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The Boeing Company (NYSE:BA)

Q1 2010 Earnings Call

April 21, 2010 10:30 am ET

Executives

Diana Sands - VP of IR and Financial Planning and Analysis

Jim McNerney - Chairman, President and CEO

James Bell - EVP, Corporate President and CFO

Analysts

Rob Spingarn - Credit Suisse

Cai von Rumohr - Cowen & Company

David Strauss - UBS

Joe Campbell - Barclays Capital

Ron Epstein - Banc of America/Merrill Lynch

Heidi Wood - Morgan Stanley

Doug Harnett - Sanford Bernstein

Howard Rubel - Jefferies & Company

Joe Nadol - JPMorgan

Troy Lahr - Stifel Nicolaus

Rob Stallard - Macquarie Research

Peter Arment - Broadpoint Gleacher

Sam Pearlstein - Wells Fargo Securities

Noah Poponak - Goldman Sachs

Susanna Ray - Bloomberg News

Dominic Gates - The Seattle Times

Operator

Thank you for standing by. Good day everyone and welcome to the Boeing Company's first quarter 2010 Earnings 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 Ms. Diana Sands, Vice President of Investor Relations and Financial Planning and Analysis for the Boeing Company. Ms. Sands, please go ahead.

Diana Sands

Thank you and good morning. Welcome to Boeing's first 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'll take your questions.

In fairness to others on the call, we do ask that you limit yourself to one question. As always, we have provided detailed financial information in the press release issued earlier 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 will turn the call over to Jim McNerney.

Jim McNerney

Thank you Diana and good morning to all. Let me start today by addressing the evolving business environment, and highlighting some of our key accomplishments during the quarter. James will walk you through our results and then we would be glad to take your questions.

Starting with the business environment on slide 2. With clear indications that a global economic recovery is underway, we are also seeing tangible signs of improvement in the commercial airplane market. Passenger air traffic is increasing led by activity in emerging markets and freighter traffic has rebounded strongly from the severely depressed levels of last year.

Consequently the financial outlook for the world's airlines has improved noticeably since last quarter. Having aggressively cut cost and capacity during the downturn, many of our airline customers are positioning for this economic recovery by ensuring that they have the most efficient airplanes with which to compete. While some customers continue to differ or cancel orders, we are seeing growing demand from other customers for those delivery slot, through both acceleration of planned deliveries and new orders.

During the first quarter, the rate of accelerations we processed was notably higher than average. The number of deferrals we processed was about the same as last quarter. But the backlog of deferral request continues to decrease.

The improving market conditions and the disciplined approach we have taken in managing production rates are paying off. As we announced last month we have accelerated plans to increase production rate on both the 777 and 747-8. And with 787 deliveries expected to ramp up over the next several years, these increases will help ensure our continued market leadership in wide body commercial airplanes. On the 737, with its solid backlog and continued strong demand, we anticipate a decision this quarter on a possible rate increase from our current 737 production level of about 31 airplanes per month.

As I have discussed before, these rate adjustments are significant business decisions for us, and consider the long-term market outlook, customer contracts and lead time and customer contracts and lead times with suppliers. Rate decisions are made only after a through analysis of these another factors. On the defense side of the business, the US Defense Department, another US Government agencies continue to face significant budget pressures.

Given this environment, we are pleased that the fiscal 2010 defense budget and the fiscal 2011 budget request contains strong support for the majority of our key programs including the F/A-18, P-8A our Chinook, Apache and Osprey rotorcraft, the brigade combat T modernization program and others.

We also continue to see strong demand internationally for our core defense and services products. There are several international opportunities we are pursuing. The fighter jets, C-17's, our rotorcraft line up and our 737 based military derivates.

Our focus in defense continues to be three fold. Extend our existing programs by bringing capability and importantly, affordability to our customers, continue a healthy share of international and service opportunities where our footprint and relationships around the world provide a competitive advantage for expanding share and driving disproportionate growth in these markets, and accelerate our repositioning with investments in adjacent markets such as Cyber Security, intelligence and surveillance and unmanned systems where growth rates are higher than the overall defense budget.

Despite some uncertainties that remain in our business environment, we are in a fundamentally solid position and our opportunities are growing, particularly in the commercial market as the world regains its economic footing. Total company backlog helps steady through the quarter as new orders largely kept pace with deliveries. While we continue to expect the book-to-bill ratio of commercial to be below one this year, we do anticipate higher orders than last year across both of our businesses.

Now let me discuss first quarter highlights on slide three. Core operating performance was strong during the quarter and we achieved some key milestones in both commercial and defense. On 787, we are making solid progress in our flight testing with four of the planned six test airplanes flying and the remaining two airplanes expected to be in the air by the end of this quarter.

Today, we have accumulated more than $500 of flight testing in over 170 flights. The airplane is performing very well and we continue to retire technical risk as we make progress in the test program.

In a major milestone last month, the static test airplane successfully completed the ultimate load test on the wing for the fully pressurized cabin. Once again validating the structural design of this airplane.

