達信公司 (TXT) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Textron's third quarter earnings call.

At this time, all participants are in listen-only mode.

Later, we will conduct question-and-answer sessions.

(OPERATOR INSTRUCTIONS).

As a reminder, today's conference is being recorded.

I would now like to turn the conference over to Vice President of Investor Relations, Mr.

Doug Wilburne.

Please go ahead.

Thank you, Ryan.

And good morning everyone.

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

Our discussion today will include remarks about future estimates and expectations.

These forward-looking statements are subject to various risk factors, which are detailed in our SEC filings and also in today's press release.

Before we begin, I would like to remind everybody that a package containing key data that we'll be covering on our call today is available on the IR section of our website.

Now moving to our results: Revenues were 3.3 billion, up 15% from a year ago.

Year-to-date manufacturing cash flow from Continuing Operations was 654 million with free cash flow up 432 million.

Earnings per share from Continuing Operations were $0.95, up 40% from a year ago and $0.20 higher than the midpoint of our guidance.

I would like to point out that the third quarter earnings included one significant timing item that had been planned for the fourth quarter which was a gain from a land sale in our industrial segment worth about $0.06 per share.

We also had a one-time gain which hadn't been in our guidance for the quarter or the year, worth about $0.05 per share, which related to an insurance settlement.

With that, I'll turn the call over to Lewis.

Thank you, Doug, and good morning everyone.

We had another very strong quarter as our 40% growth in earnings during the quarter reflected not only strong organic revenue growth but also continuing improvement in operational execution.

And we foresee continued positive operating results again in the fourth quarter and have increased our earnings and cash flow estimates accordingly.

As we continue to emphasize, the Company remains committed to value creation through a balanced strategy of investing and growth and returning cash to our shareholders.

At the beginning of October, the Company paid shareholders a $0.23 per share dividend reflecting the 19% increase in the annual dividend rate approved by our board during the third quarter.

We continue to invest in new products and capabilities for you future growth through R&D, capital expenditures and select strategic acquisitions.

Most recently, we announced our intent to acquire United Industrial Corporation, which as operates through its subsidiary AAI Corporation, and on Tuesday we launched our formal tender offer.

AAI is a very successful defense contractor with a strong well-respected management team focused on providing unmanned aircraft and ground control systems and a variety of other aerospace and defense product and services.

This acquisition will add substantially to our position in the precision engagement arena at Textron systems.

AAI also operates a helicopter engine maintenance repair and overhaul business which will nicely augment our one billion dollar aftermarket operation at Bell Helicopter So, in short, we're excited about AAI because it will make both Bell Helicopter and Textron systems strategically stronger and create significant opportunities to contribute to future growth and shareholder value.

Our strategy to invest in organic growth was also quite evident again during the quarter.

For example, industrial revenues grow by---grew by nearly 12%, led by double-digit expansion at Greenlee, Fluid and Power and Kautex while Golf and Turf were down slightly due to the sale of our commercial grounds care business last year.

We also kept pace on the execution front at Industrial with profits, excluding the land sale Doug mentioned, coming in on track with our expectations.

At Textron financial we weathered the less friendly capital markets that developed this summer and maintained excellent credit quality within our portfolio.

In fact, recent credit market disruptions are providing some growth opportunities in certain segments as weaker competitors are either unable or unwilling to follow through on loan commitments.

Okay, let me move to Bell Helicopter where we continue to focus on improving operational execution.

So far this year, we delivered 123 commercial helicopters, and that's up 17% from a year ago.

And we have seen better production flow resulting in improved delivery performance.

Now, while driving operational excellence is a priority at Bell, we haven't lost focus on our---on servicing our customers.

Far from it.

For example, in August, we received the number one rating for customer support in Aviation International News magazine's annual survey.

This is actually the second year in which AIN has conducted a helicopter service rating, and it's the second year we were the top pick.

Couple that with our thirteenth consecutive number one ranking in Pro Pilot Survey earlier this year: that says for sure we continue to lead in this important category of the helicopter business.

We're also making excellent progress on the development of the 429, our new advanced technology light twin engine helicopter.

A number of you saw the second prototype 429 on a flight test during a recent analyst briefing at our Mary Bell facility.

We have now completed over 300 flight test hours, and we're on track to begin commercial deliveries by the end of the next year.

But listen to this next piece about the 429.

We introduced the 429 at HAI in 2005, and it had an introductory price back then of 3.9 million.

We now have 240 customer purchase agreements worth $1 billion.

And we expect these orders to post to backlog after first flight of a regular production aircraft sometime around mid-next year.

With this very strong customer demand, 429 production is booked well into the next decade and new orders come with a 2007 index price of 4.9 million.

Our original business case assumed a total life cycle forecast of about 350 aircraft.

But based on this robu---the robust initial orders and the current market environment, we now forecast total demand to be 700; double our original estimate.

Okay, let's move to military front.

We're also making steady progress on our three major programs.

We delivered two additional H-1's during the quarter and should deliver the remaining three units from Lot 1 this year as well as begin delivery of the units in Lot 2.

We're working toward Phase II op eval for H-1 which is scheduled to begin early in 2008 and therefore we expect a full rate production decision by the end of next year.

On the ARH, we continue to make steady progress with the SSD program.

