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Executives

Diana Sands - Vice President of Investor Relations

Jim McNerney - Chairman, President & Chief Executive Officer

James Bell - Corporate President & Chief Financial Officer

Tom Downey - Senior Vice President of Corporate Communications

Analysts

Doug Harnett - Sanford Bernstein

Robert Spingarn - Credit Suisse

Heidi Wood - Morgan Stanley

Ron Epstein - Banc of America Merrill Lynch

Cai von Rumohr - Cowen & Company

Joe Campbell - Barclays Capital

Itay Michaeli - Citi

Howard Rubel - Jefferies

Joe Nadol - JPMorgan

Robert Stallard - Macquarie Research Equities

David Strauss - UBS

Troy Lahr - Stifel Nicolaus

Media

Susanna Ray - Bloomberg News

Anne Keeton - Dow Jones

John Austrauer - Flight International

Mike Meacham - Aviation Week

Dominic Gates - The Seattle Times

Steve Wilhelm - Puget Sound Business Journal

The Boeing Company (BA) Q3 2009 Earnings Call October 21, 2009 12:00 PM ET

Operator

Good day, everyone and welcome to The Boeing Company’s third quarter 2009 Earnings Call. Today’s call is being recorded. The management discussion and slide presentation plus the analyst and media question-and answer-sessions are being broadcast live over the internet. At this time for opening remarks and introductions, I’m turning the call over to Miss Diana Sands, Vice President of Investor Relations for The Boeing Company. Ms. Sands, please go ahead.

Diana Sands

Thank you and good morning. Welcome to Boeing’s third quarter earnings call. I’m Diana Sands, and with me today are Jim McNerney, Boeing’s Chairman, President and Chief Executive Officer; and James Bell, Boeing’s Corporate President and Chief Financial Officer. After comments by Jim and James, we will take your questions.

As always, we ask that you limit yourself to one question to be fair to others on the call. We have provided detailed financial information in our press release issued today and 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, which are detailed in our news release, in our various SEC filings, and in the forward-looking disclosures at the end of this web presentation.

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

Jim McNerney

Thank you Diana and good morning. Let me start this morning with my perspective of our performance for the quarter and a look at the business environment as we see it today. After that, James will walk you through our financials and then we’d be glad to take your questions.

Starting with slide 2, our third quarter financial results were clearly dominated by the previously announced 787 cost reclassification and the 747 charge. But excluding those impacts, the double-digit margin performance of our two core businesses continues to be strong, even despite ongoing market pressures.

As we discussed in August, our decision to reclassify costs on the first three 787 flight test airplanes to R&D expense was based on our conclusion that those planes have no commercial market value beyond the development effort. The costs through September for those aircraft resulted in adding $2.6 billion of R&D expense to the third quarter results. I will talk more about the 787 in just a few moments.

Earlier this month, we announced a $1 billion charge on our 747-8 program, due to increased production costs and difficult market conditions. Because this program is in a loss position, costs associated with these factors were immediately recorded in the third quarter for future 747-8 deliveries.

When we began assembling the first 747-8 freighter in the third quarter, we encountered significantly more rework and disruption than we expected, both in our Everett factory and in supplier factories. The root cause is something we talked about in the past. The engineering on this program was late to mature and that was compounded by the limited availability of engineering resources. In addition, we’ve been working closely with our customers in what continues to be a very challenging cargo market. These discussions drove our decision to defer a planned increase in the 747-8 production rate, which was prudent but also contributed to the charge taken this quarter. We fully understand the issues at hand and action plans are in place to address them and smooth the production flow for the airplane moving forward.

Despite these challenges, we are making good progress on this program. The first 747-8 freighter is more than 90% assembled and the second is more than 80% complete. Power on has been achieved on both airplanes. Lessons learned on the assembly of airplane one are being applied to airplane three and the initial join and integration has improved noticeably with assembly now about 75% complete.

First flight of the freighter remains expected by early next year, with first delivery scheduled in the fourth quarter of 2010.

We are operating with better discipline on the 747-8 Intercontinental, the passenger model, where development is progressing well. 75% of the engineering is released on this airplane.

Now, turning back to the 787 program, we made significant progress during the quarter on the side of body reinforcement issue that delayed first flight this past summer. The 787 team is completing and validating this week the last detail design for the stringer modifications on our flight test airplanes and the static and fatigue test air frames. Installations of the fittings are proceeding and we are pleased with the progress we are making. We will retest the modification on the full scale static test air frame after its installations are complete. Once we are cleared for flight based on that test, we will repeat some gauntlet and taxi testing on airplane number one before flying. Flight test is still expected by the end of the year and the first delivery remains scheduled for the fourth quarter of 2010.

As we forecasted, there has been and continue to be some modest orders churn on the 787 but even so, the 787 backlog remains strong with 840 orders from 55 customers around the world. As you’ve heard me say in the past, we know that we can and must do better on our development programs and I am confident that despite our setbacks, we will get the 787 and the 747-8 through the flight test program and into the hands of our customers. Jim Albaugh, in his new role leading BCA, has been fully engaged with the programs, suppliers, and our customers on these development activities. Jim’s seasoned leadership and extensive experience in engineering and manufacturing on complex programs is being felt across the board and will result in further strengthening of our team and the program management and functional disciplines needed to improve our development program performance.

Development programs aside, I remain extremely pleased with the focus of our commercial and defense teams on ensuring our core operating engine continues to run well. Production and services program in both BCA and IDS delivered solid results in the quarter. BCA deliveries remain on track for the year and the team continues to make progress on cost and productivity improvements to help offset a range of market and development program pressures.

During the third quarter, IDS delivered 34 production aircraft and two satellites, the third P8A achieved its first flight, and we achieved key milestones on directed energy programs. IDS is solidly focused on executing across its businesses.

The discipline we have maintained on cash management is also evident in our results. We continue to aggressively manage our infrastructure, costs, and investments. As of September, we have reduced our headcount by approximately 7,200 positions versus our November 2008 base line. While we are tracking somewhat short to our goal of 10,000 position reductions by years end, we expect to achieve and surpass that target in 2010.

Our prudent management of all discretionary and capital expenditures, coupled with successful debt offerings, has enabled us to invest in our development programs and maintain a solid financial position. We will continue to manage our business with the mindset of balancing financial strength and investing in our future growth.

