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BE Aerospace Inc. (NASDAQ:BEAV)

Q2 2009 Earnings Call

July 28, 2009 9:00 am ET

Executives

Greg Powell – Vice President Investor Relations

Amin Khoury – Chief Executive Officer

Thomas McCaffrey – Chief Financial Officer

Michael Baughan – President and Chief Operating Officer

Analysts

Gautam Khanna – Cowen and Company

Robert Spingarn – Credit Suisse

Myles Walton – Oppenheimer and Co.

Christina Fernandez – UBS

J. B. Groh – D.A. Davidson & Co.

Eric Hugel – Stephens and Company

Carter Leake – Davenport & Company

[Lucy Lao] – Macquarie Capital

Colin Campbell – SG Securities

Peter Arment – Broadpoint AmTech

Welcome to the B/E Aerospace second quarter 2009 earnings conference call. (Operator Instructions). I would now like to turn the call over to the B/E Aerospace Vice President of Investor Relations, Greg Powell. Mr. Powell, you may begin your conference.

Greg Powell

Today we are here to discuss our financial results for the second quarter ended June 30, 2009. By now you should have received a copy of the news release we issued earlier this morning. If you haven't received it, you'll find a copy on our website.

We will begin with remarks from Amin Khoury, Founder, Chairman, and Chief Executive Officer of B/E Aerospace and then we will take your questions. For today's call, we have prepared a few slides 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 you to refer to after the call.

Joining us for the call this morning are Mike Baughan, President and Chief Operating Officer, and Thomas McCaffrey, Senior Vice President and Chief Financial Officer.

As always, in our prepared remarks and our responses to your questions, we will rely on the Safe Harbor exemptions under the various Securities Acts and our Safe Harbor statements in the company's filings with the SEC.

We will address questions following our prepared remarks. At that time, the operator will provide instructions. As in the past, please limit your questions to no more than two at a time so that we have the opportunity to get to all of you.

And now I will turn the call over to Amin Khoury.

Amin Khoury

This morning I would like to first discuss the current macroeconomic environment and the expected impact we expect it to have on our business. Then we will review our second quarter financial and operating results, and finally, we'll discuss our guidance for 2009 and give you a preliminary view of the outlook for 2010.

First, I'll discuss the current market environment. The global recession is beginning to show some signs that it may be approaching a bottom. And while the capital markets are actually beginning to show some glimmers of improvement, consumer spending remains very weak.

The recession continues to discourage high-yield business traffic, forcing carriers to discount heavily to fill airplanes with leisure travelers. June passenger revenue was down 26% on 7% fewer passengers paying nearly 21% less per ticket than a year earlier. That's according the Air Transport Association.

In addition to lower demand for air travel, oil prices have remained volatile and have increased significantly during the second quarter. Lower demand for air travel, a disproportionate reduction in premium travel, and rising oil prices have negatively impacted our global airline customer yield.

The resulting lower yield caused the airlines to continue to increase the number of parked aircraft, to further defer new aircraft deliveries and to institute stringent cash conservation measures including retrofit program push out, refurbishment deferrals, and widespread inventory destocking. Additionally, business jet deliveries are off almost 40% and are not projected to improve until sometime in 2012.

We've responded to these macroeconomic and industry conditions by initiating further cost reduction efforts which in turn have allowed us to maintain our margins in spite of the downdraft in demand for our products.

Over the past 12 months, we've reduced our headcount by about 20%. These steps, while painful, affecting the employees and their families, are necessary, and are enabling the company to protect its balance sheet and cash flow while at the same time allowing the company to continue to invest new products and technologies in order to expand our global market leadership position.

We are the global market leader with number one market share for essentially every product category in which we compete and we operate the largest and best aerospace consumable business in the world. We are using the current period to strengthen our business processes and these actions, including the strengthening of our liquidity position and the transformation of our business mix, provide management with a higher level of confidence in our ability to expand margins, generate free cash flow and invest in the future during the current downturn.

Let's now discuss our second quarter results. As we reported earlier, airlines, MROs, and aerospace manufacturers have all implemented stringent cash conservation measures including retrofit program push outs, aircraft refurbishment deferrals and inventory destocking, all of which caused a 30% decline in B/E Aerospace revenues during the quarter.

Despite the difficult operating conditions, we generated quarterly earnings of $0.35 per share, were able to maintain healthy operating margins and generated free cash flow of nearly $29 million during the quarter, resulting in a free cash flow conversion rate of about 82%.