And yesterday, the Federal Aviation Administration granted Boeing expanded-type inspection authorization on the 787, clearing the way for its personnel to fully participate in future test flights. This was achieved by demonstrating the readiness of the airplane throughout a variety of speeds, altitudes and configurations and it marks the FAA's confirmation that the airplane and team are ready to collect additional served data.

We remain on track for the first Dreamliner delivery by years end. We have a contingency plan in place to handle discoveries in the test program. And we are working to add more contingency by further improving flight test efficiency.

787 production ramp-up is also progressing. We are working closely with our partners to anticipate and stay ahead of ramp up challenges in the supply chain and are making adjustments to component deliveries as needed to keep the production flow in balance with minimal out of sequence work. These adjustments are all being accommodated within our current customer delivery commitments.

As a reminder, we expect to be at a total production rate of 10, 787's per month by the end of 2013. Anticipating three per month will be assembled at our expanded Boeing Charleston Facility, which is now well into construction.

We continue to be pleased with the 787 market success, with approximately 865 orders from 57 customers around the world. This includes a recently finalized order for 25 airplanes from United Airlines and 10 airplanes canceled due to market conditions by Air Boeing. On the 747-8 freighter first flight occurred on February 8 with initial air worthiness achieved on March 9.

Currently, we have three airplanes flying of approximately 85 flights and 160 hours recorded to date although we have made changes to improve handling characteristics, we have not encountered any major issues in flight testing.

On the 747-8 intercontinental, we are nearing completion of engineering releases and expect to begin major assembly mid year. We continue to expect first 747-8 freighter to be delivered at the end of this year and the first intercontinental delivery in the fourth quarter 2011.

In addition to progress on our development programs, I want to highlight the fundamentally strong core performance in commercial airplanes this quarter. The 737 and 777 programs continue to deliver solid performance and make solid productivity gains. Commercial aviation services generated 12% higher revenue than first quarter of last year, reflecting growth initiatives and the beginnings of market recovery and delivered strong margins once again.

Turning to defense space and security, we also achieved some key development of production program milestones during the quarter. Airborne laser performed the first speed of light shoot down of an in flight ballistic missile target. P-8A successfully completed weapons ground vibration testing which paves the way for in-flight testing and verification of its weapons capabilities. We also demonstrated that our A160T unmanned rotorcraft system can resupply forward operating basis reducing risk for our armed forces.

Defense, space & Security delivered 25 military aircrafts and two satellites during the quarter and the global services and support unit continued to grow its revenues and generate strong margins. The current business environment will continue to put pressure on some of our Defense, Space & Security programs but we remain intensely focused on executing to plan and meeting the enduring needs of our customers with a balanced portfolio of systems, solutions and capabilities.

Our total company backlog remains at about $315 billion close to five times our current annual revenue. This backlog provides us the foundation for significant growth potential and we continue to focus on our drive to improve productivity and competitiveness throughout our business.

Now let me turn it over to James, who will discuss first quarter results and our outlook. James?

James Bell

Thank you Jim and good morning. I'll begin with our first quarter results on slide 4. Revenue for the quarter was $15.2 billion and that was down slightly from last year's driven by anticipated lower commercial airplane deliveries and reduced combat system and missile defense volume.

Net earnings were $0.70 per share that includes the previously disclosed tax charge of $0.20 per share due to healthcare legislation. Operating margins were strong at 7.7%.

Now let's turn to slide five and I'll discuss our airplane business. Boeing Commercial Airplanes' first quarter revenue was $7.5 million, down from last year's driven by lower deliveries somewhat offset by higher service revenues. We expected deliveries in the first quarter to be relatively lower than rest of this year primarily due to supplier production challenges related to fleets. Commercial operating margins expanded to 9.1% on strong operating performance. Last year's results included a $347 million 747 charge which reduced first quarter 2009 commercial margins by four points.

Gross inventory for the company now includes $8.4 million related to 787 work-in-process, supplier advances, tooling and other non-recurring costs, an increase of $1.1 billion during the quarter. We expect the rate of increase to be somewhat higher during the remainder of the year as we continue to ramp up production. We're working closely with our 787 suppliers to reach fair and equitable solutions on their assertions. We anticipate having the majority of these assertions negotiated by year-end. Customer discussions are also ongoing and both were tracking to our expectations.

We continue to make progress on further productivity improvements on the program and expect to provide more insight on the initial 787 accounting quantity and profitability later this year when we begin delivery. Boeing Commercial Airplane won 100 gross orders during the quarter including 75 737s and 25 787s while 17 orders were cancelled. The commercial backlog remained strong with over 3,300 airplanes valued at $250 billion over seven time it's projected 2010 revenue.

Now moving to slide six in our Defense, Space & Security business. Boeing's Defense, Space & Security reported revenues of $7.6 billion with margin of 8.7%. Global services and support performance was strong with 4% revenue growth and 10.9% operating margins. Boeing military aircraft margins of 8.2% reflected strong execution across its program; offset by reduced earnings on C-17's and higher R&D expenditures. Network and space systems recorded margins of 7.5% reflecting solid performance across its array of programs. During the quarter, Defense, Space & Security maintained a solid backlog of $64 billion as run off of multi-year contracts slightly exceeded additions. New orders included the ground based mid course, defense core completion contract, phase one of the U.S. Airforce QF-16 drone program and AEW&C Australia support contract and additional weapons awards.

