Spirit AeroSystems Holdings Inc (SPR) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third-Quarter 2009 Spirit AeroSystems Holdings Inc.

Earnings Conference Call.

My name is Krista and I will be your coordinator for today.

At this time all participants' lines are muted.

But, we will conduct a question-and-answer session towards the end of this call.

(OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to Mr.

Alan Hermanson, Director of Investor Relations.

Please proceed, sir.

Good morning.

Welcome to Spirit's third-quarter 2009 earnings call.

I'm Alan Hermanson and with me today are Jeff Turner, Spirit's President and Chief Executive Officer; and Phil Anderson, Spirit's Vice President and Interim Chief Financial Officer.

After brief comments by Jeff and Phil regarding our performance and outlook, we'll be glad to take your questions.

In order to allow everyone to participate in the question-and-answer segment, we do ask that you limit yourself to one or two 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, in our SEC filings, and in the forward-looking statement at the end of this Web presentation.

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

With that, I would like to turn the call over to our Chief Executive Officer, Jeff Turner.

Thank you Alan and good morning.

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

I'll begin on Slide 2.

We executed well across the Company as we delivered solid operating performance in the third quarter.

Our results reflect the improving performance as both revenues and profitability increased quarter over quarter.

Our results reflect recovery from the disrupted operations in the previous three quarters caused by the machinists' strike at Boeing and the new ERP system implementation in the first half of 2009.

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

While executing our core business during the quarter, we continued to support the 787 program, focused on making preparations for production restart and ramp-up.

The Spirit team has done a good job managing through the challenges and we look forward to getting this program onto a smoother production drumbeat.

We continue to remain cautious regarding the outlook for commercial aerospace and the overall demand for our products.

While we have seen some stabilization in global economic conditions, we remain watchful.

In my view, there is still uncertainty ahead in 2010.

Our focus is on supporting our customers, but we are also postured to react to market changes if needed.

Overall, our business is stable with a backlog at over $28 billion and a long-term strategy that is being realized.

While executing our growth and diversification strategy, we continue to make progress on our development programs.

We are roughly 60% of the way through these new programs at this point.

Our focus will be on completing these projects over the next couple of years.

Now let's talk about some of the specific accomplishments across our business during the quarter, beginning on Slide 3.

Fuselage systems delivered strong operating margins of 18.1% from $526 million in revenue during the third quarter of 2009.

The Fuselage segment has now delivered 3,100 737 next-generation fuselages.

They have now shipped the 16th 777 freighter forward fuselage, shipped the 5th P-8A test unit aircraft to Boeing and delivered the 9th 747-8 freighter.

We are currently in the process of assessing the impact from the latest Boeing scheduled change for the 747-8.

The team is progressing on the Sikorsky CH-53K program.

As with all programs, we continue to work closely with our customer to ensure that their schedule and technical needs are met.

We feel good about our progress to date and our growing relationship with Sikorsky.

On Slide 4, you see the propulsion team delivered operating margins of 13.3% on $266 million in revenue during the third quarter of 2009.

The margins were lower than the same period of 2008 due to the changes in product mix, primarily on our 747 program and lower aftermarket volumes.

The core businesses continue to perform and have now delivered 3,100 ship sets of 737 products.

Now on the new 747-8 configuration, we have delivered 6 Pylon ship sets and 3 nacelle inlet ship sets, all to master schedule.

The propulsion segment continued to make progress on the development programs by delivering the second inlet and thrust reverser flight test unit for the Rolls-Royce BR725 engine.

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

Our team continues to work with the customer to incorporate required design changes.

Additionally, our Pylon teams, supporting the design and build of the Mitsubishi Regional Jet and the Bombardier CSeries Jet, are progressing well in their early stages of development.

On Slide 5, you see the wing systems segment, which is comprised of our Spirit Europe, Spirit Malaysia, and Spirit Oklahoma operations.

The core business continues to perform well on increased volume.

The segment margins are slightly lower than a year ago due to modestly higher R&D spending, supporting 787 derivatives and the A350.

Spirit Europe continues to execute well, while adjusting to lower business jet production rates.

The group met a key milestone this quarter by delivering the 500th 777 fixed leading edge.

Spirit Malaysia continues to gain momentum.

We conducted a formal grand opening ceremony on October the 28th in Subang, Kuala Lumpur, to officially open the Malaysia operations.

The facility, which will initially produce composite sub assemblies for Airbus single aisle aircraft, also includes an in-house design engineering team, working on developing assemblies for the A350.

Our AeroStructures team in Tulsa continues to execute well on core products.

In particular, the group delivered the 9th 747-8 fixed leading edge wing section.

The Tulsa team also progressed on new programs, evidenced by the delivery of Gulfstream program test products.

