Spirit AeroSystems Holdings Inc (SPR) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen.

And welcome to the third quarter 2007 Spirit AeroSystems holdings earnings conference call.

My name is Grace Ann and I will your coordinator for today.

At this time, all participants are in a listen-only mode.

We will be facilitating a question and answer session towards the end of today's conference.

(OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to Mr.

Phil Anderson, Treasurer and Vice President of Investor Relations.

Please proceed, sir.

Good morning.

And welcome to Spirit's third quarter 2007 earnings call.

I am Phil Anderson, and with me today are Jeff Turner, Spirit's President and Chief Executive Officer, and Rick Schmidt, Spirit's Chief Financial Officer.

After brief comments by Jeff and Rick regarding our performance and outlook, we will take your questions.

As always, we have provided detailed information in the press release issued earlier today.

Before we begin, I need to remind you that any projections and goals we may including in our discussion today are likely to involve risks, which are detailed in our news release and our SEC filings, and in the forward-looking statements at the end of this presentation.

And as a reminder, you can follow today's broadcast and slide presentation on our website at spiritaero.com.

I will now turn the presentation over to Jeff Turner.

Thank you, Phil.

And good morning.

Let me also welcome you to Spirit's third quarter earnings call.

I'll start with slide two.

We had a solid third quarter and continued our year-to-year growth in revenue and profitability.

Our revenues were $968 million, an increase of 17% over the same time period of 2006.

We achieved this top line growth through increased volumes on Airbus and Boeing products.

We delivered shareholders $0.60 of EPS, up from $0.28 per share a year ago, another strong quarter of profitability compared to the same quarter last year.

Operating performance continues to improve across the company.

We expanded our operating margins to 11% from 9.3% year-over-year.

I'm very pleased with our results as we continue to focus on increasing productivity, on our growth, and on delivering shareholder value.

Our backlog grew again this quarter to $23.5 billion, as both Boeing and Airbus combined booked over 500 net orders, outpacing third quarter deliveries by almost 2.5 to 1.

I continue to be pleased with our performance on the 787 program.

We are well underway to implementing a revised schedule in the factory, and have incorporated the effects of the reschedule into our revised 2007 financial outlook announced today.

I will provide you additional thoughts on the 787 program in just a few minutes.

As we move into 2008, we will be increasing product rates and delivery volumes on Airbus and Boeing products.

We expect the volume growth to increase revenues by approximately 20% over 2007, and to deliver between $2.30 and $2.40 of fully diluted EPS.

Now let's talk about some of the specific accomplishments across the business during the quarter.

On slide three, fuselage systems continued to execute well, increasing revenues by about 5% from the third quarter of '06 by delivering strong operating margins of 18%.

The fuselage team delivered the 2,400 737 NG fuselage and the 1,400 747 forward fuselage to Boeing, and successfully completed the systems requirements review on the CH-53K heavy lift helicopter contract.

During the quarter we were pleased to join the P-8A Poseidon industry team.

The P-8A is a military derivative of the 737-800 for the United States Navy.

The aircraft is a new surveillance and reconnaissance aircraft that will replace the current fleet of P-3s.

The Navy plans to purchase 108 of these aircraft.

Toward the end of the quarter, we started the initial stages of a production rate increase to support Boeing's 2008 deliveries.

With the exception of the 787, which I will discuss in a minute, full incorporation of the higher production rates are expected to be complete by the end of the year.

On slide four you see the propulsion team also increased revenue from the same quarter last year, while delivering strong operating margins.

The propulsion systems team continues to lead the industry in the application of technology and materials with the development of the one-piece inlet for the Boeing 747-8.

This technology is designed to further improve noise abatement and to reduce manufacturing time.

787 pylon production continued to make good progress during the quarter, and is now implementing a revised schedule.

On slide five you see the wing systems team also increased revenue from the same quarter last year.

Margins expanded from 6% to 9.3% from the third quarter of '06 as higher volumes on Airbus and Boeing products, and a continued focus on cost improvements increased profitability.

Operating margins in the second quarter of '07 reflected a favorable cume catch and a favorable model mix.

Third quarter margins included no cume catch adjustments.

Spirit Europe resumed delivery of A380 products during the quarter, and is making preparations to increase product rates across Airbus product lines.

Demand for commercial aircraft remains strong, and the A320 and A330 platforms are accelerating to fill that demand.

Development programs continued to move forward, as work continues on business jet, the 787 and the 747-8 activities.

Wing systems is on track on the 787 program, and is working to incorporate a revised schedule.

Let's turn to slide six and discuss the 787.

Let me first take a moment to compliment our 787 team.

This is a group of people who have worked together tirelessly over the last few years to design and build a significant portion of a next generation large commercial aircraft.

They have demonstrated the ability to successfully develop their strategy, innovate, and to execute on a complex development program that has presented numerous challenges along the way.

