Textron Inc. (TXT) Q4 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Textron’s Fourth Quarter Earnings Call. At this time, all participants are in listen-only mode. [Operator Instructions] As a reminder, today’s call is being recorded. Now, I will turn the conference over to your host, Eric Salander, VP, Investor Relations. Please go ahead.

Thanks, Sean 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 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 4 billion, up 192 million from last year. During this year's fourth quarter, we had a couple of notable items that impacted our performance as we disclosed earlier this month in our 8-K filing. First, as a result of the recently passed Tax Cuts and Jobs Act, the company recorded provisional tax charge in the fourth quarter of 266 million or $1 per share related to the re-measurement of net deferred tax assets and the repatriation tax on our non-US undistributed earnings. Second, we recorded 55 million in pretax restructuring charges or $0.14 per share after tax. Adjusted income from continuing operations was $0.74 per share, down $0.06 from last year's fourth quarter. Manufacturing cash flow before pension contributions was 474 million compared to 727 million last year’s fourth quarter. For the year, revenues were 14.2 billion, up 3% from a year ago. Adjusted income from continuing operations was $2.45 per share compared to $2.62 last year. Manufacturing cash flow before pension contributions was 889 million, up from 573 million last year. With that, I'll turn the call over to Scott.

Thanks, Eric and good morning, everybody. Revenues were up in the quarter with increases at industrial and Bell, partially offset by lower revenues at aviation and systems. At Bell, revenues were up on higher military volumes for the quarter. We delivered 7 V-22s, up from 4 last year; 13 H-1s, up from 8 last year and 45 commercial helicopters compared to 35 in last year’s fourth quarter. On the commercial side, we continue to see a pickup in order demand across a broad base of customers. We've seen several recently signed 412 orders for customers in Southeast Asia. We received an order from Reignwood International for 50 505s as a follow on to the 60 aircraft that were ordered earlier this year. We also received an order from Mercy Flight for three 429s to upgrade the remainder of the existing air medical fleet. On the new product front, we achieved first flight of our Bell V-280 Valor tiltrotor, representing a major milestone on this important development program. The systems revenues were down on lower volumes, primarily at Weapons and Sensors related to the discontinuance of the SFW production program. In the quarter, we received an FMS order for the Afghan National Army for 55 mobile strike force vehicles with a potential for up to 200 additional units. At TRU Simulation and Training, we signed an agreement with Copa airlines to provide a Boeing 737 MAX Full Flight SIM to fulfill the Latin American Airlines growing pilot training requirements. Moving to Industrial, revenues were up 20% for the quarter, primarily reflecting the impact of Arctic Cat. We saw improved demand in the snow retail channel, allowing dealers to clear older inventory and drive 2018 model sales, including our new introductions in the youth and mountain categories. We also saw higher sales in our E-Z-GO product line, led by our new lithium powered ELiTE golf car. At Textron GSC, our ground transport business received an order from Airpro in Finland for seven [indiscernible] Typhoon de-icers. Moving to Textron Aviation, revenues were 1.4 billion, down 3%. In the quarter, we delivered 58 jets, flat with last year, 31 King Airs, up from 28 in last year’s fourth quarter and two Beechcraft T-6 trainers, down from 8 last year. For the full year, we delivered 180 jets, up from last year’s 178, including 54 Latitude deliveries. Since the introduction in 2015, we’ve now delivered 112 Latitudes, demonstrating the importance of new product development in this industry. We saw strong order intake in the quarter for both turboprops and jets, including 8 caravans for charter cargo and logistics operators in Botswana, 3 King Air 250s to a North American customer configured for air ambulance services and three Latitudes for a fractional operator in Mexico. Moving to the aftermarket, increased aircraft utilization continue to drive higher aftermarket revenues, which were up over 11% in the quarter. To summarize the year, we continued to execute our plan for growth through strategic acquisitions and new product innovation to create long term shareholder value. At Industrial, the integration of Arctic Cat continues and reflects our strategy of acquisitions that complement our core businesses and product lines. Equally important is the need to continue to innovate through new product introductions, which was evident throughout Textron’s specialized vehicles. Earlier this year, we unveiled the revolutionary E-Z-GO ELiTE lithium powered golf car, which has now seen over 21,000 units delivered. On the snow side, we introduced a class leading Arctic Cat ZR 200 new snowmobile as we continue to develop our [slate of] [ph] product line up. In December, we introduced the Textron offroad Havoc X, the best-in-class high performance side by side featuring 100 horsepower and a class leading four wheel double A-arm suspension package. At Textron systems, we advanced our ship to shore program towards first flight, introduced the night warden tactical unmanned aircraft system and received a follow-on FMS mobile strike force vehicle order. At Textron airborne solutions, we’re making the necessary investments to position the business to capitalize on the growing era of the [indiscernible] services market. Moving to Bell, we saw the V-22 fleet surpass 400,000 flight hours, demonstrating the reliability of order technology, which we further evolved to another significant milestone, which was the first flight of the V-280. On the commercial side, strong order activity for the new 505 Jet Ranger X and the resumption of the 525 relentless flight test program demonstrates Bell’s position as an innovative leader in the commercial helicopter market. At Textron Aviation, we saw improved order intake in the back half of the year as well as the strengthening of the international market. On the new product front, the Longitude is nearing the end of its flight test program and we anticipate certification in the first quarter. This new entry in the super mid-sized business aircraft market offers class leading range, payload and cruise speed along with a quietest interior in the industry. In November, we announced the Cessna SkyCourier, the new twin engine large utility turboprop. The FedEx is our launch customer with an initial fleet order of 50 aircraft. In summary, we came in to 2017 knowing it would be a challenging year with uncertainties surrounding many of our end markets, several key product development programs nearing key milestones and restructuring and integration activities in many of our businesses. That said, we have entered now on 505 into service, 525 is resuming its flight test program. We achieved first flight on the V-280. We had successful demonstration on both the Scorpion and the AT-6 in the US Air Force OA-X program. The Longitude is nearing its certification and entering to service. Denali is progressing towards first flight and we've successfully integrated the integration of Arctic Cat. With these accomplishments behind us in improving end markets, we're well positioned coming into 2018. As we look at our financial guidance, we're projecting revenues of about 14.6 billion as we expect growth at aviation and industrial, with lower revenues at Bell and Systems. We expect margin improvements across aviation, industrial and systems, with Bell about flat. EPS from continuing operations will be in the range of $2.95 to $3.15. Manufacturing cash flow before pension contributions will be in the range of 700 million to 800 million and consistent with 2017, we expect a substantial portion of the cash to be returned to shareholders through share repurchase programs again in 2018. With that, I’ll turn the call over to Frank.