Now let me turn to the market environment on slide three. The environment continues to be challenging in both commercial and defense markets. In April, we announced a reduction to our 777 production rate starting in June 2010 and we postponed rate increases planned for the 767 and 747. As mentioned earlier, in October we further deferred the increase in our 747 rates.

Consistent with these rate reductions and decisions, BCA accommodated about 85 airplane deferrals during the third quarter, in addition to the 130 they processed during the first half. The current backlog of deferral requests is about the same as it was last quarter.

There has been no change in our assessment that we can hold the 737 at its current production rate. We will continue to evaluate production rates based on market conditions and customer discussions.

Capital markets are gradually opening up for aircraft financing so our previous $1 billion estimate of BCC financing this year has been reduced to about $800 million. On the defense side, we continue to be actively engaged with our customers to work through their individual program needs amid growing budget pressures facing the U.S. Defense Department and other agencies. The vast majority of our programs are being well-supported in the budget process. We are particularly pleased with the strong congressional support of the C17 and FA18 programs. However, we do anticipate continued top line pressures on all defense programs.

Our strategy at IDS in this environment remains three-fold. To extend our existing programs that bring unmatched capability and affordability to U.S. forces, capture a healthy share of growing international defense and security opportunities, and continue repositioning or changing U.S. security priorities with investments in adjacent markets, including intel and cyber-security, unmanned systems, and services.

There is no doubt that both our commercial and defense businesses continue to face challenging times right now but I also continue to see a solid foundation from which to work through these challenges with fundamentally strong products and services, a solid balance sheet, and a large backlog, which now stands at $320 billion, nearly five times current annual revenues.

With that, let me turn it over to James who will discuss third quarter results and our outlook. James.

James Bell

Thank you, Jim and good morning. I will begin with our third quarter results on slide four.

Revenue for the quarter was $16.7 billion, up 9% from a year ago. Last year’s revenues were reduced by the strike and supplier production problems at commercial airplanes. Our reported net loss for the quarter was $2.23 per share, which includes $3.59 per share related to the 787 reclassification and the 747 charge. Underlying these impacts was solid performance in both IDS and the commercial production and service programs.

Now let’s discuss BCA in more detail on slide five. Commercial airplanes reported third quarter revenues of $7.9 billion, 13% higher than the same period last year, driven by last year’s strike and supplier production problems. Third quarter year-to-date revenues included lower services volume of over 10% due to softening in spares and freighter conversions. BCA’s third quarter operating loss of $2.8 billion reflects the 787 cost reclassification of $2.5 billion for costs incurred through July on the first three flight test airplanes, $138 million of spending on those planes in August and September, and the $1 billion 747 charge.

During the quarter, the company paid $592 million in cash for the acquisition of [Vott] 787 facilities in South Carolina, which is reflected in the investment section of our cash flow statements.

Included in gross inventory is $6 billion related to 787 work in process, supplier advances, tooling, and other non-recurring costs. This is down from the $7.9 billion reported in the second quarter due to the $2.5 billion reclassification to R&D and the reduction of $416 million in supplier advances as a result of the [Vott] acquisition. 787 inventory also includes $800 million of planned inventory build-up on the program and an additional $187 million of inventory acquired from [Vott].

As previously disclosed, the 747 program $1 billion charge includes $643 million due to higher estimated production costs at both Boeing and supplier facilities. The remaining $362 million relates to the challenging market conditions and the company’s decision to maintain the 747-8 production rate at 1.5 airplanes per month for nearly two years longer than previously planned. As we work through our development program and market challenges, the remainder of BCA is performing well as it continues to focus on productivity and cost improvements. BCA booked 96 gross orders and 17 cancellations during the third quarter. BCA’s backlog remains large at $254 billion, representing greater than seven times current annual revenues.

Now moving to slide six and our defense business, IDS revenue was $8.7 billion in the third quarter, up 3% from the prior year. Margins were 10.1%, reflecting the continued strong execution across IDS’ broad portfolio of programs. The IDS backlog is $66 billion, nearly two times expected 2009 revenues. During the quarter, $3 billion was removed from backlog due to the termination of the man ground vehicle portion of the future combat systems contract. Additions to backlog included P-8 India, International Chinook, Intelsat Satellites, and U.K. modification contracts. The IDS team continues to perform well across its business and is on track to achieve its goals for 2009.

Now turning to slide seven -- Boeing Capital delivered another solid quarter with pretax earnings of $39 million on revenues of $166 million. BCC's portfolio decreased from $6.3 billion as of the second quarter to $6.1 billion. This decrease reflects aircraft financing and other volume in the quarter totaling $153 million, which was more than offset by portfolio run-off. Our guidance now assumes that BCC will finance about $800 million of new aircraft and volume during the year.

Boeing Capital continues to evaluate the potential for debt issuance to help meet its cash requirements, which are primarily driven by debt maturities. BCC is fortunate to have good access to the debt markets at reasonable rates.

Unallocated expenses increased this quarter as compared to last year, driven by higher deferred compensation expense and workers’ compensation adjustments, somewhat offset by lower unallocated pension expense.

We continue to expect unallocated expense to be approximately $700 million in 2009 with other segment expense forecasted to be about $200 million.

The third quarter included higher interest expense and lower other income due to higher debt levels and lower interest earned on cash balances.

Now let’s turn to slide eight and discuss our cash flow. We generated $1.2 billion of operating cash flow, which reflects continued discipline in working capital management. During the quarter, we did not acquire any of our shares but paid approximately $300 million in dividends.

Turning to slide 9, our financial strength remains solid. We ended the quarter with $6.6 billion of cash and marketable securities, which reflect the strong operating cash flows and an additional $1.95 billion of new debt offset by the acquisition of Vott 787 South Carolina facility and payment of the [C-launch] guarantee. On July 1st, we paid the entire $448 million due under the [C-launch] bank guarantee. We have rights to partial reimbursement from the other [C-launch] partners and in September, we reached an agreement with one of those partners to receive payments totaling $122 million beginning in 2009 and ending in 2010.

Turning to slide 10, our financial guidance is now updated to reflect the 787 cost reclassification and the 747 charge. 2009 earnings per share is expected to be between $1.35 and $1.55 per share, with revenues of $68 billion to $69 billion. The 2009 commercial delivery forecast remains between 480 and 485 airplanes.

