Executives
Greg Powell - VP, IR
Amin Khoury - CEO
Michael Baughan - President & COO
Thomas McCaffrey - Sr. VP & CFO
Analysts
Robert Spingarn - Credit Suisse
Howard Rubel - Jefferies & Co.
Myles Walton - Oppenheimer
Troy Lahr - Stifel Nicolaus
David Strauss - UBS
Gautam Khanna - Cowen and Company
Patrick McCarthy - Friedman, Billings, Ramsey
Karl Oehlschlaeger - Macquarie Research Equities
J.B. Groh - D. A. Davidson & Co.
Eric Hugel - Stephens Inc.
B/E Aerospace, Inc. (BEAV) Q3 2008 Earnings Call October 27, 2008 9:00 PM ET
Operator
Good morning. At this time, I would like to welcome everyone to the B/E Aerospace third quarter 2008 earnings conference call. (Operator Instructions) I would now like to introduce B/E's Vice President of Investor Relations, Greg Powell. Mr. Powell, you may begin.
Greg Powell
Good morning and thank you for joining us this morning. Today we are here to discuss our financial results for the third quarter ended September, 30 2008. By now you should have received a copy of the news release we issued earlier this morning. If you haven't received it, you'll find a copy on our website.
We will begin with remarks from Amin Khoury, Founder, Chairman, and Chief Executive Officer of B/E Aerospace, and then we will take your questions. For today's call, we have prepared a few slides for you to follow along with us this morning. You can find our presentation on the B/E Aerospace website at www.beaerospace.com.
Please go to our Investor Relations page and follow the webcast. In addition, copies of the slides will be posted on our website for you to refer to after the call. Joining us for the question-and-answer session this morning are Michael Baughan, President and COO, and Tom McCaffrey, Senior Vice President and CFO.
As always, in our prepared remarks and our responses to your questions, we will rely on the Safe Harbor exemptions under the various Securities acts, and our Safe Harbor Statements in the company's filings with the SEC.
And now I would like to turn the call over Amin Khoury.
Amin Khoury
Thank you Greg and good morning everyone. Obviously a lot has changed, and it has changed pretty quickly since our last conference call. This morning I’d like to first discuss the current macroeconomic environment and the expected impact it will have on our business, and then we’ll review our third quarter financial and operating results and finally we’ll discuss our updated financial guidance for 2008 and 2009.
First let’s discuss the current environment, clearly market conditions have deteriorated, and they’ve deteriorated fairly rapidly. The impact of the high cost of energy on consumers had substantially weakened the global economy. In addition, the decline in the value of consumers’ home prices and the devastation to their 401Ks had not put consumers in a spending mood.
In addition high jet fuel costs and high airline ticket passengers have negatively impacted global passenger air travel. In response to high jet fuel costs and declining air travel, the airlines are significantly reducing capacity and implementing tough cash conservation measures.
The business jet industry has also begun to be negatively impacted by the weakened global economy, lower corporate profitability, high jet fuel costs, and difficulty in arranging aircraft financing.
The International Air Transport Association just released international traffic numbers for September where for the first time since [SARS] in 2003 there was an actual decline in passenger traffic. September traffic was down about 3%.
Asia has become the weakest region for business travel. Within Far East Asia premium travel fell by just under 8% in August. Several Chinese airlines have reported approximately 12% to 15% declines in traffic in August. The Indian airlines are also struggling. Indian passenger traffic which grew 33% last year actually had a significant reduction in revenue passenger miles in September.
There was a report this morning that traffic may have been down as much as 19% in India. Air India and Jet Airways have announced layoffs of approximately 17,000 employees and King Fisher is parking three brand new A345s. In fact Jet and King Fisher which account for 60% of Indian air traffic have announced an alliance in an attempt to stem losses.
Meanwhile in the US both American and United reported that September traffic was down about 9% while Continental Air reported that its September traffic was down about 11%. Capacity reductions are expected to reach about 1,000 aircraft worldwide or about 5% of the global fleet, including United which is parking 100 aircraft, Continental which is removing 70, and American which is removing 80 aircraft.