Now turning to slide seven and our other businesses. Boeing capital delivered another solid quarter with pre-tax earnings of $46 million on revenues of a $162 million. Its portfolio balance declined to $5.4 billion, down from $5.7 billion at the end of 2009. Other segment expenses were $50 million while unallocated expenses were $165 million, up from last year, driven by higher deferred compensation expense, reflecting the increase in our stock price as well as broader market performance.

We expect total unallocated expense for 2010 to be approximately $700 million with other segment expense forecasted to be about $200 million. Income tax expense during the quarter included $150 million charge related to healthcare legislation. First quarter did not include an R&D credit as the credit has not been signed in the law for 2010. Our guidance assumes that that credit will be signed in the law by the end of this year.

Now let's turn to slide eight and discuss cash flow. During the quarter, we used $280 million of operating cash flow reflecting our continued investment in our development programs. Gross inventories on the 787 and the 747-8 program will continue to increase as we prepare for first deliveries later this year. Capital expenditures will also begin to ramp up as construction progresses in Charleston.

I'll turn into slide nine. We ended the quarter with $10.4 billion of cash and marketable securities, down somewhat from the fourth quarter. Debt levels remained flat. We're maintaining a very disciplined cash management approach while investing in our future growth. Our current cash levels provide us with strong liquidity as our development efforts evolved into production programs.

Now turning to slide 10 in our outlook. We are maintaining our financial guidance with the exception of the $0.20 per share healthcare charge taken in the first quarter. 2010 earnings per share is now expected to be between $3.50 and $3.80. We are generally pleased with our first quarter performance but recognize there is still a lot of work to be done this year across both our businesses. Our EPS guidance continues to consider market uncertainties and development program risk. 2010 revenue guidance remains at between $64 and $66 billion while operating cash flow is expected to be approximately zero.

The commercial delivery forecast remains at between 460 and 465 airplanes. We expect some fluctuation in our quarterly 737 and 777 delivery profiles as we continue to work through customer requested delivery changes and supplier challenges. Although the 777 production rates will be higher in the first half of the year the timing of deliveries may vary from production as we resolve these challenges. The R&D expense forecast is unchanged at $3.9 to $4.1 billion and capital expenditures are expected to be $1.9 billion during 2010 and that includes the ramp up of capital investment in South Carolina. We continue to assume pension funding this year at less than a $100 million while total company non-cash pension expense is expected to be about $1.2 billion.

Commercial Airplanes revenues are forecasted to be between $31 and $32 billion with margins of 6.5% to 7.5%. As we assess Commercial Airplanes margins for the remainder of the year we expect full year margins to be lower than first quarter due to investment and productivity issues, timing of period expenses and the start of 787 and 747-8 deliveries at the end of the year. We are forecasting our defense space and security business would generate $32 to $33 billion in revenues with margins at approximately 10%. As compared to first quarter, this segment is projecting better mix, lower R&D and improved performance during the remainder of the year. As we look forward into 2011, we continue to project operating cash flows to be greater than $5 billion driven by higher deliveries of 787 and 747-8 and lower R&D expenditures. We plan to provide detailed 2011 financial guidance with our fourth quarter results.

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

Jim McNerney

Thank you James. We are off to a good start in 2010 with clear progress on the 787 and the 747-8 solid financial performance and notable improvement in our customer outlook; we continue to draw on the momentum we saw at the end of 2009. We are methodically working through our challenges and our people remained focused on satisfying our customers and leveraging growth and productivity into better bottom-line and top-line performance.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Rob Spingarn with Credit Suisse.

Rob Spingarn - Credit Suisse

James, if I could delve into the BCA margin please, just a little bit more. You did 9% of the quarter which was quite good, you just mentioned that you are guiding lower for the rest of the year, so was hoping you could talk a little bit about how you did the 9% with the lower level of 737 and 777 deliveries and what we thought were maybe some cost issues on 747-8 related to the stringer and flat issues, and so how should R&D flow for the rest of the year? How should we think about the quarters or the differences in BCA margin given that you probably simply going to deliver these lower margin airplanes in Q4 alone and then James as a last part to this if you could comment on how much of the quarterly increase in inventory on 787 is capitalized cost as opposed to undelivered units?

James Bell

Okay, let me just start with the first part of your question. Clearly we are pleased with the performance we had in first quarter with BCA. They actually did deliver pretty good performance as Jim mentioned particularly on the production program 737s and 777. There is a little time in R&D that also helps and on our periodic expense that also helps the margin in its period. So, going forward obviously the timing of that performance is something that of those activities we will see higher cost in the second, third and fourth quarter, so that's going to help bring it down. We are also going to up our spending and fleet support as we get closer to introduction of the 787 into service, so that's going to be an impact and then finally I have mentioned that we do have provision and therefore market uncertainties and risk that's part of it and so helpfully we can minimize that impact going forward.

