Boeing Co Q3 2010 Earnings Call

8/8/2019 Boeing Co Q3 2010 Earnings Call

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Boeing Co. Q3 2010 Earnings Call

Date Created: Nov-08-2010 Page 1 of 22

Boeing Co. (NYSE:BA)

Earnings Call Transcript

Wednesday, October 20, 2010 10:30 AM ET

Call Participants

Executives Analysts

Scott Fitterer George ShapiroCiti

W. McNerney Susanna RayExecutive Chairman of the Board, Chief Executive Officer,

President and Member of Special Programs CommitteeBloomberg

James Bell Dominic GatesCorporate President, Chief Financial Officer, Executive Vice

President and Member of Executive CouncilSeattle Times

Tom Downey Hal WeitzmanSenior Vice President of Communications Financial Times

Paul MarionCranes Chicago Business

Aubrey Cohen

Ronald EpsteinBofA Merrill Lynch

David StraussUBS Investment Bank

Howard Rubel

Jefferies & Company, Inc.

Noah PoponakGoldman Sachs Group Inc.

Robert SpingarnCrdit Suisse AG

Douglas HarnedBernstein Research


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J. B. GrohD.A. Davidson & Co.

Joseph NadolJP Morgan Chase & Co

Peter ArmentGleacher & Company, Inc.

Troy LahrStifel, Nicolaus & Co., Inc.

Cai Von RumohrCowen and Company, LLC

Carter LeakeDavenport & Company, LLC

Kenneth Herbert

Wedbush Securities Inc.

Myles WaltonDeutsche Bank AG

Robert StallardRBC Capital Markets Corporation


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Presentation

OperatorGood day, everyone, and welcome to the Boeing Co.'s Third Quarter 2010 Earnings Conference Call. [OperatorInstructions] The management discussion and slide presentation, plus the analyst and media question-and-answersessions are being broadcast live over the Internet. At this time, for opening remarks and introductions, I am turning thecall over to Mr. Scott Fitterer, Vice President of Investor Relations for the Boeing Co. Mr. Fitterer, please go ahead.

Scott FittererThank you, and good morning. Welcome to Boeing's third quarter earnings call. I'm Scott Fitterer, and with me today areJim McNerney, Boeing's Chairman, President and Chief Executive Officer; and James Bell, Boeing's CorporatePresident and Chief Financial Officer.

After comments by Jim and James, we will take your questions. In fairness to others on the call, we ask that you pleaselimit yourself to one question. As always, we have provided detailed financial information in our press release issuedearlier today. And as a reminder, you can follow today's broadcast and slide presentation through our website atboeing.com.

Before we begin, I need to remind you that any projections and goals we may include in our discussions this morningare likely to involve risks, which are detailed in our news release and our various SEC filings and in the forward-lookingdisclosures at the end of this web presentation.

Now I'll turn the call over to Jim McNerney.

W. McNerneyThank you, Scott, and good morning. Let me begin with a few brief comments on the business environment, followed bysome thoughts on our performance during the third quarter. After that, James will walk you through the specifics of our

results, and then we'll be glad to take your questions.

Starting with the business environment on Slide 2. Although the pace of the global economic recovery has moderated incertain areas, we continue to see growth in air travel worldwide. This growth is being experienced in all regions, withemerging markets continuing to show the strongest recovery in both passenger and freighter markets, rebounding moresharply than originally anticipated.

While the growth, that said, has begun to moderate as last year at this time, the industry started to expand from a slowrecessionary levels, yields remained strong due to the disciplined capacity management by the airlines over the past fewyears. In response to the resurgence in air travel growth and strong demand from our customers, we recentlyannounced our third 737 production rate increase this year to 38 airplanes per month beginning in the second quarter of2013. This decision was supported by our current backlog of over 2,000 737s, existing options we expect customers toexercise and ongoing sales campaigns. Demand for 777, 787s and 747-8 continue to support the production rate plans

we have previously announced.

In commercial services, we're starting to see an increase in airline discretionary spending, for example, in airplanemodifications. But we anticipate a prolonged recovery in this market as compared to prior cycles.

On the Defense side, our U.S. government customers continue to face budget pressures, while at the same time, tryingto meet extensive current requirements. Last month, the Department of Defense released details of its approach forachieving major efficiency and productivity gains in defense spending. Without a doubt, we recognize that we are in anera of significant fiscal constraint with our U.S. government customers. In return, we are accelerating our efforts toaggressively manage costs and drive further productivity to support our customers objectives and remain competitivewith our industry peers.


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In addition to rightsizing our overhead and indirect costs, we remain focused on the following key areas in Defense,Space & Security: First, extending our existing programs by bringing capability and affordability to our customers;second, capturing a growing share of international and services opportunities; and finally, accelerating our repositioning

with investments in adjacent markets.

A key win for extending existing programs this quarter was the new multi-year contract for 124 F/A-18 and EA-18Gaircraft from the U.S. Navy. On this and other programs, we are working to partner with our customers to provideinnovation and value in support of their shifting priorities and budget constraints.

Internationally, there is a clear window of opportunity for our multi-role fighter aircraft and other products, as ourinternational customers confront the need to transition to the next level of capabilities. Recent reports of a large U.S.government sale of F-15s, Apache helicopters and other systems to Saudi Arabia serve as one example of the near-term potential in the international defense marketplace.

Also, during the quarter, we closed on our previously announced acquisitions of Argon ST and Narus, whichstrengthened our capabilities in cyber security and C4ISR. We will continue to pursue opportunities in adjacent marketsand look to accelerate our repositioning with prudent investments like these.

