Rockwell Collins' (COL) CEO Kelly Ortberg on Q1 2017 Results - Earnings Call Transcript

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Rockwell Collins, Inc. (NYSE:COL) Q1 2017 Earnings Conference Call January 20, 2017 9:00 AM ET

Executives

Ryan Miller - Vice President-Investor Relations

Kelly Ortberg - Chairman, President and Chief Executive Officer

Patrick Allen - Senior Vice President and Chief Financial Officer

Analysts

Robert Stallard - Vertical Research

Myles Walton - Deutsche Bank

Robert Spingarn - Credit Suisse

Carter Copeland - Barclays

George Shapiro - Shapiro Research

Seth Seifman - JPMorgan

Hunter Keay - Wolfe Research

Sam Pearlstein - Wells Fargo

Rajeev Lalwani - Morgan Stanley

Peter Arment - Baird

Cai Von Rumohr - Cowen and Company

Peter Skibitski - Drexel Hamilton

David Strauss - UBS

Howard Rubel - Jefferies

Michael Ciarmoli - SunTrust

Ken Herbert - Canaccord

Noah Poponak - Goldman Sachs

Operator

Good morning and welcome to the Rockwell Collins First Quarter Fiscal Year 2017 Earnings Conference Call. Today’s call is being recorded. For opening remarks and management introductions, I would like to turn the call over to Rockwell Collins’ Vice President of Investor Relations, Ryan Miller. Please go ahead, sir.

Ryan Miller

Thank you, Lindsey and good morning to all of you on the call. With me on the line this morning are Rockwell Collins’ Chairman, President and Chief Executive Officer, Kelly Ortberg; and Senior Vice President and Chief Financial Officer, Patrick Allen. Today’s call is being webcast and you can view the slides we will be presenting today on our website at www.rockwellcollins.com under the Investor Relations tab. These slides include certain non-GAAP financial information and a reconciliation to the related GAAP measure.

Please note today’s presentation and webcast will include certain projections and statements that are forward-looking. Actual results may differ materially from those projected as a result of certain risks and uncertainties, including those detailed on Slide 2 of this webcast presentation and from time-to-time in the company’s Securities and Exchange Commission filings. These forward-looking statements are made as of today and the company assumes no obligation to update any forward-looking statement.

With that, I will now turn the call over to Kelly.

Kelly Ortberg

Thanks, Ryan and good morning everyone. Well, as you know this has been a very busy quarter for us with the announcement of the B/E acquisition last October. And I am very pleased to say that we certainly weren’t distracted when it comes to performance on our core business. This was a very good operational quarter with total segment operating margins increasing 90 basis points over the prior year. Our earnings per share increased 10% and that includes fuel costs, so if you strip those out along with the restructuring charge and the benefit from the Federal R&D Tax Credits in the first quarter last year, we actually say a 17% earnings per share improvement year-on-year.

Now, we knew we had some challenging sales mix issues, particularly in our commercial business and we took some strong cost management actions and those played through really in all of our businesses. From a sales perspective, the first quarter came in pretty much as we expected. Let me start with our Government Systems business. I am pleased to report our third straight quarter of growth as we pull out of the defense cycle. We are clearly on a path to achieve our objective of getting our Government Systems business back to a solid mid single-digit growth business. And in spite of operating the quarter under a continuing resolution we are seeing more and more business opportunities. Our team is very busy on bid and proposal activities, which is a great place to be right now. In our commercial business our sales were down slightly in the quarter and as we have signaled we anticipate our commercial business to be down just a little in the first half with recovery in the second half of the year. And that’s when we expect to see improved mandate comparables and the 737 MAX revenues ramping up. Biz jet demand continues to be a challenge for us, but our team is doing a nice job of filling some of that shortfall with additional customer funded engineering sales.

Moving now to our information management services business, we posted 8% sales coupled with 240 basis points of margin improvement. We saw our aviation related sales increase double digits and that delivered nice incremental margins. And we continue to lay the ground work for future growth in this business. For example, in 2016, last year, we saw 100% renewal rate for subscribers on our ARINC Global Link service. We are also making inroads in our cabin connectivity market. And we had a big with Norwegian Air Shuttle where we will be bringing a true end-to-end integrated digital solution spanning onboard equipment, the certification of the system and then the connectivity service. This is exactly the type of synergy we envisioned when we acquired ARINC and there are more opportunities like this in our pursuit pipeline. We are also continuing to build on our airports offering with acquisition of Pulse.Aero this quarter. They specialize in self bag drop applications and self bag drop is becoming a very important step to streamlining the passenger flow through airports. And where it’s being implemented, it’s delivering impressive results to the airlines, so a real nice quarter for our core business.

Now, let me give you an update on the B/E acquisition. From a regulatory perspective we cleared the HSR waiting period, so regulatory approval in the U.S. is behind us. We also have regulatory filings in Europe, China, South Korea, Turkey and the Philippines. And we continue to believe that we will obtain all the approvals from these filings that will allow us to close yet this spring. From a share owner vote perspective, we filed an amended S4 on January 10 and hope to go effective and convene our special shareholder meeting in the very near future. We have been actively meeting with investors since we announced the deal in October and people are getting comfortable with the benefits of bringing these two great companies together.

