Executives
Greg Powell – VP IR
Amin Khoury – CEO
Thomas McCaffrey – SVP & CFO
Michael Baughan – President & COO
Analysts
Robert Spingarn - Credit Suisse
Howard Rubel - Jefferies & Co.
Gautam Khanna - Cowen and Company
David Strauss - UBS
Myles Walton – Oppenheimer
Troy Lahr - Stifel Nicolaus & Company
J. B. Groh - D.A. Davidson & Co.
Patrick McCarthy - Friedman, Billings, Ramsey & Co.
Eric Hugel - Stephens
Peter Arment - American Technology Research
Carter Lake – Davenport & Company
B/E Aerospace, Inc. (BEAV) Q1 2009 Earnings Call April 27, 2009 9:00 AM ET
Operator
Good morning. At this time, I would like to welcome everyone to the B/E Aerospace first quarter 2009 earnings conference call. (Operator Instructions) As a remainder ladies and gentlemen, the conference is being recorded this day, April 27, 2009. I would now like to introduce B/E's Vice President of Investor Relations, Greg Powell. Mr. Powell, please begin.
Greg Powell
Good morning and thank you for all of you joining us this morning. Today we are here to discuss our financial results for the first quarter ended March 31, 2009. 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 this morning from Amin Khoury, Founder, Chairman, and Chief Executive Officer of B/E Aerospace and then we will take your questions.
For today's call, we have prepared a few slides to help you follow our discussion. You can find our presentation on the Investor Relations page of the B/E Aerospace website at www.beaerospace.com. In addition, copies of the slides will be posted on our website for you to refer to after the call.
Joining us this morning for the call are Mike Baughan, President and Chief Operating Officer, and Tom McCaffrey, Senior Vice President and Chief Financial Officer.
As always in our prepared remarks and our 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 filings with the SEC. We will address questions following our prepared remarks.
And now I would like to turn the call over to Amin Khoury.
Amin Khoury
Thanks Greg and good morning everyone. This morning I’d like to discuss the current macroeconomic environment, and the expected impact it will have on our business. Then we will review our first quarter financial and operating results. I’ll ask Michael Baughan to update us on current market activity, and the recent Hamburg Interior Show. And finally we’ll discuss our guidance for 2009.
First let’s discuss the current market environment, the global recession has deepened, but there are signs that we may be approaching a bottom. Capital markets do remain dysfunctional by are beginning to show some glimmers of improvement. Consumer spending however remains very weak.
These factors are all negatively impacting global air travel and demand for new commercial aircraft and business jets. The weakened global economy has caused industry conditions to continue to worsen. International passenger traffic declined by more then 10% in February, 2009 compared with February, 2008.
Premium traffic was down sharply, declining nearly 20% in the two-month period ended February, 2009 compared to the prior year period. International cargo traffic, which began falling in June of 2008 took a further steep decline of 23% in the latest three-month period ended February compared to the same period a year ago.
Air freighters are now being parked at unprecedented rates and demand for passenger to freight or conversion is expected to be soft for the foreseeable future. The resulting lower yields for the global airline industry are causing our customers to increase the numbers of parked aircraft, to further defer new aircraft deliveries and to institute tough cash conservation measures.
In addition, business jet manufactures have reduced delivery rates, in some cases by up to 40%. We believe the major commercial airframe manufactures will further reduce their delivery rates in 2010.
We’ve responded to this new further downdraft and industry conditions by initiating further cost reduction efforts. Steps we are taking while painful, effecting employees and their families, are necessary and are expected to enable the company to protect its balance sheet and cash flow 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. We are the global market leader with number one market shares for essentially every product category in which we compete and we are the largest and best aerospace consumables business in the world.
We are using the current period to strengthen our business processes from shop floor through the executive suites. These actions including the strengthening of our liquidity position and the transformation of our business mix provide management with a higher level of confidence that we will be able to successfully navigate our way through the current downturn and emerge as a stronger company.
Moving now to our first quarter results, the first quarter of 2009 presented a number of challenges including retrofit program deferrals and substantially lower commercial aircraft segment spares and consumables revenues. Spares and consumables revenues, which are among our most profitable products, were depressed due to reduced air travel, reduced fleet capacity as a result of aircraft groundings, and airline cash conservation measures.
First quarter spares and consumables orders were off by approximately 28%, which is comparable to the decline in first quarter spares orders reported by other global commercial aerospace companies.
Let’s turn to slide two and review our financial results for the first quarter of 2009. The bar chart on slide two graphically illustrates our first quarter 2009 financial performance versus the first quarter of 2008. First quarter revenues increased by 11% to $524 million. Revenue growth reflects the inclusion of the HCS business which we acquired during the third quarter of 2008.
Pro forma revenues including the HCS results in both 2008 and 2009 declined approximately 16%. Operating earnings of $81 million increased 4%. Operating earnings and operating margin exclusive of AIT costs were $84 million and 16.1% respectively. AIT costs are acquisition, integration, and transition costs associated with the HCS transaction.
