Textron Inc. (TXT) Q4 2016 Earnings Report, Transcript and Summary

Welcome to the Textron Fourth Quarter 2016 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded. At this point, I'd like to turn the conference over to our host, Vice President of Investor Relations, Mr. Eric Salander. Please go ahead, sir.

Thanks, Brad, and good morning, everyone. Before we begin, I'd like to mention we will be discussing future estimates and expectations during our call today. These forward-looking statements are subject to various risk factors, which are detailed in our SEC filings and also in today's press release. On the call today we have Scott Donnelly, Textron's Chairman and CEO; and Frank Connor, our Chief Financial Officer. Our earnings call presentation can be found in the investor relations section of our website. Textron's revenues in the quarter were $3.8 billion, down $98 million from last year's fourth quarter. During this year's fourth quarter, we recorded an $8 million pre-tax charge, or $0.02 per share after tax, related to the restructuring plan we announced this past summer. Excluding these items, adjusted income from continuing operations was $0.80 per share, down $0.01 from last year's fourth quarter. Manufacturing cash flow before pension contributions was $727 million, compared to $534 million in last year's fourth quarter. For the full year, revenues were $13.8 billion, up 2.7% from a year ago. Adjusted income from continuing operations was $2.62 per share, up 4.8% from $2.50 last year. Manufacturing cash flow before pension contributions was $573 million. With that, I will turn the call over to Scott.

Thank, Eric, and good morning, everybody. Revenues were up at Systems and Industrial, but down at Bell and Aviation, which led to an overall decrease in revenues in the quarter. Despite the decline in revenues, we're encouraged by increasing demand in Industrial, the ramp on TAPV deliveries, and strong operating performance at Bell. Bell revenues were down on lower commercial military volumes for the quarter. Despite the lower volumes in the quarter, we continued to execute, which led to a strong 14% margin. We delivered 35 commercial helicopters, down from 56 in last year's fourth quarter; 4 B-22s, down from 8 units last year; and 8 H-1s, down from 9 last year. On the new product front, our V-280 Valor program continues to progress and is on track for first flight this year. On the commercial side, we're continuing to see signs of stabilization of the market through improved order flow. Our new 505 Jet Ranger X achieved type certification from Transport Canada Civil Aviation at the end of 2016, with follow-on FAA certification anticipated in the first quarter of 2017. We've seen strong conversion of LOIs to orders on the 505 and expect solid deliveries beginning in the first quarter. On the service side, we're experiencing a positive reception to our Customer Advantage Plans, including the signing of Heliservicio's fleet of 20 Bell 412s. Moving to Systems, revenues were up on higher volumes, primarily at Marine and Land Systems. The higher volumes were driven by the ongoing ramp of TAPV deliveries to our Canadian customer in the quarter. At our Unmanned Systems business, we recently were awarded two significant contracts that display our customers' confidence in our products and support network. The first award was a $206 million contract for ongoing logistics support and sustainment on our Shadow Tactical Unmanned Aircraft System. Second, to be the sole provider of services with our Aerosonde mid-endurance unmanned aircraft for an amount of $475 million over the next several years in support of US special operations. At our TRU Simulation training business, we delivered our first 737 Max full-flight sim to Boeing's pilot training camps in Miami as part of our 10-year exclusive agreement. We continue to look for ways to leverage our platforms across our businesses, and we recently opened our Bell Helicopter Training Academy in Valencia, Spain with EASA certification of our 429 sim. Our Citation M2 and CJ4 simulators received FAA qualification in the quarter, joining the Latitude and CJ3+ at our TRU US-based training centers. Moving to Industrial, we saw a 3.8% increase in revenue, reflecting the impact of higher volumes at Kautex and specialized vehicles. As we look to continue our expansion in the powersports market and build on our recent product introductions, today we announced an agreement to acquire Arctic Cat, one of the industry's most recognized brands. This acquisition will immediately broaden our product portfolio as we add a variety of outdoor recreational and utility vehicles to our lineup, as well as an established dealer network. Also during the quarter, we released our new four-seat 80 horsepower Textron off-road Stampede XTR, maintaining our new product momentum in the sports utility market. The integration of Jacobsen into our specialized vehicle business is underway and on track to be completed this year. Moving to Textron Aviation, revenues were down $52 million. In the quarter, we delivered 58 jets compared to 60 last year and 28 King Airs, down from 33 in last year's fourth quarter. For the full year, we delivered 178 jets, up from last year's 166, including 42 Latitude deliveries. The increased Latitude deliveries include both retail customers as well as deliveries to NetJets, and we expect that trend to continue in 2017. Offsetting this growth in Latitude volume were lower deliveries on other Citation models and turboprops, for which we are lowering production in 2017. On the new product front, the second aircraft in the Longitude flight test program successfully completed its first flight just over one month after the prototype aircraft. The Longitude has performed very well, and at this year's NBAA, we announced an improved range of 3,500 nautical miles and an improved full fuel payload of 1,600 pounds. We also had a full cabin mock-up of the Citation Hemisphere on display at the show, and continue to believe this aircraft will be a game-changing platform in its segment. Moving to the Scorpion program, the first production aircraft had a successful first flight in the quarter and is performing well. Along with its first flight, we achieved a number of significant milestones in the program in 2016. We entered a US Air Force Airworthiness Assessment program, we validated production manufacturing processes, and successfully demonstrated weapons and mission Systems capabilities. With these achievements, interest in the Scorpion program is growing both domestically and in international markets. Given the status of the program at the end of 2016, we will transition financial reporting for the Scorpion to the Textron Aviation segment beginning in 2017. To summarize, we experienced a challenging year with weaker-than-expected business jet and commercial helicopter markets, but we continue to invest in our businesses through ongoing development of new products and strategic acquisitions to support growth and create long-term value. We were able to achieve significant increases in top-line growth at Industrial and Systems, with margin expansion and Systems, Bell, and Industrial. At Industrial, our growth for the year reflected our investment in new products, such as our selective catalytic reduction Systems at Kautex and our Stampede side-by-side sport utility vehicle. We also acquired Premier and SAFEAERO, two manufacturers of aircraft de-icing equipment, that allow us to expand our ground support business portfolio. At Textron Systems, we began initial deliveries of our TAPV systems and anticipate delivery of our first ship to shore connector this year. At TRU Simulation and Training, we achieved a number of milestones with initial deliveries of full flight simulators for several models into the commercial, general aviation, and helicopter training markets. At Bell, we made substantial progress on the V-280 and announced our latest innovation, the V-247 Vigilant unmanned tiltrotor, further displaying our leadership in tiltrotor technology and our commitment to meeting customer needs. On the H-1 front, we received additional orders from the DOD for 61 units, including 9 FMS units for Pakistan, taking production through the first quarter of 2019. Looking forward, foreign initiatives remain strong and we expect to secure additional contracts in 2017. On the commercial side, after a difficult period in the market with several quarters of very low order flow, we saw a significant increase in order activity in the back half of 2016 and we are looking to carry that momentum into 2017 with higher 412 and strong 505 deliveries. Textron Aviation, we saw higher Latitude volumes in 2016 and expect this trend to continue in 2017, with higher deliveries to NetJets and retail customers. On Longitude, we entered two aircraft in the flight test program and expect certification at the end of 2017, with deliveries ramping in 2018. We updated design details and performance capabilities for the Cessna Denali and Citation Hemisphere, two platforms that will make incremental revenue as we enter new markets in the coming years. To finish with Textron's 2017 financial guidance, we are projecting revenues of about $14.3 billion, as we expect growth in Industrial and Systems, with approximately flat revenue at Bell and Aviation. We expect adjusted EPS from continuing operations will be in the range of $2.50 to $2.70, and manufacturing cash flow before pension contributions in a range of $650 million to $750 million. With that, I'll turn the call over to Frank.

