Goodrich Q3 2008 Earnings Call Transcript

Goodrich (GR)

Q3 2008 Earnings Call

October 23, 2008 10:00 am ET

Executives

Paul Gifford - Vice President of Investor Relations

Marshall Larsen - Chairman, President and Chief Executive Officer

Scott Kuechle – Chief Financial Officer

Analysts

Troy Lahr - Stifel Nicolaus

Carter Copeland - Barclays Capital

Robert Spingarn - Credit Suisse

Peter Arment - American Technology Research

Cai von Rumohr - Cowen and Company

Joe Nadol – JP Morgan

Ronald Epstein - Merrill Lynch

Gary Liebowitz – Wachovia

David Strauss - UBS

Matthew Levinson - Matthew Levinson and Associates

Peter Grondin - OSS Capital

Ted Wheeler - Buckingham Research

Robert Stallard - Macquarie

Howard Rubel – Jefferies

J.B. Groh - D.A. Davidson

Presentation

Operator

Good day, everyone and welcome to the Goodrich third quarter 2008 results conference call. (Operator Instructions) At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Paul Gifford. Mr. Gifford, please go ahead sir.

Paul Gifford

Thank you for joining us today as we discuss our third quarter 2008 results. In the room today are Marshall Larsen, our Chairman, President and CEO; and Scott Kuechle, our CFO. We will start with brief prepared remarks, followed by Q&A. A presentation is available on our website, www.goodrich.com, which together with our press release provides the basis for most of our remarks.

Before we start, let me remind you that today’s remarks include forward-looking statements that involve risks and uncertainties and actual results could differ materially from those projected in the forward-looking statements. The risks and uncertainties are detailed from time to time in our reports filed with the Securities and Exchange Commission, including our annual report on Form 10-K and quarterly reports on Form 10-Q. They are also detailed in today’s earnings press release. I urge you to read them carefully. This conference call is being webcast and replays will be available at our internet site beginning this afternoon.

Now I’ll turn the call over to Marshall who will provide you with an overview of our third quarter results, our increased full year outlook for 2008, net income per diluted share and our initial 2009 outlook.

Marshall Larsen

Thanks, Paul. I assume you have all had the opportunity to read and review today’s earnings release and the related presentation. Today I will describe the key factors that led to our strong performance during the third quarter 2008, our increased EPS outlook for 2008 and our initial outlook or 2009. After I briefly cover these items, I’ll walk you through the commercial aerospace environment charts that are at the beginning of the presentation that we posted on the web. I believe these charts will help set the foundation for our 2009 outlook.

Our third quarter was another excellent quarter, with strong sales growth of 11%, including 13% sales growth in our commercial aftermarket sales channel; 12% growth in defense and space and 29% in regional, business and general aviation original equipment sales. Large commercial airplane original equipment sales were only up 1%, primarily due to the impact of the lower than expected 787 and A-380 sales.

Our segment operating income margins were also very strong, increasing to 18.2% from 17.2% in the third quarter 2007. Our third quarter 2008 net income per diluted share was $1.33 compared to third quarter 2007 net income of $0.99 per diluted share, an increase of 34%. Income per share from continuing operations increased 21% compared to the third quarter 2008.

During the third quarter and in October we had several significant accomplishments. On October 21, our board declared an increased quarterly dividend of $0.25 per common share, payable January 2, 2009 to shareholders of record on December 1, 2008. This dividend declaration represents an 11% increase over our previous quarterly dividend.

We received a contract from the U.S. Army to provide up to 1,000 vehicle health management systems for the UH-60A/L Black Hawk helicopters. This five-year indefinite delivery, indefinite quantity contract is valued at up to $300 million and covers deliveries through 2013.

We were selected by Airbus to supply the air data system and the ice detection system for the new A-350 XWB commercial aircraft. Together, these awards are expected to generate more than $600 million in original equipment and aftermarket revenue for over 20 years.

We signed a letter of intent with Rolls-Royce PLC proposing the formation of a joint venture company which would develop and supply engine controls for Rolls-Royce Aero engines. The proposed joint venture would combine our excising UK-based engine controls design and manufacturing business and Rolls-Royce’s expertise in the integration of controls into the engine. We would retain the aftermarket products and service businesses associated with the joint venture’s products.

Based on our strong results in the third quarter and continuing expectations for our commercial aftermarket and defense and space sales growth for the fourth quarter, we have increased our outlook for full year 2008 net income per diluted share to $4.90 to $5. Our outlook includes our assessment of the potential impact of the Boeing strike, assuming it concludes by early November.

In our major market channels we now expect the following growth rates for full year 2008: large commercial airplane original equipment sales are expected to grow 5% to 10% depending on the outcome of the Boeing strike. Regional business and general aviation airplane original equipment sales are expected to grow by 20%. Commercial aftermarket sales are expected to increase by about 9% to 11%, and defense and space sales are expected to increase by about 11%.

For 2008, we expect net cash provided by operating activities minus capital expenditures to approximate 65% of net income, including the impact of the anticipated inventory build-ups from the Boeing strike. Our expectations for capital expenditures for 2008 remain in the $275 million to $325 million range.

