Textron's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Jan.22.14 | About: Textron Inc (TXT)

Textron, Inc. (NYSE:TXT)

Q4 2013 Earnings Call

January 22, 2014 8:00 AM ET

Executives

Douglas Wilburne – VP, IR

Scott Donnelly – Chairman, CEO and President

Analysts

John Godyn – Morgan Stanley

Noah Poponak – Goldman Sachs

Peter Skibitski – Drexel Hamilton

Carter Copeland – Barclays

Jason Gursky – Citigroup

Robert Stallard – Royal Bank of Canada

Cai Von Rumohr – Cowen and Company

George Shapiro – Shapiro Research

Joseph Nadol – JP Morgan

Julian Mitchell – Credit Suisse

Jeff Sprague – Vertical Research Partners

Myles Walton – Deutsche Bank

Operator

Ladies and gentlemen, good morning. Thank you for standing by, and welcome to the Textron 2013 Fourth Quarter Earnings Conference Call. (Operator Instructions) And as a reminder, today’s conference is being recorded. I would now like to turn the conference over to our host, Vice President, Investor Relations, Mr. Doug Wilburne. Please go ahead.

Douglas Wilburne

Thank you, Tom, and good morning everyone. On the call today, we have Scott Donnelly, Textron's Chairman and CEO; and Frank Connor, our Chief Financial Officer. For everybody’s reference, our earnings call presentation can be found in the Investor Relations section of our website.

During the course of our call, we will be discussing future estimates and expectations including our 2014 outlook. These forward-looking statements are subject to various risk factors, which are detailed in our SEC filings and also in today's press release. We would also like to point out that our 2014 guidance will not include the impact of our planned acquisition of Beechcraft. We will update our 2014 guidance to account for the impact of the acquisition after we have closed the transaction.

Moving now to fourth quarter results, starting with slide number three in our earnings presentation. Revenues in the quarter were $3.5 billion, up 4.3% from a year ago. Income from continuing operations was $0.60 per share, compared to $0.50 in last year’s fourth quarter.

This was a few cents higher than we were expecting at the end of December when we indicated that we would likely be below the bottom end of our guidance range as a result of better operating results in our manufacturing businesses.

Moving to cash flow, fourth quarter manufacturing cash flow before pension contributions was $774 million, bringing our full year manufacturing cash flow before pension contributions to $256 million. Full year pension contributions were $194 million, which reflected a $21 million contribution during the fourth quarter.

With that, I will turn the call over to Scott.

Scott Donnelly

Thanks, Doug, and good morning, everybody. Overall, we had a good fourth quarter to close out the year with revenue growth at Cessna, Bell and Industrial and strong cash generation across all our businesses. Moving to our Textron Systems segment, revenues were down in the quarter as expected primarily due to lower UAS and precision weapon shipments in the quarter compared to a year ago. Operationally, Systems had a good quarter with 9.8% margins.

We also continued to make progress on the Ship-to-Shore Connector and Canadian Tactical Armored Patrol Vehicle program while continuing to make on-time deliveries on our existing Afghanistan National Army Vehicle contract. In our UAS business, we saw improvement in the operating reliability of our Aerosonde fee-for-service aircraft reflecting installation of Lycoming Build Engines into the fleet.

Also within the UAS business we made good progress in the shadow TCDL development program which we believe puts us on track to begin delivering production units in the second half of this year.

Finally we closed on the acquisitions of OPINICUS and Mechtronix in December and we are now in the process of combining with our existing military simulation business at AAI to establish the new Textron Simulation and Training Systems business. Jim Takats, the former CEO of OPINICUS is the President of the new unit and with his team he is busy with integration activities and business planning. As we look to 2014 for Systems, we significant top-line expansion led by growth in the UAS revenues, primarily from delivery of TCDL systems and the impact of the Simulation and Training business which should lead to improvement in full year margins.

Switching to Industrial, revenues were up 9.5% in the quarter reflecting higher volumes in each of our businesses as well as the acquisitions of Sherman & Reilly and HD Electric at Greenlee. For the year, we posted a 60 basis point improvement in margins on 3.9% revenue growth.

Looking to 2014, we are expecting continued margin expansion resulting from solid top-line growth driven by strong auto markets and our continued investments in new products sales and distribution capabilities.

Moving now to Bell, plant productivity and execution across our programs improve and that was reflected in our sequential margin recovery in the quarter. We delivered 13 V-22s, 6 H-1s and 75 commercial helicopters, versus 9 V-22s, 6 H-1s and 65 commercial helicopters in last year’s fourth quarter. During the quarter, the V-22 program was approved which contributed to an increase in overall Bell backlogs.

On the FMS front, last week the Department of Defense notified Congress that it intends to sell six V-22s to Israel with the aircrafts expected to be in field in 2016. We continue to pursue a number of additional FMS opportunities for both V-22 and H-1 aircrafts and believe we will have incremental FMS deliveries for both of these platforms.

On the commercial front, we delivered 213 helicopters for the full year, up 13% from last year’s 188 units, reflecting our investment in the products and increased focus on the commercial helicopter market.

Looking to 2014, we are expecting a flat top-line at Bell reflecting a decrease in military revenue offset by an increase in the commercial side of business. Margins are expected to be down slightly, reflecting the expected decrease in military margins and continue to back for the manufacturing efficiencies we talked about last quarter.

Wrapping up, our operations for U.S Cessna we received FAA certification for our new M2 and Sovereign in the last week of December which allowed us to deliver 12 M2s and eight Sovereigns bringing total jet deliveries in the quarter to 62. This compares with 53 units in last year’s fourth quarter.

