波音 (BA) 2006 Q2 法說會逐字稿

Good day, everyone and welcome to the Boeing Company second quarter 2006 earnings conference call.

Today's call is being recorded.

The management discussion and slide presentation plus the analyst and media question-and-answer 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.

Thank you.

Good morning and welcome to Boeing's second quarter earnings call.

I'm 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.

In the interest of time, we ask that you limit yourself to one question.

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

And as a reminder, you can follow today's broadcast and supplied presentation through our presentation at Boeing.com.

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

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

Thanks, Dave.

Good morning, everybody.

Let me begin with a few comments about our second quarter performance and then James will walk you through the numbers.

After that, I'll say a few words about the road ahead and then we'll both take your questions.

Boeing has made good progress across most areas of our business during the quarter.

We executed our plans to improve financial results with one notable exception.

And that was in our international airborne surveillance program or AEW&C.

The charge we announced for that program and for the global legal settlement reduced our reported EPS for the quarter by a combined $1.15.

Still, the bulk of our business is once again generated strong performance.

With revenues on track and outstanding cash flow of more than 2.4 billion during the quarter.

We used our cash to invest in our organic growth programs and add capabilities to our services businesses.

We also improved our liquidity position, reduced debt and returned capital to our shareholders through our dividend and share repurchase programs.

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

Overall, we continue to be well-positioned in healthy markets.

Our commercial airplanes business remains our growth catalyst, thanks to an expanding market and airline customers who increasingly prefer Boeing's value creating products.

Our defense portfolio also remains solid and we continue to have the industry's largest backlog at $78 billion.

While most IDS programs are performing well, we regret the impact that the AEW&C program delays are having on our customers in Australia and in Turkey.

We are fully committed to taking the necessary steps to meet our customers' requirements there.

We are also committed to returning to the double digit margin performance that we've all become accustomed to at IDS.

Business execution is of paramount importance to us.

It is our main focus.

Looking ahead, we have updated our '06 outlook to reflect the charges from this past quarter as well as some operating improvements going forward.

We also raised our guidance for 2007 revenue and earnings due to a stronger commercial airplanes outlook and better expected operating performance.

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

A few years ago, certain Boeing employees did some things that were wrong.

We accepted responsibility for their actions and through the settlement, we sought to put the past behind us and move toward a new era where ethics and compliance would become a competitive advantage for Boeing.

We have made substantial changes in our ethics and compliance programs and are embedding ethics and compliance in everything we do at all levels in the organization.

We have been advised that the bulk of the settlement is, in fact, tax-deductible.

And that similar deductions have been allowed in the past.

Without question, the short term financial impact of the taxability issue is significant.

However, the long-term value of Boeing's reputation is even more significant.

Accordingly, I feel strongly that the right thing for Boeing to do is not to seek tax deductibility for the settlement charges.

This should be a signal to our employees, customers, suppliers and our shareholders of our willingness to acknowledge responsibility, accept accountability and to move forward in a manner reflective of the great legacy of our company and its employees.

Simply speaking, my intent is to focus on the future and put this unfortunate part of our past behind us.

As we move forward, operating with integrity will differentiate Boeing just as much as our technology, our talented people and our attention to customers.

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

James?

Thank you, Jim.

Good morning.

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

Reported EPS was affected by the charges totaling $1.15 per share that Jim mentioned earlier.

Of that total, the global settlement charge was $0.75 per share while the AEW&C charge was $0.40 per share.

Now let's review the performance of our business.

Next slide, please.

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

Revenues for the quarter rose 10% and BCA's operating margins expanded to 10.1% driven by a 14% increase in deliveries.

We're on track to deliver 395 airplanes this year, a 36% increase over last year's total.

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

We are increasing our R&D investment in BCA primarily to reduce risks on 787 program goals related to weight and schedule.

The program remains on track to meet its performance commitments and entry into service.

We captured 311 airplane orders during the quarter with our industry-leading product line.

Our success has enabled us to grow our very large commercial airplane backlog which has now reached a record $142 million -- $142 billion.

The strong order environment and the market demand for Boeing products drove our order total for the first six months of 2006 to 487 airplanes.

And as of today, we have won net orders for 510 airplanes.

We continue to make progress on the 787.

We began manufacturing and major assembly during the quarter.

We also added to the large backlog of 787 orders in the period.