In today’s release, we also provided you with our first outlook for 2009. We expect strong sales growth in 2009 driven by increased commercial aircraft deliveries and continued commercial aftermarket growth at above-market rates. We also expect to show solid defense and space sales growth. More specifically, for the full year 2009 we expect Airbus and Boeing original equipment sales to grow by about 20% over our Boeing strike-affected sales expectation for 2008. We expect regional, business and general aviation original equipment sales to grow by about 7% to 8%; commercial aftermarket sales to grow by 4% to 7%; and defense and space sales to grow by 5% to 7% in 2009.

In total, we expect to generate $7.7 billion to $7.8 billion in annual sales in 2009, representing a growth rate of about 8% to 10%. Our outlook for 2009 income from continuing operations and net income per diluted share is $5.05 to $5.25, which reflects an increase of 2% to 8% over our outlook for 2008 income per diluted share from continuing operations.

Our 2009 outlook range includes, among other factors, significantly higher pre-tax pension expense of up to $55 million or $0.27 per diluted share. The higher pension expense assumes a negative return on plant assets of 13% in 2008 and a 2009 discount rate of approximately 7.5%, reflecting our experience through September 30 2008. Pension expense for 2009 will be finalized based on December 31 2008 actual asset values and discount rates.

The full year effective tax rate of 33% for 2009, unfavorable foreign exchange translation costs of approximately $12 million or $0.06 per diluted share; while still a slight headwind, foreign exchange translation costs have decreased with the recent strengthening of the U.S. dollar compared to the euro, British pound and Canadian dollar. And also, the closing of our Rolls-Royce joint venture around year end 2008.

For 2009, we expect net cash provided by operating activities minus capital expenditures to exceed 75% of net income. This outlook reflects a continuation of working capital investments to support the Boeing 787 Dreamliner and Airbus A-380 programs as currently scheduled; cash expenditures for investments in the Airbus A-350 XWB and capital expenditures for low-cost country manufacturing and productivity initiatives.

The company expects capital expenditures for 2009 to be in the range of $275 million to $300 million.

Most of you are well aware that we are operating in a difficult and uncertain commercial aerospace environment. Our 2009 outlook is based on detailed estimates from our businesses and some overall market-based assumptions. Any of these market-based assumptions, particularly those assumptions related to our commercial aftermarket business, are laid out on page 4 through 12 of the presentation we posted on our website. Today I’ll briefly review the key points from each of those pages as part of this conference call.

So if you go to the slide on page 4, it provides the data on fuel prices and GDP growth, just to set the stage. While fuel prices have come down, the outlook for global GDP has softened as well. The latest IMF data is predicting that 2009 will represent the low point of global GDP and the 2010 GDP will be about the same as current expectations for 2008.

On slide 5, which shows global passenger aircraft capacities since 1980 based on available seat miles, the drop of about 2% in ASMs during prior recessions and times of turbulence is approximately consistent with our expectations for ASMs in 2009. The year following a drop in ASMs has historically shown a strong rebound to a level above the long-term growth rate of 4% to 5%.

Turning to page 6 which shows global passenger capacity estimates by quarter for 2008 and 2009, we expect 2008 ASMs to grow by about 4% compared to 2007. Based on estimates, 2009 ASMs could drop by about 1.4% compared with 2008. By quarter, the largest impact is expected to be around the fourth quarter 2008 and the first quarter 2009 when capacity cuts take effect. Capacity should then slowly rebuild as new aircraft are delivered. We’re assuming ASM growth of minus 2% to plus 2% in the 2009 outlook we have provided today.

Turning the page 7 which shows expected retirements of large commercial aircraft, our outlook assumes that nearly 1,000 large commercial aircraft will be retired during 2008 and 2009, mostly in late 2008 and early 2009. We believe most of the retirements will be narrowbody aircraft. These aircraft will be mostly 737 Classics and MD-80s, airplane models in which Goodrich has little content.

Most of the initial capacity cuts were predicated on very high oil prices and expected higher airfares. While oil has decreased dramatically, demand is still likely to be weak due to global economic climate. We believe the airlines will therefore follow through with the capacity reductions they announced earlier this year.

On page 8, we show estimated capacity growth by region for 2009 versus 2008. You can see that the airline system is truly global with only about a little over 30% of passenger capacity in North America. We expect North America to be hardest hit and to show the biggest decline in capacity. Other regions are expected to fare better, but all are expected to grow at a significantly slower pace than in 2008.

Turning to slide 9, which shows large commercial aircraft estimated capacity change by airplane model, ASMs for the newer, more fuel efficient aircrafts such as the A-320, 737 MG, the 777 and the A-330 are expected to continue to grow at a robust rate in 2009 as new aircraft are added to the fleet and cycles for these aircraft remain high. Our highest content aftermarket platform is the A-320, which accounts for about 20% of worldwide capacity and is expected to continue to show significant capacity growth in 2009 compared to 2008. The models with the largest expected declines in capacity are the long out of production airplanes like the 737 Classic and MD-80 airplanes.

Page 10 shows fleet demographics versus Goodrich aftermarket sales. As we have said frequently in the past, we enjoy the benefit of having excellent positions on the newer, more fuel efficient airplanes currently in service. These positions have enabled us to report significantly above-market growth rates for commercial aftermarket sales for every year, 2005 through 2008. Many airlines have announced that they will remove some of their older airplanes, primarily MD-80s and 737 Classics from their fleets. These older airplanes represent approximately 31% of the world’s fleet of large commercial aircraft, but only 8% of our large commercial aftermarket sales, or about 2% of our total sales.