Thank you, Scott and good morning everyone. Segment profit in the quarter was 360 million, down 31 million from the fourth quarter of 2016 on 192 million increase in revenues. Let's review how each of the segments contributed, starting with Textron Aviation. At Textron Aviation, revenues of 1.4 billion were down 3% from this period last year, primarily due to lower military volume. Segment profit was 120 million, down from 135 million a year ago, primarily due to higher research and development expense, largely driven by the Longitude flight test program. Backlog in the segment ended the quarter at 1.2 billion, up 15 million from the end of the third quarter. Moving to Bell, revenues were 983 million, up 11% on higher military volumes, partially offset by lower commercial volumes. Segment profit of 114 million was down 12 million despite the increase in revenues, primarily related to a change in commercial mix. Backlog in the segment was 4.6 billion at the end of the quarter, down 407 million from the end of the third quarter. At Textron systems, revenues were 489 million, down from 532 million a year ago on lower volume at weapons and sensors. Segment profit of 37 million was down 16 million, primarily reflecting the lower volume at weapons and sensors. Backlog in the segment was 1.4 billion, down 67 million from the end of the third quarter. Industrial revenues were 1.1 billion, up 20% largely related to Arctic Cat. Segment profit was up 10 million from the fourth quarter of last year due to favorable performance. Finance segment revenues decreased 3 million and profit increased 2 million. Moving below segment profit, corporate expenses were 44 million compared to 56 million last year. This reflected the transition of the Scorpion program into the aviation segment. Interest expense was 38 million, an increase of 5 million compared to last year. With respect to our restructuring plan, we recorded pre-tax charges of 55 million on the special charges line in the quarter. This represents the final charge under our restructuring programs. We ended the year with gross manufacturing debt of 3.1 billion. For the full year, we repurchased approximately 12 million shares at an overall cost of about $582 million. Turning out to 2018, our guidance includes the impact of adopting the new revenue recognition accounting standard. This adoption principally impacts Bell and Textron Systems as we will transition government contracts from recognizing revenue at delivery to a cost incurred method. The impact of the new method will be immaterial to our overall segment profit with revenue slightly higher at Textron Systems and relatively unchanged at Bell. Also related to this adoption, we will record an increase to retained earnings of approximately $90 million in the first quarter of 2018 with no restatement of prior periods. Additionally, we are adopting a new pension accounting standard that will change how we present pension and OPEB costs on our income statement, but will not change our segment reporting. The effective adopting of this accounting standard will not have a material impact to our financial results. Finally to align with new revenue recognition standards, our R&D guidance is now presented on a gross basis whereas we previously netted US government shared R&D costs. Turning now to our presentation, I’ll begin with our segments on slide 9. At Textron aviation, we're expecting higher revenues of about $5 billion, reflecting higher volumes across all our product lines. Segment margin is expected to be approximately 8%, reflecting the higher volume and improved performance. Looking to Bell, we're expecting overall revenues will be slightly down at about 3.2 billion, reflecting lower military volumes. We're forecasting a margin of about 12%. At systems, we're estimating lower 2018 revenues of about 1.6 billion, reflecting lower volumes in unmanned systems and weapons and sensors. Segment margin is expected to be 8%. At industrial, we're expecting growth in each of our businesses resulting in projected segment revenue of about 4.7 billion and a margin of about 8%. At finance, we're forecasting segment profit of about 20 million turning. Turning to slide 10, based on a US plan discount rate of 3.75%, we're estimating 2018 pension cost to be $40 million, down from last year. Turning to slide 11, gross R&D is expected to be about 620 million, down from 634 million in 2017. We're estimating CapEx will be about 525 million, up from last year. Moving below the segment line and looking at slide 12, we're projecting about 130 million for corporate expense, 140 million for interest expense, a full year effective tax rate of about 22.5%. Our estimated tax rate for 2018 is lower than ’17 due to the enactment of the Tax Cut and Jobs Act of 2017. Our guidance assumes a share count of about 263 million shares, reflecting the continuation of our share repurchase activity in 2018. That concludes our prepared remarks. So Sean, we can open the line for questions.