Overall, we remain well positioned across our businesses with a healthy balance sheet and an expanding portfolio ofmarket-leading products and services to meet evolving customer needs.

Now let me discuss third quarter highlights on Slide 3. Our core performance was strong during the quarter, asCommercial Airplanes continue to execute exceptionally well on production and services programs.

Commercial Airplanes posted strong earnings during the period, driven by high volume and further productivity gains onthe 737 and 777 programs. On the development side, we are entering the final stages of flight test on the 787-8, withfirst delivery expected to be in mid-quarter of 2011. We now have flown more than 2,000 hours on over 650 flights withall take-off and the majority of handling characteristics testing required for entry into service complete.

During the quarter, we officially launched our 787 pilot training program. Pilots can transition to this new airplane in as

few as five days depending on their experience. With this training underway, we are making steady progress with ourentry into service preparations.

We also began fatigue testing on the 787 airframe during the quarter. This is a process that extends over several yearsand simulates up to 3x the number of flight cycles an airplane is likely to experience during its service life. To date, wehave already completed the fatigue testing required in order to deliver the first airplane.

And earlier this month, the sixth and final dedicated flight test airplane and the second powered by GE engines joinedthe test fleet. With the efficiencies and economics of this airplane validated through our testing, we are confident that787 will meet the mission needs of our customers.

From a production standpoint, quality and efficiency and final assembly has improved steadily, and we are working withour supplier partners to continue improving the production process and flow throughout the supply chain. We are also

intensely focused on managing the change of corporation process on airplanes already built or in flow. The earlydelivery schedule is comprised of a mix of airplanes coming off the production line and airplanes completing the changeof corporation process. On the 787-9, having achieved firm configuration in July, we are now working on completion ofcritical design review for next year, which paves the way for the start of fabrication and assembly.

Turning to the 747-8. Last month, we revised our schedule for first delivery to mid-2011 due to the cumulative impact ofa series of discoveries in flight test. The solutions identified to resolve these discoveries are manageable and won'trequire structural changes. But the process of addressing these issues cause disruption to certification testing that couldnot be accommodated within the previous schedule. The four 747-8 freighter flight test airplanes have accumulated over400 flights and 1,100 hours.


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Commercial orders for the quarter were encouraging, with 221 net orders worth more than $12 billion recorded duringthe period. Our commercial orders forecast continues to improve, and we are now expecting our unit book-to-bill ratio toexceed one this year.

Moving to Defense, Space & Security. We had several key achievements during the third quarter. In addition to themulti-year contract with the U.S. Navy for 124 F-18s, other key contract wins include an award from the U.S. Air Force tomodernize the weapon systems on B-52 long-range bombers over the next eight years; a NASA award to extend theinternational space station contract for sustaining engineering; and an Inmarsat contract for three 702 HP commercialsatellites. Orders in Defense, Space & Security during the quarter were approximately $13 billion, and we expect thebook-to-bill ratio in this business to also exceed one this year.

Key execution milestones in Defense, Space & Security include approval by the Defense acquisition Board for the P-8APoseidon program to begin low-rate production, approval for the Apache Block III program to begin low-rate productionand the launch and commencement of over the maneuvers and operational testing of the first Space Based SpaceSurveillance satellite.

As we look at head in the Defense business, we continue to see fiscal budget and affordability constraints puttingpressure on our margins. The realities of the contracting environment, reduced funding on programs and the need to

lower costs have driven some difficult decisions for our company in terms of restructuring operations, including selectivefacilities, consolidations and employment reductions.

In addition to actions already taken, Defense, Space & Security will evaluate further steps as necessary to ensure ourbusiness remains competitive and to minimize the impact on our margins. Looking forward, with healthy core operationsand a total company backlog exceeding $320 billion, close to 5x our current annual revenue, we have a solid foundationfor growth.

Now over to James, who will discuss the third quarter results and our outlook. James?

James BellThank you, Jim, and good morning. I'll begin with our third quarter results on Slide 4.

Revenue for the quarter was $17 billion, up slightly from last year's, primarily due to higher airplane deliveries andcommercial services volume, partially offset by reduced combat systems and missile defense volume. Net earningswere $1.12 per share, and operating margins were 8.2%, reflecting strong performance across our core businesses andhigher commercial volumes.

EPS and margins through the same period last year were lower due to the reclassification of the first three 787 flight testairplanes from program inventory to R&D expense and the charge on the 747 program.

Now let me discuss our Commercial Airplane business on Slide 5. Boeing Commercial Airplanes' third quarter revenuewas $8.7 billion, up from last year due to higher airplane deliveries and an increase in commercial aviation servicesvolume. The passenger seat production challenges that we experienced earlier this year have largely been resolved.

Commercial operating margins were strong at 11.6%, reflecting the higher deliveries and continued strong operatingperformance in production and service programs. There was no material impact this quarter from our decision to raise737 production rates in 2013, as the volume benefits were offset by cost to implement.

Gross inventory for the company now includes $11.3 billion related to 787 work in process, supplier advances, toolingand other nonrecurring costs, an increase of $1.6 billion during the quarter. As production ramps up next year, weexpect growth inventories to continue to increase, although at a moderating pace when we begin deliveries.

We're making measured progress with our 787 suppliers to reach fair and equitable solutions on their assertions.Customer discussions are also ongoing, and both are tracking to expectations. Boeing Commercial Airplanes won 257


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gross orders during the quarter, including 227 737s and 29 777s, while 36 orders were canceled. The commercialbacklog remains strong with over 3,400 airplanes valued at $255 billion, more than 7x BCA's projected 2010 revenue.