We are also making really good progress on our integration planning activities. First of all, we have our integration team identified and in place and they are actively working the integration planning activities so that we hit the ground running post-close. This includes further detailed planning around the cost and revenue synergy capture and recall that we had projected $160 million of run rate cost synergies and I remain confident in our ability to achieve these. We are also beginning planning on what I will call our Phase 2 synergies. These are potentially incremental to our baseline plan and there are areas where we have potential redundancy and overlap between our businesses and we are now beginning to work through the details to quantify those savings.

As for revenue synergies, just remember that we didn’t include these in our business case, but that didn’t mean that we are not working these opportunities to create upside opportunities. We obviously can’t go too far in our channel leverage until we combine, but I am encouraged with the opportunities that are being explored, in particular, B/E really does have some nice capabilities that we think we could further prosecute in our government channel. And there is good reason to expect that we will be able to bring these to reality and create meaningful long-term revenues for our company. So everything is moving full speed ahead and we believe we are on course for shareholder approval in early March and we should be able to then close soon after we get those regulatory approvals.

So with that, let me turn it over to Patrick and have him walk us through the details of the quarter.

Patrick Allen

Thanks Kelly. Good morning to everyone as well. I would like to know walk you through today’s presentation slides that summarize our results for the first quarter of 2017. I will begin on Slide 3 where we highlighted total company first quarter sales, earnings per share, income from continuing operations and operating cash flow. Total company sales for the quarter increased $24 million or 2% compared to the first quarter of last year due to higher Government Systems and Information Management Services sales, partially offset by lower Commercial Systems sales. Income from continuing operations increased $12 million or 9% and earnings per share from continuing operations increased $0.10 or 10% compared to the same period last year.

Earnings per share for the first quarter of 2017, includes $0.10 of deal costs related to the pending acquisition of B/E Aerospace. Earnings per share from continuing operations in the first quarter of 2016 includes a $0.21 restructuring and asset impairment charge partially offset by an $0.18 benefit from the retroactive reinstatement of the Federal Research & Development Tax Credit. And if we exclude all of those items, adjusted earnings per share increased 17% to $1.20 compared to $1.30 in the prior year. This increase was driven by higher sales and 90 basis points of higher total segment operating margins.

As we turn to Slide 4, Commercial Systems achieved revenue of $549 million in the first quarter, down 2% compared to the same period last year. Sales related to aircraft OEMs increased $5 million or 2% to $318 million, primarily due to higher product deliveries in support of the Airbus A350 and Bombardier CSeries production rate increases, favorable customer timing for airline selectable equipment and higher customer funded development program revenues, all of which was partially offset by lower business aircraft OEM production rates.

Now aftermarket sales decreased $13 million or 5% due to lower regulatory mandate sales, lower spares provisioning and lower head-up display retrofit sales to customers in China. Commercial Systems operating margins were flat at $125 million and operating margin improved 60 basis points to 22.8%. The improvement in operating margin was due to lower research and development expense and the cost savings initiatives, partially offset by lower sales and the sales mix as lower margin customer funded development revenues increased and higher margin business jet OEMs sales decreased.

Moving on to Slide 5, Government Systems overall revenue increased by 5% to $475 million, driven by higher simulation training program revenues, higher fixed-wing platform revenues and higher datalink program sales, all of which was partially offset by lower communications revenues. Government Systems first quarter operating earnings increased $10 million to $96 million, resulting in operating margin of 20.2%, 110 basis point improvement compared to the first quarter of last year. The increased operating earnings and operating margin were due to higher sales volume and our cost savings initiatives.

Turning to Slide 6, Information Management Services sales increased 8% over the prior year as aviation related sales increased double digits. Non-aviation sales increased 2% over the prior year. Information Management Services first quarter operating earnings increased $6 million to $30 million, resulting in operating margin of 17.8% compared to 15.4% in the first quarter last year. The 240 basis point increase in operating margin was due to incremental earnings and the higher sales volume and favorable sales mix.

Moving to Slide 7, we show the status of our capital structure as of the end of the first quarter compared to the end of last year. During the first three months of fiscal year 2017, our debt to EBITDA ratio has remained relatively flat with the year end at 1.7. Slide 8 provides some additional color about our anticipated near-term capital deployment in light of the pending B/E acquisition. As always, we will invest in organic growth. We will continue to invest in R&D and our capital expenditures are expected to be in the range of 3% to 3.5% of sales. We plan to use a significant portion of our free cash flow to de-lever over the next few years. At the time of the acquisition of B/E Aerospace closes, we anticipate our debt to EBITDA will be a little bit over 4. We expect our debt to EBITDA ratio will be under 3 within 2 years. And we will remain focused on shareholder return and plan to maintain a dividend payout ratio of approximately 25% of net income. We do not expect significant share repurchases over the next couple of years, just enough to offset dilution. Over time, as our leverage normalizes in the range of 2x to 2.5x debt to EBITDA, we expect to resume our normal share repurchase program. We are committed to maintain strong liquidity and flexibility and presuming our solid investment grade credit rating.

Now on to Slide 9 where we provide a summary of our fiscal year 2017 financial guidance, please note, this guidance is just for Rockwell Collins’ base business and does not include any impact from the pending acquisition of B/E Aerospace. We will update our combined guidance over the coming months as we get a better sense of the timing of the close. With that said, for 2017, we plan to generate total sales of $5.3 billion to $5.4 billion, representing growth of about 2%. This reflects Government System sales growing low to mid single-digits, accelerating growth rate from 2016. We expect Commercial Systems revenues to be about flat as benefits from market share gains near transport offset further declines in business jet OEM revenues. In the first half of fiscal 2017, we expect Commercial Systems sales to be down low single-digits due to headwinds in business jet sales and difficult comps in the aftermarket. Over the second half of the year, we expect Commercial Systems sales to increase low single-digits as air transport production rates increase, new products enter into service and ADS mandate revenues begin to accelerate.

