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Rockwell Collins (NYSE:COL)

F4Q10 Earnings Call

October 29, 2010 9:00 am ET

Executives

Clayton Jones - Chairman, Chief Executive Officer, President and Member of Executive Committee

Dan Swenson - Vice President of Investor Relations

Patrick Allen - Chief Financial Officer and Senior Vice President

Analysts

Cai Von Rumohr - Cowen and Company, LLC

Carter Copeland - Lehman Brothers

Jason Gursky - Citigroup

Carter Leake - Davenport & Company, LLC

Robert Stallard - RBC Capital Markets Corporation

George Shapiro - Citi

Joseph Nadol - JP Morgan Chase & Co

Ronald Epstein - BofA Merrill Lynch

Samuel Pearlstein - Wells Fargo Securities, LLC

Troy Lahr - Stifel, Nicolaus & Co., Inc.

Myles Walton - Deutsche Bank AG

David Strauss - UBS Investment Bank

Peter Arment - Gleacher & Company, Inc.

Operator

Good morning, and welcome to the Rockwell Collins Fourth Quarter Fiscal Year 2010 Earnings Conference Call. [Operator Instructions] For opening remarks and management introduction, I would like to turn the call over to Rockwell Collins' Vice President of Investor Relations, Dan Swenson. Please go ahead, sir.

Dan Swenson

Thank you, and good morning, everyone. With me on the line this morning are Rockwell Collins' Chairman, President and CEO, Clay Jones; and Senior Vice President and Chief Financial Officer, Patrick Allen; as well as our incoming Vice President of Investor Relations, Steve Buesing.

Today's call is being webcast, and you can view the slides we will be presenting today on our website at www.rockwellcollins.com under the Investor Relations tab. Please note, today's presentation and webcast will include certain projections and statements that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected as a result of certain risks and uncertainties including, but not limited to, those detailed on Slide 2 of this webcast presentation and from time to time in the company's Securities and Exchange Commission filings. These forward-looking statements are made as of the date hereof, and the company assumes no obligation to update any forward-looking statement.

With that, I'll now turn the call over to Clay.

Clayton Jones

Thanks, Dan, and good morning, everybody. Before I begin my formal remarks on the quarter and the year, I would like to acknowledge something that I think most of you already know, and that is today marks a transition in our Investor Relations position. Dan Swenson, who served us very well for the last two and a half years, is going to be moving to another important position in the corporation, working with our Commercial Systems group and strategic development. And I want to just formally thank Dan for the work he's done, both for our company and for our stake owners. I get a lot of feedback from many of you about the very professional job that Dan has done over this past period, and I'd like to publicly acknowledge that great work you've done for us, Dan.

And in his stead, filling that role, is going to be Steve Buesing. Steve comes out of our finance organization, and has also done an extraordinary job in the position he's held before this. And he and Dan have been working together very closely over the last month and a half, and my expectation is that we won't miss a beat in terms of providing the kind of service that all of you on this call and others expect from our company. So Dan, thank you, and good luck. And Steve, congratulations, we look forward to working with you.

With that, I'd like to proceed with the call. As our fiscal 2010 comes to an end, I would tell you that I'm very pleased with how we closed out the year. And there are a couple of key items that I'd like to highlight. First, we demonstrated very balanced growth as both government and Commercial Systems posted substantial year-over-year increases in fourth quarter revenue and earnings. That strong performance drove growth in our quarterly EPS for the first time since the first quarter of 2009. Additionally, our continued focus on cash flow management has enabled us to achieve another record year in operating cash flow of $711 million.

As we expected, it was a year of two halves, with the commercial market recovery beginning to kick in over the second half of the year. And in spite of some pretty good volatility across the year, we were able to deliver results at the upper end of our earnings per share and cash flow guidance that we laid out over a year ago. And I think the key takeaway from our performance in this quarter and for all of 2010 is our ability to execute and deliver against expectations even in a time of great uncertainty.

What we saw on the fourth quarter has also further strengthened our confidence relative to the guidance we've provided last month for fiscal year 2011. So let me add some color relative to the market environment and how we're positioned to grow as we move into 2011.

Now if we've learned anything to this point, if that this commercial air transport market recovery is very different when compared to previous cycles. In virtually every previous recovery cycle, passenger traffic increases drove the need for increased capacity, which airlines historically satisfied by bringing post-warranty aircraft out of retirement, fueling higher product service revenue. Then as the airlines realized greater profitability, we would typically see a resurgence in retrofit activity as they put in place discretionary upgrades that had been deferred during the down cycle.

All of this preceded OEM recovery and stimulated very strong aftermarket growth. However, in the current recovery cycle, airline is taking a much different approach, satisfying the increased passenger traffic demands through record high load factors and taking delivery of many more new aircrafts. These two factors have delayed the onset and are dampening the rate of aftermarket growth. Now despite all of this, we did realize a healthy aftermarket growth of 6% in the fourth quarter of 2010, although it came a bit later and was a little lower than we were thinking at the beginning of the last fiscal year. For 2011, that trend should strengthen with air transport aftermarket growth of around 8%. And if you exclude wide-body IFE service, it should actually grow in double digits.

So while all eyes were focused on the aftermarket, good things were happening in almost every other area. Passenger and cargo traffic are at levels above the 2008 and 2007 peaks. Global airline profitability predictions have soared. The book-to-bill rate for Boeing and Airbus is likely to be greater than one in 2010. Both OEMs have announced increases in production rates and are considering going even higher. And after several delays, we are cautiously optimistic that the 787 and the 747-8 will enter service in 2011. These factors are expected to drive approximately 10% of growth in our air transport OEM sales in 2011. So while this cyclical recovery is exhibiting abnormal characteristics, I very much believe that it is on balance, a faster, a stronger and a more sustainable recovery than we've experienced in the past.