During the quarter, we reached an agreement with our customer under which we recovered 13 million of unreimbursed SDD costs, which we incurred primarily in 2006.

We're also making progress on replanning the ARH production program with the U.S.

Army.

But, in the meantime, we're setting up the initial production which we expect to begin next year.

Moving to V22.

The program continues to progress on plan.

During the quarter, we delivered aircraft number 86, representing our 11th delivery this year.

And the Air Force version of the Osprey, the CV22, has just begun its operational test and readiness review.

Looking forward, we're working with our suppliers to prepare for ramping deliveries to 36 units per year by 2011.

By then we expect V22 revenues will have grown to 1.3 billion from less than 700 million this year.

As I'm sure most of on this call, the Marines have placed the Osprey into service in Iraq.

We're confident in the unique capabilities of this revolutionary air aircraft and we're fully supporting our customer to ensure an effective, successful deployment.

Wrapping up with Cessna.

Excellent execution continues as deliveries and margins in the quarter were both slightly ahead of our expectations.

We delivered 103 Citations during the quarter, a 41% increase from a year ago.

That included 15 Mustangs, bringing year-to-date delivers to this new class of business yet to 25.

We remain on track to deliver a total of 44 units of Mustangs this year, on our way to a full production target of 150 annual deliveries by 2009.

By the way, the order pace on the Mustang has picked up as we anticipated it would after we commenced initial deliveries.

Year-to-date, we have booked 153 Mustang orders, already a year's worth of full rate production, by the way, bringing the Mustang backlog to 386 units.

This is in spite of the fact that the earliest available delivery slot for a new order is now well into 2010.

The rest of our Citation product line is also experiencing a very healthy and growing global demand environment.

During the quarter we booked 205 total orders across the product line, bringing us to 609 orders year-to-date, surpassing any previous full year record with still a quarter to go.

And the further good news is that we already have a head start on fourth quarter earnings coming out in September's MBAA.

Let me explain.

We signed purchase agreements at MBAA for 101 jets.

Only 57 of the 101 were finalized by the end of the quarter.

We expect to include the remaining 44 in our fourth quarter order results.

And let me point out that this comes during a year when we did not introduce any new models, which historically generates a flurry of new orders.

We tend to focus on business jets when we talk about Cessna, but we're also seeing strong demand in our propeller product lines.

For example, demand for our Caravan line has taken off as well.

Year to date, we've taken over 170 orders which compares to this year's production schedule of only 84.

Obviously, we're planning to step up production rates on the Caravan going forward to service this surge in demand.

Earlier I was deliberate in using the term "global" to describe the market for business jets because demand outside the U.S.

has dramatically expanded over the past several years.

Fully, 51% of this year's orders have been from outside the U.S., reflecting this increased international demand, most notably from Europe.

I would also point out that during the quarter we received an order for four jets for delivery to customers into India and another order for six jets for customers in Japan.

Both of these countries have extremely low jet penetration with significant potential upside.

So, we expect international demand will further contribute to market expansion which is a noteworthy factor in our expectations for continued overall growth at Cessna.

As we announced last quarter, we plan to deliver 470 jets next year, up from 380 this year and while we have not set final production schedules for '09 we're expecting another significant increase in deliveries in addition to 50 more Mustangs over the 100 planned for '08.

Keep in mind that the entire 2000 May production schedule is sold out, so our sales team is now focusing finishing 2009 and continuing to fill 2010 slots and beyond.

In summary, our strategy of investing in organic growth is driving demand across our Enterprise.

In fact, combined backlog at Cessna and Bell Helicopter has hit another all time record high of more than 15.5 billion.

And this number excludes the one billion of order interest in the Bell 429.

I am very bullish on our Company as we move to complete another solid year of delivering solid earnings growth and outstanding total shareholder returns.

And you should note that momentum on both the top and bottom lines, coupled with the growth opportunities afforded by our recent strategic acquisitions are perfectly in line with our overall transformation strategy.

We remain confident that we will achieve our long-term outlook of 7% to 10% annual organic revenue growth, and with recent value-grading acquisitions we should be able to do even better.

You can be sure that we fully intend to leverage this revenue expansion into strong double-digit earnings growth and as a result, I would predict that our shareholders will continue to benefit significantly as far out as we can see.

Ted, take it from here.

Thanks, Lewis.

Good morning everyone.

Thanks for being with us.

Our 40% increase in earnings per share on a revenue increase of 15% represents a pretty good conversion.

So, let's start with an examination with what drove this result.

Earnings were up $0.27 a share from a year ago.

Higher pricing of about 2.7% contributed $0.21 a share, which more than offset inflation at about 2.9% which cost us $0.18.

Volume and mix provided $0.16, strong cost performance contributed $0.12.

The gain on the property sale at Industrial contributed $0.06.

And the insurance settlement was worth ($0.05.) The headwinds of engineering, R&D, depreciation and pension expense collectively cost $0.08.

Taxes were up $0.05 on a year-over-year basis, and miscellaneous items including interest and corporate expenses reduced earnings by $0.02 a share.

Now let's move to the major drivers in each of our business segments, and I'll start with Cessna.

Revenues at Cessna increased 218 million, due to higher volume, primarily related to delivering 30 more jets this year and higher pricing.

