達信公司 (TXT) 2012 Q3 法說會逐字稿

Welcome to the Textron third quarter earnings call.

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

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

(Operator Instructions)

As a reminder, this conference is being recorded.

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

Thank you, Terry.

Good morning, everyone.

Before we begin, I'd like to mention, we will be discussing future estimates and expectations during our call today.

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

On the call today, we have Scott Donnelly, Textron's Chairman and CEO and Frank Connor, our Chief Financial Officer.

Our earnings call presentation can be found in the Investor Relations section of our website.

Moving now to third quarter results.

Revenues in the quarter were $3 billion up 6.6% from a year ago.

Our income from continuing operations was $0.48 per share, up from $0.45 in the third quarter of 2011.

Third quarter manufacturing cash flow before pension contributions was $153 million compared to $339 million in last year's third quarter.

We contributed $16 million to our pension plans during the quarter.

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

Thanks, Doug.

Good morning, everybody.

Our third quarter results reflected strength in our helicopter and industrial units, continued favorable liquidation activity in our financial portfolio and good execution at Cessna in what turned out to be a weak business jet demand environment, especially in July and August.

The quarter also reflected charges associated with our new fee-for-service Unmanned Aerial Systems programs, as well as lower volumes in the Systems business.

As you know, earlier this year, our Systems won two contracts associated with our Aerosonde platform to provide UAS services to the DoD on a fee-for-service basis.

Cost estimates for these programs were based on our extensive experience operating Shadow Systems for the DoD under government-owned contractor operated contracts.

We thought most of the operating expertise would be directly transferable to the new Aerosonde platforms.

As it turns out, the operating know-how did not transfer well and we had significant start up issues during the quarter as we began Systems deployment.

To address these issues, we augmented training procedures, added resources and adjusted our estimated costs to support the programs, such that we expect they will operate at a loss during the initial phase of the contracts.

Consistent with contract accounting rules, in the third quarter, we recorded charges of about $14 million representing the expected losses on these contracts.

So we anticipate the Aerosonde activities we recorded at break even through the next three quarters, having already booked the estimated losses.

We are also experiencing some delays in our CCDL and SFW programs.

Therefore, I think it is likely that we will miss our original full-year guidance at Systems for flat revenues by about $100 million to $200 million.

Looking forward, we will focus on improving program execution at Systems.

Moving to our Finance segment.

We had a successful quarter of liquidations, as we reduced non-capital Finance receivables by another $161 million, including a $90 million reduction in our Timeshare portfolio, which included payoff of the largest remaining individual Timeshare credit plus a $60 million reduction in our Golf Mortgage portfolio, primarily as a result of loan sales.

Our non-capital Finance portfolio now stands at $458 million.

Shifting to Industrial.

Volumes reflected normal summer seasonality, but we continued to see year-over-year volume growth in our Golf and Turf and Auto Fuel Systems businesses, with an overall organic growth rate before FX of about 7.5%.

We do believe that we will see some volume softness in the fourth quarter, as it appears that the European Export Auto market and the Japanese OEM Auto business, reflecting current Japanese/Chinese tensions, are expected to be slower in the fourth quarter.

Moving now to Cessna.

We delivered 41 jets in the quarter, down from last year's 47, reflecting the weaker summer market.

Specifically, July and August were very quiet order months, with a pick up of activity in September.

In the meantime, we believe that generating essentially flat segment profit with fewer jet deliveries demonstrates the progress we're making with our overall cost structure at Cessna.

We also made good progress on the new product front during the quarter, starting with an announcement that we increased the range of our Latitude by 25%.

The Latitude will now be a 2,500 nautical mile airplane, which we believe significantly enhances the value, this offering to our customers.

Our design team was also able to announce a new top speed for the new Citation 10 at Mach .935 reserving its distinction as the fastest commercial jet in the world.

We also had important announcements in the quarter with three new global Company-owned service centers.

Most recently, we announced the acquisition of a service center in Doncaster, UK, which followed the announcements of a new service center in Valencia, Spain.

During the quarter, we also announced the opening of new joint Cessna/Bell service center in Singapore.

These investments in aftermarket infrastructure are extremely important to both Cessna and Bell, as they capture future new industry in the form of service revenue and create a stronger touch point for our customers for future sales.

To wrap up with Bell.

On the military side, we delivered 11 V-22's and 5 H-1's versus 9 V-22's and 7 H-1's in last year's third quarter.

We saw another significant increase in our commercial business with 46 units delivered in the quarter up from 26 last year.

This growth reflects continued overall strength in global helicopter markets, as well as the ramp-up in our 429 program and the success of our new 407GX.

To wrap up the quarter, we continue to make great progress shrinking the portfolio with Finance on favorable terms.

At Systems, we experienced some execution difficulties during the quarter and we are addressing those.

Industrial has maintained growth and good operational execution in an otherwise challenging economic environment.

I believe Cessna did a good job in the third quarter, closing new orders in a very thin market.

They have made substantial progress with overall cost structure over the past year.

Bell continues to execute well in both its military and commercial businesses.

Finally, across our manufacturing units, we remain committed to making investments in new product development, sales capabilities, service capabilities and manufacturing productivity.

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

Thanks, Scott.

Good morning, everyone.

Manufacturing segment profit in the quarter was $254 million, down $6 million from the third quarter of 2011 on a $154 million increase in manufacturing revenues.

