達信公司 (TXT) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Textron third-quarter earnings conference 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 our host, Doug Wilburne, Vice President of Investor Relations.

Please go ahead, sir.

Thank you, and 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, starting with slide 3. Total revenues in the quarter were $2.9 billion, down 3% from a year ago.

Our income from continuing operations was $0.35 per share, down from $0.48 in the third quarter of 2012.

Third quarter manufacturing cash flow before pension contributions was $269 million, compared to $153 million in last year's third quarter.

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

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

Thanks, Doug, and good morning, everybody.

Third-quarter revenues were down as growth at Bell Industrial and Textron Systems was more than offset by decline at Cessna, as the light to midsize business jet market remained soft.

Operationally, we saw good performance at systems and industrial.

At Cessna, despite cost actions we implemented in the second quarter, our results reflected continuing weakness in the business jet market.

Margins and revenue at Bell were below our expectations, due to manufacturing inefficiencies associated with labor disruptions resulting from negotiations with our UAW bargain employees in Fort Worth, and with the implementation of a new enterprise resource planning system.

The factory and efficiencies had a negative impact on cost, our ability to ship after market spare parts.

This did not prevent our downstream final assembly completion centers from meeting our aircraft delivery commitments.

The labor issue is now behind us, as this past weekend our employees did ratify a new five year contract; however, we will not fully recover with respect to margins in the fourth quarter, as higher cost work-in-progress makes its way through our production lines, and as we continue the ERP integration process.

From a market perspective, we saw another significant increase in our commercial business during the third quarter, with 54 units delivered, up from 46 last year.

Recent notable successes with Bell Commercial Products around the globe included the first deliveries of our 407GX into both Poland and Russia, seven orders for new helicopters at the 2013 Jet Expo Show in Moscow, delivery of the first two 429s into the UK, a purchase agreement signed in the 2013 Helitech show in London for up to 20 helicopters for a large global operator, and orders for 14 helicopters in China.

On the new product development front, we continue to make progress on our short light single and 525 Relentless programs, and we remain on track to fly both of these new aircraft by the end of next year.

On the military side, we delivered 10 V-22s and 7 H-1s in the quarter, compared to 11 V-22s and 5 H-1s in last year's third quarter.

During the quarter, we successfully demonstrated the V-22's ability to function as an air refueling tanker, which will enhance its versatility and value by expanding its mission set for future applications.

We also recently announced a number of important teaming partners on our V-280 platform for the Joint Multi-Role Tech demonstration program, including Lockheed Martin, General Electric, Moog, and GKN.

Moving to Cessna, demand continues to be soft in the light to midsize business jet segment, as we delivered 25 jets in the quarter, down from 41 last year.

Cessna recorded a segment loss of $23 million as a result of the low volume and a number of headwinds in the quarter, including used aircraft valuation adjustments.

Looking forward and taking into account where we are year-to-date, on the current state of the business jet market, we're taking a more conservative view of Cessna full-year deliveries.

Despite the lack of a near term recovery, we continue to believe that the global light to midsize jet market is a growth market in the long-term, and we remain to committed to our strategy of investing in new products.

On that front, we're on track to certify and begin delivering the M2 and a new Sovereign this quarter, and we're on track to certify and deliver the world's fastest commercial jet, the new Citation Ten, in the first quarter of next year.

Our new wide body Latitude is also on track to our first scheduled flight for next year, as we completed wing mate on our first test aircraft this past quarter.

So we believe we're doing the right things for the future success of the business with respect to attractive new products, competitive cost structure, superior service network, and expanded sales coverage.

Moving now to our finance segment, our captive business is performing well, although new loan originations have been light, consistent with the soft new jet sales at Cessna.

On the non-captive side, we continue to liquidate remaining assets at levels favorable to book value, which benefited segment profit in the quarter.

Shifting to industrial, we saw good top line growth, reflecting growth in auto markets and the impact of the Sherman & Reilly acquisition last quarter at Greenlee.

We also had good execution, with overall margin improvement of 170 basis points.

On the new product front, during the quarter, we introduced our new hybrid powered Bad Boy Ambush iS.

The vehicle gives customers three power modes -- gas for long range; electric for quiet approach, important to hunting applications; or our hybrid mode for greater power.

Moving to systems, revenues were up slightly over last year, reflecting growth in our precision munitions product line; and margins improved, reflecting better performance across most of the businesses.

On the vehicle front, preparations for the Canadian Forces' tactical armored patrol vehicle program continued, with customer testing and training activities progressing well on the first five pre-production vehicles.

We also signed an order for 28 COMMANDO armored vehicles for the Colombian National Police Force, and we are actively working with a number of customers around the world on other vehicle opportunities.

On the precision munitions front, we continued to deliver product to the Kingdom of Saudi Arabia under a contract that was definitized during the quarter, and we have a number of international opportunities under active discussion.

With respect to fee-for-service UAS program, we continued to experience unacceptable quality from our engine supplier; therefore, we have decided to transition the manufacture of that engine into Lycoming, which we believe will allow us to improve performance on the contract.

Looking forward across systems, we have a substantial amount of global sales activity underway and continue to believe this business can maintain a flat to slightly growing top line over the next several years.

To wrap up, the third quarter was disappointing with respect to performance at Bell and the continued lack of sales strength at Cessna.