And finally, we expect Information Management Services to be up mid to high single-digits in fiscal 2017. Total segment operating margins are expected to be approximately 21%, cash flow from operations is expected to be in the range of $800 million and $900 million and CapEx is expected to be approximately $200 million, all of which results from free cash flow of $600 million to $700 million. Our R&D investment in 2017 is expected to be between $900 million and $950 million and our full year income tax rate is anticipated to be in the range of 28% to 29%.

That completes my review of the financial results and projections. So Ryan, back to you to kick off the Q&A session.

Ryan Miller

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

Operator, we are now ready to open the lines.

Question-and-Answer Session

Operator

And our first question comes from the line of Robert Stallard with Vertical Research. Your line is open.

Robert Stallard

Thanks. Good morning.

Kelly Ortberg

Good morning Rob.

Robert Stallard

I would always start off by talking about the business jet aftermarket, you mentioned about mandates, so wondering if you could talk about some of the aspects of the biz jet aftermarket, what sort of growth rates you saw in discretionary and non-discretionary and what the level of interest is at the moment?

Kelly Ortberg

Yes. So let me just close out on the mandates, Rob. So last year, we saw really good revenue associated with the TCAS mandate. That’s going to be a headwind for us in the first quarter of this year or the first half of this year and we saw that in the first quarter. And then we have got the ADS-B mandate coming in, which will be a tailwind for us as we entered the second half. So we got just a little bit of a timing relative to the mandate side. The discretionary side is about the same as what we saw the second half of last year, which is pretty good upgrades on avionics. That’s actually selling better than our cabin upgrades right now, which is a little bit of a reversal for may be a year ago where we are seeing more cabin upgrades and less avionics upgrades. And I think it reflects the fact that there is kind of a fixed budget that they are putting into the aircraft and some of these avionics upgrades I think are recognized as necessary to continue to sustain the airplane or to actually turn the airplane if they are planning to sell it. So sustained aftermarket, that continues to be pretty good for us.

Robert Stallard

Okay. And then just a quick follow-up on the government side, the change in administration is coming through here, has that had any impact on order intake or usual business with the DoD?

Kelly Ortberg

Well, as I have said in my prepared remarks, we are really busy right now, there are a lot more programs, a lot more program opportunities and the scope of the programs are larger. And that’s under continuing resolution where everybody normally is kind of slow at moving on new business. So I am encouraged – I don’t know if it’s anything specific to the new administration, but they are certainly more focused on growing the defense business. And I feel really good about the opportunities and where we are seeing these programs come up that we are going to be able to, as I said, get this business back to mid single-digit strong growth business for us.

Robert Stallard

That’s great. Thanks Kelly.

Operator

Our next question comes from the line of Myles Walton with Deutsche Bank. Your line is now open.

Myles Walton

Thanks. Good morning.

Kelly Ortberg

Hi Myles.

Myles Walton

Patrick, could I start on the margins side, obviously pretty strong margins here in the first quarter, some good help on timing of R&D, but that being said, I don’t think you have had first quarter margins do anything other than ramp through the course of the year in previous years, so is it purely timing that is going to hold back the margin expansion on higher volumes as we press through the year or can you give us more color?

Patrick Allen

I would tell you Myles, I think we started with stronger margins than I anticipated in the first quarter. So I think there is some timing on R&D, particularly on the commercial side of the business. You are absolutely right, there is going to be a shift between our deferred spending and company funded spending. But I also think that – it signals, maybe there is a little opportunity in the margin side for the balance of the year.

Myles Walton

Okay. And then Kelly, can you guys make a comment on jitters and the timing that you are kind of considering there and looking forward through the course of fiscal ‘17?

Kelly Ortberg

Yes. The program continues to move forward. We completed, I think all the suppliers completed the first phase testing. And we have received the incremental order for the additional radios that will be utilized in the second phase of testing. And in fact, we are delivering those radios right now. We are still expecting a delivery order decision yet this year, probably in the third to fourth quarter of our fiscal year. And again, that’s where they will potentially down select from three current suppliers to two suppliers and make a pretty large annual buy. So we still have the test phase. The second phase of testing ahead of us and we need to get through that and then hopefully we are successful in the down selection.

Myles Walton

Got it. Thank you.

Operator

Our next question comes from the line of Robert Spingarn with Credit Suisse. Your line is now open.

Robert Spingarn

Good morning.

Kelly Ortberg

Hi Rob.

Patrick Allen

Good morning.

Robert Spingarn

Patrick, this is going to come up at some point, it’s a little bit early, but could you give us some sense of your expectation or an early read on some of these Trump reign [ph] potential accounting adjustments, tax rate, interest deductibility, depreciation, etcetera, border adjustment?

Patrick Allen

Yes. Rob, as I read and I think it’s a net positive for us. Obviously, the rate reduction is a big component of it. But the fact that I think both proposals call for the preservation of the R&D tax credit, I think is really good news for us. There is the elimination of the Section 199, the Domestic Manufacturing Deduction, which would be an offset slightly. But it also say that this border adjusted tax, as I understand it, is a net favorable for – certainly for legacy Rockwell Collins, a little bit less so for B/E, because they have got more offshore manufacturing. But I think if I balance it all out, I could see our rate coming down close to 20%.

