BE Aerospace (BEAV) Werner Lieberherr on Q2 2016 Results - Earnings Call Transcript

| About: B/E Aerospace (BEAV)

BE Aerospace, Inc. (NASDAQ:BEAV)

Q2 2016 Earnings Call

July 26, 2016 10:00 am ET

Executives

Greg Powell - Vice President-Investor Relations

Amin J. Khoury - Founder and Executive Chairman

Werner Lieberherr - President & Chief Executive Officer

Joseph T. Lower - Chief Financial Officer

Analysts

Gautam Khanna - Cowen and Company, LLC

Robert M. Spingarn - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Howard Alan Rubel - Jefferies LLC

Noah Poponak - Goldman Sachs & Co.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

David E. Strauss - UBS Securities LLC

Seth M. Seifman - JPMorgan Securities LLC

Operator

Good morning. My name is Candice Griffin, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the BE Aerospace Second Quarter 2016 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. As a reminder, ladies and gentlemen, the conference is being recorded this day, July 26, 2016. Thank you.

I would now like to introduce BE Aerospace's Vice President of Investor Relations, Greg Powell. Mr. Powell, you may begin your conference.

Greg Powell - Vice President-Investor Relations

Thank you, Candice. Good morning and thank you for joining us this morning. Today, we are here to discuss our financial results for the second quarter ended June 30, 2016.

By now, you should have received a copy of the news release we issued earlier today. If you haven't received it, you'll find a copy on our website.

We will begin this morning with remarks from Amin Khoury, our Founder and Executive Chairman. Also on the call this morning are Werner Lieberherr, President and Chief Executive Officer; and Joe Lower, Chief Financial Officer.

For today's call, we've 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 at beaerospace.com. In addition, copies of the slides will be posted on our website for you to refer to after the call.

As always, I'll remind you, in our prepared remarks and our responses to your questions, we rely on the Safe Harbor exemptions under the various securities acts and our Safe Harbor statements in the company's filings with the Securities and Exchange Commission.

We will answer questions following our prepared remarks. At that time, Candice will provide instructions for us. Please limit your questions to no more than two at a time.

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

Amin J. Khoury - Founder and Executive Chairman

Thank you, Greg, and good morning, everyone. I am pleased to report our strong second quarter results, as we continue to execute on our plan to deliver sustained revenue growth and earnings per share growth that exceeds revenue growth.

Second quarter revenues increased 7% driven by strong double-digit growth by our commercial aircraft segment. Second quarter earnings per share increased 12% as compared with the prior-year period reflecting robust organic revenue growth and the benefits of our capital allocation plan.

As a result of our strong first half results, and a continued favorable outlook, we are today increasing both our 2016 financial guidance and our 2017 outlook. We'll discuss the specifics later on in our prepared remarks.

Based on our strong free cash flow generation, and consistent with our stated capital allocation plan, we used $30 million of our cash to repurchase our shares during the second quarter and we've used $75 million for share repurchases year-to-date.

For the remainder of the year, we expect to use approximately an additional $75 million, therefore a total of approximately $150 million for the full year. When combined with dividends, we expect to return more than $235 million of cash to our shareholders this year.

We will discuss each of these items in more detail following a discussion of the current market environment and our perspectives from the recent Farnborough International Airshow. We will then review our second quarter 2016 performance, progress on our capital allocation plan, and our 2016 guidance, and our 2017 outlook.

Now, let's discuss the current market environment. Strong long term industry trends and a BFE business strategy, which is leveraged to airline profitability and traffic growth, continue to support our revenue growth outlook.

Year-to-date global traffic is up 6% through May. That's been driven primarily by the growing middle classes around the world who have begun to access air travel. Traffic growth has moderated somewhat in April and May; however, during that period it did grow at a healthy rate of 4.6%, which supports forward fleet growth. It is worth noting that Asia-Pacific and Middle East traffic are up 8.1% and 11.2% respectively year-to-date.

A number of airlines are currently facing lower unit revenue challenges as a result of lower airfares, consistent with lower fuel prices. These airlines had anticipated an increase in demand growth that has not materialized. We believe this is a relatively short-term phenomenon, and we note that airline managements are already responding appropriately and adjusting capacity to meet demand as they have done over the past decade.

Despite the challenges, the International Air Transport Association, or IATA, continues to expect record aggregate airline profits in 2016. Strong traffic growth and record airline profitability are generating high levels of aircraft deliveries by both Airbus and Boeing. Longer term, global airline traffic is expected to grow at a rate of about 4.5% to 5% annually, driven by the emerging middle classes around the world and ever increasing access to air travel.

Our commercial aircraft segment is strategically positioned to outperform in this environment, as the company has leveraged the traffic growth, airline profitability, the airline retrofit aftermarket and commercial aircraft OEM deliveries.

Currently, about 40% of our business is driven by aftermarket demand. As we look out over the next 20 years, the aftermarket portion of our business is expected to grow disproportionately and to become the largest driver of our business as a result of the doubling of the size of the worldwide fleet over that time period. The significant growth in the size of the worldwide fleet, especially wide-body aircraft, combined with our high order win rates and market share gains is expected to result in our approximate $12 billion install base currently, approximately doubling over the next 10 years and continuing to expand at a healthy clip thereafter.

Over time we expect to see a fairly dramatic shift in our business, which is expected to become much more heavily weighted to the aftermarket than to line fit associated with new aircraft deliveries.