Segment profit increased 60 million, due to the higher pricing and the impact of higher volume.

Those items were partially offset by inflation and increased product development expenses.

Cessna's backlog increased to 11.9 billion, up 1.5 billion from the end of the second quarter, reflecting continued strong demand in the global marketplace.

Moving to Bell, segment revenues increased 121 million in the third quarter, while segment profit increased 34 million.

U.S.

government revenues were up 108 due to higher volume and the benefit from acquisitions.

The volume increase is due to higher V22, H-1, Intelligent Battlefields Systems, and Armored Security Vehicle volumes.

Those items were partially offset by lower volumes of joint direct attack munitions and helicopter spares and services.

Third quarter profit in our U.S.

government business increased 24 million, primarily due to favorable performance which was partially offset by inflation.

The improved performance reflected the impact of a recovery recorded during the quarter for previously unreimbursed ARH SDD costs incurred primarily in 2006, charges recorded last year related to the H-1 program and, favorable ASV performance which resulted in a positive program adjustment that we recorded in the quarter.

Commercial revenues increased 13 million, due to higher pricing and the benefit from acquisitions, partially offset by an unfavorable mix of helicopters and lower spares and service revenues.

In the third quarter, commercial profit increased 10 million due to higher pricing, which was partially offset by inflation.

Backlog at Bell Helicopter reached 3.65 billion, an increase of about 40 million from the end of the second quarter.

Now for industrial.

Segment revenues increased 85 million, due to higher volume, favorable foreign exchange, and higher pricing.

Profit in the industrial segment increased 18 million, due to a gain on the sale of the land, higher volume and pricing, and improved cost performance, partially offset by inflation.

I would like to point out that the land sale gain contributed 15 million to segment profit, but also $0.06 to earnings per share, reflecting that the transaction did not generate any income taxes because of other tax losses in the jurisdiction in which the sale occurred.

Lastly, finance segment revenues were up 2 million, reflecting higher securitization and other fee income and higher average finance receivables.

These increases were largely offset by the impact of a transaction in 2006, associated with a leverage lease asset as well as market pricing pressures.

Profit in the finance segment increased $1 million due to an increase in securitization and other fee income, and a decrease in the provision for losses, partially offset by the impact of the 2006 leverage lease transaction and higher operating expenses.

The decrease in provision for losses is primarily attributable to lower growth in the receivable portfolio during the third quarter of '07.

Portfolio quality continues to be very good, as non performing assets were 1.37%, and 60 day plus delinquencies were 1.07%.

The delinquency rate is higher this quarter versus last quarter, reflecting three specific accounts in the Golf Finance business.

Net chargeoffs as a percentage of average finance receivables remained very low, at 0.38% for the first nine months of '07 as compared to 0.37% for the corresponding period last year.

Let me take a moment to talk about the recent financial market turmoil, because it really had a very minimal impact on our ability to access capital markets at either TFC or the corporate level.

Fortunately, we took advantage of very attractive credit markets during the first half of the year and reduced our commercial paper balances significantly as we head into August.

With only a billion or so in CP outstanding, we were able to very comfortably refinance our maturing obligations.

During the most stressful periods we did see the market for commercial paper contract to issuances of a week or less; however, since September, we have returned to more customary commercial paper trades at spreads within normal ranges.

There is one lingering issue, however.

The normal spread between LIBOR, upon which we base most of our borrowing costs and the prime rate upon which the majority of your customers' loans are indexed has narrowed.

That puts some pressure on our net interest margin.

We expect that this anomaly will resolve itself since historically it always has.

It's usually been within 30 days.

It's taking a little longer this time.

But, in the meantime we have factored continuing margin pressure throughout the fourth quarter into our TFC earnings targets.

On the share repurchase front, during the quarter we bought 1.3 million shares at a cost of about 76 million.

Now for our updated outlook.

For the full year, we're now forecasting EPS from continuing ops in a range of $3.40 to $3.50, up about $0.22 from our previous estimate.

In addition, we're now anticipating free cash flow to be in the range of 600 to 650 million for the year, and that's up about 50 million from our prior estimate.

In closing, we continue to deliver very strong financial and operational performance which allows us to further increase our near term expectations and gives us ever-increasing confidence in our long-term outlook.

And this reinforces our ongoing commitment to invest in new products, additional markets, and enhance capabilities for our talented people.

All of which should lead to continued revenue growth, sustained financial and operational performance, and expansion in shareholder value.

And now I would like to throw it back to Doug and he'll give you some additional color on our outlook.

Thank you, Ted.

Let's start with Bell.

For the fourth quarter we're forecasting segment revenue of about $980 million, with a margin of about 8%.

The sequential reduction in margin reflects higher H-1 revenues at no profit, higher ER&D spending in the fourth quarter and lower ASV volumes.

At Cessna we're expecting about 115 fourth quarter jet deliveries to drive revenues of about 1.5 billion with margins of about 16.75%.

Relative to the third quarter, margins in the fourth quarter reflect an unfavorable sales mix including higher used aircraft, international deliveries, Mustang sales and revenues from Citation shares.

It also includes the -- reflects the third quarter benefit from the insurance settlement that fell into the Cessna segment.

