Textron's (TXT) CEO Scott Donnelly on Q3 2016 Results - Earnings Call Transcript

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Textron Inc. (NYSE:TXT)

Q3 2016 Results Earnings Conference Call

October 20, 2016, 08:00 AM ET

Executives

Eric Salander - VP-IR

Scott Donnelly - Chairman, President and CEO

Frank Connor - CFO and EVP

Analysts

Gavin Parsons - Goldman Sachs

Carter Copeland - Barclays

George Shapiro - Shapiro Research

Jason Gursky - Citi

Pete Skibitski - Drexel Hamilton

Cai von Rumohr - Cowen & Company

Samuel Pearlstein - Wells Fargo

Sheila Kahyaoglu - Jefferies

Julian Mitchell - Credit Suisse

Seth Seifman - JPMorgan

Peter Arment - Baird

Myles Walton - Deutsche Bank

Ronald Epstein - Bank of America

Justin Bergner - Gabelli & Company

John Walsh - Vertical Research

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Textron Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host, Eric Salander, Vice President of Investor Relations. Please go ahead.

Eric Salander

Thanks, Stacy, and good morning, everyone. Before we begin, I'd like to mention we will be discussing future estimates and expectations during our call today. These forward-looking statements are subject to various risk factors which are detailed in our SEC filings and also in today's press release.

On the call today, we have Scott Donnelly, Textron's Chairman and CEO; and Frank Connor, our Chief Financial Officer. Our earnings call presentation can be found in the Investor Relations section of our website.

Textron's revenues in the quarter were $3.3 billion up $71 million from last year's third quarter. During this year's third quarter, we record $115 million pretax charge or $0.27 per share after tax related to the restructuring plan we announced this past summer. We also recorded a tax benefit of $0.76 per share related to a settlement of U.S. Internal Revenue Service audits

Excluding these items, adjusted income from continuing operations was $0.61 per share down $0.02 from last year's third quarter. Manufacturing cash flow before pension contributions was $94 million compared to $116 million in last year's third quarter.

With that I'll turn the call over to Scott.

Scott Donnelly

Thanks Eric and good morning everybody. 2.2% increase in third quarter revenues reflected growth of Industrial and Aviation. We had good execution in the quarter with margin improvements in our Systems and Bell businesses. Despite the increase in revenues adjusted earnings per share was down $0.02 primarily the result of higher corporate expenses which reflected higher stock-based compensation expense and higher spending on the Scorpion program.

The Bell revenues were down slightly as lower commercial units delivery in the quarter more than offset higher military volumes. Specifically we delivered 25 commercial helicopters down from 45 in last year's third quarter. We delivered 6 V-22, up from four units last year and 8 H-1s up from 5 last year.

Our V-247 Valor program continues to progress with assembly of the first aircraft approximately two-thirds complete and on track for first flight next year. We also announced a new military tiltrotor product the Bell V-247 Vigilant. The Bell V-247 Vigilant is a Group 5 unmanned aerial system that will leverage the investment we're making in the V-280 platform.

247 design will provide unmatched speed, payload long-endurance capabilities and runway independence to fill multitude of missions including maritime environments. At the AUSA show over this month customer interest was high around both our V-280 mockup and the Bell V-247 model that were on display.

On the commercial side while deliveries were down significantly in the quarter, we saw an increase in order flow. As we consider current customer activity and contract opportunities, we believe that Bell commercial helicopter demand has stabilized and maybe in the early stages of recover.

On our new 505 Jet Ranger X, we continue to make progress on certification and we expect to achieve this initial certification late this year with deliveries beginning shortly thereafter. During the quarter we were awarded two FMS contracts for 13 V-2 helicopters to be delivered in Uganda and Kenya with deliveries beginning in the fourth quarter. Overall given the challenging commercial markets, we had a strong quarter at Bell as cost productivity efforts over the past several years contributed to a 13% segment margin.

Moving to Systems, revenues were down as higher revenues at Marine and Land Systems were more than offset by lower weapons deliveries. As you know we announced we will be discontinuing production of Sensor Fuzed Weapons in March of next year. As result we're taking actions now to reduce costs across the System segment.

At TMLS we began initial TAPV deliveries to our Canadian customer in the quarter and looking to the fourth quarter we have a significant wrap in deliveries although slower than we had originally planned.

Moving to industrial, we saw some percent increase in revenues reflecting the impact of acquisitions and higher volumes in our automotive and specialized vehicle businesses. Last month we announced we will be consolidating Jacobsen with a specialized vehicle business to optimize efficiency and better serve the company's shared customers and distributors.

Also in the vehicle business we recently acquired Safeaero, a Swedish Manufacturer of De-Icer for the commercial aviation industry. Safeaero will be part of our ground support equipment portfolio which continues to grow very nicely.

In our commercial business we introduced a new line of Cushman Hauler utility vehicles. While on our consumer product line, our distributors kicked off retail sales of our new Stampede 4x4 off road product. At Kautex our selective catalytic reduction product lines continue to drive growth above the current auto market.

Moving to Textron Aviation, revenues were up $39 million in the quarter. We delivered 41 Jets compared to 37 last year and 29 King Airs flat with last year. On the new product front, the launch tube made its first flight on October 8, marking an important achievement in its part certification market entry. This first flight occurred less than a year after unveiling the launch tube at NBAA last November demonstrating our rapid new product development cycle with target certification later next year.

Customer anticipation to new aircraft remains strong as we have begun executing purchase agreements with potential customers. During the quarter we also unveiled Cessna Denali, our new clean sheets single-engine pressurized turboprop. The Denali will feature superior operating performance with the only flat floor cabin design in its class and will easily convert between passenger and cargo configurations.

