達信公司 (TXT) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Textron's third-quarter earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Eric Salander, Vice President of Investor Relations. Please go ahead.

Thanks, Stacy, 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. Textron's revenues in the quarter were $3.3 billion, up $71 million from last year's third quarter.

During this year's third quarter, we recorded $115 million pretax charge, or $0.27 per share after tax, related to the restructuring plan we announced this past summer. We also recorded tax benefit of $0.76 per share related to a settlement of US Internal Revenue Service audits. Excluding these items, adjusted income from continuing operations was $0.61 per share, down $0.02 from last year's third quarter.

Manufacturing cash flow before pension contributions was $94 million, compared to $116 million in last year's third quarter. With that, I'll turn the call over to Scott.

Thanks, Eric, and good morning, everybody. 2.2% increase in third-quarter revenues reflected growth in industrial and aviation.

We had good execution in the quarter with margin improvements, in our Systems and Bell businesses. Despite the increase in revenues, adjusted earnings per share was down $0.02, primarily the result of higher corporate expenses, which reflected higher stock-based compensation expense, and higher spending on the Scorpion program. At Bell, revenues were down slightly, as lower commercial units delivered in the quarter more than offset higher military volumes.

Specifically, we delivered 25 commercial helicopters, down from 45 in last year's third quarter. We delivered six V-22s, up from four units last year, and eight H-1s, up from five last year. Our V-280 Valor program continues to progress, with assembly of the first aircraft approximately two-thirds complete, and on track for first flight next year.

We also announced a new military tiltrotor product, the Bell V-247 Vigilant. The Bell V-247 Vigilant is a Group 5 unmanned aerial system that will leverage the investment we are making in the V-280 platform. The 247 design will provide unmatched speed, payload, long endurance capabilities, and runway independence to fill a multitude of missions, including maritime environments. At the AUSA show earlier this month, customer interest was high around both our V-280 mock-up and the Bell V-247 model that were on display.

On the commercial side, while deliveries were down significantly in the quarter, we saw an increase in order flow. As we consider current customer activity and contract opportunities, we believe that Bell commercial helicopter demand has stabilized, and may be in the early stages of recovery.

On our new 505 Jet Ranger X, we continued to make progress on certification, and we expect to achieve this initial certification late this year, with deliveries beginning shortly thereafter. During the quarter, we were awarded two FMS contracts for 13 Huey II helicopters to be delivered in Uganda and Kenya, with deliveries beginning in the fourth quarter. Overall, given the challenging commercial markets, we had a strong quarter at Bell, as cost productivity efforts over the past several years contributed to a 13% segment margin.

Moving to systems, revenues down, as higher revenues at Marine & Land Systems were more than offset by lower weapon deliveries. As you know, we announced that we will be discontinuing production of sensor fuzed weapons in March of next year. As a result, we are taking actions now to reduce costs across the systems segment.

At TMLS, we began initial TAPV deliveries to our Canadian customer in the quarter. Looking to the fourth quarter, we have a significant ramp in deliveries, although slower than we had originally planned.

Moving to industrial, we saw 7% increase in revenues, reflecting the impact of acquisitions and higher volumes in our automotive and specialized vehicle businesses. Last month, we announced we will be consolidating Jacobsen with our specialized vehicle business, to optimize efficiencies and better serve the companies, shared customers and distributors. Also in the vehicle business, we recently acquired SAFEAERO, a Swedish manufacturer of de-icers for the commercial aviation industry. SAFEAERO will be part of our ground support equipment portfolio, which continues to grow very nicely.

In our commercial business, we introduced a new line of Cushman Hauler utility vehicles, while in our consumer product line, our distributors kicked off retail sales of our new Stampede 4x4 off road product. At Kautex, our selected catalytic reduction product lines continued to drive growth above their current auto market.

Moving to Textron Aviation, revenues were up $39 million in the quarter. We delivered 41 jets, compared to 37 last year, and 29 King Airs, flat with last year.

On the new product front, the launch tube made its first flight on October 8, marking an important achievement in its path to certification and market entry. This first flight occurred less than a year after unveiling the launch tube at NBAA last November, demonstrating our rapid new product development cycle with targeted certification later next year. Customer anticipation of this new aircraft remains strong, as we have begun executing purchase agreements with potential customers.

During the quarter, we also unveiled the Cessna Denali, our new clean-sheet single-engine pressurized turboprop. The Denali will feature superior operating performance, with the only flat floor cabin design in its class, and will easily convert between passenger and cargo configurations. We are not currently serving this market segment, and believe the highly differentiated Denali will contribute to significant future growth in aviation with its best in class performance characteristics.

Moving to Scorpion, the program continues to make good progress, and we expect first flight of our initial production aircraft very soon. Last week, we conducted successful weapons testing with our existing aircraft at the US Air Force White Sands proving ground.

With the accreditation process now underway and customer interest increasing, we have accelerated investment in the program. We have begun building several aircraft to support the accreditation requirements, validate our manufacturing process, and expand our marketing and customer engagement activities. Moving to an update on our restructuring plan, we have announced additional headcount reductions across our businesses, principally through a voluntary separation plan in our aviation segment, and have increased our cost estimates accordingly.