Now on the other hand, the business jet market recovery is playing out much closer to traditional historic patterns. An increase in corporate profitability is the driving factor for the beginning of the recovery cycle, which evidences itself as improved aircraft utilization. And we clearly see this as utilization factors were up 12% in August, and the full year utilization growth forecast is now in the range of 10% to 12%. These levels of flight activity are still approximately 20% lower than the 2007 peak, but are an indicator that we're headed in the right direction. As a result, our business aircraft service and support revenue has shown strong growth over the past few quarters right in line with the utilization increases.

Along with MRO improvements, we would typically expect retrofit opportunities to increase, and that's exactly what we're experiencing. We're seeing increased retrofits from demand for cabin upgrades with our Venue system, in-flight connectivity products and operational efficiency upgrades for cockpit avionics. As a result of the increased service and retrofit activity, we are expecting growth in the midteens for our business and regional jet aftermarket in fiscal year 2011.

The recovery in the business jet aftermarket typically precedes any recovery in the OEM side. Again, this convention is playing out as OEM order books remained weak and used inventories are holding steady from last quarter at 15% of the total aircraft base. While we expect overall delivery rates to remain relatively flat in 2011, our growth will be much stronger as a result of new platform wins. We will soon begin delivering equipments for the Bombardier Global 5000 and Global Express, important positions for us in a relatively healthy long-range segment for the business jet market.

This, along with a full year production of the Cessna CJ4, should provide growth in the low teens for our business and regional OEM revenue in the coming year. So while the commercial recovery may look a little different, we believe it is gaining momentum and should remain very strong for several years as new air transport and business aircraft enter service and the overall business jet OEM build rates pickup around 2012.

Now I'd like to transition over to our Government Systems business. From a market perspective, we are prepared for the inevitable impact of budgetary pressures on domestic and international Defense Department. These are generally well understood, and their impacts contemplated in the plans that we put together for our fiscal year 2011.

In addition, Rockwell Collins uniquely will experience about $150 million of programmatic headwinds on our Government Systems business such as the wind-down of the KC-135 GATM and F-22 programs, the trough in JTRS revenues as we complete the development testing phase and await initial LRIP reports [ph], as well as the wrap-up of large deliveries of integrated vehicle safety systems that we had for the California Highway Patrol.

Now I think what is notable is that our position in the market should enable Government Systems to realize growth in 2011 even with these headwinds. This past quarter, we saw a 15% increase in deliveries of avionics for rotary wing aircraft. Looking forward to 2011, this growth is expected to continue at a similar rate through our work on programs such as the VH-60 (sic) [VH-60N] Marine One Presidential transport and the CH-47 Chinook for domestic and international customers. Additionally, sales for our special mission aircraft increased 26% in the fourth quarter of 2010 and should continue to grow into 2011, driven by the slickest program and the upgrades for the E-6 aircraft, where we're providing secure network communication suites. In precision weaponry, we were part of the winning team for the Small Diameter Bomb program. And in simulation and training, we won key programs on training systems for the E-2 aircraft.

Finally, we'll see the growth from our positions in the UAV market and the integrated ground-based infrastructure programs such as the Chris program and the recent award that we were able to get to provide ground communications infrastructure and services to support our war fighters in Afghanistan.

A common theme among these programs is that the benefit of using electronics to improve the effectiveness of existing platforms and the increasing need for cost-effective solutions to help our defense customers manage their spending in this tight budget environment.

So bringing all of that together, I believe we have our business segments focused on growth areas and all of our markets and positioned to increase revenues faster than the rate of market growth. And most importantly, we expect the leverage of our shared service business model, coupled with the work we've done over the past two years on cost management, will drive margin expansion and EPS growth as we move forward.

With that, let me hand the call now over to Patrick for the details.

Patrick Allen

Thanks, Clay, and good morning to everyone as well. Let's get started by first reviewing our results for the total company that are shown on Slides 3 and 4. Total company sales for the quarter increased 8% compared to last year's sales, while net income and earnings per share both increased 12%. This increase in net income and earnings per share came primarily from the additional earnings on the increased volume, lower company funded research and development costs and $19 million of lower restructuring charges, partially offset by $40 million of higher employee incentive compensation and pension expenses. Our effective tax rate for the quarter increased from 29.5% in the fourth quarter of 2009 to 31.8% in the fourth quarter of 2010. This rate of increase was primarily due to the absence of the Federal Research and Development Tax Credit, which expired on December 31, 2009.

Turning to Slides 5 and 6, we take a look at fourth quarter results of our Government Systems business, which achieved a revenue increase of 8% from $741 million in 2009 to $798 million in 2010. Airborne Solutions sales increased $52 million or 11% to $527 million. This growth came from an increase in revenues across fixed and rotary wing platforms as well as higher sales related to simulation and training programs.

Surface Solutions sales increased $5 million or 2% to $271 million. Increased sales of ground-based satellite communication programs was mostly offset a decrease in revenue from our JTRS programs as we begin the transition from development work towards lower rate initial production.

Page 6 shows Government Systems' fourth quarter operating earnings, which increased to 6% from $159 million in 2009 to $169 million in 2010, while operating margins declined slightly from 21.5% to 21.2%. This increase in operating earnings was primarily due to higher sales volume and lower customer-funded research and development expenditures, partially offset by higher incentive, employee incentive compensation and pension expenses.

Moving on to Page 7. Commercial Systems' fourth quarter revenues were also up 8% from $449 million in 2009 to $484 million in 2010. Sales of aircraft original equipment manufacturers increased $11 million or 5% to $231 million. Air transport OEMs sales increased $9 million or 9%, primarily due to higher revenues to Boeing from the 787 and 747-8 programs.

Business original OEM sales increased $2 million or 2% due to higher equipment sales for business jet aircraft, primarily related to the production of the CJ4 aircraft, partially offset by lower sales for Chinese turboprop aircraft. Aftermarket sales increased $37 million or 18% to $242 million. Aftermarket sales to the air transport markets increased to $8 million or 6% from higher retrofits and spares and core avionics service revenues, which were offset by a reduction in wide-body IFE service-related revenue. Aftermarket sales to the business and regional jet market increased $29 million or 41% as Air Routing sales contributed $10 million to the revenue growth, while organic sales increased $19 million due to our generally increase in retrofits, spares and service revenue, including some large spare part orders associated with the Project Liberty border patrol aircraft program.

