Spirit AeroSystems Holdings Inc (SPR) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Spirit AeroSystems Holdings earnings conference call.

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).

As a reminder, this conference is being recorded for replay purposes.

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 second quarter 2008 earnings call.

I'm Phil Anderson, and with the 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.

Before we begin, I need to remind you that any projections or goals we may include 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 statement the end of today's press release and web presentation.

As a reminder, you can follow today's broadcast and slide presentation on our website at SpiritAero.com.

I would now like to turn the presentation over to Jeff Turner.

Thank you, Phil, and good morning.

Let me welcome you to our second quarter earnings call.

I'll began on slide two.

We continued to execute well across the Company during the second quarter.

Our results reflect improving performance and increasing backlog as both revenues and profitability increased year over year and our backlog grew to almost $30 billion.

Our revenues were $1.1 billion, an increase of 11% over the same time period of 2007.

We achieved this top-line growth as volumes increased in all segments.

Operating performance was solid across the Company as we expanded our core product operating margins from 10.6% to 12.8% as improved operating efficiencies in the factory and lower period expenses were realized.

Earnings increased 27% to $0.62 per share, up from $0.49 a year ago.

Our cash flow from operations was positive during the quarter as we continued to implement our strategy, reinvesting in development programs to grow the business.

Our core businesses continue to perform well and deliver solid financial results, as expected.

While executing our core business during the quarter, we rebalanced the 787 program to the revised customer production schedule and continued to support engineering changes in customer deliveries.

We made solid progress on our large commercial aircraft, business jet and military development programs, and we expanded our presence in the large commercial aircraft market with wins on the A350 XWB.

Concurrent with our announcement on winning the center fuselage design and manufacturing work on the A350 XWB, we also announced Spirit's expansion of US operations into the state of North Carolina.

We're excited to have the opportunity to build a world-class facility that will initially support the A350 XWB program.

The facility will also serve as an important base for future growth.

We had a successful first half of 2008 and expect to maintain that momentum into the second half of the year.

However, we do remain mindful of the challenges facing airline customers both domestically and internationally as they cope with the economic realities of significantly higher fuel prices.

Let's talk about some of the specific accomplishments across the business during the quarter, beginning on slide three.

Fuselage systems delivered strong operating margins of 18.7% on almost $500 million in revenue during the second quarter of '08.

The Fuselage segment delivered the 2700th 737 next-generation fuselage, delivered the second 777 freighter forward fuselage, began major assembly on the first 747-8 freighter and the delivered the second P-8A aircraft to Boeing.

The team continues to execute well across programs while making good progress on development programs.

On slide four, you see the propulsion team increased revenue from the year-ago quarter and delivered solid 16.6% operating margins.

The team made good progress on development programs, delivering the first inlet and thrust reverser test units for the Rolls-Royce BR725 engine.

This is the engine that will be used on the Gulfstream G650 business jet.

The team also made good progress on the 747-8 and the P-8A programs.

On slide five, the Wing System segment also increased revenues and operating margins during the quarter as volumes increased, primarily on Boeing and Airbus products.

The Wing segment team continued progress on development programs, including the 747-8, the Gulfstream G650 and the Cessna Columbus Empennage.

The establishment of a Spirit Europe MRO service center and our new Spirit Malaysia facilities on track.

Recently, the Wing Systems team won new business on the A350 XWB.

There will be designing and building the wing fixed leading edges.

Not let me turn to slide six and discuss the 787.

Last quarter I told you we had three areas of focus which I would like to update you on.

The first area of focus was to rebalance our 787 resources.

We completed this effort during the quarter by realigning supply base schedules, our internal staffing as well as replanning capital and tooling investments.

However, inventories grew as we adjusted to the revised production and delivery schedules announced early in the second quarter.

The second area of focus was to continue to support required program engineering changes.

This is a work in progress.

We continue to work closely with our customer to incorporate the necessary engineering changes for the program.

The third area of focus was to maintain efficiencies at a slower production rate.

As you know, prior to receiving the revised schedule, Spirit had 22 composite forward fuselage sections in work to support the original program schedule.

Through the end of the second quarter 2008 we have delivered three forward fuselage units in support of those revised schedules.

The remaining 19 units are in process at a reduced production rate with our efforts primarily focused on systems installation and incorporation of engineering changes into units for and subsequent units.