Let's turn to slide two and review our financial results for the second quarter of 2009. The bar chart on slide two graphically illustrates our second quarter 2009 financial performance versus the second quarter of 2008.

Revenues of $475 million declined by about 30% as compared with pro forma revenues of $680 million in the second quarter of the prior year. Pro forma results include the acquired HCS distribution business as if the acquisition had occurred on January 1, 2008.

Adjusted operating earnings were $80 million and declined by 25% as compared with the second quarter of 2008. Adjusted operating margin was 16.8%, and expanded by 110 basis points as compared with pro forma operating margin in the prior year period.

Expected operating earnings and operating margins exclude $6 million of acquisition, integration and transition costs, or AIT costs, related to the HCS acquisition. Net earnings for the second quarter were nearly $35 million or $0.35 per diluted share. On an adjusted basis, net earnings were nearly $39 million or $0.39 per diluted share.

Slide three summarizes our current backlog. Bookings during the second quarter were approximately $400 million, representing a book-to-bill ratio of approximately 0.85:1. Backlog at the end of the quarter was approximately $2.75 billion, an increase of approximately 15% as compared with the company's June 30, 2008 backlog.

The pie chart on slide three indicates that the backlog continues to be very well balanced geographically with 56% of the backlog coming from international customers. Current market conditions will likely continue to impede bookings activity during 2009.

And 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.

During the second quarter, we announced that Boeing selected the B/E Aerospace digital light-emitting lighting system for the new Boeing "Sky Interior" for the B737. This B/E Aerospace SFE system will become standard equipment on all Boeing 737 aircraft beginning in the second half of 2010. In addition, our technologically advanced vacuum waste systems have been selected by a number of major business jet manufacturers for four next generation aircraft platforms.

These successes, as well as awards for our next generation galley systems for the A350 XWB, our patented oxygen systems for the A350 and our oxygen/PSU award for the B787 substantially increase our revenue content per aircraft on these important new aircraft types.

The value of the long-term unbooked SFE program awards which we have won totaled over $2.3 billion. Our backlog of $2.75 billion along with unbooked SFE awards is now in excess of $5 billion. As we deliver products from our $5 billion plus backlog, that's both booked and unbooked, we expect to substantially add to our current $7.3 billion install base, which in turn should facilitate growth in our spares business over time.

Now, I will briefly review the operating performance for each of our business segments. Let's turn to slide four and review the second quarter results for the consumables management segment. Revenues were $197 million or 30% lower than the second quarter pro forma revenues of $281 million.

The significant decline in consumables management segment revenues in the current period was due to a global destocking of consumables by airlines, MROs and aerospace manufacturers. Adjusted operating earnings, which exclude AIT costs, were $42 million, and that was 21.3% of sales and that's about a 200 basis point expansion in margin as compared with the pro forma operating margins in the prior year period.

Let's turn to slide five and review second quarter results for the commercial aircraft segment. Here again, revenues of $224 million decreased about 31% reflecting retrofit program push out, refurbishment deferrals, and lower spares revenue.

Operating earnings were $32 million or 14.1% of sales. Second quarter operating margin increased by 70 basis points as compared with the same period in the prior year reflecting successful cost reduction activates and improved manufacturing efficiency, at both of the major businesses, our consumables management segment and commercial aircraft segment, had nice improvements in operating margins during the quarter.

Our Business Jet segment generated revenues of $54 million and that was a decrease of $18 million or 25% as compared to the prior year period. Operating earnings decreased by $2.6 million or 29% reflecting the slowdown in both Business Jet deliveries and super first class product demand. Our Business Jet segment generates about 10% of our revenues and unfortunately its outlook is negative. Business in this segment is not expected to recover until about 2012 or as our two major segments are expected to recover with respect to orders in backlog in 2010 and with respect to revenues and earnings in 2011.

Please now turn to slide seven which reflects our financial position as of June 30th. We have a solid capital position and our liquidity is strong. During the second quarter we generated free cash flow of almost $29 million as a result of cash flow from operations of $34 million, less capital expenditures of $5.5 million.

The free cash flow conversion rate was about 82% of net earnings. In addition there were no outstanding balances under our $350 million revolver. We have no maturities of any debt until 2014, and we expect continued meaningful improvement in our liquidity position on a quarterly basis driven by continued quarterly profitability and effective working capital management.

