Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

The Boeing Company (NYSE:BA)

Q2 2006 Earnings Conference Call

July 26, 2006 10:30 am ET

Executives

W. James McNerney - Chairman of the Board, President, Chief Executive Officer

James A. Bell - Chief Financial Officer, Executive Vice President

David Dohnalek - Vice President, Investor Relations

Tom Downey - Vice President of Corporate Communications

Analysts

Heidi Wood - Morgan Stanley Dean Witter

Howard Rubel - Jefferies & Co.

Douglas Harned - Sanford C. Bernstein & Company, Inc.

Robert Stallard - Banc of America Securities

Byron Callan - Prudential Equity Group, LLC.

Steve Binder - Bear, Stearns & Co.

Cai von Rumohr - SG Cowen & Co.

Robert Spingarn - Credit Suisse First Boston

Joe Campbell - Lehman Brothers

Ronald Epstein - Merrill Lynch

George Shapiro - Citigroup

David Strauss - UBS

Joseph Nadol - JPMorgan Chase & Co.

Myles Walton - CIBC World Markets

Joseph San Pietro - Wachovia Securities

David Gremmels - Thomas Weisel Partners

Media

Jonathan Carp - The Wall Street Journal

Molly McMillen - The Wichita Eagle

Amik Sacheet - Chicago Tribune

Presentation

Operator

Thank you for standing by. Good day, everyone, and welcome to the Boeing Company’s second quarter 2006 earnings conference call. Today’s call is being recorded. The management discussion and slide presentation, plus the analyst and media question-and-answer session, are being broadcast live over the Internet.

At this time, for opening remarks and introductions, I am turning the call over to Mr. David Dohnalek, Vice President of Investor Relations for the Boeing Company. Mr. Dohnalek, please go ahead.

David Dohnalek

Thank you. Good morning, and welcome to Boeing’s second quarter earnings call. I am Dave Dohnalek and with me today are: Jim McNerney, Boeing’s Chairman, President, and Chief Executive Office; and James Bell, Boeing’s Chief Financial Officer.

After brief comments by Jim and James, we will take your questions. In the interest of time, we ask that you limit yourself to one question.

As always, we have provided detailed financial information in our press release issued earlier today.

As a reminder, you can follow today's broadcast and slide presentation through our website at boeing.com.

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

Now I will turn the meeting over to Jim McNerney.

W. James McNerney

Thank you, Dave, and good morning, everybody.

Let me begin with a few comments about our second quarter performance, and then James will walk you through the numbers. After that, I will say a few words about the road ahead and then we will both take your questions.

Boeing has made good progress across most areas of our business during the quarter. We executed our plans to improve financial results with one notable exception, and that was in our International Airborne Surveillance program, or AEW&C. The charge we announced for that program, and for the global legal settlement, reduced our reported EPS for the quarter by a combined $1.15.

Still, the bulk of our business has once again generated strong performance, with revenues on-track and outstanding cash flow of more than $2.4 billion during the quarter.

We used our cash to invest in our organic growth programs and add capabilities to our services businesses. We also improved our liquidity position, reduced debt and returned capital to our shareholders through our dividend and share-repurchase programs.

Our strong cash generation was driven in part by the outstanding sales success we continue to achieve in our commercial airplanes unit, which has expanded our total company backlog to another record level of $220 billion.

Overall, we continue to be well-positioned in healthy markets. Our commercial airplanes business remains our growth catalyst, thanks to an expanding market and airline customers who increasingly prefer Boeing's value-creating products.

Our defense portfolio also remains solid, and we continue to have the industry's largest backlog at $78 billion. While most IDS programs are performing well, we regret the impact the AEW&C program delays are having on our customers in Australia and in Turkey.

We are fully committed to taking the necessary steps to meet our customers' requirements there. We are also committed to returning to the double-digit margin performance that we have all become accustomed to at IDS.

Business execution is of paramount importance to us. It is our main focus.

Looking ahead, we have updated our '06 outlook to reflect the charges from this past quarter, as well as some operating improvements going forward. We also raised our guidance for 2007 revenue and earnings, due to a stronger commercial airplanes outlook and better expected operating performance.

Before I turn it over to James to provide more detail on our financial results and our updated outlook, I would like to say a few more words about the global settlement we reached with the U.S. government during the quarter and our decision not to seek tax deductibility for any of the charge associated with it.

A few years ago, certain Boeing employees did some things that were wrong. We accepted responsibility for their actions and, through the settlement, we sought to put the past behind us and move toward a new era where ethics and compliance would become a competitive advantage for Boeing.

We have made substantial changes in our ethics and compliance programs and are embedding ethics and compliance in everything we do, at all levels in the organization. We have been advised that the bulk of the settlement is in fact tax-deductible and that similar deductions have been allowed in the past.

Without question, the short-term financial impact of the taxability issue is significant. However, the long-term value of Boeing's reputation is even more significant.

Accordingly, I feel strongly that the right thing for Boeing to do is not to seek tax deductibility for the settlement charges. This should be a signal to our employees, customers, suppliers and our shareholders of our willingness to acknowledge responsibility, accept accountability and to move forward in a manner reflective of the great legacy of our company and its employees.