Clearly the downturn has begun when even our Blue Chip airline customer base in the Middle East, Europe, and Asia and the Pac rim, are pushing out programs and delaying decisions.
Business jet flight activity is also down with August business jet cycles down 18% and year-to-date cycles down 8%. In addition business jet used inventories are rising and prices for used aircraft are declining.
These conditions are negatively impacting our customers and the demand for our products. A number of our customers have asked us to stretch major retrofit programs and to move 2009 shipments to 2010 and 2011. We’ve also seen a slowdown in after-market demand for spares and consumables due to reduced capacity, lower revenue passenger miles, and airline cash conservation measures.
Clearly a downturn in the industry is upon us, but our hard work of the past five years restructuring the business to reduce fixed costs, strengthening our management team, diversifying our customer base globally and strengthening our balance sheet have positioned us well for the downturn.
We are well prepared as we enter this downturn, our enterprise has a robust balance sheet with $116 million of cash on hand, an undrawn $350 million revolver with no debt maturities until 2014, we have an experienced capable and deep management organization, a Blue Chip global customer base which is the envy of the industry, strong market leadership position, and a record $2.9 billion backlog.
In addition our company has never had a better long-term outlook. We have the strongest positions we’ve ever had on the major new generation aircraft types, both commercial airlines and business jets.
I’m talking of course about the 787, the A350 XWB, the 747-8, the A380, and a number of the new generation business jets. And while there are clearly shorter-term issues for us to deal with our 2009 earnings will be pretty good, 2010 significantly better, and the longer term outlook very strong due to our excellent strategic position on the new aircraft types.
Moving now to our third quarter results, during the quarter our operating revenues continued to grow at a faster rate then revenues. Third quarter revenues increased 37% while our operating earnings were up 60% and operating earnings adjusted to exclude the acquisition integration and transition costs were up about 66%.
Let’s turn to slide two and review our financial results for the third quarter, the bar chart on slide two graphically illustrates our third quarter 2008 financial performance versus the third quarter of 2007. It can be seen that third quarter revenues increased by 37% to $588 million.
Revenue growth reflects the acquisition of HCS and solid organic revenue growth for the distribution and business jet segment. Pro forma revenue growth was approximately 11.6%. Operating earnings of $101 million increased 60%. Operating margin expanded by 240 basis points to 17.2%. The 17.2% operating margin reflect strong margin expansion in the commercial aircraft and biz jet segments, partially offset by a lower operating margin in the distribution segment due to the inclusion of the HCS business for two months of the quarter.
Net earnings of $52 million were negatively impacted by the $3.6 million of acquisition related costs in addition to the negative impact of $3.6 million of debt prepayment costs. Net earnings adjusted to exclude these costs were $57 million, an increase by 27%.
Adjusted EPS was $0.59 and increased by 23%. Now let’s turn to slide three. Slide three summarizes our continuing backlog growth. The third quarter was a solid bookings quarter. Bookings were approximately $600 million and reflect the book-to-bill ration a little bit better then one to one.
Backlog at the end of the quarter was approximately $2.9 billion which includes the addition of backlog associated with the HCS acquisition and represents an increase of approximately 45% as compared with the company’s September 30, 2007 backlog.
In addition the pie chart on slide three indicates that the backlog continues to be very well balanced geographically. Fifty-five percent of backlog is with international customers and over 32% of the backlog is with customers in the emerging markets, particularly in Asia and in the Middle East.
US airlines represent only 8% of our current backlog. Excluded from backlog are a number of major program awards, the most important of which are the selection by airbus of B/E’s next generation galley systems for the A350 XWB, and the selection by Boeing of B/E’s oxygen/PSU system for the B787.
The A350 galley system award was the largest award the company has ever received and is valued at more then $1 billion. These awards taken together with other awards, such as our award to equip the A350 XWB with our patented passenger oxygen system as well as numerous awards from international airlines for our commercial aircraft products on the 787, the new B747-8 and the A380 provide an excellent long-term platform for revenue growth over the coming years for our commercial aircraft segment.
Revenue growth within our business jet segment is expected to be driven by the introduction of several new business jet aircraft types. We’ve been selected to deliver major new programs for a number of these new aircraft types.