Including the HCS acquisition in both periods, and excluding AIT costs in the current period, first quarter 2009 adjusted operating earnings of $84 million declined 9% as compared with first quarter 2008 pro forma operating earnings of $93 million.
Net earnings were $38 million or $0.38 per diluted share. Net earnings adjusted to exclude AIT costs were $40 million or $0.41 per diluted share.
Slide three summarizes our current backlog. Bookings during the first quarter were approximately $475 million, a book to bill ratio of 0.9:1. Backlog at the end of the quarter was approximately $2.8 billion, an increase of approximately 22% as compared with the company’s March 31, 2008 backlog but approximately 3% lower then backlog at December 31, 2008.
In addition the pie chart on slide three indicates that the backlog continues to be very well balanced geographically with 55% of backlog being with international customers. The impact of the global economic crisis on our customers has negatively impacted demand for new aircraft, for retrofit, and particularly for spares and consumables.
Lower corporate profits, dysfunctional capital markets, and negative political commentary regarding corporate offsite meetings and business jet utilization, have also impacted demand for both air travel and business jet.
These conditions will likely continue to impede bookings activity during the balance of 2009. While the near-term prospects for major new buy or retrofit programs appears to be at [trough] levels, we are pleased with the success of our strategic OEM direct or supplier furnished equipment focus which substantially increases or revenue content per aircraft.
These successes include awards for our next generation galley, Airbus 350 XWB, our patented passenger oxygen system for the A350, our oxygen/PSU award for the Boeing 787, our new LED cabin lighting systems award, and our new vacuum waste management systems awards.
The value of the long-term OEM direct program awards which we have won, now totals over $2.3 billion, only a very small portion of which is included in the company’s backlog. Our backlog of $2.8 billion along with unbooked SFE awards is in excess of $5 billion.
As we deliver our backlog, our $7.3 billion installed base is expected to grow very substantially. This increase in our installed base should eventually drive a significant increase in the size of our spares business.
Now I will briefly review the operating performance for each of our business segments, let’s turn to slide four, and review the first quarter results for the consumables management segment. Including the HCS acquisition in both periods, revenues were $239 million, or 11% lower then 2008 pro forma revenues of $269.4 million.
Operating earnings which include $3.7 million of AIT costs were $47.4 million. Operating earnings adjusted to exclude these costs were $51.1 million or 21.3% of sales as compared with 2008 pro forma operatings of approximately $51 million or 19% of sales.
Adjusted operating margin expanded 240 basis points as compared with prior year pro forma operating margin primarily due to lower margins in the HCS business in the prior year period, more efficient purchasing the current period, and initial synergies arising from the HCS acquisition.
Let’s turn to slide five and review the first quarter results for the commercial aircraft segment. Revenues of $225.9 million decreased 19% reflecting retrofit program push-outs and lower spares revenues. Spares revenues in the current period declined significantly due to reduced air travel, reduced fleet capacity, and airline cash conservation measures.
Operating earnings for the 2009 period were $28.5 million, or 12.6% of sales, an increase of about 130 basis points as compared with the same period in the prior year reflecting improved manufacturing efficiencies and successful cost reduction activities partially offset by an unfavorable mix due to the lower levels of spares revenues.
Let’s turn to slide six and review the first quarter results for the business jet segment. Our business jet segment generates about 10% of our revenues and unfortunately its outlook is quite negative and is expected to recover later then our two major segments.
Revenues decreased by $14.3 million or about 19.7% to $58.4 million. Operating earnings decreased by $5.8 million on the $14 million reduction in revenues reflecting the negative impact of reduced operating leverage and an unfavorable mix of product sold in the 2009 period as compared to the same period in 2008.
Please now turn to slide seven which reflects our financial position as of March 31. We have a solid capital position and our liquidity is strong. As of March 31, 2009 cash on hand was $115 million and there were no outstanding balances under our $350 million revolving credit facility.
During the quarter the company successfully completed its initiatives to bring the HCS inventories in line with the B/E Aerospace stocking distribution model. The investment in inventories at the consumables management segment was the principal reason for the use of cash during the quarter.
We expect to generate positive free cash flow for the balance of the year. We have two maintenance debt covenants, interest coverage and a total leverage debt. Our interest coverage was 5.45x versus a covenant of 2.25x and our leverage ratio was 2.29x versus our covenant of 4.25x.
As you can plainly see we have very substantial covenant headroom, more then ample liquidity, a $350 million undrawn revolver, and no maturities of any debt until 2014. In addition, S&P recently affirmed the company’s BBB minus corporate credit rating.
Now I’d like to ask Michael Baughan to jump in and provide you with some color related to current market dynamics and the recent activity associated with our successful efforts at the Cabin Interior Show in Hamburg, Germany.
Michael Baughan
Thanks Amin and good morning, as many of you know the annual Hamburg Interiors Expo is a premier marketing event for our industry. Airline executives from all over the world gather to review new cabin interior concepts and to evaluate these offerings for their new aircraft buys and retrofit programs.
