Spirit AeroSystems Holdings Inc (SPR) 2008 Q3 法說會逐字稿

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

My name is Francis and I will be 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 this conference.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I will now turn the presentation over to your host for today's call, Mr.

Phil Anderson, Treasurer and Vice President of Investor Relations.

Please proceed, sir.

Good morning and welcome to Spirit's third quarter 2008 earnings call.

I'm 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.

In order to allow everyone to participate in the question and answer segment, we ask that you limit yourself to one or two questions this morning.

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

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, everyone.

Let me welcome you to our third quarter earnings call and let's begin on slide 2.

We continued to execute well across our company during the third quarter, as we responded to the machinist strike at the Boeing company, Spirit's largest customer.

While we were clearly disappointed by the onset of the strike, I am extremely pleased with the performance of our team, as we quickly responded, taking the necessary and prudent steps to deal with this work stoppage.

Our efforts have been intensely focused on maintaining a healthy business and meeting customer requirements while managing the impact to our employees and shareholders.

The actions we have taken thus far were well planned and coordinated in advance and are working well.

As you know, when the strike commenced on September 6th, Spirit immediately implemented a reduced workweek production schedule on affected Boeing products.

This approach served us well in a similar situation in 2008 and continues to do so now.

We are meeting our customers' expectations, while our employees remain productive and prepare to resume full production after the strike concludes.

As you would expect, our results for the third quarter 2008 reflect the impact of the strike.

However, our balance sheet and our liquidity remain strong.

Rick will provide you more details on the strike impact in his presentation.

So let me spend a few moments to give you an update on other parts of our business.

We have made solid progress on our long-term strategy as we continue to execute well on our Airbus programs, progress on our development programs and have won new business.

Early in the quarter, our Spirit Europe team won content on the A350 XWB program by capturing a wing component package.

Our work content on the A350 XWB program is now in the $4 to $5 million per ship set range.

More recently we announced our participation on the Gulfstream G250 business jet.

We captured new business on the Mitsubishi regional jet and continued to advance our aftermarket business by securing spare part agreements with Southwest and Continental airlines.

Our backlog grew again in the third quarter and is now approximately $31.8 billion.

While Spirit is doing well overall, we remain mindful of the challenges facing airlines and businesses, both domestically and internationally, as they cope with the difficulties in the world financial markets and the impact on economies around the world.

We are closely watching and evaluating the potential impact of these developments.

Let's spend a moment to talk about some of the specific highlights across the businesses during the quarter.

We'll begin on slide 3.

All three of our business segments were impacted by the machinist strike at Boeing during the third quarter.

The strike impacted both revenues and earnings.

We delivered 9 fewer ship sets in the third quarter as a result of the strike and booked an $18 million unfavorable cumulative catch-up adjustment, most of which is reflected in the fuselage segment.

We also continued to improve productivity during the quarter as we realized a $5 million favorable cumulative catch-up adjustment which helped to offset some of the strike related impact.

These improvements were realized in both the fuselage and the propulsion segments.

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

On slide 4, you see the propulsion team's results for the third quarter.

Operating margins remain a solid 16.2% as the team manages through the effects of the strike.

Aftermarket sales for propulsion products increased over the third quarter of 2007, as we continue to penetrate that market.

The team also made good progress on development programs and just last week announced their participation as the engine pylon provider for the Mitsubishi regional jet.

On slide 5, you see the wing systems segment, which is comprised of our Spirit Europe and Okalahoma operations.

Both operations have Boeing products that were impacted by the strike, while our Airbus products remain on track.

Our Spirit Europe and aftermarket teams opened the Spirit European repair station during the quarter.

This is part of our ongoing effort to expand Spirit's presence in the aftermarket business around the globe.

And recently we announced our participation on the Gulfstream G250 program.

Spirit is designing and manufacturing the fully integrated wing at our Tulsa, Oklahoma facility.

We commenced work on the design and manufacturing planning for this Gulfstream product in 2006.

Now let me turn to slide 6 and give you a brief update on the 787.

As you would expect, deliveries to Boeing on the 787 are also impacted by the strike.

We did deliver aircraft number 4 during the quarter and met the customer's condition of assembly requirements on aircraft number 5.

Aircraft number 6, the last flight test aircraft, is progressing through the systems installation process.

Overall product quality remains high and we continue to work with the supply base to enable a smooth production ramp-up.

We are continuing to work closely with our customer on incorporating necessary engineering changes on flight test aircraft and the first in-service aircraft.