Robert Spingarn

And then just quickly for Kelly, any sense – you have talked about business jet headwinds so far throughout the morning, but any sense that that’s starting to turn?

Kelly Ortberg

Well, let’s just say it hasn’t gotten worse. I don’t know that I can say it’s starting to turn and I am probably going to stay a little bit pessimistic until I see some real signs of that. Having said that, all of our OEM customers are generally reporting a pretty good fourth quarter, calendar year fourth quarter, which is different than what we saw last year. We did not see a big true-up here with significant rate reductions this year. We didn’t see rate increases, but we didn’t see the rate reductions. So maybe stabilization is the best way to describe that. Back to the question around the new administration, I am very hopeful that anything that stimulates economic growth and tax policies that focus on boosting capital spending is going to have some juice into the business aviation marketplace and that will probably be the first place we would see that. So I am hopeful that, that all comes to fruition here today marks a big day.

Robert Spingarn

Okay. Thank you.

Operator

Our next question comes from the line of Carter Copeland with Barclays. Your line is open.

Carter Copeland

Hi, good morning. And just I wanted to extend my condolences on the loss of your colleague. We really enjoyed working with Ellen, so apologies for you guys. I wanted to ask a couple of clarifying, just sort of little ones on Commercial Systems, Patrick, can you give us a sense of the BRS OE sales, what those might have been down if you didn’t have the CSeries growth and if that sort of implies that there was another de-stock like you saw last year. And then on the cost savings, it looks like maybe implied those are sort of mid single-digits millions, is that a decent number or too high? Thanks.

Patrick Allen

Yes. Carter, I would say this, if we strip out the regional jet, which was favorably impacted by the CSeries, Bizjet was down over 20% for the quarter, which was a combination of de-stocking as well as kind of the play out of the rate reductions we saw last year. In terms of the savings, I think you got it about right, mid single-digits in the millions for the quarter.

Carter Copeland

Okay, great. I will get back in the queue.

Kelly Ortberg

Yes.

Operator

Our next question comes from the line of George Shapiro with Shapiro Research. Your line is open.

George Shapiro

Yes. Good morning. I just wanted to follow-up a little bit on the business jets Kelly, I mean you have said that you needed faster GDP growth, we seem to be getting that, you said we needed better business confidence, we seem to be getting that. And then one specific, if I look sequentially, business jet aftermarket, while up minimally, was actually up slightly Q4 to Q1, which hasn’t occurred in a lot of years, I have records back at least 5 years, so is there anything to those issues suggesting that maybe as the year goes on, you get a little bit more positive?

Kelly Ortberg

Yes. I think those are all really positive indicators, George. And I am hopeful that we will see that. I think it’s going to take a while before that actually converts into OEM rate increases, but certainly we are see it first in more activity in the aftermarket. I think we have got a good set of aftermarket solutions to prosecute that opportunity if it presents itself. So yes hopefully, we will see that improved from our current outlook. Like I said, I am just kind of waiting to see the actual numbers because we have seen some glimmer before, that’s kind of faded away and I just want to make sure it’s systemic here.

George Shapiro

Okay. And then one quick follow-up for Patrick, Patrick, government incremental margin was like 42% and 46% in IMS, are those sustainable kinds of numbers or you are just getting an inordinate amount of cost benefit this quarter?

Patrick Allen

Well, George, I would say that certainly we are going to continue to see good incremental margins and we should see the cost savings continue to play through the margins over the course of the year. I would say both Government Systems and IMS benefited from mix. And so whether the margin, the incremental margins are as rich as they are in the first quarter, I doubt they will be for the balance of the year.

George Shapiro

Okay. Thanks very much.

Operator

Our next question comes from the line of Seth Seifman with JPMorgan. Your line is now open.

Seth Seifman

Thanks very much and good morning. Patrick, just a quick one for you on the preproduction engineering cost in the cash flow statement on gross basis that says it was $38 million and yet the net amount, it looks like, was a zero, so was there – what kind of offset that $38 million, since it’s higher than usual amortization rate?

Patrick Allen

Well, if I take it down, we have $38 million of spend, about $11 million of amortization and then there was a reclassification of the remaining $27 million. That’s how you get down to flat.

Seth Seifman

Okay, great. Thank you. Thanks very much.

Operator

Our next question comes from the line of Hunter Keay with Wolfe Research. Your line is now open.

Hunter Keay

Hi. Thank you. Good morning. Kelly, did you give a consideration to a scenario of the Zodiac turnaround, VN acquisition when you laid out the scenarios of some of your revenue synergy assumptions and are you expecting now a more challenging competitor, particularly as it relates to some of the contract wins that B/E has seen over the last few years?

Kelly Ortberg

Well, yes, our baseline assumption was that Zodiac’s performance would recover and we have to expect that and we are going to plan for that. If you are talking relative to the announcement yesterday, that’s something that’s been rumored for quite some time, long before the – our B/E move. So it’s certainly something we contemplated as we went through that. Look, we don’t – we really don’t compete much with Saffron [ph] in our core markets today. So I don’t really see that combination having any dramatic impact on our plans. Obviously, they are going to be a bigger, larger company and that will create some both positive and negative potential dynamics. But we deal with that every day in our core markets. So I think full speed ahead for us. This isn’t something that derails our strategy, something we certainly thought about before we made the B/E decision.

Hunter Keay

Great. Thank you very much.

Operator

Our next question comes from the line of Sam Pearlstein with Wells Fargo. Your line is now open.