Thank you, Scott, and good morning, everyone. Segment profit in the quarter was $391 million, up $13 million from the fourth quarter of 2015 on a $98-million decrease in revenues. Let's review how each of the segments contributed, starting with Textron Aviation. At Textron Aviation, revenues were down $52 million from this period last year, primarily due to lower commercial and defense-related turboprop volumes, partially offset by higher pre-owned volume. Segment profit was $135 million, down from $138 million a year ago. Backlog in this segment ended the quarter at $1 billion, down $73 million from the end of the third quarter. Moving to Bell, revenues were down $148 million, primarily due to lower military and commercial volumes. Segment profit increased $2 million from the fourth quarter in 2015 despite the lower volumes, reflecting favorable performance. Backlog in this segment was $5.4 billion at the end of the quarter, up $416 million from the end of the third quarter. At Textron Systems, revenues were up $69 million, primarily due to higher Marine and Land Systems volumes. Segment profit was up $12 million, reflecting improved performance. Backlog in the segment was $1.8 billion, down $367 million from the end of the third quarter. Industrial revenues increased $35 million due to higher volumes at Kautex and specialized vehicles. Segment profit was flat with the fourth quarter of last year. Finance segment revenues decreased $2 million and profit increased $2 million. Moving below the segment profit, corporate expenses were $56 million compared to $52 million last year. This reflected the impact of a higher stock price on stock-based compensation. Interest expense was $33 million, essentially flat to last year. With respect to our restructuring plan in the quarter, we recorded pretax charges of $8 million on the special charges line. We ended the year with gross manufacturing debt of $2.8 billion. For the full year, we repurchased approximately 6.9 million shares at an overall cost of about $241 million. Our Board of Directors also approved a new authorization for the repurchase of up to 25 million shares. Let's turn now to our 2017 guidance beginning with our segments on slide 9. At Textron Aviation, we are expecting flattish revenues of about $5 billion, reflecting an increase in pre-owned aircraft volumes and Latitude deliveries, offset by lower defense-related turboprop volumes. Segment margin is expected to be approximately 8%, excluding the impact of the Scorpion transition, reflecting the change in mix. We expect the Scorpion program expense to be about $50 million for the year. Looking to Bell, we expect overall revenues will be essentially flat at about $3.3 billion, reflecting higher H-1 deliveries, offset by lower V-22 revenues and spares on the military side, and flattish revenues on the commercial side. We are forecasting a margin of approximately 11%. At Systems, we're estimating 2017 revenues of about $1.9 billion, up 8% from last year, reflecting a full year of TAPV deliveries and growth at TRU, partially offset by lower volumes at unmanned systems and weapons and sensors, as we exit the SFW product line. Segment margin is expected to be approximately 8.5%. The lower margin in 2017 reflects the impact of lower SFW activities and higher TAPV volumes. At Industrial, we're expecting growth in each of our businesses, resulting in projected segment revenue growth of 5% to about $4 billion, with an estimated margin of approximately 9%. As Scott discussed earlier, we've entered into an agreement to acquire Arctic Cat, and we will update our 2017 outlook to include this transaction following its close. At Finance, we are forecasting segment profit of about $20 million. Turning to slide 10, based on US pension discount rate of 4.25%, we're estimating 2017 pension costs to be flat with last year at about $81 million. Turning to slide 11, R&D is expected to be about $495 million, down from $582 million in 2016. We are expecting CapEx will be about $440 million, approximately flat with last year. Moving below the segment line and looking at slide 12, we're projecting about $115 million for corporate expense. Next year's interest expense is estimated at $140 million. We are assuming a tax rate of about 30%, and our guidance assumes a share count of about 270 million shares. So that concludes our prepared remarks. Brad, we can open the line for questions.

