Spirit AeroSystems Holdings Inc (SPR) 2012 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Spirit Aerosystems Holdings, Inc.

second quarter 2012 earnings conference call.

My name is Sandra and I will be your coordinator today.

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

Later we will conduct a question-and-answer session.

(Operator Instructions)

Please note that this conference is being recorded.

I would now like to turn the presentation over to Ms. Coleen Tabor, Director of Investor Relations.

Please proceed.

Thank you, and good morning.

Welcome to Spirit's second quarter 2012 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 will 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 question.

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

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

With that, I'd 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, then Phil will review the financial results.

After that, we'll be glad to answer your questions.

In the second quarter, our core programs demonstrated solid operating performance, as we recovered from the disruption from the severe weather in April at our Wichita, Kansas facility, and increased volumes by 12% for large commercial airplanes.

Reflecting on what our team and partners accomplished in the second quarter, I continue to be extremely proud of how we supported our customers by delivering both product and support in a timely manner.

It is a testament to the team we have here at Spirit, as well as our unions, our customers, suppliers, and our government and community partners.

As the OEM order books demonstrate, the large commercial aircraft market continues to be strong, as airlines replace less fuel-efficient airplanes and gain operational performance by growing their fleets.

This growth trend is extremely positive for Spirit, as our customers increase production rates to meet the demand, translating to our backlog of over $32 billion for our core products, and development programs transitioning to production.

While the market is strong, we remain watchful of the global economic environment.

Thus, we are closely managing our capital spend to support these increasing demands for our products.

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

Fuselage Systems delivered strong operating margins of 15% on $627 million in revenue during the second quarter, as we recovered the deliveries lost during the severe weather within the quarter, and volumes across our core programs increased.

During the quarter the Fuselage team continued to make progress on the A350 program in both our North Carolina Composite Fuselage Facility and our Saint-Nazaire Assembly Facility.

The Fuselage Segment's 737 high-rate production line surged to recover lost deliveries, delivering it's 4100 ship set of the next generation fuselage in the quarter.

Fuselage team also continued production on the 747-8 program by delivering the 52nd fuselage.

The 787 team continued to support our customer by increasing deliveries in the quarter to 11, including the forward fuselage number 75.

We continue to see progress as the joint Boeing and Spirit teams remain focused on identifying and implementing cost improvement across the 787 program, and value engineering, supply-chain architecture, and production flow.

While we are still early in the planning stages for the 737 Max, we are pleased with the evolution of this derivative product, and the plan to use our Spirit exact process to smoothly transition the efficient, high quality NG production line to the Max.

On slide 4 you see the Propulsion team delivered strong operating performance, with margins of 16% on $351 million in revenue, as we recovered the deliveries lost during the severe weather within the quarter.

The volumes across the core programs increased.

The Propulsion team also recovered from lost deliveries by surging rates to deliver the 4100 next generation 737 engine pylon sets and thrust reversers in the quarter.

The Segment's 787 team also supported our customer by delivering engine pylons for unit number 76 in the quarter.

Production continued on the 747-8 engine strut, as the Propulsion team delivered it's 46th ship set.

The team also delivered the 1030th 777 nacelle package in the quarter.

As we shared at the Investor Day in March, the Propulsion team continues to focus on value engineering, supply chain architecture, and production flow as they work closely with our customers in the design and development phases of several new programs.

The team's focus on these critical items is positioning the 737 Max, the BR725, the Mitsubishi Regional Jet Pylon, and the Bombardier AC series pylon, to extend the life of our core products and contribute to our diversification strategy.

On slide 5 you see the Wing Systems Segment, which primarily consist of our Europe, Malaysia, and Oklahoma operations.

The Wing team reported operating margins of 7.7% on $359 million in revenue during the second quarter, as volumes increased across core programs.

Spirit Europe continues to produce high volumes of hardware for our Airbus customer, surpassing line unit 5300 for the A320 wing components.