In contrast to the strength of the commercial airline market, the business jet OEM market has been and is expected to continue to be adversely impacted by macroeconomic factors such as the collapse of oil prices, the developing country currency crisis, and global economic uncertainty.

At the recent EBACE business jet conference, industry experts reported that business jet fleet remains in a state of significant oversupply with many used business jets at substantially lower and declining prices as compared to new business jets. Industry experts are expecting a decline of approximately 10% in new business jet deliveries in 2016 as compared to 2015.

In addition, the civilian helicopter market has also been adversely impacted by macroeconomic factors including particularly the collapse in oil prices.

However, the major drivers of our commercial aircraft segment which represents more than 80% of our consolidated business are global airline traffic growth and airline profitability. And as we have discussed earlier, traffic growth has been robust, driven by the emerging middle classes in Asia and the Middle East which according to IATA is expected to continue with a very healthy long-term outlook.

Sustained long-term traffic growth, coupled with sustained airline profitability should drive demand for our products, whether line fit, associated with new aircraft deliveries or aftermarket retrofit refurbishment and spares.

Now let's turn to slide two and review our bookings and backlog results for the second quarter of 2016. Bookings during the second quarter were approximately $755 million and the book-to-bill ratio was approximately 1 to 1. As of June 30, backlog was approximately $3.3 billion, while awarded but unbooked backlog was approximately $5.6 billion. Total backlog, both booked and awarded but unbooked was approximately $8.9 billion.

As can be seen from the pie chart, backlog is well dispersed geographically with 41% from the Middle East, Asia, and the Pac Rim; 41% in North America; and 18% in Europe.

Importantly, the backlog is of high quality and includes major programs from the most innovative and most important airlines in the world.

Now I'd like to ask Werner to provide highlights from the recent Farnborough Airshow and our recent market successes.

Werner Lieberherr - President & Chief Executive Officer

Thank you, Amin. A team from BE Aerospace attended the Farnborough Airshow two weeks ago. The show provides additional opportunities for us to meet with our customers and to advance discussions on new market opportunities. It also provides opportunities for our customers to announce the world (10:37) and to showcase products.

I will highlight a few such events related to BE Aerospace. At the show, Gulf Air, the national carrier of the Kingdom of Bahrain, announced that they have selected BE Aerospace to supply the business class seating for their new Boeing 787 aircraft.

The first 787 deliveries are scheduled for 2018. Their next-generation business class seat will provide Gulf Air's passengers with enhanced living space, functionality, and comfort.

Gulf Air hosted us at their chalet for the contract signing ceremony. Also in attendance were Bahrain's Minister of Transportation and Telecommunications, his Excellency Engineer Kamal bin Ahmed Mohammed and Gulf Air Chief Executive Officer, Maher Salman Al Musallam.

In addition, and as you may have heard, the Boeing 737 MAX made its international airshow debut at Farnborough. The 737 MAX that was on display was configured with a virtually complete passenger interior in the style of the first operator and our customer Southwest Airlines.

This test aircraft is equipped with numerous BE products including our advanced modular lavatory, which includes our Ecosystems toilet, our lavatory lighting and our lavatory oxygen systems, our sky interior cabin LED lighting system, our new Meridian economy class seating, and our passenger oxygen systems.

We received a number of positive comments about the innovation, quality, and aesthetics of the BE Aerospace product that were on display on the new 737 MAX aircraft.

As another example of market innovation, we also won the 2016 Gold Spark Product Design Award for our Waterfront business class seating platform. The Waterfront seating platform features seamless and holistic integration of next-generation connectivity and personal environmental controls within the high-density all-aisle-access business class seats to deliver a new level of functionality, connectivity, and comfort.

Designed to be an intimate passenger oasis with intuitive controls, Waterfront enables passengers to individually tailor their environment. Lighting is automatically adjusted to the passengers' activities and preferences, while environmental controls for seat heating, cooling, and airflow are also all personalized.

Providing an unparalleled cinema experience, the high definition 4K touchscreen monitor can be controlled by an intuitive hand-held remote or paired to the passenger's own device.

The Waterfront Seat also won the 2016 Red Dot Award, an additional international product design award. We are currently in discussions with a number of potential airline launch customers.

As Amin mentioned earlier, the global airline industry is expected to generate record profits this year. The North American carriers are expected to have the strongest financial performance. As a result of their strong and sustained profitability; the North American airlines are focusing on the passenger experience. They are adding new aircraft to their fleets and retrofitting existing aircraft.

New aircraft cabin interior products are currently being introduced at all of the major North American airlines, all of whom have selected BE Aerospace seating and food and beverage preparation and storage equipment. Of note, a number of these airlines are aligning closely with global coffee brands to deliver a unique onboard customer experience. We are proud that our line of branded beverage makers, Endura and Essence, are becoming the hot beverage maker systems of choice on all major North American carrier fleets.

The airlines in the Asia-Pacific region are expected to be the second-most profitable region this year. Last year the airlines in the Asia-Pacific region once again carried the largest number of passengers, as traffic increased 10% over the prior year. In 2015 this region had a 34% market share of the global air travel market.

The Asia-Pacific and Chinese airlines are leveraging their remarkable international traffic growth to operate new, extended range, wide-body aircraft to open new point-to-point markets around the world, and importantly, BE Aerospace is the cabin interior market leader for buyer-furnished equipment in China. As a matter of fact, over the past 12 months we won approximately 75% of the awards among Chinese airlines.

