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The Boeing Company (NYSE:BA)

Q1 2006 Earnings Conference Call

April 26, 2006, 10:00 a.m. EST

Executives

Dave Dohnalek - VP, IR

James Bell - EVP & CFO

Tom Downey - VP, Corporate Communications

Analysts

Howard Rubel - Jefferies & Co.

Cai von Rumohr - SG Cowen & Co.

Heidi Wood - Morgan Stanley

Byron Callan - Prudential Equity Group

Joe Campbell - Lehman Brothers

Steve Binder - Bear, Stearns

Doug Harned - Sanford Bernstein

George Shapiro - Citigroup

Ron Epstein - Merrill Lynch

Robert Spingarn - Credit Suisse First Boston

David Strauss - UBS

Joe Nadol - JPMorgan

Myles Walton - CIBC World Markets

Media

Lynn Lunsford - Wall St. Journal

Stanley Holmes - BusinessWeek

Molly McMillin - Wichita Eagle

Peter Pae - LA Times

James Gunsalus - The Boeing Company

Kevin Done - Financial Times

John Liang - InsideDefense.com

Robert Toomey - GT Reilly Advisors

Presentation

Operator

Thank you for standing by. Good day everyone, and welcome to The Boeing Company's first quarter 2006 earnings conference call. Today's call is being recorded.

The management discussion, slide presentation, plus the analyst and media question-and-answer sessions are being broadcast live over the Internet.

At this time for opening remarks and introductions, I'm turning the call over to 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'm Dave Dohnalek and with me today is James Bell, Boeing's Chief Financial Officer.

After James makes some comments about our performance and our outlook, we will take your questions.

In the interest of time, we ask that you limit yourself to one question and as always, we provided detailed financial information in our press release issued earlier today. As a reminder, you can follow today's broadcast and slide presentation on our website at boeing.com.

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

Now I'll turn the meeting over to James Bell.

James Bell

Thank you, Dave, and good morning. As Dave said, I will briefly review our first quarter results and discuss our outlook, then we'll take your questions.

Now, beginning this year we have moved to a split of duties between our CEO, Jim McNerney, and myself on our earnings call. Jim will participate in the calls at mid-year and at year-end and other calls on a selected basis. Of course, I will continue to be on all of Boeing’s quarterly earnings calls.

Let's begin by turning to the first slide.

Boeing is off to a very good start this year. During the first quarter, we grew revenues, net income, earnings per share, and cash flow at strong double-digit rates.

Productivity improvements we continue to make across the company and the significant increase in commercial airplane deliveries generated the strong performance this quarter. Our balanced cash deployment strategy continues to deliver value to customers and shareholders by investing in our growth and returning capital to investors.

Boeing's businesses continue to be well positioned in their markets. We expect the Commercial Airplane business will drive strong enterprise growth over the guidance period, while our Integrated Defense business will generate excellent profitability in a moderating defense budget environment.

Our total backlog grew to a record level of $213 billion, largely driven by the strong demand for our market-leading commercial airplane products, especially the 787 Dreamliner.

Coincidentally, today is the two-year anniversary of the 787 launch.

The 787 has been the most successful commercial airplane launch in Boeing's history. Today, we have 26 customers from around the globe that have placed firm orders for 350 Dreamliners.

We also continue to make good progress on the development of the 787. As on all new airplane programs at this stage of development, we are working weight and schedule challenges, and we're making steady progress in these areas.

We remain confident that we'll meet our customer commitments. We are on track to begin flight testing next year, followed by entry into service in 2008.

Last quarter we highlighted the four growth and productivity initiatives we are deploying company wide to help drive us to financial performance that matches the quality of our people and our technology.

While we're still early in this process, the implementation of those initiatives is going well. The initiatives are the tools we will use to drive growth and productivity to new levels. They are long term. Combined with our focus on leadership development, they are important keys to Boeing's future performance.

Now let's take a look at the numbers. Next slide, please. Our revenue grew 12% in the quarter, driven by increased deliveries of commercial airplanes. Reported earnings per share grew 33%, reflecting both higher revenues as well as productivity improvements across the company.

After adjusting for special items, the core operating engine of The Boeing Company generated a 49% increase in earnings per share. Our operations are running well and gaining momentum.

Now let's review the performance of our businesses. Next slide.

Our Commercial Airplane business is benefiting from a product strategy that's keenly focused on our customers, and on our commitment to continuous productivity improvement.

Revenues for the first quarter rose 48%, and BCA's operating margins expanded to 10%, driven by a 40% jump in airplane deliveries. We are on track to deliver about 395 airplanes this year, a 34% increase over last year's delivery totals.

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

We captured 176 airplane orders during the quarter, including 54 additional firm orders for the 787. Clearly the 787 continues to generate outstanding customer interest. Our success in the marketplace has enabled us to continue to add to our very large commercial airplane backlog, which has now grown to $132 billion.

The strong order environment and the success of Boeing products in the marketplace lead us to believe that our book to bill ratio will exceed one during the guidance period, and perhaps beyond.

We achieved major milestones in the quarter, including the delivery of the 5,000th 737 airplane to Southwest Airlines. We continue to expand the value of the next generation 737 product line by launching the more capable 700ER model this quarter.

We also delivered the first 777-200LR, the world's longest range commercial aircraft, to Pakistan Airlines. Clearly Boeing Commercial Airplanes is performing very well in a strong demand environment.

Next slide.

Strong profitability is a hallmark of our Integrated Defense Systems business, and that success continued during the first quarter. IDS expanded its operating margins to 11.4%, even as revenues moderated in this more challenging defense budget environment.