For the year, deliveries were down at a 139 jets compared to 181 last year. Looking towards 2014, while we are not counting on a significant change in overall market conditions, we do expect that full year deliveries of the M2 and the new Sovereign Plus introduction of our new 10 will contribute to increase in overall deliveries which should internally do an improvement in profitability.

Longer term, we are still expecting overall jet growth to develop as global economies gain momentum and combine with additional new products that are introduced. With our announced acquisition of Beechcraft, we believe we will be in an excellent position to capitalize on the rebound in the business jet and overall general aviation market.

To wrap up 2013 in Textron Systems, we continued to innovate on the product front including our expanded Commando family of armored vehicles and development of the next generation of the Shadow M2. We continue to increase our international customer base with finalization of a contract to supply Saudi Arabia with precision weapons.

We also made progress on a variety of product opportunities in international military markets which we expect to lead to a number of orders in 2014. And finally we established new business unit in the growing global aircraft simulation training market.

At Industrial last year’s 4% top-line growth reflected our continuing investment and expanded distribution in new products such as the new hybrid-powered Bad Boy Ambush iS at E-Z-GO, and the high productivity AR722T diesel turf mower Jacobsen. And our acquisitions of Sherman & Riley and HD Electric demonstrate our commitment to leverage these businesses for growth and long-term shareholder value.

At Bell, we implemented a new Enterprise Resource Planning system and now the rollout was without issues. We believe the new system will contribute to significant improvements in our manufacturing operations over the next several years. We also introduced our new short light single and continued to expand our focus on commercial markets around the world.

On the military side, we announced an important new tilt-rotor product, the V-280 Valor and propose that as Bell Solutions from U.S. DODs Future Vertical Lift program.

At Cessna, in addition to the M2 and Sovereign, we certified the Cessna TTX the world’s fastest certified fixed-gear single-engine aircraft as well as the Grand Caravan EX. Finally in December, we achieved first light of our Scorpion ISR tactical strike aircraft less than two years from when we launched our design program.

In summary, 2013 was an important year with significant new product introductions, strategic acquisitions and investments in the future of our businesses. To finish with our 2014 guidance, we are projecting an overall revenue increase of about 9% with EPS from continuing operations in the range of $2 to $2.20.

Manufacturing cash flow before pension contributions is also expected to increase significantly to a range of $600 million to $700 million. With that, I will turn the call over to Frank.

Frank Connor

Thank you, Scott and good morning everyone. Manufacturing revenue was up $153 million in the quarter generating an increase in manufacturing segment profit of $26 million.

Let’s look at how each of the manufacturing segments contributed. Cessna revenues were $923 million in the fourth quarter, an increase of $22 million on a year-over-year basis reflecting the increase in jet deliveries partially offset by a decrease in revenues at Citation X and lower caravan deliveries.

We posted an operating profit of $33 million, up $10 million from the fourth quarter of 2012 primarily as a result of improved performance reflecting an unfavorable arbitration award recorded in last year’s fourth quarter.

At Bell, revenues were up $226 million, primarily due to higher volumes across the business. Segment profit increased $1 million as the impact of higher volumes was largely offset by lower military margins and manufacturing inefficiencies related to prior period labor negotiations and the implementation of a new enterprise resource planning system.

At Textron Systems, revenue decreased to $162 million, primarily due to lower volumes. Segment profit increased $4 million as improved performance more than offset the impact of the lower volumes. Industrial revenues were up $67 million and segment profit increased $11 million, primarily due to higher volumes.

Moving to finance, segment profit was $2 million. Credit quality remained stable with non-accrual accounts at a $105 million flat with the third quarter and 60-day delinquencies were $80 million, $8 million lower than at the end of last quarter. We ended the year with approximately $1.5 billion in receivables with only $185 million remaining in the non-captive portfolio.

Moving to corporate items, corporate expenses were $57 million, up $43 million from last year reflecting the impact of – that our higher share price had on compensation expense. Interest expense was $27 million, down $11 million from a year ago primarily reflecting to retirement of our convertible debt earlier in the year. Our tax rate of 23.3% benefited from the impact of lower U.S. income and a number of one-time foreign items.

Turning now to our 2014 guidance beginning with pension expense and looking at slide 8. Based on bond rates prevailing at the end of 2013, we’ve increased our 2014 U.S. plan discount rate to 5%.

In combination with 14% returns on planned assets for 2013, unfunded liability of our defined benefit pension plans dropped to $200 million from $1.3 billion a year ago. On this basis, we are estimating 2014 pension cost of about $130 million. This will provide about $45 million in pre-tax year-over-year benefits to the P&L taking into account 2013’s higher cost of our inventories and carried over to 2014 and a portion of this year’s lower cost will be inventories and carried over into 2015.

Turning to slide 9, R&D is expected to be approximately $490 million or about 3.7% of sales, down from $511 million in 2013. We are estimating CapEx will be about $425 million, down slightly from last year’s capital expenditure of $444 million.

Flipping to slide 10 which continued to our segment guidance, at Cessna we are expecting about 19% revenue growth reflecting growth in jets and aftermarket with segment margins in the range of 2.5% to 3.5%. At Bell, we are expecting overall revenues will be approximately flat reflecting lower military revenues being offset by higher commercial revenues with expected margins in the range of 12% to 12.5%.

At Systems, we are looking for top-line growth of about 20% led by higher UAS revenues with segment margins in the range of 9.5% to 10%. At Industrial, we are expecting 10% revenues growth with the expansion of 2014 margins to be 8.25% to 8.75% range. At finance for forecasting segment profit in the range of $5 million to $10 million in 2014 with minimal upside potential from non-captive asset dispositions, now that those assets are de minimus.