[Operator Instructions]. We will go to George Shapiro with Shapiro Research. Please go ahead.

Scott, I wanted to pursue Aviation to some extent. First, I mean on the third quarter you commented you expected fourth quarter deliveries to be above last year's fourth quarter. Were any of those delayed into early this year as people may have hopes that we get better tax depreciation? And two, if you can just go through what you are seeing in the market now. Are you seeing an improvement in GDP growth, business confidence is up - are well behaved at this point, pricing seems like it's getting better so I would've thought that we would start to see some more improvement then evidently you are forecasting in 2017 guidance.

Sure George, let me start with the fourth-quarter and I think what we saw in the fourth quarter was obviously continued strength on the Latitude side. Aircraft is doing very well and demand has been strong both on the fractional side through NetJet as well as retail. I would say on the rest of the Citation family, as we went through the fourth quarter we saw a lot of price pressure and folks wanting to see lower pricing in the aircraft and what you see is that we didn't hit the volume because frankly we are not willing to go to the price levels where some people wanted to go in order to get deals done. I think the pricing on these right now remains very attractive. It remains depressed even going back into 2008 days and to levels we are just not willing to go so what happened is that we traded out of some volume because it was priced at a level we are not willing to accept. In fact in addition to that it's part of the reason - forecast this year. While we will still have continued growth on the Latitude side based on its demand, we are pulling back on the production volumes and unit volumes for 2017 for a lot of these other aircraft because again we are not willing to go to the price levels where people seem to want to go. Now in terms of Outlook in terms of the economy I don't think there's any question that if we see things happen with respect to corporate tax rates and regulation and all these things which I think frankly we all feel pretty good about, that that can make a material impact on GDP, that will help to create more confidence and more demand and if that demand comes back and it's willing to pay, you know, a fair price on the aircraft that we will address that at the time but we haven't seen that yet and so we walked from pursuing lower prices to get deals done in the fourth quarter and we will reflect that in lower pricing volumes going into 2017.

The book to bill looked like it was around.95. Was that - did that improve after the election or was there any color you can give us?

The book to bill looked like it was around 0.95. Was that - did that improve after the election or any color through the quarter you can give us?

No, I am not disappointed with the book to bill, George. It's always tough to get the book to bill in the fourth quarter to be - predict it strong, and usually it's weaker, frankly, I think, right? Because you see a lot of sales that's in Q4 and order activity doesn't usually pick up until after the first of the year. In other words, if people are going to do something, they tend to want to do it within the quarter for the fourth quarter. So I'm comfortable with our book to bill in terms of where we're going in the year. But again, we just - from a volume market perspective, it's a little bit of a wait and see, and we're going to adjust accordingly in the meantime.

And one quick one for Frank. How much of aftermarket up in the Aviation area?

Aftermarket was up, in part due to the reflection of the Able transaction. When you take that out, it was flattish.

We will go to the line of Jason Gursky with Citi. Please go ahead.

Scott, Frank, I was wondering if you could just talk a little bit more about the acquisition and the potential accretion and synergies and the longer-term strategic view of this particular market segment.