During the quarter, the team continued to make progress on the A350 program in both our North Carolina Spar Production Facility and our Prestwick Assembly Facility.

The Wing team in Tulsa delivered the 4100 next generation 737 slats and flaps in the quarter.

The team also continued to produce hardware for derivative and new programs, delivering the 49th 747-8 fixed leading edge wing section, and the 74th set of 787 slats in the second quarter.

During the quarter, the segment made progress on enhanced production plans, as the second moving line for the 737 program was initiated, along with improved production flow for our G280 and G650 programs in our Tulsa facility.

You will recall that during our Investor Day in March, we introduced these plans and shared how they optimized the flow, improved quality, and gain operational efficiency for high volume core 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 on slide number 7. Reported revenues for the second quarter of 2012 were lower as compared to the second quarter of 2011, as the prior quarter included the recognition of deferred revenue associated with the 787 contract amendment.

Excluding the deferred revenue recognized in the year ago quarter, revenue increased approximately 9% on higher volume of large commercial aircraft deliveries.

Reported operating margins for the quarter were 6.2%.

Excluding the $55 million previously announced expenses related to the severe weather at the Wichita facility, operating margins were 10.2%.

Our solid margin performance was driven by increased core business volume and operating efficiencies, which offset the headwinds of volume based pricing on core programs and the dilutive effect of some of our lower margin business, particularly the 787 and the 747-8 programs during the quarter.

The quarterly results reflect strong contributions from the core business, as the Fuselage, Propulsion, and Wing Segments each realized favorable cumulative catch-up adjustments, which together totaled approximately $6 million.

The current quarter also includes approximately $7 million of additional forward loss on the A350 nonrecurring wing program, due to additional engineering costs growth.

Second quarter 2011 operating margins were 4.3%, which included the 787 deferred revenue as zero margin, and a $53 million new program related charge.

Fully diluted earnings per share for the quarter was $0.24 per share.

Adding back the charges associated with the severe weather, and refinancing in the quarter, included a total of $0.31 of share.

Earnings per share would have been $0.55 per share, reflecting the continued strength of our core business.

Cash from operations for the second quarter of 2012 was $121 million source of cash, which included $105 million insurance cash advance and a $50 million customer advance related to the A350XWB fuselage program.

Capital expenditures were $50 million for the quarter.

The net of cash from operations and capital expenditures makes free cash flow for the quarter a positive $71 million.

Adjusting cash from operations for the unused portion of the insurance cash advance of approximately $50 million, and the customer advance of $50 million, free cash flow for the quarter was a $28 million use of cash, a nice improvement in cash flows year-over-year, driven by increased volume in the core business and fewer customer advance repayments.

On slide 8, second quarter R&D and SG&A totals approximately 3.5% of sales, and reflects our continuing disciplined expense management and stable new program related R&D.

Slide 9 summarizes cash and debt balances.

Cash balances at the end of the second quarter were $180 million, as compared to the first quarter of 2012 balances of $134 million.

At the end of the quarter, our total debt to capital ratio was 36%.

We continue to proactively manage the capital structure of the Company.

As we discussed last quarter, in April we completed a $1.2 billion refinancing of our senior secured credit facilities that included a new $650 million revolving credit facility maturing in 2017, and a new $550 million term loan maturing in 2019.

This refinancing continues to provide the appropriate liquidity and balanced maturity profile for the Company, as we invest in new programs and capacity expansions for our core programs.

Our US defined-benefit pension plan remains fully funded, while we continue to make modest cash contributions to our UK plan.

Slide 10 summarizes net inventory balances at the end of the second quarter of 2012.

Physical inventory balances decreased as we increased deliveries on new programs in the quarter.

Nonrecurring inventory balances decreased as we reached certain development milestones in the quarter.

Deferred inventory balances increased by $108 million, driven by A350XWB production, and 11 87-8 deliveries, which contributed $17 in growth, or approximately $1.5 million per unit.

787 deferred inventory growth rates continued to moderate as we continue to improve our unit cost performance, as planned.