Based on Goodrich content and our predominant positions on in-production aircraft, we estimate our 2009 commercial aftermarket growth to be in the positive 4% to 7% range.

Turning to page 11, which highlights A-320 deliveries in the installed base, in general major maintenance on our products on the A-320 is needed five to seven years after initial delivery. During the post 9/11 period, about 600 to 700 A-320 airplanes were over five years old. Now there are about 2,000 A-320s that are over five years old, a 230% increase over the installed base that was subject to major repair and overhaul during the last down cycle. This is a key difference for Goodrich when looking at the prior cycle versus the environment we are now entering.

The last slide, page 12, that I want to go over today shows the large commercial airplane delivery forecast. Our 2009 outlook assumes that Boeing and Airbus deliver 1,000 to 1,025 airplanes in 2009. This outlook assumes no 787s are delivered in 2009. We now expect large commercial OE deliveries to peak in 2010 but we expect the subsequent decrease in deliveries to be modest due to our expectation of significant increases in the 787 deliveries in the out years that should offset some weakness in other models.

In summary, we believe the 2009 outlook reflects a realistic view of the soft economic environment we expect for 2009. Despite this environment, we believe that Goodrich can continue to generate both top and bottom line growth in 2009 compared to 2008. We expect to be able to grow sales by 8% to 10% in 2009 and we expect that our income from continuing operations will also grow by as much as 10%, even after we absorb significantly higher pension expense and incremental foreign currency translation expense.

The strength of our company lies with the talent and commitment of our people, our strong positioning on the newer, more fuel efficient aircraft around the world, our diversified global customer base and our well-established global maintenance and repair infrastructure.

Now we’ll open it up for questions.

Question-and-Answer Session

Operator

Our first question comes from Troy Lahr - Stifel Nicolaus.

Troy Lahr - Stifel Nicolaus

You had really good margins here at the nacelles and interior systems business. Can you walk through that? I think you had a contract adjustment. Was that just due to operating efficiencies that you adjusted the contract or due to pricing terms with the customer?

Scott Kuechle

We did have good margins in the nacelles and interior systems business; not way out of line from what we’ve seen in prior quarters, I would point out. Relative to contract adjustments that we made during the quarter, there weren’t any particular contracts that led to that increase. As you know, we have 30 or so contracts that we adjust every quarter.

The main drivers though in those adjustments, that routinely have been positive over the last number of quarters, have been a combination of increased unit volume, price adjustments or escalation that we get on those contracts.

Then on the cost side we’ve seen cost reductions as we pushed some of our own production off into low cost country sources. We source suppliers and then just on the inside of our own manufacturing facilities, as we’ve driven cost down through continuous improvement, lean manufacturing initiatives.

It’s been a combination of factors that has led to good performance on those contracts, and we got the benefit of that again in this quarter.

Troy Lahr - Stifel Nicolaus

Okay, thanks. Another question on the 737 Classics that you talked about retiring. Are those getting parked completely? I would have thought that some of those end up in third world countries and things like that. Is that what you see?

Marshall Larsen

I think some of them will; particularly, now that the oil prices have come down. But I think our assumption is based more on them going out of the system, but any moving to another venue for which they fly somewhat will help the industry. As I said, it doesn’t have a large effect on us.

Operator

Our next question is from Carter Copeland - Barclays Capital.

Carter Copeland - Barclays Capital

Really a great quarter, Marshall.

I wonder if you’d talk a little bit more about the order rates and we’ve had a pretty big move in oil; you provided a lot of color on the growth. But in terms of the detailed reviews your businesses have been having and giving you data, have you seen any difference in activity in procurement of spares or how order rates are tracking since oil has come back down a substantial amount?

Marshall Larsen

I think it’s been pretty even; we haven’t seen a great change at all at this point in time. You think about our products, they’re very flight critical. Whether the oil price was up or down, if you are still flying the airplane, you still have to order the part.

But it’s good news now that the oil prices are down; in fact, for instance, I noted Northwest without their fuel hedge, would have made money this quarter, which I think bodes well for the industry going forward if these oil continue to stay down.

I think that airlines have taken a lot of cost out, and are positioning themselves for the possibility of returning to profitability. But for our orders, not a great deal of difference between when the oil prices were higher now that they are lower.

Carter Copeland - Barclays Capital

Great, that’s helpful. On the outlook for 2009 in the aftermarkets, since we’ve bundled up your GA and regional and large commercial, presumably the large commercial piece because of the A320 exposure is pretty strong.

Is there any color you can provide in the delta between the various pieces, whether it’s commercial versus business in GA; is it large or are they all falling within that 4 to 7 range?

Marshall Larsen

Obviously the large commercial part of it is the vast majority of our aftermarket. So while we get aftermarket spares on business for example, those are pretty steady. If corporations and individuals are running their aircraft, they spare no expense at buying a spare.

If you look at the regionals, they tend to fall more into the large commercial side, where you’re doing part 135 passenger travel and you’re going to replace those parts if you’re running the aircraft.

Operator

We go next to Robert Spingarn - Credit Suisse.

Robert Spingarn - Credit Suisse

First, I just want to thank you for what I think was a wealth of data, and a significant amount of thought going into this macro material that you gave us, but it does raise a few interesting questions.