Sure. I think that this is a great opportunity for us. We have been investing organically here over the last couple of years to move more into the consumer side of the vehicle business. Our vehicle business, obviously, has been performing really well in the golf side, the Industrial side, and our own consumer piece of the business. But the consumer business, in general is a very large market. We have been fairly under-represented in that area. We have a great product line up with our personal transport vehicles under the E-Z-GO brand that does very well; it's a very nice business for us. We wanted to get into the higher performance more off-road side of the business. We invested in the Stampede; it's a fantastic vehicle. We're really pleased with that vehicle, but we've been trying to build out the dealer side, the distribution side, which is a different distribution channel than that which we have in the rest of our vehicle business. So opportunistically, look this is a business that's been challenged in the last couple of years. The industry frankly, after a lot of years of growth that was - had some issues this year just in terms of the economy and lack of net growth. The snow side of the business, obviously, had a couple of bad winters. On the dirt side they had just, again, as an industry, not unique to Arctic Cat, a lot of stuff built up in the channel. And I think it's a business that has tremendous opportunities going forward, but it's been in a bit of a tough time unwinding and managing their way through a lot of the inventory issues, and frankly, positioning themselves for future growth. So when we looked at the company - if you look at the products that we have today and the products that we've had in development, and you look at the products they have today and the products, frankly, which they have in the development pipeline, it's just a beautiful fit. I think that dealers and customers are going to be really impressed over the next couple of years about what that product line looks like. I think it will be a very attractive line for dealers. I think a lot of progress has been made with respect to the channel. That work will have to continue after we acquire it, I think, through the first year to really get that repositioned and ready to go. So I think long term, we see this as a mid-single-digit growth business. I think we get a lot of synergies and a lot of leverage in terms of the operations, as well as, again, just fortuitously where we were really investing and where they were investing are very, very highly complementary. So I think the combined entity will have a great product lineup, a great dealer network, and I think it's really poised to deliver some nice growth going forward.

Okay. As far as near-term accretion, dilution, when do you expect to turn on that? And then, Frank, can just talk a little bit about the cash flow conversion for the year and the puts and takes that are going on there for 2017? Thanks, guys.

Sure, so look, on the dilution front, again, we don't have a hard number yet because we don't know when the deal closes. But if you assume it's going to close sometime toward the end of the quarter, which I don't think is unreasonable, we need to go through our regulatory issues, but I am not expecting any issues there. The issue right now is, and what's really been driving their performance as well as a lot of their competitor's performance, has been this issue of this clearing out a lot of the older product in the channel through rebating, and that's put a lot of pressure on their margins. So I expect to see that continue through the balance of this year once we pick up the company. So I'm guessing we're probably going to see somewhere around $0.10 dilution in 2017, with clear accretion in 2018 and beyond. Frank, you can talk to the cash conversion.

Yes. In terms of overall cash conversion for both 2016 and then going into 2017, in 2016, obviously, we ended strong after a weaker start to the year. We're looking for an increase, as we indicated, in cash and cash flow conversion going into 2017. Obviously some of that has to do with the continuing ramp-up of the TAPV deliveries, as we talked about. It also has to do with the production modification that Scott mentioned at Aviation on the legacy lines and some better performance on the inventory front there. And so, we're looking for an improvement there. As it relates to Arctic Cat, it will have some impact on that cash flow number, but not all that material of an impact in terms of the cash flow impact of the acquisition.

Year one, as you guys could expect, normal purchase accounting and inventory values and all that stuff will create some dilution, some of which will still be a cash impact, but a great deal of it won't be.

We will go to the line of Rajeev Lalwani with Morgan Stanley. Please go ahead.

Scott, just a question for you on the Scorpion. It seems like you're making some good progress there. Can you talk about whether or not this is the make-or-break year for the product, and then just any opportunities around the change in administration?

Sure. Look, I think the team made huge progress last year on some really, really important milestones. Obviously, we always knew we could make a good aircraft. One of the biggest risks was always around how you get a certification. Clearly, last year with the Air Force putting a program office together and getting under contract with them to perform the airworthiness work was a gigantic milestone. Having the conforming aircraft now flying and really working our way through our production processes so it's not just a prototype, but something that's ready to turn the button and move into production was a big milestone. And look, a lot of what we were working on was trying to position ourselves for opportunities, both internationally and domestically. As we've made those milestones, we have a lot of conversation going internationally. And I think you've all seen probably from a US standpoint, Senator McCain and his wish list of future budgets, and the Chief of the Air Force have also articulated this high-low strategy. Their expectation to run an experimentation program here in the spring, and have articulated a requirement for about 300 aircraft. Again, as we've been articulating for some time, we believe internationally as well as even domestically, there is a market for an aircraft that is much more affordable, a lot fewer dollars per hour to operate. The 10, in fact, execute a lot of missions where we don't need to have the cost, and frankly, burn hours on the airframes of very highly utilized, very expensive aircraft. So again, this is an experiment program; it's certainly not a contract. Senator McCain's desire for a program like this and the budget line item that he's put in has to work its way into an actual budget. And these are numbers they're talking about for FY18 through FY22, but we knew this opportunity was coming. We expected that there was an opportunity here and we wanted to position ourselves to be able to be in a good place for that. So we spent a fair bit of money last year to make sure we're ready for that. We feel like we are ready for that, and we'll see how that program progresses.

Thanks, and then a quick one for you on the biz jet side. Scott, you made a comment earlier about how customers looking for low prices and you just don't want to go there. What's behind that desire or the low prices? Is it competition, or is it just core demand not being there, or maybe too much supply?

