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The Boeing Company (BA)

Q1 2007 Earnings Call

April 25, 2007 10:30 am ET

Executives

Dave Dohnalek - VP, IR

Jim McNerney - Chairman, President and CEO

James Bell - CFO

Tom Downey - SVP, Corporate Communications

Analysts

Byron Callan - Prudential Equity Group

Ron Epstein - Merrill Lynch

Howard Rubel - Jefferies & Company

Steve Binder - Bear Stearns

Heidi Wood - Morgan Stanley

Joe Nadol - J.P. Morgan

Joe Campbell - Lehman Brothers

Cai von Rumohr - Cowen & Company

Robert Spingarn - Credit Suisse

Doug Harned - Sanford Bernstein

Robert Stallard - Banc of America Securities

Troy Lahr - Stifel Nicolaus

George Shapiro - Citigroup

Robert Toomey - E.K. Riley Investments.

James Wallace - Seattle P-I Newspaper

Peter Pae - LA Times

Stanley Homes - BusinessWeek

Lynn Lunsford - Wall Street Journal

Doug Cameron - Financial Times

Dominic Gates - Seattle Times

Presentation

Operator

Thank you for standing by. Good day, everyone, and welcome to the Boeing Company's First Quarter 2007 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 am turning the call over to Mr. David Dohnalek, Vice President of Investor Relations for the Boeing Company. Mr. Dohnalek, please go ahead.

Dave Dohnalek

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

After brief comments by Jim and James, we will take your questions. And in the interest of time, we ask that you limit yourself to one single part question please. As always we have provided detailed financial information in our press release issued earlier today, and as a reminder you can follow-up today's broadcast and slide presentation through our website at boeing.com.

And 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 statement at the end of this web presentation.

Now, I will turn the meeting over to Jim McNerney.

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Jim McNerney

Thank you, Dave, and good morning, everybody. Let me begin with some comments about our first quarter, and then James will walk you through our results more specifically. After that I will say a few words about what's ahead for us, and then take your questions.

In summary, we are off to a good start in 2007, we delivered solid top-line performance during the first quarter with strong double-digit growth in operating income, net income and earnings per share. These results are inline with our expectations for the quarter and represent good progress towards the challenging goals we have [set] for ourselves both this year and beyond that.

Our businesses are delivering solid performance and they are well positioned in their markets. Our Integrated Defense Systems business generated solid growth of double-digit margins by executing well on its very large and balanced portfolio of progress. IDS also made great progress on the business development side by notching some key wins from international customers. And we submitted our KC-767 Advanced Tanker proposal to the U.S. Air force also this month. We think this tanker will do for refueling what the C-17 has done for Airwest, it will revolutionize mobility operations.

Boeing Commercial Airplanes continue to build on its strong momentum during the first quarter. BCA efficiently increased production rate, [Technical Difficulty], that were slightly better than we told you to expect and continued to make progress strengthening the BCA product line with our key development programs. I will say more about that in just a couple of minutes.

First quarter revenue growth and margins from our business units are also on track. We expect BCA and IDS margins to expand from their Q1 levels, as we move through the year, consistent with the guidance levels we have given you. As expected, lower centralized costs were responsible for the bulk of our operating income growth in the quarter. That was driven mainly by last year's decision to exit our Connexion by Boeing business, and by changes we made to our share-based plans. These management actions were aimed on improving our profitability by reducing costs in our other and unallocated line items, which will benefit the company going forward.

Total company backlog expanded further this quarter to another record total of $262 billion, which represents more than four times our current revenue. Our backlog is growing 23% over the past year. Thanks to the strong demand for our commercial airplane products as well as key defense program wins.

While we make progress on our financial goals and grow our record backlog, we also continue making progress on our major development programs, including the 787 Dreamliner. Scott Carson and Mike Bair gave you a detailed 787 update last month, and as you've seen as soon as yesterday with the Virgin and Air Canada announcements, demand for the Dreamliner continues unabated. We are also making progress toward our development milestones for this year and next.

Let's review just a few of those. During the first quarter, we surpassed 500 orders for the Dreamliner, which is an unprecedented achievement by the BCA team. We now have 544 firm orders from 44 customers, which is the highest tally ever achieved by a commercial jet program within three years of its launch. We are now in the process of bringing the 787 to life. Major structural elements of the first airplane are being assembled, and in some areas we are already working parts and assemblies for airplane #5.

Fuselage sections from Japan, Italy, South Carolina, and Wichita, are coming along well, as is the wing box from NHI. Second special 747 Freighter or Dreamlifter has taken its first flight and delivered its first components. And we have a third Dreamlifter at the Mod Center and a fourth one heading there.

Our engine partners are making good progress on their flying test beds. And work on the systems side is moving ahead as we enter integration testing of these major elements. In Everett, the upgrade of the final assembly day is going well and we have started receiving components there. The horizontal stabilizer arrived just very recently and other major components will be arriving in the next few weeks.

We will rollout the first 787 out of our Everett factory on July 8th, an event we will webcast so all of you can see the airplane. As you know, we are targeting a first flight in late August, which will kick off our flight test program. We will remain on-track for first delivery to ANA in May of 2008. As we have said before, we are working late, scheduled, and supplier challenges, as we strive to meet our milestones.

These areas represent the bulk of our R&D spending at this point and we are making strides in each area. We are moving into the very critical final assembly and systems integration phases of our program, and as you can imagine the entire 787 team is working very hard to achieve our milestones. So, mindful of the inherent challenges and risks that lie ahead, particularly in the latter stages of major airplane development programs, we are nonetheless pleased with the progress we are making on the 787.