To wrap up, while several of our end-markets remained challenging in the third quarter, we still achieved top-line growth, while furthering our development efforts on major new perhaps. With that, I will turn the call over to Frank.

Thank you, Scott, and good morning, everyone. Segment profit in the quarter was $310 million, down $2 million from the third quarter of 2015, on a $71 million increase in revenues.

Let's review how each of the segments contributed, starting with Textron Aviation. At Textron Aviation, revenues were up $39 million from this period last year, primarily due to higher pre-owned aircraft volume and the impact of an acquisition. Segment profit was $100 million, down from $107 million a year ago, primarily reflecting the mix of products sold. Backlog in this segment ended the quarter at $1.1 billion, approximately flat with the second quarter.

Moving to Bell, revenues were down $22 million, primarily due to lower commercial deliveries, partially offset by higher military volumes. Segment profit decreased $2 million from the third quarter of 2015, reflecting the lower commercial aircraft deliveries. Backlog in this segment was $4.9 billion at the end of the quarter, or approximately flat with the second quarter.

At Textron Systems, revenues were down $7 million, primarily due to lower weapons volume, partially offset by higher revenues at Marine & Land. Segment profit was up $5 million, reflecting improved performance. Backlog in the segment was $2.2 billion, down $74 million from the end of the second quarter.

Industrial revenues increased $58 million, due to the impact of acquired businesses and higher volumes. Segment profit increased $5 million, reflecting improved performance. Finance segment revenues increased $3 million, and profit decreased $3 million.

Moving below the segment profit, corporate expenses were $53 million compared to $27 million last year. As Scott explained, this reflected higher stock-based compensation expense, and the accelerated spending on our Scorpion program. Interest expense was $35 million, up $2 million from last year.

With respect to our restructuring plan in the quarter, we recorded pretax charges of $115 million on the special charges line. Looking forward, our revised cost estimate for the total restructuring plan is now a range of $140 million to $170 million pretax, up from $110 million to $140 million, to reflect the additional reductions that Scott discussed.

Cash outlays associated this plan are now estimated to be in the range of $100 million to $120 million, compared to our previous estimate of $65 million to $85 million. We recorded a total income tax benefit of $319 million in the quarter, related to settlement of US IRS audits for years 1998 through 2008. $206 million, or $0.76 per share, was attributable to continuing operations.

To wrap up, we are narrowing our adjusted full-year EPS from continuing operations guidance to $2.65 to $2.75 a share, which corresponds to GAAP EPS of $3.06 to $3.21 per share. Given our accelerated spending on Scorpion, higher investment in restructuring, and slower TAPV deliveries, we are revising our outlook for cash flow from continuing operations of the manufacturing group, before pension contributions to $500 million to $600 million, down from the previous estimate of $600 million to $700 million.

That concludes our prepared remarks. Stacy, we can open the line for questions.

Thank you. We will go to Noah Poponak with Goldman Sachs. Please go ahead.

This is Gavin on for Noah. Just looking at the broader business jet market, it seems like it's weakened a little bit lately, with some of your competitors announcing production rate cuts over the last couple of quarters. And then you look at deliveries ex-Latitude, mostly flat, with a little bit worse mix. So I'm curious if somewhat on the cannibalization subject, what do deliveries look like ex-Latitude for the next couple of years, and is there pricing pressure in the market more broadly, in addition to these new model introductions you have lined up?

Gavin, I am not sure I would try to harbor a guess as to the next few years of what the market looks like, but I think that where the market is right now, it is certainly still soft. I would say it's more or less in line with what we expected this year, which is to say that most of the growth is driven by the new products that are coming onto the market. That's certainly been true with Latitude.

The market for the historical products is pretty flat, and, yes, there continues to be a pretty tight market, that's difficult to get any pricing, but it's up a little on some models, and down a little on some models. So it really is consistent with what we have been seeing for the last couple years. So our plan, obviously, is that the only growth that we have been seeing has been driven by the new products to come out into the marketplace. That's why we continue to stay focused on bringing Longitude to the market, and bringing Denali to the market, ultimately bringing the Hemisphere to the market, because I think that's -- at least if the market environment that we exist in today, that's the only way to drive growth, and you continue to expect that the legacy historical product lines will be relatively flat.

Thanks. And when you look at -- could you try to size maybe the net impact of membership clubs? Kind of Uber for business jet, if you will, where that's much higher utilization, but it's bringing in new users who potentially hadn't had access to business jets before?

Well, I don't know that I would go all the way to the Uber side. Obviously, we have a couple of very important customers that are in that non-retail own your own aircraft market. NetJets, to the extent they're obviously selling these aircraft to fractional customers, and they're card-based, and NetJets has a pretty broad range of product that they provide to reach people that aren't owning their own whole aircraft. So that's an important part of where we are today with Latitudes.

Obviously, on the King Air side, you have guys out there like Wheels Up that are operating primarily King Airs, and also aimed at a non-equity and a broader base of potential customers. So we see some of that. I mean, these are very real customers that are taking delivery of aircraft, and are running pretty significant businesses today, and appear to be doing so successfully. How much broader we see that market, or how far that reaches to what customer segments in the world, I think, is still to be determined.