On 747-8, clearly is still a program that challenging for us, we do have the issues that we have encountered on this program literally everyday, but at the same time we are working very hard on opportunities and we have been able to realize some of those along the way and so the two have been, I would say maybe we have been doing a little better on opportunities than we have on. We've been doing better managing the risk and been able to capitalize on our opportunities so that's why you didn't see any further cost pressure on that program or any forward reach on that program this quarter.

Rob Spingarn - Credit Suisse

Was that due to the higher rate, the rate acceleration?

James Bell

Well some of it was due to the rate acceleration but we also are working off slate of opportunities that allows us to improve our performance and do better on the development part of the program and then also, look at how we can drive the production cost of the production units down.

Rob Spingarn - Credit Suisse

Okay. And just on the 787 incremental inventory throughout the year, to capitalize cost versus the unit build up?

James Bell

Basically, its all unit build up. There is some supplier, none recurring cost that are in those numbers that would be reimbursed to them over the delivery of their units.

Operator

And next go to Cai von Rumohr with Cowen & Company. Please go ahead.

Cai von Rumohr - Cowen & Company

To follow up on Rob's question, James, can you give us some sense as to where are the commercial R&D would be for the year? And how it might pattern and maybe also some color on the sequential pattern in period cost and fleet introductory cost so we get a better sense of a potential flow for margins and commercial for the rest of the year?

James Bell

Yeah. I think that it will pick up a little bit in second quarter and hold flat in R&D going forward, as we continue to work of the [Dash 9]. I think that you'll see that. I think we also will see that the period expense pick up a bit and it will be relatively flat over the rest of the year. And then I think the fleet support will sort of come up in the second half of the year.

Cai von Rumohr - Cowen & Company

And where was the R&D going to be for the year, rough range for BCAG?

James Bell

It's going to be, if you look at our guidance at about three, nine to four, the bulk of that is going to be BCA. And so, we're going to get that we'll hit the guidance mark on that. So, we don't look to see us understand that by any great margin. I think we'll be right on guidance.

Operator

And next, we'll go to David Strauss with UBS, please go ahead.

David Strauss - UBS

Jim you talked about customers moving forward. I was wondering your rate adjustments on the 47 and 777 are those more to accommodate customers moving forward right now or your view that orders are going to comeback strongly beyond 2010. Obviously you have the backlog to go up right now but don't you need orders to comeback pretty strong to make these sustainable rate increases?

Jim McNerney

Well, first of all we wouldn't increase the rate unless we had a pretty visible look at demand and it's in part a couple of customers that had gotten soft firming up, it's also a couple of customers stepping up. So it's kind of, I would a representative up tick in demand, I guess would be the way to say it, versus our assumptions which was to go up a year later.

David Strauss - UBS

And then as a follow-up on 787, can you may be talk about where you are relative to plan, how much cushion you had in some of the flight test program, how much you might have been into that right now?

Jim McNerney

Well, we went into flight test with a good cushion and I think it's there for a couple of reasons. One, because data can come in more slowly for a variety of reasons, flights could be impacted or quite frankly well usually what you build cushion for is configuration changes as you go through flight tests.

What we're finding is very few configuration changes. I mean I think one of the advantages of the maturity of the plane and what that means is that we had extra time to work on it I guess is the way to say it, is that the configuration is very strong and there is very little tweaking to the airplane to date that we've had to do which has opened up some contingency. We started a little late which ate in somewhat into the contingency but we are getting more data per flight off of the airplane. The team is doing a wonderful job there and that's enabling us to satisfy some of the certain requirements with data rather than extra flights. So when you add it all up we're retaining a contingency cushion and quite frankly, the team is aiming to add to it.

Operator

Our next question is from Joe Campbell with Barclays Capital. Please go ahead.

Joe Campbell - Barclays Capital

There were some past successes in the quarter that weren't mentioned this ultimate load test you received this certification yesterday evening. What are the next big milestones that we need to watch for? I mean usually one of the dramatic ones is they bang up the tail or the EMP; the like big lightening tests. Are there some things that we might watch for in the next say quarter that will have the importance of the ultimate low test in furthering reduction in risk and moving towards certification?

Jim McNerney

I would characterize it more as stepping through a series of multiple gates that are more like the flight test programs that you've always seen, stability and control, functional reliability, fatigue testing, some weather testing as you alluded to and sort of some other more normal kinds of activities. Now that the FAA it will be flying with us and we'll get all six airplanes in there. We anticipate being able to go through these pretty straight forwardly. Now you never know we could find something but we're reducing risk everyday.

Joe Campbell - Barclays Capital

What value you mentioned in the previous calls about the over the match between your planning cushion and for production and the demand from customers with this sort of oversold number. Do you continue to have the kind of oversold numbers that you I guess you are on schedule for '10 what's the outlook maybe the better way to say it for the match between demand and production for 2011 and '12?

Jim McNerney

Joe I assume that, that center is on 737 that question?

Joe Campbell - Barclays Capital

Well I would say all of them but primarily the 737 since most of the deliveries.

