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B/E Aerospace (NASDAQ:BEAV)

Q3 2012 Earnings Call

October 23, 2012 9:00 am ET

Executives

Greg Powell - Vice President of Investor Relations

Amin J. Khoury - Co-Founder, Executive Chairman and Chief Executive Officer

Werner Lieberherr - President and Chief Operating Officer

T. P. McCaffrey - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Noah Poponak - Goldman Sachs Group Inc., Research Division

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Myles A. Walton - Deutsche Bank AG, Research Division

Robert Spingarn - Crédit Suisse AG, Research Division

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

Gautam Khanna - Cowen and Company, LLC, Research Division

David E. Strauss - UBS Investment Bank, Research Division

Operator

Good morning. My name is Jessica Morgan, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the B/E Aerospace Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, the conference is being recorded this day, October 23, 2012. Thank you.

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

Greg Powell

Thank you, Jessica. Good morning, and thank you for joining us this morning. Today, we are here to discuss our financial results for the third quarter ended September 30, 2012. By now, you should have received a copy of our news release we issued earlier today. If you haven't received it, you'll find a copy on our website.

This morning, we will begin with the remarks from Amin Khoury, Founder, Chairman and Chief Executive Officer of B/E Aerospace, and then we will take your questions.

For today's call, we've prepared a few slides to help you follow our discussion. You can find our presentation on the Investor Relations page of the B/E 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.

Joining us for the call this morning are Werner Lieberherr, President and Chief Operating Officer; and Tom McCaffrey, Senior Vice President and CFO.

As always, 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 SEC. We will address your questions following our prepared remarks. [Operator Instructions] And now I will turn the call over to Amin Khoury.

Amin J. Khoury

Thank you, Greg, and good morning, everyone. We are pleased with our third quarter results, which were announced earlier this morning. Our third quarter results include revenue growth of 21% and operating margin, adjusted to exclude AIT costs, of 18.1%, representing a 50 basis point improvement. Our revenue growth continues to be driven primarily by the robust new aircraft delivery cycle.

Approximately 61% of third quarter revenues were driven by demand for products for new-buy aircraft, reflecting both robust new aircraft deliveries and weaker aftermarket demand.

In addition, as a result of our operational outperformance, which has resulted in record operating earnings for the 9-month year-to-date period and successfully executed tax planning initiatives, we've been able to raise our 2012 earnings guidance to $2.82 per share. The $2.82 per share guidance represents a $0.17 per share increase as compared to our original guidance of $2.65 per share, which we issued at this time last year.

As we move forward, we believe we are well positioned to generate double-digit revenue growth for the next several years based on our total backlog of $8.25 billion, both booked and awarded but unbooked; rapidly growing revenues from our supplier furnished equipment awards and related retrofit activity; our expectation for significantly higher levels of wide-body aircraft deliveries; the expectation for continued growth in global passenger travel and the attended increases in capacity.

Looking specifically at 2013, we are expecting approximately 10% revenue growth, notwithstanding a continuation of the week aftermarket environment. Our revenue plan is based primarily on our high-quality backlog and on the expectation of a robust level of wide-body deliveries. In addition, we are expecting approximately 20% earnings per share growth based on a continuation of margin expansion in all 3 segments of our business.

If we're discussing third quarter financial performance and providing specific revenue and earnings guidance for 2013, I would like to spend a few moments discussing the current market environment; then, we will discuss our results for the quarter; and lastly, we will review our financial guidance for 2013.

During the quarter, we were awarded a number of significant programs. I'd like to mention 4 major aircraft cabin interior awards. These 4 awards are initially valued at approximately $400 million and are indicative of the breadth of our innovative product offerings.

The awards include the company's first Boeing 777 LED lighting retrofit program for a major global airline. In an additional market share gain, we were awarded a Pinnacle main cabin seating program for a successful narrow-body airline to retrofit 70 aircraft and to outfit its 30 new-buy aircraft. We were also awarded the Super First Class cabin program to outfit a major international Asian airline's entire new-body, wide-body fleet -- new-buy wide-body fleet, excuse me. And finally, we entered into a long-term agreement to manufacture cabin interior equipment for the new Bombardier Global 7000 and Global 8000 business jets. I'm going to ask Werner to discuss these awards in greater detail shortly.

Now let's briefly discuss the current commercial aerospace market environment. Global industry industrial -- industry fortunes track developments in the global economy. Sluggish growth in the U.S., economic contraction in the Eurozone, the slowdown in the Chinese economy and 2 successive years of declining profits among the airlines globally are taking their toll. Airlines have responded, with among other things, careful capacity management, swift cost controls and cash conservation measures.

