Boeing sets 787 accounting block at 1,100; earnings call summary

Update, from 7:30 am-the Earnings Call:

Jim McNerney (JM):

  • Passenger traffic remains resilient, but cargo traffic weakening and needs watching.
  • Interest in 737 MAX remains high, still working with customers [to define product].
  • We’re monitoring European debt crisis for impact on financing airplanes but believe any outcome will be manageable.
  • Defense spending will depend on outcome of Congressional Super Committee working to cut deficit and whether automatic cuts emerge that will harm national defense and the industrial base.
  • Sticks with goal of 10 787s/mo by the end of 2013. Sticks with first 787 from Charleston next year.
  • Change incorporation in 787s on track and defined. Challenge remains to burn down the work on timely basis.
  • Defense: continuing emphasis on cybersecurity, intelligence which are growth areas.
  • KC-46A completed first integrated review on technical specs, now focusing on preliminary design review in early 2012.

James Bell (JB)

  • 1,100 block is consistent with accounting practices. Over 20 years estimate market demand at 5,000 units. 1,100 block is 10 years of production. Initial gross margin booking rate on 787s is in low single digits, to be assessed quarterly. Deferred production balance $9.7bn for 40 airplanes and will grow as more airplanes produced. Will begin to decline after hitting 10/mo.

McNerney

  • Our clear priority [now] is executing ramp up across all programs and developing KC-46A and MAX.

Q&A

  • JM: If 787 rate of 10/mo did slip a quarter or two it wouldn’t have an impact on accounting block.
  • JM: Not really seeing cargo customers seeking 747-8F delays due to softening market.
  • JB: When we get up to rate and stabilize for a year, year and a half 787 revenue will exceed costs to build it. (In other words, 2014-2015 is when on a purely revenue/cost basis, the 787 will be profitable–Editor.) [Later]: I would assume 2015 rather than 2014. Late 14 or early 15 to be stable.
  • JB: We’ve never set the accounting block previously, so have not adjusted it. We never went through analysis to determine if there would have been a forward loss at 1,000.
  • JM: We are not over-reaching market demand, we are following market demand [with production rates]. We are not going for market share.
  • JM: We have pretty good fidelity on what the MAX is, still having discussions. It is settling down quickly on details, happy with design. We’re still thinking through where we would produce it.
  • JM: Vast majority of rework is on first 40-45 airplanes. Our plan is that after 50-60 mark we are pretty much in the clear, pretty clean after that.
  • JM: We’re in a sweet spot seeing demand for the 737NG and the 737 MAX.

Original Post:

Boeing set its long-awaited accounting block for the 787 at 1,100, an announcement coming with the third quarter earnings release today. Boeing said, “At quarter end, the 787 had 821 units sold firm and approximately 200 options.  The company established the initial accounting quantity for the 787 program at 1,100 units, consistent with accounting practices applied on other new airplane programs.”

Previous airplane programs were typically set at 400, according to a good analysis by Jon Ostrower.

Ostrower, in Hong Kong following the 787’s first flight (and thus up long before we were), had this quick take on the earnings announcement and some observations about the 787 ramp up and deliveries this year.

Boeing also lowered its delivery forecast for the 787 and 747-8 to just 15-20 combined. Originally Boeing forecast 25-40 evenly split between the two airplane types then in July 25-30, weighted toward the 747. Since then, Atlas Air canceled three 747-8s that would have been delivered and Boeing’s internal plan for the 787 has been eight while key suppliers have been telling us four-six. Boeing said in its press release today that two thirds of the deliveries will be 747s, or 10-13. Thus, this means 5-7 787s will be delivered this year if forecasts are met.