Let's look at how each of the segments contributed, starting with Cessna.

Revenues at Cessna were up $7 million on a year over year basis, primarily reflecting higher used jet sales, which more than offset lower new jet and other product line sales.

Aftermarket sales were up approximately 2%, which was against a tough comparison as aftermarket sales were up 13.7% in last year's third quarter.

Segment profit was $30 million, down $3 million from last year's third quarter.

At Bell, revenues were up $181 million primarily due to the higher deliveries of commercial units and V-22's.

Segment profit increased $22 million reflecting the higher volume.

At Textron Systems, revenues were down $62 million, primarily due to lower volumes.

Segment profit decreased $26 million reflecting the fee-for-service charges Scott described earlier and lower volume.

Industrial revenues increased $28 million, reflecting higher volumes across most of the businesses, partially offset by unfavorable foreign exchange.

Segment profit increased $1 million, primarily due to the higher volume, partially offset by cost inflation and excessive price increases.

Moving to Finance.

Total Finance receivables ended the quarter down $233 million from the prior quarter.

Non-accrual accounts ended the quarter at $145 million, a decrease of $107 million from the prior quarter.

60-day delinquencies were $114 million, a $55 million improvement from the second quarter.

Moving to corporate items.

Corporate expenses were $38 million in the quarter, up significantly from the second quarter, primarily the result of higher prevailing share price, which increased compensation related expenses.

Interest expense was $35 million, flat with the second quarter.

Moving now to cash flow.

On a year-to-date basis, cash flow from continuing operations of the manufacturing group before pension contributions was $168 million versus $455 million at this point last year.

The most significant drivers affecting the lower cash flow this year are lower advanced payments on military contracts at Bell, an increase in Cessna used inventory, reflecting higher trade-in activities and the wind down of our CitationAir fractional program, plus an increase in inventories at Systems, related to delayed program activity.

For full-year 2012 manufacturing cash flow, we are maintaining our target of $700 million to $750 million.

To conclude, in anticipation of continued positive performance at Bell and our outlook for jet demand at Cessna, in the fourth quarter, we are increasing our full-year EPS guidance from $1.80 to $2 a share to a range of $1.95 to $2.05 a share.

That concludes our prepared remarks.

So, operator, we can open the lines for questions.

Noah Poponak, Goldman Sachs.

I wanted to ask about Cessna demand in orders.

In the past couple of quarters, you've talked about cancellations still impacting the Cessna backlog.

I wondered if you could speak to where gross orders and cancellations were this quarter versus last.

Then in the context of that, I believe you've commented that Cessna book-to-bill could go above 1 before the end of this year or sometime soon, simply by having cancellations come down if gross demand doesn't change.

I wondered if you thought -- if you still think that could happen next quarter or in the next couple of quarters?

No, I would say that in terms of cancellations, the cancellation number continues to come down.

It was down again in the third quarter.

[View reports], of course, says the third quarter was fairly light in terms of gross orders.

So, order activity, as I said, was very, very light in July and August.

We did see it coming back in September.

If you look at the gross, book-to-bill number for the quarter, was probably somewhere around 0.85.

Obviously, for it to get up above 1, we need two things to happen.

We need to see a continued reduction in the number of cancellations.

I feel pretty confident that trend is obviously going to continue.

We expect that cancellations will continue to come down and are really at the point where they are becoming pretty de minimis here going forward.

But we need to get better gross orders.

Certainly, what we're expecting is that despite a pretty tough market here in the past quarter that we'll see more normal gross order level activities in the fourth quarter, as compared to what we've seen in, say, 2011 and even 2010.

So, that's, I think a reasonable assumption in terms of what we see going on in the market.

September was certainly better, but in terms of gross orders recovering from a very, very quiet July and August, just really wasn't in the cards.

Okay.

That's helpful.

When you put all of those considerations in -- anything you can share on the current thinking for where you'll put 2013 production versus 2012?

We're certainly not at a point where we're ready to give guidance yet on 2013.

We'll do that in January.

But I think, it's obvious as you watch through the course of the year and not knowing what's going on exactly in the market at this point, you probably something that's going to be around flattish, but we will give a more refined guidance for you when we get into our January call.

Okay.

Then just one more, on the Systems charge, did you say $13 million -- one, three?

$14 million, sorry -- one, four.

So, the margin would have -- I guess the operating margin would have been somewhere a little north of 8.5% excluding that -- that's trending below where you've been the past few quarters.

Is that the run rate going forward?

Or are there other reasons that should come back up on an adjusted basis?

I think that if you think about next quarter, in particular, the revenues that we book associated with that program being in the zero margin, that's probably not a bad way to think.

But in terms of a longer-term run rate, no, I think we'll still expect to be higher than that.

There were a couple of things, obviously that hit us in the quarter, one was the charge associated with these programs, which is frankly our -- just an execution problem and one that we have to go work on.

But we also had delays in some volume deliveries of programs, that are good programs and will deliver.

But we have deliveries that were supposed to be in the third quarter, which are now moved into the fourth quarter and even into 2013, that are good, normal margin programs.

That was also part of what was leading to the drag on the margins rates.

Pete Skibitski, Drexel Hamilton.

Can you tell us how many used Citations you did deliver during the quarter and maybe the sales and earnings associated with that?

Sure Pete.

This is something I think is important to understand when you do the analysis on the Cessna margin rates.

The revenues were roughly flat, but that's because we had an additional $30 million -some of used aircraft sales.