Therefore, we expect to continue to generate positive free cash flow for the balance of the year, and to end the year with about $200 million of cash. By the way, free cash flow generation will be much stronger in the fourth quarter than in the third quarter.

Now I'll spend a few minutes discussing our outlook and our guidance. As I previously mentioned the airline industry is struggling. However, we are beginning to see some signs of stabilization in our markets albeit at a much lower level.

While it appears that inventory destocking has run its course in North America this is not the case in the rest of the world, which we believe still have approximately one quarter to go before excess stocks will have been depleted.

Overall demand for spares and consumables is expected to improve during 2010. Despite the current environment we believe that we positioned the company well. We've responded quickly and decisively to reduce our cost structure and we continue to expect to be able to maintain operating margins driven by the consumables management and commercial aircraft segments.

Our balance sheet is healthy and we have no debt maturities until 2014. We believe that our strategic business decision to alter our business mix so that more than half of our business is related to consumables and spares demand, along with our strategic focus on FFE programs, will have a profound positive impact on our business in the future.

We continue to believe that 2009 will be the trough year for B/E aerospace bookings, backlog and earnings. We further expect order rates for consumables and commercial aircraft fares to begin to improve during 2010.

Between now and the end of 2010, we expect a strengthening in orders and an expansion of our backlog through the use of the conversion of SFE program awards which we have already won to purchase work. In addition, a number of airlines are in the process of final selections for their cabin interiors for their new buy aircraft, including the Boeing 787 and Boeing 777 and the Airbus 8330.

These orders along with a general firming in retrofit awards consistent with a recent pickup in retrofit RFP activity are expected to drive revenue growth in 2011 and beyond.

Now let's turn to slide eight where we can review our 2009 guidance and a preliminary view of the outlooks for 2010. The 2009 revenues are expected to come in at approximately $1.9 billion. Two thousand nine net earnings per diluted shares are expected to be approximately $1.40 per diluted share. That's in GAAP numbers.

The company expects a put-to-bill ratio which is below one and a decrease in backlog during 2009, but expects an expansion in orders and backlog beginning in 2010 due to an expected improvement in demand for consumables and spares, a conversion of unbooked SFE awards to bookings and expected new retrofit orders.

The company expects quarterly revenues and earnings to remain approximately flat for the balance of 2009. We expect to continue to generate positive free cash flow for the balance of the year and to end the year with approximately $200 million of cash.

The company plans to use approximately $100 million of this amount for debt reduction. Revenues are expected to be about 5% lower in 2010 than in 2009, so expect revenues to come in at about $1.8 billion rather than $1.9 billion this year, primarily due to the lower level of bookings in 2009, a further significant deterioration in the business debt segment in 2010 and a lower level of new commercial aircraft deliveries in 2010. The company nevertheless expects approximately flat 2010 earnings per diluted share on the lower sales due to improved margins.

Now I'd like to turn it over to Greg to begin the Q&A portion of the call.

Greg Powell

Thank you, Amin. This completes our prepared remarks and now we'll be glad to take your questions. As usual, as I mentioned earlier, please limit your questions to no more than two at a time. Now [Jessica] will provide us with instructions on how to submit your questions

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Gautam Khanna – Cowen and Company.

Gautam Khanna – Cowen and Company

Wanted to just ask about the inventory in the quarter, it was the $51 million use, wanted to know what the split is in terms of with raw materials and finished goods, and also sort of how should we think about inventory as we look forward through the year. And also, what explains the $51 million this quarter? Are we still going to see more fastener stocking or how should we think about that?

Thomas McCaffrey

Sure, Gautam, we have completed the inventory build out in our consumables management business. The growth at consumables management during the quarter was due to open POs. We weren't – you can't just cancel POs with your suppliers on a moment's notice, so there were a number of items that were in route therewith, if you will, that got shipped, and in fact we are continuing to work with our suppliers to reschedule what were open POs for the balance of 2009 and move them into 2010 consistent with our expectations for the business.

The balance of the inventory growth in that second quarter relates to the revised 787 schedule for long lead items, and on the $2.3 billion of SFE programs that we've won, but we haven't yet booked into our backlog. So we obviously will be spending money on the new oxygen systems and lighting systems and galley and waste management systems on the 787 and 8350 and the 777 for the balance of this year and into 2010.