The Bell labor situation has been resolved, and this will allow the Bell management team to return their focus to ERP integration and improving factory productivity.

We expect to get our M2 and Sovereign models certified, and that should provide a nice pickup for Cessna revenue and profit in the fourth quarter.

Overall, we are seeing improved performance at systems and will continue to pursue global sales opportunities.

Finally, industrial demonstrated solid execution, and we should expect to see top line growth in margin going forward.

Now, I'll turn the call over to Frank.

Thank you, Scott, and good morning, everyone.

Manufacturing segment profit in the quarter was $195 million, down $59 million from the third quarter of 2012 on a $65 million decrease in manufacturing revenues.

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

Revenues at Cessna were down $185 million on a year-over-year basis, reflecting lower new jet volume, partially offset by growth in after market revenue.

This segment had a loss of $23 million compared to a profit of $30 million in last year's third quarter.

At Bell, revenues were up $87 million, primarily due to higher military and commercial volumes.

Segment profit decreased $34 million, primarily reflecting unfavorable performance associated with the labor disruption and ERP system integration issues.

At Textron Systems, revenues increased $5 million, primarily due to higher volumes in weapons and sensor products, partially offset by lower UAS and marine and land systems volumes.

Segment profit increased $14 million, reflecting good performance across most of Textron Systems product lines.

Industrial revenues increased $28 million, primarily due to the impact of acquisitions and increased volumes in our fuel systems business.

Segment profit increased $14 million, primarily due to the improved performance and the higher volume.

Moving to finance, total finance receivables ended the quarter down $94 million from the prior quarter.

This segment had a profit of $13 million.

Non-accrual accounts ended the quarter at $105 million, while 60-day delinquencies ended at $88 million.

Moving to corporate items, corporate expenses were $34 million in the quarter, down $4 million from last year.

Interest expense was $25 million, down $6 million from last year, primarily reflecting retirement of our convertible debt this past May.

Moving to cash flow, we generated $269 million in free cash flow, which reflected better working capital performance.

To wrap up, as Scott discussed earlier, we are reducing our outlook for the year at Bell and Cessna.

On this basis, we are now targeting full-year manufacturing cash flow from operations before pension contributions in the range of $200 million to $300 million, with pension contributions of about $200 million.

And we are adjusting our full-year EPS outlook to a range of $1.75 to $1.85 per share.

That concludes our prepared remarks; so Operator, we can open the lines for questions.

Our first question comes from the line of Peter Skibitski with Drexel Hamilton.

Scott, can you give us a sense of how the government shutdown is expected to impact your fourth quarter?

It sounds like you don't think it will have any impact at all.

I don't think it will, Peter.

I mean, obviously, we had some concerns in the early part of the shutdown, just because of the FAA and the government inspectors are pretty important.

Frankly, on the military side the DCMA did provide inspectors and onsite support for the Bell folks, even when the shutdown was going on.

And now that the thing is over, any concerns we would have had around FAA and certification has pretty well been alleviated, so I would say no impact.

Okay, and the issues that you'd had previously on the Garmin avionics for the new programs, those are resolved as well?

Yes, that's correct.

Those have been resolved, and the M2 and Sovereign and Citation X test flights and cert process have been progressing very well.

Okay, and then just wondering what your sense is in terms of -- if you could bifurcate your thoughts on the market versus your stiffer pricing terms that you've been implementing out there?

Well, as we talked about, so we're coming out of this after the first quarter, Peter, we stopped doing a lot of the very deep discounting that I think was helping to create some demand in the marketplace.

As we went through the second quarter, obviously we saw the impacts of that in significantly reduced deliveries.

We pretty well held those prices both sequentially and year over year in terms of the third quarter, so we're keeping the pricing around where we expected it to be.

And I think as a result, we're just seeing what's the normal market out there, as opposed to dragging people into it that aren't ready to do upgrades or trade-in activity, and so that's reflecting a lower volume -- which, again, I think for the long term is healthy for the market, where we've got to let this cycle play through.

Certainly, as we went through the third quarter, we continued to see a fairly active unit market, a lot of transactions that are happening over there.

I mean, in our case we certainly sold more aircraft than we took in trades; and we continue to see the number of used aircraft available for sale, particularly in those relatively newer aircraft, continue to bleed down.

So I think at this stage of the game, we aren't happy with where we are in the cycle, but we're letting the cycle play through.

Got it.

And the comps essentially get easier for you from here on out in terms of having new aircraft to market.

Would you agree with that?

Yes, I don't think there's any question when you look at the M2 and the new X have had very nice receptivity, and we're not competing against relatively new used aircraft.

The Sovereign -- obviously, we've been out there now doing demo flights over the last few months and have started to book orders on that.

And we still have orders to go here for the fourth quarter.

But yes, I think there's no question that new product does matter in the market and does help to create demand and stimulate people to do upgrades and trade-ins.

Great.

Thanks very much for the color.

Our next question comes from the line of Robert Stallard with Royal Bank of Canada.

Scott, staying on the Cessna front, I saw your backlog was up versus last quarter.

I was wondering if you could comment on where that might have come from?

Well, we continue to book orders for sales that will be either fourth quarter or going forward.

Obviously, we started to see some Sovereign orders come into the backlog, and had no sales in that area.

We continue to see some sales activity around M2s and Latitude.