This year’s attendance was surprisingly strong both in terms of quantity and quality. Traffic at our exhibit was almost as heavy as last year’s record turnout and we were able to hold detailed meetings with approximately 25 major airlines and air framer delegations, most of whom were led by the CEO, Marketing VP, or other senior management.
Two themes emerged from this year’s show, first airlines seem to be particularly focused on supporting their new aircraft buys. Over the course of the show we reviewed interiors requirements to support more then 300 ship sets of wide body aircraft, 200 of which were for the new 787 and A350 platforms.
Additionally and somewhat surprising given the current economic environment, we identified potential retrofit requirements for an addition 100 wide bodies, some of which are tied to the new buy requirements for reasons of commonality. For instance, some airlines that need to select interiors for their upcoming 787 and/or A350 aircraft deliveries, are also beginning to think through timing and budgetary requirements to upgrade existing wide body aircraft.
In several cases we discussed retrofit A330 or 777 opportunities that would bring those existing aircraft up to planned interior standards for new 787 or A350 aircraft scheduled for delivery.
The second major theme was weight, airlines continue to be very interested in weight saving solutions for both their new aircraft and existing fleet. We received strong interest for our newer weight reduced seating, lighting, oxygen systems, and food and beverage equipment products.
Additionally, we received interest from both Boeing and Airbus to potentially expand certain of our current SFE systems offerings to other aircraft platform types, which would save weight compared to incumbent systems.
In general our customers seemed willing to separate their concerns about the current economic environment from their longer-term requirements to equip their new and existing fleets with the most innovative and competitive interior products possible.
The revenue profile for most of these opportunities begins in the 2011 to 2013 timeframe with bookings starting in 2010. I’ll now turn it back over to Amin.
Amin Khoury
Thanks Michael, I’d like now to spend a few minutes discussing our outlook and our guidance for 2009. For all the reasons I mentioned earlier, we expect global economic conditions to negatively impact our customer base for at least the remainder of 2009.
Airlines have implemented stringent cash conservation initiatives resulting in substantially lower order levels for spares and consumables. First quarter order rates for commercial aircraft segment spares and consumables were off by about 28%.
However despite current market conditions, we believe we’ve positioned the company well for the downturn, we’ve responded quickly and decisively to reduce our cost structure and despite lower near-term revenue expectations, we do expect to be able to maintain our operating margin aided by the consumables management and commercial aircraft segments.
Margins in the consumables management segment, are expected to be aided by the successful execution of our HCS integration efforts while the margins in the commercial aircraft segment are expected to be helped by our global sourcing initiatives, stringent cost controls, and our continuous improvement initiatives.
Our balance sheet is healthy, we have no debt maturities until 2014. We believe that our strategic business decision to alter our business mix so that more then half of our business is driven by demand for consumables and spares, along with our strategic focus on OEM direct or SFE programs, will have a profound positive impact on our business in the future.
We believe that 2009 will be the trough year for B/E Aerospace bookings, backlog, and earnings. Our expectation is that there will be an improvement in order rates and sales for our consumables and commercial aircraft segment spares businesses in 2010 and that beginning in 2010 there will be a strengthening in orders and an expansion of our backlog due to the conversion of SFE program awards which we have already won, to purchase orders, which will drive revenue growth in 2011 and beyond.
Nevertheless until we see order rates and shipments for consumables and spares improve, it is unlikely that quarterly earnings will exceed the first quarter 2009 levels. Let’s turn to slide 10 where we can review our 2009 guidance.
In 2009, the revenues are now expected to be approximately $1.9 billion and that would be about 23% lower then 2008 pro forma revenues giving effect to the inclusion of the HCS business for all of 2008.
Net earnings per diluted share are expected to trough in 2009 and our expected to be approximately $1.50 per diluted share excluding AIT costs of approximately $0.10 per diluted share, reflecting deterioration in mix due to lower sales of commercial aircraft segment spares, and consumables.
The company has now successfully completed its investments in consumables inventories to bring HCS in line with the B/E Aerospace inventory stocking distribution model. As expected, these investments resulted in a substantial use of cash during the first quarter.
Despite the planned use of cash in the first quarter and the company’s somewhat lower financial guidance, the company continues to expect positive cash generation for the balance of the year.
The company expects a book-to-bill ratio below one and a decrease in backlog during 2009, but expects an expansion in orders and backlog beginning in 2010 due to an expected rebound in demand for consumables and spares, and due to the conversion of unbooked SFE awards to bookings.
With that we are now ready to take your questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Robert Spingarn - Credit Suisse
Robert Spingarn - Credit Suisse
Over the course of the last six or eight months, you’ve reduced revenue guidance three times, I think by about $900 million from $2.8 billion to $1.9 today and then earnings two times. The revenue guidance decreased I calculated about 32%, the earnings about 47%, could you talk about that 32% revenue down tick from a segment perspective what your assumptions are there, where I suspect you’re seeing the heaviest impact in biz jet.
