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BE Aerospace, Inc. (NASDAQ:BEAV)

Q2 2010 Earnings Call Transcript

July 27, 2010 9:00 am ET

Executives

Greg Powell – VP, IR

Amin Khoury – Chairman and CEO

Mike Baughan – President and COO

Tom McCaffery – SVP and CFO

Analysts

Gautam Khanna – Cowen and Company

Troy Lahr – Stifel Nicolaus

Robert Spingarn – Credit Suisse

Peter Arment – Gleacher & Company

David Strauss – UBS

Howard Rubel – Jefferies

Eric Hugel – Stephens

Myles Walton – Deutsche Bank

Richard Safran – Buckingham Research Group

J.B. Groh – D.A. Davidson

Patrick McCarthy – FBR Capital Markets

Carter Leake – Davenport & Company

Ed Keller – Oppenheimer

Operator

Good morning, my name is Jessica Morgan and I'll be your conference facilitator today. At this time, I'd like to welcome everyone to the BE Aerospace second quarter 2010 earnings conference call. All audience lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions)

As a reminder, ladies and gentlemen this conference is being recorded this day, July 27th. 2010. Thank you. I'd now like to introduce the Aerospace’s Vice President of Investor Relations, Greg Powell. Mr. Powell, you may begin your conference.

Greg Powell

Thank you Jessica, good morning, everyone and thank you for joining us this morning. Today, we are here to discuss our financial results for the second quarter ended June 30, 2010. By now you should have received a copy of our news release that we issued earlier this morning. If you haven't received it, you will find a copy on our website. We will begin this morning with remarks from Amin Khoury our Founder, Chairman and Chief Executive Officer and then we will take your questions.

For today’s call we have prepared a few slides to help you follow on our discussion. You can find our presentation on the Investor Relations page of the BE Aerospace website. 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 Tom McCaffery, Senior Vice President and Chief Financial Officer. As always, in our prepared remarks and our responses to your question we will rely on the Safe Harbor exemptions under the various Securities Acts and our Safe Harbor statements in the company's filing with the SEC. After the prepared remarks, we will address your questions. At that time, Jessica will provide instructions on how to ask questions. As in the past please limit your questions to no more than two at a time so that we’d be able to get to everyone.

Now I'll turn the call over to Amin Khoury.

Amin Khoury

Thank you Greg. And good morning, everyone. I am pleased to report that our second quarter results were above our earlier expectations. Our earnings growth was driven by significant margin expansion at both our consumables management and commercial aircraft segment.

Our consumables management segment operating margin expanded by 160 basis points while our commercial aircraft segment operating margin expanded by 140 basis points. Overall, operating earnings increased 7% on a 2% increase in revenues. Operating margin expanded 70 basis points to 16.3%. Earnings before taxes exclusive of a $2.5 million debt repayment charge increased 14.6% and earnings per share excluding the $0.02 per share debt repayment charge increased by 11.4%.

In addition, our free cash flow conversion ratio was 125%. We prepaid $75 million of long term debt and for the third consecutive quarter our backlog grew. This together with recent robust increases in global passenger traffic and airline yield and profitability underscores our expectation for stronger bookings and operating results in the second half of 2010 and significant improvements thereafter.

As a result, this morning we raised our 2010 EPS guidance by $0.05 per share to approximately $1.50 per share exclusive of the $0.02 per share debt repayment charge. The $50 per share guidance is $0.10 per share better than our beginning of the year guidance and implies that our second half EPS performance is expected to be about 10% better than the first half of 2010.

This morning I'd first like to discuss the current market environment. Then we will review our second quarter financial and operating results and finally, we'll discuss our updated guidance for the remainder of 2010 and our promising outlook for 2011. Let's first discuss the current market environment.

The global macroeconomic environment appears to be slowly but steadily improving, albeit with occasional steps backward. And in spite of headwinds from the Icelandic volcano eruption in April and the ongoing European debt crisis, the important global airline metrics which we follow continue to improve significantly. International traffic was up a robust 7.2% in the first half of 2010 as compared to first half of 2009.

Premium international passenger demand has also begun to accelerate. Through May, premium traffic expanded a strong 10.5% along with increasing traffic, fares and yields have also improved significantly. In fact, during May international airline revenues from premium traffic was up an amazing 44%. U.S. airlines are also reporting an improvement in yields which is a notable [ph] part assisted by an increase in corporate spending, for example, Delta reported that revenue from corporate sales was up 60% in the second quarter. In fact, the U.S. airline June passenger revenue was up an extremely strong 25%.

In addition, the airline industry has done a respectable job of keeping capacity in check which is bolstering their efforts to raise fares and increase fees. During the month of May, international capacity grew 4.8%. While that was a largest jump in nearly two years, international capacity growth lagged the 11.7% growth in passenger traffic, pushing load factors to near record levels.

North American airlines have done even better and have shown the strongest load factors as they have more precisely matched capacity to demand. The approximate 5% growth in capacity will certainly lead to an increase in aircraft overhaul activity. During the downturn, MRO parts suppliers were struck with its steep reduction in revenue due to the effects of airlines parking aircraft and deferring maintenance compounded by MROs in airlines destocking inventory.

