達信公司 (TXT) 2019 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Textron Second Quarter Earnings Call.

(Operator Instructions) As a reminder, today's call is being recorded.

I will now turn the call over to Vice President of Investor Relations, Eric Salander.

Please go ahead, sir.

Thanks, Kevin, 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 $3.2 billion down $500 million from last year's second quarter, while net income was $0.93 per share up from $0.87 per share last year.

Manufacturing cash flow before pension contributions totaled $102 million compared to $399 million in last year's second quarter.

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

Thanks, Eric, and good morning, everybody.

Q2 was a solid quarter for Textron as we continue our focus on operational improvements across the company.

Segment profit margin was up 120 basis points as we continue to see strong execution across our businesses, driven by higher margin at Aviation and Industrial.

At Bell, revenues were down in the quarter largely due to lower military volume as we transitioned to lower production quantities on our military programs.

On the commercial side, we delivered 53 helicopters down from 57 last year.

Despite the lower commercial deliveries in the quarter, we expect to see a ramp in deliveries in the second half of the year supported by continued strong order activity and increased production rates.

In the quarter, Japan's National Police Agency placed the first order for the Bell 412 EPX, the newest upgrade of the 412 series.

This aircraft has been co-developed between Bell and Subaru Corporation for the new utility helicopter program under Japan's Ministry of Defense, and we expect this program to support the 412 program well into the future.

Within Future Vertical Lift, we continued with the flight testing and demonstration activities of our Valor V-280.

We've now demonstrated Army level 1 handling qualities, successfully proving the aircraft's maneuverability in pitch, roll and yaw.

This represents the highest performance standards for agility, which is critical to the Army mission.

We're also encouraged by the Army's recent actions regarding the potential acceleration of the future long-range assault aircraft program.

These actions include an industry day schedule at the end of this month, which should allow potential contractors to gain more insight into the Army's acquisition approach; proposed alternate procurement path through the Other Transaction Authority mechanism to be awarded in February; and identification of an engineering, manufacturing and development program or a middle-tier acquisition award date estimated to occur 19 months following the OTA award.

Also, within FVL, Bell was 1 of 5 defense contractors down-selected by the U.S. Army to progress to the next phase of the Future Attack Reconnaissance Aircraft program.

We're pleased the Army recognized our competitive offering, which we utilize advanced rotor technology and fly-by-wire flight control capabilities validated in our Bell 525 program to create an innovative aircraft that's well suited for the FARA mission.

At Systems, revenues were down largely due to lower volume at TRU Simulation + Training and Unmanned Systems.

During the second quarter, our TRU training business formed a new company with FlightSafety International called FlightSafety Textron Aviation Training.

The newly formed company, which is 30% owned by Textron, provides training services for Textron Aviation's broad product line of general aviation aircraft.

We expect the combination of the strengths and resources of these businesses will further enhance the training and services available to our customers while increasing efficiency and ensuring the extension of our high-quality training programs to new Textron Aviation aircraft.

Also in the quarter, Textron Airborne Solutions announced its ATAC subsidiary received a 1-year $56 million contract modification to provide high subsonic and supersonic aircraft services to the U.S. Navy, extending our current contract through 2020.

Within Unmanned Systems, our fee-for-service product line captured over $90 million of new wins in the quarter for the Aerosonde program.

Moving to Industrial.

Revenues were lower, primarily reflecting the impact of the disposition of the Tools & Test product line in last year's third quarter.

In Specialized Vehicles, we saw a continued favorable performance resulting from the cost reduction and manufacturing realignment actions that we initiated in the fourth quarter of last year.

Also in the quarter, we continued our onboarding Bass Pro and Cabela's stores as well as independent Tracker Marine dealers and we're seeing momentum build in this new retail channel.

Our ground support business received multiyear contracts from both American and United Airlines for our equipment across our TUG, Safeaero and Douglas brands to service their operations worldwide.

Moving to Textron Aviation.

Revenue was down largely due to lower volume on our commercial turboprop and defense product lines.

In the quarter, we delivered 46 jets, down from 48 last year; and 34 commercial turboprops, down from 47 last year's second quarter.

Beginning in late May, we experienced lower order activity across our product lines largely attributable to the uncertainties around tariffs and concerns about economic growth, which caused disruptions in both our domestic and foreign markets.

Since then, we believe these uncertainties have largely diminished as we've seen the Mexico tariff issue resolve, stronger economic indicators and a Fed bias towards further interest rate cuts, which have improved customer outlook.

Our view going into the third quarter remains positive and we expect deliveries and orders to ramp throughout the second half of the year driving revenue growth in Aviation.

Moving to Longitude.

We continue to make good progress on the certification effort.

While this has been a much larger task than originally anticipated, the documentation flow and review with FAA continues and we expect type certification deliveries of the aircraft in the third quarter.

Continuing with Hemisphere.

We determined that the engine has not yet demonstrated the performance required for the aircraft design and we have put the program on hold.

Any decision to revisit the program in the future will depend on the state of the market, proven engine performance and the competitive landscape at that time.

Our engineering focus remains on the certification of the Longitude in addition to the Sky Courier and Denali programs where we expect to complete first flights later this year.

In summary, we continue to feel good about execution across our businesses and are well positioned for second half revenue growth, of increased deliveries at Aviation driven by the Longitude entry into service as well as higher commercial orders at Bell.

We expect these developments to drive strong earnings and cash generation throughout the balance of the year.

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

Thank you, Scott, and good morning, everyone.

Segment profit in the quarter was $339 million, down $7 million from the second quarter of 2018 with segment profit margin of 10.5%, up 120 basis points from a year ago.

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

Revenues at Textron Aviation of $1.1 billion were down $153 million from last year's second quarter primarily due to lower commercial turboprop and defense volume and mix.

