達信公司 (TXT) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Textron second quarter earnings conference call.

At this time all participant lines are in a listen-only mode.

Later we will conduct a question-and-answer session.

If you wish to ask a question, please depress star and then 1 on the touch-tone phone.

You may withdraw your request from the queue by depressing the pound key.

And as a reminder, today's conference call is being recorded.

I'd like to now turn the conference over to the Vice President of Investor Relations, Doug Wilburn.

Please go ahead, sir.

Good morning and welcome to our second quarter conference call.

Joining me here today are Lewis Campbell, Textron's Chief Executive Officer; and Ted French, our Chief Financial Officer.

Before we begin, let me add that over the course of our discussions this morning, we may be making forward-looking statements and such forward-looking statements are subject to various risk factors, which are detailed in our SEC filings and also in today's press release.

Now for a summary of our second quarter results.

Revenues were $2.5 billion, up 17 million from last year.

Our reported GAAP earnings in the quarter were 71 cents per share, which included 17 cents per share in costs related to restructuring and a gain of 1 cent from the sale of the telecommunications joint venture in Brazil.

Excluding costs related to restructuring and other special items, our second quarter '04 adjusted earnings per share were 87 cents compared to 76 cents last year.

The earnings per share and cash flow amounts that we will discuss here forward will be the before restructuring costs and other special items.

The reconciliation of these items to GAAP measures is contained in our press release, a copy of which has been placed in the Investor Relations section of our website at www.textron.com.

A reconciliation of any additional non-GAAP measures that we may discuss today will also be placed in that section of our website.

Now let me turn the discussion over to Lewis.

Thank you, Doug, and good morning, everyone.

You know, we are pleased are the second quarter results primarily because they reflected 2 very positive trends.

First, our enterprise management initiatives are gaining momentum and they're beginning to manifest themselves in a meaningful way.

Cost savings from enterprise management initiatives, such as integrated supply chain, Textron's Six Sigma and others contributed to the sequential margin improvements at Cessna and Fastening Systems and the year-over-year margin improvements at Bell and Industrial.

The second trend, which also gives us encouragement, is that most of the end markets are showing either good growth or signs of solid to very strong recovery.

Now let's turn to each of the businesses.

I'll start with Cessna.

The most encouraging development was the surprisingly strong demand for business jets as we booked 72 net-new orders this quarter.

The immediate consequence of the strong orders is that we're now essentially sold out for 2004, and this means we now expect to book sales for about 180 jets this year, which is 5 more than our previous guidance.

It's readily apparent to us that the general economic recovery is reinvigorating the business jet market, and in fact, let me give you some other points.

We saw signs that the business jet market is continuing to improve, obviously from this strong order booking this last quarter.

Also, the level of used aircraft available for sale has returned to the historical average of about 13%.

We also have used prices which seem to have stabilized and in some cases even shown slight recovery.

And then finally, pricing on new aircraft, which is also important, has improved as we had a little over 2% of positive price impact on the 36 new planes we delivered during the quarter.

Okay, looking ahead, due to the current order environment, we're expecting a good growth year in 2005.

We've now booked approximately 160 orders for delivery next year.

Now, let me put that in perspective.

To give you an idea on how much the business jet market recovered, that 160 order backlog for next year compares to 83 orders that we had on hand in '04 -- or for '04 this time last year.

So, a year ago we had 83 orders, now we have 160.

Given where we expect order rates to be over the next several quarters, as well as the time required to ramp up production of the new CJ3 and Sovereign and looking at our overall production capacity, our current estimate is that we'll be able to deliver about 225 Cessna jets in '05.

Let me move back to '04 now and talk just one more minute about it.

There's relatively little market risk in '04 now.

There's really only one open item I can think of, and that's the final certification of the CJ3.

It was slowed a little bit because of engine certification issues, we're almost complete with that now.

So we're reasonably confident that the program is still on track.

Initial delivery this year will be about 6 units, I think, and deliver pretty close to 40 next year.

On the flip side, our other new plane, the Sovereign, we're very pleased we were able to obtain certification for the Sovereign this last quarter.

By the way, this is the market's best and most-demanded mid-size coast-to-coast business jet.

We plan to ship about 14 of these aircraft this year and then approximately 40 next year.

Another significant accomplishment during the quarter was that CitationShares was able to secure Part 135 certification from the FAA and this allows us to launch our new 25-hour non-equity JetCard service called "Vector."

Now, obtaining 135 certification, required citation shares to have at least 75% U.S. ownership, so during the quarter we acquired an additional 25% interest in the CitationShares joint venture from our Swiss partner, Tag Aviation.

Now we're entering the JetCard business because it represents another very effective way to create new future owners of jets.