In January, we realigned the IDS organization structure to more effectively address our customers’ needs for capability-driven solutions and to further improve execution. This quarter, we begin reporting IDS financial results in line with that reorganization. I'll say more about that in just a moment.

We achieved key milestones during the quarter on programs like JTRS and Ground-based Midcourse Defense. Our performance on other key transformational programs such as Future Combat Systems and MMA continues to be excellent. We completed the successful negotiations of the contract conversion for Future Combat Systems.

IDS continues to deliver strong profitability over its diverse portfolio of development, production and support programs in an environment of moderating growth.

Next slide, please.

Now let me say a few more words about the new IDS organization. We have laid out for you our 3 major IDS reporting segments, along with the scope of each segment and the related 2005 revenue breakouts. Included in our earnings release is a detailed, quarter-by-quarter schedule on 2005 revenue and operating margins for your reference.

As part of our realignment, IDS financials now include revenue and income associated with our Advanced Systems business, which was previously included in Boeing's other segments.

Precision Engagement & Mobility Systems addresses the precision requirements and global mobility needs identified by the U.S. Defense Department and key international customers.

Network and Space Systems focus on the military's intelligence, surveillance and integrated command and control requirements, along with our civil and commercial space customers.

Support Systems, which we believe will remain a strong driver of IDS growth, addresses the military's integrated logistics, training and product support requirements.

We are offering capability-driven solutions that are clearly and directly aligned with our customer needs. We believe this structure will allow us to better serve our customers going forward, and help us drive further productivity improvements.

Next slide.

Boeing Capital's earnings rose nearly 60% despite a slightly smaller portfolio. The aircraft financing market continues to improve, and BCC is executing well on it's mission to support Boeing's core businesses while managing its portfolio size and risks. BCC has reduced debt by $2.5 billion and paid dividends to Boeing exceeding $1 billion over the past two years.

Connexion by Boeing continues to demonstrate the potential of its satellite-based broadband service. Connexion service is now available on more than 180 daily flights. In addition to 500 orders and options from airline customers, we recently completed the first installations of Connexion service in the commercial shipping industry.

Now turning to our balance sheet on slide 8.

We continue to enjoy outstanding balance sheet strength and liquidity. We ended the first quarter with nearly $10 billion in cash and liquid investments. That's up 17% during this quarter.

Our corporate debt levels increased slightly from year-end, recognizing the impact of some capital lease obligations. BCC's debt remained stable. Financial strength and solid credit ratings continue to be a priority for us, so we're pleased that Moody upgraded its rating on Boeing and on Boeing Capital's debt last month.

Now moving to cash flow on slide 9.

Our cash flow generation remains outstanding. We've increased operating cash flow by 46% to $2.1 billion in the quarter, and that's after making $500 million in voluntary pension contribution. This cash performance reflects strong earnings, another strong quarter of airplane orders, and excellent working cash management.

Also during the quarter, we repurchased 5.5 million Boeing shares, paid a 20% higher dividend, and continue to invest in our growth program, all consistent with our balanced cash deployment strategy.

Turning to slide 10 and our financial guidance.

Today we're confirming our growth outlook and our previous guidance for 2006 and 2007. These numbers represent significant year over year increases and top line and bottom line performance.

Clearly, we've had a strong first quarter this year, [so our bias], as it relates to 2006 guidance, is positive. We will revisit guidance as we continue to make progress through the second quarter and update you as appropriate.

Boeing's 2006 revenue is expected to be approximately $60 billion, and between $63.5 billion and $64.5 billion in 2007. Our revenue guidance for 2006 includes approximately $1 billion for business planned to be part of the pending United Launch Alliance transaction. Upon completing that transaction, Boeing would use the [F] equity method of accounting for this new joint venture.

Earnings per share this year is expected to be between $3.25 and $3.45, increasing to between $4.10 to $4.30 next year. In the second quarter of this year, we expect higher expense in our other segment, as Boeing's share value trust is expected to pay a significant distribution to beneficiaries due to our strong stock price performance. This benefit is paid once every two years at most, and is expected to cause an additional pre-tax expense in the second quarter of approximately $80 million.

Looking at the quarters through the rest of 2006, we expect second quarter earnings per share to be the lowest of the remaining quarters, and fourth quarter to be the highest.

The company is maintaining its operating cash flow guidance for 2006 and 2007 at greater than $5.5 billion for each year. Detailed segment guidance is provided in our earnings release.

Now I'd like to summarize before taking your questions. Next slide, please.

We are clearly off to a strong start this year, and we're well positioned to deliver strong growth we are forecasting for 2006 and 2007.

Throughout the organization, Boeing is relentlessly focused on delivering value to our customers and our shareholders with businesses that are leaders in their market.

We are keenly aware that our success depends on providing better value to our customers, and operating our business with the highest standards of integrity.

As we continue to do that, we will achieve the strong growth and profitability we're expecting for this year and next, and we will position ourselves as the preferred global aerospace partners for customers around the world.

Now I'll be happy to take your questions.

Question and Answer Session

Operator

Thank you. (Operator Instructions)

Our first question comes from Howard Rubel of Jefferies.

Howard Rubel - Jefferies & Co.

Thank you very much. Just to return a little bit to your outlook. James, there's also some additional items that appear to have cost you in the quarter. One was satellite business and also deferred comp. R&D looks like it was fairly high. Could you elaborate a little bit on how you're thinking about those for the rest of the year, especially satellite problems you continue to suffer with?