2009 operating cash flow remains at greater than $2.5 billion.

Looking forward, we have pressure on -- we will have pressure on our 2010 cash flow as inventory continues to build on the 787 program. We expect that cash flows will improve in 2011 when we deliver more 787s and the 747-8s.

Our 2009 guidance still assumes a cash contribution to the pension plan of $500 million in the fourth quarter.

Mandatory pension funding in 2009 remains at less than $100 million. Year-to-date pension assets returns have been strong at approximately 14%, but discount rates have declined by about 50 basis points since year-end.

As we consider our overall pension status and our cash position, we are evaluating an option to make a discretionary pension contribution in stock rather than cash later this year. If we do decide to contribute stock, the amount of the contribution could exceed the $500 million currently assumed in guidance.

While we recognize contributing stock would have a dilutive impact to existing shares, there would also be a net cash benefit to the company and lower future pension expenses.

2009 pension expense is expected to be about $900 million, with slightly more than that recorded at the business units and a small offset in the unallocated segment.

The R&D expense forecast is now $6.6 billion to $6.8 billion, which reflects the reclassification to R&D of costs for the first three 787 flight test aircraft of approximately $2.7 billion, which includes $2.5 billion through July, $138 million spent in August and September, and an estimated $100 million of spending in the fourth quarter.

R&D and guidance also includes the operating model adjustment we discussed in August to better balance future 787 R&D efforts between Boeing and our suppliers. The 2009 forecast includes approximately $1.1 billion of R&D at IDS, which is higher than our prior forecast, driven by additional investments to support growth.

2010 R&D expenses will be higher than we thought at the beginning of this year due to the 787 operating model adjustment and the schedule slide announced in August. The remaining spending on the first three flight test airplanes is expected to be approximately $100 million in 2010. We will provide more detail when we issue guidance in January.

2009 capital expenditures are now expected to be approximately $1.3 billion and that’s down from our prior forecast of $1.4 billion.

Let me summarize the EPS changes we made in our forecast on the next slide. In first quarter, we updated EPS guidance for market factors impacting our escalation forecasts. This quarter, we’ve included the 747 charge, the 787 cost reclassification, and higher R&D due to the BCA operating model adjustment and additional IDS spending. Embedded within this guidance is productivity and performance at BCA that is offsetting commercial service market softening.

Now I will turn it back to Jim who will give you some final thoughts. Jim.

Jim McNerney

Thanks, James. To close, let me just say again that the fundamental operating engine of this company is running well. We are making progress on our commercial development programs and I continue to believe that when we emerge from these efforts and the current market challenges, we will be a stronger company that is offering the right products and services and better positioned to grow and improve financial performance over time.

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

Question-and-Answer Session

Operator

(Operator Instructions) We’ll first go to the line of Doug Harnett with Sanford Bernstein.

Doug Harnett - Sanford Bernstein

Next year after you are through first flight on the 787, hopefully this year, you’ll have a lot going on. You’ve got 747 and the 787 flight test programs going in parallel. You are going to be in production on both planes ahead of first deliveries. Could you talk about how you are thinking about managing this in terms of the resources you need to conduct two parallel flight test programs? And then also the number, how you are thinking about the number of airplanes that you will be completing prior to first delivery toward the end of the year?

Jim McNerney

First of all, we are looking forward and delighted at the prospect of having both of those airplanes in flight test program. Now, as you pointed out, there is significant overlap and the management challenge is not insignificant. I think we’ve done a couple of things organizationally to help this. We have recently cored up a number of our flight test organizations into one, which is going to allow us greater flexibility and greater co-mingling of the two schedules on an organized way. That’s going to help us. We have long anticipated this overlap, so we have had plenty of time to think about it. I think we are helped by the fact there is only one engine on the dash 8, which necessitates fewer planes and less data. So I think a combination of planning, organizational approach, and the number of engines involved makes this doable. The big picture is that we will be doing it.

You asked -- you also asked a question about inventory build. I think, James, you have a comment on -- I know we haven’t -- don’t have specific guidance out there next year but maybe James can give you some flavor.

James Bell

I think what you are asking was about how many airplanes we’d have completed by the time we delivered, started delivery. We will probably have around 30 or so in the system at that stage.

Doug Harnett - Sanford Bernstein

Okay, great and just on -- Jim, on your comment, when -- are you having to get more resources to do these two flight test programs together, or is this possible to do within your existing organization?

Jim McNerney

I think the concept behind coring up all the flight test programs across our company into one organization really in essence frees up flight test capacity that heretofore had been decentralized and uncoordinated. As a result, I don’t think we have to add a lot of resources, even though the management challenge is significant.

Doug Harnett - Sanford Bernstein

Okay, great. Thank you.

Operator

Your next question comes from the line of Robert Spingarn with Credit Suisse.

Robert Spingarn - Credit Suisse

A 30,000 foot question, if I may -- Jim, you’ve clearly acknowledged the challenging environment on both sides of the business. You’ve talked about the budget pressure at IDS and your three-pronged strategy there to offset. But then we have an environment where BCA rates are declining on 777 a bit, and flat at best on 737. The two new programs are coming out of the gate at zero or low margin, I think we would suspect. So the question is unless R&D declines materially, how do you grow earnings over the next three to four years, especially with the prospect of a pension headwind?

Jim McNerney

Well, I think the -- there is no doubt -- two things -- there is no doubt about two things. One is when we get to an end state, we are going to have a more competitive company and what does that look like? Well, it’s an IDS business reshaped to a certain degree as the customer asks for different kinds of goods and services but a solid double-digit basis going forward, and obviously you can see the market share gain potential associated with both the 787 and the 47-8 on top of two rock solid 737 and triple 7 production programs.

The challenge, as you point out, is getting through the next couple of years and I think that gets down to executing our plan, and the plan over the next few years, and we haven’t given guidance, so we haven’t detailed this for you, is get these planes in the flight test program, work with our partners on gross margin improvements for both of us, and at the same time, reduce R&D significantly since we don’t have an imminent new program in front of us. And how that equation all balances out, it’s a good question you are asking, we are confident that it may look a little better than your question implies but that will be provided first -- you’ll get a first look at that when we do some -- provide some guidance for you as we move into next year.

