Q3 2012 Bombardier Inc Earnings Conference Call
Dec 01, 2011 AM EST
Thomson Reuters StreetEvents Event Transcript
E D I T E D V E R S I O N
BBD.B.TO - Bombardier Inc
Q3 2012 Bombardier Inc Earnings Conference Call
Dec 01, 2011 / 03:00PM GMT
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Corporate Participants
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* Pierre Beaudoin
Bombardier Inc. - President and CEO
* Pierre Alary
Bombardier Inc. - SVP and CFO
* Shirley Chenier
Bombardier Inc. - Senior Director - IR
* Jean-Louis Fontaine
Bombardier Inc. - Vice Chairman of the Board
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Conference Call Participants
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* Cameron Doerksen
National Bank Financial - Analyst
* Fadi Chamoun
BMO Capital Markets - Analyst
* Walter Spracklin
RBC Capital Markets - Analyst
* Seth Seifman
JPMorgan - Analyst
* Chris Parkinson
Credit Suisse - Analyst
* Benoit Poirier
Desjardins Securities - Analyst
* Noah Poponak
Goldman Sachs - Analyst
* David Newman
Cormark Securities - Analyst
* Turan Quettawala
Scotia Capital - Analyst
* Marko Pencak
GMP Securities - Analyst
* Michael Willemse
CIBC World Markets - Analyst
* Stephen Trent
Citigroup - Analyst
* Anthony Scilipoti
Veritas Investment Research - Analyst
* David Tyerman
Canaccord Genuity - Analyst
* Ben Elias
Sterne, Agee & Leach, Inc. - Analyst
* Chris Murray
PI Financial - Analyst
* Tim James
TD Newcrest/Waterhouse Securities - Analyst
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Presentation
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Pierre Beaudoin, Bombardier Inc. - President and CEO [1]
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(audio in progress) We had strong profitability in Q3 with an EBITDA margin of 7.4%. Order volume in our transportation segment was at a book-to-bill of 0.7 following large orders placed in previous quarters, and we have a very strong backlog at $33 billion. At this point we do not see any shift of planned tenders, but we are closely monitoring the general economic uncertainty.
And now I would like to let Pierre Alary walk you through the financials in more detail.
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Pierre Alary, Bombardier Inc. - SVP and CFO [2]
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Thank you, Pierre. Good morning.
In the context of a continued economic uncertainty, both groups have performed well. Aerospace revenues for the quarter totaled $2.3 billion compared to $1.8 billion last year. This 26% increase results from a higher level of delivery and higher net selling price in business aircraft. EBIT totaled $129 million, or 5.6% of revenues compared to $98 million or 5.4% last year.
For Transportation, revenues totaled $2.3 billion compared to $2.2 billion last year. Excluding the positive foreign exchange impact of $90 million, this represents an increase of 3% year-over-year. EBIT totaled $172 million, which represents 7.4% of revenue compared to 7% last year.
On a consolidated basis, revenues totaled $4.6 billion while EBIT is at $301 million compared to total revenues of $4 billion and EBIT of $250 million last year.
Net financing expense is at $58 million compared to $61 million last year. And with an effective income tax rate of 21%, net income totaled $192 million or $0.11 per share compared to $147 million, or $0.08 per share last year.
Now looking at free cash flow, Aerospace free cash flow is $53 million positive for the third quarter while Transportation continues to use cash. On a year-to-date basis, Aerospace generated $425 million of cash flow from operating activity and invested $1 billion on our various development programs, resulting in a free cash flow usage of $563 million since the beginning of the year.
You may recall that the fourth quarter of last year Aerospace generated $762 million of free cash flow. And while we expect free cash flow in the fourth quarter to be positive, we do not expect it to be at last year's level.
Transportation used $347 million of cash in the third quarter, mainly due to an increase in inventory due to the ramp up of several contracts ahead of deliveries and due to delays experienced in deliveries of some rolling stock contracts, but also due to the settlement of derivative financial instruments used in a roll-forward cash flow hedge.
We have previously discussed the issue with two contracts where we have experienced delays in delivery. The deliveries of the SNCF contract have resumed towards the end of the third quarter. And with respect to the TALENT 2 contract, we obtained homologation at the beginning of the fourth quarter and we are currently defining the new delivery schedule with Deutsche Bahn. Clearly, the excess inventory and the impact of the settlement of derivatives will reverse over time. In fact, we expect inventory to decrease gradually over the next few quarters.
We expect a good free cash flow in the fourth quarter for transportation, although not sufficient to reverse the entire free cash flow usage since the beginning of the year. The cash and cash equivalents at the end of the third quarter totaled $2.7 billion, the same level as last year. And at the end of the third quarter, available short-term capital resources, which includes our revolver facility, totaled $3.5 billion. And we expect it to be above $4 billion at year end.
Now before concluding, I'd like to mention that as we mentioned at the beginning of this year, we had intended to ask our board to change our year end. Well, effectively yesterday the board approved the change in year end to December 31, effective 2011. And this has no impact on Bombardier Transportation as BT already had a calendar year end. However, the fourth quarter for Bombardier Aerospace will only include two months of operation.
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Shirley Chenier, Bombardier Inc. - Senior Director - IR [3]
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Okay, thank you. We will now start the question period for analysts and investors. I would ask you to limit yourself to two questions as usual, to give everyone a chance to participate.
Operator, we can now start the question period.
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Questions and Answers
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Operator [1]
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(Operator Instructions). Cameron Doerksen, National Bank Financial.
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Cameron Doerksen, National Bank Financial - Analyst [2]
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A question I guess on the delayed rail contracts. Just wondering if you could maybe provide a little bit more color there. I guess specifically, how many quarters are we looking at before we'll be sort of on a more normalized schedule or when the backlog that's of these trains that are in inventory are going to be cleared?
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Jean-Louis Fontaine, Bombardier Inc. - Vice Chairman of the Board [3]
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This is [Jean-Louis] speaking. This is going to take us quite a number of quarters because as you can imagine we've built up those inventory in relation to deliveries that were to take place during this year, so we've accumulated. And as we are looking at the schedule with the customers, there is so much the customer can put in operation at the time, so therefore, it is good to take several quarters before we see the effective reduction or coming back to a more normal level in terms of inventory.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [4]
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Of course -- this is Pierre Beaudoin, just adding to this, of course, as you know those are contracts, so they are sold products. They are in inventory; they will turn back into cash. Like Pierre says, that can take more time because the customer needs to be aligned with us in terms of how fast he can take the delivery.
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Cameron Doerksen, National Bank Financial - Analyst [5]
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And do you have -- or are you able to provide the dollar amount of inventory that is tied up in the two contracts you've outlined, the SNCF and the TALENT 2?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [6]
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Well, what I said is we are not going to give it to you by contract specifically. But I said that three contracts represent about $300 million effect on cash flow.
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Cameron Doerksen, National Bank Financial - Analyst [7]
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Okay. And sorry, what's the third contract?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [8]
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REGINA in Sweden.
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Pierre Alary, Bombardier Inc. - SVP and CFO [9]
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And this is in relation to cash flow and you were asking inventory -- we're entering cash flow because as you know, we are getting advances from customers. So the net impact on free cash flow is less than the inventory itself.
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Cameron Doerksen, National Bank Financial - Analyst [10]
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Right. Okay, just second question on regional aircraft orders. Obviously, the backlog in Q400's is the CRJ is getting pretty low. It does certainly seem like there is some activity out there for new orders. But I was just wondering if you can maybe provide some sort of timeline on your expectation for closing some of these deals. And how long of a delay are you able to endure here before you have to start thinking about your production rate again?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [11]
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Well, we've made our plans for next year, and we have nothing more to announce in terms of production schedule for next year. So with the orders that we have and the ones we're working on that we feel good about next year's production, but some of these discussions need to conclude soon. But I anticipate that our plan for next year is well in place at this point.