Our internal efforts remain focused on productivity improvements and increased asset utilization.

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

Thanks, Jeff, and good morning, everyone.

Slide 8 summarizes our financial results for the third quarter, which as Jeff said, were negatively impacted by the IAM strike at Boeing.

Despite that, revenues were up about 6% over the prior year period, driven by slightly higher unit deliveries to Airbus and Hawker Beechcraft, favorable volume based pricing and a more than doubling of our aftermarket sales.

Boeing deliveries were flat year-over-year.

We estimate the strike impacted third quarter deliveries by 9 units or about $53 million of revenues.

Operating profit at $111 million was up 4% as margins were largely flat year-over-year.

The strike impacted operating profit by an estimated $26 million, so absent this event, operating margins would have improved by about 170 basis points over the prior year period and would have been about the same as the second quarter.

Fully diluted earnings per share of $0.53 for the quarter were down 12% from earnings of $0.60 per share in the prior year period, largely due to the strike impact of an estimated $0.13.

The prior year period benefited by $0.09 from the recognition of higher research and experimentation and state tax credits.

The current year period has similar benefits of about $0.02 per share.

Cash flow from operations of $68 million and capital expenditures of $56 million for the quarter reflect our continued investment in the 787 program and other new programs, revised 787 payment terms negotiated earlier this year and strike related inventory build.

Slide 9 highlights our progression on key P&L metrics over the trailing four quarters.

Third quarter revenues grew 6% year-over-year, but were down 3% sequentially from the second quarter due to the $53 million strike impact.

Absent the strike, revenues would have grown 2%, the continuation of the growth trend we have experienced for eight straight quarters.

Total 787 revenues in the quarter were approximately $15 million, about the same as the second quarter, as we delivered 1 forward fuselage unit in both periods.

Operating income margins were 10.8% in the quarter, slightly below the prior year period, due to the strike impact mentioned earlier.

On a sequential quarterly basis operating margins were down about 200 basis points due almost entirely to the strike.

Lastly, third quarter fully diluted EPS of $0.53 was down 12% from the prior-year period, due to the $0.13 strike impact which also caused sequential quarterly earnings to decline.

Our effective tax rate of 29.5% in the current quarter was higher than the prior-year period, due to the increased level of state and R&E credits recognized in the prior year period.

Turning to slide 10, R&D expense in the third quarter was $13 million, about flat with the prior year period in absolute dollars, but a lower percentage of sales as the business continues to grow.

Sequentially, R&D spending grew slightly from the second quarter, as we began a modest ramp-up in spending for some of our recently announced new program wins.

SG&A expense for the quarter was $39 million, about 9% below the prior-year period, due primarily to lower non-cash stock compensation expense.

Sequentially, SG&A was down slightly from the second quarter, as we continue to tightly control administrative expenses in this uncertain market environment.

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

In the aggregate, SG&A and R&D declined from 5.8% of sales in the third quarter of '07 to 5% in the third quarter of '08, an 80-basis point improvement in operating margins.

Slide 11 summarizes the P&L for the third quarter and the year-to-date versus the same periods in the prior year.

During the quarter, Spirit realized approximately $13 million of net unfavorable changes in contract estimates versus no net change in the prior year period and a $4 million favorable change in the second quarter.

The Boeing IAM strike contributed $18 million to the current quarter performance, so absent the strike, Spirit would have recognized the $5 million favorable cum.

catch adjustment.

The strike has an unfavorable impact on Spirit's contract block profitability because it extends the timeframe for reaching the end of the block, which is measured in a fixed number of units delivered rather than time.

This incorporates more fixed costs into the current blocks, thus reducing their profitability.

Profitability of the current blocks is also impacted by the lower productivity and related disruption associated with the shortened workweek we're experiencing.

Most of the current period unfavorable cum.

catch was realized in the fuselage segment.

It should be noted that the $18 million strike related adjustment assumes the strike ends with a favorable ratification vote and a return to work by early next week, followed by an approximately 90-day transition period at Spirit.

If the strike were to extend beyond that point or the ramp-up period is longer, an additional negative cum.

catch adjustment could result in the fourth quarter.

Slide 12 summarizes the recent quarterly changes in our cash and debt balances.

Cash balances at the end of the third quarter of $178 million increased $31 million or 21% from the prior quarter end, largely due to improving cash flow from operations.

The third quarter included $55 million of customer cash advances for the 787.

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

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

At the end of the third quarter our net debt to capital ratio was under 22% versus 27% at year-end 2007, and our net debt to 2008 EBITDA ratio continues to be well below 1.