James Bell

We do believe it's going to stabilize. The charge we took on satellites was the military satellite Wideband Gapfiller -- I think we talked to you about that before -- and we think that we’ve embedded in the EAC what it's going to take now to go ahead and perform that program under the current booking position.

On the deferred comp, clearly we've been impacted as our stock has appreciated pretty significantly over the quarter. We think that will sort of normalize, although we're hoping not too much because our stock price going up is a good thing for us.

In the R&D piece, Howard, as you know, last year we did have some supplier cost sharing payments that offset some of the R&D expenses. We didn't have any reported in the first quarter but we do expect to get some, although they’ll be less than what we received last year, but I think that will normalize what you're seeing on the spending rate going forward for R&D.

Howard Rubel - Jefferies & Co.

Thank you.

Operator

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

Cai von Rumohr - Cowen & Co.

Yes, good quarter.

James Bell

Thank you, Cai.

Cai von Rumohr - Cowen & Co.

How can you do 10% commercial margin in the first quarter when R&D appears to be at a peak level, when your volume is going up, your mix should be getting better, and your commercial margin for the year is not 10% or better?

James Bell

Well, clearly, Cai, we had a good quarter with good productivity -- clearly that came through, but it also was impacted by some of the timing of some of our period expenses that we expect will hit later in the year. Clearly what BCA has done both with ramping up the production…

Cai von Rumohr - Cowen & Co.

Cai von Rumohr, Cowen & Co.

James Bell

Cai, I know who you are.

Cai von Rumohr - Cowen & Co.

That wasn't me. That was the recording -- your recording.

Dave Dohnalek

Can you hear us, Cai? Can you hear me now?

Cai von Rumohr - Cowen & Co.

Yes, I can hear you.

James Bell

Okay, good. So did you hear the first part of my answer about some of the timing of our period expenses?

Cai von Rumohr - Cowen & Co.

Yes. Could you be a little more specific? What period expenses were low that would be going up? Because the mix, the volume, and the R&D patterns look to be a pretty compelling case for higher margins.

James Bell

Well, yes, it's just the G&A expenses that we normally would have in terms of operating the business. They didn't hit from a timing standpoint all that would have normally hit in first quarter, and they will catch up.

Clearly the performance has been outstanding in BCA. There's no question about that, and we're optimistic that performance will continue. But right now, as we look at what's going to happen for the course of the year, we still believe that greater than 9.5 is what our forecast is -- excuse me, greater than 9 is what the forecast will be, but we'll see.

We're really pleased with where we are and what we've seen to date, particularly with what we've seen as they’ve been able to ramp up, particularly taking the whole supply chain up the increases in production and doing that efficiently, and we're getting good profitability.

Cai von Rumohr - Cowen & Co.

Thank you.

Operator

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

Heidi Wood - Morgan Stanley

Good morning, guys. James, a question for you -- you talk about being 98% sold out for your delivery slots in '07. I seem to recall that around the time this year for a year ahead, you're usually about 70% slots full for the next year. So can you talk about what you are in terms of percentage of slots sold out for '08, what you're looking for, what you need to see to raise production rates to respond to the kind of demand that you're characterizing as fairly strong?

James Bell

Heidi, as you well know, I can't talk about that outside of our guidance period, but clearly we are very, very pleased to see at this time in the year that we're already sold out for '07 at a 98% level.

Clearly we're always looking at, along with our supply chain, doing studies to see what we can do to increase our rate of production, but you know those are not near-term decisions. As you go through and do those studies, you really have to work your way through a lot of moving parts before you can make a decision there.

We have done very, very well with experiencing a lot of rate breaks and moving up the production rates over the first quarter and over the last couple of quarters, and we obviously will keep monitoring that. Clearly the demand is strong. We recognize that, but our focus is on making sure that we can orderly increase our production ramp up, bring our supply chain along so that we can deliver on our commitments, and deliver on our commitments with excellent profitability. That's our first priority.

Heidi Wood - Morgan Stanley

All right. You weren't that active on the share repurchase front this quarter. Can you talk a little bit about your cash deployment strategies for the rest of the year? Do you plan on being more aggressive through the balance of the year?

James Bell

Well, we plan on continuing to implement our balanced strategy. We will continue to buy back shares. Clearly we have about 18 million or 19 million shares to go under our current authorization. The plan will be to go back to the Board and ask for an additional authorization.

We will buy accordingly, as long as the stock is undervalued as it is, we will continue to have a pretty active buyback program.

Heidi Wood - Morgan Stanley

All right, great. Thanks very much.

Operator

Thank you. Our next question comes from Byron Callan of Prudential Equity Group.

Byron Callan - Prudential Equity Group

Good morning, James. What are you thinking about airplane orders for 2006? I know that's something you don't normally give guidance on, but I gather things are looking a little bit better now than they were in January for total order expectations. If you have a number, I'd appreciate it.

James Bell

Well, as you know, we booked 176 in the first quarter. That's pretty good. We do anticipate that we're going to be over a book-to-bill rate of over one this year and next, and perhaps further out.

It looks like the recovery is different than in the past, where in the past we had the high peaks and then they started to immediately come down. They’ll be down from the '05 levels but I think they’ll be higher than what our deliveries are. That's what I would tell you to look for.

Byron Callan - Prudential Equity Group

Well, has it changed from what you were thinking in January, or is this just kind of marching along as you have assumed?

James Bell

Well, we assumed that it would be that, although it's really good to get validation in first quarter that that was a good assumption. So we were very pleased to see what we saw in the first quarter, particularly because some of these deliveries are out in the future. So I think it's just good validation of our product strategy, and our customers are basically saying they need to get in line, sign up now, so they’ll be sure to get some of this great product in their fleet.