Amin Khoury
Well biz jet is the smallest of our businesses, but there has been a significant decline and I don’t have the quantitative data here to look at the segment revenue reductions from the peak in the middle of last year to the current time. We can do that together but I think that the biggest issue which you pointed out was the more rapid decline in operating earnings as compared to the decline in revenues and that is primarily a function of mix.
Sure there is some negative impact on absorption from reduced volumes in the manufacturing facilities but the principal issue is the reduction in mix and the reduction in the sales of our spares, commercial aircraft segment spares, and our consumables revenues have a disproportionately negative impact on earnings in the company.
And that is the major reason for the difference between the first quarter actual earnings results and the expected somewhat lower earnings on a quarterly basis for the balance of the year. The fact is, that the order rates for those profitable products were lower then the revenue rates. We will take a look at the quarterly decline in revenues and earnings by segment beginning in the second quarter of last year and get back to you with some, a more quantitative answer, I just don’t have that data in front of me right now.
Robert Spingarn - Credit Suisse
Maybe I should take a shot at it a slightly different way, so the $300 million or so decrease in revenue guidance today, just today’s piece, that is if I understand you correctly mostly in the consumables business.
Amin Khoury
Its both commercial aircraft segment and consumables.
Robert Spingarn - Credit Suisse
And then you mentioned order rates, the book to bill in the quarter was 0.9, $475 million in orders, we last saw you and you affirmed your guidance back on February 20, so I’m guessing you booked quite a bit of that, was the first quarter order number front ended, did things fall off a cliff in March and April, is that how we should think about it.
Amin Khoury
I don’t know about falling off a cliff, but order rates have continuously declined over the past three or four months and more importantly, order rates for our spares and consumables have declined more rapidly then order rates for, the book to bill in the consumables and spares business has been lower then the 0.9 number for the company overall.
Robert Spingarn - Credit Suisse
Okay and it sounds like you’re expecting that the $475 million in orders in the first quarter won’t be repeated. It will be lower going forward at least for a while.
Amin Khoury
I think that the order rate might be 0.9 or somewhat lower then that. For sure, I think we expect to have a book to bill which is less then one on a quarterly basis throughout the year and for the full year. Its hard to anticipate exactly what orders might look like on a quarterly basis going forward but our expectation here is that 0.9, I don’t think its going to get too much worse then 0.9 but it might be somewhat worse.
Robert Spingarn - Credit Suisse
But if you could maintain the $475 million number or in that neighborhood, would there be upside to your forecast, what I’m trying to get at is how conservative your forecast is at this point. You told us on February 20 during the Q&A that while you felt good about the numbers you put out then, you realized there could be another leg down, we’re now there, do you feel the same way or a little bit more comfortable that we’re near bottom today.
Amin Khoury
I think we’re near bottom today and I think we’ve, you know this is not a comfortable thing for us to do, to have to reduce guidance and we are trying not to have to do it again. So I think we’ve taken a pretty conservative approach. I think we are at the bottom and I think what’s driven us to the bottom is the inventory destocking in commercial aircraft segment, spares and consumables. I don’t think that that can continue indefinitely.
So we expect that to begin to rebound in 2010 and I think we’re at the bottom right now. We surely expect orders and the backlog to recover in 2010 because I think there needs to be, we’re highly confident there will be a rebound in spares and consumables orders in 2010 and we will have the conversion of this unbooked SFE backlog, a portion of it to orders, in 2010.
So in 2010 our bookings and our backlog will for sure improve as will revenues and earnings from consumables and spares. With respect to the rest, its hard to anticipate.
Robert Spingarn - Credit Suisse
You had been guiding to a cash balance at year-end I think of 250 on the basis of positive cash flow in Q2 through Q4, with the lower guidance how does that adjust.
Thomas McCaffrey
Well I think you saw in our release what we’ve guided to, is that we expect we will generate positive cash flow for the rest of the year. We’ve, Amin mentioned in the prepared remarks that we’ve now successfully completed our investments in the consumables inventory effort to bring HCS in line with our stocking model and those resulted in a substantial use of cash during the quarter.
So, despite the substantial use of cash in the first quarter and our somewhat lower guidance we continue to expect positive cash generation for the balance of the year.
Amin Khoury
We expect a significant increase in cash but we don’t want to give you a number at this time.
Operator
Your next question comes from the line of Howard Rubel - Jefferies & Co.
Howard Rubel - Jefferies & Co.
I am going to push you a little bit more on cash, I mean we’ve had this conversation a couple of times and my understanding is a big chunk of your incentive comp is tied to what you’re going to do with cash so does this mean that by dialing this back that you’re not going to make that portion of your incentive comp.
Amin Khoury
Yes.
Howard Rubel - Jefferies & Co.
And then how much in the quarter was severance and other restructuring costs because you did point out some of the positives related to the integration of HCS, because that clearly also gives us indication of some of your other operating leverage opportunities.