While we have temporarily suspended composite fabrication of additional forward fuselage sections, we're intensely focused on finding ways to improve efficiencies that can be realized when we resume the fabrication process later this year.

We will continue to update you on our progress as we go through the second half of 2008.

Let's turn to slide seven, and I'll briefly discuss our latest wins on the A350 XWB.

We are pleased to have been selected for our role on this new Airbus wide-body aircraft.

The market acceptance of the A350 XWB family has been very good with 470 orders from 28 customers to date.

This aircraft will serve airlines' future needs for the 270 to 350-passenger aircraft as well as bringing freighter capacity into the industry.

Our role on the A350 XWB is to design and produce the composite center section of the fuselage and the composite fixed leading edges of the wings.

Both of these products fit Spirit's core competencies and capabilities.

Spirit's technical capabilities and shared investment in the development effort will deliver value to our customer and shareholders for decades to come.

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

Good morning, everyone.

Slide nine summarizes our financial results for the second quarter, starting with revenues up 11% over the prior year period, driven primarily by higher delivery rates to Boeing.

Operating profit at $136 million was up 33% as margins improved significantly year over year increasing by 220 basis points.

This improvement is largely due to higher unit deliveries, productivity initiatives and lower SG&A and R&D spending.

Fully diluted earnings per share of $0.62 for the quarter were 27% higher than earnings of $0.49 per share in the prior-year period, largely due to higher sales and improving operating margins.

Cash flow from operations of $7 million and capital expenditures of $54 million for the quarter reflect our continuing investment in the 787 program and other new programs as well as revised 787 payment terms.

Slide 10 highlights our progression on key P&L metrics over the trailing four quarters.

Second-quarter revenue grew 11% year over year and 3% sequentially over Q1, both largely attributable to higher unit deliveries to Boeing, as can be seen in the unit delivery chart included with the press release.

Total 787 revenues in the quarter were approximately $17 million, about the same as Q1, as we delivered one forward fuselage unit in both periods.

Operating income margins were 12.8% in the quarter, 220 basis points above the prior-year period.

On a sequential quarterly basis operating margins were up about 20 basis points due to the benefits of higher volume and a slightly higher favorable cum catch adjustment in Q2.

Lastly, second-quarter fully diluted EPS of $0.62 grew significantly over the prior-year period, due to the improving operating margins.

Our effective tax rate of 33.9% in the current quarter was slightly higher than both the prior-year period and the first quarter.

Sequentially, EPS was up $0.01 or 2% from Q1, driven largely by higher revenues.

R&D expense in the second quarter was $11 million, 23% below the prior-year period, as we completed the R&D phase for several of our non-787-related new programs.

Sequentially, R&D spending was about flat with the first quarter.

SG&A expense for the quarter was $41 million, about 25% below the prior-year period.

Reduction is primarily due to lower non-cash stock compensation expense, lower transition expenses and the absence of almost $10 million of expenses recognized in the prior-year period related to our secondary offering.

Spending for various transition activities was largely complete in the first half of 2007.

Sequentially, SG&A was up slightly from the first quarter, in line with our expectations.

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.

In the aggregate, SG&A and R&D declined from 7.1% of sales in the second quarter of '07 to 4.9% in the second quarter of '08, a 220-basis point improvement in operating margins.

Even excluding the secondary offering expenses in the prior year, lower SG&A and R&D spending improved operating margins by 130 basis points.

Slide 12 summarizes the P&L for the second quarter versus the same period in the prior year.

During the quarter, Spirit realized approximately $4 million of net favorable changes in contract estimates, slightly above the $2 million recognized in the first quarter of 2008.

Most of the current-period benefit was realized in the Fuselage segment due to continuing productivity issues more than offsetting upward pressure on material costs.

Prior-year period included approximately $3 million of favorable cum catch adjustments, largely recognized within our Propulsion Systems segment.

Embedded in the second quarter cum catch was a small negative adjustment for the 787 reflecting continuing cost pressure and therefore lower profitability on this program.

The 787 will continue to be a significant watch item for Spirit, but to date we have been able to successfully mitigate the impact of the recent schedule slides.

Slide 13 summarizes the changes in our cash and debt balances during the quarter.