We are not currently serving this market segment and believe the highly differentiated Denali will contribute a significant future growth of aviation with its best-in-class performance characteristics.

Moving to Scorpion, the program continues to make good progress and we expect first flight of our initial production aircraft very soon. Last week we conducted a successful weapons testing with our existing aircraft at U.S. Air Force White Sands Proving Ground. With accreditation process now underway and customer interest increasing, we have accelerated investment in the program. We have begun building several aircraft to support the accreditation requirements, validate our manufacturing process, expand our marketing and customer engagement activities.

Moving to an update on our restructuring plan, we have announced additional headcount reductions across our businesses principally through a voluntary separation plan in our aviation segment and have increased our cost estimate accordingly. To wrap-up, several of our end markets remain challenging in the third quarter, we still achieve top line growth while furthering our development efforts on major new programs.

With that, I’ll turn the call over to Frank.

Frank Connor

Thank you, Scott and good morning everyone. Segment profit in the quarter was $310 million down $2 million from the third quarter of 2015 on a $71 million increase in revenues. Let's review how each of the segments contributed starting with Textron Aviation.

At Textron Aviation revenues were up 39 $million from this period last year primarily due to higher pre-owned aircraft volumes and the impact of an acquisition. Segment profit was $100 million down from $107 million a year ago primarily reflecting the mix of products sold. Backlog in this segment ended the quarter at $1.1 billion approximately flat with second quarter.

Moving to Bell, revenues were down $22 million primarily due to lower commercial deliveries partially offset by higher military volumes. Segment profit decreased $2 million from the third quarter of 2015 reflecting the lower commercial aircraft deliveries. Backlog in this segment was $4.9 billion at the end of the quarter approximately flat with the second quarter.

At Textron Systems, revenues were down $7 million primarily due to lower weapons volume partially offset by higher revenues at Marine and Land. Segment profit was up $5 million reflecting improved performance. Backlog in the segment was $2.2 billion down $74 million from the end of the second quarter.

Industrial revenues increased $58 million due to the impact of acquired businesses and higher volumes. Segment profit increased $5 million reflecting improved performance. Finance segment revenues increased $3 million and profit decreased $3 million.

Moving below the segment profit, corporate expenses were $53 million compared to $27 million last year. As Scott explained, this reflected higher stock-based compensation expense and the accelerated spending on our Scorpion program.

Interest expense was $35 million up $2 million from last year. With respect to our restructuring plan in the quarter, we recorded a pretax charges of $115 million on the special charges line. Looking forward our revised cost estimate for the total restructuring plan is now a range of $140 to $170 million pretax up from $110 million to $140 million to reflect the additional reductions that Scott discussed.

Cash outlays associated with this plan are now estimated to be in the range of $100 million to $120 million compared to our previous estimate of $65 million to $85 million. We recorded a total income tax benefit of $319 million in the quarter related to settlement of U.S. IRS audits for years 1998 through 2008, $206 million or $0.76 per share was attributable to continuing operations.

To wrap up, we are narrowing our adjusted full year EPS from continuing operations guidance to $2.65 to $2.75 a share which corresponds to GAAP EPS of $3.06 to $3.21 per share. Given our accelerated spending on Scorpion, higher investment in restructuring and slower TAPV deliveries we are revising our outlook for cash flow from continuing operations of the manufacturing group for pension contributions to $500 million to $600 million down from our previous estimate of $600 million to $700 million.

That concludes our prepared remarks. So Stacy we can open the line for questions.

Question-and-Answer Session

Operator

Thank you. And we'll go to Noah Poponak with Goldman Sachs. Please go ahead.

Gavin Parsons

This is Gavin on for Noah. Just looking at the broader business jet market, it seems like it's weakened a little bit lately, with some of your competitors announcing production rate cuts over the last couple of quarters. And then you look at deliveries ex-Latitude, mostly flat, with a little bit worse mix. So I'm curious if somewhat on the cannibalization subject, what do deliveries look like ex-Latitude for the next couple of years, and is there pricing pressure in the market more broadly, in addition to these new model introductions you have lined up?

Scott Donnelly

Gavin I’m not sure I would try to harbor guess at the next few years on what the market looks like but I think that where the market is right now is certainly still soft. I would say it's still more or less in line with what we expected this year which is to say that, most of the growth is driven by the new products that are coming on to the market that's certainly been true with latitude.

The market for historical products is pretty flat and yes, there continues to be a pretty tight market it's difficult to get any kind of pricing but you know it's up little on some models and down little on some model so it's really is consistent with what we've been seeing for the last couple of years.

So our plan obviously is that the only growth that we've been seeing is been driven by the new products come out into the marketplace and that's why we continue to stay focused on bringing longitude to the market and bring the knowledge of the market, ultimately bringing the hemisphere to the market because I think at least in the market environment we exist in today that's the only way to drive growth, and you continue to expect at the legacy historical product lines will be relatively flat.

Gavin Parsons

Thanks. And when you look at -- could you try to size maybe the net impact of membership clubs? Kind of Uber for business jet, if you will, where that's much higher utilization, but it's bringing in new users who potentially hadn't had access to business jets before?

Scott Donnelly

Well I don't know when I go all the way to the Uber side, I mean obviously we have a couple of very important customers that are in the - sort of nonretail only aircraft market niche as you know to the extent there obviously selling these aircraft to fractional customers and their car based on the niche as a pretty broad range of product that they provide to reach people aren't owning their own whole aircraft.

So that's an important part of where we today with Latitudes. Obviously on the King Air side, you have guys out there like Wheels Up that are operating primarily King Airs and also aimed at a non-equity and a broader base of potential customer.