Slide 11 summarizes our full year 2012 financial guidance.

As noted in our press release issued earlier today, our 2012 financial guidance excludes any financial impact caused by the April 14, 2012 severe weather.

We do expect to continue to incur financial impact from this event, and we'll recognize incurred expenses and potential offsetting credits in the future periods, as part of the ongoing insurance process, which we expect to be largely complete over the next 18 to 24 months.

Turning to the Company's operating outlook, the market for commercial airplanes remains strong, and we continue to increase production rates to meet customer demand.

Based on current demand, our revenue guidance for 2012 is unchanged at $5.2 billion to $5.4 billion.

Fully diluted earnings per share is unchanged, and expected to be $2 to $2.15 per share.

Again, this guidance does not include any impact associated with the severe weather event referenced earlier.

Cash flow from operations, excluding customer and insurance cash advances, for 2012 is unchanged, and expected to be greater than $300 million.

This is driven by increased core program volumes, substantially lower repayment of customer advances, and slowing inventory growth as we move through the year.

Capital expenditures are unchanged, and expected to be approximately $250 million, as we continue to invest in core program capacity expansion and appropriately time our investments in new program infrastructure.

Our 2012 tax rate is expected to be between 31% and 32%, assuming the US research tax credit is extended.

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

Thank you Phil, and I'll wrap up on slide 12.

With a strong and growing core business as our base, our foundation remain strong.

Successfully returning to production after the severe weather at our Wichita facility, and surging our lines to meet delivery schedules within the quarter, exemplifies the team's ability to deliver on our commitments to our customers, while achieving productivity and efficiency gains.

2012 remains a transitional year as we continue the momentum built in the first half of the year, and successfully achieve the upcoming rate increases on our core programs, and continue our transition of new programs to production.

As we move forward, we are well positioned to meet the demand for large aircraft with continued reliability, capability, and teamwork that align the business for the long term value creation for our customers, shareholders, and employees.

We will now be glad to take your questions.

Thank you.

We will now begin the question-and-answer session.

(Operator Instructions)

Howard Rubel, Jefferies.

It's actually Greg Konrad.

I'm in for Howard.

Just had one quick question surrounding CapEx for the year and the guidance of $250 million.

Is there any indication of anywhere where you've been able to avoid expenditures?

Let me answer that first, and then I'll let Phil add in some color if he wants to.

I mean, clearly, and as we mentioned in our remarks, clearly the timing of CapEx is a very important piece of our management strategy.

In some cases we can gain the productivity we need, and can slide some CapEx to the right, and clearly the timing of getting it in place effectively for rate increases is something that we watch and manage very closely.

There's some opportunities, and at the same time there's some occasional issues that we've got to pull some capital back to the left.

We manage that very aggressively.

Mike King, who's our head of all operations, manages that personally in a very, very effective and aggressive process.

Phil, you want to add anything to that?

No.

No, I think that's it.

Across the Company, it is intense focus, and it's really about trying to utilize our assets better in many cases, as well his be more productive with the assets we have.

Robert Spingarn, Credit Suisse.

Phil, two quick ones for you.

First, if we think about the free cash flow on the, I guess, adjusted or cleaner basis that you mentioned, I think it was negative $54 million in Q1 and negative $28 in Q2?

Yes.

You're targeting $50 million for the year.

Could you walk us through how the third and fourth quarter should look, and then if you could just review, you commented on 787 inventories, what the deferred production was?

Sure.

The deferred production balance at the end of the quarter on the 78 was $568 million.

I think about $17 million increase from quarter to quarter.

Again, a very nice improvement there.

Yes, so free cash flow, there's a normal cyclicality to our business where the second half tends to be stronger, but there are also higher volumes as we're moving into later the year on 78s, as well as other new programs, the 777 rate is coming up also the second half of the year, all of which are very positive to our cash flow at least on the core business side of the equation.

Fewer customer advances, of course, continues into the second half, which we benefited from in the first half as well.