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Cameron Doerksen, National Bank Financial - Analyst [12]
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Okay. Thanks very much.
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Operator [13]
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Fadi Chamoun, BMO Capital Markets.
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Fadi Chamoun, BMO Capital Markets - Analyst [14]
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Yes, just to follow up on this last question, can you mind sharing with us what is the plan for next year on the commercial that you just outlined? Is it going to be -- I guess it's going to be little bit down compared to last year. But if it's in place already, can you give us an idea what it is?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [15]
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No. Fadi, as you know, we give these forecasts and forward-looking statements in our Q4 and our year-end results. And we intend to do the same thing. There are several things that we do on that call and we want to leave it this way.
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Fadi Chamoun, BMO Capital Markets - Analyst [16]
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Okay. And the main question I wanted to ask is obviously, delivering the CSeries model that's on time is probably the most important factor for investors at this stage. And it is obviously high priority for you. And there has been a lot of mixed reports and media and everywhere about issues, problems causing delays. I was wondering if you can give us some clarity -- what is the program now? What are the next key milestones? How you feel about your late 2013 entry into service? Any color would be great. Thanks.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [17]
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Yes, and I expected this question. Of course, there's a lot of things being said on the CSeries at this point. And it's a little bit normal at the stage in which we are in the program. We have a lot of partners involved, some of which would be ahead of schedule, some of which would be behind schedule. And that's not unusual in managing such a complex project.
What -- we are driving for delivery in 2013. We're focused also on meeting the various customer promises that we made through the orders. And also, we're very focused on making sure that this airplane delivers the performance that was anticipated. And as you know, we finished the wind tunnel testing. And we feel very good about the performance of the aircraft. But 2012 is an execution year where we get a lot of parts -- you've got to put an airplane together. So you will get more milestones as we get into 2012. But at this point, I can assure you that the whole team is driving to the delivery in 2013.
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Fadi Chamoun, BMO Capital Markets - Analyst [18]
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Is there any sort of a critical step in the next few months that you're looking forward to see behind you that you can share with us from an integration point of view? Or it's really a bunch of small stuff that is going to happen over the next few months?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [19]
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There's quite a few things. Of course, we'll have to get the airplane on the ground, the [CIASTA] going, but we haven't given you a new specific date on that. Of course, there's the assembly of the first airplane and then there will be the first flight.
I think we'll wait a little bit until we provide exact dates on this as these things can vary. And I don't want to influence an expectation with the variation of these dates.
So step by step, right now what I'm telling you is that we are driving to 2013 with the issues that we face in airplane programs that we're used to doing. We have the experience and we have the experience to deliver this airplane on time.
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Fadi Chamoun, BMO Capital Markets - Analyst [20]
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Okay. The other quick thing, just business jet inventories, the used aircraft seems to have gone up again from I think there were 98 last quarter to 108 this quarter. Can you just explain why? I would have thought this would have come down this quarter. Why did it go up, and did you expect it to improve?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [21]
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You know, we are respecting the policy that we have not to take more than 30%. Now you can not always find that 30%. Sometimes you will hit a quarter where there's more units coming in than another quarter related to deliveries of aircraft or related to a specific deal which had a trade-in not necessarily timed with the deliveries. So you can't interpret the increase as a change in policy.
We are moving used aircraft at a good pace. If you looked -- that we've moved 28 [3Ls] in Q3 and 47 year-to-date. I don't have a major concern on this, but we are focusing very hard to make sure that these aircraft get sold.
The one thing I am very happy is the way we're taking them in. We are very conservative of the pricing, so we're able to turn these things into cash rapidly.
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Fadi Chamoun, BMO Capital Markets - Analyst [22]
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Thank you.
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Operator [23]
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Walter Spracklin, RBC Capital Markets.
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Walter Spracklin, RBC Capital Markets - Analyst [24]
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Thank you very much. Good morning, everyone.
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Shirley Chenier, Bombardier Inc. - Senior Director - IR [25]
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Walter?
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Walter Spracklin, RBC Capital Markets - Analyst [26]
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Yes, hello?
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Shirley Chenier, Bombardier Inc. - Senior Director - IR [27]
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Walter, we couldn't hear you -- maybe you --
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Walter Spracklin, RBC Capital Markets - Analyst [28]
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Okay, you can hear me now? (multiple speakers) Okay, great.
So thanks for taking up my call. The question I have and we've heard in the press somewhat about the use of your buffer in terms of timing. My question is more about the cost of the program. I think you've indicated a $3.4 billion overall project cost. Have you got buffer in there as well on the overall cost of the program? And how much -- how comfortable are you with that development cost projection?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [29]
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It's very hard to take things in pieces in an airplane program. We have to look at the overall program. Over the -- we plan these programs over 20 years. And if I look at the over overall program, I feel comfortable that we'll deliver the margin that was anticipated.
Now what goes on during the development program is some things will go out of recurring costs and we'll influence the nonrecurring costs, and so on. So I'm not prepared to give individual updates on that. But I can confirm that the overall program will deliver the anticipated return.
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Walter Spracklin, RBC Capital Markets - Analyst [30]
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There's no concern there that if there is an overrun here that it would impact your global programs at all? The 7000, 8000?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [31]
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No.
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Walter Spracklin, RBC Capital Markets - Analyst [32]
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No, okay. In terms of the -- this is for Pierre Alary; you mentioned that you won't be able to get the $1.46 billion that you did in the fourth quarter. Can you give us an order of magnitude and how much lower are we talking and whether you expect to make that up? I think you said it might be a few quarters, but is this made up in next year? Is this more of a timing issue? Or should we be prepared for perhaps another negative year for fiscal 2012?
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Pierre Alary, Bombardier Inc. - SVP and CFO [33]
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One way to give you some guidelines for the fourth quarter, I mentioned that our access to -- liquidity and access to liquidity, that is including our revolver, at the end of the third quarter, are $3.5 billion. And we expected to be above $4 billion by the end of the year. So that gives you an idea of the recovery, if you like, in terms of free cash flow. But we have to take into consideration also that we have -- we paid dividend and so on.
So we expect to end up the year above $4 billion. And if you look at -- last year at $4.2 billion cash and $4.7 billion of liquidity, that was an exceptionally high year. Because in the previous year -- previous to that it was more -- between $3 billion and $4 billion. So being at $4 billion by the end of the year, we're comfortable that we are at the right level to pursue our activities and our major investment program.
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Walter Spracklin, RBC Capital Markets - Analyst [34]
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Sorry, you said greater than $4 billion in cash or liquidity?
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Pierre Alary, Bombardier Inc. - SVP and CFO [35]
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Liquidity.
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Walter Spracklin, RBC Capital Markets - Analyst [36]
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Liquidity, okay, great. Okay, those are my questions. Thank you very much.
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Operator [37]
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Joe Nadol, JPMorgan.
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Seth Seifman, JPMorgan - Analyst [38]
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It is actually Seth on for Joe this morning. I was just wondering if we could walk through each of the three contracts that you cited in the Transportation segment. And I believe the SNCF contract in France you said was now on track. If you could talk about exactly where you stand on TALENT 2 and then with the Swedish contract as well and what milestones we're looking toward and when you expect to achieve them.