Joe Nadol of JP Morgan had this quick take:

BCA margins remained solid at just over 18% adjusted for R&D and 787, and we view this as a plus. The initial 787 accounting quantity of 1,100 units was 100 more than we had expected, drawing out somewhat the cash flow ramp we had expected. If we assume a unit price of $120 mn and an operating margin of ~20% for the 100 incremental 787s in the block, the variance from our estimate amounts to $2.4 bn of cash flow over 8-9 years. This is not a game changer, but it does beg the question of whether the program would still be profitable had the assumption been a more conservative 1,000 units.

Rob Spingarn of Credit Suisse has this quick take:

Most important this quarter is declaration of 787 accounting quantity which at 1,100 is in-line with the latest street expectations. We see this as a 10 year block, which jibes with the company’s historical practices and current production ramp plans. Also, mgmt disclosed deferred production on 787 (for 1st time) of $9.7B plus tooling of $1.8B, which we calculate as a non-cash per aircraft margin headwind of 9.5% for the entire block. Further, unit cost margin of 8.3% indicates that the first delivered 787 (which we believe was unit 8 or 9) cost ~$400M. Boeing has reached a rate of 2.5 aircraft per month on 787 in Everett – we anticipate more color on the call around ramp, but expect Boeing is aiming for 3.5/mth by year-end and 5/mth early in 2012. Charleston final assembly has started on its first aircraft and should deliver next year.

The earnings call is at 10:30 EDT. The webcast link is here (this being written in advance, not for archive).

57 Comments on “Boeing sets 787 accounting block at 1,100; earnings call summary

  1. It also begs the question whether the program will still be profitable at 1100 units if Boeing’s heroic predictions about deliveries and cost reductions are not met. Particularly bearing in mind they have not got one delivery prediction right yet. Not one.

    • just like the stock exchange, past performance does not do not guarantee the future.

  2. I think it means that 2-10 787s will be delivered? 5-7 seems a good mid-range though. 😉

    I think Mr. Nadol is quite conservative in his assumptions on the positive impact of the last 100 units in the accounting block. I would expect these to fetch more than US$120m a piece, given the current price, and consequently to contribute even more to the break-even. It is quite shocking to many observers I guess that the programme at 1,000 units might have been in a forward loss position. While even the 1,100 is subject to (presumably over-optimistic) assumptions about break-even, the expectation that the 787 should sell at least 2,000 copies, if not more, will mean this should be a profitable programme in the very long run.

  3. Because every Boeing statement on the matter has been ‘over-optimistic’, to put it mildly. Such as the forcast just three months ago that annual deliveries of 787/748 would be over twice of what they are likely to be. In this case, they are making an assumption of reaching a certain production rate at a certain time. I am sure you have read the various concerns that have been raised about this by outsiders – and in this case, outsiders thus far have been better at predicting the future than Boeing.

  4. “Over 20 years estimate market demand at 5,000 units. 1,100 block is 10 years of production.”

    If they can meet demand in the second 10 years, that is 3900 units, or 32 per month which is cranking them out.

  5. Hmmmm, let’s see now:

    -1011 delivered 767’s since 1995
    -1288 delivered 777’s since 1995
    -6600+ delivered 737’s since 1967

    …aaaand now they are glibly talking about 5000 787’s (over 20 years, no less) now that they have finally delivered 2?!

    By the way, where did that quote come from? I only see it in TC’s comment? No access to podcast.

  6. This one from flightblogger, though I believe I read this quote here also, “Though McNerney – referring to the company’s method of program accounting – assured reporters: “In the way these planes are accounted for, we will be profitable from day one.” ”

    Where is Uwe?

    This one is just waiting for him to knock it out of the park, or in european parlance, kick it into the back of the net!!!

    • You Rang, Sir ;-?

      ??
      One shouldn’t kick the fallen 😉

      Just for the fun of it I searched around for estimations on break even
      from the time the Dreamliner was a speckless mirage on the horizon:
      200, maybe a dozen more to be on the save side.

      Boeings results will be very dependent on being able to pipeline
      cost overruns onto their riskbearing partners.
      This is completely below the horizon of current investigative journalism.
      Talk is entirely limited to Boeings situation and future.