Additionally, at the end of the third quarter the Company had over $800 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 13 details our cash flow for the first nine months of 2008 versus the same prior-year period.

Year-to-date cash flow from operations was positive $147 million, as higher customer advanced payments and improved profitability continue to offset working capital growth.

The year-to-date working capital build was largely driven by the reschedule of the 787 deliveries earlier this year and preproduction and nonrecurring engineering spending for some of our other new programs, including the 747-8 and our 2 new Gulfstream programs.

Inventory growth includes an increase in capitalized development costs of $41 million for the quarter, entirely for new programs unrelated to the 787.

At the end of the quarter, capitalized development costs were $375 million in total, including $237 million for the 787.

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

The strike also contributed to higher inventory balances at the end of the quarter, due to the timing lag of rebalancing our supply chain to reduce delivery schedules.

The decline in our accounts payable balance at the end of the quarter is also a function of reduced incoming material from the supply base.

Capital expenditures of $56 million in the third quarter and $175 million year-to-date were down 19% and 23% respectively from the prior year periods, as the installation of production capacity for the 787-8 program continues to wind down.

Lastly, I'd like to update our expectations for financial guidance.

As you know, Spirit withdrew its 2008 guidance at the start of the Boeing IAM strike, knowing it would have a material impact on our 2008 results.

Given the remaining uncertainty for the final return to work date, and more importantly, the pace of the ramp-up after the strike concludes, we are not in a position to update our guidance today.

We plan to update 2008 and issue our initial 2009 guidance as soon as practical after the strike concludes and we have better visibility into the post strike delivery schedules.

The post strike delivery schedule will dictate how quickly Spirit can burn down the units built during the strike in advance of customer requirements.

We currently expect to provide 2008 and 2009 guidance no later than the end of November.

If the strike ends early next week, we estimate the post strike transition period would extend approximately 90 days, so the impact on 2009 revenues and earnings is not expected to be significant.

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

Thank you, Rick.

I'll wrap up on slide 14 with a few brief comments.

The core business is performing well and we are financially strong as we manage through the challenges of this work stoppage at Boeing.

Our continuous focus is on meeting our customer commitments, while growing and diversifying our business in what we firmly believe to be good long-term markets for commercial aerospace products.

However, there's no question that these are extraordinary times for people, for employees, for governments and businesses around the globe.

At Spirit we're working closely with our customers, our employees, our business partners and our communities as we navigate through these challenges.

Let me just add here a special note of appreciation and recognition to the Spirit AeroSystems team.

They have and continue to perform with distinction throughout the course of these disruptive times.

I have the utmost confidence in their abilities, their teamwork, their perseverance and ultimately their performance.

We'll be glad now to take your questions.

(OPERATOR INSTRUCTIONS) Robert Stallard from Macquarie.

The first question I'd like to ask you is on the timing of the catch-up after the strike.

I know there's a lot of uncertainty here.

But Rick, I was wondering if you could give us some idea of how you're expecting the revenues, earnings and cash flow to come back up in Q4 and Q1, as Boeing gets back on line?

Well, as we said, Rob, we expect there to be a 90-day transition period after the conclusion of the strike, and we need that period to, as we said, burn off the units that we've been building during the strike.

And if you look at very high level math, prior to the strike Boeing was producing about 40 units a month.

We've continued to produce at a rate of about 60% of that, so roughly 24 units a month, and by the time Boeing returns to -- assuming the ratification vote this weekend and a return to work fairly soon, we'll have about 2.5 months of time that we were producing at that rate versus Boeing's production rate, obviously, where they weren't producing.

So that would translate into somewhere around 55 to 60 units that we're ahead of Boeing, in terms of deliveries.

So, those are the units that obviously we will not deliver.

We saw the first part of that already in the third quarter and we'll see the remainder of that into the fourth quarter and probably into the first couple of weeks of 2009.

So basically, you could be out there sort of 24-month rate through the whole of this quarter and then steadily start to see things move back up to the sort of 14-months maybe into February or something like that.

That's a good analysis, Rob.

And is there anything on the cash flow side?

Is that fairly equivalent to what you see in revenues and earnings or that the inventory would wind down at a similar sort of rate and there's nothing unusual there?

We would certainly expect some inventory burn off.

We obviously have slowed down our incoming material.

We noted that there is a lag when you do that, so we probably did have some inventory build in the third quarter that we weren't expecting.

But it will take us some time to burn that off.