I congratulate them and thank them for their efforts.

The accomplishments on slide six are the results of the team's effort.

To date, we have delivered two forward fuselage sections, one flight test unit, and a static test unit.

And have a third, the fatigue test unit, ready for shipment.

To date, we have manufactured 13 composite forward fuselage barrel sections.

We have delivered 13 pylons, and six fixed leading edges, and quality across the products is very good.

As you would expect activity is underway to adjust our production plan to a revised schedule.

As a result of the revised schedules, we have reduced our 2007 revenue guidance range from $4.0 billion to $4.1 billion, to $3.9 to $4.0 billion.

Let me discuss the revised schedule in a broader context.

First and foremost, the 787 program is, and will be, a tremendous program for Spirit over the decades to come.

We continue to make significant investments in the 787, and are excited about its future.

We are committed to working with our customer and our suppliers to help make the 787 a success for all.

As I discussed with you last quarter and the quarters before, bringing the 787 supply chain on line and managing the tightness in the supply base across all programs remains challenging.

As you know, we have been intensely focused on managing this aspect of the 787 for well over a year now.

The tools we have in place to manage the supply base are working and providing the information we need to manage those supply channels.

As we have said, not all of these supply lines are as healthy as we would like, but we have a good understanding of the bottlenecks, and are managing them appropriately.

There remains a great deal of work to do as we adjust and increase production on this program.

Supply-based help and the volume of engineering changes will continue to be focus areas for Spirit as we increase production.

As you would expect, we are evaluating and planning for the impact to 2008 cash flow as a result of the schedule slide.

Now, let me turn it over to Rick, who will provide more details on our financial results and outlook.

Rick?

Thanks, Jeff.

Good morning, everyone.

Slide eight summarizes our financial results for the third quarter.

Starting with revenues up 17% over the prior year period, driven primarily by higher delivery rates to Boeing and Airbus.

Operating margins improved significantly year-over-year, increasing by 170 basis points, largely due to higher unit deliveries, productivity initiatives, and lower SG&A and R&D expense.

Fully diluted EPS of $0.60 for the quarter more than doubled year-over-year, driven by the higher sales and operating margins and a lower effective tax rate.

Cash flow from operations of $42 million and capital expenditures of $69 million were in line with our expectations and reflect our continuing investment in the new 787 program and other new programs.

Despite the significant reinvestments in our core business, we continue to have a sound balance sheet and substantial liquidity available.

I'll describe all of these items in more detail in the upcoming slides.

Slide nine highlights our progress on key P&L metrics both year-over-year and sequentially versus the first two quarters of 2007.

Revenue grew 17% year-over-year and 1% sequentially over Q2.

The year-over-year growth is largely attributable to higher unit deliveries to Boeing and Airbus, as can be seen in the unit delivery chart included with the press release.

Sequential quarterly revenues were up only modestly, as no major changes in production rates occurred during the quarter.

787 revenues in the quarter were only approximately $6 million, down about $10 million from the second quarter levels.

Also during the quarter, Spirit Europe resumed shipments of A380 products to Airbus.

Operating income margins continued to expand, reaching 11% in the quarter.

This represents a 170 basis point improvement over the prior year period, largely driven by higher sales volumes, various productivity and cost reduction initiatives, and lower SG&A and R&D spending.

On a sequential quarterly basis, operating margins were up about 40 basis points, due to the $10 million of nonrecurring equity offering expenses booked in the second quarter that obviously did not recur in the third quarter.

Lastly, fully diluted EPS grew significantly year-over-year, from $0.28 in the prior year period to $0.60 this year.

This improvement is driven by the factors mentioned previously, as well as a lower effective tax rate of 21.3% recognized in the quarter.

Changes to the tax rate were driven by two closely related factors.

First was the recent filing of our first full year federal and state tax returns for 2006, and the result in favorable true-up of various tax credits.

Related to that, as a result of the '06 filing, we now project 2007 tax credits to be larger than previously estimated.

A cumulative effect of these adjustments improved YTD EPS by $0.09, $0.06 from adjusting the first six months of the year, and $0.03 for the third quarter.

Turning to slide ten, R&D expense in the third quarter was $13 million, 9% below the prior year level, as a result of the completion of the R&D phase of the 787 program, and roughly the same amount as what was expensed in the second quarter.

While the 787 R&D phase is now complete, Spirit continues to invest R&D dollars in other new programs won to date and new technology development.

SG&A expense for the quarter was $43 million, about 28% below the prior year period, primarily due to lower non-cash stock compensation expense and transition expenses.

Sequentially, SG&A was about flat with the second quarter, after consideration of the almost $10 million of equity offering expenses booked in the second quarter.

Declining absolute dollars of R&D and SG&A expense combined with rising sales, is one of the contributing factors to Spirit's improving operating margins.