I think we feel pretty good about the cash flow in the second half.

There are some risks, I guess that I would point out in terms of new program timing.

It's really - there are some sizable developmental cash flow milestones we need to accomplish in the second half of the year.

Some of them in the fourth quarter, in fact, and those will be subject to timing and execution.

I think we've just got to be a little bit cautious on the cash flow this year, that there are some developmental milestones that we need to accomplish in order to achieve our greater than $50 free cash flow.

Phil, it sounds like if you do hit that target, it's a fourth quarter event?

We shouldn't be looking for significant improvement in Q3?

I think that's fair, Rob.

Yes, absolutely.

Carter Leake, BB&T Capital Markets.

All quiet on the G280 front in this quarter.

Should we assume that, that program is mostly de-risked?

Well Carter, I think we - I mean, we clearly came through the quarter without additional issues.

As we've been saying, and I think continue to say, and our filings all point to, I mean, this is a risky program.

We are - let me just talk about it and the G650.

In both cases, as I think I've mentioned for the last couple quarters, we are making substantial improvements in our cost curves.

Frankly, I'd like to see a little more efficiency as we come down those curves.

We're very close to meeting the curves that we've placed, but are not quite meeting them yet.

We've still got risk, as we've said, on it with some of our supply chain.

I think our design activities have settled down, and now we've got to go make sure those supply chains are strong and cost effective.

There remains risk on those programs, but I like the momentum and the trajectory, and it's just a question of whether we'll meet all the objectives were set or how close we'll come to them, or if, in fact, we'll be able to do a little better than we put in the window.

Good progress, really screaming down the cost curves on both programs, and feeling better about it, but again, and we've said all along, we've got aggressive targets on those programs and risk remains.

David Strauss, UBS.

Could you update us where you are, Phil, on the 747-8 block, when you expect to move to a new block, and could we expect you to take margin on the new -8 block?

Yes, we actually - we've completed one of the blocks here in June, and we're moving into a new block that's, how big is it Steve?

Its about 50.

About 50 units is the block we're entering into, which would take us out about, what, 18 months or so.

Are you taking margin on the new block?

Yes.

There's certain areas that are still challenged.

All three of our segments have 747-8 content.

I think Fuselage is improving, but we want to make it better.

Wing is in the same category.

Propulsion is tending to do a little bit better than where we currently see the Fuselage and the Wing components.

It's still categorized as a low- to no-margin program in some cases, and a forward loss in the Wing segment.

Okay, and then on 78, looks like you're not quite as far ahead as Boeing, ahead of Boeing at this point.

When could we expect to see you guys move up to five a month?

I think we're in the process of moving right now.

We are transitioning to the higher rates, really across our segments as we speak.

Carter Copeland, Barclays.

This is Mayer on for Carter.

Just had a question on the A350.

On the A350, can you discuss if the charge taken in the quarter, if any of that was related to the recent schedule change at Airbus, and also given the recent schedule movements by Airbus, can you address how you're thinking about the risk on that program, has anything changed?

Sure.

Let me talk a bit about the A350.

The answer to your first question about our charge and the issues that Airbus has recently talked about on the wing, those are not directly related at all.

Our development on that wing, as we've talked about, was - continues to be challenging for us to complete the engineering, get it all done and wrapped up, and we have taken some charges on that.

The overall program, we are, as we've said previously, we're now in the middle of the most challenging part of the program, certainly for us, getting all the structures completed, the engineering associated with those, get the first several units produced and into the line as appropriate.

This section 15, our Fuselage section, as you know is right in the middle of the fuselage, some of the most challenging parts of the airframe itself, as the wing and the fuselages come together there, and multiple partners in that part of the airplane.

We are tracking with the program, working that very aggressively to get the engineering completed on it, get all the parts in it, and continue to move it down the line.

The wing, little bit challenge, as you know, in our development.