So we see some of that. I mean these are very real customers. They are taking over aircraft and are running pretty significant businesses today and appear to be doing so successfully. How much broader we see that market or how far that reaches to what customer segments in the world, I think is still to be determined. It's a lot of different models out there, some of them I think are on the work and there is other ones that may not work but certainly we have a couple of key customers that are sort of inline with I think your question. How do you reach a broader base of people to get into a private aircraft and today we certainly see that happening very successfully with both the NetJets of the world as well as the Wheels Up for the world.

Gavin Parsons

Thank you.

Operator

And we'll go to line of Carter Copeland with Barclays. Please go ahead.

Carter Copeland

Hi, good morning guys. Just a quick clarification on the Scorpion comment. I think earlier in your prepared remarks, you said higher spending, and then in most of the other places, you said accelerated spending. I just want to clarify, is there any cost growth in the manufacturing efforts early on, or is this all related to pulling forward investment that you intended to do further down the line?

Scott Donnelly

Yes, the increased spending is in R&D expense right, so we’re in the process of getting ready for our first flight. We’ve also undertaken some things like going out and doing actual weapons, deliveries so the cost of those kinds of activities obviously a lot of the cost is around bringing the first production unit to the market and developing our manufacturing processes as we start sort of what I referred to is a limited rate production run, our expenses that we would accelerate.

So these are things that, that certainly could have been put off and originally would have been done in the future but I think as we’ve established this with the Air Force and now have a path of certification, the level of activity where customers has stepped up considerably and it’s the right time for us to step up and demonstrate this aircraft and its performance capability and get much more aggressive about the marketing and test flights and I think it’s the right time based on what’s going on in the customer community to really mature this program.

And so those are largely expenses that we pull forward because we think, we need to do it now. Waiting a year or spreading it out over longer period of time won't help us given the opportunities that we see out there in the - not too distant future.

Carter Copeland

Okay. Great. That's great color. And then on the comment you made regarding demand stabilization and potential recovery at Bell, I wondered if you might give us a little bit more color there, and what's driving that view? Is it customer pipeline and conversations? Obviously, the backlog was flat year over year, or sequentially. Any more color on that would be helpful.

Scott Donnelly

Sure, I think in the last quarter, we have seen a pretty significant uptick in the numbers of orders that we booked compared to the first half of the year. Now this is still down from where it wasn’t in its peak. I mean we’re not suggesting that this market has recovered and things are great but we had a year were order activity was extraordinarily weak.

And so we're starting now to see customers that are coming forward actually signing deals and closing contracts and in particular there is a number of campaigns that are in process. We're go out there activities happening and clearly deals are going to close. So that's the rational for sort of our color on that. We're coming out of a year or so here, very, very difficult environment in terms of closing any deals.

I think in the last quarter we saw lot of deals closed and lot of deals that are active in progress. So, it's - again it's not were things were in the great days but it's certainly positive to see and uptick and activity in actual orders.

Carter Copeland

Great, thanks for the color. I will let somebody else ask.

Operator

We'll go to line of George Shapiro with Shapiro Research. Please go ahead.

George Shapiro

Yes. Good morning Scott. The aviation margin was somewhat lower than what I was looking for. On the second quarter, you said that you would see lower R&D on the Longitude in the third -- in the second half of the year, and pricing may be a little bit better. So could you just comment on that? And then also, to get to the low end of your 8.5% to 9% margin would require a margin north of 11% in the fourth quarter. So is that doable? And if not, what would you suggest is the range now?

Scott Donnelly

Well so a couple of things, George first of all the R&D as we went from Q2 to Q3 did come down in the business and I think if you look at the sequential margins are pretty good from Q2 to Q3. But if you look on a year-over-year basis, there is no question that the leverage wasn't there. I’d say the most of that is a result of the fact that our revenue growth on a year-over-year basis was largely driven by used aircraft sales and the inclusion of our acquisition at Able, which is a great little business but in its first year with deal related costs and step up and all that kind of stuff its first year is kind of a breakeven.

So if you look at that model you have $50 million plus of revenue in there that’s not, there has no margins its used aircraft in the first year of that deal. So, that’s the bulk of where you don’t have leverage where you would probably have expected to see some of that leverage and the rest of its still is ongoing mix issue. So we did have positive pricing on the retail side on latitude in the quarter but it's still at lower margin rates than what we typically see in the rest of our portfolio.

And obviously all of the mix shift in the quarter as we’ll mentioned you guys see the numbers in terms of aircraft, we had a couple more Mustangs. We had a couple more in M2s, we certainly had more Latitudes but we also were down a couple XLSs and Sovereigns. So from a mix standpoint that certainly pressured some of the conversation as well on a year-over-year basis.

George Shapiro

And what would you suggest now for margin for the year, where you had been at 8.5% to 9%?

Scott Donnelly

Look I think that’s going to be at the low end of that George and part of the rational for a large driver for the rational for why you see us narrowing our range is that the top end of our original guidance range would have been stronger year in the business jet market. Obviously its continued to be pretty flat, so we're probably going to be more towards that midpoint which is why we’re revised our guidance.

As it comes to the segment, I think we’re probably expecting something more around a 10% kind of margin rate in the quarter for Aviation as oppose to something that would be high enough to bring it up into the midpoint of its range.

George Shapiro

Okay. And then if you could -- after market growth in the quarter, if you took out Able, so on an organic basis, what was that?

Scott Donnelly

Pretty flat.

George Shapiro

Okay, thanks very much. I’ll get back in the queue.

Operator

We'll go Jason Gursky with Citi. Please go ahead.