Our exceptionally strong position on these new aircraft platforms along with other current awards bodes well for the long-term future for our company and while the value of these other long-term awards currently totals well over $2 billion only a very small portion has been included in our record backlog.
Now I’ll briefly review the operating performance for each of our business segments, let’s start with our distribution segment. The recently completed acquisition of HCS has significantly strengthened our strategic position in the distribution market.
We financed this acquisition which closed on July 28, 2008 with a $1.5 billion of new debt financing. We believe the financing for this transaction was obtained on very favorable terms and in an extremely difficult market due to the strategic advantage which we have created by combining the HCS business with our own.
Clearly our financing sources, JP Morgan, Credit Suisse, and UBS, embraced our long-term value creation prospects arising from the completion of the integration of the two businesses. We firmly believe the outlook for B/E Aerospace is substantially improved as a result of the acquisition.
Let’s turn to slide four and review the strong third quarter results for the distribution segment. Revenues were $219 million, and increased by 135% reflecting the acquisition. Revenue growth on a pro forma basis was 13.8%. Operating earnings increased 97% to $42.1 million while the operating margin declined to 19.2% reflecting the inclusion of the lower margin HCS business for the last two months of the quarter.
Beginning in the latter part of 2009 and in 2010 margin expansion is expected to be driven by the synergies of the HCS acquisition. If we can now look at slide five we can see that our commercial aircraft product segment also had a very good quarter. Commercial aircraft segment revenues of $300 million were up 5% and reflect scheduled deliveries of retrofit and new buy aircraft program, a somewhat lower level of aftermarket spares revenues consistent with the slower growth in global passenger air travel, and airline cash conservation measures which began during the latter part of the quarter.
Operating earnings of $49 million increased 30% as compared with the same period in the prior year. Operating margin increased 310 basis points to 16.4%. This strong margin expansion is primarily the result of improved operational efficiencies, a favorable mix, backlog quality, and some favorable FX impacts.
Let’s now turn to slide six where we can see that our business jet segment had an outstanding quarter. The business jet segment continues to benefit from our prior investments in both our traditional business jet operations as well as in our super first class suite of products and this is reflected in our outstanding third quarter results.
Revenues increased by 42% reflecting strong shipments of both business jet interior equipment and super first class products. Operating earnings increased 165% as compared with the same period in the prior year as a result of the 42% increase in revenue and the 670 basis point increase in operating margin to 14.5%.
The significant margin expansion reflect substantially improved operational efficiency, operating leverage at the higher sales level and backlog quality. Let’s now turn to slide seven which reflects our solid financial position as of September 30. As you can see we have a robust balance sheet and a strong liquidity position.
We do not have any debt due until 2014. We have an undrawn $350 million revolver and as of September 30 we have more then $115 million of cash on hand. Finally our net debt to net capital ratio is only 39.5%.
During the third quarter we were able to generate sufficient free cash flow from operations to both invest $43 million in HCS inventory and at the same time to generate $27 million of additional free cash flow.
We plan to continue the conversion of the HCS business to the B/E inventory stocking business model during 2009 as we complete this transition. Let’s turn to slide eight where you can see our updated 2008 and 2009 financial guidance.
In 2008 earnings per share is expect to be $2.19 excluding acquisition integration and transition costs of $0.06 per share and debt prepayment costs of $0.03 per share, so about $2.10 on a GAAP basis.
In 2009 revenues are expected to increase to about $2.5 billion. In 2009, earnings per share is expected to be around $2.00 excluding acquisition integration and transition costs of about $0.10 per share. In addition a higher tax rate in 2009 is expected to negatively impact EPS by about $0.05 per share as compared to 2008.
The 2008 and 2009 estimated effective tax rate are expected to be 33.5% in 2008 and 35% in 2009. We expect total acquisition integration and transition costs of approximately $25 million from 2008 through 2010. The amount of $15 million of these costs are expected to be incurred in 2009 as the company integrates the HCS business with its existing distribution business.