There are a lot of different models out there. Some of them are going to work, and there's other ones that may not work, but certainly we have a couple key customers that are in line with I think your question. How do you reach a broader base of people to get into a private aircraft, and today, we certainly see that happening very successfully with both the NetJets of the world as well as the Wheels Up of the world.

Thank you.

We will go to Carter Copeland with Barclays. Please go ahead.

Just a quick clarification on the Scorpion comment. I think earlier in your prepared remarks, you said higher spending, and then in most of the other places, you said accelerated spending. I just want to clarify, is there any cost growth in the manufacturing efforts early on, or is this all related to pulling forward investment that you intended to do further down the line?

Yes. The increased spending is an R&D expense, all right? So we are in the process of getting ready for our first flight. We have also undertaken some things like going out and doing actual weapons deliveries. So the cost of those activities, obviously a lot of cost is around bringing the first production unit to the market, and developing our manufacturing processes, as we start what I refer to as a limited rate production run are expenses that we accelerate.

These are things that certainly could have been put off and originally would have been done in the future, but I think as we have established this with the Air Force, and now have a path to certification, the level of activity with customers has stepped up considerably, and it's the right time for us to step up and demonstrate this aircraft and its performance capability, and get much more aggressive about the marketing and test flights.

And I think it's the right time, based on what's going on in the customer community, to really mature this program. So those are largely expenses that we have pulled forward, because we think we need to do it now. I think waiting a year or spreading it out over a longer period of time won't help us given the opportunities that we see out there in the not too distant future.

Okay. Great. That's great color. And then on the comment you made regarding demand stabilization and potential recovery at Bell, I wondered if you might give us a little bit more color there, and what's driving that view?

Is it customer pipeline and conversations? Obviously, the backlog was flat year over year, or sequentially. Any more color on that would be helpful.

Sure. I think in the last quarter we have seen a pretty significant uptick in the number of orders that we booked, compared to the first half of the year. Now, this is still down from where it was in its peak. We are not suggesting that this market has recovered, and things are great. But we had a year where order activity was extraordinarily weak.

So we are starting now to see customers that are coming forward, actually signing deals and closing contracts, and in particular, there is a number of campaigns that are in process, where quotes are out there, activity is happening, and clearly deals are going to close. That's the rationale for our color on that.

We are coming out of a year or so here of a very, very, difficult environment in terms of closing any deals, and I think in the last quarter, we saw a lot of deals close, and a lot of deals that are active and in progress. So it's, again, it's not where things were in the great days, but it's certainly positive to see an uptick in activity in actual orders.

Great. Thanks for the color. I will let somebody else ask.

We will go to the line of George Shapiro with Shapiro Research. Please go ahead.

The aviation margin was somewhat lower than what I was looking for. On the second quarter, you said that you would see lower R&D on the Longitude in the third -- in the second half of the year, and pricing may be a little bit better. So could you just comment on that?

And then also, to get to the low end of your 8.5% to 9% margin would require a margin north of 11% in the fourth quarter. So is that doable? And if not, what would you suggest is the range now?

Well, a couple things, George. First of all, the R&D, as we went from Q2 to Q3, did come down in the business. I think if you look at the sequential margins, are pretty good from Q2 to Q3.

But if you look on a year-over-year basis, there is no question that the leverage wasn't there. I'd say most of that is a result of the fact that our revenue growth, on a year-over-year basis, was largely driven by used aircraft sales and the inclusion of our acquisition at Able, which is a great little business, but in its first year with deal-related costs and step-up and all that stuff, its first year is a break-even. If you look at that model, you have $50 million-plus of revenue in there that's not -- that has no margin. It's used aircraft in the first year of that deal.

So that's the bulk of where you don't have leverage, where you would probably have expected to see some of that leverage, and the rest of it still is this ongoing mix issue. We did have positive pricing on the retail side on Latitude in the quarter, but it's still at lower margin rates than what we typically see in the rest of our portfolio. Obviously, all of the mix shift in the quarter, as we mentioned, you see the numbers in terms of aircraft.

We had a couple more Mustangs. We had a couple more M-2s. We certainly had more Latitudes, but we also were down a couple of XLSs and Sovereigns, so from a mix standpoint, that certainly pressured some of the conversion as well, as on a year-over-year basis.

And what would you suggest now for margin for the year, where you had been at 8.5% to 9%?

I think that's going to be at the low end of that, George. Part of the rationale for -- a large driver for the rationale for why you see us narrowing our range is that the top end of the original guidance range would have been a stronger year in the business jet market.

Obviously, it has continued to be pretty flat, so we're probably going to be more towards that midpoint, which is why we revised our guidance. As it comes to the segment, I think we are probably expect something more around the 10% margin rate in the quarter for aviation, as opposed to something that would bring it high enough to bring it up into the midpoint of its range.

Okay. And then if you could -- after market growth in the quarter, if you took out Able, so on an organic basis, what was that?

Pretty flat.

Okay, thanks very much. I will get back in the queue.

Jason Gursky with Citi. Please go ahead.