I would expect that it will be longer than the 90-day period, but certainly during the first part of 2009 we'll burn off that inventory.

Okay.

Just as a follow-up, you mentioned that you had been delaying some of the inbound deliveries from suppliers.

As you look at your supply chain, has there been any impact of the wider financial crisis on your supply chain in terms of liquidity or financing or other sort of problems?

As yet, we've worked very closely with our supply base to keep them healthy as well to be able to support us.

So, as yet there is nothing out of the ordinary that we've had to deal with.

We do very closely monitor that, Rob, and pay attention to it on virtually a daily basis, as you can appreciate.

Doug Harned with Sanford Bernstein.

I was interested in understanding how the strike impacted each of the units.

Obviously to fuselage systems it was quite important, but can you talk about in propulsion and wing systems, what happened there?

In general, across all of our products that we're shipping to Boeing, we went immediately to a three-day workweek, which amounted to 60% production.

And physically what happens in the fuselage area you have much larger pieces of equipment, so they tend to take a lot more space a lot quicker than in some of the component areas.

But in general, it was pretty consistent across the segments that were supporting Boeing programs in terms of going to 60% production rates.

As we mentioned, Doug, the majority of kind of the net $13 million unfavorable adjustment in the quarter was reflected in fuselage, because as Jeff said, the 737 fuselage is our biggest program and it's a very high value-add, it has a lot of labor content.

So it tends to be more impacted proportionately than some of our other programs.

The propulsion business was basically kind of a net zero in cum.

catch adjustment, so they actually had some favorable adjustments on other programs or on other activities that offset the strike impact and the wing systems had a small negative cum.

catch on the order of about $2 million.

Well, on wing systems you talked about operational efficiency improvement and there's also a discussion of lower R&D there as well.

And given that there's a fair amount of new work you've got in wing systems, I'm just interested in how we look at this going forward, both in terms of where R&D would likely go there, but also when you look at the operational improvements, does this reflect better performance at Prestwick, Tulsa or expectations of what you're going to see in Malaysia?

Well, it reflects better performance at both of those locations.

The R&D expense is a major contributor.

If you look at the year-over-year improvements in margins, we had about 160 basis point improvement in margins in wing systems and that was in the face of the negative cum.

catch that I mentioned earlier.

So the improvements are coming from lower R&D expense.

We had higher levels of R&D expense in 2007 for the two Gulfstream programs in those periods.

Those are now largely complete in their R&D phase and some of the newer programs that we've won there, again, have different contract terms and as we've said previously, we don't expect to see as much R&D in those programs.

So to your question of sustainability, I do believe that the kind of margin improvements that we're seeing in both Tulsa and in Prestwick, certainly are sustainable going forward.

But the R&D, that's in contrast with what you're seeing in fuselage systems, which was up.

Fuselage was up a little bit for some of the new programs that we've won there, but it wasn't up dramatically.

Cai von Rumohr with Cowen and Company.

The $18 million cum.

catch, maybe tell us, what does that assume in terms of when the strike was going to end and your recovery, and secondly, how much if any of that is recoverable from Boeing?

In terms of the assumptions, Cai, the $18 million reflects the strike ending about now or early next week, as we said, so about in this timeframe, and assumes the 90-day ramp-up period that we talked about earlier.

So, if our crystal ball is clear enough and events happen kind of on that schedule, then that should be the preponderance of the expense that we'll recognize as related to the strike, in terms of looking backwards on our revenues.

Obviously our revenues going forward will reflect slightly lower profitability because of the cum.

catch adjustment that we referenced.

In terms of recoverability, we do have the opportunity to discuss with Boeing the disruption costs associated with the strike and I'm certain we'll have those discussions.

Okay.

And lastly, R&D increased this quarter and the new programs are ramping.

Could you tell us just qualitatively, will that continue and are you seeing any indication that your customers may delay some of those programs, given the changed environment we're operating in?

To take the second question first, Cai, we have seen no indication at all from our customers that they would delay.

We continue to talk to them about that.

I think our customers as well as we, believe strongly in the long-term viability of this market space.

So what we've seen is actually some caution maybe on production type programs, but still a very strong commitment to the new development programs.

Cai, we've mentioned in prior calls that we did expect a modest ramp-up in R&D from what we had experienced earlier this year and I think that's what we're seeing now and I would continue to describe it as a modest ramp-up.

I don't personally see R&D going up significantly from where we are today.

David Strauss with UBS.

Rick, could you just give a little bit more detail in terms of the negative cum.

adjustment?