So in general, Robert, I'd say it's just the sales activity has gotten better; certainly it got a little bit better in the September time frame.

And as a result, again, part of it unfortunately is fairly low deliveries in the third quarter generated some positive book-to-bill.

And then secondly on Cessna, there was a comment you said about a negative adjustment due to pricing.

I was wondering if you could clarify what the situation is there, and also maybe in conjunction with that, what you are seeing in terms of pricing in the used market.

So pricing on new aircraft was pretty stable.

Not a lot of change there from where we were in the second quarter.

There does continue to be softness in the used market in terms of pricing, so I think if you look at [BREF] and Blue Book, we continue to see downward motion.

So that did result in several million dollars of residual write-down of used aircraft, beyond what we saw, let's say, in the second quarter; so I'd say there's still softness.

A lot of activity and quite a lot of transactions, but still softness in pricing in the used market, but I would say stability terms of pricing in the new market.

Thanks, and you mentioned on Textron Systems you are still confident that it's a flat to up environment.

Are you anticipating more negative drag from sequester within that forecast?

As we look across those business segments, Robert, so first of all the precision munitions business is virtually entirely driven by international sales, so there's really nothing going on there from a sequester standpoint.

The same is largely true in our marine and land systems business.

Most of the sales, particularly in the vehicle side of the business, international at this point -- we do have the ship to shore connector program, which is a US government program, although at this point that's in the development phase.

So it's not a lot of money.

The business which is most subject to annual budgets and US budgets really is in our UAS business, although we haven't seen an impact at this point in sequestration.

And we do have some intelligence in software businesses, where we have seen reductions in the number of licenses and things like that.

But at this point, Robert, we certainly have not seen anything material that I would say directly from a sequestration impact.

Great.

Thanks very much.

The next question is from Jason Gursky with Citigroup.

Two quick questions.

Scott, can you update us all on the cadence of V-22 volumes as we move out over the next couple of years?

And then, I'd also be curious to know -- there's been some press reports about Beechcraft potentially being for sale.

Are you aware of Beechcraft being for sale at this point?

So on the first hand, with respect to V-22, the multi-year -- and I know there have been a couple of people with questions, because I think a couple of aircraft moved in terms of which year they're delivered; and there's nothing particularly special going on there.

It's just when the contract was definitized, the number of deliveries per year moved a little bit from what was originally discussed.

But the multi-year contract -- you may push an aircraft between years, but it still is unchanged with respect to the 99 plus so far one of the options, which has been exercised.

So there's no material change in terms of the multi-year two.

With respect to Beechcraft, we see the things in the paper; I know there's a lot of rumors and what not banging around.

Our view of Beechcraft is the same as we've discussed in the past.

There's certainly interest that we would have in some of those assets.

In terms of the status of what's going on, and all of the rumors and the articles, I guess at this point, I wouldn't comment on any of that.

And on the V-22, is there any way for you to offer up specific cadence for the next several years, just to make sure we all model it correctly?

We can certainly do that.

I'm not sure I would do it on the call; but again, it's a contract.

It's a program of record, and if there's any confusion out there as to how many aircraft in which years, we can certainly put something out that clarifies that.

It's in our presentation, Jason.

It's 36 next year and 22 in 2015.

Perfect, I appreciate that, thank you.

We have a question on the line from John Godyn with Morgan Stanley.

Scott, I was hoping to ask about how you're thinking about breakeven margins at Cessna.

And what I'm getting at is of course, the environment is soft, but you've also changed your pricing strategy a bit.

You also continue to restructure and try to drive productivity improvements.

How many jets do we need to sell in a quarter to hit breakeven, more or less?

That's a tricky question, because obviously, it depends a lot on the mix.

What I can tell you is that the way we see it right now is, given where the market has been, the amount of activity that's out there right now, we feel that about the midpoint of where we're guiding to you would basically reflect sort of a breakeven year for Cessna.

Got it.

That's very helpful, and I was also hoping to follow-up on Bell margins.

I thought I heard you say that margins wouldn't recover in the fourth quarter.

I was hoping that you could just elaborate on the specific impact of what's going on with ERP; and if we look out a year from now, should we see margins recover to what we saw earlier this year?

I'm just trying to understand some of the nuance there.

Well, so the issue for us of course is that you saw some of the margin impact in this quarter as a result of higher cost; but at the same time, obviously, we're a relatively long cycle manufacturing business.

And so there's a fair bit of product that is work in progress, which is then executed at the higher cost with those inefficiencies.

And so that will turn into revenue here as we go forward, which is why we say we would not expect a lot of change in terms of margin rate going through the fourth quarter.

I don't think we want to get into 2014 guidance at this point; but needless to say, we're going to be pressured in terms of the margins as we go through the balance of this year and into the beginning of next year, as that higher cost, less efficient production works its way through into revenue, which will happen over the course of the next year.

So the margin rates -- I think if you look at it year-to-date, where we are on Bell is at around probably an aggregate of 12.5%, and that's probably a number that we would expect to see through the balance of this year.

Great, and is there anything you can tell us, just to add clarity to kind of the impact this quarter from the labor disruption, as opposed to the ERP?

It's very difficult, because these things are compounding problems.