Now let's move to Slide 6 in our Defense, Space & Security business. Boeing Defense, Space & Security reported

revenues of $8.2 billion, with operating margins of 8.4%. Boeing's Military Aircraft revenues of $3.8 billion and margins of8.2% were down 5% as compared to last year, primarily driven by fewer deliveries and lower pricing and mix on the C-17 program.

Third quarter results also include a $42 million charge on the international tanker program as we finalized the deliveryplan with the customer. Network & Space Systems recorded $2.3 billion of revenue, down from last year, primarily dueto the expected lower volumes of the Brigade Combat Team Modernization and the ground-based midcourse defenseprograms. Operating margins of 6.5% reflect the lower volumes and earnings.

Global Services & Support revenues were essentially unchanged at $2 billion, with margins at 10.7%, driven by a strongperformance in integrated logistics. During the quarter, Defense, Space & Security increased their backlog to $66 billion,primarily driven by the F/A-18 multi-year contract award.

Now let's move to Slide 7 and our other businesses. Boeing Capital delivered another solid quarter, with pretax earnings

of $45 million on revenue of $170 million. Its portfolio balance declined to $5 billion, down from the $5.7 billion at the endof 2009.

During the quarter, we terminated our 717 lease agreements with Mexicana due to their operational challenges andbankruptcy filing. We recorded an $81 million impairment related to these assets, increasing our other segment expenseto $132 million for the quarter. We now expect other segment expense for 2010 to be approximately $300 million, withtotal unallocated expense at about $800 million.

Income tax expense to the third quarter does not include an R&D tax credit, although we expect that credit will be signedinto law in the fourth quarter. Our estimated tax rate for the year is approximately 35%, including the first quarter taxcharge due to healthcare legislation. If the R&D tax credit is not signed into law, our tax rate would increase byapproximately 3%.

Now let's move to Slide 8 and discuss cash flow. During the quarter, we generated $1.9 billion of operating cash flow.This is a result of the higher Commercial Airplane deliveries and volume, advanced payments received on orders andthe receipt timing in the Defense business.

Now let's move to Slide 9. We ended the quarter with $10 billion of cash and marketable securities, unchanged from theprior quarter. Strong operating cash flow was offset by Boeing Capital debt repayments of $500 million andapproximately $800 million paid for Argon and the Narus acquisitions. Our current cash levels provide us with strongliquidity as we head into 2011. We will continue to execute our balance cash deployment strategy and are wellpositioned to support the ramp-up of our development and our production programs.

Now let's turn to Slide 10 and our outlook. Our earnings per share guidance for 2010 is now between $3.80 and $4 pershare, up from between $3.50 to $3.80, reflecting the continued strong performance in Commercial Airplanes' coreoperations. Revenue guidance for the year is narrowed to between $64.5 billion and $65.5 billion. We still expect 2011

revenues to be higher than 2010.

2010 R&D expense forecast is unchanged at $3.9 billion to $4.1 billion. With the most recent 787 and 747-8 deliveryschedules, we now expect R&D in 2011 to decrease by approximately $500 million.

Capital expenditures are now expected to be approximately $1.6 billion in 2010. As some expenditures have shifted intonext year and we begin investments for increased production rates, we expect 2011 capital expenditures to be higherthan in 2010.

Pension funding is expected to be less than $100 million this year, while total non-cash pension expense is expected tobe about $1.2 billion. Now we are monitoring potential impacts to our 2011 pension expense based on current interest


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rates and market conditions. Through the third quarter, returns on our pension assets are approximately 12%, exceedingour assumed 8% rate of return for the year, although the discount rates have declined well below our assumed rate ofaround 6%.

Pension expense for 2011 will be determined at the end of this year based on market conditions at that time. But if weconsider recent discount rate levels and assume a 4.6% rate at the end of the year, our 2011 noncash pensionexpenses would increase to approximately $1.9 billion, including the amortization of assets and liability performanceexperienced in prior years.

Pension funding requirements for 2011 remain at less than $100 million, although we anticipate making discretionarycontributions of approximately $500 million over the course of next year. We now expect Commercial Airplanes todeliver approximately 460 airplanes in 2010, with revenues of approximately $31.5 billion. Operating margin guidance isincreased to approximately 9 1/2%, reflecting strong year-to-date performance on production and services programs.

We expect fourth quarter margins at Commercial to be lower than third quarter due to reduced volumes and higher R&D.Defense, Space & Security revenue is reaffirmed at between $32 billion to $33 billion, with margins reduced toapproximately 9%, reflecting performance to date on development programs as they near completion and the currentU.S. government contracting environment. As we look to 2011, we expect the defense environment to remain

challenging and anticipate continued pressure on margins going forward.

Moving to operating cash flow for 2010 and 2011. We are working with our commercial customers to adjust the 2011delivery sequence for the revised 787 and the 747-8 freighter schedules. Certain expenditures and investments are tiedto the phasing of deliveries on this program and will slide cash payments from 2010 into next year.

Operating cash flow for this two-year period is expected to be higher than prior guidance, with 2010 now expected to begreater than $1.5 billion, and 2011 expected to be greater than $4 billion.

2010 operating cash flow includes the impact of the revised delivery schedules, higher-than-anticipated commercialorders, lower-than-expected aircraft financing and strong earnings results.

2011 operating cash flow reflects the revised delivery schedule and anticipated pension contributions. We plan to

provide 2011 financial guidance with our fourth quarter results.

With that, I'll turn it back to Jim, who will give you some final thoughts. Jim?