Could you dive a little bit deeper into the TAPV program? You suggested volumes are going to be a little lower than initially expected. Can you tell us why and what to expect going forward? And then just comment as to whether the inventory levels on the balance sheet are related in part to the TAPV program?

Sure. So, we did make the initial deliveries in the quarter. Going through that process and dealing with normal -- I'd say normal. We had more issues, just in terms of consistency and flowing vehicles through that process, than we would have expected.

The good news is we are now -- we are making deliveries every week. We have agreed with the customer on how many units they're taking, and that process appears to be flowing. It is at a lower level than we would have originally planned in our RLP. We will make a fair number of deliveries here in the fourth quarter. We will certainly not get to where we would have expected to be, and that's part of our cash pressure.

We will have higher finished goods inventory on the TAPV program than we would have expected in our plan. So that is certainly a significant part of the downward revision on our cash for the year. So, again, there is no major issue there.

The vehicles, every week we're delivering vehicles. Vehicles are going in and being delivered to the customer. But it's at a lower run rate than we would have planned.

Great. And then, Scott, really quickly on business jets, could you talk a little bit about the fourth quarter set-up here? Does this fourth quarter feel similar to what you have experienced going into the fourth quarter the last couple of years, with regard to how many bookings you have in hand, with the pipeline, and how you close out the year? Is it going to be as seasonally strong as we've experienced here the last few years? Thanks.

We normally have still aircraft to sell. The good news is, in terms of things like the Latitude, are in a very solid position. But there are aircraft to sell, and we are closing orders, which is what we expect to see happening. We have NBAA coming up here in a couple of weeks, which is usually a pretty significant event in terms of customer interactions, and we would expect to see a number of closings come out of that, as well. So it's where we've been. We always have aircraft to sell.

Sorry. If we can go to the next question? Is that okay, Jason?

We will go to Pete Skibitski with Drexel Hamilton. Please go ahead.

Scott, on the incremental Scorpion spend, you talked a little bit about it, but could you give us an updated sense of when you are expecting certification from the Air Force? I don't know what else you would be comfortable talking about, in terms of maybe expectations for a first order or a first delivery?

We don't have a firm date yet with the Air Force. Our teams and the certification folks at Wright Pat are working together very carefully. It's frankly quite busy. There's a lot of activity going on, a lot of detailed test plans being finalized and data being reviewed. It's in the throes of the process you'd expect.

It's a very active cert program. We did a lot of work here over the last month, obviously, to get ready to do a weapons drop, which was very successful last week. So that was above and beyond the certification work. A demonstration of its capability, which I think was very important to our prospective customers, and was being watched very carefully.

The acceleration on the production process maturing obviously, we have been always planning to do this initial production configuration aircraft, to support the certification program. Given the level of activity, we have gone ahead and pulled the trigger on initiating a small production build to help validate our manufacturing processes, as well. We have a lot of customer conversations going on right now.

We think there is a number of opportunities to demonstrate this aircraft. We have a bunch of customers that want to fly the aircraft. That's really what led us to accelerate both the expense side, as well as to bring in the inventory and initiate the limited rate of production, because we needed to have these assets available for customer demonstrations, customer flights, and hopefully eventually customer sales. I won't provide any color on a specific closure date of any particular contract, but there's a lot of customer activity and a lot of discussions ongoing.

Okay. Okay. You're feeling good about that program. One follow-up on Bell. Your comments on the market, does that include the 412?

That was a rough quarter for the 412? Are there campaigns out there? Are you feeling that the 412 would come back? If you could up date us on the 525, if the flight tests are still suspended or not?

Sure, so the 412 is certainly a very important part of what we see in this recovery. There are a number of 412s, deals that have closed, and there is a number of 412 opportunities that are out there, that are actively in negotiations. So I think the 412s are an important part of what we see, making a turn as we go into 2017 and beyond. So that's very positive.

With respect to the 525, again, this is an NTSB-run investigation. They are managing that process. We are obviously cooperating and supporting them in every way that we can. The flight test program is still not moving forward. We have teams that are making preparation for what return to flight looks like, and being ready to do that.

We obviously continued to do all the non-flight test-related certification work, which is continuing to progress well. So we don't have a time or a date on the exact return to flight. That's a process we will have to manage through working with the NTSB and the FAA. But that investigation work continues to progress.

Thanks, Scott.

And we will go to Cai von Rumohr with Cowen and Company. Please go ahead.

So your corporate expense was up. Was most of that the accelerated spending on the Scorpion? If so, how does that change your R&D expectation and corporate expense expectation for the full year?

Well, it's probably about half and half split, Cai, between the accelerated spending on the Scorpion program, which is flowing through there, and also the stock-based comp, because we revisioned that a year ago. The relative year-over-year comparison is up. So it's split between those two factors.

About $0.03 to $0.04 each of an impact. And I would expect to see that flow continue through the fourth quarter, as we continue the spending on the Scorpion program, getting to first flight and continuing to work the certification and manufacturing process validation.

On the corporate expense line, that obviously will depend on what happens with stock price in the fourth quarter, and there's always those impacts, but it will probably be a touch higher than we had originally guided, in terms of total year. In terms of total R&D, it's not -- it won't change the total R&D spending.