Simply speaking, my intent is to focus on the future and put this unfortunate part of our past behind us. As we move forward, operating with integrity will differentiate Boeing just as much as our technology, our talented people, and our attention to customers.

With that said, let me turn it over to James.

James A. Bell

Thank you, Jim, and good morning.

Our revenue this quarter reached $15 billion, thanks to a 10% increase in top-line growth at our commercial airplanes unit.

Reported EPS was affected by the charges, totaling $1.15 per share that Jim mentioned earlier. Of that total, the global settlement charge was $0.75 per share, while the AEW&C charge was $0.40 per share.

Now let's review the performance of our business. Next slide, please.

Commercial airplanes is benefiting from a product strategy that is keenly focused on our customers and our commitment to continuous productivity improvement. Revenues for the quarter rose 10%, and BCA's operating margins expanded to 10.1%, driven by a 14% increase in deliveries. We are on track to deliver 395 airplanes this year, a 36% increase over last year's total.

These numbers reflect our success in working with our global partner network to efficiently increase production rates across the entire supply chain, while at the same time manage for profitability.

We are increasing our R&D investment in BCA primarily to reduce risks on 787 program goals related to weight and schedule. The program remains on track to meet its performance commitments and entry into service.

We captured 311 airplane orders during the quarter with our industry-leading product line. Our success has enabled us to grow our very large commercial airplane backlog, which has now reached a record $142 billion.

The strong order environment and the market demand for Boeing products drove our order total for the first six months of 2006 to 487 airplanes. As of today, we have won net orders for 510 airplanes.

We continue to make progress on the 787. We began manufacturing and major assembly during the quarter. We also added to the large backlog of 787 orders in the period. Since program launch, we have captured 364 firm orders from 25 customers from around the world.

We expanded our large service businesses during the quarter by completing the Carmen Systems purchase and announcing an agreement to acquire Aviall. These focused acquisitions, combined with double-digit organic growth in our service businesses at both BCA and IDS, will help us deliver enhanced capability to our customers and additional value to our shareholders.

We also achieved key milestones during the quarter, including the roll-out of our first 737-900 extended range aircraft.

Later today, we will deliver the 2,000th next generation 737 airplane. That airplane is going to Southwest Airlines, which took delivery of the first next generation 737 less than a decade ago. We have reached 2,000 deliveries quicker than any other commercial jet in history, underscoring the 737's performance, reliability, and appeal to airlines around the world.

Clearly Boeing Commercial Airplanes is performing very well in a strong market, and we are raising our guidance for BCA revenue and earnings in both 2006 and 2007. Next slide, please.

Our IDS business delivered solid performance across most of its large, diversified portfolio of defense programs. However, that performance was affected by the $496 million charge we took in the quarter for the AEW&C program. With that charge, our reported margins declined to 4% on stable revenues of $7.8 billion. Without the charge, IDS margins would have been in familiar territory above 10%.

As Jim said, we believe we have the issues on that program identified and have an achievable go-forward plan in place. We are working closely with our customers to get that program back on track.

Looking across the vast array of programs at IDS, we have made good progress.

We delivered 24 production aircraft, one satellite, and six launches during the quarter.

We also achieved key milestones in our ground-based mid-course defense program, our future combat systems program, and our EA-18G electronic attack aircraft.

During the quarter, we made progress on our proposed ULA joint venture, which we hope to complete later this year.

While growth in defense markets is expected to moderate, our IDS business remains supported by the industry's largest backlog of $78 billion. Next slide.

Boeing Capital delivered $62 million in pre-tax earnings in the quarter, and reduced its debt by nearly $600 million. The aircraft financing market continues to improve, and BCC is executing well on its mission to support Boeing's core business, while managing its portfolio size and risks. BCC has reduced debt by $2.7 billion and paid dividends to Boeing exceeding $1 billion over the past two years.

We announced last month that we are evaluating various alternatives for our Connexion by Boeing business, including a possible sell or shutdown of operations. A decision along these lines would likely result in a one-time impact to earnings in 2006 of up to $350 million pre-tax.

However, if we do decide to divest or shutdown the business, the move would be accretive to our EPS in 2007 and beyond. The impact to 2007 could be an increase to EPS of up to $0.15 per share. Neither of these numbers are included in our guidance.

Turning to our balance sheet on slide 7, we continue enjoying outstanding balance sheet strength and liquidity. We ended the second quarter with $10.6 billion in cash and liquid investments. Our total debt levels decreased about $500 million in the quarter, as BCC paid down maturing debt consistent with its reduced portfolio size.

Financial strength and solid credit quality remains priorities for us, and we are pleased to have the highest credit rating in the industry.

Moving to cash flow on slide eight, our cash flow generation remains outstanding as we delivered $2.4 billion of cash flow in the quarter, and $4.5 billion for the first six months of 2006. This cash performance reflects strong cash earnings, another strong quarter of airplane orders, and excellent working capital management.

Also during the quarter, we repurchased 6.3 million shares, paid a dividend, purchased Carmen Systems with cash, and continued to invest in our growth program such as the 787 and the new 747-8 -- all of which is consistent with our balanced deployment strategy.

