達信公司 (TXT) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Textron Third Quarter 2017 Earnings Call.

(Operator Instructions) Also as a reminder, today's teleconference is being recorded.

And at this time, we'll turn the conference over to your host, Vice President, Investor Relations, Mr. Eric Salander.

Please go ahead, sir.

Thanks, Tony, 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 $3.5 billion, up $233 million from last year's third quarter.

During this year's third quarter, we recorded $25 million of pretax special charges or $0.05 per share after tax.

Excluding these items, adjusted income from continuing operations was $0.65 per share or 4 -- up $0.04 from last year's third quarter.

Manufacturing cash flow before pension contributions was $279 million, up from $94 million in last year's third quarter.

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

Thanks, Eric, and good morning, everybody.

Revenues were up 7% in the quarter, reflecting strong commercial demand at Bell, increased deliveries at Textron Systems and higher revenues in Industrial due to the acquisition of Arctic Cat.

We saw strong execution at Bell again in the third quarter with a 13.1% operating margin.

Revenues were up on higher commercial volumes as we delivered 39 commercial helicopters, up from 25 in last year's third quarter; 8 H-1s, flat with last year; and 5 V-22s, down from 6 last year.

We delivered 5 412s in the quarter related to the improved order flow we've seen over the past year.

We also began deliveries of the 407GXP to Shaanxi Energy Group in China on the order of 100 units that we announced earlier this year.

Also during the quarter, we received an order for 8 407GXPs from Caverton Helicopters, which included Bell's Customer Advantage Plan support solutions for each of the aircraft.

Moving to military.

We delivered our first 2 FMS H-1 aircraft for Pakistan in the quarter.

On the development side, our V-280 Valor successfully achieved ground-run testing at 100% RPM and remains on track for first flight this year.

Our progress on this program was on full display at AUSA last week, where we featured a video of this achievement along with our full-sized V-280 mockup.

Our investment in this program aligns well with the Army's stated objective to accelerate product development and realize one of its key modernization priorities, the Future Vertical Lift.

Moving to Systems.

Revenues were up on higher TAPV deliveries.

At TRU, we delivered 6 full flight simulators in the quarter as we continue to grow this business.

In Unmanned Systems, we were awarded an FMS contract to Bulgaria, marking our first international Systems sale of our Aerosonde platform.

In our Textron Airborne Solutions business, we acquired a fleet of Mirage F1s in support of future adversary air contract competitions.

Moving to Industrial.

We saw an 18% increase in revenues, primarily reflecting the impact of Arctic Cat.

Overall margins were down, largely reflecting the dilutive impact of the Arctic Cat acquisition and unfavorable volume and mix in other businesses.

At Arctic Cat, we're continuing to execute to our integration plan and we remain on track for the business to be accretive in earnings in 2018.

Moving to Textron Aviation.

Revenues were down $44 million as we delivered 41 jets, flat with last year; 24 King Airs, down from 29; and 5 Beechcraft T-6 trainers compared to 8 last year.

We saw stronger international King Air and Caravan deliveries in the quarter as compared to the first half of the year.

We recently received an additional order from Babcock Scandinavian Air Ambulance for 10 King Air 250s and the first medevac-configured Citation Latitude for deliveries beginning in 2018.

This past weekend at NBAA, we celebrated the delivery of the 100th Citation Latitude, the best-selling mid-sized aircraft in the market today, achieving this milestone in just 26 months following entry into service.

Also at the show, we displayed our first production Longitude aircraft with a fully fitted interior.

Following the show, this aircraft embarked on a 46-city demonstration tour as we look to begin deliveries in 2018.

Moving to Textron Aviation Defense.

Our Scorpion and AT-6 Wolverine aircraft both performed extremely well during the U.S. Air Force's recent OA-X Light Attack Demonstration program.

And to sum up the quarter, we achieved top line growth and continued our strong cash performance while furthering our business development efforts on new products across the businesses.

With that, I'll turn it over to Frank.

Thank you, Scott, and good morning, everyone.

Segment profit in the quarter was $295 million, down $15 million from the third quarter of 2016 on a $233 million increase in revenue.

Let's review how each of the segments contributed, starting with Textron Aviation.

At Textron Aviation, revenues were down $44 million from this period last year.

Segment profit was $93 million, down from $100 million a year ago primarily as a result of unfavorable performance and lower volume and mix, partially offset by a favorable impact from pricing.

Backlog in the segment ended the quarter at $1.2 billion, up $142 million from the second quarter.

Moving to Bell.

Revenues were up $78 million due to higher commercial deliveries.

Segment profit increased $9 million from the third quarter in 2016, primarily reflecting a favorable impact from performance and other.

Backlog in the segment was $5 billion at the end of the quarter, down $413 million from the end of the second quarter.

At Textron Systems, revenues were up $45 million, primarily due to higher volumes at Marine and Land Systems, partially offset by lower volume in the Weapons and Sensors product line.

Segment profit was down $4 million.

Backlog in the segment was $1.5 billion, down $85 million from the end of the second quarter.

Industrial revenues increased $156 million largely due to the impact of the Arctic Cat acquisition.

Segment profit was down $17 million due to unfavorable volume and mix, pricing and inflation.

Finance segment revenues decreased $2 million and profit increased $4 million.

Moving below segment profit.

Corporate expenses were $30 million, down from $53 million last year, largely related to the transfer of the Scorpion program to Textron Aviation.

Interest expense was $37 million, up from $35 million a year ago.

Our effective tax rate in the third quarter of 2017 was 21.7%, included a net discrete tax benefit of $15 million largely related to state income taxes.

During the quarter, we recorded pretax special charges of $25 million.

Year-to-date 2017, we have recognized pretax charges of $42 million under the restructuring plans that we announced last year.