We expect revenues and earnings for 2010 to be higher then 2009. Depending on market conditions we expect to invest about $125 million in HCS inventories and we expect free cash flow in 2009 after this inventory investment to be about $65 million.
And with that I’ll turn it over for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Robert Spingarn - Credit Suisse
Robert Spingarn - Credit Suisse
I’d like to go to the 2009 revenue guidance and the adjustment down of what looks like a $300 million change, and can you give us some color on where that’s coming from, which segments, and to what extent it reflects deferrals that have already happened or anticipation of further backlog erosion.
Amin Khoury
We’ve talked the market conditions and when we gave you our guidance earlier in the year, we didn’t provide segment guidance, that said, we now expect each of our segments will have revenues below our prior expectations for all the reason that I discussed on the call. That includes the distribution segment which is not immune to the downturn.
But we have had several customers ask us to stretch out retrofit programs, these are big programs, and to move those deliveries from 2009 into 2010 and 2011. Now that’s impacted both our CAP segment and also our business jet segment because of the super first class piece of that business.
So each one of the businesses is seeing some downturn. Our spares business is seeing the airlines introducing cash conservation measures and reducing their purchase of consumables. Our distribution business is also seeing some tightening because of cash conservation measures. So each of the businesses is experiencing some downturn and I think prudence tells us to go ahead and be conservative in our guidance for 2009.
Robert Spingarn - Credit Suisse
So should I take that to mean that the $300 million is not simply what you’ve got in phone calls but maybe it has some cushion for further phone calls from customers.
Amin Khoury
We feel pretty good about the $2.5 billion and I think that the one thing that we have really been dependable about is exceeding guidance on a regular basis and raising guidance so we really don’t want to do this more then one time. We’ve revised our guidance, we’ve revised our earnings guidance downward, we feel very good about the guidance that we’ve set, and we feel particularly positive about the long-term because of our really outstanding positions on all these new aircraft types.
I would say in 2009 we’re going to have a pretty good year, we’ll earn around $2.00, 2010 should be significantly better, and the long-term outlook I think is excellent because of our position on these larger platforms.
We really don’t want to have to come back to you and say, you know what? We’ve had another surprise and we’re going to have to revise our guidance either for revenues or earnings down from earlier expectations. So we feel good about where we are and I think your expectation should be that we will achieve the guidance that we’ve set.
Robert Spingarn - Credit Suisse
You mentioned the commercial products, you talked about fastener distribution slowing a bit, business aftermarket, does this guidance adjustment reflect any difference in business jet OE in 2009 and then how does overnight pricing look in the fastener distribution business, how is that holding up?
Amin Khoury
The pricing on the distribution business looks excellent. We’re not experiencing any pricing issues on the consumables business. There are some lighter volumes for two reasons, the Boeing strike is negatively impacting demand from the subcontractors to Boeing who are buying a little less currently as well as the cash conservation measures of the airlines and MRO. So there’s a bit of a volume downturn there. We’ll see where that goes. But pricing looks pretty good.
With respect to the business jet segment, we don’t expect much in the way of, we don’t expect any downturn in deliveries in 2009 because of the size of the backlog particularly in the segments that we operate with a larger business jet aircraft which really aren’t experiencing that kind of downturn and have robust backlogs.
We feel pretty good about he biz jet business except for the super first class portion of that business which where we’re seeing some stretch out due to again airline conservation measures moving those shipments out of 2009 into 2010 and 2011.
Operator
Your next question comes from the line of Howard Rubel - Jefferies & Co.
Howard Rubel - Jefferies & Co.
Regarding the distribution business if you would address a couple of points, I know this is a little bit of making lemonade out of lemons but are you finding that there’s certain customers that are going to be more receptive to part of your logistics management practice because it is a lower cost alternative then what they have?
Amin Khoury
The answer is absolutely yes. Our customers have continued in their belief that we are really the best in the business. They just don’t have problems on their production floors from us and if they need something overnight they’re going to get it from us and they know that.