Byron Callan - Prudential Equity Group

Thank you.

Operator

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

Joe Campbell - Lehman Brothers

Good morning. What a nice quarter.

James Bell

Thank you, Joe.

Joe Campbell - Lehman Brothers

I wondered if we could ask, you gave us a little bit of color about the year-over-year decline in the revenues at the consolidated IDS, and then you've given us, of course, the breakout.

Could you tell us maybe some more facts about what the military satellite business that was taken out meant, and Rocketdyne, and what it is that will sort of pick up in those divisions that showed negative in Q1? You know, kind of what's happening to make them pick back up to see positive growth over the course of the year. I think this is the first negative quarter in probably seven or eight years.

James Bell

Well, so let's talk about that. Rocketdyne coming out, that surely had some impact that we'll see for the remainder -- clearly, they're gone. I don't recall exactly what the dollar values were associated with them leaving. Then of course the proprietary spending is down as a result of the restructure of the [ATHEA] program, but nonetheless, the work that remains is still sizeable and we're still performing well. We will see some growth in some of the transformational programs over the course of the year.

The other thing, Joe, is a lot of what you see down now is really timing of deliveries and timing of revenue recognition milestones, performance milestones, on some of the other contracts, so that will pick up over the course of the year.

Joe Campbell - Lehman Brothers

So the things that were negative in Q1, will they be less negative in the subsequent quarters?

James Bell

Yes.

Joe Campbell - Lehman Brothers

Or is it more that there was an absence of positives that will pick up in the…

James Bell

I think it’ll be, they’ll start to diminish over the next three quarters as we pick up the deliveries and catch up on the timing of those deliveries. Also, the revenue recognition performance milestones, they're just timed differently this year than they were last.

Joe Campbell - Lehman Brothers

On the revenue here in the IDS, it will be affected, as you indicated, by the negotiations with Lockheed? This thing seems to drag on, and I guess the papers are talking about a huge settlement that I guess Lockheed would be neutralized if you could move forward with this. Is there any update on how this thing is going or any color on what's the hang up here?

James Bell

Yes, I think it's still making good progress. Obviously they're being careful. They want to make sure they cross all of the t's and dot all of the i's -- there's no question about that. We're working pretty closely with the government relative to the ULA approval. I think they’ve even said that they're getting closer to that, so we would anticipate that hopefully sometime in the second quarter.

Joe Campbell - Lehman Brothers

Is that tied up with negotiations on the reported $750 million fine you'd pay? Or is that separate?

James Bell

No, they're completely separate issues. The ULA is only going through the FTC review basically, and that's the Federal Trades Commission review, Joe, so that's a separate issue all together, as is the negotiations on Buy 3. They're all separate. Us trying to reach a global agreement with the government to put all of this behind us is again a separate activity.

So it's not that. They're just working their way through the process. It's taking longer than all of us probably would have liked it to have taken, but I think they're making good progress. What we're doing is supporting it, and we still feel strongly about that being the right way to go, and we believe Lockheed still feels that way, too. So hopefully they’ll break the thing loose sometime in the near term.

Joe Campbell - Lehman Brothers

Just lastly, is whatever settlement you have in your guidance, or will we have to adjust the guidance by whatever your final agreement is on putting the various complaints behind you?

James Bell

There's nothing in guidance that would have to do with any global settlement.

In terms of the ULA being stood up, there's no issue there from an accounting standpoint, than what we believe will settle out on Buy 3 is in our EAC.

Joe Campbell - Lehman Brothers

No, but I meant back to the other issue. If you owe the government $750 million as Wall Street Journal says, you might have to pay, should I subtract $0.7 billion from my cash flow guidance, or is whatever it is you think will happen is in the guidance you've given us?

James Bell

Yes, because we have been working with them, Joe, and we have no estimate of what that is, or what it would take, and so that is not in any of our numbers today.

By the way, contrary to what the article says, we do not have any agreement, although we are working cooperatively with the government to try to resolve this issue.

Operator

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

Steve Binder - Bear Stearns

James, was there any block adjustments in the quarter? Also, on R&D, did I hear you correctly that there were no variable supplier payments this quarter, such that if that's the case, should reported R&D at BCAG be pretty consistent for the balance of the year from the first quarter level?

James Bell

First of all, we added 200 to the accounting quantity size on the 737. I think we added one to the 767. Other than that, there were no other changes.

On G&A, that was correct. We do not have any supplier sharing payments in the first quarter. We do anticipate getting those towards the end of the year, and we would expect the R&D guidance to be pretty much where we end the full year.

Steve Binder - Bear Stearns

All right. Then with respect to pricing in the commercial aircraft market today, and you look at 787, 777, especially the 300ER and the 737 NextGen, if you’re looking at deals that you’ve been doing here in the last three or four months, for the '08 - '09 time period -- depending on the model type, maybe 787’s further out -- if you isolate the escalator factor, how would you characterize the pricing environment, what you’ve seen in the last three or four months?

James Bell

Well, clearly it's a competitive environment, but we're really pleased with the kinds of deals we're signing. We believe we have embedded in those deals a real opportunity to create real value going forward, Steve, so we're not having fire sales.

Steve Binder - Bear Stearns

No, I'm actually wondering, are you starting to see better pricing than your normal escalators would show?

James Bell

Well, we're seeing good pricing. I think it's stabilizing, and one of the reasons is that we have differentiated products, and we think we're getting good pricing, good value in the market space.

That, coupled with what we're doing from a productivity perspective, we think we're going to be able to deliver good value on this order book.