Finally, revenues related to wide-body in-flight entertainment products decreased from $24 million in the fourth quarter of 2009 to $11 million in the fourth quarter of 2010.

On Page 8, we see Commercial Systems operating earnings increased $10 million to $81 million, and operating margins improved from 15.8% of sales to 16.7%. The improvement in operating earnings and margins were primarily driven by higher earnings on the increased revenue volume, which was partially offset by an increase in employee incentive compensation and pension expenses.

On Slide 9, we have our full year 2010 company financial results for sales, EPS, net income and operating cash flow. Of note on this slide is our record level of operating cash flow of $711 million in 2010, an increase of $78 million from operating cash flow of $633 million in 2009. The main drivers here were lower compensation payments made in 2010 related to the elimination of our employee incentive compensation during 2009 as well as overall disciplined working capital management.

Moving to Slide 10, which shows the status of our capital structure. At the end of 2010, we had $24 million in short-term borrowings and $525 million in long-term debt outstanding as compared to no short-term borrowings and about $532 million long-term debt at the end of fiscal year 2009, ending the year with a debt-to-total-capital ratio of 27%. We are comfortable at this level, which in combination with our investment grade credit ratings, provides us ample opportunity to fund our growth needs in a cost effective manner.

The updated status of the share repurchase program as of the end of 2010 is detailed on Slide 11. During the fourth quarter, we repurchased a total of 1.2 million shares at an average cost of $56.61 a share. This brings our total repurchase activity since 2002 to almost 58 million shares or $2.7 billion returned to share owners through maintaining an active share repurchase program.

Now onto our final slide, Slide 12, where we provide the details of our fiscal year 2011 financial guidance that has remained unchanged from what we originally released in September of this year. Regarding earnings per share, I'll point out the guidance range of $3.75 to $3.95 is based on effective tax rate in the range of 31% to 32% and assumes a full year of the Federal Research and Development Tax Credit. Additionally, our tax rate guidance is representative of the full year and the individual quarterly rates are likely to be lumpy and highly dependent on the timing of any R&D tax credit extension.

That completes my review of the financial results and projections. So Dan, back to you to pick up the Q&A session.

Dan Swenson

Thank you, Patrick. In order to give everyone the opportunity to ask questions, we ask that you limit your questions to two per caller. If you have further questions, simply reinsert yourself into the queue, and we'll answer those questions as time permits.

Operator, we're now ready to open the lines.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Carter Copeland from Barclays Capital.

Carter Copeland - Lehman Brothers

Clay, I wondered if there's a topic we haven't touched on in a while, and that's the development on the A350. I wondered if you might provide us with an update of how those efforts are going? What that schedule looks like? Are there things you can see at this point? Are we still a good ways away from knowing how that's all coming together?

Clayton Jones

Well, I think if we've learned anything about new aircraft development over the last five or six years, it's hard, and it would be unwise of any one to declare a victory too soon. From our perspective, the systems part of the A350 is going very well. All of our projects are in line with the schedule, we're in line with the accomplishments we're going to have to date. Obviously, it's still pretty early in the game. But since a lot of what we were doing is technology that is reusable from our work on the 787, we're actually getting benefits from that and not only the cost of development, but also the maintenance and the schedule in development. And so I would say across-the-board on our packages and the systems that we see visibility into, it's going okay. I think on new aircraft across-the-board we're seeing right now, it's much more of a structures issue because they're moving into composite structures, and it's much more difficult for me to comment on that because it's not my expertise, nor do I have specific visibility on it. But my guess is that if there are areas that they're focusing more on, making sure that they get the job done right, it's in those areas there. And so far, as what I've seen and what Airbus has said, we seem to be tracking to the entry-into-service schedules that they put out with no delays to this point.

Carter Copeland - Lehman Brothers

And one quick one for Patrick. Just you briefly touched on the capital structure and the investment grade credit rating. Rates are awfully low out there in the market, and there seems to be some opportunities that appears are taking advantage of whether it's taking advantage of low rates for the pension plan and the like. Is any of that on the table or is it not within the current capacity to keep your investment grade rating? How are you thinking about that?

Patrick Allen

I certainly think we have the capacity to do something and we're certainly mindful of the current interest rate environment and looking at it. I would say that there's no current plans, but we are evaluating our options.

Operator

Your next question comes from the line of Ron Epstein from Bank of America Merrill Lynch.

Ronald Epstein - BofA Merrill Lynch

A quick question for you. I think one of the more interesting things that happened out at NBAA was Garmin announcing the G5000 and finally breaking into the park [ph] 25 market. But how does that change the competitive landscape in the market?

Clayton Jones

Well, first thing, it shouldn't have been a surprise to anybody because they have said, and we have expected them to enter that market for quite sometime. Perhaps the only issue is at what point and how would they do so, and now we know that. First thing, I would say Garmin is an excellent company. They do very good work. They have carved out I think an enviable position in the piston and light jet aircraft market, and we're taking them very seriously as a potential future competitor. I think the answer specific to your question is we expect they are and will continue to be a very viable competitor in this, especially the light end of the business jet market, and so we're taking that seriously. And I think over time, you can expect, ultimately, even though it hasn't really been yet the battle to be joined, where we go head-to-head with them and ultimately, we'll see how that goes.

Ronald Epstein - BofA Merrill Lynch

An maybe just one more little different in the defense world. Can you talk a little bit about JTRS, how you're thinking about it now? How we should thinking about it, potential outcomes?

