Executives
Dan Swenson - VP of IR
Clayton Jones - President & CEO
Patrick Allen - Sr. VP & CFO
Analysts
Carter Copeland – Barclay’s Capital
Robert Spingarn - Credit Suisse
David Strauss - UBS
Myles Walton - Oppenheimer
Cai Von Rumohr - Cowen & Company
Joseph Nadol – JP Morgan
Robert Stallard - Macquarie Research Equities
Howard Rubel - Jefferies & Co.
Rockwell Collins, Inc. (COL) Q4 2008 Earnings Call November 3, 2008 9:00 AM ET
Operator
Good morning and welcome to the Rockwell Collins fourth quarter fiscal year 2008 earnings conference call. (Operator Instructions) For opening remarks and management introduction, I would like to turn the call over to Rockwell Collins' Vice President of Investor Relations, Dan Swenson; please go ahead, sir.
Dan Swenson
Good morning everyone. With me on the line this morning are Rockwell Collins' Chairman, President and Chief Executive Officer, Clayton Jones, and Senior Vice President and Chief Financial Officer, Patrick Allen.
Today's call is being webcast and you can view the slides we are presenting today on our website at www.rockwellcollins.com under the Investor Relations tab. Please note today's presentation and webcast will include certain projections and statements that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995.
Actual results may differ materially from those projected as a result of certain risk and uncertainties, including but not limited to those detailed on slide two of this webcast presentation, and from time-to-time in the company's Securities and Exchange Commission filings. These forward-looking statements are made as of the date hereof and the company assumes no obligation to update any forward-looking statement.
With that I'll now turn the call over to Clayton.
Clayton Jones
Thanks Dan, and good morning everybody, 2008 was another year of growth and strong operating performance for Rockwell Collins especially when you consider the tough market environment in which we saw defense programs protested and delayed, unprecedented fuel prices impacting airlines and business aircraft operations, and strikes at two of our important commercial customers.
If you look at our financial performance our total revenues for fiscal year 2008 increased 8% despite an estimated $25 million fourth quarter impact from the Boeing and Hawker Beechcraft strikes. Our total segment operating margins improved almost 100 basis points as both government and commercial systems recorded annual operating margins at all time highs, with commercial systems operating margins improving by 110 basis points over last year.
And this was achieved while again significantly boosting our rate of investment on research and development. Earnings per share grew 21% to $4.16; our fourth quarter consecutive year of EPS growth in excess of 20%.
Note that even as we saw a relative slowdown in sales growth compared to previous years we were able to deliver and EPS increase that was nearly three times the rate of revenue growth.
I’m going to let Patrick fill you in on the details behind these numbers, but my sense and the price of our stock suggests you’re more interested in future projections then past performance, so I’ll focus the balance of my remarks on our view of fiscal year 2009.
If you listened to our third quarter earnings call, you heard me talk about the high price of oil and its impact on our customers. Interesting to note that during that call oil hit its all time high, great timing, huh?. But since that time we’ve seen a remarkable reversal.
As I predicted oil prices at that level helped create demand destruction, only to happen faster then I or probably anyone else expected. It should be instructive to us all that fears of oil price increase and its impact on our commercial markets have been replaced with a new fear of global economic weakness resulting from the credit crisis in financial markets.
I don’t need to remind you that global markets are changing rapidly and uncertainty is available in full measure. But our company has a pretty good track record of assessing the situation, responding quickly, and delivering superior operating results.
So I’ll give you my perspective on how all this turbulence could affect our business. First our commercial business, let me begin with the air transport OEM sector.
One of the primary items that effected our planning for 2009 was the length of the Boeing strike. We had originally anticipated a 45-day strike but unfortunately it lasted a couple of weeks longer then we planned.
Considering the lost production and then the restart delays, we now expect the full 2009 fiscal year impact to our business to be a further reduction of about $40 million of revenues from plan which includes moving the 787 deliveries out 2009.