Sam Pearlstein

Good morning.

Kelly Ortberg

Good morning.

Patrick Allen

Good morning.

Sam Pearlstein

Since your last or I guess since October when you provided guidance, Boeing has announced the 777 – another 777 rate cut, can just talk about how that might play out for you, I don’t know that would affect ‘17 in either way, but how does that affect your outlook?

Kelly Ortberg

Yes. We had anticipated rate cuts Sam, on the 777. It did come a little earlier than we expected. So we are going to see some impact to our fiscal ‘17 commercial plan from the baseline, but it’s not overly material and it’s something that we think that is kind of within the R&O profile of the business.

Patrick Allen

Okay. And then if you look forward, we had that rate reduction baked into our longer-term outlook.

Sam Pearlstein

And I was going to ask about that longer-term outlook, so when you ask for, you have a pretty strong multiyear outlook in there for the base business and when you have talked about the double-digit accretion into ‘18, is that a reasonable baseline to be thinking about at least in the ‘18 timeframe?

Kelly Ortberg

Well, yes, I think that’s our baseline plan as of record. Just recognize that, that plan was put together last February timeframe. We will update that. I think there is puts and takes, but I think it’s a reasonable thing to look at. We might be a little sporty on the revenue side of the equation, but we think we are probably offsetting conservative on the bottom line side of that. So I think if you are looking at the top line, maybe a little bit – that might be a little bit sporty, bottom line should be good.

Sam Pearlstein

Thank you very much.

Operator

Our next question comes from the line of Rajeev Lalwani with Morgan Stanley. Your line is now open.

Rajeev Lalwani

Hi gentlemen. Thanks for the time. Kelly, I wanted to come back to your prepared remarks, you talked about looking at Phase 2 synergies, can you just provide some color on the size of those synergies and the timeline. And then just relating to the B/E transaction, as you have done your work, or more work rather, over the last few months, what stood out to you as a customer relationships, products, operations, just any thoughts there?

Kelly Ortberg

Well, we are still quantifying those costs. And they are all related to where we have overlap, either in capability manufacturing sites, where we are doing duplicate things, customer support sites, where we may have multiple facilities. I am not going to size that yet, because our teams are working right now to figure that out and in fact the timing of that as well. The area that I am and I made this comment in the prepared remarks, that I am incrementally more encouraged is around our government channel. And let me walk through an example of that to help you kind of think about that. The tanker transport market is a big market for us, important market for our core business. And we really address that market with five major product line – product portfolios. Our avionics, as you know, displays, head up, head down displays, commercial COMM/NAV surveillance, military flight management kind of capability. The second thing – second area is in electromechanical systems, horizontal trim actuator, pilot controls, throttle quadrants. The third area we address, third product portfolio is in military COMM/NAV, secure frequency hopping radios, tactical data links, [indiscernible] on radio navigation functions for the military. And then the fourth area is mission systems. Things like the air refueling that we are doing on the KC-46, command and control platforms like what we are doing on the E6, cargo handling like we are doing on the KC-390. And then the fourth area of our portfolio is around simulation – the fifth area, simulation and training and this actually is an equipment on the aircraft, but it’s procured as a part of these mods and upgrades or new aircraft programs, visual systems, image generators, maintenance and flight trainers. And we bring that whole portfolio of capability together to address the opportunities that are in that market. And if you step back from that, interesting enough, a lot of that has came from inorganic moves that we have made. Our head-up displays, all come through our Flight Dynamics acquisition. All of our electromechanical portfolio comes through Kaiser electrodeposition acquisition. All of our simulation and trainings come through the acquisition of NLX and SEOS. And so that’s what we are going to do with the B/E portfolio. And as you look at that, I am encouraged because there are some really nice capabilities. Flight deck controls, they do overhead panels, which we don’t do. They do that, for example, in CH-47. Cooling systems, avionics coolers, you think of them as doing the chillers for the food and beverage preparation, but they also do use that technology for avionics bay coolers. Data recorders from their macrolink business on the Global Hawk and PA where they are doing acoustic and secure data recording. The lighting and power coming out of the Amtec business, cockpit lights, cabin lights, exterior lights, oxygen systems for pilot and crew oxygen and they are doing that on Eurofighter 8400M, the KC-390. And then pilot and crew seating, troop seats, optionally armored seats, pilot seats. They are doing that on helicopter programs for both Airbus and Leonardo. And if I look at that portfolio of new capability, in many cases, they are kind of below the center of mass for their organization. Everybody is off pursuing these things on a one-off basis. And we are going to do just what we have done with the flight dynamics to where it has become a core part of our product offering and bring these capabilities together. So that’s what I talk – when I talk about leverage in the channel, there is great opportunities for us to do that. And I could walk through missiles and ammunitions example or rotary wing example where we will do the same thing. We have got our teams together right now, working on what those opportunities are. I even had – already had a case where military customers asking us to bid some interior work before we have even had the calls where we just have to subcontract the B/E. So we really – I do really believe we are going to be able to create these synergies. Now, if you think about them and I use IMS as an example, we just got this big Norwegian deal with IMS, took us about 3 years to get that all pulled together. We got sometimes develop equipment, get people together, bid programs, win the program, that takes time. And I think that can take some time here on exploiting the government channel. But what I like is if we can get through this, we will get all these upfront synergies that are straightforward for us to do in the first as we do the integration. And right when we got those humming and we have got the business integrated, we will start to see these revenue synergies create long-term meaningful opportunities. And we will be able to grow some more in the defense business as well. So again, I feel incrementally better about our ability to go create those revenue synergies. We are not committed to them, so they all become upside to our basic business plan.