During the quarter, we repurchased approximately 2.5 million shares, returning $122 million in cash to shareholders.

We also took the opportunity to issue $300 million of 10-year notes at a rate of 3 3/8% and used the proceeds for a voluntary contribution to our pension plans.

To wrap up, we are updating our adjusted full year EPS from continuing operations guidance to a range of $2.40 to $2.50 per share.

We are also increasing our expected full year manufacturing cash flow from continuing operations before pension contributions by $150 million to a range of $800 million to $900 million with expected pension contributions of about $355 million.

That concludes our prepared remarks.

So Tony, we can open the line for questions.

(Operator Instructions) And the first question will come from Sheila Kahyaoglu with Jefferies.

Just on the cash -- the EPS guidance tightening of $0.10, can you maybe talk about where it's coming from, and if it is the Industrial business, just what's going on within the profitability there?

Sure, Sheila.

I think there's 2 things that are contributing to sort of going towards the lower half of our original guidance.

And the first is obviously, as you know, in the first quarter, we did take a charge associated with the TAPV program.

So the business overall has performed to our plan for the balance of the year.

And we expect it to perform to the balance of the year.

But that charge in the first quarter, some of it is basically flowing through the full year overall compared to our original guidance in that segment.

And then on the Industrial side, look, I think we had a fairly tough quarter in Industrial, particularly in our vehicle business.

The Arctic Cat work is going well.

But we have thrown a lot of resources, particularly people, at making sure that integration goes well.

And frankly, we got a little behind on some of the rest of the business in terms of line rates and production output.

As we've worked our way through the quarter and as we go here in the beginning of the fourth quarter, it looks like most of the line rates are back up to where we need them to be, but we're not likely to be able to catch up on some of the miss from Q3.

And so I think if you look at those 2 dynamics, obviously Bell is, I think, coming in stronger than the guide.

Aviation will be a bit lighter, again primarily driven by some lower volume than we originally expected, but those 2 sort of offset.

So the 2 things that are driving it really at this point are the TAPV charge we took in Q1 and just a little bit lighter volume and conversion on the vehicle business.

Okay.

And then just one more, if I may, on the backlog within Aviation, it was up slightly.

Could that be attributed to the Longitude?

And then just on that program, how do we think about the ramp-up and entry into service?

So it's not really driven by Longitude, Sheila.

I mean, as you know, we don't kind of do it model-by-model.

But it really is across other aircraft platforms, which I think is good.

The Longitude, I wouldn't expect to see a lot of backlog going into that until we start getting that production aircraft out there.

A lot of people have seen the aircraft and are interested in the aircraft.

But now coming out of NBAA, where we have the first customer fitted-out version, as I noted in the remarks, it's going to be flying around here for the rest of the year doing demonstration flights for prospective customers.

And hopefully, we will start to see some backlog build as a result of that.

But that hasn't happened yet.

And just on the entry into service?

Entry into service, look, I think it's probably going to be early next year.

The flight test program is going extraordinarily well.

The aircraft is performing beautifully.

We had one of our key suppliers that had some obsolescence issues.

And we decided that it was -- it made sense to incorporate the latest and greatest new product before we went through with the certification program.

That's taken us probably a couple months longer than we would originally have liked it to.

That will push off until probably early next year but no material impact.

So we certainly expect to see solid deliveries in 2018.

Our next question will come from Carter Copeland with Melius Research.

Just a couple of quick ones.

One, Scott, I wondered if you could expand on the Industrial commentary.

It looks like maybe the shortfall there was sort of $25 million relative to the plan.

And I know you called out unfavorable volume and mix, and then additional resources and people on the integration.

How much should we think is each of those?

And how much of that is sort of temporary versus things we've got to watch out for in the future?

Well, I think on the resources piece of it, the piece specifically around Arctic Cat frankly is going to plan.

We're very happy with how that's proceeding.

The inventory levels that we knew we needed to drive down in the dealer base are happening.

Retail sales are up considerably.

There's obviously a lot of work going on and aligning the product lines and getting dealers up to speed on the full range of both what was in Arctic Cat as well as what was under development in the Textron vehicle business.

So I think that's all progressing.

The factories are up and running.

There are a lot of moving parts here, Carter.

We decided to move our engine manufacturing facility from Germany into the St.

Cloud facility.

So we're kind of centralizing all of our engine manufacturing, which is also obviously much closer to the final assembling plant in Thief River.

We did move all of our dirt manufacturing out of Augusta up to Thief River, which I think is already starting to pay dividends.

So these are all things that I think bode well for the future of the business.

But there were costs and a lot of work and distraction for the people to go pull that stuff off.

In terms of the core of the business, as I said, we got a little behind in terms of line rates and nothing particularly magical, just getting our production control and logistics programs running.

We have a new facility now down in Augusta, where we're consolidating all the Jacobsen things.

So there were just a lot of moving parts that had impacts really across the rest of the core business.

As I said, I think those line rates, as we watch them here going into the quarter, are getting back to where they need to be.

There's still some things to work on.

But I think this is something we'll have behind us as we head into 2018.

And clearly, we expect the Arctic Cat deal itself to be accretive as we go into '18.

So certainly, a misstep, a lot going on in that business between the Jacobsen integration, bringing in Arctic Cat, a lot of internal moves, which again we think are the right answers in terms of driving better productivity and better margins as we go forward but certainly an impact here on the quarter.

Okay.

And one for Frank.

Frank, was there a tax benefit, $100 million or so, from the pension prefunding that we should think about?

Yes.

On a cash basis -- so cash tax basis, we will get a deduction for that contribution.

The bulk of that will fall into this year.

We'll get some of that benefit into next year.

So it's spread between the 2 years.

Our next question comes from George Shapiro with Shapiro Research.