Textron Aviation delivered 46 jets, down from 48 last year; and 34 commercial turboprops, down from 47 last year.

Segment profit was $105 million in the second quarter, up $1 million from a year ago as favorable performance was offset by the lower volume and mix.

Textron Aviation backlog at the end of the second quarter was $1.9 billion.

Revenues at Bell of $771 million were down 7% from last year primarily on lower military volume.

Bell delivered 53 commercial helicopters in the quarter, down from 57 last year.

Segment profit of $103 million was down $14 million primarily due to lower military volume.

Bell backlog at the end of the second quarter was $6 billion.

Revenues at Textron Systems were $308 million, down from $380 million last year primarily reflecting lower volume at TRU Simulation + Training and Unmanned Systems.

Segment profit was up $9 million from last year's second quarter primarily due to an $11 million impact from performance, reflecting an $18 million gain related to the formation of our new training business with FlightSafety International.

Moving forward, we will continue to record our portion of the operating profit from the new training business.

Textron Systems' backlog at the end of the second quarter was $1.4 billion.

Industrial revenues of $1 billion decreased $213 million largely related to the impact from the disposition of our Tools & Test product line and lower volume.

Segment profit was down $4 million from the second quarter of 2018 largely due to the impact from the product line disposition and lower volume partially offset by favorable performance primarily related to the Specialized Vehicles product line.

Finance segment revenues were down $1 million and profit was up $1 million from last year's second quarter.

Moving below segment profit.

Corporate expenses were $24 million and the interest expense was $36 million.

We also repurchased 3.1 million shares at an overall cost of $159 million.

Through the first 6 months of the year, we've repurchased 7 million shares, returning $361 million in cash to shareholders.

To wrap up with guidance.

We are raising our expected full year earnings per share from continuing operations to a range of $3.65 to $3.85 per share, up $0.10 from our prior outlook.

We are reiterating our outlook for cash flow from continuing operations of the manufacturing group before pension contributions of $700 million to $800 million.

That concludes our prepared remarks.

So Kevin, we can open the line for questions.

(Operator Instructions) First question is from the line of David Strauss, Barclays.

I guess, first clarification, can you just tell us how much the gain was on the Systems side for the training JV?

It was $18 million, Dave.

Okay.

And then, Scott, could you maybe talk about the potential for your 737 MAX simulator business?

How many you've built there?

What's your ability to ramp that up given the potential training needs on the back of what's going on with MAX?

So Dave, I can't give you a whole lot of detail on it.

I mean obviously, we've been delivering MAX sims to Boeing and several 737 MAX customers.

I think a lot of that will depend on how all this plays out in terms of the recommendations or requirements that FAA and the EASA put on airlines around the need for sim training.

It looks at this point to us like it's probably going to be a requirement that allows them to get back in flying in a transition course and then would mandate actual MAX sim training later on.

So we've certainly had quite a number of inquiries from customers who are interested in going ahead and getting MAX sims on order.

We started to do some long-lead ordering already to support those deliveries next year, but I couldn't give you a firmed up number yet.

I think we're still working on that and working with Boeing to understand their strategy on a go-forward basis as well.

But we really have to kind of wait and I think see where the FAA and the EASA end up in terms of what their training mandates are.

And our next question is from the line of Carter Copeland, Melius Research.

Scott, I wondered if you could just kind of expand a little bit on the rationale that's been made here, the company you set up with FlightSafety and just what that should tell us about the -- what the implications are for your -- what you've been trying to create organically there.

How much does this change the growth expectation that you have for those efforts?

And kind of expand that much more rapidly and trading some of the profit as a result to try to get more scale there.

Just kind of give us some detail on the rationale and then what you're trying to accomplish with that.

Sure, Carter.

So as you know, we decided to get into that training business several years ago.

We thought that was a very important part of sort of the service aftermarket element of our business and we weren't really participating in that.

We had a lot of feedback from customers that they would be interested in us participating in that space.

And so, as you know, we made a couple of fairly small acquisitions.

Obviously, over the last few years we invested a fair bit in both IRAD and R&D as well as CapEx to start to build out that training capability.

The business is going very well.

Great customer feedback.

I think the training materials and the techniques and -- that we were deploying were working.

The challenge was that this -- the time frame of how long that would take to build out the number of training centers and number of locations and it was a fairly daunting task and was going to take quite some period of time to do that.

We happened to engage in discussions with FlightSafety whom we had a relationship for many years obviously in the training side.

And said, "Look, we ought to link together.

Let's take the technology and a lot of the tools and the capability that we developed organically and put these businesses together in a joint venture." And basically what that's allowing us to do is take what we think were the advantages of that business and the positive feedback we were getting from customers and expand it much more rapidly.

So this is now -- has the ability to much more quickly accelerate the returns for us.

And I think for the customers, it's sort of taken the best of both worlds, a combination of what we'd invested in organically and the significant footprint that FlightSafety has around the world so that we could touch more customers in a time frame that was much shorter than doing this just going training center by training center in terms of us putting more and more capital out there and FlightSafety already had the capital out there.

So as we said, really the gain is a function of having invested in that business and having put those assets in the joint venture.

You've got to look at sort of revaluating those assets, and obviously, we created a very valuable business.

And so that's a good thing.

I think more importantly, what we'll see going forward is the earnings as a result of our share of that joint venture, which was going to grow much faster than if we had -- we stayed just on a pure organic path.

So -- and you'll see those earnings come through Systems as we go forward.

Just in general terms, do you expect to go to 50% more or 2x?

What -- just any color around how you can help, what your expectation is or how much you've accelerated that as a result?

Well, I don't -- we don't break out the numbers at that level of detail, Carter.

But I'd say it's significantly faster in terms of the rate of return we would have had if we had played this out on a purely organic basis, let's say.