  7. What type of definition and refinements to the MAX are being made by customers? Southwest is a potential customer and I wonder what they are asking for.

  8. Bell and McNerney explained away the China Eastern cancellation of 24 787s to that lady from Bloomberg, merely as a “conversion” to 45 737NGs, because of supposedly changing “market realities” for the airline……Yeah, right!

    Hmm, no mention of China Eastern “converting” part of the 787 order to 15 A330s by the two musketeers. Despite the “changing market realities”, China Eastern has an apparent need for increased capacity sooner rather than later, and Boeing won’t admit that they cannot deliver that capacity increase within a meaningful time frame.

  9. You have to remember that the 1100 figure is assuming a ramp up significantly faster than the 777, their best ever, to levels of wide body production they have never achieved before. If they don’t hit target that 1100 number will rise rapidly.

    And they have to sell them, possibly in a market were early 787’s get leased out having been purchased at way below production cost.

  10. The 1100 figure is fiction and is derived from looking at the analysts.

    “Emerge cleansed from over optimistic thought and produce a picture
    slightly more conservative than the analyst positions.”

    Shareholders like that 😉

    • That article was written by using a time machine?

      published:
      Monday, January 10, 2011 — 16:04

      but:
      ” .. the carrier will postpone delivery to the end of 2010 at the earliest from this year .. ”
      “.. It will add six planes to its fleet in 2009, ..”

      looks like copied from the Seattle Times article from March 13, 2009 at 11:32 AM
      written by Domnic Gates without a clear attribution.

  11. Rob Spingarn of Credit Suisse has this quick take:
    “…Boeing has reached a rate of 2.5 aircraft per month on 787 in Everett – we anticipate more color on the call around ramp, but expect Boeing is aiming for 3.5/mth by year-end and 5/mth early in 2012. Charleston final assembly has started on its first aircraft and should deliver next year.”

    I am struggling to see the value in ramping up to 5/month in early 2012, when they have a huge amount of re work and almost run out of parking space for the existing aircraft.
    Have Boeing provided an indication of the delivery target for 2012?

    • Production plan Z24 sees a rate increase to 3 per month in early 2012, 5 per month by mid 2012 and 7 per month at the end of 2012.
      The average rate in 2010 was slightly more than 1,5 per month, the average 2011 rate will come close to 2,0 per month. Most of those have yet to be completed.

      • Thanks, so do you know the delivery target for 2012? What you said just reinforces my point, they are more than trebling the rate from now to end of next year, with an enormous amout of re work outstanding on the exiting aircraft, which have filled up the ramp. I don’t understand it but that’s just me…

    • Aviation Technical Services is doing a lot of the rework in their facility at the south end of Paine Field. Their car lots are over flowing.

  12. Leeham.net – w/r/t delivery rates, won’t we see a 787 delivery “bubble” in 2012-13?

    After LN60 or so, there should be essentially two distinct source channels – (1) those finished frames coming off the Everett/N. Charleston FALs in near delivery form and (2) those frames up to LN60 that require rework/change incorporation. Any dearth in deliveries now will be made up during a “delivery bubble” in 2012-13 as the two lines process in parallel. A more natural delivery rate will occur once the already built planes have worked through change incorporation and into customers hands.

    • You are generally correct, Ken. And delivery rates do not translate to production rates, one-for-one because of this bubble.

      • To gain from “dual path” delivery Boeing would have to be unconstrained in availability of qualified workers to do the tasks at hand. Otherwise this will develop into a “limited size
        bedspread” pulled up and down, left and right but always too
        small to cover all “limbs”.
        Scipio says: Has MHI started expanding their production facility?

  13. Taking everything in account (prognoses, program track record) I think 35-40 Dreamliner deliveries in 2012 would be a satisfying achievement.