Since program launch, we have captured 364 firm orders from 25 customers from around the world.

We expanded our large service businesses during the quarter by completing the Carmen systems purchase and announcing an agreement to acquire Aviall.

These focused acquisitions combined with double digit organic growth in our service businesses at both BCA and IDS will help us deliver enhanced capability to our customers and additional value to our shareholders.

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

Later today, we will deliver the 2,000 Next Generation 737 airplane.

That airplane is going to Southwest Airlines which took delivery of the first Next Generation 737 less than a decade ago.

We've reached 2,000 deliveries quicker than any other commercial jet in history.

Underscoring the 737's performance, reliability, and appeal to airlines around the world.

Clearly, Boeing commercial airlines -- airplanes is performing very well in a strong market.

And we are raising our guidance for BCA revenue and earnings in both 2006 and 2007.

Next slide, please.

Our IDS business delivered solid performance across most of its large diversified portfolio of defense programs.

However, that performance was affected by the $496 million charge we took in the quarter for AEW&C program.

With that charge, our reported margins declined to 4% on stable revenues of $7.8 billion.

Without the charge, IDS margins would have been in familiar territory above 10%.

As Jim said, we believe we have the issues on that program identified and have an achievable go forward plan in place.

We're working closely with our customers to get that program back on track.

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

We delivered 24 production aircraft.

One satellite.

And six launches during the quarter.

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

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

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

Next slide.

Boeing capital delivered 62 million in pretax earnings in the quarter and reduced its debt by nearly $600 million.

The aircraft financial markets continue to improve and BCC is executing well on its mission to support Boeing's core business while managing its portfolio size and risks.

BCC has reduced debt by $2.7 billion and paid dividends to Boeing exceeding $1 billion over the past two years.

We announced last month that we're evaluating various alternatives for our Connection by Boeing business.

Including a possible sell or shutdown of operations.

A decision along these lines would likely result in a one-time impact to earnings in 2006 of up to $350 million pretax.

However, if we do decide to divest or shutdown the business, the move would be accretive to our EPS in 2007 and beyond.

The impact of 2007 could be an increase to EPS of up to $0.15 per share.

Neither of these numbers are included in our guidance.

Now, turning to our balance sheet on slide 7.

We continue to enjoy an outstanding balance sheet strength and liquidity.

We ended the second quarter with $10.6 billion in cash and liquid investments.

Our total debt levels decreased about 500 million in the quarter as BCC paid down maturing debt consistent with its reduced portfolio size.

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

Moving to cash flow on slide eight.

Our cash flow generation remained outstanding as we delivered $2.4 billion of cash flow in the quarter and $4.5 billion for the first six months of 2006.

This cash performance reflects strong cash earnings, another strong quarter of airplane orders and excellent working capital management.

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

Now, turn to slide nine in our financial guidance.

We're adjusting our EPS guidance for 2006 to reflect the charges in some offsetting operating improvement and we're increasing '06 revenue guidance for higher BCA revenue.

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

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

Now, let me remind you that our revenue guidance for 2006 includes approximately $1 billion for business plan to be part of the pending United Launch Alliance transaction.

Upon completing that transaction, Boeing would use the equity method of accounting for this new joint venture.

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

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

We're including more R&D in the EPS forecasts.

Now expect it to be about $3 billion for each year to ensure that we provide enough resources at the right time to keep our major development program in BCA and IDS on track.

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

Next slide.

Here you see a detailed schedule of changes to our EPS guidance which breaks out the charges and the performance improvements.

In addition, additional segment guidance is provided in our earnings release.

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

Jim?

Thank you, James.

As James said, our outlook continues to strengthen.

Our businesses are strong.

Our products are valued.

They're building upon our customer relationships and we are focused simultaneously on growth and productivity.

Throughout the organization, we are committed to consistent execution, avoiding past mistakes and delivering on our commitments.

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

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

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Heidi Wood of Morgan Stanley.

Good morning.

Jim, I have a question for you, it's actually kind of a big picture question, if you don't mind.

But when we look at a quarter like this with the charge on the Delta IV because of the buy three on the EELV, the AEW &C charge, potential disposition of connection, and again another potential charge for that.

Now that you've been CEO at Boeing for a year and you said in your comments that business execution is a main focus, can you give us some specifics about how you're addressing the risk mitigation efforts through the Company so the issues come to you earlier and the charges are smaller?