Robert Spingarn - Credit Suisse

Jim, without pushing too far on this, is it fair to say that the real levers though are a few years out and that we are really no better than flattish here in the near-term?

Jim McNerney

Well again, I don’t want to make a comment that could be construed as guidance. I think the -- I think a -- the diversity of our company, which is a defense business that has shown an ability to deliver greater than industry average margins, combined with a triple 7 737 program that still has growth and margin opportunity in front of it can absorb some of the what I would call near-term pressure and on top of that, we are hard at work on improving the profitability of the two development programs.

Now again, when we are comfortable pulling that all together for you, we will do it. But it’s -- I think this discussion you and I are having, it does identify the levers. I just want to assure you that we are just not going to accept these pressures.

Robert Spingarn - Credit Suisse

Okay, thank you.

Operator

Your next question comes from the line of Heidi Wood with Morgan Stanley.

Heidi Wood - Morgan Stanley

James, a question for you -- as we compare the business case to now, to solve for revenues and think about the cost, is it correct for us to think about two layers of 787 profit, the original margin assumption at the launch of the program and secondly better-than-expected pricing versus the normal launch discounts? But I’m -- it’s a little bit long, James, so I’m going to continue the questioning before you answer it, but as I’m thinking about it, atop the positive or better pricing, 787 revenues can probably only grow 3% a year, if you get escalation but realistically could be flat. But the math of the 10 years from 2004 to 2014 means that that 30% to 35% launch customer discount erodes because the business case includes escalation, whereas the actual realized case has better pricing but no escalation. So by 2014 or so, those two are caught up, aren’t they?

James Bell

Well, I’m not sure if 2014 is where all that comes together but I think --

Heidi Wood - Morgan Stanley

But they are converging, right?

James Bell

I think they will converge and the fact of the matter is that as we continue to see how this plane operate and sell into a future market, I think we have an opportunity to get better pricing.

Also, as Jim mentioned, we’ll be working on the cost side of this equation and I think that there is still a significant opportunity in that area too.

Heidi Wood - Morgan Stanley

But on the two layers of profit then, we lose that latter one and we go back to the original margin assumptions on the business case minus two to three times higher R&D, supplier claims higher labor costs, higher raw materials, et cetera -- is that the right way for us to be conceptualizing what you are seeing?

James Bell

Well, I think the right way to look at the challenges facing us is clearly as we work our way through the development program, we are seeing claims of higher costs. We have not yet negotiated our way through and settled all those but we do believe, even in those claims, Heidi, there’s an opportunity to do better. So we’ll continue to work that.

Heidi Wood - Morgan Stanley

Okay, great. Thanks very much.

Operator

Your next question comes from the line of Ron Epstein with Banc of America Merrill Lynch.

Ron Epstein - Banc of America Merrill Lynch

Probably a 200,000 foot question -- when you think about the airplane development process at the Boeing Company, there is a long history of getting airplanes out nearly on time. And we had 787 and kind of what’s happened there and now recently 747-8. I mean, Jim, can you give us a feel for what’s wrong, what’s broken, what happened, how are you going to fix it? Because it’s really the root of everything that is kind of not going right right now.

Jim McNerney

Well, I think the industry got a little overheated. Are we really at 200,000 feet? If we are, I’ll offer -- I’ll give you that view. I mean, I think the industry over the last 10 to 15 years got a little overheated and I think base lines were set up that were very aggressive. In our case, on top of a very aggressive base line, there was significant outsourcing of both manufacturing and engineering at the same time we were dealing with a new material, new design tool. So we experienced a bridge too far leading edge kind of development, which is what we are trying to recover from right now. And I think the seeds of the -- and you’ll be hearing more, by the way, on this subject from Jim Albaugh and I going forward but the seeds of performance improvement are going to lie in places where we didn’t do as well as we should have. One is in realistic base lines that don’t try to stretch into sort of market performance that is unrealistic, at the same time remain competitive, obviously. Our competitors also had trouble with some over-reach. I think the technical and engineering oversight of programs, we have not had that balance right and when we outsource some of the engineering, that compounded the oversight process. We need to bring some more of the engineering, particularly at the systems level, back into Boeing and we need to provide better oversight of it, and so we are spending a lot of time talking about how to re-strengthen our engineering management process, shall we say.

And then the other thing is greater visibility on partner supply chains and on their MRP -- in other words, IT systems. The seeds of that are already in place in Everett as we’ve stood up a [pit] team that is managing across corporate boundaries, sort of at the program level with all of our partners, greater visibility, anticipation of issues, whether it’s chasing down parts or whether it’s process issues in factories. These are things -- so we started the process. This list that I just gave you is probably doesn’t totally shock you in the sense of it sounds like business practices that in some cases we should have been pursuing but when you look back, you see that we lost some of the discipline, particularly within the context of outsourcing so much of the work. So we’ve got to rebalance that and refocus on what successful programs are all about. And Jim Albaugh is the guy in the industry who has managed more technically difficult programs of anyone in the industry and he and I will be working together on that.

Ron Epstein - Banc of America Merrill Lynch

Is there an engineering shortage within the company?

Jim McNerney

I think -- the quick answer is no. I think the experience we had on the 47-8 as I acknowledged in my comments, was more a result of both the 87 and the 47 reaching their engineering peaks at about the same time, even though we had originally planned to have the peaks be complementary rather than overlap, but because of the delay in the 87, that didn’t work out and so our manpower planning was -- the plan was confronted with a different reality than it anticipated, and so it was more that than recruiting engineers. We still hire a lot of engineers and when we make an offer to 10 people, nine-and-a-half of them accept coming to work for our company, so we’ve -- we -- it’s more an issue of reality getting in the way of planning, quite frankly, and we’ve got to fix that too. We’ve got to be better at managing surge capacity because things do not always go as they are planned.

Ron Epstein - Banc of America Merrill Lynch

Great, thank you.

Operator

Your next question comes from the line of Cai von Rumohr with Cowen & Company.

Cai von Rumohr - Cowen & Company

This is for James -- if you take your pension guidance and we close the year about where we are, it looks like you kind of end up with maybe under-funding of about $9 billion going into next year. Maybe give us some thoughts as we think about 2011 and 12 in terms of where the pension expense is going to go and where your funding requirements are going to go and how you plan on meeting them?