Jason Gursky

Hi, good morning guys. Could you dive a little bit deeper into the TAPV program? You suggested volumes are going to be a little lower than initially expected. Can you tell us why and what to expect going forward? And then just comment as to whether the inventory levels on the balance sheet are related in part to the TAPV program?

Scott Donnelly

Sure. So, you know, we did make initial deliveries in the quarter. Kind of going through that process and dealing with normal - I'd say normal. We had more issues just in terms of consistency and flowing vehicles through that process than we would have expected. The good news is we are now - we are making deliveries every week. We are agreeing with the customer on how many units they are taking and that process appears to be flowing. But it is at a lower level than we would have originally planned in our RLP.

So while we will make a fair number of deliveries here in the fourth quarter. We will certainly not get to where we would have expected to be, and that's part of our cash pressure. We will have higher finished goods inventory on the TAPV program than we would have expected in our plan. So that is certainly a significant part of the downward revision on our cash for the year.

So, again there is no, major issue there. The vehicles every week we’re delivering vehicles, vehicles are going in and being delivered to the customer but it’s at a lower rate than we would have planned.

Jason Gursky

Great. And then, Scott, really quickly on business jets, could you talk a little bit about the fourth quarter set-up here? Does this fourth quarter feel similar to what you have experienced going into the fourth quarter the last couple of years, with regard to how many bookings you have in hand, with the pipeline, and how you close out the year? Is it going to be as seasonally strong as we've experienced here the last few years? Thanks.

Scott Donnelly

We normally have still aircraft to sell. The good news is in terms of things like the latitude or in a very solid position. But there are still aircraft to sell, and we are closing orders, which is kind of what we expect to see happening. We have NBAA coming up here in a couple of weeks which is usually a pretty significant event in terms of customer interactions and we would expect to see a number of closings come out of that, as well.

So it's kind of where we've been. We always have aircraft to sell.

Operator

And we’ll go to Pete Skibitski with Drexel Hamilton. Please go ahead.

Pete Skibitski

Hi, good morning guys. Scott, on the incremental Scorpion spend, you talked a little bit about it, but could you give us an updated sense of when you are expecting certification from the Air Force? I don't know what else you would be comfortable talking about, in terms of maybe expectations for a first order or a first delivery?

Scott Donnelly

Well, we don't have confirm date yet with Air Force, our teams and the certification folks that right paddle working together very carefully, I mean it's frankly quite busy. I mean there is a lot of activity going on. Lot of the detailed touch plans being finalized, and data been reviewed. So it's in the pros of the process you'd expect. I mean so it’s a very active cert program. We did a lot of work here over the last month obviously to get ready to do a weapons drop which was very successful last week.

So that was above and beyond certification work or demonstration of its capability which I think was very important to our prospective customers and was being watched very carefully. The acceleration on the production process maturing obviously, we've been always planning to do this initial production configuration aircraft to support certification program, but given the overall activity we've gone ahead and sort of pull the trigger on initiating our small production build to help validate our manufacturing processes as well.

So I hope we have a lot of customer conversations going on right now. We think there's a number of opportunities to demonstrate this aircraft. We have a bunch customers who want to fly the aircraft and that's really one has to accelerate both the expense side, as well as to bring in the inventory and initiate the limited rating of production because when you have these assets available for customer demonstrations, customer flights and hopefully eventually customer sales.

But I won't provide any color and I think on a specific closure date of any particular contract, but there's a lot of customer activity and lot of discussions ongoing.

Pete Skibitski

Okay. You're feeling good about that program. One follow-up on Bell. Your comments on the market, does that include the 412? That was a rough quarter for the 412? Are there campaigns out there? Are you feeling that the 412 would come back? If you could up date us on the 525, if the flight tests are still suspended or not?

Scott Donnelly

Sure. So the 412 is certainly very important part of what we see in sort of recovery or there is a number of 412 deals that have closed and there is a number of 412 opportunities that are out there that are actively in negotiation. So I think the 412 is important part of what we see making a turn as we go into '17 and beyond, so that's very positive.

With respect with 525 again this is NTSB run investigation, they are managing that process. We are obviously cooperating and supporting them in every way that we can. The flight test program is still not moving forward. We have teams that are making preparations for what return to flight looks like and being ready to do that.

We also obviously continue to do all the non-flight test related certification work which is continuing to progress well. So we don't have a time or date on the exact return to flight that's a process we have to manage through working with the NTSB and FAA, but that investigation work continues to progress.

Pete Skibitski

Thanks a lot.

Operator

And we'll go to Cai von Rumohr with Cowen & Company. Please go ahead.

Cai von Rumohr

Yes. Thank you very much. So your corporate expense was up. Was most of that the accelerated spending on the Scorpion? If so, how does that change your R&D expectation and corporate expense expectation for the full year?

Frank Connor

Well, it's probably about half and half split Cai, between the accelerated spending on the Scorpion program which is flowing through there. And also the stock based comp because reversion down a year ago so the relative year-over-year comparison is up.

So it's kind of split between those two factors about $0.02 to $0.04 each kind of an impact. I would expect to see that and I'd expect to see that flow continue through the fourth quarter as we continue the spending on the Scorpion program, getting the first flight and continuing to work the certification and manufacturing process validation program.

Scott Donnelly

So, Cai, on the corporate expense line it obviously will depend on what has stock price in the fourth quarter and there's always those impacts, but it will probably be touch higher than we had originally guided in terms of total year. And in terms of total R&D it's not - it won't change the total R&D spending.

Frank Connor

It's not a material number to the total R&D that company guide, but you know the R&D, I expect to continuing pace on the Scorpion program as we accelerated that, but obviously the stock based comp pieces is a little separate issue in terms of what that is in the fourth quarter.