When you're going through one of these big IT implementation systems, we've run into a number of issues in the implementation and just sort of working our way through those challenges; and when you do that, you need to do a certain amount of sort of brute force to try to keep things going.

And unfortunately, what we ran into was at the same time we needed to have kind of that brute force to work our way through it, we went through a labor disruption.

So it would be very, very difficult to say how many dollars is attributable to one versus the other.

I think the thing we're focused on at this point is at least we have the labor issue behind us, and now we have the human resources and our ability to get our hourly workforce focused on delivering output, and the management team focused on resolving those issues that we still have outstanding on the integration of the ERP system.

Whereas up until now, frankly our management team and salary teams were working most of their day jobs during the day and were working a lot of overtime and weekends to try to help make sure we got deliveries completed for customers, because we didn't have the ability to get our hourly team in there doing the production work.

So hard to tease out exactly.

And really, the impact here is we could handle one or the other; the fact that we had them both at the same time was a pretty serious blow.

Thanks, really appreciate the color.

We have a question from the line of John Nadol with JPMorgan.

First, at Bell, Scott, were there -- or Frank -- were there -- was there a negative cumulative adjustment taken on any of your major programs that was going to enable you to bounce back a little bit in Q4, or was this all just regular way improvement we're expecting sequentially?

I'm not sure I have the data to say any kind of -- you're talking about accum cash or ASV program adjustments?

Yes, on H-1 or V-22?

No, there was no meaningful negative adjustment; that was prior period adjustment.

Okay, and then, just on the spares issue you've highlighted for a couple quarters, maybe two or three, the ERP system and how that's negatively impacted your ability to ship.

Is the spares demand still where it was?

Because some others had been talking about significantly lower after market demand in the military side for rotorcraft?

No, our demand actually has been up; so as a result, we've actually been building some backlog in terms of spares.

So just to be clear, we kind of went through again --- this is sort of a -- I hate to make this messy, but we have a two-step process here.

With the initial problems we talked about with respect to spares in the early part of the year, when we first turned on our new system, really had to do with our inability to ship.

And when I say that, I mean that the IT system, in terms of generating demand, people knowing what parts to go in and get off the shelf and put it in a box and ship it to our customers, we had a lot of those sorts of issues when we first started our new IT system.

Those have largely been resolved; so the issues we have now in terms of building backlog is, these are parts we need to be manufacturing.

And so the slowdowns and the inability to get enough hours into the factory to actually build the parts has what's been now slowing down our delivery.

So it's purely a matter of working the stuff through and getting the volume out of the factories.

It is not in any way, shape, or form demand-related.

We've actually been building backlog, so there are demand for those parts.

We just have to get them through the factory.

Okay, that's helpful.

And over at Cessna, just on the valuation adjustment, you said it was several million dollars larger than the one you took in Q2.

So it was double digit?

Because I thought you said $8 million in Q2.

I think we're about $11 million.

If you look at forfeiture deposit and used aircraft valuation, that was about minus $11 million.

Okay, and then just finally on the cash flow, you took it down by 100 to 200, which is obviously more than the reduction in earnings.

How much of that is the residual issues at Bell, roughly, and how much of that is either incremental used aircraft or whitetails that you expect to have at Cessna?

I'd say it's predominantly related to our view on the number of Cessna deliveries we'll have, so we'll have more finished goods inventory at Cessna than we would have originally expected.

Okay, thanks.

The next question comes from Noah Poponak with Goldman Sachs.

Scott, somewhere in the call, on Cessna, you made the comment letting the cycle play through, which -- the timing of that is obviously the $1 million question here.

So I just wondered if big picture you could walk us through your own latest version of attempting to quantify how much longer that actually takes?

Well Noah, certainly, we are watching the number of used aircraft available for sale.

That's I think one of the key, if not the most significant indicator at this point; and I think there's two reasons for that, obviously.

One is we look at new aircraft that we're introducing, for which there are either none or virtually no used aircraft, that are like that kind of a product.

We see a pretty strong uptake of the product.

In the cases where we're still selling a product where there's significant competition out there in terms of relatively new used aircraft, we still see sluggish behavior in that marketplace.

So I think we watch that number pretty carefully; and certainly there's some volatility as you see aircraft coming in and going out of the market, but in general, we continue to see the number of used available for sale -- particularly in that less than five year category -- continuing to drop.

Now the pace of that is not as fast as we would like, but it does continue to go down.

So when you're looking out to 2014 for Cessna production, I know it's still October, do you have a law of small numbers situation, where Cessna almost has to be up a decent percentage, just because the starting point is so low?

And you have these multiple new product intros?

Or can some of those legacy programs where you still have a used product issue decline enough to actually keep the total production number closer to flat, or even down again?

Well, look, Noah, I hope it's a combination of both of those things.

Let me just give you -- anecdotally, if you look at something like a CJ4, which has been out there in the market for awhile, and certainly as you came out of 2008, into 2009, 2010, 2011 you got a fair number of used aircraft available for sale that were CJ4s, and we came into this year with around nine of those that were out there on the market.

And I think the soft CJ4 sales were pretty tough in the first couple of quarters.

When we got down at the end of this quarter, we're sitting there -- we know of one used CJ4 out there that's less than five years old, and we see eight sales of new CJ4s.

So there's certainly a correlation of activity between what's out there that we're competing with in the used market versus what we can sell on the new.