I wanted to pursue, Scott, you were saying in Aviation, you had some unfavorable performance.

If you could provide a little more color on that.

Well, clearly, George, the numbers, if you look year-over-year, we do have all the Scorpion spend in there.

So when you look at relative performance from last quarter to this quarter, I think that -- or third quarter to third quarter, the team actually did pretty well.

When you consider the margin rates that were delivered even with the increased spending, we still had a lot of activity going on with Scorpion and AT-6 frankly as we went through this experimentation program.

We continue to have a very high spend as we're continuing in trying to finalize the Longitude certification.

So on a cost base, nothing really beyond what we would expect.

And I think the guys did a pretty good job on that.

We are a little bit light probably to volume, where we would have liked it, particularly around the turboprops, although they were considerably stronger than they were in the first couple quarters.

So we're encouraged by what we saw in the market on both the King Airs and the Caravans now seeing stronger international demand, which are important for both those platforms but all in all, still a little bit lighter.

And I think part of that is the market and part of that is we continue to work on the pricing side, George.

We're continuing to hold the line on making sure we're getting price in the business and we saw that.

And you guys will see when the Q comes out, it's probably around $22 million year-over-year.

So it's a line that's obviously tough to hold that line in the market, but we're doing that.

And I think that's going to -- we'll continue to trade that versus some volume.

And Scorpion R&D, Scott, you had said on the second quarter would come down a little bit.

This quarter, it doesn't look like it did maybe.

But if you could expand on that and how much we might expect for the year.

Well, it did come down somewhat, George.

And it will come down pretty significantly here in the fourth quarter now that the experimentation program is done.

Okay.

And if I take a look at Latitude, Scott, you said you delivered 100.

But if I add up all your deliveries through the year, I get about 93.

I mean, is that 7 already in the fourth quarter, if you can reconcile the difference for me?

George, you probably have better data than I do on that then.

I thought it was 100 through the end of the third quarter was the number that I was referencing.

But we'll probably have to maybe have an offline call with you and try to reconcile our database and your database.

But the number should be 100 through the end of Q3.

Okay.

And then one last one on Industrial, I mean, you had guided earlier to a margin of 9%.

Then with the dilution, it came down to 7%.

I mean, what does it look like now for the year?

Well, it's going to be lower than that, obviously.

So I don't think we're probably prepared to give a specific number.

But it's going to be...

A bit lower than that.

A bit lower than that.

Next question in queue is from Seth Seifman with JPMorgan.

Scott, I wonder if you could talk about the Hemisphere program.

We had the announcement of the delay on the Silvercrest engine.

And Dassault says that all options are on the table as far as that goes.

How do we think about the future of this program from your point of view?

And how are you thinking about approaching the development next year?

Well, look, it's a good question.

We just learned about the issue on the Silvercrest compressor kind of with everybody else at NBAA.

We're obviously in discussions with their team to understand.

And frankly as they determine, I think this is still a relatively early on in terms of their understanding of what the problem is.

And they're still doing the work of exploring on what the range of options might be to solve the problem.

So it's probably premature to really know what that impact could be.

It could be a minor impact.

It could be a more significant impact.

We just -- we don't know enough yet.

All we're really familiar with is sort of how it manifests itself.

It certainly sounds like a high-pressure compressor issue, which is exactly what they're describing.

And I think that we need to give their engineering team a little bit of time here to figure out again what that range of options is.

We have continued to work on Hemisphere obviously with our customers and doing a lot of our aerodynamic work and modeling and supplier selections and all those kind of key things, which need to continue to happen.

So we are running that at a rate appropriate to that.

And I think we'll keep doing that.

And then based on where the Silvercrest is, obviously we can regulate what we do in terms of the program spend based upon that.

Great.

And then maybe one more for Frank.

It looks like you're on track this year for about $68 million of pension expense.

If the year ended today and we think about the contribution you just made, how do we think about the impact of the contribution on next year's pension expense possibly offset by the -- probably offset by the additional debt that you took on?

Yes.

Well, I mean, obviously a lot will depend on interest rates at the end of the year and returns and so on for this year.

I mean, at a simplistic level if you think about kind of the 7.5% rate of return that has been kind of our return assumption and look at the 3 3/8% cost of the debt, kind of that spread differential with some other -- kind of there are some other impacts but is generally ballpark type of impact having to do just with the contribution.

I'd say overall, from a pension standpoint, as we talked about before, we think as we move into '18, again there's a lot still to be learned about where things are set.

But we should get a little bit of a tailwind associated with pension.

Next question in queue comes from Jon Raviv with Citi.

On Bell, can you just go into a little more on the nature of the commercial positivity?

What sort of end markets is that coming from?

Or is a lot of it related to those largish deals that you signed over the past year?

I think it's -- I mean, the activity we're seeing is pretty broad-based.

So you do have deals out there that are fleet deals, like some smaller oil and gas of kind of guys.

But there's a fair bit of [activity] in executive transport going on.

There's a pretty broad range of EMS activity.

There's some foreign military, whether it be border patrol, customs, police.

It's not concentrated in any one particular area, which is good, frankly, right?

I mean, we don't see just one sector.

It's some life across most of the areas.

And it's pretty broad-based geographically as well.

So we're seeing activity in Southeast Asia.

We're seeing it in Africa.

We're seeing it in South America.

So it's fairly broad-based.

Again, we don't want to mislead, I think the overall market is still weaker than it has been in previous times.

But it's much better than it was a couple years ago.

And I think our team is doing pretty well from a competitive standpoint.

And we're seeing again strength in pretty much all the models.

Obviously, 505s are brand-new as they come out.

But sales have been good on 407s, 429s, 412s.

So it's pretty much across the breadth of our platform and to a pretty broad-based range of geographies and end applications.