The difference between having to build up that capital infrastructure versus leveraging what FlightSafety already had in the ground, it becomes more of a technology play than a CapEx play.

Our next question is from the line of Sheila Kahyaoglu, Jefferies.

Scott, just a big-picture question.

Organically, sales were down 10% in the quarter.

You've been focused on new products to gain share rightfully so in relatively tough end markets.

How do you kind of think about the levers from here just given your decision on the Hemisphere as well?

Sure.

So look, I think that for us in the quarter really and the first half of the year, the big impacts it'll change how the second half plays out here is one around Bell commercial.

And we talked last year we were seeing strong demand on the commercial side.

We indicated that we need to turn up our production rates to meet that demand.

It takes a little bit longer from the time you make that decision to the time you have aircraft coming off the line.

So when we increased the production rates on aircraft like the 407s and the 429s, we didn't have those aircraft available coming off the line until right about now.

So I think we'll see a significant impact in increases on the third and the fourth quarter.

The demand is there.

The orders are there.

It's been a matter of getting the production up and delivering at a higher rate and that's where we are now.

So you'll see the benefits of that here in the third and fourth quarter.

They're already supported by orders that we have.

We just needed to meet the demand in terms of the production side.

On the Aviation side, obviously, Longitude getting into service.

That was a huge part of our growth story on Aviation for the year and we expect that clearly will be the second half impact here.

We continue, frankly, to see good demand on the historical aircraft.

The Latitudes continue to sell very strongly.

Again, demand on the Longitude side is very good, I think, across the whole portfolio.

Clearly, we had a very strong first quarter.

Second quarter, we felt pretty good.

Things did get a little bit shaken up there right towards the end, but they're mostly customers that said, look, I want to wait for the markets to settle out and I'm going to defer this in the second half.

So I think our view of the business jet market is still very healthy and so I think between that and the Longitude coming into service, we'll see strong growth in the second half.

And then, Frank, one for you.

On working capital, it's been a [safe usage] in the first half, I think, primarily due to inventory.

How do you think about that reversing any potential risk?

Yes, Sheila.

As Scott said with that growth in the second half, we expect to kind of obviously sell off and liquidate that inventory.

The bulk of that build is at Aviation.

It's kind of certainly impacted by the Longitude moving into the second half of the year.

But it's also kind of Bell commercial and other volume that Scott indicated we were looking to have come through in the second half of the year and feel good about where we're positioned to do that.

Next question is from the line of Peter Arment, Baird.

Scott, I mean could you just give us a little more color on how things are going in terms of within the Industrial segment, particularly I guess Specialized Vehicles?

Performance seemed to be a little better than I think a lot of us were expecting.

What's -- how is the Bass pro kind of rollout going?

Just maybe some color there.

Sure.

No.

There's a couple of things there, Peter.

First of all, obviously, from an operational performance standpoint, the business is doing much better.

Historical businesses where we've had a very strong position and good performance for a long time in Golf, in ground support equipment and areas like that, I'd say our performance is back where it should be.

Guys are doing very well, the markets are healthy, and again, the team's operational execution is quite strong.

In the Off Road world, we're down in revenue.

That's quite conscious, right?

We're working very, very hard to make sure that we do a much better job in terms of how we manage those retail channels.

Snow is a good example.

A position that we took this year is we said, guys, we're only going to presell.

When you look at the North American market, which is obviously the vast majority of the market in the snow world, we went out with our programs and said, guys, we're only going to build what we've already sold.

So we went around and have deposits from customers.

This product line is basically sold out.

And so we'll be here through the whole third quarter manufacturing all those units and shipping them out.

But unlike in previous years where you'd be putting a lot of inventory out into the field and dependent on how that sold through and then getting into rebating, if it's not selling through, we said we're just not going to do that.

So we're going to do only a presale and that was, frankly, a very successful program.

We saw pretty strong demand across the product line, but we're presold.

So on the dirt side.

Obviously, that's a longer and sort of a little bit of a different selling season should you go through there.

But again, we're being very, very cautious about how we manage that channel, how much inventory we allow to be added to that channel.

We did an awful lot of hard work on looking at individual dealers and making sure that we have relationships where that relationship is a profitable relationship for both us and the dealer.

And as a result, we've dramatically reduced the number of dealers we had out there.

Because when we went back and looked at some of them, by the time you get through the rebating, we're -- it's not a profitable relationship.

And so we've taken the pains of terminating relationships with the vast majority of those folks.

Specifically, on the TRACKER front, obviously, the Bass Pro, Cabela's and their independent marine dealers is terrific channel, extraordinarily well-run.

Very, I would say, deliberate around what it does in terms of inventory.

So in terms of how they manage is quite consistent with how we want to manage the business going forward.

So we've been seeing a lot of activity and load-ins across both stores and independent dealers here over the last 6 months.

That obviously will continue through the balance of the year.

We like the trajectory.

The momentum is building.

So I think when you look year-over-year, Peter, we're much happier with where that business is both in terms of how it operates every day, how it thinks about managing some of those channels.

Some of the issues we have last year with being late with some of the new products, obviously that's -- those products did get to market and I think we have a great product lineup.

We just have to be very measured about how we manage the channels and how much inventory we allow to be out there to reduce risk and make sure that we have a good, profitable business.

Appreciate that.

And just a quick one on -- Scott, did you see any change in biz jet pricing just given the softness in the end market a little bit that you saw in May or pricing is still holding?

No, Peter.

We're still seeing pricing holding.

There's always a crazy deal or two and we choose not to participate in those, right?

So I think we make a great product, it's fairly priced.

Got a great service network behind it and there's no reason for us to chase a crazy price deal here and there.

So we're maintaining that discipline, and as we've said all along, we will trade volume rather than damaging the prices in the industry.