Slide 11 summarizes the P&L for the third quarter YTD versus the same periods in the prior year.

During the quarter, Spirit did not recognize any net favorable changes in contact estimates as we have in prior quarters.

While we had some immaterial pluses and minuses between individual contracts and segments, the net impact for the quarter was minimal.

We have been predicting that cume catch adjustments would have a smaller impact on our results, and that seems to be happening as we get more actual costs behind us and the accuracy of our forward projections continues to improve.

Keep in mind that going forward we will continue to benefit from favorable adjustments booked in prior periods.

Third quarter of the prior year includes almost $17 million of favorable cume catch adjustments, which generated a 200 basis point improvement in gross profit in that period.

On a YTD basis, revenues are up 22%.

A portion of this growth represents the acquisition of Spirit Europe, which closed on April 1, 2006.

So the prior year and nine months includes only six months of Spirit Europe revenues.

YTD operating income and EPS are up 70% and 124% respectively, reflecting the favorable impact of revenue growth, productivity improvements, lower R&D and SG&A spending, and the lower effective tax rate in 2007.

Slide 12 summarizes the changes in our cash and debt balances during the quarter.

Cash balances at the end of the quarter of $105 million remain substantial but declined about $22 million or 17% from the second quarter levels, due to expected negative free cash flow in the quarter that I'll describe in a minute.

Total debt balances declined slightly in the quarter, due to some minor scheduled repayments.

Driven by consistent profitability, Spirit's capital structure continues to improve.

At the end of Q3, our net debt to capital ratio was 30.5%, and our net debt to projected 2007 EBITDA ratio was well below 1.

Additionally, the company continues to have just under $500 million of short-term liquidity available through our existing revolver and available cash balances.

Slide 13 details our cash flow for the nine months versus the prior year.

Operating cash flow for the quarter was $42 million, in line with our expectations, but heavily influenced by working capital increases of approximately $113 million.

The working capital increase was largely driven by inventory growth primarily for the 787, as it begins to ramp up production levels and our projected deliveries have been rescheduled.

Inventory growth includes an increase in capitalized development costs of $33 million for the quarter, including $20 million for the 787 program.

At the end of the quarter, capitalized development costs were $260 million in total, including $236 million for the 787.

Capitalized development costs for the 787 should now largely be complete.

On a YTD basis, operating cash flow was $107 million, down approximately 67% from the prior year, due largely to a reduction of $206 million in customer advances and the increase in working capital that I mentioned earlier.

Capital expenditures at $69 million for the quarter remain at high levels, as we complete the installation of production capacity for the 787 program, but were down slightly from the second quarter levels.

Approximately half of our capital expenditures YTD are for the 787 program.

Overall, the net aggregation of cash flow from operations, capital expenditures, and customer reimbursement of capital expenditures was $15 million negative in the quarter, which, when combined with the minor debt repayment drove the reduction in our cash balance from the end of the second quarter.

Moving to slide 14, here we highlight several changes in our guidance for the full year 2007, based on our YTD results and expectations for the fourth quarter.

To reiterate some of the highlights, we expect revenues between $3.9 and $4.0 billion, a decline of about $100 million from prior guidance due to the recent reschedule of 787 deliveries from 2007 into 2008.

Operating income between $415 million to $425 million is still within our prior guidance range despite the lower sales, as we expect SG&A and R&D spending for the year to be modestly lower than previous expectations.

Fully diluted EPS between $2.10 and $2.15 is up $0.15 to $0.20 from our prior guidance, largely to reflect the lower effective tax rate of 29.5% that's projected for the year.

Cash flow from operations is projected around $250 million, down $30 million from prior guidance to reflect anticipated further working capital billed largely for the 787.

For the first time, we are also providing guidance for 2008, as indicated on chart 15.

We expect 2008 revenues to be around $4.7 billion, based on publicly announced delivery schedules from Boeing and our internal forecast for Airbus and other customers.

This revenue expectation assumes the delivery of approximately 45 787 ship sets during the year.

787 deliveries above or below this level would obviously impact our total revenues accordingly.

On this revenue base, we would expect fully diluted EPS of $2.30 to $2.40 per share, assuming that our effective tax rate returns to a more normal 33% to 34% of pre-tax earnings.

The projected effective tax rate assumes that the federal research and development tax credits are available for the entire year of 2008.

I'd now like to turn it back over to Jeff for some closing comments.

Thank you, Rick.

On slide 16, I'll make a few closing comments before taking your questions.

We had a strong third quarter.

While our supply base remains challenging, we continue to execute and deliver financial results that reflect the quality of our team.

We are growing our top line and our earnings in 2008 with increased volumes across Airbus and Boeing products.

As we are executing well across the business, we continue to invest in the 787 program.

We are aligning our plan to support the customer.

This process is well underway and going smoothly.