We are also pleased with the airplane's performance, which we expect will exceed the overall performance levels we committed to customers when we launched this program. We will continue to update you on the 787 as we move through our key milestones.

Scott Carson and Mike Bair will discuss the program along with the rest of BCA's business during our Annual Investor Conference in Chicago on May 23rd, and will provide another progress update in mid June during the Paris Airshow. So, let me wrap up my opening comments by saying that we have reaffirmed our financial guidance for 2007 and 2008.

Our record backlog, increasing productivity and the progress of our development programs have us on track to achieve our growth and productivity objectives.

So, let me turn it over to James for a review of the numbers. James?

James Bell

Thank you, Jim and good morning. I will begin with the first quarter results on slide 3. Our revenue increased 8% in the quarter driven by higher commercial airplane revenue and growth across all defense business segments. Our EPS grew 28% to $1.13 a share while our net income expanded 27% to $877 million.

Earnings from operations increased 36% to $1.3 billion. Our earnings were driven by solid business performance from BCA and IDS and lower centralized cost, which I will explain in more detail in a moment. Now, let's start with our business unit review with commercial airplanes on slide 4.

BCA continues to properly manage its production ramp up while achieving a record backlog and investing in its growth. BCA delivered 106 airplanes in the quarter, which alone with higher service revenues drove a 7% increase in total revenue to $7.6 billion.

The delivery mix this quarter was more heavily weighted to single out airplanes as compared to the same period last year. Operating margins grew to $706 million, producing an operating margin of 9.3% which is slightly better than what we told you we would do in the first quarter.

BCA’s margins reflect productivity improvements across its products and services offset by a planned increase of $258 million in R&D and the absence of supplier development cost sharing payments.

R&D spending for the quarter was on track at $788 million. We expect BCA’s R&D to begin declining in the second half of this year which along with productivity improvements will drive margin expansion consistent with our guidance.

Program margins exceeded unit margins this quarter due to new customer introduction costs and pricing mix that reflects airplanes sold two to three years ago in a tougher pricing environment. We captured 109 gross orders in the first quarter which lifted BCA’s backlog to another record of $188 billion which is 6 times current BCA revenues. As we look ahead, we continue to expect our book-to-bill ratio to exceed one this year.

Now Jim has already talked about the tremendous success of the 787 as enjoyed in the market and the progress we are making in its development. We also achieved important milestones on our other programs. We completed a small acquisition for our Service business, delivered the first 737-700ER to ANA and surpassed 1,500 orders for the 747 program, a phenomenal accomplishment for that legendary airplane as we transition to the new 747-8 family. So, Boeing Commercial Airplanes is off to a good start again in 2007 and is performing well in a healthy market.

Now moving to slide 5 in our Defense business. IDS delivered 7% revenue growth and double-digit margins in the first quarter driven by higher volume across its three segments. Results were led by 6% revenue growth and 12.9% margins in Precision Engagement and Mobility Systems and by 17% growth and 12.6% margins in Support Systems.

Margins in our Network and Space Systems area were affected by cost adjustments this quarter, but we expect that segment will still meet its margin guidance for the year. IDS completed major milestones during the quarter, including a successful test of the Future Combat Systems program and a sea-based radar test of the Ground-based Missile Defense program. IDS also successfully completed its critical design review of FAB-T helping to pave the way for deliveries to begin.

We have made important progress on our other international efforts during the quarter. Australia chose our Super Hornet fighter. We achieved the first international sale of the Chinook helicopter and Canada chose the C-17 for its air force.

So, summing up, IDS remains well positioned for growth and profitability with its broad portfolio of key development, production and support programs. The IDS team is performing very well across its businesses and is on track to achieve its growth and double-digit margin goals for both 2007 and 2008.

Next slide, Boeing Capital delivered another strong quarter with pre-tax earnings of $73 million on revenue of $213 million. BCC grew its earnings despite the significant plan reduction of its portfolio size last year. Consistent with this risk reduction strategy, BCC also reduced its debt by $800 million in the first quarter.

The aircraft financing market continues to be robust and BCC is executing well, as it supports Boeing's core businesses. I mentioned earlier that our centralized costs declined this quarter, which drove our overall margin expansion. This large area of costs improved significantly due in part to management decisions we made last year. The other expense category declined $59 million due to our exit from the Connexion business.

Unallocated expense also fell sharply due to lower expenses on share-based plans and deferred compensation. Both of these declined due to higher stock appreciation in the year ago quarter and changes to our long-term compensation plans we implemented last year. Non-cash pension expense grew as expected to $252 million in the first quarter.

Now, we expect to realize significant savings in these areas this year, which is included in our guidance. We expect total other expense this year to be about $150 million. We also expect total unallocated expense to be about $1.5 billion this year, which includes about $600 million in pension expense and $300 million of share-based plan expense.

Now, let's move on to our balance sheet on slide 7.

Our balance sheet and liquidity remained strong. We ended the first quarter with $8.1 billion in cash and liquid investments. This was down from the end of last year due in part to repay over $800 million of BCC debt and the repurchase of 4 million Boeing shares. And the largely discretionary contribution of $509 million to our pension plan.

The BCC debt repayment brought our total debt down by about $800 million, and after upgrade from Moody's and S&P last year we continue to enjoy strong credit rating and outstanding liquidity.

