off at the end of August by loading our shops with more work, but it has taken several months for us to begin to build work and process inventories meaningfully. As a result, our cash flow grew dramatically, which is a good thing, but we didn't recharge our plant’s production in time to avoid some margin erosion.
In September 2009, we began to see a change in some of our customers ordering pace, and that required increasing our production throughput in order to support 2010 demand. We intend to produce at the rate we are selling product in 2010. So the combination of higher demand for Aerostructures in 2010 and flat inventories requires throughput about 15% higher than 2009. Accordingly, Aerostructures looks forward to improving their results next year.
Our engineering segment has seen slow demand in the second half of 2009 given that engineering development on the Boeing 747-8 and Gulfstream G650 programs is winding down. The D3 has scaled down its workforce to meet demand, and expects to maintain gross margins. We are focusing our business development group on selling design build projects and expect to see a resumption of growth in engineering content as 2010 progresses.
The revenue may be deferred based on the amount we elect to invest in these new development programs. I will give you a bit of a snapshot of what happened in the third quarter and what we are expecting with regard to revenue. I will discuss those expectations in more detail for 2010 after Ed Dickinson has described our financial results for the third quarter. Ed.
Ed Dickinson
Thanks Ron. Good morning everybody. As usual it is a pleasure to talk with you this morning. As Ron said, the current aerospace environment presented some challenges for LMI certainly in this quarter, more so in the Aerostructures segment. And I will go through the financial results and be glad to take questions in the Q&A session.
Sales for the third quarter were $58.7 million, down from $61.9 million in the prior year. Gross profit was 21% of sales in the quarter compared to 27% in the prior year. SG&A was $7.5 million in the quarter down from $8.6 million in the prior year. And net income was $2.8 million or $0.25 a share compared to $5.2 million or $0.46 per share in the third quarter of '08.
In Aerostructures, sales were $39.8 million compared to $39.4 million in the prior year. Sequentially sales were down a bit from $40.3 million in the second quarter. Products for large commercial aircraft generated sizeable growth again this quarter, reaching $18.6 million, up from $11.3 million in 2008. Our aftermarket 767 winglet kits and leading edges generated sales of $6.9 million, up from only $300,000 in the prior year, yet down slightly from $7.6 million in the second quarter, consistent with what we suggested in our revised guidance last quarter reflective of a slackening demand for the winglets. We expect to deliver approximately 100 shipsets of winglets this year.
Excluding this item, large commercial aircraft generated $11.7 million of sales compared to $11.3 million in the prior year. Please recall the prior year experienced the initial impacts of the Boeing work stoppage in September 2008 that modestly impacted revenues in the prior year. Of note, we have seen no real change in demand due to commercial production rates, but are currently working with customers on inventory management issues.
Sales of 737 components were $6.2 million, up 11% from $5.6 million in the prior year. Net sales on the 747 generated $3.6 million up from $3.2 million in the prior year and consistent with the second quarter, sales in the third quarter were less than $100,000 on 787, down from 200,000 in the prior year.
As we look at corporate and regional sales, we get a bit of a mixed bag, but overall they were decidedly down to 10.5 million [ph] down from 13.9 million in the prior year.
Sales of large cabin Gulfstream product were $7.3 million, down 35% from $11.3 million in the prior year due to lower production rates, announced by Gulfstream in March and the resulting inventory management activities at this customer. Current quarter volume for Gulfstream was also weakened by Gulfstream's manufacturing hiatus for four weeks in July. Of particular note is the strengthening of demand currently for these products as inventories at Gulfstream seem to have stabilized.
We did generate revenues of $800,000 on the new G250, primarily for tooling and leading edge wing assemblies that were redesigned after delivery of the first units. Bombardier product also declined generating $650,000 in the quarter, down from $1.5 million in the prior year, due primarily to lower production rates. Offsetting these items was our new design build program.
As we stated last quarter, we were not yet able to name the customer or the program, but we did begin preliminary engineering work in July. Revenues of 1.2 million in the quarter were generated on this program. This program will be a joint effort between Aerostructures and the engineering services segment. Therefore the volume will be included in both segments revenues and eliminated in consolidation. For this quarter, over 95% of the value is generated by engineering services.
Military products produced revenue of $9.5 million in the third quarter, down from $10.8 million in the prior year. Blackhawk revenue was $7.8 million, down from $8.4 million in the prior year. We continued to work through inventory destocking issues with both of our primary Blackhawk customers as they increasingly tightened their inventory management policies.
