Executives
Greg Powell - Vice President, Investor Relations
Amin J. Khoury - Chairman of the Board and Chief Executive Officer
Thomas P. McCaffrey - Senior Vice President and Chief Financial Officer
Michael B. Baughan - President and Chief Operating Officer
Analysts
Troy Lahr - Stifel Nicolaus & Company
Myles Walton - Oppenheimer & Co.
Gautam Khanna - Cowen and Company
Eric Hugel - Stephens
Peter Arment - American Technology Research
Robert Spingarn - Credit Suisse
Karl Oehlschlaeger - Macquarie Research
Carter Leake - Davenport and Company
Howard Rubel - Jefferies & Co.
B/E Aerospace, Inc. (BEAV) Q4 2008 Earnings Call February 2, 2009 9:00 AM ET
Operator
Good morning. My name is John Daniels, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the B/E Aerospace Fourth Quarter 2008 Earnings Conference Call.
All lines have been placed on mute to prevent any background noise; and after the speaker's remarks, there will be a question-and-answer period. (Operator Instructions). As a remainder, ladies and gentlemen, the conference is being recorded this day, February 2nd, the year 2009. Thank you.
I would now like to introduce B/E's Vice President of Investor Relations, Greg Powell. Mr. Powell, you may begin your conference.
Greg Powell
Thank you, John. Good morning and thank you for all of you joining us on the call this morning.
Today we are here to discuss our financial results for the fourth quarter and year ended December 31st, 2008. By now, you should have received the copy of the news release we issued earlier this morning. If you haven't received it, you will find the 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 prepared a few slides to help you follow our discussion. You can find our presentation on the Investor Relations page of the B/E Aerospace website at beaerospace.com. In addition, copies of the slides will be posted on our website for your review after the call.
Joining us for the call this morning are Mike Baughan, President and COO; and Tom McCaffrey, Senior Vice President and CFO.
As always in our prepared remarks and in responses to your question, we rely on the Safe Harbor exemptions under the various securities acts and our Safe Harbor statements in the company's filing with the SEC. We will address your questions following our prepared remarks. At that time, John will provide instructions.
As in the past, please limit your questions to no more than two at a time, so that we can get to as many of you as possible during the call.
And now, I will turn the call over to Amin Khoury.
Amin J. Khoury
Thank you Greg, and good morning everyone.
As we announced last week, we expect to record a non-cash goodwill impairment charge due to adverse equity market conditions that caused a decrease in current market multiples and our company share price as of December 31, 2008.
Our discussion this morning is exclusive of the goodwill impairment charge, which has been adequately addressed in both our January 28th release and our earnings release, which was issued last night. I am pleased to report that 2008 was an outstanding year for B/E Aerospace.
A strong performance was achieved in spite of deteriorating global economic conditions beginning in the second half of the year. In fact, 2008 was a record year for the company in terms of sales, operating earnings, net income, earnings per share, bookings and backlogs. In addition during 2008, we were awarded a number of major OEM direct for supplier furnished equipment that is SFE program on new commercial aircraft and business jet platforms.
The most significant of these was the selection by airbus of our next generation galley system for the A350 XWB. This award was the largest award the company has ever received and is valued at more than $1 billion. These new OEM direct for SFE programs are valued at approximately $2.3 billion in all are awarded directly from the OEMs will significantly raise our content per aircraft and are in addition to the buyer furnished equipment, which had in the past been our traditional source of revenue from the airlines and leasing companies.
These SFE programs along with our dramatically larger spares business as a result of the very large growth in our installed base over the last several years, and most importantly of all, the fact that about half of our revenues and earnings now derive from our $1 billion plus nondiscretionary fasteners and consumables book business provide an excellent platform for revenue and profit stability during the downturn and revenue and profit growth long-term.
This morning, I'd like to first discuss the current macro economic environment and the expected impact it will have on our business. Then we will review our fourth quarter financial and operating results. And lastly, we will discuss our financial guidance for 2009.
First, I'll discuss the current market environment. Clearly, the uncontrolled expansion of credit for both institutions and individuals, dramatic lowering of credit underwriting standards and the proliferation of ever more exotic debt derivatives have pushed our financial systems to a brink of insolvency and have assured in one of the most serious economic downturns in history.
The great unwind is sorely needed and is underway, and we believe we are in for a protracted period of credit contraction. Clearly, this downturn is different. Essentially all asset classes and all geographies are correlated in a downward direction. Obviously this does impact global air travel.
The International Air Transport Association, that is IATA, reported that international passenger traffic declined by more than 4% in each of November and December. All geographic areas, all classes of service have been impacted. And it does not appear that there will be a quick rebound in traffic. IATA is forecasting that international passenger traffic will fall by an additional 3% in 2009.
On the other hand, the U.S. airlines are actually ahead of the rest of the world in terms of capacity reduction, reflecting their aggressive cuts in 2008. This bodes well for the U.S. airlines profitability in 2009. While they are planning to make additional cuts in 2009, most of their planned cuts have been made. As a result of new fees, higher ticket prices and lower fuel costs, the expectation now is that the U.S. airlines are likely to post a profitable year in 2009.
Business jet market has also begun to decline and will continue to do so. Business jet flight activity was down more than 20% on the fourth quarter. Business jet inventories are rising and prices for used aircraft declined by an average of 25% in the fourth quarter. In addition, the credit crisis is crimping the availability of financing for both airliners and new business jets. Taken together, these factors can only mean significantly lower demand for both new commercial aircrafts and new business jets.
Obviously, the impact from the deepening global recession on airline traffic and corporate profitability, the dramatically impacting airline spending and business jet demand. In response to the deepening recession, airlines are further reducing capacity and implementing tough cash conservation measures. Business jet OEMs are slashing production rates for their lower end platforms, and trimming production rates for higher end aircraft.