Smart capacity management has helped maintain historically high airline load factors which were in excess of 82% globally for August. The U.S. load factor in August was 87%. Delta, American, United Continental and Southwest have all reduced capacity, and Europe with an 84% August load factor, has also done a very good job of controlling capacity.

As a result of capacity constraints, yields have been favorable and in what now appears to be the beginning of an important global airline profits trend reversal, IATA recently increased its 2012 profit forecast for airlines globally to $4.1 billion and now forecast a near doubling in 2013 profits to about $7.5 billion.

Although traffic growth in the U.S. market is only up modestly, we do not expect any disruptions in new aircraft deliveries. Nearly all U.S. near-term new aircraft deliveries are going toward replacement, route optimization and stronger alliance versus the need for capacity expansion.

Internationally, the new aircraft delivery cycle should continue to be robust for the next several years since order books at the OEMs are at all-time highs while airlines are operating as close to capacity as they ever have. From a macro perspective, global passenger traffic continues to increase at a healthy rate, with most of this growth coming from emerging markets, including the Middle East, Latin America and certain countries within Asia.

In addition, capacity growth has stayed roughly 50 to 100 basis points behind traffic growth demonstrating that fleet size is being managed prudently.

As we reported 3 months ago, our business is experiencing weaker aftermarket demand. We believe this is due to several factors. Firstly, the growing markets of the world are, for the most part, operating new, still under warranty, aircraft which do not yet require heavy aftermarket maintenance services. Secondly, new aircraft deliveries into the developed markets are primarily for replacement of aged equipment. And finally, airlines are reducing capacity doing -- due to slowing passenger growth rates and more efficient utilization. Nevertheless, the airlines are dealing with thin margins and a negative historical 3-year profits trend. As I mentioned earlier, this trend appears to be turning around, which bodes well for a slowly improving aftermarket environment as airlines carefully control inventories and defer heavy maintenance in order to conserve cash. We do, however, expect a strong turnaround in the aftermarket demand by 2014.

Overall, we are confident in our expectation for B/E Aerospace to deliver double-digit revenue growth over the next several years due to the future market share gains, which are embedded in our backlogs; the successful R&D programs which have now generated approximately $4.5 billion in SFE awards, which will increasingly support growing bookings and deliveries over the next several years; as well as the expected continued structural growth in emerging markets passenger air travel; and importantly, our expectations for a 14% compound annual growth rate in wide-body aircraft deliveries over the next 3 years.

Before we turn to Slide 2 to discuss our third quarter financial results, I'd like to comment on a major third quarter initiative, which significantly impacted our financial reports. During the quarter, we strengthened our balance sheet by issuing $800 million of senior unsecured notes due 2022, priced to yield 4.9%, and we redeemed our $600 million issue of 8.5% senior unsecured notes. In connection with the third quarter notes redemption, the company recorded debt prepayment cost of $82.1 million or $0.56 per diluted share.

Now let's turn to Slide 2 and discuss our third quarter financial results. The bar chart on Slide 2 reflects our consolidated third quarter 2012 financial performance compared to the third quarter of 2011. Third quarter revenues increased 21% to $767 million. Organic revenue growth, excluding 2012 acquisitions, increased about 10.5%. Operating earnings, adjusted to exclude AIT costs, were $138.9 million, an increase of 24% and represent an operating margin of 18.1%, which is up 50 basis points as compared to the same period last year.

Operating earnings on a GAAP basis, to include AIT costs, were $134.3 million. Earnings per share, adjusted to exclude onetime debt prepayment costs, were $0.74 per diluted share. EPS, adjusted to exclude both onetime debt prepayment costs and AIT costs, were $0.77 per diluted share, an increase of about 20%. On a GAAP basis, to include AIT and debt prepayment costs, EPS was $0.18 per diluted share.

I'd like to now ask Werner to discuss our third quarter bookings performance. In addition, he will update you on our B/E Aerospace brand innovation initiative. And lastly, he will highlight a few of our recent significant awards.

Werner Lieberherr

Thank you, Amin. Let's review Slide 3, which summarizes our current bookings and backlog status. During the third quarter of 2012, bookings were approximately $800 million, an increase of approximately 21% as compared with the third quarter of 2011 and reflect a book-to-bill ratio of approximately 1.05:1. Approximately 65% of bookings in the current quarter are driven by a higher level of demand for products to outfit new-buy aircraft. Backlog at the end of the quarter was approximately $3.75 billion; while total backlog, both booked and awarded but unbooked, was $8.25 billion, an increase of approximately 19% as compared with September 30, 2011.