So, really what happened here in the quarter is that as a result of the light orders early in the quarter, our deliveries, as we said, was down to 41 versus 47 on the new side and that revenue or a bulk of that revenue was made up for with used jets.

Now, it's good that the used jet is market is moving and that we're able to start to move more used aircraft, but the way that we account used aircraft is basically we end up selling those at zero margin.

So that's a particularly bad mix when you see fewer new deliveries and more used to deliveries.

You effectively had $30 million plus of zero margin business in there.

When we bring used aircraft in, we book them at their market value and generally that's about where we sell them.

It's really a zero margin mix.

Understood.

Then in terms of the gains on canceled jets, less than $5 million or was that any meaningful number?

Not a meaningful number.

Yes.

Not a meaningful number.

Okay.

Then I just wanted to ask you -- one thing I'm trying to get clarity on, can you update us on the status of the business jet depreciation roles as we go into 2013?

Does accelerated depreciation end at this point?

If so, what kind of impact do you think that will have?

I think it's still a 50% first-year depreciation.

Okay.

So no meaningful change going into next year?

No.

I think the one thing -- other thing, Pete, when you talk about the-- one of the dynamics in terms of these cancellations and the forfeiture deposit gains and the other dynamic, of course, is valuation of used aircraft.

As we've said, over the last year or so, these numbers have become small numbers.

They are still small numbers.

But I do think you have to understand, I think if you went back to the third quarter of 2011 these were mid single-digit number gains, primarily driven by the fact that what few deposit forfeitures you had left was greater than revaluations.

You look at this third quarter, again, it's still mid single-digit number, but it's a mid single-digit number the other way, because there are very few forfeiture of deposit gains owing to the fact that cancellations are way down.

But there's also a little bit -- again, these are small numbers, in terms of revaluations but when you add a small number the right way and a small number the wrong way, you end up with a number that's like a $10 million number.

Understood.

If I could just sneak in one last one, I promise, the FAA denying the 429 weight increase.

Can you talk about the impact of sales that are going forward and the probability that you can work around that and maybe the timing?

Because, it does sound like that could be a catalyst if the FAA does approve it.

We certainly would see it as a catalyst if they do.

Obviously, Canada which is the primary type certificate holder has approved it.

We've had about -- I think we're up to about 10 other countries now, have approved it based on the Canadian approval.

So we have seen some sales, because we are able to market the full performance of the aircraft in those countries.

As you know, the FAA has denied that extension.

Obviously, we're appealing that and we're working with the FAA to try to find a path to do that, whether that is through just a straight appeal in the exemption or whether there are some changes in how they view the part 27 and part 29 certs.

I think the FAA is trying to work with us and understand the situation and see if there is not a path to get there.

But that will take, obviously, some period of time.

But in the meantime, in quite a number of international markets, we're able to market and sell the full capability aircraft.

Obviously, we hope to be able to do that in the US as well.

Got it.

We'll stay tuned.

Jason Gursky, Citi.

Scott, just a couple of quick questions again, on Cessna.

First, can you describe the pricing environment for new aircraft?

Then secondly, what the fourth quarter shaping up to look like from a seasonality perspective?

Sure, Jason.

Pricing remains difficult in this environment.

It's still are pretty thin market and very, very competitive.

There are some models that saw some better price and there are some models that saw some worse price.

I think that's been the story here for a little while.

I would expect it to be still a bit of a struggle going forward, given the market.

In terms of the seasonality of the fourth quarter.

Again, what we are assuming in our plan is that we'll see a fourth quarter in terms of order rates and activity that was similar to what we saw in the fourth quarter of 2010 and 2011.

Okay.

That's helpful.

Then just got one last one on Cessna.

Can you just describe where we are in China from a market development perspective and just offer up some updated thoughts there?

Sure.

So we are actively engaged -- as you know, we signed a framework agreement with AVIC.

We are in active discussions on three separate -- the structure of these is that you've got the -- AVIC and ourselves and then whatever municipal government associated with particular product lines, which are in different regions of China.

Which was -- part of the plan was to have this be in several different operations.

All those three negotiations are, I would say, progressing well.

I think we're very close to getting the finalized agreement on at least one perhaps two here in the fairly near future.

The third, which is on the back burner for a while, has come back to a more active state of negotiations and I think we'll get that done in due time as well.

So, they're all progressing as we expected.

As you can appreciate, getting through these negotiations and setting up new operations with three parties at the table is not easy but we have been working through that and I think we are making good progress.

Carter Copeland, Barclays.

I wondered if you might talk about the -- I think you mention briefly what you saw on services.

But I wondered if you could speak to Bell and what you saw in terms of spares, in terms of commercial versus military.

What trends you're seeing there?

We don't usually breakout the commercial versus military --

Were they directionally different?

I'm just trying to get -- some other competitors have talked about weak military spares, is that a trend that you're seeing in Bell?

It is not a trend that we are seeing, Carter.

Year-to-date, we're up high single-digits overall in aftermarket at Bell.

Okay, great.

Briefly, you mentioned in Industrial some anticipated softness there, later in the year.

I wondered if you might talk to the magnitude of that.

What you may be seeing in terms of order trends, especially on the Automotive side?

On the Automotive side, of course, fourth quarter seasonally is always a lighter quarter on the Automotive side of the business in general, because they tend to shut down towards the holiday seasons.