The first thing, I wanted to go back to slide 6 and look at your ASM, and a minus 1 to 2% number for 2009, I think is clearly above what the market is expecting. The investment community talks a lot about 5 to 10% down, and I think what you’re saying is that it’s not going to be that bad.

Marshall Larsen

I think if you take the mix of the total lead out there, especially when you take those in-production aircraft, what you do is do a weighted average of looking at the usage of those aircraft, and you’re not going to come up with that kind of a market down.

Then when you think about our content, which we do better, every piece of our data indicates that we’re going to have that kind of a positive growth.

Scott Kuechle

Rob, I think too a lot of people are focusing on what’s going to happen in the first quarter of 2009, and we are seeing something on the order of 3 to 4% down year-over-year. That’s because most of the retirements are concentrated right around year-end or very early in the first quarter of next year.

I think sometimes we forget that, we’re still going to deliver a thousand new airplanes or close to that in 2009 and that’s going to rebuild the capacity throughout the year, and I think that’s what we tried to illustrate on that slide.

Robert Spingarn - Credit Suisse

Absolutely, and I would agree with that and I think folks have been very focused on what’s going to happen in North America and that the numbers are better than expected, and that’s what we see in the data. These thousand aircrafts though, of course these newer airplanes don’t drive a whole lot of aftermarket at first, right?

Scott Kuechle

That’s true, but remember the airplanes that were delivered five years ago that are coming out of maintenance, are the ones that drive our growth in the aftermarket, and those again are the in-production aircraft that are just ageing by one year.

Marshall Larsen

You also get initial provisioning depending on the fleets.

Operator

We go next to Peter Arment - American Technology Research.

Peter Arment - American Technology Research

To follow up on Rob’s comment, thank you for the slides. I just wanted to talk about on slide 12 on your airplane delivery forecast. Marshall, for 2010, you are indicating a peak, albeit we could be at a more flat delivery cycle environment. I am just wondering what your assumptions are with either 787 deliveries or narrowbody rates in that period?

Marshall Larsen

We would expect the 787 deliveries to start picking up in at the end of 2009 for us. But, in terms of airplanes going into service, we don’t think they are going into service until 2010. You are still going to have a growth in deliveries.

I think Airbus is at 34 right now and they said they are going to peak out at 36, so you’re going to get little bit more increase there even if Boeing stays relatively flat. That’s why we are predicting 2010.

Whether it drops off like we are showing here in 2011 or not, or it just plateaus, I think we were just being a little more conservative in our outlook on it. But I could agree with you that we could end up with a flattening.

Peter Arment - American Technology Research

Okay. I just wanted to check that. Again, to Rob’s point that it’s not a big driver for you given that more of it’s an aftermarket mix; that makes the difference. Okay. Thank you.

Operator

We go next to Cai von Rumohr - Cowen and Company.

Cai von Rumohr - Cowen and Company

Thank you and let me share congratulations on a terrific quarter.

Marshall Larsen

Thanks, Cai.

Cai von Rumohr - Cowen and Company

If pension performance is minus 20, where would pension expense be for next year and what are your thoughts about pension contributions for this year and next year?

Scott Kuechle

What’s baked into our guidance numbers for 2009 is where we finished through September 30, which was down about 13 to 14% on a rate of return basis with a discount rate in the U.S. it’s about 7.5%.

The sensitivity against that, again just focusing on the U.S. plan, is for every 1% of rate of return, we lose $5 million pre-tax. The flipside though is, as interest rates go up, every 25 basis points of increased rate saves us $10 million. That’s what we’ve seen in the intervening period. We’ve seen lower returns though we’ve also seen discount rates continue to go up. The balance of those two would get you to whatever assumption you care to make.

Cai von Rumohr - Cowen and Company

And then, what are you thinking about of pension contributions this year and next year? Could you elaborate a little bit on your comment of 75% conversion next year and your thoughts on working capital requirement?

Scott Kuechle

On the contribution side, we’re tracking toward about a $120 million this year and assumed a base level of contributions of about $100 million in 2009. To the extent we’ve got incremental cash flow from non-operating sources, whether it’s insurance settlements or things like that, we might look to push more into the pension funds just to continue to chip away at an unfunded balance there. But I think we would tend to be opportunistic relative to that.

Cai von Rumohr - Cowen and Company

And the working capital requirements for next year; why you are at 75%?

Scott Kuechle

The assumption there is that, working capital will still continue to grow next year versus 2008. But the core working capital, so excluding that which relates to our non-product inventory and contract accounting, we would expect that to come down as a percent of sales, but still grow in absolute sense. Because we are still getting good top line growth on the OE side as well as the aftermarket military side of the business.

Operator

Our next question is from Joe Nadol – JP Morgan.

Joe Nadol – JP Morgan

On the aftermarket outlook, you’ve been growing, including this quarter, roughly 10 percentage points better than global ASMs and the guidance looks like more like 5 to 6% next year.

Can you help us flush out the difference; is that conservatism or is there some way to quantify why you’re looking for reduction in the GAAP.

And can you speak to how much of your aftermarket business is actually related to ASMs versus maybe just based on demographics like the A320 nacelles for example?