The MROs not only serviced fewer airlines but also purchased less inventory per airline to perform what maintenance was still occurring. The Aero strategy group has forecast MRO activity to increase significantly beginning in the second half of 2010 and to accelerate through 2012 as capacity increases and deferred maintenance is taken care of. The Aero strategy group expected to see airlines send a wave of deferred maintenance aircraft through heavy checks which they believe will result in an inventory restocking, as a result of the improving metrics, IRS [ph] has significantly increased its traffic and financial forecast for 2010.

The international transport association now expected 2010 international passenger traffic growth of 7.1% for the full year and cargo traffic growth of 18.5% and for airlines to post aggregate global profits of $2.5 billion. That's a $5.3 billion improvement compared with IRS March forecast which called for $2.8 billion loss at that time.

Let's turn to slide two, and review our financial results for the second quarter of 2010. The bar chart on slide two reflects our second quarter 2010 financial performance versus the second quarter of 2009. Revenues of $484 million increased 2%. Operating earnings of $79 million increased 7% and operating margin of 16.3% expanded by 70 basis points.

Earnings before taxes of $59 million exclusive of a $2.5 million non-cash debt repayment charge increased by 14.6% on the 7% increase in operating earnings and lower interest expense as a result of our ongoing debt redirection initiatives.

Net earnings were $39 million or $0.39 per diluted share increases of 12.4% and 11.4% respectively as compared with the prior year. Again, that is exclusive of a $2.5 million or $0.02 per share non-cash debt repayment charge, on a GAAP basis $0.37 per share. Free cash flow was $46.5 and represented a free cash flow conversion ratio of 125%.

Slide three, summarizes our current backlog status. Bookings during the second quarter of 2010 were strong at $550 million reflecting solid bookings with respect to both new aircraft and after market programs. The book-to-bill ratio was 1.1 to 1 for the quarter and for the third consecutive quarter represented a book-to-bill ratio in access of 1. Backlog at the end of the quarter was approximately $2.8 billion and increase of about 4% as compared with the company's June 30, 2009, backlog. And supplier furnished equipment programs awarded expanded to $2.62 billion as a result total backlog booked and unbooked expanded to a record $5.4 billion.

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 of $193 million were 1.8% lower as compared with Q2 2009. Sequentially, Q2 2010 revenues increased 3.8% as compared with the first quarter of 2010. Operating earnings increased 6.7% and operating margin of 19.8% expanded 160 basis points as compared with the second quarter of 2009.

Bookings in the first half of 2010 increased more than 10% sequentially as compared with the second half of 2009. Importantly, operating earnings in the first half of 2010 increased 10.6% on the 4.7% increase in revenues that's sequentially as compared with the second half of 2009.

Let's turn to slide five, and review the second quarter results for the commercial aircraft segment. For CAS, revenues of $236 increased a little better than 5.5% as compared with the second quarter of 2009. Commercial aircraft segment spares and bookings increased at a healthy double digit rate, as compared with the second quarter of 2009.

Operating earnings increased 15.8% and operating margin of 15.5% expanded 140 basis points as compared with the second quarter of 2009. Operating margin expanded 140 basis points primarily due to a higher level of spares revenues and ongoing operational efficiencies.

Let's turn to slide six, and review the second quarter results for the business jet segment. Revenues of $54.4 million were flat as compared with the second quarter of 2009. Operating earnings of $4 million decreased $2.5 million as compared with the second quarter '09, primarily as a result of an unfavorable mix of product revenue in the current year period.

Significant improvement is the business jet segment is expected in 2011, primarily due to the expected improvement in mix as reflected in the quality of the current business jet segment backlog.

Please now turn to slide seven, which reflects our financial position as of June 30th. Second quarter free cash flow was strong at $46.5 million or 125% of net earnings. During the quarter, we prepaid $75 million of long term debt. We have now prepaid $175 million of long term debt, since the fourth quarter of last year. Our net debt to net capital ratio is now 35.5% an improvement of 610 basis points, since June 30th of last year. As you can see from slide seven, we have a solid capital position, our liquidity is strong and both are improving.

Let's go to slide eight and spend a few minutes discussing our outlook and our 2010 guidance. As a result, of our better than expected performance during the first half of 2010, improving global air traffic and improving airline yields and profitability, we are raising our 2010 full year earnings per share guidance by another $0.05 per share to approximately $1.50 per share, exclusive of the $0.02 per share of non-cash debt prepayment charge.

2010 revenue are now expected to be about – equal to 2009 revenues of about $1.94 billion. In addition, we expect to generate free cash flow in excess of 100% of net earnings for the full year of 2010. Importantly, based upon our expectation of a continued expansion in orders and backlogs and a continued recovery in our commercial aircraft segment spares and consumables businesses during 2010, as well as higher levels of wide body aircraft deliveries in 2011, we expect a significant increase in revenues, earnings and cash flows, beginning in 2011.

With that I'll turn it back to Greg.

Greg Powell

This completes our prepared remarks. And now we'll be glad to take your questions. As usual, please again limit your questions to no more than two at a time, so that we can get to as many of you as possible. Jessica, will you now provide instructions on how to submit your questions?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question today comes from Gautam Khanna from Cowen and Company.

Gautam Khanna – Cowen and Company

Hey, guys. A couple questions. First, were there any AIT charges in the second quarter and how large were they and are we now done with those?