We are expecting it actually a little bit lighter than it normally would be.

It's really driven by two things.

As we've gone through the year, Europe, which was supposed to be very soft all year, we certainly saw some softness in Europe.

But some portions of Europe, particularly those models of vehicles, under the large sedan, higher end vehicles that are very export driven continue to be pretty strong through the year.

We've seen some softening of that here and would expect some softness of that in the fourth quarter, as the export market is a little bit slow as opposed to most of the softness being within the European consumption.

So, I think that will be a trend of some softening in the fourth quarter.

Then the other, which is a very event driven exercise, is that this latest flare-up between China and Japan has effectively led to an unofficial boycott of Japanese product in China.

So, the Japanese -- there's some export but, in particular, some of our larger customers in China are Japanese OEMs that have manufacturing facilities in China.

They're taking their volumes down dramatically as a result of Chinese people not buying Japanese branded product, even those that are made in China.

I don't think that's necessarily a macro trend and some of that share will certainly shift to other places, but it is a -- I think it will be a bit of a problem in the fourth quarter.

Just one last quick one.

With respect to the DoD contract environment and the fourth quarter activity -- usually a big quarter for the government at the end of the fiscal year.

Did you see anything that looked different either better or worse given sequestration sitting out there?

No, I can't say that we've really seen anything very different.

It is still very difficult to get through the contract negotiating process and the Auto processes.

It's taking extraordinarily long periods of time to do that.

But that's a trend that we've seen for the last couple of years.

On the sequestration front, you hear anecdotal things from different people about people either trying to accelerate getting something under contract or delaying something under contract and everybody wants to attribute to sequestration.

I'm not really sure you can do that.

I think people are trying to read the tea leaves or read things into different activities also say with sequestration.

Our view on sequestration is, in light of the fact that the government has not guided DoD.

DoD has not guided the contractors, that we need to just let this thing play out.

Obviously, some of our larger programs like multi-year that we currently have with V-22, we would not expect any impact on sequestration on that.

We don't see it as a huge issue for us in the very near-term.

So, rather than worrying a whole lot about it, I think we need to wait and let's see what happens as we go through November and go through the lame-duck session and get to where sequestration is either invoked or not invoked or how it's invoked.

I would say the good news for us is, we will give you our guidance in the mid part of January.

By that time, I think we're going to know a whole lot more about where this sequestration process is going.

But for us --

That's really good color.

Robert Stallard, Royal Bank of Canada.

Scott, I thought I'd kick off with Cessna.

You mentioned you had some -- an increase in new sales this quarter.

I was wondering if you could comment on the broader used business jet market?

How the inventories are looking?

How the pricing is looking and perhaps how Finance is tracking as well.

I'd say the used market, if you look at it, it has picked up.

The number of transactions has increased across the whole market.

Obviously, we see that in our business.

In terms of pricing, it remains quite flat.

When the books come out -- each quarter there is, obviously, there's just normal depreciation of valuations.

But we haven't seen big moves one way or the other.

We have seen some models where they have ticked up slightly and we've seen others where they have ticked down slightly, in terms of how [BRep] and the bluebook guys view the aircraft.

So I would say, on the positive side, transactions are happening, the market is moving, but again I think there's still -- even though the numbers have come down dramatically, it's still probably in all fairness more of a buyers market than it is a sellers market.

On the Finance thing, how easy is it for customers to get financing for used aircraft, do you think?

I'm not aware that there is any particular issues.

Again, most of the aircraft that we deal with particularly the older aircraft are probably at a price point right now where it doesn't take a whole lot of money to get a reasonable LTV on a note and people seem to be able to get financing.

Okay.

Secondly, on Bell, you mentioned that the civil helicopter market's showing some good strength here.

I was wondering if you could comment on how your market share has been tracking and what your initial thoughts might be for where 2013 could go in the civil helicopter market?

I think the market has remained strong.

We feel pretty good about how our products are doing out in the marketplace.

I would say that we believe we are still continuing to gain some share.

We would like to think that we'll continue to do that.

I think the 429 has proven itself to be an outstanding helicopter, is doing very well in competing and winning around the world.

Things like the new 407GX that came out is doing extraordinarily well, I think and continues to pick up share in that segment.

So, when you look at some of those new products that are out there, I think John and the team have done a very nice job of doubling down on our sales efforts and increasing the number of resources we have out there to make sure that we are covering all the regions.

We continue to do very well.

I feel pretty good that we will stay on that trend.

Jeff Sprague, Vertical Research Partners.

Just a couple other things, coming back to Cessna.

Scott, just thinking about Q4, you characterize some more seasonality to 2010 and 2011, but those were actually very different years, right?

In 2010, we had a triple in Q4 versus Q3 with that big back-end load and last year looked a little bit more normal.

I just wonder if you can put a little bit more of a fence around this and give us some color on what to expect in Q4?

What is anticipated in your guidance for Q4 for Cessna?

Look, Jeff, I think we have been guiding for the total year to be up modestly.

I still believe that's where we are going to end up, is up modestly.

As you know, we've tried to work hard all year to get this thing to be more level loaded.

We, just certainly, did not want to have the hockey stick delivery year that we saw, for instance in 2010 and to some degree in 2011.

Obviously, we were successful during that in the first couple quarters.

We saw deliveries that were well head of the pace or deliveries that were well head of the pace of what we have seen in those previous years.