We have shipped the second G250 wing and the third G650 wing to the customer.

Spirit is proud to be part of these airplanes and shared recently in Gulfstream's celebration of their rollouts for both the G250 and the G650.

Our current concentration is on cost improvements and weight reduction activities.

We continue to work closely with our customers as we are moving these programs from design into production.

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

We delivered aircraft number 9 and number 10 forward fuselage in the third quarter and have already delivered units 11 and 12 in the fourth quarter.

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

We're continuing to work closely with our customer as we incorporate the necessary engineering changes on the initial in-service airplanes.

Our internal efforts remain focused on productivity improvements and increased utilization of the capacity and capability that we have put in place.

In the near term, our team is focused on production readiness as we expect to restart forward fuselage fabrication production this quarter.

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

Thanks Jeff and good morning.

I'll begin with our key financial metrics for the third quarter on Slide No.

8.

Revenues for the quarter were $1.054 billion, up 3% compared to the third quarter of 2008, reflecting high unit deliveries on 737, 777, and 787 programs and increased development program revenue driven by completed (inaudible) milestones on the 747-8 and continued progress on the A350 XWB and other programs.

Partially offsetting the revenue increase was a decrease in the 747 program deliveries during the transition to the Dash 8 model and FX headwind attributable to the strengthening dollar.

Operating income was $131 million, up 18% from the year ago quarter that was driven by higher production and development program revenues and lower period expenses.

Profitability in the third quarter of 2008 reflects the Company's initial estimated impact of the machinists' strike at Boeing.

Operating margins were 12.4% in the current quarter compared to the prior year period of 10.8%.

Fully diluted earnings per share of $0.62 for the quarter were 17% higher than earnings of $0.53 per share earned in the same period last year, largely due to the higher sales and operating income.

Our effective tax rate of 28.2% in the current quarter was slightly lower than the rate in the comparable period last year.

The cash flow from operations of $5 million and capital expenditures of $51 million during the current quarter reflect our continued investment in the 787 and other programs along with the year-over-year decrease of $48 million in customer advance receipts.

Reductions in deferred revenue of $26 million, partially offset by higher income in the quarter, also contributed to the reduction in cash flow.

On Slide 9, R&D expense in third quarter was $14 million, up slightly from the prior year period due to modest increases for the new program development spending in our propulsion and wing segments.

G&A expense for the quarter was $31 million, down from the prior-year period, due primarily to tighter expense control and lower non-cash stock compensation expense.

Combined R&D and SG&A expenses improved as a percentage of sales from 5% over the same period in 2008 to 4.2% this quarter.

On Slide 10, summarizes the P&L for the third quarter versus the same period in the prior year.

We realized approximately $2 million of net favorable changes in contract estimates during the quarter compared to $13 million of net unfavorable changes recognized in the Q3 2008.

This is attributable to the estimated impact of the Boeing machinists' strike.

The current period benefit was realized in the fuselage segment, due to continuing productivity initiatives while improvements in the propulsion and wing segments were more than offset by upward pressure on material costs.

Year-to-date results reflect lower 2009 revenues and earnings, resulting from the Boeing machinists' strike impact during the first quarter and the unusual items recorded in the second quarter, which included the G250 program forward loss, the Cessna Columbus program termination, and the cumulative catch-up adjustment.

Slide 11 summarizes the changes in our cash and debt balances from the prior quarter.

The $207 million cash balance at Q3 reflects a $118 million increase from the prior quarter, primarily driven by the issuance of $300 million in unsecured notes.

This proceed from this bond offering were used to repay outstanding credit line borrowings and enhance the Company's overall liquidity.

The total debt balances increased $148 million as a result of the bond offering and the repayment of outstanding credit line balances.

At the end of the third quarter, our net debt to capital ratio was approximately 32% and our total debt to capital ratio was 38%, up from 35% at the end of the second quarter.

Additionally, at the end of the third quarter, we had over $900 million in short-term liquidity available through our unutilized revolving credit agreements and cash balances.

As you know, earlier this year, we amended our revolving credit facility, extending its maturity to mid-2012.

The amendment also temporarily increased our revolver capacity to $729 million through June of 2010, adjusting the $409 million through mid-2012.

We anticipate that this capacity will be adequate to fund projected cash flow needs over the next several years as we execute our growth and diversification strategy.

Slide 12 details our cash flow for the third quarter of 2009 versus 2008.

Operating cash flow was positive $5 million as increased profitability was offset by inventory growth, decreased year-over-year customer advance receipts and deferred revenue.

Inventory grew $117 million in the quarter, as core program inventories declined slightly, offset by continuing investments in the 787 and the 2 Gulfstream programs.