Marshall Larsen

You’re right, we have grown at significantly higher rates, 5 or 6 points higher than the average. But, if you think about a minus 2% next year, now you take six points higher than that, that’s where we get your 4%, so we are in the range based on what we see as a weak market condition next year for the airlines, based on capacity being taken out.

It might be a profitable year for the airlines because I think you are going to see some price increases hold in there. I think you are going to act just like the oil prices were up and keep the costs down. I think we are in the range of what we have said before.

Joe Nadol – JP Morgan

Okay. I think it’s a little bit lower, but it’s within a few percentage points, so that’s close. But, how about breaking down the aftermarket even roughly by what you think is actually related to flight hours like wheels and break spares versus what’s demographic like in the sales business?

Marshall Larsen

The sales business is driven at a higher rate if only because they have a lot of business on the A320. The wheel and brake is a steady rate that is closer to the overall market growth, albeit a little bit larger because we do have a good mix in that business too. In the sale business, we’d be at the high end.

The kind of businesses that we have that have maintenance, repair and overhaul spare parts to go on A320s will show a higher than overall rate; could be above the 4 to 7% that we give you. What we are giving you is an average based on all of our products.

Joe Nadol – JP Morgan

Okay. Secondly, Marshall you mentioned briefly during your prepared remarks the 787, you’re assuming that comes in 2010 I think. Can you elaborate on that; just what’s your view in the program from here? Do you have any insight beyond what we read in the paper?

Marshall Larsen

I heard the Boeing comments yesterday about getting back together talking today in Washington with a federal mediator and there seems to be some optimism they’re going to settle. Our assumption is that they are going to get settled here this month, and that it will have a minimal effect on next year if they do that.

And we think that because of the day for day slide on the 787, we think it’s unlikely that they get an airplane into service until 2010. They got to go through the flight schedule first.

We are not counting on deliveries for Goodrich until towards the end of 2009, which means that they won’t have airplanes into service until 2010, and then it’s like any new program, it takes awhile to build up the rate.

It’s not something we count on a lot in terms of the revenues, but it certainly has affected our cash this year because of the inventory build up for both 787 and the strike. We’d like to work some of that off during the next year.

Operator

Our next question comes from Ronald Epstein - Merrill Lynch

Ronald Epstein - Merrill Lynch

Marshall, when you like at your supply chain, some of the tier 2 and tier 3 guys who supply you, are you seeing any financial stress there because of the Boeing strike and the delays on 787?

Marshall Larsen

Actually, we’re probably seeing less because of the delays there than we have in the overall economic issue. We had one small supplier go bankrupt on us in Europe; we’ve scrambled to get alternate sources.

We continue to spend a lot of time in the small suppliers, helping them lean out their processes and take cost out and we’ve been very cognizant of not extending payables at all to these people, so we keep them as whole as we can, because they’re the most tenuous part of the supply chain, but so far so good.

Ronald Epstein - Merrill Lynch

Okay, great. Scott, looking into next year, I think Cai asked, just a follow-up on it, regarding the free cash flow conversion. What would have to happen to get that better than 75%?

Scott Kuechle

It’s really mostly a function of just where we are in the overall cycle of growth in the industry. We’re still looking at very strong year-over-year growth on the OE side of the business. The military and space as well as the aftermarket continue to grow. In that environment, you’re going to see working capital growth, you’re going to see some more capital expenditure investments to track along with that.

Then we are still concluding 787 development and starting development in a big way on A350. So in that environment, it’s hard for us to get to 100% cash flow conversion. But we’re edging our way to that point and as soon as we see that plateau in the OE cycle and we get some of these development programs behind us, that’s where we’ll be. It is 2010, 2011? It’s in that timeframe.

Operator

Our next question comes from Gary Liebowitz - Wachovia.

Gary Liebowitz - Wachovia

If I look at the reduction in the sales guidance for this year, the $200 million, is that completely related to the Boeing strike or are there other puts and takes that we should know?

Scott Kuechle

It’s predominantly related to the Boeing strike.

Gary Liebowitz - Wachovia

Okay. Is there any meaningful EPS impact?

Scott Kuechle

It’s well reflected in our guidance for 2008 as this point. We’ve been able to absorb whatever impact there is for 2008 in the increased guidance that we gave you for the full year 2008.

Gary Liebowitz - Wachovia

Okay. The other question that I had was, I’m guessing you are still looking at potential acquisitions, I’m sure pricing has come in. Just wondering how you assess the merits of acquisition versus buying back your stock at these levels more aggressively?

Marshall Larsen

As we look at acquisitions, we continue to do some of the smaller acquisitions; I think we’ve done three bolt-ons here in the last year. When it comes to something larger right now, we would be cautious about doing anything large in this kind of a credit market.

If you can get something financed that’s of size, let’s say, $1 billion, it could be very exorbitantly expensive and hard to syndicate the banks right now. While we haven’t stopped looking, I think we’ve been very cautious in taking a move like that and we don’t have to do it. We’ve got substantial growth, so we will keep blocking and tackling for now and watching the stock price at these levels and see if we spend more money on our own stock.

Joe Nadol – JP Morgan

But the guidance for 2009 continues to assume that you buy back shares at a pace that more than offsets the share creep from options?

Marshall Larsen

That’s right.

Operator

Our next question is from David Strauss - UBS.