Steve Binder - Bear Stearns

Lastly, with respect to potential replacements for the 737 NextGen, I know there's been a lot of ideas. Is there any firm sense of whether BCAG down the road would go with a single aisle configuration or a twin aisle configuration to potentially that overall narrow body market?

James Bell

Well, no, we're clearly not there yet. We will continually be working with our customers, because that's where a product development decision is going to start and end, trying to make sure that we're going to provide to them a product, and invest in that product based on what they believe their needs will be going forward.

Right now, Steve, we're just enjoying the success of the 737. As I mentioned earlier, we've delivered the 5,000th aircraft. That model is doing extremely well. It's the most popular airplane in the world. We've got over 6,000 of them on order. We'd just like to deliver on that order book, but obviously we will continue to work closely with our customers so we make the right product development decisions and we make investments according to what we think our customers want, as we've done on the 787. You've seen the benefit of that.

Operator

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

Doug Harned - Sanford Bernstein

Good morning, James. On defense, the Support Systems Precision Engagement in the new structure came in with very high margins for the first quarter, well above what you're guiding toward for the year. Could you comment on anything unusual that happened?

James Bell

I think you'll see on the first quarter normally of the year for those products where we have embedded in it our production -- particularly, I'm talking precision now -- on the production programs, we tend to have production lot close outs that provide better margin performance than we would see over the course of the year as we get into the normal production and delivery of our aircraft under our current multi-year contracts.

I think we'll see that somewhat normalize. I think the same holds true on some of the programs we have in our support area, where things like the Gunship, where we were able to close out a couple of lots, and we're just having a little more favorable mix of contracts in the first quarter. We think that will normalize over the course of the year.

Doug Harned - Sanford Bernstein

Then the new structure, how long will it be before it is all in place? In other words, people moved, functions consolidated, potentially a new customer interface set up?

James Bell

We're up and operating today.

Doug Harned - Sanford Bernstein

So in terms of any cost savings, though, and overlapping functions you may have had, that sort of thing?

James Bell

Well, we're up and operating in that structure today, but remember, we have an ongoing process of continuous productivity. So over time, we will be looking at how those new organizations are operating, and we'll see if there's some opportunity to have them operate more efficiently and if there's some gain to be harvested from a productivity improvement. We’ll be working that as we work across the Corporation.

Doug Harned - Sanford Bernstein

Okay, great.

Operator

Thank you. Our next question comes from George Shapiro of Citigroup.

George Shapiro - Citigroup

Good morning. James, can you just explain why we saw an increase in the 777 deferred production costs at this point? You'd think it would be coming down. If you can just reconcile that to the extent you can, with the fact that the unit profits were above the program profits. I guess that's probably the other programs overwhelming the 777 change?

James Bell

You know, it's simply because in the quarter, we had a lot of new customer introduction costs that drives up the unit, and then also, the customer mix of deliveries in the first quarter added to that.

It’s just simply that, George. It's not a big deal.

George Shapiro - Citigroup

Okay. Then, in the engagement area, the revenues were slightly down from last year, despite the fact that deliveries were higher. Could you just spell out what programs in that new sector maybe declined in the quarter, and as to what you might expect going forward?

James Bell

Well, the deliveries were different. I mean, some of the AW&C milestones for revenue recognition, the timing of those were different quarter over quarter, and they fell out of first quarter '06, and we'll pick them up over the next three quarters.

So it's primarily in that area. There were some F-15 deliveries that we had that are down, that are in subsequent quarters that did not hit this quarter.

George Shapiro - Citigroup

Okay. Thanks.

Operator

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

Ron Epstein - Merrill Lynch

Good morning. Just following up on Steve's question about product development. As you guys walk through more of the 787 program, what milestones should we keep an eye out for, so as outsiders looking in, we have a good idea that things are indeed on track?

James Bell

Well, I think that clearly the fact that we've gotten through firm configuration, which we did complete, we've been able to manufacture and successfully join some of the composite barrels. We powered up the auxiliary power unit. We've had the engine runs at both GE and Rolls. Now we've started, and our supply chain has started, building their plants, their factories where they can start the fabrication of the other component parts.

I think there's been a number of milestones that you can look at now and get a good sense that this development program is on track, and then those others, particularly as our supply chain starts to stand up their factories and start to work on their detail parts, I think that would be something I would watch.

Obviously, we're preparing to go into flight testing at the end of next year, or the second quarter of next year -- excuse me, in the second half, not quarter -- the second half of next year so that we'll be prepared to have this thing introduced in 2008. We do believe we're on track to make that happen.

Ron Epstein - Merrill Lynch

Okay, and then just one more question. Do you guys have a back-up plan if something were to happen with the relationship that The Boeing Company has with VSMPO, with regard to titanium sponge and titanium forging?

James Bell

Well, clearly, one, we do have a good agreement with them and a good arrangement that we're working with them to really provide us access to titanium, but they’re not our only titanium supplier. We do have others that we have agreements with that will help us to offset that risk. So we're pretty comfortable where we are on titanium.

Ron Epstein - Merrill Lynch

Okay, thank you.

Operator

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

Robert Spingarn - Credit Suisse First Boston

Good morning. James, just to follow-up from a moment ago, with regard to the 777, the capitalized costs staying flat. Was there any 200LR in there?

James Bell

I don't know specifically. There are clearly -- well there is 200/LR in there, but not necessarily being a new cost. What particularly drove the fact that it went up a bit was we had new customer introduction engineering costs that are now in that number.

Robert Spingarn - Credit Suisse First Boston

It’s just with the quantity of 777’s delivered in the quarter, being double last year, that increment seems pretty large.