Beyond the Asia-Pacific region, we also have a leading market position in the Middle East region. Our focus on emerging markets and geographic backlog diversity have been mainstays of our approach to this market. We have very strong relationships in these two important regions of the world.

At the same time, our market share in North America has been growing. Over the past 12 months we have won approximately 80% of the awards among North American airlines. Clearly, our reputation for innovation, quality, on-time delivery and global customer support are driving excellent results.

I will now turn the call back over to Amin.

Amin J. Khoury - Founder and Executive Chairman

Thank you, Werner. Now let's review our second quarter financial results. Please turn to slide three, and we will review our second quarter consolidated results.

The bar chart on slide three reflects our consolidated second quarter 2016 financial performance compared to the second quarter of 2015. Second quarter 2016 revenues of $753 million and operating earnings of $137 million each increased about 7% as compared with the prior-year period.

Operating margin of 18.1% was 10 basis points lower as compared with the prior-year period. This reflects strong performance with expanding margins by our commercial aircraft segment, partially offset by lower margins at our business jet segment.

Second quarter net earnings per share of $0.84 per share increased 12%. I think it is important to note that we delivered $0.84 per share this quarter despite a higher effective income tax rate, which caused a $0.04 per share negative drag on reported EPS for the quarter. This underlies the strength and quality of our earnings.

Now let's turn to slide four and review second quarter 2016 results for our commercial aircraft segment. Our commercial aircraft segment turned in excellent financial results for the quarter.

Second quarter 2016 commercial aircraft segment revenues of $611 million increased a very strong 13%. The revenue increase was driven primarily by higher volumes of seating products and food and beverage preparation and storage equipment for our BFE customer base, as well as shipments of A350 galleys and B737 lavatories to the OEMs.

Operating earnings of $115 million increased 15% and operating margin of 18.8% increased 30 basis points as compared with the same period of the prior year.

Now let's turn to slide five and review the results of our business jet segment for the second quarter. The strong second quarter performance by our commercial aircraft segment was partially offset by the challenged performance of our business jet segment.

Second quarter 2016 business jet segment revenues of $142 million decreased 12% as compared with the same period of the prior year. The year-over-year revenue decline reflects the broad-based downturn in the new business jet and civilian helicopter markets and lower volumes of super first class seating products.

Operating earnings of $22 million decreased 20%, and operating margin was 15.5% as a result of lower revenues and an unfavorable mix of products as compared with the prior-year period.

As we have previously discussed, we expect our business jet segment to continue to report negative revenue growth in 2016, reflecting current headwinds. We don't expect a turnaround in this business until 2018, contemporaneous with the recovery in oil and gas prices and the introduction into service of a number of new business jet platforms.

During 2016, we expect a free cash flow conversion ratio of approximately 75% growing to approximately 100% in 2017. As I mentioned earlier, based on our strong free cash flow generation and consistent with our stated capital allocation plan, we used $30 million of our cash to repurchase our shares during the second quarter, and we've used $75 million for share repurchases year-to-date. For the remainder of the year we expect to use approximately an additional $75 million for share repurchases for a total of approximately $150 million for the full year. When combined with dividends, we expect to return more than $235 million of cash to our shareholders this year.

Now let's review our outlook. Given our strong results for the first half of 2016 and the excellent performance by our commercial aircraft segment, we are raising both our 2016 financial guidance and our 2017 outlook. We now expect 2016 organic revenue growth of approximately 5% as compared to our initial 2016 revenue growth rate guidance of approximately 1% to 2%. Our initial 2016 EPS guidance was $3.15 to $3.20 per share, and we're now guiding to approximately $3.25 per share, even though we are now expecting a higher 2016 effective tax rate, which is expected to offset what would have been approximately $0.08 per share of additional EPS overachievement.

In other words, at the lower effective tax rate at which we guided full year 2016, our current 2016 EPS guidance would have been about $3.33 per share, which demonstrates, as I mentioned earlier, the strength and quality of our earnings.

Now let's turn to slide six, where we will review in detail our 2016 financial guidance. So revenues are expected to increase approximately 5% as compared to 2015. That's all organic growth. Operating margin is expected to be in excess of 18%; interest expense around $91 million.

Full year 2016 effective tax rate is now expected to be about 24%, that's about 200 basis points higher than our original expectation. Net earnings per share are expected to be approximately $3.25 per diluted share, and free cash flow conversion ratio is expected to be about 75% of net earnings.

In addition, based upon the strength of our backlog, we are also raising our 2017 revenue growth rate outlook to approximately 7% growth over our 2016 updated and raised revenue guidance. This represents approximately a 6% compound annual growth rate over the two-year period 2016 and 2017.

Our outlook for 2017 is to deliver earnings per share growth in the low teens despite the higher effective tax rate as compared with our updated and raised 2016 earnings per share guidance. In addition, we expect our free cash flow conversion ratio to improve to about 100% during 2017.

The combination of continued market success, disciplined cost control and our shareholder focused capital deployment plan supports our expectation for earnings per share to continue to grow faster than revenues.

With that, I will now turn the call back over to Greg for the Q&A portion of this morning's call.

Greg Powell - Vice President-Investor Relations

Thank you, Amin. I will now turn the call over to Candice for the Q&A portion of today's call. Please limit your questions to no more than two questions so that we can get to everyone that's on the call.

Candice, will you provide instructions on how to ask the question?