The fourth quarter also will see an increase in product development expenses and higher IP expenses for SAP.

Moving to Industrial.

Revenues are projected to be about 850 million into this quarter, with margins of about 5%, down slightly from the previous quarter, primarily as a result of the past quarter's land sale gain.

At Textron Financial we're targeting fourth quarter revenues of approximately 215 million with operating profits of about 47 million.

Other fourth quarter targets include interest expense of 21 million, corporate expense of about 63 million, and a tax rate of about 34% which should bring us in at the lower end of our full year guidance of 31% to 32%.

One final comment.

None of our outlook items include any effect of the acquisition as the impact will be dependent upon the timing of the closing.

With that, operator, we're delighted to take the first question now.

Okay.

(OPERATOR INSTRUCTIONS).

Our first question comes from the line of Nicole Parent with Credit Suisse.

Please go ahead.

Hi, guys.

Hey, Nicole.

Just real quick, I guess, could you elaborate on the Cessna insurance settlement and when we think about the ARA's, I'm not sure, did you quantify it?

Okay.

Let me address the first part.

Then I'll I'll come back to you on the second part.

I wasn't sure what the question was.

The insurance settlement impacted a number of our businesses.

We wound -- this dates back to insurance years that ran from the late '50's the early '90's where we came with an agreement with our insurer to be paid for eliminating their exposure to those years.

Total was about 17 million.

The biggest pieces hit Corporate at about 8 million, Cessna at about 6 million there were small amounts that hit Bell and some of the other industrial businesses.

And now would you repeat the ARH question?

Oh, sure.

On the reim--on the reimbursement from the prior, did you -- quantify it?

$13 million impact to the quarter and it related to certain costs that we incurred under the SDD contract that we had been working with our customer to negotiate reimbursement on.

We had expensed these costs during 2006, and we came to an agreement in the quarter with our customer that those would be reimbursable under the SDD contract.

Okay, super.

And then just one last one.

On the Finance business you cited the delinquencies moving up on the Golf Finance account.

Could you just give us a sense, which businesses within finance had the best performance in the quarter and worst?

Actually, I don't know if I have that here handy.

The delinquencies was really -- we're down to such a low level right now, that it's very lumpy and that entire increase in delinquencies was only three accounts in the Golf business.

And I will try to get -- let's go on and I'll come back to you because I don't have the segment by segment finance data here in front of me.

No worries.

Thank you.

Our next question comes from the line of Cai von Rumohr with Cowen and Company.

Please go ahead.

Yes.

Thanks a lot.

Great quarter, guys.

Thank you, Cai.

Now that 2009 looks at Cessna, looks like it's essentially---demand is not really an issue, how many Citation jets do you feel you could get out?

I mean, what's the production capacity, the capacity to build?

You said you expected higher deliveries.

What could you do?

Well, that's not resolved yet.

We're still -- we'll be meeting with Cessna in about three weeks to go through capital planning and we are having to make some investments in order to expand capacity and we haven't set that number yet.

But clearly, we'll hit the stride on Mustangs at the 150 units, which we already are capacitized for.

And, we're working to break some constraints so that the Wichita based jet production will also go up in 2009 by a reasonable amount.

But it's not nailed down yet.

Okay.

Great.

And switching topics to United Industrial.

You indicated that it's like $0.09 dilutive in 2008.

Can you walk us through how you get to that number?

I mean, a rough sense in terms of what are the intangibles because that must be a large number, so really on a---you mentioned.

It's actually accretive but intangible amortization.

Intangibles -- it would be about $0.03 accretive if it were not for what will be about I think it's 46 million of intangible amortization in the first year and then that goes on for -- let me see if I have that.

I do have that here somewhere.

It's 45 million in '08, 36 million in '09, 29 million in 2010, and then it tails off over about a 10-year period.

But it will start -- we'll have a shot at becoming accretive in the '09, '10 time frame with that amortization schedule, but on a cash basis it's positive from 2008 as it would be accretive if we didn't have the non cash intangible amortization.

Great, and last---just a quick last one.

It looks like it's pretty expensive at 11.5 times.

Can you walk us through, are there any, because of the large intangible, any 338, H-10 election tax benefits and what's the MPV of those?

Well, obviously when you roll all of the attributes together of this acquisition, we believe the IRR is nicely positive on an EVA basis versus our cost to capital.

But this is a little bit of a back end loaded deal because while we will get some cost synergies up front, it's a lot of top line synergy that's coming from this business that's really putting AAI together with systems on the precision engagement, future combat systems, intelligent battlefield, et cetera, where we think we can win more business and putting the (mac turbin) business together with the Bell performance based logistics where we think all of the real juice comes.

So this one does take a little longer to pan out and get the returns than at acquisitions that have a lot of up front cost synergies but we feel very, very good about our ability to win in the marketplace with this combination.

Thank you very much.

Our next question comes from the line of Jeff Sprague with Citi--pardon me, Citigroup.

Go ahead.

Hey, Jeff.

Thank you.

Good morning everyone.

Good morning.

Good morning.

Could we start first maybe with a question, a big picture capital allocation and the portfolio: UIC obviously does look like a great fit for systems.

Lewis, but one of your mantras has been portfolio simplification.