Well, I think it's a bit of both. I think if you looked in the Latitude space, clearly, the pricing in there has been very difficult. It has been improving, which we talked about in the past and it in continued to improve in the fourth quarter. And it's continued to improve in terms of orders that we've taken for deliveries into 2017, and we clearly expect that will continue to improve. But that's a price level that we're clearly not happy with from a profitability standpoint, so we'll keep working that. I think on the rest of the aircraft, it's - there's just not sufficient demand there yet. So I think in a lot of cases, we have people that are going to buy new aircraft. And they're looking for further incentive to do it now rather than do it sometime in the future. And it's just reached a price point where it doesn't make sense for us to build the aircraft, so that's the reason that we pulled back in the fourth quarter and anticipate pulling back through 2017. If the market changes and we see demand coming back, then obviously, we can react to that. And we're certainly hopeful that will be the case, but it needs to be at a price level that makes sense for us to sell the aircraft.

We will go to the line of Julian Mitchell with Credit Suisse. Please go ahead.

I just wanted to start with the margin guidance in Aviation. It was flattish or slightly down progression in 2017, excluding Scorpion costs. Maybe if you could parse out which is the biggest anchor on the margins, if we think about pricing, which you've talked about, also then Longitude ramp-up costs. And also then, the lower production on the turboprop side. Which of those three, if you had to rank in order of import for the margins?

Well, that's a tough choice, Julian. The answer to the question is yes, right? And so, we're going to see Latitude volumes increase probably on the order of about 30%. That's good in terms of volume and it's good in terms of getting aircraft out there and operating, demand environment is good. It's a great aircraft, but it is dilutive to our margins, it's not priced where we want it to be. And as I said, we are making progress on trying to move that price up and we're going to continue to work hard on doing that as we go through 2017. So from a mix standpoint, that's a significant volume increase of something that is dilutive to our margin rate, and trying to overcome that is a bit of a headwind. On the other hand, a lot of these historical products on both the jet side, as well as the turboprop, including the defense side of the business, which were better margin, are either down in volume, AT6, for instance, is down significantly in volume. As we've finished the JPATS program, clearly, we have some international deliveries this year, but it's going to stabilize at a lower level. And then, when you look at the rest of our historical Citation products and King Air products and Caravans, these are at better margins and those volumes are going to be down. So, and again, I am not willing to take the prices down further to try to drive that demand and end up in a situation where we have today with the Latitude, where you have a great aircraft that delivers very, very well for customers but is priced at a point that doesn't make sense for us. So it really, Julian, it's a very simple mix change, right? We're seeing about a 30% increase so that Latitude becomes a significant portion of our sales at a diluted margin. And it's the so-called legacy aircraft that are going to be down in volume and they do have better margins.

And then my second question is, maybe a little bit for Frank as well, but on the share buyback authorization announcement, should we read anything into that in terms of a change in approach by the Board and the management team regarding the appeal of buybacks in general? Some view on the stock's valuation? Or does it reflect maybe something about the scope for large M&A or the lack of opportunities for large M&A?

Julian, we, as you know, over the last few years have been executing a buyback strategy that, again, remains committed to the offset of dilution. But also, we'll do things opportunistically when we think it makes sense. And as a result, we've retired a number of shares through that and we've been working our way through the previous authorization. I think the Board is fully on board with that capital allocation strategy, and the renewal and putting 25 million share authorization is so we can continue that strategy. So we'll continue to offset dilution, and as we see appropriate opportunities that makes sense from an overall value perspective to retire shares, we'll continue to do that. And this authorization just gives us the authority and place to continue on that strategy.

And then just following up on that, so has there been any change in view on your part or the Board's part about the right level of financial leverage for Textron? Or that view is unchanged from one or two years ago?

No, I think it's pretty consistent. We're pretty happy where the balance sheet is, and I think the leverage numbers we've talked about before continue to be our target.

We will go to the line of Cai von Rumohr with Cowen and Company. Please go ahead.

So your R&D looks like it's some $40 million to $50 million in 2016 lighter than - or something like that, lighter than you've projected going into the year. And you've projected another $87 million decline in 2017. Give us some color in terms of where was it down in 2016, and where do you expect it down in 2017?

Sure. So if you looked at 2015 to 2016, Cai, the principal reduction was at Bell. And unfortunately, a lot of that was associated in one way or the other with the 525 program. Obviously, as a result of the accident, we curtailed the flight test part of the program. The good news is, I think we're getting close. We have a team working very hard to try to get that aircraft back into the flight test program here in the early part of this year. But we, obviously, through suspension of that program, our costs, our funding was lighter than we would've originally expected in 2016. If you look at the walk from 2016 to 2017, the reduction is principally in the Aviation space. And when I say Aviation, I'm including a significant reduction in spending on Longitude. We spent a lot of money last year getting those first couple aircraft into the flight test program, and that was a big milestone to get that done. But there was a lot of money spent to do that. And parallel with that, obviously we were doing a lot of work on the Scorpion program to get into the certification program. And again, getting the first production aircraft flying into that flight test program. So there was a lot of - there's always a lot of money involved in getting an aircraft into the flight test program as you complete the engineering and all the preparation for flight tests and building out the aircraft. And so with both Longitude and the production version of Scorpion flying, we'll see reduced spending on both of those programs in 2017. It's somewhat offset by some increased spending on the Hemisphere program and the Denali program, but net, that's where the reduction is. So that's - you'll see that all - it's really all in the Aviation side in 2017.