Amin Khoury

We did have AIT costs in the quarter. And as we mentioned on the last quarter call, we prefer not to break them out because they are about the same as the charges were in the second quarter of last year and the first quarter of this year. They were about flat. We do expect them to decrease significantly in the third quarter and to about disappear in the fourth quarter.

Gautam Khanna – Cowen and Company

Got it, so if we just – last quarter I believe it was 3 million and so margins were perhaps marginally sequentially down? Is that right, at the consumables segment? Was there any mix or pricing effect noteworthy?

Amin Khoury

They were about the same as the first quarter and they were significantly improved as compared to the first quarter of last year.

Gautam Khanna – Cowen and Company

And just a quick follow-up. Are you seeing any sort of differentiation in terms of spare order trend at commercial aircraft versus the consumables segment? Thanks.

Amin Khoury

Well, commercial aircraft segment spares orders trended down more quickly than the consumables orders did. And they came back more quickly as well. So we're a good six months ahead, whereas CAS spares orders really began a significant increase in the second half of last year. The consumables business order pick up, really didn't occur until the first half of this year. So first half spares orders – sorry, first half consumables orders are up at a double digit rate compared to the second half of last year. Whereas CAS spares are up at a double digit rate both with respect with the first half of last year and second half of last year.

Gautam Khanna – Cowen and Company

Got it. Thanks, guys.

Amin Khoury

Okay.

Operator

We'll move now go to Stifel Nicolaus, Troy Lahr.

Troy Lahr – Stifel Nicolaus

Thanks. I was just wondering if you can give me a little more color on 2011. I mean, can you just maybe talk if you're a little more optimistic regarding next year than you were over the past few quarters and I know, if you can talk about what discussions you had out of Farnborough and if that's helped. You kind of, clarify a little bit for 2011?

Amin Khoury

I'll ask Mike to comment on Farnborough orders. But I would say that over the past few months volume passenger – revenue passenger miles have accelerated. Spares and yields are up. Airline profitability has taken a dramatic turn for the positive, IRS has raised its forecast for profitability by more than $5 billion. Our cargo traffic is up almost 20%. So the world has started to work again. Corporate bookings from the airlines – well, delta mentioned a 60% number in the prior quarter. So the macro environment is improving significantly. Airline yields and profitability are up substantially. Backlogs at the OE's are solid and we're expecting about a 15%, 16% compounded growth in wide body deliveries over the next four years. So the environment is looking pretty positive. And we're feeling pretty positive about '11.

Troy Lahr – Stifel Nicolaus

Was Mike going to talk about Farmborough.

Mike Baughan

But dramatic Farmborough was place to, exactly what Amin was talking about, we've had three orders now of bookings are booked to bill in excess of one, much of that bookings, particularly in the second quarter are in support of new aircraft requirements. And I think Farmborough just showed how robust those requirements are that was over 400 aircraft awarded for Boeing and Airbus. A lot of that was narrow body and that gave us some comfort relative to next year and beyond that narrow body production rates, the OEM delivery rates are going to hold. So I'd say we're more confident there. Obviously, wide body rates are up ticking significantly and we're looking at a 16% tagger there for the next four years. So we're more encouraged now about OEM delivery rates than maybe we were a couple of quarters ago for '11. I would say the bookings outlook is very encouraging. In the second quarter, we had a very broad based set of bookings, mostly international carriers, mostly in support of new aircraft purchases and with an emphasis on wide body bookings.

We continue to benefit from the Kaleido [ph] issues, so we were able to take some share because of those issues from work that otherwise would have gone to Kaleido and all of the geography were strong. So particularly Middle East and China and Latin America and I think if we look ahead we're expecting more of the same. We are – expect airlines will continue to have to place their requirements to support their new aircraft requirements, particularly 787 and 777, A-330 in the coming months. I think we've talked before about those, kind of, new aircraft requirements often have to – often lead to retro fit opportunities as airlines have to harmonize their interiors and so we're expecting retro fit bookings to grow in 2011 and beyond. And all of that supports our revenue projections for '11 and '12 and '13. So we’re – we've always being pretty encouraged about '11 and we continue to be very encouraged about '11 based on what we’re seeing in the market.

Troy Lahr – Stifel Nicolaus

Okay. And you're having discussions with customers on retrofit now or you expect those discussions, kind of, start the back half of this year on retrofit.

Mike Baughan

We're, in fact, doing some retrofit work now, we’re doing work with several carriers for retrofit, so it’s not a new development, but we do retrofit work with Continental and United and contest a number of people now, but we do expect the retrofit bookings and retrofit market to grow and to expand as airlines who are looking at 787 awards and 777 awards and later on A-350 awards to migrate into those new interiors into their existing fleets.

Troy Lahr – Stifel Nicolaus

Great. Thanks, guys.

Operator

We'll take a question now from Robert Spingarn with Credit Suisse.

Robert Spingarn – Credit Suisse

Good morning.

Amin Khoury

Good morning.

Robert Spingarn – Credit Suisse

Amin, could you delve into biz yet a little bit further. I think when you first guided to down revenues for this year; it was attributable to weaker biz jet perhaps in the OE side, can you talk about what's going on there to what extent that's changed in your new guidance and how we should think about that unit in terms the mix you talked about, is that super first class, is that traditional biz jet?