Amin and I just returned from visits to a number of our Asian airline customers. I will provide more details shortly. But first, I'd like to briefly highlight the B/E Aerospace brand innovation that is driving our market share gains. Our customers associate the B/E Aerospace brand with innovation and creativity. We are known as the leading aircraft interior supplier that continues to find, develop, engineer and certify products that enhance our airline customers' value proposition to improve their profitability through market share gains, through a lower cost of ownership of our interior products due to their lower weight and lower power consumption, and through development of products, which actually increased aircraft propensity.

The airlines view us as their partner, not just a supplier. We have achieved this status by providing the airlines with more desirable, more aesthetically pleasing, more creative and more comfortable interiors. A couple of examples of the types of innovation we are offering to our customers include, working closely with our airline customers to provide them with Super First Class and business class seating products that are revolutionary and proprietary to the specific airline, and provide them with unique opportunities to increase market share. In addition, these custom-made seats are fitted on the aircraft to optimize the space within the cabin, thereby maximizing revenue generation.

We are lowering the airlines cost of ownership due to light and more reliable equipment. For example, our Pinnacle seating platform is the industry's lightest, full-featured economy class seat and has now captured awards to equip approximately 1,800 new or existing aircraft.

We are substantially improving the food and beverage service that the airlines can provide with our new Essence line on food and beverage preparation and storage equipment. The Essence products are considerably lighter than products currently on the market and include significantly improved power control and efficiency, improved reliability, superior performance and improved ergonomics and aesthetics.

Our modular lavatory, which utilizes our Spacewall technology, significantly improves passenger density by creating the opportunity to add up to 6 incremental passenger seats on each new Boeing 737 airplane.

In addition, our lavatory integrates a number of our innovative products, including our technologically advanced Aircraft Ecosystems vacuum toilet, our long-life LED lighting and our tamper-proof, state-of-the-art lavatory oxygen system. We believe our innovation efforts will continue to drive future revenue and backlog growth.

Regarding our visit with key airline customers in North Asia, we are pleased with the upbeat tone of our conversations and the continued trust these global carriers place in us to deliver highly, innovative interiors for their new airplanes and existing fleets. New twin-aisle deliveries are particularly strong in this region, and we have already received handsome orders from these customers and are working closely with them on future opportunities.

Our ability to provide integrated solutions that optimize cabin density, reduce weight, improve passenger comfort and brand aesthetics works well with these highly discriminating Asian customers. While in Asia, Amin and I commissioned our new Philippines manufacturing complex. We are very pleased that the president of the Philippines, as well as numerous Asian customers, attended our brand opening. This new state-of-the-art industrial complex will produce our A350 galley systems and our 737 advanced modular lavatory. Our new footprint in the Philippines is indicative of our commitment to both our SFE systems business and our long-term strategic position in Asia.

As Amin mentioned earlier, during the third quarter, we announced that we were awarded 4 significant aircraft cabin interior programs, all of which strengthened the depth and breadth of our high-quality backlog. I will briefly highlight each of these awards.

The first is our first full cabin Boeing 777 retrofit LED lighting program for a major North American airline. The retrofit program will be for the airline's entire Boeing 777 fleet. Our innovative all-LED lighting system features adjustable lighting with full spectrum color capability, providing superior cabin ambiance and unprecedented breadth of lighting color and control, and provides a customer experience similar to the very successful B/E Aerospace lighting system featured on all Boeing 737 Sky Interior aircraft.

In addition, the new LED lighting system reduces both weight and power consumption. Initial deliveries on this first such retrofit program are expected to commence in the fourth quarter of 2013.

Our second announced award is also market share gain. This award is from a new successful narrow-body airline. We will retrofit approximately 70 aircraft with our patented Pinnacle main cabin seating platform, and in addition, we will also provide Pinnacle seats for the airlines approximately 30 new-buy aircraft. The Pinnacle seat platform, the industry's lightest, full-featured seat, utilizes advanced proprietary technology that significantly reduce cost of ownership, simplifies maintenance and increases overall passenger living space. Initial deliveries under these programs are expected to commence in the third quarter of 2013.