Moving below the segment line and looking at slide 11, we are projecting about $150 million for corporate expense, down from 2013 primarily reflecting lower compensation expense related to change in share price. Our interest expense estimate at about $117 million is down primarily as a result of last year’s retirement of our convertible notes. And next year’s tax rate is expected to be higher at about 31.5% primarily reflecting the discontinuance of the U.S. R&D tax credit and a higher U.S. income mix.

Looking now at slide 12, our 2014 EPS guidance reflects an increase of $0.35 at the midpoint. Let’s discuss the major elements driving the increase. Tax headwinds decreased EPS by $0.14, lower expected earnings at Finance represented $0.10 headwind. Improved interest expense provides a pickup of $0.01, the absence of last year’s restructuring charge at Cessna adds $0.07 and the benefit of lower pension expense is expected to add about $0.11 per share in 2014.

And finally the contribution from our underlying manufacturing business is estimated to be $0.40 per share.

Tom, that concludes our prepared remarks. So we can open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question today comes from the line of John Godyn representing Morgan Stanley. Please go ahead.

John Godyn – Morgan Stanley

Thank you guys for taking my question. First of all, Scott, I was just hoping that now with the past at some time you could talk a little bit about maybe the internal response from the sales force as well as customer response from the announced Beech acquisition?

Scott Donnelly

Sure, I think it’s been overwhelmingly positive and we’ve had a ton of interactions with the Beechcraft customers and I think from their perspective this provides – uncertainty with a company that’s gone some pretty difficult times. So I think that all the feedback we received has been very, very positive.

I think the notion at the customer service and support will be stable through the lifecycle of these products on both the Can aero piece which I think people are fairly comfortable with, but in large part the hawker piece with a lot of customers that were concerned about where that would go has given them a great deal of comfort and the fact that it’s now in an ownership structure that’s long-term committed to the business in general aviation market has been received very, very well.

John Godyn – Morgan Stanley

Great, that’s very helpful and I was hoping that, in terms of the 2014 outlook, you could elaborate a little bit on the assumptions or expectations underlying Cessna. In particular, kind of the pricing environment that you see next year or this year, is it getting firmer, just trying to understand the $3.3 billion revenue number a little bit better, think the uptick just within the context to the E-Z comp in 2013 struck us a little bit low and so I was hoping that you could elaborate a bit on that.

Scott Donnelly

Well, I think if you look at the 2014, the comparative, first of all I’d say, the market is still challenging as I said, I don’t think we are expecting any dramatic change in terms of the market dynamic that’s out there. So, pricing for us was roughly flat year-over-year, so I’d say it has more or less stabilized in terms of where the pricing environment is, most of what we are anticipating in terms of growth is really driven by new products.

So as you look into 2014, obviously we’ve seen very strong demand around the M2 product. The Sovereign did well really at the end of the quarter obviously, the certifications happened very late in the year but will not have a full year of not just the M2 but also the Sovereign of course we are expecting the 10 to certify in the early part of this year.

So we expect the full year sales in terms of the Citation 10. So, really the dynamic is, new products matter a lot and as we talked about over the last couple of years our – one of our biggest competitors has been, our installed base have rolled to the new used aircrafts and so as we come out with new products that are differentiated from what’s available out there Interviewer he marketplace in terms of the use, the customer reception has been strong and that’s really what’s driving most of our revenue increase in 2014 which is the full year of those new products that have been well received in the marketplace.

John Godyn – Morgan Stanley

Okay, and if I could just ask a quick one on Systems, the margin outlook for 2014 suggests the margin expansion versus 2013. I was just hoping you could elaborate on what’s driving that. Thanks a lot.

Scott Donnelly

There is two parts that are driving it. One is, we are feeling better about where we stand on our fee-for-service contracts in UAS. We certainly had another challenging year in 2013 really driven by this issue of engine reliability. The indications we are getting from the field now that we have got our Lycoming Build motors out there has certainly been on a positive trend. So we are pretty confident that we should experience better performance.

It’s still a challenging program and we are booking it as your profit but again we don’t expect to see the kind of impact we’ve seen over the last couple of years in terms of losses associated with that program and then the significant piece is that all of that delivery of production TCDL units was really something we originally expected to start delivering in 2013 as a result of the development program. That really moved into 2014 and beyond.

So, we’ve been building those units. We’ve been ready to ship those units but we continue to see completing the development contract which is the cost plus low margin contract we expect that to happen here in the first half of this year and so you’ll see a positive mix in terms of now, this development program with low development margins you’ll actually see delivery of production units at better margins.

John Godyn – Morgan Stanley

Very helpful, thanks.

Scott Donnelly

Sure.

Operator

Our next question comes from the line of Noah Poponak with Goldman Sachs. Please go ahead.

Noah Poponak – Goldman Sachs

Hey, good morning everyone.

Scott Donnelly

Good morning.

Noah Poponak – Goldman Sachs

Scott, I wondered if you could maybe just elaborate on the comment you just made about not really expecting much of a change in underlying legacy light cabin business jet demand why not what are customers telling you on the ground today? What are the data points you are looking at that you still need to see change, maybe just a little bit more on sort of how things feel and what it can take to finally turn things?

Scott Donnelly

This is a tough one, obviously. We’ve been guessing at this for quite a number of years now. The key metrics that we look at obviously continue to be favorable, number of used aircrafts available out in the market continues to go down in terms of both percent and absolute number of aircrafts, so we find that encouraging. The used market has been quite active again and in 2013 in number of transactions.

Customer activity, lot of the surveys that people do out there say people are more bullish, certainly in the U.S. Although we continue to be concerned about what’s going on around the economies in Latin America and in Europe which are sort of our second and third largest markets classically for those light mid-sized business jets. So, if I looked at our legacy products which are things that we have had in production through the course of the year we are basically seeing a sort of a flattish market in that area.

