達信公司 (TXT) 2008 Q2 法說會逐字稿

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

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

Later there'll be an opportunity for your questions.

OPERATOR INSTRUCTIONS)

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

Please go ahead.

Thanks, Lea, and good morning everyone.

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

Before we begin, I'd like to mention 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 annual SEC filings and also in today's press release.

Finally, you can also find a slide deck containing key data items from today's call in the IR section of our website.

Revenues in the quarter were $3.9 billion, up 21% from a year ago.

Earnings per share from continuing operations were $1.03, up 21% from $0.85 in last year's second quarter.

Relative to our updated guidance which specified a range of $0.93 to $0.98 cents, the factors that contributed to the $0.05 cents performance above that range were two additional jet deliveries and stronger performance at Cessna and AAI.

Free cash flow through the first six months was $220 million compared to $145 million in '07.

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

Thank you, Doug.

Good morning, everybody.

You know, even in the midst of prevailing economic weakness and challenges in our Finance segment, we achieved another solid overall result this quarter, and we continue to build backlog for our future, which is also important.

Before I dive into the details, I'd like to go back and review what our initial economic assumptions were coming into 2008.

I'd say our world has changed a bit, huh?

I want to update you now on how we're thinking about the balance of the year and beyond.

In January, back then we were expecting modest world economic growth with commodity prices remaining at what was perceived to be, back then, pretty high levels.

In the United States, credit and housing issues were expected to result in a mild downturn with soft corporate profits, at least mid year.

Well, as we all know, since we first discussed our outlook, oil has been up by over $50 per barrel versus end of your last year, and other commodities are up significantly as well.

This is having a direct impact on us through increased costs, particularly in our Industrial segment.

Higher commodity costs have also further stressed the U.S.

and global economies.

Nonetheless, strong performance in our aircraft and defense businesses, the size and resiliency of our backlog, and actions we're taking give us the confidence to maintain our overall outlook for the rest of the year and beyond.

A key point.

So let's take a closer look at what's going on in each of our businesses and what we think it says about our future.

I'll start with TFC where we encountered a number of late quarter developments.

Before I do that, I'd like to revisit what I said on our call in April when we discussed the risks around TFC and its forecast.

What I said was, we believe our risk at TFC is manageable and strength and opportunities in the rest of our enterprise would substantially offset this risk.

That's exactly what happened.

Many of you also participated in our TFC investor meeting and webcast in April.

There we provided an indepth review of the portfolio and our processes to manage the risk.

We did this so you would have a better appreciation of our assets knowing that we were in a difficult credit environment.

Then in May and June, the continued difficulties in the credit environment began to more significantly affect some of our customers.

Accordingly, we conducted a very comprehensive review of our assets and have reduced our outlook for TFC for the rest of the year, reflecting sustained credit challenges.

And by the way, we'll be conducting another investor call on August 6th to provide an indepth look at the TFC portfolio in this tougher environment and to give you the benefit of reviews we've undertaken.

I hope you can all join us.

Let's move now to Industrial where the impact of the economy is somewhat different in each division, but still overall we had nearly 8% organic growth in the quarter.

For example, on the positive side, E-Z-GO sales were up significantly, as our new RXV Golf Car is selling very well and pricing is robust, almost offsetting commodity pressures.

We expect E-Z-GO will continue to have a very good year led by the RXV.

At Jacobsen, we had a pretty good quarter with positive organic growth and improved performance, but we expect softness for the rest of the year.

Demand at Fluid & Power remains very strong largely reflecting strength in the global economy sector--sorry, energy sector, pardon me.

At Greenlee, we saw demand fall off very late in the quarter and expect further weakening through the rest of the year.

However, the strength of new products we're rolling out will offset a large portion of the end-market softness.

That's good news, as well.

Finally at Kautex, there really are three separate stories.

First, non-NAFTA markets are up solidly in Q2 but expect slower growth during the second half..

Number two, in absolute contrast, North American volumes are down substantially and are expected to continue downward.

And then third, and most consequential, is the lag of pass through on commodity cost increases which is significantly pressuring margins.

We're taking appropriate cost actions to react to the volume fall-offs and we're also implementing a pricing strategy to protect us for future commodity exposure which we think will be very successful.

But, frankly, it's going to take several quarters before we see positive results on the second item.

So, at Industrial, we've slightly reduced our second half margin outlook to reflect the tougher commodity environment.

Now moving to Defense and Intelligence.

Organic growth topped 10%.

And we, again, had positive execution on a number of programs.

For example, our AAI acquisition--Doug mentioned this at the start of the call--is tracking ahead of plan.

And, looking down the road, work on new synergistic products offerings looks very promising.

We're also pursuing a number of foreign military UAV opportunities and we're pleased that the recently passed supplemental budget included funding for UAVs as well as armored security vehicles.

This extends further U.S.

government UAV production through early 2011 and ASV production through early 2010.

So we're off to a great start.

We also received a new contract for motor life boats from Mexico with deliveries in 2010.

So the outlook for the D&I remains strong and should be relatively unaffected by the economy.

Now let's move to Bell.

The business outlook is also positive and execution continues to advance.

Obviously, the market expressed concern around last week's announcement that the Army was moving forward with a non-(inaudible) review of the armed reconnaissance helicopter program.

However, we view this as positive news, as this is the next required step to get this program approved for full rate production, and given that the design has been as evolved and is the right design for the war fighter, the cost of the program has necessarily risen as a result.

While there's also the possibility that a program on review can be cancelled, the Army needs this critical capability and we believe we have the best solution from a cost, performance and schedule point of view.