Offsetting those investments are concerted efforts at each of our manufacturing facilities to increase their turns with lower manufacturing stocks and so I think that you should look for our delivery rescheduling efforts to result in relatively flat inventories, the consumables management for the balance of this year.

Gautam Khanna – Cowen and Company

Okay, and just one follow-up on the 2010 guidance, you mentioned you're going to spend – or pay back about $100 million of debt early so that's probably, I don't know, $0.05 of benefit. AIT, what's your expectation for charges in '10? It looks like you're entering with a $0.15 headwind into 2010. So if you would just walk through some of your below the line assumptions?

Thomas McCaffrey

Well, with respect to the AIT costs, we won't have essentially any AIT costs for the second half of next year, so they'll be winding down. We'll have some in the first half. They'll be winding down in the second half of the year so we'll have a little bit of carry-over into the year.

Gautam Khanna – Cowen and Company

Can you quantify them, or do you think it'll be like $0.05 or something?

Amin Khoury

I think that we can provide specific guidance on AIT costs in 2010 in the third quarter. I mean basically we're trying to give you a preliminary view of 2010 today so that you'll have a directional guidance and as you know each year in October we go to New York and we meet with investors and we talk about the specifics of 2010. I think we can provide you with the guidance at that time.

Operator

Our next question comes from Robert Spingarn – Credit Suisse.

Robert Spingarn – Credit Suisse

Hey Tom, just following up on that question, just a quick thing, are there any inventory adjustments in the quarter or anything on the balance sheet that we would want to think about and then how should we think about the other major working capital accounts for the remainder of the year, in particular with your comment on fourth quarter free cash being strongest?

Thomas McCaffrey

Let's talk about inventory for a second. We did finalize the allocation of the purchase price after the Honeywell acquisition during the quarter which you know has to be done at fair value at the acquisition date.

Our accounting methodology is more conservative than the method used by HCS which required us to reduce the value of the inventory that we acquired and reallocate the difference to goodwill. The purchased inventories in terms of the amount allocated were about $130 million, and the allocation of the purchase price reduced inventories and increased goodwill by about $36 million.

A portion of that was recorded in the first quarter, and there was some amount in the second quarter when we finished it out. So you'll see a difference between cash growth and in the cash flow statement, and on the balance sheet.

Robert Spingarn – Credit Suisse

And you said there is an income statement component to this in the second quarter?

Thomas McCaffrey

No, there is none.

Robert Spingarn – Credit Suisse

Okay, none there. And then on the working capital, receivables, payables, as you go through the year, and CapEx as well.

Thomas McCaffrey

Let me touch on CapEx first. You should expect CapEx to be about $35 million for this year, so it'll be down from our prior guidance of about $40 million. So it'll be about $35 million and it'll be a little stronger in the third quarter than in the fourth quarter.

And with respect to inventories and receivables in the balance of the drivers associated with cash flow really has to do with the timing of program shipments and when we expect to generate the cash.

Robert Spingarn – Credit Suisse

So that's back ended and then just quickly, aim on the performance in consumables, the down 30%, can you talk about any difference in performance between the core consumables business and HCS regarding the various product types and if there are certain areas with less pressure and other areas that are working more positively for you?

Amin Khoury

The business debt segment is down the most, okay? I mean Business Jet manufacturing is off 40% and we support pretty much every Business Jet manufacturer's consumables requirements in their manufacturing facilities and that's about the worst.

After that the rest of the market, whether it's aftermarket or manufacturing, is off pretty much about the same, and we are sort of bumping along at the bottom here in terms of daily orders and shipment. It isn't getting worse but it isn't getting better. And so our outlook continues to be for flat performance for the balance of the year.

Robert Spingarn – Credit Suisse

Same if we look at consumables as a whole what portion of that business, that roughly $801 billion business is BizJet OE?

Amin Khoury

You know we don't break the numbers out by individual customer segment and we've never reported that kind of information so I couldn't answer that question quantitatively. We know the answers but we can't respond.

Operator

Our next question is from Myles Walton – Oppenheimer and Co.

Myles Walton – Oppenheimer and Co.

Yes, thanks. Good margin performance in the quarter. I was wondering if I could ask you about the 2012 comment you made on the Business Jet segment and if you can slice out the two halves of that business between SFE and Business Jet, are they on the same trajectory or are they not?