James Bell

Well, but still, keep in mind that there also was some customer mix in those deliveries.

Robert Spingarn - Credit Suisse First Boston

Right. You've talked about a book-to-bill north of 1.0 during the guidance period through '07. To what extent does that contemplate activity from the North American market, particularly the Legacy guys?

James Bell

Not a lot yet. I mean, we ultimately hope they’ll come back sooner than later. They're starting to work through some of their financial difficulty, and clearly we're trying to help where we can, but probably in the 2007 range or later, they’ll come back.

I just don't have a good handle on when they’ll come back. We're not necessarily contemplating them. Obviously, we're trying to help and work with them so that they can get back in sooner, but clearly we have strong demand from other market segments that help us to believe that that's going to happen whether they get back or not during the guidance period.

Robert Spingarn - Credit Suisse First Boston

Okay, and you just mentioned the ebb and flow of the quarters from an EPS perspective for the remainder of the year. Should we be thinking flattish production on commercial aircraft, 100 per quarter? Or will we see a traditional dip in the third quarter?

James Bell

No, I think you should be thinking going out that it will be rather flat, pretty consistent quarter over quarter.

Robert Spingarn - Credit Suisse First Boston

Thank you very much.

Operator

Thank you. Our next question comes from David Strauss of UBS.

David Strauss - UBS

Good morning. James, could you talk about what impact a potential Alcoa strike could have on the business, and what precautions you have taken, as well as maybe what you're seeing out of some of your suppliers?

James Bell

Well, I think we have tried to be sure that we have multiple sources, and we'll work pretty closely with our supply chain and see what we need to do in order to deal with it, but obviously it's a challenge. We always have contingencies, so I think we’d be able to see our way through it.

David Strauss - UBS

Okay, thanks. On the tax rate side, could you talk about the tax rate in the quarter and what you're assuming on the R&D tax credit side?

James Bell

Well, I'll just say this -- if you took out what we had, relative to some tax settlements and what one would call windfalls in terms of the tax side, we’d probably be back up to close to 31% as an effective tax rate. That's what we're assuming going forward for this year. It's probably around 33% for a tax rate next year, and that's all up, including whatever credits we got from R&D.

David Strauss - UBS

Okay, and last one, on the working capital side, could you just update us there what you have taped into your operating cash flow guidance for the year? Obviously, working capital was pretty good in the quarter.

James Bell

Yes, we expect it to moderate a bit, but we expect to continue to work our working capital hard, work our total assets hard. As you know, our performance score is based on how well we deliver economic profit for the corporation, and one of the levers there are assets, and working capital as well. So we have a lot of focus across the corporation, because that's not only the score for our executives, it's also the score for our salaried employees, so all of our folks are focused on working assets, so we'll work working capital as part of that.

David Strauss - UBS

Okay, thank you.

Operator

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

Joe Nadol - JP Morgan

Thanks, good morning, James. I was wondering, you've already given us a little bit of color on the supply chain and how things went well in the quarter. Now that you're up to your sort of 100 aircraft per quarter delivery rate, it would seem that you have a pretty good handle on things.

I was wondering if you could give a little bit more color on, I guess if there are any necks of the toothpaste tube, where are they, and how you feel about it, relative to maybe three months ago or six months ago?

James Bell

Well, clearly that remains a watch item for us and we work it hard every day. We have our teams both from BCA and IDS really working very, very closely with the supply chain to make sure that we're able to get what we need when we need it.

So that's why, as we talk about raising production rates, why it's a long-term, well thought through, disciplined process that we have to integrate with our supply chain. So clearly, we're feeling I think relatively more comfortable as we see progress, particularly on the 787, with our supply chain. Clearly that has not been without it's challenges, and we've been able to work closely with our suppliers to offset any of the issues we've seen to date. We will continue doing that going forward.

Overall, we're feeling pretty comfortable about it. That's not to say that the supply chain isn't a watch item for us. It's not to say that there are no risks in it, but I think the way we're working together in an integrated fashion is allowing us to have a high degree of confidence that it's not going to cause us an issue as we work our way and harvest this up-cycle.

Joe Nadol - JP Morgan

You had some minor issues in Q4 on some of your raw material contracts. Any update on that, more clarity? How much visibility do you have over the next year-and-a-half on that specific part of your supply chain?

James Bell

Well clearly raw materials are going up. The costs are going up. We have long-term contracts. That's going to protect us in the near term but in some cases, we may have to look at some of those and see how we work with our supply chain to get to the right costs, and we'll have to embed that in the pricing going forward.

Clearly we'll have to make sure we have the right productivity initiatives in place to offset any of that growth, because our plan going forward is to clearly continue to invest in new product development, making sure that we expand our margins. Everything we know today are in the numbers we're sharing with you, but we'll continue to work that going forward.

Joe Nadol - JP Morgan

Okay, thank you.

Operator

Thank you. Our next question comes from Myles Walton of CIBC.

Myles Walton - CIBC World Markets

I know March was just one month, and it's always a challenge to use one data point, but I think it's 29 737’s and 8 777’s in that month, the strongest you've seen in quite some time.

I'm just wondering, how much of that performance should we read into as just timing that carried from other months versus actual surge capacity you have in the business?

James Bell

I think it should be looked at as timing, that we've done it over the quarter and they may have all delivered then. I wouldn't be looking at or be assuming we have that kind of surge capacity.

Myles Walton - CIBC World Markets

A quick one on the reconciliation of guidance. I think going into the quarter, we're looking for maybe a deferred tax charge. Is that going to materialize?