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Jean-Louis Fontaine, Bombardier Inc. - Vice Chairman of the Board [39]
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It is [Jean-Louis]. Let me take it step-by-step. In the past, as you know, this is a very complex train that has led to reliability issues when we introduced the train. We have started delivery again, but we need to continue to focus on continuing to improve the reliability. So it's back on delivery. I would not say it's back on track yet because we have a lot of work to do to make sure that we meet our customer's expectation, but deliveries are going on.
In TALENT 2, right now what we have obtained is homologation. And this train will be used in various regions of Germany. And we're focusing right now on one franchise, in fact, two franchises to deliver the first -- the initial train.
And right now it is discussion between us and Deutsche Bahn, how do we time this properly; how do we train the drivers to make sure that we have a good flow once we start delivering again and they can have an efficient service to their customers. So that's more right now imminent start of delivery.
And as far as the REGINA in Sweden, this is a train we know well. We did some modification in this train for additional features that the customer wants, and we have a few engineering issues. But we have started the deliveries again. And right now we're delivering to customers' expectations.
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Seth Seifman, JPMorgan - Analyst [40]
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Yes, thanks very much. And then just to follow up on a question that was asked before, when we think about how this affects cash flow next year and the fact that it will take several quarters to recover and we think about that over-time relationship between cash flow and the transportation business and EBIT, how do we think about that for next year in light of the need to catch up on some of these inventories?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [41]
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Well, maybe Pierre will also answer on this -- Pierre Alary -- but I think you've got to be careful when you think of cash flow quarter to quarter in Transport. Over time, Transport has a cash flow equal to EBIT. But quarter-to-quarter it may vary. At the same time next year, we're not only delivering these 3 contracts. We're ramping up some very big contracts that we won years before. So I don't want to tell you that you should relate the cash flow necessarily only related to these three contracts. And we will give you more view on our plan at Q4.
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Seth Seifman, JPMorgan - Analyst [42]
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Great. Thank you very much.
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Operator [43]
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Hamzah Mazari, Credit Suisse.
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Chris Parkinson, Credit Suisse - Analyst [44]
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This is Chris Parkinson on behalf of Hamzah.
Just a quick question. Given the current economic environment, could you talk a little about the current financing environments in both Transportation and Aerospace and whether or not you see any noticeable differences based on geography on the terms being offered and what you're hearing from customers?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [45]
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Well, let me start with Transportation. We don't see any big difference at this point. We know that our customers are paying more attention to the cash than they were in the past in contract discussions, if you want. But overall, we don't see a big difference.
We would get into discussions with customers on how to finance their trains in some instances. And when that happens we work with them, for example with an export credit agencies or a bank to put a structure together. But overall we don't see a big difference. But it is a situation we need to monitor very closely.
As far as Aerospace is concerned, in business aircraft, not really at this point, because we tend to sell to large corporations or high net worth individuals. And banking there is done either directly with their bank that the businesses do business with or with the wealth management bank for our customer, so no big difference there.
In commercial aviation it is challenging for some airlines, primarily based on their results. But there is availability of financing through export credit agencies or to a leasing company.
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Chris Parkinson, Credit Suisse - Analyst [46]
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Great. Thank you. And just a very quick follow-up, can you just briefly touch on the characteristics of the biz jet activity you're currently seeing in China based on the range of the aircrafts on medium for long, for instance?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [47]
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Yes, I think it's similar to the pattern where we see it worldwide right now. It's strong on the large craft; good on the midsize, if you want, Challenger-type category; and still weak on the light segment. And where we would expect the light segment to pick up first would be more in the US and Europe. So in China they will always be more skewed, at least in the short term, to large and -- super-large, if I can say it this way, and large aircraft.
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Chris Parkinson, Credit Suisse - Analyst [48]
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Perfect. Thank you very much.
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Operator [49]
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Desjardins, [Benoit Poirier].
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Benoit Poirier, Desjardins Securities - Analyst [50]
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Could you provide an update on the pricing environment for regional aircraft? I'm just wondering if you're seeing any competitors lowering prices. And do you feel you have the right pricing strategy for your products at this point?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [51]
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On regional aircraft it is a challenging market right now, primarily because Europe and the US are not -- are being affected by the economic conditions, so we are selling our aircraft in developing markets. And it is very competitive, but we think we have the right strategy, particularly for the fact that we sell great economics. If I can just compare the ERJ-190 to the CRJ-1000, we have a 16% fuel burn advantage with the 190. And that in developing markets where yields are low, it gives us a huge competitive advantage. So pricing for the aircraft, I think we're well positioned.
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Benoit Poirier, Desjardins Securities - Analyst [52]
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And when we look at your Aerospace margin, you're tracking at 5.7% year-to-date. And in your guidance you are still guiding for 5%. So how should we read Q4?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [53]
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You know, we have a two-month Q4. This is the first time that we have -- we finished on the 31 of December. You have been following us a long time. We usually have big sales in January, big deliveries in January, so that's something the team has been preparing for, for quite some time, to be ready to end the year at 31 December. It's a big change for our company.
And with two months just ahead of us, I think guiding at 5% is the appropriate thing to do. Okay. Thanks for the time.
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Operator [54]
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Noah Poponak, Goldman Sachs.
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Noah Poponak, Goldman Sachs - Analyst [55]
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On the last quarter's call you discussed having a handful -- I think you said four to five potential CSeries customers you were in deep discussions with. Can you just update us on that pool? I think you had said that it was premature to say if they were before or after Christmas, which is obviously approaching here. Does that imply we should expect to see a flurry in the next couple of months? Or what is the near term outlook for demand on CSeries?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [56]
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Well, first of all, as you know, we announced that it was jet, so there's one of the customers that were in that group. We think we're in a good position with orders on the CSeries at 133 firm. And we have 45 LOIs that we are working on that have been announced that need to be closed. And we have several others.
And the reason I introduced this, this way, is that we are working with the customers to close the orders, but at the same time, we need to make sure that we close them with conditions that are acceptable to us because we feel with the level of orders that we have to date, we don't need to make a huge compromise because we have a good backlog to start our deliveries in 2013. So there will be more announcements, but I think we're in a good position at this point.
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Noah Poponak, Goldman Sachs - Analyst [57]
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And then I just want to follow up quickly on the questions around next year's CRJ production levels. You announced they're going to come down. Presumably you wouldn't make that announcement if it was just going to be a handful of aircraft. Historically when you've had declines they've been chunkier than that.
Is that the right way to think about it, that if you were going to change just by two or three jets you would not have announced it and it's going to be larger than that? Or any other kind of granularity you can give us there.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [58]
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Yes, we are only adjusting by a couple of aircraft. That does not necessarily imply that we bring down the line rates. So it would be more than that, but we'll give you more precision in Q4.
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Noah Poponak, Goldman Sachs - Analyst [59]
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Okay. Fair enough. Thank you.
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Operator [60]
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David Newman, Cormark Securities.
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David Newman, Cormark Securities - Analyst [61]
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Pierre, just on the gross margins in BT, you said there was some execution-related issues. Does that still relate to those three contracts or is there something else going on?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [62]
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Pierre, you are at least touching two people in the room, so I will let Pierre Alary --
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Pierre Alary, Bombardier Inc. - SVP and CFO [63]
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Yes, effectively, the adjustment that we've made to the various contracts have been reflected on the third quarter.
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David Newman, Cormark Securities - Analyst [64]
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Sorry, say that again?
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Pierre Alary, Bombardier Inc. - SVP and CFO [65]
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They've been reflected -- as we identified additional costs or we identified the issue, they are being reflected on a quarterly basis on all of our contracts. So obviously, this contract does reflect the situation at the end of the third quarter.