Clayton Jones

Sure. Well, I know it's a question on a lot of peoples minds. So let me take the opportunity to kind of give you a sense of it. On the last call, we sort of outlined where we were going through the testing phase. And as we were anticipating in next calendar year and in this current fiscal year, the ultimate decision to go into low rate initial production, both on the GMR and the ground mobile radio, and handheld/manpack/small form factor or HMS. Our plans for the year would suggest a successful completion of those testing and then a milestone C or an LRIP decision probably in our third fiscal quarter and the second calendar quarter of 2011 for GMR. And then what that would be followed probably by about the end of the calendar year, a similar milestone C decision for the HMS cluster, and so our plans currently suggest that to be the case. And all of the activities relative to what the Department of Defense is doing is aimed toward those schedules that are in concert with our plans. Now as it happens, what we're seeing is a little bit of change in the testing protocols. The limited use -- we finished the systems integrations test in September and the radios performed to every specification that we had at that time. And we were expecting to go into limited user test in the fall of this year. The Department of Defense has actually now delayed limited user test into next calendar year, primarily because they're using another testing protocol for the Brigade Combat Team Modernization as a surrogate for a limited user test because the GMR is very actively involved in that. If that continues to be successful, as we believe it will, that testing will complete by the end of this calendar year, which is the same schedule we would've had for limited user test when I spoke with you last. Assuming that's successful, we think that there is at least some opportunity that the Department of Defense could accelerate milestone C and actually enter into a lower rated initial productions sooner and the schedule that I just mentioned to you, if all the programmatic details can be arranged within the Department of Defense. We know internal to the Army that there's a great desire to get these network radios out into the field and into the war fighters' hands. And now the question becomes, can we get all of the programmatics in line to be able to do that? So I guess I would summarize, Ron, by saying is our plans still call and the projections for the year call for a sort of an end of the fiscal year decision to transition to LRIP. That's why you're seeing this sort of trough effect for JTRS funding this year at our results. I think there is at least some probability we could see an acceleration of that schedule if the radio continues to perform in the Brigade Combat Team and of the programmatics and the Pentagon allow that to happen. Certainly, the congressional funding is in line to support that because as we know, there's several hundred million dollars in the 2011 funding to support that activity as well. So that's the update.

Operator

Your next question comes from the line of John (sic) [Jason] Gursky from Citi.

Jason Gursky - Citigroup

Clay, just a big picture question for you, and it's encouraging to hear the potential acceleration of the decision. That's something we don't hear very often, and that's exactly what I wanted to touch on. One of the things that we've heard from yourself and a lot of your competitors this year has been a lot of blaze. And clearly, if you look at this from a commercial perspective maybe and think about a sales cycle -- and these are just made-up numbers, but let's say that the sales cycle on the Government Systems side a couple of years ago was 12 months. It seems like potentially it's been pushed out to 18 months. And what I'm trying to get a sense of is whether that sales cycle is continuing to degrade on us, i.e. getting longer, or have we reached now you think the furthest stretched out point in the sales cycle? Maybe just give us a little bit of sense and whether you think that we are going to continue to see more and more delays or whether we're getting to some sort of normalized rate in the sales cycle on the government side?

Clayton Jones

Jason, I'd say two things to the answer to your question. First thing, I wish I was good enough to give you a good answer. And number two, I pray to God it's as far out as it's going to be. It's hard for me to imagine that the sales cycle could be delayed much further than it is now. To your point, I can almost not remember a program that started on the schedule that it was intended to, either because there was some delay in development, which obviously we're seeing; there's some delay in internal review because of personnel on hand or the ability to push it to the Pentagon, which we've seen; or even if we get those two things right, we get protests. This program that we just won for upgrading the infrastructure in Afghanistan was protested, so we're working our way through that right now. And so I guess it could extend a little bit more, but it's almost inconceivable how that could happen. So I would suggest just based on my own Kentucky windage, which many of you like so much, that it's probably at the extent it could be relative to delays, pushbacks, protests. And that's kind of become a steady state right now because we put some factor in almost every new program start to guess what we think the delay is going to be. Of course, the difficulty is guessing correctly. We've got one coming up on the tanker that was supposed to be awarded in November, and I think there are very view of us right now that think that, that date will be met. In fact, I'd say almost no one thinks that date will be met. And so we're into another evaluation delay cycle in that case.

Operator

Your next question comes from the line of from Cai Von Rumohr with Cowen and Company.

Cai Von Rumohr - Cowen and Company, LLC

Patrick, could you update us on the three expense items, you usually talk about, company-funded R&D in fiscal '11, incentive comp where that's likely to be and pension expense?

Patrick Allen

Sure, let me start with the company-funded R&D. We're looking at for FY '11 somewhere probably around 7½% of sales for company-funded R&D. And as usual, it's easily split about 2/3, 1/3, about 2/3 on Commercial System side, about 1/3 on the Government Systems side. So that's the R&D piece. Incentive compensation I guess kind of a good news bad news story there, we're expecting to increase to $100 million total next year or in FY '11, but that is now compared to about $73 million this year because we actually outperformed it on cash flow on our strategic goals, and so what we thought was about a $60 million accrual in 2009 has turned into about a $73 million accrual. So it had a little bit less going into 2011 than we had anticipated when we initially issued our guidance. On the pension side, I want to say pension costs are improving by about $40 million year-over-year, flipping from expense to income. And that really hasn't changed since we shared our guidance.

Cai Von Rumohr - Cowen and Company, LLC

And Clay, can you give us some color on the trends in Defense business? We've seen a number of other folks who've talked about increasing numbers of delays, concerns about the CR. Do you see a CR? Give us some color on those.

Clayton Jones

Well, I just answered the question about the delays. I don't really think they're increasing. I think they've been that way for the last two years, and I would expect that sort of a way of doing business that we're all having to deal with. Frankly, I don't see it getting any worse. I think it just is what it is. Relative to the CR, we looked at that very carefully. Currently, we don't anticipate relative to any of our programs there to be any significant delays accrued specifically as a result of the CR. Most of the things we have are either already authorized and appropriated against and are not new starts. And even programs like the Tanker Program, which is a new start, I think, has got sufficient funding authority from 2010 to carry it into this year to be able to start it on whatever time they choose to start it on. So that may be the one we're looking at most closely. So at least at this point in time, I'm not inordinately concerned about additional delays that might be occurred because of the CR.