So I do think that trend in terms of our volume, we certainly have an expectation that will continue to pick up, as you see these used aircraft go away.

On the other hand, certainly not by design, we're working off a very low base; so yes, at some point the absorption of those used aircraft is going to turn into demand for new aircraft.

And again on the new models, if you look at M2 is a perfect example.

We don't have M2s out there on the market.

There are no used M2s available, because it's a brand new product, and as a result, we've seen very strong uptake in terms of order generation.

So I think part of it absolutely, look, we are working off a very low base.

If you go back and look at historical cycles and sort of average out how many aircraft should go into the market, we're on the way low side of that right now, just given where we are in the cycle.

So we would expect sort of it has to go up, right?

But again, I think we've been thinking that for awhile, Noah.

Let's be honest.

It's gone down lower than we would have ever imagined it to go down, in terms of the number of new aircraft being sold into the market.

And I don't just mean Citation.

You look at the whole market, right?

The number of new aircraft in light to mid from anybody is, all total, is a very small number.

So I think that it would tell you that eventually the cycle has to move in the other direction, and of course I think the new product will help that.

Okay, that's helpful.

Just one other one on systems, with the fee-for-service product, I'm just curious if you can talk about the risk you see of cost implications as you're making that switch back internally, or if you expect that to be fairly smooth?

So I would expect it to be fairly smooth, Noah.

It's going to be accomplished in several phases, right?

So to start with, we've been able to bring in already some of the manufacturing, where we were experiencing pretty significant quality issues.

But in that case, I mean, in large part, we are manufacturing to the same sort of design criteria.

And I think there are opportunities beyond just manufacturing at higher quality, but also putting some design improvement into this product to make it a more robust product.

So that will happen here over the next 6 to 12 months as we go forward.

So the cost side of this thing, Noah, is not something I worry -- obviously we're spending some money to do that, but that's not the big issue here.

The issue for us has just been when you lose, when one of these engines fails, you lose an aircraft; and so the cost of the loss of that aircraft, which is both airframes and sensors and navigation systems, that cost is quite significant compared to the trivial amount of cost of actually manufacturing this engine.

So that's what's unfortunate with this thing.

We have a system out there that's a very complicated system.

It involves control systems; and launchers; and, obviously, airframes, and communication systems and navigation systems -- all of which are working fabulously, but the weak point in the system is this engine.

So it's not costing us a lot.

We couldn't spend too much right now to make that engine work.

Okay, great.

Thank you.

Next question is from Ron Epstein with Bank of America.

So maybe a yet an even bigger picture question.

So Scott, when you think about the portfolio of businesses that you have, I think among investors, the elephant in the room is what happens if we go through another year or two, and the mid and light market still is punky, right?

I agree with you completely, that longer term it's going to come back.

Who knows exactly when, maybe in six months, that would be great.

But say that doesn't happen, right?

So say as the leader of this organization, you're looking at your businesses -- say Cessna is still punky two years from now.

Then the question becomes, all right, Bell gets a little bit tougher.

What do you do?

I mean, how do you manage through that?

I think that's, probably, I think one of the biggest questions right now, among at least the people that I talk to.

How do you think about that?

Look, Ron, you do some things we've been trying to do over the last few years.

You continue to focus on both the cost of your current operations to try to get enough productivity to improve as much as you can; you try to make sure that you're investing in the things so that when the cycle does turn, you're in as good a position as you can be in to do that.

So I think if you look at Cessna today there's no question we've been in a very, very deep down cycle; but as you know -- and again, I don't know either.

Is it six months?

Is it two years?

That's just sort of the unknowable, but the cycle will come back around, and you've got to make sure that you're positioned to capitalize on that.

When we have seen upcycles in the business, we've been able to capitalize and take advantage of that.

But you don't do that if you don't have competitive product, and you don't have the right service network, you don't have the right sales force out there; so I think that's what we'll continue to focus on.

If you look at where we are today, obviously we've spent a lot of R&D dollars, but we're on the cusp of having a new M2, having the Sovereign, having the new X. So I think over time, those investments will have proven to be the right things to do.

As you look into 2015, you're going to have the Latitude coming in.

I think that's the right thing to do.

That program is coming along very well.

It's a significant change in our product portfolio at Cessna, I think one that will be very, very attractive to a lot of our customers out there that want to upgrade from current product into our wider body aircraft.

So I don't know, Ron, if there's really anything you would do different; if you mothball the business, if you don't invest in having the right products, you're not going to be able to capitalize on this market when it does turn.

So calling it is virtually impossible, but I think that we have to continue to do that.

I'd say the same thing is true at Bell.

We know we've enjoyed a great ramp on V-22.

We know where the production volumes of V-22 are going, but we also know that we have the ability to grow that business through the commercial side.

We've been successful at doing that over the last couple of years through some product upgrades, through better focus in terms of how we go to market in the commercial world.

But we also know we need new product, and so the investments in the 525, the investments in the SLS, clearly longer term investment on the military side on the V-280.

All we can do is make sure we're making the right investments, and that we're ready to serve that market as it turns at Cessna, and that we're ready to expand the portfolio and continue to gain share in the commercial market at Bell.

And is there any point -- and you probably can't answer this, so I'll just preface it with that.

Is there any point where -- I think you can kind of see what's going to happen in the two Vs at Bell.