Thomas McCaffrey
The acquisition integration transition costs in the quarter were $3.7 million.
Howard Rubel - Jefferies & Co.
Right but outside of that, clearly you’re downsizing the business and there’s some costs from either an administrative point of view or whatever from restructuring the business, severance and so on, is that fair or is that just going to be spread out throughout the balance of the year.
Amin Khoury
There was some costs but we didn’t highlight or separate it, we just ran it through the income statement. Its probably not more then another million dollars and you will continue to see that throughout the balance of the year. We’ll take a look at it in Q2 or Q3 because we are going to have another major decrease in our costs, but the cost decreases through severance are going to be weighted heavily from here on in to the consumables business.
Second, third and fourth quarter headcount reductions in the consumables business will be significant.
Howard Rubel - Jefferies & Co.
And then just last thing on consumables, you’ve probably have gotten some pricing, the military business should be helping matters a little bit, so if we kind of looked at what I call core commercial business, the 11% down is really more then that, isn’t it?
Amin Khoury
Yes. As I mentioned earlier, orders declined at a more rapid rate then revenues declined and the book to bill in our spares and consumables businesses was substantially less then the book to bill for the company overall. So the outlook for our business is somewhat lower revenues on a quarterly basis for the balance of the year and the lower revenues on a quarterly basis are weighted towards lower revenues from consumables and spares.
Operator
Your next question comes from the line of Gautam Khanna - Cowen and Company
Gautam Khanna - Cowen and Company
In the past you’ve talked about the difference between nondiscretionary and discretionary spares, how, can you break down the 28% spares order decline in the quarter by its component pieces, the spares in commercial aircraft versus order rates at the distribution center.
Amin Khoury
Everything was down, and it was down more or less approximately the same. Biz jet manufacturing is obviously, was hit hard. Same with the subcontract manufacturers for the major OEs. I mean there’s a major inventory destocking that has been going on with everyone trying to conserve cash and to try to reduce inventories in anticipation of lower production rates in 2010 for the major OEs, much lower rates for the biz jet manufacturers.
That’s true whether its transactional business, overnight business to MROs which had less activity. There was deferred maintenance, optional maintenance hasn’t been going on, and there’s been an inventory destocking. So its pretty much across the entire industry whether its airlines or MROs or biz jet manufacturers or subcontract manufacturers to the major OEs.
Orders were down in every category as folks tried to utilize the inventories they had and conserve cash.
Gautam Khanna - Cowen and Company
I guess what I’m wondering is before we discussed I think commercial aircraft spares typically turned down or they did in the past for 10 straight quarters due to destock. Distribution was a little bit, I think it was only two quarters, are we now two quarters into that at least a destock effect will decline, will be abating over time and we’ll just go back to reduced demand levels, or do you—
Amin Khoury
We don’t know for sure and we’ve tried to be conservative here. If you remember Rob’s question earlier, so we’ve said we expect an uptick in orders for consumables and spares in 2010. It may happen sooner and if it happens sooner, earnings might be a little better on a quarterly basis but I think that I think given where we are in the cycle and given the fact that we believe we’re at the trough, I think the likelihood is that things will get better not worse.
But we don’t want to forecast an improvement until 2010 at this point.
Operator
Your next question comes from the line of David Strauss - UBS
David Strauss - UBS
You talked about that you expect manufacturers to bring down their production rates further, could you just give some color there what you’re thinking and when you’ve guided to that 2009 is the trough, what are you therefore thinking about in terms of production rates and how that impacts your earnings in 2010.
Amin Khoury
Well given our market shares, any decrease in production has got to negatively impact our business, 777 reductions of 30% are not a positive thing for us albeit that a substantial portion of that is freighters, almost half of it.
But we generate a lot of revenues with wide body deliveries. Our expectation of the major OEs bringing down their delivery rates again is really a function of what we see in the environment as we talk to our customers all over the globe and as we see, as we, for example Michael talked the meeting and we think about when folks are planning to place orders, it just feels to us like there’s another cut coming in 2010.
That’s not the biggest impact on our business. The biggest impact on our business is basically deliveries from the backlog and deliveries against the unbooked backlog which we have which in the aggregate are $5 billion. And of course the second important thing is consumables and spares which we’ve now talked about in response to two or three different questions on the call.
So the decrease in delivery rates is not as big a factor in our thinking relative to the 2010 period which we talked about earlier. Does that answer your question?
David Strauss - UBS
Yes, I guess I’m just trying to get a little bit more substantive, are you talking when you say another cut, are you seeing wide bodies are going to go down more or are you expecting narrow bodies to be also cut as well.
Amin Khoury
Yes, we think both are going down.
David Strauss - UBS
And then just to clarify on cash, when you say positive cash generation for the balance of the year are you talking operating cash flow, free cash flow and then are you seeing you’re going to be positive for the full year 2009 or just the last three quarters of 2009.
Thomas McCaffrey
Our guidance has been for free cash flow, always has been, and we’re saying that we will be positive free cash flow for the balance of the year.