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David Newman, Cormark Securities - Analyst [66]
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And when do you anticipate that will normalize in the same sort of timeline? As the inventory has worked down? Is that kind of the -- or do you front-end load it? How do you work that?
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Pierre Alary, Bombardier Inc. - SVP and CFO [67]
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Well, when we adjust the costs on the -- let's say we adjust the costs on a contract, we adjust the margin and we do a catch-up adjustment. So therefore, going forward, the margin recognized -- is recognized at the new level of margin. So there is a catch-up adjustment in the quarter where we make the adjustment.
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David Newman, Cormark Securities - Analyst [68]
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Okay. So this quarter would have been a little bit higher than what we can anticipate going forward because it's a bit kind of retroactive almost.
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Pierre Alary, Bombardier Inc. - SVP and CFO [69]
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In terms of adjustment, yes.
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David Newman, Cormark Securities - Analyst [70]
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Okay, very good. And second thing, probably for Pierre Beaudoin, just on the BT backlog, as you look at Europe and the eurozone crisis has spread here, are you seeing anything on the cancellation front at all or any skittishness at all in terms of either what you've got in backlog or in any sort of future orders that you might be looking at?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [71]
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The answer is no, but let me give a little bit more precision. Of course, the main country for us in Europe as far as contracts -- let's start with Germany. The tenders are continuing to go on. We have quite a few tenders that we're working on.
If we look then at the UK and France, there's been no impact on the plan tender or outstanding options. When we talk to our customers they are still part of their plan.
In Spain, our focus has been on signaling. And there we think there could be some effect, although there are some big tenders on signaling right now in Spain. But since we had no rolling stock in Spain, that's not an issue and that's the same situation you would find in Greece or Portugal, in Ireland. Those were never markets for us.
The last one I want to touch on is Italy, because it's been a focus of quite a -- a lot of talk from an economic perspective. As you know, we're working on a high-speed train for Trenitalia, and they have confirmed that they need this train and the economic conditions will not influence the delivery of this train. We're also working on locomotives and they also have confirmed they need those locomotives.
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David Newman, Cormark Securities - Analyst [72]
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That's good news. And just last question for me on the BA side. In the fractional business, are you seeing any softening at all? And has there been any delay with NetJets' planned procurement for the midsize?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [73]
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Well, fractional, demand has been quite good if we look at the overall year. What has been unique this year is that we've had some months where it was very low and then some very high months. But if I look at the overall year, we've had some quite good demand. And of course, there, I'm talking of Flexjet, because we live it day-to-day and we can give you feedback more instantly, if I can say it this way.
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David Newman, Cormark Securities - Analyst [74]
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Right.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [75]
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On the procurement of NetJets, we have responded to their request for proposal. I think this could be an interesting contract for Bombardier. At the same time, though, if you want more news on their intention with the contract, you have to ask NetJets.
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David Newman, Cormark Securities - Analyst [76]
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And your sense on it -- could this be -- everybody is kind of looking at it kind of like an all or none, but it could be a split order?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [77]
------------------------------
Well, that's, again, you have to ask NetJets because as far as I'm concerned I think the best airplanes in the world are Bombardier.
------------------------------
David Newman, Cormark Securities - Analyst [78]
------------------------------
Right. Very good. Thanks a lot. We'll see you next week.
------------------------------
Operator [79]
------------------------------
Turan Quettawala, Scotia Capital.
------------------------------
Turan Quettawala, Scotia Capital - Analyst [80]
------------------------------
I just had one question on Aerospace. You know with the year-end change, Pierre, you're already pretty much halfway through Q4 and I guess maybe sort of the order flow of projects slows down in the last 15 days of December, anyway. Can you give us some sense of how that's going so far in Q4 on the order front?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [81]
------------------------------
Well I can tell you for the overall year, it's been very good in the super large airplanes, if you would; good for the Challenger category; and soft in Learjet. And that is continuing to be the trend.
------------------------------
Turan Quettawala, Scotia Capital - Analyst [82]
------------------------------
What do you think will -- how do you think 2012 will play out on that front? Do you think it's going to be more of the same there, or how should we be thinking about Learjet maybe next year?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [83]
------------------------------
You know, in this economic environment, I have a hard time to predict forward too far, but I can tell you that right now we've been seeing this trend for quite some time. And right now that we're still experiencing strong demand on the bigger airplane and the large airplane.
------------------------------
Turan Quettawala, Scotia Capital - Analyst [84]
------------------------------
Okay. And I guess just lastly, the Challenger backlog obviously has come off a little bit here as well. I know we just talked about the midsize order there, but anything else there on the order front that you're working on maybe?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [85]
------------------------------
No, the Challenger is in good demand and I feel comfortable with the backlog that we have. You can always get more, but I think if I look at the underlying demand, we're in good position with the Challenger.
------------------------------
Turan Quettawala, Scotia Capital - Analyst [86]
------------------------------
Great. Thank you very much.
------------------------------
Operator [87]
------------------------------
Marko Pencak, GMP Securities.
------------------------------
Marko Pencak, GMP Securities - Analyst [88]
------------------------------
Pierre Alary, back to the comment about the resetting of margins in Transportation, have you -- with respect to the delays that you've experienced there, have you come an agreement with your customers in terms of any penalties that you may incur? And has that already also been factored into the margin comment you made before?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [89]
------------------------------
When we settle with a customer we effectively take into account the actual settlement. And where there is a potential penalty, which have not yet been settled, we do make an estimate and take it into consideration in our adjustment. So the short answer is yes, it is taken into consideration.
------------------------------
Marko Pencak, GMP Securities - Analyst [90]
------------------------------
Okay. But just based on the fact that you're still trying to agree a final schedule, for example, on the TALENT 2, would that imply that there is still some sort of uncertainty with respect to the actual amount?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [91]
------------------------------
Yes, in the sense that if we have not certainly concluded on the final agreement. Up to when we have the final agreement, we don't know for a fact what's going to be the final answer, but we have a good estimate. And that's what we do, we make our estimate. And as any estimate, sometimes they are up; sometimes they are down. But is there uncertainty until we finalize? Yes, it's an estimate.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [92]
------------------------------
Yes, but I think, Pierre, you said it right. Our view is included in the margins we would declare on these contracts.
At the same time, I want to be precise in TALENT 2. Right now what is holding up delivery has nothing to do with this discussion. What is holding up delivery is really agreeing on a good way of introducing these products into the various franchises. So it's more of a scheduling challenge with Deutsche Bahn. I don't want to say that there is no commercial discussions going on, but we will start delivery if -- whether or not commercial discussions have been concluded.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [93]
------------------------------
And maybe one thing I should clarify -- the adjustment has not took place all in the third quarter. Because obviously the homologation issue for example on the TALENT 2 has been ongoing for awhile. So as we've seen increased engineering hours, increased work to solve those issues, we were adjusting our contract on an ongoing basis. So that means there is a number of quarters where it has been reflected.
------------------------------
Marko Pencak, GMP Securities - Analyst [94]
------------------------------
Right, but as your deliveries increase on those programs, that's when we are going to see those increased costs, be it engineering or penalties start to flow through on a match basis, right?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [95]
------------------------------
Not really. Let's say we were making -- and I'm giving a number -- let's say we were making 20% margin on a contract. And then we identified that we have additional costs, so therefore, we will not be making a 20% margin; we will be making a 17% margin. Well we make a catch-up adjustment. So the quarter where we make a catch-up adjustment, we're reversing the previous margin at 20% to reduce it to 17%. And going forward, as we will record revenue, we will record revenue with a margin of 17%. So going forward, it's adjusted to the new math.