Our first question will come from the line of Sheila Kahyaoglu from Jefferies.

I guess first one on aviation margins, you’re assuming up 150 basis points to 8% for aviation. How do we think about the R&D impact, mix and pricing factored into those assumptions?

Sheila, I think it’s largely favorable on all fronts. I mean, obviously as on the R&D front, as we finished last year's work around the Scorpion program, obviously we had a lot of work around the Longitude, we're complete with the Scorpion activity, the Longitude here will wrap up in the first quarter. Obviously, we have Denali coming along. We've got the SkyCourier, I mean, there's certainly plenty of work, but on a year-over-year basis, it's certainly a tailwind for them. As we’ve talked about, we will certainly have a better volume on our T-6 line, which has been a good business for us as we increase that. We certainly expect to see some margin improvement driven by that and we'll have a better year-over-year on the aftermarket side. We have seen a strong back half of the year, given the aircraft utilization rates are higher. So I think, particularly on a year-over-year basis, we’ll benefit from that as we go into the first half. On the jet side, I don't think there will be a huge difference. We will have the initial Longitude deliveries, which is going to be most of the increase in the jet side of things. Obviously, the first few units will be at a lower margin rate, but that will correct as we get towards the back half of the year.

And so in terms of pricing, there isn’t a major pricing assumption there?

Well, we do have price factored in. And as you will see, we had fairly strong year-over-year pricing increases here in the fourth quarter and we'll continue to do that. Part of what we're looking at in terms of volume anticipation in our plan is that, there's no question that we, I think, everyone feels much better about where we are in the end market here in terms of demand. So I think we're certainly -- compared to 2017 entering into a much better market. We are going to continue to drive price to make sure that it's healthy volume and I think that we will -- we were successful in doing that this year and I think we’ll be successful doing it next year as well. So there will be obviously a positive contribution on the pricing side.

And then as it regards to Scorpion R&D, I believe you might have ended up at 100 million for 2017, how do we think about that into 2018? Is there any way to quantify this?

It was not that high, Sheila. We don’t give R&D program by program, but certainly it's going to de minimis in 2018. There is still some customer activity going on, some demo flights, integration with a couple of different sensors that customers have asked us about, but it will be an immaterial number in 2018.

Our next question will come from the line of Carter Copeland from Melius Research.

Look, I wondered if you could give us just a little bit more color around the gross R&D disclosure. I think you don’t disclose the R&D by program, but just kind of give us a sense of some of the moving pieces there year-over-year. Clearly, you've got Longitude and Scorpion are down and 525 is up, but now you've got that government portion that you called out in there, just any chance you can give us some color on the moving pieces there, just in general terms?

I think when you look at our numbers, Carter, we’ve recast last year so that this issue of what's netted versus gross is kind of a non-issue, we were showing you the numbers on an apples-to-apples basis. So the actual reduction that we're showing, again, your dynamics that you're kind of looking at are correct, right. We have significantly lower spend on Scorpion, we will see [indiscernible] some of the more intense spending around Longitude as we get that through certification. Principally that’s offset by the fact that we have the 525 back in flight test and we have the V-280 in flight test. So that aircraft did get its first flight last year, but the guys are flying it a lot here in January and we expect to see that sustained all the way through the year. So it's largely a trade between a couple of those fixed wing programs and a couple -- some increased spending in the rotor and tiltrotor area.

And then an additional one for Frank on the pension front, any consideration around prefunding associated with the change in tax?

Well, we did that last year. We did that in the third quarter. We did an offering kind of in the third quarter for $300 million and contributed that to the pension plan. So we feel like we're in very good shape. We did have a discount rate reduction, but frankly that was offset by our performance from a return standpoint in 2017 that was well above our expected rate and so we feel like we're in good shape on the pension front and do not anticipate any contributions as we said other than the 55 million of cash related to kind of unfunded plans.

Our next question will come from the line of Robert Stallard from Vertical Research.

Scott, your counterpart over at General Dynamics had some pretty positive things to say about the bizjet market in the fourth quarter. Would you agree with her general prognosis that we've seen a distinct turn in demand environment over the last three months?

I would never disagree with Phebe. Look, I think what they're seeing in the larger aircraft is probably quite similar with what we're seeing in the light to mid-size where most of our work is. I think, the number of inquiries, the amount of activity through the fourth quarter, as you know, for us to sustain a one-to-one or greater book to bill in a fourth quarter, considering that's our seasonably very heavy sales side is a pretty significant accomplishment I think for our team to hold that book to bill. So, the amount of activity, the interest that I think is reflective of the fact that we have a stronger growth economy. Business confidence is up and these are our buyers. So I think there's no question that the level of activity out there is stronger than we've seen in some time. Again, we're being a little bit cautious and making sure that we see all the stuff really convert and continue to convert into orders at a fair price and if that continues to happen, I think we feel the same about our business that it's in a very good position. We’ve got some great new products. I think we're well positioned that if this market is in fact strengthening and it does deliver, that we’ll be in good shape to benefit from that.