We aren't exactly sure with Cessna, although long term we do think it's going to come back, that where you step out a year or two or three from now, and you have to do something strategically very different, either just pursue a different path and strategy to continue to grow the Company.

Do you ever think about that, or is it just too soon to even think about that?

Well, certainly, across all of the businesses, we look at things that we could do that are complementary to those businesses, to try to give us some more markets and give us some abilities to grow beyond just that core that we're in today.

But now, look, as we've talked about before, we're not going to stray very far from these things.

We need to do things that are the same customers and the same markets in the places that we understand and feel comfortable from an M&A standpoint.

In terms of the current businesses, if you look at Cessna, Ron -- look, if we knew we were two years from seeing a market rebound, it would be wonderful if you had some concept of a way that you could just sort of mothball a business.

I don't think there's any precedent for doing that.

This is a very highly technical business.

You need to have a great engineering team; you need to have a great sales force and you continue, obviously, to service the customers that we have out there today.

So it would be great if you could go into sort of a state of suspended animation.

I don't think you can do that.

I think you hunker down as much as you can on cost and productivity, but I think you've got to continue to make sure you're doing the right things in terms of new product, because that's what you're going to be rewarded for when the market does turn.

If you don't make those investments, then you aren't going to have the upside when it does go.

Sure, and then maybe one last question unrelated to that.

Just, I thought probably one of the coolest new things out there in the last six months was the Scorpion.

Nobody has asked about that.

Can you give us more color on the Scorpion -- and maybe more specifically, how it came to be, and maybe what your hopes are for what it could mean for Textron?

Well, look, Scorpion is a good example of some of the things we're trying to do, Ron.

And obviously we haven't talked much about that.

We kept the thing pretty well a secret for almost two years.

But as we look at what kind of technical skills we have, what we think is going on in market dynamics, and where growth opportunities are in something that's pretty close to home, namely fixed wing aviation, our perspective was that there is going to be a need out there in the market for a military aircraft that is something that has a better performance envelope; more capability than a turboprop, but not something that has the price point and the sophistication and both the acquisition cost and the maintenance and operating cost of something like an F-35.

So if you look at -- historically, the US has had a family, a range, of military product.

The industry, frankly, has usually had a range of military product that spanned all these various price points and capability points.

And the trend seems like it has been for the last 20 years or so to only invest in very, very high-performance, very high-end, fighter/attack aircraft.

And these are amazing machines.

An F-35 can do amazing things, an F-22, and so on and so forth.

But we see a very large customer base out there in both the US as well as a lot of international opportunities that will never be able to afford aircraft at those price points, and yet need a capability and need to replace aircraft here in the coming years that historically have been more affordable to acquire and operate.

And so we decided this was something that was an investment worth making.

And so I think we have positioned ourselves now where we can enter a segment where we have not participated in many, many years, because we see a gap capability in the industry.

So far, I'm not talking about too much about the program yet.

We're making very good progress towards first flight.

Just last week, we were able to run full engine power, and verify inlet designs and air flows; so we're getting very close to starting taxi and flight tests.

We've had a lot of interest from the international community as well as within the US about the aircraft.

And so it's still obviously in its very early days.

But we think it represents significant growth opportunity for the Company.

We're not talking too much about it yet, because it's not quantifiable yet.

But we're working on it.

And maybe just one last question, and then I'll hop, because I know other people have questions.

Most of your peers, as you know, if you look at any of the other defense contractors, typically they aren't willing to, so far, put their skin in the game, in terms of making a Company-funded investment in a new product, particularly a piece of big hardware like that.

When you thought about the business case for it, can you -- any color around -- and I commend you guys for doing it; I hope it's a huge success -- about doing some R&D on your own P&L for a defense product?

How did you think about that trade, because most of your peers don't do it.

Or if they do it, they do it to a very teeny tiny extent.

Well, I think within the defense community, if you look on a purely defense basis, we've been trained over the years that the way this works is that you have a customer who comes out with a requirement, and then you bid to that requirement and you design and develop to that requirement.

That can take a very long time; it's a very, very complex process, a very expensive process.

And in this case, we felt there's -- this was really thought of more along commercial lines.

In other words, when you look at our commercial businesses, we think about market opportunities, we talk to lots of different customers, and then we derive a requirement, and we go design and build to that requirement.

And then we look to go market that capability to many different customers.

So our view, again, seeing what we think is a market opportunity, the whole genesis of this thing was derived, more like you would think about the way -- the process we use for a commercial product.

Talking to lots to different customers, looking at the whole competitive dynamic in the marketplace needs, and deriving and designing and building to our own requirement.

So it's a military application that has been derived through a more commercial process, and as a result, moving more at commercial speeds and at commercial costs.

So it is different, but I think what we're trying to do here is say, look, we understand the military; we understand how you market and sell to the defense -- to the DoDs around the world.

But we're able to leverage and utilize more of a commercial practice in terms of market identification, design, and build, which we think is a unique capability.

Because we understand military, but we understand commercial.

Thank you.

We have a question from Cai von Rumohr with Cowen and Company.

So Cessna, could you give us some color?

Was R&D up, or where was R&D relative to prior quarters?

Cai, R&D was up.

As you can imagine, as we're sort of at the point right now with both the M2 and the Sovereign and the new Citation X all in the certification process, and a lot of work going on on the Latitude program.