Industry experience indicates, by the way, that about 1/3 of the JetCard owners convert to fractional ownership.

So while we're pricing the JetCard product at a level that delivers a very attractive return, more importantly, we believe that the true long-term value of the program is attracting new fractional owners.

And one final point on Cessna, with the relatively low number of jets shipped during the second quarter, again 36, it should be crystal clear that achieving a margin of nearly 9% reflects very good cost performance from our Cessna team across the board.

And let me say one more thing -- we would expect this trend to continue.

Now, let's go to Bell.

They had a very good quarter also, I would name a couple of reasons.

First, margins were up in large part due to our enterprise management and other cost reduction initiatives.

In addition, we're very encouraged by what we're seeing in the marketplace on both the military and commercial sides of the business.

Let's go to commercial first.

Order intake strengthened here as well.

Coincidentally we booked twice as many orders year-to-date as we did this time last year, somewhat similar to the Cessna story.

Most recently we won a $230 million order from Pakistan to supply 24 new model 412 helicopter and 2 used 412s that the Pakistani's intend to use for trainers.

Thanks to the hard work and responsiveness of our Bell team, we were able to deliver 7 of the new aircraft and the 2 trainers at the end of June.

By the way, we expect to deliver the remaining 17 new aircraft over the next 3 quarters.

There's one other accomplishment on the commercial side that I want to share with you, and that is, we just opened our new Customer Center at the Fort Worth Alliance Airport.

This is pretty impressive 160,000-square foot facility and it will be the home of Bell's sales and marketing, pilot and maintenance training and our product support warehouse.

This investment, together with an array of new helicopters, performance enhancements that we're rolling out on our current product line, and permanent cost improvements in our supply chain, taken together reflect our strategic commitment to profitably grow our commercial business.

On the military side, we continue to make very good progress on the V-22.

You may have heard just last week the DOD conducted its most recent Defense Acquisition Board review and the result was very positive.

The Board found the program to be making good progress and will recommend we continue into Oppeveil [ph] next year, that starts by the way first quarter of next year and should conclude in '05.

Of course, as you would expect with any new technology, the Board will make a number of further recommendations for improvements in the aircraft's reliability, and maintainability and in our ability to increase production rates, another good sign.

Obviously, we'll be very responsive to these issues as we have in the past and we'll continue to work diligently as we move forward to full-rate production.

One more point.

We believe the V-22 has a very good future; in fact, we believe we have significant potential beyond the current proposed 458 units.

Bell also advanced its after-market strategy with the acquisition of Acadian Composites.

While not large in size, this acquisition adds some important capabilities to our after-market strategy, we've talked some about that in the past, because this provides technology for the repair of structural helicopter composite panels.

So a good story at Bell as well.

Turning to Textron Systems, another good story.

Our products continue to find ever-expanding applications in today's world environment.

For example, the Army ordered another 28 of our armored security vehicles, or ASVs as they're called, and the U.S.

Government ordered 43 on behalf of the Iraqi Ministry of the Interior, and that totalled 28 plus 43, contributed $65 million in value.

Looking forward, we believe that a significant market has developed -- is developing for this vehicle, well into next year and beyond, and also for its variance.

Overall we see a very strong market for all our Systems products, not only this year, but well into the future.

Now, let's move to Fastening Systems.

We saw good growth across most of our end markets this quarter as well.

In fact automotive and electronics grew mid-single digits, and then we saw double-digit revenue growth in our industrial, aerospace and construction markets.

Now while we're anticipating some slowdown in the North American automotive market to relieve overbuilt inventories, we believe Fastening Systems will show progress on margins by the end of the year, in large part due to the impact of restructuring.

In fact, the consolidation of 2 of our European production facilities, primarily into our new facility in Wuchi, China is underway and will be mostly complete during the third quarter.

And looking to North America, the movement of products out of our 3 Midwest plants, mostly into our new facility in Greenville, Mississippi, is also on track and will also largely conclude during the third quarter.

So, as we see it, we have one more big quarter of transition costs and inefficiencies that do not qualify as restructuring, and this along with further relief of steel pricing, which Ted will more fully discuss here in a minute, gives us confidence that margins at TFS will start to move in the right direction beginning in the fourth quarter.

At our Industrial businesses we're seeing a repeat of what have we saw in the first quarter, that is: Good growth at Kautex and our electrical and plumbing tools businesses, improving signs in our golf markets, although sales were down slightly at Jake.

Telecom related sales continue to be very weak and we are reducing our presence in that market, and we're also continuing our deliberate strategy of proving unprofitable business in our Fluid and Power division.

But, again, the improvement in margins at Industrial, while helped by overall volumes, was largely the result of our transformation initiatives.

Finally, TFC.