So you made one of your children stronger here --

Simple.

Yes.

(laughter)

I'm wondering about the stepchildren, how you feel about --

Yes.

What am I going to do with those.

I wish you wouldn't use terms like that.

(laughter)

My term.

My term.

Use whatever term you like.

Well, we've -- I can't be too specific here in fairness to some of the things we're doing that we're just not going to talk about yet.

Let me say a couple things.

First of all, we still are focusing on making any additions to select businesses that make sense, which would be Textron Systems, Bell, Cessna and primarily Greenlee and, of course, TFC would be a normal--a normal receivables play that we do every year and I wouldn't expect any big acquisition there.

Secondly, we're not just focused on trying to turn on the acquisition engine.

So don't take that signal that way.

Third, we do have a commitment to continue to improve the -- I'll call it the quality of our portfolio, as measured by financial strength of each business unit and also the attractiveness of the industry they're in.

I think you could probably guess those business units that are under the most pressure.

And, it's been kind of a hallmark of ours, but we usually approach this in a very paced, measured way.

We're not in a fire sale mode.

We're not going to have any trouble with this acquisition, bringing it into our Balance Sheet, for example.

I think there's not much difference now than before except we now have this opportunity we have to meld inside our Company.

And I would predict that we'll continue to do what we've been doing over the last four, five years.

I mean, I know you can't get too specific but since it seems that everybody knows who the suspects are without naming them, what is it that -- what's the gating factor?

I mean, credit markets have changed obviously so maybe the buy side of the equation doesn't look at interesting.

Was there some internal focus on improved returns or something before you would consider---?

The gated factor is all around maximizing intrinsic value and it's around having a plan for every one of our business that's creates the most value for our shareholders and not going into too much public detail about those.

I'll drop it there.

This is obviously I think very encouraging, this ARH development swinging the other way.

You can say that again.

I guess the question would be is -- obviously there was a lot of talk this year of eating dollars on your own dime to kind of keep the program alive and such and I just wonder what kind of opportunities you have for some of these costs that you absorbed in '07, given that you pointed this was kind of an '06 issue.

Is there any opportunity for some of this '07 stuff to come back your way as we move forward?

To say is there any opportunity, you'd have to say yes.

But we test that number really seriously all the way up through our audit committee to make sure it's the right number.

And right now we think it's literally the right number.

Way back 10, 20 years ago it used to be you could be a little conservative.

You really can't even be conservative in these numbers.

You have to put down the number you thing is the right number.

Could we beat it?

We could.

Will we?

I don't know.

I think the thing that you can derive from our speech today is that although we're not out of the woods yet, anybody that heard Dick Millman up in (Meribell), he's pretty doggone confident on what he sees.

I've been here for 15 years.

Everything doesn't always turn out the way you want.

It does look like the three big programs are beginning to be well understood and the costs are being managed and we're kind of working through the issues and the more organized, understood way and I think that's what I would take away.

I think the team at Bell has done -- we put a lot of resources down there.

The team at Bell has done a really good job and they continue to do a good job.

Could we do better?

I hope so but I wouldn't guarantee it.

There was some talk out of Washington of a possible multi-year on ARH.

Is there -- is that just at this point just talk or is there some forward momentum around that?

I'm not familiar with that.

B-22 is multi-year, but I haven't heard of the ARH---

That's premature.

We're still working on the basic redefinition of the program on ARH with the customer right now and that conversation will come up and obviously our customers would like multi-years on all these programs if we can work that out.

We're not having any conversations yet on that.

On ARH, you probably wouldn't, Jeff, because a multi-year traditionally is a firm, fixed price commitment with sometimes some escalators like an EPA clause, et cetera but for the most part the supplier, that'd be us, we really have to understand your costs and we don't -- neither the customer nor ourselves on the ARH understand total cost because we don't even have the total configuration complete yet.

We're all the way up to lot -- I guess 11.

What's the first lot?

For the multi-year?

Before the V22?

What lot number, do you remember?

Is it 11.

Sounds about right.

I'm not sure.

I think it's Lot 11 or 12.

We're looking at doing a multi-year on V22.

We produced almost 90 aircraft so we understand the cost picture better.

We have to commit to a cost for three years' worth of production aircraft.

And you have to know what you're doing there.

If you beat the cost picture then you get to book more profit.

If you don't then you don't book as much profit.

Traditionally, you have you to be more of a steady state before you see a multi-year.

All right, and just one last one from me.

Looks like you took five commercial helicopters out of the schedule for '07.

I mean, I guess apparently the demand is clearly there.

So is that just a scheduling debottlenecking issue in the plant or is there something else going on there?

That's our latest best estimate of what's going to actually ship this year.

Clearly, it's not a demand issue.

It's where we think we're going to get out the door.

Thanks a lot.

Our next question comes from the line of Shannon O'Callaghan with Lehman Brothers.

Please go ahead.

Hello, Shannon.

Good morning, guys.

Good morning.

Just on the Bell margin, first half of the year after the charges, margins were pretty high and you guys had mentioned that Dick had since---he was early on in the role had maybe held back some spending, and so that was going to ramp into second half which it looks like it has.

Can you quantify that a little bit more and maybe also qualitatively is that what's going on as Dick has gotten more comfortable.