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

And I think that's part of the result of this focus.

Having said that, we've had more things to deal with than I would have liked.

I mean, I think AEW&C, we've talked about.

The charge -- the Delta charge is associated with restructuring the business into a far more viable entity going forward.

So, I think you can talk your way through that one as a way to better position your business for the longer term.

I think connection would fall into the same category.

But that does leave you with a couple of things that we're not proud of.

That, in part, were surfaced by, I think, an increased focus on accountability and execution.

So, that's not a perfect answer for you but maybe by way of explanation that, helps a bit.

All right, great, thank you.

Okay.

Your next question comes from Howard Rubel of Jefferies.

Thank you very much.

Could you explain a little bit how you can increase your revenue forecast in commercial business but not change the expectant delivery schedule?

Yes, Howard.

I think what you're seeing in both years is the fact that we're doing better in features, options and things of that nature and in '07, we're seeing increasing services.

So, that's really where it is coming from.

If you look at the increase, particularly in '07, it's about 3%.

And it's not unusual to see that as you get closer to delivery, the customer gets more specific about what are the special features and options they want on their airplanes.

Thank you.

Thank you.

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

Good morning.

I'd like to get your reaction to Airbus's wide body approach coming out of Farnborough?

And first, there are a lot more details that need to come out on the A350 but the focus of the initial airplane is that the large end of the 787 and the low end of the 777.

Not surprisingly, they're claiming better performance.

And then in addition, we're seeing Airbus pricing very aggressively to get more A-330s in the market at the same time.

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

First of all, we didn't expect them to do nothing.

They have introduced a product that, on the face of it, and since we really don't have a clear definition of what the product is beyond the concept that's been discussed, it's hard to react to the specifics with regard to performance versus our airplanes, but I will say that it seems that they're trying to cover two of our airplane families with one airplane which is a tough putt.

You're right.

It has some elements of competitiveness with the low end of the 777 line.

If they can execute along the lines of the concept they put out.

We don't see it as a -- as a plane that can compete very well with our 787 line.

It's a little big and a little heavy to do the mission that the 787 can do.

So, in summary, you've got a single airplane trying to cover two of the most successful families of airplanes that we've ever had.

And it is knowing a little bit about engine technology associated with these kinds of planes which is part of the value package as well as the plane itself.

It's an ambitious program.

Now, will it be a good airplane?

Yes.

Will it fit some missions well?

Yes.

Will they try to -- while they gear up production, which will take them two to three years longer than us getting the 787, we've already had the 777 out for 10 plus years, will they aggressively price old technology to bridge some customers?

I would be tempted to do that and that's the A-330 story.

So, what they're doing makes sense but will it be enough is, I think, the question.

You're not seeing any real change in the way you're looking at them -- at the market based on this?

I don't think so.

We expected competition in our business plans, obviously.

And I think this -- the revamped 350 concept that we're seeing is -- I don't think fundamentally changes what we're doing.

We've got -- we've got two pretty good size book ends on either side of their airplane.

Okay.

Great.

Thanks.

Thank you.

Robert Stallard of Banc of America Securities.

You may ask a question.

Good morning.

Good morning.

Jim, I would like to ask you a question about the 787.

There's been a lot of talk you may be considering an extra production line on this aircraft.

Yes.

Can you walk us through your thought process there and why you would be willing to take on potentially extra risks to produce more aircraft?

That's a good question.

There's no doubt that BCA is experiencing more demand for this -- unprecedented demand for this airplane.

And in a perfect world, we would like to be able to produce as many of these things as people have interest in but of course we have to balance orders with supply chain with development considerations and yes, there is upward pressure on our current production plans.

Alan Mulally and his team are sifting through alternatives which range from increased productivity in their current facilities, or currently being developed facilities as well as potentially, some additional facilitation but we haven't made a call there but you're right.

The demand for this airplane, the unprecedented demand for this airplane is forcing us to ask the question.

And there are worse questions to ask and answer.

And over the next year or so, we'll come up with a final answer there.

Is this plane essentially sold out until 2010?

Is that the current situation?

Beyond that.

Pretty much through -- it is into '11 pretty far, too.

Okay.

Thank you.

Thank you.

Byron Callan of Prudential Equity Group.