David Strauss - UBS
Okay so for the last three quarters.
Amin Khoury
Yes and that our cash balance at the end of the year will be higher then it is now.
Operator
Your next question comes from the line of Myles Walton – Oppenheimer
Myles Walton – Oppenheimer
I had a question with respect to consumable spares mix again, I guess you had mentioned a lower revenue for the remainder of the year from here would be weighted towards lower revenues in that area but I think also assuming the guidance is some level of margin expansion, expansion from 1Q, just hoping you could flesh out some of the color that would help you get those margins up from 1Q.
Amin Khoury
Well it will be an effort to do that. We actually did generate pretty good margins in the first quarter given the decline in revenues on a pro forma basis which we talked about earlier being about 16% and given the deterioration in mix. It was I think a pretty good result to be able to take cost out so quickly in the commercial aircraft segment and to improve the margins in the consumables business and to be able to deliver a higher margin for the company overall.
We’re hoping and we believe that we’ll be able to maintain margins for the balance of the year aided by continuing significant cost reductions in the consumables business as we substantially reduce headcount and continued I think excellent performance in our supply chain and continuous process initiatives in the commercial aircraft segment.
So its not a function so much of increasing margins on a quarterly basis and the balance of the year although there might be a little bit of increase, its really a question of maintaining those margins in the face of somewhat declining revenues on a quarterly basis over the balance of the year.
Myles Walton – Oppenheimer
I know its really early on this one, but the pig flu in Mexico and kind of the ripple effects that could have on the industry and just from where you sit, what do you looking, or how are you planning your business relative to what you’re seeing today and what you expect to see over the next few weeks and months.
Amin Khoury
Well you know there are mixed results in different states and countries depending upon where the swine flu has been detected. The only deaths have been in Mexico and there have been 80 deaths and I think they have diagnosed 1,300 I think cases. No one knows how many cases there were before they began diagnosing the swine flu. It might be 80 deaths out of 100,000. We just don’t know. But there hasn’t been any deaths in the US yet.
I think if there are deaths in other countries, it could be a significantly negative impact on air travel and revenue passenger miles. I think its too soon to predict that. We did go through the SARS incident in 2002 or 2003, I don’t remember exactly which year it was, and it did significantly reduce air travel particularly in Asia.
So its too soon to tell. We’ve been thinking about it, we’ve been talking about it. I’ve spent a lot of time reading about it over this past weekend and trying to understand it. I think that anything that we can say here would be truly speculation but I expect that there will be some negative impact in air travel, I don’t know how much, beginning almost immediately and I think the extent of the decline and the duration of any decline will have to do with the severity and if there are no deaths reported in the US or in any countries other then Mexico, I think it will be short-lived and not very steep.
Operator
Your next question comes from the line of Troy Lahr - Stifel Nicolaus & Company
Troy Lahr - Stifel Nicolaus & Company
I was wondering if you could talk about the consumables management business a little bit and just the margins quarter over quarter. You had slightly higher volumes but excluding the integration costs, it looks like your margins went from 23.9 down to 21.3, can you just give me a little more color on the quarter over quarter change in the margins.
Amin Khoury
The fourth quarter of the prior year compared to the first quarter of this year?
Troy Lahr - Stifel Nicolaus & Company
Yes,
Amin Khoury
Its just a function of mix, that’s a function of having overnight transactional business down which is a larger business and it’s a higher margin business so our margins declined compared to the fourth quarter but were up compared to the first quarter of last year.
Margins are pretty good, margins are holding up and are expected to continue to hold up or improve as we take costs out.
Troy Lahr - Stifel Nicolaus & Company
And integration costs still about maybe $11 million in the back part of the year over the next three quarters, is that kind of what we should expect?
Thomas McCaffrey
Yes.
Troy Lahr - Stifel Nicolaus & Company
And have you seen any major retrofit programs cancelled or are we still just seeing deferrals.
Amin Khoury
We don’t have any major retrofit program cancellations but there have been a number of deferrals. Michael any comments you want to make there?
Michael Baughan
No, that’s correct Amin.
Troy Lahr - Stifel Nicolaus & Company
And then just on that front, are you seeing, if you just look over the past couple of weeks, has the pace slowed in people requesting deferrals, or is the activity still pretty aggressive there.
Michael Baughan
We haven’t had any recent retrofit deferrals, the deferrals we’re talking about have happened a while back and have been replaced into our schedule. I would say going back to the Hamburg conversations, there’s some longer-term interest that surprised us, the strength of that interest in retrofit planning, that’s longer-term and its associated with in most cases, commonality with new aircraft buys, 787 and A350.
But there has not been any acceleration of retrofit deferrals or anything like that.
Amin Khoury
There’s no new negative news on retrofit deferrals to report.
Operator
Your next question comes from the line of J. B. Groh - D.A. Davidson & Co.