Cai von Rumohr

Right. But so the guide actually was narrowed, and so it sounds like we're talking $0.07, $0.08 incremental spending on Scorpion. Is there an offset to is that? A lower tax rate? Stronger ops, in terms of the outlook?

Frank Connor

We'll say all of the above. Cai, I think we've seen - if you look at where we thought from the beginning of the year I think Bell is performing very strongly, I think the Systems business is performing very well even in light of challenges around the delays on the TAPV program, industrial guys are doing quite well.

Again aviation I think is they are performing well in a very difficult environment. We're probably not going to get the leveraging growth that we would like seen to be towards the top end, but then we are throwing a little bit of acceleration on Scorpion and that's kind of where we end up with all those puts and takes around the midpoint of what we guided.

Cai von Rumohr

Got it. Last one. If you look at Bell, if you hit your target on V-22s, they are going to be down a lot in the fourth quarter. And so even if you get a pickup in commercial, and certainly based on the third quarter, you got a long way to go. Bell looks like it has a tougher fourth quarter coming up. Does your guidance there change for the year?

Frank Connor

No, I think there is a - again the performance of Bell all year has been strong. I think the productivity that we've expected has been delivered on and I think the team will close out on a strong year.

Cai von Rumohr

Thank you.

Operator

And we will go to Sam Pearlstein with Wells Fargo. Please go ahead.

Samuel Pearlstein

Good morning. Could you talk a little bit more about the restructuring? You increased it from where you thought at the end of August. You mentioned mostly on the aviation side. Is there a driver there? Is it that the pricing you thought might come through didn't, that causes you to want to restructure your costs? Could you talk a little bit about that?

Scott Donnelly

First time I wouldn't attribute it directly to pricing, but I'd say obviously the aviation market continues to be challenging and we're pleased with the impact the new products we're having, the legacy, historic market is still a challenge. And as we look at what we need to do to try to sustain margins and keep the business productive and competitive. We thought the most popular way to do that was look at another cost restructuring there, we're doing the bulk of it frankly to a voluntary program which has been well received. But we really - keep cost in line in a challenging market we thought it was appropriate this time to do that.

So that's driving the bulk of the net out of the restructuring program we're obviously interested, we needed to do with our exit of the weapons business and overall what's going on across the system segment, but it was right time to take an action in the aviation side as well just given the overall weak demand environment in that industry.

Samuel Pearlstein

In the $100 million to $120 million of actual outlays, is that all in 2016?

Scott Donnelly

No, it will be split between $0.16 and $0.17. So it's probably - it will probably close to half of this year and half in the '17. A lot of that is severance and what we have some of the - severance costs we borne this year a fair bit that will roll over into the beginning of 2017.

Samuel Pearlstein

Okay. Last question. Just looking at even the new manufacturing cash flow guidance, pretty substantial step up in Q4, over $500 million probably in free cash. What is it that drives that big step up?

Scott Donnelly

Well, we typically see a fairly strong quarter on the aviation side. All of that inventory which has been accumulating throughout the course of the year which is pretty normal for us. I think we'll also see -- we are starting to flow more deliveries on the vehicle side of the business, which is largely direct conversion in the cash. So those are probably two of the biggest movers.

Samuel Pearlstein

Okay. Thank you.

Operator

And we'll go to the line of Sheila Kahyaoglu with Jefferies. Please go ahead.

Sheila Kahyaoglu

Good morning. Just to follow up on the restructuring, how are you thinking about it across the segments? I've seen some announcements in aviation and within industrial. Anything in Bell, and also, how do you think about the payback there for 2017?

Scott Donnelly

So the bulk of the restructuring activity that we added obviously was aviation. So that the previous restructuring we talked about it was largely Systems driven or some associated with the move of the Jacobsen into the Specialized Vehicle business as we shutdown the Charlotte manufacturing operations and move that down to Augusta.

That's really the only part that's in the industrial segment. So the bulk of it is between Systems and now with the reduction at aviation pretty heavy in that segment. From a payback shareholders if there is any part of this restructuring obviously we expect to see sort of an attritional payback over typical personal related cost six or nine months for part of this obviously in particular that associated with the shutdown of the weapons and Sensors SFW line there is no payback there. This is an exit of a business.

So I think the right way to think about this on go-forward basis is that we’ll probably see annualized benefits that are roughly equivalent to that 100 million and 120 million that we’re expanding.

Sheila Kahyaoglu

Got it. And so within aviation, I guess the $30 million is roughly the payback there. Not to pin numbers down on that. And maybe just to follow on to the aviation margin questions. How could we think about the steady state margin from here. Is it the 7% to 8% mark, assuming R&D is at a normalized level and the pricing dynamic continues on the Latitude?

Scott Donnelly

Well, I think we’ll finish the year obviously clearly towards the low end or even a little below the initial guidance we would give you on the Aviation segment. On a continued basis we’re probably not ready to do 2017 guidance yet but it’ll all depend on what kind of market we see and what kind of volume leverage we think we’re going to get.

Right now we’re expecting most of it to be driven by Latitude next year with a little bit of growth driven by Longitude, we’ll hopefully get those certification done and maybe get a couple of initial deliveries in the latter part of next year but again when you look at the margin rates it’s all going to be a matter of what kind of leverage can we get and right now that’s largely new products.

Sheila Kahyaoglu

Okay. And then just last one on King Airs. Can you talk about what you are seeing in the demand environment there?

Scott Donnelly

So King Air deliveries were pretty flat and I think that the demand levels have been pretty steady through the course of the year, they’re obviously lower than they were last year. I think we had a good quarter with flat deliveries.