Now the harder part to assess is the impact of the expected economic slowdown. Over the course of this summer Airbus spoke of plans to raise their production rates but now given economic conditions they’re recently decided to shelve those plans.
Our earlier guidance did not include any of these increases so our assumptions for Airbus production remain unchanged. Except for the Boeing strike impact we expect no further erosion in 2009 air transport OEM deliveries as Boeing and Airbus have maintained backlogs in excess of six years, with customers waiting for these more fuel efficient aircraft.
Next, our business and regional jet OEM sales have been an area of double-digit growth for us over the past few years. However based on the weakening economy we do expect that growth rate to moderate but remain positive for the year.
Record backlogs at the OEMs and our market share gain should somewhat buffer the modest delivery reductions that may occur and as a result our current estimate is that the impact will be a reduction of about $10 million of revenue to our plan.
Turning to the commercial aftermarket, let me remind you that we had predicted a 5% worldwide capacity reduction resulting from airlines adjusting to the higher fuel prices. We’ve seen evidence that they’ve followed through on those plans which fortunately have helped prepare them for a downturn in travel demand that we’re starting to see.
In order to help manage load factors and yields, our guess and its just a guess, is that they may have to reduce capacity by another 400 airplanes or so to bring the worldwide capacity reductions to about 1200 to 1400 aircraft or about 8% of the fleet.
As a result of the capacity reductions and diminished demand, we now believe 2009 will be a year of flat passenger growth. In the business jet environment to date we have not seen the magnitude of impact that data from the FAA on business jet flight cycles might suggest.
But we do expect some weakness to develop. As a result of all of these items we project our overall aftermarket to be down in low single-digits for the year, or about an additional $50 million from previous guidance.
Let me now spend some time to share our view on the other half of our business, government systems, which remains a very important contributor to our revenue growth and our earnings strength.
Government systems markets are in far better shape then commercial systems but they’re not immune from changes as we approach an administration in transition. Since we announced our initial fiscal year 2009 guidance, four programs that were in our plan had been either cancelled or delayed; the KC-X tanker, and the ARH, CSAR-X, and CH-46 helicopter programs.
We still expect to see growth from government systems for 2009 but these cancellations result in about a $50 million reduction to our previous plan. To sum it all up, we’ve decided to take about $150 million out of our revenue plan for 2009 with commercial systems revenues about flat year-over-year as a result of single-digit OEM growth offset by single-digit aftermarket declines and government systems growth projections are going to be about 6%.
Now, there’s not a lot I can do about the macroeconomic conditions impacting our markets and revenues, however, there is a lot I can do to manage the potential impact of profitability so let’s talk about that.
Everyone likes to explore our margins, and understand how we’ve been able to increase them consistently by 50 to 100 basis points every year. Well let me say that we plan to do it again in fiscal year 2009.
Despite the revenue reductions I just discussed, we’re maintaining our forecast for total segment operating margins of 22.5% to 23%. We expect to accomplish this by carrying out a comprehensive roadmap of steps to reduce our spending.
These steps leverage the strength of our business which we’ve talked about for a long time. We’re exercising our lean business approach and our unique shared services environment to manage resources.
We’re sharing engineering assets across our government commercial business and we have undergone a detailed review of our business to align the infrastructure with market realities. Although these measures will involve some decrease in our R&D budget, we expect to maintain it at a very healthy 19% of revenues.
I’m very proud of the leadership team that worked with me over the past weeks to revise our plans. Every one of them acted unselfishly with the best interest of the company, customers, employees, and shareowners in mind.
With this seasoned team, most of whom have been through much worse times then this, I’m confident that we can execute to our plans and make the best of a challenging environment. Let me also state that I remain very optimistic about the long-term growth of our company. We continue to invest heavily in technology and solutions that will add to our growing market share.
Moreover our cash flow generation along with a strong balance sheet should allow us to maneuver better then most in these difficult conditions. Just as it has in prior periods of uncertainty, aggressive action now will better position us to take advantage of the eventual recovery even as we deliver solid results over the near-term.