Jim McNerney

I would say the relationship between demand and supply has increased since the last time we've talked.

Joe Campbell - Barclays Capital

So as I recall you said that it was over sold. And that oversold condition has increased I guess hence the suggestion you'll raise production.

Jim McNerney

As I said in my remarks that is the bias in the evaluation right now and I would say the data would suggest that both on an oversold and discussions we are having with the customers.

Joe Campbell - Barclays Capital

And lastly you have a new operation in Charleston two entities which were acquired and one which we see pictures of seal going up, can you just give us a kind of color on how that is proceeding, I suppose particularly with regard to the operating entities which probably weren't up to Boeing standard when you acquired them?

Jim McNerney

Well, on the piece for constructing the 87 assembly, we are slightly ahead of schedule as we fabricate the capacity, I think both the Vought facility and the GA facility where we had pretty good visibility there, because obviously we had a lot of our people on these facilities trying to look through some of the issues. So it was not a pig and the pork kind of a purchase in either case. I would say that we are working through as we integrate those facilities for the rest of our production system.

I'd say we are working through some normal integration challenges and a couple of sort of inventory balancing issues, but I don't think it was beyond the realm of expectation.

Operator

Next we go to Ron Epstein - Banc of America/Merrill Lynch. Please go ahead.

Ron Epstein - Banc of America/Merrill Lynch

Just want to follow up on different kind of R&D question but from a longer term view. When we think about 777 and maybe what has to happen there, vis-à-vis A-350 potential re-engining of the 73 if that were to occur, what kind of the normalized level of R&D? Where should it go after kind of this big hump of 787 is behind us?

Jim McNerney

Yeah. I think supporting James; you can clean up this answer by the way. No but I think this year will represent a high point for a while. Then, depending on the timing of the 737 work and the 777 work, it will obviously begin to climb again depending upon what we do. So, I think what we have immediate visibility on is plateau this year and then down next year. After that, it's going to depend on the moves we make.

Ron Epstein - Banc of America/Merrill Lynch

And then maybe one follow-on R&D question. In the release, you mentioned in the aircraft on the defense side that there was higher R&D I was just curious if you can give us some color on what the higher R&D was on and why that wasn't just billable to the government?

James Bell

Well, it was basically focused on prototyping which gives us a competitive leg up as we look at competing on some of the future work that we are looking at particularly in our proprietary world if you are able to show the customer, given him a view of something in three dimension as to what you are going to propose. You are just a little better off. So that's what we are talking about what's principally in prototyping.

Operator

And we'll go to Heidi Wood with Morgan Stanley. Please go ahead.

Heidi Wood - Morgan Stanley

I had the same question as Ron, but I'm going to ask it in a little bit of a different way. As we think about the R&D outlook over the next couple of year, can you give us some colors, when is the moment of decision on the 787-10 versus the 777 upgraded and what are the key drivers there? And I have a second follow-up.

Jim McNerney

The way it looks to us now is, the -9 capability is going to be very good. And that the kind of improvements we think we can make in the 777 both the smaller and larger versions. Maybe enough to handle the -10 the old -10 mission between the two of them. We are not sure yet, but that question is something that we are debating and modeling right now. It maybe we need a -10, but we are seeing capability in the -9 that is substantial and the extent to which we really re-do. The 777 which is a real option, the improvements are particularly the, the way to strength kind of improvements with carbon fiber and what we think we can get from the engine is substantial.

And, so we are trying to sort, I guess my, this sort of long winded answer, but it gives you a feel for the dynamic at least.

Heidi Wood - Morgan Stanley

It's a complicated question, so thank you. And then on if Airbus, announces a GTF when we talked to some of our customers. They point out remind us that you guys prefer to leave versus follow. So are you more likely to respond with a GTF counter or would you consider doing an all new plane, and if Airbus announces this in 2010. How long before we would understand where you guys are headed?

Jim McNerney

Well I think, before the end of this year Heidi on the narrow body. We'll have charted of course of either re-engineering or moving on to the new airplane. I think again it's not an uncomplicated question and that fundamental decision will be made by the end of this year.

Operator

The next question's from Doug Harnett with Sanford Bernstein. Please go ahead.

Doug Harnett - Sanford Bernstein

Going over to Defense, I am trying to understand the margins for this quarter versus your guidance and your R&D as the piece of it but networking space systems, you did get a ULA benefit this quarter. Can you explain what has changed in the mix and why this would be better in the remainder of the year?

James Bell

Yes you know really what it bows down to Doug is we are going to get higher volume in over the course of the year. This is typically lower; their volume is lower in first quarter. So we are going to see the volume go up on some of the program. We expect better performance, we expect the benefits of a lot of our productivity efforts to start showing up in second, third and fourth quarter and that's where we're going to see the better earning picture there.

Doug Harnett - Sanford Bernstein

But are there some specific things say in network and space systems when you talked about mix. Are there some specific programs you can point to how that mix will shift and improve?

James Bell

I don't have that specific we could probably get back to you and talk to you in more detail about it, but I don't have that with me right now.