Three months ago, during our third quarter earnings call, we reported to you that a number of our customers have pushed out major retrofit program, moving 2008 and 2009 shipments to 2010 and '11. At the same time, we've experienced the significant decrease in demand by airlines for aftermarket spending including spending for spares and consumables.
Earlier in 2008, we initiated contingency planning to address the various actions that might be required in the event that industry conditions will continue to deteriorate. Fortunately, we were well positioned to address the sudden decline in demand for our products as the global economy continues to deteriorate in the second half of the year. The actions we have taken include a 12% reduction in the size of our work force, which was completed by December 31.
The steps we are taking, while painful affecting employees and their families, are necessary and are expected to enable the company to protect its balance sheet and cash flows during what may well be a prolonged downturn while at the same time allowing the company to continue to invest in new products and technologies in order to expand our global market leadership position. Our cost reduction actions, when fully implemented, will provide substantial savings in 2009 and significantly more savings in 2010 and beyond.
Notwithstanding these economic conditions, as a result of our record backlog, both booked and not yet booked, as well as our substantially transformed overall strategic business mix, we are cautiously optimistic about the next couple of years. We have the best product line in the industry and the largest and best aerospace consumable business in the world, which is non-discretionary even in periods of significant contraction. We are heavily leveraged to wide-body aircraft deliveries, which should be at an acceptable level over the next two years.
In addition, airlines are continuing to burn through their existing inventory; and during the second half of 2009, we expect after market demand for our spares and consumables to improve as it has in prior downturns. So, unless there is some sudden further down drift in the economy, we expect to see our business perform reasonable well over the next two years. We are using the current period to strengthen our business processes from the shop floor through the executive suite.
These actions, including the strengthening of our liquidity position and the transformation of our business mix, provide management with the higher level of confidence that we will be able to successfully and profitability navigate our way through the current downturn and emerge as a stronger company.
Moving now to our fourth quarter results, we are pleased with the company's fourth quarter earnings and cash flow performance, particularly in light of the dramatic deterioration in global economic conditions. Our operating earnings continue to grow at a faster rate than our revenues.
Fourth quarter revenues increased 14% while our operating earnings were up 34%. Operating earnings were up 46% as adjusted to exclude $8 million of fourth quarter acquisition, integration, transition and severance costs.
Let's turn to slide 2 and review our financial results for the fourth quarter of 2008. The bar chart on slide two graphically illustrates our fourth quarter 2008 financial performance versus the fourth quarter of 2007. Fourth quarter revenues increased by 14% to $527 million; revenue growth reflects the inclusion of the HCS business acquired during the third quarter. Pro forma for the inclusion of HCS on a full-year basis, revenues declined approximately 13%.
Operating earnings of $91 million increased 34%, operating margin expanded by 260 basis points, 17.2%, 260 basis point improvements in operating margin was achieved despite the inclusion of the fourth quarter charges. Net earnings adjusted to exclude the fourth quarter charges were $52 million and increased 23%. Adjusted EPS of $0.53 increased by 15% and free cash flow during the quarter was $58 million.
Moving now to our full year 2008 results, let's turn to slide 3 and review our financial results for full year. 2008 revenues increased by 26% to $2.1 billion. Revenue growth reflects the inclusion of HCS revenues for five months of the year. Pro forma revenue growth was approximately 11%.
Operating earnings were $354 million increased 43%. Operating margin expanded by 200 basis points to 16.8%. The 16.8% operating margin reflects a 60 basis point improvement in margin at the distribution segment, 100 basis point margin expansion at the commercial aircraft segment, and a 340 basis point margin expansion at the business jet segment. The 210 basis point improvement in the operating margin was achieved despite the 2008 charges, which included $10 billion of acquisition, integration, and transition costs and $2 million of severance cost.
Net earnings of $201 million were negatively impacted by the 2008 charges and $3.6 million of debt prepayment costs. Net earnings adjusted to exclude the 2008 charges in debt free payment cost for $211 million and increased 43%, adjusted EPS of $2.22 increased 34%.
Now let's turn to slide 4. Slide 4 summarizes our current backlog. Bookings during the fourth quarter were approximately $450 million and reflect a book to bill ratio of approximately 0.85 to 1. Backlog at the end of the quarter was approximately $2.9 billion, and represents an increase of approximately 32% as compared with the company's December 31, 2007 backlog.
In addition, a pie chart on slide 4 indicates that the backlog continues to be very well balanced geographically. 55% of backlog is with international customers. About 9% of our backlog is with U.S. airlines. As a remainder, our backlog excludes a number of major program awards that are a result of the company's strategic focus on OEM direct or supplier furnished equipment for new aircraft platform.
This new significant component of B\E Aerospace's business is expected to substantially increase revenue content per aircraft on a number of major new aircraft platforms and to buffer an expected downturn in the level of record fiscal quarters. These awards provide an excellent long-term platform for revenue stability over the coming years for both our commercial aircraft and business jet segments.
The most important of these awards are the selection by Airbus, a B/E's next generation galley systems for the A350 XWB, and the selection by Boeing of B/E's oxygen and PSU system for the B787.
The longer-term outlook within the business jet segment will be enhanced by the introduction of several new business jet aircraft types. The company's exceptionally strong position on these new aircraft platforms, both commercial and business jets, bodes well for the future. While the value of the company's long-term OEM direct or SFE awards currently totals over $2.3 billion, only a very small portion has been included in the company's backlog.
Now I will briefly review the operating performance for each of our business segments.