Textron Financial delivered better than expected progress on the credit side, they've begun to add assets which grows the portfolio, and by and large had a very good quarter.

Okay, to wrap up on the quarter for Textron, our markets are improving, and we're demonstrating progress on our journey of transformation to reach our vision of becoming the premiere multi-industry company.

Recognizing that our markets are improving and with the progress we're making with our cost, we've raised our guidance for the year.

Obviously, we still have market risk to manage, things like commodity pricing pressures and the possibility of more severe sustained automotive correction is there too.

It's also critical that we continue to improve efficiencies, in other words, relentless execution of our strategy to further develop our enterprise management capabilities.

This is a must for us and we understand this.

At the same time, we have to continue to focus and reshape our portfolio.

On balance, we have to admit we're pretty excited about Textron's future.

We now have the strategy, a set of more rigorous business processes, and the organizational talent in place to deliver superior shareholder value well into the future.

Ted?

Thank you Lewis.

Good morning, everyone.

Thanks for being here with us.

I'm going to start with a review of our results and, then, Doug and I will walk you through our outlook for the balance of the year.

In April, we indicated to you that earnings per share for the second quarter would come in between 68 and 78 cents.

Obviously, we ended up exceeding the high end of that range and that was primarily due to 3 factors.

First, and most important, we delivered better than expected cost performance across most of our businesses.

Second, we had better performance, as Lewis eluded at Textron Financial.

And finally, we had better than expected volumes at Bell, including a portion of the Pakistan 412s, which at our customers' request, we expedited forward from the third quarter.

That pull-forward impact added about 5 cents to the quarter, but doesn't increase our expectations for the full year, it's just a timing issue on when those 412s are delivered.

Now let's move to the year-over-year performance.

Earnings of 87 cents were higher than a year ago by 11 cents, in spite of the fact that unfavorable volume and mix cost us 15 cents a share and virtually all of that was from lower jet deliveries at Cessna and lower V-22 revenues at Bell.

Inflation contributed negative 28 cents, that's about 2.4%, and we lost a penny for other miscellaneous items, including discontinued operations.

On the positive side, cost improvements had the greatest impact on our earnings during the quarter and contributed 40 cents.

We also generated 9 cents from favorable pricing, that's about a 7/10 of a percent price increase, and most of that was at Cessna.

And finally, another 6 cents came from improved performance at Textron Financial.

Let me go through those again quickly, start with the negatives: 15 cents volume and mix; 28 cents inflation; and a penny in miscellaneous.

On the positive side: 40 cents from cost savings; 9 cents from pricing; and 6 cents from TFC.

Now let me walk through each of the businesses, starting with Bell.

Bell segment revenues were down $29 million, while profit was up 15 million.

U.S.

Government revenues were down due to lower revenue on the V-22 program, that's about $54 million.

And that was partially offset by higher revenue on the H-1 upgrade program and higher sales of air-launched weapons.

And commercial revenues were up due to higher helicopter unit volume and higher volume in the aircraft engine business, offset by lower sales of the Huey II retrofit kits.

Segment profit was up in spite of lower sales, due to improved cost performance and a favorable resolution of warranty issue in the commercial business.

And backlog at Bell ended the quarter at 2.5 billion, that's up 1.1 billion from the first quarter, primarily due to new orders for the V-22, the Pakistani 412 order and an overall improvement in our commercial order rate.

At Cessna, revenues were down 75 million and profit was down 22.

The decline in revenues was largely the result of delivering fewer used aircraft, fewer business jets and fewer single-engine aircraft.

Profits at Cessna decreased primarily due to the lower jet volume, but were helped by improved cost performance, a little bit higher pricing and the absence of used aircraft valuation adjustments that we experienced last year.

As Lewis mentioned, we acquired an additional 25% interest in CitationShares, which requires us to consolidate CitationShares results going forward.

Because the transaction closed on June 30, that consolidation had no impact on Cessna's second quarter profit; however, the second half of the year we expect Cessna's reported revenues will be about 75 million higher as a result.

And the impact of picking up the additional 25% in CitationShares operating results is not expected to have a material impact on either Cessna's NOT [ph] or Textron's earnings per share.

Finally, consolidation requires that we no longer include Citation's orders in our reported backlog.

Accordingly, backlog at the end of the second quarter was 4.8 billion, representing only orders from unaffiliated customers.

That's up from 4.3 billion at the end of the first quarter.

In addition, at the end of the second quarter, Cessna had orders from CitationShares which total 416 million.

Next, let's go to Fastening Systems, where revenues were up 47 million and profit was up 3 million.

The increase in revenues was the result of foreign exchange, as well as higher volumes.

Profit was up due to improved cost performance, higher sales volume, and FX, but was partially offset by inflation.