No, it's not a material number to the total R&D of the Company, Cai. But the R&D, I would expect a continuing pace on the Scorpion program, as we have accelerated that. Obviously, the stock-based comp piece is a whole separate issue in terms of what that is in the fourth quarter.

Right. But so the guide actually was narrowed, and so it sounds like we're talking $0.07, $0.08 incremental spending on Scorpion. Is there an offset to is that? A lower tax rate? Stronger ops, in terms of the outlook?

I would say all of the above, Cai. I think we have seen -- if you looked at where we thought from the beginning of the year, I think Bell is performing very strongly. I think the systems business is performing very well, even in light of challenges around the delays on the TAPV program. Industrial guys are doing quite well.

Again, aviation is -- they are performing well in a very difficult environment. Probably not going to get the leverage and growth we would like to have seen to be towards the top end. Then you throw in a little bit of the acceleration on Scorpion, that's where we end up, with all those puts and takes around the midpoint of what we guided.

Last one. If you look at Bell, if you hit your target on V-22s, they are going to be down a lot in the fourth quarter. And so even if you get a pickup in commercial, and certainly based on the third quarter, you got a long way to go. Bell looks like it has a tougher fourth quarter coming up. Does your guidance there change for the year?

No. I think there is -- again, the performance at Bell all year has been strong. I think the productivity that we have expected has been delivered on, and I think the team will close out on a strong year.

Thank you.

And we will go to Sam Pearlstein with Wells Fargo. Please go ahead.

Could you talk a little bit more about the restructuring? You increased it from where you thought at the end of August. You mentioned mostly on the aviation side.

Is there a driver there? Is it that the pricing you thought might come through didn't, that causes you to want to restructure your costs? Could you talk a little bit about that?

I wouldn't attribute it directly to pricing, but I would say obviously the aviation market continues to be challenging, and while we are pleased with the impact the new products were having, the legacy historic market is still a challenge. As we look at what we need do to try to sustain margins, and keep the business productive and competitive, we thought the most appropriate way to do that was look at another cost restructuring there.

We are doing the bulk of it, frankly, through a voluntary program, which has been well received. But we really, in order to keep costs in line in a challenging market, felt it was appropriate at this time to do that. So -- and that's driving the bulk of the net add to the restructuring program. We obviously understood what we needed to do with our exit of the weapons business, and overall, what's going on across the systems segment. But it was the right time to take an action in the aviation side, as well, given the overall weak demand environment in that industry.

In the $100 million to $120 million of actual outlays, is that all in 2016?

No, it will be split between 2016 and 2017, Sam, so it's probably -- we'll probably be close to half this year and half into 2017.

Okay.

A lot of that is severance. While we have some of the severance costs will be borne this year, a fair bit of that will roll over into the beginning of 2017.

Okay. Last question. Just looking at even the new manufacturing cash flow guidance, pretty substantial step up in Q4, over $500 million probably in free cash. What is it that drives that big step up?

Well, we typically see a strong quarter on the aviation side. All of that inventory which has been accumulating throughout the course of the year, which is pretty normal for us, I think we will also see -- again, we are starting to flow more deliveries on the vehicle side of the business, which is largely direct conversion into cash. Those are two of the biggest movers.

Okay. Thank you.

And we will go to the line of Sheila Kahyaoglu with Jefferies.

Just to follow up on the restructuring, how are you thinking about it across the segments? I've seen some announcements in aviation and within industrial. Anything in Bell, and also, how do you think about the payback there for 2017?

So the bulk of the restructuring activity, that we have added, obviously was aviation. So the previous restructuring, we talked about it was largely systems driven. There is some associated with the move of Jacobsen into the specialized vehicle business, as we shut down the Charleston manufacturing operations, and moved that down to Augusta. That's really the only part that's in the industrial segment. So the bulk of it is between systems, and now with the reductions at aviation pretty heavy in that segment.

From a payback, Sheila, there is a combination -- part of this restructuring, obviously, we expect to see in the traditional pay back over a typical personnel-related cost, six to nine months. Part of this, obviously in particular with that, associated with the shutdown of the weapons and sensors, SFW line, there is no payback there. This is the exit of a business. I think the right way to think about this on a go-forward basis is that we will probably see annualized benefits that are roughly equivalent to that $100 million, $120 million that we're expending.

Got it. And so within aviation, I guess the $30 million is roughly the payback there. Not to pin numbers down on that. And maybe just to follow on to the aviation margin questions. How could we think about the steady state margin from here. Is it the 7% to 8% mark, assuming R&D is at a normalized level and the pricing dynamic continues on the Latitude?

Well, I think we'll finish the year, obviously, clearly towards the low end, or even a little below the initial guidance we would have given on the aviation segment. On a continuing basis, we are probably not ready to do 2017 guidance yet, but it will all depend on what market we see, and what volume leverage we think we're going to get. Right now, we are expecting most of it to be driven by Latitude next year, with a little bit of growth driven by Longitude. We will hopefully get that certification done, and maybe get a couple of initial deliveries in latter part of next year. But again, when you look at the margin rates, it's all going to be a matter of what leverage can we get, and right now, that's largely new products driven.