Question-and-Answer Session

Operator

Absolutely. And your first question comes from Gautam Khanna with Cowen and Company.

Gautam Khanna - Cowen and Company, LLC

Yes. Thanks. Good morning.

Werner Lieberherr - President & Chief Executive Officer

Good morning, Gautam.

Amin J. Khoury - Founder and Executive Chairman

Morning.

Gautam Khanna - Cowen and Company, LLC

I was wondering if you could square the guidance for next year's sales with recent announced cuts on like the A380. I asked last quarter, but I wanted to ask again. Do you anticipate that we're going to see a big uptick in retrofit next year to backfill any sort of wide-body reductions across the board, 777, A380, et cetera?

Amin J. Khoury - Founder and Executive Chairman

Well, we know the rate of A350 deliveries. At this point in time we are continuing to support Airbus projection of fifty A350s for this year. We are producing and delivering equipment for specific customer on-dock dates for those aircraft. We did note during the quarter that American Airlines pushed out delivery of their A350s. That is a really big deal for us, because we have about $7 million worth of content on each and every A350 American Airlines airplane. They have seats in all four classes of service as well as our galleys, our oxygen systems, our food and beverage preparation and storage equipment and so on and so forth.

So it is quite a big deal, but we have taken that into consideration as we have prepared our guidance. And as we've stated many times in the past, as this question has been asked about 777s, for example, to the extent that traffic continues to grow and the airlines continue to earn record profits, they will need the lift, whether it's retrofits associated with airplanes that they want to maintain and service, or whether it's delivery of alternative wide-body aircraft. So we have taken the expected slower growth in wide-body deliveries for a period of time here into consideration as we prepared our guidance.

Gautam Khanna - Cowen and Company, LLC

Okay. And one last one, if you could just talk about the spares trend in the quarter and what you're expecting in the back half? Thank you.

Amin J. Khoury - Founder and Executive Chairman

Well, as we've always responded to that question about expectation for spares, we never know, because spares go in and out at the same time, more or less, and there's not much backlog built. But for the quarter, spares, orders and shipments were both up double digit.

Gautam Khanna - Cowen and Company, LLC

Thanks. I'll turn it over.

Operator

Next we have Robert Spingarn with Credit Suisse.

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

Good morning.

Amin J. Khoury - Founder and Executive Chairman

Morning, Robert.

Werner Lieberherr - President & Chief Executive Officer

Morning.

Joseph T. Lower - Chief Financial Officer

Hey, Robert.

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

Amin, you talked about the mix shift over time for the aftermarket, and I guess that coincides a bit with just a little bit flatter growth in the delivery ramp. If we looked at your backlog, and I suppose this is a question about your backlog and your shadow backlog, how does that break out OE versus retrofit?

Amin J. Khoury - Founder and Executive Chairman

I don't know the answer to the question. We don't break it out that way. We could break it out that way, but our expectation is that over time the size of the fleet continues to grow. The age of the fleet is a different question, but the size of the fleet continues to grow, and I think those numbers are pretty good. And those are driven by traffic, right? And to the extent that the number of new airplane deliveries declined in any period, retrofit will be – the airlines will have to maintain the utilization of older aircraft to handle the lift. The only way that they can do that and to maintain their interiors is to do refurbishment and upgrades and retrofits and so forth.

We did talk earlier about the fact that at Hamburg we were pleasantly surprised at the number of airline management teams that had raised retrofit plan discussions with us. And so we are still expecting to book substantial additional retrofit programs over the course of the next six to 12 months.

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

On that note, it's becoming more and more clear that airlines are managing their non-discretionary spares purchasing more tightly and improving their cost structure as a result. Does that same phenomenon apply to discretionary spending by airlines? Or is the opposite true that it frees up funds that will move from non-discretionary to discretionary? In other words, is this a benefit for you as the airlines get more lean?

Amin J. Khoury - Founder and Executive Chairman

It is. I think to the extent that the airlines push out deliveries of, especially expensive wide-body aircraft, and at the same time they're booking record profits and they have heavy traffic growth, in order to maintain the high cabin standards that they are now trying to maintain, they have to spend on their aircraft interiors. And that clearly benefits our aftermarket business.

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

And just to...

Werner Lieberherr - President & Chief Executive Officer

We clearly see that growth. When you think about, you have an airline and obviously right now low fuel price, so it makes a lot of sense to keep airplanes in the air and just do a retrofit. And in our discussions, we clearly see that they have fierce competition. There's no question. And they want to keep their cabin up to date and looking good.

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

Okay, and just clarify something about Gautam's question. Your answer to Gautam's question on the wide-body cuts, just to be clear I think most of that, given the A380 is really an 2018 event, assuming you ship ahead, does your 2017 guidance here for higher revenue growth factor in the 2018 effect, the 2018 effect?

Amin J. Khoury - Founder and Executive Chairman

Does our revenue guidance for 2017...

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

In other words...

Amin J. Khoury - Founder and Executive Chairman

...factor in the 2018 effects?

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

In other words, will you see – does 2017 already factor in what might happen in 2018 or are you only looking so far out as 2017?

Amin J. Khoury - Founder and Executive Chairman

You know, Rob, in response to questions like this, we've tried to make it clear that our forecasts and our guidance are based upon specific customer orders. So our customers are the airlines, right, and the leasing companies. And the airlines and leasing companies have orders for a specific aircraft, be they A350s or 777s or A330s or whatever the aircraft happen to be. And we build our guidance based on specific customers for specific products that are going on to specific aircraft that have specific on-dock dates.