Keep in mind that an examination of alternatives was conducted by the Army last year with ARH and it proved to be the preferred solution.

So we expect the outcome will be the same this time.

We're working with our customer to expedite the review and obtain funding for the first ten production representative units.

.

In the meantime, we continue to work under the SDD contract.

Three prototype aircrafts are already flying and have accumulated nearly 1300 hours of flight testing, and are performing well.

Over on the H-1 program, (inaudible) tests were completed and we expect full rate production approval for the Yankee portion of the program later this year.

The Zulu, on the other hand, has a few fixable technical issues around systems integration of customer provided gear, and we expect to get these resolved quickly and we'll continue with limited rate production and anticipate a full-rate decision for the Zulu next year.

And finally, the V-22 program is performing very well.

We're delivering aircraft consistent with cost targets and actually ahead of schedule.

Actual operation in the theater has been very positive.

The program also received budget approval for eight additional units with deliveries beginning in 2010, providing yet further visibility in the Bell's long-term outlook.

Now let's finish with Cessna where the story remains extremely strong.

And we say this against the backdrop of the current economic environment and its potential impact on order flow, cancellations and pricing.

So let's start with current results and then talk about planned considerations for the future.

I want to remind everyone on the call, though, the last two years we've been managing a fairly aggressive expansion in capacity, importantly, doing so while still improving cost efficiencies.

With two quarters behind us, we believe we're solidly on track to deliver our target of 470 jets this year, up 21% from last year .

Also, on the execution side, our single engine prop acquisition is proceeding quite successfully with integration and revenue synergies going well and restructuring costs running less than planned.

Another good news story.

Moving to the demand front, we booked an additional 35 orders for our new Columbus product in the quarter.

This bring total Columbus orders to 71, an excellent debut for this exciting new high-revenue product.

Including Columbus, we booked a total of 201 orders in the quarter, reflecting strong demand from international markets.

Overall then, we've booked 437 total orders in the first half, most of which are earmarked for delivery in 2010 and beyond.

Including citation shares, that brings our total backlog to 1,638 jets, which is about 3.5 times our current annual production.

The point here is, this backlog gives us complete confidence to raise production next year and we're currently targeting about 535 jets for which we're 95% sold out already.

The question now becomes, where do deliveries go from here in 2010 and 2011?

Obviously the answer is the function of three things--our current backlog, where net order rates go over the next three years, and one's view of global long-term business jet demand.

Let's start with the last factor, long-term demand.

Over the past several years, we've witnessed a growth in international orders, which, in turn, is a result of early stage adoption of business jets in new markets around the world.

We do not believe this phenomenon is temporary.

In fact, we believe international market adoption rates will accelerate in concert with global economic expansion, particularly as the use of business jets continues to become more culturally acceptable, international infrastructures are built out, and sovereign policy barriers are eliminated.

Based on low existing penetration rates, our analysis suggests that global demand will grow to at least 700 Citation deliveries per year within five years.

700.

Obviously the rate of adoption will be impacted by how the world economy evolves, but this level of demand is realistic with only modest assumptions about adoption rates.

Now let me move to the second factor, net order rates which are the result of gross orders minus cancellations.

Given the current economic environment over the next several quarters, we do expect a slowing in orders at Cessna.

We've said that several quarters, by the way--at least comparing to the blistering rates we've seen over the past seven quarters.

Furthermore, with our most popular models not having availability in 2010 or 2011, and in the case of the CJ-4, 2014, one just has to expect order rates to normalize.

However, we still do not believe a severe order downturn will develop, especially when you consider the continued deterioration in the commercial travel experience and the further planned contraction in routes served.

So, as we look at '08 orders, we're very encouraged that we will likely see our original forecast of 570 orders by a significant margin, although we expect second half orders will be less than the first half, obviously, reflecting the initial surge of Columbus orders and the two successful international biz jet shows early in the year.

Looking to '09, we're not expecting a precipitous drop in orders, but we do expect rates will be less than next year's delivery plan based on the lack of availability of open slots, and also probably some softness in the economy.

Beyond that, it's too early to call, as it will depend upon how the global economy develops over the next 18 months.

So now we come to our third factor, and it's one we cannot overemphasize.

And that is the size and resiliency of our current backlog.

At 3.5 times our '08 production, this provides tremendous balance.

As we shared in January, this backlog can be stressed as severely as the last business cycle and we would still need to expand capacity to service the systemic demand that we see in the marketplace for Citations over the next several years.

Yes, sure.

Portions of our backlog are susceptible to normal cancellations or deferrals.

And we'll likely see cancellations.

However, within our backlog there's significant interest among customers to move up in their position and therefore we do not view cancellations as a significant risk to our outlook.

So, in summary, even with the current global economic environment being what it is, we believe we'll have up delivery years in 2009 and again in 2010 and again in 2011.

So let me close by saying we're pleased with our overall progress at Textron so far this year, both in terms of results and in preparing for the future, but from a management perspective, this is not a one-size-fits-all situation.

Some of our businesses are entering a period of contractions where we're responding appropriate, while others are still very much in the growth mode.

In fact, we continue to believe that Textron is somewhat unique in that the largest portion of our business should see sustained growth over the next several years.

Our total aircraft and defense backlog of $23.5 billion, another all time record, gives us visibility and confidence in this outlook.

My final comment is about our recent announcement that Scott Donnelly has joined Textron as our Chief Operating Officer.

You know, talent management is a keystone of our transformation strategy at Textron, and someone of Scott's caliber is a major addition to an already excellent team.

We're extremely pleased that Scott sees the substantial potential at Textron and wants to help shape our future.