This activity continues to make it quite difficult for us to forecast revenues and manage our own inventories. Apache helicopter revenues generated at our Sun Valley California location were $630,000, down from $1.5 million in the prior year. Technology products continue to lag generating $360,000 in the quarter, down from $1.9 million in the prior year, providing the fourth straight quarter of unusually low demand. Conversations with this customer suggests some revival of demand during 2010, but not to historic levels.
Gross margins in the quarter were 21% of sales, well below the 25% mid-point of our guidance. The inventory reduction plan Ron alluded to earlier coupled with lower volume, combined to reduce production by over 30% from the prior year suggesting lower productivity and inability to adequately cover our fixed cost. As noted in the press release, we have recharged our facilities’ production lines to increase our output. We have fallen well below where we needed to be to support 2010 demand levels.
It will take time to turn this trend as we increase hours worked. We again saw inventories drop in October, but expect to see production equal our outpace sales in November and December.
Of additional notice that 767 winglet program. As we noted a year ago, this program generated substantially lower gross profits, yet we incurred no additional admin expenses to take on this package. Therefore in our view, operating margins have been accretive. However, as volume has been short of expectations in biz jet and military this program has become a larger portion of our revenues and has had a disproportionate impact upon gross margins.
Lastly our Sun Valley location, which provides machine products to the technology and aerospace markets showed significant improvement in the third quarter, when compared to the second quarter. However, it was down significantly from the prior year. We will be testing all of the goodwill currently on our balance sheets during the fourth quarter, including the amount related to our Sun Valley location.
As stated last quarter, we could encounter additional restructuring or goodwill impairment good charges at this location. Selling, general and administrative expenses for this segment were $5.8 million, unchanged from the prior year.
Next I will address the engineering segment; revenues were light when compared to last year reflecting sales of $20.2 million, down from $22.8 million in the prior year. As previously discussed, this segment generally operates in the time and material basis, so revenues are highly correlated with employment and overtime levels. Headcount for this segment continued to decline in the quarter reaching 368 people down from 381 in the second quarter and 430 the prior year, the percentage of overtime continues at a relatively low level.
Corporate and regional engineering service segment were down 40% to $4.5 million from $7.6 in the prior year as design for the G650 matures and staffing for that program has fallen considerably. As mentioned last quarter, most of these engineers moved to military programs primarily the CH53. However, some of the engineers could not be placed and were not retained. Somewhat softening the decline of the G650 was support for the new design build program.
Large commercial aircrafts generated $7.9 million in the quarter, down from $11 million in the prior year. Design maturation on the 747-8 and the 787 reduced revenues on these programs.
Services for military programs generated $7.4 million of sales, up from $3.4 million in the prior year as engineers were shifted to the CH53 generating over 2 million of incremental revenue and additional work on various (inaudible) primarily the F-35 generating over $2.5 million of revenue.
Tooling sales were $400,000 in the quarter, down from $800,000 in the prior year. Gross profit for the engineering segment was $4 million or 20% of sales, down from 22% of sales for the prior year. As we have been saying in the last few quarters, 100 basis points of this decline in the prior year was related to a re-class of expenses considered overhead in 2009, yet were SG&A in 2008. Additionally we incurred more unbillable hours as we encountered assignment gaps in the rotation of engineers from one program to another, increasing our overhead cost.
As we look to the fourth quarter, we will remind you that we will see an abundance of holidays, which will reduce revenues and put pressure on margins. SG&A for the segment was $1.7 million, down from $2.5 million, lower payroll cost, including lower stock compensation expense and the benefit of previously mentioned reclassification generated this reduction.
Non-segment interest expense was $443,000, slightly higher than the 407,000 in the prior year. Lower interest rates substantially offset the higher borrowings related to the purchase of Intec. Income taxes were approximately 36.5% in both years.
Before lining up the income statement, I wanted to share a bit about the Intec acquisition. We experienced another weak quarter with Intec. The new contract mentioned last quarter and two additional test projects have began making their way through the shop and revenues should be improving. Additional the composite containers manufactured by Intec had also experienced weak order flow. In the last few weeks, we have seen a decided change in demand there. We had to put employees on three shifts to meet the short-term demand. We were hopeful that this segment will return to more normal demand levels. Sales for the quarter were under $1 million and we expect fourth-quarter volumes to be 50% higher.
Cash flow for the quarter was strong, as we generated free cash flow of $9.7 million, and again seeing this shift last quarter and we expected it to continue into the fourth quarter. Year-to-date free cash flow was $8.3 million. The positive cash flow resulted in revolver borrowings of $30 million and the cash balance of 2.5 million or net debt of 27.5 million. The largest contributor to this cash improvement was inventory reduction plan, and as Ron said, we reached our inventory targets a quarter early, as inventory levels neared mid-2008 levels at $51 million. As stated earlier, we likely pulled this down too quickly to have any adverse impact on margins.