Let's turn to slide 5 and review the fourth quarter results for the distribution segment. Revenues of $232.5 million increased to 132.5% reflecting the acquisition on Honeywell's HCS business. Pro forma revenue declined by 2.9%. Operating earnings, which includes $6.1 million of acquisition, integration, and transition costs were $49.5 million.
Operating margin declined 130 basis points, 21.3% primarily due to the HCS costs. Synergies from the HCS acquisition are expected to drive significant margin expansion beginning in the latter part of 2009.
Let's turn to slide 6 and review the fourth quarter results for the commercial aircraft segment. Revenues of $233 million decreased 24% and reflect retrofit program push out, reduced aircraft deliveries as a result of the Boeing strike and reduced spares revenues as a result of airline and MRO cash conservation measures.
Operating margin of 14.4% increased by 190 basis points as compared with the same period in the prior year reflecting synergies associated with the integration of the Draeger acquisition, improved efficiencies associated with major seating program, and successful cost reduction initiative.
Business jet segment; revenues increased by 7.6% to $61.1 million while operating earnings increased by $700,000 or 9.9%. Our operating margins for the quarter was 12.8%, and I'd like to point out that the business jet operating margins has increased by about 700 basis points over the last two and half years.
Let's now turn to slide 8, which reflects our financial position as of December 31st. We have a solid capital position, and our liquidity position is strong. As of December 31, 2008, cash on hand of $168 million and availability under a $350 million undrawn revolver over $515 million. As a result of the estimated goodwill impairment charge, our net debt to net capital ratio at year-end declined to 43%. Excluding the charge, our net debt to net capital ratio would have been a little under 38%.
We have two maintenance covenants in our indebtedness: interest covered and the total leverage debt. Our interest coverage for 2008 is determined on a pro forma basis, and it was 5.7 versus a covenant of 2.25. And our leverage ratio was 2.1 versus our covenant of 4.25. As you can plainly see, we have very substantial covenant headroom, more than ample liquidity and no maturities of any debt until 2014. And I point out again that during the fourth quarter, we generated about $58 million of free cash flow.
I'd like to spend a few minutes discussing our outlook and our financial guidance for 2009. As I mentioned earlier, it is expected that air traffic will continue to decline in 2009. Declining air travel is negatively impacting our customer base obviously.
Business jet market is also expecting to be severely impacted by both the recession and by the declining corporate profitability. Off cash conservation measures implemented by our customers are clearly having an impact on the demand for our products.
We were the first or at least one of the first companies, who recognized the coming downturn. We quickly responded the changing market conditions by significantly reducing our cost structure. In fact, we had reduced our headcount by approximately 12% by December 31, 2008.
In addition, we successfully implemented our strategic business decision to alter our business mix, so that approximately half of our business is related to non-discretionary consumable demand along with our strategic focus on OEM direct or SFE. We expect this will have a profound effect on our business in the future.
Based on these factors and despite the current economic environment, we are cautiously optimistic about our outlook. We expect that the first quarter of 2009 will be particularly weak. During the first quarter, significantly depressed demand caused by retrofit push out, the Boeing strike, and a weak mix in the commercial aircraft segment will negatively impact sales and earnings.
Both sales and earnings will be impacted at our business jet segment by super first class push out. In addition, we expect to be a user of cash in the first quarter due to the payment of our semi annual interest payment and an expected reduction in accounts payable and accrued liability.
Moving past the first quarter, we expect to see a step up in revenue operating margins, net earnings and free cash flow in the second, third, and fourth quarter. Overall, we expect our 2009 results to be approximate inline with the record 2008 result, which we announced this morning.
Let's turn to slide 9, where we can review our 2009 financial guidance. 2009 revenues are expected to be slightly higher compared with 2008 or approximately $2.25 billion reflecting the inclusion of HCS for the full year. On a pro forma basis, giving effect to the inclusion of the HCS business for all of 2008, our 2009 revenues are expected to decline by approximately 8%.
2009 net earnings per diluted share are expected to be slightly lower at approximately $2 per diluted share excluding AIT cost of approximately $0.10 per diluted share. Reflecting a deterioration in mix due to lower sales, higher margin aftermarket product, reduced shipments associated with new aircraft deliveries as a result of the Boeing strike, and decreased retrofit shipments.
During 2009, the company expects to invest approximately an additional $75 million in distribution segment inventories to facilitate the transition of the HCS business for the company's inventory stocking business model. Company expects to generate significant free cash flow over the course of the year even after investment of approximately $75 million in distribution segment inventory and approximately $40 million in CapEx. We expect to end the year with the cash balance in excess of $250 million.
First quarter 2009, earnings and cash flow, as I mentioned earlier are expected to be particularly weak. The company expects first quarter 2009 adjusted earnings per diluted share of approximately $0.40 as a result of a weak product mix of the commercial aircraft shipment reflecting decreased retrofit these shipments. Decreased shipments associated with new aircraft deliveries as a result of the Boeing strike, which negatively impacts sales of our profitable food and beverage preparation and storage equipments as well as seating, and lower spares revenues due to airline cash conservation measures.
In addition, the company expects particularly weak first quarter for the business jet segment as a result of super first class push out. Company expects second, third, and fourth quarters to have both higher revenues and better product mix than the first quarter of the year resulting a higher earnings and cash flows in all three quarters.
And with that, I will turn it back to Greg to begin the Q&A portion of the call.
Greg Powell
This completes our prepared remarks, and now we will be glad to take your questions. As usual, please limit your questions to no more than two at a time, so that we can get to as many of you as possible.
John will now provide instructions on how to submit your questions. John?