Hi, Jim, it's really just a follow-up on Heidi's question.

How satisfied are you that the focus on execution is such that Boeing's gone to the bottom of the barrel on some of the issues of [indiscernible] earnings lately?

Are you satisfied that you've got the risk reduction disciplines and even the culture in place that we're not going to see some of the surprises in the future?

No, I'm not totally satisfied.

None of us are.

I think -- I think we have made -- as I answered Heidi's question, I try to portray a situation where the increased focus itself is surfacing some things.

But I think, what this company does are things that no other company does.

And as a result, we can push the envelope a little bit and we have to be more careful, not only in execution but on things we choose to do.

And we're spending a lot of time focused on it.

We've got a lot of our initiatives focused on it.

And I would see every quarter, every year in improvement.

But I'm not satisfied with where we are.

And I probably never will be totally satisfied.

Because that's a little bit of the nature of the business.

So, we're going to improve.

Great.

Thanks.

Thank you.

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

How should we look at the margin guidance for BCAG for '06 and '07.

You didn't change margin guidance but you did increase the R&D expense.

So should we look at it as just block extensions.

Is it lower expected cost on programs?

Is it rate changes in the outlook?

What are the factors offsetting the R&D build?

Well, actually, Steve, we did have a block extension for the 777 block 50 this quarter and that's why you'll see that the per production costs went up slightly.

But no.

It's a combination of things.

So, we are looking at -- we're working our productivity initiative.

We are harvesting the benefit of that.

That's being somewhat offset by raw material cost.

So, we're dealing with that.

And then, clearly, the R&D that we have, we guided you to that's going up is really there.

To make sure that we can get through some of the issues you normally would encounter at this phase of a development program while raising the level of assurance that we'll be able to meet our customer commitment and our in service date schedule.

So, that's why you're seeing the balance in terms of margin guidance both this year and next at BCA.

James, does the charge that you're taking on Delta IV, the buy three agreement essentially extinguish any further risk of write-offs?

Because you had $465 million hung up on the balance sheet for production costs and tooling.

So, is this pretty much behind us now?

Thank you for that question, Steve.

Because I did want to expand on the discussion of the charges this quarter.

And clearly, we have -- this tentative agreement gives us a framework where, I think, it greatly reduces the risks of recoverability of our costs both in fixed assets and in our inventory because it provides the framework under which those costs would be recoverable.

Just as importantly, it allows us to maintain our capability to produce this product and launch it.

And so without the same risks that we had before we got this agreement.

So, I really look at that as a positive when I think about the agreement we've reached tentatively with the Air Force.

Obviously we have to work toward getting that definitized by the end of this month.

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

As the launches we have are [inaudible] under contract, if the schedule slips, you can see some slight growth in the cost of each of those launches.

But I think this agreement really, really significantly reduces the risk associated with the recovery of those costs.

Thank you.

Thank you.

Our next question comes from Cai Von Rumohr of Cowen & Co.

Thank you.

For the second quarter, BCA has done 10% margin.

Could you comment first on some of the color on that?

For example, the difference between program and unit cost narrowed.

What did the impact of the 777 block extension do?

And secondly, while you increased R&D, essentially it looks like it's going to be relatively flat next year and the volume at BCA now is going up.

So, explain to us again why those margins don't go up or, in fact, if there is a chance they could go up, what should we look for to tell whether they might?

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

And so that's some of the impact.

We are having higher R&D costs this half of the year and then we have timing on some of our period expenses primarily our selling expense.

So, that's what you're looking at and how it would moderate the fact if you took the contribution out of the second quarter, we we'd be closer to what the run rate is that we've guided you to.

We think we're pretty comfortable this year that that's about the right number.

Now, going to next year, again, Cai, it is clearly we're going to increase the R&D spend rate.

We are also going to be careful with what's going to happen with raw material costs and our productivity initiatives.

We're doing very, very well on the single aisle.

Clearly we're still challenged on how to get that out of the wide bodies.

They're more special features associated with the 777 and the 7777 as a custom built airplane.

So, we're optimistic we're going to get it but nonetheless, you could say we're being -- what I would consider, conservative at the right level.

Terrific.

Thank you.

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

Good morning.

Good morning.

Jim and James, going back to the A-350, the question asked earlier, you all might be contemplating a fourth version of the 787.