So we don't really look at the number of airplanes that might be shipped of some type in 2018 as we think through our guidance. We are looking at which of our customers is planning to do what in 2018, be it receipt of new airplanes or retrofit.

Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker)

Okay. Fair enough. Thank you.

Amin J. Khoury - Founder and Executive Chairman

Okay.

Operator

We'll move now to Myles Walton with Deutsche Bank.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Thanks. Good morning.

Amin J. Khoury - Founder and Executive Chairman

By the way, just before – Myles, just before we do that...

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Sure.

Amin J. Khoury - Founder and Executive Chairman

The comment that Werner made a moment ago about the competition among the airlines for market share on their specific routes is really an important driver of retrofit, particularly in the premium cabin. I'm sorry, Myles, go ahead.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

No. No, thanks for the clarification. So, Amin, it looks like you're trending third quarter in a row revenue upside to guidance in the second half of the year. Similarly, it looks like there could be upside to the revenue guidance as well. Maybe Werner or Amin, can you put your finger on where the surprise is coming from? Is it short order spares? Is it short order retrofit? I imagine it's not aircraft popping off the line faster than you factored in.

Amin J. Khoury - Founder and Executive Chairman

Well, year-to-date, our expectation for deferrals that we expected by specific customers are just not happening. I mean they just haven't happened. So the strength in demand is there. I think what's happening is that our strategy is really working. The fact that our business strategy is one which is a BFE strategy. It's all about airlines and leasing companies, and airline profitability and traffic growth. And whether those important metrics drive new airplane deliveries or drive retrofit, we stand to benefit. And I think that's what's happening.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Okay.

Werner Lieberherr - President & Chief Executive Officer

Exactly. And especially what we've said before, if you think about the American carriers, they are rocking the world right now. It's unbelievable. Not only from a profitability perspective, but you probably follow them very close. Look at their margins; 18%, 17%, 16%, 23%, 28% operating margins. And then you look at the load factors, it's incredible. And this type of environment just drives our business.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Okay. Maybe, Joe, because I think you're on the call, I wanted to ask you a question on cash, if I could. The capitalized development, it looks like it probably grew another $30 million or so and maybe it's over $500 million on the inventory side. Is that about right? And where do you think it ends the year?

Joseph T. Lower - Chief Financial Officer

So a little light of that this quarter, capitalized development costs, as we've said, are going to trend down this year. They were lower this quarter, and they will continue to trend down this year, as we've said. But this quarter actually was less increased than last from a capitalized development cost. And that trend generally will continue over this year, and as we've said, next year will actually start to turn around as deliveries on both of the larger SFE programs increase.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Can you size the headwind in the second half? I imagine that's a source of tailwind in the second half over first half. Can you just size that?

Joseph T. Lower - Chief Financial Officer

I would say it's marginally down from the first half.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Okay. All right. Thanks.

Amin J. Khoury - Founder and Executive Chairman

Joe, you might want to talk about free cash flow because I think it all relates to Myles's question, capital spending, free cash flow, the whole shootin' works (36:42).

Joseph T. Lower - Chief Financial Officer

Sure. So let me now take that head on. So in the quarter free cash flow was kind of within expectation, 75%. For the quarter we remain comfortable with 75% free cash flow for the year. And that strength in cash flow is what's supporting our shareholder-focused capital plan, which is to continue to pay a dividend as well as look at share buyback. As Amin mentioned, we acquired $75 million of our stock in the first half of the year. Expect to continue that program at a similar rate in the second half and continue on thereafter. So I'm very comfortable with our cash flow trending. As we typically do, it'd be a more backend loaded year, and using that cash flow, again, consistent with our capital allocation plan.

Amin J. Khoury - Founder and Executive Chairman

So, Myers, one of the major reasons why our expectation is for free cash flow to be around 100% next year is that the major SFE programs are no longer consuming cash.

Myles Alexander Walton - Deutsche Bank Securities, Inc.

Thanks.

Operator

Thank you. Now we'll hear from Howard Rubel with Jefferies.

Howard Alan Rubel - Jefferies LLC

Thank you. While we have Joe on the phone, could you address for a moment why the tax rate changed?

Joseph T. Lower - Chief Financial Officer

Sure. It's pretty simple really, it's a matter of a generation of income and income and particularly some of the growth that we've seen coming out of higher tax jurisdictions. So...

Howard Alan Rubel - Jefferies LLC

High-class..

Joseph T. Lower - Chief Financial Officer

Pardon me?

Howard Alan Rubel - Jefferies LLC

That means a high-class problem. Sometimes it could be any number of reasons. I just wasn't sure. It is notable, so that's why I raised it.

Joseph T. Lower - Chief Financial Officer

Yes, when you make more money sometimes you have to pay more.

Howard Alan Rubel - Jefferies LLC

It works for me, too. Second thing is R&D was up rather notably and was over 10% of sales. I don't know, Amin or Werner, is this in anticipation of some additional opportunities? Or does this reflect orders in hand? Could you elaborate?

Amin J. Khoury - Founder and Executive Chairman

You've got Joe on a roll here, so just let him keep going, Howard, okay?

Joseph T. Lower - Chief Financial Officer

Thanks, Amin. So, Howard, as you know, this is always going to fluctuate. It does fluctuate with timing of development programs, timing of new programs. So you are seeing it higher at times as new programs are rolling out. We still expect to be around 10%. But as we look at growth next year, as you know we continue to have to invest in those programs to bring them to market. So that's why we expect it to be around 10%, but it will fluctuate quarter to quarter.

