Spirit AeroSystems Holdings Inc (SPR) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Spirit AeroSystems Holdings, Inc.'s second-quarter 2011 earnings conference call.

My name is Crystal and I'll be your operator for today.

(Operator Instructions).

As a reminder, today's conference is being recorded.

I would now like to turn the presentation over to your host, Ms.

Coleen Tabor, Director of Investor Relations.

Please proceed.

Good morning.

Welcome to Spirit's second-quarter 2011 earnings call.

I'm Coleen Tabor, and with me today are Jeff Turner, Spirit's President and Chief Executive Officer; and Phil Anderson, Spirit's Senior Vice President and 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 the web presentation.

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

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

Thank you, Coleen, and good morning.

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

I'll begin with a look at our business and related performance.

And then, Phil will review the financial results.

After that will be glad to answer your questions.

Our core business continued to perform well in the second quarter as we delivered on increased volume and realized productivity and efficiency improvements.

As the recent order flow at Signal, we continue to see strong demand for large commercial aircraft and improving demand in the business jet market.

With an increased backlog over $29 billion, not including the recently announced orders, long-term growth perspectives for Spirit continues to be strong.

As the core operating base grows, we continue a disciplined transition to higher production rates across our sustaining products.

Throughout this transition we are focused on productivity and efficiency to drive long-term value.

With five of our development programs progressing towards certification in 2011, our priorities continue to be meeting customer commitments and positioning all of our programs for long-term value.

We recently completed our go forward plan on the 787 program, celebrated the rollout of the first C-Series test pylon from Bombardier, and announced our plans to establish a program management and production for the Gulf Stream G280 program in our Kingston, North Carolina facility.

While the outlook is positive, we remain watchful of global economic and political dynamics as we execute our growth and diversification strategy.

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

Fuselage systems delivered operating margins of 12.3% on $773 million in revenues during the second quarter, which includes the impact of deferred revenue associated with the 787 program.

The fuselage segments rate increasing 737 production line continues to perform well as the team delivered its 3,700 ship set of the next generation fuselage.

The 787 team also made further progress by delivering 7 airplane fuselage sections in the quarter including the forward fuselage number 44.

We are pleased with the progress of our joined Spirit and Boeing 787 teams.

We are pleased with the progress they are making as they work together closely to identify and implement cost improvements for the program.

The Fuselage Team also continued its progress on the 747--8 program this quarter by delivering the 31st forward fuselage.

Additionally, the A 350XWB fuselage team continues to mature the engineering on the program and panel production is nearing completion for the first article.

On slide four you see the propulsion team delivered solid operating performance with margins of 15.2% on $318 million in revenue during the second quarter.

As margins continue to improve through productivity and efficiency improvements and some additional aftermarket volume.

Segments core business continued to perform well while transitioning to higher rates surpassing line units of 3700 in the quarter for both the 737 next-generation engine pylons and thrust reversers.

In addition, progress on newer configuration pylon production hardware continues as we shift our 46 787 and 28 747--8 engine chipsets in the quarter.

The proportion team recently achieved a significant milestone as they rolled out the first test pylon for the Bombardier T series.

This milestone is the latest example of our successful diversification strategy and focus on meeting customer commitments.

The team continues to support development activities for the Rolls Royce BR725 engine to sell and design activities on the Mitsubishi regional jet program.

On slide five you see the Wing systems segment which primarily consists of our Europe, Malaysia, and Oklahoma operations.

The Wing team reported operating margins of negative 8.4% on $373 million in revenue during the second quarter which included the impact of deferred revenue associated with the 787 program and the previously announced $53 million charge on the G280 program.

Spirit Europe continued to produce significant volumes of hardware for our Airbus customer surpassing line unit 4800 for the A320 wing components.

The Wing team continued producing on new programs in our Tulsa, Oklahoma site as they delivered the 30th 747--8 fixed leading-edge wing section and the 46 set of 787 slats during the second quarter.

Early production efforts continue in Tulsa on the Gulfstream G650 and G280 wing programs as we prepare to establish production for the G280 in our Kingston, North Carolina facility.

As you can see from the picture on the slide, the global Trans Park location represents an opportunity to shift our footprint to leverage our capacity and allow our management teams to focus on the success of all of our programs

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 a look at Spirit's key financial highlights for the second quarter on slide number seven.

Revenues for the second quarter 2011 were up significantly, as expected, compared to the second quarter of 2010 as we successfully finalized and incorporated the results of the 787 contract amendment during the quarter.

Deliveries to Boeing commercial airplanes were up almost 10% over the same quarter last year while Airbus was essentially unchanged and business jet deliveries increased.