Operator

Your next question comes from the line of George Shapiro from Access 342.

George Shapiro - Citi

Yes, Clay, two questions. Given what your thinking is in the business jet market, you've had two strong quarters of aftermarket growth now. Historically, from your perspective, how much of a lag between the aftermarket and when do you start to see more of the OE pick up?

Clayton Jones

Well, I would predict right now, George, that typically set over about 12 to 18 months, and so that's why we're predicting across the market not a significant OE pickup until 2012 for the basic market and that's across all aircraft types, is that it will be basically flat during 2011. And so we believe that there will be some upside in 2012. Too early to call that right now, George, because I think we'll just be waiting to see how the economy develops this year, how orders pick up, and then that will tell us more as we get toward maybe middle part of 2011 what the velocity or the reality of that pickup will occur in 2012. As we have stated in our guidance, however, and in my opening comments today, we are actually enjoying growth in the teens, and that growth is a result of our specific positioning on new market share wins that I outlined in my opening guidance. So we're actually seeing lift earlier than what we're seeing in the underlying market give us.

George Shapiro - Citi

And then one for you, Patrick, you mentioned Project Liberty was again a benefit this quarter. I think in the last quarter, you had mentioned it was about $7 million in sales. Was it comparable this quarter? And then also, if you could provide a different growth rates between business jet aftermarket and RJ? Even I know most of your business is business jet anyway.

Patrick Allen

George, on the first, yes, the Project Liberty spare [ph], that was almost the same number. It was $6 million or $7 million in the quarter. We don't separately break out RJ revenue, service revenue and simply because we're selling a lot to the same customer, specifically Bombardier. So trying to separate that revenues is difficult. But you're absolutely right, by far and away the largest driver on that aftermarket is the biz jet area. So most of the growth, I think fairly attributed to the biz jet.

Clayton Jones

Yes, let me add some color to that too, George, not only in the biz jet side, but what we're particularly encouraged by is that most of the aftermarket growth in biz jets is in retrofits and upgrades. And what that means is first thing, it's typically very good margin products and also that suggest that people are actually in the market, fixing up the aircraft to make them more sellable or buying them and realizing they have a little discretionary investment to be able to improve the aircraft either for airspace modernization or for some of the connectivity features that bring more productivity to the airplanes. And the fact that they're spending money on that, I think, is an encouraging sign for the market in general.

Operator

Your next question comes from the line of Myles Walton from Deutsche Bank.

Myles Walton - Deutsche Bank AG

I was wondering if you could size in your forecast the KC-X and JTRS as determinants of growth? I mean, could you have growth without a KC-X finalization and also without any significant growth in JTRS beyond where you currently sit?

Clayton Jones

Are you talking about 2011, Miles?

Myles Walton - Deutsche Bank AG

I am.

Clayton Jones

First thing for JTRS, we're actually suggesting a decline in revenue in JTRS in 2011. So we're not expecting a growth, mainly because we're in the trough period I described of development and testing where you just naturally do less engineering work because most of the activity rate is being done by the government. It's just a lower activity rate. And until LRIP picks up, we won't see any significant upturn until we get into 2012.

Myles Walton - Deutsche Bank AG

So there's no upturn in the fourth quarter?

Clayton Jones

No. There may be some slight, but it's not even material, I don't think. Even if they make the LRIP decision in our third quarter, by the time you start cranking and get going in there, it's not like adding a bunch of engineers you're actually starting to produce product. Now you've got lead time away and you got to schedule for products, so it's going to be not very meaningful. In the KC-X revenue, we've loaded up probably about $60 million. And so that's very meaningful to us. When we laid out our guidance, we made that -- there's a pretty big swinger for the year relative to that program being announced and moving ahead.

Myles Walton - Deutsche Bank AG

And then one other question on Government in the margin side. I know 50% of your business is on the commercial terms, but I'm curious it's within the rest of your business, the more traditional government contracting business, you're seeing the flow-through, the efficiency initiatives in realtime, and how, if any, should we should think about the impact on those on go-forward basis?

Clayton Jones

You mean you're talking about the DoD efficiency initiatives?

Myles Walton - Deutsche Bank AG

Yes, exactly.

Clayton Jones

We're seeing nothing there. And I think it's way premature. They're are just deciding what to do in putting it in place. And even if it is an effect on those programs, I don't think we'd see it yet. But frankly, I'm not expecting there to be any material impact to our company. And as I've said before, I think these efficiency initiatives on net create opportunity for Rockwell Collins because we're very comfortable working in the fixed-price arena, as you know, and so the more that is expected, I think the more that place in our wheel house.

Operator

Your next question comes from the line of Peter Arment from Gleacher & Company.

Peter Arment - Gleacher & Company, Inc.

Clay, could you give us some -- a lot of your peers are talking about on the Defense side and the international opportunity, how shall we think about some of these international bookings that we're seeing or being rumored to be booked? How the potential impact that would be for Rockwell?

Clayton Jones

Well, we think it's going to be significant over the longer term, Peter. We're certainly focusing a lot of attention. Many of you know, we've revised our organization about a year and a half, two years ago to strengthen our international presence, to improve our skill sets and to be more aggressive going after opportunities internationally because we anticipated, we're anticipating this DoD slowdown for quite sometime. And we're seeing very good signs of strength there. One of the early strengths we're seeing is coming out of our European subsidiary where this Forward Air Controller device using GPS has been widely accepted around the world is almost the standard in doing that, and we're seeing very good growth. Again, that's a small program. It's not like a savvy program or anything like that. So specific products we think are good. Our joint venture with Collins, taking software defined radios around the world is beginning to get traction. And we've gotten initial customers on that. And then looking at larger efforts that are more visible to most of you, we have a very strong presence on many of the products that are going into the Saudi cell. So the F-15, the Black Hawk, the JDAM or all products that will serve us fairly well over long period of time. And we, like other companies, are aggressively looking at India, not so much with the big OEM products you see, but a great deal of what they're looking at is to upgrade their communications infrastructure, and we're pretty good at that. So we're in there talking to them about that. So those are just some of the areas we see with the international opportunities that I think will make up for some of the softness we see in the DoD market here in the United States.