Cash balances at the end of the quarter of $147 million decreased $56 million or 28% from the prior-year period -- prior-year quarter end, largely due to the repayment of $75 million of revolver debt during the first week of the second quarter.

Total debt balances decreased by $72 million in the quarter due to the same $75 million revolver repayment.

Driven by consistent profitability and growing shareholders equity, Spirit's capital structure continues to improve.

At the end of the second quarter our net debt to capital ratio was under 24% versus 27% at year end 2007, and our net debt to 2008 EBITDA ratio was well below 1.

Additionally, at the end of the second quarter the Company had over $790 million of short-term liquidity available through our revolving credit agreements and available cash balances, which we continue to believe is fully adequate to fund projected cash flow needs.

Slide 14 details our cash flow for the first six months of 2008 versus the same prior-year period.

Cash flow from operations for the first half was positive $78 million as higher customer advanced payments and improving profitability offset further working capital growth.

The working capital build was largely driven by the reschedule of 787 deliveries and spending for other new programs, including the 747-8.

Inventory growth includes an increase in capitalized development costs of $33 million for the quarter, entirely for new programs unrelated to the 787.

At the end of the quarter, capitalized development costs were a total of $334 million, including $237 million for the 787.

Capitalized development costs for the 787 were largely completed in the third quarter of 2007.

Included in cash flow from operations for the second quarter are cash tax payments of approximately $82 million, a level well above the tax provision for the quarter and amounts paid in the first quarter due entirely to timing.

For the year, Spirit expects cash tax payments to approximate the tax provision.

Capital expenditures of $119 million in the first half were down 25% from the prior-year period as the installation of production capacity for the 787-8 program is winding down.

Chart 15 details our updated 2008 guidance for revenue, fully diluted earnings per share and cash flow, which includes our current estimates for 787 deliveries to Boeing.

We project 2008 revenues to be around $4.4 billion and fully diluted EPS of $2.35 to $2.45 on this revenue base, assuming an effective tax rate of approximately 33% of pre-tax earnings.

The projected effective tax rate assumes federal research and development tax credits are available for the entire year, although no benefit has been recorded in the year-to-date results.

Our EPS guidance range has been increased by $0.10 to reflect our performance in the first half of 2008.

Our guidance for 2008 cash flow items remains unchanged from the prior quarter.

We expect cash flow from operations of $400 million, capital expenditures of $275 million and capital reimbursement of $116 million.

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

I'll wrap up on slide 16 with a few brief comments.

We had a solid second quarter and first half of 2008 and expect a solid second half of '08.

The core business continues to perform well, delivering top-line growth and increased profitability.

While we are paying close attention to the current market dynamics, we expect the near-term deliveries and the long-term market to remain strong.

Our continuous focus is on meeting our customer commitments while growing and diversifying our business.

We will now be glad to take your questions.

(OPERATOR INSTRUCTIONS) Ron Epstein, Merrill Lynch.

Jeff, if Boeing were to have a strike, how does that flow through for you guys?

If there was a work stoppage in Seattle, what happens to Spirit?

Well, clearly, any interruption in the production line is something that we would obviously prefer not to see.

What we would do is we would negotiate the process, determine what production needed to continue and what might need to be curtailed somewhat.

We actually had a similar situation three years ago and really worked through it fairly effectively.

Clearly, it would have some impact.

But it's too early to tell, and hopefully there won't be one.

Year over year, the margin performance, the gains were very good.

As we look forward, where can we expect to find more places for you to find more execution enhancement?

Well, certainly you've seen for a number of quarters that we continue to have small favorable cum catch adjustments and those are obviously indicative of improving performance in our overall cost structure, but specifically in our various productivity initiatives in the shop.

We continue to work very hard at those and don't see any reason at this point why they can't continue.

In the near-term, probably the biggest impact on margins will be the introduction of higher deliveries on the 787 program.

As you recall, we've been very specific that our margins on the 787 are lower than our legacy programs.

So, as we start to generate higher overall '87 revenues, that will create some downward bias on our total company margins.

Do you expect in the second half of '09, when you guys reset your blocks on the legacy programs, that that could mitigate some of that?

I'd say at this point it's probably too early to tell.

Some of our blocks do start to mature at the end of 2009 so the tail end of 2009 will start to reflect some impact from our new contract blocks, and we will certainly fully reflect that in the guidance that we provide in '09 when we do that in conjunction with our third-quarter earnings release.