Doug Harnett - Sanford Bernstein

Okay and just if I can, again on margins but on BCA, the 9.1% margin was very impressive but if you go to the unit margin it was even better, it was about 11% margin. What is going on there? What's the difference right now in those two?

James Bell

Well remember the dynamics between program accounting and unit accounting where the impact of program accounting and unit accounting, where the impact of favorable mix is better is larger in unit accounting. So in first quarter we had a real favorable mix of 777 freighters be delivered and that's what you saw in their margins that drove unit up to 11.

Operator

And next with Howard Rubel with Jefferies & Company. Please go ahead.

Howard Rubel - Jefferies & Company

Just two items, one is that you point out the C17 had some either cost or margin pressure. Let's say on an order of $30 or $40 million is that just due to the rate change or is there some fundamental manufacturing issue?

James Bell

Well it wasn't really either. It was the negotiations we had with our customers. We were delivering working under a indefinite type contract action and by the time we got to the negotiations to finalize those, a lot of that work was substantially completed and so the government positioned our customers position basically was, it wasn't as with risk associated with it and so we ended up getting lower margins than we traditionally get when we sign up to a fixed price contract, production contract in the beginning before we start working on it.

Howard Rubel - Jefferies & Company

Well James will you keep it at that rate or does it mean you should…

James Bell

No not at all. We are trying to work on the process with our customer to get these kind of fixed price production contracts negotiated earlier, but we don't find ourselves in the situation.

Howard Rubel - Jefferies & Company

And then on the 787, you talked about 500 hours of flight testing. How should we think about that from two points? One is, I mean how much does it count towards this 3,100 hours that you talk about and then what kind of performance are you seeing? I mean we don't know the airplanes are a little heavy and so what have you been able to accomplish or determine that gives you comfort that you are going to meet some of the specs that you promised to customers.

James Bell

Yes I think we are seeing very few issues particularly configuration which often times does present meddlesome issues throughout the course of flight test due to the maturity of the design and we're seeing a pretty methodical step through of the things that we need to demonstrate. I mean I think the most difficult obviously were fluttered testing, ground effects, static test on the wing and these are very fundamental tests that test the integrity of the design early and we like it that way so we find out early if there is any issues and we step through those on a pretty reasonable basis, on a very reasonable actually and we are getting more data from those test than we thought we'd get and that will help reduce number of flight hours required later as we pursue certification because that data can be substitute for actual flight hours.

So we are feeling pretty good right now and save an unknown that could hit us, we feel comfortable that with the margin we have, with the current rate of flying that we are now up to and the greater amount of data per flight I think we feel confident on our ability to complete flight test within the timeframe we have guided you towards.

Howard Rubel - Jefferies & Company

And the efficiency of the wing then is better than you planned?

James Bell

Well all the testing isn't done but the integrity of the wing okay and the configuration of the wing, superb. The efficiency will be tested with different engine types and under different conditions but we are if what you are getting at is are we confident that we can meet the mission that we promised our customers as we work off some of the weight. The answer is yes.

Operator

And we go to Joe Nadol with JPMorgan. Please go ahead.

Joe Nadol - JPMorgan

James, on the margin the guidance and commercials, just coming back to that one, seems if I just take what you are doing, what you did in Q1 and then your R&D guidance and all the rest of your guidance, it seem pretty clear there is a $500,000 or $600,000 million EBIT difference between kind of the two numbers. You get to the one you are guiding for bottom line and what you get to otherwise, and I understand part of that is this fleet support you are talking about and the period cost that come up. But I'm trying to get my arms around how much of its those items and how much of this is the contingency that you are referring to. Is the contingency half of that or is it bigger?

James Bell

Its conservative. My contingency, in that we have. I don't really want to get into how big it is because obviously, we are going to be driving performance over the next three quarters Joe but let's just say, I have what I would consider adequate contingency to cover some of the development risk that still lies ahead of us in these two major development programs.

Joe Nadol - JPMorgan

Okay. And on the 777 orders, we saw the order for 12 from the unidentified customer. Seems like there's got to be more coming to support the seven a month rates. Can you just characterize Jim, when we might see these orders? Is it in the coming weeks? Is it may be a farm borough? Just any help you can give us there?

Jim McNerney

Well, the timing of divulging these as you know really is driven by our customers. And so we are respecting their wishes and there are some unannounced orders you alluded to one of them and there are some ongoing discussions where we have high degree of confidence that are going to turn into orders and but I think we feel comfortable. I guess I would just say and I'm sorry I am being a little coy here, but I do want to respect our customers' wishes. We are comfortable that the demand will support the moving of the rate up a year.

Joe Nadol - JPMorgan

There has been some talk Jim about a modest variant 200 to 300, a 777-300ER that might be coming out, is it possible that the orders might turn into kind of a many launch for the new variant?

Jim McNerney

No, no these orders are centered on the concurrent airplane current configuration.

Operator

Next, we'll go to the line of Troy Lahr with Stifel Nicolaus, please go ahead.

Troy Lahr - Stifel Nicolaus

Can you just help me understand your thought process as you evaluate 737 production increases, are you contemplating a meaningful increase or might really we just see a small up tick on the table at this point and also is that decision just completely independent of 737 re-engining demand and the analysis that you are doing there?