Excluding the impact of the 787 contract amendment, revenues grew by approximately 7% over the same period last year.

Operating margins for the quarter were 4.3% compared to 2010 second quarter margins of 8.1%.

The second quarter of 2011 operating margins included a 3.6% negative operating margin impact associated with the previously announced G280 charge and were further impacted by the 787 program revenue which we continue to book as zero gross margins.

While the quarterly reported results reflect these two significant items, the core business and operating engine of the Company continues to perform well as we expand capacity increase production rates.

During the quarter both fuselage and propulsion segments realized favorable cumulative catch-up adjustments as these programs achieved -- these segments achieved productivity and efficiency improvements.

Fully diluted earnings per share for the quarter was $0.21 per share reflecting the $0.26 per share impact related to the G280 program, lower R&D, higher interest expense and a higher effective tax rate as compared to $0.39 per share second quarter 2010.

Second quarter of 2010 results included a $0.10 per share impact associated with the International Association of Machinists ratification of a 10-year labor contract.

Cash from operations for the second quarter of 2011 was $114 million use of cash and a net reduction of inventory was more than offset by cash advance repayments and higher AR and AP balances related to the timing and production rate increases.

Capital expenditures were $43 million for the quarter compared to $61 million during the second quarter 2010.

Quarterly capital expenditures are expected to increase as we invest in new business and capacity expansion throughout the year.

On slide 8, second quarter R&D and SG&A expenses reflect our continuing disciplined expense management and lower 787 related R&D.

SG&A expenditures increased slightly driven by stock and incentive compensation increases when compared to 2010.

The expense management continues to be a top priority for the Company as we expand our core programs and bring new programs into production.

Slide nine summarizes cash and debt balances.

Cash balances at the end of the second quarter were $154 million as compared to the first quarter 2011 balance of $311 million.

At the end of the quarter our total debt to capital ratio was 39%.

The Company's liquidity position and balance sheet remains strong as we invest in new programs and capacity expansion for our core programs.

Slide 10 summarizes net inventory balances which decreased by $212 million during the second quarter of 2011.

Physical inventories decreased by $26 million largely driven by improved inventory management practices and factory efficiencies.

Deferred production inventories decreased by $195 million related to the settlement of the 787 contract amendment and offset by increases in these programs.

Pre-production inventories decreased by $34 million during the second quarter as we incorporated the G284 loss.

Nonrecurring inventory is increased by $43 million driven primarily by our continued investment in the A350.

And over the year inventory is expected to grow though more modestly as we continue to increase production rates and invest in new programs.

Slide 11 summarizes our revised 2011 four-year financial guidance.

Based on current customer demand our revenue guidance is unchanged for 2011 and it is expected to be between $4.5 billion and $4.7 billion.

Fully diluted earnings per share is now expected to be between $1.40 per share to $1.50 per share.

The updated range includes the $0.26 per share impact from the G280 program and a lower profitability outlook on certain development programs as they progress through the design and test phases and enter initial production and volume ramp up.

Cash flow from operations for 2011 is now expected to be approximately $50 million and capital expenditures are now expected to be approximately $300 million as we invest in core program capacity expansion and new program growth.

Our updated 2011 tax rate is now expected to be approximately 30%.

The R&D and SG&A accounts together now expected to be between 4.25% and 4.5% for the full year 2011.

We continue to expect 2012 revenue to grow above the 2011 guidance range as demand increases for our core products and new products enter the production and delivery phase.

We continue to expect cash flow from operations less capital expenditures to be positive in 2012 as cash advance repayments decline and working capital investments stabilizes.

I'd now like to turn it back over to Jeff for some closing comments before we take your questions.

Thank you, Phil.

I'll wrap up on Slide 12.

As we transition to higher production rates across our core business and with some of our new programs as well, we remain focused on execution and systematic ramp up.

We will continue to strengthen our core operating base through productivity and efficiency across the business.

As many of our development programs continue to mature into early production, our teams are focused on transitioning them into stable full production.

Looking forward we will continue to benefit from the expanding demand for commercial aircraft while acting on lessons learned.

As we execute our growth and diversification strategy, we will create long-term value for our customers and shareholders and employees.

We will now be glad to take your questions.

(Operator Instructions).

We'll take our first question from the line of Robert Stallard with Royal Bank of Canada.

Please proceed.

On the free cash flow situation, you said you expected to be positive next year.

When would you think you will feel comfortable about giving some sort of framework of how positive you expect free cash flow to be next year?

Good morning, Rob.

I think as we move to the second half and we mature several of these development programs, get them certified, get the production footprints set with the G280, and then get the initial capacity installed on our other programs, I think we get much more comfortable talking about probably in the fourth quarter.