Question-and-Answer Session
Operator
Thank you, Mr. Powell. (Operator Instructions). And it does look like our first question comes from the office of Stifel Nicolaus and Troy Lahr.
Troy Lahr - Stifel Nicolaus & Company
Amin, I am wondering if you could talk a little bit about your guidance, your sales... your revised sales guidance for 2009. I think back in October, you said you felt pretty good about that, and you didn't want to have the changes for more that once. So can you maybe walk us through how you feel confident about this? And does.the change in oil prices, does that impact how your see airline fairing over the next couple of months?
Amin Khoury
Yeah, absolutely. I mean, the combination of the amount of capacities that the domestic carriers took out in 2008 together with their higher ticker prices, higher fees, in fact their yields roughly 10% over the past 24 months, and lower oil prices bodes well for the profitability of the U.S. airline.
The reason that it is different this time, so to speak, as compared to 2001 is that our company is so different at this time. I don't believe that investors understand the magnitude of transformation in our business over the last several years. I mean the dramatic growth in nondiscretionary portion of our aftermarket business. I am talking about our fastener and consumables business, which is $1 billion-plus business, plus our reduced dependence on retrofit activity during the downturn have really changed our business, that together of course with this new SFE component.
So, we expect our consumables business, which basically was only negatively impacted by a couple of quarters after 9/11/2001, the very strong business this year, and it is actually turning out that way. Even though revenues were slightly depressed in the fourth quarter, we expect that business to rebound beginning probably sometimes here in the second quarter, and certainly in the second half of the year. So we are comfortable with our guidance, because our consumables business and our spares business, which is a much, much larger business than it was in the past as a result of the very much larger installed base that we have now. Those two businesses are our most profitable businesses and are doing okay in spite of the downturn.
Troy Lahr - Stifel Nicolaus & Company
Okay, thanks. And then my second question: as you shift to more OE direct, I mean could that pressure margins to little lower? Are you concerned that the OEMs might come back to you every couple years just constently trying to take costs out, and almost you kind of get into this auto supplier type mentality. Is there a risk of that...
Amin Khoury
We have already negotiated the prices on this program.
Troy Lahr - Stifel Nicolaus & Company
And are those long-term, is it like three, four year contract?
Amin Khoury
They are life of the aircraft contract, and we've negotiated the pricing on this program and they are not going to be depressing our margins.
Troy Lahr - Stifel Nicolaus & Company
Okay. Thanks guys.
Operator
We now go to Myles Walton, Oppenheimer & Company.
Myles Walton - Oppenheimer & Co.
Thanks, good morning; just wanted to follow up on that question with respect to the 2009 guidance. Obviously, you took 300 million sales out, but had some pretty impressive margin improvements in... Amin or Mike or whomever, could you comment on the offsets, the positive offsets, the guidance that allowed you to hold up the earning side, and was it purely margins or taxes in anyway benefiting you in '09? Or just kind of walk us through the moving parts that allows you to offset the sales decline.
Amin Khoury
Okay. I would say that the reason that the margins are holding up is because it's how quickly we reacted to the changing environment. I mean we have taken out a very substantial portion of the workforce here. Workforce is declined by 12% as of the end of December. It will decline by another 9% over the course of this year, but that's primarily through attrition.
We had been very aggressive in working the integration of HCS. Our headcount reduction there is about 140 people or almost 10% of the work force so far. Other is... other critical integration tasks which are also benefiting the quarter includes the closing of an offshore call center, closing sales and purchasing offices in Shanghai and Mexicali, consolidating duplicative distribution centers in Hamburg and Toulouse.
We really accelerated inventory purchases towards the end of the year. Almost all of the Q4 inventory growth with the distribution, and this had a positive impact on our overall product cost during the quarter. We are making very good progress on the integration at the distribution business.
And finally we had favorable mix on a number of JIT contracts at the distribution segment, which further contributed to the margin expansion. And that little microcosm discussion about distribution happened in each one of our segment. We basically jumped on it quickly, reacted to the changing environment, and really dramatically took our cost structure down. And that is going to positively impact our margins in 2009 and even more so in 2010 and beyond.
Myles Walton - Oppenheimer & Co.
And may be a follow up: is there... what is the assumption for tax rate in '09?
Amin Khoury
About 35%.
Thomas McCaffrey
Yeah, 35%.
Myles Walton - Oppenheimer & Co.
Okay. Great, thanks.
Operator
We welcome an enquiry from Gautam Khanna, Cowen and Company.
Gautam Khanna - Cowen and Company
Hi guys, I wondering if you could comment on sort of what's the pricing trends are in your distribution segment and if you are able to keep some of your price hikes, are you getting any push back?
Amin Khoury
We don't talk about pricing in the distribution segment. But I can say that pricing has not weakened.
Gautam Khanna - Cowen and Company
Okay, fair enough. And you mentioned that on the commercial aircraft side, sales were down 22% obviously. Could you characterize how much after market may have been down?
Amin Khoury
I mean after market was negatively impacted even more than the average decrease in revenues for the business overall. And the spares business, so when I talk about after market, here I am talking about after market in commercial aircraft segments, they are not talking about the consumables business.
In the after market segment, when spares were impacted after 2001, spares revenues didn't come back for a couple of years. They recovered somewhat, but didn't fully recover for about 10 quarters. Consumables business was very different. It recovered after two quarters. So it's a function of discretionary versus non-discretionary nature of the revenues. And our spares business and the commercial aircraft segment were down more than the 23% or 24% and our commercial aircraft segment business was down overall.
Gautam Khanna - Cowen and Company
Okay. And last one and I'll turn it over to someone else; can you... do you guys have a sense for what percentage of sales and profits come from biz jet spares? Thanks.