Amin Khoury

No, it’s first call. And it’s primarily one very large program which was not very profitable. That will be gone by the end of this year. And the outlook for '11 based on the backlog that we’ve got and the margins that we’ve got in the backlog is that biz jet segment will have a very good year next year.

Robert Spingarn – Credit Suisse

When you talk about one particular program not being very profitable is that execution driven? Or was it just contracted at an aggressive price?

Amin Khoury

It was actually – it was contracted at an aggressive price. It wasn't known at a time how aggressive the pricing was. It was specification improved with basically what it was. But the program is behind us and the backlog is really a quality backlog, so you should expect to see first significant growth in revenues and a very substantial growth in profitability and margin expansion in that segment for 2011.

Robert Spingarn – Credit Suisse

And again, '11 is driven mostly again by this wide bodies coming in.

Amin Khoury

'11 is driven by first class because the biz jet environment per se does not look particularly healthy in 2011 except for the increase in the very small jets which don't account for much in terms of revenues.

Robert Spingarn – Credit Suisse

Okay. And then just one other thing on the consumables business, could you talk a little bit about any expansion in your catalog. Obviously, recovery is going to drive volume gains there. But at the same time can you also see opportunity from a market share perspective as you take new customers and more product?

Amin Khoury

You know, for the past two years, we have been intensely focused on completing the integration of ACS and I am thrilled to say that we have no more customers on the original BE pick IT system. We have no more inventories in that system. We are basically out of the IT system. We’ve got to close it out here during the month of July, but the integration is essentially complete. That has been an intense activity where we have had to move 3500 customers from one system to another and to operate multiple systems, moving orders back and forth between the two and so on and so forth.

So we haven't concentrated our efforts on expanding the product line during that time period. We have concentrated our efforts on trying to maintain the customers we've got and maintain the level of quality and on time delivery to be able to hold onto the base of customers that we have had during this integration. We've done a terrific job of accomplishing that objective. We've done a terrific job of accomplishing that objective. The cost of doing that is now behind us, it was a very significant cost as you know. We have some straggling costs here in the third quarter, contractual costs primarily, which declined substantially in the third quarter and essentially disappear in the fourth quarter. We are now turning our attention to product line expansions and to further geographical expansion, but I would say during the past 12 months, we haven't done much of that.

Robert Spingarn – Credit Suisse

Amin, do you have a target for market share or product line expansion and an annual growth target?

Amin Khoury

You know, at the peak, the business was operating at about a $1.2 billion rate, we were doing about $100 million a month in revenue. We're operating at a rate just under $800 million now. So we – basically as the cycle returns, we should see about a 50% growth in revenue just based on the product lines which we have. We are looking at further product line expansions and geographical expansion, but just the cycle should carry this business to about a 50% growth over the next several years.

Robert Spingarn – Credit Suisse

Okay. Thank you.

Operator

We'll move now to Gleacher & Company and Peter Arment.

Peter Arment – Gleacher & Company

Yeah, good morning. Amin, just, I guess a follow up on the last question on the consumable growth. I guess, is it reasonable to assume just given the way the bookings have sequentially improved and given the lag that you've talked about that we'll see this business return to sequentially low double digits in the second half of this year, as deferred maintenance begins to pickup. Or is it more expected for 2011? I guess, how we thinking about the pace there?

Amin Khoury

I think there we should have small improvements in the latter part of 2010. I think our bookings will start to accelerate in the latter part of 2010. And then we should have significant growth in revenues in 2011. So the way we are currently expecting it to play out is bookings continue to improve and at and add an accelerating pace in the second half of this year and then revenues accelerate in 2011.

Peter Arment – Gleacher & Company

Okay. And then maybe just a quick one for Mike, just given the – where narrow body production rates going and the number of orders that are taking place, have you had any further penetration on the – for the pinnacle amongst carriers, any update there would be great?

Mike Baughan

Pinnacle has been our most successful product launch and I would say the industry is most successful seating launch ever we’re thrilled with the success that we have with pinnacle, yes, we've won some more awards. And we've actually had our first delivery. So the program and that launch has been excellent for us.

Peter Arment – Gleacher & Company

What about the dollar volume of orders, Mike?

Mike Baughan

We have been awarded over $300 million or so at this point in awards for that product and that’s pretty much across most aircraft type narrow body and wide body…

Peter Arment – Gleacher & Company

Great. Thanks very much.

Mike Baughan

…including 787.

Peter Arment – Gleacher & Company

Great. Thanks.

Operator

We'll take a question now from David Strauss with UBS.

David Strauss – UBS

Good morning.

Amin Khoury

Good morning, David.

David Strauss – UBS

Amin, your guidance for the rest of the year outlook, it looks in the first half of the year, you did about $0.73. You're calling for $0.77 in the back half. You're going to have a bit of a benefit from lower interest expense and then AIT expenses going away. Is there anything else going on? Is there any reason why the second half wouldn't be up more given those things?

Amin Khoury

No, we don't have any negative to tell you about that might offset the improvements. Is that what your question is?

David Strauss – UBS

Yeah. It just seems pretty conservative given lower interest expense and AIT costs going away, which seems like calling for about flat sequentially, if you adjust for those two things.

Amin Khoury

Well, you know, our forecast is our forecast. We certainly don't want to fall short of any of our forecasts.