So that's kind of where it is.

Okay.

Then as a follow-up, I was wondering if you could give us a reminder of when the blocks on your largest programs roll over on next year?

Yes.

Sure.

The 737 block actually concludes later this year and the triple seven block moves to the next contract in the first quarter of next year.

So the 737 block that expired this year, that included all the production rate increases that have been announced by Boeing?

Well it certainly includes our current view.

So, yes.

I mean, the answer is yes.

But most of that volume is in the next production block.

So what we're seeing right now, you're seeing some of the capital being laid in place to expand the capacity, but the actual return on that comes into the next accounting block which we'll talk about when we roll out 2012 guidance.

Thanks very much.

You bet.

Thanks, Rob.

Our next call comes from the line of David Strauss with UBS.

Please proceed.

Good morning.

Good morning, David.

Phil, did the deferred revenue from the 787, was that $250 million or so in the quarter?

Well, that -- you can kind of look at the balance sheet and see the majority of the deferred revenue account change was driven by the contract amendment.

Yes.

And can you tell us what 787 deferred production did, the deferred production balance did in the quarter both -- I know it came down because of this, but what would it have looked like X the deferred revenue adjustment?

I mean the whole incorporation of the amendment, David, obviously reflects 4+ years of activity in the program and all flowing through here in the second quarter and reflecting the amendment that we put in place.

So I think you've really -- to the program, maybe Jeff has a comment, but the program is going quite well.

You've seen the per production coming down nicely and so all that effort continues today.

It's going to be a little bit tough to get to that number here in the second quarter given all of the moving parts.

But I would just suggest to you that it continues to improve and the third quarter will probably be a little bit of proxy for the overall improvement curve that you're trying to get to.

And my last question is the guidance, if you look at the revenue guidance what it implies for the second half is it looks like revenue, X the deferred revenue in the second quarter, it looks like the rate steps down almost from where you were, like $1.2 billion or so you were at X the deferred revenue.

And then on the margin side, is it correct, roughly, you're assuming about 11% margins in the back half of the year and is really the main upper there just related to the move to the new block on 37?

The volume line, I mean I think you're relatively calibrated on that.

The bigger the volume, the variable in the second half is 7%, 8% really so kind of depending on where we end up on deliveries for the year.

I think we've got 13 so far this year.

We kind of expect that to double as we move to the second half.

Your margins, I'll just make a comment as far as if you look through the volume here in the second quarter which I mentioned earlier the growth over the 2010 quarter was about 7%.

If you look at that revenue adjustment, you see very consistent margins for us after you kind of get through the 280 and the QM [catch], you're actually seeing margin expansion in the cross propulsion and fuselage and the wing has got a solid 9%, 10% pad in front of it.

So that's kind of how to think about the margins.

Thank you.

Our next question is from the line of Joe Nadol with JPMorgan.

Please proceed.

Thanks.

Good morning, guys.

The first question is just on the EPS guidance.

It looks like you took close to $0.10 out in addition to after you factor out the charge that you took and on the last call I think one of you guys had mentioned that the top-end of the prior range was still attainable.

So I'm wondering what changed here besides the charge?

Yes, there are really three things, David, I mentioned.

Joe.

I'm sorry, Joe.

The things I mentioned in my comments, the G650 is one of the programs we actually have lowered the profit outlook on that program for the second half and so there's volumes coming up on that program we've taken a more conservative profitability look at that as well as the 350, a wing piece and the 747-8.

All three of those programs, as you know, are in the design or test phase and even in early production in some cases so the lowering of the top-end of the range really reflects the more conservative view on those three programs in the second half.

Okay.

I just want to clarify, because you gave the 7% growth number, X the deferred revenue, but that gets you to more like $335 million of impact from the deferred revenue and it's an important difference especially when you start looking at margins and thinking about the model going forward so what's the number?

Yes, I know.

That guidance largely reflects the amendment.

And so there's a number of moving parts there on the amendment.

I don't want to go into too much detail on it.

But the third deferred revenue was one aspect of it.

There were other aspects of the amendment which were affected.

The R&D, treatment of the R&D is probably the most significant where we're actually sort of expensing amount or doing it through advanced payments.

We'll be putting that to cost of sale going forward.

And that's probably the piece that you probably haven't picked up on that.

And just finally as we look to volume, just getting on that again, in the second half of the year, you have a step down from the Q2 levels even if you X out the sales impact of the deferred revenue hit.

Why should anything step down?

I mean rates are going up, presumably you have a little bit of a lead time on that.

Is there anything going on in the aftermarket?

Is there -- is 787 volume supposed to decline for some reason or maybe just a little help on that one?