Jim McNerney

I think the determinants we are looking at a couple of options on rate increases, obviously the things we have to be sure of our backlog and demand beyond that some visibility and the readiness of our suppliers to support the upgrade and we feel pretty comfortable that in this quarter, not that we are going to be able to tell you where we're going. What was the second part of your question?

Troy Lahr - Stifel Nicolaus

Well, indeed the decision is completely independent of any pauses on re-engining?

Jim McNerney

Listen, as we look back in Boeing's history, we try to make these decisions in a way where the current demand for current products is supported as we move into derivatives or all new airplanes and we got a process in place that we don't think is going to cannibalize the demand we see now.

Troy Lahr - Stifel Nicolaus

And just one clear when you talk about several options on the rate increase are you contemplating may be you just do a small up tick a couple more months or you are also contemplating doing several more going up to say may be even like 36 something like that?

Jim McNerney

Well I would just say that we are looking at meaningful increases, I really don't want to signal exactly what we are looking at, but it will make I think you'll be pleased.

Operator

Our next question is from Rob Stallard with Macquarie Research. Please go ahead.

Rob Stallard - Macquarie Research

Just a follow up on the suppliers, a number that's been suggesting you may be cutting production as opposed to raising production, how confident are you that your supply chain is ready for these rate increases you are discussing?

James Bell

Well we wouldn't do it if they weren't ready that's a being mistake in our business. So obviously before we change the rate on the 777, we have had in depth discussions with our suppliers before we changed the rate on the 7777 we had in depth discussions with our suppliers and before we changed the rate on the 737 if we do change it, it will be done with the support of our suppliers. I am not sure what you are hearing.

Rob Stallard - Macquarie Research

Yeah and just a follow up on the 787. What sort of build rate are you expect the supply chain to be at, say by the middle of this year?

Jim McNerney

We're on a rate to support tantamount at the first part of 2013. You can see our inventory build this year, we'll have roughly somewhere near 30 airplanes by the time we start delivering at the end of the year so you can sort of interpolate.

Operator

And we'll go to Peter Arment with Broadpoint Gleacher

Peter Arment - Broadpoint Gleacher

Just following Jim again on this the TIA you were granted and it sounds like what we're getting at is you are getting more efficient with everyday passing so that with TIA that was granted I guess on monthly or give or take few days that you are gaining that back and you had some contingency built in there anyway. Is that correct?

Jim McNerney

Yes. I mean I would say the TIA ate into the contingency a little bit, but we have more there and we're at a run rate that we hope will continue to extend the contingency we have left.

Peter Arment - Broadpoint Gleacher

Okay and then just if I could have a quick follow up, you've said that orders I think you had 83 or 84 orders in the first quarter and 94 net orders to date and yet we've seen the price of oil go from $60 to $80 plus per barrel in this first quarter. Are you seeing a change in customer behavior regarding this? Is it sharpening anymore, everyone's pencil a little more about getting more efficient or maybe you could just give us a little color on that? Thanks.

Jim McNerney

I think it's more reflective of overall economic conditions and airlines in better financial shape. I think the price of oil is at least as I see it and talked to airline customers is within the zone of their assumption. So I don't think that's the delta, I think it's more their condition and a more bullish view of the economy, demand coming back a little quicker.

Operator

Our next question from Sam Pearlstein with Wells Fargo Securities. Please go ahead.

Sam Pearlstein - Wells Fargo Securities

I just wanted to follow up on the comment you made about orders being higher than last year. And I am just wondering do you think that's sufficient to hold or grow the backlog from here in terms of order of magnitude, what's the order this year than last?

Jim McNerney

I think what we said and I reiterated here is that I would anticipate book to bill being somewhat less than one this year and I think the run rate sort of indicates that so far.

Sam Pearlstein - Wells Fargo Securities

Okay and then James you alluded to the mix in the second quarter. Is that primarily on the 777s as the freight is the first quarter versus what you'll see in the second quarter or is there something in the mix as well on the 37s.

James Bell

When I was talking about mix and on BDS, I think the mix going forward would be on BCA it'll be about the same as we saw this quarter. So that's how what's going to drive us. What's going to drive it is going to be as I mentioned earlier is the timing of R&D expenditures, the timing of investment and our productivity tools and some of our fleet support cost timing as we get it closer to entering the 787 into service.

Sam Pearlstein - Wells Fargo Securities

Okay and then last question just Jim. Can you just update us in terms of where things stand with regard to an F-18 multiyear?

Jim McNerney

Discussions are maturing. It looks to us as if we will complete them sooner rather than later. So, we're feeling pretty confident that we'll be able to nail that down. That said until it's done, it's not done.

Diana Sands

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

Operator

And that will be Noah Poponak with Goldman Sachs. Please go ahead.

Noah Poponak - Goldman Sachs

Follow up on the IDS margin. You talked about some of the moving pieces. But if we take a step back, its one of the lower quarterly margins we've seen in several years. How much of it is company specific stuff and how much of it is sort of a new norm in defense profitability given a tougher customer and things of that nature?