Peter Arment - Gleacher & Company, Inc.

And then just speaking of the international market, how are you seeing things in just on the commercial side? Are you seeing any pockets of stronger than the others? i mean, Asia and Middle East, obviously, have been very strong, but are you seeing anything different out there?

Clayton Jones

I would say Asia is gangbusters. For those of you who haven't traveled over there, you wouldn't think there's a worldwide recession if you went there. And aviation is at sweet spot, I think of what they're doing because of the distances involved and moving people and products around and aiding commerce. You've seen the numbers on cargo carriers over there, so Asia is very strong. As you said, the Middle East, I think, will continue to strengthen as we look at the Middle East being sort of the hub of newfound transportation link between Asia and parts of Europe and other places. And I think the other ones they don't talk a lot about is we're seeing South America. Latin America has really strengthened down there and I think maybe Brazil is sort of the anchor emerging market. We're seeing good activity there. So I think where you're seeing emerging markets around the world, you would logically see aviation being part of the infrastructure that's helping them develop their economies.

Operator

Your next question comes from the line of Joe Nadol from JPMorgan.

Joseph Nadol - JP Morgan Chase & Co

Couple of more defense questions for you. Clay, just maybe -- or Pat, could you tell us what the backlog looks like? Or for Defense here, what percentage of your anticipated sales for this year were in backlog as of the beginning of the fiscal year? How that compares to past years and what the key pieces are? We talked about KC-X already but what are the other key pieces are that need to come through to meet or exceed your guidance?

Patrick Allen

The way I characterize the backlog, Joe, is it's pretty normal in terms of the percentage of our sales that are in backlog today. Typically, when we enter a year, it's roughly between 70% to 75%, we're right there. So nothing unusual about the year. I would say that the biggest single program is the KC-X program that we still need to get in the house. Beyond that, there's just a large number of small programs. There really isn't anything I'd highlight beyond the KC-X that would be meaningful.

Joseph Nadol - JP Morgan Chase & Co

How much of it, though, is services and aftermarket stuff and stuff that you just really can bank on and how much of it's program wins like KC-X?

Patrick Allen

I would say most of it is the former.

Clayton Jones

I'd say one of the manifestations, Joe, of this sort of slowdown is there just are fewer new starts. And so the relative numbers of competitions for new aircraft is far and less than we've seen over the last five or six years. So while there are a few of them like that, far less than we've seen in the past. So the vast majority of what we've laid in here, and I think that's endemic to the relative slower rate of growth, are a lot of follow-on contracts or extensions of what we're already doing rather than straight-up competitions, like we saw in Chris or SLICAs [ph] or some of those. Those were sort of now in the bag, and now we're looking at the growth and execution of subsequent phases of those.

Joseph Nadol - JP Morgan Chase & Co

Then the second question is just on that contract mix. You have the 50/50 between conventional or traditional and commercial. But a lot of moving parts, Clay, you highlighted in your intro remarks just on a lot of programs, $150 million of volume going away and new pieces coming in. So with all that mix shift below the relatively stable surface, how is that contract mix changing this year and what's your outlook even if we look forward to FY '12?

Clayton Jones

Well, again, we look at that very carefully, Joe. And we don't see any meaningful change in that contract mix. If anything, we see a slight decrease, I'd say may be a point or two in the cost plus development type programs. And I think there's two things that play there: fewer new starts, as I mentioned, before; and ultimately, the Pentagon moving toward defining those programs as fixed-price, not cost plus. But that's as much trend information as it is reality. Let me make a statement about that $150 million of headwind. Some of it is real headwind that we've got to make up for, things like the F-22 coming to a close, and we're waiting for the F-35 to pick upon the other end of that. But much of it is a true transition. For example, the KC-135 will be moved into Block 45 and ultimately, KC-X, which will more than make up for that. Joint Tactical Radio System, I talked about going through the bathtub now. Once we get into LRIP, it will more than make up for that because you're moving into production. So we're kind of going from an area of development into areas that are equivalent developments or moving from development into production like JTRS. So in the main, I see growth ahead of us on those programs where we're positioned beyond this 2011, and so that's where I might depart from some of my peers there as I think this 2% growth rate in our Government business is transitory, and I can see it growing better in the future. The second thing is I definitely see margin opportunity out ahead of us as many of these programs move from development into production, and we see more development-type contracts in our mix ahead.

Operator

The next question comes from the line of Robert Stallard from Royal Bank of Canada.

Robert Stallard - RBC Capital Markets Corporation

Clay, I was wondering if you could comment about the aerospace aftermarket your forecast in 2011, and what you think could be the key risk or opportunities in the buildup to that forecast?

Clayton Jones

You mean on the Commercial side?

Robert Stallard - RBC Capital Markets Corporation

Yes.

Clayton Jones

Well, the risk is that if the airlines finally achieve 100% load factor, there's probably downside. There is almost unprecedented levels that we keep wondering if they can maintain these levels or even make them higher than they are today, and I think if they are able to squeeze out more load factor, that would be, I would say, a dampening effect on that. Obviously, conversely, the opportunity is they sort of hit the wall, and now they start bringing in more of the older out-of-warranty aircraft because they just have to, and that's opportunity for us. So that would be one area that we would look for. I think in terms of the airlines the becoming more profitable, which now we're seeing a definite trend to, that tends to be a harbinger for more retrofit and spares activity. And so I think that opportunity for us we haven't baked -- we baked some into that. But if there's more pent up demand than we expect, that could be upside opportunity. Now I would say the third thing that we're looking at that is both risk and opportunity is the introduction of the 787 and the 747-8. There's obviously some initial sparing associated with that. We've tried to size that correctly. But if those programs are delayed even further, then that would delay that initial sparing, and so timing could be pushed out. If those programs hit their milestones and accelerated, and then we would be a little bit more optimistic that, that would come in.