And then sticking to Bell, thinking about the margin strength this year, you've laid out what's going on there and some of the good performance.

What's the opportunity to hold on to that kind of profitability?

As 505 ramps up, perhaps as 525 spending -- as Relentless spending picks back up again, could you give us some sense of how those things trend going forward?

Well, we've usually talked about that business being able to perform in that 10% to 12% kind of a range.

Do I think 13% is sustainable over a long period of time is a pretty tough pot, okay?

I mean, obviously the guys have done really well this year to drive productivity and efficiency and get there.

Obviously, we had a good mix with some strong 412 deliveries this quarter as well.

So 13% is too strong, but it's going to remain a good, healthy margin business.

Our next question will come from Julian Mitchell with Crédit Suisse.

Maybe just my first question on Aviation.

King Airs have had a tough time, I think, on your volume delivery profile for about 18 months now, still light in Q3.

So just wondered how you're thinking about if you still think second half deliveries can be flatfish in aggregate for those and how you're seeing overall kind of order and inquiry levels, if that's giving you any optimism for the outlook for the next year.

Well, Julian, I think that, first of all, you're right, both the King Airs, which are generally speaking have a pretty strong international marketplace, I think, over the last 18 months, have felt a lot of the pain of a very strong dollar and weaker economies.

And that's what we've been experiencing.

Again, I think the good news here is that in the third quarter, while it's not what we delivered a year ago, it was certainly a lot more inquiries and a lot more sales and order activity than we have seen for a while.

So that bodes well, I think.

Do I think we get to flat for the balance of the year?

No, probably not.

But I do think, given the level of inquiry and activity, that it's going to be stronger than it has been in the first half of the year.

So definitely, we'll finish the year here with a stronger King Air performance than we saw in the first half.

And again, to look into next year is pretty premature at this stage of the game, given the nature of how things, orders and sales convert.

But we're certainly happier with the level of activity in the marketplace right now than what we saw for the past year, let's say.

And then my second question around the cash flow, a very good performance year-to-date on working capital, particularly versus the same period in 2016.

I just wanted to clarify if all of the cash flow guidance increase was tax-related or some of that was due to working capital as well?

And then maybe any color you could give on how the introduction of the Longitude should impact your working capital from here over the next 6 months or so.

Sure, Julian.

Well, look, as Frank said, we do get some cash tax benefit here in the year.

But mostly, this is driven by better performance in terms of just manufacturing cash flow.

And a big chunk of that is, in fact, working capital.

And if you look at the numbers, we generally -- just the natural cyclicality of our businesses is that you usually see the working capital burn off through the fourth quarter.

And we are at a point of this year where we're basically kind of where we started the year.

So we've had -- the team has done a much better job on working capital management.

And by the way, that includes some pressure points, like ramping up Longitude.

So we are already in producing aircraft, which obviously won't sell until next year.

But despite that, when you look across the businesses, we already have working capital back to sort of neutral in the year.

And obviously, we'll expect a considerable burn-down here as we go through a normal cycle in the fourth quarter of seeing that working capital come down further.

So the majority of it is the team delivering better manufacturing cash flow and a big chunk of that obviously is working capital.

Our next question comes from Cai Von Rumohr with Cowen and Company.

This is Bill Ledley on for Cai this morning.

Wanted to go back to Aviation a little bit, the book-to-bill was 1.1 and you mentioned some favorable pricing.

So could you perhaps call out what's stronger both from a volume and pricing standpoint?

Is it biz jets or King Airs?

If you'd give some more color there, that would be great.

I don't think we're going to go sort of model-by-model, but we're -- the market in general has been flattish, which is kind of what we expected on the jet side of things.

I think that the pricing activities are obviously helping.

And we continue to hold the line on that.

And as I said earlier on the call, we will trade volume to price.

We just -- we're pleased with some of the increases that we've had, but it's -- the price levels are still, in my view, too low to look at the amount of investment that goes into producing these aircraft and designing these aircraft.

And we're going to continue to push on the price obviously as we go forward as well.

And if that means some lower volume, then we'll take some lower volume.

Our next question comes from Rajeev Lalwani with Morgan Stanley.

Scott, coming back to Bell, can you talk about the government side of the business and what are going to be the big drivers there over the next, say, 12 to 24 months before some of the new products get rolled in?

Well, look, over the next year or so, V-22 is a relatively flat number in general.

We expect H-1 to be up a little bit, again as we continue some FMS activity as we've seen with Pakistan this quarter.

I don't think there'll be huge shifts going on there, Rajeev.

It's going to be probably modestly up on H-1 and relatively flat on V-22.

Program performance is good.

I would expect that to be a fairly stable part of Bell here in the next couple of years.

And then moving over to the Industrial side, once we push Arctic Cat aside, what's going to be the driver there as we look forward to kind of a similar question?

Well, if you look beyond Arctic Cat, that's the core of the business that we used to have.

I think we're doing well in most of that segment.

I think if you look in the [Gulf] places our new products with the lithium-ion batteries are doing very well in the marketplace.

Frankly, it's a new product launch that's gone extremely well.

We continue to see strength in what was the TUG market in terms of GSE.

We actually continue to have strong order rates there.

We got to make sure we can line our production and get the deliveries and the output out.

But the market in terms of order activity is very strong.

And again, the rest of that market, I think, is in good shape.

Most of getting deliveries and whatnot for us here in the quarter was a matter of getting our lines up and running and getting to higher rates.

One quick housekeeping question for Frank.

Frank, what's the tax rate benefit for the year on the earnings side?

Tax rate benefit?

I mean -- well, I guess we -- given the tax rate of this quarter and year-to-date, we're looking at kind of 26.5% or so full year tax rate.