Again, that’s an area that we see and are pretty confident about the increased revenue is the fact that we now have full years for some of the new products. But if I look at things like M2s, we know what that is. We did grow our production a little bit about half way through the year because of increased demand for that product.

We feel pretty good about where we are on our sovereigns and obviously the 10 certifies, we have original backlog around that product as well. So I think that the safe assumption at this stage is to assume that the market dynamic overall is relatively flat to what it was in 2013 and then all the upside or improvements comes from introduction of new products.

Noah Poponak – Goldman Sachs

So, should we – when we are looking at total Cessna units, should we have 2014 production up something on a percentage basis, something similar to what you are telling us revenues will be compared to 2013 and then have – to think about 2015, it’s not really changing substantially from 2014 or can you really not – is it sort of short-term still that things could really change significantly still later in the year and it’s too hard to say?

Scott Donnelly

Well, I think, again the assumptions that you make around 2014 on average aircraft pricing and you are going have a mix obviously of M2s which are from a price point obviously towards the lower end of the product range. But you have the 10 and the sovereigns behind. So I think your assumptions are probably not unreasonable in terms of what you think about in terms of unit volumes in 2014.

We are certainly not – nowhere near close to 2015 yet, but I wouldn’t try to make any assumptions around the market overall. I guess the only commentary I would make with respect to 2015 is that, we certainly expect to have the latitude in the market for full year of sales in 2015. So again along the same lines that way we are thinking about today, all have been equal, these new products are things that really drive growth and we would certainly expect to see growth in 2015 driven by the introduction of the latitude.

Noah Poponak – Goldman Sachs

Okay, I appreciate the color. I’ll jump back in the queue. Thanks.

Operator

And our next question comes from the line of Peter Skibitski with Drexel Hamilton. Please go ahead sir.

Peter Skibitski – Drexel Hamilton

Good morning guys. Just a few more questions. Let me start with the maybe the XLS. Scott, when do the final assembly in China start for the XLS? And you maybe not expecting that to be a meaningful up tick XLS deliveries next year or I guess this year?

Scott Donnelly

We do expect in 2014 that we would make the first deliveries to the joint venture for the XLS just as we did for their caravan in 2013, but yes, they are relatively low unit numbers as we are just starting to ramping up that process and working the first couple aircrafts through it. So, we are still in the process of business licenses and starting to generate sales activity in China through that joint venture.

Peter Skibitski – Drexel Hamilton

Okay, got it. And then, can you maybe give us more detail on what Cessna aftermarket growth finished up at in 2014 and what’s your assumption is in 2014 and similar question on pre-owned volumes?

Scott Donnelly

So the aftermarket was up again at Cessna in the aftermarket. It wasn’t up quite as much as it was in the third quarter. But it was a pretty strong quarter in terms of aftermarket growth. The utilizations have held pretty steady. So that business continues to do well in terms of used aircraft. The dynamic that we saw was still very active market and we certainly saw more aircrafts – a net reduction in our inventory of aircrafts as we sold more than we took in trades.

Peter Skibitski – Drexel Hamilton

It seems like 2014, revenue from pre-owned, are you expecting that to be down or maybe just directionally give us a sense?

Scott Donnelly

That’s probably relatively flat. It was up this year – year-over-year but I would say, probably relatively flat next year.

Peter Skibitski – Drexel Hamilton

Got it. Okay, thanks guys.

Scott Donnelly

Sure.

Operator

Our next question is from Carter Copeland representing Barclays. Please go ahead.

Carter Copeland – Barclays

Good morning, gentlemen. Just a couple quick ones. On the Bell margin outlook for 2014, I know the sequential improvement in the fourth quarter but I was wondering why that was – what was behind the down year-over-year number there? Is that was just the V-22 in the fourth quarter? Or if that was anymore ERP bleed over from 2013? Any color there would be helpful.

Scott Donnelly

Well, certainly some of it was a bleed over from the earlier quarter in 2013. So as those inefficiencies that we had which we talked about in the largely impacting the second and third quarter, a fair amount of that stuff cost that was inventory which then will bleed out.

So it’s certainly sold as we recognize revenues on aircrafts in the fourth quarter and we’ll see that as we continue our way through 2014 as well. In terms of real-time operations, we have seen improvements in terms of some of that productivity but we still have a long way to go and continue to drive better margins.

Obviously, the other dynamic that we have which had some impact in the quarter and will have continuing impact on a go-forward basis is that we are now transitioning into lots of aircrafts that have been negotiated at lower rates than we were achieving in our earlier multi-year contract as a result of accumulated productivity over a period of a number of years.

Carter Copeland – Barclays

Correct. And I wondered if you could just clarify the UAS commentary earlier. You weren’t expecting to book, are you not booking profits at all or you are just not booking losses, is that the right clarification?

Scott Donnelly

Well, on the fee-for-service we book that at zero profit.

Carter Copeland – Barclays

And your expectation for 2014 is that that will stay that way through the course of the year?

Scott Donnelly

That’s correct. Our expectation is that we will say that way but we will not recognize any further losses on the program.

Carter Copeland – Barclays

Okay, great. Thanks, I’ll get back in the queue.

Operator

Our next question will be from the line of Jason Gursky with Citi. Please go ahead.

Jason Gursky – Citigroup

Hey, good morning everyone. Frank, I was wondering if you could just help us a little bit with the cadence of revenues throughout the year both at Cessna and its systems, just wondering if the seasonality at Cessna is perhaps going to be a little bit front-end in the past in light of the new deliveries and then the cadence that systems will be helpful given the revenues outlook quite a bit. Just getting a sense of when we are going to see an acceleration of revenues there?