We were also selected by a major global Asian airline to outfit the airline's new-buy, wide-body fleets with our industry-leading Super First Class products. Our premium class seating will provide the airline's international passengers with luxurious amenities, comfort and personal space, including a fully flat bed, highly customizable levels of privacy, an ergonomically contoured seat backrest systems, custom lighting features, and enhanced interactive in-flight entertainment. Initial deliveries under this program are expected to commence in the first quarter of 2014.

Lastly, we were awarded an exclusive long-term agreement to outfit new Bombardier Global 7000 and Global 8000 aircraft with advanced business jet seats and divans. These innovative seat and divan designs will challenge the traditional business jet limits for luxurious, comfort and functionality for the benefit of Bombardier's customers.

I will now turn the call back over to Amin.

Amin J. Khoury

Thank you, Werner. Now I will briefly review the third quarter operating performance for each of our business segments. Let's turn to Slide 4 and review the third quarter results for our commercial aircraft segment. The commercial aircraft segment leadership team turned in another outstanding performance during the quarter. Revenues of $385 million increased 16%, while operating earnings of $67 million increased 19%. The operating margin of 17.5% expanded 50 basis points due to leverage at the higher revenue level and ongoing operational efficiency initiatives.

Let's turn to Slide 5 and review third quarter results for our consumables management segment. The leadership team with consumables management segment also delivered a strong quarter, a quarter during which the CMS team was and continues to be deeply engaged in acquisition and integration activities, which are expected to continue through 2013.

Revenues of $296 million increased 24%. Operating earnings, adjusted to exclude AIT costs, were $59 million, an increase of 24% as compared with the prior year period. Operating margin, adjusted to exclude AIT costs, of 20% expanded about 10 basis points.

Let's turn to Slide 6 and review the third quarter results for our business jet segment. The business jet segment leadership team delivered a very strong quarter as shown by the substantial and continuing improvement in our business jet segment, driven by the Super First Class portion of the business. Revenues of $85 million increased 33%. Operating earnings of $12.4 million increased 57%. The operating margin of 14.5% expanded 220 basis points, reflecting the 33% increase in revenues, an improved mix of revenues and ongoing operational improvements.

Let's briefly review our financial position on Slide 7. Free cash flow of $48 million in the current quarter reflects CapEx of $30 million and an approximate 19% increase in working capital to support the approximately 21% third quarter increase in revenues and the company's expectation for double-digit revenue growth over the next several years, including deliveries of Boeing 737 modular lavatories, A350 galley systems and certain other supplier furnished equipment.

As of September 30, 2012, cash was $395 million. Net debt, which represents total long-term debt of $1.96 billion less cash, was $1.566 billion and the company's net debt-to-net capital ratio was 43%.

As of September 30, 2012, the company had no borrowings outstanding on its $950 million revolving credit facility and has no debt maturities until 2020.

Let us now briefly review our outlook. We are raising our 2012 full year guidance to $2.82 per diluted share, which is inclusive of AIT costs but which is exclusive of the debt prepayment costs. The $2.82 per diluted share guidance represents an increase of approximately 26% as compared with 2011 and is $0.17 per share better than our initial guidance of $2.65 per share, which we issued at this time last year.

Let us now briefly review our 2013 outlook. Today, we issued our full year 2013 guidance of approximately $3.38 per diluted share representing a year-over-year increase of approximately 20%. Our total backlog, both booked and awarded but unbooked, of approximately $8.25 billion; our expectation for a 14% compound annual growth rate in wide-body aircraft deliveries over the next 3 years; rapidly growing revenues from our supplier furnished equipment awards and related retrofit deliveries; and the expectation for continued growth in global passenger travel; and of course, the attendant increase in capacity all provide a solid foundation for double-digit revenue growth over the next several years.

Now let's turn to Slide 8 and review our specific 2013 financial guidance. The company expects continued strong bookings in 2013, driven by the robust wide-body aircraft delivery outlook and bookings from prior SFE awarded programs, and expects to end the year with a book-to-bill ratio in excess of 1:1. 2013 revenues are expected to be approximately $3.35 billion or approximately 10% higher than expected 2012 revenues. The company expects 2013 earnings of approximately $3.38 per diluted share. The EPS guidance of $3.38 per diluted share represents an increase of approximately 20% as compared with expected 2012 EPS of $2.82 per diluted share. The company's 2013 earnings per share guidance is inclusive of approximately $20 million of expected 2013 AIT costs. 2013 free cash flow conversion ratio is expected to be approximately 70% of net earnings.

I will now turn the call over to Greg to begin the Q&A part of today's meeting.