W. McNerneyThank you, James. Third quarter was another strong quarter for us. The core operations of our businesses areexecuting very well and providing the foundation we need as we head into 2011.

As the commercial market enters a growth phase, we have an intense focus on executing our development programsand rate increases to capture the opportunity this growth represents. At the same time, we are tightly managing ourinfrastructure to minimize the impact on our defense margins in a challenging U.S. government contracting environment.

As an enterprise, we are focused on the work at hand and are determined to succeed. We have the right leadership inplace and a talented workforce that is engaged and committed to delivering the high-quality, affordable products andservices our customers have come to expect from us.

With that said, we'd be now happy to take your questions.


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Question and Answer

Operator[Operator Instructions] Our first question comes from Cai Von Rumohr representing Cowen and Company.

Cai Von RumohrYou had super margins in Commercial, could you give us some color? It looks like the accrual rates were at leastcomparable to the earlier quarters and the period expenses were under good control. And therefore, it looks like maybethe fourth quarter can be better than your guidance. Or should we expect a ramp in period expense? And while we're notsupposed to ask a second one, I can't understand how you can get to $800 million in unallocated for the year, givenyou're well under $500 million in the first nine months.

James BellGood thing I know about that, Cai, and I'll walk you through both of them. In the fourth quarter on BCA, we're going tohave lower volume. We're going to deliver 10 or 11 fewer airplanes, and we're going to have an increase in R&D relativeto the 787-9, which is principally driven by the change we made a year ago as to how we're going to fund thedevelopment and the supply chain. So those two things, we're going to see that will moderate the earnings profile in thefourth quarter for BCA. On the unallocated, in the first half of the year, we saw some one-timers relative to ourcompensation expense as the markets were down. Those markets are back up. We would expect in the fourth quarter toreplicate what we saw relative to our expense in the third quarter. And then added to that, we're planning on refurbishingour contributions trust where we would refund that in the fourth quarter, so that going forward, we can draw on that if weneed to so we can maintain our charitable contributions.

OperatorNext question comes from Howard Rubel with Jefferies.

Howard RubelJim, I wanted to just talk a little bit about 787. And could you talk about either volatility or what you would call surprises?And to Cai's point, I'd also like to ask a small second one, which is, as you look at the order book, if someone were tostep up and ask for an airplane today, when could they get first delivery across the product line?

W. McNerneyIt would be difficult to get one before the end of 2012, in terms of your second question. In terms of the first one, listen,we're getting through more and more of the test points every day on the 87 [787] certification program. We're on atrajectory to get most of the work done by the end of the year, certify first quarter as we've discussed. The Rolls [Rolls-Royce] engine is something that we're working on. Rolls is confident that they can support our schedule with a hardwareand a software fix. It is not going to require that they recertify the engine, rather just submit some data to in essence

sustain certification. And after that, it's a matter of grinding through the data, analyzing the data as it comes off of ourtesting. Every day, there is less risk in front of us, more risk behind us. But as I always say, Howard, is there somethingthat could jump up and surprise us? Yes. Do we see anything? No, but it is possible. But we feel confident in the mid-first quarter certification schedule.

OperatorOur next question comes from Ron Epstein with Bank of America.

Ronald Epstein


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Just a question, I think, about maybe broader R&D trends. You've got 787-8 proceeding, certifying next year, 787-9following, but the 747-8, something has to happen to 737 probably, something has to happen with the 777. So as wewalk out over, say, the next couple of years, how do we think about R&D trends? I mean, would the company be willingto do two development programs at the same time again? If you could just elaborate.

W. McNerneyEverything you identified represents the reality that's in -- and I would say the opportunity in front of us, Ron. I think firstorder of business is getting these two development programs done. And the vast majority of our current spending, asyou could imagine, today, is focused on doing that. As you've heard us talk about the narrow body, we see a newairplane opportunity out in the 220 range. And therefore, are continuing to question the necessity of a re-engine in themeantime, although we're studying it hard. And it is conceivable we would conclude that re-engining makes sense. Butwith the new airplane in the 2020 timeframe, it's not clear that it would. In the meantime, we are continuing to improvethe 737. I mean, we've gotten 5% on fuel from the engines since we introduced the NG [ph], there's another 2% outahead of us that we're introducing now. There's a new interior. So there's no reason to think that we wouldn't keepimproving that, which also bears on the re-engine question. So something that may be nearer in would be the 777, andthat's something that we're studying now. And there's a range of options there. But just to get into the end zone on yourquestion, when we're done with these programs, we will have more than adequate capacity to deal with the new 737,

and whatever we do to the 777. And yes, we will try to be smart about how we schedule that work and piling two directlyon top of each other would not be the approach.

OperatorOur next question is from the line of David Strauss representing UBS.

David StraussJim or James, could you help us quantify the kind of investment that you and you think your supply chain is looking at togo up to 38 a month on the 737? And how would the investment that the supply chain has to make be handled from yourend?

W. McNerneyWell, our current investment, by and large, supports a move to 38. We have some bottleneck here, a bottleneck there.But I would not characterize it as a major investment. There are a couple of elements in our supply chain that will requiresome investment. They have indicated to us that they are both prepared and have the wherewithal to do it, or else wewouldn't have made the judgment that we could. But there is some investment out there.

OperatorOur next question is from Doug Harned with Sanford Bernstein.

Douglas Harned

On the 787, can you talk about where you currently stand with respect to supplier payment negotiations, and particularly,with respect to the five large structural suppliers?