------------------------------
Marko Pencak, GMP Securities - Analyst [96]
------------------------------
So what would have been the magnitude of the one-time catch up in Q3?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [97]
------------------------------
Well, obviously, we're not disclosing figures contract by contract.
------------------------------
Marko Pencak, GMP Securities - Analyst [98]
------------------------------
Was it material? Like I'm just trying to get a -- you know, I think all of us are just trying to understand the profile of the margin impact. And any detail you can provide would obviously be helpful for forecasting purposes.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [99]
------------------------------
Maybe the other thing I want to add to what Pierre said is that just to remind you that we do declare profits and revenue based on the progress of the contract. So once we get to delivery, most of the revenue -- before delivery, most of the revenues have been declared. And the profits have been sent to the bottom line, if I can say it this way. So when you do a catch-up towards the end, it will be more in the past than influencing the deliveries in the future.
So we're obviously customer by customer you can not talk about commercial agreements customer by customer, because some are final agreements, but most would be estimates. And we're not going to negotiate with our customers on an investor call.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [100]
------------------------------
And we do review all of our contracts every quarter. And so we have a multitude of contracts, over 1,000. Some contracts goes well; some contracts, we have issues; some contracts do better than what we had originally estimated. So as we progress on those contracts, we're also adjusting the margin. And in some cases it is a positive catch-up adjustment.
So that's why it's very difficult to pinpoint and identify in one specific contract. But obviously, it had an impact on this quarter. And you can see in fact the margin is lower and the gross margin is lower versus last year. We were at 18.3% last year. We are at 17.7% this year.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [101]
------------------------------
And the other thing is, given everything that we've told you, or you know I think one thing we can tell you, we can confirm our 8% that we have been talking about for quite a few years now, for fiscal 2013 or for calendar 2013.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [102]
------------------------------
And the other element to consider is that we have contingency level within our contracts. And the contingency level is being kept until we start delivering on contract. So when we face issues, and we're getting into delivery mode then some of those contingencies are being used to offset additional costs.
------------------------------
Marko Pencak, GMP Securities - Analyst [103]
------------------------------
Okay. Can you tell me what were the one-time costs relating to changes in Derby that you may have incurred in the quarter?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [104]
------------------------------
For the -- we have recorded I think it is $15 million -- roughly. Let me just get to it.
If you go, that would be part of note 12 to the financial statement on page 61. So we have added in terms of restructuring a charge of $15 million in the quarter.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [105]
------------------------------
Which is -- I just want to be precise. It is mainly related to UK, not necessarily only Derby.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [106]
------------------------------
That's for the overall -- in this case, it's for the overall transportation.
------------------------------
Marko Pencak, GMP Securities - Analyst [107]
------------------------------
Okay. Thank you very much.
------------------------------
Operator [108]
------------------------------
Michael Willemse, CIBC.
------------------------------
Michael Willemse, CIBC World Markets - Analyst [109]
------------------------------
Just another question on BT. Revenues in Asia Pacific were down in the quarter. It was mentioned in the MD&A that there were some programs ending. Just wondering when new programs would ramp up, just given all the kind of government investigations in China right now.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [110]
------------------------------
There's been no rescheduling of our programs, so Q3 is just a question of timing. The Bureau of Trade is making good progress.
Tell you exactly how the quarters work in China -- I wouldn't be able to tell you that, but there's no influence towards what you're mentioning of rescheduling or things that would have changed our plan.
What I can tell you is that the market -- we consider the Chinese market to continue to be a great market for us. They will continue to invest heavily in infrastructure.
The one thing that they may do is rebalance between the 200-kilometer-plus trains to the 200-kilometer train. But that is not a bad thing for Bombardier as we have products in both categories and very competitive products. So if they need to rebalance, we'll rebalance.
------------------------------
Michael Willemse, CIBC World Markets - Analyst [111]
------------------------------
So the decline this quarter, is that kind of an -- let's say, an anomaly, that it's just going to bounce around quarter to quarter?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [112]
------------------------------
Well it's -- I know it is some contracts slowing down, others accelerating. But I would have to look specifically at China to tell you this answer. But there's nothing specific that I'd like to point to. The ZEFIRO 380 will ramp up and will create additional revenue.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [113]
------------------------------
And when we're saying contracts are coming to an end and contracts are ramping up because we're recording on the percentage of completion based on cost, when we say a contract is ramping up, at the beginning, we only have labor and overhead, basically the engineering. And then when we start producing, that's when we get cost -- the bulk of the costs coming into the contract. So then the -- it's going up so it shows like more revenue.
And then as you deliver the last unit, suddenly, the next quarter, you have no revenue left on that specific contract. And the other one, if the other contract that is replacing it is at the beginning of the engineering, that's why you would see a variation from a specific country or on a specific site, for example.
------------------------------
Michael Willemse, CIBC World Markets - Analyst [114]
------------------------------
Okay, no, that's fair. And just a follow-up question, just moving to Aerospace, Pierre, you mentioned earlier that the competition of the CRJ1000 versus the Embraer planes -- Embraers had a pretty good year.
Is there any issue with some of your customers that perhaps they're waiting for the C100 and they are kind of putting off orders in the CRJ1000? Or just if you could give some color there.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [115]
------------------------------
No; and when we compete for an order on the CSeries, we never see the Embraer 190 in competition with the CSeries. That's a different category. It is a regional airplane. So when we compete with the CRJ1000, it is to compete against another regional airplane.
We've got to say that we just started delivery now of the 1000; it's been about a year. It is gaining a great reputation in terms of dispatch reliability; in terms of economics. And it is a question of building that momentum. We're starting to see some head-to-had campaign against the 190, and I think we'll do extremely well.
If you look where we've had airplanes in competition with Embraer in the past, like the ERJ-170, -175 compared to the CRJ700 and 900, we've delivered double than they did; they delivered 318 and we delivered 592. So you can see when you have an airplane that has better economics, you tend to win more often. So I think the CRJ1000 will do extremely well.
------------------------------
Michael Willemse, CIBC World Markets - Analyst [116]
------------------------------
Okay. Thank you.
------------------------------
Operator [117]
------------------------------
Stephen Trent, Citi.
------------------------------
Stephen Trent, Citigroup - Analyst [118]
------------------------------
Good morning, everybody. Just one or two questions on the Aerospace side for me. The first question is with respect to COMAC. Can we expect as you move into 2012 that you'll be giving some perhaps more formal color as to how you are -- your strategic alliance with COMAC is developing?
And then my second question pertains to what degree have you seen some of your competitors on the commercial aero side being aggressive in terms of discounting on list pricing, Sukhoi, even Embraer; what can you tell us as to what you're seeing there? Thanks.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [119]
------------------------------
Let me start by this, it is a very competitive market right now, so us and Embraer are going after less accounts than usual. So to win these accounts, it is very competitive.
We haven't seen really the other airplanes you describe on our traditional market so far, whether it is the Sukhoi; sometimes we see the Mitsubishi, but not that often. And we haven't seen the ERJ-21 in markets outside China. So it's really a competition between us and Embraer. And of course, in a tighter market they will be more competitive.
As far as COMAC, we're working on five different opportunities with COMAC, five different sections where we could collaborate. There is a lot of areas where we already know that we have commonalities like same suppliers. And our customers, both to COMAC and to the CSeries are telling us that that's a good idea for us to work if we can have more commonality because it makes it simpler for them.
So I think all of the -- we're very aligned in terms of signing some collaboration agreement, because it's good for the customer overall. We're making good progress as far as giving you a timing. That's difficult, because there's two -- I'd like it the sooner the better, but we have to make sure it makes sense for Bombardier and of course, for COMAC. So it could take some more time, but in 2012 we should be able to announce you some news.