J. B. Groh - D.A. Davidson & Co.
Just a couple of housekeeping issues on the income statement presentation, in terms of SG&A that bounced up a little bit in the first quarter from Q4, was there any one-time costs in there associated with the severance and that kind of thing and then on R&D, what are we sort of looking at in terms of percentage of sales for the year.
Thomas McCaffrey
On SG&A, in absolute terms it grew by about just $16 million. The higher SG&A in the quarter was a result of the HCS acquisition and about $3.7 million of the acquisition related costs. And nearly $4 million of negative FX in the quarter. On a quarter over quarter basis, we were a beneficiary of FX in the fourth quarter. It was $3 or $4 million positive FX and so that if you’re looking at it sequentially, that’s your difference in SG&A, really its FX which was a benefit in the fourth quarter and a cost in the first quarter.
In terms of R&D, you should expect R&D to continue at more or less the same level of about 5% of sales. That’s down significantly from last year’s level of 7.5% of sales but I think going forward given our business mix, you should think of about 5%.
Operator
Your next question comes from the line of Patrick McCarthy - Friedman, Billings, Ramsey & Co.
Patrick McCarthy - Friedman, Billings, Ramsey & Co.
Just two questions, first of all on the international side, could you just talk about what type of capacity cuts you’re looking at or contemplating there in your guidance for the year and then maybe if you could just compare that to what we’re seeing domestically.
Amin Khoury
Well the domestic airlines cut capacity much more quickly then the Europeans, they did it in, they did a lot of it in 2008. They cut capacity by almost 10% by the end of 2008. I think they’ll cut capacity by another 4% or so by the end of this year. And by the end of 2009 they will have cut capacity by about 14% over the 24-month period, 2008 to 2009.
The European and Asian carriers excluding China, we’ll come to China separately, the European and Asian carriers excluding China are going to get there but hadn’t gotten up to approximately the same level. We don’t know exactly where they’ll end up but they’ll get to approximately the same level but they will do more of it in 2009 as compared to 2008 because they got a slower start. And China they’re not cutting capacity utilization at all any more.
In fact they’re confirming receipt of orders again now and their revenue passenger miles are actually up so they’re starting to grow their businesses again. [Cassay] I think just a month, less then a month ago, reported they were going to take another 8% of capacity out by the end of 2009. So its spotty but its more in Europe and Asia, aside from China, then it is in the US.
The US I think will be another 4% or so and then in the rest of the world its going to be closer to I would say 7% or 8% in 2009.
Patrick McCarthy - Friedman, Billings, Ramsey & Co.
Okay so you are expecting some fairly significant cuts internationally still to come in your guidance.
Amin Khoury
Yes.
Patrick McCarthy - Friedman, Billings, Ramsey & Co.
My second question, if you look at, you’re talking about 2009 as essentially being a trough here and when you look at 2010 beginning to tick up a little bit, how much of that is the deferrals that you’ve seen starting to come in versus maybe an up tick in the order book excluding those deferrals.
Amin Khoury
We don’t expect any up tick in orders in 2010 except orders flowing out of our SFE unbooked backlog which we’ve already won. I mean we’ve won $2.3 billion worth of unbooked backlog, almost none of it is in backlog. That will begin to flow into our order book in 2010 so our orders and our backlog, our bookings and our backlog will improve in 2010. I’d be very surprised if they don’t.
The other up tick that we expect is some return to near normalcy in the level of inventories which the aerospace industry is carrying, those that have destocked consumables and spares in 2009. There will be some return to normalcy, closer to normalcy in 2010. So that’s why we expect an up tick in orders and an increase in our backlog in 2010. It pretty much has to happen because of the size of our unbooked SFE backlog.
Its not a function of airlines and leasing companies placing large additional orders for aircraft flowing into our order book which we’re thinking about as we think about the increase in orders and backlog in 2010.
Operator
Your next question comes from the line of Eric Hugel - Stephens
Eric Hugel - Stephens
Can you, going back to the R&D question, can you sort of give us sort of a breakdown or an indication, where are you spending your R&D dollars these days.
Amin Khoury
We spend our R&D dollars in commercial aircraft segment, obviously and in the business jet segment. We’ve won a billion dollar program for the A350. We’ve won a number of [inaudible] orders, we’ve won some major lighting business. We always have our seat development activities which are ongoing. We have a program that’s going on to upgrade our insert products, our beverage makers, our water boilers, all of the ovens and so on and so forth to make them lighter weight and more reliable.
So we’re basically spending our R&D dollars to maintain our market leadership positions in all of the products which we’ve, which the airlines rely on us to be the most innovative and advanced supplier of those products in the world.
Eric Hugel - Stephens
With regards to your SFE orders that you talked about and you talked about as those build you’re going to have increased market share, those are your proprietary designs so as you get installed base would you be selling the spares, sort of the maintenance, directly to the airlines or would that go through the OEM’s.
Amin Khoury
They would be sold to the airlines.
Eric Hugel - Stephens
Okay so we would expect that to be higher margin type of product as those orders came in.