I'm sure he will.

With that, I'll turn the call

Thanks, Lewis.

Good morning everyone.

We appreciate you being here with us.

I want to start with a few comments about the economic environment.

We're in an unprecedented territory with the current price of oil and other commodities.

And there appears to be no clear consensus on whether these rates represent some sort of bubble or if this is a new systemic level based on supply and real demand, and, as a result, where prices are going to go from here.

On the other hand, we're also entering a new world era with many emerging economies now consuming our products.

The upshot is that, while we expect some uncertainty for some period of time, plus contraction and demand in some of our markets, we believe our long-term outlook is very positive.

Now let's move onto our analysis of what drove second quarter results.

Earnings per share from continuing opps were up 18 cents from a year-ago.

Volume and mix provided $0.19.

Higher pricing of about 3.2% added $0.29 a share, while inflation, also about 3.2%, cost us $0.23 a share.

Performance across our businesses was a positive $0.19 and acquisitions provided a benefit of $0.01.

Headwinds from engineering, research, development, and depreciation cost $0.12 and Textron Financial was lower by $0.15.

So let's start our normal segment discussion, and this time with Textron Financial.

Revenues at Finance were down $62 million in the second quarter, primarily due to lower market interest rates and a decrease in fee income which reflected last year's $21 million gain from the partial sale of a leveraged lease, offset by about $5 million in higher securitization gains this year.

Revenues were also reduced by the sale in, lease out issue we announced last month.

Profits in the finance segment decreased $55 million due to an increase in the provision for loan losses, the decrease in fee income, again that $21 million gain from last year, on impact of higher borrowing costs relative to various market rate indices, and the silo adjustment.

These reductions in profit were partially offset by a benefit from increased yields on loans with interest floors and a reduction in selling and administrative expenses.

The increase in the provision for loan losses was primarily driven by a reserve established for one account in the gulf finance portfolio and an increase in the overall loan loss provision in our distribution finance portfolio, as general U.S.

economic conditions have continued to impact borrowers in certain industries.

The 60-day plus delinquency percentage increased to 0.61% of finance receivables from 0.33 at the end of the first quarter, but still a very low number.

Nonetheless, non-performing assets increased to 2.31% of total assets from our first quarter level of 1.84%.

Looking forward to the rest of the year at TSC, we've reduced our outlook to incorporate higher credit losses and continued pressure on interest margin.

Based on the composition and quality of our portfolio, we do not believe that Textron Financial represents the level of risk that the markets have seen with other financial companies.

And we look forward to having a more detailed discussion about our view with all of you on August 6th.

In conclusion, we believe our forecast properly reflects the additional stress our finance businesses will experience for the rest of the year.

Moving now to Cessna.

In the second quarter, revenues and profits were up $298 million and $62 million, respectively.

Revenues increased, primarily reflecting the delivery of 117 Citation business jets, compared to 95 last year, and also due to improved pricing.

Profits increased due to the impact from the higher volumes, improved pricing, partially offset by inflation, and increased engineering and product development expense.

Bell revenues were up $102 million, and profits were up $61 million.

Revenues in Bell's US government business increased $97 million due to higher H-1 and V-22 deliveries, and increased spares and service volume.

U.S.

government profits were up $64 million as a result of improved cost performance, largely attributable to the non-recurrence of last year's $48 million charge for the ARH and, of course, contributions from this year's higher volume.

Revenues for Bell's commercial business were up $5 million due to higher pricing and the benefit of newly acquired businesses, partially offset by lower helicopter delivery volumes.

Commercial profits were down $3 million reflecting inflation, unfavorable cost performance, and lower volumes, partially offset by stronger pricing.

Moving to the Defense and Intelligence segment.

Revenues were up $209 million due to the acquisition of AAI and higher volumes in armored security vehicle after-market products, intelligent battlefield systems, joint direct attack munitions, and Lycoming products which were partially offset by lower Sensor Fused weapons.

Profit increased $15 million as a result of the benefit of the AAI acquisition and favorable pricing which were partially offset by unfavorable cost performance and inflation.

Revenues in our Industrial segment increased $137 million, while profits were down $1 million.

Revenues increased primarily due to favorable foreign exchange, some higher volume and higher pricing, and a benefit from acquisitions.

Profit decreased as higher pricing, favorable exchange rates, and improved cost performance were essentially offset by inflation.

Now for our earnings outlook.

For the full year, we are still confident in our EPS forecast of $3.80 to $4 which is unchanged and we're initiating our third quarter earnings forecast at $0.80 to $0.90 a share.

Our projected free cash flow provided by continuing operations forecast remains unchanged at $700 million to $750 million.

Finally, on uses of cash, this year we've made three acquisitions, SkyBOOKS at Bell Helicopter and Telefonix, and most recently Utilux at Greenlee.

And we've also repurchased 3.5 million shares of stock, including 1.9 million late in the second quarter, putting us well ahead of our original full year plan.

We intend to continue making both acquisitions and share repurchases in a manner that we think maximizes value for shareholders.

Now I'm going to turn it to Doug and ask him to give you a little more 2008 modelling information.

All right.

Thank you, Ted.

I'll begin with our third quarter outlook.

At Cessna, we're expecting revenue to be approximately $1.5 billion with margins of about 16.5%.

Our expectation assumes jet deliveries in the range of 120 to 125 for the quarter.

At Bell, we're expecting third quarter revenue of around $570 million with margins of about 8%.

These revenues reflect delivery of two V-22s, two H-1s and somewhere 40 to 45 commercial helicopters.