The new customer base which is a lot of customers from HCS have seen dramatically improved performance in the short period of time since we have taken over that business. August was tough for us because of the depleted inventories which HCS had when we bought the business and stock outs and so forth for their customers, but the performance improvement has been so dramatic from the point of view of the customer base that they really value the service that we’re providing and I would say the outlook for that business looks terrific and as I commented earlier, pricing is not a problem and the customers do perceive what we’re doing as a really important valued service for them.
Howard Rubel - Jefferies & Co.
Can you parse a little bit, the revenue growth between the old business and the new business and then if I’m looking at this carefully it would seem that you still were able to get what I’ll call teens margins in HCS, is that fair? And then you talk about slowing and all that, do you think a teens sort of growth is achievable or is that a little bit aggressive?
Amin Khoury
First I’ll give you a qualitative answer to the first part of the question and that is that the operating margins in our piece of the business certainly did not decline so that the overall decline in margin was strictly a result of the inclusion of the HCS business for two months of the year so their margins are substantially less then ours and that’s what all the investment is about and I think by the end of 2009 and beginning in 2010 you will see some really nice margin expansion in that business. That’s our expectation.
Howard Rubel - Jefferies & Co.
The press release said you had basically 13.8% organic when you looked at the numbers, and—
Amin Khoury
No it was 13.8% pro forma, combined.
Howard Rubel - Jefferies & Co.
And so was that all, call it core B/E Aerospace or was it, did you have faster growth in Honeywell, and then—
Amin Khoury
Faster growth in our business but I can’t [quanitate] it. It was faster growth in our own business otherwise the rate of growth in the business would have been higher.
Howard Rubel - Jefferies & Co.
So, but this is probably the best rate you’re going to see for some time and probably the second half of September probably—
Amin Khoury
That’s probably true, now we’re moving a billion dollar business here and we are the largest by far in the industry so our growth rate is going to be mirror the growth of the business with the exception of some continued market share gains which we are experiencing and some growth in parts of the world where we don’t have a large market share so we’ll grow somewhat larger then the industry through market share gains and growth in certain geographies where we don’t have as big a share but we will certainly not be able to continue to grow at the growth rates that we have grown in the past few quarters.
Operator
Your next question comes from the line of Myles Walton - Oppenheimer
Myles Walton - Oppenheimer
Can you give us more color on 4Q guidance, you mentioned the $0.50 of EPS in the earlier announcement, what’s the sales expectation for fourth quarter or the full year?
Amin Khoury
We haven’t put revenue guidance out for the fourth quarter so obviously I can’t mention it on the call. We’ve given you guidance for the full year earnings and we’ve given you guidance for fourth quarter earnings in a prior release so you’ve got it.
Myles Walton - Oppenheimer
I’m just curious because it would either imply a significant sales decline sequentially or a margin decline sequentially and I guess just qualitatively could you comment on directionally which is working against you more.
Amin Khoury
You know our expectations for revenues in Q4 is more or less the same, slightly higher then Q3 and that would be because of the inclusion of HCS for one additional month. So our expectation for revenues in Q4 is not very much different from Q3.
Myles Walton - Oppenheimer
So then the commercial aircraft margins in 3Q obviously very attractive, but likely unsustainable into 4Q?
Amin Khoury
I think the fourth quarter margin impact for CAP will be the highest single quarter because of the lower spare sales during the quarter. The quarter which will have the most negative impact from aftermarket demand, the overnight business in consumables, and the spares business will be the fourth quarter of this year. It will be the first full quarter of cash conservation measures where the airlines are depleting their inventories and the MROs are doing the same and so there probably will be some margin impact. That’s probably what you are seeing there.
Operator
Your next question comes from the line of Troy Lahr - Stifel Nicolaus
Troy Lahr - Stifel Nicolaus
Can you talk a bit about 2010, when you say significantly better, top line and margin improvement? In the past you’ve talked about 100, 200 basis points, how should we think about margins going forward with the change in sales here?
Amin Khoury
I think you should think about a reinitiation of margin expansion in the latter part of 2009 with a major improvement in 2010 and you should expect significant increases in revenues in 2010 as well as earnings. So growth in revenues and margin expansion driving earnings growth from both those.