Patrick Allen

The only other thing I'd highlight is the area of wide-body in-flight entertainment. We get surprised this year with some disembodiments. We've taken a cut. We're expecting another decline next year but that's always a risk.

Robert Stallard - RBC Capital Markets Corporation

And then second, Clay, if you could comment on your thinking at the moment regarding cash deployments of buybacks versus acquisition?

Patrick Allen

We want to do both. We've maintained activity in the share repurchase area. We're continuing to evaluate acquisitions. Acquisitions are inherently hard to predict, so we want to make sure we have enough firepower to do both. But we're anticipating a nice mix of niche acquisitions plus share repurchases this year.

Operator

Your next question comes from the line of Troy Lahr from Stifel Nicolaus.

Troy Lahr - Stifel, Nicolaus & Co., Inc.

With most airlines flush with cash now, are you seeing discussions regarding discretionary spending start to pick back up? And what areas do you think they're starting to spend like navigation components or communications? What do you think?

Clayton Jones

Yes. To my point I just made right in the previous question, as the profitability seems to have really turned around. And one of the reasons I think this is a fast and stronger recovery is we're seeing the airlines dramatically increase their profitability here in the last few months. Typically, when that happens, they look at deploying that cash in certain ways. While there have always been discussions about what they could be done, it's when they pull the trigger that's the most critical things where retrofits are concerned. And as I've always said, that -- what day is it and I'll tell you whether they want to do it because that's a very lumpy thing and very hard to predict. I can tell you we've had numerous conversations. I think there's a lot of work they'd like to get done. It is literally a matter of them deciding today to do it because that typically is short-term in-and-out type stuff. And so from quarter-to-quarter, it's very hard to predict. You're going to see it being lumpy, but I would say that notwithstanding, the environment is getting much better for that.

Troy Lahr - Stifel, Nicolaus & Co., Inc.

But do you think they start picking up a little bit? Or I mean most of the stuff starts in 2011 and then it continues to grow on the discretionary side into 2012?

Clayton Jones

Yes, I think it will continue to grow through the next two years. What's going to be interesting is to see the rate of growth. In traditional cycles, you get a very rapid rate of growth because of pent-up demand that tends to be satiated, and then you get to a steady state. What we're seeing, for example, in the MRO side here, all of you, all of us have been waiting for this great spike in MRO, and we're not getting it. And we're not getting it for the reasons I said on the call is load factors and new aircrafts are not allowing it. And so I think we're pretty close to a steady-state rate of growth right now for MRO. And that's an okay thing. That means we're back to space normal speed. Now for retrofits, there would be an anticipation of pent-up demand. We haven't seen it yet. We hope it's out there. I think if we're going to see it, we're probably going to see it maybe sometime in 2011, and it will likely extend through '12 but not at the same rates of growth.

Troy Lahr - Stifel, Nicolaus & Co., Inc.

And with operations in Iraq starting to wind down, are you starting to see a pickup in retrofit work at all?

Clayton Jones

I wouldn't say a pickup. I think what the Pentagon has done is they programmed a certain amount of money in for things like helicopter upgrades or C-130 upgrades. And as I said before, that's growing in midteens right now, and I would expect that it would maintain itself at that rate, some of which could be equipment coming back from the forward deployment area, but a lot of which is just modernization of older airframes that sorely needed when there's not that many new airframes coming in.

Operator

Your next question comes from the line of David Strauss from UBS.

David Strauss - UBS Investment Bank

Clay, a bit of a big picture question. If you look at the Commercial Systems business peak to what is hopefully trough this cycle, you were down in the range of 25% to 30%, not that much different than what we saw during the last downturn. And exiting the last downturn, your margins, you got to a much higher peak on kind of the same run rate on revenues a couple of years later. As we think about this eventual recovery, can you kind of give us a setup for commercial margins and if you think there's upside beyond what we saw at the peak of this cycle?

Clayton Jones

Well, I think, historically, you can assume that there's no reason why we cannot get back to the margin that we saw on the last cycle. I think conditions are the same, relative growth rates would be the same, development programs would be the same. If anything, we have a little bit of a tailwind because of the market share gains we've done when those start moving through warranty periods and you see this very much more lucrative service opportunities that trail after that, that gives you an even greater volume to choose from. So I would say on its face, I would say it would be a reasonably safe bet to say we'll get back to the margins that you saw in the past. Now that said, we have a very aggressive Executive Vice President that's very focused on margin development in Commercial Systems and I think Kent Statler is going to be all over that like a bad dog, and I wouldn't bet against him, but we'll see how he does.

David Strauss - UBS Investment Bank

And then two follow ups, can you give us some color, you're forecasting 10% growth in air transport OE, can you give us a little bit of color specifically what you're assuming for 787? And then on the R&D side, can you just let us know where R&D came in for the full year and what the split was between companies buying customer funded, I know will be in your can [ph] a little bit, but if you could give it to us now.

Clayton Jones

I'm going to ask Pat answer the R&D question while I look for the 787.

Patrick Allen

From an R&D perspective, the way it came out was roughly about 7.4% of sales was company-funded R&D, and about 11% was customer-funded, so in total about 18½% of sales. It would actually maybe a little bit more than what we were anticipating.

Clayton Jones

And I'd say we have something in the area of $25 million to $30 million placed in there for 787 revenue in 2011.

Operator

Your next question comes from the line of Sam Pearlstein from Davenport & Company (sic) [Wells Fargo].

Samuel Pearlstein - Wells Fargo Securities, LLC

Just on that last question in terms of the OEM side, you mentioned 787, 747-8 and CJ4 for in terms of just helping you. I guess how should we think about margins on those initial sales? And then just what is a typical warranty period until you start to see some sort of a stream?