Frank Connor

Yes, I think you’ll see the same type of seasonality that you have seen at Cessna. It will be impart impacted a little bit by the timing of the certification of the tens which is either a late first quarter or second quarter event. But you will see kind of the same type of back-end strength relative to front-end at Cessna. And at systems, because we expect the TCDL deliveries to be second-half oriented, you’ll see seasonality there as well where the second half of the year will be substantially stronger than the first half of the year.

Jason Gursky – Citigroup

Okay, great. And then just two quick follow-ups. Actually, how much is the R&D tax credit where – is it that would have sold back in and then the second question is just the R&D trajectory for the enterprise overall beyond 2014 just general trends on up or down relative to 2014 would be helpful.

Frank Connor

Jason, on the R&D credit, I’ll get back to you on offline. We don’t have that number right in front of us.

Scott Donnelly

Yes, on the overall R&D it will be program specific at the end of the day in terms of what we are looking at. But I think, in and around these types of R&D levels with some probably modest growth is what you should expect.

Jason Gursky – Citigroup

Okay, great. That’s helpful. Thank you guys.

Operator

And we’ll go to the line of Robert Stallard, Royal Bank of Canada. Please go ahead sir.

Robert Stallard – Royal Bank of Canada

Thanks so much. Good morning.

Scott Donnelly

Good morning.

Robert Stallard – Royal Bank of Canada

Scott, can you help on Cessna, given your comments on 2014 growth. I was wondering how much of this is actually in the back half already? Do you have any remaining slots for customers at the moment or are these pretty much sold out on the – shifted to – let’s say legacy models that is still for sale?

Scott Donnelly

No we have some slots. The M2 as I said earlier, we actually added some production capacity. So we created some slots, so we do have aircrafts that are available for sale this year. Sovereign there are aircrafts that are available. We have some of the backlog and some that will be still be sales that need to convert orders. So our orders to sales in 2014 the tens are pretty well sold to this point. There is probably a couple that could be available in the latter part of the year. So the new product side is – has pretty reasonable backlog in terms of sales.

Robert Stallard – Royal Bank of Canada

Okay, and then secondly on Bell, you mentioned you turned up your contract there. There are some FMS sales floating around. Has this had any impact though on your clarity for 2015 or is it likely be a further added like 2015 and 2017.

Scott Donnelly

2015 is fairly well set, just in terms of, if you look at lead times frankly, any aircraft deliveries and the V-22 slighted for 2015 will already have had been in production. So I think the 2015 numbers that we’ve provided you guys will hold where they are that’s probably also true at this stage of the game in 2016. So when you see something like the Israeli deal, where they want to take deliveries in 2016, those are units that are actually coming out of the marine core and V-22 stream and so, as the decisions get made in terms of the government about how they want to treat those aircrafts, they are going to add additional that would probably at this point be something that would be a 2017 delivery in terms of any incremental volume opportunities.

Robert Stallard – Royal Bank of Canada

Thanks, so much.

Operator

We have a question from Cai Von Rumohr representing Cowen. Please go ahead.

Cai Von Rumohr – Cowen and Company

So, get us a little color on Cessna’s profit looked a little bit light, was there anything in terms of R&D being higher, higher used aircraft losses in the fourth quarter because the incremental margin looks like at 16% relative to the third quarter?

Scott Donnelly

Yes, on a big piece that is, with the certifications both the M2 and the Sovereign we had a lot of cost around the certification and frankly and awful lot of variants in our manufacturing side because of a lot of updates and configurations. We are building these aircrafts and went through certification that was nothing huge but there was a fair bit of a rework that went on to get those into the certification standard. So those are cost that we bore in, in the fourth quarter and of course we also had the citation 10 certification program going in those suite as well. So, it was primarily driven around cost associated to those certifications as well as a fair bit of higher cost associated with the manufacturing efficiencies of having to upgrade and modify those aircrafts as we went through the process.

Cai Von Rumohr – Cowen and Company

Got it. And then, you’ve indicated that R&D would be 490 in this year down from 511. Were the certification cost included in the R&D in 2013 and what kind of trend should we expect at both Cessna and R&D in 2014?

Scott Donnelly

If you look at R&D, Cai, obviously we don’t break the sales, business-by-business, but it’s safe to say that the majority of the reduction on a year-over-year basis is coming out of Cessna and that’s because we did have an awful lot of R&D cost this year associated with the pack that we are doing the M2 and the Sovereign and the 10 certification programs simultaneously. Obviously, as we go into 2014, we still have to complete the certification on the 10, although the majority of that I would say is behind at this stage of the game, but we still have the spending associated with the latitude program and complete the latitude design development and getting into the flight test and that certification program on that front. So, most of that R&D reduction at a corporate level really is coming out of Cessna and it’s just a function of we rarely have had a time on that. I am not sure we’ve ever had a time, but we’ve had that many parallel certification programs that we’ve been undertaking. And again it wasn’t just on the jet business but also on the prop business.

Cai Von Rumohr – Cowen and Company

So, help me understand you are talking about a 400 basis point improvement year-over-year at Cessna and it looks like we get a 100 out of the severance charge, we get close to a 100 out of pensions, we got something out of R&D. So it doesn’t looks like you are giving yourselves any credit for the higher volume. Am I missing something there?

Scott Donnelly

Well, I think if you looked at the sort of the mid-point of the guidance as you are moving to next year, the leverage in terms of the incremental margin to that revenue is going to be in the low to mid-20s.

Cai Von Rumohr – Cowen and Company

Okay, and then you had mentioned that there is a $45 million positive P&L swing in 2014 in pension expense versus it looks like a $96 million decline in pension cost. Could you give us for 2013 and what you are looking forward for 2014 the actual pension expense that will flow through – that will be in the P&L?