There is - continues to be schedule risk, as there always is on development programs, and it's part of our ongoing process to work through any schedule changes, and determine if the provisions that we've put in place are sufficient or not.

Doug Harned, Sanford Bernstein.

I first wanted to ask about the 787.

When you look forward to next year, you said you were already moving to the five per month level.

How do you foresee the rate increases to 7 and 10 next year, and do you see the introduction of the -9 as causing disruptions on the line?

How do you expect that will play out?

Well, clearly any rate increase is a challenging endeavor, requires a lot of focus from our operations team and our supply chain.

Some areas go smoother than others, depending on the rate steps that we're taking.

Clearly, we're very, very focused on this, spending a lot of management time and energy doing everything we can to anticipate issues that we'll have.

That includes planning for higher rates next year and for introduction of the -9.

That's something that is always challenging, especially on a new program, and ripe with opportunities to have issues.

We work very closely with our supply base and our customers to identify those issues, and when they arise get them worked.

That's where we are now, and that's where we'll be throughout the rate increases and the -9 introduction.

When you look at that, at those changes, I'm assuming at the same time you're looking at opportunities, either for changes in production processes or introductions - introduction of some new technologies.

When you look at the rate increase next year, do you think about process changes at the same time, or are you looking to get that rate up, and then look for the changes you can do, which may reduce costs later?

Yes.

Doug, that's actually a mixed bag.

We do both.

For example, changes on the -9 that are required for the configuration that are cost improvements, as an example, or process improvements, we try to retro that and feed it into the production line earlier if we can, and get the value associated with that.

We block point changes, and that's all kinds of change, configuration process, so on.

We've talked in the past about the activity we have underway to improve the 787 with value engineering, and supply chain design, and production efficiencies, all those things are being worked on continually, and phased in, in conjunction with rate increases and new derivatives and so on.

It's not a, we do it one way or the other, it's we look at the change, we look at how it fares in, we look at the configurations, we block point things, and drive the efficiencies as quickly as we can into the process.

Joe Nadol, JP Morgan.

Wanted to clarify something first, which was your cash flow guidance for the year on the operating cash flow side.

Just wanted to make sure we are speaking in the same terms.

You have $200 million from Airbus year-to-date, plus you have $50 million from - net from the severe weather, and so year-to-date you're are at minus $117 million.

Is that right, Phil?

Yes, I think that's right.

You're correct on the $200 million from Airbus, and the net cash proceeds, or net insurance advances.

That's all we're excluding in our $300 million of cash from operations guidance, we're excluding those two items.

Right.

What I'm saying is, you have for $417 plus to go to achieve your guidance for the second half of the year, is that --

Yes.

Okay, just want to make sure we're on the same page.

Just in terms of the revenue mix, it looks like certainly the business in regional deliveries, the Gulfstream deliveries impacted the mix of zero or low margin programs this quarter.

I think it was more like 20%, we've been running more like 15% historically.

As we look at the back part of the year, can you give a little more color, I guess, on the tempo of Gulfstream deliveries and how that revenue mix might -- how the profile looks, I guess, as we get into Q3 and Q4?

Yes, sure.

The programs we're talking about all begin to deliver higher volumes.

787, first and foremost, will be increasing as we move through the year and through '13 and on.

Gulfstream programs will be increasing in rate, both the 650 and 280, and the BR725, which is the nacelle package that we produce for the Rolls-Royce engine on the 650.

Yes, every program that's transitioning early into production throughout the year, we're going to see higher volumes in the second half of this year and then on into '13, which clearly puts some pressure on the margins.

I think as we stand today, we're doing a pretty good job of offsetting that headwind, so far, as well as offsetting some of the volume-based pricing discounts on our core business, which I mentioned earlier.

It's not lost on us.

We're certainly focused on trying to offset the headwinds we have as we ramp up some of these programs, and then frankly I think it's not just we're trying to get them to zero and hold them there.

We're trying to move towards positive contribution on the margin line from some of these programs that have been challenged through the development cycle.

Just one final detail on that.