It sounds like you've extended the time to get through the block.

So are you assuming that none of these deliveries that Boeing has effectively missed, that they're going to make those up?

Well remember, our blocks are defined in terms of the number of units, not time.

So the number of units in the block is going to be unaffected by the strike.

If there is a recovery of the units that we've lost, that would manifest itself in future blocks.

And David, clearly we're not projecting that in the timeframe of the current blocks.

David, just a way to think about the impact, on average, again, the blocks are going to extend roughly on the order of the length of the strike, so on average we're adding roughly two months -- maybe a little bit more than two months, to the average length of our contract blocks.

Okay, so we're now looking at getting to the new blocks maybe early 2010 instead of late 2009?

That's exactly right, David.

Okay.

And on 787, I might have missed this, but I heard you delivered ship set 4 and I think as of last call you had in progress 4 through 22.

Can you just maybe give a little bit more color beyond 4 and 5, where you are with things?

Sure.

We did ship number 4.

We talked about number 5 meeting the condition of assembly and ready to go.

Number 6 is also in the final installation process.

I think 7 and 8 are as well.

And I think we told you previously that the early fabrication process on the barrels had been shutdown.

It has not restarted.

We had originally planned to restart it early in the fourth quarter.

That, of course, is being extended by the strike.

So, our focus has been on making sure that we work on all the productivity issues that we can think of to work.

We're working very closely with our supply base to make sure when we begin the ramp-up, that both our internal capability and our supply base are ready to support that.

Carter Copeland with Barclays Capital.

I just want to be totally clear on this.

Rick, the $26 million in operating profit impact that you stated, does that include or exclude the $18 million cum.

catch?

It includes it.

So the remainder, the difference between $26 million and $18 million is just the normal profit--.

Margin on missed deliveries.

That's exactly right.

Right.

At the end of last quarter you had basically a negative deferred production and excess under-average cost, if you will, on several programs.

I think the amount was $44 million.

Does this adjustment now mean that that amount has been eliminated within inventory?

When you say eliminated--?

Your cost performance was running $44 million ahead of what you had originally assumed as of the end of last quarter, but now you've taken this adjustment.

Have you just taken an $18 million adjustment or did we then adjust all the way back that negative deferred production amount as well?

Well, the $18 million, in effect, recalculates the profitability on all the revenue that we've already recognized on all the programs.

So, as you remember, our current blocks go all the way back to the start of Spirit in the middle of 2005.

So you've got about $10 billion worth of revenue, roughly, that we've already recognized behind us, so that $18 million represents the profit adjustment on that $10 billion-plus revenue.

So if you kind of do the math on that, that would indicate that our total profitability, the impact is relatively small.

It's about 17 basis points over the entire length of the blocks.

Okay, but the amount that you reported last quarter of being essentially better cost performance, the $44 million of negative deferred production, wouldn't that then need to be applied over the same group -- so wouldn't we get 18 plus 44 and that would be the adjustment over the revenue pool you're talking about?

Well remember, most of this is the adjustment of costs that are still in front of us, not behind us.

So what we're adjusting now is the cost that we expect between the end of the third quarter and the end of the contract blocks.

So, deferred production actually was largely flat.

It was up a little in the quarter on a net basis, but that's after recognizing the $18 million adjustment.

Joseph Nadol with JP Morgan.

My question is on the $5 million positive cum.

catch-up.

I'm wondering if you could give any color on that, what program or at least is that a placing that's non-Boeing?

No, actually it's across all of our programs, which would indicate that it's primarily for Boeing programs.

That's a continuation of the blocking and tackling that we've seen on the operational side for quite some time.

We continue every quarter -- we continue to operationally become more efficient, find other opportunities to control our costs and what we saw in the third quarter, absent the strike, would have reflected the continuation of those trends.

Okay.

And then, how do we think about overhead absorption here in terms of the other parts of your business?

You took the negative cum.

adjustment that was specific to the Boeing programs impacted by the strike, part of the 5 offset it sounds like was Boeing programs, but there's no negative impact on other programs in terms of absorbing the fixed costs?

The $18 million includes all programs.

It's the loss of fixed cost across the board, because a lot of those costs, as you can probably appreciate, are allocated to all programs.

So it does have an impact across the board, but obviously it impacts the larger programs more immediately.

Okay.

And then secondly, you did note in your press release that you're still generating some nonrecurring revenue, I guess particularly in fuselage.

Is that 787, or any color on that?

It's a number of programs.