Now, moving to cash flow on slide 8. We generated $728 million of operating cash flow in the quarter. Strong net income and non-cash items were somewhat offset by the pension contribution and the planned increase in working capital caused by timing of payables and receipts and the expected BCA inventory build-up as our production ramps up.

We continued our balance cash deployment strategy as we invested in organic growth programs, repurchased 4 million shares for $360 million, and contribute to our pension plans, as well as, paying a 17% higher dividend to shareholders.

Now, let's turn to our financial guidance on slide 9. As Jim said, we are reaffirming the financial guidance for both 2007 and 2008 that we issued three months ago. Our outlook reflects strong performance from our core businesses, increasing commercial airplane deliveries, improving margins, lower R&D in the second half of 2007 and 2008 and company-wide productivity improvements. These numbers represent strong year-over-year growth and top and bottom line performance.

We had a strong first quarter so our bias as it relates to 2007 guidance is positive right now. We will revisit guidance as usual when we discuss our second quarter results in July. You will find more details about our outlook in the earnings release we issued this morning.

Now with that, I will turn it over to Jim for some final comments.

Jim McNerney

Thank you, James. You can see from the outlook James just discussed, that we have some ambitious goals for this year and next. We are confident we can meet those goals. Our businesses are executing well, and all of us are focused on executing even better.

We are in healthy markets pursuing prudent growth strategies and seeking to boost productivity in each of our factories and our offices. Meeting the financial commitments we make to you is as important as meeting the performance commitments we make to our customers. We are determined to deliver on both. We want to remain the world’s strongest, best integrated aerospace company.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question comes from Byron Callan of Prudential Equity Group.

Byron Callan - Prudential Equity Group

Good morning, gentlemen.

Jim McNerney

Good morning.

Byron Callan - Prudential Equity Group

Jim, you have been at the helm for almost two years. I am just curious where do you think you have made the most progress with things you want to change at Boeing. What are you most keenly focused on today? And are there areas you are disappointed with or frustrated with that you think the company can do better at? Thanks.

Jim McNerney

Yeah, sure. Listen this was certainly not a broken company when I took the helm a couple of years ago. It was a company that was doing a lot of things right and had some good strategies in both its businesses. I think though we are emerging from era of management turmoil, some uncertainty with regard to priorities and I thought, just to use a term, some of the software the company needed addressing in terms of leadership development, management needed to be infused with a little more accountability in some cases. So, it was more around the leadership. A refocus helped the company regain its confidence in itself, because the strategies were good and the products were by and large good, also focused a lot more on international I would say and some of that effort is beginning to bear fruit.

Byron Callan - Prudential Equity Group

Okay. And areas that you think you could still do better out here?

Jim McNerney

Well, I don't want to give the bullish answer which is there is nothing we can do better, because there is a lot of things we can do better. But I think with $260 billion plus backlog, the issue is obviously around execution, because the markets and our customers are accepting our technology, and the backlog represents to all of us at Boeing, both a huge opportunity and a big burden to get it done properly. And so we are focused on a lot of things that you don't see, which have to do with new ounces of making sure priorities are right, making sure people are aligned and accountable, making sure that we have balanced work across the enterprise and make sure that people feel like they are growing and are excited about what they are doing. Those are the kinds of things we are focused on now.

Byron Callan - Prudential Equity Group

Great, thank you.

Jim McNerney

You are very welcome.

Operator

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

Ron Epstein - Merrill Lynch

Yeah. Good morning.

Jim McNerney

Good morning.

James Bell

Good morning.

Ron Epstein - Merrill Lynch

Yes, Jim, I was wondering if you could share some broad thoughts on the commercial product strategy. What I mean is, in the past there was lot of talk about a replacement of the 737 and then it seems lately that maybe that discussion has moved more towards something in the wide-body market, maybe an update to the 777? And then just as a quick follow-on, how is the 777 moving line going?

Jim McNerney

The moving line is going well. I am really proud of the leadership out at Everett and the leadership of the business there. A moving line seems like a small thing, but it is a big cultural change and a big leadership challenge, and it changes people's lives on the floor and people have to believe in where they are going in order to do it and that's moving along well. So, that feels good.

As to the strategy, the two big areas that we will have to address at timing that is consistent with what customers need and the maturation of our technology, as you pointed out, are at some point narrow-body replacement and I think you are right. I think the 777 will have to be modified somewhere along the line. Which comes first? I think what we are doing is maturing the technologies and listening to customers, so we are ready to go when it becomes clear which one we need to do first.

In terms of the triple, I think we need to see what the A350 is or isn't before we can make a judgment on whether a competitive response is needed. But believe me when I tell you that we are spending a lot of time thinking through what response that might need to be, meanwhile the 777 is probably the most successful wide-body program since the 747 and it's building a terrific franchise, and we are ramping up production rates and we are trying to keep up with that. We are moving the line and all the rest of it. So, I think at the end of the day I can't give you a point prediction on where we are going to have to respond first. I am focused on making sure that everybody is ready to move as the market needs it.

Ron Epstein - Merrill Lynch

Okay, great. Thank you.

Jim McNerney

You're welcome.

Operator

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

Howard Rubel - Jefferies & Company

Thank you very much. I want to kind of go from the broad to a little bit more narrow, two things are sort of notable, one is that if you exclude the Research and Development spending from your operating profits, it looks like you are about 19.8% versus 17.5% year ago Jim. And that would sort of indicate to me that there is some real change in the way you are addressing productivity and profitability, where do you take up from here, and as we look out this could imply maybe as much as 15% operating margins in commercial, is that a fair way to think about it?