With that I’ll turn the call over to Patrick, to take you through the specific details of the 2008 fourth quarter and full year financial results.
Patrick Allen
Thanks Clayton and good morning to everyone as well. Let’s get started by first reviewing our fourth quarter results that start on slides three and four.
Total company sales increased 4%, net income is up 17%, and earnings per share increased 22%. Our EPS growth rate for the quarter was five percentage points higher then the growth rate we reported for net income, principally driven by the significant impact of our ongoing share repurchase program.
Also our effective tax rate for the fourth quarter was 24.5%, compared to 31.9% for last year’s fourth quarter. This quarter’s rate benefited from the renewal of the Federal Research Development Tax Credit included in the Emergency Economic Stabilization Act of 2008 that was signed into law on the last day of our fiscal year.
The renewal of the credit and its retroactive impact back to January 1, 2008 resulted in an eight-percentage point reduction in our effective tax rate for the fourth quarter. The resulting higher earnings in turn caused an increase in our employee incentive compensation.
These two items netted together contributed $0.08 to our earnings per share for the quarter. The other $0.12 improvement came from higher revenues, stronger margins, and the impact of our share repurchase program.
Turning to slides five and six, we have our fourth quarter results for commercial systems. You probably noticed in our earnings release that we provide detail on our wide body IFE products business. We did this to provide better insight into the underlying trends in our markets as we expect this business to decline over the next few years due to our decision in 2005 to fulfill our current customer commitments but no longer invest in this area.
As a result all of my comments on the commercial system segments will be oriented around the ongoing pieces of the OEM and aftermarket business with wide body IFE covered separately.
Total commercial systems revenues increased 6% from $605 million to $641 million. Revenues increased 11% in the original equipment product segment on higher sales due to market share gains and increased aircraft deliveries.
Aftermarket revenues increased 12% primarily due to modification programs by airlines seeking equipment to provide them greater operating efficiency, while higher service revenues and increased sales of visual systems equipment in our simulation business also contributed to the growth.
Offsetting these was the expected $25 million reduction in our wide body IFE sales. On page six operating margins increased from 21.5% in the fourth quarter 2007 to 22.5% due to the impact of higher sales, lower employee incentive compensation costs relative to 2007, and productivity improvements.
Moving on to page seven, in government systems, revenues were up a more modest 2% overall. Airborne solutions sales increased $2 million due to higher military simulation sales and a start-up of a Range Instrumentation System program. These were partially offset by lower sales on our international C-130 programs due to a significant level of sales to Pakistan in the fourth quarter last year, and the wind down of the Singapore program this year.
Surface solution sales increased to $13 million on higher DAGR and GP-GRAM sales partially offset by lower legacy data link sales due to a higher level of international orders in 2007.
Page eight shows operating margins within government systems were up to 19.7% of sales compared to 19.5% of sales from a year ago. The increase in margins and earnings was due to higher sales volume and lower employee incentive compensation costs as compared to 2007.
On slide nine we have our full year total company financial results for sales, EPS, net income, and operating cash flow. Our full year revenues were in line with guidance at $4.8 billion, with organic growth of approximately 8% from 2007.
Earnings per share rose $0.71 or 21% on a $93 million or 16% increase in net income as once again our growth in earnings per share outpaced net income due to the benefit of our share repurchase program.
We realized cash flow from operations of $620 million. This amount was slightly ahead of last year’s $607 million but short of our target of $675 million to $725 million, as the contribution to this year’s operating cash flow from the $93 million increase in net income and lower pension plan contributions was offset by a payout of higher 2007 employee incentive compensation, higher income tax payments, and lower advance payments from customers.
Inventories also increased, due to higher investments in the [inaudible] programs, lower progress payments, and overall higher inventory due to the volatility of demand we’ve seen this year.
Slide 10 provides an overview of our capital structure as of fiscal year end 2008 versus 2007. Of importance we have a strong capital structure that supports our high credit ratings for our short-term commercial paper and long-term debt.