W. McNerneyWell, the big picture is that we're burning down the notional liability about like we thought we would. And that we arecomfortable with our projection at the end. That's the big picture. The five structural suppliers, they're in varying states ofdiscussion. Some have been completed, others, an approach has been agreed, and learning curves are being workeddown, with final resolution to be adjudicated after the learning curve is identified. So each one is a little different. Overall,I would say that we're on track, and we're comfortable with our accounting estimates.


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Douglas HarnedAnd when you say that some have been completed, does this include the rate increase to 10 per year and the 787-9?

I'm just trying to get an idea where this all -- how this all comes together and where the process is right now.

W. McNerneyWell, the process I'm referring to is the one that relates to the never-ending discussion between an integrator and asupplier on when there are changes, are they the result of execution on the supplier side or scope changes on theintegrator side? And that's complicated by the changes in schedule that we've had. So within our current scheduleagainst the backdrop of that usual discussion, it's the resolution of those issues than I'm talking about.

Douglas HarnedSo it's really the first -- the earlier set of airplanes, how you get through those rather than the full, basically the fullproduction outlook.

W. McNerneyWell, Doug, often times, these resolutions contemplate an arrangement that covers a long period of time. But each oneis a little different. But there are times where certain costs are relaxed early and recruit later against quantities that we'reboth comfortable with. And so these arrangements can extend over periods of time, or they can be in kind that time.Usually, they extend over periods of time.

OperatorAnd our next question is from Noah Poponak with Goldman Sachs.

Noah Poponak

I just wanted to try the BCA margin question again, both short term and long term. In the short term, it looks like yourguidance implies you have to be sub-8 in the fourth quarter. And you made a point on volume going down. But it doeslook like both volume and mix will be almost identical to the second quarter when you did 9.2%. And then longer term,do you see margin expansion beyond '10? You've got volume on mature programs, R&D, dilution of new programs kindof the big needle movers there. Are your positives greater than your negatives going forward?

James BellLet me just go back to the first part of your question. The differential between what you saw in second quarter and nowis the R&D increase that I mentioned on the subcontractor costs relative to the 787-9. So we're pretty much clear onwhere we're going to come out margin-wise on BCA. Now there could be some ticks up or down. But we're pretty muchon the run rate for the end of this year. Now as we go into '11, obviously, we're going to have some dilution as we bringonline the 787 and start delivering those and the 747-8. And that's going to have an impact on overall margins. We don't

think that, necessarily, it's going to impact the margin on the production program. We hope to continue that performance.But in total, margins will be down because we're going to start delivering the 787s and the 747-8s and we're going tohave margin dilution.

Noah PoponakDo you see the margin dilution of new programs as a larger negative than the expansion on mature programs, and R&Drelief is a positive?


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James BellYes, I do. That's why I said they'll be down overall.

OperatorNext we will go to Robert Spingarn's line with Sell-side Analysts.

Robert SpingarnJames, can you reconcile for us the billion-dollar adjustment in next year's cash flow guidance, with whatever amountthe 747 delay might have hit the third quarter on a pull-forward basis?

James BellWell, we've tried to do that, primarily because we're showing we're getting $1.5 billion more this year. And quite frankly,some of the things that the schedules have moved around on the two major programs has caused us to deal with thedifferences in what we'll have to pay and what we'll receive in the next year. And then when you add to that, the fact thatwe are going to have an investment, a discretionary investment, in pensions of $1.5 billion, that kind of gets you there.

Robert SpingarnAnd then just for more clarity, how much was the 747 P&L impact in Q3 that obviously was absorbed in your veryconservative R&D guidance?

James BellThere was none in terms of earnings.

Robert SpingarnNo earnings impact from the...

James BellWe had no further reach in third quarter as a result of the schedule slide. Clearly, we've been working -- the risk items,clearly, we've been working our opportunities and we had a little reserved in the number in our assumptions already.And when we aggregated all three of those, we came to the conclusion there wasn't a reach.

Robert SpingarnSo it's essentially a cash event next year?

James Bell

Yes, correct.

OperatorNext question comes from Joe Nadol's line representing JPMorgan.

Joseph NadolMy question, and I have a clarification also, I think it counts as one question, I guess. But my question is just on theRolls engine. Jim, heard what you said earlier. Could you be any more specific with what exactly is wrong with theengines or what needs to be fixed? And this more data, I guess, you said it doesn't need to be recertified. Just more


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data needs to be provided to the regulator. What data on what specifically? The clarification is, on the 777 horizon or theskyline in 2012, my understanding was that there were some open slots. Is that no longer the case?

W. McNerneyLet me deal with the Rolls engine, Joe, first. The event that caused a re-submittal of some data and some modificationof hardware and software was a non-contained test stand failure that I think we all know about. And the failure has beenunderstood by Rolls as they've said, and they now have to show the regulators that the -- and I would -- tweaks may betoo weak a word, but the modifications they make to both software and hardware are sufficient to address whathappened. Now I don't want to characterize. I wasn't there. I don't want to characterize exactly what happened. Theexperts are dealing with it. But Rolls is very confident. And having been in the engine business myself, I mean, Iunderstand how these things happen. And if they say they are confident, that they understand the root cause and havethe fix in hand, then I believe them.

Joseph NadolAnd then the 777, just a clarification?

W. McNerneyThe 777 is essentially sold out through 2012. And you're probably going to ask me about the word essentially.

Joseph NadolSure.

W. McNerneyYes, we have a pipeline of opportunities, and we have a sense of where they are. And I'd be very surprised if at thecompletion of some discussions we have ongoing today, that we wouldn't be sold out through 2012.