And then a follow-up on your investment plans, in terms of company funded R&D and CapEx going forward, where do you see this heading in 2019 and 2020?

We’re just kind of recovering from our 2018 activity. I don't know if I go into ’19 and ’20 just yet, but look, I think if you look at the work that we have underway, the amount of investment that we think we need to make to make sure that we have the right products in place in our key businesses to ensure that we can capitalize on strong markets, I don't think there's going to be a huge change in the R&D. Obviously, we expect it to continue to generate a tailwind in terms of percent of sales, but we have a lot of great stuff in the pipeline in aviation. We have a lot of great stuff in the pipeline at Bell. We have a lot of great stuff going on in the vehicle business and these are things where you need to make these investments, if you're going to continue to grow the business. So again, I don't think we'll see radical changes in terms of the R&D spend, but obviously our expectation is that it will reduce as a percent of sales.

Our next question will come from the line of Peter Arment from Baird.

Scott, I guess finally to get pretty excited about the Longitude getting across the goal line here with certification. What's been some of the feedback now as you get close to kind of certification from some of the customers in terms of you've introduced before the aircraft too?

It’s been great, Peter. We have had a demo aircraft that's completely fitted out with full customer Interior that's been flying around, doing a lot of customer demos here for the last few months and I think the feedback has been great. It's a great cabin, I mean from a space standpoint, we get a lot of the same feedback that we got in the Latitude, which has been obviously a very, very well received product. Obviously, this is a bigger aircraft. It's a longer aircraft, it's a very quiet aircraft. It is the quietest aircraft in the industry and we get that feedback very strong, customers getting back of this thing and do a demo flight and are amazed at how quiet and as a result comfortable it is in the back of that aircraft. So again, the feedback is great. We need to get this thing across the goal line on the certification and we feel good about where the aircraft is. It's flown beautifully. I mean, it’s -- there's no issues there. It’s a matter of getting through the paperwork and certification process, which we will do.

And then just a quick one, maybe Frank or just on the CapEx step up, what's really driving that this year.

Well, the big step up is, as we've kind of been public with Peter is we're acquiring quite a few assets to be able to support these adversary air programs and so that's really the change in year-over-year is our acquisition of aircraft. The Navy program is in proposal phase right now. The Air Force is already having their industry days. So, there is a huge opportunity out there in terms of the number of hours that the US government and I believe, ultimately international customers as well are going to look to private contractors to provide adversary air and the reality is, if you don’t have the assets, you can’t do it. So, the only tough part of this for us is you got to get out in front of it and spend the capital to have the assets and get everything prepared in terms of maintenance facilities and demos, so there's a little bit of a drag frankly in there to support that, but it's a huge growth opportunity and one that seems to be materializing.

Our next question will come from the line of Cai Rumohr from Cowen & Company.

So last year, you projected R&D and this is on a net basis for 2017 of 495 and the gross number was 634, so what was the number apples to apples, ’17 versus -- achieved versus ’17 projected.

Hold on a second. We’re on apple-to-apple and so that we can get to your other apple-to-apple out.

If you tell me what the military is, I think we can back into it. Hello.

We're just trying to go back to the guidance number.

It was 495 net.

It was about 520.

So basically you overran your guide by 25 million and I assume a lot of that was with Scorpion and to a lesser extent the Longitude?

It was primarily driven by the support we put into the Air Force experimental program. So between mission system development on Scorpion as well as the cost to get the AT-6 up and running and configured and ready for that test, that's most of what drove the spend. So when we started the year, we didn't know anything about the Air Force experimentation program and obviously putting two aircraft in to that program was not in our plan.

All right. And maybe you said that the outlook is good to sell them. Who's going to buy it and when?

Are you talking about Scorpion?

Yeah. Scorpion or AT-6, either ones.

So, look, I think that the Air Force has been very open about the fact that they're working on determining their next steps. We have a reason to believe that they're doing that in terms of what their next step is going to be. The CR complicates that process for them, because obviously these are new programs and therefore they don't really have any budget authority under CR to do that, but we know they're working to determine what those next steps will be. I think the next steps again will be different for different platforms, but it would be presumptuous to talk much about that since they haven't been able to publicly say what they want to go do until they understand their budget situation. In terms of non-US not related things, as I said, we still have customers that are in discussions with us. There are ongoing activities. I think the level of activity in terms of what we have to spend to support those at this point is pretty de minimis, but we have customers coming in, asking questions, looking at integration of different systems and we continue to support that.

Our next question will come from the line of Pete Skibitski from Drexel Hamilton.

Scott, I was wondering if you can talk more about what you're hearing in terms of the impact of tax reform to your light bizjet customer base. They've got the corporate rate reduction, which I imagine, if you're a small business owner, that's got to be helpful. You've got, I think the media expensing up to 2022, but you've also got just kind of issue the repeal, light kind exchanges. So just wondering how you're hearing that’s all going to net out for your bizjet customer base?