One of the components of inflation during the quarter, again, was rising steel prices.

As you may recall in the first quarter, this cost us about $4 million, that's the gap between increased costs and what we're able to recover in the marketplace.

While we took actions to recover the higher steel cost, prices continued to move on us during the second quarter, peeking on July 1, at $350 a ton for nonferrous scrap, compared to 295 just back in March.

Bottom line, even though we recovered 5 million through price actions during the quarter, we ended up with another net $4 million hit.

We now have yet another round of pricing negotiations underway with our customers, and depending on the success of those negotiations and how soon we can complete them, we hope to reduce our net exposure to steel prices during the second half of the year.

But there's still risk here with respect to further increases in our cost and the success of our negotiations.

Industrial segment revenues increased by 79 million, and profits were up 21 million.

The increase in revenues was primarily due to higher sales volume at Kautex, E-Z-GO and Greenlee and also driven by foreign exchange.

The increase in profit was largely due to improved cost performance, lower fair market value adjustments for used golf cart inventory, improved credit performance and higher pricing.

Profit increased despite higher warranty cost at Kautex of about $4 million, as well as operating issues we continue to experience at our plant at Windsor, Ontario, that cost us roughly $9 million during the quarter.

We're disappointed with the pace of our progress in resolving this issue, and it obviously will be a significant challenge that we need to address during the rest of the year.

Finally, let me turn to Finance, segment revenues there decreased 5 million, but the profit was up 13 million.

The decrease in revenues was primarily due to lower average Finance receivables reflecting the liquidation of our non-core assets which are actually well ahead of our plan.

The increase in profit reflected a lower provision for loan losses, an improvement in our net interest margin, partially offset by higher operating expenses.

The decrease in the provision for loan losses was driven by an improvement in portfolio performance, as well as the lower average receivable balance.

The stats on portfolio performance are as follows: Non-performing assets came in at 2.5% compared to 2.9 at the end of the first quarter, that actually hits our year-end goal for the year and is quite a strong performance. 60-day delinquencies came in at 2.3%, down from 2.4.

And charge-offs on an annualized bases stood at 1.7% and that's down from 2.1% last year.

Now, our progress for transformation is also reflected in a significant improvement in cash flow at Textron.

Year-to-date free cash flow before restructuring came in at $360 million compared to $91 million last year.

Our focus on improving margins, reducing working capital, implementing lean business processes and improving ROIC are all contributing to a strong performance this year.

One of our key elements of transformation has also been our restructuring program and it's been very, very successful.

During this quarter, we did identify the opportunity for some additional salaried headcount reductions, and as a result, we've decided to increase the amount of forecasted restructuring expense somewhere in the range of 5 to 10 cents a share, and that will obviously result in driving additional savings from this program that will largely show up next year.

We continue to be completely on track to finish this restructuring program by December 31st of this year and any future restructuring expense will be considered just a part of our normal business operations going forward.

Now, moving to our outlook, we expect full-year earnings per share now to be between $3.10 and $3.25.

Reflecting the slightly higher jet deliveries out of Cessna and our improved cost performance in most of our businesses.

We expect third quarter earnings per share will be between 70 and 80 cents.

And finally, we are raising our full-year target for free cash flow to between 500 and $550 million reflecting our better operating performance and some improvements in working capital management.

Now I'm going to turn the call back over to Doug.

Thank you, Ted.

I have some additional outlook items, and I'll start with the operating level.

We're now targeting a total manufacturing revenue increase of a little bit more than 4% and that should bring a total manufacturing margins up about 80 basis points.

Moving to the segments, at Cessna, assuming that we continue to make progress in reducing costs and meet our delivery schedule, we would expect revenues will be up a little over 6% and we actually have a good shot at achieving a full-year NOT margin of about 10%.

We expect to deliver about 50 jets in the third quarter and the balance in the fourth quarter.

Moving on to the overall Bell segment, we're expecting a revenue decline of between 2 and 3% for the year with up to a 40 basis point improvement in overall margins.

At Fastening Systems, we're projecting the revenues will be up at least 10%, and we expect margins to improve at least 80 basis points with that big pick up in the -- pick up in the fourth quarter as the restructuring winds down during the third quarter in large part.

We expect Industrial revenues will be up around 5 to 6% with margins up about 100 basis points.

And then rounding out with Textron Financial revenues will be down slightly with a 20 to $25 million improvement in operating profit.

Finally, we're targeting corporate expenses at about $145 million.

That concludes our prepared remarks.

Before we take your questions, I would like to remind members of the media that they are in a listen-only mode.

If any of the media have questions, please feel free to give us a call after the teleconference.

Operator, we are now ready for questions.

Thank you.

Ladies and gentlemen, if you would like to ask a question, please depress star then 1 on your touch-tone phone.