Rajeev Lalwani

Thanks for the color, Kelly.

Kelly Ortberg

Yes.

Operator

Our next question comes from the line of Peter Arment with Baird. Your line is now open.

Peter Arment

Thanks. Good morning Kelly and Patrick.

Patrick Allen

Good morning.

Peter Arment

Kelly, maybe you can stick with defense, maybe just give us your updated thoughts on the impact of the CR, I know you had given some commentary that from win through March which is going to hurt your bookings, but it lingers past there, we will start to see some further impact on maybe your overall plan. And then just related to that, just there is a lot of talk about an increase in readiness spending and improving like the simulation training business, I think about your installed base of parts, what’s your thoughts on how a pickup in the O&M and how that would impact you?

Kelly Ortberg

Well, let me address the CR first. We have gone through our plan in detail around the CR. We have actually seen a little bit of impact for programs that we know are going to be delayed relative to the CR, but we have had enough opportunities as well to kind of hold that and offset that. I remain with the same position if the CR gets cleared here, I think will be okay for our fiscal ‘17 revenues. If they extend the CR even another month, it’s going to probably start to eat into our forecast and you can kind of think of that every month that increases in terms of an impact going forward. Now, everybody is focused on clearing the CR. I expect that’s going to happen but that is a risk that still remains out there for our government business.

Peter Arment

And regarding the readiness spending?

Kelly Ortberg

Regarding readiness, well, we don’t – we probably don’t see as much near-term impact from readiness. Obviously, they are flying aircraft more hours, we may see more maintenance activity. If they are buying more spares and more equipment, I am not expecting that readiness improvements going to have any meaningful impact at least for us here in fiscal ‘17.

Peter Arment

Okay. Thanks guys.

Operator

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

Cai Von Rumohr

Yes. Thank you very much. So a question about your customer Bombardier, are you seeing any impact on your deliveries to CSeries as a result of the engine delays. Secondly, how do you feel about how they are doing on the Global 7000 in terms of getting their certification. And then lastly, have they paid you, I think they owe you $25 million or $30 million as a result of the cancellation of the Lear 85? Thanks.

Kelly Ortberg

Let me address the Lear85 first and kind of go – walk back on your three questions. So we, Rockwell Collins and Bombardier, without admission of liability, have reached an amicable resolution in relations to the Lear 85 program. The details of that are confidential and so we are going to be providing any further detail around the details of that. I will just say our relationship with Bombardier is very good and we are glad to have this behind us and both focused on executing the business at hand. We have not seen any impact to our CSeries ramp, to your question about any other issues driving that. So no, we have not seen that any recent impact there. And the Global 7000 continues to move forward on schedule. So I don’t – I also don’t see any impact for the certification. Now, we only see what we see. But having said that, both those programs appear to be moving forward in a good fashion.

Cai Von Rumohr

And then they said that their Challengers and Global deliveries will be flat in 2017 and yet your business is down, does that reflect the fact that you are shipping to them at a substantially lower rate than they are shipping out the door?

Kelly Ortberg

Yes. We were ahead of them last year and that’s this inventory rationalization that we are going through. So yes, that’s the result of delivering too much last year for their deliveries.

Cai Von Rumohr

Thank you.

Operator

Our next question comes from the line of Peter Skibitski with Drexel Hamilton. Your line is now open.

Peter Skibitski

Good morning guys. I guess the only thing I would ask Kelly, is we would just like to get your thoughts on the commercial aerospace cycle, we have seen some wide-body headwinds, but still pretty large backlog on the narrow-body side, so just was wondering how you are thinking about it and what your some of your airline customers are saying?

Kelly Ortberg

Well, look, I think we are 3 years into the order cycle. I think we peaked back in ‘13 and ‘14 and we are seeing that right now. Obviously, it’s having different impacts on narrow-body and wide-body. And the real question is how long is the order cycle last and how does that convert to delivery cycle. And everybody knows that the last delivery cycle – or last order cycle didn’t convert into an overall delivery cycle because of the very strong backlogs. My feeling is the same is going to happen. I don’t think we are going to come out of the order cycle for a few more years. I think we will see that probably coincide with the 777X coming into the marketplace. I think narrow-bodies are fine. We are going to continue to see the narrow-body because of the strong backlog, continue to ramp up at both OEMs. But I do think we are going to see continued softness for the legacy wide-bodies and we have seen that already, the 777 legacy aircraft, A380 and the 747-8. So I think that’s going to continue to be a challenge and we will probably continue to see higher levels of retirements of the legacy wide-body aircraft as well until we start to see the order environment up-tick.

Peter Skibitski

Okay. And then just on some pressure on airline profits this year, are you seeing any kind of slowing of fee type orders or anything like that related to the kind of slowing of their financial position?

Kelly Ortberg

Not really. I mean they have to go make those BFE orders to take the airplane. So I think that’s going – we are seeing the impact. If they are going to delay delivery of A380s, our equipment on A380s are going to delay with that change. So any kind of deferrals will flow through our particular business. But I am not seeing anything yet that indicates we have got a large by wave of either deferrals, cancellations or reschedules coming. Having said that, I suspect we will have some of that here over the next couple of years until we come out of the order cycle.

Peter Skibitski

Got it. Thank you very much.