Yes, sure.

I think the aftermarket has picked up this year compared to last on volume and is certainly helping out on the margin side of things as well.

It's not a large piece of our business but it certainly is a piece we like.

The 787 is the biggest variable on the top line, Joe.

So it's really what volume we hit on that program and then there is the nonrecurring aspect of this business, which on the 8350 certainly has a big nonrecurring cost.

And so between the 780 and the 8350, how those move around in the second half of the year can affect the top line.

But, Joe, in general, as you can appreciate production rates are stable and increasing.

Just a little bit of anomaly with some of the lumpy items that kind of mask that underlying strength.

Thank you.

Thanks, Joe.

Our next call is from the line of Robert Spingarn with Credit Suisse.

Please proceed.

Good morning.

Can you delve a little further into -- Phil, you just mentioned the 650, the 350 and the 747-8 as being the three items that account for the additional dime or so in guidance decrease.

Where are we?

A little more detail.

How close is 650 to a forward loss?

What can you tell us?

Let me address that.

650 is a long, long ways from a forward loss.

We made some more conservative assessments of our labor productivity and our cost curves.

We think that getting the 280 moved and freeing up some space and some resources will help that program but not immediately.

There's some ramp up activity going on where we're bringing in additional resources in terms of people and training them so that the learning curves that we had hit historically we're not hitting on that program.

But that's a great program with a solid run.

We're clearing the decks to be able to do that effectively and efficiently in the facility and so that one is very solid.

The 350 as you know is in the throes of that part of the program where you're building the first sets of hardware.

We're driving into the supply base to get the parts.

This part of the schedule is highly compressed and challenging for us so it's hard to be highly optimistic.

We see the things coming together and coming together well, but with a great deal of expedite required to get it done.

And the third one is eluding me.

What was the third one?

47-8.

47-8, again, is a new program.

You know where the program is in terms of certifications and first deliveries.

We're building there, supporting the [pull] schedules, they are a bit choppy so we need to get that solidified.

There are some issues that have popped up on that program due to -- just due to our production media, if you will, that it's a mix of brand-new media and old engineering and manufacturing engineering media.

We're having to expend extra effort to clean that up that wasn't in our original plan.

So those are the ones that we're fighting through for the remainder of this year that pose a little bit of risk to us.

Phil, I think you talked about inventory on one of the slides, but the things that Jeff just talked about, how much of that excess effort and cost is going through the P&L versus the balance sheet?

Yes, I mean, some of it 's going on the balance sheet as well.

We're clearly the excess cops; as we look out in front of it, we think it's still recoverable through the current profitability rates.

But yes, it certainly is grossing up the balance sheet as well.

And just to finish up, Jeff, what do you see rate wise on 787?

What is your plan as we go forward the next few quarters?

Well, I think Phil mentioned the number of units that we had intended to ship.

It's pretty steady for us right now and we're ready to ramp again, we're pacing ourselves to the pull and are prepared and ready to deliver at an increasing rate but we are not going to anticipate that until the pull begins to come.

How about the break points in the rate?

Do you see yourself at six-month rates?

We're certainly capable of doing that.

Were capable of doing that quicker here at the early part of the program.

But again, it all depends on the pull.

Thank you.

Yes, thank you.

.

Our next call is from the line of Carter Copeland with Barclays Capital.

Please proceed.

Good morning, guys.

Good morning.

Just a couple of quick ones.

I hate to beat a dead horse here but it looks like if you look at the guidance change at the top end in excess of the $0.26 charge and then you got a $0.04 upper from the tax rate, we are talking a pretax revision of sort of high $20 millions.

And as you think about changing profit rates upon programs like the 650 and the 350, I wouldn't have expected those to have much in the way of revenue the you could see a revision this big and even the 47 should be pretty light.

So as you think about that sort of revision, how much of this is period expense or R&D or something that's going to fall in the back half of this year that's not repeatable next year?

Can you provide any color on how much of that might be a 2011 rather than a go forward number?

Yes, it's really the addition of all of those together that really brings the top end of the guidance range down.

Jeff talked about the 650.

Any one of them by themselves certainly are not that big.

But it really is a review of the forward look, the profitability on the 650, giving where it is at in the production and in the design and test phases.

Long-term programs tend to be very good programs and the 650 is very well-positioned to be that for us as well.

The 8350 is the nonrecurring part of the wing contract and we have simply just taken it down to a -- we have a little bit of [profitability] being booked on that.

We've taken that to zero, which gives us a little better risk profile going forward given as we look at all of the development programs, Carter, they tend to move to the right at some point in their design evolution so we're looking at that as well on the 350.

So it's really not about R&D at all here.