We continue to position ourselves for new business opportunities across different market segments.

The pipeline is robust, and we expect to have successes through time.

We remain focused on executing our strategy, and are well positioned to continue our growth.

We will now be happy to take your questions.

Operator, we're ready for our first question, please.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Ronald Epstein of Merrill Lynch.

Good morning, guys.

Just a couple questions, if I can.

You mentioned how well things are going on the 787 program, Jeff.

Could you give us some more color on how the yields of the process are going and so on and so forth on the 787 manufacturing?

Sure, Ron, be glad to.

Of course, we have three pieces.

But I'll concentrate, I think, on the fuselage since that was the biggest technology jump for us, if you will on the program.

The yields are going just fine.

I mentioned that we had completed 13 barrels through the winding process.

We had analyzed where we thought the bottlenecks would be in the process and thought about that for the ability to increase rates for the future.

Those turn out to be pretty much per our plan, so we're getting the kind of yields at the rates that we had expected to get, and feel good about the processes.

And I did mention high quality yields as well.

In terms of rework on the barrels, how is that?

Very, very little.

In fact, the only reworks we've had have frankly been because we had a little bit of out of sequence work that caused some issues we had to fix.

But the base process itself is going very well.

And then a question for Rick.

When you look at the R&D spending in 2007 and we think about where it could go in 2008, do you have any thoughts on that?

Well, the way I'd characterize it, Ron, for '08 in general is we're expecting that the combination of our SG&A expense and R&D expense should be largely flat in 2008.

As you know, we expect a pretty significant decline in our stock comp expense next year, based on the amortization of the expense.

We also expect a decline in our transition expenses next year that are also incorporated in SG&A, and we have the $10 million of offering-related expenses that we booked in the second quarter that will not reoccur.

So there are a number of things in SG&A expense that are going to be coming down.

Obviously, we'll be increasing in some other areas in order to continue to support our revenue growth.

But again, the combination of SG&A and R&D, we expect to be largely flat next year.

So we would expect R&D to go up some, but how much is largely going to be driven on our success in winning some of the new programs that we're working on at the moment.

Okay.

And then just one last follow-on question, if I may.

When we think about opportunities on the horizon for Spirit, is there a list of kind of near and mid term opportunities that are public that you guys can talk about?

Well, clearly, the A350 XWB, we have talked about.

So it's out there.

I'm trying to think what else might be out there.

I think that's probably the only one we've talked about publicly at this point.

Okay.

And then, do you expect to hear anything out of Airbus anytime in the near future regarding the 350 and some decisions on suppliers, particularly for Aerostructure?

We continue to work with them, and to try to close the business case for both of us, so I think that will be an ongoing process.

So I'm not prepared at all to forecast when it would be complete.

Okay, great.

Thank you.

You bet.

Thank you.

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

Thanks, guys.

The $100 million change in guidance that was due to the 787, I guess you said.

Is that getting pushed out into next year, or how do you look at that?

I guess, is it maybe 10 aircraft that just kind of gets pushed out so your whole schedule's kind of shifted to the right, or do you think you make that up near-term?

I mean, clearly, it's pushed out of '07 into '08.

It's still unclear what the total schedule will be.

But I think the best way for you to think of it is just moving it out of '07 into '08.

Between the two years, Troy, I think at this point, given the schedules that Boeing has announced, that we would still expect to ship largely the same number of units between the two years but just move some units from '07 into '08.

Okay.

And then, just, I guess a little more clarity on the 787 deliveries in 2008.

Are those more back half weighted or should we expect those to be relatively even throughout '08, that 45 that you're talking about?

Well because -- for two factors.

I mean, clearly, the rescheduling tends to shift it.

And just the right buildup on a new program would make it back weighted.

Okay.

But it's not like you're really slowing it down in the first half and then you're really ramping up pretty quickly in the back half to kind of meet Boeing's new schedule.

It's just the overall --

There will be a slope, Troy, because of the rate build up.

And there is clearly a slide out of '07 into '08.

But it's not flat across the year, clearly.

Is the slope about the same, given the old schedule and the new schedule?

It's very similar.

Okay.

And then, one other thing.

On your Prestwick margins, can you just give us an update there?

Are you continuing to see those improve?

And when do you think you'll get to where you want to be on that business?

Well, let me answer that this way.

We don't split those out.

We have a wing segment.

We'll never be totally satisfied, to answer your second question.

But we are pleased with the wing segment margin expansion.

The team is working very diligently to implement productivity improvements and to be efficient as they possibly can.

So we continue to see opportunity across that part of our business, and like I said before, we'll never be totally satisfied.

Rick, do you want to add anything to that?

No, I'm okay.

So excluding the cume catch up, though, you should see pretty good improvement at the wing systems business?

Well, you see, because of block accounting, a lot of that is already baked in.

But we will continue to work on improvements there.