Could you talk to us about where that stands and how that aircraft might help the pendoff(ph), their focus on the lower end of the 777?

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

Thank you.

Yes.

First on the so-called -10, 787 growth, we have a number of customers who are discussing with us, some would say pushing us to develop that plane.

I think when the timing is right, in all likelihood, we will.

We're just sorting through it right now with a number of customers but there is clearly demand for that airplane.

We just have to fit it into our development plans.

With the right customers, probably on a sooner rather than later basis.

But we'll see.

The -8 -- 747-8 you asked about, I would -- I think there is a good chance before the end of this year, there will be a major customer or two for the PACs version.

We have a couple of small orders for the PACs version now.

We have a pretty good pipeline there and there's no deals finally done but I'm cautiously optimistic there by year end.

C-17.

We have a number of international orders.

I think we have disclosed them.

Australia, I believe four airplanes.

Canada, I think U.K., NATO is considering some additional planes.

Not finalized yet and the U.S.

Air Force has recently taken up and I think we're solid through mid '09 now.

But having said all of that, because I know what your follow-on question is going to be, we're facing, by end of August, we're facing some tough decisions with that airplane.

And we have been carrying the supply chain for a fair amount of the year with support from our customer but we've been using customer funds to support the supply chain.

And I think the -- that will dramatically increase and we'll have some tough decisions with our supply base, with our -- with the amount of resources we put against the program if we don't get some more clarity with our customer here in the United States, on a go forward basis, which is a tough issue all around.

So, we're hopeful that'll resolve itself but that will be an inflection point for us.

Okay.

And just, if you do go forward with 787-10, how might that change the R&D picture from what you've guided to today?

Well, I think the entry into service of that plane would be 12, 13.

And therefore, I think the 787 core models would largely be completed from an engineering standpoint and the -8 engineering would be at a lower level.

So I think it is all manageable at the time when that kind of engineering would peak.

And by the way, this is not a big engineering bill to take our core 787 and extend it to a -10.

I mean it's real money but it doesn't compare with sort of the base models and I don't want to give you a number because we don't know what the airplane looks like.

But it is more of a derivative type economics.

Thank you.

Your next question comes from Joe Campbell of Lehman Brothers.

Good morning.

Hi, Joe.

We've been looking at the monthly deliveries on the 737, and we know you took a strike and had some delays in that airplane last year.

And I mean so the deliveries were 27, 27 then fell to 22, 23, then 26 in June.

And I wondered if you could just kind of give us an update on how the efforts to try and ramp up and recover from the striker going.

I mean, this is separate from an issue of how many planes you'll deliver but just sort of what are the remaining challenges midyear in '06 to trying to ramp up?

You're already up a significant percent but want to do more.

Thank you.

Hey, Joe, on the 737, we are really ramped up to our current projection as to where we wanted to go on production rates on 737.

We continue to look at what it would take to go and do studies on what it would take along with the supply chain to get higher.

But that is really what we're focused on is that rather than a catch up of the 30 airplanes that slipped out when we had the strike.

And so the focus is entirely on how to use; one, efficiently ramp up to the then current projected rates which we have completed that and they've done that in a way that allows us to deliver those airplanes profitably.

So, we're doing well there.

But the team, it's because of the demand for this airplane which we all know is oversubscribed at our per current production rates, we are continuing to look.

Does it make sense to ramp up beyond that?

And can the supply chain support?

And as we make those determinations, we would then make those decisions.

But, you had mentioned on the last call, James, that you still had some more production rate increases to go this year.

I think I had forgotten the number.

Had you so many planned and had a few under your belt.

I thought there was another to go?

We're done.

We're up to rate on all models at this stage.

Now we're just looking at can we do better than that given the demand for the various models.

You'll have to do that sometime in order to make next year's higher number.

Something will happen, I would guess in the fall?

No.

I think we're at rate right now to meet next year's numbers.

So, we may have to go up a tad bit in some of the models but on 37s, I think we're at rate.

But, we'll continue to look at that and see if we can do better because obviously we can sell more if we can build them.

Thank you very much.

Thank you.

Your next question comes from Ron Epstein of Merrill Lynch.

Yes, good morning.

A question for Jim.

In the release and on the call you guys mentioned how you're increasing R&D spend to mitigate risk and I guess wait on the 787 program.