One of the challenges for the King Air obviously is it’s a more international product and I would say probably about where we’re right now we’re about two-thirds U.S., one-third international on the King Airs and international markets have been somewhat more challenged than the U.S. market so but anyway we feel good about the King Air where it is and sales have been kind of holding in there and it continues to be a pretty popular product.

Sheila Kahyaoglu

Okay, thank you.

Operator

And we’ll go to the line of Julian Mitchell with Credit Suisse. Please go ahead.

Julian Mitchell

Good morning. My first question would be around the capital deployment. So if I think about the first half of the year, you issued debt and did some buyback. Q3, you paid down some debt, no buyback. Has anything changed on your perspective on capital deployment? And maybe give us some color around how you look at the inorganic growth opportunities today?

Scott Donnelly

Well Julian, I think our perspective hasn’t really changed. Obviously we’re committed to at least doing the buybacks to avoid share dilution and that’s been more than accomplished already in the buybacks that we did in the first quarter. We’ll continue to look at it opportunistically.

As you pointed out, we did deploy capital, repay debt here in the third quarter which was obviously something that we needed to do. In terms of on a go-forward basis again we’ll continue to provide that same guide. We’re going to avoid dilution and we’ll do the buybacks as we see opportunistically appropriate.

On the M&A front on a year it's been fairly quiet here lately, I mean there has been a couple of small deals like the Safeaero deal which is very nice little bolt-on for our ground support business which is doing very well for us. We’re very pleased with that business and so we’re continuing to round out the offering that we take through that channel to the same customers and same services support channels makes a lot of sense to us.

And on the other hand many times we continue to kind of look at things, there is nothing large that we would say is imminent but we’re always kind of keep an eye on opportunities that would help to strengthen and grow the businesses.

Julian Mitchell

Thanks.

Scott Donnelly

And clearly we have very lightly leveraged balance sheet where we’ve the capacity and the ability to do something if something comes up.

Julian Mitchell

Thanks. And just going back to the aviation restructuring again, not so much the spending and payback and so on, but more a question around the genesis of it. It doesn't sound as if the aviation market, in your perspective, changed much from July on the Q2 quarter, to today.

So, but at the same time you have launched an incremental restructuring. Is it more the case that the market maybe back in January, you thought you would see a bigger pickup in the second half than what you're actually seeing, or is it the case that the market sequentially did deteriorate slightly?

Scott Donnelly

Julian, it’s not a huge swing one way or the other. It’s just been fairly flat on those legacy sides and when we look at our cost structure I mean we obviously been spending a lot of money and doing a lot of things particularly on the R&D front and a lot new product programs and as you look at that the market environment and margins and the expectations for the kind of returns that we need to provide it made sense to take a look at it and see if there are some restructuring to do try to further improve our cost position.

So I don’t think the market in the segments that we serve have gotten dramatically worse. It just continues to be sort of a stubbornly soft market and I think it was out reaction let’s just try to improve our cost position as we find our way through that.

Julian Mitchell

Very clear. A last quick one. Bell margins. Should we expect those to come in at the high end of the initial range that you had provided?

Scott Donnelly

Yes, I think those performed extremely well in what was certainly a very difficult market and we’ll probably be towards the high end of our initial guide.

Julian Mitchell

Thank you.

Operator

And we’ll go to the line of Seth Seifman with JPMorgan. Please go ahead.

Seth Seifman

Thanks very much. Good morning. I was wondering if you could talk a little bit about the aftermarket at Bell, what it did in the quarter, and how you see it progressing in the context of this stabilization of demand that you have discussed?

Scott Donnelly

So Bell aftermarket was up in the quarter. We kind of reached the point here where we’re sort of a year, more than a year now into what was a fairly significant drop off in utilization associated with oil and gas market in particular. So we’re starting to get a little bit more favorable comps and we did have a positive quarter on the aftermarket side. Now as you know, Seth, you know, from a quarter – any given quarter to quarter it’s going to be sometimes flattish, sometimes up a few points. We expect that’s kind of the trajectory that we should be ongoing forward.

Seth Seifman

Thanks. Last one for the industrial business. The margin guidance that you have given previously implies a pretty strong fourth quarter for industrial. Not necessarily relative to what we saw in the first half, but relative to the typical seasonality in industrial. Is that something that's reasonable to expect? Is there anything in particular that's driving it?

Scott Donnelly

Nothing in particular, Seth, the industrial segment I mean there is obviously seasonality to some of the businesses and we’ll expect to see that normal seasonality but if you look at the margins that we expect on a total year basis it should be consistent with what we guided. So I don’t think there is nothing notable in the segment.

Seth Seifman

Okay, excellent. Thank you very much.

Operator

And we’ll go to Peter Arment with Baird. Please go ahead.

Peter Arment

Good morning. Most of my questions have been answered. Just a clarification, Scott. You mentioned on the Scorpion, the first flight very soon, is that still expectations before the end of the year, or a little color on that?

Scott Donnelly

Yes, I think very soon.

Peter Arment

Okay, that answers it well. Thank you, Scott.

Operator

And we’ll go to Myles Walton with Deutsche Bank. Please go ahead.

Myles Walton

Thanks good morning. I am not going to go by segment, but Scott, maybe at a high level when you started the year in sales, it was $14.3 billion of sales, if I triangulate where you are and what you said on commentary, is $13.8 billion the right range that you are shooting for? Flattish year on year in the fourth quarter?

Scott Donnelly

I haven’t gone through that number so I probably shouldn’t do math here on the call.

Myles Walton

The reason I ask, I mean it sounds like tech systems, obviously you have had a slower TAPV and that's where a lot of the growth is. Bell, you have got a tough comp with last year. Maybe a triangulation on the top line would be helpful.