We clearly have said in prior calls and conferences that we do expect that with the wing systems margins in total will improve over the next few years, that fundamentally, there's no reason that the margins in that segment can't get to the same levels that we have in our other businesses.

Okay.

Thanks, guys.

Your next question comes from the line of Lee Rawlings of Morgan Stanley.

Good morning, guys.

Nice quarter.

Just wondering, there's been talk about the possibility of, I guess, well performing suppliers on the 787 perhaps picking up share.

Is that something that's been talked about, and if so, could you kind of walk us through the mechanics of how that would work?

I'm thinking of share from, I guess, non-performing suppliers.

We are very focused, Lee, on our piece of the airplane here, and making sure that we execute our piece of the business well.

I think our basic philosophy, as we have mentioned before publicly, is that we want all the partners on this airplane to be successful.

Because this is a challenging project, as everyone knows, and we need the whole supply chain to be successful so we can get this airplane in the air and delivered.

So we're focused on our piece of it, and focused on helping the whole program be successful.

And where we can help, we do, and we are not focused on a share grab, if you will, at this point.

We are focused on having a successful airplane.

Sure.

But I guess in supporting the entire program, that does mean working with, maybe consulting for other suppliers.

Is there (inaudible) for that?

There's been a great deal of dialogue, Lee, between the partners and with the program over the development cycle.

So a lot of cross-learning has occurred, and we remain very willing to support where we're needed and able on the program.

Sure.

One more question, if I may.

Has there been any impact whatsoever -- I guess with some of the other programs in development, 747 Advance, 777 Freighter -- as a result of the slowdown in the 787 development schedule?

None that specifically jumps to mind.

I mean, clearly, when you get an environment like we're in, resource allocation becomes an issue that you manage, and you work hard to balance all that.

But again, nothing jumps to mind that is noteworthy.

Great.

So those programs look to be on schedule, as originally foreseen?

We are supporting those programs as well to the customer schedules.

Great.

Thanks a lot.

Your next question comes from the line of George Shapiro of Citigroup Global Markets.

Good morning.

Jeff, just in general, I'm trying to reconcile.

Boeing's comments were that there's no change in the production schedule at all, and obviously, you've got a change in your production schedule with the shift of revenue.

So can you just reconcile what they're saying versus what you're saying?

Well, I think a couple things, George.

As you know, there's a lot of schedules, if you will.

There's production schedules, there's delivery schedules, there's all kinds of schedules.

And this program had an original master schedule and it had some revised schedules associated with that.

So I think the issue probably is more over which rev level was being talked than it was over major [disconnect].

Okay.

And then one for Rick.

Rick, if you go back to last year's third quarter and make the adjustments for transition costs to 787 R&D, you would have had a margin of about 11.4%, which I look at as a better comp to the 11% that you did this quarter.

Now, is that decline, then, just all due to the changing mix where you had a little 787 in there, or what else is causing it?

George, I didn't hear that you normalized for the $17 million of cume catch that was in the prior year period as well.

Because that contributed 200 basis points to gross profits that, obviously, this quarter we had no net cume catch.

So I think if you adjust for that and you adjust for the -- or recognize the declines in SG&A expense that you mentioned for stock comp and transition, I think you'll see that our margins are up nicely year-over-year.

Okay.

I'll do that.

I didn't have the cume catch in there.

I had the other charges that you had in there.

And then just a couple of specific ones you alluded to.

But could you provide kind of what your actual guidance for R&D is for '08?

We haven't provided any specific guidance, George, at this point.

It's obviously early in our budgeting process, and we could potentially provide some more color on that when we do our fourth quarter earnings release.

But at this point, we didn't feel we were in a position to provide that much granularity.

But we do feel comfortable, obviously, about our earnings range for next year.

How about the pension tailwind?

Can you provide a specific number there for '08?

I would expect it to be largely unchanged from '07.

Okay.

And then I'm assuming that you won't have any transition expenses next year?

That's correct.

They'll be very modest.

All of our transition expenses, at this point, are related to finalizing our SAP implementation, and that project will be largely complete in the first quarter of '08.

And then just one last one.

What's the status of -- the last couple of quarters you've talked about this ongoing negotiation with Boeing in terms of getting some revenue reimbursement for some of the added development that you had to do.

Has that occurred yet, or are we still in negotiation?

I think what we said last quarter continues to be true.

That is, because of all the programs that we have and as much non-recurring as we do, it's a continual process.

There is some revenues in the third quarter associated with that, and it just continues to be a process that we engage in continually.

Okay.

Thanks very much.

You bet.

Thank you.

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

Yes, thanks so much.

I joined this a little late.

How many 787s are you guys expecting to deliver in the fourth quarter, approximately?

We have delivered two to date.

What we've said is we delivered two to date, we have one -- now, we're talking about fuselage sections, Cai.