Amin Khoury
Yes. Our installed base is about $7.3 billion now and that’s what generates our spares business. As we deliver against this large backlog, its about $5 billion backlog now, both booked and unbooked, our installed base should grow very substantially and our spares business should become a much larger business over time.
Operator
Your next question comes from the line of Peter Arment - American Technology Research
Peter Arment - American Technology Research
Just quickly, you’ve hit a lot of the questions but is $85 million in synergies for the HCS business still in tact or is the pace of integration, it sounds like its ahead of schedule, is there potential upside there.
Amin Khoury
Pace of integration is ahead of schedule and we expect to have the integration complete by the end of the first quarter of 2010 which is like a year ahead of where we expected it to be earlier. We have found nothing to lead us to believe that we’re not going to achieve these synergies which we expected to achieve.
Now some of the $85 million in synergies was lower cost purchases at a higher level of revenue. The revenue level is somewhat lower now. We’ll get all of the cost reduction synergies and that portion on a relative or pro rata basis that we would have gotten at the somewhat lower revenue level as compared to the higher revenue level we were talking about earlier.
Peter Arment - American Technology Research
And then just thinking about back when you troughed in 2002 and then 2003 you had a modest bookings recovery and then you saw a big upturn in 2004, but now given the size of this consumables business, how should we think about that going forward. It sounds like you’re still not calling for a big order turn next year but I would think that given the volume of this business we should see quite a bit of potential in terms of margin upside.
Amin Khoury
I think we’ll have both revenue and margin improvement in 2010. We’re hoping and expecting for a significant increase in revenues in 2010 and further significant margin improvement. We’ve got a lot of costs to take out of this business. We’re accelerating our cost reduction efforts. That’s going on as we speak and for the balance of this year we will be taking out a lot of folks so our expectation is higher revenues and higher earnings in 2010 from our consumables business.
One of the questions that was asked earlier was whether we expect our acquisition integration and transition expenses to be roughly $11 million for the balance of the year, and I think Thomas answered the question in the affirmative and that’s one thing that actually we need to check again because we’ve revised our plans again within the last couple of weeks to more aggressively take out costs and I think that that number is a pretty good number but I wouldn’t be surprised if it were to go up a little bit because we’re moving more quickly to take the costs out.
Operator
Your final question comes from the line of Carter Lake – Davenport & Company
Carter Lake – Davenport & Company
Could you please break out how much of the decline in the biz jet segment is due to super first class products and also comment on the margins in that biz jet segment if you expect that to continue at that rate going forward.
Amin Khoury
Yes, its going to be, the impact has been primarily the manufacture of product for new business jets, not a substantially lower revenue level for our super first class business. The super first class business revenues and margins are doing more or less as we expected it to do, somewhat lower but they’re doing okay.
The dramatic decline in revenues and the reduction in margin is coming from the much lower level of revenues generated in shipping products to biz jet manufacturers for new business jets. Business jet manufacturing is off by up to 40% in some instances. So that’s the decline, its really in the business jet arena and we don’t expect the margins to improve substantially nor do we expect the revenues to improve.
I think revenues might decline further which should be able to hold the margins by taking out further costs and we are aggressively cutting costs but the outlook for that business is fairly negative I would say for the next at least two or three years. So fortunately its only 10% of our revenues, unfortunately its unlikely to recover for at least the next two or three years.
Carter Lake – Davenport & Company
And can I still assume that approximately half of that segment’s revenues, its sort of a 50/50 split biz jet and super first class.
Amin Khoury
I think so, we’d have to look at it again and look at what our forecast looks like product-by-product and it may be that super first class will begin to comprise a larger percentage of revenues then the business jet portion of the business. I don’t know the answer to that right now. We will take a look at it and you’re welcomed to call and talk to Greg later in the day and we’ll take a look at our forecast and see what our expectation is vis-a-vie the two components of the business.
Carter Lake – Davenport & Company
You sort of touched on this but I want to circle back one more time, regarding the upgrade program deferrals, in the past we talked about and today we’ve confirmed, no cancellations just push-outs and then also to the push-outs were really requests of customers asking to align with their heavy checks, that would imply given how long one can defer maintenance that we should certainly see most if not all of that revenue starting to come back in in late [20 2] and all of it by 2011, is that, am I looking at that correctly. That would be revenue sort of to what Rob’s question was earlier, that would be revenue that you thought you were going to get--
Amin Khoury
I don’t think we have any retrofit program that will not be fully delivered by the end of 2012 but Michael would you be kind enough to comment on that.
Michael Baughan
Those programs were not necessarily delayed due to aligned with heavy checks, they were delayed for a variety of reasons, chiefly cash conservation measures on the part of the airlines. They’ve all been rescheduled and they’re delivering, each one different, but they’ll all be delivered by 2012. Each tail for each one is longer, its unique to the airlines. In some cases it’s a slower delivery period over a longer period of time but I think you should look at those delivering between now and mainly 2011, a little bit 2012.
Greg Powell
Thank everybody for joining us this morning.
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