So I think that's -- I think the pricing is in a place where it should be, right, and we're going to hold the line.

And I think you'll see here in the quarter we had price net of inflation up a little bit, which is healthy for the business and that's what we need to continue to do.

Next question is from the line of George Shapiro of Shapiro Research.

Yes.

Scott, the implied orders in the quarter were pretty weak and obviously the book-to-bill was less than 1. Given that you see things picking back up in the third quarter here, is it natural to expect a book-to-bill over 1 in the third quarter recovering from the second quarter?

Well, George, I would hope that, that's the case.

I mean clearly, we had a very strong first quarter on the book-to-bill front.

We still have our backlog numbers net for the first half above where it was coming into the year.

So I think we're not overly concerned by this.

As I said, things did slow down in June given some of the gyrations in the market and talks around tariffs and things like that.

But I think most of the discussions that we've had with customers, particularly in the U.S., where some things would push in the second half and those dialogues continue with customers.

So I think we're still in a pretty good place in that respect.

We were light on the turboprops, particularly in the international market.

And as you know, George, that's a little bit lumpy.

We've seen this before where it kind of goes into fits and starts.

So that's a little bit harder market to predict.

It generally affects more the turboprop than it does the jet side of the business, but we'll see how it plays out.

But certainly, my expectations would be that we would continue to see good order flow through the balance of the year.

And Frank, one for you.

Just Aviation aftermarket, how did that compare to last year?

Yes.

It was fine.

It was down just a touch, but continues to kind of be solid for us.

And the reason it's down a touch as opposed to up a little bit, any color on that?

No, no.

I mean no, nothing significant.

Kind of we've seen some variation in volume in the shops from time to time where we are looking at solid or strong second half performance there and kind of continue to be -- feel good about how we're executing there.

And next, we have Robert Stallard, Vertical Research.

Scott, on the biz jet side of things, a couple of your competitors have launched some new products so far this year, and I was wondering if you could comment on whether this could impact your market share going forward.

I don't really know of any, Robert, that are right in our wheelhouse.

I mean if you look at the -- I mean Embraer earlier in the year obviously announced Praetor.

I think that's largely those product lines from that particular competitor have been up against Latitude and obviously on Longitude.

I think our products are outstanding performers and we continue to see strong demand on the Latitude front.

And look, I think Longitude is in a very good position.

I wouldn't expect to see a lot more order activity till we get through the certification.

I mean there's plenty of customers that are in the process and many of whom I think are just waiting for the cert to be done.

So I think from a performance standpoint, we continue to get fabulous feedback from everybody that demo flies that aircraft.

So look, it's a competitive marketplace.

I think it's always been one and it will continue to be a competitive marketplace, but I think we're -- we stack up quite well to that.

So every transaction has got competitive nature to it, but I think we're winning our fair share and feel pretty good about where we stand.

Okay.

And then maybe one for Frank.

Any change to your guidance has been to up EPS by $0.10.

I was wondering if you could comment on whether you see at the halfway point in the year any changes to the divisional split for the full year.

No.

It's largely intact.

I'd say that obviously we've seen good performance out of Bell so far this year.

So kind of reflected in that $0.10 is some kind of continuing solid performance out of Bell that probably kind of gives them a little bit of upside to our original margin guidance there.

And then Systems has done a nice job as well kind of executing through the first half.

So kind of -- those are the 2 places where we're seeing some better performance that are contributing to the $0.10.

And the next question is from the line of Cai von Rumohr, Cowen and Company.

So yes, you mentioned Bell doing particularly well.

How much of the strong profit in the second quarter reflected favorable EACs on V-22

Multiyear II?

And kind of as we go into next year, are we still looking at 10 to 12?

Or can it be better?

Well, Cai, I would say that, look, we always -- I mean every quarter, we have our EAC process and there's always some performance in there.

It's certainly less than it was last year, so from a comparable place.

And then we kind of talked about this, right?

I mean we've kind of have been winding down the Multiyear II revenues and ramping up the Multiyear III revenues.

And that certainly had a lower margin.

And again, a lot of the performance and sort of reserves that you keep around Multiyear II have largely played through.

So on a year-over-year basis, the EACs are -- or the gains associated with that are down, but they're still there and I would expect they'll always be there.

I mean we always try to continue to drive productivity and performance improvement and we recognize that each time we go through an EAC.

There's always some puts and takes.

But I think the team executes quite well.

So -- but anyway, I would say along the lines of how they're performing, there continues to be strong performance.

So even though the EAC numbers might be lower gains in the quarter, we're reflecting solid operating profit across the whole business and I think we'll continue to see that.

Next year, I would say, look, we've had sort of that 10% to 12% guide out there for some time on Bell.

They certainly have been overdriving that here as we worked our way through Multiyear II.

Just -- I wouldn't change my perspective.

That's a business that's well-run and we'll continue to sit in that 10% to 12% range.

There's a fair bit of R&D, as you know, going on.

I mean 525 has been a big part of that.

V-280 has been a very large part of that.

But we will be transitioning into these cape set 1 and cape set 3 OTA programs and there's cost share associated with those, right?

So our R&D spending needs to stay at a pretty high level to support what we think are some really significant opportunities for the future of Bell.

So it's -- I think that 10% to 12% range is still how you all think about it.

And then, Frank, so you're -- maybe give us some numbers on where the net price increase at Aviation was.

It narrowed a bit in the first quarter.

So where was it in the second?

And also given that you have yet to certify the Longitude, is your full year delivery target fully intact?

Or should we be looking at a slightly smaller number this year?

Yes.

So on the price side, Cai, gross price was $13 million for the quarter and net price was $3 million.

So continued good performance on that front.

And no, I mean we continue to be positioned to deliver on Longitude once we've achieved certification and kind of we feel like we're in the right place to meet the commitments that we have for that.