Advanced payments include a decrease of $48 million between years and cash advances received, while deferred revenue also decreased $26 million between years.

The difference in advanced payment receipts along with reduction in deferred revenue in the current year largely explains the total variance in cash flow from operations between the third quarter of 2009 and 2008.

Capital expenditures were $51 million in the third quarter versus $56 million in the prior-year period as we prudently managed our expenditures while investing in new programs.

Slide 13 summarizes our updated guidance for 2009 compared to our 2008 results.

This guidance has been updated to reflect the shift in timing for certain development program settlements and our reduced capital expenditures forecast.

2009 revenues should be in the range of $4.1 billion to $4.2 billion, a 9% growth over 2008, assuming the midpoint in the range.

This growth results from resuming unit deliveries to Boeing at pre-strike levels, 787 deliveries expected in the fourth quarter, and growth in revenues from non-Boeing customers.

Partially offsetting this growth is currency headwind from our UK operations.

Assuming the current dollar-pound exchange rate, the negative currency headwind impact on 2009 revenues will approach $100 million for the year.

The Company expects $1.45 to $1.55 in fully diluted earnings per share for the year on projected revenues.

This remains unchanged from the September guidance issued in conjunction with the notes offering.

The guidance includes SG&A and R&D expenses for the year, represented approximately 5% of sales, slightly less than the percentage in 2008.

Included in our guidance is a slightly higher net interest expense and a 30% effective tax rate, slightly favorable to earlier expectations.

We expect cash flow from operations to be significantly stronger in the fourth quarter as we receive payments for development programs.

For the year, we now expect cash flow from operations, less capital expenditures and net of customer reimbursements, to be a negative $150 million or better with approximately $225 million of capital expenditures.

This updated guidance reflects a shift of payments on certain development programs from 2009 into 2010.

The primary risk to our 2009 guidance is the planned revenue and cash impact associated with our development programs.

If we do not receive these payments in the fourth quarter, they would shift into 2010.

Regarding 787, our guidance assumes that we will ship 10 ship sets in 2009, of which 6 were shipped by the third quarter of this year.

And as Jeff mentioned, we shipped an additional 2 units in October.

We are also assuming a production ramp-up in subsequent years consistent with our updated customer schedule.

If Boeing 787 schedule changes, our 2009 guidance may be impacted accordingly.

And we expect to provide 2010 financial guidance when we release our fourth-quarter and full-year 2009 results.

And now I'd like to turn the call back over to Jeff for some closing comments.

Thank you, Phil.

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

We had a solid third quarter that shows our core operating business is performing well.

Our continuous focus is on meeting our customer commitments, while managing costs and driving productivity improvements.

We continue to grow and diversify our business, as we execute our long-term strategy.

The development programs are progressing.

We've obviously experienced some growing pains in this area, but believe that we have a good go-forward plan for improvement.

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

We will now be glad to take your questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Carter Leake with Davenport Company.

Please proceed.

Good morning, gentlemen.

Just fuselage margins for cum catch-up, I get an impressive 17.3%.

Can you speak to that margin and whether you think that's sustainable?

It looks like fourth quarter would probably have to go down to meet that.

But speaking to sort of 2010 and forward?

Yes, I think it's a -- Carter, we are looking at 2010.

We're not providing guidance here today obviously.

But some things we're thinking about in 2010 alright is kind of what we know is sort of the wide body rates are coming down, 777s notably.

747-8 schedule is moving a little bit.

Boeing's announced a new schedule.

We are in the process of taking a look at that schedule.

And then, 737 all indicators are it's going to remain where it's at.

Though, I think, as Jeff said, we're watching the single aisle rates closely.

So as we go into 2010, there was a few headwinds.

One is if the volumes were to come down significantly, that's has got some negative leverage on the operating margin associated with that.

And then, we fully expect 787 to be a higher production year for us, a higher delivery year than 2009.

So, there are some headwinds as we go into '10, mainly around volume and 787 ramp-up.

Your next question comes from the line of Ron Epstein with Banc of America/Merrill Lynch.

Please proceed.

Yes, good morning, guys.

Good morning, Ron.

Just maybe I guess two questions.

Jeff, in your opening remarks you mentioned that you maybe have a little bit of caution about 2010.

Can you speak to that a little bit more?

I mean what are you thinking about in narrow body production rates, that kind of thing and what are the odds we see a cut there?

And what else maybe worries you about 2010?

Okay, sure Ron.

Be glad to.

Specifically, I think as Phil just mentioned, we are going to see some production cuts in 2010 that have already been announced, especially in the wide body, long-range products.

The single aisle, narrow body, as you know, has so far defied, if you will, the accumulated wisdom of all the analysts' forecasts.