We expect inventories to normalize around the third quarter levels as we ramp production back up. The drop-in payables is primarily related to the current year reduction in inventories as year-end balances included the liability for the late run-up of inventories and supply chain products.
We managed our raw materials more effectively during the year with the start-up of a cut-to-size operation in our Tulsa distribution center to support our Midwest plans and slowed the flow of product from the supply chain, both contributing to the drop in inventories and accounts payable.
Combination of extensions in payment terms and the growth in unbilled accounts receivable in large part attributable to the new design build program added to the gross and accounts receivable.
As we look forward to the balance of 2009, we still expect to generate a good bit of cash with free cash flow of about $15 million to $20 million for the year. Free cash flow in October continued to be very strong with revolver debt net of cash balances dipping below $20 million. We expect Capex for 2009 to come in slightly below our estimate of approximately $5 million. We do expect that our Capex budget for 2010 will be 20% to 40% higher, ranging between 6 million and 7 million, but still remained below depreciation and amortization expense.
The increase will be paced by our investment and product life cycle management software to assist us in design build, adding to the investment we have been making in 2009. The build out of a much larger clean room and related composite manufacturing equipment at Intec, equipment for the creation of a dedicated value stream production (inaudible) for new 777 work and the G650 product and the installation of a process in line in Mexicali.
With that, I'll turn it back over to Ron for his comments.
Ron Saks
Thanks Ed. Actually last night Ed and I were exchanging emails and at one point he said, he was turning it over to my closing comments given the length of our presentation today. I will try to get through the balance because I think we're going on a bit long.
During the first half of 2009, we reported to you that production rates reductions on the Gulfstream G450 and G550 as well as the Boeing 767 winglets and wing mod kits, together with the residual effects for the 2008 Boeing strike and inventory destocking policies instituted by several of our larger customers, all combined to substantially reduce our projected 2009 revenue as previously announced.
During the third quarter at our Aerostructures segment, our customers inventory adjustments continued, but began to stabilize and forecast for 2010 strengthened, especially on our Blackhawk helicopter programs. In addition, we received over 1000 orders for the passenger version of the 747-8 and received orders for several hundred G650 components, which were transferred to us from a failed supplier.
The value of the G650 transfer is over $40,000 per shipset. Anticipated sales in 2010 of APB winglets have been confirmed at 90 to 95 shipsets, orders for 737 winglet leading edges have increased in production rates for the G450, G550 have firmed to about the mid-70s.
Bombardier [ph] orders for the C series testing at our Intec division had began to build as Ed mentioned and orders from new customers, DRS Technologies and Northrop Grumman have been received in the quarter.
Aerostructures also has responded to good opportunities for complex assemblies on several legacy and new products into new production models as well as large quantities of components on existing aircraft as our customers realign their supply base for selected models. Some of the components on these quotes are from LTAs that LMI has in effect through 2011. So, there is a risk that work statement may decrease rather than grow.
We are confident however, that we will grow market share. Some Aerostructures customers have begun to request price reductions on selected items given the current state of the industry. Although this often has happened during industry downturns in the past, this time those requests represent a small portion of our total work statement, but it is troubling nonetheless.
As a result, we will be reviewing certain front-end costs on projects that are currently delayed by our customers. We are fortunate we have a division operating in Mexico, which can be used to provide our customers some relief and allows us to build critical mass at the plant. We have considerable capacity in Mexico, which did finally receive quality system and heat treat approvals from two major customers in the quarter. There are still some before we receive US state department approval for transfer of some of this work. Our customers are collaborating with us to allow these transfers.
Once the steady flow reaches a sufficient level, which we project will be early in the first quarter of 2010, we will complete $1 million processing facility at our plant in Mexicali. Several large customers are very interested in placing added work in Mexico to qualify for offsets in the industry participations. In order to support sales of their products in Mexico. So we expect the Mexico plant to be very busy by the second half of 2010.
We are also continuing to negotiate the purchase of the statement of work, including sheet metal and machine components and subassemblies to be place largely in our US plants. If successful, this volume will stabilize revenue volumes of several of those plants, including those transferring of other work to Mexico.
Our large design build project which we described to you in our last conference call commenced in July with D3 engineering design and stress and the creation of an integrated project team comprised of both D3 and Aerostructures employees. We have D3 reps in our customer and have produced revenue of about $1.3 million in the third quarter.
We are close to reaching final agreement on a long-term contract with our customer and we will disclose more details when we execute the contract. D3 has also expanded its role during the quarter on design of CH53 and (inaudible). Our strong focus on design build lead by our integrated business development team should result in added business in 2010 and largely affect the D3 revenue stream next year.