Jim McNerney

James, why don’t you tackle this specific question and I will come back with the forward-looking part of the question.

James Bell

Well, first of all Howard your math is impeccable.

Howard Rubel - Jefferies & Company

Yes.

James Bell

Yes, it’s not bad at all. And I think you are seeing the fact that we really are starting to harvest a lot of benefit not only from lean but our other productivity initiatives that we implemented a year ago, and we would expect there is more opportunity as we get the volume from our higher production rates and the lower order traffic.

And as Jim mentioned earlier, as we have the opportunity to convert this record level backlog and convert that to value. So, we will continue to be working that to see how we get these pre-R&D margins up.

Jim McNerney

And I think you said it James, I think we are going to continue to face into a competitive environment though, every dollar of improvement that we get may not flow to the bottom line because we have customers that need to be productive, and we have competitors that aren’t going to sit still and let us take easily as much of the market forever as we are taking now.

So, how that exactly gets expressed in terms of progress towards a 15% operating margin or whatever target will sort of unfold, but we are determined to be ready to make any necessary competitive responses, any kinds of investments we need to making customers and grow our margins as we move along.

Howard Rubel - Jefferies & Company

Thank you.

Jim McNerney

You're welcome.

Operator

Thank you. Your next question comes from Steve Binder of Bear Stearns.

Steve Binder - Bear Stearns

Yeah, good morning.

Jim McNerney

Good morning.

Steve Binder - Bear Stearns

Just wanted to follow-up on Howard's question, because James you touched on a difference between unit and program in your introductory comments and you did touch on pricing on the unit costs so I bet it's reflecting deliveries at a less favorable pricing and you changing your program method. So, I am just wondering the reason for that increase in the pre-R&D margin to 19.8 from the low 18% range in the fourth quarter of '06. is that really just cost system or visions or is it also reflecting a better pricing environment that’s built in to your blocks?

James Bell

It's both I would tell you its productivity and better pricing going forward. The planes which you are seeing in the unit margins and the impact of that is two or three years ago we really were faced with a much more competitive pricing environment and also a phase we are trying to have pricing that bridge us to new market particularly for the 747-8 and then also we saw a more robust market in this time period for the 777 two or three years ago and we needed to make sure we got there along with the single arm. So, I think you are seeing a combination of both the better pricing as it stabilizes today and then also our productivity efforts.

Steve Binder - Bear Stearns

Alright then it’s a follow-up. Northrop put in their 10-Q filing yesterday that they are informed by you back in April this year that you might have to incur liquidated damages because of the ways on the Wachtel program, and that they might have take a charge as much as $40 million. I am just wondering if you feel like any damages are fully reflected in your EAC so that there wouldn't be another charge require?

James Bell

Absolutely. I mean, we obviously knew before March of last year we were having technical issues on the program and we assumed that as a result of that. In worst case scenario, we would have to absorb some liquidated damages and they have been in our EAC and our Boeing position since then.

Steve Binder - Bear Stearns

Okay. Thank you.

Operator

Thank you. Our next question comes from Heidi Wood of Morgan Stanley.

Heidi Wood - Morgan Stanley

Good morning.

Jim McNerney

Good morning, Heidi.

James Bell

Good morning, Heidi.

Heidi Wood - Morgan Stanley

James and Jim, I want to also hark on the margin outlook for commercial and make sure I have got through the right puzzle pieces as we think this is true. If you look at our guidance in '07 versus '08, you are talking about 20% uptick in volume and over 13% decline in overall R&D, which means that commercial R&D is going down more, and yet only a 10% increase in BCA margins year-over-year. So, again just what are some of the key assumptions that would help offset that mix of productivity and mix in R&D tailwind?

James Bell

Are you talking going forward, Heidi?

Heidi Wood - Morgan Stanley

Yeah, I am just trying to think what keeps us from thinking about 15% margins by 2010.

James Bell

Well, principally, what's going to keep us from that by 2010 is the fact that we are going to have dilution from the 787 margins. Obviously, it's the beginning of a new program, and although it will start out more probable than any new program, any new product introduced at least in our history. It will still dilute the margins that we experienced on our mature programs. And so clearly to the 2010 timeframe that's going to have an impact particularly since we expect to deliver over 100 airplanes in the first two years and then that will grow in the third year.

Heidi Wood - Morgan Stanley

And that more than overpowers the increase in volume and decrease in R&D?

James Bell

I won't say that it more than overpower. I am just saying to you that we are going to have that dilutive impact and we will have to wait and see as we get closer if we are able to get more productivity as we ramp up on the 87 because that dilution is real. And remember just what we have been talking about 18% or 19% in these years for our pre-R&D margins on our mature program. Obviously, it's going to take us some time to get to that same level on the 787.

Heidi Wood - Morgan Stanley

Okay, great. And then as a follow-up, again for both you and Jim. How do you guys think about R&D going forward? It's traditionally been cyclical in the past. Is it going to continue to be so, and if so, when do you see it topping and what's the right level? And Jim, of course, if we look at what you did in your 3M days with R&D, you've clearly helped the organizations in the past focus and refine their R&D, how do you think about it at Boeing?

Jim McNerney

Well, as I mentioned in my earlier comments, Heidi, I think R&D expenditures are difficult to precisely predict at this point. I think you are right, I mean the R&D associated with 787 will be winding down later this year. We will still have spending on the 74-8, and then the timing gets a little less certain as we have to respond to the 777 and the narrow-body replacement.