And I just think there is enough variance between a flat production rate, if you will, which is kind of the plan for today and what you all are seeing and many other people -- observers in the world are seeing that we just remain really cautious about that.

I have nothing to report or really any forecasts other than kind of a continuation of where we are today.

But just -- there's just so many signs out there and so many prognostications that say the rates need to come up, need to trim that we look at that very frequently and look at a lot of scenarios to try to ascertain what we'll need to do if we need to trim production.

Okay great.

And then just one follow-on maybe for Phil.

As inventory was up in the quarter, what was in the inventory and when would we expect inventory to start coming down?

Great question, Ron.

So the core business inventory that's really generating revenue and earnings today, inventory is really -- is in good shape.

I mean it tends to be very stable or even slightly coming down as we're working that really hard.

The things you see growing are the development programs.

It really comes in two flavors of the capitalized preproduction costs that are growing, mainly on the G650 program at this point.

And then there's the third production costs which are contributing to the growth.

And, as you know, those are costs that are simply learning curve related where we're building the first units that are over the average costs for the block, the accounting block.

That creates deferred production.

And so that's largely getting driven by 787 as well at this point.

And that's where the growth is coming from.

Looking out over the next couple of years as we implement these development programs, I think our expectations, there will be some modest growth over the next 24 months or so before we start burning it off.

And that's where we are.

We don't expect it to be a significant growth, but it will grow modestly.

Okay, great.

Thanks.

You bet.

Your next question comes from the line of Howard Rubel with Jefferies & Company.

Please proceed.

Thank you very much.

Jeff, as you start to prepare for the restart of the 787, how should we, outside looking in, evaluate your progress?

And what have you sort of done to make this as seamless as possible?

Okay.

Howard, a couple things.

First of all, realize we've not shut down the installation assembly area.

That's been active, although at a much lower rate than we had originally projected so the system installation and the area where we've actually done a lot of change incorporation has been quite active.

The fuselage build fabrication piece, we have I think fired a couple more units since we talked to you last quarter to make sure the equipment was working, to research some processes, to look at some new ideas that we'd been able to incorporate.

So we think later this quarter, we'll fire that up again in a production mode and be production ready.

And I think the only thing I can tell you to really watch progress is of course you can ask us how we're doing.

We'll respond.

But I think also is our ability to hit the demand pull signals that we're going to get from the customer.

But right now that all looks ready to go.

And then as a follow-up on another area where it looks like you've done a nice job with costs.

Could you help me understand what you've done to -- I mean this a fairly dramatic cut in SG&A in the third quarter versus what the run rate had been.

And is that sort of what you think you can do going forward?

I think we saw a relatively deep cut in this quarter.

And there are a couple things in there that are not going to repeat themselves.

But you're going to see and I think we've predicted for several years now, you're going to see a flat to down G&A for the Company that we've -- we had some unusual things in the first several years in G&A and some stock expansion from the start-up of the Company and the IPO that are washing out of there.

You're going to see a pretty strong control of SG&A.

But the third quarter was down a bit, more so than we would normally see.

I mean you were able to sort of hold your guidance despite sort of lower revenues and higher interest expense.

So this had to contribute to that?

I think Howard we still expect, when you combine the G&A and the R&D accounts, roughly kind of 5% of sales for the full year.

Thank you.

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

Please proceed.

Hey, it's actually Joe DeNardi for Troy.

Just a couple questions on margins.

If you look at propulsion systems, they've kind of been coming down there now around 13%.

Is that how we should kind of think about those going forward, before margins pick back up?

We actually think that business unit -- it's got some issues around the, as we mentioned the 747-8 startup and it's got -- it's the area of our business where we have the biggest impact of our aftermarket.

And aftermarket's been down in terms of major repairs, overhauls of thrust reversers.

So, it's gotten an extra down from those two areas.

We think mid teens is where it can settle out with these production programs.

And that's really what we should expect.

Okay, yes, that's helpful.

And then kind of a similar question for wing systems; you know 10% going forward and I guess when the G650 work picks up, is that going to be dilutive to margins there?

Two things, again we think through time -- again historically, our wing system started at a significantly lower threshold.

We think we will continue to improve through time, although last quarter we had a setback in that improvement -- in that improvement march.

But we think it'll continue to improve through time.

What was the second part of the --?

Just when G650 --?

The G650, yes.

In general, we think that we'll see solid continued improvement through time in the wing segment.

There will be some ups and downs for various reasons.

But we expect the 650 to be a very solid program for us.

Okay, thanks.

Thanks, Joe.

Your next question comes from the line of Noah Poponak with Goldman Sachs.

Please proceed.

Hi, good morning, guys.

Hi, Noah.

Good morning.

Good quarter.

I'll try another margin question.