David Strauss – UBS

Okay. Fair enough.

Amin Khoury

I think the focus on our company is largely going to be 2011 and as we have done in prior years, our expectation is to do a meeting in New York in October and to be consistent with reporting of third quarter results, we'll update this year and then we'll give a preliminary guidance – quantitative guidance for 2011.

David Strauss – UBS

Okay. Inventory level is overall relatively flat sequentially. How do you feel about inventory levels on the consumables side, on the faster side, relative to what you see coming in terms of the order levels?

Amin Khoury

That is – that is tricky. And the reason it is, is because when you measure the number of months or years on inventory, you got on hand, you measure it based on the current rate of sell through. And the rate of sell through can pick up in a single quarter or a single six month period of time and what looked like two years of inventory instantaneously becomes nine months of inventory and a quarter later, it’s three or four months of inventory.

And that is the issue for us. So we are on sort of pins and needles right now as we – because we have sufficient inventories on hand to handle the current volume and in fact, an increase in volume. But it wouldn't surprise us at all if orders began to take off and we got ourselves into a situation where we need to begin to buy inventories again.

So I don't know that we want to make a specific prediction. I think what Tom has said in the past is that you should expect our working capital to grow at about the rate the revenues grow. And I don't think we have a need to change that guidance. Tom, would you like to expand on that?

Tom McCaffrey

Yeah. Amin, I think that sums it up fairly. With respect to consumables, we monitor demand for our parts on a regular basis and look and see what's going on and also look at lead times. So that is something that we – you look at very carefully and the other businesses, that business as well. I mean, it will show growth in working capital consistent with expected increases in revenues.

Amin Khoury

I would say – I would say David that at this point in time we're beginning to concern ourselves more with having enough inventory on hand to handle the expected buildup rather than as our – as what we had been doing basically is squeezing inventories and generating cash. I think that from here on in, you should expect working capital to grow at about the same rate as revenues.

David Strauss – UBS

Thanks for the color, Amin.

Amin Khoury

Okay.

Operator

We'll move now to Howard Rubel with Jefferies.

Howard Rubel – Jefferies

Thank you very much. Couple things, Tom, usually I give you a hard time about cash. So this time when you did a nice job, I got to give you some credit.

Tom McCaffrey

Yeah.

Howard Rubel – Jefferies

And I just wondered whether you were going to take advantage of these low rates and think about turning some of this floating debt into more permanent borrowing?

Tom McCaffrey

You know, Howard, we continue to look at our capital structure over time and there is – we're very comfortable with the bank debt that we have out there currently. It is floating rate. But it gives us the ability to prepay it at will and as we've said in the past that absent in accretive built on acquisition, we're likely to just pay down the bank debt.

Howard Rubel – Jefferies

Appreciate that. And then as a follow-up, maybe I don't know whether this is Mike or Amin, as your just talk with your airline customers, are you finding that with capacity at such high levels that the interior is starting to be a bit more of a selling point than maybe it had been in recent periods? And then just as a follow on to that, would you characterize your discussions with customers today as up sharply relative in that you need to think about increasing your production slots?

Amin Khoury

Howard, I'm going to ask Mike to answer that question but before that I'm going to ask Tom, would you please comment, mention our current interest rate on our floating rate debt, which you didn't during the – your response.

Tom McCaffrey

Yeah. Right now, we're paying about 5.5% on the bank debt, on the floating rate debt.

Howard Rubel – Jefferies

Okay. And Mike, would you comment relative to Howard's questions.

Mike Baughan

Yeah, I think Howard, airline conversations are two pronged. As I mentioned, the first is what do they need to do to equip their new aircraft purchases, that's number one. We are having a lot of discussions with airlines about retrofit and those have a lot of different drivers but two of the leading ones are weight savings and maximizing or I should say not maximizing but optimizing seating density or from a revenue model and that means all different things to different airlines. So I can mean going to lie flat seating. It can mean changing space layouts in the airplane, whatever.

And so for instance, we've had some – we have some retrofit opportunities on the table now for coach that are weight driven. What can airlines do on a given existing airframe to reduce the weight of their – say economy class cabin. So those are the kind of discussions that we're having. Relative to – is it an uptick, I would say our RSP book – I don't have the specifics. I won’t try to guess it then but it is certainly higher than it was a year ago.

Howard Rubel – Jefferies

Thank you, gentlemen.

Operator

We have a question now from Stephens with Eric Hugel.

Eric Hugel – Stephens

Hey. Good morning, guys.

Amin Khoury

Good morning, Eric.

Eric Hugel – Stephens

Amin, can you talk about, I know Hamburg was in mid-May. Can you talk about sort of level of activity at the show?

Amin Khoury

Yeah. I'm going to ask Mike to do that but it was amazing, the quality of the people that were there was amazing. The size of the teams that the major airlines sent was impressive. Mike, why don't you expand on the Hamburg meeting and I think it will help to answer Howard's last question as well. There's an awful lot of RSP activity among the major airlines both with respect to buying new aircraft and planning their first deliveries of those new aircraft and retrofitting their existing fleets for commonality. So could you – would you respond to Eric's question and may be expand on your answer to Howard's?