It's 747-8, it's 777 freighter, I think there's some P-8 money in there.

So it's across a number of our derivative programs.

Troy Lahr with Stifel Nicolaus.

Jeff, I think you said the OEMs were cautious on production programs.

Can you maybe talk about your thoughts on the out years for balancing supply with demand and how you see production schedules looking?

Do you think that schedules need to come down a little bit, given the macro environment here?

That's a great question, Troy, and I think the one we're all asking ourselves.

Clearly, we all know the strength of the backlog and any number of scenarios that talk about some level or even a melt away of those backlogs still has a very high demand.

We saw some airlines continuing to order in the middle of all this uncertainty in the markets.

I'm a huge fan of steady, stable production rates in an environment like this.

I think there are arguments to do that.

We know we have to respond to what our customers want to do.

We saw Airbus make announcements about what they were going to do with the A-320 rates, that kind of follow the steady state thesis here.

Boeing has not announced what they are going to do, so we will clearly follow and support what the customer needs.

But I think we've got a period here where 2009 looks to be pretty stable, from everything we're hearing from the marketplace and we'll see.

Like I said, I'm a huge fan of stable production rates and the long-term demand certainly seems to be there.

So, Troy, we'll see.

I think we see more wait and see than we see a strong lobbying within the customer base to do one thing or the other.

Okay.

And then on the aftermarket side, can you maybe talk about the Southwest and the Continental program, when those should really start rolling in and how does that impact margins?

Is there a learning curve associate with those or pretty good margins right away?

Those would be solid right away.

They're spares -- spares contracts primarily.

Remember we've talked about aftermarket as a good piece of business that we want to go get.

It clearly adds to our value.

It's not huge.

We've talked about it in the terms of about 5% of our total company.

But we have seen very strong moves there with both the repair business, as well as the spare business.

So those should be good, solid margin producing programs and it shouldn't take long to ramp them up, because it's a spare.

It's catalog spares in the two examples that you gave.

So it's still 5% in 2009, is the way we should think about it?

In terms of the total percent of our company?

Right.

Aftermarket as a percentage of total sales.

I think we've talked about 5% is the aspiration of what we'd like to achieve.

It's somewhere south of that right now.

Ron Epstein with Merrill Lynch.

So Jeff, a question for you.

What if the SPEA guys walk out, what impact would that have on you guys?

I assume you're talking in Seattle?

Yes.

Well, as you can appreciate, Ron, that's certainly a scenario that we've looked at.

It would have some impact.

Of course, timing and duration would be very important factors here.

Frankly, if you look at what happened in the past, it has disruptive impact, but not the extent of the full production shutdowns.

So we're looking at contingency plans now.

Clearly, we're hopeful that doesn't occur.

And we would have some impact, though in my estimation it would be less impact than what we've seen with the IAM work stoppage.

Would the legacy 7 series programs just continue kind of going?

Well, it would clearly depend on what the customer chose to do and where the customer was in their recovery from the IAM stoppage.

Okay.

And Rick, just two quick little questions for you on the financials.

When we go into Q4, what are you thinking about tax rate?

Our tax rate should be quite low in the fourth quarter because of the reinstatement of the R&E tax credit.

That legislation was passed after the third quarter ended, so our nine months results don't include any benefit from that tax credit.

For the whole year, that's about roughly $8 million for us, so all of that will be booked in the fourth quarter, so we will have quite a low tax rate in Q4.

Okay.

And then for the year, in terms of CapEx accretion, do we have any of that this year and would that be booked in Q4?

We continue to book a modest amount of CapEx accretion in our results.

I mean, it's declining over time, obviously, because the actual cash payments associated with that are now coming in.

So what you'll see in the fourth quarter is roughly what you've seen in the first three quarters of 2008, then we'll record a diminishing amount in 2009, and after 2009 it will be zero, because we will have recovered all the cash by the end of 2009.

Robert Spingarn with Credit Suisse.

I just want to go back to the strike delay and make sure I understand what Jeff said at the outset of the Q&A, which is, you had 9 aircraft delayed in Q3, so part one of my question is, that would imply at least to me, that you were still shipping to Boeing, above and beyond the number of delays that Boeing had.

Lead time may explain that.

Could you talk a little bit about how that process worked?

Did product actually move to Seattle or stay in Wichita?

And do I have this right in that the magnitude of the revenue impact of the strike would be about four to five times in Q4 what it was in Q3?

Let me try to answer your first question first.

I think I misstated maybe in my comments earlier.