Can you give us any further color on that so your outsiders looking in so that we can feel more comfortable with the development of this new airplane?

Well, the weight issues on a program like this are not unusual.

As a matter of fact, I can't remember an aircraft program that didn't have a weight issue of one form or another at this stage in the program.

I would characterize the weight issue we've got here as more normal than abnormal.

Having said that, we've got aggressive commitments for certification and for entry into service.

We want to mitigate any risk associated with not meeting those commitments.

So, I think we're attacking the weight issues aggressively and the associated schedule issues.

We still -- as we project where we're going to be, we still see the plane delivered on time.

Within the commitments, performance commitments we've made to our customers.

So, it's -- these programs are never easy.

As you design and build the four million parts that go into these aircraft, there are always going to be issues and we're paranoid every day about them.

And trying to attack them and leave no stone unturned at this stage.

I'd rather be paranoid now than deeply disappointed later.

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

Yes.

First flight. '07.

Next year.

Third quarter.

And then similar timing '08 for EIS, entry into service.

Great.

Thank you.

George Shapiro of Citigroup, you may ask your question.

Yes, Jim, on the R&D increase, I mean, effectively on commercial, you're increasing it 300 million on 2 billion so about 15%.

You just go through what the thinking is as to how you arrive at that?

Because the history is here that we'll see steady R&D increases now as over the next several quarters as we get close to initial flight.

Well, the thinking is --, we're adding up the work and we're applying the resources and we're putting a margin in for risk reduction.

That's the thinking.

It's there are -- it eventually gets down to specific parts, specific suppliers and specific people.

And that's the methodology.

There's no -- there's nothing beyond that.

There's no magic.

Okay.

And then probably for James, I assume, James that, while the R&D will be about the same in total next year, the commercial's actually going up and the military's probably down some, is that correct?

That's correct.

Absolutely.

Okay, thanks.

Thank you.

David Strauss of UBS, you may as your question.

Jim, could you just give us your current view on the status of the overall supply chain?

And incrementally, have you seen any improvement or has your costs increased over the course of the last three to six months and if any problem areas, if you could just give us some examples?

Well, we knew at the beginning that there would be issues that cropped up in the supply chain, particularly as we relied on people for higher level components.

And we tried to anticipate this by our use of IT, common engineering tools, realtime visibility across the globe in our labs and their labs, simultaneously.

We tried to anticipate it by the way we manned and worked together.

Our site and their site.

And all toward the end of seeing problems early, dealing with them aggressively, we've had a couple of instances where we've moved work but that was all part of the contingency plan where we had built extra engineering capacity in the event that someone ran into an issue on completing work and we had engineering capability and facilities ready.

That's happened once or twice.

Again, anticipated, planned for and we're dealing with it.

But I wouldn't characterize any of it as unanticipated or earth shaking.

But we're right at the stage now where the transition from engineering to development is happening.

And we're monitoring it every day.

Thank you.

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

Thanks, good morning.

I have one more on the 787 R&D.

In over the two years your R&D, God, it's gone up half a billion and it sounds like it's more than that for commercial and I guess specifically for the 787.

I'm just wondering if you could be a little more specific as to where that money is going.

Is it, are you hiring more engineers?

Are you paying overtime?

Anymore color on that.

As an adjunct to that, are your suppliers also seeing increased cost across the board or anywhere particularly?

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

But the perspective you got to have here, I think is that this will be the most efficiently developed airplane that we've ever done.

I think the strategy of working together with our partners and our suppliers where they are shouldering some of the development work in concert with us is producing a cash model for this airplane even with some risk mitigation kinds of activities that is -- that promises to be superior to anything we've ever done.

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

Are your suppliers participating in the higher costs?

Are you taking up most of the slack?

Well, they have skin in this game, too.

So, the extent to which we see together that they are falling behind in some area or where the weight is an issue in another, yes, it is their resources that they're applying.

That's part of our agreement with them.

Okay.

Thank you.

Yes.

Thank you.

Myles Walton of CIBC World Markets.

You may ask your question.

Thanks.

A question on pension.

For '06, you've lowered that number by 200 million left '07 in tact.

Given current year adjustments tend to be a little stickier.

Can you give us background on how the '06 number changed?

And also given the rising interest rates, looks like maybe 75 base points higher next year, why you left your '07 $1 billion in tact?