Our strong credit ratings allowed us to access the commercial paper market even on the worst days of the recent credit crunch. Backing up our commercial paper program is our $850 million line of credit led by a group of the largest banks in the US.
Because of our strength and ability to access the commercial paper market we have not had to utilize this credit facility and it remains undrawn.
Onto slide 11 where we review the progress and status of our share repurchase program, we remained active in the fourth quarter as we used $80 million of cash to repurchase 1.6 million shares bringing our fiscal year 2008 totals to 9 million shares repurchased for $576 million.
Our program to date recap shows that share repurchases have been a consistently utilized method for enhancing shareowner value as we’ve used about $2.3 billion of our available capital to repurchase almost 51 million shares reducing our outstanding share count by about 25 million since the inception of the program in January, 2002.
Now onto our final slide, slide 12, where we provide the detail of our fiscal year 2009 financial guidance. As Clayton detailed this guidance has been updated from that provided on September 10 due to the market conditions we’ve seen develop in the interim period.
Looking first at our revenue projection, we are now expecting revenues in 2009 of about $4.9 billion, roughly a 3.3% increase from 2008 actual results with flat revenues in our commercial systems business and 6% growth in our government systems business.
Jumping to the fifth bullet on the slide, our projected research and development expenditures have been reduced by $25 million but still represent about 19% of sales. The reduction is due to the referral of some discretionary spending principally on the commercial systems side.
Even with these reductions we still expect both commercial and government systems to recognize increases in company-funded investments while government systems shouldn’t [carry] the lion’s share of the increase in customer-funded projects.
Despite the decrease in revenue growth and the maintained relative level of R&D spending we are holding our total segment operating margin projection of about 22.5% to 23% as we execute plans to continue profit margin expansion even with more moderate revenue growth.
Looking at our EPS our expected range is now $4.25 to $4.45. In 2009 we expect earnings per share to grow due to revenue growth, expanded operating margins, and our share repurchase program however it is also accommodating about a three percentage point increase in our effective tax rate compared to 2008 primarily due to the absence of the tax settlements we benefited from during this past year.
The EPS guidance also incorporates the moderate increase in income we expect to see from our retirement plans as the increase in the discount rates used to measure our retirement liabilities more then offset the impact of losses in our pension assets.
Unprojected operating cash flow, we expect that our planned actions will allow us to meet the existing guidance. As an update we are still negotiating to receive payment from various components of our work related to the 787 program.
Our guidance also includes a planned discretionary defined benefit pension plan contribution of $75 million. Finally, with regards to how the year could play out, keep in mind that the majority of the impact of the Boeing strike and some of the impact from the aftermarket will be felt in our first quarter and will present a fair tough comparable against the prior year period.
However as our roadmaped actions are implemented and as we work past the impact of the Boeing strike we expect the subsequent quarters to show improvement.
That completes my review of the financial results and projections, so we are now ready for your questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Carter Copeland – Barclay’s Capital
Carter Copeland – Barclay’s Capital
Could you clarify something, you made a comment about moving 787 deliveries out of 2009, presumably those are the Boeing shipments, not your shipments to Boeing, could you clarify that for me.
Clayton Jones
Those are our shipments to Boeing.
Carter Copeland – Barclay’s Capital
So have you already shipped presumably all of the units they need to have all the flight test airplanes and then presumably some early production units?
Clayton Jones
Today we are assuming we have shipped all of the shipments that they will need in our fiscal year 2009.
Carter Copeland – Barclay’s Capital
On the pension if the discount rate were to actually not provide, so if spreads were to come in a bit and you didn’t have the discount rate benefit what sort of headwind would that put on the pension side?
Patrick Allen
Our discount rate provides about $5 million for every quarter point. The discount rate increased about a full percentage point from our measurement date in 2007 to our measurement date in 2008. I would say that the spreads even widened further. Since our measurement date is September 30, its about $5 million a quarter point.
Carter Copeland – Barclay’s Capital
So $20 million all in if it were just the asset hit without the discount rate benefit.
Patrick Allen
That’s correct.