The tanker program currently being bid by the US Government has been delayed for years as you know. If it is awarded in the near term, we do expect that D3 will participate in the design, assuming either Boeing or Northrop or both are awarded this contract.
We are also investing about $1 million in an expanded clean room and cutting equipment at ever Intec division in order to be eligible to manufacture larger composite components and assemblies. We expect to receive the necessary approvals by mid-2010.
We believe that our enhanced financial capability resulting from generation of 15 million to 20 million of free cash flow this year and our growing reputation for solid work with our key customers places us in an excellent position to grow market share. We intend to use our growing capital base to invest in new design and build programs and invest in acquisitions, which provide the type of products needed for the complex assemblies we are now and will be building in the future.
Eddie we will now take questions from our listeners.
Question-and-Answer Session
Operator
(Operator instructions) And we will go first to Tyler Hojo, Sidoti & Company.
Tyler Hojo – Sidoti & Company
Hi, good morning everyone.
Ron Saks
Good morning.
Ed Dickinson
Good morning.
Tyler Hojo – Sidoti & Company
First just to fill in a couple of blanks here, in terms of cash flow expectations for 2010, I don't think you addressed that and as well as depreciation and amortization?
Ed Dickinson
Again, I would expect depreciation and amortization to be somewhat unchanged next year. We did put out a Capex number here in the press release of 6 million to 7 million. So I would expect to see a little bit of cash benefit there somewhere around, I think our net income kind of the midpoint of the range would put us around 16 million. So if you add back or add in a million or two from difference between Capex and depreciation and amortization, it would put you in the upper teens in terms of where we are and depending upon work and capital demand from our customers, because we continue to see inventory and receivables pressures. At this point, I wouldn't want to put any conjecture on working capital benefits.
Tyler Hojo – Sidoti & Company
But generally speaking, you are anticipating another pretty strong year of cash flow generation in 2010?
Ed Dickinson
Yes, we are.
Ron Saks
Yes, I think that is fair especially with our expectation that earnings will increase as well. We have had as you may have noticed in our statements some sizeable increases in receivables. In October as Ed mentioned, we have had a decided reduction in our debt levels signifying free cash flow at least up through October. It is already gotten us to the level that we expected by the end of the year, and we are attempting to manage the receivables as customers keep trying to stretch, but as the inventory begins to rebound if what we are seeing begins to spread throughout the industry, the expectation is that some of that pressure on receivables may lessen.
We have to internally continue to focus on inventories because as we had this increase throughput, we need to be better at matching our sales to our overproduction. But on the basis of our experience this year, we would expect somewhat more free cash flow in 2010 and 2009.
Tyler Hojo – Sidoti & Company
Okay, great. And just on headcount, you addressed the D3 headcount of 368 down from 430, just companywide you know, kind of how do you feel it seems like there are some opportunities in Mexico. It seems like you have, there is actually quite a few opportunities there, and in regards to Mexico, just where you do you stand from a utilization standpoint?
Ed Dickinson
As we have gone through the last really nine months, we did have some layouts that we announced early in the year in late March, early April in Aerostructures where we had about 60 employees that were laid off. And since that time, we have had some attrition at our plants because we haven't been rehiring. So our headcount at the Aerostructures group has declined as has D3 a bit as we're gone through this period.
However, with all of the improvement in production efficiencies that we believe have been put in place, and with the expectation that at least in the business jet area we may see some increased quantities to build for order. We're not seeing that on large commercial production, but we are also on the Blackhawk program. Our intention is, since we’ve had excess employees, that have been working on some of these projects that we will first fill up that capacity, and then have people work some overtime until we see how far the demand increase goes and as we have additional confidence that demand is growing, we believe that there are plenty of people available to add to our employee groups in the areas where our plants are located, but with the primary emphasis for growth within the Aerostructures group, growth and headcount will be in Mexico.
Tyler Hojo – Sidoti & Company
Okay great, and just I mean, I don't know if you can quantify it, but just capacity utilization in Mexico, I mean ballpark where do you stand in that plant?
Ed Dickinson
Right now because we expanded last year in anticipation of receiving approvals to move work down to Mexico, and we have really struggled to get there, and it took a while for our customers to get going and get that together. And so we are operating around most of the year, and in October we had a bump up in productivity and we expect it for the balance of the year, but we have been operating at 50% or less in Mexico. So we have got plenty of capacity there.
Tyler Hojo – Sidoti & Company
And just quick follow up, where do you expect that to be 12 months out, capacity utilization on the…
Ed Dickinson
Well, based on a 15% increase in throughput needed throughout the system and without the benefits of this acquisition we have been negotiating, we would expect to be at capacity by the end of the year barring that acquisition.