Operator

Our next question comes from the line of David Strauss with UBS. Your line is now open.

David Strauss

Thanks. Good morning.

Kelly Ortberg

Good morning David.

David Strauss

Wanted to follow up on – someone asked a question on the S4, Kelly you said the revenue outlook included in that might be a little bit robust, but compensated on the margins side and the bottom line, what about free cash flow, it doesn’t seem like what you are implying in there gets you above 100% free cash flow conversion out over the next couple of years, which is a bit surprising to me?

Patrick Allen

I would say we are probably pretty conservative on the cash flow side as well. I would have to go back and take a look at it. But these were plans put together, really for a purpose other than providing financial guidance. They are really a strategic and financial planning item. So I would say we are probably conservative both on the EBIT side and on the free cash flow side.

Kelly Ortberg

Yes. But just to be clear, we are absolutely committed and have a plan for the combined entity cash flow and achieving that 100% cash conversion. So that is our plan, we are confident being able to achieve that?

David Strauss

Okay. And then as a follow-up, you comment on the 777 rate cut, you have had that kind of factored in, but it did come a little bit earlier than expected, how are you thinking about that 777 rate cut in relation to the B/E business and the plan there? Thanks.

Kelly Ortberg

Yes. If you look at near term, the way has forecasted their outlook or their business, it’s really much more of a backlog based analysis than what we do, which is more rule out rate analysis. So if the rates reduce because, what I will say, whitetails or aircraft that aren’t filling in that demand, really doesn’t have any impact to B/E’s near-term outlook. What does have impact is where you see shifting of the backlog. So Emirates, for example, with the A380, that’s an area which would move the revenues associated with that to the time that they move those deliveries. So I am not expecting significant impact associated with that 777 rate reductions unless we see significant rescheduling of existing backlog.

David Strauss

Alright. Thank you very much.

Operator

Our next question comes from the line of Howard Rubel with Jefferies. Your line is now open.

Howard Rubel

Thank you very much. While everybody is focusing on the big deal, I noticed Pulse is probably $11 million transaction and while that’s probably small, Kelly, could you talk a little bit about how you see this as an opportunity to expand IMS and what kind of revenue potential is related to that and are there some other things you can...?

Kelly Ortberg

I am sorry, go ahead, finish your question.

Howard Rubel

Well, I was going to say it probably gives you a further systems orientation in terms of how you are able to kind of greet the customer at the front of the airport and shepherd him through the whole process, do you have a vision for that as well?

Kelly Ortberg

Yes. If you look at our overall airport business, it’s all around providing improved flow-through the airport from walking in to boarding the aircraft. So self-service kiosk, all the ticketing self-service is a big focus in our airport business today. And the self-serve backdrop is going to be a big driver here over the next 5 years. If you haven’t used it yet, you will be using it and you will see that just like the self-service ticket kiosk, it really is a much better way to move folks through the airport. And so we thought – we saw this as a key element of driving airport upgrades. It’s a part of a portfolio for us to do that. We felt we wanted to have that because they have got some Pulse.Aero has some differentiating technology that we think will improve our win on these airport upgrade opportunities for us going forward. So yes, that is our vision, is to be able to use information, connectivity, getting through the passport control, getting through ticketing and baggage handling. And it’s all around managing that and that goes all the way to the aircraft. There will be a day where you will be able to track your bag from the seat in the aircraft throughout the mission of the flight.

Howard Rubel

And then as a follow-up, BFE is an important part of your business and while the revenue is down, could you address a little bit about some of the other elements inside the cockpit, I mean you talked about the China Eastern win and is there some further market share opportunities and in fact, it does look like you are taking share, is that fair?

Kelly Ortberg

So let me clear the HUD issue right now. So last – the HUDs that were down this quarter is in the retrofits of HUDs, not HUDs with new aircraft delivery. And the reason that’s down is that Chinese government has had an incentive plan in place where they are providing financial incentives to the airlines to retrofit their fleet with a head-up display. That incentive pool last year depleted. And it was depleted for about a little over a quarter, where we do that, they were going to put some additional funds in that and the airlines knew that, but everybody just stopped ordering retrofit HUDs while that incentive was not available to them. That incentive is now back in place and we are seeing orders. So we continue to believe that the HUD retrofit market is going to be good for us, particularly in China. Relative to other retrofits, I would say there is not much going on other than mandates. The ADS-B, the TCAS update that we had, those will be nice, but there is not much other retrofit activity. BFE competitions, we continued to do well. I believe we are gaining share, but we are at a relatively high share ratio as well. So we are going to continue to be focused on that strong BFE business. And we are pleased that the airlines are selecting our equipment for their new aircraft deliveries.

Howard Rubel

Thank you, Kelly.

Operator

Our next question comes from the line of Michael Ciarmoli with SunTrust. Your line is now open.

Michael Ciarmoli

Maybe Kelly, I don’t think it’s been brought up yet, commercial aftermarket, looks like it was the biggest rate of decline, down 7.5%, I mean is that performing as expected, I know you guys thought it was going to be weak, is it getting worse, you mentioned possibly more legacy wide-bodies, I would imagine that would further hit the recycling market, but any additional color there, I mean is that getting worse for you or is it sort of stabilized or just some comments on that?