James Bell

I just think its part of it is a C-17 piece. I think that's a piece we're have to work on going forward and the fact that we got negotiated the margins that are more end of cost site contract margins because of the lateness of definitizing the contract but other than that, I think that's the only thing that I would say that's different. Either external or internal and the rest is principally what I said was timing some of the expenditures, the prototyping earlier on and then, we're holding our guidance for the year because we believe in these the next three quarters will get back to the normal operating run rate.

Noah Poponak - Goldman Sachs

If I can throw in one quick follow up on cash flow in the quarter. Cash from ops was negative. You had said it would be the weakest quarter of the year. Can you tell us if it was better or worse than your internal plan? You guys have had some pretty steep ramps. It was okay. So if there is potentially some upside to full year zero target?

James Bell

I didn't say that, I said it was better, then we had anticipated for the first quarter. I think we still have a lot of challenges that we'll have to face into for the next three quarters and so we are still comfortable with our guidance at zero operating cash.

Operator

That completes the analysts' 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 with the questions for Jim and James, if you have questions after the session ends please call our media relations 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

And we'll go to Susanna Ray with Bloomberg News, please go ahead.

Susanna Ray - Bloomberg News

I am wondering Tim although had said at the beginning of March that there was about a month and month and half of left on the 787, so obviously you said the TIA is still a aiding to that. So I am just wondering how much margin which you say is left now?

James Bell

Well I think he may have anticipated TIA with that answer, so that's about where we are.

Susanna Ray - Bloomberg News

So you have half a month of margin left on I mean if it's a month behind to that?

James Bell

No, no I said, I think he anticipated TIA with that answer. So we are still above…

Susanna Ray - Bloomberg News

TIA at the end of March and then at the end of April

James Bell

No I am saying anticipated at being when it happened yesterday with that so its about, its about the same today

Susanna Ray - Bloomberg News

Okay I understand and you mentioned not having to make changes to configuration and what not and how that's going to help you know counter that can you just kind of elaborate more on how you are going to make up that margin. Is that the main thing or there are other…

James Bell

Well no I think one of the things that offset the TIA delay was the fact that the configuration was a lot more mature than we had planned for. So it was in that spirit that I made the comment.

Operator

And we'll go to Dominic Gates with The Seattle Times. Please go ahead.

Dominic Gates - The Seattle Times

Actually before I ask my tanker question can I just get a little data point clarified. I think you mentioned $1.9 billion projected for capital expenditure mostly BCA for the year how much of that is South Carolina and what you are doing there in [87]?

James Bell

Its $700 million Dominic I think we mentioned that on our last call.

Dominic Gates - The Seattle Times

But my main question is about tanker we saw the EAVS press conference yesterday you guys now face some pressure I believe you are doing an advance tanker with a new boom with a 787 cockpit with wing list with various changes so it's a development program with unknown there and you've got and it's a fixed price contract so can you just talk to us about how you plan to handle that given the EAVS saying that they are going to try and beat you on price.

Jim McNerney

Yeah I mean I can't speak for EAVS, I am sure they have a substantial amount of development work to do themselves, but talk to them about that there is no question that there are some development work both on the airplane and integrating the military systems but I think one of the values of doing it the way we are doing it is we've got a workforce that has lived through many, many configuration design changes on a 767. They understand the airplane and I think at the end of the day, that may offset some of the development issues that both of this face and I kind of like, I like betting on our guys in that environment.

Operator

The next question is from Josh Freed with the Associated Press. Please go ahead.

Josh Freed - Associated Press

Yesterday Delta mentioned that they took delivery on two 777 without financing and my question is whether there was any connection between that and the certain negotiations over the 787 situation with Delta?

James Bell

All right, if you're asking us did we give them to them for free the answer is no.

Josh Freed - Associated Press

Okay, if not free were they related? Is there any connection between those two?

James Bell

No

Josh Freed - Associated Press

You're looking at delivering the 787 hopefully by the end of the year, is there any significance to the 12/31/2010 date in terms of sort of delivery penalties and that kind of thing. I mean can you give me a sense of what's at stake for you financially if it does get pushed past that date?

Jim McNerney

Well every customer commitment differs a little and so if there are substantial delays, there could be some kind of settlement discussion but a, we don't anticipate and b, modest delays would be largely accommodated within our current agreement.

Operator, I believe there is one last media question in the queue. We'll take that one and then conclude the call. And then we'll go to Molly McMillin with Wichita Eagle. Please go ahead.

Molly McMillin - Wichita Eagle

Hi, good morning. Two real quick questions. One is, do you know when you guys might announce how many jobs that tanker win for you would need for Kansas? Or do you maybe have a number, do you have a number?

Jim McNerney

Well, don't have a specific number for you right now, but Tanker win for Kansas would be huge. We will depend on that work force to do a lot of the modification and final integration of the airplanes.

James Bell

That concludes our earning call. Again, for members of the media, if you have further questions, please call our media relations team at 312-544-2002.

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Source: The Boeing Company Q1 2010 Earnings Call Transcript
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