Scott Donnelly

I am not sure we have that exact number. On an year-over-year basis it’s about $45 million and of course the charge or the cost as we outlined on our schedule just $130 million.

Cai Von Rumohr – Cowen and Company

So we are ongoing with this, you are only picking up half of the decline in the cost this year and Frank alluded to the fact that the inventories flow through, should we expect the other $50 million or so to flow through in 2015 if all the assumptions remain the same?

Scott Donnelly

Yes, so, Cai, the math behind it is, we tend to inventory about a third of the pension cost differential that then gets realized in the subsequent year and so we have the benefit of the step down in 2013 to 2014 and we’ll get two-thirds of that benefit flowing through in 2014 but we will continue to have one-third of the headwind that we had from 2012 to 2013 that was inventory and therefore will be realized in 2014 P&L. So, that’s the net $45 million. If you then roll into 2015, assuming that we don’t have any further change in downward trend in discount rate or negative rates or something, we will realize the remaining one-third of this year’s benefit and then we will not have – we’ll have whatever the subsequent impact is to that following year. So, we are kind of making up for the headwind two years ago in part this year and then in 2015 it should trend even better assuming things stay on track the way they happen.

Cai Von Rumohr – Cowen and Company

Thank you very much.

Operator

And next we will go to the line of George Shapiro with Shapiro Research. Please go ahead.

George Shapiro – Shapiro Research

Hi, yes, just following-up on Cai’s question Scott, why shouldn’t the incremental margins be closer to 30% at Cessna kind of versus the low to mid 20 this year, low 20 that you are suggesting on the call.

Scott Donnelly

Well, George, because they are not. I mean, as we go through the numbers and we look at where we are in the market, you take into consideration the mix of the new products legacy products, where we are in terms of pricing in the marketplace. That’s where we end with the incremental that are kind of at the midpoint down there in the – I think it’s around 23% if you take the midpoint of the guidance. So if we see, obviously, if we see some better volume if we see the change in the market. I think there is upside to that. But we have to see some strengthening in that light to mid-sized market but as we came through 2013 and just the dynamic that we saw which was much softer than we would have expected in 2013. The impacts in terms of – which is sure volume and pricing was quite challenging and so we factor that into our expectations for 2014.

George Shapiro – Shapiro Research

Okay, and then a follow-up on your comment there. If you looked at the orders I mean we saw a big improvement in the third quarter another big improvement this quarter were the orders really were up like 30% plus in the third quarter and certainly the best since 2008. So why wouldn’t that suggest that the markets actually really beginning a big pick up here?

Scott Donnelly

Well, I mean, we’d like to think that and carry over to 2014, but again, George, if I go back to the latter part of 2012, we certainly thought there was some momentum that we are going to see coming into 2013 and we didn’t see that. As a result, we ended up with production schedules and such that we are a lot more difficult than we would have expected and so I think we need to continue as we go into 2014 despite having seen what was certainly a good quarter in terms of order activity that we are going to continue to view that the strength will be around the new products and that it will still be a challenging overall market and therefore the legacy products will be under the same sort of pressure that they were in 2013.

George Shapiro – Shapiro Research

Okay, and then just one quick one on Systems, the revenue guidance you gave is a lot higher than what I would have expected. I know in your commentary you went through some of the things, I mean, is there one or two programs that are substantially increasing at that point in time and what’s the mix between international and domestic that you would expect in the 2014 guidance?

Scott Donnelly

Well, the biggest driver in the Systems revenue growth in 2014, George, is around this TCDL program. So we should complete – it will be relatively back-end loaded. We will probably complete the development programs which includes an army test which will happen in the second quarter. So, you won’t get sign-off on the development side until probably late in the first half of the year. So that means all that production delivery will be in Q3 and Q4. Most of those assets by the way are manufacturers. So, there is – but there is not an operational risk in terms our ability to deliver on that. It’s just a matter of getting through the development program. So that will be all be third and fourth quarter but it is a significant increase in revenue over 2013 and then there is about probably $90 million to $100 million and they are incremental revenues associated with the acquisitions of Mechtronix and OPINICUS in the simulation and training business.

George Shapiro – Shapiro Research

And then Scott, what was the mix between international and domestic in 2014?

Scott Donnelly

In the systems?

George Shapiro – Shapiro Research

Yes.

Frank Connor

I don’t think we would expect a big changer because we’ve got the growth in the TCDL unit there, but we are still on track to get that near 50% in 2015, George.

Scott Donnelly

TCDL, George obviously is all – that’s all U.S. army. So that’s going to see our number a little bit and that that’s sort of demand which would have been split over several years will all be domestic. But if you look beyond that in terms of our orders and our new business activity it is still biased towards the international marketplace, which as Doug said in this year – in 2015 you are looking at more like a 50-50.

Frank Connor

Okay, thank you very much.

Operator

We will go to the line of Joe Nadol with JP Morgan. Please go ahead.

Joseph Nadol – JP Morgan

Thanks, good morning. Scott, just on the mid-sized aircrafts, it seems like you had a decent quarter in particular. XLS really picked up and then some of that timing relative to Q3. Also it seems like the sovereign adds some little more traction is that a fair statement that you try not to get ahead of yourself but things are looking a little better there?

Scott Donnelly

Well, it was certainly a good quarter in that respect Joe and obviously the introduction in the sovereign helped aircraft available for sale in the fourth quarter and now we’ll have that available for sale throughout 2014 and we do expect good performance on that platform. The XLS did very well in Q4 that was obviously some timing associated around that. But again, as we look at our forecast for 2014 we are assuming that legacy aircrafts and the XLS certainly fits that category and so it’s a great airplane and it continues to do well in the marketplace. But we are expecting the dynamic for the total year of 2014 to be very similar to what we experienced in 2013 which was pretty soft until we got into that fourth quarter.