Now, I would say that it should come down and I don't see anything that's going to drive it back up in the guidance period. But we will have significant programs to spend on over time. I mean when you get out beyond our guidance period now, the narrow-body would be a major program, it's hard to predict exactly what we will or won't be doing to the 777.

So, I think that the key point is that we will have created economic room to respond properly to those competitive environments through the productivity initiatives we are driving through some of the volume efficiencies that you pointed out, and will be ready, and exactly how that will express itself in terms of margins is hard to predict right now. But this company will be ready to make those expenditures to the degree they need to be made.

Heidi Wood - Morgan Stanley

Okay, great. Thanks very much.

Operator

Thank you. Our next question comes from Joe Nadol of J.P. Morgan.

Joe Nadol - J.P. Morgan

Thanks. Good morning.

Jim McNerney

Good morning.

Joe Nadol - J.P. Morgan

Could you just give a little more color on, I guess two areas, pricing and you’ve spoken a little bit on it already but and the Euro is hitting new highs has to be helping your pricing power vis-à-vis your competitor.

And then secondly raw material inflation which took a bit of a high risk second half of last year but it has really picked up again in the early part of this year, how do you see these two trends affecting your margin outlook, I guess, for beyond your guidance period?

James Bell

Jim, I will take that, I think what we have said to you and what we are seeing continuing today is that pricing clearly has stabilized, and it’s at a level that's better than it was two or three years ago. So, we expect that to continue as the market responds favorably to our product offering. As it relates to raw materials, they are included in our guidance number everything that we know and we have seen about the run up in cost and raw materials we have included into our assumptions for program accounting purposes, and it's included in our guidance.

It's stabilized for a minute, we’ll just have to wait and see how it goes, how it plays out, and that’s why we’ll continue to work for productivity side to help hard and anticipation that if it does grow we’ll be able to deal with it, and if it doesn’t grow we’ll just have better performance.

Joe Nadol - J.P. Morgan

James, you used the word stabilize with reference to pricing.

James Bell

Yeah.

Joe Nadol - J.P. Morgan

I am wondering just given what's going on with the currencies right now, it may not be time to use a bit of a more favorable word, are you not quite there yet?

James Bell

Well, stabilize is a good word. I like it.

Joe Nadol - J.P. Morgan

Okay. Thank you.

Operator

Thank you. Our next question comes from Joe Campbell of Lehman Brothers.

Joe Campbell - Lehman Brothers

Good morning.

Jim McNerney

Good morning, Joe.

Joe Campbell - Lehman Brothers

We were all pleased to see a good and quite, no special things going on in the various defense businesses. And I wanted to ask, you have done some acquisitions on the commercial side and I wondered whether you are now sort of comfortable enough with the defense side so that rather than these kind, I mean maybe anything as build on at the size of the Boeing defense enterprise, but whether or not you would be willing to consider what I call major defense acquisitions? I don’t mean mega mergers, I think they are probably over, but lots of people have lots of money. We can see the defense budget going on, but kind of slowing down, and there maybe some opportunities to do larger things, and I wondered if there were, whether it would be sort of conceptually within the framework of what Jim you are thinking of for the whole corporation?

Jim McNerney

Yeah. I think, you are right at this stage in cycles past, in the defense business, there has been some consolidation and I also tend to agree with you that major opportunities to do that has been done in the past may not be there at the same scale. But having said that, look we like our position with IDS. It's a good business and it's well managed. Do we have to go do deals? No. But, do I see opportunities there? Does Jim Albaugh see opportunities there? Yes. And I think we are in the flow and on deals. We are looking at them regularly. And it would not surprise me if we didn't strengthen our business with adding some vertical capability or some build on capability. So, it's builds on already a strong business and it's not that we are now at that point of the cycle where some of these opportunities may pop-up. And just because we didn't make a whole bunch last year, we made a couple, doesn't mean we are not going to make more this year. We will be opportunistic about it, but your headset is how we feel.

Joe Campbell - Lehman Brothers

Terrific. Thank you very much.

Operator

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

Cai von Rumohr - Cowen & Company

Yes, thanks a lot. If I go back to the commercial margin issue, your R&D commercial was 10.4% of sales. Even if you come in at the absolute tippy-top of your R&D estimate $3.4 billion, I mean it's got to be down at least $200 million to $250 million and unless a program accounting margin pre-R&D go down from that 19.8%, it's kind of hard for me to see how the margins for the year won't be above 11%?

Jim McNerney

Well, I think I got your question there Cai. Look, I think is there opportunity to expand our margins? Yes. Are there other things we are wrestling with to make sure they are put in the box before we revise anything? Yes. But the opportunity to continue to improve our margins in BCA certainly lies in front of us and the head set of Scott Carson and his team supported by me and James is to do just that.

James Bell

And Cai we do feel comfortable. We will hit our guidance at greater than 10.

Cai von Rumohr - Cowen & Company

Okay. And then just a follow-up, the mix you mentioned narrow-body heavy in the mix, as the mix shift toward more twin-aisles over the year and the volume goes up. Should that program accounting margin before R&D can stable to move up?

James Bell

Yes.

Cai von Rumohr - Cowen & Company

Okay, thank you.