Troy Lahr, Stifel Nicolaus.

Could you guys just tell me how much confidence you have in your full-year outlook for revenues, $4.4 billion?

I guess the first half growth was around 9.7%.

It looks like you're going to need to do 18% in the back part of the year to get to that.

Can you tell us what's going on?

Is that just 787 starting to pick back up?

There is certainly 787 pickup in that.

There's also some nonproduction components of our revenue forecast.

Can you -- like nonproduction on what?

Can you be a little more specific?

It would be some nonrecurring billings for some of our development work.

For some of our new programs.

So, you are still pretty confident in that, then?

Yes.

And then on 787, the engineering changes that you said you'd talk about, you've been working through that -- has the pace on those slowed down?

Or, is it still pretty good volume coming through on for engineering changes?

There's still some significant volume, but we have seen some reduction in that.

Clearly, for the earlier units, those are very much getting cleaned up.

So it's volume beyond what I think any of us would want, but we're seeing some mitigation to that.

When do you think that that becomes less of a concern for you guys?

Is that like a third-quarter or fourth quarter issue, or more like 2009?

I suspect it will be out a little bit.

George Shapiro, Citigroup.

Rick, I want to look at cash flow for a minute.

You had another $150 million build in inventory in the second quarter, and yet when we were out there it sure didn't look like you are doing a lot of work, as Jeff was alluding to, on the 787.

So what caused that much inventory build again?

Well, certainly the 787 is the largest individual component.

As you look at the inventory build by program, it's certainly the largest individual component.

And it's really the result of the reschedules that took place right at the beginning of the quarter.

While our folks have done a tremendous effort to mitigate the impact of the reschedules, it's very hard to shut off all of that incoming inventory build.

And frankly, all of it you don't want to shut off because the program is going to ramp up here over the course of the near-term.

So there's still some 787 build.

We fully expected to mitigate, though.

As we've said, at the end of the first quarter, we looked at working capital in the aggregate, and we had a pretty substantial increase in working capital for the first quarter, over $200 million.

At that time we said we didn't expect that the increase in total working capital would be that much again for the last three months.

We still believe that to be the case, at this point.

So you are going to see inventory growth moderate in the second half.

We also tend to get favorable performance in our accounts receivable in the second half.

Typically, our year-end is the low point for receivables for us, as you saw in 2007.

But we'll have a build down of accounts receivable in the second half that will also contribute to some positive cash flow.

So at this point, I think we still feel confident in our cash flow guidance for the year, even though we recognize that is somewhat back-end loaded.

Yes, because it implies roughly that you've got to have an $85 million or so decline in working capital in the second half to be able to get to the $400 million number.

That's right, and again, good chunk of that will come from accounts receivable.

And again, we expect inventory growth to moderate in the second half.

And it looked like, based on just looking at the advances, that probably got about another $100,000 from Boeing as part of the rescheduling plan for the 787 in the quarter.

That's about right, George.

You commented on 787 was a little bit of a negative in the quarter.

Are you guys just managing that much better than Boeing at this point?

Because they had to recognize, I'm sure you're aware, the extra allocation to the other programs where, I guess, at this point you're still okay although monitoring what's going on -- is that the best read?

The way I would describe it, George, is we went through a very extensive process in conjunction with our first-quarter close of ascertaining what the impact would be of the scheduled slides, not only on the 787 but of all of our programs and what mitigating actions the Company would have to take in order to minimize the impact.

That was fully reflect already in our first quarter results.

We've obviously refined those numbers in the second quarter as we have a better understanding of what the schedule is going to look like in the near-term.

That did result and a slightly negative cum catch adjustment on the 787.

But I think, overall, we dealt with those issues in the first quarter, updated our assessments in the second quarter.

And at this point, we still feel that it's manageable.

Robert Stallard.

MacQuarrie Securities.

Rick, I was just wondering if you could just touch on the unallocated SG&A and R&D.

As you've said, you've seen R&D trade off a bit this second quarter.

What should we expect for the rest of the year in this area?

Well, you used the term unallocated.

For us, almost all of our R&D is allocated to the segment.

So we have very little unallocated R&D by itself.

Most of our SG&A is not allocated to the segment, so it kind of goes the other way.