Look, I think it nets out all to the positive really. Right. So, there's certainly a benefit to them, sort of what I would say mechanically around tax. That is the 100% expensing is beneficial. The overall tax rate reduction for all these businesses is obviously very helpful. And I think probably even more importantly, I think everybody's expectation is that and I think we're seeing this is that the impact of the tax cuts beyond the mechanics here is to help drive economic growth and get GDP at a higher level and I think we're seeing that and that reflects when a guy is sitting there, looking at his business and what their anticipation, what their expectations are for the growth of their own business, I think this is what's driving business confidence to a very high level. So I think the combination of the direct tax benefit around expensing, the low rate that they’re experiencing in their business and probably most importantly, the level of confidence they have that they're going to see growth in their business as a result of higher economic growth, higher GDP primarily around the US is all very positive. So I think that is a huge help in terms of the US market and I think we're also seeing stimulation around the international markets. And again the US helps to drive that. If we have higher economic growth, that's good for generally speaking economies around the world, a little bit of weakening on the dollar obviously for a company like ourselves, the US manufacturer with a lot of export is beneficial. So I think that not only the direct impact around tax in the US, but the knock on benefits in some of the international markets is clearly we're seeing a different tone in those markets as well. So sort of a combination of all of the above.

One quick headwind, at systems in 2018, could you guys quantify the year-over-year headwind from the Sensor Fuzed weapon closure and then, so UAVs will be down in ‘18. Are they going to bounce back, return to growth or will that be kind of a flattish outlook going forward for UAVs?

Well, certainly, it’s going to be down this year, Peter. The question is going to be, there are a couple of new upgrade programs and things that are in the works, but again if this is one of our challenges in again that business, which has a large US centric customer base is where do the budgets go, when do we get budgets, I mean, there's a lot of noise around that. There's certainly opportunities around that class of aircraft to look at next generations of upgrades and enhancements and improvements, which we would benefit if that goes forward, but without having budgets, it's hard to figure out exactly where that is. So it's in terms of the future, it’s hard for me to comment directly on that. I can't give you the direct number, I don't think of SFW, but last year, we went basically, if you think about what our SFW was, we had about 50% of what we usually have last year and we have a 0% this year. So we’re sort of taking a two-step from what that business historically was to basically being out of that business right now. Now, there are a number of new weapons, munitions programs that we're bidding on, that we're actively pursuing. Again, the budget situation makes it difficult to know exactly where these are going, but that's certainly a business where we've gone through a steep decline as a result of the exit of SFW, but obviously we have a lot of work going on to try to get that piece of the business back in a growth trajectory.

Our next question will come from the line of Sam Pearlstein from Wells Fargo.

Can you just tell us what your underlying assumptions are in terms of aviation delivery this year? We know the Longitude is coming in, but just kind of jets versus King Airs T-6s broadly, how are you thinking about it year-over-year?

I'd say probably, Sam, the jets, we're assuming at this point largely flattish with the exception of an increase driven by the Longitude introduction. The Turboprops, clearly, we expect those to be up, T-6 and we talked about all year, this was a tough year for us in ’17 on T-6s, we see a nice increase in T-6 deliveries in 2018. We saw a fairly weak front half of the year on the commercial turboprops. Obviously, we're feeling better about where we're going in to 2018 in terms of the level of activity and frankly some backlog in those areas. So I certainly think that we'll see increases in the commercial turboprop in total as well and again, we saw strong growth in the second half of the year in the service side of the business, driven by high utilization rates. So clearly, we would expect that we'll see that continue, which means we will see particularly comparables in the first and second quarter of the year will be stronger than they were in ’17. You get to the back half of the year, I mean it's hard to say at this point, but it's -- because we saw a lot of growth year-over-year already in those two quarters. But as far as I say Sam, I think that if you look at jets principally driven in our assumptions around Longitude, service growth and clearly in material, we’ll probably see growth, especially on the military side of the business.

And is there any way to think about in terms of new programs, whether it's 525 or Longitude, how many you can expect to get out this year.

Well, so we don't go -- we don't do units by model. Obviously, we expect to get a certification by the end of the quarter, so you would expect to enter into service with first customer deliveries in the second quarter and look, again, it depends a lot on how the market is doing and I’d say, the feedback on the aircraft is very strong. As we’ve seen in recent times as you won't start to see lot of these things closed orders until you worked your way through the certification. So we kind of have to play that by year. So 525, you won't have sales this year, right. We should get all of our flight test program complete and wrapped up by the end of the year. Everything should be in to the FAA and we’ll be working at the certification process at the end of ’18. But we certainly don't expect to see sales, the first 525 sales activity should be ’19.

And then just more on Bell, I guess 12% margins on modestly lower sales, last year, you started at 11 in terms of the margin ended up doing better. It feels like what has changed in the helicopter business that’s allowing you to put up these kind of margins versus the 10% or 11% and what are those key drivers in terms of what’s down year-over-year on a sales level?