You will hear a tone indicating you have been placed in queue, and you may withdraw yourself from this queue by depressing the pound key.

We do take a question from the line of Jack Kelly from Goldman Sachs.

Please go ahead.

Good morning.

Hi, Jack.

Just 2 questions.

One in terms of incremental margins in the Industrial area, they picked up very sharply in the second quarter, it looks like incremental margin was maybe 30% versus half of that in the first quarter.

So I guess the question is, Ted, is that a sustainable number as you look ahead over the next quarter.

I realize it's not sustainable for a long period of time, because the leverage begins to peak out, but is that something that you think is sustainable, you know, for the balance of the year?

Yeah, I think, it depends on the mix, obviously, within the industrial businesses.

And in the second half of the year we'll probably see, you know, less of a growth rate at Kautex compared to some of the other businesses, that might moderate it a little, bit but that's a pretty good average.

Okay.

And then, secondly, in terms of the number you were giving on the impact of inflation and then kind of the offset to that, the pick-up on pricing, so the inflation number was a minus 28 cents, pricing was 9 cents and you mentioned that was a 70 basis point increase.

You know, putting aside the steel situation, which looks like, you know, you have it in hand, can we expect going forward that pricing number or that 9 cents to be -- that equivalent 9 cents to be more of an offset to the inflation number?

And again, this is beyond steel, it's just kind of the, you know, the basic cost versus price equation as you look across your businesses.

Is it getting easy to get price increases?

It's never easy, but I think it's getting on the margin a little bit easier to get price in a number of our businesses.

The commodity run-ups have made that possible in a couple of our businesses.

Fasteners is the place where there has been the biggest gap because there's been the biggest impact, so we have a little bit of a lag effect, you know, we're still trying to get the little bit of retro pricing for some of the steel impacts that we saw in the earlier 2 quarters.

You know, I think we've really been the leader in this industry and going out and demanding that we get paid for these increased steel prices, and I think by and large, we're having some success.

But it's a, you know, it's a slow process, there's some lag in getting it done, but I think across many of our businesses we're seeing improvements.

In the used aircraft area where we've been seeing a big negative adjustments in prior years, we actually had a little bit of the pick up in the quarter.

Same was true with golf cars, where last year and the year before we were taking mark to market adjustments and having to mark down used golf cars, we actually had a small profit in used golf car sales in the second quarter, so on the margin it's getting a little bit easier.

Final question.

On Cessna, the swing in terms of losses on sales, you mentioned that as a -- on used aircraft sales I should say, what was the swing year-over-year in that, Ted?

About 8.

Is that right?

8 or 9, yeah.

Yeah, it was about $8 million, Jack, from a slight gain this year versus a breakdown last year for a net-net of about 8 positive.

Thanks.

And we have a question from the line of Dan Wang from Lehman Brothers.

Please go ahead.

Morning, Dan.

Morning.

Hey, Dan.

How are you?

Good.

I just wanted to start off with a question on Cessna.

You know, you noted that you had 72 net-new orders during the quarter, I think that was a slight pick up from the 70 net-new orders in the first quarter, it sounds like you're pretty optimistic and confident about this whole business jet market.

Any comments on the potential net-new order trends going forward into the third and fourth quarters?

Well, here's how I see that.

First of all we did have a stronger than we thought second quarter order rate, that's for sure when you book 72 and ship 36, that's good news no matter what you're producing.

You know, since we're sold out in -- here's how I see it.

We're sold out in '04, practically speaking, we have 2 or 3 more to go, so that's just about behind us.

Now, when you think what the duty roster says at Cessna, we've got to fill out '05 now, and we're pretty much sold out on our 2 new planes, the Sovereign and CJ3, you add those 2 together, each shipping approximately 40 next year, that's 80.

So that's 80 out of the 230, so, I'm counting 225, I'm kind of thinking that, you know, order rates will probably moderate a little bit because we finished '04, so I would say that I would be happy with, probably 50 a quarter would be pretty heart strong.

That's kind of how I see it, maybe a little more.

It's a good market out there, you have to -- with all of the factors I gave you, it's coming back the way we thought it would once the corporate profitability and economy got better.

And it will clearly be that the issue with aircraft orders is they're not going to just be a linear trend, because we really are selling available slots.

And as we get into the second half of this year and we'll start to sell out the available remaining slots for '05, then you have to start trying to convince someone to give you a deposit for an airplane they're not going to get until '06 or '07.

Now we probably will see order intake rate moderate, so what's really important to us is the coverage rate, the fact that we're sitting at somewhere around 160 '05 orders right now against a production plan, again I want to caution, we have not set 225 as a production plan that's just our best guess right now.

So where we're sitting, we don't need a huge number of orders here in the second half of the year to fill that out.