Troy Lahr - Stifel Nicolaus
On 2010, do you have confidence that if oil gets back up to $100 people aren’t going to start pushing stuff out of 2010 into 2011 and have you started seeing some customers say, hey that order in 2010 can we push that out further or has 2010 been pretty stable for you?
Amin Khoury
I think 2010, 2011 are the two years into which we’re actually rescheduling all these programs. They haven’t cancelled the programs, they basically really want these products, and so they’ve rescheduled them. They’re just trying to conserve cash and build it out less quickly and who knows what will happen if oil goes above $100 a barrel again. I think the question right now is what’s going to happen, I think it’s the other way around.
I think that we might have some favorable positive impacts from oil continuing to fall. But I don’t know what might happen if oil goes to above $100 again.
Operator
Your next question comes from the line of David Strauss - UBS
David Strauss - UBS
For 2010 are you expecting Boeing and Airbus to actually have higher deliveries or you expecting deliveries to go lower?
Amin Khoury
We’re expecting 787 deliveries to be substantially larger and we’re expecting A380 deliveries to be substantially larger and there’s some new aircraft that’s being delivered so for 2010 our expectation is driven to a large extent by the push out of retrofit programs which will have a pretty positive impact on 2010 and 2011, a return to more normal inventory levels, in other words the airlines will have depleted their inventories of spares and consumables by some point in time in 2009, so they’re going to have to have normal purchasing patterns in 2010 which bodes well for both revenues and earnings. That’s pretty important.
In 2010 our installed base because of deliveries in 2008 and 2009 of some pretty high priced products is much higher and that bodes well for spares demand. That’s very important for us, the size of our installed base is growing as we speak. As for deliveries at Boeing and Airbus, we don’t expect the deliveries to be substantially higher in 2010 then they are in 2009 but the mix will be different and our position on the mix is very strong; the A380 and the B787.
David Strauss - UBS
Your free cash flow forecast for 2009, even when I adjust for the investment in HCS its still a bit lower then I would have thought, maybe if you could give some color around that number?
Thomas McCaffrey
I think the way to think about it is the following, net earnings will be about $190 million and D&A will be about $45 million or roughly equal to CapEx. We will invest about $125 million in inventories to transition the HCS business and that leaves us about $65 million of free cash flow for working capital and other investments to support the higher sales level. Those investments should be more or less offset by non-cash expenses such as restricted stock.
Operator
Your next question comes from the line of Gautam Khanna - Cowen and Company
Gautam Khanna - Cowen and Company
To follow-up on the airline inventory destocking, do you have a sense for how much in terms of months of inventory these guys may have on hand so that when your aftermarket volumes will sort of track the pace of flight hours again?
Amin Khoury
We don’t know the answer to that question and they don’t know the answer to that question. The airlines don’t know, the MROs don’t know. All they know is that they’re being told not to spend any money right now. They’ll deplete their inventory. Sometime in 2009 it will become normal again.
Gautam Khanna - Cowen And Company
We’ve heard a lot about your galley competitors sell, having trouble at Boeing, is there any near-term opportunity to take share there and if so how big could it be and could it help you in 2009?
Michael Baughan
We’re aware of those issues and we’ve been approached by various people in the industry about jumping into that market. We’ve taken a very strategic look at that business and that resulted in us getting the A350 order for Airbus which is a billion dollar program for us with deliveries starting in the late 2011 and 2012 timeframe. That’s our focus right now and we want to execute properly on that program and we think that’s the right way for us to be looking at this market.
Gautam Khanna - Cowen And Company
Could you update us on what the RFP activity has been like this past quarter in light of all these macro issues, have you still seen a robust environment for 2010 and beyond?
Michael Baughan
It’s a little odd when you think about it. There actually has been a lot of activity in the last quarter. Its changing. There’s much less retrofit activity, I’d say that is way, way down. Not surprisingly. On the other hand there’s considerable activity in the pipeline for new aircraft programs and for new aircraft platforms. Those are longer-term opportunities for us but both in business jet and in commercial we have considerable activity and things in the pipeline for new aircraft platforms, 787 activity right now, new opportunities there continues to be strong.