James Bell

Well, I think we’ve already said that we expect it to go up a tad next year. I mean, we do believe that it will be higher than this year, based on that asset performance and obviously we are looking at ways to today mitigate what that turns out to be but -- clearly it’s going to be today, given what we see the pension expense would be higher than it is today, or it’s going to be this year but -- with the mandatory funding requirements being low, we have to make a decision as to how we want to deal with that going forward, so it won't be mandatory that we put cash in. It will be discretionary but we’ll be taking a look at that because obviously we want to manage two things -- we want to manage how much cash we put in and we also want to manage the impact of the expense to earnings.

Cai von Rumohr - Cowen & Company

But when you get out to 2011, isn’t the number something like $2 billion, so it’s a very large number as we move out and while it’s not a large mandatory number next year, you know, you kind of have to have some kind of plan so --

James Bell

Are you talking expense or are you talking --

Cai von Rumohr - Cowen & Company

Contribution, contribution.

James Bell

Contribution, okay, and it’s probably 2012 is more where it would be and obviously we have to be looking at that and as I mentioned in my remarks, we are looking at alternative ways to fund our pension plan and thinking of doing that yet in the fourth quarter, that would help to mitigate some of what we would see in the out years.

Cai von Rumohr - Cowen & Company

Okay, thank you.

Operator

Your next question comes from the line of Joe Campbell with Barclays Capital.

Joe Campbell - Barclays Capital

Good morning. I wanted to ask about the supplier claims and how you are working through these, and while I know you I don’t want to ask about specific ones and you probably wouldn’t answer if I did but what I am wondering about is what is the nature of the way in which you take these claims? I mean, many of these big guys have claims that are $1 billion or certainly high hundreds of millions. And how do you settle the fact that the early ones are just going to cost lots more than anybody ever envisioned without getting signed up, since you outsourced all this stuff to having all of the unit costs rise? I remember the CFO of the program early on said well, if anything ever goes wrong with the unit price, head for the hills because they are all outsourced.

James Bell

Well, first and foremost, Joe, we haven’t defaulted to the conclusion that we are going to -- they are going to be higher than anticipated on the front-end of this program. Clearly in the -- in our current --

Joe Campbell - Barclays Capital

Excuse me, James -- you don’t think that the cost of building the first few planes or the first 50 planes after all the changes will be higher than anticipated?

James Bell

Yeah, the costs are -- you asked about the [claims] [inaudible] -- the claims, and so we’ve assumed already what those are in those higher cost of those airplanes and yes, we’ve dealt with that on the front-end. Going out, obviously we’ll have to -- we will look at every one of these claims that have been provided by the subcontract community and go through a detailed cost evaluation of them, and do an analysis on them. But we think that what we have seen today, we have a pretty good handle on what those are and what the entitlement should be relative to those and for the most part, we have looked at settling better than what we have assumed in our cost base assumption, so we’ll continue to work them, Joe. Obviously that continues to be an issue we’ll have to address and one we are putting a lot of priority on.

Joe Campbell - Barclays Capital

Well, the question I have is not whether you have got some number for them -- I’m just trying to get a sense of if the suppliers say that a part doesn’t cost X but it costs 1.5X to build, how do you work it out with them? They don’t have contracts for the dash 9. They don’t have any contracts for 10 a month and they don’t have a contract that’s for the part that you now want them to build -- they have a contract for a part that doesn’t exist anymore.

James Bell

Absolutely, Joe, and so that is also an opportunity and helping them figure out to do that part more cost effectively. Also, the fact that what they are looking at on the front-end doesn’t really project what we believe might be the inaccurate learning curve on them, so we have an opportunity to go work that. Obviously that is an open issue that we have a lot of attention focused on but clearly we see it two ways -- I mean, obviously we have to work our way through it but it doesn’t mean that the initial claim that they have put forward is what we will ultimately settle on.

Joe Campbell - Barclays Capital

No, you’re still not getting the -- so I mean, if the first parts cost lots more, forget -- I’m trying to figure out how do you get to assuming that the -- I mean, if you start on a learning curve, if the first parts cost 50% more than you thought, how do you get that the average cost is unchanged?

James Bell

Well, we didn’t -- we’ve never said that the average cost was unchanged. We have said to you that we’ve gone through and evaluated and we have an estimate in there where we think we will end up based on the fact that we are working with new materials and we have a pretty good appreciation now of what that is and we obviously recognize the fact that up-front, that these costs were more expensive on the first few airplanes but Joe, we’re talking a lot of airplanes here that we believe the market here is going to buy on this particular model and we have an opportunity over that time period, it’s a lot of airplanes and a long time, to improve this performance. And based on our past experience, we have -- we believe we have been able to demonstrate our ability to do that.

Joe Campbell - Barclays Capital

Do you think we’ll settle these things by year-end? These guys are mostly public companies.

James Bell

Absolutely not. I think we will settle some as we have settled some but this is going to be a process that goes out for a few years.

Operator

Your next question comes from the line of Itay Michaeli with Citi.

Itay Michaeli - Citi

I wanted to switch over to IDS, specifically on margins -- really two questions here. One, has your confidence around sustaining a 10% margin changed at all, given the top line pressures you alluded to earlier? And then secondly, if you could just maybe walk us through what you are looking for for Q4 margins at the three sub-segments at IDS?

James Bell

I don’t think our confidence has changed. Obviously it’s going to be more challenging as the volume has decreased as the government goes through and wrestles and has wrestled with their changing priorities, and we saw that in some of the segments where the -- clearly the volume has gone down, that’s affected total profitability. We also experienced this quarter in a contract adjustment a lower margin than that work normally has taken. We’ve gotten on it before and so we have to work through that and that was sort of an artifact of how late we were able to finalize the contract negotiation on a particular change in the -- particularly in the support business.

But overall, we think that we still have an opportunity to maintain our double-digit growth margins in the defense business and that is what the team is focused on doing through a combination of continually driving productivity and also the negotiation of contracts going forward to make sure we have a profit opportunity that would allow us to deliver on that double-digit margin commitment.