Obviously, we'd like to start working on '06, but that becomes a little more challenging.

Right.

In terms of the order mix, was there any, you know, significant shift toward the higher, you know, priced models in the second quarter versus the first, you know, were end markets kind of strained?

I don't think so.

I don't think anything noticeable.

We're really are literally selling what we have -- what we're making at this point in time.

We have got so many planes available on the schedule, particularly in this quarter as it came to filling out the balance of '04, we don't have every product available in the balance of '04, so we really are filling out the orders around what our production schedule looks like.

Okay.

And you talked about better pricing at Cessna.

Was that around certain models?

Or any additional details on that would be great.

No.

Mostly that's been around reducing sales allowances, which are percentage allowance that go across the whole product line.

Right.

Okay, great.

Moving over to Fastening Systems, you talked about the expenses that you're incurring currently in shifting the production of the plants.

Do you know how much of that was incurred during the quarter and how that might spend out third and fourth quarters?

I mean I guess it goes away in the fourth quarter.

Yeah, well, let me give you perspective on that because this is a huge quarter in the third quarter at Fasteners and getting an exact number is kind of challenging, but, you know, it's a number in the double digits, it's a $10 million plus kind of number.

What's going on right now in Fasteners, we have 3 plants in North America, in the Midwest that are all still running but on the way down and will be shuttered by the end of this quarter.

At the same time, where most of that is going into a new facility in Greenville, Mississippi, we already have almost 200 out of a planned -- little over 200 employment contingent hired, in there, training and working and absorbing all of that expense.

We also have the same situation going on in Europe, we're taking down 1 plant in Germany and 1 plant in the U.K., they're still operating, as well as we're gearing up in Wuchi, in China in order to take a lot of that production, so there's a lot of duplication going on there as well.

All of that comes to conclusion by the end of this quarter or within a few days right after the end of this quarter.

And it's having a significant impact on the performance of Fasteners as we go through the second quarter and as we go through the third quarter.

It wouldn't be fair to say that we're just going to be humming like a top.

I don't think in Q4, but a lot of that is going to be behind us and then we're really going to be into the mode of working to optimize the new footprint that we've built after those businesses have been -- those plants have been shuttered.

So we'll see, I think, some significant improvement come in Q4, but I don't think it will be fully up to run rate in Q4.

Okay, great.

My final question is regarding the improving free cash flow trends that you're seeing.

You know, you talked about the working capital improvement, and how much additional opportunity do you have to improve on that, you know, working capital, free cash flow, and any thoughts on where you might use that, you know, free cash flow, as well as the strong cash balance position you're building?

Well, I think we have a lot of opportunity over the next several years to continue to mine cash off of our balance sheet.

We have really embraced, as a part of our Six Sigma process, lean manufacturing and we got a major effort going on around many of our businesses and, frankly, we believe that we have inventories that are too high in a number of our businesses, and with the best processes and the best practices we can continue to take some off the balance sheet.

You know, this year, if you look at the targets we put out there for free cash flow, you know, just round numbers, that's going to require us to take somewhere between $50 and $100 million off the balance sheet in order to hit that range of free cash flow for the year and I think that we could continue to do that for a few years in the future.

Obviously, you can't, forever, continue to generate cash flow in excess of your net income, but I think we have the opportunity to do that for a while going forward.

One of the things to add there, I think that's important, we've used this phrase that ROIC is going to be our compass for guiding us on the cost improvement, and people have often asked me, well, have you really gotten people's attention on this?

Well, in the past, we probably had 80 -- the top 80 people in the Company had their compensation pretty closely tied to improvement in ROIC, that number is now over 1,000 people who receive annual incentive compensation are directly affected by return on invested capital, they'll make more money as ROIC improves, and makes less if it doesn't, and that is a motivating factor, obviously you get what you pay for.

So I would be darn disappointed if we don't see ever-improving cash flow numbers well into the future.

We got a lot more to go there.

All right.

And I guess, any details on potential use of that?

The free cash flow cash balance?

We get asked that a lot, and I guess an overall statement would be, you know, the combination of opportunities, which obviously, is acquisitions or share repurchases or dividend increases, is something that as a management team you have to look at all of the time and you do what's best for long term shareholder value.

That's statement number 1.

Statement number 2, is people ask us about acquisition all of the time and we've come back and said, over and over that, you know, our main focus right now is improving what we have, that's number 1.

The more improvement we put in place, the better we'll be when we do add acquisitions.

We are trying to take meaningful steps, although they're pretty small right now in adding into aftermarket for Bell, for example, I was glad to see us pick up that other 25% for CitationShares, that's a good move.

If we had a big opportunity at Cessna like Golf Stream we'd take it, but that's not going to be up for grabs.