Mike Baughan

What was notable to me at that show was, the attendance was strong. There were large delegations from major airlines there and they were there for specific reasons and seemed to want to evaluate real programs and really understand their options on a very grounded set of issues. So it wasn't a theoretical interest, it was a grounded interest in real needs that they had often time and usually a new aircraft requirement.

All of the U.S. delegations were as probably the strongest U.S. participation I've seen in a long time. Large delegations from the major international carriers, Lufthansa, Air France, Emirates, Qatar, BA, all of those kind of people were there in force. And I would say that as I mentioned earlier, our weight and optimizing revenue per aircraft were key levels of interest. What can we do for them to offer a weight efficient solution on a new aircraft or on a retrofit aircraft? How do we optimize their layouts? All those sort of things. So it was a very strong show. Out of it, came a number of very actionable authorities [ph] that we're working on now and even some bookings.

Eric Hugel – Stephens

Great. Sounds good. And Amin, last, can you comment on sort of the M&A pipeline robustness and maybe some thoughts on further industry consolidation. I know, sort of, in your space, zodiac required – announced their requiring cell. Can you talk about sort of further consolidation?

Amin Khoury

I can and I think as we have mentioned on prior calls, there are many opportunities in the consumables side both to expand product lines and to expand our customer base through acquisition. But we haven't wanted to do any of that while we were in the middle of this integration and the integration is essentially complete. We will begin looking at opportunities more thoroughly or intensely beginning in the second half of this year or more likely in the fourth quarter of this year with a view towards perhaps doing something in 2011 on the commercial aircraft segment side.

We really haven't seen any quality opportunities where we could buy something to strengthen our position in that marketplace. We have found that we can better provide for the strong growth in the future by developing programs internally, the SFE programs which had enabled us to more than double our backlogs. We're at a record now. We're at about $5.5 billion both booked and unbooked and as we begin to roll those programs out, we'll have – we should have very rapid growth over the next several years, starting in 2011 and accelerating in 2012 and 13.

So I think the bar is very high. If you look at our growth rate and our growth and earnings and our margin expansion, we don't really want to buy things that dilute our growth rate or dilute our margin expansion given the organic growth in revenues and earnings that we are going to be able to deliver over the next few years.

So the bar is high. We continue to look at things. You can expect some bolt on transactions over the next year or two. But you can see what we've done in the last six months. We've prepaid $175 million of our indebtedness and reduced our net debt to net cap ratio by 600 basis points at 35%. So you can see what we're doing with our cash and it's an ongoing program. When the right opportunity comes, we will make our move.

Eric Hugel – Stephens

Weeks over the SFE business, sort of, ramping up over the next years. Is that something you’re focused more intently on, may be supplying stuff directly to the OEMs if you can do it at a good margin?

Amin Khoury

Well, we've got two points, $2.5 billion or $2.6 billion worth of SFE program where we have been designated as the exclusive supplier. That includes PSU oxygen, lighting systems for the 787. It includes lighting for the new 737 which is first deliveries are going to begin here in a couple of months. It includes the exclusive on the A 350 galley systems and it includes some waste water systems.

So a number of programs that will go directly to the OE's, which will increase our content per aircraft. We saw the ongoing BFE business that is all the stuff that the airlines or leasing companies buy from us when they buy a new airplane but we are increasing our content for SF by selling a lot of equipment directly through the airplane manufacturers which is already on board when the airline buys the aircraft.

Operator

We have a question now from Myles Walton with Deutsche Bank.

Myles Walton – Deutsche Bank

Thanks. Good morning. Thanks for taking my question. Just wanted to follow up on the consumables management margins, I want to understand that. Make sure I understood but you were saying, Amin, about the AIT costs dwindling to nothing in the fourth quarter. So if we look back to 2009 fourth quarter, pre-AIT cost, it was 22.5%. Is that the kind of run rate, we expect as we exit the year?

Amin Khoury

You know, we're not going to forecast the margin, the specific margin number for a specific segment for a quarter. But we expect further margin expansion in the third quarter and more margin expansion in the fourth quarter as we get those costs behind us and as volume begins to improve.

Myles Walton – Deutsche Bank

Okay. I just want to make sure I'm comparing apples to apples on your numbers. And then the other question, obviously, the CapEx seems to be running lighter than the kind of $60 million, you thought about for the year. Is there a step-up in the back half of the year or is there some lower CapEx we should put into the numbers?

Tom McCaffrey

Myles, CapEx ought to be the same. I guess, 60 million, it's just timing. It’s times here but through the construction activities we have for the new plant in the Philippines to support the A350 program.

Myles Walton – Deutsche Bank

Okay. Great. Thanks, guys.

Tom McCaffrey

Sure.

Operator

We’ve a question now from Richard Safran with Buckingham Research Group.

Richard Safran – Buckingham Research Group

Good morning.

Amin Khoury

Good morning.

Richard Safran – Buckingham Research Group

I had a question for you on the interiors. You expressed a lot of confidence in what was driving airlines to upgrade their interiors and your mentioned two things weight and maximizing seat densities as motivators. I was wondering about a possible third one, American Airlines on their 2Q calls said that they were working to enhance customer experience with premium customers by upgrading interiors and this should be primarily on the 37-800. It is going to match airplanes that are being delivered. So what I was wondering is that, it seems to me that there may be another trend here where airlines are having to upgrade interiors in order to remain competitive. I want to know if that’s a trend that you are seeing. Is that a possible third driver for what's motivating airlines to upgrade interiors that kind of thing?