At D&I we're expecting revenue to be about $545 million with margins of about 9.5%.

This forecast reflects about 150 ASVs.

Industrial revenue is expected to be approximately $900 million with margins 3.5% reflecting normal seasonality at Kautex.

Finance revenues are projected to come in at $175 million, plus or minus, with segment profit at about $30 million.

Now for the full year.

For Cessna, we're expecting still '08 revenues of about $6 billion, but we slightly bumped full year margins to about 17%.

At Bell we're also reconfirming our revenue projection of around $2.6 billion with margins of about 9%.

While this margin is up from our previous full year guidance of 8.5%, when you work through your models, you'll see that second half margins are expected to be down from the first half.

Primary drivers here are positive program adjustments booked in the first half, and higher expected R&D spending in the second.

At D&I we're still on track for revenues of about $2.2 billion, with margins of about 11%, up about 100 basis points from our previous guidance.

D&I margins will also be a bit lower in the second half on a sequential basis due to the non-recurrence of favorable program adjustments.

At Industrial, revenues still expecting about $3.7 billion with lower margin expectation of about 5% now, reflecting the higher commodity costs we spoke about before.

Finally, at our Finance segment, our new outlook is for revenues of about $750 million, and we're pegging profit for the full year now at about $130 million.

We expect interest expense of about $120 million and corporate expenses about $220 million.

Our full year tax rate is expected to be between 32% and 33%.

Finally, on the call with TFC coming up on August 6th, we will be issuing a notice with all the call-in information for that, but you may want to note your calendars that we'll begin that call at 4:00 p.m.

eastern.

In addition to Ted and me, we'll also have Jay Carter president of TFC, Tom Cullen, CFO, and Angelo Butera, Chief Credit Officer at Textron Financial.

With that, that concludes our prepared remarks.

Before we go to questions, I'd like to ask each of you who queue in to please limit yourselves to one question with an optional follow-up.

With that, Lea, we're now ready to open the lines for questions.

Thank you.

(OPERATOR INSTRUCTIONS).

Our first question is from the line of Jeff Sprague from Citi Investment Research.

Please go ahead.

Thanks.

Good morning, everyone.

Hey Jeff.

I guess the fundamentals are what they are, Lewis, but everybody's scratching their head here today, right?

The stock got rattled with this guidance tightened late in the quarter.

You beat that and now we've got Q3 guidance where the margins need to be down year-over-year and sequentially in every business.

It just begs the question of the type of visibility you really have in the business and I guess I'd like a little bit more understanding of why the margins would be down sequentially across the board, Q2 into Q3.

Let me tackle the margin piece specifically and then Lewis can add in if he wants to on the visibility questions.

The largest answer to that is the continued ramp up of R&D development.

That's the primary driver at Bell's business.

When we put Dick in there, he turned down some of the investments for a period of time to make certain that he was comfortable with all the product development programs and where those programs were going and that's starting to come back onstream.

And in the second half versus the first half between I R&D and SG&A, we probably have about a $40 million growth in that investment.

Those are all investments we think are critically important to the future of the business and, you know, are driving the organic growth for many, many years to come.

But there is a bit of a timing factor between the first half and the second half.

On the Cessna side, it's somewhat the same, but it's also compounded with some product mix.

We're ramping up more Mustangs in the second half, more single engine,there's more revenues coming out of Citation shares.

And, perhaps most importantly, we have a much larger used aircraft sales coming through in the second half which essentially have no margins.

So there's nothing going on there with the fundamentals of Cessna's performance, it's really a mix of sales, and then, likewise, engineering development costs for the second half were almost $30 million higher at Cessna than in the first half.

So I would say there's nothing fundamentally different, it's really just the normal ebb and flow of how things get timed through the course of the year.

We pushed hard to get some deliveries out there in the second quarter that could have just as well have happened in the third quarter.

So nothing that's fundamental.

The thing I'd add, Jeff, is--I tried to make this point, maybe I didn't do it as well as I could have, if you think about the beginning of the year.

We've taken guidance up once already this year and the fact that oil is up basically 50%, $50 a barrel, probably a little more than that, and the fact that the global economy is certainly not gotten any better, to say, to make a simple comparison versus year-end of '07, but you know, I think our company has shown great resiliency.

And as I've said a couple times on calls in the past, it's certainly interesting to note, and should give our investors confidence, that so much of our business is very solidly locked into sector growth that doesn't relate to the economy.

You take Bell, you take access Cessna, you take Defense and Intelligence, those businesses are so solidly positioned and you really don't read anything these days that says anybody's got a better position in any of those markets than we do.

So I feel very good about Textron right now and our future, as a matter of fact.

And our backlog, needless to say, is certainly very strong.

I say that with a smile.

I've never felt better about our backlog and that bodes well for our future, as well.

As maybe a side of that confidence, there was some share repurchase in the quarter, but it was this quarter a year-ago that you guys raised the dividend and announced share repurchase.

Why not step it up here in the face of a very weak stock and a lot of uncertainty in the outlook among the investors?

We're being very tactical in that regard and we did step it up very significantly for the period of time we were able to be in the market right at the end of the second quarter.

We're balancing that against the fact that we made certain commitments when we acquired AAI that we would rapidly get the balance sheet back to where it was before the acquisition and we're way ahead of schedule on that.

We've essentially gotten there in two quarters, versus the four quarters that we originally talked to the rating agencies about.

So we've got to balance that.

We have to also balance the fact that there are some liquidity concerns out there in the market.

We have not had any real problems, but we want to be sure we don't have any problems as well.