And then as an adjunct, is most of that pension expense still flowing through BCAG?

That was about six questions, Myles.

Let me see if I can remember them all and answer them.

Well, first of all, the overall pension cost for the year is the same.

It's about a billion dollars.

What you're seeing is what actually flows through earnings for this year and that's the differential between what goes to inventory and what actually flows into expense.

In our model, we had to modify the method for making that determination and it turned out that it gave us goodness for this year.

Because the way this thing works is that which is inventoried last year gets expensed this year and then a portion of this year's cost gets expensed this year.

So, that's what you're seeing in '06.

In '07, the pension cost, as you know, is determined well in advance of what you would see in changes in interest rates.

So, that's not -- if the change in this year doesn't have a significant effect on '07 but nonetheless, that method, what you see, what we think will happen in '07 stays about the same.

Based on what we've just done.

So, it's a one-time adjustment in '06.

And most of that is flowing through BCAG?

The pension cost is allocated, probably the cash piece is probably going through -- most of it is going to BCA, but what you're looking at a lot of, too, is the adjustment that flows on -- stays on the corporate book.

The fast cash adjustment.

Thanks.

Joseph Van Pietro(ph) of Wachovia, you may ask your question.

Good morning.

Good morning.

Circling back to the connection issue.

The Company has justified it's -- or stated in the past it's justified its investment in the program, not necessarily from the revenues that can be derived from the back of the plant, but more importantly from what's going on up-front.

And my understanding is that part of the lower operating cost of future programs specifically the 787 are tied to the efficiencies that can be gained from using the connection system.

If you guys keep it or sell it to someone, I get that, but if you decide to shut it down, exactly how does that effect the operating cost for the outlook for new aircraft programs?

Not significantly is the quick answer.

But you're right.

I mean, I think the program largely justified by the back of the plane, so I differ with you a little bit there.

But also, in part, justified by facilitating operations of the airplane and some service elements.

But it's -- the facts are that our business model is not being met.

And we're taking a good swing at this business and we're falling short of where we want to be which is why we're asking a series of fundamental questions now on a going forward basis.

Restructure, terminate, affiliate, being the obvious options, but continuing to operate as we are now is not an option.

So, we're taking the fundamental look.

All elements of the business model are falling short of the projections and impact on a major restructure or terminate would not significantly impact the economics.

There are other ways to do what you're describing.

Okay.

Well, what's been the response from your customers?

I mean, specifically, it seems to be -- the system seems to be working. [inaudible] it seems to be relatively pleased.

And, it's a drag that you guys had the U.S. carriers back out due to their financial situation.

But at some point, they come back.

So, I mean, you guys weren't the only ones that invested in this so what are your partners saying?

I think -- we're talking to them right now, including [indiscernible] as you point out.

We're trying to sort through the issues.

Eventually, if the business model doesn't work at all for us, it is not going to work at all for them either.

So, but we're trying to find -- we're trying to find out through discussions and sharing with them, the reality of our situation, and you're right, the technology is performing reasonably well.

But the airlines have not -- as a group, have not aggressively adopted this service to anywhere near the extent that we had hoped.

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

Thank you, David Gremmels of Thomas Weisel Partners.

You may ask your question.

Thanks, good morning.

I just wanted to ask, maybe you could provide some additional color on the BCA pricing environment, given your competitor's issues lately, it's possible to imagine them being more aggressive with pricing, maybe to try to hold on to market share.

Are you seeing any changes in that environment?

Well, I think, the answer is yes.

I mean we have seen very aggressive pricing from our competition in part because old technology is fighting new technology.

And as a matter of fact, now that they've got some new technology, at least planned, I don't want to say the pricing's going to abate because, as a question earlier -- surfaced earlier, the A330 could be kind of a fighter transition model which -- but, I think pricing has been pretty aggressive in both the twin area and in the A-340 versus 777 area.

So, I wouldn't see it getting worse necessarily.

It's been pretty bad and now Airbus promises, hopefully by the end of the year to have a new plane to find.

And when they do, they may want to get value for that.

So we'll have to see.

Thank you.

Yes.

Thank you.

That completes -- I'm sorry, go ahead sir.

We'll move on to the media questions, please.

Thank you.

That completes the analyst question-and-answer session.