Joseph Nadol – JP Morgan

Okay. And then just one other, on the cash flow, Frank, just looking into 2014, what are the key working capital assumptions to the $600 to $700, in particularly what are you assuming add-ins within the category at Bell and Cessna?

Scott Donnelly

Yes, the working capital is about flat. So there is no real change in working capital. We would expect it – we will continue to see some inventory improvement at Bell and Cessna here earlier in the year. And so we are always going to be seasonal from a cash flow standpoint but better seasonality, certainly than we saw last year, but kind of given our expectations that those businesses will continue to show out year growth we’d expect then some kind of reversal of that that you will see later part of the year as we build into 2015 kind of particularly as we get ready for instance for the latitude launch and then other new product launches. So, kind of overall flat with some dynamic around seasonality during the year.

Joseph Nadol – JP Morgan

And what was the – can you quantify, versus maybe your expectations a year ago. The inventory build in those two businesses during 2014. how much that caused you, just in terms of Cessna deliveries not meeting your original expectations and then the issues you had at Bell.

Scott Donnelly

Joe, I think from a straight working capital management standpoint between the sort of the overbuild at Cessna part of which obviously liquidated in the fourth quarter but not fully to where we would like to have been. We had a couple of hundred million dollars of working capital different than where we would like to have been and I think what Frank is saying, is as we go through 2014 we certainly expect that we will address that issue and that we will fix that working capital problem, but it is going to be pressured as we get into the latter part of next year particularly around Latitude. We done our first engine on that aircraft. It should be flying here very soon and we’ll be into the flight test program and driving towards certifications early in 2015 obviously to get a full year sales in 2015 means we are going to go ahead and turn that production line on. So we’ll be building out those aircrafts but we won't be able to sell those aircrafts, deliver those aircrafts until that certification happens. And so that will happen probably in the very early part of 2015 but we’ll be carrying a full production line with revenues. So I think we have a plan on how we are going to address. So what I would as the overall working capital mix in 2013 but we are going to be pressured around some of the inventory particularly around the latitude at Cessna in 2014.

Joseph Nadol – JP Morgan

Okay, thank you.

Operator

Next we go to the line of Julian Mitchell representing Credit Suisse. Your line is open.

Julian Mitchell – Credit Suisse

Hi, thank you. I think it’s clear you are not going to change your incremental margin guidance on Cessna based on the last 15 questions. But I guess if you look at the – I just want to focus on the impact of the ramp up of the new jet. So how does that affects the incremental of Cessna, sort of year as a whole in 2014 and in particular in the first half. So I guess you have some better pricing but then at the same time you have got costs associated with the ramp up maybe some fixed cost on absorption early on.

Scott Donnelly

Actually, and that’s what – I think, Cai and George’s questions are good. I mean, it’s easy to – we can go through some of the beneficial things that should be flowing through the P&L and try to justify a higher number and I guess the bottom line is while we expect and the new products like the M2 and the Sovereign are good in delivering good gross margin in terms of product lines, there are no issues associated with those recurring cost on the programs but as we have introduced and you ramp these new products we have had inefficiency this year around the models we made go into certification. We would expect some of that will bleed off obviously as we go through the beginning of the new year, but the real issue here is that, despite those better volumes and fairly good confidence with respect to new product programs we think that the pricing environment the challenges in the legacy product given the dynamics in the marketplace, it’s still going to be pretty tough and so as we factor that in. That’s where we end up with the guidance number that we are giving you guys and we would over to see that be the better number and if we see some turn in the market I think we can make that happen but we were kind of burned by the going from 2012 into 2013 and so I think we are going to be very conservative about our perspective of what the overall market is doing as we go from 2013 to 2014.

Julian Mitchell – Credit Suisse

Sure and then, within Cessna off the market, it sounds like you think, this will be a pretty flattish demand here. I guess if you kind of activity take-offs and landings and so when you got some better news I guess particularly in markets like Europe versus the nine or twelve months ago the U.S. is pretty stable. I just wonder why it is you think the market is be kind of flattish.

Scott Donnelly

I think the commercial be up a bit at Cessna but – I mean the fleet does continue to grow a bit ADUs in the US have been quite stable kind of 0.68, 0.67 as we’ve grown through the – as to what happens in the European markets or the Latin American market, I think there is – it’s still bit of a wild card. But we are assuming low to mid-single-digit growth in the service business on a year-over-year basis.

Julian Mitchell – Credit Suisse

Got it. Thanks and lastly just on Systems. You got a pretty healthy profit increase in for 2014. Is that’s something we should see straight off from the beginning of the year, or you think there will be some lumpiness around that?

Scott Donnelly

I think it will be more back-end loaded, Julian, again primarily driven by the fact that the dynamic on the UAS business is transitioning from this development program which is a very low margin program to the delivery of the production programs which are reasonable and normal production sort of margins. But all those deliveries will be in the third and the fourth quarter of the year.

Julian Mitchell – Credit Suisse

Great, thanks very much.

Operator

And our next question is from the line of Jeff Sprague representing Vertical Research. Your line is open.

Jeff Sprague – Vertical Research Partners

Thank you. Good morning. Just a couple quick follow-ups. Scott, has there been any change in just the tenor of order activity around actually getting the sorts is that something really – to a significant degree for the sales effort or not really.