Amin Khoury

Well, they're more or less on the same trajectory. I mean, we are going to start to shift some equipment for added new equipment like vacuum wastewater systems for new aircraft which are expected to be introduced into service for the first time in 2012. And we are going to be the sole supplier of the vacuum waste systems on those, so there'll be some.

Tom talked about some inventory build in terms of connection with our new systems for the 787 and the rest of our assets to be booked backlog, and 737, and so on, and so forth. Well, the same thing will happen there. And so we'll start to build some inventories, and we will start to deliver some systems for initial airplanes and for prototype airplanes and so forth. But when I said an upturn, I don't mean in the Business Jet segment per se, I mean in the business of business jet deliveries.

So the super first class portion of that business, I think will improve more quickly because of the potential for retrofit activity improvement. And we are seeing a little bit up right now in retrofit RFP activity, which allows us to feel confident in our statements about the growth in orders and backlog in 2010.

The business jet business is going to be pretty soft right through 2011 we believe, but our segment may begin to improve a little bit before of the super first class portion of that business.

Myles Walton – Oppenheimer

Okay. But even under that softness on the top line you think you could hold margins in or around the 10% level?

Amin Khoury

In the BizJet segment?

Myles Walton – Oppenheimer and Co.

Yes.

Amin Khoury

I don't want to project where margins are going to be in the Business Jet segment because we are expecting another further significant downgrade in revenue in that business in 2010. And we have been very successful in our cost cutting as you can see, where revenues are off 30% and our margins are up which I think is truly amazing. We don't want to talk about margins in 2010 for the Business Jet segment just now, but obviously it's a significant chunk of the $100 million reduction in revenues next year. A significant piece of that comes from the lower Business Jet segment forum.

Myles Walton – Oppenheimer

Fair enough. And just one clarification, the flat earnings guidance, or the flat earnings color into 2010, that's flat off of the 140 or off the adjusted 150?

Amin Khoury

We're talking about GAAP [inaudible].

Operator

Our next question is from David Strauss – UBS.

Christina Fernandez – UBS

Hi, good morning. This is actually Christina Fernandez for David. Amin, in your comments you talked about the retrofit business being a trough level. Can you give us more color as to how much this is down from the peak and what if any recovery you're assuming in 2010?

Amin Khoury

Mike, why don't you jump in and just talk about the market in general and retrofit specifically and new deliveries and so forth?

Michael Baughan

Sure. With regard to retrofits, I mean obviously the market, as you know, has been very slow. However, a second quarter actually we had two important retrofit programs that booked which we found encouraging. And I think in both of those cases it illustrates the need that the airlines have to transfer new cabin technology from a launch fleet, let's say a new buy delivery, launching and expanding that technology into their other similar fleets. And they have to do that for reasons of market commonality.

So in the first case, Air France awarded us a contract to expand our next generation business class seating, which they had launched on new buy 777 aircraft, into a retrofit of their existing A330 fleet. So we got that order, that retrofit A330 order, in the second quarter.

In the other case, Continental Airlines awarded us a 767 retrofit program, also for business class. And Continental had originally ordered that product for 787 and then 777 aircraft, and those new 777 start delivering this fall. But Continental believes our product provides it with yield and density advantages over their competition, and so even in this difficult environment, they've chosen to make additional investments in existing fleets.

If we look forward, we see some other examples of airlines who are actively considering expanding new buy products into existing fleets. So we talked a little bit about this in the last call in our aircraft interiors, our Hamburg Show recap. We believe – so it's airlines that are taking 787s, 777s, A330s putting new technology into those planes, we see a number of those who are talking to us about when and how to put that into retrofit fleets.

I'd say the third part of that, Christina, is that we think that improving economic conditions in 2010 are going to favor a more significant recovery in orders in the broad retrofit market, deliveries in '11 and '12. And to deliver retrofit products in '11 and '12 with lead times, you've got to get the booking starting in 2010 or even part of 2009. So that's what's driving the retrofit market.

We see a firming in retrofit bookings between now and the end of 2010, retrofit bookings, for those reasons, but I think that the even bigger reasons that we are optimistic about backlog growth in 2010 is one thing Amin mentioned, it's the SFE conversion. Our unbooked backlog for SFE programs will start converting into booked backlog to support 787, and 748, and A380 and other type deliveries there.

And also we have a number of airlines that need to finalize their selection of BFE cabin equipment for 787, 777, A830, those type of aircrafts. So all of that together with an expected improvement in spares and consumables demand in '10 is what is driving our projected backlog growth between now and the end of 2010.