Operator
Your next question comes from the line of Robert Spingarn - Credit Suisse
Robert Spingarn - Credit Suisse
You talked about the 12% aftermarket comp, could you talk a bit about what the core spares business did within that? In other words, air transport and then biz jet regional, taking out the mods and some of the other business you mentioned.
Patrick Allen
I think our core service and support business was up roughly 5% year-over-year and now remember though that we had an extra week this year in our service business which is the one that benefits the most from the extra week so if you neutralize for that it was roughly flat year-over-year.
Robert Spingarn - Credit Suisse
That’s an improvement sequentially from June and March. That the March quarter we had negative aftermarket, the presumption we heard that business jet spares were weakening there, again in June as well. You talked about that last time, so how is that trending as we go further into this?
Patrick Allen
I think its been pretty consistent with what we saw in March and June once you normalize for all of that.
Clayton Jones
Let’s make sure we’re not going apples and oranges too because we look at the aftermarket in two big chunks, one is the base [say] MRO service and support and the other are the retrofits and those kind of things. We’re expecting that that latter group is probably going to be more impacted as the airlines cut back and cash strap and I think that’s the experience we had over this last year.
So when you look at the all in weakness in the last period, we think its directly related to airlines hording their cash and not spending any money on these discretionary type programs during that period of time. Interesting enough, this last quarter we saw an improvement in that as we had predicted and that is these required navigation performance or RNP modifications were in pretty hot demand because they gave them an efficiency edge when they were maneuvering their aircraft.
Robert Spingarn - Credit Suisse
I guess what I’m getting at is the mandated work that you just referred to and how that’s trending given the capacity cuts etc.
Clayton Jones
Well first thing, none of this is mandated. RNP is not mandated.
Robert Spingarn - Credit Suisse
Just regular spares.
Clayton Jones
Well if you’re just looking at regular brake fix MRO? Just make sure we have the terminology correct.
Robert Spingarn - Credit Suisse
Yes, because I just want to go back a quarter, you talked about the fact that fuel budgets were getting pressured and you saw people flying less. We know biz jet utilization is down, we know that air transport capacity is coming down, and so what I’m asking is how you’re seeing the trend in that side of the business?
Clayton Jones
As we always said, about two-thirds of our aftermarket is predictable MRO type and about a third is discretionary, these are the retrofits they can choose to do whenever they want to do it. Our expectation over the last year is that that latter category, the discretionary was hit the hardest because of the fuel prices.
As we go forward our predictions are we’re going to see probably a reduction in both. That’s why we’re talking single-digit declines in aftermarket year-over-year because they’re taking capacity out and so it effects some of the, as you talk about, spares. And there are less airplanes with less stuff to be fixed and we’ll probably see the same dynamic if the economy stays weak and some of these aftermarket retrofit sales notwithstanding some positive areas like RNP.
Robert Spingarn - Credit Suisse
On the OE side, you talked about Airbus and Boeing assumptions, to what extent if any do you haircut what they’re published production plans are to build some cushion in. Is there any accommodation for numbers actually coming down.
Clayton Jones
That’s interesting because Boeing has no published production plans right now. And so what we’re doing is we’re, because we have, we’re making the best guess we can of what we believe will be taken out of their previously published one, which is we assume we’re not going to recover any of the aircraft that had been lost in the strike plus what ramp up its going to take for them to get back at full speed again and that’s the $40 million that we’ve talked about there which is current production rates plus the 787 coming out.
So most of that is our assumptions not their assumptions because they haven’t published those yet. Where Airbus is concerned, I would say its pretty much inline with what the Airbus current production rates are and we’ve taken those pretty much as is because frankly I don’t expect to see any erosion of that. I think Airbus will work very hard to make sure that their current production plans are put in place and for a lot of reasons.
Robert Spingarn - Credit Suisse
And you’ve done the same with biz jet OE?
Clayton Jones
No for biz jet OE, we blended what they told us with what our expectations are for weakness to come.