Two to date, one flight and one ground task unit.

We have another ground task unit ready to go, and we anticipate we'll deliver one more.

And then we said we are anticipating approximately 45 units next year.

Okay, great.

You mentioned that the yield is good on kind of your fuselage work.

But I know that you expect Boeing wants you to kind of integrate other people's equipment into these units and then ship them, and I assume that is one of the reasons for your slip.

And could you just bring us up to date?

How are you doing in terms of getting equipment from other suppliers, distinguishing between those you chose and those Boeing chose, and kind of expected progress on that issue?

Well, let me start by saying we accept responsibility for our supply chain.

And the choosing is a joint process, it's done in the development of the airplane, of which we have been an integral part.

So assessing responsibility there, I mean there's lots of people on that bus together.

We have a couple of areas, Cai, that we have a lot of focus on.

There's a couple of detailed part suppliers for structure that we had been feeding hand to mouth and was sufficient to meet the schedules prior to their slide, but need continual development.

And then there's some of the systems elements that we need that are moving not quite as rapidly as we would like to.

There was some later definition on those.

And probably wiring is, as it always is, is the final one to fall into place.

One thing I would say is when we get things, it all fits.

It fits together really well.

So the design process, the integration, has been solid, and as we work through these issues, I think this airplane's going to go together really well.

So when you ship your units to Boeing, are they fully stuffed with all the items you were expected to put in them, or are some of them going to Boeing to have some of that work done on a traveled basis?

There was more travel work on the initial.

The ground task units are fully completed, and we anticipate a very high percentage here on out.

When will you get to 100%?

Well, every once in a while, we have to ship a current airplane with something that needs to travel.

Very seldom.

You know, it's going to take a while to get there, but that's not at all uncommon.

Thank you very much.

You bet, Cai.

Thank you.

Your next question comes from the line of Robert Stallard of Banc of America Securities.

First I was going to ask you about your blocker guarantee.

Your cumulative catch ups have clearly been a very lumpy item over the last 12 to 18 months.

Have you got any visibility of when you expect to see a major calculation on your program block sizes coming up?

I don't think we'll be having any significant changes in our block sizes for the foreseeable future.

I think we committed very early on that we would maintain our block sizes absent any really significant change, and we're not aware of any.

So right now, our current blocks extend -- it varies somewhat by contract, but right now, our current blocks extend somewhere through the middle of 2009.

So I would think that would be really the next major change that you'll see, is when we transition from -- potentially could see as we transition from our current blocks to our new blocks.

But I don't really see anything between now and then.

Because, Rick, I imagine that Boeing will be giving their updated '09 production forecast in January.

Might that be an opportunity for you to revise in your forecast?

Well, I think the we've thought about it, Rob, is we've said we -- one of the variables that we wanted to eliminate from contract accounting for us is the change in contract blocks.

So I thought we had said pretty early that we would maintain the number of units within our blocks and we would not be changing them.

So if there were to be higher production rates going forward, I think all that would mean is that we would come to the end of our current block faster than we had anticipated.

At this point, I don't see us changing our current block sizes.

Okay.

And you mentioned that you're starting to see A380 picking up.

How do you expect that to accelerate over the next, say, six months?

Well, clearly, we'll see production rate increases.

I mean, Airbus has indicated that they want to go to the neighborhood of three to four months over the near-term, so obviously, our production rates and shipments would match that output.

Did you ship any, a couple of sets or something?

We shipped two in the third quarter.

Right.

I see.

Okay, thank you.

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

Good morning, guys.

Just to go back to 787 again.

You've talked about a slope in the production ramp.

But at this stage, both with you and with Boeing and everybody else, we're talking about very small numbers of aircraft moving around.

And then there's this expectation that all of a sudden, tens of airplanes are going to start delivering next year.

And clearly, there's skepticism with regard to that.

Do you look at the 45 aircraft for 2008 as a base case scenario?

Is it a best case scenario, is it on the low end?

How should we think about that?

It's our base case scenario, Rob.

Do you think, Jeff, you could actually exceed that?

Well, we've said approximately.

Okay.

And then Rick, with regard to the tax rate moving around, and I thought it was a reasonably large change.

You're back to a more normalized number for next year.

Why does it go back so significantly?

Is there some conservatism in that number?

As I mentioned, the change that we booked in the third quarter really had two pieces of it.

One was a true-up for the 2006 tax returns.

So that part of the reserve change that we had in the third quarter, that part of it is about $5 million.

And that's obviously one time in nature and looking backwards to 2006.

The other credits, the improvement for 2007, just relates to, based on the '06 returns, reassessing the level of tax credits that we're going to get in 2007 and our current forecast for the effective tax rate represents that.

To the extent that that could have some potential favorable benefit on future tax rates, that's certainly entirely possible.