Amin Khoury

I'm going to ask Mike to answer the question. Mike, would you please specifically separate narrow bodies from wide bodies and which types in those two different types of aircraft and what American is doing as compared to what the major international airlines are doing?

Mike Baughan

Yeah. I think the short answer to the question is the absolutely yes. Airlines are continuing and have been for a while and would like to upgrade the passenger experience, particularly in premium class where they in normal times make a disproportionate share of their money. So yes, that continues and if I said maximize density so I misspoke. I would say optimize density since sometimes an optimal density is not maximum.

It’s what makes the most revenue. It could be expanding out and providing lie flat seats in business class, fewer seats with more space for the passenger giving more yield. So airlines are looking at optimizing density and that means different things to different airlines. And we work with them on an individual basis on how best to do that for them.

In American's case, one of the things that they’re doing is repositioning aircraft to longer haul service and that's been a trend for a while. So particularly, on the 757s as they fly those longer routes, they would like to have a different and better cabin for their premium passengers. And we’ve seen that with other airlines as well. For instance, Continental has done the same thing and we're working with them on that kind of program on 757s and we do that with other folks as well.

The business class market and wide body business class market and the retrofit activity associated with that market will be very much driven by what you mentioned, which is upgrading the passenger experience, upgrading yields and revenues in the premium cabins, particularly in business class.

Richard Safran – Buckingham Research Group

Okay. And then just one other thing, on Farnborough – yeah, you’re right, I mean, the order activity was way more than everybody expected. Another interesting point it was that most of the ordering seemed to be coming from international customers. Is there anyway, you could break out on how much you go – what going into backlog is coming from international versus domestic airlines?

Mike Baughan

I think we presented that in our presentation today.

Richard Safran – Buckingham Research Group

Okay. I'm talking about what you see going forward, not what was in – just how you see that trending towards the end of the year?

Mike Baughan

I see it continuing the way it has been. It will be primarily – it will be more international based. We're seeing very strong market activity in the Middle East, in China, in Latin America and we would expect to see some growth. We're seeing participation in all parts of the world but I would say it's a little bit more non-U.S. at this point.

Operator

We'll move now to J.B. Groh with D.A. Davidson.

J.B. Groh – D.A. Davidson

Thanks Mike for the clarification on optimization versus maximization. We're all breathing a sigh of relief, I think. One of the things that I've noticed and you've talked about this in the past. Premium economy, seems like I’ve heard more talk of international carriers with this fourth class. Am I right in assuming that’s – that kind of talk seems to have accelerated recently and maybe you could address that particular market segment and how you guys are looking at it?

Mike Baughan

We're in the middle of a very large premium economy program with Air France that was easily one of the largest one, is about 100 aircraft. And I think premium economy means different things for different people. But that freight [ph] that the wider seat with more pitch for Air France. And for instance with United it's a coach seat at a larger pitch and there's a lot in between.

I think premium economy works in the transatlantic markets. There were a number of people who were flying it there. I think right now our airlines are in a wait and see mode. Many of them are very intrigued and they are looking closely at Air France to see what kind of results Air France has. And I think that we'll – we won't see the next wave of activity until there's a little bit more data in from some of the existing programs.

J.B. Groh – D.A. Davidson

But this plays into your revenue optimization theme.

Mike Baughan

Absolutely. Air France is determined that by converting from coach seats to premium economy seats, they can significantly improve their revenue per aircraft.

J.B. Groh – D.A. Davidson

And for Tom – This free cash flow is obviously pretty good. But your rate on your debt is pretty attractive. What's going to be the use of that cash flow?

Tom McCaffrey

J.B, as we've talked about in the past that if we find it in accretive bolt-on acquisition that we will do that and absent that we'll pay down the debt.

Operator

We have a question now from FBR Capital Markets and Patrick McCarthy.

Patrick McCarthy – FBR Capital Markets

Good morning and thanks for taking my call. Amin, I was wondering if you had a sense of how many aircraft would come out of the desert at this point and maybe how many remain that might come out?

Amin Khoury

I don't, J.B. Mike, do you want to speak up, take a crack at that? I haven't looked at the data for a little while. I did see a report which indicated how many more they expected to come out of the desert and how many they expected never to come out. But I'd rather not just throw a number off the top of my head. I haven't looked at it for a while. Mike, do you have any?

Mike Baughan

I don't have a number either, Amin that I can throw out at this point.

Patrick McCarthy – FBR Capital Markets

Okay. And then just – when you're looking at your FBO customers, do their orders turn to revenues faster than your typical customers or they kind of were in line with everybody else?

Amin Khoury

I think you meant MRO, right?

Patrick McCarthy – FBR Capital Markets

Yes, yes.

Amin Khoury

Our MRO customers – they are about the same as the airlines. And basically, the way the MROs have been starving, I mean they've had a really tough time here. And the MROs owned by the airlines have also been operating at a very low level of capacity utilization. That is beginning to change and I did mentioned, the strategy group report. I think those guys do a pretty good job. So they're expecting a wave of aircraft to start working through heavy maintenance beginning in the second half of this year. That would be both at the airlines and the MROs.