Ron Saks
But still there are some (inaudible).
Ed Dickinson
Because our people have been accustomed to working 15% overtime. We have quite a bit of ability to expand without adding significant number of people.
Tyler Hojo – Sidoti & Company
All right. Great, thanks a lot.
Operator
We will go next to Michael Conlon, Wells Fargo Securities.
Michael Conlon – Wells Fargo Securities
Hi, good morning.
Ron Saks
Good morning Michael.
Michael Conlon – Wells Fargo Securities
It sounds like your G650 content is approaching around 300,000 per shipset based on the share gain this quarter. Is that that about right?
Ed Dickinson
It is between 250 and 300. We have some work that we were doing that currently is under – has been re-summited, and some of that work could go to the Gulfstream in Mexicali. So the 250 is a safe number, but it is likely a bit higher. We also have some proposals in to do added work on that aircraft that is being considered by our customer, and we have a significant quote to a tier 1 on that program, which would forward to a large extent.
So we're safe in saying 250 is out there, probably a bit more, but there are some significant opportunities to increase that very significantly.
Michael Conlon – Wells Fargo Securities
Would you say you could, how would you say the prospects are for getting that share up to G450, 550 levels with that 500,000 or 600,000 a shipset?
Ron Saks
I would say they are better than 50-50.
Michael Conlon – Wells Fargo Securities
Better than 50-50. Okay. And I don't know if you have quantified it, but can you tell us about how much in sales are currently going through Mexicali. Is it possible to share?
Ed Dickinson
Yes, I think our projections for the year are about 7 million, something where that. And it is starting to quicken now, but what we are expecting to do, and some of the new orders we received the DRS Technologies for example are going into Mexicali, and we think they will provide $1.5 million of additional volume to them. We have got all of these transfers coming in. So annualized by the end of the year, we should be more than double that rate.
Michael Conlon – Wells Fargo Securities
Okay. Thank you.
Operator
We will go next to Myles Walton, Oppenheimer.
Edward Yang – Oppenheimer
Hi, Ron and Ed, actually this is Ed in for Myles.
Ron Saks
Okay, good morning.
Edward Yang – Oppenheimer
Just a couple of quick questions for US, first on selling expense, could you give me the breakdown on that again by segment, and then also the sales by model for Boeing?
Ron Saks
Selling expenses in the structures group were 5.8 million, and it was unchanged in the prior year, so 5.8 the year before. In the engineering segment, it was 1.7 million down from 2.5 million. As we look at the contribution by commercial model in the quarter, 737 was 6.2 million, 747 was 3.6 million, the 767 was 7.5, recall that we were 6.9 million and that was related to the wing mod program, 777 was 1.2 million, and I think I said 787 was less than 100.
Edward Yang – Oppenheimer
Okay, and then also on the winglet program, can you just give me, I think I heard 100 is the expectation for ‘09 and 90 to 95 for 2010, is that correct first of all? And then can you describe how those orders come in and how much are in backlog now, and what the outlook might be for 2011?
Ed Dickinson
I would say your numbers are consistent with what we've been stating and we believe. So I think that is correct. The backlog that we have got on the books, it is just based on the purchase order they provided to us, which is for the 300 shipsets.
Ron Saks
And I think currently the 2011 is scheduled for 80 to 90. I saw something come through within the last few weeks that identified of the overall purchase order, what was there. So we expect 2011 to be relatively consistent with the first two full years of the program, this year and ’10. What we don't know is, and if you can tell us, we would appreciate it, what is going to happen to fuel prices, and to use those aircrafts, because initially the total market was estimated to be in the 500 aircraft range.
We have been using 300 aircraft, and so our expectations right now as we have gone through some recent discussions about projecting out to 2013 are that that program may be relatively low volume by mid-2012 and 2013. Hopefully, there will be some other programs on other aircraft that come into the time frame, but right now we don't have any thing to replace it.
Edward Yang – Oppenheimer
Okay, that is fair. Thank you for that. On Boeing on the narrow bodies, Ron I was wondering if you could tell us what you are seeing there, what your expectations are for production rates there?
Ron Saks
Now, as you know, we have been a bit more constructive about this over the last year and a half, and a lot of the forecasters, but as we discussed last quarter the concern began to grow that sometime in the latter part of 2010 there may be some reduction in rates.
In this quarter, we haven't heard a lot about what may happen with those aircraft, although Airbus has made some comments that suggest they don't anticipate any real reduction in their rates, and since we are primarily dependent on Boeing, the expectation is Boeing will try to keep up with the Airbus rates. But other than one hint that the orders are coming and that the likelihood is that orders are firming and the likelihood is that orders will at least remain through the end of 2010 and into 2011 at current rates on narrow bodies.