Howard Alan Rubel - Jefferies LLC

No. I get that. I'm just trying to capture whether this is...

Amin J. Khoury - Founder and Executive Chairman

Yes, Howard. The answer is yes.

Werner Lieberherr - President & Chief Executive Officer

Howard, it's really timing. How these programs come in, we do bespoke products, obviously we need significant amount of engineering, which drives R&D. I would say in terms of product development, we have a clear plan what we want to do when.

Howard Alan Rubel - Jefferies LLC

It's called market share.

Amin J. Khoury - Founder and Executive Chairman

Your point is well taken...

Werner Lieberherr - President & Chief Executive Officer

Howard.

Amin J. Khoury - Founder and Executive Chairman

...Howard. And the fact of the matter is when we're spending more on R&D, we're just spending on trying to build new programs. But the way I think about it is the more we spend on R&D, the better our outlook in the future.

Howard Alan Rubel - Jefferies LLC

Thank you.

Werner Lieberherr - President & Chief Executive Officer

Yeah. Okay (40:35). Thank you.

Operator

And Goldman Sachs, Noah Poponak has our next question.

Noah Poponak - Goldman Sachs & Co.

Hey. Good morning, everyone.

Amin J. Khoury - Founder and Executive Chairman

Morning Noah.

Joseph T. Lower - Chief Financial Officer

Morning.

Noah Poponak - Goldman Sachs & Co.

So, Amin, the phenomenon of maybe a lower fuel price driving a slower replacement rate, so some older aircraft are in the fleet longer and that drives retrofit activity for you. Did that drive revenues in the second quarter or the last six to nine months? Or is it more driving just discussions and orders for future revenue? I can't tell if it's impacting (41:17)?

Amin J. Khoury - Founder and Executive Chairman

That 40% of our business was aftermarket oriented in the quarter. Our expectation in future years is that it turns around and moves closer to 60% from the aftermarket and 40% associated with line fit from new airplane deliveries. And with respect to the orders part of your question, we're anticipating additional strong retrofit orders over the next six to 12 months.

Noah Poponak - Goldman Sachs & Co.

Okay. Is it fair to conclude from that that the majority of that retrofit activity tied to a slower replacement rate is still ahead of you versus has already occurred?

Amin J. Khoury - Founder and Executive Chairman

Yes. I don't know about a slower replacement rate. It could be. But a lot of the retrofit is just to bring the rest of the fleet up to the cabinet standard and the new technology product which are being embodied in the new airplanes which are being received. So to the extent that airlines receive for the first time new A350s or new 787s and they start to get a flow of the new airplanes coming in, there's a pretty stark difference often between the cabin standards and the cabin equipment in the new airplanes versus the existing fleet which they may operate for a very long time. And so they'll place retrofit orders to upgrade the balance of their fleet.

That's one driver. And then, of course, the other driver is the driver you're talking about where the airlines make a conscious decision to defer delivery of certain new wide-body airplanes. Maybe an airline wants to wait until the 777X is available and will retrofit their existing fleet and try to keep highest cabin standards they can in order to handle the competitive pressures which Werner was talking about earlier and be able to maintain their market shares on the routes.

Noah Poponak - Goldman Sachs & Co.

I see. And then could you parse out what Super First Class did versus what actual private jet did in terms of a growth rate within Business Jet in the quarter?

Amin J. Khoury - Founder and Executive Chairman

No. We've not done that I don't think ever. But for the prior quarter, all businesses were down. That is the business jet executive seating, the civilian helicopter seating and the Super First Class products were all down as compared to the same quarter of the prior year.

Noah Poponak - Goldman Sachs & Co.

Was any of them substantially different than the blended segment 12%?

Amin J. Khoury - Founder and Executive Chairman

The most negative impact on margin comes from executive seating and helicopter seating.

Noah Poponak - Goldman Sachs & Co.

Okay.

Amin J. Khoury - Founder and Executive Chairman

At higher volumes, those are very profitable products.

Noah Poponak - Goldman Sachs & Co.

I see. Okay. Thank you.

Amin J. Khoury - Founder and Executive Chairman

Okay.

Operator

Next we have Michael Ciarmoli with KeyBanc Capital Markets.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Hey. Good morning, guys. Thanks for taking my call.

Amin J. Khoury - Founder and Executive Chairman

Good morning, Mike.

Werner Lieberherr - President & Chief Executive Officer

Good morning.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Amin, maybe if we can go back to the initial line of questioning, just looking at the guidance, second half looks to be a little bit weaker than first half. And I just want to make sure, it sounds like you guys have some, call it, deferral risk embedded into the guidance both this year and next year. It sounds like with what American was supposed to take next year that maybe hit that cushion by about $28 million. Is there anything else baked into that guidance in terms of why it would be down? And what should we look for, especially on the A350 with maybe 100 or so planes expected to be delivered to the European carriers? How much cushion is left in terms of deferrals before it would have a negative impact on your guidance?

Amin J. Khoury - Founder and Executive Chairman

First, second half of the year, let me just address that, we do expect the second half of the year to be softer as compared to the first half of the year. That's just a function of on-dock delivery dates and specific customers and specific aircraft. We're at that point now where we have pretty decent outlook on the next six months, so we do expect it to be somewhat softer. And on the other hand we expect 2017 to be a really outstanding year in terms of revenues.