But I think you can continue to expect us to be very tactical in our execution and we certainly like the stock at the price right now as a buyer

Next we move to the line of Steve Tusa from JPMorgan.

Please go ahead.

Hey Steve.

Hi, good morning.

Good morning.

What's the--could you just maybe talk through what gives you the confidence in your TFC projections, given the volatility we've seen lately, maybe in a little bit more detail, and then we can get more on the August call, but just at a higher level.

We started a--let me just start by saying there's a lot of uncertainty in the markets that are out there.

It would be naive to say otherwise.

We spent the latter part of this quarter, as we started to see some things coming up, doing some very deep dives into some of our businesses, and really all our businesses, and doing it with some independent reviews where we send people from different businesses in to look at other people's businesses as opposed to their own to try to get an unbiased, unvarnished view of what can happen.

We've run a whole series of models and scenarios around rate environments and around potential charge-offs in each of the businesses, potential non-performing assets in each of the businesses.

And we've taken the number down pretty aggressively, and we have taken it down to a number that we think is the most likely case right now.

But I still say that, also, with the confidence that whichever way TFC moves around--and I think we've put the number in at a guidance that's the mid point--the range of guidance for Textron in total is still quite significant, between $3.80 and $4.

We have high confidence that that's what we're going to deliver in the end.

If TFC is a little better or worse, it's not going to take us off that march.

Okay, and maybe could you just walk through a couple of the puts and takes, and quantify them a little bit more on the Bell and D&I side with regard to the margin step down in the second half of the year looking at the volume projections.

It just looks a little bit conservative but you talked about program adjustments.

There's a lot of moving parts.

Maybe could you just step us down, help us step down to that level in the second half?

Well, I think at D&I it's primarily program adjustments.

We did, over the course of the first two quarters, close out the first two original large lots of ASVs and those both closed out with substantial profit pick-ups, as a result of our continuing learning curve performance on that program.

As we move into later lots where we had the benefit of longer history and better estimates, we have some potential--I wouldn't say there's none--to get some additional good news on those lots as they progress.

But right now we're not projecting that we'll have the same big program pick-ups on those that we had in the first half.

And that is the, that's the primary driver.

How much was that in the second quarter?

How much was the ASV pick-up in the second quarter?

Hang on one second, we'll try to find that.

And let me keep going and we'll come back to that.

In Bell, it is primarily, the issue, I think I really already gave the answer to, which is the way that they have chosen to hold down the IR&D that we'd given them as an approval for the year for the first half and some other global development expenses in SG&A.

And those two things are almost exactly $40 million higher in the second half than the first half.

That's the primary driver.

We also had net small pick-ups on program reviews at Bell in the first half that we're not projecting in the second half.

That's not as significant as the ASV pick-ups.

Sorry, what was the ASV pick-up again for the second quarter?

We're still trying to get that number.

Hang on one second.

All right, thanks a lot, and one more question.

The answer is $8 million in the second quarter.

$8 million.

And one more question.

What are the gating factors for the Cessna production target next year?

Is that an inflexible number given the supply constraints?

How much variability do you think is around that number?

If you have a pretty precise number as opposed to a range.

Well, Steve, I think that number is pretty solid.

You know, we continue to work with our suppliers which are the primary gating factors, really.

There's nothing inside our facility that keeps us from producing more aircraft.

As we tried to explain during the call, our conversation before we did the Q&A, we've looked at about every possible way you can stress the backlog, you can create whatever economic situations you want in the U.S.

or outside the U.S.

Our take on seeing increased production in '09, '10 and '11 is very solid.

Second, on next year, there's not very much going to get in our way on that number.

Right now, we don't see anything that's a bottleneck or a gating factor.

I'd be disappointed if we don't beat that a few, but we'll have to see about that.

Our (inaudible) would love us to get a few more than that and we're working hard for them to try to do it, but we have to rely on what commitments we can get out of our supply chain partners.

Okay, thanks.

Next we go to the line of Shannon O'Callaghan from Lehman Brothers.

Please go ahead.

Hi guys.

Hi.

You know, one follow-up on the Cessna production.

You know, Lewis, your comments about expected pace of orders and, obviously, at some point they have to moderate from the pace they've been at, but it sounded like you were viewing that less as the impact of the global economic slow down and more as a function of how little availability you actually have in these jets given your backlog.

So I guess I'm a little surprised you wouldn't really be pushing harder to take production rate up, if you actually think you're going to see an order impact from lack of availability.

Yeah, well I think I've done this on a couple calls, but it's been about a year since I've done it.

Let me tell you how this number rolls up because I've been here since 1992, so I've seen the planning process, so to speak, up front and personal.

We really don't set the total number of jets to produce--let's say 530--we don't really set that number that way.

We take a look at each individual model, we project a five-year run rate, and then we look at, at what point should we announce a block point change or a replacement model for that particular model.

And, some models run for 20 years and some run for 15 and some run for 10.

Gosh, I'm trying to think how long the Citation 10 has been running but it's well over 10 for sure, and probably bordering on 15.

But, my point is, that what 530 is, it's an accumulation of the volume annual deliveries for each one of the individual models.

And, of course we do have pent-up demand.

There's no doubt about that.

We're trying to predict as best we can, how to have sustained increases in volume without up one year, down the next, up one year, down the next.

If you think about it, we've increased our annual production every year since 9/11 at a fairly specific and fairly constant rate.

So Shannon, I have to tell you, could we make more?

Yeah, we probably could stretch the system and make 560.

We could.

But then again, what that does is, then if we had to slow down, we'd have to lay people off and we'd have to move production around -- sorry, employees around based on seniority.