We basically have in our projections for 2010, the assumption that rates will continue at the 31 level. And I personally feel increasingly comfortable with that as we go through time.
Edward Yang – Oppenheimer
Okay, Ed you mentioned holidays, I'm high wondering is there anything different to expect this year relative to that versus past years?
Ed Dickinson
The way the calendar falls for D3, there will be only one less holiday than there was in the fourth quarter last year. So it'll be a little differently staffing. It is also a bit different to say, even they have started off this quarter fairly robustly. So again I would add, it would not be decidedly different but I do think there is one less holiday.
Edward Yang – Oppenheimer
Okay, and then on the Sun Valley side and the goodwill, could you tell me how much goodwill you got now on the books for that?
Ed Dickinson
Yes, $3,350,000.
Edward Yang – Oppenheimer
Okay, all right. Thanks guys.
Operator
(Operator instructions) We will go next to Stan Manny, Manny Family Investment.
Stan Manny – Manny Family Investment
Hi, a couple of questions, one you mentioned in your summary, consolidation of plants to improve efficiency, can you give us a little more detail on are there any specific plants, what are you looking at?
Ron Saks
Actually, you know we talked a little bit about consolidation last quarter. Then as demand began to quicken, and as we looked at how we might consolidate, over the long term we believe given the pricing pressures that we are feeling from customers on products that can be produced in low-cost countries without high entry cost that over time, we expect that we will be transferring more and more work from US plants into low-cost countries.
And so we continue to look at consolidation opportunities, and we actually have a couple of plants in place when and if the timing is right. At the same time, we are looking pretty hard at design bills and trying to increase the complexity level of the work that is being done at a number of our plants so that they can continue to do that work as we move the simpler component and subassembly outside the US.
So we have no current plans, and in fact most of this surge of activity we expect to our Mexicali plant in 2010. We have tabled the consolidation plan for now, and are placing our emphasis on moving the work down there, and trying to finalize this acquisition so that we can restore the revenue that may be lost as our US plants transfer work down to Mexico by bringing in other work, and primarily military work that they have some more stability and be less prone to moving down out to low-cost countries.
Stan Manny – Manny Family Investment
So you said low-cost countries, but you only mentioned Mexicali. Is there something we are missing? Are there other countries that we are in with manufacturing?
Ron Saks
Currently there are none, but as we go through 2010, we have mentioned that we wanted to get Mexicali nicely full, and then we will be looking at another low-cost country, perhaps in an area where we can market the goods that we produce there. In Mexico, the Mexico facility is primarily a cost reduction facility with the products that is being produced coming back to our US and potentially foreign customers.
However, we will begin to look more closely at another low-cost country where we can put a facility and try to market within that country.
Stan Manny – Manny Family Investment
For e.g., where would that be Korea?
Ron Saks
There are several possibilities. Asia, certainly is one, and we have looked at Asia in the past, and so the logistics cost and for a company our size, the cost of trying to maintain a relatively small facility was not economical, so what we have to have if we go to that region is sufficient volume to warrant moving in and having that volume when we start.
When we began the Mexicali plant, the investment studies that we did suggested that we did not need significant volume in Mexico in order to at least match how we were doing in the US. And that has proven to be the case. So Asia is certainly one for consideration. We currently do not have, for example, (inaudible) as a customer. There may be opportunities there are also, just this morning I saw there, they may be working with the Chinese supplier to build their E190.
So we don't have any firm plan to date. We don't expect to just grow and grow the Mexicali facilitate, but rather we will split the work between at least two facilities over time as demand…
Stan Manny – Manny Family Investment
In Mexico you mean?
Ron Saks
No, just – we will fill the Mexico facility. We may grow it a bit going forward, but we will look at an alternate site as well.
Stan Manny – Manny Family Investment
In Mexico?
Ron Saks
No, we will not have a second site in Mexico.
Stan Manny – Manny Family Investment
So the second site, I think we're all confused. Where would the second site be that you are conceiving?
Ron Saks
Well, Asia is the area we are looking most closely right now.
Stan Manny – Manny Family Investment
Okay. Second question, you’ve got a – you mentioned you do and it shows a big buildup in receivables, should we be worried about any write-offs or inability to pay on any of those existing receivables?
Ed Dickinson
We don’t think so. We did an analysis of the buildup in receivables of $10 million. Primarily they were centered with several large customers that moved terms from 30 to 60 days, 60 to 90 days, and we ended up with an additional month for it. Months worth of receivables as a result of their actions.