Okay. And then just last one on King Airs. Can you talk about what you are seeing in the demand environment there?

So King Air deliveries were pretty float. I think that the demand levels have been pretty steady through the course of the year. Obviously, they are lower than they were last year. I think we had a good quarter, with flat deliveries.

One of the challenges for the King Air obviously is, it's a more international product. I'd say probably about, where we are right now, we're about two-thirds US, one-third international on the King Airs, and international markets have been somewhat more challenged than the US markets. We feel good about the King Air, where it is, and sales have been holding in there. It continues to be a pretty popular product.

Thank you.

We will go to the line of Julian Mitchell with Credit Suisse. Please go ahead.

First question would be around the capital deployment. So if I think about the first half of the year, you issued debt and did some buyback. Q3, you paid down some debt, no buyback. Has anything changed on your perspective on capital deployment? And maybe give us some color around how you look at the inorganic growth opportunities today?

Julian, I think our perspective hasn't really changed. Obviously, we are committed to at least doing the buybacks, to avoid share dilution. That has been more than accomplished already in the buybacks that we did in the first quarter. We will continue to look at it opportunistically.

As you pointed out, we did deploy capital. Repaid debt here in the third quarter, which was obviously something that we needed to do. In terms of on a go-forward basis, we continue to provide that same guide. We are going to avoid dilution, and we'll do the buybacks as we see opportunistically appropriate.

On the M&A front, on a year, it's been fairly quiet here lately. There has been a couple small deals, like the SAFEAERO deal, which is a very nice little bolt-on for our ground support business, which is doing very well for us. We are very pleased with that business.

Continuing to round out the offerings that we take through that channel to the same customers, and the same service and support channels. It makes a lot of sense to us. On the other M&A side, we continue to look at things. There is nothing large that we would say is imminent, but we're always keeping our eye on opportunities that would help to strengthen an and grow the businesses.

Clearly, we have a very lightly leveraged balance sheet. We have the capacity and the ability to do something if something comes up.

Thanks. And just going back to the aviation restructuring again, not so much the spending and payback and so on, but more a question around the genesis of it. It doesn't sound as if the aviation market, in your perspective, changed much from July on the Q2 quarter, to today.

So, but at the same time you have launched an incremental restructuring. Is it more the case that the market maybe back in January, you thought you would see a bigger pickup in the second half than what you're actually seeing, or is it the case that the market sequentially did deteriorate slightly?

Julian, it's not a huge swing one way or the other. It's just been fairly flat on those legacy sides, and when we look at our cost structure, we have obviously been spending a lot of money and doing a lot of things, particularly on the R&D front, and a lot of new product programs. And as you look at that -- the market environment and margins and I think expectations for the returns that we need to provide, it made sense to take a look at it and see if there was some restructuring we could do to try to further improve our cost position

I don't think the market in the segments we serve have gotten dramatically worse. It's a stubbornly soft market, and I think that was reaction, is just try to improve our cost position as we fight our way through that.

Very clear. A last quick one. Bell margins. Should we expect those to come in at the high end of the initial range that you had provided?

Yes. I think Bell has performed extremely well, in what was certainly a very difficult market, and will probably be towards the high end of our initial guide.

Thank you.

We go to the line of Seth Seifman with JPMorgan.

I was wondering if you could talk a little bit about the after market at Bell, what it did in the quarter, and how you see it progressing in the context of this stabilization of demand that you have discussed?

Bell after market was up in the quarter. We have reached the project here where we are more than a year now into the -- what was a fairly significant drop-off in utilization, associated with the oil and gas market in particular. We are starting to get a little bit more favorable comps, and we did have a positive quarter on the after market side. Now, as you know, Seth, from any given quarter to quarter, it's going to be sometimes flattish, sometimes up a few points, and we expect that's the trajectory that we should be on going forward.

Thanks. Last one for the industrial business. The margin guidance that you have given previously implies a pretty strong fourth quarter for industrial. Not necessarily relative to what we saw in the first half, but relative to the typical seasonality in industrial. Is that something that's reasonable to expect? Is there anything in particular that's driving it?

Nothing in particular, Seth. The industrial segment, I mean, there is obviously seasonality to some of the businesses, and we will expect to see that normal seasonality. But if you look at the margins that we expect on a total year basis, it should be consistent with what we guided. So I don't think there is -- there is nothing notable in the segment.

Okay. Excellent. Thank you very much.

And we will go to Peter Arment with Baird. Please go ahead.

Most of my questions have been answered. Just a clarification, Scott. You mentioned on the Scorpion, the first flight very soon, is that still expectations before the end of the year, or a little color on that?

Oh, yes. No. I think very soon.

Okay. That answers it well. Thank you, Scott.

And we will go to Myles Walton with Deutsche Bank. Please go ahead.

I am not going to go by segment, but Scott, maybe at a high level when you started the year in sales, it was $14.3 billion of sales, if I triangulate where you are and what you said on commentary, is $13.8 billion the right range that you are shooting for? Flattish year on year in the fourth quarter?

I haven't gone through that number. So I'm -- I probably shouldn't do math here on the call.

Yes.