We have continued to push spending.

I think on the one hand, we've cut some SG&A that's just going to stay cut to a large extent.

But there are a number of things where new management wanted to just reassess and those dollars have been pushed further out into the year.

And at this point, he's pretty adamant that as he's gotten his hands around things, he does want to start spending them.

So we'll see the pace at which that happens.

But that's clearly reflected in our current guidance.

Okay.

And any particular areas that is or is it kind of across the board at Bell?

It's all over the place.

It's in all the overhead accounts, largely.

But product is probably the biggest piece.

Okay.

And then on Cessna, I mean, can you maybe just calibrate us a little bit.

We had 282 orders last quarter, now we've had another 205 since then.

Sold out for several years here.

What's your expectation?

How should we thing about that?

Obviously those are some pretty enormous numbers which are hard to imagine continuing at that rate.

We have not expected it to continue at that rate.

It just particularly MBAA I think just kind of blew us all away.

We didn't -- we're not going to be able to continue at this two-to-one book-to-build kind of number indefinitely.

But customers are accepting that they've got to get in line sooner and we're out and about, trying to sell 2010 right now.

But it's going to have to -- the absolute order intake rate has got to slow down at some point in time but of course we've been saying that for a year.

A couple things I would add to that.

One is I wouldn't expect us to have a weak fourth quarter for example.

We're already at 44, will be under our belt as soon as we finalize the rest of MBAA.

Our guys are still selling hard.

So we ought to add more orders and deliveries in the fourth quarter, I would hope.

I tell you I do think that international piece is a wild card where that tends to be nothing but positive.

I think we're probably -- we probably don't think about--talk about it as much, but remember, our customers tend to step up and buy a Cessna more likely than that.

I think that's like seven out of ten or something.

When we get that Mustang out there, and people start flying around in that little bird, it doesn't take long before they aspire to be in a little bit bigger bird and we know that seven out of ten are going to come our way.

So I said three years ago when we talked about Mustang that one of the secret weapons of Mustang is it brings a whole fleet of people into our product line that already know us and are familiar with us.

If you notice, the Caravan big order take this year at MBAA--- don't miss the fact that's got that (Garmon) 1000 avionics package which also is in the Mustang which also is in single engine, which also is flowing into the rest of your product line.

Once you learn how to fly on a Cessna, you're darn tempted if you want a bigger one, a bigger jet to fly---to keep, stay in the Cessna strategy.

It's a well-thought out strategy thought out by Jack and (Dave Brandt) as Chief Engineer.

I'm not -- we are not going to be too easy on them on orders, I'll tell you that.

All right.

Yes.

I agree.

It's a nice model.

And last one, just on the free cash flow, I mean, that was a little stronger I thought in the quarter.

Anything particular there?

Is it some of the deposits on the planes or what are you getting?

Yes, I would say a large portion of our ability to increase the forecast this year has clearly been stronger customer deposits, partially offset by inventory and a little receivables, but mainly inventory, to get ready for the growth that continues to happen in the business.

So it's -- it was a good third quarter.

Clearly, one of the strongest ones we've had in a long time.

But no one thing or one receipt or anything of that nature.

Okay.

All right, great.

Thanks a lot.

Our next question comes from the line of Richard Safran with Goldman Sachs.

Please go ahead.

Good morning.

Just two quick questions, first is, if I did my math right, looks like your days inventory has been going up sequentially quarter-over-quarter.

I get 91 in first, 98 in second quarter, 103 in third.

I want to know if you could tell me what was driving that.

Aircraft deliveries.

Growth.

(laughter)

What's driving that is you're using historic deliveries or revenues to derive your days inventory.

Almost all of that growth is coming at Cessna and to a lesser extent at Bell.

But it's really gearing up for the sequential ramp in aircraft deliveries and you really do have to look forward instead of backwards to calculate that.

Okay.

And then just second thing is on your year-over-year causal analysis, just comparing in second quarter the contribution from price was $0.44 and now that's $0.21 in the third quarter.

And then the volume mix contribution was $0.22 versus $0.16.

I think you got share split.

I think that's what it is.

It's just strictly having to do -- there's been no real --

It was a good, strong quarter.

Okay.

Okay.

So it was just strictly --

Fewer shares outstanding, yes.

Okay.

That's it.

Thanks along lot.

Rich, you're not the first one to get a little confused on the share counts.

We do too.

The whole audience, keep in mind, we did do a share split.

I knew about the share split.

I wanted to make sure that was the only thing that was causing it.

Right.

Thanks a lot.

Our next question comes from the line of Ronald Epstein with Merrill Lynch.

Please go ahead.

Good morning, guys.

Hey, Ron.

Good morning, Ron.

So Louis, when we think about Cessna is doing great, right?

We think about the balance between the decision you have to make in terms of R&D investment and trying to optimize, maximize your EBIT margins, how should we think about that?

Another way to ask this question is kind of going forward, where can we think about Cessna margins getting to---realistically, knowing that you're going to continue to do new product development?

When you made that Cessna statement, did you comprehend large cabin or not?

Well, how about with and without?

Yes.

Well, if you didn't do large cabin, I would say you could probably expect margins to increase at a lower pace than they've increased.