Could you provide the breakout of that 19 aircraft in the quarter on the business and regional side?

How many 650s versus 280s that was?

Yes, I don't have that in front of me, Joe.

We prefer to aggregate that for customer sensitivities, frankly.

Cai von Rumohr, Cowen and Company.

Could you please give us the deferred production cost on both the A350 and then the combined G650 and BR725, and secondly, maybe give us color ranking the relative risks on your programs going forward?

Let me take the second part of that first, Cai, and then I'll let Phil address the first part of your question.

We've been talking about the relative risk ranking for several quarters now.

I don't see major changes to that.

Clearly in terms of size, the 787 remains a number one risk for us, just in terms of the girth of that program, and the status that it's in with zero margin.

In terms of size, again, A350 probably number two, although as we've talked early in the development program have issues with the wing nonrecurring, have three other pieces of that, that are well reserved and progressing.

In terms of the 747-8, we've talked about is, risk is, well we've spent quite a bit of time on that already.

Then in terms of size again, probably the 280, 650 size.

That's the way we -- of course, all of them we work aggressively, but that's the rank that I would put them in, in terms of size of risk.

Phil?

Sure.

Cai, to your detailed question on inventory, the 650 balance is, this is deferred inventory only, was $232 million at the end of the quarter, which is a $56 million increase.

The A350 XWB was at $83 million at the end of the quarter, which is a $44 million increase.

Those two are the biggest chunk, certainly, of the $108 million deferred inventory growth during the quarter, reflecting deliveries, of course, on the 650 and the A350, A350 wing specifically.

Just for clarification, if you looked at our delivery schedule in the press release, you'll note that we didn't have any A350 deliveries noted on our schedule in the press release.

It's because when we report a delivery there, we reported the fuselage delivery, which is our unit, but we did have wing deliveries during the quarter which contributed to the deferred inventory balances.

Thank you.

Actually, my question on the risk was not the five, but the probability of one of these programs coming back and biting us?

I don't think on that, Cai, we have any change from what we've been reporting.

Noah Poponak, Goldman Sachs.

Just a follow up on the margin line of questioning, I guess.

If I'm in your revenue range for the year, in order to get into the earnings range, the adjusted segment margins need to be somewhat significantly lower in the back half versus the first half.

Can you just speak to how much of that is cushion for potential one-time charges on development programs, versus layering in the dilutive effect of volume on new programs, versus something else?

Well, you certainly have the two elements nailed.

Yes, I really can't give you any more perspective than what you have there.

The dilutive effect, as I've mentioned earlier, will certainly increase as we move through the year, and then as we entered 2012, we certainly were looking at the development program risk that Jeff just walked you through, and there's still risk involved there.

We still feel like we're being appropriately conservative on the earnings guidance.

I think that's where I would leave it, Noah.

Okay.

If I'm thinking about that beyond 2012, at the Investor Day there was discussion of a 12% segment margin target longer term.

In 2013, are you starting to progress closer to that, or is 2013 going to look a lot more like '12, as you're are still kind of working through some of the development challenges and still relatively early in the ramp on new programs?

I would say it's got -- I mean, clearly it's got some of the same elements that '12 has in it.

Clearly, we're driving productivity and efficiency with the rate increases.

That's very essential to us to improve those programs, and fighting a headwind, if you will, of these big new programs that don't carry much or any margin with them.

As these big programs increase, in order to make overall improvement, we've got to make -- we've got to get substantial gain out of the rate increase on core programs.

That's our imperative, that's our focus, and of course we're not forecasting 2013 yet, but that's clearly -- I mean, you've got the elements of what we're driving.

George Shapiro, Shapiro Research.

Phil, with the steady reduction in 787 deferred, it would look to me like you probably get to breakeven around unit 100, somewhat better than what you thought before, and if that is true, you probably can - would you start to book profits next year, since you'll probably get to unit 100 by the end of this year?

Great question, George, but I'm not going to answer, by the way.