Greg Powell

Jessica, we're now ready for the Q&A. Can you tell the listeners how to ask a question?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Noah Poponak with Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Can you tell us within the 10.5% organic total company number that you provided what consumables was within that and what that -- how that compared to last quarter?

Amin J. Khoury

Consumables revenues were actually down 3% for the quarter. They were up, obviously, because of acquisitions. But organically, they were down about 3%, reflecting the continued weakness in the aftermarket environment.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Okay. And what are you assuming for that consumables organic revenue growth rate in your initial 2013 outlook?

Amin J. Khoury

Well, we're beginning to see some positive movements in the marketplace, and we're getting pretty good feedback from customers about their 2013 expectations. So it's looking as though we're going to have some modest improvements here in 2013 and then, I would say strong improvements beginning in 2014. So we're expecting sort of mid-single-digit kind of improvements in the consumables business next year.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Okay. Very helpful. And just one last topic I wanted to ask you about. What is the company's latest thinking around capital deployment strategies and priorities?

Amin J. Khoury

Well, on the CapEx side, our expectation for this year is about $135 million, and it's about the same for next year or maybe a shade under. But about the same for next year. We have about $400 million in cash as of the end of the quarter. We have $950 million available in our revolving credit facility, which is untapped. And we're generating -- we expect to generate quite a bit of cash in the coming year. So we do have some options. Now as you know, the company historically has not purchased -- repurchased shares or paid dividends. But those are subjects which we will be discussing with our board during the coming year, and management and the board will make decisions as to capital deployment options. We are continuing to see some interesting acquisition opportunities. The bar remains high. So it will depend on how much we spend for acquisitions in 2013, how much cash we generate and what decisions we make with the board.

Operator

And our next question will come from Howard Rubel with Jefferies.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

I want to go back, or I want to actually go forward a little bit. And you're talking about 70% free cash flow conversion for next year. What are some of the puts and takes that are keeping it below 1:1? I guess, the large part is obviously inventory, but maybe there's something else.

T. P. McCaffrey

Sure, Howard. Well, as Amin just mentioned, we do expect to have continued strong investments next year in capital expenditures to support our record backlog. And you should expect CapEx at about the same level, around $135 million next year consistent with this year, and then tapering off in 2014. And the CapEx investments that we have are, again, to support the -- both the booked and unbooked backlog and the long-term items, such as tooling and bringing up the facilities and investments in engineering workstations and updating the facilities. And I think that inventories ought to grow, and if your question is around inventory growth, it is consistent with about a 10% increase in revenues.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Okay. Just to talk about -- how much did the Interturbine contribute to the quarter, and how well is that being received in terms of integrating into the business? And frankly, wouldn't that sort of require a little bit more inventory as you sort of stock it out? Is that -- given the slow growth in -- I mean, frankly, given the slow growth in organics for working capital, I would have thought you've been able to show slightly -- just a slight better number.

T. P. McCaffrey

Well, the Interturbine, we don't expect that we will be ramping up investments and inventory significantly as a result of the acquisition because of the nature of the business. So it really is -- actually, the inventory growth was across each one of our business segments during the quarter and relates to the timing of deliveries and customer shipments.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

And then just one last question. It's very clear that you've been very successful, Amin, in taking existing products from the wide-body market and find applications in the wide-body business. Are there further discussions in terms of what you're going to be able to do with the lav and the wastewater business to add to the complement that you're offering?

Amin J. Khoury

There are discussions about other products and other aircraft platforms, but we really don't want to be specific about that at this point in time, Howard, for a whole lot of reasons, for competitive reasons. And I think that as we go here, I did mention that we have some confidence in double-digit revenue growth for the next several years, and we expect bookings to continue to be higher than 1:1 and for backlog to continue to grow. That is partially as a result of the backlog that we have, I mean, $8.25 billion. But it's also a result of retrofit programs, which we believe will occur, which are related to the SFE program awards that we've won. And we expect additional SFE awards of new programs for new platforms, and we'll be announcing them over the next year or 2.

Operator

And Deutsche Bank's Myles Walton has our next question.

Myles A. Walton - Deutsche Bank AG, Research Division

Amin or Tom, actually, Tom, first a clarification. Tax rate in 2013, what is the expectation there?

T. P. McCaffrey

Myles, you should expect 2013 taxes at about the same rate that we have this year, which is the same rate as we had in 2011, about 30%.

Myles A. Walton - Deutsche Bank AG, Research Division

Okay. Good. So then, implied in the margin expansion, if I have the interest expense right, is about 100 basis points of margin expansion across the company. But it sounds like consumables, you'll have roughly equivalent AIT costs, is that right? And so then, if you can just, Amin, maybe give us roughly the faster or slower margin expansion stories across the segments.