Itay Michaeli - Citi

Great, and then just on the fourth quarter, what should we expect GS&S margins to kind of revert back or --

James Bell

Yes, absolutely. That’s where the contract adjustment, that’s a one-time adjustment. We would expect them to be better in the fourth quarter.

Itay Michaeli - Citi

Okay, great. Thank you.

Operator

Your next question comes from the line of Howard Rubel with Jefferies.

Howard Rubel - Jefferies

Jim, normally when you put in the new manager, oftentimes you put in the new manager, you might very well give them a free pass to have everybody come forward and offer confessions of past sins. The platform is burning a little bit this time. Is Mr. Albaugh still going to be in a position to be able to offer up opportunities to come clean for BCA?

Jim McNerney

Well, look, I mean, we are all on the same team. We’re not on different teams, okay? Jim Albaugh and I and the whole executive team have been working together and there’s probably more sharing across the top of this company as we focus on problems in one business or one function than you would probably imagine. So Jim was not unknowledgeable of the issues at BCA that we are wrestling with, and therefore he is not startled by what he is seeing and the challenges and the opportunities. So he probably was a little more in the flow because of the way we run the company than somebody who had been plopped in from zip code A to zip code Z and had an oh my god period to go through, okay?

Now, having said that, there’s a human tendency obviously to take a fresh look at things but I think in Jim’s case, his experience and as he relates to me, is as much about the opportunities as the issues. But he does have a tiger by the tail getting the 87 completed and delivered and the same with the 47-8, and we are 100% focused on trying to knock down the issues and move forward.

Howard Rubel - Jefferies

I mean, I think you totally answered the question whether we are going to see that or whether in fact has there been a slip on the 787 schedule from the last time you spoke with us, even though you still may be able to deliver the airplane by the end of the year, for first flight?

Jim McNerney

I think our comment and our plan has always been by the end of the year and that’s where it is today, and Jim and I probably talk about it daily.

Howard Rubel - Jefferies

And we get blogs daily too, so anyhow, I appreciate that. I mean, you know, and I -- I mean, there is an element of frustration that you want to feel like you are chasing down every little nugget in terms of a move here and so what you are saying is that the schedule that you laid out a while ago with respect to the fix and in terms of implementing these changes is unchanged from where it was the last time you spoke with us?

Jim McNerney

The schedule changes every day, okay? In the sense of problems come up, we’ve got to deal with them, there’s opportunities to come up, we’ve got to deal with them. And the original guidance we gave about flying this year anticipated that process and that is the process we go through and as you add it all up, we are still on track to fly by the end of the year.

Howard Rubel - Jefferies

Thank you.

Operator

Your next question comes from the line of Joe Nadol with JPMorgan.

Joe Nadol - JPMorgan

I had a very similar question as Howard but maybe just a little bit different angle on it -- Jim came in on September, Jim Albaugh came in on September 1. One would expect he is conducting this big talked about review. He has taken ownership now of the 747 schedule effectively with the announcement earlier this month. So Jim, on the 87, and I’m thinking less about the blogs and the wing body joint fix but more about the delivery schedule and the flight test schedule. Has he expressed to you any apprehension about what is still a fairly less aggressive than it was a year ago but still a fairly aggressive flight test program? And any sentiment about pushing that up a little bit, even if you get the plane in the air by year-end?

Jim McNerney

Listen, I mean, he has accepted the flight test program and the production program. Look, I think he views it the same way I do, which is that the flight test program can produce issues that we have to deal with and if it does, we’ll deal with them. So I think he and I are both concerned at the same level there, which is the normal level of concern as you go through testing.

But Jim didn’t come into the job and then come to me and say hey, Jim, we’re four months out of bed on the flight test program, or hey, Jim, we can't make airplanes as fast as the team the minute before I got here said they could. We haven’t had that. What we have had is focus on work and focus on getting it done.

Joe Nadol - JPMorgan

And James, just on the R&D, understood the three aircraft, you gave good numbers there for the fourth quarter and next year -- just the change in the R&D model, any way you can help us understand what that might do to your R&D for the full year next year?

James Bell

No, we’ll have to give you that in January when we update ’10 guidance but clearly it obviously would have been higher than what we thought it would have been at the beginning of this year, Joe, but we’ll give you more color on that in January.

Joe Nadol - JPMorgan

Okay, and you said $0.25 for the year and that’s basically for half a year this year, so if we double that, is that --

James Bell

Pardon me, would you repeat that?

Joe Nadol - JPMorgan

Yeah, you said $0.25 in the EPS walk for this year and you changed the model around mid-year.

James Bell

Yeah, but remember a lot of that work will be over -- a lot more of the work will get done in ’10 than you see in ’09, so you can't just automatically assume that the ’09 effort would be what the ’10 impact would be but again, just know it will be a little higher than what we -- it will be higher than what we thought it would be earlier this year and we will give you that color in January.

Joe Nadol - JPMorgan

Okay. All right, thank you.

Operator

Your next question comes from the line of Robert Stallard with Macquarie Research.

Robert Stallard - Macquarie Research Equities

Jim, you mentioned that you saw 85 deferrals in the third quarter at BCA. I was wondering, has this made you any more or less confident on the projected build rates for the 737 and the triple 7 moving into next year?

Jim McNerney

Well, I think the risk to the triple 7 has been taken into account with the production rate change that we announced earlier, and the deferrals and discussion is about what we thought it would be and have anticipated. On the 73, the deferral rate, the requests have stayed about the same, which is what we anticipated and we just don’t see, when you add it all up, when you -- customer by customer add it all up and an overall trend that is not worsening significantly at all, financing markets are actually getting more robust, which I suppose is a plus moving forward. We just when you add it up airplane by airplane, customer by customer, we don’t see a need to change the 737 rate.

Robert Stallard - Macquarie Research Equities

So you are still very confident on the 737 rate but how much has the flat rate in 2010 been at the expense of pulling demand forward from out years like ’11 and ’12?

Jim McNerney

How much is -- say that again? You’re saying --

Robert Stallard - Macquarie Research Equities

-- pulling forward demand.