This is really about the profitability on the contracts and are updated view.

Is there any cushion in that to protect against one of these slipping into a forward loss position?

Yes, Absolutely.

I think as we moved to the last year given the amount of development we have in the pipeline, we've really tried to get them all structured to where they have a much better risk profile given what our experience curve has been.

And I think the 650 and the 350 fall into that category as well.

And I would give you a little bit more color on that, Carter, on especially the wing piece.

We have shipped, the first are out of our Kingston facility where it was fabricated.

It's in our Prestwick facility.

It's going together and going together well.

The key though is that it is a development program and we have shown that we can build it, we can deliver the test unit.

Now the risk comes in -- are there changes that will have to be made to it?

What will the tests show?

So right now we're feeling good about that piece coming through.

It doesn't have as much reserve in it probably as we would like, but it's got significant reserve and will see now how it matches up with the rest of the program and if it can flow through the test in good order, it'll be just fine.

If there are major issues that come out of the test, then we would have a bigger challenge on that part of the program.

We don't see that now, but we won't know until it gets through the test phase.

And one follow-up.

With respect to the amendment and the impact there is sort of 250-300 depending on what is being counted, it's not very clear.

But I wondered if you might provide some color about how we should think about the composition of that.

How much of that is in general terms a compensation for nonrecurring costs?

I mean, you talked about the aggregation of four years of expenses you have incurred and how much of that is for re-pricing of the units as part of the sort of go forward agreement?

Is one comprising the majority of that adjustment or amendment or are they sort of evenly split?

Well, I'm not really going to comment on the split, Carter.

I mean it kind of is what it is at this point.

I think there's clearly been some acknowledgment of the price adjustment needed near-term with the thought focused on getting cost to better pricing on the [outer] units.

So there's clearly a component of both, but I'm not going to really give you a sense of what's what.

Well Carter I'll give you just a little bit of color though.

We have, and I said this in my comments earlier, we have our joint teams working very effectively.

A number of improvement activities have been identified, quite a number of them driven into the Dash-9 configuration, more that are on the drawing board.

So we're right where we need to be in generating the improvement activities that have to go into that program to keep us on the curves required to manage it to what we forecast right now and to make improvements to that through time on the program.

So is it fair to say that under the terms of the new agreement as you move into 2012 the price you'll receive is going to be a lot closer to the cost of the units you're realizing?

Well it's fair to say that it still has a learning curve approach, where the initial units are higher-priced because of the cost.

As then as you come down the learning curve everything matches up.

Look, I'm not trying to be too cryptic here with you guys.

This is obviously an issue that I respect my customers' desires on and, frankly, we can't really talk about too much of it.

But I would say philosophically, when we started the program, we started it with the concept that we would have a pricing model that followed the learning curve and we are remaining true to that philosophy.

Great.

Thank guys.

Thank you.

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

Please proceed.

Thank you.

I wonder if you can tell us how much of that deferred revenue was at Fuselage versus Wing?

I mean I don't know if you want to give dollar amounts or maybe just a rough ballpark percentage?

Yes.

It's roughly two-thirds Fuselage and the remainder into Wing.

I can make a comment on propulsion.

We work with Boeing closely and now it's been probably over a year ago, we got propulsion aspect of the contract worked out.

So the amendment we finalized this quarter was largely focused on the wing and fuselage pieces.

Okay, and then just one thing on your guidance.

The high end of the range -- can you still hit the high-end of the range if you have some unfavorable contract adjustments going forward or is that -- would that move you to the low-end, I guess modest contract adjustments?

It accounts for some modest contract adjustments in that range.

Certainly, it doesn't account for anything that we experienced in the first half-year.

Let me just weigh in on that as well.

We did see, as Phil mentioned, some improvement in our base programs from our productivity and efficiency activity.

We'll watch that very closely and continue to manage it.

We could see some improvement there and if we do that's clearly got some upside.

But just so I'm clear, you said you could hit the high end of your range if you took some even modest charges in the back half of the year, not just hitting the guidance range?

Well the reason we give the range is because of the uncertainties obviously associated with it.

So we believe we've got a shot at hitting the range.

Okay, thanks guys.

Thanks, Troy.

Our next call is from the line of Cai von Rumohr with Cowen & Company.

Please proceed.

Thank you.

To go back to kind of a 787 nonrecurring impact.

So it's $335 million, but we can tell by looking at your deferred revenues ,which are down $250 million, that that's probably $250 million of it.

Phil, you mentioned treatment of our R&D.

What are you talking about?

I mean are you now being paid for R&D so that you're no longer expensing it as a line item paint over the contract?

Can you give us a little help there?

Sure.

Yes.