  14. One interesting point of the financial results is that if Boeing were to use the same accounting standards as EADS they would have to make a write off of at least 10Bn$ of advanced losses (just for the first 40 aircrafts). As they have an equity of just 6bn$ that would leave them with an equity of -4Bn$, or to put it in other way, technically insolvent.

    And they we could have a further write off for all the remaining Loss Making airfracts.

    Regards

      • The R&D costs have already been written off. The 10Bn$ is what Boeing has recognized as the cumulated loss for the first 40 aircraft (and that they have to they in the inventory).

        If you would like to be precise you would have to add to this all the remaining aircraft with losses and then apply a discount rate to calculate its present value. So probably the total would be between 10-15Bn$

        But the result would be the same, with Boeing having to make a issue of new Equity for around 10-15Bn$ (to recover the current level), so more than a 20% of its current capitalization

  15. how many a/c are sitting on the tarmac – how much effort would it take to make those ready for delivery?

    • should be around 40 now ? ( at a current book value of ~$16B and a sales value of maybe $3B )
      Fix them all up in the next 15..20 month? But how many of the near future production will need similarly extended post birth incubator service?

      Imho independent of material issues Boeing may have bookkeeping issues with shedding
      the lawndarts too fast. ( about $10++B in “inventory” evaporating i.e. ~$275m of uncompensated inventory value going away per plane changing ownership )

  16. Pabloj :
    The 10Bn$ is what Boeing has recognized as the cumulated loss for the first 40 aircraft (and that they have to they in the inventory).

    Sorry but you’re miss-understanding what that amount is.It is not a cumulative loss. It is cumulative cost of sales not being recognized at time of sales of early frames.

    Basically they are saying there is a big difference in true cost of sales between early and late frames. While this is true it doesn’t represent the performance of the company and thus an average cost of sale per frame over the accounting block is calculated from the expected total cost of sales. As frames are sold the average cost of sales is used as cost of sales and the difference between it and the true number is assigned to deferred production costs. If the true number is higher, as it is for early frames, deferred production costs increases. At the end it works the other way.

    The above process does not indicate if there is a profit or loss. For that the revenue is also needed. Program accounting requires that not only cost of sales for the accounting block is calculated but also the expected revenue. If those calculated numbers indicate a loss Boeing is required to indicate so and charge the expected loss as an expense at that time.

    Hope this helps.

    • In their filing, those 10Bn$ are defined as Deferred Production Costs, not as the full inventory of the B787. As I understand it, they have already removed the expected Revenues from the Cost of Sales.

      I could have misunderstood it (I am not an expert in reading American filings as I am more used to the European way), and in that case I stand corrected. My explanation before was based in my estimation of Cost of Sales minus revenues as you explain, so we have the same view (just a different way of understanding the filing).

      With the programme accounting approach, Boeing can use the full accounting block to check if they are in a loss making position or not. EADS approach is to do it aircraft per aircraft and book all the individual losses as soon as identified.

      Regards

  17. There is one thing I don’t understand because I am not an accountant: The 1100 block for writing off the capitalised R&D costs, which R&D costs does it include? It seems to me the 1100 block are for the 787-8 and 787-9. It seems to me that the 787-10 is not included as that is too far out and if included these costs are depreciated over 2-4 years which I think is too fast to be allowable (my guess is that 5 years is the minimum). Although the 1100 number will be easily met for the 787 family as a whole, my question is if that will be achieved for 787-8 and 787-9 combined. If the 787-10 is as great as it is supposed to be, there will be conversion from 787-9 to 787-10. On the other hand, the 787-8 and 787-9 might need a revamp after 10 years (look at 777: 772/773/77E were superseded by 77W/77L after about 10 years and the originals stopped selling). Are they taking a risk with an accounting block of 1100?