Systems opportunities in various platforms, so a different type of activity, much less retrofit but still a considerable amount of longer term new aircraft and new airframe activity.
Operator
Your next question comes from the line of Patrick McCarthy - Friedman, Billings, Ramsey
Patrick McCarthy - Friedman, Billings, Ramsey
On the networking capital related to HCS, first could you parse out maybe a little bit of how much of the networking increase that you’ve seen is related to inventory versus receivables and then how comfortable you are with the credit quality of the new customers you’ve brought on the receivables side for HCS?
Thomas McCaffrey
We’re very comfortable, we did a lot of work initially with their customer base and they’ve got a great customer base and we’re very comfortable with them and their aging looks a lot like ours. In terms of the breakout of the working capital, the lion’s share of that was with respect to inventories and the receivables as I said, they’re current, they’re turning, and we don’t see any credit issues with them at all.
Patrick McCarthy - Friedman, Billings, Ramsey
Back to the investment that you’re potentially going to make next year, is that related to specific agreements that either you’ve put in place since you’ve made that acquisition or that they had or is it entirely discretionary for B/E Aerospace?
Amin Khoury
The obligations to buy new inventories have been created by us, not by them and we are trying to get in the inventories that we need. We’d like to actually get them in faster because we’re still having gap buys which are expensive to satisfy customers because of the lack of availability of inventories which they needed at HCS.
We have buys out and deliveries that are expected over the next several years and they’re pretty small compared to our total revenues. Its our decision, we are buying and the level of purchases is pretty small compared to annual revenue each year for the next year.
Operator
Your next question comes from the line of Karl Oehlschlaeger - Macquarie Research Equities
Karl Oehlschlaeger - Macquarie Research Equities
I wanted to talk about the margin in large commercial aircraft on the quarter, year-on-year is up 300 basis points but even on a sequential basis you had revenues down but the margins were up 300 basis points. You talked about operational improvements, can you talk a bit more about what drove that improvement on a one-quarter basis.
Amin Khoury
The prior quarter as you remember was pretty negatively impacted by start up costs on larger programs that we had just begun and so the operational improvements in those programs is a big deal. We have more normal margins on those programs. In addition we had a pretty nice mix of products, that is the products that we shipped during the quarter were products that carried nice margins with them. These were shipments out of our backlog which is a high quality backlog. We had some positive benefit from FX. We just had a lot of things go right in the quarter.
Operator
Your next question comes from the line of J.B. Groh - D. A. Davidson & Co.
J.B. Groh - D. A. Davidson & Co.
Could you give us what your Boeing strike assumptions are that are imbedded within your guidance?
Amin Khoury
Our expectation is that the strike will end at some time. Our expectation is that we’re not going to be shipping much associated with Boeing aircraft for most of the fourth quarter. We don’t know when the strike is going to end but we expect a fairly significant impact in Q4 and we don’t have anything in our plan for a strike continuing for some substantial period of time into 2009.
Operator
Your final question comes from the line of Eric Hugel - Stephens Inc.
Eric Hugel - Stephens Inc.
Can you talk about with HCS, there were a number of OEM contracts that were coming due over the next let’s say year or so, can you talk about now that you’ve been in there for, you mentioned about some of the transition issues, can you give us more color as to where things stand and where, when the timing of when some of those larger contracts roll over and some of the opportunities there?
Amin Khoury
A number of them roll over by the end of 2009 as we had mentioned before and I think there are two left in 2010 and one left in 2011 and we’re working those hard. We don’t have a lot to report to you today but our expectation is that we will have some more definitive information that we can give you about that and some better margin guidance for the business and the distribution business at the next quarter conference call. We’ve only owned the business for a couple of months and we need more time, making a lot of progress but there’s a lot of work to be done.
Eric Hugel - Stephens Inc.
The tax rate for this year, I’m assuming that’s just a function of the R&D tax credit hitting in the fourth quarter pretty much.
Thomas McCaffrey
Its largely the tax credit in the fourth quarter.
Regarding the total shares outstanding at the end of the quarter, it was 99.5 million. That wraps up our call this morning. Thank you all for joining us and we look forward to joining you on the next call.
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