Turning to slide nine and our financial guidance, we are adjusting our EPS guidance for 2006 to reflect the charges and some offsetting operating improvement, and we are increasing '06 revenue guidance for higher BCA revenue.

We are also raising our 2007 revenue in EPS guidance to reflect improvements, primarily at BCA.

Our revenue guidance for this year is now increased to between $60 billion and $60.5 billion. We have increased our 2007 revenue guidance approximately $1 billion, to between $64.5 billion and $65.5 billion, due to higher BCA revenues from airplane mix and features in both years.

Let me remind you that our revenue guidance for 2006 includes approximately $1 billion for a business plan to be part of the pending United Launch Alliance transaction. Upon completing that transaction, Boeing would use the equity method of accounting for this new joint venture.

Earnings per share this year is expected to be between $2.40 and $2.55, and includes the $1.15 in charges partially offset by higher earnings at BCA and a lower pension expense.

EPS for 2007 has increased $0.15 a share to between $4.25 to $4.45, primarily due to higher revenues and earnings at Commercial Airplanes.

We are including more R&D in these EPS forecasts and now expect it will be about $3 billion for each year, to ensure that we provide enough resources at the right time to keep our major development program in BCA and IDS on track.

We are maintaining our operating cash flow guidance for 2006 and 2007 at greater than $5.5 billion for each year. Next slide.

Here you see a detailed schedule of changes to our EPS guidance, which breaks out the charges and the performance improvements. In addition, additional segment guidance is provided in our earnings release.

Now I will turn it back over to Jim for some final thoughts before we take your questions. Jim.

W. James McNerney

Thank you, James.

As James said, our outlook continues to strengthen. Our businesses are strong. Our products are valued. They are building upon our customer relationships and we are focused simultaneously on growth and productivity.

Throughout the organization, we are committed to consistent execution, avoiding past mistakes and delivering on our commitments. We are keenly aware that our success depends on providing better value to our customers and on operating our businesses with the highest levels and standards of integrity.

Now, having said this, we would be delighted to take your questions.

Question-and-Answer Session

Operator

Thank you.

(Operator Instructions)

Our first question comes from Heidi Wood of Morgan Stanley.

Heidi Wood - Morgan Stanley Dean Witter

Good morning. Jim, I have a question for you. It is actually a big picture question, if you do not mind, but when we look at a quarter like this, with the charge on the Delta 4 because of the [buy-three] on the EELV, the AEW&C charge, potential disposition of Connexion and again another potential charge for that -- now that you have been CEO at Boeing for a year and you said in your comments that business execution is a main focus, can you give us some specifics about how you are addressing the risk mitigation efforts through the company, so the issues come to you earlier and the charges are smaller?

W. James McNerney

I think, Heidi, part of the increased focus on risk management and program execution has been to service some issues over the last year. I think that is part of the result of this focus.

Having said that, we have had more things to deal with than I would have liked. AEW&C we have talked about. The Delta charge is associated with restructuring the business into a far more viable entity going forward. I think you can talk your way through that one as a way to better position your business for the longer term. I think Connexion would fall into the same category.

But that does leave you with a couple of things that we are not proud of, that in part were surfaced by I think an increased focus on accountability and execution.

That is not a perfect answer for you, but maybe by way of explanation that helps a bit.

Heidi Wood - Morgan Stanley Dean Witter

Thank you.

Operator

Thank you. Our next question comes from Howard Rubel of Jefferies.

Howard Rubel - Jefferies & Co.

Thank you very much. Could you explain a little bit how you can increase your revenue forecast in commercial business but not change the expected delivery schedule?

James A. Bell

Yes, Howard. I think what you are seeing in both years is the fact that we are doing better in features, options and things of that nature. In '07, we are seeing some increase in the service business. That is really where it is coming from.

If you look at the increase, particularly in '07, it is about 3%. It is not unusual to see that as you get closer to delivery, the customer gets more specific about what are the special features and options they want on their airplanes.

Howard Rubel - Jefferies & Co.

Thank you.

Operator

Thank you. Doug Harned, of Sanford Bernstein, you may ask your question.

Douglas Harned - Sanford C. Bernstein & Company, Inc.

Good morning. I would like to get your reaction to Airbus' wide-body approach coming out of Farnborough. First, there are a lot more details that need to come out on the A350, but the focus of the initial airplane is at the large-end of the 787 and the low-end of the 777. Not surprisingly, they are claiming better performance. In addition, we are seeing Airbus pricing very aggressively to get more A330’s in the market at the same time.

When you look at all of this, how do you see Airbus' A350 launch and approach to the A330 impacting BCA's performance and product strategy?

W. James McNerney

First of all, we did not expect them to do nothing. They have introduced a product that, on the face of it, and since we really do not have a clear definition of what the product is beyond the concept that has been discussed, it is hard to react to the specifics with regard to performance versus our airplanes.

I will say that it seems they are trying to cover two of our airplane families with one airplane, which is a tough putt. You are right, it has some elements of competitiveness with the low-end of the 777 line, if they can execute along the lines of the concept they put out.