    Another comment: profit and loss are just accounting. If you are listed on the stock market, you want profitability as high as possible to keep shareholders quiet, but if you are privately held you want to minimize profits to reduce taxes. In the end it is just accounting. What kills companies is cashflow and that is mainly unaffected by profit and loss numbers as well as depreciation. A company which is profitable can die because of running out of cash while a loss making company can survive for years if the cash in the bank allows that. Also, you see companies which when they make a loss, magnify the loss by huge amounts by writting off as many assets as possible in one go in order to be more profitable in future years. For Boeing, cashflow is the same whether the accounting block is 400 or 1100. The sole purpose of that accounting block is the satisfy the shareholders while at the same time manage taxes payable.

    • 1100 is the number they can write the development costs over, i.e when they start making a profit. $30million per aircraft on a average $120million sales price would cover the $32billion the program has cost to get into full production.

      After that, they will be making the 30million in profit on each sale. Ignoring the interest payments cost of a $32billion investment, that is.

      • AngMoh :
        The 1100 block for writing off the capitalised R&D costs, which R&D costs does it include?

        Only production related costs are included in the block. R&D is expensed directly, not capitalized.

        AngMoh :
        Another comment: profit and loss are just accounting. If you are listed on the stock market, you want profitability as high as possible to keep shareholders quiet, but if you are privately held you want to minimize profits to reduce taxes

        Profit and loss isn’t just accounting. Accounting is there to give a snapshot of the company at that moment. It means that all numbers must be included somewhere. You need to be able to justify every transaction so there is only so much “play” in how you present things.

        Stating that private companies want to minimize profits to avoid taxes is a simplification that is severely miss-leading. Tax planning often is an element but there are much, much more in play.

      • @Peter Krakow,

        Sorry but this is not how it works.

        First you need to define what you mean with making profit.

        What you have described mostly the program break even, i.e. the point where revenues collected cover R&D and all production costs.

        The 1,100 number has nothing to do with that. Let me repeat it: The 1,100 figure does not represent the program break even point.

        To understand the 1,100 number you need to remember the underlying rule of accounting – to represent an accurate picture of the companies health.

        Long time ago clever people figured out that taking the full cost of a large investment at time of purchase makes investing in something generating profits over long time look like a bad investment. So they said that since profits are generated over a long time lets make it look like we take the costs of the investment over long time too.

        A simple example. Say you’re producing a widget at a cost of 10 USD per item and you produce 10,000 per year. You invest in a machine that reduces the cost per item to 8 USD. The machine costs 100,000 and will last 10 years before it breaks down too much to be useful.

        If you take the full cost of the machine the first year it will look like each item produced cost you 18 USD. 100,000 for the machine divided by the 10,000 produced is 10 per item plus the 8.

        If we instead take the cost over the 10 years and 1,000,000 items produced in that period we instead get that each unit costs us 8.10 USD, That is the machines 100,000 divided by 1,000,000 plus the 8 USD.

        This way we avoid showing dramatic losses the first year and all in all represent the result much better.

        In the 787 case 1,100 is just the number of planes Boeing can with good accuracy state will certainly be produced. It is not the number they think will be produced. It is the sum of produced until today plus received orders the customers are expected to fulfill and future sales they have a high certainty will happen. A lot of skillful guessing.

      • Falcon :
        In the 787 case 1,100 is just the number of planes Boeing can with good accuracy state will certainly be produced. It is not the number they think will be produced. It is the sum of produced until today plus received orders the customers are expected to fulfill and future sales they have a high certainty will happen. A lot of skillful guessing.

        That’s what it should be and what Boeing says it is. But you only have to be slightly cynical to suggest that 1100 is co-incidentally the smallest number of planes Boeing needs to deliver to remain profitable on current assumptions. 1100 is a distinctive number to come up with for a delivery block that is essentially a guesstimate. Why not choose 1000?

        Falcon :
        Only production related costs are included in the block. R&D is expensed directly, not capitalized.

        Program-related development costs are surely included? The whole point of program accounting, I would have thought, is to amortize the development costs.