Operator
Your next question comes from the line of David Strauss - UBS
David Strauss - UBS
On the business jet side, so you’re adjusting what the manufacturers have actually said because as far as I know none of the OEMs have actually come out and cut their production forecast for 2009.
Clayton Jones
That’s correct, if you were to talk to the OEMs today, I’ve talked to probably two-thirds of them, personally, they’re seeing no significant cancellations. Their strong backlogs are able to accommodate the delays that they get in there now but they’re watching the same macro market dynamics that we are here and to date, they’ve make it very clear, no announcements that they’re reducing their production rates nor am I suggesting that I have any particular insight over what they’re going to do.
However we believe its prudent to take that $10 million I suggested out of the OEM forecast as a I think a reasonable and prudent measure of what might evolve over the course of our fiscal year.
David Strauss - UBS
So right now if you’re forecasting with your OEM aftermarket split I think being about 55/45, and you’re talking about the aftermarket being down a couple of percent, you’re basically at this point across the OEM side only baking in up low to mid single-digit OEM increase in 2009?
Patrick Allen
It’s a little bit higher then that only because there’s also a decline in our wide body IFE business as well.
David Strauss - UBS
Okay so the aftermarket number you’re giving out does not include that decline.
Patrick Allen
That’s correct.
David Strauss - UBS
Okay and then you talked about 2009, any color on beyond 2009, not specifically for Collins but just your thoughts on the various OEM cycles and you do have this $6.50 to $7.00 forecast out there for 2012, how do you look at that right now?
Clayton Jones
I’d love to be able to give you a perspective on that today, but I think that would just be crazy right now. The way the world is right now we can’t even predict oil prices two months from now, or two months ago much less what we think economic activity is, what all these governmental support things are going to be, how that’s going to effect going into a year from now.
I believe if I or anyone else were to tell you what conditions are going to be like in 2010, we’d have to do that after a six-pack of beer.
Operator
Your next question comes from the line of Myles Walton - Oppenheimer
Myles Walton - Oppenheimer
You talked about not being able to control the market but being able to control costs and you alluded to R&D, it sounds like you’re still going to keep internal R&D at about 8% of sales, is that about right?
Clayton Jones
That’s about right.
Myles Walton - Oppenheimer
So the cost controls beyond R&D, can you be a little more explicit there and also are you expecting commercial margins to expand despite the fact that the revenue will be flat?
Clayton Jones
The answer to that question is yes. We do expect commercial margins to expand as well as the government margins to meet those margin guidance we have, so it’ll be roughly in the same measures that we had it before with both businesses advancing. So yes, I feel confident of that.
I really can’t give you a lot more color on the other measures we’re using because this is something that I’d rather communicate to our leaders and our employees before I communicate it to you. So suffice it to say we have a very detailed plan and over the next week we’ll be talking to the people in Rockwell Collins about exactly what those plans are and then we’ll be glad to communicate them to you at that time.
Myles Walton - Oppenheimer
On the IFE, previously you had been anticipating about $60 million plus reduction in FY09, has that changed in any way in the forecast, is it going to go down even further then that or is that still about the right [bogey]?
Patrick Allen
Its about right.
Operator
Your next question comes from the line of Cai Von Rumohr - Cowen & Company
Cai Von Rumohr - Cowen & Company
If IFE still goes down 65, can you give us some sense of, you’ve had this weird pattern where its been going down but it sort of tends to have a hockey stick in the fourth quarter, should we expect that in fiscal 2009?
Patrick Allen
I’m not anticipating the same hockey stick in the fourth quarter of 2009.
Clayton Jones
At lot of that has been the result of some modifications that we’ve put in place to go from a tape player to digital file server which had a lot of retrofit activity associated with it is a very highly sought after modification.
The other was a function of some of our existing e-test customers reequipping with new aircrafts and I just don’t think that will reoccur again this year.
Cai Von Rumohr - Cowen & Company
R&D, could you tell us what was the R&D in 2008 and the split between company and customer, because it looks like its going to be relatively flat both company and customer funded in 2009, is that correct?