I would be kidding, if I didn't say I would've hoped the third quarter would've been a little bit stronger in terms of the number of deliveries.

But the summer months were pretty tough.

Again, as I have seen what happened in September.

We look at what we need our deliveries to be to be up modestly over last year, I think that's still a reasonable plan.

So, it will be a few more deliveries in the fourth quarter than I would have liked to in terms of trying to level load this thing a bit more.

Given a few deliveries light in the third quarter from where I would like to have been.

But I think given the order environment and what's going on, I think that is still in the cards.

Then just thinking about the outlook going forward and obviously everybody's crystal ball is pretty darn cloudy.

But you made the comment after a slow summer you see some return to normalcy.

Is there something your customers in particular are pointing at?

Does the market get better irregardless of who wins the election for example?

What kind of body language if you will to the extent that there is any do you get from the customer base and the outlook the next quarter in order intake?

Jeff, I would say that if you look -- again, our primary customers are small, mid-sized businesses.

There's no question that a lot of these guys are looking at a very uncertain next few months, right?

You've got an election coming up here in a few weeks, you've got holds to called fiscal cliff, you've got tax policy, you've got sequestration.

There's plenty of reasons to look right now and say, geez, I don't know what is going on.

I personally believe that -- a lot of these guys would probably prefer to see one outcome versus the other in November.

But on the other hand, I think people will wake up the morning after the election, they may be happy, they may be unhappy.

But to some degree people are going to have to dust themselves off and say, You know what?

I've got to get on with my life, right?

I think that a lot of these things that are giving people pause right now -- people will get over these things, right?

As I always like to say, would you rather have good policy then bad policy, but at least have policy.

Know where things are going.

I think that the election will play out somewhat like that.

It'd be better to go one way than the other, but either way, I think, it takes some uncertainty off the table and that is probably good for the market.

Then just finally for me and then I'll yield the floor.

Can you give us any color on where the 2013 delivery of deliverability of backlog stands?

In other words, how much long-tailed stuff is still in backlog and how much is conceptually deliverable in 2013?

Jeff, we have not been given our sold outs or anything like that.

You guys see the backlog number from a dollar basis continuing to come down.

I think that the market, the way I would see it in 2013 at this stage of the game, is going to be very much a repeat of the 2012 market.

The bulk of what's out there, the bulk of the activity that has to happen in terms of selling aircraft is involved getting orders for aircraft.

That's the way we have been playing here for while.

At this stage of the game, that would be my view of how 2013 continues to play out.

Cai von Rumohr, Cowen and Company.

How much of the $28 million in profit at Finance was gains on liquidation sales?

Sales of assets and do you expect TFC to be in the black in the fourth quarter?

Cai, I think TFC is probably closer to breakeven in the fourth quarter and of the profit at TFC about two-thirds of that profitability was non-captive, in the third quarter, related to both good liquidation activities at Golf as well as some non-accrual returns in the Timeshare business.

The captive business was about a third of the profitability, there was some good credit performance embedded in that, as well as just more normalized profitability level out of the captive business.

Okay.

Terrific.

Getting back to Cessna, Scott, could you give us some -- you've done a fairly good job, but maybe some more color with respect to strength or weakness by geographies and byproduct?

Certainly, looking at your mix in the quarter, the big stuff was up year-over-year.

The little stuff wasn't, in terms of the jet.

So, give us some color on where you see the weakness.

If you look at the deliveries of jets themselves, Cai, you are right.

The mix is favorable, in that it's been tending more to the CJ4 XLS Sovereigns than the Mustangs in particular.

That is good mix for us.

In terms of the question around geography, our deliveries in the quarter were about two-thirds in the US and about one-third international and that's versus a trend we've had that's been more like a 60/40 trend for the last few quarters or so.

If you look just at the jet deliveries themselves I think that was a positive for us in terms of mix.

The issues that were a little more struggled was having a lot of used aircraft in there, which is very bad mix and that they're basically just a pass through, not a margin.

A little bit of obviously, I would say net pricing continues to be a challenge.

So, even though you had some good mix in there, I think we continue to still battle a little bit with some loss of price.

Then as I said earlier, while they're small numbers, they do matter in terms of the overall results at this point, just because the overall number is small in terms of percent of not percent, are things like the residual and the fact that thankfully as a result of cancellations going down we are not seeing a whole lot of orcharding.

So, those are the primary issues that are going on in terms of mix, Cai, that nets out to where the operating margin landed.

Good on the new jets, challenged by used and some relatively small numbers but things that are headwinds associated with the price and just the other items like residuals, values, gains associated with deposit forfeiture.

Great.

If I look at the sales it looks like either the prices were down or the parts and services were down, because given on those delivery I would have gotten the slightly higher sale.

Is that the case?

Were parts and services down?

Secondly, was R&D up sequentially in this quarter?

No, R&D was not up sequentially so that was not a headwind for us.

Parts and services were up, but only by a very small -- 1% or 2%.

Again, we didn't see a real change in dynamic in the service business in the quarter, but we are just comparing against the third quarter last year, where it was up about 14%.

I would expect in the fourth quarter, our parts -- we'll continue to see the rate of parts and services, which was helping the quarter but it was just on a V basis.

Then you have a spectacular performance at Bell on strong V-22 deliveries.

Can you comment on how large were your cum-catch profits on that program in the quarter?

How much more gas is left in that tank?

There were not cum-catch adjustments, or EAC adjustments on those programs that had any impact on the numbers.