Amin Khoury
Yeah, biz jet spares are a relatively small portion of biz jet revenue.
Operator
We transition now out to Eric Hugel, Stephens.
Eric Hugel - Stephens
Hey, good morning guys.
Amin Khoury
Good morning.
Eric Hugel - Stephens
Can you talk about... when you talk about Q2 through Q4 being better in terms of sales and margin, how much of that is based upon what you actually what you have in backlog today versus you're hoping depending upon spares to pick up or other sort of expected orders to be coming in, your level of confidence?
Amin Khoury
Q2 will benefit from Boeing shipments. I mean Boeing is actually going to being delivering airplanes again here at some point. And our food and beverage preparation and storage equipment business and our seating business have been negatively impacted in the fourth quarter. And are being very substantially negatively impacted in the first quarter by lack of Boeing airplane delivery, and that is a function of what's in the backlog, not a function of orders that we expect to get.
With respect to our spares business in commercial aircraft segments, we are not expecting any improvements in the second quarter at all. The consumables business will pick up a little bit. So I mean our expectation about Q2 and Q3 is an expectation with a very high degree of confidence.
Eric Hugel - Stephens
Great. I guess moving on, can you talk about the margins in the distribution business were significantly better than we were looking for, and nicely higher than last quarter despite having HCS for a full quarter. Can you talk about sort of what was going on there in terms of sort of what drove those higher margins as well as your expectations for... is that a base line going forward as you sort of implement further cost reductions that we should grow from there or sort of how we set for as we progress sequentially?
Amin Khoury
Yeah, the fourth quarter was not an aberration in the business. On the one hand, we do have HCS for the full period, and we do have the negative impact of the AIT costs on margin. But margin in that business is strong as it has been and should continue to improve over the course of the year. It was a very substantial improvement, the latter part of the year as we take more costs out.
What has benefited the margin is two things; most importantly was the cost reduction programs, which I mentioned earlier, the closing of call centers, the closing of duplicative operations, taking out 140 people, the rapidity with which we were able to get in inventories during the latter part of the year. Essentially all of our inventory growth in Q4 was in the distribution business that we are having lower costs on parts. And then we had some favorable mix in some of our just-in-time contracts as production facilities for aerospace companies.
So that business is really doing a terrific job of integrating the HCS business, taking out costs, and lowering the cost of the parts that we are delivering, and it is showing in the margins of the business and the expectation is for improved margins over the course of the year.
Eric Hugel - Stephens
Great. And could you just real quickly... who are your major JIT customers, can you disclose that?
Amin Khoury
Yeah, pretty much everybody. We don't really want to talk about individual customers, but it's all the major aerospace companies.
Eric Hugel - Stephens
Right.
Amin Khoury
We can mention a couple. We got Goodrich, we've got Honeywell, we've got Boeing, we've got Boeing Defense.
Eric Hugel - Stephens
So there is pretty much big ones, you are not relying on one or two major customers.
Amin Khoury
We have many, many contracts.
Eric Hugel - Stephens
Great. Thanks a lot guys.
Operator
From Broadpoint AmTech, we go to Peter Arment.
Peter Arment - American Technology Research
Hi, good morning guys. You guys hit on my questions, and thanks again for the good color.
Amin Khoury
Good morning.
Operator
We'll transition to the office of Credit Suisse and Robert Spingarn.
Robert Spingarn - Credit Suisse
Good morning.
Amin Khoury
Good morning.
Robert Spingarn - Credit Suisse
Going back to last question, Amin, just wanted to get into more specifics on the HCS margins. It looks like if you take the 6 million, the 6.1 out, you did close to 24% margin there? Maybe that's question for Tom.
Amin Khoury
Tom, you can have a go with the same question.
Thomas McCaffrey
I think the math is, yeah, it was 23% plus margin.
Robert Spingarn - Credit Suisse
Yeah, which is fantastic. So the question really is: have you brought HCS up to the core business level? Because it would seem that you are very close or at least about double, where that business was when you acquired it.
Amin Khoury
Yeah, we're getting close. Tom, are you going to... I think Rob would like you to answer the question.
Thomas McCaffrey
Yeah, Rob, it's all the things that Amin had mentioned. I think that we... the team has really, really focused on integration; and taking the cost out of that business had been a significant impact. If we go back and will recall what our original targets were in terms of headcount reductions, we're always there.
We move the... we accelerated the consolidation of the major HCS warehouse forward one full year. We expect to have that done this year. So we are making tremendous strides there. And in the fourth quarter, we were able to bring in a lot of inventory sooner than what we thought we had and part of that is just good purchasing as well as favorable conditions from a supply perspective.
Robert Spingarn - Credit Suisse
Yeah. And Amin, here is where the questions switches in your direction. Thank you, Tom. But it seems like most of your margin strength or your margin growth at HCS has been cost driven, where you apply some of the same cost mechanics that you have in your core business. But now that you've done that, as you apply the stocking model, should there not be some more upside?
Amin Khoury
Well, as we mentioned, we expect the margins to improve bit by bit over the course of the year and to be stronger in the second half of the year than the first and to be much stronger in 2010, because we expect to basically have enclosed by December 31 of this year, and to have all accounts on our IT system and to have all of the inventories that we need to be able to apply the stocking model to all of our customer base.
So, the business is a very strong business. It's non-discretionary in nature; it's very profitable. And we are essentially the only source of overnight deliveries of those parts in the entire country.
Robert Spingarn - Credit Suisse
Okay.
Amin Khoury
All the business, which is getting stronger with lower cost and the stocking model is beginning to work.
Robert Spingarn - Credit Suisse
Right. On that note, actually just switching over now to the first quarter revenues. I think we talked about this a little bit. You talked about business aircraft. You talked about the deferral and super first class putting some pressure on the first quarter revenues.