------------------------------
Stephen Trent, Citigroup - Analyst [120]
------------------------------
Okay. That's great and makes sense to me.
And just as a very quick follow-up, I think I recall on a previous results call that Embraer had won some motors and going after some customers. I think there were one or two instances in which you walked away from the deal just because the economics perhaps didn't look so attractive and your competitor was being very aggressive. Fair to say you might be seeing some of that playing out currently?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [121]
------------------------------
Well, we have to balance. Of course, the first goal for us is to deliver great profitability, a return to our shareholder. This, combined with the fact that we need also some volumes to keep our platform competitive and economically viable, we need some volume on the CRJ. So we're trying to combine it; it's a tussle between the two when the market is not very strong like it is today. But in the end, it's got to make sense and it's got to be a good economic decision for Bombardier.
------------------------------
Stephen Trent, Citigroup - Analyst [122]
------------------------------
Fair enough. And thanks for the time and see you next week.
------------------------------
Operator [123]
------------------------------
Anthony Scilipoti, Veritas Investments.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [124]
------------------------------
My question relates to the pension plan. I wondered if you had -- or could give us some idea what the contribution might be for next year.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [125]
------------------------------
Well, as you have seen, the pension plan deficit went up significantly since the beginning of the year, about $800 million. And it is essentially due to the discount rate.
The same phenomenon happened last year and the year before, where the first three quarters because of the interest rate that we're using to discount has been going down, the liability went up and, therefore, the deficit went up. And in each of the case the last two years, end of fourth quarter, that has reversed.
So what is going to happen this year, we don't know, obviously. But if the rate doesn't change that's what we're going to see in terms of the deficit, what we've disclosed in this third quarter.
Now when we look at contribution in the following year, it's based on different calculation. It is on the funding as opposed to the accounting. And these are regulated country by country. So we [didn't] make an estimate based on the current exchange rate. We did make an estimate for next year taking into consideration some of the measure that has been announced to help corporations in terms of reducing or adjusting their contribution. And based on that, we estimate that the level we are doing this year which is about $400 million in total for the full year, we would have a similar amount next year. So therefore, we don't expect in terms of cash outflow a significant variation versus what we're doing this year.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [126]
------------------------------
But have you made in your assumption of that, made the assumption that interest rates will rise back up as they did back, last year?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [127]
------------------------------
The answer is no, we have used current interest rates.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [128]
------------------------------
Okay. And that is the key driver, is the interest rate assumption that drives that?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [129]
------------------------------
Clearly.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [130]
------------------------------
Obviously, return -- there's many components in a pension that you calculate that leads to the deficit. But if you look -- and I can refer you to the variation we have on the -- if you look on page 9 of the MD&A you can see all the pluses and minuses. But you can see that the second line, the change in discount rate represents $838 million. So it represents the bulk of the variation.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [131]
------------------------------
Okay. That's helpful; thank you.
Just looking at the trade-in commitments, and the commitments note back in note 26, it seems that the numbers are pretty high. I wondered if you could give us an understanding of what the mix of those trade-ins are? Is that business jets? Is that regional jets? And I wondered if anything changed over the last year that has led to the number staying relatively high. And maybe when this amount -- when these actual trade-ins actually come in -- is it over the next year, five years and so on?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [132]
------------------------------
Well first of all, it is mostly business aircraft that we have on those trade-in commitments. And typically those would be linked to -- in terms of when they are coming in, it would be linked to deliveries of the aircraft. So we have -- in some cases we have commitments where we have agreed with the customer we would take the trade in and their new aircraft is under completion. And as you know, it takes six months to a year, roughly, to do the completion. So we would have that commitment until we effectively delivered the new aircraft, completed. And then the customer brings the used aircraft meanwhile. So that's giving us also a chance to start marketing the same -- the used aircraft.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [133]
------------------------------
Yes, I think that's a point that's not clear sometimes. It's to our advantage to bring in an aircraft early so that we can sell it before the delivery and then we can settle with the customer. So we do that sometimes. So that's why sometimes it's hard to align the amount of trade-in that we have compared to the deliveries that we are doing in that quarter.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [134]
------------------------------
But you wouldn't take a trade-in until the new aircraft would actually be shipped?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [135]
------------------------------
No, sometimes we will take it ahead of time, but that doesn't mean we give the customer cash for the airplane. We take the airplane. And it gives us an ability -- for example, if we sell the aircraft to have cash ahead of time. So we said, if you can spare your aircraft now, give it to us now and we'll sell it and we'll adjust your payments for the new -- your milestone payment for the new aircraft. So sometimes to have it early is very good.
The issue is that most customers don't want to give it to you early, because they need an airplane to fly in the meantime.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [136]
------------------------------
For sure. And if you were to take it early then that would show up as inventory?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [137]
------------------------------
Of course. It is our aircraft.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [138]
------------------------------
Right. Okay, last quick question is related --
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [139]
------------------------------
One thing you can do is you could put a relation of the trade-in commitment in relation to the revenue. And as I mentioned, most of it is business aircraft. So if you take the revenue, after three quarters, we have $3 billion of revenue, so that is prorated to say, $4 billion a year in terms of the selling of new aircraft. So you can see the relationship there.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [140]
------------------------------
And we include the Flexjet airplanes in there.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [141]
------------------------------
True.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [142]
------------------------------
But the value of that trade-in is going to be whatever you estimate to be the value of that plane you are going to take back.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [143]
------------------------------
Yes.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [144]
------------------------------
Based on market value.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [145]
------------------------------
Understood.
Just looking at the note related to provisions -- you touched on it before, Pierre, I'm looking at the trend and I'm just seeing that the utilization seems to be higher than the additions. And yet you're still taking reversals. So I wondered why that might be occurring and what impact that has on the statements.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [146]
------------------------------
Well, it depends on which provision you are talking about.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [147]
------------------------------
I'm just taking the aggregate.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [148]
------------------------------
I'm just trying to look at it. It's mostly within product warranty. So the bulk is product warranty, which is the first column on page 61.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [149]
------------------------------
Yes.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [150]
------------------------------
So we can say effectively, addition, 140; utilization 155; and reversal. So when we do a reversal, it is done -- in Transportation, for example, it's going to be done contract by contract. And when we do reverse, it would be typically towards the end of the warranty period. So there's a question of timing. And what it may -- there's no indication other than we've been within a -- conservative and establishing the provision to start with.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [151]
------------------------------
And then but when it gets reversed, that goes to income.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [152]
------------------------------
When it gets reversed it goes to income, effectively.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [153]
------------------------------
We can't keep a warranty provision on something that the warranty has expired.
------------------------------
Anthony Scilipoti, Veritas Investment Research - Analyst [154]
------------------------------
Understood. Okay. That's very helpful. Thanks, guys.
------------------------------
Operator [155]
------------------------------
David Tyerman, Canaccord Genuity.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [156]
------------------------------
Yes, good morning. Just first, very quickly, the Aerospace delivery guidance, is there any change in that?
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [157]
------------------------------
No; overall, no.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [158]
------------------------------
Overall, but does that imply something within -- like between business jets and --?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [159]
------------------------------
It could.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [160]
------------------------------
Yes, it could, so we looked at the number overall, and overall, we feel comfortable.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [161]
------------------------------
So could you give us any indication which way we would see this change, within them? Is it going to be higher business jets and lower airliners, that type of thing?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [162]
------------------------------
When we do look at it, the level of new orders on the regional aircraft has been lower so you can have that effect.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [163]
------------------------------
Yes.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [164]
------------------------------
You know. We can, I guess, guess which way --
------------------------------
David Tyerman, Canaccord Genuity - Analyst [165]
------------------------------
Yes, okay. Fair enough.