But as we look at both of those items, I think we see some moderate growth in both R&D and SG&A in the second half.

As the business continues to expand and some of our new programs are coming online, we're building up our new facilities in Malaysia and North Carolina.

That will contribute to some growth in SG&A.

R&D -- I think we'll see some modest growth there in the second half, again, driven by some of our other new programs that are coming online.

But at this point, as we've said earlier in our investor conference, we do see that growth in R&D and SG&A moderating and that's probably the largest contributor to the increase in our guidance for 2008, is the fact that we do see that spending being a little bit below what our earlier expectations were.

Do you expect that trend line of SG&A date maybe leveling off or coming down to continue into '09 and beyond?

Well, a lot of the SG&A, the decline has been driven by our non-cash stock compensation expense, the recognition of that expense.

That expense has been declining for several years now, and it will continue to decline into 2009.

We do expect, on the other side of just what we would consider our normal operating SG&A, we do expect to see some growth in that in 2009 as, again, the business continues to build and some of our new programs come online.

We'll obviously talk in more detail about that when we release our guidance for 2009 in the third quarter.

But I would say, you can expect to continue to see tight expense control in this category from us.

Jeff, you mentioned the progress you had in winning different contracts in different areas of Aerospace.

But if you look forward conceptually, do you expect the proportion of your revenues to shift that much, say, in 2009 or 2010, from what you expect in 2008?

No, not so much that early on.

'09 and '10 are pretty much the production programs that we have now.

But I think, as you go through time, you'll see the impact of all these programs we have been winning, as those programs finish up development and then move into production.

So you're still like 80%-odd Boeing OEM?

Yes.

Rob Spingarn, Credit Suisse.

Just really following up on what George was talking about, is it fair to say the kinds of expenses that Boeing saw in the quarter, the unabsorbed 787 -- at least a portion of that was more customer oriented?

These are expenses you generally wouldn't have, to begin with?

We really don't have insight into -- any more than you do, into what was driving that.

Clearly, we've looked at ours and been as forthright and transparent as we can possibly be.

So clearly, there's dynamics on the whole airplane and with the customers that they have that we don't.

But I can't really answer that.

On the 787 schedule, Rick, could you talk a little bit more about -- this has already been touched on -- but the inflows and outflows with regard to cash on the advances in inventory side?

If I understood the settlement with Boeing on the cash, you're being paid according to the original delivery schedule -- is that correct?

That's correct.

Okay, but you're building inventory at a slower schedule?

That's also correct.

So how should we think about this in terms of unit numbers and advances versus inventory build?

Well, the advances are reflected in their own balance sheet accounts, in both the balance sheet and in our cash flow accounts.

So the advances themselves do not impact the inventory balance.

Understood, understood.

But, you might expect them to track a little bit more evenly or at least the advances, to me, might outweigh the inventory build.

Yes.

I would say, Rob -- I wouldn't think of the two of them as being linked.

The additional advances that we got in 2008 from Boeing, of which we've seen the impact for the first six months already -- those were driven by an agreement to go back to the very original schedule, which was a number of years old now.

Obviously, our inventory build today is based on a schedule that is relatively new to us.

So I wouldn't look at the two things as being linked.

Is it fair to say that advances will continue at about a flat rate for the second half of the year, as the first half?

We will continue to see advances in the second half of the year, but perhaps not to the degree that we've seen in the first half, but on that order.

I'm just thinking about -- when we contemplate the original schedule, I think you would have been at rate for most of 2008, if not all.

That's right, but we would have started being paid for our deliveries already, effective May '08, was the original schedule.

Right.

But of course, there would have been a buildup in inventory there, so a fair amount of delivery right at that front end.

That's exactly right.

The only clarification I would make here is that when you say we would be up to rate, we would be marching through a rate increase cycle.

So it wouldn't have been a specific rate, but it would have been at escalating rates.

Okay, with the back end of the year at a higher rate than the front end?

Yes, clearly.

Okay.

And then, talking about rate and the number of aircraft delivered, line number four obviously had some issues, not necessarily with you.

But notwithstanding that, that aircraft got slowed down.

I had hoped that we would have all the test aircraft delivered or in Seattle in final assembly at this point.

When should that happen?

I don't have that schedule.

I think that's one for Pat and his team to --

I'm talking about your Section 41.