And then speaking of the Longitude, you talked of deliveries ramping in 2018. I think at one point, you were indicating expected deliveries in the fourth quarter of 2017. When do you expect to make first deliveries?

Yes, I'm sorry, Cai, I didn't mean to change that. The wording's probably a little unclear. We're still expecting the first couple of deliveries of Longitude in the fourth quarter of 2018 - I'm sorry, 2017, but it's only a couple of aircraft. But that's been our plan all along. So it is still our plan that we would get FAA certification and make the first couple of deliveries late this year, and then you'd see a significant production ramp-up as we go into 2018.

We will go to the line of Sam Pearlstein with Wells Fargo. Please go ahead.

Can I just, to just tie things up, the $57 million decline in corporate expense, is that all Scorpion moving into Aviation or is there anything else going on there?

Yes, no, the bulk of that is the Scorpion program moving over to Aviation.

Okay. And then you talked, Scott, about the commercial helicopter business showing signs of bottoming in the third quarter and sounds like it's continued. Is there any way we can look at the aftermarket in this fourth quarter? Did you see any improvement there, since I would expect to see that turn first?

Not really. It was a little bit better, Sam, but not appreciably.

Okay. And, what are you expecting in terms of commercial for 2017, and in some of the products like 412s and others on the commercial side?

Well, we'll certainly see an increase in 412s. We've been pretty happy, as we talked about last quarter, and that continues in terms of some of the 412 orders closing, so our production looks pretty good right now. And then there's a couple more opportunities out there that I think will close here in the near future that will not only help us feel good about where we are in 2017, but also 2018 and beyond. So that's, I think, the 412 situation is significantly improved from where it was coming into 2016. 505 obviously is incremental; we're basically, probably selling just about as many as we can make, so we feel pretty good about where that is. The 429s are doing well. 407s are still a little soft, but again, hopefully with a little bit of the economic growth, that will shore up as well. So clearly, our expectation is that we'll have a better year on the commercial side in 2017 than we had in 2016.

We will go to the line of Pete Skibitski with Drexel Hamilton. Please go ahead.

I had a couple questions on Bell. The first on this framework agreement with China for the 100 407s. First, when do you expect that to finalize? And in terms of financials, is it going to be like a royalty type of arrangement like with the 412s in Japan?

Yes, no, I think there's been a fair bit of confusion over that agreement or some misreporting by some media things. So, just to be clear, this is a customer. So we are still in the process of negotiating with them, but this would be the acquisition of 100 aircraft. In essence, what they would do is take deliveries of these aircraft and then do local completion and finishing, depending on what application they're going to go into. So, for us this is - it's a-- we're obviously, were working with them to help them to have the capability to do what they need to do to finish and customize the aircraft in the Chinese market. But it's very much a customer relationship in terms of selling the aircraft.

And then the other one, I think I heard you say, Scott, that you finalized the Pakistan contract for nine AH-1s. I'm just wondering when do you expect the next international sales to come on. The AH1, it seems like there's a decent amount of opportunities, see in Poland, Romania, and I think there's others out there. Just curious as to the timing.

It is, it's just timing and, frankly, a couple of these customers were waiting for the administration change. And obviously, everybody is just getting into place and starting the process. So it's - I expect these to be normal FMS cases, so there's a little challenge around predicting when these things will go through. But there are, I'd say, a robust number of customers and volumes that are in discussion that are working LOAs, and it's going to happen. It's just everything was sitting on the side waiting for the administration to change, and these things now are going to move forward.

We will go to the line of Noah Poponak with Goldman Sachs. Please go ahead.

Scott, in the business jet market, given what you're describing with the price you're experiencing on your new product, and then also saying that you need to reduce production on the legacy product, I'm wondering if that has you concerned at all that the industry attempted to solve an oversupply problem with new versions of supply. Like, clearly, there was too much used inventory in the market and it, every player in the industry brought new product to stimulate demand rather than just reducing existing production to clear all that inventory. Is that a fair assessment? And if so, even if the post-election better economy hope actually happens, is there still a decent amount of inventory to clear before new sales are better?

Noah, that's a good question. The dynamic has been complicated, obviously, and the role that used aircraft play has been significant. But I think if you look at the used aircraft market, for the most part, it has been moving nicely. We've been disappointed in some of the price levels in the used market, but I do think it had its own little supply/demand problem going on. And we're sitting here today and now into 2017, and that large number of aircraft that constituted that large number of used available for sale that were built largely between 2004 and 2008 are now getting to be older aircraft, right? So I think that the attractiveness or the alternative of some of those versus the new aircraft buy is going down and just as a function of time. Again, the used aircraft market is fairly vibrant. I think it's moving, and we hear brokers starting to actually be bullish about some of these going on. We certainly feel good about where it is, with the exception of old, very high time aircraft, and we've been hit by some of that with some of the, for instance, older 10s are challenged, But for the most part, the used market is in pretty good shape right now and things are moving. So again, I think a part of the dynamic of this is obviously economic growth would matter a lot, right? We've been sitting here for a whole bunch of years with almost no economic growth. We're all pretty optimistic about what could happen in a 3% to 4% GDP place. I think that will help our industry, as it will help everybody in the economy. And the other part of it, which is we are going to see a lot of these used aircraft. They are getting older; every year they get older, which is the good news. So look, I think on - in terms of the new model side, an awful lot of the investment that we've made, as have others, is the demand for larger cabins. So when you look at the market and you talk to our customers, their expectation has moved to these bigger cabins. So when you think about the investments that we've made in Latitude, what we're doing in Longitude, ultimately into Hemisphere, people want bigger cabins. So I don't think the right answer would have been to not invest in these new spaces and expect that the older aircraft with the smaller cabins would have held in there, particularly with competition moving to bigger cabins.