And we obviously haven't adjusted the Aviation number kind of in any way.

And our next question is from the line of Seth Seifman, JPMorgan.

Just to follow up there on Aviation.

I guess the projection you've given for the segment is for about $550 million of earnings for the year.

It implies a pretty big second half.

And I think given the Longitude deliveries, that kind of -- we can understand why the second half would be bigger.

And second half is seasonally usually bigger anyway, but even bigger this time.

And so can you walk us through?

I mean do you expect a significant increase in the earnings for Aviation in the third quarter?

Or does it kind of all come in the fourth quarter with the Longitude?

And to the extent that there was any temporary softness in demand around some of those macro issues that you mentioned during the quarter, I mean have you already seen that start to come back in terms of orders or indications of interest in the first couple of weeks of the third quarter here?

Well, so I would say that our progression, as you note, I mean this is usually a business that has a back-end load.

A lot of that is driven by tax, folks wanting to get their aircraft deliveries done by the end of the year.

I don't see any change in that.

I think the progression that we normally see, we would expect to see, arguably, is going to be a little more accentuated than that just because you have the Longitude coming into service.

So yes, it'll be more of a pickup in the back half associated with that.

In terms of just the normal order flow, yes, I think things appear to be normal.

We actually did see customers that had said, I want to wait and see what happens after everything kind of got a little shaken up in that late May -- in the June time frame and did take delivery in the second quarter.

But more of them were so, look, I just want to sort of put this aside and think about this as a second half activity.

So -- and again from -- talk to our sales teams, those dialogues are ongoing.

And so I would expect that we'll see most of that come back and turn into third, fourth quarter deals.

And in fact, this summer around aircraft, there are deliveries that would be out into next year.

Right, right.

And then on the Longitude, and given I think it's probably just a handful of the initial units that are either marginally profitable or not profitable.

And so on that basis, is it possible for Longitude to contribute to earnings in Q3?

Or is the Q3 earnings that we're going to see basically all from non-Longitude platform?

Well, look, as you know, typically the initial deliveries are going to be at a lower margin.

There's -- will be some contribution.

But certainly, from a margin rate, there's no question, third quarter they would be dilutive.

So that being said, I think the performance, you've seen very strong performance in the business here in the first half.

So our relative profitability on like revenue is stronger than it has been.

So it's offsetting against what is very strong performance.

So it's still going to be respectable margins, but it will be -- if you just looked at Longitude on a stand-alone basis, it would certainly be dilutive.

And next question's from the line of Pete Skibitski of Alembic Global.

Scott, can you update us on Ship-to-Shore in terms of that initial LRIP contract that I think you're expecting in that -- if one that comes through here in the second half?

Is this some kind of return to growth on that basis?

Or maybe are the UAV headwinds still too tough right now?

Can you just update us there?

So Pete, I definitely think that -- well, first of all, Ship-to-Shore is moving along well.

The first craft is in builder's trial.

So that was a huge milestone, so we're about halfway through that process.

So we're expecting delivery of the first craft here this quarter.

The rest of the initial developmental units are moving along well behind that.

We do continue to get long-lead funding for that next production lot of aircraft.

There's actually 3 fiscal years that are in here.

We are in negotiation of that process.

I would expect here in the third quarter or fourth quarter at the latest.

Obviously, we would get that under contract.

So -- but the amount of revenue that we'll see this year is largely associated with those long-lead materials.

We do have some of the initial assembly or initial welding activity going on the first craft.

But really, you'll see the impact of that as it starts to ramp-up and generate revenue, really, will be a 2020 story.

So clearly from our perspective, Systems here is sort of bottoming in 2019, and you'll see the growth in 2020, in large part driven by that transition of Ship-to-Shore from development program to the production program.

Can I just ask one follow-up, Scott?

I haven't asked you in a while about this Marine Corps MUX program.

They're doing a lot of interesting things, I think, with the acquisition strategy.

Are you guys kind of comfortable on that program right now as an opportunity for you?

Or some of the things that they're doing, are they kind of making it tougher to bid on?

Just your thoughts.

Well, I think -- yes.

Look, I think the Marine Corps is doing a lot of work right now.

And then you see these small levels of activity and projects where they're just -- they're basically soliciting ideas, which I think is a very healthy thing to do.

Obviously, we've -- we have done a lot of work on the concept of the MUX and how we would approach that program.

The Marine Corps obviously is well aware of everything that we've done there.

We have participated in some of these other smaller projects where they are sort of going to industry and said, hey, give us your ideas around different mission systems and different concepts of operations.

So it's -- I think they're sort of in a fact-finding mode.

Obviously, we have put a lot of information in front of them over the last couple of years.

And at this point, I think most of the work that we feel like we need to do in advance of this thing, we've largely done that.

And I think here in the next couple of years, you'll see that being transitioned from sort of the solicitation of ideas to help them formulate their final specifications, if you will, around that program.

And then it will turn into a, hopefully, into a funded development program.

Obviously, we would participate in that.

I think we have a great solution to what they're looking for.

But it'll ramp over the next couple of years, I think.

And next, we have the line of Rajeev Lalwani of Morgan Stanley.

First, just a question on Hemisphere.

Can you talk more about the decision to put that on hold?

How much of it was engine versus simply what you're seeing in the overall market and the signals you're getting there?

It was really the engine.

As we've talked about for the last year or so, we think that the niche or the area that we intended to fit with that aircraft and obviously had that shared feeling with NetJets as our launch customer was an area that would be a great product and a great price point, performance point to go into the marketplace.

But the challenge was there was really only one engine in development that was suitable to meet that performance point.

And as I said in the prepared comments, that engine hasn't yet demonstrated the performance required for the aircraft.