Part of the arrangement is previously we were -- we would get advances and then liquidate the advance to the R&D line.

Now we are simply going to get paid for it and get revenue as we develop -- as we do the commission improvement activity.

So looking forward will see less on the R&D line because it's now going through the cost line, is that correct?

That's correct, Cai.

We're just moving the deck chairs.

So can you also give us some explanation, you have this $11 million of warranty, re-work reserve, and UAW reserve.

Kind of what was all of that for and are going to see more of that stuff?

Well, I mean, it just reflects to some settlement we had with some of our customers and suppliers during the quarter.

It's pretty normal activity and when you settle them up, I have to look and make sure we have the appropriate balances in the warranty reserves and that's what is reflected in this quarter.

Right.

Well you say it's pretty normal, but actually excluding the IAM you haven't had it for the last--

Well, normal being, there is always customer-supplier things you work through and when you settle them up, you settle and you have to make sure you have the right warranty reserves in place after you do get settled up.

So that activity, it's not normal every quarter, but it's normal activity that happens.

And at one point you were fairly comfortable with the A350 fuselage work, in fact, talking of booking a profit on that development.

Is that still likely?

That was expected in the second half.

And maybe give us some color, are you assuming more positive June catches in your guidance range or nothing and give us some color there?

Well, I am assuming, Cai, that our productivity and efficiency activities will continue.

We'll see them more likely in the larger higher volume production programs and so I look forward to that.

Also as we go from up blocks that we are in today to the future blocks, we should see improvements in those blocks.

The A350 development for the fuselage, there remains appropriate reserves on that.

But that is -- that program at this point in time is the piece of the program most compressed for us and where we are spending extra right now to bring that first set of production units through the very compressed manufacturing piece of it and supply chain piece of it.

So there is, as I mentioned earlier, there is some risk there, but it's adequately reserved, I believe.

But you did assume at some point you would quote develop in profits in the second half.

It sounds like that opportunity is more remote at this point.

Yes, on the Wing effort I believe that is correct.

The Wing is -- he's asking fuselage.

And I think there's still an opportunity, but it's got more risk in it now then I think it did several months ago.

Thank you very much.

Our next question comes from the line of Carter Leake with BB&T Capital Markets.

Please proceed.

Thank you for taking my call.

Before we talked, I think when you gave guidance, you spoke of a management contingency for further delays on the 78 and it doesn't look like that's going to happen.

Can you speak in any way to whether there is the possibility that we could see positive cum catches on the 78?

I would just say categorically not soon.

That is a very long run program and significant work to do to get the derivatives in place and to get the production stabilized.

Once we get to that state, and frankly, it'll be a number of units, probably a couple years, I would guess.

And we're right on the plan that we set.

It's still early in that process, but we're optimistic about our ability to do that, Carter, but not in the short term.

We think we've set that program in a position where it can be very successful long term, but it's going to take us a focused effort that we have underway with our customer to get that where we could be talking about positive cum catches on it and it's a pretty long block.

I think the first block goes into 2015-2016 time period.

Let's switch to the 747-8.

I wouldn't have initially have grouped that airplane in with the G650 and the 350 with regards to developmental risk.

Can you give more color on what's going on with the Dash 8, I mean, where Boeing yesterday came out and said that program is on track.

What are your challenges again on this program?

I'm not real clear.

Well, I think, a couple issues on the 747-8, the first being, as you know, the delivery.

The certification delivery of that has had some delays the customers talked about.

That tend to ripple back into the production demand.

We've seen some of that and then we've had some issues on the program that deal with the fact that it's like I mentioned, mixed media airplane.

It's a design that we're putting Catia into and we've got some challenges to make sure that all of our -- all the pieces of the puzzle, if you will, are done effectively and efficiently.

We've had to spend extra energy on that to make sure that we've got it all right.

And we're going to spend some -- we are spending some, money to go back and retro some of the production plans and some of the engineering drawings to close that gap between a drawing airplane and a Catia airplane.

Well, to Rob's question on the 650 when you were sort of saying look how far are you away from a forward loss and you were -- it was a comforting answer.

Can you answer the same way on the Dash 8 with what's your longer term confidence on that program?

I don't think so.

I don't think I can.

Here's another part of the puzzle, Carter, is this is a relatively short block and a significantly changed airplane and the pricing on the new changed airplane is an average pricing over a longer float, not just over the block.

So what we've got is high changed airplanes that drive us back up the learning curve, if you will, back up the cost curve in a relatively short block and then at that, a disrupted block with production flows not being -- and the pull, frankly, being as smooth as we had anticipated.

So I think what we'll see is that the long term health of the program is good.