And that has to do with specific customers and specific products and specific airplanes and on-dock dates as we have talked about before. So our guidance is developed from the bottom up. And as we get closer in time, like the second half of this year, we have a pretty good fix on it. So we do expect the second half to be softer than the first half. We expect the second half to be solidly better than the second half of last year. So the quarterly reports will be favorable compared to the same periods of the prior year, just not as strong as the first half of this year.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Okay. Well, if we take out $28 million from American in 2017, did you guys win more? What strengthened to enable you to lift that guidance despite that deferral?

Amin J. Khoury - Founder and Executive Chairman

What strengthened? Just a whole lot of customers buying a whole lot of aircraft with specific on-dock dates. We don't think about it that way.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Okay.

Amin J. Khoury - Founder and Executive Chairman

If something negative happens, we subtract it from our plan, okay.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Okay.

Amin J. Khoury - Founder and Executive Chairman

The deferral of A350s by American will negatively impact our plans in 2017, 2018. We're building our plans with consideration for those push-outs, and we get two numbers which we're using to guide. To answer your question, I'd have to go through the entire forecast by customer, which I don't think we can do.

Werner Lieberherr - President & Chief Executive Officer

Exactly. We do every month. We actually look at opportunities. And as Amin just said, I think we have a very good handle, actually, on the backlog and how we actually will deliver that backlog. Now if we would have another – let's say, A350 went with another customer, obviously, we will need to see, okay, is that something which now actually affects our top line. Or do we maybe have a retrofit opportunity which we can compensate part of it and so on. But these discussions they take place every month in great detail where we actually look at how does it shape up.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Got it. That's helpful.

Amin J. Khoury - Founder and Executive Chairman

One of the things that happened was Southwest pushed out some of their 737s, okay. At the same time, they commenced a retrofit program, which has already begun and it's underway. So there's puts and takes within the same airline and among different airlines.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Got it. No, that's helpful. Just a last one. Would you guys care to give the dollar content on that 737 MAX for Southwest that you have on there?

Amin J. Khoury - Founder and Executive Chairman

Don't have it handy, but obviously there's so much of our equipment on the 737, as Werner pointed out. And it was a wow at the Farnborough Airshow.

Werner Lieberherr - President & Chief Executive Officer

Yes.

Amin J. Khoury - Founder and Executive Chairman

Okay.

Michael F. Ciarmoli - KeyBanc Capital Markets, Inc.

Great. Thanks a lot, guys. Nice quarter.

Amin J. Khoury - Founder and Executive Chairman

Thank you.

Werner Lieberherr - President & Chief Executive Officer

Thank you.

Operator

We'll move now to David Strauss with UBS.

David E. Strauss - UBS Securities LLC

Thanks for taking my question. Good morning.

Amin J. Khoury - Founder and Executive Chairman

Hi, David.

Werner Lieberherr - President & Chief Executive Officer

Good morning, David.

Joseph T. Lower - Chief Financial Officer

Good morning, David.

David E. Strauss - UBS Securities LLC

Good morning. Amin, can you just give us an overview where you are on the Lav program for 737? What the take-up rate is on the NG? How much you're shipping for on the MAX at this point, and then where are you in terms of the retrofit opportunity?

Amin J. Khoury - Founder and Executive Chairman

Sure. Why don't I ask Joe to respond to your question, so we keep everybody busy here, David, okay?

David E. Strauss - UBS Securities LLC

Okay.

Joseph T. Lower - Chief Financial Officer

Sure. Thanks, David. David, so as of June, we now have 23 airlines that have received the new 737 with our advanced lav. And I think we've delivered 54 retrofit shipments to two customers so far. So that's what we have just kind of so far. As we go into 2017, as I think what you've heard before, we're going to be the exclusive supplier. Supplier for both the NG and the MAX. And that will be basically another 70 airlines taking delivery of their 737s with our lavs over the next two years.

And so you've got the 737 at 42 aircraft a month now, would go into 47 in 2017, and I think 52 in 2018. So as we look at that and you look out to in the future, really everyone that's going to have – taking those 737s with the advanced lav are going become potential retrofit customers. And that really is the attractiveness of this product line to us is that long sustained after-market opportunity. Hopefully that answers the question, but that's where we stand on the program. Making good progress, a lot of introductions coming and well received to-date.

David E. Strauss - UBS Securities LLC

And maybe...

Amin J. Khoury - Founder and Executive Chairman

Everything on time at solid quality and on-time delivery. No issues.

Werner Lieberherr - President & Chief Executive Officer

Yeah, exactly. And there was one of the very early questions. How does this backlog actually drive spares and so on? As you can imagine, this type of lavatories or an A350 galley obviously down the road, while these programs are challenging in the ramp-up, but they will drive a very significant aftermarket content. So when you look at our backlog, shadow backlog and normal backlog, this drives definitely spares.

David E. Strauss - UBS Securities LLC

And thanks for the color. Just as a follow-up to Joe, is your biggest year of growth just looking at the new equipment side on the lav? Is that 2017 or is it 2018?

Joseph T. Lower - Chief Financial Officer

2018.

Werner Lieberherr - President & Chief Executive Officer

It's 2018 actually. And also 2017, we are sole supplier. And then actually as Boeing goes up in the run rates, that's actually how we go up.

David E. Strauss - UBS Securities LLC

Okay, so 2018 over 2017.