So if at some point in the future in there -- that engine or whatever is demonstrated that can meet it, we would certainly revisit it.

It's just that I think too much time has gone by here, and we can't sort of hold this thing in a -- I mean we can't expect our customers to kind of wait in uncertainty or any longer.

So there's still a potential for it out there.

We have to evaluate and understand what's the competitive dynamic, what's going on in the marketplace, what's going on with customers to determine at that later time whether that product would make sense or not.

We'd be certainly happy to evaluate and look at that.

But in the meantime, clearly, we need to take our engineering resource and focus on those things that are going to drive our growth in the mid to near term here, which is not just getting Longitude done but getting SkyCourier and Denali into the queue.

And as you know, we're always kind of looking at other concepts and opportunities within our portfolio that need refreshes, updates and things like that, which is what we normally do.

So we're -- simply it's going to take all that engineering resource that would've gone into the Hemisphere program and deploy that into our current portfolio of programs.

And on the Bell side, you obviously are pretty well positioned on the long range and now the reconnaissance program.

How important are those for the future of Bell?

I mean assuming that you're not successful there, should we start thinking about an overall restructuring of the military side of the business there?

Do you feel like there's enough -- other things going on to sort of sustain what you're seeing today or add to it?

Well, I think if you look at the military side of Bell, we have good visibility on H-1 production out into the 2022 time frame.

There's a number of FMS opportunities that are out there that we're pursuing.

As you know, those always take time to get those to closure.

V-22, we're already running at that lower rate associated with Multiyear III.

Again, there's some FMS opportunity here, other things that could increase that over time.

And I think there are certainly some possibilities there.

And of course, this has become a very large installed base, so there's a ton of service business associated with this.

There's upgrades and enhancement programs, which are typical of any large defense platform, which we expect we'll continue to see into the future.

So I think Bell on the military side, just around V-22 and H-1 can sustain and be a nice, healthy business.

But clearly, looking from a growth standpoint, the opportunities that are out there around FARA; around FLRAA; there's the V-280, of course; the MUX program, which we just talked about and some other opportunities around tiltrotor is what's going to drive the growth in the future.

And I think we're pretty well positioned on several of those programs.

Will we win them all?

Probably not, but these are very large programs.

And so winning 1 or 2 of those is what would drive significant growth for Bell on top of the ongoing sustaining of the V-22 and H-1 programs.

And next question is from the line of Jon Raviv of Citi.

Can you just level set us a bit more on Systems margin going forward post the FlightSafety deal, but then also with the Ship-to-Shore Connector ramping up?

I understand that sales bottoms in 2019.

But how about the margin rates?

And I guess overall, how to think about earnings dollars growth going forward here with those 2 big moving pieces?

Yes.

We've shared, guys, I think the Systems business should be targeting around a 10% margin.

We've returned that last year.

We're on track to be in that neighborhood this year.

Obviously, this -- there has been a bit of a drag on -- associated with a fixed price development on Ship-to-Shore.

But again, as that transitions into a production program, this is a business that we should expect to see a 10% margin business.

Okay.

And then just going back to Aviation.

And in -- Scott, it seems like something really kind of scared customers in May, June, even though the market has been through some other gyrations, especially through 2018, which kind of threw that period.

You typically sounded quite positive.

So what do you think was different about the nature of this May, June move?

And what -- I mean not to beat a dead horse, but really, what gives you confidence that this is going to come back?

I mean the Fed's cutting rates because the economy is slowing.

That's probably not a good thing for customers.

Well, I think people -- when you look at the combination of -- again, we had some market gyrations.

But to your point, this happens periodically, right?

I mean -- but you had this concern over Mexico tariffs.

I mean that -- I think we had a couple of customers that just flat out do a lot of business in Mexico, and this was a big problem for them.

So that created some of that uncertainty.

Look, a lot of people were talking down saying, hey, the economy is really going to slow down dramatically and -- look, I think the numbers that actually came out would indicate that's not the case, all right?

I mean unemployment numbers are still quite good.

The GDP numbers were actually better than most economists were forecasting.

So is the market on fire?

No.

But is it healthy and steady?

I think that's more the case of where we are.

So customers that are interested in upgrading and buying new aircraft, they didn't go say, hey, I'm done.

They were, let me see what happens when things settle down a little bit.

So kind of like the timing of it.

When we get one of these perturbations in the first month of the quarter, that gives you time for customers to kind of understand where they are and get comfortable and move forward.

When it happened in the last month of the quarter, it's a little more challenging because they come back to the table, but it's now past the end of a quarter.

So I think that if that had not happened, we probably would've overdriven a few jets just given the number of things that were in the pipeline.

But I think, at least, our view right now is those were largely just activities that deferred into the third quarter.

And the next question is from the line of Robert Spingarn of Crédit Suisse.

Just a couple of things.

On the Industrial business, you're guiding, I think, pro forma for the divestiture about flat this year, and that seemed to track in the first half.

But I'm wondering about some of the moving pieces in there.

For example, how did the channel still work with the TRACKER product against streamlining your other distributors?

And how do you think about automotive in the second half given some of the macro weakness that we're expecting?

So that -- on Kautex, can you -- essentially, can H2 be flat with H1 is what I'm asking.

So I think if you look at -- let me talk to the automotive side first.

Clearly, volumes around most of the world are down.

But frankly, the comparisons on Q3, Q4 are going to be easier than Q1, Q2 because you really saw that slowdown hit in the latter part of last year.

So I think our business is performing well.

I mean we're happy with performance and operations and margins and how the guys are doing.

But there is no doubt, it is on a lower-volume basis, but more or less consistent with where we thought it would be.

And as I said, the Q3, Q4 comps are certainly easier than what we saw in Q1, Q2, just given the global automotive slowdown.

So I think we're comfortable with where we are.