David Strauss - UBS

Could you give us a little bit of color of what you’re expecting for margins, specifically in 2009. I know pensions are going to factor into that. But your margins have obviously been running well ahead of what you’ve been guiding to, so some color there?

Scott Kuechle

I think, David, if we could achieve kind of a flat margin year-over-year that would be a good result, because just the pension expense alone is going to cost us between half a point and a point on margins 2009 versus 2008. With good growth in the aftermarket, good growth in some of the other segments, we would hope to try to offset that change.

David Strauss - UBS

And by segments, Scott, what do you say?

Scott Kuechle

There is still some room for growth on the electronics side, relative to margins. We’re seeing some impact obviously near term from the Boeing strike mostly in the actuation landing systems business. Directionally, that’s probably the one opportunity we have to change.

David Strauss - UBS

Okay. And then on FX, it looks like the headwinds of 2009, it has come down. I would assume, you put on some additional hedging at lower rates, could you talk on that and touch on 2010 and where you are in terms of being hedged and what kind of headwinds you might be looking at in 2010, if any at all at this point.

Scott Kuechle

Let me start with 2009 first. We’re about 92% hedged going into 2009. So the number of 10 to $12 million of pre-tax headwinds is pretty well locked down. When we look to 2010 though, we’re about 72% hedged and based on rates where they are today, we’d expect no further deterioration going from 2009 to 2010.

David Strauss - UBS

Okay and I would assume if you continue to hedge at these rates, might even be a positive.

Scott Kuechle

Or you lock down the existing rates as they are in the marketplace. We avoided hedging when the euro and sterling in particular got up to the high points. So we paused at that point and then we’ve been more aggressive lately as the dollar has strengthened.

Marshall Larsen

Actually on the Canadian dollar.

David Strauss - UBS

As you look out to the period where OEM volumes might start to come down like what you forecasted here, can you talk about your sensitivity to that? I know you don’t have very high margins on the OEM side, but I’d think from an overhead absorption standpoint that at some point when volumes come down that starts to impact you pretty significantly and you might not have enough aftermarket growth to be able to overcome that to continue to grow earnings?

Marshall Larsen

As you look out, let’s just assume it does come down a little bit in 2011; we’ve got another couple of years of thousand aircraft a year going into the fleet. So our aftermarket business continues to grow, which is obviously the most lucrative part of our business; still have 25% of our revenues coming out of the military and space, adding decent growth rate right now.

When you look at the OE side, the part of the landing system segment is most affected by a downturn in OE is landing gear, because it has very little aftermarket. Absorption is an issue there. But we also have within that segment, wheel and brake business, that as you well know gives free of charge hardware to Airbus, Boeing and when the OE deliveries start to come down, so does the free of charge.

So that is a natural offset to some of that absorption, but we will have to take measures in terms of reducing costs in those businesses like landing gear that do have a decrease in volume and have absorption issue. We also have a couple more years of larger fleet that help us to offset and as we said before, we think we’ve got a darn good chance of growing through that.

Operator

Our next question is from Matthew Levinson - Matthew Levinson and Associates.

Matthew Levinson - Matthew Levinson and Associates

Good morning and congratulations on your quarter.

Marshall Larsen

Thank you, Matthew.

Matthew Levinson - Matthew Levinson and Associates

I realize that you expect the Boeing strike to end early November, or no later than that. But if against your expectation, it were to go through the end of the year, how might that affect your guidance?

Marshall Larsen

If it goes to the year end, we think we can still go meet the expectations within the range we’ve given you for the year.

Operator

Our next question is from Peter Grondin - OSS Capital.

Peter Grondin - OSS Capital

I’m sorry to continue on this ASM conversation, but let’s say Marshall theoretically ASMs went to minus 5%. Is there any sort of de-leveraging or do we still say, the delta that you’ve suggested still exists; i.e., minus 5% means you get plus two or plus three or something like that?

Marshall Larsen

We think that it would require a lot more announcements around the world of capacity going out. We believe those regional growth rates, some are flat, some are positive other than North America and places that have really been hit hard. But the Asian region is still going to have some growth in it.

It’s hard for us to imagine it goes down that far, but if it does, we’ve been able to continue with those in-production aircraft doing very well. And they would be probably increasing frequencies in that scenario, because you’re going to go first to the older fuel efficient aircraft, that you’re going park or take out.

We would see actually some of the A320s and 737s, 777s, A330s probably get more use. It’s hard for us to give you an exact figure, but we feel reasonably good about our mix.

Operator

Our next question is from Ted Wheeler - Buckingham Research.

Ted Wheeler - Buckingham Research

I wanted to ask question again on the pension. I do recall, I think you’re on a one year true-up. So, there’s no averaging?

Scott Kuechle

That’s correct.

Ted Wheeler - Buckingham Research

You gave us the sensitivities, but assuming you had a 10% increase in return and everything else stayed the same, that’s a $50 million benefit for 2010, would that be correct?

Scott Kuechle

You are right on the smoothing. We do not smooth on most of the planes that we operate. So, it flows through pretty quickly. We set our pension expense based on 1231.

Ted Wheeler - Buckingham Research

Right.

Scott Kuechle

So, it’s a once a year opportunity. If you get a major move one way or the other, it will affect pension expense going into next year by that calculation.

Ted Wheeler - Buckingham Research

Is there any leakage to a direct transfer of whatever happens in 2009 to the 2010 number; it is what it is?