The reason I ask, I mean it sounds like tech systems, obviously you have had a slower TAPV and that's where a lot of the growth is. Bell, you have got a tough comp with last year. Maybe a triangulation on the top line would be helpful.

Well, I say I want to be careful here, not to do too much math, and make a mistake on the systems side. Look, I think we will -- if you are thinking about year-over-year kinds of numbers, I think systems will still have a relatively strong fourth quarter. There is a couple of pieces of that, obviously. We are flowing the TAPVs, which we didn't have before.

We also have deliveries of another US contract, which is Iraq and Colombian ASVs, which will be in there. As you know, we always have a little bit of lumpiness here on our sensor fuzed weapons, and while there is none in the third quarter, it's because we have another delivery to our customer in the fourth quarter. Particular to the systems side, I think you will see a pretty strong fourth quarter, in terms of year-over-year growth.

And then Bell I would think though would be the offset to that on the lower V-22s, unless the guidance point, there's a higher delivery?

That's correct. That's correct. Certainly, on a year-over-year basis you will see a lower revenue number at Bell.

Okay. All right. And then at Bell, there -- was there any positive VAC, sizable of note, in the quarter?

Pretty much the same as it was on a year-over-year basis.

Okay. And then the last clean-up. Fourth quarter tax rate, Frank?

Probably around 30%. Full-year 29%, 29.5%.

Thanks.

And we will go to Ronald Epstein with Bank of America. Please go ahead.

Just a couple quick questions for you. Maybe I'll start off with Frank. When you look at the inventory, from quarter to quarter, it went up a couple hundred million bucks, and year over year, it looks like it was $700 million or $800 million. What's driving that?

Yes. Well, as we said, we have seen some lower deliveries on the TAPV which has contributed to a little bit of it. If you look at it, we started the year a couple hundred million dollars up in inventory, versus the end of 2015. We have, frankly, inventory has increased at about the same rate, through the first nine months of 2016, versus the first nine months of 2015.

So we are seeing the normal trending of inventory. We do have some slightly higher inventory levels than in some areas like TAPV than we would have planned for, which is putting a little bit of pressure on cash. It's not wildly off from what we had expected, or what we have seen in previous years, just given the seasonality of the business, there is some additional pressure or some additional inventory in there also for Scorpion as we talked about, that we wouldn't have on a year-over-year basis.

One more question for you, Frank, and then I have got one for Scott. Organic growth, revenue organic growth year over year, was it approximately flat if you take out the stuff from acquisitions?

Yes. It was -- yes.

Okay. Fair enough. That's what it seems like.

Yes.

And then, Scott, a lot of talk about Scorpion this morning, which, the airplane I love. We have been talking about that one for a long time. I think, and maybe you picked up a little bit of this on the call, I think there is some skepticism in the investor community about a Company-funded defense program, right? So things like the Northrop F-20 pop up and that thing. When you think about the return of investment on the Scorpion, and what your expectations are for this program, how can you make us all feel comfortable that, yes, this was a good place for Textron to invest their money?

Look, Ronald, I think we have been running this program for a few years now. We have been able, for the most part, to run this thing in a way that was at a low enough level of investment that we were making accomplishments, getting the first flights, being able to talk to customers and feel out what this market could be, from just the original theory of what it might be, to interacting with real customers, engaging their level of interest. I would say over the last few years, we have been able to run it without making an impact that would be problematic.

This is the first quarter where we have had to say, look, this is having an impact on what we would have guided you, both in terms of expense as well as some cash impact as we build inventory to actually make a run of aircraft. This is certainly not still at a short bet standpoint.

Obviously, we would not do that, and make those investments, and take that hit, in terms it of near-terms earnings and cash, if we didn't think that the level of customer interest that we are seeing, the fact that we have a path to certification, the fact that we have demonstrated weapons capabilities, the level of interest that we have had from customers that we have been talking to for a number of years, has become strong enough that we felt it was time to accelerate that spending, and be willing to invest some of our cash to be ready to do a limited production run here.

So is it a sure thing? No. Do we see that the opportunity is real, and that we think that there is a real future for this thing? And something that could be a profitable line of business for the Company? I would have to say the answer is yes, or we wouldn't have made the decisions to go ahead and take some pressure on our earnings, and pressure on cash to really take that final step and bring this thing to the market in a very real, credible way.

So one follow-on to that. When you think about the return on invested capital, one would think you could do better with this, than you can with the purely commercial program. Is that a reasonable view?

Well, I think when we look at what we believe -- and again, the conversations with customers on where we can price this aircraft, it's a very -- from a customer's perspective, a very competitive price versus the options that are out there in the market in terms of the performances that you get for the dollar, the capability per dollar. So we think we can do that, and have it be a very solid, profitable program for us.

Great. Thank you very much.

We will go to Justin Bergner with Gabelli & Company. Please go ahead.

Just a couple clean-up questions. In terms of the changed cash flow guidance, it seems like about half of the change is coming from the cash restructuring outlay, and half from perhaps higher inventories on the TAPV side. Is that how I should think of the bridge, or are there other pieces to think about?