T. P. McCaffrey

Well, Myles, with regard to AIT cost, this year, it's going to be somewhere between $15 million and $20 million. And we've said we expect AIT cost next year to be about $20 million, and that's where the -- to complete the integration of UFC and Interturbine and Satair. And then 2014, the consumables and the corporate margins ought to reflect the elimination of AIT costs and improved efficiencies from those 3 acquired businesses.

Amin J. Khoury

For 2012, we guided to about $20 million of AIT expense. It looks like it's going to be a little less. For 2013, we're guiding to $20 million of AIT expense. It looks like it might be a little more.

Myles A. Walton - Deutsche Bank AG, Research Division

And then as you look at the 3 segments in '13, Amin, are there standout segments that will expand significantly faster? Or are they all performing equally strong?

Amin J. Khoury

No, all 3 segments are contributing to margin expansion during the coming year. I mean, we're talking about 10% revenue growth and 20% earnings growth, which suggest pretty significant corporate consolidated margin expansion. So we're expecting to deliver a record operating margin next year and record operating profits, and for all 3 segments to deliver a contribution to that result.

Myles A. Walton - Deutsche Bank AG, Research Division

Okay. And then the last one is you talked about double-digit top line growth for the next several years. Is it fair to assume given the volume benefit that you'll have commensurate margin expansion in line with that top line growth?

Amin J. Khoury

Our expectation is that we will continue to expand margins, again, because of the quality of the backlog, the programs that are in backlog, and the fact that the -- what's driving the growth in new airplane deliveries over the next 3 years is wide-body deliveries. They're projected to grow at a 14% CAGR from 2012 to 2015, and that's our sweet spot. Now these premium products for wide-body aircraft is really what drives our business and those are high-priced, higher-margin products.

Operator

And we will move now to Robert Spingarn with Crédit Suisse.

Robert Spingarn - Crédit Suisse AG, Research Division

I have 2 questions, 1 on Q4. But I'll start with aftermarket. Amin, there's been some questions over the last 3 months since you offered your 6- to 18-month aftermarket outlook, and you reiterated the weakness there or the softness maybe today through 2013. Could you be a little more specific on the aftermarket outlook by segment, CAS versus CMS, over this period, and then perhaps within CAS between spares and retrofit?

Amin J. Khoury

CAS and CM spares -- CAS spares and CM are both experiencing the same kind of softness in the marketplace. Last you referred to the last quarter -- in the last quarter call I said that we expected 16- to 18-month period of time during which the aftermarket will be soft. We continue to expect that. It looks to me like the outlook for 2013 is improving. We've been out talking to every one of our important OE customers. I think the top 60 accounts, as I think about, I mean, a large number of accounts as part of our planning process here, and we're getting a lot of positive feedback relative to expectations or requirements from us for next year. We have basically discounted those -- that feedback to some extent in preparing our plan, which, I think, is a prudent thing to do. But our expectation for 2013 is, I would say, somewhat improved over where we were at this time 3 months ago. And that's based on feedback from our customers who have become somewhat more positive, I would say, in terms of what their requirements are. Now the aftermarket piece of that business, we don't really have any visibility on. I mean, the stuff is booked and shipped in the same day essentially or within a couple of days at the worst. So I really can't give you more color on that. It's going to be whatever is going to be. And the same is true to a large extent for CAS spares. For retrofit activity, the retrofit activity this year is pretty similar to that of 2011, fairly flat. Our expectation for 2013 is more or less flat, maybe slightly down, about flat, as the airlines deal primarily with large numbers of receipts of new airplanes, pretty much across our entire customer base. I mean, they're all buying new airplanes. So there's a little respite here. So we would expect an uptick, significant uptick, in retrofit activity beginning in 2014 and relatively flat activity in 2013. Does that help you?

Robert Spingarn - Crédit Suisse AG, Research Division

Okay. That's very helpful. And then just quickly, if I can, on Q4. The implied guidance is a slight downtick from Q3, I think, about $0.71. So I wanted -- despite the lighter interest expense drag, so I wanted to first ask, Tom, if you could quantify the quarterly run rate on a forward basis on interest expense. I'm guessing, it's coming down about $3 million a quarter. And then where might we see any pressure you are embedding in your guidance for Q4 relative to Q3? Why would we see down earnings, slight downtick in earnings?