OperatorThe next question is from Troy Lahr's line with Stifel, Nicolaus.

Troy LahrJames, I'm wondering if you could just clarify a little bit, on the defense margins, are you implying that in 2011, theycould decline further? Or are there some efficiencies offsetting and then some favorable international mix that couldallow you to kind of hold that 9%? I know you don't want to talk about 2011 direct margins, but maybe just directionally?

James BellYes, we think we'd be flattish in 2011. And again, we'll give you more insight of that at the end of the fourth quarter. But

we are taking into recognition that this is a much more difficult contracting environment that the defense business isfacing into. At the same time, we're doing the things that we need to do to make that business more competitive and totry to retain the profitability, as well as looking at our international opportunities to offset some of the lower margins we'refacing into domestically. But essentially, we think we would be flattish.

Troy LahrSo with backlog growth, still expecting a little bit growth on the top line?


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James BellRelatively flat from a revenue standpoint as well.

OperatorAnd we'll go to Peter Arment's line with Gleacher & Company.

Peter ArmentI guess, I'll ask a clarification question also, just following up on Defense. Jim, how do we think about, just given all theinternational activity that I think is being thrown around out there, whether it's India or Saudi, and layering in obviously,the multi-year on F-15. Is Defense for you, longer term, kind of -- are we kind of down-ticking a little bit on the top line,but I think ultimately, you're seeing some of this international activity backfilling some of the softness domestically? Howdo we think about that longer term?

W. McNerneyYes, I mean, I think that's a good question. I think the way to think about us is that with the readjustment of the old

Future Combat Systems program and ground-based missile defense having really hit us this year, we took our lumpsearly with some of the program adjustments at Pentagon. We now, in my view, and our backlog suggests it, are in prettygood shape in terms of the international opportunities, as well as some of our adjacency investments, offsettingpositively additional softness in programs. So I think we've taken a pretty good hit. I would not characterize theprospects ahead of us in defense as wild-eyed growth. But I would suggest that there is an opportunity to grow withinternational and adjacencies leading the way. And by the way, the F-18 multi-year, the Apache multi-year, a lot of ourbase programs growth in the satellite business, I think when you tear it apart, I think you'll see some opportunities therethat really haven't been -- the helicopter -- I would say, helicopter business you saw in the U.K., notwithstanding somepretty draconian cuts, the one new program that they retained was their Chinook program over there. So there's a goodfoundation in that business.

Operator

And next, we will go to J. B. Groh's line with D.A. Davidson.

J. B. GrohI was wondering if you guys could talk maybe about aftermarket trends at ABO. I know you mentioned that a pick-up indiscretionary spending on things like reconfigs and that sort of thing. But specifically, within the aftermarket business,past an inflection point, could you talk about trends there?

W. McNerneyYes, we're beginning to see a pickup in ABO, and the extent to which that represents a surrogate of aftermarket with abias toward engines, as you know. I think that's a positive sign for us. I think airframe spares are recovering a little moreslowly. I think mods have come back a little faster than we thought on the airframe side. So ABO a plus; mods a plus;

spares, signs of life.

OperatorWe have a question from Robert Stallard with the Royal Bank of Canada.

Robert StallardOn the 787, Jim, if you stick to this target of mid-Q1 delivery, at what point do you expect to tell the supply chain to startshipping again? And at what sort of rate do you expect it to take them to as you move through 2011?


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W. McNerneyWell, the supply chain has been shipping all along. We have not told them -- they are currently shipping against the

schedule. And as you may know, we are building inventory as we complete flight test. So the supply chain has not beenstood down at this stage. The supply chain is moving. There was an adjustment earlier this year that you may bethinking about, where in order to rebalance this supply chain, we had most of our supply chain slow down for a period oftime. But that has since picked up.

Robert StallardAnd in terms of the rate, you expect them to move up too in '11?

W. McNerneyYes, I mean, the supply chain -- and we'll get into more details at the end of our fourth quarter call, when we talk morespecifically about next year. But as we look at it right now, as we're thinking about deliveries next year to say, we haveconfidence the supply chain can meet the delivery profile that we're working with right now.

OperatorYou have a question from Myles Walton representing Deutsche Bank.

Myles WaltonWith the 747, similar question along the lines of Rob, in terms of what you're directing to the suppliers in terms ofshipping versus schedule. Are you signaling any slowdown to them or is the plan to just have a greater amount offinished goods at certification and delivery? And can you talk about how you're balancing that versus the risk of rework?

W. McNerney

Well, as you know, we've been working sort of four issues on the program, two of which are well in hand, the Flaps 30issue and the wheel-well finish issue. The low frequency vibration and the actuator issue, we're feeling increasinglycomfortable that we have the fixes in hand. We're going through testing right now. With those completed, those are thefour that really impacted the schedule, we feel good about the -- if the confirmation on the vibration in the actuator getsin hand, we feel good about the schedule. The supply chain knows the schedule. We've added a fifth plane to flight testto ensure that we meet cert. So I think we're pretty balanced against the new schedule with our supply chain. I'd besurprised if there was any confusion.

Myles WaltonSo they're continuing to ship to the original schedule though despite the delay?

W. McNerneyWell, there may have been some -- to be frank with you, I don't know precisely if there was some modification. Butagainst the schedule that we've got now for certification and the delivery schedule, which was not impacted dramaticallyagain, but we'll be more articulate on that next year, at the end of the next quarter, but the change in certification did notdramatically change deliveries, which means that we kept the supply chain going, as you suggest.

OperatorOur next question is from Ken Herbert with Wedbush Securities.