Amin Khoury
Yeah, first quarter is going to be a tough quarter for us. We got everything going against us. We had the Boeing strike that we are not shipping, seating, and food and beverage preparation and the storage equipment, which the latter is very profitable.
And we've got the retrofit programs pushed out. There isn't much there. We've got somewhat lower quarter in the distribution business than the quarters that we will very likely have in the latter part of the year. So there are a lot of things going on, which makes the first quarter kind of a weak quarter. It's mix related and revenue related.
Robert Spingarn - Credit Suisse
But Amin, on the biz jet in particular, what's the effect or what should we think about from corporate jet OEs. So, we know that that business is a combination of super first class, corporate jet OE, and then after market. You already commented the biz jet after market is modest in size, not to focus too much there. But how about the fact that so many corporate jet manufacturers are ratcheting down production?
Amin Khoury
I think we are going to have a really tough period here, and I think it's going to be prolonged.
Robert Spingarn - Credit Suisse
Doesn't that get you beyond the first quarter?
Amin Khoury
Well, that will get us beyond... for the first quarter has a particular mix problem. The second, third, and fourth quarter revenue levels in the business jet segment are expected to be substantially lower than the...
Robert Spingarn - Credit Suisse
Okay
Amin Khoury
...four quarters of this year, reflecting a lower level of business jet deliveries for all of next year.
Robert Spingarn - Credit Suisse
So to Eric's point before, Q2 through Q4 will see revenue recovery and things like Boeing OE and in retrofit and elsewhere, but not in biz jet really.
Amin Khoury
You'll see... biz jet revenues in the first quarter are particularly bad. They come back in the second quarter, but are still much lower than the second quarter of 2008. And they are a little better in Q3 and Q4, but not nearly as good as Q3 and Q4 of 2008.
So it's relative. We are saying the first quarter is going to be particularly bad for that business. And while the second, third, and fourth quarters are going to be better in biz jet, they won't be nearly as good as 2008 reflecting the lower level of shipments of biz jet or business jet by the OEs this year.
Robert Spingarn - Credit Suisse
Okay. And then just the only other thing I wanted to ask you is about inventories. You talked about having almost completed your migration of inventory. But to the extent that we've seen a lot of older aircraft grounded and utilizations are going down, do you have in the business anywhere any inventory obsolescence... are there any part numbers or areas of product that are new to you from HCS, which are little bit more exposed to the suite adjustments?
Amin Khoury
We don't buy long for platforms that are scheduled for retirement. So we are very, very careful about that. Tom, maybe you want to address that question.
Thomas McCaffrey
Yeah, it... Rob, as we talked about in the past, we look very carefully at that when we looked at HCS and as well as our inventories throughout the year. And we don't... we just don't see that as an issue .
Robert Spingarn - Credit Suisse
Okay, thank you both.
Thomas McCaffrey
Okay.
Operator
Karl Oehlschlaeger now joins from Macquarie Capital.
Karl Oehlschlaeger - Macquarie Research
Hey, good morning guys.
Amin Khoury
Good morning.
Karl Oehlschlaeger - Macquarie Research
When you talk about non-discretionary being... it's a more steady business, can you talk about what's the growth rate or the change you saw in the fourth quarter was? Obviously, we had some capacity reductions; I guess the traffic reductions in November, December, like you talked about. How does the volume that you saw on that non-discretionary business sort of jive with the data that has come up from the airline?
Amin Khoury
I was trying to relate the size of our business on the quarterly basis with capacity that the airlines have. Our business... I can't do it quantitatively, Karl, but I can say that our business weakened, began to weaken in the third quarter, was weak in the fourth quarter. We announced that our revenues were down on a pro forma basis in Q4.
Our... already... we are having... we did have a pretty going good January although I'm not going to talk about any specific numbers. And our expectations is that revenues for the full year will be lower than what the revenues would have been as we not had this sort of an environment. And by lower, we are talking about somewhere in the neighborhood of 20% lower than we otherwise might have expected, that's what is in our guidance.
But as it did in the period after September 11, 2001, we owned a business; of course it was a much smaller business at the time. It was $100 million business at that time. It's now $1 billion business, and we have a dominant position in the market. But the business recovered after just two down quarters.
And so our expectation is that the business will be lower than the prior year. The order of magnitude that I mentioned, but will be better in the second, third, and fourth quarters than it has been in the fourth and is in the first.
Karl Oehlschlaeger - Macquarie Research
Okay. So just to make sure I understand, on the non-discretionary business in 2009 on a pro forma basis, what sort of change are you thinking of?
Amin Khoury
As compared to our earlier expectations for that business, we are thinking that it will be down about 17% actually from what we've earlier expected that it would be. When I say earlier, I am talking about first half of the year.
Karl Oehlschlaeger - Macquarie Research
And what sort of year-on-year change is that?
Amin Khoury
We haven't given that guidance. So I can't give that guidance on the telephone.
Karl Oehlschlaeger - Macquarie Research
Okay.
Amin Khoury
I mean the business obviously is going to have to be up because of the inclusion of HCS for the full year. What's going to happen on a pro forma basis? We've given guidance for the whole company, a $2.25 billion. We've already said that that business accounts for almost half of our business.
Karl Oehlschlaeger - Macquarie Research
Okay. And then on the distribution segment in general, you talked about how excluding some of these integration costs, it would be a 23%-plus. When we think about the trends over 2009, is that sort of number that we might be wanting to look out in the fourth quarter? Is that margin improves or is that still too risk given?