Patrick Allen
I think its going to be up a little bit. Our R&D for 2008 was about $600 million. But the total R&D for 2008 was $900 million and that was a little bit less then what we had projected and it was largely on the customer funded engineering. We saw a mix shift on our government systems business between hardware and development revenues.
So we’re going to see a modest uptick I think in both company funded and customer funded next year.
Clayton Jones
In fact if you look at our guidance we’re looking at I believe $25 million to $50 million of increase in FY09 compared to where we finished in FY08.
Cai Von Rumohr - Cowen & Company
So if it was $900 million, what was the split, so customer funded was about $515, is that--?
Patrick Allen
It was about 44% of the $900 million was company funded. So it was a little bit higher then we had previously guided, I think we had said probably about 40% would be company funded, it was about 44%.
Cai Von Rumohr - Cowen & Company
Okay but so if we’re going to have this increase in 2009, it is going to be equally split between company and customer or not?
Patrick Allen
I would say roughly evenly split, probably a bit more on the customer-funded side but roughly evenly split.
Operator
Your next question comes from the line of Joseph Nadol – JP Morgan
Joseph Nadol – JP Morgan
I was wondering if you could give more detail on the cash flow in the fourth quarter and the differences from your plan.
Patrick Allen
The two areas that I would say disappointed us the most in the fourth quarter, one was progress payments. We had been anticipating about I’d say roughly $25 million more progress payments in the fourth quarter then we received principally related to one or two programs in the government systems side. The second area was inventory performance. As a result of the volatility in the demand, interestingly enough, probably more on the government system side then on the commercial system side, we ended up building more inventory then we needed and so our inventory balances principally in our finished goods area were out probably again about $25 million higher then we had anticipated in our initial guidance.
Joseph Nadol – JP Morgan
So that gives you some significant runway opportunity going into the coming year, is that why you maintained, is it fair to say your guidance would have come down ex that opportunity going into 2009?
Patrick Allen
I think that’s, we certainly view it as opportunity and it’s probably fair to say that we would have had to revisit it again if it weren’t for that opportunity.
Joseph Nadol – JP Morgan
On the mods boost, was that all RNP or were there other factors? That’s a commercial airline mod as opposed to a biz jet mod right? And is there any follow through into Q1 from that potentially?
Clayton Jones
There was more then that, I think we mentioned them, the other big is our digital systems, the former [Evans and Sutherland] had a gangbusters quarter and there was a lot of demand for that.
Patrick Allen
There was also some [displays] business in the modification programs within the air transport marketplace but if you look at air transport it was really RNP related work with customers requesting us to pull forward some of that activity and then some display retrofit programs that were really heavily involved in working into the fourth quarter.
Clayton Jones
I think what this once again illustrates is the lumpiness of this component of our business. We’ve often said this is the hardest to predict, airlines and even business jet operators spend it when they choose to. Its very discretionary and so you’re going to see these ups and downs.
Joseph Nadol – JP Morgan
So is there a follow through do you think in Q1 on some of these mod programs or do you expect it all to run off?
Clayton Jones
Extremely hard to predict.
Operator
Your next question comes from the line of Robert Stallard - Macquarie Research Equities
Robert Stallard - Macquarie Research Equities
On the dispense side, you mention there’s been a couple of adjustments to your plan because of program delays, what other risks do you see in the dispense side of the business as we move into fiscal 2009?
Clayton Jones
I think in this day and age you always worry about a program being able to start on time, if you look at last year, we had three programs protested that we were a part of. You also look at any program that you may be associated with like we were with ARH where you’re having OEM performance problems and so I think those are the two areas of risk I would say that I’m most concerned about, that is further protested actions that just continue to delay the onset of these, and then any program that’s a wounded duck is in trouble in this environment.
Robert Stallard - Macquarie Research Equities
What about programs like DAGR that have related to operations if the US starts to withdraw troops from Iraq. Do you see that as a risk then?