We followed a similar pattern to what we did in 2005, where we cut to three days a week work and shipped in place primarily, about 60% of normal volume.

So that's what we've been doing.

We've been shipping in place, completing the units, having them completely ready to ship and ship in place with Boeing.

So that books as revenue for us and profit for us as well at that point.

In terms of the impact on Q4, I think your math is roughly right.

We said we built ahead about 55 to 60 units ahead of Boeing's requirements.

We reflected 9 of that impact was in the third quarter, so that says there's somewhere around the mid to high 40s, units that will have to get burned off between the fourth quarter and the first part of 2009.

So it is roughly on the order of four times, that's correct.

So Rick, in that vein, my math says it's about half a penny an airplane, but how do we think about absorption?

There's been a lot of talk about cum.

catch-up and so on, but those get complicated.

How should we think about absorption of your fixed cost base in the quarter and how that might magnify the per aircraft impact relative to what it was in Q3?

Sure.

Well, as I said earlier, the $18 million assumes that 90-day ramp-up period after the strike concludes.

So, to the extent that our ability to forecast is accurate, I believe we've reflected as much of that impact already within the $18 million.

That's really where the majority of the $18 million comes from is you've got that fixed cost -- again, as I mentioned earlier, our blocks are measured in units, so you in effect add a couple of months to the ends of our blocks, which drags more fixed cost into those blocks.

And that's really the fixed cost that we're going to see over the course of the next three or four months.

Now, in terms of things like period costs -- SG&A, R&D, those obviously are period costs, the absolute dollars don't change that much and will reflect lower revenues.

So as a percentage of sales, those will look a little bit higher in Q4 than they have previously.

And those aircraft that shipped in place in Q3, there was cash flow on those or how did you book those on the balance sheet?

Absolutely.

Other than being shipped in place, those units were delivered to Boeing, title passed and Boeing continued to pay for them.

Okay, excellent.

And then just a final question on 787, Jeff.

Assuming we get back post this transition phase, what kind of rate were you guys capable of at this point or are you capable of at this point?

Well, that's a complex question.

Are you talking about how--?

On 787s?

For what time period?

Once we get back to normal.

I think the key is, early in the program it's all to a pull signal from the customers, so getting up on the step, I call it, and getting to a drum beat rate is still out in front of us a ways and we fully see ourselves as capable of supporting that.

And we've said all along, we've facilitized for 7 a month.

And of course the key there is to manage smoothly the supply chain and reach those kind of rates.

But our facilities and our capability is well beyond demand at this point.

The reason I asked the question is there's been this presumption all along throughout the strike that at least it's giving suppliers some additional time to get that production ramp up.

Do you feel that you've made significant progress during the last two months on whatever you might have needed to do, and how about those lower tiered guys?

Clearly, Rob, we've used the time to get required engineering change into the product, to watch the supply base and to work with the supply base where necessary.

You know, and time will tell how successful that was.

Okay.

Rick, just a final thing.

Is there a reason that you don't frame some kind of guidance, given that you know what the per aircraft impact is and where you could just give some kind of a sensitivity analysis?

Well, really two variables, Rob.

The first obvious one is the strike's not over yet.

Hopefully there will be a ratification vote this weekend and the strike will conclude next week, but certainly we're not taking that for granted.

And then secondly and what's more important is really what is the pace of the ramp-up once the strike concludes, because we articulated what we thought the ramp-up would be.

We obviously had to make certain assumptions on the ramp-up in order to properly reflect it in our financial statements.

But what the actual ramp-up is could be faster, it could be slower than what we projected.

So, that still is a variable where we need to have the dialog with our customer and determine exactly what that ramp-up looks like, then we can build our guidance around that.

Dana Merber with UBS.

It's GMP Securities.

But in any event, sorry to hammer on this, guys, but I just want to make sure I'm following Jeff's initial comments here in the Q&A.

The 50 to 60 units, that includes the ship in place units from the third quarter, so some of those units you've already booked revenue on, is that correct?

That is correct.

That's the net of what we've built, in excess of what Boeing has delivered to airlines.

Okay, so effectively then if I'm just trying to reconcile -- because generally your deliveries on a quarterly basis will mirror those from Boeing, so you obviously delivered more than Boeing actually did in this quarter--.

Right.

And that's because of the ship in place.

Okay, exactly.

That's what I wanted to check.

Thank you.

Howard Rubel with Jefferies.

The dollar has strengthened relative to the euro and if we go forward, Rick, there is a fair amount of business in the wing segment, about half, that's impacted by that.