Well, what's down on a year-over-year sales level will be on the military side, right. We'll see fewer military sales. I think that we certainly hope to turn that corner. There's a lot of FMS activity that’s going on. Obviously, we've been frustrated by lack of notifications in Congress, some things in the Middle East, but clearly we have customers that want product and we think we'll get some of that progressed into the order category here as we work our way through ’18 to try to get that turnaround. We certainly expect to be up on the commercial side. We have a good full year of strong deliveries on 505s. We've closed couple of important orders on 412s. So we’ll certainly see an increase in 412 volumes this year, which is a great product for us obviously. So, in general, you're seeing a trade between some military product that's going to be the lower volume and commercial that’s going to be at a higher volume, but net of all that, I think the team is doing a nice job of managing, driving good activity to help offset some significant investments in the new product front, but it's a pain for all for us. The 505 is driving good volume, the 412 VPI, those upgrade programs are helping to give the 412 alive and well and obviously we have the 525 and the B280 coming down the line. So, I think the business is doing a nice job of driving productivity, maintaining strong margins and yet making some pretty significant investments in products that are going to drive our future growth.

Our next question will come from the line of Justin Bergner from Gabelli and Company.

I just want to discuss the demand for business jets and tax reform. First off, as it relates to personal purchases of business jets, are you, as a team, aware of anything that would prevent someone from buying a business jet and taking the full deduction on their personal tax return to get a deduction where the state and local tax deduction might be going away for a wealthy individual.

Well, I mean, it has to be a business expense, right. So I mean we certainly have individuals that purchase aircraft and they have to pro rata the depreciation between business and personal utilization. But no, absolutely, there is nothing in the tax law that changes with respect to how that's done. The only difference is that it’s 100% expensing versus the 50%. Well, I mean, obviously, we have bonus depreciation, which is 50% year one. But no, there's no change in the tax law. It's purely a matter of allocation between a legitimate business expense or a personnel expense.

And then, there was a big article in The Sunday Times by a London based business jet broker talking about sort of extraordinary ramp up in demand for business jets. Over recent months, are you seeing any signs of sort of meaningful acceleration. I know you have a tempered guidance for business jets, but are there signs that you're seeing that suggest maybe things are going to ramp up much quicker than your guidance would suggest?

Well, I have to say I don't usually read the Sunday Times, so I don't know this, but this is a article, but look, we are -- I think the sentiment that we're seeing in customer interaction, the level of activity is all very positive, we need to see these things come to fruition. There's no question that in the used aircraft market, that's continued to be a good liquidity. People are selling aircraft. Good news for us is we see fewer trades because the market is strong enough, the brokers out there are being able to move aircraft. So what I hope is right and obviously we think with the investments that we've made and the product lineup we have that if the market strengthens, we’ll be a big beneficiary of that, but I think we need to see sort of that, the enthusiasm that we sense that's out there turning to sales.

The next question will come from the line of Jon Raviv from Citi.

When you look at slide 9 of your presentation, where do you see some of the opportunities or risks, not just in ’18 but really going forward and maybe speaking more about something like systems where in the past, we've seen double digit margin, industrial margin used to be higher and obviously aviation could be higher as well. On a long run basis, where do you want to see improvement in your segment?

Well, we'd like to see improvement everywhere. I mean I kind of still think that we work with the guys all through the year, but look aviation, when we look at the aviation number, obviously, we are assuming a relatively flattish legacy jet line. And clearly, we have the ability to flex that, if we do see stronger demand. So if we see stronger demand, if market is there, then we can see upside to that. I think at Bell, you're probably not able to see a whole lot of upside on the revenue side and we pretty much know what that number is. The guys do a good job generally as we work our way through the year on the productivity side, but I think it's a pretty solid guide. Obviously, we’ll try to work to get a little upside on the profitability side, but it's, I think, even at 12%, the business is doing really well and it's pretty balanced performance. Look, systems is tough, because if you take SFW out, which is a great program for us, we're kind of heavy right now on things like ship to shore, which are great programs, I mean there's going to be a lot of volume there and a great business going forward, but we're still in that sort of fixed price development and we’re working in the integration and testing to come along okay. We should get some major milestones this year as we get the thing into the water and get it operating and go through trials. But, I wouldn't say that there's a lot of upside there, just given the nature of the kind of programs that we're executing right now. Industrials, probably, I mean a pretty solid guide I think. I mean there's, it gets Arctic Cat to where it’s accretive, it's pretty solid performance, but I think that's where we would really expect to be. So that’s kind of color around that I guess. Clearly, the largest upside would be if the business aviation market really does start to accelerate and we’ll benefit from that.

And just in your commentary about the tax reform bill, creating changes in the economy, what do you guys doing maybe almost philosophically, how are you guys approaching the way you're managing the business, capital allocation with this relatively wide ranging bill now legislated?

It really hasn't changed our strategy. I mean, we've already been investing significantly in terms of R&D and our next generations of products. I think, we've been appropriately putting the capital in place to support that, be it in the tooling to support new product programs, continue to win and grow in our industrial businesses. So, I think our capital allocation strategy isn't really impacted. I mean, clearly, we will see a cash tax benefit in ’18 as a result of the lower tax rates. And as I said, I think from a capital allocation perspective, we'll continue to pursue what we did in ’17, which was frankly pretty aggressive on the buyback side and that's been our principal way of returning cash for our shareholders and I would expect to see that continue in ’18.

And our next question will come from the line of Seth Seifman from JPMorgan.