Scott Donnelly

Well actually I want to be careful here not to do too much math and make a mistake on the systems side. Look, I think we’ll – if you’re thinking about year-over-year kind of numbers I think systems will still have a relatively strong fourth quarter. There is a couple of piece to that. Obviously we are flowing the TAPVs which we didn’t have before.

We also have deliveries of another U.S. contract which is a rock in Columbian ASVs which will be in there. And as you know we always a little bit of lumpiness here on our Sensor Fuzed Weapon and while there is none in the third quarter it’s because we have another delivery to our customer in the fourth quarter.

So particularly to the System's side, I think, you'll see a pretty strong fourth quarter and certainly in terms of year-over-year growth.

Myles Walton

And then Bell I would think though would be the offset to that on the lower V-22s, unless the guidance point, there's a higher delivery?

Scott Donnelly

That's correct, that's correct. Certainly on a year-over-year basis, you'll see a lower revenue number at Bell.

Myles Walton

Okay. All right. And then at Bell, there -- was there any positive VAC, sizable of note, in the quarter?

Scott Donnelly

Pretty much the same as it was on a year-over-year basis.

Myles Walton

Okay. And then the last clean-up. Fourth quarter tax rate, Frank?

Frank Connor

Probably around 30%, full year 29%, 29.5%

Myles Walton

Okay. All right. Thanks guys.

Operator

And we'll go to Ronald Epstein with Bank of America. Please go ahead.

Ronald Epstein

Good morning, guys. Just a couple quick questions for you. Maybe I'll start off with Frank. When you look at the inventory, from quarter to quarter, it went up a couple hundred million bucks, and year over year, it looks like it was $700 million or $800 million. What's driving that?

Frank Connor

Well, as we said we've seen some lower deliveries on the TAPV which is contributed a little bit of it. But if you look at it, we started the year couple of $100 million up in inventory versus the end of '15. Frankly, inventory has increased at about the same rate through the first nine months of '16 versus the first nine months of '15.

So we are seeing the normal trending of inventory. We do have some slightly higher inventory levels than in some areas like TAPV, then we would have plans for, which is putting a little bit of pressure on cash. But if it's not wildly off from what we had expected or what we have seen in previous years. Just given the seasonality of the business, there is still some additional pressure or some additional inventory and they're also for Scorpion as we talked about that we wouldn't have had on a year-over-year basis.

Ronald Epstein

Okay. One more question for you, Frank, and then I have got one for Scott. Organic growth, revenue organic growth year over year, was it approximately flat if you take out the stuff from acquisitions?

Frank Connor

Yes, it was. Yes.

Ronald Epstein

Okay. That's fair enough, that seems like. And then, Scott, a lot of talk about Scorpion this morning, which, the airplane I love. We have been talking about that one for a long time. I think, and maybe you picked up a little bit of this on the call, I think there is some skepticism in the investor community about a Company-funded defense program, right?

So things like the Northrop F-20 pop up and that thing. When you think about the return of investment on the Scorpion, and what your expectations are for this program, how can you make us all feel comfortable that, yes, this was a good place for Textron to invest their money?

Scott Donnelly

Well, Ron, I think that we've been running this program for a few years now. We've been able, you know, for the most part to run this thing in a way that was at a low enough level of investment that we were making accomplishments, getting the first flights, being able to talk to customers and kind of feel out what this market could be from just the original sort of a theory of what it might be to interacting with real customers, engaging their level of interest.

And so I'd say over the last few years we've been able run it without sort of making an impact that would be problematic. This is the first quarter where we had to say, look, this is having an impact on what we would have guided you guys both in terms of expense as well as awesome cash impact as we build inventory, actually make a run of aircraft.

This is certainly not still assure bet standpoint, but I mean obviously, we would not do that and make those investments and then take that hit in terms of you know near-term earnings and cash if we didn't think that the level of customer interest that we're seeing the fact we now have a path to certification, in fact we demonstrated weapons capabilities, the level of interest we have from customers we've been talking to for a number of years has become strong enough that we felt it was time to accelerate that spending and be willing to invest some of our cash to be ready to do a limited production run here.

So is that a sure thing? No. Do we see that the opportunity is real and that we think that there is a real future for this thing, and someday could be a profitable line of business for the company? I'll have to say the answer is yes or we wouldn't have made the decisions to go ahead and take some pressure on earnings and pressure on cash to really take that final step and bring this thing to the market in a very real credible way.

Ronald Epstein

So one follow-on to that. When you think about the return on invested capital, one would think you could do better with this, than you can with the purely commercial program. Is that a reasonable view?

Scott Donnelly

Well I think when we look at what we believe and again the conversations with customers on where we can prices this aircraft it's a very, it's a from a customer perspective a very competitive price versus the options that are out there in the market in terms of the performance that you get for the dollars, the capability per dollar so we think we can do that and have it be a very solid profitable program for us.

Ronald Epstein

Okay great. Thank you very much.

Operator

And we’ll go to Justin Bergner with Gabelli & Company. Please go ahead.

Justin Bergner

Thanks and good morning Scott. Just a couple clean-up questions. In terms of the changed cash flow guidance, it seems like about half of the change is coming from the cash restructuring outlay, and half from perhaps higher inventories on the TAPV side. Is that how I should think of the bridge, or are there other pieces to think about?

Scott Donnelly

Well I’d say there is a number of pieces you know as any year right of cash coming in and out and inventory levels but for sure when you look at there is a pressure on the restructuring cash out, there is a pressure on slower TAPV deliveries and some Scorpion inventory coming in but there is some positives in other areas and some better working capital management, there's a lot of moving parts that sums to that but certainly what you mentioned are two of the, are the biggest movers in terms of contributors of the pressure.