Amin Khoury
Well, we are going to be spending $15 million for acquisition, integration, and transition cost during the course of this year. And I am pretty darn sure we are going to spend every nickel of that. And it will negatively impact our margins over the course of the year. But I expect that to be more or less behind us by the end of this year.
We... as I said earlier, we are hoping that we'll be able to close down that Carrollton, Texas facility; a year ahead of our original schedule and get out of there by the end of December of this year as compared to December of next year, which was our earlier expectation. So the integration is going well, and the margins that you are seeing there are sustainable.
Karl Oehlschlaeger - Macquarie Research
Okay. And finally on the business jet segment, you thought that the first quarter being weaker like... on a sequential basis, how should we think about the top line for that first quarter? And then in terms of margin, almost a 13% rate in the fourth quarter. Is that sort of how we should think about the run rate going forward in that business?
Amin Khoury
The first quarter would be particularly weak, a dramatic reduction in revenues as compared to the fourth quarter sequential.
Karl Oehlschlaeger - Macquarie Research
Okay.
Amin Khoury
Coming back a little bit in the second, third, and fourth quarter, and that's based on scheduled shipments, which we have a lot of confidence in. And we expect the margins to be pretty good next year in that business.
Operator
Our next signal is from Davenport and Company, Carter Leake .
Carter Leake - Davenport and Company
Good morning gentlemen. On your last outlook, you talked about 2010 being about 2009. Does that... I don't see in this current release, can you comment on that?
Amin Khoury
We are going to give some quantitative guidance on 2010 later in the year. I don't think we really want to talk about 2010 right now. We don't have... ours view is positive. I did mention in our prepared remarks that we expect the next couple of years to be pretty good. But I think quantitative guidance on 2010, I think we are comfortable talking about in the middle of this year.
Carter Leake - Davenport and Company
And then on a retrofit push outs, the thesis is that you have not had cancellations. You've have just had deferrals, which implies that we would sort of see a catch up whether it would be '09, 2010 or even 2011. Can you give any color as to how these retrofits are going or at least with regards to cancellations on the retrofits and the CAS division?
Amin Khoury
Mike, why don't you do a little work here, Mike? I want you to talk about what's going on in the market and retrofits and cancellations.
Michael Baughan
I think to your question, Carter, I mean the... we are not seeing cancellations. At least I mean really to any material degree, we're not seeing cancellations. We are seeing major retrofit program stretch out. And at this point, I think we've got agreements with our major customers on what the schedules are. And so we think we know what that looks like. But the impact of that is to move major retrofit programs really from 2009 into the 2010 and 2011 period.
That could continue to shift. But at this point, we think we know what it is, and we think we've got agreement with our major customers on those kinds of programs. I will remind people that the reasons for these retrofit programs is to improve yields or to reduce operating costs or to reduce weight and fuel burn. And so those economic drivers are still very much intact. And so airlines want to continue with these retrofit programs. And so the extend that they've started with them, they have a high interest in completing them and having commonality within their fleet.
We are seeing continued delays in the 787 delivery schedules, and that's starting now to firm. So we are seeing push back from 787 and A380 that are also impacting our 2009 sales, and putting proportionally more of that into the 2010 and 2011. So that's what we are seeing in terms of cancellations.
To speak a little bit more generally, Amin, in the prepared remarks talked a lot about the negative developments that we continue to see in the environment in terms of traffic declines, in terms of capacity declines, and the continuation of weakness in the business jet the segments.
Those are sobering developments, and I think we've commented on those quite extensively. I would say that there are some encouraging signs in the market. Some things that we do see that are on the positive side. One, Amin touched on, is that it's notable that the U.S. airlines are projecting a profit in 2009; that's significant.
They really have taken the appropriate steps to address the root cause issues of over capacity. They've gotten their pricing up. And with the help of lower-cost oil, they have been successful in staying out in front of the curve. There has been a 40-year downward trend in airline yields, and that's reversed itself in the U.S. market. So, yields have actually improved about 10% in the last two years.
And that improvement in yield doesn't only help the long-term viability of the U.S. airlines. It also plays to the strength of our development capabilities. Many of our products are designed not just to reduce cost of ownership, but to improve and provide significant top line benefits to the airlines. And so the highest yielding carriers in the U.S., United and Continental, have accredited their reduced capacity, their higher pricing, their increased ancillary revenues, but also the positive benefits of our products as important drivers to improving yields.
I think we are seeing very strong interest still in the new airframe platforms of the future. So we are not seeing cancellations for instance in terms of 787 or A350. Boeing still has about 900 aircraft in its backlog for 787. The A350 backlog is about 500 aircrafts. And as Amin has commented earlier, those and another new platform of the future have provided us $2.3 billion in un-booked backlog and a constitution entirely new source of SFE revenue for our company.
And I guess maybe, just lastly I would say that these challenging economic conditions are impacting our competitors at least as much as they are impacting us. And I think that and we think that in these kind of times its an opportunity to gain market share.
HCS is clearly one such opportunity. We are really pleased with the customer reactions of the acquisition. And as we brought them on to our stocking distributor model, we have seen a improvement in service rates for the traditional HCS account, and a significant increase in customer satisfaction. So while these are tough times, I see no reason why we can't emerge from this current recession stronger than when we went in.
Carter Leake - Davenport and Company
Great, thank you for that detail. If I may get one more question, if you can, can you give any color on military aircraft aftermarket, any thoughts on that?
Amin Khoury
I will tackle that, because our military aftermarket is primarily in the consumables business. And that represents about 20% of our consumables business; that's not down at all. So, it's actually held steady right through the third and fourth quarters, which one would... we expect. And that's another one of the differences I think between mix of our business today compared to what's the mix of our business look like after September 11, 2001. We are just a totally different company now.