Again, the team is executing quite well and delivering based on where that end market is.

So we continue to be -- feel good about new programs and new nominations, which obviously are growth and opportunities in the future as well.

On the Off Road side, we have -- I'll tell you the TRACKER, the way that the inventory and stocking model works in Bass Pro and Cabela's and their dealers is a very disciplined process.

It's a very healthy process.

And we feel very good about how that's going and the way the team there manages that.

It's a great partnership.

We're pleased with how it's going and very comfortable with just how they do business and how they manage that business.

I talked a little bit about the other pieces of the channel around snow.

We're just -- guys, look, we have some very, very good dealers out there, particularly a lot of our dealers who have a long history with that brand in the snow side.

As I said, we're being extraordinary disciplined with how we do that and how we manage that, and we'll do that on the dirt side as well because it's largely those same dealers of guys that are historical snowmobile dealers that are carrying that Arctic Cat brand of dirt.

And by the way, they are very complementary channels, right?

It's a -- the strength of that channel under that Arctic Cat brand tends to be in the northern parts of the U.S. and Canada where the snowmobile country exists.

And then most of the rest of the country happens to be where the Bass Pro, Cabela's and their independent marine dealers are very strong.

So it gives us a -- in total, I think, a very strong distribution network.

Do you find that weather is as big a factor for dirt as it is for snow?

And then one last thing I wanted to ask you is similar in commercial helicopter, similar to my first question about H2.

How do you get optimistic or as optimistic for a bounce back when the rig counts have been fairly soft, especially in the second quarter?

Well, so on the helicopter front, keep in mind that our share in those deepwater rigs, I mean we really don't address that market today.

That's part of what the 525 is about for the future.

But where our market is and where we've frankly seen strength and very strong order flow here in the last almost going on a couple of years now is really around the near-end stuff in oil and gas and frankly, a lot of emergency medical services, executive VIP, customs and border patrol, I mean it's a much broader market, police.

Really -- what really drives the 407 and the 429 markets is not the oil and gas markets.

So there is a real contrast right now between the big machines that are largely oriented to serving that offshore oil and gas market.

It's just not a market we've had a very big position.

The market that's quite strong is, again, around more the light twins, the singles.

So it's volume around 505, 407, 429 and 412, which is not that deepwater, offshore oil and gas market.

Okay.

And then just the weather question on dirt versus snow.

Well, look, I'd say it's a lot less dependent.

Snow is very dependent on the snow season.

Again, this is part of why we want to sort of insulate ourselves from that by saying, guys, we're going to presell.

So those snowmobiles are going to be built, and they'll be shipped and they're paid for.

And that will all happen before there's -- we even get into the snow season.

So by design, we were trying to insulate ourselves from that one way or the other.

And of course, we've looked very hard at what's out there in the inventory.

The inventory levels of our products, frankly, ended up at a very low level last year, well below where we originally targeted.

And that was because it did seem a relatively, in most parts, a good, strong snow season, and so our dealers did retail through a lot of product.

So I think it puts us in a very healthy position.

We have a fairly low level of inventory out there, and we've already presold all of our 2020 models that are going out.

Dirt is more difficult, I mean essentially more difficult.

I mean it's not as weather dependent, right?

You got a spring season, a fall season.

It's not -- it really doesn't -- isn't driven by a particular weather cycle on the dirt side.

Next we have Noah Poponak, Goldman Sachs.

Scott, did you actually specifically have live, in the process, kind of ready-to-rock business jet customers that then specifically cited the Mexico tariff situation as a reason to hold off as opposed to just you were talking broad macro and giving an example?

No, no.

Absolutely, Noah.

I mean there were a couple of specific transactions with customers that do a lot of business with Mexico, and their business is dependent on that, and they got pretty rattled.

Now will they come back?

I would expect so.

I think that whole issue -- I mean look, a part of it, Noah, was that came out of nowhere, right?

I mean this was a -- more of a diplomatic issue than a tariff.

They thought that the new free trade agreement and all that had -- all the dust had settled on that sort of stuff, and so this kind of came as quite a surprise.

But of course, now it's also gone away.

So I think -- I'm hopeful that those things will come back.

But yes, I think there were very specific transactions that literally stopped because of that.

And in a bigger way, it contributed just to a level of uncertainty economically.

And people don't spend big CapEx items when there is uncertainty.

Yes.

I -- yes, it's interesting.

Not to diminish the -- how meaningful that specific thing is, but it's just a pretty specific thing.

And so I guess just in trying to -- we all keep, I think, trying to ascertain where we are on the spectrum of weak market to okay market but still kind of touch and go and skittish to strong market and it -- I had interpreted some of your commentary year-to-date to suggest we had -- we're really moving towards stronger market.

And I guess how concerned are you that you just will never be able to get a fully firmed-up, tight market until we're just out of this cycle, and we're in a new cycle as long as everyone's here?

Because there's always going to be some headline not dissimilar to that, right?

Well, no, there's always and I can't predict them all either, right?

I mean -- but look, we've been playing this -- I've been in this over 10 years now.

And so yes, things get -- curveballs get thrown in there of one flavor or the other, whether it's markets or international tensions or currency.

I mean look, this is the nature of the world that we live in.

But some things are very specific, localized problems.

Some are more broad-based.

But as I said, I think you look at where the market was -- really, through 2018 and the beginning of '19, still felt very good.

I think we still feel like we have a very good list of customers.

I do think that the cycle, if you want to talk about it that way, that was the overhang of a lot of used aircraft and all these sorts of things is largely behind us.

And so that gives us a little more stability, I think, and just a general better feeling on the new side because you don't have that big overhang on the used side, which clearly is the case right now.

Most used aircraft that are out there are quite older used aircraft.

I mean those transact typically at a slower rate.