As I said, we've got first wing mate; so there's a lot of work going on, getting that aircraft prepped and ready to go into flight test starting next year.

So R&D was certainly up in the quarter, and I would expect that that we will continue to see a lot of R&D spending through the fourth quarter.

So can you give us some quantification, $5 million to $10 million or more?

Cai, we haven't historically done this on a by-business basis.

I guess all I would say is the R&D spending is on track and consistent with what we guided for the year.

And the total number we gave you -- we spent about 75% of that.

So I'd say yes, it was up, but in line with what we had guided in terms of R&D spending across the Company.

Terrific, and then can you give us some color by geography of demand at Cessna?

It stays -- both orders and deliveries in the quarter, Cai, were about two-thirds domestic and about one-third international.

And if you looked at deliveries, it was two-thirds, one-third, and that third was pretty evenly spread between Latin America, Europe, and Asia Pacific.

And then you mentioned near breakeven in the fourth quarter.

That would imply, by my math, something like $80 million -- a swing of $100 million from the third, a $400 million uptick, or a 26% incremental margin.

Is that the way you're looking at it?

Yes, I still think -- as we've always talked, Cai, I think incremental margins at Cessna should be around 25%.

When we go quarter to quarter, we've had some quarters where it's been more or less than that up or down.

And frankly, that's largely an artifact of the numbers are pretty small; and so if you get a few million dollars of aircraft valuation change, or you get a few million dollars of a LIFO or whatever adjustment, it's going to swing around a little bit.

But yes, 25% incremental conversion is about right.

And then pension, maybe you can give us some color; what was your investment performance like year-to-date?

And maybe give us some preliminary color on where you think that could be, both in terms of P&L impact and cash impact next year?

Sure.

We haven't obviously made any decisions about necessarily the 2014 plan.

But as it relates to performance to date, we've been above our expected return level, so we're positive to that.

Obviously, we need to close out the year, but that is positive.

As we look at 2014, I think we should get some tailwind on the pension side.

We'll get a little bit of tailwind from just lower prior period amortization expense.

From a P&L standpoint that's a $25 million-ish type area, when you look at what would flow through the P&L in 2014.

And as we sit here right now, the discount rate if you valued it today is probably 75 basis points higher than it was a year ago; and that would give you another $25 million-ish P&L type impact.

So as much as a kind of $50 million-ish P&L impact, based on where we are today.

Terrific.

And then last question, with regard to Beechcraft, if you were to look at it, under what circumstances would you kind of buy any or all of Beech?

What kind of financial metrics do you have to see, if you were to consider kind of any transaction?

They would have to be good.

Maybe I should jump in and say next question.

Okay, thank you.

Cai, given the nature of where all this stuff is, I just don't think we want to comment.

We certainly wouldn't go into any kind of commentary; it just wouldn't be appropriate.

Okay, thank you.

They're rumors.

Our next question then comes from the line of George Shapiro with Shapiro Research.

A couple questions on Cessna.

One, if I look at the Q3 profit or loss after the $11 million inventory adjustment, you said, so it would have been up about $2 million from the second quarter, making the same adjustments.

In essence, a loss of $12 million versus a loss of $14 million.

Based on what you just said of 25% incremental margins, since revenues were up $33 million, you would have expected the sequential profit to be up $8 million.

So is that difference of $6 million primarily R&D?

Or is it reflecting the mix difference, where you had probably higher margin XLSes versus higher deliveries of the lower margin CJ4?

Yes, George, your math is absolutely correct, and this is what I was referring to.

When we're talking about these spreads of $8 million, a few million dollars of used aircraft valuation; some number, small number of millions of dollars of R&D being up; you look at the fact that we only had a small -- 4 XLSes, which is some amount of mix that's in there.

These small numbers, you can take three or four factors and pretty quickly get to $8 million.

Okay, and then Scott, if you look at the orders itself in the third quarter, there was $654 million.

That's the best third quarter order number since -- in least four years or so.

Is there anything to draw that that is a beginning of some improvement in the market, or is it just reflecting orders for the newer planes that you have?

Well, George, we can only hope, right?

If you look at the quarter, I mean, I can tell you that July and August were -- which are typically slow -- were very, very slow this year.

September was certainly considerably better.

We just -- it would be too early to comment at this point, to know whether that's going to continue through the fourth quarter or not.

So certainly, the number on an absolute basis is encouraging; the dynamic of the fact that it was virtually all the month of September is encouraging; but whether that's the beginning of anything, or how that plays out through the fourth quarter obviously remains to be seen.

How much was the after market up at Cessna?

I know that's been running pretty double digit increases.

After market was up year over year 25%.

15 percentage points was organic, and 10% was due to some service center acquisition activity that was taking place.

Okay, and then just one last one.

Commercial helicopter deliveries.

Last year they were up 20 plus or so in the fourth quarter versus the third quarter.

Would you expect them to be up at least 20 again or maybe even more?

It's going to be in that range, George.

We would expect another pretty significant growth in Q4.

Okay, thanks very much.

Sure.

Next question is from Myles Walton with Deutsche Bank.

Just a couple of quick clean-ups.

You talked about the pension expense side.

Can you talk about the funding side for next year, Frank?

And also with respect to CapEx for the full year, what's the current guidance?