T. P. McCaffrey

Rob, you should think of -- it's a very modest change from Q3 to Q4 and for all of 2013, interest should be around $125 million. It's right in that neighborhood. So there's no change from what we've said previously.

Amin J. Khoury

Rob, Q4 usually -- don't forget Q4 always has customer shutdowns, plant shutdowns, lots of holidays and so on and so forth. So Q4 is usually a little weaker than Q3, but there isn't anything there. It's about flat.

Operator

And Peter Arment with Stern Agee has our next question.

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

Amin, I want to follow up on what I think is impressive regarding the consumables management segment margin performance. I mean, you've had a lot of acquisitions, and it's hard to get a good feel given all the integration, but yet the numbers still are showing up quite impressively even with the softer kind of top line. Can you maybe talk about some of those individual businesses that you've acquired? Satair, LaSalle, UFC, what you're seeing there, Interturbine obviously? I mean, you're not going to give us the margins by the businesses. But maybe just qualitatively, how -- what's going on regarding the integration schedules with some of those businesses?

Amin J. Khoury

Sure. It's impossible at this point to break out the numbers for any of those businesses. But we do try to give you the information, both before and after AIT costs, so you can judge for yourself. LaSalle, I would say, is gone. I mean, I think that we will have disposed of the actual LaSalle primary facility before the end of this month as I remember. The products had been totally integrated into our business. There is no LaSalle P&L or balance sheet. There is no Satair P&L or balance sheet. We have some sort of a balance sheet and income statement left for Interturbine, but we've already moved the chemicals business from UFC and our own legacy business to Interturbine. And we've already moved the hardware business from Interturbine over to the legacy business. So it is really hard to give you a specific answer vis-à-vis all of the individual businesses. Suffice it to say that by the end of the coming year, it will be essentially 100% integrated. And so I think what you're -- I think the best thing that we can do is give you the margin for all of the businesses combined, give you the AIT costs, and then track both on a quarterly basis. What we expect to see is improving margins, further improving margins, both before and after AIT expense, in the consumables business in 2013 because of the integration activities that we're talking about, and then to have a very substantial uptick in margins in 2014 as we complete the integration activities and as the acquired businesses, were they on their own, would be operating at a significantly higher margin than they were at the time that we acquired them. But I really can't talk about the margins now in those individual businesses, which you've mentioned, versus the margins when we acquired them because the businesses don't actually exist in that way any longer.

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

That's very helpful, though. And just staying within CMS. Just are you seeing, given what the airlines are being more cautious regarding their aftermarket spend, but there's also been the trend that you highlighted back in March at the Investor Day towards more outsourcing key elements of the supply chain. Are you seeing anything there, any trend that's improving? Or what can you say about that?

Amin J. Khoury

Well, I think in terms of airline attitudes, there's been a pretty good improvement over the last 3 months. I mean, I think they were really spooked with airline profitability declining successively over a 3-year period of time and moving down towards the flat line, right? This is -- this will have been the first downturn in modern airline history where the airlines didn't end up losing money at the bottom of a cycle. So the profits turnaround, which I mentioned earlier in my remarks, wherein you've got IATA for the first time saying 2012 profits are going to be better than we originally forecast and 2013 profits are going to be about double 2012 profits. That is a very important thing. I mean, the 2 factors which are most important in terms of driving the business are traffic growth and airline profitability. There aren't any more important factors than those 2. And those 2 seem to be turning fairly positive. And the conversations we're having with our customers are more positive, particularly, I would say in the last 30 or 45 days than they were during the second quarter of the year. With respect to expansion of SKUs, there is some modest expansion of SKUs, but with all of the integration activity that's going on, it is really consuming the activity of the management organization. I mean, we are closing facilities and setting up new facilities in England, in France, in Carson, California, in New York, in Canada. I mean, we are really in the middle of pretty intensive consolidation and integration activities, which is reflected by the $20 million of cost that we're talking about to complete those activities next year.

Operator

And our next question comes from Gautam Khanna with Cowan and Company.

Gautam Khanna - Cowen and Company, LLC, Research Division

Yes I just have a couple. Amin, first, I guess, can you help us understand like what level of book-to-bill people should need to see to get comfortable with 10% sales growth, because I know it's been 1.05 last couple of quarters, but we're mindful that there's a book-and-ship kind of attribute to the spares side? So what level is required to kind of have conviction on the 10% top line?