The rough math, so let me know if I'm missing something here, but it looks like if I take the revenue range and the EPS range you're giving for the full year and the comment you just made on SG&A and R&D adding up to 5% of sales.

It looks like you're calling for in the fourth quarter a pretty substantial downward movement in the operating margin relative to the first three quarters of the year.

Why would we see that?

Well no, I think -- so I think you're right.

The SG&A, you know we expect it to increase in the fourth quarter.

So when you combine that growth with the development efforts we talked about.

So we have a significant effort in the development front to get really the earnings in.

So that's -- you've some risk, some tiny risk associated with it more than anything else, which we discussed.

When you combine those two, that's kind of where you get the downside.

Now, as you know, we're what we consider appropriately conservative when we forecast things in this environment.

So I think when you combine the SG&A, the development effort and then just some conservatism, that kind of gets you there.

Yes, that makes sense.

Can you guys -- separate question, can you give us a little more color on the 250 program?

You told us you shipped a second wing.

Maybe talk about the progress, the management changes you've made over there -- have made?

And sort of how much risk remains on this program?

Sure, be glad to.

Of course, you know the backdrop we spent a lot of time talking about it in the second quarter.

We've talked about some of the industry wide dynamics that made it tough for us to staff the program, those sorts of things are, we believe, behind us.

We've had issues with change control on the program where we let the work statement creep on us and we didn't manage it tightly like we should have.

So, we've -- I think we've closed those holes.

We've got airplane wings to the customer.

They got it mated to the fuselages.

So we're clearly over the hump of getting initial hardware in place.

So all those kinds of risk factors are behind us.

The risk factors that are still in front of us are whatever comes out of flight test.

And then what is the -- what are the production rates?

And how soon can we get this program into a full-rate production mode?

Get the supply base putting out parts to us in a timely way and on a drumbeat?

I use that term drumbeat a lot because once you get programs onto a drumbeat, then there are a lot of things you can do to improve it.

Until you do that, it tends to be a herky, jerky, a disruptive type environment that's hard to manage.

I think we've got it.

We've got it under control.

We've got a good team overseeing it.

So, I think we've done the things we said we needed to do.

And it's just got to play out now, get into production and get some volume moving so that we can begin to make improvements.

And with regard to that, the OE there had -- they're kind of on schedule but at one point they had talked about maybe first flight in the third quarter and then they've most recently said early fourth quarter, which is now kind of passing us.

Do you have any sense of timing on getting into flight test?

No.

Not anything more than --

No more than you would have Noah.

Thought it'd try though.

Okay, thanks a lot guys.

Great quarter.

Thanks Noah.

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

Please proceed.

Yes, I'm joining the call a bit late.

If you haven't answered it, if you could, could you update us on how you're doing on some of your other new programs, specifically the A350?

Sure.

Cai, I'd be glad to.

First of all, you guys know, you watch this all the time.

New programs are all challenging.

They've got some of the same dynamics but to varying degrees.

The upfront original design, the specs, the -- any changes you have in loads and stress loads and so on are big deals.

If you catch them early, you can put them into the design.

If you catch them later, then you've got to do a lot of rework.

So there's a lot of give and take early in programs.

A lot of schedule movement back and forth early in programs as you balance weight and stress and all the things associated with the design evolution as it happens early in the program.

So every program has the dynamics and those risk factors.

How well you manage them throughout the whole program, with the customer, with the supply base, whatever makes a big difference in how much you're able to absorb later in the program.

And then, of course, the amount of new technology inserted into a program has a huge impact as well.

Our program -- our development programs are all across the board, some with a lot of new technology, some with less, some with lots of complexity of different products for us to build and some with just one.

So, I think overall we said we're about 60% done with our programs.

I mean clearly the first wave was 87, the 47-8, the P-8A.

We've talked about each of those.

The P-8A has been just an incredible success in terms of getting that through, getting it through on time, getting it through with good, solid performance and delivery.

There's another group kind of in the middle of our pack, the 250 we talked a lot about; the 650 we've had challenges on those as we've talked about.

But again, we're delivering hardware there and we've got to work through, as we virtually always do on every program I've ever been associated with, some weight issues and certainly getting it into production, getting those to flow.

BR725 is kind of in the same time period.

Again, we've delivered hardware and we'll work production issues with that as we get it up on the stepping on a drumbeat.

CH-53K, Sikorsky program that's in a -- right now in a heavy design release phase, trailing some of these others that I've talked about.

But we're working really hard there, doing well, meeting demands on that program.

It's a very weight-sensitive airframe.

And so we've put a lot of extra effort on making sure that we're in the envelope where we need to be on weight.

CSeries, MRJ, Pylon, those are pretty early and going well.