And in terms of creditworthiness, we have very little write-off history and our reserves are relatively low as a result. There certainly are some weaknesses in some of the companies that have large market share in the industry. We don't with the exception of one, where there had been a possibility, but that one managed to sell a major asset and generate some cash, and so we don't have much concern about that.
Stan Manny – Manny Family Investment
Okay, last question, would you kind of venture a guess on the 2010 net operating margin range, 23 to 24 is certainly higher than this year with more volume?
Ed Dickinson
I think with the guidance we put out, I think the operating range would be between, I expect a pretty broad range between 24 and 28.
Stan Manny – Manny Family Investment
24 to 28 for 2010.
Ed Dickinson
You mentioned operating, but then I think you read from gross margins.
Stan Manny – Manny Family Investment
Yes, but I'm talking about gross margins. You gave the G&A et cetera, so I guess we can tool down to the rest of it.
Ed Dickinson
Yes.
Stan Manny – Manny Family Investment
Okay. Thank you.
Operator
We will go next to Chris McDonald, Kennedy Capital.
Chris McDonald – Kennedy Capital
Hi guys, good morning.
Ron Saks
Good morning Chris.
Chris McDonald – Kennedy Capital
Thanks for taking my questions. I wanted to see if you might be willing to expand a little bit on the – how the intermediate term outlook for what you're doing with the Intec expansion, and just maybe kind of your general thought process around how the company is going to address the composites opportunity?
Ron Saks
We were actually – we were just up there this week. We had (inaudible) through the facility and, if you went through the shop, you would see some yellow tape on the floor, where we are basically going to significantly expand the clean room environment. We found that to be an obstacle in terms of getting customers interested in our ability to produce any considerable amount of volume, because of the limited size of the clean room.
That investment was agreed to on this trip, and we will start incurring some of that cost later this quarter, but the bulk of it in 2010. But I think the basic concept is to get to an ability to produce in that location a small composite product. They have got two autoclays in the location today, and have some capability there as well. So we will certainly need additional capital expenditure there, potentially some cutting equipment for the fibers. It is really just an attempt to start producing small composite product.
Ed Dickinson
I would add to in the intermediate term as you describe, thinking of intermediate in terms of the next year to 18 months, I mentioned in my comments that with the improved free cash flow we have and the reduced debt, our capability to make a larger acquisition continues to increase, and certainly one of the first places we are looking and have continued to look during this downturn is for meaningful production capacity of larger composite structures.
But during the interim, we also have our client, which is some distance from Intec, but both in Seattle market. Working closely with Intec, and as we need added size, or production capacity, we have some capability to use the (inaudible) work group to assist Intec as well either in taking over some of the container volume to make room in Intec or to actually create a nearby site in (inaudible) where we would produce more of this product.
What we will be looking is the acquisition opportunities versus the Greenfield of that activity, but we do expect within that intermediate term to not only increase the amount of products that we can produce that is relatively small at Intec, but to be in production of larger structures either (inaudible) or at an entity that we acquire.
Chris McDonald – Kennedy Capital
Okay, great. Thanks for walking through that and then just one other one. In regard to Mexicali, is that plant even with operating at relatively low capacity utilization, it still managed to deliver margins that have been at or maybe slightly above company average. Is that correct?
Ed Dickinson
Yes, historically our aim is to do that, but again as we start looking at price concessions to get products down there, it will certainly moderate that. But they have shown a very strong ability to produce consistently with the US sites at a lower cost. The more we charge that facility, the better that operation will be.
Ron Saks
We are very pleased with the senior management. At that plant, they have been very effective and they have been using this time to go through numerous production efficiencies events and training the people. We started them up. They had a little bit of a slow start, and then they surged in the second year. And when they did that, they had a lot of people. The people they have added seemed to have a very good work ethic and work well and we have transferred work down there from some of our most efficient US plants, and it hasn't taken too long for them to approach within 10% or 15% the hours that our US plants have been using to produce product, and with the significantly lower labor and overhead rates down there, we have been able to capitalize and hold those margins.
Chris McDonald – Kennedy Capital
Great. Thanks a lot.
Operator
We will take a follow-up from Tyler Hojo with Sidoti & Company.
Tyler Hojo – Sidoti & Company
Hi, too quick ones from me. Where does shipset content on 787 currently stand?