We've got a block issue here and it disruption associated with bringing fully into production and the way we like to operate, so you'll see some per base in there and I don't think it's got the same -- it's got a higher risk profile in my mind that the 650 does.

Great.

Thank you.

All right.

Thank you.

Our next question comes from the line of Sam Pearlstein with Wells Fargo.

Please proceed.

Good morning.

This is Mike Conlon standing in for Sam.

My question is can you talk about some of the moving pieces between the current 73 block and the follow up block that starts later this fall?

I mean just directionally in terms of the pensions costs, the production ramp, volume price discounts.

Any color you can give me, maybe material prices?

Well, it was largely, I mean, it looks -- the only thing that separated a block sometimes is one unit.

It's just where you draw the line at.

So it's very consistent from block to block.

Where we're at now, the pension income is we have a little bit of pension income these days so it's not a big factor.

Certainly, the program as we put more capital into it, which we're having to do with capacity expansion.

We're going to pick up some costs associated there.

But we're also getting a leverage out of the business too on the labor and the capital has the right return profile and certainly the overhead, they way we're managing the overhead it helps a lot so.

Look, this is a volume driven business.

I think we've been pretty clear about that over time and we expect as we move through the next several years in these higher volumes come at us, we see a real opportunity to improve the profitability of the program.

Thank you.

You bet.

Thank you.

Our next question comes from the line of Ron Epstein with Bank of America-Merrill Lynch.

Please proceed.

Hi, this is actually Elizabeth in for Ron.

Two questions just to clarify.

Did you say that the 787 margin is a 0% on gross margin basis?

Correct.

So what about on an operating margin basis?

Yes.

Well, it would certainly probably be somewhat negative there right?

Yes.

Right.

On any order of magnitude?

Well, we've been very consistent when we talked about the 78, for years now when we talked about the margin in the program, we were consistently talking about the gross margins.

So there's really nothing new there.

And then are there any opportunities for you on the re-engine 73?

Absolutely.

I've got to tell you, I am very, very optimistic.

I mean we spent most of this call talking about some of the nuances of this year and this quarter, which I understand, but I think it's kind of masked what's happened in the last couple weeks and it is, for us, a very, very exciting time.

I mean many of you have seen our factories here.

We've got equipment tooling capability and what's been talked about here is a derivative on our current airplanes.

We, in our supply bay are very good at doing derivatives, especially on high volume programs.

Our best development program in the last five years has been the P8A, which is a derivative of the 737.

So we've got volume coming at us.

We've got a supply base that knows what they're doing.

We've got a great airplane that's getting an uplift.

I think we're a valued partner on the 737.

We know the airplane intimately.

We know what to do.

It's got to have some things done to it that we know how to do and it's going to need pylon for a new engine.

It's going to need a new cell for a new engine.

It's going to have some, I'm sure, some upgrades to parts of the fuselage to handle the loads.

That is right -- I mean that is a change of pace down the middle of the strike zone for us.

And we anticipate it and we know exactly how to deal with it.

So, I am extremely excited about being a very significant part of this airplane and extending the capability the life of the 37.

Thank you.

Thank you.

Our next question comes from the line of Doug Harned with Sanford Bernstein.

Please proceed.

Good morning.

First, I'd like to touch again on the development programs and when you've talked about them with respect to nonrecurring costs, how do these look in terms of the actually unit cost when you look forward now?

In other words, are the issues you're having something that once you get through the nonrecurring period, you think you're going to be fine in terms of unit production?

That actually depends, Doug, on many of them, some of the newer programs in particular, we have split the development contracts, if you will, from the production contracts.

Some of the -- which is in my mind, one of the lessons learned on the programs.

Some of the programs, you clearly have when developmental issues arise then it has implications across the production because the development is amortized over usually the first block.

In some of our instances, we see our production costs rising because of some of those developmental issues.

In others we see a good solid production cost staying in the ballpark.

I would say by and large, especially when we get into these where we've had to do forward losses or bring the cost down or the profit down on them, it's developmental issues or startup issues that have contaminated it, if you will, the first block.

Well, can you say which programs that you've seen in a more risk on the unit costs side and which ones are more localized to nonrecurring?

Well, I think, I mean, clearly we've talked the biggest elephant in the room for us is the 87 and we've talked about that.

We've talked a little bit about the 47 and it's early block issues.

We've talked about the 280.

We've talked about the early part of the block on the 650.

Those are the ones that have -- and we brought a couple other programs to zero margin, some smaller ones.

It tends to be those that we've had -- that were kind of early in our development cycle that we ran into challenges on.