How fast will that benefit flow through to you?

Well, we actually have a relatively small foreign currency exposure, because our largest contract out of Prestwick, the A-320 contract, is actually denominated in pounds.

So our net currency exposure is relatively small.

That's why the impact of either strengthening or weakening of the dollar, we've always said has a really immaterial impact on our results.

The recent strengthening of the dollar, obviously as we translate those pound revenues back into dollars creates fewer dollars, so there's a little bit of headwind there.

But it's really not material to our results, Howard.

All right, that's fine.

And then the other follow-up, which is one that's a little harder is, you addressed working capital, can you help me a little bit to understand how -- I mean, you've added $400 million in inventory and while you lag Boeing on the way up for the next, we'll call it 90 to 120 days, how do you think about what will happen to working capital and especially inventory from here?

Assuming we do get back to some kind of reasonable drum beat towards the end of March.

You really have to segregate the preproduction development costs associated with our new programs, because all of our new programs will have that.

So those are costs that we recover over the life of the contract.

So, we will see some additional inventory build over time to reflect that preproduction investment.

On the other side though, you see the actual physical inventory that we have and the inventory that we have for things like nonrecurring costs that we've incurred.

Those will, over time, be burned off, as we talked about, as we absorb the inventory that we built with the strike and deliver those units and rebalance our supply chain.

So, you've really got those two opposing dynamics.

How those will net out in our 2009 numbers, we'll obviously reflect that in the guidance that we'll provide before the end of November.

I think your other preproduction costs were up about $40 or $50 million in the quarter.

Are we at a point where we're close to seeing that peaking?

And then just related to that, you still have some recovery, I guess, on 747-8.

It looks like you've got some of the 747-8 recovery.

Do you still have some more there?

I mean, just add some color and then I'm done.

We do have some additional nonrecurring recovery that we expect to get in the fourth quarter and in early 2009.

But on your other question on preproduction costs, the build that you've seen in the last couple of quarters is primarily related to our two Gulfstream programs.

We've been incurring those costs now for probably on the order of five or six quarters from the point we started, so those are approaching their peaks.

But obviously we have other new programs now that are starting to generate some spending as well, so we're starting to see some A-350 cost come in for both the Section 15 and for the Leading Edge and we'll start to see a little bit of Cessna costs over time.

So, the nature of the program will change as some mature and complete development.

But I think over time, for another year or two, we will see some continued growth in that account.

Again, we hope and expect that it will be somewhat more modest going forward, because there is customer recovery that goes along with a lot of that as well.

But we will see some growth in that part of our inventory.

The opportunity for us is to be able to reduce inventory in other parts, in our physical inventory by improving efficiencies and turnover rates and building some of the nonrecurring that you mentioned and getting the 787 delivered.

You might remember too that we entered 2008 with the expectation of building substantially more and delivering substantially more 787 units than we have and we're still carrying a lot of that inventory.

So as that program starts to ramp-up, we should certainly see that inventory start to come down as well.

Richard Safran from Goldman Sachs.

First, on the 787, I was wondering if you could comment on the status of Boeing compensating you for changes on the program?

And also, I guess you would expect the number of changes should be falling off significantly by now.

I just want to know if that's the case and what you're seeing?

First question, on the assertion process, that continues to move forward.

We are in active dialog on that.

I have nothing to report at this point.

But it does continue to move and we continue to have fruitful dialog there.

And the second question was the changes.

There continues to be changes.

I'm an old manufacturing guy, so any change is too many.

But I think the program will get through getting the flight test programs going in the first unit and we should see a slackening after that.

Okay.

And one other just quick.

I noticed you very slightly dipped into the revolver and I was wondering if you expect any more borrowings under that going forward?

We actually didn't dip into the revolver in the third quarter.

Okay, my mistake then.

I'm sorry.

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

Doug Harned with Sanford Bernstein.

I have one more question related to R&D.

Could you talk about what your engineering headcount looks like right now and how you're projecting that going forward?

Is this flat or are you planning to take that up at all in any of the units?

Doug, it's relatively flat right now.

We really are continually hiring some key engineering resources there.

Those tend to offset contract engineers or contract houses that we use for the heavy load periods of new programs.

But through time we're looking at flat to slightly up as we look at our internal resources and then mitigate the total requirements with partners from the industry.

That concludes the question and answer session.

And ladies and gentlemen, thank you all for your participation in today's conference.

This concludes the presentation and you may now disconnect and have a good day.