Scott Kuechle

I think it is what it is.

Ted Wheeler - Buckingham Research

Okay. And the impact of contributing to the plan, will that in effect reduce the overall pension expense that you recognize, or will that hold things where they are?

Scott Kuechle

One way you can deal with rising pension expenses is as you make contributions, you are able to assume that you get your expected rate of return for the balance of the year. So if you make, for example a $100 million contribution at the beginning of the year at a 9% expected rate of return, you will get $9 million less expense for the next calendar year.

Ted Wheeler - Buckingham Research

But then the base is affected by the performance of the overall plan?

Scott Kuechle

That’s correct.

Ted Wheeler - Buckingham Research

One other question on another topic. I think that you made an announcement relative to landing gear agreements with Boeing the other day or a couple of weeks ago?

Marshall Larsen

That’s right.

Ted Wheeler - Buckingham Research

Is that just an affirmation of what you had talked to us about before, or is there something new in that?

Marshall Larsen

No it’s actually concluding the formal agreement of what we’ve talked to you about before about being able to ship directly to airlines that are through Boeing to the aftermarket. It allows Boeing to reduce their inventory; allows us to increase our margin and our aftermarket sales.

Ted Wheeler - Buckingham Research

And how will that phase in? What percentage of what you’re doing today will change over the next couple of years?

Marshall Larsen

It will be pretty slow over the course of 2009 because Boeing still has a fair amount of inventory. But it will pick up as the year goes.

Ted Wheeler - Buckingham Research

By 2010 or 2011 will you be…

Marshall Larsen

By 2010, 2011 it will become more of a factor in our margins.

Ted Wheeler - Buckingham Research

Thanks for the color and great quarter.

Operator

Our next question is from Robert Stallard - Macquarie.

Robert Stallard - Macquarie

Marshall, thanks very much for the A320 information you provided. I was just going to ask you very briefly on what you think the sensitivity is now within this. In particular, where did all those A320 aircraft that were delivered in the last downturn go to? Therefore, which region should we be focusing on for any ASM changes?

Marshall Larsen

The vast majority did go to North America. So they’ve been primarily Europe and Asia.

Robert Stallard - Macquarie

If we were to see a slowdown in the Asian airlines putting aircraft on the ground,that could potentially impact your outlook on the A320 aftermarket?

Marshall Larsen

I think you understand the A320 being, along with the 737 MG, the fuel efficient workhorse, they’re going to be the last things that are used less frequently.

Robert Stallard - Macquarie

But these airlines don’t have as many DC-9 derivatives?

Marshall Larsen

That’s true. But, we factor in lower growth rates for those regions.

Robert Stallard - Macquarie

But if you were to take a top 50,000 view on this, Asia, by the look of it, is this the area where there’s probably more sensitivity to the A320 story?

Marshall Larsen

They’ve got a lot of widebodies too which will continue to flow very well for us.

One thing which you can’t call especially when you look at load factors out there, if you’ve got a 75% load factor and it goes to 65%, as long as you’re running the airplane, we still get the aftermarket. It’s only when they stop using the airplane.

Robert Stallard - Macquarie

Yes.

Marshall Larsen

It would have to get pretty dire.

Robert Stallard - Macquarie

There is a bit of uncertainty around this. Just a follow on to David’s question about 2009 margins, Scott. If you’ve got pension expense up and you’ve got mix moving against you, it would seem like a very good performance to keep operating margins flat. I was wondering if you could give us a little bit more color on what’s helping you on the margin front next year?

Scott Kuechle

I think you’ve basically got it. The negatives are pretty well understood between pension expense and the other impacts that you just described. On the plus side, we are continuing to get good volume out of the military and space side and the high margins that we get on aftermarket, even at a lower growth rate, they still help us on the margin side.

As you grow the OE side of the business, while it’s lower margin, there is some help on the incremental side; particularly in certain of our businesses. So those are the pluses and minus and I think they lead to a roughly flat environment.

Marshall Larsen

And we continue to do drive continuous improvement cost down and I would expect too, we’re going to get some more relief on commodity pricing going into 2009 [inaudible] raw material dramatically.

Operator

Our next question is from Howard Rubel - Jefferies.

Howard Rubel - Jefferies

One of the things that has happened along with declining oil prices has been plummeting commodity prices; one area has been titanium, Marshall. That clearly has got to stand you in better stead than what you would have figured not that long ago.

Could you address from both the commodity price changes and what that does to your cost; how fast we can see the benefit? And then some of the other things you are doing to in terms how the progress is going with low cost sourcing?

Marshall Larsen

I’ll start this out and finish out with Scott on it. But we’re making a concentrated effort going back to suppliers where we’re not locked into a longer term agreement; we got to push that pricing down. I don’t think that’s anything that you wouldn’t expect us to do in this environment.

We think we will be fairly successful in doing that. Of course, titanium, especially the very large forgings are a little more problematic because you’ve got less sources, but they’re coming on. So I think we’ll end up getting lower prices there particularly it helps our landing gear business as the A-380 ramps up more. Scott?

Scott Kuechle

The other comment I’d make on titanium is, we were successful locking in early on longer term contracts, so we miss some of the peak pricing that we had there. Therefore, you’re not going to capture quite as much of the favorable side as it comes down.