But at this point, we think that the 33% to 34% rate for 2008, which, as you rightfully point out, is more of our normal tax rate, that that would still be appropriate for that year.

Okay.

Going back to something that came up last quarter, fuselage growth.

Clearly, a lower growth rate than the other two segments, again for the second quarter in a row.

I think last quarter you talked about timing.

How should we think about that business and the growth rates?

The first quarter was a high number, well into the double digits, and then high single digits the last couple quarters.

I think if you look at our fuselage revenues, they obviously follow very closely with our deliveries to Boeing.

And if you look at the charts there that we provided with the press release, you could see that we actually delivered a couple of units low -- fewer in Q3 versus Q2.

And that has a direct impact on the fuselage business.

We didn't see it as much on the propulsion business, you actually saw propulsion go up a little bit.

Jeff mentioned that we did book some nonrecurring revenue in the third quarter, and most of that was centered within the propulsion business.

So it actually had some revenue growth.

It didn't quite follow the number of units that we shipped to Boeing.

And then wing systems, obviously, has a different dynamic because of the inclusion of the Airbus business with Spirit Europe which, as we've said, is about half of the business within wing systems.

Okay.

And then, just last.

You've talked about the P8 a bit today in the slides and in the press release.

But that's always been embedded in the forecast, right?

The P8 has always been in our forecast.

The P8A?

The Poseidon.

Yes.

That's in our forecast.

And that program actually is in development now.

A lot of those deliveries are outside our forecast range at this point.

Right.

So in other words, it's talked about.

I think some folks looked at that announcement as being incremental, but it's 737, essentially.

You've been on that program the whole time.

We have been involved in that the whole time.

We have done it as a sub, if you will, and now join that team as one of the partners on the team.

I see.

Thanks guys.

Thank you.

Your next question comes from the line of Richard Safran of Goldman Sachs.

Good morning.

Just staying on 787 for a second.

I know one thing that's looked at with new programs is engineering changes.

So I just wanted to know if you were able to comment on, number one, how impactful a change is it at this point, engineering changes at this point in the program.

And then second, if you could just put this in context in terms of how they've been relative to other programs?

Sure, Rich.

The first point is, clearly, the later you are in a program, the more impact an engineering change can have.

So we work very closely with the customer to minimize engineering change.

Every program has it, so we expect it, we plan for it, we hope for those to diminish as soon as possible.

And I apologize, but I do not have the data you asked for in terms of comparison to previous.

That's okay.

In general, though, would you say, it's been (inaudible) more or less than anything previously?

I really couldn't at this point.

I have to tell you though, Rich, in the middle of it, all of them feel like you'd like it to be a lot less.

But the point it, that it always happens in the program and now is the point where you really begin to squeeze and do your best to minimize it.

Okay.

Thanks a lot.

You bet.

Thank you.

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

Good morning.

Thanks.

Rick, could you just talk -- you didn't give cash flow guidance for 2008, but could you just talk about some of the moving pieces there, depending on whether 787 comes in on the revised schedule or not?

I think you've identified the major variable, David, and that's the 787.

Also, you get other variables like other new programs.

Jeff mentioned the A350 XWB potential, and there's some other things that we're working on that we've not been able to talk about publicly.

So we just felt at this point that there were too many variables to provide reasonable cash flow guidance for 2008 at this point.

But we do expect to provide that guidance in conjunction with our fourth quarter earnings release.

I guess maybe some of the moving pieces within, specifically, on 787.

Obviously, inventory, how you pay Boeing back for the advance, all those things.

How do those things kind of move?

They all do move, obviously.

But probably the single largest impact is the impact of the slide and certification.

As you know, our payment stream is tied to the airplanes being certified, and with the movement of that certification day to later in the year, that obviously has an impact on our cash flows.

As we've said, were discussing that situation with Boeing, as I'm sure other partners are as well.

And how that will be resolved, obviously, will have an impact on our '08 cash flow.

That's just another one of the variables that, at this point, our crystal ball isn't clear enough to determine how that's going to sort out.

Okay.

And then on operating margins.

You raised your guidance for '07.

But is that just because you basically slipped out some lower margin 787 deliveries, or is it actually underlying operating improvement in there that you weren't expecting?

I think it's a little bit of both, David.

Clearly, the slide out of the 87, we've said that that business has lower margins than our legacy business, so that would improve the percentage margins.

But also, you notice that we lowered the range a little bit on where we expect it to be on R&D expense and SG&A expense.

And that's coming primarily from real operating savings and some expenses that we'd expected that don't look like they're going to materialize.

So that obviously is real margin and proven.

Okay.

And the, even in looking with the revised guidance on SG&A, it looks like SG&A is going to move up pretty significantly in the fourth quarter relative to kind of the (inaudible) in the second and third quarter.

Is there anything -- I know your sales will be higher, but is there anything else going on there?