Julian Mitchell, Credit Suisse.

I had a question on the core gross margins in Cessna.

It sounds like R&D isn't doing very much.

Some effects from the used aircraft which you've discussed a lot.

Overall, when looking at the gross margins in that business, do you feel that there's still a lot of room operationally to push that higher or now it's really a function of waiting for volumes.

I guess on pricing, you had mentioned on the last earnings call that your sales force had tried a couple of price increases.

The rhetoric this time is very different.

If you could give an update on how that went on the price increase efforts and when you think you'll next try those same methods again.

Thank you.

We have made some moves on a couple of aircraft types where we saw a demand that we thought warranted the market tightening up enough that we could get some price through and we have seen that on a couple models.

But we continue to have some other models where we are not able to get price through.

There's definitely mix within each model type, Julian.

It's not that we don't believe we can get the prices on each model.

So, yes, we had some success, but in some areas we have not had success in driving that price.

Not very much has to do with just the dynamic of the market right now and the number of opportunities out there and what the competition looked like.

So, obviously that's something we'll continue to work on and getting a little bit of stronger demand obviously would help down in the marketplace.

In terms of our gross margins, we continue to work the gross margin side of the business.

We have made some overall improvements in the total cost structure of the business both fixed and variable.

We will continue to drive that.

We will not going to wait for volume to save us on that thing.

We continue to drive productivity across all sides of the business and I think there's still some opportunity for us to get better at that even with flat volume.

Obviously, our plan here is to try to position these things in the cost structure, so that we get very good leverage when the volume comes back in the business which I think is inevitable.

We're not just going to just simply sit and wait for that either, so the cost activities will continue regardless.

Got it, thanks.

Then, just quickly, I wondered on the [whole crassets], you gave some update last time.

If there was anything to add this time in your thinking?

No, there really isn't.

We haven't -- we continue to watch what is going on and obviously as everyone knows they have been in an exclusive negotiation period with the Chinese buyer and to the best of our knowledge that process is continuing.

Got it.

Then, finally.

Just quickly unveiled commercial, in a lot of industrial end markets you're seeing some slowing in larger project CapEx.

It sounds like Bell Commercial though, in terms of order intake, still very, very good.

I just wanted to make sure that was the case, you haven't seen any slowdowns or deferrals there.

No, we haven't.

Our order intake and strength in the market on the commercial side seems to be sustaining.

George Shapiro, Shapiro Research.

One more on Cessna.

Then a couple of others.

Was there any LIFO benefit last year or this year?

Yes.

There was not a LIFO benefit this year.

There was a mid single-digits benefit last year.

Okay.

Then -- actually, one more on Cessna.

Then, Scott, if you looked at September this year, how did it compared to September last year?

I don't know if this is -- if you could say or not, but if you got similar orders the rest of the year that you got in September on a month basis, would the book-to-bill be above 1 in that situation?

Before Scott answers that, let me just say that trying to down to a month by month compend is a very slippery slope.

Because when an order comes in one day to the next and so forth, I think that's a difficult thing.

Obviously, you picked up September, recovered and if that continues, that would certainly be what we hope for.

George, Doug is right.

I want to be careful here not to get into quarterly order flows.

But let's say -- from an overall color standpoint the third quarter this year was certainly very September-loaded.

If you consider that rate, than that's the market dynamic we think we need to be able to meet our total year guidance above modestly.

The answer is yes, right?

If we can maintain the order rates that we saw in September through the balance of the year, then I think we end up meeting our guidance of being up modestly for the year.

That's our expectation.

September this year, Scott, compared to September last year, was better I assume?

George, I'm sorry, I do not have the month-to-month on this year versus last year.

The third quarter this year was just slightly below the third quarter of last year.

But I'm sorry I don't know -- I just don't recall off the top of my head the dynamics of the exact number of aircraft orders for a month in the third quarter last year.

Okay.

Then switch to the Systems.

The charge that you took on those contracts, Scott, I thought those contracts were like three or five year contracts.

Are they broken into yearly pieces, so you would have a zero margin for the first year and then the opportunity to make money in the second year of those contracts?

Yes.

That is correct.

They're -- effectively, George, they're broken into options, Okay?

Or task orders is the way they do it.

But if you look at the task orders, they roughly break down to one year duration task orders.

We have already been operating under the first couple task orders associated with one contract.

We have just begun the first task order of a second contract.

So, these charges pertain to those initial task orders.

So we have effectively -- and the way we do our program accounting, the way we treat EACs, all the stuff that we would normally look at, we treat -- looking at those on a task order basis.

Yes.

The charge relates to our view of those task orders, the costs associated with those task orders and that's how we derived the charge.

You are right, these are depending on those numbers, the task orders that get exercised are probably more in the three to five year ranges.

So obviously these can still turn out to be good programs.

But our execution here in the initial phases of executing these first few task orders has not been good.

That's what's reflected in the charge and obviously we're going to do everything we can to work hard and be able to meet that even booking of the balance of these initial task orders and obviously to position ourselves in a way that we get the profitability that we expected on those future task orders.

Then maybe one for you, Frank.

Just give us an update at what pension might look like for next year?

Sure.

Obviously, there is a lot that can happen between now and year-end and we haven't tried to run any of the numbers definitively.

If we maintained the existing assumptions from this year going into next year, there'd be a slight headwind associated with next year's pension number, $15 million -ish type number.