I think just generally, you are right, as commodity prices come down, we should get to some favorability in purchase prices within our raw materials and supply chain organizations. But takes time to so to work those through the production process through inventory and then ultimately into margin.

Howard Rubel - Jefferies

It’s a 2010 story maybe, to be fair about it?

Scott Kuechle

Probably more 2009.

Marshall Larsen

I would expect us to get some of that benefit in 2009. What we do before we start each year as we put our plan together, is that we have a matrix of cost takedowns either through continuous improvement, supply chain, restructuring of businesses that add up to a substantial number for the entire corporation.

It’s divided through every one of our businesses in those categories and it goes into their plan. So we track this thing on a monthly basis. We really drive against it. We get more aggressive when we know we can take more costs out.

In the past, while we’ve had a net cost reduction, the raw material portion of it, particularly in businesses like landing gear, have been a drag, because the costs have actually gone up, and we’ve been able to take enough cost out elsewhere in indirect and in continuous improvement of our factories to offset and then some.

I would expect us to get more of the benefit in 2009 than we’ve been able to achieve in the past.

Operator

Our next question is from J.B. Groh - D.A. Davidson.

J.B. Groh - D.A. Davidson

My question is on slide 8. It looks like a lot of these capacity rationalization decisions made by airlines in North America and Europe were made when oil was $140 and we are roughly half that now.

Marshall, I was wondering what your thoughts are as to whether the airlines can hold to those promises of cutting capacity to those levels? Or you think they will stumble over themselves and maybe not follow through?

Marshall Larsen

We are assuming that they are going to go though with these capacity cuts because even oil at $70 a barrel is still a lot higher than they used to have back when it was way down and it can always spike again, you never really know.

But given the demand destruction around the world right now, we are not anticipating that. Look at American Airlines. They are getting 737s; they are getting 787s. They are going to be taking those things out in an orderly fashion.

One thing that, as you look at these MD80s and DC-9s and 737 Classics, if you have a large mixed fleet like an American Air, North West Delta, that kind of thing, if you take out those airplanes too quickly, you disrupt the flight schedules a lot. It’s got to be a very orderly transition; they can only take out so many so fast.

Meanwhile, they will run them a little longer. I don’t know, maybe you will see a little more frequency on them, while they are still on the fleet. But I still think they are going out. They are not going out in the first few quarters of this year; they are going to be going out over the next year or two, I would believe.

J.B. Groh - D.A. Davidson

But the bottom line is that even if they decided not to go through full-bore, it probably means those planes certainly are coming back and the increased frequency would happen with that narrowbodies that you got the higher content on anyway, is that correct?

Marshall Larsen

That’s right.

Operator

Our next question is from Robert Spingarn - Credit Suisse.

Robert Spingarn - Credit Suisse

This is actually a model financial type question. Your guidance implies relatively flat sequential revenues, but much lower margins. It looks very conservative. You touched on this: if the strike goes through the end of the year, you still make the number, am I thinking about this correctly?

Scott Kuechle

I think, if you’re trying to track Q3 to Q4 in terms of an EPS bridge, the things that are going to negatively affect us are principally the Boeing strike. That’s the unusual piece. We did have some favorable changes in estimates in both our missiles and interiors and our wheel and brake businesses in the third quarter. So, we expect to not have quite as favorable result in that area in Q4.

Then, the other thing is in Q4 we always have a lower aftermarket sequentially than we had in Q3. We’ve seen that in last several years as the airlines tend to run high schedules during Thanksgiving to Christmas time, so they tend not to have a lot of maintenance activity during that period.

We’re anticipating some lower aftermarket sales. We’ll still have good growth, when you compare it to fourth quarter of 2007. So still strong year-over-year growth, but on a sequential basis we will see less aftermarket as we normally do.

Robert Spingarn - Credit Suisse

But Scott, unless there is something going on the corporate line to increase that number, I see margins down in the 15% range from your guidance here and for fourth quarter and that hasn’t happened all year?

Scott Kuechle

It will be better than that, but it will be lower because of the items I mentioned. Don’t forget, the Boeing strike has a fairly significant impact.

Robert Spingarn - Credit Suisse

Okay. And to just on that to finish up, if we have this month of October that you’re forecasting, and we end the strike, it seems like the impact is much greater for you in the month of October than September, is that fair because of lead times and flow?

Marshall Larsen

Yes, that’s fair.

Robert Spingarn - Credit Suisse

Okay. And you touched on this earlier, the absorption is the issue here on the OE side?

Marshall Larsen

That’s right. If it continues to go beyond that, we’re going to have to look at some reductions in force in businesses like landing gear, just to keep from really under-absorbing.

Robert Spingarn - Credit Suisse

Okay. It just seems to me that if the strike ends in the next few weeks, your guidance is reasonably conservative for the quarter, that’s all the comment I wanted to make.

Scott Kuechle

That’s your call there.

Robert Spingarn - Credit Suisse

Okay. Thanks. Very nice quarter.

Operator

With that ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Gifford, I’ll turn the conference back over to you for any closing remarks.

Paul Gifford

Thank you, Rufus and thank you all for joining us today. Sorry we ran a couple of minutes long and I’m sure I’ll be talking to you in the future. Thanks.

Operator

Again ladies and gentlemen, this does conclude the Goodrich third quarter 2008 results conference call.

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