There's no tax benefit from a rate standpoint associated with the pension contribution, if that's part of the question.

It only impacts cash taxes.

It's actually a little bit of a headwind from a book tax standpoint, just given some other deductions and things.

Our next question will come from Peter Skibitski with Drexel Hamilton.

Scott, I think you touched on this last quarter.

But can you remind us again why the ramp on the 505 is going so slowly?

Is it -- you had a lot of LOIs last I checked.

So is it converting to LOIs?

Or is it execution at Mirabel?

Well, it's just ramping the production and it's getting the certifications outside the U.S. and getting IASA and other certification.

So there's nothing significant going on there, I mean, or different than we would really expect.

The LOI conversion rates are very high, so we're not concerned about that.

The order book is certainly there and the ramp is coming along.

Okay.

And then can you just give us an update on kind of where we go from here on Scorpion?

Well, I think in general, Peter, the Air Force, in terms of this experimentation program, has been frankly very transparent, very open about how they saw this whole thing playing out.

Dates and activities and whatnot were exactly as advertised.

I think the program went very well.

We were obviously thrilled with how the aircraft did.

We had very good feedback from Air Force pilots that flew both the Scorpion and the AT-6.

And the Air Force was also very clear through the whole process that once they finish the experimentation program, they were going to sort of take all that information and then determine what their next steps might be.

And I think that's the phase they're in.

So we're sort of standing by while they decide what -- if the next steps on either or all aircraft and how they want to move forward.

So I think they're doing that.

And we're just kind of standing by and see how it plays out.

Do you still need to wait for some sort of cert from them to get an international sale?

No, we don't.

I mean, I think, from an international standpoint, Pete, as we talk to customers and continue to have interactions with customers, there are certainly some that would want to see this thing have a U.S. certification or an airworthiness declaration of some kind.

And there are other customers that don't.

As a military aircraft, that's not necessary.

So you definitely see differences in different countries and their approach to this.

But there are certainly some that we're engaged in for whom a U.S. Air Force airworthiness certification is not required.

Our next question, that will come from Sam Pearlstein with Wells Fargo.

Just wanted to follow up in terms of we talked about the Bell margin before.

But just on the Aviation margin, given your 5.6% kind of through the 9 months, it would seem like it's going to be a challenge to get to your original plan of the 7% to 8%.

Can you just talk about how we should think about the year?

I know Scorpion R&D is supposed to be falling.

But just how should we be thinking about the remainder of the year?

So in terms of the R&D, it's obviously going to ramp down here over the course of the year.

In terms of Scorpion, the activities are pretty well wrapped up.

We'll have a little bit of activity going on with some international customer demonstration flights and some things of that nature, but it will be a relatively small number.

In terms of the overall Aviation segment number, as I said earlier on, I think it will be lighter than what we were originally guiding.

Obviously, the guide included the Scorpion spend.

But I think we're going to be probably a couple hundred million dollars under from a revenue standpoint.

But we've seen that through the course of the year, right, with particularly around the King Airs and the Caravans.

And again, we continue to push on the pricing front across all these platforms.

So we'll probably be a little bit lighter on revenue than we were anticipating in our original guide.

Okay.

And just in terms of pricing, I mean, what are you seeing in the marketplace now?

Obviously, you're trying to hold the line.

Lots of others, it sounds like there's still plenty of price discounting.

Have you seen just any overall change in the trend within the marketplace?

I don't -- I can't -- I don't know how to comment on that in any way, other than to say we still feel like we're winning our share of the deals that are out there.

We're just holding the line and trying to be responsible in terms of what we need to do as a business.

And is there any difference or change in what the other guys are doing?

I can't really speak to that, nothing that has jumped to the forefront.

But I think our share is still strong.

And look, I think customers understand that they're still pricing aircraft way below where it was historically.

I mean, it's a problem.

And I think people appreciate we're investing a ton of money in the business on things like Latitudes and Longitudes and [Denalis] and they're -- at these margin rates, I think the guys are doing a good job.

But you need to have better margin rates in a business like this to be able to sustain the level of investment that's good for our customers.

So we're going to continue to hold on, on it.

Okay.

And then if I can just follow one last question up on in terms of the Arctic Cat and the integration.

You talked about the distraction maybe impacting some of the production.

But have you seen any success in moving your product into their distribution channel and anything from the going-forward side that's showing improvement?

Yes, I think we have.

I mean, the retail sales have been strong on a year-over-year basis.

And some of that is clearing out a lot of the older inventory.

But as we've been getting the dealers together and now being able to go into those dealers and bring not only what they may have had historically from Arctic Cat but adding some of the Textron off-road product, namely the Stampede, you may have seen, we just announced the Prowler EV, so we're obviously integrating the branding and the -- at the product level and some of the technologies that we bring into the EV side.

As those products were rolling out, they're doing well in the marketplace.

And so we're seeing dealers pick these up and we're seeing retail sell-through.

So it's still early, obviously.

It's a lot of work to go through and change.

And now the good news is it's a good change for them.

It's a much broader product line.

It's a stronger product line.

But I think it's been well received.

And we feel good about where it's heading.

Our next question in queue will come from Noah Poponak with Goldman Sachs.

Scott, I guess just kind of big-picture top-down on the business jet market.

Some of the leading indicator data has improved.

Flight hour growth has accelerated.

Used inventory has come down a little bit recently, especially the youngest batch in that bucket of used inventory.

But I hear you're still calling it a flat market.

That's kind of how it felt at NBAA.

You had a little bit of sequential growth in backlog, but it sounds like turboprop got better in that.

Never quite sure what's happening with your -- the movement of fractional into that.

And maybe that helped it a little bit, too.

So I don't know, I guess sort of what's the remaining disconnect between some of this leading indicator data and having a more definitively robust business jet market?