Amin J. Khoury

Well, the quarter's orders were pretty darn good. They were $30 million higher than the second quarter in spite of a difficult environment. And booked backlog improved by 9%. And overall, total backlog improved by 19%. And so the flow of bookings comes not only from bookings from the customers on new programs, but also a flow of bookings from the SFE backlog. And we expect to begin delivering in 2013 for the first time lavatories, modular lavatories in a huge program, an $800 million program, and have very substantial shipments of both lavs and also galleys, the new galley systems in 2014. So we'll be shipping those well in advance of the deliveries of the A350 because they're going to need to have a lot of products on hand as before they actually have the entry into service date. So I think that our expectation for the 10% top line growth rate -- the compounded growth rate of 10% is related to the 14% CAGR in wide-body deliveries, a flow of orders from our SFE backlog and a turnaround in the aftermarket environment.

Gautam Khanna - Cowen and Company, LLC, Research Division

Said differently, so we should expect kind of an acceleration in the book-to-bill as the lavs and what have you closer at hand. Is that correct?

Amin J. Khoury

That's right, yes.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay. And then you mentioned the M&A pipeline having some opportunities. Can you talk about which segments you see the most promising opportunities in?

Amin J. Khoury

Not really. I mean, that's not -- we don't talk about acquisitions prior to doing acquisitions. So that's -- I think, we'll just defer on answering that question, okay, if you don't mind.

Gautam Khanna - Cowen and Company, LLC, Research Division

No, that's fine. And then lastly, if you could just talk about any changes on the competitive environment in the CMS space just given the aftermarket softening and some of your competitors trying to move into the aftermarket portion of the faster distribution side.

Amin J. Khoury

Well, we've lost 1 account in 2 years. It's the same account that we've talked about time and again. We are picking up accounts and gaining share. It's just that the environment is a little bit soft right now. Your question always underscores Boeing and Basin. And I think that they are having some modest success with respect to the 787, which has essentially no effect on us.

Operator

And that question will come from David Strauss with UBS.

David E. Strauss - UBS Investment Bank, Research Division

Amin, back to the aftermarket side of the business, your question -- the question Rob had that you addressed, I think you commented that you don't have a lot of visibility on the aftermarket, yet you have this forecast for a flat aftermarket for the next 6 to 18 months. Can you just square the two what exactly backs that forecast for flat aftermarket for the next 6 to 18 months?

Amin J. Khoury

That was a comment that we made on the second quarter call. It looks like it's improving a little bit in terms of the customer feedback, which we're getting across the board. So our expectation is for some modest improvement in the aftermarket -- in aftermarket demand in 2013 followed by strong improvement in 2014. We believe that the reason that aftermarket activity is somewhat slow now is because new airplane deliveries into the developing parts of the world are the -- sorry, the growth in traffic in the developing parts of the world are being handled with new airplanes that don't yet require heavy maintenance activities. And new airplane deliveries in the developed markets are mostly for retirement of older aircraft or route optimization. So that has to run its course. And so our expectation is for a modest improvement in 2013 and strong improvement in 2014.

David E. Strauss - UBS Investment Bank, Research Division

Okay. Could you tell us actually what your aftermarket business at CAS and CMS is running year-to-date, just so we have an idea what the comparisons are going to be like next year?

Amin J. Khoury

No, we don't break those numbers out, David.

David E. Strauss - UBS Investment Bank, Research Division

Okay. I assume they're down. Can you tell us if they're flat or down, if they're down?

Amin J. Khoury

Yes, I think we reported that organically CM -- the CM business is down 3% sequentially versus the second quarter of this year. And that's due to a soft aftermarket environment.

David E. Strauss - UBS Investment Bank, Research Division

Okay. And then my last question. I think, correct me if I'm wrong, I think you still got 5% to 10% of your revenues that are associated with the defense market. If that's correct, can you give me an idea of what you're assuming in your revenue guidance next year for the defense portion of your business?

Amin J. Khoury

Yes, we're assuming that the defense business is approximately flat next year, and that remains to be seen. It's down very substantially this year. But our expectation is flat for next year. We've looked at each and every program that we're involved in and we've talked to all of our customers. We've looked at what their expectations are and whether we believe their expectations are reasonable. And I think, we've done a pretty good job there. So our expectation for the defense side of the business, which is less than 10% of our business, is that it will be flat next year. Greg?

Greg Powell

Thank you, Jessica. That was all we have time for.

Amin J. Khoury

Thank you, everyone. Have a good day.

Greg Powell

Thank you.

T. P. McCaffrey

Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's B/E Aerospace conference call. Thank you for participating in the call.

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