    • I have a question similar to AngMoh. Are the 787-9 development costs included within the 1100 block figures? Boeing has yet to incur many of these costs.

      Arguably the 787-9 is a substantially different plane from the -8 model and should be included in a different program and accounting block. Which is another reason for being sniffy about increasing the block size from the more normal 400.

  18. In the 787 case 1,100 is just the number of planes Boeing can with good accuracy state will certainly be produced. It is not the number they think will be produced. It is the sum of produced until today plus received orders the customers are expected to fulfill and future sales they have a high certainty will happen. A lot of skillful guessing.

    You are correct up to this point, the block is not simply a guess, its the number that the costs can be spread over without there being a ‘forward loss’ . They expect to sell at least this amount and if they do the costs spread over that number would not be at a loss. It is basically what I said. Sell 1100 and they will have covered their costs.

    “The company spreads the costs of developing a new plane over an initial number of aircraft it is confident it can sell. Typically that’s around 400 airplanes for a brand-new jet like the 787 Dreamliner, much less for a derivative like the 747-8.

    If at some point anticipated expenses exceed the expected revenue from that designated block of aircraft, the company’s accountants must record charges known as “reach-forward losses.””

    http://seattletimes.nwsource.com/html/businesstechnology/2013042468_boeing01.html

    • Avoiding forward loss is not a criteria in selecting the number. It is set at the “guaranteed” number that will be produced.

      Forward loss or not is then calculated using that block number.

      And again. Development costs are not included. This is production cost.

  19. I don’t agree Peter. I don’t think the actual number where there is no longer a forward loss has been stated anywhere. It COULD be 1,100. But it could as well be 800, or indeed 600. What is clear is that it is no higher than 1,100, based on current assumptions by Boeing management (which I believe are over optimistic). I believe they have chosen 1,100 because it is a reasonable number to project given just under 800 sales at present, and one that does not get them into trouble for being too optimistic.

  20. Program-related development costs are surely included? The whole point of program accounting, I would have thought, is to amortize the development costs.

    In US GAAP essentially all R&D must be expensed. The thought is that there is no certainty if the R&D will result in actual products and even less in what the product run will be in case there is.

    • R&D is expensed if it is specifically developed for 1 customer and can not be reused for other costomers. R&D is capitalised if it can be used for more than 1 customer. I have been in the process of determining how much R&D is common and how much R&D is customer specific in order to determine what can be capitalised and what needed to be expensed. The target was to maximise the capitalisation. This was done in compliance with and audited under the requirements of the Sarbanes–Oxley Act.

      • And to follow up: for my current (European) employer, all R&D resulting in products or producing technology going into products is capitalised. All R&D which does not go into products (more precisely: is not guaranteed to go into products) is expensed. Examples of that are joint research projects which universities for which the success/outcome is far from guaranteed, e.g. company sponsored PhD projects.

        For the 787, all R&D resulted in a concrete product for many different customers, so it is capitalised.

      • ( read your addendum too )

        The thing we wondered about here recently was :
        what does Boeing subsume under “inventory” ?

        Adding and subtracting it looks like Boeing accumulates all expenses for the produced but nonready frames reaching
        $3..400m per frame. unfortunately those are then sold for
        on average (first 400 via J.Ostr.) $76m. i.e. with every delivery
        a judicious amount of money jumps from the inventory box
        to the losses bin in my understanding.
        ( My given rules here state I can’t book inventory at values over
        a possible sales price, I have to do a conservative estimation ))

    • Falcon :

      Program-related development costs are surely included? The whole point of program accounting, I would have thought, is to amortize the development costs.

      In US GAAP essentially all R&D must be expensed. The thought is that there is no certainty if the R&D will result in actual products and even less in what the product run will be in case there is.

      I don’t believe this is correct as a blanket statement. The rules are more restrictive, but for externally focused R&D which leads to income, capitalisation is possible, from what I have read.

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