Well now, that's the million-dollar question.

That's why I asked it.

So let me -- look, I can give you color on a couple of things.

So first of all, in terms of backlog, again we don't really go into model-by-model or customer-by-customer here, but there's no material impact on the fractional thing.

As we've talked about in the past, the way we tend to work with NetJets, which is obviously our big customer in that space, we're basically -- because of how we sort of look at the timeline of deliveries with NetJets, it's sort of more or less deliveries in a quarter equals the amount of aircraft we're adding back into the backlog because it's pretty steady flow of aircraft.

So from a backlog standpoint, that's not a material change.

In terms of are we seeing that activity in the market, in terms of utilization rates being up?

Absolutely.

I mean, I think we had a good quarter in the aftermarket business.

And some of that, maybe there's a little bit of pent-up demand in there.

But we just see increased flying.

That usually translates to increased activity in terms of the service side of our business.

And we certainly saw that in the quarter, which is good.

I think in the end market, look, your statistics are all correct, right?

I mean, used does continue to come down.

I think we still struggle with this notion that used aircraft pricing doesn't seem to want to move up, right?

And so that does pressure customers because the trade-in values and the step-up to a new aircraft is more challenging when these guys have lower residual values.

And despite the fact that used aircraft availability has dropped significantly over the last x number of years, we're not seeing that reflect in used aircraft pricing.

So that dynamic, I think, is still one that weighs on people and it's a nontrivial economic impact to them.

So look, I think as we move on, a lot of guys out there are flying older aircraft.

They are seeing higher maintenance costs and they do want to step up.

And look, the challenge for us is that we can't make up for that lower residual value of the used aircraft by lowering the value of our new aircraft, okay?

So that's still a pressure point, right?

People want us to try to make up for that lower residual value.

And I just can't do that and maintain any kind of reasonable margin and return in the business.

So I think the demand is going to be out there.

But again, we haven't seen -- I would love to see -- we obviously don't control it, right?

We would love to see residual values in used aircraft coming up.

And that would take some pressure off these customers.

But look, that's not something we control.

And it's a little perplexing to us as you see a tightening -- when the market tightens up for those used aircraft, why you're not seeing some lift in the pricing.

But we haven't seen that yet.

To me, when I look at that chart on a long-run basis, it has come down recently and it's been on a steady decline over the last several years.

But it's still on an absolute basis much higher than it was at any point all of last cycle.

And so it just -- it leaves me wondering if, yes, there's been a tightening, but on an absolute basis, it's just still too high and there's still too many options in the used market.

And that's why pricing hasn't firmed up there.

I mean, is that a reasonable assumption and you just have to burn it back to where it was 10 years ago or 12 years ago before you get that better pricing?

Well, I think there's a dynamic of the -- first of all, it's a much bigger market, right?

So I mean, the number of aircraft that are in the fleet is much higher.

And so therefore, with similar percents, you're going to have, for sure, more aircraft that are out there.

And I'm sure that's part of the dynamic.

I don't -- to think that we could get to where used available was in that 2006, 2007, 2008 timeframe, I don't think is realistic.

I mean, it was a distortion the other way, right?

People were selling used aircraft for more than a new aircraft because you could get one.

It was -- so I think that people have to kind of get their head out of that, that's where the world is going.

I mean, these aircraft do depreciate, right?

There is going to be a depreciation over a period of time.

It's not going to be an asset that appreciates, which is what we saw in that 2000 -- say, 2002, 2003 through 2008 time frame.

I think that was probably, as I said, a distortion in the other direction.

But at any rate, look, I think that is a dynamic, Noah, when you look at what people who have an aircraft and what the reality is of what that aircraft is worth as a used aircraft.

But the good news is there's a big market for those.

The liquidity in the market is quite high, right?

People are turning aircraft, people are buying aircraft.

This is not like it was when we were kind of in the dark days, where there was an illiquid market and nobody was buying them.

So there's a lot of transaction.

It's not hard to move used aircraft.

People just have to get comfortable with the reality of how these things depreciate and what that residual value is over time is different than it was if you went back into the early 2000s.

Okay, that's really helpful.

On that Industrial margin, so for it to be slightly less than the 7% you had previously been forecasting for the year, it would imply basically kind of stepping back up into the sort of 7% handle vicinity in the fourth quarter.

So it sounds like that 3Q number was fairly anomalous.

Is that the right interpretation?

Yes.

Yes.

Yes.

So I think, all I was saying earlier, I think we'll get things back on track here in the quarter.

But I don't see a way to make up for the NOP loss that we had from our plan in Q3.

And that's why we're kind of rolling that through the full year guidance.

Yes, just trying to understand the run rate, given the differential between the quarter and where you kind of had been.

Yes.

No, I think it's fair to say that our run rate should get back up to a normalized rate in Q4.

Okay.

And then lastly, Frank, when you're asked about tax rate, understanding there's no P&L tax benefit from what you did with pension, but there was a much lower tax rate in the quarter on the P&L.

It sounds like you are saying the new earnings guidance, P&L earnings guidance has a 26.5% tax rate in it and the prior range coming into today had a 28.5% rate in it.

Is that accurate?

Yes, basically roll through this quarter's lower rate kind of to the full year gets that type of impact.

So kind of 29%, 30-ish percent fourth quarter is where we sit right now.

Our next question in queue, that will come from Robert Stallard with Vertical Research.

Frank or Scott, whichever one of you wants to take this, you both made some comments about pricing in Aviation and how you obviously want to get better pricing, better margins going forward and you'd be prepared to sacrifice some volume.

When volumes stabilize and essentially start to go higher, what sort of incremental margin do you think we should be expecting, given this more robust stance on price?