And then just kind of related to that, the seasonal pattern, I'm just wondering -- going forward when I think about next year, because your quarters are aligned differently, how should I think about deliveries for each of the business jets and the regionals in that kind of typical year? Will they still be back-and loaded? Or you mentioned January was a big delivery month, so maybe Q1 is a bigger quarter going forward.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [166]
------------------------------
Well, we're continuing to work on making sure we balance our business better, but the pattern will continue. Unfortunately, this pattern will continue, at least for next year.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [167]
------------------------------
Okay, okay. So just sort of use the past as the guidance.
Okay and then just I'm not entirely clear on the Transport in terms of the cash changes we'll see going forward. I might have some of these numbers wrong. If I heard correctly, you have, for BT, $300 million more inventories than usual or related to these contracts that will reverse?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [168]
------------------------------
The $300 million more is in relation to the impact on free cash flow. I am specifying it because you mentioned inventory. So it could be, for example, it could be like $500 million or $600 million of inventory, and then we would have received let's say, $300 million of advances, so the net is $300 million.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [169]
------------------------------
Okay, okay. And then it sounded like there was another $300 million related to hedging. Is that correct?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [170]
------------------------------
That is correct.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [171]
------------------------------
Is that in BT, also?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [172]
------------------------------
It is in BT, yes.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [173]
------------------------------
So a total of $600 million should reverse; and it sounds like the inventories would be over several quarters. It wasn't clear on the hedging. How long will that reverse over?
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [174]
------------------------------
The hedging is very difficult to predict, because it is in relation to where the exchange rate is going to go, and the timing of the forward contract versus the timing of the actual payment to the suppliers.
Because in Transportation what we do is we hedge ourself at the beginning of the contract for any currency other than the currency of the revenue side or the country where we're in. So we're protecting ourselves at the inception of the contract. But if we're delivering the contract over a five or six-years period, then the actual payment to the suppliers will be taking part over that five or six-year period. And as we are -- our forward contracts are being renewed, let's say, on an annual basis, depending on the actual foreign exchange, there is going to be a payment to the financial institution or a receipt from the financial institution. But it really depends on what's going to be the actual exchange rate at the time of renewal. So it's almost impossible to predict the cash outflow or inflow. The only thing we can predict is that the term of the contract, the payment, the total payment will be as per the original hedge contract.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [175]
------------------------------
Right.
------------------------------
Pierre Beaudoin, Bombardier Inc. - President and CEO [176]
------------------------------
What I want to add on this, this is a larger amount than usual. And maybe to understand even better Pierre's explanation is next week at the investor day we will have slides that I think will make this very clear to you, if you can attend.
It is higher than what we've experienced in the past because it's mainly related to a contract we're doing in Switzerland. And there's not much Swiss content in that contract, so we have hedged to protect the margin, but a lot of material will come from the euro. So when you renew your hedge, if there has been wide variation in currency, you will have a short-term cash impact. And that of course, corrects itself, because we've protected the margin. But we can't predict how these currencies will vary in the next couple or few years.
------------------------------
Pierre Alary, Bombardier Inc. - SVP and CFO [177]
------------------------------
But effectively, the Swiss franc has varied significantly vis-a-vis the euro to the extent that the country decided to peg their currency.
------------------------------
David Tyerman, Canaccord Genuity - Analyst [178]
------------------------------
Right; no, I understand. That's very helpful.
Just one very quick thing, the retirement benefit calculation that you show, which is very helpful -- does that include impacts on the minimum legal funding for past service?
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Pierre Alary, Bombardier Inc. - SVP and CFO [179]
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Yes, it does.
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David Tyerman, Canaccord Genuity - Analyst [180]
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Okay. Thank you.
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Operator [181]
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Ben Elias, Sterne Agee.
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Ben Elias, Sterne, Agee & Leach, Inc. - Analyst [182]
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Ben Elias, Sterne Agee. Yes, so I just wanted to follow up on the Aerospace; I know you have those margin targets and you'll probably discuss that at a later point. But as you see the backlog on the CRJs has gone from 33 months to, now, 12, and we've seen a pickup in Global and Challenger, I was just wondering what the mix effect was on margins going forward. If you could just walk me through that.
And just second thing again relates to the CRJ. We've seen a lot of CRJ200s and some of the older planes being grounded by the regionals with the later models being flown. What is the impact with American's Chapter 11 and their impact on the regionals? Have you had some conversations?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [183]
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I will Pierre Alary comment on your margin question and I will come back on the 200 and the American Airline bankruptcy.
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Pierre Alary, Bombardier Inc. - SVP and CFO [184]
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So on the margin you refer to the long-term guidance that we've been providing?
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Ben Elias, Sterne, Agee & Leach, Inc. - Analyst [185]
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Yes, the long-term guidance.
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Pierre Alary, Bombardier Inc. - SVP and CFO [186]
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So when we issued that guidance, we had a certain number of assumptions. And there was a -- where we were explaining where the improvement would come from, going basically from 5% to 10%. And so there's a number of elements that we were working on.
And a lot of those elements are in relation to volume. For example, we did mention that the volume has to go up, so that means we need to sign the new orders that we were expecting an improvement in pricing. So improvement in pricing comes also with a demand, so therefore, it is, again, volume-related.
And the other element was that our costs would be spread over a greater number of aircraft. So, again, volume, and then we would be working on our cost.
Now the first three that I mentioned are volume-related. And we haven't seen that volume yet picking up.
And your question was the mix in between the business aircraft and the regional aircraft; well on the regional side, we haven't signed many orders up to that point. So we expect that to reverse. And I guess it's too early to date to make -- to give an update on those guidance. We typically do that update with the fourth quarter.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [187]
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Okay, so let me talk about be American Chapter 11, the American Airlines. We have 47 CRJ700s in operation at AMR. And those are very successful and possible airplanes for the airlines. So we anticipate we will have discussions during Chapter 11 like we do all the time, but I think it can represent an overall opportunities because they have smaller jets that are not as profitable for them in operation, which are not Bombardier.
And we have no backlog of AMR airplanes -- we have no backlog at all, so there's no risk for backlog.
As far as your question for inventory, there's 22 airplanes right now, CRJ 200s and 100s available on the market. I believe this is a position that is very well manageable, particularly for the fact that our aircraft is very well accepted in developing markets.
Let me take the example of Russia, where we have just about 50 airplanes in operation, CRJ 100s and 200s. And we think given the age of older Russian airplanes that some have been grounded, we think this represents a continued -- Russia represents a continued great opportunity for the CRJ 200s.
So we're developing new markets. I just took the example of Russia, but I think the fact that we're developing new markets and the airplane is well accepted, I think, positions us well to move these airplanes from the US when needed to other markets.
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Ben Elias, Sterne, Agee & Leach, Inc. - Analyst [188]
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Thanks. Just one last question -- I noticed in the MD&A you talked about lower damage payments and some cancellations. Anything to read into that or is that just a one-time issue?
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Pierre Alary, Bombardier Inc. - SVP and CFO [189]
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Well in the MD&A, we refer to the variance on the margin. So we're seeing that the margin has been impacted by the fact that we have less liquidated damages. But in reality, that is a good news, because if you have less liquidated damages that means less customers that canceled their order. So it is vis-a-vis last year. So last year we had, relatively speaking, more cancellations, therefore, more liquidated damages. So it's really (technical difficulty) with an improvement to maybe last year in terms of the business.
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Ben Elias, Sterne, Agee & Leach, Inc. - Analyst [190]
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Okay. So it was related to the number of cancellations, not the amounts you were being paid on the --
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Pierre Alary, Bombardier Inc. - SVP and CFO [191]
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Yes, the number of cancellations.