I don't think you would see it hit -- I guess it would be -- my big number might be 18 to 19, maybe.

But truthfully, I'm not really game for that, because what I would like to see is strong, steady increase in net operating profit year after year after year and the way you do that is continue to develop new products so that you have a really fresh product line.

We were -- the outstanding thing about the order year this year is not only is the number bigger than we've ever seen since Q3 total is bigger than any year we've ever seen.

We've got another quarter to go, but we didn't put any new products out there.

So you can expect -- we have never turned down a capital request for Cessna and I wouldn't expect we would.

And, of course, that also drives engineering spending.

What are they Ted, 5.6% of sales?

Yes.

5.6, 5.7, 5.8, somewhere in there.

I think the answer is margins about where they are on a lot bigger top line is what excites us most.

I remember looking at another--I almost used the name--but another competitor some time ago.

If you cut way back on -- if you cut back 2% on engineering spending, you'll get 2% more margins.

It goes right there.

Unless you throw it away someplace else.

And I for one would not be in favor of that.

I think we ought to maintain somewhere between 16 to 17, maybe a little higher if we could get there.

We're never going to let up on Jack.

And he doesn't -- he doesn't need me to tell him that.

He's a great manager.

One thing we haven't seen, and I don't think it will be for a couple years yet, but we really have not seen the effect of the lean work that we're doing.

We talked about that.

But we're probably 20% done on lean at Cessna.

We're not 80% done.

I don't think any of us know how to think about that.

I really don't.

It's just too new in our world.

It could be the wild card that makes our numbers look fantastic.

It's just a little bit too early to tell.

But that would be a year or two out.

Okay.

And what do you guys see in the supply chain, I mean with all the demand across all aviation end markets?

How is your supply chain doing, both in the airplane space and in the helicopter space?

Tight.

Straining on the edges.

We haven't missed any yet.

So we haven't -- we're not -- we have to manage it very closely but we're pretty good at that.

Our volumes are so high that we kind of get first pick on a lot of folks' production rates, but not all.

I would say this, though.

That the helicopter business and the fixed wing business on the military side is under a lot of pressure because of precious metals.

Those things are getting real expensive.

Titanium castings, a lot of them, precious metal pressure.

And that is going to be with us for some time.

That's an industry problem that we've got to all work on together.

So far it's not affecting any of our production rates, nor our future production plans.

Is that an effective curve though to how high you could go?

Pardon.

Say it again.

Is that an effective curve how high you could take rates, I mean what the chain can sustain?

It's a pacing factor.

We have to develop the supply base to bring them along.

I would tell you, though, right now the biggest constraints at Cessna are parts we make, not parts we buy.

And we're having to address that with capital.

See, way back on this, how many can you make.

Guys, we could make hundreds more a year if we set our mind to do it.

Just give us time to capitalize.

But I said this so many times.

The production rate is the cumulative effect of looking at each one of the long-term forecast delivery rates for each model.

So the more models you make, you have to cue up the ramp up, the steady state volume and then the taper off volume and then you do a block point change and you try and pick that back up.

And so when you ask us a supplier to increase rates it doesn't work very well to say give me 40% more next year and then the following year, I don't need that any so you can cut back, because they've got investment in the ground that they're going to try--want to earn a return on.

So it's to everybody's benefit to increase production at a paced rate that is predictable and sustainable over a long period of time, and that's what we like doing.

We like to just pick it up X percent each year and keep on going.

We try to do it not to lose share.

We've been pretty good at balancing that out.

Just one last detail question for Ted if I may.

On the insurance settlement, the details you gave Nicole, the 6 million for Cessna, was that actually reflected in their operating margin in the quarter?

Yes.

Okay, great, thank you.

Our next question comes from the line of Robert Stallard with Banc of America.

Please go ahead.

Good morning.

Good morning.

First of all, I was wondering if you could update us on the situation with ASD, your updated views on the outlook there given the constant evolution of the (MRAP) program.

No, we're kind of -- we're in a pretty steady state right now.

We're in the budget at about 48 a month, run rate.

This year was a little odd.

Because we built really strong in the first half, trying to demonstrate capability to our customer and to position ourselves potentially for (MRAP), which was a path we didn't go down.

We have a year this year which is very front end loaded and a very weak quarter in the fourth quarter.

I think our sales in the fourth quarter will be half of what they were in Q1.

But as we go into '08, '09 and we're in the budget really most of the way through 2010, we're going to be on average at about that 48 a month level.

There's some other opportunities but we're not banking on any of those other upside opportunities right now.

I think you said in the past you may have potential sub contracting roles in some of the (MRAP) models.

Do you think that is still a realistic chance?

We're talking to a number of folks about that but nothing has developed yet.

Secondly, on the large cabin aircraft, can you give us an update on when you expect to announce something on that plane?

And if you did go ahead with it in 2008, what impact that might have on R&D.

Sometime in the first quarter.

And I'll give you a number if you just promise not to hold me to it.

But I know you won't do that.

But -- because it's moving around.

It depends on when we pass gate three on the first design stage and when we kind of go into kickoff gear.

But best guess right now, $80 million, $85 million next year.

Just finally, I think Doug mentioned in Q4 that you have higher international shipments and those are actually margin dilutive.