We do not see it as a plane that can compete very well with our 787 line. It is a little big and a little heavy to do the mission the 787 can do.

In summary, you have a single airplane trying to cover two of the most successful families of airplanes we have ever had. Knowing a little bit about engine technology associated with these kinds of planes, which is part of the value package as well as the plane itself, it is an ambitious program.

Now, will it be a good airplane? Yes. Will it fit some missions well? Yes. Will they try to, while they gear up production -- which will take them two to three years longer than us getting the 787, we have already had the 777 out for 10-plus years -- will they aggressively price old technology to bridge some customers? I would be tempted to do that, and that is the A330 story.

What they are doing makes sense, but will it be enough is the question.

Douglas Harned - Sanford C. Bernstein & Company, Inc.

You are not seeing any real change in the way you are looking at them, at the market based on this?

W. James McNerney

I do not think so. We expected competition in our business plans, obviously, and I think the revamped 350 concept that we are seeing I do not think fundamentally changes what we are doing. We have two pretty good-sized book-ends on either side of their airplane.

Douglas Harned - Sanford C. Bernstein & Company, Inc.

Thank you.

Operator

Thank you. Robert Stallard of Banc of America Securities, you may ask your question.

Robert Stallard - Banc of America Securities

Good morning. Jim, I wanted to ask you a question about the 787. There has been a lot of talk you may be considering an extra production line on this aircraft. Can you walk us through your thought process there and why you would be willing to take on potentially extra risks to produce more aircraft?

W. James McNerney

That is a good question. There is no doubt that BCA is experiencing more demand -- unprecedented demand -- for this airplane. In a perfect world, we would like to be able to produce as many of these things as people have interest in. But of course, we have to balance orders with supply chain, with development considerations, and yes, there is upward pressure on our current production plans.

Alan Mulally and his team are sifting through alternatives, which range from increased productivity in their current facilities, or currently being developed facilities, as well as potentially some additional facilitation. We have not made a call there, but you are right -- the demand for this airplane, the unprecedented demand for this airplane is forcing us to ask the question.

There are worse questions to ask and answer, and over the next year or so, we will come up with a final answer there.

Robert Stallard - Banc of America Securities

So this plane is essentially sold out until 2010? Is that the current situation?

W. James McNerney

Beyond that -- pretty much through -- it eats into ’11 pretty far too.

Robert Stallard - Banc of America Securities

Thank you.

Operator

Thank you. Byron Callan of Prudential Equity Group, you may ask your question.

Byron Callan - Prudential Equity Group, LLC.

This is really just a follow-up on Heidi's question -- how satisfied are you that the focus on execution is such that Boeing has gotten to the bottom of the barrel on some of the issues of that have vexed earnings lately? Are you satisfied that you have the risk reduction disciplines, and even the culture in place that we are not going to see some of these surprises in the future?

W. James McNerney

No, I am not totally satisfied -- none of us are. As I answered Heidi's question, I try to portray a situation where the increased focus itself is surfacing some things.

But I think what this company does are things that no other company does and as a result, we can push the envelope a little bit. We have to be more careful, not only in execution, but on things we choose to do. We are spending a lot of time focused on it. We have a lot of our initiatives focused on it. I would see every quarter, every year, an improvement.

But I am not satisfied with where we are and I probably never will be totally satisfied, because that is a little bit of the nature of the business, but we are going to improve.

Byron Callan - Prudential Equity Group, LLC.

Thank you.

Operator

Thank you. Steve Binder of Bear Stearns, you may ask your question.

Steve Binder - Bear, Stearns & Co.

How should we look at the margin guidance for BCAG for '06 and '07? You did not change margin guidance, but you did increase the R&D expense. Should we look at it as just block extensions? Is it lower expected costs on programs? Is it rate changes in the outlook? What are the factors offsetting the R&D build?

James A. Bell

Actually, we did have a block extension for the 777 -- it was off 50 this quarter, and that is why you will see that the deferred production costs went up slightly.

But no, it is a combination of things. We are working our productivity initiatives. We are harvesting the benefit of that. That is being somewhat offset by raw material costs, so we are dealing with that.

Clearly the R&D that we have, that we guided you to that is going up, is really there to make sure that we can get through some of the issues you normally would encounter at this phase of a development program, while raising the level of insurance that we will be able to meet our customers commitment and our in-service date schedule.

That is why you are seeing the balance in terms of margin guidance, both this year and next at BCA.

Steve Binder - Bear, Stearns & Co.

James, does the charge that you are taking on delta four, the buy-three agreement, essentially extinguish any further risk of write-offs? You had $465 million hung up on the balance sheet in deferred production costs and tooling. Is this pretty much behind us now?

James A. Bell

Thank you for that question, Steve, because I did want to expand on the discussion of the charges this quarter. Clearly this tentative agreement gives us a framework where I think it greatly reduces the risks of recoverability of our costs, both in fixed assets and in our inventory, because it provides the framework under which those costs would be recoverable, and just as importantly, it allows us to maintain our capability to produce this product and launch it, and without the same risks we had before we got this agreement.

I really look at that as a positive when I think about the agreement we have reached tentatively with the Air Force. Obviously we have to work towards getting that [definitive] by the end of the month.