Well, Rob, that's -- [every couple of weeks] or so a lot of things going on right here just in terms of the investment in the business and R&D and whatnot, which obviously is quite higher this year than it was last year with Scorpion being in there.

So you can't do the usual sort of quarter-over-quarter similar volume and expect what kind of a number.

Obviously, as we've always talked about in the business, when we really do get similar mix, which again is a significant issue here, that we expect kind of 20% margin conversion.

We've been obviously pressured by achieving that number based on a couple of things.

One is obviously we've had higher R&D as we've put Scorpion into the business.

And we've had a pretty challenging mix thing as we talked about at the beginning of the year.

We've seen the reductions on the turboprop side, including our military turboprops, which are our good margin business.

And we've seen a lot of our increase this year has been around the Latitude.

Now the good news is the Latitude, as we look year-over-year based on the pricing actions that we've been taking and cost actions, and we are getting better margins, but they're dilutive to that overall 20% number.

So the mix here has been a challenge.

But on a normal -- in a normal world in terms of similar mix and whatnot, we would expect to see kind of those 20% numbers.

And presumably heading into 2018, that should be the case with Longitude coming in, Latitude being like-for-like comp, and things like that.

Well, we will always have the first, hopefully, relatively small number of Longitudes that are going to be more challenging because they're the initial production units.

But yes, as we get probably more towards the back of the year and you get production stable and kind of get real run rates going, yes, that would be true.

Okay.

And then secondly on the cash front, does this pension contribution remove any potential contributions into the future?

And if that's the case, what are you going to use that additional cash flow for in terms of returns?

So it certainly helps negate any contribution.

And so as you look at it today, kind of barring some significant market events, yes, it pushes things out so that we wouldn't expect additional required contributions other than our non-funded plans.

And obviously, as we've talked about, we'll continue to prioritize kind of use of cash the same way we have, which is continuing obviously to invest organically, which is just kind of R&D and things like that.

Obviously, capital for the business in terms of excess cash, we'll return that to shareholders through share repurchase.

And that's what we've been doing.

Obviously, we continue to buy stock in this past quarter, and we'll continue that return of capital as we proceed forward.

Our next question in queue, that will come from Peter Arment with Baird.

Just a quick one, there's been a lot of questions asked.

On the 525, the flight test program there, how do we think about the impact on kind of margins as we get into 2018?

Is it something that ramps up materially?

Or is it something that gets fairly linear and absorbed throughout the year?

I think, I mean, the 525 specifically, obviously we're back in flight test, things are going well.

That will ramp up here as we get more aircraft back in the air through the balance of next year.

I think that's factored into our overall R&D numbers, Peter.

And again, given where the program is, it sort of has peaked, I think, in terms of its R&D consumption.

And obviously, we're going through a flight test program here for the next year or so.

So that will be baked into our plans and into our guidance.

I don't see it having a material impact one way or the other.

You won't start to see deliveries of that aircraft really until 2019.

So in terms of any mix issue, I would not expect to see that in 2018.

Okay, that's helpful.

And then just a follow-up.

On Scorpion, you mentioned that you might not have to have a certification if you do some international.

But if you do pursue that, how long roughly on a timeline does that take?

It's probably something on a 18-month kind of line in terms of a U.S. Air Force process.

As you know, we're already working airworthiness with the U.S. Air Force in parallel to all this other stuff that's been going on.

So that's probably something on that timeline.

When I talk about other countries that don't need it, I mean, obviously they do their own certification work and already talking about us how we work with them to do that.

So those processes are probably a little quicker just because it's largely an internal activity but not something that would hold up sales or an order.

And that would be all incorporated as part of a program with a foreign customer.

Our next question, that will come from Myles Walton with Deutsche Bank.

The first one is on Cessna and Aviation in general.

Excluding the Latitudes -- the Longitudes coming into 2018, are you expecting jet deliveries overall to be up in '18?

Or is the expectation that Longitude is the net add maybe substracting a little bit of legacy?

Myles, I can probably answer that question for you in about 3 months.

Okay.

Well, I imagine you're working your production system.

But I was just wondering if there's any working capital management that's helping the cash flow this year as it relates to the Aviation side or it's just more broad-based?

No, it's more broad-based.

Myles, like I said, we're actually having to absorb the ramp on Longitude.

I mean, obviously the aircraft that we expect to deliver certainly at least the first half of next year.

And really probably now into the third quarter of next year, our aircrafts are already in various stages of WIP and in some cases actually are all the way to finished goods, right?

So that aircraft that we're flying around is a production unit.

So there's definitely some pressure from a working capital to support the ramp of Longitude.

But that's normal with any of our new products.

And we're just working to offset that working capital everywhere else in the business.

Okay.

And the other one, Scott, maybe in Industrial, is a higher-level question.

But if over half of the Industrial business is fuel systems and the trend to electrification is obviously long, long term, but you have to start thinking and position this business for the next 10 years.

How do you look at that piece of Industrial, change it, pivot it, just position it for what may be a different world 10, 15 years from now?

Well, Myles, I think there is no question that the automotive industry and its sort of power plant is going to change over time.

And I can tell you that a lot of the work that we're doing right now in Kautex with OEMs around the world, frankly there is already a significant shift going on in terms of how people think about hybrids.

I think the notion of full electrification is something that's going to be a much longer time frame in terms of any material portion of the industry.

But there's no question that the hybrid technology is going to become a much, much higher portion of the market here over the next 10 years.

And we're working with a lot of those customers.

It actually does require some different technology in terms of how you support and build fuel systems that are hybrid.

There's just a lot of -- not getting into too much of the technicalities here, but the structural issues around the fuel system, the fuel tank, where you don't have a constant draw of fluids and vapors out of that tank for a normal combustion engine but can run for long periods of time on the electric side of a hybrid does drive some difference in the technology.