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Ben Elias, Sterne, Agee & Leach, Inc. - Analyst [192]
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All right. Thank you very much.
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Operator [193]
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Chris Murray, PI Financial Corporation.
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Chris Murray, PI Financial - Analyst [194]
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If we could return maybe to talking about this settlement on the derivatives, I guess a couple of follow-ups on this one. The $300 million -- is that a, I guess for the lack of a better term, a mark-to-market type adjustment that you had to make, so it's a real cash payment?
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Pierre Alary, Bombardier Inc. - SVP and CFO [195]
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It is equal then to mark-to-market, because it's the settlement at the time of the hedge.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [196]
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But it is a cash payment.
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Pierre Alary, Bombardier Inc. - SVP and CFO [197]
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It is a cash payment.
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Chris Murray, PI Financial - Analyst [198]
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Okay, that's -- so what's your notional principal on that contract? And I guess if it's mainly related to the SBB contract, would it be fair to think that it is for the majority of the program?
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Pierre Alary, Bombardier Inc. - SVP and CFO [199]
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Is probably half of it, or a little bit -- in half of it is due to the Swiss franc. We have many contracts outstanding, and it does represent the overall situation. But the one we can point is the SBB. And effectively there is a significant amount in SBB. But the rate went from 1.39 to 1.25. That's a $0.14 variation, so that is significant.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [200]
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Just one thing, we've always had these variations, plus or minus, but never as significant as this. Of course, after we see these variations we discussed what are the options for us. But sticking to our policy to lock in the margin when we get the contract we still think is the appropriate thing to do. So buying hedging contracts to make sure that we lock in the margin, is the right thing to do. We could go with buying options but we think those are too expensive.
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Chris Murray, PI Financial - Analyst [201]
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Okay.
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Pierre Alary, Bombardier Inc. - SVP and CFO [202]
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(multiple speakers) contract we would have the costs and the revenue are typically in the same --
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Pierre Beaudoin, Bombardier Inc. - President and CEO [203]
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Country.
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Pierre Alary, Bombardier Inc. - SVP and CFO [204]
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The same country so the same currency. And in this case, it's very different. So it is kind of an exception, if you like.
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Chris Murray, PI Financial - Analyst [205]
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Okay. But you were saying about half the movement was related to the Swiss franc. What would be the other major currencies?
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Pierre Alary, Bombardier Inc. - SVP and CFO [206]
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Canadian and US would be one because we are hedging differently than what we do for Aerospace. Aerospace we're hedging our overall cash flow and BT we hedge our specific contract. So there's been significant variation US, Canadian also.
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Chris Murray, PI Financial - Analyst [207]
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Okay. Then I mean if you put $300 million into it, what's your total position I guess net right now?
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Pierre Alary, Bombardier Inc. - SVP and CFO [208]
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Well, what I can -- at any point in time our FX book varies from $15 billion to $20 billion. That is nominal value that -- purchase and sell. Because as we do it contract by contract, and we have to do it that way accounting-wise; that's the rule; so it is a significant amount. But typically the impact is not that significant on any given quarter except what we've seen this year.
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Chris Murray, PI Financial - Analyst [209]
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Okay. Just the next question, and you've given us some reasonable guidance on the change in year-end, but I'm just wondering -- and just maybe to confirm a couple things, you gave us an idea that you figure the BA margins may be still a little bit weak in the quarter. But is there anything that's either going to get pushed out into January or have to get dragged back in that would be like a normal recurring payment for what you would either consider an SG&A item or interest or anything not really related to the operating business?
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Pierre Alary, Bombardier Inc. - SVP and CFO [210]
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That would be proportional, you know. We would have two-thirds and SG&A would be proportioned to the level of activity.
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Chris Murray, PI Financial - Analyst [211]
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Okay. So that will all be activity-based as opposed to fixed or anything like that.
Just to confirm, what about things like pension measurement and all that kind of stuff? Is that all still scheduled to be done at the fiscal year end on December 31? Because I know there used to be some adjustments that you had to make there.
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Pierre Alary, Bombardier Inc. - SVP and CFO [212]
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It is going to be done at December 31. BT is already done on a quarterly basis. And BA, which was done on a January 31 basis, like we used the discount rate at October 31, now that we've changed our year end, it's all going to be done at December 31.
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Chris Murray, PI Financial - Analyst [213]
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Okay, great. Thank you very much.
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Operator [214]
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Thank you. Tim James, TD Securities.
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Tim James, TD Newcrest/Waterhouse Securities - Analyst [215]
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I just want to return to the pre-owned aircraft inventory levels again, at 108. Is there a target level in mind or a ceiling that you would like to keep that within? As you look forward here, do you sort of start to reduce pricing expectations in order to move that? Or how should we think about where that could potentially go from here forward?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [216]
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Well, we have (technical difficulty) ourselves a target not to take more than 30% of orders with trade-in and we are respecting that. So I guess that would be the answer to your question. And we are conservative in the pricing that we've taken these aircraft. It's a market value minus a certain percentage; that's quite aggressive. Customers don't usually like it, but they have the alternatives to sell the airplanes themselves.
So I think we've been very prudent in that and we intend to continue to apply our 30% limit.
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Tim James, TD Newcrest/Waterhouse Securities - Analyst [217]
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So, sorry, that's 30% of the orders that you take in, you would be prepared to have trade-in commitments associated with? Is that correct?
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Pierre Beaudoin, Bombardier Inc. - President and CEO [218]
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Yes.
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Pierre Alary, Bombardier Inc. - SVP and CFO [219]
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Yes, that is correct. So that means that -- you were asking if we had a limit. The limit is based on the orders, not based on the balance sheet account, per se. And the balance sheet account will vary a function of the -- when are those aircraft coming in.
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Pierre Beaudoin, Bombardier Inc. - President and CEO [220]
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The other aspect is we operate a fractional ownership business called Flexjet. And these aircraft generally come out after five years to be replaced by new aircraft; customer contracts would be five years, typically. So you have a roll through of Flexjet airplanes, which are generally at a good value, because for resale because they are airplanes with a lot of hours, but that's something that you need to consider in our numbers.
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Tim James, TD Newcrest/Waterhouse Securities - Analyst [221]
------------------------------
Thank you. And I meant I guess in terms of pricing, not so much the pricing that you provide to the customer; I'm thinking of when you turn around and try and move those aircraft off your balance sheet now, the pricing there. Presumably you need to adjust that depending on market conditions. Are you likely to become more aggressive potentially if there is an upward bias on the number of aircraft that you're holding?
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Pierre Alary, Bombardier Inc. - SVP and CFO [222]
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Well, the reason I answer you with what we give to their customers, of course, that becomes our cost, so we need to be conservative there. And at the same time, though, we view used aircraft as a product we want to turn into cash as rapidly as possible. I guess if you were asking if we think we have a big liability in our inventory, we don't think so.
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Tim James, TD Newcrest/Waterhouse Securities - Analyst [223]
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Okay, thank you. And my second question on BT, you've indicated in the press release that you don't see any impact or material impact from the fiscal issues in Europe on plan tenders. But if you can look beyond what you're seeing currently and provide us with a longer-term outlook given your experience and estimation of what's transpiring in Europe, do you think it's likely that there will be a either slower growth or a contraction in demand for rolling stock in particular, in Europe over the next several years, either because of spending decisions or because of financing limitations?
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Pierre Alary, Bombardier Inc. - SVP and CFO [224]
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Well, that becomes very hard to predict what (technical difficulty)
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