Pylons are pretty -- I mean they're new Pylons but it's pretty standard technology for us.

So we expect those to be pretty solid programs for us.

The A350, I'm pleased with where we are at the A350.

It's still in the -- clearly the first half, if not the first third of all the major work that we're doing.

So you're seeing some give and take on weight, on schedule, on loads, all those things.

I think -- I'm very pleased with our team.

We just had a celebration yesterday on some work we're doing on the wing spar and celebrated some real solid performance by our wing spar team.

So, I mean it's moving along.

It's got to be managed well.

The change control has got to be -- it's got to be managed.

The schedule, getting the drawings out, all those things.

So there's some give and take in the schedule, as there always is early on.

And now the key is going to be Cai for us to keep the changes in the window and deliver on the commitments that we've made.

From what you're saying, it sounds like the CSeries and the MRJ are really lower risk programs.

There might be more challenges potentially on the A350 and the CH-53.

You may be a little too early to tell if there's going to be a problem.

What are the milestones we should look for on those two programs?

And when do you think you'd kind of be in a situation to know clearly well whether there's going to be an issue like you had on the 650?

Well, the only thing I can say is that the program milestones themselves, we don't preannounce.

We let our customers do that.

But, I mean I think clearly the -- getting through the design phases, having the customers hit preliminary design reviews and critical design reviews and key milestones on the program, those are really important.

And incidentally, it's extremely important to really hit them and not just pass them and declare them victories.

So, I think key is watching the programs.

And if you hit the intermediate milestones, your chance of hitting the final milestone in pretty good shape is way higher than if you have to slide in (inaudible) milestone.

Terrific.

Thank you very much.

You bet.

Thank you.

Your next question comes from the line of Joe Nadol with JPMorgan.

Please proceed.

Hi, good morning, guys.

Actually, it's Seth for Joe this morning.

Hey Seth.

Just a couple of quick questions.

First of all, on margins you talked about some of the large swing factors for next year.

And I was wondering if one of them is still the renegotiation of contract blocks with Boeing?

Actually, it is not the renegotiation of contract blocks.

We set the contract blocks.

So the length of those contract blocks do have a potential impact depending on what your forecast for demand is during that period of time.

So, clearly -- let me just talk a minute about -- I think clearly we believe we're in an environment where there are more headwinds than there are tailwinds.

And I say with a little bit of tongue and cheek, but flat is the new up in the kind of environment that we're in.

So, clearly volume has a big impact on our business.

And any concerns about reducing volumes are like we're going to see in the 777.

We've got some headwind with where whatever the schedule turns out to be on the 747-8 as Boeing works through the issues of that program change.

It's a bit of a mystery to me, but we've seen parts of our supply chain that are looking for significant price increases, especially those who supply us specialty products.

And where that's the case, we're aggressively developing and looking for alternatives.

And then of course the 787.

You know that -- we're amortizing our capitalized preproduction over the first block of airplanes, which is the first 500 airplanes.

And this is going to provide headwind for us as we produce more -- produce and deliver more 787s.

So, though the 787 will get back to a more normal environment in the follow-on blocks, there's still a fair number of headwinds.

Now, though there aren't natural tailwinds, we do work very hard on productivity and supply base, both -- productivity both internally and in our supply base, given where we are in the economic cycle.

So, I hope that gave you a little bit of flavor for the way we're thinking about things.

Sure, absolutely.

That's helpful.

And then, just as a quick follow-up, on the changes to the guidance and the potential changes going forward, is it correct to assume that the settlement payments that aren't coming into this year are related to the 87 and the 47-8?

And the development program payment you're waiting on in Q4 is for the A350?

And also if you can kind of put some -- quantify the magnitude of that development payment that could come in Q4?

Yes, Seth.

This is Phil.

So the 78 is clearly the thing we're adjusting for here.

We didn't have a lot in there forecasted but clearly we think those talks have slowed.

We listened to the Boeing call as you did.

Now the rest of the Boeing product, where even just this normal course of business where we are -- we have things we negotiate all the time, those tend to go very, very well.

There's always timing associated with it.

747-8, we've had a lot of success with our customer working those things out.

So, we expect to do that here in the fourth quarter.

The 350 is going very well as we accomplish some milestones, some of which Jeff mentioned.

So we're more comfortable with the 747-8 and the A350 at this point.

And our guidance as far as sensitivity reflects the appropriate amounts of those issues.

We think we have a good foundation for getting the development revenue and earnings in, in cash.

And our guidance reflects that.

Okay, great.

Well, thanks very much, guys.

Thanks Seth.

Thank you Seth.

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

Please proceed.

Good morning.

Morning, David.

You just talked about volume being a headwind.