Jim McNerney

Again, the -- actually the deferral pressure moves the other way. I mean, the deferral pressure tends to move incrementally more planes out rather than pull them in, even though there are some pull-ins, as people opportunistically want lift. So I don’t see us pulling demand into ’10 out of ’11 and ’12 when you look at the net impact. I see probably a little -- and I don’t have the numbers in front of me specifically but I think I am right -- I see incrementally more moving the other way, so the fact that we feel comfortable holding it in ’10 is a sign of strength within that context.

Robert Stallard - Macquarie Research Equities

And just finally on this, many of your suppliers seem to be very skeptical of your ability to hold production flat. Are you a little bit concerned that if you do keep things flat, they may not be able to keep up?

Jim McNerney

Well, our suppliers -- and I was one in one life, so I understand how they feel, but I think they are recently heartened by the recent change, I would say the gradual thawing of the capital markets over the last six months, the active engagement of XM, some increase in capacity there, same thing in Europe. We try to give them visibility. I am sure they will tell you that we don’t give them enough. I get that but I don’t think there is any supplier out there that has a hardwired plan to -- that anticipates production rates coming down. If you know of any, please shoot me an email and I’ll go deal with it.

Robert Stallard - Macquarie Research Equities

Okay, thank you.

Operator

Your next question comes from the line of David Strauss with UBS.

David Strauss - UBS

Just a follow-up to Rob’s question, obviously with these deferrals, unless you are over-booked, you are having to pull customers forward to fill in those slots. Are you having -- are you seeing it more difficult to actually pull customers forward to fill in these slots?

James Bell

No, actually what we have is the over-solds that are coming down in to fill in for those that are getting deferred out to the right. And remember, our production rates are based on the backlog that we have where we have under contract, it says we have delivery commitments over a period of time and that fundamentally is what is driving the rate and that order book is [inaudible], and so that is why we are where we are and then as we do the deferrals, we continue in the out years as we get, have opportunity to oversell over the -- what our current backlog would require us to deliver in those periods and so when we get into the deferral discussions, we move those airplanes out that the customers want to defer and we move into those spots those over-solds.

David Strauss - UBS

So James, could you just give us an update where you are from an over-sold status on ’10 and ’11? I thought for ’10 you were kind of even with planned production rates. I didn’t think you were still in an over-sold --

James Bell

In ’10 we’re solid, so we’re not having a lot of debate and discussion around deferrals for ’10. It’s now we’re -- it’s moving out to ’11 and subsequent. So we are in pretty good shape there. We still have some over-solds in ’11, and so we still have some flexibility in having that dialog and discussion around what would be appropriate relative to a customer wanting to defer.

Now in ’10, we’re about a lead time away for most of the year and so those are different discussions if someone comes to us today on ’10, we’d have to have consideration to deal with that but basically ’10 is solid.

Diana Sands

Operator, we have time for one more analyst question, please.

Operator

Your next question comes from the line of Troy Lahr with Stifel Nicolaus.

Troy Lahr - Stifel Nicolaus

I’m wondering if you guys could just update us again on the timing of all six test flight aircraft for the 787, when they will be up in the air. And also, is the marketability for the three remaining test flight aircraft, I mean, are you still confident that you can get those sold?

Jim McNerney

The last assessment on the last three test airplanes are that we feel they are marketable. That assessment is consistent with the assessment we made earlier this quarter. That hasn’t changed. The -- I will have Diana call you with the specifics of the six airplanes. If I try to give you dates on all six, I will screw up one or two of them, so -- but they are as we have anticipated and are consistent with the flight test program. But it’s basically every month, every month after first flight a new one comes in. I don’t want to say anymore than that and Diana will -- Diana’s team will fill you in on that specifically.

Troy Lahr - Stifel Nicolaus

Okay, but so by June though, all six should be in the air, you think?

Jim McNerney

Yes, I mean roughly, every month starting here in the fourth quarter.

Troy Lahr - Stifel Nicolaus

Okay. Thank you.

Jim McNerney

You’re welcome.

Operator

Ladies and gentlemen, 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, Senior Vice President of Corporate Communications. Mr. Downey, please go ahead.

Tom Downey

Thank you. We will continue for a few minutes 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 interest of time, we ask that you limit everyone to just one question please.

Operator

Your next question comes from the line of Susanna Ray with Bloomberg News.

Susanna Ray - Bloomberg News

I’ve just got a question about the level of deferrals, if you could just -- you mentioned that 2010 is solid. Does that mean you are sold out for 2010 and you don’t have any open spots left? And will that level then be the same, the deferral level, will that be the same as 2009 then, is that what you are saying?

Jim McNerney

What we are saying is two things -- one that 2010 is sold out, and the level of deferral -- and deferrals remember are not cancellations. These are moving planes, either out or in, usually out. That discussion which is ongoing, that level of discussion is staying about the same as we’ve experienced over the year. It’s not getting worse, and that we have enough over-solds in the pipeline to accommodate those deferrals. That’s what we are saying.

Susanna Ray - Bloomberg News

Okay, and would the level of cancellations in 2010 be about the same as 2009 as well?

Jim McNerney

I don’t believe there were any cancellations here in the quarter but let me double --

Susanna Ray - Bloomberg News

I’m sorry, I mean for the year.

Jim McNerney

For the year, I will get you the number of cancellations as -- we’ll call you back with that. It’s a modest number.

Susanna Ray - Bloomberg News

But will it be about the same or are you expecting --

Jim McNerney

I don’t want to say it. What I want to do is have Tom’s team call you back just to be sure.

Susanna Ray - Bloomberg News

Got you, okay. And one more quick question about job cuts, you mentioned job cuts above that 10,000 figure. Can you give us a sense of what magnitude you are considering?

Jim McNerney

We are working through that right now. It will have to do with reshaping of defense programs as the defense budget, which is under pressure, sorts through its own pressures and then it makes its way back to defense contractors such as ourselves, and ongoing market pressures in BCA, which tend to relate more on the services side.

Susanna Ray - Bloomberg News

Okay, thank you.

Operator

Your next question comes from the line of Anne Keeton with Dow Jones.

Anne Keeton - Dow Jones

I have a tanker question -- there has been some talk in the marketplace that Boeing has an advantage in this competition. Could you just discuss this situation generally for us and let us know what your feeling is on tankers?

Jim McNerney

Is there a specific issue, Anne, that where we have this purported advantage, or are you asking me an open-ended question?