In addition, there was a little charge for manifest change, so I want to be transparent with that, too.

As the [launches] we have [are under locks], under contract, if the schedule slips, you can see some slight growth in the cost of each of those launches, but I think this agreement really, really significantly reduces the risk associated with the recovery of those costs.

Steve Binder - Bear, Stearns & Co.

Thank you.

Operator

Thank you. Our next question comes from Cai von Rumohr of Cowen & Company.

Cai von Rumohr - SG Cowen & Co.

Thank you. For the second quarter, BCA has done 10% margin. Could you comment first on some of the color on that? For example, the difference between program and unit cost narrowed. What did the impact of the 777 block extension do?

Secondly, while you have increased R&D, essentially it looks it is going to be relatively flat next year, and the volume at BCA now is going up. Explain to us again why those margins do not go up, or in fact, if there is a chance they could go up, what should we look for to tell whether they might?

James A. Bell

In '06, as you look at where we are this first part of the year, in the second-half of the year, we are going to have less contributions by our supply chain to our R&D. That is some of the impact.

We are having higher R&D costs this half of the year, and then we have timing on some of our expenses, primarily our selling expense. That is what you are looking at and how it would moderate. In fact, if you took the contribution out of the second quarter, we would be closer to what the run-rate is that we guided you to.

So we think we are pretty comfortable this year that that is about the right number.

Going to next year, again Cai, it is -- clearly we are going to increase the R&D spend rate. We are also going to be careful with what is going to happen with raw material costs and our productivity initiatives. We are doing very, very well on the single [L]. Clearly we are still challenged on how to get that out of the wide bodies. There are more special features associated with the 777 and the 4-7 as a custom-built airplane, but we are optimistic we are going to get it. Nonetheless, you could say we are being what I would consider conservative at the right level.

Cai von Rumohr - SG Cowen & Co.

Terrific. Thank you.

Operator

Robert Spingarn of Credit Suisse First Boston, you may ask your question.

Robert Spingarn - Credit Suisse First Boston

Good morning. Jim and James, going back to the A350, the question asked earlier, you all might be contemplating a fourth version of the 787. Could you talk to us about where that stands and how that aircraft might help the [Pindoff], their focus on the lower-end of the 777?

Also, in the same vein, if you could update us on the new 747 passenger, how those campaigns are going, and on the C-17 from an international sales perspective. Thank you.

W. James McNerney

First, on the so-called Dash-10 787 growth, we have a number of customers who are discussing with us -- some would say pushing us -- to develop that plane. I think when the timing is right, in all likelihood, we will. We are just sorting through it right now with a number of customers, but there is clearly demand for that airplane. We just have to fit it into our development plans. With the right customers, probably on a sooner-rather-than-later basis, but we will see.

The 747 Dash-8 you asked about, I think there is a good chance that before the end of this year, there will be a major customer or two for the PAX version. As you know, we have a couple of small orders for the PAX version now. We have a pretty good pipeline there and there are no deals finely done, but I am cautiously optimistic there by year-end.

C-17, we have a number of international orders. I think we have disclosed them: Australia, I believe four airplanes; Canada; U.K.; NATO is considering some additional planes, not finalized yet; and the U.S. Air Force has recently taken up. I think we are solid through mid '09 now.

But having said all of that, because I know what your follow-on question is going to be, by the end of August, we are facing some tough decisions with that airplane. We have been carrying the supply chain for a fair amount of the year, with support from our customer but we have been using customer funds to support the supply chain.

I think that will dramatically increase and we will have some tough decisions with our supply base, with the amount of resources we put against the program if we do not get some more clarity with our customer here in the United States on a go-forward basis, which is a tough issue all around. We are hopeful that will resolve itself, but that will be an inflection point for us.

Robert Spingarn - Credit Suisse First Boston

If you do go forward with 787-10, how might that change the R&D picture from what you have guided to today?

W. James McNerney

I think the entry into service of that plane would be 12, 13, and therefore, I think the 787 core models would largely be completed from an engineering standpoint. and the Dash-8 engineering would be at a lower level, so I think it is all manageable at the time when that kind of engineering would peak.

By the way, this is not a big engineering bill, to take our core 787 and extend it to a Dash-10. It is real money but it does not compare with the base models. I do not want to give you a number, because we do not know what the airplane looks like, but it is more of a derivative type of economics.

Operator

Thank you. Your next question is from Joe Campbell of Lehman Brothers.

Joe Campbell - Lehman Brothers

Good morning. We have been looking at the monthly deliveries on the 737, and we know you took a strike and had some delays in that airplane last year, so the deliveries were 27, 27, then fell to 22, 23, and then 26 in June. I wondered if you could give us an update on how the efforts to try to ramp up and recover from the strike are going. This is separate from an issue of how many planes you will deliver, but just whether the remaining challenges mid-year in ’06 to trying to ramp up -- you are already up a significant percent, but want to do more. Thank you.

James A. Bell

On the 737, we are really ramped up to our current projection as to where we wanted to go on production rates on 737. We continue to look at what it would take to go, and do studies on, what it would take, along with the supply chain, to get higher, but that is really what we are focused on, is that rather than a catch-up of the 30 airplanes that slipped out when we had the strike.