For members of the media, if you have a question, please press the star key followed by the digit one on your touch tone telephone.

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.

Thank you.

We'll continue with media questions for Jim and James.

If you have any questions, after this session, please call our communications team at 312-544-2002.

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

Thank you.

Your first question is from Jonathan Karp of Wall Street Journal.

Hi, good morning.

I just have a question on the settlement.

You've decided not to seek tax deductibility for the settlement.

Have you reached a conclusion on insurance?

Does insurance cover any part of the settlement as far as you can tell?

And will you seek a claim toward that end?

We don't believe that our insurance would cover it.

So, we don't think that's an issue.

The main issue is tax deductibility.

And, as I mentioned, we're not going to seek it.

Thank you.

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

Thank you.

Our next question comes from Dominic Gates, Seattle Times.

Hello.

Question for Jim McNerney.

Jim, at Farnborough, you, in an interview, brought up some issues on the tanker program and the [indiscernible] of the regulatory environment for Boeing versus EADS.

You brought up specifically ITAR and Foreign Corrupt Practices Act and how it was applied to you versus them.

I note that afterwards, Northrop Grumman, which the lead contractor in the rival tanker proposal reacted quite sharply to that and issued a statement saying you got your facts wrong.

So, I'm wondering is Boeing going to pursue either of those questions, either of these specific acts on the tanker thing?

I think in Farnborough, one of the IDS people mentioned that they wanted the ITAR part of the tanker proposal, they wanted inserted that in there.

Will Boeing pursue these and what's your reaction to Northrop Grumman statement?

As I pointed out, Dominic, we're just seeking a level playing field here equally applied regulatory environment for both.

I think the -- this issue was raised as we discussed Farnborough, really by the legislature.

In terms of discussions they've had and resolutions that have been put forward to ensure this level playing field.

I think our customer and the legislature behind it is probably -- are probably the ones that should push for this rather than us.

We're a self-interested party.

We're a competitor here.

We just want to make sure it's a level playing field.

And I saw your interview with Mr. Crosby, and for all I know, they are taking steps to respond to these things that I'm unaware of.

So, that's where we stand.

Thank you.

Once again for members in the media, if you have a question press star one on your phone.

Our next question is from Molly McMillen of Wichita Eagle.

My question is for Mr. McNerney.

I saw comments from Alan Mullally out of Farnborough about a plan for the 737 replacement in the future that, that plane would be more composite.

My question is what kind of impact do you anticipate that could have on Spirit Aerosystems here, which certainly has a huge portion of the current 737, and what do they need to be doing in the meantime?

Yes.

Listen, first of all, I don't think Alan meant to say -- and I don't think he did say that there was a clearly defined next next generation 737, and you probably didn't imply that in your question.

We're studying where to go.

And, obviously, composites are one of the technologies that could flow from the 787 down into the narrow body, the value of the composites, obviously strength, maintainability and weight.

And I think Spirit is doing a good job on the composite side.

So, I don't think -- and they are a very valued partner.

So, I think whatever plane we define for the future narrow body, which won't be for a number of years, keep in mind, we would hope that Spirit would remain a very important partner for the Boeing Company going forward.

And based on the capabilities I see there, I think that's going to happen.

So you'd anticipate them getting a bigger chunk than they have of the current 787 --

No, that's not what I said.

What I said is they will remain a very important partner.

It is hard to have a work statement until you have an airplane to fly.

I see the capabilities that are developed there, the quality of the people that develop there, I see them holding on to a big chunk of it and we want them to hold on to a big chunk of it.

Consistent with competing for the business which -- I think they're going to be very competitive.

Okay.

Thank you.

You're welcome.

Thank you.

Your next question comes from.

Ahmed Sachieve(ph) of Chicago Tribune.

Good morning.

Hi, Jim.

I wanted to ask with you with Airbus likely to seek new launch it's for the A350, how that might affect any potential settlement of the trade dispute.

Well, I don't think it would be helpful.

I think if they seek launch aid on the same terms that they've had or historically, I think our government would view that as a -- as a step backwards, a significant step backwards in the negotiating process.

As I said before, I hope we can find a way to negotiate something.

Our government and the European governments.

But that specific step would not be helpful in my opinion.

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

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

Thank you.

Thank you.

This concludes today's conference.

Thank you for joining.

You may disconnect at this time.