Amin J. Khoury - Founder and Executive Chairman

I don't know. I think they're both big years because 2017 is a really big year over 2016 because we go exclusive during 2017.

Werner Lieberherr - President & Chief Executive Officer

That's exactly correct, and...

Amin J. Khoury - Founder and Executive Chairman

And then 2018 we have...

Werner Lieberherr - President & Chief Executive Officer

Sorry.

Amin J. Khoury - Founder and Executive Chairman

Sorry. Go ahead, Werner.

Werner Lieberherr - President & Chief Executive Officer

No in 2017, actually, Boeing goes to 47 and then in 2018 to 52. So that's why we are really peaking at 2018 in the deliveries that then we need to see where Boeing goes from there.

David E. Strauss - UBS Securities LLC

Okay. Thanks.

Amin J. Khoury - Founder and Executive Chairman

If your question was about growth rate, it could be higher in 2017 than 2018.

Joseph T. Lower - Chief Financial Officer

Yeah. So the growth rate is higher in 2017 than it is in 2018.

David E. Strauss - UBS Securities LLC

Okay. One follow-up, Amin, you had commented on the business jet segment not returning to growth until 2018. I think before as it relates to 2017 you had said around flattish. Are you still thinking flattish for 2017 for business jet? Or are we actually looking at down now?

Amin J. Khoury - Founder and Executive Chairman

It could be down somewhat. We're not exactly sure at this point in time. Fortunately it's a 20% segment for us. 80% of our business is commercial aircraft segment. So our outlook and our guidance are not so much impacted by small changes in the biz jet business, but our expectation is that 2017 is anything but a strong year and that we don't get the turnaround until 2018. And I think that happens for two reasons. First, oil and gas prices are turning around here in 2016, and the outlook for 2017 and 2018 is continued growth. All right? Supply and demand are getting together. So it looks like by 2018 the energy companies will be in position to once again be able to and need to buy the helicopters and will be buying biz jets again, and the developing countries, who generate a lot of their national income through oil and gas will once again become net buyers rather than sellers. And that happens about the same time that a number of new business jet aircraft platforms are introduced into the marketplace.

There is definitely some negative effect right now with folks waiting for the new airplanes to be introduced into service as compared to buying the older, new delivery – new aircraft, older aircraft types, which are still in production and new. So it looks to us like 2018 should be an all cylinders type year for us with commercial aircraft segment and the biz jet segment both contributing significantly. But in 2017 we don't see much help from the biz jet segment.

Greg Powell - Vice President-Investor Relations

Candice, we have time for one more question.

Operator

Thank you. We'll take our final question from Seth Seifman with JPMorgan.

Seth M. Seifman - JPMorgan Securities LLC

Thanks very much, and good morning.

Amin J. Khoury - Founder and Executive Chairman

Good morning.

Joseph T. Lower - Chief Financial Officer

Good morning.

Seth M. Seifman - JPMorgan Securities LLC

Joe, I wonder if you could tell us about the excess-over-average balance? And when you think about the recovery period for that for the lavs and the galleys, is it roughly about – I think maybe there have been some talk in the past about it being 10 years or so. Can you tell us the period over which you expect to recover the cash?

Joseph T. Lower - Chief Financial Officer

Yeah. So there's two things there. You had excess over average in deferred development costs, right. The deferred development costs, which we were talking about earlier, we will recapture those over the duration of the program. That is correct. It is a long-term recovery. But as we've said repeatedly, it starts to be a net cash generator in 2017 and then will continue to be a net cash generator thereafter as we recover those costs over the deliveries of these programs, which as you've said, go out close to 10 years.

Amin J. Khoury - Founder and Executive Chairman

Actually we'll be delivering these products long after 10 years.

Joseph T. Lower - Chief Financial Officer

Right. But the program aspect of it is the first. And it extends with additional deliveries, as well as aftermarket. But from the amortization, it's over the initial quantities in the program.

Seth M. Seifman - JPMorgan Securities LLC

Right. Okay. I mean just to be clear, the numbers we're talking about here, I believe in the first quarter it was $34 million. It listed as I think excess over average on long-term contracts. That is deferred development costs? Or that is production costs above the average for your initial quantity?

Joseph T. Lower - Chief Financial Officer

The $34 million you're referring to is the development costs that are capitalized and put on the balance sheet.

Seth M. Seifman - JPMorgan Securities LLC

Okay.

Joseph T. Lower - Chief Financial Officer

And as I said earlier, that amount is expected to be slightly lower in the second quarter. And it will be expected to be lower in the second half versus the first half as it trails down over the course of this year.

Seth M. Seifman - JPMorgan Securities LLC

Right. Okay. Okay. All right. And then maybe as a follow-up, is your tax rate now steady at the new rate as we look forward? Or does it come back down?

Amin J. Khoury - Founder and Executive Chairman

I think we'll give guidance for 2017, specific guidance, in October, the way we normally do. I think what we've got out there now is enough for the time being. And I think any further discussion about 2017 we'll do in October.

Seth M. Seifman - JPMorgan Securities LLC

Okay. Very good. Very good. Thanks, very much.

Amin J. Khoury - Founder and Executive Chairman

Okay. Thank you.

Amin J. Khoury - Founder and Executive Chairman

And thanks, everyone. Have a great day.

Werner Lieberherr - President & Chief Executive Officer

Yeah. Thank you and good morning. Thank you.

Operator

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

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