And in response to Karl's question earlier about margins, we don't expect margin decline either of the commercial aircraft segment or biz jet business during the coming year; that is our objective. It's to hold the margins up by managing costs. And all the work that we are doing that I mentioned during our remarks in improving our processes and leaning out our business in a low cost country, sourcing, and all of the things that we are doing, reducing headcount and having reduced our fixed cost structure earlier, we are expecting to be able to hold our margins at very healthy levels in both of those businesses right through this year with the exception of the weaker first quarter, which I mentioned.
Operator
Our time allows for one final question, from Howard Rubel, Jefferies.
Howard Rubel - Jefferies & Co.
Thank you very much. Amin, could you talk a little bit about inventories. It seems to me that if the Boeing strike caused a back up in product shipments and there is what I'd call the market declining a little bit faster than probably incoming shipments in the consumables area that you should be able to do a little bit better as the markets stabilize in terms of generating cash for the year. Could you address that, please?
Amin Khoury
I am going to ask Mike to address, Mike and Tom, to address inventories in commercial aircraft segment and the biz jet segment, and I will address inventories in the consumables management segment. And Tom, would you have a got first? And then Mike you can join then. And then we'll all take a crack at answering Howard's question.
Thomas McCaffrey
Sure. Howard, I think one,this is a reminder to everyone that one of the key metrics, which we link our incentive compensation to this cash flow. And obviously managing working capital evolves in period that gets patent attention on it. It's got management's attention. It's a critical component of each of the business plans and then in the commercial aircraft and business jet segments, they are fully aware that what their targets are. And their targets are to bring their inventory levels down this year consistent with what their scheduled deliveries are and anticipated demand. So they are sort of all over that.
Mike, is there anything you want to add?
Michael Baughan
Well, I would say that in addition to being aware that we are working at really hard, we have our corporate lean team that's very well developed. We are really encouraged with the results that we're seeing on the lean and continuous improvement from last several quarters. But each of the... the lean team and each of the general managers work inventory very carefully.
We've got our folks out in our major facilities doing high zone (ph) events rebalancing lines, optimizing the shelf floor. And we started to see improvement in terms in many of our manufacturing businesses. So I think that there is a complete engagement on that issue. And our management has compensated as that being one of the metrics going forward.
Amin Khoury
On the consumables side, Howard, we are almost home but we are not quite there. I think I mentioned during my prepared remarks that we were going to have to add to our inventory levels to the tune of about $75 million over the course of this year. So we haven't been able to get everything in that we needed to get in. But we've done well, and that is reflected in the improved margins in the fourth quarter in that business as the inventories that we've gotten in.
That has also reflected itself in very much improved customer satisfaction. I mean the customers are really happy with what we are doing. And that's giving us the ability to improve our profitability and improve the pricing on some of the really nasty contracts, which we had, very lower margin contracts.
So we will add another $75 million so in the distribution business, because that's what we need to do. That is how our model works. Supplies measured on return on tangible assets in the business. So their compensation scheme is there. I talked a moment ago about profitability in that business and one of the reasons that we are turning in that profitability is because we are making progress on solving customer problems, which is reflecting itself in improved margins in the JIT contracts. And its impact is reflecting itself in margins overall. And our expectation is that that's going to continue over the course of this year.
Howard Rubel - Jefferies & Co.
So, you are getting better buys, and also it would seem to me that if I recall correctly your original expectation for adding the inventory was substantially greater was the 125 to 150 million. So there are some things here that are not all negative in.
Amin Khoury
I think it's anything, but negative. I mean when we face the downturn after the events of September 11, we are basically a company which was primarily after market retrofit domestic orientated business with a relatively small spares business.
Now half of our business is a non-discretionary consumables business, which is a high margin business where we are dominant in the business. Our spares business and the commercial aircraft segment business is dramatically bigger than it was as a result of this large increase and installed base that we have generated over the past several years.
Our business is geographically diversified. Our spares business is much bigger, so that even though it's down and won't recover for some period of time, it's a very significant, large and profitable business. And that business together with the non-discretionary , it's basically what we've got left now is non-discretionary. In other words, the spares business is less than CAS is basically the non-discretionary spares business.
Our consumables business is a non-discretionary business. And these OEMs are not going to be able to shp the new aircraft without the SFE equipment, which they have ordered from us. That's the $2.3 billion of non-booked backlog. So the business mix is so different than what it was in the past. And I would say the health of the non-discretionary spares and consumer business that we've got positions the company to do well right through the downturn.
So I talked about adding $75 million for inventories this year, and spending another 40 million on CapEx, and still ending the year with more than $250 million in cash. So, I mean our outlook for the business is good. Yeah, we need the consumables business to continue to do well. We need to be sure that it does recover after a couple of quarters. It looks like that is happening. There is always some risk in an environment like this, but we feel pretty good about the business.
Howard Rubel - Jefferies & Co.
And deferred taxes for the year, Tom, are you going to pay much in the late taxes given the acquisition benefits you are going to have?
Thomas McCaffrey
We will pay some cash taxes this year, Howard, but we... in terms of the year-over-year change, we haven't broken out separately that it might be in the neighborhood of $40 million or $50 million use of cash, maybe a little bit. We are still working on that.
Howard Rubel - Jefferies & Co.
I figure you'll do better the time the year is done. Thank you very much.
Greg Powell
That was our last question. Thank you everybody for joining us, and feel free to give myself a call right now if anybody has any further questions. Thank you.
Amin Khoury
Okay, thanks everyone. Good morning.
Operator
Ladies and gentlemen, this concludes today's B/E Aerospace conference call. Thank you again for participating in the call.
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