And that's something that we're already working.

In fact, we're already winning a number of programs that are our new products that they're going to have sort of these 7- to 10-year horizons that we're working on right now and have already won a number of programs.

So we are certainly sensitive to the changes that are going on there and working with the customers to do that.

But a full [expectation], at least I think when you look at the [other] guys, that's going to be a fairly small piece here over the next decade.

But hybrid is a whole another issue.

I think we're going to see a significant proliferation of hybrid technology.

And is that a place where you're willing to put incremental capital in terms of acquisitions despite the unknown about where the market goes over the next 20 years?

Or is this an organic you can adapt to the hybrid move?

This is purely organic.

Obviously, it's different tooling.

It's like a normal new platform, where you've got to invest in new tooling and downstream and things like that.

But this is purely organic.

And to us, while it's a different technology is not different really from a business model or business process than what we do today.

Our next question in queue will come from Ronald Epstein with Bank of America.

It's Kristine Liwag calling in for Ron.

Scott, last month, GE announced that it's grounding its fleet of corporate jets.

From your conversations with your corporate customers, do you think we'll see another wave of strategic change of how corporates look at their fleets?

And if so, how much of a headwind do you think this could be in market recovery?

Look, I don't think that it is.

I think when companies look at this thing from an economic standpoint, I think they recognize the productivity and the value of using corporate air and the time that, that saves.

I mean, it's a huge productivity boost.

I think if you talk to any of the customer trade groups, the NBAAs, people who have them and use them, it's a huge productivity boom for the company.

As to whether you use your own aircraft fleet or fractional or charter is driven by economics around how many hours a year you use those aircraft.

Look, in our view, the GE thing doesn't make any sense.

Unless you're going to stop flying corporate aircraft, when you fly that many hours, the economics says owning your own aircraft is the right way to go.

And I think that's the feedback we get from our corporate customers.

That's helpful.

And then maybe following up on your comments on pricing in Aviation, and you discussed how you're using volume to manage some of the pricing expectations in the market.

What's been your customer feedback?

And how do you approach customers that have been used to seeing discounts in the market to start getting them to believe that pricing is not coming down from here?

Well, we've been doing that by not lowering our prices.

And frankly, look, I mean, customers are always going to look for the best deal.

I think everybody does.

And as we have these conversations, they're not always easy conversations.

But we try to impress upon that, look, we're trying to run a business just like they are.

And when you look at the relative price in the market is these aircraft are a great deal, even at the current price levels compared to what they have historically been.

And it's a great value, it's performance, it's economics that works for them.

So I think customers are starting to believe it because we're not getting to the ends of quarters and giving lower discounts to move aircraft.

As I said, we will take the trade on having a lower value -- or having the lower volume on those aircraft.

And I think certainly we've had customers test that.

And we just say, "Guys, look, it's a great deal, and we want to do business with you.

But I'm not going to drop this price again." It's not sustainable to be able to make the kind of investments that we need to make to support our customers and to have those next generations of products and not have reasonable margins on the products that we're selling today.

So yes, tough discussion, but I think these things are still an incredible value at these price levels.

And as you can see, we still -- we get a lot of deal done.

But there's some where guys are still going to continue to test.

And that's fine.

We just won't close those deals.

Our next question comes from Drew Lipke with Stephens.

Real quick on Systems.

The margins there managed to hold flat sequentially despite no Sensor Fuzed Weapon sales and the unfavorable mix with TAPV.

I'm curious, what drove the margin strength there?

And what's kind of the outlook for the rest of the year?

Well, I think, the other parts of the Systems business, our unmanned business, our support and services businesses, our fee-for-service flight businesses continue to deliver solid performance.

And I mean, that's really what's making the difference.

As you know, we had higher volume or higher margins driven around some of the SFW sales, which are obviously not going to be here in the back half of the year.

But I think we're trying to stabilize the TAPV program and again just kind of get that thing behind us.

But strong performance in other parts of Systems, namely in Unmanned Systems and support solutions.

In these areas, they are helping to make up for the loss of having the SFW program here in the back half.

Okay.

And then on Bell, just maybe directionally looking at backlog there, can you parse out the commercial backlog and the changes that you're seeing maybe on a year-over-year and sequential basis again just directionally?

No, we don't.

As you know, the dynamic on the Bell backlog goes through this cycle because we don't add the next multiyear buy or the next year's multiyear component until we get into the process in the fourth quarter.

So it's really just doing its normal cycle, that's all.

Okay.

And then just last one, Aviation aftermarket, can you talk about what steps, if any, you're taking to maybe capture more within the aftermarket?

And then as we think about the ADS-B mandate and that large theoretical backlog of work there, do you think that's going to be a meaningful driver to spur aftermarket demand going forward?

And how should we think about that impact?

Well, I think the ADU is a bigger driver in terms of what we'll see in the aftermarket side of things.

As you know, we've in general been open to taking back some of our aftermarket in terms of service centers.

And we've played that out in a number of locations and that's gone well.

And we would always kind of look for opportunities to do that in the future as well because I think that we have some good third-party service guys.

But as we have opportunities to increase doing more and more of that direct, we will continue to look at those opportunities as we have done in the past.

That strategy has worked out well.

ADS-B is not a huge deal for us.

I mean, it's a huge deal to our customers and the cost.

But really, the lion's share of that is, I mean, we do a lot of those installations.

We're doing those as we speak, so it does drive business into the shop to do it.

But a lot of those dollars obviously are the equipment, which is being installed as opposed to the service labor, which is really our content of doing that.

So it's not a -- it is a significant cost to our customer, but it's not a big upside to us by any means.

Okay.

Ladies and gentlemen, that concludes our call.

Thank you for joining us, and we'll talk to you next quarter.

Thank you.

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