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Kenneth HerbertJust wanted to follow up. You've mentioned on Commercial Airplanes that you're now expecting to end the year with abook to bill of greater than one. And I know the order flow this year, I think, has clearly been a lot stronger maybe thanyou'd anticipated earlier in the year. Can you talk about some of the trends you're seeing on the order book into this

year, but then more importantly, out over the next couple of years? And are we seeing any of the orders now as pullingahead what you might have been expecting in one to two years? Or what sort of ramp are you looking at out a few yearsin terms of the order book?

W. McNerneyWell, I think you're right. The orders came in stronger this year than we anticipated. Accelerations in our supply chain,we continue to have some pressure there. Although as you know, as we discussed before, we also have some deferrals.But the net is positive. Based on the discussions we're having with customers now, while it's hard to predict exactlybecause it's somewhat dependent on the economic situation, the pipeline that we have right now would suggest acontinuation of strong-ish orders, not going back to the days of the mid-2000 and 2000s, that's not what I'm suggesting,but sort of would be in line with a slow steady kind of recovery. That's our best thinking now.

Kenneth HerbertAnd just as a quick clarification or follow-up. Are you seeing anything in terms of on the financing side that is a potentialcause for concern?

W. McNerneyI think it's fair to say we're financing somewhat less than we thought we we're going to. So we're always vigilant thereand we're part of every deal to make sure if we're needed, we're available. But we don't see anything out there that isany disruptive change. As a matter of fact, more positive than negative.

OperatorOur next question is from Jason Gursky representing Citi.

AnalystIt's actually John Ruby [ph] with the question. Just going back to the Defense margin, you talked about some of thepressure you see next year. Are you seeing that manifest itself specifically in any of the current programs like theApache F-18 multi-years, or even internationally with the Saudi program?

W. McNerneyThe international opportunities, margin-wise, are coming in about as they have historically. I think, right now, we're inperiod of pressure, as you suggest in the United States. And in many cases, like the F-18 multi-year, there is pressureon margin. The deal is pressure on margin to get volume. And that would be a common theme across most of ourproduction programs in the United States. And that's the largest source of the margin pressure.

OperatorNext, we will go to Carter Leake's line with Davenport & Company.

Carter LeakeLast quarter, you commented that the pricing outlook, you described it as stable with room to be competitive if need be.Is that still your outlook?


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W. McNerneyYes, are you talking on the commercial...

Carter LeakeI'm talking about commercial aircraft.

W. McNerneyCommercial side?

Carter LeakeYes.

W. McNerneyYes, I think that's a fair characterization, and I don't think I changed it.

OperatorOur final question today will come from George Shapiro representing Access 342.

George ShapiroCiti

Probably for James, the margin x R&D this quarter was 19.8%, well above the 18 1/2% we've seen in the first couple ofquarters. Now you clearly had favorable mix with a high percentage of freighters. But could you break down how wasdue to mix, how much productivity, and how much maybe was profit accrual increases on any of the 737 or 777?

James BellWell, it's hard to give you that kind of specific detail, George. But it wasn't just mix, it was also volume, and then also,volume coming out of cash where we saw an increase there. And that's why I said, in the fourth quarter, you'll see thatmoderate. So the productivity is running about the same over the course of the year. The pricing is holding about thesame. So all the elements that you would normally see are about the same. It's just we had more of them in the thirdquarter. And again, that'll moderate in the fourth quarter.

George ShapiroCiti

The commercial aircraft revenue number was somewhat higher than what I thought. Is that primarily due to maybehigher pricing on the freighters? Or just the aftermarket increase you alluded to?

James BellClearly, it was mix. We did have a pretty good mix of 777 freighters in third quarter. So I would suggest it would be that.And some of it was the out of the service business because of the experience we saw in ABO.

OperatorThat completes the analysts question-and-answer question session. [Operator Instructions] I will now return you to the


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Boeing Co. for introductory remarks by Mr. Tom Downey, Senior Vice President of the Corporate Communications. Mr.Downey, please go ahead.

Tom DowneyThank you. We will continue with the questions for Jim and James. If you have any questions after the session ends,please call our Media Relations team at (312)544-2002. Operator, we're ready for the first question. And in the interestof time, we ask that you limit everyone to just one question please.

OperatorOur first question comes from Susanna Ray, representing Bloomberg.

Susanna RayBloomberg

Actually, I have two quick questions, but they're quick, hopefully. You mentioned having capacity to deal with both the

737 and 777. And I'm wondering, capacity for what exactly? Like capacity for modest improvements to build or for fullnew planes in both segments?

W. McNerneyI think it's related to the production ramp-up that are in our plans and the extent to which we would have to investsignificant amounts of capital to execute them. And my answer was modest amounts of capital to implement ourannounced production rate increases on the 737 and the 777.


So you weren't talking about the changes that you're looking at in both segments? I thought the question was about likewhether you have the capacity to deal with both at the same time?

W. McNerneySusanna, are you asking about R&D? I'm sorry if I'm misunderstanding your question.


Yes, you're mentioning -- yes, capacity to deal with both, whether it's R&D for modest improvements or for full newplanes or...

W. McNerneyNo, I'm sorry. Let me reload. I answered the wrong question, I apologize. I think once we complete the 787 and the 747-8 programs, which represent a relatively high watermark of R&D spending, as you can imagine, there will be adequatecapacity to deal with both the 777 improvements that we need to make and the narrow-body 737 replacement.



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And then just separately, the headcount, is it going back up? Will it go back up? And how will you keep engineers if R&Dis coming down?