Can you explain why that might be?

Can I explain why it's margin dilutive?

It's margin dilutive in the short term because we do pay higher commissions to our sales reps for deliveries in international markets but we also have a lot less fixed cost as a result.

So I don't think it's -- it's not an inherently less profitable business model, but on an incremental basis, when we see spikes up and changes in the mix of international as we're paying those higher levels of commissions in a particular quarter, so it's dilutive to margin.

That's great.

Thank you.

Our next question comes from the line of David Bleustein with UBS.

Please go ahead.

Good morning.

Quick question, just following up on that one.

At what point -- how weak does the dollar have to get or where in the future is the cross over point where you're capturing enough price to offset the incremental cost of shipping overseas?

Well, again, I'm not sure that there is an incremental cost per se.

It's just on a change in mix in any particular quarter.

We do have lower fixed costs because of the model that we use in some of these regions where we just don't have enough volume to have a direct selling model in place.

We sell all of our product in dollars right now to all customers.

So exchange rate is really a competitiveness issue as opposed to a pricing issue.

We don't charge a customer over there a different price, per se.

Next question.

When are you shipping enough to Europe to change over to a higher fixed cost internal sales model and what kind of capital expenditures would you need in order to set up service centers and so on and so forth?

How should we think about your international expansion?

We will ultimately get to the point of putting some additional service capacity in, although right now that's being provided by our independent reps.

It's a long way I think for us going to the U.S.

direct sales model in any one region.

While international is half the business, it's spread out over dozens and dozens of countries, versus the model in the U.S.

today.

So.

Long time.

I don't think we'll see a change.

Relative to that 80 to 85 million of large cabin next year, which we're not holding you to, what was the comparable figure this year?

20-ish.

Terrific.

Thanks a bunch.

The last question we have in queue comes from the line of Steve Tusa with JP Morgan.

Please go ahead.

Good morning.

Good morning.

Just on the Bell margin, you're talking about I guess now it's kind of a net $60 million headwind this year.

Is there anything from the (air raids) charge, is there anything unusual about next year, I mean, should we -- when we're thinking about the moving parts of next year, is that something we should count on as kind of an ongoing headwind or is there something else that happens next year or next year is it more of a clean year, is the Bell operating profit basically selling at a higher base by that $60 million?

First of all, don't forget the nearly $30 million Katrina recovery that's also in those Bell margins this year.

The real answer is about 30 million.

Okay.

In the great world, those things shouldn't repeat and that ought to be some lift for next year but at the same time, don't forget we have several of these programs that are at kind of break-even phases early in their life, particularly the H-1 and the ARH.

It's possible that we have some additional charges going forward as those things get into a more mature state like the V22.

We're not counting on them.

The way the accounting works, when you're at that break-even on one of these programs, any change in future estimates for the life of the program get booked in the quarter where you make those change in estimates.

So it's always possible.

Right.

Okay.

Even ex Katrina, the kind of clean margin at Bell is 9.5 this year, right?

Around?

[inaudible - overlapping speakers] We haven't given guidance for next year yet.

When we do, just to follow up on what Ted was saying, we're going to anticipate some bumps in the road as we've been saying all along.

We've seen execution improve.

When you're operating at break-even, the smallest little thing will show up.

I know this is frustrating for you guys.

But we also will probably see growth in revenues in some of those zero profit programs next year.

So that---that can swing the margins all over the place.

Well, these results aren't that frustrating.

(laughter) But anyway, on the R&D on the Cessna side.

I think in your 10K you've given year-over-year increases in sales as well as R&D.

It appears to me that if you're spending around 6% of sales, that R&D number has been going up about in line with sales over the last couple years.

Is that correct?

Yes, I think it's -- the percent has probably stayed within 40 or 50 basis points.

You're really not milking the R&D in leveraging that R&D.

When I look at your several programs that are coming into action here, going out of R&D into production, whether it's the Mustang, the Encore Plus, the XLS Plus, the CJ4 getting to a kind of a more normalized run rate of R&D and the fact that you didn't really introduce a new plane at MBAA this year, which means you have a gap there as far as ramping up a new model, I mean, is everybody getting a little bit woofed up about the impact the LBC could have on the bottom line?

Is there more room in the R&D budget, given you haven't really been leveraging it to begin with to cover some of this spend?

That's a hard question to answer right now.

We sit down in two weeks to start our annual operating planning process, and we'll be having all those discussions with Cessna.

But I think the answer is, we have been able to grow revenues fast enough so that that R&D percent has stayed in a fairly constant range.

That being said that doesn't mean you can take the revenue growth and apply contribution and think earnings ought to go up by that amount.

That math doesn't work if R&D is growing at a steady rate and keeping in the percent.

I don't think it's going to blow us out of the water.

I guess what I'm saying is, this would just seem more manageable to me in the context of the existing R&D budget than maybe some are making it out to be.

We have never said it wouldn't be completely manageable.

At the same time, we don't want people to not recognize that it is an $85 million swing decision on 2008 and we feel obligated to have everyone know that that's out there.

I don't think we've ever said it's not manageable.

Okay.

Great.

Thanks.

Thank you very much for joining us and we'll talk to you again in a quarter.

Have a good day.

Take care.

Bye now.

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