Well, I'd say there are a number of pieces, as any year, of cash coming in and out, and inventory levels. But for sure, when you look at, there is a pressure on the restructuring cash out. There is a pressure on slower TAPV deliveries and some Scorpion inventory coming in, but there is some positives in other areas, and some better working capital management. There is a lot of moving parts, that sums to that. Certainly what you mentioned are two of the biggest movers, in terms of contributors of the pressure.

Okay. Great. And then given your glass half full comments on Bell, are you optimistic about the backlog growing in future quarters, or is it more a function of the higher orders allowing for backlog stability going forward?

I think we will see some better backlog on the commercial side. Remember that the backlog in that business is very lumpy because of the -- when the multi-year, you make sure that gets authorized and funded, that rolls into backlog. So the backlog number at Bell will always be -- you'll see some pretty significant swings, driven by particularly the military side of the business.

Okay. Thanks for taking my questions.

We will go to Jeff Sprague with Vertical Research. Please go ahead.

This is John Walsh on for Jeff. So a lot of ground covered so far, appreciate that. I wanted to go back to aviation, and think about jet lead times on new orders. Not asking for a program by program, but if you had a lumpier new and refreshed programs versus the legacy, any color on the lead time deltas between those two buckets?

I am sorry. When you say lead time?

You made a comment earlier on Latitudes, right? There is still orders to sell. I'm just trying to get a sense of the demand, how fast you can fill out a order on legacy, or if there are lead times growing for other newer, refreshed models.

Sorry, John. We try to stay away from doing any particular guidance on sold out and lead time availability on a model-by-model basis. I mean, there is a fair bit of variation across new models. There is even variation, obviously, across the so-called legacy models.

Okay. Are there any expectations that you could end up with some white tails here at year end?

We really haven't talked about white tails for a number of years. We have aircraft being delivered in the first quarter. So, obviously, we plan and always have inventory that rolls from year to year, because it's inside the manufacturing lead time to deliver aircraft when you get into the first quarter, and beginning of the second quarter. But right now, as we have been doing for quite a number of years now, we're building to a forecast, and we have been matching that fairly well to the demand.

Okay. And then one last one, on pension in the next year. Any early look on the expense side, or on any cash funding side?

Well, on the expense side, as we have said, obviously, the discount rates bouncing around, interest rates are bouncing around. But we would expect it to be no worse than flat on a year-over-year basis. And on the funding side, no additional founding other than normal course defined contribution funding, and the small amount of other funding that we do. So no pickup from this year's funding levels.

Okay. Appreciate it. Thank you.

And we will go to the line of George Shapiro with Shapiro Research. Please go ahead.

Just one follow-up, Scott. Aviation deliveries were up every quarter this year. Will you beat the 60 in the fourth quarter of this year that you delivered last year?

I would expect so.

Okay.

I think that we will, George. We will have a solid quarter, obviously, in Latitude deliveries. Net of everything, we would certainly expect to be up on a volume of jets, on a year-over-year basis.

Yes, because you had 12 Latitudes in the fourth quarter of last year. So you'll deliver more than that, you think?

Yes.

Okay. And then just the last thing. I went back and looked, and it's the first time in a number of years that you had a book to bill equal or better than 1 for two successive quarters. Does that support your comment that you are starting to see order improvement in the industry?

Well, I don't know, George. I am hesitant to forecast the future, because it's so hard. Obviously, we are always happy to get better than 1 to 1.

Okay. Thanks very much.

And we will go to the line of Pete Skibitski with Drexel Hamilton. Go ahead.

I had a question on Kautex, Scott. I think you are building a fifth plant in China, now. Can you talk about what's motivating that? Has that helped you gain share, your presence in China? Is it a growth signal? Frankly, is there a long-term competitive risk to that? I am just curious about the strategy surrounding that.

The long-term view on China is that it's -- I mean, it's a massive automotive market. It continues to grow. It's been a good market for us, frankly. We have had a very strong business in China. And as that volume continues to grow, our customers are doing well.

We -- as you know, these programs, when you are building tanks for these platforms, they tend to be fairly long cycle. When we commit to go in and invest the capital in a new plant and new machines and stuff like that, we clearly have line of sight to where that capacity is going to be utilized, and on what platforms that capacity will be utilized on. So we don't see much downside risk to underutilization of those assets. Certainly that has been our history over there, is that these plants are well utilized and deliver good returns.

Okay. So is there -- the more plants you build -- I guess is there more tailwind there, in terms of adding capacity, and maybe shifting your customer base from European OEMs to Chinese OEMs?

I'm not sure we look at it as shifting. We really do this and make these decisions based on specific opportunities, specific platforms that we win. That's what drives it. So in terms of how we think about capital allocation in that business in the future, we allocate it to the places where we won with the customer and need to produce locally.

I think if you look net this year so far, we have actually had more growth in Europe than we have had in North America or Asia, and that's because our customers in Europe have had higher growth rates. But again, our allocation of capital, and where we choose to put locations is very highly driven to how we're doing, and who we're winning with, and where in the world. So we really let that drive it, as opposed to a philosophy of being in one particular region or the other.

Okay, great. Thanks very much.

Okay. Thank you, everyone. That concludes our call for today.

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