So what we've developed is a model of production that I think is superior to anybody else in the industry.

Our quality is fabulous, our customer satisfaction is super.

Our employee work force is in a great shape morale-wise.

I just don't anticipate us going to 600 and back to 500 one year.

I think we're going to keep this same balance and we're going to try to moderate the lead times in some of our models and we're going to do that the best we can.

But again, staring at what some people think is an uncertain future, to make a statement we're going to increase production in '09, '10 and '11, that's a pretty damn solid statement.

And our customers are happy with us too as evidenced by the order intake we're receiving.

I'll give you another whack at if you want.

Yeah, no, with three and a half times backlog, as you were saying, it seems like there's some room to take it up unless, I mean--you mentioned it's logical to assume some cancellations.

Are you seeing anything on that front incrementally that keeps you cautious or no?

I'll tell you, it's you know, with everything written, I'm going to be real frank with you.

With everything that's been written about this time-I'll be real frank with you--with everything that's been written about the slow down in business jets and the cycles coming at us, we have had two--one, two--cancellations, and both of those have been discussed with customers, two of which said, can you do us a favor?

These are not business failures, these are not guys that have gone bankrupt, they're not businesses that have gone underwater.

These are two good customers of ours.

We decided to move something from year one to year two.

And, by the way, it hasn't affected us a bit because we have people ready to step up to take those jets.

We really only have two this year to date.

Very low number.

This is really more driven by making sure the overall supply change works efficiently and that we can get commitments from our suppliers, as well as internally.

We've broken most of the internal constraints.

We still have some more capital to put in to get to the level that we think we're going to need to be at five years from now.

But in the next year, it's really, what do we think we can get committed from our suppliers and safely and inefficiently build.

When we try to stretch it a little too far we get all kinds of inefficiencies in our system.

Just one more follow-up on the quarterly guidance pattern here.

I understand some of points of first half versus second half, things ramping, but you do have Bell then implied to go back up in margins sequentially in the fourth, and the same with Cessna.

Is there anything in the three Q in particular that makes it hit all, even more in one quarter?

No, they shipped some units in both cases a little bit in the second quarter that had previously been in the third quarter expectations.

So there's a little bit of move there.

But let me step back and say, when you normalize our business, the percent of EPS we have forecasted in this third quarter as a percent of the full year, is dead on our normal performance.

The third quarter's always the challenging quarter for our businesses and if you take over the last decade, what is our normalized earnings in the third quarter as a percent of the year, we're right at it.

Okay thanks a lot

Next we go to the line of Nicole Parent from Credit Suisse.

Please go ahead.

Good morning.

Not to nitpick, but I just want to get a sense of when we look at the guidance by sub segment, obviously for the full year, you got better results at Cessna, Bell, Defense and Intelligence.

You have Industrial and Finance weaker.

When I look at the corporate expense and the interest expense, it looks like in aggregate it's probably going to give you a dime higher relative to your first forecast in the first quarter.

So I'm just wondering how I should think about that.

Is that just your best guess?

Should we expect that to move around?

Or is there potential upside elsewhere or downside that we're not sure of elsewhere?

Let's do both of them.

Interest expense, there's no doubt,, we've got a little more cash in earlier in the year.

We ended up in a better position at year-end last year, and we've had a better performance earlier in the year than what we expected and rates are a little bit better on the CP side of things.

So that's real performance that happening on the interest expense side.

On the corporate expense numbers, unfortunately the way we have to account for our hedge of our stock price, is all of the noise you're seeing.

Our corporate expenses are highly predictable, they're highly stable, quarter-after-quarter-after-quarter.

All that variability you see on the corporate line is offset dollar for dollar on the tax line with virtually no EPS impact.

I apologize for the accounting rules because they sure do make it confusing and difficult for everyone, but there's really nothing on the corporate side that's running through and causing any kind of EPS noise.

It just causes line item noise.

Okay, and with respect to finance, I know we're going to get more in the August 6 call, but could you give us a sense what each of the sub segments did?

Do you have the 10Q from finance yet just to give us a better sense of where we saw--I mean, did distribution finance have a loss in the quarter?

Did golf finance have a loss?

That type of stuff?

I don't have the final details for the queue although we may be able to get it if you give us a second.

Clearly, distribution finance and golf finance were the two that had the most difficulties.

We have businesses like resorts and aviation that are ahead of plan and and doing very very well.

But the big hits were in those two businesses--distribution finance, on account of a homogenous business basis because we did see higher levels of charge-offs and issues arise late in the quarter that are consumer durable related end markets.

That's across a broad range of businesses where the golf business was all the single hit.

The bottom line, yes distribution finance lost $3 million and golf lost $7 million.

Okay, thank you, and one last one.

As we think about margins, I always look at the cost performance number you guys give on the causal analysis.

It looks like it was certainly an acceleration from the first quarter.

As we think about lean implementation, and Six Sigma, maybe Lewis give us your sense of where you think the company is in terms of how much upside is left when you think about cost performance.

I think we have more upside than we've seen so far, really.

We've had a lot of big meetings this first quarter trying to take a look at the progress we've made and where we can improve and what areas we ought to tackle next.

And had a big meeting with over 200-some folks in attendance discussing that topic, and I would expect we have, like I said, more to be gained than we've picked up.

What happens in the factories and offices you gain momentum by having a few successes and a few more and a few more and pretty soon it kind of just becomes a natural part of the DNA, and that's what's starting to take place.

Nicole, I expect us to continue to make big gains in productivity improvement, whether processing an invoice or producing a business jet, for the next decade really.

I'm excited about it.