Clayton Jones

I think, as you would expect, on 787, the initial margins would be less than our average just because you haven't gotten the economies of scale and there's a lot of buildup cost there, but we full well expect that OEM sale to be a very attractive margins once we get closer to rate production. So you should see it start out low and build up, which is again not atypical and not beyond what you would expect. And in general today, a typical warranty period's probably vary around three to five years depending on what system it is and how they do that, what I'd say a bias toward the higher rate now as we move to those levels. One of the things about the warranty periods that's a little misleading is that in the era of power by the hour, warranty is really not a factor because many of the 787 customers will opt for what we call a dispatch 100, which is essentially a power-by-hour process. And that way, you start out with maybe some early revenues that are very modest in nature, but you don't wait sort of five years for revenue to flow. So it'll depend on what the customer chooses from the menu of service opportunities.

Samuel Pearlstein - Wells Fargo Securities, LLC

If I look at from the third quarter to the fourth quarter, the Commercial Systems OEM business was relatively flat sequentially, so when does that step-up start to kick in?

Clayton Jones

Well, first thing, let me remind you that our third to fourth quarter is always relatively flat because this is the period where the biz jet OEMs kind of go through a summer shutdown. And this year, they had a real summer shutdown because of the inventory levels they build up. And so in a sequential basis, that's never very strong, but I think you will start seeing that pickup, to answer your question specifically, when two or three things happen. 787 finally enter service, 747-8 enter service, that will increase the ramp rate beyond that. So we're hoping that will begin to occur next year. And then the second thing is when the narrow-body rates begin to kick in, we'll see a little bit of that on the 320 in this fiscal year. We won't see the 737 rates increase until 2012. That'll actually be beyond our fiscal year. So when you think of the road ahead, there are a lot of very positive catalysts that actually extend beyond 2011, as you look in 2012 rates on 787, rate on 747-8 increase narrow-body rates on both 737 and A320. And then if you add any improvement in the underlying rate of the business jet, you could see a very substantial Commercial Systems bump in 2012.

Robert Stallard - RBC Capital Markets Corporation

One question for Pat, you only did about $109 million in CapEx and the guidance is late was July was something like 135, yet FY '11 didn't change. So I mean is that something that just dropped out or is everything kind of split to the right a little bit?

Patrick Allen

I think it's certainly a case of things sliding to the right. We tend to have a large amount of capital expenditures occur in the fourth quarter. I think the time we had it slipped out, I'm not in a position to change our forecast for CapEx for FY '11. I think $150 million is still in the ballpark.

Operator

Your next question comes from the line of Carter Leake from Davenport & Company.

Carter Leake - Davenport & Company, LLC

Clayton, last quarter, your outlook for recovery in aftermarket demand, you used one of my favorite expressions, you described as a pig through a python. And now your comments are more of a faster, stronger and more sustainable recovery, and obviously, your peers appear to be a bit more regular. What's driving this change?

Clayton Jones

Well, I think some of the things I made in my opening comments, I think it's a realization now, and I think your hearing it from all of our peers that this phenomenon of airline management of load factors combined with a first-ever cycle that did not include a dramatic reduction in air transport OEM build rates are the two big factors because most of the capacity growth, which we're definitely seeing, is being absorbed with newer aircraft, and newer aircraft are typically in-warranty and you don't get MRO service revenue from it. And that is essentially replacing the older out-of-warranty aircraft that we would see at this point in the cycle. And so on the MRO piece, I think that's where we've all been surprised and maybe some of you disappointed that we're not seeing this big MRO jump. And so that's a big difference. But again I would put that in context, let's not forget the great benefit that the whole industry gets from higher levels of new aircraft production because for us, it's half our business.

Carter Leake - Davenport & Company, LLC

So to that point, it seems -- are you suggesting that we might airlines as the approach sort of take load factors will pull from the desert? Because if, in fact, the airlines go down the path of new versus used on efficiency plays or well, would your air transport margins necessarily be materially impacted? In other words, aren't your BFB [ph] margins somewhat similar to the retrofit anyway? I mean, if pull from the desert.

Clayton Jones

And again, that's the differentiation for our company. That's where we depart a little bit from our peers. We have the kind of products where we make very good margin on the OE sale, and we're are tickled to death to see OE remain high and don't feel that it's necessarily hurting us or our margin or our ability to have margin grow because of that relative change. I would also say in the middle of that, that for us, it's that pent-up demand on retrofits that we're watching most closely because I think there's still opportunity there, and that it could have a different perspective that we need to watch them as we play out. So I feel pretty good about the aftermarket. It's not as strong as we thought it would, but I think there's good news on the OE side, and all that net-net is a good thing for our company.

Carter Leake - Davenport & Company, LLC

How bout an update on long-term plans on IFE? Where do you see that going?

Clayton Jones

Well, they've not changed. We made a strategic decision not to reinvest in our wide-body products. And as Pat said earlier, we're expecting both the product and ultimately, the service fails to atrophy over time, and you're seeing that and we're making it very transparent and visible so you can sort of take that and put it on the side as a strategic decision. However, we are keeping our narrow-body product line, and we feel very good about that. We're investing in it. We're winning good market share from it. We just won a position on the new COMAC 919 (sic) [COMAC C919] with that product as well as our cabin management capability. And so our strategic focus is going to be much more on the cabins of business aircraft, the bringing forward of information managements to our new Ascend product that we announced at NBAA, and through narrow-body IFE, which we believe can be done much more profitably, and also where we think we have synergy and strategic advantage between that cabin management and IFE side. So wide-body, we're not doing it anymore, but we'll support our customers. Narrow-body and cabin management and business jet aircraft, we're all over it. Okay. Well, that concludes our call. We plan to file our Form 10-K on or about November 23, so please see that document for additional notes and disclosures. Thank you for joining us and participating on today's conference call.

Operator

Thank you for your participating in today's conference call. You may now disconnect.

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