Obviously, it remains to be seen what the underlying assumptions are ultimately related to return and discount rate.

On the discount rate side, we have given some sensitivities in our 10-K but -- for instance, say a 50ish basis point change in discount rate.

It has a $30 million -ish impact on pension expense.

To give you some sensitivity around those assumptions.

That is generally the framework and obviously there is a fair amount that can happen between now and then in terms of what those numbers ultimately look like.

Myles Walton, Deutsche Bank.

As you talk about Cessna being flattish into 2013, I would have thought you'd get some contribution from the Citation Ten and M2 coming into the market.

Are those not going to be big contributors?

Or is the rush of the core business more where you're seeing the puts to the gains on the Citation Ten and M2?

We will see some Ten activity although that is very much towards the latter part of 2013.

We will have, we think a reasonable volume of M2s as that comes into production.

But we are still -- and this is why -- trying to be careful, because I'm really not trying to guide a number, okay?

But just given the overall market dynamic, there can be some positive contribution by the fact that we have some of the new product getting out there.

But we're also seeing not a market recovery through the course of this year that we would necessarily have liked to have seen building the momentum into 2013 that we would've hoped for.

Maybe that will change as we go through the fourth quarter.

The fourth quarter is always a very important quarter and we will get a lot of these other issues around elections and fiscal issues and whatnot out of the way.

I think we will be able to provide you a lot more visibility into our thoughts and rationale for how we get in 2013 guidance.

The other one, Frank, you talked about the reason for lower manufacturing cash flow year-to-date.

I think you cited Bell advances, higher Cessna use, Systems inventory growth.

Just curious, 4Q looks like it'll have to be as good as what was last year's 4Q, which was really quite impressive.

I'm just curious, are there any of those things that you talked about as being weak points in the first nine months that are the triggers for reverses to get you over the hump in the fourth quarter or just what is the put and take to get you where you need to go.

Yes.

As you do numbers, essentially, we are looking at a fourth quarter this year that was similar to fourth quarter last year.

We always have a seasonally, very strong fourth quarter.

Obviously, the seasonality at Cessna, some seasonality at Bell contributes to that.

The timing of some of the payments coming from the military customers in terms of performance-based payments and just other contract activity.

We generally see a significant inventory liquidation because of that seasonality and other seasonality with some of our other businesses result in the fourth quarter.

We do expect that we will see similar cash performance this fourth quarter as we saw last fourth quarter.

Is there a big tick up in Bell backlog in the fourth quarter?

Bell backlog, remember, there's always a couple things that happen with Bell in the military side because we take things into backlog as they are funded.

The one issue that I think we should be sensitive to is that last year was the last year of the funding of the final year of the multi-year won contract, which generally goes into our backlog in the fourth quarter.

Given that the next funding increment to go into backlog will be associated with the next multi-year contract, which I don't believe will be definitized and completed until sometime in the first, even second quarter next year -- that will come to backlog, but I don't believe it will come to backlog in the fourth quarter like it generally does.

But that is not a big year on year headwind to cash?

No, not at all.

That won't be calculated at all, not with the order.

I thought you said -- the question was order.

It was, yes.

Yes, okay.

The order seasonality will be a little bit different just because of the dynamic of the next multi-year, but that should have no impact on cash.

David Strauss, UBS.

Scott, back to Cessna, a lot of questions on what your guidance implies for the fourth quarter, but I think last you had out there you had Cessna revenue guidance for the full year at $3.4 billion.

Does that still imply?

Because if it does, it seems like it implies a fairly big delivery number in the fourth quarter.

David, Doug here, I think that our guidance will be more around a $3.3 million area plus or minus depending on where the exact deliveries come in.

Okay.

Then, while we are on that subject, because I think you said Systems now $100 million to $200 million lower.

What about Industrial and Bell relative to the prior guidance?

I think Bell will come in maybe just a little bit higher than it's original guidance of $4.2 billion.

Obviously at this point, we'll probably see the top end of our range of margins maybe by about 50 basis points.

With respect to Industrial, I think that we had originally guided to an approximately flat revenue of $2.8 million(see presentation slide "$2.8 billion"), that will probably come in about $100 million greater even with the softness in the fourth quarter.

Margins there should be at the top end of our range of 6.5% to 7.5%.

Okay.

Thanks for that.

On Systems, taking your full year guidance, it does -- it seems like it implies a fourth quarter that's flat to up versus last year as compared to this quarter that was way down.

What changes in the fourth quarter relative to what we saw in the third quarter?

Catching up with some deliveries David.

There were some deliveries that were pushed on the volume side from third quarter to fourth quarter.

Some of those actually go all the way into 2013, but certainly there is some that delivery that moved from third to fourth, as what contributes to that.

Can you tell us which programs, Scott?

Primarily around our TCL program for the Shadow, data-link updates.

Okay.

Then, last question.

Thinking about 2013 and cash, obviously you have a fair amount of debt to matures early in the year.

But thinking beyond that, could maybe, Frank, talk about pension contribution next year.

Then maybe addressing the dividend and what you are thinking on potential share repurchase for next year?

Yes, certainly on the pension fund, first of all obviously, we will give guidance in January and we will talk about that.

We are still going through our budgeting cycle.

We will continue to contribute to the pension plan in 2013.

We will continue to prioritize, as you mentioned, cash towards debt pay down early in the year where we have a significant amount of maturities coming due, but we certainly have cash on the balance sheet and cash from operations to satisfy that.