Operator

Thank you. Our next question comes from Robert Spingarn of Credit Suisse

Robert Spingarn - Credit Suisse

Good morning everyone. James, if I could ask to go back to Boeing Capital and the numbers outperformed our expectations and I think they are running ahead of your 1% return guidance for the year. And I suspect that in addition to the normal continued business operation, you have a favorable lending environment and perhaps there are some reserve reversals in there. Could you talk about the composition of the earnings at BCC and how we should think about the trend going forward this year because it seems like your guidance may be a bit conservative?

James Bell

Well, that's a mouthful. But let me just talk about what's happening in BCC and what's happening in that whole industry. We are seeing the residual values of our portfolio really strengthening. So, yes, there were some of that where we had seen in prior years on some of the models within the portfolio, the values had continued to decline. And now, they are starting to come back and that's what we are seeing across the board as we get the new appraisals. So, that's really showing up in terms of the value of the portfolio and that's been reflected in performance. So, it could turn out to be if that continues the market stays as robust as it has been, that we would see better performance then we show, but right now it's too soon to make that call, but we will stay tuned.

But the thing about BCC that's really great is the fact that they are doing an outstanding job in support and delivery of our Boeing products out of our core businesses and that they are really focused on developing and restructuring the deals in a manner that most of those products are being financed, and not all of them are being financed in the third party market, and that's really the focus, and then managing the risk.

Robert Spingarn - Credit Suisse

Thanks for the detail.

Operator

Thank you. Our next question comes from Doug Harned of Sanford Bernstein.

Doug Harned - Sanford Bernstein

Hi. Good morning.

Jim McNerney

Good morning.

Doug Harned - Sanford Bernstein

Jim, when you talked about management accountability before seeing one of the important things that you focused on, I think of the re-organization in IDS when you manage a process that’s just sort of been put in place there is a very important element of that.

And this, in the earnings release today, you referred there is some adjustments on some satellite programs, and what I am interested in is first, what programs were those and is this something that is about you are still under way and working through the processes within IDS, or are these isolated incidents that you normally see in the course of doing business in complex defense programs?

Jim McNerney

Let me make a general comment and answer to your question and then James will handle the details of the satellite question. Thus said, we have faced in specifically in IDS into a fair amount of risk over the last year and half. Call that as we saw it, did not try to bury the issues, tried to get them out and deal with them, and I think we’ve worked through a lot of that and you have seen the results of some of that, which haven’t always been pretty.

But the team took a clean look at it along the way, and I think and I am convinced that Jim has, Jim Albaugh has built a new sense of accountability and a new rhythm of evaluation in getting things done whether they are positive or minus or negative, but facing into them candidly, and more of that is behind us than in front of us in terms of the install base we are working on.

But these are very, very difficult programs, as you know, and so it's not inconceivable that what times going to have lots of small adjustments to these things as we face into the technical risk or customer changes and requirements. But I think we are making good progress there, but James on the satellites you go ahead.

James Bell

Doug, up until this quarter we had about 9-3 quarters on satellite programs where we operated [Technical Difficulty] at outstanding performance on these types of programs which really are many fixed priced to government programs and a lot of respect.

Now, the one that we specifically called out in this release was an adjustment to the new sky satellite that was lost on the failure of the Sea Launch, and it’s the difference between what we had previously thought we get an insurance proceeds and that what we now think. So that’s the specific adjustment we called out.

Operator

Thank you. Our next question comes from Robert Stallard of Banc of America.

Robert Stallard - Banc of America Securities

Good morning.

Jim McNerney

Good morning

Robert Stallard - Banc of America Securities

Jim, in the past you have talked about how fast you sold out the 787 I think you talked about say 2012 or 2013. I was wondering if you could update us on the status of that, and also for the 777 and 737, how far those have sold out as well?

Jim McNerney

The 78 is now end of 13-14 is where we are in terms of quoting any kind of a sizable quarter. In general, there is some exceptions to that, but it's about there. 737, I think we are out to about 11, and it was the 777 you are asking about.

Robert Stallard - Banc of America Securities

Yeah.

Jim McNerney

I think that's on comparable timing. Let me just check on that. I will get you a good answer. I don't have the specific time on the triple.

Robert Stallard - Banc of America Securities

But these are very distance dates, is that leaving to airlines encouraging you to raise rates how aggressively than you would like?

Jim McNerney

Yes. We have been encouraged to raise rates. But I have a fundamental belief, which is that the best customer service is to deliver on your promises. And so to raise rates and then later not be able to deliver because the supply chain was not with you and the planning was not done properly is a lesson that this industry teaches itself every decade or so, and I am bound and determined not to learn that lesson that way while in this job. So, we want to raise rates because our customers do need the airplane, and we as you noticed were raising rates and we are doing it prudently and we are going to keep looking at raising rates because we do want to satisfy these customers. But it will be done when we can do them.

Operator

Our next question comes from Troy Lahr of Stifel Nicolaus.

Troy Lahr - Stifel Nicolaus

Thanks. If you guys take a look at your Commercial Satellite business, I think you guys are planning to expand in to kind of smaller satellite really stretching the 702 satellite down a little bit into maybe 7, 8 kilowatts, is that based on customers really asking for you guys to do this, or is this just kind of a sweets spot in the market you guys are trying to target now, and how from an investment standpoint will that change anything?

James Bell

It is because we are getting interest from customers that we are looking at it. But, we are not going to get down to too small of a satellite because those satellites are commoditized, which we don't want to play in that market. We do have to have technology differentiate us, but we think there is some room for expansion of market, even with that and what we have been looking at lately. And I don't think it will effect the investments very significantly at all.