But what you're saying, does that mean that those four programs and we certainly have -- we know a lot about the 787 at this stage, but are each of those four programs now ones that you expect that your actual margin on unit production is going to be less than you had originally though as opposed to not being able to recoup the investment going into this?

Hey, Doug.

It's Phil.

I think the one that's the most risky or has the presently most challenging profile remains the 250.

That's why we've made on the 280, we've probably made some of the decisions we've made recently to get it to a difficult geographic location and allow everybody to focus more on some of these development programs in North Carolina and in Tulsa.

The rest of them want a unit cost basis.

I feel pretty good about them.

I mean I think they're in place where there's adequate contingency for the risk.

We see out there given where they are in their development cycle and I think once you get the Aerospace programs out into production, it tends to go quite well and so I think I feel pretty good about the balance of the programs, even the 650.

While the near term view is a little more risk adjusted in my mind, longer term, I think it's going to be a great program on a unit cost basis so.

I think there's just a couple of them that are more challenging and the 283 would be one of those.

And then when I look over the last couple of years, you've had very good performance on the core, more traditional, Boeing programs.

But you've, obviously, had a lot of challenges on some of these new ones.

Jeff, you just recently made a number of management changes.

Are there any specific initiatives you have under way that changed the way the company operates with respect to how you're dealing with these development programs?

Yes, absolutely, Doug, there are.

Let me just speak to them.

I mean clearly what you've seen is us make some commotions, bring some key resources in from the outside.

I think we have a great balance of internal talent and some new external talent.

By the way, that's something we've done consistently and I think blended a team that is continuously improving.

We've talked a little bit in the past, I think, about program management disciplines and some engineering management disciplines.

So we've strengthened our core functional oversight in that and manufacturing.

But I think if you really back up a ways and take a look, 11 concurrent development programs with the number of different customers that we're talking about is too many.

Now, we didn't plan to be in that mode, but we are.

And we're slugging our way through to completion on them.

I would say as we look forward, I don't see us on as many concurrent and we'll probably be more conservative in our estimate of programs ability to hold schedule.

So those are some systemic things that we've done that we look at and we've also gone out and really looked hard at some partnerships to help us through the early part of programs.

Some partnerships with some engineering companies.

Because what happens to us is we end up with a finite number of people and we have to add skills from outside the company and we're going to do that in a little bit different model going forward.

Thank you.

Thank you.

Thank you, Doug.

Operator, we have time for one more question.

Our final question comes from the line of Myles Walton with Deutsche Bank.

Please proceed.

Good morning.

Thanks for letting this last question in there.

As you're roll into the 37 and 777 next accounting blocks, will those accounting blocks be similar sized to your current accounting blocks or will they extend out further and I wonder if 2013 repricing is going to prevent you from extending it out further without visibility there?

No, they will be roughly the same size and cover the same period of time as the current ones do which will take us right up to that price point you're talking about.

Is that the reason for it or is it just that you'd like to keep the blocks continuing because obviously you have pretty good visibility, I would imagine, on the 37 beyond two years.

Right.

Yes, we do.

And I think I, you know I reflect back then when we started the Company with a long accounting block as the it got going and I think that we moved through the first block, we came into the time frame and felt more comfortable going to a two-year type of a block given it's just easier to predict costs for material and labor out into those time frames versus a four or five-year block.

So that's kind of a strategy and I think it's worked out pretty well here in this current block and I think that's the strategy going forward.

Just for clarification, why were the warranties and rework not allocated to a segment?

Just kind of curious why that didn't occur.

It was several things in there going on that were really handled at the corporate level.

But you're recording the expense at the segment level, I would imagine?

Yes.

At the reversal of the core recurred unallocated?

Right.

Okay, and then the 280, you're moving the location of the work and can you give us some -- and you clearly made it a point that there's still risk there.

Can you give us timeline as to when you'll feel comfortable that the transition risk is at least realized relative to the cost estimates you've made at this point, kind of the timeline of the relocation?

Sure.

I think a 24-month window is how I think about it.

When we announce that all the wheels are turning, we get things in place in North Carolina and we get transitioned to them.

We get a nice production run going to North Carolina and it just takes a little bit of time.

Okay, and then the last one is on CapEx, the CapEx coming down, is that a push forward into next year or is that a cost avoidance?

Yes, I think, it's just a cost avoidance but when we look into '12, we're still (inaudible) capacity for I think we're talking about one capacity expansion on the core business and the new business we are facilitating for, so 2012 where there's exact numbers, it's certainly is going to be a healthy CapEx year for us.

Okay.

Good enough.

Thanks again.

Thanks Myles.

Ladies and gentlemen, that concludes our question and answer session and that also concludes today's conference.

You may now disconnect.

Thank you for participating and have a great day.