The focus is entirely on how do you one, efficiently ramp up to the then-current projected rates, which we have completed that and we have done that in a way that allows us to deliver those airplanes profitably, so we are doing well there.

The team, because of the demand for this airplane, which we all know is over-subscribed at our current production rates, we are continuing to look so that it makes sense to ramp up beyond that, and can the supply chain support. As we make those determinations, we would then make those decisions.

Joe Campbell - Lehman Brothers

But you had mentioned in the last call, James, that you still had some more production rate increases to go this year. I have forgotten the number, but you had so many planned and had a few under your belt, I thought there was another to go.

James A. Bell

We are done. We are up to rate on all models at this stage, and now we are just looking at can we do better than that, given the demand for the various models.

Joe Campbell - Lehman Brothers

You will have to do that sometime in order to make next year’s higher number. Something will happen I would guess in the fall.

James A. Bell

No, I think we are at rates right now to meet next year’s numbers, and so we may have to go up a tad bit on some of the models, but on 777, I think we are at rate but we will continue to look at that and see if we can do better, because obviously we can sell more if we can build more.

Joe Campbell - Lehman Brothers

Thank you very much.

Operator

Thank you. Our next question comes from Ron Epstein of Merrill Lynch.

Ronald Epstein - Merrill Lynch

Good morning. A question for Jim -- in the release and the on the call, you guys mentioned how you are increasing R&D spend to mitigate risks I guess in weight on the 787 program. Can you give us any further color on that? Sort of as outsiders looking in, so we can feel more comfortable with the development of this new airplane?

W. James McNerney

The weight issues on a program like this are not unusual. As a matter of fact, I cannot remember an aircraft program that did not have a weight issue of one form or another at this stage in the program. I would characterize the weight issue we have here as more normal than abnormal.

Having said that, we have aggressive commitments from certification and for entry into service, and we want to mitigate any risk associated with not meeting those commitments.

I think we are attacking the weight issues aggressively and the associated schedule issues, we still, as we project where we are going to be, we still see the plane delivered on time, within the performance commitments we have made to our customers.

These programs are never easy. As you design and build the 4 million parts that go into these aircraft, there are always going to be issues. We are paranoid every day about them and trying to attack them and leave no stone unturned at this stage. I would rather be paranoid now than deeply disappointed later.

Ronald Epstein - Merrill Lynch

So we are still looking at first flight at the end of next year?

W. James McNerney

Yes, first flight -- ’07 and next year. It is third quarter and then similar timing ’08 for EIS, entry into service.

Ronald Epstein - Merrill Lynch

Thank you.

Operator

George Shapiro of Citigroup, you may ask your question.

George Shapiro - Citigroup

Jim, on the R&D increase and effectively on Commercial, you are increasing it $300 million on $2 billion, so about 15%. Could you just go through what the thinking is as to how you arrive at that? The history is here that we will see steady R&D increases now over the next several quarters as we get close to initial flight.

W. James McNerney

The thinking is we are adding up the work and we are applying the resources and we are putting a margin in for risk reduction. That is the thinking. It eventually gets down to specific parts, specific suppliers and specific people. That is the methodology. There is nothing beyond that. There is no magic.

George Shapiro - Citigroup

Then, probably for James, I assume that while the R&D will be about the same in total next year, the Commercial is actually going up and the Military is probably down some, is that correct?

James A. Bell

That is correct, absolutely.

George Shapiro - Citigroup

Thank you.

Operator

Thank you. David Strauss with UBS, you may ask your question.

David Strauss - UBS

Good morning, thank you. Jim, could you just give us your current view on the status of the overall supply chain? Incrementally, have you seen any improvement or has your confidence increased over the course of the last three to six months? If any problem areas, if you could just give us some examples.

W. James McNerney

We knew at the beginning that there would be issues that cropped up in the supply chain, particularly as we relied on people for higher level components, and we tried to anticipate this by our use of IT, common engineering tools, real-time visibility across the globe in our labs and their labs simultaneously. We try to anticipate it by the way we manned and worked together our site and their site -- all toward the end of seeing problems early, dealing with them aggressively.

We have had a couple of instances where we have moved work, but that was all part of the contingency plan, where we had built extra engineering capacity in the event that someone ran into an issue on completing work and we had engineering capability and facilities ready, and that has happened once or twice.

Again, anticipated, planned for, and we are dealing with it, but I would not characterize any of it as unanticipated or earth-shaking. We are right at the stage now where the transition from engineering to development is happening and we are monitoring it every day.

Operator

Thank you. Our next question comes from Joe Nadol of JPMorgan.

Joseph Nadol - JPMorgan Chase & Co.

Thank you, good morning. I have one more on the 787 R&D. Over the two years, your R&D guidance has gone up $0.5 billion. It sounds like it is more than that for Commercial, and I guess specifically for the 787. I am just wondering if you could be a little more specific as to where that money is going. Are you hiring more engineers? Are you paying overtime? Any more color on that, and then, as an adjunct to that, are your suppliers also seeing increased costs across the board or anywhere particularly?