Operator

Our next question comes from George Shapiro of Citigroup.

George Shapiro - Citigroup

Yes, good morning.

Jim McNerney

Good morning, George.

James Bell

Good morning, George.

George Shapiro - Citigroup

I wanted to pursue the R&D a little bit. You got $1 billion roughly in the first quarter, probably the same in the second quarter. And then you say it comes down in the second half, which means just by the arithmetic, it got to come down to average 700 each quarter and 200 of that is military, so it's going to come down commercial at 500.

In the next year, you basically are going to be at the same run rate of the second half of this year. I would think that next year it would have come down more after you make the initial deliveries of the plane. So, two questions. What's the confidence that you can actually have that kind of profile, or is the profile that I am laying out wrong. And then why wouldn't it come down after you make the first delivery next year?

James Bell

George, I think the R&D is coming down. But remember we also have the 747-8. We have other development programs that are underway in BCA. But I think you got it about right. It will come down at those levels and then that run rate would include the development that will remain both in BCA and IDS.

Operator

Thank you. Our next question comes from David Strauss of UBS. Sir, if you could un-mute your line. Okay, we will go to our next question, Robert Toomey of E.K. Riley Investments.

Robert Toomey - E.K. Riley Investments

Hi, good morning.

Jim McNerney

Good morning.

Robert Toomey - E.K. Riley Investments

There has been a lot of news lately about China entering the commercial jet market, and I am wondering if you could make some comment on your observations on what China maybe doing here in the near-term, I guess, in your industry in the next five years? And then also if you could make a comment on your assessment of the airline, on behalf of your major customer, the airline industry? Thank you.

Jim McNerney

Yes, I think there is no doubt that the Chinese will be someday in the commercial airplane business. There is lots of speculation on how long it will take them. It will probably take them a considerable period of time to get there, but they have a large internal market. They have technical capability, and they have the resources to do it.

So, I think whether its 10-years or 20-years, I think, we will see somebody probably in the narrow-body segment from China competing there. Listen, it is a huge market for us, we have many partnerships over there. I am one of these people who believes that partnering with people who are potentially competitors is not necessarily a bad thing. So I think we will have a headset of both competing with them and partnering locally because we benefit from it as a company, it strengthens our company.

And they will find us the top competitors and they would expect to. It’s close to what’s probably a 10% to 12% of our sales over the last few years had been in China that will moderate a bit as other parts of the world get back in the game, but they will continue to be major customers, and they have shown preference for our products, and we continue to think they will, for a pretty long period of time.

Dave Dohnalek

Operator, that will conclude the analyst Q&A portion of the program, and now we would like to shift over to the media Q&A.

Operator

Thank you. (Operator Instructions). I will now return you to the Boeing Company for introductory remarks by Mr. Tom Downey, Senior Vice President, Communications. Mr. Tom Downey, please go ahead.

Tom Downey

Thank you. We will continue with 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 are ready for the first question, and in the interest of time, we ask that you limit everyone to just one question.

Operator

Thank you. Our first question comes from James Wallace of Seattle P-I Newspaper.

James Wallace - Seattle P-I Newspaper

Yeah Jim. I’d like to follow-up on your answer to one of the analyst on whether a 777 replacement might come before a 737 replacement? Are you talking about a potentially all new airplane or tweaking the 777 or perhaps adding one more model to the mix.

Jim McNerney

Yeah I think, we don’t know, but I think the best guess would be some kind of a modification to the airplane, and obviously we really don’t know though until we see what the A350 is. I mean if the A350 presents a legitimate competitive threat to certain parts of the 777 line, we would respond, and in all likelihood it would be some kind of a modification, because we are not really due to fully replace that plane for many years out, but having said that we want to be ready to do what the market needs.

James Wallace - Seattle P-I Newspaper

Okay. Thank you.

Jim McNerney

Yeah. Sure again.

Operator

Thank you. Our next question comes from Peter Pae of LA Times.

Peter Pae - LA Times

Good morning.

Jim McNerney

Good morning.

Peter Pae - LA Times

Could you guys explain a little bit, what do you mean by sold out, does that mean you are not taking any more orders until let's say 2013 for the 87 and 20 what's that other year for the 737?

Jim McNerney

Yeah. I think when some of the questioners used the word sold out, it really reflected sort of extending lead times or getting farther out than average. And on most of our products right now, we've just come off of two of the highest order years in our history, two of the highest order years in the industry's history for that matter and that leaves us extended farther out with deliveries than we averagely are. And so we are not sold out. We just position that are little further out, that are available and we are aggressively selling them. We aggressively competing to fill those elements of our skyline and there are people buying them.

Peter Pae - LA Times

Perfect. Thank you.

Jim McNerney

Yeah.

Operator

Thank you. Our next question comes from Stanley Homes of BusinessWeek.

Stanley Homes - BusinessWeek

Good morning, Jim.

Jim McNerney

Good morning, Stanley.

Stanley Homes - BusinessWeek

Hey, I wanted to just ask you, or actually follow-up on the contingency funds that you set aside for the 787?

Jim McNerney

Yes.

Stanley Homes - BusinessWeek

Could you just wanted you to let us know how many again you have triggered and have you triggered anymore since the last time you talked about those funds and using them, setting aside those funds for some of the production issue?