James Bell

It is not and we mentioned on the fourth quarter call that we thought that it would not , occur, and we adjusted guidance for it.

Myles Walton - CIBC World Markets

Okay, thanks.

Dave Dohnalek

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

Operator

Thank you. Our final question comes from Robert Toomey of GT Reilly Advisors.

Robert Toomey - GT Reilly Advisors

Hi, good morning. Thanks very much. I'm just wondering, James, with respect to the progress you've made on improving your productivity, clearly it's really starting to show through in your margins. Do you believe that based on what you know now, the potential for margins on the 787 could be higher than your other products?

In addition to that, there has been some talk about the duration of this cycle being longer. You said earlier this is a different sort of a cycle. Can you just comment on how long you see this commercial cycle extending? Could it go out beyond '08 or '09? Thank you.

James Bell

Well, clearly the way we're building the 787 is different than the way we built the other product, and so we're pretty comfortable with the business case on that product that we're going to deliver good margins. As to whether it will ultimately be higher than the margins on other airplanes, that’s yet to be seen.

I think the thing that is clear is we're expecting to deliver a tremendous amount of value to our shareholders as it relates to the 787 program.

What was the second part of that question?

Robert Toomey - GT Reilly Advisors

Just the duration of the cycle.

James Bell

Well, clearly what typically you'd see in the cycle is a peak order year, and then that order for the next several years would drop off pretty dramatically. Although we've seen a moderation of orders this year, particularly given the 176 orders we got in the first quarter, it does look like they will level off and stabilize, is what we're thinking over the next couple of years, at least.

So that's somewhat of a different experience than we've had in the past. Then when you couple with that the traditional domestic customers, or domestic carriers, and the European carriers are not back in the market at a significant level yet, gives us some early indication that this cycle really may go longer, and may be a little more protracted and be a little different. Maybe the peak is not as high as it would’ve been. We peaked at over 1,000 orders last year.

We don't anticipate that this year, but we do anticipate getting more orders than deliveries, and we anticipate that over the guidance period, and perhaps it will be a little longer. We’ll have to see when the domestic carriers and the European, the traditional carriers there, get back into the marketplace.

Robert Toomey - GT Reilly Advisors

Thank you.

Dave Dohnalek

Operator, we can move to the media portion, please.

Operator

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

(Operator Instructions)

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

Tom Downey

Thank you. We'll continue with our questions for James. If you have any questions after the session ends, please call our Media Relations team at 312-544-2002.

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

Operator

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

Lynn Lunsford - Wall St. Journal

Good morning, James. This is just a housekeeping kind of question, but when was the last time commercial airplanes had a 10% profit margin?

James Bell

You know, we were just trying to figure that out ourselves, and I'm really not sure. I'm not sure that they have, but maybe way back in the early ‘90’s. I don't know, but I'm sure glad they got it now.

Lynn Lunsford - Wall St. Journal

Okay, thanks.

Operator

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

Stanley Holmes - BusinessWeek

Good morning, James. Could you be more specific on some of the challenges you see with the 787 in terms of production and putting the plane together? Where do you see the biggest challenges to date? You can just start with that.

James Bell

Well, Stanley, I don't see that we have a whole lot of major issues on this program yet to date, but obviously where the challenges will be is in our supply chain as some of our global partners are trying to do this for the first time.

So that's what we're monitoring very, very closely, and making sure we're there. We're having them in our shop to make sure they know how to do the processes that are necessary to make the material, and to actually perform the operations to develop the major components that they're responsible for.

So our team, our technical team in BCA, is working very, very closely with the supply chain to make sure that they can get that done. So I wouldn't necessarily call those challenges, as I would say that we've gone through and looked at this development program. We've identified where the risks would be relative to the way we're building the aircraft, and we are making sure we have the right process in place to work through those and mitigate them so they don't materialize.

Stanley Holmes - BusinessWeek

Okay, what about on the cost side? There seems to be some issues and concerns about costs from suppliers. Where would you assess your suppliers’ and Boeing's ability to maintain the entire cost of building a 787 within the parameters that you set out early in the program?

James Bell

Well, I've got to tell you, as I go through and look at the program, and I've been through a lot of development programs, because I grew up on the government side of the house, so you always are worried about the unexpected things happening that would drive you to over-run your budget.

We are well downstream on this development program. We're well within the budget, well within the business case, and it really does look good.

Stanley, all I can tell you is that right now, this looks like the best-run development program I've ever seen, but it is a development program. So clearly, we are mindful of that and making sure that we have the right resources embedded in our business case to help if something should happen.

So right now, that something hasn't happened, and we'll just have to wait and see.

Stanley Holmes - BusinessWeek

Okay. Thanks a lot, James.

Operator

Thank you. Our next question comes from Molly McMillin from the Wichita Eagle.

Molly McMillin - Wichita Eagle

Hi, James. My question is kind of two parts. First, I wanted to talk about the Wichita plant just a minute, and see what do you think you guys see as the footprint here for Wichita, say in the next three years, five years, or ten years? What's your big plan?

James Bell

Well, it's the market that's going to drive the footprint in Wichita. We've got to get the kind of work that we would put there into Wichita. So far, as you know, with what's going on on the Integrated Defense side of the business, we're actually experiencing some layoffs. That's because we don't have the work.

We're actively seeking new business that, should we capture it, I think some work would come Wichita's way, but we'll have to wait and see how that works out. We're obviously operating in an environment, particularly on the defense side of the business, where the budget is really constrained and there's a lot of requirements that are competing for a very scarce dollar. So what that means is the Wichita site has to really be able to be productive and add value, and allow us to be competitive. I think we're working all of those issues to make that happen, and if we get the work, obviously we'd put some there.