Scott Donnelly

You don’t know – Jeff, I don’t think the dynamic and people knew they were coming and very close communication with customers for quite some time in terms of the status of those things that the fact that it happened so late in the year, probably cut a few aircrafts out that we would do. Otherwise I have expected to get delivered, but that was just more around – it became such a compressed schedule right there at the end to just try to physically make the transition happen obviously we got a quite a few aircrafts sold in a very short period of time. I mean, essentially, of course the book showing the 28. So that one with window we are able to title and transfer 20 aircrafts between M2s and sovereigns. So, but I think it had happened earlier in the quarter, clearly there was an opportunity that we would have sold a few more aircrafts. I would say in terms of on a go forward basis, Jeff, it’s a biggest issue that will drive orders and backlog particularly as we look into 2015 is getting the latitude flying. So that aircraft, once it starts being able to demo the aircraft that will start to generate some order momentum and we saw that on the Sovereigns M2. So once you have aircrafts that are out flying and able to do some demonstration and get up to shows and get it around the customers, you do need to have that to start generating the order momentum.

Jeff Sprague – Vertical Research Partners

Great, but I’m just wondering on Bell, anything to be aware of their margin trajectories flows out over the year, and second the carryover inventory cost on the labor disruptions plus as we roll into the multi-year is there any – the new multi-year is there any long lead time stuff that weighs on margins in 2014 as we start the kind of movement to 2015?

Scott Donnelly

I think we are probably a little more pressured in the early part of the year. In part we are recognizing now some of these lower margin military programs, particularly in the H1s some V-22 pressure as you move through the course of the year. But because more of o our volume is going to be dependent on the commercial business. Now as you know that commercial does tend to – from a seasonality standpoint tend to be loaded more towards the latter half of the year and particularly a lot of the larger helicopter programs which tend to be the larger generator of profits in terms of the overall mix will be more skewed towards the back of the year. So, it’s going to be not a wild swing, but I would say will be more pressured in the earlier part of the year on a Bell margin that we would be in the third, fourth quarter.

Jeff Sprague – Vertical Research Partners

Okay, but for the multi-year that extended work expecting a step-down in 2015 we really feel that calendar 2015 and V-22 margins there is no kind of no early lead time stuff that starts to impact 2014.

Scott Donnelly

Now because, we do this when we recognize revenue. Now we do have some aircraft that will be delivered in the fourth calendar year of 2014 which is under that FY 2015 government calendar. So there will be some multi-year to deliveries and that will be in the fourth quarter of this year.

Jeff Sprague – Vertical Research Partners

Okay, and then just finally on V-22, at this point it’s still unclear but you would expect that the U.S. government makes the marine whole and the six unit that are going to the Israel that ultimately be made hold somewhere later in the program?

Scott Donnelly

Well, that’s certainly the marine course’s expectation, I would just caveat that was subject to all the budget stuff that’s going on. I think that remains to be definitized.

Jeff Sprague – Vertical Research Partners

Okay, thanks for color Scott.

Operator

We have a question from Myles Walton with Deutsche Bank. Your line is open sir.

Myles Walton – Deutsche Bank

Thanks, I did have just a couple follow-ups, one on Bell first. Can you give us a sense of the total revenue you have there with respect to the refurb and aftermarket services that the army does that stand down their fleet?

Scott Donnelly

Yes, if you look at the program, in total it’s typically a little under $100 million a year of revenue between refurbishments, new cabin builds, spare parts and service.

Myles Walton – Deutsche Bank

And probably a little better than or better than the Bell average I would imagine?>

Scott Donnelly

No, it’s probably about normal, if you look those total mix between new builds and spare parts.

Myles Walton – Deutsche Bank

Okay and the other follow-up was, you talked about the second half systems deliveries and just wanted to confirm, is that expectation in the backlog today or it’s in the plan but we are waiting for it to land in the backlog? I’m just curious in terms of the visibility?

Scott Donnelly

I am sorry, which program?

Myles Walton – Deutsche Bank

On the second half systems….

Scott Donnelly

Oh, yes, I am sorry. No, we had those programs, those contracts have been in-house for quite sometime and as I said, the units have actually been manufactured. So, it’s just we haven’t done condition because we can’t transfer title until after we’ve completed the development piece which is a separate contract. But we actually have two separate production contracts that we already have in-house for the production units of TCDL.

Myles Walton – Deutsche Bank

Okay, perfect. Thanks.

Frank Connor

Operator, before we go to our final or follow-up call, I just wanted to clarify on the question from Jason relative to the R&D tax credit that, in 2013 we had about $11 million of a tax credit related to 2012 plus another $15 million remain related to 2013. Obviously that is now taken on in terms of our 2014 tax rate. So with that we will take our final call operator.

Operator

All right, our final question today will come from the line of Peter Skibitski with Drexel Hamilton.

Peter Skibitski – Drexel Hamilton

Yes. Scott, just on the Bell commercial helicopter outlook I know you said, it’s up for 2014 that’s your expectation, but we had kind of a blow out this year particularly on the 407 and 429 was very strong. I am just wondering what is giving you the confidence that those that continue to see growth in 2014 on the Bell commercial side if it’s primarily oil and gas or if you see other end-markets improving as well.

Scott Donnelly

You know, it’s really been the growth and our order book has really been across the board. So oil and gas has been strong. Emergency medical service has been quite good and as I said, we’ve seen significant growth in the 40. Now the 407GX product has done extremely well in the marketplace and have been very competitive and I expect we’ll continue to see that the 429. Volumes have been up and we expect to see those volumes up again. The receptivity of the product particularly with the extra 500 pounds which we’ve seen approved in many markets around the world we are still working on that with the FAA for the US market. But most markets outside of US and Europe have given the additional 500 pound gross weight increase and that product is doing extremely well in a very broad range of markets. So, the strength in terms of what’s going on in the helicopter market has been good and our share as a result of the new product has been growing.

Peter Skibitski – Drexel Hamilton

Very good. Thanks very much.

Frank Connor

Okay that concludes our call for today. Thanks for joining us.

Operator

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