Patrick McCarthy – FBR Capital Markets

Well, okay. And then just finally, Europe and Iceland, any qualitative impact from the quarter or it was just something that you mentioned as a passing by?

Amin Khoury

No. I think the Icelandic volcano activity did reduce activities, reduced number of flights caused the European carriers to lose almost $2 billion in profitability. And yeah, there was definitely a slowdown in the April, May time period. But that's picking up again now.

Operator

We have a question now from Davenport & Company and Carter Leake.

Carter Leake – Davenport & Company

Good morning. Thanks for taking my call. Let's see. Third party commentary on yield load factors and MRO is helpful. But I view order activity you’ve seen as a vision as a far better entertainer [ph] with future end market demand. Can you give more color of what you're seeing right now on that activity?

Amin Khoury

Why would you view order activity at our unit as…?

Carter Leake – Davenport & Company

Well – the MROs would prebuy against the lead time. I would say they would prebuy for the MRO activity.

Amin Khoury

You don't know what they need. They don't know which airplanes they're going to get soon enough. And they get – MROs get a lot of surprises, both airline MROs and MROs generally, independent MROs. They have some feel for what the core products that they're going to need. They've been operating at a low level of activity. They haven't been making money. They have been reducing inventories and de-stocking, so they've been doing everything they could to conserve cash. And for them now to go out and start buying quantities of product in anticipation of future business – it's not something that we would expect and is not…

Carter Leake – Davenport & Company

What would be the lead time? What's the typical lead time? Do you know? Or is it on demand?

Amin Khoury

Yeah. That's the issue. That's why I mentioned earlier that we're on pins and needles here, because while we have sufficient inventories of essentially most of the parts that we need, we expect a jump, a sort of step function increase in orders. And the orders will be AOG type orders. We need it now. We need it tomorrow. We need it in the next couple of days. And we're preparing ourselves for it. We've been through these two or three times now and I don't think this is going to be any different.

Carter Leake – Davenport & Company

Okay. Great. Thanks for clarifying this. And I’m sorry if you said this earlier, on commercial aircraft margins, we certainly saw impressive expansion. The biggest driver of that and two the highest margin we've seen here in the past four years is around 16.4%. Is there more room to run? We posted a 15.5 in this quarter?

Amin Khoury

We think there's more room to run. And spares business is our most profitability business. I would say, a combination of the increase in spares revenues and the success that we're having with our continuous improvement initiatives and our global supply chain initiatives, low cost country sourcing. All of those activities together are driving the margin and there is further room to run.

Operator

And we'll take our last question from Ed Keller with Oppenheimer.

Ed Keller – Oppenheimer

Hi, Amin and thanks for taking my call, a nice quarter.

Amin Khoury

Thank you.

Ed Keller – Oppenheimer

I was wondering if you could comment on what impact did any of the increase in wide-body deliveries over the next couple of years will have on the company's mix of business overall, OE versus after market?

Amin Khoury

Well, our main business and all of the order – not lot of the order activity but a lot of the order activity that we are talking about in the RFP activity, has to do with premium cabins and now coach cabins in new wide-body aircraft. And at the same time the airlines are looking at RFPs and trying to place their orders for equipment for the new wide bodies. They are also looking at retrofitting their existing airplanes for commonality.

That is the main driver of our business. The value of our equipment in a wide-body airplane can be 10 times, as much now as value of the price I'm talking about, number of dollars of revenue per airplane as for a narrow body and so the 16% stagger in wide-body airplane from 10 through 14 is a really big deal for us.

Ed Keller – Oppenheimer

Okay. Thanks. And then also a couple of your competitors have stumbled during the downturn. You mentioned Koito earlier but the business in jet market has been difficult as well. So I was wondering if you could comment on what kind of market share increases you might see on seats, both large commercial and business jet, coming out of the downturn. Thank you.

Amin Khoury

On the biz jet side which you asked about first, we have done a really good job of booking the – of being selective as the exclusive supplier of a broad range of equipment, for most of the new aircraft which will be introduced into service over the next few years. Our market shares will increase significantly in biz jet seating, lighting, oxygen. We're about 100%, so it can't increase more there. Cabinetry still, our shares will be going up as deliveries begin to increase.

We measure share based on the amount of share that we have of aircraft delivered in a particular year. And our expectation is that shares will be going up. It's pretty much the same in the commercial airliner segment where we have booked major orders from customers, which had not been or our main customers in prior years. And that is basically the result of an initiative, which we began a number of years ago which has been very successful.

We've announced orders with Lufthansa and with Air France and with British Airways and Emirates and Qatar and Etihad and United and Continental. We basically – we focused on the largest airlines in the world with the largest wide body fleets. And we have worked those very hard. And so here again, as we begin to roll out some of this $5.5 billion backlog that we're talking about in Book, non-books, our shares will be going up on an annual basis.

Operator

There are no further questions and this concludes our question-and-answer session. Mr. Powell, I'll turn the conference back to you for closing comments.

Greg Powell

Great. Thank you for joining the call today. Sorry, we ran a little bit late but we have lot of questions and we look forward to talking to you again next quarter. Thank you.

Amin Khoury

Good day.

Operator

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

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Source: BE Aerospace, Inc. Q2 2010 Earnings Call Transcript
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