W. James McNerney

I think the backdrop to my answer, and the quick answer is more engineers and more overtime to execute these risk mitigation programs.

But the perspective you have to have here is that this will be the most efficiently developed airplane that we have ever done. The strategy of working together with our partners and our suppliers where they are shouldering some of the development work in concert with us is producing a cash model for this airplane, even with some risk mitigation activities, that promises to be superior to anything we have ever done.

Having said that, yes, more engineers and overtime, and not all unanticipated.

Joseph Nadol - JPMorgan Chase & Co.

Are your suppliers participating in the higher costs, or are you picking up most of the slack?

W. James McNerney

They have skin in this game to, so the extent to which we [achieve] together, that they are falling behind in some area or where the weight is an issue in another, yes, it is their resources that they are applying. That is part of our agreement with them.

Joseph Nadol - JPMorgan Chase & Co.

Thank you.

Operator

Thank you. Myles Walton of CIBC World Markets, you may ask your question.

Myles Walton - CIBC World Markets

Thank you. A question on pension. For ’06, you have lowered that number by $200 million, left ’07 intact. Given current year adjustments tend to be a little stickier, can you just give us background on how that ’06 number changed? Also, given the rising interest rates, it looks like maybe 75 basis points higher next year, why you left your ’07 $1 billion intact? Then, as an adjunct, is most of that pension expense still flowing through BCAG?

James A. Bell

Well, that was about six questions, Myles, but let me see if I can remember them all and answer them.

First of all, the overall pension cost for the year is the same. It is about $1 billion. What you are seeing is what actually flows through earnings for this year, and that is the differential between what goes to inventory and what actually flows to expense.

In our model, we had to modify the method for making that determination, and it turned out that it gave us [inaudible] for this year, because the way the thing works is that which is inventoried last year gets expensed this year, and then a portion of this year’s cost gets expensed this year. That is what you are seeing in '06.

In '07, the pension cost as you know is determined well in advance of what you would see in changes in interest rates. The change in this year does not have a significant effect on '07. Nonetheless, that method, what you see, what we think will happen in '07 stays about the same based on what we have just done.

It is a one-time adjustment in '06.

Myles Walton - CIBC World Markets

Most of that is flowing through BCAG?

James A. Bell

The pension cost is allocated -- the cash piece is probably going through, most of it is going through BCA, but then what you are looking at a lot of too is the adjustment that flows from it stays on the corporate books, the fast-cash adjustment.

Myles Walton - CIBC World Markets

Thank you.

Operator

Joseph San Pietro of Wachovia, you may ask your question.

Joseph San Pietro - Wachovia Securities

Good morning. Circling back to the Connexion issue, the company has stated in the past it has justified its investment in the program not necessarily from the revenues that can be derived from the back of the plan but more importantly from what is going on up-front.

My understanding is that part of the lower operating cost of future programs, specifically the 787, are tied to the efficiencies that can be gained from using the Connexion system. If you guys keep it or sell it to someone, I get that, but if you decide to shut it down, exactly how does that affect the operating costs for the outlook for new aircraft programs?

W. James McNerney

Not significantly is the quick answer, but you are right.

The program is largely justified by the back of the plane -- so I differ with you a little bit there -- but also in part justified by facilitating operations of the airplane and some service elements.

The facts are that our business model is not being met. We are taking a good swing at this business and we are falling short of where we want to be, which is why we are asking a series of fundamental questions now on a going-forward basis -- restructure, terminate, affiliate being the obvious options, but continuing to operate as we are now is not an option.

We are taking the fundamental look. All elements of the business model are falling short of the projections and impact on a major restructure or terminate would not significantly impact the economics. There are other ways to do what you are describing.

Joseph San Pietro - Wachovia Securities

What has been the response from your customers, specifically? The system seems to be working, I mean, Lufthansa seems to be relatively pleased. It is a drag that you guys had the U.S. carriers back out due to your financial situation, but at some point they come back. You guys were not the only ones that invested in this, so what are your partners saying?

W. James McNerney

We are talking to them right now, including Lufthansa, as you point out. We are trying to sort through the issues. Eventually, if the business model does not work at all for us, it is not going to work at all for them either.

We are trying to find out, through discussions and sharing with them the reality of our situation, and you are right -- the technology is performing reasonably well. The airlines as a group have not aggressively adopted this service to anywhere near the extent that we had hoped.

David Dohnalek

Operator, we have time for one more question from analysts, please.

Operator

Thank you. David Gremmels of Thomas Weisel Partners, you may ask your question.

David Gremmels - Thomas Weisel Partners

Good morning. I just wanted to ask, maybe you could provide some additional color on the BCA environment? Given your competitor's issues lately, it is possible to imagine them being more aggressive with pricing to try to hold on to market share, so are you seeing any changes in that environment?

W. James McNerney

The answer is yes, we have seen very aggressive pricing from our competition, in part because old technology is fighting new technology. As a matter of fact, now that they have some new technology, at least planned, I do not want to say the pricing is going to abate because as a question surfaced earlier, the A330 could be kind of a fighter transition model.