Christina Fernandez – UBS

Okay. And for Tom, how are you thinking about free cash flow in 2010 at this point?

Thomas McCaffrey

You know we haven't given any guidance at this point, Christina. We thought it would be good to give people directional revenue in earnings guidance at this point. And we'll comment on that when we give our formal guidance at the end of the third quarter.

Operator

Our next question comes from J.B. Groh – D.A. Davidson.

J. B. Groh – D.A. Davidson & Co.

Is there any way to quantify maybe what the 787 delay has meant to you in terms of, not just the SFE product, but maybe some retrofit work for as you mentioned upgrading existing fleets to sort of a newer interior?

Amin Khoury

I don't know, Mike, if you want to take a crack. It's a very material number in 2010. There's no question about that. And it's of course, in our planning. I don't know, Mike, if you care to quantify it. But I think, J.B., the way to think about is this way, I think the average revenue per aircraft shipped by Boeing for B/E Aerospace, a 787, is about a $1.5 million, okay? So if there are 20 or 30 or 40, or whatever it is, fewer 787s shipped in the year, you can more or less multiply that by 1.5 million to figure out what the materiality of the impact is on the company.

J. B. Groh – D.A. Davidson & Co.

So when you say a 1.5 million that's sort of an average of SFE included with an interior?

Amin Khoury

That's right. Maybe it's a little more than that. That's a reasonably good number to use.

J. B. Groh – D.A. Davidson & Co.

Okay. And then maybe Tom you could talk about R&D budget. It looks like you've got some interesting stuff coming up on this SFE, and how much of that is already kind of paid for and how much more do you have to spend to get it where you need it to be?

Thomas McCaffrey

You know R&D as a percentage of sales was just under 5%. I think it was 4.9% for the quarter. And I think that you should expect R&D spending to continue at about the same level, right about 5% of sales.

J. B. Groh – D.A. Davidson & Co.

I know you don't want to get too deep into 2010 but would it go up or would it stay the similar percentage?

Amin Khoury

It's going to stay at about the same rate, J.B. I think that's one of the good things that our control of costs has allowed us to do is to continue to invest in all these new programs and to book significant backlog and actually a lot of it is unbooked, but it's there. And I think it really speaks to develop the outlook of the business beginning particularly in 2011.

Operator

Our next question comes from Eric Hugel with Stephens & Company.

Eric Hugel – Stephens & Company

Good job again on the margins; pretty impressive considering the volume declines. Just wanted to delve maybe a little bit more into the consumables business and trying to square away your commentary about inventory destocking ending sort of with the results that you saw in the quarter and your sort of flattish expectations going forward.

My general thought would be if you're starting to see inventory destocking trends ending, i.e. airlines weren't ordering this quarter or last quarter and now it's – if it was going on – and now it's ending, they're going to be ordering at a rate commensurate with their activity, you would see a pretty healthy pickup in activity and you're sort of seem to be telling us flat. Can you sort of square that away?

Amin Khoury

Well, I think what we're seeing now is that the orders that we are getting are small orders for smaller numbers of units and they're more frequent orders. So I mean we are shipping nearly 8,000 a day at the current rate, so there are a lot of small orders that we're shipping and the inventory destocking is not finished. We're sure of that in parts of the world. We're in very close contact with our customers so it's not just an estimation on our part. Sure, there is some guesswork that has to go on, but we are in constant communication with our customers.

And so we don't expect a tick up to normality until sometime in 2010. I mean, if you listen to the CEOs of the airlines, for example, on their quarterly calls, they're still talking about taking out more capacity. They're still talking about perhaps the second half of the year being worse for them than the first half of the year. They're concerned with the low level of business traveler activity and what's happening to yields and the price of those tickets and corporate bookings for the fall really has them spooked.

So we just don't see the management at the airlines or the MROs allowing normality to return until sometime in 2010 and so I think here caution and conservatism are the right way for us to think about the next several quarters.

Eric Hugel – Stephens & Company

No, I understand. Could you comment – if you look at the consumables business there's about half of it is aftermarket and then a quarter is sort of OEM and military, can you just sort of give us maybe growth relative – I mean the military I'm assuming has continued to see mid-single digit and OEM you're probably focused heaving on BizJets, but that was probably well below aftermarket? Is that sort of a way to think about it?