Just going back to the future blocks, some of it has to do with what kind of profitability that you're going to assume on those blocks.

Can you just talk about that?

I mean because obviously your average -- the average kind of rates within your current blocks are actually for the most part below where we are today.

So, maybe just talk about profitability in the next blocks and what a new labor contract might do to the profitability for those blocks as well?

Sure.

I think -- really a couple thoughts, Dave.

First of all, again I talked about all the headwinds and I think you know what all those are.

You know there's one we didn't talk about.

We've had a fair amount of pension earnings in our numbers prior to this year.

And I think -- and that's reflected in some of our blocks that we don't anticipate going forward.

So there's a forecasting difference there.

And clearly, we've got labor contracts.

We had some freezing of labor in the first part of the blocks that are going to be closing.

But again, we had a -- we were in a rising-rate environment.

And the rising-rate environment does give a lot of efficiencies that you don't have in a environment where you don't anticipate the rates to continue to rise.

So we've got some -- we've got a fair amount of volume.

We've got some clouds on the horizon.

And I think we're just working really hard to weather through that and get the maximum value we can get.

We've got to work productivity.

We've got to get through, as you know, we have the labor negotiations in 2010 with the IAM at our Wichita site.

Those are big deals to us.

And we got to get through those and weather whatever is in front of us in terms of the market.

Okay.

And then on the 650 and 250, I don't know if it's been asked yet, but were there any significant movements in terms of the underlying accounting for either of those?

I mean obviously if the 250 would have gotten worse, you would have had to have taken a charge.

But did kind of the -- some of the assumptions that you've put in place at the end of the second quarter, did those improve on the 250?

And kind of same thing on the 650.

If anything, did it get worse underneath the surface?

There's no significant movement on those.

Okay.

Thanks.

As you know, David, just a little color to that, things don't tend to move real quickly.

You can -- I mean you can get a surprise like we did in the second quarter from the results of the strike and things like that or an assessment of what the market was.

But underlying assumptions that we've put in place are pretty solid.

Yes, and I would just follow on David.

You know the team in Tulsa is making headway.

So I think we feel good about the forward progress to date.

And the other thing I'd say is we don't expect real quick movement.

We expect -- in some of these things, it's a long, hard slog.

And the team's doing the job and working through the issues and making the progress that we expect them to make.

Your next question comes from the line of Carter Copeland with Barclays Capital.

Please proceed.

Good morning, gentlemen.

Morning, Carter.

I wondered if you could take a moment and talk about how the R&D profile is now kind of shaping up over a multiyear kind of basis?

Your largest customer has said on numerous occasions, stated their desire to bring a lot of the R&D back in house for things like the 787 derivatives.

And I wanted to know how that -- how you see that influencing the R&D profile you envisioned as recently as a couple quarters ago?

My thought on that Carter is we've established a level of R&D for kind of base R&D that we need to make.

And we will continue to sustain that.

They'll be some variability to that based on program to program.

But, I think R&D in this business is an extremely important part of the puzzle.

And you'll see some fluctuations in it, program specific, but not a lot I don't believe.

No, I guess I'll ask in another way just to be clear.

Due to Boeing's desire to essentially fund more of the R&D and do more of the R&D that it seems -- that they seem to be doing, is that-- do you picture that materially influencing the R&D profile you had envisioned for things like the Dash 9 over the next couple years?

I mean are you expecting on spending less in R&D or are these things that still need to be negotiated?

It could have some impact.

But it's yet to be negotiated.

Okay, and then just one quickly for Phil, just for clarification on the cash flow guidance.

I mean it's pretty obvious it incorporates something for a cash flow collection -- cash collection on the 787.

I'm just interested in your last statement that sort of guidance incorporates the uncertainty around that amount.

Does that mean that you've included it but at some reduced rate?

And if you were to actually get more than you expect, you would beat your cash flow guidance?

And if you don't collect it, it will shift into '10?

Is that the right characterization?

Yes, I think it is Carter.

I mean these things are all subject to timing.

Not if you get it, it's when you get it typically.

And, as you know, the 78's been the most challenging to make progress on.

And that's all kind of rolled into our guidance.

I think we feel much better on the 47-8, A350 and other programs we're negotiating things on.

So I think --

But you've got it in there at a sort of a presumed -- an assumed percentage of recovery, not in its entirety?

Yes, I think we have it in there at the appropriate level to make this -- makes us all comfortable here.

Okay, thanks a lot guys.

Okay, Carter.

Thank you, Carter.

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

Please proceed.

Morning.

Good morning, Rob.

How are you?

Good thanks.

Guys, a question for Phil, really a follow-up to the last one.

So if we look at the $200 million or so that you used on the operating cash flow line, the first 3 quarters.