W. McNerneyWell, headcount is moving in different directions in different parts of the company. I think there will be a plateauing and aslowdown of headcount in the commercial R&D after the completion of the 787 and the 747-8, and then a ramp-up aswe execute the other programs later in the decade. In our Defense business, as I've mentioned, there are parts ofstructure and general and administrative that are coming down in response to the cost pressure we're seeing. Someprograms have stopped in Defense which has a negative impact on headcount. So it's different dynamics in differentparts of the business.

OperatorWe'll go to Aubrey Cohen's line with SeattlePI.

Aubrey Cohen

Mr. McNerney, you said something earlier that I wanted to understand what it was that you meant. You were talkingabout the 737 reengineer replacement and then you said that the 777 might actually come down first. I was wonderingwhat you meant by that? You said actually something that maybe nearer in with the 777.

W. McNerneyWhat I meant to say was that if we do a new 737, roughly on 2020 timing, and as we're studying the market, that seemsto be a timing that our customers might require. If we did a new narrow-body then we would probably have to addresschanges to the 777 before that.

Aubrey CohenAnd when you say changes, does that mean re-engining, or can you be more specific?

W. McNerneyWe're studying everything from a completely new airplane to modifications to the weighing in the engines. We'restudying a wide range of options, and we're trying to figure out what our customers need.

OperatorOur next question comes from Hal Weitzman with Financial Times.

Hal WeitzmanFinancial Times

I wanted to go back to the Defense issue. And just so I understand it, you talk a lot about the pressure on the kind oftraditional U.S. focused defense business, and you talked about moving into adjacent sectors and international markets.But how do you look at that traditional U.S. focused defense business? Are we in a new reality of this lower spending?Or are we in a down cycle?

W. McNerneyIt's hard to know. For sure, we're in a down cycle in the United States and other more mature economies. U.K. isanother good example. And for sure, developing markets are looking to refurbish their defense technology. And so thattrend is leading toward a greater mix of international sales, I'm convinced, over the next number of years. Whether the


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U.S., it's just a down cycle or it's a new normal, that's very hard to predict. Although I don't think the threat environmentis going away.


I guess the question is, will that threat be dealt with through kind of the traditional business or through some of thesemore exciting side of businesses, whatever?

W. McNerneyWell, I think it'll be a mix of both. But the real physical threat won't go away, and there will be a new, as you imply,information-related threat. So you add that all up, it's hard to suggest that, that means dramatically less spending for anextended period of time.

Hal Weitzman

Financial Times

Am I right to understand that you suggest that you could cut more jobs or facilities on the Defense side?

W. McNerneyWell, we're responding now to the, in essence, price and volume pressure that we're seeing in our Defense business.And we're trying to do that responsibly so that we can remain competitive. But yes, it does mean headcount reductionsin our Defense business.


You mean, you could make fresh reductions?

W. McNerneyWell, we have made some, and we will likely make some more.

OperatorWe'll go to Dominic Gates' line with Seattle Times.

Dominic GatesSeattle Times

We learned some things during the quarter about plans for expansion in Seattle of what you're now calling, I think, theadvanced developmental composite center, something like that. The old D.C. on marginal way is being expanded forBCA and more works going there. Could you tell us a little bit about the plans for that?

W. McNerneyWell, I mean, I think there is a plan to do that. Composite design and manufacture remains a fundamental competitiveadvantage for this company, particularly as it's applied to commercial markets. And as we get through the 787development, it makes all kinds of sense to figure out how to go down both the design and production learning curve.And this center is designed to give us advanced capability in both.


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It's interesting that you want to do design and production research there. Would you perhaps see some significantproduction happening there on the next airplane?

W. McNerneyWell, it's hard to know where the next airplanes are going to be built. But that will depend on customer cost and servicerequirements. But clearly, the kind of advanced capability that this center would represent is something that could beapplied to any place that we would design and build airplanes, and also, design to help our suppliers as they makemajor structures for us.


And lastly, could you give us any idea on numbers or the headcount there for example?

W. McNerneyI think we're still working through that, Dominic.

OperatorOur final question today will come from Paul Marion with Crain's Chicago Business.

Paul Marion

Cranes Chicago Business

Last week, you told non-union employees that their healthcare deductibles and copayments could be going up nextyear, partly because of healthcare reform. Can you clarify how much of a factor health reform was in that decision, giventhat the tax and so forth doesn't take effect until 2018?

W. McNerneyListen, we are driving changes in our healthcare plan, which is, by the way, one of the country's best plans, when youbenchmark it against both our competition and other large companies. So we're coming from a pretty robust place.We're responding to the overall cost pressures that we see in the marketplace. It's hard to assign exactly where all thecost pressures are coming from. But the facts are we see cost pressures that we have to deal with and have to ask ouremployees to work with us on. We're going to still end up at a place that is better than the healthcare plans that mostpeople have in most companies. So I think the story is more is responding to overall cost pressures than it is trying to

assign these cost pressures to any one element.

Paul MarionCranes Chicago Business

But having a good plan is the problem in terms of the tax that'll be imposed under healthcare reform?

W. McNerneyWell, that tax, which is pretty far out there, would certainly be a cost element that we'd have to deal with.


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Scott FittererOkay, that concludes our earnings call. Again, for members of the media, if you have further questions, please call our

media relations team at (312)544-2002. Thank you.

OperatorLadies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using theAT&T Executive Teleconference. You may now disconnect.


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D t C t d N 08 2010 P 22 f 22

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Boeing Co Q3 2010 Earnings Call

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Transcript of Boeing Co Q3 2010 Earnings Call