Well, I think -- our view is we've got number four here waiting on the pull and others in the line right behind it.

So we'll be prepared to support the pull.

And Pat seemed to suggest at Farnborough that five and six looked really good, very close to 100%.

Yes.

From our perspective, four, five and six -- they all but great.

The only other thing I would ask, I guess Rick, this is for you.

On the A350 contract, can you talk a little bit more about the structure in terms of non-Spirit R&D and CapEx?

Well, when we announced the win on the Section 15, you might recall we had a short presentation that went with that, that indicated that the total spending for everything was about $700 million.

And that includes facilities and design engineering, tooling, capital -- all of that was about $700 million, and that that total would be roughly equally split between the three parties, so between ourselves, our customer and by other third parties.

Again, the new win that we just had on the leading edge, the spending level for that is not as great as the Section 15, and the financing arrangements are roughly similar to what we have there.

Dana Merber, GMP Securities.

Just a question again, Rick, on the guidance that you provided, or at least the increased guidance.

I'm just trying to get a handle specifically on what is accounting for this guidance, this increase.

I think you talked in your initial comments about the bulk of it being related to the first half of the year being maybe better than your internal projections.

But then I think you went on to say that the G&A and maybe the R&D was a little bit lower than what you had originally projected.

So can you, in as much detail, kind of break down where that $0.10 increase comes from?

Is it more first half?

Is it more better second half outlook?

Without getting to specific, as I said, the primary drivers are lower levels of SG&A and R&D for the year than we expected.

But certainly contributing as well are higher revenues.

You saw, our guidance is $4.4 billion.

We did $2.1 billion in the first half, so that implies that we would have a couple hundred million more revenues in the second half.

And that certainly will drive some additional income.

And on net revenues, we expect to have a little bit better margins than we expected.

So you saw small favorable cum catches in both Q1 and Q2.

Those obviously have a forward impact as well.

So they not only represent higher profitability for revenues that we've already recognized, but reflect higher profitabilities for future revenues as well.

So you're getting some impact from that.

But I would say, the bigger impact is more in the SG&A and R&D areas.

We had expected the ramp-up there to potentially be a little stronger than what we're seeing.

Howard Rubel, Jefferies.

Just to follow on the SG&A theme for a moment, is this like a new permanent level that you might very well see?

Have you been able to structurally reengineer the Corporation to get some operating leverage out of the business as a result?

Well, I think we've talked consistently about some lumpiness in those accounts, the R&D account, and the SG&A, I think you'll see pretty well the effect of our expense control.

We don't see a lot of -- absent some unknown event at the moment, but we don't see any big change in that.

We continue to be very aggressive in managing that account.

R&D will move a little bit, as we said.

I'm not worried about R&D.

I'm sympathetic to -- its program driven.

But what I'm seeing --

I would just say it's just fundamental blocking and tackling on controlling expenses.

And again, it doesn't just apply to SG&A, it applies to all of our overhead functions that we're been very cautious, given the market environment that we have today.

We are being very cautious about adding additional headcount, additional expense across the board.

No, I think that's terrific.

The second question that I have is, could you update us a little bit on some of the other development programs and where you stand; for example, the 747?

And you did highlight what you are doing on the G650.

How are those things coming in versus what you thought, and are there some additional opportunities out there?

Let me answer the second part first.

There are some additional opportunities, although, as I'm sure you can appreciate with the 350 and some of the things that we have won, there's a lot of the opportunities that have been turned into new business.

There remain a few opportunities in regional jet and business jet and some longer-term things that we're looking at.

Development programs across the board, as you know, are challenging.

The 650 -- I'll talk about it first.

We are at this stage of that program where we are at the maximum burn for engineering relief and getting the engineering drawings out into the manufacturing part, and that's really a mixed bag.

We have some areas that are going well.

We have some areas that need some more attention, as is pretty typical of a development program.

But that's moving well.

We're getting it into the supply base.

We're getting suppliers lined out, determining what we're going to build in-house, what were going to get from the supply base.

So a lot of activity on that program.

The 747-8 -- that one continues as well, and it's kind of across the board.

We have a piece of that in each of our segments, some going a little quicker than others, but all of them moving along and really at that point where they are beginning to transition out of engineering into the full manufacturing and supply chain phase of that.