Anne Keeton - Dow Jones

It’s kind of open-ended but I guess it’s based on what came out in the initial RFP.

Jim McNerney

Well look, I think the -- what you may be referring to is that our competition somehow feels that we have some information coming out of the last protest environment about them that they don’t have about us. I’m not sure what they mean, okay, and my suggestion would be that you talk to the -- to our customer, if that’s what you are referring to.

If you are referring more broadly, listen, we’re sorting through the RFP now. We will have some comments where we think the RFP can be improved, and I have no idea, to be honest with you, whether that advantages or disadvantages us at this standpoint but we are taking a hard look at it. I think the only thing I would say is the recent WTO ruling is one where we think the playing field is not level, basically because the ruling, at least as people have described it, point to virtually every airplane that Airbus has developed being the result of a subsidy, which including the A330, and that that should enable them to take more risks during the competition than I can take as a purely commercial operation. And so that is one area that we are probing very heavily.

Anne Keeton - Dow Jones

Okay. Thank you.

Operator

Your next question comes from the line of John [Austrauer] with Flight International.

John Austrauer - Flight International

A question for you about -- you know, we kind of come back to hearing different things about [change] of schedules, whether it’s from online news media or the financial community, and we kind of then get these very confident declarations from you guys about the status of the pace of the program. Are you guys willing to stake your leadership on this? I’m just trying to get a sense of where the buck stops after six delays here.

Jim McNerney

Listen, you’re breaking up a little bit. I think you may be on a wireless device. We didn’t hear all of the question. Could you try one more time?

John Austrauer - Flight International

I’d be happy to. I was saying every several months we hear a very confident declarations from Boeing regarding the pace of the program and the updated schedules and I’m just trying to get a sense of when we start to hear that things maybe are not going on schedule, just trying to get a sense from you guys where -- are you guys willing to stake your leadership of the company on this? Where does the buck stop ultimately?

Jim McNerney

Listen, we are all -- I assume you are talking about the 787 program and --

John Austrauer - Flight International

Yes, I am.

Jim McNerney

Yeah, and the entire leadership of the company plays a role in getting this program done and out to our customers. It has been a difficult program. It has been technologically innovative, new to the world in its characteristics, and we all wish that the program had gone more smoothly and I think we all share responsibility in it not going as smoothly as we want. But we are also going to share responsibility in its ultimate success when we get there. So we are a team going after this thing.

John Austrauer - Flight International

Thank you.

Operator

Your next question comes from the line of Mike Meacham with Aviation Week.

Mike Meacham - Aviation Week

I just want to switch to an upselling issue and that’s the choice for a second 787 --

Tom Downey

Mike, you are fading out. Can you come through a bit stronger?

Mike Meacham - Aviation Week

Sorry, I wanted to ask about decision process on the second 787 line. First question is are we really talking about a choice of two different places or are there still multiple locations? The two places being South Carolina and Everett, or are there still multiple locations under consideration?

And then second, are you moving forward that you expect the decision to be announced relatively soon?

Jim McNerney

Yes, we started with a pretty broad playing field on the second line consideration but we are really down to Everett and Charleston as the choice. We are sorting through that right now and you should expect a decision over the next couple of weeks.

Mike Meacham - Aviation Week

Okay. Thank you.

Operator

Your next question comes from the line of Dominic Gates at The Seattle Times.

Dominic Gates - The Seattle Times

On the same subject, you gave an intriguing indication earlier in the remarks to the analysts that you and Jim Albaugh would talk to us later, perhaps after the turn of the year, I would expect, when he is settled in a bit, about how things will be handled differently in BCA in the future, in terms of the problems that have arisen over sourcing of engineering and all of the things that culminated in the delays that you have had. But as you just pointed out, before you give us that indication of where you strategically go in the future, within the next couple of weeks you are going to make a decision on the second line. And so I want to ask why a lot of people see the idea of putting a line in Charleston so that you would have assembly lines on opposite coasts, see that as a decision that doesn’t make a lot of business sense because it -- because it adds tremendous risk and tremendous duplication. So the question is why would you do that now, having had all these problems with this new program, why would you introduce the risk of separating assembly lines to opposite coasts?

Jim McNerney

It’s a fair question, Dominic. There would be execution challenges associated with that choice but keep in mind that we’ve got a pretty good-sized operation down in Charleston today. And there would be some duplication. We would obviously work to minimize that. But I think having said all of that, diversifying our labor pool and labor relationship has some benefits. I think the union and the company have had trouble figuring it out between themselves over the last few contract discussions and I’ve got to figure out a way to reduce that risk to the company. And so some of the modest inefficiencies, for example, associated with the move to Charleston, are certainly more than overcome by strikes happening every three or four years in Puget Sound. And the very negative financial impact of the company, our balance sheet would be a lot stronger today had we not had a strike last year. Our customers would be a lot happier today had we not had a strike last year, and the 787 program would be in better shape had we not.

And I don’t blame this totally on the union. We just haven’t figured out a way -- the mix doesn’t -- isn’t working well yet. So we’ve either got to satisfy ourselves that the mix is different or we’ve got to diversify our labor base.

Dominic Gates - The Seattle Times

And if the union goes along with your request to them to come to some kind of no strike deal, does that mean you definitely keep it in Everett?

Jim McNerney

Listen, Dominic, the discussions and the decision-making is ongoing right now. I really -- the discussions are confidential and the decision-making will be as rational as we can make it.

Dominic Gates - The Seattle Times

All right, thanks.

Tom Downey

Operator, we have time for one last question, please.

Operator

And that will be from the line of Steve Wilhelm with the Puget Sound Business Journal.

Steve Wilhelm - Puget Sound Business Journal

I just wanted to follow-up on one question a little bit more -- can you just characterize or give some color about the discussions, you know, how often they are, just what the tone of them is with the union?

Jim McNerney

Steve, the discussions are -- you are referring to discussions in Puget Sound?

Steve Wilhelm - Puget Sound Business Journal

Yes, and related to the second line.

Jim McNerney

Yeah, I would say the discussions are occurring on a regular basis. I would say the tone is constructive and we will see what it produces.

Steve Wilhelm - Puget Sound Business Journal

Okay.

Tom Downey

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.

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Source: The Boeing Company Q3 2009 Earnings Call Transcript
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