Scott, in recent years, you guys have had some tough breaks in some of the end markets and some execution items that came up and so there's been a fair number – a fair amount of downward pressure on estimates. When you think about how you set up this year and how things are looking, I mean I know you always set the guidance and intend to make it, but in terms of like the puts and takes and how much risk there is around the guide this year compared to previous years, how would you sort of -- how would you assess that?

Well, so I think it’s kind of the walk that we just did through the page 9 is kind of where I would say the puts and takes are to this thing. I mean, as we’ve said, we’ve struggled a little bit, particularly in the third quarter in some of the industrial, on TSV. I think the guys are getting that back on track. I mean, there's obviously still work to do in finishing the integration, but we're -- I think our guidance is a fair number. There is -- I don't know that I could add a whole lot more color to it. I mean I think, yeah, we ran into some softer end markets than we expected. We had a couple of problem programs that put a lot of pressure on us in ’17, which we started the year at ’17 saying that we probably were dealing with a difficult year in terms of a lack of growth, which we've historically delivered. But I think we're positioned well going into ’18. There's all these issues to work through the year, but I think a lot of the things that we need to do, both problem programs as well as some investments that we thought we needed to do and things we had to get in place for ’18 are largely there. So I think we feel pretty good about where we are going into the year.

And just as a follow-up on V-22, maybe if you could give us an update on where you think we are in terms of signing the next multi-year in terms of you, if the type of appropriations bill that’s being talked about gets signed, if that gives you, you think, a plus up and maybe kind of take some of the sting out of the decline that’s coming for 2019 and 2020 and how you're thinking about preparing Bell for that, just sort of an overall update on V-22?

Well, so V-22 is the multi-year three, negotiations are underway, right. We're working that in real time with the customer. I think they obviously are working and I'm trying to understand their budgets and that whole process to frame the program, but right now, I would say, we're probably looking at a Q2 or so contract to get multi-year 3 underway. I think the program record is well understood. Obviously, we’ve had the ads on the Navy program that are again well understood and I don't think there's going to be a whole lot of volatility around the volumes, but it will be a step down certainly from where it was in multi-year 2. But I don’t think that’s changed. I think it is probably looking like a five year program, all right. There was a while there, people were talking maybe it could be a seven year program. It's looking to me, I think the way they're going to appropriate, it will probably be in a more of a five year contract, which is fine.

We have a question from the line of George Shapiro from Shapiro Research.

Scott, I was wondering if you could break out at least a little bit overall, the back like increase or the book to bill that would have been in commercial versus military because it seems like military was down and commercial would have been up by more.

George, I think from a color standpoint, the stuff that was in -- largely in the backlog, predominantly on the T-6 front has been there. So most of the movement you've seen was driven by the commercial side of the business.

So if you took out the military side, what would be the commercial have been up?

I don't think we'll probably do any more color than that, George in terms of the backlog.

And then on R&D, why wouldn’t R&D be down by more in ’18? I mean, I figure Scorpion was maybe 75 million in ’17, going down to pretty close to zero and you've got total backlog down, total R&D down 14 million. Longitude finishes, you start delivery here in the first quarter. So where's all the imputed higher R&D coming from?

Well, we are obviously getting a benefit significantly lower funding as you say on the Scorpion program. We do have the Longitude, which will be still strong here in the -- at least in the first quarter or so of the year as we finish the certification testing. So we will certainly have less R&D spending on the fixed wing side, but we do have the knowledge heading towards its first flight. We do have the SkyCourier program, which is I think will be a great program for us and we're being pretty aggressive about getting all over that thing and doing that program in sort of that 30-month window and have a whole team work in that. So it's not like R&D spending is going away in the fixed wing world. We do have work to do and I think programs that will be very strong growth programs for us. As I said, I think there is a bit of a shift here with 525 being back with the whole year of the flight test program, V-280, which again is a huge potential program for us. So a lot of R&D spending in that area to support that flight test program as well.

And then last one, how long would it take for you to decide that you want to increase production rates if you saw continued strengthen in the business jet market, would that be something you could do in six months or would that be something that would more affect ’19?

Well, I think we're in a position that we could affect ’18 and more in a six month kind of a window.

We have a question from the line of Ronald Epstein from Bank of America.

Can you give us an update on hemisphere in light of the engine issues, with the 5X program being killed at SO and then moving on to a different engine, where is that hemisphere and are you guys thinking about a different engine, just if you can give us an update on that.

So, our guys are actively engaged or sort of real time I guess I would say Ron on that -- the issue of where is the engine and what will the scope and timeframe be to get the engine on track. So in the case of that particular aircraft, I mean I think what you saw, the 5X carriers do is go to a larger aircraft. You have to match engine airplanes obviously pretty well to make it work. That's obviously not a strategy that we would follow. So, in our case, to do that aircraft requires that engine. I mean to get the differentiation in the market, to fuel burn efficiency range and whatnot is dependent on that aircraft or on that engine, I'm sorry and the engine performing prospects. So we are working with the guys to understand where they are and what their path forward is. And look, we’ll have to sort of gate off of that, Ron. So right now, we're in a position where we haven't spent a ton of money on that program. We continue to do a lot of the early work that you need to do around key subsystems, selections and basic air dynamic work and whatnot. That’s at a fairly low level and we'll have to make a call, when do we lean into that program or not based on what we see as the engine timeline.