Amin Khoury

Yes, I think it's a fair way to look – to think about it is that the military business continues to do well, that the BizJet business is doing worse than all the rest of the businesses, and that the aftermarket and OE non-business jet businesses are off about the same amount.

Eric Hugel – Stephens & Company

Right, and lastly in your comment, in your guidance comment you said, "lower level of new commercial aircraft deliveries in 2010." You're basically saying you're assuming that production rate's going to come down substantially in your guidance?

Amin Khoury

Yes, we continue to believe that the two major OEs are going to take narrow body deliveries down further in 2010.

Operator

Our next question comes from Carter Leake – Davenport & Company.

Carter Leake – Davenport & Company

I want to follow up on that production comment on 2010. I assume that it would probably be no later than sort of second half of 2010 on your assumptions or just because where we are do you think it could be sooner than that? Or put differently, do you – what are your assumptions on production cuts in 2010 driving the flat EPS?

Amin Khoury

Well, we've taken a fairly conservative view in that we think that deliveries of narrow body aircrafts by the two major OEs in aggregate are going to be 15% or so lower than they're currently projecting.

Carter Leake – Davenport & Company

The 1.5 million average ships at value on the 73, that is I assume your fair share portion of –

Amin Khoury

That wasn't a 73. That's a 787.

Carter Leake – Davenport & Company

Oh, the 787 rather, I'm sorry. The 787, that is sort of your – you get to that number by your fair share portion of future BFE wins, is that right?

Amin Khoury

That's right.

Carter Leake – Davenport & Company

Is there any way to get similar color on the 737 Sky interiors?

Amin Khoury

Yes, I think it's a little too soon and it's mostly [BFE]-driven for the 737 Sky interiors. We'll consider that question and think about whether we can give you a more comprehensive at the end of the third quarter, okay?

Carter Leake – Davenport & Company

Great. Just one more quick one, I appreciate the commentary with regards to specific customers. That would be very helpful in the future, and to that end is there any way that you could give us commentary now on 787 customers, because if it is the fair share portion do you have more exposure to the early deliveries? For example, ANA on the 78, that might help us in modeling 787 impacts.

Amin Khoury

Okay, let's talk about that in the third quarter also.

Operator

Our next question comes from [Lucy Lao] – Macquarie Capital.

[Lucy Lao] – Macquarie Capital

Regarding your 2010 flat year-over-year earnings guidance, how much additional cost reduction is required in order to reach that?

Amin Khoury

How much additional cost reduction? Well, we're not going to quantitate the additional cost reduction. What we've done is actually taken the first cut as our plan for 2010, and we've looked at the margins in each one of our business units and so it's not when you talk about cuts they're all different kinds of cuts. You know, it's the [Bicane] initiatives and it's the continuous improvement initiatives and process excellence and so forth. So there is no way for me to answer your question quantitatively I think.

[Lucy Lao] – Macquarie Capital

So are you saying that there will be additional cost reduction activities in order for you to reach that flat year-over-year earnings?

Amin Khoury

We will have significant additional headcount reductions in connection with the HCS integration in the balance of 2009 and 2010. And we'll also have significantly less AIT expense in 2010 as compared to 2009. We don't expect to have any AIT expense in the second half of 2010, so yes, we do expect significant cost reductions and further headcount reductions, particularly in the consumables business in 2010.

[Lucy Lao] – Macquarie Capital

And was there any mix issues on the top line? I understand volume decline is very sharp. Was there any platform mix that was negative for you on the top line?

Amin Khoury

Tom, can you think of a way to address that question?

Thomas McCaffrey

No, I can't, I mean mix is always an issue each quarter. There's some positives and some negatives. I don't think there's anything that rose to the level of us to comment on publicly.

[Lucy Lao] – Macquarie Capital

Can you maybe break out the Airbus versus Boeing revenue decline within commercial aircraft?

Amin Khoury

Well, some of it is primarily airlines and leasing companies who, right, who are buying new aircraft rather than selling directly to the OE.

[Lucy Lao] – Macquarie Capital

Right I understand, but between Airbus and Boeing platform-based revenue? But you don't look at it that way?

Amin Khoury

Do you want to comment, Mike? We certainly can't be quantitative, but…

Michael Baughan

With the exception of the continued slide of the 787 which means that we've had some lower revenue compared to original expectations there, there's no real story between Airbus and Boeing. They would be essentially the same.

Operator

Our next question is from Colin Campbell – SG Securities.