I'd just add, in spite of what looked like very good numbers there on cost performance over many, many quarters here, that number often includes a lot of investments that we've been making in the future.

So it's held back, to some extent.

Super, thank you.

Yep.

Next to the line of Robert Vallard from Macquarie.

Please go ahead.

Excuse me, Robert Stallard.

I apologize.

That's all right.

Thank you very much.

Good morning.

I have a couple questions about Cessna.

Lewis, you might be the best person for this.

I wonder if you could comment on how US demand is tracked year-to-date for new orders, and how you expect that to progress in the second half?

Yeah, well, U.S.

demand is tracking about where we expected.

And the forward forecast for U.S.

demand stays strong.

International demand is stronger than we would have predicted last year, although we kind of caught up with our forecast early in the year and saw what was happening internationally.

But the mix is pretty solid internationally, in fact more solid than I think anyone predicted.

We're seeing some, oh gosh, I'm going to say probably 70% of the current order book year-to-date being international and about 27% being domestic.

Which is really how we like to see it right now.

And we've got pretty good distribution across Europe, Latin America, Asia, Pacific, just a good balance.

So actually our order mix is flowing just about exactly as we thought it would.

So that's a positive story from my standpoint.

If we look at some of the traditional lead indicators as to where the US market is going, what are you seeing on things like usage, second hand availability, and pricing?

Well, pricing has been fine, except, if you think about it, we're three, we're out two or three years on delivery, so anything you do on price now affects something delivered in 2010, so pricing is whatever it is.

As far as use is concerned, I'd say pretty normalized.

I think it's around between 11% and 12% now, which is where we like to see it.

We have seen no absorbable deterioration in any of our prospective customers' financial situations.

That's good.

No major solvents infractional.

As I said, order cancellations, only two.

Our sales force has come back and said they think our order rate for this year should exceed 570.

That's not a forced number, that's up from the grass roots number kind of.

So, and you're not seeing any big competitor looming out there that's getting ready to take our share away.

So I think the concern over Cessna's future health is--anyone that has a concern like that is probably misplaced.

As far as we can see, every factor we look at is at least neutral, if not positive.

And just finally, if you were to look at the last (inaudible), you mentioned there were some cancellations last time around, what sort of percentage of the backlog do you think is potentially at risk in the worst case scenario?

Would you say that last sentence again?

I missed--did you say what percentage of backlog?

Yeah.

What percent of the backlog do you think is potentially at risk?

Last time we saw two years in a row with about 10% of beginning backlog cancelled within each of those years.

Right.

But again, the bigger impact was order intake falloff rather than cancellations.

That's what happened the last time.

That was the worst down cycle we've seen in general aviation for as long as we've been watching them.

That's great, thank you very much.

Hey Rob, just to clarify, on that basis, in the last down cycle, over a period of three years, we had a total of 170 orders cancelled, and we expect something less than that will occur over the next three years.

Two quarters into it, we've got two.

So I'd say we're tracking pretty well so far.

Okay, thank you.

And next we go to line of David Strauss with UBS.

Please go ahead.

Thanks.

Hey David.

Good morning.

Good morning.

Obviously new order activity at Cessna is still very strong.

What about your service business?

What did it look like in the quarter and what are you thinking for that business moving forward?

You mean Cessna service?

Yes.

It continues to increase year-over-year as far as our revenues and also profits.

We have not seen a slowness that some of the commercial after market people have been talking about, but, and and I'd even circle back to the question that Rob asked because in his question he included usage, and while usage on business jets on a per jet business is down slightly, we've never seen a correlation between usage and jet cycles.

In fact, in the last cycle, usage went up.

Usually when people have the jet, they use it.

They may choose to defer or not fly as many discretionary trips, but but it hasn't provided a real meaningful look.

Service business was up 19.2% versus prior year in the quarter.

Okay, great.

And then you talked about you haven't seen really any cancellations, but are you seeing any more more delivery slots being put up for sale in the market?

Nope.

That's not permitted at Cessna.

Our customers aren't allowed to sell a slot.

Occasionally one will sneak through on us.

And I mean one out of maybe 570 orders so it's kind of a small number.

But that's really an anomaly because we don't allow it.

We have a pretty darn good due diligence process on anybody that places an order.

We just don't take the order and say, "Thank you very much." We know every one of our customers, we know why they're buying the plane, we know what they're selling.

We know a lot about our customer base.

And one last one, Ted, do you know what the total loan loss provision was in the quarter and at TFC and the total charge-offs?

And then what your, what's basically baked into your $130 million forecast for rest of the year?

The total provision in the second quarter was 40 against charge-offs of 19.

So we built reserves of 21.

The year-to-date provision is 67 against charge-offs of 30.

So we built 37 of reserves year-to-date.

Our expectation is a provision number for the full year, somewhere in the 110 to 120 kind of range.

I don't have--I have a full year charge-off rate, but I don't have a full year charge-off dollar.

We'll see if we can find that for you.

Okay, or the rate would be fine.

The full year rate we think is going to go to about 50 basis points, up from about an unbelievable 25 the last couple years.

Okay, great.

thanks, guys.

And next we go to the line of Harry Nourse from Bank of America.

Please go ahead.

Good morning.

Good morning.

I was wondering whether you could--just quickly going back to Defense and Intelligence--if you had $8 million of benefit, that means your margin was just north of 11% in the quarter.

It's going to go down to about 9.5% for the rest of the year.

Can you just explain a bit further why it's going to go down?

Oh...

No I'm not sure I can right now.

I think $8 million was just the ASV.

I see, okay.

And we just reduced expectations.