We are continuing to improve, that's the good news, right?

Big program for Spirit.

It's been challenged, obviously, from a number of different directions, and we feel really good about the plan we're on.

Different components in our different segments will break across the average lines at different times, but you can rest assured we're all focused on making this a big successful program for our customer and Spirit.

Well, and I would just add a little bit of color to that.

Back to the fundamental question about rates, and improvements, and changes as we go to the -9, I think all that fits into, as you know, George, rate increases have a somewhat disruptive effect, and they don't disrupt the overall march down the curve, but they do have blips, and we have multiple rate changes coming in the next six quarters or so, maybe beyond that, and the -9.

There's plenty of opportunity for us to look at it and say let's don't get over-optimistic too quickly with this program.

Okay.

Let me ask another one, Phil.

The receivables in the quarter, $470 million, are way above kind of what the norm is.

I mean, I would think that, that should decline to maybe $300 million by the end of the year.

One, is that a correct assumption; and two, what's causing it to be so high?

I mean, you had the jump in the first quarter, another increase this quarter?

Yes, I think you're right on as we move through the year.

I think that's an is an accurate way to think about it.

Three things, George.

The volume's coming up, of course.

There's always timing in the working capital side of the equation.

Then there's some programs we're working with our customers on that, settling up on some of the commercial issues that are in that number as well.

I think as we move through the year, we expect to get these things resolved, in large.

Sam Pearlstein, Wells Fargo.

I guess mostly for Phil.

Just trying to understand a little bit more about the tornado cost and the insurance recovery.

Just in terms of you stated about a $400 million potential cost.

It sounds like you spent $50 million, and that's on the P&L.

I'm just trying to understand, are there cost within CapEx?

Should we see $50 million of kind of net costs on a sequential basis?

At what point will it be clear what your final net cost would be?

Yes, it's a bit difficult to answer some of those specifics right now, Sam.

It was obviously a sizable claim, 40 plus buildings on-site had some level of damage, some more severe than others.

I think over 200 structures, when you look at all the ancillary buildings around the campus had some sort of damage.

We've got a big claim.

We have a number of underwriters in our insurance syndicate that we're working with, and we're working with them all independently to get things resolved.

We're making good progress.

I think we're working well with the insurance community and our underwriters.

We're working well, and moving through it fairly rapidly.

I don't think you can take away $55 million in quarterly expense.

I think it's going to move as we reach settlements, get things accomplished and agreed to.

It'll move around, and we have to get our deductible thing settled out as well.

It's difficult for me to sit here and predict to you how it's going to go, beyond what I've already probably described to everyone.

I think what we're really trying to do, though, is give you a sense of -- we're trying to show the operating health of the Company independently from this event that we've experienced.

Regardless of how we deal with the event, you'll be able to see our operating performance, which continues to be, I think, improving as we move through time.

Okay, thanks.

Related to that is just on the SG&A.

Just looking at that, it looks like it went down sequentially by about $5 million.

Similar, I would have thought overtime and other types of things like that would have gone up with respect to the tornado cost.

How are you getting that leverage there?

Well, it's something we continue to work on as we go through this volume increase, and Jeff might have some things to amplify here.

Part of the strategy here is when times are tough, we keep the workforce intact and keep the business healthy, and as things are growing, we really work the overhead side of this equation to make sure if we're are getting efficiencies out of the back offices as well as the factories.

Some of that's just the natural benefit and improvement we are seeing through the administrative lines.

R&D is a little bit lighter than normal.

I think as we look at '12 and combine G&A and R&D together, 3.5% of sales is kind of a run rate we're thinking of through 2012, which is about where we're at year-to-date.

I think back on your specific question about overtime being high, overtime was high during that period of time, and clearly a lot of disruption and the surging to recover the schedules was a seven day a week, 24 hours.

Of course, everybody didn't work that, but we had a lot of people working 12 hour days, two shifts, working things through.