Jim McNerney

I think we are at roughly the same place we were the last time we chatted with you. I mean we have got contingency efforts in place for wiring, for tubes, for traveled work, other forms of traveled work. These break down into three teams, that we hope won't have a lot of work to do. But if they need to, they are ready to go. And we are training them and standing them up, and as we re-planned some work as pieces come into Charleston and then to Seattle and these guys will be ready to go. And I am always asking the question, so as Scott, are these teams ready? Are there enough of them in our worst case scenario? And we feel very comfortable with where we are.

So, the specific answer to your question is, there is three teams ready to go. We have retired one team actually, that was whether we got in place to make sure we had any extra composite work that needed to move around. But it turn out, we didn't need that. All the partners did their composite work that they promised they could do. So, that team is sort of gone mute.

Stanley Homes - BusinessWeek

Okay. So, you have retired a composite team and then you have three teams that are for wiring, tubes and traveled work. Those are the ones that are still sort of setup, ready to go if you need them?

Jim McNerney

Yeah, wiring and then the tubes, clips, brackets, those kinds of thing.

Stanley Homes - BusinessWeek

Alright, okay, yeah.

Jim McNerney

And then some other traveled work that we would have to plan and that, as you know, when these kinds of things, Stanley, those teams would need to be in place for their first, usually 20 airplanes or so, just as it winds down and all the work settles in and where it's going to be.

Stanley Homes - BusinessWeek

And then finally how are the Italians doing? And why were they little slower than some of the others? What were their issues? And I am assuming that they're pretty much on track, is that correct?

Jim McNerney

Yeah, I think in a word they're doing better. I think the transition from prototype to production was not easy for any of our partners, and it may have taken them a little longer, but they are now flowing with the work, and so we are feeling better about it.

Still challenges in front of us, still Boeing people working with them, but I would say we are feeling incrementally better there.

Operator

Thank you. Our next question comes from Lynn Lunsford, Wall Street Journal.

Lynn Lunsford - Wall Street Journal

Good morning, Jim.

Jim McNerney

Good morning, Lynn.

Lynn Lunsford - Wall Street Journal

This is kind of a follow-up on that, is looking at the 787 program clearly there is a whole bunch of folks who are sitting on the sideline and waiting for Boeing to stand up and say oops! and so far you keep reiterating that you are on track and on schedule. What is probably the single biggest challenge that you still have to meet? Is it making sure that all of the systems come together, and where if you just have to kind of handicap your biggest hurdle yet, what would it be?

Jim McNerney

Well, I think, obviously the system's integration at this stage in a program becomes very important and things can happen that require re-work, re-looping work, and that represents in our norm. So far that's going well, but it represents a risk. I think when you add it all up Lynn, whether the airplane flies at or around the time that our milestone says it should, will be the time when everything comes together. And if we hit that milestone on or within a reasonable time around our target there and EIS is now threatened, then I think you could look at that and say we are in good shape. Now, the next risk is what you would find out in flight test, and there could be some unknowns there as well. But as we sit here today we think it’s going to come together, and we think we will be flying.

Operator

Thank you. Your next question comes from Doug Cameron, Financial Times.

Doug Cameron - Financial Times

Hi. Good morning everyone.

Jim McNerney

Good morning.

Doug Cameron - Financial Times

Jim, you obviously involved in a whole plethora of environmental initiatives, and obviously yesterday’s announcement of Virgin is only one of many be it the oil companies etcetera. I just wondered if you could give some color on how can I predict overall uncertainty as to what a KO might do or individual countries might do going forward? How the uncertainty plays into design programs going forward such as our next generation narrow-body? How does or what may play out in the environmental space impact in your next design decisions?

Jim McNerney

I think no matter what we see out there and you are right, it’s a little more country-by-country than we’d like to see it, we’d prefer to see global standards and we are working with IK and others where we are very much in that mix trying to advocate the global standards. We’d prefer our customers to see global standards.

Now the facts are political situations around the world being what they are, we are likely to see a patchwork of global and local standards, and what we do know is, no matter what we face though, that continually improving the environmental footprint of our airplanes with each generation, each modification is going to give our customers a better chance to fit in to that environment, 787, anywhere from a 20% to 40% improvement in key metrics on the environmental footprint. We would have similar objectives for the next narrow-body and similar objectives for that day when we get around to the success for the 777. And we are very focused on that and we appreciate the partnership of Virgin and others as we push toward those industry goals.

Operator

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

Dominic Gates - Seattle Times

Good morning, Jim.

Jim McNerney

Good morning, Dominic.

Dominic Gates - Seattle Times

Actually, I have another environmental question, which is I wondered how you react to this notion that growing in places in the world that flying is central.

Jim McNerney

Dominic, you cut out, I didn't hear the last part of your question.

Dominic Gates - Seattle Times

I am sorry. Some environmental groups are pushing the notion that flying is central, what do you make of that?

Jim McNerney

Obviously, I have a more balanced position on the subject. Listen, I think in every endeavor in mankind there has to be a balance between getting things done and economic development, as well as the treating the environment properly. And I leave it to our customers and their customers and the politicians who represent them to sort of figure out what that balance is. In the meantime, I want to keep our team focused on reducing the environmental footprint of our products. So that when people do make those judgments, they will have a little less to worry about on the cost side of the environment from Boeing products.

Tom Downey

Operator, seeing as there are no further questions in the queue. That will conclude our earnings call. Again for members of the media if you have additional questions please contact our Media Relations team at 312-544-2002.

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Source: Boeing Q1 2007 Earnings Call Transcript
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