Every indication on the used aircraft market, which, obviously, we're a big participant in that market, is that if you've got newer aircraft, the kind of people that do trade in, and do buy aircraft, it's still very liquid and there's good demand.

You come out there with a good used aircraft, they transact.

So it's as healthy -- the underlying market is as healthy as it's been in a very long time.

Does that make it immune to something sort of perturbating it like we saw here?

Absolutely not.

But I still think in general, we feel good about where it is.

The dynamics of, again, used, of pricing, of new products coming into the market, that I think will help drive a lot of our growth.

Again, we've -- as you know, we've taken our approach that says, if the markets are just sort of flattish, we need to drive growth by bringing things like the Latitude into the market, by bring the Longitude into the market, by bringing the Denalis and the SkyCouriers in the market.

Those are the things that are the investments that we make to try to drive growth in the business, even if you have a flattish overall market.

Yes.

Okay.

That's really helpful.

I appreciate that.

On the Aviation margin, do we need to be aware of a substantial variance between the third quarter and the fourth quarter margin just as you bring the Longitude in, in the third quarter?

Yes.

Look, I think you're going to -- you would expect to see a somewhat lower margin in Q3 because of that dilution of the initial Longitude orders going out there.

And then you would expect to see stronger Q4 margin.

I mean as you know, Noah, look, we always -- that sort of -- just the volume and the dynamic of our business, this always kind of plays out a little bit like that anyway between Q3 and Q4.

Q3 tends to be a lower margin in Q4 largely driven by volume.

But there'll be probably a little bit of differentiation here based upon that -- the dilution of Longitude.

But again, I think the underlying performance of the business, how they are executing, the productivity, the efficiencies that has been driving a pretty significant improvement on a year-over-year basis, I mean you run like a couple of 100 basis points still better, and that will be tough to do in Q3 given the Longitude dilution.

But I think we'll -- you'll see continued strong performance from that business.

Got it.

And then last one on the cash flow.

The year needs to be meaningfully more back-end loaded than the normal historical seasonality to get to the guidance.

I'm assuming that's primarily or entirely Longitude.

Anything else in there?

Well, the biggest for Longitude is probably the deep well is certainly the single biggest driver.

We'll build these aircraft, right?

The demand is there, the customers are there.

We just got to get the certification done.

So we're -- we've got plenty of aircraft set up and ready to go.

I talked a little bit about Bell.

Obviously, we've been ramping that production rate up here.

So that's all sitting in working capital right now.

And you'll see considerably higher volumes here in Q3, Q4 on the commercial side of Bell.

And then -- I mean they're smaller numbers.

But as you look at, for instance, the snow stuff, right, I mean we've got all of that stuff going in working capital right now.

We'll produce all that stuff and sell that through mostly here in the third quarter.

The dirt side, we're always going to have a little bit of some higher inventory carry in there because we need to be able to run the factory and do nothing but snowmobile third quarter so we build up enough inventory to make sure that we can satisfy the demand in that channel as well.

So -- but again most of that -- significant dollars are associated with Longitudes and the Bell ramp, things like the snowmobile going out.

I mean I think that's why we still feel quite comfortable with our initial guidance range, albeit for sure that it's more back-end loaded than we would like.

And next, we have the line of Ronald Epstein, Bank of America.

It's Kristine Liwag calling in for Ron.

Scott, Safran just put out a press release that there's no financial impact for both of you from the contract termination on the Hemisphere.

Since the issue seems to be largely from engine performance, I was wondering why there isn't more recourse for you from Safran.

How is your contract different from your competitor that got a few hundred million dollars in penalties from them?

Well, I -- because we don't have -- we didn't have a few hundred million dollars of penalties associated with it.

But there was -- we do on a much smaller scale do R&D sharing with some of our key suppliers.

And largely, we've -- we have had a -- again, a very small, relatively speaking, number that's in there that's been supporting some of the R&D.

It is a shared program.

So we've had R&D in it, they've had R&D in it.

My understanding is they're going to look to continue to work the engine.

I mean if they can get that engine to its specification, it'd be a great engine.

So I can appreciate that they would continue to make some investment as well.

But we just -- we don't deal in these kinds of massive programs to offset these things.

And frankly, because there's not -- I mean size of the market, there's not a volume that anybody would ever invest or put up that kind of a front-end-loaded payment or obligation.

So...

And when you think about that size aircraft in the market, I mean the Hemisphere was supposed to enter in service some time next year when you first initially rolled it out.

Can you describe what's going on in that market environment today?

And is there a demand for replacement of a Hemisphere-type aircraft?

Well, the decision point was to be to launch it this year.

So the entry into service would've been out probably 5 years anyway before that would go into the market.

But it was intended to be an aircraft that would go into fleets like NetJets.

And obviously, other retail customers that had a requirement to do that longer range.

Again if -- I mean the theory of where we were in that business was that most of the large cabin manufacturers are going to ultra-long haul and even longer-range aircraft, and that there still was a demand and a right place at the right price for the right performance capability for an aircraft that was more in that 4,000, 4,500 nautical mile range.

And there really hadn't been a clean-sheet new airplane in that space in a long time, and that was where we felt the opportunity was.

Of course, the challenge there is -- you need to have the right engine-airplane combination.

And so that was always predicated on having that engine there.

And as I said, there's been a lot of hard work.

There's been a lot of progress, frankly, that the Safran team has made.

It just was not yet able to demonstrate, and we just had a time line that says, guys, we need to step back here and commit resources in other places for now.

And if the engine gets there, then we can revisit that.

Okay.

Operator, that does it for this call.

Thank you, everyone.

And you can reach me if you have any follow-up questions.

And we'll see you next quarter.

Thank you.

Ladies and gentlemen, that does conclude your conference.

We do thank you for joining.

You may now disconnect.

Have a good day.