Part of that covered with some of the insurance that we had for that kind of disruption, but clearly an incredible effort by the team to get things back in line.

I don't know if we have a specific answer on the impact that had on SG&A.

SG&A tends to be lumpy in some of the accounts anyway, quarter-to-quarter.

I don't see the direct link there.

I mean, clearly most of the people, people-wise in the SG&A accounts are the typical overhead accounts, which we tend to donate our overtime.

Myles Walton, Deutsche Bank.

Just a couple of clarification questions first, and then an actual real question.

An earlier question on business jet production for the rest of the year, it looks like Gulfstream stepped from 10 deliveries last quarter to 19 this quarter.

I wasn't clear, is your full expectation that it grows from the 2Q level or from the average of the first and second?

I think the 19 units you're referencing includes more than just Gulfstream.

It's got the G650 nacelle packages in there as well, yes.

I think it grows from the second quarter here.

Third quarter, probably more somewhat stable, but into the fourth quarter we would see some growth in that line.

Just to clarify, it doesn't have any Hawker in it anymore, correct?

No.

No, it does not.

Hawker's gone.

Okay.

Then -

We are on regional jets, that obviously we're not delivering too many of those right now, but the C-series and the MRJ would be in that line eventually.

Got it, okay.

Then the other clarification's on the 350 advances, which you're excluding from kind of the operating cash flow guidance, $200 million inflow this year.

What's the terms and condition of the burn-off profile in the coming years on that advance?

We're going to repay $1 million, $1.25 million over 400, I believe.

Okay, and the last, the real one.

You surged during the tornado [s-2s] on the 737, and like the other lines.

Curious if it highlighted CapEx avoidance that you can share with us, that would now be on the table as you look to those production increases, and given you kind of didn't miss a beat, I'd imagine that you've found some gems that maybe you can avoid some spending?

Myles, that is a great question, and one that we ask ourselves continually.

Think about it as just tremendous yeoman's effort by our team.

Lots and lots of hours.

Sometimes it's called muscling through.

So like, I call it sprinting and in the middle of a marathon.

You can do it for a little while, but you can't sustain that.

We are looking very closely for where are those areas where we surprised ourselves with what we could accomplish with the current sets of tools and the current sets of equipment.

It is clearly input that comes back into our planning process.

You should be very clear that what happened to get us through that very disruptive period was a team doing way over and beyond, and frankly, in many ways not a sustainable expenditure of energy.

We will take all the lessons learned from that and pull it back in, and I think, frankly, it has brought us to a high level of performance, expectations of ourselves and of our team, and I think we will see that, a level of that, sustained, but the very high level that we established during that recovery period is, in my opinion, unrealistic to expect sustainment of that.

Thank you, and operator, we have time for one more question.

Robert Stallard, Royal Bank of Canada.

I thought you [covered] the A350, Jeff.

I was wondering if you could say how you're contingency or buffer on the fuselage side of the 350 has tracked this quarter, relatively to maybe where you were in the first quarter?

Buffer in terms of financially?

Well, if you want to put it in financial terms, that's probably the easiest way to put it.

Well, we didn't talk about any specific changes to that.

I mean, clearly where we are on the program, we said, is at a challenging period of time.

We're seeing schedule pressure on that, and we think we've done a very adequate job of reserving on the program for contingencies that occur on development programs.

Time will tell, as we work through that.

Clearly, we think the job we've done in reserving, which by the way, we look at continually, is adequate at this point.

Just a -

Phil, do you got anything to add to that?

No.

No, I think the buffer in terms of schedule, I think we're trying to meet the customers' priorities with the schedule as well.

Buffer is probably a little closer than what we'd like.

Well, when you're in a mode like we're in, in this program.

There's not a ton of buffer.

Right.

Then Phil, just a quick one on the tax.

If the R&D tax credit doesn't get passed, what do you think your tax rate will be for the year?

It's about 1% higher.

Thank you, ladies and gentlemen.

This concludes today's call.

Thank you for participating.

You may now disconnect.