But you know, I think pricing has been pretty aggressive in both the twin area and in the A340 versus 777 area. I would not see it getting worse, necessarily. It has been pretty bad, and now Airbus promises, hopefully by the end of the year, to have a new defined, and when they do, they may want to value for that, so we will have to see.

David Gremmels - Thomas Weisel Partners

Thank you.

David Dohnalek

We will move on to the media questions.

Operator

Thank you. That completes the analyst question-and-answer session.

(Operator Instructions)

I will now return you to the Boeing company for introductory remarks by Mr. Tom Downey, Vice President of Corporate Communications. Mr. Downey, please go ahead.

Tom Downey

Thank you. We will continue with media questions for Jim and James. If you have any questions after this session, please call our communications team at 312-544-2002.

Operator, we are ready for the first question and, in the interest of time, we ask that you limit everyone to just one question, please.

Operator

The next question comes from Jonathan Carp of The Wall Street Journal.

Jonathan Carp - The Wall Street Journal

Good morning. I just have a question on the settlement. You have decided not to seek tax deductibility for the settlement. Have you reached a conclusion on insurance? Does insurance cover any part of the settlement as far as you can tell? Will you seek a claim toward that end?

James A. Bell

We do not believe that our insurance would cover it, so we do not think that is an issue. The main issue is tax deductibility, and as I mentioned, we are not going to seek it.

W. James McNerney

Even though the best advice we have is that the majority is deductible.

Operator

Thank you. Our next question comes from Dominic Gates, Seattle times.

Dominic Gates - The Seattle Times

Hello, a question for Jim McNerney. Jim, at Farnborough, you in an interview brought up some issues on the tanker program and the unfairness of the regulatory environment for Boeing versus EADF. You brought up specifically the ITAR and Foreign Practices Act and how those apply to you versus them.

I note that afterwards, Northrop Grumman, which is the lead contractor in the rival tanker proposal, reacted quite sharply to that and issued a statement saying you have your facts wrong. I am wondering, is Boeing going to pursue either of those questions, either of those specific acts on the tanker thing?

I think in Farnborough, one of the IDS people mentioned that they wanted the ITAR out of the tanker proposal, they wanted to insert that back in there. Will Boeing pursue these and what is your reaction to the Northrop Grumman statement?

W. James McNerney

As I pointed out, Dominic, we are just seeking a level playing field here, equally applied regulatory environment for both. This issue was raised as we discussed in Farnborough really by the legislature in terms of discussions they have had and resolutions that have been put forward to ensure this level playing field.

I think our customer and the legislature behind it are probably the ones that should push for this rather than us. We are a self-interested party. We are a competitor here. We just want to make sure it is a level playing field.

I saw your interview with Mr. Crosby. You know, for all I know, they are taking steps to respond to these things that I am unaware of.

That is where we stand.

Operator

(Operator Instructions)

Our next question is from Molly McMillen of Wichita Eagle.

Molly McMillen - The Wichita Eagle

Good morning. My question is for Mr. McNerney. I saw comments from Alan Mulally out of Farnborough about a plan for the 737 replacement, that that plane would be more composite. My question is, what kind of impact do you anticipate that could have on Spirit Arrow Systems here, which certainly has a huge portion of the current 737? What do they need to be doing in the meantime?

W. James McNerney

Listen, first of all, I do not think Alan meant to say, and I do not think he did say that there was a clearly defined next-next generation 737. You probably did not imply that in your question. We are studying where to go and obviously composites are one of the technologies that could flow from the 787 down into the narrow body. The value of the composites, obviously strength, maintainability and weight.

I think Spirit is doing a good job on the composite side. They are a very valued partner, so I think whatever plane we define for the future aero body -- which will not be for a number of years, keep in mind -- we would hope that Spirit would remain a very important partner for the Boeing company going forward.

Based on the capabilities I see there, I think that is going to happen.

Molly McMillen - The Wichita Eagle

So you would anticipate them getting a bigger chunk than they have of the current 787?

W. James McNerney

No, that is not what I said. That is not what I said. What I said is that they will remain a very important partner. It is hard to have a work statement until you have an airplane defined. I see the capabilities that have developed there, the quality of the people developed there, I see them holding on to a big chunk of it, and we want them to hold on to a big chunk of it, consistent with competing for the business. I think they are going to be very competitive.

Molly McMillen - The Wichita Eagle

Thank you.

Operator

Thank you. Our next question comes from [Amik Sacheet] Of Chicago Tribune.

Amik Sacheet - Chicago Tribune

Good morning. I wanted to ask you, with Airbus likely to seek new launch aid for the Air 350, how that might affect any potential settlement of the trade disputes?

W. James McNerney

Well, I do not think it would be helpful. I think if they seek launch aid on the same terms that they have had it historically, I think our government would view that as a step backwards, a significant step backwards in the negotiating process.

As I said before, I hope we can find a way to negotiate something, our government and the European governments, but that specific step, would not be helpful, in my opinion.

David Dohnalek

Operator, seeing that there are no further calls in the queue, that will conclude 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.

Operator

Thank you. This concludes today's conference. Thank you for joining. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Boeing Q2 2006 Earnings Conference Call Transcript (BA)
This Transcript
All Transcripts