And if I understand the guidance, sort of the best case scenario for Q4 is a positive $50 million, $60 million?

You're talking free cash flow --?

Well, yes.

Well I think if you look at the -- just kind of roll back and to the $150 million of -- better than $150 million -- and roll that through our CapEx, it kind of takes you to a slightly negative cash from ops line.

So, I'm sorry -- about $170 million positive.

So, that's largely related to the development programs we're talking about Rob.

Okay, cause I was going to ask you to walk through how this works.

Because if inventories are going to creep up a little bit and you're still -- you're going to be delivering 787s at negative cash flow here through next year, up to -- at least 40 units or so, right?

And how should we think about the cash treatment on the non-787 deliveries for other development programs?

Whether it be 747-8 or Gulfstream or what have you.

Are those -- do those have the same cash treatment?

No, because -- most of them except the 78 are cash as we accomplish milestones.

Okay.

So, the 787 is very unique.

I'm trying to figure out if you don't get these payments from Boeing on the 787 in the fourth quarter, that would be the basis for the language in your guidance which says best case scenario, here's what we're going to do.

Well it's actually -- let me just interject Rob.

It's actually not just the 787.

There's several programs in there that have milestone payments in the -- actually in December.

And those milestones are not hard and fixed necessarily.

There's a combination of work that we accomplished and then is accepted and approved by the customer.

And if the customer is late in getting that done then it can move weeks one way or the other, they're early or late.

And so there's just enough uncertainty with kind of the normal flow.

It happens to flow in the fourth quarter and in the last month of the fourth quarter.

But it's kind of when the milestones were set.

And so there's some uncertainty associated with those.

And then there's some negotiation that we have underway on the 47-8.

So there's several programs in there that can impact that.

Okay.

Where I'm really going with this and I know you don't want to guide to 2010, but I'm having a tough time seeing how cash flow is going to improve much next year with what's going on with the 777 coming down.

I suppose that draws down a little bit of inventory.

But Phil, how close are you at this point with the new debt and the cash flow situation to your covenants?

And were they revised at all last month?

No, look I think we've done a lot of work on the capital structure and liquidity this year.

Most of which I mentioned in my comments.

So, that's kind of off the table.

I think you're really looking for 2010 guidance, which obviously we're not prepared to provide you a lot of detail on today specifically.

So I think you have all the components for the environment of 2010 though.

You know there's known volume declines.

There's the potential for volume declines.

And then we have a development cycle we're going through here as we execute the strategy.

We'll provide you the specific 2010 guidance when we do the fourth quarter call.

But I think there's an important point here.

And that is you ask about covenants.

And we look at our covenants and we watch them.

But we are not -- it is not a concern area for us.

Don't lose sleep over that Rob.

Those are -- we're well in the range we need to be on those.

Okay, thanks guys.

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

Sir, your final question is a follow-up from Noah Poponak.

Please proceed.

Thanks.

I just wanted to follow-up on narrow body rates.

Some of the public commentary from Airbus sounds a little more squishy.

And Boeing in the third quarter actually had their total deferral number accelerate from the first and second, even though throughout the year they've talked about the request decelerating meaningfully.

How close attention are you paying to those types of things?

And maybe do you feel better, worse or the same today versus three, six months ago?

That's a good question, Noah.

Two answers, one, we pay very close attention to it.

And two, I felt terrible three months ago and six months ago, terribly worried I should say.

And I remain that way.

Like I said earlier, there's a lot of disagreement here about whether the rates can hold or not.

So far they've held.

I think in the face of many people saying they would not have held this long.

I know there's concern that holding them this long creates more of an issue.

But, I'll also say that so far both Boeing and Airbus have stated they've been able to hold their rates.

So I mean I'm pretty ambivalent on this point, frankly.

I could see both sides of it.

We know all the dynamics that we're in.

We know the upside wasn't as high.

We didn't drive deliveries near as high as we have proportional to the backlog in future cycles.

So that's a, in fact, a help to keep rates propped up in a softer sales time period.

We know the -- our backlog actually was flat from quarter to quarter in an environment where you would expect it to have had a little bit of runoff.

We had some contract extensions that propped up our backlog.

So we had flat backlog second to third quarter.

So, there's some decent signs and there's a lot of storm clouds.

So the combination of the two, is we just remain cautious.

And running scenarios and trying to stay out ahead of what the customers need.

And I know they're doing that with their customers.

So, anybody's call is as good as anybody else's I think at this point in time.

The one thing that gives me the most concern is the analyst community, and as a group, is forecasting substantially below current production rates.

And I think that's a cause for us to take serious notice and make sure we have scenario plans in place.

Yes, that's very helpful.

Thanks a lot and, again, good execution.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a wonderful day.