Justin Bergner

Okay. Great. And then given your glass half full comments on Bell, are you optimistic about the backlog growing in future quarters, or is it more a function of the higher orders allowing for backlog stability going forward?

Scott Donnelly

Well, I think we'll see some better backlog on the commercial side. Remember that the backlog on that business is very lumpy because of the multiyear you’re sure that gets authorized and funded that rolls into backlog. So the backlog number at Bell will always be, you'll see some pretty significant swings driven by particularly the military side of business.

Justin Bergner

Okay, thanks for taking my questions.

Operator

And we’ll go to Jeff Sprague with Vertical Research. Please go ahead.

John Walsh

Hi good morning. This is John Walsh on for Jeff. So a lot of ground covered so far, appreciate that. I wanted to go back to aviation, and think about jet lead times on new orders. Not asking for a program by program, but if you had a lumpier new and refreshed programs versus the legacy, any color on the lead time deltas between those two buckets?

Scott Donnelly

I am sorry. John, when you say lead time?

John Walsh

Yes, just if somebody and you made a comment earlier on Latitudes, right? There is still orders to sell. I'm just trying to get a sense of the demand, how fast you can fill out a order on legacy, or if there are lead times growing for other newer, refreshed models.

Scott Donnelly

I am sorry John, we try to stay away from doing any particular guidance on sold out and lead time availability on a model by model basis. I mean, and there is a fair bit of variation across new models, there is even variation obviously across the so called legacy models.

John Walsh

Okay. Are there any expectations that you could end up with some white tails here at year end?

Scott Donnelly

We really haven't talked about white tails for a number of years. We have aircraft being delivered in the first quarter so there's obviously we plan and always have inventory that rolls from year to year because it's inside the manufacturing lead time to deliver aircraft when you get into the first quarter and beginning of the second quarter.

But right now as we have been doing for quite a number of years now we’re building to a forecast and we’ve been matching that fairly well to the demand.

John Walsh

Okay. And then one last one, on pension in the next year. Any early look on the expense side, or on any cash funding side?

Frank Connor

Well on expense side as we’ve said obviously the discount rates bouncing around, interest rates are bouncing around but we would expect it to be kind of no worse than flat on a year-over-year basis and on the funding side no additional funding other than normal course defined contribution funding and the small amount of other funding that we do. So no pick up from this year's funding levels.

John Walsh

Okay, I appreciate it. Thank you.

Operator

And we’ll go to the line of George Shapiro with Shapiro Research. Please go ahead.

George Shapiro

Just one follow-up, Scott. Aviation deliveries were up every quarter this year. Will you beat the 60 in the fourth quarter of this year that you delivered last year?

Scott Donnelly

I would expect so. I think that we will George and we’ll have a solid quarter obviously Latitude deliveries and I think you know net of everything we would certainly expect to be up on a volume of jets on a year-over-year basis.

George Shapiro

Yes, because you had 12 Latitudes in the fourth quarter of last year. So you'll deliver more than that, you think?

Scott Donnelly

Yes.

George Shapiro

Okay. And then just the last thing. I went back and looked, and it's the first time in a number of years that you had a book to bill equal or better than 1 for two successive quarters. Does that support your comment that you are starting to see order improvement in the industry?

Scott Donnelly

Well I don’t know George, I am hesitant to forecast the future because it’s so hard but I mean obviously we’re always happy to get better than 1 to 1.

George Shapiro

Okay. Thanks very much.

Operator

And we’ll go to the line of Pete Skibitski with Drexel Hamilton. Please go ahead.

Pete Skibitski

I had a question on Kautex, Scott. I think you are building a fifth plant in China, now. Can you talk about what's motivating that? Has that helped you gain share, your presence in China? Is it a growth signal? Frankly, is there a long-term competitive risk to that? I am just curious about the strategy surrounding that.

Scott Donnelly

The long-term view on China it’s a massive automotive market, it continues to grow. It’s been a good market for us frankly. We've had a very strong business in China and as that volume continues to grow our customers are doing well and we - as you know these programs when you're building tanks for these platform they tend to be fairly long cycle.

So when we commit to go in and invest the capital in a new plant and a new machines and stuff like that, we clearly have line of sight to where that capacity is going to be utilized and on what platforms that capacity will be utilized on. So we don't see much downside risk to underutilization of those assets and certainly that’s been our history over there is that these plants are well utilized and deliver good returns.

Pete Skibitski

Okay. So is there -- the more plants you build -- I guess is there more tailwind there, in terms of adding capacity, and maybe shifting your customer base from European OEMs to Chinese OEMs?

Scott Donnelly

Well I am not sure, the way we look at it as shifting I mean again, we really do this and make these decisions based on specific opportunities, specific platforms that we win and that's what drives us. So in terms of how we think about capital allocation in that business in the future we allocate it to the places where we've won with a customer and need to produce locally. So I think if you look in net this year so far we’ve actually have more growth in Europe than we've had in North America or Asia and that’s because our customers in Europe have had higher growth rates.

But again our allocation of our capital and where we choose to put locations is very highly driven to how we’re doing and who we’re winning with and where in the world. So we really let that drive - drive it as opposed to a philosophy of being in one particular region or the other.

Pete Skibitski

Okay, great. Thanks very much.

Scott Donnelly

Okay. Thank you everyone. That concludes our call for today.

Operator

Thank you, ladies and gentlemen. This conference will be available for replay after 10:00 o'clock a.m. today running through January 18, 2017 till midnight. You may access the AT&T Replay System at any time by dialing 1800-475-6701 or 1320-365-3844, and when prompted enter the access code of 373340. Those numbers again, 1800-475-6701 or 1320-365-3844, access code 373340.

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