Then from there, we will look at other applications of cash.

We're just going through our planning cycle right now.

So it's too early to talk about what that looks like.

The focus certainly for the first part of the year will continue to be on that debt reduction and contributions to the pension plan.

We have talked in our disclosures about, over the next number of years continuing to prioritize some amount of cash towards pensions in the amount of $52 million, as much as $400 million a year, to continue to fund those liabilities.

That all depends around, in part, the interest-rate environment and the discount rate environment and therefore the funded position as well as the performance of the portfolio.

We will continue to look at that as we plan on next year as we go through the next couple of months.

Steve Levenson, Stifel Nicolaus.

Could you give us figures?

What percent of the fleet at Cessna is available for sale and within that, what percent is current models?

You have to get the numbers out of here, because I don't want to quote an incorrect number.

But there has not been in huge change really since last quarter.

We were still sitting in the 12% total fleet, but I don't know that we give them a model by model basis but of the in production models, the numbers really been sitting down around the 6% range.

Single-digits depending on the model.

Yes.

Okay.

That is good enough, thanks.

Do you find yourself any closer to potential orders for V-22 internationally?

I would say that the international V-22 opportunities are, in my view, still looking very feasible.

There are several that are in process with customers that are -- appear to have a very high level of interests and are requesting information and initiating that process.

They're all FMS programs so they have to go to through the LOA/LOR notification to Congress -- going through that whole exercise but they are in various states of making progress.

Sam Pearlstein, Wells Fargo.

On the last call, you had talked about R&D ticking up in the second half of this year at Cessna.

I know you don't want to talk about specific dollars or percent of sales.

But can you just talk a little bit about how the R&D profile looks now with latitude, longitude, Ten and others.

Then year-over-year how should we be thinking about next year's growth in R&D?

As I said, we don't like to get into the numbers on a business by business basis.

I would say that like everything else, one of the things we're trying to do is make sure that we're being productive and efficient in our R&D spending.

So, it is still a very high level of spending compared to revenue, but I do think we have reached a point where it's probably not a headwind when we think about our percent of sales on a go forward basis.

I know we have talked a lot about Cessna but just as you look at the fourth quarter, there is really only ten weeks to go.

Do you have unsold positions remaining this year in this fourth quarter?

Is Cessna all of the variance between in the $0.10 between the low-end and the top-end of the EPS guidance?

Yes, there are unsold positions.

That has been sort of typical as we have gone through the last few years.

There are obviously a lot of discussions going on with customers.

So the process we go through to determine what we think the deliveries will be, is in fact based on some orders converting to sales within the quarter.

In terms of the variability of the range, there are a couple moving parts in there, certainly, Cessna is part of that.

If we were to come up light on deliveries that would obviously be part of that.

There are still a lot of things on the Systems side of the business that have to deliver in the quarter.

That drives part of that variability.

That's probably the bulk of the range.

But for sure Cessna is always in the market that we have been in a significant piece of the variability of our range.

Peter Skibitski, Drexel Hamilton.

Just a follow-up on the used aircraft sales at Citation.

I was just wondering, is the majority of that related to trade-ins on the large net jets order that you guys had?

If so, I'm just wondering what the profile is going forward.

Should we assume that $30 million is constant over the next couple of years or do you expect that come down?

Just any kind of color there if you are able to.

As Frank said, there is a portion, maybe two-thirds of the used that's going on in inventory and in terms of our increase in sales associated with trade-in aircraft.

I think that trade-in aircraft is a bit of the reality of where we are in the market right now, because when you talk about relatively short cycles sales, the ability for people to go out and externally market that aircraft and wait for it to sale before they take delivery is challenging.

So, as a result, we have been doing that.

Then we take it and turn those aircraft over.

The other part of the used, in terms of inventory and obviously some of the sales is the unwind of our CitationAir fractional business.

Those aircraft are put back and we unwind those fractional transactions.

Those also go into our used aircraft.

Then we turn around need to go market and sell those aircraft.

I don't know -- I would say right now, that we probably have had more trade-ins on a per aircraft -- new aircraft transaction than we typically do and we would expect over time to see that number start to come down again.

Yes there are certain --

You would expect to be less of a headwind in 2013, is that a fair statement?

Margin-wise?

We would like to see (inaudible) Yes.

We would like to see fewer trade-ins.

Just to be clear, that $30 million was the year-over-year change in used, that is not the total used.

The total used was a larger number than that.

Total used --

Okay.

Right.

When I gave the $30 million -some number that's a year-over-year comparison that we had, greater -- $30 million -some greater in used aircraft sales as opposed to new jet sales.

Cai von Rumohr, Cowen and Company.

Yes, just a quick one.

What is your year-to-date return on your pension plans, approximately, through September?

Cai, I think we are low teens type number.

All right, ladies and gentlemen, that concludes our call today.

Thanks for joining us.

Ladies and gentlemen, this conference will be available for replay starting today at 10.00AM and going through January 17 of 2013 at midnight.

You may access the AT&T Teleconference Replay system at any time by dialing 1-800-475-6701 and entering the access code 225827.

For international participants the number is 1-320-365-3844.

Again those numbers are 1-800-475-6701 and for international participants it is 1-320-365-3844 with an access code of 225827.

That does conclude your conference call for today.

Thank you for your participation and for using AT&T Executive Teleconference service.

You may now disconnect.