Nothing specifically.

It's just continuing to build out our organization to support higher levels of sales in the future.

Okay.

But then in '08 those levels are going to come down, and that's just because of transition expenses are going away on some other things?

That's right.

Because in '08, there's really three major elements in our SG&A expense that are significant in '07.

And those are stock comp, non cash stock compensation expense.

It's the almost $10 million of expense we had in relation to our follow-on offering in May, and then it's transition expenses.

All three of those will be significantly lower.

The follow-on expenses, obviously, would not reoccur unless we did another offering.

Transition expenses, as we said earlier, will be largely complete, and stock comp will go down significantly because of the vesting schedule for those expenses.

So that will, all by itself, will drive SG&A to lower levels in '08.

And we expect the core SG&A, so the people and the support staff would increase again to support higher revenues in the future.

And we do, as I said earlier, we do expect some increase in R&D expense as well.

But between the two of them, we're thinking that '08 will be largely flat with '07.

Okay.

And one last one.

You said capitalized development costs as far as 787 are basically done at this point.

So you're assuming no additional 787 spending, even though the schedule slipped out six months?

Well, at this point, all the spending relates to building the production units.

So all of those get wrapped up into our normal contract costs.

It's not really pre-development anymore, pre-production costs, they're really normal production costs at this point.

Okay.

Thank you.

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

Your final question comes from the line of Carter Copeland of Lehman Brothers.

Good morning, guys.

I wanted to ask Lee's question another way, but have you seen any incremental revenues, or do you expect to see any incremental revenues as a result of supporting the program, as you put it?

Regarding share?

Yes.

So if it's the case that other suppliers are not pulling their weight and you're coming in there, you talked about, obviously conversations, and you guys have been sharing information all along.

But is there real business tied to this, or is it just information?

At this point, it's just information.

Okay.

I wondered, Jeff, if you could tell us just a little bit about 787, and I know we've hit on this in a couple of different ways, but is there a point where you're constrained in your factory by a lack of space at the Boeing [fal], or how many units can you store before you become sort of tool constrained?

We have looked at all the plans and the schedules that we're planning on for the rest of this year and next year, and we're fine in that regard.

So you can store a number of units and it's not a -- I guess what I'm getting at is, it's not a more aggressive ramp in the back half of '08?

Is it more or less aggressive than what you were thinking prior to the delay?

I think it's pretty close to what we were thinking.

Well, clearly, it's got to be more aggressive, because we're delaying some shipments.

But we work very closely with the program to make sure that we take all those things into account.

How fast you have to ramp, how many you'd have to hold, what the working capital build is, all those things.

So at this point in time, we think we have a plan that fits all those together.

Great.

I notice you said you delivered to 787s, but the documentation says one.

Do you not count the static test unit as a (inaudible)?

Well, actually, Carter, we worked hard to make sure we were clear on that, because there is a little bit of ambiguity there.

Clearly, there are units for us, they're full structure --

And they're revenue, right?

They are not revenue, that's the key.

The ground test units are not revenue for us.

It's only the flight test units that are revenue.

So they become, probably, capitalized development, is what you're saying?

Well, they're part of the contract costs.

Okay.

Rick, a couple of quick ones for you.

I know you didn't have any cume catches in the quarter, but did you make changes in either direction to your 787 block margins as a result of the delay?

Just some very minor tweaks.

But again, we've recognized very little revenue on the 787, so you wouldn't really expect to see any significant cume catch.

Well, you don't have any cost difference, but presumably, if the same number of units stretched out over a longer period of time, then you could have overheads that were different.

Absolutely.

But that would manifest itself in higher or lower margins on future shipments.

Cume catch is only related to revenues that --

No, I'm talking about the assumed margins, not what you actually would recognize in the quarter.

No.

They were largely unchanged, that's because they were relatively low to begin with.

Okay.

And if you were to adjust not 787, but if you were to adjust the timeline of existing blocks, not the block sizes, would that occur at the time that Boeing is delivering guidance in January?

Is that roughly when you do that sort of evaluation?

I'm not sure I understand your question, Carter.

We've set our block size for 500 units for the 787, and we will stay with that block size.

No, no.

For non-787.

So for the other programs where you have existing block sizes that, when you answered Rob's question, run somewhere in the mid 09.

If the rates were to change and you were to adjust the timeline of those blocks, not the block size --

I understand.

No, theoretically, to the extent that you're pushing more absorption, more hours into '08 and '09, all other things being equal, that would have a favorable impact on your profitability.

Of course.

But when is the time that that happens?

Does that normally happen around --

We update all of our contract estimates every quarter.

So if there was a change that we became aware of within the fourth quarter, that would be reflected in our fourth quarter [miex].

Okay, great.

Thank you very much, guys.

Thank you.

Thank you, Carter.

Operator, that concludes our call.

Thank you.