Kelly Ortberg

Yes. The market – the aftermarket was not strong this first quarter, but that would then come as a surprise to us and we talked about the mandate timing both in biz jet and air transport. The one thing that we haven’t said, that maybe is a little bit of new information is in the used parts area. We were down in our enter trade business in the first quarter. That’s been a growth area for us as we have seen a lot of this recycling going on in the past couple of years. I am not expecting to see much growth out of our enter trade business this year. A lot of people have jumped into that segment and the whole trick here is having a balance of supply and demand, making sure you don’t pay too much for the used parts or you don’t buy a bunch of used parts that there is excess in the market you can’t turn. So I have said we are going to stay disciplined in this segment and we are. Having said that, I think the market may be losing a little bit of discipline. So I don’t think we are going to see that driving a lot of growth for us. We are going to stay there because I really like the visibility it gives to what’s going on in the aftermarket relative to used components. But again, I don’t see it as a growth driver for us for this fiscal year.

Michael Ciarmoli

Got it, that’s helpful. Thanks a lot guys.

Operator

Our next question comes from the line of Ken Herbert with Canaccord. Your line is now open.

Ken Herbert

Hi, good morning.

Kelly Ortberg

Good morning.

Patrick Allen

Good morning.

Ken Herbert

Just wanted to follow-up Patrick, quickly on the commercial transport aftermarket, if you back out the headwinds from initial provisioning and I think you said both 787-A and A350, fair to say you were down just low single-digits, is that the right magnitude of the impact there?

Patrick Allen

That’s pretty close.

Ken Herbert

Okay. And then on that – I am sorry.

Patrick Allen

It’s a low to mid single-digit. Yes.

Ken Herbert

Yes. Okay, perfect. And on the provisioning, obviously Airbus ended the year I think stronger than we all expected with the A350 deliveries, can you talk about maybe as we move into the second half of this year or when you expect to see that become perhaps more of a meaningful contributor and when do the 787 initial provisioning comps start to get a little easier?

Kelly Ortberg

Well, on 787, we are really starting to enter into a normal provisioning cycle. And I mean there will be a little bit of lumpiness. But even the sparing that we were down in the first quarter wasn’t large number. So it’s much more of a regular run rate. The provisioning on A350 really goes with the number of new airlines that are taking aircraft. So it’s not necessarily linear to the production rate deliveries, it’s more focused on is there a new type airline taking the deliveries, which means it’s a little bit lumpy. And as we have said, A350 provisioning is not near as big because we aren’t provisioning the cockpit. So we don’t have near as big provisioning as we had say, on 787. Now, we will start to see some provisioning here this year on 737 MAX and that will be a tailwind for us over the next 3 years.

Ken Herbert

Great. Thank you very much.

Operator

[Operator Instructions] Your next question comes from the line of Noah Poponak with Goldman Sachs. Your line is now open.

Noah Poponak

Hey, good morning everyone.

Kelly Ortberg

Hi Noah.

Noah Poponak

Just to stay on the aftermarket line of questioning there Patrick, the down low to mid-single you just said, is that – is that ex provisioning or is that more ex everything that’s lumpy or sort of non-recurring?

Patrick Allen

Well, let me put it this way. I think if you look at total air transport aftermarket, we are expected to be down low single-digits, all in. I think the question that I was answering was if I – if you look at just the first quarter and look at just taking up the provisioning, we were down probably low to mid single-digits. So think of Commercial Systems in total aftermarket down low single-digits.

Noah Poponak

Is that also – but in addition to it – it sounds like in addition to a provisioning lumpiness headwind that also had a mandate lumpiness headwind, a China HUD headwind and an energy headwind, is that correct?

Patrick Allen

That’s true, yes.

Noah Poponak

So I guess I am just trying to get…

Patrick Allen

So if you take out all of those headwinds, we are roughly flat for the quarter.

Noah Poponak

Okay. And maybe that’s too much, the growth excluding everything that’s not growing metric. But I am just trying to better understand like the real core underlying ongoing aftermarket trends?

Patrick Allen

Think of that is being pretty flat, excluding those headwinds, that headwinds you just mentioned.

Noah Poponak

Okay. And then how should I think about ex headwind for the full year?

Patrick Allen

I think you are probably roughly flat again.

Noah Poponak

Okay. And then CSeries, would you be willing to put any numbers around how big CSeries gets for you in the fiscal ‘17 outlook and/or how big it can get for Rockwell Collins wanted that rate?

Patrick Allen

Well, look. We have – we don’t give the actual dollar value per aircraft per fiscal year. We do have 30 ships that’s of deliveries for CSeries baked into our fiscal ‘17 forecast. That will help you.

Noah Poponak

Okay. Can you categorize how the first quarter compared to that 30 for the full year?

Kelly Ortberg

It continues to ramp.

Noah Poponak

Okay, fair enough. Thank you.

Kelly Ortberg

Okay. Operator, we have time for one more question.

Operator

There are no further questions in queue at this time. This concludes the question-and-answer session. I would now like to turn the call back over to Ryan Miller for any closing remarks.

Kelly Ortberg

Before I turn the call back to Ryan, I do want to publicly acknowledge a big loss that we had at Rockwell Collins last week. I think many of you are – have interacted with Ellen Dennis, who has been our long-standing assistant for our Investor Relations team. And sadly, Ellen passed away last week. So she is one of those people that you love to be around, smart, witty, always trying to make our company better. So we are going to miss her.

Ryan Miller

Thanks Kelly for the acknowledgment, really missing Ellen greatly. And thank you all for joining us in today’s conference call. We plan to file our 10-Q later next week, so please read that document for additional disclosures.

Operator

This concludes today’s conference call. You may now disconnect.

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