Colin Campbell – SG Securities

Just very encouraged by the margin performance on a 30% volume decline for EBIT margin to go up is really quite a significant effort, and can you just highlight – I know you've highlighted the labor coming out. Are there any other flexible costs you've taken out and if we see an increase in volumes do we get some operational leverage on the upside still? So that would be one on margins.

And secondly, where are we now with the Honeywell consumable margins in relation to the old B consumable margin?

Amin Khoury

The biggest drivers of our 5% margin reduction are headcount reductions. They're off 20% from this time last year and a very substantial effort was made in slashing management in low cost company sourcing. The other major activity is our continuous improvement initiative and the company has now a myriad, a verified number of black belt trained LEAN managers who work for the person who's responsible for operational excellence in the company. And we are basically broadening best business practices at each location that transfer those to every location in the company.

And the combination of this drive on process improvement and continuous improvement in the company, which drives down warranty cost, which improves yields, which reduced the cost of [inaudible], which improves the cost of safety, I mean it's pretty much everywhere in the business. Together with our supply chain management and low cost country sourcing initiatives, are what is driving the improvements in Martins and is offsetting what otherwise would be very large decremental reductions in profitability from the largest reductions in revenues. I think the company's performance there has been outstanding.

You asked the question whether or not we would expect that to improve margins as volumes begin to improve on the upside. The answer is absolutely yes, we would expect margins to expand significantly. As return occurs and as auctions improve and as we get a higher level of manufacturing facility utilization and as we implement these process improvements and supply chain improvements over a larger volume of business. So I think we are doing a good job, we've done a good job, in the outlook I would say is pretty positive. There may have been one other question you asked?

Colin Campbell – SG Securities

Yes just lastly on where we are now with the Honeywell consumable margin? I think the target was to get that closer to your own B consumable margin.

Amin Khoury

You can't actually report Honeywell margins anymore because it's not a freestanding business, they are pretty much integrated and we're reporting through a single IT system. Actually we still have to, but it is no longer possible to determine what the revenues and margins are in each business. It's a combined number now because of the degree of integration which is already occurred.

And we will have completed this integration a year ahead of schedule if we complete it by the end of the second half of next year. And at this point it looks like we're going to have it essentially complete by the end of the first quarter. So that issue has basically gone away as an issue. We can actually no longer report that sales or margins of either of them.

Operator

Our final question today is from Peter Arment – Broadpoint AmTech.

Peter Arment – Broadpoint AmTech

Just following back on the destocking question, destocking declined in the U.S. You said the pace is abating somewhat, but you still have another quarter to go I guess on the international front, but I just wanted to get a little more color given the additional capacity cuts that we're seeing heading into 2010. I think what you mentioned, now why wouldn't the international destocking take longer at least equal to what the U.S. had?

Amin Khoury

Why wouldn't it take longer? We expect it to take longer. I think in the U.S. it's done. I think you're right, it will take longer. I think it's going to take several more months. Basically what we've done is we've looked at what's happened to our U.S. system. We've looked at weekly, daily, monthly orders and shipments. We've looked at how long it's taken for the rest of the world to actually begin to decline. The U.S. started its decline much sooner than the rest of the world, especially Europe, Asia and the Middle East, which are the three big ones for us.

So we are guessing when we say that we think it's going to take another quarter, but by the end of that quarter we should see the same firming that we have begun to see in the U.S. So it's not an absolute. We don't know absolutely for sure, but we think that based on what's happened in the U.S. and when it started in the U.S. and when it seems to have ended and when it started in Europe, we would expect it to end around the end of third quarter even.

Peter Arment – Broadpoint AmTech

That's helpful, thank you, Amin. And just, Tom, a quick one on free cash flow I know you're not getting into 2010, but I think given that you have you know the decline in the top line won't be as much near expecting some improvement in margin. Is it safe to assume that we'd see some improvement in free cash flow heading into 2010?

Thomas McCaffrey

That's right Peter because we won't have the major investment that we had in the HCS business to bring their stocking levels in line with ours.

Peter Arment – Broadpoint AmTech

Nice results in a tough environment, thanks.

Greg Powell

Thank you all for joining us this morning on the call.

Operator

Ladies and gentlemen, this concludes today's B/E Aerospace conference call. Thank you for participating in the call.

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Source: BE Aerospace Inc. Q2 2009 Earnings Call Transcript
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