I mentioned the P-8A, pretty well through the line.

We've now built the second unit, so that's going really well.

The 777 freighter -- we talked about that, and that's the second or third unit.

So they're all coming through the line and all have the challenges associated with new development, but all are progressing and progressing as they need to, to get into production.

Doug Harned, Sanford Bernstein.

I'm interested in production rates.

When you look forward, there's obviously a lot of concern about the overall dynamics of the airline industry.

When you look, say, at Airbus planning to go to 40 per month on the A320 family by 2010 or in 2010, are you currently on a plan to ramp up to that rate?

If not, when do you have to commit to go there?

Doug, in general, taking steps in production up requires roughly 12 to 18 months of prep time, and especially in an environment like we're in now, where the supply bases are pretty loaded.

And in each of our cases, our contract are requirements contracts.

So when a customer pulls from us, it's our responsibility to have units ready to meet their production demands.

So, as long as the customers are -- and the specific example you gave, we are prepared to meet the demand of the customer.

And if you were to see any pullback, typically, how far in advance would you expect to hear about that from Boeing or Airbus?

Well, typically, that will depend on market conditions.

There are lead times in each of our contracts associated with both a speed-up and a slowdown.

So, if it's within lead time, it varies.

I think the shortest one is probably six months and the longest is probably 12 or 18 months.

And it varies by program, and frankly it varies by how complex it is to speed up or slow down.

And absent some major unforeseen event, usually those things are done well outside of lead times.

So we have plenty of time to either ramp up or slow down.

And then on Fuselage Systems, getting back at the cum catch-up you took, could you talk a little bit about going forward both in terms of the kind of productivity improvements that led you to that cum catch-up and some sense of what you've got planned going forward?

And also, you are no longer -- you are doing this with the P-8 going through, which appears to not have had any disruption on the business either.

So are there some things that you've got specifically in mind over the next year or so?

Sure.

We are smile a big here when you said the P-8A went through without any -- I think that was clearly the deck above the water and the deck below the water.

That one was a very big pill to swallow, and the fuselage team just did a marvelous job.

But I think part of the improvement we are seeing is, we had the 777 freighter going through, we were starting the 747-8.

We had the P-8A going through, all at the same time.

The team swallowed that, saw some improvements in their productivity as a result of that, and I think we were able to reflect that.

And then, of course, countervailing that is that all the issues we're having on the 787.

And I mentioned clearly earlier in my prepared remarks, we're putting a lot of emphasis on lean manufacturing techniques and what can we do to improve productivity when we get that line rolling again.

So clearly, lean manufacturing, improvements with the whole supply chain, manufacturing improvements that we can make internally, overhead, strong overhead management control -- all those things go into us building better productivity through time.

But no specific initiatives that you'd highlight?

I know you talked about some of the changes, the more dramatic changes I think you want to see over the long-term in terms of how that line runs, back at your investor conference.

Are there any specific initiatives that you think would have substantial impact over the next year?

None that we highlight.

It's a lot of blocking and tackling and everyday making improvements.

Cai von Rumohr, Cowen & Company.

To get back to the issue, you mentioned non-production revenues in 2008.

Is that about $40 million to $50 million?

What programs is that for, and what sort of gross margin does that revenue have?

Typically, our, what we would consider non-production revenues, will average 5% to 10% of revenue in a specific quarter.

The single biggest component of that is our aftermarket business, which obviously is independent of our contract profitabilities and our OE deliveries.

But it also includes things like, we sell tooling to third parties on occasion.

It includes the gas company that we have to consolidate.

It includes nonrecurring billings on some of the programs, some of our new programs that Jeff described.

Right now, obviously the big ones would be the things like the 747-8 and on the 777, where we do engineering work for those programs that we get reimbursed for.

So generally -- so, again, to 5% to 10% of our revenue, it tends to be somewhat lumpy on a quarterly basis.

Some quarters will be more than others.

But the profitability of that tends to be pretty much in line with our production programs.

I wouldn't say that it's dramatically higher or lower than our production programs.

Secondly, R&D is lower than I estimated, and yet, you have a terrific win rate.

Is the reason the R&D is lower is that more of it is being done under contract, and therefore out of your expenses?

That certainly is a major contributor.

David Strauss, UBS.

Just back on the second half, the implied guidance, you did $1.23 in earnings in the first half.