There's nothing big in helicopters.

We've been trying to find a good move in tools, but there's nothing really on the horizon there that I know of.

Systems would be something we'd like to add to, but actually we're seeing so much organic growth with that ASV that there's really not the urgency to do that, either.

So that boils it down to, you know, you're not going to buy your debt down, so you've got to come up with some approach that maximizes value, which will probably a combination of shares and however we decide to use the rest of the money.

Great, thank you very much.

Yeah.

And we have a question from Jeff Sprague from Smith Barney.

Please go ahead.

Hi, thanks.

Just a couple of things.

First, could you size the warranty adjustment that impacted Bell's margins?

Yeah.

We really had 2 warranty items that hit the business during the course of the second quarter.

Favorable one at Bell, which was about $6 million that related to a problem we had with engines on one of our aircraft last year and we set up a reserve for warranty when the problem occurred, and during the second quarter this year, the engine supplier agreed that they were responsible and they were going to take care of it, so we did not need that reserve any longer.

And then we had about $4 million going the other way, at Kautex that related to some warranty issues with both -- Toyota was the large one and a smaller one with Mazda, so net-net about $2 million favorable.

And kind of on Kautex and auto in general as it touches Kautex and Fasteners.

Could you give us a little bit of a view of what you see playing out in production schedules, but, maybe, more importantly, we can all kind of watch production schedules.

Can you give us any color on what you see going on with your penetration rates or kind of key models you're coming on to or maybe even dropping off of that we need to keep an eye for?

I don't have the model-specific info or I would give it to you, because it's certainly not something we're trying to hide.

I'll make a couple of comments here.

It's going to come across a little bit like you're bragging, but it's just a matter of fact.

We brought Kautex into our Company in 1997, their they're one of the strongest operating companies we have, a tremendously strong operating process in every one of their facilities worldwide.

And they also have proven that they have a kind of a unique ability to predict good selling models and have been unusually fortunate to be on the right models, both transplants and domestic, and they have a 3-pronged strategy of driving technology, focusing on penetrating all of the specific OEMs, no matter where they are, and, then, also, getting a meaningful presence in each one of the big markets and the last of which is the major push their making right now into China, for example.

Now that being said, I don't recall the number exactly, but I know for sure that we have increased our market share relative to the competition every year since 1997.

So we have been very strong at doing that, and I think it's because we have demonstrated an ability to produce product at the volumes, rates, and quality levels that our customers demand, and also we've been able to add innovation in there, which always drives for the customer always wanting to come back for the next new model.

So Kautex is by and large -- there's no comparison to how strong it is versus its competition.

I don't think there's another competitor out there that comes even close.

I was also pleased, and Ted mentioned this, I was pleased that we were able to pass price along, Fastening Systems into the big auto supplier, auto OEMs, because they're tough customers, but they realize that we have superior products and that we are producing products for them that they really need.

And so that kind of surprised us, positively, saying that we had more market presence than we thought.

Now, if you stand back and say, what's going to happen to North American auto build rates?

Which is the big question, we're a little less bullish on the third and fourth quarter, as I said, because anybody that picks up the paper sees that the inventories are a little high right now, but that can moderate, because days outstanding is a factor of how many are out there and what you're seeing in the showroom everyday.

So if showroom traffic picks up, days outstanding gets fixed pretty quick.

So a little early to tell on what's going to happen for the balance of the year, but I think it's probably going to cool off a little bit.

It's safe to say that our current guidance reflects our conservatism with regard to what we think may happen in the second half.

One last one around the issue of cost.

You made a comment, I think it was directed to Fasteners, but maybe it was a general comment that you'd have less pressure from steel in the second half.

Were you referring to kind of less pressure in the form of you've got more price or are you actually looking for steel to decline?

Let me -- yeah, let me try to help.

This has been an interesting 6 months, certainly been an interesting if you're a steel supplier and I think they've had a lot of fun.

Not so much fun for the rest of us.

But, when we went in this thing and had the run-up in the first quarter, all of the primary steel suppliers were putting through scrap surcharges that were pretty much moving with what was happening in the scrap market.

And they held their base prices fairly constant.

Then what happened, late in the second quarter, as we went into the June time period in particular, the scrap prices started to moderate when it looked like, you know, the Chinese were kind of cooling down a little bit on what they were going to do.

The scrap prices started to come down, the steel companies felt they're in such a strong position that while the surcharges they were charging the customers came down, they went in and put dollar for dollar base price increases in, so that effectively, there was no reduction when the scrap market started to come down in the June time frame.