Ed Dickinson
You know, we had so little activity on it as Boeing and Tier 1 have been focused on getting this plane to fly. We don’t – we haven't seen much change in that value. So at this point we would say it is around $150,000. But the order activity has been so low, it has very difficult for us to really confirm where it stands. I would think to some extent similar to what you are going to see on the G650 as the plane starts moving, we will see there is a little bit of redistribution of product around the supply chain. So at this point, we don't have a much better data. Ron you might…
Ron Saks
No, I was just going to say interestingly just in the last week or so, given Boeings purchases some facilities in South Carolina that also included an Italian supplier of Boeing, we have been making some 787 products for the Italian supplier and Boeing is now calling orders for that product since they have taken over the facilities. That is really the first evidence we have that there is some new look at the product we have been building. And I shouldn't say the first, because we have orders out through 2011, a Tier 1 supplier for which we are also producing the work.
Some of it is firm with orders, but I agree with that there hasn't been a lot of activity. And given some of the financial weakness of some of the supply base, and the fact that as this is going to be a high-volume aircraft and having capacity and systems available to handle it, we are optimistic that we will see more of kind of work we can currently produce on that aircraft, but ultimately perhaps especially on derivatives that they use different materials and different processes for composites, we hope to be in a position to be able to provide some composite product on that aircraft as well.
Tyler Hojo – Sidoti & Company
I mean, would you think that it would be maybe overly optimistic that you would be able to get the shipset content, did you say 300,000 from your current level?
Ron Saks
I would say that is optimistic, based on what we know today, but that is partially from not knowing exactly what the habits are going to be of the customers in particular the Tier 1. The Japanese have these and the large Tier 1 that are participating in that program. A lot of that work has been done internally, and increasingly over time, normally as production picks up some of that work moves out so that the Tier 1 can take on some production on even newer development projects.
So it is hard to tell right now, because this aircraft is new to know whether, the Tier 1 are going to use that same approach or not, but we are going to be in a position to produce composites that can be used on the aircraft, but we are not targeting that aircraft for increased use of composites. We are looking at the type of composite components and subassemblies that can be used on other existing legacy aircraft as well.
Tyler Hojo – Sidoti & Company
Okay, that makes sense and then just lastly on the 2009 guidance, if I've done my map currently, just implied fourth-quarter guidance for revenues would be somewhere in the 55 to almost $70 million range, and you know certainly I get how you get to the low-end of that. But maybe if you could, you know give us a couple of pieces of commentary just in regard to how you get to the high end there.
Ron Saks
We don't expect to get to the high-end. And we do expect D3 looks like it is going to be a little firmer. And Aerostructures may fall a little short, but we still expect to be within the range.
Tyler Hojo – Sidoti & Company
Fair enough. All right, great. Thanks a lot guys.
Operator
We will take a follow-up from Myles Walton, Oppenheimer.
Ed Yang – Oppenheimer
Hi, this is Edward in again for Myles. I guess I was going to ask a question along the same lines, the range on a current guidance for ‘09 is about as wide as it was when you first provided it, and in past years, you have been able to bring that down quite a bit in ‘07, all the way down to about 3 million I think, I am just wondering if you could add any again add any color there, characterize that to help us think about that in more narrow terms and if not, what is it about the fourth quarter that is providing the uncertainty? Thank you.
Ed Dickinson
What will be providing the uncertainty if we can't narrow the range. We could have narrowed the range because, and based on these questions, we don't expect to hit the high-end. I think the acquisition we have been anticipating depending on how quickly it occurs, could have an impact on the quarter, although increasingly as we get further into this quarter, it is unlikely it is going to have as dramatic an impact as we originally thought it might. And we didn't build that into the original guidance, but then when we stood back and looked at where we were.
We left some room for us in case that were to occur. But I think it is fair to say that, we would be between the low end and the midpoint of the guidance that we have given you rather than on the high end.
Edward Yang – Oppenheimer
Okay, thank you.
Operator
And with no further questions in the queue, I like to turn the conference back over to our presenters for any additional or closing remarks.
Ron Saks
Well, thank you all for attending. This call went on for quite a bit longer than many, and we appreciate the questions and the interest in how we are doing. The basic thing we are trying to express here is we are pleased with what appears to be some increasing demand. We are somewhat cautious about the tactics we are going to use going forward, but as we have gone through this quarter rather than being buffeted by some relatively consistent negative news, we found a pretty good balance between the positive and the negative.
And sooner than that continues we look forward to a more successful 2010, and more success doesn’t just mean more sales and more earnings, but more opportunities to grow market share and to land some meaningful design build contracts. Our primary focus on D3, several years ago, had been design build contracts. We have a large one, which we are working very hard to try to monitor, and make sure we understand how we're doing at every point in time so that we are better equipped as we go into new design build projects to estimate them accurately and to make them profitable.
And that is where a lot of our emphasis will be, and you will hear more and more about that as we go through coming quarters. So thanks for your attention and we look forward to talking with you again next year.
Operator
This concludes today's conference. We appreciate your participation.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!