The second half, your guidance implies flat to slightly down.

You're obviously going to have a couple hundred million dollars in extra revenues.

You've talked maybe SG&A and R&D may be a little bit higher.

But it's still seems fairly conservative in the back half of the year, what you're forecasting.

Do you have any conservatism baked into your guidance for the potential of a Boeing strike?

Well, I wouldn't point specifically to what might happen with Boeing as being reflected in our guidance, because, again, I don't think anybody's crystal ball is clear enough to determine, is there going to be a strike and how long is it going to be and what impact is going to be on the business.

So we certainly haven't attempted to reflect that into our guidance.

More what you're seeing is the fact that some of the second half revenues that you're going to see are going to be 787 related, which, as we've clearly said, don't drive a lot of income.

And we said that we expect R&D and SG&A to ramp up a little bit in the second half.

I think how quickly those things ramp up and what happens with some of our other programs will determine if we move towards the higher or lower end of our guidance.

But at this point, we attempted to find the right balance between fully reflecting what -- the good performance that we've had in the first half and what we expect to see for the second half.

When Boeing had its last strike, back in late 2005, do you have an idea of how much your revenues dropped off during that or immediately following the strike?

I'm sure we could resurrect that.

We don't have that really available.

Well, you might recall if you go back and you look at probably back in the S-1 is where you'd originally see it.

We did have a ship-in-place program where we continued to deliver, albeit at a reduced rate, during the strike period.

But we did continue to deliver during that period because of just the discussions and agreements that we had between ourselves and Boeing.

Carter Copeland, Lehman Brothers.

One quick clarification here on overheads and the costs in the 787.

I just want to be really clear here.

The revisions to the various allocated overheads that you would layer onto the 787 were made in Q1 and are now included in your updated block estimates, correct?

That's correct, yes.

The preponderance of that impact was reflected in our Q1 results.

So there's no other changes in overhead out here that aren't already fully incorporated?

Well, as you can appreciate, this is always driven by forecasts between where we are today and the end of our contract blocks.

So it's somewhat dependent on our ability to forecast.

But if you look back at the last couple of years, our ability to forecast has I think proven to be pretty good.

So we clearly are factoring in what we expect to happen with 787 rates and deliveries and certainly the same for our other programs as well.

Joe Nadol, JP Morgan.

Back on the strike a few years ago, they took all the fuselages you were building.

I recognize that was a much lower rate on the '37, but that was the experience?

No, it was not.

What we did is we reduced production rate.

We went to a three-day work week here, and we did what was called ship-in-place, which allowed us to keep our production lines running and allowed us to have some finished goods inventory, if you will, in fact, paid-for finished goods inventory that was available to be shipped as soon as the production lines kicked back up in Seattle.

So the rates at that point were a lot lower?

The rates were lower, that's right.

Ben Fidler, Deutsche Bank.

Just on 787, I think it was on the Q1 call that you mentioned you expect below 5% gross margin on the first 500 blocks.

Now you've clearly revisited your 787 assumptions, as we saw with the small negative cum catch-up.

I just wondered to if you could comment how that has impacted those comments you made on the Q1 call, if at all?

Well, certainly, the fact that we recognized the negative cum catch in the second quarter would indicate that our margins are going to be a little bit lower than what we thought.

So, if they were below 5% now, they are still below 5%, maybe a little bit smaller than what we originally thought.

So it still is a program that has a relatively low level of profitability.

And I wouldn't read too much into our comments there.

The change there was relatively small, but again, we continued to evaluate the impact of the reschedules and our new production rates on the whole contract block.

As you probably recall, our contract block for the 787 extends quite a bit further.

It extends for the first 500 units, so there's more forecast variability on that program than perhaps on some of our legacy programs.

So it was a relatively minor change, but we did see a little bit of a decline in our overall profitability for that first 500 unit block.

Another one on the 787, if I could.

Could you tell us how many Section 41 units you expect to ship by the end of this year?

We have not been specific on that.

I think what we've said is that, clearly, we are working on for through six, which are the test units, and have those ready for the pull.

It will just simply be determined by what pull comes from the program.

Ladies and gentlemen, this will conclude our Q&A session as well as the conference call for today.

We thank you for your participation in today's call, and you may now disconnect.

Have a good day.