Did I hear you say Latitude up about 30% in units in 2017?

Yes, that's right. It will be up probably about 30%, and then evenly split between incremental sales to NetJets and retail customers.

And could you quantify, even if not as precisely, the order of magnitude of the decline on the rest of the portfolio? In terms of Cessna.

No, I don't think we want to get into unit by unit, but it's pretty well across all of the historical--

I don't mean unit by unit. I just mean like total not Latitude.

In terms of unit volumes?

It sounds like you're saying you are cutting production in Cessna jets that are not Latitude. Is that correct?

Yes, exactly. Look, it ends up being about the same number of units.

Okay.

I think if you looked at jet units on a year-over-year basis, it's going to be about flat. Over every incremental Latitude, you're taking out an aircraft that was either Sovereign or XLS or CJ4, CF3+ or M2, roughly.

Got it. And then just last one on the market, would full CapEx expensing in year one materially help your end market there? Or, does existing pretty substantial accelerated depreciation, is that already a pretty large input into demand in the business jet market?

You already have bonus depreciations doing a 50-50, Noah, so I'm not sure it would make a huge difference. I think that, from my perspective anyway, I think what would provide a lot more stimulation to our customer base would be overall reductions in taxes, and a lot of reduced regulation and just creating a higher growth environment. I think that's a lot more impactful than the depreciation curve.

We will go to the line of Myles Walton with Deutsche Bank. Please go ahead.

Just a couple quick ones. One is on the Scorpion expense of $50 million in 2017 and the decision to put it into one of the operating segments. So it is a twofold question. One is what's the trend line of program expenditures after 2017? And Scott, to put it into a business where the business is probably, obviously, got a lot of other priorities and is trying to get to the bottom line, is this the sink or swim decision for the Scorpion? So is it now on a clock, and also, what's your expectation for expenses beyond 2017? Thanks.

I think it is on a bit of a clock and not for any negative reasons. It's just when you get to a point where the things that you needed to be able to check off when customers talk to you about, hey we're interested but here's what we have to see, A, you've got to be able to tell us how you're going to get to certification. So we're now on that path. You need to show us that you could actually build these on a - what's the production conforming version of the aircraft? We now have that flying. And we had customers, including our US customers, saying, look, this is a weapons system; we want to see that it's capable of delivering munitions. And so we did that; we went to White Sands and we fired several different precision and non-precision weapons and had raving success in a pretty short period of time. So I think when you have conversations with customers, be it international or domestic, they said, here's the things we need to see to be able to really consider this platform. So we've done that now, so we don't have those impediments. So I think we are now on a reasonable time that says, guys, we either need to see these discussions move to some form of an order, something more concrete, or we need to spend more money on it. So I think 2016 was a huge year for us in terms of being able to say, okay, guys, now we've checked these things off; albeit, not until December, obviously, in terms of getting the first flight of the production aircraft going. So I think this is now the time to see, do these things move from discussion to something that's serious. Now, the move to put it into the business wasn't portending anything particular, right? Look, the expense is there, regardless of how we've accounted for it, but we've always had this in corporate because it was an experiment, right? And this was not something that was - had a clear linkage to a particular business to drive revenue and margin. But I think now as we get into a point that says, alright, this thing is now ready to fully be able to go to market, well that's the business' job, right? Corporate doesn't do that. And so I think now having this where the team in Aviation, particularly on our defense side, will pick up the marketing and drive this thing to achieve its milestones, get certifications done and try to bring this thing to fruition in terms of orders, it's appropriate that those expenses be in that segment where you would also then record revenue and margin. So it's a big change for where the program was which was in a very experimental phase up until now. To where now, we have these critical things out of the way, a clear path to a real marketable product, and therefore, it makes sense to be in business.

And the $50 million step, or $50 million in 2017, is there a big step down no matter what in 2018 within Aviation?

Well, I think you're either going to be see a big step down or you're going to see a step up, because there's a real order and an opportunity that we need to go exit into.

We will go to the line of Sheila Kahyaoglu with Jefferies. Please go ahead.

Just a few follow-ups if that's okay. On the legacy aircraft, I think the tone has been it's rough, it's a challenging market, but it's flattish. And it seems like it changed in Q4 and that's driving some of the production cuts. Can you talk about that a bit? Why the tone changed in the last quarter.