Is there an opportunity there to maybe use Canada engine or something like that or is that kind of not a possibility?

Well, I think the challenge to do, to make that aircraft be what we want it to be, that’s the engine that makes it work. So if you go to a larger engine, then you've got to go to a larger aircraft and that's a path that we're not going to do. Ultimately, again, it all depends on where this engine is. If the engine is not there, then you're kind of would do a step back and say, okay guys, what do we want to do. Going bigger doesn't make sense to us, so we would have to evaluate a change in our strategy, but again, it’s all predicated on where the engine is and we just don't know yet.

And then maybe just a follow-on from that, if something didn't go well with Safran, is there any recourse for you guys or is it still too early to even project that?

Well, no, not really, Ron. But again, we haven't put an enormous amount of money to that anyway at this stage of the game. So, there's obviously, I mean, you could, like I said, you could step back, you could suspend the program, you could -- there's a whole bunch of options here, but there's no significant financial harm that's been caused. So I mean, it's not like we would go back with any kind of recourse. You just have to wait and see how the engine program progresses.

And then if I can, maybe just one more really big picture question. There's been a lot of talk in the general aviation community about like the electrification of aircraft, particularly around propulsion. Is Cessna looking at that at all? Do you have any thoughts on if that’s kind of to Buck Rogers and far out there, is that something that could be more of a reality sooner?

Look, we have spent some time and our kind of advanced concepts guys running numbers and looking at that, it's tough math, right. I mean when you look at how much energy is required to take an aircraft and go any kind of range with any kind of a weight, the energy storage technology just isn't there, right. I mean when you talk about anything in the air, weight is not your friend. So, we continue to look at that. By the way, we are doing the same thing on the rotorcraft side, right. I mean, we've probably done more work on the rotorcraft side because there are some small drone technologies and smaller vehicles that don't have to go this far and just the nature of a helicopter, you tend to do shorter ranges and less weight, so it's probably more feasible in the rotorcraft world. We’re doing short hop kind of things as opposed to the longer haul that you see in the fixed wing aviation side. But it's largely going to be driven by energy storage and electric propulsion, which for us is -- that's our supply base that does that. So are we actively engaged with guys that are working on that? Absolutely. Do I see it as becoming a material thing that is going to happen in the sort of mid timeframe? Probably not.

Our next question will come from the line of Rajeev Lalwani from Morgan Stanley.

Just a question for you on the M&A landscape and how you’re approaching it this year, whether it’s a buyer or seller of assets?

We don't make any comments with respect to M&A on either front, Rajeev.

And then as it relates to Bell, Scott, you were talking about not seeing too much in terms of margin opportunity, can you maybe highlight how an oil and gas opportunity would fit into that, just with oil and gas prices obviously a bit better here?

Well, I don't think it has anything to do with the margin side of things, Rajeev. Yeah. I mean, we’re expecting the business around 12%. If you think about oil and gas, which I agree, I mean there is some -- certainly some strengthening in that -- in that end market, I think in terms of sales into the oil and gas industry, we are actually seeing some of that already, I mean, in some of the more near end, so therefore some the smaller helicopters, there is clearly opportunity in the longer haul here in terms of things like 525. But there is also a lot a assets out there, right. I mean as they went through a pretty tough contraction, they’ve got a lot of assets back to work, but clearly we see that end market as a big opportunity for the 525 and hopefully here as we see that end market start to strengthen and we get the 525 through certification, we’ll be about lined up in the right place, but it certainly won't be a 2018 impact.

And a quicker clarification on Arctic Cat, could you say that is going to hit the target of being accretive this year.

Yes.

Our next question will come from the line of Drew Lipke from Stephens.

On aviation and commercial turboprop, King Air deliveries still kind of a low level here in the second half, caravan deliveries were down pretty significantly year-over-year. You talked about inquiries picking up a little bit last quarter. Did you see that convert into increased orders and then maybe just a little commentary on that market for 2018?

We did. I think the senior market started in the earlier part of last year, a little soft. It certainly strengthened as the year went on. I think we'll be in a pretty solid position here as we go through ‘18. Caravan similarly, we're quite soft in the first half of the year, got stronger as the year went on. I think we've seen a pretty strong level of order activity on caravan. So we feel very good about those going into 2018.

And then on Bell commercial, how much of the order book build or the strength that you've seen there has been tied to the China market and how much of that is due to just some of the regulatory changes that we've seen in that market and how is your opportunity there and how sustainable is it in your opinion?

Well, I think we haven't seen a lot of change on the regulatory side in the low altitude spaces. I mean that has been certainly more noise than other areas. We continue to feel very good about China in terms of how we're doing and particularly on the light side. So this past year obviously, we have large orders for 407s, large orders for 505s. So I think we feel very good about our position in the Chinese market, particularly as it has to do with the light, so particularly the 505 and the 407. And I think our deliveries into China this year as we look at our backlog and our customer base is, I think will be pretty strong.

Okay. Ladies and gentlemen, thank you for joining us today and that concludes our call.

Thank you. Ladies and gentlemen, thank you for today’s call. It is concluded. You may now disconnect.