On the commercial side of the house, we have quite a bit of work there, and we think that will be going for the foreseeable future.

Molly McMillin - Wichita Eagle

Okay. What kind of work are you guys looking at trying to grab for Wichita?

James Bell

Well clearly, we had to look to tankers in the past, and we have our international tanker work, some of the work being there. We've just gotten the request for interest for the U.S. tanker, so we'll have to work our way through that, but it's principally modification-type work that would be in that, that we'd put in that shop.

So it would have to be work where we have to do a lot of mods on airplanes, and that's generally where we think it's the right kind of work to put in Wichita. So we have to get those kind of contracts that would allow us to have some of that be deployed there.

Molly McMillin - Wichita Eagle

On the tanker, at one point you guys were talking about instead of doing the modifications after the fact, if you guys got the tanker contract, rather than fly them to Wichita and then do the modifications, put those down the line as you're going to do the MMA. Has there been a decision made on that which way you guys are going to propose?

James Bell

No, there has not. We don't know yet what the requirements are. We just got the request for interest from the government. It just got released on Tuesday. We're working our way through it. So it's really too early, just premature for us to understand yet, how we would propose on that.

Molly McMillin - Wichita Eagle

Okay. Thank you.

Operator

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

Peter Pae - LA Times

Good morning. If I was an airline and I ordered a 787 today, when can I expect a delivery?

James Bell

I think we're sold out in the first few years, so it would be in the 2010, 2011.

Peter Pae - LA Times

A follow-up to that, considering that this is a new way of developing or making the aircraft, how difficult would it be to ramp up production, or what kind of challenges would you have?

James Bell

Well, a ramp up is complex and difficult, whether it's a new model or an old model, but we're always studying that. We have a global supply chain that has to be taken into consideration. They're not sitting around just waiting for us to up production. They do have other work and other requirements. So we’d have to work our way through in an integrated fashion.

It is a very complex, detailed study that has to take place, and generally, once you get through that, the implementation of it is in the future. It's not something that you can turn on immediately.

Peter Pae - LA Times

Okay, thanks.

Operator

Thank you. Our next question comes from James Gunsalus of Bloomberg News.

James Gunsalus - Bloomberg News

With the RFI out for the tanker, one of the big things that jumped out there was the subsidiary disclosure request by the Air Force. Do you see that being any kind of advantage in your bid?

James Bell

Did you say subsidiary or did you say subsidy?

James Gunsalus - Bloomberg News

I'm sorry. If I said subsidiary, I meant to say subsidy.

James Bell

It's too early for us to say, and I haven't seen it. Our people just got it, so I really can't comment on that.

James Gunsalus - Bloomberg News

Okay, and just as a follow-up for the settlement story that was in the Journal, what are you guys doing in anticipation of that in terms of reserves? Is there anything you can share with us on that?

James Bell

There's nothing to reserve. That was just a news article. We are all working cooperatively with the U.S. Government to try to resolve it, but there's no probability of any of this happening, and there's nothing that we can estimate if it did happen, what the ultimate cost would be.

Clearly we don't meet the accounting rules. We have put a disclosure though in our filings that says if we were to be able to settle this, it could be meaningful, just so that we cover ourselves. We just have no idea at this stage how that is going to conclude.

James Gunsalus - Bloomberg News

Given the nature of the settlement or what's being negotiated, it doesn't meet accounting rules for reserves?

James Bell

That's correct.

James Gunsalus - Bloomberg News

Okay, thanks.

Operator

Thank you. Our next question comes from Kevin Done of Financial Times.

Kevin Done - Financial Times

Hello, just wondering if you could give us a sense of what the production lifetime outlook is now for the 767? Also, what is the sort of timing that one is expecting for an eventual order for refueling tankers from the U.S. Government ? Thank you.

James Bell

All I can tell you is what's been in the paper. They just released the request for information to the supply chain on Tuesday. I think the timing they have is that they would release a proposal some time at the end of the year.

We just don't know what's going to happen. It could be late '07 or it could fly it out. It is the U.S. Government, so they could fly it out as they work their way through whatever the funding constraints are. I can't predict that.

The 767, I think we still have a few orders yet to produce. I don't know the exact date, but some time towards the end of the year we'll be taking a look at it.

Kevin Done - Financial Times

Thank you very much.

Tom Downey

Operator, we have time for one more question.

Operator

Thank you. Our next question comes from John Liang of InsideDefense.com.

John Liang - InsideDefense.com

Just under the wire. Good morning, sir. On the C-17 program, how long do you think you can keep the line open with the seven aircraft that are in the unfunded list, as well as your current international orders?

James Bell

Well, our current contract runs out in '08. Obviously, if we got seven more plus an international order, it could run a little longer. We're hopeful that we'll continue to work with our customers and we'll be able to work with Congress, because Congress has basically called for procurement up to 222 aircraft, and we'll see what we can do to work it.

It's good to know that they have seven that they're working on near term. It's good to know that Australia’s interested in four, because that will help us to extend the line.

We'll keep working with the Air Force and with Congress to make sure that we keep the line open as long as they want it open, as evidenced by new orders.

John Liang - InsideDefense.com

Just to make sure, hypothetically, if you only had this, what you have right now, how far would that take you through?

James Bell

Well, the contract would end in '08.

John Liang - InsideDefense.com

Okay, thank you very much.

Tom Downey

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

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Source: The Boeing Company Q1 2006 Earnings Conference Call Transcript (BA)
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