Well, look, Sheila, I think that we were seeing some incremental pricing, we were feeling good about stabilization. And it seemed like when we got to the fourth quarter, we had a number of transactions where people just wanted to go to even lower prices, and we said that we're just not - we can't do that. We can't make it unhealthy for the business. So again, as I said earlier, I think that's where we see it at this point, and that led us to back off on some of these production volumes because we're just not going to create capacity out there if it's not a market that's willing to at least pay a fair price for the aircraft. We're certainly hopeful that will change. And if we see that dynamic change, we can obviously react very quickly to try to get additional aircraft into the market. But we were seeing, as we went through the year, what we thought was a reasonable progression of feeling like the pricing was firming up. And it seemed like in the fourth quarter, given the number of aircraft that were out there, the demand just didn't match up and it wanted to see a lower price point. And, as I said, we're just, we're not going there.

Understood. That makes sense. Another one on Aviation margins. I understand that the Latitude is dilutive and that might be half due to the NetJets deliveries and the competition with the legacies. And just how do you think about the market as we - the market for the Longitude, just given that there's no competitor out there, or new model out there for that aircraft. And how - if that's dilutive or not as we start production deliveries in 2017 and into 2018?

Sure. Well, look, Sheila, obviously, the situation with Latitude, we're not happy with where that is, right? We feel like we delivered a great aircraft to the marketplace, customers loved the aircraft, it's performing well, there's just - the thing is a home run. But we're not enjoying the benefit of that because it's in there at a price point that we're not happy with, and that was obviously a competitive dynamic that caused that to happen. Where we're positioning the Longitude, we're not going to let that happen. I think when you look at what's out there competing with it, we have superior performance, and we're going to start holding the price line from day one that has to make that an attractive aircraft for us, as well as for our customers. And so far, the discussions we're having with customers. And look, we are taking deposits on the aircraft. Obviously, we're not through certification testing and all that, so we're not going to see - you're not going to see a big impact on backlog yet. But I think the product is being very well received by customers. There's a pretty strong interest, but it's at a price level that's a fair price. And so I think we just have to make sure that in the future, our new models are good for us and our customer.

Understood, and then just last one on Bell. What's the sequential pickup in the backlog? And then can we talk about the moving pieces within Bell profitability? I know there are a lot of moving pieces, but it seems 412 is the only one that really matters. Just looking at the second half, 2016 margins, they were pretty good, so if you could talk about that a bit.

Sure, so Bell backlog is up. Part of that, of course, is that we put the multi-year volumes in on a year-by-year basis, and we always do that in the fourth quarter when it gets appropriate. So part of that is the military side, which is our normal cycle. But we also had some positive backlog build on the commercial side. And again, as we talked about the Q3 and Q4, we did see nice increases in order activity on the commercial side. So they both contributed to the increase in backlog. There's no question when you look at the mix in the business certainly matters on the commercial side. And 2016, we did have some 412 sales here in the end of the quarter. H-1s - I'm sorry, Huey IIs do well and we had some Huey II volumes in the year as well. Again, as we look into 2017, we expect we'll be down a little bit on the B-22's which has been consistent with the plan. I think we'll do fine on the H-1s, and we'll see a little bit of an uptick on the commercial side in a number of the models. But the one that's most important from a profitability standpoint is the 412s.

We will go to the line of Peter Arment with Baird. Please go ahead.

Scott, just a quick one. You've had a ton of questions on Latitude, so I will just ask one. Back in, at MBAA, the increases that we were thinking about for 2017 was 15% to 20%, so obviously, it's doing great in the marketplace. Is this just mainly what we're seeing demand from North America, or are you seeing some other pockets that you're picking up strength, just from a geography standpoint?

We're starting to pick up some international orders on Latitude, but it's still very much a US story at this point, I would say.

And our next question comes from Robert Stallard with Vertical Research.

Just a couple of quick ones, Scott. First of all, on these customers that wanted the lower prices and you weren't prepared to give them in Aviation, do you know if they went to other manufacturers or are they still in the market?

No, I think they're still in the market. And again, part of this is these are customers, a lot of these folks are guys who our customers today, they operate our aircraft today and they're very happy with our aircraft. And I think, ultimately, they're going to stay in our aircraft. But if they're not ready, if they're happy with their current aircraft and they're willing to wait and run that aircraft for another year or two, then that's fine. We just don't need to take pricing to a level that doesn't make sense in order to try to make that happen now, and that's why we feel like adjusting this demand by taking the production down is fine. If the market's not --if it's fewer aircraft, then we're going to build fewer aircraft in that space and not do that. Now, some are competitive, and obviously, and we walk away from some deals. But I think we need to do that to create some price integrity in the marketplace. It just doesn't make sense to get it to where it - it doesn't make sense to sell aircraft at that low price.

Okay. And then, secondly, on Kautex, is there any implications from this tax legislation that's being discussed in DC?

I'm sorry, I'm not, there's a lot of tax discussion, Robert. Is there something more particular, because I don't know of anything that would directly affect Kautex.

Yes, in terms of the context of their based overseas and linked to the automotive industry.

Yes, Kautex manufactures and ships and sells in those markets. So we go where our customers are building automobiles. And so, it's - we wouldn't expect a material impact. Now obviously, if you begin to see auto production shift, we'll follow that auto production accordingly, but we don't expect a big impact.

And no further questions at this time. I will turn the call back over to our speakers.

Okay, thank you. Bye.