Unfortunately, the deal we had gone out and negotiated with our customers was a pass through of whatever happened on the surcharge base, and we'd gotten a number of them to agree to that and thought that sort of innoculated us to what might happen with price levels, but as they raised their base prices, unfortunately, that put us having to go back in to our customers again and say, no, we need to be a mechanism to pass on the entirety of any change in the prices, and that's what we're working on negotiating with them right now.

Then, we came into July, and we saw the scrap prices turn right back around and soar back up again to roughly 350 a ton for nonferrous, which, we've never seen before.

And so I guess right now our plan is to pretty much -- that we're going to stay at that kind of a level through the balance of the year.

Right now, at Fasteners, we're looking at about $45 million of unfavorable cost increases over what our plan was for this year, and an expectation that we're going to recover somewhere between 30 and 35 million of that through these pricing actions during the course of the year.

So it's a big deal.

But, we don't think it's going to go necessarily much higher than this, we're trying to negotiate pricing structures with our customer so that we're innoculated if it does.

But we're still in the middle of those discussions.

How about aluminum as we think about [inaudible] volume ramping up?

We've seen some.

Commodities have been all over the place, when you get through to what really impacts Textron, it's really been bar steel that we use for Fasteners, but it's been in flat steel as well, we've seen it at Jacobsen and E-Z-GO, Jacobsen in particular has had a very well -- done a very good job of being able to price that through to their customers.

We are seeing a little bit in aluminum.

It's not a big number to Textron, but E-Z-GO is screaming bloody murder over batteries because of lead prices going through the roof.

So we're seeing it in a bunch of other areas, but when it's all said and done, total steel, net of what we were able to get back in pricing for all of Textron for the first 6 months has hurt us for $11 million and 8 of that was at Fasteners.

So the rest of the Company we've been able to pretty well get it covered.

Thanks a lot.

Okay.

Operator, we may want to make one more call for questions if there are any out there.

Certainly.

Ladies and gentlemen, please press star 1 if do you have a question.

And if we have no further questions pending, we can conclude the call, operator.

So, unless a call is coming in, if you want to read the replay information, thank you to everybody for joining us today.

We actually do have a follow-up from Jeff Sprague.

Okay.

Go ahead, sir.

Thanks.

I passed because I figured you had a queue to deal with.

So let me just ask you a couple more if I could.

Go ahead.

Go for it.

Can you give us, you know, just run down through the segments and give us kind of the organic and FX affect on the revenues?

Sure.

For the quarter, let's see, this is organic growth excluding foreign exchange.

Bell was down about 5%, Cessna's down about 13%.

There's no FX really in any of those numbers, so you could actually get that right off the sheet.

Fasteners big FX impact, so excluding FX, Fasteners was up 5.3%, and the Industrial businesses also had a meaningful FX impact and without it, we're up about 7%.

And how does that roll up to the manufacturing -- total manufacturing on Textron, then?

Down right at 1%.

And could I also ask, just on CitationShares, so that -- we should think of that business as a $150 million in annual sales business with just kind of marginal profitability?

You should think of that business as being bigger than that next year.

The growth rates are pretty strong at CitationShares and as we bring Vector in, you know, north of 200 million of revenues next year.

And, yeah, probably pretty close to break-even.

And just as a -- just as a business strategy, is that how you look at running that business, close to break-even, it's more about kind of building the farm team, if you will?

For the --

No.

No.

Nope.

There's no business that I can think of we want to own that we only run it break-even.

Full-stop-period.

We just spent a day down there with those guys and there's an advantage of coming into an industry after others have come in because you get to copy everything that everybody has done right and you get to avoid everything that somebody has done wrong, so I'm going to be very disappointed if we don't start seeing and getting ourselves in the black, even if just a little bit next year and even stronger thereafter.

This business should be a contributor to profit for us.

It does a lot of good things, obviously, because when we finally book the sales of CitationShares into their customer base, we get to ring the bell for Textron, but I would be surprised if we don't create a very good business there.

Obviously, our partner TAG Aviation agrees with us, because they would only sell us 25% so they wanted to stay in this game for an obvious reason, they plan to make some money out of it.

And just one final one for me on Cessna.

It doesn't appear people were overly fixated on this bonus depreciation, I mean you got good orders on the other side of the expiration of that --

Yep.

But just with the passage of another quarter, did you have kind of a clearer view on what impact it has had on the orders, if any?

Well, it has had impact, but it's impact is zero now because basically, there's no more opportunity there and that bill by the way that could extend it is sitting, with the right kind of language, going into committee to get reconciled for a possible vote when Congress comes back.

Too early to tell whether that vote will be positive, because it's not the only thing in the bill.

But if that would be positive that would be another good thing for us, but quite frankly, we're kind of assuming nothing is going to happen there.

But, you don't have any impact in the order rate that I know of based on this.

Right.

Thanks a lot.

Yep.

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