On the funding side, again, we haven't made any decision yet.

We'll see how things close out here.

But I would expect that the funding will come down from what we've been doing in the past couple of years.

So I think they will be with a higher discount rate and with good returns, and therefore a significant reduction in the overall kind of liability relative to the asset pool.

I think we'll be looking at pulling our funding activity down as we look at 2014.

On the CapEx side for this year, we're in the $5 million to $10 million-ish type area at this point, and so we've continued to look hard at the CapEx budgets, and are still spending a lot of money to push forward on all of the important programs that we have.

But we're clamping down a bit on some of the other things.

Okay, so a little bit of a pullback from where you started the year, but not -- you're still implying a pretty big Q4 number?

We've tended to under-spend over the past couple of years what people have looked to want to do.

And we're doing -- we're kind of in the same type of position this year.

Okay, and Scott, on the 25% incremental margins, you pointed out the light versus the heavy.

But what about new versus current -- new products versus in-production products?

How much of a discrepancy are we going to see in the incremental margin as it folds in over the next several quarters?

I don't think you should expect to see very much in terms of the change.

In other words, if you looked at the margin rates of Sovereigns versus new Sovereigns; or you look at the margin rates of M2 versus CJ or the Mustang class, there's not big discrepancies in there.

So I think we'll continue to see a fairly similar margin rate, depending on the mix of the size aircraft you're talking about.

Okay, and the last one for me.

Early in the conversation, you talked about managing the down cycle at Cessna.

But managing the down cycle at Bell is really a lot different, because you can see, map, know exactly at least what the military production is going to be contractually.

So from a standpoint of getting the cost structure right for 2015, when the production, right, of the V-22 aircraft, can you put up the same margins?

Can you put up 13% margins in a context of V-22s at 22, that you can put up at V-22s in the context of 40 deliveries a year?

Again, we don't want to do any long term guiding here, but certainly we have a lot more visibility at Bell today and very good visibility, obviously, with respect to V-22.

And so in terms of cost actions, these have already started.

We've already done several pretty significant reductions at Bell, and clearly there will be more to come as that volume works its way through the factory.

We know exactly what we need to do in terms of the V-22 volumes, and we'll be making adjustments accordingly.

Plus the other part of that, Myles, is not just the reduction in volume, but the contractual rates that we're going to be able to earn on those contracts are different.

So at the end of the day you can't make up all that margin out of cost savings.

Okay, great, thanks much.

We have a question from Julian Mitchell with Credit Suisse.

It's Charlie for Julian.

I just didn't know -- just two real quick ones, because obviously, we're running over here.

Just to know just for expectations, if you could frame, just -- probably don't want to get into specific numbers, but just maybe frame a range, or what you are thinking for M2s; or what you are thinking for the new Sovereigns, just to put expectations in context for Q4.

In terms of--

Just delivery.

Deliveries on aircraft?

We haven't been providing any sort of guidance on particular models, so I don't think we probably want to go there.

Okay, or even just for mediums versus lights?

I mean -- any -- obviously, I think mediums -- sorry, lights through the first three quarters, down about 40; and mediums down a little over that.

But anything different end of Q4?

No?

Well, all I'm going say is you certainly would expect to see more of the mediums in Q4, because we're at least back shipping Sovereigns again that were absent in the second and third quarter.

But that's really the only color, I guess, I would provide on that.

Yes, I just didn't know if you thought, like, Sovereign would be between 5 and 10, or --- obviously, I think it would be higher than that; but if 10 to 20 is a range, but I guess you want to get away from that.

No.

We haven't provided that number.

No.

Yes.

I just -- and then just real quick at Bell, obviously commercial has been strong.

I just didn't know if you had any color on customers, just end market customers.

Is it still a lot of oil and gas?

Where are the customers coming from here?

Oil and gas has still been strong.

A lot of foreign military customers are still in there, a lot of police, emergency medical services.

It really has been reasonably across-the-board.

I think I'd say also, in Scott's comments, we're seeing a lot of good development in demand around the globe outside the United States, like Russia, and China, and Middle East.

Thanks.

One more question, then, Roxanne, as we come up on the hour here.

Last question is from Sam Pearlstein with Wells Fargo.

Just on the Cessna deliveries, I know you don't want to get into specific models, but the increase in the finished goods inventory that you see at year-end -- is that M2s and Sovereigns because the timing of the certification?

Or is it anticipation of the Xs?

Can you give any color as to what's increasing in terms of finished goods?

Well, certainly Xs, because we originally had been manufacturing, expecting to get cert by late this year; those have all moved into 2014.

Beyond that, I guess I wouldn't provide any guidance.

It will depend on obviously how the quarter plays out, and what the orders and sales conversion looks like.

Okay.

And then if I can ask you just a question on Bell and the V-22 multi-year.

You talked about some of the delivery expectations over that multi-year.

We have seen recently companies like Sikorsky talk about a reduction in volume, even within a multi-year.

And so is there flexibility from the customer to adjust those units in delivery and still be able to move that, even though there is a firm commitment on the total?

No, it would be a renegotiation if there was a change.

That's a fixed multi-year contract.

Okay.

Thank you.

Okay, Ladies and Gentlemen.

Thank you for joining us today, and we know we have a couple follow-up calls in queue, that we'll call back.

Thank you very much.

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