As you roll the pricing forward on the basis of your past performance, then you have a lower target margin in the program going forward.

Yep, that's right.

Okay, and on Industrial, can you just give a bit more detail on the cost growth?

Perhaps give an idea of how much of your operating costs oil now takes up.

Well, I've got, I know the year-over-year impacts, I don't know too specifically.

Let's just see.

This is not Industrial either.

This is everyone.

Okay .

All the major commodities across the industrial businesses are up, forecasted to be about an $80 million increase this year.

And of course, we're out trying to price through as much of that as we can and some of our businesses are fairly successful in doing it.

Our most challenged in doing it in the short-term is Kautex where resin prices have been significant.

We probably--total company hit on resin costs this year is over $30 million, and in the year we're not going to get, we'll get half or better of that back, but we're not going to get much more than that back in the year.

We're working hard to renegotiate our commercial contracts to put more and more pass through clauses in so that we can have a more immediate adjustment to those kind of costs, but in the short-term we don't have that.

Okay, thanks very much.

And next we go to the line of Cai von Rumohr from Cowen & Company.

Please go ahead.

Yes, thank you very much.

Your guidance for this year implies that the margins pop-up in the fourth quarter at Cessna, and yet your delivery plan for next year, if we kind of back out the Mustang where at one point you talked about going from 100 to 150, really only implies a 4% increase in Citation jets.

Is that conservative?

Or is the that you'll be a big uptick in the Mustang and much less growth in the Citations?

I think that's a problem of being too literal.

We're going to do about 100 Mustangs this year and about 150 next year, but you can't just simply take that as a guarantee that it's going to be a 50 increase.

Maybe, maybe a little different number than that.

But you know, I think it's, as Lewis said, we're going to do what we can to try to get a few more units out.

I think that's a solid number.

We feel very comfortable, we have all our supply-base lined up to deliver that number for next year, but we have customers that would like us to do more, and if we can, we'll try to get a few more out, but you know, it's not going to be a material difference.

Okay, and then you--

Let me just follow-up on that, Cai.

Again going back to Lewis's comments about you have to look at the planning process and it's not like, "Okay, let's decide how many jets we're going to ship next year." In a large way, that decision was made a year or more ago, two, three years ago, in some cases, with respect to your supply chain.

What has happened is that as we've seen orders come from the international markets, as this S-curve adoption has come along, we have raised considerably our outlook for world shipments on a systemic basis.

Basically capacity now has to catch up with that new view where we're heading, say, over the next five years, to a 700 level.

We're very capacity constrained relative to the supply chain and, will we get a couple more out of there?

Maybe, but I would not characterize our view of next year as a conservative view.

We're two years into what will probably now be a seven year plan to put capacity up at Cessna.

Those plans are set in place and discussed with all the supply chain to get everyone on board.

It's not something we can jerk around by 20 airplanes in one year because there's a stronger backlog.

Could you follow-up?

So you're basically saying the upper end still looks good, which seems to be the trends we're seeing in the biz jet market, particularly if your international business is strong.

I would assume that would say the upper upper end of your product line--and obviously the Mustang, too--would be where you're seeing the strenth.

Can you give us any color generally about the upper versus the lower end of the line in terms of order strength?

It's pretty balanced.

It's amazingly balanced actually.

I'm trying to think--there are not many models you can get in 2010 actually.

It's age of model rather than size.

Probably the most available aircraft we have is the Encore Plus and it's one of our longest in the tooth aircraft..

So it's more a function of how recently we've developed a product versus high end, low end.

Mustangs are selling like crazy.

Terrific.

Thank you very much.

Yeah.

And we have a question from Ron Epstein from Merrill Lynch.

Please go ahead.

Hey guys.

Quick question for you, at Bell, on the commercial side, have you guys discussed what kind of pricing increases you've seen over the past couple years?

Yeah, the last couple years, it's probably been close to double digits two years ago, and then it was moderated this last year down to kind of mid single digits, but it's been very strong.

We kind of took one step function up, I want to say, almost 24 months ago.

I may be off by a quarter or two.

We took a pretty big step function increase when the demand really started to build up out there.

Last year, we didn't need to do quite as much but I think it was still between 4% and 5% percent.

The interesting thing now is that we have backlog in the commercial helicopter business that we've never had before in this business.

We've got our, of our four major models, when we're now reconfiguring and we're discontinuing a few models to focus on the long 206, the 407, the 412, and the 429.

Other than the 412 which has some near term availability, the 206 and the 407 are out to 2010, and, obviously, the 429, which hasn't launched yet, is booked out to 2014.

Okay, great and one other quick question.

I think you mentioned the flight hours flown for business aviation, year-to-date, do you guys have an idea of where that's gone?

Yeah, well total flight hours flown is up.

But flight hours on a same-ship basis is off just a touch, In fact, until last month.

For about six months in a row, we were seeing utilization rates, so that's existing aircraft flying X number of hours this year versus last year.

Down just a skosh, which we think is somewhat fuel price related, but that number has been overwhelmed by the fleet size growth in the one year.

So obviously it's not a very big number.

So total flight hours is up, flight hours on a per ship basis is just marginally down.

I think most of that decrease in utilization per ship is coming in the fractional segment of the market where people, who in the past have a tendency to fly more hours than purchased, are economizing to stick within their hours.

They are the ones that see the fuel surcharge right on the invoice, whereas most of our customers don't see that quite so obviously.

Great, super, guys.

Thank you.

Lea, do we have more questions in queue?

No we do not.

Great, then thanks everybody for joining us.

Have a good day.

Thank you all.

Take care

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