Clayton Jones
Well we’re expecting in our guidance we’re expecting the DAGR sales to begin to diminish, reduce. We had a particularly good year this year because the [Op tempo] stayed higher with the surge and we’re thinking as we look into next year, that there will probably be some continued draw down in Iraq and even if they move to Afghanistan we’re expecting that the relative rate of both production and sales of DAGRs to draw down a little bit. But that’s imbedded in the guidance.
Robert Stallard - Macquarie Research Equities
If you look longer term on the defense side, which perhaps has the more visibility, what’s your thinking now on where the long-term trajectory for defense spending could be going given the [fiscal] situation in the USA?
Clayton Jones
Well I think its going to be a softening. I think that as you know, I’ve been sort of predicting that for the last couple of years and I’ve been thankfully wrong where defense spending has stayed up in the mid to high single-digits. I think you’re going to see that slow down. My prediction is rate of inflation and I think that is going to be a floor, a mandatory floor, just because of the threat situation around the world and the need to reset the forces.
And again there’s a lot of anxiety right now with the potential change of administration starting tomorrow, but I believe if you look at both candidates, they’re very strong on maintaining the support of the troops and the [armorment] they need to do what they do in harm’s way and I think that will support it there. At least there’s still a lot of talk of increasing the size of the ground forces and so I think there is some good with some other side that all of us will have to watch carefully.
For me, again I’m not worried about that because we’re so ubiquitous across all the services and a lot of programs. So just as we saw with ARH, we don’t know how that’s going to go but we know that the key to a warrior is a hook-up that they’re going to have to have and they’re going to have to upgrade it. And just as we saw in the cancellation of the Comanche, we actually came out better for that with the insulation of our avionics and our cast cockpit that if we had of moved on with the relatively low rate modernization program. I think post ARH, we’re likely to see something like that. I would say the same thing about KC-X. We all know its going to take a year or two at least to recompete that tanker program. In the meantime there are a lot of KC-135 modifications to come our way. We’ve performed stellar on that and they’re accelerating the KC-10 modifications and we’re going to go after that.
I feel sort of okay as long as there’s a relative continuation and not a gutting of the defense budget and I don’t think there will be that.
Operator
Your final question comes from the line of Howard Rubel - Jefferies & Co.
Howard Rubel - Jefferies & Co.
Usually you don’t comment on the quarter and you clearly gave us some cautionary comments with respect to that, my math would say that the current quarter is going to feel the bulk of the Boeing strike and maybe spill into a little bit in the following one, and then with respect to some of the defense delays that you talked about is doesn’t sound like they shift in this first month, could you elaborate a bit on that? Am I thinking about that you may have a tough revenue comp in this first quarter?
Patrick Allen
Yes, as I indicated I think that the tough revenue comp will be principally in the commercial systems side and it will be related to the Boeing impact. So if you take that $40 million impact, that’s split between two components, one is the strike related and the other is pushing out the 787 deliveries. The strike piece of it will largely be a first quarter event and we’ll get through it. There may be a little bit of a trickle into our second quarter but most of that is going to be in the first quarter.
Howard Rubel - Jefferies & Co.
You focused a lot on the balance sheet in your commentary and while I do agree you have a pretty strong balance sheet, one of the rules of thumbs are you’re not supposed to use short-term borrowings to buy, to invest in long-term things, like buying back your stock, is there consideration to issuing some longer term debt to match this ongoing effort to buy back stock?
Patrick Allen
I would say this, we continue to monitor the markets. I would say that over the last few months it has been a good time to access the long-term markets. We’ve been very fortunate that we’re able to access the short-term commercial paper market and I don’t think we’re overly exposed to that market. We have under $300 million of commercial paper right now. I would say, we’ll continue to monitor the long-term market and hopefully find an opportunity where we can repay some additional long-term debt.
Operator
There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.
Dan Swenson
We plan to file our Form 10-K including our complete annual financial statements and footnotes in a couple of weeks time period, so keep an eye out for that. Thank you all for joining us this morning and participating on today’s conference call.
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